1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THIS (Mark One) SECURITIES EXCHANGE ACT OF 1934 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________________ to ________________ Commission file number 0-14289 --------- GREENE COUNTY BANCSHARES, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) TENNESSEE 62-1222567 - --------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 100 NORTH MAIN STREET, GREENEVILLE, TENNESSEE 37743 - --------------------------------------------- ------------ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (423) 639-5111. Securities registered pursuant to Section 12(b) of the Act: NONE. Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $10.00 PER SHARE ---------------------------------------- (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 amendment to this Form 10-K. [ ] The registrant's voting stock is not regularly and actively traded in any established market, and there are no regularly quoted bid and asked prices for the registrant's common stock. Based upon recent negotiated trading of the common stock at a price of $107 per share, the registrant believes that the aggregate market value of the voting stock on March 25, 1998 was $144.9 million. For purposes of this calculation, it is assumed that directors, officers and beneficial owners of more than 5% of the registrant's outstanding voting stock are not affiliates. On such date, 1,354,572 shares of the common stock were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE The following lists the documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated: 1. Portions of the Annual Report to Shareholders for the fiscal year ended December 31, 1997. (Parts I and II) 2. Portions of Proxy Statement for 1998 Annual Meeting of Shareholders. (Part III) 2 PART I FORWARD-LOOKING STATEMENTS THIS ANNUAL REPORT ON FORM 10-K, INCLUDING ALL DOCUMENTS INCORPORATED HEREIN BY REFERENCE, CONTAINS FORWARD-LOOKING STATEMENTS. ADDITIONAL WRITTEN OR ORAL FORWARD-LOOKING STATEMENTS MAY BE MADE BY THE COMPANY FROM TIME TO TIME IN FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION OR OTHERWISE. THE WORDS "BELIEVE," "EXPECT," "SEEK," AND "INTEND" AND SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE THE STATEMENT IS MADE. SUCH FORWARD-LOOKING STATEMENTS ARE WITHIN THE MEANING OF THAT TERM IN SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. SUCH STATEMENTS MAY INCLUDE, BUT ARE NOT LIMITED TO, PROJECTIONS OF INCOME OR LOSS, EXPENDITURES, ACQUISITIONS, PLANS FOR FUTURE OPERATIONS, FINANCING NEEDS OR PLANS RELATING TO SERVICES OF THE COMPANY, AS WELL AS ASSUMPTIONS RELATING TO THE FOREGOING. FORWARD-LOOKING STATEMENTS ARE INHERENTLY SUBJECT TO RISKS AND UNCERTAINTIES, SOME OF WHICH CANNOT BE PREDICTED OR QUANTIFIED. FUTURE EVENTS AND ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN, CONTEMPLATED BY OR UNDERLYING THE FORWARD-LOOKING STATEMENTS. ITEM 1. BUSINESS THE COMPANY Greene County Bancshares, Inc. (the "Company") is a Tennessee corporation that serves as the bank holding company and sole stockholder for Greene County Bank ("GCB") and Premier Bank of East Tennessee ("Premier Bank"), both of which are Tennessee-chartered commercial banks. GCB and Premier Bank are referred to herein as the "Banks." The Company also wholly-owned American Fidelity Bank, which was merged into GCB during 1996. The Company's assets consist primarily of its investment in the Banks, liquid investments and fixed assets. Its primary activities are conducted through the Banks. At December 31, 1997, the Company's consolidated total assets were $534.1 million, its consolidated net loans were $441.4 million, its total deposits were $461.7 million and its total stockholders' equity was $50.1 million. The principal executive offices of the Company are located at 100 North Main, Greeneville, Tennessee 37743 and its telephone number is (423) 639-5111. GREENE COUNTY BANK GCB is a Tennessee-chartered commercial bank established in 1890 and which has its principal executive offices in Greeneville, Tennessee. The principal business of GCB consists of attracting deposits from the general public and investing those funds, together with funds generated from operations and from principal and interest payments on loans, primarily in commercial loans, commercial real estate loans, consumer loans and single-family mortgage loans. GCB also provides collection and other banking services, including separate finance, mortgage and acceptance corporations. During 1997 GCB discontinued its trust activities. At December 31, 1997, Greene County Bank had seven full service banking offices located in Greene County, Tennessee; three full service banking offices located in Washington County, Tennessee; two full service banking offices located in Blount County, Tennessee, two full service banking offices located in Hamblen County, Tennessee, and a full service banking office located in each of Sullivan County, Knox County and Hawkins County, Tennessee. GCB also conducts separate businesses through three wholly-owned subsidiaries. Through Superior Financial Services, Inc., GCB operates eight consumer finance company offices located in Greene, Hamblen, Blount, Washington, Sullivan, Sevier and McMinn Counties, Tennessee. Through its subsidiary, Superior Mortgage Company, GCB operates a mortgage banking operation through its sole office in Knox County, Tennessee and 1 3 through its representatives located throughout the Company's branch system. Through GCB Acceptance Corporation, GCB operates a subprime automobile lending company with a sole office in Johnson City, Tennessee. PREMIER BANK OF EAST TENNESSEE Premier Bank is a Tennessee-chartered commercial bank established in 1911 as the Bank of Niota and which has its principal executive offices in Niota, Tennessee. The primary business of Premier Bank consists of attracting deposits from its primary market area and investing those deposits, together with funds generated from operations, in consumer, single-family mortgage and small business loans. Premier Bank conducts its business from a main office located in Niota, Tennessee which operates under the trade name "Bank of Niota" and a second office in Athens, Tennessee which operates under the trade name "Bank of Athens." Premier Bank was acquired upon the acquisition of its parent company, Premier Bancshares, Inc. ("Premier"), by the Company on January 1, 1996. At that time, Premier had assets of approximately $24.2 million, deposits of approximately $22.0 million and stockholders' equity of approximately $1.7 million. The purchase price of Premier was $3,140,000, consisting of cash of $708,582 and the Company's promissory notes to the sellers in the aggregate principal amount of $2,431,418, plus $230,000 for non-compete agreements with the sellers. The transaction was accounted for as a purchase. On March 29, 1996, Premier was merged with and into the Company, with the Company as the survivor, and Premier Bank thereby became a wholly-owned subsidiary of the Company. Deposits of the Banks are insured by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC") to a maximum of $100,000 for each insured depositor. The Banks are subject to supervision and regulation by the Tennessee Department of Financial Institutions (the "Banking Department") and the FDIC. See "Regulation, Supervision and Governmental Policy." LENDING ACTIVITIES General. The loan portfolio of the Company is comprised of mortgage installment loans, commercial loans, real estate loans and consumer loans. Such loans are originated within the Company's market area of East Tennessee and are generally secured by residential or commercial real estate or business or personal property located in the East Tennessee counties of Greene, Washington, Hamblen, Sullivan, Hawkins, Blount, Knox and McMinn Counties, Tennessee. Loan Composition. The following table sets forth the composition of the Company's loans for the periods indicated. At December 31, ----------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (In thousands) Commercial ....................... $ 108,985 $ 97,340 $ 75,503 $ 56,754 $ 51,533 Commercial real estate ........... 125,359 108,936 74,276 64,211 44,783 Mortgage installment ............. 146,227 108,878 92,276 79,705 63,605 Installment consumer ............. 72,752 71,354 55,876 44,025 38,249 Other ............................ 3,154 5,797 2,772 2,832 1,246 --------- --------- --------- --------- --------- Total loans ................... $ 456,477 $ 392,305 $ 300,703 $ 247,527 $ 199,416 Less: Unearned discount ....... (5,933) (3,702) (2,215) (2,827) (4,227) Allowance for loan losses (9,154) (7,331) (4,654) (3,447) (3,062) --------- --------- --------- --------- --------- Total loans, net ................. $ 441,390 $ 381,272 $ 293,834 $ 241,253 $ 192,127 ========= ========= ========= ========= ========= 2 4 Loan Maturities. The following table reflects at December 31, 1997 the dollar amount of loans maturing or subject to rate adjustment based on their contractual terms to maturity. Loans with fixed rates are reflected based upon the contractual repayment schedule while loans with variable interest rates are reflected based upon the contractual repayment schedule up to the contractual rate adjustment date. Demand loans, loans having no stated schedule of repayments and loans having no stated maturity are reported as due within three months. Due in One Due After One Year Due After Year or Less through Five Years Five Years Total ------------ ------------------ ---------- ----- (In thousands) Commercial .................... 57,525 47,927 3,533 108,985 Commercial real estate ........ 93,941 25,501 5,917 125,359 Mortgage installment .......... 63,058 72,459 10,710 146,227 Installment consumer .......... 41,874 25,278 5,600 72,752 Other ......................... 574 2,580 -- 3,154 -------- -------- ------- -------- $256,972 $173,745 $25,760 $456,477 ======== ======== ======= ======== The following table sets forth the dollar amount of the loans maturing subsequent to the year ending December 31, 1998 between those with predetermined interest rates and those with floating or adjustable interest rates. Predetermined Floating or Rates Adjustable Rates Total ---------------- ------------------- -------------- (In thousands) Commercial ....................... 17,226 356 17,582 Commercial real estate ........... 54,576 11,515 66,091 Mortgage installment ............. 49,913 22,450 72,363 Installment consumer ............. 42,176 1,293 43,469 -------- -------- -------- $163,891 $ 35,614 $199,505 ======== ======== ======== Commercial Loans. The Company's principal lending activities include the origination of commercial loans in the Company's primary lending area. Commercial loans are made for a variety of business purposes, including working capital, inventory and equipment and capital expansion. At December 31, 1997, commercial loans outstanding totaled $108.9 million, or 24.7% of the Company's total net loan portfolio. The terms for commercial loans are generally one to seven years. Commercial loan applications must be supported by current financial information on the borrower and, where appropriate, by adequate collateral. Commercial loans are generally underwritten by addressing cash flow (debt service coverage), primary and secondary sources of repayment, financial strength of any guarantor, liquidity, leverage, management experience, ownership structure, economic conditions and industry-specific trends and collateral. The loan to value ratio depends on the type of collateral. Generally speaking, accounts receivable are financed at 60% of accounts receivable less than 90 days past due. If other collateral is taken to support the loan, the loan to value of accounts receivable may approach 85%. Inventory financing will range between 25% and 60% depending on the borrower and nature of inventory. The Company requires a first lien position for such loans. These types of loans are generally considered to be a higher credit risk than other loans originated by the Company. Commercial Real Estate Loans. The Company originates commercial loans, generally to existing business customers, secured by real estate located in the Company's market area. At December 31, 1997, commercial real estate loans totaled $125.4 million, or 28.4% of the Company's total net loan portfolio. The terms of such loans are generally for ten to twenty years and are priced based in part upon the New York prime rate, as reported in The Wall Street Journal. Commercial real estate loans are generally underwritten by addressing cash flow (debt service coverage), primary and secondary source of repayment, financial strength of any guarantor, strength of the tenant (if any), liquidity, leverage, management experience, ownership structure, economic conditions and industry specific trends and collateral. Generally, the Company will loan up to 80% of the value of improved property, 65% of the 3 5 value of raw land and 75% of the value of undeveloped land. A first lien on the property and assignment of lease is required if the collateral is rental property, with second lien positions considered on a case by case basis. Mortgage Installment Loans. The Company also originates one-to-four family, owner-occupied residential mortgage loans secured by property located in the Company's primary market area. The majority of the Company's residential mortgage loans consists of loans secured by owner-occupied, single-family residences. At December 31, 1997, the Company had $146.2, or 33.1% of its total net loan portfolio, in mortgage installment loans. The Company also originates, to a limited extent, installment real estate loans for other types of real estate acquisitions. Mortgage installment and installment real estate loans generally have a loan to value ratio of 85%. These loans are underwritten by giving consideration to the ability to pay, stability of employment or source of income, credit history and loan to value ratio. Mortgage loans originated by GCB and Premier Bank are not underwritten in conformity with secondary market guidelines and therefore are not readily salable. The Company has not previously engaged in sales of its loans in the secondary market. Beginning in April 1997, the Company began selling one-to-four family mortgage loans in the secondary market to the Federal Home Loan Mortgage Corporation (also referred to as "Freddie Mac") through GCB's mortgage banking subsidiary, Superior Mortgage. Sales of such loans totaled $14.1 million during 1997, and the related mortgage servicing rights were sold together with the loan. Installment Consumer Loans. At December 31, 1997, the Company's installment consumer loan portfolio totaled $72.7 million, or 16.5% of the Company's total net loan portfolio. The Company's consumer loan portfolio is comprised of loans originated by GCB and Premier Bank and personal loans, both secured and unsecured, originated by Superior Financial. In both cases, such loans generally have a higher risk of default than other loans originated by GCB and Premier Bank. Further, consumer loans originated by Superior Financial, a finance company rather than a bank, generally have a greater risk of default than such loans originated by commercial banks and accordingly carry a higher interest rate. The performance of consumer loans will be affected by the local and regional economy as well as the rates of personal bankruptcies, job loss, divorce and other individual-specific characteristics. During the year ended December 31, 1997, the Company's provision for loan losses was increased by approximately $2.7 million to reflect actual or potential losses arising from this loan portfolio. See "-- Allowance for Loan Losses." Past Due, Special Mention, Classified and Non-Accrual Loans. The Company classifies its problem loans into four categories: past due loans, special mention loans, classified loans (which are still accruing interest) and non-accrual loans. When management determines that a loan no longer satisfies the criteria for performing loans and that collection of interest appears doubtful, the loan is placed on non-accrual status. All loans that are 90 days past due are considered non-accrual, unless they are adequately secured and there is reasonable assurance of full collection of principal and interest. Management closely monitors all loans that are contractually 90 days past due, treated as "special mention" or otherwise classified or on non-accrual status. Non-accrual loans that are 120 days past due without assurance of repayment are charged off against the allowance for loan losses. 4 6 The following table sets forth information with respect to the Company's non-performing assets at the dates indicated. At these dates, the Company did not have any restructured loans within the meaning of Statement of Financial Accounting Standards No. 15. At December 31, --------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (In thousands) Loans accounted for on a non-accrual basis ................................. $2,265 $ 616 $ 902 $ 649 $ 554 Accruing loans which are contractually past due 90 days or more as to interest or principal payments ................. 1,583 1,486 1,044 656 3,256 ------ ------ ------ ------ ------ Total non-performing loans ............... 3,848 2,102 1,946 1,305 3,810 Real estate owned ........................ 508 223 122 85 1,014 ------ ------ ------ ------ ------ Total non-performing assets ........... $4,356 $2,325 $2,068 $1,390 $4,824 ====== ====== ====== ====== ====== Non-accrual loans increased $1,649,000, or 267.7%, from $616,000 at December 31, 1996 to $2,265,000 at December 31, 1997. The increase principally reflects the nonaccrual status in October 1997 of GCB's $1.1 million participation in a $3.5 million commercial loan to a nonprofit entity for a hotel development project. The loan is secured by a hotel building and underlying commercial real estate in Greeneville, Tennessee which was last appraised in 1996 at approximately $8 million. GCB is currently engaged in discussions with the borrower and the other banks participating in the loan to determine the timing and extent of repayment, if any. During 1997, the Company recorded a $500,000 charge to income through its provision for loan losses to reflect anticipated losses arising from this loan. The Company's continuing efforts to resolve non-performing loans occasionally includes foreclosures, which result in the Company's ownership of the real estate underlying the mortgage. If non-accrual loans at December 31, 1997 had been current according to their original terms and had been outstanding throughout 1997, or since origination if originated during the year, interest income on these loans would have been $112,300. Interest actually recognized on these loans during 1997 was not significant. The increase in real estate owned during 1997 from $223,000 at December 31, 1996 to $508,000 at December 31, 1997 primarily reflects GCB's foreclosure on three single-family residential homes that served as collateral on a $400,000 commercial real estate loan to a single developer. As of February 28, 1998, one home had been sold and the remaining two homes were valued in the aggregate at approximately $387,000. At December 31, 1997, the Company had approximately $3.1 million in loans that are not currently classified as non-accrual or 90 days past due or otherwise restructured and where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with present loan repayment terms. Such loans were considered classified by the Company and comprised various commercial and commercial real estate loans, including a $700,000 commercial loan secured by automobiles and a $400,000 group of commercial real estate loans secured by commercial real estate and equipment. For further information, see Note 1 of Notes to Consolidated Financial Statements. Allowance for Loan Losses. The allowance for loan losses is maintained at a level which management believes is adequate to absorb all potential losses on loans then present in the loan portfolio. The amount of the allowance is affected by: (1) loan charge-offs, which decrease the allowance; (2) recoveries on loans previously charged-off, which increase the allowance; and (3) the provision of possible loan losses charged to income, which increases the allowance. In determining the provision for possible loan losses, it is necessary for management to monitor fluctuations in the allowance resulting from actual charge-offs and recoveries, and to periodically review the size and composition of the loan portfolio in light of current and anticipated economic conditions in an effort to evaluate portfolio risks. If actual losses exceed the amount of the allowance for loan losses, earnings of the 5 7 Company could be adversely affected. The amount of the provision is based on management's judgment of those risks and therefore the allowance represents general, rather than specific, reserves. The following is a summary of activity in the allowance for loan losses for the periods indicated: Year Ended December 31, ----------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (In thousands) Balance at beginning of year .......................... $ 7,330 $ 4,654 $ 3,447 $ 3,062 $2,529 Charge-offs: Commercial ......................................... (563)(b) (162) (a) (a) (a) Commercial real estate ............................. (129) (32) (a) (a) (a) ------- ------- -------- -------- ------- Subtotal ........................................ (692) (194) (26) (103) (50) Mortgage installment ............................... -- -- (a) (a) (a) Installment consumer ............................... (4,450) (1,089) (a) (a) (a) ------- ------- -------- -------- ------- Subtotal ........................................ (4,450) (1,089) (646) (1,256) (457) Other .............................................. (342) ------- ------- -------- -------- ------- Total charge-offs ............................... (5,142) (1,625) (672) (1,359) (507) ------- ------- -------- -------- ------- Recoveries Commercial ......................................... 56 62 (a) (a) (a) Commercial real estate ............................. 4 -- (a) (a) (a) ------- ------- -------- -------- ------- Subtotal ........................................ 60 62 9 199 57 ------- ------- -------- -------- ------- Mortgage installment ............................... (a) (a) (a) Installment consumer ............................... 951 755 (a) (a) (a) ------- ------- -------- -------- ------- Subtotal ........................................ 951 755 447 551 149 Other .............................................. 2 71 -- -- -- ------- ------- -------- -------- ------- Total recoveries ................................ 1,013 888 456 750 206 ------- ------- -------- -------- ------- Net charge-offs ....................................... (4,129) (737) (216) (609) (301) Provision for loan losses ............................. 5,953(b) 2,973 1,423 994 834 Balances acquired in acquisition of Premier Bank ...................................... -- 440 -- -- -- ------- -------- -------- -------- ------- Balance at end of year................................. $ 9,154 $ 7,330 $ 4,654 $ 3,447 $3,062 ======= ======== ======== ======== ======= Ratio of net charge-offs to average loans outstanding, net of unearned discount, during the period ............... 0.96% 0. 21% 0.08% 0.28% 0.16% ======= ======== ======== ======== ======= Ratio of allowance for loan losses to non-performing loans ............................... 237.89% 348.72% 239.16% 264.14% 80.37% Ratio of allowance for loan losses to total loans ........................................ 2.01% 1.87% 1.55% 1.39% 1.54% (a) Prior to 1996, the Company did not maintain records of individual balances in these types of categories and therefore such amounts are reflected herein only in the aggregate. (b) Includes a $500,000 charge-off against the Company's $1.1 million participation in a $3.5 million commercial loan to a nonprofit entity for a hotel development project. See " - Past Due, Special Mention, Classified and Non-Accrual Loans." 6 8 The following table presents an allocation of the Company's allowance for loan losses at the dates indicated and the percentage of loans represented by each category to total loans: At December 31, ----------------------------------------------------------------------------- 1997 1996 1995 ---------------------- --------------------- ---------------------- % Amount % Amount % Amount - ------ - ------ - ------ (Dollars in thousands) Commercial................. 23.88% $2,186 24.82% $1,819 (a) (a) Commercial real estate..... 27.46% 2,514 27.85% 2,042 (a) (a) ------- ------ ------- ------ ------- ------- Subtotal............. 51.34% 4,700 52.67% 3,861 49.60% $ 2,042 ------- ------ ------- ------ ------- ------- Mortgage installment....... 32.03% 2,932 27.75% 2,034 (a) (a) Installment consumer....... 15.94% 1,459 18.17% 1,332 (a) (a) ------- ------ ------- ------ ------- ------- Subtotal............. 47.97% 4,391 45.92% 3,366 50.40% 2,612 ------- ------ ------- ------ ------- ------- Other................... 0.69% 63 1.41% 103 (a) (a) ------- ------ ------- ------ ------- ------- Total allowance......... 100.00% $9,154 100.00% $7,330 100.00% $ 4,654 ======= ====== ======= ====== ======= ======= At December 31, ----------------------------------------------------- 1994 1993 ---------------------- ------------------------- % Amount % Amount - ------ - ------ (Dollars in thousands) Commercial................. (a) (a) (a) (a) Commercial real estate..... (a) (a) (a) (a) ------- ------ ------- ------ Subtotal............. 48.60% $1,758 47.90% $1,317 ------- ------ ------- ------ Mortgage installment....... (a) (a) (a) (a) Installment consumer....... (a) (a) (a) (a) ------- ------ ------- ------ Subtotal............. 51.40% $1,689 52.10% 1,745 ------- ------ ------- ------ Other................... (a) (a) (a) (a) ------- ------ ------- ------ Total allowance......... 100.00% $3,447 100.00% $3,062 ======= ====== ======= ====== (a) Prior to 1996, the Company did not maintain records of individual balances in these types of categories and therefore such amounts are reflected herein only in the aggregate. INVESTMENT ACTIVITIES General. The Company maintains a portfolio of investments to provide liquidity and an additional source of income. Securities by Category. The following table sets forth the amount of securities by major categories held by the Company at December 31, 1997, 1996 and 1995. At December 31, ------------------------------------- 1997 1996 1995 ---- ---- ---- (In thousands) Securities Held to Maturity: Obligations of states and political subdivisions $7,627 $9,456 $9,375 ------ ------ ------ Total ....................................... $7,627 $9,456 $9,375 ====== ====== ====== Securities Available for Sale: U.S. Treasury securities and obligations of U.S. government corporations and agencies ........ $30,284 $39,337 $59,834 Obligations of states and political subdivisions 1,153 1,329 -- Corporate and other securities ................. 2,415 2,259 1,066 ------- ------- ------- Total ....................................... $33,852 $42,925 $60,900 ======= ======= ======= For information regarding the amortized cost of securities at December 31, 1997, 1996 and 1995, see Note 3 of Notes to Consolidated Financial Statements. 7 9 Maturity Distributions of Securities. The following table sets forth the distributions of maturities of securities at amortized cost as of December 31, 1997. Due in One Due After One Year Due After Five Years Year or Less through Five Years through Ten Years ------------ ------------------ ----------------- (Dollars in thousands) U.S. treasury securities -- available for sale ..... $ 606 $ 1,793 $ -- Federal agency obligations - available for sale ............................................ 2,365 3,617 6,618 Obligations of state and political subdivisions - available for sale ............... 150 895 100 Obligations of state and political subdivisions -- held to maturity ................ 3,950 3,277 -- Other securities -- available for sale ............. 2,415 -- -- ------- ------- ------- Total .................................... $ 9,486 $ 9,582 $ 6,718 ======= ======= ======= Market value adjustment on available for sale securities ................................. $ 1 $ 55 $ 22 ------- ======= ------- Total ..................................... $ 9,487 $ 9,637 $ 6,740 ======= ======= ======= Weighted average yield (%)(a) ...................... 5.53% 5.64% 7.06% ======= ======= ======= Due After Ten Years Total --------------- ----- (Dollars in thousands) U.S. treasury securities -- available for sale ..... $ -- $ 2,399 Federal agency obligations - available for sale ............................................ 15,133 27,733 Obligations of state and political subdivisions - available for sale ............... -- 1,145 Obligations of state and political subdivisions -- held to maturity ................ 400 7,627 Other securities -- available for sale ............. -- 2,415 ------- ------- Total .................................... $15,533 $41,319 ======= ======= Market value adjustment on available for sale securities ................................. $ 82 $ 160 ------- ------- Total ..................................... $15,615 $41,479 ======= ======= Weighted average yield (%)(a) ...................... $ 6.91% 6.32% ======= ======= (a) Yields on tax-exempt obligations have not been computed on a tax-equivalent basis. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. For information regarding the amortized cost and approximate market value of securities at December 31, 1997, by contractual maturity, see Note 3 of Notes to Consolidated Financial Statements. DEPOSITS Deposits are the primary source of funds for the Company. Such deposits consist of checking accounts, regular savings deposits, NOW accounts, Money Market Accounts and market rate Certificates of Deposit. Deposits are attracted from individuals, partnerships and corporations in the Company's market area. In addition, the Company obtains deposits from state and local entities and, to a lesser extent, U.S. Government and other depository institutions. The Company's policy permits the acceptance of limited amounts of brokered deposits, but no such deposits had been obtained as of or during the year ended December 31, 1997. 8 10 The following table sets forth the average balances and average interest rates based on daily balances for deposits for the periods indicated. Year Ended December 31, --------------------------------------------------------------------------------------- 1997 1996 1995 -------------------------- -------------------------- ---------------------------- Average Average Average Average Average Average Deposits Rate Deposits Rate Deposits Rate -------- ---- -------- ---- -------- ---- (Dollars in thousands) Non-interest bearing demand deposits .................... $ 33,540 --% $ 30,945 --% $ 24,424 --% Interest bearing demand deposits 103,288 2.61 105,386 2.23 91,407 2.40 Savings deposits ............... 46,801 2.65 45,491 2.61 38,638 2.50 Time deposits .................. 253,840 5.49 207,441 5.61 172,627 5.71 -------- -------- -------- Total deposits .............. $437,469 $389,263 $327,096 ======== ======== ======== The following table indicates the amount of the Company's certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 1997. Certificates of Maturity Period Deposits - ----------------------------------------------- ------------------ (In thousands) Three months or less.......................... $16,067 Over three through six months................. 13,092 Over six through twelve months................ 18,768 Over twelve months............................ 13,075 ------- Total...................................... $61,002 ======= COMPETITION To compete effectively, the Company relies substantially on local commercial activity; personal contacts by its directors, officers, other employees and shareholders; personalized services; and its reputation in the communities it serves. According to data as of June 30, 1997 supplied by the FDIC, GCB ranked as the largest independent commercial bank in its market area, which includes Greene, Hamblen, Washington and Blount Counties and portions of Cocke, Hawkins, Jefferson and Knox Counties. In Greene County, there are six commercial banks and one savings bank, operating 23 branches and holding an aggregate of approximately $661 million in deposits as of June 30, 1997. Through Premier Bank, the Company also competes with five commercial banks and one savings bank in McMinn County, Tennessee. Under the federal Bank Holding Company Act of 1956 (the "Holding Company Act"), as amended by the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), Tennessee banks and their holding companies may be acquired by out-of-state banks or their holding companies, and Tennessee banks and their holding companies may acquire out-of-state banks without regard to whether the transaction is prohibited by the laws of any state. In addition, the Riegle-Neal Act authorizes the federal banking agencies, effective June 1, 1997, to approve interstate merger transactions without regard to whether such transactions are prohibited by the law of any state, unless the home state of one of the banks opts out of the Riegle-Neal Act by adopting a law that applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. The effect of the Riegle-Neal Act may be to increase competition within the State of Tennessee among banking institutions located in Tennessee and from banking companies located anywhere in the country. 9 11 EMPLOYEES As of December 31, 1997, the Company employed 268 persons. None of the Company's employees are presently represented by a union or covered under a collective bargaining agreement. Management of the Company considers relations with employees to be good. REGULATION, SUPERVISION AND GOVERNMENTAL POLICY The following is a brief summary of certain statutes, rules and regulations affecting the Company and the Banks. A number of other statutes and regulations have an impact on their operations. The following summary of applicable statutes and regulations does not purport to be complete and is qualified in its entirety by reference to such statutes and regulations. Bank Holding Company Regulation. The Company is registered as a bank holding company under the Holding Company Act and, as such, subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve Board (the "FRB"). Acquisitions and Mergers. Under the Holding Company Act, a bank holding company must obtain the prior approval of the FRB before (i) acquiring direct or indirect ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, the bank holding company would directly or indirectly own or control more than 5% of such shares; (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company. Also, any company must obtain approval of the FRB prior to acquiring control of the Company or the Banks. For purposes of the Holding Company Act, "control" is defined as ownership of more than 25% of any class of voting securities of the Company or the Banks, the ability to control the election of a majority of the directors, or the exercise of a controlling influence over management or policies of the Company or the Banks. The Holding Company Act, as amended by the Riegle-Neal Act, generally permits the FRB to approve interstate bank acquisitions by bank holding companies without regard to any prohibitions of state law. See "Competition". The Change in Bank Control Act and the related regulations of the FRB require any person or persons acting in concert (except for companies required to make application under the Holding Company Act), to file a written notice with the FRB before such person or persons may acquire control of the Company or the Banks. The Change in Bank Control Act defines "control" as the power, directly or indirectly, to vote 25% or more of any voting securities or to direct the management or policies of a bank holding company or an insured bank. The Company is not aware of any such notice having been filed with the FRB during 1997. The Holding Company Act also prohibits, with certain exceptions, a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of a company that is not a bank or a bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. Capital Requirements. The Company is also subject to FRB guidelines that require bank holding companies to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See "-- Capital Requirements." Dividends. The FRB has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The FRB has issued a policy statement expressing its view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the company's 10 12 capital needs, asset quality, and overall financial condition. The Company does not believe this policy statement will limit the Company's activity to maintain its dividend payment rate. Support of Banking Subsidiaries. Under FRB policy, the Company is expected to act as a source of financial strength to its banking subsidiaries and, where required, to commit resources to support each of such subsidiaries. This support may be required at times when, absent such FRB policy, the Company may not be inclined to provide it. Moreover, if one of its banking subsidiaries should become undercapitalized, under FDICIA the Company would be required to guarantee the subsidiary bank's compliance with its capital plan in order for such plan to be accepted by the federal regulatory authority. Under the "cross guarantee" provisions of the Federal Deposit Insurance Act (the "FDI Act"), any FDIC-insured subsidiary of the Company may be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the "default" of any other commonly controlled FDIC-insured subsidiary or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured subsidiary "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. Because it is a bank holding company, any capital loans made by the Company to its banking subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a banking subsidiary will be assumed by the bankruptcy trustee and entitled to a priority of payment over certain other creditors of the bank holding company, including the holders of its subordinated debt. Transactions with Affiliates. Provisions of the Federal Reserve Act impose restrictions on the type, quantity and quality of transactions between "affiliates" (as defined below) of an insured bank and the insured bank (including a bank holding company and its nonbank subsidiaries). The purpose of these restrictions is to prevent misuse of the resources of the insured institution by its uninsured affiliates. An exception to most of these restrictions is provided for transactions between two insured banks that are within the same holding company where the holding company owns 80% or more of each of these banks (the "sister bank" exception). The restrictions also do not apply to transactions between an insured bank to its wholly-owned subsidiaries. These restrictions include limitations on the purchase and sale of assets and extensions of credit by the insured bank to its holding company or its nonbank subsidiaries. An insured bank and its subsidiaries are limited in engaging in "covered transactions" with their nonbank or nonsavings-bank affiliates to the following amounts: (i) in the case of any one such affiliate, the aggregate amount of covered transactions of the insured bank and its subsidiaries may not exceed 10% of the capital stock and surplus of the insured bank and (ii) in the case of all affiliates, the aggregate amount of covered transactions of the insured bank and its aggregate amount of covered transactions of the insured bank and its subsidiaries may not exceed 20% of the capital stock and surplus of the bank. "Covered transactions" are defined by statute to include loans or other extensions of credit as well as purchases of securities issued by an affiliate, purchases of assets (unless otherwise exempted by the Federal Reserve Board), the acceptance of securities issued by the affiliate as collateral for a loan and the issuance of a guarantee, acceptance or letter of credit issued on behalf of an affiliate. Further, provisions of the Holding Company Act prohibit a bank holding company and its subsidiaries from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. As used herein, "affiliate" means generally any company that controls the insured bank, a company which is under common control with the insured bank and a subsidiary of the insured bank. Bank Regulation. As a Tennessee banking institution, each of the Banks is subject to regulation, supervision and regular examination by the Banking Department. The deposits of each Bank are insured by the FDIC to the maximum extent provided by law (a maximum of $100,000 for each insured depositor). Tennessee and federal banking laws and regulations control, among other things, required reserves, investments, loans, mergers 11 13 and consolidations, issuance of securities, payment of dividends, and establishment of branches and other aspects of the Banks' operations. Supervision, regulation and examination of the Company and the Banks by the bank regulatory agencies are intended primarily for the protection of depositors rather than for holders of the Common Stock of the Company. Extensions of Credit. Under joint regulations of the federal banking agencies, including the FDIC, banks must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards, including loan-to-value limits, that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements. A bank's real estate lending policy must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies (the "Interagency Guidelines") that have been adopted by the federal bank regulators. The Interagency Guidelines, among other things, call upon depository institutions to establish internal loan-to-value limits for real estate loans that are not in excess of the loan-to-value limits specified in the Guidelines for the various types of real estate loans. The Interagency Guidelines state that it may be appropriate in individual cases to originate or purchase loans with loan-to-value ratios in excess of the supervisory loan-to-value limits. The aggregate amount of loans in excess of the supervisory loan-to-value limits, however, should not exceed 100% of total capital and the total of such loans secured by commercial, agricultural, multifamily and other non-one-to-four family residential properties should not exceed 30% of total capital. Federal Deposit Insurance. Each of the Banks is subject to FDIC deposit insurance assessments. The FDIC has established a risk-based deposit insurance assessment system for insured depository institutions, under which insured institutions are assigned assessment risk classifications based upon capital levels and supervisory evaluations. Under these regulations, the FDIC set the 1997 insurance assessment rates for BIF-insured banks such as the Banks from $ 0 per year for the highest rated institutions to 0.27% of insured deposits for the lowest rated institutions. On September 30, 1996, President Clinton signed into law the Deposit Insurance Funds Act of 1996 (the "1996 Act"), which, among other things, (i) recapitalized the Savings Association Insurance Fund ("SAIF") by imposing a special one-time assessment on SAIF-insured institutions, (ii) from January 1, 1997 through December 31, 1999, requires BIF member banks to pay one-fifth of the assessment rate imposed upon savings institutions to cover the annual payments on the bonds issued by the Financing Corporation ("FICO") and (iii) from January 1, 2000 until the date the FICO bonds are retired, will require BIF members and SAIF members to pay FICO assessments on a pro rata basis. In accordance with the 1996 Act's requirements, the FDIC has set the 1998 FICO assessment rate for BIF member banks at .012% of insured deposits. The annual insurance assessment rates payable by BIF member banks for the first half of 1998, however, remain fixed at 0% to 0.27%, depending on an individual bank's risk classification. Safety and Soundness Standards. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") required the federal bank regulatory agencies to prescribe, by regulation, non-capital safety and soundness standards for all insured depository institutions and depository institution holding companies. The FDIC and the other federal banking agencies have adopted guidelines prescribing safety and soundness standards pursuant to FDICIA. The safety and soundness guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. Among other things, the guidelines require banks to maintain appropriate systems and practices to identify and manage risks and exposures identified in the guidelines. In addition, the FDIC and the other federal banking agencies have proposed guidelines for asset quality and earnings standards as required by FDICIA. Under the proposed standards, a bank would be required to maintain systems, commensurate with its size and the nature and scope of its operations, to identify problem assets and prevent deterioration in those assets as well as to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves. 12 14 Capital Requirements. The FRB has established guidelines with respect to the maintenance of appropriate levels of capital by registered bank holding companies, and the FDIC has established similar guidelines for state-chartered banks that are not members of the FRB. The regulations of the FRB and FDIC impose two sets of capital adequacy requirements: minimum leverage rules, which require the maintenance of a specified minimum ratio of capital to total assets, and risk-based capital rules, which require the maintenance of specified minimum ratios of capital to "risk-weighted" assets. At December 31, 1997, the Company and each of the Banks satisfied the minimum required regulatory capital requirements. See Note 14 of Notes to Consolidated Financial Statements. Under FDICIA, the federal banking agencies were required to revise their risk-based capital standards to ensure that such standards take adequate account of interest rate risk, concentration of credit risk and the risks of nontraditional activities. The FDIC and the other banking agencies have amended the risk-based capital standards to take account of a bank's concentration of credit risk, the risk of nontraditional activities, and a bank's exposure to declines in the economic value of its capital resulting from changes in interest rates. The revised capital guidelines do not, however, codify a measurement framework for assessing the level of a bank's interest rate exposure. On June 26, 1996, the FDIC and the other banking agencies adopted a joint policy statement requiring that banks adopt comprehensive policies and procedures for managing interest rate risk and setting forth general standards for such internal policies. Unlike an earlier proposal by the federal banking agencies, the joint policy statement does not contain a standardized measure of or explicit capital charge for interest rate risk. The Company does not believe that this new policy statement will have a material effect on the Company's operations or financial results. The FDIC has issued final regulations that classify insured depository institutions by capital levels and provide that the applicable agency will take various prompt corrective actions to resolve the problems of any institution that fails to satisfy the capital standards. Under such regulations, a "well-capitalized" bank is one that is not subject to any regulatory order or directive to meet any specific capital level and that has or exceeds the following capital levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. As of December 31, 1997, each of the Banks was "well-capitalized" as defined by the regulations. See Note 14 of Notes to Consolidated Financial Statements for further information. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth information regarding the executive officers of the Company. Age At Name December 31, 1997 Title - ------------------------- ------------------- -------------------------------------------------- R. Stan Puckett 41 President and Chief Executive Officer Davis Stroud 64 Executive Vice President and Secretary William F. Richmond 48 Senior Vice President and Chief Financial Officer R. STAN PUCKETT currently serves as President and Chief Executive Officer of the Company and has held that position since 1990. He has served as President and Chief Executive Officer of GCB since February 1989. He is a graduate of Bristol University with a degree in business administration. He served as President of First American National Bank of Johnson City, Tennessee from December 1987 to February 1989 and as its Vice President from June 1986 to December 1987. He was Assistant Vice President of First Union National Bank in Asheville, North Carolina from September 1983 to June 1986 and served as commercial loan officer of Signet Bank in Bristol, Virginia from September 1977 to June 1983. DAVIS STROUD is currently Executive Vice President of the Company and GCB. Mr. Stroud joined GCB in 1952 and became its Senior Vice President and Cashier in 1973. He became Executive Vice President and Secretary of the Company and GCB in 1988 and has also served as a director of the Company and GCB since December 1989. Mr. Stroud is a member of First Christian Church and Greeneville Masonic Lodge No. 3, and he also serves as Treasurer of Greene County Foundation. 13 15 WILLIAM F. RICHMOND joined the Company in February 1996 and currently serves as Senior Vice President and Chief Financial Officer of the Company and GCB. Prior to joining the Company, Mr. Richmond served, subsequent to the acquisition of Heritage Federal Bancshares, Inc. ("Heritage") by First American Corporation, as transition coordinator for various financial matters from November 1995 through January 1996. Heritage was the parent of Heritage Federal Bank for Savings located in Kingsport, Tennessee. He served as Senior Vice President and Chief Financial Officer for Heritage from June 1991 through October 1995 and as controller from April 1985 through May 1991. He has been active in community activities in the Tri-Cities, Tennessee area, having served on the Board of Directors of Boys and Girls Club, Inc. and as President of the Tri-Cities Estate Planning Council. He has served in various capacities with the United Way of Greater Kingsport and is a Paul Harris Fellow in Rotary International. He is licensed as a Certified Public Accountant in Virginia and Tennessee and is also a Certified Financial Planner. ITEM 2. PROPERTIES The Company's principal executive offices are located at 100 North Main Street, Greeneville, Tennessee in facilities owned by GCB. At December 31, 1997, the Company maintained a main office in Greeneville, Tennessee, 16 branches in counties in East Tennessee for the operation of GCB, of which seven are in leased operating premises, and two branches in McMinn County, Tennessee for the operation of Premier Bank. ITEM 3. LEGAL PROCEEDINGS. From time to time, the Company and its subsidiaries are parties to various legal proceedings incident to its business. At December 31, 1997, there were no legal proceedings which management anticipates would have a material adverse effect on the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders of the Company through a solicitation of proxies or otherwise. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information contained under the section captioned "Market and Dividend Information" in the Company' 1997 Annual Report to Shareholders (the "Annual Report") filed as Exhibit 13 hereto is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The information contained in the table captioned " Selected Financial Highlights" in the Company's Annual Report is incorporated herein by reference. 14 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information set forth under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Sensitivity" is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements contained in the Annual Report are incorporated herein by reference. ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information concerning the Board of Directors of the Company, the information contained under the section captioned "Election of Directors" in the Company's definitive proxy statement for the Company's 1998 Annual Meeting of Shareholders (the "Proxy Statement") is incorporated herein by reference. Information regarding executive officers of the Company is contained in the section captioned "Executive Officers of the Registrant" under Part I hereof and is incorporated herein by reference. Information regarding delinquent Form 3, 4 or 5 filers is incorporated herein by reference to the section entitled "Beneficial Ownership Reports" in the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information contained under the section captioned "Election of Directors -- Executive Compensation and Other Benefits" in the Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. (b) Security Ownership of Management Information required by this item is incorporated herein by reference to the sections captioned "Security Ownership of Certain Beneficial Owners and Management" and "Election of Directors" in the Proxy Statement. 15 17 (c) Changes in Control Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference to the section captioned "Election of Directors" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) The following consolidated financial statements of the Company included in the Annual Report are incorporated herein by reference from Item 8 of this Report. The remaining information appearing in the Annual Report to Shareholders is not deemed to be filed as part of this Report, except as expressly provided herein. 1. Report of Independent Auditors. 2. Consolidated Balance Sheets - December 31, 1997 and 1996. 3. Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995. 4. Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995. 5. Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995. 6. Notes to Consolidated Financial Statements. (a)(2) All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (a)(3) The following exhibits either are filed as part of this Report or are incorporated herein by reference: Exhibit No. 3. Articles of Incorporation and Bylaws (i) Amendment dated September 24, 1997 to Restated and Amended Articles of Incorporation. (ii) Bylaws - incorporated herein by reference to the Company's Registration Statement on Form S-14 (File No. 2-96273). 16 18 Exhibit No. 10. Employment Agreements (i) Employment agreement between the Company and R. Stan Puckett -- incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. (ii) Employment agreement between the Company and Davis Stroud -- incorporated herein by reference to the Company's Registration Statement on Form S-14 (File No. 2-96273). Exhibit No. 13. Annual Report to Shareholders Except for those portions of the Annual Report to Shareholders for the year ended December 31, 1997, which are expressly incorporated herein by reference, such Annual Report is furnished for the information of the Commission and is not to be deemed "filed" as part of this Report. Exhibit No. 21. Subsidiaries of the Registrant A list of subsidiaries of the Registrant is included as an exhibit to this Report. Exhibit No. 23. Consent of Coopers & Lybrand L.L.P. Exhibit No. 27. Financial Data Schedule (SEC USE ONLY) (b) Reports on Form 8-K. No Reports on Form 8-K were filed by the Company during the last quarter of the fiscal year covered by this report. (c) Exhibits. The exhibits required by Item 601 of Regulation S-K are either filed as part of this Annual Report on Form 10-K or incorporated herein by reference. (d) Financial Statements and Financial Statement Schedules Excluded From Annual Report. There are no financial statements and financial statement schedules which were excluded from the Annual Report pursuant to Rule 14a-3(b)(1) which are required to be included herein. 17 19 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on behalf by the undersigned, thereunto duly authorized. GREENE COUNTY BANCSHARES, INC. Date: March 25, 1998 By: /s/ R. Stan Puckett ----------------------- R. Stan Puckett Director, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated and on the dates indicated. SIGNATURE AND TITLE: DATE: /s/ R. Stan Puckett March 25, 1998 - --------------------------------- R. Stan Puckett Director, President and Chief Executive Officer (Principal Executive Officer) /s/ William F. Richmond March 25, 1998 - --------------------------------- William F. Richmond Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) /s/ Harrison Lamons March 25, 1998 - --------------------------------- Harrison Lamons Chairman of the Board /s/ Helen Horner March 25, 1998 - --------------------------------- Helen Horner Director /s/ J. W. Douthat March 25, 1998 - --------------------------------- J.W. Douthat Director /s/ Phil M. Bachman, Jr. March 25, 1998 - ------------------------------------- Phil M. Bachman, Jr. Director 18 20 /s/ Terry Leonard March 25, 1998 - --------------------------------- Terry Leonard Director /s/ Ralph T. Brown March 25, 1998 - --------------------------------- Ralph T. Brown Director /s/ James A. Emory March 25, 1998 - --------------------------------- James A. Emory Director /s/ Patrick Norris March 25, 1998 - --------------------------------- Patrick Norris Director /s/ Jerald K. Jaynes March 25, 1998 - --------------------------------- Jerald K. Jaynes Director /s/ Charles S. Brooks March 25, 1998 - --------------------------------- Charles S. Brooks Director /s/ Davis Stroud March 25, 1998 - --------------------------------- Davis Stroud Director /s/ W. T. Daniels March 25, 1998 - --------------------------------- W.T. Daniels Director 19 21 EXHIBIT 13 SELECTED FINANCIAL DATA 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (In thousands of dollars, except per share data) Total interest income .................................. $ 49,005 $ 39,521 $ 31,387 $ 23,625 $ 21,638 Total interest expense ................................. 19,144 15,825 13,444 8,497 8,197 --------- --------- --------- --------- --------- Net interest income .................................... 29,861 23,696 17,943 15,128 13,441 Provision for loan losses .............................. (5,953) (2,973) (1,424) (994) (834) Net interest income after provision for loan losses .... 23,908 20,723 16,519 14,134 12,607 Non-interest income: Investment securities gains ....................... 2 -- 1 -- 15 Other income ...................................... 3,919 3,411 2,597 2,368 1,951 Non-interest expense ................................... (17,009) (14,800) (11,257) (9,491) (8,035) --------- --------- --------- --------- --------- Income before income taxes ............................. 10,820 9,334 7,860 7,011 6,538 Income tax expense ..................................... (3,990) (3,371) (2,752) (2,510) (2,221) --------- --------- --------- --------- --------- Net income before accounting change .................... 6,830 5,963 5,108 4,501 4,317 Accounting change ...................................... -- -- - -- (52) --------- --------- --------- --------- --------- Net income ............................................. $ 6,830 $ 5,963 $ 5,108 $ 4,501 $ 4,265 ========= ========= ========= ========= ========= Per Share Data:(1) Net income ........................................ $ 5.03 $ 4.43 $ 3.82 $ 3.38 $ 3.18 Dividends declared ................................ $ 1.92 $ 1.72 $ 1.53 $ 1.35 $ 1.22 Book value ........................................ $ 37.00 $ 33.76 $ 30.94 $ 28.02 $ 26.42 Financial Condition Data: Assets ............................................ $ 534,102 $ 478,048 $ 420,581 $ 45,525 $ 313,577 Loans, net ........................................ $ 441,390 $ 381,272 $ 293,834 $ 241,253 $ 192,127 Cash and investment securities .................... $ 62,166 $ 73,713 $ 83,998 $ 85,460 $ 99,815 Federal funds sold ................................ $ 5,500 -- $ 23,800 $ 3,550 $ 8,270 Deposits .......................................... $ 461,728 $ 408,722 $ 365,951 $ 98,162 $ 267,281 Long-term debt .................................... $ 15,487 $ 15,806 $ 3,448 $ 3,688 $ 3,914 Other borrowed funds .............................. $ 1,414 $ 3,272 $ 4,784 $ 3,879 $ 5,644 Shareholders' equity .............................. $ 50,113 $ 45,725 $ 41,074 $ 37,190 $ 35,046 Selected Ratios: Interest rate spread .............................. 5.70% 5.16% 4.57% 4.57% 4.46% Net yield on interest-earning assets .............. 6.21% 5.65% 5.09% 4.96% 4.84% Return on average assets .......................... 1.33% 1.32% 1.35% 1.38% 1.41% Return on average equity .......................... 13.93% 13.23% 13.17% 12.32% 12.35% Average equity to average assets .................. 9.55% 9.94% 10.24% 11.17% 11.43% Dividend payout ratio ............................. 38.08% 39.05% 40.17% 39.96% 38.39% Ratio of nonperforming assets to total assets ..... 0.81% 0.49% 0.57% 0.40% 1.54% Ratio of allowance for loan losses to Nonperforming assets ........................ 210.15% 315.27% 225.05% 247.99% 63.47% Ratio of allowance for loan losses to total loans . 2.01% 1.87% 1.55% 1.39% 1.54% (1) Amounts have been restated to reflect the effect of the Company's 3-for-1 stock split effected in October 1997. 1 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF CHANGES IN FINANCIAL CONDITION AND RESULTS OF OPERATION FORWARD-LOOKING INFORMATION THE INFORMATION CONTAINED HEREIN CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. A NUMBER OF FACTORS, INCLUDING THOSE DISCUSSED HEREIN, COULD CAUSE RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED BY SUCH FORWARD-LOOKING STATEMENTS. IN ADDITION, SUCH FORWARD-LOOKING STATEMENTS ARE NECESSARILY DEPENDENT UPON ASSUMPTIONS, ESTIMATES AND DATA THAT MAY BE INCORRECT OR IMPRECISE. ACCORDINGLY, ANY FORWARD-LOOKING STATEMENTS INCLUDED HEREIN DO NOT PURPORT TO BE PREDICTIONS OF FUTURE EVENTS OR CIRCUMSTANCES AND MAY NOT BE REALIZED. FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY, AMONG OTHER THINGS, THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "INTENDS," "BELIEVES," "EXPECTS," "MAY," "WILL," "SHOULD," "SEEKS," "PRO FORMA" OR "ANTICIPATES," OR THE NEGATIVES THEREOF, OR OTHER VARIATIONS THEREON OF COMPARABLE TERMINOLOGY, OR BY DISCUSSIONS OF STRATEGY OR INTENTIONS. GENERAL Greene County Bancshares, Inc. (the "Company") was formed in 1985 and serves as the bank holding company for Greene County Bank ("GCB") and Premier Bank of East Tennessee ("Premier Bank") (collectively, the "Banks"), which are Tennessee-chartered commercial banks that conduct the principal business of the Company. The Company also wholly owned American Fidelity Bank, whose assets were combined with GCB during 1996. In addition to its commercial banking operations, GCB conducts separate businesses through its three wholly-owned subsidiaries: Superior Financial Services, Inc. ("Superior Financial"), a consumer finance company; Superior Mortgage Company ("Superior Mortgage"), a mortgage banking company; and GCB Acceptance Corporation ("GCB Acceptance"), a subprime automobile lending company. The principal business of the Company consists of accepting deposits from the general public and investing these funds and borrowed funds primarily in loans and, to a limited extent, securities available for sale or held to maturity. Loans are originated by the Company within its primary market area of east Tennessee and include commercial loans, commercial real estate loans, mortgage installment loans and installment consumer loans. The Company's net income is dependent primarily on its net interest income, which is the difference between interest income earned on its loans, investment assets and other interest-earning assets and interest paid on deposits and other interest-bearing liabilities. To a lesser extent, the Company's net income also is affected by the level of non-interest expenses such as compensation and employee benefits and Federal Deposit Insurance Corporation premiums. The operations of the Company are significantly affected by prevailing economic conditions, competition and the monetary, fiscal and regulatory policies of governmental agencies. Lending activities are influenced by the general credit needs of small businesses in the Company's market area, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities and the levels of personal income and savings in the Company's market area. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY. Liquidity refers to the ability or the financial flexibility to manage future cash flows to meet the needs of depositors and borrowers and fund operations. Maintaining appropriate levels of liquidity allows the Company to have sufficient funds available for reserve requirements, customer demand for loans, withdrawal of deposit balances and maturities of deposits and other liabilities. The Company's primary source of liquidity is dividends paid by the Banks. Applicable Tennessee statutes and regulations impose restrictions on the amount of dividends that may be declared by the subsidiary Banks. Further, any dividend payments are subject to the continuing ability of each of the Banks to maintain their respective compliance with minimum federal regulatory capital requirements and to retain their characterization under federal regulations as "well-capitalized" institutions. In addition, the Company maintains a line of credit of $20 million with the Federal Home Loan Bank of Cincinnati and three federal funds lines of credit totaling $20 million at three correspondent banks. In 1997, operating activities of the Company provided $12,958,120 of cash flows. Net income of $6,830,174 adjusted for non-cash operating activities, including $5,953,205 in provision for loan losses and amortization and depreciation of $1,146,564, provided the bulk of the cash generated from operations. 2 23 Investing activities, including lending, used $63,165,851 of the Company's cash flow. Loans originated net of principal collected used $66,708,497 in funds. Net additional cash inflows of $49,562,770 were provided by financing activities. Net deposit growth accounted for $54,337,729 of the increase. Other increases arose from proceeds from issuance of common stock of $2,701. Offsetting these increases were a decrease in securities sold under agreements to repurchase of $1,858,000, cash dividends paid to shareholders of $2,600,640, net payments on long-term debt of $269,020 and payments on related party notes payable of $50,000. CAPITAL RESOURCES. The Company's capital position is reflected in its shareholders' equity, subject to certain adjustments for regulatory purposes. Shareholders' equity, or capital, is a measure of the Company's net worth, soundness and viability. The Company continues to exhibit a strong capital position while consistently paying dividends to its stockholders. Further, the capital base of the Company allows it to take advantage of business opportunities while maintaining the level of resources deemed appropriate by management of the Company to address business risks inherent in the Company's daily operations. Shareholders' equity on December 31, 1997 was $50,112,860, an increase of $4,387,524 or 9.59%, from $45,725,336 on December 31, 1996. The increase in shareholders' equity reflects net income for 1997 of $6,830,174 ($5.04 per share, or $5.03 per share assuming dilution), the increase in equity associated with the increase in the value of securities available for sale of $155,289 and proceeds from stock issuances during 1997 totaling $2,701. This increase was offset in part by quarterly dividend payments during 1997 totaling $2,600,640 ($1.92 per share). Risk-based capital regulations adopted by the Board of Governors of the Federal Reserve Board (the "FRB") and the Federal Deposit Insurance Corporation ("FDIC") require bank holding companies and banks, respectively, to achieve and maintain specified ratios of capital to risk-weighted assets. The risk-based capital rules are designed to measure Tier 1 Capital and Total Capital in relation to the credit risk of both on- and off-balance sheet items. Under the guidelines, one of four risk weights is applied to the different on-balance sheet items. Off-balance sheet items, such as loan commitments, are also subject to risk weighting after conversion to balance sheet equivalent amounts. All bank holding companies and banks must maintain a minimum total capital to total risk-weighted assets ratio of 8.00%, at least half of which must be in the form of core, or Tier 1, capital (consisting of stockholders' equity, less goodwill). At December 31, 1997, the Company and the Banks each satisfied their respective minimum regulatory capital requirements, and each of the Banks was "well-capitalized" within the meaning of federal regulatory requirements. ASSET/LIABILITY MANAGEMENT The operations and profitability of the Company are largely impacted by changes in interest rates and management's ability to control interest rate sensitivity. Management believes that its asset/liability strategy reduces the risk associated with fluctuation in interest rates. The Company strives to be neither asset sensitive nor liability sensitive by relying upon a mix of fixed rate and variable rate products. At December 31, 1997, approximately 46.4% of the Company's gross loans had adjustable rates. The Company has a mixture of fixed rate loans and loans tied to its Prime Rate, and this also applies to the investment portfolio. It is management's belief that while this mixture may not give maximum returns under certain market conditions, it can prevent severe swings in earnings under other conditions. Management believes the Company is somewhat asset sensitive; therefore, in a falling rate environment earnings will tend to fall, while in a rising rate environment earnings will tend to improve. Despite the implementation of strategies to achieve a matching position of assets and liabilities and to reduce the exposure to fluctuating interest rates, the results of operations of the Company will remain subject to the level and movement of interest rates. CHANGES IN RESULTS OF OPERATIONS NET INCOME. Net income for 1997 was $6,830,174, an increase of $866,912 or 14.54% as compared to net income of $5,963,262 for 1996. The increase resulted primarily from an increase in net interest income of $6,164,660, or 26.0%, to $29,860,866 in 1997 from $23,696,206 in 1996, and an increase in non-interest income of $510,336, or 15.0%, to $3,921,116 in 1997 from $3,410,780 in 1996. The increase in net interest income primarily reflects the Company's continued growth in loan production, primarily increases in mortgage installment, commercial real estate and commercial loans as the Company continues to take advantage of its branch network presence throughout East Tennessee. These increases were offset in part by the $2,208,929, or 14.93% increase in non-interest expense to $17,008,839 in 1997 from $14,799,910 in 1996, attributable primarily to increasing compensation and occupancy expenses associated with branch operations. 3 24 Net income for 1996 was $5,963,262, an increase of $854,822 or 16.7% as compared to net income of $5,108,440 for 1995. The increase resulted primarily from an increase in net interest income of $5,752,956, or 32.1%, to $23,696,206 in 1996 from $17,943,250 in 1995, and an increase in non-interest income of $812,505, or 31.3%, to $3,410,780 in 1996 from $2,598,275 in 1995. The increase in net interest income reflects the Company's continued growth in loan production through its expanding branch network (primarily increases in commercial, commercial real estate and consumer loans) as well as increases arising from the Company's acquisition during 1996 of Premier Bank of East Tennessee. These increases were offset in part by the $3,542,742, or 31.5% increase in non-interest expense to $14,799,910 in 1996 from $11,257,168 in 1995, attributable primarily to increasing compensation and furniture and equipment expenses associated with the growth of the Company's branch network. NET INTEREST INCOME. The largest source of earnings for the Company is net interest income, which is the difference between interest income on interest-earning assets and interest paid on deposits and other interest-bearing liabilities. The primary factors which affect net interest income are changes in volume and yields of earning assets and interest-bearing liabilities, which are affected in part by management's responses to changes in interest rates through asset/liability management. During 1997, net interest income was $29,860,866 as compared to $23,696,206 in 1996, an increase of 26.0%. This increase was due primarily to a $61,212,715 increase in average interest-earning assets during 1997 as compared to 1996, offset by a $53,509,868 increase in average interest bearing liabilities during the same period to fund such growth. At the same time, the Company's net interest margin increased in 1997 to 6.21% from 5.65% in 1996. This increase in net interest margin reflects the Company's focus on commercial and commercial real estate loans, which generally have shorter terms and are priced based upon the prime rate offered by New York banks as reported in The Wall Street Journal. The Company's loan yields were thus enhanced by the 25 basis point prime rate increase in the first quarter of 1997. Commercial and commercial real estate loans comprised, in the aggregate, 51.3% of the Company's gross loan portfolio at December 31, 1997. Offsetting the growth in interest income during 1997 was the related increase in interest expense arising primarily from the 12.7% increase in 1997 in the Company's average deposit base. Net interest income for 1996 increased $5,752,956 or 32.1%, to $23,696,206 in 1996 from $17,943,250 in 1995. This increase was primarily the result of increased lending volume funded in part by a shift by the Company away from an emphasis on lower-yielding securities investments. Further, the Company also experienced a shift in its lending portfolio to higher-yielding installment loans. This series of shifts is reflected in the Company's interest rate spread increasing to 5.16% in 1996 from 4.57% in 1995, and the increase in the Company's net yield on interest earning assets to 5.65% in 1996 from 5.09% in 1995. Average Balances, Interest Rates and Yields. Net interest income is affected by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities ("interest rate spread") and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The Company's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. When the total of interest-earning assets approximates or exceeds the total of interest-bearing liabilities, any positive interest rate spread will generate net interest income. Another indication of an institution's net interest income is its "net yield on interest-earning assets," which is net interest income divided by average interest-earning assets. 4 25 The following table sets forth certain information relating to the Company's consolidated average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the periods presented. During the periods indicated, non-accruing loans, if any, are included in the net loan category. 1997 --------------------------------------------------- Average Revenue/ Yield/ Balance Expense Rate ------- ------- ---- INTEREST-EARNING ASSETS: Loans - ----- Commercial.................. $240,601,635 $ 21,476,951 8.93% Installment - net........... 190,304,270 22,024,965 11.57% Fees on loans.............. 2,502,460 ------------ ------------ Total loans (including fees)........ $430,905,905 $ 46,004,376 10.68% Investment securities - --------------------- Taxable.................... $ 38,079,718 $ 2,467,835 6.48% Tax exempt................. 9,210,719 403,507 4.38% ------------ ------------ Total investment........... $ 47,290,437 $ 2,871,342 6.07% Securities: Other short-term investments.............. 2,409,152 129,080 5.36% ------------ ------------ Total interest- earning assets................ $480,605,494 $ 49,004,798 10.20% ------------ ------------ NON-INTEREST-EARNING ASSETS: Cash and due from banks.................... $ 17,589,326 Premises and .............. equipment................ 9,355,616 Other, less allowance for loan losses.......... 5,945,568 ------------ Total non-interest- Earning Assets........................ $ 32,890,510 ------------ Total assets.................. $513,496,004 ============ 1996 ---------------------------------------------- Average Revenue/ Yield/ Balance Expense Rate ------- ------- ---- INTEREST-EARNING ASSETS: Loans - ----- Commercial.................. $173,178,149 $ 14,967,334 8.64% Installment - net........... 174,667,162 19,022,302 10.89% Fees on loans.............. 1,395,467 ------------ Total loans (including fees)........ $347,845,311 $ 35,385,103 10.17% Investment securities - --------------------- Taxable.................... $ 51,687,569 $ 3,125,592 6.05% Tax exempt................. 10,953,312 496,705 4.53% ------------ ------------ Total investment........... $ 62,640,881 $ 3,622,297 5.78% Securities: Other short-term investments.............. 8,906,587 513,326 5.76% ------------ ------------ Total interest- earning assets................ $419,392,779 $39,520,726 9.42% ------------ ------------ NON-INTEREST-EARNING ASSETS: Cash and due from banks.................... $ 15,979,895 Premises and .............. equipment................ 9,379,752 Other, less allowance for loan losses.......... 8,457,324 ------------ Total non-interest- Earning Assets........................ $ 33,816,971 ------------ Total assets.................. $453,209,750 ============ 1995 ------------------------------------------------- Average Revenue/ Yield/ Balance Expense Rate ------- ------- ---- INTEREST-EARNING ASSETS: Loans - ----- Commercial.................. $141,349,273 $ 12,335,077 8.73% Installment - net........... 130,530,479 13,469,095 10.32% Fees on loans.............. 850,861 ------------ ------------ Total loans (including fees)........ $271,879,752 $ 26,655,033 9.80% Investment securities - --------------------- Taxable.................... $ 59,939,744 $3,735,181 6.23% Tax exempt................. 9,117,893 369,795 4.06% ------------ ------------ Total investment........... $ 69,057,637 $4,104,976 5.94% Securities: Other short-term investments.............. 11,571,548 627,135 5.42% ------------ ------------ Total interest- earning assets................ $352,508,937 $31,387,144 8.90% ------------ ------------ NON-INTEREST-EARNING ASSETS: Cash and due from banks.................... $ 12,668,334 Premises and .............. equipment................ 6,916,037 Other, less allowance for loan losses.......... 6,649,556 ------------ Total non-interest- Earning Assets........................ $ 26,233,927 ------------ Total assets.................. $378,742,864 ============ (Continued on following page) 5 26 1997 ---------------------------------------------- Average Revenue/ Yield/ Balance Expense Rate ------- ------- ---- INTEREST-BEARING LIABILITIES: Savings, NOW accounts, and money markets............ $150,088,946 $ 3,930,293 2.62% Time deposits................... 253,840,096 13,947,656 5.49% ------------ ----------- Total deposits............... $403,929,042 $17,877,949 4.43% Securities sold under Repurchase agreement and short-term borrowings.................. 4,949,115 236,553 4.78% Debt .......................... 16,147,018 1,029,430 6.38% ---------- ----------- Total interest-bearing Liabilities............... $425,025,175 $19,143,932 4.50% ----------- NON-INTEREST-BEARING LIABILITIES: Demand deposits................. $ 33,540,018 Other liabilities............... 5,904,610 ------------ Total liabilities............ $ 39,444,628 Stockholders' equity...... 49,026,201 ------------ Total liabilities and stockholders' equity............ $513,496,004 ============ Net interest income................ $29,860,866 =========== MARGIN ANALYSIS: Interest rate spread............ 5.70% ===== Net yield on interest- earning assets (net Interest margin)........ 6.21% ===== 1996 --------------------------------------------- Average Revenue/ Yield/ Balance Expense Rate ------- ------- ---- INTEREST-BEARING LIABILITIES: Savings, NOW accounts, and money markets............ $150,877,450 $3,536,624 2.34% Time deposits................... 207,440,687 11,641,179 5.61% ----------- ---------- Total deposits............... $358,318,137 $15,177,803 4.24% Securities sold under Repurchase agreement and short-term borrowings.................. 4,931,307 227,613 4.62% Debt .......................... 8,265,863 19,104 5.07% ---------- ------- Total interest-bearing Liabilities............... $371,515,307 $15,824,520 4.26% ----------- NON-INTEREST-BEARING LIABILITIES: Demand deposits................. $30,945,475 Other liabilities............... 5,680,694 ----------- Total liabilities............ $36,626,169 Stockholders' equity...... 45,068,274 ----------- Total liabilities and stockholders' equity............ $453,209,750 ============ Net interest income................ $23,696,206 =========== MARGIN ANALYSIS: Interest rate spread............ 5.16% ===== Net yield on interest- earning assets (net Interest margin)........ 5.65% ===== 1995 ------------------------------------------------ Average Revenue/ Yield/ Balance Expense Rate ------- ------- ---- INTEREST-BEARING LIABILITIES: Savings, NOW accounts, and money markets............ $130,045,108 $3,167,357 2.44% Time deposits................... 172,627,254 9,849,464 5.71% ----------- ---------- Total deposits............... $302,672,362 $13,016,821 4.30% Securities sold under Repurchase agreement and short-term borrowings.................. 4,553,803 231,581 5.09% Debt .......................... 3,559,135 195,492 5.49% ------------ ----------- Total interest-bearing Liabilities............... $310,785,300 $13,443,894 4.33% ----------- NON-INTEREST-BEARING LIABILITIES: Demand deposits................. $24,424,083 Other liabilities............... 4,745,198 ------------ Total liabilities............ $ 29,169,281 Stockholders' equity...... 38,788,283 ------------ Total liabilities and stockholders' equity............ $378,742,864 ============ Net interest income................ $17,943,250 =========== MARGIN ANALYSIS: Interest rate spread............ 4.57% ===== Net yield on interest- earning assets (net Interest margin)........ 5.09% ===== 6 27 Rate/Volume Analysis. The following table analyzes net interest income in terms of changes in the volume of interest-earning assets and interest-bearing liabilities and changes in yields and rates. The table reflects the xtent to which changes in the interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate) and changes in rate (changes in rate multiplied in prior year volume). Changes attributable to the combined impact of volume and rate have been separately identified. 1997 vs. 1996 ----------------------------------------------------------- Rate/ Total Volume Rate Volume Change -------- -------- -------- -------- INTEREST INCOME - --------------- Loans net of unearned income............ $ 8,449 $ 1,752 $ 418 $ 10,619 Investment securities: Taxable.............................. (823) 224 (59) (658) Tax exempt........................... (79) (17) 3 (93) Other short-term investments............ (374) (36) 26 (384) -------- -------- -------- -------- Total interest income................ 7,173 1,923 388 9,484 -------- -------- -------- -------- INTEREST EXPENSE - ---------------- Savings, NOW accounts, and money market accounts............. (18) 414 (2) 394 Time deposits........................ 2,603 (243) (54) 2,306 Short-term borrowings................ 1 8 -- 9 Debt................................. 399 108 103 610 -------- -------- -------- -------- Total interest expense............... 2,985 287 47 3,319 -------- -------- -------- -------- Net interest income..................... $ 4,188 $ 1,636 $ 341 $ 6,165 ======== ======== ======== ======== 1996 vs. 1995 ------------------------------------------------------------ Rate/ Total Volume Rate Volume Change -------- -------- ------- --------- INTEREST INCOME - --------------- Loans net of unearned income............ $ 7,472 $ 983 $ 275 $ 8,730 Investment securities: Taxable.............................. (514) (111) 15 (610) Tax exempt........................... 74 44 9 127 Other short-term investments............ (144) 40 (9) (113) -------- -------- ------- --------- Total interest income................ 6,888 956 290 8,134 -------- -------- ------- --------- INTEREST EXPENSE - ---------------- Savings, NOW accounts, and money market accounts............. 507 (119) (19) 369 Time deposits........................ 1,987 (162) (33) 1,792 Short-term borrowings................ 19 (21) (2) (4) Debt................................. 259 (15) (20) 224 -------- -------- ------- --------- Total interest expense............... 2,772 (317) (74) 2,381 -------- -------- ------- --------- Net interest income..................... $ 4,116 $ 1,273 $ 364 $ 5,753 ======== ======== ======= ========= 7 28 At December 31, 1997, loans, net of unearned income and allowance for loan losses, were $441.4 million compared to $381.3 million at 1996 year end. The increase is primarily due to increases in commercial and installment lending. Average loans, net of unearned interest, for 1997 were $430.9 million, up 23.9% from the 1996 average of $347.8 million. The average outstanding loans for 1995 were $271.9 million. The average growth in loans for the past three years can be attributed to the market expansion into surrounding counties through the Company's branch network and indirect financing. During 1997, the prime rate increased 25 basis points in the first quarter, from 8.25% to 8.50%. This movement in the prime rate basically accounts for the slight increase in overall loan yields in 1997 compared to 1996. During 1996, the prime rate was generally constant at 8.25%, down slightly from 1995 levels but still well above the levels in 1994. This movement in the prime rate principally accounts for the slight reduction in yield on commercial loans in 1996 compared to 1995. Average investment securities for 1997 were $47.3 million, compared to $62.6 million in 1996, and $69.1 million in 1995. In 1997, the average yield on investments was 6.07%, an increase from 5.78% in 1996 and 5.94% in 1995. This trend is reflective of the Company's substantial proportion of adjustable-rate securities comprising its investment portfolio and the increase in the prime rate during 1997, which together resulted in the 1997 increase in average yields. Income provided by the investment portfolio in 1997 was $2,871,342 as compared to $3,662,297 in 1996, and $4,104,976 in 1995. The decline in investment securities from 1996 to 1997 was the result of funding the loan growth experienced by the Company during 1997. Income provided by federal funds sold totaled $129,080 in 1997, compared to $513,326 in 1996 and $627,135 in 1995. The reduction in income from federal funds sold in 1997 compared to 1996 was primarily the result of decreases in volume to fund loan growth as well as a decrease in average yields on federal funds sold in 1997 to 5.36%, as compared to 5.76% in 1996 and 5.42% in 1995. PROVISION FOR LOAN LOSSES. The Company's provision for loan losses increased $2,980,012, or 100.23%, to $5,953,205 in 1997 from $2,973,193 in 1996. A principal reason for the increase was the Company's determination in October 1997 to write off approximately $1.5 million in consumer finance loans originated by Superior Financial following an internal audit that disclosed significant collectibility problems with these loans. Senior management of Superior Financial has since resigned and the Company has placed GCB personnel in the subsidiary to supervise its ongoing operations pending the hiring of a permanent replacement. The increase in the provision for loan losses is also attributable to a $400,000 increase in the reserve for loan losses of Premier Bank relating to management's concern about the increasing level of past due and nonperforming loans in Premier Bank's portfolio that were not otherwise appropriately supported by borrowers' cash flow or the underlying value of the collateral. Further, the increase relates to provisions for subprime automobile loans originated by GCB Acceptance, due to management's concern about increasing losses in the subprime lending industry. This increase also relates to management's concerns about the loss potential arising from the increase in the Company's nonperforming assets to $4.4 million in 1997 from $2.3 million in 1996. These loans are comprised of a mixture of loan types. Management attributes the increase in the amount of nonperforming loans to the higher individual balances of individual commercial loans originated during 1997 and the increase in the consumer loan portfolio, primarily through Superior Financial. Consumer loans originated by the Company's finance company subsidiary, Superior Financial, are generally considered to carry a higher risk of loss than consumer, commercial and housing loans originated by GCB. During 1997, the consumer finance company originated approximately $24.4 million in consumer loans. At December 31, 1997, the Company's consumer finance loans that were nonperforming were $242,000, or 6.29% of total nonperforming loans. Management of the Company does not anticipate a further increase in nonperforming loans during 1998. In addition, the increase reflects management's assessment of the risk of loss in its loan portfolio, as indicated by its increasing amount of charge-offs. In 1997, the Company's net charge-offs increased $3.4 million or 456% to $4.1 million from $737,000 in 1996. The Company's net charge-offs to average loans outstanding increased in 1997 to 0.95% from 0.21% in 1996, a 352% growth that exceeded the growth in the Company's average loans outstanding during the same period. These charge-offs were primarily attributable to consumer loans originated by Superior Financial during the period 1994 through 1997 and both secured and unsecured loans. The Company intends to continue originating consumer loans through GCB and its subsidiaries and believes that it has taken appropriate steps necessary to reduce the adverse effect to the Company of any future charge-offs. The Company is also aware of emerging concern among federal banking regulators of the effect of the Year 2000 Problem on lending customers. See "Year 2000 Problem." In particular, regulators anticipate a 8 29 heightened credit risk associated with the effect on operations of lending customers of this problem and the consequential inability of the customers to make timely payments on all outstanding loans. The Company is currently evaluating the credit risk impact on its current loan portfolio. At December 31, 1997, the Company's allowance for loan losses did not reflect any potential impact of the Year 2000 Problem among its customers. The ratio of loans past due to total gross loans for consumer loans originated by Superior Financial decreased from 7.61% at December 31, 1996 to 5.12% at December 31, 1997. Management of the Company believes that these past due and nonperforming loans originated by its consumer finance subsidiary reflect the risk inherent in this type of business. However, management also believes this risk is also offset by the net benefits attributable to operation of the finance company, including a higher net yield on these types of loans, market penetration and diversification of the Company's activities into non-traditional lending areas. To further manage its credit risk on loans, the Company maintains a "watch list" of loans that, although currently performing, have characteristics that require closer supervision by management. At December 31, 1997, the Company had identified $13.7 million in loans that were placed on its "watch list." The Company's provision for loan losses in 1996 increased by $1,549,541 or 108.8%, to $2,973,193 in 1996 from $1,423,656 in 1995. This increase reflects the Company's more aggressive identification of potential problem loans and the inclusion of the risks associated with such loans in the determination of the Company's allowance for losses. In addition, the provision reflects the perceived risk associated with commercial loans originated by the Company which have higher individual balances and are more susceptible to delinquency than mortgage installment and installment real estate loans. This approach is consistent with the Company's concurrent imposition during 1995 of stricter loan underwriting standards. From 1995 to 1996, nonperforming assets increased $0.2 million, or 9.5%, from $2.1 million in 1995 to $2.3 million in 1996. NON-INTEREST INCOME. Income that is not related to interest-earning assets, consisting primarily of service charges, commissions and fees, has become more important as increases in levels of interest-bearing deposits and other liabilities make it more difficult to maintain interest rate spreads. Total non-interest income for 1997 was $3,921,116 as compared to $3,410,780 in 1996 and $2,598,275 in 1995. The largest components of non-interest income are service charges, commissions and fees, which totaled $3,168,699 in 1997, $2,593,594 in 1996 and $1,861,244 in 1995. The increase from 1996 to 1997 reflects management's continued focus on the generation of fee income and additional fee income generated by the subsidiaries of Greene County Bank. NON-INTEREST EXPENSE. Control of non-interest expense also is an important aspect in managing net income. Non-interest expense includes, among others, personnel, occupancy, and other expenses such as data processing, printing and supplies, legal and professional fees, postage and Federal Deposit Insurance Corporation assessments. Total non-interest expense was $17,008,839 in 1997, compared to $14,799,910 in 1996 and $11,257,168 in 1995. Personnel costs are the primary element of the Company's non-interest expenses. In 1997, salaries and benefits represented $9,525,202 or 56.0% of total non-interest expenses. This was an increase of $1,631,567 or 20.7% over 1996's total of $7,893,635. Personnel costs for 1996 increased $2,067,071 or 35.5% over 1995's total of $5,826,564. These increases were due to opening new branches requiring increased staff levels and increased employee benefit costs, including health insurance and retirement benefit costs. Overall, the number of full-time equivalent employees at December 31, 1997 was 268 versus 233 at December 31, 1996, an increase of 15%. Occupancy and furniture and equipment expense exhibited the same upward trend during the past three years as did personnel costs due to essentially the same reasons referenced above. At December 31, 1997, the Company had 29 branches compared to 27 branches at December 31, 1996. Assessments by the FDIC decreased from $346,501 in 1995 to $6,187 in 1996 and increased to $54,989 in 1997. These premiums have been consistently reduced and essentially eliminated for well-capitalized banks such as those owned by the Company, although premiums are still being assessed for repayment of debt incurred by the federal government in connection with the deposit insurance fund (i.e., the "FICO bonds"). For 1998, the FDIC premiums (including assessments for the FICO bonds) for well-capitalized banks are calculated at 1.244 basis points 9 30 on the assessable deposit base. The Company estimates its total premiums for 1998 at approximately $67,000 based on its deposit levels at December 31, 1997. Other expenses increased only $85,012, or 1.8%, from 1996 to 1997, while the increase from 1995 to 1996 of $1,445,639, or 43.6%, represented increases in dealer commissions on indirect loans acquired and expenses related to the Company's significant market expansion activities. CHANGES IN FINANCIAL CONDITION Total assets at December 31, 1997 were $534.1 million, an increase of $56.1 million, or 11.7%, over 1996's year end total assets of $478.0 million. Average assets for 1997 were $513.5 million, an increase of $60.3 million or 13.3% over 1996 average assets of $453.2 million. This increase was the result of normal asset growth, which was funded primarily by increases in deposits. Return on average assets was 1.33% in 1997, as compared to 1.32% in 1996 and 1.35% in 1995. Earning assets consist of loans, investment securities and short-term investments that earn interest. Average earning assets during 1997 were $480.6 million, an increase of 14.6% from an average of $419.4 million in 1996. Non-performing loans include non-accrual and classified loans. The Company has a policy of placing loans 90 days delinquent in non-accrual status and charging them off at 120 days past due. Other loans past due that are well secured and in the process of collection continue to be carried on the Company's balance sheet. For further information, see Note 1 of the Notes to Consolidated Financial Statements. The Company has aggressive collection practices in which senior management is significantly and directly involved. The Company maintains an investment portfolio to provide liquidity and earnings. Investments at year end 1997 with an amortized cost of $41.3 million had a market value of $41.5 million. At year end 1996, investments with an amortized cost of $52.5 million had a market value of $52.3 million. This decline in investments in 1997 reflects the Company's shift of funds to higher-yielding commercial and consumer lending. The funds to support the Company's asset growth over the past three years have been provided by increased deposits, which were $461.7 million at December 31, 1997. This represents an increase of $53.0 million, or 13.0%, from the $408.7 million of deposits at December 31, 1996. The increase is primarily the result of the Company's aggressive efforts to attract new deposit customers. In 1997, demand deposit balances increased 5.3% from 1996. Demand deposit balances were $35.7 million and $33.9 million at December 31, 1997 and 1996, respectively. Average interest-bearing deposits increased $45.6 million, or 12.7%, in 1997. In 1996, average interest-bearing deposits increased $55.7 million or 18.4% over 1995. These increases in deposits are reflective of the Company's aggressive efforts to attract new deposit customers for the purpose of funding various lending programs. The Company's continued ability to fund its loan and overall asset growth will depend in large part upon the availability of deposit market share in the Company's existing market of East Tennessee. As of June 1997, approximately 64.4% of the deposit base of East Tennessee was controlled primarily by five commercial banks and one savings bank and, as of September 1997, the total deposit base of Tennessee commercial banks had a weighted average rate of 4.23%. Management of the Company does not anticipate further significant growth in its deposit base unless it either offers interest rates well above its prevailing weighted average rate of 4.43% or it acquires deposits from other financial institutions. During 1997, the premiums charged in Tennessee by selling financial institutions for deposit accounts ranged from 6.6% to 13.4%. If the Company takes action to increase its deposit base by offering above-market interest rates or by acquiring deposits from other financial institutions and thereby increases its overall cost of deposits, its net interest income could be adversely affected if it is unable to correspondingly increase the rates it charges on its loans. 10 31 Interest paid on deposits in 1997 totaled $17,877,949 reflecting a 4.43% cost on average interest-bearing deposits of $403.9 million. In 1996, interest of $15,177,803 was paid at a cost of 4.24% on average deposits of $358.3 million. In 1995, interest of $13,016,821 was paid at a cost of 4.30% on average deposits of $302.7 million. INTEREST RATE SENSITIVITY Deregulation of interest rates and more volatile short-term, interest-bearing deposits have created a need for shorter maturities of earning assets. An increasing percentage of commercial and installment loans are being made with variable rates or shorter maturities to increase liquidity and interest rate sensitivity. The difference between interest-sensitive asset repricing and interest-sensitive liability repricing within time periods is referred to as the interest rate sensitivity gap. Gaps are identified as either positive (interest sensitive assets in excess of interest sensitive liabilities) or negative (interest sensitive liabilities in excess of interest sensitive assets). The Company currently believes it is slightly asset sensitive. The Company considers certain demand and time deposits as having longer maturities than what may be considered typical for the industry and, thus, its liabilities are not as sensitive to changes in interest rates. On December 31, 1997, the Company had a positive cumulative one-year gap position of $51.6 million, indicating that while $314.9 million in assets were repricing, only $263.3 million in liabilities would reprice in the same time frame. 11 32 The following table reflects the Company's interest rate gap position at December 31, 1997 based upon repricing dates rather than maturity dates. This table represents a static point in time and does not consider other variables such as changing relationships or interest rate levels. --------------------------------------------------------------------------- Expected Maturity Date --------------------------------------------------------------------------- 1998 1999 2000 2001 2002 ----------- ---------- ---------- ---------- --------- (Dollars in Thousands) Interest-Earning Assets: Loans, net of allowance for loan losses ....................... $277,046 $ 62,403 $46,552 $31,902 $ 11,746 Average interest rate ............. 9.71% 9.72% 9.63% 9.38% 9.41% Investment securities ................. $ 32,397 $ 3,629 $ 1,748 $ 1,883 $ 954 Average interest rate ............. 5.75% 5.71% 4.52% 6.02% 4.70% Federal funds sold .................... $ 5,500 -- -- -- -- Average interest rate ............. 5.25% -- -- -- -- -------- -------- ------- ------- -------- Total interest-earning assets ........................ $314,943 $ 66,032 $48,300 $33,785 $ 12,700 -------- -------- ------- ------- -------- Interest-Bearing Liabilities: Savings and time deposits ............. $218,721 $ 54,638 $19,370 $ 5,006 $ 6,778 Average interest rate ............. 5.32% 5.24% 4.37% 2.83% 3.85% Money market and transaction accounts .............. $ 31,785 $ 18,509 $18,509 $13,301 $ 13,301 Average interest rate ............. 2.05% 2.02% 2.02% 1.87% 1.87% Debt and other borrowed money(2)........................... $ 11,456 $ 400 $ 400 $ 400 $ 500 Average interest rate ............. 6.11% 5.50% 5.50% 5.50% 6.03% Securities sold under agreement to repurchase ........... $ 1,414 -- -- -- -- Average interest rate ............. 4.33% -- -- -- -- -------- -------- ------- ------- -------- Total interest-bearing liabilities ........................ $263,376 $ 73,547 $38,279 $18,707 $ 20,579 -------- -------- ------- ------- -------- Interest sensitivity gap .................. $ 51,567 $(7,515) $10,021 $15,078 $(7,879) ======== ======== ======= ======= ======== Cumulative interest sensitive gap ...................... $ 51,567 $ 44,052 $54,073 $69,151 $ 61,272 ======== ======== ======= ======= ======== Interest sensitive gap to total assets ........................ 9.65% (1.41)% 1.88% 2.82% (1.48)% ======== ======== ======= ======= ======== Cumulative interest sensitive gap to total assets ........ 9.65% 8.25% 10.12% 12.95% 11.47% ======== ======== ======= ======= ======== ------------------------------------- Expected Maturity Date ------------------------------------- Thereafter Total Fair Value ---------- --------- ----------- (Dollars in Thousands) Interest-Earning Assets: Loans, net of allowance for loan losses ....................... $17,674 $447,323 $438,824 Average interest rate ............. 9.16% 9.65% Investment securities ................. $ 868 $ 41,479 $ 42,294 Average interest rate ............. 4.92% 5.67% Federal funds sold .................... -- $ 5,500 $ 5,500 Average interest rate ............. -- 5.25% ------- -------- -------- Total interest-earning assets ........................ $18,542 $494,302 $486,618 ------- -------- -------- Interest-Bearing Liabilities: Savings and time deposits ............. $ 9,342 $313,855 $310,940 Average interest rate ............. 2.59% 5.09% Money market and transaction accounts .............. $16,760 $112,165 $ 99,632 Average interest rate ............. 1.57% 1.92% Debt and other borrowed money(2) .............................. $ 2,331 $ 15,487 $ 15,348 Average interest rate ............. 8.13% 6.36% Securities sold under agreement to repurchase ........... -- $ 1,414 $ 1,414 Average interest rate ............. -- 4.33% ------- -------- -------- Total interest-bearing liabilities ........................ $28,433 $442,921 $427,344 ------- -------- -------- Interest sensitivity gap .................. ($9,891) $ 51,381 $ 59,274 ======== ======== ======== Cumulative interest sensitive gap ...................... $51,381 $ 51,381 $ 59,274 ======= ======== ======== Interest sensitive gap to total assets ........................ (1.85)% 9.62% 11.10% ======= ======== ======== Cumulative interest sensitive gap to total assets ........ 9.62% 9.62% 11.10% ======= ======== ======== (1) The Company has presented substantial balances of deposits as non-rate sensitive and/or not repricing within one year. (2) For further information regarding fair value of debt instruments, see Note 18 of Notes to Consolidated Financial Statements. Aounts also include a note payable to a related party. See Note 5 of Notes to Consolidated Financial Statements. The above table reflects a positive cumulative gap position in all maturity classifications. This is the result of core deposits being used to fund shorter term interest earning assets, such as loans and investment securities. A positive cumulative gap position implies that interest earning assets (loans and investments) will reprice at a faster 12 33 rate than interest-bearing liabilities (deposits). In a rising rate environment, this position will generally have a positive effect on earnings, while in a falling rate environment this position will generally have a negative effect on earnings. Other factors, however, including the speed at which assets and liabilities reprice in response to changes in market rates and the interplay of competitive factors, can also influence the overall impact on net income of changes in interest rates. Management believes that a rapid, significant and prolonged increase or decrease in rates could have a substantial adverse impact on the Company's net interest margin. INFLATION The effect of inflation on financial institutions differs from its impact on other types of businesses. Since assets and liabilities of banks are primarily monetary in nature, they are more affected by changes in interest rates than by the rate of inflation. Inflation generates increased credit demand and fluctuation in interest rates. Although credit demand and interest rates are not directly tied to inflation, each can significantly impact net interest income. As in any business or industry, expenses such as salaries, equipment, occupancy, and other operating expenses also are subject to the upward pressures created by inflation. Since the rate of inflation has been stable during the last several years, the impact of inflation on the earnings of the Company has been insignificant. EFFECT OF NEW ACCOUNTING STANDARDS In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which (i) replaces the presentation of primary earnings per share ("EPS") with a presentation of basic EPS; (ii) requires dual representation of basic and diluted EPS on the face of the consolidated statements of income regardless of whether basic and diluted EPS are the same; and (iii) requires a reconciliation of the numerator and denominator used in computing basic and diluted EPS. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS pursuant to Accounting Principles Board Opinion No. 15. SFAS No. 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. Adoption of this new standard did not have a material impact on the disclosure of earnings per share in the financial statements of the Company. In June, 1997, the FASB issued SFAS No. 130, "Reporting of Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a complete set of financial statements. This statement also requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods for comparative purposes is required. The Company does not anticipate that adoption of SFAS 130 will have any material effect on the Company's financial condition or the results of its operations. Also in June, 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for reporting by public companies of operating segments in annual financial statements and requires that those enterprises also report selected information about operating segments in interim financial reports issued to shareholders. This statement also establishes standards for related disclosures about products and services, geographic areas, and major customers. This statement requires the reporting of financial and descriptive information about an enterprise's reportable operating segments. This statement is effective for periods beginning after December 15, 1997. In the initial year of application, comparative 13 34 information for earlier years must be restated. The Company is evaluating SFAS No. 131 to determine the impact, if any, on the Company's reporting and disclosure requirements. During February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." The statement revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. The statement is effective for fiscal years beginning after December 15, 1997. Restatement of disclosures for earlier periods for comparative purposes is required. The Company is evaluating SFAS No. 132 to determine the impact on the Company's reporting and disclosure requirements. YEAR 2000 PROBLEM The Company is aware of the current concerns throughout the business community of reliance upon computer software programs that do not properly recognize the year 2000 in date formats, often referred to as the "Year 2000 Problem." The Year 2000 Problem is the result of software being written using two digits rather than four digits to define the applicable year (i.e., "98" rather than "1998"). A failure by a business to properly identify and correct a Year 2000 Problem in its operations could result in system failures or miscalculations. In turn, this could result in disruptions of operations, including among other things a temporary inability to process transactions, send invoices or otherwise engage in routine business transactions on a day-to-day basis. Operations of the Company depend upon the successful operation on a daily basis of its computer software programs. The Company relies upon software purchased from third party vendors rather than internally generated software. In its analysis of the software, and based upon its ongoing discussions with these vendors, the Company has determined that its key operational software does not yet reflect changes necessary to avoid the Year 2000 Problem. The Company expects to update this software during 1998 but is still assessing the timeframe necessary to update its remaining software. This update is not expected to have any adverse material financial impact on the Company. Banks may also be indirectly affected by the effects of the Year 2000 Problem to the extent their lending customers are unable to make timely loan payments because of their own business problems caused by the Year 2000 Problem. Federal banking regulators have recently taken steps to advise banks of this concern and propose credit evaluation methodology intended to assess the effect on credit risk among existing and potential borrowers. 14 35 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors Greene County Bancshares, Inc. We have audited the accompanying consolidated balance sheets of Greene County Bancshares, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Greene County Bancshares, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ COOPERS & LYBRAND L.L.P. Knoxville, Tennessee January 30, 1998 15 36 GREENE COUNTY BANCSHARES, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996 1997 1996 ASSETS Cash and due from banks $ 20,687,367 $ 21,332,328 Securities available-for-sale (Note 3) 33,851,953 42,924,649 Securities held-to-maturity - approximate market value of $7,637,774 and $9,417,689 in 1997 and 1996, respectively (Note 3) 7,627,126 9,456,437 Federal funds sold 5,500,000 - Loans, net (Notes 4 and 5) 441,389,766 381,272,115 Premises and equipment, net (Note 6) 9,803,199 9,839,369 Accrued interest receivable 4,377,481 4,090,877 Deferred income taxes (Note 12) 2,447,858 1,968,356 Cash surrender value of life insurance contracts 3,904,675 3,750,672 Other assets 4,512,276 3,413,503 ------------ ------------ $534,101,701 $478,048,306 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 16 37 1997 1996 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits (Note 7): Noninterest bearing demand deposits $ 35,708,317 $ 33,892,483 Interest bearing accounts: NOW 81,936,674 81,334,083 Money market transaction 30,228,480 29,348,009 Savings 46,800,738 46,170,980 Certificates of deposit $100,000 and over 61,002,308 46,118,347 Other certificates of deposit 206,052,041 171,857,795 ------------- ------------- Total deposits 461,728,558 408,721,697 ------------- ------------- Securities sold under agreements to repurchase 1,414,000 3,272,000 Accrued interest and other liabilities 5,359,563 4,523,533 Related party notes payable (Note 5) 2,561,418 2,611,418 Long-term debt (Note 8) 12,925,302 13,194,322 ------------- ------------- Total liabilities 483,988,841 432,322,970 ------------- ------------- Commitments and contingencies (Notes 9, 11, 13, 14 and 17) Shareholders' equity (Note 10): Common stock, par value $10, authorized 3,000,000 shares; issued and outstanding 1,354,500 and 1,354,455 shares in 1997 and 1996, respectively 13,545,000 4,514,850 Paid in capital 4,135,460 4,132,909 Retained earnings 32,332,574 37,133,040 Net unrealized (depreciation) appreciation on available-for-sale securities, net of income tax expense (benefit) of $60,469 and $(33,186) in 1997 and 1996, respectively 99,826 (55,463) ------------- ------------- Total shareholders' equity 50,112,860 45,725,336 ------------- ------------- $ 534,101,701 $ 478,048,306 ============= ============= The accompanying notes are an integral part of these consolidated financial statements. 17 38 GREENE COUNTY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1997 1996 1995 Interest income: Loans $ 46,004,376 $ 35,385,103 $ 26,655,033 Securities available-for-sale 2,342,170 3,111,304 3,680,264 Securities held-to-maturity 529,172 510,993 424,712 Federal funds sold 129,080 513,326 627,135 ------------ ------------ ------------ Total interest income 49,004,798 39,520,726 31,387,144 ------------ ------------ ------------ Interest expense: Deposit accounts 17,877,949 15,177,803 13,016,821 Securities sold under agreements to repurchase 236,553 227,613 231,581 Related party notes payable 249,829 160,718 - Long-term debt 779,601 258,386 195,492 ------------ ------------ ------------ Total interest expense 19,143,932 15,824,520 13,443,894 ------------ ------------ ------------ Net interest income 29,860,866 23,696,206 17,943,250 Provision for loan losses 5,953,205 2,973,193 1,423,656 ------------ ------------ ------------ Net interest income after provision for loan losses 23,907,661 20,723,013 16,519,594 ------------ ------------ ------------ Noninterest income: Service charges, commissions and fees 3,168,699 2,593,594 1,861,244 Net realized gains on sales of available-for-sale securities - - 1,373 Net realized gains on calls of available-for-sale securities 1,982 - - Net realized gains on calls of held-to-maturity securities - - 4,000 Gain on sale of branch 191,261 - - Other income 559,174 817,186 731,658 ------------ ------------ ------------ Total noninterest income 3,921,116 3,410,780 2,598,275 ------------ ------------ ------------ Noninterest expense: Salaries and benefits 9,525,202 7,893,635 5,826,564 Occupancy expenses 1,219,125 1,057,418 815,506 Furniture and equipment expense 1,354,745 1,315,721 1,048,160 (Gain) loss on other real estate owned 6,053 (240,252) (97,637) Net realized losses on sales of available-for-sale securities - 3,488 - Federal insurance premiums 54,989 6,187 346,501 Other expenses 4,848,725 4,763,713 3,318,074 ------------ ------------ ------------ Total noninterest expense 17,008,839 14,799,910 11,257,168 ------------ ------------ ------------ Income before income taxes 10,819,938 9,333,883 7,860,701 Income tax expense: State 670,691 515,065 346,843 Federal 3,319,073 2,855,556 2,405,418 ------------ ------------ ------------ Total income tax expense 3,989,764 3,370,621 2,752,261 ------------ ------------ ------------ Net income $ 6,830,174 $ 5,963,262 $ 5,108,440 ============ ============ ============ Per share of common stock: Net income $ 5.04 $ 4.43 $ 3.83 ======== ======== ======== Net income, assuming dilution $ 5.03 $ 4.43 $ 3.82 ======== ======== ======== The accompanying notes are an integral part of these consolidated financial statements. 18 39 GREENE COUNTY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 NET UNREALIZED APPRECIATION (DEPRECIATION) ON COMMON PAID IN RETAINED AVAILABLE-FOR-SALE STOCK CAPITAL EARNINGS SECURITIES TOTAL ----- ------- -------- ---------- ----- December 31, 1994 $ 4,424,440 $ 2,914,724 $ 30,442,388 $ (591,255) $ 37,190,297 Net income - - 5,108,440 - 5,108,440 Change in unrealized appreciation, net of tax - - - 827,715 827,715 Dividends paid ($1.53 per share) - (2,052,192) - (2,052,192) ------------ ------------ ------------ ------------ ------------ December 31, 1995 4,424,440 2,914,724 33,498,636 236,460 41,074,260 Net income - - 5,963,262 - 5,963,262 Change in unrealized appreciation, net of tax - - - (291,923) (291,923) Dividends paid ($1.72 per share) - - (2,328,858) - (2,328,858) Issuance of 27,123 shares 90,410 1,135,381 - - 1,225,791 Tax benefit from exercise of non- incentive stock options - 82,804 - - 82,804 ------------ ------------ ------------ ------------ ------------ December 31, 1996 4,514,850 4,132,909 37,133,040 (55,463) 45,725,336 Net income - - 6,830,174 - 6,830,174 Change in unrealized appreciation, net of tax - - - 155,289 155,289 Dividends paid ($1.92 per share) - - (2,600,640) - (2,600,640) Issuance of 45 shares 150 2,551 - - 2,701 Three-for-one stock split 9,030,000 - (9,030,000) - - ------------ ------------ ------------ ------------ ------------ December 31, 1997 $ 13,545,000 $ 4,135,460 $ 32,332,574 $ 99,826 $ 50,112,860 ============ ============ ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 19 40 GREENE COUNTY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1997 1996 1995 Net cash provided by operating activities: Net income $ 6,830,174 $ 5,963,262 $ 5,108,440 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 5,953,205 2,973,193 1,423,656 Provision for depreciation and amortization 1,146,564 1,096,120 651,997 Amortization of investment security premiums, net of accretion 420,829 515,996 368,321 Net realized gains on calls of securities held-to-maturity - - (4,000) Net realized (gains) losses on available-for-sale securities (1,982) 3,488 (1,373) (Gain) loss on other real estate owned 6,053 (240,252) (97,637) Gain on sale of branch (191,261) - - Increase in cash surrender value of life insurance contracts (154,003) (170,472) (171,987) Deferred income tax benefit (573,157) (677,653) (568,718) Change in accrued income and other assets (1,033,423) 1,238,459 (1,379,867) Change in accrued interest and other liabilities 555,121 (1,047,045) 1,035,754 ------------ ------------ ------------ Net cash provided by operating activities 12,958,120 9,655,096 6,364,586 ------------ ------------ ------------ Cash flows from investing activities: Acquisition of bank, net of acquired cash - 1,022,043 - Purchases of available-for-sale securities (578,184) (14,766,578) (21,848,101) Proceeds from sales of available-for-sale securities - 2,000,000 787,017 Proceeds from maturities of available-for-sale securities 9,510,288 36,488,422 21,991,907 Purchases of securities held-to-maturity - (6,815,907) (2,909,704) Proceeds from maturities of securities held-to-maturity 1,800,000 6,748,835 3,050,011 Net originations of loans (66,708,497) (76,092,935) (53,970,350) Proceeds from sales of other real estate owned 347,370 337,605 148,400 Fixed asset additions (1,048,526) (1,845,545) (1,979,839) Net decrease (increase) in federal funds sold (5,500,000) 23,800,000 (20,250,000) Cash transferred in sale of branch (988,302) - - ------------ ------------ ------------ Net cash used by investing activities (63,165,851) (29,124,060) (74,980,659) ------------ ------------ ------------ (continued) 20 41 GREENE COUNTY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1997 1996 1995 Cash flows from financing activities: Net increase in demand deposits, NOW, money market and savings accounts 5,259,522 11,056,917 11,135,801 Net increase in certificates of deposit 49,078,207 9,708,911 56,652,831 Increase (decrease) in securities sold under agreements to repurchase (1,858,000) (1,512,000) 905,000 Payments on related party notes payable (50,000) (50,000) - Payments on long-term debt (19,769,657) (19,718,151) (239,537) Borrowings of long-term debt 19,500,637 29,500,000 - Proceeds from issuance and sale of common stock 2,701 484,366 851,530 Cash dividends paid (2,600,640) (2,328,858) (2,052,192) ------------ ------------ ------------ Net cash provided by financing activities . 49,562,770 27,078,185 67,253,433 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents (644,961) 7,609,221) (1,362,640) ------------ ------------ ------------ Cash and cash equivalents at beginning of year 21,332,328 13,723,107 15,085,747 ------------ ------------ ------------ Cash and cash equivalent at end of year $ 20,687,367 $ 21,332,328 $ 13,723,107 ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 21 42 GREENE COUNTY BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The accounting policies of Greene County Bancshares, Inc. (the Corporation) and subsidiaries conform to generally accepted accounting principles and to general practices of the banking industry. The following is a summary of the more significant policies. Certain reclassifications have been made in the 1996 and 1995 consolidated financial statements and accompanying notes to conform with the 1997 presentation. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of Greene County Bancshares, Inc. and its wholly owned subsidiaries, Greene County Bank and Premier Bank of East Tennessee (the Banks). Superior Financial, Inc. and GCB Acceptance, Inc., consumer finance companies, are wholly owned subsidiaries of Greene County Bank. Superior Mortgage, Inc., a mortgage company, is also a wholly owned subsidiary of Greene County Bank. All material intercompany balances and transactions have been eliminated in consolidation. CASH AND DUE FROM BANKS - For purposes of reporting cash flows, cash and due from banks include cash on hand, cash items in the process of collection and amounts due from banks with a maturity of less than three months. The Banks are required to maintain certain daily reserve balances on hand in accordance with Federal Reserve Board requirements. The average reserve balance maintained in accordance with such requirements was approximately $6,331,000 and $5,594,000 for the years ended December 31, 1997 and 1996, respectively. INVESTMENT SECURITIES - Investments in certain debt and equity securities are classified as either Held-to-Maturity (reported at amortized cost), Trading (reported at fair value with unrealized gains and losses included in earnings), or Available-for-Sale (reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity). Premiums and discounts on investment securities are recognized in interest income on a method which approximates the level yield method over the period to maturity. Gains and losses from sales of investment securities are recognized at the time of sale based upon specific identification of the security sold. LOANS - Loans are stated at principal amounts outstanding, reduced by unearned income and an allowance for loan losses. Interest income on installment loans is recognized in a manner that approximates the level yield method when related to the principal amount outstanding. Interest on other loans is calculated using the simple interest method on the principal amount outstanding. 22 43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: The Banks provide an allowance for loan losses and include in operating expenses a provision for loan losses determined by management. Management's periodic evaluation of the adequacy of the allowance is based on the Banks' past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers' experience, estimated value of any underlying collateral, and current economic conditions. Management believes it has established the allowance in accordance with generally accepted accounting principles and has taken into account the views of its regulators and the current economic environment. The Corporation uses several factors in determining if a loan is impaired under Statement of Financial Accounting Standards (SFAS) No. 114. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payment status, borrowers' financial data and borrowers' operating factors such as cash flows, operating income or loss, etc. A loan is considered impaired, based on current information and events, if it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. At December 31, 1997 and 1996, the recorded investment in loans for which impairment has been recognized was approximately $5,339,000 and $5,996,000, respectively, and these loans had a corresponding valuation allowance of $800,786 and $891,700, respectively. The impaired loans at December 31, 1997 and 1996, were measured for impairment using the fair value of the collateral as all of these loans were collateral dependent. For the years ended December 31, 1997 and 1996, the average recorded investment in impaired loans was approximately $6,964,000 and $4,353,000, respectively. Increases and decreases in the allowance from loan losses due to changes in the measurement of the impaired loans are included in the provision for credit losses. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable. When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance. Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or is partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. 23 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms of interest and principal. While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding, except in the case of loans with scheduled amortizations where the payment is generally applied to the oldest payment due. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. PREMISES AND EQUIPMENT - Premises and equipment are stated at cost less accumulated depreciation and amortization computed principally on the straight-line method based on the estimated useful lives of the respective assets. Leasehold improvements are stated at cost adjusted for accumulated amortization computed on a straight-line method over the shorter of the estimated useful life of the assets or the term of the lease. OTHER REAL ESTATE OWNED - Other real estate owned represents real estate acquired through foreclosure or repossession and is initially recorded at the lower of cost (principal balance and any accrued interest of the former loan plus costs of obtaining title and possession) or fair value minus estimated costs to sell. Initial writedowns are charged against the allowance for loan losses. Initial costs relating to the development and improvement of the property are capitalized and considered in determining the fair value of the property, whereas those costs relating to holding the property are expensed. Valuations are periodically performed by management and if the carrying value of a property exceeds its net realizable value, the property is written down by a charge against income. OTHER ASSETS - Included in other assets are core deposit intangibles and goodwill which arose from the acquisition of Premier Bancshares in 1996. Management periodically evaluates the net realizability of the carrying amount of such assets. These assets will be amortized on a straight-line basis over their estimated useful lives of ten years. INCOME TAXES - The Corporation files a consolidated federal income tax return. There are two components of the income tax provision; current and deferred. Current income tax provisions approximate taxes to be paid or refunded for the applicable period. Balance sheet amounts of deferred taxes are recognized on the temporary differences between the bases of assets and liabilities as measured by tax laws and their bases as reported in the financial statements. Deferred tax expense or benefit is then recognized for the change in deferred tax liabilities or assets between periods. 24 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: Recognition of deferred tax assets is based on management's belief that it is more likely than not that the tax benefit associated with certain temporary differences and tax credits will be realized in that sufficient taxes have been paid in prior years to provide for such realization. RETIREMENT BENEFITS - The Corporation has established two defined contribution plans, the cost of which is charged to current operations. Additionally, the Corporation has established certain supplemental deferred compensation plans which are funded through insurance policies as described in Note 11. STOCK-BASED COMPENSATION - On January 1, 1996, the Corporation adopted Statement of Accounting Standards No. 123, Accounting for Stock Based Compensation (SFAS 123). As permitted by SFAS 123, the Corporation has chosen to apply APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations in accounting for its Plans. The pro forma disclosures of the impact of SFAS 123 is described in Note 10 of the financial statements. NET INCOME PER SHARE OF COMMON STOCK - On December 31, 1997, the Corporation adopted Statement of Financial Accounting Standards No. 128, Earnings Per Share, which changes the calculations used for earnings per share (EPS) and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. The adoption of this Statement had no effect on basic EPS for the year ended December 31, 1996, and resulted in a $0.01 increase in basic EPS for the year ended December 31, 1995. The Statement had no effect on the diluted EPS. STOCK SPLIT - On September 5, 1997, the Corporation announced a 3-for-1 stock split effected in the form of a 200% stock dividend, payable on October 3, 1997, to shareholders of record as of September 19, 1997. All references to the outstanding number of shares and earnings/dividends per share have been restated to reflect the split. SIGNIFICANT ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. One significant estimate of the Corporation is the allowance for loan losses. Actual results could differ from this estimate. 25 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. ACQUISITION: On January 1, 1996, the Corporation acquired 100% of the stock of Premier Bancshares, Inc. (Premier), a one-bank holding company for Premier Bank of East Tennessee, Niota, Tennessee (Premier Bank). As of the acquisition date, Premier had assets of approximately $24.2 million, deposits of approximately $22.0 million, debt and other liabilities of approximately $.5 million, and capital of approximately $1.7 million. The purchase price of Premier was $3,140,000, consisting of cash of $708,582 and the Corporation's promissory notes to the sellers in the aggregate principal amount of $2,431,418, plus $230,000 for noncompete agreements with the sellers. The transaction was accounted for as a purchase, resulting in the recording of a core deposit intangible of approximately $1.1 million, goodwill of approximately $1.3 million, and an increase to deferred tax and other liabilities of approximately $.4 million. Amortization of the intangibles was approximately $216,000 in 1997 and 1996, respectively. Prior to March 31, 1996, the Corporation merged Premier into the Corporation since Premier had no assets other than the stock of Premier Bank. This transaction resulted in the Corporation owning 100% of the stock of Premier Bank. 3. SECURITIES: At December 31, 1997 and 1996, securities have been classified in the consolidated financial statements according to management's intent. The carrying amount of securities and their approximate market values at December 31, 1997 and 1996, were as follows: 1997 ---- GROSS GROSS GROSS APPROXIMATE AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ---- ----- ------ ----- Available-for-sale: U.S. treasury securities and obligations of U.S. government corporations and agencies $30,132,241 $ 317,549 $ 165,945 $30,283,845 Obligations of state and political subdivisions 1,144,316 9,541 849 1,153,008 Federal Home Loan Bank stock 2,415,100 - - 2,415,100 ----------- ----------- ----------- ----------- $33,691,657 $ 327,090 $ 166,794 $33,851,953 =========== =========== =========== =========== Held-to-maturity: Obligations of state and political subdivisions $ 7,627,126 $ 43,507 $ 32,859 $ 7,637,774 =========== =========== =========== =========== 26 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 3. SECURITIES, CONTINUED: GROSS GROSS GROSS APPROXIMATE AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ---- ----- ------ ----- 1996 - ---- Available-for-sale: U.S. treasury securities and obligations of U.S. government corporations and agencies $39,409,885 $ 411,145 $ 484,074 $39,336,956 Obligations of state and political subdivisions 1,344,513 - 15,720 1,328,793 Federal Home Loan Bank stock 2,258,900 - - 2,258,900 ----------- ----------- ----------- ----------- $43,013,298 $ 411,145 $ 499,794 $42,924,649 =========== =========== =========== =========== Held-to-maturity: Obligations of state and political subdivisions $ 9,456,437 $ 44,046 $ 82,794 $ 9,417,689 =========== =========== =========== =========== Interest income from securities for the years ended December 31, 1997, 1996 and 1995, consist of: 1997 1996 1995 U.S. treasury securities $ 165,720 $ 421,236 $1,084,503 Obligations of other U.S. government corporations and agencies 2,105,423 2,622,980 2,590,906 Obligations of states and political subdivisions 387,097 479,174 370,034 Other securities 213,102 98,907 59,533 ---------- ---------- ---------- $2,871,342 $3,622,297 $4,104,976 ========== ========== ========== Gross realized gains and losses on all sales of securities for the years ended December 31, 1997, 1996 and 1995, are as follows: 1997 1996 1995 Gross realized gains: Available-for-sale $1,982 $ - $1,373 ====== ====== ====== Gross realized losses: Available-for-sale $ - $3,488 $ - ====== ====== ====== 27 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 3. SECURITIES, CONTINUED: Debt securities at December 31, 1997, will mature on the following schedule: AVAILABLE-FOR-SALE HELD-TO-MATURITY ------------------ ---------------- APPROXIMATE APPROXIMATE BOOK MARKET BOOK MARKET VALUE VALUE VALUE VALUE ----- ----- ----- ----- Due in one year or less $ 5,535,647 $ 5,537,057 $ 3,950,002 $ 3,959,490 Due after one year through five years 6,304,469 6,359,844 3,277,124 3,310,974 Due after five years through ten years 6,718,422 6,740,203 - - Due after ten years 15,133,119 15,214,849 400,000 367,310 ----------- ----------- ----------- ----------- $33,691,657 $33,851,953 $ 7,627,126 $ 7,637,774 =========== =========== =========== =========== Investment securities with book and market values of $4,918,255 and $4,953,389 at December 31, 1997, respectively and $31,076,496 and $31,112,304 at December 31, 1996, respectively, were pledged to secure public and trust deposits and for other purposes as required or permitted by law. 4. LOANS: Major classifications of loans at December 31, 1997 and 1996, are summarized as follows: 1997 1996 Commercial $ 108,985,440 $ 97,339,711 Commercial real estate 125,357,908 108,935,984 Mortgage installment 146,226,882 108,877,733 Installment consumer 72,751,994 71,354,067 Other loans 3,154,342 5,797,753 ------------- ------------- 456,476,566 392,305,248 Less: Unearned income (5,932,977) (3,702,457) Allowance for loan losses (9,153,823) (7,330,676) ------------- ------------- $ 441,389,766 $ 381,272,115 ============= ============= 28 49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 4. LOANS, CONTINUED: At December 31, 1997 and 1996, loans on which the accrual of interest had been discontinued totaled $2,264,634 and $616,000, respectively. Unrecorded interest income on these loans aggregated approximately $112,300, $169,100 and $116,300 for 1997, 1996 and 1995, respectively. A summary of activity in the allowance for loan losses for the years ended December 31, 1997, 1996 and 1995, was as follows: 1997 1996 1995 Balance at beginning of year $ 7,330,676 $ 4,654,234 $ 3,446,762 Balances acquired in acquisition of Premier Bank - 440,000 - Provision for loan losses 5,953,205 2,973,193 1,423,656 Recoveries 1,012,092 888,249 455,778 ------------ ------------ ------------ 14,295,973 8,955,676 5,326,196 Loans charged to allowance (5,142,150) (1,625,000) (671,962) ------------ ------------ ------------ Balance at end of year $ 9,153,823 $ 7,330,676 $ 4,654,234 ============ ============ ============ 5. RELATED PARTY TRANSACTIONS: Certain officers, employees and directors and/or companies in which they have ten percent or more beneficial ownership were indebted to the Banks as indicated below. In the opinion of management, all such loans were made in the ordinary course of business on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated borrowers and did not involve more than the normal risk of collectibility. Balance, December 31, 1995 $ 12,936,017 Additions 5,346,426 Reductions (6,894,192) ------------ Balance, December 31, 1996 11,388,251 Additions 2,711,499 Reductions (3,849,713) ------------ Balance, December 31, 1997 $ 10,250,037 ============ 29 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 5. RELATED PARTY TRANSACTIONS, CONTINUED: In addition to the above, the Banks provide financing for purchasers of automotive and other transportation equipment from dealerships in which directors have more than a ten percent beneficial interest. Loans originated through these dealerships aggregated $1,583,653 during 1997 and $1,837,032 for 1996. Such financing is represented by installment notes that are the obligations of the purchasers and are primarily collateralized by the equipment. Some of these notes, totaling $8,868 and $30,126 at December 31, 1997 and 1996, respectively, are secondarily collateralized by dealer finance reserves and also provide for recourse against the dealerships to further protect the Banks against potential losses. As described in Note 2, the acquisition of Premier Bank generated promissory notes to the sellers and noncompete agreements with the sellers, a related party. These notes can be summarized as follows at December 31, 1997: Noncompete agreement, payable in yearly principal installments through January 2000 $ 130,000 8% note, interest payments due quarterly, principal payments January 15, 2003 through January 8, 2015 231,418 8% note, interest payments due quarterly, principal payments January 15, 2002 through January 8, 2015 2,200,000 --------- $2,561,418 ========== Scheduled principal maturities of notes payable as of December 31, 1997, are: 1998 $ 50,000 1999 40,000 2000 40,000 2001 - 2002 100,000 Thereafter 2,331,418 --------- $2,561,418 ========== 30 51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 6. PREMISES AND EQUIPMENT: Premises and equipment at December 31, 1997 and 1996, was comprised of the following: 1997 1996 Land $ 1,763,220 $ 1,763,220 Banking quarters 6,951,635 6,613,397 Leasehold improvements 1,195,989 1,331,231 Furniture and fixtures 5,356,170 6,029,526 Construction in progress 117,352 54,748 Automobiles 378,996 282,838 ------------ ------------ 15,763,362 16,074,960 Less accumulated depreciation and amortization (5,960,163) (6,235,591) ------------ ------------ $ 9,803,199 $ 9,839,369 ============ ============ 7. DEPOSITS: The components of interest expense on deposits for the years ended December 31, 1997, 1996 and 1995, were: 1997 1996 1995 Interest bearing accounts: NOW $ 1,556,528 $ 1,400,414 $ 1,385,871 Money market transaction 1,132,337 950,906 796,167 Savings 1,241,428 1,185,304 985,319 Certificates of deposit $100,000 and over 3,093,701 2,080,723 1,723,218 Other certificates of deposit 10,853,955 9,560,456 8,126,246 ----------- ----------- ----------- $17,877,949 $15,177,803 $13,016,821 =========== =========== =========== 8. LONG-TERM DEBT: The Banks have entered into long-term debt arrangements with the Federal Home Loan Bank of Cincinnati (FHLB) to provide funding for the origination of fixed rate mortgages. This debt is collateralized by the Banks' blanket pledge of mortgage loans aggregating approximately $59,438,000 and stock of the Federal Home Loan Bank. 31 52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 8. LONG-TERM DEBT, CONTINUED: Long-term debt at December 31, 1997 and 1996, was summarized as follows: 1997 1996 5.82% note, interest payments due monthly, principal due February 15, 1998 $ 4,000,000 $ 4,000,000 5.88% note, interest payments due monthly, principal due May 20, 1998 4,000,000 4,000,000 5.81% note, interest payments due monthly, principal due December 2, 1998 2,000,000 2,000,000 5.65% note, payable in monthly installments of $21,854 through July 1, 2003 1,253,257 1,438,966 6.35% note, payable in monthly installments of $7,368 through September 1, 2013 878,824 910,337 6.10% note, payable in monthly installments of $8,493 through July 1, 2008 793,221 845,019 ----------- ----------- $12,925,302 $13,194,322 =========== =========== Scheduled principal maturities of long-term debt outstanding as of December 31, 1997, are: 1998 $10,309,612 1999 303,605 2000 321,755 2001 340,993 2002 361,383 Thereafter 1,287,954 ----------- $12,925,302 =========== At December 31, 1997, the Corporation maintained three unused federal fund lines of credit totaling $20,000,000 with interest at the federal funds buy rate at three correspondent banks. The Corporation also maintains an unused line of credit of $20,000,000 with the Federal Home Loan Bank of Cincinnati with the option of selecting a variable rate of interest for up to 90 days. The line of credit will expire on September 5, 1998. The Bank also maintains a $25,000,000 letter of credit with the FHLB, which is used to pledge the Corporation's public deposits with the state collateral pool, at a quoted one-year variable interest rate which will expire December 16, 1998. 32 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 9. LEASES: The Corporation leases certain banking facilities and equipment under long-term operating lease agreements, which generally contain renewal options for periods ranging from 5 to 30 years, and require the payment of certain additional costs (generally maintenance and insurance). Future minimum lease payments for these noncancelable operating leases, with a term in excess of one year, at December 31, 1997, for each of the years in the five year period ending December 31, 2001, and thereafter were as follows: 1998 $234,577 1999 169,074 2000 61,491 2001 15,138 -------- $480,280 ======== The total rental expense for operating leases was $164,506, $305,618 and $164,977 for the years ended December 31, 1997, 1996 and 1995, respectively. 10. STOCK OPTIONS: On January 6, 1989, the Corporation established a stock option plan, whereby a certain key executive was granted options to purchase 300 shares per year of the Corporation's stock at one and one-half times book value at each year end. The number of options granted per year was increased to 600 as a result of a 1991 stock split, and 1,800 as a result of a 1997 stock split. The options are fully vested, expire ten years from the date of grant and are cancelled if the key executive voluntarily resigns his employment or is terminated for cause. Compensation expense recognized was $82,800, $30,000 and $24,000 for the years ended December 31, 1997, 1996 and 1995, respectively. During 1993, the Corporation granted certain other key executives stock option awards to purchase shares of the Corporation's stock. Shares under this plan are to be awarded at market price at the date of grant. In 1997, 1996 and 1995, the Corporation granted additional stock options to certain key executives to purchase 5,540, 4,980 and 3,900 shares at $100, $71.67 and $60 per share, respectively. If a key executive is a ten percent or greater stockholder at the time of exercise, the option price is increased by ten percent. The options granted in 1993 and 1994 are nonincentive stock options and are fully vested. The options granted in 1995 and subsequent years are incentive stock options and vest at the rate of twenty percent per year and expire ten years from the date of grant. 33 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 10. STOCK OPTIONS, CONTINUED: A summary of the status of the Corporation's Plans as of December 31, 1997 and 1996, and changes during the years ended on those dates is presented below: 1997 - ---- KEY EXECUTIVE OTHER KEY EXECUTIVES ------------- -------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE ------- -------------- ------- -------------- Outstanding at beginning of year 1,800 $50.64 13,803 $ 60.99 Granted 1,800 55.50 5,540 100.00 Exercised - - (45) 60.00 ----- ------ ------ ------- Outstanding at end of year 3,600 $53.07 19,298 $ 72.19 ===== ====== ====== ======= Options exercisable at year end 3,600 $53.07 7,434 $ 55.63 ===== ====== ====== ======= Fair value of each option granted during the year $46.99 $19.20 ====== ====== 1996 - ---- Outstanding at beginning of year 11,244 $38.27 9,900 $ 54.44 Granted 1,800 50.64 4,980 71.67 Exercised (11,244) 38.27 (1,077) 50.19 ------- ------ ------ ------- Outstanding at end of year 1,800 $50.64 13,803 $ 60.99 ======= ====== ====== ======= Options exercisable at year end 1,800 $50.64 5,703 $ 52.21 ======= ====== ====== ======= Fair value of each option granted during the year $26.72 $13.97 ====== ====== 1997 - ---- WEIGHTED AVERAGE OPTIONS EXERCISE PRICE ------- -------------- Outstanding at beginning of year 15,603 $59.80 Granted 7,340 89.09 Exercised (45) 60.00 ------ ------ Outstanding at end of year 22,898 $69.19 ====== ====== Options exercisable at year end 11,034 $54.79 ====== ====== Fair value of each option granted during the year 1996 - ---- Outstanding at beginning of year 21,144 $45.84 Granted 6,780 66.07 Exercised (12,321) 39.31 ------- ------ Outstanding at end of year 15,603 $59.80 ======= ====== Options exercisable at year end 7,503 $51.83 ======= ====== Fair value of each option granted during the year The following table summarizes information about the Plans' stock options at December 31, 1997: OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------- ----------------------------------------- NUMBER NUMBER WEIGHTED RANGE OF OUTSTANDING WEIGHTED-AVERAGE REMAINING EXERCISABLE AVERAGE EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE AT 12/31/97 EXERCISE PRICE --------------- ----------- ---------------- ----------- -------------- $50.64 - $55.50 3,600 9.5 years 3,600 $53.07 $48.33 - $100.00 19,298 8.5 years 7,434 $55.63 34 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 10. STOCK OPTIONS, CONTINUED: Had compensation cost for the Corporation's Plans been determined based on the fair value at the grant dates for awards under the Plans consistent with the method of SFAS 123, the Corporation's net income and net income per share would have been reduced to the pro forma amounts indicated below: 1997 1996 ------------------------------------------------------------------------ As reported Proforma As Reported Proforma ----------- -------- ----------- -------- Net income $6,830,174 $6,775,830 $5,963,262 $5,924,579 Net income per share $5.04 $5.00 $4.43 $4.40 Net income per share, assuming dilution $5.03 $4.99 $4.43 $4.40 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1997 and 1996, respectively: dividend growth rate of 12% and 12%; expected volatility of 10.38% and 7.75%: risk-free interest rates of 5.5% and 6.6%; and expected lives of 7 years and 7 years. 11. PROFIT SHARING AND DEFERRED COMPENSATION: The Corporation has a contributory profit-sharing plan covering certain employees with one year or more of service. Participating employees have the option to contribute from three to seven percent of their monthly salary to the Plan. The Corporation has made no contributions to this plan for the years ended December 31, 1997, 1996 and 1995. The Corporation also has a contributory money purchase plan covering certain employees with one year or more of service. While the employees do not contribute to the plan, the Corporation makes contributions in an amount equal to 10% of each eligible participant's compensation actually paid or received. Additional amounts up to 15% may be contributed at the option of the Board of Directors. The contributions by the Corporation for the money purchase plan were $571,569, $505,031, $427,666 for 1997, 1996 and 1995, respectively. The Banks have established supplemental benefit plans for selected officers and directors. These plans are nonqualified and therefore, in general, a participant's or beneficiary's claim to benefits is as a general creditor. Certain current and retired key officers participate in a deferred compensation plan which provides for a defined benefit upon retirement. Payment of benefits under such plans is contingent upon employment to retirement, obtaining retirement age in the event of disability, or upon death. The cost of such plans is being charged to operations over the period of active employment from the contract date. In 1993, a plan was established whereby directors of the Corporation and the Banks have the right to participate in a deferred compensation plan which permits the directors to defer director compensation and earn a guaranteed interest rate on such deferred amounts. Compensation costs associated with the plan are charged to operations. 35 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 11. PROFIT SHARING AND DEFERRED COMPENSATION, CONTINUED: Included in accrued interest and other liabilities in the consolidated financial statements is $938,323 and $817,623 at December 31, 1997 and 1996, respectively, related to the above supplemental benefit plans. To fund these plans, the Corporation purchased single premium universal life insurance contracts on the lives of the related directors and officers. The cash surrender value of such contracts is included in the consolidated balance sheets. If all of the assumptions regarding mortality, interest rates, policy dividends, and other factors are realized, the Corporation will ultimately realize its full investment in such contracts. 12. INCOME TAXES: The components of income tax expense for the years ended December 31, 1997, 1996 and 1995, were: 1997 1996 1995 Current income taxes Federal $ 3,831,898 $ 3,461,877 $ 2,914,271 State 731,023 586,397 406,708 ----------- ----------- ----------- 4,562,921 4,048,274 3,320,979 Deferred income tax benefit (573,157) (677,653) (568,718) ----------- ----------- ----------- $ 3,989,764 $ 3,370,621 $ 2,752,261 =========== =========== =========== A reconciliation of expected federal tax expense based on the federal statutory rate of 34 percent to consolidated tax expense for the years ended December 31, 1997, 1996 and 1995, was as follows: 1997 1996 1995 Tax at statutory rates $ 3,678,779 $ 3,173,520 $ 2,672,638 Tax increases (decreases) attributable to: Tax exempt interest (131,613) (180,099) (122,480) State income tax less federal tax benefit 482,475 387,022 268,427 Interest expense disallowed 38,813 20,040 23,860 Dividends (27,797) (11,551) - Option compensation 28,152 10,200 9,120 Goodwill amortization 36,031 35,785 - Cash surrender value earnings (66,718) (58,557) (48,059) Other (48,358) (5,739) (51,245) ----------- ----------- ----------- $ 3,989,764 $ 3,370,621 $ 2,752,261 =========== =========== =========== 36 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 12. INCOME TAXES, CONTINUED: The significant components of the Corporation's deferred tax assets and liabilities at December 31, 1997 and 1996, were as follows: 1997 1996 Deferred tax assets: Allowance for loan losses and other real estate owned $3,162,045 $2,358,372 Unrealized depreciation on available-for-sale securities - 33,186 Deferred compensation 355,992 310,257 Accruals and other - 100,129 ---------- ---------- Gross deferred tax assets 3,518,037 2,801,944 ---------- ---------- Deferred tax liabilities: Depreciation 533,785 385,060 Unrealized appreciation on available-for-sale securities 60,469 - Core deposit intangible 334,481 376,290 FHLB stock 141,444 72,238 ---------- ---------- Gross deferred tax liabilities 1,070,179 833,588 ---------- ---------- Net deferred tax asset $2,447,858 $1,968,356 ========== ========== 13. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK: The Banks are party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of their customers and to reduce their own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in consolidated balance sheets. The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Banks use the same credit policies in making these commitments and conditional obligations as they do for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no 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 commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Banks upon extension of credit is based on management's credit evaluation of the borrower. Collateral held varies but may include marketable securities, trade accounts receivable, property, plant, and equipment and/or income-producing commercial properties. 37 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 13. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK, CONTINUED: Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Most of the Banks' business activities are with customers located within the state of Tennessee for residential, consumer and commercial loans. A majority of the loans are secured by residential or commercial real estate or other personal property. The loans are expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrowers. Outstanding standby letters of credit as of December 31, 1997 and 1996 amounted to $1,931,888 and $2,269,878, respectively. Outstanding commitments to lend at fixed rates were $1,608,807 and $3,755,700 and at variable rates were $3,423,217 and $8,429,531 at December 31, 1997 and 1996, respectively. Undisbursed advances on customer lines of credit were $61,141,551 and $52,021,000 at December 31, 1997 and 1996, respectively. The amount available for borrowing under inventory collateralized loans was $3,970,495 at December 31, 1997 and $5,941,000 at December 31, 1996. The Banks do not anticipate any losses as a result of these transactions that would be unusual in relation to its historical levels of loan losses on its recorded loan portfolio. 14. CAPITAL REQUIREMENTS AND DIVIDEND RESTRICTIONS: The Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involves quantitative measures of the Banks' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997 and 1996, respectively, that the Banks meet all capital adequacy requirements to which they are subject. 38 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 14. CAPITAL REQUIREMENTS AND DIVIDEND RESTRICTIONS, CONTINUED: The Banks are well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Banks must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Banks' category. ACTUAL ----------------- AMOUNT RATIO ------ ----- As of December 31, 1996: Total Capital (to Risk Weighted Assets): Consolidated $47,860,000 12.69% Greene County Bank 46,247,000 13.01% Premier Bank 2,625,000 11.94% Tier I Capital (to Risk Weighted Assets): Consolidated 43,112,000 11.43% Greene County Bank 41,772,000 11.75% Premier Bank 2,349,000 10.69% Tier I Capital (to Average Assets): Consolidated 43,112,000 9.16% Greene County Bank 41,772,000 9.60% Premier Bank 2,349,000 7.32% As of December 31, 1997: Total Capital (to Risk Weighted Assets): Consolidated $53,035,000 12.33% Greene County Bank 51,457,000 12.87% Premier Bank 3,217,000 11.14% Tier I Capital (to Risk Weighted Assets): Consolidated 47,612,000 11.07% Greene County Bank 46,415,000 11.61% Premier Bank 2,854,000 9.88% Tier I Capital (to Average Assets): Consolidated 47,612,000 9.30% Greene County Bank 46,415,000 9.80% Premier Bank 2,854,000 7.67% REGULATORY REQUIREMENTS FOR CAPITAL ADEQUACY PURPOSES ----------------------------- AMOUNT RATIO ------ ----- As of December 31, 1996: Total Capital (to Risk Weighted Assets): Consolidated $30,178,000 greater than or equal to 8% Greene County Bank 28,441,120 greater than or equal to 8% Premier Bank 1,758,640 greater than or equal to 8% Tier I Capital (to Risk Weighted Assets): Consolidated 15,088,760 greater than or equal to 4% Greene County Bank 14,220,560 greater than or equal to 4% Premier Bank 879,320 greater than or equal to 4% Tier I Capital (to Average Assets): Consolidated 18,821,120 greater than or equal to 4% Greene County Bank 17,413,200 greater than or equal to 4% Premier Bank 1,283,640 greater than or equal to 4% As of December 31, 1997: Total Capital (to Risk Weighted Assets): Consolidated $34,408,000 greater than or equal to 8% Greene County Bank 31,981,840 greater than or equal to 8% Premier Bank 2,310,320 greater than or equal to 8% Tier I Capital (to Risk Weighted Assets): Consolidated 17,204,000 greater than or equal to 4% Greene County Bank 15,990,920 greater than or equal to 4% Premier Bank 1,155,160 greater than or equal to 4% Tier I Capital (to Average Assets): Consolidated 20,481,840 greater than or equal to 4% Greene County Bank 18,939,440 greater than or equal to 4% Premier Bank 1,487,560 greater than or equal to 4% TO BE WELL CAPITALIZED UNDER PROMPT CORRECTIVE ACTION PROVISIONS -------------------------------- AMOUNT RATIO ------ ----- As of December 31, 1996: Total Capital (to Risk Weighted Assets): Consolidated $37,721,900 greater than or equal to 10% Greene County Bank 35,551,400 greater than or equal to 10% Premier Bank 2,198,300 greater than or equal to 10% Tier I Capital (to Risk Weighted Assets): Consolidated 22,633,140 greater than or equal to 6% Greene County Bank 21,330,840 greater than or equal to 6% Premier Bank 1,318,980 greater than or equal to 6% Tier I Capital (to Average Assets): Consolidated 23,526,400 greater than or equal to 5% Greene County Bank 21,766,500 greater than or equal to 5% Premier Bank 1,604,550 greater than or equal to 5% As of December 31, 1997: Total Capital (to Risk Weighted Assets): Consolidated $43,010,000 greater than or equal to 10% Greene County Bank 39,977,300 greater than or equal to 10% Premier Bank 2,887,900 greater than or equal to 10% Tier I Capital (to Risk Weighted Assets): Consolidated 25,806,000 greater than or equal to 6% Greene County Bank 23,986,380 greater than or equal to 6% Premier Bank 1,732,740 greater than or equal to 6% Tier I Capital (to Average Assets): Consolidated 25,602,300 greater than or equal to 5% Greene County Bank 23,674,300 greater than or equal to 5% Premier Bank 1,859,450 greater than or equal to 5% 39 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 14. CAPITAL REQUIREMENTS AND DIVIDEND RESTRICTIONS, CONTINUED: The Corporation's principal source of funds is dividends received from the Banks. Under applicable banking laws, the Banks may only pay dividends from retained earnings and only to the extent that the remaining balance of retained earnings is at least equal to the capital stock amounts of the respective Banks. As a practical matter, dividend payments by the Banks to the Corporation would be limited by the necessity to maintain appropriate amounts for capital adequacy purposes. 15. ADDITIONAL CASH FLOW INFORMATION: Income taxes paid during the years ended December 31, 1997, 1996 and 1995 amounted to $4,460,000, $5,273,919 and $3,617,622, respectively. Interest expense paid in cash during the years 1997, 1996 and 1995 amounted to $18,970,895, $15,632,435 and $12,360,091, respectively. Significant noncash transactions for the years ended December 31, 1997, 1996 and 1995, were as follows: 1997 1996 1995 Financed sales of other real estate owned $ 147,128 $ 59,750 $ 159,000 Foreclosed loans transferred to OREO 784,769 380,587 124,767 Assets acquired/generated through bank purchase: Investments - 6,750,643 - Loans, net - 14,638,794 - Property, plant and equipment, net - 567,992 - Other assets - 450,034 - - Intangibles - 2,159,966 - Liabilities assumed/generated through bank purchase: Deposits - 22,005,281 - Accrued interest and other liabilities - 546,483 - Notes payable - 2,431,418 - Noncompete payable - 230,000 - Deferred tax liability - 376,290 40 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 16. PARENT COMPANY FINANCIAL INFORMATION: Condensed financial information for Greene County Bancshares, Inc. (parent company only) was as follows: CONDENSED BALANCE SHEETS DECEMBER 31, ------------------------------ 1997 1996 ASSETS Cash $ 983,385 $ 1,099,373 Investment in subsidiaries 50,043,024 44,756,925 Premises and equipment, net - 695,117 Cash surrender value of life insurance contracts 193,524 184,108 Other assets 1,758,294 1,976,263 ----------- ------------ Total assets $52,978,227 $ 48,711,786 =========== ============ LIABILITIES Deferred income taxes $ 302,980 $ 343,104 Related party notes payable 2,561,418 2,611,418 Other liabilities 969 31,928 ----------- ------------ 2,865,367 2,986,450 ----------- ------------ SHAREHOLDERS' EQUITY Common stock 13,545,000 4,514,850 Paid-in capital 4,135,460 4,132,909 Retained earnings 32,332,574 37,133,040 Net unrealized depreciation on available-for-sale securities, net of income tax expense (benefit) of $60,469 and $(33,186) in 1997 and 1996, respectively 99,826 (55,463) ----------- ------------ Total shareholders' equity 50,112,860 45,725,336 ----------- ------------ Total liabilities and shareholders' equity $52,978,227 $ 48,711,786 =========== ============ 41 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 16. PARENT COMPANY FINANCIAL INFORMATION, CONTINUED: CONDENSED STATEMENTS OF EARNINGS YEARS ENDED DECEMBER 31, ---------------------------------------------- 1997 1996 1995 Revenue: Equity in undistributed earnings of subsidiaries $ 3,902,503 $3,862,086 $2,366,336 Dividends from subsidiaries 3,347,855 3,022,100 2,818,338 Other income 126,212 107,871 53,837 ----------- ---------- ---------- Total revenue 7,376,570 6,992,057 5,238,511 Related party interest expense 247,215 160,718 - Other expense 556,784 524,547 92,586 ----------- ---------- ---------- Income before income taxes 6,572,571 6,306,792 5,145,925 Income tax expense (benefit) (257,603) 343,530 37,485 ----------- ---------- ---------- Net income $ 6,830,174 $5,963,262 $5,108,440 =========== ========== ========== 42 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 16. PARENT COMPANY FINANCIAL INFORMATION, CONTINUED: CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 Cash flows from operating activities: Net income $ 6,830,174 $ 5,963,262 $ 5,108,440 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiaries (3,902,503) (3,862,086) (2,366,336) Depreciation and amortization 215,999 232,855 18,233 Change in other assets (71,344) 537,500 (493,106) Change in other liabilities (30,959) (22,236) (18,597) ----------- ----------- ----------- Net cash provided by operating activities 3,041,367 2,849,295 2,248,634 ----------- ----------- ----------- Cash flows from investing activities: Acquisition of bank - (708,582) - Increase in cash surrender value of life insurance contracts (9,416) (6,128) (9,492) ----------- ----------- ----------- Net cash used by investing activities (9,416) (714,710) (9,492) ----------- ----------- ----------- Cash flows from financing activities: Capital contributed to subsidiary (500,000) - - Proceeds from issuance and sale of common stock 2,701 484,366 - Proceeds from sale of common stock subject to rescission - - 851,530 Repayments of related party debt (50,000) (50,000) - Repayments of debt - (327,239) - Dividends paid (2,600,640) (2,328,858) (2,052,192) ----------- ----------- ----------- Net cash used by financing activities (3,147,939) (2,221,731) (1,200,662) ----------- ----------- ----------- Net increase (decrease) in cash (115,988) (87,146) 1,038,480 Cash at beginning of year 1,099,373 1,186,519 148,039 ----------- ----------- ----------- Cash at end of year $ 983,385 $ 1,099,373 $ 1,186,519 =========== =========== =========== 43 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. COMMITMENTS AND CONTINGENCIES: The Corporation and Banks are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Corporation's consolidated financial position, results of operations, or cash flows. 18. FAIR VALUES OF FINANCIAL INSTRUMENTS: The following information is presented as required by Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments. For financial instruments not described below, generally short term financial instruments, book value approximates fair value. The following methods and assumptions were used to estimate the fair value of each class of financial instruments: SECURITIES AND INTEREST BEARING DEPOSITS - Fair values of securities and interest bearing deposits are based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. FEDERAL FUNDS SOLD - Fair values of federal funds sold are based on quoted market prices. LOANS, NET - The fair value for loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. DEPOSITS - The fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the current rate offered for similar deposits with the same remaining maturities. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - Fair values of securities sold under agreements to repurchase are based on quoted market prices. 44 65 18. FAIR VALUES OF FINANCIAL INSTRUMENTS, CONTINUED: The estimated fair values of the Corporation's financial instruments at December 31, 1997 and 1996, were as follows (rounded to the nearest thousand): 1997 1996 ----------------------------------------------------------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE ----- ----- ----- ----- Financial assets: Securities $ 41,319,000 $ 42,294,000 $ 52,470,000 $ 51,390,000 Federal funds sold 5,500,000 5,500,000 - - Loans, net 441,390,000 438,824,000 381,272,000 378,528,000 Financial liabilities: Deposits $461,729,000 $444,939,000 $408,722,000 $388,942,000 Securities sold under agreements to repurchase 1,414,000 1,414,000 3,272,000 3,272,000 Long-term debt 12,925,000 12,917,000 13,194,000 13,027,000 The Corporation believes that the fair value of commitments to extend credit and standby letters of credit approximate the stated amounts at December 31, 1997 and 1996. 19. NET INCOME PER SHARE OF COMMON STOCK: Net income per share of common stock is computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding during each year. Stock options are regarded as common stock equivalents. Common stock equivalents are computed using the treasury stock method. 45 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 19. NET INCOME PER SHARE OF COMMON STOCK, CONTINUED: The following is a reconciliation of the numerators and denominators used in the basic and diluted earnings per share computations for the years ended December 31, 1997, 1996 and 1995: 1997 1996 1995 ------------------------ --------------------------- ----------------------------- INCOME SHARES INCOME SHARES INCOME SHARES ------ ------ ------ ------ ------ ------ (NUMERATOR) (DENOMINATOR) (NUMERATOR) (DENOMINATOR) (NUMERATOR) (DENOMINATOR) BASIC EPS Income available to common shareholders $6,830,174 1,354,498 $5,963,262 1,344,852 $5,108,440 1,335,678 EFFECT OF DILUTIVE SECURITIES Stock options outstanding - 4,109 - 2,664 - 2,778 ---------- --------- ---------- --------- ---------- --------- DILUTED EPS Income available to common shareholders plus assumed conversions $6,830,174 1,358,607 $5,963,262 1,347,516 $5,108,440 1,338,456 ========== ========= ========== ========= ========== ========= 20. YEAR 2000: The Corporation has conducted an inventory and risk assessment on how its systems applications will be affected by the year 2000. The Corporation's current version of its mission critical applications are not yet year 2000 compliant. The Corporation has been assured that a current market version of this application is year 2000 compliant and plans to install this upgrade by April 1998. However, the Corporation is still assessing the timing of when other less than mission critical applications such as its online teller software and platforming software can be upgraded for the year 2000. The Corporation has developed a project plan with strict project management, due in part to its establishment of a year 2000 committee and the completed inventory and risk assessment, in order to ensure an uninterruptible supply of service to its customers for the year 2000 and beyond. 46 67 MARKET AND DIVIDEND INFORMATION As of March 25, 1998, there were 1,354,572 shares of Common Stock outstanding and approximately 1,519 holders of record. There is no established public trading market in which shares of the Common Stock are regularly traded, nor are there any uniformly quoted prices for shares of the Common Stock. The following table sets forth certain information known to management as to the prices at the end of each quarter for the Common Stock and cash dividends declared per share of Common Stock for the calendar quarters indicated. Sales Price at Dividends Declared Quarter-End Per Share (2) ----------- ------------- 1996: First quarter $ 63.33(1) $ 0.373(1) Second quarter 66.67(1) 0.373(1) Third quarter 66.67(1) 0.374(1) Fourth quarter 71.67(1) 0.600(1) ------- $ 1.720 ======= 1997: First quarter $ 76.67(1) $ 0.416(1) Second quarter 76.67(1) 0.417(1) Third quarter 83.33(1) 0.417(1) Fourth quarter 100.00(1) 0.670(1) ------- $ 1.920 ======= - ------------ (1) The sales price and dividend information has been restated to reflect the effect of the Company's 3-for-1 stock split effected as a stock dividend in October 1997. (2) For information regarding restrictions on the payment of dividends by the Banks to the Company, see "Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources" in this Annual Report. See also Note 14 of Notes to Consolidated Financial Statements. 47