HFB FINANCIAL CORPORATION
1602 CUMBERLAND AVENUE
MIDDLESBORO, KENTUCKY 40965
(606) 248-1095
January 15, 2004
Dear Shareholder:
You are cordially invited to attend the special meeting of shareholders of
HFB Financial Corporation, on February 24, 2004 at 2:00 p.m., local time, at
Pine Mountain State Resort Park, Pineville, Kentucky. At the special meeting,
you will be asked to approve and adopt an Agreement and Plan of Merger. The
merger agreement provides for the merger of HFB Financial with HFB Merger Corp.,
a wholly-owned subsidiary of HFB Financial, with HFB Financial as the surviving
entity in what is commonly referred to as a "going private" transaction. The
proposed merger will reduce the number of shareholders of record to fewer than
300, as required for the termination of the registration of our common stock
under federal securities laws, and thereby eliminate the significant expense
required to comply with the reporting and related requirements of those laws.
Under the terms of the merger agreement, each share of HFB Financial common
stock owned of record at the effective time of the merger:
- by a shareholder of fewer than 250 shares, will be converted into the
right to receive from HFB Financial an amount equal to $22.75 in cash per
share; and
- by a shareholder of 250 or more shares, will remain as outstanding shares
of HFB Financial common stock after the merger.
Because HFB Financial has a large number of shareholders who own fewer than
250 shares each, we expect that the number of shareholders of record will be
reduced from 372 to approximately 212, while the number of outstanding shares
will decrease by approximately 20,589 as a result of the merger.
The board of directors believes that the merger agreement is in the best
interests of HFB Financial and its shareholders and unanimously recommends that
shareholders vote "FOR" the approval of the merger agreement. The approval and
adoption of the merger agreement require the affirmative vote of the holders of
at least a majority of all of the outstanding shares of HFB Financial common
stock. Whether or not you plan to attend the special meeting, you are urged to
sign, date and return your enclosed proxy as soon as possible in the
pre-addressed prepaid envelope supplied for your convenience.
We urge you to review carefully the enclosed proxy statement that describes
the merger agreement in detail. On behalf of the board of directors, thank you
for your cooperation and continued support.
Sincerely,
/s/ David B. Cook
DAVID B. COOK
President and Chief Executive Officer
HFB FINANCIAL CORPORATION
1602 CUMBERLAND AVENUE
MIDDLESBORO, KENTUCKY 40965
(606) 248-1095
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD FEBRUARY 24, 2004
To Our Shareholders:
A Special Meeting of Shareholders of HFB Financial Corporation, a Tennessee
corporation, will be held at Pine Mountain State Resort Park, Pineville,
Kentucky at 2:00 p.m., local time, on Tuesday, February 24, 2004, for the
following purpose:
- to approve the Agreement and Plan of Merger, dated as of October 28,
2003, by and between HFB Financial and HFB Merger Corp., a Tennessee
corporation and wholly-owned subsidiary of HFB Financial ("merger
subsidiary"), pursuant to which merger subsidiary will merge (the
"merger") with and into HFB Financial, with HFB Financial being the
surviving corporation.
We have fixed the close of business on January 14, 2004 as the record date
for determining those shareholders entitled to notice of and to vote at the
special meeting. As of January 14, 2004, there were 1,301,101 shares of HFB
Financial common stock outstanding. The accompanying proxy statement is dated
January 15, 2004, and is being first mailed to shareholders on or about January
21, 2004. Shareholders are entitled to assert dissenters' rights pursuant to the
Tennessee Business Corporation Act. A copy of the dissenters' rights provisions
is attached to the enclosed proxy statement as Appendix C.
Shareholders are cordially invited to attend the special meeting in person.
Whether planning to attend the special meeting or not, shareholders are urged to
complete, date and sign the enclosed proxy and to return it promptly in the
enclosed, addressed envelope. If your shares are held in the name of a broker,
trust or other nominee, you will need a proxy or letter from the broker, trustee
or nominee in order to vote those shares personally at the special meeting. Any
proxy given pursuant to this solicitation may be revoked by the person giving it
at any time before it is voted at the special meeting. Proxies may be revoked by
delivering to Earl Burchfield, Secretary, 1602 Cumberland Avenue, Middlesboro,
Kentucky 40965, a written notice of revocation bearing a later date than the
proxy, by duly executing and delivering to the Secretary a subsequently dated
proxy relating to the same shares or by attending the special meeting and voting
in person, although attendance at the special meeting will not in and of itself
constitute revocation of a proxy. The enclosed, addressed envelope requires no
postage if mailed in the United States.
The board of directors of HFB Financial has carefully considered the terms
of the merger agreement and believes that the merger is fair to, and in the best
interests of, HFB Financial and its shareholders. The board of directors
unanimously approved the merger agreement and unanimously recommends that you
vote "FOR" the approval of the merger agreement.
By order of the Board of Directors,
/s/ Earl Burchfield
EARL BURCHFIELD
Secretary
January 15, 2004
YOUR VOTE IS IMPORTANT
PROXY STATEMENT
FOR THE SPECIAL MEETING OF THE
SHAREHOLDERS OF
HFB FINANCIAL CORPORATION
The board of directors of HFB Financial provides this proxy statement to
you to solicit your vote on the approval of the Agreement and Plan of Merger,
dated as of October 28, 2003, by and between HFB Financial and HFB Merger Corp.,
a newly-formed subsidiary of HFB Financial organized for the sole purpose of
facilitating this proposed transaction. Pursuant to the merger agreement, HFB
Merger Corp. will merge with and into HFB Financial, with HFB Financial
continuing as the surviving corporation after the merger. If HFB Financial's
shareholders approve the merger agreement, each shareholder (other than
shareholders who properly exercise their dissenters rights):
- holding fewer than 250 shares of HFB Financial common stock at the
effective time of the merger will receive $22.75 in cash, without
interest, per share from HFB Financial; or
- holding 250 or more shares at the effective time of the merger will
continue to hold the same number of shares after the merger and will not
receive any cash payment from HFB Financial.
After the merger, HFB Financial anticipates it will have approximately 212
shareholders of record. As a result, HFB Financial will no longer be subject to
the annual and periodic reporting and related requirements under the federal
securities laws that are applicable to public companies.
The merger cannot occur unless the holders of at least a majority of the
issued and outstanding shares of HFB Financial common stock approve the merger
agreement. The board of directors has scheduled a special meeting of
shareholders to vote on the merger as follows:
February 24, 2004 at 2:00 p.m.
Pine Mountain State Resort Park
Pineville, Kentucky 40977
This document provides you with detailed information about the proposed
merger. Please see "Where You Can Find More Information" on page 49 for
additional information about HFB Financial on file with the Securities and
Exchange Commission.
This proxy statement and proxy card are being mailed to shareholders of HFB
Financial beginning about January 21, 2004.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THIS TRANSACTION, PASSED UPON THE
MERITS OR FAIRNESS OF THIS TRANSACTION, OR PASSED UPON THE ACCURACY OR ADEQUACY
OF THE INFORMATION CONTAINED IN THIS DOCUMENT. ANY REPRESENTATION TO THE
CONTRARY IS UNLAWFUL.
TABLE OF CONTENTS
<Table>
CERTAIN DEFINITIONS......................................... 1
NOTE REGARDING NUMBER OF SHARES TO BE CASHED-OUT IN
MERGER.................................................... 1
SUMMARY TERM SHEET.......................................... 1
QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING AND THE
MERGER.................................................... 5
SUMMARY FINANCIAL INFORMATION............................... 8
SPECIAL FACTORS............................................. 10
Background of the Merger.................................. 10
Purpose and Reasons for the Merger........................ 14
Recommendation of the Board of Directors; Fairness of the
Merger Proposal........................................ 15
Opinion of Financial Advisor.............................. 18
Certain Effects of the Merger............................. 24
Effect of the Merger on Shareholders...................... 26
Merger Subsidiary's Determination of Fairness of the
Merger Proposal........................................ 29
Interests of Executive Officers and Directors in the
Merger................................................. 29
Conduct of HFB Financial's Business After the Merger...... 29
Fees and Expenses......................................... 30
Anticipated Accounting Treatment.......................... 30
Certain U.S. Federal Income Tax Consequences.............. 30
Dissenters' and Appraisal Rights.......................... 32
Regulatory Requirements................................... 34
PRO FORMA FINANCIAL INFORMATION............................. 35
FINANCIAL INFORMATION....................................... 39
Per Share Market Prices and Dividend Information.......... 39
HFB Financial Common Stock Repurchase Information......... 39
THE PARTIES................................................. 39
HFB Financial............................................. 39
Principal Shareholders.................................... 41
Security Ownership of Management.......................... 41
Directors and Executive Officers of HFB Financial......... 42
HCB Merger Corp........................................... 43
THE SPECIAL MEETING......................................... 43
General................................................... 43
Who Can Vote at the Special Meeting....................... 43
Attending the Special Meeting............................. 44
Annual Report and Quarterly Report........................ 44
Vote Required............................................. 44
Solicitation of Proxies................................... 45
Recommendation of the Board of Directors.................. 45
THE MERGER AGREEMENT........................................ 45
Structure of the Merger................................... 45
Conversion of Shares in the Merger........................ 45
Exchange of Certificates.................................. 47
Timing of the Merger...................................... 48
Directors and Officers.................................... 48
Charter and Bylaws........................................ 48
Representations and Warranties............................ 48
Conditions to the Completion of the Merger................ 48
Termination of Merger Agreement........................... 48
OTHER MATTERS............................................... 49
</Table>
<Table>
WHERE YOU CAN FIND MORE INFORMATION......................... 49
DOCUMENTS INCORPORATED BY REFERENCE......................... 49
APPENDICES
Agreement and Plan of Merger.............................. A
Opinion of Professional Bank Services, Inc. .............. B
Chapter 23 of the Tennessee Business Corporation Act...... C
HFB Financial Corporation Annual Report on Form 10-KSB for
the Year Ended December 31, 2002....................... D
HFB Financial Corporation Quarterly Report on Form 10-QSB
for the Nine Months Ended September 30, 2003........... E
</Table>
CERTAIN DEFINITIONS
As used in this proxy statement, "HFB Financial," "we," "our," "ours," "us"
and the "Company" refer to HFB Financial Corporation and all of its
subsidiaries; "merger subsidiary" refers to HFB Merger Corp., and "merger
agreement" refers to the Agreement and Plan of Merger, dated as of October 28,
2003, by and between HFB Financial and merger subsidiary.
NOTE REGARDING NUMBER OF SHARES TO BE CASHED-OUT IN MERGER
The board of directors of HFB Financial believes, based on the information
available to it on the date hereof, that there are approximately 160
shareholders, representing in the aggregate 20,589 shares, who own fewer than
250 shares of HFB Financial common stock and, as a result, will receive cash in
the merger as more full explained in this proxy statement. If the anticipated
20,589 shares are cashed-out in the merger, the cost to HFB Financial will be
approximately $468,400. Under the merger agreement, however, HFB Financial may
acquire up to 131,868 shares costing $3.0 million in the aggregate. In order to
show the full potential impact of the merger on HFB Financial, we assume that
HFB Financial will acquire all 131,868 shares in the merger, unless we
specifically state that we are assuming that 20,589 shares will be cashed-out in
the merger.
SUMMARY TERM SHEET
The following summary term sheet, together with the "Questions and Answers
About the Special Meeting and the Merger" following this Summary Term Sheet
highlight selected information from the proxy statement about our proposed
merger and the special meeting. This Summary Term Sheet and the Questions and
Answers section may not contain all of the information that is important to you.
To better understand, and for a more complete description of the merger, you
should carefully read this proxy statement and all of its appendices before you
vote. For your convenience, we have directed your attention in parentheses to
the location in this proxy statement where you can find a more complete
discussion of each item listed below.
THE MERGER AGREEMENT. (PAGE 45)
On October 28, 2003, we signed the merger agreement, under which merger
subsidiary, a newly-formed subsidiary of HFB Financial, is to merge with and
into HFB Financial. Under the terms of the merger agreement, if the merger is
completed:
- our shareholders holding fewer than 250 shares of HFB Financial common
stock as of the effective time of the merger will receive a cash payment
of $22.75 per share;
- our shareholders holding 250 or more shares of HFB Financial common stock
as of the effective time of the merger will continue to hold their
shares; and
- the officers and directors of HFB Financial at the effective time of the
merger will be the officers and directors of HFB Financial immediately
after the merger.
The merger agreement has specific provisions regarding the treatment of
shares held in street name. For a description of these provisions as well as the
terms of the merger agreement generally, please see page 45 of this proxy
statement. A copy of the merger agreement is attached as Appendix A to this
proxy statement.
THE PARTIES. (PAGE 39)
- HFB Financial is a Tennessee corporation and a registered bank holding
company.
- Merger subsidiary is a recently-formed Tennessee corporation organized as
a wholly-owned subsidiary of HFB Financial for the sole purpose of the
merger.
- The principal executive offices of both HFB Financial and merger
subsidiary are located at 1602 Cumberland Avenue, Middlesboro, Kentucky
40965.
- The telephone number for both HFB Financial and merger subsidiary is
(606) 248-1095.
1
VOTE REQUIRED; RECORD DATE. (PAGE 44)
Approval of the merger agreement requires the approval of the holders of at
least a majority of the outstanding shares of HFB Financial common stock
entitled to vote on the merger agreement at the special meeting. As of the close
of business on January 14, 2004, there were 1,301,101 shares of our common stock
entitled to notice of, and to vote at, the special meeting. All holders of
record of our common stock as of January 14, 2004, will receive a copy of this
proxy statement and are entitled to vote at the special meeting.
REASONS FOR THE MERGER. (PAGE 14)
The board of directors of HFB Financial has determined that, for the
reasons discussed in detail in the proxy statement, the transaction is in the
best interests of HFB Financial and its shareholders including unaffiliated
shareholders. HFB Financial believes the transaction would:
- relieve HFB Financial of the administrative burden and cost associated
with filing reports and otherwise complying with the requirements of
registration under the Securities Exchange Act of 1934 (the "Exchange
Act"), by terminating the registration of its common stock under the
Exchange Act;
- eliminate the expense and burden of interacting with HFB Financial's high
number of shareholders holding small positions in HFB Financial's stock;
- afford shareholders who own fewer than 250 shares of HFB Financial
immediately before the transaction the opportunity to receive cash for
their shares at a price that represents a premium of 12.3% and 14.0% over
the average 30 and 60 trading closing price before the public
announcement of the proposed going private transaction and without having
to pay brokerage commissions; and
- increase management's flexibility to consider and initiate actions that
may produce long-term benefits and growth without the pressure and
expectation to produce quarterly earnings per share growth.
BACKGROUND OF THE MERGER PROPOSAL. (PAGE 10)
Please see "Special Factors -- Background of the Merger Proposal" on page
10 for a discussion of the events leading up to the signing of the merger
agreement.
EFFECTS OF THE MERGER. (PAGE 24)
As a result of the merger:
- HFB Financial will terminate the registration of its common stock under
the Exchange Act and will no longer be a public company subject to the
reporting and other obligations of the Exchange Act;
- HFB Financial common stock will no longer be traded on the NASDAQ
SmallCap Market and price quotations for our common stock will no longer
be available from NASDAQ -- any trading in our common stock after the
transaction will only occur in privately negotiated sales or possibly in
the "pink sheets";
- HFB Financial will have the same board of directors and executive
officers as it currently has;
- cashed-out shareholders will no longer have voting rights or an ownership
interest in, or be a shareholder of, HFB Financial and, therefore, they
will not be able to participate in HFB Financial's future earnings and
growth, if any;
- management anticipates that the number of record shareholders will be
reduced from approximately 372 to approximately 212, and the number of
outstanding shares of HFB Financial common stock will decrease from
1,301,101 to approximately 1,280,512, assuming 20,589 shares are
cashed-out in the merger;
- management anticipates that the percentage of ownership of common stock
of HFB Financial beneficially held by the current executive officers and
directors of HFB Financial as a group will increase from 15.46% to
approximately 17.20%, assuming the maximum of 131,868 shares are cashed-
out in the merger;
2
- aggregate shareholders' equity of HFB Financial as of September 30, 2003,
will be reduced from approximately $24,015,700 on a historical basis to
at least $21,875,759 on a pro forma basis, assuming the maximum of
131,868 shares are cashed-out in the merger;
- the book value per share of common stock as of September 30, 2003, will
be reduced from approximately $18.46 per share on a historical basis to
at least $17.85 per share on a pro forma basis, assuming the maximum of
131,868 shares are cashed-out in the merger; and
- HFB Financial's capital will be reduced, including a decrease in HFB
Financial's Tier 1 capital as of September 30, 2003, from $23,099,262 on
a historical basis to approximately $19,959,821 on a pro forma basis as
of September 30, 2003 and a corresponding decrease in HFB Financial's
Tier 1 risk based capital ratio from 14.20% on a historical basis to
approximately 12.52% on a pro forma basis, a decrease in HFB Financial's
total risk based capital ratio from 15.12% on a historical basis to
approximately 13.32% on a pro forma basis and a decrease in HFB
Financial's leverage ratio from 8.93% on a historical basis to
approximately 7.82% on a pro forma basis, assuming the maximum of 131,868
shares are cashed-out in the merger and no shareholders perfect their
dissenters' rights.
CONDITIONS TO THE COMPLETION OF THE MERGER. (PAGE 48)
The completion of the merger depends upon the satisfaction of a number of
conditions, unless waived, including:
- approval of the merger agreement by the holders of at least a majority of
our outstanding shares, which approval cannot be waived;
- the aggregate cost of the shares to be converted into cash in the merger
and dissenting shares does not exceed $3,000,000; and
- no litigation is pending regarding the merger.
TERMINATION OF MERGER AGREEMENT. (PAGE 48)
We may terminate the merger agreement at any time before the merger is
effective.
U.S. FEDERAL INCOME TAX CONSEQUENCES. (PAGE 30)
The receipt of cash in the merger will be taxable for federal income tax
purposes. You will be treated as either having sold your shares of HFB Financial
common stock for the cash received or as having received the cash as a dividend.
In general, your receipt of cash in exchange for your shares of HFB Financial
common stock will be treated as a sale or exchange and you will recognize gain
or loss in an amount equal to the cash received less your adjusted tax basis of
your shares exchanged for such cash if you actually and constructively own no
shares of HFB Financial common stock immediately after the exchange.
Shareholders who do not receive cash should not recognize any gain or loss on
continuing to hold their shares of HFB Financial common stock as a result of the
merger.
For a more complete description of the federal income tax consequences to
you as a result of the merger, please read the discussion under "Special
Factors -- Certain U.S. Federal Income Tax Consequences."
DISSENTERS' AND APPRAISAL RIGHTS. (PAGE 32)
Under Tennessee law, you are entitled to dissent from the merger and you
may have appraisal rights in connection with the merger. To exercise your
appraisal rights, you must comply with all procedural requirements of Tennessee
law. A description of the relevant sections of Tennessee law is provided in
"Dissenters' and Appraisal Rights" on page 32, and the full text of the
applicable sections of the Tennessee General Corporation Act is attached as
Appendix C to this proxy statement. FAILURE TO TAKE ANY STEPS REQUIRED BY
TENNESSEE LAW MAY RESULT IN A TERMINATION OR WAIVER OF YOUR APPRAISAL RIGHTS.
OPINION OF FINANCIAL ADVISOR. (PAGE 18)
Professional Bank Services, Inc., financial advisor to HFB Financial, has
delivered to the board of directors of HFB Financial its written opinion, dated
January 12, 2004, to the effect that, as of the date of such
3
opinion and based upon and subject to certain matters stated in the opinion, the
cash consideration to be paid in the merger is fair, from a financial point of
view, to our shareholders, including the unaffiliated shareholders who will
receive cash in the merger and unaffiliated shareholders who will retain their
shares in the merger. The full text of the written opinion of Professional Bank
Services, which sets forth the assumptions made, matters considered and
limitations on the review undertaken, is attached as Appendix B to this proxy
statement. You should read the fairness opinion in its entirety, along with the
discussion under "Special Factors -- Opinion of Financial Advisor."
The opinion of Professional Bank Services is directed to the board of
directors of HFB Financial, addresses only the fairness to holders of HFB
Financial common stock from a financial point of view of the cash consideration
to be paid in the merger and does not constitute a recommendation to any
shareholder as to how such shareholder should vote at the special meeting.
FINANCIAL EFFECTS OF THE MERGER; FINANCING OF THE MERGER. (PAGE 26)
We estimate that $468,400 will be the total amount of cash required to fund
the payment of the consideration to be paid to cashed-out shareholders, assuming
20,589 shares are cashed-out in the merger. We also estimate that the total
funds to pay our fees and expenses relating to the merger will be approximately
$125,000. We will fund the purchase of the cashed-out shares and any dissenting
shares, as well as the fees and expenses relating to the merger through cash on
hand or a dividend from our banking subsidiary.
RECOMMENDATION OF THE BOARD OF DIRECTORS. (PAGE 15)
The board of directors of HFB Financial believes that the merger agreement
is fair to, and in the best interests of, HFB Financial and its shareholders,
including both affiliated and unaffiliated shareholders, and unanimously
recommends that shareholders of HFB Financial vote "FOR" the approval of the
merger agreement. As used in this proxy statement, the term "affiliated
shareholder" means any shareholder who is a director or executive officer of HFB
Financial, and the term "unaffiliated shareholder" means any shareholder other
than an affiliated shareholder. HFB Financial's directors have indicated that
they will vote all of their shares of HFB Financial common stock in favor of the
merger agreement. As of January 14, 2004, the directors and executive officers
of HFB Financial beneficially owned a total of 201,163 shares of HFB Financial
stock, or approximately 15.46% of the total shares entitled to vote at the
annual meeting. See "The Parties -- Security Ownership of Management."
4
QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING AND THE MERGER
Q: WHY DID YOU SEND ME THIS PROXY STATEMENT?
A: We sent you this proxy statement and the enclosed proxy card because our
board of directors is soliciting your votes for use at the special meeting.
This proxy statement summarizes information that you need to know in order to
cast an informed vote at the special meeting. However, you do not need to
attend the special meeting to vote your shares. Instead, you may simply
complete, sign and return the enclosed proxy card.
We will begin sending this proxy statement, notice of special meeting and the
enclosed proxy card on or about January 21, 2004, to all shareholders
entitled to vote. Holders of our common stock are entitled to vote at the
special meeting. The record date for those entitled to vote is January 14,
2004. On September 30, 2003, there were 1,301,101 shares of our common stock
outstanding. Shareholders are entitled to the one vote for each share of
common stock held as of the record date.
Q: WHAT IS THE TIME AND PLACE OF THE SPECIAL MEETING?
A: The special meeting will be held at Pine Mountain State Resort Park,
Pineville, Kentucky at 2:00 p.m., local time, on Tuesday, February 24, 2004.
Q: WHAT AM I BEING ASKED TO VOTE ON?
A: You are being asked to vote on the approval of the merger agreement between
HFB Financial and merger subsidiary, pursuant to which merger subsidiary will
merge with and into HFB Financial.
Q: WHO MAY BE PRESENT AT THE SPECIAL MEETING AND WHO MAY VOTE?
A: All holders of our common stock and other invitees of HFB Financial may
attend the special meeting in person. However, only holders of our common
stock of record as of January 14, 2004 may cast their votes in person or by
proxy at the special meeting.
Q: WHAT IS THE VOTE REQUIRED?
A: The vote required to approve the merger agreement is the affirmative vote of
the holders of at least a majority of the shares of HFB Financial common
stock issued and outstanding as of the record date. If you do not vote your
shares, either in person or by proxy, or if you abstain from voting on this
matter, it has the same effect as if you voted against this proposal. In
addition, if you do not instruct your broker on how to vote on this proposal,
your broker will not be able to vote for you. This will have the same effect
as a vote against the proposal.
Q: WHO IS SOLICITING MY PROXY?
A: The board of directors of HFB Financial.
Q: WHAT IS THE RECOMMENDATION OF OUR BOARD OF DIRECTORS REGARDING THE PROPOSAL
TO APPROVE THE MERGER AGREEMENT?
A: Our board of directors has determined that the merger is advisable and in the
best interests of HFB Financial and its shareholders. Our board of directors
has therefore unanimously approved the merger agreement and recommends that
you vote "FOR" approval of the merger agreement at the special meeting.
Q: WHAT DO I NEED TO DO NOW?
A: Please sign, date and complete your proxy card and promptly return it in the
enclosed, self addressed, prepaid envelope so that your shares can be
represented and voted at the special meeting.
Q: IF MY SHARES ARE HELD IN "STREET NAME" BY MY BROKER, WILL MY BROKER VOTE MY
SHARES FOR ME?
A: Your broker will vote your shares for you ONLY if you instruct your broker
how to vote for you. Your broker should mail information to you that will
explain how to give these instructions.
5
Q: CAN I CHANGE MY VOTE AFTER I HAVE MAILED MY SIGNED PROXY CARD?
A: Yes. Just send by mail a written revocation or a later-dated, completed and
signed proxy card before the special meeting or simply attend the special
meeting and notify the secretary of the special meeting that you want to vote
in person. You may not change your vote by facsimile or telephone.
Q: WHAT IF I DON'T SEND BACK A PROXY CARD OR VOTE MY SHARES IN PERSON AT THE
SPECIAL MEETING?
A: If you don't return your proxy card or vote your shares in person at the
special meeting, each of those shares will be treated as a non-vote and will
have the effect described above under "What is the vote required?"
Q: SHOULD I SEND IN MY STOCK CERTIFICATES NOW?
A: No. After the merger is completed, we will send instructions on how to
receive any cash payments you may be entitled to receive. If you are not
cashed-out in the merger, you will not receive a letter of transmittal and
you do not need to send in your stock certificates.
Q: WHAT WILL I RECEIVE IN THE MERGER?
A: If you own fewer than 250 shares of HFB Financial common stock as of the
effective time of the merger, you will receive $22.75 in cash for each share
you own. If you own 250 or more shares of HFB Financial common stock as of
the effective time of the merger, you will continue to own your shares of HFB
Financial common stock. The merger agreement has specific provisions
regarding the treatment of shares held in street name. Please read the
discussion under "The Merger Agreement -- Conversion of Shares in the Merger"
for a description of these provisions generally as well as the terms of the
merger agreement.
Q: WHAT IF I HOLD SHARES IN STREET NAME?
A: HFB Financial intends for the transaction to treat shareholders holding
common stock in street name through a nominee (such as a bank or broker) in
the same manner as shareholders whose shares are registered in their names.
However, nominees may have different procedures and shareholders holding
common stock in street name should contact their nominees. Please read the
discussion under "The Merger Agreement -- Conversion of Shares in the Merger"
for a description of these provisions generally as well as the terms of the
merger agreement.
Q: HOW WILL HFB FINANCIAL BE OPERATED AFTER THE MERGER?
A: After the merger, HFB Financial will no longer be subject to the reporting
and related requirements under the federal securities laws that are
applicable to public companies. HFB Financial expects its business and
operations to continue as they are currently being conducted and, except as
disclosed in this proxy statement, the merger is not anticipated to have any
effect upon the conduct of such business. Our board of directors believes the
going-private transaction is consistent with HFB Financial's vision of
maintaining an independent banking strategy. As a result of the merger,
shareholders of HFB Financial who receive cash for their shares in the merger
will no longer have a continuing interest as shareholders of HFB Financial
and will not share in any future earnings and growth of HFB Financial.
Q: WHEN DO YOU EXPECT THE MERGER TO BE COMPLETED?
A: We are working toward completing the merger as quickly as possible and we
expect the merger to be completed shortly after the special meeting.
Q: WHAT ARE THE FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER TO ME?
A: The receipt of cash in the merger will be taxable for federal income tax
purposes. Shareholders who do not receive cash in the merger should not be
subject to taxation as a result of the merger. To review the material tax
consequences in greater detail, please read the discussion under "Special
Factors -- Certain U.S. Federal Income Tax Consequences."
6
Q: MAY I BUY ADDITIONAL SHARES IN ORDER TO REMAIN A SHAREHOLDER OF HFB
FINANCIAL?
A: Yes. The key date is how many shares of common stock you own at the effective
time of the merger. So long as you are able to acquire a sufficient number of
shares so that you own 250 or more shares at the effective time of the
merger, which we anticipate to occur at 5:00 p.m. on February 24, 2004 or as
soon as practicable thereafter, your shares of HFB Financial common stock
will not be cashed-out in the transaction.
7
SUMMARY FINANCIAL INFORMATION
SUMMARY UNAUDITED PRO FORMA FINANCIAL INFORMATION OF HFB FINANCIAL
The following summary unaudited pro forma consolidated income statement
data and per share information of HFB Financial for the year ended December 31,
2002, gives effect to the merger as if it had occurred on January 1, 2002. The
unaudited consolidated pro forma balance sheet of HFB Financial for the
nine-month period ended September 30, 2003, gives effect to the merger as if it
had occurred on September 30, 2003. The unaudited consolidated pro forma
consolidated income statement date and per share information of HFB Financial
for the nine months ended September 30, 2003, gives effect to the merger as if
it had occurred on January 1, 2003. You should read the summary unaudited pro
forma financial information in conjunction with the Unaudited Pro Forma
Consolidated Financial Statements and the related assumptions and notes included
elsewhere in this proxy statement. See "Pro Forma Financial Information"
beginning on page 35.
As described in such assumptions, the pro forma financial data assumes that
131,868 shares of HFB Financial common stock will receive cash in connection
with the merger, which represents the maximum number of shares we are required
to repurchase under the merger agreement. The actual number of shares of HFB
Financial common stock that will receive cash in the merger may be significantly
lower. Management anticipates that HFB Financial will purchase approximately
20,589 shares, although we cannot assure you of the number of shares that we
will purchase. The pro forma information set forth below is not necessarily
indicative of what HFB Financial's actual financial position or results of
operations would have been had the merger been consummated as of the above
referenced dates or of the financial position or results of operations that may
be reported by HFB Financial in the future.
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
2003
-----------------
BALANCE SHEET DATA:
Total assets................................................ $253,548,588
Loans, net of allowance for loan losses and unearned
interest unearned interest................................ 187,799,158
Allowance for loan losses................................... 1,494,678
Total deposits.............................................. 201,900,098
Other debt.................................................. 28,084,688
Shareholders' equity........................................ 20,875,759
</Table>
<Table>
<Caption>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
2002 2003
------------ -----------------
INCOME STATEMENT DATA:
Interest income............................................. $16,354,584(1) $11,601,311
Interest expense............................................ 6,817,396 4,359,854
----------- -----------
Net interest income......................................... 9,537,188 7,246,727
Provision for credit losses................................. 468,554 315,000
----------- -----------
Net interest income after provision for credit losses....... 9,068,634 6,931,727
Noninterest income.......................................... 1,213,674 984,732
Noninterest expense......................................... 6,731,264 5,320,283
----------- -----------
Income before income taxes.................................. 3,551,044 2,596,176
Income tax expense.......................................... 1,137,532(2) 778,510
----------- -----------
Net income.................................................. $ 2,413,512 $ 1,817,606
=========== ===========
</Table>
8
<Table>
<Caption>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
2002 2003
------------ -----------------
PERFORMANCE DATA:
Return on average total assets.............................. 1.02% 0.96%
Return on average shareholders' equity...................... 12.60% 11.73%
Average shareholders' equity to average assets.............. 8.11% 8.20%
Total gross loans to total deposits at year-end............. 84.06% 93.76%
</Table>
- ---------------
(1) Assuming the opportunity cost of funding the $3,125,000 is 1% per annum.
(2) The income tax rate assumed for this transaction is 36.25%.
SELECTED PER SHARE FINANCIAL INFORMATION
The following table sets forth selected historical per share financial
information for HFB Financial and unaudited pro forma per share financial
information for HFB Financial giving effect to the merger as if it had been
consummated as of the end of each period presented, in the case of book value
information, and as of the beginning of the respective reporting periods, in the
case of income statement information. The information presented below is derived
from (i) the consolidated historical financial statements of HFB Financial,
including the related notes thereto, and (ii) the Unaudited Pro Forma
Consolidated Financial Statements, including the assumptions and notes thereto,
contained elsewhere in this proxy statement. You should read this table together
with the Unaudited Pro Forma Consolidated Financial Statements and the related
assumptions and notes and the Selected Historical Financial Data included
elsewhere in this proxy statement and the consolidated financial statements of
HFB Financial and the notes thereto included in our 2002 Annual Report of Form
10-KSB to shareholders, included in this proxy statement as Appendix D and our
Quarterly Report on Form 10-QSB to shareholders for the quarter ended September
30, 2003, included in this proxy statement as Appendix E.
As described in the assumptions to the Unaudited Pro Forma Consolidated
Financial Statements, the pro forma per share information assumes that 131,868
shares of HFB Financial common stock are cashed-out in connection with the
merger. The pro forma information set forth below is not necessarily indicative
of what HFB Financial's actual financial position or results of operations would
have been had the merger been consummated as of the above referenced dates or of
the financial position or results of operations that may be reported by HFB
Financial in the future.
<Table>
<Caption>
PRO FORMA
HISTORICAL COMBINED
---------- ---------
Earnings (loss) per common share from continuing operations:
Basic
Nine Months Ended September 30, 2003................... $ 1.46 $ 1.61
Year Ended December 31, 2002........................... 1.95 2.16
Diluted
Nine Months Ended September 30, 2003................... 1.45 1.60
Year Ended December 31, 2002........................... 1.93 2.15
Book value per common share
Nine Months Ended September 30, 2003................... 18.46 17.85
Year Ended December 31, 2002........................... 18.12 17.48
Tier 1 leverage ratio
Nine Months Ended September 30, 2003................... 8.93% 7.82%
Year Ended December 31, 2002........................... 8.69% 7.55%
Tier 1 risk based capital ratio
Nine Months Ended September 30, 2003................... 14.20% 12.52%
Year Ended December 31, 2002........................... 15.07% 12.92%
Total risk based capital ratio
Nine Months Ended September 30, 2003................... 15.12% 13.46%
Year Ended December 31, 2002........................... 15.88% 13.73%
</Table>
9
SPECIAL FACTORS
BACKGROUND OF THE MERGER
Overview. Of HFB Financial's approximately 372 current record
shareholders, approximately 160 hold fewer than 250 shares (not including
beneficial owners whose shares may be registered in "street name").
Collectively, these 160 record holders, who comprise approximately 44% of all
record holders, own an aggregate of approximately 20,589 shares, representing
approximately 1.6% of our outstanding shares.
We have no direct knowledge of the number of shares of our common stock
owned beneficially (but not of record) by persons who own fewer than 250 shares
of our common stock and hold the shares in street name. However, based on the
number of sets of proxy materials that we are requested to provide to brokers,
banks and other nominees, we estimate that there are at least 108 holders owning
beneficially approximately 468,777 shares of HFB Financial common stock.
Accordingly, HFB Financial estimates that there are approximately 2,470 shares
of its common stock being held by shareholders holding fewer than 250 shares. In
making the computations presented elsewhere in this proxy statement (including
the preparation of the pro forma financial information included herein), HFB
Financial has assumed that a substantial portion of the beneficial owners of
shares held in nominee name hold 250 or more shares and will therefore remain
shareholders of HFB Financial after the merger.
As a public company, HFB Financial is required to prepare and file with the
Securities and Exchange Commission (the "SEC"), among other items, the
following:
- Quarterly Reports on Form 10-QSB;
- Annual Reports on Form 10-KSB;
- Proxy Statements and annual shareholder reports as required by Regulation
14A under the Exchange Act; and
- Current Reports on Form 8-K.
The costs associated with these reports and other filing obligations
comprise a significant overhead expense. These costs include professional fees
for our auditors and corporate counsel, printing and mailing costs, internal
compliance costs and transfer agent costs. These SEC registration related costs
have been increasing over the years, and we believe that they will continue to
increase, particularly as a result of the additional reporting and disclosure
obligations imposed on public companies by the recently enacted Sarbanes-Oxley
Act of 2002.
Accordingly, the board of directors determined in the fourth quarter of
2002 that the recurring expense and burden of maintaining so many small
shareholder accounts, coupled with the costs associated with maintaining the
registration of HFB Financial's common stock under the Exchange Act, was not
cost efficient for HFB Financial. Additionally, the board of directors
determined that, even as a publicly traded company there is a very limited
trading market in our common stock, especially for sales of larger blocks of our
common stock, and that our shareholders derive little benefit from HFB
Financial's status as a publicly-held corporation. The board of directors also
concluded that, as a private company, management would have increased
flexibility to consider and initiate actions that may produce long-term benefits
and growth without the pressure and expectation to produce quarterly earnings
per share growth. As a result, the board asked our management to begin to
explore the possibility of reducing the number of our shareholders of record to
below 300 in order to suspend our periodic reporting obligations to the SEC.
The merger proposal is being made at this time because the sooner the
proposal can be implemented, the sooner HFB Financial will cease to incur the
expenses and burdens associated with having our common stock registered under
the Exchange Act and the sooner shareholders who are to receive cash in the
merger will receive and be able to reinvest or otherwise make use of such cash
payments.
10
Alternatives Considered. In making this determination, the board of
directors considered other means of achieving the same result, but rejected
these alternatives because the board of directors believed that the merger would
be simpler and less costly. These alternatives were:
- Tender Offer at a Similar Price Per Share. The board of directors was
uncertain as to whether this alternative would result in shares being
tendered by a sufficient number of record shareholders so as to
accomplish the going private objective and to reduce recurring costs. The
board found it unlikely that many holders of small numbers of shares
would make the effort to tender their shares.
- Reverse Stock Split. This alternative would accomplish the objective of
reducing the number of record shareholders, assuming approval of the
reverse stock split by HFB Financial's shareholders. In a reverse stock
split, HFB Financial would acquire the interests of the cashed-out
shareholders pursuant to an amendment to HFB Financial's Articles of
Incorporation to reduce the number of issued and outstanding shares of
common stock such that the cashed-out shareholders would own less than
one full share of HFB Financial common stock. HFB Financial would then
distribute cash for the resulting fractional share interests. The reverse
stock split and the merger would both achieve the same objective of
reducing the number of record shareholders, assuming shareholder
approval. Nonetheless, the board of directors chose the merger because
the board concluded that a reverse stock split would cost HFB Financial
more capital. In a reverse stock split, HFB Financial would have to pay
cash to any large shareholders for their fractional shares, even though
they would remain shareholders after the transaction.
- Purchase of Shares in the Open Market. The board rejected this
alternative because it concluded that it was highly unlikely that HFB
Financial could acquire shares from a sufficient number of holders to
accomplish the board's objectives. The board also concluded that such a
repurchase program would provide arbitrage opportunities that would
enable certain market makers to profit at the expense of HFB Financial,
while failing to treat all of the shareholders uniformly.
After consideration of the various alternatives described above, the board
determined that the merger proposal was the best choice for the shareholders and
HFB Financial. Significantly, HFB Financial estimates that, following the
proposed merger, it should have approximately 212 shareholders of record, which
will permit HFB Financial to terminate the registration of its common stock
under the Exchange Act.
Board of Directors. In late 2002, the board of directors began to consider
the feasibility of terminating the registration of its common stock under the
Exchange Act in what is commonly referred to as a "going private" transaction.
Over the last few years, the board has made significant efforts to reduce HFB
Financial's operating costs and continually evaluates the relative costs and
benefits of additional cost cutting measures. HFB Financial incurs significant
costs associated with having its shares being publicly traded on NASDAQ and the
registration of its shares with the SEC. In evaluating the benefits of being
publicly traded, the board concluded that HFB Financial was deriving limited
benefit from its status as a public company: no analysts followed or reported on
the Company, and shares of common stock traded in low volume. In addition, the
board concluded that HFB Financial had limited access to the public debt or
equity markets, in a cost effective manner, due to its size and market, and its
common stock would not make an attractive form of currency in an acquisition of
another financial institution. In addition, the costs associated with being a
reporting company had been substantial and, especially in light of the passage
of the Sarbanes-Oxley Act in 2001, continue to rise.
At its meeting on July 15, 2003, management reported to the board that
management had discussed the feasibility of going private with the HFB
Financial's accountants and legal advisors and that our advisors believed the
benefits of our engaging in a going private transaction exceeded the drawbacks.
The board of directors also discussed the ongoing costs associated with HFB
Financial's status as a public company. The board considered the impact of a
going private transaction on our shareholders, our customers, our creditors and
the communities in which we operate. The board also considered the impact that a
going private transaction would have on our stock's liquidity.
At its meeting on July 19, 2003, the board of directors continued to
discuss the feasibility of a going private transaction and reviewed various
share repurchase structures, including odd-lot share repurchases,
11
tender offers and reverse stock splits. The board initially preferred a
structure that would allow the shareholders to decide if they wanted to sell
their shares, but recognized the uncertainty of having fewer than 300
shareholders of record at the consummation of such a transaction. In light of
the potential savings from a going private transaction, the board invited its
attorneys to attend the next board meeting to discuss the alternative
structures, as well as their potential implications, for accomplishing a going
private transaction. In particular, the board was concerned about the perception
that a coercive going private transaction would have on shareholders who bought
our common stock during our 1992 conversion from a mutual to a stock holding
company. In addressing this concern, the board considered the $10.00 per share
purchase price from the conversion, as well as the dividends of $4.95 that have
been paid on a share of HFB Financial common stock since 1992. In addition, the
board recognized the significant premium over $10.00 that HFB Financial would
pay in the merger. The board determined that, even though some shareholders who
purchased shares in the conversion would be cashed-out in the merger, those
shareholders had received a good return on their investment.
At a board meeting held on July 30, 2003, the board considered alternative
structures for proceeding with a going private transaction, including a reverse
stock split, a tender offer and a cash-out merger, as well as the board's
fiduciary duties in connection with each transaction. In addition, management
discussed the cost savings and benefits of proceeding with a going private
transaction. The board decided to confer with HFB Financial's accountants before
finally determining whether to initiate and, if so, by what structure to
accomplish, a going private transaction.
On July 31, 2003, the board held discussions with its accountants and,
although the accountants did not have specific figures applicable to HFB
Financial, they did advise the board that they believe the cost of being a
public company would increase as a result of Sarbanes-Oxley. The board also
reviewed the cost of remaining public versus the costs of the proposed
transaction. In 2002, management estimated that it spent $125,000 associated
with being a public company and estimated expenses of $149,300 in 2003. The
board also discussed whether outside financing would be required to fund the
repurchase of the shares in a going private transaction. The board did not make
any final determinations regarding the going private transaction at this
meeting.
On August 19, 2003, the board met with its legal advisors and accountants
and renewed its discussion on the prospect of going private. The board discussed
the likelihood of having fewer than 300 shareholders of record under each of the
going private transaction structures. After reconsidering all the alternatives
that had been presented, the board determined that accomplishing the transaction
through a cash-out merger would provide the greatest certainty that, after the
merger, we would have fewer than 300 shareholders of record and would be able to
terminate the registration of our common stock under the Exchange Act. After
lengthy discussion, the board approved the structure of the going private
transaction by means of the cash-out merger.
Also at that meeting, the board authorized management to proceed with any
additional steps necessary to bring the merger proposal to the point where its
terms could be considered and voted upon. Specifically, the board authorized
management to interview and engage an independent financial advisor to advise
the board on the financial terms of the proposed transaction and, based on the
terms selected, to render a fairness opinion on the terms of the proposed merger
from a financial point of view to both the affiliated and unaffiliated
shareholders. Additionally, the board authorized management to prepare and
execute the documents necessary to incorporate the merger subsidiary.
Between August 19, 2003 and September 26, 2003, management of HFB Financial
interviewed several financial advisors. Based on its experience and familiarity
with HFB Financial, management ultimately engaged Professional Bank Services,
Inc. ("PBS") to act as financial advisor to the board.
At a board meeting held on September 26, 2003, members of management of HFB
Financial described to the board its meetings with PBS and the reasons for its
engagement of PBS. Management stated that it had engaged legal counsel,
developed the structure of the transaction, and reviewed the shareholder list to
ascertain the effect of different minimum ownership levels since the August 19,
2003 meeting. The board ratified the appointment of PBS to serve as its
financial advisor.
12
Also at the September 26, 2003 board meeting, the board of directors
discussed the different appraisal methods, including the judicial interpretation
of "fair value" under the TBCA, and the board's fiduciary duties in establishing
the price to be paid to cashed-out shareholders. The board discussed the
Delaware Block Method, as the leading appraisal method under Tennessee law as
well as valuation techniques currently utilized by Delaware courts. Based on
these discussions, the board authorized management to send an instruction letter
to PBS authorizing PBS to appraise the HFB Financial common stock under the
Delaware Block Method as well as the appraisal techniques utilized by Delaware
courts and to report its findings to the board.
On October 21, 2003, PBS delivered to the board of directors its appraisal
on the fair value of HFB Financial's common stock. PBS's valuation indicated
that the fair value of HFB Financial common stock based on June 30, 2003
financial information under the Delaware Block Method was $21.00 per share and
under a going concern valuation technique, which considered control value
excluding synergies and costs savings as a result of the merger, was $22.75 per
share. The report PBS provided to the board included a detailed explanation of
the financial analyses supporting the range of values.
After reviewing the valuation of PBS, the board at its October 21, 2003
meeting met with representatives of PBS to review its appraisals. The board
discussed in detail the different appraisal techniques utilized by PBS and the
assumptions underlying PBS's analysis. PBS described that, although HFB
Financial's appraisal was based on financial information through June 30, 2003,
PBS had reviewed our results for the third quarter of 2003 and its analysis had
not changed. The board considered both the analyses and conclusions of PBS
regarding the appraised value of the HFB Financial common stock under the
Delaware Block Method and under the appraisal techniques utilized by Delaware
courts. Although the board considered all of the valuations, it relied on and
adopted the conclusions reached by PBS with respect to value under such
appraisal techniques utilized by Delaware courts, also referred to as the going
concern value. Ultimately, the board decided that going concern value was more
appropriate for the valuation of HFB Financial common stock especially in light
of the coercive nature of the merger to holders of fewer than 250 shares. After
considerable discussion, the board of directors unanimously agreed that $22.75
was a fair value for the shares of common stock to be purchased by HFB Financial
in the proposed merger and was a fair value to all of its shareholders,
including unaffiliated shareholders who will receive cash and who will retain
their shares. After the board had agreed to a price of $22.75 per share, it
requested PBS to confirm that PBS would issue a fairness opinion at that price.
In response, PBS orally confirmed to management that the price of $22.75 per
share established by the board of directors is fair, from a financial point of
view, to the shareholders of HFB Financial who own fewer than 250 shares of HFB
Financial common stock, including unaffiliated shareholders
Next, the board of directors discussed how many shares a shareholder must
own in order to remain a shareholder after the merger. The discussion focused on
two issues: ensuring that HFB Financial had fewer than 300 shareholders of
record after the merger and the cost of cashing-out shareholders. The board of
directors discussed several levels of share ownership and selected 250 shares as
the ownership minimum because it represented a logical breakpoint among
shareholders in order to enhance the likelihood that, after completion of the
merger, the number of record shareholders would be fewer than the 300
shareholder limit necessary to terminate the registration of its common stock
under the Exchange Act, while at the same time it involved a relatively small
number of shares (estimated at that time to be approximately 20,589, or 1.6%, of
HFB Financial's outstanding shares) that would be cashed-out in the proposed
merger.
Also at the October 21, 2003 meeting, the board of directors considered the
merger agreement. The board also reviewed the terms of the proposed transaction,
the related documentation and certain legal considerations with the HFB
Financial's legal counsel. HFB Financial's management also made presentations to
the board regarding various financial and other matters and answered questions
of the board concerning the proposed transaction. Management's presentation to
the board included a discussion of the terms of the merger agreement and how
cashed-out shareholders would receive cash for their shares. In addition,
management presented the proposed costs of the transaction and described how, if
the amount to be paid to cashed-out shareholders in the merger would exceed $3.0
million, the board could terminate the merger agreement. The board discussed
whether the termination right should be lower, but decided to keep it at
13
$3.0 million. Management also described other conditions under the merger
agreement to HFB Financial's obligation to consummate the merger.
Following the presentations described above at the October 21, 2003,
meeting and a full discussion regarding the information presented, the directors
unanimously determined, after giving careful consideration to a number of
factors, that the merger agreement and the merger were fair to, and in the best
interests of, HFB Financial and its shareholders, including unaffiliated
shareholders, and unanimously approved the merger agreement and the merger.
The board believes that the merger agreement is fair to and in the best
interests of HFB Financial shareholders, including both unaffiliated
shareholders who will receive cash in the merger and those who will retain their
shares in the merger. In making this determination, the board did not utilize
the following procedural safeguards:
- the merger transaction was not structured to require separate approval by
a majority of those shareholders who are not executive officers or
directors of HFB Financial; and
- the board of directors did not retain any unaffiliated representative to
act solely on behalf of shareholders who are not officers or directors
for purposes of negotiating the terms of the merger transaction or to
prepare a report regarding the fairness of the transaction.
The board did not consider a possible sale of HFB Financial. No offers were
presented to the board, and no offers were solicited in keeping with the board
of directors strategic determination to maintain HFB Financial's independence.
On October 28, 2003, HFB Financial and the merger subsidiary entered into
the merger agreement. On October 28, 2003, HFB Financial publicly announced the
execution of the merger agreement and the proposed merger.
PURPOSE AND REASONS FOR THE MERGER
For the past several years, there has been minimal trading activity in our
common stock. As a result, our shareholders have limited options in selling
their shares of common stock despite the fact that we are quoted on the NASDAQ
SmallCap Market and our common stock is registered under the Exchange Act. In
addition, we have never used our common stock as currency in an acquisition and
the board has no current intent to do so. The board of directors also concluded
that, as a private company, management would have increased flexibility to
consider and initiate actions that may produce long term benefits and growth,
despite short term costs, without the pressure and expectation to produce
quarterly earnings per share growth. As a result, our board of directors has
determined that it is in the best interests of HFB Financial and its
shareholders to go private by reducing the total number of shareholders to below
300.
In addition, the board of directors noted that a relatively large number of
shareholders who hold fewer than 250 shares own in the aggregate only about 1.6%
of HFB Financial's outstanding shares. As a result, the board concluded the
costs associated with reducing the number of shareholders of record below 300
was reasonable in view of the anticipated benefits of being privately held.
The purpose of the proposed merger is to cash-out the equity interests in
HFB Financial of the approximately 160 record holders of common stock that, at
the effective time of the merger, own fewer than 250 shares of common stock at a
price determined to be fair by the entire board of directors. The merger will
allow HFB Financial to reduce the number of shareholders of record to fewer than
300 so as:
- to permit cashed-out shareholders to receive cash for their shares
without having to pay brokerage commissions at a price that represents a
premium of 16% over the most recent sales price for the common stock
prior to announcement of the merger agreement. If the merger is
implemented, the officers and directors of HFB Financial (and all other
holders of 250 or more shares) will benefit by a small increase in their
percentage ownership of HFB Financial common stock. However, the net book
value of their holdings will decrease;
14
- to relieve HFB Financial of the administrative burden and cost associated
with filing reports and otherwise complying with the reporting
requirements of the Exchange Act by terminating the registration of our
common stock under the Exchange Act;
- to decrease the expense and burden of dealing with HFB Financial's high
number of shareholders holding small positions in HFB Financial common
stock; and
- to increase management's flexibility to consider and initiate actions
that may produce long-term benefits and growth, despite short-term costs,
without the pressure and expectation to produce quarterly earnings per
share growth.
The board believes that the disadvantages of having HFB Financial continue
to be a public company outweigh any advantages. The board has no present
intention to raise capital through sales of securities in a public offering in
the future or to acquire other business entities using stock as the
consideration for any such acquisition. Accordingly, HFB Financial is not likely
to make use of any advantage (for raising capital, effecting acquisitions or
other significant purposes) that HFB Financial's status as a public company may
offer.
HFB Financial incurs direct and indirect costs associated with compliance
with the SEC's filing and reporting requirements imposed on public companies.
HFB Financial also incurs substantial indirect costs as a result of, among other
things, the executive time spent to prepare and review such filings. Because HFB
Financial has relatively few executive personnel, these indirect costs can be
substantial. HFB Financial's direct and indirect costs related to being a public
company are estimated to approximate, on an annual basis, $149,300 as follows:
<Table>
Independent auditors........................................ $ 30,000
NASDAQ Fee.................................................. 15,000
SEC counsel................................................. 16,300
Printing and mailing........................................ 10,000
EDGAR Consultants........................................... 5,000
Consulting for 302 & 906 Certification...................... 12,000
Press Releases.............................................. 1,000
Internal Compliance Costs................................... 60,000
--------
Total..................................................... $149,300
========
</Table>
RECOMMENDATION OF THE BOARD OF DIRECTORS; FAIRNESS OF THE MERGER PROPOSAL
The board of directors unanimously determined that the merger is fair to,
and in the best interests of, HFB Financial and its shareholders, including both
unaffiliated shareholders who will receive cash and those who will retain their
shares. The board of directors also believes that the process by which the
transaction is to be approved is fair. The board of directors unanimously
recommends that the shareholders vote "FOR" approval of the merger agreement.
Each member of the board of directors and each executive officer of HFB
Financial has advised HFB Financial that he or she intends to vote their shares
in favor of the merger agreement for the reasons described below. As of January
14, 2004, the directors and executive officers of HFB Financial beneficially
owned a total of 201,163 shares of HFB Financial common stock, or approximately
15.46% of the total shares entitled to vote at the special meeting.
The board has the authority to reject (and not implement) the merger (even
after approval thereof by shareholders).
The board considered numerous factors, discussed below, in reaching its
conclusion as to the fairness of the merger to our shareholders, including both
unaffiliated shareholders who will receive cash and those who will retain their
shares of HFB financial common stock. In reviewing the factors below, the board
considered the factors in the way that they affected the unaffiliated
shareholders who will receive cash and the unaffiliated shareholders who will
retain their shares of common stock. The board did not assign any specific
weights to the
15
factors listed below in determining the price to be paid to cashed-out
shareholders. Moreover, in their considerations individual directors may have
given differing weights to different factors.
- Historical Market Prices of HFB Financial Common Stock. HFB Financial's
common stock is quoted on the NASDAQ SmallCap Market and is thinly
traded. The board reviewed high and low sales prices for the common stock
from January 1, 2001 to September 30, 2003, which ranged from $11.00 to
$20.50 per share. You should read the discussion under "Financial
Information -- Per Share Market Prices and Dividend Information" for more
information about our stock prices. The last sale price of HFB Financial
common stock known to management that occurred prior to the public
announcement of the merger agreement was $21.92 on October 28, 2003.
- Going Concern Value. The board valued HFB Financial shares on the basis
of a going concern, without giving effect to any anticipated effects of
the merger. Also, the board did consider the amount per share that might
be realized in a sale of 100% of the stock of HFB Financial, but adjusted
to eliminate the impact on value from costs savings and synergies that
are unique to a third party purchaser. The board determined that
consideration of a control value without adjusting for costs savings and
synergies was inappropriate in the context of a transaction that would
not result in the acquisition of HFB Financial by a third party financial
institution. In determining the going concern value of HFB Financial's
shares held by cashed-out shareholders, the board adopted the analyses
and conclusions of its financial advisor with respect to its financial
advisor's going concern value appraisal, which are described under
"-- Opinion of the Financial Advisor" below.
- Earnings. The board reviewed the earnings of HFB Financial for the
previous three fiscal years and for the first three quarters of 2003. For
the three years ended December 31, 2000, 2001 and 2002, adjusted to
reflect HFB Financial's conversion in 2002 from a fiscal year ended June
30 to a calendar year, HFB Financial reported net income of approximately
$2,063,731, $1,447,421 and $1,286,866, respectively. For the nine months
ended September 30, 2003, HFB Financial reported net income of
$1,817,606. The board believes that HFB Financial's earnings over the
last three years provide a basis for reasonable expectation of further
performance and an expectation of future benefits, if any. Based on its
review of the earnings of HFB Financial, the board concluded that the
price of $22.75 per share is fair when compared to comparable
transactions reported on by its financial advisor. In its review of HFB
Financial's earnings, the board adopted the analyses and conclusions of
its financial advisor, which are described under "-- Opinion of Financial
Advisor" below.
- Opinion of the Financial Advisor. The board considered the valuation
report prepared by PBS distributed to the board in advance of, and
presented to the board at, the October 21, 2003 meeting. The board also
considered the written fairness opinion prepared by PBS, dated January
12, 2004, to the effect that, as of the date of such opinion and based
upon and subject to certain matters stated therein, the cash
consideration to be paid in the merger is fair, from a financial point of
view, to HFB Financial shareholders, including unaffiliated who will be
cashed-out in the merger and those who will retain their shares. The
board also reviewed and considered the financial analyses supporting the
opinion of the financial advisor. You should read the discussion under
"-- Opinion of the Financial Advisor" below. A copy of the opinion of PBS
is attached as Appendix B to this proxy statement.
- Opportunity to Liquidate Shares of Common Stock. The board considered
the opportunity the merger presents for shareholders owning fewer than
250 shares to liquidate their holdings without incurring brokerage costs,
particularly given the relatively illiquid market for shares of HFB
Financial common stock, at a price that represents a premium over
historical sales prices.
The board also recognized that the merger consideration to be paid to the
cashed-out shareholders in the merger reflected a premium over the trading
prices for the HFB Financial common stock prior to the announcement of the
merger.
In determining how to value shares of HFB Financial common stock, the board
of directors instructed PBS to appraise the HFB Financial common stock under the
Delaware Block Method and the going concern value methodologies. The board asked
its financial advisor to appraise the HFB Financial common stock under the
Delaware Block Method because the courts of Tennessee favor the Delaware Block
Method for
16
determining the fair value of corporate stock being repurchased by corporations
in conjunction with certain mergers and other corporate events. The board also
required its financial advisor to appraise the HFB Financial common stock under
the going concern value which represents the more modern valuation trend in
states other than Tennessee.
Under the Delaware Block Method three factors: (1) the earnings value, (2)
the asset value (and its corollary, liquidation value) and (3) the market value
of the stock, must be taken into account in determining fair value. In
determining the value of the HFB Financial common stock, the board reviewed the
report of PBS on fair value under the Delaware Block Method and adopted the
findings of PBS's report as conclusive of the appraised value of HFB Financial
common stock under the Delaware Block Method. However, the board ultimately
chose not use the Delaware Block Method as a separate consideration because
asset value was not relevant and the board separately reviewed the earnings and
market values of HFB Financial common stock.
In addition, the board did not separately consider the book value per share
in reaching its conclusion as to fair value. In the experience of the board and
its financial advisors, book value represents an historical cost and is not an
accurate indication of value. Accordingly, the board determined that it was not
directly relevant. The board did, however, acknowledge that the per share cash
price of $22.75 payable in the merger reflected a multiple of 1.22 times HFB
Financial's June 30, 2003, book value per share.
In connection with its deliberations, the board did not consider, and did
not request that its financial advisor evaluate, other than in the context of
the Delaware Block Method, HFB Financial's liquidation value. The board did not
view liquidation value as applicable to the valuation of HFB Financial's common
stock in the merger. However, an evaluation of liquidation value could produce a
higher valuation than book value per share. Additionally, HFB Financial can give
no assurance that the liquidation value would not produce a higher valuation of
HFB Financial than its value as a going concern.
No firm offers have been made by an unaffiliated person during the
preceding two years for (i) the merger or consolidation of HFB Financial into or
with such person, (ii) the sale or other transfer of all or any substantial part
of the assets of HFB Financial, or (iii) the purchase of a number of shares of
common stock that would enable the holder thereof to exercise control of HFB
Financial.
After consideration of all this information, the board determined that
$22.75 per share is a fair price to be paid in the merger to shareholders owning
fewer than 250 shares at the effective time of the merger to both affiliated and
unaffiliated shareholders. The board also concluded that the price of $22.75 per
share is fair to the unaffiliated shareholders who will retain their shares.
The transaction is not structured so that approval of at least a majority
of unaffiliated shareholders is required. The board determined that any such
voting requirement would usurp the power of the holders of a majority of HFB
Financial outstanding shares to consider and approve the merger agreement as
provided under Tennessee law, HFB Financial's charter documents and the terms of
the merger agreement. The board also considered such a provision unnecessary in
light of the right of shareholders, whether affiliated or unaffiliated and
regardless of the number of shares they own, to dissent from the merger. See
"Dissenters' and Appraisal Rights."
Because all of our directors own more than 250 shares, no independent
committee of the board was convened to review the fairness of the merger
proposal. No unaffiliated representative acting solely on behalf of the
shareholders for the purpose of negotiating the terms of the merger proposal or
preparing a report covering the fairness of the merger proposal was retained by
HFB Financial or by a majority of directors who are not employees of HFB
Financial.
HFB Financial has not made any provision in connection with the merger to
grant unaffiliated shareholders access to HFB Financial's corporate files or to
obtain counsel or appraisal services at HFB Financial's expense. With respect to
unaffiliated shareholders' access to HFB Financial's corporate files, the board
determined that this proxy statement, together with HFB Financial's other
filings with the SEC, provide adequate information for unaffiliated shareholders
to make an informed decision with respect to the merger. The board also
considered the fact that under Tennessee corporate law, and subject to certain
conditions set forth under Tennessee law, shareholders have the right to review
HFB Financial's relevant books and records of account. The board did not
consider these steps necessary to ensure the fairness of the merger proposal.
The
17
board determined that providing additional access to corporate files or
obtaining counsel or financial advisor services for unaffiliated shareholders
would be costly and would not provide any meaningful additional benefits. The
board noted the fact that the financial advisor engaged by HFB Financial
considered and rendered its opinion as to the fairness, from a financial point
of view, of the consideration payable in the merger to HFB Financial's
shareholders, including unaffiliated shareholders who will receive cash in the
merger.
After consideration of the factors described above, the board believes that
the transaction is fair, notwithstanding the absence of such an unaffiliated
shareholder approval requirement, independent committee or unaffiliated
representative. The board believes that the transaction is procedurally fair
because, after consideration of all aspects of the proposed transaction as
described above, all of the directors, including the directors who are not
employees of HFB Financial, approved the merger and the merger agreement. PBS
delivered its written fairness opinion to board on January 12, 2004.
HFB Financial has filed a copy of PBS's appraisal as an exhibit to the
Schedule 13E-3 that HFB Financial filed with the Securities and Exchange
Commission and the appraisal is available for inspection on the SEC's website,
www.sec.gov. In addition, HFB Financial will make the appraisal available at its
main office during regular business hours for inspection and copying by
shareholders.
THE BOARD UNANIMOUSLY RECOMMENDS THAT YOU VOTE "FOR" THE APPROVAL OF THE
MERGER AGREEMENT.
OPINION OF FINANCIAL ADVISOR
PBS was engaged by HFB Financial to advise HFB Financial's board of
directors as to the fairness of the consideration, from a financial perspective,
to the shareholders receiving cash in a proposed merger transaction whereby the
merger subsidiary will be merged with and into HFB Financial, with HFB Financial
being the survivor of the merger. Under the terms of the proposed merger,
shareholders of HFB Financial owning fewer than 250 shares will receive $22.75
in cash per share at the effective time of the merger.
PBS is a bank consulting firm with offices located throughout the United
States. As part of its investment banking business, PBS is regularly engaged in
reviewing the fairness of financial institution corporate transactions from a
financial perspective and in the valuation of financial institutions and other
businesses and their securities in connection with mergers, acquisitions, estate
settlements, and other transactions. Neither PBS nor any of its affiliates has a
material financial interest in HFB Financial. PBS was selected to advise HFB
Financial's board of directors based upon its familiarity with Kentucky and
Tennessee financial institutions and knowledge of the banking industry as a
whole. In addition, PBS has been engaged in the past to consult with HFB
Financial's board of directors to advise on strategic planning issues. The board
also considered PBS's familiarity with HFB Financial in selecting PBS as its
financial advisor.
PBS performed certain analyses described herein and presented the range of
values for HFB Financial, resulting from such analyses, to the board of
directors of HFB Financial in connection with its advice as to the fairness of
the consideration to be paid.
A Common Stock Fair Value Appraisal prepared by PBS was delivered to the
board of directors of HFB Financial prior to its October 21, 2003 meeting. A
copy of the Common Stock Fair Value Appraisal, which includes a summary of the
assumptions made and information analyzed in deriving the fairness opinion, is
attached as an exhibit to the Schedule 13E-3 filed by the HFB Financial with the
SEC and you are urged to read it in its entirety.
In arriving at its fairness opinion, PBS reviewed certain publicly
available business and financial information relating to HFB Financial. PBS
considered certain financial and stock market data of HFB Financial, and
compared that data with similar data for certain other publicly-held bank and
thrift holding companies. PBS also considered such other information, financial
studies, analyses and investigations and financial, economic and market criteria
that it deemed relevant. In connection with its review, PBS did not
independently verify the foregoing information and relied on such information as
being complete and accurate in all material respects. Financial forecasts
prepared by PBS were based on assumptions believed by PBS to be reasonable and
to reflect currently available information. PBS did not make an independent
evaluation or appraisal of the assets of HFB Financial.
18
For purposes of rendering its fairness opinion, PBS reviewed and analyzed
the historical performance of HFB Financial and its wholly owned subsidiary,
Home Federal Bank Corporation, including:
- June 30, 1999, 2000, 2001, 2002 and December 31, 2002 audited financial
statements and Forms 10-KSB of HFB Financial;
- December 31, 2002, March 31, 2003 and June 30, 2003 Consolidated Reports
of Condition and Income filed by Home Federal Bank Corporation;
- March 31, 2003 and June 30, 2003 Forms 10-QSB filed by HFB Financial with
the SEC;
- April 9, 2003 Information Statement filed by HFB Financial;
- June 30, 2003 Uniform Holding Company Performance Report of HFB
Financial;
- December 31, 2002, March 31, 2003 and June 30, 2003 FR Y-9C filed by HFB
Financial with the Federal Reserve; and
- the historical common stock trading activity of HFB Financial.
PBS reviewed statistical data regarding the loan portfolio, securities
portfolio and other performance ratios and statistics. Financial projections
were prepared and analyzed as well as other financial studies, analyses and
investigations as deemed relevant for the purposes of the opinion. In its review
of the aforementioned information, PBS took into account its assessment of
general market and financial conditions, its experience in other transactions,
and its knowledge of the banking industry generally.
In connection with rendering the fairness opinion and preparing its written
and oral presentation to HFB Financial's board of directors, PBS performed a
variety of financial analyses, including those summarized herein. The summary
does not purport to be a complete description of the analyses performed by PBS
in this regard. The preparation of a fairness opinion involves various
determinations as to the most appropriate and relevant methods of financial
analysis and the application of these methods to the particular circumstances
and therefore, such an opinion is not readily susceptible to summary
description. Accordingly, notwithstanding the separate factors summarized below,
PBS believes that its analyses must be considered as a whole and that selecting
portions of its analyses and of the factors considered by it, without
considering all analyses and factors, could create an incomplete view of the
evaluation process underlying its opinion. In performing its analyses, PBS made
numerous assumptions with respect to industry performance, business and economic
conditions and other matters, many of which are beyond HFB Financial's control.
The analyses performed by PBS are not necessarily indicative of actual values or
future results, which may be significantly more or less favorable than suggested
by such analyses.
As a part of its engagement of PBS, the board of directors instructed PBS
to perform to separate appraisals. The board instructed PBS to evaluate the
value of HFB Financial common stock under the Delaware Block Method, as the
leading valuation techniques under Tennessee case law, and in conformance with
more modern valuation trends in the leading corporate jurisdictions. With regard
to the latter, the board of directors requested that PBS employ all of the
evaluation methodologies and techniques that are appropriate considering the
circumstances and purposes of PBS's evaluation, including net asset value,
investment value and market value; but that it not employ a minority discount or
a liquidity discount. Finally, the board of directors instructed PBS not to
assume a pro forma sale of HFB Financial, but to assume the shareholders are
willing to maintain their investment in HFB Financial as though the transaction
in question had not occurred.
The Delaware Block Method. Under the Delaware Block Method and current
Tennessee case law, the concept of fair value requires explicit utilization and
the appropriate weighting of three valuation methods normally considered by
analysts and the courts to determine fair value: the Transaction Value Method,
the Asset Value Method and the Earnings Value Method. The Transaction Value
Method of valuing a share of common stock is determined by examining a number of
transactions that are assumed to have occurred at arm's length. The Asset Value
Method is based on adjusted value of net assets. The Earnings Value Method, as
utilized under the Delaware Block Method and Tennessee case law, involves an
estimation of the present value of a company's future earnings. Under that
method, an estimate of a company's future earnings is derived by averaging the
company's recent earnings over a relevant period and applying a capitalization
rate or
19
price to earnings ratio to this future earnings estimate. Following is a
discussion of PBS's analysis under each of these valuation methodologies:
- Transaction Value Method: The Transaction Value represents the price(s)
at which shares of common stock in HFB Financial have exchanged hands
between a willing buyer and seller. As of August 11, 2003, HFB Financial
has 1,301,101 common shares outstanding. As of September 26, 2003, HFB
Financial's common shares closed trading on the NASDAQ SmallCap Market at
$19.91 per share. From June 25, 2003 to October 21, 2003, HFB Financial
has had 28,826 of its common shares trade on the NASDAQ SmallCap Market
between $18.35 and $20.50 per common share.
- Asset Value Method: PBS analyzed and reviewed HFB Financial's balance
sheet data in the June 30, 2003 FR Y-9C and Form 10-QSB to determine the
amount of material adjustments required to the stockholders' equity of
HFB Financial based on differences between the market value of HFB
Financial's assets and their value reflected on HFB Financial's financial
statements. PBS determined that one adjustment was warranted. The only
adjustment that PBS deemed warranted was a $99,000 downward adjustment
for intangibles assets. The adjusted net asset value of HFB Financial was
determined to be $18.54 per share.
- Earnings Value Method: The Earnings Value Method equates the fair value
of a company to the present value of its anticipated future earnings. An
estimate of HFB Financial's future earnings is derived utilizing an
average of HFB Financial's reported earnings since 2001. HFB Financial's
earnings over the last three years are a more accurate predictor of HFB
Financial's future earnings than what would be attained by including more
historic operating results. The following table presents HFB Financial's
estimated future earnings to be utilized under the Earnings Value Method:
<Table>
June 30, 2001 Company Net Income............................ $1,489,000
June 30, 2002 Company Net Income............................ 1,589,000
June 30, 2003 Last Twelve Month Net Income.................. 2,484,000
----------
Average Company Net Income Since 2001....................... $1,854,000
==========
</Table>
Under the Earnings Value Method HFB Financial's estimated future earnings
are multiplied by an appropriate price to earnings ratio in order to
determine the fair value of HFB Financial's common shares. The price to
earnings multiple utilized in determination of fair value under this
methodology is 15.67 times earnings. The 15.67 times earnings ratio
represents the median last twelve month price earnings ratio of a large
subsection of publicly traded banks and thrifts. The composition of this
group consists of all 292 exchange traded banks and thrifts, excluding
mutual holding companies, in the states of Alabama, Arkansas, Florida,
Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan,
Minnesota, Mississippi, Missouri, Nebraska, North Carolina, North Dakota,
Ohio, Pennsylvania, South Carolina, South Dakota, Tennessee, Virginia,
West Virginia and Wisconsin which are not currently being acquired and
have total assets between $100.0 million and $5.0 billion and have a last
twelve month return on average equity greater then 5.0%. This price to
earnings multiple embodies a median of what community banks and thrifts
currently trade for without significant consideration being given to the
size, location, balance sheet structure or operating results of this group
beyond a minimum level. The value determined under the Earnings Value
Method was $22.33 per share.
In determination of the fair value of HFB Financial's common shares under
the Delaware Block Method, PBS concluded that the Asset Value Method represents
more of an historical cost that does not reflect the going concern aspect of HFB
Financial's business and is therefore not included in its opinion of value.
PBS weighed the Transaction Value as 55% and the Earnings Value as 45% in
determining the Delaware Block Method Value. In determining the weights to
assign to the Transaction Value and the Earnings Value, PBS considered earnings
growth prospects of HFB Financial and the price to earnings ratios of a
comparable bank group. PBS felt that, although the average of HFB Financial's
earnings over the last three years may somewhat understate HFB Financial's
future earnings potential; the median price to earnings ratio of the comparable
group was still higher than should be applicable to HFB Financial. PBS based
this conclusion on its assessment that HFB Financial has lower potential
long-term earnings growth prospects then the median of
20
the comparable group. In addition, PBS judged that HFB Financial has significant
reliance on interest sensitive non-core funding, which over the long-term, would
curtail HFB Financial's earnings growth. PBS found that over twelve month period
ended June 30, 2003, HFB Financial increased its deposit 1.19% compared to a
median deposit growth of 9.14% for the comparable bank group utilized in the
Earnings Value Method. In addition, PBS's analysis concluded that the core
markets in which HFB Financial operates have exhibited an aggregate three-year
compound rate of deposit growth of only 3.38%. Based on PBS's analysis, PBS
weighted the Earnings Value less heavily than the Transaction Value.
It was PBS's opinion that the fair value of HFB Financial's common stock
utilizing the Delaware Block Method of determining fair value is $21.00 per
common share without the application of any marketability or minority discounts.
Consideration of Recent Fair Value Case Law. PBS reviewed recent rulings
by courts in Delaware and a number of other states that have augmented the
original Delaware Block Method with a number of additional valuation techniques
in determining fair value. PBS determined that the most theoretically sound and
fundamentally significant of these additional methods utilized in the
determination of fair value are as follows:the Adjusted Book Value Method, the
Investment Value Method, the Discounted Cashflow Method, and the Acquisition
Comparable Method, each of which is described below:
- Adjusted Book Value Method and Investment Value Method: The Adjusted
Book Value Method evaluates prevailing market conditions for companies by
comparing the market price to book value ratios of comparable publicly
traded organizations to those of the subject company. The Investment
Value Method analyzes comparable publicly traded organizations and then
compares the market price to earnings per share of these organizations to
the subject company's current earnings. PBS compiled a comparable peer
group consisting of all banks and thrifts traded on the NASDAQ, AMEX or
NYSE which are not currently under agreement to be acquired, have total
assets between $150 million and $500 million, are headquartered in
Alabama, Arkansas, Georgia, Indiana, Kentucky, Mississippi, North
Carolina, Ohio, Tennessee or Virginia, have a core return on average
equity between 8.00% and 12.00% over the most recently reported last
twelve month period, have an equity to assets ratio between 8.50% and
10.50% and also regularly pay dividends to common shareholders (the
"Comparable Bank Group"). PBS chose to use a smaller sample in creating
the Comparable Bank Group than it had reviewed under the Delaware Block
Method in order to provide a more financially comparable group in terms
of performance and operating attributes.
The following table provides a summary analysis of the Adjusted Book Value
Method and the Investment Value Method of the Comparable Bank Group.
COMPARABLE BANK GROUP ADJUSTED BOOK VALUE AND
INVESTMENT VALUE METHOD SEPTEMBER 26, 2003
<Table>
<Caption>
ADJUSTED
BOOK VALUE INVESTMENT
BANK CITY METHOD VALUE METHOD
- ---- ---------------- ---------- ------------
BOE Financial Services of Virginia....... Tappahannock, VA 1.36X 13.27X
Classic Bancshares, Inc.................. Ashland, KY 1.40 13.53
Community Financial Corporation.......... Staunton, VA 1.36 11.25
FFW Corporation.......................... Wabash, IN 1.20 12.59
Shore Financial Corporation.............. Olney, VA 1.43 15.71
Logansport Financial Corporation......... Logansport, IN 1.10 14.24
LSB Financial Corp....................... Lafayette, IN 1.24 12.18
Pinnacle Bancshares, Inc................. Jasper, AL 1.10 10.83
MEDIAN................................. 1.30X 12.93
</Table>
- ---------------
Source: Financial information supplied by SNL Financial L.P. DataSource. Pricing
as of September 26, 2003
21
The application of the above median multiples to HFB Financial's book
value and year-to-date earnings per share resulted in a value of $24.20
per common share under the Adjusted Book Value Method and $25.18 per
common share under the Investment Value Method.
- Discounted Cash Flow Analysis: The Discounted Cash Flow Method relates
fair value to the future earnings and dividend capacity of a company. A
discounted cash flow analysis was performed by PBS pursuant to which a
range of values of HFB Financial was determined by adding (i) the present
value of an estimated future dividend stream that HFB Financial could
generate over a five-year period and (ii) the present value of the
"terminal value" of HFB Financial's earnings at the end of the fifth
year.
The "terminal value" of HFB Financial's earnings at the end of the
five-year period was determined by applying a multiple of 12.93 times HFB
Financial's projected earnings. The 12.93 multiple represents the median
multiple of core earnings at which the members of the Comparable Bank
Group traded as of September 26, 2003. Dividend streams and terminal
values were discounted to present values using a discount rate of 15.50%.
This rate reflects assumptions regarding the rate of return sought by
holders or buyers of HFB Financial's common stock. The value of HFB
Financial's common stock determined in this manner was $22.05 per share.
The following tables demonstrate the five-year summary financial data
utilized in the determination of the Discounted Cash Flow Analysis:
5 YEAR SUMMARY PROJECTED DATA
<Table>
<Caption>
YEAR ASSETS NET INCOME DIVIDENDS EQUITY
---- -------- ---------- --------- -------
1 $274,326 $2,606 $ 652 $26,171
2 293,528 2,935 734 28,372
3 314,075 3,298 824 30,845
4 336,061 3,697 924 33,618
5 359,585 4,135 1,034 36,719
</Table>
PROJECTED FINANCIAL RATIOS
<Table>
<Caption>
YEAR RETURN ON ASSETS RETURN ON EQUITY EQUITY/ASSETS
---- ---------------- ---------------- -------------
1 0.95% 9.96% 9.54%
2 1.00 10.35 9.67
3 1.05 10.69 9.82
4 1.10 11.00 10.00
5 1.15 11.26 10.21
</Table>
In addition, using the five-year projection as a base, PBS calculated a
twenty-year projection assuming an annual growth rate in assets of 7.0%
in years one through five and 6.0% in years six through twenty. Return on
assets was projected to increase from 0.95% in year one to 1.15% in year
five and then increase to 1.25% by year seven and remain constant at that
level for the remainder of the analysis. Dividends representing 25% of
net income were assumed to be paid in years one through five and then
increased to 60% of net income in years six through twenty. PBS used the
same 15.50% discount rate. This long-term projection resulted in a value
per share of $16.16.
- Acquisition Comparable Method: PBS also considered an Acquisition
Comparable Method in its determination as to the fairness of the proposed
cash fair value of HFB Financial's common shares. PBS performed an
analysis of bank and thrift acquisition transactions in which
transactions that were deemed to be comparable to HFB Financial's
proposed merger were analyzed. In the utilization of this method, PBS
performed an analysis of acquisition transactions where the consideration
received by the selling institution was cash and where the acquiror was a
newly formed holding company created for the purpose of acquiring the
seller. While none of the transactions analyzed involved a going private
transaction similar to HFB Financial's proposed transaction, the
rationale for the selection of these transactions as being comparable to
HFB Financial's proposed transaction focuses on several similarities.
First, all of the selected transactions were acquisitions in which the
seller had a return on average
22
equity greater than five percent and assets over $20 million. Second, all
of the selected transactions had only cash as the merger consideration.
Third, the acquirer was a newly formed holding company or an investor
group and not a third party financial institution. As a result, the
acquirors in the selected transactions would, in PBS's opinion, be unable
to realize the degree of cost savings and synergies available in most
acquisition transactions where the acquirer is an existing financial
institution and it is unlikely that the acquisition pricing reflected any
significant synergies or cost savings. Finally, PBS limited its search to
transactions announced since June 30, 2001 when the acquisition
accounting rules were changed.
PBS's analysis under the Acquisition Comparable Method mitigated the
synergies and cost savings present in most acquisition pricing. PBS is
unaware of a method of completely isolating or excluding these effects
from the overall price. PBS's analysis revealed that, without limiting
the Comparable Bank Group, the cost savings and synergies in operations
that allow third party acquirers to pay a higher price than would
otherwise be possible would skew its analysis of a fair price for HFB
Financial common stock.
PBS determined that seven acquisition transactions were comparable to HFB
Financial's proposed merger. The median multiples of book value and
earnings of the comparable acquisition transactions were 1.55 and 11.66,
respectively. The application of these multiples to HFB Financial
resulted in values of $28.85 based on the multiple of book value and
$22.71 based on the multiple of earnings. It is PBS's opinion that the
majority of the premium paid in most financial institution acquisitions
is attributable to the cost savings and synergies rather than simply
control.
Summary of Methodologies. The following table presents a summary of
previously derived methodologies.
<Table>
<Caption>
VALUE PER SHARE MULTIPLE OF BOOK
--------------- ----------------
Transaction Value...................................... $19.91 1.07X
Asset Value Method..................................... 18.54 1.00
Earnings Value Method.................................. 22.33 1.20
Adjusted Book Value:
Comparable Bank Group................................ 24.20 1.30
Investment Value:
Comparable Bank Group................................ 25.18 1.35
Discounted Cash Flow Value:
Short Term........................................... 22.05 1.18
Long Term............................................ 16.16 0.87
Acquisition Comparables:
Multiple of Book Value............................... 28.85 1.55
Multiple of Earnings................................. 22.71 1.22
AVERAGE................................................ 22.21 1.19
MEDIAN................................................. 22.33 1.20
</Table>
The average and median of the above values are $22.21 and $22.33, respectively,
including the Asset Value Method. As mentioned previously, PBS believes that the
Asset Value Method reflects historical cost and was not taken into consideration
in determining fair value because it does not accurately reflect the going
concern aspect of HFB Financial's business. The median and average of the above
values excluding the Asset Value Method are $22.52 and $22.67, respectively.
Implicit in several of the above described valuation methodologies is the
assumption that HFB Financial's operating attributes equal the median of the
Comparable Bank Group and that HFB Financial will meet PBS's financial
projections. In determining the fair value of HFB Financial's common shares,
PBS's analysis reflects the fact that HFB Financial's operating performance,
dividends and other performance characteristics are distinguishable from the
median of the Comparable Bank Group. PBS did not rely on the average or median
values in its determination of fair value.
23
- Slight premium for financial performance above the Comparable Bank
Group. PBS adjusted its determination of fair value per share of HFB
Financial common stock to reflect a slight premium on HFB Financial
common stock attributable to its financial performance when compared to
the Comparable Bank Group. PBS's analysis revealed a median return on
average equity for the Comparable Bank Group over the last twelve months
ending June 30, 2003 equal to 10.41% compared to 10.65% for HFB
Financial. However, PBS also found that HFB Financial's last twelve month
efficiency ratio of 61.66% is above the Comparable Bank Group median
efficiency ratio of 57.92% and HFB Financial's last twelve months return
on average assets of 0.98% is below the Comparable Bank Group median of
1.06%.
- Slight discount for lower level of dividends compared to the Comparable
Bank Group. PBS also adjusted its determination of fair value per share
of HFB Financial common stock due to HFB Financial's lower dividend
payout ratio when compared to the Comparable Bank Group. HFB Financial's
semi-annual dividend payments equal 23.35% of its net income over the
last twelve months ending June 30, 2003 compared to the Comparable Bank
Group's median last twelve month dividend payout ratio of 26.64%
- Discount for risks associated with rapid loan growth and asset quality
issues. The premium which could be justified on HFB Financial's common
shares relative to the Comparable Bank Group for financial performance is
more than offset by risks associated with the adequacy of HFB Financial's
allowance for loan and lease losses. As of June 30, 2003, HFB Financial's
loan loss allowance equals 0.75% of total loans compared to the median of
the Comparable Bank Group of 1.27%. As of June 30, 2003, HFB Financial's
loan loss reserves equals 40.80% of non-accrual loans plus loans 90+ days
past due and still accruing and other real estate owned compared to the
median of the Comparable Bank Group of 110.77%. In addition, HFB
Financial's non-accrual loans plus loans 90+ days past due and still
accruing and other real estate owned equal 1.31% of assets at June 30,
2003 compared to the median of the Comparable Bank Group of 0.86%. Of
further concern, as of June 30, 2003 HFB Financial has an additional $2.8
million in loans 30 to 89 days past due and still accruing.
Based on the foregoing, the economic and demographic characteristics of the
specific markets in which HFB Financial operates, as well as, all other factors
deemed relevant and assuming accuracy and completeness of information provided
by HFB Financial, it is PBS's opinion as an independent appraiser that the cash
consideration of $22.75 per share to be paid to the shareholders of HFB
Financial common stock who hold fewer than 250 shares of HFB Financial common
stock, in accordance with the merger agreement, is fair, from a financial point
of view, to all shareholders of HFB Financial including to all of the
unaffiliated shareholders of HFB Financial whether they receive cash or remain
shareholders following the merger.
PBS will receive fees of $7,500 for all services performed in connection
with rendering of the Common Stock Fair Value Appraisal and fairness opinion. In
addition, HFB Financial has agreed to indemnify PBS and its directors, officers
and employees, from liability in connection with the transaction, and to hold
PBS harmless from any losses, actions, claims, damages, expenses or liabilities
related to any of PBS' acts or decisions made in good faith and in the best
interest of HFB Financial. As disclosed above, PBS has, in the past, been
engaged by HFB Financial to provide consulting and strategic planning advice.
Over the past two years, payments by HFB Financial to PBS have represented less
than 1% of PBS's income during the same period.
CERTAIN EFFECTS OF THE MERGER
The merger will have various effects on HFB Financial, as described below.
Reduction in the Number of Shareholders. We believe that the merger will
reduce the number of record shareholders from approximately 372 to approximately
212. As noted earlier, in addition to the approximately 20,589 shares held by
shareholders of record with fewer than 250 shares in their account, HFB
Financial assumes that beneficial owners of approximately 2,470 shares held in
street name will receive cash for their shares in the merger. Accordingly, the
number of outstanding shares of common stock will decrease from 1,301,101, as of
the record date, to approximately 1,280,512, after the merger.
24
Decrease in Book Value. Because (i) the price to be paid to holders of
fewer than 250 shares of common stock will be $22.75 per share, (ii) the maximum
number of shares of common stock expected to be cashed-out as a result of the
merger is 131,868, (iii) the total cost to HFB Financial (including expenses) of
effecting the merger is expected to be approximately $3,134,961, and (iv) at
September 30, 2003, aggregate shareholders' equity in HFB Financial was
approximately $24,015,700, or $18.46 per share, HFB Financial expects that, as a
result of the merger:
- aggregate shareholders' equity of HFB Financial as of September 30, 2003,
will be reduced from approximately $24,015,700 on a historical basis to
approximately $20,875,759 on a pro forma basis;
- the book value per share of common stock as of September 30, 2003, will
be reduced from approximately $18.46 per share on a historical basis to
approximately $17.85 per share on a pro forma basis; and
- net income per share of common stock (including non-recurring income and
expenses) for the year ended September 30, 2003, will increase from $1.46
on a historical basis to $1.61 on a pro forma basis.
Decrease in Capital. As a result of the merger, HFB Financial's capital
will be reduced. However, HFB Financial anticipates that it will remain "well
capitalized" for bank regulatory purposes. HFB Financial's capital will be
reduced, including a decrease in HFB Financial's Tier 1 capital as of September
30, 2003, from $23,099,262 on a historical basis to approximately $19,959,821 on
a pro forma basis as of September 30, 2003 and a corresponding decrease in HFB
Financial's Tier 1 risk-based capital ratio from 14.20% on a historical basis to
approximately 12.52% on a pro forma basis, a decrease in HFB Financial's total
risk based capital ratio from 15.12% on a historical basis to approximately
13.46% on a pro forma basis and a decrease in HFB Financial's leverage ratio
from 8.93% on a historical basis to approximately 7.82% on a pro forma basis,
assuming the maximum of 131,868 shares are cashed-out in the merger and no
shareholders perfect their dissenters' rights.
Termination of Exchange Act Registration. Our common stock is currently
registered under the Exchange Act. We plan to terminate the registration of our
common stock once our common stock is held by fewer than 300 shareholders of
record. Termination of registration of our common stock under the Exchange Act
will substantially reduce the information we are required to furnish to our
shareholders and to the SEC. It would also make certain provisions of the
Exchange Act, such as proxy statement disclosure in connection with shareholder
meetings and the related requirement of an annual report to shareholders, no
longer applicable to HFB Financial. Accordingly, we estimate it will eliminate
costs and expenses associated with continuance of the Exchange Act registration,
estimated at approximately $149,300 per year. We intend to apply for such
termination as soon as practicable following completion of the merger.
In the event the registration of our common stock is terminated under the
Exchange Act, executive officers, directors and other affiliates would no longer
be subject to many of the reporting requirements and restrictions of the
Exchange Act including, but without limitation, the reporting and short swing
profit provisions of Section 16.
Effect on Market for Shares. Our common stock is currently traded on the
NASDAQ SmallCap Market. After the merger and the subsequent termination of the
registration of our common stock under the Exchange Act our common stock will be
ineligible for listing on the NASDAQ SmallCap Market or on the OTC Bulletin
Board. Any trading in our common stock after the transaction will only occur in
the "pink sheets" or in privately negotiated sales. The "pink sheets" are
maintained by Pink Sheets LLC (formerly The National Quotation Bureau, Inc.).
Pink Sheets is a quotation service that collects and publishes market maker
quotes for over-the-counter securities. The pink sheets are not a stock exchange
or a self regulated entity. Price quotations are provided by the
over-the-counter market makers and company information is provided by the
over-the-counter companies. Although shares of our common stock may trade in the
pink sheets, shareholders of HFB Financial will experience a significant
reduction in the liquidity of the HFB Financial common stock.
Dividend Policy. Given the relatively small percentage of shares of common
stock being repurchased in the merger, we do not anticipate that the merger will
have a material effect on our dividend policy.
25
Financial Effects of the Merger; Financing of the Merger. We expect that
the purchase of the cashed-out shares in the merger will cost not more than
approximately $468,400, which does not include approximately $125,000 in
professional fees and other expenses related to the transaction. In addition, we
do not expect that the completion of the merger will have any material adverse
effect on our capital adequacy, liquidity, results of operations or cash flow.
Because we do not currently know the actual number of shares that will be
cashed-out in the merger, we do not know the exact amount of cash we will pay to
shareholders in the merger. However, our obligation to consummate the merger
under the merger agreement is conditioned on the total cost of paying for the
shares cashed-out in the merger and dissenters' shares not exceeding $3.0
million. Accordingly, we do know that, unless we waive that condition, the
maximum amount that we anticipate paying to shareholders in the merger is $3.0
million. You should read the discussion under "The Merger
Agreement -- Conditions to Completion of the Merger" for a description of
conditions to the obligations of the parties to consummate the merger and
"Special Factors -- Fees and Expenses" for a description of the fees and
expenses that we expect to incur in connection with the merger.
We expect to finance the merger, including the related costs and expenses,
through cash at HFB Financial and, if necessary, a dividend from our subsidiary,
Home Federal Bank Corporation.
Increased Share Ownership of Officers and Directors. As a result of the
merger, we expect that: (a) the percentage of ownership of common stock of HFB
Financial held by current officers and directors of HFB Financial as a group
will increase from 15.46% to approximately 17.20%, (b) the collective book value
as of September 30, 2003, of the shares of our common stock held by our current
officers and directors, as a group, will decrease from $3,713,469 on a
historical basis to approximately $3,590,760 on a pro forma basis, and (c) the
collective pro rata interest of our current officers and directors, as a group,
in the net income of HFB Financial for the nine-month period ended September 30,
2003 will increase from $283,321 on a historical basis (based on the number of
shares beneficially owned by such officers and directors as of the record date)
to approximately $312,639 on a pro forma basis (based on the number of shares we
anticipate such officers and directors to own beneficially immediately after the
merger). For a description of the assumptions used in determining the numbers of
shares and related percentages that we expect to be held by executive officers
and directors immediately following the merger, please see footnotes (1) and (2)
under "The Parties -- Security Ownership of Management."
No Further Reporting Obligations under the Securities Exchange Act. Our
common stock is currently registered under the Exchange Act. After the merger,
we plan to terminate that registration if our common stock is no longer held by
300 or more shareholders of record. Termination of registration of our common
stock under the Exchange Act would substantially reduce the information we are
required to furnish to our shareholders and the SEC. It would also make certain
provisions of the Exchange Act, such as the short saving profit recovery
provisions of Section 16(b), proxy statement disclosure in connection with
shareholder meetings and the related requirement of an annual report to
shareholders, no longer applicable to HFB Financial. Accordingly, we estimate it
will eliminate costs and expenses associated with continuance of the Exchange
Act registration, estimated at approximately $149,300 a year. We intend to apply
for such termination as soon as practicable following completion of the
transaction. In the event the registration of our common stock is terminated
under the Exchange Act, we will no longer file Forms 10-QSBs, 10-KSBs, 8-Ks or
any other forms with the SEC.
EFFECT OF THE MERGER ON SHAREHOLDERS
General. The merger will have same effects on shareholders regardless of
whether they are affiliated or unaffiliated shareholders. The determination of
whether or not any particular shares of HFB Financial common stock will be
cashed-out in the merger will be based on whether the holder of those shares
holds either fewer than 250 shares or 250 or more shares. Since a shareholder
may beneficially own shares held by more than one holder of record, a
shareholder may beneficially own both shares that will be cashed-out in the
merger and shares that will remain outstanding in the merger. We expect that our
executive officers and directors will continue to own beneficially a total of
approximately 201,163 shares, or 17.2% of the outstanding shares immediately
after the merger. We do not anticipate any affiliated shareholder's shares being
cashed-out
26
in the merger. All of the effects to shareholders described below assume that
the maximum of 131,868 shares are cashed-out in the merger, unless otherwise
noted.
- Cashed-Out Shareholders. Shareholders owning fewer than 250 shares
immediately prior to the effective time of the merger will, upon
consummation of the merger:
- receive $22.75 in cash, without interest, per share, and therefore will
not participate in HFB Financial future potential earnings or growth, if
any, as a shareholder;
- no longer have any equity interest in HFB Financial and therefore will
not participate in its future potential earnings or growth, if any, as a
shareholder;
- not be able to re-acquire an equity interest in HFB Financial unless
they purchase shares from the remaining shareholders, although HFB
Financial does not anticipate that the remaining shareholders will
transfer their shares to third parties; and
- be required to pay federal and, if applicable, state and local income
taxes on the cash amount received in the merger. See "Special
Factors -- Certain U.S. Federal Income Tax Consequences."
- Remaining Shareholders. The effects of the merger on shareholders owning
250 or more shares immediately prior to the effective time of the merger
will upon consummation of the merger include:
- shareholders who own 250 or more shares immediately prior to the
effective time of the merger will continue to be shareholders of HFB
Financial and will own the same number of shares after the merger as
they owned immediately before the merger;
- remaining shareholders will have an increased ownership percentage in
HFB Financial as a result of the merger;
- if the merger is effected, we intend to terminate the registration of
our common stock under the Exchange Act. As a result, we will no longer
be subject to the periodic reporting requirements and the proxy rules of
the Exchange Act;
- the directors and executive officers will no longer be subject to the
reporting and short swing profit provisions under the Exchange Act with
respect to charges in their beneficial ownership of HFB Financial common
stock;
- the liquidity of the shares of common stock held by remaining
shareholders may be further reduced by the merger due to the termination
of the registration of our common stock under the Exchange Act. Any
trading in our common stock after the merger will only occur in the
"pink sheets" or privately negotiated transactions;
- HFB Financial's capital will be reduced, including a decrease in HFB
Financial's Tier 1 capital as of September 30, 2003, from approximately
$23,099,262 on a historical basis to approximately $19,959,821 on a pro
forma basis, and a corresponding decrease in our leverage ratio of 8.93%
on a historical basis to approximately 7.82% on a pro forma basis;
- the book value per share of common stock as of September 30, 2003, will
be reduced from $18.46 per share on a historical basis to approximately
$17.85 per share on a pro forma basis for decrease of approximately
3.3%;
- net income per share of common stock (including non-recurring income and
expenses) for the year ended December 31, 2002, will increase from $1.95
on a historical basis to approximately $2.16 on a pro forma basis for a
increase of 10.77%. Net income per share for the nine months ended
September 30, 2003 will increase from $1.46 on a historical basis to
approximately $1.61 on a pro forma basis for an increase of 10.3%;
- a result of the merger, we expect that: (a) the percentage of ownership
of common stock of HFB Financial held by executive officers and
directors of HFB Financial as a group will increase from 15.46%, as of
the record date, to approximately 17.20%, and (b) the collective pro
rata interest of HFB Financial's current executive officers and
directors, as a group, in the net income of HFB Financial for the year
ended December 31, 2002, will increase from $376,209 on a historical
basis (based on the number of shares beneficially owned by such officers
and directors as of the record
27
date) to approximately $415,124 on a pro forma basis (based on the
number of shares HFB Financial anticipates such executive officers and
directors to own beneficially immediately after the merger) and for the
nine months ended September 30, 2003, will increase from approximately
$283,321 on a historical basis to approximately $312,639 on a pro forma
basis.
Examples. In general, the merger can be illustrated by the following
examples:
<Table>
<Caption>
HYPOTHETICAL SCENARIO RESULT
--------------------- ------
Ms. Smith owns 150 shares of HFB Ms. Smith's 150 shares will be canceled
Financial common stock registered in her and converted into the right to receive
own name at the effective time of the cash in the amount of $22.75 per share.
merger. Ms. Smith holds no other shares
If Ms. Smith wants to continue her
investment in HFB Financial, she would
need to buy at least 100 shares of HFB
Financial common stock (such purchase
must be in her own name so as to make it
more readily apparent that she holds 250
or more shares). Ms. Smith should act far
enough in advance of the effective time
of the merger so that the purchase is
complete and registered on the books of
HFB Financial before the merger.
Mr. Brown owns 200 shares of HFB Mr. Brown's 200 shares will be converted
Financial that are held in a brokerage into the right to receive cash in an
account at the effective time of the amount equal to $22.75 per share. Mr.
merger. Mr. Brown owns no other shares Brown will no longer be a shareholder of
HFB Financial.
Mr. Jones owns 200 shares of HFB If either HFB Financial or Mr. Jones can
Financial registered in his own name and establish to HFB Financial's satisfaction
200 shares that are held in a brokerage that he, in fact, holds greater than 250
account at the effective time of the shares, Mr. Jones' 400 shares will remain
merger. Mr. Jones owns no other shares outstanding after the merger. Otherwise,
HFB Financial will presume that all of
the shares are held by a holder of fewer
than 250 shares and were therefore
canceled in the merger and converted into
the right to receive cash in an amount
equal to $22.75 per share. Mr. Jones will
be able to rebut the presumption that his
shares were cashed-out in the merger by
certifying in the letter of transmittal
sent to him after the merger that he
holds 250 or more shares and by providing
HFB Financial such other information as
it may request to verify that fact. HFB
Financial has the sole discretion in
rendering such a determination.
</Table>
As described in the section "The Merger Agreement -- Conversion of Shares
in the Merger," the merger agreement contains specific provisions regarding the
treatment of shares held in nominee form, or "street name." In determining the
number of shares held beneficially in street name by any shareholder, HFB
Financial may, in its discretion, rely on "no objection" lists provided by any
nominee holder. Further, after the merger, HFB Financial will deliver to each
shareholder who would appear to be entitled to receive cash in the merger in
consideration for his or her shares a letter of transmittal requesting certain
information from such shareholder and requiring the shareholder to certify as to
the number of shares actually held, whether in registered form, or in street
name. Letters of transmittal will be delivered to any shareholder who: (a) holds
of record fewer than 250 shares, (b) according to records made available to HFB
Financial from the nominee holder for any shares held in street name, holds
fewer than 250 shares in street name or (c) holds shares in
28
street name and with respect to which HFB Financial is not provided by the
nominee holder the number of shares so held.
If you want to continue to hold HFB Financial common stock after the
merger, you may do so by purchasing a sufficient number of shares of HFB
Financial Common stock on the NASDAQ SmallCap Market so that you hold at least
250 shares at the effective time of the merger.
MERGER SUBSIDIARY'S DETERMINATION OF FAIRNESS OF THE MERGER PROPOSAL
Merger subsidiary and its board of directors believe that the merger is
fair to, and in the best interests of, each of HFB Financial's shareholders,
including unaffiliated shareholders, whether such shareholder will receive cash
in the merger or will retain their shares of common stock after the merger. In
reaching this conclusion, merger subsidiary relied upon the factors considered
by, and the analysis and conclusions of, the board of directors of HFB Financial
and adopted all of the analyses and conclusions of the board of directors of HFB
Financial. See "Special Factors -- Recommendation of the Board of Directors;
Fairness of the Merger Proposal." The merger agreement has been approved by
merger subsidiary's board of directors and HFB Financial, as the sole
shareholder of merger subsidiary.
INTERESTS OF EXECUTIVE OFFICERS AND DIRECTORS IN THE MERGER
We refer you to the information under the heading "The Parties -- Security
Ownership of Management" for information regarding our current executive
officers and directors and their stock ownership in HFB Financial. As a result
of the merger, HFB Financial expects that: (a) the beneficial ownership of
common stock of HFB Financial held by current executive officers and directors
of HFB Financial, as a group, will increase from 15.46% to approximately 17.20%,
(b) the collective book value as of September 30, 2003, of the shares of HFB
Financial common stock held by HFB Financial's current executive officers and
directors, as a group, will decrease from $3,713,469 on a historical basis to
approximately $3,590,760 on a pro forma basis (based on the number of shares HFB
Financial anticipates such executive officers and directors to own beneficially
immediately before and after the merger, respectively), and (c) the collective
pro rata interest of HFB Financial's current executive officers and directors,
as a group, in the net income of HFB Financial for the year ended December 31,
2002 will increase from $376,209 on a historical basis (based on the number of
shares beneficially owned by such executive officers and directors as of the
record date) to approximately $415,124 on a pro forma basis (based on the number
of shares HFB Financial anticipates such executive officers and directors to own
beneficially immediately after the merger) and for the nine months ended
September 30, 2003, will increase from approximately $283,321 on a historical
basis to approximately $312,639 on a pro forma basis. For a description of the
assumptions HFB Financial used in determining the numbers of shares and related
percentages that HFB Financial expects to be held by current executive officers
and directors immediately after the merger, please see footnotes (1) and (2)
under "The Parties -- Security Ownership of Management."
CONDUCT OF HFB FINANCIAL'S BUSINESS AFTER THE MERGER
Following the merger, HFB Financial and its subsidiaries, including Home
Federal Bank Corporation, will continue to conduct their existing operations in
the same manner as they are now conducted. The executive officers and directors
of HFB Financial immediately prior to the merger will be the executive officers
and directors of HFB Financial after the merger. The charter and bylaws of HFB
Financial will remain in effect and unchanged by the merger. The deposits of
Home Federal Bank Corporation will continue to be insured by the FDIC, and HFB
Financial and Home Federal Bank Corporation will continue to be regulated by the
same regulatory agencies as before the merger.
HFB Financial believes that there are significant advantages in becoming a
private company, and HFB Financial plans to avail itself of any opportunities it
may have as a private company, including, but not limited to, making any public
or private offering for its shares, or entering into any other arrangement or
transaction as it may deem appropriate. Although management does not presently
have an intent to enter into any such transaction nor is management currently in
negotiations with respect to any such transaction, there exists the possibility
that HFB Financial may enter into such an arrangement or transaction in the
future and the
29
remaining shareholders of HFB Financial may receive payment for their shares in
any such transaction lower than, equal to or in excess of the amount paid to
cashed-out shareholders in the merger.
Other than as described in this proxy statement, neither HFB Financial nor
its management has any current plans or proposals to effect any extraordinary
corporate transaction, such as a merger, reorganization or liquidation; to sell
or transfer any material amount of its assets; to change its board of directors
or management; to change materially its indebtedness or capitalization; or
otherwise to effect any material change in its corporate structure or business.
The shares of HFB Financial common stock converted in the merger into the right
to receive $22.75 in cash will, after the merger, be included in HFB Financial's
authorized but unissued shares and would be available for issuance in the
future.
FEES AND EXPENSES
HFB Financial estimates that merger related fees and expenses, consisting
primarily of financial advisory fees, SEC filing fees, fees and expenses of
attorneys and accountants and other related charges, will total approximately
$125,000, assuming the merger is completed. This amount consists of the
following estimated fees:
<Table>
<Caption>
DESCRIPTION AMOUNT
- ----------- --------
Advisory fees and expenses.................................. $ 25,000
Legal fees and expenses..................................... 75,000
Accounting fees and expenses................................ 15,000
SEC filing fee.............................................. 38
Printing, solicitation and mailing costs.................... 10,000
--------
Total..................................................... $125,038
========
</Table>
ANTICIPATED ACCOUNTING TREATMENT
HFB Financial anticipates that it will account for the purchase of
outstanding HFB Financial common stock in the merger from shareholders as a
treasury stock transaction.
CERTAIN U.S. FEDERAL INCOME TAX CONSEQUENCES
The following discussion summarizes the material U.S. federal income tax
consequences to the shareholders of HFB Financial with respect to the merger.
The discussion is based upon the Internal Revenue Code of 1986, as amended, its
legislative history, applicable U.S. Treasury regulations, existing
administrative interpretations and court decisions currently in effect. Any of
these authorities could be repealed, overruled or modified at any time after the
date of this proxy statement, and any such change could be applied
retroactively. This discussion does not address any alternative minimum tax
consequences or the tax consequences under state, local or foreign laws.
The discussion that follows neither binds nor precludes the Internal
Revenue Service from adopting a position contrary to that expressed in this
document, and we cannot assure you that such a contrary position could not be
asserted successfully by the Internal Revenue Service or adopted by a court if
the positions were litigated. HFB Financial has not obtained a ruling from the
Internal Revenue Service or a written opinion from tax counsel with respect to
the federal income tax consequences discussed below.
This discussion assumes that you hold your shares of HFB Financial common
stock as a capital asset within the meaning of section 1221 of the Internal
Revenue Code. This discussion summarizes the tax consequences that are generally
applicable to shareholders of HFB Financial with respect to the merger but this
discussion does not address all tax considerations that may be important to you
in light of your particular circumstances (such as the alternative minimum tax
provisions) under certain special rules. Special rules may apply to shareholders
who are not citizens or residents of the United States, financial institutions,
tax-exempt organizations and entities (including IRAs), insurance companies,
dealers in securities, shareholders, who hold options to acquire shares of our
common stock, and shareholders who acquired their shares of common stock through
the exercise of employee stock options or similar derivative securities or
otherwise as compensation.
30
Federal income tax consequences to shareholders who do not receive cash in
the merger. If you (1) continue to hold HFB Financial common stock immediately
after the merger, and (2) you receive no cash as a result of the merger, then
you will not recognize any gain or loss in the merger and you will have the same
adjusted tax basis and holding period in your HFB Financial common stock as you
had in such stock immediately prior to the merger.
Federal income tax consequences to shareholders who receive cash in the
merger. An exchange of shares of HFB Financial common stock for cash pursuant
to the merger will be a taxable transaction. If you receive cash in exchange for
HFB Financial common stock as a result of the merger, the cash you received will
be treated as a redemption of the shares of HFB Financial common stock exchanged
therefor under Section 302 of the Internal Revenue Code. Under Section 302 of
the Internal Revenue Code, a shareholder who exchanges his or her shares of HFB
Financial common stock for cash will be treated as having sold his or her shares
if the exchange meets one of the following three tests:
- the exchange results in a "complete termination" of his or her equity
interest in HFB Financial;
- the exchange is "substantially disproportionate" with respect to the
shareholder; or
- the cash received is "not essentially equivalent to a dividend" with
respect to the shareholder.
For purposes of these tests, in addition to the shares you actually own,
you will be deemed to own constructively certain shares under the constructive
ownership rules of Section 318 of the Internal Revenue Code. Generally, the
constructive ownership rules under Section 318 of the Internal Revenue Code
treat a shareholder as owning:
- shares of stock owned by certain relatives, related corporations,
partnerships, estates or trusts, and
- shares of stock the shareholder has an option to acquire.
Because the constructive ownership rules are complex, each shareholder
should consult his or her own tax advisor as to the applicability of these
rules.
Cashed-out shareholders who do not actually or constructively Own any
shares of HFB Financial common stock after the merger. In general, if you
receive cash in exchange for HFB Financial common stock as a result of the
merger and do not own any shares of HFB Financial common stock immediately after
the merger, you will be treated as having sold your shares of HFB Financial
common stock for the cash received. You will recognize gain or loss on the
exchange in an amount equal to the difference between the cash you receive for
your cashed-out stock and your aggregate adjusted tax basis in such stock. Your
gain will be a capital gain provided you held your shares of HFB Financial
common stock as a capital asset within the meaning of Section 1221 of the
Internal Revenue Code as of the effective time change effective time of the
merger.
Shareholders receiving cash who actually or constructively continue to own
any shares of HFB Financial common stock after the merger. If you receive cash
in exchange for HFB Financial common stock as a result of the merger and are
treated as directly or constructively owning shares of HFB Financial immediately
after the merger, then you will be treated as having sold your shares for the
cash received only if you meet one of the three tests mentioned above and
described below.
You will satisfy the "complete termination" test if you receive cash in
exchange for your shares of HFB Financial common stock pursuant to the merger
and you completely terminate your direct and constructive ownership interest in
HFB Financial. If you would otherwise satisfy the complete termination
requirement but for your constructive ownership of shares held by family
members, you may, in certain circumstances, be entitled to disregard such
constructive ownership. You should check with your own tax advisor as to whether
you would be entitled to disregard such constructive ownership and the required
filings with the Internal Revenue Service pursuant to such a decision.
You will satisfy the "substantially disproportionate" test if immediately
after the merger you actually and constructively own less than 50% of the total
combined voting power of all classes of our stock entitled to vote and your
percentage interest in HFB Financial (i.e., the number of voting shares actually
and constructively owned by you divided by the number of voting shares
outstanding) is less than 80% of your percentage interest in HFB Financial
immediately prior to the merger.
31
You will satisfy the "not essentially equivalent to a dividend" test if the
reduction in your percentage interest in HFB Financial, as described above,
constitutes a "meaningful reduction of your proportionate interest" given your
particular facts and circumstances. The Internal Revenue Service has indicated
in published rulings that a minority shareholder whose relative stock interest
is minimal (i.e., less than 1%) and who exercises no control with respect to
corporate affairs is considered to have a "meaningful reduction" generally if
the shareholder has some reduction in the shareholder's stock ownership
percentage.
If you satisfy one of these three tests, you will be treated as having sold
your shares of HFB Financial common stock for the cash exchanged therefor and
will recognize gain or loss on the exchange in an amount equal to the difference
between the cash you receive for your cashed-out stock and your aggregate
adjusted tax basis in such stock. Your gain will be a capital gain provided you
held your shares of HFB Financial common stock as a capital asset within the
meaning of Section 1221 of the Internal Revenue Code as of the effective time of
the merger.
If you do not satisfy one of these three tests, you will be treated as
having received a dividend to the extent of our current and accumulated earnings
and profits, which we anticipate will be sufficient to cover the amount of any
such dividend an will be includible in your gross income as ordinary income in
its entirety, without reduction for the tax basis of the shares sold. No loss
will be recognized. If the exchange is treated as a dividend, your tax basis in
the shares sold generally will be added to your tax basis in your remaining
shares. To the extent that cash received in exchange for shares is treated as a
dividend to a corporate shareholder, the shareholder will be: (i) eligible for a
dividends-received deduction (subject to applicable limitations); and (ii)
subject to the "extraordinary dividend" provisions of the Internal Revenue Code.
To the extent, if any, the cash received by you exceeds our current and
accumulated earnings and profits, it will be treated first as a tax-free return
of your tax basis in the shares surrendered and thereafter as a capital gain.
Capital gain and loss. For individuals, net capital gain (defined
generally as your total capital gains in excess of capital losses for the year)
recognized upon the sale of capital assets that have been held for more than 12
months generally will be subject to tax at a rate not to exceed 15%. Net capital
gain recognized from the sale of capital assets that have been held for 12
months or less will continue to be subject to tax at ordinary income tax rates.
In addition, capital gain recognized by a corporate taxpayer will continue to be
subject to tax at the ordinary income tax rates applicable to corporations.
There are limitations on the deductibility of capital losses.
Backup withholding. Shareholders will be required to provide their social
security or other taxpayer identification numbers (or, in some instances,
additional information) in connection with the merger to avoid backup
withholding requirements that might otherwise apply. The letter of transmittal
will require each shareholder to deliver such information when the common stock
certificates are surrendered following the effective time of the merger. Failure
to provide such information may result in backup withholding.
AS EXPLAINED ABOVE, THE AMOUNTS PAID TO YOU AS A RESULT OF THE MERGER MAY
RESULT IN DIVIDEND INCOME, CAPITAL GAIN INCOME, OR SOME COMBINATION OF DIVIDEND
AND CAPITAL GAIN INCOME TO YOU DEPENDING ON YOUR INDIVIDUAL CIRCUMSTANCES. THE
U.S. FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS BASED UPON PRESENT LAW,
WHICH IS SUBJECT TO CHANGE POSSIBLY WITH RETROACTIVE EFFECT. YOU SHOULD CONSULT
YOUR TAX ADVISOR AS TO THE PARTICULAR FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER
TAX CONSEQUENCES OF THE TRANSACTION THAT ARE APPLICABLE TO YOU IN LIGHT OF YOUR
SPECIFIC CIRCUMSTANCES.
DISSENTERS' AND APPRAISAL RIGHTS
If you were a shareholder of HFB Financial as of the record date, you may
exercise dissenters' rights in connection with the merger by complying with
Chapter 23 of the Tennessee Business Corporation Act (the "TBCA"). By exercising
dissenters' rights, you will be entitled to receive, if the merger is
consummated, the "fair value" of the shares of HFB Financial common stock that
you owned as of the time immediately before the effectuation of the merger. This
value may differ from the value of the consideration that you would otherwise
receive in the merger. The following is a summary of the statutory procedures
that you must follow in the event you elect to exercise your dissenters' rights
under the TBCA. This summary is not complete and is qualified in its entirety by
reference to Chapter 23 of the TBCA, the text of which is set forth in full in
Appendix C to this proxy statement.
32
How to exercise and perfect your right to dissent. In order to be eligible
to exercise your right to dissent from the merger and to receive, upon
compliance with the statutory requirements summarized below, the fair value of
your shares of HFB Financial common stock as of the time immediately before the
completion of the merger, excluding any appreciation of depreciation in
anticipation of the merger, you must:
- deliver to HFB Financial, before the vote is taken at the special
meeting, written notice of your objection and intent to demand payment of
the fair value of your HFB Financial common stock if the merger is
completed;
- not vote your shares of HFB Financial common stock in favor of the merger
agreement; and
- address any written objection with notice of intent to exercise the right
of dissent, as follows: HFB Financial Bancshares, Inc., Attention:
Corporate Secretary, HFB Financial Corporation, 1602 Cumberland Ave,
Middlesboro, KY 40965.
In order to properly exercise dissenter's rights, you must refrain from
voting by proxy or in person in favor of the merger agreement. Failure to vote
against the merger agreement will not constitute a waiver of your right to
dissent. A shareholder who executes and returns an unmarked proxy card will have
his or her shares voted "FOR" the merger agreement and, as a consequence
thereof, such shareholder will be foreclosed from exercising rights as a
dissenting shareholder.
Dissenter's Notice. If you perfect your right to dissent by complying with
the requirements above, and if and the merger is completed, HFB Financial, as
the surviving corporation, will within 10 days of the completion of the merger
or the date of the special meeting, whichever is earlier, mail to you a written
dissenters' notice. The dissenters' notice will include:
- a statement that the merger has been completed;
- directions and a form for demanding payment;
- a statement of the of the date of the first announcement to news media or
to shareholders of the principal terms of the merger; and
- a date by which HFB Financial must receive the payment demand.
Your demand for payment. Within one (1) month from the date the notice is
sent to you by HFB Financial, you must return to HFB Financial, in compliance
with the directions in the dissenters' notice, a demand for payment of the fair
value of your shares of HFB Financial common stock. Such demand must include:
- a written statement of demand for payment; and
- a written certification concerning whether or not you acquired beneficial
ownership of your shares before the date set forth in the dissenters'
notice.
In order to preserve your dissenters' rights, you must also submit your
stock certificates to HFB Financial in accordance with the directions contained
in the dissenters' notice. Once you have made a demand for payment in compliance
with the requirements set forth above, your demand may not be withdrawn unless
HFB Financial, as the surviving corporation to the merger, consents. The fair
value of your shares of HFB Financial common stock will be the value of the
shares immediately before the effectuation of the merger, excluding any
appreciation or depreciation in anticipation of the merger.
If you should fail to make such a demand within the one month period, you
will lose the right to dissent and will be bound by the terms of the merger
agreement unless a court of competent jurisdiction for good and sufficient cause
shown directs otherwise. Any notice addressed to HFB Financial must be addressed
to:
HFB Financial Corporation
Attn: Corporate Secretary
1602 Cumberland Ave
Middlesboro, KY 40965
HFB Financial's action upon receipt of your demand for payment. Pursuant
to Sections 48-23-206 and 48-23-208 of the TBCA, HFB Financial's action upon
receipt of your demand for payment will depend on
33
whether you were the beneficial owner of the HFB Financial shares before the
date set forth in the dissenters' notice, or whether you acquired the shares
acquired after this date ("after-acquired shares").
- Election to withhold payment for after-acquired shares. If you are the
holder of after-acquired shares, HFB Financial may elect to withhold
immediate payment in response to your written payment demand. To the
extent that HFB Financial elects to withhold payment, after completing
the merger, HFB must estimate the fair value of the shares, plus any
accrued interest, and must offer this amount to you. HFB Financial must
pay you the offered amount if you agree to accept it in full satisfaction
of your dissenters' demand. HFB Financial must include with its offer
statement, an explanation of how the interest was calculated and a
statement of your rights to demand payment under Chapter 23 of the TBCA.
- Payment to all other dissenting shareholders. If you are not the owner
of after-acquired shares, and if you have satisfied the requirements to
demand payment, HFB Financial must pay you the amount it estimates to be
the fair value of your shares, plus accrued interest, as soon as the
merger completed, or upon receipt of your demand, whichever is earlier.
The payment must be accompanied by the following:
- a copy of HFB Financial's financial statements as of a fiscal year
ending not more than sixteen (16) months before the date of the payment;
- a statement of HFB Financial's estimate of fair value of the shares;
- an explanation of how interest was calculated; and
- a statement of your rights if you are dissatisfied with the payment.
Commencement of legal proceedings if a demand for payment remains
unsettled. If your demand for payment remains unsettled, HFB Financial must
file a petition in a court of record having equity jurisdiction in Campbell
County, Tennessee, asking for a finding and determination of the fair value of
the shares. The proceeding must be filed within two (2) months from the time HFB
Financial receives your payment demand. If HFB Financial does not commence the
proceeding within the two month period, it must pay you the amount demanded.
HFB Financial must make all dissenters (whether or not residents of
Tennessee) whose demands remain unsettled, parties to the proceeding. As a
party, you must be served with a copy of the petition. The court may appoint one
(1) or more persons as appraisers to receive evidence and recommend a decision
on the question of fair value. The appraisers will have any powers described in
the court order appointing them. As dissenters, you will be entitled to the same
discovery rights as parties in other civil proceedings. You will also be
entitled to judgment for (i) the amount, if any, by which the court finds the
fair value of your shares, plus accrued interest, that exceeds any amount paid
by the HFB Financial; or (ii) the fair value, plus accrued interest, of any
after-acquired shares for which the HFB Financial elected to withhold payment.
REGULATORY REQUIREMENTS
In connection with the merger, HFB Financial will be required to make a
number of filings with and obtain a number of approvals from various federal and
state governmental agencies, including:
- filing of articles of merger with the Secretary of State of the State of
Tennessee in accordance with the TBCA after the approval of the merger
agreement by HFB Financial's shareholders; and
- complying with federal and state securities laws, including HFB
Financial's and merger subsidiary's filing, prior to the date of this
proxy statement, of a Rule 13e-3 Transaction Statement on Schedule 13E-3
with the SEC.
34
PRO FORMA FINANCIAL INFORMATION
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following unaudited pro forma consolidated balance sheet as of
September 30, 2003, and the unaudited pro forma consolidated income statement
for the year ended December 31, 2002, and the nine months ended September 30,
2003 give effect to the following:
- We have assumed that the merger occurred as of September 30, 2003, for
purposes of the consolidated balance sheet, and as of January 1, 2002,
with respect to the consolidated income statements for the year ended
December 31, 2002, and as of January 1, 2003, with respect to the
consolidated income statement for the nine-month period ended September
30, 2003.
- We have assumed that a total of 131,868 shares are cashed-out in the
merger at a price of $22.75 per share for a total of $3.0 million.
Pursuant to the merger agreement, a condition to our obligation to
complete the merger is that not more than 131,868 shares are either
cashed-out or dissent. We estimate the actual number of shares to be
cashed-out to be approximately 20,589 shares. Additionally, we have
assumed that we have incurred or will incur $3,134,961 in costs and
expenses relating to the merger.
- We have assumed that the maximum amount of cash necessary to consummate
the merger to be $3,000,000.
- We have not reflected the anticipated special cost savings, estimated to
be approximately $149,300 per year that we expect as a result of the
merger.
The unaudited pro forma information is not necessarily indicative of the
results that would have occurred had the merger actually taken place at the
respective time periods specified, nor does such information purport to project
the results of operations for any future date or period.
The unaudited pro forma financial statements should be read in conjunction
with the historical financial statements and accompanying footnotes of HFB
Financial included in our Annual Report on Form 10-KB for the year ended
December 31, 2002, which is incorporated in this proxy statement by reference
and attached hereto as Appendix D and our Quarterly Report on Form 10-QSB for
the nine months ended September 30, 2003, which is incorporated by reference and
attached hereto as Appendix E.
The board of directors of HFB Financial believes, based on the information
available to it on the date hereof, that approximately 160 shareholders of HFB
Financial who own, in the aggregate, 20,589 shares will receive cash in the
merger. Under the merger agreement, however, HFB Financial may acquire up to
131,868 shares costing $3.0 million in the aggregate. In order to show the full
potential impact of the merger on HFB Financial, we have assumed that HFB
Financial will acquire all 131,868 shares in the merger unless the we
specifically state that we are assuming that 20,589 shares will be cashed-out in
the merger.
35
PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF SEPTEMBER 30, 2003
<Table>
<Caption>
PRO FORMA PRO FORMA
HISTORICAL ADJUSTMENTS COMBINED
------------ ----------- -----------
ASSETS
Cash and cash equivalents.......................... $ 5,99,208 $(3,139,941)(1) $ 2,859,267
Available-for-sale securities...................... 49,858,124 $49,858,124
Loans, net of allowance for loan losses and
unearned interest unearned interest.............. 187,799,158 187,799,158
Premises and equipment............................. 4,794,767 4,794,767
Federal Home Loan Bank stock....................... 1,730,300 1,730,300
Interest Receivable................................ 1,446,375 1,446,375
Assets held for sale............................... 1,224,079 1,224,079
Other assets....................................... 925,303 925,303
Cash surrender value of life insurance............. 2,911,215 2,911,215
------------ ----------- -----------
Total assets.................................. 256,688,529 (3,139,941) 253,548,588
============ =========== ===========
LIABILITIES
Deposits
Non-interest bearing demand...................... 8,553,692 8,553,692
Savings, NOW and money market.................... 28,751,087 28,751,087
Certificate of deposits.......................... 164,595,319 164,595,319
------------ -----------
Total deposits................................ 201,900,098 201,900,098
------------ -----------
Long-term debt..................................... 28,084,688 28,084,688
Interest payable................................... 842,656 842,656
Other liabilities.................................. 1,845,387 1,845,387
------------ -----------
Total liabilities............................. 232,672,829 232,672,829
------------ -----------
STOCKHOLDERS' EQUITY
Issued and outstanding -- 1,589,303 shares......... 1,589,303 1,589,303
Additional paid-in-capital......................... 8,768,874 8,768,874
Less: Common stock acquired by Rabbi trusts for
deferred compensation plans...................... (500,446) (500,446)
Retained earnings.................................. 16,049,953 (14,941) 16,035,012
Accumulated other comprehensive income............. 670,014 670,014
------------ ----------- -----------
26,577,698 (14,941) 26,562,757
Treasury stock, at cost............................ (2,561,998) (3,125,000) (5,686,998)
------------ ----------- -----------
Total stockholders' equity.................... 24,015,700 (3,139,941) 20,875,759
------------ ----------- -----------
Total liabilities and stockholders' equity.... 256,688,529 (3,139,941) 253,548,588
============ =========== ===========
Outstanding common shares.......................... 1,301,101 1,169,233
Shareholders' equity per share..................... $ 18.46 $ 17.85
</Table>
- ---------------
(1) Repurchase of approximately 131,868 shares of stock at $22.75 per share and
associated fees of $125,000, and opportunity cost, net of taxes of $14,941
36
PRO FORMA CONSOLIDATED INCOME STATEMENT
YEAR ENDED DECEMBER 31, 2002
<Table>
<Caption>
PRO FORMA PRO FORMA
HISTORICAL ADJUSTMENTS COMBINED
----------- ----------- -----------
Interest income...................................... $16,385,834 $(31,250)(1) $16,354,584
Interest expense..................................... 6,817,396 6,817,396
----------- -------- -----------
Net interest income.................................. 9,568,438 (31,250) 9,537,188
Provision for loan losses.......................... 468,554 468,554
----------- -------- -----------
Net interest income after provision for loan
losses............................................. 9,099,884 (31,250) 9,068,634
Noninterest income................................... 1,213,674 1,213,674
Noninterest expenses................................. 6,731,264 6,731,264
----------- -------- -----------
Income before income tax expense..................... 3,582,294 (31,250) 3,551,044
Income tax expense................................... 1,148,860 (11,328)(2) 1,137,532
----------- -------- -----------
Net income........................................... $ 2,433,434 $(19,992) $ 2,413,512
=========== ======== ===========
Net income per share
Basic.............................................. 1.95 2.16
Fully diluted...................................... 1.93 2.15
Weighted average shares outstanding
Basic.............................................. 1,250,000 1,118,132
Fully diluted...................................... 1,258,000 1,124,132
</Table>
- ---------------
(1) Assuming the opportunity cost of funding the $3,125,000 is 1% per annum.
(2) The income tax rate assumed for this transaction is 36.25%.
37
PRO FORMA CONSOLIDATED INCOME STATEMENT
NINE MONTHS ENDED SEPTEMBER 30, 2003
<Table>
<Caption>
PRO FORMA PRO FORMA
HISTORICAL ADJUSTMENTS COMBINED
----------- ----------- -----------
Interest income: .................................... $11,624,748 $(23,437)(1) $11,601,311
Interest expense: ................................... 4,354,584 4,354,584
----------- -------- -----------
Net interest income.................................. 7,270,164 (23,437) 7,246,727
Provision for loan losses.......................... 315,000 315,000
----------- -------- -----------
Net interest income after provision for loan
losses............................................. 6,955,164 (23,437) 6,931,727
Noninterest income................................... 984,732 984,732
Noninterest expenses................................. 5,320,283 5,320,283
----------- -------- -----------
Income before income tax expense..................... 2,619,613 (23,437) 2,596,176
Income tax expense................................... 787,006 (8,496)(2) 778,510
----------- -------- -----------
Net income........................................... 1,832,607 (14,941) 1,817,666
=========== ======== ===========
Net income per share
Basic.............................................. 1.46 1.61
Fully diluted...................................... 1.45 1.60
Weighted average shares outstanding
Basic.............................................. 1,259,488 1,127,620
Fully diluted...................................... 1,264,486 1,132,618
</Table>
- ---------------
(1) Assuming the opportunity cost of funding the $3,125,000 is 1% per annum
(2) The income tax rate assumed for this transaction is 36.25%.
38
FINANCIAL INFORMATION
PER SHARE MARKET PRICES AND DIVIDEND INFORMATION
HFB Financial common stock is quoted on the NASDAQ SmallCap Market of the
NASDAQ Stock Market, Inc. ("NASDAQ") under the symbol "HFBA." The table below
sets forth the high and low sales prices for the common stock from January 1,
2001 through January 7, 2004, as reported by NASDAQ for the quarters indicated
and the dividends declared for the same period. For the past two years, HFB
Financial has paid dividends semi-annually in March and September.
<Table>
<Caption>
MARKET PRICE CASH
--------------- DIVIDENDS
HIGH LOW DECLARED
------ ------ ---------
2001
First Quarter............................................. $12.00 $11.00 $0.19
Second Quarter............................................ 12.88 11.00 N/A
Third Quarter............................................. 13.00 11.55 0.19
Fourth Quarter............................................ 14.50 12.03 N/A
2002
First Quarter............................................. 14.60 13.75 0.20
Second Quarter............................................ 14.75 13,99 N/A
Third Quarter............................................. 14.50 12.90 0.21
Fourth Quarter............................................ 13.26 11.50 N/A
2003
First Quarter............................................. 17.00 13.79 0.25
Second Quarter............................................ 18.50 15.09 N/A
Third Quarter............................................. 20.50 18.35 0.25
Fourth Quarter............................................ 22.25 19.00 N/A
2004
First Quarter (through January 7, 2004)................... 21.90 21.26 N/A
</Table>
HFB Financial board of directors, in its discretion, will determine whether
to declare and pay dividends in the future. Currently, the board of directors
does not anticipate that the merger will have a material effect on our dividend
policy. However, any future declaration and payment of dividends will depend
upon, among other factors, our results of operations and financial condition,
future prospects, regulatory capital requirements, and other factors deemed
relevant by the board of directors.
The last sale price of HFB Financial common stock known to management that
occurred prior to the public announcement of the merger agreement was $21.92 on
October 28, 2003. As of the record date (January 14, 2004), we had approximately
372 shareholders of record.
HFB FINANCIAL COMMON STOCK REPURCHASE INFORMATION
Since January 1, 2001, HFB Financial has not repurchased any shares of its
common stock.
THE PARTIES
HFB FINANCIAL
HFB Financial Corporation, a Tennessee Corporation, was formed in September
1992 at the direction of Home Federal Bank Corporation, for the purpose of
becoming a holding company for Home Federal Bank Corporation as part of its
conversion from mutual to stock form. HFB Financial currently owns one hundred
percent (100%) of the issued and outstanding common stock of Home Federal Bank
Corporation.
HFB Financial's primary activity is its investment in Home Federal Bank
Corporation. Home Federal Bank Corporation operates under the day-to-day
management of its own officers, and each entities' individual boards of
directors formulates its own policies. A number of directors of HFB Financial
are also directors or
39
officers of Home Federal Bank Corporation. HFB Financial conducts no activity
other than the operation of Home Federal Bank Corporation. HFB Financial derives
its revenues primarily from the operation of Home Federal Bank Corporation in
the form of dividends paid by Home Federal Bank Corporation to HFB Financial.
HFB Financial does not engage in any nonbanking activities at this time.
If, in the future, HFB Financial proposes to engage in any nonbanking
activities, it would be restricted to those nonbanking activities permitted
under applicable law or regulations of the Board of Governors of the Federal
Reserve System (the "Federal Reserve Board").
As of September 30, 2003, HFB Financial had, on a consolidated basis, total
assets of approximately $256,689,000, total deposits of approximately
$201,900,000, total loans (net of unearned income and allowance for loan and
lease losses) of approximately $187,799,000, and total shareholders' equity of
approximately $24,016,000.
Home Federal Bank Corporation. Home Federal Bank Corporation is a
Kentucky-chartered commercial banking corporation. The bank traces its origins
back to 1920 when it first opened for business as Peoples Building and Loan
Association. In the last quarter of 2001, the bank converted from a federal
thrift charter to a state chartered commercial bank as a means for management to
focus more on commercial lending and other activities permissible. Home Federal
Bank Corporation operates through three full-service offices in the southeastern
Kentucky communities of Middlesboro and Harlan and one full-service office in
the eastern Tennessee community of New Tazewell. Additionally, in January of
2003, Home Federal Bank Corporation opened a temporary office in the East
Tennessee community of Jacksboro.
At September 30, 2003, Home Federal Bank Corporation had approximately
$257,013,000 in assets, $203,380,000 in deposits, $187,799,000 in loans (net of
unearned income and allowance for loan and lease losses), and $23,772,000 in
shareholder's equity. Home Federal Bank Corporation is regulated and supervised
by Kentucky Department of Financial Institutions and its deposits are insured by
the Federal Deposit Insurance Corporation.
Home Federal Bank Corporation is principally engaged in the business of
accepting deposits from the general public and originating permanent loans,
which are secured by one-to-four family residential properties located in its
market area. Home Federal Bank Corporation also originates consumer loans and
commercial real estate loans, and maintains a substantial investment portfolio
of mortgage-backed and other investment securities.
Home Federal Bank Corporation operates Home Service Corporation as its only
subsidiary. Home Service Corporation engages in the ownership and rental of the
Home Federal Bank Corporation's main office building and operations center in
Middlesboro, Kentucky and a branch office in New Tazewell, Tennessee. Home
Service Corporation also owns and rents other properties to unrelated parties.
40
PRINCIPAL SHAREHOLDERS
At January 14, 2004, HFB financial had 372 shareholders of record. The
following table sets forth information concerning the securities of HFB
Financial owned beneficially at such time by each person, group or entity known
by management of the Company to own beneficially more than 5% of the shares of
any class of such securities.
<Table>
<Caption>
AMOUNT AND NATURE PERCENTAGE
NAME AND ADDRESS OF OF BENEFICIAL PERCENTAGE OF CLASS
BENEFICIAL OWNER OWNERSHIP(1)(2)(3) OF CLASS(4) (PRO FORMA)
- ------------------- ------------------ ----------- -----------
David B. Cook............................... 108,334 8.33% 9.27%
3226 W. Cumberland Avenue
Middlesboro, KY 40965
</Table>
- ---------------
(1)(2)(3)(4) See corresponding footnotes in table below.
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth the number of shares of HFB Financial common
stock beneficially owned (i) by each director of HFB Financial (ii) by the
executive officer of HFB Financial and (iii) by the directors and executive
officers of HFB Financial as a group as of January 14, 2004. Unless otherwise
stated below, the business address and telephone number of each shareholder
listed below is c/o HFB Financial Corporation, 1602 Cumberland Ave, Middlesboro,
KY 40965 (606) 248-1095.
<Table>
<Caption>
NUMBER OF SHARES
BENEFICIALLY OWNED PERCENTAGE
AS OF JANUARY 14, PERCENTAGE OF CLASS
NAME 2004(1)(2)(3) OF CLASS(4) (PRO FORMA)
- ---- ------------------------------ ----------- -----------
Robert V. Costanzo................... 18,665 1.43% 1.60%
Frances Coffey Rasnic................ 8,643 * *
David B. Cook........................ 108,334 8.33% 9.27%
Earl Burchfield...................... 34,610 2.66% 2.96%
Kenneth V. Jones..................... 4,867 * *
Roger Roper.......................... 12,434 * *
Stanley Alexander, Jr. .............. 13,610 1.05% 1.06%
All Directors and Executive Officers
as a group (7 persons)............. 201,163 15.46% 17.20%
</Table>
- ---------------
* Represents ownership of less than 1%.
(1) HFB Financial's directors and executive officers, includes 4,767 shares,
7,225 shares, and 11,992 shares which may be acquired by Mr. Jones, Ms.
Rasnic and all directors and executive officers as a group, respectively,
upon the exercise of stock options granted under the HFB Financial
Corporation 1992 Stock Option Plan (the "1992 Stock Option Plan"). In
accordance with Rule 13d-3 under the Exchange Act, a person is deemed to be
the beneficial owner, for purposes of this table, of any shares of common
stock if he or she has or shares voting or investment power with respect to
such common stock or has a right to acquire beneficial ownership at any time
within 60 days from the record date. As used herein, "voting power" is the
power to vote or direct the voting of shares and "investment power" is the
power to dispose or direct the disposition of shares. Except as otherwise
noted, ownership is direct, and the named individuals and group exercise
sole voting and investment power over the shares of the common stock.
(2) Includes 4,660 shares, 11,695 shares, 5,617 shares and 21,969 shares held
for the benefit of Directors Cook, Burchfield, Costanzo and all directors
and executive officers as a group, respectively, through trusts established
under Home Federal Bank Corporation's discontinued and current deferred
compensation plans for directors.
(3) Includes shares held by certain directors and executive officers as
custodians under Uniform Transfers to Minors Acts, by their spouses and
children and for the benefit of certain directors and executive officers
under individual retirement accounts ("IRAs").
41
(4) Unless otherwise indicated, all shares listed are held of record by the
individual indicated with sole power to vote and to dispose of such shares.
Percentages are based on 1,301,101 shares outstanding on a historical basis
and 1,169,233 shares outstanding on a pro forma basis assuming the
acquisition 131,868 shares in the merger.
DIRECTORS AND EXECUTIVE OFFICERS OF HFB FINANCIAL
The following table sets forth information concerning the executive
officers and directors of HFB Financial. Directors serve for staggered 3-year
terms ending at the third succeeding annual meeting of shareholders after
election, or until their successors are elected and qualified. Executive
officers serve at the pleasure of HFB Financial's board of directors. Included
in the following table are the names , ages and positions held by each person
with HFB Financial.
<Table>
<Caption>
NAME POSITIONS HELD WITH HFB FINANCIAL
- ---- ---------------------------------
Robert V. Costanzo (47)........................... Chairman and Director
Frances Coffey Rasnic (55)........................ Director
David B. Cook (53)................................ President and CEO, Director
Earl Burchfield (73).............................. Secretary-Treasurer and Director
Kenneth V. Jones (46)............................. Chief Operating Officer and Director
Roger Roper (59).................................. Vice President and Director
Stanley Alexander, Jr. (54)....................... Chief Financial Officer
</Table>
The principal occupation of each director, and each executive officer of
the HFB Financial during the last five years is set forth below.
Robert V. Costanzo is Chairman of the Board of HFB Financial. A 1989
graduate of Salmon P. Chase College of Law, Mr. Costanzo serves as District
Judge of Bell County, Kentucky. He is a member of the Kentucky Bar Association
and presently serves on the Kentucky Bar Association's House of Delegates. He is
a member of the Kiwanis International and St. Julian Catholic Church in
Middlesboro.
Frances Coffey Rasnic has been a lifelong resident of Claiborne County. She
graduated from the University of Tennessee and holds 45 hours above her Masters
in Education. She has served her community in various civic and school groups.
She has been self-employed in real estate development and in her previously
owned family business, Coffey Funeral Home, in New Tazewell and Harrogate,
Tennessee where she is currently employed. She is a businesswoman who remains
active in the Claiborne County Chamber of Commerce and serves as Memorial
Secretary of the American Cancer Society and Chairperson of the Tourism
Committee and Board Member of the Clinch-Powell Enterprise Community. She is a
member of the New Tazewell United Methodist Church.
David B. Cook currently serves as president and chief executive officer of
HFB Financial and Home Federal Bank Corporation. A graduate of Western Kentucky
University and a member of First Baptist Church in Middlesboro, Mr. Cook has
served as president of both the Lexington Chapter of the Society of Real Estate
Appraisers and the ROHO Club of Middlesboro. He has previously served as a board
member on the Bell County Chamber of Commerce, the Board of Housing Appeals for
the City of Middlesboro and as a member of the "Advisory Group" of the
Middlesboro City Council's Finance Committee. He is a past board member of the
Bluegrass Council of Boy Scouts of America, Lexington, Kentucky. Mr. Cook has
also served as president of the Kentucky Thrift Foundation, board member of the
Central Kentucky League of Savings Associations and board member of the Kentucky
Bankers Association. Mr. Cook is currently president of the Bell County
Industrial Foundation and Revolving Loan Committee.
Earl Burchfield is retired as a newspaper publisher. Mr. Burchfield is a
past member of the Middlesboro Rotary Club, a past trustee of Appalachian
Hospitals, a past member of Bell County and Claiborne County Chambers of
Commerce and active in the area Gideons organization. He serves as a Nursing
Home Volunteer, as well as church treasurer and Deacon.
Kenneth V. Jones joined Home Federal Bank Corporation in October of 1999
and was appointed Chief Operations Officer on May 15, 2000. Prior to joining
Home Federal Bank Corporation, Mr. Jones served as Executive Vice President,
Chief Financial Officer and Director of Citizens Bank, New Tazewell, TN, with
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24 years of experience in both operations and lending. He received his Bachelor
of Science Degree in Business Administration from the University of Tennessee
and graduated with honors from the American Bankers Association Graduate School
of Banking. Mr. Jones serves as director and secretary of the Bell County
Chamber of Commerce and director of the Bell County Industrial Foundation. Mr.
Jones also served as past president and director of the Claiborne County Chamber
of Commerce.
Roger Roper is currently the manager of Home Federal Bank Corporation's
branch in Harlan, Kentucky. Mr. Roper has over 29 years of banking experience.
Prior to joining Home Federal Bank Corporation in 1996, Mr. Roper was serving as
President, CEO of Harlan Federal Bank Corporation. He began his banking career
in the early 1960s as a trainee at Harlan National Bank while still in college.
Active in local civic affairs, Mr. Roper has served on numerous boards and
committees. He has been a member of the CVADD Loan Review Committee for over 15
years, a member and past president of the Harlan Kiwanis Club, a member of the
first Harlan County Industrial Development Board, former member of the Board of
Christian Outreach for Appalachian People, and a 32nd Degree Mason for over 25
years.
Stanley Alexander, Jr. is currently Home Federal Bank Corporation's and HFB
Financial's Chief Financial Officer. Mr. Alexander received Bachelor of Science
Degree in Accounting from Lincoln Memorial University, graduated from the
Graduate School of Banking at the University of Wisconsin in 1984 and had 17
years of banking experience prior to joining Home Federal Bank Corporation in
1991. He has served as treasurer of the Middlesboro-Bell County Airport Board,
Secretary of the ROHO Club, Adjutant for American Legion Dewey Guy Post 14 and
as a member of the "Advisory Group" to the Middlesboro City Council's Finance
Committee. Mr. Alexander currently serves as Finance Officer for American Legion
Dewey Guy Post 14 and is a member of the Middlesboro-Bell County 4 H Advisory
Council.
There are no family relationships among any of the directors or principal
officers. None of the directors currently serves as a director of any other
company with a class of securities registered pursuant to Section 12 of the
Securities Exchange Act of 1934. The business address and telephone number of
each director and executive officer is c/o HFB Financial Corporation, 1602
Cumberland Ave, Middlesboro, KY 40965 (606) 248-1095.
HCB MERGER CORP.
HCB Merger Corp. is a recently-formed Tennessee corporation. It was
organized for the sole purpose of facilitating the merger. It has engaged in no
business activities and has no assets or liabilities of any kind, other than
those incident to its formation. HCB Merger Corp. does not own any shares of HFB
Financial common stock, nor will it acquire any such shares before the merger.
Its existence will cease upon consummation of the merger. The address and
telephone number of principal offices of HCB Merger Corp. are the same as HFB
Financial.
THE SPECIAL MEETING
GENERAL
We are providing this proxy statement to HFB Financial shareholders of
record as of January 14, 2004, along with proxy card that the HFB Financial
board of directors is soliciting for use at the special meeting of shareholders
of HFB Financial to be held on Tuesday, February 24, 2004, at the time and place
and for the purposes set forth in the accompanying notice and at any recess or
adjournments thereof. At the special meeting, shareholders of HFB Financial will
vote to approve the Agreement and Plan of Merger, dated as of October 28, 2003,
providing for the merger of merger HFB Merger Corp. with and into HFB Financial.
A copy of the merger agreement is attached as Appendix A.
WHO CAN VOTE AT THE SPECIAL MEETING
You are entitled to vote your HFB Financial common stock if our records
show that you held your shares as of the record date, which is January 14, 2004.
On the record date, we had 1,301,101 shares of common stock outstanding, held by
approximately 372 holders of record. Each share of HFB Financial common stock is
entitled to one vote on each matter submitted at the special meeting.
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ATTENDING THE SPECIAL MEETING
All of our shareholders are invited to attend the special meeting. If you
are a beneficial owner of HFB Financial common stock held by a broker, bank or
other nominee (i.e., in "street name"), you will need proof of ownership to be
admitted to the special meeting. A recent brokerage statement or letter from a
bank or broker are examples of proof of ownership. If you want to vote your
shares of HFB Financial common stock held in street name in person at the
special meeting, you will have to get a written proxy in your name from the
broker, bank or other nominee who holds your shares.
ANNUAL REPORT AND QUARTERLY REPORT
HFB Financial Annual Report to Shareholders for the fiscal year ended
December 31, 2002 on Form 10-KSB is attached to this proxy statement as Appendix
D and incorporated by reference in this proxy statement. HFB Financial Quarterly
Report to Shareholders for the quarter ended September 30, 2003 on Form 10-QSB
is attached to this proxy statement as Appendix E and incorporated by reference
in this proxy statement. See "Where You Can Find More Information" and
"Documents Incorporated by Reference."
VOTE REQUIRED
Approval of the merger agreement requires the affirmative vote of the
holders of a majority of the shares of the HFB Financial common stock issued and
outstanding as of the record date. IF YOU DO NOT VOTE YOUR SHARES, IT WILL HAVE
THE SAME EFFECT AS A VOTE "AGAINST" THE MERGER AGREEMENT. Accordingly, the board
of directors urges you to complete, date and sign the accompanying proxy card
and return it promptly in the enclosed, self-addressed, prepaid envelope.
The proposal to adopt the merger agreement is a "non-discretionary" item,
meaning that brokerage firms cannot vote shares in their discretion on behalf of
a client if the client has not given voting instructions. Accordingly, shares
held in street name that have been designated by brokers on proxy cards as not
voted with respect to that proposal will not be counted as votes cast on the
proposal. Your broker may allow you to deliver your voting instructions via the
telephone or the internet. Please see the voting instruction form from your
broker. If your shares are not registered in your name, you will need additional
documentation from your record holder to vote the shares in person. Shares with
respect to which proxies have been marked as abstentions also will not be
counted as votes cast on that proposal.
The board of directors is not aware of any other business to be presented
at the special meeting other than matters incidental to the conduct of the
special meeting.
As of the record date, the directors and executive officers of HFB
Financial beneficially owned a total of approximately 201,163 of the outstanding
shares of HFB Financial common stock or 15.46% of the shares entitled to vote at
the special meeting.
The original solicitation will be made by mail. The total expense of such
solicitation will be borne by HFB Financial and will include reimbursement paid
to brokerage firms and other custodians, nominees and fiduciaries for their
reasonable expenses incurred in forwarding solicitation material regarding the
special meeting to beneficial owners. Further solicitation of proxies may be
made personally, electronically or by telephone following the original
solicitation. All further solicitation will be by regular employees of HFB
Financial, who will not be additionally compensated therefor.
Any proxy given pursuant to this solicitation may be revoked by the person
giving it at any time before it is voted at the special meeting. Proxies may be
revoked by delivering to the Secretary of HFB Financial, Earl Burchfield, HFB
Financial Corporation, 1602 Cumberland Ave, Middlesboro, Kentucky 40965, a
written notice of revocation bearing a later date than the proxy, by duly
executing and delivering to the Secretary a subsequently dated proxy relating to
the same shares or by attending the special meeting and voting in person
(although attendance at the special meeting will not in and of itself constitute
revocation of a proxy).
All shares entitled to vote represented by a properly executed and
unrevoked proxy received in time for the special meeting will be voted at the
special meeting in accordance with the instructions given, but in the absence of
instructions to the contrary, such shares will be voted "FOR" approval of the
merger agreement. Persons empowered as proxies will also be empowered to vote in
their discretion upon such other matters as
44
may properly come before the special meeting or any adjournment thereof, except
that discretionary authority on the part of the proxies will be limited to
matters of which we did not have notice a reasonable time before our mailing of
this proxy statement and the proxy. The proxy statement and the proxy card are
being mailed to shareholders on or about January 21, 2004.
SOLICITATION OF PROXIES
Directors, officers and other employees of HFB Financial or its
subsidiaries may solicit proxies personally, by telephone or by facsimile. None
of these people will receive any special compensation for solicitation
activities. HFB Financial will arrange with brokerage firms and other
custodians, nominees and fiduciaries for the forwarding of solicitation material
to the beneficial owners of stock held of record by such brokerage firms and
other custodians, nominees and fiduciaries, and HFB Financial will reimburse
these record holders for their reasonable out-of-pocket expenses.
RECOMMENDATION OF THE BOARD OF DIRECTORS
The board of directors of HFB Financial has approved the merger agreement
and believes that the proposed transaction is fair to and in the best interests
of HFB Financial and its shareholders including its unaffiliated shareholders.
The board of directors unanimously recommends that the HFB Financial
shareholders vote "FOR" approval of the merger agreement.
THE MERGER AGREEMENT
The following is a summary of the material terms of the merger agreement, a
copy of which is attached as Appendix A to this proxy statement. Because this is
a summary, it does not include all of the information that may be important to
you. You should read the entire merger agreement and this proxy statement and
related appendices before deciding how to vote at the special meeting.
STRUCTURE OF THE MERGER
The merger subsidiary will be merged with and into HFB Financial, which
will be the surviving corporation. The merger will occur following the approval
of the merger agreement by the shareholders of HFB Financial and the
satisfaction of other conditions to the merger set forth in the merger
agreement.
CONVERSION OF SHARES IN THE MERGER
The merger agreement provides that, at the effective time of the merger:
- all outstanding shares of HFB Financial common stock, whether record
shares (as defined below) or street shares (as defined below), held of
record by a holder (as defined below) holding fewer than 250 shares of
HFB Financial common stock immediately prior to the effective time will,
without any action on the part of the holder thereof, be converted into
the right to receive cash equal to $22.75 per share (the "merger
consideration"). HFB Financial may presume that all street shares are
held by holders holding fewer than 250 shares immediately prior to the
effective time unless a beneficial owner of street shares is able to
demonstrate to HFB Financial's satisfaction that such shares are held
beneficially by a holder holding 250 or more shares immediately prior to
the merger date. In that case, such shares will remain outstanding with
all rights, privileges, and powers existing immediately before the
merger;
- all outstanding shares of HFB Financial common stock other than those
described above as being converted into the right to receive the merger
consideration or shares for which dissenters' rights are perfected will
remain outstanding with all rights, privileges, and powers existing
immediately before the merger; and
- the outstanding shares of the merger subsidiary will, without any action
on the part of the holder thereof, be canceled.
The merger agreement further provides that:
- no holder holding, of record or beneficially, immediately prior to the
merger 250 or more shares (including any combination of record shares or
street shares) in the aggregate will be entitled to
45
receive any merger consideration with respect to the shares so held other
than by exercising his or her dissenter's rights; and
- it is a condition precedent to the right of any holder to receive the
merger consideration, if any, payable with respect to the shares held by
such holder that such holder certify to HFB Financial in the letter of
transmittal delivered by HFB Financial as described below that such
holder held of record and beneficially, immediately prior to the merger,
fewer than 250 shares (including any combination of record shares and
street shares) in the aggregate.
For purposes of the merger agreement:
- the term "record shares" means shares of HFB Financial common stock other
than street shares, and any record shares will be deemed to be held by
the registered holder thereof as reflected on the books of HFB Financial;
- the term "street shares" means shares of HFB Financial common stock held
of record in street name, and any street shares will be deemed to be held
by the beneficial owner thereof as reflected on the books of the nominee
holder thereof; and
- the term "holder" means
- any record holder or holders of record shares who would be deemed, under
Rule 12g5-1 under the Exchange Act as described below, to be a single
"person" for purposes of determining the number of record shareholders
of HFB Financial, and
- any other person or persons who would be deemed to be a "holder" under
the above clause if the shares it holds beneficially in street name were
held of record by such person or persons.
The merger agreement provides that HFB Financial (along with any other
person or entity to which it may delegate or assign any responsibility or task
with respect thereto) will have full discretion and exclusive authority (subject
to its right and power to so delegate or assign such authority) to:
- make such inquiries, whether of any shareholder(s) or otherwise, as it
may deem appropriate for purposes of confirming the above provisions, and
- resolve and determine, in its sole discretion, all ambiguities, questions
of fact and interpretive and other matters relating to such provisions,
including, without limitation, any questions as to the number of shares
held by any holder immediately prior to the merger. All such
determinations by HFB Financial will be final and binding on all parties,
and no person or entity will have any recourse against HFB Financial or
any other person or entity with respect thereto.
For purposes of the above provisions, HFB Financial may in its sole
discretion, but will not have any obligation to do so,
- presume that any shares of HFB Financial common stock held in a discrete
account (whether record or beneficial) are held by a person distinct from
any other person, notwithstanding that the registered or beneficial
holder of a separate discrete account has the same or a similar name as
the holder of a separate discrete account; and
- aggregate the shares held (whether of record or beneficially) by any
person or persons that HFB Financial determines to constitute a single
holder for purposes of determining the number of shares held by such
holder.
Rule 12g5-1 under the Exchange Act provides that, for the purpose of
determining whether an issuer is subject to the registration provisions of the
Exchange Act, securities will be deemed to be "held of record" by each person
who is identified as the owner of such securities on records of security holders
maintained by or on behalf of the issuer, subject to the following:
- In any case where the records of security holders have not been
maintained in accordance with accepted practice, any additional person
who would be identified as such an owner on such records if they had been
maintained in accordance with accepted practice will be included as a
holder of record.
46
- Securities identified as held of record by a corporation, a partnership,
a trust whether or not the trustees are named, or other organization will
be included as so held by one person.
- Securities identified as held of record by one or more persons as
trustees, executors, guardians, custodians or in other fiduciary
capacities with respect to a single trust, estate or account will be
included as held of record by one person.
- Securities held by two or more persons as co-owners will be included as
held by one person.
- Securities registered in substantially similar names where the issuer has
reason to believe because of the address or other indications that such
names represent the same person, may be included as held of record by one
person.
EXCHANGE OF CERTIFICATES
The merger agreement provides that promptly after the merger, HFB Financial
will mail a letter of transmittal to each shareholder, who based on information
available to HFB Financial, appears to have their shares converted into the
right to receive the merger consideration (other than shares as to which
dissenters' rights have been perfected). The letter of transmittal will contain
a certification as to the number of shares held and such other matters as HFB
Financial may determine and will specify that delivery will be effected, and
risk of loss and title to the certificates representing shares of HFB Financial
common stock ("Certificates") will pass, only upon delivery of the Certificates
to Registrar and Transfer Company, as HFB Financial's transfer agent, and
instructions to effect the surrender of the Certificates in exchange for the
merger consideration, if any, payable with respect to such Certificates.
Upon surrender of a Certificate for cancellation to HFB Financial, together
with a letter of transmittal, duly completed and executed and containing the
certification that the holder of the Certificate holds fewer than 250 shares,
and such other customary documents as may be required pursuant to such
instructions, the holder of such Certificate will, subject to the above
provisions of the merger agreement, be entitled to receive the merger
consideration. In the event of a transfer of ownership of shares which is not
registered in the share transfer records of HFB Financial, the merger
consideration, if any, payable in respect of such shares may be paid or issued
to the transferee if the Certificate representing such shares is presented to
HFB Financial, accompanied by all documents required to evidence and effect such
transfer and by evidence that any applicable stock transfer taxes have been
paid.
YOU SHOULD NOT SEND YOUR STOCK CERTIFICATES NOW. YOU SHOULD SEND THEM ONLY
AFTER YOU RECEIVE A LETTER OF TRANSMITTAL FROM HFB FINANCIAL. LETTERS OF
TRANSMITTAL WILL BE MAILED SOON AFTER THE MERGER IS COMPLETED.
Soon after the merger becomes effective, HFB Financial will mail to each
shareholder who appears may be entitled to a cash payment pursuant to the merger
agreement two items:
- a letter of transmittal and instructions explaining how to exchange their
stock certificates for cash; and
- a certification and instructions explaining how shareholders who own more
than 250 shares of HFB Financial common stock can certify their ownership
to HFB Financial.
If a shareholder owns fewer than 250 shares, he should follow the
instructions accompanying the letter of transmittal and submit the duly
completed letter of transmittal together with the Certificates to Registrar and
Transfer Company, as exchange agent. The letter of transmittal will contain a
certification that the shareholder owns fewer than 250 shares of HFB Financial
common stock. Upon surrender to HFB Financial of valid Certificates and properly
completed letters of transmittal, along with such other documents as HFB
Financial may reasonably require, cashed-out shareholders will be entitled to
receive $22.75 in cash per share. Until surrendered in this manner, each
Certificate representing cashed-out shares will represent only the right to
receive the cash consideration payable in the merger. No service charges will be
payable by shareholders in connection with the exchange of Certificates or the
payment of cash pursuant to the merger agreement, all expenses of which will be
borne by HFB Financial.
If a shareholder receives a letter of transmittal from HFB Financial but
owns more than 250 shares, as a result of owning some or all of his shares in
street name, he should follow the instructions accompanying the certification
and submit the duly completed certification along with such other documents as
required by the
47
certification or that HFB Financial may reasonably require. Until a
certification is received and approved by HFB Financial, all shares held by a
shareholder who received a letter of transmittal and has not returned either a
duly completed letter of transmittal or certification shall be deemed cashed-out
shares and will represent only the right to receive the cash consideration
payable in the merger. We encourage any shareholder intending to complete a
certification to have returned it to HFB Financial no later than March 5, 2004.
If you have not returned a certification by March 19, 2004, HFB Financial will
presume that you own less than 250 shares of HFB Financial common stock and your
shares will be converted into the right to receive $22.75 per share pursuant to
the merger agreement.
YOU SHOULD NOT SEND YOUR STOCK CERTIFICATES NOW. YOU SHOULD SEND THEM ONLY
AFTER YOU RECEIVE A LETTER OF TRANSMITTAL FROM HFB FINANCIAL. LETTERS OF
TRANSMITTAL AND CERTIFICATIONS WILL BE MAILED SOON AFTER THE MERGER IS
COMPLETED.
TIMING OF THE MERGER
If the merger agreement is approved by the HFB Financial shareholders, the
merger closing will take place as soon as practicable after the special meeting,
provided that all other conditions to the merger have been satisfied or waived.
On the date of the merger closing, articles of merger will be filed with the
Secretary of State of the State of Tennessee. The merger will become effective
on the date the articles of merger are filed with the Secretary of State of
Tennessee.
DIRECTORS AND OFFICERS
The merger agreement provides that the directors and executive officers of
HFB Financial immediately prior to the merger will be the directors and
executive officers of HFB Financial, as the surviving corporation, immediately
after the merger.
CHARTER AND BYLAWS
The merger agreement provides that the charter and bylaws of HFB Financial
in effect immediately prior to the merger will be the charter and bylaws of HFB
Financial, as the surviving corporation, immediately after the merger.
REPRESENTATIONS AND WARRANTIES
The merger agreement contains customary representations and warranties made
by HFB Financial and HFB Merger Corp. regarding various matters, including
representations by them as to the enforceability of the merger agreement.
CONDITIONS TO THE COMPLETION OF THE MERGER
The obligations of HFB Financial and HFB Merger Corp. to complete the
merger are subject to the satisfaction or waiver of all of the following
conditions:
- approval of the merger agreement by the holders of at least a majority of
our outstanding shares, which cannot be waived;
- all of the representations and warranties made in the merger agreement
must be true and correct in all material respects as of the effective
time of the merger;
- the aggregate cost of the shares to be converted into cash in the merger
and dissenting shares does not exceed $3.0 million; and
- no litigation is pending regarding the merger.
TERMINATION OF MERGER AGREEMENT
The merger agreement may be terminated by either HFB Financial or HFB
Merger Corp. at any time prior to the effective time of the merger.
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OTHER MATTERS
Management of HFB Financial knows of no other business to be presented at
the special meeting, other than procedural matters relating to the conduct of
the special meeting, but if other matters do properly come before the special
meeting, unless otherwise instructed, it is intended that the persons named in
the proxy card will vote shares according to their best judgment.
WHERE YOU CAN FIND MORE INFORMATION
HFB Financial files reports, proxy statements and other information with
the SEC under the Securities Exchange Act of 1934, as amended. Please call the
SEC at 1-800-SEC-0330 for further information on the public reference rooms. You
may read and copy, at the prescribed rates, this information at the SEC's Public
Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549. The SEC also
maintains an Internet world wide web site that contains reports, proxy
statements and other information about issuers, including HFB Financial, who
file electronically with the SEC. The address of that site is
http://www.sec.gov.
HFB Financial and the merger subsidiary have filed with the SEC a Rule
13e-3 Transaction Statement on Schedule 13E-3 in respect of the merger. As
permitted by the SEC, this proxy statement omits certain information contained
in the Schedule 13E-3. The Schedule 13E-3, including any amendments and exhibits
filed or incorporated by reference as a part thereof, is available for
inspection or copying as set forth above or is available electronically at the
SEC's website.
DOCUMENTS INCORPORATED BY REFERENCE
The SEC allows HFB Financial to "incorporate by reference" information into
this document. This means that we can disclose important information to you be
referring you to another document filed separately with the SEC. The information
incorporated by reference is considered to be a part of this document, except
for any information that is superseded by information that is included directly
in this document or in any other subsequently filed document that also is
incorporated by reference herein.
This document incorporates by reference the documents listed below that HFB
Financial has filed previously with the SEC. They contain important information
about HFB Financial and its financial condition.
- HFB Financial's Annual Report on Form 10-KSB for the year ended December
31, 2002.
- HFB Financial's Quarterly Report on Form 10-QSB for the nine months ended
September 30, 2003.
We also incorporate by reference any additional documents that we may file
with the SEC under Section 13(a), 13(c), 14 or 15(d) of the Securities Exchange
Act of 1934, as amended, between the date of this document and the date of HFB
Financial's special meeting.
We will provide, without charge, to each person to whom this proxy
statement is delivered, upon written or oral request of such person and by first
class mail or other equally prompt means within one business day of receipt of
such request, a copy of any and all information that has been incorporated by
reference, without exhibits unless such exhibits are also incorporated by
reference in this proxy statement. You may obtain a copy of these documents and
any amendments thereto by writing to Earl Burchfield, Secretary, at the
following address: HFB Financial Corporation, 1602 Cumberland Avenue,
Middlesboro, Kentucky 40965, telephone number (606) 248-1095.
These documents are also included in our SEC filings, which you can access
electronically at the SEC's website at http://www.sec.gov.
---------------------
We have not authorized anyone to give any information or make any
representation about the merger or us that differs from, or adds to, the
information in this proxy statement or in our documents that are publicly filed
with the SEC. If anyone does give you different or additional information, you
should not rely on it.
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APPENDIX A
AGREEMENT AND PLAN OF MERGER
This Agreement and Plan of Merger (this "Agreement") is made and entered
into as of this 28th day of October 2003, by and between HFB Financial
Corporation, a Tennessee corporation (the "Company"), and HFB Merger Corp., a
Tennessee corporation ("Newco").
WITNESSETH
WHEREAS, the Company is a corporation duly incorporated and validly
existing under the laws of the State of Tennessee, with authorized capital stock
consisting of 6,000,000 total shares consisting of 5,000,000 shares are common
stock, par value of $1.00 per share, and $1,000,000 shares are preferred stock,
par value of $1.00 per share, of which 1,301,101 shares of common stock and no
shares of preferred stock are issued and outstanding as of the date hereof, and
288,202 shares are held as treasury stock; and
WHEREAS, Newco is a corporation duly organized and validly existing under
the laws of the State of Tennessee, with authorized capital stock consisting of
1,000 shares of common stock, no par value per share (the "Newco Stock"), of
which 1,000 shares are issued and outstanding; and
WHEREAS, the boards of directors of each of the Company and Newco, pursuant
to the authority given by and in accordance with the provisions of the Tennessee
Business Corporation Act (the "TBCA"), have approved this Agreement under which
Newco will be merged with and into the Company (the "Merger") with the Company
surviving the Merger and have authorized the execution hereof; and
WHEREAS, as and when required by the provisions of this Agreement, all such
actions as may be necessary or appropriate shall be taken by the Company and
Newco to consummate the Merger;
NOW, THEREFORE, in consideration of the foregoing premises and of the
mutual covenants and undertakings contained herein, and for such other good and
valuable consideration the receipt and sufficiency of which are hereby
acknowledged, the parties to this Agreement hereby agree as follows:
ARTICLE I
MERGER
1.01. General. At the Effective Time (as defined in Article VIII below)
of the Merger and pursuant to the provisions of this Agreement, the corporate
existence of Newco will be merged with and into the Company (hereinafter
referred to as the "Surviving Corporation" whenever reference is made to it as
of the Effective Time or thereafter) and continued in the Surviving Corporation,
and the Surviving Corporation shall be deemed to be a continuation of the
entities and identities of Newco and the Company.
1.02. Name and Organization. The name of the Surviving Corporation shall
remain and thereafter be "HFB Financial Corporation" The Charter and Bylaws of
the Company in effect at the Effective Time shall remain the Charter and Bylaws
of the Surviving Corporation until changed as provided therein or by law. The
established offices and facilities of the Company shall remain the established
offices and facilities of the Surviving Corporation. The registered office and
registered agent of the Company shall remain the registered office and
registered agent of the Surviving Corporation.
1.03. Rights and Interests. At the Effective Time, all rights,
franchises, titles and interests of the Company and Newco, respectively, in and
to every type of property shall be transferred to and vested in the Surviving
Corporation by virtue of the Merger without any deed or other transfer. The
Surviving Corporation at the Effective Time, and without any order or other
action on the part of any court or otherwise, shall hold and enjoy all rights of
property, franchises, titles and interests, including appointments, powers,
designations, and nominations, and all other rights and interests as trustee,
executor, administrator, agent, transfer agent, registrar of stocks and bonds,
administrator of estates, assignee, and receiver, and in every other fiduciary
and
A-1
agency capacity in the same manner and to the same extent as such rights,
franchises, and interests were held or enjoyed by the Company and Newco,
respectively, immediately prior to the Effective Time.
1.04. Liabilities and Obligations. Except as otherwise provided herein,
the Surviving Corporation shall be liable for all liabilities of the Company and
Newco. All debts, liabilities, obligations, and contracts of the Company and
Newco, matured or unmatured, whether accrued, absolute, contingent, or
otherwise, and whether or not reflected or reserved against on the balance
sheets, books of account, or records of the Company or Newco, as the case may
be, shall be those of, and are hereby expressly assumed by, the Surviving
Corporation and shall not be released or impaired by the Merger. All rights of
creditors and other obligees and all liens on property of either the Company or
Newco shall be preserved unimpaired. At the Effective Time, a proceeding pending
by or against either Newco or the Company may be continued as if the Merger did
not occur, or the Surviving Corporation may be substituted by the proceedings.
1.05. Directors and Officers. The directors, advisory directors, and
officers of the Surviving Corporation at the Effective Time shall be those
persons who were directors, advisory directors, and officers, respectively, of
the Company immediately before the Effective Time and shall hold office from the
Effective Time until their respective successors are duly elected or appointed.
The committees of the Board of Directors of the Surviving Corporation at the
Effective Time shall be the same as, and shall be composed of the same persons
who were serving on, the committees appointed by the Board of Directors of the
Company as they existed immediately before the Effective Time.
1.06. Adoption. Unless contrary to the laws of the State of Tennessee or
the United States of America or other applicable laws, all corporate acts,
plans, policies, applications, agreements, orders, registrations, licenses,
approvals, and authorizations of the Company and Newco, their respective
shareholders, boards of directors, committees elected or appointed by their
boards of directors or officers, and agents that were valid and effective
immediately before the Effective Time shall be taken for all purposes at and
after the Effective Time as the acts, plans, policies, applications, agreements,
orders, registrations, licenses, approvals, and authorizations of the Surviving
Corporation and shall be effective and binding thereon as the same were with
respect to the Company and Newco immediately before the Effective Time.
ARTICLE II
TERMS OF THE MERGER
2.01 General. The manner of exchanging and converting the issued and
outstanding shares of Company Stock and Newco Stock shall be as hereinafter
provided in this Article II.
2.02 Conversion and Cancellation of Stock. At the Effective Time,
(a) all outstanding shares of Company Stock, whether Record Shares (as
hereinafter defined) or Street Shares (as hereinafter defined), held by a
Holder (as hereinafter defined) holding fewer than 250 shares of Company
Stock immediately prior to the Effective Time shall, without any action on
the part of the holder thereof, be canceled and converted into the right to
receive cash equal to $22.75 per share of Company Stock (the "Cash Merger
Consideration") other than shares for which dissenters' rights have been
perfected; provided, however, that the Company may presume that all Street
Shares are held by Holders holding fewer than 250 shares of Company Stock
immediately prior to the Effective Time unless the Holder or a beneficial
owner of Street Shares is able to demonstrate to the Company's satisfaction
that such shares are held beneficially by a Holder holding 250 or more
shares of Company Stock immediately prior to the Effective Time, in which
event such shares of Company Stock shall remain outstanding with all
rights, privileges, and powers existing immediately before the Effective
Time;
(b) all outstanding shares of Company Stock other than those described
in Section 2.02 (a) hereof as being converted into the right to receive the
Cash Merger Consideration shall remain outstanding with all rights,
privileges, and powers existing immediately before the Effective Time; and
(c) the outstanding shares of Newco Stock shall, without any action on
the part of the holder thereof, be canceled.
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(d) Except as provided in Section 2.04, in no event shall any Holder
holding, of record or beneficially, immediately prior to the Effective Time
250 or more shares of Company Stock (including any combination of Record
Shares and Street Shares) in the aggregate be entitled to receive any Cash
Merger Consideration with respect to the shares of Company Stock so held.
It shall be a condition precedent to the right of any Holder to receive the
Cash Merger Consideration, if any, payable with respect to the shares of
Company Stock held by such Holder that such Holder certify to the Company
in the letter of transmittal delivered by the Company as described in
Section 2.03 that such Holder held, of record and beneficially, immediately
prior to the Effective Time fewer than 250 shares of Company Stock
(including any combination of Record Shares and Street Shares) in the
aggregate.
For purposes hereof,
(1) the term "Record Shares" shall mean shares of Company Stock other
than Street Shares and any Record Share shall be deemed to be held by the
registered holder thereof as reflected on the books of the Company;
(2) the term "Street Shares" shall mean shares of Company Stock held
of record in street name, and any Street Share shall be deemed to be held
by the beneficial owner thereof as reflected on the books of the nominee
holder thereof;
(3) the term "Holder" shall mean (i) any record holder or holders of
Record Shares who would be deemed, under Rule 12g5-1 promulgated under the
Securities Exchange Act of 1934, as amended, to be a single "person" for
purposes of determining the number of record shareholders of the Company,
and (ii) any other person or persons who would be deemed to be a "Holder"
under clause (i) above if the shares of Company Stock such person holds
beneficially either in street name were held of record by such person or
persons; and
(4) the term "Cash-Out Shares" shall mean any shares of Company Stock
that are converted into the right to receive the Cash Merger Consideration
pursuant to this Section 2.02.
The Company (along with any other person or entity to which it may delegate
or assign any responsibility or task with respect thereto) shall have full
discretion and exclusive authority (subject to its right and power to so
delegate or assign such authority) to (i) make such inquiries, whether of any
shareholder(s) or otherwise, as it may deem appropriate for purposes of this
Section 2.02 and (ii) resolve and determine, in its sole discretion, all
ambiguities, questions of fact and interpretive and other matters relating to
this Section 2.02, including, without limitation, any questions as to the number
of shares of Company Stock held by any Holder immediately prior to the Effective
Time. All determinations by the Company under this Section 2.02 shall be final
and binding on all parties, and no person or entity shall have any recourse
against the Company or any other person or entity with respect thereto.
For purposes of this Section 2.02, the Company may in its sole discretion,
but shall not have any obligation to do so, (i) presume that any shares of
Company Stock held in a discrete account (whether record or beneficial) are held
by a person distinct from any other person, notwithstanding that the registered
or beneficial holder of a separate discrete account has the same or a similar
name as the holder of a separate discrete account; and (ii) aggregate the shares
of Company Stock held (whether of record or beneficially) by any person or
persons that the Company determines to constitute a single Holder for purposes
of determining the number of shares of Company Stock held by such Holder.
2.03 Exchange of Certificates.
(a) Payment Procedure. Promptly after the Effective Time, the Surviving
Corporation will mail to each holder of a certificate or certificates which
immediately prior to the Effective Time evidenced outstanding shares of Company
Stock that appear, based on information available to the Company, may have been
converted into the right to receive the Cash Merger Consideration (other than
shares of Company Stock as to which rights of dissent have been perfected as
provided in Section 2.04) (the "Certificates"), a letter of transmittal (which
shall include the certification described in Section 2.02 and such other matters
as the Surviving Corporation may determine and shall specify that delivery shall
be effected, and risk of loss and title
A-3
to the Certificates shall pass, only upon delivery of the Certificates to the
Surviving Corporation) and instructions to effect the surrender of the
Certificates in exchange for the Cash Merger Consideration, if any, payable with
respect to such Certificates. Upon surrender of a Certificate for cancellation
to the Surviving Corporation, together with such letter of transmittal, duly
completed and executed and containing the certification contemplated by Section
2.02, and such other customary documents as may be required pursuant to such
instructions, the holder of such Certificate shall, subject to the provisions of
Section 2.02, be entitled to receive in exchange therefor the Cash Merger
Consideration payable with respect to the shares of Company Stock formerly
represented by such Certificate and the Certificate so surrendered shall
forthwith be canceled. In the event of a transfer of ownership of shares of
Company Stock which is not registered in the share transfer records of the
Company, the Cash Merger Consideration, if any, payable in respect thereof may
be paid or issued to the transferee if the Certificate representing such shares
of Company Stock is presented to the Surviving Corporation, accompanied by all
documents required to evidence and effect such transfer and by evidence that any
applicable stock transfer taxes have been paid.
(b) Abandoned Property Laws. The Surviving Corporation shall not be liable
to any holder of a Certificate for any cash properly delivered to a public
official pursuant to any applicable abandoned property, escheat or similar law.
2.04. Appraisal Rights of Shareholders. Shareholders may dissent from the
Merger and exercise their appraisal rights pursuant to and subject to the
provisions of Chapter 23 of the Tennessee Business Corporation Act.
ARTICLE III
REPRESENTATIONS, WARRANTIES, AND COVENANTS OF THE COMPANY
The Company hereby represents, warrants, and covenants to and with Newco as
of the date of this Agreement and as of the Closing Date (as defined in Article
VIII below) as follows:
3.01. Organization. The Company is a business corporation duly
incorporated, validly existing, and in good standing under the laws of the State
of Tennessee. The Company has full corporate power and authority to conduct its
business as is now conducted and is qualified to do business in every
jurisdiction in which the character and location of the assets owned by it or
the nature of the business transacted by it requires qualification. The Company
has full corporate power and authority to make this Agreement and, subject to
the requisite approval of the shareholders to consummate the transactions
contemplated herein. This Agreement has been duly executed and delivered by the
Company as, subject to such shareholder approval, is a valid and binding
agreement of the Company in accordance with the its terms and subject to laws
relating to Creditors' rights generally.
3.02. Authorized and Outstanding Stock. The authorized capital stock of
the Company consists of 5,000,000 shares of common stock and 1,000,000 shares of
preferred stock, par value $1.00 per share. As of the date hereof, 1,301,101
shares of Company common stock are fully paid, validly issued, nonassessable and
outstanding, and 288,202 shares of common stock are held as treasury stock. No
shares of preferred stock are issued or outstanding.
3.03. Consents, Approvals, Filings, etc. of Governmental
Authorities. Neither the business nor operations of the Company requires any
consent, approval or authorization of, or declaration, filing or registration
with, any governmental or regulatory authority in connection with the execution
and delivery of this Agreement, and the consummation of the transactions
contemplated herein, except for (i) such filings with the Securities and
Exchange Commission required for "going private" transactions; (ii) filings and
approvals required by the Federal Reserve Board, if any, and; (iii) the filing
of this Agreement together with articles of merger with corporate and regulatory
authorities, as appropriate.
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ARTICLE IV
REPRESENTATIONS, WARRANTIES, AND COVENANTS OF NEWCO
Newco hereby represents, warrants, and covenants to and with the Company as
of the date of this Agreement and as of the Closing Date as follows:
4.01. Organization. Newco is a business corporation duly incorporated,
validly existing, and in good standing under the laws of the State of Tennessee.
Newco has full corporate power and authority to enter into this Agreement and,
subject to the requisite approval of its sole shareholder, to consummate the
transactions contemplated herein. Newco has the corporate power and authority to
carry on its business as is presently being conducted and is qualified to do
business in every jurisdiction in which the character and location of the assets
owned by it or the nature of the businesses conducted by it requires
qualification. This Agreement has been duly executed and delivered by Newco and,
subject to such shareholder approval, is a valid and binding agreement of Newco
in accordance with the its terms and subject to laws relating to creditors'
rights generally.
4.02. Capital Stock. The authorized capital stock of Newco consists of
1,000 shares of common stock, no par value per share. As of the date hereof,
1,000 shares of Newco are fully paid, validly issued, nonassessable and
outstanding.
4.03. Consents, Approvals, Filings, etc. of Governmental
Authorities. Neither the business nor operations of Newco requires any consent,
approval or authorization of, or declaration, filing or registration with, any
governmental or regulatory authority in connection with the execution and
delivery of this Agreement, and the consummation of the transactions
contemplated herein, except for the filing of this Agreement together with
articles of merger with corporate and regulatory authorities, as appropriate.
ARTICLE V
CONDITIONS TO OBLIGATIONS OF NEWCO
The obligations of Newco to cause the Merger to be consummated shall be
subject to the satisfaction on or before the Closing Date of all of the
following conditions, except as Newco may waive such conditions in writing:
5.01. Shareholder Approval. This Agreement shall have been approved by
the sole shareholder of Newco, which cannot be waived.
5.02. Litigation. On the Closing Date, there shall not be pending or
threatened litigation in any court or any proceeding by any governmental
commission, board, or agency with a view to seeking, or in which it is sought,
to restrain or prohibit consummation of the Merger, or in which it is sought to
obtain divestiture, rescission, or damages in connection with the Merger or the
consummation of the Merger, and to the knowledge of any of the parties hereto,
no investigation by any governmental agency shall be pending or threatened that
might result in any such suit, action, or other proceeding.
5.03. Representations and Warranties. All representations and warranties
of the Company contained in this Agreement, other than any representations and
warranties as to future events, shall be true in all material respects on and as
of the Closing Date as if such representations and warranties were made on and
as of the Closing Date, and the Company shall have performed all agreements and
covenants required by this Agreement to be performed by it on or prior to the
Closing Date.
A-5
ARTICLE VI
CONDITIONS TO OBLIGATIONS OF THE COMPANY
The obligations of the Company to cause the Merger to be consummated shall
be subject to the satisfaction on or before the Closing Date of all the
following conditions, except as the Company may waive such conditions in
writing:
6.01. Litigation. On the Closing Date, there shall not be pending or
threatened litigation in any court or any proceeding by any governmental
commission, board, or agency with a view to seeking, or in which it is sought,
to restrain or prohibit consummation of the Merger, or in which it is sought to
obtain divestiture, rescission, or damages in connection with the Merger or the
consummation of the Merger, and to the knowledge of any of the parties hereto,
no investigation by any governmental agency shall be pending or threatened that
might result in any such suit, action, or other proceeding.
6.02. Representations and Warranties. All representations and warranties
of Newco contained in this Agreement, other than any representations and
warranties as to future events, shall be true in all material respects on and as
of the Closing Date as if such representations and warranties were made on and
as of the Closing Date, and Newco shall have performed all agreements and
covenants required by this Agreement to be performed by it on or prior to the
Closing Date.
6.03. Shareholder Approval. This Agreement shall have been approved by a
vote of the holders of not less than a majority of the outstanding shares of
Company Stock, which cannot be waived.
6.04. Dissenting and Cash-Out Shares. The aggregate number of Cash-Out
Shares and shares of Company Stock held by shareholders who shall have delivered
notice of their intent to exercise their dissenters' rights with respect to the
Merger shall not exceed 131,868.
ARTICLE VII
EXPENSES
Costs and expenses relating to the negotiation and drafting of this
Agreement and the transactions contemplated hereby shall be borne and paid by
the Company.
ARTICLE VIII
CLOSING DATE AND EFFECTIVE TIME
The closing of this Agreement and the transactions contemplated hereby
shall be held on the Closing Date (as defined in this Article VIII) at such time
and place as the parties hereto may mutually agree upon. The "Closing Date"
shall be such date as the Presidents of the Company and Newco, respectively, may
agree upon. Subject to the terms and upon satisfaction on or before the Closing
Date of all requirements of law and conditions specified in this Agreement, the
Company and Newco shall, at the Closing Date, execute, acknowledge, and deliver
such other documents and instruments and take such further action as may be
necessary or appropriate to consummate the Merger. The "Effective Time" is the
date on which the Merger is effective, which shall be on the date the articles
of merger are filed with the Secretary of State of Tennessee.
ARTICLE IX
AMENDMENTS
This Agreement may be amended only by written agreement duly authorized by
the boards of directors of the parties hereto prior to the Closing Date.
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ARTICLE X
TERMINATION
This Agreement may be terminated by either the Company or Newco at any time
prior to the Effective Time. In the event of a termination of this Agreement,
this Agreement shall become void and shall have no effect and create no
liability on the part of any of the parties hereto or their respective
directors, officers, or shareholders.
ARTICLE XI
NOTICES
All notices, requests, demands, and other communications under this
Agreement shall be in writing and shall be deemed to have been duly given at the
time either personally delivered or sent by registered or certified mail,
postage prepaid, as follows:
<Table>
If to the Company, at 1602 Cumberland Avenue
Middlesboro, KY 40965
If to Newco, at 1602 Cumberland Avenue
Middlesboro, KY 40965
</Table>
ARTICLE XII
MISCELLANEOUS
12.01. Further Assurances. Each party hereto agrees to perform any
further acts and to execute and deliver any further documents that may be
reasonably necessary to carry out the provisions of this Agreement.
12.02. Severability. In the event that any of the provisions, or portions
thereof, of this Agreement are held to be illegal, unenforceable, or invalid by
any court of competent jurisdiction, the legality, enforceability, and validity
of the remaining provisions, or portions thereof, shall not be affected thereby,
and, in lieu of the illegal, unenforceable, or invalid provision, or portion
thereof, there shall be added a new legal, enforceable, and valid provision as
similar in scope and effect as is necessary to effectuate the results intended
by the deleted provision or portion.
12.03. Construction. Whenever used herein, the singular number shall
include the plural, and the plural number shall include the singular.
12.04. Gender. Any references herein to the masculine gender, or to the
masculine form of any noun, adjective, or possessive, shall be construed to
include the feminine or neuter gender and form, and vice versa.
12.05. Headings. The headings contained in this Agreement are for
purposes of reference only and shall not limit or otherwise affect the meaning
of any of the provisions contained herein.
12.06. Multiple Counterparts. This Agreement may be executed in multiple
counterparts, each of which shall be deemed to be an original but all of which
together shall constitute one and the same instrument.
12.07. Governing Law. THIS AGREEMENT HAS BEEN EXECUTED IN AND SHALL BE
GOVERNED BY THE LAWS OF THE STATE OF TENNESSEE, WITHOUT GIVING EFFECT TO THE
CONFLICT OF LAWS RULES THEREOF OR OF ANY STATE. ANY ACTION OR PROCEEDING ARISING
OUT OF OR RELATING IN ANY WAY TO THIS AGREEMENT OF THE SUBJECT MATTER HEREOF
SHALL BE BROUGHT AND ENFORCED EXCLUSIVELY IN COMPETENT COURTS OF CAMPBELL
COUNTY, TENNESSEE AND THE PARTIES HEREBY CONSENT TO THE EXCLUSIVE JURISDICTION
OF SUCH COURTS IN RESPECT OF SUCH ACTION OR PROCEEDING.
12.08. Court Costs and Attorneys' Fees. If any action at law or in
equity, including an action for declaratory relief, is brought to enforce or
interpret the provisions of this Agreement, the prevailing party shall
A-7
be entitled to recover costs of court and reasonable attorneys' fees from the
other party or parties to such action, which fees may be set by the court in the
trial of such action or may be enforced in a separate action brought for that
purpose, and which fees shall be in addition to any other relief that may be
awarded.
12.09. Inurement. Subject to any restrictions against transfer or
assignment as may be contained herein, the provisions of this Agreement shall
inure to the benefit of, and shall be binding on, the assigns and successors in
interest of each of the parties hereto.
12.10. Waivers. No waiver of any provision or condition of this Agreement
shall be valid unless executed in writing and signed by the party to be bound
thereby, and then only to the extent specified in such waiver. No waiver of any
provision or condition of this Agreement shall be construed as a waiver of any
other provision or condition of this Agreement, and no present waiver of any
provision or condition of this Agreement shall be construed as a future waiver
of such provision or condition.
12.11. Entire Agreement. This Agreement contains the entire understanding
between the parties hereto concerning the subject matter contained herein. There
are no representations, agreements, arrangements, or understandings, oral or
written, between or among the parties hereto relating to the subject matter of
this Agreement that are not fully expressed herein.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
by as of the date first written above.
HFB FINANCIAL CORPORATION
By: /s/ DAVID B. COOK
------------------------------------
David B. Cook
Its: President
HFB MERGER CORP.
By: /s/ DAVID B. COOK
------------------------------------
David B. Cook
Its: President
A-8
(PROFESSIONALBANKSERVICES LOGO) APPENDIX B
<Table>
Professional Bank Services,
Incorporated
Atlanta, Chicago, Louisville,
Nashville, Ocala
Consultants to the Financial
Industry
ProfessionalBANKServices
Professional Bank Services, The 1000 Building
Incorporated 6300 Dutchman's Lane, Suite 305
Louisville, Kentucky 40205
Atlanta, Chicago, Louisville, 502 451-6633
Nashville, Ocala 502 451-6755 (FAX)
800-523-4778 (WATS)
Consultants to the Financial
Industry
ProfessionalBANKServices
</Table>
January 12, 2004
Board of Directors
HFB Financial Corporation
1602 Cumberland Avenue
Middlesboro, Kentucky 40965
To The Directorate:
You have requested our opinion as investment bankers as to the fairness of
the cash value to be paid to Company common shareholders owning less than 250
Company common shares of the Company's common shares in a proposed merger
transaction, as well as to the unaffiliated shareholders from a financial point
of view. In the proposed merger transaction, a new Tennessee corporation will be
merged with and into the Company with the Company being the survivor of the
merger (the "Merger"). Under the terms of the proposed Merger, Company common
shareholders owning less than 250 Company common shares will receive fair value
in cash in exchange for their shares of Company common stock. This opinion is
based on a review of the financial condition and history of the Company and its
wholly owned subsidiary, Home Federal Bank Corporation, Middlesboro, Kentucky
(the "Bank"), regulatory and audit reports, and other such summary information
available and deemed appropriate.
Professional Bank Services, Inc. ("PBS") has performed stock appraisals for
numerous financial institutions in Kentucky and throughout the United States.
Our knowledge of the financial industry evolves from an experienced staff and a
history as consultants and financial advisors to the banking industry. PBS'
wholly owned subsidiary, Investment Bank Services, Inc., is a registered
Broker/Dealer with the Securities and Exchange Commission ("SEC").
For purposes of this fairness opinion, we have reviewed and analyzed the
historical performance of the Company and the Bank, including: (i) June 30,
1999, 2000, 2001, 2002 and December 31, 2002 audited financial statements and
Forms 10-KSB of the Company; (ii) December 31, 2002, March 31, 2003 and June 30,
2003 Consolidated Reports of Condition and Income filed by the Bank; (iii) March
31, 2003 and June 30, 2003 forms 10-QSB filed by the Company with the SEC; (iv)
April 9, 2003 Form DEF 14C Proxy Statement filed by the Company; (v) June 30,
2003 Uniform Bank Performance Report of the Company; (v) December 31, 2002,
March 31, 2003 and June 30, 2003 FR Y-9C filed by the Company with the Federal
Reserve, and (vi) the historical common stock trading activity of the Company.
We have reviewed statistical data regarding the loan portfolio, securities
portfolio and other performance ratios and statistics. Financial projections
have been prepared and analyzed as well as other financial studies, analyses and
investigations as deemed relevant for the purposes of this appraisal. In review
of the aforementioned information, we have taken into account our assessment of
general market and financial conditions, our experience in other transactions,
and our knowledge of the banking industry generally.
We have not compiled, reviewed or audited the financial statements of the
Company or the Bank, nor have we independently verified any of the information
reviewed; we have relied upon such information as being complete and accurate in
all material respects. We have not made an independent evaluation of the assets
of the Company or the Bank.
B-1
Board of Directors
HFB Financial Corporation
Page 2
PBS, its officers, and its staff have no present business interest in the
Company. No benefits will accrue to PBS as a result of this review, other than
the professional fees previously agreed to by the Company. Fees paid to PBS for
the preparation of this fairness opinion are neither dependent or contingent
upon any transaction or upon the results of the review.
Based on the foregoing, and all other factors deemed relevant and assuming
accuracy and completeness of information provided by the Company, it is our
opinion, as investment bankers, that the $22.75 per common share to be paid to
Company common shareholders owning less then 250 Company common shares under the
terms of the proposed Merger is fair to the those shareholders as well as to the
unaffiliated shareholders from a financial perspective.
Very truly yours,
/s/ PROFESSIONAL BANK SERVICES, INC.
PROFESSIONAL BANK SERVICES, INC.
B-2
APPENDIX C
CHAPTER 23 OF THE TENNESSEE BUSINESS CORPORATION ACT
TITLE 48, TENNESSEE CODE, CHAPTER 23
DISSENTERS' RIGHTS
PART 1
RIGHT TO DISSENT AND OBTAIN PAYMENT FOR SHARES
48-23-101. CHAPTER DEFINITIONS.
As used in this chapter, unless the context otherwise requires:
(1) "Beneficial shareholder" means the person who is a beneficial
owner of shares held by a nominee as the record shareholder;
(2) "Corporation" means the issuer of the shares held by a dissenter
before the corporate action, or the surviving or acquiring corporation by
merger or share exchange of that issuer;
(3) "Dissenter" means a shareholder who is entitled to dissent from
corporate action under sec. 48-23-102 and who exercises that right when and
in the manner required by part 2 of this chapter;
(4) "Fair value", with respect to a dissenter's shares, means the
value of the shares immediately before the effectuation of the corporate
action to which the dissenter objects, excluding any appreciation or
depreciation in anticipation of the corporate action;
(5) "Interest" means interest from the effective date of the corporate
action that gave rise to the shareholder's right to dissent until the date
of payment, at the average auction rate paid on United States treasury
bills with a maturity of six (6) months (or the closest maturity thereto)
as of the auction date for such treasury bills closest to such effective
date;
(6) "Record shareholder" means the person in whose name shares are
registered in the records of a corporation or the beneficial owner of
shares to the extent of the rights granted by a nominee certificate on file
with a corporation; and
(7) "Shareholder" means the record shareholder or the beneficial
shareholder.
[Acts 1986, ch. 887, sec. 13.01.]
48-23-102. RIGHT TO DISSENT.
(a) A shareholder is entitled to dissent from, and obtain payment of the
fair value of the shareholder's shares in the event of, any of the following
corporate actions:
(1) Consummation of a plan of merger to which the corporation is a
party:
(A) If shareholder approval is required for the merger by
sec. 48-21-104 or the charter and the shareholder is entitled to vote on
the merger; or
(B) If the corporation is a subsidiary that is merged with its
parent under sec. 48-21-105;
(2) Consummation of a plan of share exchange to which the corporation
is a party as the corporation whose shares will be acquired, if the
shareholder is entitled to vote on the plan;
(3) Consummation of a sale or exchange of all, or substantially all,
of the property of the corporation other than in the usual and regular
course of business, if the shareholder is entitled to vote on the sale or
exchange, including a sale in dissolution, but not including a sale
pursuant to court order or a sale for cash pursuant to a plan by which all
or substantially all of the net proceeds of the sale will be distributed to
the shareholders within one (1) year after the date of sale;
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(4) An amendment of the charter that materially and adversely affects
rights in respect of a dissenter's shares because it:
(A) Alters or abolishes a preferential right of the shares;
(B) Creates, alters, or abolishes a right in respect of redemption,
including a provision respecting a sinking fund for the redemption or
repurchase, of the shares;
(C) Alters or abolishes a preemptive right of the holder of the
shares to acquire shares or other securities;
(D) Excludes or limits the right of the shares to vote on any
matter, or to cumulate votes, other than a limitation by dilution
through issuance of shares or other securities with similar voting
rights; or
(E) Reduces the number of shares owned by the shareholder to a
fraction of a share, if the fractional share is to be acquired for cash
under sec. 48-16-104; or
(5) Any corporate action taken pursuant to a shareholder vote to the
extent the charter, bylaws, or a resolution of the board of directors
provides that voting or nonvoting shareholders are entitled to dissent and
obtain payment for their shares.
(b) A shareholder entitled to dissent and obtain payment for the
shareholder's shares under this chapter may not challenge the corporate action
creating the shareholder's entitlement unless the action is unlawful or
fraudulent with respect to the shareholder or the corporation.
(c) Notwithstanding the provisions of subsection (a), no shareholder may
dissent as to any shares of a security which, as of the date of the effectuation
of the transaction which would otherwise give rise to dissenters' rights, is
listed on an exchange registered under sec. 6 of the Securities Exchange Act of
1934, as amended, or is a "national market system security," as defined in rules
promulgated pursuant to the Securities Exchange Act of 1934, as amended.
[Acts 1986, ch. 887, sec. 13.02.]
48-23-103. DISSENT BY NOMINEES AND BENEFICIAL OWNERS.
(a) A record shareholder may assert dissenters' rights as to fewer than all
the shares registered in the record shareholder's name only if the record
shareholder dissents with respect to all shares beneficially owned by any one
(1) person and notifies the corporation in writing of the name and address of
each person on whose behalf the record shareholder asserts dissenters' rights.
The rights of a partial dissenter under this subsection are determined as if the
shares as to which the partial dissenter dissents and the partial dissenter's
other shares were registered in the names of different shareholders.
(b) A beneficial shareholder may assert dissenters' rights as to shares of
any one (1) or more classes held on the beneficial shareholder's behalf only if
the beneficial shareholder:
(1) Submits to the corporation the record shareholder's written
consent to the dissent not later than the time the beneficial shareholder
asserts dissenters' rights; and
(2) Does so with respect to all shares of the same class of which the
person is the beneficial shareholder or over which the person has power to
direct the vote.
[Acts 1986, ch. 887, sec. 13.03.]
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PART 2
PROCEDURE FOR EXERCISE OF DISSENTERS' RIGHTS
48-23-201. NOTICE OF DISSENTERS' RIGHTS.
(a) If proposed corporate action creating dissenters' rights under
sec. 48-23-102 is submitted to a vote at a shareholders' meeting, the meeting
notice must state that shareholders are or may be entitled to assert dissenters'
rights under this chapter and be accompanied by a copy of this chapter.
(b) If corporate action creating dissenters' rights under sec. 48-23-102 is
taken without a vote of shareholders, the corporation shall notify in writing
all shareholders entitled to assert dissenters' rights that the action was taken
and send them the dissenters' notice described in sec. 48-23-203.
(c) A corporation's failure to give notice pursuant to this section will
not invalidate the corporate action.
[Acts 1986, ch. 887, sec. 13.20.]
48-23-202. NOTICE OF INTENT TO DEMAND PAYMENT.
(a) If proposed corporate action creating dissenters' rights under
sec. 48-23-102 is submitted to a vote at a shareholders' meeting, a shareholder
who wishes to assert dissenters' rights must:
(1) Deliver to the corporation, before the vote is taken, written
notice of the shareholder's intent to demand payment for the shareholder's
shares if the proposed action is effectuated; and
(2) Not vote the shareholder's shares in favor of the proposed action.
No such written notice of intent to demand payment is required of any
shareholder to whom the corporation failed to provide the notice required
by sec. 48-23-201.
(b) A shareholder who does not satisfy the requirements of subsection (a)
is not entitled to payment for the shareholder's shares under this chapter.
[Acts 1986, ch. 887, sec. 13.21.]
48-23-203. DISSENTERS' NOTICE.
(a) If proposed corporate action creating dissenters' rights under
sec. 48-23-102 is authorized at a shareholders' meeting, the corporation shall
deliver a written dissenters' notice to all shareholders who satisfied the
requirements of sec. 48-23-202.
(b) The dissenters' notice must be sent no later than ten (10) days after
the corporate action was authorized by the shareholders or effectuated,
whichever is the first to occur, and must:
(1) State where the payment demand must be sent and where and when
certificates for certificated shares must be deposited;
(2) Inform holders of uncertificated shares to what extent transfer of
the shares will be restricted after the payment demand is received;
(3) Supply a form for demanding payment that includes the date of the
first announcement to news media or to shareholders of the principal terms
of the proposed corporate action and requires that the person asserting
dissenters' rights certify whether or not the person asserting dissenters'
rights acquired beneficial ownership of the shares before that date;
(4) Set a date by which the corporation must receive the payment
demand, which date may not be fewer than one (1) nor more than two (2)
months after the date the subsection (a) notice is delivered; and
(5) Be accompanied by a copy of this chapter if the corporation has
not previously sent a copy of this chapter to the shareholder pursuant to
sec. 48-23-201.
C-3
48-23-204. DUTY TO DEMAND PAYMENT.
(a) A shareholder sent a dissenters' notice described in sec. 48-23-203
must demand payment, certify whether the shareholder acquired beneficial
ownership of the shares before the date required to be set forth in the
dissenters' notice pursuant to sec. 48-23-203(b)(3), and deposit the
shareholder's certificates in accordance with the terms of the notice.
(b) The shareholder who demands payment and deposits the shareholder's
share certificates under subsection (a) retains all other rights of a
shareholder until these rights are cancelled or modified by the effectuation of
the proposed corporate action.
(c) A shareholder who does not demand payment or deposit the shareholder's
share certificates where required, each by the date set in the dissenters'
notice, is not entitled to payment for the shareholder's shares under this
chapter.
(d) A demand for payment filed by a shareholder may not be withdrawn unless
the corporation with which it was filed, or the surviving corporation, consents
thereto.
[Acts 1986, ch. 887, sec. 13.23.]
48-23-205. SHARE RESTRICTIONS.
(a) The corporation may restrict the transfer of uncertificated shares from
the date the demand for their payment is received until the proposed corporate
action is effectuated or the restrictions released under sec. 48-23-207.
(b) The person for whom dissenters' rights are asserted as to
uncertificated shares retains all other rights of a shareholder until these
rights are cancelled or modified by the effectuation of the proposed corporate
action.
[Acts 1986, ch. 887, sec. 13.24.]
48-23-206. PAYMENT.
(a) Except as provided in sec. 48-23-208, as soon as the proposed corporate
action is effectuated, or upon receipt of a payment demand, whichever is later,
the corporation shall pay each dissenter who complied with sec. 48-23-204 the
amount the corporation estimates to be the fair value of each dissenter's
shares, plus accrued interest.
(b) The payment must be accompanied by:
(1) The corporation's balance sheet as of the end of a fiscal year
ending not more than sixteen (16) months before the date of payment, an
income statement for that year, a statement of changes in shareholders'
equity for that year, and the latest available interim financial
statements, if any;
(2) A statement of the corporation's estimate of the fair value of the
shares;
(3) An explanation of how the interest was calculated;
(4) A statement of the dissenter's right to demand payment under
sec. 48-23-209; and
(5) A copy of this chapter if the corporation has not previously sent
a copy of this chapter to the shareholder pursuant to sec. 48-23-201 or
sec. 48-23-203.
[Acts 1986, ch. 887, sec. 13.25.]
48-23-207. FAILURE TO TAKE ACTION.
(a) If the corporation does not effectuate the proposed action that gave
rise to the dissenters' rights within two (2) months after the date set for
demanding payment and depositing share certificates, the
C-4
corporation shall return the deposited certificates and release the transfer
restrictions imposed on uncertificated shares.
(b) If, after returning deposited certificates and releasing transfer
restrictions, the corporation effectuates the proposed action, it must send a
new dissenters' notice under sec. 48-23-203 and repeat the payment demand
procedure.
[Acts 1986, ch. 887, sec. 13.26.]
48-23-208. AFTER-ACQUIRED SHARES.
(a) A corporation may elect to withhold payment required by sec. 48-23-206
from a dissenter unless the dissenter was the beneficial owner of the shares
before the date set forth in the dissenters' notice as the date of the first
announcement to news media or to shareholders of the principal terms of the
proposed corporate action.
(b) To the extent the corporation elects to withhold payment under
subsection (a), after effectuating the proposed corporate action, it shall
estimate the fair value of the shares, plus accrued interest, and shall pay this
amount to each dissenter who agrees to accept it in full satisfaction of the
dissenter's demand. The corporation shall send with its offer a statement of its
estimate of the fair value of the shares, an explanation of how the interest was
calculated, and a statement of the dissenter's right to demand payment under
sec. 48-23-209.
[Acts 1986, ch. 887, sec. 13.27.]
48-23-209. PROCEDURE IF SHAREHOLDER DISSATISFIED WITH PAYMENT OR OFFER.
(a) A dissenter may notify the corporation in writing of the dissenter's
own estimate of the fair value of the dissenter's shares and amount of interest
due, and demand payment of the dissenter's estimate (less any payment under
sec. 48-23-206), or reject the corporation's offer under sec. 48-23-208 and
demand payment of the fair value of the dissenter's shares and interest due, if:
(1) The dissenter believes that the amount paid under sec. 48-23-206
or offered under sec. 48-23-208 is less than the fair value of the
dissenter's shares or that the interest due is incorrectly calculated;
(2) The corporation fails to make payment under sec. 48-23-206 within
two (2) months after the date set for demanding payment; or
(3) The corporation, having failed to effectuate the proposed action,
does not return the deposited certificates or release the transfer
restrictions imposed on uncertificated shares within two (2) months after
the date set for demanding payment.
(b) A dissenter waives the dissenter's right to demand payment under this
section unless the dissenter notifies the corporation of the dissenter's demand
in writing under subsection (a) within one (1) month after the corporation made
or offered payment for the dissenter's shares.
[Acts 1986, ch. 887, sec. 13.28.]
PART 3
JUDICIAL APPRAISAL OF SHARES
48-23-301. COURT ACTION.
(a) If a demand for payment under sec. 48-23-209 remains unsettled, the
corporation shall commence a proceeding within two (2) months after receiving
the payment demand and petition the court to determine the fair value of the
shares and accrued interest. If the corporation does not commence the proceeding
within the two-month period, it shall pay each dissenter whose demand remains
unsettled the amount demanded.
C-5
(b) The corporation shall commence the proceeding in a court of record
having equity jurisdiction in the county where the corporation's principal
office (or, if none in this state, its registered office) is located. If the
corporation is a foreign corporation without a registered office in this state,
it shall commence the proceeding in the county in this state where the
registered office of the domestic corporation merged with or whose shares were
acquired by the foreign corporation was located.
(c) The corporation shall make all dissenters (whether or not residents of
this state) whose demands remain unsettled, parties to the proceeding as in an
action against their shares and all parties must be served with a copy of the
petition. Nonresidents may be served by registered or certified mail or by
publication as provided by law.
(d) The jurisdiction of the court in which the proceeding is commenced
under subsection (b) is plenary and exclusive. The court may appoint one (1) or
more persons as appraisers to receive evidence and recommend decision on the
question of fair value. The appraisers have the powers described in the order
appointing them, or in any amendment to it. The dissenters are entitled to the
same discovery rights as parties in other civil proceedings.
(e) Each dissenter made a party to the proceeding is entitled to judgment:
(1) For the amount, if any, by which the court finds the fair value of
the dissenter's shares, plus accrued interest, exceeds the amount paid by
the corporation; or
(2) For the fair value, plus accrued interest, of the dissenter's
after-acquired shares for which the corporation elected to withhold payment
under sec. 48-23-208.
[Acts 1986, ch. 887, sec. 13.30.]
48-23-302. COURT COSTS AND COUNSEL FEES.
(a) The court in an appraisal proceeding commenced under sec. 48-23-301
shall determine all costs of the proceeding, including the reasonable
compensation and expenses of appraisers appointed by the court. The court shall
assess the costs against the corporation, except that the court may assess costs
against all or some of the dissenters, in amounts the court finds equitable, to
the extent the court finds the dissenters acted arbitrarily, vexatiously, or not
in good faith in demanding payment under sec. 48-23-209.
(b) The court may also assess the fees and expenses of counsel and experts
for the respective parties, in amounts the court finds equitable against:
(1) The corporation and in favor of any or all dissenters if the court
finds the corporation did not substantially comply with the requirements of
part 2 of this chapter; or
(2) Either the corporation or a dissenter, in favor of any other
party, if the court finds that the party against whom the fees and expenses
are assessed acted arbitrarily, vexatiously, or not in good faith with
respect to the rights provided by this chapter.
(c) If the court finds that the services of counsel for any dissenter were
of substantial benefit to other dissenters similarly situated, and that the fees
for those services should not be assessed against the corporation, the court may
award to these counsel reasonable fees to be paid out of the amounts awarded to
the dissenters who were benefited.
[Acts 1986, ch. 887, sec. 13.31.]
C-6
APPENDIX D
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-KSB
<Table>
(Mark One)
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2002
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE TRANSITION PERIOD FROM JULY 1, 2002 TO DECEMBER 31, 2002
</Table>
COMMISSION FILE NO. 0-20956
HFB FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
<Table>
TENNESSEE 61-1228266
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification No.)
1602 CUMBERLAND AVENUE, MIDDLESBORO, KENTUCKY 40965
(Address of principal executive offices) (Zip Code)
</Table>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(606) 248-1095
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NOT APPLICABLE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK (PAR VALUE $1.00 PER SHARE)
TITLE OF CLASS
Indicate by check mark whether the registrant (1) has filed all reports
required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or 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-B 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-KSB or any amendment to
this Form 10-KSB. [X]
Registrant's revenues for the fiscal year ended December 31, 2002:
$8,799,754.
The registrant's voting stock is listed on the Nasdaq SmallCap Market. The
aggregate market value of the voting stock held by nonaffiliates of the
registrant, based on the $16.50 per share closing sales price of the
registrant's common stock as quoted on the Nasdaq SmallCap Market on March 25,
2002, was $18,328,695. For purposes of this calculation, it is assumed that
directors and officers of the registrant are affiliates. As of March 2002, the
registrant had 1,301,101 shares of common stock outstanding, of which 190,271
were held by affiliates.
Transitional Small Business Disclosure Format Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of Information Statement for the 2003 Annual Meeting of
Stockholders. (Part III)
D-1
PART I
ITEM 1. BUSINESS.
GENERAL
HFB Financial Corporation (the "Company") is the sole stockholder of, and
acts as the holding company for, Home Federal Bank Corporation ("Home Federal"
or the "Bank"). The Company was organized at the direction of the Bank in
September 1992 to acquire all of the capital stock issued by the Bank in its
conversion from a mutual to stock form. The Company has no significant assets
other than capital stock of the Bank and a portfolio of trading account equity
securities. The Company qualifies as a bank holding company and is subject to
regulation by the Federal Reserve Board ("FRB"). The Company's principal
business is the business of the Bank and its subsidiary. Therefore, references
to the "Company" in this Form 10-KSB are to both the Company and the Bank. The
Bank operates through three full-service offices in the southeastern Kentucky
communities of Middlesboro and Harlan and two full-service offices in the
eastern Tennessee communities of New Tazewell and Jacksboro. At December 31,
2002, the Company had total assets of $253.5 million, deposits of $199.3
million, net loans receivable of $166.3 million and stockholders' equity of
$23.6 million.
The executive offices of the Company are located at 1602 Cumberland Avenue,
Middlesboro, Kentucky 40965, and the telephone number is (606) 248-1095.
The Company is engaged principally in the business of accepting deposits
from the general public and originating permanent loans that are secured by one-
to-four-family residential properties located in its market area. The Company
also originates consumer loans and commercial real estate loans and maintains a
substantial investment portfolio of mortgage-backed and other investment
securities.
CHANGE IN FISCAL YEAR
On February 19, 2002, the board of directors of the Company made a
determination to change the registrant's fiscal year-end from June 30 to
December 31, effective July 1, 2002. The Company filed an Annual Report on Form
10-K with the Securities and Exchange Commission for its fiscal year ended June
30, 2002. Pursuant to the change in fiscal year, the Company has filed this Form
10-K transition report with the Securities and Exchange Commission for the
six-month period ending December 31, 2002. Audited financial statements covering
the six-month period ending December 31, 2002 are part of this 10-K transition
filing.
The Company changed its fiscal year in order to facilitate the
comparability of the Company to other bank holding companies, which have
historically utilized a December 31 year-end. Moving to a December 31 year-end
has aligned the Company's financial reporting with its peer group and with
publicly held bank holding companies in the United States.
APPROVAL FOR NEW BRANCH OFFICE
On July 8, 2002, the Bank received regulatory approval to establish a
branch office in the City of Jacksboro, Tennessee. Jacksboro is county seat for
Campbell County and is located in the northeastern portion of Tennessee. The
Bank has originated loans in this market over the last 20 years and presently
has a portfolio of loans in excess of $50.0 million within this market.
Management believes that the Bank's presence in Jacksboro through an office will
assist in increasing the Bank's loan portfolio and obtaining new deposits. The
new branch was opened during January 2003 in a temporary location. The Company's
wholly owned subsidiary, Home Service Corporation, has paid $510,000 for a
commercial lot in Jacksboro. Home Service Corporation will build the branch
office and lease it to the Bank. The total cost of the land and building is
estimated at $1.5 million. The new branch office building is expected to be
ready for occupancy in approximately 18 months.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain matters discussed in this document are "forward-looking
statements," intended to qualify for the safe harbors from liability established
by the Private Securities Legislation Reform Act of 1995. These
D-2
forward-looking statements can generally be identified as such because the
context of the statement will include words such as the Company "believes,"
"anticipates," "expects" or "estimates," or words of similar import. Similarly,
statements that describe the Company's future plans, objectives or goals are
also forward-looking statements. Such forward-looking statements are subject to
certain risks and uncertainties which are described in close proximity to such
statements and which could cause actual results to differ materially from those
anticipated as of the date of this report. Shareholders, potential investors and
other readers are cautioned not to place undue reliance on such forward-looking
statements. The forward-looking statements included herein are made only as of
the date of this report and the Company undertakes no obligation to publicly
update such forward-looking statements to reflect subsequent events or
circumstances.
LENDING ACTIVITIES
General. The Company originates loans primarily through its main office
located in Middlesboro, Kentucky. The principal lending activity of the Company
is the origination of conventional mortgage loans for the purpose of purchasing
or refinancing owner-occupied, one- to four-family residential properties in its
primary market areas. Conventional mortgage loans are primarily adjustable-rate
mortgage loans with a smaller amount of fixed-rate mortgage loans which are not
insured or guaranteed by federal agencies. The Company does not originate
Federal Housing Administration-insured or Veterans Administration-insured loans.
The Company does originate consumer loans on a direct basis. In addition, the
Company also makes conventional mortgage loans for the purpose of constructing
one- to four-family residences and loans to construct commercial and multifamily
real estate.
The Company emphasizes the origination of adjustable-rate loans and
short-term loans in order to increase the interest rate sensitivity of its loan
portfolio. However, the Company also continues to offer long-term, fixed-rate
conventional mortgage loans (30-year terms or less), originated for its
portfolio. The ratio of fixed-rate loans to adjustable-rate loans has increased
significantly during the last six months due to the current low-interest-rate
environment.
Analysis of Loan Portfolio. Set forth below is selected data relating to
the composition of the Company's loan portfolio at the dates indicated. As of
December 31, 2002, the Company had no concentrations of loans exceeding 10% of
total loans other than as disclosed below.
<Table>
<Caption>
AT AT JUNE 30,
DECEMBER 31, ----------------------------------------------------
2002 2002 2001 2000 1999 1998
-------------- -------- -------- -------- -------- --------
(IN THOUSANDS) (IN THOUSANDS)
Real estate loans:
Single and multifamily mortgage
loans.......................... $126,571 $125,901 $114,442 $111,157 $ 95,294 $ 94,153
Commercial real estate loans..... 25,211 19,409 14,295 11,478 10,745 10,411
Real estate construction loans... 13,871 6,231 4,721 6,690 12,996 8,636
-------- -------- -------- -------- -------- --------
Total real estate loans.......... 165,653 151,541 133,458 129,325 119,035 113,200
-------- -------- -------- -------- -------- --------
Consumer loans(1)................ 5,971 7,409 6,276 5,286 5,912 6,473
-------- -------- -------- -------- -------- --------
Commercial loans................. 2,195 1,973 506 193 98 353
-------- -------- -------- -------- -------- --------
Total gross loans................ 173,819 160,923 140,240 134,804 125,045 120,026
Less:
Undisbursed portion of mortgage
loans.......................... 5,566 4,843 2,311 2,529 2,931 2,757
Allowances for loan losses....... 1,192 975 718 645 1,212 973
Unamortized discount and deferred
loan fees, net................. 726 655 348 236 160 125
-------- -------- -------- -------- -------- --------
Total............................ $166,335 $154,450 $136,863 $131,394 $120,742 $116,171
======== ======== ======== ======== ======== ========
</Table>
D-3
- ---------------
(1) Includes loans on deposits, home improvement loans, automobile loans and
other loans.
The following table sets forth certain information as of December 31, 2002
the regarding the dollar amount of principal repayments becoming due during the
periods indicated for loans. Demand loans, loans having no schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table below does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Company's actual repayment experience to differ from that shown below.
<Table>
<Caption>
DUE AFTER ONE
DUE IN ONE YEAR THROUGH DUE AFTER
YEAR OR LESS FIVE YEARS FIVE YEARS TOTAL
------------ ------------- ---------- --------
(IN THOUSANDS)
Real estate mortgage loans............. $4,746 $22,684 $124,352 $151,782
Real estate construction loans......... 379 1,816 11,676 13,871
Consumer loans......................... 1,765 4,179 27 5,971
Commercial loans....................... 612 1,583 -- 2,195
------ ------- -------- --------
Total gross loans...................... $7,502 $30,262 $136,055 $173,819
====== ======= ======== ========
</Table>
The following table sets forth as of December 31, 2002 the dollar amount of
all the loans due after one year ending December 31, 2002 and distinguishes
between those with predetermined (i.e., fixed) interest rates and those with
floating or adjustable interest rates.
<Table>
<Caption>
PREDETERMINED FLOATING OR
RATE ADJUSTABLE RATES TOTAL
------------- ---------------- --------
(IN THOUSANDS)
Real estate mortgage loans..................... $34,276 $112,760 $147,036
Real estate construction loans................. 10,119 3,373 13,492
Consumer loans(1).............................. 4,158 48 4,206
Commercial loans............................... 1,069 514 1,583
------- -------- --------
Total gross loans.............................. $49,622 $116,695 $166,317
======= ======== ========
</Table>
- ---------------
(1) Includes loans on deposits, home improvement loans, automobile loans and
other loans.
The primary emphasis of the Company's lending activity is the origination
of conventional loans secured by owner-occupied, one- to four-family residential
properties. The Company's conventional mortgage loan originations are generally
for terms of 10 to 30 years, amortized on a monthly basis, with principal and
interest due each month. Borrowers may refinance or prepay loans at their option
without penalty. Conventional residential mortgage loans granted by the Company
customarily contain "due-on-sale" clauses which permit the Company to accelerate
the indebtedness of the loan upon transfer of ownership of the mortgaged
property.
The Company's lending policies generally limit the maximum loan-to-value
ratio on mortgage loans secured by owner-occupied properties to 81% and 95% of
the lesser of the appraised value or purchase price. The maximum loan-to-value
ratio on mortgage loans secured by non-owner-occupied properties and/or used for
refinancing purposes is also 80%. The Company does originate some 81% to 95%
loan-to-value ratio loans. The Company requires private mortgage insurance on
loans with loan-to-value ratios of 91% and over and charges a higher effective
interest rate on such loans to account for the additional risk these loans
carry.
The Company also originates conventional fixed-rate mortgage loans on
one-to four-family residential properties, the majority of which have a maximum
term to maturity of 30 years. The Company originates and holds its fixed-rate
mortgage loans in its portfolio as long-term investments.
In addition, the Company engages in a limited but increasing amount of
construction lending involving loans to qualified borrowers for construction of
one- to four-family residential properties. These properties are primarily
located in the Company's market area. All construction loans are secured by a
first lien on the
D-4
property under construction. Construction/permanent loans generally have
adjustable interest rates and are underwritten in accordance with the same terms
and requirements as the Company's permanent mortgages, except the loans
generally provide for disbursement in stages during a construction period of up
to 12 months, during which period the borrower is required to make monthly
payments of accrued interest on the outstanding loan balance. Interim
construction loans generally have fixed interest rates, terms of up to 12 months
and a maximum loan-to-value ratio of 80%. Borrowers must satisfy all credit
requirements which would apply to the Company's permanent mortgage loan
financing for the subject property.
The Company also originates consumer loans, primarily savings account
loans, automobile loans, home equity loans and lines of credit, second mortgage
loans and other consumer loans secured by mortgages on residences. The Company
also makes a limited amount of unsecured loans.
The Company has historically engaged in a limited amount of commercial and
multifamily real estate lending but has increased originations of such loans
over the past 12 months. The Company generally makes commercial and multifamily
real estate loans available on properties in its market area, with terms of 20
years or less, loan-to-value ratios of 80% or less and adjustable rates of
interest. In addition, the Company, from time to time, purchases whole loans or
participation interests in loans on commercial and multifamily real estate
located in Kentucky and eastern Tennessee.
Asset Classification and Allowance for Loan Losses. The Company classifies
its loan assets as a "substandard," "doubtful" or "loss," if warranted. Assets
classified as substandard or doubtful require a general allowance for loan
losses. If an asset is classified as loss, the loan must be charged off. An
asset which does not currently warrant classification but which possesses
weaknesses or deficiencies deserving close attention is required to be
designated as "special mention." Currently, general loss allowances established
to cover possible losses related to assets classified substandard or doubtful
may be included in determining an institution's regulatory capital, while
specific valuation allowances for loan losses do not qualify as regulatory
capital. The Company has determined that at December 31, 2002 it had $2.2
million in assets classified as substandard, $688,000 in assets classified as
doubtful and no assets classified as loss. In addition, the Company had $1.6
million in assets designated as special mention. Depending on their future
performance, it is possible that these loans might be required to be classified
in future periods.
D-5
The following table sets forth an analysis of the Company's allowance for
loan losses for the periods indicated.
<Table>
<Caption>
SIX MONTHS ENDED YEAR ENDED JUNE 30,
DECEMBER 31, ------------------------------------
2002 2002 2001 2000 1999 1998
---------------------- ---- ---- ------ ------ ----
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
Balance at Beginning of Period...... $ 975 $718 $645 $1,212 $ 973 $710
------ ---- ---- ------ ------ ----
Loan charge-offs:
Real estate:
Residential.................... 6 20 24 87 -- --
Commercial..................... 31 38 9 -- -- --
Consumer.......................... -- 9 10 12 16 11
Commercial........................ -- -- -- 34 -- --
------ ---- ---- ------ ------ ----
Total charge-offs................... 37 67 43 133 16 11
Recoveries:
Real estate:
Residential.................... 20 8 9 -- -- --
Consumer....................... -- -- 2 3 2 --
Commercial........................ -- 9 -- -- -- --
------ ---- ---- ------ ------ ----
Total Recoveries.................... 20 17 11 3 2 --
Net loan recoveries (charge-offs)... (17) (50) (32) (130) (14) (11)
------ ---- ---- ------ ------ ----
Provision (Adjustment) for Loan
Losses............................ 234 307 105 (437) 253 274
------ ---- ---- ------ ------ ----
Balance at end of period............ $1,192 $975 $718 $ 645 $1,212 $973
====== ==== ==== ====== ====== ====
Ratio of allowance for losses to
gross loans receivable............ 0.71% 0.63% 0.52% 0.49% 0.97% 0.81%
====== ==== ==== ====== ====== ====
Ratio of net loan charge-offs to
average loans outstanding during
the period........................ .01% .03% .02% 0.10% 0.01% 0.01%
====== ==== ==== ====== ====== ====
</Table>
The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not necessarily indicative of
future losses and does not restrict the use of the allowance to absorb losses in
any category.
<Table>
<Caption>
JUNE 30,
DECEMBER 31, ---------------------------------
2002 2002 2001
--------------- --------------- ---------------
AMOUNT % AMOUNT % AMOUNT %
------ ------ ------ ------ ------ ------
(DOLLARS IN (DOLLARS IN THOUSANDS)
THOUSANDS)
Residential and commercial real
estate loans.................... $1,156 96.97% $946 96.97% $714 99.44%
Consumer loans.................... 4 .34 4 .41 4 .56
Commercial loans.................. 32 2.69 25 2.64 -- --
------ ------ ---- ------ ---- ------
Total allowance for loan
losses....................... $1,192 100.00% $975 100.00% $718 100.00%
====== ====== ==== ====== ==== ======
</Table>
D-6
<Table>
<Caption>
JUNE 30,
---------------------------------------------------
2000 1999 1998
--------------- --------------- ---------------
AMOUNT % AMOUNT % AMOUNT %
------ ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Residential and commercial real
estate loans.................... $618 95.94% $1,210 95.19% $970 94.31%
Consumer loans.................... 27 3.92 2 4.72 3 5.39
Commercial loans.................. -- 0.14 -- 0.09 -- 0.30
---- ------ ------ ------ ---- ------
Total allowance for loan
losses....................... $645 100.00% $1,212 100.00% $973 100.00%
==== ====== ====== ====== ==== ======
</Table>
Nonperforming Loans and Other Problem Assets. Management reviews the
credit quality of the Company's loans on a regular basis. After residential
mortgage loans become past due more than 90 days, the Company generally
establishes an allowance for uncollectible interest for the amount by which the
principal balance and uncollected interest exceeds 90% of the appraised value of
the property. Commercial and multifamily real estate loans generally are placed
on nonaccrual status if the borrower is placed in bankruptcy proceedings or
management concludes that payment in full is not likely. Consumer and commercial
loans generally are charged off, or any expected loss is reserved for, after
they become more than 90 days past due. The Company accrues interest on
delinquent loans past due more than 90 days without establishing a reserve when
management concludes such action is warranted, such as in the event the loan is
exceptionally well collateralized or the borrower establishes the temporary
nature of the delinquency. Loans are charged off when management concludes that
they are uncollectible.
Real estate acquired by the Company as a result of foreclosure is
classified as real estate owned until such time as it is sold. When such
property is acquired, it is recorded at the lower of the unpaid principal
balance or its fair market value (less estimated selling cost at the date of
foreclosure). Any required write-down of the loan to its fair market value upon
foreclosure is charged against the allowance for loan losses.
The following table sets forth information with respect to the Company's
nonperforming assets at the dates indicated. The Company has no restructured
loans.
<Table>
<Caption>
JUNE 30,
DECEMBER 31, ----------------------------------------
2002 2002 2001 2000 1999 1998
------------ ------ ------ ------ ------ ----
(DOLLARS IN (DOLLARS IN THOUSANDS)
THOUSANDS)
Loans accounted for on a nonaccrual
basis(1)............................. $2,376 $2,110 $2,231 $1,613 $1,416 $ --
------ ------ ------ ------ ------ ----
Accruing loans which are contractually
past due 90 days or more(1):
Real estate....................... $ -- $ -- $ 134 $ 614 $ 521 $677
Consumer.......................... -- -- -- 15 5 40
------ ------ ------ ------ ------ ----
Total of nonaccrual and 90 days or
more past due loans............... $2,376 $2,110 $2,365 $2,242 $1,942 $717
------ ------ ------ ------ ------ ----
Real estate owned...................... 1,674 1,559 105 333 -- --
------ ------ ------ ------ ------ ----
Total nonperforming assets............. $4,050 $3,669 $2,470 $2,575 $1,942 $717
====== ====== ====== ====== ====== ====
Nonaccrual and 90 days or more past
due loans as a percentage of total
loans, net........................ 1.43% 2.38% 1.73% 1.96% 1.96% 0.62%
====== ====== ====== ====== ====== ====
Nonaccrual and 90 days or more past
due loans as a percentage of total
assets, net....................... 0.94% .86% 1.09% 1.10% 1.02% 0.41%
====== ====== ====== ====== ====== ====
Nonperforming assets as a percentage of
total assets......................... 1.60% 1.49% 1.14% 1.25% 1.02% 0.41%
====== ====== ====== ====== ====== ====
</Table>
D-7
- ---------------
(1) Interest on delinquent loans is accrued to income to the extent considered
collectible.
As of December 31, 2002, the Company had a total of $1.1 million in 22
single-family loans classified as "substandard." As of December 31, 2002, the
Company had $1.0 million in commercial real estate loans and $588,000 in
single-family residential loans classified as "special mention."
In addition, the Company had two commercial real estate loans totaling
$643,000 which had been classified as "substandard" and one real estate
development loan in the amount of $563,000 had been classified as "doubtful."
The property securing these loans is single-family and multifamily residential
and commercial real estate. Management believes that these loans have been
adequately classified and reserved for, but continues to monitor them as to
their collectibility and as to any possible losses the Company could incur, or
additional reserves that may need to be established.
As of December 31, 2002, the Company had a total of $1.7 million in real
estate owned.
At December 31, 2002, the Company had no other loans of a material amount
which were not classified as nonaccrual, past due 90 days or more or
restructured but where known information about possible credit problems of
borrowers caused management to have serious doubts as to the ability of the
borrowers to comply with present loan repayment terms and could result in future
disclosure as nonaccrual, 90 days past due or restructured.
INVESTMENT ACTIVITIES
The Company is required under federal regulations to maintain a minimum
amount of liquid assets, which can be invested in specified short-term
securities, and is also permitted to make certain other investments. Liquidity
levels may be increased or decreased depending upon the yields on investment
alternatives, management's judgment as to the attractiveness of the yields then
available in relation to other opportunities, its expectations of the level of
yield that will be available in the future and its projections as to the
short-term demand for funds to be used in the Company's loan origination and
other activities.
The general objectives of the Company's investment policy are to (i)
protect the Company's depositor resources, (ii) maintain liquidity levels to
meet the operational needs of the Company and applicable regulatory
requirements, (iii) reduce credit risk by investing in high-quality, diverse
investments, (iv) serve as a hedge against significant interest rate shifts, (v)
contribute to earnings in a stable and dependable manner without compromising
the goals of liquidity and safety, and (vi) provide collateral for pledging
needs. The Company's investment activities are managed by Chief Financial
Officer, Stanley Alexander, Jr., with oversight by the Investment Committee and
under the supervision of the Board of Directors. An investment policy has been
adopted by the Board which provides for maintenance of the investment portfolio
for the purpose of providing earnings and ensuring a minimum liquidity reserve.
In accordance with the investment policy, management has primarily invested in
U.S. Treasury securities backed by the full faith and credit of the United
States and government agency securities, mortgage-backed securities issued by
FHLMC, FNMA or GNMA, federal funds sold, and federally insured interest-bearing
deposits in other financial institutions. General obligation and bank qualified
bonds of municipalities within the market areas served by the Company and which
are considered to possess acceptable credit and limited default risk are also
considered for investment.
The Board of Directors of the Company has authorized the existence of a
trading account in an amount not to exceed 8% of total assets for the purpose of
taking advantage of favorable short-term market conditions. The Company's
investment policy specifies that securities traded within this account must be
U.S. Treasury or agency obligations. Securities in the trading account are
marked to market on a monthly basis. During the six months ended December 31,
2002, there was no trading activity. At December 31, 2002, there were no
securities held in the Company's trading account.
The Board of Directors of the Company had authorized a trading account of
up to $1.0 million for investing in common stocks of publicly traded thrifts
which are considered to be previously undervalued.
D-8
Management decided to cease trading account activity and had previously
completely liquidated the Company's trading account.
The Company, in accordance with generally accepted accounting principles,
reports its investment securities available for sale, at current market value,
with unrealized gains or losses, net of tax effect, adjusted through equity and
realized gains or losses in income when securities are sold. Investment
securities held to maturity are reported at cost as adjusted for unaccredited
discounts and unamortized premiums.
The following table sets forth the carrying value of the Company's
investment securities at the dates indicated.
<Table>
<Caption>
AT JUNE 30,
AT DECEMBER 31, ---------------------------
2002 2002 2001 2000
--------------- ------- ------- -------
(IN THOUSANDS) (IN THOUSANDS)
Investment securities, available for sale:
U.S. Treasury, Federal Agency obligations,
Corporate bonds and municipal
obligations............................. $22,663 $22,618 $32,855 $23,736
Investment and Securities held to
maturity, U.S. Treasury and Federal
Agency obligations...................... -- -- -- 13,201
------- ------- ------- -------
Total investment securities, available for
sale.................................... $22,663 $22,618 $32,855 $36,937
======= ======= ======= =======
</Table>
The following table sets forth the maturities and Weighted Average Yields
of securities at December 31, 2002.
<Table>
<Caption>
AT DECEMBER 31, 2002
----------------------------------------------------------------
ONE YEAR ONE TO FIVE TO MORE THAN TOTAL INVESTMENT
OR LESS FIVE YEARS TEN YEARS TEN YEARS PORTFOLIO
-------- ---------- --------- --------- ----------------
(DOLLARS IN THOUSANDS)
Investment securities, available
for sale:
U.S. Treasury, Federal Agency
obligations, corporate bonds
and municipal obligations.... $2,213 $12,113 $1,755 $6,582 $22,663
Total investment securities,
available for sale.............. $2,213 $12,113 $1,755 $6,582 $22,663
====== ======= ====== ====== =======
Weighted average yield............ 5.05% 5.64% 5.45% 4.62% 5.28%
====== ======= ====== ====== =======
</Table>
MORTGAGE-BACKED SECURITIES ACTIVITIES
In accordance with the Company's investment policy, management invests in
mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae. In
addition, the Company's investment policy permits investment in collateralized
mortgage obligations.
D-9
The following table sets forth the composition of the Company's
mortgage-backed securities portfolio at the dates indicated.
<Table>
<Caption>
AT JUNE 30,
AT DECEMBER 31, ------------------------------------------------------
2002 2002 2001 2000
---------------- ---------------- ---------------- ----------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT %
------- ------ ------- ------ ------- ------ ------- ------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities,
available for sale:
Freddie Mac......................... $ 7,519 15.75% $ 9,462 18.20% $ 5,569 22.96% $ 3,311 13.55%
Fannie Mae.......................... 16,754 35.08 19,610 37.72 8,955 36.92 3,678 15.05
Ginnie Mae.......................... 6,414 13.43 7,611 14.64 -- -- -- --
Collateralized mortgage
obligations....................... 17,068 35.74 15,307 29.44 9,731 40.12 5,947 24.34
------- ------ ------- ------ ------- ------ ------- ------
Total mortgage-backed securities
available for sale................ 47,755 100.00 51,990 100.00 24,255 100.00 12,936 52.94
------- ------ ------- ------ ------- ------ ------- ------
Mortgage-backed securities, held to
maturity:
Freddie Mac......................... -- -- -- -- -- -- 1,658 6.79
Fannie Mae.......................... -- -- -- -- -- -- 6,727 27.54
Ginnie Mae.......................... -- -- -- -- -- -- 3,111 12.73
------- ------ ------- ------ ------- ------ ------- ------
Total mortgage-backed securities,
held to maturity.................. -- -- -- -- -- -- 11,496 47.06
------- ------ ------- ------ ------- ------ ------- ------
Total mortgage-backed securities,
available for sale and held to
maturity.......................... $47,755 100.00% $51,990 100.00% $24,255 100.00% $24,432 100.00%
======= ====== ======= ====== ======= ====== ======= ======
</Table>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
General. Deposits are a significant source of the Company's funds for
lending and other investment purposes. In addition to deposits, the Company
derives funds from loan principal repayments and interest payments and maturing
investment securities. Loan repayments and interest payments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings may
be used on a short-term basis to compensate for reductions in the availability
of funds from other sources, or on a longer term basis for general business
purposes.
Deposits. Deposits are attracted principally from within the Company's
primary market area through the offering of a variety of deposit instruments,
including passbook and statement accounts and certificates of deposit. Deposit
account terms vary, principally on the basis of the minimum balance required,
the time periods the funds must remain on deposit and the interest rate. The
Company also offers individual retirement accounts ("IRAs") and Keogh Plans.
The Company's policies are designed primarily to attract deposits from
local residents through its branch network rather than to solicit deposits from
areas outside its primary market. The Company does not accept deposits from
brokers due to the volatility and rate sensitivity of such deposits. Interest
rates paid, maturity terms, service fees and withdrawal penalties are
established by the Company on a periodic basis. Determination of rates and terms
are predicated upon funds acquisition and liquidity requirements, rates paid by
competitors, growth goals and federal regulations.
D-10
The following table sets forth the average balances and interest rates for
the Company's deposit accounts by type of deposit for the periods indicated.
<Table>
<Caption>
FOR THE
SIX MONTHS ENDED FOR THE YEAR ENDED JUNE 30,
DECEMBER 31, ------------------------------------------------------------
2002 2002 2001 2000
------------------ ------------------ ------------------ ------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE AMOUNT RATE AMOUNT RATE
-------- ------- -------- ------- -------- ------- -------- -------
NOW and money market
deposit accounts....... $ 22,681 0.90% $ 19,206 .76% $ 17,708 0.95% $ 15,702 1.69%
Passbook accounts........ 8,182 0.82 7,590 1.16 7,357 1.31 7,604 2.22
Certificates............. 168,921 3.32 163,144 4.44 156,883 5.48 140,019 5.08
-------- ---- -------- ---- -------- ---- -------- ----
Total.................... $199,784 2.86% $189,940 3.93% $181,948 4.87% $163,325 4.62%
======== ==== ======== ==== ======== ==== ======== ====
</Table>
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,
2002. Most of the Company's deposits of over $100,000 come from individual
depositors in the Company's market area.
<Table>
<Caption>
MATURITY PERIOD CERTIFICATES OF DEPOSIT
- --------------- -----------------------
(IN THOUSANDS)
Three months or less........................................ $12,748
Over three through six months............................... 7,289
Over six through 12 months.................................. 25,272
Over 12 months.............................................. 17,832
-------
Total....................................................... $63,141
=======
</Table>
Management attributes the net decrease in deposits for the six months ended
December 31, 2002 to general economic conditions and competition in the local
market. The Company does not offer premiums for deposits and in the past has not
offered interest rates on deposits which exceed the average rates paid by other
financial institutions in its market area.
Borrowings. Savings deposits historically have been the primary source of
funds for the Company's lending and investment activities and for its general
business activities. The Company is authorized, however, to use advances from
the FHLB of Cincinnati to supplement its supply of lendable funds and to meet
deposit withdrawal requirements. All of the advances are collateralized by FHLB
stock and single-family first mortgage loans with aggregate principal balances
totaling 150% of the outstanding amount of advances. The FHLB of Cincinnati
functions as a central reserve bank providing credit for savings institutions
and certain other member financial institutions. As a member, the Company is
required to own capital stock in the FHLB and is authorized to apply for
advances on the security of such stock and certain of its home mortgages and
other assets (principally, securities which are obligations of, or guaranteed
by, the United States), provided certain standards related to creditworthiness
have been met. The Company had $1.4 million in short-term borrowings outstanding
at December 31, 2002. The average balance of short-term borrowings during the
six months ended December 31, 2002 was $1.5 million with a weighted average rate
of 1.7%. The maximum balance of short-term borrowings during the six months
ended December 31, 2002 was $7.7 million.
At December 31, 2002, the Company had $26.3 million in long-term advances
at an average rate of 4.46% outstanding with the Federal Home Loan Bank. The
average balance of these advances for the six months ended December 31, 2002 was
$22.4 million at a weighted-average rate of 5.5%. At December 31, 2002, the
Company had sufficient collateral to borrow another $77 million, including a
$13.6 million unexercised line of credit, from the Federal Home Loan Bank.
D-11
SUBSIDIARY ACTIVITIES
The Company's only subsidiary other than the Bank is Home Service
Corporation, which engages in the ownership and rental of the Company's main
office building and operations center in Middlesboro, Kentucky and a branch
office in New Tazewell, Tennessee. Home Service Corporation also owns and rents
other properties to unrelated parties.
COMPETITION
The Company experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.
Direct competition for savings deposits comes from other savings
institutions, credit unions, regional bank holding companies and commercial
banks located in its primary market area. Significant competition for the
Company's other deposit products and services comes from money market mutual
funds, brokerage firms, insurance companies and retail stores. The primary
factors in competing for loans are interest rates and loan origination fees and
the range of services offered by various financial institutions. Competition for
origination of real estate loans normally comes from other savings institutions,
commercial banks, mortgage bankers, mortgage brokers and insurance companies.
The Company's primary competition comprises the commercial banks near each
of the Company's branch offices. In Middlesboro, where the Company's main office
is located, primary competition consists of four banks. In Harlan, Kentucky,
where two branch offices are located, the Company's primary competition is two
banks. In New Tazewell, Tennessee, where a branch office is located, the Bank's
primary competition is three banks.
The Company is able to compete effectively in its primary market area by
offering competitive interest rates and loan fees, and a wide variety of deposit
products, and by emphasizing personal customer service. Management believes
that, as a result of the Company's commitment to competitive pricing, varied
products and personal service, the Company has developed a solid base of core
deposits and the loan origination quality and volume are among the leaders in
the Company's market area.
EMPLOYEES
As of December 31, 2002, the Company and its subsidiary had 70 full-time
employees, none of whom was represented by a collective bargaining agreement.
The Company believes that it enjoys excellent relations with its personnel.
REGULATION
GENERAL
The Company and the Bank are subject to the policies of various regulatory
authorities. In particular, bank holding companies and their subsidiaries are
affected by the credit and monetary policies of the Federal Reserve Board (the
"FRB"). The Company and the Bank are subject to numerous federal and state laws
and regulations affecting their business and also must undergo periodic
examination by federal and state financial institution examiners. The earnings
of the Bank, and the earnings of the Company, are affected not only by the laws
and regulations applicable to the banking business, but also by the policies and
interpretations of regulatory authorities.
The supervision and regulation of bank holding companies and their
subsidiaries is intended primarily for the protection of depositors, the deposit
insurance funds of the FDIC and the banking system as a whole, and not for the
protection of the bank holding company shareholders or creditors. The banking
agencies have broad enforcement power over bank holding companies and banks,
including the power to impose substantial fines and other penalties for
violations of laws and regulations, to issue cease and desist or removal orders,
to
D-12
seek injunctions and publicly disclose such actions, and extensive authority to
police unsafe or unsound practices.
The following description summarizes some of the laws to which the Company
and the Bank are subject. References herein to applicable statutes and
regulations are brief summaries thereof, do not purport to be complete and are
qualified in their entirety by reference to such statutes and regulations.
REGULATION OF THE BANK
Home Federal is a Kentucky-chartered commercial banking corporation the
deposits of which are insured by the FDIC. Prior to the Bank's conversion from a
federally chartered savings bank to a Kentucky-chartered commercial bank, the
Bank was subject to regulation by the Office of Thrift Supervision (the "OTS").
The Bank is not a member of the Federal Reserve System. The Bank is subject to
supervision and regulation by the FDIC and the Kentucky Department of Financial
Institutions. Such supervision and regulation subjects the Bank to special
restrictions, requirements, potential enforcement actions and periodic
examination by the FDIC and the Kentucky Department of Financial Institutions.
Because the FRB regulates the bank holding company parent of the Bank, the FRB
also has supervisory authority that directly affects the Bank.
The Kentucky banking statutes prescribe the permissible activities in which
a Kentucky bank may engage and where those activities may be conducted.
Kentucky's statutes contain a "super-parity" provision that permits a well-rated
Kentucky banking corporation (such as the Bank) to engage in any banking
activity in which a national or state bank operating in any other state or a
federal savings association meeting the qualified thrift lender test and
operating in any state could engage, provided it first obtains a legal opinion
specifying the statutory or regulatory provisions that permit the activity.
Branching. Kentucky law currently expressly permits a Kentucky-chartered
bank to establish a branch office in any county in Kentucky. Kentucky banking
statutes also permit a Kentucky bank, with prior regulatory approval, to
establish a branch office outside of Kentucky. Well-capitalized Kentucky banks
that have been in operation at least three years and that satisfy certain
criteria relating to, among other things, their composite and management
ratings, may establish a branch without the approval of the Commissioner of the
Department of Financial Institutions upon notice to the Department and any other
state bank with its main office located in the county where the new branch will
be located. Branching by all other banks requires the approval of the
Commissioner, who must ascertain and determine that the public convenience and
advantage will be served and promoted and that there is reasonable probability
of the successful operation of the branch. In any case, the transaction must
also be approved by the FDIC, which considers a number of factors, including
financial history, capital adequacy, earnings prospects, character of
management, needs of the community and consistency with corporate powers. An
out-of-state bank is permitted to establish branch offices in Kentucky by
merging with a Kentucky bank. De novo branching into Kentucky by an out-of-state
bank is not permitted by the Kentucky banking statutes.
Restrictions on Affiliate Transactions. Transactions between the Bank and
its nonbanking affiliates, including the Company, are subject to Section 23A of
the Federal Reserve Act. In general, Section 23A imposes limits on the amount of
such transactions and also requires certain levels of collateral for loans to
affiliated parties. It also limits the amount of advances to third parties which
are collateralized by the securities or obligations of the Company or its
subsidiary.
Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act, which generally requires that certain transactions between the Bank
and its affiliates be on terms substantially the same, or at least as favorable
to the Bank, as those prevailing at the time for comparable transactions with or
involving other nonaffiliated persons.
The Bank's regulatory lending limit to one borrower was $3.6 million at
December 31, 2002. Currently, the Bank has only one borrower, a real estate
developer, that approaches that limit, with a balance of $2.7 million. The Bank
imposes the same limits to affiliates and insiders. At December 31, 2002, loans
to directors, executive officers and control persons totaled $634,000 in
aggregate.
D-13
Restrictions on Distribution of Subsidiary Bank Dividends and
Assets. Dividends paid by the Bank have provided substantially all of the
Company's operating funds, and for the foreseeable future it is anticipated that
dividends paid by the Bank to the Company will continue to be the Company's
principal source of operating funds. Capital adequacy requirements and state law
serve to limit the amount of dividends that may be paid by the Bank. Under
federal law, the Bank cannot pay a dividend if, after paying the dividend, the
Bank will be "undercapitalized." The FDIC may declare a dividend payment to be
unsafe and unsound even though the Bank would continue to meet its capital
requirements after the dividend. Under Kentucky banking law, the dividends the
Bank can pay during any calendar year are generally limited to its profits for
that year, plus its retained net profits for the two preceding years, less any
required transfers to surplus or to fund the retirement of preferred stock or
debt, absent approval of the Commissioner of the Kentucky Department of
Financial Institutions.
Because the Company is a legal entity separate and distinct from its
subsidiary, its right to participate in the distribution of assets of any
subsidiary upon the subsidiary's liquidation or reorganization will be subject
to the prior claims of the subsidiary's creditors. In the event of a liquidation
or other resolution of an insured depository institution, the claims of
depositors and other general or subordinated creditors are entitled to a
priority of payment over the claims of holders of any obligation of the
institution to its shareholders, including any depository institution holding
company (such as the Company) or any shareholder or creditor thereof.
Deposit Insurance Assessments. Currently, the FDIC maintains two funds for
the insurance of deposits of financial institutions: the Bank Insurance Fund
("BIF") for deposits originated by banks and the Savings Association Insurance
Fund ("SAIF") for deposits originated by savings associations, including savings
association deposits acquired by banks. The Bank must pay assessments to the
FDIC for federal deposit insurance protection based on a risk-based assessment
system. Under this system, FDIC-insured depository institutions pay insurance
premiums at rates based on their risk classification. Institutions assigned to
higher-risk classifications (that is, institutions that pose a greater risk of
loss to their respective deposit insurance funds) pay assessments at higher
rates than institutions that pose a lower risk. An institution's risk
classification is assigned based on its capital levels and the level of
supervisory concern the institution poses to the regulators. In addition, the
FDIC can impose special assessments in certain instances. The current range of
BIF and SAIF assessments is between 0% and .27% of deposits.
The Deposit Insurance Funds Act of 1996 requires both BIF and SAIF insured
institutions to share the cost of the Financing Corporation bonds, which were
issued to initially fund the SAIF, through additional assessments on insured
deposits.
Cross-guarantee Provisions. The Federal Deposit Insurance Act contains a
"cross-guarantee" provision which generally makes commonly controlled insured
depository institutions liable to the FDIC for any losses incurred in connection
with the failure of a commonly controlled depository institution.
Consumer Laws and Regulations. In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds
Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity
Act, the Real Estate Settlement Procedures Act and the Fair Housing Act, among
others. These laws and regulations mandate certain disclosure requirements and
regulate the manner in which financial institutions must deal with clients when
taking deposits or making loans. The Bank must comply with the applicable
provisions of these consumer protection laws and regulations as part of its
ongoing business operations.
REGULATION OF THE COMPANY
Prior to the Company's conversion from a savings and loan holding company
to a bank holding company, the Company was subject to regulation by the OTS. As
a bank holding company, the Company is subject to supervision, regulation and
examination by the FRB. The Bank Holding Company Act of 1956, as amended (the
"BHCA"), and other federal laws subject bank holding companies to particular
restrictions on the types
D-14
of activities in which they may engage and to a range of supervisory
requirements and activities, including regulatory enforcement actions for
violations of laws and regulations.
Bank Acquisitions by Bank Holding Companies. The Company is required to
obtain the prior approval of the FRB under the BHCA before it may acquire all or
substantially all of the assets of any bank, or ownership or control of any
voting shares of any bank, if after such acquisition it would own or control,
directly or indirectly, more than 5% of the voting shares of such bank. In
approving bank acquisitions by bank holding companies, the FRB is required to
consider the financial and managerial resources and future prospects of the bank
holding company and the banks concerned, the convenience and needs of the
communities to be served and various competitive factors. Consideration of
convenience and needs issues includes the parties' performance under the
Community Reinvestment Act of 1977, as amended ("CRA"). Under the CRA, all
financial institutions have a continuing and affirmative obligation consistent
with safe and sound operation to help meet the credit needs of their entire
communities, including low- to moderate-income neighborhoods. By virtue of the
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, the
geographic location of the bank is no longer a factor. Under that Act, a
well-capitalized and well-managed bank holding company may acquire a bank
located in any state, subject to certain deposit percentage limitations and age
requirements.
Gramm-Leach-Bliley Act. On November 12, 1999, the Gramm-Leach-Bliley Act
was signed into law, eliminating many of the remaining barriers to full
convergence of the banking, securities and insurance industries. The major
provisions of the Act took effect March 12, 2000.
The Gramm-Leach-Bliley Act enables a broad-scale consolidation among banks,
securities firms and insurance companies by creating a new type of financial
services company called a "financial holding company," a bank holding company
with dramatically expanded powers. Financial holding companies can offer
virtually any type of financial service, including banking, securities
underwriting, insurance (both agency and underwriting) and merchant banking. In
addition, the Act permits the FRB and the Treasury Department to authorize
additional activities for financial holding companies, but only if they jointly
determine that such activities are "financial in nature" or "complementary to
financial activities."
The FRB serves as the primary "umbrella" regulator of financial holding
companies, with jurisdiction over the parent company and more limited oversight
over its subsidiaries. The primary regulator of each subsidiary of a financial
holding company depends on the activities conducted by the subsidiary. A
financial holding company need not obtain FRB approval prior to engaging, either
de novo or through acquisitions, in financial activities previously determined
to be permissible by the FRB. Instead, a financial holding company need only
provide notice to the FRB within 30 days after commencing the new activity or
consummating the acquisition.
The Gramm-Leach-Bliley Act includes consumer privacy protections and CRA
"sunshine" rules, "modernizes" various other banking-related statutes, permits
mutual bank holding companies and requires a number of studies and reports to
Congress.
Safe and Sound Banking Practices. Bank holding companies are not permitted
to engage in unsafe and unsound banking practices. The FRB may prohibit a bank
holding company from engaging in an activity if it believes that the transaction
would constitute an unsafe or unsound practice or would violate any law or
regulation. The FDIC and the Kentucky Department of Financial Institutions have
similar authority with respect to the Company's bank subsidiary.
Source of Strength. Under FRB policy, a bank holding company is expected
to act as a source of financial strength to each of its banking subsidiaries and
to commit resources to their support. Such support may be required at times
when, absent this FRB policy, a holding company may not be inclined to provide
it. As noted below, a bank holding company may also be required to guarantee the
capital restoration plan of an undercapitalized banking subsidiary.
D-15
CAPITAL ADEQUACY REQUIREMENTS
Capital Guidelines. The FRB and FDIC have substantially similar risk-based
and leverage ratio guidelines for banking organizations, which are intended to
ensure that banking organizations have adequate capital related to the risk
levels of assets and off-balance-sheet instruments. Under the risk-based
guidelines, specific categories of assets are assigned different risk weights,
based generally on the perceived credit risk of the asset. These risk weights
are multiplied by corresponding asset balances to determine a "risk-weighted"
asset base. The guidelines require a minimum total risk-based capital ratio of
8.0%, of which at least 4.0% is required to consist of Tier 1 capital elements
(generally, common shareholders' equity, minority interests in the equity
accounts of consolidated subsidiaries, noncumulative perpetual preferred stock,
less goodwill and certain other intangible assets). Total capital is the sum of
Tier 1 and Tier 2 capital. Tier 2 capital generally may consist of limited
amounts of subordinated debt, qualifying hybrid capital instruments, other
preferred stock, loan loss reserves and unrealized gains on certain equity
securities. As of December 31, 2002, the Company's ratio of Tier 1 capital to
total risk-weighted assets was 15.0% and its ratio of total capital to total
risk-weighted assets was 15.8%. As of December 31, 2002, the Bank's ratio of
Tier 1 capital to total risk-weighted assets was 14.5% and its ratio of total
capital to total risk-weighted assets was 15.3%.
In addition to the risk-based capital guidelines, the FRB uses a leverage
ratio as an additional tool to evaluate the capital adequacy of bank holding
companies. The leverage ratio is a company's Tier 1 capital divided by its
average total consolidated assets (less goodwill and certain other intangible
assets). Certain highly rated bank holding companies may maintain a minimum
leverage ratio of 3.0%, but other bank holding companies may be required to
maintain a leverage ratio of up to 200 basis points above the regulatory
minimum. As of December 31, 2002, the Company's leverage ratio was 8.7%. The
FDIC's leverage guidelines require state banks to maintain Tier 1 capital of no
less than 5% of average total assets, except in the case of certain highly rated
banks for which the requirement is 3% of average total assets. As of December
31, 2002, the Bank's ratio of Tier 1 capital to average total assets (leverage
ratio) was 8.4%. [See Note 11 in Item 7.]
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
FRB guidelines also provide that banking organizations experiencing internal
growth or making acquisitions will be expected to maintain strong capital
positions substantially above the minimum supervisory levels, without
significant reliance on intangible assets. The FDIC may establish higher minimum
capital adequacy requirements if, for example, a bank has previously received
special attention or has a high susceptibility to interest rate risk.
Corrective Measures for Capital Deficiencies. The federal banking
regulators are required to take "prompt corrective action" with respect to
capital-deficient institutions. Agency regulations define, for each capital
category, the levels at which institutions are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." Under these regulations, a "well capitalized"
bank has a total risk-based capital ratio of 10% or higher; a Tier 1 risk-based
capital ratio of 6% or higher; and a leverage ratio of 5% or higher and is not
subject to any written agreement, order or directive requiring it to maintain a
specific capital level for any capital measure. An "adequately capitalized" bank
has a total risk-based capital ratio of 8% or higher; a Tier 1 risk-based
capital ratio of 4% or higher; and a leverage ratio of 4% or higher (3% or
higher if the bank was rated a CAMEL 1 in its most recent examination report and
is not experiencing significant growth) and does not meet the criteria for a
well capitalized bank. A bank is "undercapitalized" if it fails to meet any one
of the ratios required to be adequately capitalized.
Undercapitalized institutions are required to submit a capital restoration
plan, which must be guaranteed by any holding company of the institution. In
addition, agency regulations contain broad restrictions on certain activities of
undercapitalized institutions, including asset growth, acquisitions, branch
establishment and expansion into new lines of business. With certain exceptions,
an insured depository institution is prohibited from making capital
distributions, including dividends, and is prohibited from paying management
fees to
D-16
control persons if the institution would be undercapitalized after any such
distribution or payment. A bank's capital classification will also affect its
ability to accept brokered deposits. Under the FDIC regulations, a bank may not
lawfully accept, roll over or renew brokered deposits unless either it is well
capitalized or it is adequately capitalized and receives a waiver from the FDIC.
As an institution's capital decreases, the FDIC's enforcement powers become
more enhanced. A significantly undercapitalized institution is subject to
mandated capital raising activities, restrictions on interest rates paid and
transactions with affiliates, removal of management and other restrictions. The
FDIC has only very limited discretion in dealing with a critically
undercapitalized institution and is virtually required to appoint a receiver or
conservator.
Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital.
ITEM 2. DESCRIPTION OF PROPERTY.
(a) Properties. The Company's principal executive offices are located at
1602 Cumberland Avenue, Middlesboro, Kentucky, in facilities leased to the Bank
by its wholly owned subsidiary, Home Service Corporation. The Company also
maintains operations offices at 1608 Cumberland Avenue, Middlesboro, Kentucky,
and has branch offices located at 600 Fifth Avenue, New Tazewell, Tennessee, and
102 Cumberland Avenue, Harlan, Kentucky, which are all leased from Home Service
Corporation. In addition, the Company has one other branch office located at
Village Center, Harlan, Kentucky, which is leased from a third party. The Bank's
wholly owned subsidiary, Home Service Corporation, also has purchased property
for the construction of a new branch office in Jacksboro, Tennessee. Management
believes that each of the properties is suitable for its purpose and anticipated
need.
(b) Investment Policies. See "Item 1. Business" above for a general
description of the Bank's investment policies and any regulatory or Board of
Directors' percentage of assets limitations regarding certain investments. All
of the Bank's investment policies are reviewed and approved by the Board of
Directors of the Bank, and the policies, subject to any regulatory restrictions,
can be changed without a vote of stockholders. The Bank's investments are
primarily acquired to produce income, and, to a lesser extent, possible capital
gains.
(1) Investments in Real Estate or Interests in Real Estate. See "Item
1. Business -- Lending Activities," "Item 1. Business -- Regulation of the
Bank," and "Item 2. Description of Property -- (a) Properties" above.
(2) Investments in Real Estate Mortgages. See "Item 1.
Business -- Lending Activities" and "Item 1. Business -- Regulation of the
Bank."
(3) Securities of or Interests in Persons Primarily Engaged in Real
Estate Activities. See "Item 1. Business -- Investment Activities" and
"Item 1. Business -- Subsidiary Activities."
(c) Description of Real Estate and Operating Data. Not applicable.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, the Company is a party to various routine legal
proceedings incident to its business, including loan foreclosure actions. There
are currently no material legal proceedings to which the Company, the Bank or
its subsidiary is a party or to which any of their property is subject.
D-17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's common stock is listed on the NASDAQ small cap market under
the symbol "HFBA". There are currently 1,301,101 shares of the common stock
outstanding and approximately 390 holders of record of the common stock (not
including shares held in "street name").
The following table sets forth certain information as to the range of the
high and low bid prices for the Company's common stock for the calendar quarters
indicated:
<Table>
<Caption>
DIVIDENDS
HIGH BID(1) LOW BID(1) PAID
----------- ---------- ---------
2001
First quarter..................................... $12.000 $11.000 $.19
Second quarter.................................... 12.880 11.000
Third quarter..................................... 13.000 11.450 .19
Fourth quarter.................................... 14.150 12.030
2002
First quarter..................................... $14.600 $13.450 $.20
Second quarter.................................... 14.750 13.000
Third quarter..................................... 14.500 12.900 .21
Fourth quarter.................................... 14.500 13.260
</Table>
- ---------------
(1) Quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions.
The latest bid price as of March 25, 2003 was $16.50.
The Company's primary source of funds for the payment of dividends is
dividends from the Bank.
For information regarding restrictions on the payment of dividends see
"Item 1, Business -- Regulation -- Regulation of Home Federal -- Restrictions on
Distribution of Subsidiary Bank Dividends and Assets."
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
HFB Financial Corporation, a Tennessee corporation, was organized by Home
Federal to be a savings institution holding company. The Company was organized
at the direction of the Bank in September 1992 to acquire all of the capital
stock issued by the Bank upon the conversion of the Bank from mutual to stock
form. The Company has no significant assets other than capital stock of the
Bank. The Company's principal business is the business of the Bank and its
subsidiary. Therefore, the discussion in this Management's Discussion and
Analysis relates to the Bank and its operations.
Home Federal's results of operations in recent years have reflected the
fundamental changes which have occurred in the regulatory, economic and
competitive environment in which banks operate. The Bank's results of operations
are primarily dependent on its net interest income, which is the difference
between interest income on interest-earning assets and interest expense on
interest-bearing liabilities. Interest income is a function of the balances of
interest-earning assets outstanding during the period and the yields earned on
such assets. Interest expense is a function of the amount of interest-bearing
liabilities outstanding during the period and the rates paid on such
liabilities. The Bank also generates non-interest income, such as service
charges on
D-18
transaction accounts and other fees. Net income is further affected by the level
of non-interest expenses, such as personnel expenses, occupancy and equipment
expenses, federal deposit insurance premiums and other expenses.
The operations of Home Federal and banks generally are significantly
influenced by general economic conditions and the monetary and fiscal policies
of governmental regulatory agencies. Deposit flows and costs of funds are
influenced by interest rates on competing investments and prevailing market
rates of interest. Lending activities are affected by the demand for financing
real estate and other types of loans, which, in turn, is affected by the
interest rates at which such financing may be offered and other factors
affecting loan demand and the availability of funds. Just as the Bank's
operations are influenced by regulatory authorities, so are its liquidity levels
and capital resources.
RESULTS OF OPERATIONS
<Table>
<Caption>
SIX-MONTH PERIOD
ENDED
DECEMBER 31, CHANGE
----------------- -----------------
2002 2001 AMOUNT PERCENT
------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Interest income................................... $8,193 $7,789 $ 404 5.19%
Interest expense.................................. 3,409 4,461 (1,052) (23.58)
------ ------ -------
Net interest income............................... 4,784 3,328 1,456 43.75
Provision for loan losses......................... 234 85 149 175.29
------ ------ -------
Net interest income after provision for loan
losses.......................................... 4,550 3,243 1,307 16.30
Other income...................................... 607 489 118 24.13
Other expenses.................................... 3,366 2,633 733 27.84
Income taxes...................................... 574 356 218 61.23
------ ------ -------
Net income........................................ 1,217 743 474 63.80
</Table>
ASSET/LIABILITY MANAGEMENT
Key components of a successful asset/liability strategy are the monitoring
and managing of interest rate sensitivity of both the interest-earning asset and
interest-bearing liability portfolios. Home Federal has employed various
strategies intended to minimize the adverse effect of interest rate risk on
future operations by providing a better match between the interest rate
sensitivity between its assets and liabilities. In particular, the Bank's
strategies are intended to stabilize net interest income for the long term by
protecting its interest rate spread against increases in interest rates. Such
strategies include the origination for portfolio of adjustable-rate mortgage
loans secured by one to four family residential real estate and the origination
of consumer and other loans with greater interest rate sensitivities than
long-term, fixed-rate residential mortgage loans. At December 31, 2002,
approximately 72% of the loans in the Bank's mortgage loan portfolio were
adjustable-rate mortgages. The Bank has used excess funds to invest in various
short-term investments, including mortgage-backed securities, with a
weighted-average life of seven years or less, U.S. Government Treasury and
agency securities with terms of seven years or less and other short-term
investments.
Asset/liability management in the form of structuring cash instruments
provides greater flexibility to adjust exposure to interest rates. During
periods of high interest rates, management believes it is prudent to offer
competitive rates on short-term deposits and less competitive rates for
long-term liabilities. This posture allows the Bank to benefit quickly from
declines in interest rates. Likewise, offering more competitive rates on
long-term deposits during the low interest rate periods allows the Bank to
extend the repricing and/or maturity of its liabilities thus reducing its
exposure to rising interest rates.
D-19
INTEREST RATE SENSITIVITY
Net portfolio value (NPV) analysis provides a quantification of interest
rate risk. In essence, this approach calculates the difference between the
present value of liabilities, expected cash flows from assets and cash flow from
off-balance-sheet contracts.
The following table sets forth, as of December 31, 2002, the estimated
changes in the Bank's NPV, i.e., the present value of expected cash flows from
assets, liabilities and off-balance-sheet contracts, assuming immediate and
permanent changes in interest rates up 200 and down 100 basis points.
NET PORTFOLIO EQUITY
(DOLLARS IN THOUSANDS)
<Table>
<Caption>
CHANGE IN
INTEREST RATES
(BASIS POINTS) ESTIMATED NPV AMOUNT OF CHANGE PERCENT OF CHANGE
- -------------- ------------- ---------------- -----------------
+200 $21,970 $12,737 (36.7)%
+100 26,898 7,809 (22.5)
0 34,707 -0- -0-
-100 44,234 9,527 27.5
</Table>
As noted above, the market value of the Bank's net assets would be
anticipated to decline significantly in the event of certain designated
increases in interest rates. For instance, in the event of a 200 basis point
increase in interest rates, NPV is anticipated to fall by $12.7 million, or 37%.
Conversely, a 100 basis point decrease in interest rates is anticipated to cause
a $9.5 million, or 28% increase in NPV. Subject to market conditions, management
intends to continue to restructure the Bank's assets and liabilities over time
to attempt to better manage the Bank's NPV volatility.
Certain assumptions utilized in assessing the interest rate risk of the
Bank were employed in preparing the previous table. These assumptions relate to
interest rates, loan prepayment rates, deposit decay rates and the market values
of certain assets under the various interest rate scenarios. It was also assumed
that delinquency rates will not change as a result of changes in interest rates
although there can be no assurance that this will be the case. In the event that
interest rates do not change in the designated amounts, there can be no
assurance that the Bank's assets and liabilities would perform as set forth
above. In addition, a change in Treasury rates in the designated amounts
accompanied by a change in the shape of the Treasury yield curve would cause
significantly different changes to the NPV than indicated above.
FINANCIAL CONDITION
The Corporation's assets increased by 3.0% to $253.5 million at December
31, 2002 compared to $246.2 million at June 30, 2002. The majority of this
increase is reflected in loans, which was primarily funded by a decrease in cash
and cash equivalents and investments and an increase in borrowings.
Cash and cash equivalents decreased by $255,000 to $4.97 million at
December 31, 2002 from $5.225 million at June 30, 2001, primarily due to
increases in the loan portfolio.
The Bank augments its lending activities and increases its asset yields to
a significant extent by investing in investment securities such as
mortgage-backed securities "MBSs", U.S. Government securities, municipal
securities and corporate securities. During the six months ended December 31,
2002, investments decreased $4.2 million to $70.4 million at December 31, 2002
compared to $74.6 million at June 30, 2002, primarily due to growth in the
Bank's loan portfolio. Also, during the six months ended December 31, 2002,
Management purchased $10.8 million in investment securities. These purchases
were mostly funded from proceeds from called and maturing investment securities,
principal collected on MBSs and the sale of investment securities. At December
31, 2002, the balance of investment securities available for sale (AFS) was
$70.4 million with a net unrealized gain of $2.2 million.
D-20
During the six months ended December 31, 2002, total loans receivable, net
increased 7.7% to $166.3 million compared to $154.4 million at June 30, 2002.
Management has taken a more aggressive stance in growing the loan portfolio
since the Bank's conversion to a commercial bank charter in December 2001. A
substantial portion of this growth was in commercial real estate loans.
At June 30, 2002, allowance for loan losses was $1.192 million, or 0.71%,
of loans receivable compared to $975,000, or 0.63%, of loans receivable at June
30, 2002.
Premises and equipment increased by $588,000 to $4.455 million at December
31, 2002 from $3.867 million at June 30, 2002. Most of this increase was related
to the purchase of land for construction of the new branch office in Jacksboro,
Tennessee.
Total deposits decreased $2.0 million to $199.3 million at June 30, 2002
from $201.3 million at June 30, 2002. During the six months ended December 31,
2002, CDs decreased $3.0 million while non-interest-bearing, savings and NOW
accounts increased $1.0 million. During the six months ended December 31, 2002,
competition for deposits in local markets has been intense with several
institutions offering deposit rates well above national averages. In response,
Management took the position to fairly price deposits and not to match these
excessively priced promotions.
Total borrowings increased $7.8 million to $27.7 million at December 31,
2002 from $19.9 million at June 30, 2002, primarily as the result of a
leveraging strategy implemented during the six months ended December 31, 2002.
The Bank borrowed $7.5 million with an average maturity of three years and used
the proceeds to purchase securities with similar maturities.
At December 31, 2002, the Bank met all regulatory capital requirements.
Tier I capital to averaged assets was 8.4%, tier I capital to risk-weighted
assets was 14.5% and total capital to risk-weighted assets was 15.3% at December
31, 2002 compared to 8.2%, 14.8% and 15.6%, respectively, at June 30, 2002.
The following table sets forth the financial position of the Corporation on
the dates indicated.
<Table>
<Caption>
CHANGE
DECEMBER 31, JUNE 30, -----------------
2002 2002 AMOUNT PERCENT
------------ -------- ------- -------
(DOLLARS IN THOUSANDS)
Total assets................................ $253,535 $246,164 $ 7,371 3.00%
Net loans................................... 166,335 154,450 11,885 7.70
Investment securities -- available for
sale...................................... 70,418 74,637 (4,219) (5.65)
Deposits.................................... 199,285 201,323 (2,038) (1.01)
Stockholders' equity........................ 23,580 22,141 1,439 6.50
Number of shares outstanding................ 1,301 1,296
</Table>
COMPARISON OF SIX-MONTH PERIOD ENDED DECEMBER 31, 2002 TO SIX-MONTH PERIOD
ENDED DECEMBER 31, 2001
General. Net income increased by $474,000 to $1.217 million for the six
months ended December 31, 2002 as compared to $743,000 for the six months ended
December 31, 2001. The primary reasons for the increase were a $1,456 million
increase in net interest income and a $118,000 increase in non-interest income
offset by a $218,000 increase in income tax expense, a $149,000 increase in
provision for loan losses and a $733,000 increase in non-interest expense.
Net Interest Income. Net interest income increased to $4.784 million for
the six months ended December 31, 2002 from $3.328 million for the six months
ended December 31, 2001. The increase was primarily due to an increase in the
net interest margin. The net interest margin increased by 85 basis points to
4.09% for the six months ended December 31, 2002 compared to 3.24% for the six
months ended December 31, 2001. Most of this increase was attributable to a
lower weighted-average cost of funds.
Interest Income. Interest income for the six months ended December 31,
2002 and 2001 was $8.193 million and $7.789 million, respectively. The increase
for the six months ended December 31, 2002
D-21
over the six months ended December 31, 2001 was due primarily to an increase in
the average balance of interest-earning assets, as the yields declined in the
six months ended December 31, 2002. Yields on such assets were 7.01% for the six
months ended December 31, 2002 compared to 7.57% for the six months ended
December 31, 2001.
Average interest-earning assets were $233.7 million and $205.7 million for
the six months ended December 31, 2002 and 2001, respectively. The increase in
the average balance of interest-earning assets was primarily due to an increase
in loan originations.
Interest Expense. Interest expense for the six months ended December 31,
2002 and 2001 was $3.409 million and $4.461 million, respectively. The decrease
in interest expense of $1.052 million for the six months ended December 31, 2002
over the six months ended December 31, 2001 was primarily due to a decrease in
the rate of interest paid on deposits. The cost of interest-bearing liabilities
decreased to 3.08% for the six months ended December 31, 2002 compared to 4.55%
for the six months ended December 31, 2001. In addition, the average balance of
interest-bearing liabilities increased by $25.6 million due to increased
deposits and borrowings, which was primarily used to fund loan demand.
Provision for Loan Losses. The provision for loan losses for the six
months ended December 31, 2002 and 2001 was $234,000 and $85,000, respectively.
The increase of $149,000 was primarily due to an increase in commercial loan
originations. The provision was determined by management's evaluation of the
adequacy of the allowance for loan losses, including consideration of recoveries
of loans previously charged off, the perceived risk exposure among loan types,
actual loss experience, delinquency rates and current economic conditions.
Other Income. Other income for the six months ended December 31, 2002 was
$607,000 compared to $489,000 for the six months ended December 31, 2001, an
increase of $118,000. The increase was primarily the result of an $89,000
increase in service charges on deposits, a $27,000 decrease in gains on trading
account securities, a $5,000 increase in other fees, a $16,000 decrease in gain
on the sale of real estate and an increase of $76,000 in the increase in cash
surrender value of bank-owned life insurance.
Other Expenses. Other expenses increased $733,000 to $3.366 million for
the six months ended December 31, 2002 from $2.633 million for the six months
ended December 31, 2001. Compensation and benefits increased by $464,000,
primarily the result of a $398,000 increase in general compensation expense and
an increase of $66,000 in the cost of funding the Bank's employee retirement
fund. Since December 31, 2001 to December 31, 2002, the Bank has increased its
full time equivalent employees from 63 to 70 due to growth and staffing for the
new Jacksboro, Tennessee branch which opened in January 2003.
Legal and professional fees increased $114,000 to $263,000 for the six
months ended December 31, 2002 compared to $149,000 for the six months ended
December 31, 2001. Legal expenses increased $76,000 primarily due to expenses
related to foreclosures and corporate matters. Consulting fees increased $50,000
as the result of payment for services for the development and implementation of
new procedures for loan operations.
Other expenses increased $186,000 to $655,000 for the six months ended
December 31, 2002 compared to $442,000 for December 31, 2001, primarily due to
an increase of $118,000 in other real estate owned expenses. The increase
included the write down of two foreclosed real estate development properties
recently reappraised. All other categories of other expense increased $95,000
with no substantial increase or decrease in any one category.
Income Tax Expense. Income tax expense increased $218,000 to $574,000 for
the six months ended December 31, 2002 compared to $356,000 for the six months
ended December 31, 2001 due to increased earnings for the six months ended
December 31, 2002.
COMPARISON OF YEAR ENDED JUNE 30, 2002 TO YEAR ENDED JUNE 30, 2001
General. Net income increased by $100,000 to $1.589 million for the fiscal
year ended June 30, 2002. The primary reasons for the increase were a $1.222
million increase in net interest income, a $107,000 increase
D-22
in non-interest income and a $21,000 decrease in income tax expense offset by a
$202,000 increase in provision for loan losses and a $1.048 million increase in
non-interest expense.
Net Interest Income. Net interest income increased to $7.440 million for
fiscal 2002 from $6.218 million for fiscal 2001. The increase was primarily due
to an increase in the net interest margin. The net interest margin increased by
34 basis points to 3.42% for the year ended June 30, 2002 compared to 3.08% for
the year ended June 30, 2001. Most of this increase was attributable to a lower
weighted-average cost of funds.
Interest Income. Interest income for the fiscal years ended June 30, 2002
and 2001 was $15.716 million and $15.713 million, respectively. This modest
increase for fiscal 2002 over fiscal 2001 was due primarily to an increase in
the average balance of interest-earning assets, as the yields declined in fiscal
2002. Yields on such assets were 7.23% in fiscal 2002 compared to 7.77% in
fiscal 2001.
Average interest-earning assets were $217.2 million and $202.2 million for
the fiscal years ended June 30, 2002 and 2001, respectively. The increase in the
average balance of interest-earning assets was primarily due to an increase in
loan originations and purchases of investment securities.
Interest Expense. Interest expense for fiscal 2002 and 2001 was $8.276
million and $9.495 million, respectively. The decrease in interest expense of
$1.219 million in fiscal 2002 over fiscal 2001 was primarily due to a decrease
in the rate of interest paid on deposits. The cost of interest-bearing
liabilities decreased to 4.03% for fiscal 2002 compared to 5.08% for fiscal
2001. In addition, the average balance of interest-bearing liabilities increased
by $18.43 million due to increased deposits, which was primarily used to fund
loan demand.
Provision for Loan Losses. The provision for loan losses for the fiscal
years ended June 30, 2002 and 2001 was $307,000 and $105,000, respectively. The
increase of $202,000 was primarily due to increase in commercial loan
originations. The provision was determined by management's evaluation of the
adequacy of the allowance for loan losses, including consideration of recoveries
of loans previously charged off, the perceived risk exposure among loan types,
actual loss experience, delinquency rates and current economic conditions.
Other Income. Other income for fiscal 2002 was $1.106 million compared to
$999,000 for fiscal 2001, an increase of $107,000. The increase was primarily
the result of a $108,000 increase in service charges on deposits, a $238,000
decrease in gains on trading account securities, a $21,000 increase in other
fees, a $101,000 increase in gain on the sale of real estate and an increase of
$76,000 in the increase in cash surrender value of bank-owned life insurance.
Other Expenses. Other expenses increased $1.048 million to $5.903 million
for fiscal 2002 from $4.855 million for fiscal 2001. Compensation and benefits
increased by $499,000, primarily the result of a $300,000 increase in general
compensation expense and an increase of $199,000 in the cost of funding the
Bank's employee retirement fund.
Occupancy expense increased $54,000 to $379,000 for fiscal 2002 compared to
$325,000 for fiscal 2001. This increase was primarily due to increased
depreciation, taxes and utilities resulting from the addition of the Bank's new
annex building in Middlesboro, Kentucky and the purchase of the new branch
building in Harlan, Kentucky.
Equipment expense increased $84,000 to $516,000 for fiscal 2002 compared to
$432,000 for fiscal 2001, primarily the result of higher depreciation and
maintenance fees associated with the purchase of new computer and communications
equipment.
Data processing expense decreased $21,000 to $239,000 for fiscal 2002
compared to $260,000 for 2001 primarily due to the elimination of some services
with the Bank's data processor.
Legal and professional fees increased $238,000 to $457,000 for fiscal 2002
compared to $219,000 for 2001. Legal expenses increased $119,000 primarily due
to foreclosure expenses. Consulting fees increased $139,000 as the result of
payment for services for the implementation of new operating procedures.
D-23
Other expenses increased $203,000 to $1.240 million for fiscal 2002
compared to $1.037 million for 2001, primarily due to the write down of other
real estate owned by $272,000. The write down primarily involved two foreclosed
real estate development properties recently reappraised. All other categories of
other expense decreased $70,000 with no substantial increase or decrease in any
one category.
Income Tax Expense. Income tax expense decreased $21,000 to $746,000 for
fiscal 2002 compared to $767,000 for fiscal 2001 due to a greater amount of
tax-exempt income in fiscal 2002.
COMPARISON OF YEAR ENDED JUNE 30, 2001 TO YEAR ENDED JUNE 30, 2000
General. Net income increased by $48,000 to $1.489 million for the fiscal
year ended June 30, 2001. The primary reasons for the increase were an $87,000
increase in net interest income, a $638,000 increase in non-interest income and
a $21,000 decrease in income tax expense offset by a $542,000 increase in
provision for loan losses and a $156,000 increase in non-interest expense.
Net Interest Income. Net interest income increased to $6.218 million for
fiscal 2001 from $6.131 million for fiscal 2000. The increase was primarily due
to an increase in volume. Even though net income increased, the net interest
margin decreased by 16 basis points to 3.08% for the year ended June 30, 2001
compared to 3.24% for the year ended June 30, 2000. Most of this decrease was
attributable to a higher weighted average cost of funds.
Interest Income. Interest income for fiscal years ended June 30, 2001 and
June 30, 2000 was $15.713 million and $14.396 million, respectively. The
increase in fiscal 2001 over fiscal 2000 was due primarily to an increase in the
average balance of interest-earning assets. Yields on such assets were 7.77% in
fiscal 2001 compared to 7.60% in fiscal 2000.
Average interest-earning assets were $202.2 million and $189.4 million for
the fiscal years ended June 30, 2001 and June 30, 2000, respectively. The
increase in the average balance of interest-earning assets was primarily due to
an increase in loan originations.
Interest Expense. Interest expense for fiscal 2001 and 2000 was $9.495
million and $8.265 million, respectively. The increase in interest expense of
$1.230 million in fiscal 2001 over fiscal 2000 was primarily due to an increase
in the rate of interest paid on deposits. The cost of interest-bearing
liabilities increased to 5.08% for fiscal 2001 compared to 4.68% for fiscal
2000. In addition, the average balance of interest-bearing liabilities increased
by $10.5 million due to increased deposits, which was used to fund loan demand.
Provision for Loan Losses. The provision for loan losses for the fiscal
years ended June 30, 2001 and June 30, 2000 was $105,000 and ($437,000),
respectively. The increase of $542,000 was primarily due to unanticipated
collections on loans that, during the fiscal year ended June 30, 1999, were
impaired with specific allowances included in the allowance for loan losses. The
provision was determined by management's evaluation of the adequacy of the
allowance for loan losses, including consideration of recoveries of loans
previously charged off, the perceived risk exposure among loan types, actual
loss experience, delinquency rates and current economic conditions.
Other Income. Other income for fiscal 2001 was $998,000 compared to
$361,000 for fiscal 2000, an increase of $637,000. The increase is primarily the
result of a $254,000 increase in service charges on deposits, a $421,000
increase in gains on trading account securities and a $22,000 increase in other
fees. During fiscal 2001, management instituted a new overdraft privilege
product, which increased deposit service charge income significantly.
Other Expenses. Other expenses increased $156,000 to $4.855 million for
fiscal 2001 from $4.699 million for fiscal 2000. Compensation and benefits
increased by $86,000, primarily the result of a $77,000 decrease in the amount
of loan origination fees deferred related to compensation expense net of the
amount amortized in the current period.
Occupancy expense increased $29,000 to $325,000 for fiscal 2001 compared to
$296,000 for fiscal 2000. This increase was primarily due to increased
depreciation, taxes and utilities resulting from the addition of the
D-24
Bank's new annex building in Middlesboro, Kentucky and the purchase of the new
branch building in Harlan, Kentucky.
Equipment expense increased $152,000 to $432,000 for fiscal 2001 compared
to $280,000 for fiscal 2000, primarily the result of higher depreciation and
maintenance fees associated with the purchase of new computer and communications
equipment.
Data processing expense decreased $17,000 to $260,000 for fiscal 2001
compared to $277,000 for 2000 primarily due to one-time expenses associated with
the conversion and addition of the new Harlan branch in fiscal 2000.
Professional services decreased $163,000 due to the fees paid to
consultants for assistance in developing a sales culture for the Bank in fiscal
2000.
State deposit and franchise taxes increased $11,000 primarily due to a
benefit received with the Bank's purchase of the new Harlan branch, which was
realized in fiscal 2000 that was not available to the Bank in 2001.
Other expense increased $58,000, primarily due to a $36,000 increase in
telephone expense. All other categories of other expense increased $50,000 with
no substantial increase or decrease in any one category.
Income Tax Expense. Income tax expense decreased $21,000 to $767,000 for
fiscal 2001 compared to $788,000 for fiscal 2000 due to a greater amount of
tax-exempt income in fiscal 2001.
D-25
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and the average cost of liabilities for the
periods and dates indicated. Such yields and costs are derived by dividing
income or expense by the average balance of assets or liabilities, respectively,
for the periods presented. Average balances are derived from month-end balances.
Management does not believe that the use of month-end balances instead of
average daily balances has caused any material difference in the information
presented.
<Table>
<Caption>
SIX MONTHS ENDED
DECEMBER 31, 2002 YEAR ENDED JUNE 30, 2002
-------------------------------- --------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
-------- -------- ---------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
Interest-earning assets
Loans, net(1).................. $159,328 $6,241 7.83% $145,034 $11,801 8.14%
Investment securities.......... $ 72,248 1,906 5.28% 66,578 3,759 5.65%
Federal Home Loan Bank stock
and deposits with financial
institutions................ $ 2,425 46 4.33% 5,617 156 2.78%
-------- ------ -------- -------
Total interest-earning
assets.................... $233,701 $8,193 7.01% $217,229 $15,716 7.23%
======== ====== ======== =======
Interest-bearing liabilities
Deposits....................... $199,784 $2,853 2.86% $189,940 $ 7,458 3.93%
Short-term borrowings and long-
term debt................... $ 21,770 $ 556 5.10% 15,582 818 5.25%
-------- ------ -------- -------
Total interest-bearing
liabilities............... $221,554 $3,409 3.08% $205,522 $ 8,276 4.03%
======== ====== ======== =======
Net interest income.............. $4,784 $ 7,440
====== =======
Interest rate spread............. 3.93% 3.20%
======= =======
Net yield on interest-earning
assets......................... 4.09% 3.42%
======= =======
Ratio of average interest-earning
assets to average
interest-bearing liabilities... 105.48% 105.70%
======= =======
</Table>
- ---------------
(1) Includes nonaccrual loans.
D-26
<Table>
<Caption>
YEAR ENDED JUNE 30, 2001 YEAR ENDED JUNE 30, 2000
-------------------------------- --------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
-------- -------- ---------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
Interest-earning assets
Loans, net(1)................. $137,874 $11,655 8.45% $124,003 $10,218 8.24%
Investment securities......... 61,243 3,885 6.34 62,882 4,062 6.46
Federal Home Loan Bank stock
and deposits with financial
institutions............... 3,038 173 5.69 2,538 116 4.57
-------- ------- -------- -------
Total interest-earning
assets................... $202,155 $15,713 7.77% $189,423 $14,396 7.60%
======== ======= ======== =======
Interest-bearing liabilities
Deposits...................... $174,532 $ 8,807 5.05% $163,325 $ 7,549 4.62%
Short-term borrowings and
long-term debt............. 12,559 688 5.48 13,196 716 5.43
-------- ------- -------- -------
Total interest-bearing
liabilities.............. $187,091 $ 9,495 5.08% $176,521 $ 8,265 4.68%
======== ======= ======= ======== ======= =======
Net interest income............. $ 6,218 $ 6,131
======= =======
Interest rate spread............ 2.69% 2.92%
======= =======
Net yield on interest-earning
assets........................ 3.08% 3.24%
======= =======
Ratio of average
interest-earning assets to
average interest-bearing
liabilities................... 108.72% 107.31%
======= =======
</Table>
- ---------------
(1) Includes nonaccrual loans.
D-27
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in volume multiplied by old rate); (ii) changes in rate (change in rate
multiplied by old volume); and (iii) changes in rate/volume (changes in rate
multiplied by changes in volume). Average balances are derived from month-end
balances. Management does not believe that the use of month-end balances instead
of average daily balances has caused any material differences in the information
presented.
<Table>
<Caption>
SIX MONTHS ENDED DECEMBER 31, 2002 VS.
SIX MONTHS ENDED DECEMBER 31, 2001
----------------------------------------
INCREASE (DECREASE) DUE TO
----------------------------------------
VOLUME RATE RATE/VOLUME TOTAL
------ ------- ----------- -------
(IN THOUSANDS)
Interest income
Loans receivable(1)........................ $ 828 $ (414) $ (58) $ 356
Investment securities...................... 286 (144) (23) 119
Other dividend income and deposits with
financial institutions.................. (49) (37) 16 (70)
------ ------- ----- -------
Total interest-earning assets........... 1,065 (595) (65) 405
------ ------- ----- -------
Interest expense
Deposits................................... 364 (1,496) (132) (1,264)
Short-term borrowings and long-term debt... 257 (25) (19) 213
------ ------- ----- -------
Total interest-bearing liabilities...... 621 (1,521) (151) (1,051)
------ ------- ----- -------
Change in net interest income................ $ 444 $ 926 $ 86 $ 1,456
====== ======= ===== =======
</Table>
<Table>
<Caption>
YEAR ENDED JUNE 30, 2002 VS. 2001
----------------------------------------
INCREASE (DECREASE) DUE TO
----------------------------------------
VOLUME RATE RATE/VOLUME TOTAL
------ ------- ----------- -------
(IN THOUSANDS)
Interest income
Loans receivable(1)........................ $ 606 $ (437) $ (23) $ 146
Investment securities...................... 338 (427) (37) (126)
Other dividend income and deposits with
financial institutions.................. 147 (89) (75) (17)
------ ------- ----- -------
Total interest-earning assets........... 1,091 (953) (135) 3
------ ------- ----- -------
Interest expense
Deposits................................... 777 (1,953) (173) (1,349)
Short-term borrowings and long-term debt... 166 (29) (7) 130
------ ------- ----- -------
Total interest-bearing liabilities...... 943 (1,982) (180) (1,219)
------ ------- ----- -------
Change in net interest income................ $ 148 $ 1,029 $ 45 $ 1,222
====== ======= ===== =======
</Table>
- ---------------
(1) For purposes of calculating volume, rate and rate/volume variances,
nonaccrual loans were included in the weighted-average balance outstanding.
D-28
<Table>
<Caption>
YEAR ENDED JUNE 30, 2001 VS. 2000
-------------------------------------
INCREASE (DECREASE) DUE TO
-------------------------------------
VOLUME RATE RATE/VOLUME TOTAL
------ ----- ----------- ------
(IN THOUSANDS)
Interest income
Loans receivable(1).......................... $1,143 $ 264 $ 30 $1,437
Investment securities........................ (106) (73) 2 (177)
Other dividend income and deposits with
financial institutions.................... 23 29 6 58
------ ----- ---- ------
Total interest-earning assets............. 1,060 220 38 1,318
------ ----- ---- ------
Interest expense
Deposits..................................... 518 693 48 1,259
Short-term borrowings and long-term debt..... (35) 7 -- (28)
------ ----- ---- ------
Total interest-bearing liabilities........ 483 700 48 1,231
------ ----- ---- ------
Change in net interest income.................. $ 577 $(480) $(10) $ 87
====== ===== ==== ======
</Table>
- ---------------
(1) For purposes of calculating volume, rate and rate/volume variances,
nonaccrual loans were included in the weighted-average balance outstanding.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity is dividends paid by the Bank.
The Company repurchases shares of its common stock in order to improve earnings
per share and return on stockholders' equity. To date, the Company has
repurchased 288,202 of its shares (as restated for a 20% stock dividend on June
14, 2000 and a 5-for-3 stock split on June 30, 1997) of common stock at a cost
of $8.7 million.
Home Federal's capital ratios are substantially in excess of regulatory
minimum capital requirements. At December 31, 2002, the Bank's Tier I capital to
averaged assets ratio was 8.4% or 4.4% in excess of the Bank's current 4.0% Tier
I to averaged capital ratio requirement. Additionally, the Bank's Tier I capital
to risk-weighted assets ratio was 14.5% and total capital to risk-weighted
assets was 15.3% or 6.5% and 7.3%, respectively, in excess of the minimum
regulatory requirements of 4.0% and 8.0%, respectively.
Home Federal's principal sources of funds for operations are deposits from
its primary market area, principal and interest payments on loans and
mortgage-backed securities and proceeds from maturing investment securities. In
addition, as a member of the FHLB of Cincinnati, the Bank is eligible to borrow
funds from the FHLB of Cincinnati in the form of advances. At December 31, 2002,
the Bank had $27.7 million outstanding in advances and an unexercised credit
line of $13.6 million at the FHLB. The Bank also had sufficient collateral to
borrow an additional $63.4 million from the FHLB at December 31, 2002.
Investments serve as a source of liquid funds which the Bank may use to
meet deposit withdrawals and other short-term needs. The Bank's most liquid
assets are cash and cash equivalents, which are short-term, highly liquid
investments with original maturities of three months or less that are readily
convertible to known amounts of cash. The levels of such assets are dependent
upon the Bank's operating, financing and investment activities at any given
time. Management believes that the liquidity levels maintained are fully
adequate to meet potential deposit outflows, loan demand and normal operations.
The primary source of cash from operating activities is net earnings. The
primary uses of funds are lending activities and investments in mortgage-backed
and investment securities. Cash received from net loan repayments and other
sources is used to purchase investment and mortgage-backed securities. Financing
sources consist principally of net increases in deposits. Other financing
sources include short and long-term borrowings.
D-29
RECENT ACCOUNTING DEVELOPMENTS
There has been an ongoing review over many years of the accounting
principles and practices used by financial institutions. This review is expected
to continue by the banking regulators, the Securities and Exchange Commission
("SEC"), the Financial Accounting Standards Board ("FASB"), the American
Institute of Certified Public Accountants ("AICPA") and other organizations. As
a result of this process, there have been new accounting pronouncements which
have had an impact on the Company and the Bank. Further developments may be
forthcoming in light of this ongoing review process.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations," which addresses the
recognition and measurement of obligations associated with the retirement of
tangible long-lived assets. SFAS No. 143 is effective January 1, 2003, with
early adoption permitted. The Company plans to adopt SFAS No. 143 effective
January 1, 2003 and does not expect the adoption of the statement to have a
material effect on the financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal activities.
Under SFAS No. 146, such costs will be recognized when the liability is
incurred, rather than at the date of commitment to an exit plan. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002, with early application permitted. Management is currently evaluating the
impact of the adoption of SFAS No. 146 on its financial statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions, an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9," which addresses accounting for purchases of certain
financial institutions. SFAS No. 147 is effective October 1, 2002, with early
application permitted. The Company does not have any goodwill that was subject
to Statement No. 72 and therefore the provisions of Statement No. 147 required
no change in classification or treatment of recorded goodwill.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure -- an amendment of FASB Statement No.
123," which provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of SFAS No. 123
to require prominent disclosure in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company has adopted the
requirements of SFAS No. 123 in January 2000 and SFAS No. 148 effective December
31, 2002 with no material effect on its financial statements.
LEGISLATIVE, LEGAL AND REGULATORY DEVELOPMENTS
The banking industry is generally subject to extensive regulatory
oversight. The Company, as a publicly held bank holding company, and the Bank,
as a Kentucky-chartered commercial bank with deposits insured by the FDIC, are
subject to a number of laws and regulations. Many of these laws and regulations
have undergone significant change in recent years. These laws and regulations
impose restrictions on activities, minimum capital requirements, lending and
deposit restrictions and numerous other requirements. Future changes to these
laws and regulations, and other new financial services laws and regulations, are
likely and cannot be predicted with certainty. Future legislative or regulatory
change, or changes in enforcement practices or court rulings, may have a
dramatic and potentially adverse impact on the Company and its bank and other
subsidiaries.
FDIC. The FDIC and members of the United States Congress have recently
proposed new legislation that would reform the bank deposit insurance system.
This reform could merge BIF and SAIF insurance funds, increase the deposit
insurance coverage limits and index future coverage limitations, among other
changes. Most significantly, reform proposals could allow the FDIC to raise or
lower (within certain limits) the currently mandated designated reserve ratio
requiring the FDIC to maintain a 1.25% reserve ratio ($1.25 against $100 of
insured deposits), and require certain changes in the calculation methodology.
Although it is
D-30
too early to predict the ultimate impact of such proposals, they could, if
adopted, result in the imposition of deposit insurance premium costs on the
Company.
Sarbanes Oxley Act. On July 30, 2002, the President signed into law the
Sarbanes-Oxley Act of 2002 (the S-O Act) implementing legislative reforms
intended to address corporate and accounting fraud. In addition to the
establishment of a new accounting oversight board which will enforce auditing,
quality control and independence standards, and will be funded by fees from all
publicly traded companies, the law restricts provision of both auditing and
consulting services by accounting firms. To ensure auditor independence, certain
permitted non-audit services being provided to an audit client will require
preapproval by a company's audit committee members. In addition, the audit
partners must be rotated. Chief executive officers and chief financial officers,
or their equivalent, are required to certify to the accuracy of periodic reports
filed with the SEC, subject to civil and criminal penalties if they knowingly or
willfully violate this certification requirement. In addition, under the S-O
Act, counsel will be required to report evidence of a material violation of the
securities laws or a breach of fiduciary duty by a company to its chief
executive officer or its chief legal officer, and, if such officer does not
appropriately respond, to report such evidence to the audit committee or other
similar committee of the board of directors or the board itself. Longer prison
terms and increased penalties will be applied to corporate executives who
violate federal securities laws, the period during which certain types of suits
can be brought against a company or its officers has been extended, and bonuses
issued to top executives prior to restatement of a company's financial
statements are now subject to disgorgement if such restatement was due to
corporate misconduct. Executives are also prohibited from insider trading during
retirement plan "blackout" periods, and loans to company executives are
restricted.
The S-O Act also increases the oversight of, and codifies certain
requirements relating to audit committees of public companies and how they
interact with a company's "registered public accounting firm". Audit committee
members must be independent and are barred from accepting consulting, advisory
or other compensatory fees from the issuer. In addition, companies must disclose
whether at least one member of the committee is a "audit committee financial
expert" and if not, why not. Under the S-O Act, a "registered public accounting
firm" is prohibited from performing statutorily mandated audit services for a
company if such company's chief executive officer, chief financial officer,
comptroller, chief accounting officer, or any person serving in equivalent
positions has been employed by such firm and participated in the audit of such
company during the one-year period preceding the audit initiation date. The S-O
Act also prohibits any officer or director of a company or any other person
acting under their direction from taking any action to fraudulently influence,
coerce, manipulate, or mislead any independent public or certified accountant
engaged in the audit of a company's financial statements for the purpose of
rendering the financial statement's materially misleading.
The board is determined to continue a corporate governance structure that
meets or exceeds the requirements of the Sarbanes-Oxley Act.
NASDAQ. Also during 2002, the Nasdaq proposed numerous corporate
governance rules intended to address a heightened public perception of
shortcomings in corporate accountability among public companies generally. These
rules, if adopted, would affect the Company because its common stock is listed
on the Nasdaq Small Cap Market under the symbol "HFBA." The proposed changes
include ensuring that a majority of a board of directors are independent of
management, establishing and publishing a code of conduct for directors and
officers and requiring stockholder approval of all new stock option plans and
all modifications. These rules are still tentative in nature because they are
subject to SEC review and approval, which is expected to occur later this year
and would then be followed by an anticipated six-month transition period.
USA Patriot Act. The President of the United States signed the USA PATRIOT
Act into law on October 26, 2001. The USA PATRIOT Act establishes a wide variety
of new and enhanced ways of combating international terrorism. The provisions
that affect national banks (and other financial institutions) most directly are
contained in Title III of the act. In general, Title III amends current
law -- primarily the Bank Secrecy Act -- to provide the Secretary of Treasury
(Treasury) and other departments and agencies of the federal government with
enhanced authority to identify, deter, and punish international money laundering
and other crimes.
D-31
Among other things, the USA PATRIOT Act prohibits financial institutions
from doing business with foreign "shell" banks and requires increased due
diligence for private banking transactions and correspondent accounts for
foreign banks. In addition, financial institutions will have to follow new
minimum verification of identity standards for all new accounts and will be
permitted to share information with law enforcement authorities under
circumstances that were not previously permitted. These and other provisions of
the USA PATRIOT Act became effective at varying times and the Treasury and
various federal banking agencies are responsible for issuing regulations to
implement the new law.
D-32
ITEM 7. FINANCIAL STATEMENTS.
D-33
(BKD LOGO)
INDEPENDENT ACCOUNTANTS' REPORT
To the Stockholders and
Board of Directors
HFB Financial Corporation
Middlesboro, Kentucky
We have audited the accompanying consolidated balance sheets of HFB
Financial Corporation as of December 31, 2002 and June 30, 2002 and 2001, and
the related consolidated statements of income, stockholders' equity and cash
flows for the six months ended December 31, 2002 and years ended June 30, 2002
and 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of HFB
Financial Corporation as of December 31, 2002 and June 30, 2002 and 2001, and
the results of their operations and their cash flows for the six months ended
December 31, 2002 and years ended June 30, 2002 and 2001, in conformity with
accounting principles generally accepted in the United States of America.
BKD, LLP
Evansville, Indiana
February 14, 2003
D-34
HFB FINANCIAL CORP
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND JUNE 30, 2002 AND 2001
<Table>
<Caption>
JUNE 30,
DECEMBER 31, ---------------------------
2002 2002 2001
------------ ------------ ------------
ASSETS
Cash and due from banks................................. $ 4,467,188 $ 4,775,348 $ 5,112,788
Federal funds sold...................................... 500,000 450,000 8,775,000
------------ ------------ ------------
Cash and cash equivalents.......................... 4,967,188 5,225,348 13,887,788
Trading assets, at fair value........................... -- -- 1,049,327
Available-for-sale securities........................... 70,418,282 74,636,556 57,109,780
Loans, net of allowance for loan losses of $1,191,849,
$975,000 and $718,267 at December 31, 2002 and June
30, 2002 and 2001, respectively...................... 166,334,655 154,449,553 136,863,425
Premises and equipment.................................. 4,455,209 3,867,217 4,242,655
Federal Home Loan Bank stock............................ 1,679,700 1,622,100 1,527,400
Interest receivable..................................... 1,513,376 1,638,218 1,790,607
Foreclosed assets held for sale......................... 1,030,310 1,560,805 504,960
Other assets............................................ 330,038 353,189 428,647
Cash surrender value of life insurance.................. 2,806,103 2,811,018 --
------------ ------------ ------------
Total assets....................................... $253,534,861 $246,164,004 $217,404,589
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Noninterest bearing demand........................... $ 6,398,430 $ 7,343,530 $ 4,631,492
Savings, NOW and money market........................ 26,643,742 24,734,538 20,433,508
Certificates of deposit.............................. 166,243,106 169,245,427 156,883,478
------------ ------------ ------------
Total deposits..................................... 199,285,278 201,323,495 181,948,478
Short-term debt......................................... 1,375,000 -- --
Long-term debt.......................................... 26,277,967 19,871,257 12,452,796
Interest payable........................................ 629,653 855,075 962,143
Other liabilities....................................... 2,386,636 1,973,592 1,572,344
------------ ------------ ------------
Total liabilities.................................. 229,954,534 224,023,419 196,935,761
------------ ------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value
Authorized and unissued -- 1,000,000 shares
Common stock, $1.00 par value; authorized 5,000,000
shares; issued and outstanding 1,589,303 shares,
1,584,513 and 1,579,582 shares at December 31, 2002
and June 30, 2002, and 2001, respectively............ 1,589,303 1,584,513 1,579,582
Additional paid-in capital.............................. 8,768,874 8,749,714 8,729,990
Retained earnings....................................... 14,867,147 13,922,605 12,839,997
Common stock acquired by Rabbi Trust for deferred
compensation plans................................... (500,446) (488,102) (488,102)
Accumulated other comprehensive income.................. 1,417,447 933,853 291,628
------------ ------------ ------------
26,142,325 24,702,583 22,953,095
Treasury stock at cost December 31, 2002 and June 30,
2002 -- 288,202 shares, 2001 -- 282,728 shares....... (2,561,998) (2,561,998) (2,484,267)
------------ ------------ ------------
Total stockholders' equity......................... 23,580,327 22,140,585 20,468,828
------------ ------------ ------------
Total liabilities and stockholders' equity......... $253,534,861 $246,164,004 $217,404,589
============ ============ ============
</Table>
See Notes to Consolidated Financial Statement
D-35
HFB FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
SIX MONTHS ENDED DECEMBER 31, 2002 AND YEARS ENDED JUNE 30, 2002 AND 2001
<Table>
<Caption>
SIX MONTHS ENDED YEARS ENDED JUNE 30,
DECEMBER 31, -------------------------
2002 2002 2001
---------------- ----------- -----------
INTEREST INCOME
Loans............................................ $6,240,851 $11,800,842 $11,654,613
Investment securities............................ 1,944,642 3,759,455 3,885,382
Other............................................ 7,424 155,827 172,532
---------- ----------- -----------
Total interest income......................... 8,192,917 15,716,124 15,712,527
---------- ----------- -----------
INTEREST EXPENSE
Deposits......................................... 2,853,119 7,457,692 8,806,524
Short-term debt.................................. 12,931 -- --
Long-term debt................................... 542,648 818,029 688,074
---------- ----------- -----------
Total interest expense........................ 3,408,698 8,275,721 9,494,598
---------- ----------- -----------
NET INTEREST INCOME................................ 4,784,219 7,440,403 6,217,929
PROVISION FOR LOAN LOSSES.......................... 234,227 307,485 104,980
---------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES........................................... 4,549,992 7,132,918 6,112,949
---------- ----------- -----------
NONINTEREST INCOME
Service charges on deposit accounts.............. 451,473 738,580 630,588
Other customer fees.............................. 61,949 100,930 80,125
Net gains on trading securities.................. -- 21,426 259,697
Net realized gains (losses) on sales of
available-for-sale securities................. -- 6,058 (670)
Other............................................ 93,415 238,660 29,133
---------- ----------- -----------
Total noninterest income...................... 606,837 1,105,654 998,873
---------- ----------- -----------
NONINTEREST EXPENSE
Salaries and employee benefits................... 1,728,757 2,691,733 2,192,803
Net occupancy and equipment expense.............. 178,094 379,270 325,243
Equipment expenses............................... 225,747 516,031 431,970
Data processing fees............................. 124,015 238,818 260,021
Legal and professional fees...................... 263,164 456,681 218,505
Advertising...................................... 125,488 224,913 221,741
State franchise and deposit taxes................ 65,157 155,251 167,515
Other............................................ 655,210 1,240,193 1,037,342
---------- ----------- -----------
Total noninterest expense..................... 3,365,632 5,902,890 4,855,140
---------- ----------- -----------
INCOME BEFORE INCOME TAXES......................... 1,791,197 2,335,682 2,256,682
PROVISION FOR INCOME TAXES......................... 574,430 746,314 767,364
---------- ----------- -----------
NET INCOME......................................... $1,216,767 $ 1,589,368 $ 1,489,318
========== =========== ===========
BASIC EARNINGS PER SHARE........................... $ .97 $ 1.27 $ 1.20
========== =========== ===========
DILUTED EARNINGS PER SHARE......................... $ .96 $ 1.27 $ 1.18
========== =========== ===========
</Table>
See Notes to Consolidated Financial Statement
D-36
HFB FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED DECEMBER 31, 2002 AND YEARS ENDED JUNE 30, 2002 AND 2001
<Table>
<Caption>
ADDITIONAL
COMPREHENSIVE COMMON PAID-IN RABBI RETAINED
INCOME STOCK CAPITAL TRUSTS EARNINGS
------------- ---------- ---------- --------- -----------
BALANCE, JULY 1, 2000............................. $1,574,282 $8,708,790 $(515,623) $11,843,918
Comprehensive income
Net income.................................... $1,489,318 -- -- -- 1,489,318
Change in unrealized appreciation on
available-for-sale securities, net of
reclassification adjustment................. 1,478,222 -- -- -- --
Dividends on common stock, $0.38 share.......... -- -- -- -- (493,239)
Stock issued upon exercise of stock options..... -- 5,300 21,200 -- --
Purchase of treasury stock...................... -- -- -- -- --
Stock withdrawn from Rabbi Trusts............... -- -- -- 8,355 --
Net change in fair value of Rabbi Trust shares,
net of tax.................................... -- -- -- 19,166 --
---------- ---------- ---------- --------- -----------
Comprehensive income............................ $2,967,540
==========
BALANCE, JULY 1, 2001............................. 1,579,582 8,729,990 (488,102) 12,839,997
Comprehensive income
Net income.................................... $1,589,368 -- -- -- 1,589,368
Change in unrealized appreciation on
available-for-sale securities, net of
reclassification adjustment................. 642,225 -- -- -- --
Dividends on common stock, $0.38 share.......... -- -- -- -- (506,760)
Stock issued upon exercise of stock options..... -- 4,931 19,724 -- --
Purchase of treasury stock...................... -- -- -- -- --
---------- ---------- ---------- --------- -----------
Comprehensive income............................ $2,231,593
==========
BALANCE, JUNE 30, 2002............................ 1,584,513 8,749,714 (488,102) 13,922,605
Comprehensive income
Net income.................................... $1,216,767 -- -- -- 1,216,767
Change in unrealized appreciation on
available-for-sale securities, net of
reclassification adjustment................. 483,594 -- -- -- --
Dividends on common stock, $0.21 share.......... -- -- -- -- (272,225)
Stock issued upon exercise of stock options..... -- 4,790 19,160 -- --
Purchase of stock by Rabbi Trusts............... -- -- -- (4,225) --
Stock withdrawn from Rabbi Trusts............... -- -- -- 7,482 --
Net change in fair value of Rabbi Trust shares,
net of tax.................................... -- -- -- (15,601) --
---------- ---------- ---------- --------- -----------
Comprehensive income............................ $1,700,361
==========
BALANCE, DECEMBER 31, 2002........................ $1,589,303 $8,768,874 $(500,446) $14,867,147
========== ========== ========= ===========
<Caption>
ACCUMULATED
OTHER
COMPREHENSIVE TREASURY
INCOME (LOSS) STOCK TOTAL
------------- ----------- -----------
BALANCE, JULY 1, 2000............................. $(1,186,594) $(2,438,366) $17,986,407
Comprehensive income
Net income.................................... -- -- 1,489,318
Change in unrealized appreciation on
available-for-sale securities, net of
reclassification adjustment................. 1,478,222 -- 1,478,222
Dividends on common stock, $0.38 share.......... -- -- (493,239)
Stock issued upon exercise of stock options..... -- -- 26,500
Purchase of treasury stock...................... -- (45,901) (45,901)
Stock withdrawn from Rabbi Trusts............... -- -- 8,355
Net change in fair value of Rabbi Trust shares,
net of tax.................................... -- -- 19,166
----------- ----------- -----------
Comprehensive income............................
BALANCE, JULY 1, 2001............................. 291,628 (2,484,267) 20,468,828
Comprehensive income
Net income.................................... -- -- 1,589,368
Change in unrealized appreciation on
available-for-sale securities, net of
reclassification adjustment................. 642,225 -- 642,225
Dividends on common stock, $0.38 share.......... -- -- (506,760)
Stock issued upon exercise of stock options..... -- -- 24,655
Purchase of treasury stock...................... -- (77,731) (77,731)
----------- ----------- -----------
Comprehensive income............................
BALANCE, JUNE 30, 2002............................ 933,853 (2,561,998) 22,140,585
Comprehensive income
Net income.................................... -- -- 1,216,767
Change in unrealized appreciation on
available-for-sale securities, net of
reclassification adjustment................. 483,594 -- 483,594
Dividends on common stock, $0.21 share.......... -- -- (272,225)
Stock issued upon exercise of stock options..... -- -- 23,950
Purchase of stock by Rabbi Trusts............... -- -- (4,225)
Stock withdrawn from Rabbi Trusts............... -- -- 7,482
Net change in fair value of Rabbi Trust shares,
net of tax.................................... -- -- (15,601)
----------- ----------- -----------
Comprehensive income............................
BALANCE, DECEMBER 31, 2002........................ $ 1,417,447 $(2,561,998) $23,580,327
=========== =========== ===========
</Table>
See Notes to Consolidated Financial Statement
D-37
HFB FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED DECEMBER 31, 2002 AND YEARS ENDED JUNE 30, 2002 AND 2001
<Table>
<Caption>
SIX MONTHS ENDED YEARS ENDED JUNE 30,
DECEMBER 31, ---------------------------
2002 2002 2001
---------------- ------------ ------------
OPERATING ACTIVITIES
Net income................................................ $ 1,216,767 $ 1,589,368 $ 1,489,318
Items not requiring (providing) cash
Amortization of intangible assets....................... 37,966 89,602 107,525
Depreciation of premises and equipment.................. 201,943 445,431 378,780
Amortization of premiums and discounts on securities.... 169,183 263,388 (138,780)
Premises and equipment gains............................ -- -- (9,976)
Permanent decline in fair market value of assets held
for sale.............................................. -- 191,127 --
Increase in cash surrender value of life insurance...... (75,924) (75,924) --
Provision for loan losses............................... 234,227 307,485 104,980
Deferred income taxes................................... -- (109,000) (54,620)
Net realized (gains) losses on available-for-sale
securities............................................ -- (6,058) 670
Net realized (gain) loss of sale of assets held for
sale.................................................. 65,225 (101,677) 204
Federal Home Loan Bank stock dividends.................. (57,600) (94,700) (107,700)
Changes in
Trading assets, at fair value........................... -- 1,049,327 (290,757)
Interest receivable..................................... 124,842 152,389 117,415
Other assets............................................ (14,815) (14,144) 436,657
Interest payable........................................ (225,422) (107,068) 111,372
Other liabilities....................................... 105,861 145,061 (103,055)
------------ ------------ ------------
Net cash provided by operating activities............. 1,782,253 3,724,607 2,042,033
------------ ------------ ------------
INVESTING ACTIVITIES
Net originations of loans................................. (12,821,375) (19,928,905) (5,679,617)
Purchase of premises and equipment, net................... (789,935) (69,993) (1,277,442)
Proceeds from sales of premises and equipment............. -- -- 137,323
Proceeds from the sales of available-for-sale
securities.............................................. -- 9,134,652 3,649,998
Proceeds from maturities of available-for-sale
securities.............................................. 15,635,935 41,576,950 11,572,457
Purchases of available-for-sale securities................ (10,811,668) (67,488,296) (14,300,249)
Proceeds from maturities of held-to-maturity securities... -- -- 5,794,382
Development cost of assets held for sale.................. -- (116,128) --
Proceeds from sales of assets held for sale............... 1,167,316 1,006,125 345,587
Purchase of life insurance................................ -- (2,735,094) --
Proceeds from life insurance.............................. 80,839 -- --
------------ ------------ ------------
Net cash provided by (used in) investing activities... (7,538,888) (38,620,689) 242,439
------------ ------------ ------------
FINANCING ACTIVITIES
Net increase (decrease) in demand deposits, money market,
NOW and savings accounts................................ 964,104 7,013,068 (180,009)
Net increase in certificates of deposit................... (3,002,321) 12,361,949 9,591,476
Net decrease in short-term borrowings..................... 1,375,000 -- (400,000)
Purchase of treasury stock................................ -- (77,731) (45,901)
Proceeds from exercise of stock options................... 23,950 24,655 26,500
Purchase of stock by Rabbi Trusts......................... (4,225) -- --
Common stock withdrawn from Rabbi Trusts.................. 7,482 -- 8,355
Dividends paid............................................ (272,225) (506,760) (493,240)
Repayments of long-term debt.............................. (43,290) (81,539) (75,254)
Proceeds from long-term debt.............................. 6,450,000 7,500,000 --
------------ ------------ ------------
Net cash provided by financing activities............. 5,506,925 26,233,642 8,431,927
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ (258,160) (8,662,440) 10,716,399
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 5,225,348 13,887,788 3,171,389
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 4,967,188 $ 5,225,348 $ 13,887,788
============ ============ ============
SUPPLEMENTAL CASH FLOWS INFORMATION
Interest paid........................................... $ 3,634,120 $ 8,382,789 $ 8,147,294
Income taxes paid (net of refunds)...................... $ -- $ 935,211 $ 690,254
Collateral repossessed.................................. $ 702,046 $ 2,035,292 $ 104,960
</Table>
See Notes to Consolidated Financial Statement
D-38
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 AND JUNE 30, 2002 AND 2001
(TABLE DOLLAR AMOUNTS IN THOUSANDS)
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
HFB Financial Corporation (Company) is a bank holding company whose
principal activity is the ownership and management of its wholly-owned
subsidiary, Home Federal Bank Corporation (Bank) and the Bank's wholly-owned
subsidiary, Home Service Corporation.
During the year ended June 30, 2002, the Bank, which provides full banking
services, changed its charter from a federal savings bank to a state bank. As a
state Bank, the Bank is subject to regulation by the Federal Deposit Insurance
Corporation and Kentucky Department of Financial Institutions. Subsequent to
June 30, 2002, the Company changed its year end to December 31. Therefore,
financial statements as of and for the six months ended December 31, 2002, have
been presented. The Bank generates commercial, mortgage and consumer loans and
receives deposits from customers located primarily in Bell County, Kentucky,
surrounding counties and the surrounding states of Tennessee and Virginia. The
Bank's loans are generally secured by specific items of collateral including
real property, consumer assets and business assets.
The accounting and reporting policies of the Company and its wholly-owned
subsidiary conform to accounting principles generally accepted in the United
States of America and reporting practices followed by the banking industry. The
more significant of the policies are described below.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and the Bank after elimination of all material intercompany transactions and
accounts.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses and the valuation
of real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowance for loan losses and
the valuation of foreclosed assets held for sale, management relies on
independent appraisals for significant properties.
CASH EQUIVALENTS
The Company considers all liquid investments with original maturities of
three months or less to be cash equivalents. Cash equivalents at December 31,
2002 and June 30, 2002 and 2001, consisted of federal funds sold to regional
banks.
SECURITIES
Trading securities, which include any security held primarily for near-term
sale, are carried at fair value. Gains and losses on trading securities, both
realized and unrealized, are included in other income.
Available-for-sale securities, which include any security for which the
Company has no immediate plan to sell but which may be sold in the future, are
carried at fair value. Realized gains and losses, based on
D-39
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amortized cost of the specific security, are included in other income.
Unrealized gains and losses are recorded, net of related income tax effects, in
stockholders' equity. Premiums and discounts are amortized and accreted,
respectively, to interest income using the level-yield method over the period to
maturity.
Held-to-maturity securities, which include any security for which the
Company has the positive intent and ability to hold until maturity, are carried
at historical cost adjusted for amortization of premiums and accretion of
discounts. Premiums and discounts are amortized and accreted, respectively, to
interest income using the level-yield method over the period to maturity.
Interest and dividends on investments in debt and equity securities are
included in income when earned.
LOANS
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
principal balances adjusted for any charge-offs, the allowance for loan losses,
any deferred fees or costs on originated loans and unamortized premiums or
discounts on purchased loans. Interest income is reported on the interest method
and includes amortization of net deferred loan fees and costs over the loan
term. Generally, loans are placed on non-accrual status at ninety days past due
and interest is considered a loss, unless the loan is well-secured and in the
process of collection.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loan
losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any,
are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to repay,
estimated value of any underlying collateral and prevailing economic conditions.
This evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
A loan is considered impaired when, based on current information and
events, it is probable that the Bank will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. Impairment is measured on a loan-by-loan basis for
commercial and construction loans by either the present value of expected future
cash flows discounted at the loan's effective interest rate, the loan's
obtainable market price or the fair value of the collateral if the loan is
collateral dependent.
Large groups of smaller balance homogenous loans are collectively evaluated
for impairment. Accordingly, the Bank does not separately identify individual
consumer and residential loans for impairment disclosures.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost net of accumulated depreciation.
Depreciation is computed using straight-line and accelerated methods based
principally on the estimated useful lives of the assets. Maintenance and repairs
are expensed as incurred while major additions and improvements are capitalized.
Gains and losses on dispositions are included in current operations.
FORECLOSED ASSETS HELD FOR SALE
Assets acquired through, or in lieu of, loan foreclosure are held for sale
and are initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure, valuations are
periodically performed by management and the assets are carried at the lower of
carrying amount or fair value
D-40
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
less cost to sell. Revenue and expenses from operations and changes in the
valuation allowance are included in net expenses from foreclosed assets.
FEDERAL HOME LOAN BANK STOCK
Federal Home Loan Bank (FHLB) stock is required investment for institutions
that are members of the FHLB system. The required investment in the common stock
is based on a predetermined formula.
TREASURY STOCK
Treasury stock is stated at cost. Cost is determined by the first-in,
first-out method.
EMPLOYEE STOCK OWNERSHIP PLAN
The Company accounts for its employee stock ownership plan (ESOP) in
accordance with American Institute of Certified Public Accountants (AICPA)
Statement of Position 93-6, Employer's Accounting for Employee Stock Ownership
Plans. The cost of shares issued to the ESOP, but not yet allocated to
participants, are presented in the consolidated balance sheet as a reduction of
stockholders' equity. Compensation expense is recorded based on the market price
of the shares as they are committed to be released for allocation to participant
accounts. The difference between the market price and the cost of the shares
committed to be released is recorded as an adjustment to paid-in capital.
Dividends on allocated ESOP shares are recorded as a reduction of retained
earnings; dividends on unallocated ESOP shares are reflected as a reduction of
debt.
Shares will be considered outstanding for earnings per share calculations
when they are committed to be released; unallocated shares are not considered
outstanding.
STOCK OPTIONS
At December 31, 2002, the Company has a stock-based employee compensation
plan, which is described more fully in Note 13. The Company accounts for this
plan under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No stock-
based employee compensation cost is reflected in net income, as all options
granted under those plans had an exercise price equal to the market value of the
underlying common stock on the grant date. Proforma information not presented
since no options were granted during the periods presented, and accordingly,
there would be no income statement effect under FASB Statement No. 123,
Accounting for Stock-Based Compensation.
INCOME TAX
Income tax in the consolidated statement of income includes deferred income
tax provisions or benefits for all significant temporary differences in
recognizing income and expenses for financial reporting and income tax purposes.
The Company files consolidated income tax returns with its subsidiaries.
EARNINGS PER SHARE
Earnings per share have been computed based upon the weighted-average
common shares outstanding during each year.
RECLASSIFICATIONS
Certain reclassifications have been made to the June 30, 2002 and 2001
financial statements to conform to the December 31, 2002 financial statement
presentation. These reclassifications had no effect on net earnings.
D-41
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2: INVESTMENTS
AVAILABLE-FOR-SALE SECURITIES
The amortized cost and approximate fair values of securities classified as
available for sale are as follows:
<Table>
<Caption>
DECEMBER 31, 2002
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAINS (LOSSES) FAIR VALUE
--------- ---------- ---------- -----------
Other asset-backed securities............. $16,859 $ 216 $ (8) $17,067
Corporate bonds........................... 7,634 355 -- 7,989
U.S. Government agencies.................. 9,156 228 (100) 9,284
Mortgage-backed securities................ 29,371 1,317 -- 30,688
State and political subdivisions.......... 5,169 221 -- 5,390
------- ------ ----- -------
$68,189 $2,337 $(108) $70,418
======= ====== ===== =======
</Table>
<Table>
<Caption>
JUNE 30, 2002
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAINS (LOSSES) FAIR VALUE
--------- ---------- ---------- -----------
Other asset-backed securities............. $15,127 $ 180 $ -- $15,307
Corporate bonds........................... 7,668 264 -- 7,932
U.S. Government agencies.................. 10,673 252 (73) 10,852
Mortgage-backed securities................ 36,002 681 -- 36,683
State and political subdivisions.......... 3,717 146 -- 3,863
------- ------ ---- -------
$73,187 $1,523 $(73) $74,637
======= ====== ==== =======
</Table>
<Table>
<Caption>
JUNE 30, 2001
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED APPROXIMATE
COST GAINS (LOSSES) FAIR VALUE
--------- ---------- ---------- -----------
U.S. Treasury............................. $ 1,000 $ 24 $ -- $ 1,024
Corporate bonds........................... 7,735 50 (2) 7,783
U.S. Government agencies.................. 22,767 256 (60) 22,963
Mortgage-backed securities................ 24,146 219 (110) 24,255
State and political subdivisions.......... 1,021 64 -- 1,085
------- ---- ----- -------
$56,669 $613 $(172) $57,110
======= ==== ===== =======
</Table>
D-42
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Maturities of available-for-sale debt investments at December 31, 2002:
<Table>
<Caption>
AMORTIZED APPROXIMATE
COST FAIR VALUE
--------- -----------
One year or less............................................ $ 2,183 $ 2,213
After one through five years................................ 11,612 12,113
After five through ten years................................ 1,696 1,755
After ten years............................................. 6,468 6,582
Mortgage and other asset-backed securities not due on a
single maturity date...................................... 46,230 47,755
------- -------
$68,189 $70,418
======= =======
</Table>
The book value and fair value of securities pledged as collateral to secure
public deposits and for other purposes amounted to $0 at December 31, 2002,
$2,750,000 at June 30, 2002 and $4,850,000 at June 30, 2001, respectively.
Proceeds from the sale of securities available for sale during the years
ended June 30, 2002 and 2001, were $9,134,652 and $3,649,998, respectively.
Gross gains of $63,334 and gross losses of $57,276 were realized from sales
during 2002, and gross gains of $13,074 and gross losses of $13,744 were
realized from sales during 2001. There were no sales during the six months ended
December 31, 2002.
Unrealized holding gains on trading securities of $0, $0 and $259,697 were
included in earnings for the six months ended December 31, 2002, and the years
ended June 30, 2002 and 2001.
NOTE 3: LOANS AND ALLOWANCE FOR LOAN LOSSES
Categories of loans at December 31, 2002 and June 30, 2002 and 2001,
include:
<Table>
<Caption>
JUNE 30,
DECEMBER 31, -------------------
2002 2002 2001
------------ -------- --------
Commercial and industrial.......................... $ 28,190 $ 21,382 $ 14,801
Residential real estate............................ 119,495 120,403 111,783
Construction....................................... 13,871 6,231 4,721
Consumer........................................... 5,971 7,409 6,276
-------- -------- --------
Total loans................................... 167,527 155,425 137,581
Less
Allowance for loan losses........................ (1,192) (975) (718)
-------- -------- --------
Net loans..................................... $166,335 $154,450 $136,863
======== ======== ========
</Table>
Impaired loans totaled $1,386,000, $1,122,000 and $1,387,000 and had an
allowance for loan losses of $405,000, $365,000 and $124,000 at December 31,
2002 and June 30, 2002 and 2001, respectively.
Interest of $19,000, $45,000 and $146,000 was recognized on average
impaired loans of $1,388,000, $1,128,000 and $1,420,000 for December 31, 2002
and June 30, 2002 and 2001, respectively. Interest of $18,000, $45,000 and
$146,000 was recognizable on impaired loans on the cash basis of accounting
during the six months ended December 31, 2002 and for the years ended June 30,
2002 and 2001, respectively.
D-43
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Activity in the allowance for loan losses was as follows:
<Table>
<Caption>
YEARS ENDED
SIX MONTHS ENDED JUNE 30,
DECEMBER 31, -----------
2002 2002 2001
---------------- ---- ----
Balance, beginning of year............................. $ 975 $718 $645
Provision charged to expense........................... 234 307 105
Losses charged off, net of recoveries of $42, $38 and
$11 for December 31, 2002 and June 30, 2002 and 2001,
respectively......................................... (17) (50) (32)
------ ---- ----
Balance, end of year................................... $1,192 $975 $718
====== ==== ====
</Table>
NOTE 4: PREMISES AND EQUIPMENT
Major classifications of premises and equipment, stated at cost, are as
follows:
<Table>
<Caption>
JUNE 30,
DECEMBER 31, -----------------
2002 2002 2001
------------ ------- -------
Land and buildings................................... $ 4,328 $ 4,216 $ 4,158
Furniture and equipment.............................. 2,757 2,505 2,468
------- ------- -------
7,085 6,721 6,626
Less accumulated depreciation........................ (2,630) (2,429) (1,983)
------- ------- -------
Net premises and equipment......................... $ 4,455 $ 4,292 $ 4,643
======= ======= =======
</Table>
NOTE 5: INTANGIBLE ASSETS
The carrying basis and accumulated amortization of recognized intangible
assets at December 31, 2002 and June 30, 2002 and 2001, were:
<Table>
<Caption>
JUNE 30,
DECEMBER 31, -------------------------------------------------------------
2002 2002 2001
----------------------------- ----------------------------- -----------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------------- ------------ -------------- ------------ -------------- ------------
Core deposits........ $459 $327 $459 $289 $459 $200
==== ==== ==== ==== ==== ====
</Table>
Amortization expense for the six months ended December 31, 2002 and for the
years ended June 30, 2002 and 2001, was $40,000, $89,000 and $108,000,
respectively. Estimated amortization expense for each of the following four
years is:
<Table>
2003........................................................ $ 61,000
2004........................................................ 42,000
2005........................................................ 24,000
2006........................................................ 5,000
--------
$132,000
========
</Table>
D-44
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6: CERTIFICATES OF DEPOSIT
Certificates of deposit in denominations of $100,000 or more were
$63,141,000, $56,363,000 and $53,469,000 on December 31, 2002 and June 30, 2002
and 2001, respectively.
At December 31, 2002, the scheduled maturities of certificates of deposit
are as follows:
<Table>
2003........................................................ $113,526
2004........................................................ 32,432
2005........................................................ 4,088
2006........................................................ 2,363
2007........................................................ 11,062
Thereafter.................................................. 2,772
--------
$166,243
========
</Table>
NOTE 7: SHORT-TERM BORROWINGS AND LINE OF CREDIT
In 2002 and 2001, the Company had available a 90-day revolving line of
credit up to a maximum of $15,000,000. The line of credit bears interest at a
daily variable rate which is set by the Federal Home Loan Bank.
At December 31, 2002, the Company had drawn $1,375,000 on the line of
credit. At June 30, 2002 and 2001, the Company had not drawn on the line of
credit.
The line of credit is collateralized by FHLB stock and single-family first
mortgage loans with aggregate principal balances totaling 150% of the
outstanding amount.
NOTE 8: LONG-TERM DEBT
<Table>
<Caption>
JUNE 30,
DECEMBER 31, -----------------
2002 2002 2001
------------ ------- -------
Federal Home Loan Bank advances, variable rates due
at various dates through March 2010................ $26,278 $19,871 $12,453
======= ======= =======
</Table>
These advances are collateralized by FHLB stock and single-family first
mortgage loans with aggregate principal balances totaling 150% of the
outstanding amount of advances or $17,519,000. Advances are subject to
restrictions or penalties in the event of prepayment.
Maturities in years ending December 31 were as follows:
<Table>
2003........................................................ $ 1,045
2004........................................................ 3,553
2005........................................................ 6,061
2006........................................................ 3,469
2007........................................................ 600
Thereafter.................................................. 11,550
-------
$26,278
=======
</Table>
D-45
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9: OTHER COMPREHENSIVE INCOME
<Table>
<Caption>
DECEMBER 31, 2002
---------------------------------
BEFORE-TAX TAX NET-OF-TAX
AMOUNT EXPENSE AMOUNT
---------- ------- ----------
Unrealized gains on securities
Unrealized holding gains arising during the year.... $775 $(291) $484
Less: Reclassification for net gains realized during
the year......................................... -- -- --
---- ----- ----
Net unrealized gains................................ $775 $(291) $484
==== ===== ====
</Table>
<Table>
<Caption>
JUNE 30, 2002
---------------------------------
BEFORE-TAX TAX NET-OF-TAX
AMOUNT EXPENSE AMOUNT
---------- ------- ----------
Unrealized gains on securities
Unrealized holding gains arising during the
year........................................... $1,008 $(363) $645
Less: Reclassification for net gains realized
during the year................................ 6 (3) 3
------ ----- ----
Net unrealized gains............................. $1,002 $(360) $642
====== ===== ====
</Table>
<Table>
<Caption>
JUNE 30, 2001
---------------------------------
BEFORE-TAX TAX NET-OF-TAX
AMOUNT EXPENSE AMOUNT
---------- ------- ----------
Unrealized gains on securities
Unrealized holding gains arising during the year.... $2,318 $(841) $1,477
Less: Reclassification for net losses realized
during the year.................................. (1) -- (1)
------ ----- ------
Net unrealized gains................................ $2,319 $(841) $1,478
====== ===== ======
</Table>
NOTE 10: INCOME TAXES
The provision for income taxes includes these components:
<Table>
<Caption>
YEARS ENDED
SIX MONTHS ENDED JUNE 30,
DECEMBER 31, -----------
2002 2002 2001
---------------- ---- ----
Taxes currently payable
Federal.............................................. $ 671 $800 $758
State................................................ 37 55 63
Deferred income taxes
Federal.............................................. (127) (99) (45)
State................................................ (7) (10) (9)
----- ---- ----
Income tax expense................................... $ 574 $746 $767
===== ==== ====
</Table>
D-46
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of income tax expense at the statutory rate to the Bank's
actual income tax expense is shown below:
<Table>
<Caption>
YEARS ENDED
SIX MONTHS ENDED JUNE 30,
DECEMBER 31, -----------
2002 2002 2001
---------------- ---- ----
Computed at the statutory rate (34%)................... $609 $794 $767
Increase (decrease) resulting from
Effect of state income taxes......................... 13 31 36
Tax-exempt income.................................... (37) (43) --
Increase in cash surrender value of life insurance... (26) (26) --
Other................................................ 15 (10) (36)
---- ---- ----
Actual tax expense................................ $574 $746 $767
==== ==== ====
</Table>
The tax effects of temporary differences related to deferred taxes shown on
the balance sheets were:
<Table>
<Caption>
JUNE 30,
DECEMBER 31, ---------------
2002 2002 2001
------------ ------- -----
Deferred tax assets
Deferred compensation................................ $ 110 $ 122 $ 122
Deferred compensation -- Rabbi Trust................. 56 86 85
Deposit-based intangible............................. 82 74 53
Allowance for loan losses............................ 218 76 5
Accrued wages........................................ 25 -- --
------- ------- -----
491 358 265
------- ------- -----
Deferred tax liabilities
Depreciation......................................... (123) (109) (79)
Federal Home Loan Bank stock dividends............... (396) (382) (351)
Other................................................ (16) (15) (92)
Unrealized gains on available-for-sale securities.... (800) (521) (158)
------- ------- -----
(1,335) (1,027) (680)
------- ------- -----
Net deferred tax liability........................ $ (844) $ (669) $(415)
======= ======= =====
</Table>
Retained earnings include approximately $2,096,000 for which no deferred
income tax liability has been recognized. This amount represents an allocation
of income to bad debt deductions as of June 30, 1988 for tax purposes only.
Reduction of amounts so allocated for purposes other than tax bad debt losses
including redemption of bank stock, payment of excess dividends, or loss of
"bank" status, would create income for tax purposes only, which income would be
subject to the then-current corporate income tax rate. At December 31, 2002, the
unrecorded deferred income tax liability on the above amount was approximately
$800,000.
NOTE 11: REGULATORY MATTERS
The Bank is 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
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the
D-47
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Bank's assets, liabilities and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification 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 Bank 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, 2002 and June 30,
2002 and 2001, that the Bank met all capital adequacy requirements to which it
is subject.
As of December 31, 2002, the most recent notification from the Bank's
regulators categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized,
the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I
leverage ratios as set forth in the table. There are no conditions or events
that have occurred since that notification that management believes have changed
the Bank's category.
The Bank's actual capital amounts and ratios are also presented in the
table.
<Table>
<Caption>
MINIMUM REQUIRED
MINIMUM TO BE WELL
REQUIRED FOR CAPITALIZED UNDER
CAPITAL ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
--------------- ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- -------- ------ -------- ------
AS OF DECEMBER 31, 2002
Total Capital (to Risk-Weighted
Assets).............................. $22,385 15.29% $11,713 8.00% $14,641 10.00%
Tier I Capital (to Risk-Weighted
Assets).............................. 21,193 14.48 5,856 4.00 8,785 6.00
Tier I Capital (to averaged assets)..... 21,193 8.36 10,142 4.00 12,667 5.00
AS OF JUNE 30, 2002
Total Capital (to Risk-Weighted
Assets).............................. 20,907 15.55 10,756 8.00 13,445 10.00
Tier I Capital (to Risk-Weighted
Assets).............................. 19,932 14.83 5,378 4.00 8,067 6.00
Tier I Capital (to averaged assets)..... 19,932 8.19 9,730 4.00 12,163 5.00
AS OF JUNE 30, 2001
Total Capital (to Risk-Weighted
Assets).............................. 17,886 15.74 9,089 8.00 11,361 10.00
Tier I Capital (to Risk-Weighted
Assets).............................. 18,718 16.48 4,544 4.00 6,816 6.00
Core Capital (to adjusted total
assets).............................. 18,718 8.65 8,657 4.00 10,821 5.00
Core Capital (to adjusted tangible
assets).............................. 18,718 8.67 4,317 2.00 N/A N/A
Tangible Capital (to adjusted total
assets).............................. 18,718 8.65 3,246 1.50 N/A N/A
</Table>
Without prior approval, the Bank is restricted as to the maximum amount of
dividends it can pay to the Company to net profits (as defined) for the current
year plus the previous two years.
NOTE 12: EMPLOYEE BENEFIT PLANS
PENSION PLAN
The Company is a participant in a pension fund known as The Pentegra Group
(formerly the Financial Institutions Retirement Fund). This plan is a
multi-employer plan; separate actuarial valuations are not made with respect to
each participating employer. Plan benefits are fully vested after five years of
service and are based on an employee's years of service and a percentage of the
employee's average salary using the five highest consecutive years proceeding
retirement. The Bank's funding policy is to make contributions to the
D-48
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
plan equal to the amount accrued as pension expense. The Bank expense was
$151,000, $204,000 and $0 for the six months ended December 31, 2002 and years
ended June 30, 2002 and 2001, respectively.
SUPPLEMENTAL RETIREMENT PLAN
The Bank also has supplemental retirement plan arrangements for the benefit
of certain officers and directors. These arrangements are funded by life
insurance contracts which have been purchased by the Bank and a portion of the
death benefit has been endorsed to the employee. The Bank's expense for the Plan
was $9,000, $9,000 and $0 for the six months ended December 31, 2002 and years
ended June 30, 2002 and 2001.
EMPLOYEE STOCK OWNERSHIP PLAN
The Bank has an Employee Stock Ownership Plan (Plan) for the benefit of
participating employees. Generally, all employees age 21 or older are eligible
to participate upon completion of one year of service. The Plan contains 101,177
shares of Company stock, all of which are allocated. The cost of the Plan is
borne by the Company through contributions to an employee stock ownership trust
in amounts determined by the Board of Directors. The contributions to the Plan
for the six months ended December 31, 2002 and years ended June 30, 2002 and
2001, were $2,000, $19,000 and $8,000, respectively.
DEFERRED COMPENSATION AGREEMENTS (RABBI TRUSTS)
Prior to its conversion, the Bank maintained an unfunded deferred
compensation plan for members of the Board of Directors who elected to
participate in any one year. Benefits were payable upon a participating
director's retirement, resignation, disability or death unless the plan
committee permitted earlier distributions in the event of a participant's
emergency or necessity. The Bank established individual grantor trusts (Rabbi
Trusts) for each director who had deferred compensation, contributed funds
sufficient to equal the deferred fees for each director and purchased a total of
44,473 shares of HFB Financial Corporation common stock at its conversion date.
The assets of the individual Rabbi Trusts are available to the general creditors
of the Bank in the event of the Bank's insolvency. In 1994, the Bank adopted a
new Deferred Compensation Agreement for the directors similar to the old
agreement. All deferred payments are paid to these same Rabbi Trusts.
The Rabbi Trusts purchased 4,225 shares of stock during the six months
ended December 31, 2002 and 0 shares of stock during the years ended June 30,
2002 and 2001, respectively. A total of 7,482, 1,670 and 0 shares were
distributed to a trust beneficiary during the six months ended December 31, 2002
and years ended June 30, 2002 and 2001, respectively. The Bank's liability at
December 31, 2002, was $612,000 and at June 30, 2002 and 2001, was $574,300.
Deferred amounts are included in other liabilities. The stock in the grantor
trusts is shown as a contra-capital account until distributed to the directors
over a five-year period beginning at their retirement, resignation or death. The
amount charged to expense was $0 for the six months ended December 31, 2002 and
years ended June 30, 2002 and 2001.
NOTE 13: STOCK OPTION PLAN
The Company has an incentive stock option plan in which 144,500 shares have
been reserved for future issuance by the Company to directors and employees of
the Company and its subsidiary. The plan provides for a term of ten years after
which no awards may be made unless earlier terminated by the Board of Directors.
At December 31, 2002, options to purchase 143,641 shares had been granted.
Under the Company's incentive stock option plan, which is accounted for in
accordance with Accounting Principles Board Opinion (APB) No. 25, Accounting for
Stock Issued to Employees,and related interpretations, the Company grants
selected executives and other key employees stock option awards which vest and
become fully exercisable immediately. The exercise price of each option, which
has a ten-year life, is equal to
D-49
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the market price of the Company's stock on the date of the grant; therefore, no
compensation expense is recognized. No options were granted during the periods
presented.
The following is a summary of the status of the Company's stock option plan
and changes in that plan as of and for the six months ended December 31, 2002
and years ended June 30, 2002 and 2001.
<Table>
<Caption>
YEARS ENDED JUNE 30,
SIX MONTHS ENDED -----------------------------------------------------
DECEMBER 31, 2002 2002 2001
------------------------- ------------------------- -------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ ---------------- ------ ---------------- ------ ----------------
Outstanding, beginning of
year...................... 16,783 $9.08 21,714 $8.15 27,014 $7.53
Exercised................... (4,791) 5.00 (4,931) 5.00 (5,300) 5.00
------ ----- ------ ----- ------ -----
Outstanding, end of year.... 11,992 10.70 16,783 9.08 21,714 8.15
====== ===== ====== ===== ====== =====
Options exercisable at year
end....................... 11,992 10.70 16,783 9.08 21,714 8.15
</Table>
As of December 31, 2002, the 11,992 options outstanding have exercise
prices ranging from $10.63 to $10.75 and a weighted-average remaining
contractual life of 5.07 years.
NOTE 14: EARNINGS PER SHARE
Earnings per share were computed as follows:
<Table>
<Caption>
SIX MONTHS ENDED DECEMBER 31, 2002
-----------------------------------
WEIGHTED- PER SHARE
INCOME AVERAGE SHARES AMOUNT
------ -------------- ---------
NET INCOME........................................... $1,217
======
BASIC EARNINGS PER SHARE
Income available to common stockholders............ $1,217 1,250 $0.97
EFFECT OF DILUTIVE SECURITIES
Stock options...................................... -- 8
------ -----
DILUTED EARNINGS PER SHARE
Income available to common stockholders and assumed
conversions..................................... $1,217 1,258 $0.96
====== ===== =====
</Table>
<Table>
<Caption>
YEAR ENDED JUNE 30, 2002
-----------------------------------
WEIGHTED- PER SHARE
INCOME AVERAGE SHARES AMOUNT
------ -------------- ---------
NET INCOME........................................... $1,589
======
BASIC EARNINGS PER SHARE
Income available to common stockholders............ $1,589 1,247 $1.27
EFFECT OF DILUTIVE SECURITIES
Stock options...................................... -- 9
------ -----
DILUTED EARNINGS PER SHARE
Income available to common stockholders and assumed
conversions..................................... $1,589 1,256 $1.27
====== ===== =====
</Table>
D-50
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
YEAR ENDED JUNE 30, 2001
-----------------------------------
WEIGHTED- PER SHARE
INCOME AVERAGE SHARES AMOUNT
------ -------------- ---------
NET INCOME........................................... $1,489
======
BASIC EARNINGS PER SHARE
Income available to common stockholders............ $1,489 1,246 $1.20
EFFECT OF DILUTIVE SECURITIES
Stock options...................................... -- 15
------ -----
DILUTED EARNINGS PER SHARE
Income available to common stockholders and assumed
conversions..................................... $1,489 1,261 $1.18
====== ===== =====
</Table>
NOTE 15: DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents estimated fair values of the Company's
financial instruments. The fair values of certain of these instruments were
calculated by discounting expected cash flows, which method involves significant
judgments by management and uncertainties. Fair value is the estimated amount at
which financial assets or liabilities could be exchanged in a current
transaction between willing parties, other than in a forced or liquidation sale.
Because no market exists for certain of these financial instruments and because
management does not intend to sell these financial instruments, the Company does
not know whether the fair values shown below represent values at which the
respective financial instruments could be sold individually or in the aggregate.
<Table>
<Caption>
JUNE 30,
DECEMBER 31, -----------------------------------------
2002 2002 2001
------------------- ------------------- -------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- -------- -------- --------
Financial assets
Cash and cash equivalents... $ 4,967 $ 4,967 $ 5,225 $ 5,225 $ 13,888 $ 13,888
Trading securities.......... -- -- -- -- 1,049 1,049
Available-for-sale
securities............... 70,418 70,418 74,637 74,637 57,110 57,110
Loans, net of allowance for
loan losses.............. 166,335 173,687 154,450 158,385 136,863 142,967
FHLB stock.................. 1,680 1,680 1,622 1,622 1,527 1,527
Cash surrender value of life
insurance................ 2,806 2,806 2,811 2,811 -- --
Interest receivable......... 1,513 1,513 1,638 1,638 1,791 1,791
Financial liabilities
Deposits.................... 199,300 203,266 201,323 204,289 181,948 180,962
Long-term debt.............. 26,278 29,444 19,871 20,056 12,453 12,614
Interest payable............ 630 630 855 855 962 962
Unrecognized financial
instruments (net of
contract amount)
Commitments to extend
credit................... -- -- -- -- -- --
Letters of credit........... 1,375 1,375 -- -- -- --
</Table>
D-51
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments.
CASH AND CASH EQUIVALENTS
For these short-term instruments, the carrying amount approximates fair
value.
INVESTMENT SECURITIES
Fair values for securities equal quoted market prices, if available. If
quoted market prices are not available, fair value is estimated based on quoted
market prices of similar securities.
LOANS
The fair value of 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. Loans with similar
characteristics were aggregated for purposes of the calculations. The carrying
amount of accrued interest approximates its fair value.
FEDERAL HOME LOAN BANK STOCK
Fair value of FHLB stock is based on the price at which it may be resold to
the FHLB.
CASH SURRENDER VALUE OF LIFE INSURANCE
The fair value of cash surrender values of life insurance approximate
carrying value.
DEPOSITS
The fair value of demand deposits, savings accounts, NOW accounts and
certain money market deposits is the amount payable on demand at the reporting
date, i.e., their carrying amount. The fair value of fixed-maturity time
deposits is estimated using a discounted cash flow calculation that applies the
rates currently offered for deposits of similar remaining maturities. The
carrying amount of accrued interest payable approximates its fair value.
FEDERAL FUNDS PURCHASED
For these short-term instruments, the carrying amount is a reasonable
estimate of fair value.
COMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT
The fair value of commitments is estimated using the fees currently charged
to enter into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference between
current levels of interest rates and the committed rates. The fair value of
letters of credit is based on fees currently charged for similar agreements or
on the estimated cost to terminate or otherwise settle the obligations with the
counterparties at the reporting date.
NOTE 16: COMMITMENTS AND CREDIT RISK
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 a portion of the commitments may expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Each
D-52
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
customer's creditworthiness is evaluated on a case-by-case basis. The amount of
collateral obtained, if deemed necessary, is based on management's credit
evaluation of the counterparty. Collateral held varies, but may include accounts
receivable, inventory, property, plant and equipment, commercial real estate and
residential real estate.
At December 31, 2002 and June 30, 2002 and 2001, the Company had
outstanding commitments to originate loans aggregating approximately
$10,182,000, $3,613,000 and $3,257,000, respectively. The commitments extended
over varying periods of time with the majority being disbursed within a one-year
period.
Letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements, including
commercial paper, bond financing and similar transactions. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loans to customers.
The Company had total outstanding letters of credit amounting to $457,000,
$446,000 and $517,000 at December 31, 2002 and June 30, 2002 and 2001,
respectively, with terms ranging from 30 days to one year.
NOTE 17: CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
Presented below is condensed financial information as to the financial
position, results of operation and cash flows of the Company:
CONDENSED BALANCE SHEETS
<Table>
<Caption>
JUNE 30,
DECEMBER 31, -----------------
2002 2002 2001
------------ ------- -------
ASSETS
Cash and due from banks............................ $ 644 $ 922 $ 25
Trading assets, at fair value...................... -- -- 1,049
Investment in common stock of subsidiaries......... 22,842 21,109 19,269
Other assets....................................... 112 112 126
------- ------- -------
Total assets.................................... $23,598 $22,143 $20,469
======= ======= =======
LIABILITY............................................ $ 18 $ 2 $ --
STOCKHOLDERS' EQUITY................................. 23,580 22,141 20,469
------- ------- -------
Total liabilities and stockholders' equity...... $23,598 $22,143 $20,469
======= ======= =======
</Table>
D-53
HFB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED STATEMENTS OF INCOME
<Table>
<Caption>
YEARS ENDED
SIX MONTHS ENDED JUNE 30,
DECEMBER 31, ---------------
2002 2002 2001
---------------- ------ ------
INCOME
Dividends from subsidiaries....................... $ -- $ 404 $ 426
Net gain on trading securities.................... -- 21 260
Other income...................................... -- 4 2
------ ------ ------
Total income................................... 0 429 688
EXPENSES -- Other................................... 45 34 62
------ ------ ------
INCOME BEFORE INCOME TAX AND EQUITY INUNDISTRIBUTED
INCOME OF SUBSIDIARIES............................ (45) 395 626
INCOME TAX EXPENSE.................................. -- 4 82
------ ------ ------
INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOMEOF
SUBSIDIARIES...................................... (45) 391 544
EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES...... 1,262 1,198 945
------ ------ ------
NET INCOME.......................................... $1,217 $1,589 $1,489
====== ====== ======
</Table>
CONDENSED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
SIX MONTHS YEARS ENDED
ENDED JUNE 30,
DECEMBER 31, ----------------
2002 2002 2001
------------ ------- ------
OPERATING ACTIVITIES
Net income.......................................... $ 1,217 $ 1,589 $1,489
Adjustments to reconcile net income to net cash
provided by operating activities
Equity in undistributed income of subsidiaries... (1,262) (1,198) (945)
Net change in
Trading assets, at fair value.................. -- 1,049 (290)
Other assets and other liabilities............. 16 17 21
Other............................................ -- -- (7)
------- ------- ------
Net cash provided by (used in) operating
activities................................ (29) 1,457 268
------- ------- ------
FINANCING ACTIVITIES
Cash dividends...................................... (272) (507) (493)
Proceeds from exercise of stock options............. 23 25 27
Common stock withdrawn from Rabbi Trust............. -- -- 8
Purchase stock...................................... -- (78) (46)
------- ------- ------
Net cash used in financing activities....... (249) (560) (504)
------- ------- ------
NET CHANGE IN CASH AND CASH EQUIVALENTS............... (278) 897 (236)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR.......... 922 25 261
------- ------- ------
CASH AND CASH EQUIVALENTS, END OF YEAR................ $ 644 $ 922 $ 25
======= ======= ======
</Table>
D-54
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable. In June 2001, the Company's accountant, Olive LLP, merged
with Baird, Kurtz and Dobson into the Company's current accountant, BKD, LLP.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The information contained under the section captioned "Board of Directors"
and "Executive Officer Who is Not a Director" in the Information Statement is
incorporated herein by reference.
For information regarding delinquent filers and the disclosure required
pursuant to Item 405 of Regulation S-KSB, reference is made to the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the
Information Statement which information is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
The information contained under the section captioned "Executive
Compensation" in the Information Statement is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to the
information under the captions "Security Ownership" of the Information
Statement.
Equity Compensation Plan Information. The following table sets forth
certain information with respect to securities to be issued under the Company's
equity compensation plans as of December 31, 2002.
<Table>
<Caption>
(C)
(B) NUMBER OF SECURITIES
(A) WEIGHTED-AVERAGE REMAINING AVAILABLE FOR
NUMBER OF SECURITIES EXERCISE PRICE OF FUTURE ISSUANCE UNDER
TO BE ISSUED UPON OUTSTANDING EQUITY COMPENSATION
EXERCISE OF OPTIONS, PLANS (EXCLUDING
OUTSTANDING OPTIONS, WARRANTS AND SECURITIES REFLECTED IN
PLAN CATEGORY WARRANTS AND RIGHTS RIGHTS COLUMN (A))
- ------------- -------------------- ----------------- -----------------------
Equity compensation plans
approved by security holders:
1992 Stock Option Plan.......... 11,992 $10.70 2,769
2000 Long-term Incentive
Compensation Plan............. -- -- 65,000
Equity compensation plans not
approved by security
holders:...................... N/A N/A N/A
------ ------ ------
Total........................... 11,992 $10.70 67,769
====== ====== ======
</Table>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" of the Information
Statement.
D-55
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
(a) List of Documents Filed as Part of This Report. The following exhibits
are either attached to or incorporated by reference in this Annual Report on
Form 10-KSB.
<Table>
<Caption>
DESCRIPTION
-----------
3.1 Articles of Incorporation of HFB Financial Corporation*
3.2 Bylaws of HFB Financial Corporation*
4 Common Stock Certificate of HFB Financial Corporation*
10.1 HFB Financial Corporation Stock Option Plan*
10.2 Home Federal Bank, Federal Savings Bank Management*
Recognition Plan
10.3 Home Federal Bank, Federal Savings Bank Supplemental*
Executive Retirement Plan
10.4 2000 Long-Term Incentive Compensation Plan**
10.5 Amended and Restated Employment Agreement between the Bank
and David B. Cook***
10.6 Amended and Restated Employment Agreement between the Bank
and Stanley Alexander, Jr.***
10.7 Amended and Restated Employment Agreement between the Bank
and Kenneth Jones***
21 Subsidiaries of the Registrant
99.1 CEO Certification under Section 906 of the Sarbanes-Oxley
Act
99.2 CFO Certification under Section 906 of the Sarbanes-Oxley
Act
</Table>
- ---------------
* Incorporated by reference to the Corporation's Registration Statement on
Form S-1 (33-52308) filed with the Securities and Exchange Commission on
September 23, 1992.
** Incorporated by reference to the Corporation's Annual Report on Form 10-KSB
for the fiscal year ended June 30, 2000.
*** Incorporated by reference to the Corporation's Annual Report on Form 10-KSB
for the fiscal year ended June 30, 2002.
(b) Reports on Form 8-K. On October 18, 2002, the Company filed Form 8-K
announcing its Chief Executive Officer and Chief Financial Officer submitted
certification to the Securities and Exchange Commission as required by Section
906 of the Sarbanes-Oxley Act of 2002.
ITEM 14. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. We maintain
disclosure controls and procedures (as defined in Securities Exchange Act 1934
Rules 13a-14(c) and 15d-14(c)) that are designed to ensure that information
required to be disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms, and that such information is accumulated
and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
Within 90 days prior to the date of this annual report, we carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on the foregoing, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective.
(b) Changes in Internal Controls. There have not been any significant
changes in our internal controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation. There were no
significant deficiencies or material weaknesses, and, therefore, no corrective
actions were taken.
D-56
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HFB FINANCIAL CORPORATION
By /s/ DAVID B. COOK
------------------------------------
David B. Cook
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 and on the dates indicated.
<Table>
/s/ DAVID B. COOK President and Chief Executive March 25, 2003
- -------------------------------------- Officer and Director (Principal
David B. Cook Executive Officer)
/s/ STANLEY ALEXANDER, JR. Chief Financial Officer (Principal March 25, 2003
- -------------------------------------- Financial and Accounting Officer)
Stanley Alexander, Jr.
/s/ KENNETH V. JONES Chief Operating Officer and March 25, 2003
- -------------------------------------- Director
Kenneth V. Jones
/s/ ROGER ROPER Vice President and Director March 25, 2003
- --------------------------------------
Roger Roper
/s/ FRANCES COFFEY RASNIC Director March 25, 2003
- --------------------------------------
Frances Coffey Rasnic
/s/ EARL BURCHFIELD Secretary-Treasurer and Director March 25, 2003
- --------------------------------------
Earl Burchfield
/s/ ROBERT V. COSTANZO Chairman and Director March 25, 2003
- --------------------------------------
Robert V. Costanzo
</Table>
D-57
CERTIFICATIONS
I, David B. Cook, certify that:
1. I have reviewed this annual report on Form 10-KSB of HFB Financial
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By /s/ DAVID B. COOK
------------------------------------
Chief Executive Officer
Date March 25, 2003
D-58
CERTIFICATIONS
I, Stanley Alexander, Jr., certify that:
1. I have reviewed this annual report on Form 10-KSB of HFB Financial
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By /s/ STANLEY ALEXANDER JR.
------------------------------------
Chief Financial Officer
Date March 25, 2003
D-59
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
PARENT
HFB Financial Corporation
<Table>
<Caption>
STATE OR OTHER
JURISDICTION OF PERCENTAGE
SUBSIDIARIES(1) INCORPORATION OWNERSHIP
- --------------- --------------- ----------
Home Federal Bank Corporation............................... Kentucky 100%
SUBSIDIARY OF HOME FEDERAL BANK CORPORATION
Home Service Corporation.................................... Kentucky 100%
</Table>
- ---------------
(1) The assets, liabilities and operations of the subsidiary are included in the
consolidated financial statements contained in the annual Report to
Stockholders attached hereto as an exhibit.
D-60
EXHIBIT 99.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the annual report of HFB Financial Corporation (the
"Company") on Form 10-KSB for the six-month transition period ended December 31,
2002 as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), I, David B. Cook, President and Chief Executive Officer of the
Company, certify, to the best of my knowledge, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
(1) The Report fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
A signed original of this written statement required by Section 906 has
been provided to the Company and will be retained by the Company and furnished
to the Securities and Exchange Commission or its staff upon request.
/s/ DAVID B. COOK
--------------------------------------
David B. Cook
President and Chief Executive Officer
March 25, 2003
D-61
EXHIBIT 99.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the annual report of HFB Financial Corporation (the
"Company") on Form 10-KSB for the six-month transition period ended December 31,
2002 as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), I, Stanley Alexander, Jr., President and Chief Executive Officer
of the Company, certify, to the best of my knowledge, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
A signed original of this written statement required by Section 906 has
been provided to the Company and will be retained by the Company and furnished
to the Securities and Exchange Commission or its staff upon request.
/s/ STANLEY ALEXANDER, JR.
--------------------------------------
Stanley Alexander, Jr.
Chief Financial Officer
March 25, 2003
D-62
APPENDIX E
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
<Table>
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</Table>
COMMISSION FILE NO. 0-20956
HFB FINANCIAL CORPORATION
<Table>
A TENNESSEE CORPORATION NO. 61-1228266
I.R.S. Employer Identification
1602 CUMBERLAND AVENUE
MIDDLESBORO, KENTUCKY 40965 (606) 248-1095
Address Telephone Number
</Table>
Indicate by check mark whether the registrant (1) has filed all reports
required by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding twelve 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 [ ]
The number of shares of the registrant's $1 par value common stock
outstanding at November 7, 2003 was 1,301,101.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
E-1
HFB FINANCIAL CORPORATION
INDEX
<Table>
<Caption>
PAGE NO.
--------
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets....................... E-3
Condensed Consolidated Statements of Income................. E-4
Condensed Consolidated Statement of Stockholders' Equity.... E-5
Condensed Consolidated Statements of Cash Flows............. E-6
Notes to Condensed Consolidated Financial Statements........ E-7-8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... E-9-13
PART II -- OTHER INFORMATION.......................................... E-14
SIGNATURES............................................................ E-15
CEO CERTIFICATION UNDER SECTION 302 OF THE SARBANES-OXLEY ACT......... E-16
CFO CERTIFICATION UNDER SECTION 302 OF THE SARBANES-OXLEY ACT......... E-17
EXHIBIT 99.1.......................................................... E-18
EXHIBIT 99.2.......................................................... E-19
</Table>
E-2
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(UNAUDITED)
ASSETS
Cash and cash equivalents................................... $ 5,999,208 $ 4,967,188
Available-for-sale securities............................... 49,858,124 70,418,282
Loans, net of allowance for loan losses of $1,494,678 and
$1,191,849 at September 30, 2003 and December 31, 2002,
respectively.............................................. 187,799,158 166,334,655
Premises and equipment...................................... 4,794,767 4,455,209
Federal Home Loan Bank stock................................ 1,730,300 1,679,700
Interest Receivable......................................... 1,446,375 1,513,376
Assets held for sale........................................ 1,224,079 1,030,310
Other assets................................................ 925,303 330,038
Cash surrender value of life insurance...................... 2,911,215 2,806,103
------------ ------------
Total assets........................................... $256,688,529 $253,534,861
============ ============
LIABILITIES
Deposits
Non-interest bearing demand............................... $ 8,553,692 $ 6,398,430
Savings, NOW and money market............................. 28,751,087 26,643,742
Certificate of deposits................................... 164,595,319 166,243,106
------------ ------------
Total deposits......................................... 201,900,098 199,285,278
Short-term debt............................................. -- 1,375,000
Long-term debt.............................................. 28,084,688 26,277,967
Interest payable............................................ 842,656 629,653
Other liabilities........................................... 1,845,387 2,386,636
------------ ------------
Total liabilities...................................... 232,672,829 229,954,534
------------ ------------
STOCKHOLDERS' EQUITY
Issued and outstanding -- 1,589,303 shares.................. 1,589,303 1,589,303
Additional paid-in-capital.................................. 8,768,874 8,768,874
Less: Common stock acquired by Rabbi trusts for deferred
compensation plans........................................ (500,446) (500,446)
Retained earnings........................................... 16,049,953 14,867,147
Accumulated other comprehensive income...................... 670,014 1,417,447
------------ ------------
26,577,698 26,142,325
Treasury stock, at cost, 288,202 shares..................... (2,561,998) (2,561,998)
------------ ------------
Total stockholders' equity............................. 24,015,700 23,580,327
------------ ------------
Total liabilities and stockholders' equity............. $256,688,529 $253,534,861
============ ============
</Table>
See notes to condensed consolidated financial statements.
E-3
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
THREE-MONTHS ENDED NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ----------- -----------
(UNAUDITED)
INTEREST INCOME
Loans receivable......................... $3,152,047 $3,071,713 $ 9,543,787 $ 8,987,988
Investment securities.................... 605,538 1,019,271 2,057,735 3,004,121
Other.................................... 5,192 5,379 23,226 31,522
---------- ---------- ----------- -----------
Total interest income................. 3,762,777 4,096,363 11,624,748 12,023,631
---------- ---------- ----------- -----------
INTEREST EXPENSE
Deposits................................. 1,055,165 1,509,570 3,395,583 4,848,812
Short term borrowings.................... -- 490 -- --
Long term debt........................... 337,939 251,224 959,001 727,326
---------- ---------- ----------- -----------
Total interest expense................ 1,393,104 1,761,284 4,354,584 5,576,138
---------- ---------- ----------- -----------
NET INTEREST INCOME........................ 2,369,673 2,335,079 7,270,164 6,447,493
Provision for loan losses................ 105,000 129,227 315,000 351,712
---------- ---------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES.............................. 2,264,673 2,205,852 6,955,164 6,095,781
---------- ---------- ----------- -----------
OTHER INCOME
Service charges for deposit accounts..... 267,498 207,829 770,638 584,425
Other customer fees...................... 24,928 27,024 93,324 70,873
Net realized gain on sales of available
for sale securities................... -- -- 1,243 5
Other income............................. 52,845 40,670 119,527 237,151
---------- ---------- ----------- -----------
Total other income.................... 345,271 275,523 984,732 892,454
---------- ---------- ----------- -----------
OTHER EXPENSES
Salaries and employee benefits........... 952,627 881,807 2,761,638 2,309,416
Net occupancy expenses................... 94,568 84,664 288,966 274,217
Equipment expenses....................... 131,438 111,392 395,873 382,050
Data processing fees..................... 81,144 59,947 225,016 181,367
Deposit insurance expense................ 8,105 11,290 24,489 28,068
Legal and professional fees.............. 181,851 101,666 445,826 408,814
Advertising.............................. 68,561 66,000 200,658 187,043
State franchise and deposit taxes........ 52,295 8,131 154,945 75,206
Other expenses........................... 258,848 339,037 822,872 1,087,225
---------- ---------- ----------- -----------
Total other expenses.................. 1,829,437 1,663,934 5,320,283 4,933,406
---------- ---------- ----------- -----------
INCOME BEFORE INCOME TAX................... 780,507 817,441 2,619,613 2,054,829
Income tax expense....................... 215,201 253,686 787,006 644,179
---------- ---------- ----------- -----------
NET INCOME................................. $ 565,306 $ 563,755 $ 1,832,607 $ 1,410,650
========== ========== =========== ===========
BASIC EARNINGS PER SHARE................... $ 0.45 $ 0.45 $ 1.46 $ 1.16
DILUTED EARNINGS PER SHARE................. $ 0.45 $ 0.45 $ 1.45 $ 1.15
</Table>
See notes to condensed consolidated financial statements.
E-4
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
NINE-MONTHS ENDED SEPTEMBER 30, 2003
<Table>
<Caption>
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RABBI TREASURY COMPREHENSIVE RETAINED COMPREHENSIVE
STOCK CAPITAL TRUSTS STOCK INCOME EARNINGS INCOME
---------- ---------- --------- ----------- ------------- ----------- -------------
BALANCES, DECEMBER
31, 2002........... $1,589,303 $8,768,874 $(500,446) $(2,561,998) $14,867,147 $1,417,447
Net income........... $1,832,607 1,832,607
Other comprehensive
income, net of tax
Unrealized gain on
securities....... (747,433) (747,433)
----------
Comprehensive
income............. $1,085,174
==========
Cash dividends
declared ($.50 per
share)............. (649,801)
---------- ---------- --------- ----------- ----------- ----------
SEPTEMBER 30, 2003
(UNAUDITED)........ $1,589,303 $8,768,874 $(500,446) $(2,561,998) $16,049,953 $ 670,014
========== ========== ========= =========== =========== ==========
<Caption>
TOTAL
STOCKHOLDERS'
EQUITY
-------------
BALANCES, DECEMBER
31, 2002........... $23,580,327
Net income........... 1,832,607
Other comprehensive
income, net of tax
Unrealized gain on
securities....... (747,433)
Comprehensive
income.............
Cash dividends
declared ($.50 per
share)............. (649,801)
-----------
SEPTEMBER 30, 2003
(UNAUDITED)........ $24,015,700
===========
</Table>
See notes to condensed consolidated financial statements.
E-5
HFB FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
NINE-MONTHS ENDED SEPTEMBER 30,
-------------------------------
2003 2002
-------------- --------------
(UNAUDITED)
OPERATING ACTIVITIES
Net cash provided by operating activities................. $ 1,228,096 $ 2,812,333
------------ ------------
INVESTING ACTIVITIES
Purchases of securities available for sale................ (16,764,230) (30,618,120)
Development costs of assets held for sale................. -- (32,321)
Proceeds from maturities of securities available for
sale................................................... 30,946,623 19,670,515
Proceeds from sales of securities available for sale...... 4,955,255 5,745
Net change in loans....................................... (21,149,503) (23,438,460)
Proceeds from sales of assets held for sale............... 107,657 1,544,870
Proceeds from life insurance.............................. -- (2,654,256)
Purchases of premises and equipment....................... (688,619) (232,849)
------------ ------------
Net cash used by investing activities................ (2,592,817) (35,754,876)
------------ ------------
FINANCING ACTIVITIES
Net change in
Non interest-bearing, interest-bearing and savings
deposits............................................. 4,262,607 8,345,171
Certificates of deposit................................ (1,647,787) 2,556,578
Short term borrowings.................................. (1,375,000) 1,525,000
Proceeds of long term debt................................ 2,825,000 12,500,000
Repayment of long term debt............................... (1,018,278) (63,015)
Cash dividends............................................ (649,801) (532,583)
Proceeds from exercise of options on common stock......... -- 24,655
Purchase of treasury stock................................ -- (77,731)
------------ ------------
Net cash provided by financing activities............ 2,396,741 24,278,075
------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS..................... 1,032,020 (8,664,468)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 4,967,188 13,594,073
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 5,999,208 $ 4,929,605
============ ============
ADDITIONAL CASH FLOWS INFORMATION
Interest paid............................................. $ 4,141,581 $ 2,827,488
Income tax paid........................................... 967,512 292,282
</Table>
See notes to condensed consolidated financial statements.
E-6
HFB FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial information for the
three-month periods ended September 30, 2003 and 2002 includes the results of
operations of HFB Financial Corporation (the "Company") and its wholly owned
subsidiary Home Federal Bank Corporation ("Home Federal" or the "Bank"). The
accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial statements and with the instructions to Form 10-QSB.
Certain information and note disclosures normally included in the company's
annual financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted. It is suggested that these statements and notes be read in conjunction
with the financial statements and notes thereto included in the Company's annual
report for the year ended December 31, 2002 on Form 10-KSB filed with the
Securities and Exchange Commission.
In the opinion of management, the financial information reflects all
adjustments (consisting only of normal recurring adjustments), which are
necessary for a fair presentation of the financial position, results of
operations and cash flows of the Company but should not be considered as
indicative of results for a full year.
The condensed consolidated balance sheet of the Company as of December 31,
2002 has been derived from the audited consolidated balance sheet of the Company
as of that date.
2. NON-PERFORMING LOANS AND PROBLEM ASSETS
The following sets forth the activity in the Company's allowance for loan
losses for the nine-months ended September 30, 2003 and 2002:
<Table>
<Caption>
2003 2002
------ ------
(DOLLARS IN
THOUSANDS)
Balance January 1........................................... $1,192 $ 780
Charge offs................................................. (12) (79)
Recoveries.................................................. -- 47
Provision for loan losses................................... 315 351
------ ------
Balance September 30........................................ $1,495 $1,099
====== ======
</Table>
Information on impaired loans is summarized below:
<Table>
<Caption>
AT SEPTEMBER 30
---------------
2003 2002
----- -------
Impaired loans with an allowance............................ $304 $1,154
Allowance for impaired loans (included in the Company's
allowance for loan losses)................................ $ 30 $ 298
</Table>
<Table>
<Caption>
THREE-MONTHS
ENDED
SEPTEMBER 30
-------------
2003 2002
---- ------
Average balance of impaired loans........................... $870 $1,138
Interest income recognized on impaired loans................ $ 9 $ 0
Cash-basis interest received................................ $ 0 $ 0
</Table>
E-7
HFB FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. EARNINGS PER SHARE
Earnings per share (EPS) were computed as follows:
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30, 2003
-------------------------------------
WEIGHTED- PER SHARE
INCOME AVERAGE SHARES AMOUNT
-------- -------------- ---------
Net income......................................... $565,306
--------
Basic earnings per share
Income available to common stockholders.......... $565,306 1,261,690 $0.45
=====
Effect of dilutive securities
Stock options.................................... -- 5,575
-------- ---------
Diluted earnings per share
Income available to common stockholders and
assumed conversions........................... $565,306 1,267,265 $0.45
======== ========= =====
</Table>
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30, 2002
-------------------------------------
WEIGHTED- PER SHARE
INCOME AVERAGE SHARES AMOUNT
-------- -------------- ---------
Net income......................................... $563,755 1,246,604
-------- ---------
Basic earnings per share
Income available to common stockholders.......... $563,755 $0.45
=====
Effect of dilutive securities
Stock options.................................... -- 3,141
-------- ---------
Diluted earnings per share
Income available to common stockholders and
assumed conversions........................... $563,755 1,249,745 $0.45
======== ========= =====
</Table>
4. STOCK OPTIONS
At September 30, 2003 the Company has a stock-based compensation plan which
is described more fully in the notes to the Company's December 31, 2002 audited
financial statements contained in the Company's annual report. The Company
accounts for this plan under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under those plans had an exercise price that was
equal to or greater than the market value of the underlying common stock on the
grant date. Proforma information is not presented since all options granted by
the Company were granted and vested in periods previous to those presented.
Therefore, no expense would be recognized for the periods presented had the
Company applied the fair value provisions of FASB statement No. 123, Accounting
for Stock-Based Compensation, to stock-based employee compensation.
5. RECLASSIFICATIONS
Reclassifications of certain amounts in the September 30, 2002 consolidated
statement have been made to conform to the September 30, 2003 presentation.
E-8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain matters discussed in this Quarterly Report on Form 10-QSB are
"forward-looking statements" intended to qualify for the safe harbors from
liability established by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements can generally be identified as such because the
context of the statement will include words such as the Company "believes",
"anticipates", "expects", "estimates" or words of similar import. Similarly,
statements that describe the Company's future plans, objectives or goals are
also forward-looking statements. Such forward-looking statements are subject to
certain risks and uncertainties, which are described in, close proximity to such
statements and which could cause actual results to differ materially from those
anticipated as of the date of this report. Shareholders, potential investors and
other readers are urged to consider these factors in evaluating the
forward-looking statements and are cautioned not to place undue reliance on such
forward-looking statements. The forward-looking statements included herein are
only made as of the date of this report and the Company undertakes no obligation
to publicly update such forward-looking statements to reflect subsequent events
or circumstances.
GENERAL
HFB Financial Corporation, a Tennessee Corporation, was formed in September
1992 at the direction of Home Federal Bank, Federal Savings Bank for the purpose
of becoming a holding company for the Bank as part of its conversion from mutual
to stock form. The Company's primary operation is its investment in the common
stock of the Bank.
The Bank is principally engaged in the business of accepting deposits from
the general public and originating permanent loans, which are secured by
one-to-four family residential properties located in its market area. The Bank
also originates consumer loans and commercial real estate loans, and maintains a
substantial investment portfolio of mortgage-backed and other investment
securities. During the quarter ended December 31, 2001, the Bank converted from
a federal thrift charter to a state chartered commercial bank as a means for
management to focus more on commercial lending and other activities permissible
for commercial banks.
The operations of Home Federal are significantly influenced by general
economic conditions and the monetary and fiscal policies of government
regulatory agencies. Deposit flows and costs of funds are influenced by interest
rates on competing investments and prevailing market rates of interest. Lending
activities are affected by the demand for financing real estate and other types
of loans, which in turn are influenced by the interest rates at which such
financing may be offered and other factors related to loan demand and the
availability of funds.
FINANCIAL CONDITION
The Corporation's assets increased by 1.26% to $256.7 million at September
30, 2003 compared to $253.5 million at December 31, 2002. The majority of this
increase is reflected in increases in loans. The increase was financed primarily
by increases deposits and long-term borrowings and decreases in investment
securities.
Investment securities, available for sale, decreased $20.5 million to $49.9
million at September 30, 2003 from $70.4 million at December 31, 2002 primarily
as the result of increased prepayments on mortgage backed securities "MBSs".
Loans, net, increased by $21.5 million to $187.8 million at September 30,
2003 from $166.3 million at December 31, 2002 as the result of continued 1-4
family mortgage loan demand and an increase in commercial real estate loans.
Since the Banks conversion to a commercial bank, Management has focused on
originating commercial real estate loans.
At September 30, 2003, the allowance for loan losses was $1.5 million or
..79% of loans receivable compared to $1.2 million or .71% of loans receivable at
December 31, 2002.
E-9
Total deposits increased by $2.6 million to $201.9 million at September 30,
2003 from $199.3 million at December 31, 2002. During the nine months ended
September 30, 2003, certificates of deposit decreased $1.6 million and NOW
accounts and savings deposits increased $4.2 million.
Long-term borrowings increased by $1.8 million to $28.1 million at
September 30, 2003 from $26.3 million at September 30, 2002. Most of this
increase originated from 10 year advances which were used to fund the purchase
of municipal securities with an average maturity of 15 years.
At September 30, 2003, the Bank met all regulatory requirements. Tier I
capital to averaged assets was 8.8%. Tier I capital to risk-weighted assets was
14.0% and total capital to risk-weighted assets was 14.9% at September 30, 2003
compared to 8.4%, 14.5% and 15.3%, respectively, at December 31, 2002.
RESULTS OF OPERATIONS FOR THE THREE-MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Net income increased by $2,000 to $565,000 for the three-month period ended
September 30, 2003 from $563,000 for the three-month period ended September 30,
2002. The primary reasons for the increase were a $35,000 increase in net
interest income, a $24,000 decrease in the provision for loan losses, a $70,000
increase in other income and a $39,000 decrease in income tax expense offset by
a $166,000 increase in other expense.
Interest income decreased by $334,000 for the three-month period ended
September 30, 2003 as compared to the three-month period ended September 30,
2002, primarily a result of lower yields on earning assets during the three
months ended September 30, 2003.
Interest on loans increased by $80,000 to $3.152 million for the
three-month period ended September 30, 2003 as compared to $3.072 million for
the three-month period ended September 30, 2002. This increase is mainly
attributable to a higher average balance of loans during the three months ended
September 30, 2003 even though the weighted-average yield was lower than that of
the quarter ended September 30, 2002.
Interest on investment securities, other dividend income and interest on
deposits with financial institutions decreased by $414,000 to $611,000 for the
three-month period ended September 30, 2003 from $1.025 million for the
three-month period ended September 30, 2002. This decrease is primarily the
result of a lower average balance of investments during the three months ended
September 30, 2003. The weighted average yield on investments during the same
period was also lower than that of the three months ended September 30, 2002.
Interest expense on deposits decreased by $454,000 to $1.055 million for
the three-month period ended September 30, 2003 from $1.509 million for the
three-month period ended September 30, 2002 as a result of a significant drop in
rates paid on deposit accounts.
Interest expense on short-term and long-term debt increased by $86,000 to
$338,000 for the three-month period ended September 30, 2003 from $252,000 for
the three-month period ended September 30, 2002, primarily due to a higher level
of long-term debt outstanding during the three months ended September 30, 2003.
The provision for loan losses decreased by $24,000 for the three-month
period ended September 30, 2003 as compared to the same period in 2002. The
provision was the result of management's evaluation of the adequacy of the
allowance for loan losses including consideration of recoveries of loans
previously charged off, the perceived risk exposure among loan types, actual
loss experience, delinquency rates, and current economic conditions. The Bank's
allowance for loan losses as a percent of total loans at September 30, 2003 was
0.79%.
Non-interest income increased by $70,000 to $345,000 for the three-month
period ended September 30, 2003 as compared to $275,000 for the same period in
2002. The decrease was largely attributable to an increase of $60,000 in service
charges on deposits, an increase of $12,000 in other income offset by a $2,000
decrease in other customer fees.
Non-interest expense increased by $166,000 to $1.829 million for the
three-month period ended September 30, 2003 as compared to $1.663 million for
the same period in 2002.
E-10
Compensation and benefits increased by $71,000 to $953,000 for the
three-month period ended September 30, 2003 as compared to $882,000 for the
three-months ended September 30, 2002 primarily as the result of annual
increases in salaries, wages and commissions and a $18,000 increase in the cost
of funding the Banks retirement plan. In addition, the Banks staffing was
increased due to growth and the opening of a branch office in Jacksboro,
Tennessee in January 2003. At September 30, 2003, the Bank had 74 full time
equivalent employees compared to 63 at September 30, 2002.
Occupancy expense increased by $10,000 to $95,000 for the three-month
period ended September 30, 2003 as compared to $85,000 for the three-months
ended September 30, 2002 primarily as the result increased expenses for repairs
and maintenance and rent for the new Jacksboro branch office.
Equipment expense increased by $20,000 to $131,000 for the three-month
period ended September 30, 2003 as compared to $111,000 for the three-months
ended September 30, 2002 primarily due to increases in depreciation for new data
processing equipment recently acquired.
Data processing expenses increased by $21,000 to $81,000 for the
three-month period ended September 30, 2003 as compared to $60,000 for the
three-months ended September 30, 2002 as the result of the addition of a new
branch office and other specialized programming requests.
Legal and professional fees increased by $80,000 to $182,000 for the
three-month period ended September 30, 2003 from $102,000 for the three-month
period ended September 30, 2002 primarily due to an increase of $40,000 in legal
expenses, an increase of $6,000 in accounting fees, an increase of $9,000 in
fees for software support and an increase of $12,000 in other consulting fees.
State deposit and franchise taxes increased by $44,000 to $52,000 for the
quarter ended September 30, 2003 compared to $8,000 for the quarter ended
September 30, 2002. As a result of the Banks recent conversion from a thrift to
a commercial bank and determining the differences in the method of taxation
between banks and thrifts, deposit and franchise taxes were over accrued during
the quarter ended September 30, 2002.
Other expenses decreased by $80,000 to $259,000 for the three-month period
ended September 30, 2003 from $339,000 for the three-month period ended
September 30, 2002, primarily due to a $93,000 decrease in expenses associated
with the acquisition and sale of other real estate owned. Income tax expense
decreased by $39,000 to $215,000 for the three-month period ended September 30,
2003 compared to $254,000 for the three-months ended September 30, 2002 due a
lower level of taxable income.
RESULTS OF OPERATIONS FOR THE NINE-MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Net income increased by $422,000 to $1.833 million for the nine-month
period ended September 30, 2003 from $1.411 million for the nine-month period
ended September 30, 2002. The primary reasons for the increase were a $823,000
increase in net interest income, a $37,000 decrease in the provision for loan
losses and a $92,000 increase in other income offset by a $387,000 increase in
other expense and a $143,000 increase in income tax expense.
Interest income decreased by $399,000 for the nine-month period ended
September 30, 2003 as compared to the nine-month period ended September 30,
2002, primarily a result of lower yields on earning assets during the nine
months ended September 30, 2003.
Interest on loans increased by $556,000 to $9.544 million for the
nine-month period ended September 30, 2003 as compared to $8.988 million for the
nine-month period ended September 30, 2002. This increase is mainly attributable
to a higher average balance of loans during the nine months ended September 30,
2003 even though the weighted-average yield was lower than that of the quarter
ended September 30, 2002.
Interest on investment securities, other dividend income and interest on
deposits with financial institutions decreased by $955,000 to $2.081 million for
the nine-month period ended September 30, 2003 from $3.036 million for the
nine-month period ended September 30, 2002. This decrease is primarily the
result of a lower average balance of investments during the nine months ended
September 30, 2003. The weighted
E-11
average yield on investments during the same period was also lower than that of
the nine months ended September 30, 2002.
Interest expense on deposits decreased by $1.453 million to $3.396 million
for the nine-month period ended September 30, 2003 from $4.849 million for the
nine-month period ended September 30, 2002 as a result of a significant drop in
rates paid on deposit accounts.
Interest expense on short-term and long-term debt increased by $232,000 to
$959,000 for the nine-month period ended September 30, 2003 from $727,000 for
the nine-month period ended September 30, 2002, primarily due to a higher level
of long-term debt outstanding during the nine months ended September 30, 2003.
The provision for loan losses decreased by $37,000 for the nine-month
period ended September 30, 2003 as compared to the same period in 2002. The
provision was the result of management's evaluation of the adequacy of the
allowance for loan losses including consideration of recoveries of loans
previously charged off, the perceived risk exposure among loan types, actual
loss experience, delinquency rates, and current economic conditions. The Bank's
allowance for loan losses as a percent of total loans at September 30, 2003 was
0.79%.
Non-interest income increased by $92,000 to $984,000 for the nine-month
period ended September 30, 2003 as compared to $892,000 for the same period in
2002. The increase was mainly attributable to an increase of $186,000 in service
charges on deposits, an increase of $22,000 in other customer fees offset by a
$118,000 decrease in other income. The decrease in other income was primarily
due to a $84,000 decrease in gain on the sale of real estate and equipment.
Non-interest expense increased by $387,000 to $5.320 million for the
nine-month period ended September 30, 2003 as compared to $4.933 million for the
same period in 2002.
Compensation and benefits increased by $453,000 to $2.762 million for the
nine-month period ended September 30, 2003 as compared to $2.309 million for the
nine-months ended September 30, 2002 primarily as the result of annual increases
in salaries, wages and commissions and a $48,000 increase in the cost of funding
the Banks retirement plan. In addition, the Banks staffing was increased due to
growth and the opening of a branch office in Jacksboro, Tennessee in January
2003. At September 30, 2003, the Bank had 74 full time equivalent employees
compared to 63 at September 30, 2002.
Data processing expenses increased by $44,000 to $225,000 for the
nine-month period ended September 30, 2003 as compared to $181,000 for the
nine-months ended September 30, 2002 as the result of the addition of a new
branch office and other specialized programming requests.
Legal and professional fees increased by $37,000 to $446,000 for the
nine-month period ended September 30, 2003 from $409,000 for the nine-month
period ended September 30, 2002 primarily due to an increase in legal expenses
for the nine-months ended September 30, 2003.
State deposit and franchise taxes increased by $80,000 to $155,000 for the
quarter ended September 30, 2003 compared to $75,000 for the quarter ended
September 30, 2002. As a result of the Banks recent conversion from a thrift to
a commercial bank and determining the differences in the method of taxation
between banks and thrifts, deposit and franchise taxes were over accrued during
the quarter ended September 30, 2002.
Other expenses decreased by $264,000 to $823,000 for the nine-month period
ended September 30, 2003 from $1.087 million for the nine-month period ended
September 30, 2002, primarily due to a $381,000 decrease in expenses associated
with the acquisition and sale of other real estate owned, a $33,000 increase in
printing supplies resulting from a systems conversion, a $54,000 increase in
other services and fees and a $20,000 increase in telephone expense due to
duplicate service used during the conversion to a new system.
Income tax expense increased by $143,000 to $787,000 for the nine-month
period ended September 30, 2003 compared to $644,000 for the nine-months ended
September 30, 2002 due a higher level of taxable income.
E-12
CRITICAL ACCOUNTING POLICIES
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to income. Loan losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to repay,
estimated value of any underlying collateral and prevailing economic conditions.
This evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
A loan is considered impaired when, based on current information and
events, it is probable that the Bank will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. Factors considered by management in determining impairment
include payment status, collateral value and the probability of collecting
scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified
as impaired. Management determines the significance of payment delays and
payment shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including the length of the
delay, the reasons for the delay, the borrower's prior payment record and the
amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis for commercial and construction
loans by either the present value of expected future cash flows discounted at
the loan's effective interest rate, the loan's obtainable market price or the
fair value of the collateral if the loan is collateral dependent.
E-13
HFB FINANCIAL CORPORATION
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of Security Holders during the quarter
ended September 30, 2003.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
<Table>
99.1 CEO Certification under Section 906 of the Sarbanes-Oxley
Act
99.2 CFO Certification under Section 906 of the Sarbanes-Oxley
Act
</Table>
b. Reports on Form 8-K
On October 29, 2003, the Company filed a form 8-K announcing that earnings
for the quarter ended September 30, 2003 were released on October 28, 2003.
On October 29, 2003, the Company filed a form 8-K announcing its proposed
plan to terminate registration of its common stock with the Securities and
Exchange Commission, which was released on October 28, 2003
ITEM 7. CONTROLS AND PROCEDURES
A review and evaluation was performed by the Company's management,
including the Company's Chief Executive Officer (the "CEO") and Chief Financial
Officer (the "CFO"), of the effectiveness of the design and operation of the
Company's disclosure controls and procedures as of a date within 90 days prior
to the filing of this quarterly report pursuant to Rule 13a-14 of the Securities
Act of 1934. Based on that review and evaluation, the CEO and CFO have concluded
that the Company's current disclosure controls and procedures, as designed and
implemented, were effective. There have been no significant changes in the
Company's internal controls or in other factors that could significantly affect
the Company's internal controls subsequent to the date of their evaluation.
There were no significant material weaknesses identified in the course of such
review and evaluation and, therefore, no corrective measures were taken by the
Company.
E-14
HFB FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed in its behalf by the
undersigned, thereunto duly authorized.
HFB FINANCIAL CORPORATION
By: /s/ DAVID B. COOK
------------------------------------
David B. Cook
President and
Chief Executive Officer
By: /s/ STANLEY ALEXANDER, JR.
------------------------------------
Stanley Alexander, Jr.
Chief Financial Officer
Dated November 7, 2003
E-15
CERTIFICATIONS
I, David B. Cook, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of HFB Financial
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By /s/ DAVID B. COOK
------------------------------------
David B. Cook
Chief Executive Officer
Date November 7, 2003
E-16
CERTIFICATIONS
I, Stanley Alexander, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-QSB of HFB Financial
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By /s/ STANLEY ALEXANDER, JR.
------------------------------------
Stanley Alexander, Jr.
Chief Financial Officer
Date November 7, 2003
E-17
EXHIBIT 99.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report of HFB Financial Corporation (the
"Company") on Form 10-QSB for the three-month period ended September 30, 2003 as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, David B. Cook, President and Chief Executive Officer of the
Company, certify, to the best of my knowledge, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
(1) The Report fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
A signed original of this written statement required by Section 906 has
been provided to the Company and will be retained by the Company and furnished
to the Securities and Exchange Commission or its staff upon request.
/s/ DAVID B. COOK
--------------------------------------
David B. Cook
President and Chief Executive Officer
November 7, 2003
E-18
EXHIBIT 99.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the annual report of HFB Financial Corporation (the
"Company") on Form 10-QSB for the three-month period ended September 30, 2003 as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, Stanley Alexander, Jr., Chief Financial Officer of the Company,
certify, to the best of my knowledge, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
A signed original of this written statement required by Section 906 has
been provided to the Company and will be retained by the Company and furnished
to the Securities and Exchange Commission or its staff upon request.
/s/ STANLEY ALEXANDER, JR.
--------------------------------------
Stanley Alexander, Jr.
Chief Financial Officer
November 7, 2003
E-19