UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
Mark One
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE UNITED STATES
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004.
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
Commission File Number: 0-23551
UNITED TENNESSEE BANKSHARES, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
TENNESSEE 62-1710108
- ---------------------------------- ------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
344 Broadway, Newport, Tennessee 37821
- ---------------------------------- ------------------
(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code: (423) 623-6088
Check whether the issuer: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past ninety days:
Yes [X] No [ ]
State the number of shares outstanding of each of the issuer's classes of common
stock as of the latest practicable date: 1,196,999
---------
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
CONTENTS
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of
September 30, 2004 (Unaudited) and December 31, 2003 3
Consolidated Statements of Income for the
Three-Month and Nine-Month Periods Ended September 30,
2004 and 2003 (Unaudited) 4
Consolidated Statements of Comprehensive Income for the
Three-Month and Nine-Month Periods Ended September 30,
2004 and 2003 (Unaudited) 5
Consolidated Statement of Changes in Shareholders'
Equity for the Nine-Month Period Ended September 30,
2004 (Unaudited) 6
Consolidated Statements of Cash Flows for the Nine-Month
Periods Ended September 30, 2004 and 2003 (Unaudited) 7-8
Notes to Consolidated Financial Statements for the
Three-Month and Nine-Month Periods Ended September 30,
2004 and 2003 (Unaudited) 9-12
Item 2. Management's Discussion and Analysis or Plan of Operation 13-19
Item 3. Controls and Procedures 19
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
CERTIFICATIONS 22-23
-2-
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
September 30,
2004 December 31,
(Unaudited) 2003
------------------ -----------------
(In Thousands)
Assets
Cash and amounts due from depository institutions $ 2,621 $ 5,196
Investment securities available for sale, at fair value 37,308 29,756
Loans receivable, net 78,526 77,953
Premises and equipment, net 1,216 996
Foreclosed real estate - held for sale 74 49
Accrued interest receivable 662 559
Goodwill, net of amortization 733 793
Cash surrender value of life insurance 1,581 1,529
Prepaid expenses and other assets 50 151
------------------ ------------------
Total assets $ 122,771 $ 116,982
================== ==================
Liabilities and Equity
Liabilities:
Deposits $ 102,593 $ 98,107
Accrued interest payable 101 79
Accrued income taxes 68 0
Deferred income taxes 683 653
Accrued benefit plan liabilities 1,299 1,183
Other liabilities 171 67
------------------ ------------------
Total liabilities 104,915 100,089
------------------ ------------------
Shareholders' equity:
Common stock - no par value, Authorized 20,000,000 shares;
issued and outstanding 1,196,999 shares (1,230,379 in 2003) $ 11,105 $ 11,665
Unearned compensation - ESOP (180) (351)
Shares in grantor trust - contra account (224) (216)
Shares in stock option plan trusts - contra account (708) (1,122)
Retained earnings 6,681 5,785
Accumulated other comprehensive income 1,182 1,132
------------------ ------------------
Total shareholders' equity 17,856 16,893
------------------ ------------------
Total liabilities and equity $ 122,771 $ 116,982
================== ==================
The accompanying notes are an integral part of these financial statements.
-3-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
(In Thousands Except (In Thousands Except
per Share Information) per Share Information)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- -----------------------------------
2004 2003 2004 2003
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
--------------- -------------- --------------- ---------------
Interest income:
Loans $ 1,337 $ 1,413 $ 4,046 $ 4,314
Investment securities 393 294 1,055 849
Other interest-earning assets 3 5 8 21
--------------- -------------- --------------- ---------------
Total interest income 1,733 1,712 5,109 5,184
--------------- -------------- --------------- ---------------
Interest expense:
Deposits 430 438 1,197 1,350
Advances from Federal Home Loan Bank 1 0 1 0
--------------- -------------- --------------- ---------------
Total Interest Expense 431 438 1,198 1,350
--------------- -------------- --------------- ---------------
Net interest income 1,302 1,274 3,911 3,834
Provision for loan losses 24 36 76 108
--------------- -------------- --------------- ---------------
Net interest income after provision for loan
losses 1,278 1,238 3,835 3,726
--------------- -------------- --------------- ---------------
Noninterest income:
Deposit account service charges 80 88 227 225
Loan service charges and fees 29 31 84 85
Net gain (loss) on sales of investment
securities available for sale 26 0 26 13
Other 22 15 83 48
--------------- -------------- --------------- ---------------
Total noninterest income 157 134 420 371
--------------- -------------- --------------- ---------------
Noninterest expense:
Compensation and benefits 415 324 1,264 986
Occupancy and equipment 55 61 205 189
Federal deposit insurance premiums 5 15 13 45
Data processing fees 86 72 251 204
Advertising and promotion 17 20 52 57
Net (gain) loss on foreclosed real estate (2) 0 (10) 10
Amortization 20 20 60 60
Other 133 145 431 444
--------------- -------------- --------------- ---------------
Total noninterest expense 729 657 2,266 1,995
--------------- -------------- --------------- ---------------
Income before income taxes 706 715 1,989 2,102
Income taxes 259 278 651 817
--------------- -------------- --------------- ---------------
Net income $ 447 $ 437 $ 1,338 $ 1,285
=============== ============== =============== ===============
Earnings per share:
Basic $ 0.37 $ 0.34 $ 1.10 $ 1.00
=============== ============== =============== ===============
Diluted $ 0.37 $ 0.34 $ 1.09 $ 1.00
=============== ============== =============== ===============
The accompanying notes are an integral part of these financial statements.
-4-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTH AND NINE MONTH PERIOD ENDED SEPTEMBER 30, 2004
Three Months Ended Nine Months Ended
------------------------- -------------------------
September 30, September 30
------------------------- -------------------------
2004 2003 2004 2003
----------- ---------- ----------- -----------
(Unaudited - In thousands) (Unaudited - In thousands)
Net Income $ 447 $ 447 $ 1,338 $ 1,285
----------- ---------- ----------- -----------
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on investment securities 607 (100) 106 (331)
Less reclassification adjustment for gains/losses
included in net income (26) 0 (26) (13)
Less income taxes related to unrealized
gains/losses on investment securities (220) 38 (30) 131
----------- ---------- ----------- -----------
Other comprehensive income (loss), net of tax 361 (62) 50 (213)
----------- ---------- ----------- -----------
Comprehensive income(loss) $ 808 $ 375 $ 1,388 $ 1,072
----------- ---------- ----------- -----------
The accompanying notes are an integral part of these financial statements.
-5-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2004
Shares in Shares in Accumulated
Unearned Grantor Stock Option Other Total
Common Compensation- Trust-Contra Plan Trust- Retained Comprehensive Shareholders'
Stock ESOP Account Contra Account Earnings Income Equity
--------- ------------ ----------- ------------ ---------- ------------- ------------
Balances, beginning of
period $ 11,665 $ (351) $ (216) $ (1,122) $ 5,785 $ 1,132 $ 16,893
Net income 0 0 0 0 1,338 0 1,338
Other comprehensive
income (loss) 0 0 0 0 0 50 50
Retirement of Stock held
in the Stock Option
Plan Trusts (560) 0 0 560 0 0 0
Purchase of Stock to be
held in the Grantor
Trust Plan 0 0 (8) 8 0 0 0
Purchase of Stock to be
held in the Stock Option
Plan Trusts 0 0 0 (74) 0 0 (74)
Payment on ESOP loan
principal 0 171 0 0 0 0 171
Dividends paid 0 0 0 0 (442) 0 (442)
Proceeds from exercise
of stock options 0 0 0 206 0 0 206
Decrease in Cost of
Shares in Stock Option
Plan Trusts 0 0 0 27 0 0 27
Costs associated with
stock options surrendered 0 0 0 (313) 0 0 (313)
--------- ------------ ----------- ------------ ---------- ------------- -------------
Balances, end of period $ 11,105 $ (180) $ (224) $ (708) $ 6,681 $ 1,182 $ 17,056
========= ============ =========== ============ ========== ============= =============
The accompanying notes are an integral part of these financial statements.
-6-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2004 AND 2003
Nine Months Ended
September 30,
-------------------------------
2004 2003
(Unaudited - in thousands)
-------------------------------
Operating Activities:
Net income $ 1,338 $ 1,285
-------------------------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 76 108
Depreciation 69 72
Amortization of goodwill 60 60
Net (gain) loss on sales of foreclosed real estate (10) 10
Federal home loan bank stock dividends (29) (27)
Net (gain) loss on sales of investment securities
available for sale (26) (13)
Increase in cash surrender value of bank-owned life insurance (52) 0
(Increase) Decrease in:
Accrued interest receivable (103) 28
Other assets 101 70
Increase (Decrease) in:
Accrued interest payable 22 (10)
Accrued income taxes 68 62
Accrued benefit plan liabilities 116 57
Other liabilities 104 91
-------------------------------
Total adjustments 396 508
-------------------------------
Net cash provided by operating activities 1,734 1,793
-------------------------------
Investing Activities:
Purchases of investment securities available for sale (14,799) (12,184)
Proceeds from maturities of investment securities available for sale 0 1,031
Payments received on investment securities available for sale 6,664 4,126
Proceeds from sales of investment securities available for sale 718 1,107
Net (increase) decrease in loans (1,075) (230)
Purchases of premises and equipment, net (289) (69)
Purchase of bank-owned life insurance 0 (1,512)
Proceeds from sales of foreclosed real estate 411 118
-------------------------------
Net cash used in investing activities (8,370) (7,613)
-------------------------------
The accompanying notes are an integral part of these financial statements.
-7-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2004 AND 2003
Nine Months Ended
2004 2003
--------------------------------
(Unaudited - in thousands)
Financing Activities:
Dividends paid (442) (420)
Costs associated with stock options surrendered (313) (327)
Net increase (decrease) in deposits 4,486 5,400
Purchase of common stock (74) (47)
Proceeds from exercise of stock options 206 9
Proceeds from dividends of shares in stock option plan 27 0
Issuance of common stock for MRP plan 0 56
Purchase of common stock pursuant director's long-term
incentive plan 0 (1)
Payment on ESOP loan and release of shares 171 116
Net repayment of advances from Federal Home Loan Bank 0 0
--------------------------------
Net cash provided by (used in) financing activities 4,061 4,786
--------------------------------
Net increase (decrease) in cash and cash equivalents (2,575) (1,034)
Cash and cash equivalents, beginning of period 5,196 5,350
--------------------------------
Cash and cash equivalents, end of period $ 6,621 $ 4,316
================================
Supplementary disclosures of cash flow information:
Cash paid during the period for:
Interest $ 1,220 $ 1,360
Income taxes $ 426 $ 784
Supplementary disclosures of noncash investing activities:
Acquisition of foreclosed real estate $ 436 $ 48
Change in unrealized gain\loss on investment securities
available for sale $ 80 $ (344)
Change in deferred income taxes associated with unrealized
gain\loss on investment securities available for sale $ 30 $ (131)
Change in net unrealized gain\loss on investment
securities available for sale $ 50 $ (213)
The accompanying notes are an integral part of these financial statements
-8-
UNITED TENNESSEE BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE-MONTH AND NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 2004 AND 2003 (UNAUDITED)
Note 1 - Basis of Presentation and Principles of Consolidation and Significant
Accounting Policies
United Tennessee Bankshares, Inc. ("Company") was incorporated under the laws of
the State of Tennessee for the purpose of becoming the holding company of
Newport Federal Savings and Loan Association ("Association"), in connection with
the Association's conversion from a federally chartered mutual savings and loan
association to a federally chartered capital stock savings bank. The Company had
no assets or operations prior to the conversion. On January 1, 1998, the
Association converted from a mutual savings association to a capital stock
savings bank, changed its name to Newport Federal Bank ("Bank"), and was
simultaneously acquired by its holding company, United Tennessee Bankshares,
Inc.
The Bank provides a variety of financial services to individuals and corporate
customers through its three offices in Newport, Tennessee. The Bank's primary
deposit products are interest-bearing savings accounts and certificates of
deposit. The Bank's primary lending products are one-to-four family first
mortgage loans.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with the instructions for Form 10-QSB and on the same basis as the
Company's audited consolidated financial statements. In the opinion of
management, all adjustments, consisting of normal recurring accruals, necessary
to present fairly the financial position, results of operations, and cash flows
for the interim periods presented have been included. The results of operations
for such interim periods are not necessarily indicative of the results expected
for the full year.
The consolidated financial statements include the accounts of the Company and
the Bank. All intercompany accounts have been eliminated.
The Company has a stock-based employee compensation plan, which is described
more fully in Note 5. 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
date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation.
Three Months Ended Nine Months Ended
------------------------- ----------------------
September 30, September 30,
------------------------- ----------------------
(In thousands, except per share data) 2004 2003 2004 2003
------------ ---------- ---------- ---------
Net Income, as reported $ 447 $ 437 $ 1,338 $ 1,285
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
to calculate earnings per share 0 (1) 0 (7)
------------ ---------- ---------- ---------
Pro forma net income $ 447 $ 436 $ 1,338 $ 1,278
============ ========== ========== =========
Earnings per share:
Basic - as reported $ 0.37 $ 0.34 $ 1.10 $ 1.00
============ ========== ========== =========
Basic - pro forma $ 0.37 $ 0.34 $ 1.10 $ 1.00
============ ========== ========== =========
Diluted - as reported $ 0.37 $ 0.34 $ 1.09 $ 1.00
============ ========== ========== =========
Diluted - pro forma $ 0.37 $ 0.34 $ 1.09 $ 0.99
============ ========== ========== =========
-9-
Note 2 - Earnings Per Share
Basic earnings per share represent income available to shareholders divided by
the weighted average number of shares outstanding during the period. Diluted
earnings per share reflect additional shares that would have been outstanding if
dilutive potential shares had been issued, as well as any adjustment to income
that would result from the assumed issuance. Potential shares that may be issued
by the Company relate solely to outstanding stock options, and are determined
using the treasury stock method.
Earnings per share have been computed based on the following:
Three Months Ended Nine Months Ended
-------------------------- --------------------------
September 30, September 30,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Average number of shares outstanding 1,201,502 1,268,030 1,219,150 1,281,777
Effect of dilutive options 0 1,390 9,658 6,908
----------- ----------- ----------- -----------
Average number of shares outstanding used
to calculate earnings per share 1,201,502 1,269,420 1,228,808 1,288,685
=========== =========== =========== ===========
Note 3 - Comprehensive Income
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income." This
statement establishes standards for reporting comprehensive income and its
components in the financial statements. The objective of the statement is to
report a measure of all changes in equity of an enterprise that results from
transactions and other economic events of the period other than transactions
with owners. Items included in comprehensive income include revenues, gains, and
losses that under generally accepted accounting principles are directly charged
to equity. Examples include foreign currency translations, pension liability
adjustments and unrealized gains and losses on investment securities available
for sale. The Company has included its comprehensive income in a separate
financial statement as part of its consolidated financial statements.
Note 4 - Management Recognition Plan
In January 1999, the Company's board of directors approved a Management
Recognition Plan (MRP), and in May 1999, the Company's shareholders ratified the
plan. The plan authorizes the board of directors to award up to 58,190 shares of
restricted common stock to members of the board of directors and senior
management.
The Company's board of directors awarded 54,517 shares of restricted common
stock to certain members of the board of directors and senior management. The
shares were awarded 25% per year. The Company and its subsidiary shared the cost
of the Plan and accrued the estimated cost of repurchasing shares to be reissued
as restricted stock over the period that such awards are earned.
-10-
Activity in the MRP plan is as follows:
Nine Month
Period Ended September 30,
---------------------------
2004 2003
------------ -----------
Accrued Liability Balance at Beginning of Period $ 0 $ 5,538
Amount Charged to Expense 0 5,698
Less Cost of Shares Issued 0 (11,236)
------------ -----------
Accrued Liability at End of Period $ 0 $ 0
============ ===========
The Company paid out the remaining distribution of the MRP in the third quarter
of 2003 and cancelled the remaining 3,673 shares of its common stock in trust
and closed out the contra-equity account.
Note 5 - Stock Option Plan
In January 1999, the Company's board of directors approved the Company's 1999
stock option plan, and in May 1999, the Company's shareholders ratified the
plan. The plan reserved 209,299 shares of the Company's common stock for
issuance pursuant to the options to be granted. These shares will be either
newly issued shares or shares purchased on the open market.
The Company's board of directors has approved the issuance of stock options
under the Plan to certain members of the board of directors and senior
management. The options vest at a rate of 25% per year, expire in ten years, and
provide for the purchase of stock at an exercise price equal to the fair value
of the Company's stock on the date the option is granted. Holders of the options
can also surrender the options and be paid cash for the difference between the
exercise price and the stock's fair value on the date surrendered. The board of
directors granted 202,676 options in 1999 and 6,623 options in 2001. During the
nine month period ended September 30, 2004, 31,069 options were surrendered at a
total cost of $312,682 (62,264 shares for $337,396 in 2003). Stock options
awarded and outstanding totaled 46,988 and 112,057 as of September 30, 2004 and
2003, respectively.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
Period Ended
---------------------------------
September 30,
---------------------------------
2004 2003
--------------- --------------
Dividend Yield 3.5% 3.5%
Expected Life 8.5 years 8.5 years
Expected Volatility 52.0% 52.0%
Risk-Free Interest Rate 4.8% 4.8%
-11-
A summary of the status of the Company's stock option plan is presented below:
Nine Months Ended September 30,
--------------------------------------------------------------------------
2004 2003
----------------------------------------- -----------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------------------------ -------------- ----------- --------------
Outstanding at Beginning of Period 102,057 $ 8.59 175,321 $ 8.59
Granted 0 0
Exercised (24,000) (1,000)
Surrendered (31,069) 8.60 (62,264) 8.60
Forfeited 0 0
------------------------ -----------
Outstanding at End of Period 46,988 $ 8.59 112,057 $ 8.59
======================== ===========
Options Exercisable at Period-End 45,332 $ 8.59 108,746 $ 8.59
Weighted-Average Fair Value of
Options Granted during the period n/a n/a
Information pertaining to options outstanding at September 30, 2004 is as
follows:
Options Outstanding Options Exercisable
------------------------------------------------ -------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- -------------------- -------------- -------------- ------------ --------------- ------------
$8.00 - $9.00 46,988 4.8 years $ 8.59 45,332 $ 8.59
The Company has purchased 49,010 and 100,249 shares as of September 30, 2004 and
December 31, 2003, respectively, of its common stock, which is being held in
trusts for when the stock options are exercised. A contra-equity account has
been established to reflect the costs of such shares held in trusts.
The Company applies APB Opinion 25 and related Interpretations in accounting for
its stock option plan. Accordingly, no compensation cost has been recognized.
Note 6 - Improvement Plan for Main Office Facility
The company has begun construction on a new main office facility of 15,000
square feet, with an estimated completion date of July 2005.
Note 7 - Recent Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities. This statement amends Statement 133 for
decisions made as part of the Derivatives Implementation Group process and other
board projects and in conjunction with other implementation issues. Since the
Company does not invest in derivatives or engage in hedging activities,
management does not expect this statement to have any impact on the Company's
consolidated financial position or results of operations.
-12-
In May 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. Since
the Company has not yet issued any instruments of the type discussed in the
statement, management does not expect this statement to have a significant
impact on the Company's consolidated financial position or results of
operations.
Item 2. Management's Discussion and Analysis or Plan of Operation
This report contains "forward-looking statements" relating to, without
limitation, future economic performance, plans and objective of management for
future operations, and projections of revenues and other financial items that
are based on the beliefs of management, as well as assumptions made by and
information currently available to management. The words "expect," "anticipate,"
and "believe," as well as similar expressions, are intended to identify
forward-looking statements. Our actual results may differ materially from the
results discussed in the forward-looking statements.
General
The principal business of United Tennessee Bankshares, Inc. and our wholly owned
subsidiary Newport Federal Bank ("we," "us," etc.) consists of accepting
deposits from the general public through our main office and two branch offices
and investing those funds in loans secured by one- to four-family residential
properties located in our primary market area. We also maintain a portfolio of
investment securities and originate a limited amount of commercial real estate
loans and consumer loans. Our investment securities portfolio consists of U.S.
Treasury notes and U.S. government agency securities, local municipal bonds and
mortgage-backed securities that are guaranteed as to principal and interest by
the Federal Home Loan Mortgage Corporation (FHLMC), Government National Mortgage
Association (GNMA) or Federal National Mortgage Association (FNMA). We also
maintain an investment in Federal Home Loan Bank of Cincinnati common stock and
FHLMC common stock.
Our net income primarily depends on our net interest income, which is the
difference between interest income earned on loans and investment securities and
interest paid on customers' deposits and other borrowings. Our net income is
also affected by noninterest income, such as service charges on customers'
deposit accounts, loan service charges and other fees, and noninterest expense,
primarily consisting of compensation expense, deposit insurance and other
expenses incidental to our operations.
Our operations and those of the thrift industry as a whole are significantly
affected by prevailing economic conditions, competition and the monetary and
fiscal policies of governmental agencies. Our lending activities are influenced
by demand for and supply of housing and competition among lenders and the level
of interest rates in our market area. Our deposit flows and costs of funds are
influenced by prevailing market rates of interest, primarily on competing
instruments, account maturities and the levels of personal income and savings in
our market area.
The following is a discussion of our financial condition as of September 30,
2004 and for the three-month and nine-month periods ended September 30, 2004
These comments should be read in conjunction with our consolidated financial
statements and accompanying footnotes appearing in this report.
-13-
Comparison of Financial Condition at September 30, 2004 and December 31, 2003
Total assets increased from December 31, 2003 to September 30, 2004 by $5.8
million, or 4.9%, from $117.0 million at December 31, 2003 to $122.8 million at
September 30, 2004. The increase in assets was principally the result of an
increase in investment securities. Investment securities increased by $7.6
million offset by a decrease in cash and amounts due from depository
institutions of $2.6 million.
Loans receivable increased from December 31, 2003 to September 30, 2004 as
originations exceeded repayments for the period by approximately $573,000. The
following table sets forth information about the composition of our loan
portfolio by type of loan at the dates indicated. At September 30, 2004 and
December 31, 2003, we had no concentrations of loans exceeding 10% of gross
loans other than as disclosed below.
September 30, 2004 December 31, 2003
------------------------ -----------------------
Amount Percent Amount Percent
Type of Loan:
- -------------
Real estate loans:
One- to four-family residential $ 63,443 77.9% $ 63,335 79.2%
Commercial 9,263 11.4% 9,261 11.6%
Construction 3,808 4.7% 1,769 2.2%
Consumer loans:
Automobile 1,443 1.8% 1,488 1.9%
Loans to depositors, secured by deposits 1,275 1.6% 1,293 1.6%
Home equity and second mortgage 637 0.8% 1,341 1.7%
Other 1,538 1.9% 1,504 1.9%
----------------------- -----------------------
81,407 100.0% 79,991 100.0%
---------------======== ----------------=======
Less:
Loans in process 1,571 764
Deferred fees and discounts 352 352
Allowance for loan losses 958 922
---------------- ---------------
Total $ 78,526 $ 77,953
================ ===============
We actively monitor our asset quality and charge off loans and properties
acquired in settlement of loans against the allowances for losses on such loans
and such properties when appropriate and provide specific loss allowances when
necessary. Although we believe we use the best information available to make
determinations with respect to the allowances for losses, future adjustments may
be necessary if economic conditions differ substantially from the economic
conditions in the assumptions used in making the initial determinations.
-14-
The following table sets forth information about our allowance for loan losses
for the period indicated.
Nine Nine
Months Ended Months Ended
September 30, September 30,
2004 2003
------------------- --------------------
(In Thousands)
Balance at beginning of period $ 921 $ 803
------------------- --------------------
Charge-offs:
Consumer (19) (20)
Mortgage (22) 0
Recoveries:
Consumer 2 1
Mortgage 0 0
------------------- --------------------
Net Charge-offs (39) (19)
Provision for loan losses 76 108
------------------- --------------------
Balance at end of period $ 958 $ 892
=================== ====================
The following table sets forth information about our nonperforming assets at the
dates indicated.
September 30, September 30,
2004 2003
------------------- --------------------
(In Thousands)
Nonaccrual Loans $ - $ -
Accruing loans which are contractually past due
90 days or more:
Real Estate:
Residential 64 283
Non-Residential 4 66
Consumer 15 11
------------------- --------------------
Total $ 83 $ 360
=================== ====================
We conduct regular reviews of our assets and evaluate the need to establish
allowances on the basis of this review. Allowances are established on a regular
basis based on an assessment of risk in our assets taking into consideration the
composition and quality of the portfolio, delinquency trends, current charge-off
and loss experience, the state of the real estate market, regulatory reviews
conducted in the regulatory examination process, general economic conditions and
other factors deemed relevant by us. Allowances are provided for individual
assets, or portions of assets, when ultimate collection is considered improbable
based on the current payment status of the assets and the fair value or net
realizable value of the collateral.
During the nine months ended September 30, 2004, the Company increased its
liabilities by $4.8 million, or 4.8%. Total deposits increased $4.5 million or
4.6% from $98.1 million at December 31, 2003 to $102.6 million at September 30,
2004.
During 2004, the Bank has accepted deposits totaling approximately $8.3 million
from various governmental and institutional customers, some of which are outside
of its traditional market area. The average term of these deposits is
approximately six months. Management is unable to determine
-15-
whether the Bank will retain these deposits upon maturity. In the event the Bank
is not able to retain these deposits, management has various sources of
liquidity available including cash and amounts due from depository institutions
and investment securities, which are available for sale. In addition, the Bank
has borrowing authority from the Federal Home Loan Bank of approximately $4.0
million.
Our shareholders' equity increased $1.0 million from $16.9 million at December
31, 2003 to $17.9 million at September 30, 2004. The Company's equity increased
primarily due to net income of $1.3 million and proceeds from stock options
exercised of $206,000, and a decrease in unearned compensation related to the
Company's ESOP of $171,000 and an increase in other accumulated comprehensive
income of $50,000, offset by dividends paid of $442,000, decreases due to stock
options surrendered at a cost of $313,000 and the purchase and retirement of
$69,000 of the Company's common stock. The Company's board of directors
announced a plan to extend the current stock repurchase plan an additional two
years and purchase an additional $500,000, up to a total of $606,000 of its
stock in the open market, depending upon the stock price.
Discussion of Results of Operations for the Three Months Ended September 30,
2004 and 2003
Our net income for the three months ended September 30, 2004 was $447,000, which
was an increase of $10,000 from the amount we earned during the three months
ended September 30, 2003. Basic and diluted earnings per share for the three
months ended September 30, 2004 were each $0.37 compared to $0.34 for the same
period in 2003. Basic average shares outstanding for three months ended
September 30, 2004 was 1,201,502 shares and 1,269,420 shares for the three
months ended September 30, 2003. Average dilutive potential shares outstanding
were 0 and 1,390 respectively.
Interest income increased $21,000, or 1.2%, from $1.71 million for the three
months ended September 30, 2003 to $1.73 million for the three months ended
September 30, 2004. The increase in interest income is a result of an increase
in investment securities interest of $99,000 offset by a decrease in interest
income on loans of $76,000.
Interest expense on deposits decreased $8,000 from $438,000 for the three months
ended September 30, 2003 to $430,000 for the three months ended September 30,
2004, primarily due to the decrease in deposit account interest rates.
Net interest income increased $28,000, or 2.2%, between the periods as a result
of the larger decrease in interest expense than the decrease in interest income.
The Company's net interest margin narrowed to 4.47% for the three months ended
September 30, 2004 compared to 4.68% for the comparable period of 2003. The
narrowing of the net interest margin reflects the current rate environment and
the fact that our yield on loans and investments has reduced.
Noninterest income increased $23,000 from $134,000 for the three months ended
September 30, 2003 to $157,000 for the three months ended September 30, 2004.
The increase in noninterest income was due to a $26,000 gain on the sale of an
investment security.
Noninterest expenses increased $72,000 from $657,000 for the three months ended
September 30, 2003 to $729,000 for the three months ended September 30, 2004.
The increase in noninterest expense was primarily from an increase compensation
and benefits of $91,000, offset by a reduction in other noninterest expenses of
$12,000. The increase compensation and benefits resulted from the mark to market
adjustment on the Directors Incentive Plan of $40,000 and a $23,000 increase to
the directors deferred compensation liability. The directors have an option of
deferring their fees and earning a market
-16-
return on the balance. The return on both plans is based on the percentage
increase or decrease in the market value of United Tennessee Bankshares stock
for the period.
Our effective tax rates for the three months ended September 30, 2004 and 2003
were 36.7% and 38.9%, respectively. The decrease in our effective tax rate for
the period in 2004 was due to the surrender of stock options, which provide a
tax benefit to the Company.
Discussion of Results of Operations for the Nine Months Ended September 30, 2004
and 2003
Our net income for the nine months ended September 30, 2004 was $1,338,000,
which was an increase of $53,000 from the amount we earned during the nine
months ended September 30, 2003. Basic and diluted earnings per share for the
nine months ended September 30, 2004 were $1.10 and $1.09, respectively,
compared to $1.00 for each the same period in 2003. Basic average shares
outstanding for the nine months ended September 30, 2004 was 1,219,150 shares
and 1,281,777 shares for the nine months ended September 30, 2003. Average
dilutive potential shares outstanding were 8,096 and 6,908 respectively.
Interest income decreased $75,000, or 1.4%, from $5.18 million for the nine
months ended September 30, 2003 to $5.11 million for the nine months ended
September 30, 2004. The decrease in interest income is a result of a decrease in
the yields on our loan and investment portfolios.
Interest expense on deposits decreased $153,000 from $1.35 million for the nine
months ended September 30, 2003 to $1.20 million for the nine months ended
September 30, 2004, primarily due to the decrease in deposit account interest
rates.
Net interest income increased $77,000, or 2.0%, between the periods as a result
of the larger decrease in interest expense than the decrease in interest income.
The Company's net interest margin narrowed to 4.61% for the nine months ended
September 30, 2004 compared to 4.69% for the comparable period of 2003. The
narrowing of the net interest margin reflects the current rate environment and
the fact that our yield on loans and investments has reduced.
Noninterest income increased $49,000 from $371,000 for the nine months ended
September 30, 2003 to $420,000 for the nine months ended September 30, 2004. The
increase in noninterest income was due to $51,000 in income from bank owned life
insurance.
Noninterest expenses increased $271,000 from $2.0 million for the nine months
ended September 30, 2003 to $2.3 million for the nine months ended September 30,
2004. The increase in noninterest expense was primarily from an increase in
compensation and benefits of $278,000. The increase compensation and benefits
resulted primarily from the mark to market adjustment on the Directors Incentive
Plan of $127,000 and a $69,000 increase to the directors deferred compensation
liability. The directors have an option of deferring their fees and earning a
market return on the balance. The return on both plans is based on the
percentage increase or decrease in the market value of United Tennessee
Bankshares stock for the period.
Our effective tax rates for the nine months ended September 30, 2004 and 2003
were 32.7% and 38.9%, respectively. The decrease in our effective tax rate for
the period in 2004 was due to the surrender of stock options, which provide a
tax benefit to the Company.
Liquidity and Capital Resources
The Company does not currently have any business activities other than the
operation of the Bank and does not have significant on-going funding commitments
other than the payment of dividends to
-17-
shareholders. To date, the Company has used the proceeds from its initial public
offering and dividends from the Bank to meet its liquidity needs. The Bank is
subject to various regulatory limitations on the payment of dividends to the
Company.
Our most liquid assets are cash and amounts due from depository institutions,
which are short-term highly liquid investments with original maturities of less
than three months that are readily convertible to known amounts of cash. The
levels of these assets are dependent on our operating, financing and investing
activities during any given period. Our primary sources of funds are deposits,
proceeds from principal and interest payments on loans and investment securities
and earnings. While scheduled principal repayments on loans and investment
securities are a relatively predictable source of funds, deposit flows and loan
and investment securities prepayments are greatly influenced by general interest
rates, economic conditions, competition and other factors. We do not solicit
deposits outside of our market area through brokers or other financial
institutions; however, we do accept deposits from various governmental and
institutional investors outside our traditional market area from time to time.
We have also designated all of our investment securities as available for sale
in order to meet liquidity demands. In addition to internal sources of funding,
as a member of the Federal Home Loan Bank we have substantial borrowing
authority with the Federal Home Loan Bank. Our use of a particular source of
funds is based on need, comparative total costs and availability.
We have historically maintained substantial levels of capital. The assessment of
capital adequacy depends on several factors, including asset quality, earnings
trends, liquidity and economic conditions. We seek to maintain high levels of
regulatory capital to give us maximum flexibility in the changing regulatory
environment and to respond to changes in market and economic conditions. These
levels of capital have been achieved through consistent earnings enhanced by low
levels of noninterest expense and have been maintained at those high levels as a
result of our policy of moderate growth generally confined to our market area.
At September 30, 2004 and December 31, 2003, we exceeded all current regulatory
capital requirements and met the definition of a "well-capitalized" institution,
the highest regulatory capital category.
Interest Rate Sensitivity
The Bank's profitability is dependent to a large extent upon net interest
income, which is the difference between its interest income on interest-earning
assets and interest expense on interest-bearing liabilities. In recent years,
the banking industry has experienced steady interest rates, which have likewise
produced steady growth in net interest income as the bank has grown. The Bank
will be affected by changes in levels of interest rates and other economic
factors beyond its control, particularly to the extent that such factors affect
the overall volume of its lending and deposit activities. A sudden increase in
interest rates could have a negative impact on the bank's net income through a
narrower interest margin and/or reduced lending volume.
The bank's Asset/Liability Committee ("ALCO" committee) follows the
Asset/Liability Management Policy approved by the board of directors. The ALCO
committee meets at least quarterly or more often as considered necessary to
discuss asset/liability management issues and make recommendations to the board
of directors regarding prudent asset/liability management policies and
procedures. Some of the issues the ALCO committee considers include: local and
national economic forecasts; interest rate forecasts and spreads; mismatches
between the maturities of the banks assets (loans, and investments) and
liabilities (deposits); anticipated loan demands; and the liquidity position of
the bank.
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. The interest rate sensitivity
gap is defined as the difference between the amount of interest-earning assets
maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within that time period. A
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities. A gap is considered
negative when
-18-
the amount of interest rate sensitive liabilities exceeds the amount of interest
rate sensitive assets. During a period of rising interest rates, a negative gap
would tend to adversely affect net interest income while a positive gap would
tend to result in an increase in net interest income. During a period of falling
interest rates, a negative gap would tend to result in an increase in net
interest income while a positive gap would tend to adversely affect net interest
income.
Item 3. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. The Company's chief
executive officer and chief financial officer have evaluated the effectiveness
of the design and operation of the Company's disclosure controls and procedures
(as defined in Exchange Act Rule13a-14(c)) as of September 30, 2004. Based on
that evaluation, the chief executive officer and chief financial officer have
concluded that the Company's disclosure controls and procedures are effective to
ensure that material information relating to the Company and the Company's
consolidated subsidiaries is made known to such officers by others within these
entities, particularly during the period this quarterly report was prepared, in
order to allow timely decisions regarding required disclosure.
(b) Changes in Internal Controls. There have not been any significant changes in
the Company's internal controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation.
-19-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
The following exhibits are filed as a part of this report:
3.1/1 Charter of United Tennessee Bankshares, Inc.
3.2/1 Bylaws of United Tennessee Bankshares, Inc.
4/1 Form of Stock Certificate of United Tennessee Bankshares, Inc.
10.1/2 United Tennessee Bankshares, Inc. 1999 Stock Option Plan
10.2/2 United Tennessee Bankshares, Inc. Management Recognition Plan
10.3(a)/1 Employment Agreements between Newport Federal Savings and Loan
Association and Richard G. Harwood, Nancy L. Bryant and Peggy
Holston
10.3(b)/1 Forms of Guarantee Agreements between United Tennessee
Bankshares, Inc. and Richard G. Harwood, Nancy L. Bryant and
Peggy Holston
10.4/1 Newport Federal Savings and Loan Association Long-Term
Incentive Plan
10.5/1 Newport Federal Savings and Loan Association Deferred
Compensation Plan
31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Richard G.
Harwood, President and Chief Executive Officer of United Tennessee
Bankshares, Inc.
31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Chris H.
Triplett, Controller.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Richard G.
Harwood, President and Chief Executive Officer of United Tennessee
Bankshares, Inc.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Chris H.
Triplett, Controller.
- ---------------
1/ Incorporated by reference to United Tennessee Bankshares, Inc.'s
Registration Statement on Form SB-2, File No. 333-36465.
2/ Incorporated by reference to United Tennessee Bankshares, Inc.'s
Registration Statement on Form S-8, File No. 333-82803.
(b) Reports on Form 8-K:
United Tennessee Bankshares, Inc. did not file a current report on Form
8-K during the quarter covered by this report.
-20-
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
UNITED TENNESSEE BANKSHARES, INC.
Registrant
Date: November 12, 2004 /S/ Richard G. Harwood
----------------------------------------------------
Richard G. Harwood
President and Chief Executive Officer
(Duly Authorized Representative and
Principal Financial and Accounting Officer)