10KSB 1 vbi10ksb02.txt ANNUAL REPORT ON FORM 10-KSB FORM 10-KSB SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 000-22473 VOLUNTEER BANCORP, INC. (Name of small business issuer in its charter) TENNESSEE 62-1271025 (State or other jurisdiction of (I.R.S. Employer Identification No.) corporation or organization) 210 East Main Street Rogersville, Tennessee 37857 (Address of principal executive offices and Zip Code) Issuer's telephone number (423) 272-2200 Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock Check whether the issuer (1) 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 90 days. Yes X No --- --- Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will 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 ] The registrant's revenues for the twelve months ended December 31, 2002 were $7,658,504. The aggregate market value of the shares of Common Stock held by nonaffiliates of the registrant as of March 17, 2003 is approximately $4.9 million. (For purposes of this calculation only, all executive officers and directors are classified as affiliates.) Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Outstanding at March 17, 2003, Common Stock, $.01 par value, 539,027. Documents Incorporated by Reference: None - 1 - PART I ITEM 1. DESCRIPTION OF BUSINESS THE COMPANY Volunteer Bancorp, Inc. is a registered bank holding company organized under the laws of Tennessee, chartered in 1985. Volunteer, with consolidated total assets of approximately $111 million at December 31, 2002, is headquartered in Rogersville, Tennessee with offices in Church Hill and Sneedville, Tennessee, and we conduct operations through our subsidiary, The Citizens Bank of East Tennessee (the "Bank"), a state bank organized under the laws of the state of Tennessee in April 1906. We do not engage in any activities other than acting as a bank holding company for the Bank. We believe we can present an alternative to recent mega-mergers by offering local ownership, local decision making and other personalized service characteristics of community banks. The holding company structure provides flexibility for expansion of our banking business through acquisition of other financial institutions and provision of additional banking-related services which the traditional commercial bank may not provide under present laws. The Bank provides a full range of retail banking services, including (i) the acceptance of demand, savings and time deposits; (ii) the making of loans to consumers, businesses and other institutions; (iii) the investment of excess funds in the sale of federal funds, U.S. government and agency obligations, and state, county and municipal bonds; and (iv) other miscellaneous financial services usually handled for customers by commercial banks. MARKET AREA AND COMPETITION We compete with other commercial banks, savings and loan associations, credit unions and finance companies operating in Hancock and Hawkins counties and elsewhere. One other commercial bank is doing business in Hancock County, and in Hawkins County there are five commercial banks and savings and loan associations. The Bank is subject to substantial competition in all aspects of its business. Intense competition for loans and deposits comes from other financial institutions in the market area. In certain aspects of its business, the Bank also competes with credit unions, small loan companies, insurance companies, mortgage companies, finance companies, brokerage houses and other financial institutions, some of which are not subject to the same degree of regulation and restriction as the Bank and some of which have financial resources greater than those of the Bank. The future success of the Bank will depend primarily upon the difference between the cost of its borrowing (primarily interest paid on deposits) and income from operations (primarily interest or fees earned on loans, sales of loans and investments). The Bank competes for funds with other institutions, which, in most cases, are significantly larger and are able to provide a greater variety of services than the Bank and thus may obtain deposits at lower rates of interest. - 2 - NET INTEREST INCOME The following table sets forth weighted average yields earned by Volunteer on our earning assets and the weighted average rates paid on our average deposits and other interest-bearing liabilities for the years indicated, and certain other information:
2002 2001 (Fully taxable equivalent) Interest Average Interest Average (Dollars in thousands except Average Income/ Yields/ Average Income/ Yields/ for per share data) Balance Expense Rate Balance Expense Rate ------- ------- ---- ------- ------- ---- Assets: Interest-earning assets: Loans net of unearned income $69,672 $5,711 8.20% $ 74,989 $7,137 9.52% U.S. Treasury and other U.S. government agencies 23,468 1,117 4.76% 24,585 1,468 5.97% States and municipalities 5,541 367 6.62% 2,889 190 6.58% FHLB stock 361 16 4.43% 341 23 6.74% Federal funds sold 4,924 74 1.50% 6,056 234 3.86% ----- -- ----- --- Total interest-earning assets/interest income 103,966 7,285 7.01% 108,860 9,052 8.32% ------- ----- ------- ----- Cash and due from banks 2,936 2,953 Other assets 6,250 6,626 Allowance for loan losses (995) (971) ----- ----- Total $112,157 $117,468 ======== ======== Liabilities and stockholders' equity: Interest-bearing liabilities: Demand deposits $ 19,303 239 1.24% $ 21,541 $ 644 2.99% Savings 7,096 106 1.49% 5,477 135 2.46% Individual retirement accounts 8,768 284 3.24% 8,829 471 5.33% Time certificates 53,857 1,694 3.15% 59,843 3,331 5.57% FHLB advances 0 0 0.00% 162 7 4.32% Securities sold under repurchase 1,749 50 2.86% 992 53 5.34% Note payable 1,841 71 3.86% 2,186 139 6.36% ----- ----- ----- ------ Total interest-bearing liabilities/interest expense 92,614 2,444 2.64% 99,030 4,780 4.83% ------ ----- ------ ----- Non-interest bearing demand deposits 12,276 11,328 Other liabilities 677 1,510 Stockholders' equity 6,590 5,600 ------ ------ Total $112,157 $117,468 ======== ======== Net interest earnings $4,841 $4,272 ------ ------ Net interest on interest earning assets 4.66% 3.92% ----- ----- Return on average assets 0.34% 0.53% Return on average equity 5.87% 11.19% Cash dividends declared $ 53,903 $ 75,464 Dividend payout ratio 13.94% 12.04% Net income $386,577 $626,659
- 3 - The following table presents a summary of changes in interest income, interest expense, and the interest rate differential aggregated by the changes in volumes and rates:
December 31, December 31, 2002 2001 versus versus December 31, December 31, 2001 2000 Increases (decreases) Increases (decreases) (Dollars in Thousands) Change Due To: (1) Change Due To: (1) Volume Rate Total Volume Rate Total Increase (decrease) in: Loans net of unearned income $ (460) $ (966) $ (1,426) $ 297 $ (316) $ (19) U.S. Treasury and other U.S. Government agencies (56) (295) (351) 146 (105) 41 States and municipalities 175 2 177 (99) 3 (96) FHLB stock 1 (8) (7) 2 (2) 0 Federal funds sold (23) (137) (160) 183 (124) 59 Total interest income $ (363) $ (1,404) $ (1,767) $ 529 $ (544) $ (15) Increase (decrease) in: Demand deposits $ (34) $ (371) $ (405) $ 50 $ (258) $(208) Savings 31 (60) (29) 21 (28) (7) Individual retirement accounts (2) (185) (187) 1 (34) (33) Time certificates (215) (1,422) (1,637) 243 (167) 76 FHLB advances 34 (37) (3) 1 (3) (2) Securities sold under repurchase (16) (52) (68) (12) (3) (15) Note payable (19) (9) (28) (23) (50) (73) Total interest expense $ (221) $ (2,136) $ (2,357) $ 281 $ (543) $(262) Increase (decrease) in net interest income $ (142) $ 732 $ 590 $ 248 $ (1) $ 247
(1) Increases (decreases) are attributable to volume changes and rate changes on the following basis: Volume Change equals change in volume times prior year rate. Rate Change equals change in rate times prior year volume. The Rate/Volume Change equals the change in volume times the change in rate, and it is allocated between Volume Change and Rate Change at the ratio that the absolute value of each of these components bears to the absolute value of their total. For purposes of this schedule, non-accruing loans are included in the average balances and tax exempt income is reflected on a tax equivalent basis. As tax exempt income is exempt only for Federal income tax purposes and not Tennessee purposes, tax equivalent income is based upon an effective 34% tax rate. Loan fees included in interest income are not material to the presentation. LIABILITY AND ASSET MANAGEMENT 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 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. The asset/liability committee, which consists of Reed D. Matney, Jim Friddell and other officers, is charged with monitoring the liquidity and funds position of Volunteer. The Committee regularly reviews (a) the rate - 4 - sensitivity position on a three-month, six-month, and one-year time horizon; (b) loans to deposit ratios; and (c) average maturity for certain categories of liabilities. We currently utilize the asset/liability modeling services of First Tennessee Financial Corporation, with which we simulate operations and subsequently develop policies regarding permitted gap positions, permitted risks in deviations from budget earnings and liquidity. We apply the system quarterly using rate fluctuations of +/-2%. At December 31, 2002, we had a negative cumulative repricing gap within one year of approximately $29.4 million, or approximately 29.03% of total earning assets. This negative repricing gap indicates that our future earnings may be materially adversely impacted by a rise in market interest rates, as occurred in early 1995, and such impact would primarily be felt in the twelve month period after such a rise in rates. The following table represents an interest sensitivity profile for Volunteer as of December 31, 2002 and 2001. The table represents a static point in time and does not consider other variables, such as changing spread relationships or interest rate levels. "Net repricing gap" is the difference between total earning assets and total interest-bearing liabilities repricing in any given period and "cumulative gap" is the sum of the net repricing gap from period to period. Interest-bearing demand, savings and money market account deposits are presented as repricing in the earliest period presented.
December 31, 2002 ---------------------------------------------------- After 3 After 12 months months Within Within 12 Within 5 After 3 months months years 5 years Total -------- --------- -------- ------- ----- (Dollars in thousands) Earning assets: Loans $19,426 $18,321 $16,443 $13,935 $68,125 Investment securities: Available for sale 576 543 8,729 16,087 25,935 Held to maturity 1,053 1,053 Equity securities 1,831 1,831 Federal funds sold 4,450 4,450 ----- ------- ------- ------- -------- Total earning assets $26,283 $18,864 $25,172 $31,075 $101,394 ======= ======= ======= ======= ======== Interest-bearing liabilities: Interest-bearing deposits $47,322 $23,161 $17,315 $87,798 Securities sold under repurchase agreements 2,289 2,289 Long-term debt 1,810 1,810 ----- ------- ------- ------- ------- Total interest-bearing liabilities $51,421 $23,161 $17,315 $0 $91,897 ======= ======= ======= ====== ======= Net repricing gap ($25,138) ($4,297) $7,857 $31,075 $9,497 --------- -------- ------ ------- ------ Rate sensitivity gap: Net repricing gap as a percentage of total earning assets (24.79)% (4.24)% 7.75% 30.65% 9.37% -------- --------- --------- ------ ------ Cumulative gap ($25,138) ($29,435) ($21,578) $9,497 --------- --------- --------- ------ Cumulative gap as a percentage of total earning assets (24.79)% (29.03)% (21.28)% 9.37% --------- --------- --------- ------
- 5 -
December 31, 2001 ------------------------------------------------------ After 3 After 12 Within months months Within 12 Within 5 After 3 months months years 5 years Total -------- ------ ----- ------- ----- (Dollars in thousands) Earning assets: Loans $22,733 $16,073 $27,656 $ 6,604 $ 73,066 Investment securities: Available for sale 2,849 523 5,705 16,535 25,612 Held to maturity 584 43 627 FHLB stock 355 355 Federal funds sold 6,275 6,275 ------ ------- ------- ------- -------- Total earning assets $32,212 $16,596 $33,945 $23,182 $105,935 ======= ======= ======= ======= ======== Interest-bearing liabilities: Interest-bearing deposits $53,637 $33,725 $ 5,213 $ 92,575 Securities sold under repurchase agreements 1,110 1,110 Long-term debt 2,170 2,170 ----- ------- ------- ------- -------- Total interest-bearing liabilities $56,917 $33,725 $ 5,213 $ 0 $ 95,855 ======= ======= ======= ======= ======== Net repricing gap ($24,705) ($17,129) $28,732 $23,182 $ 10,080 --------- --------- ------- ------- ------- Rate sensitivity gap: Net repricing gap as a percentage of total earning assets (23.32)% (16.17)% 27.12% 21.88% 9.52% --------- --------- ------- ------- ------- Cumulative gap ($24,705) ($41,834) ($13,102) $10,080 --------- --------- --------- ------- Cumulative gap as a percentage of total earning assets (23.32)% (39.49)% (12.37)% 9.52% -------- -------- -------- -------
Management has made the following assumptions in the above analysis: (a) Assets and liabilities are generally assigned to a period based upon their earliest repricing period when the repricing is less than the contractual maturity. (b) Nonaccrual loans are included in the loan category. (c) Investment securities available for sale are currently treated in the same manner as comparable securities in the investment securities held to maturity portfolio in that they are scheduled according to the earlier of their contractual maturities or earliest repricing dates; however, the maturities of callable agency securities are scheduled according to their call dates when valued at a premium to par. (d) Money market deposits and savings deposits that have no contractual maturities are scheduled in the within 3 months category. - 6 - DEPOSITS Our primary source of funds is interest-bearing deposits. The following table sets forth our deposit structure at December 31, 2002 and 2001.
December 31 ----------------------- 2002 2001 ---- ---- Non interest-bearing deposits: Individuals, partnerships and corporations $11,036 $ 10,604 U.S. Government and states and political subdivisions 716 106 Commercial banks and other depository institutions 63 133 Certified and official checks 345 492 ------- -------- Total non-interest bearing deposits 12,160 11,335 ------- -------- Interest-bearing deposits: Interest-bearing demand accounts 20,791 18,455 Savings accounts 7,062 6,112 Individual retirement accounts 2,405 2,204 Certificates of deposit, less than $100,000 40,421 45,548 Certificates of deposit, greater than $100,000 17,119 20,256 ------- -------- Total interest-bearing deposits 87,798 92,575 ------- -------- Total deposits $99,958 $103,910 ======= ========
The following table presents a breakdown by category of the average amounts of deposits and the weighted average rate paid on deposits for the periods indicated:
December 31, -------------------------------------------------------- 2002 2001 ------------------------ ------------------------ Non-interest bearing deposits $ 12,276 $ 11,328 Savings deposits 7,096 1.49% 5,477 2.46% Individual retirement accounts 8,768 3.24% 8,829 5.33% Time deposits 53,857 3.15% 59,843 5.57% Interest bearing demand deposits 19,303 1.24% 21,541 2.99% -------- -------- Total deposits $101,300 $107,018 ======== ========
At December 31, 2002 and 2001, time deposits greater than $100,000 aggregated approximately $17 million and $20 million, respectively. The following table indicates, as of December 31, 2002 and 2001, the dollar amount of $100,000 or more deposits by time remaining until maturity:
December 31, 2002 December 31, 2001 --------------------------------- --------------------------------------- 1 year 1 year 3 Months 3 to 12 through 3 Months 3 to 12 through or less Months 5 years Total or less Months 5 years Total ------- ------ ------- ----- ------- ------ ------- ------ (In thousands) Time certificates $2,948 6,785 7,386 $17,119 $5,927 12,905 1,424 $20,256
- 7 - ASSETS Our management considers many criteria in managing assets, including creditworthiness, diversification and structural characteristics, maturity and interest rate sensitivity. The following table sets forth our interest earning assets by category at December 31, 2002 and 2001. December 31, 2002 2001 ---- ---- (In thousands) Investment securities: Available for sale U.S. Government and agencies $ 19,392 $ 21,948 Obligations of states and political subdivisions 6,543 3,664 FHLB stock 371 355 FNMA preferred stock 1,460 -------- -------- Total available for sale 27,766 25,967 Held to maturity 1,053 627 Federal funds sold 4,450 6,275 Loans: Real estate 50,702 46,552 Commercial and other 17,423 26,514 -------- -------- Total loans 68,125 73,066 Interest earning assets $101,394 $105,935 ======== ======== INVESTMENT PORTFOLIO At year end 2002, obligations of the United States Government or its agencies and obligations of states and political subdivisions represented 100.00% of the investment portfolio. The following table sets forth the composition of the carrying value of our investment portfolio at December 31, 2002 and 2001: December 31, ------------------------- 2002 2001 ---- ---- (In thousands) Held to maturity: Obligations of U.S. Government agencies $ 1,053 $ 627 ------- ------- Available for sale: U.S. Treasury securities $ 515 $ 523 Obligations of U.S. Government agencies 18,877 21,425 Obligations of states and political subdivisions 6,543 3,664 FNMA preferred stock 1,460 0 FHLB stock 371 355 ------- ------- $27,766 $25,967 ======= ======= - 8 - The following table presents the maturity distribution of the amortized cost and estimated market value of the Volunteer's debt securities at December 31, 2002 and 2001. The weighted average yields on these instruments are presented based on final maturity. Yields on states and political subdivisions have not been adjusted to a fully-taxable equivalent basis.
December 31, 2002 December 31, 2001 ------------------------------- --------------------------------- Estimated Weighted Estimated Weighted Amortized Market Average Amortized Market Average Cost Value Yield Cost Value Yield ---- ------ ----- ---- ----- ----- (Dollars in thousands) Held to maturity: Obligations of U.S. Government agencies: Due after 1 year but within 5 years $ 585 $ 583 Due after 5 years but within 10 years $ 6 $ 7 8 9 Due after 10 years 1,047 1,047 34 35 ------- ----- -- -- Total $ 1,053 $ 1,054 4.82% $ 627 $ 627 3.28% ------- ------ ------- ------- Available for sale: --------- --- ----- U.S. Securities: Due within 1 year 501 515 Due after 1 year but within 5 years 502 523 ---- ---- Total 501 515 5.44% 502 523 5.47% --- --- --- --- Obligations of U.S. Government agencies: Due within 1 year 38 38 36 36 Due after 1 year but within 5 years 6,113 6,213 4,605 4,556 Due after 5 years but within 10 years 6,775 6,912 88,958 8,952 Due after 10 years 5,545 5,714 7,895 7,881 ----- ----- ----- ----- Total 18,471 18,877 4.68% 21,431 21,425 5.21% ------ ------ ------ ------ Obligations of states and political subdivisions Due after 1 year but within 5 years 495 515 1,231 1,250 Due after 5 years but within 10 years 2,365 2,414 1,585 1,563 Due after 10 years 3,516 3,614 887 851 ----- ----- --- --- Total 6,376 6,543 5.92% 3,703 3,664 4.30% ----- ----- ----- ----- Total $25,348 $25,935 4.87% $25,636 $25,612 5.04% ======= ======= ===== ======= ======= Equity securities with No stated maturity: FHLB stock $ 371 $ 371 $ 355 $ 355 FNMA stock 1,475 1,460 0 0 ------- ------- ------- ------- $ 1,846 $ 1,831 4.55% $ 355 $ 355 6.74% ======= ======= ======= =======
- 9 - INVESTMENT POLICY The objective of our investment policy is to invest funds not otherwise needed to meet the loan demand of its market area to earn the maximum return, yet still maintain sufficient liquidity to meet fluctuations in our loan demand and deposit structure. In doing so, we balance the market and credit risks against the potential investment return, make investments compatible with the pledge requirements of our deposits of public funds, maintain compliance with regulatory investment requirements, and assist the various public entities with their financing needs. Reed D. Matney is authorized to execute security transactions for the investment portfolio based on the decisions of the investment committee. The investment committee, which consists of the President and Chief Executive Officer, the Executive Vice President and the Senior Vice President, has full authority over the investment portfolio and makes decisions on purchases and sales of securities. All the investment transactions occurring since the previous board of directors' meeting are reviewed by the board at its next monthly meeting, and the entire portfolio is reviewed on a semi-annual basis. The investment policy allows portfolio holdings to include short-term securities purchased to provide Volunteer needed liquidity and longer term securities purchased to generate level income for us over periods of interest rate fluctuations. Our investment securities portfolio of $28,818,746 at December 31, 2002, consisted of $1,052,991 of securities held to maturity, which are carried at amortized cost and $27,765,755 of securities available for sale which are carried at market value. In addition, unrealized gains on investment securities available for sale were $596,270 and unrealized losses were $19,431. Our investment securities portfolio of $26,593,781 at December 31, 2001, consisted of $626,859 of securities held to maturity, which are carried at amortized cost and $25,966,922 of securities available for sale which are carried at market value. In addition, unrealized gains on investment securities available for sale were $142,971 and unrealized losses were $166,745. As reflected in Note 2 to Consolidated Financial Statements, the investment securities held to maturity had unrealized gains of $1,430 at December 31, 2002, compared to $1,597 unrealized gains and $1,867 unrealized losses at year end December 31, 2001. LOAN PORTFOLIO Total loans of $68,125,000 at December 31, 2002, reflected a decrease of $4,941,000 compared to total loans for the year ended December 31, 2001. Residential real estate loans, which historically have had low loss experience, increased $2,371,000 or 8.14%. Construction and land development loans, loans secured by farmland and commercial real estate loans increased by $1,779,000 or 6.0%. Commercial and industrial loans and agricultural loans decreased by $3,924,000 or 34.95%. These types of loans carry a higher level of risk in that the borrowers' ability to repay may be affected by local economic trends. Installment and other consumer loans decreased by $5,322,000, or 34.90%. These loans, generally secured by automobiles and other consumer goods, contain a historically higher level of risk; however, this risk is mitigated by the fact that these loans generally consist of small individual balances. As the loan portfolio is concentrated in Hawkins and surrounding counties, there is a risk that the borrowers' ability to repay the loans could be affected by changes in local economic conditions. The following table sets forth the composition of Volunteer's loan portfolio as December 31, 2002 and 2001. December 31, -------------------------- (In thousands) 2002 2001 ---- ---- Real estate loans: Construction and land development $ 2,647 $ 4,296 Secured by farmland and improvements 1,403 1,491 Secured by residential properties 31,482 29,111 Commercial real estate loans 15,170 11,654 ------- ------- Total real estate loans 50,702 46,552 Loans to farmers 1,413 1,862 Commercial and industrial loans 5,889 9,364 Installment loans 7,725 11,923 Other consumer loans 2,233 3,357 All other loans 163 8 ------- ------- Total loans $68,125 $73,066 ======= ======= - 10 - The following table sets forth the maturities of the loan portfolio and the sensitivity to interest rate changes of that portion of Volunteer's loan portfolio that matures after one year.
December 31, 2002 -------------------------------------------------------------- Maturity Range -------------------------------------------------------------- One Year One Through Over or Less Five Years Five Years Total (In thousands) Real estate construction loans $ 2,278 $ 14 $ 355 $ 2,647 Real estate mortgage loans 11,839 11,164 25,052 48,055 Commercial and industrial loans 4,663 1,011 215 5,889 Agricultural loans 1,101 312 1,413 All other loans 2,745 6,891 485 10,121 ------- ------- ------- ------- Total loans $22,626 $19,392 $26,107 $68,125 ======= ======= ======= =======
The sensitivity to interest rate changes of that portion of Volunteer's loan portfolio that matures after one year is set below: Real estate, commercial and industrial and agricultural loans maturing after one year as of December 31, 2002 (in thousands); Fixed rate $ 20,678 Floating rate 17,445 -------- 38,123 ======== Other loans maturing after one year: Fixed rate $ 7,356 Floating rate 20 -------- 7,376 Total loans maturing after one year $ 45,499 ======== LOAN POLICY All of our lending activities are under the direct supervision and control of the Executive Vice President and Senior Credit Officer and the Board loan committee, which consists of eight directors. The loan committee enforces loan authorizations for each officer, decides on loans exceeding such limits, services all requests for officer credits to the extent allowable under current laws and regulations, administers all problem credits, and determines the allocation of funds for each lending division. Our established maximum loan volume to deposits is 85%. The loan portfolio consists primarily of real estate, commercial, farming and installment loans. Commercial loans consist of either real estate loans or term loans. Maturity of term loans is normally limited to five to seven years. Conventional real estate loans may be made up to 90% of the appraised value or purchase cost of the real estate for no more than a thirty-year term. Installment loans are based on the earning capacity and vocational stability of the borrower. The board of directors at its regularly scheduled meetings reviews all new loans in excess of $100,000 made the preceding month. Loans which are 30 days or more past due are reviewed monthly. Management periodically reviews the loan portfolio, particularly nonaccrual and renegotiated loans. The review may result in a determination that a loan should be placed on a nonaccrual status for income recognition. In addition, to the extent that management identifies potential losses in the loan portfolio, it reduces the book value of such loans, through charge-offs, to their estimated collectible value. Volunteer's policy is to classify as nonaccrual any loan on which payment of principal or interest is 90 days or more past due except where there is adequate collateral to cover principal and accrued interest and the loan is in the process of collection. Management defines "in the process of collection" as that point where the customer has agreed to an accelerated repayment plan to bring the loan current, which definition is in accordance with generally accepted accounting principles ("GAAP") but is not in accordance with such definition as contained in Banking Bulletin 91-19. No concessions are granted and late fees are collected. In addition, a loan will be classified as nonaccrual if, in the opinion of the management, based upon a review of the borrower's or guarantor's financial condition, collateral value or other factors, payment is questionable, even though payments are not 90 days or more past due. - 11 - When a loan is classified as nonaccrual, any unpaid interest is reversed against current income. Interest is included in income thereafter only to the extent received in cash. The loan remains in a nonaccrual classification until such time as the loan is brought current, when it may be returned to accrual classification. When principal or interest on a nonaccrual loan is brought current, if in management's opinion future payments are questionable, the loan would remain classified as nonaccrual. After a nonaccrual or renegotiated loan is charged off, any subsequent payments of either interest or principal are applied first to any remaining balance outstanding, then to recoveries and lastly to income. The large number of consumer installment loans and the relatively small dollar amount of each makes an individual review impracticable. It is Volunteer's policy to charge off any consumer installment loan which is past due 90 days or more. In addition, mortgage loans secured by real estate are placed on nonaccrual status when the mortgagor is in bankruptcy, or foreclosure proceedings are instituted. Any accrued interest receivable remains an obligation of the borrower, except in those cases when the loan to value ratio is more than adequate to recover accrued principal and interest. Our underwriting guidelines are applied to four major categories of loans, commercial and industrial, consumer, agricultural and real estate which includes residential, construction and development and certain other real estate loans. We require our loan officers and loan committee to consider the borrower's character, the borrower's financial condition as reflected in current financial statements, the borrower's management capability, the borrower's industry and the economic environment in which the loan will be repaid. Before approving a loan, the loan officer or committee must determine that the borrower is basically creditworthy, determine that the borrower is a capable manager, understand the specific purpose of the loan, understand the source and plan of repayment, determine that the purpose, plan and source of repayment as well as collateral are acceptable, reasonable and practical given the normal framework within which the borrower operates. CREDIT RISK MANAGEMENT AND RESERVE FOR LOAN LOSSES Credit risk and exposure to loss are inherent parts of the banking business. Management seeks to manage and minimize these risks through its loan and investment policies and loan review procedures. Management establishes and continually reviews lending and investment criteria and approval procedures that it believes reflect the risk sensitive nature of Volunteer. The loan review procedures are set to monitor adherence to the established criteria and to ensure that on a continuing basis such standards are enforced and maintained. Management's objective in establishing lending and investment standards is to manage the risk of loss and provide for income generation through pricing policies. To effectuate this policy, we make commercial real estate and farming loans with one year or less fixed maturity. The loan portfolio is regularly reviewed and management determines the amount of loans to be charged-off. In addition, such factors as Volunteer's previous loan loss experience, prevailing and anticipated economic conditions, industry concentrations and the overall quality of the loan portfolio are considered. While management uses available information to recognize losses on loans and real estate owned, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowances for losses on loans and real estate owned. Such agencies may require us to recognize additions to the allowances based on their judgments about information available at the time of their examinations. In addition, any loan or portion thereof which is classified as a "loss" by regulatory examiners is charged-off. The reserve for loan losses is increased by provisions charged to operating expense. The reserve is reduced by charging off loans or portions of loans at the time they are deemed by management to be uncollectible and increased when loans previously charged off are recovered. The resulting reserve for loan losses is viewed by management as a single, unallocated reserve available for all loans and, in management's opinion, is adequate to provide for reasonably foreseeable potential loan losses. Rules and formulas relative to the adequacy of the reserve, although useful as guidelines to management, are not rigidly applied. The reserve, however, is determined by management based on formulas and techniques applied by the Bank's regulatory agencies. The reserve for loan losses was $1,110,481 at year end 2002, or 1.63% of loans outstanding, net of unearned income, compared to $908,016 or 1.24% at year end 2001. - 12 - RESERVE FOR LOAN LOSSES The following table presents the data related to Volunteer's reserve for loan losses for the years ended December 31, 2002 and 2001: December 31, ------------------- 2002 2001 ---- ---- (In thousands) Balance at beginning of period $ 908 $ 986 Charge offs: Commercial, financial and agricultural (174) (32) Real estate mortgage (90) (64) Installment loans to individuals (371) (271) ------ ------ (635) (367) ------ ------ Recoveries: Commercial, financial and agricultural 7 Real estate mortgage 4 Installment loans to individuals 35 20 ------ ------ 42 24 ------ ------ Net charge offs (593) (343) ------ ------ Additions charged to operations 795 265 ------ ------ Balance at end of period $1,110 $ 908 ------ ------ Ratio of net charge offs during the period to average loans outstanding during the period 0.85% 0.46% ------ ------ Average allowance for loan losses to average total loans 1.43% 1.29% ------ ------ At December 31, 2002 and 2001, the allowance for loan losses was allocated as follows: (In thousands)
December 31, 2002 December 31, 2001 ------------------------------------------------------- Percent of Percent of Amount category Amount category ------ ---------- ------- ---------- Commercial, financial and agricultural $ 236 10.96% $ 62 15.36% Real estate mortgage 178 74.42% 221 63.71% Installment loans to individuals 696 14.62% 625 20.93% ------ ------- ---- ------ $1,110 100.00% $908 100.00% ------ ------- ---- -------
The allocation of the allowance is presented based in part on evaluations of past history and composition of the loan portfolio. Since these factors are subject to change, the current allocation of the allowance is not necessarily indicative of the breakdown of future losses. - 13 - The following table sets forth information with respect to nonperforming loans of Volunteer on the dates indicated. Accrual of interest is discontinued when there is reasonable doubt as to the full, timely collections of interest or principal. When a loan becomes contractually past due 90 days with respect to interest or principal, it is reviewed and a determination is made as to whether it should be placed on nonaccrual status. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to principal and interest and when, in the judgment of management, the loans are estimated to be fully collectible as to principal and interest. Restructured loans are those loans on which concessions in terms have been granted because of a borrower's financial difficulty. Interest is generally accrued on such loans in accordance with the new terms. Non-performing assets (In thousands)
December 31 ------------------------ 2002 2001 ---- ---- Nonaccrual loans $ 923 $ 619 Restructured loans - - Other loans past due 90 days or more to principal or interest payments $ 673 $1,640 Non-performing loans as a percentage of net loans before allowance for loan losses 2.34% 3.09% Allowance for loan losses as a percentage of nonperforming loans 69.55% 40.19%
CAPITAL RESOURCES/LIQUIDITY Of primary importance to depositors, creditors and regulators is the ability to have readily available funds sufficient to repay fully maturing liabilities. Our liquidity, represented by cash and cash due from banks, is a result of its operating, investing and financing activities. In order to insure funds are available at all times, we devotes resources to projecting on a monthly basis the amount of funds which will be required and maintains relationships with a diversified customer base so funds are accessible. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets which are generally matched to correspond to the maturity of liabilities. Although we have no formal liquidity policy, in the opinion of management, its liquidity levels are considered adequate. We are not subject to any specific liquidity requirements imposed by regulatory orders. The Bank is subject to general FDIC guidelines which do not require a minimum level of liquidity. Management believes its liquidity ratios meet or exceed these guidelines. Management does not know of any trends or demands which are reasonably likely to result in liquidity increasing or decreasing in any material manner. The following table sets forth liquidity ratios for the periods indicated: 2002 2001 ---- ---- Average loans to average deposits 68.78% 70.07% IMPACT OF INFLATION AND CHANGING PRICES. The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time and due to inflation. The impact of inflation on operations of Volunteer is reflected in increased operating costs. Unlike most industrial companies, virtually all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services. CAPITAL ADEQUACY Capital adequacy refers to the level of capital required to sustain asset growth over time and to absorb losses. The objective of our management is to maintain a level of capitalization that is sufficient to take advantage of profitable growth opportunities while meeting regulatory requirements. This is achieved by improving profitability through effectively allocating resources to more profitable businesses, improving asset quality, strengthening service quality, and streamlining costs. The primary measures used by management to monitor the results of these efforts are the ratios of average equity to average assets, average tangible equity to average tangible assets, and average equity to net loans. The Federal Reserve Board has adopted capital guidelines governing the activities of bank holding companies. These guidelines require the maintenance of an amount of capital based on risk-adjusted assets so that categories of assets with potentially higher credit risk will require more capital backing than assets with lower risk. In addition, banks - 14 - and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as loan commitments. The capital guidelines classify capital into two tiers, referred to as Tier I and Tier II. Under risk-based capital requirements, total capital consists of Tier I capital which is generally common stockholders' equity less goodwill and Tier II capital which is primarily a portion of the allowance for loan losses and certain qualifying debt instruments. In determining risk-based capital requirements, assets are assigned risk-weights of 0% to 100%, depending primarily on the regulatory assigned levels of credit risk associated with such assets. Off-balance sheet items are considered in the calculation of risk-adjusted assets through conversion factors established by the regulators. The framework for calculating risk-based capital requires banks and bank holding companies to meet the regulatory minimums of 4% Tier I and 8% total risk-based capital. In 1990 regulators added a leveraged computation to the capital requirements, comparing Tier I capital to total average assets less goodwill. Our consolidated capital ratios are set forth below. See Note 12 to the Notes to Consolidated Financial Statements for Bank-only capital ratios. December 31 December 31 2002 2001 ---- ---- (Dollars in thousands) Capital: Tier I capital: Stockholders' common equity $ 6,834 $ 6,132 Accumulated comprehensive income (355) 15 Dissallowed intangibles (131) (131) -------- -------- Total Tier I capital 6,348 6,016 Tier II capital: ALL 867 907 -------- -------- Total capital $ 7,215 $ 6,923 -------- -------- Risk-adjusted assets $ 69,115 $ 72,575 Quarterly average assets $111,032 $114,415 Ratios: Tier I capital to risk-adjusted assets 9.18% 8.29% Tier II capital to risk-adjusted assets 1.25% 1.25% Total capital to risk-adjusted assets 10.44% 9.54% Leverage - Tier I capital to quarterly average assets less disallowed intangibles 5.72% 5.26% The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") established five capital categories for banks and bank holding companies. The bank regulators adopted regulations defining these five capital categories in September 1992. Under these new regulations each bank is classified into one of the five categories based on its level of risk-based capital as measured by Tier I capital, total risk-based capital, and Tier I leverage ratios and its supervisory ratings. - 15 - The following table lists the five categories of capital and each of the minimum requirements for the three risk-based capital ratios.
Total Risk-Based Tier I Risk-Based Leverage Capital Ratio Capital Ratio Ratio ------------- ------------- ------------ Well-capitalized..................................... 10% or above 6% or above 5% or above Adequately capitalized............................... 8% or above 4% or above 4% or above Undercapitalized..................................... Less than 8% Less than 4% Less than 4% Significantly undercapitalized....................... Less than 6% Less than 3% Less than 3% Critically undercapitalized.......................... -- -- 2% or less
On December 31, 2002, the Bank and Volunteer exceeded the regulatory minimums and qualified under the regulations as a well-capitalized institution and an adequately capitalized institution, respectively. CERTAIN REGULATORY CONSIDERATIONS As a bank holding company, Volunteer is subject to the regulation and supervision of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") under the Bank Holding Company Act of 1956, as amended (the "BHCA"). Under the BHCA, bank holding companies may not in general directly or indirectly acquire the ownership or control of more than 5% of the voting shares or substantially all the assets of any company, including a bank, without the prior approval of the Federal Reserve Board. The BHCA also restricts the types of activities in which a bank holding company and its subsidiaries may engage. Generally, activities are limited to banking and activities found by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto. In addition, the BHCA prohibits the Federal Reserve Board from approving an application by a bank holding company to acquire shares of a bank or bank holding company located outside the acquiror's principal state of operations unless such an acquisition is specifically authorized by statute in the state in which the bank or bank holding company whose shares are to be acquired is located. Tennessee has adopted legislation that authorizes nationwide interstate bank acquisitions, subject to certain state law reciprocity requirements, including the filing of an application with and approval of the Tennessee Commissioner of Financial Institutions. The Tennessee Bank Structure Act of 1974, as amended, restricts the acquisition by bank holding companies of banks in Tennessee. A bank holding company is prohibited from acquiring any bank in Tennessee as long as banks that it controls retain 30% or more of the total deposits in individual, partnership and corporate demand and other transaction accounts and in savings accounts and time deposits in all federally insured financial institutions in Tennessee, subject to certain limitations and exclusions. Also, under this act, no bank holding company may acquire any bank in operation for less than five years or begin a de novo bank in any county in Tennessee with a population, in 1970, of 200,000 or less, subject to certain exceptions. Under Tennessee law, branch banking is permitted in any county in the state. The Bank is a Tennessee state-chartered bank and is subject to the regulations of and supervision by the Federal Deposit Insurance Corporation (the "FDIC") as well as the Department of Financial Institutions, Tennessee's state banking authority. The Bank is also subject to various requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon and limitations on the types of investments that may be made and the type of services that may be offered. Various consumer laws and regulations also affect the operations of the Bank. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy. As a result of certain findings in the Tennessee Department of Financial Institution's Report of Examination dated June 4, 2001, the Board of Directors of Bank entered into a Memorandum of Understanding (Memorandum), dated August 16, 2001, with the Commissioner of the Tennessee Department of Financial Institutions and the Memphis Regional Director of the Federal Deposit Insurance Corporation. A Memorandum of Understanding is an informal administrative tool for institutions that have some weaknesses that if not properly addressed and corrected could lead to supervisory concern requiring formal administrative action. The areas addressed in the Memorandum cover capital adequacy, laws and regulations, data processing audit and review, investment policy maturity strategies, adequate documentation of each of the foregoing but primarily credit administration. As a result, the Board has revised a number of the Bank's policies and procedures including its loan policy and has incorporated recommendations designed to strengthen credit quality and the Bank's review procedures regarding loan loss reserve adequacy. Management of Volunteer and the Bank believe that the Bank is in substantial compliance with the provisions of the Memorandum. As a result of certain findings in the Federal Reserve Bank's review of Volunteer as of September 17, 2002, Volunteer's Board of Directors adopted certain Board Resolutions as of October 31, 2002. Board Resolutions are recommendations of the Federal Reserve adopted by Volunteer's Board of Directors requesting that certain actions be taken to strengthen the financial condition of Volunteer and its subsidiary. The areas addressed in the Board Resolutions include restrictions on incurring additional debt, declaration and payment of dividends to Volunteer's shareholders, and certain capital transactions. Management of Volunteer believes that Volunteer is in substantial compliance with the provisions of the Resolutions. - 16 - PAYMENT OF DIVIDENDS Volunteer is a legal entity separate and distinct from its banking subsidiary. The principal source of cash flow of Volunteer, including cash flow to pay dividends on its stock or principal (premium, if any) and interest on debt securities, is dividends from the Bank. There are statutory and regulatory limitations on the payment of dividends by the Bank to Volunteer, as well as by Volunteer to its shareholders. The Bank is subject to the Tennessee Banking Act, which provides that dividends will be paid out of undivided profits. Capital surplus, however, must equal or exceed 50% of capital stock, and in the event capital surplus falls below 50% of capital stock, no dividends may be paid until net profits have been transferred to capital surplus so that it equals 50% of capital stock. Thereafter, 10% of net profits must be transferred to capital surplus prior to payment of dividends until capital surplus equals capital stock. The Bank is also subject to the minimum capital requirements of the FDIC which impact the Bank's ability to pay dividends. If the Bank fails to meet these standards, it may not be able to pay dividends or to accept additional deposits because of regulatory requirements. See "Certain Regulatory Considerations." Under current Tennessee tax law, cash dividends paid by Tennessee banks to Tennessee residents are exempt from state income tax. Under federal income tax law, dividends paid by the Bank would be considered taxable. If, in the opinion of the applicable federal bank regulatory authority, a depository institution or a holding company is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution or holding company, could include the payment of dividends), such authority may require that such institution or holding company cease and desist from such practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution's or holding company's capital base to an inadequate level would be such an unsafe and unsound banking practice. Moreover, the Federal Reserve Board, the Comptroller of the Currency and the FDIC have issued policy statements which provide that bank holding companies and insured depository institutions generally should only pay dividends out of current operating earnings. The payment of dividends by Volunteer and the Bank may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. TRANSACTIONS WITH AFFILIATES There are various legal restrictions on the extent to which we can borrow or otherwise obtain credit from the Bank. There are also legal restrictions on the Bank's purchases of or investments in the securities of and purchase of assets from Volunteer, a bank's loans or extensions of credit to third parties, collateralized by the securities or obligations of Volunteer, the issuance of guaranties, acceptances and letters of credit on behalf of Volunteer, and certain bank transactions with Volunteer, or with respect to which Volunteer acts as agent, participates or has a financial interest. Subject to certain limited exceptions, the Bank may not extend credit to Volunteer or to any other affiliate in an amount which exceeds 10% of the Bank's capital stock and surplus and may not extend credit in the aggregate to such affiliates in an amount which exceeds 20% of its capital stock and surplus. Further, there are legal requirements as to the type, amount and quality of collateral which must secure such extensions of credit by the Bank to Volunteer or to such other affiliates. Also, extensions of credit and other transactions between the Bank and Volunteer or such other affiliates must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the Bank as those prevailing at the time for comparable transactions with non-affiliated companies. Also, Volunteer and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. HOLDING COMPANY STRUCTURE AND SUPPORT OF THE BANK Because Volunteer is a holding company, its right to participate in the assets of any subsidiary upon the latter's liquidation or reorganization will be subject to the prior claims of the subsidiary's creditors (including depositors in the case of bank subsidiaries) except to the extent that Volunteer may itself be a creditor with recognized claims against the subsidiary. Under Federal Reserve Board policy, Volunteer is expected to act as a source of financial strength to, and commit resources to support, the Bank. This support may be required at times when, absent such Federal Reserve Board policy, Volunteer may not be inclined to provide it. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. CROSS-GUARANTEE LIABILITY Under the Federal Deposit Insurance Act (the "FDIA"), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The FDIC's claim for damages is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institution. The Bank is subject to these cross- - 17 - guarantee provisions. As a result, any loss suffered by the FDIC in respect of the Bank would likely result in assertion of the cross- guarantee provisions, and a potential loss of Volunteer's investment in the Bank. FDICIA The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") which was enacted on December 19, 1991, substantially revised the depository institution regulatory and funding provisions of the FDIA and made revisions to several other federal banking statutes. Among other things, FDICIA requires the federal banking regulators to take "prompt corrective action" in respect of FDIC-insured depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Under applicable regulations, a FDIC-insured depository institution is defined to be well capitalized if it maintains a Leverage Ratio of at least 5%, a risk adjusted Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at least 10% and is not subject to a directive, order or written agreement to meet and maintain specific capital levels. An insured depository institution is defined to be adequately capitalized if it meets all of its minimum capital requirements as described above. In addition, an insured depository institution will be considered undercapitalized if it fails to meet any minimum required measure, significantly undercapitalized if it is significantly below such measure and critically undercapitalized if it fails to maintain a level of tangible equity equal to not less than 2% of total assets. An insured depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. The capital-based prompt corrective action provision of FDICIA and their implementing regulations apply to FDIC- insured depository institutions and are not directly applicable to holding companies which control such institutions. However, the Federal Reserve Board has indicated that, in regulating bank holding companies, it will take appropriate action at the holding company level based on an assessment of the effectiveness of supervisory actions imposed upon subsidiary depository institutions pursuant to such provisions and regulations. FDICIA generally prohibits an FDIC-insured depository institution from making any capital distribution (including payment of dividends) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. A depository institution's holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution's assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator generally within 90 days of the date on which they became critically undercapitalized. We believe that at December 31, 2002, the Bank was well capitalized under the criteria discussed above. FDICIA contain numerous other provisions, including new accounting, audit and reporting requirements, beginning in 1995 termination of the "too big to fail" doctrine except in special cases, limitations on the FDIC's payment of deposits at foreign branches, new regulatory standards in such areas as asset quality, earnings and compensation and revised regulatory standards for, among other things, powers of state banks, real estate lending and capital adequacy. FDICIA also requires that a depository institution provide 90 days prior notice of the closing of any branches. Various other legislation, including proposals to revise the bank regulatory system and to limit the investments that a depository institution may make with insured funds, is from time to time introduced in Congress. INTERSTATE ACT The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act"), which was enacted on September 29, 1994, among other things and subject to certain conditions and exceptions, permits on an interstate basis (i) bank holding company acquisitions commencing one year after enactment of banks (of a minimum age of up to five years as established by state law in any state), (ii) mergers of national and state banks after May 31, 1997 unless the home state of either bank has opted out of the interstate bank merger provision, (iii) branching de novo by national and state banks if the host state has opted-in to this provision of the Interstate Act, and (iv) certain bank agency activities after one year after enactment. The Interstate Act contains a 30% intrastate deposit cap, except for the initial acquisition in the state, restriction that applies to certain interstate acquisitions unless a different intrastate cap has been adopted by the applicable state pursuant to the provisions of the Interstate Act and a 10% national deposit cap restriction. Regulations have not yet been issued under the Interstate Act. A bill has been enacted by the Tennessee legislature which repeals the Tennessee Reciprocal Banking Act, amends the Tennessee Bank Structure Act of 1974, and amends Tennessee's bank branching laws by opting in to the Interstate Act. Management cannot predict the extent to which the business of Volunteer and the Bank may be affected. - 18 - BROKERED DEPOSITS AND PASS-THROUGH INSURANCE The FDIC has adopted regulations under FDICIA governing the receipt of brokered deposits and pass- through insurance. Under the regulations, a bank cannot accept or rollover or renew brokered deposits unless (i) it is well capitalized or (ii) it is adequately capitalized and receives a waiver from the FDICIA. A bank that cannot receive brokered deposits also cannot offer "pass-through" insurance on certain employee benefit accounts. Whether or not it has obtained such a waiver, an adequately capitalized bank may not pay an interest rate on any deposits in excess of 75 basis points over certain index prevailing market rates specified by regulation. There are no such restrictions on a bank that is well capitalized. Because we believe that the Bank was well capitalized as of December 31, 2001, we believe the brokered deposits regulation will have not material effect on the funding or liquidity of the Bank. FDIC INSURANCE PREMIUMS The Bank is required to pay semiannual FDIC deposit insurance assessments. As required by FDICIA, the FDIC adopted a risk-based premium schedule which increased the assessment rates for most FDIC-insured depository institutions. Under the schedule, the premiums initially range from $.23 to $.31 for every $100 of deposits. Each financial institution is assigned to one of three capital groups -- well capitalized, adequately capitalized or undercapitalized -- and further assigned to one of three subgroup within a capital group, on the basis of supervisory evaluations by the institution's primary federal and, if applicable, state supervisors and other information relevant to the institution's financial condition and the risk posed to the applicable FDIC deposit insurance fund. The actual assessment rate applicable to a particular institution will, therefore, depend in part upon the risk assessment classification so assigned to the institution by the FDIC. Under the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a federal bank regulatory agency. DEPOSITOR PREFERENCE The Omnibus Budget Reconciliation Act of 1993 provides that deposits and certain claims for administrative expenses and employee compensation against an insured depositary institution would be afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the "liquidation or other resolution" of such an institution by any receiver. EFFECT OF GOVERNMENTAL POLICIES The Bank is affected by the policies of regulatory authorities, including the Federal Reserve System. An important function of the Federal Reserve System is to regulate the national money supply. Among the instruments of monetary policy used by the Federal Reserve are: purchases and sales of U.S. Government securities in the marketplace; changes in the discount rate, which is the rate any depository institution must pay to borrow from the Federal Reserve; and changes in the reserve requirements of depository institutions. These instruments are effective in influencing economic and monetary growth, interest rate levels and inflation. The monetary policies of the Federal Reserve System and other governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Because of changing conditions in the national economy and in the money market, as well as the result of actions by monetary and fiscal authorities, it is not possible to predict with certainty future changes in interest rates, deposit levels, loan demand or the business and earnings of Volunteer and the Bank or whether the changing economic conditions will have a positive or negative effect on operations and earnings. Bills are pending before the United States Congress and the Tennessee General Assembly which could affect the business of Volunteer and the Bank, and there are indications that other similar bills may be introduced in the future. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which the business of Volunteer and the Bank subsidiaries may be affected thereby. EMPLOYEES At December 31, 2002, Volunteer had a total of 57 employees with 4 of those employed on a part-time basis. ITEM 2. DESCRIPTION OF PROPERTY The Bank's main office is located at 210 East Main Street in Rogersville, Tennessee. The property consists of a masonry building with approximately 10,000 square feet, 7,500 square feet of which is used by the Bank. The Bank has a branch in Sneedville, Tennessee which is a masonry building of approximately 7,000 square feet, which is constructed on a half acre of land owned by the Bank. The Bank operates a third location as a branch in Church Hill. All facilities have improvements including drive-through tellers, vaults, night depository and certain facilities have safe deposit boxes. During 2002, the Bank acquired a building adjacent to its main office which is being utilized by the loan administration department on the first floor and as storage on the second floor. ITEM 3. LEGAL PROCEEDINGS The Bank is currently involved in litigation as the plaintiff in a suit against another financial institution involving a participation loan purchase from that financial institution. In the opinion of management, no material adverse effect on the financial position of Volunteer and the Bank is anticipated as a result of this litigation. - 19 - There are no other material pending legal proceedings to which Volunteer or the Bank is a party or of which any of their properties are subject; nor are there material proceedings known to us to be contemplated by any governmental authority; nor are there other material proceedings known to us, pending or contemplated, in which any director, officer or affiliate or any principal security holder of Volunteer, or any associate of any of the foregoing, is a party or has an interest adverse to Volunteer or the Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS We conducted a public offering of our Common Stock in 1997 at a price of $15 per share (the "Offering"). There is no established public market for the shares. Management is aware that isolated transactions in the Common Stock occur from time to time. To our best knowledge the most recent transaction in the Common Stock was December 17, 1997 and was for the price of $15.00 per share. There were 483 holders of record of the Common Stock as of March 17, 2003. Payment of dividends is at the discretion of the board of directors but is presently subject to the approval of the Federal Reserve in accordance with the Board Resolutions adopted October 31, 2002. While we have paid dividends in recent years, the board of directors cannot predict when such dividends, if any, will be made. The payment of dividends, if any, shall at all times be subject to the payment of our expenses, the maintenance of reasonable working capital and risk reserves, and minimum capitalization requirements for state banks. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The purpose of this discussion and analysis is to provide the reader with a concise description of our financial condition and changes therein and results of our operations and the Bank for the years ended December 31, 2002 and 2001. This discussion and analysis is intended to complement the audited financial statements and footnotes and the supplemental financial data and charts appearing elsewhere in this report, and should be read in conjunction therewith. This discussion and analysis will focus on the following major areas: Results of Operations, Financial Position, Capital Resources, Asset Quality, and Liquidity and Interest-Sensitivity. RESULTS OF OPERATIONS Net income for 2002 was $386,577 decreasing $240,082 compared with net income of $626,659 for 2001. Our return on average assets was 0.34% for 2002 or 64% the return on average assets of 0.53% for 2001. Our return on average equity decreased to 5.87% for 2002 compared with 11.19% for 2001. Our net income for 2002 and 2001 were impacted by the following: -- The yield on average interest earnings assets was 7.01% for 2002 decreasing 131 basis points from 8.32% for 2001. -- Average earning assets decreased $4,894,000 to $103,966,000 for 2002 compared to $108,860,000 for 2001. -- Yield on average interest bearing liabilities decreased 219 basis points from 4.83% in 2001 to 2.64% for 2002. -- Average interest bearing liabilities decreased $6,416,000 to $92,614,000 for 2002 compared to $99,030,000 for 2001. -- Average interest earning assets to average total assets increased slightly from 92.67% for 2001 to 92.70% for 2002. -- Average interest bearing liabilities to average total assets decreased from 84.30% for 2001 to 82.58% for 2002. As a result of the foregoing net interest income as a percentage of average interest earning assets increased from 3.92% for 2001 to 4.66% for 2002. Accordingly, net interest income for 2002 of $4,715,248 was $508,424 greater than net interest income of $4,206,824 for 2001. Net interest income for 2002 was positively impacted by a decrease in interest expense of $68,000 on parent company only borrowings. Average parent company only borrowings were $1,841,000 for 2002 or a decrease of $345,000 compared to 2001 of $2,186,000. The decrease of $68,000 was attributable to a decrease in the average rate on such outstanding borrowings from 6.36% for 2001 to 3.86% for 2002. The borrowing was incurred in order to increase the capital of our subsidiary bank. Without this borrowing, the Bank would not have had sufficient capital to permit the Bank to open branches in Rogersville and Church Hill. - 20 - Volunteer is in violation of certain loan covenants with respect to this loan in that annualized earnings to tangible assets are less than the 0.75% required and the ratio of nonperforming assets is greater than 2.5%. These violations have not been waived by the lender. Because of these violations, the lender may, at its option, by notice to Volunteer declare the note in default. In such an event Volunteer would have ten days to remedy compliance with all loan covenants. If Volunteer did not or could not comply with all loan covenants within such ten day period the note would be in default. In such a case the lender may declare the note immediately due and payable and among other things proceed to foreclose upon 100% of the stock of Citizens Bank of East Tennessee which is pledged as security for the note. The lender has been notified by Volunteer of our non-compliance with certain covenants of the note that could lead to the lender declaring the note in default. However, the lender has not given us notification that we are in default under the terms of the loan agreement. Volunteer is in discussions with the lender and anticipates the lender to first pursue remedies other than foreclosure. Accordingly, Volunteer expects that the note will be restructured resulting in, among other things, increasing the interest rate on the note and substantially reducing the final maturity date on the note. In such a case, there can be no assurance that Volunteer could satisfy the restructured debt without obtaining new financing from other lenders or funds from a stock offering. Further, there can be no assurance that a stock offering by Volunteer would be successful or that new lenders would provide funds to Volunteer. - 21 - The following table indicates the average balance, interest income or expense, average interest rates earned or paid, interest rate spread, and interest margin for the years ended December 31, 2002 and 2001.
2002 2001 (Fully taxable equivalent) Interest Average Interest Average (Dollars in thousands except Average Income/ Yields/ Average Income/ Yields/ for per share data) Balance Expense Rate Balance Expense Rate ------- ------- ---- ------- ------- ---- Assets: Interest-earning assets: Loans net of unearned income $ 69,672 $5,711 8.20% $ 74,989 $7,137 9.52% U.S. Treasury and other U.S. government agencies 23,468 1,117 4.76% 24,585 1,468 5.97% States and municipalities 5,541 367 6.62% 2,889 190 6.58% FHLB stock 361 16 4.43% 341 23 6.74% Federal funds sold 4,924 74 1.50% 6,056 234 3.86% -------- ------ -------- ------ Total interest-earning assets/interest income 103,966 7,285 7.01% 108,860 9,052 8.32% -------- ------ -------- ------ Cash and due from banks 2,936 2,953 Other assets 6,250 6,626 Allowance for loan losses (995) (971) -------- -------- Total $112,157 $117,468 ======== ======== Liabilities and stockholders' equity: Interest-bearing liabilities: Demand deposits $ 19,303 239 1.24% $ 21,541 $ 644 2.99% Savings 7,096 106 1.49% 5,477 135 2.46% Individual retirement accounts 8,768 284 3.24% 8,829 471 5.33% Time certificates 53,857 1,694 3.15% 59,843 3,331 5.57% FHLB advances 0 0 0.00% 162 7 4.32% Securities sold under repurchase 1,749 50 2.86% 992 53 5.34% Note payable 1,841 71 3.86% 2,186 139 6.36% -------- ------ -------- ------ Total interest-bearing liabilities/interest expense 92,614 2,444 2.64% 99,030 4,780 4.83% -------- ------ -------- ------ Non-interest bearing demand deposits 12,276 11,328 Other liabilities 677 1,510 Stockholders' equity 6,590 5,600 -------- -------- Total $112,157 $117,468 ======== ======== Net interest earnings $4,841 $4,272 ------ ------ Net interest on interest earning assets 4.66% 3.92% ----- ----- Return on average assets 0.34% 0.53% Return on average equity 5.87% 11.19% Cash dividends declared $53,903 $75,464 Dividend payout ratio 13.94% 12.04% Net income $386,577 $626,659
- 22 - Non-interest expense increased $574,848 from $3,312,050 for 2001 to $3,886,898 for 2002. Non-interest expense as a percentage of average assets increased by 0.65% from 2.82% in 2001 to 3.47% for 2002. The following table presents non-interest expense for 2002 compared to 2001 as a percentage of average assets and the changes therein (in thousands): NONINTEREST EXPENSE % Average % Average 2002 Assets 2001 Assets ---- ------ ---- ------ Salaries and employee benefits $1,846 1.65% $1,743 1.48% Occupancy, net 263 0.23% 267 0.23% Furniture and equipment 399 0.36% 368 0.31% Directors fees 68 0.06% 76 0.06% Advertising 31 0.03% 30 0.03% FDIC insurance 48 0.04% 17 0.01% Office supplies 133 0.12% 117 0.10% Professional services 206 0.18% 75 0.06% Telephone 53 0.05% 51 0.04% Postage and courier 79 0.07% 60 0.05% Loss on other real estate owne 299 0.27% 89 0.08% Other 462 0.41% 419 0.36% ------ ------ $3,887 3.47% $3,312 2.82% ====== ===== ====== ===== Non-interest expenses increased 17.36% in absolute terms from 2001 to 2002 and increased as a percentage of average total assets. The increase is primarily attributable to losses on other real estate sales, FDIC insurance, professional services, telephone and postage and courier expenses. Occupancy expense increased in 2002 by 4.25% primarily attributable to increased furniture and equipment expenses. Non-interest expense as a percentage of average assets is expected to decline as growth in Bank assets is expected to increase faster than the growth in non-interest expense. The provision for loan losses in 2002 was $795,000 and for 2001 was $265,000. The provision for loan losses is the amount management deems necessary to maintain a reserve for loan losses at a level sufficient to meet risks inherent in the Bank's loan portfolio. The level of the reserve is determined by management after considering ongoing reviews of the loan portfolio as well as considering the level and magnitude of non-performing assets and loan delinquencies, general economic conditions in the areas served by Volunteer, historic loan-loss experience, loan mix and the level of loans relative to reserves. Non-interest income increased $159,732 from $339,884 in 2001 to $499,616 in 2002 primarily due to an increase in service charges on deposit accounts. Income tax expense decreased $196,610 from $342,999 in 2001 to $146,389 in 2002. FINANCIAL POSITION Our total assets decreased 2.52% or $2.88 million during 2002 to $111.37 million at year end 2002 from $114.25 million at year end 2001. This decrease is primarily attributable to a decrease of $2.77 million in deposits and securities sold under repurchase agreements during 2002 to $102.25 million at year end 2002 from $105.2 million at year end 2001. Portfolio securities increased $2.23 million in 2002 to $28.82 million at year end 2002 from $26.59 million at year end 2001 while federal funds decreased $1.83 million during 2002. Loans decreased $4.95 million during 2002 to $68.12 million at year end 2002 compared to $73.07 million at year end 2001. Real estate and commercial mortgage loans increased $4.15 million in 2002 and consumer loans decreased $8.0 million in 2002. Real estate mortgage loans represented 74.42% of gross outstanding loans at year end 2002. Consumer loans represented 14.62% of gross outstanding loans at year end 2002. Commercial loans represented 8.64% of gross outstanding loans at year end 2002. - 23 - Deposits and securities sold under repurchase agreements decreased $2.77 million in 2002 from $105.02 million at year end 2001 to $102.25 million at year end 2002. CAPITAL REQUIREMENTS Our equity capital was $6.83 million at year end 2002 compared to $6.13 million at year end 2001. This increase of approximately $700,000 consists of our net income for 2002 of $386,577, an increase in the accumulated other comprehensive income of $370,000 less dividends paid of $53,903. Volunteer is a "small one-bank holding company" within the meaning of regulations promulgated by the Board of Governors of the Federal Reserve System. Accordingly, Volunteer's capital compliance, for bank holding company purposes, will be measured solely with respect to the Bank and not on a consolidated basis. Management believes, as of December 31, 2002, that we meet all capital requirements to which we are subject and that we are in compliance with all conditions and commitments to banking regulators regarding the approval and opening of branches in Rogersville and Church Hill, Tennessee. However, events beyond our control, such as a downturn in the local economy, could adversely affect future earnings and, consequently, our ability of to meet our future minimum capital requirements. The Bank would be considered "well capitalized" within the applicable regulatory capital guidelines at December 31, 2002. LIQUIDITY RESOURCES Liquidity management focuses on the need to meet both short-term funding requirements and long-term growth objectives. Primary sources for liquidity include deposits, loan repayments and security repayments or sales of available for sale securities. ASSET LIABILITY MANAGEMENT Our long-term profitability depends on properly priced products and services, asset quality and asset- liability management. Historically, we have had a mismatch between the maturities of our assets and liabilities because customers have traditionally preferred short-term deposits and longer-term loans. This mismatch makes us sensitive to changes in interest rates and the resulting effect on interest income and the market value of assets. We attempt to manage this mismatch and thus reduce its effect on earnings during periods of significant changes in interest rates. Our strategies include the origination of shorter-term fixed rate loans and adjustable rate loans or loans with call provisions. We also emphasize checking accounts and other transaction accounts which management believes are less rate sensitive than certificate accounts. A traditional measure of interest rate sensitivity and its impact upon the next years earnings is our one-year gap position (total assets subject to repricing less total liabilities subject to repricing). A negative one-year gap position generally exposes our earnings to rising short term rates over the period and thus reduced net interest income because current liabilities reprice faster than current assets. However, this earnings exposure can be mitigated during the period if total asset growth is sufficient such that new assets are priced at relatively higher rates and new deposit maturities are extended. At December 31, 2002 we had a cumulative one year negative gap of (29.03%) or a net of $29.44 million in liabilities repricing faster than assets. While the one-year-gap measure helps provide some information about a financial institution's interest sensitivity, it does not predict the trends of future earnings. ASSET QUALITY Non-performing and other loans past due 90 days or more were $1,595,984 at year end 2002 compared to $2,258,495 at year end 2001 representing a decrease of $662,511. Non-performing loans as a percentage of net loans before the allowance for loan losses was 2.34% at year end 2002 and 3.09% at year end 2001. The reserve for loan losses to non-performing loans, which is a measure of the Bank's ability to cover problem assets with existing reserves, was 69.55% at year end 2002 and 40.19% at year end 2001. Other real estate owned increased $96,632 to $1,241,402 at year end 2002 compared to $1,144,770 at year end 2001. We had no material restructured loans in 2002 or 2001. Our asset quality has deteriorated as a result of a weakening economy and a lapse in underwriting at one of our branches. Our loan policies and procedures have been tightened and the problems have been addressed. We intent to continue aggressive collection efforts. The level of non-accrual loans and other real estate owned is mainly attributable to a real estate development and commercial real estate loans. Management has adopted more stringent underwriting guidelines to address this problem along with aggressive collection efforts. In addition, the Bank hired, in February 2002 a senior experienced credit officer to oversee credit administration, including policies and procedures, underwriting, and credit analysis. EFFECTS OF INFLATION AND CHANGING PRICES The consolidated financial statements and related financial data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in relative purchasing power over time due to inflation. - 24 - Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than does the effect of inflation. In the current interest rate environment, the liquidity and maturity structures of our assets and liabilities are critical to maintenance of acceptable performance levels. Item 7. Financial Statements Index to Consolidated Financial Statements: Page ---- Independent Auditor's Report.................................................F-1 Consolidated Balance Sheets at December 31, 2002 and 2001....................F-2 Consolidated Statements of Earnings for the years ended December 31, 2002 and 2001.................................................F-3 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2002 and 2001......................F-4 Consolidated Statements of Cash Flows for the years ended December 31, 2002 and 2001...........................................F-5 Notes to Consolidated Financial Statements...................................F-6 Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure None PART III Item 9. Directors, Executive Officers, Promoters and Control Persons Following is certain information regarding the nominee directors and executive officers of Volunteer. Reed D. Matney (53) assumed the position of Chief Executive Officer in November 1996 and has served as the President and a Director since 1994. Mr. Matney was employed by First Union National Bank of Tennessee until April 1994 and he was employed by the Bank in May 1994. G. Douglas Price (62) has served as a Director since 1994. Mr. Price is retired and was the former Executive for Hawkins County, Tennessee. William E. Phillips (55) has served as Chairman of the Board since 1994. Mr. Phillips is an attorney with the law firm of Phillips and Hale in Rogersville, Tennessee. Gary E. Varnell (56) has served as a Director since 1994. Mr. Varnell is the owner and operator of a retail office products store in Rogersville, Tennessee. George L. Brooks (73) has served as a Director since 1994. Mr. Brooks retired from Citizens Union Bank in 1993 and resides in Rogersville, Tennessee. Shirley A. Price (68) has served as a Director since 1994. Ms. Price is an insurance agent in Rogersville, Tennessee. Leon Gladson (77) has served as a Director since 1994. Mr. Gladson is a retired businessman and resides in Rogersville, Tennessee. Neil D. Miller (83) has served as a Director since 1994. Mr. Miller is a farmer in Rogersville, Tennessee. M. Carlin Greene (60) has served as a Director since 1994. Mr. Greene is a real estate agent and farmer in Sneedville, Tennessee. Scott F. Collins (54) has served as a Director since 1994. Mr. Collins is the Hancock County Clerk & Master in Sneedville, Tennessee. Lawrence E. Gray (58) has served as a Director since 1994 and formerly served as Executive Vice President of the Bank. Jim Friddell (52) has served as a Director since 2002. Mr. Friddell is the former president of Tennessee State Bank and currently resides in Rogersville, Tennessee. - 25 - No director of Volunteer is a director or executive officer of another bank holding company, bank, savings and loan association, or credit union. During 2002 the Board of Directors of Volunteer held 3 meetings. The Directors of Volunteer also serve as directors of the Bank. The Board of Directors of the Bank held 15 meetings in 2002. No director attended less than 75% of the meetings held by Volunteer or the Bank during 2002. The Directors received no compensation as directors of Volunteer but as directors of the Bank received $300 for each meeting attended. The Board of Directors has three committees. Messrs. Phillips, Miller and Matney serve as the Executive Committee, Messrs. Doug Price, Gladson and Collins serve as members of the Audit Committee and Messrs. Phillips, Matney, and G. Douglas Price serve as members of the Trust Committee. These persons receive no compensation as members of such committees. Item 10. Executive Compensation. The following table sets forth the aggregate cash compensation paid by Volunteer to the chief executive officer of Volunteer. No other executive officer of Volunteer received cash compensation in excess of $100,000 (determined as of the end of 2002) for the years ended December 31, 2002, 2001 and 2000. Annual Compensation Name and Position Year Salary ($) ---- --- -------- ---- ---------- Reed Matney 2002 105,000 Chief Executive Officer and President 2001 105,000 2000 100,000 Item 11. Security Ownership of Certain Beneficial Owners and Management As of March 15, 2003, Volunteer's records indicated that the following number of shares were beneficially owned by (i) each person known by Volunteer to beneficially own more than 5% of Volunteer's shares; (ii) directors and persons nominated to become directors of Volunteer and executive officers; and (iii) directors and executive officers of Volunteer as a group. Amount and Nature Name of of Beneficial Ownership Percent Beneficial Owner (Number of Shares) of Class ---------------- ------------------------ ----------------- (i) Ralph T. Hurley........... 85,500 15.86% Rt. 2 Box 157 Sneedville, TN 37869 (ii) William E. Phillips(1).... 22,495 4.17 Lawrence E. Gray(2)....... 18,641 3.46 Shirley A. Price.......... 7,962 1.48 Reed D. Matney............ 8,393 1.56 Leon Gladson.............. 3,723 * G. Douglas Price(3)....... 15,934 2.96 Gary E. Varnell(4)........ 16,260 3.02 Scott F. Collins.......... 1,647 * George L. Brooks.......... 6,165 1.14 M. Carlin Greene.......... 14,238 2.64 Neil D. Miller............ 11,150 2.07 Jim Friddell.............. - 0 - * (iii) Directors and executive officers as a group (12 persons)... 126,608 23.49% * Less than 1% (1) Includes 12,211 shares owned by the Joe H. Wilson Trust, for which Mr. Phillips serves as co-trustee. (2) Includes 12,211 shares owned jointly with his father, for which he disclaims voting and investment power. (3) Includes 6,105 shares owned by his spouse, for which he disclaims voting and investment power. (4) Includes 320 shares owned jointly with his two sons. Item 12. Certain Relationships and Related Transactions Volunteer expects to have in the future banking and other business transactions in the ordinary course of its banking business with directors, officers, and 10% beneficial owners of Volunteer and their affiliates, including members of their families, or corporations, partnerships, or other organizations in which such officers or directors have a controlling interest, on substantially the same terms (including price, or interest rates and collateral) as those prevailing at the time for comparable transactions with unrelated parties. Any such banking transactions will not involve more than the normal risk of collectibility nor present other unfavorable features to Volunteer or the Bank. - 26 - Item 13. Exhibits and Reports on Form 8-K (1) Exhibits -------- Exhibit Number Description -------------- ------------ 3.1* Articles of Incorporation of Volunteer Bancorp, Inc., as amended 3.2* Bylaws of Volunteer Bancorp, Inc. 21.1 List of Subsidiaries 99.1** Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Reed D. Matney, the President of Volunteer Bancorp, Inc. on March 28, 2003. 99.2** Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Greg Oliver, Vice President and Cashier of Volunteer Bancorp, Inc. on March 28, 2003. * Incorporated by reference to exhibits filed with Volunteer's Registration Statement on Form SB-1, Registration No. 33-94050. ** A signed original of this written statement required by Section 906 has been provided to Volunteer and will be retained by Volunteer and furnished to the Securities and Exchange Commission or its staff upon request. (2) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended December 31, 2002. Item 14. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. Volunteer's President and its Vice President and Cashier have evaluated the effectiveness of the design and operation of Volunteer's disclosure controls and procedures (as defined in Exchange Act Rule 13a-14(c)) as of a date within 90 days of the filing date of this annual report. Based on that evaluation, the President and the Vice President and Cashier have concluded that Volunteer's disclosure controls and procedures are effective to ensure that material information relating to Volunteer and Volunteer's consolidated subsidiaries is made known to such officers by others within these entities, particularly during the period this annual 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 Volunteer's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. - 27 - In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VOLUNTEER BANCORP, INC. By: /s/ Reed D. Matney ------------------------------- President Date: March 28, 2003 In accordance with the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Capacity Date ---------- -------- ----- /s/ William E. Phillips ------------------------- William E. Phillips Chairman of the Board and Director March 28, 2003 /s/ Reed D. Matney --------------------------- President and Director March 28, 2003 Reed D. Matney (principal executive officer) /s/ Greg Oliver --------------------------- Vice President and Cashier March 28, 2003 Greg Oliver (principal accounting officer) /s/ Carlin Greene ---------------------------- Director March 28, 2003 Carlin Greene /s/ Douglas Price --------------------------- Director March 28, 2003 Douglas Price /s/ Gary Varnell --------------------------- Director March 28, 2003 Gary Varnell /s/ George Brooks --------------------------- Director March 28, 2003 George Brooks /s/ Shirley Price --------------------------- Director March 28, 2003 Shirley Price /s/ Neil Miller --------------------------- Director March 28, 2003 Neil Miller /s/ Lawrence Gray ---------------------------- Director March 28, 2003 Lawrence Gray /s/ Scott Collins ---------------------------- Director March 28, 2003 Scott Collins /s/ Leon Gladson ---------------------------- Director March 28, 2003 Leon Gladson /s/ Jim Friddell ---------------------------- Director March 28, 2003 Jim Friddell Certification of President Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Reed D. Matney, certify that: 1. I have reviewed this annual report on Form 10-KSB of Volunteer Bancorp, Inc. ("Volunteer"); 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; and 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 Volunteer 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 we 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 function): 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 or not 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. Date: March 28, 2003 /s/ Reed D. Matney ------------------------------ Reed D. Matney President Certification of Vice President and Cashier Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Greg Oliver, certify that: 1. I have reviewed this annual report on Form 10-KSB of Volunteer Bancorp, Inc. ("Volunteer"); 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; and 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 Volunteer 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 we 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 function): 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 or not 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. Date: March 28, 2003 /s/ Greg Oliver ------------------------------ Greg Oliver Vice President and Cashier INDEPENDENT AUDITOR'S REPORT To the Board of Directors Volunteer Bancorp, Inc. We have audited the accompanying consolidated balance sheets of Volunteer Bancorp, Inc. and subsidiary as of December 31, 2002 and 2001, and the related consolidated statements of earnings, changes in stockholders' equity, cash flows and comprehensive income for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 audit provides 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 Volunteer Bancorp, Inc. and subsidiary as of December 31, 2002 and 2001, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. /s/ Welch & Associates, Ltd. February 6, 2003 Nashville, Tennessee F - 1 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidated Balance Sheets December 31, 2002 and 2001 --------------------------------------------------------------------------------
2002 2001 ------ ----- ASSETS Cash and due from banks (note 11) $ 4,705,507 $ 2,628,179 Federal funds sold 4,450,000 6,275,000 ----------------- --------------- Cash and cash equivalents 9,155,507 8,903,179 Investment securities available for sale (amortized cost of $27,192,916 and $25,990,696, respectively) (note 2) 27,765,755 25,966,922 Investment securities held to maturity (estimated market value of $1,054,421 and $626,589, respectively) (note 2) 1,052,991 626,859 Loans, less allowance for possible loan losses of $1,110,481 and $908,016, respectively (note 3) 67,014,982 72,158,156 Accrued interest receivable 935,616 1,066,479 Premises and equipment, net (note 4) 3,788,671 3,866,358 Other real estate 1,241,402 1,144,770 Deferred income taxes (note 9) 34,962 114,935 Goodwill (note 1) 131,259 131,259 Other assets 250,870 268,822 ----------------- --------------- Total assets $ 111,372,015 $ 114,247,739 ================= =============== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits (notes 2 and 5) Non-interest bearing $ 12,159,852 $ 11,334,627 Interest bearing 87,797,905 92,575,028 ----------------- --------------- Total deposits 99,957,757 103,909,655 Accrued interest payable 411,322 894,347 Securities sold under repurchase agreements (note 17) 2,288,784 1,109,603 Other accrued taxes, expenses and liabilities 69,910 32,466 Long-term debt (note 6) 1,810,000 2,170,000 ----------------- --------------- Total liabilities 104,537,773 108,116,071 ----------------- --------------- Commitments and contingent liabilities (note 10) Stockholders' equity: Common stock, $0.01 par value, 1,000,000 shares authorized, 539,027 shares issued and outstanding 5,390 5,390 Additional paid-in capital 1,916,500 1,916,500 Retained earnings 4,557,192 4,224,518 Accumulated other comprehensive income (note 1) 355,160 (14,740) ----------------- --------------- Total stockholders' equity 6,834,242 6,131,668 ----------------- --------------- Total liabilities and stockholders' equity $ 111,372,015 $ 114,247,739 ================= ===============
See accompanying notes to consolidated financial statements F - 2 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Earnings December 31, 2002 and 2001 --------------------------------------------------------------------------------
2002 2001 ------ ----- Interest income: Interest and fees on loans $ 5,710,663 $ 7,136,898 Interest on federal funds 73,631 233,982 Interest on investment securities: Taxable 1,132,633 1,490,965 Exempt from Federal income tax 241,961 125,126 ------------------- ------------------ Total interest income 7,158,888 8,986,971 ------------------- ------------------ Interest expense: Interest on deposits 2,322,582 4,581,452 Interest on other borrowed funds 121,058 198,695 ------------------- ------------------ Total interest expense 2,443,640 4,780,147 ------------------- ------------------ Net interest income 4,715,248 4,206,824 Provisions for possible loan losses (note 3) 795,000 265,000 ------------------- ------------------ Net interest income after provision for possible loan losses 3,920,248 3,941,824 ------------------- ------------------ Non-interest income: Service charges on deposit accounts 297,299 164,833 Other fees and commissions 107,193 101,151 Securities gains (note 2) 39,222 25,260 Other non-interest income 55,902 48,640 ------------------- ------------------ Total non-interest income 499,616 339,884 ------------------- ------------------ Non-interest expense: Salaries and employee benefits (note 8) 1,834,197 1,742,511 Occupancy expenses, net 262,800 266,854 Furniture and equipment expense 399,402 368,363 Other non-interest expense (note 8) 1,390,499 934,322 ------------------- ------------------ Total non-interest expense 3,886,898 3,312,050 ------------------- ------------------ Net earnings before income taxes 532,966 969,658 Income tax expense (note 9) 146,389 342,999 ------------------- ------------------ Net income $ 386,577 $ 626,659 =================== ================== Income per common share $ 0.72 $ 1.16 =================== ================== Common shares outstanding 539,027 539,027 =================== ==================
See accompanying notes to consolidated financial statements F - 3 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Changes in Stockholders' Equity For the Years Ended December 31, 2002 and 2001 --------------------------------------------------------------------------------
Accumulated Common Other Stock Additional Compre- Common Stated Paid-In Retained hensive Shares Value Capital Earnings Income Total -------- ----- --------- -------- ------ ----- Balance January 1, 2001 $ 539,027 $ 5,390 $ 1,916,500 $ 3,673,323 $ (275,080) $ 5,320,133 Net income - - - 626,659 - 626,659 Dividends declared - - - (75,464) - (75,464) Other comprehensive income - - - - 260,340 260,340 ------------- ------------- ---------------- ------------------ ----------------- ---------------- Balance December 31, 2001 539,027 5,390 1,916,500 4,224,518 (14,740) 6,131,668 Net income - - - 386,577 - 386,577 Dividends declared - - - (53,903) - (53,903) Other comprehensive income - - - - 369,900 369,900 ------------- ------------- ---------------- ------------------ ----------------- ---------------- Balance December 31, 2002 $ 539,027 $ 5,390 $ 1,916,500 $ 4,557,192 $ 355,160 $ 6,834,242 ============= ============= ================ ================== ================= ================
See accompanying notes to consolidated financial statements F - 4 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows December 31, 2002 and 2001 --------------------------------------------------------------------------------
2002 2001 ------ ----- Cash Flows from Operating Activities: Net income $ 386,577 $ 626,659 Adjustments to reconcile net income to net cash provided by operating activities: Deferred income taxes (146,740) 46,859 Provision for loan losses 795,000 265,000 Provision for depreciation and amortization 205,483 241,231 Securities (gain) (39,222) (25,260) FHLB stock dividends (16,400) (22,800) Decrease in interest receivable 130,863 146,840 (Increase) in other assets (78,680) (651,068) (Decrease) in other liabilities (445,581) (337,246) -------------------- ------------------- Net cash provided by operating activities 791,300 290,215 -------------------- ------------------- Cash Flows from Investing Activities: Proceeds from calls and maturity of held to maturity securities 591,252 1,730,177 Purchase of held to maturity securities (1,017,384) (1,290,488) Purchase of investment securities available for sale (20,071,988) (33,025,682) Proceeds from calls and maturities of available for sale securities 13,142,700 21,879,350 Proceeds from sale of available for sale securities 5,782,690 11,070,043 Net decrease in loans 4,348,174 615,764 Capital expenditures (127,796) (37,662) -------------------- ------------------- Net cash provided by investing activities 2,647,648 941,502 -------------------- ------------------- Cash Flows from Financing Activities: Net increase (decrease) in demand deposits, NOW accounts, IRA and savings accounts 4,310,945 (1,897,674) Net (decrease) in certificates of deposit (8,262,843) (200,357) Net increase in securities sold under repurchase agreements 1,179,181 57,090 FHLB advances - 2,000,000 Repayment of FHLB advances - (2,000,000) Dividends paid (53,903) (75,464) Repayment of long-term debt (360,000) (325,000) -------------------- ------------------- Net cash (used) by financing activities (3,186,620) (2,441,405) -------------------- ------------------- Increase (decrease) in cash and cash equivalents 252,328 (1,209,688) Cash and cash equivalents beginning of year 8,903,179 10,112,867 -------------------- ------------------- Cash and cash equivalents end of year (note 1) $ 9,155,507 $ 8,903,179 ==================== =================== Supplemental Disclosure of Cash Flow Information: Cash paid during the period for: Interest $ 2,926,665 $ 5,025,833 ==================== =================== Income taxes $ 278,526 $ 479,254 ==================== ===================
See accompanying notes to consolidated financial statements F - 5 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Comprehensive Income December 31, 2002 and 2001 --------------------------------------------------------------------------------
2002 2001 ---- ---- Net income $ 386,577 $ 626,659 -------------------- ------------------- Other comprehensive income, before tax: Unrealized gains on securities available for sale: Unrealized holding gains arising during the period 635,835 445,164 Less: reclassification adjustment for gains included in income 39,222 25,260 -------------------- ------------------- Other comprehensive income 596,613 419,904 Income taxes related to other comprehensive income (226,713) (159,564) -------------------- ------------------- Other comprehensive income, net of income taxes 369,900 260,340 -------------------- ------------------- Total comprehensive income $ 756,477 $ 886,999 ==================== ===================
See accompanying notes to consolidated financial statements F - 6 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- 1. Summary of Significant Accounting Policies ------------------------------------------ The accounting policies of Volunteer Bancorp, Inc. (the Company) conform to generally accepted accounting principles and to general practices within the banking industry. The following is a summary of the significant policies. a. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiary, Citizens Bank of East Tennessee (the "Bank") of which the Company owns 133,300 (100.0%) shares of the Bank's 133,300 issued and outstanding shares of voting common stock at December 31, 2002 and 2001. All material inter-company accounts and transactions have been eliminated in consolidation. b. Investment Securities Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities" requires investments in equity securities that have a readily determinable fair value and investments in debt securities to be classified into three categories, as follows: held to maturity debt securities, trading securities, and securities available for sale. Classification of a debt security as held to maturity is based on the Company's positive intent and ability to hold such security to maturity. Securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts, unless there is a decline in value which is considered to be other than temporary, in which case the cost basis of such security is written down to market and the amount of the write-down is included in earnings. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading account securities, which are valued at market with unrealized gains and losses included in earnings. Gains or losses on sales and adjustments to market value of trading account securities are included in non-interest income in the income statements. Securities classified as available for sale are reported at market value with unrealized gains and losses excluded from earnings and reported, net of tax, in a separate component of stockholders' equity and include all securities not classified as trading account securities or securities held to maturity. These include securities used as part of the Company's asset/liability strategy which may be sold in response to changes in interest rates, prepayment risk, the need or desire to increase regulatory capital, and other similar factors. Gains or losses on sale of securities available for sale are recognized at the time of sale, based upon specific identification of the security sold, and are included in non-interest income in the income statements. Interest income on investments is computed on the par value of the outstanding investment. Amortization of discounts and accretion of premiums is recorded as an adjustment to interest income utilizing the effective yield method. F - 7 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- c. Loans, Less Allowance for Possible Loan Losses Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting By Creditors For Impairment Of A Loan," as amended by SFAS No. 118, "Accounting By Creditors For Impairment Of A Loan - Income Recognition And Disclosures" state that an impaired loan is generally any loan, excluding certain homogeneous small balance credits such as credit card indebtedness, that is not performing in accordance with its contractual terms. SFAS No. 114 requires that impairment on a loan be measured by the difference between carrying value and the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the collateral's value if the loan is collateral dependent. The amount of a loan's impairment or changes therein require charges to earnings. SFAS No. 118 allows a creditor to use existing methods for the recognition of interest income on an impaired loan. SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and the Extinguishment of Liabilities," establishes, among other things, new criteria for determining whether a transfer of financial assets for cash or other considerations should be accounted for as a sale or as a pledge of collateral in a secured borrowing. There are certain criteria that must be met for the transfer to be recorded as a sale: The transferred assets have been isolated from the transferor - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership. Each transferee obtains the right - free of conditions that constrain it from taking advantage of that right - to pledge or exchange the transferred assets. If these criteria are not met, the transfer must be recorded as a secured borrowing. SFAS No. 125 also addresses repurchase agreements that might allow the transferor to maintain control over the transferred asset. If such an agreement exists, a transfer should be accounted for as a secured borrowing if (a) the assets to be repurchased are substantially the same, (b) they can be repurchased on substantially the agreed terms, (c) repurchase will occur before maturity at a fixed and determinable price, and (d) the agreement was entered into concurrently with the transfer. Loans are stated at the principal amount outstanding reduced by unearned interest and an allowance for loan losses. Unearned interest on loans, which relates principally to installment loans, is recognized by the sum of the months' digits method, which, in the current case, approximates the level yield method. Interest on all other loans is computed on the outstanding loan balance. The allowance method is used by the Company to provide for possible loan losses. Accordingly, all loan losses are charged to the allowance for possible loan losses and all recoveries are credited to it. Loans are charged against the allowance when management believes that the collection of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible. The provision for possible loan losses charged to operating expense is the amount management considers necessary to bring the allowance to an adequate level based on past loan loss experience and other factors which, in management's judgment, deserve current recognition in estimating possible loan losses. Such other factors considered by management include growth and composition of the loan portfolio, the relationship of the allowance for possible loan losses to outstanding loans and current economic conditions that may affect the borrower's ability to repay. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that the collection of interest is doubtful. F - 8 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- d. Loan Fees Loan fees are credited to income at the time of loan origination. Direct origination costs for loans are charged to expenses when incurred. The results of using this accounting method do not differ materially from generally accepted accounting principles requiring the use of the level interest yield method. e. Premises and equipment Premises and equipment are stated at cost. Depreciation is computed primarily by the straight line method over the estimated useful lives of the related assets. Gain or loss on items retired or otherwise disposed of is credited or charged to operations and cost and related accumulated depreciation are removed from the asset and accumulated depreciation accounts. Expenditures for major renewals and improvements of premises and equipment are capitalized and those for maintenance and repairs are charged to earnings as incurred. f. Other Real Estate Real estate acquired in foreclosure or in settlement of debt or repossessed in substance is carried at the lower of cost or fair market value less estimated costs to sell. Fair market value at the time of foreclosure or settlement of debt is based on a current appraisal of the property. Any reduction in carrying value to fair market value at the time the property is acquired is accounted for as a loan loss. Management evaluates the fair market value of individual properties in other real estate periodically and any subsequent write-downs of the carrying value of the properties are charged to losses on other real estate and credited directly to the carrying value of individual properties. If an individual property is in condition for use or sale at the time of foreclosure, any subsequent holding costs are included in expense as incurred. If an individual property is not in condition for use or sale at the time of foreclosure, completion and holding costs are capitalized until the property is in condition for use or sale. All legal fees and other direct costs incurred in foreclosure are expensed as incurred. g. Income Taxes The provision for income taxes relates primarily to items of income and expenses after elimination of tax exempt interest on investments and loans. Deferred income taxes are provided on all significant timing differences between income determined for financial and tax reporting purposes principally related to the methods used to report depreciation, and the provision for possible loan losses. The Company and the Bank file consolidated income tax returns. Therefore, the provision arising from the operations of the Bank is payable to the Company as the amounts are utilized in the consolidated income tax returns. The amount due the Company at December 31, 2002 and 2001 was $10,516 and $13,111, respectively. F - 9 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 h. Goodwill The Company's acquisition during 1995 and 1994 of 18,360 shares of subsidiary Bank stock held by minority shareholders of the Bank was accounted for by the purchase method of accounting and resulted in the recording of goodwill in the amount of $261,226. Total costs for the 18,360 shares amounted to $559,306. Goodwill represents the excess cost over the fair value of the assets acquired of the subsidiary. SFAS No. 142, "Goodwill and Other Intangible Assets", is effective for fiscal years beginning after December 15, 2001. This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supercedes APB Opinion No. 17, "Intangible Assets". It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Under this Statement, goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment. Intangible assets that have finite useful lives will continue to be amortized over their useful lives, but without the constraint of an arbitrary ceiling. This Statement provides specific guidance for testing goodwill for impairment. The Company adopted the provisions of Statement 142 effective January 1, 2002. As of the date of adoption, the Company had unamortized goodwill in the amount of $131,259. As part of its adoption of Statement 142, the Company has performed a transitional impairment test on its goodwill assets, which indicated that no impairment charge was required. The Company does not currently have any other indefinite-lived intangible assets recorded in its statement of financial condition. The full impact of adopting Statement 142 resulted in an increase in net income of approximately $17,883 or approximately $0.03 per share in 2002 as a result of the Company no longer having to amortize goodwill against earnings. Assuming retroactive adoption of Statement 142, net income for the year ended December 31, 2001 would have been $644,542, and earnings per share would have been $1.19. The following table sets forth the reconcilement of net income and earnings per share excluding goodwill amortization for the year ended December 31, 2001.
For the Year Ended December 31, 2001 ------------------------------------------ Net Earnings Income Per Share Earnings per common share computation: Net income/EPS as reported $ 626,659 $ 1.16 Add back: Goodwill amortization 17,883 0.03 ---------------------- ------------------ Adjusted net income /EPS $ 644,542 $ 1.19 ====================== ==================
F - 10 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 i. Cash Flows For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. j. Advertising Cost All advertising costs are expensed when incurred. Other advertising expense was $31,287 and $29,594 for the years ended December 31, 2002 and 2001, respectively. There was no direct-response advertising costs incurred for 2002 or 2001. k. Stock Based Compensation During 1997, the Company adopted SFAS No. 123, "Accounting for Stock Based Compensation." The Company utilizes the fair value method of determining compensation for stock based plans wherein compensation cost is measured at the grant date at fair value and is recognized over the service period. l. Risk Factors The Company's operations are affected by various risk factors, including interest-rate risk, credit risk, and risk from geographic concentrations of lending activities. Management attempts to manage interest-rate risk through various asset/liability management techniques designed to match maturities of assets and liabilities. Loan policies and administration are designed to provide assurance that loans will only be granted to credit-worthy borrowers, although credit losses are expected to occur because of subjective factors and factors beyond the control of the Company. In addition, most of the Company's lending activities are within the geographic area where it is located. As a result, the Company and its borrowers may be vulnerable to the consequences of changes in the local economy. m. Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount 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 may differ from those estimates. The determination of the allowance for loan losses is a material estimate that is particularly susceptible to material change. While management uses available information to recognize losses on loans, further reductions in the carrying amount of loans may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Bank to recognize additional losses based on their judgements about information available to them at the time of their examination. F - 11 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- n. Accumulated Other Comprehensive Income Comprehensive income is the change in the Company's equity during a period from transactions and other events except those resulting from investments by investors and distributions to those investors. Comprehensive income includes net income and other changes in assets and liabilities that are not reported in net income, but instead reported as a separate component of stockholders' equity. Accumulated other comprehensive income is the cumulative amount of revenues, expenses, and gains and losses that under Generally Accepted Accounting Principles are included as a component of stockholders' equity, but excluded from net income. The net unrealized gain on investment securities available for sale is the only item of other comprehensive income currently recognized by the Company. 2. Investment Securities --------------------- The carrying value of investment securities classified as available for sale at December 31, are as follows:
Available for Sale -------------------------------------------------------- December 31, 2002 ----------------- Gross Gross Amortized Unrealized Unrealized Carrying Cost Gains Losses Value --------- ---------- ---------- -------- Securities of U.S. Treasury $ 500,901 $ 13,789 $ - $ 514,690 Securities of U.S. Government agencies 18,470,129 411,984 (4,760) 18,877,353 Obligations of states and political subdivisions 6,376,115 166,497 - 6,542,612 FNMA preferred stock 1,474,671 - (14,671) 1,460,000 Restricted securities: Federal Home Loan Bank stock 371,100 - - 371,100 ------------------- --------------- ----------------- ------------------ $ 27,192,916 $ 592,270 $ (19,431) $ 27,765,755 =================== =============== ================= ==================
F - 12 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 --------------------------------------------------------------------------------
Available for Sale ------------------------------------------------------ December 31, 2001 ----------------- Gross Gross Amortized Unrealized Unrealized Carrying Cost Gains Losses Value --------- ---------- ----------- --------- Securities of U.S. Treasury $ 502,094 $ 21,346 $ - $ 523,440 Securities of U.S. Government agencies 21,431,334 101,069 (107,499) 21,424,904 Obligations of states and political subdivisions 3,702,668 20,556 (59,246) 3,663,978 Restricted securities: Federal Home Loan Bank stock 354,600 - - 354,600 ------------------- --------------- ----------------- ------------------ $ 25,990,696 $ 142,971 $ (166,745) $ 25,966,922 =================== =============== ================= ==================
The Bank is a member of the Federal Home Loan Bank (FHLB) and as such is required to maintain an investment in the capital stock of the FHLB of Cincinnati. The FHLB stock is carried at cost which approximates the market value of the stock. The amount of stock required to be held by the Bank is adjusted annually based on a determination made by the FHLB of Cincinnati. The amortized cost and approximate market value of investment securities classified as held to maturity at December 31, follows:
Held to Maturity --------------------------------------------------- December 31, 2002 ----------------- Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ---------- ---------- --------- Securities of U.S. Government agencies $ 1,052,991 $ 1,430 $ - $ 1,054,421 =============== ============= ============ ==============
Held to Maturity --------------------------------------------------- December 31, 2001 ----------------- Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ---------- ---------- --------- Securities of U.S. Government agencies $ 626,859 $ 1,597 $ (1,867) $ 626,589 =============== ============= ============ ==============
F - 13 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- The components of the net unrealized (loss) gain on investment securities available for sale at December 31, recorded as a component of stockholders' equity are as follows: 2002 2001 ---- ---- Gross unrealized gains $ 592,270 $ 142,971 Gross unrealized losses (19,431) (166,745) ----------------- ---------------- Gross unrealized (loss) gain, net 572,839 (23,774) Deferred tax effect (217,679) 9,034 ----------------- ---------------- Net unrealized (loss) gain $ 355,160 $ (14,740) ================= ================ The amortized cost and estimated market value of debt securities at December 31, 2002, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Available for Sale Held to maturity ------------------ ---------------- Estimated Estimated Amortized Market Amortized Market Cost Value Cost Value --------- ---------- --------- --------- Due in one year or less $ 539,136 $ 552,925 $ 371 $ 371 Due after one year and through five years 6,607,754 6,728,291 - - Due after five years and through ten years 9,139,649 9,325,151 5,696 6,358 Due after ten years 9,060,606 9,328,288 1,046,924 1,047,692 ------------------- ------------------- ---------------- ----------------- Total debt securities 25,347,145 25,934,655 1,052,991 1,054,421 Equity securities with no stated maturity 1,845,771 1,831,100 - - ------------------- ------------------- ---------------- ----------------- Total investment securities $ 27,192,916 $ 27,765,755 $ 1,052,991 $ 1,054,421 =================== =================== ================ =================
The following table presents the gross realized gains and losses on investment securities transactions for the years ended December 31, 2002 and 2001. Realized gains Realized Losses -------------- --------------- 2002 2001 2002 2001 ---- ---- ---- ---- Available for sale securities $ 39,222 $ 25,260 $ - $ - Held to maturity securities - - - - ------------------------------------ $ 39,222 $ 25,260 $ - $ - ======== ======== ===== ===== F - 14 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 At December 31, 2002 a net gain of $24,204 was realized , or a gain of $39,222 net of a tax expense of $15,018. At December 31, 2001, a net gain of $15,671 was realized, or a gain of $25,260 net of a tax expense of $9,589. Investment securities with amortized cost of approximately $11,601,000 and market value of approximately $11,888,000 at December 31, 2002 were pledged to secure public deposits and for other purposes required or permitted by law. In 2001, investment securities with amortized cost of approximately $11,653,000 and market value of approximately $11,714,000 were pledged. 3. Loans and Allowances for Possible Loan Losses --------------------------------------------- The Bank makes commercial, consumer, and real estate loans to its customers, located principally within the Bank's primary markets, which consists of Hancock, Hawkins and surrounding counties. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon economic conditions within its primary markets. Loans are either secured or unsecured based upon the financial condition of the borrower. The loans are expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrower; however, the Bank is exposed to risk of loss on loans due to a borrower's difficulties, which may arise from any number of factors including problems within the respective industry or economic conditions, including those within the Bank's primary market. Loans, less allowance for possible loan losses at December 31, are summarized as follows:
2002 2001 ---- ---- Commercial, financial and agricultural $ 7,302,050 $ 11,226,026 Real estate - construction 2,647,018 4,296,010 Real estate - mortgage 48,055,327 42,256,099 Consumer 9,958,068 15,280,036 Other 163,000 8,001 -------------------- -------------------- 68,125,463 73,066,172 Less allowance for possible loan losses 1,110,481 908,016 -------------------- -------------------- $ 67,014,982 $ 72,158,156 ==================== ====================
Transactions in the allowance for possible loan losses of the Bank for the years ended December 31, are summarized as follows:
2002 2001 ---- ---- Balance - beginning of year $ 908,016 $ 985,784 Provisions charged to operating expense 795,000 265,000 Loans charged-off (635,246) (367,126) Recoveries 42,711 24,358 ------------------ ------------------ Balance - end of year $ 1,110,481 $ 908,016 ================== ==================
F - 15 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- Loans at December 31, 2002 are scheduled to mature as follows:
Commercial, Financial & Real Estate Real Estate Agricultural Construction Mortgage Consumer Other ------------ ------------ ----------- -------- ----- One year or less $ 5,763,734 $ 2,278,182 $ 11,838,852 $ 2,699,019 $ 144,805 After one through five years 1,323,123 13,710 11,164,252 6,873,221 18,195 After five years through ten years 123,342 - 6,371,743 307,572 - After ten years 91,851 355,126 18,680,480 78,256 - --------------- --------------- ----------------- --------------- --------------- Total $ 7,302,050 $ 2,647,018 $ 48,055,327 $ 9,958,068 $ 163,000 =============== =============== ================= =============== ===============
At December 31, 2002, fixed and variable rate loans were as follows: Fixed rate loans $ 36,860,494 Variable rate loans 31,264,969 -------------------- $ 68,125,463 ==================== Non-performing assets at December 31, were as follows: 2002 2001 ---- ---- Loans past due over 90 days $ 673,292 $ 1,639,927 Non - accrual loans 922,692 618,568 Other real estate owned 1,241,402 1,144,770 ------------------------------ $ 2,837,386 $ 3,403,265 ============================== Foregone interest income on the above non - accrual loans was approximately $37,000 and $75,000 at December 31, 2002 and 2001, respectively. At December 31, 2002, the Company's recorded investment in impaired loans were as follows: Amount Valuation ------ ---------- Impaired Loans $ 1,595,984 $ 155,196 =============== ============== Interest payments received on impaired loans are recorded as interest income unless collection of the remaining recorded loan investment is doubtful at which time payments received are recorded as reductions of principal. The average recorded investment in impaired loans approximates the recorded investment in impaired loans at December 31, 2002. The valuation allowance above is included with and a part of the allowance for loan losses on the Company's balance sheet. F - 16 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- At December 31, 2002 and 2001, the Bank had loans to its executive officers, directors and their affiliates of $295,048 and $450,255, respectively. At December 31, 2002 and 2001, the Bank had commitments to extend credit to its executive officers, directors and their affiliates of $1,160,389 and $1,127,044, respectively. All such loans and commitments were made in the ordinary course of business on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties. An analysis of related party loans from January 1 to December 31 is as follows: 2002 2001 ---- ---- Balance January 1 $ 450,255 $ 415,954 Payments received (263,792) (187,028) Advances made 108,585 221,329 ------------ ----------- Balance December 31 $ 295,048 $ 450,255 ============ =========== 4. Premises and Equipment, Net --------------------------- The detail of premises and equipment, net at December 31, is as follows: 2002 2001 ---- ---- Land $ 619,168 $ 619,168 Buildings 3,317,755 3,252,099 Furniture and equipment 1,258,516 1,365,272 ------------------------------------ 5,195,439 5,236,539 Less accumulated depreciation 1,406,768 1,370,181 ------------------------------------ $ 3,788,671 $ 3,866,358 ==================================== Depreciation related to premises and equipment for the years ended December 31, 2002 and 2001 was $205,483 and $223,348, respectively. The Bank leases a parcel of real estate in Rogersville . The parcel is leased through September 1, 2009. The Bank subleased this parcel on January 15, 2000, to the town of Rogersville through January 1, 2006. The Bank leases a portion of a building in Rogersville used as a branch location. This lease expires on December 1, 2009. In addition, certain computer and other equipment is leased under various long term operating leases. Total net rental expense for these leases, net of sublease income of $12,000 per year, was $182,092 and $154,168 for December 31, 2002 and 2001, respectively. F - 17 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- Future net minimum rental commitments under noncancellable leases and subleases are as follows: Gross Net Year Rents Sublease Rents ---- ----- -------- ----- 2003 166,418 (12,000) $ 154,418 2004 129,393 (12,000) 117,393 2005 129,393 (12,000) 117,393 2006 118,411 - 118,411 2007 73,148 - 73,148 Thereafter 80,035 - 80,035 -------- --------- ------------ Total $696,798 $(36,000) $ 660,798 ======== ========= ============ 5. Deposits -------- Deposits at December 31, are summarized as follows: 2002 2001 ---- ---- Demand deposits $ 12,159,852 $ 11,334,627 NOW and money market accounts 20,790,523 18,455,488 Savings 7,062,092 6,111,829 Individual retirement accounts 2,404,901 2,204,479 Certificates of deposits - under $100,000 40,421,176 45,547,468 Certificates of deposits - over $100,000 17,119,213 20,255,764 ------------- ------------- $ 99,957,757 $ 103,909,655 ============= ============= The amounts and scheduled maturities of certificate accounts at December 31, are as follows: 2002 2001 ---- ---- Within one year $ 40,225,573 $ 60,590,293 After one but within two years 14,879,842 3,992,953 After two but within three years 2,219,974 1,187,986 After three but within four years 15,000 28,000 After four but within five years 200,000 4,000 ----------------- ----------------- $ 57,540,389 $ 65,803,232 ================= ================= Demand deposits reclassified as loans (overdrafts) aggregated approximately $38,000 at December 31, 2002 and 2001, respectively. F - 18 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- Deposits of executive officers, directors and their affiliates aggregated approximately $1,901,000 and $2,061,000 at December 31, 2002 and 2001, respectively. 6. Long-term debt -------------- The Company's long-term debt consists of a single note payable in the amount of $1,810,000 due an unaffiliated national bank. The interest rate on the note adjusts quarterly and is equal to the three-months London Interbank Offered Rate (Three Month LIBOR) plus 1.95% per annum or at the option of the Company the rate on the note is equal to the lender's index rate as such rate changes from time to time. The Company may change interest rate options at any time with prior notice to the lender. Interest is payable quarterly. At December 31, 2002 the rate on the note was 3.60875% per annum. Principal is payable annually commencing January 31, 1996 and each January 31 thereafter as follows: January 31, Principal Due ----------- ------------------ 2003 395,000 2004 435,000 2005 470,000 2006 (Final Maturity) 510,000 ------------------ $ 1,810,000 ================== The loan is secured by all of the stock of Citizens Bank of East Tennessee owned by the Company. The Company is in violation of certain loan covenants with respect to this loan in that annualized earnings to tangible assets are less than the 0.75% required and the ratio of nonperforming assets is greater than 2.5%. These violations have not been waived by the lender. Because of these violations, the lender may, at its option, by notice to the Company declare the note in default. In such an event the Company would have ten days to remedy compliance with all loan covenants. If the Company did not or could not comply with all loan covenants within such ten day period the note would be in default. In such a case the lender may declare the note immediately due and payable and among other things proceed to foreclose upon 100% of the stock of Citizens Bank of East Tennessee which is pledged as security for the note. The lender has been notified by the Company of its non-compliance with certain covenants of the note that could lead to the lender declaring the note in default. However, the lender has not notified the Company that it is in default under the terms of the loan agreement. The Company is in discussions with the lender and anticipates the lender to first pursue remedies other than foreclosure. Accordingly, the Company expects that the note will be restructured resulting in, among other things, increasing the interest rate on the note and substantially reducing the final maturity date on the note. In such a case, there can be no assurance that the Company could satisfy the restructured debt without obtaining new financing from other lenders or funds from a stock offering. Further, there can be no assurance that a stock offering by the Company would be successful or that new lenders would provide funds to the Company. F - 19 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- 7. FHLB Advances ------------- The Bank has an agreement with the Federal Home Loan Bank which allows it borrow up to an established amount. Any advances are secured by a blanket pledge of the Bank's qualifying 1-4 mortgage loans. The Bank is required to maintain eligible collateral representing 165 percent of the current outstanding balance of all advances. The Bank had no outstanding advances at December 31, 2002 and 2001. 8. Other Non-Interest Expenses --------------------------- The major components of other non-interest expense at December 31, are summarized as follows: 2002 2001 ---- ---- Directors fees $ 68,000 $ 76,500 Professional services 206,453 74,802 Postage and courier 78,851 59,613 Stationary and printing 99,269 87,085 Loss on other real estate owne 299,179 88,813 Other 638,747 547,509 ------------ ----------- Total other non-interest expense $ 1,390,499 $ 934,322 ============ =========== 9. Income Taxes ------------ The components of income tax expense are as follows: 2002 2001 ---- ---- Current $ 293,129 $ 296,140 Deferred (146,740) 46,859 ------------ ----------- $ 146,389 $ 342,999 ============ =========== The sources of deferred income taxes and the tax effect of each are as follows: 2002 2001 ---- ---- Accrual to cash conversion $ 1,721 $ 2,148 Provision for loan losses (77,524) 29,521 Accelerated depreciation (2,841) (9,352) FHLB stock dividends 6,280 8,655 Other Real Estate charge-offs (61,846) - Other, net (12,530) 15,887 ------------ ----------- $ (146,740) $ 46,859 ============ =========== F - 20 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 A reconciliation of the provision for income taxes as shown in the statements of earnings with that which would be computed by applying the statutory Federal income tax rate of 34 percent to income before income taxes is as follows: 2002 2001 ---- ---- Tax expense at statutory rate $ 181,208 $ 329,684 Increase (decrease) in taxes resulting from: Tax-exempt interest (74,301) (34,768) Amortization of goodwill - 6,080 State income taxes net of Federal income tax 22,911 38,860 Other, net 16,571 3,143 ----------- ----------- $ 146,389 $ 342,999 =========== =========== The components of the net deferred tax asset/liability recognized by the Company at December 31, are as follows: 2002 2001 ---- ---- Deferred tax liabilities: FHLB stock dividends $ (32,255) $ (25,975) Accumulated depreciation (48,570) (51,411) Unrealized gain on securities available for sale (217,679) - Other, net - (7,725) ----------- ----------- Total liabilities (298,504) (85,111) ----------- ----------- Deferred tax assets: Accrual to cash conversion - 1,721 Allowances for loan losses 266,815 189,291 Other real estate owned charge-off 61,846 - Unrealized loss on securities available for sale - 9,034 Other, net 4,805 - ----------- ----------- Total assets 333,466 200,046 ----------- ----------- Net deferred tax asset/liability $ 34,962 $ 114,935 =========== =========== 10. Commitments and Contingencies ----------------------------- The Bank is currently involved in litigation as the plaintiff in a suit against another financial institution involving a participation loan purchased from that financial institution. In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities that are not presented in the accompanying balance sheet. The commitments and contingent liabilities may include various guarantees, commitments to extend credit, standby letters of credit, and litigation. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance- sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk. F - 21 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- 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. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment. Standby 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. Most guarantees expire within one year with some having automatic one year renewals cancelable by the Company. The credit risk in issuing letters of credit is essentially the same as that involved in extending loans to customers. The following table summarizes the Company's significant commitments and contingent liabilities at December 31: 2002 2001 ---- ---- Commitments to extend credit $ 5,845,319 $ 4,281,297 Standby letters of credit 202,725 122,725 -------------- --------------- $ 6,048,044 $ 4,404,022 ============== =============== In the opinion of management, no material adverse effect on the financial position of the Company and its subsidiary is anticipated as a result of these items. 11. Cash and Due From Banks ----------------------- The Bank is required to maintain a minimum cash reserve with the Federal Reserve Bank and/or in vault cash. The minimum requirement at December 31, 2002 and 2001 was $470,000 and $483,000, respectively. At December 31, 2002, the Bank had cash on deposit of approximately $277,000 at other financial institutions in excess of the amounts insured by the FDIC 12. Stockholder's Equity --------------------- The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. F - 22 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- 13. 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 possible additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. The regulations require a bank to meet specific capital adequacy guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance- sheet items as calculated under regulatory accounting practices. The Bank's capital classification is also subject to qualitative judgments by the regulators about components, risk weights, 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 Tier I capital as defined in the regulations) to total average assets (as defined), and minimum ratios of Tier I and total capital (as defined) to risk-weighted assets (as defined). To be considered adequately capitalized (as defined) under the regulatory framework for prompt corrective action, the Bank must maintain minimum Tier I leverage, Tier I risk-based, and total risk-based ratios as set forth in the table. The Bank's actual capital amounts and ratios, at December 31, are also presented in the tables below.
December 31, 2002 ---------------------------------------------------- Capital Adequacy Prompt Corrective Action ------------------------------------ ---------------------------------- Required Actual Required Actual -------- ------ -------- ------ (In Thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- ------ ----- Tier I Capital (to average assets) $4,436 4.00% $8,116 7.32% $4,436 4.00% $8,116 7.32% ====== ===== ====== ===== ====== ===== ====== ===== Tier I Capital (to risk- weighted assets) $2,764 4.00% $8,116 11.73% $2,764 4.00% $8,116 11.73% ====== ===== ====== ====== ====== ===== ====== ====== Total Capital (to risk- weighted assets) $5,529 8.00% $8,983 13.00% $5,529 8.00% $8,983 13.00% ====== ===== ====== ====== ====== ===== ====== ====== December 31, 2001 ---------------------------------------------------- Capital Adequacy Prompt Corrective Action ------------------------------------ ---------------------------------- Required Actual Required Actual -------- ------ -------- ------ (In Thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- ------ ----- Tier I Capital (to average assets) $4,571 4.00% $8,122 7.10% $4,571 4.00% $8,122 7.10% ====== ===== ====== ===== ====== ===== ====== ===== Tier I Capital (to risk- weighted assets) $2,903 4.00% $8,122 11.19% $2,903 4.00% $8,122 11.19% ====== ===== ====== ====== ====== ===== ====== ====== Total Capital (to risk- weighted assets) $5,806 8.00% $9,030 12.44% $5,806 8.00% $9,030 12.44% ====== ===== ====== ====== ====== ===== ====== ======
F - 23 Based solely upon the foregoing ratios the Bank would be considered "well capitalized" within applicable Federal banking regulatory guidelines. The Company is a "small one-bank holding company" within the meaning of regulations promulgated by the Board of Governors of the Federal Reserve System. Accordingly, the Company's capital compliance, for bank holding company purposes, will be measured solely with respect to the Bank and not on a consolidated basis. Management believes, as of December 31, 2002, that the Bank and Company meet all capital requirements to which they are subject. However, events beyond the control of the Company, such as a downturn in the local economy, could adversely affect future earnings and, consequently, the ability of the Company to meet its future minimum capital requirements. As a result of certain findings in the Tennessee Department of Financial Institution's Report of Examination dated June 4, 2001, the Board of Directors of Bank entered into a Memorandum of Understanding (Memorandum), dated August 16, 2001, with the Commissioner of the Tennessee Department of Financial Institutions and the Memphis Regional Director of the Federal Deposit Insurance Corporation. A Memorandum of Understanding is an informal administrative tool for institutions that have some weaknesses that if not properly addressed and corrected could lead to supervisory concern requiring formal administrative action. The areas addressed in the Memorandum cover capital adequacy, laws and regulations, data processing audit and review, investment policy maturity strategies, adequate documentation of each of the foregoing but primarily credit administration. As a result, the Board has revised a number of the Bank's policies and procedures including its loan policy and has incorporated recommendations designed to strengthen credit quality and the Bank's review procedures regarding loan loss reserve adequacy. Management of the Company and the Bank believe that the Bank is in substantial compliance with the provisions of the Memorandum. As a result of certain findings in the Federal Reserve Bank's review of Volunteer Bancorp, Inc. as of September 17, 2002, the Company's Board of Directors adopted certain Board Resolutions as of October 31, 2002. Board Resolutions are recommendations of the Federal Reserve adopted by the Company's Board of Directors requesting that certain actions be taken to strengthen the financial condition of the Company and its subsidiary. The areas addressed in the Board Resolutions include restrictions on incurring additional debt, declaration and payment of dividends to the Company's shareholders, and certain capital transactions. Management of the Company believe that the Company is in substantial compliance with the provisions of the Resolutions. F - 24 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- 14. Condensed Financial Information ------------------------------- Following is condensed financial information of Volunteer Bancorp, Inc. Volunteer Bancorp, Inc. (Parent Company Only) Condensed Balance Sheets
December 31 ----------------------- 2002 2001 ---- ---- Assets: Cash $ 28,538 $ 59,536 Investment in subsidiary 8,485,186 8,106,525 Goodwill 131,259 131,259 Deferred income tax - 6,869 Tax benefit receivable 10,516 13,111 ------------------ ----------------- $ 8,655,499 $ 8,317,300 ================== ================= Liabilities and stockholders' equity Long-term debt $ 1,810,000 $ 2,170,000 Accrued interest payable 11,257 15,632 Stockholders' equity 6,834,242 6,131,668 ------------------ ----------------- $ 8,655,499 $ 8,317,300 ================== ================= Volunteer Bancorp, Inc. (Parent Company Only) Condensed Statements of Earnings Years Ended December 31 2002 2001 ---- ---- Income: Dividends from subsidiary $ 435,798 $ 485,336 ------------------ ----------------- Expenses: Interest 71,421 139,123 Professional services 21,115 40,212 Other (income) expenses (4,405) 12,869 ------------------ ----------------- Total expense 88,131 192,204 ------------------ ----------------- Income (loss) before tax benefit and equity in undistributed subsidiary income 347,667 293,132 Tax benefit 30,149 68,576 Equity in undistributed subsidiary income 8,761 264,951 ------------------ ----------------- Net income $ 386,577 $ 626,659 ================== =================
F-25 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- Volunteer Bancorp, Inc. (Parent Company Only) Condensed Statements of Cash Flows
Years Ended December 31 ----------------------- 2002 2001 ---- ----- Operating Activities: Net income $ 386,577 $ 626,659 Adjustment to reconcile net income to net cash provided by operating activities: Equity in undistributed subsidiary earnings (8,761) (264,951) Deferred income taxes 6,869 270 Amortization - 17,883 Decrease in other assets 2,595 89,871 (Decrease) in other liabilities (4,375) (21,193) ------------------ ----------------- Net cash provided by operating activities 382,905 448,539 ------------------ ----------------- Financing activities: Dividends paid (53,903) (75,464) Repayment of note payable (360,000) (325,000) ------------------ ----------------- Net cash(used) provided by financing activities (413,903) (400,464) ------------------ ----------------- Change in cash and equivalents (30,998) 48,075 Cash and equivalents - beginning 59,536 11,461 ------------------ ----------------- Cash and equivalents - ending $ 28,538 $ 59,536 ================== ================= Volunteer Bancorp, Inc. (Parent company only) Condensed Statements of Comprehensive Income Years Ended December 31 ----------------------- 2002 2001 ---- ---- Net income $ 386,577 $ 626,659 ------------------ ----------------- Other comprehensive income: Company's share of subsidiary's other comprehensive income (loss), net of tax 369,900 260,340 ------------------ ----------------- Total comprehensive (loss) income $ 756,477 $ 886,999 ================== =================
The Company is a legal entity separate and distinct from its banking subsidiary. The principal sources of cash flow for the Company, to pay dividends and service Company debt, are dividends from its banking subsidiary. There are statutory and regulatory limitations on the payment of dividends from banking subsidiaries to their parent companies as well as statutory and regulatory restrictions on the payment of dividends by the Company (note 12 and 13). F - 26 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- 15. Fair Value of Financial Instruments ----------------------------------- The fair value of financial instruments at December 31, are as follows:
2002 2001 ---- ---- Carrying Fair Carrying Fair Value Value Value Value -------- ------ -------- ------ Financial assets: Cash and due from banks $ 4,705,507 $ 4,713,642 $ 2,628,179 $ 2,628,179 Federal funds sold 4,450,000 4,450,000 6,275,000 6,275,000 Investment securities: 28,818,746 28,820,176 26,593,781 26,593,511 Loans, net 67,014,982 70,002,286 72,158,156 75,955,019 -------------------- -------------------- ------------------- ------------------- $ 104,989,235 $ 107,986,104 $ 107,655,116 $ 111,451,709 ==================== ==================== =================== =================== Financial liabilities: Deposits $ 99,957,757 $ 103,281,008 $ 103,909,655 $ 107,771,715 Securities sold under repurchase agreements 2,288,784 2,288,784 1,109,603 1,109,603 Long-term debt 1,810,000 1,810,000 2,170,000 2,170,000 -------------------- -------------------- ------------------- ------------------- $ 104,056,541 $ 107,379,792 $ 107,189,258 $ 111,051,318 ==================== ==================== =================== =================== Unrecognized financial instruments: Commitments to extend credit $ - $ - $ - $ - Standby letters of credit $ - $ - $ - $ - -------------------- -------------------- ------------------- ------------------- $ - $ - $ - $ - ==================== ==================== =================== ===================
F - 27 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value: Cash and Federal funds sold: For these short-term instruments, the carrying value is a reasonable estimate of fair value. Investments: Fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loans, net The fair value of fixed rate loans is estimated by discounting expected future cash flows using current rates at which similar fixed rate loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The carrying value of variable rate loans is assumed to approximate fair value. Deposits: The fair value of demand deposits, IRAs, savings accounts and NOW and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-rate- maturity certificates of deposits is estimated using the rates currently offered for deposits of similar remaining maturities using a discounted cash flow method. Securities sold under repurchase agreements: The fair value of fixed-rate term securities sold under repurchase agreements is estimated using the rates currently in effect offered for repurchase agreements of similar remaining maturities using a discounted cash flow method. Long-term debt: Rates currently available to the Company for debt with similar terms and maturities are used to estimate fair value of existing debt using a discounted cash flow method. Commitments to extend credit and standby letters of credit: The fair value of commitments is estimated by considering the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. For fixed rate loan commitments, fair value also considers current level of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements. For this caption, the "carrying amount" represents the accrual or deferred income (fees) arising from the related unrecognized financial instruments. 16. Profit-Sharing Plan ------------------- The Company's subsidiary, The Citizens Bank of East Tennessee, has a profit-sharing retirement plan. All employees who meet certain age and length of service requirements are eligible to participate on a voluntary basis. Benefits, which become 20% vested after two years, 40% after three years, 60% after four years, 80% after five years, and 100% after six years, are paid on death, disability or retirement. F - 28 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- The Board of Directors has discretion in establishing the amount of the Bank's contributions to the plan, if any. Beginning in 2002, a participant cannot elect to defer annually more than $11,000 (which amount shall increase by $1,000 each year to 2006) under all salary reduction arrangements with all employers in which the individual participates. Effective January 1, 2002, employees who are at least age 50 at any time during the calender year can make an additional $1,000 of "catch-up" elective deferrals (which "catch-up" amount will increase by $1,000 each year through 2006). The participants are fully vested in any voluntary contributions they make. The Bank contributed $15,910 and $18,530 to the plan for the years ended December 31, 2002 and 2001, respectively. 17. Securities Sold Under Repurchase Agreements ------------------------------------------- At December 31, 2002 and 2001, the carrying value of the securities sold under repurchase agreements, including accrued interest, was $3,924,710 and $2,895,706, respectively. The maximum amount outstanding during 2002 and 2001 was $2,364,513 and $1,109,603, respectively. The daily average of outstanding agreements during 2002 and 2001 was $1,748,884 and $991,783, respectively. The securities underlying the agreements are maintained under the Bank's control. 18. Reclassification ---------------- Certain reclassifications have been made to the December 31, 2001 financial statements in order to conform with the presentation of the December 31, 2001 financial statements. 19. Impact of Recently Issued Accounting Standards ---------------------------------------------- SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. This Statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. This statement replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguisments of Liabilities". It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS No. 125's provisions without reconsideration. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities. Those standards are based on consistent application of a financial- components approach that focuses on control. Under the approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The adoption of the provisions of this Statement did not have any material impact upon the financial position or results of operation of the Company. F - 29 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 -------------------------------------------------------------------------------- SFAS No. 142, "Goodwill and Other Intangible Assets", is effective for fiscal years beginning after December 15, 2001. This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supercedes APB Opinion No. 17, "Intangible Assets". It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Under this Statement, goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment. Intangible assets that have finite useful lives will continue to be amortized over their useful lives, but without the constraint of an arbitrary ceiling. This Statement provides specific guidance for testing goodwill for impairment. The adoption of the provisions of this Statement did have any material impact upon the financial position or results of operation of the Company. SFAS No. 147, "Acquisitions of Certain Financial Institutions - an Amendment of SFAS No. 72 and No. 144 and FASB Interpretation No. 9." SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions, and FASB Interpretation No. 9, "Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution is Acquired in a Business Combination Accounted for by the Purchase Method", provided interpretive guidance on the application of the purchase method to acquisitions of financial institutions. Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both Statement No. 72 and Interpretation No. 9 and requires that those transactions be accounted for in accordance with F=SFAS Statements No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible Assets". Thus, the requirement in paragraph 5 of Statement No. 72 to recognize (and subsequently amortize) any excess of the fair value liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset no longer applies to the acquisitions within the scope of this Statement. In addition, this statement amends SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", to include in its scope long-term customer-relationship intangible assets of a financial institutions such as depositor- and borrower-relationship intangible assets and credit card holder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that Statement No. 144 requires for other long-lived assets that are held and used. Paragraph 5 of this Statement, which relates to the application of the purchase method of accounting, is effective for acquisitions for which the date of acquisition is on or after October 1, 2002. The provisions in paragraph 6 related to accounting for the impairment or disposal of certain long-term customer-relationship intangible assets are effective on October 1, 2002. Transition provisions for previously recognized unidentifiable intangible assets in paragraphs 8 - 14 are effective on October 1, 2002, with earlier application permitted. The adoption of the provisions of this Statement did have any material impact upon the financial position or results of operation of the Company. F - 30 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001 SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of SFAS No. 123". This Statement amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide for alternative methods of transition for a voluntary change ot the fair value based method of accounting for sock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stack-based employee compensation and the effect of the method use on the reported results. This Statement permits tow additional transition methods for entities that adopt the preferable method of accounting for stock- based employee compensation. Both of those methods avoid the ramp-up effect arising from prospective application of the fair value based method. In addition, to address concerns raised by some constituents about the lack of comparability caused by multiple transition methods, this Statement does not permit the use of the original Statement No. 123 prospective method of transition for changes to the fair value based method made in fiscal years beginning after December 15, 2003. The adoption of the provisions of this Statement did have any material impact upon the financial position or results of operation of the Company. SFAS No. 149, "Accounting for Certain Financial Instruments with Characteristics of Liabilities and Equity" is expected to be issued in the first quarter of 2003. This Statement establishes standards for issuers' classification as liabilities in the statement of financial position of the following financial instruments that have characteristics of both liabilities and equity: (a) Financial instruments that are mandatorily redeemable on a fixed or determinable date or upon an event certain to occur even if the instrument si in th form of equity shares. (b) Financial instruments embodying, or indexed to, an obligation to repurchase an issuers' equity shares that requires or could require settlement by transfer of assets shall be classified as a liability (or in some circumstances as an asset). Examples include written put options or forward purchase contracts that are physically settled or net cash settled. (c) Financial instruments embodying an obligation that the issuer must or could settle by issuing a variable number of its equity shares shall be classified as a liability if the monetary value of the obligation is based solely or predominately on (a) a fixed monetary amount known at inception, (b) variations in something other than the fair value of the issuers' equity shares, or (c) variations in the fair value of the issuers' equity shares, but in the direction opposite to those variations. Examples include, but are not limited to, a payable settleable with a variable number of issuer shares, a financial instrument indexed to the S&P 500 and settleable with a variable number of issuer shares, and a written put option that could be net share settled. This Statement will be effective for all contracts created or modified after the date the Statement is issued and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. It will be effected by reporting the cumulative effect of a change in accounting principle for contracts created before the issuance date and still existing at the beginning of that interim period. For nonpublic companies, mandatory redeemable financial instruments have special presentation requirements and are subject to the provisions of this Statement for the first fiscal period beginning after December 15, 2003. The adoption of the provisions of this Statement is not anticipated to have any material impact upon the financial position or results of operation of the Company. 20. Selected Quarterly Financial Data (Unaudited) --------------------------------------------- Summarized below are selected financial data regarding results of operations for the periods indicated. F - 31 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 2002 and 2001
First Second Third Fourth Quarter Quarter Quarter Quarter Year ------------------- ------------------ ------------------ ------------------ ------------------ 2002 ------------------- ------------------ ------------------ ------------------ ------------------ Total interest income $ 1,829,512 $ 1,874,864 $ 1,769,573 $ 1,684,939 $ 7,158,888 Net interest income 1,107,894 1,249,725 1,206,847 1,150,782 4,715,248 Provision for loan losses 90,000 455,000 50,000 200,000 795,000 Non-interest income 105,478 99,777 130,414 163,497 499,166 Non-interest expense 894,175 1,090,092 915,309 987,332 3,886,908 Income before income taxes 229,197 (195,590) 371,952 127,407 532,966 (benefit) expense Net income (loss) $ 152,857 $ (110,055)$ 247,140 $ 96,635 $ 386,577 =================== ================== ================== ================== ================== Common shares outstanding 539,027 539,027 539,027 539,027 539,027 =================== ================== ================== ================== ================== Net income (loss) per common share outstanding $ 0.28 $ (0.20) $ 0.46 $ 0.18 $ 0.72 =================== ================== ================== ================== ================== First Second Third Fourth Quarter Quarter Quarter Quarter Year ------------------- ------------------ ------------------ ------------------ ------------------ 2001 ------------------- ------------------ ------------------ ------------------ ------------------ Total interest income $ 2,393,691 $ 2,353,824 $ 2,218,588 $ 2,020,868 $ 8,986,971 Net interest income 1,021,976 1,059,909 1,053,609 1,071,330 4,206,824 Provision for loan losses 75,000 85,000 - 105,000 265,000 Non-interest income 90,139 82,962 87,136 79,647 339,884 Non-interest expense 802,684 815,878 803,221 890,267 3,312,050 Income before income taxes 236,431 241,993 337,524 153,710 969,658 (benefit) Net income $ 152,197 $ 155,084 $ 214,769 $ 104,609 $ 626,659 =================== ================== ================== ================== ================== Common shares outstanding 539,027 539,027 539,027 539,027 539,027 =================== ================== ================== ================== ================== Net income per common share outstanding $ 0.28 $ 0.29 $ 0.40 $ 0.19 $ 1.16 =================== ================== ================== ================== ==================
F - 32 INDEPENDENT AUDITOR'S REPORT Our audit was made for the purpose of forming an opinion of the consolidated financial statements taken as a whole. The consolidating information represented on the following pages is presented for purposes of additional analysis and is not a required part of the consolidated financial statements. Such information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and, in our opinion, the information is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole. /s/ Welch & Associates, Ltd. February 6, 2003 Nashville, Tennessee F - 33 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidating Balance Sheet December 31, 2002
Volunteer Citizens Bank Consolidated Bancorp, of East Volunteer Inc. Tennessee Bancorp, Inc. ASSETS (Parent) (Subsidiary) Eliminations and Subsidiary ------ -------- ------------ ------------ -------------- Cash and due from banks $ 28,538 $ 4,705,507 $ (28,538) $ 4,705,507 Federal funds sold - 4,450,000 - 4,450,000 Investment in subsidiary 8,485,186 - (8,485,186) - Investment available for sale - 27,765,755 - 27,765,755 Investments held to maturity - 1,052,991 - 1,052,991 Loans, net - 67,014,982 - 67,014,982 Accrued interest receivable - 935,616 - 935,616 Premises and equipment - 3,788,671 - 3,788,671 Other real estate - 1,241,402 - 1,241,402 Deferred income taxes - 34,962 - 34,962 Goodwill 131,259 - - 131,259 Other assets 10,516 240,354 - 250,870 ------------ --------------- --------------- ----------------- Total assets $ 8,655,499 $ 111,230,240 $ (8,513,724) $ 111,372,015 ============ =============== =============== ================= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Liabilities: Deposits $ - $ 99,986,295 $ (28,538) $ 99,957,757 Accrued interest payable 11,257 400,065 - 411,322 Securities sold under repurchase agreements - 2,288,784 - 2,288,784 Other liabilities - 69,910 - 69,910 Long-term debt 1,810,000 - - 1,810,000 ------------ --------------- --------------- ------------------ Total liabilities 1,821,257 102,745,054 (28,538) 104,537,773 ------------ --------------- --------------- ------------------ Stockholders' equity: Capital stock 5,390 666,500 (666,500) 5,390 Additional paid-in capital 1,916,500 5,068,016 (5,068,016) 1,916,500 Retained earnings 4,557,192 2,395,510 (2,395,510) 4,557,192 Accumulated other comprehensive income 355,160 355,160 (355,160) 355,160 ------------ ---------------- --------------- ------------------ Total stockholders' equity 6,834,242 8,485,186 (8,485,186) 6,834,242 ------------ ---------------- --------------- ------------------ Total liabilities and stockholders' equity $ 8,655,499 $ 111,230,240 $ (8,513,724) $ 111,372,015 ============ ================ =============== ==================
F-34 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidating Balance Sheet December 31, 2001
Volunteer Citizens Bank Consolidated Bancorp, of East Volunteer Inc. Tennessee Bancorp, Inc. ASSETS (Parent) (Subsidiary) Eliminations and Subsidiary ------ -------- ------------ ------------ -------------- Cash and due from banks $ 59,536 $ 2,628,179 $ (59,536) $ 2,628,179 Federal funds sold - 6,275,000 - 6,275,000 Investment in subsidiary 8,106,525 - (8,106,525) - Investment available for sale - 25,966,922 - 25,966,922 Investments held to maturity - 626,859 - 626,859 Loans, net - 72,158,156 - 72,158,156 Accrued interest receivable - 1,066,479 - 1,066,479 Premises and equipment - 3,866,358 - 3,866,358 Other real estate - 1,144,770 - 1,144,770 Deferred income taxes 6,869 108,066 - 114,935 Goodwill 131,259 - - 131,259 Other assets 13,111 255,711 - 268,822 ------------ ------------- -------------- -------------- Total assets $ 8,317,300 $ 114,096,500 $ (8,166,061) $ 114,247,739 ============ ============= ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Liabilities: Deposits $ - $ 103,969,191 $ (59,536) $ 103,909,655 Accrued interest payable 15,632 878,715 - 894,347 Securities sold under repurchase agreements - 1,109,603 - 1,109,603 Other liabilities - 32,466 - 32,466 Long-term debt 2,170,000 - - 2,170,000 ------------ ------------- ------------- -------------- Total liabilities 2,185,632 105,989,975 (59,536) 108,116,071 ------------ ------------- ------------- -------------- Stockholders' equity: Capital stock 5,390 666,500 (666,500) 5,390 Additional paid-in capital 1,916,500 5,068,016 (5,068,016) 1,916,500 Retained earnings 4,224,518 2,386,749 (2,386,749) 4,224,518 Accumulated other comprehensive income (14,740) (14,740) 14,740 (14,740) ------------ ------------- ------------- -------------- Total stockholders' equity 6,131,668 8,106,525 (8,106,525) 6,131,668 ------------ ------------- ------------- -------------- Total liabilities and stockholders' equity $ 8,317,300 $ 114,096,500 $ (8,166,061) $ 114,247,739 ============ ============= ============= ==============
F - 35 VOLUNTEER BANCORP, INC. Consolidating Statement of Earnings December 31, 2002
Citizens Consolidated Volunteer Bank Volunteer Bancorp, of East Bancorp, Inc. Inc. Tennessee and (Parent) (Subsidiary) Eliminations Subsidiary ---------- ---------- ------------ ------------ Interest income: Interest and fees on loans $ - $ 5,710,663 $ - $ 5,710,663 Interest on federal funds - 73,631 - 73,631 Interest and dividends on investments: Taxable - 1,132,633 - 1,132,633 Exempt from federal income taxes - 241,961 - 241,961 ------------------ ------------------ ---------------- ------------------- Total interest income - 7,158,888 - 7,158,888 ------------------ ------------------ ---------------- ------------------- Interest expense: Interest on deposits - 2,322,582 - 2,322,582 Interest on other borrowed funds 71,421 49,637 - 121,058 ------------------ ------------------ ---------------- ------------------- Total interest expense 71,421 2,372,219 - 2,443,640 ------------------ ------------------ ---------------- ------------------- Net interest income (71,421) 4,786,669 - 4,715,248 Provision for possible loan losses - 795,000 - 795,000 ------------------ ------------------ ---------------- ------------------- Net interest income after loan provision (71,421) 3,991,669 - 3,920,248 ------------------ ------------------ ---------------- ------------------- Non-interest income: Equity in earnings of subsidiary 444,559 - (444,559) - Service charges - 297,299 - 297,299 Other income - 202,317 - 202,317 ------------------ ------------------ ---------------- ------------------- 444,559 499,616 (444,559) 499,616 ------------------ ------------------ ---------------- ------------------- Non-interest expense: Salaries and benefits - 1,834,197 - 1,834,197 Other 16,710 2,035,991 - 2,052,701 ------------------ ------------------ ---------------- ------------------- 16,710 3,870,188 - 3,886,898 ------------------ ------------------ ---------------- ------------------- Income before taxes 356,428 621,097 (444,559) 532,966 Income tax (benefit) expense (30,149) 176,538 - 146,389 ------------------ ------------------ ---------------- ------------------- Net income $ 386,577 $ 444,559 $ (444,559) $ 386,577 ================== ================== ================ ===================
F - 36 VOLUNTEER BANCORP, INC. Consolidating Statement of Earnings December 31, 2001
Citizens Consolidated Volunteer Bank Volunteer Bancorp, of East Bancorp, Inc. Inc. Tennessee and (Parent) (Subsidiary) Eliminations Subsidiary --------- ------------ ------------ ------------ Interest income: Interest and fees on loans $ - $ 7,136,898 $ - $ 7,136,898 Interest on federal funds - 233,982 - 233,982 Interest and dividends on investments: Taxable - 1,490,965 - 1,490,965 Exempt from federal income taxes - 125,126 - 125,126 ------------------ ------------------ ---------------- ------------------- Total interest income - 8,986,971 - 8,986,971 ------------------ ------------------ ---------------- ------------------- Interest expense: Interest on deposits - 4,581,452 - 4,581,452 Interest on other borrowed funds 139,123 59,572 - 198,695 ------------------ ------------------ --------------- ------------------- Total interest expense 139,123 4,641,024 - 4,780,147 ------------------ ------------------ --------------- ------------------- Net interest income (139,123) 4,345,947 - 4,206,824 Provision for possible loan losses - 265,000 - 265,000 ------------------ ------------------ --------------- ------------------- Net interest income after loan provision (139,123) 4,080,947 - 3,941,824 ------------------ ------------------ --------------- ------------------- Non-interest income: Equity in earnings of subsidiary 750,287 - (750,287) - Service charges - 164,833 - 164,833 Other income - 175,051 - 175,051 ------------------ ------------------ --------------- ------------------- 750,287 339,884 (750,287) 339,884 ------------------ ------------------ --------------- ------------------- Non-interest expense: Salaries and benefits - 1,742,511 - 1,742,511 Other 53,081 1,516,458 - 1,569,539 ------------------ ------------------ --------------- ------------------- 53,081 3,258,969 - 3,312,050 ------------------ ------------------ --------------- ------------------- Income before taxes 558,083 1,161,862 (750,287) 969,658 Income tax (benefit) expense (68,576) 411,575 - 342,999 ------------------ ------------------ --------------- ------------------- Net income $ 626,659 $ 750,287 $ (750,287) $ 626,659 ================== ================== =============== ===================
F - 37 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidating Statement of Cash Flows December 31, 2002
Citizens Consolidated Volunteer Bank Volunteer Bancorp, of East Bancorp, Inc. Inc. Tennessee and (Parent) (Subsidiary) Eliminations Subsidiary ----------------- ----------------- ----------------- ---------------- Cash Flows From Operating Activities: Net income $ 386,577 $ 444,559 $ (444,559) $ 386,577 Adjustments to reconcile net income to net cash provided by operating activities: Subsidiary earnings undistributed (8,761) - 8,761 - Deferred income taxes 6,869 (153,609) - (146,740) Provision for loan losses - 795,000 - 795,000 Depreciation and amortization - 205,483 - 205,483 Securities (gains) - (39,222) - (39,222) FHLB stock dividends - (16,400) - (16,400) Decrease in other assets 2,595 49,588 - 52,183 (Decrease) in other liabilities (4,375) (441,206) - (445,581) ----------------- ----------------- ----------------- ----------------- Net cash provided by operating activities 382,905 844,193 (435,798) 791,300 ----------------- ----------------- ----------------- ----------------- Cash Flows From Investing Activities: {Increase) in investment securities - (1,572,730) - (1,572,730) Decrease in loans - 4,348,174 - 4,348,174 Capital expenditures - (127,796) - (127,796) ----------------- ----------------- ----------------- ----------------- Net cash provided by investing activities - 2,647,648 - 2,647,648 ----------------- ----------------- ----------------- ----------------- Cash Flows From Financing Activities: (Decrease) in deposits - (3,982,896) 30,998 (3,951,898) Increase in securities sold under repurchase agreements - 1,179,181 - 1,179,181 Dividends paid (53,903) (435,798) 435,798 (53,903) Repayment of long-term debt (360,000) - - (360,000) ----------------- ----------------- ----------------- ----------------- Net cash (used) by financing activities (413,903) (3,239,513) 466,796 (3,186,620) ----------------- ----------------- ----------------- ----------------- Change in cash and equivalents (30,998) 252,328 30,998 252,328 Cash and equivalents - beginning 59,536 8,903,179 (59,536) 8,903,179 ----------------- ----------------- ----------------- ----------------- Cash and equivalents - ending $ 28,538 $ 9,155,507 $ (28,538) $ 9,155,507 ================= ================= ================= =================
F - 38 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidating Statement of Cash Flows December 31, 2001
Citizens Consolidated Volunteer Bank Volunteer Bancorp, of East Bancorp, Inc. Inc. Tennessee and (Parent) (Subsidiary) Eliminations Subsidiary ----------------- ----------------- ----------------- ------------------ Cash Flows From Operating Activities: Net income $ 626,659 $ 750,287 $ (750,287) $ 626,659 Adjustments to reconcile net income to net cash provided by operating activities: Subsidiary earnings undistributed (264,951) - 264,951 - Deferred income taxes 270 46,589 - 46,859 Provision for loan losses - 265,000 - 265,000 Depreciation and amortization 17,883 223,348 - 241,231 Securities (gains) - (25,260) - (25,260) FHLB stock dividends - (22,800) - (22,800) Decrease (increase) in other assets 89,871 (491,117) (102,982) (504,228) (Decrease) in other liabilities (21,193) (419,035) 102,982 (337,246) ----------------- ----------------- --------------- ----------------- Net cash provided by operating activities 448,539 327,012 (485,336) 290,215 ----------------- ----------------- --------------- ----------------- Cash Flows From Investing Activities: Decrease in investment securities - 363,400 - 363,400 Decrease in loans - 615,764 - 615,764 Capital expenditures - (37,662) - (37,662) ----------------- ----------------- --------------- ----------------- Net cash provided by investing activities - 941,502 - 941,502 ----------------- ----------------- --------------- ----------------- Cash Flows From Financing Activities: (Decrease) in deposits - (2,049,956) (48,075) (2,098,031) Increase in securities sold under repurchase agreements - 57,090 - 57,090 Dividends paid (75,464) (485,336) 485,336 (75,464) Repayment of long-term debt (325,000) - - (325,000) ----------------- ----------------- --------------- ----------------- Net cash (used) by financing activities (400,464) (2,478,202) 437,261 (2,441,405) ----------------- ----------------- --------------- ----------------- Change in cash and equivalents 48,075 (1,209,688) (48,075) (1,209,688) Cash and equivalents - beginning 11,461 10,112,867 (11,461) 10,112,867 ----------------- ----------------- --------------- ----------------- Cash and equivalents - ending $ 59,536 $ 8,903,179 $ (59,536) $ 8,903,179 ================= ================= =============== =================
F - 39 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Consolidating Statements of Comprehensive Income December 31, 2002 and 2001
December 31, 2002 ------------------------------------------------------------------------------------------------------------------------- Citizens Consolidated Volunteer Bank Volunteer Bancorp, of East Bancorp, Inc. Inc. Tennessee and (Parent) (Subsidiary) Eliminations Subsidiary -------- ------------ ------------ ------------ Net income $ 386,577 $ 444,559 $ (444,559) $ 386,577 ------------------ ----------------- ------------------ ------------------ Other comprehensive income, before tax: Unrealized gain on securities available or sale: Unrealized holding gains arising during the period - 635,835 - 635,835 Less: reclassification adjustments for gains included in net income - 39,222 - 39,222 ------------------ ----------------- ------------------ ------------------ Other comprehensive income - 596,613 - 596,613 Income taxes - (226,713) - (226,713) ------------------ ----------------- ------------------ ------------------ Other comprehensive income net of income taxes - 369,900 - 369,900 Company's share of subsidiary's other comprehensive income, net of tax 369,900 - (369,900) - ------------------ ----------------- ------------------ ------------------ Total comprehensive income $ 756,477 $ 814,459 $ (814,459) $ 756,477 ================== ================= ================== ================== December 31, 2001 -------------------------------------------------------------------------------------------------------------------------- Net income $ 626,659 $ 750,287 $ (750,287) $ 626,659 ------------------ ----------------- ------------------ ------------------ Other comprehensive income, before tax Unrealized gains on securities available for sale: Unrealized holding gains arising during the period - 445,164 - 445,164 Less: reclassification adjustments for (Losses) included in net income - 25,260 - 25,260 ------------------ ----------------- ------------------ ------------------ Other comprehensive income - 419,904 - 419,904 Income taxes - (159,564) - (159,564) ------------------ ----------------- ------------------ ------------------ Other comprehensive income net of income taxes - 260,340 - 260,340 Company's share of subsidiary's other comprehensive income, net of tax 260,340 - (260,340) - ------------------ ----------------- ------------------ ------------------ Total comprehensive income $ 886,999 $ 1,010,627 $ (1,010,627) $ 886,999 ================== ================= ================== ==================
F - 40