10KSB 1 vol10k2003.txt ANNUAL REPORT ON FORM 10-KSB SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 [ ] 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.) incorporation 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, 2003 were $6,905,274. The aggregate market value of the shares of Common Stock held by nonaffiliates of the registrant as of March 22, 2004 is approximately $4.8 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 22, 2004, Common Stock, $.01 par value, 539,027. Documents Incorporated by Reference: Current Report on Form 8-K filed July 21, 2003 (Part II hereof) and Proxy Statement for the 2004 Meeting of Shareholders (Part III hereof) 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 $108.9 million at December 31, 2003, 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 eight 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 us 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:
2003 2002 ------------------------------ ----------------------------- (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 $69,038 $4,977 7.21% $69,672 $5,711 8.20% U.S.Treasury and other U.S. government agencies 23,210 784 3.38% 23,468 1,117 4.76% States and municipalities 7,017 439 6.26% 5,541 367 6.62% FHLB stock 377 15 3.98% 361 16 4.43% Federal funds sold 1,877 24 1.28% 4,924 74 1.50% ------ --- ----- ------ ----- ----- Total interest-earning assets/interest income 101,519 6,239 6.15% 103,966 7,285 7.01% ------- ----- ------- ----- Cash and due from banks 2,708 2,936 Other assets 8,661 6,250 Allowance for loan losses (999) (995) ----- ----- Total $111,889 $112,157 ======== ======== Liabilities and stockholders'equity: Interest-bearing liabilities: Demand deposits $22,217 161 0.72% $19,303 239 1.24% Savings 7,067 27 0.38% 7,096 106 1.49% Individual retirement accounts 8,364 207 2.47% 8,768 284 3.24% Time certificates 49,639 1,204 2.43% 53,857 1,694 3.15% FHLB advances 0 0 0.00% 0 0 0.00% Fed funds purchased 196 3 1.53% 0 0 0.00% Securities sold under repurchase 1,666 32 1.92% 1,749 50 2.86% Note payable 1,448 48 3.31% 1,841 71 3.86% ----- -- ----- -- Total interest-bearing liabilities/interest expense 90,597 1,682 1.86% 92,614 2,444 2.64% ------ ----- ------ ----- Non-interest bearing demand deposits 13,694 12,276 Other liabilities 523 677 Stockholders' equity 7,075 6,590 ----- ----- Total $111,889 $112,157 ======== ======== Net interest earnings 4,557 $4,841 ----- ------ Net interest spread 4.29% 4.37% ----- ----- Net interest margin 4.49% 4.66% ----- ----- Performance Ratios and Other Data Return on average assets 0.54% 0.34% Return on average equity 8.55% 5.87% Cash dividends declared $0 $53,903 Dividend payout ratio 0 13.94% Net income $604,622 $386,577
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, 2003 2002 versus versus December 31, December 31, 2002 2001 Increases (decreases) Increases (decreases) (Dollars in Thousands) Change Due To: (1) Change Due To: (1) Volume Rate Total Volume Rate Total Loans net of unearned income $ (52) $ (682) $ (734) $ (460) $ (966) $ (1,426) U.S. Treasury and other U.S. Government agencies (12) (321) (333) (56) (295) (351) States and municipalities 94 (22) (72) 175 2 177 FHLB stock 1 (2) (1) 1 (8) (7) Federal funds sold (40) (10) (50) (23) (137) (160) ------------------------------------- --------------------------------------- Total interest income $ (9) $ (1,037) $ (1,046) $ (363) $ (1,404) $ (1,767) ===================================== ======================================= Increase (decrease) in: Demand deposits $ 45 $ (123) $ (78) $ (34) $ (371) $ (405) Savings 0 (79) (79) 31 (60) (29) Individual retirement accounts (13) (64) (77) (2) (185) (187) Time certificates (125) (365) (490) (215) (1,422) (1,637) FHLB advances 0 0 0 (7) 0 (7) Fed funds purchased 3 0 3 0 0 0 Securities sold under repurchase (2) (16) (18) (34) (37) (5) Note payable (14) (9) (23) (16) (52) (68) ------------------------------------- --------------------------------------- Total interest expense $ (106) $ (656) $ (762) $ (207) $ (2,127) $ (2,336) Increase (decrease in net interest income $ 97 $ (381) $ (284) $ (154) $ 723 $ 569 ===================================== =======================================
(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 4 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 our liquidity and funds position. The Committee regularly reviews (a) the rate 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 use 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, 2003, we had a negative cumulative repricing gap within one year of approximately $40 million, or approximately 40.85% 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 our interest sensitivity profile as of December 31, 2003 and 2002. 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, 2003 ----------------------------------------------------- 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 $26,074 $9,733 $16,289 $17,535 $69,631 Investment securities: Available for sale 1,372 20 12,583 12,101 26,076 Held to maturity - 265 445 - 710 Equity securities 1,386 - - - 1,386 Federal funds sold 354 - - - 354 ------- ------- Total earning assets $29,186 $10,018 $29,317 $29,636 $98,157 ======= ======= ======= ======= ======= Interest-bearing liabilities: Interest-bearing deposits $46,317 $28,763 $7,066 - $82,146 Securities sold under repurchase agreements 746 613 - - 1,359 Federal funds purchased 1,450 - - - 1,450 Long-term debt 1,415 - - - 1,415 ------- ------- Total interest-bearing liabilities $49,928 $29,376 $7,066 $ - $86,370 ======= ======= ====== ===== ======= Net repricing gap ($20,742) ($19,358) $22,251 $29,636 $11,787 --------- --------- ------- ------- ------- Rate sensitivity gap: Net repricing gap as a percentage of total earning assets (21.13%) (19.72%) 22.67% 30.19% 12.01% --------- --------- --------- ------- ------ Cumulative gap ($20,742) ($40,100) ($17,849) $11,787 --------- --------- --------- ------- Cumulative gap as a percentage of total earning assets (21.13%) (40.85%) (18.18%) 12.01% -------- -------- -------- -------
5
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 FHLB stock 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% --------- --------- --------- ------
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, 2003 and 2002.
December 31 --------------------------- 2003 2002 ---- ---- Non interest-bearing deposits: Individuals, partnerships and corporations $12,513 $11,036 U.S. Government and states and political subdivisions 251 716 Commercial banks and other depository institutions 36 63 Certified and official checks 408 345 ------ ------ Total non-interest bearing deposits 13,208 12,160 ------ ------ Interest-bearing deposits: Interest-bearing demand accounts 20,895 20,791 Savings accounts 7,355 7,062 Individual retirement accounts 2,300 2,405 Certificates of deposit, less than $100,000 36,502 40,421 Certificates of deposit, greater than $100,000 16,453 17,119 ------ ------ Total interest-bearing deposits 83,505 87,798 ------ ------ Total deposits $96,713 $99,958 ======= =======
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, --------------------------------------------------------- 2003 2002 ---- ---- Non-interest bearing deposits $13,694 $12,276 Savings deposits 7,067 .38% 7,096 1.49% Individual retirement accounts 8,364 2.47% 8,768 3.24% Time deposits 49,639 2.43% 53,857 3.15% Interest bearing demand deposits 22,217 .72% 19,303 1.24% -------- -------- Total deposits $100,981 $101,300 ======== ========
At December 31, 2003 and 2002, time deposits greater than $100,000 aggregated approximately $16 million and $17 million, respectively. The following table indicates, as of December 31, 2003 and 2002, the dollar amount of $100,000 or more deposits by time remaining until maturity:
December 31, 2003 December 31, 2002 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 $5,140 8,948 2,365 $16,453 $2,948 6,785 7,386 $17,119 ------ ----- ----- ------- ------ ----- ----- -------
7 SHORT-TERM BORROWINGS Short-term borrowings are generally comprised of federal funds purchased and repurchase agreements. Federal funds purchased are overnight borrowings from various correspondent banks. Repurchase agreements are advances by customers that are not covered by federal deposit insurance. This obligation of the bank is secured by bank-owned securities held in safekeeping at a correspondent bank. The balances at year-end are shown below: Repurchase Federal Funds Agreements Purchased ---------- ------------- (Amounts in thousands) Outstanding at December 31, 2003 $ 1,359 $ 1,450 Average interest rate at year-end 1.27% 1.25% Average balance during year 1,666 196 Average interest rate during year 1.92% 1.53% Maximum month end balance during year 2,103 2,275 Outstanding at December 31, 2002 $ 2,289 $ 0 Average interest rate at year-end 2.47% 0% Average balance during year 1,749 0 Average interest rate during year 2.86% 0% Maximum month end balance during year 2,365 0 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, 2003 and 2002. December 31, ------------------------- 2003 2002 ---- ---- (In thousands) Investment securities: Available for sale U.S. Government and agencies $18,959 $19,392 Obligations of states and political FHLB stock 386 371 FNMA preferred stock 1,000 1,460 ----- ----- Total available for sale 27,462 27,766 Held to maturity 710 1,053 Federal funds sold 354 4,450 Loans: Real estate 55,580 50,702 Commercial and other 14,051 17,423 ------ ------ Total loans 69,631 68,125 Interest earning assets $98,157 $101,394 ======= ======== 8 INVESTMENT PORTFOLIO At year end 2003, 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, 2003 and 2002: December 31, ------------------------- 2003 2002 ---- ---- (In thousands) Held to maturity: Obligations of U.S. Government agencies $710 $1,053 ---- ------ Available for sale: U.S. Treasury securities 0 $515 Obligations of U.S. Government agencies 18,959 18,877 Obligations of states and political subdivisions 7,117 6,543 FNMA preferred stock 1,000 1,460 FHLB stock 386 371 ------- ------- $27,462 $27,766 ======= ======= 9 The following table presents the maturity distribution of the amortized cost and estimated market value of our debt securities at December 31, 2003 and 2002. The weighted average yields on these instruments are presented based on final maturity. Yields on states and political subdivisions have been adjusted to a fully-taxable equivalent basis.
December 31, 2003 December 31, 2002 --------------------------------- -------------------------------- 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 Due after 5 years but within 10 years 690 697 6 7 Due after 10 years 20 20 1,047 1,047 ---- ---- ------ ------ Total $710 $717 4.05% $1,053 $1,054 4.82% ==== ==== ====== ====== Available for sale: ------------------ U.S. Securities: Due within 1 year 0 0 501 515 Due after 1 year but within 5 years Total 0 0 0% 501 515 5.44% ---- ---- --- --- Obligations of U.S. Government agencies: Due within 1 year 38 38 Due after 1 year but within 5 years 1,320 1,345 6,113 6,213 Due after 5 years but within 10 years 6,663 6,693 6,775 6,912 Due after 10 years 10,872 10,921 5,545 5,714 ------ ------ ----- ----- Total 18,855 18,959 3.44% 18,471 18,877 4.68% ------ ------ ------ ------ Obligations of states and political subdivisions Due after 1 year but within 5 years 901 940 495 515 Due after 5 years but within 10 years 3,343 3,455 2,365 2,414 Due after 10 years 2,627 2,722 3,516 3,614 ------- ------- ------- ------- Total 6,871 7,117 6.04% 6,376 6,543 5.92% ------- ------- ------- ------- $25,726 $26,076 4.13% $25,348 $25,935 4.87% ======= ======= ======= ======= Equity securities with No stated maturity: FHLB stock $386 $386 $371 $371 FNMA stock 1,000 1,000 1,475 1,460 ------ ------ ------ ------ $1,386 $1,386 3.84% $1,846 $1,831 4.55% ====== ====== ====== ======
10 INVESTMENT POLICY The objective of our investment policy is to invest funds not otherwise needed to meet the loan demand of our 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. The CEO 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 us needed liquidity and longer term securities purchased to generate level income for us over periods of interest rate fluctuations. Our investment securities portfolio of $28,172,007 at December 31, 2003, consisted of $709,910 of securities held to maturity, which are carried at amortized cost and $27,462,097 of securities available for sale which are carried at market value. In addition, unrealized gains on investment securities available for sale were $404,783 and unrealized losses were $54,562. 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 $592,270 and unrealized losses were $19,431. As reflected in Note 2 to Consolidated Financial Statements, the investment securities held to maturity had unrealized gains of $7,446 at December 31, 2003, compared to $1,430 unrealized gains at year end December 31, 2002. LOAN PORTFOLIO Total loans of $69,631 at December 31, 2003, reflected an increase of $1,506 compared to total loans for the year ended December 31, 2002. Residential real estate loans, which historically have had low loss experience, increased $3,841 or 12.2%. Construction and land development loans, loans secured by farmland and commercial real estate loans increased by $1,037 or 5.4%. Commercial and industrial loans and agricultural loans decreased by $1,691 or 23.16%. 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 $2,192 or 22.02%. 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 our loan portfolio as December 31, 2003 and 2002. 11 December 31, ----------------------------- (In thousands) 2003 2002 ---- ---- Real estate loans: Construction and land development $992 $2,647 Secured by farmland and improvements 823 1,403 Secured by residential properties 35,323 31,482 Commercial real estate loans 18,442 15,170 ------ ------ Total real estate loans 55,580 50,702 Loans to farmers 890 1,413 Commercial and industrial loans 4,721 5,889 Installment loans 5,588 7,725 Other consumer loans 2,178 2,233 All other loans 674 163 --- --- Total loans $69,631 $68,125 ======= ======= The following table sets forth the maturities of the loan portfolio and the sensitivity to interest rate changes of that portion of our loan portfolio that matures after one year.
December 31, 2003 ----------------------------------------------------- Maturity Range ----------------------------------------------------- One Year One Through Over or Less Five Years Five Years Total (In thousands) Real estate construction loans $678 $10 $304 $992 Real estate mortgage loans 17,253 10,694 26,641 54,588 Commercial and industrial loans 3,212 1,397 112 4,721 Agricultural loans 715 175 0 890 All other loans 2,626 4,738 1,076 8,440 ----- ----- ----- ----- Total loans $24,484 $17,014 $28,133 $69,631 ======= ======= ======= =======
The sensitivity to interest rate changes of that portion of our 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, 2003 (in thousands); Fixed rate $27,146 Floating rate 12,187 ------ $39,333 Other loans maturing after one year: 12 Fixed rate $5,190 Floating rate 624 ------- $5,814 ------- Total loans maturing after one year $45,147 ------- 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. Our 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. 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. 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 our 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 where 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 13 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 our company. 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 our 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 probable incurred loan losses. The reserve is determined by management, based on formulas and techniques applied similar to those used by the Bank's regulatory agencies. The reserve for loan losses was $911,538 at year end 2003, or 1.31% of loans outstanding, net of unearned income, compared to $1,110,481 or 1.63% at year end 2002. 14 RESERVE FOR LOAN LOSSES The following table presents the data related to our reserve for loan losses for the years ended December 31, 2003 and 2002: December 31, ---------------------------- 2003 2002 -------- ---------- (In thousands) Balance at beginning of period $1,110 $ 908 Charge offs: Commercial, financial and agricultural (129) (174) Real estate mortgage (400) (90) Installment loans to individuals (183) (371) ------- ------- (712) (635) ------- ------- Recoveries: Commercial, financial and agricultural 1 7 Real estate mortgage Installment loans to individuals 47 35 ------- ------- 48 42 ------- ------- Net charge offs (664) (593) ------- ------- Additions charged to operations 465 795 ------- ------- Balance at end of period $911 $1,110 ------- ------- Ratio of net charge offs during the period to average loans outstanding during the period 0.96% 0.85% ------- ------- Average allowance for loan losses to average total loans 1.32% 1.43% ------- ------- At December 31, 2003 and 2002, the allowance for loan losses was allocated as follows: (In thousands)
December 31, 2003 December 31, 2002 -------------------- ------------------- Percent of Percent of Amount category Amount category ------ ---------- ------- ---------- Commercial, financial and agricultural $102 9.03% $236 10.96% Real estate mortgage 598 79.82% 178 74.42% Installment loans to individuals 211 11.15% 696 14.62% ------ ---------- ------- --------- 911 100.00% $1,110 100.00% ------ ---------- ------- ---------
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. The following table sets forth information with respect to our nonperforming loans 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. 15
Non-performing assets (In thousands) December 31 --------------------------- 2003 2002 ---- ---- Nonaccrual loans $175 $923 Restructured loans - - Other loans past due 90 days or more to principal or interest payments $1,035 $673 Non-performing loans as a percentage of net loans before allowance for loan losses 1.74% 2.34% Allowance for loan losses as a percentage of nonperforming loans 75.29% 69.55% Foregone interest on nonaccrual loans $ 5 $ 37
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 our operating, investing and financing activities. In order to insure funds are available at all times, we devote resources to projecting on a monthly basis the amount of funds which will be required and maintain 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, our 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: 2003 2002 ---- ---- Average loans to average deposits 68.37% 68.78% 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 our operations 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. 16 IMPACT OF PROSPECTIVE ACCOUNTING STANDARDS For discussion regarding the impact of new accounting standards, refer to Note 1 of Notes to Consolidated Financial Statements. 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 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. 17 December 31 December 31 2003 2002 ---- ---- (Dollars in thousands) Capital: Tier I capital: Stockholders' common equity $ 7,301 $ 6,834 Accumulated comprehensive income (217) (355) Disallowed intangibles (131) (131) --------- --------- Total Tier I capital 6, 953 6,348 Tier II capital: ALL 901 867 --------- -------- Total capital $ 7,854 $ 7,215 --------- -------- Risk-adjusted assets $ 72,050 $ 69,115 Quarterly average assets $109,820 $111,032 Ratios: Tier I capital to risk-adjusted assets 9.65% 9.18% Total capital to risk-adjusted assets 10.90% 10.44% Leverage - Tier I capital to quarterly average assets less disallowed intangibles 6.33% 5.72% 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. 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, 2003 and 2002, the Bank and Volunteer exceeded the regulatory minimums and qualified under the regulations as well capitalized. 18 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 our company as of September 17, 2002, our Board of Directors adopted certain Board Resolutions as of October 31, 2002. Board Resolutions are recommendations of the Federal Reserve adopted by our Board of Directors requesting that certain actions be taken to strengthen our financial condition and that of our subsidiary. The areas addressed in the Board Resolutions include restrictions on incurring additional debt, declaration and payment of dividends to our shareholders, and certain capital transactions. Our management believes that we are in substantial compliance with the provisions of the Resolutions. 19 PAYMENT OF DIVIDENDS We are a legal entity separate and distinct from our banking subsidiary. The principal source of cash flow of our company, including cash flow to pay dividends on its stock or principal 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 us, as well as by us to our 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." 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 us 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 our company, a bank's loans or extensions of credit to third parties, collateralized by the securities or obligations of our company, the issuance of guaranties, acceptances and letters of credit on behalf our company, and certain bank transactions with our company, or with respect to which we act as agent, participate or have a financial interest. Subject to certain limited exceptions, the Bank may not extend credit to us 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 our company or to such other affiliates. Also, extensions of credit and other transactions between the Bank and our company 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, we and our 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 we are 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 we may ourself be a creditor with recognized claims against the subsidiary. 20 Under Federal Reserve Board policy, we are 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, we 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-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 our 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 21 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, 2003, 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 our business and that of the Bank may be affected. 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, 2003, 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 22 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 us 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 our business and that of 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 our business and the business of Bank subsidiaries may be affected thereby. EMPLOYEES At December 31, 2003, we had a total of 55 employees with 6 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 There are no material pending legal proceedings to which we 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, 23 officer or affiliate or any principal security holder of our company, or any associate of any of the foregoing, is a party or has an interest adverse to us 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 22, 2004. 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 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, 2003 and 2002. 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 2003 was $604,622 increasing $218,045 compared with net income of $386,577 for 2002. Our return on average assets was 0.54% for 2003 compared to 0.34% for 2002. Our return on average equity increased to 8.55% for 2003 compared with 5.87% for 2002. Our net income for 2003 and 2002 was impacted by the following: 24 -- The yield on average interest earning assets was 6.15% for 2003 decreasing 86 basis points from 7.01% for 2002. - Average earning assets decreased $2,447,000 to $101,519,000 for 2003 compared to $103,966,000 for 2002. -- Yield on average interest bearing liabilities decreased 78 basis points from 2.64% in 2002 to 1.86% for 2003. -- Average interest bearing liabilities decreased $2,017,000 to $90,597,000 for 2003 compared to $92,614,000 for 2002. -- Average interest earning assets to average total assets decreased slightly from 92.70% for 2002 to 90.73% for 2003. -- Average interest bearing liabilities to average total assets decreased from 82.58% for 2002 to 80.97% for 2003. As a result of the foregoing net interest income as a percentage of average interest earning assets decreased from 4.66% for 2002 to 4.49% for 2003. Accordingly, net interest income for 2003 of $4,408,075 was $307,173 less than net interest income of $4,715,248 for 2002. Net interest income for 2003 was positively impacted by a decrease in interest expense of $23,838 on parent company only borrowings. Average parent company only borrowings were $1,448,000 for 2003 or a decrease of $393,000 compared to 2002 of $1,841,000. The decrease of $23,838 was attributable to a decrease in the average rate on such outstanding borrowings from 3.86% for 2002 to 3.31% for 2003. 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. We are 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 us declare the note in default. In such an event we would have ten days to remedy compliance with all loan covenants. If we 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 The Citizens Bank of East Tennessee which is pledged as security for the note. We have notified the lender 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. We are in discussions with the lender and anticipate the lender to first pursue remedies other than foreclosure. Accordingly, we expect 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 we 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 us would be successful or that new lenders would provide funds to us. 25 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, 2003 and 2002.
2003 2002 ----------------------------------- ---------------------------------- (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 $ 69,038 $4,977 7.21% $ 69,672 $ 5,711 8.20% U.S. Treasury and other U.S. government agencies 23,210 784 3.38% 23,468 1,117 4.76% States and municipalities 7,017 439 6.26% 5,541 367 6.62% FHLB stock 377 15 3.98% 361 16 4.43% Federal funds sold 1,877 24 1.28% 4,924 74 1.50% -------- ------ -------- ------- assets/interest income 101,519 6,090 6.00% 103,966 7,285 7.01% -------- ------ -------- ------- Cash and due from banks 2,708 2,936 Other assets 8,661 6,250 Allowance for loan losses (999) (995) -------- -------- Total $111,889 $112,157 -------- -------- Liabilities and stockholders' equity: Interest-bearing liabilities: Demand deposits $ 22,217 $161 0.72% $ 19,303 $ 239 1.24% Savings 7,067 27 0.38% 7,096 106 1.49% Individual retirement accounts 8,364 207 2.47% 8,768 284 3.24% Time certificates 49,639 1,204 2.43% 53,857 1,694 3.15% FHLB advances 0 0 0.00% 0 0 0.00% Fed funds purchased 196 3 1.53% Securities sold under repurchase 1,666 32 1.92% 1,749 50 2.86% Note payable 1,448 48 3.31% 1,841 71 3.86% -------- ------ -------- ------- Total interest-bearing liabilities/interest expense 90,597 1,682 1.86% 92,614 2,444 2.64% -------- ------ -------- ------- Non-interest bearing demand deposits 13,694 12,276 Other liabilities 523 677 Stockholders' equity 7,075 6,590 -------- -------- Total $111,889 $112,157 ======== -------- Net interest earnings 4,557 $ 4,841 ------ ------- Net interest on interest earning assets 4.49% 4.66% ----- ----- Performance ratios and other data Return on average assets 0.54% 0.34% Return on average equity 8.55% 5.87% Cash dividends declared $0 $53,903 Dividend payout ratio 0 13.94% Net income $604,684 $386,577
26 NONINTEREST EXPENSE Non-interest expense increased $51,226 from $3,886,898 for 2002 to $3,938,124 for 2003. Non-interest expense as a percentage of average assets increased by 0.05% from 3.47% in 2002 to 3.52% for 2003. The following table presents non-interest expense for 2003 compared to 2002 and as a percentage of average assets for each year (in thousands):
% Average % Average 2003 Assets 2002 Assets ---- ------- ---- ------ Salaries and employee benefits $1,970 1.76% $1,846 1.65% Occupancy, net 247 .22 263 0.23% Furniture and equipment 387 .35 399 0.36% Directors fees 72 .06 68 0.06% Advertising 27 .02 31 0.03% FDIC insurance 46 .04 48 0.04% Office supplies 96 .09 133 0.12% Professional services 218 .19 206 0.18% Telephone 66 .06 53 0.05% Postage and courier 88 .08 79 0.07% Loss on other real estate owned 97 .09 299 0.27% Other 624 .56 462 0.41% ------ ------ $3,938 3.52% $3,887 3.47% ====== ===== ====== =====
Non-interest expenses increased 1.35% in absolute terms from 2002 to 2003 and increased as a percentage of average total assets. The increase is primarily attributable to an increase in salaries and employee benefits. The provision for loan losses in 2003 was $465,000 and for 2002 was $795,000. 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 us, historic loan-loss experience, loan mix and the level of loans relative to reserves. Non-interest income increased $281,292 from $499,616 in 2002 to $780,908 in 2003 primarily due to an increase in service charges on deposit accounts and gains on sales of securities. Income tax expense increased $34,848 from $146,389 in 2002 to $181,237 in 2003. FINANCIAL POSITION Our total assets decreased 2.42% or $2.69 million during 2003 to $108.68 million at year end 2003 from $111.37 million at year end 2002. This decrease is primarily attributable to a decrease of $4.17 million in deposits and securities sold under repurchase agreements during 2003 to $98.07 million at year end 2003 from $102.25 million at year end 2002. Portfolio securities decreased $650,000 in 2003 to $28.17 million at year end 2003 from $28.82 million at year end 2002 while federal funds decreased $4.1 million during 2003. 27 Loans increased $1.51 million during 2003 to $69.63 million at year end 2003 compared to $68.12 million at year end 2002. Real estate and commercial mortgage loans increased $4.88 million in 2003 and consumer loans decreased $2.2 million in 2003. Real estate mortgage loans represented 79.82% of gross outstanding loans at year end 2003. Consumer loans represented 11.15% of gross outstanding loans at year end 2003. Commercial loans represented 6.78% of gross outstanding loans at year end 2003. Deposits and securities sold under repurchase agreements decreased $4.17 million in 2003 from $102.25 million at year end 2002 to $98.07 million at year end 2003. CAPITAL REQUIREMENTS Our equity capital was $7.30 million at year end 2003 compared to $6.83 million at year end 2002. This increase of approximately $466,600 consists of our net income for 2003 of $604,622 less the decrease in the accumulated other comprehensive income of $138,022. No dividends were paid in 2003. We are a "small one-bank holding company" within the meaning of regulations promulgated by the Board of Governors of the Federal Reserve System. Accordingly, our 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, 2003, 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, 2003. 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. The consolidated statement of cash flows provides an indication of the cash in-flows and out-flows and the Company's ability to meet its liquidity needs. Additionally, the Bank has established relationships with correspondent banks and the FHLB to borrow an additional approximately $14 million to meet liquidity requirements. 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, 2003 we had a cumulative one year negative gap of (40.85%) or a net of $40.10 million in liabilities repricing faster than assets. 28 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 $1,210,115 at year end 2003 compared to $1,595,984 at year end 2002 representing a decrease of $385,869. Non-performing loans as a percentage of net loans before the allowance for loan losses was 1.74% at year end 2003 and 2.34% at year end 2002. 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 75.29% at year end 2003 and 69.55% at year end 2002. Other real estate owned increased $292,347 to $1,533,749 at year end 2003 compared to $1,241,402 at year end 2002. We had no material restructured loans in 2003 or 2002. The level of non-accrual loans is primarily comprised of installment/consumer loans. Seventy-four percent of other real estate owned relates to one real estate development project. The remaining twenty-six percent consists of one-to-four family mortgage loans. 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. 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. 29 Item 7. Financial Statements Index to Consolidated Financial Statements: Page ---- Independent Auditor's Report.............................................F-1 Consolidated Balance Sheets at December 31, 2003 and 2002................F-2 Consolidated Statements of Income for the years ended December 31, 2003 and 2002..........................................F-3 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2003 and 2002......................F-4 Consolidated Statements of Cash Flows for the years ended December 31, 2003 and 2002....................................F-5 Notes to Consolidated Financial Statements...............................F-6 Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure The information called for by this item is incorporated by reference to our Current Report on Form 8-K which was filed with the Securities and Exchange Commission on July 21, 2003. Item 8A. Controls and Procedures An evaluation was conducted under the supervision and with the participation of our management, including our Chief Executive Officer and President and our Senior Vice President and Cashier, of the effectiveness of Volunteer's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and President and Senior Vice President and Cashier have concluded that our disclosure controls and procedures are, to the best of their knowledge, effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There were no significant changes in our internal control over financial reporting that occurred during the last fiscal quarter covered by this report that have materially affected or are reasonably likely to materially affect our internal control over financial reporting. 30 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 (54) 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 (63) has served as a Director since 1994. Mr. Price is retired and was the former Executive for Hawkins County, Tennessee. William E. Phillips (56) 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 (57) has served as a Director since 1994. Mr. Varnell is the manager of a retail office products store in Rogersville, Tennessee. George L. Brooks (74) has served as a Director since 1994. Mr. Brooks retired from Citizens Union Bank in 1993 and resides in Rogersville, Tennessee. Shirley A. Price (69) has served as a Director since 1994. Ms. Price is an insurance agent in Rogersville, Tennessee. Leon Gladson (78) has served as a Director since 1994. Mr. Gladson is a retired businessman and resides in Rogersville, Tennessee. Neil D. Miller (84) has served as a Director since 1994. Mr. Miller is a farmer in Rogersville, Tennessee. M. Carlin Greene (61) has served as a Director since 1994. Mr. Greene is a real estate agent and farmer in Sneedville, Tennessee. Scott F. Collins (55) has served as a Director since 1994. Mr. Collins is the Hancock County Clerk & Master in Sneedville, Tennessee. Lawrence E. Gray (59) has served as a Director since 1994 and formerly served as Executive Vice President of the Bank. Jim Friddell (53) has served as a Director since 2002. Mr. Friddell is the former president of Tennessee State Bank and currently resides in Rogersville, Tennessee. None of our directors is a director or executive officer of another bank holding company, bank, savings and loan association, or credit union. During 2003 our Board of Directors held 2 meetings. The Directors of Volunteer also serve as directors of the Bank. The Board of Directors of the Bank held 12 meetings in 2003. No director attended less than 75% of the meetings held by Volunteer or the Bank during 2003. The Directors received no compensation as directors of Volunteer but as directors of the Bank received $500 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, Phillips 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. 31 Audit Committee Financial Expert The Board of Directors has determined that there is at least one audit committee financial expert, G. Douglas Price, serving on the Audit Committee. Mr. Price is not independent under the independence standards of the National Association of Securities Dealers ("NASD"). We believe the cost related to retaining a financial expert that satisfies NASD's independence standards is prohibitive at this time. Corporate Code of Ethics The Board of Directors has adopted a Corporate Code of Ethics which applies to all of our directors, officers and employees. A copy of our code of ethics may be obtained free of charge by making a written request to our corporate office located at 210 East Main Street, Rogersville, Tennessee 37857. Item 10. Executive Compensation. The following table sets forth the aggregate cash compensation paid by us to the chief executive officer of Volunteer. No other executive officer received cash compensation in excess of $100,000 (determined as of the end of 2003) for the years ended December 31, 2003, 2002 and 2001. Annual Compensation ------------------- Name and Position Year Salary ($) ---- --- -------- ---- ------------------- Reed Matney 2003 110,000 Chief Executive Officer and President 2002 105,000 2001 105,000 Item 11. Security Ownership of Certain Beneficial Owners and Management As of March 15, 2004, our records indicated that the following number of shares were beneficially owned by (i) each person known by us to beneficially own more than 5% of our shares; (ii) directors and persons nominated to become directors of Volunteer and executive officers; and (iii) our directors and executive officers 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% (ii) William E. Phillips(1).......................... 22,495 4.17 Lawrence E. Gray(2)............................. 13,201 2.49 Shirley A. Price................................ 7,937 1.47 Reed D. Matney.................................. 8,393 1.56 Leon Gladson.................................... 3,723 * G. Douglas Price(3)............................. 15,934 2.96 Gary E. Varnell(4).............................. 22,365 4.15 Scott F. Collins................................ 1,647 * George L. Brooks................................ 6,165 1.14 M. Carlin Greene................................ 16,465 3.05 Neil D. Miller(5)............................... 11,150 2.07 Jim Friddell.................................... 1,685 * (iii) Directors and executive officers as a group (12 persons)..................................... 131,160 24.33
--------------- * Less than 1% (1) Includes 12,211 shares owned by the Joe H. Wilson Trust, for which Mr. Phillips serves as co-trustee. Also includes 700 shares owned by his spouse. 32 (2) Includes 665 shares owned by his spouse. (3) Includes 6,105 shares owned by his spouse, for which he disclaims voting and investment power. (4) Includes 200 shares owned jointly with his two sons. (5) Includes 11,150 shares owned by Miller Family Trust, for which Mr. Miller serves as trustee Item 12. Certain Relationships and Related Transactions The information required by this item is incorporated by reference from Volunteer's Proxy Statement to be dated approximately April 23, 2004. 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. 16** Letter from Welch & Associates, Ltd., to the Securities and Exchange Commission dated July 21, 2003. 21.1 List of Subsidiaries 31.1*** Certification of Reed D. Matney, Chief Executive Officer and President of Volunteer Bancorp, Inc., Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2*** Certification of Greg Oliver, Senior Vice President and Cashier of Volunteer Bancorp, Inc., Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1*** Certification of Reed D. Matney, Chief Executive Officer and President of Volunteer Bancorp, Inc., Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2*** Certification of Greg Oliver, Senior Vice President and Cashier of Volunteer Bancorp, Inc., Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Incorporated by reference to exhibits filed with Volunteer's Registration Statement on Form SB-1, Registration No. 33-94050. ** Incorporated by reference to Volunteer's 8-K dated July 16, 2003. *** A signed original of this written statement 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, 2003. Item 14. Principal Accounting Fees and Services Incorporated by reference from Volunteer's Proxy Statement to be dated approximately April 23, 2004. 33 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 ------------------- Reed D. Matney Chief Executive Officer and President Date: March 29, 2004 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 --------------------------- Chairman of the Board and Director March 29, 2004 William E. Phillips /s/ Reed D. Matney --------------------------- Chief Executive Officer and President and March 29, 2004 Reed D. Matney Director (principal executive officer) /s/ Greg Oliver --------------------------- Vice President and Cashier March 29, 2004 Greg Oliver (principal accounting officer) /s/ Carlin Greene ---------------------------- Director March 29, 2004 Carlin Greene /s/ Douglas Price --------------------------- Director March 29, 2004 Douglas Price /s/ Gary Varnell --------------------------- Director March 29, 2004 Gary Varnell /s/ George Brooks --------------------------- Director March 29, 2004 George Brooks /s/ Shirley Price --------------------------- Director March 29, 2004 Shirley Price /s/ Neil Miller --------------------------- Director March 29, 2004 Neil Miller /s/ Lawrence Gray ---------------------------- Director March 29, 2004 Lawrence Gray /s/ Scott Collins ---------------------------- Director March 29, 2004 Scott Collins /s/ Leon Gladson ---------------------------- Director March 29, 2004 Leon Gladson /s/ Jim Friddell ---------------------------- Director March 29, 2004 Jim Friddell
VOLUNTEER BANCORP, INC. AND SUBSIDIARY Rogersville, Tennessee CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 and 2002 VOLUNTEER BANCORP, INC. AND SUBSIDIARY Rogersville, Tennessee CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 and 2002 Contents REPORT OF INDEPENDENT AUDITORS............................................. F-1 FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS............................................. F-2 CONSOLIDATED STATEMENTS OF INCOME ...................................... F-3 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME......................... F-4 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY.............. F-5 CONSOLIDATED STATEMENTS OF CASH FLOWS................................... F-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.............................. F-8 REPORT OF INDEPENDENT AUDITORS Board of Directors Volunteer Bancorp, Inc. Rogersville, Tennessee We have audited the accompanying consolidated balance sheet of Volunteer Bancorp, Inc. and Subsidiary as of December 31, 2003, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements of Volunteer Bancorp, Inc. and Subsidiary for the year ended December 31, 2002 were audited by other auditors, whose report dated February 6, 2003 expressed an unqualified opinion on those statements. 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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, 2003, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ Crowe Chizek and Company LLC Crowe Chizek and Company LLC Lexington, Kentucky February 20, 2004 F-1 REPORT OF INDEPENDENT AUDITORS Board of Directors Volunteer Bancorp, Inc. Rogersville, Tennessee We have audited the accompanying consolidated balance sheet of Volunteer Bancorp, Inc. as of December 31, 2002, and the related consolidated statements of income and retained earnings and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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. as of December 31, 2002 and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. /s/ Welch & Associates, Ltd. Welch & Associates, Ltd. Nashville, Tennessee February 6, 2003 F-2 VOLUNTEER BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31 --------------------------------------------------------------------------------
2003 2002 ---- ---- ASSETS Cash and due from banks $ 2,881,551 $ 4,705,507 Federal funds sold 354,371 4,450,000 ---------------- ---------------- Cash and cash equivalents 3,235,922 9,155,507 Securities Available for sale 27,462,097 27,765,755 Held to maturity 709,910 1,052,991 Loans, less allowance for loan losses 68,719,127 67,014,982 Accrued interest receivable 759,388 935,616 Premises and equipment, net 3,715,926 3,788,671 Real estate acquired through foreclosure 1,533,749 1,241,402 Goodwill 131,259 131,259 Cash surrender value of life insurance 2,088,704 - Other assets 322,846 285,832 ---------------- ---------------- Total assets $ 108,678,928 $ 111,372,015 ================ ================ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing $ 13,207,426 $ 12,159,852 Interest bearing 83,505,414 87,797,905 ---------------- ---------------- Total deposits 96,712,840 99,957,757 Accrued interest payable 317,580 411,322 Federal funds purchased 1,450,000 - Securities sold under repurchase agreements 1,358,902 2,288,784 Other accrued taxes, expenses and liabilities 123,765 69,910 Long-term debt 1,415,000 1,810,000 ---------------- ---------------- Total liabilities 101,378,087 104,537,773 Stockholders' equity Common stock, $0.01 par value; 1,000,000 shares authorized; 539,027 shares issued and outstanding in 2003 and 2002 5,390 5,390 Additional paid-in capital 1,916,500 1,916,500 Retained earnings 5,161,814 4,557,192 Accumulated other comprehensive income 217,137 355,160 ---------------- ---------------- Total stockholders' equity 7,300,841 6,834,242 ---------------- ---------------- Total liabilities and stockholders' equity $ 108,678,928 $ 111,372,015 ================ ================
F-3 CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31 --------------------------------------------------------------------------------
2003 2002 ---- ---- Interest income Loans, including fees $ 4,975,865 $ 5,710,663 Federal funds 23,830 73,631 Securities Taxable 799,954 1,132,633 Tax exempt 289,929 241,961 ------------- -------------- 6,089,578 7,158,888 Interest expense Deposits 1,599,433 2,322,582 Repurchase agreements and other borrowings 82,070 121,058 ------------- -------------- 1,681,503 2,443,640 Net interest income 4,408,075 4,715,248 Provision for loan losses 465,000 795,000 ------------- -------------- Net interest income after provision for loan losses 3,943,075 3,920,248 Other income Service charges 476,504 297,299 Fees and commissions 87,719 107,193 Securities gains (losses), net 106,465 39,222 Other 110,220 55,902 ------------- -------------- 780,908 499,616 Other expenses Salaries and employee benefits 1,970,417 1,834,197 Occupancy expenses 247,485 262,800 Furniture and equipment 387,293 399,402 Other 1,332,929 1,390,499 ------------- -------------- 3,938,124 3,886,898 Income before income taxes 785,859 532,966 Provision for income taxes 181,237 146,389 ------------- -------------- Net income $ 604,622 $ 386,577 ============= ============== Basic and diluted earnings per share $ 1.12 $ 0.72 Average common shares outstanding 539,027 539,027
F-4 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31 --------------------------------------------------------------------------------
2003 2002 ---- ---- Net income $ 604,622 $ 386,577 Other comprehensive income (loss), net of tax: Unrealized gains (losses) on securities arising during the period (116,153) 635,835 Reclassification of realized amount 106,465 39,222 ------------- -------------- Other comprehensive income (222,618) 596,613 Income taxes related to other comprehensive income 84,595 (226,713) ------------- -------------- Other comprehensive income, net of income taxes (138,023) 369,900 ------------- -------------- Total comprehensive income $ 466,599 $ 756,477 ============= ==============
F-5 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2003, 2002 and 2001 --------------------------------------------------------------------------------
Accumulated Additional Other Total Common Stock Paid-In Retained Comprehensive Stockholders' Shares Amount Capital Earnings Income Equity ------ ------------ ---------- -------- ------------- ------------- Balances, January 1, 2002 539,027 $ 5,390 $ 1,916,500 $ 4,224,518 $ (14,740) $ 6,131,668 Net income - - - 386,577 - 386,577 Dividends declared ($0.10 per share) - - - (53,903) - (53,903) Other comprehensive income - - - - 369,900 369,900 -------- -------- ----------- ----------- ----------- ----------- Balances, December 31, 2002 539,027 5,390 1,916,500 4,557,192 355,160 6,834,242 Net income - - - 604,622 - 604,622 Other comprehensive income (138,023) (138,023) -------- -------- ----------- ----------- ----------- ----------- Balances, December 31, 2003 539,027 $ 5,390 $ 1,916,500 $ 5,161,814 $ 217,137 $ 7,300,841 ======== ======== =========== =========== =========== ===========
F-6 CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31 --------------------------------------------------------------------------------
2003 2002 ---- ---- Cash flows from operating activities Net income $ 604,622 $ 386,577 Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization 204,558 205,483 Provision for loan losses 465,000 795,000 Securities (gains) losses, net (106,465) (39,222) Federal Home Loan Bank stock dividends (14,900) (16,400) Write downs of other real estate 40,000 235,528 (Gain) loss on sale of other real estate 56,758 38,425 Increase in bank owned life insurance (88,704) - Changes in: Interest receivable 176,228 130,863 Other assets 47,581 (128,788) Other liabilities (39,887) (445,581) ------------- -------------- Net cash from operating activities 1,344,791 1,161,885 Cash flows from investing activities Securities available for sale Purchases (21,853,726) (20,071,988) Proceeds from calls and maturities 15,899,444 13,142,700 Proceeds from sales 5,904,082 5,782,690 Securities held to maturity Purchases (445,779) (1,017,384) Proceeds from calls and maturities 788,860 591,252 Net change in loans (2,738,970) 3,207,275 Investment in bank owned life insurance (2,000,000) - Proceeds from sale of other real estate 433,325 770,314 Purchases of premises and equipment, net (131,813) (127,796) ------------- -------------- Net cash from investing activities (4,144,577) 2,277,063 Cash flows from financing activities Net change in deposits (3,244,917) (3,951,898) Net change in repurchase agreements (929,882) 1,179,181 Federal funds purchased 1,450,000 - Dividends paid - (53,903) Repayment of long-term debt (395,000) (360,000) ------------- -------------- Net cash from financing activities (3,119,799) (3,186,620) ------------- -------------- Net change in cash and cash equivalents (5,919,585) 252,328 Cash and cash equivalents at beginning of year 9,155,507 8,903,179 ------------- -------------- Cash and cash equivalents at end of year $ 3,235,922 $ 9,155,507 ============= ==============
F-7 CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31 --------------------------------------------------------------------------------
2003 2002 ---- ---- Supplemental disclosures of cash flow information: Cash paid during the year for: Interest expense $ 1,775,245 $ 2,926,665 Income taxes 128,704 278,526 Supplemental non-cash disclosures: Transfers from loans to other real estate 822,430 1,140,900
F-8 VOLUNTEER BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 and 2002 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation: The consolidated financial statements include the accounts of Volunteer Bancorp, Inc. (the Company), its wholly-owned subsidiary, Citizens Bank of East Tennessee (the Bank), and the Bank's wholly-owned investment subsidiary, Sierra Securities, Inc. Intercompany transactions and balances have been eliminated in consolidation. Nature of Operations: The Bank operates under a state bank charter and provides full banking services, including trust services. As a state bank, the Bank is subject to regulation by the Tennessee Department of Financial Institutions and the Federal Deposit Insurance Corporation (FDIC). The Company, a bank holding company, is regulated by the Federal Reserve. Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses and fair value of financial instruments are particularly subject to change. Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and certain short-term investments with maturities of less than three months. Generally, federal funds are sold for one-day periods. Net cash flows are reported for loan, deposit and short-term borrowing transactions. Securities: The Company is required to classify its securities portfolio into three categories: trading securities, securities available for sale and securities held to maturity. Fair value adjustments are made to the securities based on their classification with the exception of the held to maturity category. The Company has no investments classified as trading. Securities available for sale are carried at fair value. The difference between amortized cost and fair value is recorded in stockholders' equity, net of related income tax, under accumulated other comprehensive income. Changes in this difference are recorded as a component of comprehensive income. Amortization of premiums and accretion of discounts are recorded as adjustments to interest income using the constant yield method. Securities for which the Company has the positive intent and ability to hold to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts which are recorded as adjustments to interest income using the constant yield method. Federal Home Loan Bank stock is carried at cost. F-9 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Gains or losses on dispositions are based on the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. Loans: Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest income on loans is recognized on the accrual basis except for those loans on a nonaccrual status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers' financial condition is such that collection of interest is doubtful. When interest accrual is discontinued, interest income received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogenous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Premises and Equipment: Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 2 to 15 years. F-10 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Real Estate Acquired Through Foreclosure: Real estate acquired through foreclosure is carried at the lower of the recorded investment in the property or its fair value. The value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged to operating expenses. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses. Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance. Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. The Company uses the liability method for computing deferred income taxes. Under the liability method, deferred income taxes are based on the change during the year in the deferred tax liability or asset established for the expected future tax consequences of differences in the financial reporting and tax bases of assets and liabilities. Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share include the dilutive effect of additional potential common shares issuable under certain financial instruments. The Company has no dilutive instruments outstanding. Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as a separate component of equity. Goodwill: Goodwill results from prior business acquisitions, and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. Industry Segments: While the Company's chief decision makers monitor the revenue streams of the various Company products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company's operations are considered by management to be aggregated into one reportable operating segment. F-11 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Adoption of New Accounting Standards: During 2003, the Company adopted FASB Statement 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, FASB Statement 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities, FASB Statement 132 (revised 2003), Employers' Disclosures about Pensions and Other Postretirement Benefits, FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, and FASB Interpretation 46, Consolidation of Variable Interest Entities. Adoption of the new standards did not materially affect the Company's operating results or financial condition. Reclassifications: Certain reclassifications were made to the prior year financial statements to conform to the current year presentation. NOTE 2 - SECURITIES Year-end securities are as follows:
Fair Unrealized Unrealized Value Gains Losses ----- ----------- ---------- Available for Sale 2003 U. S. government agencies $ 2,071,245 $ 43,451 $ - States and political subdivisions 7,116,882 246,017 - Mortgage-backed 16,887,970 115,315 (54,562) FNMA preferred stock 1,000,000 - - Federal Home Loan Bank stock 386,000 - - --------------- ------------- -------------- Total $ 27,462,097 $ 404,783 $ (54,562) =============== ============= ============== Fair Unrealized Unrealized Value Gains Losses ----- ----------- ---------- Available for Sale 2002 U. S. Treasury $ 514,690 $ 13,789 $ - U. S. government agencies 18,877,353 411,984 (4,760) States and political subdivisions 6,542,612 166,497 - FNMA preferred stock 1,460,000 - (14,671) Federal Home Loan Bank stock 371,100 - - --------------- ------------- -------------- Total $ 27,765,755 $ 592,270 $ (19,431) =============== ============= ==============
F-12 NOTE 2 - SECURITIES (Continued) Year-end securities are as follows:
Carrying Unrecognized Unrecognized Fair Amount Gains Losses Value ------ ----- ------ ----- Held to Maturity ---------------- 2003 ---- Mortgage-backed securities $ 709,910 $ 7,447 $ - $ 717,357 2002 ---- Mortgage-backed securities $ 1,052,991 $ 1,430 $ - $ 1,054,421
The amortized cost and fair value of securities at December 31, 2003, by category and 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. Securities not due at a single maturity are shown separately.
Available Held to Maturity for Sale ---------------- -------- Carrying Fair Fair Amount Value Value Due in one year or less $ - $ - $ - Due after one year through five years - - 1,959,120 Due after five years through ten years - - 4,506,824 Due after ten years - - 2,722,183 --------------- ------------- -------------- - - 9,188,127 Mortgage-backed 709,910 717,357 16,887,970 Equity - - 1,386,000 --------------- ------------- -------------- Total $ 709,910 $ 717,357 $ 27,462,097 =============== ============= ==============
Proceeds from sales of securities during 2003 and 2002 were $5,904,082 and $5,782,690. Gross gains of $107,903 and $39,222 and gross losses of $1,438 and $0, were realized on those sales. Securities with an approximate carrying value of $14,576,734 and $11,888,000 at December 31, 2003 and 2002, were pledged to secure public deposits, trust funds, securities sold under agreements to repurchase and for other purposes as required or permitted by law. F-13 NOTE 2 - SECURITIES (Continued) Securities with unrealized losses at year-end 2003, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
Less than 12 Months 12 Months or More Total ------------------- ----------------- ----- Fair Unrealized Fair Unrealized Fair Unrealized Description of Securities Value Loss Value Loss Value Loss ------------------------- ----- ---- ----- ---- ----- ---- Mortgage backed securities $ 9,007,399 $ 54,562 $ $ $9,007,399 $ 54,562 =========== ========== ========== ========= ========== ============
Unrealized losses on securities have not been recognized into income because the securities are of high credit quality, management has the intent and ability to hold for the foreseeable future, and the decline in fair value is largely due to increases in market interest rates. The fair value is expected to recover as the bonds approach their maturity and/or market rates decline. NOTE 3 - LOANS Loans at year-end were as follows:
2003 2002 ---- ---- Commercial $ 4,720,539 $ 7,302,050 Real estate construction 992,161 2,647,018 Real estate mortgage 54,588,204 48,055,327 Consumer 7,765,185 9,958,068 Other 1,564,576 163,000 ---------------- ---------------- Subtotal 69,630,665 68,125,463 Less: Allowance for loan losses (911,538) (1,110,481) ---------------- ---------------- Loans, net 68,719,127 67,014,982 ================ ================
Activity in the allowance for loan losses was as follows:
2003 2002 ---- ---- Beginning balance $ 1,110,481 $ 908,016 Charge-offs (712,391) (635,246) Recoveries 48,448 42,711 Provision for loan losses 465,000 795,000 ---------------- ---------------- Ending balance $ 911,538 $ 1,110,481 ================ ================
F-14 NOTE 3 - LOANS (Continued) Impaired loans were as follows:
2003 2002 ---- ---- Year-end loans with no allocated allowance for loan losses $ - $ - Year-end loans with allocated allowance for loan losses 1,210,115 1,595,984 ----------- ----------- Total $ 1,210,115 $ 1,595,984 =========== =========== Amount of the allowance for loan losses allocated $ 181,517 $ 155,196 2003 2002 ---- ---- Average of impaired loans during the year $ 692,400 $ 873,750 Interest income recognized during impairment - - Cash-basis interest income recognized - - Nonperforming loans were as follows: 2003 2002 ---- ---- Loans past due over 90 days still on accrual $ 1,034,715 $ 673,292 Nonaccrual loans 175,400 922,692
Nonperforming loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. Certain directors and executive officers of the Company and companies in which they have beneficial ownership were loan customers of the Bank during 2003 and 2002. An analysis of the activity with respect to all director and executive officer loans is as follows: 2003 ---------- Balance, beginning of year $ 295,048 Additions, including loans now meeting disclosure requirements 428,290 Amounts collected, including loans no longer meeting disclosure requirements 239,298 ------------- Balance, end of year $ 484,040 ============= F-15 NOTE 4 - PREMISES AND EQUIPMENT Year-end premises and equipment were as follows: 2003 2002 ---- ---- Land $ 619,168 $ 619,168 Buildings 3,317,755 3,317,755 Furniture and equipment 1,312,572 1,258,516 -------------- --------------- 5,249,495 5,195,439 Less accumulated depreciation 1,533,569 1,406,768 -------------- --------------- $ 3,715,926 $ 3,788,671 ============== =============== Depreciation expense was $204,558 and $205,483 in 2003 and 2002. 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 $145,324 and $182,092 for December 31, 2003 and 2002. Rent commitments under noncancelable operating leases were as follows, before considering renewal options that generally are present. 2004 $ 102,361 2005 92,076 2006 77,436 2007 36,408 2008 36,408 NOTE 5 - DEPOSITS Time deposits of $100,000 or more were $16,453,000 and $17,119,000 at year-end 2003 and 2002. At December 31, 2003, the scheduled maturities of all time deposits are as follows: 2004 $ 45,889,000 2005 4,294,000 2006 2,075,000 2007 697,000 -------------- $ 52,955,000 F-16 NOTE 5 - DEPOSITS (Continued) Certain directors and executive officers of the Company and companies in which they have beneficiary ownership are deposit customers of the Bank. The amount of these deposits was approximately $1,944,000 and $1,901,000 at December 31, 2003 and 2002. NOTE 6 - SHORT-TERM BORROWINGS Short-term borrowings are generally comprised of federal funds purchased and repurchase agreements. Federal funds purchased are overnight borrowings from various correspondent banks. Repurchase agreements are advances by customers that are not covered by federal deposit insurance. This obligation of the Bank is secured by bank-owned securities held in safekeeping at a correspondent bank. The balances are shown below: Repurchase Federal Funds Agreements Purchased ------------ ------------ (Amounts in thousands) Outstanding at December 31, 2003 $ 1,359 $ 1,450 Average interest rate at year-end 1.27% 1.25% Average balance during year $ 1,666 $ 196 Average interest rate during year 1.92% 1.53% Maximum month end balance during year $ 2,103 $ 2,275 Outstanding at December 31, 2002 $ 2,289 $ 0 Average interest rate at year-end 2.47% 0% Average balance during year $ 1,749 $ 0 Average interest rate during year 2.86% 0% Maximum month end balance during year $ 2,365 $ 0 NOTE 7 - LONG-TERM DEBT The Company's long-term debt consists of a single note payable in the amount of $1,415,000 and $1,810,000 at December 31, 2003 and 2002 due to an unaffiliated commercial bank. The interest rate on the note adjusts quarterly and is equal to the three-month 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, 2003, the rate on the note was 3.12% per annum. F-17 NOTE 7 - LONG-TERM DEBT (Continued) Principal is payable each January 31 as follows: 2004 $ 435,000 2005 470,000 2006 510,000 --------------- $ 1,415,000 The loan is secured by all of the stock of the Bank. 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 that would result in the note being 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. NOTE 8 - FEDERAL HOME LOAN BANK ADVANCES The Bank owns stock of the Federal Home Loan Bank (FHLB) of Cincinnati, Ohio. This stock allows the Bank to borrow advances from the FHLB. Any advances are secured by physical delivery of the Bank's qualifying 1-4 mortgage loans. The Bank is required to maintain eligible collateral representing 125 percent of the current outstanding balance of all advances. The Bank had no outstanding advances at December 31, 2003 and 2002. F-18 NOTE 9 - INCOME TAXES Income tax expense was as follows: 2003 2002 ---- ---- Current $ 103,836 $ 293,129 Deferred 77,401 (146,740) ------------- --------------- $ 181,237 $ 146,389 ============= =============== Year-end deferred tax assets and liabilities were due to the following. No valuation allowance for the realization of deferred tax assets is considered necessary. 2003 2002 ---- ---- Deferred tax assets Allowance for loan losses $ 181,029 $ 266,815 Other real estate 34,394 61,846 AMT credit carryforward 53,085 - Other - 4,805 Deferred tax liabilities Unrealized gain on securities (133,084) (217,679) Bank premises and equipment (55,974) (48,570) FHLB stock (37,294) (32,255) --------- --------- Net deferred tax asset (liability) $ 42,156 $ 34,962 Effective tax rates differ from federal statutory rates applied to financial statement income due to the following: 2003 2002 ---- ---- Tax expense at statutory rate $ 267,192 $ 181,208 Increase (decrease) in taxes resulting from: Tax-exempt investment income (102,890) (74,301) Non-deductible interest expense related to carrying tax-exempt investments 2,544 7,965 State income taxes net of federal benefit 30,096 22,911 Other (15,705) 8,606 ---------- ----------- $ 181,237 $ 146,389 F-19 NOTE 10 - RETIREMENT PLANS The Company has a qualified profit sharing plan which covers substantially all employees and includes a 401(k) provision. Profit sharing contributions, excluding the 401(k) provision, are at the discretion of the Company's Board of Directors. Expense recognized in connection with the plan was $16,891 and $15,910 in 2003 and 2002. NOTE 11 - COMMITMENTS AND CONTINGENCIES Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements. 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. 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 creditworthiness 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. F-20 NOTE 11 - COMMITMENTS AND CONTINGENCIES (Continued) At December 31, 2003 and 2002, the Bank had the following financial instruments whose contract amounts represent credit risk: 2003 2002 ---- ---- Standby letters of credit $ 236,225 $ 202,725 Commitments to extend credit $ 6,278,327 $ 5,845,319 NOTE 12 - LIMITATION ON BANK DIVIDENDS The Company's principal source of funds is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid by the Bank without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year's net profits, as defined, combined with the retained net profits of the preceding two years. During 2004 the Bank could declare dividends of approximately $226,000 plus any 2004 net profits retained to the date of the dividend declaration, subject to the provisions of the Memorandum of Understanding described in Note 14. NOTE 13 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The fair values of the Company's financial instruments at December 31, 2003 and 2002 are as follows:
------------2003------------- ------------2002------------- Carrying Carrying Amount Fair Value Amount Fair Value -------- ---------- -------- ---------- Financial assets Cash and due from banks $ 2,881,551 $ 2,881,551 $ 4,705,507 $ 4,705,507 Securities 28,172,007 28,179,454 28,818,746 28,820,176 Federal funds sold 354,371 354,371 4,450,000 4,450,000 Loans, net 68,719,127 70,594,251 67,014,982 70,002,286 Accrued interest receivable 759,388 759,388 935,616 935,616 Financial liabilities Deposits $ 96,712,840 $ 96,996,529 $ 99,957,757 $ 103,281,008 Securities sold under agreements to repurchase 1,358,902 1,358,902 2,288,784 2,288,784 Federal funds purchased 1,450,000 1,450,000 - - Long-term debt 1,415,000 1,415,000 1,810,000 1,810,000 Accrued interest payable 317,580 317,580 411,322 411,322
F-21 NOTE 13 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) Carrying amount is the estimated fair value for cash and cash equivalents, short-term borrowings, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, short-term debt, and deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For loans or deposits and for deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The fair value of commitments to extend credit and standby letters of credit is not considered material. NOTE 14 - CAPITAL REQUIREMENTS Regulatory Matters: The Company and the Bank are 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 Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2003 and 2002, that the Company and the Bank meet all capital adequacy requirements to which they are subject. The most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution's category. F-22 NOTE 14 - CAPITAL REQUIREMENTS (Continued) The Company's and the Bank's actual amounts and ratios are presented in the table below:
To Be Well Capitalized Under Prompt For Capital Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- 2003 (Dollars in Thousands) ---- Consolidated Total Capital (to Risk-Weighted Assets) $ 7,854 10.90% $ 5,764 8% $ 7,205 10% Tier I Capital (to Risk-Weighted Assets) 6,953 9.65 2,882 4 4,323 6 Tier I Capital (to Average Assets) 6,953 6.33 4,398 4 5,491 5 Bank Only Total Capital (to Risk-Weighted Assets) $ 9,249 12.84% $ 5,763 8% $ 7,204 10% Tier I Capital (to Risk-Weighted Assets) 8,348 11.59 2,882 4 4,322 6 Tier I Capital (to Average Assets) 8,348 7.60 4,392 4 5,490 5 2002 ---- Consolidated Total Capital (to Risk-Weighted Assets) $ 7,215 10.44% $ 5,529 8% $ 6,912 10% Tier I Capital (to Risk-Weighted Assets) 6,348 9.18 2,765 4 4,147 6 Tier I Capital (to Average Assets) 6,348 5.72 4,441 4 5,552 5 Bank Only Total Capital (to Risk-Weighted Assets) $ 8,983 13.00% $ 5,529 8% $ 6,911 10% Tier I Capital (to Risk-Weighted Assets) 8,116 11.73 2,764 4 4,147 6 Tier I Capital (to Average Assets) 8,116 7.32 4,436 4 5,545 5
F-23 NOTE 14 - CAPITAL REQUIREMENTS (Continued) 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 the prohibition of incurring additional debt, declaration and payment of dividends to the Company's shareholders, and certain capital transactions, without the prior written approval of the Federal Reserve Board. Management of the Company believe that the Company is in substantial compliance with the provisions of the Resolutions. F-24 NOTE 15 - PARENT COMPANY FINANCIAL STATEMENTS Condensed Balance Sheets December 31
2003 2002 ---- ---- ASSETS Cash on deposit with subsidiary $ 15,747 $ 28,538 Investment in subsidiary 8,696,100 8,616,445 Tax benefit receivable 11,527 10,516 ------------- -------------- Total assets $ 8,723,374 $ 8,655,499 ============= ============== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Long-term debt $ 1,415,000 $ 1,810,000 Accrued interest payable 7,533 11,257 Stockholders' equity 7,300,841 6,834,242 ------------- -------------- Total liabilities and stockholders' equity $ 8,723,374 $ 8,655,499 ============= ==============
F-25 NOTE 15 - PARENT COMPANY FINANCIAL STATEMENTS (Continued) Condensed Statements of Income Years Ended December 31
2003 2002 ---- ---- Income Dividends from subsidiary $ 435,122 $ 435,798 Expenses Interest 47,583 71,421 Professional services 34,033 21,115 Other 40 (4,405) ----------- ----------- 81,656 88,131 Income before income taxes and equity in undistributed income of subsidiary 353,466 347,667 Applicable income tax (expense) benefits 33,479 30,149 Equity in undistributed income of subsidiary 217,677 8,761 ----------- ----------- Net income $ 604,622 $ 386,577 =========== ===========
F-26 NOTE 15 - PARENT COMPANY FINANCIAL STATEMENTS (Continued) Condensed Statements of Cash Flows Years Ended December 31
2003 2002 ---- ---- Cash flows from operating activities Net income $ 604,622 $ 386,577 Adjustments to reconcile net income to net cash from operating activities Equity in undistributed earnings of subsidiary (217,677) (8,761) Deferred income taxes - 6,869 Change in other assets (1,012) 2,595 Change in other liabilities (3,724) (4,375) ----------- ----------- Net cash from operating activities 382,209 382,905 Cash flows from financing activities Dividends paid - (53,903) Repayment of note payable (395,000) (360,000) ----------- ----------- Net cash from financing activities (395,000) (413,903) ----------- ----------- Net change in cash (12,791) (30,998) Cash at beginning of year 28,538 59,536 ----------- ----------- Cash at end of year $ 15,747 $ 28,538 =========== ===========
F-27