ITEM 1. BUSINESS THE COMPANY AND THE BANKS Incorporated in Kentucky in 1981, Trans Financial Bancorp, Inc. (the "company") is a bank holding company registered under the Bank Holding Company Act of 1956, and a savings and loan holding company registered under the Home Owners' Loan Act. The company has two commercial bank subsidiaries, Trans Financial Bank, National Association, located in Bowling Green, Kentucky ("TFBNA"), and Trans Financial Bank, located in Pikeville, Kentucky ("TFB-Pikeville"), and two thrift subsidiaries, Trans Financial Bank, Federal Savings Bank, located in Russellville, Kentucky ("TFBFSB"), and Trans Financial Bank of Tennessee, FSB, located in Tullahoma, Tennessee ("TFB of TN") (collectively referred to as the" banks"). The company acquired its first thrift subsidiary, TFBFSB, in November 1990. Effective January 1, 1991, the company's two former bank subsidiaries were consolidated into one national banking institution, TFBNA. On August 30, 1991, as the result of a joint bid with PNC Bank for certain deposits and assets of Future Federal Savings Bank, Louisville, Kentucky, under the Accelerated Resolution Program of the Resolution Trust Corporation, TFBNA assumed approximately $75.9 million in deposits and acquired approximately $11 million in consumer loans and received approximately $64.3 million in cash (net of a $1.0 million premium), all related to the Glasgow, Kentucky and Tompkinsville, Kentucky branches of Future Federal Savings Bank. Effective March 26, 1992, the company acquired First Federal Savings Bank of Tennessee, Tullahoma, Tennessee, and effective March 27, 1992, the company acquired Maury Federal Savings Bank, Columbia, Tennessee. These two Tennessee thrift institutions were merged on November 27, 1992, to form TFB of TN. On August 7, 1992, the company acquired (through First Federal Savings Bank of Tennessee) the deposits and branch operations of five middle Tennessee branches of Heritage Federal Bank for Savings, a Tennessee-based savings bank. In this transaction, the company's Tullahoma-based affiliate assumed approximately $55 million in deposits, acquired approximately $2.3 million in premises and equipment and received approximately $52 million in cash (net of a premium). On December 31, 1992, the company merged with Dawson Springs Bancorp, Inc. (DSB), the holding company for Kentucky State Bank, Scottsville, Kentucky, and Commercial Bank of Dawson Springs, Dawson Springs, Kentucky. These banks were merged into TFBNA on December 31, 1992. On July 6, 1993, in a transaction accounted for as a purchase, the company acquired Trans Kentucky Bancorp, Pikeville, Kentucky, the holding company for The Citizens Bank of Pikeville. At the acquisition date, TFB-Pikeville (the former Citizens Bank of Pikeville) had total assets of $188.7 million, net loans of $107.6 million and total deposits of $163.9 million. The aggregate cost, including consideration and acquisition costs, totaled $18.8 million. On December 31, 1993, the company had total consolidated assets of $1.169 billion, total loans of $769 million, total deposits of $994 million and shareholders' equity of $76 million. On February 15, 1994, the company merged with Kentucky Community Bancorp, Inc. ("KCB") of Maysville, Kentucky, the holding company for The State National Bank, Peoples First Bank of Morehead, and Farmers Liberty Bank, with combined assets of approximately $175 million. Under the terms of the merger, all shares of KCB common stock outstanding were converted into 1,374,962 shares of company common stock. The transaction was accounted for as a pooling of interests. On December 27, 1993, the company entered into a definitive agreement providing for the acquisition of Peoples Financial Services, Inc. ("Peoples Financial") in an all stock transaction. Peoples Financial, headquartered in the middle Tennessee community of Cookeville, is a two bank holding company for Peoples Bank and Trust of the Cumberlands and Citizens Federal Savings Bank, with combined assets of approximately $120 million. Under the terms of the agreement, Peoples Financial shareholders will receive 5.5 shares of company common stock for each share of Peoples Financial stock or a total of approximately 1,315,770 shares. The transaction is subject to regulatory and Peoples Financial shareholder approval. On January 28, 1994, the company entered into a definitive agreement providing for the acquisition of FGC Holding Company ("FGC") in an all stock transaction. FGC, headquartered in the eastern Kentucky community of Martin, is a one bank holding company for First Guaranty National Bank, with $126 million in assets. Under the terms of the agreement, FGC shareholders will receive 419.83 shares of company common stock for each share of FGC common stock, or a total of approximately 1,050,000 shares. The transaction is subject to regulatory and FGC shareholder approval. It is anticipated these two pending acquisitions will constitute tax free reorganizations and qualify for the pooling of interests method of accounting. Interest on domestic, commercial and mortgage loans constitutes the largest contribution to the operating revenues of the banks. TFBNA and TFB-Pikeville provide a full range of corporate and retail banking services, including the acceptance of deposits for checking, savings and time deposit accounts; making of secured and unsecured loans to corporations, individuals and others; issuance of letters of credit; rental of safe deposit boxes; and financial counseling for individuals and institutions. In addition, TFBNA is an equity partner in Quest, a partnership of several Kentucky banks engaged in the development and operation of a regional automated teller machine network.
- 3 - TFBNA provides a wide variety of personal and corporate trust and trust-related services, including serving as executor of estates; as trustee under testamentary and inter vivos trusts; as guardian of the estates of minors and incompetents; as escrow agent under various agreements; and as financial advisor to and custodian for individuals, corporations and others. Corporate trust services include serving as registrar and transfer agent for corporate securities and as corporate trustee under corporate trust indentures. At December 31, 1993, approximately $294 million in assets were managed by the trust department of TFBNA. Historically, the principal business of TFBFSB and TFB of TN has been the acceptance of savings deposits from the general public and the origination and purchase of mortgage loans for the purpose of constructing, financing or refinancing one- to four-family dwellings. Since its acquisition of TFBFSB in November 1990, the company has introduced a variety of additional products and services designed to attract a more diverse customer base, including checking accounts, consumer, installment and commercial loans, trust and brokerage services. Similar products are now being offered at TFB of TN since its acquisition in March 1992. TFBNA has thirteen offices, six located in Bowling Green, Kentucky, two located in Glasgow, Kentucky, two located in Scottsville, Kentucky and one located in each of Dawson Springs, Tompkinsville and Barren County in Kentucky. TFB-Pikeville has seven offices - three located in Pikeville, Kentucky, and one each in Elkhorn City, Meta, Belfry and Virgie, Kentucky. TFBFSB has two offices - - one located in Russellville, Kentucky, and one in Auburn, Kentucky. TFB of TN has 14 branch locations - two in Columbia, Tennessee, and one each in the Tennessee communities of Tullahoma, Mt. Pleasant, Clarksville, Cookeville, Franklin, Lebanon, Manchester, McMinnville, Murfreesboro, Shelbyville, Sparta and Winchester. In addition to its full service branches, TFB of TN has a mortgage operations center in Tullahoma and loan production offices in Nashville and Chattanooga.
COMPETITION The deregulation of the banking industry and the enactment in Kentucky and other states of legislation permitting multi-bank holding companies as well as interstate banking has created a highly competitive environment for banking in the company's market area. TFBNA competes in the Bowling Green area with four commercial banks and two savings associations, in the Glasgow/Cave City area with two commercial banks and one savings association, in the Scottsville area with one commercial bank and one savings association, in the Dawson Springs area with three commercial banks and two savings associations, and in the Tompkinsville area with two larger commercial banks. TFB-Pikeville competes with two commercial banks and two savings associations in the Pikeville area. In the Russellville area, TFBFSB competes with five commercial banks located in the county. TFB of TN's primary market area is middle Tennessee. Based on assets at June 30, 1993, (the latest date for which competitive infomation is available) TFBNA was the largest financial institution in Bowling Green and Glasgow, the second largest financial institution in Scottsville and the 6th largest financial institution in Dawson Springs. TFB-Pikeville was the third largest financial institution in Pikeville as of June 30, 1993, TFBFSB was the third largest financial institution in Russellville, and TFB of TN was the fourth largest of the 34 thrift institutions headquartered in the state of Tennessee.
The company actively competes in its markets with other commercial banks and financial institutions for all types of deposits, loans, trust accounts and the provision of financial, trust and other services. The company also competes generally with insurance companies, savings and loan associations, credit unions, other financial institutions, and institutions which have expanded into the quasi-financial market. Many of these competitors have resources substantially in excess of those of the company, have broader geographic markets and higher lending limits than the banks and, therefore, are able to make larger loans, sell a broader product line, and make more effective use of advertising than can the company or the banks.
SUPERVISION AND REGULATION Bank holding companies, commercial banks and savings banks are extensively regulated under both federal and state law. Any change in applicable law or regulation may have a material effect on the businesses and prospects of the company and the banks. The company, as a registered bank holding company, is subject to the supervision of and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956. Also, as a registered savings and loan holding company, the company is subject to the supervision of and regulation by the Office of Thrift Supervision (OTS). In addition, the company is subject to the provisions of Kentucky's and Tennessee's banking laws regulating bank acquisitions and certain activities of controlling bank shareholders. TFBNA is subject to the supervision of, and regular examination by, the Office of the Comptroller of the Currency. TFB-Pikeville is subject to the supervision of, and regular examination by, the Federal Deposit Insurance Corporation and, as a state-chartered bank, it is subject to Kentucky's banking laws. TFBFSB and TFB of TN are subject to the supervision of, and regular examination by, the OTS. The FDIC insures the deposits of the banks to the current maximum of $100,000
- 4 - per depositor. The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA"), signed into law in 1989, amended provisions of the Bank Holding Company Act to specifically authorize a bank holding company, upon receipt of appropriate approvals from the Federal Reserve Board and the Director of the OTS, to acquire control of any savings association or holding company thereof wherever located. Similarly, a savings and loan holding company may now acquire control of a bank. Pursuant to rules promulgated pursuant to FIRREA, a savings association acquired by a bank holding company (i) may, so long as it continues to meet the qualified thrift lender test, continue to branch to the same extent as permitted to other nonaffiliated savings associations similarly chartered in the state, and (ii) may not continue any non-banking activities not authorized for bank holding companies. Savings associations acquired by a banking holding company may, if located in a state where the bank holding company is legally authorized to acquire a bank, be converted, to the extent permitted by state law, to the status of a bank but deposit insurance assessments and payments continue to be paid by the association to the Savings Association Insurance Fund of the FDIC. A savings association so converted to a bank becomes subject to the branching restrictions applicable to banks. Under certain circumstances, a savings association acquired by a bank holding company may be merged with an existing bank subsidiary of a holding company. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), effective December 19, 1991, has resulted in extensive changes to the federal banking laws. A primary purpose of the law is to authorize additional borrowings by the FDIC in order to provide funds for the resolution of failing financial institutions. FDICIA instituted certain changes to the supervisory process and contains various provisions that affect the operations of banks and savings institutions. Not all of the regulations implementing FDICIA have been adopted. As a result, the full effect of FDICIA on the operation of the company cannot be determined.
STATISTICAL INFORMATION Certain statistical information is included in a separate section of the report on pages 17 through 29 and on page 40, and those pages are incorporated herein by reference.
ITEM 2.


ITEM 2. PROPERTIES The main banking office of TFBNA, which also serves as the principal office of the company, is located at 500 East Main Street, Bowling Green, Kentucky 42101. In addition, TFBNA operates twelve branches. Each branch offers a full range of banking services and is equipped with an automated teller machine for 24-hour banking services. TFBNA owns all of the properties at which it conducts its business except the Ashley Circle, Nashville Road and Tompkinsville branches. TFBFSB owns its main banking office at 135 West Fourth Street, Russellville, Kentucky and leases its branch facility at 107 West Main, Auburn, Kentucky. TFB of TN owns all the properties at which it conducts business except the Chattanooga and Nashville loan production offices and the Blythewood branch office. TFB-Pikeville owns all the properties at which it conducts business except the Virgie branch and one of its Pikeville branches (the North Mayo Trail branch).
- 5 - Note 7 to the company's consolidated financial statements included on page 41 of this report contains additional information relating to amounts invested in premises and equipment.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS In the ordinary course of operations, the banks are defendants in various legal proceedings. In the opinion of management, there is no proceeding pending, or to the knowledge of management, threatened in which an adverse decision could result in a material adverse change in the business or consolidated financial position of the company or the banks.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the last quarter of the period covered by this report.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth the name, age and position with the company and the banks of the executive officers of the company as of December 31, 1993. Officers of the company and the banks are elected annually.
Mr. Lester joined TFBNA as its President and Chief Executive Officer in 1984, prior to the time the company became the holding company of TFBNA. Mr. Berta joined the company in April 1993. Prior to that, he was Vice President and Manager of Functional Control with PNC Bank. Mr. Bray joined TFBNA in 1982 and has served as Chief Credit Officer since 1984. Mr. Bray was elected President of TFBNA in December, 1991. He was elected Executive Vice President of the company in 1988. Mr. Lundin, until joining TFBNA in 1986, was employed by a division of PACCAR, Inc., an automotive-related company, as Manager of Employee Relations. Mr. Matthews joined Citizens Bank and Trust Company (a predecessor of TFBNA) in 1972, and continued as President of Citizens Bank and Trust Company until his election as Chief Executive Officer in 1987. In January 1991, Citizens Bank and Trust Company was merged with TFBNA and Mr. Matthews was elected President of the Glasgow Division of TFBNA. He became Vice President of the company in 1987.
- 6 - Mr. Perkins joined TFBNA in 1973 and has served as Chief Operations Officer since 1981. Ms. Schaaf joined the company in November 1992. Prior to that, she was Examiner-In-Charge of Asset Quality for regional banks with the Office of Comptroller of Currency. Mr. Simmons joined the company in November 1993. Prior to that, he was a partner in a Denver law firm, specializing in financial institutions law, and was a vice president on the legal staff of Colorado National Bankshares, Inc. None of the above officers is related to another and there are no arrangements or understandings between them and any other person pursuant to which any of them was elected as an officer, other than arrangements or understandings with directors or officers of the company acting solely in their capacities as such, and other than the employment agreements of Messrs. Lester and Matthews. Mr. Lester's employment agreement with the company and TFBNA became effective January 1, 1991. Mr. Matthews' employment agreement with TFBNA was also effective January 1, 1991.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The registrant's common stock is traded on the NASDAQ National Market System under the symbol TRFI. As of December 31, 1993, there were 1,253 shareholders of record. Following is a summary of market prices and dividends declared for the registrant's common stock for the quarterly periods indicated (adjusted for the 4-for-3 stock split effected February 1, 1993):
Additional information for this item is included in Note 10 to the consolidated financial statements on page 43 of this report.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA The information for this item is included in the section entitled "Consolidated Statistical Information" on page 29 of this report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information for this item is included in the section entitled "Management's Discussion and Analysis," on pages 13 through 28 of this report.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated financial statements of the registrant and report of independent auditors are included in a separate section of this report on pages 30 through 48: Report of KPMG Peat Marwick, Independent Auditors Consolidated Balance Sheets - December 31, 1993 and 1992 Consolidated Statements of Income - Years ended December 31, 1993, 1992 and Consolidated Statements of Changes in Shareholders' Equity - Years ended December 31, 1993, 1992 and 1991 Consolidated Statements of Cash Flows - Years ended December 31, 1993, 1992 and 1991
- 7 - Notes to Consolidated Financial Statements
Additional information for this item is included in the section entitled "Quarterly Results" on page 28 of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.
PART III
ITEM 10.


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set out in the section entitled "Voting Securities and Ownership Thereof," "Election of Directors," "Compensation Committee Interlocks and Insider Participation," and "Transactions with Management and Others" of the registrant's Proxy Statement on pages 2 through 9 and 14 through 16, and the information set out in the section entitled "Executive Officers of the Registrant" on pages 6 and 7 of Part I of this report are incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION The information set out in the section entitled "Executive Compensation and Other Information," of the registrant's Proxy Statement at pages 9 through 15 is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set out in the section entitled "Voting Securities and Ownership Thereof" of the registrant's Proxy Statement at pages 2 through 4 is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set out in the sections entitled "Transactions with Management and Others" and "Compensation Committee Interlocks and Insider Participations" of the registrant's Proxy Statement on pages 14 through 16 is incorporated herein by reference.
- 8 - PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) (1) Financial statements filed The list of consolidated financial statements together with the report thereon of KPMG Peat Marwick, as set forth in Part II, Item 8 of this report is incorporated herein by reference. (2) Financial statement schedules Schedules to the consolidated financial statements are omitted, as the required information is not applicable. (3) List of exhibits The list of exhibits listed on the Exhibit Index on pages 49 through 51 of this report is incorporated herein by reference. The management contracts and compensatory plans or arrangements required to be filed as exhibits to this Form 10-K pursuant to Item 14(c) are noted by asterisk (*) in the Exhibit Index.
(b) Reports on Form 8-K The registrant did not file any reports on Form 8-K during the last quarter of the period covered by this report.
(c) Exhibits The exhibits listed on the Exhibit Index on pages 49 through 51 of this Form 10-K are filed as a part of this report.
(d) Financial statement schedules No financial statement schedules are required to be filed as a part of this report.
- 9 - SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Trans Financial Bancorp, Inc. ----------------------------- (Registrant)
By: /s/ Douglas M. Lester -------------------------- Douglas M. Lester Chairman of the Board, President and Chief Executive Officer
Date: March 31, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 31, 1994, by the following persons on behalf of the registrant and in the capacities indicated.
(a) Principal Executive Officer:
/s/ Douglas M. Lester ---------------------- Douglas M. Lester Chairman of the Board, President and Chief Executive Officer
(b) Principal Financial Officer:
/s/ Vince A. Berta ---------------------- Vince A. Berta Executive Vice President and Chief Financial Officer
(c) Principal Accounting Officer:
/s/ Edward R. Matthews ---------------------- Edward R. Matthews Controller
- 10 -
(c) Directors:
- 11 -
TRANS FINANCIAL BANCORP, INC.
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1993
ITEMS 1, 2, 5, 6, 7, 8 AND 14 (A)(1)
Financial Statements and Supplementary Data Market for the Registrant's Common Equity and Related Shareholder Matters Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations
- 12 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL OVERVIEW
Trans Financial Bancorp, Inc., (the company) is a bank holding company registered under the Bank Holding Company Act of 1956, and a savings and loan holding company registered under the Home Owners' Loan Act. The company has two subsidiary banks - Trans Financial Bank, N.A. ("Trans Financial Bank") and Trans Financial Bank, Pikeville, Kentucky ("TFB-Pikeville") - and two thrift subsidiaries - Trans Financial Bank, FSB and Trans Financial Bank of Tennessee, FSB ("TFB-Tennessee"). Collectively, these four institutions are referred to in this report as the banks. The company has achieved its earnings growth by expanding through acquisitions, streamlining operations and building non-interest income. At December 31, 1993, the company had total consolidated assets of $1.169 billion, total loans of $769 million, total deposits of $994 million and shareholders' equity of $76 million. For the year ended December 31, 1993, the company's net income increased 2.8%, from $9.1 million to $9.3 million, although earnings per share decreased 4.6%, from $1.30 to $1.24 per common share. During 1992 and 1993, the company completed several acquisitions without compromising overall asset quality. Effective March 26, 1992, the company acquired First Federal Savings Bank of Tennessee, Tullahoma, Tennessee, in a combination stock and cash purchase valued at $11.3 million. On March 27, 1992, the company acquired Maury Federal Savings Bank, Columbia, Tennessee, for $11.1 million in cash. These two Tennessee thrift institutions had combined assets of $279 million, net loans of $185 million and deposits of $252 million when they were merged on November 27, 1992. On August 7, 1992, the company acquired the deposits and branch operations of five middle Tennessee branches of Heritage Federal Bank for Savings ("Heritage Federal"). TFB-Tennessee assumed approximately $55 million in deposits, acquired approximately $2.3 million in premises and equipment and received approximately $52 million in cash (net of a premium). These acquisitions have been accounted for under the purchase method of accounting. On December 31, 1992, the company merged with Dawson Springs Bancorp, Inc. (DSB), the holding company for Kentucky State Bank, Scottsville, Kentucky, and Commercial Bank of Dawson, Dawson Springs, Kentucky, by issuing 560,088 shares of its common stock. These two banks, with combined assets of approximately $73 million, were merged into Trans Financial Bank on December 31, 1992. The DSB merger was accounted for on a pooling of interests basis and, accordingly, all financial data for prior periods have been restated as if the entities were combined for all periods prior to the merger. On July 6, 1993, in a transaction accounted for as a purchase, the company acquired Trans Kentucky Bancorp, Inc., Pikeville, Kentucky, the holding company for The Citizens Bank of Pikeville. At the acquisition date, TFB-Pikeville (the former Citizens Bank of Pikeville) had total assets of $188.7 million, net loans of $107.6 million and total deposits of $163.9 million. The aggregate cost, including consideration and acquisition costs, totaled $18.8 million. Over the last three years, the company has emphasized investment in infrastructure in order to control operating risks, support future acquisitions and internal growth and allow the company to introduce new products. Investments have been made primarily in data processing hardware and software upgrades which enable the company to process transactions more efficiently and to accommodate growth in transaction volume and product array, while realizing economies of scale and maintaining quality control. Management believes that these expenditures have enhanced the company's franchise and positioned it for future acquisitions.
The discussion that follows is intended to provide insight into the results of operations and financial condition of the company. This discussion should be read in conjunction with the Consolidated Financial Statements and accompanying notes presented elsewhere in this report. As previously discussed, the company consummated several business combinations which were accounted for under the purchase method. Accordingly, the results of operations of those acquired entities prior to the acquisition dates have not been included in the results of operations. Therefore, ratios or analyses for periods before and after these purchase acquisitions will not be comparable. The DSB merger was accounted for as a pooling of interests and, accordingly, all financial data for prior periods were restated as if the entities had been combined for all periods prior to the merger. See Note 3 to the Consolidated Financial Statements for additional information regarding business combinations. All per share data in this report give effect to stock splits.
INCOME STATEMENT REVIEW
GENERAL Net income was $9.3 million ($1.24 per share) in 1993, compared with $9.1 million ($1.30 per share) for 1992, and $4.5 million ($1.17 per share fully diluted) in 1991. The higher net income in 1993 was due to (in thousands):
- The TFB-Pikeville acquisition (net of the related interest on debt) $ 791 Excluding TFB-Pikeville: - Increased net interest income 5,904 - Increased non-interest income 1,930 - Lower income taxes 652 - Increased non-interest expense (8,575) - Increased provision for loan losses (446) ---------------------------------------------------------- Total increase in net income $ 256 ==========================================================
The increase in non-interest expense was spread over several categories, particularly compensation and benefits ($3.1 million, excluding TFB-Pikeville), occupancy, furniture and equipment ($1.2 million), professional fees ($.9 million), and postage and express charges ($.4 million). The majority of increases are related to the purchase acquisitions consummated in 1992 and 1993. In general, the remaining increases are related to an effort to build the company's infrastructure to accommodate future growth, requiring investments in staff as well as in buildings, equipment and information systems. Earnings per share decreased in 1993 because of the increased number of average shares outstanding - a result of the full-year impact of 1) the 1992 public stock offering, 2) conversion to common stock of the remaining debentures, and 3) stock issued in connection with the TFB-Tennessee acquisition. The increase in earnings in 1992 versus 1991 was attributable to an increase in net interest income ($12.7 million), due to growth in interest-earning assets from the TFB-Tennessee acquisition, coupled with a higher net interest margin. Also contributing to the increase in earnings in 1992 were increases in fee income generated from deposit accounts ($.6 million), loan servicing fees ($1.1 million), securities gains ($.7 million), and gains on mortgage loan sales ($.6 million). These increases were partially offset by higher non-interest expenses ($9.5 million).
TRANS FINANCIAL BANCORP, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME
NET INTEREST INCOME Net interest income - the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities - totaled $40.6 million in 1993, compared with $31.4 million in 1992. This represents a 29.3% increase over 1992. The increase from 1991 to 1992 was 67.6%. The increase in net interest income in both 1992 and 1993 was primarily a result of an increase in average interest-earning assets, which was further enhanced by an increase in the net interest margin. Average interest-earning assets for 1993 increased $206 million, while net interest margin increased 7 basis points. The increase in average interest-earning assets in 1993 was due to the TFB-Pikeville acquisition (providing an $89 million increase in the company's average interest-earning assets), loan growth ($86 million excluding TFB-Pikeville) and the full-year impact of investment securities purchased from funds provided in the Heritage Federal branch acquisition. In 1992, average interest-earning assets increased $293 million and the net interest margin increased 12 basis points. TFB-Tennessee, acquired at the end of the first quarter of 1992, added approximately $217 million to average interest-earning assets during 1992, while the Future Federal branch acquisition of August 1991 and the Heritage Federal branch acquisition of August 1992 together contributed approximately $72 million to average earning asset growth in 1992. Average loans increased $174 million in 1992 as a result of the addition of TFB-Tennessee's loan portfolio, combined with the increase in loans associated with significant residential mortgage and corporate loan demand. Average securities increased $115 million with the addition of TFB-Tennessee's securities and the increased investment in mortgage-backed securities associated with funds available from the Heritage Federal branch acquisition.
NET INTEREST MARGIN AND SPREAD COMPARISON
(1) Net interest spread is the difference between the average rate of interest earned on interest-earning assets and the average rate of interest expensed on interest-bearing liabilities.
(2) Net interest margin is net interest income divided by average interest- earning assets.
The net interest margin and net interest-rate spread increased over the past two years due to the company's interest-bearing liabilities repricing downward more rapidly than yields on interest-earning assets. During that time, the market spread between the prime rate and the federal funds rate has increased. A significant amount of Trans Financial Bank's loans are tied to the prime rate and a significant amount of its deposits are relatively short term. Short-term deposits tend to follow movements in short-term U.S. Treasury securities, rates which move up or down more quickly than the prime rate. Accordingly, as the spread between the prime rate and shorter-term rates has widened, so has the company's net interest margin and net interest-rate spread. One factor which partially offsets the widening interest spread effect noted above has been the inclusion of TFB-Tennessee in the company's consolidated financial statements since the first quarter of 1992. TFB-Tennessee's interest-earning assets are concentrated in relatively low yielding residential mortgage loans and investment securities. TFB-Tennessee's deposit base also has a larger proportion of higher-rate certificates of deposit. The interest spread increase was also lessened by the Tennessee branch acquisition in August 1992, which added approximately $51 million of interest-earning assets at an initial net interest spread of approximately 60 basis points.
AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS
Net interest margin is net interest income divided by average interest-earning assets. For computational purposes, nonaccrual loans are included in interest-earning assets. Loan fees are included in interest income on loans. Net interest spread is the difference between the average rate of interest earned on interest-earning assets and the average rate of interest expensed on interest-bearing liabilities. Average balances are based on daily balances for all periods, except that for 1992 averages, the average balances related to one affiliate comprising approximately 28% of average interest-earning assets are computed based on month-end balances.
ANALYSIS OF YEAR-TO-YEAR CHANGES IN NET INTEREST INCOME The following table shows changes in interest income and interest expense resulting from changes in volume and interest rates for the years ended December 31, 1993 and 1992, as compared to the previous year.
The change in interest due to both rate and volume has been allocated to changes in average volume and changes in average rates in proportion to the relationship of absolute dollar amounts of change in each.
PROVISION FOR LOAN LOSSES The provision for loan losses was $1.7 million (.25% of average loans) in 1993 compared with $1.2 million (.24% of average loans) in 1992 and $.8 million (.22% of average loans) in 1991. Net loan charge-offs increased to $1.3 million in 1993, from $.9 million in 1992 and $.7 million in 1991. As a percentage of average loans, net charge-offs were .20% in 1993, compared with .17% for 1992, .19% for 1991 and .22% for the five year period 1989-1993. The provision for loan losses and the level of the allowance for loan losses reflect the quality of the loan portfolio and result from management's evaluation of the risks in the loan portfolio. In 1992, the ratio of the allowance for loan losses to period-end loans declined to 1.01% from 1.21% in 1991. The decline was a reflection of the change in the loan portfolio to a higher proportion of traditionally lower risk residential mortgage loans as a result of the acquisition of TFB-Tennessee. In 1993 that ratio increased to 1.08% as commercial loans increased from 26% of total loans at year-end 1992 to 28% at December 31, 1993. Further discussion on loan quality and the allowance for loan losses is included later in this review in the Asset Quality discussion.
NON-INTEREST INCOME Non-interest income for 1993 increased $2.7 million over 1992, including $.8 million from the TFB-Pikeville acquisition, $.8 million in increased deposit account service charges (excluding TFB-Pikeville), $.6 million in increased mortgage loan servicing fees and $.2 million in increased INVEST
securities brokerage revenues. These increases were partially offset by a $.4 million decline in gains on sales of securities and mortgage loans. In 1992, non-interest income increased $4.5 million compared with 1991. TFB-Tennessee contributed $3.5 million of this increase, of which $.6 million was due to nonrecurring security gains arising from the restructuring of the acquired investment portfolio. INVEST revenues increased $.3 million (91%) in 1992. INVEST is a third-party non-affiliate which provides access to full-service brokerage services and a wide variety of complementary investment products, including financial planning. Revenues generated from mortgage-banking activities (loan servicing fees and mortgage loan sale gains) increased in 1993 and 1992, attributable to the mortgage-banking activities of TFB-Tennessee. The portfolio of loans serviced for others has grown to $690 million, which increased mortgage servicing fees from $.4 million in 1991, to $1.5 million in 1992, and $2.0 million in 1993. Gains on sales of mortgage loans increased from $.7 million in 1991, to $1.3 million in 1992 as a result of the increased activity related to mortgage loan originations, related loan sales and the sale of other residential portfolio mortgage loans. Substantially all the 1992 increase in gains on sales of mortgages and loan servicing fees is attributable to the Tennessee operation. In 1993 gains on sales of mortgages declined to $.7 million due to the absence of any substantial residential portfolio mortgage sales. Service charges on deposits increased $1.2 million in 1993 compared with 1992, a result of deposit growth and the assessment of fees for formerly complimentary services. Service charges increased $.6 million in 1992 over 1991, $.4 million of which was from TFB-Tennessee. Other non-interest income, which includes credit card fees, data processing revenue, QUEST (ATM network) income, credit life insurance commissions, and other miscellaneous income, increased $.9 million in 1993 and $1.2 million in 1992.
NON-INTEREST EXPENSES Non-interest expenses increased $11.5 million from 1992 to 1993, after increasing $9.5 million from 1991 to 1992. The increases in 1993 are due primarily to the Tennessee thrift acquisitions during 1992 and to the TFB-Pikeville acquisition early in the third quarter of 1993. Professional fees, principally related to acquisitions, increased $.9 million. This increase, coupled with other expenses related to the opening of an operation center, were the underlying causes of the higher non-interest expenses in 1993. Non-interest expenses of TFB-Tennessee caused 65% of the increase from 1991 to 1992. Compensation and benefits increased $4.4 million, or 35%, from 1992 to 1993 ($3.1 million excluding TFB-Pikeville) - the result of an expansion of the professional staff as well as 1993 being the first full year of TFB-Tennessee being included in the company's operating results. The 1992 increase in compensation and benefits was $4.1 million, or 48%. Personnel expenses attributable to TFB-Tennessee's operations were $2.9 million of this increase. Other increases came from merit/promotional increases ($1.0 million), group insurance ($.2 million), and incentive pay ($.2 million). Occupancy and furniture and equipment costs increased $1.9 million in 1993 compared with 1992. TFB-Pikeville accounted for $.7 million of this increase, with depreciation, the renovation of the Russellville and corporate offices, and the opening of an operation center comprising the remaining portion of the increase. In 1992, these costs were up $1.6 million compared with 1991, with TFB-Tennessee making up 58% of the increase and the remainder primarily due to maintenance and depreciation associated with facility enhancements and computer equipment purchases. FDIC deposit insurance expense increased $.7 million from 1991 to 1992. Fifty-nine percent of this increase was attributable to TFB-Tennessee and the remainder to the increase in the premium combined with deposit growth at Trans Financial Bank. In 1993, deposit insurance expense increased 23% - a rate approximating the rate of increase in average deposits. Other non-interest expenses were up $3.1 million in 1993, including $.7 million due to the TFB-Pikeville acquisition, $.5 million attributable to the consolidation and conversion of mortgage loan operations, $.2 million of amortization of intangible assets related to purchase acquisitions, $.3 million of insurance (other than deposit insurance), $.2 million related to the prepayment of mortgage loans serviced for others, and $.2 million of expenses related to foreclosed and repossessed assets. In 1992 other non-interest expenses increased $3.2 million over 1991 due to Tennessee operations ($2 million), professional fees ($.3 million), advertising and public relations ($.1 million), postage ($.1 million) and other general operating expenses attributable to the general increase in business activity, none of which individually increased more than $.1 million.
INCOME TAXES In the first quarter of 1993 the company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", resulting in a $91 thousand decrease in net income in 1993. Excluding the effect of adopting Statement 109, the company had income tax expense of $4.2 million in 1993, compared with $4.7 million in 1992 and $2.0 million in 1991. These represent effective tax rates of 31.1%, 34.1% and
30.9%, respectively. The higher effective income tax rate for 1992 resulted from non-taxable sources of income making up a smaller proportion of income and the effects of state income taxes associated with TFB-Tennessee. Further information on the company's income tax position can be found in Note 11 to the consolidated financial statements.
BALANCE SHEET REVIEW
Assets at year-end 1993 totaled $1.169 billion, compared with $978 million at December 31, 1992, and $587 million at the end of 1991. Average total assets increased $223 million in 1993 to $1.051 billion. Average interest-earning assets increased 27% to $966 million, after increasing 63% in 1992. The TFB-Pikeville acquisition contributed $193 million to total assets at year-end 1993 and $89 million to the increase in average interest-earning assets for the year. The acquisition of TFB-Tennessee contributed $217 million to the increase in average interest-earning assets in 1992.
LOANS Total loans, net of unearned income, averaged $691 million in 1993, compared with $516 million in 1992. At year-end 1993, loans net of unearned income totaled $769 million, compared with $546 million at December 31, 1992. TFB-Pikeville's loan portfolio at December 31, 1993, represents $121 million of the increase from year-end 1992 to 1993. Much of the remaining increase in both commercial and mortgage loans represents loans to finance the operations of corporate customers. While many of these loans are structured as mortgages, very few are dependent on the collateral to service the loan. The growth in the corporate loan portfolio reflects the strength of the regional market. TFB-Tennessee's loans made up $175 million of the 1992 increase, with corporate loan growth at Trans Financial Bank contributing $11 million of the increase. The following table presents a summary of the loan portfolio by category for each of the last five years. Other than the categories noted, there is no concentration of loans in any industry greater than 5% in the portfolio. Trans Financial has no foreign loans or highly leveraged transactions in its loan portfolio.
LOANS OUTSTANDING
The following table sets forth the maturity distribution and interest sensitivity of selected loan categories at December 31, 1993. Maturities are based upon contractual terms. The company's policy is to specifically review and approve any loan renewed; no loans are automatically rolled over. The table excludes real estate mortgage loans, consumer loans and other loans.
LOAN MATURITIES AND INTEREST SENSITIVITY
ASSET QUALITY With respect to asset quality, management considers three categories of assets to merit constant scrutiny. These categories include (a) loans which are currently nonperforming, (b) other real estate and loans classified as in-substance foreclosures (ISF), and (c) loans which are currently performing but which management believes require special attention. Nonperforming loans, which include nonaccrual loans, accruing loans past due over 90 days and restructured loans, totaled $6.6 million at the end of 1993, an increase of $.6 million from 1992. The ratio of nonperforming loans to year-end loans was .86% compared with 1.11% at year-end 1992 and 2.06% at December 31, 1991. Nonperforming assets, which include nonperforming loans, other real estate, and loans classified as in-substance foreclosures, totaled $11.2 million at year-end 1993. The ratio of nonperforming loans and other real estate to total assets decreased from 1.38% to .96% at year-end 1993. The following table presents information concerning nonperforming assets, including nonaccrual and restructured loans. Management classifies a loan as nonaccrual when principal or interest is past due 90 days or more and the loan is not adequately collateralized and in the process of collection, or when, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the obligation. Consumer installment loans are charged off after 120 days of delinquency unless adequately secured and in the process of collection. Loans are not reclassified as accruing until principal and interest payments are brought current and future payments appear certain. Loans are categorized as restructured if the original interest rate, repayment terms, or both were restructured due to a deterioration in the financial condition of the borrower. However, restructured loans that demonstrate performance under restructured terms and that yield a market rate of interest are removed from restructured status in the year following the restructure.
NONPERFORMING ASSETS
Included in the $4.9 million in nonaccrual loans at December 31, 1993, is $1.8 million attributable to the TFB-Pikeville acquisition. Two credit relationships account for $3 million, or 61%, of the December 31, 1993, nonaccrual balance. The first of these loans is to a manufacturing concern and is secured by commercial real estate and equipment. The loan was first placed on nonaccrual in 1992. During 1993, $775,000 of the loan balance was charged off, reducing the loan to its present balance of $1.5 million. Appropriate amounts have been specifically allocated in the evaluation of the allowance for loan losses for this credit exposure. The second loan was acquired in the TFB-Pikeville acquisition. It also has an outstanding principal balance of $1.5 million and is secured by commercial real estate. The borrower filed for Chapter 11 bankruptcy protection during the third quarter of 1993. It is management's opinion that the existing credit exposure is adequately supported by the collateral value and no future losses are anticipated. The remaining December 31, 1993, nonaccrual balance consists of various commercial and consumer loans. A significant portion of accruing loans contractually past due 90 days or more is comprised of residential mortgage loans at TFB-Tennessee. The past-due loans, making up .33% and .96% of TFB-Tennessee's mortgage portfolio as of December 31, 1993 and 1992, respectively, are generally well secured and no significant losses are expected. The balance of other real estate and in-substance foreclosures as of December 31, 1993, includes two properties with an aggregate book value of $3.5 million, or 76% of the outstanding balance. The first property was acquired through foreclosure in 1986 with an unsatisfied loan balance at the time of $1.8 million. In order to facilitate the disposal of the property, the company entered into a joint venture with a real estate developer and developed the land for industrial and other commercial use. In the third quarter of 1993, the company dissolved the joint venture and retained title to the property. Several parcels have been sold at a profit. The book value of the property as of December 31, 1993 and 1992, including development costs, was $1.8 million and $2.1 million, respectively. Based on a recent appraisal of the property and previous sales experience, management does not anticipate any significant losses to be incurred on disposition. The second property included in other real estate and in-substance foreclosures is carried at a book value of $1.7 million and relates to a wood products manufacturing facility. The facility was closed in 1992 and is presently listed for sale with a commercial real estate firm. The carrying value of the property at the beginning of 1993 was $2.4 million. During the year, $400,000 was converted via negotiation to a restructured loan and continues to be reported as such at year-end 1993, approximately $140,000 was reduced by the sale of collateral, and $146,000 was written off. Based on an appraisal of the collateral, management is of the opinion that no significant loss will be incurred in the disposal of the collateral. As of December 31, 1993, the company had $5.9 million of loans which were not included in the past due, nonaccrual or restructured categories, but for which known information about possible credit problems caused management to have serious doubts as to the ability of the borrowers to comply with the present loan repayment terms. Based on management's evaluation, including current market conditions, cash flow generated and recent appraisals, management currently anticipates no significant losses will be incurred in connection with these loans. These loans are subject to continuing management attention and are considered by management in determining the level of the allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged to expense. The allowance represents an amount which, in management's judgment, will be adequate to absorb probable losses on existing loans. At December 31, 1993, the allowance was $8.3 million, compared with $5.5 million at December 31, 1992, and $4.2 million at December 31, 1991. The allowance as a percentage of nonperforming loans - an indication of the relative ability to cover problem loans with existing reserves - increased from 59% at December 31, 1991, to 92% at December 31, 1992, and to 126% at year-end 1993. The ratio of the allowance for loan losses to total loans at year-end 1993 was 1.08% versus 1.01% at December 31, 1992, and 1.21% at December 31, 1991.
Following is a summary of the changes in the allowance for loan losses for each of the past five years.
SUMMARY OF LOAN LOSS EXPERIENCE
The adequacy of the allowance for loan losses is determined on an ongoing basis through analysis of the overall quality of the loan portfolio, historical loan loss experience, loan delinquency trends and the economic conditions within the company's market area. Additional allocations from the allowance are based on specifically identified potential loss situations. These potential loss situations are identified by account officers' evaluation of their own portfolios as well as by an independent loan review function. The tables below set forth an allocation of the allowance for loan losses by category of loan and a percentage distribution of the allowance allocation. In making the allocation, consideration was given to such factors as management's evaluation of risk in each category, current economic conditions and charge-off experience. An allocation of the allowance for loan losses is an estimate of the portion of the allowance which will be used to cover future charge-offs in each loan category, but it does not preclude any portion of the allowance allocated to one type of loan from being used to absorb losses of another loan type.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
ALLOCATION OF YEAR-END ALLOWANCE FOR LOAN LOSSES AND PERCENTAGE OF EACH TYPE OF LOAN TO TOTAL LOANS
SECURITIES, FEDERAL FUNDS SOLD AND RESALE AGREEMENTS Securities, including those classified as held to maturity and available for sale, decreased from $257 million at December 31, 1992, to $249 million at year-end 1993. TFB-Pikeville provided an initial securities portfolio of $61 million, indicating a total decrease of $69 million. Due to the declining rate environment over the past two years, the mortgage-backed securities portfolio has experienced a high level of prepayments. To a large extent, the proceeds of these prepayments were invested in commercial, consumer loans and mortgages held for sale. Effective December 31, 1993, the company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Accordingly, all debt securities in which the company does not have the ability or management does not have the positive intent to hold to maturity are classified as securities available for sale and are carried at market value. In conjunction with the adoption of Statement 115, $153.4 million of investment securities were transferred to securities available for sale. All equity securities are classified as available for sale at December 31, 1993. Unrealized gains and losses on securities available for sale are reported as a separate component of shareholders' equity (net of tax) beginning December 31, 1993. In the fourth quarter of 1992, the company reclassified $33.5 million of investment securities to securities available for sale. This reclassification had no impact on results of operations as the reclassified portfolio's aggregate market value exceeded book value and securities classified as available for sale prior to December 31, 1993, were carried at the lower of aggregate cost or market value. Securities in this classification before year-end 1993 were those that management intended to use as part of its asset/liability strategy and that could be sold in response to changes in interest rates and repayment risk and other factors related to these changes. Securities increased from $167 million at December 31, 1991, to $257 million in 1992. TFB-Tennessee provided an initial securities portfolio of $64 million and the Heritage Federal branch acquisition in Tennessee provided funding for an additional $51 million of mortgage-backed securities purchases. Average securities increased from $116 million in 1991 to $231 million in 1992. The excess of the average increase over the actual increase in securities of $25 million is due to the full-year effect of the securities funded by the September 1991 Future Federal deposit acquisition being included for the entire period in 1992. The percentage of collateralized mortgage obligations and mortgage-backed securities to total securities declined
to 51% at December 31,1993, from 75% at December 31,1992. This decline was due to significant refinancing of residential mortgages and the resulting prepayment of mortgage-related securities, coupled with management's desire to decrease the company's exposure to mortgage-related securities. Due to the unpredictable nature of residential mortgage prepayments, the average and final maturities of the related securities vary. In a rising rate environment this will result in securities of a longer than expected life, while in a declining rate environment the securities will have a shorter than expected life. Management limits this prepayment and payment extension risk principally by investing in planned amortization class CMO's, which have less volatility than other mortgage-backed securities and have an average life of three to five years. The tables below present the carrying value of securities for each of the past three years and the maturities and yield characteristics of securities as of December 31, 1993.
CARRYING VALUE OF SECURITIES
MATURITY DISTRIBUTION OF SECURITIES
(1) Collateralized mortgage obligations and mortgage-backed securities are grouped into average lives based on December 1993 prepayment projections. (2) The weighted average yields are based on carrying value and effective yields weighted for the scheduled maturity of each security.
Federal funds sold and securities purchased under agreements to resell declined to $12.2 million at December 31, 1993, from $53.7 million at December 31, 1992. On the last day of 1991, these short-term assets totaled $1.8 million. Average federal funds sold and resale agreements, however, were $18.0 million for 1993, $9.8 million for 1992 and $7.4 million for 1991. The unusually high balance at December 31, 1992, was attributed to a large inflow of short-term deposits at year end.
DEPOSITS AND BORROWED FUNDS Total deposits averaged $910 million in 1993, a 26% increase over 1992. Most of the increase was in interest-bearing accounts, which increased $150 million, or 23%. Non-interest-bearing accounts increased $37 million, or 61%, year-to-year. Substantially all of the increase in interest-bearing accounts is attributable to acquisitions consummated during 1992 and 1993, while $23 million of the increase in non-interest-bearing accounts was due to acquisitions. The TransPlus checking account introduced in 1989, which pays interest on a tiered deposit balance structure, continued to grow in popularity during 1993, increasing $19 million. Total deposits averaged $723 million in 1992, an increase of $272 million, or 60%, over 1991. Most of the increase is attributable to interest-bearing accounts, as in 1993. In 1992, interest-bearing accounts increased $253 million, or 62%, on average. Non-interest-bearing accounts increased $18 million, or 42%, compared to the 1991 average. As was the case in 1993, virtually all the increase was a result of the company's acquisition activity. In both 1993 and 1992, the company experienced heavy redemption of certificates of deposit, with average decreases of $37 million and $47 million, respectively, net of acquisitions. These decreases appear to be the result of today's lower-interest-rate environment and retail customers' unwillingness to invest long term at the lower rates. Instead, they have chosen shorter-term interest-bearing accounts, as evidenced by increases in interest-bearing demand accounts, net of acquisitions, of $31 million in 1993 and $47 million in 1992. Long-term debt and other borrowings averaged $32.7 million in 1993, an increase of $28.2 million from 1992. This increase is the result of the issuance of $33 million of 7.25% Subordinated Notes in a public offering and a $15 million advance from the Federal Home Loan Bank to the company's TFB-Tennessee subsidiary. Both borrowings occurred in the third quarter. In 1992, average borrowings were $4.5 million, a decrease of $8.2 million from 1991. The company's 8.5% Convertible Subordinated Debentures of $4.9 million were called December 15, 1991, and were converted in January 1992 into common stock, decreasing the company's long-term debt by 60%. The payoff of a $5 million term loan in September 1991 and a secured note payable of $2.4 million in December 1992 further reduced the company's borrowings. Offsetting these decreases, Trans Financial Bank received a $10 million advance from the Federal Home Loan Bank to fund fixed-rate commercial loans. The advance bears interest at a rate of 4.5% payable monthly with principal due May 9, 1994. The company has a $3 million unsecured operating line of credit with an unaffiliated commercial bank that is used from time-to-time to supplement the company's cash requirements. At year-end 1992, $600,000 was outstanding under the line of credit. The line was not in use at December 31, 1993. The company's leveraged ESOP obtained additional financing from an unaffiliated commercial bank in 1992. Total ESOP debt was $3.9 million at both December 31, 1993 and 1992. See Note 8 to the consolidated financial statements for a further description of the terms of these borrowings. Time deposits of $100,000 or more totaled $119,533,000 at December 31, 1993, and $70,725,000 at December 31, 1992. Interest expense on time deposits of $100,000 or more was $4,818,000 in 1993 and $4,656,000 in 1992. The table below provides information on the maturities of time deposits of $100,000 or more at December 31, 1993.
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
Information regarding federal funds purchased and repurchase agreements is presented below. Substantially all of these short-term borrowings mature in one business day.
FEDERAL FUNDS PURCHASED AND REPURCHASED AGREEMENTS
CAPITAL RESOURCES AND LIQUIDITY At December 31, 1993, retained earnings of the banks were $23.4 million, of which $12.2 million were available for the payment of dividends to the parent company. The company issued on September 16, 1993, $33 million of 7.25% Subordinated Notes in a public offering. The net proceeds were approximately $32 million, of which $12 million was used to repay debt incurred in the TFB-Pikeville transaction and the balance is available for general corporate purposes, including augmenting the capital of the banks, as needed, and financing possible future acquisitions. On March 10, 1992, the company issued 1.265 million shares of common stock in a public stock offering. The offering price was $14.75 per share and the net proceeds were approximately $17.1 million. The net proceeds were used in connection with the acquisitions of Maury Federal and First Federal, now TFB-Tennessee. Also during 1992, the company redeemed the remaining shares of its Class A Preferred Stock, 1990 Series ($999,000) and all of the outstanding shares of other preferred stock, which was related to Dawson Springs Bancorp, Inc. ($1.286 million). The company's capital ratios at December 31, 1993 and 1992 (calculated in accordance with regulatory guidelines) were as follows:
Capital ratios of all of the company's subsidiaries are in excess of applicable minimum regulatory capital ratio requirements at December 31, 1993. The increase in equity capital during 1992 was due to the common stock issuance in connection with the acquisition of TFB-Tennessee, the underwritten public stock offering, the debenture conversion, and retained earnings. The increase during 1993 was nearly all provided by retained earnings and reinvested dividends. Generally speaking, the company relies upon net inflows of cash from financing activities, supplemented by net inflows of cash from operating activities, to provide cash used in its investing activities. As is typical of most banking companies, significant financing activities include issuance of common stock, deposit gathering, use of short-term borrowing facilities, such as federal funds purchased and repurchase agreements, and the issuance of long-term debt. The company's primary investing activities include purchases of securities and loan originations, offset by maturities and sales of securities, and loan payments.
ASSET/LIABILITY MANAGEMENT A primary objective of asset/liability management is to manage the company's exposure to interest-rate risk. The company's Asset/Liability Committee monitors and adjusts exposure to interest rates in response to economic conditions and the flow of loans and deposits, provides oversight to the asset/liability management process and approves policy guidelines. Further, asset/liability activity is reviewed by the Board of Directors. An earnings simulation model is used to monitor and evaluate the exposure and impact of changing interest rates on earnings. This dynamic model captures all interest-earning assets, interest-bearing liabilities and off-balance-sheet financial instruments. The model combines the various factors affecting rate sensitivity into an earnings outlook that incorporates management's view of the most likely interest rate environment for the next 24 months. Rate sensitivity is determined by assessing the impact on net interest income in multiple rising and falling interest-rate scenarios. The model is updated at least monthly and more often if necessary. The simulation model provides a more dynamic assessment of interest-rate sensitivity than does a portrayal of the static interest-rate sensitivity gap, compiled as of a point in time. Static gap analysis does not reflect the multiple effects of interest rate movements on the whole range of assets, liabilities, and off-balance-sheet financial instruments. Moreover, in today's financial environment, which includes a complex array of both on- and off-balance-sheet financial instruments, static gap analysis does not provide the most comprehensive and informative disclosures about interest-rate risks. The model presents a sharper and more complete picture of the company's interest-rate sensitivity, which allows management to emphasize stable net interest income throughout rate cycles, with the result that intermediate and longer-term implications take precedence over short-term profitability. Because it includes significant variables identified as being affected by interest rates, the earnings simulation model provides better information to management. For example, among the factors the model captures which static gap analysis does not are 1) rate of change differentials, such as federal funds rates versus savings account rates; 2) maturity effects, such as calls on securities; 3) rate barrier effects, such
as caps or floors on loans; 4) changing balance sheet levels, such as loans and mortgage outstandings; 5) floating rate loans that may be tied or related to prime, treasury notes, CD rates or other rate indices, which do not necessarily move identically as rates change; 6) leads and lags that occur as rates move away from current levels; and 7) the effects of prepayments on various fixed rate assets such as residential mortgages, mortgage-backed securities, collateralized mortgage obligations, and consumer loans. These, and certain other effects, are evaluated to develop multiple scenarios from which the sensitivity of earnings to changes in interest rates is determined. It should be noted, however, the model does not take into account future actions that could be undertaken to reduce this impact if there were a change in management's interest rate expectations or the actual level of interest rates. The model combines the pivotal factors that affect interest-rate sensitivity into a comprehensive outlook for the next 24 months. In assessing multiple rate scenarios, the following illustrates the effects on net interest income of varying rate environments compared to a consensus economic forecast (considered most likely). For example, in the most likely rate scenario, the company assumed that the federal funds rate and prime rate would increase gradually over the next year to 3.75% and 6.50%, respectively. Following is a summary of the assumptions used in the model at the end of 1993, along with the resultant projected impact on net interest income.
Management concludes that the company is asset sensitive at December 31, 1993, which indicates that in a uniformly rising rate environment the company's net interest income will be impacted positively.
QUARTERLY RESULTS
Following is a summary of the company's operating results for the past eight quarters.
QUARTERLY RESULTS OF OPERATIONS
The large increase in non-interest income in the first quarter of 1993 was due to the realization of $1.0 million of gains on the sale of securities available for sale. The $2,034,000 increase in net interest income from the second to third quarters of 1993 was primarily due to the TFB-Pikeville acquisition. In the fourth quarter of 1993, continued growth in earning assets were the driving force for the $252,000 increase in net interest income. The company experienced strong fee income related to mortgage banking - due to heavy mortgage loan origination activity and large gains on sale of mortgage loans - in the fourth quarter as well. These increases in fourth quarter income were partially offset, however, by continued growth in non-interest expenses.
CONSOLIDATED STATISTICAL INFORMATION (1)(2)
(1) During 1993, 1992, 1991 and 1990, the company acquired one commercial bank, three thrift institutions and certain branches of two other thrift institutions in transactions accounted for using the purchase method. Financial data pertaining to the acquired entities since the acquisition dates have been included in the consolidated financial statements. See Note 3 to the consolidated financial statements.
(2) On December 31, 1992, the company merged with Dawson Springs Bancorp, Inc. in a transaction accounted for as a pooling-of-interests. Accordingly, all financial data has been restated as if the entities were combined for all periods presented. See Note 3 to Consolidated Financial Statements.
(3) All per common share data has been adjusted to reflect the 4-for-3 stock splits effected December 18, 1992, and December 16, 1991 and the 3-for-2 stock split effected February 13, 1989.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders Trans Financial Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Trans Financial Bancorp, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Trans Financial Bancorp, Inc., and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, in 1993 the company adopted the provisions of the Financial Accounting Standards Board's Statements of Financial Accounting Standards No. 109, "Accounting for Income Taxes" and No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
KPMG PEAT MARWICK Louisville, Kentucky January 25, 1994, except as to Note 3(b), which is as of February 15, 1994
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FIANANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. A description of the more significant accounting policies follows.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Trans Financial Bancorp, Inc. (the company) and its wholly-owned subsidiaries, Trans Financial Bank, National Association and Trans Financial Bank, Pikeville, Kentucky (the "banks"), Trans Financial Bank of Tennessee, FSB and Trans Financial Bank, Federal Savings Bank (the "savings banks"). Significant intercompany transactions and accounts have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform with 1993 presentations.
SECURITIES
Effective December 31, 1993, the company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Accordingly, all debt securities in which the company does not have the ability or management does not have the positive intent to hold to maturity are classified as securities available for sale and are carried at market value. All equity securities are classified as available for sale at December 31, 1993. Unrealized gains and losses on securities available for sale are reported as a separate component of shareholders' equity (net of income taxes) beginning December 31, 1993. Securities classified as available for sale prior to December 31, 1993, are reported at the lower of aggregate cost or market value. Securities classified as held to maturity are carried at amortized cost. The company has no securities classified as trading securities.
Amortization of premiums and accretion of discounts are recorded by a method which approximates a level yield and which, in the case of mortgage-backed securities, considers prepayment risk. The specific identification method is used to determine the cost of securities sold.
LOANS
Loans are stated at the unpaid principal balance. Interest income on loans is recorded on the accrual basis except for those loans in a nonaccrual income status. Loans are placed in nonaccrual status when, in the opinion of management, the prospects for recovering principal or interest is considered doubtful. Unearned income, arising principally from consumer installment loans or the deferral of certain loan fees, is recognized as income using a method that approximates the interest method.
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are carried at the lower of aggregate cost or market value, as determined by outstanding loan commitments from investors or current yield requirements.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level that adequately provides for estimated losses in the loan portfolio. The level of the allowance is based on an evaluation of the loan portfolio which includes reviews of individual credits, consideration of past loan loss experience, loan delinquency trends, changes in the composition of the loan portfolio and the impact of current economic conditions. The allowance for loan losses is increased by the provision for loan losses and reduced by net charge-offs. The level of the allowance and the amount of the provision for loan losses involve uncertainties and matters of judgment and therefore, cannot be determined with precision.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation of premises and equipment is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line method over the term of the related lease or over the useful life of the improvements, whichever is shorter. Leasing commitments are insignificant.
GAIN OR LOSS ON SALE OF MORTGAGE LOANS HELD FOR SALE
The company sells mortgage loans held for sale for cash proceeds equal to the principal amount of loans sold plus or minus market gains or losses. Gain or loss is recorded at the time of sale in an amount reflecting the difference between the contractual interest rates of the loans sold and the current market rate.
PURCHASED MORTGAGE SERVICING RIGHTS AND EXCESS SERVICE FEES
The cost of purchased mortgage loan servicing rights ("PMSR's") ($3,049,000 and $2,454,000 at December 31,1993 and 1992, respectively, net of accumulated amortization) is amortized against service fee income in proportion to, and over the period of, estimated net servicing revenues.
The carrying value of PMSR's and the related amortization are periodically evaluated using a discounted valuation method, in relation to estimated future net servicing revenues. The company evaluates the carrying value of the PMSR's by estimating the future net servicing income of the rights based on management's best estimate of remaining loan lives.
The normal agency (GNMA, FNMA or FHLMC) servicing fee is used in the capitalization of any excess service fees. When participating interests in loans sold have an average contractual interest rate, as adjusted for normal servicing costs, which differs from the agreed yield to the purchaser, gains or losses are recognized equal to the present value of such differential over the estimated remaining life of such loans. Amortization of capitalized excess servicing fees is reflected as a reduction of loan servicing income using the interest method over the estimated remaining life of such loans, adjusted for actual prepayments.
OTHER ASSETS
Included in other assets is real estate acquired in settlement of loans and loans classified as in-substance foreclosure, which are carried at the lower of cost or fair value less estimated selling costs. The excess of cost over fair value less the estimated costs to sell at the time of foreclosure is charged to the allowance for loan losses. Provisions for subsequent declines in fair value are included in other non-interest expense. Other costs relating to holding real estate acquired in settlement of loans and in-substance foreclosures are charged to other non-interest expense as incurred. Costs related to real estate in the process of development are capitalized.
INCOME TAXES
The company adopted as of January 1, 1993, Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". Under this statement, a current or deferred income tax liability is recognized, subject to certain limitations, for the current or deferred tax consequences of all events that have been recognized in the financial statements. The deferred income tax liability or asset is measured by the provisions of enacted tax laws. Income taxes for prior years were determined in accordance with Accounting Principles Board Opinion No. 11. The cumulative effect of this change in accounting principle, determined as of January 1, 1993, is reported separately in the consolidated statement of income for the year ended December 31, 1993.
EARNINGS PER COMMON SHARE
Primary earnings per share is computed by dividing net income applicable to common stock by the weighted average number of shares of common stock outstanding during the period. Fully diluted earnings per share is computed based on the weighted average number of shares of common stock outstanding during the period, assuming conversion, for 1991, of the convertible subordinated capital debentures into common stock and giving effect to the elimination from net income of interest expense related to the debentures (net of income tax effects). Net income for both calculations is reduced for dividends on preferred stock.
On December 18, 1992 and December 16, 1991, the company's Board of Directors authorized 4-for-3 stock splits effected in the form of a 33.3% stock dividend. All per share information gives effect to the stock splits. The weighted average number of shares outstanding after giving effect to these stock splits were as follows:
(2) STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks.
The following summarizes supplemental cash flow data for the years ended December 31, 1993, 1992 and 1991:
Certain non-cash investing and financing transactions are summarized as follows. See note 3 which summarizes assets and liabilities associated with acquisitions:
(3) BUSINESS COMBINATIONS
a) COMBINATIONS CONSUMMATED THROUGH DECEMBER 31, 1993
On July 6, 1993, the company acquired all of the outstanding stock of Trans Kentucky Bancorp, Inc., the holding company for The Citizens Bank of Pikeville, now Trans Financial Bank. The aggregate costs, including consideration and acquisition costs were $18.778 million. The excess of the costs over the fair value of net assets acquired of $117,000 was recorded as goodwill.
This acquisition has been accounted for under the purchase method and, accordingly, the results of operations and cash flows of this entity have been included in the consolidated financial statements since the date of acquisition.
The aggregate fair value of net assets acquired included the following:
Following is a presentation of pro forma financial information of the company for the years ended December 31, 1993 and 1992, assuming this acquisition had occurred on January 1, 1992. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the entities been combined throughout those periods.
On March 26, 1992, the company acquired First Federal Savings Bank of Tennessee and its wholly-owned subsidiaries, now Trans Financial Bank of Tennessee, FSB, for cash and common stock of the company. The aggregate costs, including consideration and acquisition costs, were $11.270 million. The 412,389 shares of common stock issued were valued at $6.0 million. The excess of costs over the fair value of net assets acquired of $17,000 was recorded as goodwill.
On March 27, 1992, the company acquired Maury Federal Savings Bank for cash of $10.989 million. Aggregate consideration and acquisition costs totaled $11.110 million. The excess of the fair value of net assets over costs (negative goodwill) of $468,000 was allocated to reduce the values assigned to premises and equipment. On November 27, 1992, this entity was merged with Trans Financial Bank of Tennessee, FSB.
These two acquisitions have been accounted for under the purchase method and, accordingly, the results of operations and cash flows of these two entities have been included in the consolidated financial statements since the dates of acquisition.
On August 7, 1992, the company acquired five middle Tennessee branches of Heritage Federal Bank for Savings. In this transaction the company's wholly-owned subsidiary, Trans Financial Bank of Tennessee, FSB, assumed approximately $55 million in deposits, acquired approximately $2.3 million in premises and equipment, and received approximately $52 million in cash, net of a $.8 million premium.
On December 31, 1992, the company merged with Dawson Springs Bancorp, Inc. (DSB), the holding company for Kentucky State Bank and Commercial Bank of Dawson. Under the terms of the merger all shares of DSB common stock outstanding were converted into 560,088 shares of Trans Financial Bancorp, Inc. common stock. The transaction was accounted for as a pooling of interests and, accordingly, all financial data has been restated as if the entities were combined for all periods presented. On December 31, 1992 these banks were merged into Trans Financial Bank, N.A.
On August 30, 1991, in connection with the company's acquisition from the Resolution Trust Company (RTC) of certain deposits and assets of Future Federal Savings Bank, Louisville, Kentucky, the Bank assumed approximately $75.9 million in deposits, acquired approximately $11 million in consumer loans and received approximately $64.3 million in cash (net of a premium of $1.0 million paid to the RTC), all related to the Glasgow and Tompkinsville, Kentucky branches of Future Federal Savings Bank.
Intangibles (goodwill and deposit base premium) from the above transactions, as well as acquisitions consummated in 1990 and 1985, are being amortized over periods ranging from ten to twenty years using straight-line and accelerated methods and had a combined unamortized balance of $5,234,000 and $5,925,000 at December 31, 1993 and 1992, respectively.
b) COMBINATION CONSUMMATED AFTER DECEMBER 31, 1993
On February 15, 1994, the company merged with Kentucky Community Bancorp, Inc. (KCB) of Maysville, Kentucky, the holding company for The State National Bank, Peoples First Bank, and Farmers Liberty Bank. Under the terms of the merger all shares of KCB common stock outstanding were converted into 1,374,962 shares of Trans Financial Bancorp, Inc. common stock. The transaction will be accounted for as a pooling of interests.
The following tables present pro forma financial information for the company and KCB as if this transaction had been consummated as of December 31, 1993.
c) PENDING BUSINESS COMBINATIONS
On December 27, 1993, Trans Financial entered into a definitive agreement providing for the acquisition of 100% of Peoples Financial Services, Inc. in an all stock transaction. Peoples Financial, headquartered in the middle Tennessee community of Cookeville, is a two bank holding company for Peoples Bank and Trust of the Cumberlands and Citizens Federal Savings Bank with combined assets of approximately $120 million. Under the terms of the agreement, Peoples Financial shareholders will receive 5.5 shares of Trans Financial Bancorp common stock for each share of Peoples Financial stock or a total of approximately 1,315,770 shares. It is anticipated that the transaction will constitute a tax free reorganization and qualify for the pooling of interests method of accounting. The transaction is subject to regulatory and Peoples Financial shareholder approval.
On January 28, 1994, Trans Financial entered into a definitive agreement providing for the acquisition of 100% of FGC Holding Company, in an all stock transaction. FGC Holding Company, headquartered in the eastern Kentucky community of Martin, is a one bank holding company for First Guaranty National Bank with $126 million in assets. Under the terms of
the agreement, FGC Holding Company shareholders will receive 419.83 shares of Trans Financial Bancorp common stock for each share of FGC Holding Company common stock, or a total of approximately 1,050,000 shares. It is anticipated that the transaction will constitute a tax free reorganization and qualify for the pooling of interests method of accounting. The transaction is subject to regulatory and FGC Holding Company shareholder approval.
(4) CASH AND DUE FROM BANKS
Regulatory authorities require the company's subsidiaries to maintain reserve balances on customer deposits. The amounts of required reserves totaled $14,880,000 at December 31,1993, and $14,208,000 at December 31,1992.
(5) SECURITIES
Effective December 31, 1993, the company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Accordingly, all debt securities in which the company does not have the ability or management does not have the positive intent to hold to maturity are classified as securities available for sale and are carried at market value. All equity securities are classified as available for sale at December 31, 1993. In conjunction with the adoption of Statement 115, $153.4 million of investment securities were transferred to securities available for sale. Unrealized gains and losses on securities available for sale are reported as a separate component of shareholders' equity (net of tax) beginning December 31, 1993. Securities available for sale at December 31, 1992, are carried at the lower of aggregate cost or market value.
The following summarizes securities available for sale at December 31, 1993 and 1992.
The amortized cost and approximate market values of securities held to maturity as of December 31, 1993 and 1992, follows:
Included in equity securities at December 31, 1993, are Federal Home Loan Bank and Federal Reserve Bank stock of $4,325,000 and $744,000, respectively. At December 31, 1992, these stock investments were $4,130,000 and $744,000, respectively.
The amortized cost and approximate market value of debt securities at December 31, 1993, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed obligations generally have contractual maturities in excess of ten years, but shorter expected maturities as a result of prepayments.
Securities with a par value, which approximates carrying value, of approximately $110,229,000 and $94,671,000 at December 31, 1993 and 1992, respectively, were pledged to secure public funds, trust funds and for other purposes.
Gross gains of $1,054,000, $923,000, and $202,000 and gross losses of $20,000, $50,000, and $-0- were realized on sales of securities in 1993, 1992, and 1991, respectively.
(6) LOANS
The company grants commercial loans, real estate loans, consumer loans and lease financing to customers primarily in the immediate market areas of its subsidiaries in western and eastern Kentucky and middle Tennessee. The composition of loans at December 31, 1993 and 1992 follows:
The principal balance of nonaccrual and restructured loans at December 31, 1993 and 1992 was $5,387,000 and $3,405,000, respectively. The interest that would have been recorded if all such loans were on a current status in accordance with their original terms was approximately $365,000 in 1993, $390,000 in 1992 and $683,000 in 1991. The amount of interest income that was recorded for such loans was approximately $32,000 in 1993, $101,000 in 1992 and $428,000 in 1991.
Loans to executive officers and directors and their associates, including loans to affiliated companies for which these individuals are principal owners, amounted to approximately $24,566,000 at December 31, 1993 and $19,953,000 at December 31, 1992. During 1993, new loans of $18,132,000 were made and repayments of $11,948,000 were received. Other changes include increases for changes in executive officers and directors of $5,338,000 and decreases related to participations sold of $6,909,000. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for other customers.
An analysis of the changes in the allowance for loan losses follows:
During 1993 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"). This statement must be adopted on a prospective basis by January 1995. SFAS 114 requires that impaired loans be measured at the present value of expected future cash flows, discounted at the loan's effective interest rate, at the loan's observable market price, or at the fair value of the collateral if the loan is collateral dependent. The company is currently evaluating when and how it will adopt SFAS 114, as well as its possible financial impact on the company.
(7) PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 1993 and 1992, follows:
(8) LONG-TERM DEBT AND OTHER BORROWINGS
Long-term debt consisted of the following at December 31, 1993 and 1992:
Short-term borrowings, other than federal funds purchased and repurchase agreements, consisted of the following at December 31, 1993 and 1992:
===================================================================
The prime interest rate and base rate associated with certain of the above obligations was 6.0% at December 31, 1993 and 1992.
The company has a $3,000,000 unsecured operating line of credit with an unaffiliated bank, with an outstanding balance of $600,000 at December 31, 1992. The line was not in use at December 31, 1993. This obligation has the same restrictive covenants as the ESOP loan due July 31, 1994, as described below.
The advances from the Federal Home Loan Bank are collateralized by the company's Federal Home Loan Bank stock and certain first mortgage loans in the approximate amount of 150% of the debt.
The ESOP note payable due July 31, 1994 is guaranteed by the company and enables the ESOP to borrow up to $4.0 million. The related loan agreement has a number of restrictive covenants, including maintaining capital levels of the company, the banks and savings banks at least at the minimum levels required by applicable regulatory agencies; maintaining the company's risk-weighted capital ratio, as defined, at not less than 9.25%; maintaining the company's leverage ratio, as defined, at not less than 5.25%; maintaining the company's annualized return on assets at the date of financial reports required by regulations at no less than .50%; maintaining nonperforming loans, as defined, at less than 2.50% of gross loans at the date of required financial reports; and maintaining on a consolidated basis an allowance for loan losses of at least .75% of gross loans. The ESOP note payable due July 31, 1996 is also guaranteed by the company. The loan obligations of the ESOP are recorded on the consolidated balance sheet with a corresponding amount recorded as a reduction of the company's shareholders' equity. Both the loan obligation and the reduction of shareholders' equity will be reduced by the amount of any loan repayments made by the ESOP.
Principal payments required for the years 1993 through 1998 on long-term debt at December 31, 1993, are as follows:
(9) SHAREHOLDERS' EQUITY COMMON STOCK
The company has stock option plans which permit options to be granted for a maximum of 432,889 shares of common stock of the company. Under the terms of the plans, options with ten-year terms may be granted to certain key employees to purchase common stock at not less than fair value of the common stock at the date of grant. A summary of share data related to the option plan, adjusted for stock splits, follows:
Of the options outstanding, 81,859 were exercisable as of December 31, 1993.
The company's Employee Stock Ownership Plan (ESOP) is described in Note 12 to the consolidated financial statements.
PREFERRED STOCK AND RIGHTS PLAN
During 1992, the company's Articles of Incorporation were amended to eliminate two series of Class A Preferred Stock, designated the 1988 and 1990 Series, and to authorize the issue of 5,000,000 shares of Class B Preferred Stock, Series 1992. Series 1992 Class B Preferred Stock is issuable in connection with the company's Rights Plan and carries the right to cumulative annual dividends of $6.00 per share or 133 times dividends per common share (subject to adjustment), whichever is greater.
On January 20, 1992, the company's Board of Directors adopted a Shareholder Rights Plan. Under the plan, the Board declared a dividend of one right (adjusted to 3/4 of a right by virtue of the four-for-three stock split effected December 18, 1992) for each outstanding share of common
stock. In addition, the company will issue one right with respect to each share of common stock issued subsequent to that date. Each right, when and if it becomes exercisable, will entitle the registered holder to purchase from the company 1/100 of a share of Series 1992 Preferred Stock, subject to adjustment, at an exercise price of $45. The description and terms of the rights are set forth in a Rights Agreement, dated as of January 20, 1992, between the company and Chemical Bank, as Rights Agent. The Board may redeem the rights in whole, but not in part, at a price of $.01 per right.
The rights become exercisable only if a person or group acquires, or obtains the right to acquire, beneficial ownership of 15% or more of the company's outstanding common stock, the Board determines that a beneficial owner of at least 10% of the company's outstanding common stock has a detrimental effect on the company or its shareholders, or a tender or exchange offer is commenced for 25% or more of the outstanding common stock.
After the rights become exercisable, if any person becomes the beneficial owner of more than 15% of the outstanding common stock, or the Board determines that a beneficial owner of at least 10% of the company's outstanding common stock has a detrimental effect on the company or its shareholders, then the rights will entitle each holder of a right to purchase, for the exercise price, the number of shares of preferred stock which at the time of the transaction would have a market value twice the exercise price.
(10) DIVIDEND RESTRICTIONS
Payment of dividends by the company's subsidiaries is restricted by national and state banking and thrift laws and regulations. Also, certain notes payable described in note 8 include restrictive covenants related to the maintenance of minimum capital ratios by the banks and savings banks, which effectively restrict the payment of dividends. At December 31, 1993, retained earnings of the company's subsidiaries were approximately $23.4 million, of which approximately $12.2 million is available as of January 1, 1994 for the payment of dividends under the most restrictive of the above restrictions.
Certain notes payable described in note 8 include restrictive covenants related to the maintenance of minimum capital ratios, which effectively restrict the payment of dividends by the company. Also, minimum regulatory capital requirements effectively limit the payment of dividends. At December 31, 1993, the most restrictive of the covenants limited the payment of dividends by the company to approximately $9.9 million.
(11) INCOME TAXES
As discussed in note 1, the company adopted in 1993 Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". The cumulative effect of this change in accounting for income taxes, determined as of January 1, 1993, was a reduction in net income of $91,000 and is reported separately in the consolidated statement of income for 1993. Financial statements for prior years have not been restated to apply the provisions of Statement 109.
Prior purchase business combinations were adjusted to reflect the implementation of Statement 109, however the impact of these adjustments was not significant and is included in income from continuing operations.
Total income tax expense for the year ended December 31, 1993 was allocated as follows:
The components of income tax expense (benefit) were as follows:
An analysis of the differences between the effective tax rates and the statutory U.S. federal income tax rate is as follows:
The sources of timing differences and the resulting deferred income tax expense (benefit) for 1992 and 1991, follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1993, are presented below:
Cumulative deferred income taxes were an asset of $82,000 at December 31, 1993, and a liability of $238,000 at December 31, 1992.
Shareholder's equity of the savings banks at December 31, 1993 and 1992 includes approximately $3,768,000 and $4,536,000 respectively, for which no deferred Federal income tax liability has been recognized. These amounts represent an allocation of income to bad debt deductions for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carrying back net operating losses to prior years may create income for tax purposes only, which would be subject to the then current corporate income tax rate.
(12) EMPLOYEE BENEFIT PLANS
The company has an employee stock ownership plan (ESOP) under which the company and its subsidiaries will contribute to the ESOP an amount determined by the respective Boards of Directors at their discretion. The company recognized expenses related to the ESOP based on cash contributions, with such amounts exceeding the amount computed under the shares allocated method. The interest incurred on the ESOP note payable, the amount contributed by the company to the ESOP and the amount of dividends on ESOP shares used for debt service by the ESOP for 1993, 1992 and 1991 were as follows:
The company has a profit sharing plan qualified under Section 401(k) of the Internal Revenue Code. Under the amended profit sharing plan, the company and its subsidiaries will provide funds to match the contribution made by the participating employee up to a maximum of 4% of the employee's salary. Contributions in accordance with the profit sharing plan were approximately $360,000 in 1993, $214,000 in 1992, and $173,000 in 1991.
Former full-time employees of Kentucky State Bank who meet certain requirements as to age and length of service are covered by a defined benefit pension plan. Pension expense for this plan was $2,000 in 1993, $14,000 in 1992, and $15,000 in 1991. The plan's funded status at December 31, 1993 was composed of plan assets of $503,000 and a projected benefit obligation of approximately $544,000.
The company has no significant commitments to pay post-retirement or post-employment benefits other than as described above.
Stock options granted to key employees are described in Note 9 to the consolidated financial statements.
During 1993, AICPA Statement of Position ("SOP") 93-6, Employers' Accounting for Employee Stock Ownership Plans, was issued. The SOP will change the accounting for the company's ESOP once all unallocated shares held by the ESOP on December 31, 1992, are exhausted. Shares acquired after December 31, 1992, will also be subject to the accounting prescribed in the SOP. The changes include recognition of compensation cost, accounting for dividends on allocated and unallocated shares, and the inclusion of committed shares in earnings per share computations. The company is currently reviewing the SOP to determine the potential impact it will have on its consolidated financial statements.
(13) COMMITMENTS AND CONTINGENT LIABILITIES OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
The company's consolidated financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business to meet the financing needs of customers. These include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate and liquidity risk in excess of the amount recognized in the consolidated balance sheet. The extent of the company's involvement in various commitments is expressed by the contract amount of such instruments.
Commitments to extend credit, which amounted to $174,793,000 at December 31, 1993, and $187,402,000 at December 31,1992 are agreements to lend to a customer as long as all conditions established in the contract are fulfilled. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitments 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 upon extension of credit, is based upon management's credit evaluation of the customer. Collateral varies but may include accounts receivable, inventory, property, plant, equipment, residential properties, income-producing commercial properties, marketable securities and interest-bearing time deposits.
Standby letters of credit are conditional commitments issued by the company guaranteeing the performance of a customer to a third party. Those guarantees primarily consist of performance assurances made on behalf of customers who have a contractual commitment to produce or deliver goods or services. Most guarantees are for one year or less. The risk to the company arises from its obligation to make payment in the event of the customer's contractual default and is essentially the same as that involved in extending loan commitments to customers. The amount of collateral obtained, if deemed necessary, is based upon management's credit evaluation of the customer. Collateral held varies. The company had standby letters of credit outstanding totaling $32,196,000 and $28,232,000 at December 31, 1993 and 1992, respectively.
Commercial letters of credit are short-term commitments generally used to finance a commercial contract for the shipment of goods from seller to buyer. At December 31, 1993, the company had $4,861,000 in commercial letters of credit outstanding.
At year-end 1993, the company was not a party to any off-balance-sheet derivative contracts.
With respect to mortgage loans sold to investors, such loans are generally sold with servicing rights retained, with only the normal legal representations and warranties regarding recourse to the company. Management believes that any liabilities which may result from such recourse provisions are not significant.
LEGAL PROCEEDINGS
As of December 31, 1993, there were various pending legal actions and proceedings against the company in which claims for damages are asserted. Management, after discussion with legal counsel, believes that the ultimate result of these legal actions and proceedings will not have a material adverse effect upon the consolidated financial statements of the company.
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the company's financial instruments are as follows:
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
CASH, SHORT-TERM INVESTMENTS, FEDERAL FUNDS PURCHASED AND REPURCHASES
For these short-term instruments, the financial statement carrying amount approximates fair value.
SECURITIES
The fair value of securities is estimated by discounting future cash flows using current rates at which investments would be made in similar instruments with similar credit ratings and equivalent remaining maturities.
LOANS
The fair value of loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
DEPOSITS
The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.
LONG-TERM DEBT AND OTHER SHORT-TERM BORROWINGS
Rates currently available to the company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
COMMITMENTS TO EXTEND CREDIT AND STAND-BY LETTERS OF CREDIT
The fair values of loan commitments and letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The value of these financial instruments was not material at December 31, 1993 and 1992.
LIMITATIONS ON FAIR VALUE REPORTING
The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments. Because no market exists for a significant portion of the company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
The fair value estimates are based on financial instruments only. The company has not attempted to estimate the value of assets and liabilities not considered to be financial instruments, such as premises and equipment, the mortgage banking operation and the intangible value of its core deposits and branch system. Accordingly, the fair value estimates do not represent a fair value for the company as a whole.
(15) PARENT COMPANY FINANCIAL STATEMENTS
Condensed financial data for Trans Financial Bancorp, Inc. (parent company only) as of December 31, 1993 and 1992 and for the years ended December 31, 1993, 1992 and 1991 are as follows:
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME
CONDENSED STATEMENTS OF CASH FLOWS
EXHIBITS
* Denotes a management contract or compensatory plan or arrangement of the registrant required to be filed as an exhibit pursuant to Item 601 (10) (iii) of Regulation S-K.