ITEM 1. Description of Business
General
We are the largest Tennessee bank holding company headquartered in Nashville, Tennessee. We conduct our banking business through five (5) bank subsidiaries:
- Bank of Mason, a Tennessee state chartered bank with one (1) office in Tipton County, Tennessee,
- Bank of Dyer, a Tennessee state chartered bank with four (4) offices in Gibson and Madison County, Tennessee,
- Cumberland Bank, a Tennessee state chartered bank with nine (9) offices in Macon, Smith, Sumner, Robertson and Warren Counties, Tennessee,
- BankTennessee, a Tennessee state chartered bank with six (6) offices in Shelby and Lauderdale Counties, Tennessee and
- The Community Bank, a Tennessee state chartered bank, with three (3) offices in Davidson and Williamson Counties, Tennessee.
Our Tennessee banks are collectively referred to as our bank subsidiaries or our banks. We also own a fifty percent (50%) interest in The Murray Bank, a federal savings bank, which opened for business June 15,
1999 and has grown to total assets of more than $41.9 million at December 31, 2000. We also own a fifty percent (50%) interest in the Insurors Bank of Tennessee, a state chartered, Federal Reserve Bank member bank which opened for business November 20, 2000. The Insurors Bank had total assets of $7 million at December 31, 2000.
Our operations principally involve commercial and residential real estate lending, commercial business lending, consumer lending, construction lending and other financial services, including credit card services and brokerage services. We had total assets of more than $643 million as of December 31, 2000.
The following table represents our bank's growth in branch offices and total assets from the years ended December 31, 1994 and December 31, 1997 to December 31, 2000. Data for BankTennessee and The Community Bank for 1994 and 1997 are for their respective predecessor entities.
We have eight (8) bank branch offices that are less than three years old as of December 31, 2000. We also have broadened our mix of products and expanded our customer base through a combination of internal growth and acquisitions. Our growth has been directed by a senior management team composed of individuals with an average of more than twenty-one (21) years of banking experience in Tennessee.
Cumberland Bank. Cumberland Bank has been in business in Smith County for more than twenty-five (25) years. It was originally organized as a state savings and loan association in 1975 in Carthage and converted to a Tennessee state bank in 1991. Its first office was in Carthage with later expansion to Gallatin. We believe that Cumberland Bank also has a well established base in Sumner County with offices in Gallatin,
White House, and Portland, Tennessee. Another office operates in Gordonsville in Smith County. Cumberland Bank opened a new office in Lafayette, Macon County, Tennessee during the fourth quarter of 1999. It acquired two branch offices in the third quarter of 1999, both of which are located in Warren County, Tennessee. Cumberland Bank provides lending and other financial services through its subsidiary, Cumberland Finance Company, which has offices in Gallatin and Murfreesboro, Tennessee. Cumberland Bank offers investment services and other financial services through its subsidiary CBC Financial Services, Inc., which has offices in Carthage and Gallatin, Tennessee. Cumberland Bank also manages and owns a fifty percent (50%) interest in a full service, independent insurance agency, InsureTennessee, Inc. InsureTennessee represents more than twenty (20) different companies offering automobile, home, life, health, disability and other types of insurance. InsureTennessee shares an office location in Carthage with CBC Financial Services and an office in Collierville, Tennessee in BankTennessee's building on New Byhalia Road. InsureTennessee opened a new office in Cross Plains, Tennessee during the third quarter 2000. A new branch building also was constructed in the fourth quarter of 2000 in Lafayette, Tennessee.
We have entered into a joint venture with InsCorp, Inc., a Tennessee bank holding company, under which we acquired a fifty percent (50%) interest in Insurors Bank of Tennessee, a de novo state chartered bank located in Nashville, Davidson County, Tennessee. InsCorp owns the remaining interest in the bank, which opened for business on November 20, 2000.
BankTennessee. BankTennessee was originally organized as a federal savings association, First Federal Savings and Loan Association in 1934 and later changed its name to First Federal Bank of Memphis. It converted to a Tennessee state bank in 1997. BankTennessee's senior management team has over seventy-five (75) years of banking experience, with three former bank presidents on staff. BankTennessee is Tennessee's largest Small Business Administration lender according to "SBA Lenders". Also, residential construction loans account for a substantial percentage of BankTennessee's loan portfolio compared to other Tennessee banks. BankTennessee's recent growth includes completion of a new $3.0 million main office in Collierville and a recently completed branch office in Ripley, Tennessee.
The Community Bank. The Community Bank was originally organized as a federal savings association, First Southern Federal Savings Bank, and later First Federal Bank of Nashville, in 1976. It converted to a Tennessee state bank in 1997. It has three (3) offices, one in Nashville, Tennessee, opened in 1976, one in Brentwood, Williamson County, opened in 1996, and a new facility in Franklin, Williamson County, constructed in 2000.
Except for Macon, Gibson, Smith, Lauderdale, Warren, Robertson, Tipton and northern Sumner Counties which are predominantly rural, our banks are located in growing metropolitan areas including Collierville and eastern Shelby County in Metropolitan Memphis, and Green Hills, Brentwood, Franklin and Gallatin in Metropolitan Nashville. Management believes that the markets in which our banks operate offer an environment for continued growth with respect to our target market, which includes local consumers, professionals and small businesses. Our banks do not have a concentration of deposits obtained from a single person or entity, or a small group of persons or entities, the loss of which would have a material adverse effect on our business or the business of our banks. Construction and development loans of approximately $73.7 million made up 14.5% of our loan portfolio as of December 31, 2000.
Our banks provide a range of customary services which include checking, NOW accounts, money market and savings accounts, certificates of deposit, individual retirement accounts, money transfers, and safe deposit facilities. Lending services include construction lending, commercial, consumer, commercial and residential real estate, home equity and home improvements. In addition, the banks offer various uninsured, non-deposit products including annuities and mutual funds, brokerage services, and secondary market mortgage processing services. The banks are not authorized to provide trust services.
Our banks are subject to the regulatory authority of the Department of Financial Institutions of the State of Tennessee and the Federal Reserve Board of Governors and the Federal Deposit Insurance Corporation (the "FDIC") which currently insures the depositors of each member bank to a maximum of $100,000 per depositor. For this protection, each bank pays a quarterly statutory assessment and is subject to the rules and regulations of the FDIC.
Market Areas
We operate principally in twelve (12) market areas in Tennessee: Macon County, Shelby County, Madison County, Robertson County, Gibson County, Tipton County, Smith County, Sumner County, Warren County and Southern Davidson/Williamson County. We also have a bank branch in Lauderdale County and a finance company office in Rutherford County.
Employees
We had approximately 321 full-time equivalent employees as of December 31, 2000. None of our employee's or our banks' employees are represented by a collective bargaining group. We consider relations with our employees to be excellent. We and our banks provide several employee benefit programs, including a 401(k) plan, group life and health insurance, an annual merit program, paid vacations, and sick leave.
Competition
Our banks have substantial competition in attracting and retaining deposits and in lending funds. The primary factors in competing for deposits are the range and quality of financial services offered, the ability to offer attractive rates and the availability of convenient office locations. Such competition is heightened by the fact that Tennessee law permits any bank or savings association located in Tennessee to branch in any county in Tennessee. Additional significant competition for savings deposits comes from other investment alternatives, such as money market funds and corporate and government securities. Primary factors in competing for loans are the range and quality of lending services offered, interest rates and loan origination fees. Competition for the origination of loans normally comes from other savings and financial institutions, commercial banks, credit unions, insurance companies and other financial service companies.
Except in our Smith County market, our banks have relatively small market shares in their respective markets. Competitors of each of our banks generally possess substantially greater financial resources that those available to our banks. In addition, these institutions generally have higher lending limits than our banks and may provide various services for their customers which our banks do not offer.
We believe our strategy of relationship banking and local autonomy in the communities we serve allows flexibility in rates and products offered in response to local needs in a way that can enhance profitability for our banks, particular as consolidation of the banking industry occurs and larger institutions exit markets that are only marginally profitable for them. We believe our emphasis on community banking, customer service and relationships is the most effective method we have of competing with these larger regional bank holding companies as well as smaller community banks.
Lending Procedures and Loan Approval Process
Lending Procedures. Lending procedures of our banks reflect our philosophy of granting local control to decision making. Although the overall lending policy of the banks is set by our board of directors and is subject to the oversight and control of our board of directors, we depend, to a great degree, upon the judgment of our loan officers and senior management at each bank to assess and control lending risks.
Individual loan officers have discretionary authority to approve certain loans at each of our banks without prior approval. The discretionary limit at BankTennessee varies by loan officer based upon seniority. For example, the bank's president has discretionary approval authority up to $750,000 for certain secured loans, while executive vice presidents have discretionary approval authority up to $250,000 for certain secured loans. At Cumberland Bank, certain individual loan officers have discretionary approval authority up to $100,000 on certain secured loans while the bank's president has discretionary approval authority up to $500,000 on secured loans. At The Community Bank, certain individual loan officers have discretionary approval authority of up to $250,000 on certain secured loans. At Bank of Dyer, certain loan offices have discretionary approval authority up to $100,000 on certain secured loans. At Bank of Mason, the president has discretionary approval authority up to $25,000 on certain secured loans.
Each of our banks utilize a loan committee to review loan requests exceeding the discretionary limit of the loan officer or branch manager, or for which the loan officer or branch manager chooses not to exercise his or her discretionary authority. Each of the banks, except Bank of Mason, has its own officer loan committee, reflecting our emphasis on local control and decision making.
Loans are reviewed periodically by our banks' senior lending officers. We utilize this process to grade each of our banks' loans and determine the adequacy of our banks' loan loss reserve. Past due loans are reviewed by an internal loan officer committee, and a summary report of such loans is reviewed monthly by the board of directors of the Company. A report of loan review findings is presented quarterly to the bank's board of directors.
Asset/Liability Management
Each of our banks has a committee comprised of its senior officers and outside directors charged with managing assets and liabilities pursuant to our asset-liability management policy. Each committee's task is to maximize and stabilize the net interest margin, and to provide reasonable growth of assets, earnings and return on equity capital while maintaining credit quality, reasonable interest rate risk, adequate capital and liquidity. To meet these objectives, each committee monitors its bank's progress and assists in directing overall acquisition and allocation of funds. Each committee meets monthly to review liquidity and funds position, and to review the general economic condition and other factors affecting the availability and use of funds of its bank. Each committee reports monthly to our and the individual banks' boards of directors explaining variances between budget and actual results, providing the likely reasons for such variances and reporting management's course of action in light of any budget variances. Our asset liability management policy is reviewed annually by each bank's board of directors.
Investment Activities
Our banks maintain separate investment portfolios consisting primarily of investment grade securities, including federal agency obligations, corporate bonds and asset-backed securities. Federal regulations limit the types and quality of instruments in which the banks may invest.
A key objective of each of our banks' investment portfolios is to provide a balance with the banks' loans consistent with each bank's liability structures, and to assist in management of interest rate risk. The
investment portfolio generally receives more weight than loans in the risk-based capital formula, and provides the necessary liquidity to meet fluctuations in credit demands and fluctuations in deposit levels of the local communities served. The portfolios also provide collateral for pledging against public deposits and income for our banks.
Each of the banks manages its own investment portfolios. They utilize investment advice provided primarily by reputable, independent brokerage firms.
Non-Depository Business
Cumberland Finance Company. Cumberland Finance, a wholly-owned subsidiary of Cumberland Bank, was formed in 1994 for the purpose of offering high risk, higher yield credit to people located in Smith County, Tennessee. In 1995, Cumberland Finance expanded its operations to Murfreesboro in Rutherford County, Tennessee. Cumberland Finance was profitable in its first year of operations but has struggled financially since then due to problems associated with growth and underwriting functions. Cumberland Finance was profitable in 2000.
CBC Financial Services, Inc. CBC Financial Services, a wholly-owned subsidiary of Cumberland Bank, opened its first office in Carthage, Tennessee in 1993 and thereafter expanded its operations to Gallatin, Tennessee in 1997. It provides both full-service brokerage services and financial estate planning services to customers within Smith and Sumner Counties, Tennessee. CBC Financial Services has experienced operating losses in recent years as a result of costs attributable to its growth, but we expect that its will be profitable in the year 2001, based upon current trends of increased gross revenue and decreased monthly losses. Under its current management, CBC Financial Services has grown to a business with over $50 million in assets under administration as of December 31, 2000.
InsureTennessee, Inc. InsureTennessee is a fully-licensed insurance agency, owned fifty percent (50%) by Cumberland Bank and fifty percent (50%) by a long-time West Tennessee insurance agent. It provides insurance products to customers in Shelby, Sumner and Smith Counties, Tennessee through its offices in Carthage, Gallatin and most recently Collierville, Tennessee. InsureTennessee continued to experience operating losses the past year as a result of costs attributable to its growth, but we expect that it will be profitable in the year 2001, based upon current trends of increased gross revenue and decreased monthly losses.
Joint Ventures
The Murray Bank. On October 1, 1998, we entered into a joint venture with BancKentucky for the purposes of forming and operating a federal savings bank pursuant to Section 5(c) of the Home Owners Loan Act, as amended. By virtue of the joint venture, we own a fifty percent (50%) interest in the voting common stock of The Murray Bank a federal savings bank located at 405 South 12th Street, Murray, Kentucky. BancKentucky owns the additional fifty percent (50%) of The Murray Bank. The Murray Bank opened for business to the public on June 15, 1999.
Of the 20,000 shares of common stock, $10.00 par value issued by the Murray Bank, we acquired 10,000 of these shares at $215 per share for a total consideration of $2.15 million. The board of directors of The Murray Bank consists of thirteen (13) directors, of which four (4) have been designated by us. Under the terms of our agreement with BancKentucky, we also provide investment, accounting, auditing, human resource management, and loan review services to The Murray Bank on a fee for services basis, and will continue to do so as long as we have beneficial ownership of at least fifty percent (50%) of the voting stock of The Murray Bank.
The Insurors Bank. On August 26, 1999, we entered into a joint venture with InsCorp, Inc. for the purposes of forming and operating a state-chartered bank. By virtue of the joint venture, we own a fifty percent (50%) interest in the voting common stock of Insurors Bank of Tennessee located at 2500 Hillsboro Road, Nashville, Tennessee. InsCorp owns the additional fifty percent (50%) of Insurors Bank of Tennessee. InsCorp is a company primarily owned by independent insurance agents in Tennessee. Insurors Bank opened for business to the public on November 20, 2000.
Of the 590,000 shares of common stock issued by Insurors Bank of Tennessee, we acquired 295,000 of these shares at $10 per share for a total consideration of $2,950,000. The board of directors of Insurors Bank of Tennessee consists of thirteen (13) directors, of which three (3) have been designated by us. Under the terms of our agreement with InsCorp, we also provide accounting, auditing, investment, human resource management, back-office operations, to Insurors Bank of Tennessee on a fee for service basis.
Monetary Policies
The result of operations of the Bank and the Company are affected by credit policies of monetary authorities, particularly the Federal Reserve Board. The instruments of monetary policy employed by the Federal Reserve Board include open market operations in U.S. government securities, changes in the discount rate on bank borrowings and changes in reserve requirements against bank deposits. In view of changing conditions in the national economy and in the money markets, as well as the effects of actions by monetary and fiscal authorities, including the Federal Reserve Board, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the effect of such matters on the business and earnings of the Company.
Supervision and Regulation
We, along with our banks, are subject to state and federal banking laws and regulations which impose specific requirements or restrictions and provide for general regulatory oversight with respect to virtually all aspects of our and our banks' operations. These laws and regulations are generally intended to protect depositors, not shareholders. The following summaries of statutes and regulations affecting banks and bank holding companies do not purport to be complete. These summaries are qualified in their entirety by reference to the statutes and regulations described.
General. As a bank holding company, we are regulated under the Bank Holding Company Act of 1956, as amended, and are inspected, examined and supervised by the Board of Governors of the Federal Reserve System. Under the BHCA, bank holding companies generally may not acquire the ownership or control of more than 5% of the voting shares, or substantially all the assets, of any company, including a bank, without the Federal Reserve's prior approval. In addition, bank holding companies generally may engage, directly or indirectly, only in banking and such other activities as are determined by the Federal Reserve to be closely related to banking. Under the recently enacted Gramm-Leach-Bliley Act, bank holding companies may elect to become financial holding companies, which are permitted to engage in activities that are financial in nature or incidental to a financial activity. We have not elected to become a financial holding company.
Various governmental requirements, including Sections 23A and 23B of the Federal Reserve Act, as amended, limit borrowings by us and our nonbank subsidiaries from our affiliate banks. These requirements also limit various other transactions between us and our nonbank subsidiaries, on the one hand, and our banks, on the other. For example, Section 23A limits to no more than 10% of its total capital the aggregate outstanding amount of any bank's loans and other "covered transactions" with any particular nonbank affiliate, and limits to no more than 20% of its total capital the aggregate outstanding amount of any bank's "covered transactions" with all of its nonbank affiliates. Section 23A also generally requires that a bank's loans to its
nonbank affiliates be secured, and Section 23B generally requires that a bank's transactions with its nonbank affiliates be on arm's length terms.
All of our banks are incorporated under the banking laws of the State of Tennessee and, as such, are governed by the applicable provisions of those laws. Consequently, the Tennessee Department of Financial Institutions supervises and regularly examines our banks. Our banks' deposits are insured by the FDIC through the Bank Insurance Fund, and therefore are governed by the provisions of the Federal Deposit Insurance Act and examined by the FDIC. The TDFI and the FDIC regulate or monitor virtually all areas of our banks' operations. The Murray Bank is a federal savings bank organized under the laws of the United States of America. The Murray Bank is primarily regulated and examined by the Office of Thrift Supervision. The FDIC also regulates various operations of The Murray Bank.
Branching. Tennessee law imposes limitations on the ability of a state bank to establish branches in Tennessee. Under current Tennessee law, any Tennessee bank domiciled in Tennessee may establish branch offices at any location in any county in the state. Furthermore, Tennessee and federal law permits out-of-state acquisitions by bank holding companies, interstate merging by banks, and de novo branching of interstate banks, subject to certain conditions. These powers may result in an increase in the number of competitors in our banks' markets. We believe our banks can compete effectively in their markets despite any impact of these branching powers, but there can be no assurance that future developments will not affect our banks' ability to compete effectively.
Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal bank regulatory agencies responsible for evaluating us and our banks, evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility.
Capital Requirements Generally. The federal regulatory agencies that evaluate us and our banks use capital adequacy guidelines in their examination and regulation of banks. If the capital falls below the minimum levels established by these guidelines, the banks may be denied approval to acquire or establish additional banks or non-bank businesses, or to open facilities, or the banks may be regulated by additional regulatory restrictions or actions.
Risk-Based Capital Requirements. All of the federal regulatory agencies have adopted risk-based capital guidelines for banks and bank holding companies. These risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The ratios are minimums. The guidelines require all federally-regulated banks to maintain a minimum risk-based total capital ratio of 8%, of which at least 4% must be Tier I capital, as described below.
A banking organization's qualifying total capital consists of two components: Tier I, or "core," capital and Tier 2, or "supplementary," capital. Tier I capital is an amount equal to the sum of: (1) common shareholders' equity, including adjustments for any surplus or deficit; (2) non-cumulative perpetual preferred stock; and (3) the company's minority interests in the equity accounts of consolidated subsidiaries. With limited exceptions for goodwill arising from certain supervisory acquisitions, intangible assets generally must be deducted from Tier I capital. Other intangible assets may be included in an amount up to 25% of Tier I capital, so long as the asset is capable of being separated and sold apart from the banking organization or the bulk of its assets. Additionally, the market value of the asset must be established on an annual basis through an
identifiable stream of cash flows and there must be a high degree of certainty that the asset will hold this market value notwithstanding the future prospects of the banking organization. Finally, the banking organization must demonstrate that a liquid market exists for the asset. Intangible assets in excess of 25% of Tier I capital generally are deducted from a banking organization's regulatory capital. At least 50% of the banking organization's total regulatory capital must consist of Tier I capital.
Tier 2 capital is generally considered to be an amount equal to the sum of the following:
- the allowance for possible credit losses in an amount up to 1.25 % of risk-weighted assets;
- cumulative perpetual preferred stock with an original maturity of 20 years or more and related surplus;
- hybrid capital instruments defined as instruments with characteristics of both debt and equity, perpetual debt and mandatory convertible debt securities; and
- in an amount up to 50% of Tier I capital, eligible term subordinated debt and intermediate-term preferred stock with an original maturity of five years or more, including related surplus.
Investments in unconsolidated banking and finance subsidiaries, investments in securities subsidiaries and reciprocal holdings of capital instruments must be deducted from capital. The federal regulatory agencies may require other deductions on a case-by-case basis.
Under the risk-weighted capital guidelines, balance sheet assets and certain off-balance sheet items like standby letters of credit, are assigned to one of four risk-weight categories according to the nature of the asset and its collateral or the identity of any obligor or guarantor. These four categories are 0%, 20%, 50% or 100%. For example, cash is assigned to the 0% risk category, while loans secured by one-to-four family residences are assigned to the 50% risk category. The aggregate amount of assets and off-balance sheet items in each risk category is adjusted by the risk-weight assigned to that category to determine weighted values, which are added together to determine the total risk-weighted assets for the banking organization. Accordingly, an asset, like a commercial loan, which is assigned to a 100% risk category is included in risk-weighted assets at its nominal face value, whereas a loan secured by a single-family home mortgage is included at only 50% of its nominal face value. The application ratios are equal to capital, as determined, divided by risk-weighted assets, as determined.
Leverage Capital Requirements. The federal regulatory agencies have issued a final regulation requiring certain banking organizations to maintain additional capital of 1% to 2% above a 3% minimum Tier I leverage capital ratio equal to Tier I capital, less intangible assets, to total assets. In order for an institution to operate at or near the minimum Tier I leverage capital ratio of 3%, the banking regulators expect that the institution would have well-diversified risk, no undue rate risk exposure, excellent asset quality, high liquidity and good earnings. In general, the bank would have to be considered a strong banking organization, rated in the highest category under the bank rating system and have no significant plans for expansion. Higher Tier I leverage capital ratios of up to 5% will generally be required if all of the above characteristics are not exhibited, or if the institution is undertaking expansion, seeking to engage in new activities, or otherwise faces unusual or abnormal risks.
Institutions not in compliance with these regulations are expected to be operating in compliance with a capital plan or agreement with that institution's regulator. If they do not do so, they are deemed to be engaging in an unsafe and unsound practice and may be subject to enforcement action. Failure to maintain a Tier I leverage capital ratio of at least 2% of assets constitutes an unsafe and unsound practice and may result in enforcement action against an institution justifying termination of that institution's FDIC insurance.
At December 31, 2000, the Company's subsidiary bank's risk-based Tier 1 Capital and risk-based Total Capital ratios were 7.42% and 10.79%, respectively.
Liability for Bank Subsidiaries. Under the Federal Reserve policy, we, as a bank holding company, are expected to act as a source of financial and managerial strength to each of our banks and to maintain resources adequate to support each of our banks. This support may be required at times when we may not have the resources to provide it. Any depository institution insured by the FDIC can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC in connection with the default of a commonly-controlled, FDIC-insured depository institution like a bank subsidiary. Additionally, depository institutions insured by the FDIC may be held liable to the FDIC for any loss incurred or reasonably expected to be incurred in connection with any assistance provided by the FDIC to a commonly-controlled, FDIC-insured depository institution in danger of default. "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance. All of our banks are FDIC-insured depository institutions. Also, in the event that such a default occurred with respect to one of our banks, any capital loans from us to that bank would be subordinate in right of payment to payment of the bank's depositors and other of the bank's obligations.
Dividend Restrictions. Federal and Tennessee law limits the payment of dividends by banks. Under Tennessee law, the directors of a state bank, after making proper deduction for all expenditures, expenses, taxes, losses, bad debts, and any write-offs or other deductions required by the TDFI, may credit net profits to the bank's undivided profits account. Thereafter, the bank may quarterly, semi-annually, or annually declare a dividend from that account in an amount judged expedient by the bank's board of directors. Before declaring the dividend, the board of directors must deduct any net loss from the undivided profits account and transfer to the bank's surplus account (1) the amount, if any, required to raise the surplus to 50% of the capital stock and (2) the amount required, if any, but not less than 10% of net profits, to make the paid-in-surplus account equal the capital stock account. Thereafter, the bank may declare a dividend if the bank is adequately reserved against deposits and those reserves will not be impaired by the declaration of the dividend.
A state bank, with the approval of the TDFI, may transfer funds from its surplus account to the undivided profits or retained earnings account or any part of its paid-in-capital account. The payment of dividends by any bank is dependent upon its earnings and financial condition and, also may be limited by federal and state regulatory agency protections against unsafe or unsound banking practices. The payment of dividends could, depending upon the financial condition of a bank, constitute an unsafe or unsound banking practice. When a bank's surplus account is less than its capital stock account, Tennessee law imposes other restrictions on dividends. Finally, the FDIC prohibits a state bank, the deposits of which are insured by the FDIC, from paying dividends if it is in default in the payment of any assessments due the FDIC.
The Federal Reserve also imposes dividend restrictions on our banks as state member banks of the Federal Reserve. Our banks may not declare or pay a dividend if that dividend would exceed the bank's undivided profits, unless the bank has received the prior approval of the Board of Governors of the Federal Reserve. Additionally, our banks may not permit any portion of their "permanent capital" to be withdrawn unless the withdrawal has been approved by the Board of Governors of the Federal Reserve. Permanent capital is defined as the total of a bank's perpetual preferred stock and related surplus, common stock and surplus, and minority interest in consolidated subsidiaries. Finally, if one of our banks has a capital surplus in excess of that required by law, that excess may be transferred to the bank's undivided profits account and be available for the payment of dividends so long as (1) the amount came from the earnings of prior periods, excluding earnings transferred as a result of stock dividends and (2) the bank's board and the Board of Governors of the Federal Reserve approved the transfer.
In 2000, cash dividends totaling $0.10 per share were declared and $0.075 cents per share were paid in the calendar year. In the first quarter of 2001, a cash dividend was declared in the amount of $0.03 cents per share payable on April 14, 2001 to shareholders of record on March 1, 2001.
Deposit Insurance Assessments. The deposits of each of our banks are insured up to regulatory limits by the FDIC and we are required under the FDIC's deposit insurance assessments to maintain the Bank Insurance Fund (BIF) and Savings Association Insurance Fund (SAIF). The FDIC has adopted regulations establishing a permanent risk-related deposit insurance assessment system. Each financial institution is assigned to one of three capital groups -- well capitalized, adequately capitalized or undercapitalized -- and further assigned to one of three subgroups within a capital group. A bank's assignment is based on supervisory evaluations by the institution's primary federal regulator and, if applicable, other information relevant to the institution's financial condition and the risk posed to the applicable insurance fund. The assessment rate applicable to our banks in the future will depend in part upon the risk assessment classification assigned to each bank by the FDIC and in part on the BIF assessment schedule adopted by the FDIC. Institutions are prohibited from disclosing the risk classification to which they have been assigned. The Deposit Insurance Funds Act of 1996 provides for assessments to be imposed on insured depository institutions with respect to deposits insured by the BIF and the SAIF. Currently, the annual insurance premiums on bank deposits insured by the BIF and SAIF vary between $0.00 to $0.27 per $100 of deposits.
Effects of Governmental Policies. The difference between interest earned by our banks on their loans and investments and the interest paid by them on their deposits or other borrowings affects our banks' earnings. The yields on their assets and the rates paid on their liabilities are sensitive to changes in prevailing market rates of interest. Thus, the general economic conditions, fiscal policies of the federal government, and the policies of regulatory agencies, particularly the Federal Reserve, which establishes national monetary policy, will influence our banks' earnings and growth. The nature and impact of any future changes in fiscal or monetary policies cannot be predicted.
Commercial banks are affected by the credit policy of various regulatory authorities, including the Federal Reserve. An important function of the Federal Reserve is to regulate the national supply of bank credit. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. Government securities, changes in reserve requirements on bank deposits, changes in the discount rate on bank borrowings, and limitations on interest rates that banks may pay on time and savings deposits. The Federal Reserve uses these means in varying combinations to influence overall growth of bank loans, investments and deposits, and also to affect interest rates charged on loans, received on investments or paid for deposits.
The monetary and fiscal policies of regulatory authorities, including the Federal Reserve, also affect the banking industry. Through changes in the reserve requirements against bank deposits, open market operations in U.S. Government securities and changes in the discount rate on bank borrowings, the Federal Reserve influences the cost and availability of funds obtained for lending and investing. No prediction can be made with respect to possible future changes in interest rates, deposit levels or loan demand or with respect to the impact of these changes on the business and earnings of our banks.
From time to time, various federal and state laws, rules and regulations, and amendments to existing laws, rules and regulations, are enacted that affect banks and bank holding companies. Future legislation and regulation could significantly change the competitive environment for banks and bank holding companies. We cannot predict the likelihood or effect of any such legislation or regulation.
ITEM 2.
ITEM 2. Description of Property
Our principal and executive offices are located at 4205 Hillsboro Road, Suite 101, Nashville, Tennessee 37215 in a leased facility with over 5,000 square feet of office space used by The Community Bank as its Green Hills branch. The Community Bank also operates two other branch offices located in Brentwood and Franklin, Williamson County, Tennessee. BankTennessee currently conducts business in six (6) offices located in Shelby and Lauderdale Counties, Tennessee. Bank of Dyer has four offices located in Madison and Gibson Counties. Bank of Mason has one office in Fayette County. Cumberland Bank currently conducts business at nine (9) offices located in Macon, Smith, Sumner, Robertson and Warren Counties, Tennessee. CBC Financial Services conducts business at two offices, one in Smith County and one in Sumner County. Cumberland Finance conducts business at two offices, one located in Sumner County and one in Rutherford County, Tennessee. InsureTennessee conducts business at two offices, one in Smith County and one in Shelby County that it shares with BankTennessee.
We own all of our branch office locations except for seven leased operations which include Cumberland Bank's office in Gallatin, and McMinnville, The Community Bank's offices in Green Hills, BankTennessee's Collierville Square office, Cumberland Finance's Murfreesboro office and CBC Financial Services' office in Carthage.
Cumberland Bank also operates off-site ATM's at leased locations in Smith and Sumner Counties.
ITEM 3.
ITEM 3. Legal Proceedings
The nature of the banking business generates a certain amount of litigation against us and our banks involving matters in the ordinary course of business. None of the legal proceedings currently pending or threatened to which we or our subsidiaries are a party or to which any of our properties are subject will have, or have, in the opinion of management, a material effect on our business or financial condition.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Shareholders
No matter was submitted to a vote of security holders during the fourth quarter of the Company's fiscal year ending December 31, 2000.
ITEM 5.
ITEM 5. Market for Registrant's Common Equity and Related Shareholder Matters
We have no established public trading market for our shares. Accordingly, there is no comprehensive record of trades or the prices of any trades. The following table reflects stock prices for our shares to the extent any information is available. We did not declare any cash dividends for fiscal years ended December 31, 1998 or 1999. In 2000, cash dividends totaling $.10 per share were declared.
Cumberland Bancorp Incorporated Common Stock(1)
(1) The amounts per share have been adjusted for a stock split and stock dividend prior to December 31, 2000. This data does not reflect subsequent stock splits.
As of February 28, 2001, we had approximately 1,139 record shareholders. At that date, 6,946,878 shares were outstanding.
In the first quarter of 2001, a cash dividend was declared in the amount of $0.03 per share payable on April 14, 2001 to shareholders of record on March 1, 2001.
We review our dividend policy at least annually. The amount of the dividend, while in our sole discretion, depends in part upon the performance of our banks. Our ability to pay dividends is restricted by federal laws and regulations applicable to bank holding companies, by commitments we have made to federal banking regulators and by Tennessee laws relating to the payment of dividends by Tennessee corporations. Because substantially all of our operations are conducted through our subsidiaries, our ability to pay dividends also depends on the ability of our banks to pay a dividend to us. The ability of the banks to pay cash dividends is restricted by applicable regulations of the TDFI, the Federal Reserve, the OTS and the FDIC. As a result, we may not be able to declare a dividend to holders of the shares even if the present dividend policy were to change. See "Supervision and Regulation - Dividend Restrictions."
ITEM 6.
ITEM 6. Selected Consolidated Financial Data (unaudited)
The table below provides selected consolidated financial data for our company as of and for the five years ended December 31, 2000, 1999, 1998, 1997 and 1996. This information does not include financial data of BankTennessee or The Community Bank before the July 1997 merger of First Federal Bancshares, Inc. into us. The merger was accounted using the purchase method of accounting. In accordance with purchase accounting, the results of operations for BankTennessee and The Community Bank are included in the selected consolidated financial data since the date of the merger. You should read the following selected consolidated financial information in conjunction with our financial statements and the notes to those statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations" located elsewhere in this document.
ITEM 7.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Certain of the statements contained in this discussion may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which are intended to be covered by the "safe harbors" created thereby. Those statements include, but may not be limited to, the discussions of the Company's expectations concerning its future profitability, operating performance, growth strategy and its assumptions regarding other matters. Also, when any of the words "believes", "expects", "anticipates", "intends", "estimates", "plans", or similar terms or expressions, are used in this discussion, forward-looking statements are being made.
You should be aware that, while the Company believes the expectations reflected in those forward-looking statements are reasonable, they are inherently subject to risks and uncertainties which could cause the Company's future results and stockholder values to differ materially from the Company's expectations. Because of these factors, there can be no assurance that the forward-looking statements included or incorporated by reference herein will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included or incorporated by reference herein, you should not regard the inclusion of such information as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. In addition, the Company does not intend to, and is not obligated to, update these forward-looking statements after the date of this Annual Report on Form 10-K, even if new information, future events or other circumstances have made them incorrect or misleading as of any future date.
You should read the following discussion in conjunction with our financial statements and the notes to those statements appearing elsewhere in this document.
Cumberland Bancorp, Incorporated had several significant events that occurred during 2000 which affected its financial condition and results of operations. A Trust Preferred issuance was completed in the last month of the year which raised approximately $8.0 million in net additional capital. Bank of Mason (a $9 million bank) was consolidated as of September 2000. This transaction was accounted for as a purchase. No prior period amounts have been restated.
Our total assets grew from $525.6 million at year-end 1999 to $643.5 million at December 31, 2000, a $118 million increase or 22%. The primary changes in assets was the $66 million increase in net loans and the $36 million increase in liquid assets: cash, interest bearing deposits, and federal funds sold. In addition, fixed assets increased $8.9 million during the year. This increase is primarily due to the construction of new branch buildings. Federal funds sold increased $22 million in 2000. We funded these increases primarily by an increase in deposits of $89 million and the $8 million issuance of Trust Preferred securities, discussed in more detail in note 15 to the consolidated financial statements.
Our total liabilities grew from $490 million at year end 1999 to $596 million at December 31, 2000, a $106 million increase or 22%. In addition to the deposit growth mentioned above, federal funds purchased increased $7.3 million and advances from the Federal Home Loan Bank increased $6.7 million.
Shareholders' equity increased $4.2 million to $39.5 million at December 31, 2000. The increase is primarily related to 2000 earnings. Our leverage capital ratio increased from 6.84% at December 31, 1999 to 7.42% at December 31, 2000. See note 17 to our consolidated financial statements for more information relating to capital.
Results of Operations Year ended December 31, 2000 Compared to the Year ended December 31, 1999
Net earnings were $4.2 million in 2000 compared to $3.5 million in 1999. Total revenues increased 32% while total expenses increased 33% during 2000 as compared to the prior year.
Net interest income increased $4.5 million, or 23%, to $24.6 million in 2000 from $20.1 million in 1999. The increase is a result of growth in average earning assets of our bank subsidiaries throughout the year, and the results of our branch expansion efforts.
The Company's net interest spread and net yield on earning assets were 4.69% and 4.65% respectively, in 2000 as compared to 4.66% and 4.71% in 1999. The increase in net interest spread was the result of yields on earning assets increasing faster than rates paid on interest bearing liabilities. The decrease in net yield on earning assets was the result of average interest bearing liabilities increasing more than average interest earning assets. Net interest spread represents the difference in the yield on earning assets and the rate paid on interest bearing liabilities. Net yield on earning assets is net interest income divided by average earning assets.
The provision for loan losses was $2.6 million in 2000 compared to $1.6 million in 1999, a 62.4% increase. The increase in the provision was attributable to the 15% increase in loans and an increase in net loan charge-offs. Net loan charge-offs were $1.7 million in 2000 compared to $0.6 million in 1999. Charge-offs increased due to increased losses in consumer, real estate and commercial loans.
Noninterest income increased $1.5 million, or 35%, to $5.7 million in 2000 from $4.3 million in 1999. Mortgage banking income declined $126,000 or 13% from 1999 levels, primarily due to reduction in mortgage activity related to rising interest rates.
Noninterest expense increased $4.0 million, or 24%, to $21.1 million in 2000 from $17.1 million in 1999. Included in noninterest expense are increases in data processing expenses of $474,000 and postage, freight and courier expense of $90,000. Other increases in other expenses are primarily a result of overall growth. Salaries and benefits increased from $9.2 million in 1999 to $11.2 million in 2000 or an increase of 21%.
Results of Operations Year ended December 31, 1999 Compared to the Year ended December 31, 1998
Net earnings were $3.5 million in 1999 compared to $3.3 million in 1998. Total revenues increased 16% while total expenses increased 18% during 1999 as compared to the prior year. As discussed in more detail later, our portion of the operating loss in The Murray Bank, expenses relating to the acquisition of Bancshares of Dyer, Inc. and start up costs associated with other market expansions negatively affected earnings in 1999.
Net interest income increased $4.2 million, or 26%, to $20.1 million in 1999 from $17.4 million in 1998. The increase is a result of growth in average earning assets of our Cumberland Bank subsidiary throughout the year, and our BankTennessee and Community Bank subsidiaries for the last six months.
The Company's net interest spread and net yield on earning assets were 4.66% and 4.71% respectively, in 1999 as compared to 4.41% and 4.50% in 1998. The increase in net interest spread and net yield on earning assets was the result of yields on earning assets increasing faster than rates paid on interest bearing liabilities. Net interest spread represents the difference in the yield on earning assets and the rate paid on interest bearing liabilities. Net yield on earning assets is net interest income divided by average earning assets.
The provision for loan losses was $1.6 million in 1999 compared to $1.2 million in 1998, a 37% increase. The increase in the provision was primarily attributable to the 36.3% increase in loans.
Noninterest income increased $120,000, or 3%, to $4.4 million in 1999 from $4.3 million in 1998. Mortgage banking income declined $443,000 or 32% from 1998 levels, primarily due to reduction in mortgage activity related to rising interest rates.
Noninterest expense increased $3.6 million, or 26%, to $17.2 million in 1999 from $13.6 million in 1998. Included in noninterest expense is approximately $116,000 in 1999 related to losses of unconsolidated affiliates, compared to $92,000 in the prior year. Also included in 1999 are expenses of approximately $102,000 related to organization of new entities and to mergers and acquisitions. Other increases in other expenses are primarily a result of overall growth. Salaries and benefits increased from $7.1 million in 1998 to $9.2 million in 1999 or an increase of 29%.
Loans
The following table presents various categories of loans contained in our banks' loan portfolio for the periods indicated and the total amount of all loans for such period:
Loan growth was $66.9 million, or 15.2%, during 2000, and $118 million, or 36.3%, during 1999. Of this increase, $3.5 million, or 5.2% was as a result of our acquisition of the Bank of Mason. We believe that the remaining loan growth reported in 2000 approximates normal growth for our other four operating bank subsidiaries. Loans continued to grow during 2000 as a result of strong economic conditions in our banks' primary markets, with commercial loans experiencing the largest growth. We believe that commercial loans and loans to the residential real estate industry will continue to be our two primary loan categories.
At December 31, 2000, 1-4 family residential real estate loans constituted 36% of total loans and construction and development loans constituted 14% of total loans. Construction and development loans typically involve 1-4 family residential properties or loans to develop subdivisions of such properties. More than half of our construction and development loans are made to finance speculative construction by builders. The remaining builder loans are for custom-built homes with sales contracts in place. Most of our real estate loans are secured by properties located in the primary service areas of our banks.
The following is a presentation of an analysis of maturities of loans as of December 31, 2000:
At December 31, 2000, $144 million in loans due after one year had predetermined interest rates and $172 million in loans due after one year had floating interest rates.
It is our philosophy to pursue real estate lending as our core type of lending relationship. Of our combined loan portfolio, 62.5% is secured by residential and other real estate. Management believes this type of lending has allowed us to maintain low levels of charge-offs and non-performing loans. However, the real estate lending market has traditionally been sensitive to increases in interest rates, and the volume of such loans may decline if interest rates increase.
Provision for Loan Losses and Asset Quality
The provision for loan losses represents charges made to earnings to maintain an adequate allowance for loan losses. The allowance is maintained at an amount believed by management to be sufficient to absorb losses in the loan portfolio. Factors considered in establishing an appropriate allowance include an assessment of the financial condition of the borrower; a determination of the value and adequacy of underlying collateral; the condition of the local economy and the condition of the specific industry of the borrower; an analysis of the levels and trends of loan categories; and a review of delinquent and classified loans. We apply a systematic process for determining the adequacy of the allowance for loan losses, including an internal loan review function and a monthly analysis of the adequacy of the allowance. Our monthly analysis includes determination of specific potential loss factors on individual classified loans, historical potential loss factors derived from actual net charge-off experience and trends in nonperforming loans, and potential loss factors for other loan portfolio risks such as loan concentrations, local economy, and the nature and volume of loans.
An analysis of our loss experience, as well as a breakdown of the allowance for possible loan losses, is furnished in the following table for the periods indicated:
The recorded values of loans actually removed from the consolidated balance sheets are referred to as charge-offs and, after netting out recoveries on previously charged-off assets, become net charge-offs. Our policy is to charge off loans, when, in management's opinion, the loan is deemed uncollectible, although concerted efforts are made to maximize recovery. Our level of net charge-offs to average loans was 0.35% in 2000 and 0.17% in 1999. Charge-offs were higher due to real estate foreclosures and consumer bankruptcies in 2000. During 2000, the provision for loan losses of $2.6 million was $1,013,000 more than the preceding year. Factors which gave rise to the increased provision in 2000 were the loan growth our institutions sustained, a substantial increase in commercial loan losses in BankTennessee's portfolio and real estate losses at all of our banks.
The level of non-performing loans is an important element in assessing asset quality and the relevant risk in the credit portfolio. Non-performing loans include non-accrual loans, restructured loans and loans delinquent 90 days or more. Loans are classified as non-accrual when management believes that collection of interest is doubtful. When loans are placed on nonaccrual status, all unpaid accrued interest is reversed. Another element associated with asset quality is foreclosed properties, which represent real estate or personal property acquired through loan defaults by customers.
The following table presents information regarding nonaccrual, past due and restructured loans, and foreclosed properties at the dates indicated:
- ---------
(1) As of December 31, 2000, all restructured loans were in compliance with their modified terms.
Non-performing loans were 1.2% and 0.8% of loans at December 31, 2000 and 1999, respectively. The dollar increase in non-performing loans during 2000 is due to a growing and maturing portfolio, along with conditions in the marketplace. Additional interest income of approximately $499,000 in 2000, $125,000 in 1999, $121,000 in 1998, $79,000 in 1997, and $33,000 in 1996 would have been recorded if all loans accounted for on a non-accrual basis had been current in accordance with their original terms. No interest income has been recognized during the five year period ended December 31, 2000 on loans that have been accounted for on a non-accrual basis.
Management has internally classified approximately $6.3 million in loans as substandard based upon other possible credit problems. These loans are not included in the above amounts. These loans are performing loans but are classified as substandard due to payment history, decline in the borrowers' financial position or decline in collateral value. Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Loans so classified must have a well-defined weakness or weakness that jeopardize the liquidation of the debt. Loans classified as doubtful have all the weaknesses inherent in one classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.
As of December 31, 2000, there are no loans classified by our regulators or management as loss, doubtful or substandard that have not been disclosed above or which represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.
The allocation of the allowance for loan losses by loan category at December 31, for the years indicated is presented below:
As of December 31, 2000, real estate mortgage loans constituted 62.5% of outstanding loans. Approximately $143 million, or 45%, of this category represents first mortgage residential real estate mortgages where the amount of the original loan generally does not exceed 80% of the appraised value of the collateral. We have $73.7 million in construction and development loans, which are primarily related to the home building industry in Shelby, Williamson, Davidson and Sumner Counties, Tennessee. The remaining portion of this category consists primarily of commercial real estate loans. Risk of loss for these loans is generally higher than residential loans. Therefore, management has allocated a significant portion of the allowance for loan losses to this category.
Securities
Our banks' securities portfolios are primarily used as a source of liquidity. Total securities were $24.0 million at year-end 2000, which is up $1.2 million from year-end 1999. The securities portfolios comprised 3.7% of total assets at year-end 2000. Our banks' policy guidelines are designed to minimize credit, market and liquidity risk. Securities generally must be investment grade or higher to be purchased. Over the last year, a majority of newly-purchased securities have been designated as Available for Sale to increase flexibility for asset liability management. Approximately 64% of securities held at year-end 2000 were pledged for public deposits. Other than commitments to originate or sell mortgage loans, our banks do not invest in off-balance sheet or derivative financial instruments.
We invest primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States, other taxable securities and in certain obligations of states, counties and municipalities ("SCM"). The majority of the mortgage-backed securities are instruments of U.S. Government agencies. In addition, we enter into federal funds transactions with our principal correspondent banks, and act as a net seller of such funds. We did not hold securities of any single issuer that exceeded ten percent of shareholders' equity.
The following tables present, for the periods indicated, the carrying amount of our securities portfolio, including mortgage-backed securities, segregated into available for sale and those held to maturity categories.
The following table indicates, for the year ended December 31, 2000, the amount of investments due in (1) one year or less, (2) one to five years, (3) five to ten years, and (4) over ten years:
(1) Yields are presented based on adjusted cost basis of securities available for sale. Yields based on carrying value would be higher since fair value is less than adjusted cost. (2) Marketable equity securities are included in the over 10 year category as there is no maturity.
Deposits and Borrowings
Deposits are our primary source of funding loans. Depending upon current market rates, we may from time to time use FHLB borrowings to complement our funding needs. See Liquidity and Interest Rate Sensitivity. We believe we have the ability to generate deposit growth within our local markets as loan demand dictates. Our long-term strategy has been to match the competition on popular deposit products such as money market demand accounts and certificates of deposit. FHLB advances, while typically more costly than deposit funding, are typically the lowest cost borrowed funds available to institutions such as our banks. Our banks utilize short-term borrowing from the FHLB to sustain the available for sale loans until they are sold. The marketable time table has increased slightly, therefore, short-term borrowings have increased. Of a total $46.2 million in FHLB borrowings at year-end 2000, $17.1 million matures before December 31, 2001.
Total deposits grew at a rate of 20.4% during 2000, resulting from the opening of new branch locations, and more attractive pricing for deposits. Deposit growth was greater than loan growth in 2000, resulting in a decrease in loan to deposit ratio from 101% at year end 1999 to 96.8% at year end 2000. The increase in deposit growth over loan growth resulted in an increase of federal funds sold of $22 million at the end of 2000.
We operate retail bank branches in twelve (12) different Tennessee counties, have fifty percent (50%) ownership of a stand-alone federal savings bank in one Kentucky county through a joint venture, and have fifty percent (50%) ownership of a de novo bank in Nashville, Tennessee through a joint venture. Each local market has its own unique deposit customer base. Deposit growth has been strong in the communities where new additional branches have been established. In general, large certificate of deposit customers tend to be more sensitive to interest rate levels, making these deposits less reliable sources of funding from liquidity planning purposes than core deposits. We have normally had to pay a small premium for these types of deposits above current rates. However, we believe that we have long-term customers who maintain substantial deposits with our banks based upon personal relationships with each bank's officers and employees.
Average amount of and average rate paid for our deposits for year-end 1998, 1999, and 2000 are represented by deposit category on the table on pages 25 through 26 of this section of the documents.
The following table indicates amounts outstanding of time certificates of deposit of $100,000 or more and respective maturities for the year ended December 31, 2000:
CUMBERLAND BANCORP, INC. AND SUBSIDIARIES Consolidated Average Balance Sheets, Net Interest Revenue and Changes in Interest Income and Interest Expense
The following table shows the consolidated average monthly balances of each principal category of assets, liabilities and stockholders' equity of the Company, and an analysis of net interest revenue, and the change in interest income and interest expense segregated into amounts attributable to changes in volume and changes in rates.
1 Changes in interest income and expense not due solely to balance or rate changes are included in the rate category. 2 Interest income includes fees on loans of $3,164 in 2000 and $2,551 in 1999. 3 Nonaccrual loans are included in average loan balances and the associated income (recognized on a cash basis) is included in interest. 4 No taxable equivalent adjustments have been made since the effect of tax exempt income is insignificant.
CUMBERLAND BANCORP, INC. AND SUBSIDIARIES Consolidated Average Balance Sheets, Net Interest Revenue and Changes in Interest Income and Interest Expense
The following table shows the consolidated average monthly balances of each principal category of assets, liabilities and stockholders' equity of the Company, and an analysis of net interest revenue, and the change in interest income and interest expense segregated into amounts attributable to changes in volume and changes in rates.
1 Changes in interest income and expense not due solely to balance or rate changes are included in the rate category. 2 Interest income includes fees on loans of $2,551 in 1999 and $1,748 in 1998. 3 Nonaccrual loans are included in average loan balances and the associated income (recognized on a cash basis) is included in interest.
Equity and Capital Resources
Our capital ratio's were in the "well capitalized" category for all three regulatory capital calculations at December 31, 2000. Our leverage capital ratio was 7.42% in 2000 and 6.84% in 1999, with shareholders' equity of $39.5 million at year-end 2000. For a discussion of capital requirements see Supervision and Regulation - Capital Requirements.
In September 1999, we completed an Initial Public Offering (IPO) of 700,000 shares of our common stock at a price of $12.50 per share for a total consideration of $8,500,000, before fees and expenses. In connection with the purchase of the two branches from a financial institution, we issued 47,000 shares valued at $588,000. To purchase the minority interest shares of Bank of Dyer in 1999 we issued 7,704 shares of stock valued at approximately $99,000.
Items that represent common stock equivalents include 460,035 common stock options outstanding at December 31, 2000. At December 31, 2000, there were 69,790 additional common shares available for grant under the stock option plan. We plan to continue granting stock options to selected officers, directors, and other key employees.
Return on Equity and Assets
Returns on average consolidated assets and average consolidated equity for the periods indicated are as follows:
Liquidity
It is a primary concern to depositors, creditors, and regulators that banks demonstrate the ability to have readily available funds sufficient to repay fully-maturing liabilities. Our liquidity, represented by cash and cash due from banks, is a result of our operating, investing and financing activities. In order to insure funds are available at all times, we devote resources to projecting on a monthly basis the amount of funds that will be required and maintain relationships with a diversified customer base so funds are accessible. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets, which are generally matched to correspond to the maturity of liabilities.
Our banks have liquidity policies and, in the opinion of management, the overall liquidity level is considered adequate. Neither we, nor our banks, are subject to any specific liquidity requirements imposed by regulatory authorities. Our banks are subject to general Federal Reserve guidelines, which do not require a minimum level of liquidity. The ratio for average loans to average deposits for 1999 was 96.6% and for 2000 was 98.1%. We do not know of any trends or demands that are reasonably likely to result in liquidity increasing or decreasing.
Interest Rate Sensitivity
A key element in the financial performance of financial institutions is the level and type of interest rate risk assumed. The single most significant measure of interest rate risk is the relationship of the repricing periods of earning assets and interest-bearing liabilities. The more closely the repricing periods are correlated, the less interest rate risk we assume. In general, community bank customer preferences tend to push the average repricing period for costing liabilities to a shorter time frame than the average repricing period of earning assets, resulting in a net liability sensitive position in time frames less than one year. A summary of the repricing schedule of our interest earning assets and interest-bearing liabilities (GAP) at year-end 2000 follows:
As shown in the table, we have a cumulative GAP of approximately 1.46% and (11.72)% at the end of 90 days and one year, respectively. Management believes that this level of GAP is appropriate since many of the liabilities which are immediately repriceable can be effectively repriced more slowly than the assets which are contractually immediately repriceable in a rising rate environment. Conversely, those liabilities can often be repriced downward more rapidly than contractually required assets repricing in a downward rate
environment. The degree to which management can control the rate of change in deposit liabilities, which are immediately repriceable, is affected to a large extent by the speed and amount of interest rate movements.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
Our primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which possess a short term to maturity. Based upon the nature of our operations, we do not maintain any foreign currency exchange or commodity price risk.
The following table provides information about our financial instruments that are sensitive to changes in interest rates as of December 31, 2000. These market risk sensitive instruments have been entered into by us for purposes other than trading. We do not hold market risk sensitive instruments for trading purposes. Amounts described below do not take into account possible loan, security, or interest bearing deposit renewals or repricing for such renewals. The information provided by this table should be read in connection with our audited consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operation.
- ------------------
(1) Loan amounts and weighted average interest rates for loans net out any undisbursed loan proceeds, make no assumptions about loan prepayments, and do not include the allowance for loan losses.
(2) Securities include our investment in obligations of certain political subdivisions within the State of Tennessee. Average interest rates have not been adjusted for any federal, state, or municipal tax liability that we may incur.
INDEPENDENT AUDITORS' REPORT
The Board of Directors Cumberland Bancorp, Incorporated
We have audited the consolidated balance sheets of Cumberland Bancorp, Incorporated and Subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of earnings, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cumberland Bancorp, Incorporated and Subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with generally accepted accounting principles.
/s/ Heathcott & Mullaly, P.C. Brentwood, Tennessee February 26, 2001, except for Note 24, as to which the date is March 15, 2000
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2000 and 1999
See accompanying notes to consolidated financial statements.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Consolidated Statements of Earnings Years ended December 31, 2000, 1999 and 1998
See accompanying notes to consolidated financial statements.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Consolidated Statements of Changes in Shareholders' Equity Years ended December 31, 2000, 1999 and 1998
See accompanying notes to consolidated financial statements.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 2000, 1999 and 1998
See accompanying notes to consolidated financial statements.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(1) Summary of Significant Accounting Policies
The accounting policies of Cumberland Bancorp, Incorporated and Subsidiaries conform to generally accepted accounting principles and to general practices within the banking and financial services industry. The significant policies are summarized as follows:
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Cumberland Bancorp, Incorporated (the Company) and its subsidiaries. Material intercompany accounts and transactions have been eliminated in consolidation.
Nature of Operations
Substantially all of the assets, liabilities, and operations presented in the consolidated financial statements are attributable to the five subsidiary banks: Cumberland Bank, BankTennessee, The Community Bank, Bank of Dyer and Bank of Mason. The Banks provide a variety of banking services to individuals and businesses through their eighteen branches located across ten counties in Middle and West Tennessee. Their primary deposit products are demand deposits, savings deposits, and certificates of deposit, and their primary lending products are commercial business, real estate mortgage, and installment loans. Other financial services such as credit insurance, investment products, consumer loan services, and property and casualty insurance are also provided by subsidiaries or divisions of the Banks.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Due From Banks
Included in cash and due from banks are legal reserve requirements which must be maintained on an average basis in the form of cash and balances due from the Federal Reserve and other banks.
Securities
In accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Debt and Equity Securities" (SFAS 115) securities are classified into three categories: held to maturity (HTM), available for sale (AFS), and trading.
Securities classified as held to maturity, which are those the Company has the positive intent and ability to hold to maturity, are reported at amortized cost. Securities classified as available for sale may be sold in response to changes in interest rates, liquidity needs, and for other purposes. Available for sale securities are reported at fair value and include securities not classified as held to maturity or trading. Trading securities are those held principally for the purpose of selling in the near future and are carried at fair value. The Company currently has no trading securities.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(1) Summary of Significant Accounting Policies, continued
Unrealized holding gains and losses for available for sale securities are excluded from earnings and reported, net of any income tax effect, as other comprehensive income in shareholders' equity. Realized gains and losses are reported in earnings based on the adjusted cost of the specific security sold.
Loans
Loans which the Company has the positive intent and ability to hold to maturity are stated at the principal amount outstanding. Unearned discounts, deferred loan fees and the allowance for loan losses are shown as reductions of loans. Loan origination fees are deferred, to the extent they exceed direct origination costs, and recognized over the life of the related loans as yield adjustments. Interest income on loans is computed based on the outstanding loan balance.
Loans are generally placed on nonaccrual when a loan is specifically determined to be impaired or when the collection of interest is less than probable or collection of any amount of the principal is doubtful, after considering economic and business conditions and collection efforts. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level which, in management's judgement, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with the regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management's estimate of credit losses inherent in the loan portfolio and the related allowance may change materially in the near term. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries.
Mortgage Banking Activities
The Banks originate mortgage loans for sale and these loans are generally sold at origination. Loans held for sale are carried at the lower of cost or fair value. Origination fees are recorded as income when the loans are sold to third party investors.
Transfer and Servicing of Financial Assets and Extinguishments of Liabilities
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", was issued in September 2000 and revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. The statement supersedes SFAS No. 125, although it retains most of SFAS No. 125's provisions without modification. SFAS No. 140 is effective for transactions occurring after March 31, 2001 and is not expected to have a material effect on the Corporation's results of operations, financial position or liquidity. Disclosure regarding securitizations are effective for all fiscal years ending after December 15, 2000.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(1) Summary of Significant Accounting Policies, continued
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation has been computed on straight-line and accelerated methods, based on the estimated useful lives of the respective asset.
Other Intangible Assets
Other intangible assets consist of goodwill and a core deposit intangible. Goodwill consists of the excess of cost over the fair value of the assets acquired from Bancshares of Dyer, Inc. and the excess cost over the fair value of net assets purchased in the acquisition of Bank of Mason. Goodwill is being amortized over 15 years. The core deposit intangible represents the value assigned to a deposit base acquired in the acquisition of another financial institution's branch banking operations in Warren County, Tennessee and is being amortized on the straight line basis over 15 years.
Income Taxes
The Company and its subsidiaries file a consolidated federal income tax return. The subsidiaries provide for income taxes on a separate-return basis and remit to or receive from the Company amounts currently payable or receivable. Income taxes have been provided using the liability method in accordance with SFAS No. 109, "Accounting for Income Taxes".
A valuation allowance is required by SFAS 109 if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. This allowance is evaluated periodically by management and adjusted based on current circumstances.
Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", requires entities to disclose the estimated fair value of its financial instrument assets and liabilities. Management is concerned that the required disclosures under SFAS No. 107 may lack reasonable comparability between financial institutions due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.
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. These fair values are provided for disclosure purposes only and do not impact carrying values of financial statement amounts.
Cash, interest bearing deposits in financial institutions and federal funds sold -- The carrying amounts reported in the balance sheet for cash, interest bearing deposits in financial institutions and federal funds sold approximate those assets' fair values.
Securities (including mortgage-backed securities) -- Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(1) Summary of Significant Accounting Policies, continued
Loans receivable -- For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently offered for loans with similar terms to borrowers of similar credit quality.
Restricted equity securities -- The carrying amounts reported in the balance sheet for restricted equity securities approximate their fair value.
Investments in unconsolidated affiliates -- The carrying amounts reported in the balance sheet for investments in unconsolidated affiliates approximate their fair values.
Loan servicing rights -- The carrying amounts reported in the balance sheet for servicing rights approximate their fair value.
Deposits with defined maturities -- The fair value for deposits with defined maturities is calculated by discounting future cash flows to their present value. Future cash flows, consisting of both principal and interest payments, are discounted with the Bank's current rates for similar instruments applicable to the remaining maturity. For purposes of this disclosure, deposits with defined maturities include all certificates of deposits and other time deposits.
Deposits with undefined maturities -- The fair value of deposits with undefined maturities is equal to the carrying value. For purposes of this disclosure, deposits with undefined maturities include noninterest-bearing demand, interest-bearing demand and savings accounts.
Federal funds purchased -- The carrying amounts reported in the balance sheet for federal funds purchased approximate their fair value.
Notes payable, and Federal Home Loan Bank advances -- The fair values of notes payable and advances from the Federal Home Loan Bank are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
Accrued Interest -- The carrying amounts of accrued interest approximate their fair values.
Trust Preferred Securities -- Fair values of Trust Preferred Securities are based on quoted market prices of comparable instruments.
Off-Balance Sheet Financial Instruments -- Fair values for off-balance sheet lending commitments are based on fees currently charged to enter into similar agreements taking into account the remaining terms of the agreements and the counter parties' creditworthiness.
Cash and Cash Equivalents
Cash and cash equivalents includes amounts in the balance sheet caption, cash and due from banks.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(1) Summary of Significant Accounting Policies, continued
Earnings per Share
Earnings per share (EPS) is calculated in accordance with Statement of Financial Accounting Standards (SFAS) No. 128, issued in February 1997. The statement requires the dual presentation of basic and diluted EPS on the income statement. Basic EPS excludes dilution, and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if options to issue common stock were exercised or converted into common stock that then shared in the earnings of the entity. EPS has been adjusted for stock splits, but does not include the 2 for 1 split announced subsequent to December 31, 2000, discussed in note 24. In addition, average shares outstanding was increased by 511,783 shares to reflect the pooling of interests with Bancshares of Dyer, Inc. in all periods presented.
Effect of New Accounting Pronouncements
In July 1997, the FASB issued SFAS No. 130, "Comprehensive Income". The statement establishes standards for reporting and presentation of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. It requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is presented with the same prominence as other financial statements. This statement requires that companies (i) classify items of other comprehensive income by their nature in a financial statement and (ii) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the statement of financial condition.
This statement is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comprehensive purposes is required.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information". The statement establishes standards for disclosure about operating segments in annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. This statement supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise". This statement becomes effective for the Company's fiscal year ending December 31, 1998, and requires that comparative information from earlier years be restated to conform to its requirements. The adoption of the provisions of this statement did not have a material impact on the Company.
In October 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This Statement amends SFAS No. 65, which required that retained securities be classified as trading securities. SFAS No. 134 allows these securities to be classified as trading, held to maturity or available for sale based on the intent and ability of the enterprise. This Statement is effective January 1, 1999, did not materially impact the Company's financial position or results of operations.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(1) Summary of Significant Accounting Policies, continued
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 established a new model for accounting for derivatives and hedging activities and supersedes and amends a number of existing standards. SFAS 133 is effective for fiscal years beginning after June 15, 2000, but earlier application is permitted as of the beginning of any fiscal quarters subsequent to June 15, 1998. Upon the statement's initial application, all derivatives are required to be recognized in the statement of financial position as either assets or liabilities and measured at fair value. In addition, all hedging relationships must be designated, reassessed, and documented pursuant to the provisions of SFAS 133. Upon adoption of SFAS 133 on January 1, 2001, the statement did not have a material financial statement impact on the Corporation's financial position or operating results.
In April 1998, the American Institute of Certified Public Accountants issued SOP 98-5, "Reporting on the Costs of Start-up Activities." This Statement requires that the costs of start-up activities, including organization costs, be expensed as incurred. When adopted, previously capitalized start-up and organization costs should be written off and reported as the cumulative effect of a change in accounting principle. The Statement is effective for fiscal years beginning after December 15, 1998 and did not materially impact the Company's financial position or results of operations.
Reclassifications
Certain reclassifications have been made to prior year amounts to conform to the 2000 presentation.
(2) Interest Bearing Deposits
At December 31, 1999, the Company had certificates of deposit with the Federal Home Loan Bank totaling $4,696,000 and certificates of deposit with a related party institution totaling $700,000.
At December 31, 2000, the Company had demand deposits totaling $4,448,000 and certificates of deposits totaling $10,000,000 at the Federal Home Loan Bank. In addition, $520,000 in certificates of deposit were with non-affiliated banks. The Company also had demand deposits of $20,000 with non-financial institutions.
(3) Securities
The following table reflects the amortized cost and estimated fair values of securities, as well as gross unrealized gains and gross unrealized losses as of December 31, 2000 and 1999.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000, 1999 and 1998
(3) Securities, continued
The carrying amounts and estimated fair value of securities at December 31, 2000 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(3) Securities, continued
Securities carried at approximately $15,283,000 at December 31, 2000 and $9,572,000 at December 31, 1999 were pledged to secure deposits and for other purposes as required or permitted by law. The fair value of the securities portfolio is established by an independent pricing service as of the approximate dates indicated.
At December 31, 1999, the Company did not hold securities of any single issuer, other than obligations of the U.S. Treasury and other U.S. Government agencies, whose aggregate book value exceeded ten percent of shareholders' equity.
(4) Loans
A summary of loans outstanding by category follows:
In addition to the loans shown above, loans serviced for others totaled $102,622,000 and $92,208,000 at December 31, 2000 and 1999, respectively.
Certain parties (principally directors and officers of the Company or the Banks, including their affiliates, families, and companies in which they hold ten percent or more ownership) were customers of, and had loans and other transactions with the Banks in the ordinary course of business. The outstanding balances of such loans totaled $6,160,000 and $4,147,000 as of December 31, 2000 and 1999, respectively. These loan transactions were made on substantially the same terms as those prevailing at the time for comparable loans to other persons. They did not involve more than the normal risk of collectibility or present other unfavorable features. During 2000, the Company advanced $5,109,000 and received payments of $3,096,000 on such loans.
(5) Financial Instruments With Off-Balance Sheet Risk
The Banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Banks have in those particular financial instruments.
The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual or notional amount of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(5) Financial Instruments With Off-Balance Sheet Risk, continued
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Banks upon extension of credit is based on management's credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
The Banks have a recourse obligation for 90 days from the purchase date for loans sold to investors. At December 31, 2000, loans sold to the investors with existing recourse approximated $12,366,000. The obligation on these loans relates to performance by the borrower.
(6) Concentrations of Credit
The Banks grant agribusiness, commercial, construction, and individual loans to customers located primarily within the middle and western portion of Tennessee. Concentration by type of loans are presented in note 3.
(7) Allowance for Loan Losses
Transactions in the allowance for loan losses were as follows:
The Company had approximately $5,953,000 and $2,687,000 at December 31, 2000 and 1999, respectively, in loans which were considered impaired under SFAS 114. Accrual of interest had been discontinued on these loans as of those dates. The allowance for loan losses related to these loans was approximately $893,000 and $537,000 at December 31, 2000 and 1999, respectively. If such loans had been on an accrual basis, interest income would have been approximately $499,000, $125,000 and $121,000 higher in 2000, 1999 and 1998, respectively.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(8) Premises and Equipment
Premises and equipment are summarized as follows:
Depreciation expense related to premises and equipment amounted to $1,440,000 in 2000, $1,114,000 in 1999 and $928,000 in 1998.
A director's construction company was paid $2,784,000 as the general contractor for building a branch of one of the subsidiaries. In another transaction, $250,000 was paid to a director of the Company and his associate by one subsidiary to purchase a building site for a new branch. Also, a partnership, in which a director of one subsidiary was a partner, was paid $680,000 for a branch office. These transactions were made on substantially the same terms as those prevailing at the time for comparable transactions with other persons.
(9) Investment in Unconsolidated Affiliates
Investments in unconsolidated affiliates consist of the following:
The Company uses the equity method of accounting in recording investments in unconsolidated subsidiaries. The initial investment is recorded at cost and the carrying amount of the investment is increased or decreased by the proportionate share of earnings or losses. Any dividends received are recorded as a reduction in the investment.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(10 Restricted Equity Securities
Restricted equity securities consist of securities which are restricted as to transferability. These securities are recorded at cost.
(11) Other Intangible Assets
A summary of other intangible assets at December 31, 2000 and 1999 follows:
Amortization expense related to intangible assets amounted to $103,000 and $25,000 in 2000 and 1999.
(12) Deposits
A summary of deposits at December 31, 2000 and 1999 follows:
At December 31, 2000 scheduled maturities of time deposits are as follows:
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(13) Advances From Federal Home Loan Bank
The Company is participating in a program with the Federal Home Loan Bank (FHLB) of Cincinnati to provide funds to the public for affordable housing. The FHLB advances funds to the Company with the requirement that the advances are secured by qualifying loans, essentially home mortgages (1-4 family residential). To participate in this program, the Company is required to be a member of the Federal Home Loan Bank and own stock in the FHLB. The Company has $3,551,000 of such stock at December 31, 2000 to satisfy this requirement.
At December 31, 2000 and 1999, advances from the FHLB totaled $46,211,000 and $39,554,000, respectively. The interest rates on these advances ranged from 4.79% to 9.125%. Qualifying loans totaling $75,128,000 were pledged as security under a blanket pledge agreement with the FHLB at December 31, 2000.
Maturities of the advances from FHLB at December 31, 2000 are as follows:
(14) Notes Payable
Notes payable consist of the following:
347 735
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(14) Notes Payable, continued
Minimum annual principal payments for future years are as follows:
The Company has agreed to certain covenants in connection with the notes payable to the lending institution. These covenants include, among other things, minimum financial ratios for the subsidiary Banks. The Banks were in compliance with all of the provisions of the loan covenants as of December 31, 2000.
The Company entered into a new loan agreement for a $6,000,000 line of credit during 1998. In the loan agreement, the lending institution placed a covenant restricting capital. The covenant states if the Company is current on principal and interest payments, it will be permitted to pay dividends to shareholders not exceeding twenty-five percent of net earnings.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(15) Trust Preferred Securities
On December 29, 2000, Cumberland Bancorp, Incorporated, through Cumberland Capital Trust I and with the assistance of its Placement Agent, sold to institutional investors $8,000,000 of capital securities. Cumberland Capital Trust I, a Delaware business trust wholly owned by Cumberland Bancorp, Incorporated, issued $8,000,000 of Floating Rate Capital Securities. Holders of the Capital Securities are entitled to receive preferential cumulative cash distributions from the Trust, at a rate per annum reset quarterly equal to the sum of three month LIBOR plus 350 basis points applied to the liquidation amount of $1,000 per Capital Security, accruing from the date of original issuance and payable quarterly in arrears on January 1, April 1, July 1 and October 1 each year commencing April 1, 2001. The rate was 9.93% at December 31, 2000. The Company can defer payment of interest on the subordinated debt securities at any time or from time to time for a period not to exceed twenty consecutive quarters.
The proceeds were upstreamed to Cumberland Bancorp, Incorporated as junior subordinated debt under the same terms and conditions. Cumberland Bancorp, Incorporated has, through various contractual arrangements, fully and unconditionally guaranteed all of Cumberland Capital Trust I's obligations with respect to the capital securities. These Capital Securities qualify as a Tier I Capital and are presented in the Consolidated Balance Sheets as Trust Preferred Securities. The sole asset of Cumberland Capital Trust I is $8,000,000 of junior subordinated debentures issued by Cumberland Bancorp, Incorporated. These junior subordinated debentures also carry the same floating rate and both mature on December 25, 2025; however, the maturity of both may be shortened to a date not earlier than December 25, 2005.
(16) Income Taxes
Income tax expense (benefits) consist of the following:
Significant temporary differences between tax and financial reporting that give rise to deferred tax assets (liabilities) included in other assets on the consolidated balance sheet are as follows at December 31, 2000 and 1999:
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(16) Income Taxes, continued
A reconciliation of the provision for income taxes with the amount of income taxes computed by applying the federal statutory rate (34%) to earnings before income taxes follows:
During 1996, the subsidiary Banks began computing their tax bad debt reserves under the rules which apply to commercial banks. In years prior to 1996, the Banks obtained tax bad debt deductions of approximately $1.8 million in excess of their financial statement allowance for loan losses for which no provision for federal income tax was made. These amounts are subject to federal income tax in future years if used for purposes other than to absorb bad debt losses. This excess reserve is subject to recapture only if a bank ceases to qualify as a bank as defined in the Internal Revenue Code.
(17) Minimum Capital Standards
The Company and its Bank subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its Bank subsidiaries must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2000 and 1999, that all capital adequacy requirements to which they are subject are met.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(17) Minimum Capital Standards, continued
As of December 31, 2000, the most recent notification from the Federal Reserve Bank categorized the Company and all Bank subsidiaries as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Company and the Banks must maintain total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the category.
The Company has reached an agreement with the Federal Reserve Bank to maintain the Bank subsidiaries as well capitalized for a period of two years beginning October 2000 and for the Company to maintain a total capital to risk-weighted assets ratio of at least 10%.
The Company and the Banks' actual capital amounts and ratios at December 31, 2000 and 1999, are as follows:
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(17) Minimum Capital Standards, continued
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(17) Minimum Capital Standards, continued
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(18) Employee Benefits
The Company maintains a 401(k) savings plan for all employees who have completed six months of service and are 21 or more years of age. Employer contributions to the plan are determined annually by the board of directors. The Company's expenses related to the plan were $414,139 in 2000, $273,848 in 1999 and $138,839 in 1998.
(19) Fair Values of Financial Instruments
The estimated fair values of the Company's financial instruments are as follows at December 31, 2000 and 1999:
The carrying values in the preceding table are included in the consolidated balance sheets under the applicable captions.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000, 1999 and 1998
(20) Business Combinations and Acquisitions
On December 31, 1999, Cumberland Bancorp, Incorporated (CBI) acquired for approximately 511,783 shares of its common stock, all of the outstanding capital stock of Bancshares of Dyer, Inc. (BDI), a bank holding company in Dyer, Tennessee, which owned approximately 98% of Bank of Dyer. The merger has been accounted for as a pooling of interests and accordingly, financial information for periods prior to the merger reflect retroactive restatement of the companies' combined financial position and operating results. No adjustments were necessary to conform the accounting practices of the companies.
The following presents certain financial data for the separate entities prior to the combination of CBI with BDI for the years ended December 31, 1999 and 1998.
*Total revenue is net interest income and noninterest income
The minority interest in Bank of Dyer was acquired in a purchase transaction for cash of approximately $10,000 and 7,704 shares of CBI common stock valued at $12.50 per share.
Effective September 24, 1999, the Company's Cumberland Bank subsidiary purchased certain assets and assumed certain liabilities of American City Bank's McMinnville, Tennessee branch. As part of the transaction, the Company issued 47,000 shares of its common stock. The liabilities assumed exceeded the assets received in the transaction (deposit premium) by $1,475,000. Assets purchased and liabilities assumed at the acquisition date are summarized as follows:
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(20) Business Combinations and Acquisitions, continued
During 2000, the Company purchased additional shares of stock in the Bank of Mason for $365,000 giving the Company 53% of the outstanding stock at December 31, 2000. The excess cash paid over the fair value of net assets acquired is recorded as goodwill in the consolidated financial statements. The Bank of Mason has been appropriately included in the consolidated financial statements of the Company for the period in which Cumberland Bancorp, Incorporated had controlling interest. Bank of Mason has approximately $9 million in total assets. Its operations are not material to the consolidated financial statements. Subsequent to December 31, 2000, the Company issued 53,250 shares for the remaining interest in Bank of Mason.
(21) Commitments and Contingencies
The Company has entered into various noncancellable operating lease arrangements in connection with its operating locations. Based upon these agreements at December 31, 2000, future minimum lease commitments are as follows:
Rentals relating to these agreements which are included in occupancy expense amounted to $265,000 in 2000, $196,000 in 1999 and $212,000 in 1998.
During 2000, the subsidiaries of the Company leased certain premises from related parties. The related expense from the leases totaled approximately $49,000 in 2000.
During 1997, the Company entered into an agreement with a group of investors to open a BankTennessee branch in Ripley, Tennessee. In return, these investors purchased 222,500 shares (as adjusted for the March 1998 stock split) of the Company's common stock for $4.49 per share (as adjusted for the March 1998 stock split). The agreement with the Ripley group addresses a spin-off of the Ripley branch into a separate entity after the branch reaches $30 million in assets and becomes profitable. It is anticipated that the Ripley group will own 50% of the new entity and Cumberland Bancorp, Incorporated will own 50% of the new entity. However, there are several provisions in the agreement that could alter the anticipated structure.
During 1999 and 1998, the Company invested approximately $2,300,000 representing a 50% interest in a de novo bank in Murray, Kentucky. The Company's pro rata portion of the organization and start-up costs of approximately $92,500 in 1998 and $60,000 in 1999, in the respective periods have been expensed.
The Murray Bank opened in June, 1999 and it incurred an operating loss of approximately $275,000 in 1999. Earnings of approximately $26,000 were reported in 2000. This investment is being accounted for by the equity method of accounting, whereby the Company's pro rata share of its operations are shown as an adjustment of the original investment and included in other operating expenses on the consolidated statements of earnings.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(21) Comments and Contingencies, continued
The investors that bought the remaining 50% of the Murray Bank exercised their rights to purchase $250,000 worth of stock based upon a price of 1.5 multiplied by the Company's book value when the charter was granted to the Murray Bank by the OTS. An additional $250,000 in stock options become exercisable at 1.5 multiplied by the Company's book value if the Murray Bank attains certain financial objectives.
During 1999, the Company became involved in organizing a de novo bank called Insurors Bank of Tennessee. The Company owns 50% and the remaining 50% is owned by InsCorp, Inc., which is primarily owned by Independent Insurance Agents in the State of Tennessee. The Company invested approximately $2,830,000 during 2000 and 1999. Organization and start-up costs were approximately $191,859 for 2000 and $24,000 in 1999. In November 2000, the Insurors Bank of Tennessee opened and incurred an operating loss of approximately $492,000 for the year ended December 31, 2000.
In the normal course of business there are commitments outstanding and contingent liabilities such as legal proceedings pending against the Bank. In the opinion of management, no material adverse effect on the financial position is anticipated as a result of these items.
(22) Stock Options
The Company issues non-qualified stock options to employees, non-employee directors, and bank advisory board members. The option plan provides for the issuance of the Company's common stock at a price determined by the plan's committee, which is the Board of Directors of the Company. As a matter of policy, the Board of Directors has issued options at an exercise price equal to the fair market value of the Company's common stock at the date of grant. Share and per share amounts in the accompanying text and tables have been adjusted for stock splits and stock dividends (excluding the split announced subsequent to December 31, 2000 described in note 24).
In 1995, SFAS No. 123 "Accounting for Stock Based Compensation" changed the method for recognition of cost of plans similar to those of the Company. As is permitted, management has elected to continue accounting for the plan under APB Opinion 25 and related Interpretations. Accordingly, no compensation cost has been recognized for the stock option plan. However, under SFAS No. 123, the Company is required to make proforma disclosures as if cost had been recognized in accordance with the pronouncement. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method of SFAS No. 123, the Company's net earnings and net earnings per common share would have been as follows:
The fair value of the options granted is estimated as of the date granted using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants: dividend yield of 0.8% in 2000 and 0% in prior years, risk-free interest rate of 6.0 percent in all years, expected lives of five years, and expected volatility of 40 percent in 2000, 47 percent in 1999 and 53 percent in 1998.
The weighted-average fair value of options, calculated using the Black-Scholes option pricing model, granted during 2000, 1999 and 1998 was $5.19, $6.09 and $3.16, respectively.
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(22) Stock Options, continued
Effective March 1, 1998, the Company approved 550,000 shares available for a stock option plan. These options become exercisable at a rate of 20% per year or at the end of five years. These options generally expire within six to ten years or earlier if an employee leaves.
A summary of the stock option activity for 2000, 1999 and 1998 is as follows:
The following table sets forth the computation of basic net earnings per share and diluted net earnings per share adjusted for stock splits and stock dividends.
(23) Other Operating Expenses
Other operating expenses consists of the following:
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(24) Subsequent Event
Subsequent to December 31, 2000, the Company's board of directors approved a 2 for 1 stock split for shareholders of record as of March 22, 2001, payable April 22, 2001. Per share amounts have not been adjusted since shares related to the stock split will not be issued until April 22, 2001.
(25) Parent Company Only Financial Information
CUMBERLAND BANCORP, INCORPORATED AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998
(25) Parent Company Only Financial Information, continued
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There have been no disagreements with the Company's independent auditors on any matters of accounting principles or practices or financial statement disclosure during the fiscal year ended December 31, 2000.
ITEM 10. Directors and Executive Officers of the Registrant
The information required by this item with respect to the directors and named executive officers is incorporated herein by reference to the Proxy Statement relating to the Annual Meeting of Shareholders to be held April 26, 2001. The information required by this item for other executive officers is set forth below:
Mark C. McDowell (43) - Mr. McDowell has served as our chief administrative officer since July 1997. Mr. McDowell is responsible for overseeing our administrative functions, including regulatory and financial matters as well as shareholder issues. Mr. McDowell served as president of Community Bancserve, a bank consulting business, from January 1996 to July 1997. From 1980 to 1996, Mr. McDowell served as a bank examiner for the Tennessee Department of Financial Institutions, serving as director of its Applications Section beginning in 1989.
ITEM 11. Executive Compensation
The information required by this item with respect to executive compensation is incorporated herein by reference to the Proxy Statement relating to the Annual Meeting of Shareholders to be held April 26, 2001.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
Information with respect to the security ownership of certain beneficial owners and management is incorporated herein by reference to the Proxy Statement relating to the Annual Meeting of Shareholders to be held April 26, 2001.
ITEM 13. Certain Relationships and Related Transactions
Information with respect to certain relationships and related transactions is incorporated herein by reference to the Proxy Statement relating to the Annual Meeting of Shareholders to be held April 26, 2001.
ITEM 14. Exhibits and Reports on Form 8-K
(a)(1) Financial Statements. See Item 8.