**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC  20549**

 

----

 

**FORM 10-KSB**

 
| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|-------------------------------------------------------------------------------------------|
|       | **For the fiscal year ended  March 31, 2002**                                        |

 

**OR**

 
| **o**  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                                                                                                          |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | **For  the transition period  from                                    to                                    ** |

 

**COMMISSIONFILE NUMBER 0-27170**

 

**CLASSIC BANCSHARES, INC.**

(Exact Name ofSmall Business Issuer as Specified in its Charter)

 

| **Delaware**                                                                   |   | **61-1289391**                        |
|--------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization)                |   | (I.R.S. Employer  Identification No.) |
|                                                                           |   |                                  |
| **344  Seventeenth Street, Ashland, Kentucky**                                 |   | **41101**                             |
| (Address of principal  executive offices)                                      |   | (Zip Code)                            |
|                                                                           |   |                                  |
| Issuer’s telephone  number, including area code:  **(606) 326-2800** |

 

SecuritiesRegistered Pursuant to Section 12(b) of the Act:

 

**None**

 

SecuritiesRegistered Pursuant to Section 12(g) of the Act:

 

**CommonStock, par value $.01 per share**

 

Check whether the Issuer (1)filed all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past twelve months (or for such shorter period that the Issuerwas required to file such reports), and (2) has been subject to suchrequirements for the past 90 days.   YESý   NO o

 

Check if there is nodisclosure of delinquent filers in response to Item 405 of Regulation S-Bcontained in this form, and no disclosure will be contained, to the best ofIssuer’s knowledge, in definitive proxy or information statements incorporatedby reference in Part III of this Form 10-KSB or any amendment to this Form10-KSB. ý

 

The Issuer had $14.8 millionin gross income for the year ended March 31, 2002.

 

As of June 28, 2002, therewere issued and outstanding 1,120,586 shares of the Issuer’s Common Stock. Theaggre­gate market value of the voting stock held by non-affiliates of theIssuer, computed by reference to the last sale price of such stock on theNasdaq SmallCap Market as of June 28, 2002 was approximately $15.8 million. (The exclusion from such amount of the market value of the shares ownedby any person shall not be deemed an admission by the Issuer that such personis an affiliate of the Issuer.)

 

 

----

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

PART III of Form 10-KSB—Proxy Statement forthe 2002 Annual Meeting of Stockholders.

PART IV of Form 10-KSB—2002 Annual Report toStockholders

 

2

----

 

**PART I**

 

**Item 1.    Business**

 

**General**

 

Classic Bancshares, Inc.(“Classic” or the “Company”), a Delaware corporation, is a financial holdingcompany which has as its primary wholly-owned subsidiary Classic Bank, aKentucky chartered commercial bank.  TheCompany was organized in 1995 by Classic Bank for the purpose of becoming thesavings and loan holding company of Classic Bank in connection with ClassicBank’s conversion from mutual to stock form of organization (the “Conversion”)on December 28, 1995.  The Companybecome a bank holding company effective September 30, 1996 and a financialholding company effective June 30, 2000.

 

On September 30, 1996, FirstNational Bank of Paintsville (“Paintsville Bank”) became a subsidiary of theCompany upon consummation of the Company’s acquisition of First PaintsvilleBancshares, Inc. (“First Paintsville”), the former holding company ofPaintsville Bank.  See“—Acquisitions.”  On June 30, 2000,Classic Bank converted from a federal savings bank to a Kentucky chartered commercialbank.  On March 16, 2001, PaintsvilleBank merged into Classic Bank in order to improve the efficiency of theiroperations.   Unless the contextotherwise requires, all references herein to Classic Bank, Paintsville Bank orthe Company include the Company, Classic Bank and Paintsville Bank on aconsolidated basis.

 

At March 31, 2002, theCompany had total consolidated assets of $215.4 million, deposits of $158.9million and stockholders’ equity of $22.0 million.   On such date, the Company’s assets consisted of all of theoutstanding capital stock of Classic Bank and cash and cash equivalents.  The executive office of the Company islocated at 344 Seventeenth Street, Ashland, Kentucky 41101 and itstelephone number is (606) 326-2800.

 

As a community-orientedfinancial institution, Classic Bank seeks to serve the financial needs ofcommunities in its market area.  Itscurrent business strategy involves attracting deposits from the general publicand using such deposits, together with other funds, to originate primarilycommercial business, consumer, commercial real estate, one-to-fourfamily residential mortgages and to a lesser extent multi-family andconstruction loans in its market areas. Classic Bank also invests in mortgage-backed and related securities andinvestment securities and other permissible investments.  See “Investment Activities.”

 

The Company and Classic Bankare subject to comprehensive regulation. See “Regulation.”

 

**Forward-LookingStatements**

 

When used in this Form10-KSB and in future filings by the Company with the Securities and ExchangeCommission (the “SEC”), in the Company’s press releases or other public orshareholder communications, and in oral statements made with the approval of anauthorized executive officer, the words or phrases “will likely result,” “areexpected to,” “will continue,” “is anticipated,” “estimate,” “project” orsimilar expressions are intended to identify “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of1995.  Such statements are subject tocertain risks and uncertainties, including changes in economic conditions inthe Company’s market area, changes in policies by regulatory agencies,fluctuations in interest rates, real estate values in the Company’s marketarea, demand for loans in the Company’s market area and competition, that couldcause actual results to differ materially from historical earnings and thosepresently anticipated or projected.  TheCompany wishes to caution readers not to place undue reliance on any suchforward-looking statements, which

 

3

----

 

speak only as of the date made.  The Company wishes to advise readers thatthe factors listed above could affect the Company’s financial performance andcould cause the Company’s actual results for future periods to differ materiallyfrom any opinions or statements expressed with respect to future periods in anycurrent statements.

 

The Company does notundertake—and specifically declines any obligation—to publicly release theresult of any revisions which may be made to any forward-looking statements toreflect events or circumstances after the date of such statements or to reflectthe occurrence of anticipated or unanticipated events.

 

**Acquisitions**

 

On September 30, 1996, theCompany acquired First Paintsville, the former holding company of PaintsvilleBank, for $9.3 million in cash.  AtSeptember 30, 1996, First Paintsville had total assets of $66.6 million,deposits of $52.8 million and stockholders’ equity of $10.2 million.  Paintsville Bank engaged in retail andcommercial banking, including one-to four-family, consumer and commercialbusiness lending, and provided trust services.

 

On May 14, 1999, the Companycompleted its acquisition of Citizens Bank, Grayson (Grayson, Kentucky).  In the transaction, Citizens Bank was mergedwith and into Classic Bank, with Classic Bank as the survivinginstitution.  Shareholders of CitizensBank received an aggregate consideration of $4.5 million. On the date of theclosing, Citizens had total assets of approximately $13.7 million and totaldeposits of $12.0 million.  CitizensBank’s office is now operated as a branch office of Classic Bank.

 

**Market Area**

 

Classic Bank serves itsmarket area through its main office in Ashland, Kentucky and eight branchoffices.  Classic Bank’s primary marketarea includes the Kentucky counties of Boyd, Carter, Greenup, and JohnsonCounties and portions of Martin, Floyd, Magoffin and Lawrence Counties alsolocated in Kentucky.  The economic basein Boyd, Carter and Greenup Counties was in the past primarily industrial andreliant upon a small number of large employers particularly in the steel andpetroleum industries. Over the last several years, diversification of theemployment base into more retail and service businesses has resulted in aslowing of previously experienced declines in population.  Per capita income in these counties remainsbelow the national average. Boyd County exceeds the state average of per capitaincome while Carter and Greenup Counties remain below the state average.  While unemployment has declined, theunemployment rate for these counties continues to exceed the national and stateunemployment rate.

 

The economy in Johnson,Martin, Floyd, Magoffin and Lawrence Counties has historically been based onmanufacturing and coal mining related industries, but now also includes retail,medical, and government sectors.    Percapita income for these counties is below the national average and the stateaverage.  The unemployment rate exceedsthe national and state unemployment rates.

 

**Lending Activities**

 

***General.***  The principal lending activity of the Company historically wasthe origination of one-to-four family residential loans.  Currently, the Company puts greater emphasison the origination of commercial business, consumer, commercial real estate,and, to a lesser extent, construction and multi-family loans in its marketarea.  At March 31, 2002, loansreceivable, net, totaled $160.3 million. See “Originations, Purchases and Sales of Loans.”

 

4

----

 

***Loan Portfolio Composition.***  The following table presents the compositionof the Company’s loan portfolio in dollar amounts and in percentages (beforedeductions for loans in process, deferred fees and discounts and allowances forlosses) as of the dates indicated.

 
|                         |   | **March 31,**               |    |
|------------------------------|--------|-----------------------------|---------|
|                         |   | **2002**                    |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                         |   | **Amount**                  |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                         |   | **(Dollars in  Thousands)** |    |
| Real Estate Loans            |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family          |   | $                           | 74,321  |   | 45.9 | % | $ | 73,576 |   | 52.5 | % | $ | 71,928 |   | 55.7 | % | $ | 61,992 |   | 63.0 | % | $ | 66,078 |   | 72.6 | % |
| Commercial                   |   | 23,105                      |    | 14.3 |   | 16,877 |   | 12.0 |   | 15,216 |   | 11.8 |   | 10,136 |   | 10.3 |   | 8,970 |   | 9.9 |   |
| Multi-family                 |   | 1,083                       |    | 0.7 |   | 1,342 |   | 1.0 |   | 1,486 |   | 1.2 |   | 1,179 |   | 1.2 |   | 1,497 |   | 1.6 |   |
| Construction                 |   | 4,823                       |    | 3.0 |   | 3,287 |   | 2.3 |   | 2,670 |   | 2.0 |   | 2,513 |   | 2.6 |   | 426 |   | 0.5 |   |
| Total real estate loans      |   | 103,332                     |    | 63.9 |   | 95,082 |   | 67.8 |   | 91,300 |   | 70.7 |   | 75,820 |   | 77.1 |   | 76,971 |   | 84.6 |   |
|                         |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Loans                  |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer Loans:              |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposit account              |   | 2,098                       |    | 1.3 |   | 1,176 |   | 0.8 |   | 1,369 |   | 1.1 |   | 383 |   | 0.4 |   | 526 |   | 0.6 |   |
| Credit Card                  |   | —                      |    | — |   | — |   | — |   | — |   | — |   | 3 |   | — |   | 218 |   | 0.2 |   |
| Installment                  |   | 22,784                      | (1)     | 14.0 |   | 16,406 | (1) | 11.7 |   | 12,457 |   | 9.6 |   | 7,347 |   | 7.5 |   | 5,380 |   | 5.9 |   |
| Other                        |   | 84                          |    | 0.1 |   | 667 |   | 0.5 |   | 250 |   | 0.2 |   | 68 |   | 0.1 |   | 991 |   | 1.1 |   |
| Total consumer loans         |   | 24,966                      |    | 15.4 |   | 18,249 |   | 13.0 |   | 14,076 |   | 10.9 |   | 7,801 |   | 8.0 |   | 7,115 |   | 7.8 |   |
| Commercial business loans    |   | 33,448                      | (2)     | 20.7 |   | 26,727 |   | 19.1 |   | 23,539 |   | 18.3 |   | 14,747 |   | 14.9 |   | 6,942 |   | 7.6 |   |
| Commercial agriculture loans |   | 74                          |    | — |   | 119 |   | 0.1 |   | 148 |   | 0.1 |   | 17 |   | — |   | — |   | — |   |
| Total other loans            |   | 58,488                      |    | 36.1 |   | 45,095 |   | 32.2 |   | 37,763 |   | 29.3 |   | 22,565 |   | 22.9 |   | 14,057 |   | 15.4 |   |
| Total loans                  |   | 161,820                     |    | 100.0 | % | 140,177 |   | 100.0 | % | 129,063 |   | 100.0 | % | 98,385 |   | 100.0 | % | 91,028 |   | 100.0 | % |
|                         |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans in process             |   | —                      |    |   |   | — |   |   |   | (10 | ) |   |   | (23 | ) |   |   | (29 | ) |   |   |
| Deferred fees and discounts  |   | 124                         |    |   |   | 92 |   |   |   | 44 |   |   |   | 26 |   |   |   | (68 | ) |   |   |
| Allowance for loan losses    |   | (1,628                      | )       |   |   | (1,407 | ) |   |   | (1,289 | ) |   |   | (861 | ) |   |   | (831 | ) |   |   |
| Total loans receivable, net  |   | $                           | 160,316 |   |   |   | $ | 138,862 |   |   |   | $ | 127,808 |   |   |   | $ | 97,527 |   |   |   | $ | 90,100 |   |   |   |

 

----

(1)                                  Included $10.4million of automobile loans, $2.4 million of home equity loans, and $3.8million of recreational vehicle loans at March 31, 2002 and $6.9 million ofautomobile loans, $1.7 million of home equity loans, and $1.7 million ofrecreational vehicle loans at March 31, 2001.

(2)                                  Does not includethe unfunded portion of commercial lines of credit of $6.3 million.

 

5

----

 

The following table showsthe composition of the Company’s loan portfolio by fixed and adjustable ratesat the dates indicated.

 
|                        |   | **March 31**                |    |
|-----------------------------|--------|-----------------------------|---------|
|                        |   | **2002**                    |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                        |   | **Amount**                  |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                        |   | **(Dollars in  Thousands)** |    |
| Fixed-Rate Loans:           |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate:                |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family         |   | $                           | 43,646  |   | 26.9 | % | $ | 44,020 |   | 31.4 | % | $ | 44,377 |   | 34.4 | % | $ | 33,944 |   | 34.5 | % | $ | 33,253 |   | 36.5 | % |
| Commercial                  |   | 11,039                      |    | 6.8 |   | 9,031 |   | 6.4 |   | 8,829 |   | 6.8 |   | 5,329 |   | 5.4 |   | 3,348 |   | 3.7 |   |
| Multi-family                |   | 625                         |    | 0.4 |   | 832 |   | 0.6 |   | 903 |   | 0.7 |   | 850 |   | 0.9 |   | 1,278 |   | 1.4 |   |
| Construction                |   | 1,648                       |    | 1.1 |   | 1,959 |   | 1.4 |   | 1,950 |   | 1.5 |   | 1,815 |   | 1.9 |   | 426 |   | 0.5 |   |
| Total real estate loans     |   | 56,958                      |    | 35.2 |   | 55,841 |   | 39.8 |   | 56,059 |   | 43.4 |   | 41,938 |   | 42.7 |   | 38,305 |   | 42.1 |   |
| Consumer                    |   | 20,967                      |    | 13.0 |   | 16,773 |   | 12.0 |   | 12,543 |   | 9.7 |   | 7,053 |   | 7.2 |   | 6,161 |   | 6.8 |   |
| Commercial business         |   | 9,916                       |    | 6.1 |   | 9,916 |   | 7.1 |   | 8,861 |   | 6.9 |   | 8,137 |   | 8.2 |   | 2,649 |   | 2.9 |   |
| Commercial agriculture      |   | 74                          |    | — |   | 119 |   | 0.1 |   | 148 |   | 0.1 |   | 17 |   | — |   | — |   | — |   |
| Total fixed-rate loans      |   | 87,915                      |    | 54.3 |   | 82,649 |   | 59.0 |   | 77,611 |   | 60.1 |   | 57,145 |   | 58.1 |   | 47,115 |   | 51.8 |   |
|                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Adjustable-Rate Loans:      |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate:                |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family         |   | 30,675                      |    | 18.9 |   | 29,556 |   | 21.0 |   | 27,551 |   | 21.3 |   | 28,048 |   | 28.5 |   | 32,825 |   | 36.1 |   |
| Commercial                  |   | 12,066                      |    | 7.5 |   | 7,846 |   | 5.6 |   | 6,387 |   | 4.9 |   | 4,807 |   | 4.9 |   | 5,622 |   | 6.2 |   |
| Multi-family                |   | 458                         |    | 0.3 |   | 511 |   | 0.4 |   | 583 |   | 0.5 |   | 329 |   | 0.3 |   | 219 |   | 0.2 |   |
| Construction                |   | 3,175                       |    | 2.0 |   | 1,328 |   | 0.9 |   | 720 |   | 0.6 |   | 698 |   | 0.7 |   | — |   | — |   |
| Total real estate loans     |   | 46,374                      |    | 28.7 |   | 39,241 |   | 27.9 |   | 35,241 |   | 27.3 |   | 33,882 |   | 34.4 |   | 38,666 |   | 42.5 |   |
| Consumer                    |   | 3,999                       |    | 2.5 |   | 1,476 |   | 1.1 |   | 1,533 |   | 1.2 |   | 748 |   | 0.8 |   | 954 |   | 1.0 |   |
| Commercial business         |   | 23,532                      |    | 14.5 |   | 16,811 |   | 12.0 |   | 14,678 |   | 11.4 |   | 6,610 |   | 6.7 |   | 4,293 |   | 4.7 |   |
| Total adjustable-rate loans |   | 73,905                      |    | 45.7 |   | 57,528 |   | 41.0 |   | 51,452 |   | 39.9 |   | 41,240 |   | 41.9 |   | 43,913 |   | 48.2 |   |
| Total loans                 |   | 161,820                     |    | 100.0 | % | 140,177 |   | 100.0 | % | 129,063 |   | 100.0 | % | 98,385 |   | 100.0 | % | 91,028 |   | 100.0 | % |
|                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans in process            |   | —                      |    |   |   | — |   |   |   | (10 | ) |   |   | (23 | ) |   |   | (29 | ) |   |   |
| Deferred fees and discounts |   | 124                         |    |   |   | 92 |   |   |   | 44 |   |   |   | 26 |   |   |   | (68 | ) |   |   |
| Allowance for loan losses   |   | (1,628                      | )       |   |   | (1,407 | ) |   |   | (1,289 | ) |   |   | (861 | ) |   |   | (831 | ) |   |   |
| Total loans receivable, net |   | $                           | 160,316 |   |   |   | $ | 138,862 |   |   |   | $ | 127,808 |   |   |   | $ | 97,527 |   |   |   | $ | 90,100 |   |   |   |

 

6

----

 

The following scheduleillustrates the interest rate sensitivity of the Company’s loan portfolio atMarch 31, 2002.  Mortgages whichhave adjustable or renegotiable interest rates are shown as maturing in theperiod during which the contract is due. The schedule does not reflect the effects of possible prepayments orenforcement of due-on-sale clauses.

 
|                |   | **Real Estate**             |       | **Commercial**                          |   |             |   |                              |   |
|---------------------|--------|-----------------------------|------------|-----------------------------------------|--------|------------------|--------|-----------------------------------|--------|
|                |   | **One-to-Four  Family**     |       | **Multi-family  and********Commercial** |   | **Construction** |   | **Consumer**                      |   | **Business** |   | **Other** |   | **Total** |   |
|                |   | **Amount**                  |       | **Weighted  Average********Rate**       |   | **Amount**       |   | **Weighted  Average********Rate** |   | **Amount** |   | **Weighted  Average********Rate** |   | **Amount** |   | **Weighted  Average********Rate** |   | **Amount** |   | **Weighted  Average********Rate** |   | **Amount** |   | **Weighted  Average********Rate** |   | **Amount** |   | **Weighted  Average********Rate** |   |
|                |   | **(Dollars in  Thousands)** | ** ** |
| Due                 |   |                        |       |                                    |   |             |   |                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Within one year(1)  |   | $                           | 1,503      |                                    | 6.5    | %                | $      | 886                               |   | 5.6 | % | $ | 3,725 |   | 6.5 | % | $ | 5,846 |   | 6.6 | % | $ | 14,988 |   | 5.4 | % | $ | 55 |   | 7.7 | % | $ | 27,003 |   | 5.5 | % |
| One to two years    |   | 232                         |       | 9.2                                     |   | 265              |   | 7.3                               |   | 250 |   | 5.8 |   | 1,879 |   | 9.9 |   | 1,788 |   | 7.2 |   | — |   | — |   | 4,414 |   | 8.4 |   |
| Two to three years  |   | 792                         |       | 8.4                                     |   | 592              |   | 7.5                               |   | 280 |   | 6.5 |   | 2,991 |   | 9.2 |   | 1,399 |   | 7.8 |   | 7 |   | 13.0 |   | 6,061 |   | 8.5 |   |
| Three to five years |   | 3,196                       |       | 7.6                                     |   | 3,706            |   | 5.7                               |   | 39 |   | 12.4 |   | 9,947 |   | 7.7 |   | 5,603 |   | 6.6 |   | 12 |   | 6.0 |   | 22,503 |   | 7.1 |   |
| Five to ten years   |   | 11,950                      |       | 7.7                                     |   | 9,412            |   | 6.2                               |   | 383 |   | 6.7 |   | 2,090 |   | 9.3 |   | 6,092 |   | 6.6 |   | — |   | — |   | 29,927 |   | 7.1 |   |
| Ten to 15 years     |   | 23,354                      |       | 7.5                                     |   | 8,673            |   | 6.7                               |   | 146 |   | 7.9 |   | 2,100 |   | 9.1 |   | 3,360 |   | 5.2 |   | — |   | — |   | 37,633 |   | 7.2 |   |
| Over 15 years       |   | 33,294                      |       | 7.4                                     |   | 654              |   | 7.1                               |   | — |   | — |   | 113 |   | 8.3 |   | 218 |   | 6.0 |   | — |   | — |   | 34,279 |   | 7.4 |   |
| Totals              |   | $                           | 74,321     |                                    |   |             | $      | 24,188                            |   |   |   | $ | 4,823 |   |   |   | $ | 24,966 |   |   |   | $ | 33,448 |   |   |   | $ | 74 |   |   |   | $ | 161,820 |   |   |   |
|                     |        |                             |            |                                         |        |                  |        |                                   |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) Includes demand loans, loans having nostated maturity and overdraft loans.

 

The total amount of loansdue after March 31, 2003 which have predetermined interest rates is$80.9 million, while the total amount of loans due after such date whichhave floating or adjustable interest rates is $53.9****million.

 

7

----

 

***Commercial Business Lending****.*  The Company originates a significant volumeof secured and unsecured commercial business loans to a wide variety of localbusinesses.  The borrowers on theCompany’s commercial business loans included health care providers, servicebusinesses, retail establishments and small manufacturers.** **TheCompany generally seeks to make commercial business loans on a “relationship”rather than a “transaction” basis.  AtMarch 31, 2002, the Company’s commercial business loans totaled $33.4 million,or 20.7% of total loans.   In addition,as of such date, the Company had $6.3 million of unfunded commercial businessloan commitments.

 

The Company’s commercialbusiness loans generally have terms of up fifteen years and generally carryadjustable rates of interest based on the prime rate, plus or minus amargin.  If secured, such loansgenerally carry security interests on inventory, accounts receivable and fixedassets located in the Company’s market area. The Company’s commercial business loans are generally personallyguaranteed by one or more of the principals of the borrower.

 

Commercial business loansare typically made on the basis of the borrower’s ability to make repaymentfrom the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercialbusiness loans may be substantially dependent on the success of the businessitself.  Further, the collateral, ifany, securing the loans may depreciate over time, may be difficult to appraiseand may fluctuate in value based on the success of the business.  Accordingly, there can be no assurance thatthe Company’s non-performing commercial business loans will not increase in thefuture.

 

The Company’s commercialbusiness lending volume has increased significantly in the last several yearsas a result of management’s continued focus on the Company’s commercialrelationships, its commitment to igniting interest rate sensitive assets aswell as a reduction in the number of locally owned business lenders.  The Company intends to continue to increaseits commercial business lending activities in the future.

 

***Consumer Lending***.  In order to increase the yield and interestrate sensitivity of its loan portfolio and as part of its communitybank-oriented strategy, the Company has increased the type and volume of itsconsumer loans to include unsecured and secured consumer loans, with emphasison direct automobile financing, recreational vehicle, home equity and boatfinancing.**** Consumer loan terms vary according to thetype and value of collateral, length of contract and credit worthiness of theborrower.  During fiscal 2002, consumerloans increased by $6.7 million as a result of this strategy.  At March 31, 2002, consumer loans totaled$25.0 million, or 15.4% of the Company’s total loan portfolio.

 

The underwriting standardsemployed by the Company for consumer loans include a determination of theapplicant’s payment history on other debts and ability to meet existingobligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration,the underwriting process also includes a comparison of the value of thesecurity, if any, in relation to the proposed loan amount.  Consumer loans, other than loans secured bydeposit accounts, may entail greater credit risk than certain mortgage loans,particularly in the case of consumer loans which are unsecured or are securedby rapidly depreciable assets, such as automobiles.  In such cases, any repossessed collateral for a defaultedconsumer loan may not provide an adequate source of repayment of theoutstanding loan balance as a result of the greater likelihood of damage, lossor deprecation.  In addition, consumerloan collections are dependent on the borrower’s continuing financialstability, and thus are more likely to be affected by adverse personalcircumstances.  Furthermore, theapplication of various federal and state laws, including bankruptcy and insolvencylaws, may limit the amount which can be recovered on such loans.  In view of the expansion of the Company’sconsumer lending activities, there can be no assurances that delinquencies inthe consumer loan portfolio will not increase in the future.

 

8

----

 

***One-to-Four-Family Residential Real EstateLending. ***A portion ofthe Company’s lending program is the origination of loans secured by mortgageson owner-occupied one-to-four-family residences. In recent years, the Companyhas reduced somewhat its emphasis on originating these types of loans for itsown portfolio.  In order to satisfycustomer demand, when the Company does not wish to hold for its own portfolio aresidential loan sought by a customer, the Company may utilize an arrangementwith another lending institution whereby the Company takes applications andreceives an origination fee on any loan actually funded by such institution.

 

The Company’s residentialloan portfolio has a measure of interest rate risk.  A portion of the Company’s fixed rate residential loans haveoriginal terms to maturity in excess of 15 years, although most of theCompany’s current fixed rate loans have terms of 15 years or less.  In addition, the interest rate sensitivity ofthe Company’s adjustable rate loans is limited by rate caps and indices thatmay lag general interest rate movements.

 

***Commercial******and Multi-Family Real EstateLending.***  The Company hasincreased its commercial real estate lending in recent years as a part of itsstrategy to increase the yield and reduce the term of its lendingportfolio.  The Company generallyfocuses its commercial real estate lending efforts on borrowers (such asprofessionals) who occupy some or all of the property securing the loan.  The Company’s commercial real estate loanportfolio includes loans secured by office and professional buildings, medicalfacilities, churches and other non-residential properties. To a lesser degree,the Company originates multi-family real estate loans, primarily apartmentcomplexes with established and predictable rent rolls.  At March 31, 2002, the Company had $23.1million in commercial real estate loans representing 14.3% of the Company’stotal loan portfolio.  At March 31,2002, multi-family real estate loans totaled $1.1 million representing 0.7% ofthe total loan portfolio.

 

Commercial real estate andmulti-family loans generally present a higher level of risk than loans securedby one-to-four family residences.  Thisgreater risk is due to several factors, including the concentration ofprincipal in a limited number of loans and borrowers, the effects of generaleconomic conditions on income producing properties and the increased difficultyof evaluating and monitoring these types of loans.  Furthermore, the repayment of loans secured by commercial andmulti-family real estate is typically dependent upon the successful operationof the related real estate project.  Ifthe cash flow from the project is reduced (for example, if leases are notobtained or renewed), the borrower’s ability to repay the loan may be impaired.

 

***Construction Lending***.  The Company originates a limited amount ofconstruction loans for the construction of residential and to a lesser degree,commercial real estate.  Construction lendingis generally considered to involve a higher level of credit risk thanone-to-four family residential lending since the risk of loss on constructionloans is dependent largely upon the accuracy of the initial estimate of theindividual property’s value upon completion of the project and the estimatedcost (including interest) of the project. At March 31, 2002, the Company’s construction loan portfolio totaled$4.8 million or 3.0% of its total portfolio.

 

**Originations,Purchases and Sales of Loans**

 

Loans are originated by theCompany’s staff of salaried loan officers through marketing activities andreferrals.  Monetary incentives areawarded to lending personnel based on pre-determined production levels.  The Company’s ability to originate loans isdependent upon customer demand for loans in its market area and to a limitedextent, various marketing efforts. Demand is affected by both the local economy and the interest rateenvironment.  See “Market Area.”  Under current policy, all loans originatedby the Company are retained in the Company’s portfolio, other than portions ofcertain large loans which may be sold (in the form of participations) to otherfinancial institutions in order to limit our

 

9

----

 

overall exposure to individualborrowers.  From time to time, theCompany purchases loans from other financial institutions under the sameunderwriting guidelines established for loans it originates.

 

The Company also takesresidential loan applications for another residential lender.  Although the Company does not make thesubject loans, the Company receives an origination fee on any loan actuallyfunded by the other lender.   Theseloans are generally offered to customers seeking loans which the Company, eitherbecause of rate or type, does not wish to include in the portfolio.

 

From time to time, in orderto supplement loan originations, the Company has acquired mortgage-backed andrelated securities which are held, depending on the investment intent, in the“available-for-sale” portfolios.  See“Investment Activities - Mortgage-Backed and Related Securities” and Note 4 tothe Notes to Consolidated Financial Statements.

 

**Delinquenciesand Non-Performing Assets**

 

***Delinquency Procedures***.  When a borrower fails to make the requiredpayments on a loan, the Company attempts to cure the delinquency throughestablished collection procedures.  If aloan becomes contractually delinquent 90 days, the Company normally initiatesappropriate legal action for collection. The decision as to whether and when to initiate legal action is basedupon such factors as the amount of the outstanding loan in relation to theoriginal indebtedness, current value of collateral (if secured), the extent andfrequency of delinquency and the borrower’s ability and willingness tocooperate in curing delinquencies.  Bypolicy, when a loan becomes delinquent 90 days or more, the Company will placethe loan on non-accrual status unless the loan is both well secured and in theprocess of collection, or loans guaranteed by an agency of the U.S. Government,such as the Small Business Administration. When placed on non-accrual status, the previously accrued interestincome on the loan is taken out of the current income.  Future interest income may be applieddirectly to the principal balance of the loan. Loans placed on non-accrual are not placed back on an accruing basisuntil a satisfactory payment history has been established.

 

Real estate acquired by theCompany as a result of foreclosure or deed in lieu of foreclosure is classifiedas real estate owned until it is sold. When property is acquired by foreclosure or deed in lieu of foreclosure,it is recorded at the lower of cost or estimated fair value (as determined byappraisal) less estimated selling costs. After acquisition, all costs incurred in maintaining the property areexpensed.  Costs relating to thedevelopment and improvement of the property are capitalized.

 

10

----

 

The following table setsforth loan delinquencies by type, by amount and by percentage of type atMarch 31, 2002.

 
|                |   | **Loans  Delinquent For:**  |   |
|---------------------|--------|-----------------------------|--------|
|                |   | **60 -89  Days**            |   | **90 Days  and Over** |   | **Total  Delinquent Loans** |   |
|                |   | **Number**                  |   | **Amount** |   | **Percent********of  Loan********Category** |   | **Number** |   | **Amount** |   | **Percent********of  Loan********Category** |   | **Number** |   | **Amount** |   | **Percent********of  Loan********Category** |   |
|                |   | **(Dollars  in Thousands)** |   |
| Real Estate:        |   |                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family |   | 4                           |   | $ | 223 |   | 0.3 | % | 6 |   | $ | 157 |   | 0.2 | % | 10 |   | $ | 380 |   | 0.5 | % |
| Commercial          |   | —                      |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Construction        |   | —                      |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Consumer            |   | 6                           |   | 24 |   | 0.1 |   | 4 |   | 22 |   | 0.1 |   | 10 |   | 46 |   | 0.2 |   |
| Commercial Business |   | —                      |   | — |   | — |   | 2 |   | 65 |   | 0.2 |   | 2 |   | 65 |   | 0.2 |   |
|                |   | 10                          |   | $ | 247 |   |   |   | 12 |   | $ | 244 |   | 0.2 | % | 22 |   | $ | 486 |   | 0.3 | % |

 

***Classification of Assets***.  Federal regulations require that each bankclassify its own assets on a regular basis. There are three classifications for problem assets.  Substandard, Doubtful and Loss.  Substandard assets have one or more definedweaknesses and are characterized by the distinct possibility that theInstitution will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses ofSubstandard assets, with the additional characteristics that the weaknessesmake collection or liquidation in full on the basis of currently existingfacts, conditions and values questionable, and there is a high possibility ofloss.  An asset classified Loss isconsidered uncollectible and of such little value that continuance as an asseton the balance sheet of the institution is not warranted.  Assets which do not currently expose aninstitution to sufficient risk to warrant classification of the aforementionedcategories, but possess weaknesses are required to be designated “Other AssetsEspecially Mentioned” by the institution.

 

On the basis of management’sreview of its assets, at March 31, 2002, the Company had the followingclassified assets:

 

|            |   | **At********March 31,  2002** |   |
|-----------------|--------|-------------------------------|--------|
|            |   | **(In  Thousands)**           |   |
|            |   |                          |   |
| Substandard     |   | $                             | 1,585  |   |
| Doubtful        |   | 77                            |   |
| Loss            |   | —                        |   |
| Special Mention |   | 829                           |   |
| Total           |   | $                             | 2,491  |   |

 

11

----

 

***Non-Performing Assets***.  The following table sets forth the amountsand categories of non-performing assets in the loan portfolio.  For all years presented, the Company has hadno troubled debt restructurings (which involve forgiving a portion of interestor principal on any loans or making loans at a rate materially less than thatof market rates).   Foreclosed assetsincluded assets acquired in settlement of loans.

 
|                                       |   | **March 31,**               |   |
|--------------------------------------------|--------|-----------------------------|--------|
|                                       |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                       |   | **(Dollars  in Thousands)** |   |
|                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Non-accruing loans:                        |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                        |   | $                           | 282    |   | $ | 423 |   | $ | 296 |   | $ | 97 |   | $ | 296 |   |
| Multi-family                               |   | —                      |   | 15 |   | — |   | — |   | — |   |
| Commercial real estate                     |   | 50                          |   | 207 |   | 134 |   | — |   | — |   |
| Consumer                                   |   | —                      |   | — |   | — |   | — |   | 12 |   |
| Commercial business                        |   | 80                          |   | — |   | 190 |   | 218 |   | — |   |
| Land                                       |   | —                      |   | 17 |   | — |   | — |   | — |   |
| Total                                      |   | 412                         |   | 662 |   | 620 |   | 315 |   | 308 |   |
|                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Accruing loans delinquent 90 days or more: |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                        |   | 157                         |   | 75 |   | 143 |   | 86 |   | 13 |   |
| Commercial real estate                     |   | —                      |   | 43 |   | — |   | — |   | 7 |   |
| Consumer                                   |   | 22                          |   | 6 |   | 10 |   | 5 |   | 5 |   |
| Commercial Business                        |   | 65                          |   | — |   | — |   | — |   | — |   |
|                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Foreclosed assets:                         |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                        |   | 46                          |   | 17 |   | 62 |   | 32 |   | 35 |   |
| Commercial real estate                     |   | 32                          |   | 194 |   | 194 |   | 194 |   | 194 |   |
| Consumer                                   |   | 4                           |   | 17 |   | 40 |   | — |   | — |   |
|                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Total non-performing assets                |   | $                           | 738    |   | $ | 1,014 |   | $ | 1,069 |   | $ | 632 |   | $ | 562 |   |
| Total as a percentage of total assets      |   | 0.3                         | %      | 0.5 | % | 0.6 | % | 0.4 | % | 0.4 | % |

 

For the year ended March 31,2002, gross interest income which would have been recorded had the non-accruingloans been current in accordance with their original terms amounted to $36,000.The amount that was included in interest income on such loans was $22,000 forthe year ended March 31, 2002.  Theaverage balance of non-accrual loans for the year ended March 31, 2002 was$430,000.  The allowance for loan andlease losses on non-accrual loans amounted to $96,000 at March 31, 2002.

 

***Other Assets of Concern***.  In addition to the non-performing assets setforth in the table above, as of March 31, 2002, there were no loans or otherassets with respect to which known information about the possible creditproblems of the borrowers or the cash flows of the security properties havecaused management to have concerns as to the ability of the borrowers to complywith present loan repayment terms and which may result in the future inclusionof such items in the non-performing asset categories.

 

Management considersnon-performing assets in establishing its allowances for loan losses.

 

12

----

 

***Allowance for Loan Losses***.  The following table sets forth an analysisof the allowances for loan losses.

 
|                                                                                       |   | **Year Ended  March 31,**   |   |
|--------------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                       |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                                       |   | **(Dollars  in Thousands)** |   |
|                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Balance at beginning of period                                                             |   | $                           | 1,407  |   | $ | 1,289 |   | $ | 861 |   | $ | 831 |   | $ | 801 |   |
| Acquisition of Citizens Bank                                                               |   | —                      |   | — |   | 506 |   | — |   | — |   |
| Charge-offs:                                                                               |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                                                                        |   | 33                          |   | 8 |   | 139 |   | 23 |   | 49 |   |
| Commercial real estate                                                                     |   | —                      |   | — |   | 4 |   | — |   | — |   |
| Commercial business                                                                        |   | 69                          |   | 108 |   | 155 |   | 8 |   | 1 |   |
| Consumer                                                                                   |   | 80                          |   | 74 |   | 71 |   | 84 |   | 102 |   |
| Credit cards                                                                               |   | —                      |   | — |   | 2 |   | 2 |   | 21 |   |
| Total charge-offs                                                                          |   | 182                         |   | 190 |   | 371 |   | 117 |   | 173 |   |
|                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Recoveries:                                                                                |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                                                                        |   | 5                           |   | 5 |   | 8 |   | 15 |   | — |   |
| Commercial business                                                                        |   | —                      |   | 2 |   | 27 |   | — |   | 26 |   |
| Consumer                                                                                   |   | 35                          |   | 40 |   | 34 |   | 32 |   | 16 |   |
| Credit cards                                                                               |   | —                      |   | — |   | 1 |   | — |   | 3 |   |
| Total recoveries                                                                           |   | 40                          |   | 47 |   | 70 |   | 47 |   | 45 |   |
| Net charge-offs                                                                            |   | 142                         |   | 143 |   | 301 |   | 70 |   | 128 |   |
| Additions charged to operations                                                            |   | 363                         |   | 261 |   | 223 |   | 100 |   | 158 |   |
| Balance at end of period                                                                   |   | $                           | 1,628  |   | $ | 1,407 |   | $ | 1,289 |   | $ | 861 |   | $ | 831 |   |
|                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Ratio of net charge-offs during the period to average loans  outstanding during the period |   | 0.1                         | %      | 0.1 | % | 0.2 | % | 0.1 | % | 0.1 | % |
|                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Ratio of net charge-offs during the period to average non-performing  assets               |   | 13.9                        | %      | 12.4 | % | 30.0 | % | 9.3 | % | 15.4 | % |

 

The allowances for loanlosses is established through a provision for loan losses charged to earningsbased on management’s evaluation of probable accrued losses in the portfolio,the risk inherent in its entire portfolio and changes in the nature and volumeof its loan activity.  Such evaluation,which includes a formal review of all loans of which full collectibility maynot be reasonably assured, considers the market value of the underlyingcollateral, growth and composition of the loan portfolio, the relationship ofthe allowance to outstanding loans, historical loss experience, delinquencytrends, prevailing and projected economic conditions and other factors thatwarrant recognition in providing for an adequate allowance for loanlosses.  In determining the generalreserves under these policies, historical charge-offs and recoveries, changesin the mix and level of the various types of loans, net realizable values, thecurrent loan portfolio and current economic conditions are considered.

 

While management believesthat it uses the best information available to determine the allowance for loanlosses, unforeseen economic and market conditions could result in adjustmentsto the allowance for loan losses, and net earnings could be significantlyaffected, if circumstances differ substantially from the assumptions used inmaking the final determination.

 

13

----

 

The distribution of theallowance for loan losses at the dates indicated is summarized as follows:

 
|                   |   | **March 31,**                             |   |
|------------------------|--------|-------------------------------------------|--------|
|                   |   | **2002**                                  |   | **2001** |   | **2000** |   |
|                   |   | **Amount of********Loan Loss  Allowance** |   | **Loan  Amounts  by  Category** |   | **Percent  of Loans  in Each  Category  to Total  Loans** |   | **Amount of********Loan Loss  Allowance** |   | **Loan  Amounts  by  Category** |   | **Percent  of Loans  in Each  Category  to Total  Loans** |   | **Amount of********Loan Loss  Allowance** |   | **Loan  Amounts  by  Category** |   | **Percent  of Loans  in Each  Category  to Total  Loans** |   |
|                   |   | **(Dollars in Thousands)**                |   |
|                   |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family    |   | $                                         | 207    |   | $ | 74,321 |   | 45.9 | % | $ | 197 |   | $ | 73,576 |   | 52.5 | % | $ | 185 |   | $ | 71,928 |   | 55.7 |   |
| Multi-family           |   | 17                                        |   | 1,083 |   | 0  .7 |   | — |   | 1,342 |   | 1.0 |   | — |   | 1,486 |   | 1.2 |   |
| Commercial real estate |   | 41                                        |   | 23,105 |   | 14.3 |   | 172 |   | 16,877 |   | 12.0 |   | 99 |   | 15,216 |   | 11.8 |   |
| Construction           |   | —                                    |   | 4,823 |   | 3.0 |   | 49 |   | 3,287 |   | 2.3 |   | — |   | 2,670 |   | 2.0 |   |
| Consumer               |   | 29                                        |   | 24,966 |   | 15.4 |   | 91 |   | 18,249 |   | 13.0 |   | 97 |   | 14,076 |   | 10.9 |   |
| Commercial business    |   | 34                                        |   | 33,448 |   | 20.7 |   | 150 |   | 26,727 |   | 19.1 |   | 431 |   | 23,539 |   | 18.3 |   |
| Commercial agriculture |   | —                                    |   | 74 |   | — |   | — |   | 119 |   | 0.1 |   | — |   | 148 |   | 0.1 |   |
| Unallocated            |   | 1,300                                     |   | — |   | — |   | 748 |   | — |   | — |   | 477 |   | — |   | — |   |
| Total                  |   | $                                         | 1,628  |   | $ | 161,820 |   | 100.0 | % | $ | 1,407 |   | $ | 140,177 |   | 100.0 | % | $ | 1,289 |   | $ | 129,063 |   | 100.0 |   |
|                        |        |                                           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                   |   | **March 31,**                             |   |
|------------------------|--------|-------------------------------------------|--------|
|                   |   | **1999**                                  |   | **1998** |   |
|                   |   | **Amount of********Loan  Loss Allowance** |   | **Loan  Amounts  by  Category** |   | **Percent  of Loans  in Each  Category  to Total  Loans** |   | **Amount of********Loan  Loss Allowance** |   | **Loan  Amounts  by  Category** |   | **Percent  of Loans  in Each  Category  to Total  Loans** |   |
|                   |   | **(Dollars in Thousands)**                |   |
|                   |   |                                      |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family    |   | $                                         | 180    |   | $ | 61,992 |   | 63.0 | % | $ | 221 |   | $ | 66,078 |   | 72.6 | % |
| Multi-family           |   | —                                    |   | 1,179 |   | 1.2 |   | 2 |   | 1,497 |   | 1.6 |   |
| Commercial real estate |   | 34                                        |   | 10,136 |   | 10.3 |   | 45 |   | 8,970 |   | 9.9 |   |
| Construction           |   | —                                    |   | 2,513 |   | 2.6 |   | — |   | 426 |   | 0.5 |   |
| Consumer               |   | 60                                        |   | 7,801 |   | 8.0 |   | 35 |   | 7,115 |   | 7.8 |   |
| Commercial business    |   | 80                                        |   | 14,747 |   | 14.9 |   | 52 |   | 6,942 |   | 7.6 |   |
| Commercial agriculture |   | —                                    |   | 17 |   | — |   | — |   | — |   | — |   |
| Unallocated            |   | 507                                       |   | — |   | — |   | 476 |   | — |   | — |   |
| Total                  |   | $                                         | 861    |   | $ | 98,385 |   | 100.0 | % | $ | 831 |   | $ | 91,028 |   | 100.0 | % |

 

14

----

 

**InvestmentActivities**

 

***General.***  Generally, the investment policy of the Company is to investfunds among categories of investments and maturities based upon theasset/liability management policies, investment quality, loan and depositvolume, liquidity needs and performance objectives.  The Company’s securities are classified into three categories:trading, held to maturity and available–for–sale.  Securities that are bought and heldprincipally for the purpose of selling them in the near term are classified astrading securities and are reported at fair value with unrealized gains andlosses included in trading account activities in the statement of operations.  Securities that the Company has the positiveintent and ability to hold to maturity are classified as held–to–maturityand reported at amortized cost.  Allother securities not classified as trading or held–to–maturity areclassified as available–for–sale. At March 31, 2002, the Company had no securities which wereclassified as trading.  Available–for–salesecurities are reported at fair value with unrealized gains and lossesincluded, on an after–tax basis, in a separate component of retainedearnings.  At March 31, 2002, $9.1million of investment securities or mortgage–backed and relatedsecurities were classified as available–for–sale.

 

**Securities.**

 

The Company invests inliquidity investments and in high-quality investments, such as U.S. Treasuryand agency obligations, in order to supplement lending volume and providecollateral for public funds deposited with the Company.  Investment securities may also be used toadjust the term to repricing of the Company’s assets.  At March 31, 2002, the Company’s investment securitiesportfolio totaled $27.3 million.  AtMarch 31, 2002, the Company did not own any investment securities of asingle issuer which exceeded 10% of the Company’s stockholders’ equity, otherthan U.S. government securities and federal agency obligations.  See Note 4 of the Notes to theConsolidated Financial Statements for additional information regarding theCompany’s investment securities portfolio.

 

The following table setsforth the composition of the Company’s securities at the dates indicated. Allinvestment securities held by the Company were classified as available forsale.

 
|                                                                  |   | **March 31,**               |   |
|-----------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                  |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                                                  |   | **Carrying  Value**         |   | **% of  Total** |   | **Carrying  Value** |   | **% of  Total** |   | **Carrying  Value** |   | **% of  Total** |   |
|                                                                  |   | **(Dollars in  Thousands)** |   |
| Investment securities:                                                |   |                        |   |   |   |   |   |   |   |   |   |   |   |
| U.S. government securities                                            |   | $                           | — |   | — |   | $ | — |   | — |   | $ | 995 |   | 4.0 |   |
| Federal agency obligations                                            |   | 2,488                       |   | 9.1 |   | 3,083 |   | 11.8 |   | 3,202 |   | 12.7 |   |
| Municipal bonds                                                       |   | 17,042                      |   | 62.5 |   | 16,356 |   | 62.5 |   | 14,931 |   | 59.4 |   |
| Other debt securities                                                 |   | 6,273                       |   | 23.0 |   | 5,355 |   | 20.4 |   | 3,987 |   | 15.9 |   |
| Other equity securities                                               |   | —                      |   | — |   | — |   | — |   | 558 |   | 2.2 |   |
| FHLB and FRB stock                                                    |   | 1,480                       |   | 5.4 |   | 1,394 |   | 5.3 |   | 1,462 |   | 5.8 |   |
| Total securities and FHLB and FRB stock                               |   | $                           | 27,283 |   | 100.0 | % | $ | 26,188 |   | 100.0 | % | $ | 25,135 |   | 100.0 | % |
|                                                                  |   |                        |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining life of investment securities                       |   | 14  yrs                     |   |   |   | 13  yrs |   |   |   | 14  yrs |   |   |   |
|                                                                  |   |                        |   |   |   |   |   |   |   |   |   |   |   |
| Other interest-earning assets:                                        |   |                        |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits with banks                                  |   | $                           | 448    |   | 100.0 | % | $ | 113 |   | 69.3 | % | $ | 60 |   | 31.4 | % |
| Federal Funds Sold and securities purchasedunder  agreement to resell |   | —                      |   | — |   | 50 |   | 30.7 |   | 131 |   | 68.6 |   |

 

15

----

 

The composition andmaturities of the securities portfolio, excluding FHLB and FRB stock, areindicated in the following table.

 
|                       |   | **March 31,  2002**    |   |
|----------------------------|--------|-----------------------------|--------|
|                       |   | **Less Than********1 Year** |   | **1 to 5********Years** |   | **5 to 10********Years** |   | **Over********10 Years** |   | **Total  Securities** |   |
|                       |   | **Carrying********Value**   |   | **Carrying********Value** |   | **Carrying********Value** |   | **Carrying********Value** |   | **Carrying********Value** |   | **Market  Value** |   |
|                       |   | **(Dollars in  Thousands)** |   |
|                       |   |                        |   |   |   |   |   |   |   |   |   |   |   |
| Federal agency obligations |   | $                           | — |   | $ | — |   | $ | 2,488 |   | $ | — |   | $ | 2,488 |   | $ | 2,488 |   |
| Municipal bonds            |   | 152                         |   | 2,618 |   | 1,652 |   | 12,620 |   | 17,042 |   | 17,042 |   |
| Corporate debt securities  |   | —                      |   | — |   | — |   | 6,273 |   | 6,273 |   | 6,273 |   |
| Total securities           |   | $                           | 152    |   | $ | 2,618 |   | $ | 4,140 |   | $ | 18,893 |   | $ | 25,803 |   | $ | 25,803 |   |
|                       |   |                        |   |   |   |   |   |   |   |   |   |   |   |
| Weighted average yield(1)  |   | 7.8                         | %      | 7.1 | % | 7.1 | % | 7.4 | % | 7.4 | % | 7.4 | % |

 

----

(1) Yields have been computed on atax-equivalent basis.

 

See Note 4 of the Notesto the Consolidated Financial Statements for a discussion of the Company’ssecurities portfolio.

 

***Mortgage-Backed and Related Securities*****.**  In order to supplement loanand investment activities, the Company has invested in mortgage-backed andrelated securities.

 

At March 31, 2002, $1.2million, or 12.5% of the Company’s mortgage-backed and related securities, hadadjustable interest rates.  Forinformation regarding the mortgage-backed and related securities portfolio, seeNote 4 of the Notes to the Consolidated Financial Statements.

 

As of  March 31, 2002, all of themortgage-backed and related securities owned by the Company were issued,insured or guaranteed either directly or indirectly by a federal agency.   Except with respect to these federal agencysecurities, the Company did not have any mortgage-backed or related securitiesin excess of 10% of stockholders’ equity except for federal agency obligations.

 

In addition to itsconventional mortgage-backed securities, from time to time, the Company investsin collateralized mortgage obligations (“CMOs”) and real estate mortgageinvestment conduits (“REMICs”).  CMOsand REMICs are securities derived by reallocating the cash flows frommortgage-backed securities or pools of mortgage loans in order to createmultiple classes, or tranches, of securities with coupon rates and averagelives that differ from the underlying collateral as a whole.  The terms to maturity of any particulartranche is dependent upon the prepayment speed of the underlying collateral aswell as the structure of the particular CMO or REMIC.  As a result, the cash flow and hence the value of CMOs and REMICsare subject to substantial change.  AtMarch 31, 2002, the Company had $371,000 of CMOs and REMICs.

 

To assess price volatility,the Federal Financial Institutions Examination Council (“FFIEC”) requiresClassic Bank to annually test its CMOs and other mortgage-related securities todetermine

 

16

----

 

whether they are high-risk or nonhigh-risksecurities.  Mortgage derivative productswith an average life or price volatility in excess of a benchmark 30-year,mortgage-backed, pass-through security are considered high-risk mortgagesecurities. At March 31, 2002, none of the Company’s****mortgage-backed securities were classifiedas “high–risk.”

 

The following table setsforth the contractual maturities of the Company’s mortgage–backedsecurities at March 31, 2002.

 

 

|            |   | **Over 1 to 5********Years** |   | **Over 5 to********10  Years** |   | **Over 10 to********20 Years** |   | **Over 20********Years** |   | **Balance********Outstanding** |   |
|-----------------|--------|------------------------------|--------|--------------------------------|--------|--------------------------------|--------|--------------------------|--------|--------------------------------|--------|
|            |   | **(In  Thousands)**          |   |
|            |   |                         |   |                           |   |                           |   |                     |   |                           |   |
| FHLMC           |   | $                            | — |                           | $      | 455                            |   | $                        | 6,555  |                           | $      | 492 |   | $ | 7,502 |   |
| FNMA            |   | —                       |   | —                         |   | 430                            |   | 653                      |   | 1,083                          |   |
| GNMA            |   | —                       |   | —                         |   | —                         |   | —                   |   | —                         |   |
| Other           |   | —                       |   | —                         |   | 107                            |   | —                   |   | 107                            |   |
| CMOs and REMICs |   | —                       |   | 371                            |   | —                         |   | —                   |   | 371                            |   |
|            |   |                         |   |                           |   |                           |   |                     |   |                           |   |
| Total           |   | $                            | — |                           | $      | 826                            |   | $                        | 7,092  |                           | $      | 1,145 |   | $ | 9,063 |   |

 

At March 31, 2002, thedollar amount of all mortgage-backed and related securities due afterMarch 31, 2003, which had fixed interest rates and floating or adjustablerates totaled $7.9 million and $1.2 million, respectively.

 

The market values of aportion of the Company’s mortgage-backed and related securitiesheld-to-maturity have been from time to time lower than their carryingvalues.  However, for  financial reporting purposes, such declinesin value are considered to be temporary in nature since they have been due tochanges in interest rates rather than credit concerns.  See Note 4 of the Notes to theConsolidated Financial Statements.

 

The following table setsforth the composition of the mortgage-backed securities at the dates indicated.

 
|                                           |   | **March 31,**               |   |
|------------------------------------------------|--------|-----------------------------|--------|
|                                           |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                           |   | **Amortized********Cost**   |   | **Market  Value** |   | **Amortized********Cost** |   | **Market  Value** |   | **Amortized********Cost** |   | **Market  Value** |   |
|                                           |   | **(Dollars in  Thousands)** |   |
|                                           |   |                        |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed securities available for sale: |   |                        |   |   |   |   |   |   |   |   |   |   |   |
| FHLMC                                          |   | $                           | 7,602  |   | $ | 7,502 |   | $ | 1,075 |   | $ | 1,091 |   | $ | 1,210 |   | $ | 1,181 |   |
| FNMA                                           |   | 1,062                       |   | 1,083 |   | 1,841 |   | 1,787 |   | 1,468 |   | 1,449 |   |
| Other                                          |   | 108                         |   | 107 |   | 133 |   | 131 |   | 175 |   | 172 |   |
| CMOs/REMICs                                    |   | 378                         |   | 371 |   | 440 |   | 435 |   | 439 |   | 428 |   |
| Total mortgage-backed securities               |   | $                           | 9,150  | (1) | $ | 9,063 |   | $ | 3,489 |   | $ | 3,444 |   | $ | 3,292 |   | $ | 3,230 |   |

 

----

(1)                                  Include $1.2million of mortgage backed securities with adjustable interest rates**.**

 

 

17

----

 

The following table showsmortgage-backed and related securities purchase, sale and repayment activitiesfor the periods indicated.

 
|                             |   | **Year Ended  March 31,** |   |
|----------------------------------|--------|---------------------------|--------|
|                             |   | **2002**                  |   | **2001** |   | **2000** |   |
|                             |   | **(In  Thousands)**       |   |
| Purchases:                       |   |                      |   |   |   |   |   |
| Adjustable-rate(1)               |   | $                         | — |   | $ | — |   | $ | — |   |
| Fixed-rate(1)                    |   | 6,991                     |   | 757 |   | — |   |
| CMOs and REMICs                  |   | —                    |   | — |   | — |   |
| Total purchases                  |   | 6,991                     |   | 757 |   | — |   |
|                             |   |                      |   |   |   |   |   |
| Sales:                           |   |                      |   |   |   |   |   |
| Adjustable-rate(1)               |   | —                    |   | — |   | — |   |
| Fixed-rate(1)                    |   | —                    |   | — |   | — |   |
| CMOs and REMICs                  |   | —                    |   | — |   | — |   |
| Total sales                      |   | —                    |   | — |   | — |   |
|                             |   |                      |   |   |   |   |   |
| Principal repayments             |   | 1,306                     |   | (549 | ) | (1,176 | ) |
| Other increases (decreases), net |   | (24                       | )      | (11 | ) | (47 | ) |
| Net increase (decrease)          |   | $                         | 5,661  |   | $ | 197 |   | $ | (1,223 | ) |

 

----

(1) Consists of pass-through securities.

 

**Sources ofFunds**

 

***General.***  The Company’s primary sources of funds are deposits, payments(including prepayments) of loan principal, interest earned on loans andsecurities, repayments of securities, borrowings and funds provided fromoperations.  Borrowings may be used on ashort-term basis to compensate for seasonal reductions in deposits or depositinflows at less than projected levels and may be used on a longer-term basis tosupport expanded lending activities.

 

***Deposits.***  The Company offers deposit accounts having awide range of interest rates and terms. The Company’s deposits consist of savings, money market, variouscertificate and interest- and noninterest-bearing checking accounts. TheCompany currently relies primarily on competitive pricing policies and productofferings, convenient locations and business hours, customer service and crossmarketing to attract and retain deposits. The Company also cross markets tocurrent customers and utilizes newspaper, television, billboard and radioadvertisements.

 

The Company serves as adepository for public funds for various municipalities and related entities.  At March 31, 2002, the amount of public fundson deposit with the Company was $14.6 million. These accounts are subject to volatility depending on government fundingneeds and the Company’s desire to price competitively to attract such funds.

 

The Company manages thepricing of its deposits in keeping with its asset/liability management,profitability and growth objectives. For additional information regarding the Company’s deposit accounts, seeNote 7 of the Notes to the Consolidated Financial Statements.

 

18

----

 

The following table setsforth the dollar amount of savings deposits in the various types of depositprograms offered as of the dates indicated.

 
|                                 |   | **As of March  31,**        |    |
|--------------------------------------|--------|-----------------------------|---------|
|                                 |   | **2002**                    |    | **2001** |   | **2000** |   |
|                                 |   | **Amount**                  |    | **Percent  of Total** |   | **Amount** |   | **Percent  of Total** |   | **Amount** |   | **Percent  of Total** |   |
|                                 |   | **(Dollars in  Thousands)** |    |
|                                 |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Deposits:                            |   |                        |    |   |   |   |   |   |   |   |   |   |   |
|                                 |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing demand deposits |   | $                           | 20,404  |   | 12.8 | % | $ | 17,186 |   | 11.8 | % | $ | 14,749 |   | 10.9 | % |
| Interest bearing demand deposits     |   | 25,075                      |    | 15.9 |   | 23,344 |   | 16.1 |   | 22,195 |   | 16.4 |   |
| Savings Accounts                     |   | 13,893                      |    | 8.7 |   | 11,924 |   | 8.2 |   | 12,736 |   | 9.4 |   |
| Money Market Accounts                |   | 18,466                      |    | 11.6 |   | 13,538 |   | 9.3 |   | 10,877 |   | 8.2 |   |
| Total Deposits                       |   | $                           | 77,838  |   | 49.0 | % | $ | 65,992 |   | 45.4 | % | $ | 60,557 |   | 44.9 | % |
|                                 |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Certificates:                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |
|                                 |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| 0.00 - 4.00%                         |   | $                           | 54,196  |   | 34.1 |   | $ | 1,193 |   | 0.8 |   | $ | 1,055 |   | 0.8 |   |
| 4.01 - 6.00%                         |   | 22,411                      |    | 14.1 |   | 34,938 |   | 24.0 |   | 61,018 |   | 45.2 |   |
| 6.01 - 8.00%                         |   | 4,429                       |    | 2.8 |   | 43,307 |   | 29.8 |   | 12,267 |   | 9.1 |   |
| Total Certificates                   |   | 81,036                      |    | 51.0 |   | 79,438 |   | 54.6 |   | 74,340 |   | 55.1 |   |
| Total Deposits                       |   | $                           | 158,874 |   | 100.0 | % | $ | 145,430 |   | 100.0 | % | $ | 134,897 |   | 100.0 | % |

 

The following table showsrate and maturity information for the Company’s certificates of deposit as ofMarch 31, 2002.

 

 
|                                             |   | **0.00 -********4.00%**     |   | **4.01 -********6.00%** |   | **6.01 -********8.00%** |   | **Total** |   | **Percent  of Total** |   |
|--------------------------------------------------|--------|-----------------------------|--------|-------------------------|--------|-------------------------|--------|-----------|--------|-----------------------|--------|
|                                             |   | **(Dollars  in Thousands)** |   |
| Certificate accounts maturing in quarter ending: |   |                        |   |                    |   |                    |   |      |   |                  |   |
|                                             |   |                        |   |                    |   |                    |   |      |   |                  |   |
| June 30, 2002                                    |   | $                           | 10,935 |                    | $      | 9,869                   |   | $         | 2,272  |                  | $      | 23,076 |   | 28.5 | % |
| September 30,  2002                              |   | 11,401                      |   | 5,256                   |   | 292                     |   | 16,949    |   | 20.9                  | %      |
| December 31,  2002                               |   | 7,602                       |   | 2,306                   |   | 825                     |   | 10,733    |   | 13.2                  | %      |
| March 31, 2003                                   |   | 9,838                       |   | 2,280                   |   | 237                     |   | 12,355    |   | 15.2                  | %      |
| June 30, 2003                                    |   | 4,845                       |   | 877                     |   | 13                      |   | 5,735     |   | 7.1                   | %      |
| September 30,  2003                              |   | 6,587                       |   | 512                     |   | 79                      |   | 7,178     |   | 8.9                   | %      |
| December 31,  2003                               |   | 540                         |   | 199                     |   | 23                      |   | 762       |   | 0.9                   | %      |
| March 31, 2004                                   |   | 1,761                       |   | 53                      |   | 100                     |   | 1,914     |   | 2.4                   | %      |
| June 30, 2004                                    |   | 153                         |   | 52                      |   | —                  |   | 205       |   | 0.3                   | %      |
| September 30,  2004                              |   | 98                          |   | 138                     |   | —                  |   | 236       |   | 0.3                   | %      |
| December 31,  2004                               |   | 161                         |   | 49                      |   | —                  |   | 210       |   | 0.3                   | %      |
| March 31, 2005                                   |   | 115                         |   | 120                     |   | 275                     |   | 510       |   | 0.6                   | %      |
| Thereafter                                       |   | 160                         |   | 700                     |   | 313                     |   | 1,173     |   | 1.4                   | %      |
| Total                                            |   | $                           | 54,196 |                    | $      | 22,411                  |   | $         | 4,429  |                  | $      | 81,036 |   | 100.0 | % |
|                                             |   |                        |   |                    |   |                    |   |      |   |                  |   |
| Percent of total                                 |   | 66.8                        | %      | 27.7                    | %      | 5.5                     | %      | 100.0     | %      |                  |   |

 

19

----

 

The following tableindicates the amount of the certificates of deposit and other deposits by timeremaining until maturity as of March 31, 2002.

 
|                                         |   | **Maturity**          |   |
|----------------------------------------------|--------|-----------------------|--------|
|                                         |   | **3 Months  or Less** |   | **Over  3 to 6  Months** |   | **Over********6 to 12  Months** |   | **Over  12  months** |   | **Total** |   |
|                                         |   | **(In Thousands)**    |   |
| Certificates of deposit  less than $100,000  |   | $                     | 13,975 |   | $ | 11,355 |   | $ | 16,503 |   | $ | 12,310 |   | $ | 54,143 |   |
| Certificates of deposit  of $100,000 or more |   | 7,543                 |   | 3,933 |   | 6,108 |   | 5,208 |   | 22,792 |   |
| Public funds                                 |   | 1,558                 |   | 1,661 |   | 477 |   | 405 |   | 4,101 |   |
| Total certificates of  deposit               |   | $                     | 23,076 |   | $ | 16,949 |   | $ | 23,088 |   | $ | 17,923 |   | $ | 81,036 |   |

 

For additional informationregarding thecomposition of the Company’s deposits, see Note 7 of the Notes to the ConsolidatedFinancial Statements.

 

***Borrowings.***  Other available sources offunds include advances from the FHLB of Cincinnati and other borrowings.  As a member of the FHLB of Cincinnati,Classic Bank is required to own capital stock in the FHLB of Cincinnati and isauthorized to apply for advances from the FHLB of Cincinnati.  Each FHLB credit program has its owninterest rate, which may be fixed or variable, and range of maturities.  The FHLB of Cincinnati may prescribe theacceptable uses for these advances, as well as limitations on the size of theadvances and repayment provisions.

 

FHLB borrowings are alsoused to fund loan demand and other investment opportunities, to offset depositoutflows and achieve the Company’s asset/liability management objectives.  The Company also has utilized borrowingswhen their cost is more favorable than that of deposits.  At March 31, 2002,the Company had $27.4 million of FHLB advances outstanding.  See Note 8 of the Notes to the ConsolidatedFinancial Statements.

 

The following table setsforth the maximum month-end balance and average balance of the Company’sborrowings for the periods indicated.

 
|                            |   | **Year Ended March 31,** |   |
|---------------------------------|--------|--------------------------|--------|
|                            |   | **2002**                 |   | **2001** |   | **2000** |   |
|                            |   | **(In Thousands)**       |   |
| Maximum Balance:                |   |                     |   |   |   |   |   |
| Repurchase agreements           |   | $                        | 5,873  |   | $ | 3,690 |   | $ | 4,251 |   |
| Federal funds purchased         |   | —                   |   | 18 |   | 749 |   |
| Other Borrowings                |   |                     |   |   |   |   |   |
| Treasury tax and loan  note     |   | 467                      |   | 927 |   | 897 |   |
| Notes payable                   |   | —                   |   | 257 |   | 536 |   |
| FHLB advances                   |   | $                        | 27,401 |   | $ | 21,894 |   | $ | 17,075 |   |
|                            |   |                     |   |   |   |   |   |
| Average Balance:                |   |                     |   |   |   |   |   |
| Repurchase agreements           |   | 4,553                    |   | 3,028 |   | 2,989 |   |
| Federal funds purchased         |   | —                   |   | 2 |   | 263 |   |
| Other Borrowings                |   |                     |   |   |   |   |   |
| Treasury tax and loan  note     |   | 317                      |   | 451 |   | 468 |   |
| Notes payable                   |   | —                   |   | 60 |   | 210 |   |
| FHLB advances                   |   | 19,753                   |   | 19,124 |   | 8,930 |   |
|                            |   |                     |   |   |   |   |   |
| Weighted average  interest rate |   | 3.4                      | %      | 6.2 | % | 4.9 | % |

 

20

----

 

The following table setsforth certain information as to the Company’s borrowings at the datesindicated.

 
|                                                                                  |   | **March 31,**               |   |
|---------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                  |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                                                                  |   | **(Dollars in  Thousands)** |   |
| Repurchase  agreements                                                                |   | $                           | 5,396  |   | $ | 3,180 |   | $ | 2,652 |   |
| Federal funds  purchased                                                              |   | —                      |   | — |   | 36 |   |
| Other Borrowings                                                                      |   |                        |   |   |   |   |   |
| Treasury tax and  loan note                                                           |   | 446                         |   | 234 |   | 574 |   |
| FHLB advances                                                                         |   | $                           | 27,401 |   | $ | 16,636 |   | $ | 17,075 |   |
| Total Borrowings                                                                      |   | $                           | 33,243 |   | $ | 20,050 |   | $ | 20,337 |   |
|                                                                                  |   |                        |   |   |   |   |   |
| Weighted average  interest rate of repurchase agreements  and federal funds purchased |   | 1.7                         | %      | 4.2 | % | 5.7 | % |
|                                                                                  |   |                        |   |   |   |   |   |
| Weighted average  interest rate ofother borrowings                                    |   | 3.5                         | %      | 5.5 | % | 6.3 | % |

 

21

----

 

**TrustServices**

 

The Company has trust powerswith its state charter but has chosen to limit its scope to a small group ofcustomers.   Limited services providedinclude managing and investing trust assets, disbursing funds as required bytrust agreements and arranging for maintenance at two local cemeteries.  For fiscal year 2002, gross trust fees wereless then $1,000.

 

**Competition**

 

The Company facesstrong competition from large regional and national banks, as well as localinstitutions in originating loans and attracting deposits.  Competition in originating loans comesprimarily from commercial banks (national, regional and local), savingsinstitutions, credit unions and mortgage bankers which also makes loans toborrowers located in the Company’s primary market area.  At March 31, 2002, there were sixteencommercial banks and savings institutions and five credit unions  located in Boyd, Johnson, Carter and GreenupCounties, Kentucky.  The Companycompetes for loans principally on the basis of the interest rates and loan feesit charges, the types of loans it originates and the quality of services itprovides to borrowers.

 

Competition for depositscomes principally from commercial banks, savings institutions, credit unions,mutual funds and securities firms located in the same communities.  The ability of the Company to attract andretain deposits depends on its ability to provide an investment opportunitythat satisfies the requirements of investors as to the rate of return,liquidity, risk, convenient locations, investment products, convenient businesshours and a customer oriented staff.  AtJune 30, 2001, the Company’s share of deposits in the above market area wasapproximately 8.8%.  This is based onthe most recent information available from the Federal Deposit InsuranceCorporation.

 

**Employees**

 

At March 31, 2002, theCompany and its subsidiary had a total of 79 full-time employees.  None of the Company’s employees arerepresented by any collective bargaining agreement.  Management considers its employee relations to be good.

 

22

----

 

**REGULATION**

 

**General**

 

Classic Bank is a Kentuckychartered commercial bank that converted from a federally chartered savingsassociation in June 2000.  The depositsof Classic Bank are insured by the FDIC. Accordingly, Classic Bank is subject to broad state and federalregulation and oversight extending to all its operations.  Classic Bank is a member of the FHLB ofCincinnati and is subject to certain limited regulation by the Federal ReserveBoard. In March 2001, Paintsville Bank, a national bank subsidiary of theCompany, merged into Classic Bank.

 

Certain of these regulatoryrequirements and restrictions are discussed below or elsewhere in thisdocument.

 

**State andFederal Regulation of Classic Bank**

 

As a Kentucky charteredbank, Classic Bank is subject to the regulation and supervision of the KentuckyDepartment of Financial Institutions (“DFI”). The FDIC also has regulatory and examination authority over Classic Bankas its federal regulator.  As part ofthis authority, Classic Bank is required to file periodic reports with the DFIand the FDIC and is subject to periodic examinations by the DFI and the FDIC.  When these examinations are conducted by theDFI and the FDIC, the examiners may require Classic Bank to provide for highergeneral or specific loan loss reserves.

 

The DFI and the FDIC alsohave extensive enforcement authority over their regulated institutions,including Classic Bank.  This enforcementauthority includes, among other things, the ability to assess civil moneypenalties, to issue cease-and-desist or removal orders and to initiateinjunctive actions.  In general, theseenforcement actions may be initiated for violations of laws and regulations andunsafe or unsound practices.  Otheractions or inactions may provide the basis for enforcement action, includingmisleading or untimely reports filed with the FDIC.  Except under certain circumstances, public disclosure of finalenforcement actions by the FDIC is required.

 

In addition, the investment,lending and branching authority of Classic Bank is prescribed by state andfederal laws and it is prohibited from engaging in any activities not permittedby such laws.  Under federal law, astate bank may not make any equity investment not permitted for a national bankand may only engage in activities not permitted for a national bank if itreceives prior FDIC approval.  ClassicBank is in compliance with the noted restrictions.  Within the Commonwealth of Kentucky, Classic Bank has the expressauthority to branch without regard to geographic limitations.  See “—Interstate Banking and Branching” forrestrictions applicable to interstate branching by Classic Bank.

 

Classic Bank’s generalpermissible lending limits for loans to one borrower is equal to 20% of capitalstock and surplus (except for loans fully secured by certain collateral, inwhich case the limit is increased to 30% of capital stock and surplus).  At March 31, 2002, Classic Bank’s lendinglimit was $2.7 million and Classic Bank was in compliance with theloans-to-one-borrower limitation.

 

The FDIC, as well as otherfederal banking agencies, has adopted guidelines establishing safety andsoundness standards on such matters as loan underwriting and documentation,internal controls and audit systems, interest rate risk exposure andcompensation and other employee benefits. Any institution which fails to comply with these standards must submit acompliance plan.  A failure to submit aplan or

 

23

----

 

to comply with an approved plan will subjectthe institution to further enforcement action.

 

**Insuranceof Accounts and Regulation by the FDIC**

 

Its deposits are insured upto applicable limits by the FDIC and such insurance is backed by the full faithand credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums and isauthorized to conduct examinations of and to require reporting by FDIC-insuredinstitutions. including Classic Bank. It also may prohibit any FDIC-insured institution from engaging in anyactivity the FDIC determines by regulation or order to pose a serious risk tothe Savings Account Insurance Fund or the Bank Insurance Fund.  The FDIC also has the authority to initiateenforcement actions against FDIC insured banks, and may terminate aninstitution’s deposit insurance if it determines that the institution hasengaged in unsafe or unsound practices or is in an unsafe or unsound condition.

 

The FDIC’s deposit insurancepremiums are assessed through a risk-based system under which all insureddepository institutions are placed into one of nine categories and assessedinsurance premiums based upon their level of capital and supervisoryevaluation.  Under the system,institutions classified as well capitalized (i.e., a core capital ratio of atleast 5%, a ratio of Tier 1 or core capital to risk-weighted assets (“Tier 1risk-based capital”) of at least 6% and a risk-based capital ratio of at least10%) and considered healthy pay the lowest premium while institutions that areless than adequately capitalized (i.e., core or Tier 1 risk-based capitalratios of less than 4% or a risk-based capital ratio of less than 8%) andconsidered of substantial supervisory concern pay the highest premium.  Risk classification of all insuredinstitutions is made by the FDIC for each semi-annual assessment period.

 

**RegulatoryCapital Requirements of State Banks**

 

Classic Bank is subject tothe capital regulations of the FDIC.  The FDIC’s regulations establish three capital standards for FDICsupervised state banks: a leverage requirement, a Tier 1 risk based capitalrequirement and a risk-based capital requirement.  In addition, the FDIC may, on a case-by-case basis, establish individualminimum capital requirements for a state bank that vary from the requirementswhich would otherwise apply under FDIC regulations.

 

The leverage ratio adoptedby the FDIC requires a minimum ratio of “Tier 1 capital” to adjusted totalassets of 3% for state banks rated composite 1 under the CAMELS rating systemfor banks.  Banks not rated composite 1under the CAMELS rating system for banks are required to maintain a minimumratio of Tier 1 capital to adjusted total assets of 4%.  For purposes of the FDIC’s leveragerequirement, Tier 1 capital generally consists of the common stockholder’sequity and retained income and non-cumulative preferred stock, except that nointangibles, other than certain purchased mortgage servicing rights, andpurchased credit card receivables may be included in capital.

 

At March 31, 2002,Classic Bank had Tier 1 capital equal to $14.6 million, or 7.1% of adjustedtotal assets, which is $6.4 million above the minimum leverage ratiorequirement of 4% as in effect on that date.

 

FDIC regulated banks arealso required to maintain a Tier 1 risk based capital ratio of at least4%.  This requirement is the ratio ofTier 1 capital to risk-weighted assets. At March 30, 2002, Classic Bank had a Tier 1 capital of $14.6 million or9.5% of risk weighted assets, which was $8.5 million above the minimum Tier 1risk based capital ratio of 4% on that date.

 

The FDIC’s risk-basedcapital requirements require state banks to maintain “total capital” equal toat least 8% of total risk-weighted assets. For purposes of the risk-based capital requirement, “total capital”means Tier 1 capital (as described above) plus “Tier 2 capital” (as describedbelow), provided that the amount of Tier 2 capital may not exceed the amount ofTier 1 capital, less certain assets. The

 

24

----

 

components of Tier 2 capital consists of corecapital, as defined above, and supplementary capital.  Supplementary capital consists of certain permanent and maturingcapital instruments that do not qualify as core capital and general valuationloan and lease loss allowances up to a maximum of 1.25% of risk-weightedassets.  Supplementary capital may beused to satisfy the risk-based requirement only to the extent of corecapital.  The FDIC is also authorized torequire a bank to maintain an additional amount of total capital to account forconcentration of credit risk and the risk of non-traditional activities.  At March 31, 2002, Classic Bank had nocapital instruments that qualify as supplementary capital and $1.6 million ofgeneral loss reserves, which was less than 1.25% of risk-weighted assets.  At March 31, 2002, Classic Bank was incompliance with its capital requirements. See “Management’s Discussion and Analysis of Financial Condition andResults of Operations - Liquidity and Capital Resources”, for additionalinformation regarding Classic Bank’s compliance with its capital requirements.

 

In determining the amount ofrisk-weighted assets, all assets, including certain off-balance sheet items,will be multiplied by a risk weight, ranging from 0% to 100%, based on the riskinherent in the type of asset.  Forexample, the FDIC has assigned a risk weight of 50% for prudently underwrittenpermanent one- to four-family first lien mortgage loans not more than 90 daysdelinquent and having a loan to value ratio of not more than 80% at originationunless insured to such ratio by an insurer approved by the FNMA or FHLMC.

 

On March 31, 2002,Classic Bank had total capital of $16.3 million (including $14.7 million incore capital and $1.6 million in qualifying supplementary capital) andrisk-weighted assets of $153.4 million or total capital of 10.6% ofrisk-weighted assets.   This amount was$4.0 million above the 8% requirement in effect on that date.

 

**PromptCorrective Action**

 

The FDIC is authorized and,under certain circumstances required, to take certain actions against banksthat fail to meet their capital requirements. The FDIC is generally required to take action to restrict the activitiesof an “undercapitalized bank” (generally defined to be one with less thaneither a 4% core capital ratio, a 4% Tier 1 risked–based capitalratio or an 8% risk-based capital ratio). Any such bank must submit a capital restoration plan and until such planis approved by the FDIC may not increase its assets, acquire anotherinstitution, establish a branch or engage in any new activities, and generallymay not make capital distributions.  TheFDIC is authorized to impose the additional restrictions that are applicable tosignificantly undercapitalized bank.

 

As a condition to theapproval of the capital restoration plan, any company controlling anundercapitalized bank must agree that it will enter into a limited capitalmaintenance guarantee with respect to the institution’s achievement of itscapital requirements.

 

Any bank that fails tocomply with its capital plan or is “significantly undercapitalized” (*i.e.*, Tier 1 risk-based or corecapital ratios of less than 3% or a risk-based capital ratio of less than 6%)must be made subject to one or more of additional specified actions andoperating restrictions which may cover all aspects of its operations andinclude a forced merger or acquisition of the bank.  A bank that becomes “critically undercapitalized” (*i.e.*, a tangible capital ratio of 2% orless) is subject to further mandatory restrictions on its activities inaddition to those applicable to significantly undercapitalized banks.  In addition, the FDIC must appoint areceiver (or conservator with the concurrence of the FDIC) for a bank, withcertain limited exceptions, within 90 days after it becomes criticallyundercapitalized.  Any undercapitalizedbank is also subject to the general enforcement authority of the FDIC,including the appointment of a conservator or a receiver.

 

The FDIC is also generallyauthorized to reclassify a bank into a lower capital category and

 

25

----

 

impose the restrictions applicable to suchcategory if the institution is engaged in unsafe or unsound practices or is inan unsafe or unsound condition.

 

The imposition by the FDICof any of these measures on Classic Bank would likely have a substantialadverse effect on Classic Bank’s operations and profitability and the value ofthe Company’s common stock.  TheCompany’s shareholders do not have preemptive rights, and therefore, if theCompany is directed by the FDIC to issue additional shares of common stock,such issuance may result in the dilution in the percentage of ownership ofcurrent stockholders of the Company.

 

**Limitationson Dividends and Other Capital Distributions**

 

Kentucky banks are generallypermitted to pay dividends in any calendar year equal to net income for thatyear plus retained earnings for the preceding two years.  Dividends in excess of such amount requireprior approval by the DFI.

 

**CommunityReinvestment Act**

 

Under the CommunityReinvestment Act (“CRA”), every FDIC insured institution, including ClassicBank, has a continuing and affirmative obligation consistent with safe andsound banking practices to help meet the credit needs of its entire community,including low- and moderate-income neighborhoods.  The CRA does not establish specific lending requirements or programsfor financial institutions nor does it limit an institution’s discretion todevelop the types of products and services that it believes are best suited toits particular community, consistent with the CRA.  The CRA requires the appropriate Federal regulator, in connectionwith the examination of an insured institution, to assess the institution’srecord of meeting the credit needs of its community and to take such recordinto account in its evaluation of certain applications, such as a merger or theestablishment of a branch, by Classic Bank. An unsatisfactory rating may be used as the basis for the denial of anapplication by the FDIC.

 

Classic Bank was examinedfor CRA compliance in July 1999 and received a satisfactory rating.

 

**Transactionswith Affiliates**

 

Generally, transactionsbetween a bank or its subsidiaries and its affiliates are required to be onterms as favorable to the bank as transactions with non-affiliates.  In addition, certain of these transactions,such as loans to an affiliate, are restricted to a percentage of the bank’scapital.  Affiliates of Classic Bankinclude the Company and any other company which is under common control withClassic Bank.  The  Federal Reserve Board has the discretion totreat a subsidiary of a bank as an affiliate on a case-by-case basis.

 

Certain transactions withdirectors, officers or controlling persons are also subject to conflict ofinterest regulations enforced by the FDIC. These conflict of interest regulations and other statutes also imposerestrictions on loans to such persons and their related interests.  Among other things, such loans must be madeon terms substantially the same as for loans to unaffiliated individuals.

 

**RecentLegislation**

 

On November 12, 1999, theGramm-Leach-Bliley Act, which modernized the financial services industry by,among other things, permitting banking, insurance and securities companies tocombine, was signed into law.  It isunclear what impact this legislation will have on the Company, although theanticipated creation of larger and stronger financial services competitorscould materially affect the Company.

 

26

----

 

**HoldingCompany Regulation**

 

***General.***  The Company is a holding company that elected to be treated as afinancial holding company by the Federal Reserve Board.  Financial holding companies are subject tocomprehensive regulation by the Federal Reserve Board under the Bank HoldingCompany Act, and the regulations of the Federal Reserve Board.  As a financial holding company, the Companyis required to file reports with the Federal Reserve Board and such additionalinformation as the Federal Reserve Board may require, and is subject to regularexaminations by the Federal Reserve Board. The Federal Reserve Board also hasextensive enforcement authority over financial holding companies, including,among other things, the ability to assess civil money penalties, to issue ceaseand desist or removal orders and to require that a holding company divestsubsidiaries (including its bank subsidiaries).  In general, enforcement actions may be initiated for violationsof law and regulations and unsafe or unsound practices.

 

Under Federal Reserve Boardpolicy, a financial holding company must serve as a source of strength for itssubsidiary banks.  Under this policy theFederal Reserve Board may require, and has required in the past, a holdingcompany to contribute additional capital to an undercapitalized subsidiarybank.

 

Under the Bank HoldingCompany Act, a financial holding company must obtain Federal Reserve Boardapproval before: (i) acquiring, directly or indirectly, ownership orcontrol of any voting shares of another bank or bank holding company if, aftersuch acquisition, it would own or control more than 5% of such shares (unlessit already owns or controls the majority of such shares); (ii) acquiringall or substantially all of the assets of another bank or bank holding company;or (iii) merging or consolidating with another bank holding company.

 

The Bank Holding Company Actalso prohibits a financial holding company, with certain exceptions, fromacquiring direct or indirect ownership or control of more than 5% of the votingshares of any company which is not a bank or bank holding company, or fromengaging directly or indirectly in activities other than those involvingbanking, securities, insurance or merchant banking.  The Company has no present plans to engage in any of the expandedactivities permissible for a financial holding company.

 

***Interstate Banking and Branching*****.**  Under Federal law, the FederalReserve Board is authorized to approve an application of an adequatelycapitalized and adequately managed bank holding company to acquire control of,or acquire all or substantially all of the assets of, a bank located in a stateother than such holding company’s home state, without regard to whether thetransaction is prohibited by the laws of any state.  The Federal Reserve Board may not approve the acquisition of abank that has not been in existence for the minimum time period (not exceedingfive years) specified by the statutory law of the host state.  Federal law also prohibits the FederalReserve Board from approving an application if the applicant (and itsdepository institution affiliates) controls or would control more than 10% ofthe insured deposits in the United States or 30% or more of the deposits in thetarget bank’s home state or in any state in which the target bank maintains abranch.  This provision does not affectthe authority of states to further limit the percentage of total insured depositsin the state which may be held or controlled by a bank or bank holding companyto the extent such limitation does not discriminate against out-of-state banksor bank holding companies.  Individualstates may also waive the 30% state-wide concentration limit.  The Commonwealth of Kentucky currentlyprovides for deposit concentration limits and reciprocal requirements.

 

27

----

 

The Federal banking agenciesare also authorized to approve interstate merger transactions without regard towhether such transaction is prohibited by the law of any state, unless the homestate of one of the banks has, prior to June 1, 1997, enacted legislation thatexpressly prohibits merger transactions involving out-of-state banks.  Interstate acquisitions of branches arepermitted only if the law of the state in which the branch is located permitssuch acquisitions. Interstate mergers and branch acquisitions are also subjectto the nationwide and statewide insured deposit concentration amounts describedabove.

 

The Act authorizesinterstate branching de novo by national and state banks, only in states whichspecifically allow for such branching.

 

***Dividends*****.**  The Federal Reserve Board hasissued a policy statement on the payment of cash dividends by bank holdingcompanies, which expresses the Federal Reserve Board’s view that a bank holdingcompany should pay cash dividends only to the extent that the Company’s netincome for the past year is sufficient to cover both the cash dividends and arate of earning retention that is consistent with the Company’s capital needs,asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriatefor a company experiencing serious financial problems to borrow funds to paydividends.  Furthermore, under theprompt corrective action regulations adopted by the Federal Reserve Board, theFederal Reserve Board may prohibit a bank holding company from paying anydividends if the holding company’s bank subsidiary is classified as“undercapitalized”.  See “— PromptCorrective Action.”

 

Bank holding companies arerequired to give the Federal Reserve Board prior written notice of any purchaseor redemption of its outstanding equity securities if the gross considerationfor the purchase or redemption, when combined with the net consideration paidfor all such purchases or redemptions during the preceding 12 months, is equalto 10% or more of their consolidated net worth.  The Federal Reserve Board may disapprove such a purchase orredemption if it determines that the proposal would constitute an unsafe orunsound practice or would violate any law, regulation, Federal Reserve Boardorder, or any condition imposed by, or written agreement with, the Federal ReserveBoard. This notification requirement does not apply to any company that meetsthe well-capitalized standard for commercial banks, has a safety and soundnessexamination rating of at least a “2” and is not subject to any unresolvedsupervisory issues.

 

***Capital Requirements*****.**  The Federal Reserve Board hasestablished capital requirements for certain bank and financial holdingcompanies that generally parallel the capital requirements for FDIC insuredbanks.  On March 31, 2002, the Companyhad Tier 1 capital of $16.7 million or 8.0% of average total assets of $208.2million, which was $8.4 million above the 4% requirement of $8.3 million onthat date.  In addition, on that datethe Company had a Tier 1 capital ratio of 10.9%, which was $10.5 million abovethe 4% requirement of $6.2 million, total capital of $18.3 million (including$16.7 million in core capital and $1.6 million in qualifying supplementalcapital) and risk-weighted assets of $154.0 million or total capital of 11.9%of risk weighted assets.  This amountwas $6.0 million above the 8% requirement in effect on that date.

 

**FederalSecurities Law**

 

The Company’s common stockis registered with the SEC under the Securities Exchange Act of 1934, asamended (the “Exchange Act”).  TheCompany is subject to the information, proxy solicitation, insider tradingrestrictions and other requirements of the SEC’s rules under the Exchange Act.

 

Company stock held bypersons who are affiliates (generally officers, directors and principal

 

28

----

 

stockholders) of the Company may not beresold without registration or unless sold in accordance with certain resalerestrictions.  If the Company meetsspecified current public information requirements, each affiliate of the Companyis able to sell in the public market, without registration, a limited number ofshares in any three-month period.

 

29

----

 

**FederalReserve System**

 

The Federal Reserve Boardrequires all depository institutions to maintain noninterest–bearingreserves at specified levels against their transaction accounts (primarilychecking, NOW and Super NOW checking accounts).  At March 31, 2002, Classic Bank was in compliance with thesereserve requirements.

 

**Federal HomeLoan Bank System**

 

Classic Bank is a member ofthe FHLB of Cincinnati, which is one of 12 regional FHLBs that administer thehome financing credit function of banks and savings associations.  Each FHLB serves as a reserve or central bankfor its members within its assigned region. It is funded primarily from proceeds derived from the sale ofconsolidated obligations of the FHLB System. It makes loans to members (*i.e.*,advances) in accordance with policies and procedures, established by the boardof directors of the FHLB, which are subject to the oversight of the FederalHousing Finance Board.  All advancesfrom the FHLB are required to be fully secured by sufficient collateral asdetermined by the FHLB.  In addition,all long-term advances are required to provide funds for residential homefinancing.

 

As a member, Classic Bank isrequired to purchase and maintain stock in the FHLB of Cincinnati.  At March 31, 2002, Classic Bank had$1.5 million in FHLB stock, which was in compliance with this requirement.  In past years, Classic Bank has receivedsubstantial dividends on their FHLB stock. Over the past five fiscal years, such dividends paid to Classic Bankhave averaged 6.9% and were 6.1% for fiscal 2002.

 

Under federal law, the FHLBsare required to provide funds for the resolution of troubled savingsassociations and to contribute to low- and moderately priced housing programsthrough direct loans or interest subsidies on advances targeted for communityinvestment and low- and moderate-income housing projects.  These contributions have affected adverselythe level of FHLB dividends paid and could continue to do so in thefuture.  These contributions could alsohave an adverse effect on the value of FHLB stock in the future.  A reduction in value of Classic Bank’s FHLBstock may result in a corresponding reduction in Classic Bank’s capital.

 

**Change inControl Regulations**

 

The Change in Bank ControlAct, the Bank Holding Company Act and the regulations of the Federal ReserveBoard promulgated under those acts, require that the consent of the FederalReserve Board be obtained prior to any person or company acquiring “control” ofa financial holding company.  Control isconclusively presumed to exist if an individual or company acquires more than25% of any class of voting stock of a financial holding company.  Control is rebuttably presumed to exist ifthe person acquires 10% or more of any class of voting stock of a financialholding company if either (i) the financial holding company has registeredsecurities under Section 12 of the Exchange Act or (ii) no other person willown a greater percentage of that class of voting securities immediately afterthe transaction.  The regulationsprovide a procedure to rebut the rebuttable control presumption.  Since the Company’s Common Stock isregistered under Section 12 of the Exchange Act, any acquisition of 10% or moreof the Company’s Common Stock will give rise to a rebuttable presumption thatthe acquiror of such stock controls the Company, requiring the acquiror, priorto acquiring such stock, to rebut the presumption of control to thesatisfaction of the Federal Reserve Board or obtain Federal Reserve Boardapproval for the acquisition of control.

 

30

----

 

**Federal andState Taxation**

 

***Federal Taxation.*** In addition tothe regular income tax, corporations, including state chartered commercialbanks, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% onalternative minimum taxable income, which is the sum of a corporation’s regulartaxable income (with certain adjustments) and tax preference items, less anyavailable exemption.  The alternativeminimum tax is imposed to the extent it exceeds the corporation’s regular incometax and net operating losses can offset no more than 90% of alternative minimumtaxable income.

 

The Company and itssubsidiaries file consolidated federal income tax returns on a fiscal yearbasis using the accrual method of accounting.

 

The Company and itsconsolidated subsidiaries have been audited by the IRS with respect toconsolidated federal income tax returns through December 31, 1993.  With respect to years examined by the IRS,either all deficiencies have been satisfied or sufficient reserves have beenestablished to satisfy asserted deficiencies. In the opinion of management, any examination of still open returns(including returns of subsidiary and predecessors of, or entities merged intothe Company) would not result in a deficiency which could have a materialadverse effect on the financial condition or results of operations of theCompany and its consolidated subsidiaries.

 

***Kentucky Taxation*****.**  Classic Bank is subject to astate franchise tax equal to 1.1% of Classic Bank’s average five year equitycapital adjusted to eliminate the effect of certain U.S. Government obligationsheld by Classic Bank.  The Company issubject to Kentucky income tax at a rate of 4% - 8.25% and a Kentucky corporatelicensing fee equal to .0021 times capital employed.

 

***Delaware Taxation.***  As a Delaware holding company, the Companyis exempt from Delaware corporate income tax but is required to file an annualreport with and pay an annual fee to the State of Delaware.  The Company is also subject to an annualfranchise tax imposed by the State of Delaware.

 

**ExecutiveOfficers Who Are Not Directors**

 

The business experience ofthe executive officers who are not also directors is set forth below.

 

***Robert S. Curtis***, age 53, isPresident and Director of Classic Bank, a position he has held since March2001.   Prior to becoming President, Mr.Curtis was Executive Vice President and Senior Lending Officer.  Mr. Curtis is also Senior Vice President ofthe Company, a position he has held since September 1995.  Prior to joining Classic Bank in May 1995,Mr. Curtis served as Vice President and Real Estate Lending Division Manager ofFirst American Bank, a $225 million bank located in Ashland, Kentucky from 1990until May 1995.  As Vice President andReal Estate Lending Division Manager, Mr. Curtis was responsible for the bank’sresidential real estate portfolio that totaled in excess of $35.0 million.  Mr. Curtis began his career with FirstAmerican Bank in 1973.

 

**Item 2.    Description of Properties**

 

The Company conductsbusiness at its main office located in Ashland, Kentucky.  The following table sets forth informationrelating to each of our properties as of March 31, 2002.

 

31

----

 
| **Location**                                 |   | **Year  Acquired** |   | **Owned  or  Leased** |   | **Total  Approximate  Square  Footage** |   | **Book Value at  March 31, 2002** |   |
|----------------------------------------------|--------|--------------------|--------|-----------------------|--------|-----------------------------------------|--------|-----------------------------------|--------|
|                                         |   |               |   |                  |   |                                    |   | **(Dollars in Thousands)**        |   |
| **Main Office:**                             |   |               |   |                  |   |                                    |   |                              |   |
| 1737 Carter Avenue  Ashland, Kentucky        |   | 1994               |   | Owned                 |   | 1,200                                   |   | 78                                |   |
|                                         |   |               |   |                  |   |                                    |   |                              |   |
| 344 Seventeenth StreetAshland, Kentucky      |   | 1963               |   | Owned                 |   | 6,000                                   |   | 411                               |   |
| 340 Seventeenth Street  Ashland, Kentucky    |   | N/A                |   | Leased                |   | 9,400                                   |   | N/A                               |   |
| **Branch Offices**:                          |   |               |   |                  |   |                                    |   |                              |   |
| 1500 Diederich Blvd.Russell, Kentucky        |   | 1998               |   | Owned                 |   | 2,000                                   |   | 449                               |   |
| 10700 U.S. 60  Ashland, Kentucky             |   | 1998               |   | Owned                 |   | 2,000                                   |   | 440                               |   |
| 575 N. Carol Malone Blvd.  Grayson, Kentucky |   | 1999               |   | Owned                 |   | 7,000                                   |   | 471                               |   |
| 240 Main Street  Paintsville, Kentucky       |   | 1959               |   | Owned                 |   | 11,000                                  |   | 89                                |   |
| 603 South Mayo Trail  Paintsville, Kentucky  |   | 1971               |   | Owned                 |   | 2,200                                   |   | 37                                |   |
| 440 North Mayo TrailPaintsville, Kentucky    |   | 2001               |   | Owned                 |   | 2,000                                   |   | 524                               |   |

 

We also purchased land at1414 Ashland Road, Greenup, Kentucky on April 4, 2002 for $282,000 to build abranch office.  We believe that ourcurrent facilities are adequate to meet our present and foreseeable needs,subject to possible future expansion.

 

The Company’s depositor andborrower customer files are maintained in-house using our current dataprocessing and computer equipment.  Thenet book value of the data processing and computer equipment utilized by theCompany at March 31, 2002 was approximately $184,000.

 

32

----

 

**Item 3.    Legal Proceedings**

 

The Company, Classic Bank isinvolved, from time to time, as plaintiff or defendant in various legal actionsarising in the normal course of its businesses.  While the ultimate outcome of these proceedings cannot bepredicted with certainty, it is the opinion of management, after consultationwith counsel, that the resolution of these proceedings should not have amaterial effect on the Company’s financial condition or results of operationson a consolidated basis.

 

**Item 4.    Submission of Matters to a Vote of SecurityHolders**

 

No matter was submitted to avote of security holders, through the solicitation of proxies or otherwise,during the quarter ended March 31, 2002.

 

**PART II**

 

**Item 5.    Market for Common Equity and RelatedStockholder Matters**

 

Pages 51 to 52 of theCompany’s Annual Report filed herewith is incorporated by reference herein.

 

**Item 6.    Management’s Discussion and Analysis ofFinancial Condition and Results of Operation**

 

Pages 1 to 13 of theCompany’s Annual Report filed herewith is incorporated by reference herein.

 

**Item 7.    Financial Statements and Supplementary Data**

 

The following informationappearing in the Company’s Annual Report filed herewith is incorporated hereinby reference.

 
| **Annual  Report Section**                                                                                 |   | **Pages in  Annual Report** |
|------------------------------------------------------------------------------------------------------------|--------|-----------------------------|
| Report of Independent Certified Public Accountants                                                         | 14     |
| Consolidated Balance Sheets (March 31, 2002 and 2001)                                                      | 15     |
| Consolidated Statements of  Earnings (For the Years Ended March 31, 2002,  2001 and 2000)                  | 16     |
| Consolidated Statements of  Stockholders’ Equity (For the Years Ended  March 31, 2002, 2001 and 2000) | 18     |
| Consolidated Cash Flow  Statements For the Years Ended March 31, 2002,  2001 and 2000)                     | 19     |
| Notes to Consolidated Financial Statements                                                                 | 21     |

 

With the exception of theaforementioned information in Part II of the Form 10-KSB, the Annual Report isnot deemed filed as part of this annual report on Form 10-KSB.

 

33

----

 

**Item 8.****                            ****Changes In and Disagreements With Accountants on Accounting and FinancialDisclosure**

 

Therehas been no changes in the Company’s independent accountants during theCompany’s two most recent fiscal years.

 

**PART III**

 

**Item 9.****                            ****Directors, Executive Officers, Promoters and Control Persons; Compliancewith Section 16(a) of the Exchange Act**

 

**Directors**

 

Information concerningdirectors of the Company is incorporated herein by reference from the Company’sdefinitive Proxy Statement for the Annual Meeting of Stockholders to be held in2002, which will be filed with the SEC.

 

**ExecutiveOfficers**

 

Information concerning theexecutive officers of the Company who are not directors is incorporated byreference from Part I of this Form 10-KSB under the caption “Executive Officersof the Registrant Who Are Not Directors.”

 

**Section16(a) Beneficial Ownership Reporting Compliance**

 

Information concerningcompliance with Section 16(a) reporting requirements by the Company’s directorsand executive officers is incorporated herein by reference from the Company’sdefinitive proxy statement for the Annual Meeting of Stockholders to be held in2002, which will be filed with the SEC.

 

**Item 10. Executive Compensation**

 

Information concerningexecutive compensation is incorporated herein by reference from the definitiveProxy Statement for the Annual Meeting of Stockholders to be held in 2002,which will be filed with the SEC.

 

34

----

 

**Item 11. Security Ownership of Certain Beneficial Ownersand Management**

 

Information concerningsecurity ownership of certain beneficial owners and management is incorporatedherein by reference from the definitive Proxy Statement for the Annual Meetingof Stockholders to be held in 2002, which will be filed with the SEC.

 

The following table setsforth information with respect to securities to be issued under the Company’sequity compensation plans as of March 31, 2002.

 

**Equity Compensation Plan Information**

 
|                                                        |   | **(a)**                                                                                           |   | **(b)**                                                                          |   | **(c)**                                                                                                                                           |
|-------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
| **Plan  Category**                                          |   | **Number of  securities to be issued upon exercise of outstanding options, warrants and  rights** |   | **Weighted-average  exercise price of outstanding options, warrants and rights** |   | **Number of  securities remaining available for future issuance under equity compensation  plans (excluding securities reflected in column (a))** |
| Equity compensation plans approved by security  holders:    |   |                                                                                              |   |                                                                             |   |                                                                                                                                              |
|                                                        |   |                                                                                              |   |                                                                             |   |                                                                                                                                              |
| 1.  1996  Recognition and Retention Plan               |   | 1.  1,390  (Awarded but unvested)                                                            |   | 1.  N/A                                                                     |   | 1.  114                                                                                                                                      |
| 2.  1996  Stock Option and Incentive Plan              |   | 2.  131,950(1)                                                                               |   | 2.  $11.29                                                                  |   | 2.  300                                                                                                                                      |
| 3.  1998 Premium Price Stock OptionGrowth Plan         |   | 3.  48,400(1)                                                                                |   | 3.  $12.88                                                                  |   | 3.  1,100                                                                                                                                    |
| 4.  2001 Premium Price Stock OptionGrowth Plan         |   | 4.  —(2)                                                                                |   | 4.  —                                                                  |   | 4.  50,000                                                                                                                                   |
| Equity compensation plans not approved by security  holders |   |                                                                                              |   |                                                                             |   |                                                                                                                                              |
|                                                        |   | N/A                                                                                               |   | N/A                                                                              |   | N/A                                                                                                                                               |
| Total                                                       |   | 180,489(1)                                                                                        |   | N/A                                                                              |   | 51,514                                                                                                                                            |

 

----

(1)  Includes issued but unvested options

(2)  Does not include options on 7,000 shares issued on May 20, 2002.

 

**Item 12.****                     ****Certain Relationships and Related Transactions**

 

Information concerningcertain relationships and related transactions is incorporated herein byreference from the definitive Proxy Statement for the Annual Meeting ofStockholders to be held in 2002, which will be filed with the SEC.

 

35

----

 

**Item 13.****                     ****Exhibits and Reports on Form 8-K**

 

**(a)  Exhibits**

 

| **Regulation  S-B  Exhibit  Number** |   | **Document**                                                                 |   | **Reference to  Prior Filing or  Exhibit Number********Attached  Hereto** |
|--------------------------------------|--------|------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|
|                                 |   |                                                                         |   |                                                                      |
| 2                                    |   | Plan of acquisition, reorganization, arrangement,  liquidation or succession |   | None                                                                      |
| 3(a)                                 |   | Articles of Incorporation                                                    |   | *                                                                         |
| 3(b)                                 |   | By-Laws                                                                      |   | *                                                                         |
| 4                                    |   | Instruments defining the rights of security holders,  including debentures   |   | *                                                                         |
| 9                                    |   | Voting Trust Agreement                                                       |   | None                                                                      |
| 10                                   |   | Material contracts:                                                          |   |                                                                      |
|                                 |   |                                                                         |   |                                                                      |
|                                 |   | 1996 Stock  Option and Incentive Plan                                        |   | **                                                                        |
|                                 |   | 1996 Recognition  and Retention Plan                                         |   | **                                                                        |
|                                 |   | 1998 Premium  Price Stock Option Growth Plan                                 |   | ***                                                                       |
|                                 |   | 2001 Premium  Price Stock Option Growth Plan                                 |   | ******                                                                    |
|                                 |   | Employment  Agreement with David B. Barbour                                  |   | ****                                                                      |
|                                 |   | Employment  Agreement with Lisah Frazier                                     |   | ****                                                                      |
|                                 |   | Employment  Agreement with Robert S.Curtis                                   |   | 10                                                                        |
|                                 |   | Change in  Control Severance Agreement withRobert L. Bayes                   |   | *****                                                                     |
| 11                                   |   | Statement regarding computation of per share  earnings                       |   | None                                                                      |
| 13                                   |   | Annual Report to Security Holders                                            |   | 13                                                                        |
| 16                                   |   | Letter regarding change in certifying accountants                            |   | None                                                                      |
| 18                                   |   | Letter regarding change in accounting principles                             |   | None                                                                      |
| 21                                   |   | Subsidiaries of Registrant                                                   |   | 21                                                                        |
| 22                                   |   | Published report regarding matters submitted to vote  of security holders    |   | None                                                                      |
| 23                                   |   | Consents of Experts and Counsel                                              |   | 23                                                                        |
| 24                                   |   | Power of Attorney                                                            |   | None                                                                      |
| 99                                   |   | Additional Exhibits                                                          |   | None                                                                      |

 

----

*       Filed as exhibits to the Company’s Form S-1registration statement filed on December 19, 1995 (File No. 33–87580)pursuant to Section 5 of the Securities Act of 1933.  All of such previously filed documents are hereby incorporatedherein by reference in accordance with Item 601 of Regulation S–B.

 

**Filed asexhibits to the Company’s Annual Report on Form 10-KSB for the fiscal yearended March 31, 1996 (File             No. 0-27170).  All of such previously filed documents arehereby incorporated herein by reference in accordance with Item 601 ofRegulation S-B.

 

36

----

 

***Filed asAppendix A to the Company’s definitive proxy solicitating materials filed onJune 26, 1998 (File No. 0–27170). Such previously filed document ishereby incorporated herein by reference in accordance with Item 601  of Regulation S-B.

 

****Filed as exhibits to the Company’s Annual Report on Form 10-KSB forthe fiscal year ended March 31, 2001 (File No. 0-27170).  All of such previously filed documents arehereby incorporated herein by reference in accordance with Item 601 ofRegulation S-B.

 

*****Filed as Exhibit to the Company’s Annual Report on Form 10-KSB forthe fiscal year ended March 31, 2000 and incorporated by reference herein.

 

******Filed as an Exhibit to the Company’s 2001 Proxy Statement andincorporated by reference herein.  Suchpreviously filed document is hereby incorporated herein by reference inaccordance with Item 601 of Regulation S-B.

 

**(b)     Reports on Form 8–K**

 

During the quarter endedMarch 31, 2002, the Company filed a Current Report on Form 8-K dated February4, 2002 to report under Item 5 for Form 8-K the issuance of a press releaseannouncing its earnings for the quarter ended December 31, 2002.

 

37

----

 

**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the ExchangeAct, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|   | **CLASSIC BANCSHARES, INC.**                         |
|--------|------------------------------------------------------|
|   |                                                 |   |
|   |                                                 |   |
|   |                                                 |   |
|   | By: /s/ David B. Barbour                             |   |
|   | David B. Barbour, President, Chief Executive Officer |
|   | and Director *(Duly  Authorized Representative)*     |
|        |                                                      |  |  |

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons in the capacities and on the datesindicated.

 
| /s/ David B. Barbour                                                                                                                     |          |                                                    | /s/ C. Cyrus Reynolds  |   |
|------------------------------------------------------------------------------------------------------------------------------------------|---------------|---------------------------------------------------------|------------------------|--------|
| David B. Barbour, President, Chief ExecutiveOfficer and  Director *(Principal Executive and**Operating  Officer)*                   |          | C. Cyrus Reynolds, Chairman of the Board                |
|                                                                                                                                     |          |                                                    |                   |   |
| Date:                                                                                                                                    | June 28, 2002 |                                                    |                   | Date:  | June 28, 2002 |
|                                                                                                                                     |          |                                                    |                   |   |
|                                                                                                                                     |          |                                                    |
| /s/ Lisah M. Frazier                                                                                                                     |          |                                                    | /s/ Robert L. Bayes    |   |
| Lisah M. Frazier, Chief Operating Officerand Chief Financial  Officer  and Director*(Principal**Financial and  Accounting Officer)* |          | Robert L. Bayes, Executive Vice President and  Director |
|                                                                                                                                     |          |                                                    |                   |   |
| Date:                                                                                                                                    | June 28, 2002 |                                                    |                   | Date:  | June 28, 2002 |
|                                                                                                                                     |          |                                                    |
|                                                                                                                                     |          |                                                    |
| /s/ John W. Clark                                                                                                                        |          |                                                    | /s/ E. B. Gevedon, Jr. |   |
| John W. Clark, Director                                                                                                                  |          | E. B. Gevedon, Jr.,   Vice Chairman of the Board   |
|                                                                                                                                     |          |                                                    |                   |   |
| Date:                                                                                                                                    | June 28, 2002 |                                                    |                   | Date:  | June 28, 2002 |
|                                                                                                                                     |          |                                                    |                   |   |
|                                                                                                                                     |          |                                                    |
| /s/ Robert B. Keifer                                                                                                                     |          |                                                    | /s/ David A. Lang      |   |
| Robert B. Keifer, Jr., Director                                                                                                          |          | David A. Lang, Director                                 |
|                                                                                                                                     |          |                                                    |                   |   |
| Date:                                                                                                                                    | June 28, 2002 |                                                    |                   | Date:  | June 28, 2002 |
|                                                                                                                                     |          |                                                    |                   |   |
|                                                                                                                                     |          |                                                    |
| /s/ Jeffrey P. Lopez                                                                                                                     |          | /s/ Robert A. Moyer                                     |                   |   |
| Jeffrey P. Lopez, Director                                                                                                               |          | Robert A. Moyer, Jr., Director                          |
|                                                                                                                                     |          |                                                    |                   |   |
| Date:                                                                                                                                    | June 28, 2002 |                                                    |                   | Date:  | June 28, 2002 |
|                                                                                                                                          |               |                                                         |                        |        |  |  |  |  |  |  |  |  |

 

38

----

 

**INDEX TO EXHIBITS**

 
| **Number** |                                       |
|------------|--------------------------------------------|
|       |                                       |
| 10         | Employment Contract with  Robert S. Curtis |
|       |                                       |
| 13         | Annual Report to  Stockholders             |
|       |                                       |
| 14         | Subsidiaries of the  Registrant            |
|       |                                       |
| 15         | Consent of Independent  Auditors           |

 

----