10-Q 1 g72811e10-q.txt AREA BANCSHARES CORPORATION U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarter ended September 30, 2001 Commission File Number 0-26032 AREA BANCSHARES CORPORATION --------------------------- (Exact name of registrant as specified in its charter) INCORPORATED IN KENTUCKY IRS EMPLOYER ID NUMBER NO. 61-0902343 230 FREDERICA STREET OWENSBORO, KENTUCKY 42301 ------------------------- (Address of principal executive offices, including zip code) Registrant's telephone number, including area code: (270) 926-3232 Former name, former address and former fiscal year, if changed since last report: N/A Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Class: Common stock No Par Value Shares Outstanding: As of October 31, 2001: 23,906,188 1 AREA BANCSHARES CORPORATION TABLE OF CONTENTS PART I - FINANCIAL INFORMATION PAGE NUMBER Item 1. Financial Statements Unaudited consolidated balance sheets, September 30, 2001, December 31, 2000, and September 30, 2000 3 Unaudited consolidated statements of income, three and nine months ended September 30, 2001 and 2000 4 Unaudited consolidated statements of comprehensive income, three and nine months ended September 30, 2001 and 2000 5 Unaudited consolidated statement of shareholders' equity, nine months ended September 30, 2001 6 Unaudited consolidated statements of cash flows for the nine months ended September 30, 2001 and 2000 7 Notes to unaudited consolidated financial statements 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Results of operations 16 Financial position 27 Liquidity 30 Item 3. Quantitative and Qualitative Disclosures About Market Risk 31 PART II - OTHER INFORMATION Item 1. Legal Proceedings 31 Item 2. Changes in Securities 31 Item 3. Defaults Upon Senior Securities 31 Item 4. Submission of Matters to a Vote of Security Holders 32 Item 5. Other Information 32 Item 6. Exhibits and Reports on Form 8-K 32

2 AREA BANCSHARES CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED BALANCE SHEETS (Amounts in thousands, except share data)

SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 3 AREA BANCSHARES CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF INCOME THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Amounts in thousands, except per share data)

SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 4 AREA BANCSHARES CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Amounts in thousands)

SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 5 AREA BANCSHARES CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2001 (Amounts in thousands, except share and per share data)

SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 6 AREA BANCSHARES CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Amounts in thousands)

CONTINUED 7 AREA BANCSHARES CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Amounts in thousands)

SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 8 AREA BANCSHARES CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 AND 2000 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying interim unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been reflected in the accompanying unaudited consolidated financial statements. Results of interim periods are not necessarily indicative of results to be expected for the full year. The accounting and reporting policies of AREA Bancshares Corporation ("AREA") and its subsidiaries conform to accounting principles generally accepted in the United States of America and general practices within the banking industry. The consolidated financial statements include the accounts of AREA and its wholly-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. A full description of significant accounting policies as well as a complete set of footnotes are presented in the 2000 annual report and Form 10-K to shareholders. NOTE 2. BUSINESS COMBINATIONS (COMPLETED MERGERS AND ACQUISITIONS) On January 31, 2000, AREA acquired Peoples Bank of Murray, Murray, Kentucky; Dees Bank of Hazel, Hazel, Kentucky; Bank of Lyon County, Eddyville, Kentucky; and Bank of Livingston County, Tiline, Kentucky ("Western Kentucky Group"). AREA paid $77.75 million in cash for these banking companies. On January 31, 2000, total assets of these four affiliated banking companies were $383.35 million, total loans were $220.03 million, total deposits were $327.97 million and total shareholders' equity was $43.97 million. The transaction was accounted for as a purchase transaction; accordingly, the results of operations of these banks have been included in the unaudited consolidated financial statements since the date of acquisition. In conjunction with the acquisition, approximately $32.95 million of intangible assets were recorded and are being amortized over a 10 to 20-year period. On July 16, 2001, AREA acquired the assets of Associates Mortgage Group, Inc. of Louisville, Kentucky and its Calvary Title Company. Associates Mortgage is Louisville's largest non-bank mortgage loan orginator, with loan closings totaling over $100.00 million annually. After the acquisition, it has become AREA Mortgage, a division of AREA Bank. NOTE 3. ADOPTION OF NEW ACCOUNTING PRINCIPLE In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133. - Accounting for Derivative Instruments and Hedging Activities (SFAS 133). In June 1999 and June 2000, the FASB issued SFAS No. 137 - Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, and Amendment of FASB Statement No. 133, and SFAS No. 138 - Accounting for Derivative Instruments and Hedging Activities, and Amendment of FASB Statement No. 133, respectively. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133, as amended, requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge in one of three categories. The accounting for changes in the fair value of a derivative (i.e., gains and losses) depends on the intended use of the derivative and the resulting designation. Under SFAS No. 133, as amended, an entity that elects to apply hedge accounting is required to establish, at the inception of the hedge, the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk. AREA utilizes derivative instruments and hedging activities to assist in the management of interest rate sensitivity and to modify the repricing, maturity, and option characteristics of certain assets and liabilities. The following is a summary of accounting policies for derivative instruments and hedging activities under SFAS 133, as amended; 9 AREA BANCSHARES CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 AND 2000 NOTE 3. ADOPTION OF NEW ACCOUNTING PRINCIPLE (CONTINUED) INTEREST RATE SWAP AGREEMENTS - CASH FLOW HEDGES. Interest rate swap agreements designated as cash flow hedges are accounted for at fair value. The effective portion of the change in the cash flow hedge's gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the underlying transaction affects earnings. The ineffective portion of the change in the cash flow hedge's gain or loss is recorded in earnings on each quarterly measurement date. The cash flow hedges are accounted for on an accrual basis with the net interest differential being recognized as an adjustment to interest income or interest expenses of the related asset or liability. INTEREST RATE SWAP AGREEMENTS - FAIR VALUE HEDGES. Interest rate swap agreements designated as fair value hedges are accounted for at fair value. The ineffective portion of the change in the fair value hedge's gain or loss and the corresponding change in the fair value of the underlying asset or liability are recorded in earnings on each quarterly measurement date. The fair value hedges are accounted for on an accrual basis with the net interest differential being recognized as an adjustment to interest income or interest expense of the related asset or liability. On January 1, 2001, AREA implemented SFAS No. 133, as amended. At that date, AREA had three interest rate swap agreements. One of the agreements, with a notional value of $10.00 million was classified as a fair value hedge. Upon implementation of SFAS No. 133, as amended, these derivative instruments were recognized in the financial statements. An asset related to the derivative instruments of $354 thousand, an increase in deferred tax liabilities of $124 thousand and a cumulative effect of the change in accounting principle of $230 thousand were recorded. During the first quarter of 2001 an interest rate swap with a notional value of $40.00 million was terminated. Proceeds of $140 thousand were received in consideration of this termination. As of September 30, 2001, AREA had swaps outstanding with a notional value of $16.26 million. During the quarter ended September 30, 2001, $54 thousand was recognized as a pre-tax expense ($36 thousand after-tax) to adjust the swaps to market value while $37 thousand pre-tax ($24 thousand after-tax) was recorded as a reduction in interest expense as a result of the payments received from counter parties. The swaps had an unfavorable market value of $136 thousand. NOTE 4. NET INCOME PER COMMON SHARE Basic earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share give effect to the increase in the average shares outstanding that would have resulted from the exercise of dilutive stock options. The components of basic and diluted earnings per share are as follows:

10 AREA BANCSHARES CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 AND 2000 NOTE 5. SECURITIES The amortized cost and approximate fair values of securities as of September 30, 2001 and December 31, 2000 are as follows:

NOTE 6. RECENTLY ISSUED ACCOUNTING STANDARDS In July 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. SFAS No. 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. 11 AREA BANCSHARES CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 AND 2000 NOTE 6. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED) The provisions of SFAS No. 141 are required to be adopted immediately and SFAS No. 142 will be effective January 1, 2002. Furthermore, any goodwill and any intangible assets determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-SFAS No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of SFAS No. 142. SFAS No. 141 will require upon adoption of SFAS No. 142, that AREA evaluate its existing intangible assets and goodwill that were acquired in prior purchase business combinations, and that AREA make any necessary reclassifications in order to conform with the new criteria in SFAS No. 141 for recognition apart from goodwill. Upon adoption of SFAS No. 142, AREA will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, a test will be required to be made of the intangible asset for impairment in accordance with the provisions of SFAS No. 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. In connection with the transitional goodwill impairment evaluation, SFAS No. 142 will require an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. This will be accomplished through the identification of reporting units and determination of the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. AREA will have up to six months from the date of adoption to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. To the extent a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and then the second step of the transitional impairment test must be performed. (In the second step, the implied fair value must be compared to the reporting unit's goodwill, determined by allocating the reporting unit's fair value to all of it assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with SFAS No. 141, to the carrying amount, both of which would be measured as of the date of adoption.) This second step is required to be completed as soon as possible, but no later than the end of the year of adoption. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the statement of earnings. As of the date of adoption of SFAS No. 142, AREA expects to have unamortized goodwill in the amount of $48.98 million and unamortized identifiable intangible assets in the amount of $5.70 million, all of which will be subject to the transition provisions of SFAS No. 141 and SFAS No. 142. Pre-tax amortization expense related to goodwill was $4.44 million and $3.41 million for the year ended December 31, 2000 and the nine months ended September 30, 2001, respectively. As a result of the extensive effort needed to comply with adopting SFAS No. 141 and SFAS No. 142, it is not practicable to reasonably estimate whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that Statement. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. However, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. By broadening the presentation of discontinued operations to include more disposal transactions, the FASB has enhanced managements' ability to provide information that helps financial statement users to assess the effects of a disposal transaction on the ongoing operations of an entity. 12 AREA BANCSHARES CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 AND 2000 NOTE 6. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED) SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. Early application is encouraged. Management has not yet determined the impact, if any, of adopting SFAS No. 144. NOTE 7. SEGMENT INFORMATION AREA engages in two lines of business: traditional banking operations, which includes commercial and retail banking, and trust operations. Selected financial information by business segment is summarized below. This unaudited financial information is derived from the internal reporting systems used by management to assess segment performance. COMMERCIAL AND RETAIL BANKING Commercial and retail banking is conducted at 72 branches of AREA Bank and The Vine Street Trust Company (AREA's two banking affiliates) by providing traditional commercial and retail banking products and services to individual consumers and small to medium-size businesses. Products and services offered include commercial loans; small business loans; mortgage loans; home equity loans and lines of credit; installment loans; and demand, savings and time deposit accounts. These services are provided through retail branch offices, ATMs, and PC banking options. The marketing effort of AREA's bank subsidiaries focuses on lending and deposit gathering activities within local markets served which encompass the Commonwealth of Kentucky. TRUST OPERATIONS The trust line of business is conducted at 5 facilities of AREA Trust Company (AREA's only trust company) and at the home office of The Vine Street Trust Company by providing investment management, personal trust services, and employee benefit administration services. Assets under management totaled $1.28 billion as of September 30, 2001. The following unaudited financial information summarizes the results for AREA's two lines of business for the three and nine-month periods ended September 30, 2001. Prior to the third quarter of 2000, AREA's lines of business were not separated, thus information for the quarter and year-to-date periods ended September 30, 2000 are not available. As of September 30, 2001, substantially all of AREA's assets were committed to the commercial and retail banking segment. Total assets of AREA Trust were $10.91 million and equity totaled $10.60 million on September 30, 2001.

13 AREA BANCSHARES CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 AND 2000 NOTE 7. SEGMENT INFORMATION (CONTINUED)

NOTE 8. INTANGIBLES As of September 30, 2001, intangibles totaled $58.97 million compared to $63.95 million on December 31, 2000. The excess cost over fair value of net assets acquired in purchase business combinations (goodwill) of $50.46 million and $53.52 million net of accumulated amortization as of September 30, 2001 and December 31, 2000, respectively, is being amortized over 10-20 year periods on a straight-line basis. Other intangible assets consist of the book value of core deposits purchased of approximately $8.51 million and $10.42 million, net of accumulated amortization, as of September 30, 2001 and December 31, 2000, respectively, which is being amortized by an accelerated method over ten years. Amortization expense for the three-month periods ended September 30, 2001 and 2000 was $1.77 million and $1.57 million, respectively. Amortization expense for the nine-month periods ended September 30, 2001 and 2000 was $5.32 million and $5.05 million, respectively. NOTE 9. STOCK SPLIT During November 2000, AREA's Board of Directors declared a 3-for-2 stock split of AREA's common stock, payable in December 2000. The stock split resulted in the issuance of 8.11 million shares of common stock along with a corresponding capitalization of $9.31 million of retained earnings. All references to the number of shares (other than common stock issued or outstanding on the September 30, 2000 Consolidated Balance Sheet), per share amounts, cash dividends, and any other references to shares in the unaudited consolidated financial statements and accompanying Notes to Unaudited Consolidated Financial Statements, unless otherwise noted, have been adjusted to reflect the split on a retroactive basis. Previously awarded stock options and restricted awards have been adjusted to reflect the split. NOTE 10. NAME CHANGE AND CONSOLIDATION OF OPERATIONS Prior to the third quarter of 2000, each of AREA's seventeen banks were operated separately under individual charters. Each bank operated within its local market and retained its individual name. Management made the decision to merge the individual charters of all the banks with the exception of The Vine Street Trust Company and adopt a common name, AREA Bank. In addition to better name recognition, AREA's extensive investment in technology was optimized to reduce redundancies resulting from the numerous charters. In addition, customers are able to receive better service through a wider range of products. During the third and fourth quarters of 2000, AREA consolidated the charters of its affiliate banks with the exception of The Vine Street Trust Company, Lexington, Kentucky. At the time of the consolidation of the charters, the trust operations of those banks with trust departments were transferred to AREA Trust Company, a state chartered non-depository trust company. 14 AREA BANCSHARES CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 10. NAME CHANGE AND CONSOLIDATION OF OPERATIONS (CONTINUED) After the consolidation, both lending and deposit decisions continue to be made on a local level, thus maintaining the quality of service of an individual bank. In matters affecting their customers, the local banking centers continue to have broad discretion. The merged banks maintained their local boards which enables AREA Bank to continue to be sensitive to local needs and customer preferences. The operational functions such as accounting, item processing, loan servicing, mortgage servicing and credit administration are being performed on a centralized basis in Owensboro, Kentucky. AREA incurred after-tax charges in the third quarter of 2000 totaling approximately $1.49 million ($2.29 million pre-tax), or $0.06 per diluted share, related to the consolidation of its subsidiary banks. These charges related primarily to employee severance payments and other costs of integrating the operations of the merged banks. NOTE 11. MERGER AGREEMENT WITH BB&T CORPORATION On November 8, 2001, AREA announced it had entered into an Agreement and Plan of Reorganization with BB&T Corporation (BB&T), a regional bank holding company with approximately $70.3 billion in assets. Under the agreement, each share of common stock of AREA will be converted into the right to receive 0.55 of a share of common stock of BB&T, plus cash in lieu of any fractional share of BB&T common stock. The merger, which is subject to the approval of AREA's shareholders and banking regulators, is expected to be completed in the second quarter of 2002. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL AREA, the largest bank holding company headquartered in Kentucky, is a $2.95 billion multi-bank holding company with its principal offices in Owensboro, Kentucky. As of September 30, 2001, AREA owned two banks ("banking affiliates") and a trust company conducting business in offices throughout Kentucky (see Note 10 in the accompanying unaudited consolidated financial statements for details). The banking affiliates provide a wide range of financial services, such as accepting demand and time deposits; providing checking and money market accounts; making commercial, consumer and mortgage loans; issuing and servicing credit cards; leasing; providing trust services for personal and corporate customers; providing safe deposit facilities; and offering alternative investments and brokerage services. The trust company offers comprehensive trust and investment services to a broad range of companies and individuals. As of September 30, 2001, AREA had approximately $1.28 billion of assets under management through AREA Trust and the trust department of The Vine Street Trust Company. AREA also has seven active non-bank affiliates that provide services incidental to AREA's operations. AREA has established an internet website (http://www.abcbank.com) which provides additional information about the products and services offered by its affiliates. The parent company furnishes specialized services to its affiliated banks and subsidiaries including: supervision, administration and review of loan portfolios: administration of investment portfolios, insurance programs and employee benefit plans: and assistance with respect to accounting and operating systems and procedures, personnel, marketing, cash management services, and equipment management. AFFILIATED BANKS AND TRUST COMPANY The two affiliated banks operated throughout Kentucky in 39 cities with 72 banking locations as of September 30, 2001. These banks serve both rural and metropolitan areas. As of September 30, 2001, AREA Bank had total assets of $2.63 billion and The Vine Street Trust Company had total assets of $298.49 million. AREA Trust had $1.02 billion of assets under management while The Vine Street Trust Company managed $256.5 million of trust assets. The discussion that follows is intended to provide additional insight into AREA's financial condition and results of operations which includes the acquisitions of the Western Kentucky Group since January 31, 2000, Associates Mortgage Group, Inc. and Calvary Title Company since July 16, 2001 (see Note 2 in the accompanying unaudited consolidated financial statements for details of this transaction). Where considered significant, the impact of these transactions on AREA's results of operations and financial condition is discussed. This discussion should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Item 1 of Part I of this Form 10-Q. 15 FORWARD LOOKING STATEMENTS Various statements contained in this Quarterly Report on Form 10-Q and the exhibits to this quarterly report that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the "Act"). In addition, various statements in filings by AREA with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of AREA that are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (1) projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure and other financial items; (2) statements of AREA's plans and objectives, including those relating to products or services; (3) statements of future economic performance; and (4) statements of assumptions underlying such statements. Words such as "believes," "anticipates," "expects," "intends," "targeted," and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to: (1) the strength of the U.S. economy in general and the strength of the local economies in which operations are conducted; (2) the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (3) inflation, interest rate, market and monetary fluctuations; (4) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (5) changes in consumer spending, borrowing and saving habits; (6) technological changes; (7) acquisitions; (8) the ability to increase market share and control expenses; (9) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which AREA and its subsidiaries must comply; (10) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board; (11) changes in AREA's organization, compensation and benefit plans; (12) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; and (13) AREA's success managing the risks involved in the foregoing. Forward-looking statements speak only as of the date on which the statements are made, and AREA undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which a statement is made to reflect the occurrence of unanticipated events. A. RESULTS OF OPERATIONS Net income for the quarter ended September 30, 2001 was $9.46 million versus $6.67 million in the same period of 2000. Diluted earnings per share for the third quarter of 2001 were $0.39 compared to $0.27 for the same period in 2000. The increase during the current quarter compared to the second quarter of 2000 was $2.79 million, or 41.8%, for net income and $0.12, or 44.4%, per diluted share. Return on average assets was 1.31% (annualized) in the third quarter of 2001 compared to 0.97% (annualized) in the same period of last year. Return on average equity was 12.28% (annualized) in the third quarter of 2001 compared to 9.71% (annualized) during the third quarter of 2000. The increase in earnings during the current quarter compared to the third quarter of 2000 was largely the result of an increase in net interest income on a taxable equivalent basis totaling $1.68 million, or 5.8%, to $30.46 million, growth in noninterest income of $1.84 million, or 25.2%, to $9.13 million partially off-set by an increase in noninterest expenses (excluding the consolidation charge in the third quarter of 2000) of $1.08 million, or 4.8%, to $23.55 million. Year-to-date net earnings were $25.09 million verses $29.98 million for the first nine months of 2000. Diluted earnings per share totaled $1.03 for the current year-to-date period compared to $1.21 during the same period in 2000. The year-to-date decreases were $4.89 million, or 16.3%, for net income and $0.18, or 14.9%, per diluted share. Net income for the first nine months of the year resulted in a return on average assets of 1.21% (annualized) compared to 1.48% (annualized) during the first three quarters of 2000 and a return on average equity of 11.25% (annualized) versus 14.62% (annualized) in the nine months of 2000. The reduction in earnings during the current nine-month period compared to the same period of 2000 was largely the result of a decrease in security gains. During the first nine months of 2001 security gains were $2 thousand after-tax ($3 thousand pre-tax) compared to $8.97 million after-tax ($15.60 million pre-tax) during the first three quarters of 2000. The difference in security gains was $8.95 million after-tax ($15.57 million pre-tax) or $0.36 per diluted share. Net interest income on a taxable equivalent basis increased $5.27 million, or 6.3%, to $88.22 million during the first three quarters of 2001 compared to the same period in 2000, noninterest income (excluding infrequently occurring items) increased $1.24 million, or 5.6%, to $23.29 million. These increases were partially off-set by a $2.49 million, or 3.7%, increase to $69.84 million in 16 A. RESULTS OF OPERATIONS (CONTINUED) noninterest expenses (excluding infrequently occurring items). The gains on the sale of securities during the first nine months of 2000 reflected AREA's strategy to improve the performance of its investment portfolio through repositioning portions of the portfolio as market conditions warranted. The current year-to-date period includes the results of operations of the Western Kentucky Group (see Note 2 in the accompanying unaudited consolidated financial statements) for the entire nine months while the first three quarters of 2000 included the Western Kentucky Group from January 31, 2000 (date of acquisition). In addition, the results of operations for Associates Mortgage Group, Inc. and Calvary Title are included from July 16, 2001. Identification of the various components of income and expense for the Western Kentucky group is not possible as a result of the consolidation of operations of the Western Kentucky Group into AREA Bank. CORE OPERATING NET INCOME AREA believes that a meaningful comparison of the results of operations excludes infrequently occurring items. Although these calculations are helpful in understanding the performance of AREA, core operating net income should not be considered a substitute for net income or cash flow as indicators of AREA's financial performance or its ability to generate liquidity. In addition, core operating net income are not in accordance with accounting principles generally accepted in the United States of America and may not allow comparison with other bank holding companies. Core operating income during the third quarter of 2001 and 2000, which is net income adjusted for infrequently occurring items, totaled $8.86 million or $0.36 per diluted share and $8.16 million or $0.33 per diluted share, respectively. Core operating net income increased $694 thousand, or 8.5%, and core operating diluted earnings per share increased $0.03, or 9.1%, from the third quarter of 2000. During the third quarter of 2001 there were two infrequently occurring items: a $2 thousand after-tax ($3 thousand pre-tax) gain on the sale of securities and a $602 thousand after-tax ($940 thousand pre-tax), or $0.02 per diluted share, gain on the sale of loan servicing. The third quarter of 2000 contained consolidation charges of $1.49 million after-taxes ($2.29 million pre-tax), or $0.06 per diluted share. During the first nine months of 2001 there were two infrequently occurring items; a $2 thousand after-tax ($3 thousand pre-tax) gain on the sale of securities and a $602 thousand after-tax ($940 thousand pre-tax), or $0.02 per diluted share, gain on the sale of loan servicing. The first three quarters of 2000 included security gains totaling $8.97 million after-tax ($15.60 million pre-tax), or $0.36 per diluted share, a gain totaling $93 thousand after-tax ($143 thousand pre-tax) on the sale of premises and equipment, and merger-related adjustments along with consolidation charges which totaled $1.74 million after-tax ($2.68 million pre-tax), or $0.07 per diluted share. The merger and consolidation charges related to the acquisition of the Western Kentucky Group and the consolidation of the charters. Core operating net income, which is net income adjusted for these items, increased $1.83 million, or 8.1%, to $24.49 million from $22.65 million while core operating diluted earnings per share increased $0.10, or 11.0%, to $1.01 from $0.91 in the first nine months of 2001. The following table presents the core operating net income and various core operating performance ratios:

17 A. RESULTS OF OPERATIONS (CONTINUED) The table below provides selected operating data, per share data, selected ratios and average balances for the three and nine-month periods ended September 30, 2001 and 2000:

(1) Excludes items presented in the Core Operating Net Income table above. (2) Percentages annualized. CORE OPERATING CASH-BASED EARNINGS AREA believes it is important to also disclose cash-based core operating net income, which excludes infrequently occurring items and intangible asset amortization from core operating net income. Although these calculations are helpful in understanding the performance of AREA, cash-based core operating net income should not be considered a substitute for net income or cash flow as indicators of AREA's financial performance or its ability to generate liquidity. In addition, cash-based earnings are not in accordance with accounting principles generally accepted in the United States of America and may not allow for comparison with other bank holding companies. 18 CORE OPERATING CASH-BASED EARNINGS (CONTINUED) The following table presents the cash-based core operating net income and various cash-based performance ratios:

(1) Excludes items presented in the Core Operating Net Income table above. NET INTEREST INCOME The largest component of AREA's operating income is net interest income, which is the difference between interest income and interest expense. Sources of interest income include interest on loans and investments while interest expense includes interest paid on deposits and borrowings. The amount of net interest income is the result of a number of factors, including the volume, mix and maturity of earning assets, and interest-bearing liabilities; fluctuations in the level of interest rates; and asset quality. In addition, the amount of interest-bearing assets funded by interest-free sources (largely shareholders' equity and noninterest-bearing deposits) impacts net interest income. Changes in net interest income are frequently measured by two percentages: net interest margin and net interest spread. Net interest margin is expressed as net interest income (on a tax-equivalent basis) divided by average earning assets. Net interest spread is the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities. For purposes of this discussion, net interest income is presented on a fully-taxable equivalent basis, which adjusts tax-exempt income to an amount that would yield the same after-tax income had the income been subject to taxation at the federal statutory income tax rate which is currently 35%. Net interest income, on a tax equivalent basis, increased $1.68 million, or 5.8%, to $30.46 million during the quarter ended September 30, 2001 compared to the same quarter in 2000. The increase in net interest income was due largely to an increase in the spread from 3.81% during the quarter ended September 30, 2000 to 3.89% during the current quarter. The spread widened as a result of the average rate on interest-bearing liabilities declining more than the average rate on earning assets. The average rate on interest-bearing liabilities declined 1.01% while the average rate on interest-earning assets declined 0.93%. The decline in the average rate on interest-bearing liabilities was due in part to management's effort to aggressively reprice interest-bearing deposits downward as rates declined during the first nine months of 2001. Average earning assets for the third quarter of 2001 were $2.68 billion, an increase of $170.49 million, or 6.8%, from the same period of 2000. The growth in average earning assets was largely the result of the leveraging transaction discussed below. AREA's net interest margin decreased slightly from 4.56% during the quarter ended September 30, 2000 to 4.51% during the current quarter. This decrease was largely the result of the addition of approximately $200.00 million of earning assets with a spread of 1.50% acquired as part of the leveraging transaction. The average rate on interest earning assets decreased from 8.56% during the third quarter of 2000 to 7.72% in the current quarter while the average rate on interest bearing liabilities decreased from 4.84% to 3.83%. 19 NET INTEREST INCOME (CONTINUED) For the nine months ended September 30, 2001, net interest income, on a tax equivalent basis, increased $5.26 million, or 6.3%, to $88.22 million from $82.96 million in same period in 2000. The increase in net interest income was due largely to an increase in average earning assets and an increase in the net interest margin. Average earning assets for the first nine months of 2001 were $2.58 billion, an increase of $78.5 million, or 3.1%, from the same period in 2000. AREA's net interest margin (which is computed by dividing net interest income on a fully taxable equivalent basis by average earning assets) increased from 4.43% during the nine months ended September 30, 2000 to 4.58% in the first three quarters of 2000. The average rate on interest earning assets decreased from 8.32% during the first three quarters of 2000 to 8.19% for the first nine months of 2001 largely as a result of adjustable-rate earning assets repricing downward due to the steep decline in interest rates in 2001. As an off-set, the average rate on interest bearing liabilities decreased from 4.63% to 4.31%. The decline in the average rate on interest-bearing liabilities was due in part to management's effort to aggressively reprice interest-bearing deposits downward as rates declined during the first nine months of 2001. These changes resulted in an increase from 3.69% to 3.88% in the net interest spread during the first nine months of 2001 versus the same period in 2000. The following two tables present the components of net income on a taxable equivalent basis for the three and nine-month periods ended September 30, 2001 and 2000, respectively:

20 NET INTEREST INCOME (CONTINUED)

The following table summarizes the fully-taxable equivalent interest spread, which is the difference between the average yield on earning assets and the average rate on interest-bearing liabilities as well as the net interest margin, which is the fully-taxable equivalent net interest income divided by the average earning assets for the three and nine-months ended September 30, 2001 and 2000.

Leveraging Transaction During July 2001 AREA announced that it had entered into a leveraging transaction to enhance net interest income through better utilization of current capital levels. The leveraging was achieved by borrowing approximately $200.00 million from the Federal Home Loan Bank and investing the funds primarily in fixed-rate mortgage-backed securities issued by government sponsored enterprises. The initial spread on these assets over the cost of borrowed funds averaged 150 basis points (1.50%). PROVISION FOR LOAN LOSSES The allowance for loan losses is maintained at a level management believes is adequate to absorb estimated losses inherent in the portfolio. Management determines the adequacy of the allowance based upon reviews of individual loans, evaluation of the risk characteristics of the loan portfolio, including the impact of current economic conditions on the borrowers' ability to repay, past collection, and loss experience as well as other factors that in management's judgment deserve current recognition. However, actual losses could differ significantly from the amount estimated by management. The allowance for loan losses is established by charges to operating earnings. 21 PROVISION FOR LOAN LOSSES (CONTINUED) An analysis of the changes in the allowance for loan losses and selected ratios follows:

The provision for loan losses, charged to operating expenses, depends on factors including loan growth and changes in the composition of the loan portfolio, net charge-off levels and management's assessment of the allowance for loan losses based upon AREA's credit review policies and procedures. The provision for loan losses totaled $900 thousand during the quarter ended September 30, 2001 compared to $588 thousand during the same period last year. During the nine months ended September 30, 2001, the provision for loan losses increased $1.48 million, or 120.6%, to $2.70 million from $1.22 million in the first nine months of 2000. The increase in the provision for loan losses during both the current three-month and the year-to-date periods compared to the year earlier amounts was due mainly to a higher level of net charge-offs as discussed below. The provision for loan losses as a percentage of average loans totaled 0.19% (annualized) during the quarter ended September 30, 2001 compared to 0.12% (annualized) during the third quarter of last year. For the nine-month period ended September 30, 2001, the provision for loan losses as a percentage of average loans increased to 0.19% (annualized) from 0.09% (annualized) during the same period in 2000. Net charge-offs increased to $1.74 million in the third quarter of 2001 from $338 thousand during the same quarter of the prior year while increasing from $896 thousand in the first nine months of 2000 to $3.74 million in the first three quarters of 2001. The charge-offs for the both the third quarter and first nine months of 2001 involved all categories of loans. Only one of the charge-offs exceeded $400 thousand and is discussed in more details in the "Asset Quality" section. Net loan charge-offs (loan charge-offs less recoveries) to average loans during the current quarter increased to 0.36% (annualized) from 0.07% (annualized) during the quarter ended September 30, 2000 largely as a result of an increase in loans charged-off from $696 thousand to $2.26 million in the current quarter. Recoveries totaled $514 thousand in the current quarter compared to $358 thousand in the third quarter of 2000. Net loan charge-offs increased to 0.26% (annualized) of average loans during the nine months ended September 30, 2001 compared to 0.06% (annualized) in the same period in 2000. The increase in net charge-offs during the first three quarters of 2001 compared to the same period in 2000 was largely the result of one large charge-off which is discussed in the "Asset Quality" section. The allowance for loan losses was 1.36% of total loans on September 30, 2001, as compared to 1.43% on December 31, 2000 and 1.44% on September 30, 2000. 22 NONINTEREST INCOME The tables that follow set forth the components of noninterest income for the three-and nine-month periods ended September 30, 2001 and 2000. The amounts presented below for the three-and nine-month periods include adjustments for infrequently occurring noninterest income for comparability purposes.

23 NONINTEREST INCOME (CONTINUED) Noninterest income totaled $9.13 million and $24.23 million for the three-and nine-month periods ended September 30, 2001. These amounts represent an increase of $1.84 million, or 25.2%, and a decrease of $13.57 million, or 35.9%, during the current quarter and year-to-date periods, respectively, when compared to 2000 period totals. To compare recurring noninterest income, the following analysis has excluded, for both the current quarter and the nine months ended September 30, 2001, a gain of $940 thousand on the sale of loan servicing and security gains of $3 thousand. Also excluded for the year-to-date period ended September 30, 2000 is a gain on the sale of premises and equipment that totaled $143 thousand and $15.60 million of security gains. Excluding these items, recurring noninterest income increased $893 thousand, or 12.2%, to $8.19 million from $7.30 million in the third quarter of 2000 and increased $1.24 million, or 5.6%, to $23.29 million from $22.05 million during the first nine months of 2000. Commissions and fees on fiduciary activities increased $54 thousand, or 3.6%, to $1.57 million in the third quarter of 2001 and increased $313 thousand, or 7.2%, during the current nine-month period compared to the same periods last year largely as a result of successful new business development efforts. Commissions and fees on fiduciary activities generally track the amount of total assets under management; as a result, these fees often are assessed on the market value of funds that are managed. In both the current quarter and the year-to-date periods, the decrease in the equity markets reduced the growth in commissions and fees on fiduciary activities that would have otherwise been recorded. Service charges on deposit accounts increased $276 thousand, or 8.0%, to $3.73 million and $1.30 million, or 13.8%, to $10.76 million during the three-and nine-month periods ended September 30, 2001, respectively, when compared to similar period totals in 2000, due primarily to increases in per transaction fees charged. The consolidation of charters and the corresponding standardization of service charges also contributed to the growth in both the current quarter and year-to-date periods. Other service charges, commissions and fees totaled $1.87 million and $5.74 million during the third quarter of 2001 and year-to-date periods ended September 30, 2001 compared to $1.84 million and $5.97 million in the same periods, respectively of 2000. These amounts represent increases of $30 thousand, or 1.6%, and a decline of $230 thousand, or 3.9%, from the third quarter and year-to-date periods of 2000, respectively. The decrease during the current year-to-date period was largely the result of a decline in credit card discounts and loan servicing fees. Gains on the sales of loans increased $349 thousand, or 171.1%, to $553 thousand in the third quarter of 2001 compared to the same period in 2000 and increased $634 thousand, or 132.9%, to $1.11 million in the first three quarters of the year compared to the first three quarters of 2000. Gains on the sales of loans were favorably impacted during the third quarter and first nine months of 2001 by lower interest rates and a strong refinancing market. Other income totaled $467 thousand during the three months ended September 30, 2001 compared to $283 thousand in the third quarter of 2000 and $992 thousand during the first three quarters of 2001 versus $1.77 million in the same period of 2000. The current amounts represent an increases of $184 thousand, or 65.0%, and a decrease of $782 thousand, or 44.1%, during the third quarter and year-to-date periods, respectively. The increase during the current quarter compared to the same quarter in 2000 was primarily the result of an increased level of check charges. The decrease during the year-to-date period was largely the result of a reduction of income earned from the sale of call options related to AREA's equity investment portfolio. The amount earned during the first three quarters of 2000 on call options was $713 thousand. Security gains totaled $3 thousand in the first nine months of 2001 compared to gains of $15.60 million during the same period 2000. The gains on the sale of securities during 2000 reflected AREA's strategy to improve the performance of its investment portfolio through repositioning portions of the portfolio as market conditions changed. 24 NONINTEREST EXPENSES The tables that follow set forth the components of noninterest expense for the three and nine-month periods ended September 30, 2001 and 2000. The amounts presented below for the three-and nine-month periods include adjustments for infrequently occurring noninterest expenses for comparability purposes.

25 NONINTEREST EXPENSES (CONTINUED) Noninterest expenses totaled $23.55 million and $69.84 million during the three and nine-month periods ended September 30, 200. These amounts represent decreases of $1.21 million, or 4.9%, in the current quarter compared to the same period in 2000 and $191 thousand, or 0.3%, during the first nine months of 2001 compared to the first three quarters of 2000. Excluded in the following analysis is $2.29 million of consolidation expenses in the third quarter of 2000. In addition, during the nine months ended September 30, 2000, $2.29 million of consolidation expenses and $382 thousand of merger and acquisition expenses have been excluded. During the current quarter and year-to-date periods there were no infrequently occurring noninterest expense items. Excluding infrequently occurring items, recurring noninterest expenses increased $1.08 million, or 4.8%, to $23.55 million in the current quarter compared to the same period last year and increased $2.49 million, or 3.7%, during the current year-to date period compared to the first nine months of 2001. Salaries and benefits increased $586 thousand, or 5.6%, to $11.04 million in the third quarter of 2001 while rising $1.10 million, or 3.6%, during the current nine-month period. The increase during the current quarter compared to the third quarter of 2000 was primarily the result of the addition of Associate Mortgage Group, Inc. (see Note 2 in the accompanying unaudited consolidated financial statements for details). Net occupancy expenses increased $38 thousand, or 2.3%, to $1.67 million and $458 thousand, or 10.1%, to $4.98 million, respectively, for the three-and nine-month periods ended September 30, 2001, when compared to similar period totals in 2000, due primarily to expenses related to the modernization of several facilities, higher utility costs, and increased property taxes. Furniture and equipment expenses totaled $1.74 million and $5.46 million during the third quarter of 2001 and year-to-date periods ended September 30, 2001. The current quarter reflected a decrease of $28 thousand, or 1.6%, while the year-to-date period increased $224 thousand, or 4.3%. The increase for the year-to-date period was primarily the result of an increase in service contracts on AREA's equipment. Data processing expenses totaled $1.10 million during the current quarter compared to $1.30 million in the same period in 2000 and totaled $3.28 million during the nine months ended September 30, 2001 versus $4.05 million during the first three quarters of 2000. The decreases, $204 thousand, or 15.6%, and $774 thousand, or 19.1%, for the quarter and year-to-date periods, respectively, were the result of the consolidation of operations which enabled AREA to obtain volume discounts from its third party data service provider. Advertising and community relations expense increased $100 thousand, or 11.4%, to $974 thousand during the current quarter and $339 thousand, or 13.1%, to $2.92 million during the nine months ended September 30, 2001 when compared to the same periods in 2000. An increase in expenses related to customer awareness of the consolidated bank was primarily responsible for the increases along with the added costs of the introduction of several new products. Insurance and taxes totaled $1.44 million during the current quarter compared to $1.01 million during the same period in 2000 and totaled $4.07 million in the current nine-month period versus $3.17 million during the first three quarters of 2000. The increases were $432 thousand, or 42.9%, and $909 thousand, or 28.7%, for the three-month and nine-month periods ended September 30, 2001 compared to the similar periods in 2000. The increases were primarily the result of increased state and local taxes on AREA's banks. Professional fees decreased $149 thousand, or 13.3%, and $632 thousand, or 16.1%, during the current quarter and year-to-date periods compared to similar periods in 2000. The decreases during both the current quarter and year-to-date periods were the result of reduced merger and acquisition activities. Other noninterest expenses totaled $2.75 million during the current quarter compared to $2.63 million for the same period in 2000 and totaled $8.89 million during the nine months ended September 30, 2001 compared to $8.11 million in the same period in 2000. The current quarter reflected an increase of $116 thousand, or 4.4%, while the year-to-date period increased of $777 thousand, or 9.6%. The increase during the year-to-date period was largely the result of increases in postage, other real estate expenses, and office supplies. INCOME TAX EXPENSE Income tax expense totaled $4.18 million and $10.88 million for the three-and nine-month periods ended September 30, 2001 compared to $2.70 million and $15.60 million during the same periods in 2000. The reduced level of income tax expense for the current nine-month period was the result of a lower level of pre-tax income caused primarily by a reduced security gains. The effective tax rates were 30.6% and 30.4% during the three-and nine-month periods ended September 30, 2001 compared to 28.8% and 34.2% during the same periods of 2000. The effective tax rate differs from the marginal income tax rate of 35% in both 2001 and 2000 due primarily to the effects of tax exempt interest, goodwill amortization in both 2000 and 2001 and state taxes on security gains in 2000. The effective tax rates decreased during the current year-to-date period compared to the same period in 2000 largely as a result of state taxes on security gains in 2000. 26 B. FINANCIAL POSITION Total assets grew $177.48 million, or 6.4%, to $2.95 billion from December 31, 2000 and $199.25 million, or 7.3%, from September 30, 2000. Assets averaged $2.87 billion in the quarter ended September 30, 2001 compared to $2.72 billion during the same period in 2000. The growth in average assets from the quarter ended September 30, 2000 to the quarter ended September 30, 2001 was $146.91 million, or 5.4%. Earning assets totaled $2.72 billion on September 30, 2001 and reflected an increase of $220.21 million, or 8.8%, from December 31, 2000 earning assets which totaled $2.50 billion. Earning assets grew $229.45 million, or 9.2%, from September 30, 2000 to September 30, 2001. Earning assets averaged $2.68 billion in the current quarter compared to $2.51 billion in the same period in 2000. The growth in total assets, average assets and earning assets was largely the result of the approximately $200.00 million of securities acquired in a leveraging transaction discussed in "Leveraging Transaction" in the "Net Interest Income" section. SHORT-TERM INVESTMENTS AND SECURITIES Short-term investments, which include interest-bearing deposits with banks and federal funds sold, totaled $4.00 million on September 30, 2001, as compared to $5.99 million at year-end and $5.78 million on September 30, 2000. Securities represented 27.4% of earning assets on September 30, 2001 and totaled $744.85 million, an increase of $195.00 million, or 35.5%, from $549.85 million on December 31, 2000. The securities portfolio increased $198.00 million, or 36.2%, from September 30, 2000. The increases, during both the quarter and year-to-date periods, were largely the result of securities acquired in a leveraging transaction (see "Leveraging Transaction" in the "Net Interest Income" section for additional details) partially off-set by securities being called. The transaction involved the purchasing of approximately $200.00 million of fixed-rate mortgage-backed securities issued by government sponsored enterprises. The held-to-maturity and available-for-sale portfolios as of September 30, 2001 consisted of 7.1% in U.S. and other government agency securities, 58.2% in mortgage-backed securities, 29.8% in state and municipal securities and 4.9% in equity and other securities. The comparable distributions at December 31, 2000 were 25.0%, 35.3%, 33.0% and 6.7%, respectively. Since year-end the percentage of U.S. and other government agency securities declined from 25.0% to 7.1% as a result of maturities that were not re-invested due to the opportunity to obtain higher yields in other types of securities. The percentage of mortgage-backed securities increased from 35.3% on December 31, 2000 to 58.2% on September 30, 2001 primarily as a result of securities acquired in the leveraging transaction (see "Leveraging Transaction" in the "Net Interest Income" section for additional details). Note 5 to the accompanying unaudited consolidated financial statements provides additional details concerning AREA's investments. LOANS Loans, including loans held for sale, increased $27.20 million, or 1.4%, to $1.97 billion on September 30, 2001 from $1.94 billion on December 31, 2000. Loans, including loans held for sale, grew $33.23 million, or 1.7%, from September 30, 2000 to September 30, 2001. Loans, including loans held for sale, represent the largest category of earning assets, comprising 72.5% of earning assets as of September 30, 2001, 77.8% as of December 31, 2000 and 77.8% as of September 30, 2000. The following table presents the major categories of loans, net of unearned discount:

The changes in the balances of commercial and real estate loans from September 30, 2000 to September 30, 2001 were caused primarily by significant reclassifications between those two categories. The reclassifications were the result of AREA's consolidation of operations (see Note 10 in the accompanying unaudited consolidated financial statements). Commercial and real estate loans were reviewed and changes were made as necessary to reflect banking industry standard classifications. 27 DEPOSITS Deposits totaled $2.09 billion on September 30, 2001, a decrease of $58.68 million, or 2.7%, from $2.15 billion on December 31, 2000. Noninterest-bearing deposits declined $32.06 million, or 9.6%, to $300.53 million from December 31, 2000. The decrease in noninterest-bearing deposits from year-end totals was partially the result of customers' desire to substitute their noninterest-bearing deposits for interest-bearing deposits plus the effects of corporate customers moving funds into checking accounts over year-end and reducing those balances early in the year. Interest-bearing deposits decreased $26.62 million, or 1.5%, from year-end balances. Average total deposits were very stable, decreasing $896 thousand, or 0.04%, to $2.10 billion during the quarter ended September 30, 2001 compared to the fourth quarter of 2000. Average noninterest-bearing deposits decreased $6.26 million, or 2.1%, to $292.97 million while average interest-bearing deposits increased $5.36 million, or 0.30%, to $1.81 billion from the fourth quarter of 2000 to the third quarter of 2001. The following table summarizes the composition of deposits:

BORROWED FUNDS AREA's primary source of funding for earning assets is customers' deposits; however, outside funding sources are also used. These outside funding sources include: federal funds purchased and securities sold under agreements to repurchase which include short-term borrowings from commercial customers as part of a cash management service, notes payable to the U. S. Treasury that are short-term borrowings in connection with treasury, tax and loan deposits, Federal Home Loan Bank advances which generally include intermediate-term borrowings by AREA's affiliate banks, and other borrowings. Borrowed funds increased by $216.01 million, or 71.6%, to $517.59 million from $301.58 million on December 31, 2000 and increased $150.23 million, or 40.9%, from September 30, 2000. Borrowed funds increased during the current quarter primarily as a result of the addition of approximately $200.00 million of borrowings used in a leveraging transaction entered into during July 2001. AREA entered into this leveraging transaction to enhance earnings through better utilization of capital levels. The leveraging was achieved by borrowing approximately $200.00 million from the Federal Home Loan Bank and investing the funds primarily in fixed-rate mortgage-backed securities issued by government sponsored enterprises (see "Leveraging Transaction" in the "Net Interest Income" section for additional details). CAPITAL RESOURCES Shareholders' equity totaled $307.20 million at September 30, 2001, an increase of $20.56 million, or 7.2%, from $286.64 million on December 31, 2000 and an increase of $29.49 million, or 10.6%, from September 30, 2000. During the first three quarters of 2001 shareholders' equity grew as a result of net income which totaled $25.09 million and an increase totaling $5.68 million in accumulated other comprehensive income. Other comprehensive income, which is comprise solely of the after-tax net unrealized gain on securities available for sale, increased primarily as a result of the effect of falling interest rates on AREA's fixed income securities. As an off-set to the growth in shareholders' equity, dividends of $3.28 million were paid during the first nine months of the year and a total of 420,250 shares were repurchased at a total cost of $7.15 million. The increase in accumulated other comprehensive income occurred primarily as a result of AREA's fixed income securities increasing in value due to interest rates declining since early in 2001. The shareholders' equity-to-asset ratio was 10.43% at September 30, 2001 compared to 10.35% on December 31, 2000 and 10.11% on September 30, 2000. During the third quarter of 2001 AREA purchased 410,250 shares of its common stock at an average price of $17.07 while 420,250 shares were repurchased during the first three quarters of 2001 at an average price of $17.01. 28 CAPITAL RESOURCES (CONTINUED) Book value per share was $12.85, $11.79 and $11.35 on September 30, 2001, December 31, 2000 and September 30, 2000, respectively. During the first three quarters of 2001, AREA paid cash dividends of $0.135 per share for a total of $3.28 million, an increase of $0.018, or 15.4% per share, compared to the same period in 2000. A summary of the regulatory capital ratios for AREA is shown below:

ASSET QUALITY Each of AREA's affiliated banks provides as an expense an amount for expected loan losses. This amount is called the provision for loan losses and increases the allowance for loan losses. The allowance for loan losses is maintained at a level management believes is adequate to absorb estimated losses inherent in the loan portfolio, considering nonperforming loans and overall economic conditions. Actual losses on loans are charged against the allowance for loan losses. At September 30, 2001, the allowance for loan losses was $26.59 million, or 1.36%, of period-end loans, as compared to $27.63 million, or 1.43%, of loans at December 31, 2000 and $27.71 million, or 1.44%, of September 30, 2000 loans outstanding. The ratio of the allowance for loan losses to nonperforming assets was 252.5% as of September 30, 2001 compared with 356.2% at December 31, 2000 and 440.1% on September 30, 2000. Nonperforming assets consist of nonaccrual loans, loans past due ninety days or more that are still accruing interest, restructured loans and other real estate owned. Nonperforming assets totaled $10.53 million on September 30, 2001 compared to $7.76 million on December 31, 2000 and $6.30 million on September 30, 2000. The increase has been $2.77 million since year-end and occurred primarily as a result of an increase from $1.76 million to $3.73 million in loans contractually past due 90 days or more as to interest or principal and still accruing. Currently, year-to-date net charge-offs (loan charge-offs less recoveries) are at 0.26% (annualized) of average year-to-date loans compared to 0.06% (annualized) during the same period in 2000. The following schedule details the dollar amount of nonperforming assets at September 30, 2001, December 31, 2000 and September 30, 2000, represented by nonaccrual loans, loans contractually past due ninety days or more as to interest or principal payments and still accruing and other real estate owned:

Included in nonaccrual loans at June 30, 2001, and disclosed in the June 30, 2001 Form 10-Q, was a $2.0 million loan related to a single commercial customer engaged in the transportation industry. This loan relationship was placed on nonaccrual status effective June 30, 2001 and identified as impaired. During the quarter ended September 30, 2001, $1.27 million of this loan was charged-off. Management believes that this charge-off has reduced the loan to its realizable value and no additional charge-offs are expected. On June 30, 2001 nonperforming assets totaled $8.89 million. The increase from June 30, 2001 to September 30, 2001 was largely related to one loan placed on nonaccrual with a total balance of $3.65 million and an appraised value of the underlying collateral of $4.00 million. 29 ASSET QUALITY (CONTINUED) Management, with accountability for the credit relationships, reviews selected credits to identify loans with increased risk or potential losses. In addition to this initial review, AREA's credit review function, its outside independent auditors, as well as its internal auditors and regulatory agencies supplement management's review. Further, the adequacy of the allowance for loan losses is monitored on a quarterly basis and is based on management's evaluation of several key factors, including the quality of the current portfolio, current national and local economic conditions, concentrations in loan types, evaluation of problem loans, and a review of historical charge-off and recovery experience. The allocation of the allowance for loan losses is an estimate of the portion which will be used to cover future charge-offs in each loan category, but does not preclude any portion of the allowance allocated to one type of loan from being used to absorb losses of another loan type. This allocation is determined by the estimated loss within each loan pool as well as any specific allocations that may be assigned to specific loans within the same portfolio section with the remainder being assigned to the unallocated category. A continuous and comprehensive loan review program is maintained by AREA. The purpose of this program is to provide periodic review and inspection of loans to ensure the safety, liquidity and profitability of the loan portfolio. AREA's credit review department is entrusted with the responsibility to identify foreseeable problems, measure compliance with established loan and operating policies and provide objective loan portfolio appraisals to the Board of Directors and management. Management believes that the allowance for loan losses, including amounts specifically allocated for nonaccrual loans and nonperforming loans is adequate in relation to probable losses inherent in the loan portfolio as of September 30, 2001. C. LIQUIDITY The purpose of liquidity management is to match the sources of funds with anticipated customer borrowings as well as withdrawals and other obligations. This is accomplished by balancing changes in demand for funds with changes in the supply of funds. Liquidity to meet demand is provided by maturing assets, the ability to attract deposits and borrowings from third parties such as the Federal Home Loan Bank. Deposits have historically provided AREA with a major source of stable and relatively low-cost funding. Secondary sources of liquidity include federal funds purchased, securities sold under agreements to repurchase, notes payable to the U.S. Treasury, advances from the Federal Home Loan Bank and other borrowings. During the nine months ended September 30, 2001, $92.15 million of net cash was provided through operating activities. This compares to $55.56 during the same period in 2000. The primary source of these funds in 2001 were proceeds from the sale of mortgage loans held for sale which totaled $63.90 million compared to $36.17 million in the same period of 2000. The increase in the sale of mortgages held for sale in 2001 compared to 2000 was the result of declining interest rates which caused customers to re-finance into fixed-rate loans which were sold. In the first nine months of 2001 a total of $273.42 million of net cash was used in investing activities compared to $93.90 million in 2000. Purchases of securities available for sale accounted for $279.57 million of cash used in investing activities in 2001 while purchases of securities available for sale accounted for $160.59 million in 2000. The increase in purchases of securities available for sale in 2001 compared to 2000 was primarily the result of securities purchased as part of the leveraging transaction (see "Leveraging Transaction" in the "Net Interest Income" section). Net cash used in financing activities totaled $146.96 million and $49.44 million during the first three quarters of 2001 and 2000, respectively. An increase in Federal Home Loan Bank advances of $173.15 million as a result of the leveraging transaction was the primary reason for the increase in net cash used in financing activities during the first nine months of 2001. During the first three quarters of 2001, these changes resulted in a $34.30 million decrease in cash and due from banks to $84.65 million while the changes above in the first nine months of 2000 resulted in an increase in cash and due of $11.09 million to $109.69 million on September 30, 2000. As of September 30, 2001, 70.97% of total assets were funded by core deposits while 17.57% were funded with secondary sources of liquidity discussed above, compared to 77.6% and 10.9%, respectively, as of December 31, 2000. As of September 30, 2000, those percentages were 75.6% and 13.4%, respectively. The percentage of assets funded by core deposits decreased during the quarter compared to both December 31, 2000 and September 30, 2000 as a result of the leveraging transaction (see "Leveraging Transaction" in the "Net Interest Income" section). The leveraging transaction used borrowed funds to increase assets by approximately $200.00 million. The net loan-to-deposit ratio increased from 88.8% on December 31, 2000 to 92.3% on September 30, 2001, as a result of an increase in loans and a decline in deposits during the period. 30 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For financial institutions, interest rate movements can have a critical impact on net interest income, and hence net income. The primary objective of interest rate risk management is to control and monitor the effects of those fluctuations and their impact on net income. Management considers interest rate risk to be the most significant market risk. Management views computer simulations as a more relevant measurement of the impact of changes in interest rates on net interest income, and hence net income, than other techniques that use interest rate sensitivity gap analysis. AREA uses a net income simulation model to measure near-term (next 12 months) risk due to changes in interest rates. The model incorporates substantially all of AREA's assets and liabilities, together with forecasted changes in the balance sheet mix and assumptions that reflect the current interest rate environment. Balance sheet changes are based on forecasted changes in loans, securities and deposits as well as historical pricing spreads. The model is updated at least quarterly with the current balance sheet structure and the current forecast of expected balance sheet changes. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure net income or exactly predict the impact of fluctuations in interest rates on net interest income. Actual results will differ from simulated results due to timing and amount of interest rate changes as well as changes in market conditions and management strategies. Management uses the model to simulate the effect of immediate and sustained parallel shifts upward and downward in the yield curve of 100 basis points (1.00%) and 200 basis points (2.00%). AREA's interest rate risk management focuses on maintaining consistent growth in net interest income within Board-approved policy limits. AREA's management monitors and manages interest rate risk to maintain an acceptable level of change to net interest income as a result of changes in interest rates. The following table illustrates the simulation analysis, using the methodology described above, of the impact of a 100 and 200 basis point upward and downward movement in interest rates on net income and earnings per share.

Given an immediate and sustained parallel shift upward of 200 basis points to the yield curve used in the simulation model, it is estimated that net income for AREA would increase by $7.87 million over the next year. Estimated diluted earnings per share would increase by $0.32 over the same period. A 200 basis point immediate and sustained parallel shift downward in the yield curve would decrease net income by an estimated $8.37 million over the next year while decreasing diluted earnings per share $0.34. All of the above changes in net income are within the policy guidelines established by the Board of Directors. In order to assist in reducing the exposure to interest rate fluctuations and manage liquidity, AREA sells virtually all long-term fixed-rate, single-family residential mortgages that are originated. These loans are underwritten according to Federal Home Loan Mortgage Corporation or Fannie Mae guidelines and are sold upon origination. In addition to the use of core deposits, which fund the primary portion of earning assets, AREA's affiliate banks borrow from the Federal Home Loan Bank to provide funds within time frames that are not available or are only available at higher costs through retail sources. Finally, management continually evaluates other interest rate risk management opportunities, including the use of derivative financial instruments. PART II. OTHER INFORMATION Item 1. Legal Proceedings Not applicable. Item 2. Changes in Securities Not applicable Item 3. Defaults Upon Senior Securities Not applicable. 31 Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- Not applicable. Pursuant to Rule 14a-4(c)(1) promulgated under to Securities Exchange Act of 1934, as amended, shareholders desiring to present a proposal for consideration at the 2002 Annual Meeting of Shareholders must notify AREA in writing at its principal office at P.O. Box 786, Owensboro, Kentucky 42302-0786 of the contents of such proposal no later than November 1, 2001. Failure to timely submit such a proposal will enable the proxies appointed by management to exercise their discretionary voting authority when the proposal is raised at the Annual Meeting of Shareholders without any discussion of the matter in the proxy statement. Item 5. Other Information On November 13, 2001, AREA filed a report on Form 8-K reporting its previously announced merger agreement with BB&L Corporation. Item 5, Other Events, stated "On November 8, 2001, BB&T Corporation announced plans to buy AREA Bancshares Corporation in a $450.6 million stock swap. The exchange will be fixed at 0.55 of a share of BB&T Corporation stock for each AREA Bancshares shares". In addition, a copy of the press release was attached as Exhibit 99-1 to the Form 8-K. Item 6. Exhibits and Reports on Form 8-K

32 Item 6. Exhibits and Reports on Form 8-K (continued) --------------------------------------------

33 Item 6. Exhibits and Reports on Form 8-K (continued) --------------------------------------------

34 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AREA BANCSHARES CORPORATION Date: November 14, 2001 By: /s/ Thomas R. Brumley --------------------- ------------------------------------------- Thomas R. Brumley President and Chief Executive Officer (Principal Executive Officer) Date: November 14, 2001 By: /s/ Edward J. Vega --------------------- ------------------------------------------- Edward J. Vega Senior Vice President-Chief Financial Officer (Principal Financial Officer) Date: November 14, 2001 By: /s/ Gary R. White --------------------- ------------------------------------------- Gary R. White Vice President, Controller (Principal Accounting Officer) 35

AREA BANCSHARES CORP 10-Q