SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to _______________
Commission File No.: 0-27388
HFNC Financial Corp.
(Exact name of registrant as specified in its charter)
North Carolina 56-1937349
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
139 South Tryon Street
Charlotte, North Carolina 28202
(Address) (Zip Code)
Registrant's telephone number, including area code: (704) 373-0400
Securities registered pursuant to Section 12(b) of the Act: Not Applicable
Securities registered pursuant to Section 12(g) of the Act
Common Stock (par value $.01 per share)
---------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
<PAGE>
Based upon the $16.00 closing price of the Registrant's common stock as of
September 26, 1997, the aggregate market value of the 14,775,901 shares of the
Registrant's common stock deemed to be held by non-affiliates of the Registrant
was: $236.4 million. Although directors and executive officers of the Registrant
and certain of its employee benefit plans were assumed to be "affiliates" of the
Registrant for purposes of this calculation, the classification is not to be
interpreted as an admission of such status.
Number of shares of Common Stock outstanding as of September 26, 1997:
17,192,500
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and
the Part of the Form 10-K into which the document is incorporated.
(1) Portions of the Annual Report to Stockholders for the year ended June 30,
1997 are incorporated into Part II, Items 5 through 8 of this Form 10-K.
(2) Portions of the definitive proxy statement for the 1997 Annual Meeting of
Stockholders to be filed within 120 days of June 30, 1997 are incorporated into
Part III, Items 9 through 13 of this Form 10-K.
<PAGE>
PART I
Item 1. Business.
General
HFNC Financial Corp. (the "Company") is a North Carolina corporation
organized in August 1995 by Home Federal Savings and Loan Association ("Home
Federal" or the "Association") for the purpose of becoming a unitary holding
company of the Association. The Association's conversion to stock form and the
concurrent offer and sale of the Company's common stock was consummated on
December 28, 1995 (the "Conversion"). The only significant assets of the Company
are the capital stock of the Association and the capital stock of HFNC
Investment Corp., a Delaware chartered finance subsidiary ("Investment Corp.").
The business and management of the Company consists of the business and
management of the Association and Investment Corp. At June 30, 1997, the Company
had $892.9 million in total assets, $731.9 million in total liabilities and
$161.1 million in total equity.
Home Federal conducts business from its main office and eight branch
offices and a loan origination office, all located in Mecklenberg County, North
Carolina. All but one of the Association's offices are located in Charlotte. The
region has become a major center for financial services, distribution and
transportation. Home Federal's deposits are insured by the Savings Association
Insurance Fund ("SAIF"), which is administered by the Federal Deposit Insurance
Corporation ("FDIC"), to the maximum extent permitted by law.
The Association is a community oriented savings institution which has
traditionally offered a wide variety of savings products to its retail customers
while concentrating its lending activities on the origination of loans secured
by one- to four-family residential dwellings, including an emphasis on loans for
construction of residential dwellings. To a significantly lesser extent, the
Association's activities have also included origination of commercial real
estate, land and consumer loans. In addition, the Company maintains a
significant portfolio of investment securities, which amounted to $175.7 million
or 19.7% of total assets at June 30, 1997, approximately 37% of which have
maturities of under five years. In addition to interest income on loans and
investments, the Company receives other income primarily from loan fees and
various service charges.
The Association currently exceeds all minimum regulatory capital
requirements. At June 30, 1997, the Association had tangible, core and
risk-based capital ratios of 18.9%, 18.9% and 36.5%, respectively, as compared
to the minimum requirements of 1.5%. 3.0% and 8.0%, respectively.
The Association is subject to examination and comprehensive regulation
by the Office of Thrift Supervision ("OTS"), which is the Association's
chartering authority and primary regulator. The Association is also regulated by
the FDIC, the administrator of the SAIF. The Association is also subject to
certain reserve requirements established by the Federal Reserve Board and is a
member of the Federal Home Loan Bank ("FHLB") of Atlanta, which is one of the 12
regional banks comprising the FHLB System.
Lending Activities
General. At June 30, 1997, the Association's total loans receivable
portfolio ("total loan portfolio") amounted to $704.3 million, or 78.9% of total
assets at such date. The Association has traditionally concentrated its lending
activities on conventional first mortgage loans secured by single-family
residential properties. Consistent with its lending orientation, $561.4 million
or 79.7% of the Association's total loan portfolio consisted of one-to-four
family residential loans at June 30, 1997. In addition, the Association
originates residential construction loans, commercial real estate loans, land
loans and consumer loans. At June 30, 1997, such loan categories amounted to
$68.4 million, $30.6 million, $20.0 million and $23.9 million, respectively, or
9.7%, 4.3%, 2.8% and 3.5% of the total loan portfolio, respectively. The
Association does not offer loans which are insured by the Federal Housing
Administration or partially guaranteed by the Office of Veterans Affairs.
Virtually all of the Association's mortgage loans are secured by properties
located in its primary market area.
1
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Loan Portfolio Composition. The following table sets forth the
composition of the Association's loan portfolio by type of loan at the dates
indicated.
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------------------------------
1997 1996 1995
----------------------------- --------------------- -------------------
Amount % Amount % Amount %
---------------- ----------- --------- --------- --------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Residential real estate $561,352 79.7% $416,711 75.4% $353,801 74.7%
Construction 68,366 9.7 61,015 11.1 50,068 10.6
Commercial real estate (1) 30,631 4.3 29,343 5.3 25,403 5.4
Land 19,992 2.8 22,844 4.1 19,326 4.1
Consumer loans:
Home equity 14,495 2.1 13,697 2.5 15,370 3.2
Credit cards 6,198 0.9 5,644 1.0 5,349 1.1
Other 3,255 0.5 3,278 0.6 4,356 0.9
-------- ----- --------- ----- ------- -----
Total loans receivable 704,289 100.0% 552,532 100.0% 473,673 100.0%
-------- ===== --------- ===== ------- =====
Less:
Allowance for loan losses 7,612 7,496 8,088
Loans in process 33,030 34,846 24,643
Deferred loan fees 5,324 5,059 4,934
Other -- -- --
-------- -------- --------
Loans receivable, net $658,323 $505,131 $436,008
======== ======== ========
<PAGE>
<CAPTION>
June 30,
------------------------------------------------
1994 1993
-------------------- ----------------------
Amount % Amount %
-------- --------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Residential real estate $346,599 72.0% $371,883 71.0%
Construction 51,557 10.7 53,488 10.2
Commercial real estate (1) 30,631 6.4 37,762 7.2
Land 27,066 5.6 25,635 4.9
Consumer loans:
Home equity 14,245 3.0 16,368 3.1
Credit cards 5,863 1.2 7,044 1.3
Other 5,301 1.1 11,844 2.3
-------- ----- -------- -----
Total loans receivable 481,262 100.0% 524,024 100.0%
-------- ===== -------- =====
Less:
Allowance for loan losses 7,828 7,181
Loans in process 31,304 28,297
Deferred loan fees 5,453 6,600
Other 35 50
-------- --------
Loans receivable, net $436,642 $481,896
======= ========
</TABLE>
- ----------------------
(1) Includes $134,000, $191,000, $640,000, $419,000 and $761,000 of
commercial business loans (i.e., working capital and inventory loans)
at June 30, 1997, 1996, 1995, 1994 and 1993, respectively.
2
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Contractual Principal Repayments and Interest Rates. The following
table sets forth certain information at June 30, 1997 regarding the dollar
amount of loans maturing in the Association's total loan portfolio, based on the
contractual terms to maturity. Loans having no stated schedule of repayments and
no stated maturity are reported as due in one year or less.
<TABLE>
<CAPTION>
Due 5 or more
Due 1 year Due 1-5 years years after
or less after June 30, 1997 June 30, 1997 Total
--------------------- ----------------------- ----------------- -------------
(In Thousands)
<S> <C> <C> <C> <C>
First mortgage loans:
Residential real estate $ 12,467 $ 23,975 $524,910 $561,352
Construction 62,967 4,967 432 68,366
Commercial real estate 11,449 17,610 1,572 30,631
Land 9,204 10,788 -- 19,992
Consumer 22,284 1,147 517 23,948
-------- -------- -------- --------
Total $118,371 $ 58,487 $527,431 $704,289
======== ======== ======== ========
</TABLE>
The following table sets forth the dollar amount of total loans due
after one year from June 30, 1997, as shown in the preceding table, which have
fixed interest rates or which have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Fixed rate Floating or adjustable-rate Total
----------------------- --------------------------- -----------------------
(In Thousands)
<S> <C> <C> <C>
First mortgage loans:
Residential real estate $425,882 $123,003 $548,885
Construction 5,399 -- 5,399
Commercial real estate 18,661 521 19,182
Land 10,788 -- 10,788
Consumer 1,664 -- 1,664
-------- -------- --------
Total $462,394 $123,524 $585,918
======== ======== ========
</TABLE>
Scheduled contractual maturities of loans do not necessarily reflect
the actual term of the Association's portfolio. The average life of mortgage
loans is substantially less than their average contractual terms because of loan
prepayments and enforcement of due-on-sale clauses, which give the Association
the right to declare a loan immediately due and payable in the event, among
other things, that the borrower sells the real property subject to the mortgage
and the loan is not repaid. The average life of mortgage loans tends to
increase, however, when current mortgage loan rates substantially exceed rates
on existing mortgage loans and, conversely, decrease when rates on existing
mortgage loans substantially exceed current mortgage loan rates. In addition,
management believes that a significant number of the Association's residential
mortgage loans are outstanding for a period significantly less than their
contractual terms. The Association attributes this to the mobile nature of the
people who reside in its market area which, over the past decade, has developed
as a regional corporate and banking center.
3
<PAGE>
Origination, Purchase and Sale of Loans. The lending activities of the
Association are subject to the written, non-discriminatory, underwriting
standards and loan origination procedures established by the Association's Board
of Directors and management. Loan originations are obtained from a variety of
sources, including builders, realtors, walk-in customers, loan officers, outside
loan correspondents and advertising. In its marketing, the Association
emphasizes its community ties, customized, personal service and an efficient
underwriting and approval process. The Association uses its in-house appraisal
staff for most residential real estate loans and construction loans secured by
property located in Mecklenberg County, North Carolina and outside appraisers
for most residential real estate loans and construction loans secured by
property located outside of Mecklenberg County and all commercial real estate
and land loans. The Association requires hazard, title and, to the extent
applicable, flood insurance on all security property.
Mortgage loan applications are initially processed by loan officers and
are required to be approved by the Association's Loan Committee, a management
committee consisting of the Association's mortgage lending manager and two
additional senior officers with lending expertise. Mortgage loans must be
approved by two of the three members of the Loan Committee. In addition, the
Association's President or Executive Vice President may act in the place of one
of the existing members of the Loan Committee. Notwithstanding the foregoing,
all loans over $1.0 million must be approved in advance by the Board of
Directors. Consumer loans are initially processed by consumer loan officers and
are required to be approved by designated officers of the Association depending
on both the amount and nature of the loan. All loans are ratified by the
Association's Board of Directors.
Historically, the Association has not been an active purchaser of loans
or participation interests in loans. The Association purchased $4.4 million of
loans during fiscal 1997, none during 1996, and $53,000 during 1995.
Loans have, from time to time, been sold by the Association primarily
to the Federal National Mortgage Association ("FNMA"), a quasi-governmental
agency, with servicing retained and without recourse. The Association did not
sell any loans during fiscal 1997, 1996 or 1995. However, management may sell
loans in the future to the extent that it believes the interest rate environment
is unfavorable and interest rate risk is unacceptable.
When loans are sold to the FNMA, the Association retains the
responsibility for servicing the loans, including collecting and remitting
mortgage loan payments, accounting for principal and interest and holding and
disbursing escrow or impound funds for real estate taxes and insurance premiums.
The Association receives a servicing fee for performing these services for
others. The Association's servicing portfolio amounted to $735.2 million at June
30, 1997, including $30.9 million of loans serviced for others.
4
<PAGE>
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------
1997 1996 1995
--------- --------- ---------
(In Thousands)
<S> <C> <C> <C>
Loan originations:
Residential real estate $ 170,561 $ 107,029 $ 28,100
Construction 74,114 65,508 56,677
Commercial real estate 8,072 10,105 2,500
Land 13,624 16,071 4,145
Consumer 5,494 4,117 6,332
--------- --------- ---------
Total loans originated 271,865 202,830 97,754
Loans purchased 4,366 -- 53
--------- --------- ---------
Total loans originated and
purchased 276,231 202,830 97,807
Loan principal reductions (123,360) (121,845) (101,315)
Transfer of loans to real estate owned (1,114) (2,127) (4,081)
--------- --------- ---------
Net increase (decrease) in total loan portfolio(1) $ 151,757 $ 78,858 $ (7,589)
========= ========= =========
</TABLE>
- ----------------------------
(1) The increase in the Association's loan portfolio in fiscal 1997 and
1996 was due to the use of loan correspondents in the origination
process and to the development of new mortgage loan products.
A savings institution generally may not make loans to one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus, although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities. At June 30, 1997, the Association's limit on
loans to one borrower was approximately $28.0 million. At June 30, 1997, the
Association's largest loan or groups of loans to one borrower, including persons
or entities related to the borrower, amounted to $6.2 million. This amount
consists of $3.0 million on construction loans for single-family residences,
$2.2 million in acquisition and development loans, and $1.0 million in
miscellaneous other loans, including land, commercial real estate and consumer
loans.
One-to-Four Family Residential Real Estate Loans. The Association has
historically concentrated its lending activities on the origination of loans
secured by first mortgage liens on existing one-to-four family residences
located in its market area. At June 30, 1997, $561.4 million or 79.7% of the
Association's total loan portfolio consisted of permanent one-to-four family
residential real estate loans. The Association originated $170.6 million, $107.0
million and $28.1 million of one-to-four family residential real estate loans in
fiscal 1997, 1996 and 1995, respectively. The increase in residential real
estate loan originations during fiscal 1997 and 1996 over prior years was due to
the use of loan correspondents in the origination process and to the development
of new mortgage loan products. The Association intends to continue to emphasize
the origination of permanent loans secured by first mortgage liens on
one-to-four family residential properties in the future.
5
<PAGE>
The Association's fixed-rate loans generally have maturities ranging
from 15 to 30 years and are fully amortizing with monthly payments sufficient to
repay the total amount of the loan with interest by the end of the loan term.
Such loans are originated under terms, conditions and documentation which permit
them to be sold to U.S. Government sponsored agencies such as the FNMA. The
Association's fixed-rate loans customarily include "due on sale" clauses, which
give the Association the right to declare a loan immediately due and payable in
the event the borrower sells or otherwise disposes of the real property subject
to the mortgage and the loan is not repaid.
The Association also originates for its portfolio one-to-four family
residential real estate loans which provide for an interest rate which adjusts
every year or which is fixed for a three or five year period and adjusts every
year after the initial period (such adjustable-rate loans are referred to as
"ARMs"). The Association's one-year ARM adjusts every year in accordance with
the national monthly median cost of funds index while the interest rate
adjustment for its three and five year ARMs after the initial fixed period is
based on the one year U.S. Treasury securities rate. The Association's ARMs are
typically based on a 30-year amortization schedule. The amount of any increase
or decrease in rate after the initial term is limited to 2% per year, with a
limit of 6% over the life of the loan. The Association qualifies the borrowers
on its loans which are fixed for three or five years based on the initial rate
and qualifies its borrowers for its one-year ARM based on the fully indexed
rate. The adjustable rate loans offered by the Association may generally be
converted to a fixed-rate loan within five years from the start of the initial
adjustment period. The Association does not offer deep discount rates and its
adjustable rate loans do not provide for negative amortization.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because as interest rates
rise, the payment by the borrower rises to the extent permitted by the terms of
the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates. The Association believes that these risks, which have not had a
material adverse effect on the Association to date, generally are less than the
risks associated with holding fixed-rate loans in an increasing interest rate
environment.
The Association's residential mortgage loans typically do not exceed
80% of the appraised value of the security property. Pursuant to underwriting
guidelines adopted by the Board of Directors, the Association can lend up to 95%
of the appraised value of the property securing a one-to-four family residential
loan; however, the Association generally obtains private mortgage insurance on
the portion of the principal amount that exceeds 80% of the appraised value of
the security property.
Construction Loans. The Association originates primarily residential
construction loans to local real estate builders, generally with whom it has an
established relationship. To a significantly lesser extent, the Association
originates such loans to individuals who have a contract with a builder for the
construction of their residence. The Association's construction loans are
secured by property located primarily in the Association's primary market area.
At June 30, 1997, construction loans amounted to $68.4 million or 9.7% of the
Association's total loan portfolio. In addition, at such date, the Association
had $33.0 million of undisbursed funds for construction loans in process. The
Association originated $74.1 million, $65.5 million and $56.7 million of
construction loans in fiscal 1997, 1996 and 1995, respectively.
The Association's construction loans generally have fixed interest
rates for a term of one year. Construction loans to builders are typically made
with a maximum loan-to-value ratio of 75%. Construction loans to individuals are
typically made in connection with the granting of the permanent financing on the
property. Such loans convert to a fully amortizing adjustable or fixed-rate loan
at the end of the construction term. The Association typically requires that
permanent financing with the Association or some other lender be in place prior
to origination of any construction loan to an individual.
The Association's construction loans to local builders are made on
either a pre-sold or speculative (unsold) basis. However, the Association
generally limits the number of unsold homes under construction to its builders,
with the amount dependent on the Association's prior experience with the
builder, the Association's present exposure to the
6
<PAGE>
builder, the location of the property and the number of unsold homes in the
development. The Association originates a significant portion of its
construction loans to builders on a speculative basis.
Prior to making a commitment to fund a construction loan, the
Association requires an appraisal of the property by the Association's appraisal
staff or independent state-licensed and qualified appraisers approved by the
Board of Directors. The Association's appraisal staff also reviews and inspects
each project at the commencement of construction and prior to every disbursement
of funds during the term of the construction loan. Loan proceeds are disbursed
after inspections of the project based on a percentage of completion. The
Association requires monthly interest payments during the construction term. The
amount of funds available for advance under the Association's construction loans
usually include an amount from which the borrower can pay the stated interest
due thereon until completion of the loan term.
Construction lending is generally considered to involve a higher level
of risk as compared to permanent one-to-four family residential lending, due to
the concentration of principal in a limited number of borrowers and the effects
of general economic conditions on developers and builders. Moreover, a
construction loan can involve additional risks because of the inherent
difficulty in estimating both a property's value at completion of the project
and the estimated cost (including interest) of the project. The nature of these
loans is such that they are generally more difficult to evaluate and monitor. In
addition, speculative construction loans to a builder are not pre-sold and thus
pose a greater potential risk to the Association than construction loans to
individuals on their personal residences.
The Association has attempted to minimize the foregoing risks by, among
other things, limiting the extent of its construction lending generally and by
limiting its construction lending to primarily residential properties. In
addition, the Association has adopted underwriting guidelines which impose
stringent loan-to-value, debt service and other requirements for loans which are
believed to involve higher elements of credit risk, by limiting the geographic
area in which the Association will do business to its existing market and by
working primarily with builders with whom it has established relationships. It
is also the Association's general policy to obtain personal guarantees from the
principals of its corporate borrowers on its construction loans.
Commercial Real Estate Loans. The Association originates mortgage loans
for the acquisition and refinancing of commercial real estate properties. The
Association generally offers such loans to accommodate its present customers. At
June 30, 1997, $30.6 million or 4.3% of the Association's total loan portfolio
consisted of loans secured by existing commercial real estate properties. The
majority of the Association's commercial real estate loans are secured by office
buildings, warehouses and manufacturing facilities, all of which are secured by
property located in the Association's market area. Management does not
anticipate that commercial real estate loans will comprise a substantial portion
of the loan portfolio in the future.
The Association requires appraisals of all properties securing
commercial real estate loans. Appraisals are performed by an independent
appraiser designated by the Association, all of which are reviewed by
management. The Association considers the quality and location of the real
estate, the credit of the borrower, the cash flow of the project and the quality
of management involved with the property.
The Association will primarily originate commercial real estate loans
with fixed interest rates subject to call provisions after three or five years.
Such loans are typically based on a 15 or 25 year amortization schedule.
Loan-to- value ratios on the Association's commercial real estate loans are
generally limited to 75%. As part of the criteria for underwriting commercial
real estate loans, the Association generally imposes a debt coverage ratio (the
ratio of net cash from operations before payment of debt service to debt
service) of not less than 1.2. It is also the Association's general policy to
obtain personal guarantees from the principals of its corporate borrowers on its
commercial real estate loans.
Commercial real estate lending entails significant additional risks as
compared with single-family residential property lending. Such loans typically
involve large loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans is typically dependent on the successful
operation of the real estate project. The
7
<PAGE>
success of such projects is sensitive to changes in supply and demand conditions
in the market for and commercial real estate as well as regional and economic
conditions generally. At June 30, 1997, the Association had $969,000 of
non-performing commercial real estate loans, which constituted 15.3% of total
non-performing loans at such date.
Land Loans. The Association originates land loans to local developers
for the purpose of developing the land (i.e., roads, sewer and water) for sale.
Such loans are secured by a lien on the property, are generally limited to 75%
of the developed value of the secured property and are typically made for a
period of three years with an interest rate that adjusts every year. The
Association requires monthly interest payments during the term of the land loan.
The amount of funds available under the Association's land loans usually include
an amount from which the borrower can pay the stated interest due thereon until
completion of the loan term. The principal of the loan is reduced as lots are
developed, sold and released. The Association's land loans are structured so
that the Association is repaid in full upon the sale of approximately 85% of the
available lots by the borrower. All of the Association's land loans are secured
by property located in its primary market area. In addition, the Association
attempts to obtain personal guarantees from its borrowers and originates such
loans to developers with whom it has established relationships. At June 30,
1997, the Association had $3.1 million of non-accruing land loans, which
constituted 48.7% of total non-performing loans at such date. Such amount
primarily consists of land loans to one borrower who has experienced financial
difficulties and is involved in litigation with the Association. See Item 3 -
Legal Proceedings.
Consumer Loans. The Association offers consumer loans in order to
provide a full range of financial services to its customers. The consumer loans
offered by the Association primarily consist of home equity loans and unsecured
loans through both MasterCard and VISA credit cards. Consumer loans amounted to
$23.9 million or 3.5% of the total loan portfolio at June 30, 1997, $14.5
million and $6.2 million of which consisted of home equity loans and credit card
debt, respectively.
The largest component of the Association's consumer loan portfolio is
home equity loans, which are secured by the underlying equity in the borrower's
home or second residence. Home equity loans are revolving loans and generally
have variable interest rates based on the prime rate plus a margin and maximum
terms of 15 years. The Association's home equity loans generally require
loan-to-value ratios of 80% or less after taking into consideration the first
mortgage loan.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. These risks are not as prevalent in the case of the
Association's consumer loan portfolio, however, because a high percentage of the
portfolio is comprised of home equity loans which are secured by real estate and
underwritten in a manner such that they result in a lending risk which is
substantially similar to single-family residential loans.
Loan Fee Income. In addition to interest earned on loans, the
Association receives income from fees in connection with loan originations, loan
modifications, late payments and for miscellaneous services related to its
loans. Income from these activities varies from period to period depending upon
the volume and type of loans made and competitive conditions.
The Association charges loan origination fees which are generally
calculated as a percentage of the amount borrowed. Loan origination and
commitment fees, as well as loan origination costs, are deferred and recognized
over the contractual remaining lives of the related loans on a level yield
basis. Discounts and premiums on loans purchased are accreted and amortized in
the same manner. In accordance with FASB Statement No. 91, the Association
recognized $1.7 million, $2.0 million and $1.7 million of deferred loan fees
during fiscal 1997, 1996 and 1995, respectively, in connection with loan
refinancing, payoffs and ongoing amortization of outstanding loans.
8
<PAGE>
Asset Quality
When a borrower fails to make a required payment on a loan, the
Association attempts to cure the deficiency by contacting the borrower and
seeking the payment. Contacts are generally made 15 days after a payment is due.
In most cases, deficiencies are cured promptly. If a delinquency continues,
additional contact is made either through a notice or other means and the
Association will attempt to work out a payment schedule. While the Association
generally prefers to work with borrowers to resolve such problems, the
Association will institute foreclosure or other proceedings, as necessary, to
minimize any potential loss. The Association generally initiates such
proceedings when a loan becomes 90 days delinquent.
Loans are placed on non-accrual status when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When a loan is placed on non-accrual
status, previously accrued but unpaid interest is deducted from interest income.
Presently, the Association does not accrue interest on real estate loans past
due 90 days or more. Loans may be reinstated to accrual status when payments are
under 90 days past due and, in the opinion of management, collection of the
remaining balance can be reasonably expected.
Real estate acquired by the Association as a result of foreclosure or
by deed in lieu of foreclosure is classified as other real estate owned until
sold. Pursuant to a statement of position ("SOP 92-3") issued by the AICPA in
April 1992, which provides guidance on determining the balance sheet treatment
of foreclosed assets in annual financial statements for periods ending on or
after December 15, 1992, there is a rebuttable presumption that foreclosed
assets are held for sale and such assets are recommended to be carried at the
lower of fair value minus estimated costs to sell the property, or cost
(generally the balance of the loan on the property at the date of acquisition).
After the date of acquisition, all costs incurred in maintaining the property
are expensed and costs incurred for the improvement or development of such
property are capitalized up to the extent of their net realizable value. The
Association's accounting for its real estate acquired by foreclosure complies
with the guidance set forth in SOP 92-3.
Under generally accepted accounting principles, the Association is
required to account for certain loan modifications or restructurings as
"troubled debt restructurings." In general, the modification or restructuring of
a debt constitutes a troubled debt restructuring if the Association for economic
or legal reasons related to the borrower's financial difficulties grants a
concession to the borrower that the Association would not otherwise consider.
Debt restructurings or loan modifications for a borrower do not necessarily
always constitute troubled debt restructurings, however, and troubled debt
restructurings do not necessarily result in non-accrual loans. The Association
had $643,000 of troubled debt restructurings as of June 30, 1997.
Federal regulations require that each insured savings association
classify its assets on a regular basis. There are three classifications for
problem assets: "substandard," "doubtful" and "loss." At June 30, 1997, the
Association had $10.9 million of classified assets.
9
<PAGE>
Non-Performing Assets. The following table sets forth the amounts and
categories of the Association's non-performing assets at the dates indicated.
<TABLE>
<CAPTION>
June 30,
---------------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Residential real estate $ 1,856 $ 2,632 $ 2,365 $ 5,516 $ 6,625
Construction 130 350 149 2,026 4,622
Commercial real estate 969 967 1,138 2,647 3,792
Land 3,076 4,082 4,405 6,847 7,623
Consumer 288 13 344 363 1,948
------- ------- ------- ------- -------
Total non-accruing loans 6,319 8,044 8,401 17,399 24,610
------- ------- ------- ------- -------
Real estate acquired in settlement
of loans, net of reserves 868 2,539 2,034 2,636 6,579
------- ------- ------- ------- -------
Total non-performing assets $ 7,187 $10,583 $10,435 $20,035 $31,189
------- ======= ======= ======= =======
Troubled debt restructurings $ 643 $ 525 $ 2,422 $ 1,208 $ 949
======= ======= ======= ======= =======
Total non-performing loans and
troubled debt restructurings as
a percentage of total net loans 1.06% 1.70% 2.48% 4.26% 5.30%
======= ======= ======= ======= =======
Total non-performing assets and
troubled debt restructurings as
a percentage of total assets 0.87% 1.41% 2.17% 3.70% 5.46%
======= ======= ======= ======= =======
</TABLE>
10
<PAGE>
For the year ended June 30, 1997, approximately $472,000 in gross
interest income would have been recorded on loans accounted for on a non-accrual
basis and troubled debt restructurings if such loans had been current in
accordance with their original terms and had been outstanding throughout the
year or since origination if held for part of the year. For the year ended June
30, 1997, $113,000 was included in net income for these same loans prior to the
time they were placed on non-accrual status or were restructured as a troubled
debt restructuring.
Total non-performing loans and troubled debt restructurings as a
percentage of total net loans have decreased significantly to 1.06% at June 30,
1997 from 5.30% at June 30, 1993. Correspondingly, total non-performing assets
and troubled debt restructurings as a percentage of total assets decreased to
0.87% from 5.46% during the same period. As discussed below, the decrease during
this period in non-performing construction and land loans was primarily due to
the resolution or reduction of large concentrations of loans to one local
developer who was experiencing debt service problems. The decrease in
non-performing residential real estate loans during the same period was
primarily due to the resolution or reduction of a large concentration of loans
to one borrower, including related entities, and, to a lesser extent, to the
continued improvement in the local economy.
In fiscal 1992, with the down-turn then being experienced in the
economy generally, and in the real estate market in particular, one local
developer began experiencing debt service problems with respect to his loans
from the Association and eventually filed for bankruptcy. At June 30, 1993, this
borrower's non-performing loans amounted to $1.6 million in residential loans,
$1.1 million in construction loans, $6.3 million in land loans and $1.8 million
in commercial loans, totaling more than $10.8 million of the $24.6 million in
total non-performing loans at June 30, 1993. As a result of charge-offs,
repayments and transfers to real estate owned since fiscal 1993, the Association
has substantially reduced its loans to this borrower to $3.3 million at June 30,
1997, consisting of nine non-accruing land loans amounting to $3.1 million and
three non-accruing commercial real estate loans amounting to $232,000. In
addition, during fiscal 1992 and 1993, the Association experienced similar
difficulties with respect to a large concentration of non-performing loans to
another borrower, including $1.6 million in residential real estate loans, $2.4
million in construction loans, $1.2 million in land loans and $1.0 million in
consumer and commercial real estate loans at June 30, 1993. These loans totaled
$6.2 million of the $24.6 million in total non-performing loans at June 30,
1993. As of June 30, 1997, the loans outstanding to this borrower have been
reduced to $1.2 million in residential rental real estate properties, all of
which are now fully performing.
At June 30, 1997, the $1.9 million of non-accruing residential real
estate loans consisted of 16 loans secured by single-family residential real
estate located primarily in the Association's market area. The largest
outstanding loan balance at such date amounted to $405,000, and the average
outstanding loan balance amounted to $116,000. Substantially all of such loans
were made to separate borrowers.
The $3.1 million of non-accruing land loans at June 30, 1997 consisted
of the nine loans to the local developer referred to above. All of such loans
are presently subject to litigation between the borrower and the Association.
See Item 3 - Legal Proceedings.
The $868,000 of real estate acquired in settlement of loans at June 30,
1997 consists of developed and undeveloped residential property and
single-family residential properties.
Allowance for Loan Losses. It is management's policy to maintain an
allowance for estimated losses based on the perceived risk of loss in the loan
portfolio and the adequacy of the allowance. Management's periodic evaluation of
the adequacy of the allowance is based on the Association's past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower's ability to repay, the estimated value of the
underlying collateral and current economic conditions. The allowance is
increased by provisions for loan losses which are charged against income.
Although management uses the best information available to make
determinations with respect to the provisions for loan losses, additional
provisions for loan losses may be required to be established in the future
should
11
<PAGE>
economic or other conditions change substantially. In addition, the OTS and the
FDIC, as an integral part of their examination process, periodically review the
Association's allowance for possible loan losses. Such agencies may require the
Association to recognize additions to such allowance based on their judgments
about information available to them at the time of their examination.
The following table sets forth an analysis of the Association's
allowance for loan losses during the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
period $ 7,496 $ 8,088 $ 7,828 $ 7,181 $ 4,013
------- ------- ------- ------- -------
Charge-offs:
Residential real estate (16) (16) (63) (368) (1,204)
Construction -- -- -- -- --
Commercial real estate (233) (1,086) (145) (127) (304)
Land -- (349) (16) -- (27)
Consumer (95) (41) (171) (247) (142)
------- ------- ------- ------- -------
Total charge-offs (344) (1,492) (395) (742) (1,677)
------- ------- ------- ------- -------
Recoveries:
Residential real estate 11 -- 80 -- --
Construction -- -- -- -- --
Commercial real estate 50 -- 85 24 42
Land 450 25 -- -- --
Consumer 8 538 4 13 12
------- ------- ------- ------- -------
Total recoveries 519 563 169 37 54
------- ------- ------- ------- -------
Net (charge-offs) recoveries 175 (929) (226) (705) (1,623)
------- ------- ------- ------- -------
Provision (recovery) for
losses on loans (59) 337 486 1,352 4,791
------- ------- ------- ------- -------
Balance at end of period $ 7,612 $ 7,496 $ 8,088 $ 7,828 $ 7,181
======= ======= ======= ======= =======
Allowance for loan losses as a
percent of total loans
outstanding 1.08% 1.36% 1.71% 1.63% 1.37%
======= ======= ======= ======= =======
Allowance for loan losses as a
percent of nonperforming loans
and troubled debt restructurings 109.33% 87.48% 74.73% 42.07% 28.10%
======= ======= ======= ======= =======
Ratio of net charge-offs (recoveries)
to average loans outstanding (0.03)% 0.20% 0.05% 0.16% 0.33%
======= ======= ======= ======= =======
</TABLE>
12
<PAGE>
The following table sets forth information concerning the allocation of
the Association's allowance for loan losses by loan category at the dates
indicated.
<TABLE>
<CAPTION>
June 30,
-------------------------------------------------------------------------------------
1997 1996 1995
----------------------- -------------------------- ------------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Each Each Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Residential real estate $4,319 79.7% $3,474 75.4% $3,029 74.7%
Construction 780 9.7 350 11.1 351 10.6
Commercial real estate 543 4.3 444 5.3 1,068 5.4
Land 1,697 2.8 3,012 4.1 3,265 4.1
Consumer 273 3.5 216 4.1 375 5.2
------ ----- ------ ----- ------ -----
Total $7,612 100.0% $7,496 100.0% $8,088 100.0%
------ ----- ====== ===== ====== =====
<CAPTION>
June 30,
-------------------------------------------------------
1994 1993
------------------------ ------------------------
Percent of Percent of
Loans in Loans in
Each Each
Category to Category to
Amount Total Loans Amount Total Loans
------ ----------- ------ -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Residential real estate $2,336 72.0% $2,767 71.0%
Construction 220 10.7 440 10.2
Commercial real estate 760 6.4 743 7.2
Land 4,075 5.6 2,469 4.9
Consumer 437 5.3 762 6.7
------ ----- ------ -----
Total $7,828 100.0% $7,181 100.0%
====== ===== ====== =====
</TABLE>
13
<PAGE>
Investment Securities
The investment policy of the Company, as established by the Board of
Directors, is designed primarily to provide and maintain liquidity and to
generate a favorable return on investments without incurring undue interest rate
risk, credit risk, and investment portfolio asset concentrations. The Company's
investment policy is currently implemented by the Association's President and
Chief Financial Officer within the parameters set by the Board of Directors.
The Association is authorized to invest in obligations issued or fully
guaranteed by the U.S. Government, certain federal agency obligations, certain
time deposits, negotiable certificates of deposit issued by commercial banks and
other insured financial institutions, investment grade corporate debt securities
and other specified investments.
Securities that management has the intent and positive ability to hold
to maturity are classified as held to maturity and are reported at amortized
cost. Securities classified as available for sale are reported at fair value,
with unrealized gains and losses, net of deferred income taxes, excluded from
earnings and reported as a separate component of equity. At June 30, 1997, all
$175.7 million of the Company's investment securities were classified as
available for sale. On December 31, 1995, management of the Company reevaluated
its intent with respect to its investment portfolio and, accordingly,
reclassified all investments and mortgage-backed securities from the held to
maturity classification to the available for sale classification. Prior to this
election, the majority of the Company's securities were included in its held to
maturity portfolio. At June 30, 1997, investments in the debt and/or equity
securities of any one issuer did not exceed more than 10% of the Company's
stockholders' equity. See Notes 1 and 2 of the Notes to the Consolidated
Financial Statements in the 1997 Annual Report to Stockholders filed as Exhibit
13 hereto (the "1997 Annual Report").
During fiscal 1997, the Company also invested its funds in
mortgage-backed securities. Mortgage-backed securities (which also are known as
mortgage participation certificates or pass-through certificates) typically
represent a participation interest in a pool of single-family or multi-family
mortgages, the principal and interest payments on which are passed from the
mortgage originators, through intermediaries (generally U.S. Government agencies
and government sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Association. Such
U.S. Government agencies and government sponsored enterprises, which guarantee
the payment of principal and interest to investors, primarily include the FNMA,
the Federal Home Loan Mortgage Corporation and the Government National Mortgage
Association.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages, i.e., fixed rate or adjustable rate, as well as
the prepayment risk, are passed on to the certificate holder. Accordingly, the
life of a mortgage-backed pass-through security approximates the life of the
underlying mortgages.
The actual maturity of a mortgage-backed security may be less than its
stated maturity due to prepayments of the underlying mortgages. Prepayments that
are faster than anticipated may shorten the life of the security and adversely
affect its yield to maturity. The yield is based upon the interest income and
the amortization of any premium or discount related to the mortgage-backed
security. In accordance with generally accepted accounting principles, premiums
and discounts are amortized over the estimated lives of the loans, which
decrease and increase interest income, respectively. The prepayment assumptions
used to determine the amortization period for premiums and discounts can
significantly affect the yield of the mortgage-backed security, and these
assumptions are reviewed periodically to reflect actual prepayments. Although
prepayments of underlying mortgages depend on many factors, including the type
of mortgages, the coupon rate, the age of mortgages, the geographical location
of the underlying real estate collateralizing the mortgages and general levels
of market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most significant determinant of the rate of prepayments. During periods of
falling mortgage interest rates, if the coupon rate of the underlying mortgages
exceeds the prevailing market interest rates offered for mortgage loans,
refinancing generally increases and accelerates the
14
<PAGE>
prepayment of the underlying mortgages and the related security. Under such
circumstances, the Association may be subject to reinvestment risk because to
the extent that the Association's mortgage-backed securities amortize or prepay
faster than anticipated, the Association may not be able to reinvest the
proceeds of such repayments and prepayments at a comparable rate.
For additional information relating to the Company's mortgage-backed
securities, see Note 2 of the Notes to the Consolidated Financial Statements in
the 1997 Annual Report.
The following table sets forth certain information relating to the
Company's investment portfolio at the dates indicated. At June 30, 1997, all of
the Company's investment securities were classified as available for sale.
<TABLE>
<CAPTION>
June 30,
-------------------------------------------------
1997 1996 1995
--------------- -------------- --------------
(In Thousands)
<S> <C> <C> <C>
U.S. Government and agency obligations $114,261 $119,805 $109,963
Mortgage-backed securities 53,197 123,087 --
FHLMC stock 8,252 5,553 4,424
-------- ------- --------
Total $175,710(1) $248,445 $114,387
======== ======== ========
</TABLE>
- -----------------
(1) Such amount includes $8.5 million of unrealized gains and $2.1 million
of unrealized losses.
15
<PAGE>
The following table sets forth the amount of the Company's investment
securities which mature during each of the periods indicated and the weighted
average yields for each range of maturities at June 30, 1997. The actual
maturity of the Company's investment securities may differ from contractual
maturity since certain of the Company's investment securities are subject to
call provisions which allow the issuer to accelerate the maturity date of the
security.
<TABLE>
<CAPTION>
Contractually Maturing
-------------------------------------------------------------------------------------
Weighted Weighted
Average Average
Under 1 Year Yield 1-5 Years Yield 5-10 Years
--------------- ------------ ------------------- ----------- -------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
U.S. Government and agency $10,959 4.93% $65,423 5.59% $6,831
obligations
Mortgage-backed securities -- -- -- -- --
FHLMC stock 8,252 1.39 -- -- --
------- ------- ------
Total $19,211 3.41% $65,423 5.59% $6,831
======= ==== ======= ==== ======
<CAPTION>
Contractually Maturing
-----------------------------------------------
Weighted Weighted
Average Greater Than Average
Yield 10 Years Yield
---------- -------------- ---------------
(Dollars in Thousands)
<S> <C> <C> <C>
U.S. Government and agency 6.86% $31,049 7.39%
obligations
Mortgage-backed securities -- 53,197 7.40
FHLMC stock -- -- --
-------
Total 6.86% $84,246 7.40%
==== ======= ====
</TABLE>
16
<PAGE>
Sources of Funds
General. Deposits are the primary source of the Association's funds for
lending and other investment purposes. In addition to deposits, the Association
derives funds from loan principal repayments and prepayments, securities sold
under repurchase agreements and advances from the FHLB of Atlanta. Loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows are significantly influenced by general interest rates and money market
conditions. Borrowings may be used to compensate for reductions in the
availability of funds from other sources and for general business purposes.
Deposits. The Association's deposit products include a broad selection of
deposit instruments, including negotiable order of withdrawal ("NOW") accounts,
money market accounts, regular savings accounts and term certificate accounts.
Deposit account terms vary, with the principal differences being the minimum
balance required, the time periods the funds must remain on deposit and the
interest rate.
The Association utilizes traditional marketing methods to attract new
customers and savings deposits. The Association does not advertise for deposits
outside of its primary market area and management believes that an insignificant
number of deposit accounts were held by non-residents of North Carolina at June
30, 1997. The Association does accept deposits placed by deposit brokers but
does not pay fees to such brokers for obtaining deposits. The Association's
management believes that the amount of deposits received through brokers
amounted to approximately $34.5 million at June 30, 1997. Although such deposits
have not been a volatile source of funds, deposits received from brokers are not
generally considered core deposits.
The Association has been competitive in the types of accounts and in
interest rates it has offered on its deposit products. Deposit levels were
higher during fiscal 1995 primarily as a result of an increase in rates offered
by the Association during that year as part of a special marketing program as
well as in response to a general increase in market interest rates. While the
average rate paid during fiscal 1995 was 4.74%, the weighted average rate at
June 30, 1995 was 5.67%. The effect of these rates continued in fiscal 1996,
resulting in an average rate paid during the year of 5.54%, compared to 4.74%
during fiscal 1995. The weighted average rate of deposits at June 30, 1996,
however, declined to 5.42%. During fiscal 1997, the downward trend in deposit
rates continued as the Association sought to moderate its cost of deposits by
not renewing high rate certificates of deposit as they have matured, or by
renewing them at market rates. As a result, the cost of deposits declined to
5.34% for the fiscal year ended June 30, 1997, with a year end weighted average
cost of 5.24%. Although market demand generally dictates which deposit
maturities and rates will be accepted by the public, the Association intends to
continue to promote checking and NOW accounts as well as longer term
certificates of deposit to the extent possible and consistent with its asset and
liability management goals.
17
<PAGE>
The following table sets forth the dollar amount of deposits in the
various types of deposit programs offered by the Association at the dates
indicated.
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------- -------------------------- --------------------------
Amount Percentage Amount Percentage Amount Percentage
-------------- ------------- ---------- -------------- --------- -------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Checking accounts $ 9,193 2.1% $ 9,326 2.1% $ 7,348 1.5%
NOW accounts 15,168 3.4 13,638 3.0 13,187 2.7
Passbook accounts 14,447 3.3 15,141 3.4 16,099 3.3
Money market 34,760 7.8 32,315 7.2 40,683 8.3
Certificates of deposit 370,272 83.4 378,151 84.3 413,249 84.2
-------- -------- --------
Total deposits $443,840 100.0% $448,571 100.0% $490,566 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
The following table presents the average balance of each deposit type and
the average rate paid on each deposit type for the periods indicated.
<TABLE>
<CAPTION>
June 30,
---------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- ------------------------ --------------------------
Average Average Average Average Average Average
Balance Rate Paid Balance Rate Paid Balance Rate Paid
------------- ----------- ---------- ----------- ------------ ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Checking $ 8,451 --% $ 7,565 --% $ 7,148 --%
NOW accounts 14,749 2.79 22,828 2.82 13,902 2.78
Passbook accounts 14,929 2.50 16,574 2.50 17,326 2.50
Money market 30,813 2.87 38,082 2.92 53,446 2.99
Certificates of deposit 371,957 5.90 406,016 6.17 360,675 5.28
-------- -------- --------
Total deposits $440,899 5.34% $491,065 5.54% $452,497 4.74%
======== ==== ======== ==== ======== ====
</TABLE>
<PAGE>
The following table sets forth the savings activities of the Association
during the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------
1997 1996 1995
-------- -------- -------
(In Thousands)
<S> <C> <C> <C>
Net increase (decrease) before
interest credited $(19,939) $(60,148) $31,405
Interest credited 15,208 18,152 13,665
-------- -------- -------
Net increase (decrease) in
deposits $ (4,731) $(41,996) $45,070
======== ======== =======
</TABLE>
18
<PAGE>
The following table shows the interest rate and maturity information for
the Association's certificates of deposit at June 30, 1997.
<TABLE>
<CAPTION>
Maturity Date
-----------------------------------------------------------------------------------
One Year Over 1-2 Over 2-3 Over 3
or Less Years Years Years Total
--------------- --------------- ------------- ------------- -----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
2.00 - 4.00% $ 3,932 $ 8 $ -- $ -- $ 3,940
4.01 - 6.00% 196,403 28,513 1,849 1,660 228,425
6.01 - 8.00% 91,280 26,052 11,146 5,830 134,308
8.01 - 10.00% 35 991 2,373 -- 3,399
10.01% - or more -- 200 -- -- 200
-------- -------- -------- -------- --------
Total $291,650 $ 55,764 $ 15,368 $ 7,490 $370,272
======== ======== ======== ======== ========
</TABLE>
The following table sets forth the maturities of the Association's
certificates of deposit having principal amounts of $100,000 or more at June 30,
1997.
<TABLE>
<CAPTION>
Amount
------
(In Thousands)
<S> <C>
Certificates of deposit maturing
in quarter ending:
September 30, 1997 $ 51,756
December 31, 1997 23,066
March 31, 1998 18,700
June 30, 1998 20,420
After June 30, 1998 31,159
--------
Total certificates of deposit with
balances of $100,000 or more $145,101
========
</TABLE>
19
<PAGE>
Borrowings. The Association may also obtain advances from the FHLB of
Atlanta upon the security of the common stock it owns in that bank and certain
of its residential mortgage loans, provided certain standards related to
creditworthiness have been met. Such advances are made pursuant to several
credit programs, each of which has its own interest rate and range of
maturities. Such advances are generally available to meet seasonal and other
withdrawals of deposit accounts and to permit increased lending.
The Association has also utilized securities sold under repurchase
agreements. These are agreements to sell securities under terms which require
the Association to repurchase the same or substantially similar securities by a
specified date.
The following table sets forth information with respect to the
Association's FHLB advances and securities sold under repurchase agreements at
and during the periods indicated.
<TABLE>
<CAPTION>
At or For the Year Ended June 30,
-------------------------------------------------------------------------------
1997 1996 1995
------------------------ ------------------------ -----------------------
(Dollars in Thousands)
<S> <C> <C> <C>
FHLB Advances:
Maximum balance $129,000 $10,000 $55,000
Average balance 61,093 1,038 46,197
Year end balance $129,000 $ -- $10,000
Weighted average interest rate:
At end of year 5.90% --% 6.75%
During the year 5.92% 5.89% 5.80%
Repurchase Agreements:
Maximum balance $120,000 $85,000 $ 8,000
Average balance 117,397 13,385 1,644
Year end balance $120,000 $85,000 $ --
Weighted average interest rate:
At end of year 5.81% 5.55% --%
During the year 5.78% 5.35% 6.63%
</TABLE>
Employees
The Company had 118 full-time employees and 10 part-time employees at June
30, 1997. None of these employees is represented by a collective bargaining
agent, and the Company believes that it enjoys good relations with its
personnel.
20
<PAGE>
Subsidiaries
The Company has two wholly owned subsidiaries consisting of the
Association and Investment Corp. Investment Corp. was formed in December 1995 as
a Delaware-chartered finance subsidiary. In addition to funds held by Investment
Corp. which were contributed to Investment Corp. by the Company in connection
with the Conversion, Investment Corp. also loaned $9.0 million to the Employee
Stock Ownership Plan. Investment Corp. generated net income of approximately
$2.3 million during fiscal 1997.
The Association is permitted to invest up to 2% of its assets in the
capital stock of, or secured or unsecured loans to, subsidiary corporations,
with an additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. The Association's only
subsidiary, Home Federal Savings Service Corporation ("Service Corporation"),
was formed in 1972. Service Corporation is involved in the sale of annuities and
various insurance products to the Association's customers and others. Service
Corporation generated net income of approximately $129,000 during fiscal 1997.
Competition
Charlotte is the third largest financial center in the nation after New
York and San Francisco. The Association faces strong competition in its local
market area both in attracting deposits and making real estate loans. Its most
direct competition for deposits has historically come from commercial banks and
other savings associations, including many large financial institutions which
have greater financial and marketing resources available to them. In addition,
during times of low interest rates, the Association has faced additional
significant competition for investors' funds from short-term money market
securities, mutual funds and other corporate and government securities. The
ability of the Association to attract and retain savings deposits depends on its
ability to generally provide a rate of return, liquidity and risk comparable to
that offered by competing investment opportunities. The Association experiences
strong competition for real estate loans principally from commercial banks and
mortgage companies. The Association competes for loans principally through the
interest rates and loan fees it charges and the efficiency and quality of
services it provides borrowers.
REGULATION
Set forth below is a brief description of those laws and regulations which
relate to the Company and the Association. The description of the laws and
regulations hereunder, as well as descriptions of laws and regulations contained
elsewhere herein, does not purport to be complete and is qualified in its
entirety by reference to applicable laws and regulations.
The Company
General. The Company is a savings and loan holding company within the
meaning of the Home Owners Loan Act ("HOLA") and is subject to OTS regulations,
examinations, supervision and reporting requirements. As a subsidiary of a
savings and loan holding company, the Association is subject to certain
restrictions in its dealings with the Company and affiliates thereof.
Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings institution. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings institution, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings institution; (ii)
transactions between the savings institution and its affiliates; and (iii) any
activities of the savings institution that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and
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loan holding companies, if the savings institution subsidiary of such a holding
company fails to meet the QTL test, as discussed under "- The Association -
Qualified Thrift Lender Test", then such unitary holding company also shall
become subject to the activities restrictions applicable to multiple savings and
loan holding companies and, unless the savings institution requalifies as a QTL
within one year thereafter, shall register as, and become subject to the
restrictions applicable to, a bank holding company. See "- The Association -
Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Association,
the Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, as set forth below, the activities of the Company and any of its
subsidiaries (other than the Association or other subsidiary savings
institutions) would thereafter be subject to further restrictions. Among other
things, no multiple savings and loan holding company or subsidiary thereof which
is not a savings institution shall commence or continue for a limited period of
time after becoming a multiple savings and loan holding company or subsidiary
thereof any business activity, upon prior notice to, and no objection by the
OTS, other than: (i) furnishing or performing management services for a
subsidiary savings institution; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings institution; (iv) holding or managing properties used
or occupied by a subsidiary savings institution; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding companies; or (vii)
unless the Director of the OTS by regulation prohibits or limits such activities
for savings and loan holding companies, those activities authorized by the
Federal Reserve Board as permissible for bank holding companies. Those
activities described in (vii) above also must be approved by the Director of the
OTS prior to being engaged in by a multiple savings and loan holding company.
Limitations on Transactions with Affiliates. Transactions between savings
institutions and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
savings institution. In a holding company context, the parent holding company of
a savings institution (such as the Company) and any companies which are
controlled by such parent holding company are affiliates of the savings
institution. Generally, Sections 23A and 23B (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such institution's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and other similar transactions. In
addition to the restrictions imposed by Sections 23A and 23B, no savings
institution may (i) loan or otherwise extend credit to an affiliate, except for
any affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the savings institution.
In addition, Sections 22(h) and (g) of the Federal Reserve Act places
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a savings institution, and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the savings
institution's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons and also requires prior board approval for certain loans. In addition,
the aggregate amount of extensions of credit by a savings institution to all
insiders cannot exceed the institution's unimpaired capital and surplus.
Furthermore, Section 22(g) places additional restrictions on loans to executive
officers. At June 30, 1997, the Association was in compliance with the above
restrictions.
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Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other savings institution or
savings and loan holding company or substantially all the assets thereof or (ii)
more than 5% of the voting shares of a savings institution or holding company
thereof which is not a subsidiary. Except with the prior approval of the
Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may acquire control of any savings institution, other than
a subsidiary savings institution, or of any other savings and loan holding
company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if (i) the multiple savings and loan holding
company involved controls a savings institution which operated a home or branch
office located in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by the state-chartered institutions or savings and loan holding
companies located in the state where the acquiring entity is located (or by a
holding company that controls such state-chartered savings institutions).
Under the Bank Holding Company Act of 1956, the FRB is authorized to
approve an application by a bank holding company to acquire control of a savings
institution. In addition, a bank holding company that controls a savings
institution may merge or consolidate the assets and liabilities of the savings
institution with, or transfer assets and liabilities to, any subsidiary bank
which is a member of the Bank Insurance Fund ("BIF") with the approval of the
appropriate federal banking agency and the FRB. As a result of these provisions,
there have been a number of acquisitions of savings institutions by bank holding
companies in recent years.
The Association
General. The OTS has extensive authority over the operations of federally
chartered savings institutions. As part of this authority, savings institutions
are required to file periodic reports with the OTS and are subject to periodic
examinations by the OTS and the FDIC. The investment and lending authority of
savings institutions are prescribed by federal laws and regulations, and such
institutions are prohibited from engaging in any activities not permitted by
such laws and regulations. Those laws and regulations generally are applicable
to all federally chartered savings institutions and may also apply to
state-chartered savings institutions. Such regulation and supervision is
primarily intended for the protection of depositors.
The OTS' enforcement authority over all savings institutions and their
holding companies includes, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS.
Insurance of Accounts. The deposits of the Association are insured to the
maximum extent permitted by the SAIF, which is administered by the FDIC, and are
backed by the full faith and credit of the U.S. Government. As insurer, the FDIC
is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings institutions, after giving the OTS an
opportunity to take such action.
The BIF fund met its target reserve level in September 1995, but the SAIF
was not expected to meet its target reserve level until at least 2002.
Consequently, in late 1995, the FDIC approved a final rule regarding deposit
insurance premiums which, effective with respect to the semiannual premium
assessment beginning January 1, 1996, reduced
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deposit insurance premiums for BIF member institutions in the lowest risk
category. Deposit insurance premiums for SAIF members were maintained at their
existing levels (23 basis points for institutions in the lowest risk category).
On September 30, 1996, President Clinton signed into law legislation to
eliminate the premium differential between SAIF-insured institutions and
BIF-insured institutions by recapitalizing the SAIF's reserves to the required
ratio of 1.25% of insured deposits. The legislation provided that the holders of
SAIF-assessable deposits pay a one-time special assessment to recapitalize the
SAIF. The legislation also provided for the merger of the BIF and the SAIF, with
such merger being conditioned upon the prior elimination of the thrift charter.
Effective October 8, 1996, FDIC regulations imposed a one-time special
assessment equal to 65.7 basis points for all SAIF-assessable deposits as of
March 31, 1995, which was collected on November 27, 1996.
Following the imposition of the one-time special assessment, the FDIC
lowered assessment rates for SAIF members to reduce the disparity in the
assessment rates paid by BIF and SAIF members. Beginning October 1, 1996,
effective BIF and SAIF rates both range from zero basis points to 27 basis
points. From 1997 through 1999, FDIC- insured institutions will pay
approximately 1.3 basis points of their BIF-assessable deposits and 6.4 basis
points of their SAIF-assessable deposits to fund the Financing Corporation.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Association, if it determines after a hearing that
the institution has engaged or is engaging in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Association's deposit insurance.
Regulatory Capital Requirements. Federally insured savings institutions
are required to maintain minimum levels of regulatory capital. The OTS has
established capital standards applicable to all savings institutions. These
standards generally must be as stringent as the comparable capital requirements
imposed on national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual institutions on a
case-by-case basis.
Current OTS capital standards require savings institutions to satisfy
three different capital requirements. Under these standards, savings
institutions must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets, "core" capital equal to at least 3.0% of adjusted total assets and
"total" capital (a combination of core and "supplementary" capital) equal to at
least 8.0% of "risk-weighted" assets. For purposes of the regulation, core
capital generally consists of common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings institution's intangible assets, with only a limited exception
for purchased mortgage servicing rights. The Association had no goodwill or
other intangible assets at June 30, 1997. Both core and tangible capital are
further reduced by an amount equal to a savings institution's debt and equity
investments in subsidiaries engaged in activities not permissible to national
banks (other than subsidiaries engaged in activities undertaken as agent for
customers or in mortgage banking activities and subsidiary depository
institutions or their holding companies). These adjustments do not materially
affect the Association's regulatory capital.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to include both core capital and supplementary
capital in its total capital, provided that the amount of supplementary capital
included does not exceed the savings institution's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and
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intermediate-term preferred stock; and general allowances for loan losses up to
a maximum of 1.25% of risk-1eighted assets. In determining the required amount
of risk-based capital, total assets, including certain off-balance sheet items,
are multiplied by a risk weight based on the risks inherent in the type of
assets. The risk weights assigned by the OTS for principal categories of assets
are (i) 0% for cash and securities issued by the U.S. Government or
unconditionally backed by the full faith and credit of the U.S. Government; (ii)
20% for securities (other than equity securities) issued by U.S.
Government-sponsored agencies and mortgage-backed securities issued by, or fully
guaranteed as to principal and interest by, the FNMA or the FHLMC, except for
those classes with residual characteristics or stripped mortgage-related
securities; (iii) 50% for prudently underwritten permanent one- to four-family
first lien mortgage loans not more than 90 days delinquent and having a
loan-to-value ratio of not more than 80% at origination unless insured to such
ratio by an insurer approved by the FNMA or the FHLMC, qualifying residential
bridge loans made directly for the construction of one- to four-family
residences and qualifying multi-family residential loans; and (iv) 100% for all
other loans and investments, including consumer loans, commercial loans, and
one- to four-family residential real estate loans more than 90 days delinquent,
and for repossessed assets.
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest rate risk
will be subject to a deduction of its interest rate risk component from total
capital for purposes of calculating its risk-based capital. As a result, such an
institution will be required to maintain additional capital in order to comply
with the risk-based capital requirement. An institution with a greater than
"normal" interest rate risk is defined as an institution that would suffer a
loss of net portfolio value exceeding 2.0% of the estimated economic value of
its assets in the event of a 200 basis point increase or decrease (with certain
minor exceptions) in interest rates. The interest rate risk component will be
calculated, on a quarterly basis, as one-half of the difference between an
institution's measured interest rate risk and 2.0% multiplied by the economic
value of its assets. The rule also authorizes the Director of the OTS, or his
designee, to waive or defer an institution's interest rate risk component on a
case-by-case basis. The final rule was originally effective as of January 1,
1994, subject however to a two quarter "lag" time between the reporting date of
the data used to calculate an institution's interest rate risk and the effective
date of each quarter's interest rate risk component. However, in October 1994
the Director of the OTS indicated that it would waive the capital deductions for
institutions with a greater than "normal" risk until the OTS publishes an
appeals process. On August 21, 1995, the OTS released Thrift Bulletin 67 which
established (i) an appeals process to handle "requests for adjustments" to the
interest rate risk component and (ii) a process by which "well-capitalized"
institutions may obtain authorization to use their own interest rate risk model
to determine their interest rate risk component. The Director of the OTS
indicated, concurrent with the release of Thrift Bulletin 67, that the OTS will
continue to delay the implementation of the capital deduction for interest rate
risk pending the testing of the appeals process set forth in Thrift Bulletin 67.
Any savings institution that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on the institution's operations,
termination of federal deposit insurance and the appointment of a conservator or
receiver. The OTS' capital regulation provides that such actions, through
enforcement proceedings or otherwise, could require one or more of a variety of
corrective actions.
Liquidity Requirements. All savings institutions are required to maintain
an average daily balance of liquid assets equal to a certain percentage of the
sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings institutions. At the present time, the required minimum
liquid asset ratio is 5%. At June 30, 1997, the Association' liquidity ratio was
10.8%.
Capital Distributions. OTS regulations govern capital distributions by
savings institutions, which include cash dividends, stock redemptions or
repurchases, cash-out mergers, interest payments on certain convertible debt and
other transactions charged to the capital account of a savings institution to
make capital distributions. Generally, the regulation creates a safe harbor for
specified levels of capital distributions from institutions meeting at least
their minimum capital requirements, so long as such institutions notify the OTS
and receive no objection to the distribution
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from the OTS. Savings institutions and distributions that do not qualify for the
safe harbor are required to obtain prior OTS approval before making any capital
distributions.
Generally, a savings institution that before and after the proposed
distribution meets or exceeds its fully phased-in capital requirements (Tier 1
institutions) may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
is defined to mean the percentage by which the institution's ratio of total
capital to assets exceeds the ratio of its fully phased-in capital requirement
to assets. "Fully phased-in capital requirement" is defined to mean an
institution's capital requirement under the statutory and regulatory standards
applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the institution. Failure to
meet fully phased-in or minimum capital requirements will result in further
restrictions on capital distributions, including possible prohibition without
explicit OTS approval. See "- Regulatory Capital Requirements."
Tier 2 institutions, which are institutions that before and after the
proposed distribution meet or exceed their minimum capital requirements, may
make capital distributions up to a specified percentage of their net income
during the most recent four quarter period, depending on how close the
institution is to meeting its fully phased-in capital requirements. Tier 3
institutions, which are institutions that do not meet current minimum capital
requirements, or which have been otherwise notified by the OTS that it will be
treated as a Tier 3 institution because they are in need of more than normal
supervision, cannot make any capital distribution without obtaining OTS approval
prior to making such distributions.
In order to make distributions under these safe harbors, Tier 1 and Tier 2
institutions must submit 30 days written notice to the OTS prior to making the
distribution. The OTS may object to the distribution during that 30-day period
based on safety and soundness concerns. At June 30, 1997, the Association was a
Tier 1 institution for purposes of this regulation.
Loans to One Borrower. The permissible amount of loans to one borrower now
generally follows the national bank standard for all loans made by savings
institutions. The national bank standard generally does not permit loans to one
borrower to exceed the greater of $500,000 or 15% of unimpaired capital and
surplus. Loans in an amount equal to an additional 10% of unimpaired capital and
surplus also may be made to a borrower if the loans are fully secured by readily
marketable securities.
Classified Assets. Federal regulations require that each insured savings
institution classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets, with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. Another category
designated "special mention" also must be established and maintained for assets
which do not currently expose an insured institution to a sufficient degree of
risk to warrant classification as substandard, doubtful or loss. Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses. If an asset or portion thereof is classified
loss, the insured institution must either establish specific allowances for loan
losses in the amount of 100% of the portion of the asset classified loss, or
charge-off such amount. General loss allowances established to cover possible
losses related to assets classified substandard or doubtful may be included in
determining an institution's regulatory capital up to certain amounts, while
specific valuation allowances for loan losses do not qualify as regulatory
capital. Federal examiners may disagree with an insured institution's
classifications and amounts reserved.
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Branching by Federal Savings Institutions. OTS policy permits interstate
branching to the full extent permitted by statute (which is essentially
unlimited). Generally, federal law prohibits federal savings institutions from
establishing, retaining or operating a branch outside the state in which the
federal institution has its home office unless the institution meets the IRS'
domestic building and loan test (generally, 60% of a thrift's assets must be
housing-related) ("IRS Test"). The IRS Test requirement does not apply if, among
other things, the law of the state where the branch would be located would
permit the branch to be established if the federal savings institution were
chartered by the state in which its home office is located. Furthermore, the OTS
will evaluate a branching applicant's record of compliance with the Community
Reinvestment Act of 1977 ("CRA"). An unsatisfactory CRA record may be the basis
for denial of a branching application.
Qualified Thrift Lender Test. All savings institutions are required to
meet a QTL test to avoid certain restrictions on their operations. A savings
institution that does not meet the QTL test must either convert to a bank
charter or comply with the following restrictions on its operations: (i) the
institution may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for a
national bank; (ii) the branching powers of the institution shall be restricted
to those of a national bank; (iii) the institution shall not be eligible to
obtain any advances from its FHLB; and (iv) payment of dividends by the
institution shall be subject to the rules regarding payment of dividends by a
national bank. Upon the expiration of three years from the date the savings
institution ceases to be a QTL, it must cease any activity and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations).
Currently, the QTL test requires that 65% of an institution's "portfolio
assets" (as defined) consist of certain housing and consumer-related assets on a
monthly average basis in nine out of every 12 months. Assets that qualify
without limit for inclusion as part of the 65% requirement are loans made to
purchase, refinance, construct, improve or repair domestic residential housing
and manufactured housing; home equity loans; mortgage-backed securities (where
the mortgages are secured by domestic residential housing or manufactured
housing); stock issued by the FHLB of Atlanta; and direct or indirect
obligations of the FDIC. In addition, the following assets, among others, may be
included in meeting the test subject to an overall limit of 20% of the savings
institution's portfolio assets: 50% of residential mortgage loans originated and
sold within 90 days of origination; 100% of consumer and educational loans
(limited to 10% of total portfolio assets); and stock issued by the FHLMC or the
FNMA. Portfolio assets consist of total assets minus the sum of (i) goodwill and
other intangible assets, (ii) property used by the savings institution to
conduct its business, and (iii) liquid assets up to 20% of the institution's
total assets. At June 30, 1997, the qualified thrift investments of the
Association were approximately 88.3% of its portfolio assets.
Accounting Requirements. Applicable OTS accounting regulations and
reporting requirements apply the following standards: (i) regulatory reports
will incorporate GAAP when GAAP is used by federal banking agencies; (ii)
savings institution transactions, financial condition and regulatory capital
must be reported and disclosed in accordance with OTS regulatory reporting
requirements that will be at least as stringent as for national banks; and (iii)
the Director of the OTS may prescribe regulatory reporting requirements more
stringent than GAAP whenever the Director determines that such requirements are
necessary to ensure the safe and sound reporting and operation of savings
institutions.
The accounting principles for depository institutions are currently
undergoing review to determine whether the historical cost model or market-based
measure of valuation is the appropriate measure for reporting the assets of such
institutions in their financial statements. Such proposal is controversial
because any change in applicable accounting principles which requires depository
institutions to carry mortgage-backed securities and mortgage loans at fair
market value could result in substantial losses to such institutions and
increased volatility in their liquidity and operations. Currently, it cannot be
predicted whether there may be any changes in the accounting principles for
depository institutions in this regard beyond those imposed by SFAS No. 115 or
when any such changes might become effective.
Federal Home Loan Bank System. The Association is a member of the FHLB
of Atlanta, which is one of 12 regional FHLBs that administers the home
financing credit function of savings institutions. Each FHLB serves as a
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reserve or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLB. At
June 30, 1997, the Association had FHLB advances amounting to $129.0 million.
See "Business - Sources of Funds - Borrowings."
As a member, the Association is required to purchase and maintain stock in
the FHLB of Atlanta in an amount equal to 1% of its aggregate unpaid residential
mortgage loans, home purchase contracts or similar obligations at the beginning
of each year or 5% of FHLB advances, whichever is greater. At June 30, 1997, the
Association had $6.5 million in FHLB stock, which was in compliance with this
requirement.
The FHLBs are required to provide funds for the resolution of troubled
savings institutions and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid in the past and could
continue to do so in the future. These contributions also could have an adverse
effect on the value of FHLB stock in the future.
Federal Reserve System. The FRB requires all depository institutions to
maintain reserves against their transaction accounts (primarily NOW and Super
NOW checking accounts) and non-personal time deposits. As of June 30, 1997, no
reserves were required to be maintained on the first $4.3 million of transaction
accounts, reserves of 3% were required to be maintained against the next $52.0
million of net transaction accounts (with such dollar amounts subject to
adjustment by the FRB), and a reserve of 10% (which is subject to adjustment by
the FRB to a level between 8% and 14%) against all remaining net transaction
accounts. Because required reserves must be maintained in the form of vault cash
or a noninterest-bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce an institution's earning assets.
TAXATION
Federal Taxation
General. The Company and Association are subject to the generally
applicable corporate tax provisions of the Code, and Association is subject to
certain additional provisions of the Code which apply to thrift and other types
of financial institutions. The following discussion of federal taxation is
intended only to summarize certain pertinent federal income tax matters material
to the taxation of the Company and the Association and is not a comprehensive
discussion of the tax rules applicable to the Company and Association.
Year. The Company and Association file a federal income tax return on
the basis of a fiscal year ending on June 30.
Bad Debt Reserves. Savings institutions, such as the Association, which
meet certain definitional tests primarily relating to their assets and the
nature of their businesses, historically have been permitted to establish a
reserve for bad debts and to make annual additions to the reserve. These
additions may, within specified formula limits, be deducted in arriving at the
institution's taxable income. For purposes of computing the deductible addition
to its bad debt reserve, the institution's loans are separated into "qualifying
real property loans" (i.e., generally those loans secured by certain interests
in real property) and all other loans ("non-qualifying loans"). The deduction
with respect to non-qualifying loans must be computed under the experience
method, while, prior to fiscal 1997, a deduction with respect to qualifying
loans may be computed using a percentage based on actual loss experience or a
percentage of taxable income.
Recently enacted legislation will affect the Association's method of
establishing a tax reserve for bad debts and its ability to make annual
additions thereto. Pursuant to such legislation, the percentage of taxable
income method has been repealed. In addition, the Association is permitted to
deduct bad debts only as they occur and is required to
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recapture (i.e. take into income) over a six-year period the excess of the
balance of its bad debt reserves as of June 30, 1996 over the balance of such
reserves as of June 30, 1988. It is anticipated that any recapture of the
Association's bad debt reserves accumulated after 1987 would not have a material
adverse effect on the Company's financial condition and results of operations.
Under the previous percentage of taxable income method, the bad debt
deduction equals 8% of taxable income determined without regard to that
deduction and with certain adjustments. The availability of the percentage of
taxable income method permits a qualifying savings institution to be taxed at a
lower effective federal income tax rate than that applicable to corporations in
general. This resulted generally in an effective federal income tax rate payable
by a qualifying savings institution fully able to use the maximum deduction
permitted under the percentage of taxable income method, in the absence of other
factors affecting taxable income, of 32.2% exclusive of any minimum tax or
environmental tax (as compared to 35% for corporations generally). Any savings
institution at least 60% of whose assets are qualifying assets, as described in
the Code, was generally eligible for the full deduction of 8% of taxable income.
At June 30, 1997, the federal income tax reserves of the Company included
$16.9 million for which no federal income tax has been provided. Because of
these federal income tax reserves the stockholders' equity of the Company is
substantially restricted.
Distributions. If the Association were to distribute cash or property to
its sole stockholder, and the distribution was treated as being from its
accumulated bad debt reserves, the distribution would cause the Association to
have additional taxable income. A distribution is deemed to have been made from
accumulated bad debt reserves to the extent that (a) the reserves exceed the
amount that would have been accumulated on the basis of actual loss experience,
and (b) the distribution is a "non-qualified distribution." A distribution with
respect to stock is a non-qualified distribution to the extent that, for federal
income tax purposes, (i) it is in redemption of shares, (ii) it is pursuant to a
liquidation of the institution, or (iii) in the case of a current distribution,
together with all other such distributions during the taxable year, it exceeds
the institution's current and post-1951 accumulated earnings and profits. The
amount of additional taxable income created by a non-qualified distribution is
an amount that when reduced by the tax attributable to it is equal to the amount
of the distribution.
Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%.
The alternative minimum tax generally applies to a base of regular taxable
income plus certain tax preferences ("alternative minimum taxable income" or
"AMTI") and is payable to the extent such AMTI is in excess of an exemption
amount. The Code provides that an item of tax preference is the excess of the
bad debt deduction allowable for a taxable year pursuant to the percentage of
taxable income method over the amount allowable under the experience method.
Other items of tax preference that constitute AMTI include (a) tax-exempt
interest on newly issued (generally, issued on or after August 8, 1986) private
activity bonds other than certain qualified bonds and (b) 75% of the excess (if
any) of (i) adjusted current earnings as defined in the Code, over (ii) AMTI
(determined without regard to this preference and prior to reduction by net
operating losses).
Net Operating Loss Carryovers. A financial institution may carry back net
operating losses ("NOLs") to the preceding three taxable years and forward to
the succeeding 15 taxable years. This provision applies to losses incurred in
taxable years beginning after 1986. At June 30, 1997, the Company had no NOL
carryforwards for federal income tax purposes.
Capital Gains and Corporate Dividends-Received Deduction. Corporate net
capital gains are taxed at a maximum rate of 35%. The corporate
dividends-received deduction is 80% in the case of dividends received from
corporations with which a corporate recipient does not file a consolidated tax
return, and corporations which own less than 20% of the stock of a corporation
distributing a dividend may deduct only 70% of dividends received or accrued on
their behalf. However, a corporation may deduct 100% of dividends from a member
of the same affiliated group of corporations.
29
<PAGE>
Other Matters. Federal legislation is introduced from time to time that
would limit the ability of individuals to deduct interest paid on mortgage
loans. Individuals are currently not permitted to deduct interest on consumer
loans. Significant increases in tax rates or further restrictions on the
deductibility of mortgage interest could adversely affect the Association.
The Association's federal income tax returns for the tax years ended June
30, 1995 forward are open under the statute of limitations and are subject to
review by the IRS.
State Taxation
Unless authorized under special circumstances by the North Carolina
Department of Revenue, the filing of a consolidated state income tax return is
not permitted. Accordingly, each of the Company and its subsidiaries, including
the Association, but excluding Investment Corp., is subject to an annual
corporate income tax of 7.75% of its federal taxable income as computed under
the Code, subject to certain prescribed adjustments. In addition to the state
corporate income tax, the Company and the Association will be subject to an
annual state franchise tax, which is imposed at a rate of .15% applied to the
greatest of each institution's (i) capital stock, surplus and undivided profits,
(ii) investment in property in North Carolina or (iii) appraised valuation of
property in North Carolina.
Investment Corp. is subject to a Delaware franchise tax based on
Investment Corp.'s authorized capital stock or on its assumed par and no-par
capital, whichever yields a lower result. Under the authorized capital method,
each share is taxed at a graduated rate based on the number of authorized shares
with a maximum aggregate tax of $150,000 per year. Under the assumed par-value
capital method, Delaware taxes each $1,000,000 of assumed par-capital at the
rate of $200.
30
<PAGE>
PART II.
Item 2. Properties.
At June 30, 1997, the Company conducted its business from its executive
office in Charlotte, North Carolina, nine full service offices and one mortgage
loan office. The following table sets forth the net book value (including
leasehold improvements and equipment) and certain other information with respect
to the offices and other properties of the Company at June 30, 1997.
<TABLE>
<CAPTION>
Leased/ Net Book Value
Description/Address Owned of Property Amount of Deposits
- ---------------------------------------------- --------------- ----------------------- ---------------------
(In Thousands)
<S> <C> <C> <C>
Main Office:
139 South Tryon Street
Charlotte, North Carolina Owned $1,531 $116,961
Branch Offices:
6342 Carmel Road
Charlotte, North Carolina 28226 Owned 386 24,092
4400 Randolph Road
Charlotte, North Carolina 28211 Owned 249 68,140
5601 Reddman Road
Charlotte, North Carolina 28212 Owned 559 71,088
I-77 and Route 73
Cornelius, North Carolina 28031 Owned 344 26,199
4323 Park Road
Charlotte, North Carolina 28209 Leased(1) -- 80,500
4519 Sharon Road
Charlotte, North Carolina 28211 Leased(2) 166 37,916
8601 John Maynard Keynes Drive
Charlotte, North Carolina 28262 Owned 1,527 18,046
Mortgage Loan Office:
6310 Fairview Road
Charlotte, North Carolina 28211(3) Owned 4,475 898
</TABLE>
- ------------------------------------
(1) This property is subject to a lease that expires in 1999.
(2) This property is subject to a lease that expires in 2002 and the
Association has an option to renew the lease for one additional period
of five years.
(3) This property is also used as a branch office.
31
<PAGE>
Item 3. Legal Proceedings.
In June 1995, a lawsuit was initiated against the Association by a
borrower's affiliated companies in which the plaintiffs alleged that the
Association wrongfully set-off certain funds in an account being held and
maintained by the Association. In addition, the plaintiffs alleged that as a
result of the wrongful set-off, the Association wrongfully dishonored a check in
the amount of $270,000. Plaintiffs further alleged that the actions on behalf of
the Association constituted unfair and deceptive trade practices, thereby
entitling plaintiffs to recover treble damages and attorneys' fees. The
Association denied any wrongdoing and filed a motion for summary judgment. Upon
consideration of the motion, the United States Bankruptcy Judge entered a
Recommended Order Granting Summary Judgment, recommending the dismissal of all
claims asserted against the Association. The Recommended Order is now before the
United States District Court for the Western District of North Carolina and the
parties are awaiting the Federal District Court's decision of whether to enter
an Order Granting Summary Judgment in accordance with the Recommended Order by
the United States Bankruptcy Judge.
In December 1996, the Association filed a suit against the borrower and
his company and against the borrower's wife, daughter and a company owned by his
wife and daughter, alleging transfers of assets to the wife, daughter, and their
company in fraud of creditors, and asking that the fraudulent transfers be set
aside. The objective of the lawsuit is to recover assets which may be used to
satisfy a portion of the judgments obtained in favor of the Association in prior
litigation. The borrower's wife filed a counterclaim against the Association
alleging that she borrowed $750,000 from another financial institution, secured
by a deed of trust on her principal residence, the proceeds of which were paid
to the Association for application on debt owed by one of her husband's
corporations, claiming that officers of the Association promised to resume
making loans to her husband's corporation after the payment. Home Federal and
its officers vigorously deny all of her allegations. The case is scheduled for
discovery in September 1997, after which the Association intends to file a
motion for summary judgment for dismissal of the counterclaim.
In February 1997, two companies affiliated with those referred to in
the first paragraph above filed an additional action against two executive
officers of the Association and against an officer of another financial
institution. The action was removed from the state court and is presently
pending in the United States Bankruptcy Court for the Western District of North
Carolina. At the same time, the borrower, who is affiliated with all of these
companies, also filed an action against the two executive officers of the
Association and against an officer of another financial institution. The
Complaints in both actions assert virtually identical claims. The plaintiffs in
both lawsuits allege that the officers of both financial institutions engaged in
a conspiracy to wrongfully declare loans to be in default so as to eliminate
those companies as borrowers of the Association. Plaintiffs allege
misrepresentation, breach of fiduciary duty, constructive fraud, interference
with business expectancy, wrongful bank account set-off, and unfair and
deceptive acts and practices. Plaintiffs claim actual damages, treble damages
and punitive damages together with interest, attorneys' fees and other costs.
The Association has agreed to indemnify both of its officers with respect to
costs, expense and liability which might arise in connection with both of these
cases.
In July 1997, the above borrower and affiliated companies filed an
additional action against HFNC Financial Corp., the Association, and the other
financial institution referred to in the paragraph above, alleging that previous
judgments in favor of Home Federal and the other financial institution obtained
in prior litigation were obtained by the perpetration of fraud on the Bankruptcy
Court, U.S. District Court, and the 4th Circuit Court of Appeals. The plaintiffs
are seeking to have the judgments set aside on that basis. Home Federal has not
yet filed a responsive pleading. The Association vehemently denies that any
fraud was perpetrated upon the courts and intends to vigorously contest this
matter.
The Association and its officers continue to deny any liability in the
above described cases and continue to vigorously defend against the claims.
However, based on the advice of legal counsel, the Association is unable to give
an opinion as to the likely outcome of the litigation or estimate the amount or
range of potential loss, if any. See Note 11 of the Notes to the Consolidated
Financial Statements.
32
<PAGE>
Except as set forth above, the Association is not involved in any legal
proceedings other than those occurring in the ordinary course of business.
Management believes that such other legal proceedings will not have a material
adverse impact on the Association's financial condition or results of
operations.
Item 4. Submission of Matters to a Vote of Security-Holders.
Not applicable.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The information required herein, to the extent applicable, is
incorporated by reference from page 45 of the Company's 1997 Annual Report
("1997 Annual Report").
Item 6. Selected Financial Data.
The information required herein is incorporated by reference from page
1 of the 1997 Annual Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The information required herein is incorporated by reference from pages
2 to 15 of the 1997 Annual Report.
Item 8. Financial Statements and Supplementary Data.
The information required herein is incorporated by reference from pages
16 to 44 of the 1997 Annual Report.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III.
Item 10. Directors and Executive Officers of the Registrant.
The information required herein is incorporated by reference from pages
3 to 7 of the definitive proxy statement of the Company for the Annual Meeting
of Stockholders to be held on October 24, 1997, which was filed on October 3,
1997 ("Definitive Proxy Statement").
Item 11. Executive Compensation.
The information required herein is incorporated by reference from pages
11 to 16 of the Definitive Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required herein is incorporated by reference from pages
8 to 10 of the Definitive Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
The information required herein is incorporated by reference from page
16 of the Definitive Proxy Statement.
33
<PAGE>
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents Filed as Part of this Report
(1) The following financial statements are incorporated by
reference from Item 8 hereof (see Exhibit 13):
Report of Independent Auditors.
Consolidated Balance Sheets as of June 30, 1997 and 1996.
Consolidated Statements of Income for the Fiscal Periods Ended
June 30, 1997, 1996 and 1995.
Consolidated Statements of Changes in Shareholders' Equity for
the Fiscal Periods Ended June 30, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the Fiscal Periods
ended June 30, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements.
(2) All schedules for which provision is made in the applicable
accounting regulation of the SEC are omitted because of the absence of
conditions under which they are required or because the required information is
included in the consolidated financial statements and related notes thereto.
(3) The following exhibits are filed as part of this Form 10-K, and
this list includes the Exhibit Index:
<TABLE>
<CAPTION>
Exhibit Index
-------------
Page
----
<S> <C> <C>
2.0 Plan of Conversion *
3.1 Articles of Incorporation of HFNC Financial Corp. *
3.2 Bylaws of HFNC Financial Corp. *
4.0 Specimen Stock Certificate of HFNC Financial Corp. **
10.1 Employment Agreement among HFNC Financial Corp.,
Home Federal Savings and Loan Association and H. Joe King, Jr. *
10.2 Employment Agreement among HFNC Financial Corp.,
Home Federal Savings and Loan Association and J. Harold Barnes, Jr. *
13.0 1997 Annual Report to Stockholders E-1
21.0 Subsidiaries of the Registrant - Reference is made to "Item 2.
Business" for the required information
(*) Incorporated herein by reference from the Company's Registration
Statement on Form S-1 (Registration No. 33-97497) filed by the Company
with the SEC on September 20, 1995, as subsequently amended.
(**) Incorporated herein by reference from the Company's Annual Report on
Form 10-K for the year ended June 30, 1996.
</TABLE>
34
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HFNC FINANCIAL CORP.
By: /s/H. Joe King, Jr.
---------------------------------------
H. Joe King, Jr.
President, Chief Executive Officer
and Chairman of the Board
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
- ---- ----- ----
<S> <C> <C>
/s/H. Joe King, Jr. President, Chief Executive Officer September 29, 1997
- ------------------------------ and Chairman of the Board
H. Joe King, Jr.
/s/J. Harold Barnes, Jr. Executive Vice President and September 29, 1997
- ------------------------------ Director
J. Harold Barnes, Jr.
/s/Ray W. Bradley, Jr.
- ------------------------------ Director September 29, 1997
Ray W. Bradley, Jr.
/s/Joe M. Logan
- ------------------------------ Director September 29, 1997
Joe M. Logan
/s/John M. McCaskill
- ------------------------------ Director September 29, 1997
John M. McCaskill
/s/Lewis H. Parham, Jr.
- ----------------------------- Director September 29, 1997
Lewis H. Parham, Jr.
/s/Willie E. Royal
- ----------------------------- Director September 29, 1997
Willie E. Royal
/s/A. Burton Mackey, Jr. Vice President and Treasurer September 29, 1997
- ----------------------------- (principal financial officer)
A. Burton Mackey, Jr.
</TABLE>
HFNC Financial Corp.
- --------------------------------------------------------------------------------
1997
ANNUAL
REPORT
<PAGE>
Letter to Shareholders
- --------------------------------------------------------------------------------
Dear Fellow Shareholders:
We are pleased to present to you our second annual report, covering the
fiscal year ended June 30, 1997. Our first full fiscal year of operation as a
public company has been an eventful one. We have seen substantial progress in
resolving the deposit insurance premium disparity between thrifts and banks.
Though the $3.1 million up-front cost was considerable, our deposit insurance
cost in the future will be greatly reduced. Also during this year, we have been
able to return $5.26 per share to our shareholders through dividends, of which
95% represents a non-taxable return of capital. Our assets have increased to
$893 million, an increase of 13%, even after payment of the special distribution
of approximately $86 million. The asset growth occurred primarily in the loan
portfolio, which has grown by more than $153 million, an increase of over 30%
during this year alone. Contributing to the growth in our loan portfolio was the
opening of our Fairview Office, which is a meaningful addition to our customer
service delivery infrastructure. At this very desirable location, we have opened
a new branch and consolidated our mortgage loan department.
Fiscal 1997 Results
Consolidated net income for the year amounted to $7.4 million, or $.46
per share, compared to $7.6 million for the 1996 fiscal year. The fiscal 1997
net earnings, however, were impacted by a one time cost of $3.1 million ($1.9
million or $.12 per share after tax) pertaining to a special assessment by the
Federal Deposit Insurance Corporation to recapitalize the Savings Association
Insurance Fund. Earnings for the 1997 fiscal year were also lessened due to the
liquidation of securities to fund the $86 million special dividend paid to
shareholders on March 18, 1997. After-tax earnings were reduced by approximately
$1.1 million, or $.07 per share, due to this reduction in interest income. Net
interest income for the year totaled $30.7 million, an increase of $6.6 million,
or 27%, over the prior year.
Of significance this year has been our continued improvement in asset
quality. Nonperforming assets have declined 29.5% during the year, to $7.8
million at June 30, 1997 from $11.1 million at June 30, 1996. This represents a
decline from 1.4% of total assets to 0.9% during the twelve month period. The
June 30, 1997 allowance for loan losses stands at 109.3% of nonperforming loans,
as compared to 87.5% a year ago.
Outlook
Looking to the year ahead we will continue to look for ways to enhance
shareholder value while maintaining our commitment to provide the very best
quality service to our customers. Interest rates have remained relative stable
and the area real estate market continues to be very good. As a result, loan
demand is expected to continue to be brisk. Through the variety of loan programs
that we are now offering, combined with the outstanding location of our new loan
center, we expect continued growth in loan production while maintaining our
emphasis on asset quality.
In the past year there were several extraordinary charges as we have
reported to you. With these costs behind us, we anticipate earnings improvements
in the year ahead. This has been a good year for your company and its
shareholders. We were delighted to be able to pay the $5 special distribution
and will continue to look for ways to increase shareholder value. We look ahead
with anticipation.
We solicit your business and ask that you recommend Home Federal to
others. You can thus play a part in the growth and success of your company. I am
grateful to our directors, officers and employees for their commitment to
service. I appreciate your support and welcome your comments.
Sincerely,
/s/H. Joe King, Jr.
H. Joe King, Jr.
Chairman of the Board,
President and Chief Executive Officer
<PAGE>
Corporate Profile
- --------------------------------------------------------------------------------
HFNC Financial Corp. (the "Company") was incorporated in August 1995 under North
Carolina law for the purpose of acquiring all of the capital stock issued by
Home Federal Savings and Loan Association ("Home Federal" or the "Association")
in connection with its conversion from a federally chartered mutual savings and
loan association to a federally chartered stock savings and loan association
(the "Conversion"). The Conversion was consummated on December 28, 1995 and, as
a result, the Company became a unitary savings and loan holding company of the
Association. The Company has no significant assets other than the shares of the
Association's common stock acquired in the Conversion and the common stock of
HFNC Investment Corp., a wholly-owned, Delaware chartered finance subsidiary of
the Company. The Company has no significant liabilities.
The Association is a federally chartered stock savings and loan association
which believes that it is the oldest thrift presently operating in the
Carolinas. The Association dates back to 1883 with the founding of Mechanics
Perpetual Building and Loan Association. Home Federal conducts business from its
main office and eight branch offices and a loan origination office, all located
in Mecklenburg County, North Carolina. The Association is a community oriented
savings institution which has traditionally offered a wide variety of savings
products to its retail customers while concentrating its lending activities on
the origination of loans secured by one- to four-family residential dwellings,
including an emphasis on loans for construction of residential dwellings. To a
significantly lesser extent, the Association's activities have also included
origination of commercial real estate, land and consumer loans. In addition, the
Association maintains a significant portfolio of investment securities which are
issued by the United States government or agencies thereof, or government
sponsored enterprises.
At June 30, 1997, the Company had total assets of $892.9 million, total deposits
of $443.8 million and shareholders' equity of $161.1 million. The Company's and
the Association's principal executive offices are located at 139 South Tryon
Street, Charlotte, North Carolina 28202, and their telephone number is (704)
373-0400.
<PAGE>
Table of Contents
President's Letter to
Shareholders
Corporate Profile
PAGE
Selected Consolidated
Financial Highlights 1
Management's Discussion and
Analysis of Financial
Condition and Results of
Operations 2
Report of Independent
Certified Public Accountants 17
Financial Statements 18
Home Federal Savings and
Loan Association Account
Services
Shareholder Information
HFNC Financial Corp.
Directors and Officers
Home Federal Savings and
Loan Association Officers
and Banking Locations
<PAGE>
<TABLE>
<CAPTION>
SELECTED CONSOLIDATED FINANCIAL HIGHLIGHTS
- ------------------------------------------------------------------------------------------------------------------------------------
AS OF OR FOR THE YEAR ENDED JUNE 30,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
----------------------------------------------------------------------------
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Selected Consolidated Financial Data:
Total assets ................................... $ 892,920 $788,878 $589,659 $574,676 $588,337
Securities ..................................... 175,710 248,445 114,387 101,249 61,277
Loans receivable, net .......................... 658,323 505,131 436,008 436,642 481,896
Real estate .................................... 868 2,539 2,804 3,818 7,960
Deposits ....................................... 443,840 448,571 490,566 445,496 465,434
Other borrowings ............................... 277,000 85,000 10,000 50,000 56,000
Shareholders' equity ........................... 161,060 246,504 81,812 73,172 60,803
Book value, per share .......................... $ 9.37 $ 14.34 N/A N/A N/A
Nonperforming assets ........................... 7,830 11,108 12,857 21,243 32,138
Selected Operating Data:
Net interest and dividend income ............... $ 30,697 $ 24,133 $ 21,870 $ 27,462 $ 28,717
Provision for loan losses
(recovery of allowance) ....................... (59) 337 486 1,352 4,791
Other operating income ......................... 1,202 1,817 1,430 2,636 1,341
Other operating expenses ....................... 19,985 12,423 12,807 12,051 11,476
Net income ..................................... $ 7,364 $ 7,574 $ 6,150 $ 12,369 $ 6,578
Earnings per share:
Excluding SAIF assessment .................... 0.58 N/A N/A N/A N/A
Including SAIF assessment .................... 0.46 N/A N/A N/A N/A
Dividends per share ............................ 5.26 N/A N/A N/A N/A
Selected Operating Ratios:
Average interest rate spread * ................. 2.35% 2.34% 3.35% 4.64% 4.77%
Net interest margin * .......................... 3.70 3.65 3.89 5.01 5.08
Ratio of interest-earning assets
to interest-bearing liabilities ............... 1.32 1.31 1.12 1.10 1.07
Return on average assets:
Excluding SAIF assessment .................... 1.08 1.11 1.05 2.15 1.11
Including SAIF assessment .................... 0.86 1.11 1.05 2.15 1.11
Return on average equity:
Excluding SAIF assessment .................... 4.34 4.22 7.89 17.57 11.18
Including SAIF assessment .................... 3.46 4.22 7.89 17.57 11.18
Full-service offices at end of period .......... 9 8 8 8 8
<PAGE>
<CAPTION>
SELECTED CONSOLIDATED FINANCIAL HIGHLIGHTS
- ------------------------------------------------------------------------------------------------------------------------------------
AS OF OR FOR THE YEAR ENDED JUNE 30,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
----------------------------------------------------------------------------
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Asset Quality Ratios:
Nonperforming loans and troubled
debt restructurings as a percent
of net loans .................................. 1.06% 1.70% 2.48% 4.26% 5.30%
Nonperforming assets and
troubled debt restructurings as a
percent of total assets ....................... 0.87 1.41 2.17 3.70 5.46
Allowance for loan losses as a
percent of nonperforming loans and
troubled debt restructurings .................. 109.33 87.47 74.73 42.07 28.10
</TABLE>
* Average yield information has been computed using the historical cost balances
of investments available for sale and does not give effect to changes in fair
value that are reflected as a component of shareholders' equity.
- 1 -
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The operating results of the Company depend primarily upon its net
interest income, which is determined by the difference between interest and
dividend income on interest-earning assets, which consist principally of loans,
and securities and other investments, and interest expense on interest-bearing
liabilities, which consist principally of deposits and other borrowings. The
Company's net income also is affected by its provision for loan losses, as well
as the level of its other operating income, including loan fees and service
charges, gains on sale of loans and on sale of real estate owned ("REO"), and
its other operating expenses, including personnel expenses, occupancy expense,
federal deposit insurance premiums, net cost of real estate operations and
miscellaneous other expenses, and income taxes.
The following discussion provides an overview of the financial
condition and results of operations of the Company, and should be read in
conjunction with the Company's consolidated financial statements presented
elsewhere herein.
Summary of Changes in Financial Condition
The Company's assets increased by $104.0 million, or 13.2%, to $892.9
million at June 30, 1997 from $788.9 million at June 30, 1996. The increase in
assets primarily reflects the leveraging of the Company's capital through growth
in loans receivable. Net loan originations amounted to $152.5 million during the
year, compared to $70.1 million in fiscal 1996. The growth in loans was offset
somewhat by the payment of a $5 per share special distribution to shareholders
on March 18, 1997. This distribution was partially funded by the sale of
securities, which declined $72.7 million to $175.7 million at June 30, 1997.
Total liabilities increased $189.5 million, or 34.9%, during the 1997 fiscal
year due to an increase in other borrowed funds of $192.0 million. These
borrowings were used to fund the loan portfolio growth and a portion of the cost
of the special distribution. Shareholders' equity decreased $85.4 million to
$161.1 million or 18.0% of total assets at June 30, 1997. This decrease reflects
the payment of $83.1 millon in distributions to shareholders during the fiscal
year (including the special distribution discussed above) and the net increase
in cost of unearned Employee Stock Ownership Plan ("ESOP") shares and unvested
restricted stock in the Recognition and Retention Plan amounting to
approximately $14.4 million, offset somewhat by an increase in unrealized gain
on securities available for sale of $4.2 million and earnings during the period
of $7.4 million.
Securities. At June 30, 1997, total securities amounted to $175.7
million, a decrease of $72.7 million, or 29.3%, from the prior year level. This
decrease was due to the liquidation of securities to partially fund the special
distribution to shareholders in March 1997. Securities at June 30, 1997
consisted of $53.2 million of mortgage-backed securities, with the remaining
$122.5 million invested primarily in agency securities held principally for
liquidity purposes. The corresponding amounts at June 30, 1996 were $125.7
million and $123.2 million, respectively.
The Company's securities have been classified by management as
"available for sale." Under this classification, management may utilize these
securities for various asset/liability management purposes, and they may be sold
in response to liquidity needs, changes in interest rates, and other factors.
They are accounted for at fair value, with unrealized gains and losses recorded
as a separate component of shareholders' equity.
- 2 -
<PAGE>
Loans. Net loans receivable increased $153.2 million, or 30.3% , to
$658.3 million at June 30, 1997, compared to $505.1 million at June 30, 1996.
This increase primarily resulted from the use of outside loan correspondents to
supplement the efforts of the Association's own loan officers. These
correspondent loans were originated using the Association's normal underwriting
standards, rates, and terms, and were approved by the Association's loan
committee prior to origination. The subject properties were all in the
Association's market area. The Association intends to continue its use of loan
correspondents as long as management deems their use to be beneficial to the
Association. However, the Association has no agreement or obligation to continue
their use. A significant portion of the new loans are adjustable rate loans that
are fixed for the first three or five years, then adjust annually for the
remainder of the life of the loan. Most of these loans are convertible to a
fixed rate during the first five years of the adjustable period, upon payment of
a one-time fee. Adjustable rate loans amounted to $139.6 million at June 30,
1997, compared to $67.4 million at June 30, 1996, an increase of $72.2 million,
or 107.1%.
As a result of the growth in permanent residential mortgage loans in
the fiscal 1997 year, these loans have increased as a percentage of the total
loan portfolio to 79.7% at June 30, 1997, up from 75.4% at June 30, 1996. The
remainder of the loan portfolio at June 30, 1997 consisted of construction loans
(9.7%), commercial real estate loans (4.3%) land loans (2.8%), and consumer
loans (3.5%). The comparable percentages at June 30, 1996 were construction
loans (11.1%), commercial real estate loans (5.3%), land loans (4.1%), and
consumer loans (4.1%).
Unearned loan fee income at June 30, 1997 was $5.3 million, up from
$5.1 million at June 30, 1996. These unearned fees are recognized as an
adjustment to yield over the contractual lives of the related loans. Undisbursed
amounts of loans in process (primarily construction loans) were $33.0 million at
June 30, 1997, compared to $34.8 million at June 30, 1996.
Borrowed Funds. Borrowed funds increased $192.0 million, to $277.0
million at June 30, 1997 from $85.0 million at June 30, 1996. The additional
borrowings during fiscal 1997 consisted of $35.0 million in securities sold
under repurchase agreements, $129.0 million in Federal Home Loan Bank advances,
and a $28.0 million short-term bank loan. These borrowings were used to fund
loan growth and a portion of the special distribution to shareholders.
- 3 -
<PAGE>
Average Balances, Net Interest Income and Yields Earned and Rates Paid.
The following table sets forth, for the periods and at the date indicated,
information regarding the Company's average balance sheet. Information is based
on average daily balances during the periods presented.
<TABLE>
<CAPTION>
Year Ended June 30,
At -------------------------------------------
June 30,
1997 1997
------------ -------------------------------------------
Weighted Average
Yield/ Average Yield/
Rate(1) Balance Interest Rate
------------ ------------- ----------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Interest-earning assets:
Investment securities 5.79% $119,816 $ 7,443 6.21%
Mortgage-backed securities 7.40 101,010 6,990 6.92
Loans receivable 7.97 584,418 49,101 8.40
Other interest-earning assets 5.91 25,216 1,781 7.06
------- -------
Total interest-earning assets 7.57% 830,460 65,315 7.87%
==== ======= ====
Noninterest-earning assets 24,315
--------
Total assets $854,775
========
Interest-bearing liabilities:
Deposits 5.24% $440,899 $23,565 5.34%
Other borrowed funds 5.85 186,657 11,054 5.92
-------- -------
Total interest-bearing
liabilities 5.46% $627,556 $34,619 5.52%
==== ======= ====
Noninterest-bearing liabilities 14,130
--------
Total liabilities 641,686
Equity 213,089
--------
Total liabilities and equity $854,775
========
Net interest-earning assets $202,904
========
Net interest income/interest
rate spread $30,696 2.35%
======= ====
Net interest margin (2) 3.70%
====
Ratio of average interest-earning
assets to average interest-bearing
liabilities 1.32
====
<PAGE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------------------------------------------
1996 1995
----------------------------------------- ---------------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
---------- ---------- ---------- -------- ----------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment securities $119,069 $ 6,818 5.73% $114,483 $ 6,246 5.46%
Mortgage-backed securities 38,912 2,730 7.02 -- -- --
Loans receivable 454,168 39,995 8.81 433,081 38,909 8.98
Other interest-earning assets 49,873 2,599 5.21 15,353 966 6.29
-------- ------- -------- ------
Total interest-earning assets 662,022 $52,142 7.88% 562,917 $46,121 8.19%
======= ==== ====== ====
Noninterest-earning assets 24,696 24,605
-------- --------
Total assets $686,718 $587,522
======== ========
Interest-bearing liabilities:
Deposits $491,065 $27,218 5.54% $452,497 $ 21,464 4.74%
Other borrowed funds 14,423 790 5.48 48,101 2,787 5.79
-------- ------- -------- -------
Total interest-bearing
liabilities $505,488 $28,008 5.54% 500,598 $ 24,251 4.84%
======= ==== ======= ====
Noninterest-bearing liabilities 11,786 8,933
-------- --------
Total liabilities 517,274 509,531
Equity 169,444 77,991
-------- --------
Total liabilities and equity $686,718 $587,522
======== ========
Net interest-earning assets $156,534 $ 62,319
======== ========
Net interest income/interest
rate spread $ 24,134 2.34% $ 21,870 3.35%
======== ==== ======= ====
Net interest margin (2) 3.65% 3.89%
==== ====
Ratio of average interest-earning
assets to average interest-bearing
liabilities 1.31 1.12
==== ====
</TABLE>
(1) Includes non-accrual loans.
(2) Net interest income divided by average interest-earning assets.
- 4 -
<PAGE>
Rate/Volume Analysis. The following table sets forth the extent to
which changes in interest rates and changes in volume of interest-related assets
and liabilities have affected the Company's interest income and expense during
the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior year rate) and (ii)
changes in rate (change in rate multiplied by prior year volume). The net change
attributable to the combined impact of volume and rate has been allocated
proportionately to the change due to volume and the change due to rate.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
Increase Increase
(Decrease) Due to (Decrease) Due to
---------------------- ------------------------
Total Total
Increase Increase
Rate Volume (Decrease) Rate Volume (Decrease)
---------- --------- ----------- ----------- ----------- -----------
(In Thousands)
<C> <C> <C> <C> <C> <C>
Interest-earnings assets:
Investment securities $ 582 $ 43 $ 625 $ 316 $ 256 $ 572
Mortgage-backed securities (37) 4,297 4,260 -- 2,730 2,730
Loans receivable, net (1,737) 10,843 9,106 (753) 1,830 1,077
Other interest-earning assets 2,089 (2,907) (818) (129) 1,771 1,642
----- ------- ------- -------- --------
Total interest-earning assets 897 12,276 13,173 (566) 6,587 6,021
------- ------ ------ -------- -------- --------
Interest-bearing liabilities:
Deposits (954) (2,699) (3,653) 3,823 1,931 5,754
Other borrowed funds 69 10,195 10,264 (141) (1,855) (1,996)
----- ------ ------ -------- -------- --------
Total interest-bearing liabilities (885) 7,496 6,611 3,682 76 3,758
----- ----- ------ -------- -------- --------
Increase (decrease) in net interest income $1,782 $4,780 $6,562 $ (4,248) $ 6,511 $ 2,263
----- ----- ----- ======== ======== ========
</TABLE>
- 5 -
<PAGE>
Results of Operations
Net Income. The Company reported net income of $7.4 million for the
fiscal year ended June 30, 1997, compared to $7.6 million for the fiscal year
ended June 30, 1997, a decrease of $210,000, or 2.8%. This decrease was
attributable to a decrease in other operating income of $615,000, or 33.8%, and
an increase in other operating expenses of $7.6 million, or 60.9%. The increase
in other operating expenses included a $3.1 million one-time federal deposit
insurance assessment, as discussed below. These changes were partially offset by
an increase in net interest income of $6.6 million, or 27.2%, and a decrease in
the provision for loan losses of $396,000. The Company reported net income of
$7.6 million for the fiscal year ended June 30, 1996, compared to $6.2 million
for the fiscal year ended June 30, 1995, an increase of $1.4 million or 23.2%.
This increase was attributable to an increase in net interest and dividend
income of $2.3 million, or 10.3%, an increase in other operating income of
$386,000, or 27.0%, and a decrease in other operating expenses of $384,000, or
3.0%. Such results were partially offset by an increase in the income tax
provision of $709,000, or 18.4%, and an after-tax one-time cost of $1.1 million
resulting from the adoption of Statement of Financial Accounting Standard
("SFAS") No. 106 related to post-retirement benefits.
The current year was impacted by a $3.1 million one-time special
assessment by the Federal Deposit Insurance Corporation ("FDIC") to recapitalize
the Savings Association Insurance Fund ("SAIF"). Due to this recapitalization of
the SAIF, annual insurance premiums for savings and loan associations were
reduced from $.23 per $100 of deposits to approximately $.064 per $100, a level
more comparable to that of commercial banks. The reduced premiums took effect in
January 1997 and will benefit the Company's net income in future periods.
Net Interest Income. Net interest income is determined by the Company's
interest rate spread (i.e., the difference between the yields earned on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities. The Company's net interest income increased $6.6 million, or 27.2%,
to $30.7 million for the year ended June 30, 1997, compared to $24.1 million for
the prior year. This increase consisted of a $13.2 million, or 25.3%, increase
in interest income, offset somewhat by a $6.6 million, or 23.6%, increase in
interest expense. The Company's net interest income increased $2.3 million, or
10.3%, to $24.1 million for the year ended June 30, 1996, compared to $21.9
million for the prior year. This consisted of a $6.0 million or 13.1% increase
in interest income, offset somewhat by a $3.8 million or 15.5% increase in
interest expense.
During the current year, the Company's net interest margin increased
slightly to 3.70% from 3.65% during the prior year, and the net interest rate
spread increased similarly to 2.35% from 2.34%. These minor changes were due to
relatively consistent overall yields and costs on interest-earning assets and
interest-bearing liabilities. The net interest margin declined, however, to
3.28% during the quarter ended June 30, 1997 due to the payment of the special
distribution to shareholders in March 1997, which decreased interest-earning
assets without a corresponding decline in interest-bearing liabilities. The
ratio of average interest-earning assets to average interest-bearing liabilities
declined to 1.2 during the quarter ended June 30, 1997, compared to 1.3 during
the prior fiscal year. The net interest margin in future periods will continue
to be impacted by this payment of interest-earning funds.
During fiscal 1996, the Company's net interest margin declined to 3.65%
from 3.89% in the fiscal year ended June 30, 1995 and the net interest rate
spread decreased to 2.34% from 3.35%. These decreases were due to the continuing
effects of the interest rate increases and flattening of the yield curve
- 6 -
<PAGE>
experienced during late 1994 and early 1995, which increased the Association's
cost of funds during that period. Fiscal 1996 net interest and dividend income
increased over the prior year, however, because the decrease in spread was more
than offset by an increase in the ratio of average interest earning assets to
average interest-bearing liabilities to 1.3 for the year ended June 30, 1996
from 1.1 for the year ended June 30, 1995. This increase was primarily due to
investment of the proceeds of the Conversion and a significant increase in loan
originations during the year, which combined to increase interest earning assets
to an average of $662.0 million in 1996 from $562.9 million in 1995. In
addition, the Company experienced a moderation in the cost of deposits during
the period, with the weighted average cost of deposits dropping to 5.42% at June
30, 1996, compared to 5.67% at June 30, 1995, though the average rate paid for
the year was higher than the average rate for fiscal year 1995. Consequently,
the net interest margin improved over the course of fiscal 1996, amounting to
4.23% during the quarter ended June 30, 1996, compared to 3.54% during the
quarter ended June 30, 1995.
Interest Income. During fiscal 1997, interest income increased $13.2
million, or 25.3%, from the prior year due primarily to continued loan growth
and to a lesser extent, to a higher average balance in mortgage-backed
securities. Average loans outstanding increased during the current fiscal year
to $584.4 million from $454.2 million in the prior year due to continued
leveraging of the Company's capital (discussed more extensively at "Summary of
Changes in Financial Condition -- Loans"). The average balance of
mortgage-backed securities increased to $101.0 million in the current year,
compared to $38.9 million in the prior year. These securities were purchased
with a portion of the proceeds of the stock conversion during the third quarter
of the 1996 fiscal year and were therefore outstanding for less than two
quarters of fiscal 1996. Approximately one-half of these securities were sold
during the third quarter of fiscal 1997 to fund a portion of the special
distribution to shareholders, while the remainder continued to be outstanding
throughout fiscal 1997. Consequently, the average for the current year was
significantly higher than the average for the prior year. These increases in
average earning assets were complemented by an increase in the average yield on
securities, and offset to some extent by a decrease in average yield on loans.
The average yield on securities increased to 6.59% in the current year, compared
to 5.84% in the prior year, due to increased investment in longer term, and
higher yielding, securities, including mortgage-backed securities, than in the
time period prior to the conversion to stock ownership in fiscal 1996. The
average yield on loans declined during the current year to 8.40% from 8.81% due
to two primary factors. First, the initial rate of the new adjustable rate loan
products introduced during the last two years is at a moderate discount compared
to the rate for fixed rate loans. These initial rates are fixed for the first
three or five years before adjusting to market rates. Secondly, current interest
rates for new loan originations in the overall market are lower than the average
rate of the portfolio, so that new originations reduce the portfolio's average
rate. During fiscal 1996, interest and dividend income increased $6.0 million or
13.1% from the prior year due to the investment of the conversion proceeds into
interest-earning assets, including loans and securities. The positive impact of
an increase in the average balance of interest-earning assets was somewhat
offset by moderate declines in the yields on loans and other interest-earnings
assets. The average balance of investment securities amounted to $119.1 million
during the year ended June 30, 1996, compared to an average balance of $114.5
million during the prior year, while the average yield increased to 5.73% from
5.46%. The average balance increased due to the temporary deployment of
conversion proceeds, while the average yield increased due to investment in
longer term and higher yielding securities than in the 1995 year. The average
balance of mortgage-backed securities increased from none during the prior year
to $38.9 million during fiscal 1996 due to investment of a portion of the
conversion proceeds in these securities during the latter half of the year. The
average yield on these securities was 7.02%. Net loans receivable averaged
$454.2 million during the year ended June 30, 1996, compared to an average of
$433.1 million during the year ended June 30, 1995, while the average yield
declined to 8.81% from 8.98%. The
- 7 -
<PAGE>
increase in the average balance was largely due to the heavy volume of loan
originations during the last quarter of fiscal 1996, during which time net loans
outstanding increased $43.1 million. This growth resulted from new loan products
and from the use of outside loan correspondents in generating new loans. The
average yield generally declined due to the flattening of the yield curve noted
above and to the new adjustable rate loan products that were originated at lower
initial rates then fixed rate loans, though allowing greater interest rate
sensitivity in future periods.
Interest Expense. During fiscal 1997, interest expense increased $6.6
million, or 23.6%, compared to the prior year primarily due to an increase in
the average balance of other borrowed funds and an increase in the average rate
paid on these funds. The average balance of other borrowings increased to $186.7
million in the current year from $14.4 million in the prior year in order to
fund the growth in assets and therefore leverage the Company's capital. The
average rate paid on these borrowings increased to 5.92%, compared to 5.48% in
fiscal 1996. This increase in the average rate of borrowings was somewhat offset
by a decrease in the cost of deposits. The Association has sought to moderate
its cost of deposits by not renewing high rate certificates of deposit as they
have matured, or by renewing them at market rates. As a result, the cost of
deposits declined to 5.34% for the fiscal year ended June 30, 1997 from 5.54% in
the prior year. Interest expense for the year ended June 30, 1996 increased $3.8
million, or 15.5% compared to the prior year primarily due to an increase in
interest paid on customer deposits of $5.8 million, offset somewhat by a
decrease in the interest on other borrowings of $2.0 million. Interest on
deposits primarily increased due to an increase in the average rate paid to
5.54% in fiscal 1996 from 4.74% in the prior year. An increase in the average
balance of deposits to $491.1 million during the year ended June 30, 1996 from
$452.5 million during the year ended June 30, 1995 also contributed to the
increase in interest expense. The increase in the average balance was partially
due to stock subscription funds that were temporarily held in deposit accounts
pending the close of the stock conversion in December 1995. The increase in the
average rate paid primarily resulted from the continuing effects of the higher
rates paid on certain certificates of deposit opened during the third and fourth
quarters of fiscal 1995. As noted above, many of these certificates have matured
and have either not been renewed or have been renewed at lower rates, but a
portion of these products remain on the Association's books and will continue to
impact the Association's interest expense through the second quarter of the 1997
fiscal year. Interest on other borrowings decreased due to a decrease in the
average balance outstanding to $14.4 million for the year ended June 30, 1996
from $48.1 million in the prior year as well as a decline in average rate paid
to 5.48% in 1996 from 5.79% in 1995.
Provision for Loan Losses. The Company establishes provisions for loan
losses, which are charged to operations, in order to maintain the allowance for
loan losses at a level which is deemed to be appropriate by the Company
considering industry standards, past due loans, economic conditions in its
market area, and other factors related to the collectibility of the loan
portfolio. The Company recorded a $59,000 recovery of allowance during the year
ended June 30, 1997 compared to a provision for loan losses of $337,000 during
the year ended June 30, 1996. The recovery of allowance in the current year was
due to improvements in the level and nature of the Company's non-performing
loans, particularly related to one large borrower who has been involved in a
legal dispute with the Company since 1991. Overall, nonperforming loans declined
$1.6 million during fiscal year ended June 30, 1997, to $7.0 million from $8.6
million at the prior year end. The allowance for loan losses amounted to $7.6
million at June 30, 1997, or 109.3% of nonperforming loans at June 30, 1997,
compared to $7.5 million, or 87.5% of nonperforming loans at June 30, 1996. The
Company recorded a $175,000 net recovery of charged-off loans during the 1997
fiscal year, compared to a net charge-off of $929,000 in the 1996 fiscal year.
The 1996 charge-offs included a charge-off of $909,000 related to one borrower.
- 8 -
<PAGE>
Other Operating Income. Total other operating income amounted to $1.2
million during the fiscal year ended June 30, 1997, compared to $1.8 million in
the prior year, a decrease of $615,000, or 33.8%. This decrease was due
primarily to a fiscal 1996 gain of $658,000 on the sale of excess land adjacent
to a branch office, with no such sale in the current year. In fiscal 1996, total
other operating income increased $387,000, or 27.0% over the prior year, due
primarily to a gain of $658,000 on the sale of excess land adjacent to a branch
office. This was offset somewhat by a decline of $124,000 in other miscellaneous
items of operating income, the most significant of which was a reduction of
$262,000 in commissions from the sale of annuities and various insurance
products by the Association's wholly owned subsidiary.
Other Operating Expenses. Total other operating expenses during the
current year increased $7.6 million, or 60.9%, as compared to the 1996 fiscal
year. This increase resulted from a $4.4 million increase in personnel expenses,
a $3.1 million one-time assessment to recapitalize the SAIF and an increase in
other miscellaneous expenses category of $882,000. These increases were
partially offset by a $449,000 decrease in federal deposit insurance premiums
and a $272,000 decrease in the net cost of real estate operations.
The fiscal 1997 increase in personnel expenses included the $2.2
million fair market value of 61,953 vested shares of stock granted to the
Company's three executive officers in December 1996 and 61,955 vested shares
granted to the Company's Board of Directors and various employees and members of
management during the quarter ended March 31, 1997 pursuant to the Recognition
and Retention Plan and Trust adopted by the shareholders on December 30, 1996.
An additional cost of $1.0 million was accrued during the third and fourth
quarters for shares awarded under the plan that will vest in fiscal 1998. Due to
the vesting schedule and accrual of fiscal 1998 cost, the current fiscal year
included approximately 1.5 years of cost related to the plan. Costs related to
the ESOP represent the other significant component of the increase in personnel
expenses. Generally accepted accounting principles require recognition of
compensation expense for shares released from the ESOP at the fair value of the
shares at the time they are committed to be released rather than at the cost of
the shares to the ESOP. Because the ESOP was in existence for the full fiscal
year in 1997 and only two quarters of the 1996 fiscal year and due to the
significant increase in stock price during the 1997 fiscal year, the accounting
cost recognized for the ESOP increased markedly, to $1.5 million in the 1997
fiscal year compared to a fiscal 1996 cost of $425,000.
The increase in fiscal 1997 other miscellaneous expenses is
attributable to two primary factors. The Company experienced a $460,000 increase
in legal and professional fees to determine the nature, tax treatment, and other
implications of the special distribution to shareholders paid in March 1997 and
for legal costs associated with the ongoing lawsuit by a former borrower. The
Company also experienced $237,000 in new corporate costs during the current year
such as a new franchise tax, annual and special meeting costs, quarterly and
annual reports, shareholder mailings, and stock market listing fees. The
$449,000 decrease in the federal deposit insurance premiums was due to a
reduction in the annual rate paid by the Association for FDIC insurance premiums
beginning in January 1997, resulting from the special assessment in the first
fiscal quarter. The net cost of real estate operations declined primarily due to
a $149,000 net gain on the sale of foreclosed real estate in the current year
compared to a $179,000 net loss in the prior year, a difference of $328,000 from
fiscal 1996 to fiscal 1997.
Total other operating expenses during fiscal 1996 declined $384,000, or
3.0%, resulting from a decline in the net cost of real estate operations of
$916,000 and a decline in personnel expenses of $255,000, which were partially
offset by an increase in the "other" category of $571,000 and several less
significant increases in other components of non-interest expenses. The primary
component of the
- 9 -
<PAGE>
cost of real estate operations is the provision for losses on foreclosed
properties, which declined from $1.2 million in the prior year to $140,000 in
the current year. This decline resulted from the resolution of several
significant groups of foreclosed properties during the 1995 fiscal year and a
lower level of additional foreclosures in the 1996 year. The decline in
personnel expenses was due to several changes. A retirement plan for the Board
of Directors and several officers was implemented in the year ended June 30,
1995, resulting in the recognition of an initial implementation cost of
$751,000, compared to a periodic cost in fiscal 1996 of only $25,000. This
decline in cost was substantially offset by increases in the periodic cost of
post-retirement benefits following the implementation of SFAS No. 106 with a
year-to-date cost of $251,000 (see "Change in Accounting Principle" below) and
to costs associated with the employee stock ownership plan adopted in connection
with the Conversion. Such costs amounted to $425,000 in fiscal 1996. Other
miscellaneous operating expenses increased due to the accumulated effect of
several cost factors.
Provision for Income Taxes. The Company recorded a provision for income
taxes of $4.6 million, $4.6 million, $3.9 million for the fiscal years ended
June 30, 1997, 1996 and 1995, respectively. The effective tax rates for these
years were 38.5%, 34.6% and 38.5%, respectively.
Change in Accounting Principle. The Company adopted SFAS No. 106,
"Employers' Accounting for Post-retirement Benefits Other Than Pensions" during
the 1996 fiscal year. As a result, the Company recognized a $1.7 million
accumulated post-retirement benefit obligation effective July 1, 1995. On an
after-tax basis, this charge amounted to approximately $1.1 million and is
reported as a change in accounting principle for the year ended June 30, 1996.
Ongoing periodic costs of such benefits are included in operating expenses
subsequent to adoption.
Asset and Liability Management
The Company's principal business is the making of loans, funded by
customer deposits and, to the extent necessary, other borrowed funds.
Consequently, a significant portion of the Company's assets and liabilities are
monetary in nature and fluctuations in interest rates will affect the Company's
future net interest income and cash flows. This interest rate risk is the
Company's primary market risk exposure. The Company manages this risk
principally through the use of simulation modeling under various rate scenarios.
Using this model, the Company computes, among other things, the change in
projected net interest income over a rolling 12 month period, taking into
consideration asset and liability maturity dates and repricing opportunities, as
well as assumptions utilized by the FHLB of Atlanta regarding core deposit decay
rates, loan prepayment rates, etc. The analyses comprehend all interest rate
sensitive assets and liabilities such as securities, loans, deposits and other
borrowed funds. The Company holds none of these assets in a trading portfolio;
all are held to maturity or available for sale. Certain shortcomings, however,
are inherent in any modeling technique. The model utilized by the Company
assumes an instantaneous and sustained change in rates, various assumptions
about customer behavior in varied market environments, and assumes no subsequent
actions by management to respond to changes in rates. At June 30, 1997, the
Company's simulation model indicated that a 200 basis point increase in interest
rates would reduce the Company's projected net interest income over the next
twelve months by $4.4 million, or 18.9%. A 200 basis point change in rates was
used because management considers this to be a reasonably possible near-term
change in rates.
The Company also measures interest rate sensitivity as the difference
between amounts of interest-earning assets and interest-bearing liabilities
which either reprice or mature
- 10 -
<PAGE>
within a given period of time. The difference, or the interest rate repricing
"gap," provides an indication of the extent to which an institution's interest
rate spread will be affected by changes in interest rates. A gap is considered
positive when the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities, and is considered negative when the amount
of interest-rate sensitive liabilities exceeds the amount of interest-rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap within shorter maturities would adversely affect net interest
income, while a positive gap within shorter maturities would result in an
increase in net interest income, and during a period of falling interest rates,
a negative gap within shorter maturities would result in an increase in net
interest income while a positive gap within shorter maturities would have the
opposite effect. As of June 30, 1997, the amount of the Company's
interest-bearing liabilities which were estimated to mature or reprice within
one year exceeded the Company's interest-earning assets with the same
characteristics by $391.1 million or 43.7% of the Company's total assets.
The Company's actions with respect to interest rate risk and its
asset/liability gap management are taken under the guidance of the
Asset/Liability Management Committee, which is comprised of certain members of
senior management. This committee meets quarterly to review the Company's
current composition of assets and liabilities in light of the prevailing
interest rate environment and to devise a quarterly interest rate risk strategy
which is reviewed by the Board of Directors.
The Company has historically emphasized the origination of fixed-rate
residential real estate loans and other fixed-rate loans for retention in its
portfolio. As a result, at June 30, 1997, $564.7 million or 80.2% of the
Company's total loan portfolio consisted of fixed-rate loans. Although the
Company anticipates that a majority of its loan portfolio will continue to
consist of fixed-rate loans, the Company has recently attempted to mitigate the
interest rate risk of holding a significant portion of fixed-rate loans in its
portfolio through the origination of ARMs, commercial real estate loans with
call provisions after three or five years and short-term consumer loans.
Historically, however, consumers tend to favor fixed-rate loans in a decreasing
interest rate environment and, as a result, the origination of adjustable-rate
loans will typically be negatively impacted in such an interest rate
environment. In addition, while consumer loans generally have shorter terms and
higher interest rates than mortgage loans, such loans generally involve more
credit risk than mortgage loans because of the type and nature of the collateral
and, in certain cases, the absence of collateral. At June 30, 1997, $175.7
million or 19.7% of the Company's total assets consisted of investment
securities. The classification of such securities as available for sale and the
relatively short-term nature of such portfolio permits reinvestment of such
funds into securities or other assets at then market rates. Notwithstanding the
foregoing, the Company's present negative gap will continue to expose the
Company to material and prolonged increases in interest rates and will adversely
affect net interest income in an increasing interest rate environment. During
periods of rising interest rates, the Company has historically relied and will
continue to rely on its strong capital base.
- 11 -
<PAGE>
The following table summarizes the anticipated maturities or repricing
of the Company's interest-earning assets and interest-bearing liabilities as of
June 30, 1997, based on the information and assumptions set forth in the notes
to the table.
<TABLE>
<CAPTION>
More Than More Than Three Years
Within Six Six to Twelve One Year to to Five Over Five
Months Months Three Years Years Years Total
------------ ------------ ------------- ------------ ------------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Investment and $17,918 $8,411 $66,391 $20,012 $62,438 $175,710
mortgage-backed
securities(1)
Loans receivable, net(2) 64,342 95,864 160,380 141,958 195,779 658,323
Other interest-earning assets 31,370 -- -- -- -- 31,370
---------- ------------ ------------ ---------- ----------- -------
Total interest-earning
assets 113,630 104,275 227,311 161,970 258,217 865,403
---------- ---------- ------- ------- ------- -------
Interest-bearing liabilities:
Deposits(3) 131,879 200,152 86,346 13,621 11,842 443,840
Other borrowings 173,000 104,000 -- -- -- 277,000
---------- ---------- ---------- -------- --------- -------
Total interest-bearing
liabilities 304,879 304,152 86,346 13,621 11,842 720,840
---------- --------- --------- --------- --------- -------
Excess (deficiency) of
interest-earning assets over
interest-bearing liabilities $(191,249) $(199,877) $ 140,965 $ 148,349 $ 246,375
======== ======== ======== ======== ========
Cumulative excess (deficiency)
of interest-earning assets
over interest-bearing
liabilities $(191,249) $(391,126) $(250,161) $(101,812) $144,563
======== ======== ======== ======== =======
Cumulative excess (deficiency)
of interest-earning assets
over interest-bearing
liabilities as a percentage of
total assets (21.4)% (43.8)% (28.0)% (11.4)% 16.2%
==== ==== ==== ==== ====
</TABLE>
- ---------------------------
(1) Reflects repricing or contractual maturity.
(2) Fixed rate loans are included in the periods in which they are
scheduled to be repaid, based on scheduled amortization, adjusted to
take into account estimated prepayments. Adjustable-rate loans are
included in the periods in which interest rates are next scheduled to
adjust rather than in the period in which they are due. Non-accruing
loans are assumed to reprice within six months.
(3) Although the Company's negotiable order of withdrawal ("NOW") accounts,
money market deposit ("MMDA") accounts, and passbook savings accounts
are subject to immediate withdrawal, management considers a substantial
amount of such accounts to be core deposits having significantly longer
effective maturities based on the Company's retention of such deposits
in changing interest rate environments. Based on decay rate assumptions
utilized by the FHLB of Atlanta, the above table assumes that funds
will be withdrawn from deposit accounts as follows: NOW and
noninterest-bearing checking accounts -- 37% during periods within the
first 12 months, 33.87% during the more than one year- to three-year
period, 9.06% during the more than three- years to five-year period,
and 20.07% thereafter; MMDA accounts -- 79% during periods within the
first twelve months, 11% during the more than one-year to three-year
period, 5.24% during the more than three-year to five-year period, and
4.76% thereafter; and passbook accounts -- 17% during periods within
the first twelve months, 25.82% during the more than one-year to
three-year period, 16.83% during the more than three-year to five-year
period and 40.35% thereafter.
- 12 -
<PAGE>
The preceding table was summarized from data provided by the FHLB of
Atlanta using certain assumptions based on data for the second calendar quarter
of 1997. Certain shortcomings are inherent in the method of analysis presented
in the above table. Although certain assets and liabilities may have similar
maturities or periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types of assets and liabilities may lag behind
changes in market interest rates.
The OTS adopted a final rule in August 1993 incorporating an interest
rate risk component into the risk-based capital rules. Under the rule, an
institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate component from total capital for
purposes of calculating the risk-based capital requirement. An institution with
a greater than "normal" interest rate risk is defined as an institution that
would suffer a loss of net portfolio value ("NPV") exceeding 2.0% of the
estimated market value of its assets in the event of a 200 basis point increase
or decrease in interest rates. NPV is the difference between incoming and
outgoing discounted cash flows from assets, liabilities, and off-balance sheet
contracts. A resulting change in NPV of more than 2% of the estimated market
value of an institution's assets will require the institution to deduct from its
capital 50% of that excess change for regulatory capital purposes. The rule
provides that the OTS will calculate the interest rate risk component quarterly
for each institution. The OTS has recently indicted that no institution will be
required to deduct capital for interest rate risk until further notice. However,
utilizing this measurement concept, at June 30, 1997, there would be a decrease
in the Company's NPV of approximately 6.8% of the estimated market value of the
Company's assets, assuming a 200 basis point increase in interest rates.
Accordingly, if the regulation had been implemented as of June 30, 1997, the
Company would have been required to deduct 50% of the excess amount (2.4% or
$21.7 million) from its risk-based capital.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, repayments,
prepayments and maturities of outstanding loans, maturities of investment
securities and other short-term investments, and funds provided from operations.
While scheduled loan repayments and maturing investment securities and
short-term investments are relatively predictable sources of funds, deposit
flows and loan prepayments are greatly influenced by the movement of interest
rates in general, economic conditions and competition. The Company manages the
pricing of its deposits to maintain a deposit balance deemed appropriate and
desirable. In addition, the Company's available for sale securities and
short-term interest-earning assets provide liquidity to meet lending and other
operational requirements. Although the Company's deposits have historically
represented the majority of its total liabilities, the Company also utilizes
other borrowing sources, primarily FHLB advances and securities sold under
repurchase agreements. At June 30, 1997, the Company had $120.0 million of
securities sold under repurchase agreements, FHLB advances totalling $129.0
million and a $28.0 million short-term bank loan.
Liquidity management is both a daily and long-term function. Excess
liquidity is generally invested in short-term investments such as cash and cash
equivalents, and U.S. Government agency securities. On a longer-term basis, the
Company invests in various lending products and investment securities. The
Company uses its sources of funds primarily to meet its ongoing commitments to
pay maturing savings certificates and savings withdrawals, fund loan commitments
and maintain an investment securities portfolio. At June 30, 1997, the total
approved loan commitments outstanding (excluding undisbursed portions of loans
in process) amounted to $15.7 million. At the same date, the unadvanced portion
of loans in process approximated $33.0 million. Certificates of deposit
scheduled to mature in one
- 13 -
<PAGE>
year or less at June 30, 1997, totalled $291.7 million. Management of the
Company believes that the Company has adequate resources, including principal
prepayments and repayments of loans and maturing investments, to fund all of its
commitments to the extent required. Based upon its historical run-off
experience, management believes that a significant portion of maturing deposits
will remain with the Company. See Note 6 of the Notes to the Consolidated
Financial Statements of the 1997 Annual Report.
The Association is required by the OTS to maintain average daily
balances of liquid assets and short-term liquid assets (as defined) in amounts
equal to 5% and 1%, respectively, of net withdrawable deposits and borrowings
payable in one year or less to assure its ability to meet demand for withdrawals
and repayment of short-term borrowings. The liquidity requirements may vary from
time to time at the direction of the OTS depending upon economic conditions and
deposit flows. The Association's average monthly liquidity ratio and short-term
liquid assets for June 1996, was 10.8% and 2.5%, respectively.
As of June 30, 1997, the Company had regulatory capital which was in
excess of applicable limits. At June 30, 1997, the Association's tangible, core
and risk-based capital ratios amounted to 18.9%, 18.9% and 36.5%, respectively,
compared to regulatory requirements of 1.5%, 3.0% and 8.0%, respectively. See
also Note 12 to the Notes to the Consolidated Financial Statement to the 1997
Annual Report.
Recent Accounting Pronouncements
In May 1993, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," affecting the accounting for investments in debt and equity
securities, which are to be classified into one of three categories. Securities
which management has positive intent and ability to hold until maturity are to
be classified as held to maturity and reported at amortized cost. Securities
that are bought and held principally for the purpose of selling them in the near
term are to be classified as trading securities and reported at fair value, with
unrealized gains and losses included in earnings. All other securities are to be
classified as available for sale securities and reported at fair value, with
unrealized gains and losses excluded from earnings and reported as a separate
component of equity until realized. The Company adopted SFAS No. 115 as of July
1, 1994. The Company had previously classified its debt and equity securities in
its Consolidated Statements of Financial Condition as held for investment.
However, on December 31, 1995, management of the Company reevaluated its intent
with respect to its investment portfolio, and, accordingly, reclassified all
investments and mortgage-backed securities to the available for sale
classification. As of June 30, 1997, the Company had designated $122.5 million
of investment securities and $53.2 million of mortgage-backed securities as
"available for sale." The Company classifies its investment and mortgage-backed
securities at the time of purchase of such assets. As a result of its adoption
of SFAS No. 115, the Company included in stockholders' equity at June 30, 1997
an unrealized gain net of taxes of $4.0 million on securities available for
sale. See also Note 1 of the Notes to the Consolidated Financial Statements.
In November 1993, the AICPA issued SOP 93-6, Employers' Accounting for
Employee Stock Ownership Plans, which applied to the Company for its fiscal year
beginning July 1, 1995. SOP 93-6 requires the measurement of compensation
expense recorded by employers for leveraged ESOPs at the fair value of ESOP
shares. Under SOP 93-6, the Company recognizes compensation cost equal to the
fair value of the ESOP shares during the periods in which they become committed
to be released. To the extent that fair value of the Company's ESOP shares
differ from the cost of such shares, this differential will be charged or
credited to equity. Employers with internally leveraged ESOPs such as the
Company will not report the loan receivable from the ESOP as an asset and will
not report the ESOP debt from the
- 14 -
<PAGE>
employer as a liability. The application of SOP 93-6 has not had a material
impact on the Company's financial condition.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements of the Company and related notes
presented herein have been prepared in accordance with generally accepted
accounting principles ("GAAP") which require the measurement of financial
position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Unlike most industrial companies, substantially all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services, since such prices are affected by inflation to a
larger extent than interest rates. In the current interest rate environment,
management of liquidity and the maturity structure of the Company's assets and
liabilities are critical to the maintenance of acceptable performance levels.
- 15 -
<PAGE>
[PAGE 16 INTENTIONALLY LEFT BLANK]
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
HFNC Financial Corp.
Charlotte, North Carolina
We have audited the consolidated statements of financial position of HFNC
Financial Corp. and its subsidiaries (the "Company") as of June 30, 1997 and
1996, and the related consolidated statements of income, equity, and cash flows
for each of the three years in the period ended June 30, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at June 30, 1997 and
1996, and the results of its operations and its cash flows for each of the three
years in the period ended June 30, 1997 in conformity with generally accepted
accounting principles.
As discussed in Note 11 to the consolidated financial statements, the Company is
a defendant in certain litigation in which the ultimate outcome cannot presently
be determined. Accordingly, no provision for any loss that may result upon
resolution of these matters has been made in the accompanying financial
statements.
As discussed in Note 1 to the consolidated financial statements, effective July
1, 1995, the Company changed its method of accounting for postretirement
benefits to conform with the provisions of Statement of Financial Accounting
Standards No. 106 and effective July 1, 1994, the Company changed its method of
accounting for investments in debt and equity securities to conform with the
provisions of Statement of Financial Accounting Standards No. 115.
August 12, 1997
-17-
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
JUNE 30, 1997 AND 1996
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
CASH AND CASH EQUIVALENTS:
Cash $ 9,934,359 $ 6,769,598
Federal funds sold 21,436,000 2,836,000
------------- -------------
Total cash and cash equivalents 31,370,359 9,605,598
------------- -------------
SECURITIES - Available for sale, at fair value (amortized
cost: $169,285,103 and $248,922,746, at June 30, 1997 and 1996,
respectively) 175,710,104 248,445,333
LOANS RECEIVABLE, NET (allowance for loan losses:
$7,611,675 and $7,495,515, at June 30, 1997 and 1996,
respectively) 658,323,320 505,130,813
REAL ESTATE, NET 867,876 2,539,014
OFFICE PROPERTIES AND EQUIPMENT, NET 10,099,107 5,846,103
STOCK OF FEDERAL HOME LOAN BANK OF ATLANTA -
At cost 6,450,000 5,062,100
NET DEFERRED INCOME TAX ASSET 3,390,125 5,805,502
OTHER ASSETS 6,709,218 6,443,605
------------- -------------
TOTAL $ 892,920,109 $ 788,878,068
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
DEPOSITS $ 443,839,542 $ 448,570,916
OTHER BORROWED FUNDS 277,000,000 85,000,000
OTHER LIABILITIES 11,020,650 8,802,696
------------- -------------
Total liabilities 731,860,192 542,373,612
------------- -------------
SHAREHOLDERS' EQUITY:
Common stock, par value $0.01 per share: 25,000,000 shares
authorized; 17,192,500 shares issued and outstanding 171,925 171,925
Additional paid-in capital 89,967,883 168,390,571
ESOP loan and unvested restricted stock (23,137,490) (8,700,000)
Retained income 90,106,224 86,896,095
Unrealized gain (loss) on securities available for sale (net of
deferred taxes: $2,473,626 and $223,278 at June 30, 1997 and
1996, respectively) 3,951,375 (254,135)
------------- -------------
Total shareholders' equity 161,059,917 246,504,456
------------- -------------
TOTAL $ 892,920,109 $ 788,878,068
============= =============
</TABLE>
See notes to consolidated financial statements.
- 18 -
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
INTEREST INCOME:
Interest on loans $ 49,101,206 $ 39,995,122 $ 38,918,640
Interest on securities 16,214,450 12,146,926 7,202,264
------------ ------------ ------------
Total 65,315,656 52,142,048 46,120,904
------------ ------------ ------------
INTEREST EXPENSE:
Interest on customer deposits 23,564,888 27,218,333 21,464,269
Interest on other borrowed funds 11,053,822 790,224 2,786,523
------------ ------------ ------------
Total 34,618,710 28,008,557 24,250,792
------------ ------------ ------------
NET INTEREST INCOME 30,696,946 24,133,491 21,870,112
PROVISION FOR LOAN LOSSES (RECOVERY OF
ALLOWANCE) (59,286) 336,957 486,101
------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES (RECOVERY OF ALLOWANCE) 30,756,232 23,796,534 21,384,011
------------ ------------ ------------
OTHER OPERATING INCOME:
Service charges and fees 715,265 735,362 689,840
Gain on sale of office properties and equipment -- 657,616 192,436
Gain on sale of securities 19,379 -- --
Other income 467,209 423,619 547,737
------------ ------------ ------------
Total 1,201,853 1,816,597 1,430,013
------------ ------------ ------------
OTHER OPERATING EXPENSES:
Personnel expenses 10,429,710 6,046,919 6,302,236
Federal deposit insurance premiums 664,860 1,113,602 1,027,961
Special SAIF recapitalization assessment 3,077,275 -- --
Occupancy 1,817,445 1,937,129 1,752,760
Net cost of real estate operations 70,249 341,800 1,257,792
Advertising 841,896 797,040 869,141
Data processing 420,862 406,429 387,380
Other expenses 2,662,324 1,780,266 1,209,561
------------ ------------ ------------
Total 19,984,621 12,423,185 12,806,831
------------ ------------ ------------
<PAGE>
<CAPTION>
HFNC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
INCOME BEFORE INCOME TAXES AND
CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE 11,973,464 13,189,946 10,007,193
PROVISION FOR INCOME TAXES 4,609,783 4,565,844 3,857,182
------------ ------------ ------------
INCOME BEFORE CUMULATIVE EFFECT OF A
CHANGE IN ACCOUNTING PRINCIPLE 7,363,681 8,624,102 6,150,011
CUMULATIVE EFFECT ON PRIOR YEARS OF A
CHANGE IN ACCOUNTING PRINCIPLE -- (1,050,000) --
------------ ------------ ------------
NET INCOME $ 7,363,681 $ 7,574,102 $ 6,150,011
============ ============ ============
NET INCOME PER SHARE OF COMMON STOCK $ 0.46 N/A N/A
============
AVERAGE NUMBER OF SHARES OUTSTANDING 15,995,345 N/A N/A
==========
</TABLE>
See notes to consolidated financial statements.
- 19 -
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Unearned Net Unrealized
ESOP and Gain (Loss) on
Additional Unvested Securities
Common Paid-In Retained Restricted Available for
Stock Capital Income Shares Sale (1) Total
----- ------- ------ ------ -------- -----
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JUNE 30, 1994 $73,171,982 $73,171,982
Net income 6,150,011 6,150,011
Net unrealized gain on
securities available for
sale upon adoption
of SFAS No. 115 -- 2,207,105 2,207,105
Change in net unrealized
gain on securities
available for sale -- 283,013 283,013
----------- ---------- ------------
BALANCE, JUNE 30, 1995 79,321,993 2,490,118 81,812,111
Net income 7,574,102 -- 7,574,102
Net proceeds of
common stock issued $171,925 $168,266,013 -- (9,000,000) -- 159,437,938
Shares released from
ESOP -- 124,558 -- 300,000 -- 424,558
Net unrealized gain on
securities transferred
to available for sale
portfolio -- -- -- -- 248,231 248,231
Change in net unrealized
gain on securities
available for sale -- -- -- -- (2,992,484) (2,992,484)
-------- ----------- ----------- ------------ ---------- ------------
BALANCE, JUNE 30, 1996 171,925 168,390,571 86,896,095 (8,700,000) (254,135) 246,504,456
-------- ----------- ----------- ------------ ---------- ------------
Net income -- -- 7,363,681 -- -- 7,363,681
Shares released from
ESOP and restricted
stock trusts -- 494,810 -- 3,269,211 -- 3,764,021
Dividends paid -- (78,917,498) (4,153,552) -- -- (83,071,050)
Purchase of ESOP and
restricted stock -- -- -- (17,706,701) -- (17,706,701)
Change in net unrealized
loss on securities
available for sale -- -- -- -- 4,205,510 4,205,510
-------- ----------- ----------- ------------ ---------- ------------
BALANCE, JUNE 30, 1997 $171,925 $89,967,883 $90,106,224 $(23,137,490) $3,951,375 $161,059,917
======== =========== =========== ============ ========== ============
</TABLE>
(1) Net of deferred income taxes.
See notes to consolidated financial statements.
- 20 -
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 7,363,681 $ 7,574,102 $ 6,150,011
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of a change in accounting principle -- 1,050,000 --
Depreciation and amortization 901,982 533,049 511,339
Amortization of net deferred loan fees (1,788,109) (2,038,329) (1,718,914)
Provision for losses on loans (recovery of allowance) (59,286) 336,957 486,101
Provision for losses on real estate 92,379 139,812 1,236,027
Deferred income tax (benefit) provision (281,527) 329,276 (427,055)
Amortization of unearned stock compensation 3,764,021 424,558 --
(Gain) loss on sales of:
Fixed assets -- (657,616) (192,436)
Real estate owned (149,136) 179,258 (29,497)
Investments (19,379) (15,157) --
Increase in other assets (265,613) (1,474,967) (2,124,908)
Increase in other liabilities 2,217,954 472,522 2,932,697
------------- ------------- -------------
Net cash provided by operating activities 11,776,967 6,853,465 6,823,365
------------- ------------- -------------
INVESTING ACTIVITIES:
Proceeds from maturities of investment securities 8,394,737 42,469,426 6,000,000
Proceeds from sales of securities available for sale 67,279,572 7,515,157 --
Purchases of securities available for sale (6,950,000) (193,170,501) (14,987,327)
Purchases of Federal Home Loan Bank stock (1,387,900) -- --
Principal repayment on mortgage-backed securities 10,584,525 4,449,592 --
Proceeds from sales of real estate held for
development -- 700,000 412,565
Proceeds from sales of real estate owned 2,841,885 1,911,353 3,475,871
Net loan originations (152,459,102) (70,086,708) (2,213,974)
Proceeds from disposals of office properties and
equipment -- 1,497,098 361,804
Purchases of office properties and equipment (4,806,798) (98,415) (157,473)
------------- ------------- -------------
Net cash used in investing activities (76,503,081) (204,812,998) (7,108,534)
------------- ------------- -------------
- 21 -
<PAGE>
HFNC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1997, 1996 AND 1995
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
FINANCING ACTIVITIES:
(Decrease) increase in deposits (4,731,374) (41,995,531) 45,070,553
Proceeds from other borrowed funds 192,000,000 85,000,000 60,000,000
Purchases of restricted stock for benefit plan (17,706,701) -- --
Repayments of Federal Home Loan Bank advances -- (10,000,000) (100,000,000)
Net proceeds from the sale of stock -- 159,437,938 --
Dividends paid (83,071,050) -- --
------------- ------------- -------------
Net cash provided by financing activities 86,490,875 192,442,407 5,070,553
------------- ------------- -------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS- 21,764,761 (5,517,126) 4,785,384
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 9,605,598 15,122,724 10,337,340
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END
OF YEAR $ 31,370,359 $ 9,605,598 $ 15,122,724
============= ============= =============
SUPPLEMENTAL DISCLOSURES:
Cash paid during the year for:
Interest $ 49,205,450 $ 28,048,607 $ 23,343,529
Income taxes 4,696,284 2,482,214 3,985,685
Non-cash investing activities:
Transfers from loans to real estate acquired in
settlement of loans 1,113,990 2,127,081 4,080,832
Unrealized net gain (loss) on securities available
for sale, net of deferred income taxes 4,205,510 2,744,253 (2,490,118)
Investment securities transferred from held to
maturity to available for sale, at fair value
(amortized cost $0, $108,288,966 and $2,745,308,
respectively) -- 108,537,197 4,952,413
</TABLE>
See notes to consolidated financial statements.
- 22 -
<PAGE>
HFNC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1997 AND 1996
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Principles of Consolidation - HFNC Financial Corp. (the
"Corporation") was incorporated under North Carolina law in August 1995 by
Home Federal Savings and Loan Association (the "Association") in
connection with the conversion of the Association from a federally
chartered mutual savings and loan association to a federally chartered
stock savings and loan association, the issuance of the Association's
stock to the Corporation and the offer and sale of the Corporation's
common stock by the Corporation (the "Conversion"). The Conversion,
completed on December 28, 1995, resulted in the issuance and sale of
17,192,500 shares of $0.01 par value common stock. The accompanying
consolidated financial statements include the accounts of the Corporation
and its wholly owned subsidiaries, HFNC Investment Corp. and Home Federal
Savings and Loan Association (collectively referred to herein as the
"Company"). The Company's consolidated financial statements also include
the accounts of the Association's wholly owned subsidiary, Home Federal
Savings Service Corporation ("HFSS"). HFSS participates in real estate
joint ventures for the development and sale of residential lots, and the
sale of annuities and various insurance products. All significant
intercompany balances and transfers have been eliminated in consolidation.
The following is a description of the more significant accounting policies
which the Company follows in preparing and presenting its consolidated
statements.
Accounting Principles - The accounting and reporting policies of the
Company conform to generally accepted accounting principles and to the
general practices within the savings and loan industry.
Financial Statement Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Cash Equivalents - Cash and cash equivalents include cash on hand and on
deposit and federal funds sold with a maturity date of three months or
less.
Investment Securities - The Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments
in Debt and Equity Securities, effective July 1, 1994. SFAS No. 115
requires investments to be classified in three categories. Debt securities
that the Company has the positive intent and ability to hold to maturity
are classified as "held to maturity securities" and reported at amortized
cost. Debt and equity securities that are bought and held principally for
the purpose of selling in the near term are classified as "trading
securities" and reported at fair value, with unrealized gains and losses
included in earnings. Debt securities not classified as either held to
maturity securities or trading securities and equity securities not
classified as trading securities are to be classified as "available for
sale securities" and reported at fair value, with unrealized gains and
losses excluded from earnings and reported as a separate component of
shareholders' equity. As of June 30, 1997, all investments are classified
as available for sale.
- 23 -
<PAGE>
In November 1995, the FASB issued a Special Report, A Guide to
Implementation of Statement 115 on Accounting for Certain Debt and Equity
Securities, which included a transition provision allowing all entities to
reassess the appropriateness of the classifications of all securities held
and account for any resulting reclassifications at fair value.
Reclassifications from the held to maturity category resulting from this
one-time reassessment will not call into question, or "taint," the intent
of the entity to hold other debt securities to maturity in the future. In
accordance with this Special Report, the Association transferred
securities with a fair value and amortized cost of approximately $108
million from held to maturity to available for sale. This transfer is
disclosed as a noncash transaction in the statements of cash flows.
Realized gains and losses on investment securities are recognized at the
time of sale based upon the specific identification method. Premiums and
discounts are amortized to expense and accreted to income over the lives
of the securities.
Loans - Loans held for investment are recorded at cost. Mortgage loans
held for sale are valued at the aggregate lower of cost or market as
determined by outstanding commitments from investors or current investor
yield requirements calculated on the aggregate loan basis. No loans have
been classified as held for sale.
Nonaccrual loans are those loans on which the accrual of interest has
ceased. Loans are placed on nonaccrual status if, in the opinion of
management, principal or interest is not likely to be paid in accordance
with the terms of the loan agreement, or when principal or interest is
past due 90 days or more. Interest accrued but not collected at the date a
loan is placed on nonaccrual status is reversed against interest income in
the current period. Interest income on nonaccrual loans is recognized only
to the extent received in cash. However, where there is doubt regarding
the ultimate collectibility of the loan principal, cash receipts, whether
designated as principal or interest, are thereafter applied to reduce the
carrying value of the loan. Loans are restored to accrual status only when
interest and principal payments are brought current and future payments
are reasonably assured.
Restructured loans are those for which concessions, such as the reduction
of interest rates or deferral of interest or principal payments, have been
granted due to a deterioration in the borrower's financial condition.
Interest on restructured loans is accrued at the restructured rates. The
difference between interest that would have recognized under the original
terms of nonaccrual and restructured loans and interest actually
recognized on such loans was not a material amount for the years ended
June 30, 1997, 1996 and 1995.
Effective July 1, 1995, the Company adopted SFAS No. 114, Accounting by
Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosures.
SFAS No. 114 requires that the carrying value of an impaired loan be based
on the present value of expected future cash flows discounted at the
loan's effective interest rate or, as a practical expedient, at the loan's
observable market price or the fair value of the collateral, if the loan
is collateral-dependent. Under SFAS No. 114, a loan is considered impaired
when, based on current information, it is probable that the borrower will
be unable to pay contractual interest or principal payments as scheduled
in the loan agreement. SFAS No. 114 applies to all loans except
smaller-balance homogenous mortgage and consumer loans, loans carried at
fair value or the lower of cost or fair value, debt securities, and
leases. Generally, the Company applies SFAS No. 114 to nonaccrual
commercial loans and restructured loans.
- 24 -
<PAGE>
SFAS No. 118 permits a creditor to use existing methods for recognizing
interest revenue on impaired loans. The Company recognizes interest income
on impaired loans pursuant to the discussion above for nonaccrual and
renegotiated loans.
Allowance for Loan Losses - The Company provides for loan losses using the
allowance method. Accordingly, all loan losses are charged to the related
allowance, and all recoveries are credited to the allowance. Additions to
the allowance for loan losses are provided by charges to operations based
on various factors which, in management's judgment, deserve current
recognition in estimating losses. Because of the uncertainty inherent in
the estimation process, management's estimate of the allowance for loan
losses may change in the near term. However, the amount of the change that
is reasonably possible cannot be estimated.
Real Estate Acquired in Settlement of Loans - Real estate acquired in
settlement of loans is initially recorded at fair value at the date of
acquisition, establishing a new cost basis. After acquisition, valuations
are performed periodically by management and the real estate is carried at
the lower of cost or fair value minus estimated costs of disposal.
Revenues, expenses and additions to the valuation allowance related to
real estate acquired in settlement of loans are included in net cost of
real estate operations.
Real Estate Held for Development or Resale - Real estate held for
development or resale is carried at the lower of cost or estimated net
realizable value. Costs related to the development or improvement of
property are capitalized to the extent such costs are estimated to be
recoverable, whereas those costs related to holding the property are
expensed.
Office Properties and Equipment - Office properties and equipment are
carried at cost, net of accumulated depreciation and amortization.
Depreciation is computed primarily on the straight-line method over
estimated useful lives of up to fifty years for buildings, ten years for
building improvements, four to ten years for furniture, fixtures and
equipment and four years for automobiles. Leasehold improvements are
amortized on the straight-line method over the term of the lease.
Interest Income and Fees - Interest income on loans is accrued on a
monthly basis. Servicing fees are credited to income as earned.
Loan Origination Fees - The Company defers loan origination fees, as well
as certain direct loan origination costs and amortizes such costs and fees
to interest income as an adjustment to yield over the contractual lives of
the related loans utilizing a method of amortization that approximates the
level yield method.
Postretirement Benefits - Effective July 1, 1995, the Company adopted SFAS
No. 106, Employers' Accounting for Postretirement Benefits Other Than
Pensions. SFAS No. 106 requires the Company to accrue the estimated cost
of retiree benefit payments during the years the employee provides
services. The Company previously expensed the cost of these benefits,
which are principally health care, as premiums were paid. SFAS No. 106
allows recognition of the cumulative effect of the liability in the year
of adoption or the amortization of the obligation over a period of up to
twenty years. The Company has elected to recognize the cumulative effect
of this obligation upon adoption. The cumulative effect of adopting SFAS
No. 106 as of July 1, 1995 was an increase in accrued postretirement
health care costs of $1,700,000 and a decrease in net income of $1,050,000
(net of deferred income taxes of $650,000) for the year ended June 30,
1996.
Advertising Costs - The Company expenses advertising costs as incurred.
- 25 -
<PAGE>
Income Taxes - Provisions for income taxes are based on amounts reported
in the consolidated statements of income (after exclusion of nontaxable
income such as interest on state and municipal securities) and include
changes in deferred income taxes. Deferred taxes are computed using the
asset and liability approach. The tax effects of differences between the
tax and financial accounting basis of assets and liabilities are reflected
in the balance sheets at the tax rates expected to be in effect when the
differences reverse.
Earnings Per Share - For the year ended June 30, 1997, earnings per share
of common stock is based on the weighted average number of common shares
outstanding during the year. As the Company did not complete its stock
conversion from a mutual association until December 28, 1995, no earnings
per share have been shown for any periods prior to the year ended June 30,
1997.
Accounting Standards Implemented in the Year Ended June 30, 1997 - The
Company implemented SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, effective
July 1, 1996. SFAS No. 121 establishes accounting standards for the
impairment of long-lived assets, certain identifiable intangible assets
and goodwill related to those assets to be held and used and for
long-lived assets to be held and certain intangible assets to be disposed
of. The adoption of this standard did not have a significant impact on
financial condition or results of operations.
The Company also implemented SFAS No. 122, Accounting for Mortgage
Servicing Rights, prospectively effective July 1, 1996. SFAS No. 122
amends SFAS No. 65 and the principal effect for the Company is the
elimination of the accounting distinction between rights to service
mortgage loans for others that are acquired through loan origination
activities and those acquired through purchase transactions. When a
mortgage banking enterprise purchases or originates mortgage loans and
sells or securitizes those loans with servicing rights retained, it should
allocate the total cost of the mortgage loans to the mortgage servicing
rights and the loans (without the mortgage servicing rights) based on
their relative fair values if it is practicable to estimate those fair
values. Any cost allocated to mortgage servicing rights should be
recognized as a separate asset and amortized in proportion to and over the
period of the estimated net servicing income. Implementation of the
provisions of SFAS No. 122 did not have a material impact on the Company's
financial condition or results of operations.
In June 1996, the FASB issued SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities. This
Statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. It
requires that liabilities and derivatives incurred or obtained by
transferors as part of financial assets be initially measured at fair
value, if practicable. It also requires that servicing assets and other
retained interests in the transferred assets be measured by allocating the
previous carrying amount between the assets sold, if any, and retained
interests, if any, based on their relative fair values at the date of the
transfer. Servicing assets and liabilities must be subsequently measured
by amortization in proportion to and over the period of estimated net
servicing income or loss and assessment for asset impairment or increased
obligation based on their fair values. This Statement is effective for
transfers and servicing of financial assets and extinguishments of
liabilities occurring after December 31, 1996. In December 1996, the FASB
issued SFAS No. 127, Deferral of the Effective Date of Certain Provisions
of FASB Statement No. 125. This Statement defers the effective date of
application of certain transfer and collateral provisions of SFAS No. 125
until January 1, 1998.
On January 1, 1997, the Company implemented the provisions of SFAS No. 125
which were not deferred by SFAS No. 127. Its adoption did not have a
significant impact on financial position or results of operations.
- 26 -
<PAGE>
Recently Issued Accounting Standards - The FASB has recently issued three
new accounting standards that will affect the reporting and disclosure of
financial information by the Company. Management has not determined the
effects of adopting these statements, but their adoption will not impact
financial condition or results of operations because they deal with
reporting and disclosure. The following is a summary of the standards and
their required implementation dates:
SFAS No. 128, Earnings Per Share - This statement establishes
standards for computing and presenting earnings per share ("EPS"). It
will require the presentation of basic EPS on the face of the income
statement with dual presentation of both basic and diluted EPS for
entities with complex capital structures. Basic EPS excludes the
dilutive effect that could occur if any securities or other contracts
to issue common stock were exercised or converted into or resulted in
the issuance of common stock. Basic EPS is computed by dividing
income available to common shareholders by the weighted-average
number of common shares outstanding for the period. The computation
of diluted EPS is similar to the computation of basic EPS except the
denominator is increased to include the number of additional common
shares that would have been outstanding if the dilutive potential
common shares had been issued. In the case of certain convertible
securities, the numerator may also be increased by related interest
or dividends. This statement will be effective for interim and annual
periods ending after December 31, 1997.
SFAS No. 130, Reporting Comprehensive Income - This statement
establishes standards for reporting and disclosure of comprehensive
income and its components (revenues, expenses, gains and losses).
This statement requires that all items that are required to be
recognized under accounting standards as components of comprehensive
income (including, for example, unrealized holding gains and losses
on available for sale securities) be reported in a financial
statement similar to the statement of income and retained income. The
accumulated balance of other comprehensive income will be disclosed
separately from retained income in the shareholders' equity section
of the balance sheet. This statement is effective for the Company for
the fiscal year beginning July 1, 1998.
SFAS No. 131, Disclosures About Segments of an Enterprise and
Related Information - This statement establishes standards for the
way public business enterprises report information about operating
segments and establishes standards for related disclosures about
products and services, geographic areas and major customers.
Operating segments are components of an enterprise about which
separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. Information required
to be disclosed includes segment profit or loss, certain specific
revenue and expense items, segment assets and certain other
information. This statement is effective for the Company for
financial statements issued for the fiscal year beginning July 1,
1998.
Reclassifications - Certain June 30, 1996 and 1995 amounts have been
reclassified to conform to the June 30, 1997 presentation.
- 27 -
<PAGE>
2. SECURITIES
The maturities, amortized cost, unrealized gains, unrealized losses and
fair values of securities at June 30, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997
------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
United States Government
Agency debt securities:
Due within one year $ 11,000,000 $ 4,165 45,579 $ 10,958,586
Due after one year but
within five years 66,013,428 91,680 682,172 65,422,936
Due after five years but
within ten years 7,000,000 -- 169,373 6,830,627
Due after ten years 31,971,799 -- 923,042 31,048,757
Federal Home Loan
Mortgage Corporation
common and preferred
stocks 249,358 8,002,792 -- 8,252,150
------------ ------------ ------------ ------------
Total investment
securities 116,234,585 8,098,637 1,820,166 122,513,056
------------ ------------ ------------ ------------
Mortgage-backed securities:
Federal National
Mortgage Association 12,939,158 -- 75,957 12,863,201
Government National
Mortgage Association 40,111,360 405,425 182,938 40,333,847
------------ ------------ ------------ ------------
Total mortgage-backed
securities 53,050,518 405,425 258,895 53,197,048
------------ ------------ ------------ ------------
Total $169,285,103 $ 8,504,062 $ 2,079,061 $175,710,104
============ ============ ============ ============
</TABLE>
- 28 -
<PAGE>
<TABLE>
<CAPTION>
1996
---------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
United States Government
Agency debt securities:
Due within one year $ 2,000,000 -- $ 5,140 $ 1,994,860
Due after one year but
within five years 82,935,029 $ 166,528 1,692,814 81,408,743
Due after five years but
within ten years 8,000,000 -- 267,511 7,732,489
Due after ten years 29,969,822 -- 1,300,699 28,669,123
Federal Home Loan
Mortgage Corporation
common and preferred
stocks 273,905 5,279,533 -- 5,553,438
------------ ------------ ------------ ------------
Total investment
securities 123,178,756 5,446,061 3,266,164 125,358,653
------------ ------------ ------------ ------------
Mortgage-backed securities:
Federal National
Mortgage Association 28,328,508 -- 494,668 27,833,840
Government National
Mortgage Association 97,415,482 -- 2,162,642 95,252,840
------------ ------------ ------------ ------------
Total mortgage-backed
securities 125,743,990 -- 2,657,310 123,086,680
------------ ------------ ------------ ------------
Total $248,922,746 $ 5,446,061 $ 5,923,474 $248,445,333
============ ============ ============ ============
</TABLE>
As of June 30, 1997, there were approximately $73 million of investments
with call options, all of which are callable within one year. As of June
30, 1996, there were approximately $93 million of investments with call
options, of which $90 million are callable within one year.
Gross realized gains and losses on sales of securities were $714,527 and
$695,148, respectively, in fiscal 1997. Gross realized gains and losses on
sales of securities were $30,782 and $15,625, respectively, in fiscal
1996. There were no sales of investment securities for the year ended June
30, 1995.
- 29 -
<PAGE>
3. LOANS RECEIVABLE
Loans receivable at June 30, 1997 and 1996 consisted of the following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Residential (1 - 4 family) real estate loans $ 561,352,476 $ 416,710,946
Construction loans 68,365,540 61,015,061
Commercial loans 30,631,001 29,342,750
Land loans 19,991,562 22,843,531
Consumer loans:
Home equity 14,494,824 13,696,894
Credit card 6,198,263 5,644,392
Other 3,255,459 3,277,814
Total 704,289,125 552,531,388
Deduct:
Allowance for loan losses (7,611,675) (7,495,515)
Undisbursed portion of loans in process (33,029,829) (34,846,054)
Unearned loan fees, net (5,324,301) (5,059,006)
------------- -------------
Loans receivable, net $ 658,323,320 $ 505,130,813
============= =============
</TABLE>
The changes in the allowance for loan losses consisted of the following:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Allowance, beginning of year $ 7,495,515 $ 8,088,462 $ 7,828,492
Provision for loan losses (recovery of allowance) (59,286) 336,957 486,101
Write-offs (344,230) (1,493,125) (395,182)
Recoveries 519,676 563,221 169,051
----------- ----------- -----------
Allowance, end of year $ 7,611,675 $ 7,495,515 $ 8,088,462
=========== =========== ===========
</TABLE>
Residential real estate loans are presented net of loans serviced for
others totaling $30.9 million, $36.6 million and $43.0 million at June 30,
1997, 1996 and 1995, respectively. Loans sold in the secondary market are
generally sold without recourse. Servicing loans for others generally
consists of collecting mortgage payments, maintaining escrow accounts,
disbursing payments to investors and foreclosure processing. In connection
with these loans serviced for others, the Company held borrowers' escrow
balances of $339,899, $393,826 and $476,131 at June 30, 1997, 1996 and
1995, respectively.
Loans not currently accruing interest at June 30, 1997 and June 30, 1996
amounted to $6.3 million and $8.0 million, respectively. Interest income
that would have been accrued on these loans if they were fully accruing
amounted to $472,000 and $791,000 for the 1997 and 1996 fiscal years,
respectively.
In accordance with SFAS Nos. 114 and 118, the recorded investment in
impaired loans was $4,385,280 and $6,275,358 at June 30, 1997 and 1996,
respectively. The related allowance for loan losses on these loans was
$1,979,647 and $2,804,497 at June 30, 1997 and 1996, respectively. All
impaired loans required an allowance for loan loss and were evaluated
using the fair value of the collateral. The average recorded investment in
impaired loans was $4,896,308 and $6,346,184 at June 30, 1997 and 1996,
respectively, and the cash income recognized for the years ended June 30,
1997 and 1996 was $68,000 and $121,000, respectively.
- 30 -
<PAGE>
The Company is not committed to lend additional funds to debtors whose
loans have been modified.
4. REAL ESTATE
Real estate consisted of the following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Acquired in settlement of loans $ 1,138,277 $ 3,682,554
Less allowance for estimated losses (270,401) (1,143,540)
----------- -----------
Real estate, net $ 867,876 $ 2,539,014
=========== ===========
</TABLE>
The changes in the allowance for losses on real estate acquired in
settlement of loans consisted of the following:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Allowance, beginning of year $ 1,143,540 $ 1,542,253 $ 1,920,257
Provision 92,379 139,812 1,236,027
Write-offs (965,518) (538,525) (1,614,031)
----------- ----------- -----------
Allowance, end of year $ 270,401 $ 1,143,540 $ 1,542,253
=========== =========== ===========
</TABLE>
5. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment consisted of the following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Land $ 2,863,967 $ 1,921,737
Office buildings and improvements 9,741,536 6,463,490
Office equipment and leasehold improvements 2,922,692 2,336,170
Automobiles 100,388 100,388
------------ ------------
Total 15,628,583 10,821,785
Less accumulated depreciation and amortization (5,529,476) (4,975,682)
------------ ------------
Office properties and equipment, net $ 10,099,107 $ 5,846,103
============ ============
</TABLE>
- 31 -
<PAGE>
6. DEPOSITS
Customer deposits at June 30, 1997 and 1996 consisted of the following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Checking accounts $ 9,192,647 $ 9,326,000
NOW accounts - 2.50% at June 30, 1997 and 1996 11,798,817 10,109,446
Flexible rate checking:
Money market deposit accounts, 2.50% to 4.89% at
June 30, 1997 and 2.50% to 2.90% at June 30, 1996 34,759,502 32,315,154
Other - 2.50% to 2.55% at June 30, 1997 and 2.50% to
2.55% at June 30, 1996
3,369,134 3,528,117
------------ ------------
Total checking accounts 59,120,100 55,278,717
------------ ------------
Passbook accounts - 2.50% at June 30, 1997 and 1996 14,447,314 15,141,246
------------ ------------
Certificate accounts:
2.50% - 3.95%
3,940,677 1,764,422
4.00% - 4.95% 15,680,883 33,454,451
5.00% - 6.95% 320,077,671 284,252,015
7.00% - 8.95% 29,712,983 57,854,550
9.00% and over 859,914 825,515
------------ ------------
Total certificate accounts 370,272,128 378,150,953
------------ ------------
Total deposits $443,839,542 $448,570,916
============ ============
</TABLE>
- 32 -
<PAGE>
The weighted average coupon rate on customer deposits at June 30, 1997 and
1996 was 5.24% and 5.42%, respectively.
Scheduled maturities of certificate accounts at June 30, 1997 were as
follows:
Year Ending June 30, Amount
- -------------------- ------
1998 $291,650,026
1999 55,764,166
2000 15,368,010
2001 3,529,827
2002 2,968,272
Thereafter 991,827
------------
Total certificate accounts $370,272,128
============
The aggregate amount of certificate accounts in excess of $100,000 was
$145,100,828 and $129,249,220 at June 30, 1997 and 1996, respectively.
Deposits in excess of $100,000 are not federally insured.
- 33 -
<PAGE>
Interest expense by type of deposit for the years ended June 30, 1997,
1996 and 1995 was as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Checking accounts $ 1,349,244 $ 1,510,906 $ 2,029,954
Passbook accounts
237,366 341,530 374,275
Certificate accounts 22,035,269 25,429,660 19,194,800
Less: Penalty income (56,991) (63,763) (134,760)
------------ ------------ ------------
Total interest expense $ 23,564,888 $ 27,218,333 $ 21,464,269
============ ============ ============
</TABLE>
7. OTHER BORROWED FUNDS
At June 30, 1997, the Company had $129.0 million of outstanding advances
from the Federal Home Loan Bank of Atlanta ("FHLB"). No advances were
outstanding at June 30, 1996. Advances were at fixed rates. The maximum
amount of outstanding advances at any month-end during 1997 and 1996 was
$129.0 million and $10.0 million, respectively, and the average balance
outstanding for such years was approximately $61.1 million and $1.0
million respectively. The weighted average interest rate during fiscal
years 1997 and 1996 was 5.90% and 5.89%, respectively.
The Company pledges as collateral for these borrowings their FHLB stock
and has entered into blanket collateral agreements with the FHLB whereby
the Company maintains, free of other encumbrances, qualifying mortgages
(as defined) with unpaid principal balances, when discounted at 75% of the
unpaid principal balances, of at least 100% of total advances.
The Company also borrowed funds using securities sold under repurchase
agreements during 1997 and 1996. At June 30, 1997 and 1996, $120.0 million
and $85.0 million of such borrowings were outstanding, respectively. The
maximum amount of outstanding agreements at any month-end during 1997 and
1996 was $120.0 million and $85.0 million, respectively, and the average
outstanding balance of such agreements for the years were approximately
$117.4 million and $13.4 million, respectively. Collateral for the
securities sold under repurchase agreements consisted of U.S. Government
Agency securities and mortgage-backed securities which were transferred to
a third party for safekeeping during the terms of the agreements. At June
30, 1997, the market value of such collateralized securities totaled
approximately $114.4 million (amortized cost of approximately $115.6
million).
During the 1997 fiscal year, the Company also borrowed $28.0 million in
short term funds from a commercial bank to fund a portion of a $5 per
share special distribution paid to shareholders on March 18, 1997. The
loan, at prime rate less .5%, was obtained on March 18, 1997 and was paid
off subsequent to June 30, 1997.
8. INCOME TAXES
The provision for income taxes is summarized as follows:
- 34 -
<PAGE>
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Current provision:
Federal $ 4,656,460 $ 3,925,383 $ 3,907,273
State 234,850 311,185 376,964
----------- ----------- -----------
Total current 4,891,310 4,236,568 4,284,237
----------- ----------- -----------
<CAPTION>
Year Ended June 30,
----------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Deferred (benefit) provision:
Federal $ (225,828) $ 253,845 $ (331,675)
State (55,699) 75,431 (95,380)
----------- ----------- -----------
Total deferred (281,527) 329,276 (427,055)
----------- ----------- -----------
Total provision for income taxes $ 4,609,783 $ 4,565,844 $ 3,857,182
=========== =========== ===========
</TABLE>
For the years ended June 30, 1997 and 1996, deferred tax liabilities
(assets) of $2,473,626 and $(223,278), respectively, were allocated to
equity for the tax effect of the unrealized gain (loss) on investment
securities available for sale.
Income taxes differed from amounts computed by applying the statutory
federal rate (34%) to income before income taxes and cumulative effect of
a change in accounting principle (see Note 1) as follows:
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Tax at federal income tax rate $4,070,978 $4,484,581 $3,402,446
(Decrease) increase resulting from:
Statutory bad debt deduction for tax purposes -- (520,000) --
State income tax expense, net of federal benefit 118,240 255,166 185,845
Other, net 420,565 346,097 268,891
---------- ---------- ----------
Total $4,609,783 $4,565,844 $3,857,182
========== ========== ==========
Effective tax rate 38.5% 34.6% 38.5%
========== ========== ==========
</TABLE>
The tax effects of significant items comprising the Company's net deferred
tax asset at June 30, 1997 and 1996 are as follows:
- 35 -
<PAGE>
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Deferred tax assets:
Differences between book and tax basis bad debt reserves $ 3,290,767 $ 3,606,805
Difference between book and tax basis of deferred loan fees 966,132 1,183,796
Deferred compensation 2,011,241 1,466,286
Net operating loss carryforward 677,562 --
Other (160,101) 247,187
----------- -----------
Total deferred tax assets 6,785,601 6,504,074
----------- -----------
Deferred tax liabilities:
Differences between book and tax basis of Federal Home Loan
Bank of Atlanta stock 921,850 921,850
Unrealized gain (loss) on securities available for sale 2,473,626 (223,278)
----------- -----------
Total deferred tax liabilities 3,395,476 698,572
----------- -----------
Net deferred tax asset $ 3,390,125 $ 5,805,502
=========== ===========
</TABLE>
- 36 -
<PAGE>
The realization of the entire amount of the deferred tax asset is
considered to be more likely than not; therefore, no valuation allowance
has been provided.
The Company is permitted a bad debt deduction in determining federal
taxable income that may differ from actual experience, subject to certain
limitations. If the amounts that qualify as bad debt deductions for
federal income tax purposes are later used for purposes other than for bad
debt losses, they will be subject to federal income tax at the then
current statutory rate. As permitted under SFAS No. 109, no deferred tax
liability is provided for approximately $16.9 million (approximately $6.4
million tax effect) of such tax basis bad debt reserves that arose prior
to June 30, 1988.
9. BENEFIT PLANS
401(k)/Profit Sharing Plan - Effective November 30, 1995, the Company
modified its non-contributory qualified defined contribution retirement
plan to a contributory 401(k) profit sharing plan. The profit sharing plan
permits all full time employees with at least one year of service to
contribute up to 9% of their salary to the plan each year. The plan
provides for matching contributions by the Company equal to 100% of
employee contributions up to the first 3% of compensation. The Company
may, at its discretion, make profit sharing contributions to the plan.
Plan participants' accounts are 100% vested in Company contributions after
5 years of qualifying service. The Company's matching contribution charged
to expense for the years ended June 30, 1997 and 1996 was approximately
$76,000 and $69,000, respectively.
The plan, prior to modification, was a non-contributory plan which covered
all full time employees with at least one year of service. Annual employer
contributions under the plan were based on a percentage of compensation of
all regular employees (as defined) less termination credits. Retirement
expenses relating to this plan were funded as accrued and amounted to
$352,094 and $608,782 for the years ended June 30, 1996 and 1995,
respectively.
Stock Option and Management Recognition and Retention Plans - In December,
1996, the Company's shareholders approved the Stock Option Plan ("SOP")
and Management Recognition and Retention Plan ("MRRP").
Stock Option Plan - The SOP provides for the Company's Board of Directors
to award incentive stock options, non-qualified or compensatory stock
options and stock appreciation rights representing up to 1,719,250 shares
of Company stock. One-third of the options granted vested immediately upon
grant, with the balance vesting in equal amounts on the two subsequent
anniversary dates of the grant. Options granted vest immediately in the
event of retirement, disability, or death. Outstanding stock options can
be exercised over a ten year period.
Under the SOP, options have been granted to directors and key employees to
purchase common stock of HFNC Financial Corp. The exercise price in each
case equals the fair market value of the Corporation's stock at the date
of grant which has been adjusted for the impact of the $5 per share
special distribution to shareholders on March 18, 1997. Options granted in
the current year have exercise prices ranging from $13.67 to $14.78, and a
weighted average contract life of 8.5 years.
- 37 -
<PAGE>
A summary of the status of the Company's stock option plan as of June 30,
1997 and changes during the year ending on that date is presented below:
<TABLE>
Weighted
Average
Exercise
Options Shares Price
<S> <C> <C>
Outstanding at beginning of year -- --
Granted 1,548,471 $13.92
Exercised -- --
Forfeited (1,398) 14.78
---------
Outstanding at June 30, 1997 1,547,073 $13.92
========= ======
Options exercisable at June 30, 1997 516,157 $13.92
========= ======
</TABLE>
The Company applies the provisions of APB Opinion No. 25 in accounting for
its stock option plan, as allowed under SFAS No. 123, Accounting for
Stock-Based Compensation. Accordingly, no compensation cost has been
recognized for options granted to employees. Had compensation cost for
these plans been determined based on the fair value at the grant dates for
awards under those plans consistent with the methods of SFAS No. 123, the
Company's pro forma net income and pro forma earnings per share would have
been as follows:
<TABLE>
<CAPTION>
1997
--------------------------
As Reported Proforma
<S> <C> <C>
Net income $7,363,681 $6,510,387
Earnings per share $ .46 $ .41
</TABLE>
In determining the above pro forma disclosure, the fair value of options
granted during the year was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions: expected volatility - 18.23%, expected life of grant - 3.83
years, risk-free interest rate - 6.28%, and expected dividend rate -
1.70%. The weighted average fair value of options granted during the
fiscal year ended June 30, 1997 was $2.69 per share.
Management Recognition and Retention Plan - The MRRP provides for the
Company's Board of Directors to award restricted stock to officers and key
employees as well as non-employee directors. The MRRP authorizes the
Company to grant up to 687,700 shares of Company stock. One-fifth of the
shares granted to date vested immediately on the date of grant. The
remainder will vest at a rate of 25% per year over the next four
anniversary dates of the grants. As is the case with the SOP, shares
granted will
- 38 -
<PAGE>
be deemed vested in the event of retirement, disability, or death. The
shares available for award under this plan were purchased on the open
market at a total cost of $13.0 million. An additional 25,704 shares at a
cost of $472,000 were purchased using a portion of the $5 per share
special distribution attributable to ungranted shares. Approximately $3.2
million in compensation expense was recognized during the current year
related to the MRRP. The following table presents the status of the MRRP
as of June 30, 1997, and changes during the year:
<TABLE>
<CAPTION>
Weighted
Average
Grant
Restricted Stock Award Plan Shares Price
<S> <C> <C>
Outstanding at beginning of year -- --
Granted 619,540 $ 17.41
Vested (123,908) 18.07
Forfeited (600) 17.25
--------
Outstanding at June 30, 1997 495,032 $ 17.25
======== =========
</TABLE>
Employee Stock Ownership Plan - In connection with the Conversion (Note
1), the Company established an Employee Stock Ownership Plan ("ESOP"). In
order to fund the ESOP, 900,000 shares of the Corporation's common stock
were purchased on December 28, 1995 by the ESOP with the proceeds of a
$9.0 million loan from the Corporation's wholly owned subsidiary, HFNC
Investment Corp. Unearned ESOP shares are shown as a reduction of
shareholders' equity. As the loan is internally leveraged, the note
receivable from the ESOP is not reported as an asset nor is the ESOP's
debt reported as a liability. An additional 230,154 shares,costing $4.2
million, were purchased by the plan using the $5 per share special
distribution attributable to unallocated shares in the plan. Expense
related to the ESOP was $1.5 million and $424,000 for the years ended June
30, 1997 and 1996, respectively.
Other Postretirement Benefits - The Company provides certain health care
and life insurance benefits for substantially all of its retired
employees. The Company's postretirement plans currently are not funded. As
discussed in Note 1, the Company adopted SFAS No. 106, resulting in an
increase in accrued postretirement health care costs of $1.7 million and a
decrease in net income of $1.1 million (after deeferred income tax credits
of $650,000), which has been included in the Company's consolidated
statement of income for the year ended June 30, 1996. The status of the
plans were as follows:
Accumulated postretirement benefit obligation at June 30, 1997 and June
30, 1996:
1997 1996
---------- ----------
Retirees $ 457,067 $ 460,129
Fully eligible active plan participants 572,783 629,967
Other active plan participants 830,975 836,692
---------- ----------
Accumulated postretirement benefit obligation 1,860,825 1,926,788
Unrealized net gain 260,081 8,103
---------- ----------
Accrued postretirement benefit liability $2,120,906 $1,934,891
========== ==========
- 39 -
<PAGE>
Net periodic postretirement benefit cost for the period ended June 30,
1997 and June 30, 1996 consisted of the following components:
1997 1996
---------- ----------
Service cost - benefits earned during the year $ 91,491 $ 115,169
Interest cost on accumulated postretirement
benefit obligation 132,418 135,406
Unrecognized gain (5,537) ---
--------- ---------
Net periodic postretirement benefit cost $ 218,372 $ 250,575
========= =========
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligation as of June 30, 1997 was 9%, decreasing
linearly each successive year until it reaches 6% in 2000, after which it
remains constant. A one percentage point increase in the assumed health
care cost trend rate for each year would increase the accumulated
postretirement benefit obligation as of June 30, 1997 by approximately
$327,000 and net annual postretirement benefit cost by approximately
$46,000. The assumed discount rate used in determining the accumulated
postretirement benefit obligation for both years was 8%.
10. DEFERRED COMPENSATION AGREEMENTS AND NON-EMPLOYEE DIRECTORS'
RETIREMENT PLAN
The Company has entered into deferred compensation agreements with the
President and CEO, Executive Vice President, Vice President and Treasurer,
and certain other Vice Presidents and is providing for the present value
of such benefits over the anticipated remaining periods of employment. The
agreements will be funded through life insurance policy investments owned
by the Company, on the lives of such employees. Deferred compensation
expense was approximately $32,000, $31,000 and $115,000 for the years
ended June 30, 1997, 1996 and 1995, respectively.
On August 25, 1994, the Company adopted the Non-employee Directors'
Retirement Plan (the "Directors' Plan"). Under the Directors' Plan, a
non-employee director becomes a participant upon completion of ten years
of continuous service as a director. Full benefits under the Director's
Plan are payable at the later of attaining age 65 or retiring from the
Board of Directors. Retirement with reduced benefits is available
beginning at age 62. The annual benefit for a retired director is equal to
the amount of compensation to which the director was entitled to receive
in the twelve months preceding retirement. This annual benefit is to be
paid quarterly for a ten year period.
The Directors' Plan also contains provisions for death benefits to a
surviving spouse at 100% of the retirement benefit that would have been
paid to the director upon retirement or would be payable over the
remaining term if the director was already receiving retirement benefits.
In the year ended June 30, 1995, the Company accrued approximately
$750,000 related to the Directors' Plan. This accrual represented vested
benefits as of the adoption date and benefits accumulated from the date of
adoption through June 30, 1995. Such pension expense for the years ended
June 30, 1997 and 1996 was approximately $54,000 and $25,000,
respectively.
- 40 -
<PAGE>
11. COMMITMENTS AND CONTINGENCIES
Loan Commitments - The Company, in the normal course of business, is a
party to financial instruments and commitments which involve, to varying
degrees, elements of risk in excess of the amounts recognized in the
consolidated financial statements. These financial instruments and
commitments include unused consumer lines of credit and commitments to
extend credit. Loan commitments, excluding undisbursed portions of loans
in process, were approximately $15.7 million at June 30, 1997.
Commitments, which are disbursed subject to certain limitations, extend
over periods of time with the majority of such commitments disbursed
within a six-month period. Also, at June 30, 1997, the Company had
commitments approximating $12.7 million representing available credit
under open line loans and approximately $600,000 under outstanding letters
of credit.
Concentrations of Credit Risk - Most of the Company's business activity is
with customers in the Charlotte, North Carolina area. The majority of the
Company's loans are residential mortgage loans, construction loans for
residential property and land loans for development of residential real
estate. The Company's policy generally permits mortgage loans up to 80% of
the value of the real estate that is pledged as collateral or up to 95%
with private mortgage insurance.
Interest Rate Risk - The Company's profitability depends to a large extent
on its net interest income, which is the difference between interest
income from loans and investments and interest expense on deposits and
other borrowed funds. Like most financial institutions, the Company's
interest income and interest expense are significantly affected by changes
in market interest rates and other economic factors beyond its control.
The Company's interest-earning assets consist primarily of long-term,
fixed-rate mortgage loans and investments which adjust more slowly to
changes in interest rates than its interest-bearing liabilities which are
primarily term deposits and advances. Accordingly, the Company's earnings
would be adversely affected during periods of rising interest rates and
would be positively impacted during periods of declining interest rates.
Litigation - In June 1995, a lawsuit was initiated against the Association
by a borrower's affiliated companies in which the plaintiffs alleged that
the Association wrongfully set-off certain funds in an account being held
and maintained by the Association. In addition, the plaintiffs alleged
that as a result of the wrongful set-off, the Association wrongfully
dishonored a check in the amount of $270,000. Plaintiffs further alleged
that the actions on behalf of the Association constituted unfair and
deceptive trade practices, thereby entitling plaintiffs to recover treble
damages and attorney fees. The Association denied any wrongdoing and filed
a motion for summary judgment. Upon consideration of the motion, the
United States Bankruptcy Judge entered a Recommended Order Granting
Summary Judgment, recommending the dismissal of all claims asserted
against the Association. The Recommended Order is now before the United
States District Court for the Western District of North Carolina and the
parties are awaiting the Federal District Court's decision of whether to
enter an Order Granting Summary Judgment in accordance with the
Recommended Order by the United States Bankruptcy Judge.
In December 1996, the Association filed a suit against the borrower and
his company and against the borrower's wife, daughter and a company owned
by his wife and daughter, alleging transfers of assets to the wife,
daughter, and their company in fraud of creditors, and asking that the
fraudulent transfers be set aside. The objective of the lawsuit is to
recover assets which may be used to satisfy a portion of the judgments
obtained in favor of the Association in prior litigation. The borrower's
wife filed a
- 41 -
<PAGE>
counterclaim against the Association alleging that she borrowed $750,000
from another financial institution, secured by a deed of trust on her
principal residence, the proceeds of which were paid to the Association
for application on a debt owed by one of her husband's corporations,
claiming that officers of the Association promised to resume making loans
to her husband's corporation after the payment. Home Federal and its
officers vigorously deny all of her allegations. The case is scheduled for
discovery in September 1997, after which the Association intends to file a
motion for summary judgment for dismissal of the counterclaim.
In February 1997, two companies affiliated with those referred to in the
first paragraph above filed an additional action against two executive
officers of the Association and against an officer of another financial
institution. The action was removed from the state court and is presently
pending in the United States Bankruptcy Court for the Western District of
North Carolina. At the same time, the borrower, who is affiliated with all
of these companies, also filed an action against the two executive
officers of the Association and against an officer of another financial
institution. The Complaints in both actions assert virtually identical
claims. The plaintiffs in both lawsuits allege that the officers of both
financial institutions engaged in a conspiracy to wrongfully declare loans
to be in default so as to eliminate those companies as borrowers of the
Association. Plaintiffs allege misrepresentation, breach of fiduciary
duty, constructive fraud, interference with business expectancy, wrongful
bank account set-off, and unfair and deceptive acts and practices.
Plaintiffs claim actual damages, treble damages and punitive damages
together with interest, attorneys' fees and other costs. The Association
has agreed to indemnify both of its officers with respect to costs,
expense and liability which might arise in connection with both of these
cases.
In July 1997, the above borrower and affiliated companies filed an
additional action against HFNC Financial Corp., the Association, and the
other financial institution referred to in the paragraph above, alleging
that previous judgments in favor of the Association and the other
financial institution obtained in prior litigation were obtained by the
perpetration of fraud on the Bankruptcy Court, U.S. District Court, and
the 4th Circuit Court of Appeals. The plaintiffs are seeking to have the
judgments set aside on that basis. The Association has not yet filed a
responsive pleading. The Association vehemently denies that any fraud was
perpetrated upon the courts and intends to vigorously contest this matter.
In August 1997, the borrower filed a lawsuit against attorneys for the
Association, attorneys for the other financial institution, and two United
States Bankruptcy Judges in which the borrower alleges that the defendants
have conspired against him and his corporations by allowing the
Association to obtain judgments against him and his various corporations.
The Association and its officers continue to deny any liability in the
above described cases and continue to vigorously defend against the
claims. However, based on the advice of legal counsel, the Association is
unable to give an opinion as to the likely outcome of the litigation or
estimate the amount or range of potential loss, if any.
12. REGULATORY CAPITAL REQUIREMENTS
The Association is subject to various regulatory capital requirements
imposed by the federal financial institution agencies. Failure to meet
minimum capital requirements can result in certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on the Company's financial statements. Under
capital adequacy guidelines and the regulatory
- 42 -
<PAGE>
framework for prompt corrective action, the Association must meet specific
capital guidelines that involve quantitative measures of the Association's
assets, liabilities and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Association's capital amounts
and classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Association to maintain minimum amounts and ratios. Under
regulations of the OTS, the Association must have: (i) core capital equal
to 3% of adjusted total assets, (ii) tangible capital equal to 1.5% of
adjusted total assets and (iii) total capital equal to 8.0% of
risk-weighted assets. In measuring compliance with all three capital
standards, institutions must deduct from their capital (with several
exceptions primarily for mortgage banking subsidiaries and insured
depository institution subsidiaries) their investments in, and advances
to, subsidiaries engaged (as principal) in activities not permissible for
national banks, and certain other adjustments. Management believes, as of
June 30, 1997, that the Association meets all capital adequacy
requirements to which it is subject.
The following is a reconciliation of the Association's equity reported in
the consolidated financial statements under generally accepted accounting
principles to OTS regulatory capital requirements (dollars in thousands):
<TABLE>
<CAPTION>
Tangible Core Risk-Based
Capital Capital Capital
--------- --------- ---------
<S> <C> <C> <C>
June 30, 1997
Total equity as reported in the consolidated financial
statements $ 172,894 $ 172,894 $ 172,894
General allowance for loan losses -- -- 5,936
Unrealized loss on available for sale securities (3,951) (3,951) (3,951)
Investments not includable in regulatory capital (1,716) (1,716) (1,746)
--------- --------- ---------
Regulatory capital $ 167,227 $ 167,227 $ 173,133
========= ========= =========
June 30, 1996
Total equity as reported in the consolidated financial
statements $ 161,163 $ 161,163 $ 161,163
General allowance for loan losses
-- -- 4,770
Unrealized loss on available for sale securities
(787) (787) (787)
Investments not includable in regulatory capital
(1,587) (1,587) (1,667)
--------- --------- ---------
Regulatory capital $ 158,789 $ 158,789 $ 163,479
========= ========= =========
</TABLE>
- 43 -
<PAGE>
The Association's actual and required capital amounts and ratios are
summarized as follows (in thousands):
<TABLE>
<CAPTION>
Minimum
Actual Requirement
--------------------------- ------------------------
Amount Ratio Amount Ratio
<S> <C> <C> <C> <C>
June 30, 1997
Tangible capital (to total assets) $167,227 18.9% $13,291 1.5%
Core capital (to adjusted total assets) $167,227 18.9% $26,582 3.0%
Risk-based capital (to risk-weighted assets) $173,133 36.5% $37,960 8.0%
June 30, 1996
Tangible capital (to total assets) $158,789 22.3% $10,667 1.5%
Core capital (to adjusted total assets) $158,789 22.3% $21,332 3.0%
Risk-based capital (to risk-weighted assets) $163,479 42.9% $30,462 8.0%
</TABLE>
As of June 30, 1997 and 1996, the most recent respective notifications
from the OTS classified the Association as well capitalized under the
regulatory framework for prompt corrective action. There are no conditions
or events since the most recent notification that management believes have
changed the Association's category. To be categorized as well capitalized,
the Association must maintain minimum ratios of total capital to
risk-weighted assets, core capital to risk-weighted assets and core
capital to adjusted total assets.
The Association's actual and minimum capital requirements to be well
capitalized under prompt corrective action provisions are as follows
(dollars in thousands):
<TABLE>
<CAPTION>
Minimum
Actual Requirement
--------------------------- -------------------------
Amount Ratio Amount Ratio
<S> <C> <C> <C> <C>
June 30, 1997
Tier I Capital (to adjusted total assets) $167,227 18.9% $44,303 5.0%
Tier I Capital (to risk-weighted assets) $167,227 35.2% $28,470 6.0%
Total Capital (to risk-weighted assets) $173,133 36.5% $47,450 10.0%
June 30, 1996
Tier I Capital (to adjusted total assets) $158,789 22.3% $35,555 5.0%
Tier I Capital (to risk-weighted assets) $158,789 41.7% $22,847 6.0%
Total Capital (to risk-weighted assets) $163,479 42.9% $38,078 10.0%
</TABLE>
On September 30, 1996, legislation was enacted to recapitalize the Savings
Association Insurance Fund. The effect of this legislation is to require a
one-time assessment on all federally insured savings associations'
deposits and was levied by the Federal Depository Insurance Corporation
("FDIC") at .657% of insured deposits at June 30, 1996. The amount of the
Association's assessment was approximately $3.1 million. The assessment
was accrued as a charge to earnings in the quarter ended September 30,
1996 and paid on November 27, 1996.
- 44 -
<PAGE>
13. FAIR VALUE DISCLOSURE
The carrying and estimated fair value amounts of financial instruments as
of June 30, 1997 and 1996, are summarized below:
<TABLE>
<CAPTION>
1997 1996
---------------------------------------- ----------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
<S> <C> <C> <C> <C>
Assets:
Cash and cash
equivalents $ 31,370,359 $ 31,370,359 $ 9,605,598 $ 9,605,598
Securities available
for sale 175,710,104 175,710,104 248,445,333 248,445,333
Loans receivable 658,323,320 653,393,693 505,130,813 491,177,000
Stock of Federal
Home Loan Bank
of Atlanta 6,450,000 6,450,000 5,062,100 5,062,100
Other assets 6,151,280 6,151,280 5,907,147 5,907,147
Liabilities:
Demand deposits $ 73,567,414 $ 73,567,414 $ 70,419,963 $ 70,419,963
Time deposits 370,272,128 370,720,757 378,150,953 380,838,000
Other borrowed funds 277,000,000 277,354,949 85,000,000 84,975,000
Other liabilities 4,961,756 4,961,756 4,361,974 4,361,974
</TABLE>
Cash and cash equivalents have maturities of three months or less, and
accordingly, the stated amount of such instruments is deemed to be a
reasonable estimate of fair value. The fair value of securities is based
on quoted market prices obtained from independent pricing services. The
fair values of loans, time deposits and other borrowings are estimated
based on present values using applicable risk-adjusted spreads to the U.S.
Treasury curve and other applicable market rates to approximate current
entry-value interest rates applicable to each category of such financial
instruments. Investment in stock of the Federal Home Loan Bank is required
by law for every federally insured savings institution. No ready market
exists for this stock, and it has no quoted market value. However,
redemption of this stock has historically been at par value. Accordingly,
the stated amount is deemed to be a reasonable estimate of fair value.
Other assets primarily represent accrued interest receivable; other
liabilities primarily represent advances from borrowers for taxes and
insurance and accrued interest payable. Since these financial instruments
will typically be received or paid within three months, the stated amounts
of such instruments are deemed to be a reasonable estimate of fair value.
The Company had off-balance sheet financial commitments to originate loans
and fund unused consumer lines of credit (see Note 11) of $29.0 million
and $31.0 million at June 30, 1997 and 1996, respectively. Since the loan
commitments are at interest rates that approximate current market rates,
the estimated fair value of the commitments have no other financial
statement impact.
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that
could result from offering for sale the Company's entire holdings of a
particular financial instrument. Because no active market exists for a
significant portion of the Company's financial instruments, fair value
estimates are based on judgments regarding future expected loss
experience, current economic
- 45 -
<PAGE>
conditions, current interest rates and prepayment trends, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters
of significant judgment and therefore cannot be determined with precision.
Changes in any of these assumptions used in calculating fair value also
would significantly affect the estimates. Further, the fair value
estimates were calculated as of June 30, 1997 and 1996. Changes in market
interest rates and prepayment assumptions could change significantly the
fair value.
Fair value estimates are based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. For example, the Company has
significant assets and liabilities that are not considered financial
assets or liabilities including real estate, deferred tax liabilities and
premises and equipment. In addition, the tax ramifications related to the
realization of the unrealized gains and losses can have a significant
effect on fair value estimates and have not been considered in any of
these estimates.
14. SPECIAL DISTRIBUTION TO SHAREHOLDERS
On March 18, 1997, the Company paid to its shareholders a special
distribution of $78.9 million, or $5 per share. The Company has determined
that 95% of all shareholder distributions during the year represent a
return of shareholder capital. Consequently, the return of capital portion
has been reflected in the Company's financial records as a reduction of
additional paid-in capital and the remainder has been reflected as a
reduction of retained income.
15. HFNC FINANCIAL CORP.
The following condensed statements of financial condition, as of June 30,
1997 and 1996 and condensed statements of income and cash flows for the
year ended June 30, 1997 and for the period from August 29, 1995 (date of
incorporation) to June 30, 1996 for HFNC Financial Corp. should be read in
conjunction with the consolidated financial statements and the notes
thereto.
<TABLE>
<CAPTION>
Statement of Financial Position 1997 1996
<S> <C> <C>
Assets
Cash and cash equivalents $ 42,904 $ 553,980
Equity investment in subsidiaries 188,324,313 245,950,476
Deferred tax asset 990,521 --
------------ ------------
Total $189,357,738 $246,504,456
============ ============
Liabilities and Shareholders' Equity
Note payable $ 28,000,000
Other liabilities 297,821
Shareholders' equity 161,059,917 $246,504,456
------------ ------------
Total $189,357,738 $246,504,456
============ ============
- 46 -
<PAGE>
<CAPTION>
Statement of Income 1997 1996
<S> <C> <C>
Dividends from subsidiaries $ 75,912,925 $ 50,000
Interest income 14,365 3,980
------------ ------------
Total income 75,927,290 53,980
------------ ------------
Interest expense 651,778 --
Other expense 674,150 --
------------ ------------
Total expense 1,325,928 --
Income before taxes and equity in
undistributed earnings of subsidiaries 74,601,362 53,980
Income tax benefit 988,963 --
------------ ------------
Income before equity in earnings of subsidiaries 75,590,325 53,980
Equity in undistributed earnings of subsidiaries
(excess of dividends from subsidiaries over
earnings from subsidiaries) (68,226,644) 7,520,122
------------ ------------
Total $ 7,363,681 $ 7,574,102
============ ============
<CAPTION>
Statement of Cash Flows 1997 1996
<S> <C> <C>
Operating activities:
Net income $ 7,363,681 $ 7,574,102
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income tax benefit (990,521) --
Dividends on unallocated ESOP and MRRP shares, net (6,394,971) --
Amortization of unearned stock compensation 3,764,021 --
Increase in other liabilities 297,821
Equity in undistributed earnings of subsidiaries
(excess of dividends from subsidiaries over earnings
from subsidiaries) 68,226,644 (7,520,122)
------------- -------------
Net cash provided by operating activities 72,266,675 53,980
Investing activities:
Purchase of capital stock of subsidiaries -- (167,937,938)
------------- -------------
Net cash used in investing activities -- (167,887,938)
------------- -------------
Financing activities:
Net proceeds from sale of common stock -- 168,437,938
Proceeds from note payable 28,000,000 --
Dividends paid (83,071,050) --
Purchases of restricted stock for benefit plans (17,706,701) --
------------- -------------
Net cash (used in ) provided by financing activities (72,777,751) 168,437,938
Net increase in cash and cash equivalents (511,076) 553,980
Cash and cash equivalents at beginning of period 553,980 --
------------- -------------
Cash and cash equivalents at end of period $ 42,904 $ 553,980
============= =============
</TABLE>
**********
- 47 -
<PAGE>
Shareholder Information
- --------------------------------------------------------------------------------
HFNC Financial Corp. is a unitary savings and loan holding company
conducting business through its wholly-owned subsidiary, Home Federal
Savings and Loan Association. The Association is a federally-chartered,
SAIF-insured savings institution operating through its main office and
eight branch offices and a loan origination office. The Company's
headquarters are located at 139 South Tryon Street, Charlotte, North
Carolina 28202.
-------------------------------------------------
TRANSFER AGENT / REGISTRAR
-------------------------------------------------
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
- --------------------------------------------------------------------------------
Shareholder Requests
- --------------------------------------------------------------------------------
Shareholders needing assistance with stock records, transfers or lost
certificates, please contact the Company's transfer agent, Registrar and
Transfer Company.
Requests for annual reports, quarterly reports and related shareholder
literature should be directed to Corporate Secretary, HFNC Financial Corp.,
139 South Tryon Street, Charlotte, North Carolina 28202.
<PAGE>
Common Stock Information
- --------------------------------------------------------------------------------
Shares of HFNC Financial Corp.'s common stock are traded nationally under
the symbol "HFNC" on the Nasdaq National Market System. At September 5,
1997, the Company had 17,192,500 shares of common stock outstanding and had
approximately 2,625 shareholders of record. Such holdings do not reflect
the number of beneficial owners of common stock.
The following table sets forth the reported high and low sale prices of a
share of the Company's common stock as reported by Nasdaq (the common stock
commenced trading on the Nasdaq National Market System on December 28,
1995).
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
QUARTER ENDED FISCAL YEAR ENDED JUNE 30, 1997 FISCAL YEAR ENDED JUNE 30, 1996
- -----------------------------------------------------------------------------------------------------------------
HIGH LOW DIVIDEND HIGH LOW DIVIDEND
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
September 30 $18.38 $15.75 $0.05 - - -
December 31 18.13 17.00 0.07 $13.38 $12.63 -
March 31 22.25 16.63 5.07 15.13 12.88 -
June 30 19.88 15.88 0.07 16.63 13.75 -
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-END> JUN-30-1997
<CASH> 9,934,359
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 21,436,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 175,710,104
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 665,934,995
<ALLOWANCE> 7,611,675
<TOTAL-ASSETS> 892,920,109
<DEPOSITS> 443,839,542
<SHORT-TERM> 277,000,000
<LIABILITIES-OTHER> 11,020,650
<LONG-TERM> 0
0
0
<COMMON> 171,925
<OTHER-SE> 160,887,992
<TOTAL-LIABILITIES-AND-EQUITY> 892,920,109
<INTEREST-LOAN> 49,101,206
<INTEREST-INVEST> 16,214,450
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 65,315,656
<INTEREST-DEPOSIT> 23,564,888
<INTEREST-EXPENSE> 34,618,710
<INTEREST-INCOME-NET> 30,696,946
<LOAN-LOSSES> (59,286)
<SECURITIES-GAINS> 19,379
<EXPENSE-OTHER> 19,984,621
<INCOME-PRETAX> 11,973,464
<INCOME-PRE-EXTRAORDINARY> 11,973,464
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,363,681
<EPS-PRIMARY> .46
<EPS-DILUTED> .46
<YIELD-ACTUAL> 7.87
<LOANS-NON> 6,319,367
<LOANS-PAST> 0
<LOANS-TROUBLED> 642,885
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 7,495,515
<CHARGE-OFFS> 344,229
<RECOVERIES> 519,675
<ALLOWANCE-CLOSE> 7,611,675
<ALLOWANCE-DOMESTIC> 7,611,675
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
