UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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 number 0-27388
HFNC FINANCIAL CORP.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
North Carolina 56-1937349
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
139 South Tryon Street, Charlotte, North Carolina 28202
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(Address of principal executive offices)
(Zip Code)
(704) 373-0400
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such report[s]), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
$0.01 Par Value Common Stock 17,192,500 shares
- ---------------------------- -----------------
Class of Stock Outstanding at May 6, 1998
<PAGE>
HFNC FINANCIAL CORP.
TABLE OF CONTENTS
Part I. Financial Information
Item 1. Financial Statements:
Consolidated Condensed Balance Sheets,
March 31, 1998 and June 30, 1997
Consolidated Condensed Statements of Income,
Three and Nine Months Ended
March 31, 1998 and 1997
Consolidated Condensed Statements of Changes in
Shareholders' Equity, Nine Months Ended
March 31, 1998 and 1997
Consolidated Condensed Statements of Cash Flows
Nine Months Ended March 31, 1998 and 1997
Notes to Consolidated Condensed Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Part II. Other Information
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
<PAGE>
Item 1.
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP.
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
As of
--------------------------------
March 31, June 30,
ASSETS 1998 1997
------------- -------------
<S> <C> <C>
CASH AND CASH EQUIVALENTS:
Cash ................................................................... $ 7,550,233 $ 9,934,359
Federal funds sold ..................................................... 12,168,000 21,436,000
------------- -------------
Total ............................................................ 19,718,233 31,370,359
------------- -------------
SECURITIES - Available for sale, at fair value (amortized cost:
$129,288,280 and $169,285,103, at March 31 and June 30, respectively) .... 132,253,852 175,710,104
LOANS RECEIVABLE, NET .................................................... 790,254,193 658,323,320
REAL ESTATE, NET ......................................................... 2,573,609 867,876
OFFICE PROPERTIES AND EQUIPMENT, NET ..................................... 9,989,286 10,099,107
STOCK OF FEDERAL HOME LOAN BANK OF ATLANTA - At cost ..................... 13,650,000 6,450,000
DEFERRED INCOME TAX ASSET, NET ........................................... 4,722,024 3,390,125
OTHER ASSETS ............................................................. 6,392,766 6,709,218
------------- -------------
TOTAL .................................................................... $ 979,553,963 $ 892,920,109
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
DEPOSITS ................................................................. $ 432,053,516 $ 443,839,542
OTHER BORROWED FUNDS ..................................................... 368,800,000 277,000,000
OTHER LIABILITIES ........................................................ 9,780,651 11,020,650
------------- -------------
Total liabilities .................................................. 810,634,167 731,860,192
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP.
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
(continued)
As of
--------------------------------
March 31, June 30,
1998 1997
------------- -------------
<S> <C> <C>
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 ............................................. 89,971,485 89,967,883
ESOP loan and unvested restricted stock ................................ (19,741,959) (23,137,490)
Retained income ........................................................ 96,694,518 90,106,224
Unrealized gain on securities available for sale (net of deferred taxes:
$1,141,745 and $2,473,626 at March 31 and June 30, respectively) ..... 1,823,827 3,951,375
------------- -------------
Total shareholders' equity ....................................... 168,919,796 161,059,917
------------- -------------
TOTAL .................................................................... $ 979,553,963 $ 892,920,109
============= =============
</TABLE>
See notes to consolidated condensed financial statements.
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Interest on loans ...................... $ 15,554,946 $ 12,605,762 $ 43,965,366 $ 35,835,117
Interest on securities ................. 2,606,528 4,010,549 8,177,630 12,966,122
------------ ------------ ------------ ------------
Total ............................ 18,161,474 16,616,311 52,142,996 48,801,239
------------ ------------ ------------ ------------
INTEREST EXPENSE:
Interest on deposits ................... 5,590,335 5,801,495 17,427,204 17,682,886
Interest on other borrowed funds ....... 4,748,825 2,906,014 12,587,958 7,243,373
------------ ------------ ------------ ------------
Total ............................ 10,339,160 8,707,509 30,015,162 24,926,259
------------ ------------ ------------ ------------
NET INTEREST INCOME ...................... 7,822,314 7,908,802 22,127,834 23,874,980
PROVISION FOR LOAN LOSSES (RECOVERY
OF ALLOWANCE) .......................... (47,768) 239,283 (45,707) 200,149
------------ ------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES (RECOVERY OF ALLOWANCE) .... 7,870,082 7,669,519 22,173,541 23,674,831
------------ ------------ ------------ ------------
OTHER OPERATING INCOME:
Service charges and fees ............... 195,496 170,613 509,111 558,808
Gain on sale of securities ............. 907,808 19,379 5,741,123 19,379
Other income ........................... 67,134 123,564 224,398 367,408
------------ ------------ ------------ ------------
Total ............................ 1,170,438 313,556 6,474,632 945,595
------------ ------------ ------------ ------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Unaudited)
(continued)
Three Months Ended Nine Months Ended
March 31, March 31,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
OTHER OPERATING EXPENSES:
Personnel expenses ..................... 2,427,662 3,302,129 7,630,470 7,756,832
Federal deposit insurance premiums ..... 69,974 70,930 211,100 593,317
Special SAIF recapitalization assessment -- -- -- 3,077,275
Occupancy .............................. 446,799 434,425 1,371,192 1,244,569
Net cost of real estate operations ..... 6,315 20,266 125,238 101,192
Advertising ............................ 181,517 253,433 640,362 626,414
Data processing ........................ 125,378 119,962 347,461 315,016
Other expenses ......................... 594,248 742,356 1,854,965 2,238,283
------------ ------------ ------------ ------------
Total ............................ 3,851,893 4,943,501 12,180,788 15,952,898
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES ............... 5,188,627 3,039,574 16,467,385 8,667,528
PROVISION FOR INCOME TAXES ............... 2,029,791 1,170,236 6,442,041 3,336,998
------------ ------------ ------------ ------------
NET INCOME ............................... $ 3,158,836 $ 1,869,338 $ 10,025,344 $ 5,330,530
============ ============ ============ ============
Earnings per share ....................... $ 0.20 $ 0.12 $ 0.64 $ 0.33
Earnings per share assuming dilution ..... $ 0.20 $ 0.11 $ 0.61 $ 0.33
Dividends per share ...................... $ 0.08 $ 5.07 $ 0.22 $ 5.19
</TABLE>
See notes to consolidated condensed financial statements.
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED MARCH 31, 1998 AND 1997
(Unaudited)
ESOP and Net Unrealized
Unvested Gain (Loss) on
Restricted Securities
Common Additional Retained Stock Available for
Stock Paid-In Capital Income Sale (1) Total
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE,
JUNE 30, 1996 ........... $ 171,925 $ 168,390,571 $ 86,896,095 $ (8,700,000) $ (254,135) $ 246,504,456
Net income................. -- -- 5,330,530 -- -- 5,330,530
Shares released from ESOP
and restricted stock trusts -- 303,575 -- 2,866,603 -- 3,170,178
Shares purchased for ESOP
and restricted stock trusts -- -- -- (15,949,032) -- (15,949,032)
Dividends paid............. -- (75,997,906) (5,954,990) -- -- (81,952,896)
Change in net unrealized
loss on securities
available for sale......... -- -- -- -- 1,632,565 1,632,565
------------- ------------- ------------- ------------- ------------- -------------
BALANCE,
MARCH 31, 1997 .......... $ 171,925 $ 92,696,240 $ 86,271,635 $ (21,782,429) $ 1,378,430 $ 158,735,801
============= ============= ============= ============= ============= =============
BALANCE,
JUNE 30, 1997 ........... $ 171,925 $ 89,967,883 $ 90,106,224 $ (23,137,490) $ 3,951,375 $ 161,059,917
Net income................. -- -- 10,025,344 -- -- 10,025,344
Shares released from ESOP
and restricted stock trusts -- 3,602 -- 3,395,531 -- 3,399,133
Dividends paid............. -- -- (3,437,050) -- -- (3,437,050)
Change in net unrealized
gain on securities
available for sale......... -- -- -- -- (2,127,548) (2,127,548)
------------- ------------- ------------- ------------- ------------- -------------
BALANCE,
MARCH 31, 1998 .......... $ 171,925 $ 89,971,485 $ 96,694,518 $ (19,741,959) $ 1,823,827 $ 168,919,796
============= ============= ============= ============= ============= =============
</TABLE>
(1) Net of deferred income taxes.
See notes to consolidated condensed financial statements.
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
March 31,
--------------------------------
1998 1997
------------- -------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income ............................................ $ 10,025,344 $ 5,330,530
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation ........................................ 492,217 373,830
Net amortization of premiums on investment securities 124,308 338,277
Amortization of net deferred loan fees .............. (1,526,695) (1,310,887)
Provision for loan loss (recovery of allowance) ..... (45,707) 200,149
Provision for losses on real estate ................. 4,381 92,379
Amortization of unearned stock compensation ......... 3,399,133 3,170,178
Gain on sales of:
Real estate ....................................... (39,331) (90,437)
Investments ....................................... (5,741,123) (19,379)
Decrease (increase) in other assets ................. 316,452 (189,214)
(Decrease) increase in other liabilities ............ (1,239,997) 2,520,729
------------- -------------
Net cash provided by operating activities ......... 5,768,982 10,416,155
------------- -------------
INVESTING ACTIVITIES:
Proceeds from maturities of investment securities ... 34,966,184 5,000,000
Proceeds from sales of securities available for sale 55,979,989 67,279,569
Purchases of securities available for sale .......... (52,062,538) (6,950,000)
Purchases of Federal Home Loan Bank stock ........... (7,200,000) (312,300)
Principal repayment on mortgage-backed securities ... 6,729,985 9,405,098
Proceeds from sales of real estate .................. 1,406,872 2,214,110
Net loan originations ............................... (133,436,127) (112,564,945)
Purchases of office properties and equipment ........ (382,397) (4,588,133)
------------- -------------
Net cash used in investing activities ............. (93,998,032) (40,516,601)
------------- -------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HFNC FINANCIAL CORP.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
(continued)
Nine Months Ended
March 31,
--------------------------------
1998 1997
------------- -------------
<S> <C> <C>
FINANCING ACTIVITIES:
Decrease in deposits ................................ (11,786,026) (713,128)
Proceeds from other borrowed funds .................. 153,000,000 140,000,000
Repayments of other borrowed funds .................. (61,200,000) --
Purchases of restricted stock for benefit plan ...... -- (15,949,032)
Dividends paid ...................................... (3,437,050) (81,952,896)
------------- -------------
Net cash provided by financing activities ......... 76,576,924 41,384,944
------------- -------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ...... (11,652,126) 11,284,498
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ...... 31,370,359 9,605,598
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............ $ 19,718,233 $ 20,890,096
============= =============
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest ......................................... $ 30,265,045 $ 25,226,620
Income taxes ..................................... 6,402,190 2,781,284
Loans foreclosed .................................... 3,077,656 936,473
Change in unrealized (loss) gain on investment
securities available for sale, net of taxes ....... (2,127,548) 1,632,565
</TABLE>
See notes to consolidated condensed financial statements.
<PAGE>
HFNC FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
1. BASIS OF PRESENTATION
HFNC Financial Corp. (the "Company") 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 Company and the
offer and sale of the Company's common stock by the Company (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 gross proceeds of
the Conversion totaled $171,925,000, of which $171,925 was allocated to common
stock and $168,266,013 (net of conversion costs of $3,487,062) is included in
additional paid-in capital. Approximately 50% of the net proceeds from the
Conversion were used to acquire 100% of the common stock of the Association.
Substantially all of the remaining net proceeds from the Conversion were
retained by HFNC Investment Corp., a wholly owned subsidiary of the Company.
The accompanying consolidated condensed financial statements of the Company have
been prepared in accordance with instructions to Form 10-Q. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. However, such
information reflects all adjustments (consisting solely of normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
statement of results for the interim periods.
The results of operations for the three and nine months ended March 31, 1998 are
not necessarily indicative of the results to be expected for the year ending
June 30, 1998. The consolidated financial statements and notes thereto should be
read in conjunction with the audited financial statements and notes thereto for
the year ended June 30, 1997, contained in the Company's 1997 annual report.
Earnings Per Share -- Earnings per share has been computed by dividing net
income by the weighted average number of shares of common stock outstanding
during the period. In accordance with generally accepted accounting principles,
employee stock ownership plan and restricted stock shares are only considered
outstanding for the basic earnings per share calculations when they are vested
or committed to be released. The weighted average shares outstanding were
15,718,872 and 15,660,061, respectively, for the three and nine months ended
March 31, 1998, and 15,785,575 and 16,199,519, respectively, for the three and
nine months ended March 31, 1997.
Stock options and unvested restricted stock represented additional potentially
dilutive securities and are given effect in the computation of earnings per
share assuming dilution. Potential dilution from these options and restricted
shares amounted to 14,611 and 459,781 shares, respectively, for the quarter
ended March 31, 1998 and 135,394 and 557,067 shares, respectively, for the nine
months ended March 31, 1998. Potential dilution from these options and
restricted shares amounted to 121,269 and 563,792 shares, respectively, for the
quarter ended March 31, 1997, while no potentially dilutive securities were
outstanding for a significant period prior to the March 1997 quarter. The total
weighted average shares outstanding utilized in computing earnings per share
assuming dilution for the three and nine months ended March 31, 1998 therefore
amounted to 16,193,264 and 16,352,522 shares, respectively. The shares
outstanding assuming dilution for the three and nine months ended March 31, 1997
amounted to 16,470,636 and 16,370,784 shares, respectively.
<PAGE>
2. 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. On October 11, 1997, the United States District Court
for the Western District of North Carolina entered an Order Granting Summary
Judgment in accordance with the Recommended Order by the United States
Bankruptcy Judge. The borrower has appealed the Order Granting Summary Judgment
in favor of the Association.
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 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 corporations after the payment. Home Federal and
its officers vigorously deny all of her allegations. On February 18, 1998 the
Association filed a Motion for Summary Judgment seeking dismissal of the
counterclaim. Oral argument on the Motion was heard on April 28, 1998 and the
Association is currently awaiting a ruling on the Motion.
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 to 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 in the Superior
Court for Mecklenburg County, North Carolina 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. On
January 29, 1998, the Superior Court of Mecklenburg County granted the Motion
for Summary Judgment filed by the officers of the Association dismissing the
lawsuit against them. The borrower has appealed the Order granting summary
judgment in favor of the Association's officers. The litigation in the United
States Bankruptcy Court referenced above remains pending. The Association agreed
to indemnify both of its officers with respect to certain costs, expenses, and
liability that might arise in connection with both of these cases.
<PAGE>
In July 1997, the above borrower and affiliated companies filed an additional
action in the United States District Court for the Western District of North
Carolina 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,
US 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 filed a
motion to dismiss this lawsuit and is awaiting ruling on that motion. 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 another lawsuit action in the United States
District Court for the Western District of North Carolina 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. All defendants have filed
motions to dismiss this lawsuit. On December 4, 1997, this lawsuit was dismissed
as to all defendants. The borrower has appealed. The Association agreed to
indemnify the attorneys for the Association with respect to certain costs,
expenses, and liabilities that might arise in connection with this matter.
On April 13, 1998 the borrower, individually, filed a voluntary petition for
Chapter 11 bankruptcy protection.
The Association, its officers and its attorneys 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
at the present time to give an opinion as to the likely outcome of the lawsuits
or estimate the amount or range of potential loss, if any.
<PAGE>
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Condition
The Company's assets amounted to $979.6 million at March 31, 1998, compared to
$892.9 million at June 30, 1997, an increase of $86.6 million or 9.7%. This
increase in total assets was due to growth in loans receivable of $131.9
million, to $790.3 million at March 31, 1998 compared to $658.3 million at June
30, 1997. This asset growth was partially offset by a decrease in securities of
$43.5 million to $132.3 at March 31, 1998 and a decrease in cash and cash
equivalents of $11.7 million. The securities sold were yielding less than
current market rates and were sold to reinvest the proceeds into higher yielding
assets, primarily loans, and to partially repay borrowed funds. Approximately
$6.4 million of the securities sold were equity securities that had appreciated
significantly in value and were sold at a $6.2 million gain. An additional $49.6
million were investment securities which were also yielding less than current
market rates and were sold at a $476,000 loss. In addition to the growth in
loans receivable, net real estate increased $1.7 million over the June 30, 1997
amount due to the foreclosure of real estate loans and the transfer of these
assets at net realizable value to real estate owned. Total liabilities increased
$78.8 million from the June 30, 1997 level due primarily to a $91.8 million
increase in other borrowed funds during the nine month period ended March 31,
1998. These funds, combined with funds derived from the sale of securities
during the period, were principally used to fund loan originations. Deposits
amounted to $432.1 million at March 31, 1998, a decline of $11.8 million from
June 30, 1997. Shareholders' equity increased $7.9 million due to net income of
$10.0 million and to the release of shares from the ESOP and restricted stock
trusts amounting to $3.4 million, partially offset by a decrease in unrealized
gains on securities available for sale (net of tax) of $2.1 million and
dividends paid of $3.4 million.
Results of Operations for the Three Months Ended March 31, 1998 and 1997
General: Net income for the three months ended March 31, 1998 amounted to $3.2
million, an increase of $1.3 million from the comparable quarter of 1997. This
increase was primarily due to a $287,000 decrease in the loan loss provision
(from a net provision of $239,000 in the prior year quarter to a $48,000 net
recovery in the 1998 quarter), an increase in other operating income of
$857,000, and a decrease in other operating expenses of $1.1 million, which were
partially offset by a decrease in net interest income of $86,000 and an increase
in the provision for income taxes of $860,000.
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 decreased $86,000 or 1.1% to $7.8
million for the three months ended March 31, 1998, compared to $7.9 million for
the three months ended March 31, 1997. This decrease is primarily the result of
a reduction in the ratio of interest-earning assets to interest-bearing
liabilities to 1.19 during the quarter ended March 31, 1998 from 1.34 during the
quarter ended March 31, 1997. This ratio declined due to the liquidation of a
<PAGE>
significant portion of the securities portfolio to fund the $5 per share special
distribution paid to shareholders in March 1997, coupled with the Company's
additional borrowings to fund loan growth. This effect was somewhat offset,
however, by an increase in the interest rate spread to 2.55% in the quarter
ended March 31, 1998, from 2.33% in the prior year quarter, resulting from the
balance sheet restructuring discussed at "Financial Condition" above. The net
interest margin declined to 3.43% in the current quarter from 3.69% in the prior
year quarter, also due to the reduction in the ratio of interest-earning assets
to interest-bearing liabilities following the special distribution.
Interest Income: Interest income increased $1.5 million or 9.3% over the prior
year quarter due to an increase in interest on loans of $2.9 million and a
decrease in interest on securities of $1.4 million. The increase in loan
interest resulted from loan growth during the year, with the average balance
outstanding during the 1998 quarter amounting to $763.2 million compared to
$605.1 million in the prior year quarter, an increase of $158.1 million or
26.1%. The average yield on loans decreased somewhat, to 8.15% from 8.33%, due
to general declines in market rates and to a larger proportion of the
Association's loan portfolio consisting of loan products that have a moderate
rate discount during the first three to five years. At the end of the initial
period, the loans convert to a fixed rate or one year adjustable rate loan at
the full market rate. These competitive loan products were instrumental in the
loan growth during the past year and the yields are expected to rise somewhat
when the initial terms expire. The decrease in interest on securities primarily
resulted from a $102.7 million or 40.7% decline in the average balance of
securities to $149.4 million for the quarter ended March 31, 1998 from $252.1
million in the prior year quarter. This decrease was due to the sale of
securities to fund the special $5 distribution paid to shareholders in March
1997 and to the additional sale of lower yielding securities during the nine
months ended March 31, 1998 discussed at "Financial Condition" above. This sale
of securities did, however, improve the Company's yield on securities to 6.98%
in the current quarter, compared to 6.36% in the prior year quarter.
Interest Expense: Total interest expense for the quarter ended March 31, 1998
increased $1.6 million, or 18.7%, over the quarter ended March 31, 1997.
Interest on other borrowed funds increased $1.8 million to $4.7 million for the
quarter ended March 31, 1998 from $2.9 million in the prior year quarter. This
increase was due to an increase in the average balance of borrowed funds to
$331.5 million in the current quarter from $201.7 million in the prior year
quarter, resulting from the use of borrowed funds to support the Company's loan
growth during the past year. This increase in the average balance was partially
offset by a decrease in the average rate paid on these borrowings to 5.73% from
5.76%. Interest on deposits during the current quarter was down $211,000, or
3.6%, from the prior year quarter, with the average balance and the average rate
paid declining 1.8% and 1.9%, respectively, from the prior year levels.
<PAGE>
Provision for Loan Losses (Recovery of Allowance): The Company's allowance for
loan losses is maintained at a level which is deemed to be appropriate based
upon an assessment of prior loss experience, the volume and type of lending
presently being conducted by the Company, industry standards, past due loans,
general economic conditions in the Company's market area, and to other factors
related to the collectibility of the loan portfolio. During the quarter ended
March 31, 1998, the Association recorded a $48,000 net recovery of its allowance
for loan losses compared to a net provision for losses during the prior year
quarter of $239,000. The recovery of allowance during the current quarter was
due to a significant reduction in problem loans during the current quarter
compared to the prior year. Nonperforming loans have declined to $4.6 million at
March 31, 1998, compared to $7.1 million at March 31, 1997. Management's
assessment indicates that the severity and loss potential among these loans has
declined as well. Consequently, the specific reserves for identified loan losses
have declined from $1.6 million at March 31, 1997 to $63,000 at March 31, 1998.
On the other hand, general reserves for unspecified potential loan losses have
increased from $6.3 million to $7.0 million during the same period. At March 31,
1998, the total allowance for loan losses amounted to 153.2% of nonperforming
loans and 0.89% of total loans.
Other Operating Income: Other operating income increased $857,000, to $1.2
million compared to $314,000 in the prior year quarter, due to a current quarter
$908,000 gain on the sale of securities. This sale is discussed in "Financial
Condition" above.
Other Operating Expenses: Total other operating expenses amounted to $3.9
million, a decline of $1.1 million from the prior year, as personnel expenses
declined $874,000 from the prior year quarter, and miscellaneous other expenses
declined $148,000 from the 1997 quarter. The current year reduction in personnel
expenses resulted from a nonrecurring level of prior year costs associated with
the Company's Management Recognition and Retention Plan (MRRP) approved by
shareholders in December 1996. The March 1997 quarter included the $1.1 million
fair market value of shares of stock granted pursuant to the plan during the
quarter to the Association's Board of Directors and certain employees and
members of management. These shares represented a portion of the total shares to
be granted under the MRRP, with this portion vesting immediately and future
grants to vest over the next four years. Beginning in the March 1997 quarter,
each quarter has included accrued costs for shares that will vest in the
subsequent year. Consequently, the quarter ended March 31, 1997 included five
quarters of cost under this plan, while the current year quarter includes only
the cost associated with one quarter. The decrease in miscellaneous other
operating expenses was primarily due to a $95,000 decline in legal expenses in
the current quarter as compared to the prior year quarter. The level of legal
costs in the 1997 quarter was atypical and was largely associated with the
determination of the nature, tax treatment, and other implications of the $5.00
per share special distribution paid in March 1997, as well as ongoing litigation
involving a former borrower.
Results of Operations for the Nine Months Ended March 31, 1998 and 1998
General: Net income for the nine months ended March 31, 1998 amounted to $10.0
million, an increase of $4.7 million from the comparable quarter of 1997. This
was primarily due to an increase in other operating income of $5.5 million and a
decline in other operating expenses of $3.8 million. These increases were
partially offset by a $1.7 million reduction in net interest income and a $3.1
million increase in the provision for income taxes. Net Interest Income: The
<PAGE>
Company's net interest income for the nine months ended March 31, 1998 decreased
$1.7 million, or 7.3%, from the comparable prior year period. This decline was
due to a reduction in the ratio of interest-earning assets to interest-bearing
liabilities from 1.37 during the nine months ended March 31, 1997 to 1.20 during
the nine months ended March 31, 1998, resulting primarily from the liquidation
of securities to fund the $5 per share special distribution paid to shareholders
in March 1997 and from the Company's additional borrowings to fund loan growth.
The sale of securities during the current period had a less significant effect
than the sale of securities to fund the special distribution because the
proceeds were reinvested in mortgage loans or used to partially repay borrowed
funds. The effect of this decline in earning assets was moderated to some extent
by an increase in the interest rate spread from 2.35% during the prior year
period to 2.44% in the nine month period ended March 31, 1998. These two factors
combined to produce a 3.37% net interest margin during the nine months ended
March 31, 1998, compared to 3.83% during the prior year period.
Interest Income: Interest income for the nine months ended March 31, 1998
increased $3.3 million or 6.8% over the prior year period, to $52.1 million from
$48.8 million. This increase was due to the growth in the loan portfolio, to an
average balance during the nine months ended March 31, 1998 of $713.3 million
from an average balance of $567.0 million during the prior year period. This
more than compensated for a decline in the average yield of the loan portfolio
from 8.43% to 8.22%. Income from securities decreased $4.8 million due to
decreases in the average balance to $161.4 million from $264.6 million in the
prior year period. The decline in the average balance from the prior year was
offset to some extent by an increase in the average yield to 6.75% in the
current period from 6.53% in the prior year.
Interest Expense: Interest on deposits was relatively unchanged from the prior
year, as average balances and yields on customer deposits were relatively
constant for the nine month period ended March 31, 1998 compared to the same
period in the prior year. Interest on other borrowed funds increased $5.3
million over the period ended March 31, 1997 due to additional borrowings to
support loan growth. The average balance of other borrowed funds increased 73.6%
to $289.6 million during the nine months ended March 31, 1998 compared to the
same period in the prior year. The average cost of these borrowings was
consistent at 5.80% during the current period compared to 5.79% in the prior
year period.
Other Operating Income: Other operating income increased $5.5 million due to
$5.7 million in gains on the sale of securities during the nine months ended
March 31, 1998, with a minimal level of such sales during the prior year period.
These sales were discussed at "Financial Condition" above.
Other Operating Expenses: Other operating expenses for the nine months ended
March 31, 1998 declined $3.8 million from the comparable prior year period,
resulting primarily from the $3.1 million one-time Savings Association Insurance
Fund (SAIF) assessment paid in the prior year period, the resultant $382,000
current period reduction in the cost of deposit insurance premiums, and a
$383,000 reduction in miscellaneous other operating expenses. The Association
was required to pay a $3.1 million special one-time assessment in September 1996
to recapitalize the SAIF. This payment reduced the future periodic cost of
federal deposit insurance premiums, resulting in a reduction in current year
premium costs as compared to the prior year. Miscellaneous other operating
<PAGE>
expenses declined from the prior year levels principally due to reduced legal
costs in connection with the Association's litigation involving a former
borrower who is in bankruptcy (see Note 2 of "Notes to Consolidated Condensed
Financial Statements") and to nonrecurring legal costs in the prior year
associated with the determination of the nature, tax treatment, and other
implications of the $5.00 per share special distribution paid in March 1997.
Liquidity and Capital Resources
The Company's liquidity, represented by cash and cash equivalents, is a product
of its operating, investing and financial activities. The Company's primary
sources of funds are deposits, borrowings, amortization, prepayments and
maturities of outstanding loans, sales of loans, maturities of investment
securities and other short-term investments and funds provided from operations.
While scheduled loan amortization and maturing investment securities and
short-term investments are relatively predictable sources of funds, deposit
flows and loan prepayments are greatly influenced by general interest rates,
economic conditions and competition. The Company invests excess funds in
overnight deposits and other short-term interest-earning assets. The Company can
use cash generated through the retail deposit market, its traditional funding
source, to offset the cash utilized in investing activities. The Company's
available for sale securities and short-term interest-earning assets can also be
used to provide liquidity for lending and other operational requirements. As an
additional source of funds, the Company may borrow from the FHLB of Atlanta or
through securities sold under repurchase agreements.
The Association is required by Office of Thrift Supervision regulations to
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 equal
to at least 8.0% of risk-weighted assets. The Association substantially exceeded
such requirements with tangible, core and total capital equal to 15.4%, 15.4%
and 29.4%, respectively, at March 31, 1998.
Year 2000 Issue
The Company began planning for the Year 2000 problem during 1997 and formed a
project committee to develop the Company's plans for potential problems in this
area. The Company has completed its assessment of the Company's vulnerability to
Year 2000 problems, has determined its course of action with respect to its
non-Year 2000 compliant systems, and has prepared initial estimates of the costs
of resolution. The Company's most critical computer system is utilized by its
subsidiary, Home Federal Savings and Loan Association, for loan, deposit, and
accounting functions, and is maintained by a third party service bureau. The
costs of compliance will be borne by the vendor under the contract. While this
system is presently substantially Year 2000 compliant, Association personnel
will participate in tests of the system during the latter part of 1998 to ensure
full compliance. Failure to prepare this system for the Year 2000 would
materially affect the Association's ability to operate and serve its customers.
The Company's other information technology-controlled systems have also been
identified and are in various states of readiness. Certain software and hardware
systems have been identified that will need to be replaced, with implementation
of the new systems completed by early 1999. Such costs will be capitalized and
amortized over the useful lives of the assets, while other costs, including
costs to modify current systems, will be expensed as incurred. Management's
<PAGE>
current estimate of the cost of Year 2000 compliance is approximately $700,000,
nearly all of which will be capitalized in accordance with accounting standards.
These estimates were derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved at the cost disclosed or within the timeframes
currently estimated. Further, in the course of its business the Association
regularly exchanges data electronically with other financial institutions,
customers, and regulatory agencies. There can be no guarantee that those
external systems will be properly converted, or that a failure to properly
convert by these other entities will not have a detrimental impact on the
Company.
The Company is aware of the issues associated with the programming code in
existing computer systems as the Year 2000 approaches. The Year 2000 Issue is
the result of computer programs being written using two digits rather than four
digits to define the applicable year. Computer programs that have time-sensitive
coding may recognize a date using "00" as the year 1900 rather than the year
2000. Systems that do not properly recognize such information could generate
erroneous data or cause a system to fail.
The Bank has conducted a review of its computer systems to identify the systems
that could be affected by the Year 2000 Issue and is developing an
implementation plan to resolve the issue. The majority of the Bank's data
processing is provided by a third party service bureau. The servie bureau is
actively involved in resolving Year 2000 issues and has provided the Bank with
frequent updates regarding their progress. The service bureau has advised the
Bank that it expects to have the majority of the Year 2000 issues resolved
before the end of 1998 to allow the Bank to test their system for Year 2000
compliance. The Bank presently believes that, based on the progress of the
Bank's service bureau, the Year 2000 problem will not pose significant
operational problems for the Bank's computer system.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
For a discussion of the Company's asset and liability management policies as
well as the potential impact of interest rate changes upon the market value of
the Company's portfolio equity, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations on the Company's 1997 Annual
Report to Stockholders. There has been no material change in the Company's asset
and liability position or the market value of the Company's portfolio equity
since June 30, 1997.
<PAGE>
HFNC FINANCIAL CORP.
Part II
Item 1. Legal Proceedings
Other than as discussed in Note 2 of the Notes to Consolidated
Condensed Financial Statements, the Company is not engaged in any
legal proceedings at the present time other than those generally
associated with the normal course of business.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
None.
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
Date: May 6, 1998 By: \s\ H. Joe King, Jr.
--------------------
H. Joe King, Jr.
President and
Chief Executive Officer
Date: May 6, 1998 By: \s\ A. Burton Mackey, Jr.
-------------------------
A. Burton Mackey, Jr.
Vice President and Treasurer
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> MAR-31-1998
<CASH> 7,550,233
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 12,168,000
<TRADING-ASSETS> 0
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<TOTAL-ASSETS> 979,553,963
<DEPOSITS> 432,053,516
<SHORT-TERM> 368,800,000
<LIABILITIES-OTHER> 9,780,651
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0
0
<COMMON> 171,925
<OTHER-SE> 168,747,871
<TOTAL-LIABILITIES-AND-EQUITY> 979,553,963
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<INTEREST-TOTAL> 52,142,996
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<EXPENSE-OTHER> 12,180,788
<INCOME-PRETAX> 16,467,385
<INCOME-PRE-EXTRAORDINARY> 10,025,344
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<NET-INCOME> 10,025,344
<EPS-PRIMARY> .64
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