<PAGE>
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1996
--------------------------
Commission file number 1-14266
------------------------------
SCOTLAND BANCORP, INC.
(Name of small business issuer in its charter)
North Carolina 56-1955133
- ------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
505 South Main Street,
Post Office Box 1468
Laurinburg, North Carolina 28353-1468
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(910) 276-2703
---------------------------
(Issuer's telephone number)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Common Stock, no par value American Stock Exchange
- ------------------------------ ------------------------------------------------
(Title of class) (Name of each exchange on which registered)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 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
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year $4,950,005
----------------
State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days.
Common Stock, no par value -- $21,898,003 (based on the price at which the stock
was sold on December 13, 1996).
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Common Stock, no par value 1,840,000
- ---------------------------- ----------------------------------
(Class) (Outstanding at December 16, 1996)
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended September 30,
1996 (the "1996 Annual Report"), are incorporated by reference into Part I and
Part II.
Portions of the Proxy Statement for the Annual Meeting of Stockholders to be
held on January 17, 1996 (the "Proxy Statement"), are incorporated by reference
into Part III.
Transitional Small Business Disclosure Format (Check one): Yes No X
--- ---
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<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Prior to March 29, 1996, Scotland Savings Bank, Inc., SSB (the "Bank")
operated as a mutual North Carolina-chartered savings bank. On March 29, 1996,
the Bank converted from a North Carolina-chartered mutual savings bank to a
North Carolina-chartered stock savings bank (the "Conversion"). In connection
with the Conversion, all of the issued and outstanding capital stock of the Bank
was acquired by Scotland Bancorp, Inc., a North Carolina corporation (the
"Company") which was organized to become the Bank's holding company. At that
time, the Company had an initial public offering of its common stock, no par
value (the "Common Stock").
The Company is a bank holding company registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve") under the Bank
Holding Company Act of 1956, as amended (the "BHCA") and the savings bank
holding company laws of North Carolina. The Company's and the Bank's principal
office is located at 505 South Main Street, Laurinburg, North Carolina. The
Company's activities consist of investing the proceeds of its initial public
offering which were retained at the holding company level and owning the Bank.
The Company's principal sources of income are earnings on its investments. In
addition, the Company will receive any dividends which are declared and paid by
the Bank on its capital stock.
The Bank was originally chartered in 1923 as a North Carolina-chartered
building and loan association under the name Scotland County Building and Loan
Association. The Bank later converted to a North Carolina-chartered savings and
loan association and operated under the name Scotland Savings and Loan
Association until December of 1992, when it converted to a North Carolina-
chartered savings bank under its current name. The Bank has been a member of
the Federal Home Loan Bank ("FHLB") system since 1933, and its deposits have
been federally insured since 1949.
The Bank is primarily engaged in soliciting deposit accounts from the
general public, making mortgage loans to finance the acquisition and
construction of residential dwellings and making limited types of consumer
loans. The Bank's primary source of revenue is interest income from its lending
activities. The Bank's other major sources of revenue are interest and dividend
income from investments and mortgage-backed securities, interest income from its
interest-bearing deposit balances in other depository institutions and fee
income from its lending and deposit activities. The major expenses of the Bank
are interest on deposits and noninterest expenses such as compensation and
fringe benefits, federal deposit insurance premiums, data processing expenses
and branch occupancy and related expenses.
The operations of the Bank and depository institutions in general are
significantly influenced by general economic conditions and by related monetary
and fiscal policies of depository institution regulatory agencies, including the
Federal Reserve, the Federal Deposit Insurance Corporation (the "FDIC") and the
North Carolina Administrator, Savings Institutions Division, North Carolina
Department of Commerce (the "Administrator"). Deposit flows and cost of funds
are influenced by interest rates on competing investments and general market
rates of interest. Lending activities are affected by the demand for financing
of real estate and other types of loans, which in turn are affected by the
interest rates at which such financing may be offered and other factors
affecting local demand and availability of funds.
<PAGE>
Primary Market Area
The Bank's primary market area is Scotland County and portions of Moore
County, North Carolina. The Bank's principal office is in Laurinburg, North
Carolina and it has one full-service branch in Pinehurst, North Carolina.
Scotland County is in southeastern North Carolina along the North Carolina/South
Carolina stateline southwest of Fayetteville, North Carolina. Pinehurst in
Moore County, is immediately north of Scotland County and northwest of
Fayetteville.
The Bank's loans and deposits are primarily generated from the areas where
its offices are located. It does not solicit deposits and loans outside its
primary market area and does not use brokers to obtain deposits. Approximately
85% of the Bank's deposits are at the Laurinburg office and the majority of its
customers are residents of Laurinburg and Scotland County. Scotland County is
largely rural with a population of 35,000. Its economy is diversified among
agriculture, manufacturing and services. Major area employers include Abbott
Laboratories, Campbell Soup Company, LOF Glass and Westpoint-Stevens. Although
the economy is diversified and generally stable, population and household
growth, and median and per capita income levels for Scotland County are
generally lower than comparable levels for North Carolina and the nation, while
unemployment levels are generally higher. Management regards the Scotland County
market area as a low growth area in which there is significant competition among
financial services providers for market share. Management believes that
opportunities for future earnings growth in the Bank's home market area are
limited in light of these factors.
By comparison, in Pinehurst and Moore County, where the Bank has fewer
deposits and customers, growth and income levels exceed North Carolina and
national figures, reflecting the development of Pinehurst and Moore County as
golfing, resort and retirement centers. The major employers in Moore County
include Moore Regional Hospital, Resorts of Pinehurst and Ithaca Industries.
There is significant competition among providers of financial services in these
markets and the Bank's market share is not large.
Net Interest Income
The Company's results of operations depend primarily on its net interest
income, which is the difference between interest income from interest-earning
assets and interest expense on interest-bearing liabilities. Net interest
income represents the difference between income derived from interest-earning
assets and interest expense incurred on interest-bearing liabilities. Net
interest income is affected by both (i) the difference between the rates of
interest earned on interest-earning assets and the rates paid on interest-
bearing liabilities ("interest rate spread") and (ii) the relative amounts of
interest-earning assets and interest-bearing liabilities outstanding during the
period. Net interest income increased by $491,330 to $2,660,853 for the year
ended September 30, 1996 from $2,169,523 reported in 1995. The increase in net
interest income during 1996 was attributable to an increase in the average
balance of interest earning assets due to the proceeds received from the stock
offering. The average balance of interest earning assets increased by
approximately $8.1 million during 1996. The increase in interest earning assets
allowed net interest income to increase even though the Bank's net interest rate
spread decreased from 3.27% in 1995 to 2.84% in 1996, primarily due to an
increase in the Bank's cost of funds.
The following table analyzes the dollar amount of changes in interest
income and interest expense for major components of interest earning assets and
interest bearing liabilities. The table distinguishes between (i) changes
attributable to volume (changes in volume multiplied by the prior period's rate)
(ii) changes attributable to rate (changes in rate multiplied by the prior
period's volume) and (iii) mixed changes (changes in volume multiplied by change
in rate).
2
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
1996 vs. 1995
--------------------------------------
Increase (Decrease) Attributable to
--------------------------------------
Volume Rate Rate/Volume Net
------- ------ ----------- -----
(In Thousands)
<S> <C> <C> <C> <C>
Interest income on:
Interest-bearing deposits $ 133 $ (36) $(19) $ 78
Investments, at cost 106 20 3 129
Mortgage-backed securities (13) 3 (1) (11)
Loans receivable 353 6 -- 359
Total interest income on ----- ----- ---- ----
interest-earning assets
579 (7) (17) 555
----- ----- ---- ----
Interest expense on:
Passbook accounts 33 3 -- 36
Transaction accounts (50) (20) 4 (66)
Certificates of deposit (130) 192 (14) 48
FHLB advances -- -- 47 47
Other -- -- -- --
Total interest expense on ----- ----- ---- ----
interest-bearing liabilities
(147) 175 37 65
----- ----- ---- ----
Increase (decrease) in net
interest income $ 726 $(182) $(54) $490
===== ===== ==== ====
</TABLE>
Interest Income
Total interest income increased by $556,389 during 1996, from $4,313,318 in
1995 to $4,869,707 in 1996. The increase in interest income during 1996 was
attributable to an $8.1 million increase in the average balance of interest
earnings assets due to the proceeds received from the stock offering. The
Bank's overall yield on interest earning assets declined slightly during 1996,
from 7.70% in 1995 to 7.60% in 1996. During 1995, interest income increased by
approximately $425,000 due primarily to an increase in the Bank's yields from
7.17% in 1994 to 7.70% in 1995. Changes in the volume of average interest
earning assets during 1995, which increased by $1.8 million, also positively
impacted interest income.
Interest Expense
Total interest expense increased to $2,208,854 in 1996 from $2,143,795 in
1995, an increase of $65,059 or 3.0%. The increase in the Bank's cost of funds
on longer term certificate of deposits more than offset declines in its cost of
funds on transaction accounts during 1996. The Bank's cost of funds was 4.76%
in 1996 as compared to 4.43% in 1995. Changes in the Bank's cost of funds
during 1996 were
3
<PAGE>
similar to changes in overall market rates. The Bank's average balance of
outstanding deposits decreased by approximately $3.1 million during 1996 and
lowered the increase in interest expense for the period. Interest on borrower
funds had an immaterial impact on the increase in interest expense in 1996.
During 1995, interest expense increased by approximately $391,000 due primarily
to an increase in the Bank's cost of funds, which increased from 3.67% in 1994
to 4.43% in 1995.
The following table provides additional information concerning the
Company's yields on interest earning assets cost of funds on interest bearing
liabilities over the two year period ended September 30, 1996.
4
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------------------------
1996 1995
------------------------------ ---------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest earning assets:
Interest-bearing deposits $ 6,059 $ 326 5.38% $ 3,939 $ 248 6.30%
Investments, at cost (1) 14,550 840 5.77% 12,656 711 5.62%
Mortgage-backed securities 605 68 11.24% 729 79 10.84%
Loans receivable 42,878 3,635 8.48% 38,709 3,276 8.46%
------- ------ 7.60% ------- ------
Total interest-earning assets 64,092 $4,869 56,033 $4,314 7.70%
------ ------
Non-interest-earning assets 345 1,806
------- -------
Total $64,437 $57,839
======= =======
Liabilities and retained earnings:
Interest-bearing liabilities:
Passbook accounts $ 5,541 $ 160 2.89% $ 4,383 $ 124 2.83%
Transaction accounts 7,024 194 2.76% 8,688 260 2.99%
Certificates of deposit 32,339 1,808 5.59% 34,908 1,760 5.04%
FHLB advances 958 47 4.91% --- --- ---
Other 587 --- 0.00% 386 --- 0.00%
------- ------ ------- ------
Total interest-bearing liabilities 46,449 $2,209 4.76% 48,365 $2,144 4.43%
Non-interest-bearing liabilities 400 ------ 1,007 ------
Equity 17,588 8,467
------- -------
Total $64,437 $57,839
======= =======
Net interest income and interest
rate spread (2) $2,660 2.84% $2,170 3.27%
Net yield on interest-earning ====== ======
assets (3) 4.15% 3.87%
Ratio of interest-earning assets to
interest-bearing liabilities 137.98% 115.85%
</TABLE>
(1) Includes investment securities and FHLB of Atlanta common stock.
(2) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Net yield on interest-earning assets represents net interest income divided
by average interest-earning assets.
5
<PAGE>
Asset/Liability Management
The Bank's asset/liability management, or its management of interest rate
risk, is focused primarily on evaluating and managing the Bank's net interest
income given various risk criteria. Factors beyond the Bank's control, such as
market interest rates and competition, may also have an impact on the Bank's
interest income and interest expense. In the absence of other factors, the
Bank's overall yield on interest-earning assets will increase as will its cost
of funds on its interest-bearing liabilities when market rates increase over an
extended period of time. Inversely, the Bank's yields and cost of funds will
decrease when market rates decline. The Bank is able to manage these swings to
some extent by attempting to control the maturity or rate adjustments of its
interest-earning assets and interest-bearing liabilities over given periods of
time.
The Bank's management monitors interest rate sensitivity through the use of a
model which estimates the change in net portfolio value ("NPV") and net interest
income in response to a range of assumed changes in market interest rates. NPV
is the difference between incoming and outgoing discounted cash flows from
assets, liabilities, and off-balance sheet contracts. The table below presents
the Bank's NPV at September 30, 1996, as calculated by the FHLB, based on
quarterly information voluntarily provided to the FHLB by the Bank. Certain
assumptions were employed by the FHLB in preparing the table. These assumptions
relate to interest rates, loan prepayment rates, deposit decay rates, and the
market values of certain assets under the various interest rate scenarios. It
was also assumed that delinquency rates will not change as a result of changes
in interest rates, although there can be no assurance that this will be the
case. Even if interest rates change in the designated amounts, there can be no
assurance that the Bank's assets and liabilities would perform as set forth
below.
As a result, certain shortcomings are inherent in the following NPV table
because the data reflects hypothetical changes in NPV based upon assumptions
used by the FHLB in the computation. However, based on the data below, net
interest income should decline with instantaneous increases in interest rates
while net interest income should increase with instantaneous declines in
interest rates. Generally, during periods of increasing interest rates, the
Bank's interest rate sensitive liabilities would reprice faster than its
interest rate sensitive assets, causing a decline in the Bank's interest rate
spread and margin. This would result from an increase in the Bank's cost of
funds that would not be immediately offset by an increase in its yield on
earning assets. An increase in the cost of funds without an equivalent increase
in the yield on earning assets would tend to reduce net interest income. In
times of decreasing interest rates, fixed rate assets would increase in value
and the lag in repricing of interest rate sensitive assets could be expected to
have a positive effect on the Bank's net interest income.
6
<PAGE>
<TABLE>
<CAPTION>
Net Portfolio Value NPV as a % of PV of Assets
------------------------------------ ---------------------------
Change in Rates $ Amount $ Change (1) % Change (2) NPV Ratio (3) Change (4)
- --------------- ------------------------------------ ---------------------------
<S> <C> <C> <C> <C> <C>
+400 bp 13,063 -5,207 -29% 21.39% -853 bp
+300 bp 14,431 -3,839 -21% 23.63% -629 bp
+200 bp 15,799 -2,471 -14% 25.87% -405 bp
+100 bp 17,034 -1,236 -7% 27.89% -203 bp
0 bp 18,270 -- -- 29.92% --
- -100 bp 19,242 972 5% 31.51% +159 bp
- -200 bp 20,214 1,944 11% 33.10% +318 bp
- -300 bp 20,861 2,591 14% 34.16% +424 bp
- -400 bp 21,508 3,238 18% 35.22% +530 bp
</TABLE>
(1) Represents the excess (deficiency) of the estimated NPV assuming the
indicated change in interest rates minus the estimated NPV assuming no
change in interest rates.
(2) Calculated as the amount of change in the estimated NPV divided by the
estimated NPV assuming no change in interest rates.
(3) Calculated as the estimated NPV divided by present value of total assets.
(4) Calculated as the excess (deficiency) of the NPV ratio assuming the
indicated change in interest rates over the estimated NPV ratio assuming no
change in interest rates.
At September 30, 1996, a change in interest rates of a positive 200 basis
points would have resulted in a 405 basis point decrease in NPV as a percentage
of the present value of the Bank's total assets while a change in interest rates
of a negative 200 basis points would have resulted in a 318 basis point increase
in NPV as a percentage of the present value of the Bank's total assets.
In order to minimize the potential effects of adverse material and prolonged
increases or decreases in market interest rates on the Bank's operations,
management has implemented an asset/liability program designed to improve the
Bank's interest rate sensitivity. The program emphasizes the origination of
adjustable rate loans, which are held in the portfolio, the investment of excess
cash in short or intermediate term interest earning assets, and the solicitation
of passbook or transaction deposit accounts which are less sensitive to changes
in interest rates and can be repriced rapidly.
Lending Activities
General. The Bank's primary source of revenue is interest and fee income
from its lending activities, consisting primarily of mortgage loans for the
purchase or refinancing of one-to-four family residential real property located
in its primary market area. The Bank also makes loans secured by improved
nonresidential real estate (including loans secured by undeveloped real estate),
construction
7
<PAGE>
loans, unsecured loans, loans secured by motor vehicles and other personal
property, mobile home loans, savings account loans and other loans. The Bank's
net loan portfolio totaled approximately $45.1 million on September 30, 1996, or
66% of its total assets. On that date, approximately $38.7 million or 85% of
loans outstanding consisted of loans secured by mortgages on one-to-four family
residential properties, $2.2 million or 5% were loans secured by multifamily
residential properties, approximately $939,000 or 2% of loans were secured by
non-residential real estate, including loans secured by undeveloped land,
approximately $1.1 million, net of loans in process, or 2% were loans secured by
residential construction loans, approximately $2.3 million or 5% were line of
credit loans, and approximately $346,000 or 1% were loans secured by savings
accounts, automobiles or other collateral. As of September 30, 1996, all of the
loans in the Bank's real estate loan portfolio were secured by properties in
North Carolina. On September 30, 1996, the Bank's largest single outstanding
loan had a balance of approximately $645,000. This loan was performing in
accordance with its original terms. In addition to interest earned on loans,
the Bank receives fees in connection with loan originations, loan servicing,
loan modifications, late payments, loan assumptions and other miscellaneous
services.
Generally, adjustable rate loans are originated with the intention that they
will be held in the Bank's loan portfolio. The Bank currently originates a
small number of loans which do not satisfy the purchase requirements of the
Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal National
Mortgage Association ("FNMA"), including loan to value ratios, income
requirements and credit history standards. The Bank originates such
nonconforming loans if they satisfy its underwriting requirements which are
tailored for the local community. While these loans generally produce a higher
yield than would be produced by loans which conform to the purchase requirements
of FHLMC and FNMA, such loans are not readily saleable in the secondary market
and could be sold only after the Bank incurred certain costs or discounted the
purchase price. The Bank plans to continue to originate a small number of
nonconforming loans because such loans meet the needs of its local community and
because such loans have historically had high rates of return and have performed
within acceptable levels.
8
<PAGE>
Analysis of Loan Portfolio. Set forth below is selected data relating to the
composition of the Bank's loan portfolio by type of loan on the dates indicated.
<TABLE>
<CAPTION>
At September 30,
----------------
1996 1995
---- ----
% of % of
Amount Total Amount Total
------ ----- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $38,695 85.84% $35,644 86.51%
Residential multi-family 2,153 4.78% 962 2.33%
Nonresidential real estate 939 2.08% 1,509 3.66%
Residential construction 2,608 5.79% 1,845 4.48%
Line of credit 2,332 5.17% 2,289 5.56%
------- ------ ------- ------
Total real estate loans 46,727 103.66% 42,249 102.54%
------- ------ ------- ------
Consumer loans:
Passbook or certificate 23 .05% 130 0.31%
Automobile 137 .30% 129 0.31%
Other 186 .41% 230 0.56%
------- ------ ------- ------
Total consumer loans 346 .76% 489 1.18%
------- ------ ------- ------
Less:
Deferred loan fees 235 .52% 195 0.47%
Loans in process 1,534 3.40% 1,132 2.75%
Allowance for loan losses 225 .50% 207 0.50%
------- ------ ------- ------
Total reductions 1,994 4.42% 1,534 3.72%
------- ------ ------- ------
Total loans receivable, net $45,079 100.00% $41,204 100.00%
======= ====== ======= ======
</TABLE>
Loan Maturity Schedule. The following table sets forth the time to
contractual maturity of the Bank's loan portfolio at September 30, 1996. Loans
which have adjustable rates are shown as being due in the period during which
rates are next subject to change while fixed rate and other loans are shown as
due in the period of contractual maturity. Demand loans, loans having no stated
maturity and overdrafts are reported as due in one year or less. The table does
not include prepayments or scheduled principal repayments. Prepayments and
scheduled repayments in the loan portfolio totaled $9.2 million and $7.5 million
in the fiscal years ended September 30, 1996, and 1995, respectively. Amounts
in the table are net of loans in process and are net of unamortized loan fees.
9
<PAGE>
<TABLE>
<CAPTION>
At September 30, 1996
---------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or Less 3 Years 5 Years 10 Years Years Total
--------- ------- -------- -------- ------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Adjustable rate 1-4 family $10,518 $2,483 $1,178 $3,190 $ 30 $17,399
residential
Fixed rate 1-4 family 56 445 362 3,501 20,293 24,657
residential
Other adjustable rate real 602 436 10 229 19 1,296
estate loans
Other fixed rate real estate -- 131 49 25 1,420 1,625
loans
Other loans 143 121 40 23 -- 327
Less:
Allowance for loan losses (225) -- -- -- -- (225)
------- ------ ------ ------ ------- -------
$11,094 $3,616 $1,639 $6,968 $21,762 $45,079
======= ====== ====== ====== ======= =======
</TABLE>
The following table sets forth the dollar amount at September 30, 1996 of all
loans maturing or repricing on or after September 30, 1997 which have fixed or
adjustable interest rates.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
----- ----------
(In Thousands)
<S> <C> <C>
Mortgage loans $26,226 $7,575
Other loans 184 --
------- ------
$26,410 $7,575
======= ======
</TABLE>
Residential Real Estate Lending. The Bank's primary lending activity, which
it intends to continue to emphasize, is the origination of fixed and adjustable
rate first mortgage loans to enable borrowers to purchase or refinance one-to-
four family residential real property. Consistent with the Bank's emphasis on
being a community-oriented financial institution, it is and has been the Bank's
strategy to focus its lending efforts in Scotland and Moore Counties, North
Carolina and in contiguous counties. On September 30, 1996, approximately
85.84% of the Bank's total net real estate loan portfolio consisted of one-to-
four family residential real estate loans. These include both loans secured by
detached single-family residences and condominiums and loans secured by housing
containing not more than four separate dwelling units. Of such loans, 40.17%
had adjustable interest rates.
10
<PAGE>
The Bank originates adjustable rate mortgage loans secured by owner occupied
property generally having terms of 30 years in amounts of up to 95% of the value
of the property. Private mortgage insurance is always required if the loan
amount exceeds 80% of the value of the property. In addition, the Bank makes
adjustable rate loans secured by non-owner occupied residential real estate
generally having terms of 20 years in amounts of up to 75% of the value of the
property.
Interest rates on adjustable rate residential mortgage loans are tied to the
weekly average yield on United States Treasury securities adjusted to a constant
maturity of one year. Rates are subject to change annually, although in some
programs the period to the initial rate adjustment is as long as three years.
The loans have rate adjustment caps which limit the amount of rate adjustments
at any one time and over the lives of the loans.
Adjustable rate loans are generally considered to involve a greater degree of
risk than fixed rate loans because borrowers may have difficulty meeting their
payment obligations if interest rates and required payment amounts increase
substantially.
The Bank also originates fixed-rate mortgage loans secured by owner occupied
property having terms generally ranging from 15 to 30 years in amounts of up to
95% of the value of the property. Private mortgage insurance is always required
if the loan amount exceeds 80% of the value of the property. In addition, the
Bank makes fixed-rate loans secured by non-owner occupied residential real
estate generally having terms of 20 years in amounts of up to 75% of the value
of the property. Substantially all of the fixed-rate loans in the Bank's
mortgage loan portfolio have due on sale provisions allowing the Bank to declare
the unpaid balance due and payable in full upon the sale or transfer of an
interest in the property securing the loan.
While one-to-four family residential loans are normally originated for 15 to
30 year terms, such loans customarily remain outstanding for substantially
shorter periods because borrowers often prepay their loans in full upon sale of
the property pledged as security or upon refinancing the original loan. Thus,
average loan maturity is a function of, among other factors, the level of
purchase and sale activity in the real estate market, prevailing interest rates,
and the interest rates payable on outstanding loans. The thrift and mortgage
banking industries have generally used 12-year and 7-year average loan lives in
calculations calling for prepayment assumptions for 30-year residential loans
and 15-year residential loans, respectively. Management believes that the
Bank's recent loan prepayment experience has been shorter than these assumed
average loan lives due to recent periods of low interest rates and resulting
high levels of refinancing.
The Bank requires title insurance for its one-to-four family residential
loans. The Bank also requires that fire and extended coverage casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least equal to the loan amount or replacement cost of the improvements on the
property securing the loans, whichever is greater.
Residential Multifamily. At September 30, 1996, the Bank had approximately
$2,153,000 in outstanding loans secured by multifamily residential real estate,
comprising approximately 4.78% of its loan portfolio as of that date.
Substantially all of the Bank's loans secured by multifamily residential real
estate have adjustable rates. Such loans are typically made to a maximum of 75%
of the lesser of the purchase price or appraised value of the property for a
maximum term of 20 years. All such loans are personally guaranteed by
individuals.
11
<PAGE>
Nonresidential Real Estate Lending. On September 30, 1996, the Bank had
$939,000 in outstanding loans secured by nonresidential real estate, including
undeveloped land, comprising approximately 2.08% of its net loan portfolio as of
that date. Most of these loans are secured by office, retail, other commercial
real estate, as well as church properties, and have adjustable interest rates.
These loans generally do not exceed 80% of the appraised value of the real
estate securing the loans. Loans secured by commercial real estate and
undeveloped land generally are larger than one-to-four family residential loans
and involve a greater degree of risk. Payments on these loans depend to a large
degree on results of operations and management of the properties and may be
affected to a greater extent by adverse conditions in the real estate market or
the economy in general. As of September 30, 1996, the largest nonresidential
real estate loan in the Bank's loan portfolio totaled $161,635. This loan was
performing in accordance with the original loan contract.
Lines of Credit. At September 30, 1996, the Bank had approximately $2.3
million in line of credit loans, representing approximately 5.17% of its net
loan portfolio. These loans are often originated at the time of the closing of
a one-to-four family residential real estate loan secured by the same property.
The Bank's home equity lines of credit have adjustable interest rates tied to
prime interest rates plus a margin. The home equity lines of credit require
monthly payments until the loan is paid in full. Home equity lines of credit
are generally secured by subordinate liens against residential real property.
The Bank requires that fire and extended coverage casualty insurance (and, if
appropriate, flood insurance) be maintained in an amount at least sufficient to
cover its loan. Home equity loans are generally limited so that the amount of
such loans, along with any senior indebtedness, does not exceed 90% of the value
of the real estate security. Because home equity loans involve revolving lines
of credit which can be drawn over a period of time, the Bank faces risks
associated with changes in the borrower's financial condition. Because home
equity loans have adjustable interest rates with no rate caps (other than usury
limitations), increased delinquencies could occur if interest rate increases
occur and borrowers are unable to satisfy higher payment requirements. The Bank
intends to continue to emphasize its home equity program. The presence of home
equity loans in the Bank's portfolio allows the institution to manage the
interest sensitivity of its assets and liabilities because home equity lines of
credit have adjustable rates which are subject to change monthly and without any
significant rate caps.
Construction Lending. The Bank makes construction loans primarily for the
construction of single-family dwellings. The aggregate outstanding balance of
such loans on September 30, 1996 was approximately $1.1 million, net of loans in
process, representing approximately 2.37% of the Bank's net loan portfolio.
Most of these loans were made to persons who are constructing properties for the
purpose of occupying them. Loans made to individual property owners are both
pure construction loans and "construction-permanent" loans which generally
provide for the payment of interest only during a construction period, after
which the loans convert to a permanent loan at fixed or adjustable interest
rates having terms similar to other one-to-four family residential loans.
Construction loans to persons who intend to occupy the finished premises
generally have a maximum loan-to-value ratio of 80%.
Construction loans are generally considered to involve a higher degree of
risk than long-term financing secured by real estate which is already occupied.
A lender's risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at the completion of
construction and the estimated cost (including interest) of construction. If the
estimate of construction costs proves to be inaccurate, the lender may be
required to advance funds beyond the amount originally committed in order to
permit completion of construction. If the estimate of anticipated value proves
to be inaccurate, the lender may have security which has value insufficient to
assure full repayment.
12
<PAGE>
Consumer Loans. In addition to the loans described above, the Bank also
offers loans which are primarily secured by various items of personal property
or which are unsecured. As of September 30, 1996, the Bank had approximately
$346,000 of such loans outstanding, representing approximately .76% of its net
loan portfolio. Many of these loans are secured by deposits, new and used motor
vehicles, mobile homes and other properties. New and used motor vehicle
financing is available for terms of up to four years. Generally, financing of
new and current year models does not exceed 80% of the sticker price. Financing
of used motor vehicles does not exceed the loan value provided in the current
Southeastern Edition of the NADA Used Car Guide.
Financing of new mobile homes generally does not exceed 80% of the purchase
price or the retail invoice value of the mobile home and has a maximum term of
15 years. Loans may also be secured by used mobile homes for up to 80% of the
book value as determined by the current NADA Mobile Home Appraisal Guide and
have a maximum term of 15 years.
The Bank makes unsecured consumer loans in amounts of up to 10% of an
individual borrower's verifiable net worth. Some of these loans are payable at
maturity and have a term of 90 days. Others require monthly payments and have a
term of up to 24 months. In addition, the Bank provides overdraft lines of
credit in amounts of up to $5,000. Payments are required in amounts of 5% of
the outstanding balance or $20, whichever is greater.
Loan Solicitation, Processing and Underwriting. Loan originations are derived
from a number of sources such as referrals from real estate brokers, present
depositors and borrowers, builders, attorneys, walk-in customers and in some
instances, other lenders.
During its loan approval process, the Bank assesses the applicant's ability
to make principal and interest payments on the loan and the value of the
property securing the loan. The Bank obtains detailed written loan applications
to determine the borrower's ability to repay and verifies responses on the loan
application through the use of credit reports, financial statements, and other
confirmations. Under current practice, the loan officer of the Bank analyzes the
loan application and the property involved, and an appraiser inspects and
appraises the property. The Bank requires independent fee appraisals on all
loans originated primarily on the basis of real estate collateral. The Bank also
obtains information concerning the income, financial condition, employment and
the credit history of the applicant.
Mortgage loans of up to $150,000 may be approved by certain designated loan
officers and the chief lending officer of the Bank in cases where the loan meets
all of the Bank's underwriting guidelines. Loans of over $150,000 must be
approved by the Bank's loan committee which is composed of its President, Senior
Vice President and three other members of the Board of Directors. The loan
committee also reviews all other mortgage loan approvals.
Normally, upon approval of a residential mortgage loan application, the Bank
gives a commitment to the applicant that it will make the approved loan at a
stipulated rate any time within a 30-day period. The loan is typically funded at
such rate of interest and on other terms which are based on market conditions
existing as of the date of the commitment. As of September 30, 1996, the Bank
had $621,000 in such unfunded mortgage loan commitments. In addition, on such
date the Bank had $2.8 million in unfunded commitments for unused lines of
credit and letters of credit.
Origination of Loans. Generally, the Bank has originated its one-to-four
family residential mortgage or other loans with the capability, but not the
intention, that they will be sold in the secondary market. The Bank originates
a small number of loans which satisfy the Bank's underwriting requirements
13
<PAGE>
and are tailored to its local community but do not necessarily satisfy various
requirements imposed by the FHLMC and FNMA, including some loans which do not
satisfy loan-to-value requirements, income requirements and credit history
standards.
Although the Bank believes that many of its nonconforming loans are readily
saleable in the secondary market, some of such nonconforming loans could be sold
only after the Bank incurred certain costs and/or discounted the purchase price.
As a result, the Bank's loan portfolio is slightly less liquid than would be the
case if it was composed entirely of loans originated in conformity with
secondary market requirements. In addition, certain types of nonconforming
loans are generally thought to have greater risks of default and nonperformance.
However, such loans generally produce a higher yield than would be produced by
conforming loans, and the Bank has historically found that its origination of
such loans has not resulted in a high level of nonperforming assets. See "--
Nonperforming Assets and Asset Classification". These nonconforming loans
satisfy a need in the Bank's local community, and the Bank intends to continue
to originate a small number of nonconforming loans. Any such nonconforming
loans will satisfy FHLMC and FNMA requirements with respect to income and credit
history. However, if the loan amount is less than $30,000 and the loan to value
ratio is less than 80%, the current tax value may be used to establish the
property value rather than a full appraisal. Any decision to use the tax value
must be approved by the Bank's management.
For the years ended September 30, 1996 and 1995, the Bank's loan originations
totaled $13.2 million and $12.1 million, respectively.
In addition to earning interest on loans, the Bank receives fees in
connection with originating loans. Fees for loan servicing, loan modifications,
late payments, loan assumptions and other miscellaneous services in connection
with loans are also charged by the Bank.
Nonperforming Assets and Asset Classification. When a borrower fails to make
a required payment on a loan and does not cure the delinquency promptly, the
loan is classified as delinquent. Delinquencies on all loans are reviewed
monthly by the Board of Directors. The normal procedure followed by the Bank
once a loan is classified as delinquent is to make contact with the borrower at
prescribed intervals in an effort to bring the loan to a current status, and
late charges are assessed as allowed by law. In most cases, delinquencies are
cured promptly. If a delinquency is not cured, the Bank normally, subject to
any required prior notice to the borrower, commences foreclosure proceedings.
If the loan is not reinstated within the time permitted for reinstatement, or
the property is not redeemed prior to sale, the property may be sold at a
foreclosure sale. In foreclosure sales, the Bank may acquire title to the
property through foreclosure, in which case the property so acquired is offered
for sale and may be financed by a loan involving terms more favorable to the
borrower than those normally offered. Any property acquired as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until such time as it is sold or otherwise disposed of by the Bank to recover
its investment. As of September 30, 1996, the Bank did not own any real estate
acquired in settlement of loans. Real estate acquired through, or in lieu of,
loan foreclosure is initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. After foreclosure, valuations are periodically
performed by management, and the real estate is carried at the lower of cost or
fair value minus costs to sell. Revenue and expenses from holding the
properties and additions to the valuation allowance are included in operations.
Accrual of interest income on loans is suspended when, in management's
judgment, doubts exist as to the collectibility of additional interest within a
reasonable time. Loans are returned to accrual status when management
determines, based upon an evaluation of the underlying collateral, together with
the borrower's payment record and financial condition, that the borrower has the
capability and intent to meet
14
<PAGE>
the contractual obligations of the loan agreement. Interest on loans placed on
nonaccrual status is generally reversed by the establishment of an allowance
for uncollected interest. The allowance is established by a charge to interest
income equal to all interest previously accrued, and income is subsequently
recognized only to the extent cash payments are received until the loan is
returned to accrual status. For the fiscal year ended September 30, 1996,
interest income that would have been recorded on nonaccrual loans under the
original terms of such loans was zero.
The following table sets forth information with respect to nonperforming
assets identified by the Bank, including nonaccrual loans and real estate owned
at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
----------------
1996 1995
---- ----
(Dollars in Thousands)
<S> <C> <C>
Total nonaccrual loans:
Mortgage Loans delinquent 90 days or more $ 32 $ --
Consumer loans delinquent 90 days or more -- --
Real estate owned -- --
------ ------
Total non-performing assets $ 32 $ --
====== ======
Non-performing loans to total loans 0.07% --
Non-performing assets to total assets 0.05% --
Total assets $68,622 $57,718
Total loans $45,079 $41,204
</TABLE>
Applicable regulations require the Bank to "classify" its own assets on a
regular basis. In addition, in connection with examinations of savings
institutions, regulatory examiners have authority to identify problem assets
and, if appropriate, classify them. Problem assets are classified as
"substandard," "doubtful" or "loss," depending on the presence of certain
characteristics as discussed below.
An asset is considered "substandard" if not adequately protected by the
current net worth and paying capacity of the obligor or the collateral pledged,
if any. "Substandard" assets include those characterized by the "distinct
possibility" that the insured institution will sustain "some loss" if the
deficiencies are not corrected. Assets classified as "doubtful" have all of the
weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable". Assets classified "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a loss reserve is not warranted.
As of September 30, 1996, the Bank had no loans internally classified as
"substandard", "doubtful" or "loss".
15
<PAGE>
The Bank also identifies assets which possess credit deficiencies or
potential weaknesses deserving close attention by management. These assets may
be considered "special mention" assets and do not yet warrant adverse
classification. At September 30, 1996, the Bank had no loans in the "special
mention" category.
When an insured institution classifies problem assets as either substandard
or doubtful, it is required to establish general allowances for loan losses in
an amount deemed prudent by management. These allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities and the risks associated with particular problem assets.
When an insured institution classifies problem assets as "loss," it charges off
the balance of the asset. The Bank's determination as to the classification of
its assets and the amount of its valuation allowances is subject to review by
the FDIC and the Administrator which can order the establishment of additional
loss allowances.
Allowance for Loan Losses. In originating loans, the Bank recognizes that
credit losses will be experienced and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan and, in the case of a secured loan, the
quality of the security for the loan as well as general economic conditions. It
is management's policy to maintain an adequate allowance for loan losses based
on, among other things, the Bank's historical loan loss experience, evaluation
of economic conditions and regular reviews of delinquencies and loan portfolio
quality. Specific allowances are provided for individual loans when ultimate
collection is considered questionable by management after reviewing the current
status of loans which are contractually past due and considering the net
realizable value of the security for the loans. The Bank adopted SFAS No. 114
Accounting by Creditors for Impairment of a Loan which was subsequently amended
by SFAS No. 118 Accounting by Creditors for Impairment of a Loan-Income
Recognition and Disclosures during 1996. SFAS No. 114 requires that the Bank
establish specific loan loss allowances on impaired loans if it is doubtful that
all principal and interest due according to the loan terms will be collected.
The adoption of SFAS No. 114 did not have an effect on the Bank's reporting for
impaired loans since the Bank had no loans outstanding during the year ended
September 30, 1996 which it considers to be impaired. Therefore, there is no
specific SFAS No. 114 allowance for impaired loans at September 30, 1996.
Management continues to actively monitor the Bank's asset quality, to
charge off loans against the allowance for loan losses when appropriate and to
provide specific loss reserves when necessary. Although management believes it
uses the best information available to make determinations with respect to the
allowance for loan losses, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations.
The following table describes the activity related to the Bank's allowance
for loan losses for the periods indicated.
16
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------
1996 1995
---- ----
(Dollars in Thousands)
<S> <C> <C>
Balance, beginning of period $ 207 $ 196
Provision for loan losses 25 11
Charge-offs 7 --
Recoveries -- --
------- -----
Balance, end of period $ 225 $ 207
======= =====
Net charge-offs as a % of average loans .02% --
outstanding
Allowance at period end as a % of nonperforming 714.97% --
loans
</TABLE>
The following table sets forth the composition of the allowance for loan
losses by type of loan at the dates indicated. The allowance is allocated to
specific categories of loans for statistical purposes only, and may be applied
to loan losses incurred in any loan category.
<TABLE>
<CAPTION>
At September 30,
----------------
1996 1995
---- ----
Amount of Amount of
Amount of Loans to Amount of Loans to
Allowance Gross Loans Allowance Gross Loans
--------- ----------- --------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $ 93 82.21% $ 91 83.40%
Residential multi-family 5 4.57% 7 2.25%
Nonresidential real estate 60 1.99% 25 3.53%
Residential construction 6 5.54% 10 4.32%
Line of credit 32 4.95% 35 5.36%
---- ------ ---- ------
Total real estate loans 196 99.26% 168 98.86%
---- ------ ---- ------
Consumer loans:
Passbook or certificate -- 0.05% -- 0.30%
Automobile 21 0.29% 22 0.30%
Other 8 0.40% 17 0.54%
---- ------ ---- ------
Total consumer loans 29 0.74% 39 1.14%
---- ------ ---- ------
Total allowance for loan losses $225 100.00% $207 100.00%
==== ====== ==== ======
</TABLE>
17
<PAGE>
Investment Securities
Interest and dividend income from investment securities generally provides
the second largest source of income to the Company after interest on loans. In
addition, the Company receives interest income from deposits in other financial
institutions. On September 30, 1996, the carrying value of the Company's
investment securities portfolio totaled approximately $21.5 million and
consisted of U.S. government and agency securities, mortgage-backed securities,
FHLMC stock, stock in the FHLB of Atlanta and in Central Service Corporation,
and deposits in other financial institutions. The mortgage-backed securities
consist of mortgage-backed securities issued by the GNMA.
Investments in mortgage-backed securities involve a risk that, because of
changes in the interest rate environment, actual prepayments will be greater
than estimated prepayments over the life of the security, which may require
adjustments to the amortization of any premium or accretion of any discount
relating to such instruments, thereby reducing the net yield on such securities.
There is also reinvestment risk associated with the cash flows from such
securities. In addition, the market value of such securities may be adversely
affected by changes in interest rates.
Investments may be classified in one of three categories and accounted for
as follows: (1) debt securities that the entity has the positive intent and
ability to hold to maturity are classified as held-to-maturity and reported at
amortized cost; (2) debt and equity securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and reported at fair value, with net unrealized gains and
losses included in earnings; and (3) debt securities not classified as either
held-to-maturity or trading securities and equity securities not classified as
trading securities are classified as securities available-for-sale and reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of equity. The Company has no trading
securities. See Notes 1 and 2 of "Notes to Financial Statements".
The amortized cost of securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest
income from investments. Realized gains and losses, and declines in value
judged to be other than temporary are included in net securities gains (losses).
The cost of securities sold is based on the specific identification method.
As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in stock of the FHLB of Atlanta equal to the greater of 1% of the
Bank's outstanding home loans or 5% of its outstanding advances from the FHLB of
Atlanta. No ready market exists for such stock, which is carried at cost. As
of September 30, 1996, the Bank's investment in stock of the FHLB of Atlanta was
$595,400.
North Carolina regulations require the Bank to maintain a minimum amount of
liquid assets which may be invested in specified short-term securities. The Bank
is also permitted to make certain other securities investments.
18
<PAGE>
The Company's current investment policy states that the Company's
investments will be limited to U.S. Treasury obligations, federal agency
securities, municipal obligations of the State of North Carolina or its
political subdivisions rated A and above, pass-through and planned amortization
class collateralized mortgage obligations, stock of the FHLB of Atlanta and
certificates of deposits of $100,000 or less in federally issued financial
institutions.
Investment decisions are made by authorized officers of the Bank or the
Company under policies established by the Boards of Directors. Such investments
are managed in an effort to produce the highest yield consistent with
maintaining safety of principal and compliance with regulations governing the
savings industry.
The following tables set forth certain information regarding the Company's
interest bearing deposits and the amortized cost and market values of the
Company's investment and mortgage-backed securities portfolio at the dates
indicated.
19
<PAGE>
<TABLE>
<CAPTION>
At September 30,
----------------
1996 1995
---- ----
Amortized Cost Market Value Amortized Cost Market Value
-------------- ------------ -------------- ------------
(In Thousands)
<S> <C> <C> <C> <C>
Interest-bearing deposits $ 4,352 $ 4,352 $ 2,366 $ 2,366
------- ------- ------- -------
Mortgage-backed securities, held to 545 617 652 724
maturity ------- ------- ------- -------
Investment securities:
Held to maturity or for investment:
U.S. Treasury and agency securities 2,502 2,494 7,939 7,958
Available for sale:
U.S. Treasury and agency securities 12,812 12,690 2,406 2,420
Federal Home Loan Mortgage
Corporation stock 31 775 31 549
Non-marketable equity securities:
Federal Home Loan Bank stock 595 595 595 595
Central Service Corporation stock 4 4 4 4
------- ------- ------- -------
15,944 16,558 10,975 11,526
------- ------- ------- -------
Total $20,841 $21,527 $13,993 $14,616
======= ======= ======= =======
</TABLE>
The following table sets forth certain information regarding the carrying
value, weighted average yields and contractual maturities of the Company's
interest bearing deposits, investment and mortgage-backed securities as of
September 30, 1996.
20
<PAGE>
<TABLE>
<CAPTION>
After One Year After Five Years
One Year or Less Through Five Years Through Ten Years
---------------- ------------------ -----------------
Carrying Weighted Carrying Weighted Carrying Weighted
Value Average Yield Value Average Yield Value Average Yield
----- ------------- ----- ------------- ----- -------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits $4,352 5.79% $ -- -- $ -- --
Mortgage-backed securities -- -- -- -- -- --
U.S. Treasury securities
Held to maturity 2,002 6.44% 500 6.05% -- --
Available for sale 1,998 5.82% 10,584 6.17% 108 6.10%
Federal Home Loan Mortgage
Corporation stock (1) 775 1.44% -- -- -- --
Federal Home Loan
Bank stock (2) -- -- -- -- -- --
Central Service Corporation
stock (2) -- -- -- -- -- --
----- ----- ------ ----- --- -----
Total $9,127 5.57% $11,084 6.16% $108 6.10%
===== ===== ====== ===== === =====
<CAPTION>
After Ten Years Total
--------------- -----
Carrying Weighted Carrying Weighted
Value Average Yield Value Average Yield
----- ------------- ----- -------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Interest-bearing deposits $ -- -- $ 4,352 5.79%
Mortgage-backed securities 545 11.25% 545 11.25%
U.S. Treasury securities
Held to maturity -- -- 2,502 6.36%
Available for sale -- -- 12,690 6.12%
Federal Home Loan Mortgage
Corporation stock (1) -- -- 775 1.44%
Federal Home Loan
Bank stock (2) 595 7.29% 595 7.29%
Central Service Corporation
stock (2) 4 -- 4 --
----- ----- ------ -----
Total $1,144 9.15% $21,463 6.07%
===== ===== ====== =====
</TABLE>
(1) Equity security with no stated maturities; readily available and assumed to
mature in less than one year.
(2) Nonmarketable equity security; substantially all required to be maintained
and assumed to mature in periods greater than 10 years.
21
<PAGE>
Deposits and Borrowings
General. Deposits are the primary source of the Bank's funds for lending
and other investment purposes. In addition to deposits, the Bank derives funds
from loan principal repayments, interest payments, investment income, interest
from its own interest-bearing deposits, interest income from mortgage-backed
securities and otherwise from its operations. Loan repayments are a relatively
stable source of funds while deposit inflows and outflows may be significantly
influenced by general interest rates and money market conditions. Borrowings
may be used on a short-term basis to compensate for reductions in the
availability of funds from other sources. They may also be used on a longer
term basis for general business purposes. The Bank has no borrowings
outstanding at September 30, 1996; however, it does maintain borrowing
capabilities through the FHLB of Atlanta.
Deposits. On September 30, 1996 and September 30, 1995, the Bank's
deposits totaled $42.4 million and $48.2 million, respectively. A majority of
the $5.8 million decrease is attributable to the withdrawal of deposits by
account holders to purchase shares of common stock of the Company in the
Conversion. Due to its excess liquidity, the Bank elected to allow certain
higher cost certificate accounts to leave the Bank upon maturity. As a result,
the Bank was able to lower its average weighted cost of funds at September 30,
1996 from such cost incurred during 1996.
The following table sets forth information relating to the Bank's deposit
flows during the periods shown and total deposits at the end of the periods
shown.
<TABLE>
<CAPTION>
At or For the Year Ended September 30,
--------------------------------------
1996 1995
---- ----
(In Thousands)
<S> <C> <C>
Total deposits at beginning of period $48,203 $48,995
Net increase (decrease) before (7,704) (2,453)
interest credited
Interest credited 1,911 1,661
------- -------
Total deposits at end of period $42,410 $48,203
======= =======
</TABLE>
The Bank attracts both short-term and long-term deposits from the general
public by offering a variety of accounts and rates. The Bank offers statement
savings accounts, negotiable order of withdrawal accounts, money market
accounts, and fixed interest rate certificates with varying maturities. The
Bank also offers an adjustable rate certificate in its individual retirement
account program. All deposit flows are greatly influenced by economic
conditions, the general level of interest rates, competition, and other factors,
including the restructuring of the thrift industry. The Bank's savings deposits
traditionally have been obtained primarily from its primary market area. The
Bank utilizes traditional marketing methods to attract new customers and savings
deposits, including print media advertising and direct mailings. The Bank does
not advertise for deposits outside of its local market area or utilize the
services of deposit brokers. The vast majority of the Bank's depositors are
residents of North Carolina. In the unlikely event the Bank is liquidated
following the Conversion, depositors will be entitled to full payment of their
deposit accounts prior to any payment being made to stockholders.
22
<PAGE>
The following table sets forth certain information regarding the Bank's
savings deposits at the dates indicated.
23
<PAGE>
<TABLE>
<CAPTION>
At September 30,
1996 1995
---------------------------------- -----------------------------------
Weighted % of Weighted % of
Amount Average Rate Deposits Amount Average Rate Deposits
------- ------------ ---------- ------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Demand accounts:
Passbook accounts $ 4,310 2.88% 10.16% $ 4,173 2.82% 8.66%
NOW accounts 2,631 2.00% 6.20% 2,651 2.00% 5.50%
Money market deposit accounts 4,206 2.87% 9.92% 5,659 2.91% 11.74%
Noninterest bearing accounts 512 -- 1.21% 394 -- 0.81%
------- ---- ------ ------- ---- ------
Total demand deposits 11,659 2.56% 27.49% 12,877 2.60% 26.71%
Time deposits 30,694 5.42% 72.38% 35,294 5.63% 73.22%
Accrued interest 57 -- .13% 32 0.07%
------- ------ ------- ------
Total deposits $42,410 4.63% 100.00% $48,203 4.88% 100.00%
======= ==== ====== ======= ==== ======
- ------------------------------------------------------------------------------------------------------------
</TABLE>
24
<PAGE>
As of September 30, 1996, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $3.8 million. (Some of
these deposits were deposits of state and local governments which are subject to
rebidding from time to time and to securitization requirements.) The following
table presents the maturity of these time certificates of deposit at the dates
indicated.
<TABLE>
<CAPTION>
At
September 30, 1996
-------------------
(In Thousands)
<S> <C>
3 Months or less $1,517
Over 3 months through 6 months 987
Over 6 months through 12 months 1,079
Over 12 months 200
------
Total $3,783
======
</TABLE>
Borrowings. The FHLB system functions in a reserve credit capacity
for savings institutions. As a member, the Bank is required to own capital stock
in the FHLB of Atlanta and is authorized to apply for advances from the FHLB of
Atlanta on the security of that stock and a floating lien on certain of its real
estate secured loans and other assets. Each credit program has its own interest
rate and range of maturities. Depending on the program, limitations on the
amount of advances are based either on a fixed percentage of an institution's
net worth or on the FHLB of Atlanta's assessment of the institution's
creditworthiness. The Company and the Bank had no outstanding borrowings at
September 30, 1996 or 1995. However, during 1996 the Bank obtained and repaid
$3.0 million in Federal Home Loan Bank advances and the Bank retains borrowing
capacity through the Federal Home Loan Bank of Atlanta.
Subsidiaries
The Company has no subsidiaries other than the Bank. The Bank has no
subsidiaries.
Competition
The Bank faces strong competition both in attracting deposits and
making real estate and other loans. Its most direct competition for deposits
has historically come from other savings institutions, credit unions and
commercial banks located in its primary market area, including large financial
institutions which have greater financial and marketing resources available to
them. The Bank has also faced additional significant competition for investors'
funds from short-term money market securities and other corporate and government
securities. At September 30, 1996, there were at least 6 other commercial
banks, credit unions and mortgage companies as well as numerous other financial
services providers located in the Bank's primary market area. At September 30,
1996, the Bank had a deposit market share of approximately 20% in Scotland
County. In Moore County where the Pinehurst branch is located, the Bank had
less than 1% of the deposit market share as of that same date. The ability of
the Bank 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.
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The Bank experiences strong competition for real estate loans from
other savings institutions, commercial banks, and mortgage banking companies.
The Bank competes for loans primarily through the interest rates and loan fees
it charges, the efficiency and quality of services it provides borrowers, and
its more flexible underwriting standards. Competition may increase as a result
of the continuing reduction of restrictions on the interstate operations of
financial institutions.
Employees
As of September 30, 1996, the Bank had 14 full-time employees. All
full-time employees of the Bank are covered as a group for basic
hospitalization, including major medical, dental, accidental death and
dismemberment insurance. Optional medical and dental insurance is available for
dependents which must be partially paid by the employee. In addition, the Bank
maintains a defined benefit retirement plan. The Bank also maintains a 401(k)
retirement plan. The Bank anticipates continuing both the defined benefit
retirement plan and the 401(k) retirement plan after the Conversion. In
connection with the Conversion, the Bank adopted an employee stock ownership
plan which will provide benefits to the Bank's employees.
Employees are not represented by any union or collective bargaining
group, and the Bank considers its employee relations to be good.
Federal Income Taxation
Savings institutions such as the Bank are subject to the taxing
provisions of the Code, for corporations, as modified by certain provisions
specifically applicable for financial or thrift institutions. Income is reported
using the accrual method of accounting. The maximum corporate federal income
tax rate is 35%.
For fiscal years beginning prior to December 31, 1995, thrift
institutions which qualified under certain definitional tests and other
conditions of the Code were permitted certain favorable provisions regarding
their deductions from taxable income for annual additions to their bad debt
reserve. A reserve could be established for bad debts on qualifying real
property loans (generally loans secured by interests in real property improved
or to be improved) under (i) a method based on a percentage of the institution's
taxable income, as adjusted (the "percentage of taxable income method") or (ii)
a method based on actual loss experience (the "experience method"). The reserve
for nonqualifying loans was computed using the experience method.
The percentage of taxable income method was limited to 8% of taxable
income. This method could not raise the reserve to exceed 6% of qualifying real
property loans at the end of the year. Moreover, the additions for qualifying
real property loans, when added to nonqualifying loans, could not exceed 12% of
the amount by which total deposits or withdrawable accounts exceed the sum of
surplus, undivided profits and reserves at the beginning of the year. This
limitation precluded the Bank from taking a bad debt deduction in its 1996 and
1995 tax returns. The experience method was the amount necessary to increase
the balance of the reserve at the close of the year to the greater of (i) the
amount which bore the same ratio to loans outstanding at the close of the year
as the total net bad debts sustained during the current and five preceding years
bore to the sum of the loans outstanding at the close of such six years or (ii)
the balance in the reserve account at the close of the last taxable year
beginning before 1988 (assuming that the loans outstanding have not declined
since such date).
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In order to qualify for the percentage of income method, an
institution had to have at least 60% of its assets as "qualifying assets" which
generally included, cash, obligations of the United States government or an
agency or instrumentality thereof or of a state or political subdivision,
residential real estate-related loans, or loans secured by savings accounts and
property used in the conduct of its business. In addition, it had to meet
certain other supervisory tests and operate principally for the purpose of
acquiring savings and investing in loans.
Institutions which became ineligible to use the percentage of income
method had to change to either the reserve method or the specific charge-off
method that applied to banks. Large thrift institutions, those generally
exceeding $500 million in assets, had to convert to the specific charge-off
method.
Bad debt reserve balances in excess of the balance computed under the
experience method or amounts maintained in a supplemental reserve built up prior
to 1962 ("excess bad debt reserve") require inclusion in taxable income upon
certain distributions to its stockholders. Distributions in redemption or
liquidation of stock or distributions with respect to its stock in excess of
earnings and profits accumulated in years beginning after December 31, 1951, are
treated as a distribution from the excess bad debt reserve. When such a
distribution takes place and it is treated as from the excess bad debt reserve,
the thrift is required to reduce its reserve by such amount and simultaneously
recognize the amount as an item of taxable income increased by the amount of
income tax imposed on the inclusion. Dividends not in excess of earnings and
profits accumulated since December 31, 1951 will not require inclusion of part
or all of the bad debt reserve in taxable income. The Bank has accumulated
earnings and profits since December 31, 1951 and has an excess in its bad debt
reserve. Distributions in excess of current and accumulated earnings and
profits will increase taxable income. Net retained earnings at September 30,
1996 includes approximately $1,422,000 for which no provision for federal income
tax has been made. See Note 7 to "Notes to Financial Statements".
Legislation passed by the U.S. Congress and signed by the President in
August 1996 contains a provision that repeals the percentage of taxable income
method of accounting for thrift bad debt reserves for tax years beginning after
December 31, 1995. The legislation will trigger bad debt reserve recapture for
post-1987 excess reserves over a six-year period. At June 30, 1996, the Bank's
post-1987 excess reserves amounted to approximately $333,000. A special
provision suspends recapture of post-1987 excess reserves for up to two years
if, during those years, the institution satisfies a "residential loan
requirement." This requirement will be met if the principal amount of the
institution's residential loans exceeds a base year amount, which is determined
by reference to the average of the institution's residential loans during the
six taxable years ending before January 1, 1996. However, notwithstanding this
special provision, recapture will begin no later than the first taxable year
beginning after December 31, 1997.
The Bank may also be subject to the corporate alternative minimum tax
("AMT"). This tax is applicable only to the extent it exceeds the regular
corporate income tax. The AMT is imposed at the rate of 20% of the
corporation's alternative minimum taxable income ("AMTI") subject to applicable
statutory exemptions. AMTI is calculated by adding certain tax preference items
and making certain adjustments to the corporation's regular taxable income.
Preference items and adjustments generally applicable to financial institutions
include, but are not limited to, the following: (i) the excess of the bad debt
deduction over the amount that would have been allowable on the basis of actual
experience; (ii) interest on certain tax-exempt bonds issued after August 7,
1986; and (iii) 75% of the excess, if any, of a corporation's adjusted earnings
and profits over its AMTI (as otherwise determined with certain adjustments).
Net operating loss carryovers, subject to certain adjustments, may be utilized
to offset up to 90% of the AMTI. Credit for AMT paid may be available in future
years to reduce future regular federal income tax liability. The Bank has not
been subject to the AMT in recent years.
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The Bank's federal income tax returns have not been audited in the
last five years.
State and Local Taxation
Under North Carolina law, the corporate income tax is 7.75% of federal
taxable income as computed under the Code, subject to certain prescribed
adjustments. In addition, for tax years beginning in 1991, 1992, 1993 and 1994,
corporate taxpayers were required to pay a surtax equal to 4%, 3%, 2% and 1%,
respectively, of the state income tax otherwise payable by it. An annual state
franchise tax is imposed at a rate of 0.15% applied to the greatest of the
institutions (i) capital stock, surplus and undivided profits, (ii) investment
in tangible property in North Carolina or (iii) appraised valuation of property
in North Carolina.
The North Carolina corporate tax rate will drop to 7.50% in 1997,
7.25% in 1998, 7.00% in 1999 and 6.90% thereafter .
Regulation of the Company
General. The Company was organized for the purpose of acquiring and
holding all of the capital stock of the Bank to be issued in the Conversion. As
a bank holding company subject to the Bank Holding Company Act of 1956, as
amended ("BHCA"), the Company will become subject to certain regulations of the
Federal Reserve. Under the BHCA, the Company's activities and those of its
subsidiaries are limited to banking, managing or controlling banks, furnishing
services to or performing services for its subsidiaries or engaging in any other
activity which the Federal Reserve determines to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
The BHCA prohibits the Company from acquiring direct or indirect control of more
than 5% of the outstanding voting stock or substantially all of the assets of
any bank or savings bank or merging or consolidating with another bank holding
company or savings bank holding company without prior approval of the Federal
Reserve.
Additionally, the BHCA prohibits the Company from engaging in, or
acquiring ownership or control of, more than 5% of the outstanding voting stock
of any company engaged in a nonbanking business unless such business is
determined by the Federal Reserve to be so closely related to banking as to be
properly incident thereto. The BHCA generally does not place territorial
restrictions on the activities of such nonbanking related activities.
Similarly, Federal Reserve approval (or, in certain cases, non-
disapproval) must be obtained prior to any person acquiring control of the
Company. Control is conclusively presumed to exist if, among other things, a
person acquires more than 25% of any class of voting stock of the holding
company or controls in any manner the election of a majority of the directors of
the holding company. Control is presumed to exist if a person acquires more
than 10% of any class of voting stock and the stock is registered under Section
12 of the Exchange Act or the acquiror will be the largest shareholder after the
acquisition.
There are a number of obligations and restrictions imposed on bank
holding companies and their depository institution subsidiaries by law and
regulatory policy that are designed to minimize potential loss to the depositors
of such depository institutions and the FDIC insurance funds in the event the
depository institution becomes in danger of default or in default. For example,
under the 1991 Banking Law, to avoid receivership of an insured depository
institution subsidiary, a bank holding company is required to guarantee the
compliance of any insured depository institution subsidiary that may become
"undercapitalized" with the terms of any capital restoration plan filed by such
subsidiary with its appropriate federal banking agency up to the lesser of (i)
an amount equal to 5% of the institution's total
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assets at the time the institution became undercapitalized or (ii) the amount
which is necessary (or would have been necessary) to bring the institution into
compliance with all acceptable capital standards as of the time the institution
fails to comply with such capital restoration plan. Under a policy of the
Federal Reserve with respect to bank holding company operations, a bank holding
company is required to serve as a source of financial strength to its subsidiary
depository institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. The Federal Reserve
under the BHCA also has the authority to require a bank holding company to
terminate any activity or to relinquish control of a nonbank subsidiary (other
than a nonbank subsidiary of a bank) upon the Federal Reserve's determination
that such activity or control constitutes a serious risk to the financial
soundness and stability of any bank subsidiary of the bank holding company.
In addition, the "cross-guarantee" provisions of the Federal Deposit
Insurance Act, as amended ("FDIA") require insured depository institutions under
common control to reimburse the FDIC for any loss suffered by either the Savings
Association Insurance Fund (the "SAIF") or the Bank Insurance Fund (the "BIF")
as a result of the default of a commonly controlled insured depository
institution or for any assistance provided by the FDIC to a commonly controlled
insured depository institution in danger of default. The FDIC may decline to
enforce the cross-guarantee provisions if it determines that a waiver is in the
best interest of the SAIF or the BIF or both. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
As a result of the Company's ownership of the Bank, the Company will
be registered under the savings bank holding company laws of North Carolina.
Accordingly, the Company is also subject to regulation and supervision by the
Administrator.
Federal regulations require that the Company must notify the Federal
Reserve Bank of Richmond prior to repurchasing Common Stock in excess of 10% of
its net worth during a rolling 12 month period. Also, no stock repurchases may
be made for at least one year after Conversion unless approved by the
Administrator, who may approve such repurchases only upon a finding that the
safety and soundness of the Bank would not be adversely affected thereby.
Capital Adequacy Guidelines for Holding Companies. The Federal
Reserve has adopted capital adequacy guidelines for bank holding companies. For
bank holding companies with less than $150 million in consolidated assets, the
guidelines are applied on a bank-only basis unless the parent bank holding
company (i) is engaged in nonbank activity involving significant leverage or
(ii) has a significant amount of outstanding debt that is held by the general
public.
Bank holding companies are required to comply with the Federal
Reserve's risk-based capital guidelines. Under these regulations, the minimum
ratio of total capital to risk-weighted assets (including certain off-balance
sheet activities, such as standby letters of credit) is 8%. At least half of
the total capital is required to be "Tier I capital," principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock, and a
limited amount of cumulative perpetual preferred stock, less certain goodwill
items and other intangible assets. The remainder ("Tier II capital") may
consist of a limited amount of subordinated debt, certain hybrid capital
instruments and other debt securities, perpetual preferred stock, and a limited
amount of the general loan loss allowance. In addition to the risk-based
capital guidelines, the Federal Reserve has adopted a minimum Tier I capital
(leverage) ratio, under which a bank holding company must maintain a minimum
level of Tier I capital to average total consolidated assets of at least 3% in
the case of a bank holding company which has the highest regulatory examination
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rating and is not contemplating significant growth or expansion. All other bank
holding companies are expected to maintain a Tier I capital (leverage) ratio of
at least 1% to 2% above the stated minimum.
Federal Securities Law. The Company has registered its Common Stock
with the SEC pursuant to Section 12(b) of the Exchange Act and will not
deregister the Common Stock for a period of three years following the completion
of the Conversion. As a result of such registration, the proxy and tender offer
rules, insider trading reporting requirements, annual and periodic reporting and
other requirements of the Exchange Act are applicable to the Company.
The registration under the Securities Act of the Offerings of the
Common Stock does not cover the resale of such shares. Shares of the Common
Stock purchased by persons who are not affiliates of the Company may be resold
without registration. Shares purchased by an affiliate of the Company are
subject to the resale provisions of Rule 144 under the Securities Act. So long
as the Company meets the current public information requirements of Rule 144
under the Securities Act, each affiliate of the Company who complies with the
other conditions of Rule 144 (including those that require the affiliate's sale
to be aggregated with those of certain other persons) will be able to sell in
the public market, without registration, a number of shares not to exceed, in
any three-month period, the greater of (i) 1% of the outstanding shares of the
Company or (ii) the average weekly volume of trading in such shares during the
preceding four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under the
Securities Act under certain circumstances. There are currently no demand
registration rights outstanding. However, in the event the Company at some
future time determines to issue additional shares from its authorized but
unissued shares, the Company might offer registration rights to certain of its
affiliates who want to sell their shares.
Regulation of the Bank
General. Federal and state legislation and regulation have
significantly affected the operations of federally insured savings institutions
and other federally regulated financial institutions in the past several years
and have increased competition among savings institutions, commercial banks and
other providers of financial services. In addition, federal legislation has
imposed new limitations on investment authority, and higher insurance and
examination assessments on savings institutions and has made other changes that
may adversely affect the future operations and competitiveness of savings
institutions with other financial institutions, including commercial banks and
their holding companies. The operations of regulated depository institutions,
including the Bank, will continue to be subject to changes in applicable
statutes and regulations from time to time.
The Bank is a North Carolina-chartered savings bank, is a member of
the FHLB system, and its deposits are insured by the FDIC through the SAIF. It
is subject to examination and regulation by the FDIC and the Administrator and
to regulations governing such matters as capital standards, mergers,
establishment of branch offices, subsidiary investments and activities, and
general investment authority. Generally, North Carolina state chartered savings
banks whose deposits are issued by the SAIF are subject to restrictions with
respect to activities and investments, transactions with affiliates and loans-
to-one borrower similar to those applicable to SAIF insured savings
associations. Such examination and regulation is intended primarily for the
protection of depositors and the federal deposit insurance funds.
The Bank is subject to various regulations promulgated by the Federal
Reserve including, without limitation, Regulation B (Equal Credit Opportunity),
Regulation D (Reserves), Regulation E (Electronic Fund Transfers), Regulation O
(Loans to Executive Officers, Directors and Principal Shareholders), Regulation
Z (Truth in Lending), Regulation CC (Availability of Funds) and Regulation DD
(Truth in
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Savings). As creditors of loans secured by real property and as owners of real
property, financial institutions, including the Bank, may be subject to
potential liability under various statutes and regulations applicable to
property owners generally, including statutes and regulations relating to the
environmental condition of real property.
The FDIC has extensive enforcement authority over North Carolina-
chartered savings banks, including the Bank. This enforcement authority
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 in response to violations of
laws and regulations and unsafe or unsound practices.
The grounds for appointment of a conservator or receiver for a North
Carolina savings bank on the basis of an institution's financial condition
include: (i) insolvency, in that the assets of the savings bank are less than
its liabilities to depositors and others; (ii) substantial dissipation of assets
or earnings through violations of law or unsafe or unsound practices; (iii)
existence of an unsafe or unsound condition to transact business; (iv)
likelihood that the savings bank will be unable to meet the demands of its
depositors or to pay its obligations in the normal course of business; and (v)
insufficient capital or the incurring or likely incurring of losses that will
deplete substantially all of the institution's capital with no reasonable
prospect of replenishment of capital without federal assistance.
Transactions with Affiliates. Under current federal law, transactions
between the Bank and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of the Bank is any company or entity that
controls, is controlled by or is under common control with the savings bank.
Generally, subsidiaries of a bank, other than a bank subsidiary, and certain
other types of companies are not considered to be affiliates. Generally,
Sections 23A and 23B (i) establish certain collateral requirements for loans to
affiliates; (ii) limit the extent to which the Bank or its subsidiaries may
engage in "covered transactions" with any one affiliate to an amount equal to
10% of such the Bank'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 (iii) require that all such transactions be on
terms substantially the same, or at least as favorable, to the Bank or the
subsidiary as those provided to a nonaffiliate. The term "covered transaction"
includes the making of loans or other extensions of credit to an affiliate, the
purchase of assets from an affiliate, the purchase of, or an investment in, the
securities of an affiliate, the acceptance of securities of an affiliate as
collateral for a loan or extension of credit to any person, or issuance of a
guarantee, acceptance or letter of credit on behalf of an affiliate.
Further, current federal law has extended to savings banks the
restrictions contained in Section 22(h) of the Federal Reserve Act with respect
to loans to directors, executive officers and principal stockholders. Under
Section 22(h), loans to directors, executive officers and stockholders who,
directly or indirectly, own more than 10% of any class of voting securities of a
savings bank, and certain affiliated entities of any of the foregoing, may not
exceed, together with all other outstanding loans to such person and affiliated
entities, the savings bank's loans-to-one borrower limit as established by
federal law (as discussed below). Section 22(h) also prohibits loans above
amounts prescribed by the appropriate federal banking agency to directors,
executive officers or stockholders who own more than 10% of a savings bank, and
their respective affiliates, unless such loan is approved in advance by a
majority of the disinterested directors of the board of directors of the savings
bank and the Company. Any "interested" director may not participate in the
voting. The Federal Reserve has prescribed the loan amount (which includes all
other outstanding loans to such person), as to which such prior board of
director approval is required, as being the greater of $25,000 or 5% of
unimpaired capital and unimpaired surplus (up to $500,000). Further, pursuant to
Section 22(h) the Federal Reserve requires that loans to directors, executive
officers,
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and principal stockholders based on underwriting standards not less stringent
than those applied in comparable transactions with other persons and made on
terms substantially the same as offered in comparable transactions to other
persons and not involve more than the normal risk of repayment or present other
unfavorable features.
Insurance of Deposit Accounts. The FDIC administers two separate
deposit insurance funds. The SAIF maintains a fund to insure the deposits of
institutions the deposits of which were insured by the Federal Savings and Loan
Insurance Corporation (the "FSLIC") prior to the enactment of FIRREA, and the
BIF maintains a fund to insure the deposits of institutions the deposits of
which were insured by the FDIC prior to the enactment of FIRREA. The Bank is a
member of the SAIF of the FDIC.
As a SAIF-insured institution, the Bank is subject to insurance
assessments imposed by the FDIC. Effective January 1, 1993, the FDIC replaced
its uniform assessment rate with a transitional risk-based assessment schedule
issued by the FDIC pursuant to the 1991 Banking Law, which imposes assessments
ranging from 0.23% to 0.31% of an institution's average assessment base. The
actual assessment to be paid by each SAIF member is based on the institution's
assessment risk classification, which will be determined based on whether the
institution is considered "well capitalized," "adequately capitalized" or
"undercapitalized" (as such terms have been defined in federal regulations), and
whether such institution is considered by its supervisory agency to be
financially sound or to have supervisory concerns.
As a result of subsequent changes to the assessment schedule,
financial institutions such as the Bank that are members of the SAIF, are
currently required to pay higher deposit insurance premiums than financial
institutions which are members of the BIF (primarily commercial banks), because
the BIF has higher reserves than the SAIF and has been responsible for fewer
troubled institutions. This had created a disparity between SAIF and BIF
assessments. Annual assessments for BIF members in the lowest risk categories
are now only $2,000. The Bank's federal deposit insurance premium expense was
$116,300 and $111,600 for the years ended September 30, 1996 and 1995,
respectively. The FDIC has noted that the premium differential may have adverse
consequences for SAIF members, including reduced earnings and an impaired
ability to raise funds in capital markets. In addition, SAIF members, such as
the Bank, could be placed at a substantial competitive disadvantage to BIF
members with respect to pricing of loans and deposits and the ability to achieve
lower operating costs.
A comprehensive continuing appropriations bill enacted on September
30, 1996 reduced this premium differential between BIF- and SAIF-insured
institutions but did not eliminate it. As a result of this legislation, it is
now anticipated that, beginning on January 1, 1997, BIF-insured institutions,
except those in higher risk categories, will pay deposit insurance premiums
equal to approximately 1.3 cents per $100 of insured domestic deposits and SAIF-
insured institutions, except those in higher risk categories, will pay deposit
insurance premiums equal to approximately 6.4 cents per $100 of insured domestic
deposits. This premium differential is expected to exist until at least January
1, 1999.
The above-described comprehensive continuing appropriations bill
enacted on September 30, 1996 also provides for a one-time assessment on SAIF
members to recapitalize the SAIF. The assessment is equal to 65.7 cents per
each $100 of insured domestic deposits. Such premium will have the effect of
immediately reducing the capital of SAIF-member institutions by the amount of
the assessment. SAIF-member institutions will not be allowed to amortize the
expense of the one-time assessment over a period of years. The one-time
assessment, which will be based on the Bank's deposits as of March 31, 1995, is
approximately $320,750 on a before tax basis and be payable prior to December,
1996. This one-time assessment to recapitalize the SAIF had an adverse effect
on the operating expenses and results of operations of the Bank for the year
ended September 30, 1996.
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Community Reinvestment Act. The Bank, like other financial
institutions, is subject to the Community Reinvestment Act, as amended ("CRA").
A purpose of this Act is to encourage financial institutions to help meet the
credit needs of its entire community, including the needs of low- and moderate-
income neighborhoods. During the Bank's last compliance examination, which was
performed by the FDIC under the old CRA regulations in January 1994, the Bank
received a "satisfactory" rating with respect to CRA compliance. The Bank's
rating with respect to CRA compliance would be a factor to be considered by the
Federal Reserve and FDIC in considering applications submitted by the Bank to
acquire branches or to acquire or combine with other financial institutions and
take other actions and could result in the denial of such applications.
The federal banking regulatory agencies have issued a rewrite of the
CRA regulations, which became effective on January 1, 1996, to implement a new
evaluation system that rates institutions based on their actual performance in
meeting community credit needs. Under the regulations, a savings bank will be
evaluated and rated under three categories: a lending test, an investment test
and a service test. For each of these three tests, the savings bank will be
given a rating of either "outstanding," "high satisfactory," "low satisfactory,"
"needs to improve" or "substantial non-compliance." A set of criteria for each
rating has been developed and is included in the regulation. If an institution
disagrees with a particular rating, the institution has the burden of rebutting
the presumption by clearly establishing that the quantative measures do not
accurately present its actual performance, or that demographics, competitive
conditions or economic or legal limitations peculiar to the service area should
be considered. The ratings received under the three tests will be used to
determine the overall composite CRA rating. The composite ratings will be the
same as those that are currently given: "outstanding," "satisfactory," "needs to
improve" or "substantial non-compliance."
Capital Requirements Applicable To The Bank. The FDIC requires the
Bank to have a minimum leverage ratio of Tier I capital (principally consisting
of common stockholders' equity, noncumulative perpetual preferred stock and
minority interests in consolidated subsidiaries, less certain intangible items,
goodwill items, identified losses and investments in securities subsidiaries) to
total assets of at least 3%; provided, however that all institutions, other than
those (i) receiving the highest rating during the examination process and (ii)
not anticipating or experiencing any significant growth, are required to
maintain a ratio of 1% or 2% above the stated minimum, with an absolute minimum
leverage ratio of not less than 4%. The FDIC also requires the Bank to have a
ratio of total capital to risk-weighted assets, including certain off-balance
sheet activities, such as standby letters of credit, of at least 8%. At least
half of the total capital is required to be Tier I capital. The remainder
("Tier II capital") may consist of a limited amount of subordinated debt,
certain hybrid capital instruments, other debt securities, certain types of
preferred stock and a limited amount of loan loss allowance.
An institution which fails to meet minimum capital requirements may be
subject to a capital directive which is enforceable in the same manner and to
the same extent as a final cease and desist order, and must submit a capital
plan within 60 days to the FDIC. If the leverage ratio falls to 2% or less, the
bank may be deemed to be operating in an unsafe or unsound condition, allowing
the FDIC to take various enforcement actions, including possible termination of
insurance or placement of the institution in receivership. At September 30,
1996, the Bank had a leverage ratio of 26.45%.
The Administrator requires that net worth equal at least 5% of total
assets. Intangible assets must be deducted from net worth and assets when
computing compliance with this requirement.
At September 30, 1996, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.
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The 1991 Banking Law required each federal banking agency to revise
its risk-based capital standards to ensure that those standards take adequate
account of interest rate risk, concentration of credit risk, and the risk of
nontraditional activities, as well as reflect the actual performance and
expected risk of loss on multi-family mortgages. On August 2, 1995, the federal
banking agencies issued a joint notice of adoption of final risk based capital
rules to take account of interest rate risk. The final regulation required an
assessment of the need for additional capital on a case-by-case basis,
considering both the level of measured exposure and qualitative risk factors.
The final rule also stated an intent to, in the future, establish an explicit
minimum capital charge for interest rate risk based on the level of a bank's
measured interest rate risk exposure.
Effective June 26, 1996, the federal banking agencies issued a joint
policy statement announcing the agencies' election not to adopt a standardized
measure and explicit capital charge for interest rate risk at that time.
Rather, the policy statement (i) identifies the main elements of sound interest
rate risk management, (ii) describes prudent principles and practices for each
of those elements, and (iii) describes the critical factors affecting the
agencies' evaluation of a bank's interest rate risk when making a determination
of capital adequacy. The joint policy statement is not expected to have a
material impact on the Bank's management of interest rate risk.
The FDIC has adopted a final rule changing its risk-based capital
rules to recognize the effect of bilateral netting agreements in reducing the
credit risk of two types of financial derivatives - interest and exchange rate
contracts. Under the rule, savings banks are permitted to net positive and
negative mark-to-market values of rate contracts with the same counterparty,
subject to legally enforceable bilateral netting contracts that meet certain
criteria. This represents a change from the prior rules which recognized only a
very limited form of netting. The Bank does not anticipate that this rule will
have a material effect upon its financial statements.
Loans-To-One-Borrower. The Bank is subject to the Administrator's
loans-to-one-borrower limits. Under these limits, no loans and extensions of
credit to any borrower outstanding at one time and not fully secured by readily
marketable collateral shall exceed 15% of the net worth of the savings bank.
Loans and extensions of credit fully secured by readily marketable collateral
may comprise an additional 10% of net worth. These limits also authorize
savings banks to make loans-to-one-borrower, for any purpose, in an amount not
to exceed $500,000. A savings bank also is authorized to make loans-to-one-
borrower to develop domestic residential housing units, not to exceed the lesser
of $30 million or 30% of the savings bank's net worth, provided that the
purchase price of each single-family dwelling in the development does not exceed
$500,000 and the aggregate amount of loans made under this authority does not
exceed 150% of net worth. These limits also authorize a savings bank to make
loans-to-one-borrower to finance the sale of real property acquired in
satisfaction of debts in an amount up to 50% of net worth.
As of September 30, 1996, the largest aggregate amount of loans which
the Bank had to any one borrower was $729,951. The Bank had no loans
outstanding which management believes violate the applicable loans-to-one-
borrower limits. The Bank does not believe that the loans-to-one-borrower
limits will have a significant impact on its business, operations and earnings.
Limitations on Rates Paid for Deposits. Regulations promulgated by
the FDIC pursuant to the 1991 Banking Law place limitations on the ability of
insured depository institutions to accept, renew or roll over deposits by
offering rates of interest which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
having the same type of charter in such depository institution's normal market
area. Under these regulations, "well capitalized" depository
34
<PAGE>
institutions may accept, renew or roll such deposits over without restriction,
"adequately capitalized" depository institutions may accept, renew or roll such
deposits over with a waiver from the FDIC (subject to certain restrictions on
payments of rates) and "undercapitalized" depository institutions may not
accept, renew or roll such deposits over. The definitions of "well
capitalized," "adequately capitalized" and "undercapitalized" are the same as
the definitions adopted by the FDIC to implement the corrective action
provisions of the 1991 Banking Law.
Federal Home Loan Bank System. The FHLB system provides a central
credit facility for member institutions. As a member of the FHLB of Atlanta,
the Bank is required to own capital stock in the FHLB of Atlanta in an amount at
least equal to the greater of 1% of the aggregate principal amount of its unpaid
residential mortgage loans, home purchase contracts and similar obligations at
the end of each calendar year, or 5% of its outstanding advances (borrowings)
from the FHLB of Atlanta. On September 30, 1996, the Bank was in compliance
with this requirement with an investment in FHLB of Atlanta stock of $595,400.
FIRREA has had the effect of reducing the dividends that the Bank
receives on its stock in the FHLB of Atlanta. During fiscal 1995 and 1996, the
Bank recorded dividend income of $42,700 and $43,200, respectively, with respect
to its FHLB of Atlanta stock. FIRREA requires each FHLB to contribute a certain
amount of its reserves and undivided profits to fund the principal and a portion
of the interest on certain bonds and certain other obligations which are used to
fund the resolution of troubled savings association cases. In addition, FIRREA
requires each FHLB to transfer a percentage of its annual net earnings to the
Affordable Housing Program. That amount will increase from 5% of the annual net
income of the FHLB in 1990 to at least 10% of its annual net income in 1995 and
subsequent years. As a result of these FIRREA requirements, it is anticipated
that the FHLB of Atlanta's earnings will be reduced and that the Bank will
receive reduced dividends on its FHLB of Atlanta stock in future periods.
Federal Reserve System. Federal Reserve regulations require savings
banks, not otherwise exempt from the regulations, to maintain reserves against
their transaction accounts (primarily negotiable order of withdrawal accounts)
and certain nonpersonal time deposits. The reserve requirements are subject to
adjustment by the Federal Reserve. As of September 30, 1996, the Bank was in
compliance with the applicable reserve requirements of the Federal Reserve.
Restrictions on Acquisitions. Federal law generally provides that no
"person," acting directly or indirectly or through or in concert with one or
more other persons, may acquire "control," as that term is defined in FDIC
regulations, of an insured institution, such as the Bank, without giving at
least 60 days' written notice to the FDIC and providing the FDIC an opportunity
to disapprove the proposed acquisition. Pursuant to regulations governing
acquisitions of control, control of an insured institution is conclusively
deemed to have been acquired by, among other things, the acquisition of more
than 25% of any class of voting stock. In addition, control generally is
presumed to have been acquired, subject to rebuttal, upon the acquisition of
more than 10% of any class of voting stock. Such acquisitions of control may be
disapproved if it is determined, among other things, that (i) the acquisition
would substantially lessen competition; (ii) the financial condition of the
acquiring person might jeopardize the financial stability of the savings bank or
prejudice the interests of its depositors; or (iii) the competency, experience
or integrity of the acquiring person or the proposed management personnel
indicates that it would not be in the interest of the depositors or the public
to permit the acquisitions of control by such person.
For three years following completion of the Conversion, North Carolina
conversion regulations require the prior written approval of the Administrator
before any person may directly or indirectly offer to acquire or acquire the
beneficial ownership of more than 10% of any class of an equity security of the
35
<PAGE>
Bank. If any person were to so acquire the beneficial ownership of more than
10% of any class of any equity security without prior written approval, the
securities beneficially owned in excess of 10% would not be counted as shares
entitled to vote and would not be voted or counted as voting shares in
connection with any matter submitted to stockholders for a vote. Approval is
not required for (i) any offer with a view toward public resale made exclusively
to the Bank or its underwriters or the selling group acting on its behalf or
(ii) any offer to acquire or acquisition of beneficial ownership of more than
10% of the common stock of the Bank by a corporation whose ownership is or will
be substantially the same as the ownership of the Bank, provided that the offer
or acquisition is made more than one year following the consummation of the
Conversion. The regulation provides that within one year following the
Conversion, the Administrator would approve the acquisition of more than 10% of
beneficial ownership only to protect the safety and soundness of the
institution. During the second and third years after the Conversion, the
Administrator may approve such an acquisition upon a finding that (i) the
acquisition is necessary to protect the safety and soundness of the Company and
the Bank or the Boards of Directors of the Company and the Bank support the
acquisition, (ii) the acquiror is of good character and integrity and possesses
satisfactory managerial skills, and will be a source of financial strength to
the Company and the Bank; and (iii) the public interests will not be adversely
affected.
Liquidity. The Bank is subject to the Administrator's requirement
that the ratio of liquid assets to total assets equal at least 10%. The
computation of liquidity under North Carolina regulation allows the inclusion of
mortgage-backed securities and investments which, in the judgment of the
Administrator, have a readily marketable value, including investments with
maturities in excess of five years. On September 30, 1996, the Bank's liquidity
ratio, calculated in accordance with North Carolina regulations, was
approximately 32%.
Additional Limitations on Activities. Recent FDIC law and regulations
generally provide that the Bank may not engage as principal in any type of
activity, or in any activity in an amount, not permitted for national banks, or
directly acquire or retain any equity investment of a type or in an amount not
permitted for national banks. The FDIC has authority to grant exceptions from
these prohibitions (other than with respect to non-service corporation equity
investments) if it determines no significant risk to the insurance fund is posed
by the amount of the investment or the activity to be engaged in and if the Bank
is and continues to be in compliance with fully phased-in capital standards.
National banks are generally not permitted to hold equity investments other than
shares of service corporations and certain federal agency securities. Moreover,
the activities in which service corporations are permitted to engage are limited
to those of service corporations for national banks.
Savings banks are also generally prohibited from directly or
indirectly acquiring or retaining any corporate debt security that is not of
investment grade (generally referred to as "junk bonds"). State savings banks
are also required to notify the FDIC at least 30 days prior to the establishment
or acquisition of any subsidiary, or at least 30 days prior to conducting any
such new activity. Any such activities must be conducted in accordance with the
regulations and orders of the FDIC and the Administrator.
Impact of the 1991 Banking Law. The 1991 Banking Law became effective
on December 19, 1991. Among other things, the 1991 Banking Law provided
increased funding for the BIF and provided for expanded regulation of depository
institutions and their affiliates, including bank holding companies.
The 1991 Banking Law provided the federal banking agencies with broad
powers to take corrective action to resolve problems of insured depository
institutions. The extent of these powers will depend upon whether the
institutions in question are "well capitalized," "adequately capitalized,"
"undercapitalized,"
36
<PAGE>
"significantly undercapitalized," or "critically undercapitalized." Under the
FDIC regulations applicable to the Bank, an institution is considered "well
capitalized" if it has (i) a total risk-based capital ratio of 10% or greater,
(ii) a Tier I risk-based capital ratio of 6% or greater, (iii) a leverage ratio
of 5% or greater and (iv) is not subject to any order or written directive to
meet and maintain a specific capital level for any capital measure. An
"adequately capitalized" institution is defined as one that has (i) a total
risk-based capital ratio of 8% or greater, (ii) a Tier I risk-based capital
ratio of 4% or greater and (iii) a leverage ratio of 4% or greater (or 3% or
greater in the case of an institution with the highest examination rating and
which is not experiencing or anticipating significant growth). An institution
is considered (A) "undercapitalized" if it has (i) a total risk-based capital
ratio of less than 8%, (ii) a Tier I risk-based capital ratio of less than 4% or
(iii) a leverage ratio of less than 4% (or 3% in the case of an institution with
the highest examination rating and which is not experiencing or anticipating
significant growth); (B) "significantly undercapitalized" if the institution has
(i) a total risk-based capital ratio of less than 6%, or (ii) a Tier I risk-
based capital ratio of less than 3% or (iii) a leverage ratio of less than 3%
and (C) "critically undercapitalized" if the institution has a ratio of tangible
equity to total assets equal to or less than 2%.
To facilitate the early identification of problems, the 1991 Banking
Law required the federal banking agencies to review and, under certain
circumstances, prescribe more stringent accounting and reporting requirements
than those required by generally accepted accounting principles. The FDIC
issued a final rule, effective July 2, 1993, implementing those provisions. The
rule, among other things, requires that management of institutions with $500
million or more in assets report on the institution's responsibility for
preparing financial statements and establishing and maintaining an internal
control structure and procedures for financial reporting and compliance with
designated laws and regulations concerning safety and soundness, and that
independent auditors attest to and report separately on assertions in
management's reports concerning compliance with such laws and regulations, using
FDIC-approved audit procedures.
The 1991 Banking Law further requires the federal banking agencies to
develop regulations requiring disclosure of contingent assets and liabilities
and, to the extent feasible and practicable, supplemental disclosure of the
estimated fair market value of assets and liabilities. The 1991 Banking Law also
requires annual examinations of all insured depository institutions by the
appropriate federal banking agency, with some exceptions for small, well-
capitalized institutions and state chartered institutions examined by state
regulators. Moreover, the 1991 Banking Law, as modified by the Federal Housing
Enterprises Financial Security and Soundness Act, requires the federal banking
agencies to set operational and managerial, asset quality, earnings and stock
valuation standards for insured depository institutions and depository
institution holding companies, as well as compensation standards (but not dollar
levels of compensation) for insured depository institutions that prohibit
excessive compensation, fees or benefits to officers, directors, employees, and
principal stockholders. The federal banking agencies have issued final
regulations, effective August 9, 1995, implementing these standards in
accordance with the 1991 Banking Law. Those agencies have also issued a joint
advance notice of proposed rulemaking soliciting comments on the addition of
asset quality and earnings guidelines to these safety and soundness standards.
The foregoing necessarily is a general description of certain
provisions of the 1991 Banking Law and does not purport to be complete. The
effect of the 1991 Banking Law on the Bank has not yet been fully ascertained.
Interstate Branching. A bank or savings bank holding company and its
subsidiaries are currently prohibited from acquiring any voting shares of, or
interest in, any banks or savings banks located outside of the state in which
the operations of the savings bank holding company's subsidiaries are located,
unless
37
<PAGE>
the acquisition is specifically authorized by the statutes of the state in which
the target bank is located. However, in September 1994, Congress passed the
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act"). The Interstate Banking Act permitted adequately
capitalized bank and savings bank holding companies to acquire control of banks
and savings banks in any state beginning on September 29, 1995, one year after
the effectiveness of the Interstate Banking Act. In addition, states may
specifically permit interstate acquisitions prior to September 29, 1995, by
enacting legislation that provides for such transactions. North Carolina
adopted nationwide reciprocal interstate acquisition legislation in 1994.
Such interstate acquisitions are subject to certain restrictions.
States may require the bank or savings bank being acquired to have been in
existence for a certain length of time but not in excess of five years. In
addition, no bank or saving bank may acquire more than 10% of the insured
deposits in the United States or more than 30% of the insured deposits in any
one state, unless the state has specifically legislated a higher deposit cap.
States are free to legislate stricter deposit caps and, at present, 18 states
have deposit caps lower than 30%.
The Interstate Banking Act also provides for interstate branching.
The McFadden Act of 1927 established state lines as the ultimate barrier to
geographic expansion of a banking network by branching. The Interstate Banking
Act withdraws these barriers, effective June 1, 1997, allowing interstate
branching in all states, provided that a particular state has not specifically
denied interstate branching by legislation prior to such time. Unlike
interstate acquisitions, a state may deny interstate branching if it
specifically elects to do so by June 1, 1997. States may choose to allow
interstate branching prior to June 1, 1997 by opting-in to a group of states
that permits these transactions. These states generally allow interstate
branching via a merger of an out-of-state bank with an in-state bank, or on a de
novo basis. North Carolina has enacted legislation permitting branching
transactions.
It is anticipated that the Interstate Banking Act will increase
competition within the markets in which the Bank now operates, although the
extent to which such competition will increase in such markets or the timing of
such increase cannot be predicted. In addition, there can be no assurance as to
whether, or in what form, legislation may be enacted in North Carolina in
reaction to the Interstate Banking Act or what impact such legislation or the
Interstate Banking Act might have upon the Bank.
The Interstate Banking Act also modifies the controversial safety and
soundness provisions contained in Section 39 of the 1991 Banking Law which
required the banking regulatory agencies to write regulations governing such
topics as internal controls, loan documentation, credit underwriting, interest
rate exposure, asset growth, compensation and fees and whatever else those
agencies determined to be appropriate. The legislation exempts bank holding
companies from these provisions and requires the agencies to write guidelines,
as opposed to regulations, dealing with these areas. It also gives more
discretion to the banking regulatory agencies with regard to prescribing
standards for banks' asset quality, earnings and stock valuation.
The Interstate Banking Act also expands current exemptions from the
requirement that banks be examined on a 12-month cycle. Exempted banks will be
inspected every 18 months. Other provisions address paperwork reduction and
regulatory improvements, small business and commercial real estate loan
securitization, truth-in-lending amendments on high cost mortgages,
strengthening of the independence of certain financial regulatory agencies,
money laundering, flood insurance reform and extension of certain statutes of
limitations.
38
<PAGE>
Restrictions on Dividends and Other Capital Distributions. A North
Carolina-chartered stock savings bank may not declare or pay a cash dividend on,
or repurchase any of, its capital stock if the effect of such transaction would
be to reduce the net worth of the institution to an amount which is less than
the minimum amount required by applicable federal and state regulations. In
addition, a North Carolina-chartered stock savings bank, for a period of five
years after its conversion from mutual to stock form, must obtain the written
approval from the Administrator before declaring or paying a cash dividend on
its capital stock in an amount in excess of one-half of the greater of (i) the
institution's net income for the most recent fiscal year end, or (ii) the
average of the institution's net income after dividends for the most recent
fiscal year end and not more than two of the immediately preceding fiscal year
ends, if applicable. Under FDIC regulations, stock repurchases may be made by
the savings bank only upon receipt of FDIC approval.
Also, without the prior written approval of the Administrator, a North
Carolina-chartered stock savings bank, for a period of five years after its
conversion from mutual to stock form, may not repurchase any of its capital
stock. The Administrator will give approval to repurchase only upon a showing
that the proposed repurchase will not adversely affect the safety and soundness
of the institution.
In addition, the Bank is not permitted to declare or pay a cash
dividend on or repurchase any of its capital stock if the effect thereof would
be to cause its net worth to be reduced below the amount required for the
liquidation account established in connection with the Bank's conversion from
mutual to stock ownership.
In connection with the Conversion, the Company and the Bank have
agreed with the FDIC that, during the first year after the Conversion, the Bank
will not pay any dividend or make any other distribution to its stockholder
which represents, is characterized as or is treated for federal tax purposes as,
a return of capital.
Other North Carolina Regulations. As a North Carolina-chartered
savings bank, the Bank derives its authority from, and is regulated by, the
Administrator. The Administrator has the right to promulgate rules and
regulations necessary for the supervision and regulation of North Carolina
savings banks under his jurisdiction and for the protection of the public
investing in such institutions. The regulatory authority of the Administrator
includes, but is not limited to, the establishment of reserve requirements; the
regulation of the payment of dividends; the regulation of stock repurchases, the
regulation of incorporators, stockholders, directors, officers and employees;
the establishment of permitted types of withdrawable accounts and types of
contracts for savings programs, loans and investments; and the regulation of the
conduct and management of savings banks, chartering and branching of
institutions, mergers, conversions and conflicts of interest. North Carolina
law requires that the Bank maintain federal deposit insurance as a condition of
doing business.
The Administrator conducts regular annual examinations of North
Carolina-chartered savings banks. The purpose of such examinations is to assure
that institutions are being operated in compliance with applicable North
Carolina law and regulations and in a safe and sound manner. These examinations
are usually conducted on a joint basis with the FDIC. In addition, the
Administrator is required to conduct an examination of any institution when he
has good reason to believe that the standing and responsibility of the
institution is of doubtful character or when he otherwise deems it prudent. The
Administrator is empowered to order the revocation of the license of an
institution if he finds that it has violated or is in violation of any North
Carolina law or regulation and that revocation is necessary in order to preserve
the assets of the institution and protect the interests of its depositors. The
Administrator has the power to issue cease and desist orders if any person or
institution is engaging in, or has engaged in, any
39
<PAGE>
unsafe or unsound practice or unfair and discriminatory practice in the conduct
of its business or in violation of any other law, rule or regulation.
A North Carolina-chartered savings bank must maintain net worth,
computed in accordance with the Administrator's requirements, of 5% of total
assets and liquidity of 10% of total assets, as discussed above. Additionally,
a North Carolina-chartered savings bank is required to maintain general
valuation allowances and specific loss reserves in the same amounts as required
by the FDIC.
Subject to limitation by the Administrator, North Carolina-chartered
savings banks may make any loan or investment or engage in any activity which is
permitted to federally chartered institutions. However, a North Carolina-
chartered savings bank cannot invest more than 15% of its total assets in
business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutorily permitted
investments, including but not limited to (i) obligations of the United States,
or those guaranteed by it; (ii) obligations of the State of North Carolina;
(iii) bank demand or time deposits; (iv) stock or obligations of the federal
deposit insurance fund or a FHLB; (v) savings accounts of any savings
institution as approved by the board of directors; and (vi) stock or obligations
of any agency of the State of North Carolina or of the United States or of any
corporation doing business in North Carolina whose principal business is to make
education loans.
North Carolina law provides a procedure by which savings institutions
may consolidate or merge, subject to approval of the Administrator. The
approval is conditioned upon findings by the Administrator that, among other
things, such merger or consolidation will promote the best interests of the
members or stockholders of the merging institutions. North Carolina law also
provides for simultaneous mergers and conversions and for supervisory mergers
conducted by the Administrator.
ITEM 2. DESCRIPTION OF PROPERTY
The following table sets forth the location of the Bank's principal
office in Laurinburg and its full service branch office in Pinehurst, as well as
certain other information relating to these offices as of September 30, 1996.
The Bank owns the Laurinburg office. The Bank is a 50% owner of the Pinehurst
office. A golf course designer owns and has offices in the other half of the
building. All taxes, insurance, utilities and maintenance are paid by each
owner for their respective one-half of the building. The net book value of the
Pinehurst property listed below is for the Bank's one-half interest.
<TABLE>
<CAPTION>
Net Book Value Deposits
Address of Property (In Thousands)
------- -------------- --------------
<S> <C> <C>
Laurinburg:
505 South Main Street $592,975 $36,376
P.O. Box 1468
Laurinburg, North Carolina 28352
Pinehurst:
77 Cherokee Road 171,035 6,034
Pinehurst, North Carolina 28374 -------- -------
$764,010 $42,410
======== =======
</TABLE>
40
<PAGE>
The Bank's management considers the property to be in good condition.
The total net book value of the Bank's furniture, fixtures and equipment on
September 30, 1996 was $55,464.
ITEM 3. LEGAL PROCEEDINGS
In the opinion of management, neither the Company nor the Bank is
involved in any pending legal proceedings other than routine, non-material
proceedings occurring in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's stockholders during
the quarter ended September 30, 1996.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
See the information under the section captioned "Common Stock
Information" on the inside back cover of the Company's 1996 Annual Report, which
section is incorporated herein by reference. See "Item 1. DESCRIPTION OF
BUSINESS--Regulation of the Bank--Restrictions on Dividends and Other Capital
Distributions" above for regulatory restrictions which limit the ability of the
Bank to pay dividends to the Company.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
See the information set forth under Item I above and the information
set forth under the section captioned "Management's Discussion and Analysis" on
pages 3 through 10 in the Company's 1996 Annual Report, which section is
incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of the Company set forth on
pages 12 through 38 in the Company's 1996 Annual Report are incorporated herein
by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
N/A.
41
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH 16(a) OF THE EXCHANGE ACT
The information required by this Item regarding directors and executive
officers of the Company is set forth under the sections captioned "Proposal 1 -
Election of Directors" on page 6 of the Proxy Statement and "Executive Officers"
on page 9 of the Proxy Statement, which sections are incorporated herein by
reference.
The information required by this Item regarding compliance with Section
16(a) of the Securities Exchange Act of 1934 is set forth under the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" set forth on
page 5 of the Proxy Statement, which is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the sections
captioned "Proposal 1 - Election of Directors - Directors Compensation" on
page 8 and " - Management Compensation" on pages 9 through 11 of the Proxy
Statement, which sections are incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from the
section captioned "Security Ownership of Certain Beneficial Owners" on pages 2
through 5 of the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There have been no reportable transactions during the two most recent
fiscal years nor are any reportable transactions proposed as of the date of this
Form 10-KSB.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
13(a) Exhibits
(3)(i) Certificate of Incorporation, incorporated herein by reference to
Exhibit (3)(i) to the Registration Statement on Form S-1,
Registration No. 33-99916, dated November 30, 1995 and amended on
January 31, 1996 and February 7, 1996.
(3)(ii) Bylaws, incorporated herein by reference to Exhibit (3)(ii) to the
Registration Statement on Form S-1, Registration No. 33-99916,
dated November 30, 1995 and amended on January 31, 1996 and
February 7, 1996.
(4) Specimen Stock Certificate incorporated herein by reference to
Exhibit 4 to the Registration Statement on Form S-1, Registration
No. 33-99916, dated November 30, 1995 and amended on January 31,
1996 and February 7, 1996.
42
<PAGE>
10(a) Employment Agreement with William C. Fitzgerald, III
10(b) Special Termination Agreement with John B. Clark
10(c) Deferred Compensation Agreements with James E. Milligan,
James S. Mitchener and Sam T. Snowdon, Jr.
(11) Statement Regarding Computation of Per Share Earnings
(13) Portions of the 1996 Annual Report to Stockholders
(23) Consent of McGladrey & Pullen, LLP
(27) Financial Data Schedule
13(b) The Company filed no reports on Form 8-K during the last quarter
of the fiscal year ended September 30, 1996
43
<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.
SCOTLAND BANCORP, INC.
Dated: December 20, 1996 By: /s/ William C. Fitzgerald, III
--------------------------------------
William C. Fitzgerald, III
President and Chief Executive Officer
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 and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ William C. Fitzgerald, III President, Chief Executive December 20, 1996
- ------------------------------ Officer and Director
William C. Fitzgerald, III
/s/ Debora B. Steagall Assistant Treasurer December 20, 1996
- ------------------------------
Debora B. Steagall
/s/ John B. Clark Senior Vice-President and December 20, 1996
- --------------------------- Director
John B. Clark
/s/ Clifton P. Buie Director December 20, 1996
- ---------------------------
Clifton P. Buie
/s/ E. S. Hill, Jr. Director December 20, 1996
- ---------------------------
E. S. Hill, Jr.
/s/ John W. Hudson Director December 20, 1996
- ---------------------------
John W. Hudson
/s/ James W. Mason Director December 20, 1996
- ---------------------------
James W. Mason
/s/ James E. Milligan Director December 20, 1996
- ---------------------------
James E. Milligan
/s/ James S. Mitchener, Jr. Director December 20, 1996
- ---------------------------
James S. Mitchener, Jr.
/s/ S. T. Snowdon, Jr. Director December 20, 1996
- ---------------------------
S. T. Snowdon, Jr.
/s/ James T. Willis Director December 20, 1996
- ---------------------------
James T. Willis
</TABLE>
44
<PAGE>
Index To Exhibits
Exhibit No. Description
10(a) Employment Agreement with William C. Fitzgerald, III
10(b) Special Termination Agreement with John B. Clark
10(c) Deferred Compensation Agreements with James E. Milligan,
James S. Mitchener and Sam T. Snowdon, Jr.
(11) Statement Regarding Computation of Per Share Earnings
(13) Portions of the 1996 Annual Report to Stockholders
(23) Consent of McGladrey & Pullen, LLP
(27) Financial Data Schedule
<PAGE>
Exhibit 10(a)
SCOTLAND SAVINGS BANK, INC., SSB
EMPLOYMENT AGREEMENT
THIS AGREEMENT entered into as of March 29, 1996, by and between SCOTLAND
SAVINGS BANK, INC., SSB (hereinafter referred to as the "Savings Bank") and
WILLIAM C. FITZGERALD, III (hereinafter referred to as the "Officer") and is
joined in by SCOTLAND BANCORP, INC., the parent holding company of the Savings
Bank (hereinafter referred to as the "Holding Company").
WHEREAS, the Officer has heretofore been employed by the Savings Bank as
its President and Chief Executive Officer; and
WHEREAS, the Savings Bank is a state-chartered stock savings bank and the
wholly-owned subsidiary of the Holding Company; and
WHEREAS, the Savings Bank desires to retain the services of the Officer as
the President and Chief Executive Officer of the Savings Bank upon the terms and
conditions set forth herein; and
WHEREAS, the services of the Officer, his experience and knowledge of the
affairs of the Savings Bank, and his reputation and contacts in the industry and
the local community are extremely valuable to the Savings Bank; and
WHEREAS, the Savings Bank wishes to attract and retain such well-qualified
executives and it is in the best interest of the Savings Bank and of the Officer
to secure the continued services of the Officer notwithstanding any change in
control of the Savings Bank or the Holding Company; and
WHEREAS, the Savings Bank considers the establishment and maintenance of a
sound and vital management to be part of its overall corporate strategy and to
be essential to protecting and enhancing the best interests of the Holding
Company, the Savings Bank and their stockholders; and
<PAGE>
WHEREAS, the parties desire to enter into this Agreement in order to set
forth the terms and conditions of the Officer's employment relationship with the
Savings Bank.
NOW, THEREFORE, for and in consideration of the premises and mutual
promises, covenants and conditions hereinafter set forth and other good and
valuable considerations, the receipt and sufficiency of which hereby are
acknowledged, the parties hereby do agree as follows:
1. Employment. The Savings Bank hereby agrees to employ the Officer and
----------
the Officer hereby agrees to accept employment, upon the terms and conditions
stated herein, as the President and Chief Executive Officer of the Savings Bank.
The Officer shall render such administrative and management services to the
Savings Bank as are customarily performed by persons situated in a similar
executive capacity. The Officer shall promote the business of the Savings Bank
and perform such other duties as shall, from time to time, be reasonably
prescribed by the Board of Directors of the Savings Bank (the "Board").
2. Compensation. The Savings Bank shall pay the Officer during the term
------------
of this Agreement, as compensation for all service rendered by him to the
Savings Bank, a base salary at the rate of $93,500 per annum, payable in cash
not less frequently than monthly; provided that the rate of such salary shall be
reviewed by the Board not less often than annually. Such rate of salary, or
increased rate of salary, as the case may be, may be further increased, but not
decreased, from time to time in such amounts as the Board, in its discretion,
may decide. In determining salary increases, the Board shall compensate the
Officer for increases in the cost of living and may also provide for performance
or merit increases. Participation in incentive compensation, deferred
compensation, discretionary bonus, profit-sharing, retirement, stock option and
other employee benefit plans that the Savings Bank or the Holding Company have
adopted or may from time to time
2
<PAGE>
adopt, and participation in any fringe benefits, shall not reduce the salary
payable to the Officer under this Section. The Officer will be entitled to such
customary fringe benefits, vacation and sick leave as are consistent with the
normal practices and established policies of the Savings Bank.
3. Annual Bonus. The Savings Bank agrees to pay the Officer an annual
------------
bonus (the "Annual Bonus"), payable on or before December 1 of each year, equal
to a certain percentage of the "Net Profit" of the Company and the Savings Bank,
on a consolidated basis, for the immediately preceding "Accounting Year". For
the purposes of this Agreement, "Accounting Year" shall be October 1st through
September 30th of each year. For the purposes of this Agreement, "Net Profit"
shall be the net profit of the Holding Company and the Savings Bank, on a
consolidated bases, before income taxes (as determined by the Savings Bank's
certified public accountants ("CPA's") and certified by CPA's to the Board of
Directors of the Savings Bank in the annual audit report prepared by said CPA's
and covering the subject Accounting Year). The percentage of Net Profit the
Officer shall be entitled to receive pursuant to this Paragraph 3 shall be
calculated by the Savings Bank's CPA's using the criteria set forth on Schedule
A attached hereto and incorporated herein by reference.
4. Discretionary Bonuses. During the term of this Agreement, the Officer
---------------------
shall be entitled in an equitable manner with all other key management personnel
of the Savings Bank, to such discretionary bonuses as may be authorized,
declared and paid by the Directors to the Savings Bank's key management
employees. No other compensation provided for in this Agreement shall be deemed
a substitute for the Officer's right to such discretionary bonuses when and as
declared by the Directors.
3
<PAGE>
5. Participation in Retirement and Employee Benefit Plans; Fringe
--------------------------------------------------------------
Benefits. The Officer shall be entitled to participate in any plan relating to
- --------
deferred compensation, stock awards, stock options, stock ownership plan, stock
purchases, pension, thrift, profit sharing, group life insurance, medical and
dental coverage, disability coverage, education, or other retirement or employee
benefits that the Savings Bank or the Holding Company have adopted, or may, from
time to time adopt, for benefit of their executive employees and for employees
generally, subject to the eligibility rules of such plans.
The Officer shall also be entitled to participate in any other fringe
benefits which are now or may be or become applicable to the Officer or the
Savings Bank's other executive employees, including the payment of reasonable
expenses for attending annual and periodic meetings of trade associations, and
any other benefits which are commensurate with the duties and responsibilities
to be performed by the Officer under this Agreement. The Savings Bank agrees to
provide the Officer with one automobile of an appropriate class and quality
owned or leased by the Savings Bank for use in connection with the Officer's
duties hereunder. The Savings Bank further agrees to pay on behalf of the
Officer during the term of this Agreement the regular monthly dues for the
Officer's membership in the Scotch Meadows Country Club and the Laurinburg
Rotary Club. The Savings Bank shall reimburse the Officer for all out-of-pocket
reasonable and necessary business expenses which the Officer may incur in
connection with his services on behalf of the Savings Bank. Additionally, the
Officer shall be entitled to such vacation and sick leave as shall be
established under uniform employee policies promulgated by the Directors.
6. Term. The initial term of employment under this Agreement shall be for
----
the period commencing upon the effective date of this Agreement and ending three
(3) calendar years from the
4
<PAGE>
effective date of this Agreement. On each anniversary of the effective date of
this Agreement, the term of this Agreement shall automatically be extended for
an additional one year period beyond the then effective expiration date unless
written notice from the Savings Bank or the Officer is received 90 days prior to
an anniversary date advising the other party that this Agreement shall not be
further extended; provided that the Directors shall review the Officer's
performance annually and make a specific determination pursuant to such review
to renew this Agreement prior to the 90 day notice period.
7. Loyalty. The Officer shall devote his full efforts and entire business
-------
time to the performance of his duties and responsibilities under this Agreement.
The Officer agrees that he will hold in confidence all knowledge or
information of a confidential nature with respect to the respective businesses
of the Holding Company, the Savings Bank or of their subsidiaries, if any,
received by him during the term of this Agreement and will not disclose or make
use of such information, except in the ordinary course of his duties under this
Agreement, without the prior written consent of the Holding Company or the
Savings Bank.
8. Standards. The Officer shall perform his duties and responsibilities
---------
under this Agreement in accordance with such reasonable standards expected of
employees with comparable positions in comparable organizations and as may be
established from time to time by the Board. The Savings Bank will provide the
Officer with the working facilities and staff customary for similar executives
and necessary for him to perform his duties.
9. Termination and Termination Pay.
-------------------------------
(a) The Officer's employment under this Agreement shall be terminated upon
the death of the Officer during the term of this Agreement, in which event, the
Officer's estate shall be entitled
5
<PAGE>
to receive the compensation due the Officer through the last day of the calendar
month in which his death shall have occurred and for a period of one month
thereafter.
(b) The Officer's employment under this Agreement may be terminated at any
time by the Officer upon sixty (60) days' written notice to the Board of
Directors. Upon such termination, the Officer shall be entitled to receive
compensation through the effective date of such termination.
(c) In the event the Officer becomes disabled during the term of his
employment under this Agreement and it is determined by the Savings Bank that
the Officer is permanently unable to perform his duties hereunder, the Savings
Bank shall continue to compensate the Officer at the level of compensation
described in Paragraph 2 above, and shall continue to provide the Officer each
of the other benefits set forth or described in this Agreement, for the
remaining term of this Agreement, less any other payments provided under any
disability income plan of the Savings Bank which is applicable to the Officer.
In the event of any disagreement between the Officer and the Savings Bank as to
whether the Officer is physically or mentally incapacitated such as will result
in the termination of the Officer's employment pursuant to this Paragraph 9(c),
the question of such incapacity shall be submitted to an impartial and reputable
physician for determination, selected by mutual agreement of the Officer and the
Savings Bank or, failing such agreement, by two (2) physicians (one (1) of whom
shall be selected by the Savings Bank and the other by the Officer), and such
determination of the question of such incapacity by such physician or physicians
shall be final and binding on the Officer and the Savings Bank. The Savings
Bank shall pay the reasonable fees and expenses of such physician or physicians
in making any determination required under this Paragraph 9(c).
6
<PAGE>
(d) The Board may terminate the Officer's employment at any time, but any
termination by the Board, other than termination for cause, shall not prejudice
the Officer's right to compensation or other benefits under this Agreement for
the remaining period which would have been covered by this Agreement if such
termination had not occurred. The Officer shall have no right to receive
compensation or other benefits for any period after termination for "cause."
Termination for "cause" shall include termination because of the Officer's
personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty
involving personal profit, intentional failure to perform stated duties, willful
violation of any law, rule, regulation (other than traffic violations or similar
offenses) or final cease-and-desist order, or material breach of any provisions
of this Agreement.
10. Additional Regulatory Requirements.
----------------------------------
(a) If the Officer is suspended and/or temporarily prohibited from
participating in the conduct of the Savings Bank's affairs by a notice served
under Section 8(e)(3) or Section 8(g)(1) of the Federal Deposit Insurance Act
(12 U.S.C. 1818(e)(3) and (g)(1)), the Savings Bank's obligations under this
Agreement shall be suspended as of the date of service, unless stayed by
appropriate proceedings. If the charges in the notice are dismissed, the
Savings Bank shall (i) pay the Officer all of the compensation withheld while
its contract obligations were suspended and (ii) reinstate (in whole or in part)
any of its obligations which were suspended.
(b) If the Officer is removed and/or permanently prohibited from
participating in the conduct of the Savings Bank's affairs by an order issued
under Section 8(e)(4) or Section 8(g)(1) of the Federal Deposit Insurance Act
(12 U.S.C. 1818(e)(4) and (g)(1)), all obligations of the Savings
7
<PAGE>
Bank under this Agreement shall terminate as of the effective date of the order,
but vested rights of the contracting parties shall not be affected.
(c) If the Savings Bank is in default as defined in Section 3(x)(1) of the
Federal Deposit Insurance Act (12 U.S.C. (S) 1818(x)(1)), all obligations under
this Agreement shall terminate as of the date of default, but this paragraph
shall not affect any vested rights of the contracting parties.
(d) All obligations under this Agreement shall be terminated, except to the
extent determined that continuation of the Agreement is necessary for the
continued operation of the Savings Bank, (i) by the Federal Deposit Insurance
Corporation (the "Corporation"), at the time the Corporation enters into an
agreement to provide assistance to or on behalf of the Savings Bank under the
authority contained in Section 13(c) of the Federal Deposit Insurance Act (12
U.S.C. (S) 1818(c)); or (ii) by the Administrator of the Savings Institutions
Division of the North Carolina Department of Commerce (the "Administrator"), at
the time the Administrator approves a supervisory merger to resolve problems
related to operation of the Savings Bank or when the Savings Bank is determined
by the Administrator to be in an unsafe or unsound condition. Any rights of the
parties that have already vested, however, shall not be affected by such action.
11. Change in Control.
-----------------
(a) In the event of a "Change in Control" (as defined in Subparagraph (c)
below), the term of employment under this Agreement automatically shall be
extended for a period of three (3) years beginning on the date of the Change in
Control, and the acquiror shall be bound by the terms of this Agreement and
shall be prohibited, during the remainder of such term, from:
8
<PAGE>
(i) Assigning Officer any duties and/or responsibilities that are
inconsistent with his position, duties, responsibilities or status at
the time of the Change in Control or with his reporting
responsibilities or equivalent titles with the Savings Bank in effect
at such time; or
(ii) Adjusting Officer's annual base salary rate other than in
accordance with the provisions of Subparagraph 11(b) of this
Agreement; or
(iii) Failing to award any discretionary bonuses in accordance with
Paragraph 4;
(iv) Reducing in level, scope or coverage or eliminating Officer's
life insurance, medical or hospitalization insurance, disability
insurance, profit sharing plans, stock option plans, stock purchase
plans, deferred compensation plans, management retention plans,
retirement plans, stock ownership plan or similar plans or benefits,
including, without limitation, the provision of the Officer's
automobile and payment of civic and social club dues, being provided
by the Savings Bank or the Holding Company to the Officer as of the
effective date of the Change in Control; or
(v) Transferring Officer to a location outside of Scotland County,
North Carolina, without the Officer's express written consent.
(b) In the event of a Change in Control, in lieu of continuing to receive
the Annual Bonus described in Paragraph 3, the Officer's base salary shall be
adjusted to include an amount equal to the average of the two previous years'
Annual Bonus; and such adjusted base salary shall be increased by not less than
six percent (6%) annually beginning at the date of the Change in Control and
continuing each year for the three year term thereafter.
(c) For the purposes of this Agreement, the term "Change in Control" shall
mean any of the following events:
(i) a change in control of a nature that would be required to be
reported in response to Item 1 of the Current Report on Form 8-K, as
in effect on the date hereof, pursuant to Section 13 or 15(d) of the
9
<PAGE>
Securities Exchange Act of 1934, as amended (the "Exchange Act"); or
(ii) such time as any "person" (as such term is used in Sections
13(d) and 14(d) of the Exchange Act) is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of securities of the Holding Company or Savings Bank
representing 25 percent or more of the combined voting power of the
outstanding Common Stock of the Holding Company or Common Stock of the
Savings Bank, as applicable; or
(iii) individuals who constitute the Board or board of directors of
the Holding Company on the date hereof (the "Incumbent Board" and
"Incumbent Holding Company Board," respectively) cease for any reason
to constitute at least a majority thereof, provided that any person
becoming a director subsequent to the date hereof whose election was
approved by a vote of at least three-quarters of the directors
comprising the Incumbent Board or Incumbent Holding Company Board, as
applicable, or whose nomination for election by the Savings Bank's or
Holding Company's shareholders was approved by the Savings Bank's or
Holding Company's Board of Directors or Nominating Committee, as
applicable, shall be considered as though he or she were a member of
the Incumbent Board or Incumbent Holding Company Board, as applicable;
or
(iv) either the Holding Company or the Savings Bank consolidates or
merges with or into another corporation, association or entity or is
otherwise reorganized, where neither the Holding Company nor the
Savings Bank, respectively, is the surviving corporation in such
transaction; or
(v) all or substantially all of the assets of either the Holding
Company or the Savings Bank are sold or otherwise transferred to or
are acquired by any other entity or group.
Notwithstanding the other provisions of this Paragraph 11, a transaction or
event shall not be considered a Change in Control if, prior to the consummation
or occurrence of such transaction or event, Officer and Savings Bank agree in
writing that the same shall not be treated as a Change in Control for purposes
of this Agreement.
10
<PAGE>
(d) In the event any dispute shall arise between the Officer and the
Savings Bank as to the terms or interpretation of this Agreement, including this
Section 11, whether instituted by formal legal proceedings or otherwise,
including any action taken by the Officer to enforce the terms of this Section
11 or in defending against any action taken by the Savings Bank, the Savings
Bank shall reimburse the Officer for all costs and expenses incurred in such
proceedings or actions, including attorney's fees, in the event the Officer
prevails in any such action.
12. Successors and Assigns.
----------------------
(a) This Agreement shall inure to the benefit of and be binding upon any
corporate or other successor of the Savings Bank which shall acquire, directly
or indirectly, by conversion, merger, consolidation, purchase or otherwise, all
or substantially all of the assets of the Holding Company or the Savings Bank.
(b) Since the Savings Bank is contracting for the unique and personal
skills of the Officer, the Officer shall be precluded from assigning or
delegating his rights or duties hereunder without first obtaining the written
consent of the Savings Bank.
13. Modification; Waiver; Amendments. No provision of this Agreement may
--------------------------------
be modified, waived or discharged unless such waiver, modification or discharge
is agreed to in writing, signed by the Officer and on behalf of the Savings Bank
by such officer as may be specifically designated by the Directors. No waiver
by either party hereto, at any time, of any breach by the other party hereto of,
or compliance with, any condition or provision of this Agreement to be performed
by such other party shall be deemed a waiver of similar or dissimilar provisions
or conditions at the same or at any prior or subsequent time. No amendments or
additions to this
11
<PAGE>
Agreement shall be binding unless in writing and signed by both parties, except
as herein otherwise provided.
14. Applicable Law. This Agreement shall be governed in all respects
--------------
whether as to validity, construction, capacity, performance or otherwise, by the
laws of North Carolina, except to the extent that federal law shall be deemed to
apply.
15. Severability. The provisions of this Agreement shall be deemed
------------
severable and the invalidity or unenforceability of any provision shall not
affect the validity or enforceability of the other provisions hereof.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first hereinabove written.
SCOTLAND SAVINGS BANK, INC., SSB
By:/s/ James W. Mason
--------------------------------------------
Chairman of the Board
/s/ William C. Fitzgerald, III
-----------------------------------------(SEAL)
William C. Fitzgerald, III
The foregoing Agreement is consented and agreed to by Scotland Bancorp,
Inc., the parent holding company of Scotland Savings Bank, Inc., SSB.
SCOTLAND BANCORP, INC.
By:/s/ James W. Mason
--------------------------------------------
Chairman of the Board
12
<PAGE>
SCHEDULE A
ANNUAL BONUS CRITERIA
The amount of the Annual Bonus shall be computed using criteria based on
rate of return on assets and maintenance of asset quality.
1. Rate of Return on Assets ("ROA").
If the ROA of the Savings Bank and the Company on a consolidated basis is:
ROA Annual Bonus
--- ------------
Less than .75% .75% of Net Profit
.75% or greater 1.00% of Net Profit
In computing ROA and Net Profit, unusual or nonrecurring items, such as
gains and losses on the sale of assets and any SAIF assessment, will be
excluded.
2. Maintenance of Asset Quality
If nonperforming assets (loans deliquent more than 90 days plus REO) and
loan chargeoffs are:
Nonperforming Assets
to Total Assets Annual Bonus
-------------------- ------------
Less than 1.00% No change in computation
Less than 2.00% but
more than 1.00% Computed Annual Bonus reduced by 10%
More than 2.00% Computed Annual Bonus reduced by 20%
Loan Chargeoffs Annual Bonus
--------------- ------------
Less than $100,000 No change in computation
Less than $200,000 but
more than $100,000 Computed Annual Bonus reduced by 10%
More than $200,000 Computed Annual Bonus reduced by 20%
For example, if based on a ROA of 1.00% the Annual Bonus was computed to be
$9,000 and the Nonperforming Assets to Total Assets was 1.5% and the Loan
Chargeoffs were $150,000, the Annual Bonus awarded to the officer would be
$7,200, a reduction of $1,800 ($900 for Nonperforming Assets and $900 for Loan
Chargeoffs).
13
<PAGE>
Exhibit 10(b)
SPECIAL TERMINATION AGREEMENT
THIS AGREEMENT entered into as of March 29, 1996, by and between SCOTLAND
SAVINGS BANK, INC., SSB (the "Savings Bank") and JOHN B. CLARK (the "Employee")
and is joined in by SCOTLAND BANCORP, INC., the parent holding company of the
Savings Bank (the "Holding Company").
WHEREAS, the Employee has heretofore been employed by the Savings Bank as
its Senior Vice President; and
WHEREAS, the Savings Bank is a North Carolina-chartered stock saving bank
and the wholly-owned subsidiary of the Holding Company; and
WHEREAS, the services of the Employee, his experience and knowledge of the
affairs of the Savings Bank, and his reputation and contacts in the community
are extremely valuable to the Savings Bank; and
WHEREAS, the Savings Bank wishes to attract and retain such well-qualified
employees and it is in the best interests of the Savings Bank and of the
Employee to secure the continued services of the Employee notwithstanding any
change in control of the Savings Bank or the Holding Company; and
WHEREAS, the Savings Bank considers the establishment and maintenance of a
sound and vital management to be part of its overall corporate strategy and to
be essential to protecting and enhancing the best interests of the Savings Bank,
the Holding Company and their shareholders; and
WHEREAS, the parties desire to enter into this Agreement to provide the
Employee with security in the event of a change in control of the Savings Bank
or the Holding Company to ensure the continued loyalty of the Employee.
<PAGE>
NOW, THEREFORE, for and in consideration of the premises and mutual
promises, covenants and conditions hereinafter set forth, and other good and
valuable consideration, the receipt and sufficiency of which hereby are
acknowledged, the parties hereby agree as follows:
1. Term. The initial term of employment under this Agreement shall be for
----
the period commencing upon the effective date of this Agreement and ending three
(3) calendar years from the effective date of this Agreement. On each
anniversary of the effective date of this Agreement, the term of this Agreement
shall automatically be extended for an additional one year period beyond the
then effective expiration date unless written notice from the Savings Bank or
the Employee is received 90 days prior to an anniversary date advising the other
party that this Agreement shall not be further extended; provided that the
Directors shall review the Employee's performance annually and make a specific
determination pursuant to such review to renew this Agreement prior to the 90
day notice period.
2. Change in Control.
-----------------
(a) In the event of a termination of the Employee's employment in
connection with, or within twenty-four (24) months after, a "Change in
Control" (as defined in Subparagraph (e) below) of the Savings Bank or the
Holding Company, for reasons other than for "cause" (as defined in
Subparagraph (b) below), the Employee shall be entitled to receive the
amounts set forth in Subparagraphs (d) and (f) below. Said sum shall be
payable as provided in Subparagraph (g) below.
(b) For purposes of this Agreement, termination for "cause" shall
include termination because of the Employee's personal dishonesty,
incompetence, willful misconduct, breach of fiduciary duty involving
personal profit, intentional failure to perform stated duties, or
2
<PAGE>
willful violation of any law, rule, or regulation (other than traffic
violations or similar offenses) or final cease-and-desist order.
(c) The Employee shall have the right to terminate his employment and
this Agreement with the Savings Bank upon the occurrence of any of the
following events (the "Termination Events") within twenty-four (24) months
following a Change in Control of the Holding Company or the Savings Bank:
(i) Employee is assigned any duties and/or responsibilities that
are inconsistent with his position, duties, responsibilities or
status at the time of the Change in Control or with his reporting
responsibilities or titles with the Savings Bank in effect at such
time; or
(ii) Employee's annual base salary rate is reduced below the
annual amount in effect as of the effective date of a Change in
Control or as the same shall have been increased from time to time
following such effective date; or
(iii) Employee's life insurance, medical or hospitalization
insurance, disability insurance, stock option plans, stock
purchase plans, deferred compensation plans, management retention
plans, retirement plans or similar plans or benefits being
provided by the Savings Bank or the Holding Company to the
Employee as of the effective date of the Change in Control are
reduced in their level, scope or coverage, or any such insurance,
plans or benefits are eliminated, unless such reduction or
elimination applies proportionately to all salaried employees of
the Savings Bank or the Holding Company who participated in such
benefits prior to such Change in Control; or
(iv) Employee is transferred to a location which is an
unreasonable distance from his current principal work
3
<PAGE>
location, without the Employee's express written consent.
A Termination Event shall be deemed to have occurred on the date such
action or event is implemented or takes effect.
(d) In the event that the Employee's employment is terminated as set forth
in Paragraphs 2(a) or 2(c), the Savings Bank will be obligated to pay or cause
to be paid to Employee an amount equal to two (2) times the Employee's "base
amount" as defined in Section 280G(b)(3) of the Internal Revenue Code of 1986,
as amended (the "Code").
(e) For the purposes of this Agreement, the term Change in Control shall
mean: (i) a change in control of a nature that would be required to be reported
in response to Item 1 of the Current Report on Form 8-K, as in effect on the
date hereof, pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"); (ii) such time as any "person" (as such
term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly
or indirectly, of securities of the Holding Company or Savings Bank representing
25 percent or more of the combined voting power of the outstanding common stock
of the Holding Company or outstanding common stock of the Savings Bank, as
applicable; or (iii) individuals who constitute the board of directors of the
Holding Company or board of directors of the Savings Bank on the date hereof
(the "Incumbent Board" and "Incumbent Savings Bank Board," respectively) cease
for any reason to constitute at least a majority thereof, provided that any
person becoming a director subsequent to the date hereof whose election was
approved by a vote of at least three-quarters of the directors comprising the
4
<PAGE>
Incumbent Board or Incumbent Savings Bank Board, as applicable, or whose
nomination for election by the Holding Company's or Savings Bank's shareholders
was approved by the Holding Company's or Savings Bank's board of directors or
Nominating Committee, shall be considered as though he or she were a member of
the Incumbent Board or Incumbent Savings Bank Board, as applicable; or (iv)
either the Holding Company or the Savings Bank consolidates or merges with or
into another corporation, association or entity or is otherwise reorganized,
where neither the Holding Company nor the Savings Bank, respectively, is the
surviving corporation in such transaction; or (v) all or substantially all of
the assets of either the Holding Company or the Savings Bank are sold or
otherwise transferred to or are acquired by any other entity or group.
Notwithstanding the other provisions of this Paragraph 2, a transaction or
event shall not be considered a Change in Control if, prior to the consummation
of occurrence of such transaction or event, Employee and Savings Bank agree in
writing that the same shall not be treated as a Change in Control for purposes
of this Agreement.
(f) Such amounts payable pursuant to this Paragraph 2 shall be paid, at the
irrevocable option of the Employee, as follows:
Participant's Initials
- ----------------------
(i) ___________________ Payment in a lump-sum.
(ii) ___________________ Payment in monthly installments over a fixed
reasonable period of time. Such payments shall begin
within thirty (30) days following the calendar month
in which the Employee terminates his employment with
the Savings Bank.
5
<PAGE>
(g) Following a Termination Event which gives rise to Employee's
rights hereunder, the Employee shall have twelve (12) months from the date of
occurrence of the Termination Event to terminate his employment with the Savings
Bank pursuant to this Paragraph 2. Any such termination shall be deemed to have
occurred only upon delivery to the Savings Bank (or to any successor
corporation) of written notice of termination which describes the Change in
Control and Termination Event. If the Employee does not so terminate his
employment with the Savings Bank within such twelve-month period, he shall
thereafter have no further rights hereunder with respect to that Termination
Event, but shall retain rights, if any, hereunder with respect to any other
Termination Event as to which such period has not expired.
(h) In the event any dispute shall arise between the Employee and the
Savings Bank as to the terms or interpretation of this Agreement, including this
Paragraph 2, whether instituted by formal legal proceedings or otherwise,
including any action taken by the Employee to enforce the terms of this
Paragraph 2 or in defending against any action taken by the Savings Bank, the
Savings Bank shall reimburse the Employee for all costs and expenses incurred in
such proceedings or actions, including attorneys' fees, in the event the
Employee prevails in any such action.
3. Successors and Assigns. This Agreement shall inure to the benefit of
----------------------
and be binding upon any corporate or other successor of the Savings Bank which
shall acquire, directly or indirectly, by conversion, merger, consolidation,
purchase or otherwise, all or substantially all of the assets of the Holding
Company or of the Savings Bank.
6
<PAGE>
4. Modification; Waiver; Amendments. No provision of this Agreement may
--------------------------------
be modified, waived or discharged unless such waiver, modification or discharge
is agreed to in writing and signed by the Employee and the Savings Bank, except
as herein otherwise provided. No waiver by either party hereto, at any time, of
any breach by the other party hereto of, or compliance with, any condition or
provision of this Agreement to be performed by such other party shall be deemed
a waiver of similar or dissimilar provisions or conditions at the same or at any
prior or subsequent time. With the exception of Paragraph 2(f) of this
Agreement which may not be amended, no amendments or additions to this Agreement
shall be binding unless in writing and signed by both parties, except as herein
otherwise provided.
5. Applicable Law. This Agreement shall be governed in all respects
--------------
whether as to validity, construction, capacity, performance or otherwise, by the
laws of North Carolina, except to the extent that federal law shall be deemed to
apply.
6. Severability. The provisions of this Agreement shall be deemed
------------
severable and the invalidity or unenforceability of any provision shall not
affect the validity or enforceability of the other provisions hereof.
7
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement under seal as
of the day and year first hereinabove written.
SCOTLAND SAVINGS BANK, INC., SSB
(CORPORATE SEAL)
By: /s/ William C. Fitzgerald, III
--------------------------------------
William C. Fitzgerald, III, President
ATTEST:
/s/ Freddie C. Davis
- ------------------------
Secretary /s/ John B. Clark
- ------ -----------------------------------(SEAL)
John B. Clark
The foregoing agreement is consented and agreed to by Scotland Bancorp,
Inc., the parent holding company of Scotland Savings Bank, Inc., SSB.
(CORPORATE SEAL) SCOTLAND BANCORP, INC.
ATTEST: By: /s/ William C. Fitzgerald, III
---------------------------------------
William C. Fitzgerald, III, President
/s/ John B. Clark
- ------------------------
Secretary
- ------
8
<PAGE>
Exhibit 10(c)
RETIREMENT PAYMENT AGREEMENT
AGREEMENT entered into as of 1st day of April, l987 between Scotland
Savings & Loan Association, a domestic corporation having its principal office
in Laurinburg, North Carolina (hereinafter referred to as the Association) and
James S. Mitchner of Laurinburg, North Carolina (hereinafter referred to as the
Director).
WITNESSETH:
WHEREAS, the Director is rendering valuable service and it is the desire of
the Association to have the benefit of his continued loyalty and service and
also to assist him in providing for the contingencies of retirement and death;
and,
WHEREAS, the Director hereby agrees to waive fees paid to him as a Director
in the amount of $250.00 per month for seven years from the date of the
execution of this agreement;
NOW THEREFORE, in consideration of the premises contained herein, the
parties hereto mutually agree as follows:
1. Retirement Benefit: Should the Director still be in the Directorship
------------------
of the Association upon attainment of his 71st birthday, the Association will
commence to pay him $566.00 per month for a continuous period of 120 months. In
the event that the Director should die after becoming entitled to receive said
monthly installments but before any or all of said installments have been paid,
the Association will pay or will continue to pay said installments to such
beneficiary or beneficiaries as the Director has directed by filing with the
Association a notice in writing. In the event of the death of the last named
beneficiary before all the unpaid payments have been made, the balance of any
amount which remains unpaid at said death shall be commuted on the basis of 6
percent per annum compound interest and shall be paid in a single sum to the
executor or administrator of the estate of the last named beneficiary to die.
In the absence of any such beneficiary designation, any amount remaining unpaid
at the Director's death shall be commuted on the basis of 6 percent per annum
compound interest and shall be paid in a single sum to the executor or
administrator of the Director's estate.
2. Death Benefit: Should the Director die while in the Directorship of
-------------
the Association and prior to the attainment of his 71st birthday, the
Association (beginning at a date to be determined by the Association but within
six months from the date of such death) wil1 commence to pay $566.00 per month
for a continuous period of 120 months to such beneficiary or beneficiaries as
the Director has directed by filing with the Association a notice in writing.
Irrespective of the above, however, if the Director dies as a result of suicide
within two years of the execution of this agreement, the death benefit shall not
exceed an amount equal to his waived Directors' fees plus
<PAGE>
interest at the rate of 7 1/2 percent per annum compounded annually. In the
event of the death of the last named beneficiary before all the unpaid payments
have been made, the balance of any amount which remain unpaid at said death
shall be commuted on the basis of 6 percent per annum compound interest and
shall be paid in a single sum to the executor or administrator of the estate of
the last named beneficiary to die. In the absence of any such beneficiary
designation, any amount remaining unpaid at the Director's death shall be
commuted on the basis of 6 percent per annum compound interest and shall be paid
in a single sum to the executor or administrator of the Director's estate.
3. Termination of Directorship:
---------------------------
A. If the Director terminates his Directorship, for reasons other than
death or the attainment of his 71st birthday, prior to two years
from the execution date of this Agreement, the Director's benefits
shall be limited to his waived Director fees plus interest at the
rate of 7 1/2 percent per annum compounded annually and shall be
paid in a single sum as soon as practical following the termination
of his Directorship.
B. If the Director terminates his Directorship, for reasons other than
death or the attainment of his 71st birthday, at the end of two or
more years from the execution date of this Agreement, he or his
beneficiary, as applicable, shall be entitled upon the attainment
of his 71st birthday, or his prior death, to a percentage of the
retirement benefits stated in Section 1 of this Agreement as
determined by the following table:
<TABLE>
<CAPTION>
FULL NUMBER OF YEARS SERVED
AS DIRECTOR FROM DATE OF PERCENTAGE OF RETIREMENT
EXECUTION OF THIS AGREEMENT BENEFITS STATED IN SECTION 1
UNTIL TERMINATION OF OF THIS AGREEMENT TO WHICH
DIRECTORSHIP THE DIRECTOR IS ENTITLED
------------ ------------------------
<S> <C>
2 20%
3 40%
4 60%
5 80%
6 100%
</TABLE>
<PAGE>
4. Forfeiture Provisions:
---------------------
A. During the period the retirement benefit is payable to the Director
under Section 1 of this Agreement, the Director shall not engage in
business activities which are in competition with the Association
without first obtaining the written consent of the Association.
B. During the period the retirement payment is payable to the Director
under Section 1 of the Agreement, the Director shall be available
to render consulting services to the Association upon request by an
officer of the Association, but such request shall not be made more
frequently than once each month. The Director shall not be
considered to have breached this condition if he is unable to
consult because of his mental or physical disability.
C. Payment of the retirement benefit under this Agreement may be
terminated by the Association, if the Directors fails to comply
with either of the conditions set forth in paragraph (A) and (B) of
this Section 4.
5. General Provisions:
------------------
A. Except as otherwise provided by this Agreement, it is agreed that
neither the Director, nor his beneficiary shall have any right to
commute, sell, assign, transfer or otherwise convey the right to
receive any payments hereunder, which payments and the right
thereto are expressly declared to be nonassignable and
nontransferable.
B. The benefits payable under this Agreement shall be independent of,
and in addition to, any other employment agreements that may exist
from time to time between the parties hereto, concerning any other
compensation payable by the Association to the Director whether as
salary, bonus, or otherwise. This Agreement shall not be deemed to
constitute a contract of employment between the parties hereto, nor
shall any provision hereof restrict the right of the Association to
discharge the Director or restrict the right of the Association to
discharge the Director or restrict the right of the Director to
terminate his Directorship.
C. The rights of the Director under this Agreement and of any
beneficiary of the Director shall be solely those of an unsecured
creditor of the Association. Any asset acquired by the Association
in connection with the liabilities assumed by it hereunder, shall
not be deemed to be held under any trust for
<PAGE>
the benefit of the Director or his beneficiaries or to be
considered security for the performance of the obligations of the
Association but shall be, and remain, a general, unpledged,
unrestricted asset of the Association.
D. The Association hereby reserves the right to accelerate the
payments specified in Sections 1, 2 and 3 above without the consent
of the Director, his estate, beneficiaries, or other person
claiming through or under him.
E. The Association agrees that it will not merge or consolidate with
any other Association or organization, or permit its business
activities to be taken over by any other organization unless and
until the succeeding or continuing Association or other
organization shall expressly assume the rights and obligations of
the Association herein set forth. The Association further agrees
that it will not cease its business activities or terminate its
existence, other than as heretofore set forth in this Section,
without having made adequate provision for the fulfilling of its
obligations hereunder.
F. This Agreement may be revoked or amended in whole or in part by a
writing signed by both of the parties hereto.
G. Thin Agreement shall be subject to and construed under the laws of
the State of North Carolina.
IN WITNESS WHEREOF, the said Association has caused this agreement to be
signed in its Corporate name by its duly authorized officer, and impressed with
its corporate seal, attested by its Secretary, and the said Director has
hereunto set his hand and seal, all on the day and year first above written.
SCOTLAND SAVINGS & LOAN ASSOCIATION
By:/s/ George W. Thomas (SEAL)
---------------------------
President
/s/ James E. Mitchener (SEAL)
---------------------------
(The Director)
ATTEST:
/s/ Deane B. Phillips
- ------------------------------------
WITNESS: /s/ Freddie C. Davis
---------------------------
<PAGE>
BENEFICIARY DESIGNATION FORM
As Beneficiary to receive any death benefits payable on my behalf from
Scotland Savings and Loan Association, I designate the following:
PRIMARY
- -------
DATE OF
NAME BIRTH ADDRESS RELATIONSHIP
---- ----- ------- ------------
Sara C. Mitchener 2-23-1925 Morison Lane Wife
CONTINGENT, If Any:
- ------------------
(Note: If more than one primary beneficiary is named, the benefit will be paid
in equal shares to those living. Should the contingent beneficiaries be
eligible to receive the benefits, such benefits will be paid in equal shares to
such living contingent beneficiaries. If none of the designated beneficiaries
as living at such time as the death benefit is payable, such benefit will be
paid to the Executor or Administrator of your Estate.)
Name of Spouse if not given above:
---------------------------------------------
/s/ Deane B. Phillips /s/ James S. Mitchener
- ------------------------------ -----------------------------
Witness Signature of Director
7-9-87
-----------------------------
Date
<PAGE>
RETIREMENT PAYMENT AGREEMENT
AGREEMENT entered into as of 1st day of April, l987 between Scotland
Savings & Loan Association, a domestic corporation having its principal office
in Laurinburg, North Carolina (hereinafter referred to as the Association) and
James E. Milligan of Laurinburg, North Carolina (hereinafter referred to as the
Director).
WITNESSETH:
WHEREAS, the Director is rendering valuable service and it is the desire of
the Association to have the benefit of his continued loyalty and service and
also to assist him in providing for the contingencies of retirement and death;
and,
WHEREAS, the Director hereby agrees to waive fees paid to him as a Director
in the amount of $250.00 per month for seven years from the date of the
execution of this agreement;
NOW THEREFORE, in consideration of the premises contained herein, the
parties hereto mutually agree as follows:
1. Retirement Benefit: Should the Director still be in the Directorship
------------------
of the Association upon attainment of his 69th birthday, the Association will
commence to pay him $647.00 per month for a continuous period of 120 months. In
the event that the Director should die after becoming entitled to receive said
monthly installments but before any or all of said installments have been paid,
the Association will pay or will continue to pay said installments to such
beneficiary or beneficiaries as the Director has directed by filing with the
Association a notice in writing. In the event of the death of the last named
beneficiary before all the unpaid payments have been made, the balance of any
amount which remains unpaid at said death shall be commuted on the basis of 6
percent per annum compound interest and shall be paid in a single sum to the
executor or administrator of the estate of the last named beneficiary to die.
In the absence of any such beneficiary designation, any amount remaining unpaid
at the Director's death shall be commuted on the basis of 6 percent per annum
compound interest and shall be paid in a single sum to the executor or
administrator of the Director's estate.
2. Death Benefit: Should the Director die while in the Directorship of
-------------
the Association and prior to the attainment of his 69th birthday, the
Association (beginning at a date to be determined by the Association but within
six months from the date of such death) wil1 commence to pay $647.00 per month
for a continuous period of 120 months to such beneficiary or beneficiaries as
the Director has directed by filing with the Association a notice in writing.
Irrespective of the above, however, if the Director dies as a result of suicide
within two years of the execution of this agreement, the death benefit shall not
exceed an amount equal to his waived Directors' fees plus
<PAGE>
interest at the rate of 7 1/2 percent per annum compounded annually. In the
event of the death of the last named beneficiary before all the unpaid payments
have been made, the balance of any amount which remain unpaid at said death
shall be commuted on the basis of 6 percent per annum compound interest and
shall be paid in a single sum to the executor or administrator of the estate of
the last named beneficiary to die. In the absence of any such beneficiary
designation, any amount remaining unpaid at the Director's death shall be
commuted on the basis of 6 percent per annum compound interest and shall be paid
in a single sum to the executor or administrator of the Director's estate.
3. Termination of Directorship:
---------------------------
A. If the Director terminates his Directorship, for reasons other than
death or the attainment of his 69th birthday, prior to two years
from the execution date of this Agreement, the Director's benefits
shall be limited to his waived Director fees plus interest at the
rate of 7 1/2 percent per annum compounded annually and shall be
paid in a single sum as soon as practical following the termination
of his Directorship.
B. If the Director terminates his Directorship, for reasons other than
death or the attainment of his 69th birthday, at the end of two or
more years from the execution date of this Agreement, he or his
beneficiary, as applicable, shall be entitled upon the attainment
of his 69th birthday, or his prior death, to a percentage of the
retirement benefits stated in Section 1 of this Agreement as
determined by the following table:
<TABLE>
<CAPTION>
FULL NUMBER OF YEARS SERVED
AS DIRECTOR FROM DATE OF PERCENTAGE OF RETIREMENT
EXECUTION OF THIS AGREEMENT BENEFITS STATED IN SECTION 1
UNTIL TERMINATION OF OF THIS AGREEMENT TO WHICH
DIRECTORSHIP THE DIRECTOR IS ENTITLED
------------ ------------------------
<S> <C>
2 20%
3 40%
4 60%
5 80%
6 100%
</TABLE>
<PAGE>
4. Forfeiture Provisions:
---------------------
A. During the period the retirement benefit is payable to the Director
under Section 1 of this Agreement, the Director shall not engage in
business activities which are in competition with the Association
without first obtaining the written consent of the Association.
B. During the period the retirement payment is payable to the Director
under Section 1 of the Agreement, the Director shall be available
to render consulting services to the Association upon request by an
officer of the Association, but such request shall not be made more
frequently than once each month. The Director shall not be
considered to have breached this condition if he is unable to
consult because of his mental or physical disability.
C. Payment of the retirement benefit under this Agreement may be
terminated by the Association, if the Directors fails to comply
with either of the conditions set forth in paragraph (A) and (B) of
this Section 4.
5. General Provisions:
------------------
A. Except as otherwise provided by this Agreement, it is agreed that
neither the Director, nor his beneficiary shall have any right to
commute, sell, assign, transfer or otherwise convey the right to
receive any payments hereunder, which payments and the right
thereto are expressly declared to be nonassignable and
nontransferable.
B. The benefits payable under this Agreement shall be independent of,
and in addition to, any other employment agreements that may exist
from time to time between the parties hereto, concerning any other
compensation payable by the Association to the Director whether as
salary, bonus, or otherwise. This Agreement shall not be deemed to
constitute a contract of employment between the parties hereto, nor
shall any provision hereof restrict the right of the Association to
discharge the Director or restrict the right of the Association to
discharge the Director or restrict the right of the Director to
terminate his Directorship.
C. The rights of the Director under this Agreement and of any
beneficiary of the Director shall be solely those of an unsecured
creditor of the Association. Any asset acquired by the Association
in connection with the liabilities assumed by it hereunder, shall
not be deemed to be held under any trust for
<PAGE>
the benefit of the Director or his beneficiaries or to be
considered security for the performance of the obligations of the
Association but shall be, and remain, a general, unpledged,
unrestricted asset of the Association.
D. The Association hereby reserves the right to accelerate the
payments specified in Sections 1, 2 and 3 above without the consent
of the Director, his estate, beneficiaries, or other person
claiming through or under him.
E. The Association agrees that it will not merge or consolidate with
any other Association or organization, or permit its business
activities to be taken over by any other organization unless and
until the succeeding or continuing Association or other
organization shall expressly assume the rights and obligations of
the Association herein set forth. The Association further agrees
that it will not cease its business activities or terminate its
existence, other than as heretofore set forth in this Section,
without having made adequate provision for the fulfilling of its
obligations hereunder.
F. This Agreement may be revoked or amended in whole or in part by a
writing signed by both of the parties hereto.
G. Thin Agreement shall be subject to and construed under the laws of
the State of North Carolina.
IN WITNESS WHEREOF, the said Association has caused this agreement to be
signed in its Corporate name by its duly authorized officer, and impressed with
its corporate seal, attested by its Secretary, and the said Director has
hereunto set his hand and seal, all on the day and year first above written.
SCOTLAND SAVINGS & LOAN ASSOCIATION
By:/s/ George W. Thomas (SEAL)
---------------------------
President
/s/ James E. Milligan (SEAL)
---------------------------
(The Director)
ATTEST:
/s/ Deane B. Phillips
- ------------------------------------
WITNESS: /s/ Freddie C. Davis
---------------------------
<PAGE>
BENEFICIARY DESIGNATION FORM
As Beneficiary to receive any death benefits payable on my behalf from
Scotland Savings and Loan Association, I designate the following:
PRIMARY
- -------
DATE OF
NAME BIRTH ADDRESS RELATIONSHIP
---- ----- ------- ------------
Doris B. Milligan 5/11/1928 1205 Dunbar Drive Wife
Laurinburg, N.C.
CONTINGENT, If Any:
- ------------------
Michael E. Milligan Son
Stephen F. Milligan Son
Kathy V. Milligan Daughter
(Note: If more than one primary beneficiary is named, the benefit will be paid
in equal shares to those living. Should the contingent beneficiaries be
eligible to receive the benefits, such benefits will be paid in equal shares to
such living contingent beneficiaries. If none of the designated beneficiaries
as living at such time as the death benefit is payable, such benefit will be
paid to the Executor or Administrator of your Estate.)
Name of Spouse if not given above:
----------------------------------------------
/s/ Deane B. Phillips /s/ James E. Milligan
- ------------------------- --------------------------
Witness Signature of Director
7-9-87
--------------------------
Date
<PAGE>
RETIREMENT PAYMENT AGREEMENT
AGREEMENT entered into as of 1st day of April, l987 between Scotland
Savings & Loan Association, a domestic corporation having its principal office
in Laurinburg, North Carolina (hereinafter referred to as the Association) and
Sam T. Snowdon, Jr. of Laurinburg, North Carolina (hereinafter referred to as
the Director).
WITNESSETH:
WHEREAS, the Director is rendering valuable service and it is the desire of
the Association to have the benefit of his continued loyalty and service and
also to assist him in providing for the contingencies of retirement and death;
and,
WHEREAS, the Director hereby agrees to waive fees paid to him as a Director
in the amount of $250.00 per month for seven years from the date of the
execution of this agreement;
NOW THEREFORE, in consideration of the premises contained herein, the
parties hereto mutually agree as follows:
1. Retirement Benefit: Should the Director still be in the Directorship
------------------
of the Association upon attainment of his 67th birthday, the Association will
commence to pay him $735.00 per month for a continuous period of 120 months. In
the event that the Director should die after becoming entitled to receive said
monthly installments but before any or all of said installments have been paid,
the Association will pay or will continue to pay said installments to such
beneficiary or beneficiaries as the Director has directed by filing with the
Association a notice in writing. In the event of the death of the last named
beneficiary before all the unpaid payments have been made, the balance of any
amount which remains unpaid at said death shall be commuted on the basis of 6
percent per annum compound interest and shall be paid in a single sum to the
executor or administrator of the estate of the last named beneficiary to die.
In the absence of any such beneficiary designation, any amount remaining unpaid
at the Director's death shall be commuted on the basis of 6 percent per annum
compound interest and shall be paid in a single sum to the executor or
administrator of the Director's estate.
2. Death Benefit: Should the Director die while in the Directorship of
-------------
the Association and prior to the attainment of his 67th birthday, the
Association (beginning at a date to be determined by the Association but within
six months from the date of such death) wil1 commence to pay $735.00 per month
for a continuous period of 120 months to such beneficiary or beneficiaries as
the Director has directed by filing with the Association a notice in writing.
Irrespective of the above, however, if the Director dies as a result of suicide
within two years of the execution of this agreement, the death benefit shall not
exceed an amount equal to his waived Directors' fees plus
<PAGE>
interest at the rate of 7 1/2 percent per annum compounded annually. In the
event of the death of the last named beneficiary before all the unpaid payments
have been made, the balance of any amount which remain unpaid at said death
shall be commuted on the basis of 6 percent per annum compound interest and
shall be paid in a single sum to the executor or administrator of the estate of
the last named beneficiary to die. In the absence of any such beneficiary
designation, any amount remaining unpaid at the Director's death shall be
commuted on the basis of 6 percent per annum compound interest and shall be paid
in a single sum to the executor or administrator of the Director's estate.
3. Termination of Directorship:
---------------------------
A. If the Director terminates his Directorship, for reasons other than
death or the attainment of his 67th birthday, prior to two years
from the execution date of this Agreement, the Director's benefits
shall be limited to his waived Director fees plus interest at the
rate of 7 1/2 percent per annum compounded annually and shall be
paid in a single sum as soon as practical following the termination
of his Directorship.
B. If the Director terminates his Directorship, for reasons other than
death or the attainment of his 67th birthday, at the end of two or
more years from the execution date of this Agreement, he or his
beneficiary, as applicable, shall be entitled upon the attainment
of his 67th birthday, or his prior death, to a percentage of the
retirement benefits stated in Section 1 of this Agreement as
determined by the following table:
<TABLE>
<CAPTION>
FULL NUMBER OF YEARS SERVED
AS DIRECTOR FROM DATE OF PERCENTAGE OF RETIREMENT
EXECUTION OF THIS AGREEMENT BENEFITS STATED IN SECTION 1
UNTIL TERMINATION OF OF THIS AGREEMENT TO WHICH
DIRECTORSHIP THE DIRECTOR IS ENTITLED
------------ ------------------------
<S> <C>
2 20%
3 40%
4 60%
5 80%
6 100%
</TABLE>
<PAGE>
4. Forfeiture Provisions:
---------------------
A. During the period the retirement benefit is payable to the Director
under Section 1 of this Agreement, the Director shall not engage in
business activities which are in competition with the Association
without first obtaining the written consent of the Association.
B. During the period the retirement payment is payable to the Director
under Section 1 of the Agreement, the Director shall be available
to render consulting services to the Association upon request by an
officer of the Association, but such request shall not be made more
frequently than once each month. The Director shall not be
considered to have breached this condition if he is unable to
consult because of his mental or physical disability.
C. Payment of the retirement benefit under this Agreement may be
terminated by the Association, if the Directors fails to comply
with either of the conditions set forth in paragraph (A) and (B) of
this Section 4.
5. General Provisions:
------------------
A. Except as otherwise provided by this Agreement, it is agreed that
neither the Director, nor his beneficiary shall have any right to
commute, sell, assign, transfer or otherwise convey the right to
receive any payments hereunder, which payments and the right
thereto are expressly declared to be nonassignable and
nontransferable.
B. The benefits payable under this Agreement shall be independent of,
and in addition to, any other employment agreements that may exist
from time to time between the parties hereto, concerning any other
compensation payable by the Association to the Director whether as
salary, bonus, or otherwise. This Agreement shall not be deemed to
constitute a contract of employment between the parties hereto, nor
shall any provision hereof restrict the right of the Association to
discharge the Director or restrict the right of the Association to
discharge the Director or restrict the right of the Director to
terminate his Directorship.
C. The rights of the Director under this Agreement and of any
beneficiary of the Director shall be solely those of an unsecured
creditor of the Association. Any asset acquired by the Association
in connection with the liabilities assumed by it hereunder, shall
not be deemed to be held under any trust for
<PAGE>
the benefit of the Director or his beneficiaries or to be
considered security for the performance of the obligations of the
Association but shall be, and remain, a general, unpledged,
unrestricted asset of the Association.
D. The Association hereby reserves the right to accelerate the
payments specified in Sections 1, 2 and 3 above without the
consent of the Director, his estate, beneficiaries, or any other
person claiming through or under him.
E. The Association agrees that it will not merge or consolidate with
any other Association or organization, or permit its business
activities to be taken over by any other organization unless and
until the succeeding or continuing Association or other
organization shall expressly assume the rights and obligations of
the Association herein set forth. The Association further agrees
that it will not cease its business activities or terminate its
existence, other than as heretofore set forth in this Section,
without having made adequate provision for the fulfilling of its
obligations hereunder.
F. This Agreement may be revoked or amended in whole or in part by a
writing signed by both of the parties hereto.
G. This Agreement shall be subject to and construed under the laws of
the State of North Carolina.
IN WITNESS THEREOF, the said Association has caused this agreement to be
signed in its Corporate name by its duly authorized officer, and impressed with
its corporate seal, attested by its Secretary, and the said Director has
hereunto set his hand and seal, all on the day and year first above written.
SCOTLAND SAVINGS & LOAN ASSOCIATION
By: /s/ George W. Thomas (SEAL)
-------------------------------
President
/s/ Sam T. Snowdon, Jr. (SEAL)
-------------------------------
(The Director)
ATTEST:
/s/ Deane B. Phillips
- -----------------------------
WITNESS: /s/ Freddie C. Davis
---------------------
<PAGE>
BENEFICIARY DESIGNATION FORM
As Beneficiary to receive any death benefits payable on my behalf from
Scotland Savings and Loan Association, I designate the following:
PRIMARY
- -------
DATE OF
NAME BIRTH ADDRESS RELATIONSHIP
---- ----- ------- ------------
Mildred B. Snowdon 8-30-1929 721 King Street Wife
Laurinburg, N.C.
CONTINGENT, If Any:
- ------------------
(Note: If more than one primary beneficiary is named, the benefit will be paid
in equal shares to those living. Should the contingent beneficiaries be
eligible to receive the benefits, such benefits will be paid in equal shares to
such living contingent beneficiaries. If none of the designated beneficiaries
as living at such time as the death benefit is payable, such benefit will be
paid to the Executor or Administrator of your Estate.)
Name of Spouse if not given above:
----------------------------------------------
/s/ Deane B. Phillips /s/ Sam T. Snowdon, Jr.
- ------------------------------------ ----------------------------------
Witness Signature of Director
7-9-87
----------------------------------
Date
<PAGE>
Exhibit 11
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
The Conversion was effective March 29, 1996. Accordingly, earnings per
share data for the year ended September 30, 1996 is comprised of the earnings
for the post-Conversion period. The weighted average number of shares
outstanding includes all shares issued and outstanding of 1,840,000 less 144,552
shares purchased by the ESOP at the time of the Conversion plus the pro-rata
portion of shares committed to be released through September 30, 1996.
Net income for the period from March 29, 1996 to September 30, 1996 $ 419,827
Weighted average number of shares outstanding $1,695,448
Earnings per share $ 0.25
<PAGE>
Exhibit 13
SCOTLAND BANCORP, INC.
======================
1996 Annual Report
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
Page
- ------------------------------------------------------------------------------------------------------
<S> <C>
Selected Consolidated Financial Data 1
Report to Stockholders 2
Management's Discussion and Analysis 3 - 10
Independent Auditor's Report 11
Consolidated Financial Statements:
Statements of financial condition at September 30, 1996 and 1995 12
Statements of income for the years ended September 30, 1996 and 1995 13
Statements of stockholders' equity for the years ended September 30, 1996 and 1995 14
Statements of cash flows for the years ended September 30, 1996 and 1995 15 - 16
Notes to Consolidated Financial Statements 17 - 38
Corporate Information 39
</TABLE>
This annual report to stockholders contains certain forward-looking statements
consisting of estimates with respect to the financial condition, results of
operations and other business of the Company that are subject to various factors
which could cause actual results to differ materially from those estimates.
Factors which could influence the estimates include changes in the national,
regional and local market conditions, legislative and regulatory conditions, and
an adverse interest rate environment.
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
September 30,
--------------------------------------------------------------------------------
1996 1995 1994 1993 1992
-------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C>
Financial Condition Data:
Total assets $ 68,622 $ 57,718 $ 57,715 $ 55,068 $ 54,544
Investments securities (1) 21,464 14,525 19,273 12,791 6,859
Loans receivable, net 45,079 41,204 36,661 40,626 46,155
Deposits 42,410 48,203 48,995 47,477 47,720
Stockholders' equity (2) 24,791 8,580 7,761 6,875 6,144
Book value per share 13.47 - - - -
Years Ended September 30,
--------------------------------------------------------------------------------
1996 1995 1994 1993 1992
-------------------------------------------------------------------------------
Operating Data: ( Dollars in Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C>
Interest and dividend income $ 4,870 $ 4,313 $ 3,889 $ 4,249 $ 4,731
Interest expense 2,209 2,144 1,753 1,979 2,628
-------------------------------------------------------------------------------
Net interest income 2,661 2,169 2,136 2,270 2,103
Provision for loan losses 25 11 20 25 76
Noninterest income 80 73 71 71 112
Noninterest expense 1,549 1,158 1,263 1,114 1,037
-------------------------------------------------------------------------------
Income before income taxes 1,167 1,073 924 1,202 1,102
Income tax expense 409 352 292 470 413
-------------------------------------------------------------------------------
Net income $ 758 $ 721 $ 632 $ 732 $ 689
===============================================================================
Earnings per share (2)(3) $ 0.25 $ - $ - $ - $ -
Dividends per share (2) 0.15 - - - -
Selected Other Data:
Return on average assets 1.18% 1.25% 1.13% 1.33% 1.28%
Return on average equity 4.31% 8.52% 8.49% 11.21% 11.81%
Interest rate spread 2.84% 3.27% 3.50% 3.78% 3.48%
Net interest margin 4.15% 3.87% 3.94% 4.24% 4.03%
Allowance for loan losses to
nonperforming loans (4) 714.97% 0.00% 0.00% 0.00% 136.04%
Nonperforming loans to total loans 0.07% 0.00% 0.00% 0.00% 0.24%
</TABLE>
(1) Includes interest earning deposits, federal funds sold, investment
securities and mortgage-backed securities
(2) On March 29, 1996, Scotland Savings converted from a state chartered mutual
savings bank to a state chartered stock savings bank and became a wholly
owned subsidiary of Scotland Bancorp, Inc.
(3) Earnings per share is based on earnings from March 29, 1996 to September 30,
1996 divided by the weighted average number of shares outstanding during the
same period
(4) Nonperforming loans include mortgage loans and consumer/commercial loans 90
days or more delinquent
1
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
The following discussion and analysis is intended to assist readers in
understanding the results of operations in 1996 and 1995, and changes in
financial position for the years ended September 30, 1996 and 1995,
respectively. This discussion and analysis is intended to compliment, and should
be read in conjunction with the audited consolidated financial statements and
related notes appearing elsewhere in this annual report to stockholders.
Description of Business
Scotland Bancorp, Inc. (the "Company") was incorporated under the laws of the
State of North Carolina for the purpose of becoming the bank holding company of
Scotland Savings Bank, Inc., SSB (the "Bank" or "Scotland Savings") in
connection with the Bank's conversion from a state chartered mutual savings bank
to a state chartered stock savings bank, pursuant to its Plan of Conversion. The
Company was organized to acquire all of the common stock of Scotland Savings
upon its conversion to stock form. A subscription and community offering of the
Company's shares closed on March 29, 1996, at which time the Company acquired
all of the shares of the Bank and commenced operations.
In accordance with the Plan of Conversion, the Company issued common stock of
$18,400,000 and received proceeds of $17,419,336, net of conversion costs. The
Company transferred $7,752,868 of the net proceeds to Scotland Savings for the
purchase of all of the capital stock of the Bank.
The Company has no operations and conducts no business of its own other than
owning Scotland Savings, investing its portion of the net proceeds received in
the Conversion, and lending funds to the Employee Stock Ownership Plan (the
"ESOP") which was formed in connection with the Conversion. The principal
business of the Bank is accepting deposits from the general public and using
those deposits and other sources of funds to make loans secured by real estate
and other forms of collateral located in the Bank's primary market area of
Scotland and Moore counties in North Carolina.
Scotland Savings's results of operations depend primarily on its net interest
income, which is the difference between interest income from interest-earning
assets and interest expense on interest-bearing liabilities. The Bank's
operations are also affected by noninterest income, such as miscellaneous income
from loans, customer deposit account service charges, and other sources of
revenue. The Bank's principal operating expenses, aside from interest expense,
consist of compensation and associated benefits, federal deposit insurance
premiums, occupancy costs, and other general and administrative expenses.
3
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Comparison of Financial Condition at September 30, 1996 and 1995
Total consolidated assets increased by $10.9 million during 1996, from $57.7
million at September 30, 1995 to $68.6 million at September 30, 1996. The
increase resulted primarily from the net proceeds received from the Company's
stock offering which closed on March 29, 1996 and resulted in a $17.4 million
increase in capital. Some of the Bank's depositors withdrew amounts from their
deposit accounts to purchase shares of stock in the Company. Accordingly, the
total proceeds from the issuance of common stock did not result in a
corresponding increase in total assets.
Investments, including short term interest-earning deposits, federal funds sold,
U.S. Treasury and agency obligations, municipal obligations, and mortgage-backed
securities increased by $6.9 million, primarily as a result of investing a
portion of the proceeds received from the stock offering. Funds generated from
operations also provided a source for additional investments.
Loans receivable increased by approximately $3.9 million during 1996 to $45.1
million at September 30, 1996. The markets in which the Bank operates have
experienced consistent yet limited growth in recent years. The area of Scotland
County, where the majority of the Bank's customers reside, is largely rural
though the economy is diversified and generally stable. Management considers the
loan growth during 1996 and 1995 to be greater than what is historically typical
for its market.
Savings deposits decreased by approximately $5.8 million during 1996 and totaled
$42.4 million at September 30, 1996. The majority of the decrease is
attributable to the withdrawal of deposits by account holders to purchase shares
of common stock of the Company in the Conversion. Due to its excess liquidity,
the Bank elected to allow certain higher cost certificate accounts to leave the
Bank upon maturity. As a result, the Bank was able to lower its average weighted
cost of funds at September 30, 1996 from such cost incurred during 1996.
The Company had no outstanding borrowings at September 30, 1996 or 1995.
However, during 1996 $3,000,000 in Federal Home Loan Bank advances were obtained
and repaid, and the Bank retains borrowing capacity through the Federal Home
Loan Bank of Atlanta.
The Company's return on average assets was 1.18% and 1.25%, and its return on
average equity was 4.31% and 8.52%, for 1996 and 1995, respectively. The return
on average assets in 1996 would have been 1.50% had the Bank not been required
to expense the cost associated with the special SAIF assessment during 1996. The
passage of the "Deposit Insurance Funds Act of 1996" was undertaken to
recapitalize the SAIF insurance fund of the FDIC and required a one time
assessment to the Bank of 65.7 basis points of its assessable deposit base as of
March 31, 1995. The expense recorded for this special assessment amounted to
$320,750 (See Note 8 to the consolidated financial statements). The decline in
the return on average equity from 1995 to 1996 was due primarily to the proceeds
received from the stock offering and resulting increase in equity, and to a
lesser extent, the special SAIF assessment that the Bank was required to expense
during 1996.
The Bank is required to meet certain capital requirements as established by the
FDIC and the North Carolina Savings Institutions Division. At September 30,
1996, the Bank's capital was significantly in excess of regulatory capital
requirements (See Note 9 to the consolidated financial statements).
4
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Comparison of Operating Results for 1996 and 1995
Net Income
Net income for the years ended September 30, 1996 and 1995 was $757,519 and
$721,214, respectively. Net income in 1996 would have been approximately
$208,000 higher than reported earnings without the expense associated with the
special assessment that occurred as a result of the legislation to recapitalize
the Savings Association Insurance Fund (SAIF). Earnings on the invested proceeds
from the Company's stock offering had a significant positive impact on net
interest income and net income during 1996.
Net Interest Income
Net interest income represents the difference between income derived from
interest-earning assets and interest expense incurred on interest-bearing
liabilities. Net interest income is affected by both (i) the difference between
the rates of interest earned on interest-earning assets and the rates paid on
interest-bearing liabilities ("interest rate spread") and (ii) the relative
amounts of interest-earning assets and interest-bearing liabilities outstanding
during the period. Net interest income increased by $491,330 to $2,660,853 for
the year ended September 30, 1996 from $2,169,523 reported in 1995. The increase
in net interest income during 1996 was attributable to an increase in the
average balance of interest earning assets due to the proceeds received from the
stock offering. The average balance of interest earning assets increased by
approximately $8.1 million during 1996. The increase in interest earning assets
allowed net interest income to increase even though the Bank's net interest rate
spread decreased from 3.27% in 1995 to 2.84% in 1996, primarily due to an
increase in the Bank's cost of funds.
Interest Income
Total interest income increased by $556,389 during 1996, from $4,313,318 in 1995
to $4,869,707 in 1996. The increase in interest income during 1996 was
attributable to an $8.1 million increase in the average balance of interest
earning assets due to the proceeds received from the stock offering. The Bank's
overall yield on interest earning assets declined slightly during 1996, from
7.70% in 1995 to 7.60% in 1996. During 1995, interest income increased by
approximately $425,000 due primarily to an increase in the Bank's yields from
7.17% in 1994 to 7.70% in 1995. Changes in the volume of average interest
earning assets during 1995, which increased by $1.8 million, also positively
impacted interest income.
Interest Expense
Total interest expense increased to $2,208,854 in 1996 from $2,143,795 in 1995,
an increase of $65,059 or 3.0%. The increase in the Bank's cost of funds on
longer term certificate of deposits more than offset declines in its cost of
funds on transaction accounts during 1996. Scotland Savings's cost of funds was
4.76% in 1996 as compared to 4.43% in 1995. Changes in the Bank's cost of funds
during 1996 was similar to changes in overall market rates. The Bank's average
balance of outstanding deposits decreased by approximately $2.9 million during
1996 and lowered the increase in interest expense for the period. Interest on
borrowed funds had an immaterial impact on the increase in interest expense in
1996. During 1995, interest expense increased by approximately $391,000 due
primarily to an increase in the Bank's cost of funds, which increased from 3.67%
in 1994 to 4.43% in 1995.
5
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Provision For Loan Losses and Asset Quality
The Bank's provision for loan losses amounted to $24,528 and $11,000 for the
years ended September 30, 1996 and 1995, respectively. The provision, which is
charged to operations, and the resulting loan loss allowances are amounts
Scotland Savings's management believes will be adequate to absorb losses on
existing loans that may become uncollectible. Loans are charged-off against the
allowance when management believes that collectibility is unlikely. An
evaluation to increase the provision and resulting allowances is based on
factors, such as changes in the nature and volume of the loan portfolio, overall
portfolio quality, and current economic conditions. Scotland Savings has adopted
policies which it believes provides for prudent and adequate levels of loan loss
allowances.
The Bank's level of nonperforming loans, defined as loans past due 90 days or
more, are relatively insignificant as percentage of total loans outstanding,
both historically and at September 30, 1996 and 1995. Scotland Savings
charged-off loans amounting to $6,648 and $-0- during 1996 and 1995,
respectively.
Noninterest Income
Noninterest income amounted to $80,298 and $73,456 in 1996 and 1995,
respectively. Noninterest income consists primarily of service charges and fees
associated with the Bank's loan and savings accounts. Scotland Savings's level
of noninterest income has remained stable during 1996 and 1995.
Noninterest Expense
Noninterest expense consists primarily of operating expenses for compensation
and associated benefits, occupancy, federal insurance premiums and operating
assessments, and data processing charges as well as various administrative
expenses. Noninterest expense amounted to $1,549,739 and $1,158,550 in 1996 and
1995, respectively. During 1996, the Bank accrued and expensed $320,750 for a
special assessment required to recaptialize the Savings Association Insurance
Fund of the FDIC which accounted for 82.0% of the $391,189 increase in
noninterest expense between 1996 and 1995. Noninterest expense decreased by
$103,945 from 1994 to 1995 primarily due to certain conversion costs associated
with the termination of a proposed merger which were expensed in 1995.
Compensation and employee benefits increased by $47,530 during 1996 primary due
to expense associated with forming the ESOP during 1996. Deposit insurance,
excluding the special SAIF assessment in 1996, fluctuates with the level of
deposits outstanding during the periods. None of the other noninterest expense
categories changed significantly during 1996 and 1995.
Income Taxes
The Company's effective income tax rate was 35.08% and 32.81% in 1996 and 1995,
respectively. The differences in rates were due to changes in the components of
permanent tax differences.
6
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Capital Resources and Liquidity
During 1996, Scotland Bancorp, Inc. paid a regular quarterly dividend of $.075 a
share on July 26, 1996 and declared a regular quarterly $.075 on September 17,
1996 paid on October 25, 1996 to stockholders of record as of October 15, 1996.
Although the Company anticipates that it will continue to declare cash dividends
on a regular basis, the Board of Directors will continue to review its policy on
the payment of dividends on an ongoing basis, and such payment will be subject
to future earnings, cash flows, capital needs, and regulatory restrictions.
The objective of the Company's liquidity management is to ensure the
availability of sufficient cash flows to meet all financial commitments and to
capitalize on opportunities to enhance stockholders' value. More specifically,
liquidity ensures that adequate funds are available to meet deposit withdrawals,
fund loan commitments, maintain reserve requirements, pay operating expenses,
distribute dividends to stockholders, and other institutional commitments. Funds
are primarily provided through financial resources from operating activities,
expansion of the deposit base, the sale or maturity of investments, or the
ability to raise equity capital.
During the year ended September 30, 1996, cash and cash equivalents, a
significant source of liquidity, increased by approximately $9.7 million. Cash
and cash equivalents decreased by $809,133 during 1995. Cash flow resulting from
internal operating activities provided increases of $1,139,430 and $601,996 in
cash during the years ended September 30, 1996 and 1995, respectively. Also,
financing activities have provided sources of funds for asset growth and
liquidity. For the year ended September 30, 1996, deposits decreased by $5.8
million but proceeds from the stock offering provided an additional $17.4
million of cash. The proceeds from the stock offering were used primarily to
fund investment and loan growth as well as enable the Bank to fund deposit
outflows, that occurred primarily because certain depositers used available
deposits at the Bank to purchase stock in the Company. Deposits decreased by
approximately $792,000 during 1995. The Bank's ability to generate deposits has
historically been sufficient to fund its loan demand and provide for adequate
liquidity without the need to access other forms of credit availability. The
recent stock offering will also enhance the Bank's ability to grow, and lessen
to some extent its reliance on its deposit base for financing its operations. In
addition, the Bank has a readily available source of credit through its
borrowing capacity at the Federal Home Loan Bank of Atlanta.
Cash provided by operating and financing activities is used to originate new
loans to customers, to maintain liquid investment portfolios, and to meet short
term liquidity requirements. During 1996 and 1995, loans outstanding increased
by $3.9 million and $4.6 million, respectively. During 1996 and 1995, the
Company purchased investment securites amounting to $9.7 million and $4.6
million, respectively, and received proceeds from sales or maturities of
investment securities amounting to $4.7 million and $6.2 million, respectively.
As a state chartered savings bank, Scotland Savings must meet certain liquidity
requirements which are established by the Administrator of the North Carolina
Savings Institutions Division. The Bank's liquidity ratio at September 30, 1996,
as computed under such regulations, was in excess of such requirements. Given
its excess liquidity and its ability to borrow from the Federal Home Loan Bank,
the Bank believes that it will have sufficient funds available to meet
anticipated future loan commitments, unexpected deposit withdrawals, and other
cash requirements.
7
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Asset/Liability Management
Scotland Savings's asset/liability management, or its managment of interest rate
risk, is focused primarily on evaluating and managing the Bank's net interest
income given various risk criteria. Factors beyond the Bank's control, such as
market interest rates and competition, may also have an impact on the Bank's
interest income and interest expense.
In the absence of other factors, the Bank's overall yield on interest-earning
assets will increase as will its cost of funds on its interest-bearing
liabilities when market rates increase over an extended period of time.
Inversely, the Bank's yields and cost of funds will decrease when market rates
decline. The Bank is able to manage these swings to some extent by attempting to
control the maturity or rate adjustments of its interest-earning assets and
interest-bearing liabilities over given periods of time.
The Bank's "gap" is typically described as the difference between the amounts of
such assets and liabilities which reprice within a period of time. In a
declining interest rate environment, a negative gap, or a situation where the
Bank's interest-bearing liabilities subject to repricing exceed the level of
interest-earning assets which will mature or reprice, will have a favorable
impact of the Bank's net interest income. Conversely, an increase in general
market rates over a sustained period of time will tend to adversely affect
Scotland Savings's net interest income. At September 30, 1996, the Bank had a
negative gap position.
In order to minimize the potential effects of adverse material and prolonged
increases or decreases in market interest rates on the Bank's operations,
management has implemented an asset/liability program designed to improve the
Bank's interest rate gap. The program emphasizes the origination of adjustable
rate loans, and to a lesser extent shorter term construction and consumer loans,
all of which are held in the portfolio, the investment of excess cash in short
or intermediate term interest earning assets, and the solicitation of
transaction deposit accounts which are less sensitive to changes in interest
rates and can be repriced rapidly.
Although the Bank's asset/liability management program has generally helped to
decrease the exposure of its earnings to interest rate increases, the Bank
continues to have a negative gap position which will be adversely impacted
during prolonged periods of rising interest rates and positively affected during
prolonged periods of interest rate declines.
Impact of Inflation and Changing Prices
The consolidated financial statements and accompanying footnotes 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 consideration for changes in the relative
purchasing power of money over time due to inflation. The assets and liabilities
of the Company are primarily monetary in nature and changes in interest rates
have a greater impact on the Company's performance than do the effects of
inflation.
8
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Future Reporting Requirements
The Financial Accounting Standards Board has issued SFAS No. 123, Accounting for
Stock-Based Compensation which the Company has not been required to adopt as of
September 30, 1996. The Statement, which will be in effect for the Company's
fiscal year ending September 30, 1997, will require an accounting for stock
based compensation plans using a fair value based method which measures
compensation cost at the grant date based upon the value of the award, which is
then recognized over the service period, usually the vesting period. The
accounting requirements of the Statement apply to grants or awards entered into
in fiscal years that begin after December 15, 1995. The Statement will allow the
Company to continue to use APB Opinion No. 25 to measure compensation cost, but
requires that the pro forma effects on net income and earnings per share be
disclosed to reflect the difference between the compensation cost, if any, from
applying APB Opinion No. 25 and the related cost measured by the fair value
method defined in the Statement. The Statement will not change the reporting
required for the ESOP plan. In addition, the Statement is not expected to have a
material effect on the Company's consolidated financial statements because
management is expected to elect to continue to use the accounting and reporting
permitted by APB Opinion No. 25 as it relates to any future stock award plan.
Impact of New Legislation
Deposit Insurance/SAIF Recapitalization
For the first three quarters of calendar year 1996, SAIF-insured institutions
paid deposit insurance assessment rates of $0.23 to $0.31 per $100 of deposits.
In contrast, institutions insured by the FDIC's Bank Insurance Fund (the "BIF")
that were well capitalized and without any significant supervisory concerns paid
the minimum annual assessment of $2,000, and all other BIF-insured institutions
paid deposit insurance assessment rates of $0.03 to $0.27 per $100 of deposits.
In response to the SAIF/BIF assessment disparity, the Deposit Funds Insurance
Act of 1996 (the "Funds Act") was enacted into law on September 30, 1996.
The Funds Act authorized the FDIC to impose a special assessment on all
institutions with SAIF-assessable deposits in the amount necessary to
recapitalize the SAIF. As implemented by the FDIC, institutions with
SAIF-assessable deposits will pay a special assessment, subject to adjustment,
of 65.7 basis points per $100 of the SAIF-assessable deposits held at March 31,
1995. Based on the foregoing, the Bank charged $320,750 against pretax earnings
for the quarter ended September 30, 1996. The assessment is deductible in the
taxable year paid.
Due to the recapitalization of the SAIF, the FDIC proposed on October 8, 1996 to
reduce the assessment rate for SAIF-assessable deposits for periods beginning on
October 1, 1996. The proposed assessment rates would range from 18 to 27 basis
points per $100 of deposits for the last calendar quarter of 1996 and would
range from -0- to 27 basis points per $100 of deposits for subsequent assessment
periods. However, the Funds Act also provides that the FDIC cannot assess
regular insurance assessments for an insurance fund unless required to maintain
or achieve the designated reserve ratio of 1.25% per $100 of deposits, except
for institutions that are not classified as "well capitalized" or that have
moderately severe or unsatisfactory financial, operational, or compliance
weaknesses as determined by the FDIC. The Bank has not been so classified.
9
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Impact of New Legislation
Deposit Insurance/SAIF Recapitalization (Continued)
Accordingly, assuming the designated reserve ratio is maintained by the SAIF
after collection of the special assessment, the Bank will pay substantially
lower regular SAIF assessments compared to those paid by the Bank in recent
years, as long as it maintains its current regulatory status, .
In addition, the Funds Act expanded the assessment base for the payment of
interest on FICO bonds, which were issued in the late 1980's by the Financing
Corporation to recapitalize the now defunct Federal Savings and Loan Insurance
Corporation, to include the deposits of both BIF and SAIF insured institutions
beginning January 1, 1997. Until December 31, 1999, or until such earlier date
on which the last savings association ceases to exist, the rate of assessment
for BIF insured deposits will be one-fifth of the rate imposed on
SAIF-assessable deposits. The current estimate of the assessment rate for the
payment of the FICO interest is approximately 1.3 basis points for
BIF-assessable deposits and 6.4 basis points for SAIF-assessable deposits.
The Funds Act also provides for the merger of the BIF and SAIF on January 1,
1999, assuming the prior elimination of the thrift charter. The Secretary of the
Treasury is required to conduct a study of the relevant factors for the
development of a common charter for banks and thrifts and report conclusions and
findings to Congress on or before March 31, 1997.
Recapture of Tax Bad Debt Reserves
Prior to the enactment of the Small Business Job Protection Act of 1996 (the
"1996 Act") on August 20, 1996, thrift institutions which met certain
definitional tests, were permitted to establish tax reserves for bad debts and
to deduct annual additions to such reserves in arriving at taxable income. The
Bank was permitted to compute the annual bad debt deduction based upon an
experience method or a percentage equal to 8.0% of the Bank's taxable income
(the "PTI Method") before such bad debt deduction, subject to certain
limitations. Under the 1996 Act, the PTI Method was repealed and the Bank will
be required to use the experience method for computing its annual bad debt
deduction for taxable years beginning on or after October 1, 1996.
The Bank will also have to recapture its tax bad debt reserves which have
accumulated since 1987 amounting to approximately $333,000 over a six year
period. The tax associated with the recaptured reserves is approximately
$127,000. The recapture is scheduled to begin with the Bank's 1997 year, but can
be delayed up to two years if the Bank originates a certain level of residential
mortgage loans over the next two years. Deferred income taxes have been
previously established for the taxes associated with the recaptured reserves and
the ultimate payment of the taxes will not result in a charge to earnings.
10
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Scotland Bancorp, Inc. and Subsidiary
Laurinburg, North Carolina
We have audited the accompanying consolidated statements of financial condition
of Scotland Bancorp, Inc. and subsidiary as of September 30, 1996 and 1995, and
the related consolidated statements of income, stockholders' equity, and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Scotland Bancorp, Inc. and
subsidiary as of September 30, 1996 and 1995, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
Raleigh, North Carolina
October 22, 1996
11
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 1996 and 1995
<TABLE>
<CAPTION>
ASSETS 1996 1995
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and short-term investments:
Interest-bearing $ 4,251,813 $ 815,505
Noninterest-bearing 754,110 723,190
Federal funds sold 100,000 1,550,000
Investment securities: (Note 2)
Held to maturity; market value $2,493,515 ($7,958,342 in 1995) 2,502,326 7,938,833
Available for sale, at estimated market value 13,465,261 2,969,589
Nonmarketable equity securities, at cost 599,400 599,400
Loans receivable, net (Note 3) 45,078,860 41,204,318
Mortgage-backed securities, held to maturity, market value
$616,580 ($724,371 in 1995) (Note 4) 545,290 652,445
Accrued interest receivable:
Loans and mortgage-backed securities 129,094 92,807
Investment securities 223,190 203,754
Property and equipment, net (Note 5) 819,474 835,666
Prepaid expenses and other assets 152,747 132,027
----------------------------------
$ 68,621,565 $ 57,717,534
==================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits (Note 6) $ 42,409,568 $ 48,203,443
Accounts payable and accrued expenses (Note 11) 404,558 237,713
Advanced payments by borrowers for insurance and taxes 156,525 209,418
Special SAIF assessment (Note 8) 320,750 -
Income taxes payable 136,090 11,349
Deferred income taxes (Note 7) 402,802 475,506
----------------------------------
43,830,293 49,137,429
----------------------------------
Commitments and contingencies (Notes 12 and 14)
Stockholder's Equity (Note 9):
Preferred stock, authorized 5,000,000 shares; none issued - -
Common stock, no par value, authorized 20,000,000 shares;
issued and outstanding 1,840,000 in 1996 - -
Additional paid-in capital 17,420,468 -
Note receivable from ESOP (Note 13) (1,772,292) -
Net unrealized gain on investment securities available for sale,
net of related tax effect 411,135 351,300
Retained earnings, substantially restricted (Notes 7 and 9) 8,731,961 8,228,805
----------------------------------
24,791,272 8,580,105
----------------------------------
$ 68,621,565 $ 57,717,534
==================================
</TABLE>
See Notes to Consolidated Financial Statements.
12
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended September 30, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest and dividend income:
Loans $ 3,635,301 $ 3,275,904
Investment securities 840,176 710,704
Mortgage-backed securities 68,193 78,674
Other interest-bearing deposits 326,037 248,036
----------------------------------
Total interest income 4,869,707 4,313,318
----------------------------------
Interest expense:
Savings accounts (Note 6) 2,162,223 2,143,795
FHLB advances 46,631 -
----------------------------------
Total interest expense 2,208,854 2,143,795
----------------------------------
Net interest income 2,660,853 2,169,523
Provision for loan losses (Note 3) 24,528 11,000
----------------------------------
Net interest income after provision for loan losses 2,636,325 2,158,523
----------------------------------
Noninterest income:
Service charges and other fees 54,059 52,865
Other 26,239 20,591
----------------------------------
80,298 73,456
----------------------------------
Noninterest expense:
Compensation and employee benefits 670,483 622,953
Occupancy 88,859 85,667
Insurance 127,817 121,719
Special SAIF assessment (Note 8) 320,750 -
Data processing 97,490 91,413
Furniture and fixture expense 37,039 39,206
Other 207,301 197,592
----------------------------------
1,549,739 1,158,550
----------------------------------
Income before income taxes 1,166,884 1,073,429
----------------------------------
Income taxes (Note 7):
Current 512,893 381,797
Deferred (103,528) (29,582)
----------------------------------
409,365 352,215
----------------------------------
Net income $ 757,519 $ 721,214
==================================
Earnings per share (Note 1) $ 0.25 $ -
==================================
Cash dividends per share $ 0.15 $ -
==================================
</TABLE>
See Notes to Consolidated Financial Statements.
13
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended September 30, 1996 and 1995
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Additional Note Unrealized
Paid in Receivable Gain on Retained
Capital ESOP Securities Earnings Total
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, October 1, 1994 $ - $ - $ 253,574 $ 7,507,591 $ 7,761,165
Change in net unrealized
gain on securities
available for sale - - 97,726 - 97,726
Net income - - - 721,214 721,214
----------------------------------------------------------------------
Balance, September 30, 1995 - - 351,300 8,228,805 8,580,105
Net proceeds from
issuance of
common stock 17,419,336 - - - 17,419,336
Purchase of common
stock by the ESOP - (1,772,292) - - (1,772,292)
ESOP contribution 1,132 - - - 1,132
Cash dividends - - - (254,363) (254,363)
Change in net unrealized
gain on securities
available for sale - - 59,835 - 59,835
Net income - - - 757,519 757,519
----------------------------------------------------------------------
Balance, September 30, 1996 $ 17,420,468 $ (1,772,292) $ 411,135 $ 8,731,961 $ 24,791,272
======================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
14
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows From Operating Activities
Net income $ 757,519 $ 721,214
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 45,463 48,016
Provision for loan losses 24,528 11,000
Net amortization/(accretion) on investment securities 3,179 (5,480)
Net (gain) loss on sale of investments available for sale 2,462 (1,396)
Loss on sale of investment held to maturity (Note 2) - 990
ESOP contribution expense credited to paid-in capital 1,132 -
Changes in assets and liabilities:
Increase in:
Accrued interest receivable,
prepaid expenses and other assets (65,661) (114,429)
Increase (decrease) in:
Deferred income taxes (103,528) (29,582)
Income taxes payable 124,741 (22,655)
Accounts payable and accrued expenses 28,845 (5,682)
Special SAIF assessment 320,750 -
-------------------------------
Net cash provided by operating activities 1,139,430 601,996
-------------------------------
Cash Flows From Investing Activities
Proceeds from maturities of investment securities
held to maturity $ 500,000 $ 5,000,000
Proceeds from sale of an investment security
held to maturity (Note 2) - 499,063
Purchases of investment securities held to maturity (500,000) (2,435,834)
Proceeds from maturities of investment securities
available for sale 1,000,000 500,000
Proceeds from sales of investment securities
available for sale 3,228,099 233,249
Purchases of investment securities available for sale (9,202,247) (2,134,814)
Principal collected on mortgage-backed securities 107,155 178,030
Net increase in loans receivable (3,899,070) (4,554,748)
Purchases of property and equipment (29,271) (32,062)
-------------------------------
Net cash used in investing activities (8,795,334) (2,747,116)
-------------------------------
</TABLE>
15
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended September 30, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows From Financing Activities
Net decrease in savings accounts (5,793,875) (791,790)
Decrease in escrow deposits (52,893) (17,343)
Proceeds from FHLB advances 3,000,000 -
Repayments of FHLB advances (3,000,000) -
Loan to ESOP for purchase of common stock (1,772,292) -
Cash dividends paid (127,144) -
Proceeds from issuance of common stock 17,419,336 -
----------------------------
Net cash provided by (used in) financing activities 9,673,132 (809,133)
----------------------------
Net increase (decrease) in cash and cash equivalents 2,017,228 (2,954,253)
Cash and cash equivalents:
Beginning 3,088,695 6,042,948
----------------------------
Ending $ 5,105,923 $ 3,088,695
============================
Cash and cash equivalents:
Cash and short-term investments $ 5,005,923 $ 1,538,695
Federal funds sold 100,000 1,550,000
----------------------------
$ 5,105,923 $ 3,088,695
============================
Supplemental Disclosure of Cash Flow Information
Cash payments for:
Interest $ 2,184,189 $ 2,148,641
============================
Income taxes $ 388,153 $ 404,453
============================
Supplemental Disclosure of Noncash Investing Activities
Transfer of investments from held to maturity to
available for sale $ 5,432,551 $ -
============================
Supplemental Disclosure of Noncash Financing Activities
Dividends accrued $ 127,219 -
============================
</TABLE>
See Notes to Consolidated Financial Statements.
16
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies
Conversion and organization of holding company: On March 29, 1996, pursuant to a
- ----------------------------------------------
Plan of Conversion which was approved by its members and regulators, Scotland
Savings Bank, SSB ("Scotland Savings" or the "Bank") converted from a North
Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank (the "Conversion"), and became a wholly-owned subsidiary of
Scotland Bancorp, Inc. (the "Company"). The Company was formed to acquire all of
the common stock of the Bank upon its conversion to stock form. The Company has
no operations and conducts no business of its own other than owning Scotland
Savings, investing its portion of the net proceeds received in the Conversion,
and lending funds to the Employee Stock Ownership Plan (the "ESOP") which was
formed in connection with the Conversion.
Nature of business: The Company is a bank holding company registered with the
- ------------------
Board of Governors of the Federal Reserve System under the Bank Holding Company
Act of 1956, as amended, and the savings bank holding company laws of North
Carolina. The Bank operates as a stock savings bank and its primary activities
consist of obtaining deposits and providing credit in the form of loans to
customers in its primary markets, Scotland and Moore counties of North Carolina.
The Bank's primary regulators are the Federal Deposit Insurance Company ("FDIC")
and the Administrator of the North Carolina Savings Institutions Division (the
"NC Administrator"). The Bank's deposits are insured by the Savings Association
Insurance Fund ("SAIF") of the FDIC.
Basis of financial statement presentation: The accounting and reporting policies
- -----------------------------------------
of the Company conform to generally accepted accounting principles and general
practices within the financial services industry. In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the date of the
balance sheet and revenues and expenses for the period. Actual results could
differ from those estimates.
A summary of the Company's significant accounting policies follows:
Principles of consolidation: The consolidated financial statements for the year
- ---------------------------
ended September 30, 1996 include the accounts of Scotland Bancorp, Inc. and its
wholly-owned subsidiary, Scotland Savings. Scotland Bancorp, Inc. was
capitalized on March 29, 1996; therefore, the consolidated financial statements
include the operations of the Company for periods subsequent to March 29, 1996.
The financial statements for the year ended September 30, 1995 present only the
accounts and operations of Scotland Savings. All significant intercompany
accounts and transactions have been eliminated in consolidation.
Cash and cash equivalents: For purposes of reporting cash flows, the Company
- -------------------------
considers all interest-bearing deposits with maturities of less than three
months at acquisition, noninterest-bearing deposits, federal funds sold, and
cash on hand to be cash equivalents. At times, the Company maintains deposits in
correspondent banks in amounts that may be in excess of the FDIC insurance
limit.
17
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies (Continued)
Investments and mortgage-backed securities:
- -------------------------------------------
Held to Maturity: Investments and mortgage-backed securities held to
----------------
maturity are carried at cost, adjusted for amortization of premiums and
accretion of discounts using a method that approximates level yield.
Identification of securities as held to maturity indicates that such
securities will be held until their contractual maturities, and will not
be available to be sold even in response to certain conditions such as
changes in market interest rates, needs for liquidity, or changes in the
availability of and the yield on alternative investments.
Available for Sale: Investments available for sale are carried at market
------------------
with unrealized holding gains and losses excluded from earnings and
reported net of related income taxes in a separate component of equity.
Such securities may be sold in response to certain conditions such as
changes in market interest rates, needs for liquidity, or changes in the
availability of and yield on alternative investments, but are not bought
and held principally for the purpose of selling in the near term with the
objective of generating profits on short-term differences in price.
Trading: Trading securities are held in anticipation of short-term market
-------
gains and such securities are carried at fair value with realized and
unrealized gains and losses included in earnings. The Company currently
has no securities which are classified as held for trading.
Loan fees: The Bank receives fees for originating and servicing mortgage loans.
- ---------
The Bank defers all origination fees less certain direct costs as an adjustment
to yield with subsequent amortization taken into interest income over the life
of the related loan. The method of amortization used is the interest method.
Allowance for loan losses: The allowance for loan losses is established through
- -------------------------
provisions for loan losses charged to operations. Loans are charged off against
the allowance when management believes that collectibility is unlikely. The
allowance is an amount that management believes will be adequate to absorb
losses on existing loans that may become uncollectible based on evaluations of
the collectibility of loans and prior loan loss experience. The evaluations take
into account such factors as changes in the nature and volume of the loan
portfolio, overall portfolio quality, review of specific problem loans and
current economic conditions that may affect the borrowers' ability to pay. While
management uses the best information available to make evaluations, future
adjustments may be necessary, if economic or other conditions differ
substantially from the assumptions used.
The Bank adopted SFAS No. 114 Accounting by Creditors for Impairment of a Loan
which was subsequently amended by SFAS No. 118 Accounting by Creditors for
Impairment of a Loan- Income Recognition and Disclosures during 1996. SFAS No.
114 requires that the Bank establish specific loan loss allowances on impaired
loans if it is doubtful that all principal and interest due according to the
loan terms will be collected. The adoption of SFAS No. 114 did not have an
effect on the Bank's reporting for impaired loans since the Bank had no loans
outstanding during the year ended September 30, 1996 which it considers to be
impaired. Therefore, there is no specific SFAS No. 114 allowance for impaired
loans at September 30, 1996.
18
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies (Continued)
Interest income: The Bank adopted SFAS No. 118 during 1996 which requires the
- ---------------
disclosure of the Bank's method of accounting for interest income on impaired
loans. The Bank does not record interest on loans delinquent 90 days or more
unless in the opinion of management, collectibility is assured. If
collectibility is not certain, the Bank establishes a reserve for uncollected
interest. Interest collected while the loan is in such status is credited to
income in the period received. If the loan is brought to a status in which it is
no longer delinquent 90 days, the reserve for uncollected interest is reversed
and interest income is recognized. The Bank anticipated that it will account for
interest on impaired loans in a similar fashion in the future if and when it has
impaired loans.
Property, equipment and depreciation: Property and equipment are stated at cost
- ------------------------------------
less accumulated depreciation. The Company computes depreciation primarily by
use of the straight-line method.
Advances from borrowers for insurance and taxes: Certain borrowers make monthly
- -----------------------------------------------
payments, in addition to principal and interest, in order to accumulate funds
from which the Bank can pay the borrowers' property taxes and insurance
premiums.
Income taxes: Deferred income taxes are provided on a liability method whereby
- ------------
deferred tax assets are recognized for deductible temporary differences and
deferred tax liabilities are recognized for taxable temporary differences.
Temporary differences are differences between the reported amounts of assets and
liabilities and their tax bases. Deferred tax assets are reduced by a valuation
allowance if in the opinion of management it is more likely than not that some
portion or all of the deferred tax assets will not be realized. Deferred tax
assets and liabilities are adjusted for the effects of changes in tax laws and
rates on the date of enactment.
Benefit plans: The Bank has a defined benefit pension plan covering
- -------------
substantially all of its employees. The Bank's funding policy is to make the
maximum annual contribution that is allowable for income tax purposes. The Bank
also has an ESOP which covers substantially all of its employees. Contributions
to the plan are based upon the amortization requirements of the ESOP's debt to
the Company subject to compensation limitations, and are expensed in accordance
with the AICPA's Statement of Position 93-6, Employers' Accounting for Employee
Stock Ownership Plans.
Additionally, the Bank has a 401(k) retirement plan available to substantially
all employees. The Bank matches certain portions of voluntary contributions by
participating employees.
Earnings per share: The earnings per share computation for 1996 is based on net
- ------------------
income earned form the date of Conversion, March 29, 1996, divided by the
weighted average number of shares outstanding from the date of Conversion to the
end of the 1996 fiscal year. For purposes of this computation, the number of
shares of common stock purchased by the Bank's employee stock ownership plan
which have not been allocated to participant accounts are not assumed to be
outstanding.
Off-balance-sheet and concentration of credit risk: The Bank is a party to
- --------------------------------------------------
financial instruments with off-balance-sheet risk such as commitments to extend
credit. Management assesses the risk related to these instruments for potential
loss. The Bank lends primarily on one-to-four family residential loans
throughout its primary lending area which encompasses Scotland and Moore
counties of North Carolina.
19
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies (Continued)
Fair Value of financial instruments: The Company adopted SFAS 107 Disclosure
- -----------------------------------
about Fair Value of Financial Instruments in 1996. The estimated fair values
required under SFAS No. 107 have been determined by the Company using available
market information and appropriate valuation methodologies. However,
considerable judgment is required to develop the estimates of fair value.
Accordingly, the estimates presented in Note 15 for the fair value of the
Company's financial instruments are not necessarily indicative of the amounts
the Company could realize in a current market exchange. The use of different
market assumptions or estimation methodologies may have a material effect on the
estimated fair value amounts. In addition, the fair value estimates presented in
Note 15 are based on pertinent information available to management as of
September 30, 1996. Although management is not aware of any factors that would
significantly affect the estimated fair value amounts, such amounts have not
been comprehensively revalued for purposes of these consolidated financial
statements since that date, and therefore, current estimates of fair value may
differ significantly from the amounts presented herein. The following methods
and assumptions were used by the Company in estimating its fair value
disclosures for financial instruments:
Cash and cash equivalents, federal funds sold, and accrued interest
-------------------------------------------------------------------
receivable: The carrying amounts reported in the statement of financial
----------
condition approximate those assets' fair values.
Investment and mortgage-backed securities: The fair values of investment
-----------------------------------------
and mortgage-backed securities are determined based on quoted market
values. For the Bank's investments in Federal Home Loan Bank stock and
CSC stock, no ready market exists and it has no quoted market value. For
disclosure purposes, such stock is assumed to have a fair value which is
equal to its cost.
Loans receivable: The fair value for loans has been estimated by
----------------
discounting the projected future cash flows using the rate at which
similar loans would be made to borrowers with similar credit ratings and
for similar maturities or repricing periods. The discount rate used has
been adjusted by an estimated credit risk factor to approximate the
adjustment that would be applied in the marketplace for any nonperforming
loans. Certain prepayment assumptions have also been made depending upon
the original contractual lives of the loans.
Deposits: The fair value of deposits with no stated maturities, money
--------
market accounts and passbook savings accounts, is estimated to be equal
to the amount payable on demand at September 30, 1996. The fair value of
certificates of deposit is based upon the discounted value of future
contractual cash flows. The discount rate is estimated using the rates
offered on September 30, 1996 for deposits of similar remaining
maturities.
Off-balance-sheet commitments: Because the Bank's commitments, which
-----------------------------
consist entirely of loan commitments, are either short-term in nature or
subject to immediate repricing, no fair value has been assigned to these
off-balance-sheet items.
20
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 2. Investment Securities
The amortized cost, estimated market value and gross unrealized gains and losses
of the Company's investment securities at September 30, 1996 and 1995 are as
follows:
<TABLE>
<CAPTION>
1996
----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
Held to maturity:
U. S. Government and federal
agency securities $ 2,502,326 $ 5,484 $ 14,295 $ 2,493,515
----------------------------------------------------------
Available for sale:
U. S. Government and federal
agency securities 12,497,063 17,648 140,859 12,373,852
Municipal securities 314,152 3,273 1,549 315,876
FHLMC stock 31,114 744,419 - 775,533
----------------------------------------------------------
12,842,329 765,340 142,408 13,465,261
----------------------------------------------------------
Nonmarketable equity securities:
FHLB stock 595,400 - - 595,400
CSC stock 4,000 - - 4,000
----------------------------------------------------------
599,400 - - 599,400
----------------------------------------------------------
$ 15,944,055 $ 770,824 $ 156,703 $ 16,558,176
==========================================================
<CAPTION>
1995
----------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
Held to maturity:
U. S. Government and federal
agency securities $ 7,938,833 $ 46,015 $ 26,506 $ 7,958,342
----------------------------------------------------------
Available for sale:
U. S. Government and federal
agency securities 2,406,202 16,293 2,075 2,420,420
FHLMC stock 31,114 518,055 - 549,169
-----------------------------------------------------------
2,437,316 534,348 2,075 2,969,589
-----------------------------------------------------------
Nonmarketable equity securities:
FHLB stock 595,400 - - 595,400
CSC stock 4,000 - - 4,000
-----------------------------------------------------------
599,400 - - 599,400
-----------------------------------------------------------
$ 10,975,549 $ 580,363 $ 28,581 $ 11,527,331
===========================================================
</TABLE>
21
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 2. Investment Securities (Continued)
The amortized cost and estimated market value of debt securities held to
maturity and available for sale at September 30, 1996 by contractual maturity
are shown below:
<TABLE>
<CAPTION>
Held to maturity Available for Sale
---------------------------------------------------------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $ 2,002,326 $ 2,007,810 $ 1,999,761 $ 1,998,125
Due in one year through five years 500,000 485,705 10,707,302 10,584,178
Due in five years or more - - 104,152 107,425
---------------------------------------------------------------
$ 2,502,326 $ 2,493,515 $ 12,811,215 $ 12,689,728
===============================================================
<CAPTION>
Summarized below is the sales activity in investment securities:
Years Ended September 30,
-----------------------------
1996 1995
-----------------------------
<S> <C> <C>
Proceeds from the sale of available for sale securities $ 3,228,099 $ 233,249
Proceeds from the sale of held to maturity securities - 499,063
Realized gains (2,397) (1,396)
Realized losses 4,859 990
-----------------------------
Cost of investment securities sold $ 3,230,561 $ 731,906
=============================
</TABLE>
Sales of held to maturity securities in 1995 were made within three months of
scheduled maturity dates such that interest rate risk was substantially
eliminated as a pricing factor.
During 1995, the Financial Accounting Standards Board issued a special report, A
Guide to the Implementation of Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities. In accordance with the report, on
December 28, 1995, the Bank reclassified certain previously held to maturity
debt securities, with a cost basis of $5,432,551 and a fair value of $5,478,047
as available for sale. Such securities were transferred at fair value with the
unrealized gain, net of tax effect, reported as an increase to the separate
component of stockholders' equity previously established.
The Bank, as a member of the Federal Home Loan Bank system, is required to
maintain an investment in capital stock of the Federal Home Loan Bank in an
amount equal to the greater of 1% of its outstanding home loans or one-twentieth
of its outstanding advances. No ready market exists for the bank stock and it
has no quoted market value. For disclosure purposes, such stock is assumed to
have a market value which is equal to cost.
22
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 2. Investment Securities (Continued)
The change in net unrealized gains and losses shown as a separate component of
equity for the years ended September 30, 1996 and 1995 is as shown below:
1996 1995
-----------------------
Balance in equity component, beginning $ 351,300 $ 253,574
Change in net unrealized gains 90,659 148,069
Less change in deferred income taxes (30,824) (50,343)
-----------------------
Balance in equity component, ending $ 411,135 $ 351,300
=======================
Investment securities with aggregate cost of $500,000 and estimated market value
of $504,375 are pledged at September 30, 1996 to collateralize certain public
deposits.
Notes 3. Loans Receivable
Loans receivable consist of the following:
<TABLE>
<CAPTION>
1996 1995
----------------------------
<S> <C> <C>
Real estate loans:
Residential, one-to-four units $ 38,694,588 $ 35,643,897
Residential, multifamily 2,152,855 962,082
Nonresidential real estate 939,058 1,509,151
Residential construction 2,608,500 1,844,800
Line of credit 2,331,895 2,289,413
----------------------------
46,726,896 42,249,343
Share loans 22,660 130,270
Automobile 136,853 128,830
Other 186,530 230,583
----------------------------
47,072,939 42,739,026
----------------------------
Less:
Undisbursed portion of loans in process 1,533,995 1,132,385
Allowance for loan losses 225,352 207,472
Deferred loan fees 234,732 194,851
----------------------------
1,994,079 1,534,708
----------------------------
$ 45,078,860 $ 41,204,318
============================
</TABLE>
23
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 3. Loans Receivable (Continued)
The following summarizes transactions in the Bank's allowance for loan losses:
1996 1995
-----------------------
Balance at the beginning of year $ 207,472 $ 196,472
Provisions charged to operations 24,528 11,000
Charge-offs (6,648) -
-----------------------
Balance at the end of the year $ 225,352 $ 207,472
=======================
The Bank does not accrue interest on loans past due 90 days or more if in the
opinion of management, collectibility is in doubt. Such interest is removed from
income through the establishment of a reserve for uncollected interest. At
September 30, 1996 a reserve for uncollected interest was not established
because management expects that all such interest is fully collectible. There
were no loans delinquent more than 90 days as of September 30, 1995.
The Bank adopted SFAS No. 114 Accounting by Creditors for Impairment of a Loan
during 1996 which requires that the Bank establish a specific allowance on
impaired loans. The Bank had no loans outstanding during the year ended
September 30, 1996 which it considers to be impaired. Therefore, there is no
specific SFAS No. 114 allowance for impaired loans at September 30, 1996.
The following summarizes transactions during the years ended September 30, 1996
and 1995 for loans made by the Bank to the Company's officers, directors and
their affiliates:
1996 1995
----------------------------
Principal balances, beginning of year $ 1,436,552 $ 1,213,393
New loans originated 224,696 290,591
Principal repayments (201,688) (67,432)
----------------------------
Principal balances, end of year $ 1,459,560 $ 1,436,552
============================
The Bank has pledged all of its stock in the Federal Home Loan Bank and entered
into a security agreement with a blanket floating lien pledging mortgage loans
to secure potential borrowings from the Federal Home Loan Bank of Atlanta.
Unused borrowing capacity from the Federal Home Loan Bank amounts to
approximately $10 million at September 30, 1996. No advances were outstanding at
September 30, 1996 or 1995.
24
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Mortgage-Backed Securities
Mortgage-backed securities consist of the following at September 30, 1996 and
1995:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Estimated
September 30 Cost Gains Losses Market Value
-------------------------------------------------------------------------
<S> <C> <C> <C> <C>
GNMA mortgage-backed
securities
1996 $ 545,290 $ 71,290 $ - $ 616,580
1995 652,445 71,926 - 724,371
</TABLE>
Mortgage-backed securities with aggregate cost of $181,399 and estimated market
value of $199,182 are pledged at September 30, 1996 to collateralize certain
public deposits.
All of the Bank's mortgage-backed securities have been classified as "held to
maturity" at September 30, 1996 and 1995.
Note 5. Property and Equipment
Property and equipment consist of the following at September 30, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
----------------------------
<S> <C> <C>
Land $ 141,406 $ 141,406
Office buildings and improvements 954,661 948,473
Furniture and fixtures 297,887 274,804
----------------------------
1,393,954 1,364,683
Less accumulated depreciation (574,480) (529,017)
----------------------------
$ 819,474 $ 835,666
============================
</TABLE>
25
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 6. Deposits
Deposits consist of the following at September 30, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
-----------------------------
<S> <C> <C>
Regular savings, 2.88% (2.82% in 1995) $ 4,310,396 $ 4,172,730
MMDA accounts, 2.87% (2.91% in 1995) 4,205,597 5,658,859
NOW accounts, 2.00% (2.00% in 1995) 2,321,234 2,328,668
Super NOW accounts, 2.25% (2.25% in 1995) 309,628 322,105
Noninterest-bearing accounts 511,470 394,496
-----------------------------
11,658,325 12,876,858
-----------------------------
Certificate of deposit accounts:
0.00% to 3.00% 34,342 31,424
3.01% to 5.00% 8,770,704 7,129,565
5.01% to 7.00% 21,292,981 27,372,042
7.01% to 9.00% 596,187 761,190
-----------------------------
30,694,214 35,294,221
-----------------------------
Accrued interest on savings 57,029 32,364
-----------------------------
$42,409,568 $48,203,443
=============================
Weighted average cost of savings 4.63% 4.88%
=============================
<CAPTION>
Certificates of deposit by range of rate and maturity at September 30, 1996 are
summarized as follows:
Amounts Maturing During
------------------------------------------------------------
Rate Range 1997 1998 1999 Thereafter Total
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
0.00% to 3.00% $ 34,342 $ - $ - $ - $ 34,342
3.01% to 5.00% 8,570,798 196,826 3,080 - 8,770,704
5.01% to 7.00% 17,511,820 3,591,488 67,666 122,007 21,292,981
7.01% to 9.00% - 596,187 - - 596,187
------------------------------------------------------------
$26,116,960 $4,384,501 $ 70,746 $122,007 $30,694,214
============================================================
</TABLE>
26
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 6. Deposits (Continued)
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 at September 30, 1996 is as shown below:
Maturity Amount
- -------------------------------------------------------------------------------
Less than 3 months $ 1,516,734
3 to 6 months 986,683
6 to 12 months 1,079,260
More than 12 months 200,000
------------
$ 3,782,677
============
Interest expense on deposit accounts for the years ended September 30, 1996 and
1995 is summarized as follows:
1996 1995
-----------------------------
Regular savings accounts $ 160,204 $ 124,203
MMDA and NOW accounts 193,701 259,438
Certificate of deposit accounts 1,808,318 1,760,154
-----------------------------
$ 2,162,223 $ 2,143,795
=============================
Note 7. Income Taxes
Under the Internal Revenue Code, the Bank is allowed a special bad debt
deduction related to additions to tax bad debt reserves established for the
purpose of absorbing losses. Through 1996, the provisions of the Code permitted
the Bank to deduct from taxable income an allowance for bad debts based upon a
percentage of taxable income (8%) before such deduction or actual loss
experience. The Bank was unable to take a bad debt deduction in its 1996 and
1995 income tax returns due to limitations imposed by the IRS Code. In addition,
legislation passed in 1996 eliminates the percentage of taxable income method as
an option for computing bad debt deductions in all future years. The Bank will
still be permitted to take deductions for bad debts, but will be required to
compute such deductions using an experience method.
The Bank will also have to recapture its tax bad debt reserves which have
accumulated since 1987 and amount to approximately $333,000 over a six year
period. The tax associated with the recaptured reserves is approximately
$127,000. The recapture is scheduled to begin with the Bank's 1997 year, but can
be delayed up to two years if the Bank originates a certain level of residential
mortgage loans over the next two years. Deferred income taxes have been
previously established for the taxes associated with the recaptured reserves and
the ultimate payment of the taxes will not result in a charge to earnings.
27
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 7. Income Taxes (Continued)
Deferred taxes have been provided for certain increases in the Bank's tax bad
debt reserves subsequent to December 31, 1987 in excess of additions to recorded
loan loss allowances. At September 30, 1996, retained earnings contain certain
historical additions to bad debt reserves for income tax purposes of
approximately $1,422,000, the balance at December 31, 1987, for which no
deferred taxes have been provided because the Bank does not intend to use these
reserves for purposes other than to absorb losses. If amounts which qualified as
bad debt deductions are used for purposes other than to absorb bad debt losses
or adjustments arising from the carryback of net operating losses, income taxes
may be imposed at the then existing rates. The approximate amount of
unrecognized tax liability associated with these historical additions is
$540,000. In the future, if the Bank does not meet the income tax requirements
necessary to permit the deduction of an allowance for bad debts, the Bank's
effective tax rate would be increased to the maximum percent under existing law.
Deferred income taxes consist of the following components as of September 30,
1996 and 1995:
1996 1995
-----------------------
Deferred tax assets:
Deferred directors retirement expense $ 6,862 $ 11,026
Excess book pension expense 7,625 9,099
Allowance for loan losses 85,634 78,839
Special SAIF assessment 121,885 -
-----------------------
Total deferred tax assets 222,006 98,964
-----------------------
Deferred tax liabilities:
Market valuation of investments 211,797 180,973
Tax bad debt reserves 126,375 128,902
Excess accumulated tax depreciation 183,838 180,800
Federal Home Loan Bank stock basis 83,795 83,795
Other 19,003 -
-----------------------
Total deferred tax liabilities 624,808 574,470
-----------------------
Net deferred tax liabilities $ 402,802 $ 475,506
=======================
The Company's effective income tax rate differs from the federal statutory rate
of 35% as follows:
1996 1995
--------------------
Statutory federal income tax rate 35.00 % 35.00 %
State income taxes, net of federal benefit 1.60 0.31
Other, net (1.52) (2.50)
---------------------
Effective income tax rate 35.08 % 32.81 %
=====================
28
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 8. Special SAIF Assessment
On September 30, 1996, the "Deposit Insurance Funds Act of 1996" was signed into
law. The legislation included a special assessment to recapitalize the SAIF
insurance fund up to it statutory goal of 1.25% of insured deposits. The
assessment is equal to approximately 65.7 basis points of the SAIF assessable
deposit base as of March 31, 1995. Although the assessment will be paid during
the three month period ended December 31, 1996, the Bank was required to accrue
and expense such cost as of September 30, 1996. In addition, this assessment can
not be deducted for tax purposes until paid. The expense recorded for the
special assessment amounted to $320,750.
Note 9. Stockholders' Equity
On March 29, 1996, Scotland Bancorp, Inc. completed and closed its stock
offering. Gross proceeds form the sale of 1,840,000 shares amounted to
$18,400,000 and were reduced by conversion costs of $980,664. The Company paid
$7,752,868 for all of the common stock of the Bank, and retained the remaining
net proceeds.
Concurrent with the Conversion, the Bank established a liquidation account in an
amount equal to its net worth as reflected in its latest statement of financial
condition used in its final offering circular. The liquidation account will be
maintained for the benefit of eligible deposit account holders and supplemental
eligible deposit account holders who continue to maintain their deposit accounts
in the Bank after the Conversion. Only in the event of a complete liquidation
will eligible deposit account holders and supplemental eligible deposit account
holders be entitled to receive a liquidation distribution from the liquidation
account in the amount of the then current adjusted sub-account balance for
deposit accounts then held before any liquidation distribution may be made with
respect to common stockholders.
Subject to applicable law, the Board of Directors of Scotland Savings and
Scotland Bancorp, Inc. may each provide for the payment of dividends. Future
declarations of cash dividends, if any, by the Company may depend upon dividend
payments by the Bank to the Company. Subject to regulations promulgated by the
NC Administrator, the Bank will not be permitted to pay dividends on its common
stock if its stockholder's equity would be reduced below the amount required for
the liquidation account or its capital requirement.
For a period of five years after its conversion from mutual to stock form,
Scotland Savings must obtain the written approval from the NC Administrator
before declaring or paying a cash dividend to Scotland Bancorp, Inc. on its
capital stock in an amount in excess of one-half of the greater of (i) the
Bank's net income for the most recent fiscal year end or (ii) the average of the
Bank's net income after dividends for the most recent fiscal year-end and not
more than two of the immediately preceding fiscal year ends. During 1996, the
Bank paid $135,000 in dividends to Scotland Bancorp, Inc.
Scotland Bancorp, Inc. paid a regular quarterly dividend of $0.075 a share on
July 26, 1996 to stockholders of record as of July 15, 1996, and on September
17, 1996, declared a regular quarterly dividend of $0.075 a share which was paid
on October 25, 1996 to shareholders of record as of October 15, 1996.
29
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 9. Stockholders' Equity (Continued)
The FDIC requires Scotland Savings to have a minimum leverage ratio of Tier I
Capital to total assets of 3% based on the Bank's latest regulatory examination.
The FDIC also requires that the Bank maintain a ratio of total capital to
risk-weighted assets of 8%, of which at least 4% must be in the form of Tier I
Capital. The North Carolina Savings Institutions Division requires a net worth
equal to at least 5% of total assets.
At September 30, 1996, Scotland Savings complied with all capital requirements
described above as shown below:
<TABLE>
<CAPTION>
September 30, 1996
--------------------------------------------------------------
Leverage Tier I NC
Ratio of Risk- Risk- Savings
Tier I Adjusted Based Bank
Capital Capital Capital Capital
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Scotland Bancorp Inc. consolidated
stockholders' equity $ 24,791,272 $ 24,791,272 $ 24,791,272 $ 24,791,272
Unrealized gain on securities (411,135) (411,135) (411,135) (411,135)
Equity of Scotland Bancorp, Inc. (7,942,699) (7,942,699) (7,942,699) (7,942,699)
Loan loss allowances - - 225,352 225,352
--------------------------------------------------------------
Regulatory capital 16,437,438 16,437,438 16,662,790 16,662,790
Minimum capital requirement 1,864,624 1,120,202 2,240,403 3,048,162
--------------------------------------------------------------
Excess regulatory capital $ 14,572,814 $ 15,317,236 $ 14,422,387 $ 13,614,628
==============================================================
Total Bank-only assets at
September 30, 1996 $ 60,963,237
Average Bank-only assets for the
quarter ended September 30, 1996 $ 62,154,117
Risk-weighted Bank-only assets at
September 30, 1996 $ 28,005,039 $ 28,005,039
Capital as a percentage of assets:
Actual 26.45% 58.69% 59.50% 27.33%
Required 3.00% 4.00% 8.00% 5.00%
--------------------------------------------------------------
Excess 23.45% 54.69% 51.50% 22.33%
==============================================================
</TABLE>
30
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 9. Stockholders' Equity (Continued)
Under the FDIC prompt corrective action regulations, a savings institution is
considered to be well capitalized if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier 1 capital to risk-weighted assets is
at least 6.0%, and its ratio of Tier 1 capital to total average assets is at
least 5.0%. The Bank meets all of the above requirements and is considered to be
well capitalized under the prompt corrective action regulations.
Note 10. Employee Retirement Plans
Pension expense under the Bank's defined benefit plan amounted to $62,720 and
$41,212 in 1996 and 1995, respectively. The components of pension cost charged
to expense for 1996 and 1995 consist of the following:
<TABLE>
<CAPTION>
1996 1995
-------------------------
<S> <C> <C>
Service cost-benefits earned during the period $ 45,594 $ 35,442
Interest cost on projected benefit obligation 40,993 29,910
Actual return on plan assets (39,202) (33,182)
Amortizations and deferrals 15,335 9,042
-------------------------
Net periodic pension expense $ 62,720 $ 41,212
=========================
</TABLE>
The following table sets forth the plan's funded status as of September 30, 1996
and 1995 and the amounts recognized in the statement of financial position at
September 30, 1996 and 1995:
<TABLE>
<CAPTION>
September 30,
---------------------------
1996 1995
---------------------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefits $ 466,889 $ 313,949
==========================
Accumulated benefits $ 503,664 $ 330,662
==========================
Projected benefits $ 672,199 $ 491,386
Plan assets at fair value, held in savings deposits
of the Bank and outside insurance products 487,951 411,722
--------------------------
Projected benefit obligation in excess of plan assets (184,248) (79,664)
Transition obligation 20,616 21,738
Unrecognized prior service cost 100,689
Unrecognized net loss, past experience different
from that assumed 47,230 45,419
--------------------------
Accrued pension cost included in other liabilities $ (15,713) $ (12,507)
==========================
</TABLE>
31
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 10. Employee Retirement Plans (Continued)
The weighted average discount rate and rate of increase in future compensation
used in determining the actuarial present value of the projected benefit
obligation are 7% and 5%, respectively. The expected long-term rate of return on
plan assets is 7%.
In addition, Scotland Savings Bank has a 401(k) retirement plan which contains
provisions for specified matching contributions by the Bank. The Bank funds
contributions as they accrue and 401(k) plan expense amounted to $7,001 and
$6,057 for the years ended September 30, 1996 and 1995, respectively.
Note 11. Deferred Director's Compensation
The Bank has a deferred compensation plan for certain of its directors under
which the directors, or their designated beneficiaries, would be paid specified
amounts over a ten-year period in return for the deferral of certain amounts of
directors fees over a seven-year period. Three directors participate in the
plan. The Bank has purchased life insurance policies with the Bank named as the
beneficiary to fund the benefits. Total expense related to the plan amounted to
$12,419 and $10,446 for the years ended September 30, 1996 and 1995,
respectively. The Bank's accrued liability for plan obligations amounted to
$118,161 and $129,119 at September 30, 1996 and 1995, respectively.
Note 12. Commitments and Contingencies
The Bank has entered into an employment agreement with a key executive officer
to ensure a stable and competent management base. The agreement provides for a
three-year term, but upon each anniversary, the agreement may be extended for an
additional year so that the remaining term shall always be three years. The
agreement provides for benefits as spelled out in the contract and cannot be
terminated by the Board of Directors, except for cause, without prejudicing the
officer's right to receive vested rights, including compensation, for the
remaining term of the agreement. In the event of a change in control of the
Bank, as defined in the agreement, the agreement will automatically be extended
for three years from the date of such change in control and the acquiror will be
bound to the terms of the contract for that period.
In addition the Bank has entered into a special termination agreement with
another key employee which provides for severance pay benefits in the event of a
change in control of the Bank which results in the termination of such employee
or diminished compensation, duties or benefits within two years of a change in
control. The employee covered under this agreement is entitled to a cash payment
equal to two times his average annual compensation for income tax purposes for
the most recent five tax years prior to the change in control. The agreement is
initially effective for a three year period and may be extended annually for an
additional year.
The Bank has also adopted a severance plan for the benefit of its employees in
the event of a change in control of the Bank which provides for varying
severance benefits for employees based on their salaries and length of service
with the Bank.
32
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 12. Commitments and Contingencies (Continued)
The Company's stockholders will be asked to consider at future stockholders
meeting approval of a management recognition plan. Such a plan is designed to
provide the directors, officers and certain employees of the Bank with an
ownership interest in the Company to encourage their continued service to the
Bank. Up to 73,600 shares of the Company's stock would be awarded under the
plan. The stockholders will also be asked to approve certain stock option plans
for directors, officers and employees of the Bank. The plans may provide for the
issuance of incentive or non-incentive options. As many as 184,000 shares are
expected to be reserved for future issuance under the stock option plans. The
Company may elect to fund any approved plans through the issuance of authorized
but unissued shares, or may elect to purchase the shares to fund the plans in
the open market. Before any plan is implemented, regulatory approval must be
obtained.
Note 13. Employee Stock Ownership Plan
The Bank has established an employee stock ownership plan (ESOP) to benefit all
qualified employees. The ESOP purchased 147,200 shares of common stock in the
open market subsequent to the Conversion with proceeds received from a loan from
the Company.
The Company's note receivable is to be repaid based upon 15 annual installments
of principal and interest on March 31 of each year through March 31, 2011.
Interest is based upon prime, which will be adjusted and paid annually. The note
may be prepaid without penalty. The unallocated shares of stock held by the ESOP
are pledged as collateral for the debt. The ESOP is funded by contributions made
by the Bank in amounts sufficient to retire the debt. At September 30, 1996, the
outstanding balance of the note receivable is $1,772,292 and is presented as a
reduction of stockholders' equity.
Shares released as the debt is repaid and earnings from the common stock held by
the ESOP are allocated among participants on the basis of compensation in the
year of allocation. Benefits become 100% vested after five years of credited
service. Forfeitures of nonvested benefits will be reallocated among remaining
participating employees in the same proportion as contributions.
Dividends on unallocated shares may be used by the ESOP to repay the debt to the
Company and are not reported as dividends in the financial statements. Dividends
on allocated or committed to be allocated shares are credited to the accounts of
the participants and reported as dividends in the financial statements.
Expense of $33,006 during 1996 has been incurred in connection with the ESOP.
The expense includes, in addition to the cash contribution necessary to fund the
ESOP, $1,132, which represents the difference between the fair market value of
the shares which have been released or committed to be released to participants,
and the cost of these shares to the ESOP. The Bank has credited this amount to
paid-in capital in accordance with the provisions of AICPA Statement of Position
93-6.
At September 30, 1996, 2,648 shares held by the ESOP have been released or
committed to be released to the plan's participants for purposes of computing
earnings per share. The fair value of the unallocated shares amounted to
approximately $2.0 million at September 30, 1996.
33
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 14. Concentration of Credit Risk and Off-Balance-Sheet Risk
The Bank originates residential and commercial real estate loans and consumer
and commercial loans within its primary lending area of Scotland and Moore
counties.
The Bank is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit, the undisbursed
portion of construction loans, and unused portions of equity lines of credit.
Those instruments involve, to varying degrees, elements of credit risk and
interest rate risk in excess of the amounts recognized in the balance sheet.
Commitments to extend credit (which were principally variable rate commitments)
amounted to approximately $621,000 and $420,000 at September 30, 1996 and 1995,
respectively. The undisbursed portion of construction loans amounted to
$1,533,995 and $1,132,385 and the unused portion of equity lines of credit
totaled approximately $2,815,000 and $2,454,000 at September 30, 1996 and 1995,
respectively.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since commitments may expire without being drawn upon,
the total commitment amounts above do not necessarily represent future cash
requirements. The Bank evaluates each customer's creditworthiness on a case by
case basis. The amount of collateral obtained depends upon management's credit
evaluation of the customer. Collateral held varies, but may include residential
real estate, equipment, autos, and income-producing commercial real estate.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The Bank
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments.
34
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 15. Fair Value of Financial Instruments
The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments at September 30, 1996. See Note 1 for a
description of the Company's accounting policies and the limitations of its
disclosures in reporting on the fair value of its financial instrument.
<TABLE>
<CAPTION>
Carrying Fair
Amount Value
-----------------------------
<S> <C> <C>
Financial assets:
Cash and short-term cash investments $ 5,005,923 $ 5,005,923
Federal funds sold 100,000 100,000
Investment securities:
Held to maturity 2,502,326 2,493,515
Available for sale 13,465,261 13,465,261
Nonmarketable equity securities 599,400 599,400
Loans receivable 45,078,860 45,051,588
Mortgage-backed securities 545,290 616,580
Accrued interest receivable 352,284 352,284
Financial liabilities:
Deposits 42,409,568 42,531,568
</TABLE>
35
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 16. Parent Company Financial Data
The following is a summary of the condensed financial statements of Scotland
Bancorp, Inc. as of and for the year ended September 30, 1996:
<TABLE>
<CAPTION>
Condensed Balance Sheet
September 30, 1996
<S> <C>
Assets:
Cash $ 4,157,420
Investment securities 3,708,652
Investment in Scotland Savings 16,851,668
Accrued interest receivable 140,414
Prepaids and other assets 82,537
Deferred income taxes 1,594
-------------
$ 24,942,285
=============
Liabilities and Stockholder's Equity:
Liabilities:
Accrued dividends payable $ 138,000
Other accrued expenses 2,566
Accrued income taxes 10,446
-------------
151,012
-------------
Stockholder's equity:
Additional paid-in capital 25,986,966
Note receivable ESOP (1,772,292)
Unrealized gain on available for sale securities, net of tax 411,135
Retained earnings 165,464
-------------
24,791,273
-------------
$ 24,942,285
=============
<CAPTION>
Condensed Statement of Income
Period From March 29, 1996 to September 30, 1996
<S> <C>
Interest income $ 281,982
Equity in earnings of Scotland Savings 251,941
Miscellaneous expense (22,150)
Income taxes (91,946)
-------------
$ 419,827
=============
</TABLE>
36
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 16. Parent Company Financial Data (Continued)
<TABLE>
<CAPTION>
Condensed Statement of Cash Flows
Period From March 29, 1996 to September 30, 1996
<S> <C>
Cash Flows from Operating Activities:
Net income $ 419,827
Noncash income items:
Equity in earnings of Scotland Savings (251,941)
Other 2,186
Change in assets and liabilities:
Increase in accrued interest receivable and prepaids (212,168)
Increase in accrued income taxes 10,446
Increase in other accrued expenses 2,566
-------------
Net cash used in operating activities (29,084)
-------------
Cash Flows from Investing Activities:
Purchase of investment securities available for sale (3,715,528)
Upstream dividend from Scotland Savings 135,000
Initial investment in Scotland Savings (7,752,868)
Loan to ESOP for purchase of common stock (1,772,292)
-------------
Net cash used in investing activities (13,105,688)
-------------
Cash Flows from Financing Activities:
Common stock proceeds received from the Conversion 17,419,336
Payment of dividends (127,144)
-------------
Net cash provided by financing activities 17,292,192
-------------
Net increase in cash 4,157,420
Cash, beginning -
-------------
Cash, ending $ 4,157,420
=============
Supplemental Disclosure of Noncash Financing Activities:
Dividends accrued $ 127,219
=============
</TABLE>
37
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 17. Future Reporting Requirements
The Financial Accounting Standards Board has issued SFAS No. 123, Accounting for
Stock-Based Compensation which the Company has not been required to adopt as of
September 30, 1996.
The Statement, which will be in effect for the Company's fiscal year ending
September 30, 1997, will require that the Company account for stock based
compensation plans using a fair value based method which measures compensation
cost at the grant date based upon the value of the award, which is then
recognized over the service period, usually the vesting period. The accounting
requirements of the Statement apply to grants or awards entered into in fiscal
years that begin after December 15, 1995. The Statement allows entities to
continue to use APB Opinion No. 25 to measure compensation cost, but requires
that the proforma effects on net income and earnings per share be disclosed to
reflect the difference between the compensation cost, if any, from applying APB
Opinion No. 25 and the related cost measured by the fair value method defined in
the Statement. The Statement is not expected to have a material impact on the
Company's accounting for stock compensation plans because (i) the Statement does
not apply to the ESOP plan nor will it change the accounting requirements of the
proposed management recognition plan, and (ii) the Company expects to account
for the proposed stock option plans using the accounting treatment permitted
under APB Opinion No. 25.
38
<PAGE>
<TABLE>
<CAPTION>
CORPORATE INFORMATION
EXECUTIVE OFFICERS:
<S> <C> <C>
William C. Fitzgerald, III John B. Clark
President and CEO Vice President/Secretary
DIRECTORS:
James W. Mason
Chairman; Attorney
S. T. Snowdon, Jr. William C. Fitzgerald, III John B. Clark
Vice Chairman; President and CEO Vice President/Secretary
Retired Architect of Scotland Bancorp, Inc. of Scotland Bancorp, Inc.
James E. Milligan Clifton P. Buie James S. Mitchener, Jr.
Retired Newspaper Publisher VP of Manufacturing, Retired Surgeon
Charles Craft, Inc
E. S. Hill, Jr. John W. Hudson James T. Willis
General Manager, Retired Plant Manager, VP of Adams & Willis, Inc.
Eaton Corp. LOF Glass GM of Firestone Store
Stock Transfer Agent Annual Meeting
Registrar and Transfer Company The 1997 annual meeting of stockholders of
10 Commerce Drive Scotland Bancorp, Inc. will be held at 4:00 p.m.
Cranford, NJ 07016 on January 16, 1997 at the Company's corporate
office at 505 South Main Street, Laurinburg, NC.
Special Legal Counsel
Brooks, Pierce, McLendon, Form 10-KSB
Humphrey & Leonard, LLP A copy of Form 10-KSB as filed with the Securities and
2000 Renaissance Plaza Exchange Commission will be furnished without
230 North Elm Street charge to the Company's stockholders upon written
Greensboro, NC 27420 request to Scotland Bancorp, Inc., P. O. Box 1468,
Laurinburg, NC 28353.
Independent Auditors
McGladrey & Pullen, LLP Corporate Office
2418 Blue Ridge Road 505 South Main Street
Raleigh, NC 27605 Laurinburg, NC 28301
</TABLE>
Common Stock Information
The Company's stock began trading on March 29, 1996. There are 1,840,000 shares
of common stock outstanding which were held by approximately 499 stockholders of
record (excluding shares held in street name) on September 30, 1996. The
Company's common stock is quoted on the American Stock Exchange under the symbol
"SSB." The high and low bids for the common stock for the quarter ended June 30,
1996 were $12 3/8 and $11 5/8, respectively; and for the quarter ended September
30, 1996, $13 7/8 and $11 7/8, respectively. On July 26, 1996, the Company paid
a regular quarterly dividend of $.075 a share to stockholders of record on July
15, 1996 and declared a regular quarterly dividend of $.075 a share on September
17, 1996 for stockholders of record as of October 15, 1996 to be paid on October
25, 1996.
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the incorporation by reference into all Registration
Statements on Form S-8 of Scotland Bancorp, Inc. of our report dated October 22,
1996, relating to the consolidated financial statements of Scotland Bancorp,
Inc. and subsidiary, which report appears in the Company's 1996 annual report on
Form 10-KSB.
McGladrey & Pullen, LLP
December 20, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> OCT-01-1995
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0
0
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</TABLE>
