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UNITED STATES
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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, 1997
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Commission file number 1-14266
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SCOTLAND BANCORP, INC.
(Name of small business issuer in its charter)
North Carolina 56-1955133
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
505 South Main Street, 28353-1468
Post Office Box 1468 -----------------
Laurinburg, North Carolina (Zip Code)
- ----------------------------------------
(Address of principal executive offices)
(910) 276-2703
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(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 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. [X]
State issuer's revenues for its most recent fiscal year $5,477,690
----------
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 -- $15,324,248 (based on the price at which the stock
was sold on December 9, 1997).
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 1,913,600
-------------------------- -------------------------------
(Class) (Outstanding at December 9, 1997)
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended September 30,
1997 (the "1997 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 15, 1998 (the "Proxy Statement"), are incorporated by reference
into Part III.
Transitional Small Business Disclosure Format (Check one): Yes No X
--- ---
<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, holding the
indebtedness outstanding from the Scotland Savings Bank, Inc., SSB Employee
Stock Ownership Plan (the "ESOP") and owning the Bank. The Company's principal
sources of income are earnings on its investments and interest payments received
from the ESOP with respect to the ESOP loan. 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 and has been a member of the
Federal Home Loan Bank ("FHLB") system since 1933. The deposits of the Bank are
insured by the Savings Association Insurance Fund (the "SAIF") of the Federal
Deposit Insurance Corporation (the "FDIC") to the maximum amount permitted by
law.
The Bank conducts business through its full service offices in
Laurinburg and Pinehurst, North Carolina. Its 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; 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, data processing expenses and branch occupancy and related
expenses.
At September 30, 1997, the Company had total assets of $64,399,000,
net loans of $46,463,000, deposits of $43,140,000, investment securities of
$16,110,000 and stockholders' equity of $14,561,000.
At September 30, 1997, the Company and the Bank had a total of 14
employees, all of whom are full-time.
The Company has no operations and conducts no business of its own
other than owning the Bank, investing its portion of the net proceeds received
in the Conversion and lending funds to the ESOP. Accordingly, the discussion of
the business which follows in the Form 10-KSB concerns the business conducted by
the Bank, unless otherwise indicated.
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 is in
Moore County, immediately north of Scotland County and northwest of
Fayetteville.
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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.
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, 1997, 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.
2
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<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)
- --------------- --------------------------------------- ---------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
+400 bp 16,449 (4,292) -21% 25.88% -676 bp
+300 bp 17,621 (3,120) -15% 27.73% -491 bp
+200 bp 18,794 (1,947) - 9% 29.57% -307 bp
+100 bp 19,768 (973) -5% 31.11% -153 bp
0 bp 20,741 -- -- 32.64% --
-100 bp 21,330 589 3% 33.56% +92 bp
-200 bp 21,918 1,177 6% 34.49% +185 bp
-300 bp 22,384 1,643 8% 35.22% +258 bp
-400 bp 22,849 2,108 10% 35.96% +332 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, 1997, a change in interest rates of a positive 200
basis points would have resulted in a 307 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 185 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 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 $46.5 million on
September 30, 1997, or 72.1% of its total assets. On that date, approximately
3
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$41.0 million or 88.3% of loans outstanding consisted of loans secured by
mortgages on one-to-four family residential properties; $2.1 million or 4.4%
were loans secured by multifamily residential properties; approximately $907,000
or 2.0% of loans were secured by non-residential real estate; approximately
$20,000 net of loans in process or 0.1% were loans secured by residential
construction loans; approximately $2.5 million or 5.5% were line of credit
loans; and approximately $391,000 or 0.8% were loans secured by savings
accounts, automobiles or other collateral. As of September 30, 1997,
approximately 98% of the loans in the Bank's real estate loan portfolio were
secured by properties in North Carolina. 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.
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,
----------------
1997 1996
---- ----
% of % of
Amount Total Amount Total
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(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $41,018 88.28% $38,695 85.84%
Residential multi-family 2,052 4.42% 2,153 4.78%
Nonresidential real estate 907 1.95% 939 2.08%
Residential construction 634 1.36% 2,608 5.79%
Line of credit 2,540 5.47% 2,332 5.17%
------- ------ ------- ------
Total real estate loans 47,151 101.48% 46,727 103.66%
------- ------ ------- ------
Consumer loans:
Passbook or certificate 71 0.15% 23 .05%
Automobile 119 0.26% 137 .30%
Other 201 0.43% 186 .41%
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Total consumer loans 391 0.84% 346 .76%
------- ------ ------- ------
Less:
Deferred loan fees 216 0.46% 235 .52%
Loans in process 614 1.32% 1,534 3.40%
Allowance for loan losses 249 0.54% 225 .50%
------- ------ ------- ------
Total reductions 1,079 2.32% 1,994 4.42%
------- ------ ------- ------
Total loans receivable, net $46,463 100.00% $45,079 100.00%
======= ====== ======= ======
</TABLE>
4
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Loan Maturity Schedule. The following table sets forth the time to
contractual maturity of the Bank's loan portfolio at September 30, 1997. Loans
which have adjustable rates and fixed rates and other loans all 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. Prepayments and scheduled repayments in the loan
portfolio totaled $7.1 million and $9.2 million in the fiscal years ended
September 30, 1997, and 1996, respectively. Amounts in the table are net of
loans in process and are net of unamortized loan fees.
<TABLE>
<CAPTION>
At September 30, 1997
-------------------------------------------------------------------
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
--------- ------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
(In Thousands)
Mortgage loans:
Adjustable rate 1-4 family $ 7,460 $4,189 $3,024 $2,405 $ 6,084 $23,162
residential
Fixed rate 1-4 family 50 282 391 4,679 13,849 19,251
residential
Other adjustable rate real 2,775 124 220 28 30 3,177
estate loans
Other fixed rate real estate 10 64 192 417 48 731
loans
Other loans 171 186 22 12 -- 391
Less:
Allowance for loan losses (249) -- -- -- -- (249)
------- ------ ------ ------ ------- -------
$10,217 $4,845 $3,849 $7,541 $20,011 $46,463
======= ====== ====== ====== ======= =======
</TABLE>
The following table sets forth the dollar amount at September 30, 1997
of all loans maturing or repricing on or after September 30, 1998 which have
fixed or adjustable interest rates.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
------- ----------
(In Thousands)
<S> <C> <C>
Mortgage loans $19,922 $16,104
Other loans 220 --
------- -------
$20,142 $16,104
======= =======
</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, 1997,
approximately 88.3% of the Bank's total
5
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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, 51.0% had adjustable interest
rates.
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.
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, 1997, the Bank had
approximately $2.1 million in outstanding loans secured by multifamily
residential real estate, comprising approximately 4.4% 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.
Nonresidential Real Estate Lending. On September 30, 1997, the Bank
had $907,000 in outstanding loans secured by nonresidential real estate,
comprising approximately 2.0% 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
6
<PAGE>
or the economy in general. As of September 30, 1997, the largest nonresidential
real estate loan in the Bank's loan portfolio totaled $146,000. This loan was
performing in accordance with the original loan contract.
Lines of Credit. At September 30, 1997, the Bank had approximately
$2.5 million in line of credit loans, representing approximately 5.5% 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, 1997 was approximately $20,000, net of loans in
process, representing approximately 0.1% 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.
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, 1997, the Bank had
approximately $391,000 of such loans outstanding, representing approximately
0.8% 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.
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.
7
<PAGE>
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, 1997,
the Bank had $214,000 in such unfunded mortgage loan commitments. In addition,
on such date the Bank had $3.0 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 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, 1997 and 1996, the Bank's loan
originations totaled $8.5 million and $13.2 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,
8
<PAGE>
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, 1997, 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 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, 1997, 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,
----------------
1997 1996
---- ----
(Dollars in Thousands)
<S> <C> <C>
Total nonaccrual loans:
Mortgage Loans delinquent 90 days or more $ 30 $ 32
Consumer loans delinquent 90 days or more -- --
Real estate owned -- --
Total non-performing assets $ 30 $ 32
======= =======
Non-performing loans to total loans 0.06% 0.07%
Non-performing assets to total assets 0.05% 0.05%
Total assets $64,399 $68,622
Total loans $46,463 $45,079
</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
9
<PAGE>
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, 1997, the Bank had $30,000 in loans internally
classified as "substandard", none as "doubtful" and none as "loss".
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, 1997, 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 of the Savings Institutions
Division of the North Carolina Department of Commerce (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 Bank had one loan amounting to $30,000 which was assessed for impairment at
September 30, 1997. This loan is collateral dependent and management has
determined that the underlying collateral is in excess of the carrying amount.
Therefore, there is no specific SFAS No. 114 allowance for impaired loans at
September 30, 1997. The Bank charged a provision to the allowance for loan
losses of $24,000 and $25,000 during the years ended September 30, 1997 and
1996, respectively. These provisions were charged to make the Bank's allowance
for loan losses reflect the economic environment and to conservatively reserve
for any future loan losses.
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.
10
<PAGE>
The following table describes the activity related to the Bank's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------
1997 1996
---- ----
<S> <C> <C>
(Dollars in Thousands)
Balance, beginning of period $ 225 $ 207
Provision for loan losses 24 25
Charge-offs -- 7
Recoveries -- --
----- -------
Balance, end of period $ 249 $ 225
===== =======
Net charge-offs as a % of average loans outstanding -- .02%
Allowance at period end as a % of nonperforming
loans 830.00% 714.97%
</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,
------------------
1997 1996
---- ----
Amount of Amount of
Amount of Loans to Amount of Loans to
Allowance Gross Loans Allowance Gross Loans
--------- ----------- --------- -----------
<S> <C> <C> <C> <C>
(Dollars in Thousands)
Real estate loans:
Residential 1-4 family $123 86.28% $ 93 82.21%
Residential multi-family 5 4.32% 5 4.57%
Nonresidential real
estate 57 1.91% 60 1.99%
Residential construction 1 1.33% 6 5.54%
Line of credit 35 5.34% 32 4.95%
---- ------- ---- -------
Total real estate
loans 221 99.18% 196 99.26%
---- ------- ---- -------
Consumer loans:
Passbook or certificate -- 0.15% -- 0.05%
Automobile 18 0.25% 21 0.29%
Other 10 0.42% 8 0.40%
---- ------- ---- -------
Total consumer loans 28 0.82% 29 0.74%
---- ------- ---- -------
Total allowance for loan
losses $249 100.00% $225 100.00%
==== ======= ==== =======
</TABLE>
11
<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, 1997, the carrying value of the
Company's investment securities portfolio totaled approximately $16.1 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, federal funds sold and deposits in other financial institutions.
The mortgage-backed securities consist of mortgage-backed securities issued by
the GNMA.
Investment securities decreased by $5.4 million during 1997 due to the
Company selling investment securities and using the proceeds to pay a $6 return
of capital dividend to the shareholders. See Note 10 of "Notes to Consolidated
Financial Statements."
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 Consolidated 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, 1997, 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.
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 insured 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 financial services industry.
12
<PAGE>
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.
<TABLE>
<CAPTION>
At September 30,
----------------
1997 1996
Amortized Market Amortized Market
Cost Value Cost Value
------------- ---------- ------------ ----------
(In Thousands)
<S> <C> <C> <C> <C>
Interest-bearing deposits $ 6,131 $ 6,131 $ 4,352 $ 4,352
------ ------ ------ ------
Mortgage-backed
securities, held to
maturity 419 481 545 617
------ ------ ------ ------
Investment securities:
Held to maturity or for
investment:
U.S. Treasury and
agency securities 500 494 2,502 2,494
Available for sale:
U.S. Treasury and
agency securities 2,500 2,480 12,812 12,690
State revenue bonds 5,100 5,100 -- --
Federal Home Loan Mortgage
Corporation stock 25 881 31 775
Non-marketable equity
securities:
Federal Home Loan Bank
stock 595 595 595 595
Central Service
Corporation stock 4 4 4 4
------ ------ ------ ------
8,724 9,554 15,944 16,558
------ ------ ------ ------
Available for sale market
adjustment 836 623
--- ---
Total $16,110 $16,166 $21,464 $21,527
====== ====== ====== ======
</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, 1997.
13
<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 $6,131 5.58% $ -- -- $ -- --
Mortgage-backed securities -- -- -- -- -- --
U.S. Treasury securities
Held to maturity -- -- 500 6.05% -- --
Available for sale -- -- 2,480 6.09% -- --
Federal Home Loan Mortgage
Corporation stock (1) 881 4.89% -- -- -- --
Federal Home Loan
Bank stock (2) -- -- -- -- -- --
Central Service Corporation
stock (2) -- -- -- -- -- --
----- ----- ----- ----- ---- ----
Total $7,012 5.49% $2,980 6.08% $ -- --
===== ===== ===== ===== === ====
After Ten Years Total
--------------- -----
Carrying Weighted Average Carrying Weighted Average
Value Yield Value Yield
----- ----- ----- -----
(Dollars in Thousands)
Interest-bearing deposits $ -- -- $ 6,131 5.58%
Mortgage-backed securities 419 11.25% 419 11.25%
U.S. Treasury securities
Held to maturity -- -- 500 6.05%
Available for sale 5,100 5.51% 7,580 5.70%
Federal Home Loan Mortgage
Corporation stock (1) -- -- 881 4.89%
Federal Home Loan
Bank stock (2) 595 7.24% 595 7.24%
Central Service Corporation
stock (2) 4 -- 4 --
----- ---- ------ -----
Total $6,118 6.07% $16,110 5.82%
===== ==== ====== =====
</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.
14
<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, 1997; however, it does maintain
borrowing capabilities through the FHLB of Atlanta.
Deposits. On September 30, 1997 and September 30, 1996, the Bank's
deposits totaled $43.1 million and $42.4 million, respectively.
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,
----------------------------------------
1997 1996
---- ----
<S> <C> <C>
(In Thousands)
Total deposits at beginning of period $42,410 $48,203
Net(decrease) before interest credited (1,252) (7,704)
Interest credited 1,982 1,911
------- -------
Total deposits at end of period $43,140 $42,410
======= =======
</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.
The following table sets forth certain information regarding the
Bank's savings deposits at the dates indicated.
15
<PAGE>
<TABLE>
<CAPTION>
At September 30,
1997 1996
------------------------------------ ----------------------------------
Weighted Average % of % of
------- ---- Weighted ----
Amount Rate Deposits Amount Average Rate Deposits
------- ---- -------- ------- ------------ --------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Demand accounts:
Passbook accounts $ 4,106 2.92% 9.52% $ 4,310 2.88% 10.16%
NOW accounts 2,984 2.03% 6.92% 2,631 2.03% 6.20%
Money market deposit accounts 5,381 4.33% 12.47% 4,206 2.87% 9.92%
Noninterest bearing accounts 633 -- 1.47% 512 -- 1.21%
------- ----- ------- ------- ----- -------
Total demand deposits 13,104 3.16% 30.38% 11,659 2.56% 27.49%
Time deposits 29,988 5.45% 69.51% 30,694 5.42% 72.38%
Accrued interest 48 0.11% 57 0.13%
------- ------- ------- -------
Total deposits $43,140 4.74% 100.00% $42,410 4.63% 100.00%
======= ===== ======= ======= ===== =======
</TABLE>
16
<PAGE>
As of September 30, 1997, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $2.7 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, 1997
-------------------
(In Thousands)
<S> <C>
3 Months or less $1,150
Over 3 months through 6 months 923
Over 6 months through 12 months 434
Over 12 months 200
------
Total $2,707
======
</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 with the FHLB at September 30, 1997 or 1996. During 1997 the Bank
did not obtain any Federal Home Loan Bank advances, however the Bank retains
borrowing capacity through the Federal Home Loan Bank of Atlanta.
The Company had outstanding borrowings of $5.5 million in the form of
a bank note payable at September 30, 1997. The note is unsecured, bears
interest at prime minus 2% and is due in full on October 31, 1997.
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, 1997, 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,
1997, 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.
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.
17
<PAGE>
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 savings bank holding company subject to the BHCA, the Company is subject to
certain regulations of the Federal Reserve. Under the BHCA, the Company's
activities and those of its subsidiary are limited to banking, managing or
controlling banks, furnishing services to or performing services for its
subsidiary 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.
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,
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 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, insured depository institutions under common control are
required to reimburse the FDIC for any loss suffered by either 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.
Federal regulations require that the Company must notify the Federal
Reserve Bank of Richmond prior to repurchasing Common Stock in excess of ten
percent of its net worth during a rolling twelve month period. As a result of
the Company's ownership of the Bank, the Company is registered under the savings
bank holding company laws of North Carolina. Accordingly, the Company is also
subject to regulation and supervision by the Administrator.
18
<PAGE>
Capital Adequacy Guidelines for Holding Companies. The Federal
Reserve has adopted capital adequacy guidelines for bank holding companies and
banks that are members of the Federal Reserve system and have consolidated
assets of $150 million or more. 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. 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 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(g) of the Securities Exchange Act of 1934 (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.
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 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.
19
<PAGE>
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) 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 (ii) 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 and its
implementing regulations with respect to loans to directors, executive officers
and principal stockholders. Under Section 22(h), loans to directors, executive
officers and stockholders who own more than 10% 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 and all loans
to such persons may not exceed the institution's unimpaired capital and
unimpaired surplus. Section 22(h) also prohibits loans above amounts prescribed
by the appropriate federal banking agency to directors, executive officers and
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,
and principal stockholders be 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. Section 22(h) also
generally prohibits a depository institution from paying the overdrafts of any
of its executive officers or directors.
Deposit Insurance. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Regulation of the Bank - Prompt
Corrective Regulatory Action." Within each capital group, institutions are
assigned to one of three subgroups on the basis of supervisory evaluations by
the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit
20
<PAGE>
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken. The
assessment rate for SAIF members had ranged from 0.23% of deposits for well
capitalized institutions in Subgroup A to 0.31% of deposits for undercapitalized
institutions in Subgroup C while assessments for over 90% of the BIF members had
been the statutory minimum of $2,000. Recently enacted legislation provided for
a one-time assessment of 65.7 basis points of insured deposits as of March 31,
1995, that fully capitalized the SAIF and had the effect of reducing future SAIF
assessments. Accordingly, although the special assessment resulted in a one-
time charge to the Bank in 1996 of approximately $321,000 pre-tax, the
recapitalization of the SAIF had the effect of reducing the Bank's future
deposit insurance premiums to the SAIF. Under the recently enacted legislation,
both BIF and SAIF members will be assessed an amount for the Financing
Corporation Bond payments. BIF members will be assessed approximately 1.3 basis
points while the SAIF rate will be approximately 6.4 basis points until January
1, 2000. At that time, BIF and SAIF members will begin pro rata sharing of the
payment at an expected rate of 2.43 basis points.
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 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 quantitative 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,
1997, the Bank had a leverage ratio of 28.65%.
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<PAGE>
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, 1997, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.
Each federal banking agency is required to establish risk-based
capital standards that 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 multifamily
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 Bank's management of interest rate risk.
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, 1997, the largest aggregate amount of loans which
the Bank had to any one borrower was $716,000. 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.
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, 1997, the Bank was in compliance
with this requirement with an investment in FHLB of Atlanta stock of $595,400.
Each FHLB is required to contribute at least 10% 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, and to transfer a percentage of its annual
net earnings to the Affordable Housing Program. These contributions continue to
reduce the FHLB of Atlanta's earnings and the Bank's dividends on its FHLB of
Atlanta stock.
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<PAGE>
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 a state savings 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 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.
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, 1997, the Bank's liquidity
ratio, calculated in accordance with North Carolina regulations, was
approximately 18.9%.
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.
Prompt Corrective Regulatory Action. Federal law provides the federal
banking agencies with broad powers to take corrective action to resolve problems
of insured depository institutions. The extent of these powers depends upon
whether the institutions in question are "well capitalized," "adequately
capitalized," "undercapitalized," "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%.
23
<PAGE>
Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Banking Act"), effective September 29,
1995, permits adequately capitalized bank and savings bank holding companies to
acquire control of banks and savings banks in any state. The 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.
The Interstate Banking Act also provides for interstate branching,
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.
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.
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.
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<PAGE>
The Administrator conducts regular 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 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.
Future Requirements. Statutes and regulations are regularly
introduced which contain wide-ranging proposals for altering the structures,
regulations and competitive relationships of financial institutions. It cannot
be predicted whether or what form any proposed statute or regulation will be
adopted or the extent to which the business of the Company and the Bank may be
affected by such statute or regulation.
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, 1997.
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.
25
<PAGE>
<TABLE>
<CAPTION>
Net Book Value Deposits
Address of Property (In Thousands)
------- -------------- --------------
<S> <C> <C>
Laurinburg:
505 South Main Street $574,513 $37,023
P.O. Box 1468
Laurinburg, North Carolina 28352
Pinehurst:
77 Cherokee Road 166,220 6,117
Pinehurst, North Carolina 28374 -------- -------
$740,733 $43,140
======== =======
</TABLE>
The Bank's management considers the property to be in good condition
and is of the opinion that it is adequately covered by insurance. The total net
book value of the Bank's furniture, fixtures and equipment on September 30, 1997
was $51,626. 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 in an effort to recover its
investment. As of September 30, 1997, the Bank had no recorded real estate
acquired in settlement of loans.
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, 1997.
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 1997 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 4 through 14 in the Company's 1997 Annual Report, which section is
incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of the Company set forth on
pages 16 through 48 in the Company's 1997 Annual Report are incorporated herein
by reference.
26
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
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 8 of the Proxy Statement and
"Executive Officers" on page 10 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 6 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
9 and " - Management Compensation" on pages 10 through 16 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.
27
<PAGE>
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.
10(a) Employment Agreement with William C. Fitzgerald, III
incorporated herein by reference to the Form 10-KSB for the
fiscal year ended dated September 30, 1996, file number
1-14266, filed with the SEC on December 23, 1996.
10(b) Special Termination Agreement with John B. Clark
incorporated herein by reference to the Form 10-KSB for the
fiscal year ended dated September 30, 1996, file number
1-14266, filed with the SEC on December 23, 1996.
10(c) Deferred Compensation Agreements with James E. Milligan,
James S. Mitchener and Sam T. Snowdon, Jr. incorporated
herein by reference to the Form 10-KSB for the fiscal year
ended dated September 30, 1996, file number 1-14266, filed
with the SEC on December 23, 1996.
10(d) Scotland Savings Bank, Inc. SSB Management Recognition
Plan and Trust.
10(e) Scotland Bancorp, Inc. Stock Option Plan.
(11) Statement Regarding Computation of Per Share Earnings
(13) Portions of 1997 Annual Report to Stockholders
(21) See Item 1. Description of Business for discussion of
subsidiaries
(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, 1997.
28
<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.
Date: December 16, 1997 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 16, 1997
- -------------------------------- Officer and Director
William C. Fitzgerald, III
/s/ John B. Clark Senior Vice-President and December 16, 1997
- -------------------------------- Director
John B. Clark
/s/ Debora B. Steagall Assistant Treasurer December 16, 1997
- --------------------------------
Debora B. Steagall
/s/ Clifton P. Buie Director December 16, 1997
- --------------------------------
Clifton P. Buie
/s/ E. S. Hill, Jr. Director December 16, 1997
- --------------------------------
E.S. Hill, Jr.
/s/ John W. Hudson Director December 16, 1997
- --------------------------------
John W. Hudson
/s/ James W. Mason Director December 16, 1997
- --------------------------------
James W. Mason
/s/ James E. Milligan Director December 16, 1997
- --------------------------------
James E. Milligan
/s/ James S. Mitchener, Jr. Director December 16, 1997
- --------------------------------
James S. Mitchener, Jr.
/s/ S. T. Snowdon, Jr. Director December 16, 1997
- --------------------------------
S. T. Snowdon, Jr.
/s/ James T. Willis Director December 16, 1997
- --------------------------------
James T. Willis
</TABLE>
29
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
10(d) Scotland Savings Bank, Inc., SSB Management Recognition Plan
10(e) Scotland Bancorp, Inc. Stock Option Plan
11 Statement Regarding Computation of Per Share Earnings
13 Portions of the 1997 Annual Report to Stockholders
23 Consent of McGladrey & Pullen, LLP
27 Financial Data Schedule
30
<PAGE>
SCOTLAND SAVINGS BANK, INC., SSB
MANAGEMENT RECOGNITION PLAN AND TRUST AGREEMENT
Scotland Savings Bank, Inc., SSB, a North Carolina chartered savings bank
(the "Bank"), does herein set forth the terms of its Management Recognition Plan
(the "Plan") and Trust (the "Trust") and the Trustees hereby accept this Trust
and agree to hold the Trust assets existing on the date of the Agreement and all
additions and accretions thereto upon the terms and conditions hereinafter
stated.
Section 1. Purpose of this Plan. The purpose of this Plan is to provide
---------- --------------------
to the directors, officers and employees (the "Participants") of the Bank and of
any corporation or other entity of which the Bank owns, directly or indirectly,
not less than fifty percent (50%) of any class of the equity securities thereof
(a "Subsidiary"), an ownership interest in the Bank's parent holding company,
Scotland Bancorp, Inc. (the "Corporation") by making awards (hereinafter
referred to as "Awards" or singularly, "Award") of shares of common stock of the
Corporation (the "Common Stock"). The Board of Directors of the Bank (the
"Board") and the Board of Directors of the Corporation believe that
participation in the ownership of the Corporation will induce Participants to
continue to serve the Bank or any Subsidiary as directors, officers and/or
employees and encourage them to contribute to the future growth and profits of
the Bank and the Corporation. In addition, the existence of this Plan will make
it possible for the Bank and its Subsidiaries to attract capable individuals to
serve as directors or officers of the Bank and its Subsidiaries. The Board
believes that the existence of this Plan will provide incentives to the
directors, officers and employees of the Bank and any Subsidiaries which will
contribute materially to the success of such companies.
Section 2. Administration of this Plan.
---------- ---------------------------
(a) This Plan shall be administered by a committee of the Board (the
"Committee") which shall consist of not less than two members of the Board who
are "Non-Employee Directors" as defined in Rule 16 b-3(b)(3) of the Rules and
Regulations under the Securities Exchange Act of 1934 (the "Exchange Act"). In
the absence of a duly appointed Committee, the Plan shall be administered by the
Board. The Committee shall have full power and authority to construe, interpret
and administer this Plan. All actions, decisions, determinations, or
interpretations of the Committee shall be final, conclusive, and binding upon
all parties. Members of the Committee shall serve at the pleasure of the Board.
(b) The Committee shall decide (i) to whom Awards shall be made under this
Plan, (ii) the number of shares of Common Stock subject to each award, (iii) the
number of additional shares, if any, to be purchased or allocated for the
purposes of this Plan, (iv) the determination of leaves of absence which may be
granted to Participants without constituting a termination of their employment
for purposes of the Plan and (v) such additional terms and conditions for Awards
as the Committee shall deem appropriate, including, without limitation, any
determinations as to the restrictions or conditions on transfer of shares of
Common Stock that are necessary or appropriate to satisfy all applicable
securities laws, rules, regulations, and listing requirements.
(c) The Committee may designate any officers or employees of the Bank or of
any Subsidiary to assist in the administration of this Plan. The Committee may
authorize such individuals to
<PAGE>
execute documents on its behalf and may delegate to them such other ministerial
and limited discretionary duties as the Committee may see fit.
(d) Any shares of Common Stock held under this Plan, including
without limitation unallocated, undistributed and forfeited shares, shall be
held by the Trust.
(e) The Trustees shall be appointed by the Board.
Section 3. Contributions to Trust.
- ---------- ----------------------
(a) The Board shall determine the amount (or the method of
computing the amount) and timing of any contributions by the Bank and any
Subsidiaries to the Trust established under this Plan. Such amounts may be paid
in cash or in shares of Common Stock and shall be paid to the Trust at the
designated time of contribution. No contributions by Participants shall be
permitted.
(b) Subject to Section 9 hereof, the Trustees shall invest all of the
Trust's assets primarily in Common Stock. The Trust shall acquire, in the
aggregate, 73,600 shares of Common Stock, which is equal to four percent (4%) of
the shares of Common Stock issued in connection with the conversion of the Bank
from a North Carolina chartered mutual savings bank to a North Carolina
chartered stock savings bank on March 29, 1996 (the "Conversion"). Such shares
of Common Stock may be purchased by the Trust in the open market, or, subject to
approval of the Board of Directors of the Corporation, may be acquired through
the issuance by the Corporation to the Trust of authorized but unissued shares
of Common Stock on such terms as may be approved by the Committee and the Board
of Directors of the Corporation. Such shares (the "Plan Shares") shall be held
by the Trust until they have been awarded and distributed pursuant to the terms
of this Plan. In the event that the Trust receives cash pursuant to receipt of
dividends on Common Stock held by the Trust which has not been awarded to
participants, including the receipt of a special cash dividend or return of
capital with respect to such shares, then such funds may be used by the Trustees
to purchase additional shares of Common Stock available for future award under
this Plan or the Trustees may distribute such cash received by the Trust along
with the Common Stock upon which it was earned upon the award of such previously
unallocated shares.
(c) The principal of the Trust, and any earnings thereon, shall be held
separate and apart from other funds of the Bank and shall be used exclusively
for the uses and purposes of Participants and general creditors as herein set
forth. Participants and their beneficiaries shall have no preferred claim on,
or any beneficial ownership interest in, any assets of the Trust. Any rights
created under the Plan and the Trust shall be mere unsecured contractual rights
of Participants and their beneficiaries against the Bank. Any assets held by
the Trust will be subject to the claims of the Bank's general creditors under
federal and state law in the event of insolvency or bankruptcy, as defined in
Section 9(e) herein.
2
<PAGE>
Section 4. Eligibility and Award of Plan Shares.
---------- ------------------------------------
(a) The Participants in this Plan to whom Awards may be made shall
be the following: members of the Board, members of the Board of Directors of any
Subsidiary, and such officers and employees of the Bank and/or of any Subsidiary
as may be designated by the Committee.
(b) As promptly as practicable after a determination is made that
an Award of Plan Shares is to be made, the Committee shall notify the
Participant in writing of the grant of the Award, the number of Plan Shares
covered by the Award, and the terms upon which the Plan Shares subject to the
Award shall vest and be distributed to the Participant. Awards of Plan Shares
under this Plan shall be effective upon execution and delivery of the Stock
Grant Agreement which sets forth the terms and conditions of the Award of Plan
Shares (the "Stock Grant Agreement").
(c) Notwithstanding anything to the contrary contained in Sections
4(a) and 4(b) above, no Participant shall have any right or entitlement to
receive a Plan Share Award hereunder, such awards being at the total discretion
of the Committee.
Section 5. Vesting and Distribution of Plan Shares.
---------- ---------------------------------------
(a) Shares granted under this Plan shall vest and the right of a
Participant to the Plan Shares shall be nonforfeitable as determined by the
Committee and as set forth in the Stock Grant Agreement.
(b) In determining the number of shares vested under any applicable
vesting schedule, a Participant shall not receive fractional shares. If the
product resulting from multiplying the vested percentage times the allocated
shares results in a fractional share, then a Participant's vested right shall be
rounded down to the nearest whole number of shares.
(c) In the event any Participant shall no longer be either a
director or an employee of the Bank or any Subsidiary for any reason (whichever
position resulted in the award, as set forth in the Stock Grant Agreement),
other than as provided in Sections 5(d) and 5(e) below, and such Participant
does not have a 100% vested interest in his or her shares under the Plan, then
any shares which are not vested based upon the applicable schedule set forth in
the Stock Grant Agreement shall be forfeited and, provided this Plan has not
terminated pursuant to Section 16 below, shall be available again for Awards to
Participants as may be determined by the Committee.
(d) In the event that a Participant shall no longer be an employee
or a director of the Bank or any Subsidiary (whichever position resulted in the
award, as set forth in the Stock Grant Agreement), because of such Participant's
disability or death, prior to the date when all shares allocated to him or her
would be 100% vested in accordance with the schedule set forth in the Stock
Grant Agreement, then, notwithstanding such vesting schedule, all shares
allocated to such Participant shall immediately become fully vested and
nonforfeitable. For purposes of this Plan, the term "disability" shall be
defined in the same manner as such term is defined in Section 22(e)(3) of the
Internal Revenue Code of 1986, as amended (the "Code").
3
<PAGE>
(e) In the event that a Participant ceases to be an employee or a
director of the Bank or a Subsidiary (whichever position resulted in the award,
as set forth in the Stock Grant Agreement), for any reason after the occurrence
of a "change in control" and prior to the time that all shares allocated to him
or her would be 100% vested in accordance with the schedule set forth in the
Stock Grant Agreement, then, notwithstanding such vesting schedule, all shares
allocated to such Participant shall immediately become fully vested and
nonforfeitable. For purposes of this Plan, a "change in control" shall mean (i)
a change in control of a nature that would be required to be reported by the
Corporation 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 Exchange Act;
(ii) such time as any "person" (as such term is used in Sections 13(d) and 14(d)
of the Exchange Act) other than the Corporation is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of securities of the Corporation or Bank representing 25 percent or
more of the combined voting power of the outstanding Common Stock of the
Corporation or outstanding common stock of the Bank, as applicable; or (iii)
individuals who constitute the board of directors of the Corporation or the
Board on the date hereof (the "Incumbent Board" and "Incumbent 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 Incumbent Board or Incumbent Bank Board, as applicable, or whose
nomination for election by the Corporation's or Bank's shareholders was approved
by the Corporation's or 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 Bank Board, as applicable; or (iv) either the Corporation or the Bank
consolidates or merges with or into another corporation, association or entity
or is otherwise reorganized, where neither the Corporation nor the Bank,
respectively, is the surviving corporation in such transaction; or (v) all or
substantially all of the assets of either the Corporation or the Bank are sold
or otherwise transferred to or are acquired by any other entity or group.
(f) Plan Shares which have vested shall be distributed to the
Participant or any transferee permitted by Section 11 (a "Permitted
Transferee"), as the case may be, as soon as practicable after such Plan Shares
have vested in accordance with the schedule contained in the Stock Grant
Agreement.
(g) The Trustees, the Corporation, the Bank and any Subsidiary
shall have the right to require any Participant or Permitted Transferee to remit
to the Corporation, the Bank or any Subsidiary an amount sufficient to satisfy
any federal, state and/or local withholding tax requirements prior to the
delivery or release of any certificate or certificates for Plan Shares or
delivery of any cash or other assets with respect to Plan Shares or otherwise
pursuant to this Plan. Alternatively, the Trustees, Corporation, Bank and any
Subsidiary may deliver or release Shares or make other distributions of cash or
other assets net of the number of shares or cash sufficient to satisfy the
withholding tax requirements. For withholding tax purposes, the shares of stock,
cash and other assets to be distributed shall be valued on the date the
withholding obligation is incurred.
(h) Each Participant receiving an Award of Plan Shares under this
Plan shall deliver to the Bank a Stock Grant Agreement, which shall be signed by
such Participant.
4
<PAGE>
Section 6. Restrictions on Selling of Plan Shares. Plan Share Awards may
---------- --------------------------------------
not be sold, assigned, pledged or otherwise disposed of prior to the time that
they are vested and distributed pursuant to the terms of this Plan. The Board
of Directors or the Committee may require the Participant or his Permitted
Transferee, as the case may be, to agree not to sell or otherwise dispose of his
distributed Plan Shares except in accordance with all then applicable federal
and state securities laws, and the Board of Directors or the Committee may cause
a legend to be placed on the stock certificate(s) representing the distributed
Plan Shares in order to restrict the transfer of the distributed Plan Shares for
such period of time or under such circumstances as the Board of Directors or the
Committee, upon the advice of counsel, may deem appropriate.
Section 7. Effect of Award on Status of Participant. The fact that an
---------- ----------------------------------------
Award is made to a Participant under this Plan shall not confer on such
Participant any right to continued service on the Board or on the Board of
Directors of any Subsidiary, nor any right to continued employment with the Bank
or any Subsidiary; nor shall it limit the right of the Bank, the Corporation, or
any Subsidiary to remove such Participant from any such boards, or to terminate
his or her employment at any time.
Section 8. Voting Rights; Dividends; Other Distributions. After an Award
---------- ---------------------------------------------
of Plan Shares has been made, the Participant or Permitted Transferee shall be
entitled to direct the Trustees as to the voting of the Plan Shares which are
covered by the Award and which are not yet vested and distributed to him,
subject to rules and procedures adopted by the Committee for this purpose. All
shares of Common Stock held by the Trust which have not been awarded under an
Award of Plan Shares and shares which have been awarded as to which Participants
or Permitted Transferees have not directed the voting shall be voted by the
Trustees in the same proportion as the trustees of the Bank's Employee Stock
Ownership Plan votes Common Stock held in trust associated therewith, and in the
absence of any such voting, shall be voted in the manner directed by the Board
of Directors.
Any cash dividends or other cash or noncash distributions
(including special large and nonrecurring dividends and including one that has
the effect of a return of capital to the Corporation's stockholders) or stock
dividends declared in respect of each unvested Plan Share will be held by the
Trustees for the benefit of the Participant or Permitted Transferee on whose
behalf such Award is then held by the Trust and such dividends, including any
interest thereon, will be paid out proportionately by the Trust to the
Participant or Permitted Transferee thereof as soon as practicable after the
Plan Shares become vested in accordance with the Stock Grant Agreement, or
otherwise. Any cash dividends, cash or noncash distributions or stock dividends
declared in respect of each vested Plan Share held by the Trust will be paid by
the Trust, as soon as practicable after the Trust's receipt thereof, to the
Participant or Permitted Transferee on whose behalf such Plan Share is then held
by the Trust. In the event that the Trust receives cash pursuant to receipt of
dividends or other distributions on Common Stock held by the Trust and
unallocated to participants (including the receipt of a special cash dividend or
return of capital) then such funds may be used by the Trust to purchase
additional shares of Common Stock available for future award under this Plan, or
the Committee or Board may distribute such cash received by the Trust along with
the Common Stock upon which it was earned upon the award of such previously
unallocated shares.
5
<PAGE>
Section 9. Trust.
---------- -----
(a) The Trustees shall receive, hold, administer, invest and make
distributions and disbursements from the Trust in accordance with the provisions
of this Plan and Trust and the applicable directions, rules, regulations,
procedures and policies established by the Board of Directors or the Committee
pursuant to the Plan.
(b) It is the intent of this Plan and Trust that the Trustees shall
have complete authority and discretion with respect to the arrangement, control
and investment of the Trust, and that the Trustees shall invest all assets of
the Trust in Common Stock to the fullest extent practicable, except to the
extent that the Trustees determine that the holding of monies in cash or cash
equivalents is necessary to meet the obligations of the Trust. In performing
their duties, the Trustees shall have the power to do all things and execute
such instruments as may be deemed necessary or proper, including the following
powers;
(i) To invest up to one hundred percent (100%) of all Trust
assets in Common Stock without regard to any law now or hereafter in force
limiting investments for trustees or other fiduciaries. The investment
authorized herein may constitute the only investment of the Trust, and in making
such investment, the Trustees are authorized to purchase Common Stock from the
Corporation or from any other source, and such Common Stock so purchased may be
outstanding, newly issued, or treasury shares.
(ii) To invest any Trust assets not otherwise invested in
accordance with (a) above, in deposit accounts and certificates of deposit at
the Bank or in obligations of the United States Government or its agencies or
such other investments as shall be considered the equivalent of cash.
(iii) To sell, exchange or otherwise dispose of any property
at any time held or acquired by the Trust.
(iv) To cause stocks, bonds or other securities to be
registered in the name of a nominee, without the addition of words indicating
that such security is an asset of the Trust (but accurate records shall be
maintained showing that such security is an assets of the Trust).
(v) To hold cash without interest in such amounts as may in
the opinion of the Trustees be reasonable for the proper operation of the Plan
and Trust.
(vi) To employ brokers, agents, custodians, consultants and
accountants.
(vii) To hire counsel to render advice with respect to their
rights, duties and obligations hereunder, and such other legal services or
representation as the Trustees deem desirable.
(viii) To hold funds and securities representing the amounts to
be distributed to a Recipient or his Beneficiary as a consequence of a dispute
as to the disposition thereof, whether in a segregated account or held in common
with other assets of the Trust.
6
<PAGE>
Notwithstanding anything herein contained to the contrary, the Trustees
shall not be required to make any inventory, appraisal or settlement or report
to any court, or to secure any order of court for the exercise of any power
herein contained, or give bond.
(c) The Trustees shall maintain accurate and detailed records and
accounts of all transactions of the Trust, which shall be available at all
reasonable times for inspection by any legally entitled person or entity to the
extent required by applicable law, or by any other person determined by the
Board of Directors or the Committee.
(d) Notwithstanding anything to the contrary in this Plan or Trust,
the assets of the Plan and Trust are subject to the payment of the claims of
creditors of the Bank in the event of its insolvency or bankruptcy. The Bank is
insolvent or bankrupt if it is the subject of a proceeding under the Bankruptcy
Code, 11 U.S.C. Section 101 et seq. or is unable to pay its debts. The Board of
Directors or the chief executive officer of the Bank must give written notice to
the Trustees of the Corporation's bankruptcy or insolvency as soon as
practicable following the occurrence of such event. Upon receipt of such notice
or other written allegations of the Bank's bankruptcy or insolvency, or in the
case of the Trustees' actual knowledge of or determination of the Bank's
bankruptcy or insolvency, the Trustees shall discontinue delivery of Trust
assets to the Participants or the Bank and shall hold the assets of the Trust
for the benefit of the Bank's general creditors and, upon a determination that
the Bank is bankrupt or insolvent, shall distribute such assets to or for the
benefit of the general creditors. The Trustees shall resume delivery of Trust
assets to the Participants or the Bank only after it is determined that the Bank
is no longer bankrupt or insolvent. Determination of the bankruptcy or
insolvency shall be determined by a court of competent jurisdiction or by an
arbitrator selected by and pursuant to rules of the American Arbitration
Association upon petition by an interested party.
Section 10. Adjustment Upon Changes in Capitalization; Dissolution or
----------- ---------------------------------------------------------
Liquidation. In the event of a change in the number or type of shares of Common
- -----------
Stock outstanding, or in the event shares of Common Stock are decreased, changed
into or exchanged for securities of a different entity, by reason of a
reclassification, recapitalization, reorganization, other similar capital
adjustment; by reason of a merger or consolidation of the Corporation; by
reason of the sale by the Corporation of all or a substantial portion of its
assets; or by reason of the occurrence of any other event which could affect
the implementation of this Plan and the realization of its objectives, the
number or kind of shares subject to Awards which have occurred, or could occur,
under this Plan shall be proportionately and equitably adjusted by the
Committee.
Section 11. Non-Transferability.
----------- -------------------
Prior to the time Plan Share Awards become vested and are distributed by
the Trustees, Plan Share Awards may not be sold, pledged, assigned,
hypothecated, transferred or disposed of in any manner other than by will or by
the laws of descent and distribution. Notwithstanding the foregoing, or any
other provision of this Plan, a Participant who holds Plan Share Awards may
transfer such awards to his or her spouse, lineal ascendants, lineal
descendants, or to a duly established trust for the benefit of one or more of
these individuals. Plan Share Awards so transferred may thereafter be
transferred only to the Participant who originally received the grant or to an
individual or trust to whom the Participant could have initially transferred the
awards pursuant to this Section 11. Plan Share Awards which are transferred
pursuant to this Section 11 shall be subject to the same terms and conditions as
applied to the
7
<PAGE>
Participant. In addition, such shares may be tendered in response to a tender
offer for or a request or invitation to tenders of greater than fifty percent
(50%) of the outstanding Common Stock and may be surrendered in a merger,
consolidation or share exchange involving the Corporation; provided, however, in
each case, that except as otherwise provided herein, the securities or other
consideration received in exchange therefor shall thereafter be subject to the
restrictions and conditions set forth in this Plan.
Section 12. Impact of Award on Other Benefits of Participant. The value
----------- ------------------------------------------------
of any Award, either on the date of the Award or at the time such shares become
vested, shall not be includable as compensation or earnings for purposes of any
other benefit plan offered by the Bank, the Corporation or any Subsidiary other
than any qualified employee benefit plan which provides that such value shall be
included as compensation or earnings for purposes of such plan.
Section 13. Corporate Action. The making of an Award under this Plan
----------- ----------------
shall not affect in any way the right or power of the Corporation or its
shareholders or the Bank or its shareholders or any Subsidiary or its
shareholders to make or authorize any adjustment, recapitalization,
reorganization, or other change in the Corporation's, the Bank's or any
Subsidiary's capital structure or its business, or any merger or consolidation
of the Corporation, the Bank or any Subsidiary, or the issuance of any bonds,
debentures, preferred or other capital stock or rights with respect thereto, or
the dissolution or liquidation of the Corporation, the Bank or any Subsidiary,
or any sale or transfer of all or any part of the Corporation's, the Bank's or
any Subsidiary's assets or business.
Section 14. Exculpation and Indemnification. In connection with this
----------- -------------------------------
Plan, no member of the Board, no member of the Board of Directors of the
Corporation, no member of the Committee and no Trustee shall be personally
liable for any act or omission to act in his capacity as a member of the Board,
the Board of Directors of the Corporation or the Committee or as Trustees, nor
for any mistake in judgment made in good faith, unless arising out of, or
resulting from, such person's own bad faith, willful misconduct, or criminal
acts. To the extent permitted by applicable law and regulation, the Bank shall
indemnify, defend and hold harmless the members of the Board, the members of the
Board of Directors of the Corporation, the members of the Board of Directors of
any Subsidiary, the Committee and each Trustee and each other officer or
employee of the Bank, the Corporation or of any Subsidiary to whom any duty or
power relating to the administration or interpretation of this Plan may be
assigned or delegated, from and against any and all liabilities (including any
amount paid in settlement of a claim with the approval of the Board) and any
costs or expenses (including counsel fees) incurred by such persons arising out
of, or as a result of, any act or omission to act in connection with the
performance of such person's duties, responsibilities, and obligations under
this Plan, other than such liabilities, costs, and expenses as may arise out of,
or result from, the bad faith, willful misconduct, or criminal acts of such
persons.
Section 15. Amendment and Modification of this Plan. The Board may at any
----------- ---------------------------------------
time, and from time to time, amend or modify this Plan (including the form of
Stock Grant Agreement) in any respect, subject to any applicable regulatory
requirements and any required stockholder approval or any stockholder approval
which the Board may deem advisable for any reason, such as for the purpose of
obtaining or retaining any statutory or regulatory benefits under tax,
securities or other laws or satisfying applicable stock exchange or quotation
system listing requirements. However, any amendment or modification of this
Plan shall not in any manner affect any Award of shares theretofore made to a
8
<PAGE>
Participant under this Plan without the consent of such Participant or any
Permitted Transferee of such Participant.
Section 16. Termination and Expiration of this Plan. This Plan may be
----------- ---------------------------------------
abandoned, suspended, or terminated, in whole or in part, at any time by the
Board; provided, however, that abandonment, suspension, or termination of this
Plan shall not affect any Award theretofore made under this Plan. Unless sooner
terminated, this Plan shall terminate at the close of business on the day that
is the tenth (10th) anniversary of the date of approval of the Plan by the
shareholders of the Corporation; and no Award of shares may be made under this
Plan thereafter. Such termination shall not effect any Award of shares
theretofore made. In the event that the Board terminates this Plan in whole,
any shares held by the Trust which have not been allocated to eligible
Participants, together with any other assets held by the Trust, shall revert to
the Bank.
17. Tax Status of Trust. It is intended that the trust established hereby
-------------------
be treated as a Grantor Trust of the Corporation under the provisions of Section
671 et seq. of the Code, as the same may be amended from time to time.
-- ---
18. Miscellaneous.
-------------
(a) This Plan has been adopted by the Board to be effective as of the date
of approval of the Plan by the shareholders of the Corporation.
(b) Captions and paragraph headings used herein are for convenience only,
do not modify or affect the meaning of any provision herein, are not a part
hereof, and shall not serve as a basis for interpretation or construction of
this Plan or Trust. As used herein, the masculine gender shall include the
feminine and neuter, and the singular number shall include the plural, and vice
versa, whenever such meanings are appropriate.
(c) All costs and expenses incurred in the operation and administration of
this Plan shall be borne by the Bank or by a Subsidiary, or in the discretion of
the Bank, the Trust.
(d) Without regard to the principles of conflicts of laws, the laws of the
State of North Carolina shall govern and control the validity, interpretation,
performance, and enforcement of this Plan and Trust.
(e) A copy of this Plan, and any amendments thereto, shall be maintained
by the Secretary of the Bank and shall be shown to any proper person making
inquiry about it.
9
<PAGE>
STATE OF NORTH CAROLINA
COUNTY OF SCOTLAND
STOCK GRANT AGREEMENT
THIS STOCK GRANT AGREEMENT (the "Agreement") is made and entered into as of
the ____ of ___________________, _______ (the "Effective Date"), by and among
Scotland Savings Bank, Inc., SSB (the "Bank"), a North Carolina corporation,
_______________________ (the "Participant") and ______________________,
___________________ and ____________________ (the "Trustees").
WHEREAS, a Management Recognition Plan (the "Plan") was adopted by the
Board of Directors of the Bank (the "Bank") and approved by the Board of
Directors and by the shareholders of Scotland Bancorp, Inc., the holding company
of the Bank (the "Corporation") on ________________, 1997.
WHEREAS, it has been determined that it is desirable and in the best
interest of the Bank to make an award (the "Award") of certain shares of the
Common Stock of the Corporation, under the Plan, to the Participant, subject to
certain restrictions as specified below; and
WHEREAS, capitalized terms not otherwise defined herein shall have the same
meaning given to such terms in the Plan.
NOW, THEREFORE, the Parties agree as follows:
1. Date of Award. The date of making the Award under this Agreement is
-------------
the _____ day of _________________, ______. This Award has been made in
recognition of the Participant's status and service as a ____________________ of
_____________________________________________. The Participant is ____ or _____
is not a director or executive officer of the Bank.
2. Award of Plan Shares. The Participant is awarded, in the aggregate,
--------------------
___________________________ (__________) shares of Common Stock (the "Plan
Shares"), which shares become vested and nonforfeitable pursuant to paragraph 5
of this Agreement.
3. Investment Representation and Transfer Restrictions.
---------------------------------------------------
(a) Investment Representation. Participant makes and agrees to the
-------------------------
investment representation, if any, attached hereto as Annex A, and the Committee
may cause a legend to be placed on any certificate representing any of the Plan
Shares to make appropriate reference to such representation, as necessary.
(b) Securities Law and Regulations. The Participant agrees that the Plan
-------------------------------
Shares shall be subject to such stop-transfer orders and other restrictions as
the Committee may deem advisable under the rules, regulations, and other
requirements of the Securities and Exchange Commission, any stock exchange or
interdealer quotation system upon which the Common Stock is then listed and any
other applicable federal or state securities laws, rules or regulations, and the
Committee may cause a legend or legends to be placed on any certificate
representing any of the Plan Shares to make appropriate reference to such
restrictions.
(c) Other Transfer Restrictions. (Intentionally omitted.)
---------------------------
<PAGE>
4. Receipt by the Trustees. The Trustees acknowledge and agree that the
-----------------------
Plan Shares shall be held by the Trustees and distributed or transferred in
accordance with the Plan and as set forth herein.
5. Vesting and Delivery of Plan Shares by the Trustees.
---------------------------------------------------
(a) Periodic Vesting. Plan Shares shall vest and become nonforfeitable
----------------
in accordance with the following schedule:
_________ shares on ___________________, 19___
_________ shares on ___________________, 19___
_________ shares on ___________________, 19___
_________ shares on ___________________, 20___
In addition, Plan Shares shall become vested and nonforfeitable upon disability,
death and a change in control as set forth in the Plan.
(b) Delivery of Vested Plan Shares to the Participant. After the date
-------------------------------------------------
on which the Plan Shares have become vested as provided in this Agreement and in
the Plan, the Committee shall instruct the Trustees to deliver to the
Participant, the Participant's designee, such other person as shall have been
designated as Participant's beneficiary in accordance with this Agreement, or
any other permitted recipient pursuant to the Plan, as applicable, certificates
representing the Plan Shares which have become vested and nonforfeitable, as the
Committee shall determine, free from any restrictions imposed by this Agreement
other than such restrictions and conditions as may be deemed necessary by the
Committee pursuant to paragraph 3 above.
(c) Delivery of Forfeited Plan Shares. If the Plan Shares, or any of
---------------------------------
them, are forfeited pursuant to the Plan, the Committee shall instruct the
Trustees concerning the disposition of such forfeited shares. Thereafter such
forfeited shares shall cease to be subject to this Agreement.
6. Payment of Dividends. As soon as practicable after the Plan Shares have
--------------------
become vested and delivered, the Trustees shall pay to the Participant, the
Participant's designee, such other person as shall have been designated as
Participant's beneficiary in accordance with the Agreement or any other
permitted recipient pursuant to the Plan, the proportional amount of any cash or
stock dividend, or other cash or noncash distributions,including any interest
earned thereon, declared in respect of such vested Plan Shares, which had been
held in the Trust for the benefit of the above-named person(s).
7. Designation of Beneficiary. The Participant hereby designates the
--------------------------
person(s) described on Annex B as the beneficiary or beneficiaries who shall be
entitled to receive the Plan Shares and other assets, if any, distributable to
the Participant upon his death. The Participant may, from time to time, revoke
or change his beneficiary designation without the consent of any prior
beneficiary, if any, by filing a new designation with the Committee. The last
such designation received by the Committee shall be controlling; provided,
however, that no designation, or change or revocation thereof, shall be
effective unless received by the Committee prior to the Participant's death, and
in no event shall it be effective as of a date prior to such receipt.
11
<PAGE>
If no such beneficiary designation is in effect at the time of the
Participant's death, or if no designated beneficiary survives the Participant,
or if such designation conflicts with law, the Participant's estate shall be
deemed to have been designated his beneficiary and shall receive the Plan Shares
and other assets, if any, distributable to the Participant upon his death. If
the Committee is in doubt as to the right of any person to receive such
distribution, the Committee may direct the Trustees to retain the Plan Shares
and other assets, without liability for any interest in respect thereof, until
the rights thereto are determined, or the Committee may direct the transfer of
such Plan Shares into any court of appropriate jurisdiction and such transfer
shall be deemed a complete discharge of the obligations of the Bank, the
Corporation, the Committee and Trustees hereunder.
8. Effect of Award on Status of Participant. The fact that an Award has
----------------------------------------
been made to the Participant under this Plan shall not confer on the Participant
any right to continued service on the Board, on the board of directors of the
Corporation or on the board of directors of any Subsidiary, nor to continued
employment with the Bank, the Corporation or any Subsidiary; nor shall it limit
the right of the Bank, the Corporation or of any Subsidiary to remove the
Participant from any such boards, or to terminate his employment at any time
without prior notice.
9. Impact of Award on Other Benefits of Participant. The value of the
------------------------------------------------
Plan Shares on the date of the Award or at the time the Plan Shares becomes
vested, shall not be includable as compensation or earnings for purposes of any
other benefit plan offered by the Bank, the Corporation or any Subsidiary other
than any qualified employee benefit plan which provides that such value shall be
included as compensation or earnings for purposes of such plans.
10. Tax Withholding. All Plan Shares distributed pursuant to this
---------------
Agreement shall be subject to applicable federal, state and local withholding
for taxes. The Participant expressly acknowledges and agrees to such
withholding without regard to whether the Plan Shares may then be sold or
otherwise transferred by the Participant. The Participant acknowledges and
agrees to the tax withholding provisions which are set forth in the Plan.
11. Notices. Any notices or other communications required or permitted to
-------
be given under this Agreement shall be in writing and shall be deemed to have
been sufficiently given if delivered personally or three business days after
deposit in the United States mail by Certified Mail, return receipt requested,
properly addressed and postage prepaid, if to the Bank, the Committee or the
Trustees at the Bank's principal office address at 505 South Main Street,
Laurinburg, North Carolina 28352; and, if to the Participant, at his last
address appearing on the books of the Bank. The Bank and the Participant may
change their address or addresses by giving written notice of such change as
provided herein. Any notice or other communication hereunder shall be deemed to
have been given on the date actually delivered or as of the third (3rd) business
day following the date mailed as set forth above, as the case may be.
12. Construction Controlled by Plan. The Plan, a copy of which is
-------------------------------
attached hereto as Annex C, is incorporated herein by reference. The Award of
Restricted Shares shall be subject to the terms and conditions of the Plan, and
the Participant hereby assumes and agrees to comply with all of the obligations
imposed upon the Participant in the Plan. This Agreement shall be construed so
as to be consistent with the Plan; and the provisions of the Plan shall be
deemed to be controlling in the event that any provision hereof should appear to
be inconsistent therewith.
12
<PAGE>
13. Severability. Whenever possible, each provision of this Agreement
------------
shall be interpreted in such a manner as to be valid and enforceable under
applicable law, but if any provision of this Agreement is determined to be
unenforceable, invalid or illegal, the validity of any other provision or part
thereof shall not be affected thereby and this Agreement shall continue to be
binding on the parties hereto as if such unenforceable, invalid or illegal
provision or part thereof had not been included herein.
14. Governing Law. Without regard to the principles of conflicts of laws,
-------------
the laws of the State of North Carolina shall govern and control the validity,
interpretation, performance, and enforcement of this Agreement.
15. Modification of Agreement; Waiver. This Agreement may be modified,
---------------------------------
amended, suspended or terminated, and any terms, representations or conditions
may be waived, but only by a written instrument signed by each of the parties
hereto or their successors in interest. No waiver hereunder shall constitute a
waiver with respect to any subsequent occurrence or other transaction hereunder
or of any other provision hereof.
16. Binding Effect. This Agreement shall be binding upon and shall inure
--------------
to the benefit of the parties hereto, and their respective heirs, legatees,
personal representatives, executors, and administrators, successors and assigns.
17. Entire Agreement. This Agreement and the Plan constitute and embody
----------------
the entire understanding and agreement of the parties hereto and, except as
otherwise provided hereunder, there are no other agreements or understandings,
written or oral, in effect between the parties hereto relating to the matters
addressed herein.
18. Counterparts. This Agreement may be executed in any number of
------------
counterparts, each of which when executed and delivered shall be deemed an
original, but all of which taken together shall constitute one and the same
instrument.
19. Substitution of Trustees. In the event any new trustee is substituted
------------------------
for any Trustee pursuant to the Plan, such substitute trustee shall also be
substituted as a Trustee hereunder.
13
<PAGE>
IN WITNESS WHEREOF, the Bank has caused this instrument to be executed in
its corporate name by its President, or one of its Vice Presidents, and attested
by its Secretary or one of its Assistant Secretaries, and its corporate seal to
be hereto affixed, all by, authority of its Board of Directors first duly given;
and each individual party hereto has hereunto set his hand and adopted as his
seal the typewritten word "SEAL" appearing beside his name, all done this the
day and year first above written.
SCOTLAND SAVINGS BANK, INC., SSB
By:
-------------------------------------
President
----------------------
ATTEST:
- ---------------------------------
Secretary
- -----------------
[Corporate Seal]
PARTICIPANT
(SEAL)
--------------------------------
(SEAL)
--------------------------------
TRUSTEE
(SEAL)
--------------------------------
TRUSTEE
(SEAL)
--------------------------------
TRUSTEE
14
<PAGE>
ANNEX A
Investment Representation
-------------------------
<PAGE>
ANNEX B
Management Recognition Plan
---------------------------
Beneficiary Designation Form
----------------------------
As Beneficiary to receive any shares of stock distributable on my behalf
pursuant to the Scotland Savings Bank, Inc., SSB Management Recognition Plan, I
hereby designate the following:
Name Address Relationship
Primary Beneficiary: ___________________________________________________________
___________________________________________________________
___________________________________________________________
Contingent Beneficiary:
(if any) ___________________________________________________________
___________________________________________________________
___________________________________________________________
If more than one primary beneficiary is named, shares will be paid in equal
shares to surviving primary beneficiaries. Should the contingent beneficiaries
be eligible to receive the benefits (i.e., all primary beneficiaries are
deceased), such benefits will be paid in equal shares to such surviving
contingent beneficiaries.
Name of Spouse if not given above: _____________________________________________
- ------------------------------------ -----------------------------------------
Witness Participant
-----------------------------------------
Date
<PAGE>
ANNEX C
Management Recognition Plan
---------------------------
<PAGE>
SCOTLAND BANCORP, INC.
STOCK OPTION PLAN
THIS IS THE STOCK OPTION PLAN ("Plan") of Scotland Bancorp, Inc. (the
"Corporation"), a North Carolina corporation, with its principal office in
Laurinburg, Scotland County, North Carolina, adopted by the Board of Directors
of the Corporation and effective upon the approval of the Plan by the
shareholders of the Corporation, under which options may be granted from time to
time to eligible directors and employees of the Corporation, Scotland Savings
Bank, Inc., SSB (the "Bank") and of any corporation or other entity of which
either the Corporation or the Bank owns, directly or indirectly, not less than
50% of any class of equity securities (a "Subsidiary"), to purchase shares of
common stock of the Corporation ("Common Stock"), subject to the provisions set
forth below:
1. PURPOSE OF THE PLAN. The purpose of the Plan is to aid the
-------------------
Corporation, the Bank and any Subsidiary in attracting and retaining capable
directors and employees and to provide a long range incentive for directors and
employees to remain in the management of the Corporation, the Bank or any
Subsidiary, to perform at increasing levels of effectiveness and to acquire a
permanent stake in the Corporation with the interest and outlook of an owner.
These objectives will be promoted through the granting of options to acquire
shares of Common Stock pursuant to the terms of this Plan.
2. ADMINISTRATION. The Plan shall be administered by a committee (the
--------------
"Committee"), which shall consist of not less than two members of the Board of
Directors of the Corporation (the "Board") who are "Non-Employee Directors" as
defined in Rule 16b-3(b)(3) of the Rules and Regulations under the Securities
Act of 1934 (the "Exchange Act"). Members of the Committee shall serve at the
pleasure of the Board. In the absence at any time of a duly appointed
Committee, this Plan shall be administered by the Board. The Committee may
designate any officers or employees of the Corporation, the Bank or any
Subsidiary to assist in the administration of the Plan and to execute documents
on behalf of the Committee and perform such other ministerial duties as may be
delegated to them by the Committee.
Subject to the provisions of the Plan, the determinations or the
interpretation and construction of any provision of the Plan by the Committee
shall be final and conclusive upon all persons affected thereby. By way of
illustration and not of limitation, the Committee shall have the discretion (a)
to construe and interpret the Plan and all options granted hereunder and to
determine the terms and provisions (and amendments thereof) of the options
granted under the Plan (which need not be identical); (b) to define the terms
used in the Plan and in the options granted hereunder; (c) to prescribe, amend
and rescind the rules and regulations relating to the Plan; (d) to determine the
individuals to whom and the time or times at which such options shall be
granted, the number of shares to be subject to each option, the option price,
and the determination of leaves of absence which may be granted to participants
without constituting a termination of their employment for the purposes of the
Plan; and (e) to make all other determinations necessary or advisable for the
administration of the Plan.
It shall be in the discretion of the Committee to grant options which
qualify as "incentive stock options," as that term is defined in Section 422 of
the Internal Revenue Code of 1986, as amended (the
<PAGE>
"Code") ("Incentive Stock Options") or which do not qualify as Incentive Stock
Options ("Nonqualified Stock Options") (herein referred to collectively as
"Options;" however, whenever reference is specifically made only to "Incentive
Stock Options" or "Nonqualified Stock Options," such reference shall be deemed
to be made to the exclusion of the other). Any options granted which fail to
satisfy the requirements for Incentive Stock Options shall become Nonqualified
Stock Options.
3. STOCK AVAILABLE FOR OPTIONS. In the discretion of the Committee, the
---------------------------
stock to be subject to Options under the Plan shall be authorized but unissued
shares of Common Stock which are issued directly to optionees upon exercise of
options and/or shares of Common Stock which are acquired by the Plan or the
Corporation in the open market. The total number of shares of Common Stock for
which Options may be granted under the Plan is 184,000 shares, which is 10% of
the total number of shares of Common Stock issued by the Corporation in
connection with the conversion of the Bank from a North Carolina mutual savings
bank to a North Carolina stock savings bank on March 29, 1996 (the
"Conversion"). Such number of shares is subject to any capital adjustments as
provided in Section 16. In the event that an Option granted under the Plan is
forfeited, released, expires or is terminated unexercised as to any shares
covered thereby, such shares thereafter shall be available for the granting of
Options under the Plan; however, if the forfeiture, expiration, release or
termination date of an Option is beyond the term of existence of the Plan as
described in Section 21, then any shares covered by forfeited, unexercised,
released or terminated options shall not reactivate the existence of the Plan
and therefore may not be available for additional grants under the Plan. The
Corporation, during the term of the Plan, will reserve and keep available a
number of shares of Common Stock sufficient to satisfy the requirements of the
Plan. In the discretion of the Committee, the shares of Common Stock necessary
to be delivered to satisfy exercised options may be from authorized and unissued
shares of Common Stock or may be purchased in the open market.
4. ELIGIBILITY. Options shall be granted only to individuals who meet
-----------
all of the following eligibility requirements:
(a) Such individual must be an employee or a member of the Board of
Directors of the Corporation, the Bank or a Subsidiary. For this purpose, an
individual shall be considered to be an "employee" only if there exists between
the Corporation, the Bank or a Subsidiary and the individual the legal and bona
fide relationship of employer and employee. In determining whether such
relationship exists, the regulations of the United States Treasury Department
relating to the determination of such relationship for the purpose of collection
of income tax at the source on wages shall be applied.
(b) Such individual must have such knowledge and experience in financial
and business matters that he or she is capable of evaluating the merits and
risks of the investment involved in the exercise of the Options.
(c) Such individual, being otherwise eligible under this Section 4, shall
have been selected by the Committee as a person to whom an Option shall be
granted under the Plan.
In determining the directors and employees to whom Options shall be granted
and the number of shares to be covered by each Option, the Committee shall take
into account the nature of the services rendered by respective directors and
employees, their present and potential contributions to
2
<PAGE>
the success of the Corporation, the Bank and any Subsidiary and such other
factors as the Committee shall deem relevant. A director or employee who has
been granted an Option under the Plan may be granted an additional Option or
Options under the Plan if the Committee shall so determine.
If, pursuant to the terms of the Plan, it is necessary that the percentage
of stock ownership of any individual be determined, stock ownership in the
Corporation or of a related corporation which is owned (directly or indirectly)
by or for such individual's brothers and sisters (whether by the whole or half
blood), spouse, ancestors, and lineal descendants or by or for any corporation,
partnership, estate or trust of which such employee is a shareholder, partner or
beneficiary shall be considered as owned by such director or employee.
5. OPTION GRANTS. Subject to the provisions of this Plan, Options shall
-------------
be awarded to the directors and employees in such amounts as are determined by
the Committee. The proper officers on behalf of the Corporation and each
Optionee shall execute a Stock Option Grant and Agreement (the "Option
Agreement") which shall set forth the total number of shares of Common Stock to
which it pertains, the exercise price, whether it is a Nonqualified Stock Option
or an Incentive Stock Option, and such other terms, conditions, restrictions and
privileges as the Committee in each instance shall deem appropriate, provided
they are not inconsistent with the terms, conditions and provisions of this
Plan. Each Optionee shall receive a copy of his executed Option Agreement. Any
Option granted with the intention that it will be an Incentive Stock Option but
which fails to satisfy a requirement for Incentive Stock Options shall continue
to be valid and shall be treated as a Nonqualified Stock Option.
6. OPTION PRICE.
------------
(a) The option price of each Option granted under the Plan shall be not
less than 100% of the market value of the stock on the date of grant of the
Option. In the case of incentive stock options granted to a shareholder who
owns stock possessing more than 10% of the total combined voting power of all
classes of stock of the Corporation, the Bank or a Subsidiary (a "ten percent
shareholder"), the option price of each Option granted under the Plan shall not
be less than 110% of the market value of the stock on the date of grant of the
Option. If the Common Stock is listed on a national securities exchange
(including for this purpose the Nasdaq Stock Market, Inc. National Market) on
the date in question, then the market value per share shall be not less than the
average of the highest and lowest selling price on such exchange on such date,
or if there were no sales on such date, then the market price per share shall be
equal to the average between the bid and asked price on such date. If the Common
Stock is traded otherwise than on a national securities exchange (including for
this purpose the Nasdaq Stock Market, Inc. National Market) on the date in
question, then the market price per share shall be equal to the average between
the bid and asked price on such date, or, if there is no bid and asked price on
such date, then on the next prior business day on which there was a bid and
asked price. If no such bid and asked price is available, then the market value
per share shall be its fair market value as determined by the Committee, in its
sole and absolute discretion. The Committee shall maintain a written record of
its method of determining such value.
3
<PAGE>
(b) The option price shall be payable to the Corporation either (i) in
cash or by check, bank draft or money order payable to the order of the
Corporation, or (ii) at the discretion of the Committee, through the
delivery of shares of the common stock of the Corporation owned by the
optionee with a market value (determined in a manner consistent with (i)
above) equal to the option price, or (iii) at the discretion of the
Committee by a combination of (i) and (ii) above. No shares shall be
delivered until full payment has been made.
7. EXPIRATION OF OPTIONS. The Committee shall determine the expiration
---------------------
date or dates of each Option, but such expiration date shall be not later than
10 years after the date such Option is granted. In the event an Incentive Stock
Option is granted to a ten percent shareholder, the expiration date or dates of
each Option shall be not later than 5 years after the date such Option is
granted. The Committee, in its discretion, may extend the expiration date or
dates of an Option after such date was originally set; however, such expiration
date may not exceed the maximum expiration date described in this Section 7.
8. TERMS AND CONDITIONS OF OPTIONS.
-------------------------------
(a) All Options must be granted within 10 years of the Effective Date
of this Plan as defined in Section 20.
(b) The Committee may grant Options which are intended to be Incentive
Stock Options and Nonqualified Stock Options, either separately or jointly,
to an eligible employee.
(c) The grant of Options shall be evidenced by a written instrument (an
Option Agreement) containing terms and conditions established by the
Committee consistent with the provisions of this Plan.
(d) Not less than 100 shares may be purchased at any one time unless
the number purchased is the total number at that time purchasable under the
Plan.
(e) The recipient of an Option shall have no rights as a shareholder
with respect to any shares covered by his Option until payment in full by
him for the shares being purchased. No adjustment shall be made for
dividends (ordinary or extraordinary, whether in cash, securities or other
property) or distributions or other rights for which the record date is
prior to the date such stock is fully paid for, except as provided in
Section 16.
4
<PAGE>
(f) The aggregate fair market value of the stock (determined as of the
time the Option is granted) with respect to which Incentive Stock Options are
exercisable for the first time by any participant during any calendar year
(under all benefit plans of the Corporation, the Bank or any Subsidiary, if
applicable) shall not exceed $100,000; provided, however, that such $100,000
limit of this subsection (f) shall not apply to the grant of Nonqualified Stock
Options. The Committee may grant Options which are exercisable in excess of the
foregoing limitations, in which case Options granted which are exercisable in
excess of such limitation shall be Nonqualified Stock Options.
(g) All stock obtained pursuant to an option which qualifies as an
Incentive Stock Option shall be held in escrow for a period which ends on the
later of (i) two (2) years from the date of the granting of the Option or (ii)
one (1) year after the transfer of the stock pursuant to the exercise of the
Option. The stock shall be held by the Corporation or its designee. The
employee who has exercised the Option shall during such holding period have all
rights of a shareholder, including but not limited to the rights to vote,
receive dividends and sell the stock. The sole purpose of the escrow is to
inform the Corporation of a disqualifying disposition of the stock within the
meaning of Section 422 of the Code, as amended, and it shall be administered
solely for that purpose.
9. EXERCISE OF OPTIONS.
-------------------
(a) Options granted to an optionee by virtue of his position as a
nonemployee director of the Corporation or the Bank (as stated in the Option
Agreement) or to an employee by virtue of his position as an employee (as stated
in the Option Agreement) shall become vested and exercisable at the times, at
the rate and subject to such limitations as may be set forth in the Option
Agreement executed in connection therewith; provided, however, that all
outstanding and nonforfeited options shall be exercisable, if not sooner, on the
day prior to the expiration date thereof.
(b) Unless the Committee shall specifically state otherwise at the time an
Option is granted, all Options granted hereunder shall become vested and
exercisable upon the optionee's death, retirement or disability within the
meaning of Section 22(e)(3) of the Code, and in the event of a change in control
as set forth in Section 13 of this Plan.
(c) The exercise of any Option must be evidenced by written notice to the
Corporation that the optionee intends to exercise his Option. In no event shall
an Option be deemed granted by the Corporation or exercisable by a recipient
prior to the mutual execution by the Corporation and the recipient of an Option
Agreement which comports with the requirements of Section 5 and Section 8(c).
(d) Any right to exercise Options in annual installments shall be
cumulative and any vested installments may be exercised, in whole or in part, at
the election of the optionee.
5
<PAGE>
(e) The inability of the Corporation or Bank to obtain approval from any
regulatory body or authority deemed by counsel to be necessary to the lawful
issuance and sale of any shares of Common Stock hereunder shall relieve the
Corporation and the Bank of any liability in respect of the non-issuance or sale
of such shares. As a condition to the exercise of an option, the Corporation
may require the person exercising the Option to make such representations and
warranties as may be necessary to assure the availability of an exemption from
the registration requirements of federal or state securities laws.
(f) The Committee shall have the discretionary authority to impose in the
Option Agreements such restrictions on shares of Common Stock as it may deem
appropriate or desirable, including but not limited to the authority to impose a
right of first refusal or to establish repurchase rights or both of these
restrictions.
(g) Notwithstanding anything to the contrary herein, an optionee receiving
the grant of an Option by virtue of his or her position as a director or as an
employee of the Corporation, the Bank or a Subsidiary (as stated in the Option
Agreement), shall be required to exercise his or her Options within the periods
set forth in Sections 10, 11 and 12 below.
10. TERMINATION OF EMPLOYMENT - EXCEPT BY DISABILITY, RETIREMENT OR
---------------------------------------------------------------
DEATH. If any optionee receiving the grant of an Option by virtue of his
- -----
position as a director (as stated in the Option Agreement) ceases to be a
director of the Corporation, the Bank or any Subsidiary for any reason other
than death, retirement (as defined in Section 11) or disability (as defined in
Section 11) or if any optionee receiving the grant of an Option by virtue of his
position as an employee (as stated in the Option Agreement) ceases to be an
employee of the Corporation, the Bank or any Subsidiary for any reason other
than death, retirement (as defined in Section 11) or disability (as defined in
Section 11), he may, (i) at any time within three (3) months after his date of
termination, but not later than the date of expiration of the Option, exercise
any Option designated in the Option Agreement as an Incentive Stock Option and
(ii) at any time prior to the date of expiration of the Option, exercise any
option designated in the Option Agreement as a Nonqualified Stock Option.
However, in either such event the optionee may exercise any Option only to the
extent it was vested and he or she was entitled to exercise the Option on the
date of termination. Any Options or portions of Options of terminated optionees
not so exercised shall terminate and be forfeited.
11. TERMINATION OF EMPLOYMENT - DISABILITY OR RETIREMENT. If any
----------------------------------------------------
optionee receiving the grant of an Option by virtue of his position as a
director (as stated in the Option Agreement) ceases to be a director of the
Corporation, the Bank or any Subsidiary due to his becoming disabled within the
meaning of Section 22(e)(3) of the Code, or if any employee receiving the grant
of an Option by virtue of his position as an employee (as stated in the Option
Agreement) ceases to be employed by the Corporation, the Bank or any Subsidiary
due to his becoming disabled within the meaning of Section 22(e)(3) of the Code,
all unvested and forfeitable Options of such optionee shall immediately become
vested and nonforfeitable and he may, (i) at any time within 12 months after his
date of termination, but not later than the date of expiration of the Option,
exercise any option designated in the Option Agreement as an Incentive Stock
Option with respect to all shares subject thereto and (ii) at any time prior to
the date of expiration of the Option, exercise any Option designated in the
Option Agreement as a Nonqualified Stock Option with
6
<PAGE>
respect to all shares subject thereto. Any portions of Options of optionees who
are terminated because they become disabled which are not so exercised shall
terminate.
If any optionee receiving the grant of an Option by virtue of his position
as a director (as stated in the Option Agreement) ceases to be a director of the
Corporation, the Bank or any Subsidiary due to his retirement, or if any
employee receiving the grant of an Option by virtue of his position as an
employee (as stated in the Option Agreement) ceases to be employed by the
Corporation, the Bank or any Subsidiary due to his retirement, all unvested and
forfeitable Options of such optionee shall immediately become vested and
nonforfeitable and he may at any time prior to the date of expiration of the
Option, exercise such Option, provided, however, that if the Option is exercised
more than three (3) months after such retirement, the Option may be treated as a
Nonqualified Stock Option. Any portions of Options of retired directors or
employees not so exercised shall terminate. For purposes of this Plan, the term
"retirement," as it relates to any optionee receiving a grant of an Option as a
result of his or her position as an employee of the Corporation, the Bank or any
Subsidiary, shall mean (i) the termination of the optionee's employment under
conditions which would constitute retirement under any tax qualified retirement
plan maintained by the Corporation, the Bank or a Subsidiary, or (ii)
termination of employment after attaining age 65. The term "retirement," as it
relates to any optionee receiving a grant of an Option as a result of his or her
position as a director, shall mean the cessation of membership on such board of
directors (i) with the approval of such board of directors, at any time after
such optionee reaches age 65, or (ii) at the election of the optionee at any
time after not less than 25 years of service as a member of the such board of
directors, as applicable.
12. TERMINATION OF EMPLOYMENT - DEATH. If an optionee receiving the
---------------------------------
grant of an option by virtue of his position as a director (as stated in the
Option Agreement) dies while a director of the Corporation, the Bank or any
Subsidiary or if any employee receiving the grant of an option by virtue of his
position as an employee (as stated in the Option Agreement) dies while in the
employment of the Corporation, the Bank or a Subsidiary, all unvested and
forfeitable Options of such optionee shall immediately become vested and
nonforfeitable and the person or persons to whom the Option is transferred by
will or by the laws of descent and distribution may exercise the Option at any
time until the term of the Option has expired, with respect to all shares
subject thereto, to the same extent and upon the same terms and conditions the
optionee would have been entitled to do so had he lived. Any Options or
portions of options of deceased directors or employees not so exercised shall
terminate.
13. CHANGE IN CONTROL. In the event that an optionee ceases to be an
-----------------
employee or a director of the Corporation, the Bank or a Subsidiary (which
position resulted in his or her receipt of an option pursuant to this Plan) for
any reason after the occurrence of a "change in control" and prior to the time
that all shares allocated to him or her would be 100% vested, nonforfeitable and
exercisable in accordance with Sections 9 and 10 above, then, notwithstanding
Sections 9 and 10 above, all Options granted to such optionee shall immediately
become fully vested and nonforfeitable. For purposes of this Plan, a "change in
control" shall mean (i) a change in control of a nature that would be required
to be reported by the Corporation 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 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 Corporation or Bank representing 25% or more of
the
7
<PAGE>
combined voting power of the outstanding Common Stock of the Corporation or
outstanding common stock of the Bank, as applicable; or (iii) individuals who
constitute the Board or the board of directors of the Bank on the date hereof
(the "Incumbent Board" and "Incumbent 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 Incumbent
Board or Incumbent Bank Board, as applicable, or whose nomination for election
by the Corporation's or Bank's shareholders was approved by the Corporation's or
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 Bank Board, as
applicable; or (iv) either the Corporation or the Bank consolidates or merges
with or into another corporation, association or entity or is otherwise
reorganized, where neither the Corporation nor the Bank, respectively, is the
surviving corporation in such transaction; or (v) all or substantially all of
the assets of either the Corporation or the Bank are sold or otherwise
transferred to or are acquired by any other entity or group.
As set forth in Section 10, in the event of such a termination after a
change in control, the Optionee must exercise any Incentive Stock Options within
three (3) months after his date of termination, but in no event later than the
date of expiration of the Option and may exercise any Nonqualified Stock Options
at any time prior to the date of expiration of the Option.
14. OPTIONAL CASH PAYMENT. Upon the exercise of an Option, at the
---------------------
written request of the optionee, the Committee, in its sole and absolute
discretion, may make a cash payment to the optionee, in whole or in part, in
lieu of the delivery of shares of Common Stock. Such cash payment to be paid in
lieu of delivery of Common Stock shall be equal to the difference between the
market value per share (determined as set forth in Section 6 above) of Common
Stock on the date of the Option exercise and the exercise price per share of the
Option. Such cash payment shall be in exchange for the cancellation of such
Option. Notwithstanding the above, such cash payment shall not be made in the
event that such transaction would result in liability to the optionee and the
Company under Section 16(b) of the Exchange Act, and the regulations promulgated
thereunder.
15. RESTRICTIONS ON TRANSFER. An Option granted under this Plan may not
------------------------
be transferred except by will or the laws of descent and distribution and,
during the lifetime of the optionee to whom it was granted, may be exercised
only by such optionee.
16. CAPITAL ADJUSTMENTS AFFECTING COMMON STOCK.
------------------------------------------
(a) If the outstanding shares of Common Stock of the Corporation are
increased, decreased, changed into or exchanged for a different number or kind
of shares or other securities of the Corporation or another entity as a result
of a recapitalization, reclassification, stock dividend, stock split, amendment
to the Corporation's Certificate of Incorporation, reverse stock split, merger
or consolidation, an appropriate adjustment shall be made in the number and/or
kind of securities allocated to the Options previously and subsequently granted
under the Plan, without change in the aggregate purchase price applicable to the
unexercised portion of the outstanding Options but with a corresponding
adjustment in the price for each share or other unit of any security covered by
the Options.
8
<PAGE>
(b) In the event that the Corporation shall declare and pay any dividend
with respect to the Common Stock (other than a dividend payable in shares of the
Corporation's Common Stock or a regular quarterly cash dividend), including a
dividend which results in a nontaxable return of capital to the holders of
shares of Common Stock for federal income tax purposes, or otherwise than by
dividend makes distribution of property to the holders of its shares of Common
Stock, the Committee, in its discretion applied uniformly to all outstanding
Options, may adjust the exercise price per share of outstanding Options in such
a manner as the Committee may determine to be necessary to reflect the effect of
the dividend or other distribution on the fair market value of a share of Common
Stock.
(c) To the extent that the foregoing adjustments described in Sections
16(a) and (b) above relate to particular Options or to particular stock or
securities of the Corporation subject to Option under this Plan, such
adjustments shall be made by the Committee, whose determination in that respect
shall be final and conclusive.
(d) The grant of an Option pursuant to this Plan shall not affect in any
way the right or power of the Corporation to make adjustments,
reclassifications, reorganizations or changes of its capital or business
structure or to merge or to consolidate or to dissolve, liquidate or sell, or
transfer all or any part of its business or assets.
(e) No fractional shares of stock shall be issued under the Plan for any
such adjustment.
(f) Any adjustment made pursuant to this Section 16, shall be made, to the
extent practicable, in such manner as not to constitute a modification of any
outstanding Incentive Stock Options within the meaning of Section 424(h) of the
Code.
17. INVESTMENT PURPOSE. At the discretion of the Committee, any Option
------------------
Agreement may provide that the optionee shall, by accepting the Option,
represent and agree, for himself and his transferees by will or the laws of
descent and distribution, that all shares of stock purchased upon the exercise
of the Option will be acquired for investment and not for resale or
distribution, and that upon each exercise of any portion of an Option, the
person entitled to exercise the same shall furnish evidence of such facts which
is satisfactory to the Corporation. Certificates for shares of stock acquired
under the Plan may be issued bearing such restrictive legends as the Corporation
and its counsel may deem necessary to ensure that the optionee is not an
"underwriter" within the meaning of the regulations of the Securities Exchange
Commission.
18. APPLICATION OF FUNDS. The proceeds received by the Corporation from
--------------------
the sale of Common Stock pursuant to Options will be used for general corporate
purposes.
19. NO OBLIGATION TO EXERCISE. The granting of an Option shall impose
-------------------------
no obligation upon the optionee to exercise such Option.
20. EFFECTIVE DATE OF PLAN. The Plan will become effective upon the
----------------------
approval of the Plan by the shareholders of the Corporation and receipt of any
necessary regulatory approvals.
9
<PAGE>
21. TERM OF PLAN. Options and may be granted pursuant to this Plan from
------------
time to time within ten (10) years from the effective date of the Plan.
22. TIME OF GRANTING OF OPTIONS. Nothing contained in the Plan or in
---------------------------
any resolution adopted or to be adopted by the Committee or the shareholders of
the Corporation and no action taken by the Committee shall constitute the
granting of any Option hereunder. The granting of an Option pursuant to the
Plan shall take place only when an Option Agreement shall have been duly
executed and delivered by and on behalf of the Corporation at the direction of
the Committee.
23. WITHHOLDING TAXES. Whenever the Corporation proposes or is required
-----------------
to cause to be issued or transferred shares of stock, cash or other assets
pursuant to this Plan, the Corporation shall have the right to require the
optionee to remit to the Corporation an amount sufficient to satisfy any
federal, state and/or local withholding tax requirements prior to the issuance
of any certificate or certificates for such shares or delivery of such cash or
other assets. Alternatively, the Corporation may issue or transfer such shares
of stock or make other distributions of cash or other assets net of the number
of shares or other amounts sufficient to satisfy the withholding tax
requirements. For withholding tax purposes, the shares of stock, cash and other
assets to be distributed shall be valued on the date the withholding obligation
is incurred.
24. TERMINATION AND AMENDMENT. The Board may at any time alter,
-------------------------
suspend, terminate or discontinue the Plan, subject to any applicable regulatory
requirements and any required stockholder approval or any stockholder approval
which the Board may deem advisable for any reason, such as for the purpose of
obtaining or retaining any statutory or regulatory benefits under tax,
securities or other laws or satisfying applicable stock exchange or quotation
system listing requirements. The Board may not, without the consent of the
holder of an Option previously granted, make any alteration which would deprive
the optionee of his rights with respect thereto.
25. CAPTIONS AND HEADINGS; GENDER AND NUMBER. Captions and paragraph
----------------------------------------
headings used herein are for convenience only, do not modify or affect the
meaning of any provision herein, are not a part, and shall not serve as a basis
for interpretation or construction of, this Plan. As used herein, the masculine
gender shall include the feminine and neuter, and the singular number shall
include the plural, and vice versa, whenever such meanings are appropriate.
10
<PAGE>
26. COST OF PLAN; EXCULPATION AND INDEMNIFICATION. All costs and
---------------------------------------------
expenses incurred in the operation and administration of the Plan shall be borne
by the Corporation, the Bank and the Subsidiaries. In connection with this
Plan, no member of the Board, no member of the Board of Directors of the Bank,
and no member of the Board of Directors of any Subsidiary, and no member of the
Committee shall be personally liable for any act or omission to act, nor for any
mistake in judgment made in good faith, unless arising out of, or resulting
from, such person's own bad faith, willful misconduct or criminal acts. To the
extent permitted by applicable law and regulation, the Corporation shall
indemnify, defend and hold harmless the members of the Board, the members of the
Board of Directors of the Bank and the members of the Board of Directors of any
Subsidiary, and members of the Committee, and each other officer or employee of
the Bank, the Corporation or of any Subsidiary to whom any power or duty
relating to the administration or interpretation of this Plan may be assigned or
delegated, from and against any and all liabilities (including any amount paid
in settlement of a claim with the approval of the Board), and any costs or
expenses (including counsel fees) incurred by such persons arising out of or as
a result of, any act or omission to act, in connection with the performance of
such person's duties, responsibilities and obligations under this Plan, other
than such liabilities, costs, and expenses as may arise out of, or result from
the bad faith, willful misconduct or criminal acts of such persons.
27. GOVERNING LAW. Without regard to the principles of conflicts of
-------------
laws, the laws of the State of North Carolina shall govern and control the
validity, interpretation, performance, and enforcement of this Plan.
28. INSPECTION OF PLAN. A copy of this Plan, and any amendments
------------------
thereto, shall be maintained by the Secretary of the Corporation and shall be
shown to any proper person making inquiry about it.
29. OTHER PROVISIONS. The Option Agreements authorized under this Plan
----------------
shall contain such other provisions not inconsistent with the foregoing,
including, without limitation, increased restrictions upon the exercise of
options, as the Committee may deem advisable.
11
<PAGE>
STOCK OPTION GRANT AND AGREEMENT
THIS STOCK OPTION GRANT AND AGREEMENT ("Agreement"), being made according
to and subject to the terms and conditions of the STOCK OPTION PLAN of Scotland
Bancorp, Inc. ("Plan"), a copy of which is attached hereto as Annex A and is
hereby incorporated by reference and made a part of this Agreement, is herein
executed and effective the ____ day of _______________, _____, between Scotland
Bancorp, Inc. (the "Corporation") and ____________________ ("Optionee"):
1. Grant. As of the above date, the Corporation hereby grants to
-----
the Optionee (applicable provisions are marked):
[_] an Incentive Stock Option [as that term is defined in Section 422
of the Internal Revenue Code of 1986, as amended (the "Code")] to
purchase ________ shares of Common Stock of the Corporation at the
price stated in this Agreement;
[_] a Nonqualified Stock Option to purchase __________ shares of
Common Stock of the Corporation at the price stated in this Agreement.
The Option(s) granted under this section and as described in this
Agreement is (are) in all respects subject to and conditioned by the
terms, definitions, and provisions of this Agreement and of the Plan.
Capitalized terms in this Agreement which are not otherwise defined
but which are defined in the Plan shall have the same meaning given to
those terms in the Plan.
The Optionee has been granted Options under the Plan as a result of
the Optionee's position as a [_] director [_] employee of the
Corporation or the Bank.
2. Price. The Option price is $_____________ for each share.
-----
3. Exercise of Option. The Option(s) granted under this Agreement
------------------
shall be exercisable pursuant to the terms and conditions of
the Plan and as set forth below:
(a) Right to Exercise: In addition to the terms and conditions
-----------------
imposed on the Optionee's right to exercise his Options imposed in the
Plan, the following terms and conditions are applicable:
----------------------------------------------------------------------
----------------------------------------------------------------------
12
<PAGE>
(b) [_] (Marked if applicable) Annual Installments: Subject to the
-------------------
terms and conditions of the Plan, the Incentive Stock Options can be
exercised in annual installments as follows:
__________________ shares beginning on ______________, 19__
__________________ shares beginning on ______________, 19__
__________________ shares beginning on ______________, 19__
__________________ shares beginning on ______________, 20__
Subject to the terms and conditions of the Plan, the Nonqualified
Options can be exercised in annual installments as follows:
__________________ shares beginning on ______________, 19__
__________________ shares beginning on ______________, 19__
__________________ shares beginning on ______________, 19__
__________________ shares beginning on ______________, 20__
The right to exercise the Option(s) in annual installments shall be
cumulative. In addition, the option(s) shall be exercisable upon
disability, death, retirement and a change in control as set forth in
the Plan.
(c) [_] (Marked if applicable) Immediate Vesting: Subject to the
-----------------
terms and conditions of the Plan, all of the Options are vested,
nonforfeitable and exercisable.
(d) Method of Exercise: The Options granted under this Agreement
------------------
shall be exercisable by a written notice to the Secretary of the
Corporation which shall:
(1) State the election to exercise the Option, the number of
shares in respect of which the Option is being exercised, the
person in whose name any stock certificate or certificates for
such shares of Common Stock is to be registered or to whom any
cash is to be paid, his or her address, and social security
number;
(2) Contain any such representation and agreements as to
Optionee's investment intent with respect to shares of Common
Stock as may be required by the Committee;
(3) Be signed by the person entitled to exercise the Option
and, if the Option is being exercised by any person or persons
other than the Optionee, be accompanied by proof, satisfactory
to the
13
<PAGE>
Corporation, of the right of such person or persons to
exercise the Option in accordance with the Plan; and
(4) Be accompanied by payment of the purchase price of any
shares with respect to which the Option is being exercised
which payment shall be in form acceptable to the Committee
pursuant to Section 6(b) of the Plan.
(e) Representations and Warranties: In order to exercise an
------------------------------
Option, the person exercising the Option must make the representations
and warranties to the Corporation as may be required by any applicable
law or regulation, or as may otherwise be required pursuant to the
Plan.
(f) Approvals. In order for an Option to be exercised, all filings
---------
and approvals required by applicable law and regulations or pursuant
to the Plan must have been made and obtained.
4. Non-transferability. This Option may not be transferred in any
-------------------
manner otherwise than by will or the laws of descent and distribution
and such Option may be exercised during the life of the Optionee only
by him or her.
5. Investment Purpose. This Option may not be exercised if the issuance
------------------
of shares or payment of cash upon such exercise would constitute a
violation of any applicable federal or state securities law or other
law or valid regulation.
6. Expiration. This Option shall expire on _____________, _________.
----------
7. Escrow. All stock purchased pursuant to an Incentive Stock Option
------
shall be held in escrow for a period which ends on the later of (i)
two (2) years from the date of the granting of the option or (ii) one
(1) year after the transfer of the stock pursuant to the exercise of
the Option. The stock shall be held by the Corporation or its
designee. The Optionee who has exercised the Option shall have all
rights of a stockholder, including, but not limited to, the rights to
vote, receive dividends and sell the stock. The sole purpose of the
escrow is to inform the Corporation of a disqualifying disposition of
the stock within the meaning of Section 422 of the Code, and it shall
be administered solely for this purpose.
14
<PAGE>
8. Tax Withholding. All stock, cash and other assets distributed pursuant
---------------
to this Agreement shall be subject to applicable federal, state and
local withholding for taxes. The Optionee expressly acknowledges and
agrees to such withholding. The Optionee acknowledges and agrees to
the tax withholding provisions which are set forth in the Plan.
9. Resolution of Disputes. Any dispute or disagreement which should arise
----------------------
under, or as a result of, or in any way relate to, the interpretation,
construction, or application of this Agreement or the Plan will be
determined by the Committee designated in Section 2 of the Plan. Any
determination made by such Committee shall be final, binding, and
conclusive for all purposes.
10. Construction Controlled by Plan. The Options evidenced hereby shall be
-------------------------------
subject to all of the requirements, conditions and provisions of the
Plan. This Agreement shall be construed so as to be consistent with
the Plan; and the provisions of the Plan shall be deemed to be
controlling in the event that any provision should appear to be
inconsistent therewith.
11. Severability. Whenever possible, each provision of this Agreement
------------
shall be interpreted in such a manner as to be valid and enforceable
under applicable law, but if any provision of this Agreement is
determined to be unenforceable, invalid or illegal, the validity of
any other provision or part thereof shall not be affected thereby and
this Agreement shall continue to be binding on the parties hereto as
if such unenforceable, invalid or illegal provision or part thereof
had not been included herein.
12. Modification of Agreement; Waiver. This Agreement may be modified,
---------------------------------
amended, suspended or terminated, and any terms, representations or
conditions may be waived, but only by a written instrument signed by
each of the parties hereto and only subject to the limitations set
forth in the Plan. No waiver hereunder shall constitute a waiver with
respect to any subsequent occurrence or other transaction hereunder or
of any other provision.
13. Captions and Headings; Gender and Number. Captions and paragraph
----------------------------------------
headings used herein are for convenience only, do not modify or affect
the meaning of any provision herein, are not a part, and shall not
serve as a basis for interpretation or construction, of this
Agreement. As used herein, the masculine gender shall include the
feminine and neuter, and the singular number shall include the plural,
and vice versa, whenever such meanings are appropriate.
15
<PAGE>
14. Governing Law; Venue and Jurisdiction. Without regard to the
-------------------------------------
principles of conflicts of laws, the laws of the State of North
Carolina shall govern and control the validity, interpretation,
performance, and enforcement of this Agreement.
15. Binding Effect. This Agreement shall be binding upon and shall inure
--------------
to the benefit of the Corporation, and its successors and assigns, and
shall be binding upon and inure to the benefit of the Optionee, and
his or her heirs, legatees, personal representative, executor,
administrator and permitted assigns.
16. Entire Agreement. This Agreement and the Plan constitute and embody
----------------
the entire understanding and agreement of the parties hereto and,
except as otherwise provided hereunder, there are no other agreements
or understandings, written or oral, in effect between the parties
hereto relating to the matters addressed herein.
17. Counterparts. This Agreement may be executed in any number of
------------
counterparts, each of which when executed and delivered shall be
deemed an original, but all of which taken together shall constitute
one and the same instrument.
IN WITNESS WHEREOF, the parties have set their hands and seals the day and
year first above written.
ATTEST: SCOTLAND BANCORP, INC.
By:
- ---------------------------------- ------------------------------------
(Corporate Seal) President
----------------------
OPTIONEE:
(SEAL)
----------------------------------
16
<PAGE>
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
The weighted average number of shares outstanding includes all shares
issued and outstanding of 1,913,600 less 147,200 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, 1997, plus the pro rata portion of shares which
have vested under the Bank's Management Recognition Plan through September 30,
1997.
<TABLE>
<S> <C>
Net income for the period from September 30, 1996 to September 30,
1997 $1,258,260
Weighted average number of shares outstanding 1,705,453
Earnings per share $0.74
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
SELECTED CONSOLIDATED FINANCIAL DATA
September 30,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
-----------------------------------------------------------------------
(Dollars In Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C>
Financial Condition Data:
Total assets $ 64,399 $ 68,622 $ 57,718 $ 57,715 $ 55,068
Investments securities /(1)/ 16,110 21,464 14,525 19,273 12,791
Loans receivable, net 46,463 45,079 41,204 36,661 40,626
Deposits 43,140 42,410 48,203 48,995 47,477
Stockholders' equity /(2)/ 14,561 24,791 8,580 7,761 6,875
Book value per share /(2)/ 7.61 13.47 -- -- --
</TABLE>
<TABLE>
<CAPTION>
Years Ended September 30,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
-----------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C>
Operating Data:
Interest and dividend income $ 5,171 $ 4,870 $ 4,313 $ 3,889 $ 4,249
Interest expense 1,983 2,209 2,144 1,753 1,979
-----------------------------------------------------------------------
Net interest income 3,188 2,661 2,169 2,136 2,270
Provision for loan losses 24 25 11 20 25
Noninterest income 306 80 73 71 71
Noninterest expense 1,680 1,549 1,158 1,263 1,114
-----------------------------------------------------------------------
Income before income taxes 1,790 1,167 1,073 924 1,202
Income tax expense 532 409 352 292 470
-----------------------------------------------------------------------
Net income $ 1,258 $ 758 $ 721 $ 632 $ 732
=======================================================================
Earnings per share /(2)//(3)/ $ 0.74 $ 0.25 $ -- $ -- $ --
Dividends per share /(2)/ 6.30 0.15 -- -- --
Dividend payment ratio /(2)//(6)/ 851.35% 60.00% -- -- --
</TABLE>
(Continued)
1
<PAGE>
<TABLE>
<CAPTION>
Years Ended September 30,
-----------------------------------------------------------------------
1997 1996 1995 1994 1993
-----------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C>
Selected Other Data:
Return on average assets 1.84% 1.18% 1.25% 1.13% 1.33%
Return on average equity 5.14% 4.31% 8.52% 8.49% 11.21%
Average equity to average assets 35.80% 27.38% 14.67% 13.31% 11.86%
Interest rate spread 3.05% 2.84% 3.27% 3.50% 3.78%
Net interest margin 4.75% 4.15% 3.87% 3.94% 4.24%
Efficiency ratio /(5)/ 48.08% 56.51% 51.65% 57.23% 47.59%
Allowance for loan losses to
nonperforming loans /(4)/ 830.00% 714.97% 0.00% 0.00% 0.00%
Nonperforming loans to total loans 0.06% 0.07% 0.00% 0.00% 0.00%
</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.. The Bank issued regular
cash dividends per share totaling $0.30 and $0.15 for the years ended
September 30, 1997 and 1996 and a return of capital dividend of $6.00
during the year ended September 30, 1997.
/(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 for the year ended September 30, 1996.
/(4)/ Nonperforming loans include mortgage loans and consumer/commercial loans
90 days or more delinquent.
/(5)/ The efficiency ratio represents non-interest expense as a percentage of
the sum of net interest income and non-interest income.
/(6)/ The dividend payment ratio represents dividends per share as a percent of
earnings per share. Dividends per share include a $6.00 return of capital
dividend during the year ended September 30, 1997.
2
<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 for 1997 and 1996, and changes in
financial position for the years ended September 30, 1997 and 1996,
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 (the "Conversion"), 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. On September 30, 1997,
approximately 99% of the Bank's net loan portfolio was composed of real estate
loans.
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.
Because the Company has no operations and conducts no business other than as
described above, the discussion contained in this "Management's Discussion and
Analysis" concerns primarily the business of the Bank. However, for ease of
reading, and because the financial statements are presented on a consolidated
basis, the Company and the Bank are collectively referred to herein as the
"Company", unless otherwise noted.
4
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Comparison of Financial Condition at September 30, 1997 and 1996
Total consolidated assets decreased by $4.2 million during 1997, from $68.6
million at September 30, 1996 to $64.3 million at September 30, 1997. The
decrease resulted primarily from the Company's utilization of cash and
investments to assist funding of the special return of capital dividend of $6
per share on the Company's 1,913,600 issued and outstanding shares of stock,
totaling $11.5 million.
Investments, including short term interest-earning deposits, federal funds sold,
U.S. Treasury and agency obligations, municipal obligations, and mortgage-backed
securities decreased by $5.4 million, primarily as a result of the return of
capital dividend. Funds generated from operations also provided a source for
cash to purchase additional investments.
Loans receivable increased by approximately $1.4 million during 1997 to $46.5
million at September 30, 1997. 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 1997 and 1996 to be average for its market.
Savings deposits increased by approximately $730,000 during 1997 and totaled
$43.1 million at September 30, 1997. The increase is a recovery from the prior
year decrease which was attributable to the withdrawal of deposits by account
holders to purchase shares of common stock of the Company in the Conversion.
The Company had $5.5 million in borrowings outstanding at September 30, 1997.
The $5.5 million in borrowings was incurred to facilitate disbursement of the
return of capital dividend and was repaid subsequent to year end (See Note 7 to
the consolidated financial statements). During 1997, the Bank obtained no
advances from the Federal Home Loan Bank, however the Bank retains borrowing
capacity through the Federal Home Loan Bank of Atlanta.
The Company's return on average assets was 1.84% and 1.18%, and its return on
average equity was 5.14% and 4.31%, for 1997 and 1996, 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 9 to the consolidated financial statements).
The Bank is required to meet certain capital requirements as established by the
FDIC and the North Carolina Savings Institutions Division. At September 30,
1997, the Bank's capital was significantly in excess of regulatory capital
requirements (See Note 10 to the consolidated financial statements).
5
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Comparison of Operating Results for 1997 and 1996
Net Income
Net income for the years ended September 30, 1997 and 1996 was $1,258,260 and
$757,519, respectively. Net income in 1996 would have been approximately
$208,000 higher than reported earnings without the income tax effected expense
associated with the special assessment that occurred as a result of the
legislation to recapitalize the 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 1997 and 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 ("net
earning balance"). The following table on page 7 sets forth information relating
to average balances of the Company's assets and liabilities for the years ended
September 30, 1997 and 1996. For the periods indicated, the table reflects the
average yield on interest-earning assets and the average cost of
interest-bearing liabilities (derived by dividing income or expense by the
monthly average balance of interest-earning assets or interest-bearing
liabilities, respectively) as well as the net yield on interest-earning assets
(which reflects the impact of the net earning balance). Nonaccruing loans were
included in the computation of average balances.
Interest Income
Total interest income increased by $301,711 during 1997, from $4,869,707 in 1996
to $5,171,418 in 1997. The increase in interest income during 1997 was
attributable to a $3.0 million increase in the average balance of
interest-earning assets due primarily to the proceeds received from the stock
offering. The Bank's overall yield on interest-earning assets increased slightly
during 1997, from 7.60% in 1996 to 7.70% in 1997. During 1996, interest income
increased by approximately $556,000 due primarily to an increase in the Bank's
average balance of interest-earning assets totaling approximately $8.1 million.
Interest Expense
Total interest expense decreased to $1,982,955 in 1997 from $2,208,854 in 1996,
a decrease of $225,899 or 10.2%. Scotland Savings's cost of funds was 4.65% in
1997 as compared to 4.76% in 1996. Changes in the Bank's cost of funds during
1997 was similar to changes in overall market rates. The Bank's average balance
of outstanding deposits decreased by approximately $2.3 million during 1997
resulting in a decrease in interest expense for the period. Additionally, the
average balance on borrowings declined $1.5 million to $15,000 for 1997 from
$1.5 million during 1996. Interest on borrowed funds had an immaterial impact on
the increase in interest expense in 1997.
6
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------------
1997
At -------------------------------------------------------
September
30, 1997 (Dollars in Thousands)
Average
Yield/ Average Average
Rate(4) Balance Interest Yield/Rate
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
Assets:
Interest earning assets:
Interest-bearing deposits 5.58% $ 4,194 $ 237 5.65%
Investments, at cost (1) 5.74% 14,587 934 6.40%
Mortgage-backed securities 11.25% 466 52 11.16%
Loans receivable 8.10% 47,890 3,948 8.24%
------------- ------------- -------------
Total interest-earning assets 7.54% 67,137 $ 5,171 7.70%
-------------
Non-interest earning assets 1,415
-------------
Total $ 68,552
=============
Liabilities and retained earnings:
Interest-bearing liabilities:
Passbook accounts 2.92% $ 4,094 $ 119 2.91%
Transaction accounts 3.51% 8,562 249 2.91%
Certificates of deposit 5.45% 29,952 1,614 5.39%
FHLB advances - - - -
Other 6.50% 15 1 6.67%
------------- ------------- -------------
Total interest-bearing liabilities 5.00% 42,623 $ 1,983 4.65%
-------------
Non-interest bearing liabilities 1,448
Equity 24,481
-------------
Total $ 68,552
=============
Net interest income and interest
rate spread (2) 2.54% 3,188 3.05%
=============
Net yield on interest-earning
assets (3) 4.75%
Ratio of interest-earning assets to
interest-bearing liabilities 157.51%
</TABLE>
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------------
1997
-------------------------------------------------------
(Dollars in Thousands)
Average Average
Balance Interest Yield/Rate
------------ ------------- -------------
<S> <C> <C> <C>
Assets:
Interest earning assets:
Interest-bearing deposits $ 6,059 $ 326 5.38%
Investments, at cost (1) 14,550 840 5.77%
Mortgage-backed securities 605 68 11.24%
Loans receivable 42,878 3,635 8.48%
----------- -------------
Total interest-earning assets 64,092 $ 4,869 7.60%
-------------
Non-interest earning assets 345
-----------
Total $ 64,437
============
Liabilities and retained earnings:
Interest-bearing liabilities:
Passbook accounts $ 5,541 $ 160 2.89%
Transaction accounts 7,024 194 2.76%
Certificates of deposit 32,339 1,808 5.59%
FHLB advances 958 47 4.91%
Other 587 - -
------------- -------------
Total interest-bearing liabilities 46,449 $ 2,209 4.76%
-------------
Non-interest bearing liabilities 400
Equity 17,588
-------------
Total $ 64,437
=============
Net interest income and interest
rate spread (2) 2,660 2.84%
=============
Net yield on interest-earning
assets (3) 4.15%
Ratio of interest-earning assets to
interest-bearing liabilities 137.98%
</TABLE>
(1) Includes investment securities and FHLB of Atlanta 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.
(4) The weighted average rate represents the coupon associated with each asset
and liability, weighted by the principle balance associated with each asset
and liability.
7
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Rate/Volume Analysis
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 on page 9 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) net change (the sum of the previous
columns). The change attributable to both rate and volume (changes in rate
multiplied by changes in volume) has been allocated equally to both the changes
attributable to volume and the changes attributable to rate.
Provision For Loan Losses and Asset Quality
The Bank's provision for loan losses amounted to $24,000 and $24,528 for the
years ended September 30, 1997 and 1996, 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 the 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, 1997 and 1996. Scotland Savings'
charged-off loans amounted to $492 and $6,648 for the years ended 1997 and 1996,
respectively.
Noninterest Income
Noninterest income amounted to $306,272 and $80,298 in 1997 and 1996,
respectively. Noninterest income consists primarily of service charges and fees
associated with the Bank's loan and savings accounts. The increase in Scotland
Savings's level of noninterest income during 1997 relates mainly to the gain on
sale of investments of $240,726 (See Note 2 of the consolidated financial
statements).
8
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
1997 vs. 1996 1996 vs. 1995
-------------------------------------------- ---------------------------------------------
Increase (Decrease) Attributable to Increase (Decrease) Attributable to
-------------------------------------------- ---------------------------------------------
Volume Rate Rate/Volume Net Volume Rate Rate/Volume Net
--------- -------- ----------- --------- -------- --------- ----------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income on:
Interest-bearing deposits $ (100) $ 16 $ (5) $ (89) $ 133 $ (36) $ (19) $ 78
Investments, at cost 2 92 - 94 106 20 3 129
Mortgage-backed securities (15) (1) - (16) (13) 3 (1) (11)
Loans receivable 425 (103) (9) 313 353 6 - 359
--------- -------- ----------- --------- -------- --------- ----------- --------
Total interest income on
interest-earning assets 312 4 (14) 302 579 (7) (17) 555
--------- -------- ----------- --------- -------- --------- ----------- --------
Interest expense on:
Passbook accounts (42) 1 - (41) 33 3 - 36
Transaction accounts 42 11 2 55 (50) (20) 4 (66)
Certificates of deposit (133) (65) 4 (194) (130) 192 (14) 48
FHLB advances and other (46) - - (46) - - 47 47
--------- -------- ----------- --------- -------- --------- ----------- --------
Total interest expense
on interest-bearing liabilities (179) (53) 6 (226) (147) 175 37 65
--------- -------- ----------- --------- -------- --------- ----------- --------
Increase (decrease) in net
interest income $ 491 $ 57 $ (20) $ 528 $ 726 $ (182) $ (54) $ 490
========= ======== =========== ========= ======== ========= =========== ========
</TABLE>
9
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
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 $1,680,265 and $1,549,739 in 1997 and
1996, respectively.
Compensation and employee benefits increased by $433,399 during 1997 primary due
to expenses associated with the ESOP and the Management Recognition Plan which
totaled $408,093 and $33,006 for the years ended September 30, 1997 and 1996
respectively. Deposit insurance, excluding the special SAIF assessment in 1996,
fluctuates with the level of deposits outstanding during the periods and
decreased $96,156 to $31,661 in 1997 compared to $127,817 in 1996. Noninterest
expenses were increased by the one time SAIF assessment of $320,750 in 1996.
None of the other noninterest expense categories changed significantly during
1997 and 1996.
Income Taxes
The Company's effective income tax rate was 29.72% and 35.08% in 1997 and 1996,
respectively. The differences in rates were due to changes in the components of
permanent tax differences (See Note 8 to the consolidated financial statements).
Capital Resources and Liquidity
Scotland Bancorp, Inc. paid regular cash dividends of $.30 per share during the
year ended September 30, 1997. The Company also paid a special return of capital
dividend of $6 per share during the last quarter of 1997. 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, 1997, cash and cash equivalents, a
significant source of liquidity, increased by approximately $1.7 million. Cash
and cash equivalents increased by $2.0 million during 1996. Cash flow resulting
from internal operating activities provided increases of $1,173,256 and
$1,139,430 in cash during the years ended September 30, 1997 and 1996,
respectively. Also, financing activities have provided sources of funds for
asset growth and liquidity. For the year ended September 30, 1997, deposits
increased by $730,000 and borrowings provided $5.5 million in cash but the
return of capital dividends decreased cash by $11.5 million. Deposits decreased
by approximately $5.8 million while proceeds from the issuance of common stock
provided funds totaling $17.4 million during 1996.
10
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
during 1996. 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 1997 and 1996, loans outstanding increased
by $1.4 million and $3.9 million, respectively. During 1997 and 1996, the
Company purchased investment securities amounting to $11.1 million and $9.7
million, respectively, and received proceeds from sales or maturities of
investment securities amounting to $18.6 million and $4.7 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, 1997,
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.
Asset/Liability Management
Scotland Savings'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 "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, 1997, 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
11
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
be repriced rapidly. In addition to shortening the average repricing of its
assets, the Bank has sought to be price rate competitive in the marketplace on
its maturing certificates of deposit to encourage depositors to reinvest in
certificates with the Bank. The Bank has approximately $25.3 million in
certificates maturing in 1998 and management believes that substantially all of
the maturing certificates will be renewed.
Although the Company's asset/liability management program has generally helped
to decrease the exposure of its earnings to interest rate increases, the Company
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. Modeling used by the Company
indicates that, as of September 30, 1997, its net portfolio value (present value
of cash flows from assets, liabilities and off-balance sheet items) could
decrease by 29.57% in the event of an instantaneous and permanent 200 basis
point increase in market interest rates and could increase by 34.49% in the
event of a 200 basis point decrease in market rates. Such modeling also
indicates that, as of September 30, 1997, such a 200 basis point increase in
market rates would result in a 9% decrease in net interest income and that a 200
basis point decrease in such rates would result in a 6% increase in net interest
income.
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.
Future Reporting Requirements
The FASB has issued SFAS No. 128, Earnings Per Share, which the Company has not
been required to adopt as of September 30, 1997. The Statement, which will be
effective for the Company's interim period ending after December 15, 1997,
specifies the computation, presentation and disclosure requirements for earnings
per share. The Company does not anticipate the effect of adoption of SFAS No.
128 to significantly impact earnings per share presentation.
The FASB has issued SFAS No. 130, Reporting Comprehensive Income, which the
Company has not been required to adopt as of September 30, 1997. The Statement,
which is effective for fiscal years beginning after December 15, 1997,
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. This statement requires that all items
that are recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements.
12
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Impact of New Legislation
Deposit Insurance/SAIF Recapitalization
For 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.
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.
13
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
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 $340,000 over a six year
period. The tax associated with the recaptured reserves is approximately
$130,000. 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. The Bank was able to delay the recapture
of its bad debt reserves for the 1997 year. 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.
14
<PAGE>
[LOGO OF MCGLADREY & PULLEN, LLP APPEARS HERE]
McGLADREY & PULLEN, LLP
-----------------------
Certified Public Accountants and Consultants
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, 1997 and 1996, 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, 1997 and 1996, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
McGladrey & Pullen, LLP
Charlotte, North Carolina
October 23, 1997
15
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents:
Interest-bearing deposits $ 2,931,343 $ 4,251,813
Noninterest-bearing deposits 626,905 754,110
Federal funds sold 3,200,000 100,000
Securities held to maturity (fair value 1997 $494,060;
1996 $2,493,515) (Note 2) 500,000 2,502,326
Securities available for sale (Note 2) 8,460,850 13,465,261
Nonmarketable equity securities, at cost (Note 2) 599,400 599,400
Loans receivable, net (Note 3) 46,463,348 45,078,860
Mortgage-backed securities, held to maturity, (fair value 1997
$481,325; 1996 $616,580) (Note 4) 418,657 545,290
Accrued interest receivable on loans 160,821 129,094
Accrued interest receivable on investment securities 49,938 223,190
Office properties and equipment, net (Note 5) 792,359 819,474
Prepaid expenses and other assets 195,666 152,747
---------------------------------
Total assets $ 64,399,287 $ 68,621,565
=================================
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
-----------------------------------------------------------------------------------------------------------------
Liabilities:
Savings deposits (Note 6) $ 43,139,725 $ 42,409,568
Note payable (Note 7) 5,500,000 -
Accounts payable and accrued expenses (Note 12) 447,422 404,558
Advances from borrowers for taxes and insurance 160,229 156,525
Special SAIF assessment (Note 9) - 320,750
Income taxes payable 37,383 136,090
Deferred income taxes (Note 8) 553,766 402,802
---------------------------------
Total liabilities 49,838,525 43,830,293
---------------------------------
Commitments and contingencies (Notes 13 and 16)
Stockholder's Equity (Note 10):
Preferred stock, authorized 5,000,000 shares; none issued - -
Common stock, no par value, authorized 20,000,000 shares;
1997 1,913,600 shares issued; 1996 1,840,000 shares issued - -
Additional paid-in capital 7,939,945 17,420,468
Note receivable from ESOP (Note 15) (1,708,545) (1,772,292)
Unrealized gain on securities available for sale, net of tax (Note 2) 518,552 411,135
Deferred management recognition plan (Note 14) (824,167) -
Unearned compensation (Note 15) (834,558) -
Retained earnings, substantially restricted (Notes 8 and 10) 9,469,535 8,731,961
---------------------------------
Total stockholder's equity 14,560,762 24,791,272
---------------------------------
Total liabilities and stockholders' equity $ 64,399,287 $ 68,621,565
=================================
</TABLE>
See Notes to Consolidated Financial Statements.
16
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended September 30, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
-----------------------------------------------------------------------------------------------------------------
Interest and dividend income:
<S> <C> <C>
Loans $ 3,948,280 $ 3,635,301
Investment securities 934,000 840,176
Mortgage-backed securities 51,846 68,193
Other interest-bearing deposits 237,292 326,037
------------------------------------
5,171,418 4,869,707
------------------------------------
Interest expense:
Deposits (Note 6) 1,982,058 2,162,223
Federal Home Loan Bank advances and other 897 46,631
------------------------------------
1,982,955 2,208,854
------------------------------------
Net interest income 3,188,463 2,660,853
Provision for loan losses (Note 3) 24,000 24,528
------------------------------------
Net interest income after provision for loan losses 3,164,463 2,636,325
------------------------------------
Noninterest income:
Gain (loss) on sale of investments (Note 2) 240,726 (2,462)
Service charges and other fees 44,183 54,059
Other 21,363 28,701
------------------------------------
306,272 80,298
------------------------------------
Noninterest expenses:
Compensation and employee benefits 1,103,882 670,483
Occupancy 86,990 88,859
Insurance 31,661 127,817
Special SAIF assessment (Note 9) -- 320,750
Data processing 94,871 97,490
Furniture and fixture expense 29,660 37,039
Other 333,201 207,301
------------------------------------
1,680,265 1,549,739
------------------------------------
Income before income taxes 1,790,470 1,166,884
------------------------------------
Income taxes (Note 8):
Current 487,272 512,893
Deferred 44,938 (103,528)
------------------------------------
532,210 409,365
------------------------------------
Net income $ 1,258,260 $ 757,519
====================================
Earnings per share (Note 1) $ 0.74 $ 0.25
====================================
Regular cash dividends per share $ 0.30 $ 0.15
====================================
Return of capital dividend per share $ 6.00 $ -
====================================
</TABLE>
See Notes to Consolidated Financial Statements.
17
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended September 30, 1997 and 1996
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Deferred
Additional Note Management
Paid in Receivable Recognition
Capital ESOP Plan
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, September 30, 1995 $ - $ - $ -
Net proceeds from issuance of
common stock 17,419,336 - -
Purchase of common
stock by the ESOP - (1,772,292) -
ESOP contribution 1,132 - -
Cash dividends - - -
Change in net unrealized gain on
securities available for sale - - -
Net income - - -
---------------------------------------------------------------------------
Balance, September 30, 1996 17,420,468 (1,772,292) -
Cash dividends - - -
Return of capital dividend (10,647,042) - -
Change in net unrealized gain on
securities available for sale - - -
Adoption of deferred management
recognition plan 1,150,000 (1,150,000)
Vesting of deferred management
recognition plan - - 325,833
ESOP contribution 16,519 - -
Principal payment on note
receivable from ESOP - 63,747 -
Net income - - -
---------------------------------------------------------------------------
Balance, September 30, 1997 $ 7,939,945 $ (1,708,545) $ (824,167)
===========================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
18
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
Unrealized
Gain on
Securities Total
Unearned Available Retained Stockholders'
Compensation for Sale Earnings Equity
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
$ - $ 351,300 $ 8,228,805 $ 8,580,105
- - - 17,419,336
- - - (1,772,292)
- - - 1,132
- - (254,363) (254,363)
- 59,835 - 59,835
- - 757,519 757,519
- ----------------------------------------------------------------------------------------------------
- 411,135 8,731,961 24,791,272
- - (520,686) (520,686)
(834,558) - - (11,481,600)
- 107,417 - 107,417
- - - -
- - - 325,833
- - - 16,519
- - - 63,747
- - 1,258,260 1,258,260
- ----------------------------------------------------------------------------------------------------
$ (834,558) $ 518,552 $ 9,469,535 $ 14,560,762
====================================================================================================
</TABLE>
19
<PAGE>
(This page intentionally left blank)
20
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows From Operating Activities
Net income $ 1,258,260 $ 757,519
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 36,017 45,463
Provision for loan losses 24,000 24,528
Net amortization/(accretion) on securities (7,729) 3,179
Net (gain) loss on sale of securities available for sale (240,726) 2,462
ESOP contribution expense 16,519 1,132
Vesting of deferred management recognition plan 325,833 -
Deferred income taxes 44,938 (103,528)
Changes in assets and liabilities:
(Increase) decrease in:
Accrued interest receivable,
prepaid expenses and other assets 98,606 (65,661)
Increase (decrease) in:
Income taxes payable (98,707) 124,741
Accounts payable and accrued expenses 36,995 28,845
Special SAIF assessment (320,750) 320,750
----------------------------------------------
Net cash provided by operating activities 1,173,256 1,139,430
----------------------------------------------
Cash Flows From Investing Activities
Proceeds from maturities of securities held to maturity 2,000,000 500,000
Purchases of securities held to maturity - (500,000)
Proceeds from maturities of securities available for sale 600,000 1,000,000
Proceeds from sales of securities available for sale 15,968,635 3,228,099
Purchases of securities available for sale (11,100,000) (9,202,247)
Principal collected on mortgage-backed securities 126,633 107,155
Net increase in loans receivable (1,408,488) (3,899,070)
Purchases of property and equipment (8,902) (29,271)
----------------------------------------------
Net cash provided by (used in) investing activities 6,177,878 (8,795,334)
----------------------------------------------
</TABLE>
(Continued)
21
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended September 30, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows From Financing Activities
Net increase (decrease) in savings accounts 730,157 (5,793,875)
Increase (decrease) in escrow deposits 3,704 (52,893)
Proceeds from FHLB advances - 3,000,000
Repayments of FHLB advances - (3,000,000)
Proceeds from borrowings on note payable 5,500,000 -
Loan to ESOP for purchase of common stock - (1,772,292)
Principal payment received on note receivable from ESOP 63,747 -
Cash dividends paid (514,817) (127,144)
Return of capital dividends (11,481,600) -
Proceeds from issuance of common stock - 17,419,336
----------------------------------------------------
Net cash provided by (used in) financing activities (5,698,809) 9,673,132
-----------------------------------------------------
Net increase in cash and cash equivalents 1,652,325 2,017,228
Cash and cash equivalents:
Beginning 5,105,923 3,088,695
----------------------------------------------------
Ending $ 6,758,248 $ 5,105,923
=====================================================
Cash and cash equivalents:
Cash and short-term investments $ 3,558,248 $ 5,005,923
Federal funds sold 3,200,000 100,000
-----------------------------------------------------
$ 6,758,248 $ 5,105,923
=====================================================
Supplemental Disclosure of Cash Flow Information
Cash payments for:
Interest $ 1,991,907 $ 2,184,189
Income taxes 585,979 388,153
Supplemental Disclosure of Noncash Investing Activities
Transfer of investments from held to maturity to
available for sale - 5,432,551
Change in unrealized gain on securities available for sale 213,443 90,659
Supplemental Disclosure of Noncash Financing Activities
Dividends accrued 133,088 127,219
Adoption of deferred management recognition plan 1,150,000 -
</TABLE>
See Notes to Consolidated Financial Statements
22
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies
Nature of business: Scotland Bancorp, Inc. (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 Company owns 100% of the common
stock of Scotland Savings Bank ("Scotland Savings" or the "Bank"), which
converted to stock form (the "Conversion") on March 29, 1996. The Company has no
operations and conducts no business of its own other than owning the Bank,
income derived from 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.
Scotland Savings Bank operates as a stock savings bank and its principal
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.
The following is a description of the significant accounting policies used in
the preparation of the accompanying financial statements.
Principles of consolidation: The consolidated financial statements include the
- ---------------------------
accounts of Scotland Bancorp, Inc. and its wholly-owned subsidiary, Scotland
Savings Bank. Scotland Bancorp, Inc. was capitalized on March 29, 1996,
therefore, the consolidated financial statements for the year ended September
30, 1996 include the operations of the Company for the periods subsequent to
March 29, 1996, and the Bank for the entire fiscal year. All significant
intercompany transactions and balances have been eliminated in consolidation.
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 financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities as of the date of the financial statements and the
reported revenues and expenses for the period. Actual results could differ from
those estimates.
Cash and cash equivalents: For purposes of reporting the statements of 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. The Company maintains
amounts due from banks which, at times, may exceed federally insured limits. The
Company has not experienced any losses in such accounts.
Investment securities: The Bank has investments in debt and equity securities.
- ---------------------
Debt securities consist primarily of U. S. Treasury Notes, Federal Farm Credit
Notes, Federal Home Loan Bank bonds and state revenue bonds. Equity securities
consist of Federal Home Loan Mortgage Corporation (FHLMC) stock.
23
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies (Continued)
Management classifies all debt securities and certain equity securities as
trading, available for sale, or held to maturity as individual investment
securities are acquired, and thereafter the appropriateness of such
classification is reassessed at each statement of financial condition date.
Because the Bank does not buy investment securities in anticipation of
short-term fluctuations in market prices, none of the investment securities are
classified as trading in accordance with SFAS No. 115. All securities have been
classified as either available for sale or held to maturity.
Securities available for sale: Securities classified as available for sale are
- -----------------------------
those securities that the Bank intends to hold for an indefinite period of time
but, as in the case of debt securities, not necessarily to maturity. Any
decision to sell a security classified as available for sale would be based on
various factors, including significant movements in interest rates, changes in
the maturity mix of the Bank's assets and liabilities, liquidity needs,
regulatory capital considerations, and other similar factors. Securities
available for sale are carried at fair value. Unrealized gains or losses are
reported as increases or decreases in equity, net of the related deferred tax
effect. Realized gains or losses, determined on the basis of the cost of
specific securities sold, are included in income.
Securities held to maturity: Securities classified as held to maturity are those
- ---------------------------
securities for which the Bank has both the intent and ability to hold to
maturity regardless of changes in market conditions, liquidity needs or changes
in general economic conditions. These securities are carried at cost adjusted
for amortization of premium and accretion of discount, computed by the interest
method over their contractual lives. Based on the Bank's financial position and
liquidity, management believes the Bank has the ability to hold these securities
to maturity.
Investment in Federal Home Loan Bank stock: The Bank, as a member of the Federal
- ------------------------------------------
Home Loan Bank (FHLB) 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 5% of advances from the FHLB. No ready market
exists for the Federal Home Loan Bank stock, and it has no quoted market value.
Loans receivable: Loans receivable are stated at unpaid principal balances, less
- ----------------
the allowance for loan losses, the undisbursed portion of construction loans,
and net deferred loan-origination fees and costs. The Bank's loan portfolio
consists principally of mortgage loans collateralized by first trust deeds on
single family residences, other residential property, commercial property and
land.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries) based on the Bank's evaluation of the potential
and inherent risk of losses in its loan portfolio. Management's periodic
evaluation of the adequacy of the allowance is based on the Bank's past loan
loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay, the estimated value of any
underlying collateral, and current economic conditions. While management uses
the best information available to make evaluations, future adjustments may be
necessary, if economic or other conditions differ or change substantially from
the assumptions used.
24
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies (Continued)
Impaired loans: SFAS No. 114 requires that the Bank establish a specific loan
- --------------
allowance on an impaired loan if the present value of the future cash flows
discounted using the loan's effective interest rate is less than the carrying
value of the loan. An impaired loan can also be valued based upon its fair value
or the market value of the underlying collateral if the loan is primarily
collateral dependent. The Bank assesses for impairment all loans delinquent more
than 90 days. See Note 3 for a further explanation of the Statement. No loans
were impaired at September 30, 1997, and there is no specific SFAS No. 114
allowance associated with the portfolio.
Interest income: The Bank recognizes interest income on loans using the interest
- ---------------
method over the contractual life of the 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
anticipates that it will account for interest on impaired loans in a similar
fashion in the future if and when it has impaired loans.
Loan-origination fees and related costs: Loan fees and certain direct loan
- ---------------------------------------
origination costs are deferred, and the net fee or cost is recognized as an
adjustment to interest income using the interest method over the contractual
life of the loans, adjusted for actual prepayments.
Real estate acquired in settlement of loans: Real estate acquired in settlement
- -------------------------------------------
of loans is initially recorded at estimated fair value at the date of
foreclosure establishing a new cost basis. Subsequent to foreclosure, valuations
of the property are periodically performed by management and the real estate is
carried at the lower of cost or fair value minus estimated costs to sell. Costs
relating to improvement of the property are capitalized, while holding costs of
the property are charged to expense in the period incurred. The Bank has no real
estate acquired in settlement of loans at September 30, 1997.
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.
Office properties and equipment: Office properties and equipment are stated at
- -------------------------------
cost less accumulated depreciation computed principally by the straight-line
method over estimated useful lives.
Income taxes: Deferred income taxes are provided on a liability method whereby
- ------------
deferred tax assets are recognized for deductible temporary differences and
operating loss and tax credit carryforwards, 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 when, 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.
25
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies (Continued)
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 Company has implemented a qualified stock option plan
authorizing the grant of up to 184,000 stock options to all officers, directors
and employees at the time of the adoption, either in the form of incentive stock
options or non-incentive stock options. The Bank has also implemented a
management recognition plan by reserving 73,600 shares of common stock for
issuance to all officers, directors and employees at the time of adoption.
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 is based on net income
- ------------------
earned divided by the weighted average number of shares outstanding from the
beginning of the fiscal year to the end of the fiscal year. The computation for
1996 is based on net income earned from the date of Conversion, March 29, 1996,
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-statement of financial condition risk: The Bank is a party to financial
- -----------------------------------------
instruments with off-statement of financial condition risk such as commitments
to extend credit and home equity lines of credit. Management assesses the risk
related to these instruments for potential losses on an ongoing basis.
Fair value of financial instruments: The estimated fair values required under
- -----------------------------------
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, 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 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 market value amounts.
The fair value estimates presented are based on pertinent information available
to management as of September 30, 1997 and 1996. Although management is not
aware of any factors that would significantly affect the estimated fair value
amount, such amounts have not been comprehensively revalued for purposes of
these financial statements since that date and therefore, current estimates of
fair value may differ significantly from the amounts presented herein.
26
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 2. Investment Securities
Investment securities have been classified in the statement of financial
condition according to management's intent. The carrying amount of securities
and approximate fair values at September 30, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997
--------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Held to maturity:
U. S. Government and federal
agency securities $ 500,000 $ - $ (5,940) $ 494,060
--------------------------------------------------------------------------
Available for sale:
U. S. Government and federal
agency securities 2,500,000 - (20,470) 2,479,530
State revenue bonds 5,100,000 - - 5,100,000
FHLMC stock 24,475 856,845 - 881,320
--------------------------------------------------------------------------
7,624,475 856,845 (20,470) 8,460,850
--------------------------------------------------------------------------
Nonmarketable equity securities:
FHLB stock 595,400 - - 595,400
CSC stock 4,000 - - 4,000
--------------------------------------------------------------------------
599,400 - - 599,400
--------------------------------------------------------------------------
$ 8,723,875 $ 856,845 $ (26,410) $ 9,554,310
==========================================================================
<CAPTION>
1996
--------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
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 - 775,553
--------------------------------------------------------------------------
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
==========================================================================
</TABLE>
27
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 2. Investment Securities (Continued)
The amortized cost and fair value of debt securities held to maturity and
available for sale at September 30, 1997 by contractual maturity are shown
below. Equity securities are not included in the maturity categories because
they do not have contractual maturities.
<TABLE>
<CAPTION>
Held to maturity Available for Sale
---------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year through five years $ 500,000 $ 494,060 $ 2,500,000 $ 2,479,530
Due in five years or more - - 5,100,000 5,100,000
---------------------------------------------------------------------
$ 500,000 $ 494,060 $ 7,600,000 $ 7,579,530
=====================================================================
</TABLE>
Summarized below is the sales activity in investment securities:
<TABLE>
<CAPTION>
Years Ended September 30,
--------------------------------------
1997 1996
--------------------------------------
<S> <C> <C>
Proceeds from the sale of available for sale securities $ 15,968,635 $ 3,228,099
Realized gains (240,726) (2,397)
Realized losses - 4,859
--------------------------------------
Cost of investment securities sold $ 15,727,909 $ 3,230,561
======================================
</TABLE>
Subsequent to year end, the Bank sold investments with an amortized cost of
$5,000,000 to fund the payoff of the Company's note payable discussed in Note 7.
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.
28
<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, 1997 and 1996 is as shown below:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------
<S> <C> <C>
Balance in equity component, beginning $ 411,135 $ 351,300
Change in net unrealized gains 213,443 90,659
Less change in deferred income taxes (106,026) (30,824)
--------------------------------------
Balance in equity component, ending $ 518,552 $ 411,135
======================================
</TABLE>
Investment securities with aggregate cost of $700,000 and estimated fair value
of $693,000 are pledged at September 30, 1997 to collateralize certain public
deposits.
Note 3. Loans Receivable
Loans receivable at September 30, 1997 and 1996 consist of the following:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------
<S> <C> <C>
Real estate loans:
Residential, one-to-four units $ 41,018,267 $ 38,694,588
Residential, multifamily 2,052,097 2,152,855
Nonresidential real estate 907,451 939,058
Residential construction 634,100 2,608,500
Line of credit 2,539,817 2,331,895
--------------------------------------
47,151,732 46,726,896
Share loans 71,058 22,660
Automobile 119,019 136,853
Other 201,381 186,530
--------------------------------------
47,543,190 47,072,939
--------------------------------------
Less:
Undisbursed portion of loans in process 614,230 1,533,995
Allowance for loan losses 248,860 225,352
Deferred loan fees 216,752 234,732
--------------------------------------
1,079,842 1,994,079
--------------------------------------
$ 46,463,348 $ 45,078,860
======================================
</TABLE>
29
<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:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------
<S> <C> <C>
Balance at the beginning of year $ 225,352 $ 207,472
Provisions charged to operations 24,000 24,528
Charge-offs (492) (6,648)
--------------------------------------
Balance at the end of the year $ 248,860 $ 225,352
======================================
</TABLE>
SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by
SFAS No. 118 Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosure, requires that the Bank establish a specific allowance on
impaired loans and disclosure of the Bank's method of accounting for interest
income on impaired loans. The Bank assesses all loans delinquent more than 90
days for impairment and such loans amounted to approximately $30,000 at
September 30, 1997. This loan is collateral dependent and management has
determined that the underlying collateral is in excess of the carrying amounts.
As a result, the Bank has determined that a specific allowance on this loan is
not required.
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, 1997 a reserve for uncollected interest was not established
because management expects that all such interest is fully collectible.
The following summarizes transactions during the years ended September 30, 1997
and 1996 for loans made by the Bank to the Company's officers, directors and
their affiliates:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------
<S> <C> <C>
Principal balances, beginning of year $ 1,459,560 $ 1,436,552
New loans originated 224,903 224,696
Principal repayments (195,436) (201,688)
--------------------------------------
Principal balances, end of year $ 1,489,027 $ 1,459,560
======================================
</TABLE>
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 $10 million
at September 30, 1997. No advances were outstanding at September 30, 1997 or
1996.
30
<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, 1997 and
1996:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
September 30 Cost Gains Losses Value
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
GNMA mortgage-backed
securities
1997 $ 418,657 $ 62,668 $ -- $ 481,325
1996 545,290 71,920 -- 616,580
</TABLE>
All of the Bank's mortgage-backed securities have been classified as "held to
maturity" at September 30, 1997 and 1996 and the Bank has had no sales during
the years ended September 30, 1997 and 1996.
Note 5. Office Properties and Equipment
Office properties and equipment consist of the following at September 30, 1997
and 1996:
<TABLE>
<CAPTION>
1997 1996
---------------------------------
<S> <C> <C>
Land $ 141,406 $ 141,406
Office buildings and improvements 954,661 954,661
Furniture and fixtures 306,789 297,887
---------------------------------
1,402,856 1,393,954
Accumulated depreciation (610,497) (574,480)
---------------------------------
$ 792,359 $ 819,474
=================================
</TABLE>
31
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 6. Savings Deposits
Savings deposits consist of the following at September 30, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------
<S> <C> <C>
Regular savings, 2.92% (2.88% in 1996) $ 4,106,067 $ 4,310,396
MMDA accounts, 4.33% (2.87% in 1996) 5,380,543 4,205,597
NOW accounts, 2.00% (2.00% in 1996) 2,620,405 2,321,234
Super NOW accounts, 2.25% (2.25% in 1996) 364,073 309,628
Noninterest-bearing accounts 633,056 511,470
-------------------------------------
13,104,144 11,658,325
-------------------------------------
Certificates of deposit: weighted average rate of 5.45% (5.32% in 1996)
0.00% to 3.00% 139,441 34,342
3.01% to 5.00% 9,277,632 8,770,704
5.01% to 7.00% 19,958,213 21,292,981
7.01% to 9.00% 612,218 596,187
-------------------------------------
29,987,504 30,694,214
-------------------------------------
Accrued interest payable 48,077 57,029
-------------------------------------
$ 43,139,725 $ 42,409,568
=====================================
Weighted average cost of savings deposits 4.74% 4.63%
=====================================
</TABLE>
Certificates of deposit by range of rate and maturity at September 30, 1997 are
summarized as follows:
<TABLE>
<CAPTION>
Amounts Maturing During
--------------------------------------------------------------------------------------
Rate Range 1998 1999 2000 Thereafter Total
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
0.00% to 3.00% $ 25,051 $ 114,390 $ - $ - $ 139,441
3.01% to 5.00% 8,052,423 1,054,519 154,449 16,241 9,277,632
5.01% to 7.00% 16,603,124 3,065,996 269,446 19,647 19,958,213
7.01% to 9.00% 612,218 - - - 612,218
--------------------------------------------------------------------------------------
$ 25,292,816 $ 4,234,905 $ 423,895 $ 35,888 $ 29,987,504
======================================================================================
</TABLE>
32
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 6. Savings Deposits (Continued)
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 at September 30, 1997 is as shown below:
<TABLE>
<CAPTION>
Maturity Amount
------------------------------------------------------------------------------------------------------------------
<S> <C>
Less than 3 months $ 1,149,516
3 to 6 months 922,618
6 to 12 months 434,376
More than 12 months 200,354
-------------------
$ 2,706,864
===================
</TABLE>
Interest expense on savings deposit accounts for the years ended September 30,
1997 and 1996 is summarized as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------------------------
<S> <C> <C>
Regular savings accounts $ 119,308 $ 160,204
MMDA and NOW accounts 248,592 193,701
Certificate of deposit accounts 1,614,158 1,808,318
--------------------------------------
$ 1,982,058 $ 2,162,223
======================================
</TABLE>
Note 7. Note Payable
The Company has an unsecured note payable to another bank for $5,500,000 which
bears interest at 6.5% (prime minus 2%) and is due in full on October 31, 1997.
Maximum borrowings outstanding during the year ended September 30, 1997 was
$5,500,000.
Note 8. 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 income
tax returns due to limitations imposed by the IRS Code. In addition, legislation
passed in 1996 eliminated 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.
33
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 8. Income Taxes (Continued)
The Bank will also have to recapture its tax bad debt reserves which have
accumulated since 1987 and amount to approximately $340,000 over a six year
period. The tax associated with the recaptured reserves is approximately
$130,000. The recapture began with the Bank's 1997 year. 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.
Deferred taxes have been provided for certain increases in the Bank's tax bad
debt reserves subsequent to 1987 which are in excess of additions to recorded
loan loss allowances. At September 30, 1997, 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
approximately $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,
1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------------------------------
<S> <C> <C>
Deferred tax assets:
Deferred directors retirement expense $ 2,262 $ 6,862
Excess book pension expense 22,673 7,625
Allowance for loan losses 94,567 85,634
Special SAIF assessment - 121,885
Deferred management recognition plan 36,417 -
------------------------------------
Total deferred tax assets 155,919 222,006
------------------------------------
Deferred tax liabilities:
Market valuation of investments 317,823 211,797
Tax bad debt reserves 126,375 126,375
Excess accumulated tax depreciation 177,621 183,838
Federal Home Loan Bank stock basis 83,795 83,795
Other 4,071 19,003
------------------------------------
Total deferred tax liabilities 709,685 624,808
------------------------------------
Net deferred tax liabilities $ 553,766 $ 402,802
====================================
</TABLE>
34
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 8. Income Taxes (Continued)
The Company's effective income tax rate differs from the federal statutory rate
of 35% as follows:
1997 1996
-----------------------
Statutory federal income tax rate 35.00 % 35.00 %
State income taxes, net of federal benefit 1.80 1.60
Non-taxable municipal interest (4.86) -
Other, net (2.22) (1.52)
-----------------------
Effective income tax rate 29.72 % 35.08 %
=======================
Note 9. 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 was 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 was not
deducted for tax purposes until paid. The expense recorded for the special
assessment for the year ending September 30, 1996 was $320,750.
Note 10. Stockholders' Equity
On March 29, 1996, Scotland Bancorp, Inc. completed and closed its stock
offering. Gross proceeds from 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.
35
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 10. Stockholders' Equity (Continued)
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 1997, the
Bank paid $306,000 in dividends to Scotland Bancorp, Inc. Subsequent to
year-end, with the permission of the NC Administrator, the Bank paid $5,481,600
in dividends to the Company to pay off the note payable discussed in Note 7.
Scotland Bancorp, Inc. paid regular cash dividends totaling $0.30 per share and
a return of capital dividend of $6.00 per share during the year ended
September 30, 1997.
36
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 10. 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, 1997, Scotland Savings complied with all capital requirements
described above as shown below:
<TABLE>
<CAPTION>
September 30, 1997 (Bank only)
---------------------------------------------------------------------
Leverage Tier I NC
Ratio of Risk- Risk- Savings
Tier I Adjusted Based Bank
Capital Capital Capital Capital
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
GAAP capital $ 18,705,009 $ 18,705,009 $ 18,705,009 $ 18,705,009
Unrealized gain on securities (518,552) (518,552) (518,552) (518,552)
Allowances for loan losses - - 248,860 248,860
---------------------------------------------------------------------
Regulatory capital 18,186,457 18,186,457 18,435,317 18,435,317
Minimum capital requirement 1,904,130 1,232,836 2,465,673 3,177,593
---------------------------------------------------------------------
Excess regulatory capital $ 16,282,327 $ 16,953,621 $ 15,969,644 $ 15,257,724
=====================================================================
Total Bank-only assets at
September 30, 1997 $ 63,551,855
Average Bank-only assets for the
quarter ended September 30, 1997 $ 63,471,000
Risk-weighted Bank-only assets at
September 30, 1997 $ 30,820,911 $ 30,820,911
Capital as a percentage of assets:
Actual 28.65% 59.01% 59.81% 29.01%
Required 3.00% 4.00% 8.00% 5.00%
---------------------------------------------------------------------
Excess 25.65% 55.01% 51.81% 24.01%
=====================================================================
</TABLE>
37
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10. 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 11. Employee Retirement Plans
The Bank's pension plan was transferred into The Financial Institutions
Retirement Fund during 1997. The Financial Institutions Retirement Fund is a
tax-qualified pension trust covering multiple-employers and is administered by
the Pentegra Group. Multiple-employer plans do not provide or segregate the
acturarial valuations with respect to each employer. Therefore, the components
of pension cost charged to expense for 1997 are unavailable.
Pension expense under the Bank's defined benefit plan amounted to $39,600 and
$62,720 in 1997 and 1996, respectively. The components of pension cost charged
to expense for 1996 consisted of the following:
<TABLE>
<CAPTION> 1996
-------------------
<S> <C>
Service cost-benefits earned during the period $ 45,594
Interest cost on projected benefit obligation 40,993
Actual return on plan assets (39,202)
Amortizations and deferrals 15,335
-------------------
Net periodic pension expense $ 62,720
===================
</TABLE>
38
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 11. Employee Retirement Plans (Continued)
The following table sets forth the plan's funded status as of September 30, 1996
and the amounts recognized in the statement of financial position at September
30, 1996:
<TABLE>
<CAPTION>
1996
------------
<S> <C>
Actuarial present value of benefit obligations:
Vested benefits $ 466,889
============
Accumulated benefits $ 503,664
============
Projected benefits $ 672,199
Plan assets at fair value, held in savings deposits
of the Bank and outside insurance products 487,951
------------
Projected benefit obligation in excess of plan assets (184,248)
Transition obligation 20,616
Unrecognized prior service cost 100,689
Unrecognized net loss, past experience different
from that assumed 47,230
------------
Accrued pension cost included in other liabilities $ (15,713)
------------
</TABLE>
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 at September 30, 1996 was 7%.
In addition, Scotland Savings 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 $2,024 and
$7,001 for the years ended September 30, 1997 and 1996, respectively.
Note 12. 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
$11,271 and $12,419 for the years ended September 30, 1997 and 1996,
respectively. The Bank's accrued liability for plan obligations amounted to
$106,057 and $118,161 at September 30, 1997 and 1996, respectively.
39
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 13. 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 indicated 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
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.
Note 14. Management Recognition Plan and Stock Option Plan
The Company's stockholders approved the Bank's Management Recognition Plan (the
"MRP") and the Company's stock option plan on April 17, 1997. The stock option
plan provides for the issuance of up to 184,000 stock options to all officers,
directors, and employees in the form of incentive stock options or non-incentive
stock options. The exercise price of the stock options may not be less than the
fair market value of the Company's common stock at the date of grant. Under the
Plan 177,000 of options, which vest at the rate of 25% annually beginning at the
date of grant, were all granted on May 13, 1997 and expire on May 13, 2007. As
permitted under the generally accepted accounting principles, grants under the
plan are accounted for following the provisions of APB Opinion No. 25 and its
related interpretations. Accordingly, no compensation cost has been recognized
for grants made to date. Had compensation cost been determined based on the fair
value method prescribed in FASB Statement No. 123, the pro forma effect on
reported net income for the year ended September 30, 1997 would be as follows:
<TABLE>
<S> <C>
Net income
As reported $ 1,258,260
Pro forma 926,256
Earnings per share
As reported 0.74
Pro forma 0.54
</TABLE>
40
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 14. Management Recognition Plan and Stock Option Plan (Continued)
In determining the fair value of the option grant as prescribed in Statement No.
123, the Black-Scholes option pricing model was used with the following
assumptions: a risk-free interest rate of 6.86%, expected lives of 9.33 years,
expected volatility of 18.88% and expected dividends of $0.30 per year.
At September 30, 1997, 177,000 options have been granted at an exercise price of
$15.625, of which 44,250 options are currently exerciseable. No options have
been exercised to date and all options granted are outstanding at September 30,
1997. The MRP reserved for issuance 73,600 shares of common stock to all
officers, directors, and employees at the time of the adoption. The Bank issued
shares to fund the MRP in May of 1997. The restricted common stock under the MRP
vests at the rate of 20% annually beginning at the date of grant. The expense
related to the vesting of the MRP totaled $325,833 for the year ended September
30, 1997.
Note 15. 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, 1997 and
1996, the outstanding balance of the note receivable is $1,708,545 and
$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. Special
return of capital dividends on unallocated ESOP shares totaling $834,558 are
recorded as unearned compensation, and reported as a separate component of
stockholders' equity.
Expense of $82,260 and $33,006 during 1997 and 1996 has been incurred in
connection with the ESOP. The expense includes, in addition to the cash
contribution necessary to fund the ESOP, $16,519 in 1997 and $1,132 and 1996,
which represents the difference between the fair 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.
41
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 15. Employee Stock Ownership Plan (Continued)
At September 30, 1997, 8,108 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 $1.7 million at September 30, 1997.
Note 16. Concentration of Credit Risk and Off-Statement of Financial
Condition 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-statement of financial
condition 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
statement of financial condition. Commitments to extend credit (which were
principally variable rate commitments) amounted to approximately $214,000 and
$621,000 at September 30, 1997 and 1996, respectively. The undisbursed portion
of construction loans amounted to $614,230 and $1,533,995 and the unused portion
of equity lines of credit totaled approximately $2,989,000 and $2,815,000 at
September 30, 1997 and 1996, 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-statement of financial condition instruments.
42
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 17. Fair Value of Financial Instruments
The following table reflects a comparison of carrying amounts and the fair
values of the financial instruments as of September 30, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------------------------------------------------------
Financial assets:
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 3,558,248 $ 3,558,248 $ 5,005,923 $ 5,005,923
Federal funds sold 3,200,000 3,200,000 100,000 100,000
Securities held to maturity 500,000 494,060 2,502,326 2,493,515
Securities available for sale 8,460,850 8,460,850 13,465,261 13,465,261
Nonmarketable equity securities 599,400 599,400 599,400 599,400
Loans receivable 46,463,348 46,531,442 45,078,860 45,051,588
Mortgage-backed securities 418,657 481,325 545,290 616,580
Accrued interest receivable 210,759 210,759 352,284 352,284
Financial liabilities:
Savings deposits 43,139,724 43,373,536 42,409,568 42,531,568
Note payable 5,500,000 5,500,000 - -
</TABLE>
The fair values utilized in the table were derived using the information
described below for the group of instruments listed. It should be noted that the
fair values disclosed in this table do not represent market values of all assets
and liabilities of the Company and, thus, should not be interpreted to represent
the market or liquidation value of the Company.
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:
Cash, cash equivalents and federal funds sold: The carrying amounts for cash,
- ---------------------------------------------
cash equivalents and federal funds approximate their fair values.
Investment and mortgage-backed securities: Fair values for securities are based
- -----------------------------------------
on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of similar securities.
Nonmarketable equity securities: The fair value of the nonmarketable equity
- -------------------------------
securities is the stated value by the FHLB and the cost of CSC stock.
43
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 17. Fair Value of Financial Instruments (Continued)
Loans receivable: The fair value of fixed rate loans is estimated by discounting
- ----------------
the future cash flows using the current rates at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities. The fair value of variable rate loans approximates their carrying
value as these loans reprice frequently.
Accrued interest receivable: The fair value of accrued interest receivable is
- ---------------------------
the amount receivable on demand at the statement of financial condition date.
Savings deposits: The fair value of demand deposits, savings accounts and
- ----------------
certain money market deposits is the amount payable on demand at the statement
of financial condition date. The fair value of fixed maturity certificates of
deposit are estimated based upon the discounted value of contractual cash flows
using rates currently offered for deposits with similar remaining maturities.
Note payable: The fair value of the note payable approximates its carrying
- ------------
amount due to its short term nature.
Off-statement of financial condition instruments: Fair values for the Bank's
- ------------------------------------------------
off-statement of financial condition instruments (loan commitments) are based on
fees currently charged for similar agreements, taking into account the remaining
terms of the agreements and the counterparties' credit standings. The fair value
for such commitments is nominal.
44
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 18. Parent Company Financial Data
The following is a summary of the condensed financial statements of Scotland
Bancorp, Inc. as of and for the periods ended September 30, 1997 and 1996:
Condensed Balance Sheets
September 30, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
--------------------------------
Assets:
<S> <C> <C>
Cash $ 2,110,284 $ 4,157,420
Securities available for sale - 3,708,652
Investment in Scotland Savings Bank 17,880,843 16,851,668
Accrued interest receivable 73,204 140,414
Prepaids and other assets 146,584 82,537
Deferred income taxes - 1,594
--------------------------------
$ 20,210,915 $ 24,942,285
================================
Liabilities and Stockholders' Equity:
Liabilities:
Note payable $ 5,500,000 $ -
Accrued dividends payable 143,520 138,000
Other accrued expenses 5,469 2,566
Income taxes payable - 10,446
Deferred income taxes 1,164 -
--------------------------------
5,650,153 151,012
--------------------------------
Stockholders' Equity:
Additional paid-in capital 16,506,442 25,986,966
Note receivable ESOP (1,708,545) (1,772,292)
Deferred management recognition plan (824,167) -
Unearned compensation (834,558) -
Unrealized gain on available for sale securities, net of tax 518,552 411,135
Retained earnings 903,038 165,464
--------------------------------
14,560,762 24,791,273
--------------------------------
$ 20,210,915 $ 24,942,285
================================
</TABLE>
45
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 18. Parent Company Financial Data (Continued)
Condensed Statements of Income
Year Ended September 30, 1997 and the period from March 29, 1996 to
September 30, 1996
<TABLE>
<CAPTION>
1997 1996
------------------------------
<S> <C> <C>
Interest income $ 587,304 $ 281,982
Equity in earnings of Scotland Savings Bank 888,500 251,941
Miscellaneous expense (114,043) (22,150)
Income taxes (103,501) (91,946)
------------------------------
$ 1,258,260 $ 419,827
==============================
</TABLE>
46
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 18. Parent Company Financial Data (Continued)
Condensed Statements of Cash Flows
Year Ended September 30, 1997 and the period from March 29, 1996 to
September 30, 1996
<TABLE>
<CAPTION>
1997 1996
--------------------------------
Cash Flows from Operating Activities:
<S> <C> <C>
Net income $ 1,258,260 $ 419,827
Equity in earnings of Scotland Savings Bank (888,500) (251,941)
Other 1,164 2,186
Gain on the sale of securities available for sale (6,779) -
Change in assets and liabilities:
(Increase) decrease in other assets 2,813 (212,168)
Increase (decrease) in accrued income taxes (10,446) 10,446
Increase in other accrued expenses 2,902 2,566
--------------------------------
Net cash provided by (used in) operating activities 359,414 (29,084)
--------------------------------
Cash Flows from Investing Activities:
Purchase of investment securities available for sale (6,000,000) (3,715,528)
Proceeds from sale of investment securities available for sale 9,720,120 -
Upstream dividend from Scotland Savings Bank 306,000 135,000
Initial investment in Scotland Savings Bank - (7,752,868)
Loan to ESOP for purchase of common stock - (1,772,292)
Principal payment received on note receivable from ESOP 63,747 -
--------------------------------
Net cash provided by (used in) investing activities 4,089,867 (13,105,688)
--------------------------------
Cash Flows from Financing Activities:
Proceeds from borrowings on note payable 5,500,000 -
Common stock proceeds received from the Conversion - 17,419,336
Payment of dividends (514,817) (127,144)
Return of capital dividends (11,481,600) -
--------------------------------
Net cash provided by (used in) financing activities (6,496,417) 17,292,192
--------------------------------
Net increase (decrease) in cash (2,047,136) 4,157,420
Cash, beginning 4,157,420 -
--------------------------------
Cash, ending $ 2,110,284 $ 4,157,420
================================
Supplemental Disclosure of Noncash Financing Activities:
Dividends accrued $ 133,088 $ 127,219
Supplemental Disclosure of Noncash Investing Activities:
Change in unrealized gain on securities available for sale 4,689 4,689
</TABLE>
47
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 19. Future Reporting Requirements
The FASB has issued SFAS No. 128, Earnings Per Share, which the Company has not
been required to adopt as of September 30, 1997. The Statement, which will be
effective for the Company's interim period ending after December 15, 1997,
specifies the computation, presentation and disclosure requirements for earnings
per share. The Bank does not anticipate the effect of adoption of SFAS No. 128
to significantly impact earnings per share presentation.
The FASB has issued SFAS No. 130, Reporting Comprehensive Income, which the
Company has not been required to adopt as of September 30, 1997. The Statement,
which is effective for fiscal years beginning after December 15, 1997,
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. This statement requires that all items
that are recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements.
48
<PAGE>
CORPORATE INFORMATION
EXECUTIVE OFFICERS:
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 VP of Manufacturing, Retired Surgeon
Publisher 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 1998 annual meeting of stockholders
10 Commerce Drive Scotland Bancorp, Inc. will be held at
Cranford, NJ 07016 4:00 p.m. on January 15, 1998 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
2000 Renaissance Plaza Securities and Exchange Commission will
230 North Elm Street be furnished without charge to the
Greensboro, NC 27420 Company's stockholders upon written
request to Scotland Bancorp, Inc., P.O.
Box 1468, Laurinburg, NC 28301.
Independent Auditors
McGladrey & Pullen, LLP Corporate Office
6805 Morrison Boulevard 505 South Main Street
Charlotte, NC 28211 Laurinburg, NC 28301
Common Stock Information
There are 1,913,600 shares of common stock outstanding which were held by
approximately 488 stockholders of record (excluding shares held in street name)
on September 30, 1997. The Company's common stock is quoted on the American
Stock Exchange under the symbol "SSB." The following table reflects the stock
trading and dividend payment frequency of the Company for the years ended
September 30, 1997 and 1996.
49
<PAGE>
<TABLE>
<CAPTION>
Dividends Stock Price
Regular Special High Low
--------------------------------------------------
1997:
<S> <C> <C> <C> <C>
First Quarter $ 0.075 $ - $ 14.375 $ 12.750
Second Quarter 0.075 - 16.750 14.250
Third Quarter 0.075 - 16.375 14.750
Fourth Quarter 0.075 6.00 19.250 12.500
1996:
First Quarter $ - $ - $ - $ -
Second Quarter - - - -
Third Quarter 0.075 - 12.375 11.625
Fourth Quarter 0.075 - 13.875 11.875
</TABLE>
50
<PAGE>
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the incorporation by reference into all Registration
Statements on Form 10-KSB of Scotland Bancorp, Inc. of our report dated October
23, 1997, relating to the consolidated statements of financial condition of
Scotland Bancorp, Inc. and subsidiary as of September 30, 1997 and 1996, and the
related consolidated statements of income, stockholders' equity and cash flows
for the years then ended, which report appears in the Company's 1997 annual
report on Form 10-KSB.
McGLADREY & PULLEN, LLP
/s/ McGLADREY & PULLEN,LLP
Charlotte, North Carolina
December 16, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> SEP-30-1997 SEP-30-1996
<PERIOD-START> OCT-01-1996 OCT-01-1995
<PERIOD-END> SEP-30-1997 SEP-30-1996
<CASH> 627 754
<INT-BEARING-DEPOSITS> 2,931 4,252
<FED-FUNDS-SOLD> 3,200 100
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 8,461 13,465
<INVESTMENTS-CARRYING> 500 2,502
<INVESTMENTS-MARKET> 494 2,494
<LOANS> 46,463 45,079
<ALLOWANCE> 249 225
<TOTAL-ASSETS> 64,399 68,622
<DEPOSITS> 43,140 42,410
<SHORT-TERM> 5,500 0
<LIABILITIES-OTHER> 1,199 1,421
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 14,561 24,791
<TOTAL-LIABILITIES-AND-EQUITY> 64,399 68,622
<INTEREST-LOAN> 3,948 3,635
<INTEREST-INVEST> 934 840
<INTEREST-OTHER> 289 395
<INTEREST-TOTAL> 5,171 4,870
<INTEREST-DEPOSIT> 1,982 2,162
<INTEREST-EXPENSE> 1,983 2,209
<INTEREST-INCOME-NET> 3,188 2,661
<LOAN-LOSSES> 24 25
<SECURITIES-GAINS> 241 (2)
<EXPENSE-OTHER> 1,680 1,550
<INCOME-PRETAX> 1,790 1,167
<INCOME-PRE-EXTRAORDINARY> 1,790 1,167
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 1,258 758
<EPS-PRIMARY> 0.74 0.25
<EPS-DILUTED> 0.74 0.25
<YIELD-ACTUAL> 7.70 7.60
<LOANS-NON> 30 32
<LOANS-PAST> 0 0
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 225 207
<CHARGE-OFFS> 0 7
<RECOVERIES> 0 0
<ALLOWANCE-CLOSE> 249 225
<ALLOWANCE-DOMESTIC> 249 225
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 0 0
</TABLE>
