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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, 1998
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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
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
505 South Main Street,
Post Office Box 1468 28353-1468
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
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. [ ]
State issuer's revenues for its most recent fiscal year $4,638,721
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 -- $16,657,956 (based on the price at which the
stock was sold on December 11, 1998).
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
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(Class) (Outstanding at December 11, 1998)
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended September 30,
1998 (the "1998 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 28, 1999 (the "Proxy Statement"), are incorporated by
reference into Part III.
Transitional Small Business Disclosure Format (Check one): Yes No X
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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, 1998, the Company had total assets of $60,730,000, net
loans of $42,485,000, deposits of $44,271,000, investment securities of
$16,137,000 and stockholders' equity of $15,337,000.
At September 30, 1998, the Company and the Bank had a total of 13
employees, all of whom are full-time.
On August 26, 1998, the Company entered into an Agreement and Plan of
Reorganization and Merger (the "Merger Agreement") with Centura Banks, Inc., a
North Carolina corporation ("Centura") that is a bank holding company registered
with the Federal Reserve. The Merger Agreement provides for the following
transactions to effect the proposed merger of the Company with and into Centura
(the "Merger"):
1. Centura will create Scotland Acquisition Corporation, a North Carolina
business corporation, as a wholly-owned subsidiary;
2. Scotland Acquisition Corporation will merge with and into the Company,
making the Company a wholly-owned subsidiary of Centura;
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3. The Bank will merge with and into Centura Bank, Centura's wholly-
owned bank subsidiary, and thereafter the Bank's two offices will
operate as branches of Centura Bank;
4. The Company will merge with and into Centura.
The Merger is subject to certain regulatory approvals. Centura has
applied to (i) the Federal Reserve for approval to acquire the Company and to
merge the Company with and into Centura and to merge the Bank into Centura Bank
and to establish new branch offices at the Bank's current offices and (ii) the
North Carolina Commissioner of Banks and the North Carolina Banking Commission
for the merger of the Bank into Centura Bank and the establishment of new
branches at the Bank's current offices. The Company has applied to the
Administrator of the Savings Institutions Division, North Carolina Department of
Commerce for approval for its merger with Scotland Acquisition Corporation and
Centura and for the merger of the Bank into Centura Bank.
The Merger also is subject to approval from the Company's stockholders.
The proposal to approve the Merger Agreement and Merger will be considered at
the Company's 1999 annual meeting to be held on January 28, 1999. The Merger
will not occur if the Company and Centura do not receive all the required
regulatory approvals and the Company does not receive stockholder approval at
the annual meeting in January 1999. If stockholder and all regulatory approvals
are received, the Company and Centura anticipate consummating the Merger on
February 5, 1999.
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.
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.
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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, 1998, 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.
<TABLE>
<CAPTION>
Estimated Change in NPV as a % of PV of Assets
Net Portfolio Value ----------------------------------
-------------------------------------------------
Change in Rates $ Amount $Change(1) % Change(2) NPV Ratio(3) Change(4)
- --------------- ------------------------------------------------------ ----------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
+400 bp $10,317 $(5,143) -33% 17.33% -864 bp
+300 bp $11,641 $(3,819) -25% 19.55% -642 bp
+200 bp $12,965 $(2,495) -16% 21.78% -419 bp
+100 bp $14,213 $(1,247) - 8% 23.87% -210 bp
0 bp $15,460 --- --- 25.97% ---
- -100 bp $16,537 $ 1,077 7% 27.77% +180 bp
- -200 bp $17,614 $ 2,154 14% 29.58% +361 bp
- -300 bp $18,909 $ 3,449 22% 31.76% +579 bp
- -400 bp $20,204 $ 4,744 31% 33.93% +796 bp
</TABLE>
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(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, 1998, a change in interest rates of a positive 200
basis points would have resulted in a 419 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 361 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 $42.5 million on
September 30, 1998, or 70.0% of its total assets. On that date, approximately
$36.4 million or 85.7% of loans outstanding consisted of loans secured by
mortgages on one-to-four family residential properties; $2.5 million or 5.9%
were loans secured by multifamily residential properties; approximately $775,000
or 1.8% of loans were secured by non-residential real estate; approximately
$400,000 net of loans in process or 0.9% were loans secured by residential
construction loans; approximately $2.4 million or 5.7% were line of credit
loans; and approximately $437,000 or 1.0% were loans secured by savings
accounts, automobiles or other collateral. As of September 30, 1998, 99% 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.
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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,
----------------
1998 1997
---- ----
% of % of
Amount Total Amount Total
------ ----- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $36,424 85.73% $41,018 88.28%
Residential multi-family 2,514 5.92% 2,052 4.42%
Nonresidential real estate 755 1.78% 907 1.95%
Residential construction 1,593 3.75% 634 1.36%
Line of credit 2,406 5.66% 2,540 5.47%
------- ------- ------- -------
Total real estate loans 43,692 102.84% 47,151 101.48%
------- ------- ------- -------
Consumer loans:
Passbook or certificate 50 0.12% 71 0.15%
Automobile 209 0.49% 119 0.26%
Other 178 0.42% 201 0.43%
------- ------- ------- -------
Total consumer loans 437 1.03% 391 0.84%
------- ------- ------- -------
Less:
Deferred loan fees 197 0.46% 216 0.46%
Loans in process 1,192 2.81% 614 1.32%
Allowance for loan losses 255 0.60% 249 0.54%
------- ------- ------- -------
Total reductions 1,644 3.87% 1,079 2.32%
------- ------- ------- -------
Total loans receivable, net $42,485 100.00% $46,463 100.00%
======= ======= ======= =======
</TABLE>
Loan Maturity Schedule. The following table sets forth the time to
contractual maturity of the Bank's loan portfolio at September 30, 1998. 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 $12.7 million and $7.1 million in the fiscal years ended
September 30, 1998, and 1997, respectively. Amounts in the table are net of
loans in process and are net of unamortized loan fees.
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<TABLE>
<CAPTION>
At September 30, 1998
-------------------------------------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or Less 3 Years 5 Years 10 Years Years Total
--------- -------- -------- -------- ------- -----
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Adjustable rate 1-4 family
residential $ 40 $ 214 $ 414 $ 734 $ 16,866 $ 18,268
Fixed rate 1-4 family
residential 72 296 327 4,155 16,488 21,338
Other adjustable rate real
estate loans 1,932 51 56 115 98 2,252
Other fixed rate real estate
loans 66 19 -- 74 286 445
Other loans 207 102 123 5 -- 437
Less:
Allowance for loan losses (255) -- -- -- -- (255)
-------- -------- -------- -------- -------- --------
$ 2,062 $ 682 $ 920 $ 5,083 $ 33,738 $ 42,485
======== ======== ======== ======== ======== ========
</TABLE>
The following table sets forth the dollar amount at September 30, 1998
of all loans maturing or repricing on or after September 30, 1999 which have
fixed or adjustable interest rates.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
----- ----------
(In Thousands)
<S> <C> <C>
Mortgage loans $21,645 $18,548
Other loans 230
------- -------
$21,875 $18,548
======= =======
</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, 1998,
approximately 85.7% of the Bank's total net real estate loan portfolio consisted
of one-to-four family residential real estate loans. These include both loans
secured by detached single-family residences and condominiums and loans secured
by housing containing not more than four separate dwelling units. Of such loans,
50.0% 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
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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, 1998, the Bank had
approximately $2.5 million in outstanding loans secured by multifamily
residential real estate, comprising approximately 5.9% 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, 1998, the Bank had
$755,000 in outstanding loans secured by nonresidential real estate, comprising
approximately 1.8% of its net loan portfolio as of that date. Most of these
loans are secured by office, retail, other commercial real estate, as well as
church properties, and have adjustable interest rates. These loans generally do
not exceed 80% of the appraised value of the real estate securing the loans.
Loans secured by commercial real estate and undeveloped land generally are
larger than one-to-four family residential loans and involve a greater degree of
risk. Payments on these loans depend to a large degree on results of operations
and management of the properties and may be affected to a greater extent by
adverse conditions in the real estate market or the economy in general. As of
September 30, 1998, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $92,000. This loan was performing in accordance with the
original loan contract.
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Lines of Credit. At September 30, 1998, the Bank had approximately $2.4
million in line of credit loans, representing approximately 5.7% 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, 1998 was approximately $400,000, net of loans in
process, representing approximately 0.9% 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, 1998, the Bank had approximately
$437,000 of such loans outstanding, representing approximately 1.0% 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.
8
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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, 1998, the Bank
had $134,000 in such unfunded mortgage loan commitments. In addition, on such
date the Bank had $3.1 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, 1998 and 1997, the Bank's loan
originations totaled $8.7 million and $8.5 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
9
<PAGE>
reviewed monthly by the Board of Directors. The normal procedure followed by the
Bank once a loan is classified as delinquent is to make contact with the
borrower at prescribed intervals in an effort to bring the loan to a current
status, and late charges are assessed as allowed by law. In most cases,
delinquencies are cured promptly. If a delinquency is not cured, the Bank
normally, subject to any required prior notice to the borrower, commences
foreclosure proceedings. If the loan is not reinstated within the time permitted
for reinstatement, or the property is not redeemed prior to sale, the property
may be sold at a foreclosure sale. In foreclosure sales, the Bank may acquire
title to the property through foreclosure, in which case the property so
acquired is offered for sale and may be financed by a loan involving terms more
favorable to the borrower than those normally offered. Any property acquired as
a result of foreclosure or by deed in lieu of foreclosure is classified as real
estate owned until such time as it is sold or otherwise disposed of by the Bank
to recover its investment. As of September 30, 1998, 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, 1998, 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,
-----------------
1998 1997
---- ----
(Dollars in Thousands)
<S> <C> <C>
Total nonaccrual loans:
Mortgage Loans delinquent 90 days or more $ 28 $ 30
Consumer loans delinquent 90 days or more -- --
Real estate owned -- --
------- -------
Total non-performing assets $ 28 $ 30
======= =======
Non-performing loans to total loans 0.06% 0.06%
Non-performing assets to total assets 0.05% 0.05%
Total assets $60,730 $64,399
Total loans $42,485 $46,463
</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
10
<PAGE>
and, if appropriate, classify them. Problem assets are classified as
"substandard," "doubtful" or "loss," depending on the presence of certain
characteristics as discussed below.
An asset is considered "substandard" if not adequately protected by the
current net worth and paying capacity of the obligor or the collateral pledged,
if any. "Substandard" assets include those characterized by the "distinct
possibility" that the insured institution will sustain "some loss" if the
deficiencies are not corrected. Assets classified as "doubtful" have all of the
weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable". Assets classified "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a loss reserve is not warranted.
As of September 30, 1998, the Bank had $28,000 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, 1998, 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 $28,000 which was assessed for impairment at
September 30, 1998. This loan is collateral dependent and management has
determined that the underlying collateral value is in excess of the carrying
amount. Therefore, there is no specific SFAS No. 114 allowance for impaired
loans at September 30, 1998. The Bank charged a provision to the allowance for
loan losses of $6,000 and $24,000 during the years ended September 30, 1998 and
1997, 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
11
<PAGE>
loan losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determinations.
The following table describes the activity related to the Bank's
allowance for loan losses for the periods indicated.
Year Ended September 30,
------------------------
1998 1997
---- ----
(Dollars in Thousands)
Balance, beginning of period $ 249 $ 225
Provision for loan losses 6 24
Charge-offs -- --
Recoveries -- --
----- -----
Balance, end of period $ 255 $ 249
===== =====
Net charge-offs as a % of average loans outstanding -- --
Allowance at period end as a % of nonperforming loans 910.71% 830.00%
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,
----------------
1998 1997
---- ----
Amount of Amount of
Amount of Loans to Amount of Loans to
Allowance Gross Loans Allowance Gross Loans
--------- ----------- --------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $ 124 82.54% $ 123 86.28%
Residential multi-family 6 5.70% 5 4.32%
Nonresidential real estate 48 1.71% 57 1.91%
Residential construction 4 3.61% 1 1.33%
Line of credit 33 5.45% 35 5.34%
----- ------- ------ ------
Total real estate loans 215 99.01% 221 99.18%
----- ------- ------ ------
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Consumer loans:
Passbook or certificate -- 0.11% -- 0.15%
Automobile 32 0.47% 18 0.25%
Other 8 0.41% 10 0.42%
----- ------- ------ ------
Total consumer loans 40 0.99% 28 0.82%
----- ------- ------ ------
Total allowance for loan losses $ 255 100.00% $ 249 100.00%
===== ======= ====== =======
</TABLE>
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, 1998, 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, federal funds sold and
deposits in other financial institutions. The mortgage-backed securities consist
of mortgage-backed securities issued by the GNMA.
Investments in mortgage-backed securities involve a risk that, because
of changes in the interest rate environment, actual prepayments will be greater
than estimated prepayments over the life of the security, which may require
adjustments to the amortization of any premium or accretion of any discount
relating to such instruments, thereby reducing the net yield on such securities.
There is also reinvestment risk associated with the cash flows from such
securities. In addition, the market value of such securities may be adversely
affected by changes in interest rates.
Investments may be classified in one of three categories and accounted
for as follows: (1) debt securities that the entity has the positive intent and
ability to hold to maturity are classified as held-to-maturity and reported at
amortized cost; (2) debt and equity securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and reported at fair value, with net unrealized gains and
losses included in earnings; and (3) debt securities not classified as either
held-to-maturity or trading securities and equity securities not classified as
trading securities are classified as securities available-for-sale and reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of equity. The Company has no trading
securities. See Notes 1 and 2 of "Notes to 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, 1998, 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.
13
<PAGE>
The Company's current investment policy states that the Company's
investments will be limited to U.S. Treasury obligations, federal agency
securities, municipal obligations of the State of North Carolina or its
political subdivisions rated A and above, pass-through and planned amortization
class collateralized mortgage obligations, stock of the FHLB of Atlanta and
certificates of deposits of $100,000 or less in federally 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.
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,
----------------
1998 1997
---- ----
Amortized Amortized
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
(In Thousands)
<S> <C> <C> <C> <C>
Interest-bearing deposits $ 7,162 $ 7,162 $ 6,131 $ 6,131
----- ----- ----- ------
Mortgage-backed securities, held to maturity 301 342 419 481
----- ----- ----- ------
Investment securities:
Held to maturity:
U.S. Treasury and agency securities -- -- 500 494
Available for sale:
U.S. Treasury and agency securities 1,000 1,003 2,500 2,480
State revenue bonds 5,828 5,831 5,100 5,100
Federal Home Loan Mortgage
Corporation stock 25 1,241 25 881
Non-marketable equity securities:
Federal Home Loan Bank stock 595 595 595 595
Certificate of Participation Interest 4 4 4 4
----- ----- ----- ------
7,452 8,674 8,724 9,554
Available for sale market adjustment 1,222 836
------- -------
Total $16,137 $16,178 $16,110 $16,166
======= ======= ======= =======
</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, 1998.
14
<PAGE>
<TABLE>
<CAPTION>
After One Year After Five Years
One Year or Less Through Five Years Through Ten Years
---------------- ------------------ -----------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
----- ----- ----- ------ ----- -----
Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits $7,162 5.50% $ -- -- $ -- --
Mortgage-backed securities -- -- -- -- -- --
U.S. Treasury and agency
securities and state revenue bonds 226 4.20% 1,208 5.62% -- --
Federal Home Loan Mortgage -- -- --
Corporation stock (1) 1,241 4.89% -- -- -- --
Federal Home Loan Bank stock(2) -- -- -- -- -- --
Certificate of Participation -- -- -- --
Interest(2) -- -- -- -- -- --
------ ----- ------ ------ ---- ----
Total $8,629 5.38% $1,208 5.62% $ -- --
====== ===== ====== ====== ==== ====
<CAPTION>
After Ten Years Total
--------------- -----
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
----- ------ ----- -----
Interest-bearing deposits $ -- -- $ 7,162 5.50%
Mortgage-backed securities 301 11.53% 301 11.53%
U.S. Treasury and agency
securities and state revenue bonds 5,400
Federal Home Loan Mortgage -- 5.46% 6,834 5.45%
Corporation stock (1) -- -- 1,241 4.89%
Federal Home Loan Bank stock(2) 595 7.24% 595 7.24%
Certificate of Participation
Interest(2) 4 -- 4 --
------- ------ ------- ------
Total $ 6,300 5.91% $16,137 5.61%
======= ====== ======= =======
</TABLE>
(1) Equity security with no stated maturities; readily available and assumed to
mature in the period one year or less.
(2) Nonmarketable equity security; substantially all required to be maintained
and assumed to mature in periods greater than 10 years.
15
<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, 1998; however, it does maintain
borrowing capabilities through the FHLB of Atlanta.
Deposits. On September 30, 1998 and September 30, 1997, the Bank's
deposits totaled $44.3 million and $43.1 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,
--------------------------------------
1998 1997
---- ----
(In Thousands)
<S> <C> <C>
Total deposits at beginning of period $43,140 $42,410
Net decrease before interest credited (989) (1,252)
Interest credited 2,120 1,982
------- -------
Total deposits at end of period $44,271 $43,140
======= =======
</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.
16
<PAGE>
<TABLE>
<CAPTION>
At September 30,
1998 1997
---------------------------- -----------------------------
Weighted Weighted
Average % of Average % of
Amount Rate Deposits Amount Rate Deposits
----- ---- -------- ------ ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Demand accounts:
Passbook accounts $ 3,866 2.93% 8.73% $ 4,106 2.92% 9.52%
NOW accounts 2,822 2.06% 6.37% 2,984 2.03% 6.92%
Money market deposit
accounts 6,335 4.36% 14.31% 5,381 4.33% 12.47%
Noninterest bearing accounts 678 -- 1.54% 633 -- 1.47%
------ ------ ------ ------ ------ ------
Total demand deposits 13,701 3.29% 30.95% 13,104 3.16% 30.38%
Time deposits 30,536 5.36% 68.98% 29,988 5.45% 69.51%
Accrued interest 34 0.07% 48 0.11%
------ ------- ------ -------
Total deposits $44,271 4.81% 100.00% $43,140 4.74% 100.00%
====== ===== ======= ====== ===== =======
</TABLE>
As of September 30, 1998, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $3.8 million. (Some of
these deposits were deposits of state and local governments which are subject to
rebidding from time to time and to securitization requirements.) The following
table presents the maturity of these time certificates of deposit at the dates
indicated.
At
September 30, 1998
------------------
(In Thousands)
3 Months or less $1,334
Over 3 months through 6 months 1,150
Over 6 months through 12 months 1,022
Over 12 months 301
------
Total $3,807
======
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, 1998 or 1997. During 1998 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, which had an interest rate of
prime minus 2%, was paid in full on October 27, 1997.
17
<PAGE>
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, 1998, 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,
1998, 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.
Supervision and Regulation
Bank holding companies and state savings banks are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes and rules and regulations that affect or will affect the
Company and the Bank. This summary is qualified in its entirety by reference to
the particular statute and regulatory provisions referred to below and is not
intended to be an exhaustive description of the statutes or regulations
applicable to the business of the Company and the Bank. Supervision, regulation
and examination of the Company and the Bank by the regulatory agencies are
intended primarily for the protection of depositors rather than shareholders of
the Company.
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.
18
<PAGE>
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.
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
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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 significantly
affect the operations of federally insured savings institutions and other
federally regulated financial institutions. The operation of regulated
depository institutions, including the Bank, is subject to changes in applicable
statutes and regulations from time to time. Such changes may or may not be
favorable to the Bank.
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.
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
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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 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
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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,
1998, the Bank had a leverage ratio of 20.26%.
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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, 1998, 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, 1998, the largest aggregate amount of loans which
the Bank had to any one borrower was $684,000. 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, 1998, 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
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Program. These contributions continue to reduce the FHLB of Atlanta's earnings
and the Bank's dividends on its FHLB of Atlanta stock.
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, 1998, the Bank's liquidity
ratio, calculated in accordance with North Carolina regulations, was
approximately 16.5%.
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
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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%.
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.
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.
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
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institutions, mergers, conversions and conflicts of interest. North Carolina law
requires that the Bank maintain federal deposit insurance as a condition of
doing business.
The Administrator conducts regular 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, 1998.
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.
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Net Book Value Deposits
Address of Property (In Thousands)
------- -------------- ------------
Laurinburg: $556,058 $37,116
505 South Main Street
P.O. Box 1468
Laurinburg, North Carolina 28352
Pinehurst: 162,340 7,155
-------- ------
77 Cherokee Road
Pinehurst, North Carolina 28374
$718,398 $44,271
======== =======
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, 1998
was $37,583. 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, 1998, 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, 1998.
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 1998 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
27
<PAGE>
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 1998 Annual Report, which section is
incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of the Company set forth on pages
15 through 45 in the Company's 1998 Annual Report are incorporated herein by
reference.
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 2 -
Election of Directors" on page 30 of the Proxy Statement and "Executive
Officers" on page 32 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 8 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 2 - Election of Directors - Directors Compensation" on page
31 and " - Management Compensation" on pages 32 through 37 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
6 through 8 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.
28
<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 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 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 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 incorporated herein by
reference to the Form 10-KSB for the fiscal year
ended September 30, 1997, file number 1-14266, filed
with the SEC on December 16, 1997.
10(e) Scotland Bancorp, Inc. Stock Option Plan incorporated
herein by reference to the Form 10-KSB for the fiscal
year ended September 30, 1997, file number 1-14266,
filed with the SEC on December 16, 1997.
(11) Statement Regarding Computation of Per Share Earnings
(13) Portions of 1998 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) On August 28, 1998, the Company filed a Form 8-K disclosing that it had
entered into an Agreement and Plan of Reorganization and Merger with
Centura Banks, Inc.
29
<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 18, 1998 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>
<S> <C> <C>
Signature Title Date
- --------- ----- ----
/s/ William C. Fitzgerald, III President, Chief Executive December 18, 1998
- ----------------------------------------------- Officer and Director
William C. Fitzgerald, III
/s/ John B. Clark Senior Vice-President and December 18, 1998
- ----------------------------------------------- Director
John B. Clark
/s/ Debora B. Steagall Assistant Treasurer December 18, 1998
- -----------------------------------------------
Debora B. Steagall
/s/ Clifton P. Buie Director December 18, 1998
- -----------------------------------------------
Clifton P. Buie
/s/ E. S. Hill, Jr. Director December 18, 1998
- -----------------------------------------------
E.S. Hill, Jr.
/s/ John W. Hudson Director December 18, 1998
- -----------------------------------------------
John W. Hudson
/s/ James W. Mason Director December 18, 1998
- -----------------------------------------------
James W. Mason
/s/ James E. Milligan Director December 18, 1998
- -----------------------------------------------
James E. Milligan
/s/ James S. Mitchener, Jr. Director December 18, 1998
- -----------------------------------------------
James S. Mitchener, Jr.
/s/ S. T. Snowdon, Jr. Director December 18, 1998
- -----------------------------------------------
S. T. Snowdon, Jr.
/s/ James T. Willis Director December 18, 1998
- -----------------------------------------------
James T. Willis
</TABLE>
30
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
11 Statement Regarding Computation of Per Share Earnings
13 Portions of the 1998 Annual Report to Stockholders
23 Consent of McGladrey & Pullen, LLP
27 Financial Data Schedule
<PAGE>
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
See Note 9 to the Financial Statements contained in the 1998 Annual
Report to Security Holders.
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
Page
- ------------------------------------------------------------------------------------------------------
<S> <C>
Selected Consolidated Financial Data 1 - 2
Management's Discussion and Analysis 4 - 14
Independent Auditor's Report 15
Consolidated Financial Statements:
Statements of financial condition at September 30, 1998 and 1997 16
Statements of income for the years ended September 30, 1998 and 1997 17
Statements of stockholders' equity for the years ended September 30, 1998 and 1997 18 - 19
Statements of cash flows for the years ended September 30, 1998 and 1997 20 - 21
Notes to Consolidated Financial Statements 22 - 45
Corporate Information 46 - 47
</TABLE>
This annual report to stockholders contains certain forward-looking statements
consisting of estimates with respect to the financial condition, results of
operations and other business of the Company that are subject to various factors
which could cause actual results to differ materially from those estimates.
Factors which could influence the estimates include changes in the national,
regional and local market conditions, legislative and regulatory conditions, and
an adverse interest rate environment.
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------------------------------------------------------------------------
(Dollars In Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C>
Financial Condition Data:
Total assets $ 60,730 $ 64,399 $ 68,622 $ 57,718 $ 57,715
Investments securities (1) 16,137 16,110 21,464 14,525 19,273
Loans receivable, net 42,485 46,463 45,079 41,204 36,661
Deposits 44,271 43,140 42,410 48,203 48,995
Stockholders' equity (2) 15,337 14,561 24,791 8,580 7,761
Book value per share 8.01 7.61 13.47 - -
Years Ended September 30,
-------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
Operating Data:
Interest and dividend income $ 4,564 $ 5,171 $ 4,870 $ 4,313 $ 3,889
Interest expense 2,122 1,983 2,209 2,144 1,753
-------------------------------------------------------------------------------------
Net interest income 2,442 3,188 2,661 2,169 2,136
Provision for loan losses 6 24 25 11 20
Noninterest income 74 306 80 73 71
Noninterest expense 1,676 1,680 1,549 1,158 1,263
-------------------------------------------------------------------------------------
Income before income taxes 834 1,790 1,167 1,073 924
Income tax expense 305 532 409 352 292
-------------------------------------------------------------------------------------
Net income $ 529 $ 1,258 $ 758 $ 721 $ 632
=====================================================================================
Basic earnings per share (2)(3) $ 0.32 $ 0.74 $ 0.25 $ - $ -
Diluted earnings per share (2)(3) 0.32 0.73 0.25 - -
Dividends per share (2) 0.20 6.30 0.15 - -
Dividend payment ratio (2)(6) 62.50% 851.35% 60.00% - -
</TABLE>
(Continued)
1
<PAGE>
<TABLE>
<CAPTION>
Years Ended September 30,
-----------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-----------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C>
Selected Other Data:
Return on average assets 0.86% 1.84% 1.18% 1.25% 1.13%
Return on average equity 3.52% 5.14% 4.31% 8.52% 8.49%
Average equity to average assets 24.41% 35.80% 27.38% 14.67% 13.31%
Interest rate spread 2.89% 3.05% 2.84% 3.27% 3.50%
Net interest margin 4.07% 4.75% 4.15% 3.87% 3.94%
Efficiency ratio (5) 66.62% 48.08% 56.51% 51.65% 57.23%
Allowance for loan losses to
nonperforming loans (4) 910.71% 830.00% 714.97% 0.00% 0.00%
Nonperforming loans to total loans 0.06% 0.06% 0.07% 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 $0.20, $0.30, and $0.15 for the years ended
September 30, 1998, 1997, and 1996, respectively. The Bank also issued a
return of capital dividend of $6.00 per share during the year ended
September 30, 1997.
(3) Earnings per share has been calculated in accordance with the Statement of
Financial Accounting Standards No. 128, "Earnings Per Share", and is based
on net income for the year, divided by the weighted average number of
shares outstanding for the year. In accordance with the AICPA's SOP 93-6,
unallocated ESOP shares were deducted from outstanding shares used in the
computation of earnings per share. Diluted earnings per share includes the
effect of dilutive common stock equivalents in the weighted average number
of shares outstanding.
(4) Nonperforming loans include mortgage loans and consumer/commercial loans 90
days or more delinquent.
(5) The efficiency ratio represents noninterest expense as a percentage of the
sum of net interest income and noninterest income.
(6) The dividend payment ratio represents dividends per share as a percent of
earnings per share. Dividends per share include a $6.00 per share 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 in 1998 and 1997, and changes in
financial position for the years ended September 30, 1998 and 1997,
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. 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, 1998
approximately 99% of the Bank's net loan portfolio was composed of real estate
loans.
Scotland Savings' 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, 1998 AND 1997
Total consolidated assets decreased by $3.7 million during 1998, from $64.4
million at September 30, 1997 to $60.7 million at September 30, 1998. The
decrease resulted primarily due to the drop in fixed long term interest rates,
which caused the loan portfolio to decrease.
Investments, including short term interest-earning deposits, federal funds sold,
U.S. Treasury and agency obligations, municipal obligations, and mortgage-backed
securities increased by $26,000 during 1998 and totaled $16.1 million at
September 30, 1998. During the year ended September 30, 1998, investment
securities totaling $5.6 million were sold in order to pay off the note payable
described below, $1.5 million of securities were called, $5.8 million of
securities were purchased, and the unrealized gain on the securities available
for sale portfolio increased by $385,000.
Loans receivable decreased by approximately $4.0 million during 1998 to $42.5
million at September 30, 1998, primarily as a result of the drop in fixed, long-
term interest rates. Also, many balloon mortgages were paid off during the year
while few balloons were originated. 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.
Savings deposits increased by approximately $1.1 million during 1998, equating
to 2.62% growth, and totaled $44.3 million at September 30, 1998. This increase
is comparable to the increase in 1997 of 1.72%. The increase is attributed to
our concentration on steady and controlled growth in our deposit base.
The Company repaid the $5.5 million note payable during 1998 which was incurred
in September of 1997, thus eliminating the Company's external debt. The $5.5
million in borrowings was incurred to facilitate disbursement of the return of
capital dividend (See Note 7 to the consolidated financial statements). During
1998, 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 0.86% and 1.84%, and its return on
average equity was 3.52% and 5.14%, for 1998 and 1997, respectively.
The Bank is required to meet certain capital requirements as established by the
FDIC and the North Carolina Savings Institutions Division. At September 30,
1998 and 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
MANAGMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
COMPARISON OF OPERATING RESULTS FOR 1998 AND 1997
NET INCOME
Net income for the years ended September 30, 1998 and 1997 was $528,749 and
$1,258,260, respectively. As discussed below, the decrease in net income was
primarily attributable to a decrease in net interest income due to a lower level
of loans receivable and moderate deposit growth.
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, 1998 and 1997. 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 decreased by $607,266 during 1998, from $5,171,418 in
1997 to $4,564,152 in 1998. The decrease in interest income during 1998 was
attributable to a lower level of interest-earning assets, primarily loans
receivable as previously discussed. The Bank's overall yield on interest-
earning assets decreased slightly during 1998, from 7.70% in 1997 to 7.60% in
1998. Interest-earning assets amounted to $58.6 million at September 30, 1998
as compared to $62.6 million at September 30, 1997. Approximately 97% of the
Company's assets were interest-earning at September 30, 1998, and approximately
73% of such interest-earning assets were held in the form of loans receivable.
INTEREST EXPENSE
Total interest expense increased to $2,122,320 in 1998 from $1,982,955 in 1997,
an increase of $139,365 or 7.03%. Scotland Saving's cost of funds was 4.71% in
1998 and 4.65% in 1997. Stability in the Bank's cost of funds during 1998 was
similar to stability in overall market rates. The Bank's average balance of
outstanding deposits increased by approximately $2.4 million during 1998
resulting in an increase in interest expense for the period. Additionally,
interest on borrowed funds had an immaterial impact on the increase in interest
expense in 1998.
6
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------------------
At 1998
------------------------------------------------------------
September
30, 1998 (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 5.50% $ 7,457 $ 412 5.53%
Investments, at cost (1) 5.45% 7,232 399 5.52%
Mortgage-backed securities 11.53% 361 41 11.36%
Loans receivable 7.93% 44,986 3,712 8.25%
------------------ ----------------- -----------------
Total interest-earning assets 7.52% 60,036 $ 4,564 7.60%
-----------------
Non interest-earning assets 1,514
------------------
Total $ 61,550
==================
Liabilities and retained earnings:
Interest-bearing liabilities:
Passbook accounts 2.93% $ 4,017 $ 118 2.94%
Transaction accounts 3.65% 10,106 327 3.24%
Certificates of deposit 5.36% 30,905 1,675 5.42%
Other - 30 2 6.67%
------------------ ----------------- -----------------
Total interest-bearing liabilities 4.81% 45,058 $ 2,122 4.71%
-----------------
Non interest-bearing liabilities 1,467
Equity 15,025
------------------
Total $ 61,550
==================
Net interest income and interest
rate spread (2) 2.71% 2,442 2.89%
=================
Net yield on interest-earning
assets (3) 4.07%
Ratio of interest-earning assets to
interest-bearing liabilities 133.24%
<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 $ 4,194 $ 237 5.65%
Investments, at cost (1) 14,587 934 6.40%
Mortgage-backed securities 466 52 11.16%
Loans receivable 47,890 3,948 8.24%
----------------- ----------------- -----------------
Total interest-earning assets 67,137 $ 5,171 7.70%
-----------------
Non interest-earning assets 1,415
-----------------
Total $ 68,552
=================
Liabilities and retained earnings:
Interest-bearing liabilities:
Passbook accounts $ 4,094 $ 119 2.91%
Transaction accounts 8,562 249 2.91%
Certificates of deposit 29,952 1,614 5.39%
Other 15 1 6.67%
----------------- ----------------- -----------------
Total interest-bearing liabilities 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) 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>
(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 table on page 9 analyzes the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and interest-
bearing liabilities. This table distinguishes between (i) changes attributable
to volume (changes in volume multiplied by the prior period's rate), (ii)
changes attributable to rate (changes in rate multiplied by the prior period's
volume), and (iii) 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 $6,000 and $24,000 for the
years ended September 30, 1998 and 1997, respectively. The provision, which is
charged to operations, and the resulting loan loss allowances are amounts
Scotland Savings' 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, 1998 and1997. Scotland Savings' charged-
off loans amounted to $50 and $492 for the years ended September30,1998 and
1997, respectively.
NONINTEREST INCOME
Noninterest income amounted to $74,569 and $306,272 in 1998 and 1997,
respectively. Noninterest income consists primarily of service charges and fees
associated with the Bank's loan and savings accounts. The decrease in Scotland
Savings' level of noninterest income during 1998 relates mainly to the gain on
sale of investments of $240,726 which occurred in 1997 (See Note 2 to the
consolidated financial statements).
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 $1,676,409 and $1,680,265 in 1998 and
1997, respectively. None of the noninterest expense categories changed
significantly during 1998 and 1997.
INCOME TAXES
The Company's effective income tax rate was 36.60% and 29.72% in 1998 and 1997,
respectively. The differences in rates were due to changes in the components of
permanent tax differences (See Note 8 to the consolidated financial statements).
8
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
1998 vs. 1997
---------------------------------------------------------------------------------
Increase (Decrease) Attributable to
---------------------------------------------------------------------------------
Volume Rate Rate/Volume Net
------------------ ------------------ ----------------- -----------------
<S> <C> <C> <C> <C>
Interest income on:
Interest-bearing deposits $ 184 $ (5) $ (4) $ 175
Investments, at cost (471) (129) 65 (535)
Mortgage-backed securities (12) 1 - (11)
Loans receivable (239) 4 (1) (236)
----------------- ------------------ ----------------- -----------------
Total interest income on
interest-earning assets (538) (129) 60 (607)
----------------- ------------------ ----------------- -----------------
Interest expense on:
Passbook accounts (2) 1 - (1)
Transaction accounts 45 28 5 78
Certificates of deposit 52 9 - 61
FHLB advances and other 1 - - 1
----------------- ------------------ ----------------- -----------------
Total interest expense
on interest-bearing liabilities 96 38 5 139
----------------- ------------------ ----------------- -----------------
Increase (decrease) in net
interest income $ (634) $ (167) $ 55 $ (746)
================= ================== ================= =================
<CAPTION>
1997 vs. 1996
----------------------------------------------------------------------------------
Increase (Decrease) Attributable to
----------------------------------------------------------------------------------
Volume Rate Rate/Volume Net
------------------ ------------------ ----------------- ------------------
(In Thousands)
<S> <C> <C> <C> <C>
Interest income on:
Interest-bearing deposits $ (100) $ 16 $ (5) $ (89)
Investments, at cost 2 92 - 94
Mortgage-backed securities (15) (1) - (16)
Loans receivable 425 (103) (9) 313
------------------ ------------------ ----------------- ----------------
Total interest income on
interest-earning assets 312 4 (14) 302
------------------ ------------------ ------------------ ----------------
Interest expense on:
Passbook accounts (42) 1 - (41)
Transaction accounts 42 11 2 55
Certificates of deposit (133) (65) 4 (194)
FHLB advances and other (46) - - (46)
------------------ ------------------ ------------------ ----------------
Total interest expense
on interest-bearing liabilities (179) (53) 6 (226)
------------------ ------------------ ------------------ ----------------
Increase (decrease) in net
interest income $ 491 $ 57 $ (20) $ 528
================== ================== ================== ================
</TABLE>
9
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
CAPITAL RESOURCES AND LIQUIDITY
Scotland Bancorp, Inc. paid regular cash dividends of $0.20 and $0.30 per share
during the years ended September 30, 1998 and 1997, respectively. 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 up until the time of the Company's
anticipated merger with Centura Banks, Inc. is consummated, 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 meet 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, 1998, cash and cash equivalents, a
significant source of liquidity, increased by approximately $1.2 million. Cash
and cash equivalents increased by $1.7 million during 1997. Cash flow resulting
from internal operating activities provided increases of $498,654 and $1,173,256
in cash during the years ended September 30, 1998 and 1997, respectively. Also,
financing activities have provided sources of funds for asset growth and
liquidity. For the years ended September30,1998, and 1997, respectively,
deposits increased by $1.1 million and $730,000.
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 1998 and 1997, loans outstanding decreased
by $4.0 million and increased $1.4 million, respectively. During 1998 and 1997,
the Company purchased investment securities amounting to $5.8 million and $11.1
million, respectively, and received proceeds from sales or maturities of
investment securities amounting to $7.1 million and $18.6 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,
1998, 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.
10
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
ASSET/LIABILITY MANAGEMENT
Scotland Savings' 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' net interest income. At September 30, 1998, the Bank had a
negative gap position.
In order to minimize the potential effects of adverse material and prolonged
increases or decreases in market interest rates on the Bank's operations,
management has implemented an asset/liability program designed to improve the
Bank's interest rate gap. The program emphasizes the origination of adjustable
rate loans, and to a lesser extent shorter term construction and consumer loans,
all of which are held in the portfolio, the investment of excess cash in short
or intermediate term interest earning assets, and the solicitation of
transaction deposit accounts which are less sensitive to changes in interest
rates and can be repriced rapidly. 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 $26.5
million in certificates maturing in 1999 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, 1998, 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, 1998, 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
11
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
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. 130, "Reporting Comprehensive Income," which the
Company has not been required to adopt as of September 30, 1998. 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.
The FASB has issued SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," which the Company has not been required to adopt as of
September 30, 1998. This Statement, which is effective for fiscal years
beginning after December 15, 1997, requires that a public business enterprise
report financial and descriptive information about its reportable operating
segments. Operating segments are components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. Generally, financial information is required to be
reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments.
The FASB has issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which the Company has not been required to adopt as of
September 30, 1998. This Statement, which is effective for fiscal years
beginning after June 15, 1998, establishes accounting and reporting standards
for derivative instruments embedded in other contracts, (collectively referred
to as derivatives) and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (a) a hedge
of the exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-currency- denominated
forecasted transaction. This Statement is not expected to have a significant
impact on the Company.
The FASB has issued SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise," an amendment of FASB Statement No. 65, which the Company
has not been required to adopt as of September 30, 1998. Statement No. 65, as
amended by FASB Statements No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," and No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting
12
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
mortgage-backed security as a trading security. This Statement further amends
Statement No. 65 to require that after the securitization of mortgage loans held
for sale, an entity engaged in mortgage banking activities classify the
resulting mortgage-backed securities or other retained interests based on its
ability and intent to sell or hold those investments. This Statement conforms
the subsequent accounting for securities retained after the securitization of
mortgage loans by a mortgage banking enterprise with the subsequent accounting
for securities retained after the securitization of other types of assets by a
nonmortgage banking enterprise. This Statement is effective for fiscal years
beginning after December 15, 1998, and is not expected to have a significant
impact on the Company.
RECAPTURE OF TAX BAD DEBT RESERVES
Prior to the enactment of the Small Business Job Protection Act of 1996 (the
"1996 Act") on August20,1996, 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
$126,000. The recapture was scheduled to begin with the Bank's 1997 year, but
has been delayed two years as the Bank originated a certain level of residential
mortgage loans. 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.
IMPACT OF THE YEAR 2000
A lot of attention has been given to the impact that the year 2000 date change
will have on businesses, utilities and other organizations that rely on
computerized systems to help run their operations. The year 2000 date change
can affect any system that uses computer software or computer chips including
automated equipment and machinery. For example, many computer programs and
computer chips store the calendar year portion of the date as two digits rather
than four digits. These software programs and chips record the year 1999 as
"99". This approach works until the year 2000 when the "00" may be interpreted
as the year 1900 instead of the year 2000. Banks use computer systems to
perform financial calculations, transfer funds, record deposits and loan
payments, run security systems and vaults and a myriad of other functions.
Because banks rely heavily on their computer systems, the Federal Financial
Institutions Examination Council ("FFIEC") has placed significant emphasis on
the problems surrounding the year 2000 issues and has required financial
institutions to document the assessment, testing and corrections made to ready
their computer systems and programs for the year 2000 date change. The FFIEC
has strict regulations, guidelines, and milestones in place that each FDIC
insured financial institution must follow in order to remain operational. The
Company's board of directors has remained informed of the Company's position and
progress in its year 2000 project.
As previously noted, Scotland Bancorp, Inc. has entered into an agreement to
sell the Company to Centura Banks, Inc. Upon completion of the sale, Centura
will convert the Company's computer systems to their own, which are anticipated
to be year 2000 compliant. However, since the sale is contingent upon
13
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
shareholder and regulatory approval, Scotland Bancorp, Inc. is going forward
with the current year 2000 remediation plan.
The Company's year 2000 project remains on schedule according to the guidelines
set forth by the FFIEC. The Company's most critical external exposure to year
2000 system problems is with its data processing provider, Fiserv. Fiserv
renovated its systems in June 1998 and is currently testing its remediation
efforts. Fiserv plans to have all of its systems year 2000 compliant by
December 1998. In addition, the Company has contacted its major customers and
vendors to inquire about their progress in addressing the year 2000 problem and
does not believe that the problems of such customers and vendors will have a
material adverse effect on the Company or its operations. The Company will
continue to monitor the progress of these parties in addressing the year 2000
problem as the new millennium approaches. Management estimated the cost to
replace the computer hardware and software with year 2000 compliment equipment
to be approximately $160,000.
The year 2000 problems can affect the Company's operation in a number of ways
but the mission critical issue is maintaining customers' account information
including tracking deposits, interest accruals and loan payments. The Company
is dependent upon electricity, telephone lines, computer hardware and Fiserv's
data processing capability.
The Company is in contact with its electric utility and phone company, and
assurances have been given that no major problems exist and that both companies
will have all year 2000 problems addressed well before December 31, 1999. If
the electric utility is unable to certify that its renovation is completed by
June 30, 1999, the Company will acquire portable generators with sufficient
capacity to run the system servers and at least one work station in each branch
office.
To prevent difficulties in the event there is an unforeseen interruption in
either telephone or electrical service when the year changes, the Company will
print hard copies of all account information. In addition, the Company will
download all account information into programs on the Company's hardware that
will allow bank personnel to extract customer information without regard to
outside sources.
Fiserv has responded to the Company that renovation of its program is virtually
complete. In the event that Fiserv is unable to make the necessary corrections
to its programs to accommodate the year 2000, the Company will convert its data
to one of the other Fiserv programs that is able to operate in the 2000
environment.
SALE OF THE COMPANY
On August 26, 1998 Scotland Bancorp, Inc. and Centura Banks, Inc. announced that
Centura will acquire Scotland Bancorp, which is the holding company for Scotland
Savings Bank, in a cash transaction. The parties' agreement provides for each
share of Scotland Bancorp's common stock to be exchanged for $11.75 in cash.
This transaction is contingent upon receiving approvals from regulatory
authorities and from Scotland Bancorp's shareholders. A special meeting of
Scotland shareholders is planned after required regulatory approvals are
received. It is anticipated that the transaction will be completed in the
second quarter of fiscal 1999.
14
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Scotland Bancorp, Inc. and Subsidiary
Laurinburg, North Carolina
We have audited the accompanying consolidated statements of financial condition
of Scotland Bancorp, Inc. and subsidiary as of September 30, 1998 and 1997, 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Scotland Bancorp,
Inc. and subsidiary as of September 30, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ McGLADREY & PULLEN, LLP
Charlotte, North Carolina
October 23, 1998
15
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents:
Interest-bearing deposits $ 2,162,224 $ 2,931,343
Noninterest-bearing deposits 767,594 626,905
Federal funds sold 5,000,000 3,200,000
Securities held to maturity (fair value 1998 $0;
1997 $494,060) (Note 2) - 500,000
Securities available for sale (Note 2) 8,074,324 8,460,850
Nonmarketable equity securities, at cost 599,400 599,400
Loans receivable, net (Note 3) 42,484,729 46,463,348
Mortgage-backed securities, held to maturity, (fair value 1998
$341,980; 1997 $481,325) (Note 4) 301,097 418,657
Accrued interest receivable on loans 169,281 160,821
Accrued interest receivable on investment securities 38,128 49,938
Office properties and equipment, net (Note 5) 755,981 792,359
Income tax refund receivable 145,658 -
Prepaid expenses and other assets 231,464 195,666
--------------------------------------
TOTAL ASSETS $ 60,729,880 $ 64,399,287
======================================
- -----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------
Liabilities:
Savings deposits (Note 6) $ 44,270,688 $ 43,139,725
Note payable (Note 7) - 5,500,000
Accounts payable and accrued expenses (Note 12) 276,354 447,422
Advances from borrowers for taxes and insurance 129,851 160,229
Income taxes payable - 37,383
Deferred income taxes (Note 8) 715,934 553,766
--------------------------------------
TOTAL LIABILITIES 45,392,827 49,838,525
--------------------------------------
Commitments and contingencies (Notes 13, 16 and 20)
Stockholders' Equity (Note 10):
Preferred stock, authorized 5,000,000 shares; none issued - -
Common stock, no par value, authorized 20,000,000 shares;
1,913,600 shares issued - -
Additional paid-in capital 7,922,762 7,939,945
Unearned ESOP (Note 15) (1,602,395) (1,708,545)
Unrealized gain on securities available for sale, net of tax 757,272 518,552
Deferred management recognition plan (Note 14) (594,167) (824,167)
Unearned compensation (Note 15) (802,458) (834,558)
Retained earnings, substantially restricted (Notes 8 and 11) 9,656,039 9,469,535
--------------------------------------
TOTAL STOCKHOLDERS' EQUITY 15,337,053 14,560,762
--------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 60,729,880 $ 64,399,287
======================================
</TABLE>
See Notes to Consolidated Financial Statements.
16
<PAGE>
See Notes to Consolidated Financial Statements.
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest and dividend income:
Loans $ 3,712,042 $ 3,948,280
Investment securities 399,173 934,000
Mortgage-backed securities 41,293 51,846
Other interest-bearing deposits 411,644 237,292
-------------------------------------
4,564,152 5,171,418
-------------------------------------
Interest expense:
Deposits (Note 6) 2,120,334 1,982,058
Other borrowings 1,986 897
-------------------------------------
2,122,320 1,982,955
-------------------------------------
NET INTEREST INCOME 2,441,832 3,188,463
Provision for loan losses (Note 3) 6,000 24,000
-------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,435,832 3,164,463
-------------------------------------
Noninterest income:
Gain of sale of investments (Note 2) - 240,726
Service charges and other fees 51,208 44,183
Other 23,361 21,363
-------------------------------------
74,569 306,272
-------------------------------------
Noninterest expenses:
Compensation and employee benefits 1,079,689 1,103,882
Occupancy 86,455 86,990
Insurance 38,091 31,661
Data processing 97,813 94,871
Furniture and fixture expense 31,554 29,660
Other 342,807 333,201
-------------------------------------
1,676,409 1,680,265
-------------------------------------
INCOME BEFORE INCOME TAXES 833,992 1,790,470
-------------------------------------
Income taxes (Note 8):
Current 289,386 487,272
Deferred 15,857 44,938
-------------------------------------
305,243 532,210
-------------------------------------
NET INCOME $ 528,749 $ 1,258,260
=====================================
Basic earnings per share (Note 9) $ 0.32 $ 0.74
=====================================
Diluted earnings per share (Note 9) $ 0.32 $ 0.73
=====================================
Regular cash dividends per share $ 0.20 $ 0.30
=====================================
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, 1998 AND 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
Deferred
Additional Management
Paid-in Unearned Recognition
Capital ESOP Plan
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
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)
Cash dividends - - -
Change in net unrealized gain on
securities available for sale - - -
Amortization of unearned
compensation - - -
Vesting deferred management
recognition plan - - 230,000
ESOP contribution (17,183) - -
Principal payment on note
receivable from ESOP - 106,150 -
Net income - - -
------------------------------------------------------------
Balance, September 30, 1998 $ 7,922,762 $ (1,602,395) $ (594,167)
============================================================
</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>
$ - $ 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
- - (342,245) (342,245)
- 238,720 - 238,720
32,100 - - 32,100
- - - 230,000
- - - (17,183)
- - - 106,150
- - 528,749 528,749
- --------------------------------------------------------------------------
$ (802,458) $ 757,272 $ 9,656,039 $ 15,337,053
==========================================================================
</TABLE>
19
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows From Operating Activities
Net income $ 528,749 $ 1,258,260
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 44,944 36,017
Provision for loan losses 6,000 24,000
Net accretion on securities (3,443) (7,729)
Amortization of unearned compensation 32,100 -
Net (gain) loss on sale of securities available for sale - (240,726)
ESOP contribution (17,183) 16,519
Vesting of deferred management recognition plan 230,000 325,833
Deferred income taxes 15,857 44,938
(Increase) decrease in:
Accrued interest receivable,
prepaid expenses and other assets (32,448) 98,606
Income tax refund receivable (145,658) -
Increase (decrease) in:
Income taxes payable (37,383) (98,707)
Accounts payable and accrued expenses (122,881) 36,995
Special SAIF assessment - (320,750)
-------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 498,654 1,173,256
-------------------------------------------
Cash Flows From Investing Activities
Proceeds from maturities of securities held to maturity 500,000 2,000,000
Proceeds from maturities of securities available for sale 1,000,000 600,000
Proceeds from sales of securities available for sale 5,600,000 15,968,635
Purchases of securities available for sale (5,825,000) (11,100,000)
Principal collected on mortgage-backed securities 117,560 126,633
Net (increase) decrease in loans receivable 3,972,619 (1,408,488)
Purchases of property and equipment (8,566) (8,902)
-------------------------------------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 5,356,613 6,177,878
-------------------------------------------
Cash Flows From Financing Activities
Net increase in savings accounts 1,130,963 730,157
Increase (decrease) in escrow deposits (30,378) 3,704
Proceeds from borrowings on note payable - 5,500,000
Payment of note payable (5,500,000) -
Principal payment on note receivable from ESOP 106,150 63,747
Payment of dividends (390,432) (514,817)
Return of capital dividends - (11,481,600)
-------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (4,683,697) (5,698,809)
-------------------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,171,570 1,652,325
Cash and cash equivalents:
Beginning 6,758,248 5,105,923
-------------------------------------------
Ending $ 7,929,818 $ 6,758,248
===========================================
</TABLE>
(Continued)
20
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------
Cash and cash equivalents:
Cash and short-term investments $ 2,929,818 $ 3,558,248
Federal funds sold 5,000,000 3,200,000
-----------------------------------------
$ 7,929,818 $ 6,758,248
=========================================
Supplemental Disclosure of Cash Flow Information
Cash payments for:
Interest 2,136,409 1,991,907
Income taxes 472,427 585,979
Supplemental Disclosure of Noncash Investing Activities
Change in unrealized gain on securities available for sale 238,720 107,417
Supplemental Disclosure of Noncash Financing Activities
Dividends accrued 84,901 133,088
Adoption of deferred management recognition plan - 1,150,000
</TABLE>
See Notes to Consolidated Financial Statements.
21
<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,
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. 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.
22
<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. Premiums and discounts are
amortized using the interest method over the contractual lives. Unrealized
gains or losses are reported as increases or decreases in stockholders' 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.
23
<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, 1998 and 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 lives 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
lives 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,
1998 and 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.
24
<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 deferred compensation and retirement plan
- -------------
agreements for the benefit of three members of the Board of Directors. The
plans are unfunded and the liabilities are being accrued over the terms of
active service of the directors. 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 certain 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 certain officers, directors and employees at the time of
adoption.
The Bank has a 401(k) retirement plan available to substantially all employees.
The Bank will match certain portions of voluntary contributions by participating
employees.
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 current financial instruments are not necessarily
indicative of the amounts the Company could realize in 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, 1998 and 1997. 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.
25
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2. DEBT AND EQUITY SECURITIES
Debt and equity 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, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998
------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available for sale:
U. S. Government and federal
agency securities $ 1,000,000 $ 2,657 $ - $ 1,002,657
State revenue bonds 5,828,443 2,500 - 5,830,943
FHLMC stock 24,475 1,216,249 - 1,240,724
------------------------------------------------------------------------
6,852,918 1,221,406 - 8,074,324
------------------------------------------------------------------------
Nonmarketable equity securities:
FHLB stock 595,400 - - 595,400
Fiserv stock 4,000 - - 4,000
------------------------------------------------------------------------
599,400 - - 599,400
------------------------------------------------------------------------
$ 7,452,318 $ 1,221,406 $ - $ 8,673,724
========================================================================
</TABLE>
<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
Fiserv stock 4,000 - - 4,000
---------------------------------------------------------------------
599,400 - - 599,400
---------------------------------------------------------------------
$ 8,723,875 $ 856,845 $ (26,410) $ 9,554,310
=====================================================================
</TABLE>
26
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2. DEBT AND EQUITY SECURITIES (CONTINUED)
The amortized cost and fair value of debt securities available for sale at
September 30, 1998 by contractual maturity are shown below. Equity securities
are not included in the maturity categories because they do not have contractual
maturities.
<TABLE>
<CAPTION>
Available for Sale
----------------------------------------
Amortized Fair
Cost Value
----------------------------------------
<S> <C> <C>
Due in one year or less $ 225,425 $ 225,873
Due in one year through five years 1,203,018 1,207,727
Due in five years or more 5,400,000 5,400,000
----------------------------------------
$ 6,828,443 $ 6,833,600
========================================
</TABLE>
Summarized below is the sales activity in investment securities:
<TABLE>
<CAPTION>
Years Ended September 30,
----------------------------------------
1998 1997
----------------------------------------
<S> <C> <C>
Proceeds from the sale of available for sale securities $ 5,600,000 $ 15,968,635
Realized gains - (240,726)
Realized losses - -
----------------------------------------
Cost of investment securities sold $ 5,600,000 $ 15,727,909
========================================
</TABLE>
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.
The change in net unrealized gains and losses shown as a separate component of
stockholders' equity for the years ended September 30, 1998 and 1997 is as shown
below:
<TABLE>
<CAPTION>
1998 1997
-------------------------------------
<S> <C> <C>
Balance in equity component, beginning $ 518,552 $ 411,135
Change in net unrealized gains 385,031 213,443
Less change in deferred income taxes (146,311) (106,026)
-------------------------------------
Balance in equity component, ending $ 757,272 $ 518,552
=====================================
</TABLE>
Investment securities with aggregate cost of $700,000 and estimated fair value
of $702,000 are pledged at September 30, 1998 to collateralize certain public
deposits.
27
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 3. LOANS RECEIVABLE
Loans receivable at September, 1998 and 1997 consist of the following:
<TABLE>
<CAPTION>
1998 1997
----------------------------------------
Real estate loans:
<S> <C> <C>
Residential, one-to-four units $ 36,423,685 $ 41,018,267
Residential, multifamily 2,513,660 2,052,097
Nonresidential real estate 755,218 907,451
Residential construction 1,593,400 634,100
Line of credit 2,406,102 2,539,817
----------------------------------------
43,692,065 47,151,732
Share loans 49,737 71,058
Automobile 209,397 119,019
Other 178,059 201,381
----------------------------------------
44,129,258 47,543,190
----------------------------------------
Less:
Undisbursed portion of loans in process 1,192,273 614,230
Allowance for loan losses 254,810 248,860
Deferred loan fees 197,446 216,752
----------------------------------------
1,644,529 1,079,842
----------------------------------------
$ 42,484,729 $ 46,463,348
========================================
</TABLE>
The following summarizes transactions in the Bank's allowance for loan losses:
<TABLE>
<CAPTION>
1998 1997
-----------------------------------------
<S> <C> <C>
Balance at the beginning of year $ 248,860 $ 225,352
Provisions charged to operations 6,000 24,000
Charge-offs (50) (492)
-----------------------------------------
Balance at the end of the year $ 254,810 $ 248,860
=========================================
</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 $28,000 and $30,000
at September 30, 1998 and 1997, respectively. These loans are collateral
dependent and management had determined that the underlying collateral value is
in excess of the carrying amount. As a result, the Bank determined that
specific allowances on these loans is not required.
28
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3. LOANS RECEIVABLE (CONTINUED)
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, 1998 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, 1998
and 1997 for loans made by the Bank to the Company's officers, directors and
their affiliates:
<TABLE>
<CAPTION>
1998 1997
-----------------------------------------
<S> <C> <C>
Principal balances, beginning of year $ 1,489,027 $ 1,459,560
New loans originated 160,875 224,903
Principal repayments (601,284) (195,436)
-----------------------------------------
Principal balances, end of year $ 1,048,618 $ 1,489,027
=========================================
</TABLE>
The Bank has pledged its stock in the Federal Home Loan Bank and entered into a
security agreement with a blanket floating lien pledging mortgage loans to
secure potential borrowings from the Federal Home Loan Bank of Atlanta. Unused
borrowing capacity from the Federal Home Loan Bank amounts to approximately $10
million at September 30, 1998. No advances were outstanding at September 30,
1998 or 1997.
NOTE 4. MORTGAGE-BACKED SECURITIES
Mortgage-backed securities consist of the following at September 30, 1998 and
1997:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
September 30 Cost Gains Losses Value
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
GNMA mortgage-backed
securities
1998 $ 301,097 $ 40,883 $ - $ 341,980
1997 418,657 62,668 - 481,325
</TABLE>
All of the Bank's mortgage-backed securities have been classified as held to
maturity at September 30, 1998 and 1997, and there have been no sales during the
years ended September 30, 1998 and 1997.
29
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 5. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment consist of the following at September 30, 1998
and 1997:
<TABLE>
<CAPTION>
1998 1997
-----------------------------------------
<S> <C> <C>
Land $ 141,406 $ 141,406
Office buildings and improvements 954,743 954,661
Furniture and fixtures 195,335 306,789
-----------------------------------------
1,291,484 1,402,856
Accumulated depreciation (535,503) (610,497)
-----------------------------------------
$ 755,981 $ 792,359
=========================================
</TABLE>
NOTE 6. SAVINGS DEPOSITS
Savings deposits consist of the following at September 30, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
-----------------------------------------
<S> <C> <C>
Regular savings, 2.93% (2.92% in 1997) $ 3,866,118 $ 4,106,067
MMDA accounts, 4.36% (4.33% in 1997) 6,334,998 5,380,543
NOW accounts, 2.03% (2.00% in 1997) 2,507,891 2,620,405
Super NOW accounts, 2.25% (2.25% in 1997) 313,794 364,073
Noninterest-bearing accounts 678,437 633,056
-----------------------------------------
13,701,238 13,104,144
-----------------------------------------
Certificates of deposit: weighted average rate of 5.36% (5.45% in 1997)
0.00% to 3.00% 96,410 139,441
3.01% to 5.00% 7,951,887 9,277,632
5.01% to 7.00% 22,487,165 19,958,213
7.01% to 9.00% - 612,218
-----------------------------------------
30,535,462 29,987,504
-----------------------------------------
Accrued interest payable 33,988 48,077
-----------------------------------------
$ 44,270,688 $ 43,139,725
=========================================
Weighted average cost of savings deposits 4.81% 4.74%
=========================================
</TABLE>
30
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 6. SAVINGS DEPOSITS (CONTINUED)
At September 30, 1998, the scheduled maturities of certificates of deposit are
as follows:
<TABLE>
<S> <C>
1999 $ 26,489,774
2000 3,855,885
2001 164,385
2002 25,418
---------------
$ 30,535,462
===============
</TABLE>
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 at September 30, 1998 is as shown below:
<TABLE>
<CAPTION>
Maturity Amount
- -------------------------------------------------------------------------------
<S> <C>
Less than 3 months $ 1,334,083
3 to 6 months 1,149,734
6 to 12 months 1,021,887
More than 12 months 301,310
---------------
$ 3,807,014
===============
</TABLE>
Eligible savings accounts are insured up to $100,000 by the SAIF which is
administered by the FDIC.
Interest expense on savings deposit accounts for the years ended September 30,
1998 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------
<S> <C> <C>
Regular savings accounts $ 118,082 $ 119,308
MMDA and NOW accounts 327,229 248,592
Certificate of deposit accounts 1,675,023 1,614,158
------------------------
$ 2,120,334 $ 1,982,058
========================
</TABLE>
NOTE 7. NOTE PAYABLE
The Company had an unsecured note payable to another bank for $5,500,000 at
September 30, 1997 which bears interest at 6.5% (prime minus 2%) and was due in
full on October 31, 1997. Maximum borrowings outstanding during the years ended
September 30, 1998 and 1997 were $5,500,000.
31
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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. 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.
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
$126,000. The recapture was scheduled to begin with the Bank's 1997 year, but
has been delayed two years since the Bank originated a required minimum level of
residential mortgage loans. 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 December 31, 1987 in excess of additions to recorded
loan loss allowances. At September 30, 1998, retained earnings contain certain
historical additions to bad debt reserves for income tax purposes of
approximately $1,422,000, the balance at December 31, 1987, for which no
deferred taxes have been provided because the Bank does not intend to use these
reserves for purposes other than to absorb losses. If amounts which qualified as
bad debt deductions are used for purposes other than to absorb bad debt losses
or adjustments arising from the carryback of net operating losses, income taxes
may be imposed at the then existing rates. The approximate amount of
unrecognized tax liability associated with these historical additions is
$540,000. In the future, if the Bank does not meet the income tax requirements
necessary to permit the deduction of an allowance for bad debts, the Bank's
effective tax rate would be increased to the maximum percent under existing law.
Deferred income taxes consist of the following components as of September 30,
1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---------------------
Deferred tax assets:
<S> <C> <C>
Deferred directors retirement expense $ - $ 2,262
Excess book pension expense 4,380 22,673
Allowance for loan losses 96,828 94,567
Deferred management recognition plan 36,417 36,417
---------------------
Total deferred tax assets 137,625 155,919
---------------------
Deferred tax liabilities:
Market valuation of investments 464,134 317,823
Tax bad debt reserves 126,375 126,375
Excess accumulated tax depreciation 173,425 177,621
Federal Home Loan Bank stock basis 83,795 83,795
Other 5,830 4,071
---------------------
Total deferred tax liabilities 853,559 709,685
---------------------
Net deferred tax liabilities $ 715,934 $ 553,766
=====================
</TABLE>
32
<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:
<TABLE>
<CAPTION>
1998 1997
------------------------
<S> <C> <C>
Statutory federal income tax rate 35.00 % 35.00 %
State income taxes, net of federal benefit 4.10 1.80
Nontaxable municipal interest (1.02) (4.86)
Other, net (1.48) (2.22)
------------------------
Effective income tax rate 36.60 % 29.72 %
========================
</TABLE>
NOTE 9. EARNINGS PER SHARE
Earnings per share has been calculated in accordance with Financial Accounting
Standards Board Statement No. 128, "Earnings Per Share," and Statement of
Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans." 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. MRP restricted stock
awards and stock options for the year ended September 30, 1998 have not been
included in diluted earnings per share since they are anti-dilutive. The
following are reconciliations of the amounts used in the per share calculations:
<TABLE>
<CAPTION>
For the Year Ended September 30, 1998
---------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------------------------------------
<S> <C> <C> <C>
BASIC AND DILUTED EPS
Income available to stockholders $ 528,749 1,676,597 $ 0.32
=======================================
For the Year Ended September 30, 1997
---------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------------------------------------
BASIC EPS
Income available to stockholders $ 1,258,260 1,705,453 $ 0.74
========
EFFECT OF DILUTIVE SECURITIES
MRP restricted stock awards - 2,948
Stock options - 9,893
--------------------------
DILUTED EPS
Income available to stockholders $ 1,258,260 1,718,294 $ 0.73
=======================================
</TABLE>
33
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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.
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 stockholders' equity would be reduced below the amount required for
the liquidation account or its capital requirement.
For a period of five years after its conversion from mutual to stock form,
Scotland Savings must obtain the written approval from the NC Administrator
before declaring or paying a cash dividend to Scotland Bancorp, Inc. on its
capital stock in an amount in excess of one-half of the greater of (i) the
Bank's net income for the most recent fiscal year end or (ii) the average of the
Bank's net income after dividends for the most recent fiscal year-end and not
more than two of the immediately preceding fiscal year ends. During 1998 and
1997, the Bank paid $335,000 and $306,000, respectively, in regular dividends
to Scotland Bancorp, Inc. In 1998, with the permission of the NC Administrator,
the Bank paid $5,481,600 in special dividends to the Company to pay off the note
payable discussed in Note 7.
Scotland Bancorp, Inc. paid regular cash dividends totaling $0.20 per share and
$0.30 per share during the years ended September 30, 1998 and 1997,
respectively, and a return of capital dividend of $6.00 per share during 1997.
34
<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, 1998 and 1997, Scotland Savings complied with all capital
requirements described above as shown below:
<TABLE>
<CAPTION>
September 30, 1998 (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 $ 12,977,896 $ 12,977,896 $ 12,977,896 $ 12,977,896
Unrealized gain on securities (757,272) (757,272) (757,272) (757,272)
Allowance for loan losses - - 254,810 254,810
---------------------------------------------------------------------------
Regulatory capital 12,220,624 12,220,624 12,475,434 12,475,434
Minimum capital requirement 1,809,630 1,442,720 2,885,440 2,952,420
---------------------------------------------------------------------------
Excess regulatory capital $ 10,410,994 $ 10,777,904 $ 9,589,994 $ 9,523,014
===========================================================================
Total Bank-only assets at
September 30, 1998 $ 59,048,393
Average Bank-only assets for the
quarter ended September 30, 1998 $ 60,321,000
Risk-weighted Bank-only assets at
September 30, 1998 $ 36,068,000 $ 36,068,000
Capital as a percentage of assets:
Actual 20.26% 33.88% 34.59% 21.13%
Required 3.00% 4.00% 8.00% 5.00%
---------------------------------------------------------------------------
Excess 17.26% 29.88% 26.59% 16.13%
===========================================================================
</TABLE>
35
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 10. STOCKHOLDERS' EQUITY (CONTINUED)
<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 $ 17,880,843 $ 17,880,843 17,880,843 $ 17,880,843
Unrealized gain on securities (518,552) (518,552) (518,552) (518,552)
Allowance for loan losses - - 248,860 248,860
---------------------------------------------------------------------------
Regulatory capital 17,362,291 17,362,291 17,611,151 17,611,151
Minimum capital requirement 1,904,130 1,232,836 2,465,673 3,177,593
---------------------------------------------------------------------------
Excess regulatory capital $ 15,458,161 $ 16,129,455 $ 15,145,478 $ 14,433,558
===========================================================================
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 27.35% 56.33% 57.14% 27.71%
Required 3.00% 4.00% 8.00% 5.00%
---------------------------------------------------------------------------
Excess 24.35% 52.33% 49.14% 22.71%
===========================================================================
</TABLE>
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.
36
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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
actuarial valuations with respect to each employer. Therefore the components of
pension cost charged to expense for 1998 and 1997 are unavailable.
Pension expense under the Bank's defined benefit plan amounted to $97,100 and
$39,600 in 1998 and 1997, respectively.
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 $0 and $2,024
for the years ended September 30, 1998 and 1997, 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
$10,004 and $11,271 for the years ended September 30, 1998 and 1997,
respectively. The Bank's accrued liability for plan obligations amounted to
$92,685 and $106,057 at September 30, 1998 and 1997, respectively.
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 defined 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 acquirer 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 base amount of compensation, as defined
by Internal Revenue Service Code Section 280G(b)(3), 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.
37
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13. COMMITMENT AND CONTINGENCIES (CONTINUED)
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 issuance of up to 184,000 stock options to certain officers,
directors, and employees either 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 value of the Company's common stock at date of grant. Under
the Plan, 177,000 of the 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. The MRP stock awards and the stock options become fully vested if
the employee is terminated after a greater than 50% change in control of the
Company. As permitted under the generally accepted accounting principles, grants
under the stock option plan are accounted for following the provisions of APB
Opinion No. 25 and its related interpretations. Accordingly, no compensation
cost has been recognized for stock option 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 and earnings per share for
the years ended September 30, 1998 and 1997 would be as follows:
<TABLE>
<CAPTION>
1998 1997
-----------------------------------------
<S> <C> <C>
Net income
As reported $ 528,748 $ 1,258,260
Pro forma 296,866 926,256
Basic earnings per share
As reported 0.32 0.74
Pro forma 0.18 0.54
Diluted earnings per share
As reported 0.32 0.73
Pro forma 0.18 0.54
</TABLE>
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 10 years,
expected volatility of 18.88% and expected dividends of $.30 per year.
38
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 14. MANAGEMENT RECOGNITION PLAN AND STOCK OPTION PLAN (CONTINUED)
At September 30, 1998, 177,000 options have been granted at an exercise price of
$10.50, as adjusted for the return of capital dividend, of which 88,500 options
are currently exercisable. No options have been exercised to date and all
options granted are outstanding at September 30, 1998.
The MRP reserved for issuance 73,600 shares of common stock to certain 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 relating to
the vesting of the MRP totaled $230,000 and $325,833 for the years ended
September 30, 1998 and 1997, respectively.
NOTE 15. EMPLOYEE STOCK OWNERSHIP PLAN
The Bank has established an employee stock ownership plan ("ESOP") to benefit
all qualified employees. The ESOP purchased 233,492 shares of common stock in
the open market subsequent to the Conversion with proceeds received from a loan
from the Company and from dividends paid to the ESOP.
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, 1998 and 1997, the outstanding balance of the note receivable is
$1,602,395 and $1,708,545 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. All ESOP
shares would also become fully vested to the participants upon a greater than
50% change in ownership of the Company.
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 paid on 139,093 unallocated
ESOP shares totaled $834,558 on September 30, 1997 and are being amortized as
compensation expense in subsequent periods as ESOP shares are released to the
participants.
39
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 15. EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED)
Expense of $96,059 and $82,260 during 1998 and 1997 has been incurred in
connection with the ESOP. The expense includes, in addition to the cash
contribution necessary to fund the ESOP, ($17,183) in 1998 and $16,519 in 1997,
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 (debited) this amount to paid-in
capital in accordance with the provisions of AICPA Statement of Position 93-6.
At September 30, 1998, 17,884 shares held by the ESOP have been released or
committed to be released to the plan's participants for purposes of computing
earnings per share. The fair value of the unallocated shares amounted to
approximately $2.4 million at September 30, 1998.
NOTE 16. CONCENTRATION OF CREDIT RISK AND OFF-STATEMENT OF FINANCIAL CONDITION
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 courseof business to meet the financing needs of
its customers. These financial instruments include commitments to extend
credit, the undisbursed portion of construction loans, and unused portions of
equity lines of credit. Those instruments involve, to varying degrees, elements
of credit risk and interest rate risk in excess of the amounts recognized in the
balance sheet. Commitments to extend credit (which were principally variable
rate commitments) amounted to approximately $134,000 and $214,000 at September
30, 1998 and 1997, respectively. The undisbursed portion of construction loans
amounted to $1,192,273 and $614,230 and the unused portion of equity lines of
credit totaled approximately $3,062,000 and $2,989,000 at September 30, 1998 and
1997, 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.
40
<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, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 2,929,818 $ 2,929,818 $ 3,558,248 $ 3,558,248
Federal funds sold 5,000,000 5,000,000 3,200,000 3,200,000
Securities held to maturity - - 500,000 494,060
Securities available for sale 8,074,324 8,074,324 8,460,850 8,460,850
Nonmarketable equity securities 599,400 599,400 599,400 599,400
Loans receivable 42,484,729 43,316,387 46,463,348 46,531,442
Mortgage-backed securities 301,097 341,980 418,657 481,325
Accrued interest receivable 207,409 207,409 210,759 210,759
Financial liabilities:
Savings deposits 44,270,688 43,912,820 43,139,724 43,373,536
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 sold approximate their fair values.
Nonmarketable equity securities: The fair value of nonmarketable equity
- --------------------------------
securities is the stated value by the FHLB and the cost of Fiserv stock.
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.
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 is the amount
- ----------------------------
receivable on demand at the statement of financial condition date.
41
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 17. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
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.
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 years ended September 30, 1998 and 1997:
CONDENSED BALANCE SHEETS
SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------------------------------
<S> <C> <C>
Assets:
Cash $ 2,168,725 $ 2,110,284
Investment in Scotland Savings Bank 12,977,896 17,880,843
Accrued interest receivable 66,112 73,204
Prepaids and other assets 225,191 146,584
------------------------------------
$ 15,437,924 $ 20,210,915
====================================
Liabilities and Stockholders' Equity:
Liabilities:
Note payable $ - $ 5,500,000
Accrued dividends payable 95,680 143,520
Other accrued expenses 5,191 5,469
Deferred income taxes - 1,164
------------------------------------
100,871 5,650,153
------------------------------------
Stockholders' equity:
Additional paid-in capital 16,489,259 16,506,442
Note receivable ESOP (1,602,395) (1,708,545)
Deferred management recognition plan (594,167) (824,167)
Unearned compensation (802,458) (834,558)
Unrealized gain on securities available for sale, net of tax 757,272 518,552
Retained earnings 1,089,542 903,038
------------------------------------
15,337,053 14,560,762
------------------------------------
$ 15,437,924 $ 20,210,915
====================================
</TABLE>
42
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 18. PARENT COMPANY FINANCIAL DATA (CONTINUED)
CONDENSED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------------------------------
<S> <C> <C>
Interest income $ 237,979 $ 587,304
Equity in earnings of Scotland Savings Bank 462,117 888,500
Miscellaneous expense (140,307) (114,043)
Income taxes (31,040) (103,501)
----------------------------------
Net income $ 528,749 $ 1,258,260
==================================
</TABLE>
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-----------------------------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 528,749 $ 1,258,260
Equity in earnings of Scotland Savings Bank (462,117) (888,500)
Amortization of unearned compensation 32,100 -
Other (1,164) 1,164
Gain on sale of securities available for sale - (6,779)
Change in assets and liabilities:
(Increase) decrease in other assets (71,167) 2,813
Decrease in accrued income taxes - (10,446)
Increase (decrease) in other accrued expenses (278) 2,902
-----------------------------------
Net cash provided by operating activities 26,123 359,414
-----------------------------------
Cash Flows from Investing Activities:
Purchase of investment securities available for sale - (6,000,000)
Proceeds from sale of investment securities available for sale - 9,720,120
Upstream dividend from Scotland Savings Bank 5,816,600 306,000
Principal payment received on note receivable from ESOP 106,150 63,747
-----------------------------------
Net cash provided by investing activities 5,922,750 4,089,867
-----------------------------------
Cash Flows from Financing Activities:
Proceeds from borrowing on note payable - 5,500,000
Payment of note payable (5,500,000) -
Payment of dividends (390,432) (514,817)
Return of capital dividends - (11,481,600)
-----------------------------------
Net cash used in financing activities (5,890,432) (6,496,417)
-----------------------------------
Net increase (decrease) in cash 58,441 (2,047,136)
Cash, beginning 2,110,284 4,157,420
-----------------------------------
Cash, ending $ 2,168,725 $ 2,110,284
===================================
Supplemental Disclosure of Noncash Financing Activities:
Dividends accrued $ 84,901 $ 133,088
Supplemental Disclosure of Noncash Investing Activities:
Change in unrealized gain on securities available for sale - 4,689
</TABLE>
43
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 19. FUTURE REPORTING REQUIREMENTS
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income," which the
Company has not been required to adopt as of September 30, 1998. 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.
The FASB has issued SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," which the Company has not been required to adopt as of
September 30, 1998. This Statement, which is effective for fiscal years
beginning after December 15, 1997, requires that a public business enterprise
report financial and descriptive information about its reportable operating
segments. Operating segments are components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. Generally, financial information is required to be
reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments.
The FASB has issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which the Company has not been required to adopt as of
September 30, 1998. This Statement, which is effective for fiscal years
beginning after June 15, 1998, establishes accounting and reporting standards
for derivative instruments embedded in other contracts, (collectively referred
to as derivatives) and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (a) a hedge
of the exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-currency- denominated
forecasted transaction. This Statement is not expected to have a significant
impact on the Company.
44
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 19. FUTURE REPORTING REQUIREMENTS (CONTINUED)
The FASB has issued SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise," an amendment of FASB Statement No. 65, which the Company
has not been required to adopt as of September 30, 1998. Statement No. 65, as
amended by FASB Statements No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," and No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed security as a trading
security. This Statement further amends Statement No. 65 to require that after
the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments. This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a nonmortgage banking enterprise.
This Statement is effective for fiscal years beginning after December 15, 1998,
and is not expected to have a significant impact on the Company.
NOTE 20. SALE OF THE COMPANY
In August of 1998, Scotland Bancorp, Inc. entered into an agreement to sell the
Company to Centura Banks, Inc. in a cash transaction for $11.75 per share of
Scotland Bancorp, Inc. stock. The sale is contingent upon regulatory and
shareholder approval and is anticipated to be completed during the second
quarter of fiscal year 1999.
45
<PAGE>
CORPORATE INFORMATION
EXECUTIVE OFFICERS:
<TABLE>
<S> <C> <C>
WILLIAM C. FITZGERALD, III JOHN B. CLARK
President and CEO Vice President/Secretary
DIRECTORS:
S.T. SNOWDON, JR.
Chairman; Retired Architect
JAMES E. MILLIGAN WILLIAM C. FITZGERALD, III JOHN B. CLARK
Vice Chairman; President and CEO Vice President/Secretary
Retired Newspaper Publisher of Scotland Bancorp, Inc. of Scotland Bancorp, Inc.
JAMES W. MASON CLIFTON P. BUIE JAMES S. MITCHENER, JR.
Retired Attorney VP of Manufacturing, Retired Surgeon
Charles Craft, Inc.
E. S. HILL, JR. JOHN W. HUDSON JAMES T. WILLIS
General Manager, Retired Plant Manager, VP of Adams & Willis, Inc.
Eaton Corp. LOF Glass GM of Firestone Store
STOCK TRANSFER AGENT ANNUAL MEETING
Registrar and Transfer Company The 1999 annual meeting of stockholders of
10 Commerce Drive Scotland Bancorp, Inc. will be held at 4:00 p.m.
Cranford, NJ 07016 on January 28, 1999 at the Company's corporate
office at 505 South Main Street, Laurinburg, NC.
SPECIAL LEGAL COUNSEL
Brooks, Pierce, McLendon, FORM 10-KSB
Humphrey & Leonard, LLP A copy of Form 10-KSB as filed with the Securities and
2000 Renaissance Plaza Exchange Commission will be furnished without charge
230 North Elm Street to the Company's stockholders upon written request to
Greensboro, NC 27420 Scotland Bancorp, Inc., P. O. Box 1468, Laurinburg, NC 28353.
INDEPENDENT AUDITORS
McGladrey & Pullen, LLP CORPORATE OFFICE
6805 Morrison Boulevard 505 South Main Street
Charlotte, NC 28211 Laurinburg, NC 28301
</TABLE>
46
<PAGE>
COMMON STOCK INFORMATION
There are 1,913,600 shares of common stock outstanding which were held by
approximately 470 stockholders of record (excluding shares held in street name)
on September 30, 1998. 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, 1998 and 1997.
<TABLE>
<CAPTION>
Dividends Stock Price
-----------------------------------------------------------------
Regular Special High Low
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
1998:
First Quarter $ 0.050 $ - $ 12.875 $ 9.875
Second Quarter 0.050 - 11.375 9.750
Third Quarter 0.050 - 9.750 8.125
Fourth Quarter 0.050 - 11.250 10.750
</TABLE>
<TABLE>
<CAPTION>
Dividends Stock Price
-----------------------------------------------------------------
Regular Special High Low
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
1997:
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
</TABLE>
47
<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, 1998, relating to the consolidated statements of financial condition of
Scotland Bancorp, Inc. and subsidiary as of September 30, 1998 and 1997, and the
related consolidated statements of income, stockholders' equity and cash flows
for the years then ended, which report appears in the Company's 1998 annual
report on Form 10-KSB.
[SIGNATURE APPEARS HERE]
Charlotte, North Carolina
December 18, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> SEP-30-1998 SEP-30-1997
<PERIOD-START> OCT-01-1997 OCT-01-1996
<PERIOD-END> SEP-30-1998 SEP-30-1997
<CASH> 768 627
<INT-BEARING-DEPOSITS> 2,162 2,931
<FED-FUNDS-SOLD> 5,000 3,200
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 8,074 8,461
<INVESTMENTS-CARRYING> 900 1,518
<INVESTMENTS-MARKET> 941 1,575
<LOANS> 42,740 46,712
<ALLOWANCE> 255 249
<TOTAL-ASSETS> 60,730 64,399
<DEPOSITS> 44,271 43,140
<SHORT-TERM> 0 5,500
<LIABILITIES-OTHER> 1,122 1,199
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 15,337 14,561
<TOTAL-LIABILITIES-AND-EQUITY> 60,730 64,399
<INTEREST-LOAN> 3,712 3,948
<INTEREST-INVEST> 440 986
<INTEREST-OTHER> 412 237
<INTEREST-TOTAL> 4,564 5,171
<INTEREST-DEPOSIT> 2,120 1,982
<INTEREST-EXPENSE> 2,122 1,983
<INTEREST-INCOME-NET> 2,442 3,188
<LOAN-LOSSES> 6 24
<SECURITIES-GAINS> 0 241
<EXPENSE-OTHER> 1,676 1,680
<INCOME-PRETAX> 834 1,790
<INCOME-PRE-EXTRAORDINARY> 834 1,790
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 529 1,258
<EPS-PRIMARY> 0.32 0.74
<EPS-DILUTED> 0.32 0.73
<YIELD-ACTUAL> 7.60 7.70
<LOANS-NON> 28 30
<LOANS-PAST> 28 30
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 249 225
<CHARGE-OFFS> 0 0
<RECOVERIES> 0 0
<ALLOWANCE-CLOSE> 255 249
<ALLOWANCE-DOMESTIC> 255 249
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 0 0
</TABLE>
