<PAGE>
UNITED STATES
SECURITIES EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------------------
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
-----------------
Commission file number 1-14230
------------
STONE STREET BANCORP, INC.
--------------------------
(Exact name of registrant as specified in its charter)
NORTH CAROLINA 56-1949352
------------------------------ -----------------------------------
State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
232 SOUTH MAIN STREET
MOCKSVILLE, NORTH CAROLINA 27028
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (704) 634-5936
Securities Registered Pursuant to Section 12(b) of the Act: None
----
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, no par value
--------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and ask prices of such
stock, as of a specified date within 60 days prior to the date of filing.
$39,578,682 common stock, no par value, based on the closing price of such
- --------------------------------------------------------------------------
common stock on March 17, 1997.
- -------------------------------
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 1,825,050 shares of common
--------------------------
stock, no par value, outstanding at March 17, 1997.
- ---------------------------------------------------
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report of Stone Street Bancorp, Inc. for the year ended
December 31, 1996 (the "1996 Annual Report"), are incorporated by reference into
Part I, Part II and Part IV.
Portions of the Proxy Statement for the 1997 (the "Proxy Statement") Annual
Meeting of Shareholders of Stone Street Bancorp, Inc. to be held on April 15,
1997, are incorporated by reference into Part III.
1
<PAGE>
PART I
ITEM 1. BUSINESS
General
Prior to March 29, 1996, Mocksville 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 Stone Street Bancorp, Inc., a North Carolina corporation (the
"Company") which was organized to become the holding company for the Bank. 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 232 South Main Street, Mocksville, North Carolina. The
Company's activities consist of investing the proceeds of its initial public
offering which were retained at the holding company level and owning the Bank.
The Company's principal sources of income include earnings on its investments.
In addition, the Company will receive any dividends which are declared and paid
by the Bank on its capital stock. The Company did not commence operations until
March 29, 1996 and conducted business from that date through the year ended
December 31, 1996 in its first year. The following general business discussion
pertains primarily to Mocksville Savings.
The Bank was originally chartered in 1921. It has been a member of the
Federal Home Loan Bank ("FHLB") system since 1946 and its deposits are federally
insured up to allowable limits.
The Bank is engaged primarily in the business of attracting deposits from
the general public and using such deposits to make mortgage loans secured by
real estate. Mocksville makes mortgage loans secured by residential real
property, including one-to-four family residential real estate loans, home
equity line of credit loans and other subordinate lien loans, loans secured by
improved nonresidential real property, loans secured by undeveloped real
property and construction loans. Mocksville also makes a limited number of
loans which are not secured by real property, such as loans secured by pledged
deposit accounts, and other personal property, mobile home loans and unsecured
loans. Mocksville's primary source of revenue is interest income from its
lending activities. Mocksville's other major sources of revenue are interest
and dividend income from investments and mortgage-backed securities, interest
income from its interest-bearing deposit balances in other depository
institutions and fee income from its lending and deposit activities. The major
expenses of Mocksville are interest on deposits and borrowings and noninterest
expenses such as compensation and fringe benefits, federal deposit insurance
premiums, data processing expenses and branch occupancy and related expenses.
The operations of the Bank and depository institutions in general are
significantly influenced by general economic conditions and by related monetary
and fiscal policies of depository institution regulatory agencies, including the
Federal Reserve, the Federal Deposit Insurance Corporation (the "FDIC") and the
North Carolina Administrator, Savings Institutions Divisions, North Carolina
Department of Commerce (the "Administrator"). Deposit flows and cost of funds
are influenced by interest rates on competing investments and general market
rates of interest. Lending activities are affected by the demand for financing
of real estate and other types of loans, which in turn are affected by the
interest rates at which such financing may be offered and other factors
affecting local demand and availability of funds.
2
<PAGE>
Market Area
The Bank's primary market area consists of Davie County, North Carolina.
Mocksville is located between Winston-Salem, North Carolina and Statesville,
North Carolina on Interstate 40. Employment in Davie County includes furniture
manufacturing, machine tooling, equipment assembly, and the opportunities
generated by Wake Forest University and Bowman Grey Medical School in Winston-
Salem. In addition, home construction and real estate development are major
industries because Davie County attracts many retirees. Bermuda Run Golf and
Country Club in Davie County is the home of the Bing Crosby Invitational Golf
Tournament. In addition, six other golf courses are in or near Davie County,
including Tanglewood Park Golf Course, the site of the PGA Vantage Tournament.
Major area employers include Lee Jeans, Jockey International, Reynolds Tobacco,
and Hanes Hosiery.
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 single family homes located in its primary market
area. The Bank also makes loans secured by multi-family residential properties,
improved nonresidential real estate, construction loans, loans secured by
undeveloped real estate, unsecured loans, and other personal property, mobile
home loans, savings account loans and other loans. Over 99.6% of the Bank's net
loan portfolio is secured by real estate. As of December 31, 1996, all of the
loans in the Bank's real estate loan portfolio were secured by properties in
North Carolina. On December 31, 1996, the Bank's largest single outstanding
loan had a balance of approximately $1,303,000. This loan was performing in
accordance with its original terms. In addition to interest earned on loans,
the Bank receives fees in connection with loan originations, loan servicing,
loan modifications, late payments, loan assumptions and other miscellaneous
services.
Loan Portfolio Composition. The Bank's net loan portfolio totalled
approximately $83.0 million at December 31, 1996 representing 78.44% of
Mocksville's total assets at such date. At December 31, 1996, 81.75% of
Mocksville's net loan portfolio was composed of one-to-four family residential
mortgage loans. Home equity and subordinate lien loans represented 2.98% of the
Bank's net loan portfolio, and nonresidential real estate loans represented
6.89% of the Bank's net loan portfolio on such date.
As part of its interest rate risk management program, the Bank has
increased the amount of adjustable rate mortgage loans in its portfolio in
recent years. As of June 30, 1990, the Bank had approximately $1,566,000 of
adjustable rate mortgage loans outstanding, as compared to approximately
$2,820,000 as of December 31, 1996.
The following table sets forth the composition of the Bank's loan portfolio
by type of loan at the dates indicated.
3
<PAGE>
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------------------------------------------------------------------------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Real estate loans:
Residential
1-4 family............. $67,844 81.75% $63,329 84.33% $54,321 82.34% $45,724 81.81% $41,355 82.70%
Residential multi-
family and
nonresidential
real estate........... 5,716 6.88 4,260 5.67 4,987 7.56 5,312 9.50 5,059 10.12
Home Equity and
other subordinate
lien loans............ 2,473 2.98 2,185 2.91 1,423 2.16 1,447 2.59 1,492 2.98
Residential
construction.......... 12,492 15.05 11,735 15.63 11,589 17.56 8,033 14.37 6,433 12.87
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate
loans: 88,525 106.66 81,509 108.54 72,320 109.62 60,516 108.27 54,339 108.67
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Other installment
loans................. 372 .45 222 .30 197 0.30 133 0.24 201 0.40
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Less:
Unearned fees and
discounts.............. 1,009 1.22 962 1.29 1,095 1.66 711 1.27 577 1.15
Loans in process . 4,385 5.28 5,211 6.94 5,334 8.09 3,959 7.08 3,894 7.79
Allowance for
loan losses........... 511 .61 462 .61 115 0.17 89 0.16 65 0.13
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total reductions...... 5,905 7.11 6,635 8.84 6,544 9.92 4,759 8.51 4,536 9.07
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans
receivable, net...... $82,992 100.00% $75,096 100.00% $65,973 100.00% $55,890 100.00% $50,004 100.00%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
</TABLE>
The following table sets forth the time to contractual maturity of the
Bank's loan portfolio at December 31, 1996. Loans which have adjustable rates
are shown as being due in the period during which rates are next subject to
change while fixed rate and other loans are shown as due over the 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,
however, it does include scheduled principal repayments. Prepayments and
scheduled repayments in the loan portfolio totaled $16.2 million, $12.2 million
and $13.6 million in fiscal years ended December 31, 1996, 1995 and 1994,
respectively. Amounts in the table are net of loans in process and are net of
unamortized loan fees.
4
<PAGE>
<TABLE>
<CAPTION>
At December 31, 1996
----------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or less 3 Years 5 Years 10 Years Years Total
-------- ------ -------- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Fixed rate 1-4 family
residential $ 6,260 $ 479 $1,356 $21,647 $36,465 $66,207
Adjustable rate 1-4 family
residential 629 629
Adjustable home equity
loans 2,191 2,191
Other fixed rate loans 2,158 48 841 815 10,243 14,105
Other loans 45 55 115 137 20 372
Less:
Allowance for loan losses (511) (511)
------- ------ -------- -------- -------- -----
$10,772 $ 582 $2,312 $22,599 $46,728 $82,993
======= ====== ======== ======= ======== =======
</TABLE>
The following table sets forth the dollar amount at December 31, 1996 of
all loans maturing or repricing on or after December 31, 1997.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
------- ----------
<S> <C> <C>
(In Thousands)
Mortgage loans $59,947 $ -
Other loans 12,274 -
------- ----------
$72,221 $ -
======= ==========
</TABLE>
ORIGINATION OF LOANS. Historically, the Bank has not originated its one-
to-four family residential mortgage or other loans with the intention that they
will be sold in the secondary market. Accordingly, the Bank originates fixed
rate one-to-four family residential real estate loans which satisfy the Bank's
underwriting requirements and are tailored to its local community, but do not
necessarily satisfy various technical FHLMC and FNMA underwriting requirements
and purchase requirements not related to documentation.
Although the Bank believes that many of its nonconforming loans are
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 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. These nonconforming
loans satisfy a need in the Bank's local community, and the Bank intends to
continue to originate nonconforming loans.
5
<PAGE>
Substantially all of the one-to-four family residential mortgage loans
originated by the Bank have a fixed rate of interest because there is very
little demand for adjustable rate loans in the Bank's market area. As a result,
Mocksville limits the term of substantially all of its fixed rate residential
real estate loans to a shorter term, 15 years, and, includes a 10-year call
provision in all other fixed rate residential real estate loans.
The Bank has instituted a new marketing program in which all of the Bank's
loan officers visit local realtors to promote the Bank's residential mortgage
products.
The table below sets forth the Bank's loan origination, purchase activity
and loan portfolio repayment experience during the periods indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------
1996 1995 1994
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Loans receivable, net beginning of period $ 75,096 $ 65,973 $ 55,890
Loan originations:
Residential 1-4 family 11,880 7,812 9,372
Residential multifamily and
nonresidential real estate 1,730 1,736 1,863
Home equity and second mortgage 901 1,005 327
Residential construction 8,412 10,117 12,304
Consumer 410 469 231
-------- -------- --------
Total loan originations 23,333 21,439 24,127
Principal repayments (16,167) (12,225) (13,635)
Other changes, net 730 (91) (409)
-------- -------- --------
Increase in loans receivable (15,437) (12,316) (14,044)
-------- -------- --------
Loans receivable, net, end of period $ 82,992 $ 75,096 $ 65,973
======== ======== ========
</TABLE>
6
<PAGE>
ONE-TO-FOUR FAMILY 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 single family homes. The Bank also makes loans secured by
two-to-four family residential properties. 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 Davie County, North Carolina and
in contiguous counties. On December 31, 1996, approximately 81.75% 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 .93% had
adjustable interest rates.
The Bank originates some adjustable rate mortgage loans secured by owner
occupied property generally having terms of 30 years in amounts of up to 90% of
the value of the property. Private mortgage insurance is generally required if
the loan amount exceeds 80% 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. 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 primarily originates fixed-rate mortgage loans secured by owner
occupied property having terms generally ranging from 15 to 30 years in amounts
of up to 90% of the value of the property. Any fixed rate loan with a term
greater than 20 years includes a ten-year call option. Private mortgage
insurance is generally 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 15 years in amounts
of up to 80% 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
or 30 year terms with a ten-year call option, 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 assumption
for 30-year residential loans and 15-year residential loans, respectively.
Management believes that the Bank's recent loan prepayment experience has been
shorter than these assumed average loan lives due to recent periods of low
interest rates and resulting high rates of refinancing.
The Bank generally requires title insurance for its one-to-four family
residential loans. The Bank generally 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, whichever is less,
of the improvements on the property securing the loans.
Multifamily Residential and Nonresidential Real Estate Lending. On
December 31, 1996, the Bank had $5.7 million in outstanding loans secured by
nonresidential real estate, including undeveloped land, comprising approximately
of 6.89% of its net loan portfolio as of that date. Most of these loans are
secured
7
<PAGE>
by land, church properties, apartments and commercial real estate, and normally
have fixed interest rates. The loans generally do not exceed 75% 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 a result, the Bank has re-
evaluated its nonresidential lending policies and revised its commercial loan
underwriting procedures in order to, among other things, improve loan
documentation. As of December 31, 1996, the largest nonresidential real estate
loan in the Bank's loan portfolio totalled $1,303,000. This loan was performing
in accordance with the original loan contract. See "-Lending Activities-
Nonperforming Assets and Asset Classification."
HOME EQUITY LINES OF CREDIT AND SUBORDINATE LIEN LOANS. At December
31, 1996, the Bank had approximately $2.5 million in home equity and other
subordinate lien loans, representing approximately 2.98% of its net loan
portfolio. Of this amount, $2.2 million was composed of home equity line of
credit loans. 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 of 2% of the outstanding balance or $100, whichever is greater.
These loans mature in fifteen years. Home equity lines of credit are generally
secured by subordinate liens against residential real property. The Bank may
require title insurance in connection with these loans, but in the past only
required opinions of title from attorneys. 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 80% 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. The Bank intends to continue to emphasize its
home equity program. The presence of home equity loans in the Bank's portfolio
has assisted the institution in improving the interest sensitivity of its assets
and liabilities because home equity liens 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 December 31, 1996 was approximately $12.5 million, representing
approximately 15.05% 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; some were made to builders who were constructing properties for sale.
Loans made to individual property owners and builders are "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 interest rates having terms similar to other one-to-four family
residential loans.
Construction loans made to builders who are building to resell generally
have a maximum loan-to-value ratio of 80% of the appraised value of the
property. Construction loans to persons who intend to occupy the finished
premises generally have a maximum loan-to-value ratio of 80% without private
mortgage insurance and up to 90% with private mortgage insurance.
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
8
<PAGE>
may have security which has value insufficient to assure full repayment. In
addition, repayment of loans made to builders to finance construction of
properties is often dependent upon the builder's ability to sell the property
once construction is completed.
OTHER INSTALLMENT LOANS. In addition to the loans described above, the Bank
also offers loans which are primarily secured by savings deposits held by the
Bank or which are unsecured. As of December 31, 1996, the Bank had approximately
$127,000 of such loans outstanding, representing approximately .15% of its net
loan portfolio.
Financing of new mobile homes generally does not exceed 75% of the purchase
price or the retail invoice value of the mobile home, including land value, and
has a maximum term of 15 years.
The Bank also makes other secured consumer loans such as automobiles,
campers and boats and generally lends up to 80% of the purchase price.
The Bank makes unsecured consumer loans in amounts of up to $25,000. These
loans 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 $10,000.
Payments are required in amounts of 2% of the outstanding balance or $100,
whichever is greater.
LOAN SOLICITATION, PROCESSING AND UNDERWRITING. Loan originations were
derived from a number of sources such as referrals form real estate brokers,
present depositors and borrowers, builders, attorneys, walk-in customers and in
some instances, other lenders.
During its loan approval process, the Bank assesses the applicant's ability
to make principal and interest payments on the loan and the value of the
property securing the loan. The Bank obtains detailed written loan applications
to determine the borrower's ability to repay and verifies responses on the loan
application through the use of credit reports, financial statements, and other
confirmations. Under current practice, the responsible officer or 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 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, other than home equity loans, of up to $50,000 may be
approved by certain designated loan officers of the Bank in cases where the loan
meets all of the Bank's underwriting guidelines. Mortgage loans of over $50,000
up to $85,000 may be approved by the Officers' Loan Committee. The Officers'
Loan Committee also reviews all other mortgage loan approvals. All mortgage
loans of over $85,000 up to $200,000 may be approved by the Bank's Directors'
Loan Committee which is composed of its President and three outside directors
appointed by the Chairman of the Board. All mortgage loans of over $200,000
must be approved by the Bank's full Board of Directors. Loans secured by
savings deposits follow the same approval procedures as mortgage loans.
All consumer loans of up to $2,500 may be approved by designated loan
officers. Consumer loans in excess of $2,500 up to $5,000 may be approved by
the Officers' Loan Committee. Consumer loans in excess of $5,000 up to $50,000
may be approved by the Directors' Loan Committee. Consumer loans greater than
$50,000 must be approved by the full Board of Directors.
All employee, church and commercial loans, including loans secured by
apartments, of up to $200,000 are approved by the Directors' Loan Committee, and
above $200,000, by the full Board of Directors.
Home equity loans up to $25,000 may be approved by loan officers; between
$25,000 and $50,000 by the Officers' Loan Committee; between $50,000 and
$200,000 by the Directors' Loan Committee; and over $200,000, by the full Board
of Directors.
9
<PAGE>
Normally, upon approval of a residential mortgage loan application,
Mocksville 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 December 31,
1996, the Bank had $4.4 million in such unfunded mortgage loan commitments. In
addition, on such date the Bank had $1.7 million in unfunded commitments for
unused lines of credit and letters of credit.
INTEREST RATES, TERMS, POINTS AND FEES. Interest rates and fees charged on
the Bank's loans are affected primarily by the market demand for loans,
competition, the supply of money available for lending purposes and the Bank's
cost of funds. These factors are affected by, among other things, general
economic conditions and the policies, of the federal government, including the
Federal Reserve, tax policies and governmental budgetary matters.
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 the Bank fails to make
a required payment on a loan and does not cure the delinquency promptly, the
loan is classified as delinquent. In this event, the normal procedure followed
by the Bank 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 borrowers, 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
December 31, 1996, the Bank did not own any real estate acquired in settlement
of loans. Real estate acquired through, or in lieu of, loan foreclosure is
initially recorded at the lower cost or 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.
Interest on loans is recorded as borrowers' monthly payments become due.
Accrual of interest income on loans is suspended, when, in management's
judgment, doubts exist as to the collectibility of additional interest within
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.
The Bank continues to accrue interest on loans delinquent 90 days or more if the
loans are well secured and the Bank is in the process of collecting payments on
the loans. Interest on loans placed on nonaccrual status is generally charged
off. The allowance is established by a charge to interest income equal to all
interest previously accrued, and income is subsequently recognized only to the
extend cash payments are received until the loan is returned to accrual status.
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.
10
<PAGE>
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Total nonaccrual loans
Mortgage loans delinquent 90 days or more $ - $ - $ - $ - $ 53
Consumer loans delinquent 90 days or more - - - - -
Real estate owned - - - - -
-------- ------- ------- ------- -------
Total non-performing assets $ - $ - $ - $ - $ 53
======== ======= ======= ======= =======
Accruing loans, delinquent 90 days or more $ 423 $ 201 $ 280 $ 292 $ 437
======== ======= ======= ======= =======
Non-performing loans to total loans 0.00% 0.00% 0.00% 0.00% 0.11%
Non-performing assets to total assets 0.00% 0.00% 0.00% 0.00% 0.08%
Total assets $105,807 $87,751 $81,560 $75,826 $64,445
Total loans, net $ 82,992 $75,097 $65,973 $55,890 $50,004
</TABLE>
Applicable regulations require the Bank to "classify" its own assets on a
regular basis. In addition, in connection with examinations of savings
institutions, regulatory examiners have authority to identify problem assets
and, if appropriate, classify them. Problem assets are classified as
"substandard," "doubtful" or "loss," depending on the presence of certain
characteristics as discussed below.
An asset is considered "substandard" if not adequately protected by the
current net worth and paying capacity of the obligor or the collateral pledged,
if any. "Substandard" assets include those characterized by the "distinct
possibility" that the insured institution will sustain "some loss" if the
deficiencies are not corrected. Assets classified as "doubtful" have all of the
weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable". Assets classified "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a loss reserve is not warranted.
As of December 31, 1996, the Bank had approximately $423,000 of
loans internally classified as "substandard", and no loans classified as
"doubtful" or "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 December 31, 1996, the Bank had no loans in the
"special mention" category.
When an insured institution classifies problem assets as either substandard
or doubtful, it is required to establish general allowances for loan losses in
an amount deemed prudent by management. These allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities and the risks associated with particular problem assets.
When an insured institution classifies problem assets as "loss," it charges off
the balance of the asset. The Bank's determination as to the classification of
its assets and the amount of its valuation allowances is subject to review by
the FDIC and the Administrator which can order the establishment of additional
loss allowances.
11
<PAGE>
The following table sets forth at December 31, 1996, the Bank's aggregate
carrying value of the assets classified as substandard, doubtful, loss or
"special mention":
<TABLE>
<CAPTION>
Special Mention List Substandard Doubtful Loss
-------------------- --------------- ------------------- ----------------
Number Amount Number Amount Number Amount Number Amount
------- ------ ------ ------ ----------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(In Thousands)
Real estate loans:
Residential 1-4 family - $ - 14 $ 423 - $ - - $ -
Residential multifamily
and nonresidential
real estate - - - - - - - -
Home equity and second
mortgage - - - - - - - -
Residential construction - - - - - - - -
------ ------ ---- ------ ------ ------ ------ ------
Total real estate loans - - 14 423 - - - -
------ ------ ---- ------ ------ ------ ------ ------
Consumer loan - - - - - - - -
------ ------ ---- ------ ------ ------ ------ ------
Total - $ - 14 $423 - $ - $ - $ -
====== ====== ==== ====== ====== ====== ====== ======
</TABLE>
ALLOWANCE FOR LOAN LOSSES. In originating the 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 in doubt by management after reviewing the current
status of loans which are contractually past due and considering the fair value
of the security for the loans.
Management continues to actively monitor the Bank's asset quality, to
charge off loans against the allowance for loan losses when appropriate and to
provide specific loss reserves when necessary. Although management believes it
uses the best information available to make determinations with respect to the
allowance for loan losses, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations.
12
<PAGE>
The following table describes the activity related to the Bank's allowance
for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Six Months Year
Ended Ended
Year Ended December 31, December 31, June 30,
------------------------------------- ----------- --------
1996 1995 1994 1993 1992 1992
----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Balance, beginning of period $ 462 $ 115 $ 89 $ 65 $ 48 $ 38
Provision for loan losses 50 350 26 25 17 10
Charge-offs:
Residential 1-4 family - - - - - -
Consumer 1 3 - 1 - -
Recoveries:
Residential 1-4 family - - - - - -
Consumer - - - - - -
----- ----- ----- ----- ----- -----
Balance, end of period $ 511 $ 462 $ 115 $ 89 $ 65 $ 48
===== ===== ===== ===== ===== =====
Net charge-offs as a % of average
loans outstanding - - - - - -
Allowance at period end as a % of
nonperforming loans - - - - - -
Allowance at period end as a % of
nonperforming assets - - - - - -
Allowance at period end as a % of
total gross loans .57% .57% .16% .15% .12% .09%
</TABLE>
The following table sets forth the composition of the allowance for loan
losses by type of loan at the dates indicated. The allowance is allocated to
specific categories of loans for statistical purposes only, and may be applied
to loan losses incurred in any loan category.
13
<PAGE>
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------------- ------------------- -------------------- ------------------- ------------------
Amount Amount Amount Amount Amount
of of of of of
Loans to Loans to Loans to Loans to Loans to
Amount of Gross Amount of Gross Amount of Gross Amount of Gross Amount of Gross
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
--------- -------- --------- -------- --------- -------- --------- -------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential
1-4 family $ 138 76.32% $ 127 77.48& $ 45 74.91% $35 75.39% $26 75.82%
Residential multifamily
and nonresidential
real estate 153 6.43 138 5.21 23 6.88 19 8.76 15 9.28
Home equity and
second mortgage 52 2.78 46 2.67 12 1.96 10 2.39 7 2.73
Residential construction 128 14.05 115 14.36 24 15.98 16 13.24 11 11.80
----- ------ ----- ------ ---- ------ --- ------ --- ------
Total real estate loans 471 99.58 426 99.72 104 99.73 80 99.78 59 99.63
Consumer loans 40 .42 36 .28 11 0.27 9 0.22 6 0.37
----- ------ ----- ------ ---- ------ --- ------ --- ------
Total allowance for loan
losses $ 511 100.00% $ 462 100.00% $115 100.00% $89 100.00% $65 100.00%
===== ====== ===== ====== ==== ====== === ====== === ======
</TABLE>
14
<PAGE>
INVESTMENT SECURITIES
Interest and dividend income from investment securities generally provides
the second largest source of income to the Bank after interest on loans. In
addition, the Bank receives interest income from deposits in other financial
institutions. On December 31, 1996, the carrying value of the Bank's investment
securities portfolio totaled $19.6 million and consisted of interest-bearing
deposits, U.S. government and agency securities, mortgage-backed securities, and
stock in the FHLB of Atlanta. The mortgage-backed securities consist of
mortgage-backed securities issued by the GNMA and FHLMC.
The investment securities portfolio includes interest-bearing deposits of
$7.9 million at December 31, 1996 which includes amounts received from the
Company's stock offering in connection with the Conversion.
Investments in mortgage-backed securities involve a risk that, because of
changes in the interest rate environment, actual prepayments may 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 interest 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.
The FASB has issued Statement of Financial Accounting Standards No. 115
(SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities"
which addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values and for all investments in
debt securities. These investments are to be classified in 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 Bank has no trading securities.
The Bank adopted SFAS 115 on January 1, 1993. The adoption affected only the
held-to-maturity and available-for-sale classifications, with the net unrealized
securities gains (loss) on the securities available-for-sale of $122,855, net of
related deferred taxes of $25,230, reported as a separate component of equity in
its financial statements at December 31, 1993. See Note 8 of "Notes to
Financial Statements".
The amortized cost of securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest
income from investments. Realized gains and losses, and declines in value
judged to be other than temporary are included in net securities gains (losses).
The cost of securities sold is based on the specific identification method.
As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in stock of the FHLB of Atlanta equal to the greater of 1% of the
Bank's outstanding home loans or 5% of its outstanding advances form the FHLB of
Atlanta. No ready market exists for such stock, which is carried at cost. As
of December 31, 1996, the Bank's investment in stock of the FHLB of Atlanta was
$667,000.
North Carolina regulations require the Bank to maintain a minimum amount of
liquid assets which may be invested in specified short-term securities. The
Bank is also permitted to make certain other securities investments. The Bank's
current investment policy states that the Bank's investments will be limited to
U.S. Treasury obligations, federal agency securities, mortgage backed
securities, municipal securities, corporate notes and time deposits in the FHLB.
15
<PAGE>
Investment decisions are made by authorized officers of the Bank under
policies established by the Board of Directors. Such investments are managed in
an effort to produce the highest yield consistent with maintaining safety of
principal and compliance with regulations governing the savings industry.
The following table sets forth certain information regarding the Bank's
interest-bearing deposits and the amortized cost and market values of the Bank's
investment and mortgage-backed securities portfolios at the dates indicated.
16
<PAGE>
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------- ----------------- ----------------- ---------------- -----------------------
Amortized Market Amortized Market Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value Cost Value Cost Value
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-bearing
deposits in other
financial
institutions $7,916 $7,916 $2,737 $2,737 $3,941 $3,941 $9,125 $9,125 $6,971 $6,971
Securities available-
for-sale:
Obligations of
states
and political
subdivisions $2,019 $2,011 $1,629 $1,630 $2,644 $2,521 $ - $ - $ - -
Mutual fudns 712 712 670 672 616 616 - - - -
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total securities
available-for-
sale $2,731 $2,723 $2,299 $2,302 $3,260 $3,137 $ - $ - $ - $ -
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Securities held-
to-maturity:
U.S. government
and agency
securities $4,753 $4,756 $2,995 $3,016 $4,799 $4,635 $5,013 $5,057 $3,007 $3,086
Mortgage-backed
securities 2,983 3,024 274 274 319 334 479 479 898 968
Obligations of
states
and political
subdivisions - - 1,310 1,318 566 561
Mutual funds - - 605 605 - -
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total securities
held-to-maturity $7,736 $7,780 $3,236 $3,290 $5,118 $4,969 $7,407 $7,459 $4,471 $4,615
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
(1) The net unrealized gain (loss) at December 31, 1996 and 1995 relates to
available for sale securities in accordance with SFAS No. 115. The Net
unrealized gain (loss) is represented in order to reconcile the "Amortized
Cost" of the Bank's securities portfolio in the "carrying Cost," as
reflected in the Statements of Financial Condition.
The following table sets forth certain information regarding the
carrying value, weighted average yields and contractual maturities of the Bank's
interest-bearing deposits, investment and mortgage-backed securities as of
December 31, 1996.
17
<PAGE>
<TABLE>
<CAPTION>
After One Year After One Year
through through
One Year or Less Five Years Ten Years After Ten Years Total
------------------ ------------------- ----------------- ---------------- -------------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------- --------- -------- ---------- -------- -------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits
in other financial
institutions $ 7,916 5.20% $ - -% $ - -% $- % $ 7,916 5.20%
------- ---- -------- --------- -------- ------- -------- ------- ------- ----
Securities available-
for-sale:
Obligations of
states and
political
subdivisions(1) $ 164 5.90% $1,088 6.38% $759 6.16% $ - -% $ 2,011 6.26%
Mutual funds 712 5.87 - - - - - - 712 587
------- ---- ------ ---- ---- ---- ------ ---- ------- ----
Total securities
available-for-sale $ 876 5.88% $1,088 6.38% $759 6.16% $ - % $ 2,723 6.16%
------- ---- ------ ---- ---- ---- ------ ---- ------- ----
Securities held-to-
maturity:
U.S. government
and agency
securities $ 2,009 6.54% $2,744 5.59% $ - -% $ - % $ 4,753 5.99%
Mortgage-backed
securities $2,983 7.03% $ 2,983 7.03
------- ---- ------ ---- ---- ---- ------ ---- ------- ----
Total securities
held-to-maturity $ 2,009 6.54% $2,744 5.59% $ - - $2,983 7.03% $ 7,736 6.39%
------- ---- ------ ---- ---- ---- ------ ---- ------- ----
Total investments, at
carrying value $ 2,885 6.34% $3,832 5.81% $759 $6.16% $2,983 7.03% $10,459 6.33%
------- ---- ------ ---- ---- ---- ------ ---- ------- ----
Total interest-bearing
deposits and
investments $10,801 5.50% $3,832 5.81% $759 6.16% $2,983 7.03% $18,375 5.84%
======= ==== ======== ========= ======== ======= ======== ======= ======= ====
- ------------------------
</TABLE>
(1) Yields on obligations of states and political subdivisions are not
calculated on a tax-equivalent basis.
18
<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, loan interest income, the stock offering,
investment income, interest-bearing deposit income, 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 form other sources. They may also be
used on a longer term basis for general business purposes. The Bank has no
borrowings outstanding at December 31, 1996; however, it does maintain borrowing
capabilities through the FHLB of Atlanta.
DEPOSITS. On December 31, 1996, 1995 and 1994, the Bank's deposits totaled
$66.5 million, $73.0 million and $69.1 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>
Six Months Year
Ended Ended
At or For the Year Ended December 31, December 31, June 30,
----------------------------------------
1996 1995 1994 1993 1992 1992
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Total deposits at
beginning of period $73,035 $69,140 $64,282 $54,475 $52,367 $47,111
Net increase (decrease)
before interest credited (9,518) 914 3,021 7,842 1,067 2,138
Interest credited 3,047 2,981 1,837 1,965 1,041 3,118
------- ------- ------- ------- ------- -------
Total deposits at end of
period $66,564 $73,035 $69,140 $64,282 $54,475 $52,367
======= ======= ======= ======= ======= =======
</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 passbook
savings accounts, negotiable order of withdrawal accounts, money market
accounts, and fixed interest rate certificates with varying maturities. 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, local radio 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.
19
<PAGE>
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------------------------------------
1996 1995 1994
---------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Average % of Average % of Average % of
Amount Rate Deposits Amount Rate Discount Amount Rate Deposit
------ -------- -------- ------ -------- -------- ------- -------- --------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Demand Accounts:
Passbook and statement accounts $11,377 3.00% 16.06% $ 9,309 3.00% 12.75% $11,382 3.00% 16.46%
NOW accounts 1,514 0.73 2.14 1,762 0.69 2.41 1,592 7.82 2.30
Money market deposit accounts 2,416 2.45 3.41 2,584 2.46 3.54 3,254 2.47 4.71
------- ---- ------ ------- ---- ------ ------- ---- ------
Total demand deposits 15,307 2.69 21.61 13,655 2.60 18.70 16,228 3.36 23.47
------- ---- ------ ------- ---- ------ ------- ---- ------
Time Deposits:
Certified accounts with
original maturities of:
3 months or less 3,786 4.86 5.34 1,253 5.22 1.72 205 5.07 0.30
3-6 months 9,205 5.23 12.99 7,823 5.53 10.71 9,285 4.97 13.43
11-12 months 17,089 5.40 24.13 21,950 6.11 30.05 16,560 5.07 23.95
18 months 5,183 5.59 7.32 5,607 5.98 7.68 5,994 5.07 8.66
24 months 3,483 5.98 4.92 4,510 5.97 6.17 4,291 5.45 6.21
30 months 16,781 6.16 23.69 18,235 6.00 24.97 16,566 5.63 23.96
60 months - - - - - - 11 8.00 0.02
------- ---- ------ ------- ---- ------ ------- ---- ------
Total certificates 55,527 5.62 78.39 59,378 5.96 81.30 52,912 5.26 76.53
------- ---- ------ ------- ---- ------ ------- ---- ------
Total deposits $70,834 4.99% 100.00% $73,033 5.33% 100.00% $69,140 4.81% 100.00%
======= ==== ====== ======= ==== ====== ======= ==== ======
</TABLE>
20
<PAGE>
As of December 31, 1996, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $5.1 million.
<TABLE>
<CAPTION>
At
December 31, 1996
-----------------
<S> <C>
(In Thousands)
3 Months or less $1,989
Over three months through 6 months 1,264
Over 6 months through 12 months 1,032
Over 12 months 860
------
Total $5,145
======
</TABLE>
BORROWINGS. The FHLB system functions in a reserve credit capacity for
savings institutions. As a member, the Bank is required to own capital stock in
the FHLB of Atlanta and its 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 Bank has not had any outstanding borrowings from the FHLB
of Atlanta or any other source in the last five years.
21
<PAGE>
SUBSIDIARIES
The Bank is the only subsidiary of the Company. 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 for
short-term money market securities and other corporate and government
securities. At December 31, 1996 there were at least six other commercial
banks, credit unions and mortgage companies as well as numerous other financial
services providers located in the Bank's market area. At December 31, 1996, the
Bank had a deposit market share of approximately 27% in Davie County. 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 form other
savings institutions, commercial banks, and mortgage banking companies. The
Bank competes for loans primarily through the interest rates and loan fees it
charges, the efficiency and quality of services it provides borrowers, and its
more flexible underwriting standards. Competition may increase as a result of
the continuing reduction of restrictions on the interstate operations of
financial institutions.
EMPLOYEES
As of December 31, 1996, the Bank had 18 full-time employees. All full-
time employees of the Bank are covered as a group for basic hospitalization,
including major medical, dental, accidental death and dismemberment insurance as
well as life and long term disability insurance. Optional medical and dental
insurance is available for dependents which must be partially paid by the
employee. In addition, in connection with the Conversion, the Bank adopted an
employment stock ownership plan which will provide benefits to the Bank's
employees.
Employees are not represented by any union or collective bargaining group,
and the Bank considers its employee relations to be good.
FEDERAL INCOME TAXATION
Savings institutions such as the Bank are subject to the taxing provisions
of the Code, for corporations, as modified by certain provisions specifically
applicable for financial or thrift institutions. Income is reported using the
accrual method of accounting. The maximum corporate federal income tax rate is
34%.
For fiscal years beginning prior to December 31, 1995, thrift institutions
which qualified under certain definitional tests and other conditions of the
Code were permitted certain favorable provisions regarding their deductions from
taxable income for annual additions to their bad debt reserve. A reserve could
be established for bad debts on qualifying real property loans (generally loans
secured by interests in real property improved or to be improved) under (i) a
method based on a percentage of the institution's taxable income as adjusted
(the "percentage of taxable income method") or (ii) a method based on actual
loss experience (the "experience method"). The reserve for nonqualifying loans
was computed using the experience method.
22
<PAGE>
The percentage of taxable income method was limited to 8% of taxable
income. This method could not raise the reserve to exceed 6% of qualifying real
property loans at the end of the year. Moreover, the additions for qualifying
real property loans, when added to nonqualifying loans, could not exceed 12% of
the amount by which total deposits or withdrawable accounts exceed the sum of
surplus, undivided profits and reserves at the beginning of the year. This
limitation precluded the Bank from taking a bad debt deduction in its 1996 and
1995 tax returns. The experience method was the amount necessary to increase
the balance of the reserve at the close of the year to the greater of (i) the
amount which bore the same ratio to loans outstanding at the close of the year
as the total net bad debts sustained during the current and five preceding years
bore to the sum of the loans outstanding at the close of such six years or (ii)
the balance in the reserve account at the close of the last taxable year
beginning before 1988 (assuming that the loans outstanding have not declined
since such date).
In order to qualify for the percentage of income method, an institution had
to have at least 60% of its net assets as "qualifying assets" which generally
included, cash, obligations of the United States government or an agency or
instrumentality thereof or of a state or political subdivision, residential real
estate-related loans, or loans secured by savings accounts and property used in
the conduct of its business. In addition, it had to meet certain other
supervisory tests and operate principally for the purpose of acquiring savings
and investing loans.
Institutions which became ineligible to use the percentage of income method
had to change to either the reserve method or the specific charge-off method
that applied to banks. Large thrift institutions, those generally exceeding
$500 million in assets, had to convert to the specific charge-off method. In
computing its bad debt reserve for federal income taxes, the Bank used the
reserve method in fiscal years 1996, 1995 and 1994.
Bad debt reserve balances in excess of the balance computed under the
experience method or amounts maintained in a supplemental reserve built up prior
to 1962 ("excess bad debt reserve") require inclusion in taxable income upon
certain distributions to its stockholders. Distributions in redemption or
liquidation of stock or distributions with respect to its stock in excess of
earnings and profits accumulated in years beginning after December 31, 1951, are
treated as a distribution from the excess bad debt reserve. When such a
distribution takes place and it is treated as from the excess bad debt reserve,
the thrift is required to reduce its reserve by such amount and simultaneously
recognize the amount as a item of taxable income increased by the amount of
income tax imposed on the inclusion. Dividends not in excess of earnings and
profits accumulated since December 31, 1951 will not require inclusion in part
or all of the bad debt reserve in taxable income. The Bank has accumulated
earnings and profits since December 31, 1951 and has an excess in its bad debt
reserve. Distribution in excess of current and accumulated earnings and
profits will increase taxable income. Net retained earnings at December 31,
1996 includes approximately $2.6 million for which no provision for federal
income tax has been made. See Note 12 to "Notes to Financial Statements".
Legislation passed by the U.S. Congress and signed by the President in
August 1996 contains a provision that repeals the percentage of taxable income
method of accounting for thrift bad debt reserves for tax years beginning after
December 31, 1995. The legislation will trigger bad debt reserve recapture for
post-1987 excess reserves over a six-year period. At December 31, 1996, the
Bank had no post-1987 excess reserves. A special provision suspends recapture of
post-1987 excess reserves for up to two years if, during those years, the
institution's residential loans exceeds a base year amount, which is determined
by reference to the average of the institution's residential loans during the
six taxable years ending January 1, 1996. However, notwithstanding this special
provision, recapture will begin no later than the first taxable year beginning
after December 31, 1997.
The Bank may also be subject to the corporate alternative minimum tax
("AMT"). This tax is applicable only to the extent it exceeds the regular
corporate income tax. The AMT is imposed at the rate of 20% of the
corporation's alternative minimum taxable income ("AMTI") subject to applicable
statutory exemptions. AMTI is calculated by adding certain tax preference items
and making certain adjustments to the corporation's regular taxable income.
Preference items and adjustments generally applicable to financial
23
<PAGE>
institutions include, but are not limited to, the following: (i) the excess of
the bad debt deduction over the amount that would have been allowable on the
basis of actual experience; (ii) interest on certain tax-exempt bonds issued
after August 7, 1986; and (iii) 75% of the excess, if any, of a corporation's
adjusted earnings and profits over its AMTI (as otherwise determined with
certain adjustments). Net operating loss carryovers, subject to certain
adjustments, may be utilized to offset up to 90% of the AMTI. Credit for AMT
paid may be available in future years to reduce future regular federal income
tax liability. The Bank has not been subject to the AMT in recent years.
The Bank's federal income tax returns have not been audited in over ten
years.
State Taxation
Under North Carolina law, the corporate income tax is 7.75% of federal
taxable income as computed under the Code, subject to certain prescribed
adjustments. An annual state franchise tax is imposed at a rate of 0.15%
applied to the greatest of the institutions (i) capital stock, surplus and
undivided profits, (ii) investment in tangible property in North Carolina or
(iii) appraised valuation of property in North Carolina.
The North Carolina corporate tax rate will drop to 7.50% in 1997, 7.25% in
1998, 7.00% in 1999 and 6.90% thereafter.
SUPERVISION AND REGULATION
REGULATION OF THE COMPANY
GENERAL. The Company was organized for the purpose of acquiring and
holding all of the capital stock of the Bank to be issued in the Conversion. As
a bank holding company subject to the Bank Holding Company Act of 1956, as
amended ("BLHCA"), the Company will become subject to certain regulations of the
Federal Reserve. Under the BHCA, the Company's activities and those of its
subsidiaries are limited to banking, managing or controlling banks, furnishing
services to or performing services for its subsidiaries or engaging in any other
activity which the Federal Reserve determines to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
The BHCA prohibits the Company from acquiring direct or indirect control of more
than 5% of the outstanding voting stock or substantially all of the assets of
any bank or savings bank or merging or consolidating with another bank holding
company or savings bank holding company without prior approval of the Federal
Reserve.
Additionally, the BHCA prohibits the Company from engaging in, or acquiring
ownership or control of, more than 5% of the outstanding voting stock of any
company engaged in nonbanking business unless such business is determined by the
Federal Reserve to be so closely related to banking as to be properly incident
thereto. The BHCA generally does not place territorial restrictions on the
activities of such nonbanking related activities.
Similarly, Federal Reserve approval (or, in certain cases, non-disapproval)
must be obtained prior to any person acquiring control of the Company. Control
is conclusively presumed to exist if, among other things, a person acquired more
than 25% of any class of voting stock of the holding company or controls in any
manner the election of a majority of the directors of the holding company.
Control is presumed to exist if a person acquires more than 10% of any class of
voting stock and the stock is registered under Section 12 of the Exchange Act or
the acquiror will be the largest shareholder after the acquisition.
There are a number of obligations and restrictions imposed on bank holding
companies and their depository institution subsidiaries by law and regulatory
policy that are designed to minimize potential loss to the depositors of such
depository institutions and the FDIC insurance funds in the event the depository
institution becomes in danger of default or in default. For example, under the
1991 Banking Law, to avoid
24
<PAGE>
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, the "cross-guarantee" provisions of the Federal Deposit Act,
as amended ("FDIA") require insured depository institutions under common control
to reimburse the FDIC for any loss suffered by either the Savings Association
Insurance Fund (the "SAIF") or the Bank Insurance Fund (the "BIF") as a result
of the default of a commonly controlled insured depository institution or for
any assistance provided by the FDIC to a commonly controlled insured depository
institution in danger of default. The FDIC may decline to enforce the cross-
guarantee provisions if it determines that a waiver is in the best interest of
the SAIF of the BIF or both. The FDIC's claim for damages is superior to claims
of stockholders of the insured depository institution or its holding company but
is subordinate to claims of depositors, secured creditors and holders of
subordinated debt (other than affiliates) of the commonly controlled insured
depository institutions.
As a result of the Company's ownership of the Bank, the Company will be
registered under the savings bank holding company laws of North Carolina.
Accordingly, the Company is also subject to regulation and supervision by the
Administrator.
Federal regulations require that the Company must notify the Federal
Reserve Bank of Richmond prior to repurchasing Common Stock in excess of 10% of
its net worth during a rolling 12 month period. Also, no stock repurchases may
be made for at least one year after Conversion unless approved by the
Administrator, who may approve such repurchases only upon a finding that the
safety and soundness of the Bank would not be adversely affected thereby.
CAPITAL ADEQUACY GUIDELINES FOR HOLDING COMPANIES. The Federal Reserve has
adopted capital adequacy guidelines for bank holding companies. For bank
holding companies with less than $150 million in consolidated assets, the
guidelines are applied on a bank-only basis unless the parent bank holding
company (i) is engaged in nonbank activity involving significant leverage or
(ii) has a significant amount of outstanding debt that is held by the general
public.
Bank holding companies are required to comply with the Federal Reserve's
risk-based capital guidelines. Under these regulations, the minimum ratio of
total capital to risk-weighted assets (including certain off-balance sheet
activities, such as standby letters of credit) is 8%. At least half of the
total capital is required to be "Tier I capital," principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock, and a
limited amount of cumulative perpetual preferred stock, less certain goodwill
items and other intangible assets. The remainder ("Tier II capital") may
consist of a limited amount of subordinated debt, certain hybrid capital
instruments and other debt securities, perpetual preferred stock, and a limited
amount of the general loan loss allowance. In addition to the risk-based
capital guidelines, the Federal Reserve has adopted a minimum Tier I capital
(leverage) ratio, under which a bank holding company must maintain a minimum
level of Tier I capital to average total consolidated assets of at least 3% in
the case of a bank holding company which has the highest regulatory examination
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.
25
<PAGE>
FEDERAL SECURITIES LAW. The Company has registered its Common Stock with the
SEC pursuant to Section 12(b) of the Exchange Act and will not deregister the
Common Stock for a period of three years following the completion of the
Conversion. As a result of such registration, the proxy and tender offer rules,
insider trading reporting requirements, annual and periodic reporting and other
requirements of the Exchange Act are applicable to the Company.
The registration under the Securities Act of the Offerings of the Common
Stock does not cover the resale of such shares. Shares of the Common Stock
purchased by persons who are not affiliates of the Company may be resold without
registration. Shares purchased by an affiliate of the Company are subject to
the resale provisions of Rule 144 under the Securities Act. So long as the
Company meets the current public information requirements of Rule 144 under the
Securities Act, each affiliate of the Company who complies with the other
conditions of Rule 144 (including those that require the affiliate's sale to be
aggregated with those of certain other persons) will be able to sell in the
public market, without registration, a number of shares not to exceed, in any
three-month period, the greater of (i) 1% of the outstanding shares of the
Company or (ii) the average weekly volume of trading in such shares during the
preceding four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under the
Securities Act under certain circumstances. There are currently no demand
registration rights outstanding. However, in the event the Company at some
future time determines to issue additional shares from its authorized but
unissued shares, the Company might offer registration rights to certain of its
affiliates who want to sell their shares.
REGULATION OF THE BANK
GENERAL. Federal and state legislation and regulation have significantly
affected the operations of federally insured savings institutions and other
federally regulated financial institutions in the past several years and have
increased competition among savings institutions, commercial banks and other
providers of financial services. In addition, federal legislation has imposed
new limitations on investment authority, and higher insurance and examination
assessments on savings institutions and has made other changes that may
adversely affect the future operations and competiveness of savings institutions
with other financial institutions, including commercial banks and their holding
companies. The operations of regulated depository institutions, including the
Bank, will continue to be subject to changes in applicable statutes and
regulations form time to time.
The Bank is a North Carolina-chartered savings bank, is a member of the
FHLB system, and its deposits are insured by the FDIC through the SAIF. It is
subject to examination and regulation by the FDIC and the Administrator and to
regulations governing such matters as capital standards, mergers, establishment
of branch offices, subsidiary investments and activities, and general investment
authority. Generally, North Carolina state chartered savings banks whose
deposits are insured 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 state-
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.
26
<PAGE>
The grounds for appointment of a conservator or receiver for a North
Carolina savings bank on the basis of an institution's financial condition
include: (i) insolvency, in that the assets of the savings bank are less than
its liabilities to depositors and others; (ii) substantial dissipation of assets
or earnings through violations of law or unsafe or unsound practices; (iii)
existence of an unsafe or unsound condition to transact business; (iv)
likelihood that the savings bank will be unable to meet the demands of its
depositors or to pay its obligations in the normal course of business; and (v)
insufficient capital or the incurring or likely incurring of losses that will
deplete substantially all of the institution's capital with no reasonable
prospect of replenishment of capital without federal assistance.
TRANSACTIONS WITH AFFILIATES. Under current federal law, transactions
between the Bank and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of the Bank is any company or entity that
controls, is controlled by or is under common control with the savings bank.
Generally, subsidiaries of a bank, other than a bank subsidiary, and certain
types of companies are not considered to be affiliates. Generally, Sections 23A
and 23B (i) establish certain collateral requirements for loans to affiliates;
(ii) limit the extent to which the Bank or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
the Bank's capital stock and surplus, and contain an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital stock
and surplus and (iii) require that all such transactions be on terms
substantially the same, or at least as favorable, to the Bank or the subsidiary
as those provided to a nonaffiliate. The term "covered transaction" includes
the making of loans or other extensions of credit to an affiliate, the
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 or an affiliate.
Further, current federal law has extended to saving banks the restrictions
contained in Section 22(h) of the Federal Reserve Act with respect to loans to
directors, executive officers and principal stockholders. Under Section 22(h),
loans to directors, executive officers and stockholders who, directly or
indirectly, own more than 10% of any class of voting securities of a savings
bank, and certain affiliated entities of any of the foregoing, may not exceed,
together with all other outstanding loans to such person and affiliated
entities, the savings bank's loans-to-one borrower limit as established by
federal law (as discussed below). Section 22(h) also prohibits loans above
amounts prescribed by the appropriate federal banking agency to directors,
executive officers or stockholders who own more than 10% of a savings bank, and
their respective affiliates, unless such loan is approved in advance by a
majority of the disinterested directors of the board of directors of the savings
bank and the Company. Any "interested" director may not participate in the
voting. The Federal Reserve has prescribed the loan amount (which includes all
other outstanding loans to such person), as to which such prior board of
director approval is required, as being the greater of $25,000 or 5% of
unimpaired capital and unimpaired surplus (up to $500,000). Further, pursuant
to Section 22(h) the Federal Reserve requires that loans to directors, executive
officers, and principal stockholders based on underwriting standards not less
stringent than those applied in comparable transactions with other persons and
made on terms substantially the same as offered in comparable transactions to
other persons and not involve more than the normal risk of repayment or present
other unfavorable features.
INSURANCE OF DEPOSIT ACCOUNTS. The FDIC administers two separate deposit
insurance funds. The SAIF maintains a fund to insure the deposits of
institutions the deposits of which were insured by the Federal Savings and Loan
Insurance Corporation (the "FSLIC") prior to the enactment of FIRREA, and the
BIF maintains a fund to insure the deposits of institutions the deposits of
which were insured by the FDIC prior to the enactment of FIRREA. The Bank is a
member of the SAIF of the FDIC.
As a SAIF-insured institution, the Bank is subject to insurance assessments
imposed by the FDIC. Effective January 1, 1993, the FDIC replaced its uniform
assessment rate with a transitional risk-based assessment schedule issued by the
FDIC pursuant to the 1991 Banking Law, which imposes assessments ranging from
0.23% to 0.31% of an institution's average assessment base. The actual
assessment to be paid by each SAIF member is based on the institution's
assessment risk classification, which will be determined based on whether the
institution is considered "well capitalized," "adequately capitalized" or
"undercapitalized" (as such terms have been defined in federal regulations), and
whether such institution is considered by its supervisory agency to be
financially sound or to have supervisory concerns.
27
<PAGE>
As a result of subsequent changes to the assessment schedule, financial
institutions such as the Bank that are members of the SAIF, are currently
required to pay higher deposit insurance premiums than financial institutions
which are members of the BIF (primarily commercial banks), because the BIF has
higher reserves than the SAIF and has been responsible for fewer troubled
institutions. This had created a disparity between SAIF and BIF assessments.
Annual assessments for BIF members in the lowest risk categories are now only
$2,000. For the years ended December 31, 1996 and 1995, the Bank's federal
deposit insurance premium expense was approximately $125,000 and $158,000, not
including a one time special SAIF assessment totaling $456,000 for the year
ended December 31, 1996. The FDIC has noted that the premium differential may
have adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in capital markets. In addition, SAIF members,
such as the Bank, could be placed at a substantial competitive disadvantage to
BIF members with respect to pricing of loans and deposits and the ability to
achieve lower operating costs.
A comprehensive continuing appropriations bill enacted on September 30,
1996 reduced this premium differential between BIF-and SAIF-insured institutions
but did not eliminate it. As a result of this legislation, it is now
anticipated that, beginning on January 1, 1997, BIF-insured institutions, except
those in higher risk categories, will pay deposit insurance premiums equal to
approximately 1.3 cents per $100 of insured domestic deposits and SAIF-insured
institutions, except those in higher risk categories, will pay deposit insurance
premiums equal to approximately 6.4 cents per $100 of insured domestic deposits.
This premium differential is expected to exist until at least January 1, 1999.
The above-described comprehensive continuing appropriations bill enacted on
September 30, 1996 also provided for a one-time assessment on SAIF members to
recapitalize the SAIF. The assessment was equal to 65.7 cents per each $100 of
insured domestic deposits. Such premium had the effect of immediately reducing
the capital of SAIF-member institutions by the amount of the assessment. SAIF-
member institutions were allowed to amortize the expense of the one-time
assessment over a period of years. The one-time assessment, was based on the
Bank's deposits as of March 31, 1995, and was approximately $456,000 on a before
tax basis and was paid prior to December, 1996. This one-time assessment to
recapitalize the SAIF had an adverse effect on the operating expenses and
results of operations of the bank during the quarter ended September 30, 1996.
COMMUNITY REINVESTMENT ACT. The Bank, like other financial institutions,
is subject to the Community Reinvestment Act, as amended ("CRA"). A purpose of
this Act is to encourage financial institutions to help meet the credit needs of
its entire community, including the needs of low-and moderate-income
neighborhoods. During the Bank's last compliance examination, which was
performed by the FDIC under the old CRA regulations in January 1994, the Bank
received a "satisfactory" rating with respect to CRA compliance. The Bank's
rating with respect to CRA compliance would be a factor to be considered by the
Federal Reserve and FDIC in considering applications submitted by the Bank to
acquire branches or to acquire or combine with other financial institutions and
take other actions and could result in the denial of such applications.
The federal banking regulatory agencies have issued a rewrite of the CRA
regulations, which became effective on January 1, 1996, to implement a new
evaluation system that rates institutions based on their actual performance in
meeting community credit needs. Under the regulations, a savings bank will be
evaluated and rated under three categories: a lending test, an investment test
and a service test. For each of these three tests, the savings bank will be
given a rating of either "outstanding," "high satisfactory," "low satisfactory,"
needs to improve" or "substantial noncompliance". A set of criteria for each
rating has been developed and is included in the regulation. If an institution
disagrees with a particular rating, the institution has the burden of rebutting
the presumption by clearly establishing that the quantative measures do not
accurately present its actual performance or that demographics, competitive
conditions or economic or legal limitations peculiar to the service area should
be considered. The ratings received under the three tests will be used to
determine the overall composite CRA rating. The composite ratings will be the
same as those that are currently given: "outstanding," "satisfactory," "needs
to improve" or "substantial noncompliance."
28
<PAGE>
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 unsold condition, allowing
the FDIC to take various enforcement actions, including possible termination of
insurance or placement of the institution in receivership. At December 31,1996,
the Bank had a leverage ratio of 25.90%.
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 December 31, 1996, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.
The 1991 Banking Law required each federal banking agency to revise its
risk-based capital standards to ensure that those standards take adequate
account of interest rate risk, concentration of credit risk, and the risk of
nontraditional activities, as well as reflect the actual performance and
expected risk of loss on multi-family mortgages. On August 2, 1995, the federal
banking agencies issued a joint notice of adoption of final risk based capital
rules to take account of interest rate risk. The final regulation required an
assessment of the need for additional capital on a case-by-case basis,
considering both the level of measured exposure and qualative risk factors. The
final rule also stated an intent to, in the future, establish an explicit
minimum capital charge for interest rate risk based on the level of a bank's
measured interest rate risk exposure.
Effective June 26, 1996, the federal banking agencies issued a joint policy
statement announcing the agencies' election not to adopt a standardized measure
and explicit capital charge for interest rate risk at that time. Rather, the
policy statement (i) identifies the main elements of sound interest rate risk
management, (ii) describes prudent principles and practices for each of those
elements, and (iii) describes the critical factors affecting the agencies'
evaluation of a bank's interest rate risk when making a determination of capital
adequacy. The joint policy statement is not expected to have a material impact
on the Bank's management of interest rate risk.
The FDIC has adopted a final rule changing its risk-based capital rules to
recognize the effect of bilateral netting agreements in reducing the credit risk
of two types of financial derivatives - interest and exchange rate contracts.
Under the rule, savings banks are permitted to net positive and negative mark-
to-market values of rate contracts with the same counterparty, subject to
legally enforceable bilateral netting contracts that meet certain criteria.
This represents a change from the prior rules which recognized only a very
limited form of netting. The Bank does not anticipate that this rule will have
a material effect upon its financial statements.
LOANS-TO-ONE-BORROWER. The Bank is subject to the Administrator's loans-
to-one-borrower limits. Under these limits, no loans and extensions of credit
to any borrower outstanding at one time and not fully secured by readily
marketable collateral shall exceed 15% of the net worth of the savings bank.
Loans and
29
<PAGE>
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
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 or real property acquired in satisfaction of debts in an
amount up to 50% of net worth.
As of December 31, 1996, the largest aggregate amount of loans which the
Bank had to any one borrower was $1.3 million. The Bank had no loans outstanding
which management believes violate the applicable loans-to-borrower limits. The
Bank does not believe that the loans-to-one-borrower limits will have a
significant impact on its business, operations and earnings.
LIMITATIONS ON RATES PAID FOR DEPOSITS. Regulations promulgated by the
FDIC pursuant to the 1991 Banking Law place limitations on the ability of
insured depository institutions to accept, renew or roll over deposits by
offering rates of interest which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
having the same type of charter in such depository institution's normal market
area. Under these regulations, "well capitalized" depository institutions may
accept, renew or roll such deposits over without restriction, "adequately
capitalized" depository institutions may accept, renew or roll such deposits
over with a waiver from the FDIC (subject to certain restrictions on payments of
rates) and "undercapitalized" depository institutions may not accept, renew or
roll such deposits over. The definitions of "well capitalized," "adequately
capitalized" and "undercapitalized" are the same as the definitions adopted by
the FDIC to implement the corrective action provisions of the 1991 Banking Law.
FEDERAL HOME LOAN BANK SYSTEMS. 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, of 5% of its outstanding advances (borrowings)
from the FHLB of Atlanta. On December 31, 1996, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of approximately
$667,000.
FIRREA has had the effect of reducing the dividends that the Bank receives
on its stock in the FHLB of Atlanta. During fiscal 1996 and 1995, the Bank
recorded dividend income of $46,900 and $40,500 respectively, with respect to
its FHLB of Atlanta stock. FIRREA requires the FHLB to contribute a certain
amount of its reserves and undivided profits to fund the principal and a portion
of the interest on certain bonds and certain other obligations which are used to
fund the resolution of troubled savings association cases. In addition, FIRREA
requires each FHLB to transfer a percentage of its annual net earnings to the
Affordable Housing Program. That amount will increase from 5% of the annual net
income of the FHLB in 1990 to at least 10% of its annual net income in 1995 and
subsequent years. As a result of these FIRREA requirements, it is anticipated
that the FHLB of Atlanta's earnings will be reduced and that the Bank will
receive reduced dividends on its FHLB of Atlanta stock in future periods.
FEDERAL RESERVE SYSTEMS. Federal Reserve regulations require savings
banks, not otherwise exempt from the regulations, to maintain reserves against
their transaction accounts (primarily negotiable order of withdrawal accounts)
and certain nonpersonal time deposits. The reserve requirements are subject to
adjustment by the Federal Reserve. As of December 31, 1996, the Bank was in
compliance with the applicable reserve requirements of the Federal Reserve.
30
<PAGE>
RESTRICTIONS ON ACQUISITIONS. Federal law generally provides that no
"person," acting directly or indirectly or through or in concert with one or
more other persons, may acquire "control," as that term is defined in FDIC
regulations, of an insured institution, such as the Bank, without giving at
least 60 days' written notice to the FDIC and providing the FDIC an opportunity
to disapprove the proposed acquisition. Pursuant to regulations governing
acquisitions of control, control of an insured institution is conclusively
deemed to have been acquired by, among other things, the acquisition of more
than 25% of any class of voting stock. In addition, control generally is
presumed to have been acquired, subject to rebuttal, upon the acquisition of
more than 10% of any class 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 saving 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 acquisition of control by such person.
For three years following completion of the Conversion, North Carolina
conversion regulations require the prior written approval of the Administrator
before any person may directly or indirectly offer to acquire or acquire the
beneficial ownership of more than 10% of any class of an equity security of the
Bank. If any person were to so acquire the beneficial ownership of more than
10% of any class of any equity security without prior written approval, the
securities beneficially owned in excess of 10% would not be counted as shares
entitled to vote and would not be voted or counted as voting shares in
connection with any matter submitted to stockholders for a vote. Approval is
not required for (i) any offer with a view toward public resale made exclusively
to the bank or its underwriters or the selling group acting on its behalf or
(ii) any offer to acquire or acquisition of beneficial ownership of more than
10% of the common stock of the Bank by a corporation whose ownership is or will
be substantially the same as the ownership of the Bank, provided that the offer
or acquisition is made more than one year following the consummation of the
Conversion. The regulation provides that within one year following the
Conversion, the Administrator would approve the acquisition of more than 10% of
beneficial ownership only to protect the safety and soundness of the
institution. During the second and third years after the Conversion, the
Administrator may approve such an acquisition upon a finding that (i) the
acquisition is necessary to protect the safety and soundness of the Company and
the Bank or the Boards of Directors of the Company and the Bank support the
acquisition, (ii) the acquiror is of good character and integrity and possesses
satisfactory managerial skills, and will be a source of financial strength to
the Company and the Bank; and (iii) the public interests will not be adversely
affected.
LIQUIDITY. The Bank is subject to the Administrator's requirement that the
ratio of liquid assets to total assets equal at least 10%. The computation of
liquidity under North Carolina regulation allows the inclusion of mortgage-
backed securities and investments which, in the judgment of the Administrator,
have a readily marketable value, including investments with maturities in excess
of five years. On December 31, 1996, the Bank's liquidity ratio,calculated in
accordance with North Carolina regulations, was approximately 10.14%.
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 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.
31
<PAGE>
IMPACT OF THE 1991 BANKING LAW. The 1991 Banking Law became effective on
December 19, 1991. Among other things, the 1991 Banking Law provided increased
funding for the BIF and provided for expanded regulation of depository
institutions and their affiliates, including bank holding companies.
The 1991 Banking Law provided the federal banking agencies with broad
powers to take corrective action to resolve problems of insured depository
institutions. The extent of these powers will depend upon whether the
institutions in question are "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," or "critically
undercapitalized." Under the FDIC regulations applicable to the Bank, an
institution is considered "well capitalized" if it has (i) a total risk-based
capital ratio of 10% or greater, (ii) a Tier I risk-based capital ratio of 6% or
greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any
order or written directive to meet and maintain a specific capital level for any
capital measure. An "adequately capitalized" institution is defined as one that
has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier I risk-
based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or greater
(or 3% or greater in the case of an institution with the highest examination
rating and which is not experiencing or anticipating significant growth). An
institution is considered (A) "undercapitalized" if it has (i) a total risk-
based capital ratio of less than 8%, (ii) a Tier I risk-based capital ratio of
less than 4% or (iii) a leverage ratio of less than 4% or 3% in the case of an
institution with the highest examination rating and which is not experiencing or
anticipating significant growth); (B) "significantly undercapitalized" if the
institution has (i) a total risk-based capital ratio of less than 6%, or (ii) a
Tier I risk-based capital ratio of less than 3% or (iii) a leverage ratio of
less than 3% and (C) "critically undercapitalized" if the institution has a
ratio of tangible equity to total assets equal to or less than 2%.
To facilitate the early identification of problems, the 1991 Banking Law
required the federal banking agencies to review and, under certain
circumstances, prescribe more stringent accounting and reporting requirements
than those required by generally accepted accounting principles. The FDIC
issued a final rule, effective July 2, 1993, implementing those provisions. The
rule, among other things, requires that management of institutions with $500
million or more in assets report on the institution's responsibility for
preparing financial statements and establishing and maintaining an internal
control structure and procedures for financial reporting and compliance with
designated laws and regulations concerning safety and soundness, and that
independent auditors attest to and report separately on assertions in
management's reports concerning compliance with such laws and regulations, using
FDIC-approved audit procedures.
The 1991 Banking Law further requires the federal banking agencies to
develop regulations requiring disclosure of contingent assets and liabilities
and, to the extent feasible and practicable, supplemental disclosure of the
estimated fair market value of assets and liabilities. The 1991 Banking Law
also requires annual examinations of all insured depository institutions by the
appropriate federal banking agency, with some exceptions for small, well-
capitalized institutions and state chartered institutions examined by state
regulators. Moreover, the 1991 Banking Law, as modified by the Federal Housing
Enterprises Financial Security and Soundness Act, requires the federal banking
agencies to set operational and managerial, asset quality, earnings and stock
valuation standards for insured depository institutions and depository
institution holding companies, as well as compensation standards (but not dollar
levels of compensation) for insured depository institutions that prohibit
excessive compensation, fees or benefits to officers, directors, employees, and
principal stockholders. The federal banking agencies have issued final
regulations, effective August 9, 1995, implementing these standards in
accordance with the 1991 Banking Law. Those agencies have also issued a joint
advance notice of proposed rule making soliciting comments on the addition of
asset quality and earnings guidelines to these safety and soundness standards.
The foregoing necessarily is a general description of certain provisions of
the 1991 Banking Law and does not purport to be complete. The effect of the
1991 Banking Law on the Bank has not yet been fully ascertained.
INTERSTATE BRANCHING. A bank or savings bank holding company and its
subsidiaries are currently prohibited from acquiring any voting shares of, or
interest in, any banks or savings banks located outside of the state in which
the operations of the savings bank holding company's subsidiaries are located,
unless the
32
<PAGE>
acquisition is specifically authorized by the statutes of the state in which the
target bank is located. However, in September 1994, Congress passed the Riegle-
Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate
Banking Act"). The Interstate Banking Act permitted adequately capitalized bank
and savings bank holding companies to acquire control of banks and savings banks
in any state beginning on September 29, 1995, one year after the effectiveness
of the Interstate Banking Act. In addition, states may specifically permit
interstate acquisitions prior to September 29, 1995, by enacting legislation
that provides for such transactions. North Carolina adopted nationwide
reciprocal interstate acquisition legislation in 1994.
Such interstate acquisitions are subject to certain restrictions. States
may require the bank or savings bank being acquired to have been in existence
for a certain length of time but not in excess of five years. In addition, no
bank or savings bank may acquire more than 10% of the insured deposits in the
United States or more than 30% of the insured deposits in any one state, unless
the state has specifically legislated a higher deposit cap. States are free to
legislate stricter deposit caps and, at present, 18 states have deposit caps
lower than 30%.
The Interstate Banking Act also provides for interstate branching. The
McFadden Act of 1927 established state lines as the ultimate barrier to
geographic expansion of a banking network by branching. The Interstate Banking
Act withdraws these barriers, effective June 1, 1997, allowing interstate
branching in all states, provided that a particular state has not specifically
denied interstate branching by legislation prior to such time. Unlike
interstate acquisitions, a state may deny interstate branching if it
specifically elects to do so by June 1, 1997. States may choose to allow
interstate branching prior to June 1, 1997 by opting-in to a group of states
that permits these transactions. These states generally allow interstate
branching via a merger of an out-of-state bank with an in-state bank, or on a de
novo basis. North Carolina has enacted legislation permitting branching
transactions.
It is anticipated that the Interstate Banking Act will increase competition
within the markets in which the Bank now operates, although the extent to which
such competition will increase in such markets or the timing of such increase
cannot be predicted. In addition, there can be no assurance as to whether, or
in what form, legislation may be enacted in North Carolina in reaction to the
Interstate Banking Act or what impact such legislation or the Interstate Banking
Act might have upon the Bank.
The Interstate Banking Act also modifies the controversial safety and
soundness provisions contained in Section 39 of the 1991 Banking Law which
required the banking regulatory agencies to write regulations governing such
topics as internal controls, loan documentation, credit underwriting, interest
rate exposure, asset growth, compensation and fees and whatever else those
agencies determined to be appropriate. The legislation exempts bank holding
companies from these provisions and requires the agencies to write guidelines,
as opposed to regulations, dealing with these areas. It also gives more
discretion to the banking regulatory agencies with regard to prescribing
standards for banks' asset quality, earnings and stock valuation.
The Interstate Banking Act also expands current exemptions from the
requirement that banks be examined on a 12 month cycle. Exempted banks will be
inspected every 18 months. Other provisions address paperwork reduction and
regulatory improvements, small business and commercial real estate loan
securitization, truth-in-lending amendments on high cost mortgages,
strengthening of the independence of certain financial regulatory agencies,
money laundering, flood insurance reform and extension of certain statutes of
limitations.
RESTRICTIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS. A North
Carolina state-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.
33
<PAGE>
Also, without the prior written approval of the Administrator, a North
Carolina-chartered stock savings bank, for a period of five years after its
conversion from mutual to stock form, may not repurchase any of its capital
stock. The Administrator will give approval to repurchase only upon a showing
that the proposed repurchase will not adversely affect the safety and soundness
of the institution.
In addition, the Bank is not permitted to declare or pay a cash dividend on
or repurchase any of its capital stock if the effect thereof would be to cause
its net worth to be reduced below the amount required for the liquidation
account established in connection with the Bank's conversion from mutual to
stock ownership.
In connection with the Conversion, the Company and the Bank have agreed
with the FDIC that, during the first year after the Conversion, the Bank will
not pay any dividend or make any other distribution to its stockholder which
represents, is characterized as or is treated for federal tax purposes as, a
return of capital.
OTHER NORTH CAROLINA REGULATIONS. As a North Carolina-chartered savings
bank, the Bank derives its authority from, and is regulated by, the
Administrator. The Administrator has the right to promulgate rules and
regulations necessary for the supervision and regulation of North Carolina
savings banks under his jurisdiction and for the protection of the public
investing in such institutions. The regulatory authority of the Administrator
includes, but is not limited to, the establishment of reserve requirements; the
regulation of the payment of dividends; the regulation of stock repurchases, the
regulation of incorporators, stockholders, directors, officers and employees;
the establishment of permitted types of withdrawable accounts and types of
contracts for savings programs, loans and investments; and the regulation of the
conduct and management of savings banks, chartering and branching of
institutions, mergers, conversions and conflicts of interest. North Carolina
law requires that the Bank maintain federal deposit insurance as a condition of
doing business.
The Administrator conducts regular annual examinations of North Carolina-
chartered savings banks. The purpose of such examinations is to assure that
institutions are being operated in compliance with applicable North Carolina law
and regulations and in a safe and sound manner. These examinations are usually
conducted on an alternating 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, and 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 ins 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.
34
<PAGE>
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.
35
<PAGE>
ITEM 2. PROPERTIES
At December 31, 1996, the Company conducted its business from its two
offices in Mocksville and Advance, North Carolina. The following table sets
forth certain information regarding the Company's properties as of December 31,
1996. All properties are owned by the Company.
<TABLE>
<CAPTION>
Net Book Value Deposits
Address of Property (In Thousands)
- ------- -------------- --------------
<S> <C> <C>
Mocksville: $ 67,947 $54,112
232 South Main Street
Mocksville, North Carolina 27028
Advance: $637,943 $12,452
5361 U.S. Highway 158
Advance, North Carolina 27006
</TABLE>
The Bank's management considers the property to be in very good condition.
The total net book value of the Bank's furniture, fixtures, equipment and
vehicles on December 31, 1996 was $193,661.
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 December 31, 1996.
36
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
See the information under the section captioned "Capital Stock"
in the Company's 1996 Annual Report, which section is incorporated herein by
reference. See "Item 1, 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. SELECTED FINANCIAL DATA
The information required by this Item is set forth in the table captioned
"Selected Financial Data" in the Company's 1996 Annual Report which is
incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
OPERATING RESULTS
See also the information set forth under Item 1 above and the information
set forth under the section captioned "Management's Discussion and Analysis"
on pages 5 through 17 in the Company's 1996 Annual Report which section is
incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The consolidated financial statements of the Bank set forth on pages 18
through 40 of the Company's 1996 Annual Report is incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on accounting and
financial disclosure during the fiscal year ended December 31, 1996 and
subsequent interim period.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item regarding directors and executive
officers of the Company is set forth under the sections captioned "Proposal 1 -
Election of Directors-General" and "-Executive officers" contained in 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" in the Proxy
Statement, which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION AND TRANSACTIONS
The information required by this Item is set forth under the sections
captioned "Proposal 1 - Election of Directors - Directors Compensation" and
"-Executive Compensation" contained in the Proxy Statement, which sections are
incorporated herein by reference.
37
<PAGE>
ITEM 12. 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" contained in
the Proxy Statement.
ITEM 13. 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-K. See also the section captioned "Proposal 1 - Election of Directors -
Certain Indebtedness and Transactions of Management" contained in the Proxy
Statement, which section is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
14(a)1 Consolidated Financial Statements are contained in the Bank's 1996
Annual Report attached hereto as Exhibit (13) and incorporated
herein by reference
(a) Independent Auditors' Report
(b) Consolidated Balance Sheets as of December 31, 1996 and 1995
(c) Consolidated Statements of Income for the Years Ended December 31,
1996, 1995 and 1994
(d) Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1996, 1995 and 1994
(e) Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994
(f) Notes to Consolidated Financial Statements
14(a)2 Financial Statement Schedules
All schedules have been omitted as the required information is either
inapplicable or included in the Notes to Consolidated Financial
Statements.
38
<PAGE>
<TABLE>
<CAPTION>
14(a)3 Exhibits
<S> <C>
Exhibit (3)(i) Articles of Incorporation, incorporated herein by reference to Exhibit 3.1
of the Company's Registration Statement on Form S-1 (No. 33-80085) filed on
December 5, 1995 and amended on January 31, 1996 and February 8, 1996
Exhibit (3)(ii) Bylaws, incorporated herein by reference to Exhibit 3.2 of the Company's
Registration Statement on Form S-1 (No. 33-80085) filed on December 5, 1995
as amended January 31, 1996 and February 8, 1996
Exhibit (4) Specimen Stock Certificate, incorporated herein by reference to Exhibit 4.1 of
the Company's Registration Statement on Form S-1 (No. 33-80085) filed on
December 5, 1995 and amended on January 31, 1996 and February 8, 1996
Exhibit (10)(ii)(a) Stone Street Bancorp, Inc. Stock Option Plan
Exhibit (10)(ii)(b) Mocksville Savings Bank, Inc., SSB Management Recognition Plan
Exhibit (10)(ii)(c) Employment Agreeemnt between Mocksville savings Bank, Inc., SSB and J.
Charles Dunn, incorporated herein by reference to Exhibit 10.2 of the
Company's Registration Statement on Form S-1 (No. 33-80085) filed on
December 5, 1996 and amended on January 31, 1996 and February 8, 1996
Exhibit (11) Statement Regarding Computation of Per Share Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) Portions of 1996 Annual Report to Security Holders
Exhibit (21) Subsidiaries of the Registrant
Exhibit (27) Financial Data Schedule
</TABLE>
14(b) The Company filed no reports on Form 8-K during the last quarter of the
fiscal year ended December 31, 1996.
39
<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.
STONE STREET BANCORP, INC.
Date: March 27, 1997 By: /s/ J. Charles Dunn
____________________________________________
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:
Signature Title Date
- --------- -----
/s/ J. Charles Dunn President and Director March 27, 1997
- ---------------------- (Principal Executive
J. Charles Dunn Officer)
/s/ Allen W. Carter
- ---------------------- Senior Vice President March 27, 1997
Allen W. Carter
/s/ Marjorie D. Foster Vice President and March 27, 1997
- ---------------------- Controller (Principal
Marjorie D. Foster Financial Officer and
Principal Accounting
Officer)
/s/ Robert B. Hall
- ---------------------- Director March 27, 1997
Robert B. Hall
/s/ William F. Junker
- ---------------------- Director March 27, 1997
William F. Junker
/s/ Donald G. Bowles
- ---------------------- Director March 27, 1997
Donald G. Bowles
/s/ J. Roy Harris
- ---------------------- Director March 27, 1997
J. Roy Harris
/s/ Claude R. Horn, Jr.
- ---------------------- Director March 27, 1997
Claude R. Horn, Jr.
/s/ George W. Martin
- ---------------------- Director March 27, 1997
George W. Martin
/s/ Lois C. Shore
- ---------------------- Director March 27, 1997
Lois C. Shore
/s/ Ronald H. Vogler
- ---------------------- Director March 27, 1997
Ronald H. Vogler
40
<PAGE>
EXHIBIT 11
STATEMENT REGARDING COMPUTATION PER SHARE EARNINGS
Earnings per share has been computed as if the 1,825,050 shares issued on
March 29, 1996 had been outstanding for the full year.
<PAGE>
EXHIBIT 12
STATEMENT REGARDING COMPUTATION OF RATIOS
The averages used in computing the performance ratios provided in Item 6
represent average daily balances.
<PAGE>
EXHIBIT 13
1996 ANNUAL REPORT TO SECURITY HOLDERS
<PAGE>
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Six
Months Year
Ended Ended
Year Ended December 31, Dec. 31, June 30,
1996 1995 1994 1993 1992 1992
- ----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS:
Interest income $ 8,008 $ 6,602 $ 5,996 $ 5,680 $ 2,745 $ 5,399
Interest expense 3,610 3,607 2,862 2,730 1,401 3,118
-------- ------- ------- ------- ------- -------
Net interest income 4,398 2,995 3,134 2,950 1,344 2,281
Provision for loan losses 50 350 26 25 17 9
-------- ------- ------- ------- ------- -------
Net interest income after provision for loan losses 4,348 2,645 3,108 2,925 1,327 2,272
Other income 114 127 111 125 54 311
Other expenses (1) 2,123 1,605 1,495 1,202 528 1,052
-------- ------- ------- ------- ------- -------
Income before tax expense 2,339 1,167 1,724 1,848 853 1,531
Income tax expense 858 430 617 700 326 573
Cumulative effect of a change in accounting
principle (24)
-------- ------- ------- -------- ------- -------
Net income $ 1,481 $ 737 $ 1,107 $ 1,124 $ 527 $ 958
======== ======= ======= ======= ======= =======
SELECTED YEAR-END BALANCES:
Total assets $105,807 $87,751 $81,560 $75,826 $64,445 $61,913
Loans receivable, net 82,992 75,097 65,973 55,890 50,004 47,274
Investments (2) 16,889 8,884 12,693 17,022 11,906 12,258
Deposits 66,564 73,035 69,140 64,282 54,475 52,367
FHLB Advances - 1,000 - - - -
Stockholders' equity 37,368 12,562 11,729 10,719 9,595 9,068
AVERAGE BALANCE SHEET DATA:
Total assets $103,874 $83,921 $78,890 $70,256 $63,859 $58,856
Total earning assets 102,336 83,058 76,125 67,128 61,192 56,798
Loans receivable, net 78,797 70,397 61,301 52,288 49,030 46,145
Investments (2) 22,907 12,481 14,825 14,840 12,163 10,654
Deposits 68,684 70,541 66,713 59,301 53,877 49,739
FHLB Advances 83 167 - - - -
Stockholders' equity 33,115 12,283 11,317 10,219 9,379 8,589
SELECTED FINANCIAL RATIOS:
Return on average assets 1.43% .88% 1.40% 1.60% 1.65% 1.64%
Return on average equity 4.48% 6.00% 9.78% 11.00% 11.24% 11.06%
Average equity to average assets 31.88% 14.64% 14.34% 14.54% 14.69% 14.87%
Interest rate spread (tax equivalent basis) 2.62% 2.86% 3.59% 3.86% 3.77% 4.08%
Net interest margin (tax equivalent basis) 4.32% 3.62% 4.12% 4.39% 4.39% 4.09%
Dividend payout ratio 54.32 N/A N/A N/A N/A N/A
Cash dividends declared per common share $ 0.44 N/A N/A N/A N/A N/A
Earnings per share (3) $ 0.82 N/A N/A N/A N/A N/A
</TABLE>
- -------------
(1) Of the amounts in 1996, $456,000 resulted from a one time special assessment
imposed on Savings Association Insurance Fund (SAIF) insured institutions
to recapitalize the SAIF.
(2) Includes investment securities, mortgage backed-securities, interest-bearing
deposits, and federal funds
(3) Earnings per share were computed as if the 1,825,050 shares issued on March
29, 1996 had been outstanding on January 1, 1996.
1
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
Management's discussion and analysis is intended to assist readers in the
understanding and evaluation of the financial condition and results of
operations of Stone Street Bancorp, Inc. and Mocksville Savings Bank, Inc., SSB
(collectively referred to as the "Company"). It should be read in conjunction
with the audited consolidated financial statements and accompanying notes
included in this report and the supplemental financial data appearing throughout
this discussion and analysis.
ANALYSIS OF RESULTS OF OPERATIONS
The Company's results of operations depend primarily on net interest income,
which is the difference between interest income from interest-earning assets and
interest expense on interest-bearing liabilities. Operations are also affected
by non-interest income, such as income from customer service charges, loan fee
income and other sources of income. The Company's principal operating expenses,
aside from interest expense, consist of compensation and employee benefits,
federal deposit insurance premiums, data processing expenses, office occupancy
costs, equipment expense and income taxes.
The Company completed its first year as a public company with record earnings.
Net income increased to $1.5 million for the year ended December 31, 1996
compared to $.7 million in 1995 and $1.l million in 1994. Growth in net
interest income outpaced a decline in other income and an increase in other
expense to make 1996 the most profitable year in the Company's seventy-five year
history.
Income and Expense
------------------
Net interest income is the Company's primary source of earnings. Table 1
shows that tax-equivalent net interest income increased by $1.4 million or 46.8%
in 1996 to $4.4 million from $3.0 million in 1995. Tax equivalent net interest
income in 1995 was $136,000 or 4.3% lower than in 1994. Net interest income is
analyzed on a tax-equivalent basis to adjust for the nontaxable status of income
earned on certain investments such as municipal bonds.
The increase in tax-equivalent interest income in 1996 as compared to 1995 was
primarily the result of a $18.8 million or 22.7% increase in average earning
assets. Average loans increased by $8.4 million or 11.9% to $78.8 million.
Average investments increased by $10.4 million or 83.5% as stock conversion
proceeds were invested primarily in liquid interest bearing deposits in the FHLB
due to liquidity needs for funding loan growth. The weighted average yield on
interest-earning assets decreased by .10% in 1996, largely due to a reduction in
loan rates. In 1995, tax-equivalent interest income rose 10.2% primarily due to
increases in the average yield which increased by 9 basis points.
Interest expense increased by only $4,000 in 1996. Average interest-bearing
liabilities decreased by $1.8 million or 2.74% in 1996 while the average rate
paid on those liabilities increased by 14 basis points. As a result, the
increase in interest expense in 1996 was due primarily to increases in deposit
rates. In 1995, interest expense rose 26.0% due to increases in deposit rates
and the average balance.
Interest rate spread (on a tax equivalent basis) declined to 2.62% in 1996 from
2.86% in 1995 and 3.59% in 1994 as the increase in the cost of interest-bearing
liabilities outpaced the increase in the yield on interest-earning assets.
Despite the decline in interest rate spread, net interest margin (on a tax
equivalent basis) increased to 4.32% in 1996 from 3.62% in 1995, and 4.12% in
1994. While Conversion proceeds were invested at yields somewhat less than the
weighted average yield on total interest-earning assets, those investments
contributed to the increase in net interest margin.
Table 2 shows the effect of variances in volume and rate on taxable-equivalent
interest income, interest expense, and net interest income. The table shows
that increases in net interest income were primarily due to volume changes in
1996 while decreases in net interest income in 1995 were primarily due to rate
changes.
2
<PAGE>
TABLE 1: NET INTEREST INCOME ANALYSIS-TAX EQUIVALENT
- -----------------------------------------------------
<TABLE>
<CAPTION>
1996 1995 1994
--------------------------- -------------------------- -----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- -------- ------- ------- -------- ------- ------- ------- ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable (1) $ 78,797 $6,662 8.45% $70,397 $5,983 8.50% $61,301 $5,289 8.63%
Investment securities (2) 7,617 607 7.97% 8,646 383 4.43% 9,159 423 4.62%
Interest-bearing deposits 14,645 692 4.72% 3,273 198 6.04% 5,169 253 4.89%
FHLB common stock 645 47 7.29% 562 41 7.30% 496 31 6.16%
-------- ------ ------ ------- ------ ------ ------- ------ ------
Total interest-earning assets 101,704 8,008 7.87% 82,878 6,605 7.97% 76,125 5,996 7.88%
Non-interest-earning assets 2,170 1,043 2,765
-------- ------- -------
TOTAL $103,874 $83,921 $78,890
======== ======= =======
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts $ 68,684 3,604 5.24% $70,541 $3,607 5.11% $66,713 $2,862 4.29%
FHLB advances 83 7 8.43%
-------- ------ ------
Total interest-bearing liabilities 68,767 3,611 5.25% 70,541 3,607 5.11% 66,713 2,862 4.29%
Non-interest-bearing liabilities 1,992 1,097 860
Stockholders' equity 33,115 12,283 11,317
-------- ------- -------
TOTAL $103,874 $83,921 $78,890
======== ======= =======
Net interest income and interest rate
spread $4,397 2.62% $2,998 2.86% $3,134 3.59%
====== ====== ====== ====== ====== ======
Net interest-earning assets
and net interest margin $ 32,937 4.32% $12,337 3.62% $ 9,412 4.12%
======== ====== ======= ====== ======= ======
Ratio of interest-earning assets
to interest bearing liabilities 147.90% 117.49% 114.11%
====== ====== ======
</TABLE>
- -----------
(1) Includes nonaccrual loans
(2) Interest earned on tax-exempt investment securities has been adjusted to a
tax-equivalent basis using the applicable combined federal and state rates
of 34% and 7.75%, respectively, and reduced by the nondeductible portion of
interest expense.
TABLE 2: RATE/VOLUME ANALYSIS
- ------------------------------
<TABLE>
<CAPTION>
1996 vs 1995 1995 vs 1994
------------- ------------- ---------------- -----------------------------
Rate/ Rate/
Volume Rate Volume Net Volume Rate Volume Net
------------- ------------- ------- ------- ------- ------ ------- ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income (tax-equivalent) on:
Loans $ 714 (31) $ (4) $ 679 $785 $ (79) $(12) $ 694
Investment securities (45) 306 (37) 224 (24) (17) 1 (40)
Interest-bearing deposits 687 (43) (150) 494 (93) 59 (21) (55)
FHLB common stock 6 - - 6 2 7 1 10
------ ---- ----- ------ ---- ----- ---- -----
Total interest income 1,362 232 (191) 1,403 670 (30) (31) 609
------ ---- ----- ------ ---- ----- ---- -----
Deposit accounts (95) 92 - (3) 165 548 32 745
FHLB advances 7 - - 7 - - - -
------ ---- ----- ------ ---- ----- ---- -----
Total interest expense (88) 92 - 4 165 548 32 745
------ ---- ----- ------ ---- ----- ---- -----
Increase (decrease) in net interest income $1,450 $140 $(191) $1,399 $505 $(578) $(63) $(136)
====== ==== ===== ====== ==== ===== ==== =====
</TABLE>
3
<PAGE>
INCOME AND EXPENSES Continued
PROVISION FOR LOAN LOSSES
The provision for loan losses is charged to earnings to maintain the total
allowance for loan losses at a level considered adequate to cover loan losses
based on existing loan levels and types of loans outstanding, nonperforming
loans, prior loan loss experience, industry standards and general economic
conditions. Provisions for loan losses were $50,000 in 1996 compared to
$350,000 in 1995, and $26,000 in 1994. During 1995, the provision and resulting
allowance for loan losses were increased based on management's efforts to
reflect industry practices regarding the allowance for loan losses. During
1996, the provision was lowered, largely as a result of an improved level of the
relationship between the allowance and outstanding loans.
OTHER INCOME
Other income decreased from $127,000 in 1995 to $114,000 in 1996, and was
$111,000 in 1994. The reduction in other income was primarily in loan fees and
charges which decreased $8,000 in 1996 from the 1995 level. Other income in
1995 increased $16,000 over the 1994 amount. This increase was primarily in
loan fees and charges that totaled $53,000 in 1995 compared to $41,000 in 1994.
OTHER EXPENSES
Other expenses increased by 32.3% in 1996 compared to an increase of 7.4% in
1995. As a percent of average assets, other expense for 1996 was 2.0% as
compared to 1.9% in 1995 and 1.9% in 1994.
Compensation and fringe benefits, in 1996 representing over 47.72% of total
other expenses increased, by $56,000 or 5.9% over 1995. Compensation and fringe
benefits in 1995 increased $52,000 or 5.7% over 1994. Salaries decreased by
$41,800 in 1996 but increased by $28,000 in 1995 over 1994, while retirement
expense increased by $24,000 in 1996 but decreased by $21,000 in 1995.
Retirement expense in 1996 reflects the implementation of the Bank's Employee
Stock Ownership Plan ("ESOP") which provides a higher level of retirement
benefits to employees than the retirement plan which was in place in previous
years. Director's compensation increased by $21,500 in 1996 due to extra
meetings associated with the Conversion and employee benefit programs.
The Company plans to award 4% of the outstanding stock or approximately 73,002
shares upon stockholder approval under the Mocksville Saving's Bank, Inc., SSB
Management Recognition Plan ("MRP") which has been approved by the board of
directors. Management estimates that pre-tax expenses associated with the MRP
will total approximately $300,000 per year for a period of five years.
Occupancy and equipment expense decreased by $26,000 in 1996 while increasing by
$26,000 in 1995. Reasons for the increase in 1995 included investments in
technology primarily the installation of an ATM machine, and related costs.
Deposit insurance premiums increased $423,000 over the 1995 level due to the
special one time assessment by the FDIC in September, 1996. Deposit insurance
premiums totaled $158,000 in 1995 compared to $148,000 in 1994, a $10,000 or
6.8% increase. Professional fees increased by $5,000 in 1996 and $21,000 in
1995 as the Company obtained assistance in making the transition from mutual to
stock ownership.
Management continues to look for ways to improve cost efficiency while offering
new services to its customers.
INCOME TAX EXPENSE
Income tax expense increased 99.5% to $858,000 in 1996 from $430,000 in 1995.
The effective tax rate declined from 36.8% in 1995 to 36.7% in 1996, reflecting
a higher level of tax-exempt income in 1996. Income tax expense totaled
$617,000 in 1994, and the effective tax rate was 35.8%. Changes in income tax
expenses were caused primarily by changes in net income.
4
<PAGE>
ANALYSIS OF FINANCIAL CONDITION
-------------------------------
On March 29, 1996 Mocksville Savings Bank,, Inc., SSB (the "Bank") completed
its conversion from a mutual to a stock saving bank through the sale of
1,825,050 shares of no par common stock of Stone Street Bancorp, Inc. (the
"Parent"). Total proceeds of $27,375,750 were reduced by Conversion expenses of
$1,116,905. The Parent retained 50% of the net conversion proceeds after
deducting the proceeds of a loan to the Bank's Employee Stock Ownership Plan
("ESOP") and paid the balance to the Bank in exchange for the common stock of
the Bank issued in the Conversion. The increase in assets from $87.8 million at
December 31, 1995 to $105.8 million at December 31, 1996 is directly
attributable to proceeds of the Conversion which were invested in loans and
investment securities.
LOANS
The Company's primary source of revenue is interest and fee income from
lending activities, consisting primarily of one-to-four family residential
mortgage loans located in its primary market area. The Company also makes loans
secured by improved nonresidential real estate, construction loans, loans
secured by undeveloped real estate, home equity loans, and consumer loans, both
secured and unsecured.
At December 31, 1996, the net loan portfolio totaled $83.0 million and
represented 78% of total assets. During 1996, loans increased by $7.9 million
or 11%. Loan originations increased from $21.4 million in 1995 to $23.3 million
in 1996, largely in response to the Company's efforts to expand its loan
programs into adjacent counties. The relative composition of the Company's loan
portfolio has remained consistent during recent years, with residential one-to-
four family loans comprising approximately 82% of the portfolio as of December
31, 1996. Table 3 sets forth the composition of the loan portfolio at the dates
indicated.
<TABLE>
<CAPTION>
TABLE 3: TYPES OF LOANS
- --------------------------------------------------------------------------------
December 31,
---------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------- --------------- --------------- --------------- ---------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estates loans:
Residential 1-4 family $67,844 81.75% $63,329 84.33% $54,321 82.34% $45,724 81.81% $41,355 82.70%
Nonresidential real estate 5,716 6.88 4,260 5.67 4,987 7.56 5,312 9.50 5,059 10.12
Home equity and other
second mortgage 2,473 2.98 2,185 2.91 1,423 2.16 1,447 2.59 1,492 2.98
Construction 12,492 15.05 11,735 15.63 11,589 17.56 8,033 14.37 6,433 12.87
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate loans 88,525 106.66 81,509 108.54 72,320 109.62 60,516 108.27 54,339 108.67
Other installment loans 372 .45 222 .30 197 0.30 133 0.24 201 0.40
Less:
Unearned fees 1,009 1.22 962 1.29 1,095 1.66 711 1.27 577 1.15
Loans in process 4,385 5.28 5,211 6.94 5,334 8.09 3,959 7.08 3,894 7.79
Allowance for loan losses 511 .61 462 .61 115 0.17 89 0.16 65 .13
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total reductions 5,905 7.11 6,635 8.84 6,544 9.92 4,759 8.51 4,536 9.07
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans, net $82,992 100.00% $75,096 100.00% $65,973 100.00% $55,890 100.00% $50,004 100.00%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
- --------------------------------------------------------------------------------
</TABLE>
In order to protect the Company's net interest margin, management has, as part
of its interest rate risk management program, placed an emphasis on increasing
adjustable rate mortgage loans and home equity lines of credit in its portfolio.
This strategy will result in more consistent net interest income and lower
interest sensitivity than experienced by traditional fixed-rate residential
mortgage lending.
The following table sets forth the time to repricing or contractual maturity of
the Company's loan portfolio at December 31, 1996. Loans which have adjustable
rates are shown as being due in the period during which rates are next subject
to change while fixed rate and other loans are shown as due in the period of
contractual maturity. Demand loans, loans having no stated maturity and
overdrafts are reported as due in one year or less. The table does not include
prepayments or scheduled principle repayments. Amounts in the table are net of
loans in process.
5
<PAGE>
TABLE 4: LOAN MATURITIES
- -------------------------
<TABLE>
<CAPTION>
December 31, 1996
-------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or Less 3 Years 5 Years 10 Years Years Total
------- ------- -------- -------- -------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Fixed rate 1-4 family $ 6,260 $479 $1,356 $21,647 $36,465 $66,207
Adjustable rate 1-4 family 629 629
Adjustable home equity 2,191 2,191
Other fixed rate loans 2,158 48 841 815 10,243 14,105
Other loans 45 55 115 137 20 372
Less:
Allowance for loan losses (511) (511)
------- -------
Total Loans $10,772 $582 $2,312 $22,599 $46,728 $82,993
======= ==== ====== ======= ======= =======
- --------------------------------------------------------------------------------
</TABLE>
ASSET QUALITY AND ALLOWANCE FOR LOAN LOSSES
The following table sets forth information with respect to nonperforming assets
including nonaccrual loans and real estate owned at the dates indicated.
TABLE 5: SUMMARY OF NONPERFORMING AND PROBLEM ASSETS
- -----------------------------------------------------
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------
1996 1995 1994 1993 1992
--------- -------- -------- -------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total nonaccrual loans $ - $ - $ - $ - $ 53
Total restructured loans - - - - -
-------- ------- ------- ------- -------
Total nonperforming loans - - - - 53
-------- ------- ------- ------- -------
Real estate owned - - - - -
In-substance foreclosures - - - - -
-------- ------- ------- ------- -------
Total foreclosed property - - - - -
-------- ------- ------- ------- -------
Total nonperforming assets $ - $ - $ - $ - $ 53
======== ======= ======= ======= =======
Accruing loans, delinquent 90 days or more $ 423 $ 201 $ 280 $ 292 $ 437
======== ======= ======= ======= =======
Nonperforming loans to total loans 0.00% 0.00% 0.00% 0.00% 0.11%
Nonperforming assets to total assets 0.00% 0.00% 0.00% 0.00% 0.08%
Total assets $105,807 $87,751 $81,560 $75,826 $64,445
Total loans, net $ 82,992 $75,097 $65,973 $55,890 $50,004
</TABLE>
6
<PAGE>
- -------------------------------------------------------------------------------
The allowance for loan losses represents management's estimate of an amount
adequate to provide for potential losses inherent in the loan portfolio. The
adequacy of the allowance for loan losses and the related provision are based
upon management's evaluation of the risk characteristics of the loan portfolio
under current economic conditions with consideration to such factors as
financial condition of the borrowers, collateral values, growth and composition
of the loan portfolio, the relationship of the allowance for loan losses to
outstanding loans, and delinquency trends. Management believes that the
allowance for loan losses is adequate. While management uses all available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. Various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's allowance for loan losses. Such agencies may require the Company
to recognize additions to the allowance based on their judgments about
information available to them at the time of their examination.
The provision for loan losses is calculated and charged to earnings to maintain
the total allowance for loan losses at a level considered adequate to cover loan
losses based on existing loan levels, types of loans outstanding, nonperforming
loans, prior loan loss experience, industry standards and general economic
conditions. Provisions for loan losses were $50,000 in 1996 compared to
$350,000 in 1995, and $26,000 in 1994. During 1995, the provision and resulting
allowance for loan losses were increased based on management's efforts to
reflect industry practices regarding the allowance for loan losses. During
1996, the provision was lowered, largely as a result of an improved level of the
relationship between the allowance and outstanding loans.
The following tables describe the activity related to the allowance for loan
losses and the allocation of the allowance for loan losses to various categories
of loans for the periods indicated.
TABLE 6: ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
- ---------------------------------------------------
<TABLE>
<CAPTION>
Six Months Year Ended
Ended Ended
December 31, June 30,
1996 1995 1994 1993 1992 1992
---- ---- ---- ---- ------------ --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance, beginning of period $ 462 $ 115 $ 89 $ 65 $ 48 $ 38
Provision for loan losses 50 350 26 25 17 10
Charge-offs 1 3 - 1 - -
Recoveries - - - - - -
----- ----- ----- ----- ----- -----
Balance, end of period $ 511 $ 462 $ 115 $ 89 $ 65 $ 48
===== ===== ===== ===== ===== =====
Allowance as a percentage of loans .62% .62% .17% .16% .13% .10%
</TABLE>
7
<PAGE>
TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
- -----------------------------------------------------
<TABLE>
<CAPTION>
December 31,
---------------------------------
1996 1995 1994 1993 1992
----- ----- ----- ----- -----
(in thousands)
<S> <C> <C> <C> <C> <C>
Residential 1-4 family $ 138 $ 127 $ 45 $ 35 $ 26
Nonresidential real estate 153 138 23 19 15
Home equity and other second mortgage 52 46 12 10 7
Construction 128 115 24 16 11
----- ----- ----- ----- -----
Total real estate loans 471 426 104 80 59
Other loans 40 36 11 9 6
----- ----- ----- ----- -----
Total allowance for loan losses $ 511 $ 462 $ 115 $ 89 $ 65
===== ===== ===== ===== =====
</TABLE>
The allocation of the allowance for loan losses to the respective loan
classifications is not necessarily indicative of future losses or future
allocations. Refer to Table 3 for percentages of loans in each category to
total loans.
INVESTMENT SECURITIES
Interest and dividend income from interest bearing deposits and investment
securities generally provides the second largest source of income to the Company
after interest on loans. The Company's interest bearing deposits primarily
include deposits with the FHLB of Atlanta and federal funds while its portfolio
of investment securities includes U.S. government and agency securities,
mortgage-backed securities, obligations of states and local governments and
mutual funds. The mortgage-backed securities consist of collateralized mortgage
obligations issued by the GNMA and FHLMC which are secured by mortgage-backed
securities guaranteed by the GNMA or FHLMC.
Interest bearing deposits totaled $7.9 at December 31, 1996, an increase of $5.2
million over 1995. The Company also had $570,000 of federal funds sold at
December 31, 1996.
Investment securities totaled $10.5 million at December 31, 1996, an increase of
$4.9 million from $5.6 million at December 31, 1995. This growth is
attributable to management placing in investment securities the net Conversion
proceeds over and above the amounts needed to fund anticipated loan demand which
was placed in federal funds and interest bearing deposits. At December 31,
1996, net unrealized losses of $7,600 were included in the carrying value of
securities classified available-for-sale compared to net unrealized gains of
$3,000 on such securities at December 31, 1995. Net unrealized losses were
caused by fluctuations in market interest rates rather than by concerns about
the issuer's ability to meet their obligations.
Table 8 shows maturities of investment securities held by the Company at
December 31, 1996 and the weighted average tax-equivalent yields for each type
of security and maturity. Further information about the Company's investment
securities as of December 31, 1996 and 1995 is presented in Note 2 of the notes
to the consolidated financial statements.
8
<PAGE>
TABLE 8: INVESTMENT SECURITIES - MATURITY/YIELD SCHEDULE
- ---------------------------------------------------------
<TABLE>
<CAPTION>
More Than More Than
One Year or Less 1 Year to 5 Years 5 Years to 10 Years Over 10 Years Total
------------------ ------------------ ------------------- ------------------ -----------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- --------- -------- --------- -------- --------- -------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Held-to-Maturity:
U.S. government and agency $2,009 6.54% $2,744 5.59% $ - -% $ - - % $ 4,753 5.99%
Mortgage-backed
securities (1) - - - - - - $2,983 - 2,983 7.03
------ ---- ------ ---- -------- -------- -------- -------- ------- ----
Total held-to-maturity $2,009 6.54% $2,744 5.59% $ - -% $2,983 - % $ 7,736 6.39%
------ ---- ------ ---- -------- -------- -------- -------- ------- ----
Available-for-sale:
State and local
government (1) $ 164 5.90 $1,088 6.38 $759 6.16 $ - - $ 2,011 6.26
Mutual funds 712 5.87 712 5.87
------ ---- ------- ----
Total available-for-sale $ 876 5.88 1,088 6.38 759 6.16 - - 2,723 6.16
------ ---- ------ ---- -------- -------- -------- -------- ------- ----
Total investments
at carrying value $2,885 6.34% $3,832 5.81% $759 6.16% $2,983 7.03% $10,459 6.33%
====== ==== ====== ==== ======== ======== ======== ======== ======= ====
</TABLE>
(1) Mortgage-backed securities are shown at their weighted average expected
life obtained from an outside evaluation of the average remaining life of each
security based on historic prepayment speeds of the underlying mortgages at
December 31, 1996.
(2) Yields are stated on taxable equivalent basis assuming statutory tax rates
of 34% for federal and 7.75% for state purposes. Book yields without regard to
tax-equivalent adjustments are: one year or less, 3.60%; two to five years,
4.29%; six to ten years, 4.60%; total, 4.35%
In addition to the investment securities discussed above, the Company also earns
interest on its correspondent bank account at the Federal Home Loan Bank
("FHLB") of Atlanta and dividends on its FHLB stock. The Bank is required to
maintain, as a condition of membership, an investment in stock of the FHLB of
Atlanta equal to the greater of 1% of outstanding home loans or 5% of its
outstanding advances. No ready market exists for such stock, which is carried
at cost. As of December 31, 1996, the Company's investment in stock of the FHLB
of Atlanta was $667,000.
FUNDING SOURCES
Deposits are the primary source of the Company's funds for lending and other
investment purposes. The Company attracts both short-term and long-term
deposits from the general public by offering a variety of accounts with varying
maturities. Deposit inflows and outflows are significantly influenced by
general interest rates and other market conditions, primarily competition. As
competition for deposits has increased both from larger financial institutions
in its local market place and from mutual funds and other investments,
borrowings have provided an additional source of funding. The use of borrowed
funds to provide liquidity assists the Company in matching the interest rates on
its assets and liabilities because the interest rates on most borrowed funds are
fixed and therefore more predictable than the costs of deposits which are
subject to change based upon market conditions and other factors.
DEPOSITS
Deposits totaled $66.6 million at December 31, 1996, compared to $73.0
million at December 31, 1995. The decrease reflects approximately $6.8 million
of deposits which customers used to purchase the Parent's stock in the
Conversion. The following table sets forth certain information regarding the
Company's average savings deposits for the last three years.
9
<PAGE>
<TABLE>
<CAPTION>
TABLE 9: AVERAGE DEPOSITS
- -----------------------------------------------
1996 1995 1994
----------------- ----------------- -----------------
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate
------- ------- ------- ------- ------ -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
NOW and money market deposit account $ 3,996 1.80% $ 4,521 1.81% $ 4,849 1.98%
Savings account 9,270 3.51 9,525 3.02 14,314 3.25
Certificates of deposit 55,418 5.84 56,495 5.73 47,550 4.84
------- ---- ------- ---- ------- ----
Total deposits $68,684 5.24% $70,541 5.11% $66,713 4.29%
======= ==== ======= ==== ======= ====
</TABLE>
As of December 31, 1996, the Company had outstanding $5,145,000 in time
certificates of deposit of $100,000 or more. Maturities of certificates of
deposits of $100,000 or more at December 31, 1996 were as follows: three months
or less, $1,989,000, over three months through six months, $1,264,000, over six
months through twelve months $1,032,000: and over twelve months through twenty-
four months, $860,000.
BORROWINGS
The Company's principal source of long-term borrowings are advances from the
FHLB of Atlanta. As a requirement for membership, the Bank is required to own
capital stock in the FHLB of Atlanta and is authorized to apply for advances on
the security of that stock and a floating lien on its family residential
mortgage loans. Each credit program has its own interest rate and range of
maturities. At December 31, 1996, the Company had no outstanding FHLB advances,
compared to $1 million at December 31, 1995. Additional information on
borrowings is provided in Note 6 of the notes to the consolidated financial
statements.
LIQUIDITY AND INTEREST RATE RISK MANAGEMENT
------------------------------------------
Liquidity is the ability to raise funds or convert assets to cash in order to
meet customer and operating needs. The Company's primary sources of liquidity
are its portfolio of investment securities available-for-sale, principal and
interest payments on loans and mortgage-backed securities, interest income from
investment securities, maturities of investment securities held-to-maturity,
increases in deposits, and advances from the FHLB of Atlanta. At December 31,
1996, the Bank had $12 million of credit available from the FHLB which would be
collateralized by a blanket lien on qualifying loans secured by first mortgages
on family residences. Additional amounts may be made available under this
blanket floating lien or by using investment securities as collateral.
Management believes that it will have sufficient funds available to meet its
anticipated future loan commitments as well as other liquidity needs.
Interest rate risk is the sensitivity of interest income and interest expense to
changes in interest rates. Management continues to structure its assets and
liabilities in an attempt to protect net interest income from large fluctuations
associated with changes in interest rates. Table 10 shows the amount of
interest-earning assets and interest-bearing liabilities outstanding at December
31, 1996 which are projected to reprice or mature in each of the future time
periods shown. At December 31, 1996, the Company had a negative cumulative one
year asset-sensitive gap position of $14.9 million or 14.28% of interest-earning
assets. This generally indicates that net interest income would decrease in a
rising rate environment and would experience upward trend in a declining rate
environment.
A static interest rate "gap" analysis may not be an accurate indicator of how
net interest income will react to changes in interest rates. A static gap
computation uses contractual maturities and does not make assumptions for
prepayments, scheduled loan principal payments or deposit decays. Income
associated with interest-earning assets and costs associated with interest-
bearing liabilities may not react uniformly to changes in interest rates. In
addition, the magnitude and duration of changes in interest rates may have a
significant impact on net interest income. For example, although certain assets
and liabilities may have similar maturities or periods to repricing, they may
react in different degrees to changes in market interest rates. Interest rates
on certain types of assets and liabilities typically fluctuate in advance of
changes in general market interest rates, while interest rates on other types
may lag behind changes in general market rates.
10
<PAGE>
It should be noted that this table reflects the interest-sensitivity of the
balance sheet as of a specific date and is not necessarily indicative of future
results. The computations were made without using assumptions for loan
repayments or deposit delays. Except as stated below, the amounts of assets and
liabilities shown which reprice or mature within a given period were determined
in accordance with contractual terms of the assets or liabilities. In making
the computations, all adjustable rate loans were considered to be due at the end
of the next upcoming adjustment period. Fixed rate loans were considered to
reprice at their contractual maturities with no consideration given to
prepayments or scheduled payments. Liquid interest-earning investments with no
contractual maturities are assumed to be subject to immediate repricing.
Statement savings and money market accounts are subject to immediate
availability and repricing and have been placed in the earliest gap category.
In addition, fixed maturity deposits were assumed to reprice at their
contractual maturities without consideration for early withdrawals. The
interest rate sensitivity of the Company's assets and liabilities illustrated in
the following table would vary substantially if different assumptions were used
or if actual experience differs from that indicated by such assumptions.
Because of these and other limitations, management also monitors interest rate
sensitivity through the use of a model which estimates the change in net
portfolio value and net interest income in response to a range of assumed
changes in market interest rates. Based on interest sensitivity measures as of
December 31, 1996, management realizes its need to improve the Company's
interest rate exposure and has developed strategies to address this issue.
TABLE 10: INTEREST SENSITIVITY
- -------------------------------
<TABLE>
<CAPTION>
December 31, 1996
-----------------------------------------------------------------------------------
More than More than
3 Months 4 to 12 1 Year to 3 Years to Over Over
Or Less Months 3 Years 5 Years 5 Years 10 years Total
---------- ---------- ----------- ------------ ---------- --------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest earning assets
Mortgage loans:
Fixed rate residential 1-4 family $ - $ 6,260 $ 479 $ 1,355 $ 21,647 $36,465 $ 66,206
Adjustable rate residential 1-4 family - 629 - - - - 629
Adjustable home equity 2,191 - - - - - 2,191
Other fixed rate loans - 2,158 48 841 815 10,243 14,105
-------- -------- -------- -------- -------- ------- --------
Total mortgage loans 2,191 9,047 527 2,196 22,462 46,708 83,131
Other loans 45 55 115 137 20 372
-------- -------- -------- -------- ------- --------
Total loans 2,191 9,092 582 2,311 22,599 46,728 83,503
Interest-bearing deposits(2) 8,486 8,486
Investment securities (1) - 2,885 - 3,832 759 2,983 10,459
FHLB common stock 667 - - - - - 667
-------- -------- -------- -------- -------- ------- --------
Total interest-earning assets $ 11,344 $ 11,977 $ 582 $ 6,143 $ 23,358 $49,711 $103,115
-------- -------- -------- -------- -------- ------- --------
Interest-bearing liabilities
Deposits:
Fixed maturity deposits $ 13,424 $ 27,726 $ 12,621 $ - $ - $ - $ 53,771
NOW accounts money market accounts 3,932 - - - - - 3,932
Savings accounts 8,861 - - - - - 8,861
-------- -------- -------- -------- -------- ------- --------
Total deposits 26,217 27,726 12,621 - - - 66,564
-------- -------- -------- -------- -------- ------- --------
Total interest-bearing liabilities $ 26,217 $ 27,726 $ 12,621 $ - $ - $ - $ 66,564
-------- -------- -------- -------- -------- ------- --------
Interest sensitivity gap per period $(14,873) $(15,749) $(12,039) $ 6,143 $ 23,358 $49,711 $ 36,551
Cumulative interest-sensitivity gap $(14,873) $(30,622) $(42,661) $(36,518) $(13,160) $36,551 $ 36,551
Cumulative gap as a percentage of
total interest-earning assets (14.42%) (29.70%) (41.37%) (35.41%) (12.67%) 35.45% 35.45%
Cumulative interest-earning assets as a
percentage of interest-bearing liabiliti 43.27% 43.23% 35.91% 45.14% 80.23% 154.91% 154.91%
</TABLE>
(1) Includes investments and mortgage-backed securities
(2) Includes interest-bearing deposits and federal funds
11
<PAGE>
CAPITAL RESOURCES
-----------------
Stockholders' equity increased from $12.6 million at December 31, 1995 to
$37.4 million at December 31, 1996, largely as a result of the Conversion.
As a state savings bank holding company, the Parent is regulated by the Board of
Governors of the Federal Reserve Board ("FRB") and is subject to securities
registration and public reporting regulations of the Securities and Exchange
Commission. The Bank is regulated by the Federal Deposit Insurance Corporation
("FDIC)" and the Savings Institutions Division, North Carolina Department of
Commerce ("the Administrator").
The Bank must comply with the capital requirements of the FDIC and the
Administrator. The FDIC requires the Bank to maintain minimum ratios of Tier I
capital to total risk-weighted assets and total capital to risk-weighted assets
of 4% and 8%, respectively. Tier I capital consists of total stockholders'
equity calculated in accordance with generally accepted accounting principles
less intangible assets, and total capital is comprised of Tier 1 capital plus
certain adjustments, the only one of which applicable to the Bank is the
allowance for loan losses. Risk weighted assets reflect the Bank's on-and off-
balance sheet exposures after such exposures have been adjusted for their
relative risk levels using formulas set forth in FDIC regulations. The Bank is
also subject to a leverage capital requirement, which calls for a minimum ratio
of Tier I capital (as defined above) to quarterly average total assets of 3% to
5%, depending on the institution's composite ratings as determined by its
regulators. The Administrator requires a net worth equal to at least 5% of
assets.
At December 31, 1996 and 1995, the Bank was in compliance with all of the
aforementioned capital requirements as summarized in Table 11. Refer note 7 to
the consolidated financial statements for a discussion of other matters that may
affect the Company's capital resources.
<TABLE>
<CAPTION>
TABLE 11: REGULATORY CAPITAL
- ------------------------------------------------------------------------
At December 31,
-----------------------
1996 1995
---------- ----------
(dollars in thousands)
<S> <C> <C>
Risk-Based and Leverage Capital
Tier I capital:
Common stockholders' equity $ 24,967 $ 12,563
Unrealized holding loss (gain) on securities available-for-sale (7) (1)
---------- ----------
Total Tier I leverage capital 24,960 12,562
Tier II Capital:
Qualifying allowances for loan losses
Tier II capital additions 511 462
---------- ----------
Total risk-based capital $ 25,471 $ 13,024
Risk-weighted assets 48,072 41,214
Fourth quarter average assets 96,363 86,864
Risk-based capital ratios:
Tier-I capital as a percent of risk-weighted assets 51.92% 30.48%
Minimum Required Tier I capital 4.00% 4.00%
Total risk-based capital as a percent of risk-weighted assets 52.99% 31.60%
Minimum required total risk-based capital 8.00% 8.00%
Leverage capital ratios:
Tier I leverage capital as a percent of fourth quarter average assets 25.90% 14.46%
Minimum required Tier I leverage capital 3.00-5.00% 3.00-5.00%
North Carolina regulatory capital:
Total risk-based capital as a percent of fourth quarter average assets 26.43% 14.99%
Minimum required North Carolina capital 5.00% 5.00%
</TABLE>
12
<PAGE>
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and accompanying footnotes have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without consideration for changes in the relative purchasing
power of money over time due to inflation. The assets and liabilities of the
Company are primarily monetary in nature, and changes in interest rates have a
greater impact on the Company's performance than do the effects of inflation.
Accounting Issues
-----------------
The Company prepares its consolidated financial statements and related
disclosures in conformity with standards established by, among others, the
Financial Accounting Standards Board (the "FASB"). Because the information
needed by users of financial reports is dynamic, the FASB frequently has new
rules and proposed new rules for companies to apply in reporting their
activities. The following discussion addresses such changes as of December 31,
1996 that will affect the Company's future reporting.
The FASB has issued Statement of Financial Accounting Standards ("SFAS") No 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." SFAS 121 requires that long-lived assets and certain
identifiable intangibles to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. In evaluating
recoverability, if estimated future cash flows, undiscounted and without
interest charges, are less than the carrying amount of the asset, an impairment
loss is recognized. SFAS 121 also requires that certain long-lived assets and
certain identifiable intangibles to be disposed of be reported at the lower of
carrying amount or fair value less cost to sell. SFAS 121 applies prospectively
for fiscal years beginning after December 15, 1995. The adoption of this
accounting standard did not affect the financial statements for 1996.
The FASB has also issued SFAS NO. 122, "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65," which provides guidance for the
capitalization of originated as well as purchased mortgage servicing rights and
the measurement of impairment of those rights. SFAS 122 requires that an entity
recognize as separate assets the rights to service mortgage loans for others,
however those servicing rights are acquired. SFAS 122 also requires that an
entity assess its capitalized mortgage servicing rights for impairment based on
the fair value of those rights. It should satisfy its mortgage servicing rights
based on one or more predominant risk characteristics of the underlying loans,
and recognize impairment through a valuation allowance for each impaired
stratum. SFAS 122 applies prospectively for fiscal years beginning after
December 15, 1995. The adoption of this accounting standard did not affect the
financial statements in 1996
In October, 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation". The Statement defines a fair value method of accounting for an
employee stock option or similar equity instrument and encourages all entities
to adopt that method of accounting for all of their employee stock compensation
plans. It also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed in
Accounting Principles Board Opinion Number 25 ("APB No. 25") "Accounting for
Stock Issued to Employees". SFAS No. 123 requires that an employers' financial
statements include certain disclosures about stock-based compensation
arrangements regardless of the method used to account for them. Entities
electing to remain with the accounting in APB No. 25 must make pro forma
disclosures of net income and, if presented, earnings per share, as if the fair
value based method of accounting defined in SFAS No. 123 had been applied. The
disclosure requirements of the statement are effective for financial statements
for fiscal years beginning after December 15, 1995, or for an earlier fiscal
year for which this statement is initially adopted for recognizing compensation
cost. Pro forma disclosures required for entities that elect to continue to
measure compensation cost using APB No. 25 must include the effects of all
awards granted in fiscal years that begin after December 15, 1994. The adoption
of this accounting standard did not affect the financial statements in 1996.
13
<PAGE>
- --------------------------------------------------------------------------------
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" was issued in June 1996. This statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control. It
distinguishes transfers of financial assets that are sales from transfers that
are secured borrowings. Under the financial-components approach, after a
transfer of financial assets, an entity recognizes all financial and servicing
assets it controls and liabilities it has incurred and derecognizes financial
assets it no longer controls and liabilities that have been extinguished. The
financial-components approach focuses on the assets and liabilities that exist
after the transfer. If a transfer does not meet the criteria for a sale, the
transfer is accounted for as a secured borrowing with pledge of collateral.
This statement is effective for transfer and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, and is to be
applied prospectively. Management anticipates that the adoption of the
statement should have no material impact on its consolidated financial
statements.
14
<PAGE>
INDEPENDENT AUDITORS' REPORT
----------------------------
The Board of Directors and Stockholders
Stone Street Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Stone Street
Bancorp, Inc. and subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the years in the three-year period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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 Stone Street
Bancorp, Inc. and subsidiary as of December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the years in the three year
period ended December 31, 1996, in conformity with generally accepted accounting
principles.
As discussed in notes 2 and 8, respectively, to the consolidated financial
statements, on July 1, 1993, the Company adopted the provisions of the Financial
Accounting Standards Board's Statement of Financial Accounting Standards No 115,
"Accounting for Certain Investments in Debt and Equity Securities," and the
provisions of the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes".
/s/ Weir Smith Jones Miller & Elliott
Weir Smith Jones Miller & Elliott
Statesville, North Carolina
January 31, 1997
15
<PAGE>
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31, 1996 and 1995
<TABLE>
<CAPTION>
Notes 1996 1995
----- --------- --------
(in thousands)
<S> <C> <C> <C>
ASSETS
Cash $ 1,319 $ 2,162
Federal funds sold 570
Interest-bearing deposits in other financial institutions 7,916 2,737
Investment securities 2
Held-to-maturity (Market value: $7,780 in 1996
and $3,290 in 1995) 7,736 3,269
Available-for-sale (Cost: $2,731 in 1996
and $2,299 in 1995) 2,723 2,302
Loans receivable (net of allowance for loan losses of
$511 in 1996 and $462 in 1995) 3 82,992 75,096
Federal Home Loan Bank stock at cost 667 576
Premises and equipment 4 900 949
Accrued interest receivable 310 104
Deferred income tax 376 334
Refundable income tax 77 21
Prepaid expenses and other assets 8 93 137
Cash surrender value of life insurance 128 64
-------- -------
Total assets $105,807 $87,751
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits: 5
Savings accounts 8,861 9,309
NOW and MMDA 3,932 4,348
Other certificates of deposit 48,626 54,344
Certificates of deposit, $100,000 and over 5,145 5,034
-------- -------
Total deposits 66,564 73,035
Advances from the Federal Home Loan Bank 6 1,000
Amounts payable under remittance service agreement 636 595
Accrued interest payable 170 147
Accrued expenses and other liabilities 667 412
Accrued cash dividends payable 402
--------
Total liabilities 68,439 75,189
-------- -------
Stockholders' Equity:
Common stock, no par value 20,000,000 shares authorized:
1,825,050 shares issued and outstanding 1 26,333
Note receivable from ESOP for purchase of common stock (2,198)
Retained earnings, substantially restricted 7,8 13,241 12,563
Unrealized holding gains (losses) on available-for-sale securities, net (8) (1)
-------- -------
Total stockholders' equity 37,368 12,562
-------- -------
Commitments and contingencies 3,9
Total liabilities and stockholders' equity $105,807 $87,751
======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
16
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS OF INCOME
-------------------------------------------
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
Notes 1996 1995 1994
----- ------ ------ ------
(in thousands)
<S> <C> <C> <C> <C>
Interest income:
Interest on loans $6,662 $5,980 $5,289
Interest on deposits in other financial institutions 692 198 312
Interest and dividends on investment securities:
Taxable 563 336 302
Non-taxable 91 88 93
------ ------ ------
Total interest income 8,008 6,602 5,996
------ ------ ------
Interest expense:
Interest on deposits 5 3,604 3,607 2,862
Interest on borrowings 6
------ ------ ------
Total interest expense 3,610 3,607 2,862
------ ------ ------
Net interest income 4,398 2,995 3,134
Provision for loan losses 3 50 350 26
------ ------ ------
Net interest income after provision for loan losses 4,348 2,645 3,108
------ ------ ------
Other income:
Loan fees and charges 45 53 41
Customer service and other fees 56 57 54
Other 13 17 16
------ ------ ------
Total other income 114 127 111
------ ------ ------
Other expenses:
Compensation and related benefits 1,013 957 805
Deposit insurance premiums 581 158 148
Occupancy and equipment expense 216 242 216
Professional fees 36 31 10
Other 277 217 316
------ ------ ------
Total other expenses 2,123 1,605 1,495
------ ------ ------
Income before income tax expense 2,339 1,167 1,724
Income tax expense 8 858 430 617
------ ------ ------
Net income $1,481 $ 737 $1,107
====== ====== ======
Net income per share 1 $0.82 N/A N/A
====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
17
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
For the Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
Note Unrealized Total
Shares Common Receivable Retained Holding Stockholders'
Outstanding Stock ESOP Earnings Gains/Losses Equity
----------- ------- ----------- --------- ------------- --------------
(in thousands, except shares outstanding)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 - $ - $ - $10,719 $ - $10,719
Net income - - - 1,107 - 1,107
Change in unrealized holding
gains (losses), net of
income taxes of $25 - - - - (97) (97)
----------- ------- ---------- ------- ------------ -------
Balance at December 31, 1994 - - - 11,826 (97) 11,729
Net income - - - 737 - 737
Change in unrealized holding
gains (losses), net of income
taxes of $24 - - - - 96 96
----------- ------- ---------- ------- ------------ -------
Balance at December 31, 1995 - - - 12,563 (1) 12,562
Net income - - - 1,481 - 1,481
Net proceeds from issuance of
no par common stock 1,825,050 26,333 - - - 26,333
Common stock acquired by
ESOP - - (2,198) - - (2,198)
Cash dividends declared
($.44 per share) - - - (803) - (803)
Change in unrealized holding
gains (losses),net of income
taxes of $3 - - - - (7) (7)
----------- ------- ---------- ------- ------------ -------
Balance at December 31, 1996 1,825,050 $26,333 $(2,198) $13,241 $ (8) $37,368
=========== ======= ========== ======= ============ =======
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
-------- ------- --------
(in thousands)
<S> <C> <C> <C>
Operating activities:
Net income $ 1,481 $ 737 $ 1,107
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 96 85 88
Provision for loan losses 350 26
Deferred income taxes (42) (66) (102)
Decrease (increase) in accrued interest receivable (206) 28 (44)
Increase in cash surrender value of life insurance (64) (64)
Decrease (increase) in refundable income taxes (56) 40 (55)
Increase (decrease) in amounts payable under remittance
service agreement 41 296 (290)
(Increase) decrease in other assets 44 (90) (17)
Increase (decrease) in accrued interest payable 23 25 34
Accrued cash dividends payable 402
Increase (decrease) in other liabilities 281 143 122
-------- ------- --------
Net cash provided by operating activities 2,000 1,484 869
-------- ------- --------
Investing activities:
Net increase in loans held for investment (7,946) (9,474) (12,130)
Principal collected on mortgage-backed securities 108
Purchase of investment securities classified as available-for-sale (860) (630)
Purchase of investment securities classified as held-to-maturity (2,760) (500)
Purchase of mortgage-backed securities classified as held-to-maturity (2,298)
Proceeds from maturities of investment securities classified
as available-for-sale 439
Proceeds from maturities of investment securities held-to-maturity 500 3,280 1,700
Purchase of FHLB Stock (91) (79)
Purchase of premises and equipment (47) (92) (35)
-------- ------- --------
Net cash used by investing activities (12,955) (6,865) (11,095)
-------- ------- --------
Financing activities:
Net increase (decrease) in deposits (6,471) 3,895 4,858
Proceeds from borrowings 1,000
Repayments of borrowings (1,000)
Proceeds from issuance of no par common stock 26,333
Loan to ESOP for the purchase of common stock (2,198)
Cash dividends paid to shareholders (803)
--------
Net cash provided by financing activities 15,861 4,895 4,858
-------- ------- --------
Increase (decrease) in cash and cash equivalents 4,906 (486) (5,368)
Cash and cash equivalents at beginning of period 4,899 5,385 10,753
-------- ------- --------
Cash and cash equivalents at end of period $ 9,805 $ 4,899 $ 5,385
======== ======= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 3,587 $ 3,581 $ 2,828
======== ======= ========
Income taxes $ 914 $ 390 $ 737
======== ======= ========
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on available-for-sale securities, net of deferred
taxes (benefit) of $3 for 1996, $24 for 1995 and $25 for 1994 $ 8 $ 95 $ (97)
======== ======= ========
Dividends declared but unpaid $ 402 $ - $ -
======== ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(1) Significant Accounting Policies
-------------------------------
Organization and Operations
---------------------------
In March 29, 1996, pursuant to a Plan of Conversion approved by its members
and regulators, Mocksville Savings Bank, Inc., SSB (the "Bank") amended and
restated its charter to effect its conversion from a North Carolina chartered
mutual savings bank to a North Carolina chartered stock savings bank (the
"Conversion"), and became a wholly-owned subsidiary of Stone Street Bancorp,
Inc. (the "Parent"), a holding company formed in connection with the
Conversion. The Bank is primarily engaged in the business of obtaining
savings deposits and providing loans to the general public. The principal
activity of the Parent is ownership of the Bank.
Basis of Presentation
---------------------
The consolidated financial statements include the accounts of the Parent and
the Bank, together referred to as "the Company". All significant
intercompany transactions and balances are eliminated in consolidation. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the balance sheets and
the reported amounts of income and expenses for the periods presented.
Actual results could differ significantly from those estimates. Material
estimates that are particularly susceptible to significant changes in the
near-term relate to the determination of the allowance for loan losses.
Investment and Mortgage-Backed Securities
-----------------------------------------
Management determines the appropriate classification of investment and
mortgage-backed securities at the time of purchase and reevaluates such
designation at each reporting date. Securities are classified as held-to-
maturity when the Company has both the positive intent and ability to hold
the securities to maturity. Held-to-maturity securities are stated at
amortized cost. Securities not classified as held-to-maturity are classified
as available-for-sale. Available-for-sale securities are stated at fair
value, with the unrealized gains and losses, net of tax, reported in a
separate component of stockholders' equity. The Company has no trading
securities.
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.
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
Loans Receivable
----------------
Loans held for investment are carried at their principal amount outstanding,
net of deferred loan origination fees.
Interest on loans is recorded as borrowers' monthly payments become due.
Accrual of interest income on loans is suspended when, in management's
judgment, doubts exist as to the collectibility of principal and interest.
Loans are returned to accrual status when management determines, based on 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.
Loan fees are accounted for in accordance with Statement of Financial
Accounting Standards No. 91. Loan origination fees and certain direct loan
origination costs are deferred and the net amount amortized as an adjustment
of the related loans' yield over the life of the related loans using a level-
yield method. Unamortized net loan fees or costs on loans sold are recorded
as gain or loss on sale in the year of disposition.
Allowance for Loan Losses
-------------------------
The Company provides for loan losses on the allowance method. Accordingly,
all loan losses are charged to the allowance and all recoveries are credited
to it. Additions to the allowance for loan losses are provided by charges to
operating expense. The provision is based upon management's evaluation of
the risk characteristics of the loan portfolio under current economic
conditions and considers such factors as financial condition of the borrower,
collateral values, growth and composition of the loan portfolio, the
relationship of the allowance for loan losses to outstanding loans, and
delinquency trends.
At December 31, 1996, substantially all of the Company's loans were
collateralized by real estate in Davie and adjacent counties. The collateral
is predominately owner-occupied residential real estate in which the borrower
does not rely on underlying cash flows from the property to satisfy debt
service. The ultimate collectibility of a substantial portion of the loan
portfolio is susceptible to changes in market conditions in the Company's
market area. While management uses available information to recognize losses
on loans, future additions to the allowance may be necessary based on changes
in economic conditions. Various regulatory agencies, as an integral part of
their examination processes, periodically review the Company's allowance for
loan losses. Such agencies may require the Company to recognize additions to
the allowance based on their judgments about information available to them at
the time of their examinations.
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(1) Significant Accounting Policies, Continued
------------------------------------------
Effective January 1, 1995, as required, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan," as amended by Statement of Financial Accounting
Standards No. 118, "Accounting by Creditors for Impairment of a Loan: Income
Recognition" (collectively referred to hereafter as "SFAS No. 114"). The
adoption of SFAS No. 114 did not have a material effect on the Company's
financial condition or results of operations. Under the provisions of SFAS
No. 114, the 1996 provision for loan losses related to loans that are
identified for impairment in accordance with SFAS No. 114 is based on
discounted cash flows using the loans' initial interest rate or the fair
value of the collateral if the loan is collateral dependent. Large groups of
smaller balance homogenous loans that are collectively evaluated for
impairment (such as residential mortgage and consumer installment loans) are
excluded from this impairment evaluation in accordance with SFAS No. 114, and
their allowance for loan losses is calculated in accordance with the
allowance for loan losses policy described above.
Investment in Federal Home Loan Bank Stock
------------------------------------------
As a requirement for membership, the Bank invests in stock of the Federal
Home Loan Bank of Atlanta (FHLB) in the amount of 1% of its outstanding
residential loans or 5% of its outstanding advances from the FHLB, whichever
is greater. At December 31, 1996, the Bank owned 6,669 shares of the FHLB's
$100 par value capital stock.
Premises and Equipment
----------------------
Premises and equipment are stated at cost. Provisions for depreciation are
computed principally using the straight-line method and charged to operations
over the estimated useful lives of the assets over 20 years for office
buildings and 3 to 10 years for furniture, fixtures, and equipment and other
improvements.
Income Taxes
------------
In February of 1992, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for
Income Taxes". Statement 109 requires a change from the deferred method of
accounting for income taxes of APB Opinion 11 to the asset and liability
method of accounting for income taxes. Under the asset and liability method
of Statement 109, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under
Statement 109, the effect on deferred tax assets and liabilities of a change
in tax rates is recognized in income in the period that includes the
enactment date. Effective January 1, 1993, the Company adopted Statement
109.
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(1) Significant Accounting Policies, Continued
------------------------------------------
Retirement Plan
---------------
The Bank has an employee stock ownership plan which covers substantially all
of its employees. Contributions to the plan are determined annually by the
Board of Directors based on employee compensation. Prior to establishment of
the employee stock ownership plan, the Company had a self-administered,
defined contribution retirement plan that covered all eligible employees.
This plan was terminated as of January 1, 1996 in conjunction with the
Conversion. The Bank also has a 401(k) plan that covers all eligible
employees.
Cash and Cash Equivalents
-------------------------
For purposes of reporting cash flows, the Company considers cash, Federal
funds sold and interest-bearing deposits in other institutions with original
maturities of three months or less to be cash equivalents.
Earnings Per Share
------------------
Earnings per share has been computed as if the 1,825,050 shares issued on
March 29, 1996 had been outstanding for the full year. For purposes of this
computation, the number of shares purchased by the Bank's employee stock
ownership plan which were purchased with a loan by the Parent Company are not
assumed to be outstanding.
New Accounting Pronouncements
-----------------------------
The FASB has issued SFAS No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-lived Assets to be Disposed Of". SFAS 121 requires
that long-lived assets and certain identifiable intangibles to be held and
used by an entity be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In evaluating recoverability, if estimated future cash flows,
undiscounted and without interest charges, are less than the carrying amount
of the asset, an impairment loss is recognized. SFAS 121 also requires that
certain long-lived assets and certain identifiable intangibles to be disposed
of be reported at the lower of carrying amount or fair value less cost to
sell. SFAS 121 applies prospectively for fiscal years beginning after
December 15, 1995. The adoption of this accounting standard did not affect
the 1996 financial statements.
The FASB has also issued SFAS No. 122, "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65," which provides guidance for
the capitalization of originated as well as purchased mortgage servicing
rights and the measurement of impairment of those rights. SFAS 122 requires
that an entity recognize as separate assets the rights to service mortgage
loans for others, however those servicing rights are acquired. SAFS 122 also
requires that an entity assess its capitalized mortgage servicing rights for
impairment based on the fair value of those rights. It should stratify its
mortgage servicing rights based on one or more predominant risk
characteristics of the underlying loans, and recognize impairment through a
valuation allowance for each impaired stratum. SFAS 122 applies
prospectively for fiscal years beginning after December 15, 1995. The
adoption of this accounting standard did not affect the 1996 financial
statements.
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(1) Significant Accounting Policies, Continued
------------------------------------------
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation". The statement defines a fair value method of accounting for
an employee stock option or similar equity instrument and encourages all
entities to adopt that method of accounting for all of their employee stock
compensation plans. It also allows an entity to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting prescribed in Accounting Principles Board Opinion Number 25 ("APB
No. 25"). "Accounting for Stock Issued to Employees". SFAS No. 123 requires
that an employers' financial statements include certain disclosures about
stock-based compensation arrangements regardless of the method used to
account for them. Entities electing to remain with the accounting in APB No.
25 must make pro forma disclosures of net income and, if presented, earnings
per share, as if the fair value based method of accounting defined in SFAS
No. 123 had been applied. The disclosure requirements of the statement are
effective for financial statements for fiscal years beginning after December
15, 1995, or for an earlier fiscal year for which this statement is initially
adopted for recognizing compensation cost. Pro forma disclosures required
for entities that elect to continue to measure compensation cost using APB
No. 25 must include the effects of all awards granted in fiscal years that
begin after December 15, 1994. The adoption of this accounting standard had
no material impact on the 1996 financial statements.
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" was issued in June 1996. This statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control. It
distinguishes transfers of financial assets that are sales from transfers
that are secured borrowings. Under the financial-components approach, after
a transfer of financial assets, an entity recognizes all financial and
servicing assets it controls and liabilities it has incurred and does not
recognize financial assets it no longer controls and liabilities that have
been extinguished. The financial-components approach focuses on the assets
and liabilities that exist after the transfer. If a transfer does not meet
the criteria for a sale, the transfer is accounted for as a secured borrowing
with pledge of collateral. This statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring
after December 31, 1996, and is to be applied prospectively. Management
anticipates that the adoption of the statement should have no material impact
on its consolidated financial statements.
Reclassifications
-----------------
Certain reclassifications have been made for 1995 and 1994 to conform with
the 1996 presentation. The reclassifications had no effect on previously
reported net income or stockholders' equity.
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(2) Investment Securities
---------------------
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments
in Debt and Equity Securities". This statement addresses the accounting and
reporting for investments in equity securities that have readily determinable
fair values and for all investments in debt securities. These investments
are to be classified in 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 and equity securities not classified as
either held-to-maturity or 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 adopted SFAS 115 on January 1, 1993. The adoption affected only
the held-to-maturity and available-for-sale classifications, with the net
unrealized securities gains on the securities available-for-sale of $122,855
net of related deferred taxes of $25,230, reported as a separate component of
equity at December 31, 1993. The Company has no trading securities.
The following is a summary of the securities portfolios by major
classification:
<TABLE>
<CAPTION>
December 31, 1996
--------------------------------------------
(in thousands)
Estimated
Amortized Unrealized Unrealized market
cost gains losses value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Securities held-to-maturity:
US government and agency securities $4,753 $21 $18 $4,756
Mortgage-backed securities (1) 2,983 41 - 3,024
------ --- --- ------
Total securities held-to-maturity 7,736 62 18 7,780
====== === === ======
Securities available-for-sale:
States and local governments $2,019 $ 4 $12 $2,011
Mutual funds 712 - - 712
------ --- --- ------
Total securities available-for-sale $2,731 $ 4 $12 $2,723
====== === === ======
<CAPTION>
December 31, 1995
-----------------------------------------------
(in thousands)
Estimated
Amortized Unrealized Unrealized market
cost gains losses value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Securities held-to-maturity:
US government and agency securities $2,995 $24 $ - $3,016
Mortgage-backed securities (1) 274 - - 274
------ --- --- ------
Total securities $3,269 $24 $ - $3,290
====== === === ======
Securities available-for-sale:
State and local governments $1,629 $ 3 $ 2 $1,630
Mutual funds 670 2 - 672
------ --- --- ------
Total securities available-for-sale $2,299 $ 5 $ 2 $2,302
====== === === ======
</TABLE>
(1) At December 31, 1996 and 1995, the Company owned mortgage-backed securities
issued by the General National Mortgage Association (GNMA) and the Federal Home
Loan Mortgage Corporation (FHLMC) with an aggregate amortized cost of $2,801,000
and $183,000 respectively, and a market value of $2,825,000 and $199,500.
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(2) Investment Securities, Continued
--------------------------------
The aggregate amortized cost and approximate market value of the available-
for-sale and held-to-maturity securities portfolios at December 31, 1996, by
remaining contractual maturity are as follows:
<TABLE>
<CAPTION>
Securities available-for-sale Securities held-to-maturity
----------------------------- ---------------------------
(in thousands)
Estimated Estimated
Amortized market Amortized market
cost value cost value
--------- ---------- ------------ -----------
<S> <C> <C> <C> <C>
US government securities:
Due in 1 year or less $ - $ - $ 998 $1,003
Due in 1 year through 5 years - - 499 495
US government agencies securities:
Due in 1 year or less - - 1,011 1,012
Due in 1 year through 5 years - - 2,245 2,246
Obligations of states local governments:
Due in 1 year or less 165 164 - -
Due 1 year through 5 years 1,475 1,478 - -
Due after 5 through 10 years 379 369 - -
Mortgage-backed securities 2,983 3,024
Mutual funds 712 712 - -
------ ------ ------ ------
Total securities $2,731 $2,723 $7,736 $7,780
====== ====== ====== ======
</TABLE>
There was no sales activity for held-to-maturity or available-for-sale
securities for the years ended December 31, 1996, 1995 and 1994.
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(3) Loans Receivable
Loans receivable consist of the following:
<TABLE>
<CAPTION>
December 31,
-----------------
1996 1995
------- -------
(in thousands)
<S> <C> <C>
Loans secured by first mortgages on real estate:
Mortgage loans held for investment, primarily one-to-four family $67,844 $63,329
Construction loans 12,492 11,735
Nonresidential real estate 5,716 4,260
------- -------
86,052 79,324
Home equity lines of credit 2,191 1,890
Other second mortgage loans 282 295
Other installment loans 372 222
------- -------
88,897 81,731
Undisbursed proceeds on loans in process (4,385) (5,211)
Deferred loan fees (1,009) (962)
Allowance for loan losses (511) (462)
------- -------
$82,992 $75,096
======= =======
</TABLE>
An analysis of the allowance for loan losses follows:
<TABLE>
<CAPTION>
1996 1995 1994
----- ------- -------
(in thousands)
<S> <C> <C> <C>
Balance at beginning of period $ 462 $ 115 $ 89
Provision for loan losses 50 350 26
Loans charged off (1) (3) -
Recoveries - - -
----- ------- -------
Balance at end of period $ 511 $ 462 $ 115
===== ======= =======
</TABLE>
At December 31, 1996 and 1995, the Company had no loans which were in
nonaccrual status and $486,875 and $248,645, respectively, which were
contractually delinquent for 90 days or more and still accruing.
At December 31, 1996, the Company had mortgage loan commitments outstanding of
$4,383,000, and preapproved but unused lines of credit totaled $1,700,000.
The Company's exposure to credit loss for commitments to extend credit and
standby letters of credit is the contractual amount of those financial
instruments. The Company uses the same credit policies for making commitments
and issuing standby letters of credit as it does for on-balance sheet
financial instruments. Each customer's creditworthiness is evaluated on an
individual basis. The amount and type of collateral, if deemed necessary by
management, is based upon this evaluation of creditworthiness. Collateral
obtained varies but may include marketable securities, deposits, real estate,
investment assets, and property and equipment. In management's opinion, these
commitments, and undisbursed proceeds on loans in process reflected above,
represent no more than normal lending risk to the Company and will be funded
from normal sources of liquidity.
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(3) Loans Receivable, Continued
---------------------------
The Bank makes loans to executive officers and directors of the Company and to
their associates. It is management's opinion that such loans are made on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with unrelated
persons and do not involve more than the normal risk of collectibility.
Following is a reconciliation of loans outstanding to executive officers,
directors, and their associates for the year ending December 31, 1996.
<TABLE>
<S> <C>
Balance at December 31, 1995 $1,762,792
New loans 835,534
Repayments (694,444)
----------
Balance at December 31, 1996 $1,903,882
==========
</TABLE>
(4) Premises and Equipment
----------------------
Premises and equipment consist of the following:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------------- ----------------------------------
Accumulated Net book Accumulated Net book
Cost depreciation value Cost depreciation value
------ ------------ --------- ---------- ------------ --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Land $ 258 $ - $258 $ 258 $ - $258
Office buildings and improvements 834 386 448 834 348 486
Furniture, fixtures and equipment 500 330 170 478 276 202
Vehicles 26 2 24 13 10 3
------ ------------ ---- ---------- ------------ --------
$1,618 $718 $900 $ 1,583 $634 $949
====== ============ ==== ========== ============ ========
</TABLE>
(5) Deposits
--------
Time deposits of $100,000 or more totaled $5,144,587 and $5,033,864 at
December 31, 1996 and 1995, respectively.
Interest expense on deposits includes $343,000, $431,000 and $275,000 for the
years ended December 31, 1996, 1995 and 1994, respectively, on time deposits
of $100,000 or more.
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(6) Advances from the Federal Home Loan Bank
----------------------------------------
Advances from the Federal Home Loan Bank of Atlanta, with weighted average
interest rates, are as follows:
<TABLE>
<CAPTION>
December 31, 1995
-----------------
(in thousands)
<S> <C>
6.25% due on or before December 20, 1996 $ 500
5.85% due on or before December 28, 1996 500
------
$1,000
======
</TABLE>
There were no FHLB advances outstanding at December 31, 1996. At December 31,
1996, the Bank had additional credit availability from the Federal Home Loan
Bank of $12,000,000.
All advances are secured by all stock in the Federal Home Loan Bank and a
blanket floating lien on the Bank's one-to-four family residential mortgage
loans.
(7) Regulatory Restrictions
-----------------------
CAPITAL REQUIREMENTS: The Parent is regulated by the Board of Governors of
the Federal Reserve System ("FRB") and is subject to securities registration
and public reporting regulations of the Securities and Exchange Commission.
The Bank is regulated by the Federal Deposit Insurance Corporation ("FDIC")
and the Administrator, Savings Institutions Division, North Carolina
Department of Commerce (the "Administrator").
The Bank is subject to capital requirements of the FDIC and the Administrator.
The FDIC requires the Bank to maintain minimum ratios of Tier 1 capital to
total risk-weighted assets and total capital to risk-weighted assets of 4% and
8%, respectively. Tier 1 capital consists of total shareholders' equity
calculated in accordance with generally accepted accounting principles less
intangible assets, and total capital is comprised of Tier 1 capital plus
certain adjustments, the only one of which applicable to the Bank is the
allowance for possible loan losses. Risk-weighted assets refer to the on- and
off-balance sheet exposures of the Bank adjusted for their relative risk
levels using formulas set forth in FDIC regulations. The Bank is also subject
to a FDIC leverage capital requirement, which calls for a minimum ratio of
Tier 1 capital (as defined above) to quarterly average total assets of 3% to
5%, depending on the institution's composite ratings as determined by its
regulators. The Administrator requires a net worth equal to at least 5% of
total assets.
At December 31, 1996, the Bank was in compliance with all of the
aforementioned capital requirements.
LIQUIDATION ACCOUNT: At the time of Conversion, the Bank established a
liquidation account in an amount equal to its net worth at December 31, 1995.
The liquidation account will be maintained for the benefit of eligible deposit
account holders who continue to maintain their deposit accounts in the Bank
after Conversion. Only in the event of a complete liquidation will each
eligible deposit account holder be entitled to receive a liquidation
distribution from the liquidation account in the amount of the then current
adjusted subaccount balance for deposit accounts then held before any
liquidation distribution may be made with respect to the Parent's common
stock. Dividends cannot be paid from this liquidation account.
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(7) Regulatory Restrictions, continued
----------------------------------
DIVIDENDS: Subject to applicable law, the Boards of Directors of the Bank and
the parent may each provide for the payment of dividends. Future declarations
of cash dividends, if any, by the Parent may depend upon dividend payments by
the Bank to the Parent. Subject to regulations of the Administrator, the Bank
may not declare or pay a cash dividend on or repurchase any of its common
stock if its stockholders' equity would thereby be reduced below either the
aggregate amount then required for the liquidation account or the minimum
regulatory capital requirements imposed by federal and state regulations. In
addition, for a period of five years after the Conversion, the Bank will be
required, under existing North Carolina regulations, to obtain prior written
approval of the Administrator before it can declare and pay a cash dividend on
its capital stock in an amount in excess of one-half of the greater of (i) its
net income for the most recent fiscal year, or (ii) the average of its net
income after dividends for the most recent fiscal year and not more than two
of the immediately preceding fiscal years, if applicable. As a result of this
limitation, the Bank cannot pay a dividend in excess of $563,500 without the
approval of the Administrator.
(8) Income Taxes
------------
As discussed in note 1, effective January 1, 1993, the Company adopted
Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting
for Income Taxes". There was a cumulative effect of the change in accounting
for income taxes totaling $23,539 in 1993.
The components of income tax expense (benefit) were as follows:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
(in thousands)
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Currently payable:
Federal $ 757 $ 530 $ 583
State 139 80 93
----- ----- -----
896 610 676
----- ----- -----
Deferred:
Federal (31) (147) (47)
State (7) (33) (12)
----- ----- -----
(38) (180) (59)
----- ----- -----
$ 858 $ 430 $ 617
===== ===== =====
</TABLE>
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(8) Income Taxes, Continued
-----------------------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are shown
below:
<TABLE>
<CAPTION>
December 31,
--------------
1996 1995
------ ------
(in thousands)
<S> <C> <C>
Allowance for loan losses (net) $ 204 $ 184
Deferred loan origination fees, net of deferred costs
Gross deferred tax assets 404 384
Valuation allowance 608 568
----- -----
Net deferred tax assets 608 568
----- -----
Accelerated depreciation 52 72
FHLB stock dividends 180 162
----- -----
Gross deferred tax liabilities 232 234
----- -----
Net deferred tax asset $ 376 $ 334
===== =====
</TABLE>
The Company has no valuation allowance at December 31, 1996 or 1995 because it
has sufficient taxable income in the carryback period to support the
realizability of the net deferred tax asset.
The reconciliation of income taxes at statutory tax rates to income tax
expense reported in the statements of income follows:
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1995 1994
------ ------ ------
(in thousands)
<S> <C> <C> <C>
Income taxes at the statutory federal tax rate $ 798 $ 397 $ 586
State income taxes less federal benefit 120 59 88
Tax exempt interest (38) (40) (70)
Other (22) 14 13
----- ----- -----
Total tax expense $ 858 $ 430 $ 617
===== ===== =====
</TABLE>
Retained earnings at December 31, 1996 includes approximately $2,577,990 for
which no provision for federal income tax has been made. This amount
represents allocations of income to bad debt deductions for tax purposes only.
Reduction of such amount for purposes other than tax bad debt losses will
create income for tax purposes only, which will be subject to the then current
corporate income tax rate. Legislation passed in 1996 eliminates the
percentage of taxable income method as an option for computing bad debt
deductions for 1996 and 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.
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(9) Employee and Director Benefit Plans
-----------------------------------
DEFINED CONTRIBUTION RETIREMENT PLAN: The Bank has had a self-administered,
defined contribution retirement plan that covered all eligible employees. The
Bank's policy has been to fund retirement costs accrued. Under the plan, the
Bank contributed an actuarially determined amount based on a participants
compensation and years service. In conjunction with the Conversion, the
defined contribution retirement plan was terminated as of January 1, 1996.
Funds were distributed in 1996. There was no gain or loss upon the
termination of the defined contribution retirement plan. Retirement expense
of this plan totaled approximately $84,000 in 1995, and $58,000 in 1994.
401(k) PLAN: During 1994, the Bank implemented a 401(k) plan that covers all
eligible employees. During years prior to 1996, the Bank has matched 50% of
employee contributions, with the Bank's contribution limited to 3% of each
employee's salary. 401(k) matching contributions are funded when accrued.
Matching expense totalled approximately $1,900 in 1996, $10,000 in 1995, and
$8,000 in 1994.
EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP"): The Bank has an ESOP whereby an
aggregate number of shares amounting to $130,400 were purchased for future
allocation to employees. Contributions to the ESOP are made by the Bank on a
discretionary basis, and are allocated among ESOP participants on the basis of
relative compensation in the year of allocation. Benefits will vest in full
upon five years of service with credit given for years of service prior to the
conversion.
The ESOP has been funded by a loan from the Parent in the amount of
$2,198,064. The loan is secured by shares of stock purchased by the ESOP and
is not guaranteed by the Bank. Principal and interest payments on this loan
are funded primarily from discretionary contributions by the Bank. Dividends,
if any, paid on shares held by the ESOP may also be used to reduce the loan.
The $175,000 cash contribution was used to allocate 7,205 shares to ESOP
participants in December 1996. At December 31, 1996, there remain 123,195
unearned ESOP shares with a total fair value of approximately $2,525,500.
Dividends on unallocated shares are used by the ESOP to repay the debt to the
Parent and are not reported as dividends in the consolidated financial
statements. Dividends on allocated shares are credited to the accounts of
the participants and reported as dividends in the consolidated financial
statements.
MANAGEMENT RECOGNITION PLAN: The Company plans to adopt a Management
Recognition Plan ("MRP") which has been approved by the Parent's and the
Bank's Boards of Directors and will be submitted to the stockholders of the
Parent for approval. The MRP serves as a means of providing existing
directors and employees of the Bank with an ownership interest in the Company.
Approximately 4% of shares outstanding or 73,002 shares can be awarded under
the Plan. No amounts were charged to expense in 1996, 1995 or 1994 in
connection with this plan.
STOCK OPTION PLAN: The Company plans to adopt a Stock Option Plan which has
also been approved by the Parent's and the Bank's Boards of Directors and will
be submitted to the stockholders of the Parent for approval. The Stock Option
Plan is to provide for the granting of options to purchase 182,505 shares, or
10% of the shares issued in the Conversion to employees and directors. No
amounts have been charged to expense in 1996, 1995, or 1994 in connection
with this plan.
32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(9) Employee and Director Benefit Plans, continued
----------------------------------------------
DIRECTOR 'S DEFERRED COMPENSATION PLAN: The Bank has a deferred compensation
plan for its directors under which the directors would be paid specified
amounts during the ten year period following the date that the director
becomes 65 years of age. The Bank has purchased life insurance policies with
the Bank named as beneficiary to fund the benefits. Total expense related to
these plans was approximately $48,000 for 1996, $70,000 for 1995, and $120,000
for 1994.
EMPLOYMENT AGREEMENTS: In connection with the Conversion, the Bank entered
into an employment agreement with its chief executive officer in order to
ensure a stable and competent management base. The agreement provides for a
three-year term, but upon each anniversary, the agreement automatically
extends so that the remaining term shall always be three years. The agreement
provides that the nature of the covered employee's compensation, duties or
benefits cannot be diminished following a change in control of the Company.
SEVERANCE PLAN: In connection with the Conversion, the Bank adopted a
Severance Plan for the benefit of its employees. The Plan provides for
severance pay benefits in the event of a change in control which results in
the termination of such employees or diminished compensation, duties, or
benefits within two years of a change in control. The employees covered would
be entitled to a severance benefit of the greater of (a) the amount equal to
two weeks' salary at the existing salary rate multiplied by the employee's
number of completed years of service or (b) the amount of one month's salary
at the employee's salary rate at the time of termination, subject to a maximum
payment equal to two times the employee's annual salary.
33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(10) Quarterly Financial Data (Unaudited)
------------------------------------
Summarized unaudited quarterly financial data for the year ended December 31,
1996 is as follows:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- -------- --------- ----------
(in thousands except per share amounts)
<S> <C> <C> <C> <C>
OPERATING SUMMARY:
Interest income $ 1,774 $ 2,082 $ 2,086 $ 2,066
Interest expense 1,016 884 860 850
Net interest income 758 1,198 1,226 1,216
Provision for loan losses - 15 15 20
Net interest income after provision for
loan losses 758 1,183 1,211 1,196
Other income 26 29 31 27
Other expenses 439 368 847 468
Income before income tax expense 345 844 395 755
Income taxes 141 305 126 286
Net income 204 539 269 469
PER SHARE DATA:
Earnings N/A .30 .15 .26
Cash dividends declared N/A .11 .11 .22
Dividend payout N/A 37% 73% 85%
Book value per share N/A 21.00 20.18 20.47
SELECTED AVERAGE BALANCES:
Assets $92,835 $108,766 $108,343 $105,691
Investment securities 14,871 28,281 25,237 21,296
Loans, net 75,883 77,704 79,520 82,081
Interest-bearing deposits 72,692 67,951 67,613 66,480
Stockholders' equity 16,621 39,401 38,944 37,494
</TABLE>
Summarized unaudited quarterly financial data for the year ended December 31,
1995 is as follows:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- -------- -------- --------
(in thousands except per share amounts)
<S> <C> <C> <C> <C>
OPERATING SUMMARY:
Interest income $ 1,581 $ 1,615 $ 1,684 $ 1,722
Interest expense 825 883 928 971
Net interest income 756 732 756 751
Provision for loan losses - - 335 15
Net interest income after provision for
loan losses 756 732 421 736
Other income 28 38 33 28
Other expenses 373 399 382 451
Income before income tax expense 411 371 72 313
Income taxes 153 140 20 117
Net income 258 231 52 196
PER SHARE DATA:
Earnings N/A N/A N/A N/A
Cash dividends declared N/A N/A N/A N/A
Dividend payout N/A N/A N/A N/A
Book value per share N/A N/A N/A N/A
SELECTED AVERAGE BALANCES:
Assets $82,162 $ 82,685 $ 84,300 $ 86,594
Investment securities 9,469 9,259 8,411 7,445
Loans, net 66,918 68,654 71,768 74,249
Interest-bearing deposits 69,596 69,387 70,769 72,410
Stockholders' equity 11,931 12,209 12,475 12,516
</TABLE>
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(11) Parent Company Financial Data
-----------------------------
Condensed financial information for Stone Street Bancorp, Inc. (Parent
Company) is as follows:
<TABLE>
<CAPTION>
December 31, 1996
-----------------
(in thousands)
<S> <C>
CONDENSED BALANCE SHEET
Assets:
Cash on deposit with bank subsidiary $ 4,272
Interest bearing deposits 7,531
Investment securities available for sale at market value:
Obligations of states and local governments, cost $860,000 859
Investment in bank subsidiary 25,230
Other assets 164
-------
Total assets $38,056
=======
Liabilities and stockholders' equity:
Accrued taxes, expenses and other liabilities $ 418
Stockholders' equity, net 37,638
-------
Total liabilities and stockholders' equity $38,056
=======
<CAPTION>
Year Ended
December 31, 1996
-----------------
(in thousands)
<S> <C>
CONDENSED STATEMENT OF INCOME
Interest income from bank subsidiary $ 30
Interest on interest bearing deposits 483
Interest on loan from bank subsidiary ESOP 93
Interest on investment securities 5
-------
Total income 611
Operating expenses 30
-------
Income before income taxes 581
Income tax expense 227
-------
Income before equity in undistributed net income of subsidiary 354
Equity in undistributed net income of bank subsidiary 1,127
-------
Net income $ 1,481
=======
</TABLE>
35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(11) Parent Company Financial Data, Continued
----------------------------------------
<TABLE>
<CAPTION>
Yearr Ended
December 31, 1996
-----------------
(in thousands)
<S> <C>
Cash flows from operating activities:
Net income $ 1,481
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary (1,127)
Increase in other assets (164)
Increase in other liabilities 418
--------
Net cash provided by operating activities 608
--------
Cash flows from investing activities:
Purchase of available for sale securities (860)
--------
Net cash used by investing activities (860)
Cash flows from financing activities:
Proceeds of issuance of no par common stock 26,333
Loan to ESOP for purchase of common stock (2,198)
Capital contribution to Mocksville Savings Bank (11,277)
Cash dividends paid to stockholders (803)
--------
Net cash provided by financing activities 12,055
--------
Net increase in cash and cash equivalents 11,803
Cash and cash equivalents at beginning of year -
--------
Cash and cash equivalents at end of year $ 11,803
========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 283
========
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on securities available for sale
net of deferred tax benefit of $1 $ 1
========
Unrealized gains (losses) on subsidiary's securities
available for sale, net of deferred tax benefit of $3 $ 7
========
Dividends declared but unpaid $ 418
========
</TABLE>
36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(12) Fair Value of Financial Instruments
-----------------------------------
Fair value estimates are made by management at a specific point in time,
based on relevant information about the financial instrument and the market.
These estimates do not reflect any premium or discount that could result from
offering for sale at one time the Company's entire holdings of a particular
financial instrument nor are potential taxes and other expenses that would be
incurred in an actual sale considered. Fair value estimates are based on
judgements regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions and/or the methodology used could
significantly affect the estimates disclosed. Similarly, the fair values
disclosed could vary significantly from amounts realized in actual
transactions.
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not
considered financial instruments.
The following table presents the carrying values and estimated fair values of
the Company's financial instruments at December 31, 1996:
<TABLE>
<CAPTION>
Carrying Estimated
value fair value
--------- ----------
(in thousands)
<S> <C> <C>
Financial assets:
Cash and interest-bearing deposits $ 9,805 $ 9,805
Investment securities:
Available-for-sale 2,723 2,723
Held-to-maturity 7,736 7,780
Net loans 82,992 82,617
Federal Home Loan Bank stock 667 667
Federal liabilities:
Deposits 66,564 66,667
</TABLE>
The estimated fair values of net loans and deposits are based on cash flows
discounted at market interest rates. The carrying values of other financial
instruments, including various receivables and payables, approximate fair
value.
At December 31, 1996, the Company had outstanding commitments to extend
credit. These off-balance sheet financial instruments are generally
exercisable at the market rate prevailing at the date the underlying
transaction will be complete, and, therefore, they are deemed to have no
current fair market value. Refer to note 3.
37
<PAGE>
CAPITAL STOCK
-----------------------
Stone Street Bancorp's common stock is traded on the American Stock Exchange
under the symbol SSM. As of December 31, 1996, there were 1,825,050 shares
outstanding and 721 shareholders of record, not including the number of
persons or entities whose stock is held in nominee or street name through
various brokerage firms or banks. Payment of dividends by the Bank subsidiary
to the Parent is subject to various restrictions. Under applicable banking
regulations, the Bank may not declare a cash dividend if the effect thereof
would be to reduce its net worth to an amount less than the minimum required
by federal and state banking regulations. In addition, for a period of five
years after the consummation of the Bank's stock conversion, which occurred on
March 29, 1996, the Bank will be required to obtain prior written approval
from the Administrator of the Savings Institutions Division, North Carolina
Department of Commerce, before it can declare a cash dividend in an amount in
excess of one-half the greater of (i) its net income for the most recent
fiscal year of (ii) the average of its net income after dividends for the most
recent fiscal year and not more than two of the immediately preceding fiscal
years, as applicable.
QUARTERLY COMMON STOCK PERFORMANCE AND DIVIDENDS DECLARED
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
Stock Price
------------------
High Low Dividends Declared, Per Share
------- ------- -----------------------------
<S> <C> <C> <C>
Second quarter ended June 30* $18 5/8 $16 1/2 $.11
Third quarter ended September 30 18 16 .11
Fourth quarter ended December 31 (1) 20 5/8 18 1/8 .22
</TABLE>
- -----------------
*The common stock did not begin trading until April 1, 1996
(1) Includes regular cash dividend of $.11 per share and special dividend of
$.11.
38
<PAGE>
EXHIBIT 21
SUBSIDIARY OF THE REGISTRANT
The registrant has one subsidiary, Mocksville Savings Bank, Inc., SSB, a
North Carolina corporation. The subsidiary does business under its corporate
name "Mocksville Savings Bank" and "Mocksville Savings Bank SSB."
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,319
<INT-BEARING-DEPOSITS> 7,916
<FED-FUNDS-SOLD> 570
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 2,723
<INVESTMENTS-CARRYING> 7,736
<INVESTMENTS-MARKET> 7,780
<LOANS> 82,992
<ALLOWANCE> 511
<TOTAL-ASSETS> 105,807
<DEPOSITS> 66,564
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,875
<LONG-TERM> 0
0
0
<COMMON> 24,135
<OTHER-SE> 13,233
<TOTAL-LIABILITIES-AND-EQUITY> 105,807
<INTEREST-LOAN> 6,662
<INTEREST-INVEST> 654
<INTEREST-OTHER> 692
<INTEREST-TOTAL> 8,008
<INTEREST-DEPOSIT> 3,604
<INTEREST-EXPENSE> 3,610
<INTEREST-INCOME-NET> 4,398
<LOAN-LOSSES> 50
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,123
<INCOME-PRETAX> 2,339
<INCOME-PRE-EXTRAORDINARY> 1,481
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,481
<EPS-PRIMARY> 0.82
<EPS-DILUTED> 0
<YIELD-ACTUAL> 4.32
<LOANS-NON> 0
<LOANS-PAST> 423
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 462
<CHARGE-OFFS> 1
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 511
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 511
</TABLE>
