<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, 1997
-----------------
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 (336) 751-5936
--------------
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.
$31,363,444 common stock, no par value, based on the closing price of such
- --------------------------------------------------------------------------
common stock on March 18, 1998.
- -------------------------------
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 1,898,052 shares of common
--------------------------
stock, no par value, outstanding at March 18, 1998.
- ---------------------------------------------------
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report of Stone Street Bancorp, Inc. for the year ended
December 31, 1997, (the "1997 Annual Report") are incorporated by reference into
Part I, Part II and Part IV.
Portions of the Proxy Statement for the 1998, Annual Meeting of Shareholders of
Stone Street Bancorp, Inc. to be held on April 21, 1998 (the "Proxy Statement"),
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 source of income is 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>
Asset/Liability Management
Quantitative Aspects of Market Risk. The Bank does not maintain a trading
account for any class of financial instrument. Further, it is not currently
subject to foreign currency exchange rate risk or commodity price risk. The
stock in the FHLB of Atlanta does not have equity price risk because it is
issued only to members and is redeemable for its $100 par value. The following
table illustrates quantitative sensitivity to interest rate risk for financial
instruments other than cash and cash equivalents, FHLB stock and demand accounts
for the Bank as of December 31, 1997.
<TABLE>
<CAPTION>
Maturing in Years Ended December 31,
------------------------------------------------------------
1999- 2001- 2003-
1998 2000 2002 2007 Thereafter Total
-------- -------- -------- -------- ---------- --------
(Dollars in Thousands)
Assets
------
<S> <C> <C> <C> <C> <C> <C>
Loans receivable:
Amount $ 3,837 $ 516 $ 3,643 $ 34,885 $ 50,086 $ 92,967
Average interest rate 9.48% 8.95% 8.40% 7.79% 7.71% 7.82%
Mortgage-backed securities:
Amount - - - - 2,400 2,400
Average interest rates - % - % - % - % 7.38% 7.38%
Investment Securities:
Amount 3,839 740 - 764 - 5,343
Average interest rates 5.63% 5.22% - % 6.28% - % 5.67%
Liabilities
-----------
Deposit Certificate Accounts:
Amount 38,474 11,667 2,938 - - 53,079
Average interest rates 5.55% 5.84% 5.71% - % - % 5.62%
FHLB Advances:
Amount 7,800 - - - - 7,800
Average interest rates 6.50% - % - % - % - % 6.50%
</TABLE>
Qualitative Aspects of Market Risk. One of the Bank's principal financial
-----------------------------------
objectives is to achieve long-term profitability while reducing its exposure to
fluctuations in interest rates. The Bank has sought to reduce exposure of its
earnings to changes in market interest rates by managing the mismatch between
asset and liability maturities and interest rates. The principal element in
achieving this objective has been to increase the interest-rate sensitivity of
the Bank's assets by originating loans with interest rates subject to periodic
repricing to market conditions and shortening the term of its fixed rate loans
to 20 years and including a 10 year call in all other fixed rate residential
real estate loans. Accordingly, the Bank has emphasized the origination of home
equity loans adjustable rate mortgage loans, shorter term fixed rate residential
loans with call provisions, short term and adjustable-rate commercial loans, and
consumer loans for retention its portfolio.
An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If the Bank's
assets mature or reprice more quickly or to a greater extent than its
liabilities, the Bank's net portfolio value and net interest income would tend
to increase during the periods of rising interest rates but decrease during
periods of falling interest rates. If the Bank's assets mature or reprice more
slowly or to a lesser extent than its liabilities, the Bank's net portfolio
value and net interest income would tend to decrease during periods of rising
interest rates but decrease during periods of falling interest rates.
The Bank's Board of Directors has formulated in Interest Rate Risk
Management policy designed to promote long-term profitability while managing
interest-rate risk. The Board of Directors has established an Asset/Liability
Committee which consists primarily of the management team of the Bank. This
committee meets periodically and reports to the Board of Directors quarterly
concerning asset/liability policies, strategies and the Bank's current interest
rate risk position. The committee's first priority is to structure and price
the Bank's assets
3
<PAGE>
and liabilities to maintain an acceptable interest rate spread while reducing
the net effects of changes in interest rates.
Management's principal strategy in managing the Bank's interest rate risk
has been to maintain short and intermediate term assets in the portfolio,
including one and three year adjustable rate mortgage loans, as well as
increased levels of commercial and consumer loans, which typically are for short
or intermediate terms and carry higher interest rates than residential mortgage
loans. In addition, in managing the Bank's portfolio of investment securities
and mortgage-backed and related securities, management seeks to purchase
securities that mature on a basis that approximates as closely as possible the
estimated maturities of the Bank's liabilities or purchase securities that have
adjustable rate provisions. The Bank does not engage in hedging activities.
In addition to shortening the average repricing of its assets, the Bank has
sought to lengthen the average maturity of its liabilities by adopting a tiered
pricing program for its certificates of deposit, which provides higher rates of
interest on its longer term certificates in order to encourage depositors to
invest in certificates with longer maturities. This policy is blended with
management's strategy for reducing the overall balance in certificate accounts
in order to reduce the Bank's interest expense.
There have been no significant changes in the Bank's primary market risk
------------------------------------------------------------------------
exposures or methods for managing those exposures since December 31, 1997.
- --------------------------------------------------------------------------
Our Board of Directors is responsible for reviewing our asset and liability
policies. On at least a quarterly basis, the Board reviews interest rate risk
and trends, as well as liquidity and capital ratios and requirements. Our
management is responsible for administering the policies and determinations of
the Board of Directors with respect to our asset and liability goals and
strategies.
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 99.3% of the Bank's net
loan portfolio is secured by real estate. As of December 31, 1997, all of the
loans in the Bank's real estate loan portfolio were secured by properties in
North Carolina. On December 31, 1997, the Bank's largest single outstanding
loan had a balance of approximately $1,270,400. 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 totaled
approximately $93.0 million at December 31, 1997 representing 86.01% of
Mocksville's total assets at such date. At December 31, 1997, 78.72% of
Mocksville's net loan portfolio was composed of one-to-four family residential
mortgage loans. Home equity and subordinate lien loans represented 2.88% of the
Bank's net loan portfolio, and nonresidential real estate loans represented
10.27% of the Bank's net loan portfolio on such date.
4
<PAGE>
As part of its interest rate risk management program, the Bank continues to
offer adjustable rate mortgage loans to its customers. As of December 31, 1997,
the Bank had approximately $1,247,000 of adjustable rate mortgage loans
outstanding.
The following table sets forth the composition of the Bank's loan portfolio
by type of loan at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------------------------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
------- ------ ------- ------ ------- ------- -------- ------- -------- ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential
1-4 family.................. $76,894 82.71% $67,844 81.75% $63,329 84.33% $54,321 82.34% $45,724 81.81%
Residential multi-
family and
nonresidential
real estate................ 9,541 10.26 5,716 6.88 4,260 5.67 4,987 7.56 5,312 9.50
Other subordinate
lien loans................. 2,675 2.88 2,473 2.98 2,185 2.91 1,423 2.16 1,447 2.59
Residential
construction............... 8,571 9.22 12,492 15.05 11,735 15.63 11,589 17.56 8,033 14.37
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate
loans: 97,681 105.07 88,525 106.66 81,509 108.54 72,320 109.62 60,516 108.27
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Other installment
loans...................... 632 .68 372 .45 222 .30 197 0.30 133 0.24
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Less:
Unearned fees and
discounts................... 1,058 1.14 1,009 1.22 962 1.29 1,095 1.66 711 1.27
Loans in process............ 3,718 4.00 4,385 5.28 5,211 6.94 5,334 8.09 3,959 7.08
Allowance for
loan losses................ 570 .61 511 .61 462 .61 115 0.17 89 0.16
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total reductions............ 5,346 5.75 5,905 7.11 6,635 8.84 6,544 9.92 4,759 8.51
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans
receivable net $92,967 100.00% $82,992 100.00% $75,096 100.00% $65,973 100.00% $55,890 100.00%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
The following table sets forth the time to contractual maturity of the
Bank's loan portfolio at December 31, 1997. 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 $18.1 million, $16.2 million
and $12.2 million in fiscal years ended December 31, 1997, 1996 and 1995,
respectively. Amounts in the table are net of loans in process and are net of
unamortized loan fees.
5
<PAGE>
<TABLE>
<CAPTION>
At December 31, 1997
----------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or less 3 Years 5 Years 10 Years Years Total
-------- ------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Fixed rate 1-4 family
residential $ 89 $ 475 $ 2,934 $31,027 $45,154 $79,679
Adjustable rate 1-4 family
residential 1,247 - - - - 1,247
Adjustable home equity
loans 2,438 - - - - 2,438
Other fixed rate loans 1 41 709 3,858 4,932 9,541
Other loans 632 - - - - 632
Less:
Allowance for loan losses (570) - - - - (570)
------ ------ ------- ------- ------- -------
$3,837 $ 516 $ 3,643 $34,885 $50,086 $92,967
====== ====== ======= ======= ======= =======
</TABLE>
The following table sets forth the dollar amount at December 31, 1997 of
all loans maturing or repricing on or after December 31, 1998.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
------- ----------
(In Thousands)
<S> <C> <C>
Mortgage loans $79,590 $ -
Other loans 9,540 -
------- ---------
$89,130 $ -
======= =========
</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.
6
<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, 20 years, and, includes a 10-year call
provision in all other fixed rate residential real estate loans over 20 years.
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.
December 31,
------------------------------
1997 1996 1995
-------- -------- --------
(In Thousands)
Loans receivable, net beginning of period $ 82,992 $ 75,096 $ 65,973
Loan originations:
Residential 1-4 family 12,575 11,880 7,812
Residential multifamily and
nonresidential real estate 4,772 1,730 1,736
Home equity and second mortgage 1,038 901 1,005
Residential construction 7,975 8,412 10,117
Consumer 1,195 410 469
-------- -------- --------
Total loan originations 27,555 23,333 21,439
Principal repayments (18,139) (16,167) (12,225)
Other changes, net 559 730 (91)
-------- -------- --------
Increase in loans receivable 9,975 (15,437) (12,316)
-------- -------- --------
Loans receivable, net, end of period $ 92,967 $ 82,992 $ 75,096
======== ======== ========
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, 1997, approximately 78.72% 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 4.42% 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.
7
<PAGE>
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, 1997, the Bank had $9.5 million in outstanding loans secured by
nonresidential real estate, including undeveloped land, comprising approximately
of 10.27% of its net loan portfolio as of that date. Most of these loans are
secured 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, 1997, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $1,270,400. 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,
1997, the Bank had approximately $2.6 million in home equity and other
subordinate lien loans, representing approximately 2.88% of its net loan
portfolio. Of this amount, $2.4 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
8
<PAGE>
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, 1997 was approximately $8.6 million, representing
approximately 9.22% 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 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, 1997, the Bank had
approximately $186,100 of such loans outstanding, representing approximately
2.00% 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 from real estate brokers,
present depositors and borrowers, builders, attorneys, walk-
9
<PAGE>
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 obtains information concerning the income, financial
condition, employment and the credit history of the applicant.
The Bank has developed the following lending thresholds to approve loans.
All loans, regardless of type, are approved based on the following lending
limits, assuming the loan meets all of the Bank's underwriting guidelines. Loan
officers may approve loans up to $85,000. The Senior Vice President of lending
approves loans from $85,000 to $100,000. The President and Senior Vice
President of the bank have the authority to approve loans from $100,000 to
$150,000. The Bank's Directors' Loan Committee, which is composed of its
President and three outside directors appointed by the Chairman of the Board,
approve loans from $150,000 to $250,000. All remaining loan requests over
$250,000 up to the legal lending limit of the bank must be approved by the
bank's full Board of Directors.
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,
1997, the Bank had $4.1 million in such unfunded mortgage loan commitments. In
addition, on such date the Bank had $2.1 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 a borrower 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, 1997, the Bank did not own any real estate
acquired in settlement of loans. Real estate acquired through, or in lieu of,
loan foreclosure is initially recorded at 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.
10
<PAGE>
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.
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Total nonaccrual loans
Mortgage loans delinquent 90 days or more $ - $ - $ - $ - $ -
Consumer loans delinquent 90 days or more - - - - -
Real estate owned - - - - -
--------- --------- -------- -------- --------
Total non-performing assets $ - $ - $ - $ - $ -
========= ========= ======== ======== ========
Accruing loans, delinquent 90 days or more $ 295 $ 423 $ 201 $ 280 $ 292
========= ========= ======== ======== ========
Non-performing loans to total loans 0.00% 0.00% 0.00% 0.00% 0.00%
Non-performing assets to total assets 0.00% 0.00% 0.00% 0.00% 0.00%
Total assets $ 108,092 $ 105,807 $ 87,751 $ 81,560 $ 75,826
Total loans, net $ 92,967 $ 82,992 $ 75,097 $ 65,973 $ 55,890
</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, 1997, the Bank had approximately $295,000 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, 1997, the Bank had no loans in the "special
mention" category.
11
<PAGE>
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.
The following table sets forth at December 31, 1997, 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
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family - $ - 6 $ 295 - $ - - $ -
Residential multifamily
and nonresidential
real estate - - - - - - - -
Home equity and second
mortgage - - - - - - - -
Residential construction - - - - - - - -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total real estate loans - - 6 $ 295 - - - -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Consumer loan - - - - - - - -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total - $ - 6 $ 295 - $ - - $ -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
</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>
Year Ended December 31,
--------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Balance, beginning of period $ 511 $ 462 $ 115 $ 89 $ 65
Provision for loan losses 60 50 350 26 25
Charge-offs:
Residential 1-4 family - - - - -
Consumer 1 1 3 - 1
Recoveries:
Residential 1-4 family - - - - -
Consumer - - - - -
----- ----- ----- ----- -----
Balance, end of period $ 570 $ 511 $ 462 $ 115 $ 89
===== ===== ===== ===== =====
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 .58% .57% .57% .16% .15%
</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,
---------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- ------------------- ------------------- ------------------- -------------------
Amount of Amount of Amount of Amount of Amount 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 $ 154 78.21% $ 138 76.32% $ 127 77.48% $ 45 74.91% $ 35 75.39%
Residential multifamily
and nonresidential
real estate 171 9.71 153 6.43 138 5.21 23 6.88 19 8.76
Home equity and
second mortgage 58 2.72 52 2.78 46 2.67 12 1.96 10 2.39
Residential construction 143 8.72 128 14.05 115 14.36 24 15.98 16 13.24
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
Total real estate loans 526 99.36 471 99.58 426 99.72 104 99.73 80 99.78
Consumer loans 44 .64 40 .42 36 .28 11 0.27 9 0.22
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
losses $ 570 $ 100.00% $ 511 100.00% $ 462 100.00% $ 115 100.00% $ 89 100.00%
========= ========= ========= ========= ========= ========= ========= ========= ========= =========
</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, 1997, the carrying value of the Bank's investment
securities portfolio totaled $10.4 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
$2.5 million at December 31, 1997. 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, 1997, the Bank's investment in stock of the FHLB of Atlanta was
$741,000.
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.
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.
15
<PAGE>
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>
1997 1996 1995 1994 1993
----------------- ----------------- ----------------- ----------------- -----------------
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 $2,701 $2,701 $7,916 $7,916 $2,737 $2,737 $3,941 $3,941 $9,125 $9,125
Securities available-
for-sale:
Obligations of states
and political
subdivisions $1,854 $1,859 $2,019 $2,011 $1,629 $1,630 $2,644 $2,521 $ - $ -
Mutual funds 0 0 712 712 670 672 616 616 - -
------ ------ ------ ------ ------ ------ ------ ------ --------- ------
Total securities
available-for-
sale $4,555 $4,555 $2,731 $2,723 $2,299 $2,302 $3,260 $3,137 $ - $ -
====== ====== ====== ====== ====== ====== ====== ====== ========= ======
Securities held-
to-maturity:
U.S. government
and agency
securities $3,489 $3,494 $4,753 $4,756 $2,995 $3,016 $4,799 $4,635 $5,013 $5,057
Mortgage-backed
securities 2,400 2,446 2,983 3,024 274 274 319 334 479 479
Obligation of State
and political
subdivisions - - - - - - - - 1,310 1,318
Mutual funds - - - - - - - - 605 605
------ ------ ------ ------ ------ ------ ------ ------ --------- ------
Total securities
held-to-maturity $5,889 $5,940 $7,736 $7,780 $3,236 $3,290 $5,118 $4,969 $7,407 $7,459
====== ====== ====== ====== ====== ====== ====== ====== ========= ======
</TABLE>
(1) The net unrealized gain (loss) at December 31, 1997 and 1996 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, 1997.
17
<PAGE>
<TABLE>
<CAPTION>
After One Year Through After Five Years Through
One Year or Less Five Years Ten Years
------------------ ---------------------- ------------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits
in other financial
institutions $ 2,701 6.00% $ - - % $ - - %
-------- -------- -------- -------- -------- --------
Securities available-
for-sale:
Obligations of states
and political
subdivisions(1) $ 1,090 5.96% $ - - % $ 764 6.28%
Mutual funds
Total securities
available-for-sale $ 1,090 5.69% $ - - % $ 764 6.28%
-------- -------- -------- -------- -------- --------
Securities held-to-
maturity:
U.S. government and
agency securities $ 2,749 5.59% $ 740 5.22% $ - - %
Mortgage-backed
securities - - - - - -
-------- -------- -------- -------- -------- --------
Total securities
held-to-maturity $ 2,749 5.59% $ 740 5.22% $ - - %
-------- -------- -------- -------- -------- --------
Total investments, at
carrying value $ 3,839 5.63% $ 740 5.22% $ 764 $ 6.28%
======== ======== ======== ======== ======== ========
Total interest-bearing
deposits and
investments $6,540 5.78% $ 740 5.22% $ 764 6.28%
======== ======== ======== ======== ======== ========
<CAPTION>
After Ten Years Total
------------------- -------------------
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Interest-bearing deposits
in other financial
institutions $ - - % $ 2,701 6.00%
-------- -------- -------- --------
Securities available-
for-sale:
Obligations of states
and political
subdivisions(1) $ - - % $ 1,854 6.10%
Mutual funds
Total securities
available-for-sale $ - - % $ 1,854 6.10%
-------- -------- -------- --------
Securities held-to-
maturity:
U.S. government and
agency securities $ - - % $ 3,489 5.52%
Mortgage-backed
securities $ 2,400 7.38% $ 2,400 7.38
-------- -------- -------- --------
Total securities
held-to-maturity $ 2,400 7.38% $ 5,889 6.28%
-------- -------- -------- --------
Total investments, at
carrying value $ 2,400 7.38% $ 7,743 6.24%
======== ======== ======== ========
Total interest-bearing
deposits and
investments $ 2,400 7.38% $ 10,444 6.19%
======== ======== ======== ========
</TABLE>
- ------------
(1) Yields on obligations of sates 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 from other sources. They may also be
used on a longer term basis for general business purposes. The Bank had
borrowings outstanding of $7.8 million at December 31, 1997 with the FHLB of
Atlanta. The borrowings are due by December 31, 1998 and have a weighted
average rate of 6.50%.
Deposits. On December 31, 1997, 1996 and 1995, the Bank's deposits totaled
$67.0 million, $66.5 million and $73.0 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.
At or For the Year Ended December 31,
---------------------------------------------
1997 1996 1995 1994 1993
-------- -------- ------- ------- -------
Total deposits at
beginning of period $66,564 $73,035 $69,140 $64,282 $54,475
Net increase (decrease)
before interest credited (2,713) (9,518) 914 3,021 7,842
Interest credited 3,122 3,047 2,981 1,837 1,965
------- ------- ------- ------- -------
Total deposits at end of
period $66,973 $66,564 $73,035 $69,140 $64,282
======= ======= ======= ======= =======
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 1996 1995
----------------------------- -------------------------------- ------------------------------
Weighted Weighted Weighted
Average % of Average % of Average % of
Amount Rate Deposits Amount Rate Deposits Amount Rate Deposits
------- -------- -------- ------ -------- -------- ------ -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Demand Accounts:
Passbook and statement
accounts $9,189 3.00% 13.72% $11,377 3.00% 16.06% $9,309 3.00% 12.75%
NOW accounts 2,242 .61 3.35 1,514 0.73 2.14 1,762 0.69 2.41
Money market deposit
accounts 2,463 2.46 3.68 2,416 2.45 3.41 2,584 2.46 3.54
------- ---- ------ ------- ---- ------ ------- ---- ------
Total demand deposits 13,894 2.61 20.75 15,307 2.69 21.61 13,655 2.60 18.70
------- ---- ------ ------- ---- ------ ------- ---- ------
Time Deposits:
Certified accounts with
original maturities of:
3 months or less 1,348 4.80 2.01 3,786 4.86 5.34 1,253 5.22 1.72
3-6 months 7,894 5.33 11.79 9,205 5.23 12.99 7,823 5.53 10.71
11-12 months 14,924 5.53 22.28 17,089 5.40 24.13 21,950 6.11 30.05
13 months 3,494 5.94 5.22
18 months 4,908 5.74 7.33 5,183 5.59 7.32 5,607 5.98 7.68
24 months 3,508 5.70 5.24 3,483 5.98 4.92 4,510 5.97 6.17
25 months 2,017 5.84 3.01
30 months 14,986 5.71 22.37 16,781 6.16 23.69 18,235 6.00 24.97
------- ---- ------ ------- ---- ------ ------- ---- ------
Total certificates 53,079 5.62 79.25 55,527 5.62 78.39 59,378 5.96 81.30
------- ---- ------ ------- ---- ------ ------- ---- ------
Total deposits $66,973 4.88% 100.00% $70,834 4.99% 100.00% $73,033 5.33% 100.00%
======= ==== ====== ======= ==== ====== ======= ==== ======
</TABLE>
20
<PAGE>
As of December 31, 1997, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $5.5 million.
At
December 31, 1997
------------------
(In Thousands)
3 Months or less $1,181
Over three months through 6 months 1,494
Over 6 months through 12 months 1,708
Over 12 months 1,131
------
Total $5,514
======
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. At December 31, 1997 the Bank had outstanding borrowings from
the FHLB of Atlanta totaling $7,800,000. These borrowings have a weighted
average rate of 6.50% and mature by December 31, 1998.
Subsidiaries
The Bank is the only subsidiary of the Company. The Bank has one wholly-
owned subsidiary, Stone Street Financial Services, Inc. which was established in
1997 to provide investment discount brokerage services to the public.
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, 1997 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, 1997, 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, 1997, the Bank had 20 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
21
<PAGE>
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.
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 1997 and
1996 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 1997, 1996 and 1995.
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,
22
<PAGE>
1997 includes approximately $2.6 million for which no provision for federal
income tax has been made. See Note 8 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, 1997, 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 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 years to reduce 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 7.50% 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 7.25% 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
23
<PAGE>
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 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 or the BIF or both. The FDIC's claim for damages is superior to claims
of stockholders of the insured depository institution or its holding company but
is subordinate to claims of depositors, secured creditors and holders of
subordinated debt (other than affiliates) of the commonly controlled insured
depository institutions.
As a result of the Company's ownership of the Bank, the Company will be
registered under the savings bank holding company laws of North Carolina.
Accordingly, the Company is also subject to regulation and supervision by the
Administrator.
Federal regulations require that the Company must notify the Federal
Reserve Bank of Richmond prior to repurchasing Common Stock in excess of 10% of
its net worth during a rolling 12 month period.
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
24
<PAGE>
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.
Federal Securities Law. The Company has registered its Common Stock with
the SEC pursuant to Section 12(b) of the Exchange Act and will not deregister
the Common Stock for a period of three years following the completion of the
Conversion. As a result of such registration, the proxy and tender offer rules,
insider trading reporting requirements, annual and periodic reporting and other
requirements of the Exchange Act are applicable to the Company.
The registration under the Securities Act of the Offerings of the Common
Stock does not cover the resale of such shares. Shares of the Common Stock
purchased by persons who are not affiliates of the Company may be resold without
registration. Shares purchased by an affiliate of the Company are subject to
the resale provisions of Rule 144 under the Securities Act. So long as the
Company meets the current public information requirements of Rule 144 under the
Securities Act, each affiliate of the Company who complies with the other
conditions of Rule 144 (including those that require the affiliate's sale to be
aggregated with those of certain other persons) will be able to sell in the
public market, without registration, a number of shares not to exceed, in any
three-month period, the greater of (i) 1% of the outstanding shares of the
Company or (ii) the average weekly volume of trading in such shares during the
preceding four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under the
Securities Act under certain circumstances. There are currently no demand
registration rights outstanding. However, in the event the Company at some
future time determines to issue additional shares from its authorized but
unissued shares, the Company might offer registration rights to certain of its
affiliates who want to sell their shares.
Regulation of the Bank
General. Federal and state legislation and regulation have significantly
affected the operations of federally insured savings institutions and other
federally regulated financial institutions in the past several years and have
increased competition among savings institutions, commercial banks and other
providers of financial services. In addition, federal legislation has imposed
new limitations on investment authority, and higher insurance and examination
assessments on savings institutions and has made other changes that may
adversely affect the future operations and competitiveness of savings
institutions with other financial institutions, including commercial banks and
their holding companies. The operations of regulated depository institutions,
including the Bank, will continue to be subject to changes in applicable
statutes and regulations 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
25
<PAGE>
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.
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 be based on underwriting standards not less
stringent than those applied in comparable transactions with other persons and
be made on terms substantially the same as offered in comparable transactions to
other persons and not involve more than the normal risk of repayment or present
other unfavorable features.
Deposit Insurance. The Bank's deposit accounts are insured by the FDIC
under the SAIF to the maximum extent permitted by law. The Bank pays deposit
insurance premiums to the FDIC based on a risk-based assessment system
established by the FDIC for all SAIF-member institutions. Under applicable
regulations, institutions are assigned to one of three capital groups that are
based solely on the level of an institution's capital "well capitalized,"
"adequately capitalized" or "undercapitalized"), which are defined in the same
26
<PAGE>
manner as the regulations establishing the prompt corrective action system
discussed below. The matrix so created results in nine assessment risk
classifications, with rates that, until September 30, 1996, ranged from 0.23%
for well capitalized, financially sound institutions with only a few minor
weaknesses to 0.31% for undercapitalized institutions that pose a substantial
risk to the SAIF unless effective corrective action is taken.
Pursuant to the DIF Act, which was enacted on September 30, 1996, the FDIC
imposed a special assessment on each depository institution with SAIF-assessable
deposits which resulted in the SAIF achieving its designated reserve ratio. In
connection therewith, the FDIC reduced the assessment schedule for SAIF members,
effective January 1, 1997, to a range of 0% to 0.27%, with most institutions
paying 0%. This assessment schedule is the same as that for the BIF, which
reached its designated reserve ratio in 1995. In addition, since January 1,
1997, SAIF members are charged an assessment of 0.065% of SAIF-assessable
deposits for the purpose of paying interest on the obligations issued by the
Financing Corporation ("FICO") in the 1980s to help fund the thrift industry
cleanup. BIF-assessable deposits will be charged an assessment to help pay
interest on the FICO bonds at a rate of approximately .013% until the earlier of
December 31, 1999 or the date upon which the last savings association ceases to
exist, after which time the assessment will be the same for all insured
deposits.
The DIF Act provides for the merger of the BIF and the SAIF into the
Deposit Insurance Fund on January 1, 1999, but only if no insured depository
institution is a savings association on that date. The DIF Act contemplates the
development of a common charter for all federally chartered depository
institutions and the abolition of separate charters for national banks and
federal savings associations. It is not known what form the common charter may
take and what effect, if any, the adoption of a new charter would have on the
operation of the Bank.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations, or has violated any applicable law, regulation, order or
any condition imposed by an agreement with the FDIC. It also may suspend
deposit insurance temporarily during the hearing process for the permanent
termination of insurance, if the institution has no tangible capital. If
insurance of accounts is terminated, the accounts at the institution at the time
of termination, less subsequent withdrawals, shall continue to be insured for a
period of six months to two years, as determined by the FDIC. Management is
aware of no existing circumstances that could result in termination of the
deposit insurance of the Bank.
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. A savings bank is 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 is given a rating of either "outstanding," "high
satisfactory," "low satisfactory," "needs to improve" or "substantial non-
compliance." A set of criteria for each rating is included in the regulation.
If an institution disagrees with a particular rating, the institution has the
burden of rebutting the presumption by clearly establishing that the
quantitative measures do not accurately present its actual performance, or that
demographics, competitive conditions or economic or legal limitations peculiar
to the service area should be considered. The ratings received under the three
tests are used to determine the overall composite CRA rating or "outstanding,"
"satisfactory," "needs to improve" or "substantial non-compliance."
During the Bank's last compliance examination, which was performed by the
FDIC under the new CRA regulations in October 1997, 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.
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
27
<PAGE>
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,
1997, the Bank had a leverage ratio of 25.92%.
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, 1997, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.
Each federal banking agency was required by law to revise its risk-based
capital standards to ensure that those standards take adequate account of
interest rate risk, concentration of credit risk, and the risk of nontraditional
activities, as well as reflect the actual performance and expected risk of loss
on multi-family mortgages. On August 2, 1995, the federal banking agencies
issued a joint notice of adoption of final risk based capital rules to take
account of interest rate risk. The final regulation required an assessment of
the need for additional capital on a case-by-case basis, considering both the
level of measured exposure and qualitative risk factors. The final rule also
stated an intent to, in the future, establish an explicit minimum capital charge
for interest rate risk based on the level of a bank's measured interest rate
risk exposure.
Effective June 26, 1996, the federal banking agencies issued a joint policy
statement announcing the agencies' election not to adopt a standardized measure
and explicit capital charge for interest rate risk at that time. Rather, the
policy statement (i) identifies the main elements of sound interest rate risk
management, (ii) describes prudent principles and practices for each of those
elements, and (iii) describes the critical factors affecting the agencies'
evaluation of a bank's interest rate risk when making a determination of capital
adequacy. The joint policy statement is not expected to have a material impact
on the Bank's management of interest rate risk.
The FDIC has adopted a final rule changing its risk-based capital rules to
recognize the effect of bilateral netting agreements in reducing the credit risk
of two types of financial derivatives - interest and exchange rate contracts.
Under the rule, savings banks are permitted to net positive and negative mark-
to-market values of rate contracts with the same counterparty, subject to
legally enforceable bilateral netting contracts that meet certain criteria.
This represents a change from the prior rules which recognized only a very
limited form of netting. The Bank does not anticipate that this rule will have
a material effect upon its financial statements.
Loans-To-One-Borrower. The Bank is subject to the Administrator's loans-
to-one-borrower limits. Under these limits, no loans and extensions of credit
to any borrower outstanding at one time and not fully secured by readily
marketable collateral shall exceed 15% of the net worth of the savings bank.
Loans and extensions of credit fully secured by readily marketable collateral
may comprise an additional 10% of net worth. These limits also authorize
savings banks to make loans-to-one-borrower, for any purpose, in an amount not
to exceed $500,000. A savings bank also is authorized to make loans-to-one-
borrower to develop domestic residential housing units, not to exceed the
lesser of $30 million or 30% of the savings bank's net worth, provided that the
purchase price of each single-family dwelling in the development does not exceed
$500,000 and 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
28
<PAGE>
amount up to 50% of net worth.
As of December 31, 1997, 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.
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, or 5% of its outstanding advances (borrowings)
from the FHLB of Atlanta. On December 31, 1997, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of approximately
$741,000.
FIRREA has had the effect of reducing the dividends that the Bank receives
on its stock in the FHLB of Atlanta. During fiscal 1997 and 1996, the Bank
recorded dividend income of $52,600 and $46,900 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, 1997, the Bank was in
compliance with the applicable reserve requirements of the Federal Reserve.
Restrictions on Acquisitions. Federal law generally provides that no
"person," acting directly or indirectly or through or in concert with one or
more other persons, may acquire "control," as that term is defined in FDIC
regulations, of an insured institution, such as the Bank, without giving at
least 60 days' written notice to the FDIC and providing the FDIC an opportunity
to disapprove the proposed acquisition. Pursuant to regulations governing
acquisitions of control, control of an insured institution is conclusively
deemed to have been acquired by, among other things, the acquisition of more
than 25% of any class of voting stock. In addition, control generally is
presumed to have been acquired, subject to rebuttal, upon the acquisition of
more than 10% of any class voting stock. Such acquisitions of control may be
disapproved if it is determined, among other things, that (i) the acquisition
would substantially lessen competition; (ii) the financial condition of the
acquiring person might jeopardize the financial stability of the savings bank or
prejudice the interests of its depositors; or (iii) the competency, experience
or integrity of the acquiring person or the proposed management personnel
indicates that it would not be in the interest of the depositors or the public
to permit the 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
29
<PAGE>
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, 1997, the Bank's liquidity ratio, calculated in
accordance with North Carolina regulations, was approximately 10%.
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.
Prompt Corrective Regulatory Action. Federal law provides the federal
banking agencies with broad powers to take corrective action to resolve problems
of insured depository institutions. The extent of these powers depends upon
whether the institutions in question are "well capitalized," "adequately
capitalized", "undercapitalized," "significantly undercapitalized," or
"critically undercapitalized." Under the FDIC regulations applicable to the
Bank, an institution is considered "well capitalized" if it has (i) a total
risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital
ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not
subject to any order of 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) total risk-based capital ratio of less that 8%,
(ii) a Tier I risk-based capital ratio or less than 4% of (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%. As of December 31, 1997, the most
recent notification received by the Bank from the FDIC categorized the Bank as
well-capitalized.
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
30
<PAGE>
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 Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Banking Act"), effective September 29,
1995, permits adequately capitalized bank and savings bank holding companies to
acquire control of banks and savings banks in any state. The states may
specifically permit interstate acquisitions prior to September 29, 1995, by
enacting legislation that provides for such transactions. North Carolina
adopted nationwide reciprocal interstate acquisition legislation in 1994,.
Such interstate acquisitions are subject to certain restrictions. States
may require the bank or savings bank being acquired to have been in existence
for a certain length of time but not in excess of five years. In addition, no
bank or 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.
The Interstate Banking Act also provides for interstate branching,
effective June 1, 1997, allowing interstate branching in all states, provided
that a particular state has not specifically denied interstate branching by
legislation prior to such time. Unlike interstate acquisitions, a state may deny
interstate branching if it specifically elects to do so by June 1, 1997. States
may choose to allow interstate branching prior to June 1, 1997 by opting-in to a
group of states that permits these transactions. These states generally allow
interstate branching via a merger of an out-of-state bank with an in-state bank,
or on a de novo basis. North Carolina has enacted legislation permitting
branching transactions.
It is anticipated that the Interstate Banking Act will increase competition
within the markets in which the Bank now operates, although the extent to which
such competition will increase in such markets or the timing of such increase
cannot be predicted.
Restrictions on Benefit Plans. FDIC regulations provide that for a period
of one year from the date of the Conversion, the Bank may not implement or adopt
a stock option plan or restricted stock plan, other than a tax-qualified plan or
ESOP, unless: (1) the plans are fully disclosed in the Conversion proxy
soliciting and stock offering material, (2) all such plans are approved by a
majority of the Company's stockholders prior to implementation and no earlier
than six months following the Conversion, (3) for stock option plans, the
exercise price must be at least equal to the market price of the stock at the
time of grant, and (4) for restricted stock plans, no stock issued in connection
with the Conversion may be used to fund the plan.
The FDIC regulations provide that, in reviewing plans submitted to the
stockholders within one year after the consummation of the Conversion, the FDIC
will presume that excessive compensation will result if stock based benefit
plans fail to satisfy percentage limitations on management stock-based benefit
plans set forth in the regulations of the Office of Thrift Supervision ("OTS").
Those regulations provide that (1) for stock option plans, the total number of
shares for which options may be granted may not exceed 10% of the shares issued
in the Conversion, (2) for restricted stock plans, the shares issued may not
exceed 3% of the shares issued in the Conversion (4% for institutions with
tangible capital of 10% or greater after the Conversion), (3) the aggregate
amount of stock purchased by the ESOP shall not exceed 10% (8% for well-
capitalized institutions utilizing a 4% restricted stock plan), (4) no
individual employee may receive more than 25% of the available awards under
31
<PAGE>
any plan, and (5) directors who are not employees may not receive more than 5%
individually or 25% in the aggregate of the awards under any plan. The awards
and grants to be made under the Management Recognition Plan ("MRP") and Stock
Option Plan will conform to these requirements if such plans are submitted for
stockholder approval within one year after the Conversion is consummated.
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.
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 had agreed with
the FDIC that, during the first year after the Conversion, the Bank would 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. Subsequent to this one year period, in July, 1997 the
Company did pay a special dividend representing a $4.00 return of capital to its
stockholders.
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.
32
<PAGE>
A North Carolina-chartered savings bank must maintain net worth, computed
in accordance with the Administrator's requirements, of 5% of total assets and
liquidity of 10% of total assets, as discussed above. Additionally, a North
Carolina-chartered savings bank is required to maintain general valuation
allowances and specific loss reserves in the same amounts as required by the
FDIC.
Subject to limitation by the Administrator, North Carolina-chartered
savings banks may make any loan or investment or engage in any activity which is
permitted to federally chartered institutions. However, a North Carolina-
chartered savings bank cannot invest more than 15% of its total assets in
business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutorily permitted
investments, including but not limited to (i) obligations of the United States,
or those guaranteed by it; (ii) obligations of the State of North Carolina;
(iii) bank demand or time deposits; (iv) stock or obligations of the federal
deposit insurance fund or a FHLB; (v) savings accounts of any savings
institution as approved by the board of directors; and (vi) stock or obligations
of any agency of the State of North Carolina or of the United States or of any
corporation doing business in North Carolina whose principal business is to make
education loans.
North Carolina law provides a procedure by which savings institutions may
consolidate or merge, subject to approval of the Administrator. The approval is
conditioned upon findings by the Administrator that, among other things, such
merger or consolidation will promote the best interests of the members or
stockholders of the merging institutions. North Carolina law also provides for
simultaneous mergers and conversions and for supervisory mergers conducted by
the Administrator.
Future Requirements. Statutes and regulations are regularly introduced
which contain wide-ranging proposals for altering the structures, regulations
and competitive relationships of financial institutions. It cannot be predicted
whether or what form any proposed statute or regulation will be adopted or the
extent to which the business of the Company and the Bank may be affected by such
statute or regulation.
ITEM 2. PROPERTIES
At December 31, 1997, 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, 1997. All properties are owned by the Company.
Net Book Value Deposits
Address of Property (In Thousands)
------- ---------------- ----------------
Mocksville: $ 55,583 $ 54,638
232 South Main Street
Mocksville, North Carolina 27028
Advance: $ 612,621 $ 12,335
5361 U.S. Highway 158
Advance, North Carolina 27006
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, 1997 was $155,361.
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.
33
<PAGE>
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, 1997.
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 1997 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 1997 Annual Report which is
incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
OPERATING RESULTS
See the information set forth under Item 1 above and the information set
forth under the section captioned "Management's Discussion and Analysis" on
pages 4 through 16 in the Company's 1997 Annual Report which section is
incorporated herein by reference.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is set forth under the section
captioned "Management's Discussion and Analysis" on pages 4 through 16 in the
Company's 1997 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 17
through 38 of the Company's 1997 Annual Report are 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, 1997 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.
34
<PAGE>
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.
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 1997
Annual Report attached hereto as Exhibit (13) and incorporated herein
by reference
(a) Independent Auditors' Report
(b) Consolidated Balance Sheets as of December 31, 1997 and 1996
(c) Consolidated Statements of Income for the Years Ended December
31, 1997, 1996 and 1995
(d) Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1997, 1996 and 1995
(e) Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995
(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.
14(a)3 Exhibits
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 (Previously Filed)
Exhibit (3)(ii) Bylaws, incorporated herein by reference to Exhibit
3.2 of the Company's
35
<PAGE>
Registration Statement on Form S-1 (No. 33-80085)
filed on December 5, 1995 and amended January 31,
1996 and February 8, 1996 (Previously Filed)
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 (Previously Filed)
Exhibit (10)(ii)(a) Stone Street Bancorp, Inc. Stock Option Plan
(Previously Filed)
Exhibit (10)(ii)(b) Mocksville Savings Bank, Inc., SSB Management
Recognition Plan (Previously Filed)
Exhibit (10)(ii)(c) Employment Agreement 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 (Previously Filed)
Exhibit (11) Statement Regarding Computation of Per Share
Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) Portions of 1997 Annual Report to Security Holders
Exhibit (21) Subsidiaries of the Registrant
Exhibit (23) Consent of Independent Certified Public Accountants
Exhibit (27) Financial Data Schedule
14(b) The Company filed no reports on Form 8-K during the last quarter of the
fiscal year ended December 31, 1997.
36
<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, 1998 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, Chief Executive Officer March 27, 1998
- ------------------------- and Director
J. Charles Dunn
/s/ Allen W. Carter Senior Vice President March 27, 1998
- -------------------------
Allen W. Carter
/s/ Marjorie D. Foster Vice President and Controller March 27, 1998
- -------------------------
Marjorie D. Foster
/s/ Robert B. Hall Director March 27, 1998
- -------------------------
Robert B. Hall
/s/ William F. Junker Director March 27, 1998
- -------------------------
William F. Junker
/s/ Donald G. Bowles Director March 27, 1998
- -------------------------
Donald G. Bowles
/s/ J. Roy Harris Director March 27, 1998
- -------------------------
J. Roy Harris
/s/ Claude R. Horn, Jr. Director March 27, 1998
- -------------------------
Claude R. Horn, Jr.
/s/ George W. Martin Director March 27, 1998
- -------------------------
George W. Martin
/s/ Terry Bralley Director March 27, 1998
- -------------------------
Terry B. Bralley
/s/ Ronald H. Vogler Director March 27, 1998
- -------------------------
Ronald H. Vogler
37
<PAGE>
STATEMENT REGARDING COMPUTATION PER SHARE EARNINGS
Earnings per share - basic and earnings per share - diluted have been
computed based on weighted average shares outstanding for 1997 of 1,875,451
shares. Earnings per share for 1996 has been computed as if the 1,825,050
shares issued at March 29, 1996 had been outstanding for the full year.
Exhibit 11
<PAGE>
STATEMENT REGARDING COMPUTATION OF RATIOS
The averages used in computing the performance ratios provided in Item 6
represent average daily balances.
Exhibit 12
<PAGE>
SELECTED FINANCIAL DATA
---------------------
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Summary of Operations:
Interest income $ 8,353 $ 8,008 $ 6,602 $ 5,996 $ 5,680
Interest expense 3,491 3,610 3,607 2,862 2,730
-------------------------------------------------
Net interest income 4,862 4,398 2,995 3,134 2,950
Provision for loan losses 60 50 350 26 25
-------------------------------------------------
Net interest income after
provision for loan losses 4,802 4,348 2,645 3,108 2,925
Other income 145 114 127 111 125
Other expenses (1) 2,514 2,123 1,605 1,495 1,202
-------------------------------------------------
Income before tax expense 2,433 2,339 1,167 1,724 1,848
Income tax expense 901 858 430 617 700
Cumulative effect of a
change in accounting
principle (24)
-------------------------------------------------
Net income $ 1,532 $ 1,481 $ 737 $ 1,107 $ 1,124
=================================================
Selected Year-End Balances:
Total assets $108,092 $105,807 $87,751 $81,560 $75,826
Loans receivable, net 92,967 82,992 75,097 65,973 55,890
Investments (2) 11,483 18,945 8,884 12,693 17,022
Deposits 66,973 66,564 73,035 69,140 64,282
FHLB Advances 7,800 - 1,000 - -
Stockholders' equity 31,076 37,368 12,562 11,729 10,719
Average Balance Sheet Data:
Total assets $105,617 $103,874 $83,921 $78,890 $70,256
Total earning assets 101,909 102,336 83,058 76,125 67,128
Loans receivable, net 87,489 78,797 70,397 61,301 52,288
Investments (2) 13,696 22,907 12,481 14,825 14,840
Deposits 66,520 68,684 70,541 66,713 59,301
FHLB Advances 2,788 83 167 - -
Stockholders' equity 33,869 33,115 12,283 11,317 10,219
Selected Financial Ratios:
Return on average assets 1.45% 1.43% .88% 1.40% 1.60%
Return on average equity 4.52% 4.48% 6.00% 9.78% 11.00%
Average equity to average
assets 32.07% 31.88% 14.64% 14.34% 14.54%
Interest rate spread (tax
equivalent basis) 3.16% 2.62% 2.86% 3.59% 3.86%
Net interest margin (tax
equivalent basis) 4.77% 4.32% 3.62% 4.12% 4.39%
Dividend payout ratio 55.22 54.32 N/A N/A N/A
Cash dividends declared
per common share (3) $ 4.45 $ 0.44 N/A N/A N/A
Earnings per
share--basic(4) $ 0.82 $ 0.82 N/A N/A N/A
Earnings per
share--diluted (4) $ 0.82 $ 0.82 N/A N/A N/A
</TABLE>
(1) In 1996, a one time special assessment of $456,000 was 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) Includes a $4.00 special return of capital dividend paid on July 11, 1997.
(4) Earnings per share--basic and diluted for 1997 was calculated using weighted
average shares outstanding of 1,872,451 shares. Earnings per share for 1996
was 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.
In 1997 the Company completed its year once again with record earnings. Net
income increased to $1.53 million for the year ended December 31, 1997 compared
to $1.48 million in 1996 and $.7 million in 1995. Growth in net interest income
combined with an increase in other income outpaced an increase in other expense
to make 1997 the most profitable year for the Company.
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 $464,000 or 10.6% in
1997 to $4.9 million from $4.4 in 1996. Tax equivalent net interest income in
1996 was $4.4 million as compared to $3.0 million in 1995, an increase of $1.4
million or 46.7%. 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 1997 as compared to 1996 was
primarily the result of the increase in the weighted average yield from 7.87% in
1996 to 8.20% in 1997 combined with an increase in the average balances.
Average loans increased by $8.7 million or 11.0% to $87.5 million. Average
investments increased by $1.9 million or 24.9% as stock conversion proceeds
which were initially invested in liquid interest-bearing deposits in the FHLB
were used to purchase investments. The weighted average yield on interest-
earning assets increased by 33 basis points in 1997. In 1996, tax-equivalent
interest income rose 21.2% primarily due to increases in the average balances of
interest-earning assets of 22.7% increasing from $82.9 million in 1995 to $101.7
million in 1996.
Interest expense decreased by $119,000 in 1997 due primarily to a reduction in
the weighted average rate paid on interest- bearing liabilities of 19 basis
points. The balance of average interest-bearing liabilities increased $541,000
or .78% primarily due to the $2.8 million increase in average balance of
borrowings from the FHLB net of $2.2 decrease in average deposits.
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.
Interest rate spread (on a tax equivalent basis) increased to 3.16% in 1997 from
2.62% in 1996 due to the increase in the yield on interest earning assets
combined with the decrease in average rate on interest bearing liabilities. Net
interest margin increased to 4.77% in 1997 from 4.32% in 1996. Interest rate
spread declined to 2.62% in 1996 from 2.86% in 1995 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. 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.
4
<PAGE>
- --------------------------------------------------------------------------------
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 due to volume and rate changes in
1997 while increases in net interest income in 1996 were primarily due to volume
changes.
<TABLE>
<CAPTION>
Table 1: NET INTEREST INCOME ANALYSIS-TAX EQUIVALENT
- -------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- --------------------------- --------------------------
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) $ 87,489 $7,490 8.56% $ 78,797 $6,662 8.45% $70,397 $5,980 8.50%
Investment securities (2) 9,517 519 5.45% 7,617 607 6.75% 8,646 383 4.43%
Interest-bearing deposits 4,179 291 6.96% 14,645 692 4.72% 3,273 198 6.04%
FHLB common stock 724 53 7.32% 645 47 7.29% 562 41 7.30%
--------------------------- --------------------------- --------------------------
Total interest-earning assets 101,909 8,353 8.20% 101,704 8,008 7.87% 82,878 6,602 7.97%
Non-interest-earning assets 3,708 2,170 1,043
-------- -------- -------
TOTAL $105,617 $103,874 $83,921
======== ======== =======
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts $ 66,520 $3,345 5.03% $ 68,684 3,604 5.24% $70,541 $3,607 5.11%
FHLB advances 2,788 146 5.24% 83 6 8.43% - - -
--------------------------- --------------------------- --------------------------
Total interest-bearing liabilities 69,308 3,491 5.04% 68,767 3,610 5.25% 70,541 3,607 5.11%
Non-interest-bearing liabilities 2,440 1,992 1,097
Stockholders' equity 33,869 33,115 12,283
-------- -------- -------
TOTAL $105,617 $103,874 $83,921
======== ======== =======
Net interest income and interest
rate spread $4,862 3.16% $4,398 2.62% $2,995 2.86%
====== ====== ====== ====== ====== ======
Net interest- earning assets
and net interest margin $ 32,601 4.77% $ 32,937 4.32% $12,337 3.62%
======== ====== ======== ====== ======= ======
Ratio of interest-earning assets
to interest bearing liabilities 147.04% 147.90% 117.49%
====== ====== ======
</TABLE>
(1) Includes nonaccrual loans
(2) Interest earned on tax-exempt investment securities has been adjusted to a
tax-equivalent basis using the applicable federal rate of 34% and state
rates in 1997 and 1996 of 7.50%, and 7.75% respectively, and reduced by the
nondeductible portion of interest expense.
<TABLE>
<CAPTION>
Table 2: RATE/VOLUME ANALYSIS
- --------------------------------------------------------------------------------------------------------------
1997 vs 1996 1996 vs 1995
----------------------------- --------------------------------
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 $ 734 (86) (8) 828 $ 714 (31) $ (4) $ 679
Investment securities 151 (191) (48) (88) (45) 306 (37) 224
Interest-bearing deposits (494) 328 (235) (401) 687 (43) (150) 494
FHLB common stock 6 - - 6 6 - - 6
----------------------------- --------------------------------
Total interest income 397 223 (275) 345 1,362 232 (191) 1,403
----------------------------- --------------------------------
Deposit accounts (113) (151) 5 (259) (95) 92 - (3)
FHLB advances 228 (3) (85) 140 7 - - 7
----------------------------- --------------------------------
Total interest expense 115 (154) (80) (119) (88) 92 - 4
----------------------------- --------------------------------
Increase (decrease) in net interest income $ 282 377 (195) 464 $1,450 $140 $(191) $1,399
============================= ================================
</TABLE>
5
<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 $60,000 in 1997 compared to $50,000
in 1996, and $350,000 in 1995. 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
and 1997, 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 increased from $114,000 in 1996 to $145,000 in 1997, and was
$127,000 in 1995. The increase in other income was primarily in customer
service charges and other fees which increased $30,000 in 1997 from the 1996
level. Other income in 1996 decreased $8,000 over the 1995 amount. This
decrease was primarily in loan fees and charges that totaled $45,000 in 1996
compared to $53,000 in 1995.
Other Expenses
Other expenses increased by 18.4% in 1997 compared to an increase of 32.3% in
1996. As a percent of average assets, other expense for 1997 was 2.4% as
compared to 2.0% in 1996 and 1.9% in 1995.
Other expenses totaled $2,514,000 in 1997 compared to $2,123,000 and $1,605,000
in 1996 and 1995, respectively. This significant increase was primarily
attributable to large expenses that occurred in the second quarter of fiscal
year 1997 related to the ESOP and MRP plans of the Company. First, in 1997, the
Company recorded $351,000 of compensation expense related to the Company's
employee stock ownership plan ("ESOP"), primarily associated with the release
and allocation of approximately 23,617 shares of common stock of the Parent to
participants of the ESOP during 1997. The special dividend paid on the Parents
stock on July 11, 1997 and management's decision to use the special dividends
paid on the unallocated shares of the Parent's common stock held by the ESOP to
pre-pay the ESOP loan from the Parent to the ESOP resulted in a significant
portion of that share release, approximately 15,869 shares. As a result,
approximately, $171,000 of the ESOP-related compensation expense is deemed to be
of a non-recurring nature.
Without the effect of the non-recurring portion of ESOP-related compensation
expense, other expenses would have totaled $2,343,000, a $220,000 increase from
1996. Compensation and fringe benefits, excluding non-recurring items,
increased by $569,000 to $1,582,000 compared to $1,013,000 in 1996, primarily
related to the ESOP and the Company's management recognition plan ("MRP"). The
ESOP, which was established in conjunction with the Conversion in 1996 provides
a potentially higher level of retirement benefits to employees than the previous
retirement plan. The recurring portion of ESOP-related compensation expense for
1997 totaled $180,000 compared to $175,000 recorded for 1996. Also contributing
to the increase in compensation expense was $353,000 of amortization of deferred
compensation associated with the MRP implemented May 9, 1997.
"Other" other expenses increased $113,000 to $390,000 in 1997 from $277,000 in
1996 due to increases in marketing expenses, shareholder reporting expenses, and
franchise tax expenses. These increased expenses are mitigated to a degree by a
$535,000 decrease in FDIC-insurance premiums to $46,000 for 1997 from $581,000
for 1996 which included a special one time assessment of $456,000. Deposit
insurance premiums decreased starting with the quarter ended December 31, 1996.
The reduced level of FDIC-insurance premiums is anticipated to continue into the
future.
Occupancy and equipment expense increased by $45,000 or 20.8% in 1997 over 1996
as the Bank improved its customer information technology. Professional fees
increased $28,000 from 1996 which included costs associated with the conversion
and regulatory filings.
6
<PAGE>
- --------------------------------------------------------------------------------
ANALYSIS OF FINANCIAL CONDITION
---------------------------
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.
Compensation and fringe benefits in 1996 representing over 47.72% of total other
expenses increased by $56,000 or 5.9% over 1995. Retirement expense increased
by $24,000 in 1996 over 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.
Occupancy and equipment expense decreased by $26,000 in 1996 from 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. Professional fees increased by $5,000 in 1996
compared to 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 $43,000 or 5.0% to $901,000 in 1997 from
$858,000 in 1996. The effective tax rate was 37.0% in 1997 to 36.7% in 1996.
Income tax expense totaled $430,000 in 1995, and the effective tax rate was
36.8%. Changes in income tax expenses were caused primarily by changes in net
income.
ANALYSIS OF FINANCIAL CONDITION
---------------------------
On March 29, 1996 Mocksville Savings Bank, Inc., SSB (the "Bank") completed
its conversion from a mutual to a stock savings 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, 1997, the net loan portfolio totaled $93.0 million and
represented 86% of total assets. During 1997, loans increased by $10.0 million
or 12%. Loan originations increased from $23.3 million in 1996 to $27.6 million
in 1997, 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, 1997. Table 3 sets forth the composition of the loan portfolio at the dates
indicated.
7
<PAGE>
<TABLE>
<CAPTION>
Table 3: TYPES OF LOANS
- -----------------------------------------------------------------------------------------------------------------------------------
December 31,
-----------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------ ------------------- ------------------ ------------------ ------------------
Amount Percentage Amount Percentage Amount Percentage Amount Percentage Amount Percentage
------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $76,894 82.71% $67,844 81.75% $63,329 84.33% $54,321 82.34% $45,724 81.81%
Nonresidential real estate 9,541 10.26 5,716 6.88 4,260 5.67 4,987 7.56 5,312 9.50
Home equity and other
second mortgage 2,675 2.88 2,473 2.98 2,185 2.91 1,423 2.16 1,447 2.59
Construction 8,571 9.22 12,492 15.05 11,735 15.63 11,589 17.56 8,033 14.37
--------------- --------------- --------------- --------------- ---------------
Total real estate loans 97,681 105.07 88,525 106.66 81,509 108.54 72,320 109.62 60,516 108.27
Other installment loans 632 .68 372 .45 222 .30 197 0.30 133 0.24
Less:
Unearned fees 1,058 1.14 1,009 1.22 962 1.29 1,095 1.66 711 1.27
Loans in process 3,718 4.00 4,385 5.28 5,211 6.94 5,334 8.09 3,959 7.08
Allowance for loan losses 570 .61 511 .61 462 .61 115 0.17 89 0.16
--------------- --------------- --------------- --------------- ---------------
Total reductions 5,346 5.75 5,905 7.11 6,635 8.84 6,544 9.92 4,759 8.51
--------------- --------------- --------------- --------------- ---------------
Total loans, net $92,967 100.00% $82,992 100.00% $75,096 100.00% $65,973 100.00% $55,890 100.00%
=============== =============== =============== =============== ===============
- -----------------------------------------------------------------------------------------------------------------------------------
</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, 1997. 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.
<TABLE>
<CAPTION>
Table 4: LOAN MATURITIES
- -----------------------------------------------------------------------------------------------
December 31, 1997
------------------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or Less 3 Years 5 Years 10 Years Years Total
------ ----- ------ ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
Fixed rate 1-4 family $ 89 $475 $2,934 $31,027 $45,154 $79,679
Adjustable rate 1-4 family 1,247 1,247
Adjustable home equity 2,438 2,438
Fixed rate-nonresidential 1 41 709 3,858 4,932 9,541
Other loans 632 632
Less:
Allowance for loan losses (570) (570)
------ ---- ------ ------- ------- -------
Total Loans $3,837 $516 $3,643 $34,885 $50,086 $92,967
====== ==== ====== ======= ======= =======
- -----------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE>
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
December 31,
--------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- -------- -------- --------
(dollars in thousands)
Total nonaccrual loans $ - $ - $ - $ - $ -
Total restructured loans - - - - -
-------- -------- ------- ------- -------
Total nonperforming loans - - - - -
-------- -------- ------- ------- -------
Real estate owned - - - -
In-substance foreclosures - - - - -
-------- -------- ------- ------- -------
Total foreclosed property - - - - -
-------- -------- ------- ------- -------
Total nonperforming assets $ - $ - $ - $ - $ -
======== ======== ======= ======= =======
Accruing loans, delinquent
90 days or more $ 295 $ 423 $ 201 $ 280 $ 292
======== ======== ======= ======= =======
Nonperforming loans to
total loans 0.00% 0.00% 0.00% 0.00% 0.00%
Nonperforming assets to
total assets 0.00% 0.00% 0.00% 0.00% 0.00%
Total assets $108,092 $105,807 $87,751 $81,560 $75,826
Total loans, net $ 92,967 $ 82,992 $75,097 $65,973 $55,890
- --------------------------------------------------------------------------------
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 $60,000 in 1997 compared to $50,000
in 1996, and $350,000 in 1995. 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
and 1997, the provision was lowered, largely as a result of an improved level of
the relationship between the allowance and outstanding loans.
9
<PAGE>
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
Year Ended December 31
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(in thousands)
Balance, beginning of period $ 511 $ 462 $ 115 $ 89 $ 65
Provision for loan losses 60 50 350 26 25
Charge-offs 1 1 3 - 1
Recoveries - - - - -
----- ----- ----- ----- -----
Balance, end of period $ 570 $ 511 $ 462 $ 115 $ 89
===== ===== ===== ===== =====
Allowance as a percentage of loans .61% .62% .62% .17% .16%
Table 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
- --------------------------------------------------------------------------------
December 31,
---------------------------------
1997 1996 1995 1994 1993
---------------------------------
(in thousands)
Residential 1-4 family $ 154 $ 138 $ 127 $ 45 $ 35
Nonresidential real estate 171 153 138 23 19
Home equity and other second mortgage 58 52 46 12 10
Construction 143 128 115 24 16
---------------------------------
Total real estate loans 526 471 426 104 80
Other loans 44 40 36 11 9
---------------------------------
Total allowance for loan losses $ 570 $ 511 $ 462 $ 115 $ 89
=================================
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 $2.5 million at December 31, 1997, a decrease
of $5.4 million from 1996. These funds were used to pay the special dividend of
$4.00 per share in July 1997 to the stockholders. The Company also had
$1,034,000 of federal funds sold at December 31, 1997, an increase of $464,000
over 1996.
10
<PAGE>
Investment securities totaled $7.7 million at December 31, 1997, a decrease of
$2.7 million from $10.4 million at December 31, 1996. Proceeds from matured
investments were also used to fund the special dividend paid to stockholders in
1997. At December 31, 1997, net unrealized gains of $4,678 were included in the
carrying value of securities classified available-for-sale compared to net
unrealized losses of $7,600 on such securities at December 31, 1996. Net
unrealized gains or 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.
Table 8: INVESTMENT SECURITIES - MATURITY/YIELD SCHEDULE
- ---------------------------------------------------------
<TABLE>
<CAPTION>
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 $ 2,749 5.59% $ 740 5.22% $ - -% $ - - $ 3,489 5.53%
Mortgage-backed securities (1) - - - - - - 2,400 7.38 % 2,400 7.38
-------------- -------------- ---------------- ---------------- ---------------
Total held-to-maturity $ 2,749 5.59% $ 740 5.22% $ - -% $ 2,400 7.38 % $ 5,889 6.28%
-------------- -------------- ---------------- ---------------- ---------------
Available-for-sale:
State and local government (2) $ 1,090 5.69% $ - - $ 764 6.28% $ - - $ 1,854 5.93%
-------------- -------------- ---------------- ---------------- ---------------
Total available-for-sale $ 1,090 5.69% - - 764 6.28% - - 1,854 5.93%
-------------- -------------- ---------------- ---------------- ---------------
Total investments
at carrying value $ 3,839 5.63% $ 740 5.22% $ 764 6.28% $ 2,400 7.38% $ 7,743 6.20%
============== ============== ================ ================ ===============
</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, 1997.
(2) Yields are stated on taxable equivalent basis assuming statutory tax rates
of 34% for federal and 7.50% for state purposes. Book yields without regard to
tax-equivalent adjustments are: one year or less, 5.18%; two to five years,
5.22%; six to ten years, 4.60%; more than ten year, 7.38%; total, 5.81%.
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, 1997, the Company's investment in stock of the FHLB
of Atlanta was $741,000.
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.
11
<PAGE>
Deposits
- --------------------------------------------------------------------------------
Deposits totaled $67.0 million at December 31, 1997, compared to $66.6
million at December 31, 1996, an increase of approximately $409,000. The
following table sets forth certain information regarding the Company's average
savings deposits for the last three years.
Table 9: AVERAGE DEPOSITS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
----------------- ------------------ ------------------
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 $ 4,260 1.71% $ 3,996 1.80% $ 4,521 1.81%
Savings account 11,928 3.00 9,270 3.51 9,525 3.02
Certificates of deposit 50,332 5.79 55,418 5.84 56,495 5.73
---------------- --------------- ----------------
Total deposits $66,520 5.03% $68,684 5.24% $70,541 5.11%
================ =============== ================
</TABLE>
As of December 31, 1997, the Company had outstanding $5,514,098 in time
certificates of deposit of $100,000 or more. Maturities of certificates of
deposits of $100,000 or more at December 31, 1997 were as follows: three months
or less, $2,480,837; over three months through six months, $794,089, over six
months through twelve months $1,607,599; and over one year through twenty-four
months, $528,495; and over twenty-four months, $103,078.
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, 1997, the Company had outstanding FHLB advances
totaling $7,800,000, compared to no advances outstanding at December 31, 1996.
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,
1997, the Bank had an additional $4 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, 1997 which are projected to reprice or mature in each of the future time
periods shown. At December 31, 1997, the Company had a negative cumulative one
year asset-sensitive gap position of $47.6 million or 45.14% 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.
12
<PAGE>
- --------------------------------------------------------------------------------
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.
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, 1997, 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, 1997
-------------------------------------------------------------------------------------
More than More than Over
3 Months 4 to 12 1 Year to 3 Years to 5 Years to Over
Or Less Months 3 Years 5 Years 10 Years 10 Years Total
---------- ---------- ----------- ------------ ------------ --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest earning assets (dollars in thousands)
Mortgage loans:
Fixed rate residential 1-4 family $ - $ 89 $ 475 $ 2,934 $ 31,027 $45,154 $ 79,679
Adjustable rate residential 1-4 family - 1,247 - - - - 1,247
Adjustable home equity 2,438 - - - - - 2,438
Fixed rate-nonresidential - 1 41 709 3,858 4,932 9,541
-------- -------- -------- -------- -------- ------- --------
Total mortgage loans 2,438 1,337 516 3,643 34,885 50,086 92,905
Other loans 632 - - - - - 632
-------- -------- -------- -------- -------- ------- --------
Total loans 3,070 1,337 516 3,643 34,885 50,086 93,537
Interest-bearing deposits(2) 3,531 - - - - - 3,531
Investment securities (1) 3,838 - - 740 770 2,400 7,748
FHLB common stock 741 - - - - - 741
-------- -------- -------- -------- -------- ------- --------
Total interest-earning assets $ 11,180 $ 1,337 $ 516 $ 4,383 $ 35,655 $52,486 $105,557
-------- -------- -------- -------- -------- ------- --------
Interest-bearing liabilities
Deposits:
Fixed maturity deposits $ 12,522 $ 25,954 $ 14,603 $ - $ - $ - $ 53,079
NOW accounts money market accounts 4,704 - - - - - 4,704
Savings accounts 9,190 - - - - - 9,190
-------- -------- -------- -------- -------- ------- --------
Total deposits 26,416 25,954 14,603 - - - 66,973
FHLB advances 7,800 7,800
-------- -------- -------- -------- -------- ------- --------
Total interest-bearing liabilities $ 26,416 $ 33,754 $ 14,603 $ - $ - $ - $ 74,773
-------- -------- -------- -------- -------- ------- --------
Interest sensitivity gap per period $(15,236) $(32,417) $(14,087) $ 4,383 $ 35,655 $52,486 $ 30,784
Cumulative interest-sensitivity gap $(15,236) $(47,653) $(61,740) $(57,357) $(21,702) $30,784 $ 30,784
Cumulative gap as a percentage of
total interest-earning assets (14.43 %) (45.14%) (58.49%) (54.34%) (20.56%) 29.16% 29.16%
Cumulative interest-earning assets as a
percentage of interest-bearing liabilities 42.32% 20.80% 17.43% 23.29% 70.98% 141.17% 141.17%
</TABLE>
(1) Includes investments and mortgage-backed securities
(2) Includes interest-bearing deposits and federal funds
13
<PAGE>
- --------------------------------------------------------------------------------
Capital Resources
---------------
Stockholders' equity decreased from $37.4 million at December 31, 1996 to
$31.0 million at December 31, 1997, largely as a result of the $4.00 special
dividend paid to stockholders in July, 1997 which totaled $7,592,000.
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, 1997 and 1996, the Bank was in compliance with all of the
aforementioned capital requirements as summarized in Table 11. Refer to Note 7
of the consolidated financial statements for a discussion of other matters that
may affect the Company's capital resources.
Table 11: REGULATORY CAPITAL
- --------------------------------------------------------------------------------
At December 31,
------------------------
1997 1996
------------------------
Risk-Based and Leverage Capital (dollars in thousands)
Tier I capital:
Common stockholders' equity $ 26,030 $ 24,967
Unrealized holding loss (gain) on securities
available-for-sale (3) 7
------------------------
Total Tier I leverage capital 26,027 24,974
Tier II Capital:
Qualifying allowances for loan losses
Tier II capital additions 570 511
------------------------
Total risk-based capital $ 26,597 $ 25,485
Risk-weighted assets 61,531 48,072
Fourth quarter average assets 102,598 96,363
Risk-based capital ratios:
Tier-I capital as a percent of risk-weighted assets 42.30% 51.95%
Minimum Required Tier I capital 4.00% 4.00%
Total risk-based capital as a percent of
risk-weighted assets 43.23% 53.01%
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 25.37% 25.92%
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 25.92% 26.45%
Minimum required North Carolina capital 5.00% 5.00%
14
<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,
1997 that will affect the Company's future reporting.
In August 1996, the Financial Accounting Standard Board ("FASB") issued
Statement of financial Accounting Standards No. 125 ("SAFS 125"), "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities". 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 transfer and servicing of
financial assets and extinguishments of liabilities occurring after December 31,
1996, and is to be applied prospectively. The Company adopted this statement on
January 1, 1997 without any impact on its consolidated financial statements.
In February 1997, the financial Accounting Standards Board issued Statement
of financial Accounting Standards No. 128 ("SAFS 128"), "Earnings Per Share".
SFAS 128 establishes standards of computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock or potential
common stock. This statement simplifies the standards for computing earnings
per share previously found in APB Opinion No. 15, "Earnings Per Share", and
makes them comparable to international EPS standards. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also requires
dual presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures and requires a reconciliation
of the numerator and denominator of the basic EPS computation to the numerator
and denominator of the diluted EPS computation. SFAS 128 is effective for
financial statements issued for periods ending after December 15, 1997 and
requires restatement of all prior period EPS data presented. The Company
adopted SFAS 128 in fiscal year 1997 without any significant impact on its
consolidated financial statements.
In February 1997, the FASB issued Statement of financial Accounting Standards
No. 129 ("SFAS 129"), "Disclosure of information about Capital Structure". SFAS
129 establishes standards for disclosing information about an entity's capital
structure and is applicable to all entities. It contains no change in
disclosure requirements for entities that were previously subject to the
requirements of APB Opinion No. 10, "Omnibus Opinion - 1996", APB Opinion No.
15, "Earnings Per Share", and Statement of Financial Accounting Standards No.
47, "Disclosure of Long-Term Obligations". SFAS 129 is effective for financial
statements for periods ending after December 15, 1997. The Company adopted SFAS
129 in fiscal 1997 without any impact on its consolidated financial statements.
15
<PAGE>
- --------------------------------------------------------------------------------
In June 1997, the FASB issued Statement of financial Accounting Standards No.
130 ("SFAS 130"), "Reporting Comprehensive Income". SFAS 130 establishes
standards for reporting and displaying comprehensive income and its components
(revenues, expenses, gains, and losses) in a full set of general-purpose
financial statements. This Statement requires that an enterprise (a) classify
items of other comprehensive income by their nature in the financial statement
and (b) display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in-capital in the equity section of a
statement of financial position. SFAS 130 is effective for fiscal years
beginning after December 15, 1997. Reclassification of financial statements for
earlier periods provided for comparative purposes is required. The company
plans to adopt the SFAS 130 is fiscal year 1998 and has not determined the
impact on its consolidated financial statements.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related
Information". SFAS 131 established standards for the way that public businesses
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. This Statement is effective for
financial statements for periods beginning after December 31, 1997 and in the
initial year of application, comparative information for earlier years is to be
restated. The Company plans to adopt SFAS 131 in fiscal year 1998 without any
significant impact on its consolidated financial statements.
Year 2000 Issue
-------------
The Company has completed its assessment of the Company's vulnerability to
Year 2000 issues. The Company's most critical computer system is utilized by
its subsidiary, Mocksville Savings Bank, for loans, deposit and accounting
functions, and is maintained by a third party service bureau. The costs of
compliance will be borne by the vendor under the contract. While this system is
presently substantially Year 2000 compliant, Bank personnel will participate in
tests of the system during 1998 to ensure full compliance. Failure to prepare
this system for the Year 2000 would materially affect the Bank's ability to
operate and serve its customers. The Company's other information technology-
controlled systems have also been identified and are in various states of
readiness. Progress is under way to address these issues, with an estimated
cost of $60,000; the actual amount will depend on choices made by management in
the coming months. This amount could increase materially if problems are noted
in the testing processes that have not yet been identified. The majority of
these costs are expected to be incurred during the calendar year 1998; all such
costs will be charged to expense as incurred.
16
<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, 1997 and 1996, 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, 1997. 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, 1997 and 1996, and the results
of their operations and their cash flows for each of the years in the three year
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Weir Smith Jones Miller & Elliott
Weir Smith Jones Miller & Elliott
Statesville, North Carolina
January 30, 1998
17
<PAGE>
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31, 1997 and 1996
1997 1996
-------- --------
(dollars in thousands)
ASSETS
Cash $ 968 $ 1,319
Federal funds sold 1,034 570
Interest-bearing deposits in other
financial institutions 2,701 7,916
Investment securities (note 2)
Held-to-maturity (Market value:
$5,940 in 1997 and $7,780 in 1996) 5,889 7,736
Available-for-sale (Cost: $1,854 in
1997 and $2,731 in 1996) 1,859 2,723
Loans receivable (net of allowance
for loan losses of $570 in 1997 and
$511 in 1996) (note 3) 92,967 82,992
Federal Home Loan Bank stock at cost 741 667
Premises and equipment (note 4) 824 900
Accrued interest receivable 284 310
Deferred income tax 412 376
Refundable income tax 126 77
Prepaid expenses and other assets (note 8) 141 93
Cash surrender value of life insurance 146 128
-------- --------
Total assets $108,092 $105,807
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (note 5):
Savings accounts 9,190 8,861
NOW and MMDA 4,704 3,932
Other certificates of deposit 47,565 48,626
Certificates of deposit, $100,000 and over 5,514 5,145
-------- --------
Total deposits 66,973 66,564
Advances from the Federal Home Loan Bank (note 6) 7,800 -
Amounts payable under remittance service agreement 1,175 636
Accrued interest payable 144 170
Accrued expenses and other liabilities 924 667
Accrued cash dividends payable 0 402
-------- --------
Total liabilities 77,016 68,439
-------- --------
Stockholders' Equity:
Preferred stock, no par value, 5,000,000 shares
authorized; none issued (note 1) - -
Common stock, no par value 20,000,000 shares authorized:
1,898,052 and 1,825,050 shares issued and outstanding,
respectively (note 1) 20,611 26,333
Unearned ESOP shares (1,948) (2,198)
Unamortized deferred compensation (1,518) -
Retained earnings, substantially
restricted (notes 7 and 8) 13,928 13,241
Unrealized holding gains (losses) on
available-for-sale securities, net 3 (8)
-------- --------
Total stockholders' equity 31,076 37,368
-------- --------
Commitments and contingencies (notes 3 and 9)
Total liabilities and stockholders' equity $108,092 $105,807
======== ========
See accompanying notes to consolidated financial statements.
18
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS OF INCOME
-------------------------------------------
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
-------------- -------------- -------------
(dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Interest on loans $7,490 $6,662 $5,980
Interest on deposits in other
financial institutions 291 692 198
Interest and dividends on
investment securities:
Taxable 486 563 336
Non-taxable 86 91 88
------ ------ ------
Total interest income 8,353 8,008 6,602
------ ------ ------
Interest expense:
Interest on deposits (note 5) 3,345 3,604 3,607
Interest on borrowings 146 6
------ ------
Total interest expense 3,491 3,610 3,607
------ ------ ------
Net interest income 4,862 4,398 2,995
Provision for loan losses (note 3) 60 50 350
------ ------ ------
Net interest income after
provision for loan losses 4,802 4,348 2,645
------ ------ ------
Other income:
Loan fees and charges 49 45 53
Customer service and other fees 86 56 57
Other 10 13 17
------ ------ ------
Total other income 145 114 127
------ ------ ------
Other expenses:
Compensation and related
benefits (note 9) 1,753 1,013 957
Deposit insurance premiums 46 581 158
Occupancy and equipment expense 261 216 242
Professional fees 64 36 31
Other 390 277 217
------ ------ ------
Total other expenses 2,514 2,123 1,605
------ ------ ------
Income before income tax expense 2,433 2,339 1,167
Income tax expense (note 8) 901 858 430
------ ------ ------
Net income $1,532 $1,481 $ 737
====== ====== ======
Net income per share--basic (note 1) $0.82 $0.82 N/A
====== ====== ======
Net income per share--diluted (note 1) $0.82 $0.82 N/A
====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
For the Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Unearned Unamortized Unrealized Total
Shares Common ESOP Deferred Retained Holding Stockholders'
Outstanding Shares Shares Compensation Earnings Gains/Losses Equity
----------- -------- --------- ------------- --------- ------------- --------------
(in thousands, except shares outstanding)
<S> <C> <C> <C> <C> <C> <C> <C>
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
Net income 1,532 1,532
Common stock acquired
by ESOP (329) (329)
Release of ESOP shares 579 579
Cash dividends
($4.45 per share) ** (7,593) (845) (8,438)
Change in unrealized
holding gains (losses)
net of income taxes
of $4 11 11
Issuance of restricted stock 73,002 1,871 (1,871)
Amortization of unearned
compensation 353 353
----------- -------- --------- ------------- --------- ------------- --------------
Balance at
December 31, 1997 1,898,052 $20,611 $(1,948) $(1,518) $13,928 $ 3 $31,076
=========== ======== ========= ============= ========= ============= ==============
</TABLE>
** Includes $4.00 special return of capital dividend paid on July 11, 1997.
See accompanying notes to consolidated financial statements.
20
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the Years ended December 31, 1997, 1996 and 1995
1997 1996 1995
-----------------------------
Operating activities: (dollars in thousands)
Net income $ 1,532 $ 1,481 $ 737
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 86 96 85
Provision for loan losses 60 50 350
Deferred income taxes (36) (42) (66)
Contributions allowing the release of ESOP shares 579
Compensation earned under the Management
Recognition Plan 353
Decrease (increase) in accrued interest
receivable 26 (206) 28
Increase in cash surrender value of life
insurance (18) (64) (64)
Decrease (increase) in refundable income taxes (49) (56) 40
Increase (decrease) in amounts payable under
remittance service agreement 539 41 296
(Increase) decrease in other assets (48) 44 (90)
Increase (decrease) in accrued interest payable (26) 23 25
Increase (decrease) in accrued cash dividends
payable (402) 402
Increase (decrease) in other liabilities 257 281 143
-------- -------- -------
Net cash provided by
operating activities 2,853 2,050 1,484
-------- -------- -------
Investing activities:
Net increase in loans held for investment (10,035) (7,996) (9,474)
Principal collected on
mortgage-backed securities 597 108
Purchase of investment securities classified as
available-for-sale - (860)
Purchase of investment securities classified as
held-to-maturity (750) (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 875 439
Proceeds from maturities of investment securities
held-to-maturity 2,000 500 3,280
Purchase of FHLB Stock (74) (91) (79)
Purchase of premises and equipment (10) (47) (92)
-------- -------- -------
Net cash used by investing activities (7,397) (13,005) (6,865)
-------- -------- -------
Financing activities:
Net increase (decrease) in deposits 409 (6,471) 3,895
Proceeds from borrowings 7,800 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 (329) (2,198)
Cash dividends paid to shareholders (8,438) (803)
-------- -------- -------
Net cash provided by financing activities (558) 15,861 4,895
-------- -------- -------
Increase (decrease) in cash and cash
equivalents (5,102) 4,906 (486)
Cash and cash equivalents at beginning of period 9,805 4,899 5,385
-------- -------- -------
Cash and cash equivalents at end of period $ 4,703 $ 9,805 $ 4,899
======== ======== =======
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 3,517 $ 3,587 $ 3,581
======== ======== =======
Income taxes $ 949 $ 914 $ 390
======== ======== =======
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on available-for-sale
securities, net of deferred taxes (benefit) of
$2 for 1997, $3 for 1996 and $24 for 1995 $ 3 $ 8 $ 95
======== ======== =======
Dividends declared but unpaid $ - $ 402 $ -
======== ======== =======
See accompanying notes to consolidated financial statements.
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(1) Significant Accounting Policies
-------------------------------
Organization and Operations
---------------------------
On 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. In 1997, the Bank
formed a subsidiary, Stone Street Financial Services, Inc. for the purpose
of offering investment discount brokerage services to the public.
Basis of Presentation
---------------------
The consolidated financial statements include the accounts of the Parent and
the Bank and its wholly-owned subsidiary, 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 as 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.
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.
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(1) Significant Accounting Policies, Continued
------------------------------------------
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, 1997, 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.
For all specifically reviewed loans for which it is probable that the Bank
will be unable to collect all amounts due according to the terms of the loan
agreement, the Bank determines fair value either 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 impairment evaluation, 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, 1997, the Bank owned 7,410 shares of the FHLB's
$100 par value capital stock. No ready market exists for such stock, which
is carried at cost.
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.
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.
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(1) Significant Accounting Policies, Continued
------------------------------------------
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
------------------
The Company adopted the provisions of SFAS No. 128, "Earnings Per Share"
during 1997. Presentation of both basic and diluted earnings per share have
been presented in the financial statements. Because the Company's stock
options would have an antidilutive effect on earnings per share due to the
average marked price not exceeding the exercise price during the period,
both basic and diluted earnings per share are the same. Weighted average
shares outstanding for 1997 was 1,875,541 shares and for 1996, 1,825,050
shares were assumed outstanding for the full year.
New Accounting Pronouncements
-----------------------------
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, 1997 that will affect the Company's future reporting.
In August 1996, the financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 125 ("SFAS 125"),
"Accounting for Transfers and Servicing of financial assets and
Extinguishments of Liabilities". 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 transfer and servicing of
financial assets and extinguishments of liabilities occurring after December
31, 1996, and is to be applied prospectively. The Company adopted this
statement on January 1, 1997 without any impact on its consolidated
financial statements.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per
Share". SFAS 128 establishes standards of computing and presenting earnings
per share (EPS) and applies to entities with publicly held common stock or
potential common stock. This statement simplifies the standards for
computing earnings per share previously found in APB Opinion No. 15,
"Earnings Per Share", and makes them comparable to international EPS
standards. It replaces the presentation of primary EPS with a presentation
of basic EPS. It also requires dual presentation of basic and diluted EPS on
the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator of
the basic EPS computation to the numerator and denominator of the diluted
EPS computation. SFAS 128 is effective for financial statements issued for
periods ending after December 15, 1997 and requires restatement of all prior
period EPS data presented. The Company adopted this statement in fiscal year
1997 and has disclosed the required information in the financial statements.
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 129 ("SFAS 129"), "Disclosure of Information about Capital
Structure". SFAS 129 establishes standards for disclosing information about
an entity's capital structure and is applicable to all entities. It
contains no change in disclosure requirements for entities that were
previously subject to the requirements of APB Opinion No. 10, "Omnibus
Opinion - 1996", APB Opinion No. 15, "Earnings Per Share", and Statement of
financial Accounting Standards No. 47, "Disclosure of Long-Term
Obligations". SFAS 129 is effective for financial statements for periods
ending after December 15, 1997. The Company adopted this statement in
fiscal year 1997 with no impact on its consolidated financial statements.
Reclassifications
-----------------
Certain reclassifications have been made for 1996 and 1995 to conform with
the 1997 presentation. The reclassifications had no effect on previously
reported net income or stockholders' equity.
(2) Investment Securities
---------------------
The following is a summary of the investment securities portfolios by major
classification:
December 31, 1997
--------------------------------------------
(in thousands)
Estimated
Amortized Unrealized Unrealized market
cost gains losses value
--------- ---------- ---------- ---------
Securities held-to-maturity:
US government and agency
securities $ 3,489 $ 6 $ 1 $ 3,494
Mortgage-backed securities (a) 2,400 46 2,446
--------- ---------- ---------- ---------
Total securities
held-to-maturity 5,889 52 1 5,940
========= ========== ========== =========
Securities available-for-sale:
States and local governments $ 1,854 $ 6 $ 1 $ 1,859
--------- ---------- ---------- ---------
Total securities
available-for-sale $ 1,854 $ 6 $ 1 $ 1,859
========= ========== ========== =========
December 31, 1996
--------------------------------------------
(in thousands)
Estimated
Amortized Unrealized Unrealized market
cost gains losses value
--------- ---------- ---------- ---------
Securities held-to-maturity:
US government and agency
securities $ 4,753 $ 21 $ 18 $ 4,756
Mortgage-backed securities (a) 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
========= ========== ========== =========
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(2) Investment Securities, Continued
--------------------------------
<TABLE>
<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 $ 3,016
Mortgage-backed 274 - - 274
------- ------- ------ -------
Total securities held-to-maturity $ 3,269 $24 $ 3 $ 3,290
======= ======= ====== =======
Securities available-for-sale
State and local governments $ 1,629 $ 3 $ 2 $ 1,630
Mutual Funts 670 2 - 672
------- ------- ------ -------
Total securities available-for-sale $ 2,299 $ 5 $ 2 $ 2,302
======= ======= ====== =======
</TABLE>
(a) At December 31, 1997 and 1996, 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
$2,400,000 and $2,983,000 respectively, and a market value of $2,446,000
and $3,024,000.
The aggregate amortized cost and approximate market value of the available-
for-sale and held-to-maturity securities portfolios at December 31, 1997,
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 $ - $ - $ 500 $ 499
Due in 1 year through 5 years
US government agencies securities:
Due in 1 year or less 2,249 2,250
Due in 1 year through 5 years 740 745
Obligations of states and local governments:
Due in 1 year or less 1,090 1,089
Due 1 year through 5 years - -
Due after 5 through 10 years 764 770 - -
Mortgage-backed securities - - 2,400 2,446
----------------------------- ----------------------------
Total securities $ 1,854 $1,859 $5,889 $5,940
============================= ============================
</TABLE>
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
There was no sales activity for held-to-maturity or available-for-sale
securities for the years ended December 31, 1997, 1996 and 1995.
(3) Loans Receivable
----------------
<TABLE>
<CAPTION>
December 31,
-----------------
Loans receivable consist of the following: 1997 1996
------- -------
(in thousands)
Loans secured by first mortgages on real estate:
Mortgage loans held for investment, primarily one-to-four family $76,894 $67,844
Construction loans 8,571 12,492
Nonresidential real estate 9,541 5,716
------- -------
95,006 86,052
Home equity lines of credit 2,438 2,191
Other second mortgage loans 237 282
Other installment loans 632 372
------- -------
98,313 88,897
Undisbursed proceeds on loans in process (3,718) (4,385)
Deferred loan fees (1,058) (1,009)
Allowance for loan losses (570) (511)
------- -------
$92,967 $82,992
======= =======
<CAPTION>
An analysis of the allowance for loan losses follows:
1997 1996 1995
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Balance at beginning of period $ 511 $ 462 $ 115
Provision for loan losses 60 50 350
Loans charged off (1) (1) (3)
Recoveries - - -
------- ------- -------
Balance at end of period $ 570 $ 511 $ 462
======= ======= =======
</TABLE>
At December 31, 1997 and 1996, the Company had no loans which were in
nonaccrual status and $294,858 and $486,875 respectively, which were
contractually delinquent for 90 days or more and still accruing.
At December 31, 1997, the Company had mortgage loan commitments outstanding of
$4,102,595 and preapproved but unused lines of credit totaled $2,132,705. 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.
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, 1997.
<TABLE>
<CAPTION>
<S> <C>
Balance at December 31, 1996 $1,903,882
New loans 334,550
Repayments 209,480
----------
Balance at December 31, 1997 $2,028,952
==========
</TABLE>
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
-------------------------------------------
(4) Premises and Equipment
----------------------
Premises and equipment consist of the following:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
---------------------------------------- --------------------------------------
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 834 423 411 834 386 448
Furniture, fixtures and
equipment 507 371 136 500 330 170
Vehicles 26 7 19 26 2 24
---------------------------------------- --------------------------------------
$ 1625 $ 801 $ 824 $1,618 $ 718 $ 900
======================================== ======================================
</TABLE>
(5) Deposits
--------
Time deposits of $100,000 or more totaled $5,514,098 and $5,144,587 at
December 31, 1997 and 1996, respectively.
Interest expense on deposits includes $196,905, $343,000 and $431,000 for
the years ended December 31, 1997, 1996 and 1995, respectively, on time
deposits of $100,000 or more.
Contractual maturities of time deposits are as follows:
Total
Year Ending December 31, Maturities
------------------------ ----------------------
(dollars in thousands)
1998 $ 38,474
1999 11,667
2000 2,938
---------
Total time deposits $ 53,079
=========
(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:
December 31, 1997
----------------------
(in thousands)
6.50% due on or before December 31, 1998 $ 7,800
========
There were no FHLB advances outstanding at December 31, 1996. At December
31, 1997, the Bank had additional credit availability from the Federal
Home Loan Bank of $4,200,000.
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
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(7) Stockholders' Equity
--------------------
Common Stock
------------
The Company is authorized to issue 20,000,000 shares of common stock. The
common stock has no par value. As of December 31, 1997 and 1996, there were
1,898,052 and 1,825,050 shares of common stock issued and outstanding,
respectively. The increase is attributable to an additional 73,002 shares
of common stock issued for the MRP as discussed in Note 9 to the
consolidated financial statements.
Preferred Stock
----------------
The Company is authorized to issue up to 5,000,000 shares of preferred
stock. No shares of preferred stock have been issued or were outstanding at
December 31, 1997 or 1996. Such preferred stock may be issued in one or
more series with such rights, preferences, and designations as the Board of
Directors of the Parent may from time to time determine subject to
applicable law and regulations. If and when such shares are issued, holders
of such shares may have certain preferences, powers, and rights (including
voting rights) senior to the rights of the holders of the common stock of
the Company. The Board of Directors of the Parent can (without stockholder
approval) issue preferred stock with voting and conversion rights which
could, among other things, adversely affect the voting power of the holders
of the common stock of the company and assist management in an unfriendly
takeover or attempted change in control of the Company that some
stockholders may consider to be in their best interest but to which
management is opposed. The Company has no current plans to issue preferred
stock.
As of December 31, 1997, the FDIC categorized the Bank as "well-
capitalized". The Bank is required to meet minimum ratios for total risk-
based, and Tier I leverage (the ratio of Tier I capital to average assets)
as set forth in the following table. There are no events or conditions
since the notification that management believes have changed the Bank's
category.
<TABLE>
<CAPTION>
Minimum Ratios
-----------------------------
For To Be Well
Capital Amount Ratio Capital Capitalized Under
---------------- -------------- Adequacy Prompt Corrective
1997 1996 1997 1996 Purposes Action Provisions
------- ------- ------ ------ --------- ------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31:
Tier I Capital (ratio to risk-weighted assets): $26,027 $24,974 42.30% 51.95% 4.00% 6.00%
Tier Capital - Tier II capital (ratio to risk-
weighted assets): 26,597 25,485 43.23% 53.01% 8.00% 10.00%
Leverage - Tier I capital (ratio to average
Assets): 26,027 24,974 25.92% 25.90% 4.00% 5.00%
</TABLE>
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) Stockholders' Equity - 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 $663,215 without the approval of the Administrator.
Capital Adequacy
----------------
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, 1997 and 1996, the Bank was in compliance with all of the
aforementioned capital requirements.
(8) Income Taxes
------------
The components of income tax expense (benefit) were as follows:
Year ended December 31,
------------------------------
(in thousands)
1997 1996 1995
------------------------------
Currently payable:
Federal $ 798 $ 757 $ 530
State 145 139 80
------------------------------
943 896 610
------------------------------
Deferred:
Federal (34) (31) (147)
State (8) (7) (33)
------------------------------
(42) (38) (180)
------------------------------
$ 901 $ 858 $ 430
==============================
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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:
December 31,
----------------
1997 1996
----------------
(in thousands)
Allowance for loan losses (net) $ 229 $ 204
Deferred loan origination fees, net of deferred costs 424 404
------- -------
Gross deferred tax assets 653 608
Valuation allowance 0 0
------- -------
Net deferred tax assets 653 608
------- -------
Accelerated depreciation 46 52
FHLB stock dividends 180 180
Other temporary differences creating deferred tax assets 15
------- -------
Gross deferred tax liabilities 241 232
------- -------
Net deferred tax asset $ 412 $ 376
======= =======
The Company has no valuation allowance at December 31, 1997 or 1996 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:
December 31,
----------------------
1997 1996 1995
------ ------ ------
(in thousands)
Income taxes at the statutory federal tax rate $ 827 $ 798 $ 397
State income taxes less federal benefit 120 120 59
Tax exempt interest (29) (38) (40)
Other (17) (22) 14
------ ------ ------
Total tax expense $ 901 $ 858 $ 430
====== ====== ======
Retained earnings at December 31, 1997 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.
(9) Employee and Director Benefit Plans
-----------------------------------
DEFINED CONTRIBUTION RETIREMENT PLAN: The Bank had a self-administered,
defined contribution retirement plan that covered all eligible employees.
The Bank's policy has been to fund retirement costs accrued for the year.
Under the plan, the Bank contributed an actuarially determined amount based
on a participants compensation and years of 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.
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(9) Employee and Director Benefit Plans - Continued
------------------------------------------------
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 totaled approximately $866 in 1997, $1,900 in 1996, and $10,000 in
1995.
EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP"): The Bank has an ESOP whereby an
aggregate number of shares amounting to 146,004 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 was funded in December, 1996 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. 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 amounts of the participants and reported as dividends in the
consolidated financial statements.
During 1997, the Bank made a $250,491 contribution to the ESOP, representing
the normal principal payment due for the year and the application of
dividends on unallocated shares to the principal balance of the loan. This
contribution resulted in the release of 23,617 shares to individual
participant accounts. At December 31, 1997, a total of 30,822 shares have
been released and allocated to participants and 115,182 shares remain
unallocated.
Total compensation expense associated with the ESOP for the years ended
December 31, 1997 and 1996 was $180,000 and $175,000, respectively. At
December 31, 1997, there were 115,182 unallocated ESOP shares with a total
fair value of approximately $2,555,601.
In fiscal year 1996, the $175,000 cash contribution made for the year ended
December 31, 1996 was used to release 7,205 shares to ESOP participants.
During the year ended December 31, 1997, 23,617 shares were considered
committed to be released to ESOP participants, and compensation expense of
$180,000 associated with those shares was recorded.
Management Recognition Plan ("MRP")
-----------------------------------
The Bank's MRP was approved by stockholders of the Parent and by the
Parent's and the Bank's Boards of Directors during fiscal year 1997. The MRP
serves as a means of providing existing directors and employees of the Bank
with an ownership interest in the Company. Shares of the Company's common
stock awarded under the MRP vest equally over a five year period.
Compensation expense related to those shares is recognized on a straight-
line basis corresponding with the vesting period. Prior to vesting, each
participant granted shares under the MRP may direct the voting of the shares
allocated to the participant and will be entitled to receive any dividends
or other distributions paid on such shares. On May 9, 1997, 73,002 shares
were awarded under the MRP. Total compensation expense associated with the
MRP for the year ended December 31, 1997 was $352,779.
32
<PAGE>
NOTES TO FINANCIAL STATEMENTS - Continued
-----------------------------------------
(9) Employee and Director Benefit Plans - Continued
-----------------------------------------------
Stock Option Plan
-----------------
The Company adopted a Stock Option Plan which has also been approved by the
stockholders of the Parent and by the Parent's and the Bank's Boards of
Directors. The Stock Option Plan makes available options to purchase 182,505
shares, or 10% of the shares issued in the conversion to employees and
directors. Options granted under the Stock Option Plan to directors vest
immediately while options granted to employees have a vesting schedule which
provides that 20% of the options granted vest in the first year, and 20%
will vest on each subsequent anniversary date, so that options would be
completely vested within five years from the date of grant. Options become
100% vested upon death or disability, if earlier. Unexercised options expire
within ten years from the date of grant. The exercise price for options
granted in 1997 was the fair market value at the date of grant (May 9, 1997)
of $25.625 per share and was adjusted to $21.75 to reflect the $4.00 special
return of capital dividend paid to stockholders in 1997.
The weighted-average fair value per share of options granted in 1997
amounted to $6.26. Fair values were estimated at the date of the grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions.
Risk-free interest rate 6.75%
Dividend yield 3.90
Volatility 30.00
Expected life 7 years
A summary of the Company's stock option activity and related information for
the year ended December 31, 1997 follows:
Outstanding Exercisable
------------------ -----------------
Weighted Weighted
Average Average
Option Exercise Option Exercise
Shares Price Shares Price
-------- -------- ------- --------
At December 31, 1996 - $ - - $ -
Granted 172,244 21.75 78,241 21.75
Exercised - - - -
Forfeited - - - -
-------- -------- ------- --------
At December 31, 1997 $172,244 $ 21.75 $78,241 $ 21.75
======== ======== ======= ========
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 $123,271 for 1997, $48,000 for 1996, and
$70,000 for 1995.
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'
33
<PAGE>
NOTES TO FINANCIAL STATEMENTS - Continued
-----------------------------------------
(9) Employee and Director Benefit Plans - Continued
-----------------------------------------------
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.
The Company has elected to follow APB Opinion No. 25 ("APB 25"),
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock options as permitted under SFAS NO. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation". In accordance with APB
25, no compensation cost is recognized by the Company when stock options
are granted because the exercise price of the Company's stock options
equals the market price of the underlying common stock on the date of
grant. As required by SFAS 123, disclosures are presented below for the
effect on the net income and net income per share that would result from
the use of the fair value based method to measure compensation cost related
to stock option grants in 1997. The effects of applying the provisions of
SFAS 123 in 1997 are not necessarily indicative of future effects.
Amount
------
(in thousands, except per share data)
Net income
As reported $ 1,532
Pro forma 1,498
Net income per share
As reported $ .82
Pro forma .80
(10) Quarterly Financial Data (Unaudited)
------------------------------------
Summarized unaudited quarterly financial data for the year ended December
31, 1997 is as follows:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
Operating Summary: (in thousands except per share amounts)
<S> <C> <C> <C> <C>
Interest income $ 2,110 $ 2,050 $ 2,099 $ 2,094
Interest expense 826 840 890 935
-------- -------- -------- --------
Net interest income 1,284 1,210 1,209 1,159
Provision for loan losses 15 15 15 15
-------- -------- -------- --------
Net interest income after provision for loan
losses 1,269 1,195 1,194 1,144
Other income 34 33 36 42
Other expenses 450 826 604 634
-------- -------- -------- --------
Income before income tax expense 853 402 626 552
Income taxes 327 144 240 190
-------- -------- -------- --------
Net income 526 258 386 362
Per Share Data:
Net Income per share--basic .29 .14 .20 .19
Net Income per share--diluted .29 .14 .20 .19
Cash dividends declared .1125 .1125 4.1125 .1125
Dividend payout 39.04 82.74 55.27 59.01
Book value per share 20.76 16.13 16.32 16.37
Selected Average Balances:
Assets $104,971 $105,946 $103,526 $105,630
Investment securities 17,149 14,494 11,471 10,529
Loans, net 84,256 86,024 87,469 91,095
Interest-bearing deposits 65,938 71,490 65,553 66,414
FHLB advances - - 3,390 6,555
Stockholders' equity 37,587 34,212 30,799 31,027
</TABLE>
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(10) Quarterly Financial Data (Unaudited) - Continued
------------------------------------------------
Summarized unaudited quarterly financial data for the year ended December
31, 1996 is as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------------
Operating Summary: (in thousands except per share amounts)
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:
Net income per share--basic N/A .30 .15 .26
Net income per share--diluted N/A .30 .15 .26
Cash dividends declared N/A .11 .11 .22
Dividend payout N/A 37.29 74.72 85.00
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
35
<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:
December 31, December 31,
1997 1996
------- -------
Condensed Balance Sheet (in thousands)
Assets:
Cash on deposit with bank subsidiary $ 3,957 $ 4,272
Interest bearing deposits 204 7,531
Investment securities available for sale at
market value:
Obligations of states and local governments,
cost $860,000 859 859
Investment in bank subsidiary 26,030 25,230
Other assets 118 164
------- -------
Total assets $31,168 $38,056
======= =======
Liabilities and stockholders' equity:
Accrued expenses and other liabilities $ 92 $ 418
Stockholders' equity, net 31,076 37,638
------- -------
Total liabilities and stockholders' equity $31,168 $38,056
======= =======
Year Ended December 31, December 31,
1997 1996
------- -------
Condensed Statement of Income (in thousands)
Dividends from bank subsidiary $ 619 $ 435
Interest income from bank subsidiary 203 30
Interest on interest bearing deposits 149 483
Interest on loan from bank subsidiary ESOP 182 93
Interest on investment securities 33 5
------- -------
Total income 1,186 1,046
Operating expenses 241 30
------- -------
Income before income taxes 945 1,016
Income tax expense 120 227
------- -------
Income before equity in undistributed net
income of subsidiary 825 789
Equity in undistributed net income of bank
subsidiary 707 692
------- -------
Net income $ 1,532 $ 1,481
======= =======
36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
------------------------------------------------------
(11) Parent Company Financial Data - Continued
-----------------------------------------
Year Ended
December 31, December 31,
1997 1996
------- -------
Condensed Statement of Cash Flows (in thousands)
Cash flows from operating activities:
Net income $ 1,532 $ 1,481
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary (707) (692)
Payments on ESOP loan receivable from bank
subsidiary 579 -
(Increase) (decrease) in other assets 47 (164)
Increase in other liabilities (326) 418
------- --------
Net cash provided by operating activities 1,125 1,043
------- --------
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 (329) (2,198)
Capital contribution to bank subsidiary - (11,712
Cash dividends paid to stockholders (8,438) (803)
------- --------
Net cash provided by financing activities (8,767) 11,620
------- --------
Net increase in cash and cash equivalents (7,642) 11,803
Cash and cash equivalents at beginning of year 11,803 -
------- --------
Cash and cash equivalents at end of year $ 4,161 $ 11,803
======= ========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 149 $ 283
======= ========
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on securities
available for sale net of deferred tax benefit
of $1 in each year $ (1) $ (1)
======= ========
Unrealized gains (losses) on subsidiary's
securities available for sale, net of deferred
tax benefit of $2 and $3 in 1997 and 1996,
respectively $ 4 $ (7)
======= ========
Dividends declared but unpaid $ - $ 402
======= ========
37
<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 judgments 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, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
-------------------- --------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value fair value
-------- ---------- -------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and interest-bearing deposits $ 4,703 $ 4,703 $ 9,805 $ 9,805
Investment securities:
Available-for-sale 1,854 1,859 2,723 2,723
Held-to-maturity 5,889 5,940 7,736 7,780
Net loans 92,967 92,549 82,992 82,617
Federal Home Loan Bank stock 741 741 667 667
Financial liabilities:
Deposits 66,973 67,106 66,564 66,667
Advance from FHLB 7,800 7,805 - -
</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, 1997, 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.
38
<PAGE>
CAPITAL STOCK
-----------------------
Stone Street Bancorp's common stock is traded on the American Stock Exchange
under the symbol "SSM". As of December 31, 1997, there were 1,898,052 shares
outstanding and 720 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 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, as applicable.
Quarterly Common Stock Performance and Dividends Declared
For the Year Ended December 31, 1997
<TABLE>
<CAPTION>
Stock Price Dividends Declared, Per Share
----------------- -----------------------------
High Low
------ -----
<S> <C> <C> <C>
First Quarter ended January 31 $ 27 1/2 $ 20 1/8 $ .1125
Second quarter ended June 30 27 1/2 20 15/16 .1125
Third quarter ended September 30 (1) 22 1/8 21 1/8 4.1125
Fourth quarter ended December 31 22 7/8 18 1/2 .1125
- ----------------------------------
</TABLE>
(1) Includes regular cash dividend of $.1125 per share and a return of
capital dividend of $4.00 per share.
40
<PAGE>
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". Mocksville
Savings Bank, Inc., SSB has a wholly-owned subsidiary, Stone Street Financial
Services, Inc., a North Carolina Corporation.
Exhibit 21
<PAGE>
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the incorporation by reference into all Registration
Statements on Form 10-K of Stone Street Bancorp, Inc. of our report dated
January 30, 1998, relating to the consolidated balance sheets of Stone Street
Bancorp, Inc. and subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of income, stockholders' equity and cash flows for the
years then ended, which report appears in the Company's 1997 annual report on
Form 10-K.
/s/ Weir Smith Jones Miller & Elliott
Weir Smith Jones Miller & Elliott
Statesville, North Carolina
March 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 968
<INT-BEARING-DEPOSITS> 2,701
<FED-FUNDS-SOLD> 1,034
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,859
<INVESTMENTS-CARRYING> 5,889
<INVESTMENTS-MARKET> 5,940
<LOANS> 92,967
<ALLOWANCE> 570
<TOTAL-ASSETS> 108,092
<DEPOSITS> 66,973
<SHORT-TERM> 7,800
<LIABILITIES-OTHER> 2,243
<LONG-TERM> 0
0
0
<COMMON> 20,611
<OTHER-SE> 10,465
<TOTAL-LIABILITIES-AND-EQUITY> 108,092
<INTEREST-LOAN> 7,490
<INTEREST-INVEST> 572
<INTEREST-OTHER> 291
<INTEREST-TOTAL> 8,353
<INTEREST-DEPOSIT> 3,345
<INTEREST-EXPENSE> 3,491
<INTEREST-INCOME-NET> 4,862
<LOAN-LOSSES> 60
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,514
<INCOME-PRETAX> 2,433
<INCOME-PRE-EXTRAORDINARY> 2,433
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,532
<EPS-PRIMARY> .82
<EPS-DILUTED> .83
<YIELD-ACTUAL> 4.77
<LOANS-NON> 0
<LOANS-PAST> 295
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 511
<CHARGE-OFFS> 1
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 570
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 570
</TABLE>
