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, 1998
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
incorporation or organization Identification No.)
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.
$23,143,135 common stock, no par value, based on the closing price of such
common stock on March 18, 1999.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 1,638,452 shares of common
stock, no par value, outstanding at March 18,1999.
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report of Stone Street Bancorp, Inc. for the year ended
December 31, 1998, (the "1998 Annual Report") are incorporated by reference into
Part I, Part II and Part IV.
Portions of the Proxy Statement for the 1999, Annual Meeting of Shareholders of
Stone Street Bancorp, Inc. to be held on April 20, 1999 (the "Proxy Statement"),
are incorporated by reference into Part III.
<PAGE>
PART I
ITEM 1. BUSINESS
General
Prior to March 29, 1996, Stone Street Bank and Trust (formerly
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 Stone Street Bank and Trust.
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. Stone Street 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. Stone Street 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. Stone Street's primary source of revenue is interest income from its
lending activities. Stone Street'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 Stone Street 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.
<PAGE>
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>
Interest Rate Risk 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, 1998.
<TABLE>
<CAPTION>
Maturing or Repricing in Years Ended December 31,
----------------------------------------------------------------------------------------
2000- 2002- 2004-
1999 2001 2003 2008 Thereafter Total
---------- --------- -------- ---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets
Loans receivable:
Amount .................. $ 4,394 $ 1,649 $ 4,559 $ 42,350 $ 49,597 $ 102,549
Average interest rate ... 8.66% 8.72% 8.40% 7.52% 7.47% 7.60%
Mortgage-backed securities:
Amount .................. 9,662 -- -- -- 1,744 11,406
Average interest rates .. 5.79% --% -- % -- 7.24% 6.02%
Investment Securities:
Amount .................. 748 386 378 -- -- 1,512
Average interest rates .. 6.35% 4.73% 4.25% -- -- % 5.41%
Liabilities
Deposit Certificate Accounts:
Amount .................. 49,853 7,965 1,454 -- -- 59,272
Average interest rates .. 5.48% 5.51% 5.30% -- --% 5.48%
FHLB Advances:
Amount .................. 6,967 -- 2,000 15,000 -- 23,967
Average interest rates .. 5.78% --% 5.52% 5.09% --% 5.33%
</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 option
on 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 in its
portfolio.
<PAGE>
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 increase 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 and liabilities to maintain an acceptable interest rate spread
while reducing the net effects of changes in interest rates.
3
<PAGE>
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 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, 1998.
The Board of Directors is responsible for reviewing the Bank's 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. The management is responsible for administering the policies and
determinations of the Board of Directors with respect to its 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 Gray 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, Sara Lee and Ingersol-Rand.
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, and other personal property, mobile home (including
land) loans, savings account loans and other loans. Over 98.77% of the Bank's
net loan portfolio is secured by real estate. As of December 31, 1998, all of
the loans in the Bank's real estate loan portfolio were secured by properties in
North Carolina. On December 31, 1998, the Bank's largest single outstanding loan
had a balance of approximately $1,223,400. 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 modifications,
late payments, loan assumptions and other miscellaneous services.
<PAGE>
Loan Portfolio Composition. The Bank's net loan portfolio totaled
approximately $102.5 million at December 31, 1998 representing 80.57% of Stone
Street's total assets at such date. At December 31, 1998, 82.00% of Stone
Street's net loan portfolio was composed of one-to-four family residential
mortgage loans. Home equity and subordinate lien loans represented 2.42% of the
Bank's net loan portfolio, and nonresidential real estate loans represented
9.38% 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, 1998, the Bank had approximately $926,000 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,
---------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------- ------------------ -------------------- ------------------- -------------------
% 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 ....... $ 84,094 82.00% $ 76,894 82.71% $ 67,844 81.75% $ 63,329 84.33% $ 54,321 82.34%
Residential multi-
family and
nonresidential
real estate ..... 9,619 9.38 9,541 10.26 5,716 6.88 4,260 5.67 4,987 7.56
Other subordinate
lien loans ...... 2,477 2.42 2,675 2.88 2,473 2.98 2,185 2.91 1,423 2.16
Residential
construction .... 12,670 12.35 8,571 9.22 12,492 15.05 11,735 15.63 11,589 17.56
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate
loans: .......... 108,860 106.15 97,681 105.07 88,525 106.66 81,509 108.54 72,320 109.62
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Other installment
loans ........... 1,265 1.23 632 .68 372 .45 222 .30 197 0.30
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Less:
Unearned fees and
discounts ........ 1,212 1.18 1,058 1.14 1,009 1.22 962 1.29 1,095 1.66
Loans in process . 5,614 5.47 3,718 4.00 4,385 5.28 5,211 6.94 5,334 8.09
Allowance for
loan losses ..... 750 .73 570 .61 511 .61 462 .61 115 0.17
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total reductions . 7,576 7.38 5,346 5.75 5,905 7.11 6,635 8.84 6,544 9.92
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans
receivable net .. $102,549 100.00% $ 92,967 100.00% $ 82,992 100.00% $ 75,096 100.00% $ 65,973 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
</TABLE>
<PAGE>
The following table sets forth the time to contractual maturity of the
Bank's loan portfolio at December 31, 1998. 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 $33.7 million, $18.1 million
and $16.2 million in fiscal years ended December 31, 1998, 1997 and 1996,
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, 1998
--------------------------------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or less 3 Years 5 Years 10 Years Years Total
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Fixed rate 1-4 family
residential ............ $ 22 $ 1,134 $ 4,246 $ 38,953 $ 44,249 $ 88,604
Adjustable rate 1-4 family
residential ............ 1,455 -- -- -- -- 1,455
Adjustable home equity
loans ................... 2,356 -- -- -- -- 2,356
Other fixed rate loans ... 46 515 313 3,397 5,348 9,619
Other loans ................ 1,265 -- -- -- -- 1,265
Less:
Allowance for loan losses (750) -- -- -- -- (750)
--------- --------- --------- --------- --------- ---------
$ 4,394 $ 1,649 $ 4,559 $ 42,350 $ 49,597 $ 102,549
========= ========= ========= ========= ========= =========
</TABLE>
The following table sets forth the dollar amount at December 31, 1998
of all loans maturing or repricing on or after December 31, 1999.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
----------- -----------
(In Thousands)
<S> <C> <C>
Mortgage loans $ 88,582 $ -
Other loans 9,573 -
----------- -----------
$ 98,155 $ -
=========== ===========
</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.
<PAGE>
Although the Bank believes that many of its nonconforming loans are
salable 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,
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1998 1997 1996
---------- ---------- -----------
(In Thousands)
<S> <C> <C> <C>
Loans receivable, net beginning of period $ 92,967 $ 82,992 $ 75,096
Loan originations:
Residential 1-4 family 26,932 12,575 11,880
Residential multifamily and
nonresidential real estate 3,818 4,772 1,730
Home equity and second mortgage 793 1,038 901
Residential construction 10,019 7,975 8,412
Consumer 2,079 1,195 410
---------- ---------- -----------
Total loan originations 43,641 27,555 23,333
Principal repayments (33,725) (18,139) (16,167)
Other changes, net (334) 559 730
---------- ---------- -----------
Increase in loans receivable 9,582 9,975 7,896
---------- ---------- -----------
Loans receivable, net, end of period $ 102,549 $ 92,967 $ 82,992
========== ========== ===========
</TABLE>
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, 1998, approximately 82.00% 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 .35% had adjustable interest
rates.
<PAGE>
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, 1998, the Bank had $9.6 million in outstanding loans secured by
nonresidential real estate, including undeveloped land, comprising approximately
of 9.38% 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
<PAGE>
nonresidential lending policies and revised its commercial loan underwriting
procedures in order to, among other things, improve loan documentation. As of
December 31, 1998, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $1,223,400. 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,
1998, the Bank had approximately $2.5 million in home equity and other
subordinate lien loans, representing approximately 2.42% of its net loan
portfolio. Of this amount, $2.2 million was composed of home equity line of
credit loans. These loans are often originated at the time of the closing of a
one-to-four family residential real estate loan secured by the same property.
The Bank's home equity lines of credit have adjustable interest rates tied to
prime interest rates plus a margin. The home equity lines of credit require
monthly payments of 2% of the outstanding balance or $100, whichever is greater.
These loans mature in fifteen years. Home equity lines of credit are generally
secured
8
<PAGE>
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, 1998 was approximately $12.7 million, representing
approximately 12.35% 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, 1998, the Bank had
approximately $235,200 of such loans outstanding, representing approximately
.23% 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
90% of the purchase price.
<PAGE>
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-in customers and in
some instances, other lenders.
9
<PAGE>
During its loan approval process, the Bank assesses the applicant's
ability to make principal and interest payments on the loan and the value of the
property securing the loan. The Bank obtains detailed written loan applications
to determine the borrower's ability to repay and verifies responses on the loan
application through the use of credit reports, financial statements, and other
confirmations. Under current practice, the 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 generally 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 up to $100,000. The President and Senior
Vice President of the bank have the authority to approve loans up 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,
Stone Street 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, 1998,
the Bank had $5.6 million in such unfunded mortgage loan commitments. In
addition, on such date the Bank had $2.8 million in unfunded commitments for
unused lines of credit and letters of credit.
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 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
<PAGE>
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, 1998, the Bank did not own any real estate acquired in settlement
of loans. Real estate acquired through, or in lieu of, loan foreclosure is
initially recorded at the lower cost or fair value at the date of foreclosure,
establishing a new cost basis. After foreclosure, valuations are periodically
performed by management, and the real estate is carried at the lower of cost or
fair value minus costs to sell. Revenue and expenses from holding the properties
and additions to the valuation allowance are included in operations.
Interest on loans is recorded as borrowers' monthly payments become
due. Accrual of interest income on loans is suspended, when, in management's
judgment, doubts exist as to the collectibility of additional interest within
reasonable time. Loans are returned to accrual status when management
determines, based upon an
10
<PAGE>
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,
-------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ----------- ----------- ---------- -----------
(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 $ 243 $ 295 $ 423 $ 201 $ 280
========== =========== =========== ========== ===========
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 $ 127,273 $ 108,092 $ 105,807 $ 87,751 $ 81,560
Total loans, net $ 102,549 $ 92,967 $ 82,992 $ 75,097 $ 65,973
</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
"uncollectable" and of such little value that their continuance as assets
without the establishment of a loss reserve is not warranted.
<PAGE>
As of December 31, 1998, the Bank had approximately $243,000 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, 1998, the Bank had no loans in the "special
mention" category.
When an insured institution classifies problem assets as either
substandard or doubtful, it is required to establish general allowances for loan
losses in an amount deemed prudent by management. These allowances represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities and the risks associated with particular
problem assets. When an insured institution classifies problem assets as "loss,"
it charges off the balance of the asset. The Bank's determination as to the
classification of its
11
<PAGE>
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, 1998, 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 - $ -- - $ 243 - $ - - $ -
Residential multifamily
and nonresidential
real estate - - - - - - - -
Home equity and second
mortgage - - - - - - - -
Residential construction - - - - - - - -
--------- --------- --------- -------- --------- --------- --------- ---------
Total real estate loans - - - $ 243 - - - -
--------- --------- --------- -------- --------- --------- --------- ---------
Consumer loan - - - - - - - -
--------- --------- --------- -------- --------- --------- --------- ---------
Total - $ - - $ 243 - $ - - $ -
========= ========= ========= ======== ========= ========= ========= =========
</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,
-------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- ------ --------
<S> <C> <C> <C> <C> <C>
Balance, beginning of period $ 570 $ 511 $ 462 $ 115 $ 89
Provision for loan losses 180 60 50 350 26
Charge-offs:
Residential 1-4 family - - - - -
Consumer - 1 1 3 -
Recoveries:
Residential 1-4 family - - - - -
Consumer - - - - -
-------- -------- -------- ------- --------
Balance, end of period $ 750 $ 570 $ 511 $ 462 $ 115
======== ======== ======== ======= ========
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 .69% .58% .57% .57% .16%
</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,
-----------------------------------------------------------------------------------------------------
1998 1997 1996 1995
------------------------- ----------------------- ----------------------- -----------------------
(In Thousands)
Amount of Amount of Amount of Amount of
Amount of Loans to Amount of Loans to Amount of Loans to Amount of Loans to
Allowance Gross Loans Allowance Gross Loans Allowance Gross Loans Allowance Gross Loans
--------- ----------- --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential
1-4 family $ 188 76.37% $ 154 78.21% $ 138 76.32% $ 127 77.48%
Residential multifamily
and nonresidential
real estate 263 8.74 171 9.71 153 6.43 138 5.21
Home equity and
second mortgage 53 2.25 58 2.72 52 2.78 46 2.67
Residential construction 188 11.50 143 8.72 128 14.05 115 14.36
------- ------ ------- ------ ------ ------ -------- ------
Total real estate loans 692 98.86 526 99.36 471 99.58 426 99.72
Consumer loans 58 1.14 44 .64 40 .42 36 .28
------- ------ ------- ------ ------ ------ -------- ------
Total $ 750 100.00% $ 570 100.00% $ 511 100.00% $ 462 100.00%
======= ====== ======= ====== ====== ====== ======== ======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
At December 31,
------------------------
Amount of
Amount of Loans to
Allowance Gross Loans
--------- -----------
<S> <C> <C>
Real estate loans:
Residential
1-4 family $ 45 74.91%
Residential multifamily
and nonresidential
real estate 23 6.88
Home equity and
second mortgage 12 1.96
Residential construction 24 15.98
------- ------
Total real estate loans 104 99.73
Consumer loans 11 0.27
------- ------
Total $ 115 100.00%
======= ======
</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, 1998, the carrying value of the Bank's
investment securities portfolio totaled $19.7 million and consisted of
interest-bearing deposits, U.S. government and agency securities,
mortgage-backed securities, federal funds sold and stock in the FHLB of Atlanta.
The mortgage-backed securities consist of mortgage-backed securities issued by
the GNMA, FHLMC and SBA.
The investment securities portfolio includes interest-bearing deposits
of $4.4 million at December 31, 1998. 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 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 but the
Bank may redeem the stock with the FHLB at its par value. As of December 31,
1998, the Bank's investment in stock of the FHLB of Atlanta was $1,569,800.
<PAGE>
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.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- ---------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing
deposits in other
financial
institutions ............. $ 4,406 $ 4,406 $ 2,701 $ 2,701 $ 7,916 $ 7,916
------- ------- ------- ------- ------- -------
Securities available-
for-sale:
Obligations of states
and political
subdivisions ........... $ 764 $ 783 $ 1,854 $ 1,859 $ 2,019 $ 2,011
Mortgage-backed securities 9,662 9,575 -- -- -- --
Mutual funds ............. 0 0 0 0 712 712
------- ------- ------- ------- ------- -------
Total securities
available-for-
sale ................... $10,426 $10,358 $ 1,854 $ 1,859 $ 2,731 $ 2,723
------- ------- ------- ------- ------- -------
Securities held-
to-maturity:
U.S. government
and agency
securities ............. $ 748 $ 750 $ 3,489 $ 3,494 $ 4,753 $ 4,756
Mortgage-backed
securities ............. 1,744 1,741 2,400 2,446 2,983 3,024
------- ------- ------- ------- ------- -------
Total securities
held-to-maturity ......... $ 2,492 $ 2,491 $ 5,889 $ 5,940 $ 7,736 $ 7,780
======= ======= ======= ======= ======= =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
December 31
--------------------------------------------
1995 1994
--------------------------------------------
Amortized Market Amortized Market
Cost Value Cost Value
------- ------- ------- -------
<S> <C> <C> <C> <C>
Interest-bearing
deposits in other
financial
institutions ............. $ 2,737 $ 2,737 $ 3,941 $ 3,941
------- ------- ------- -------
Securities available-
for-sale:
Obligations of states
and political
subdivisions ........... $ 1,629 $ 1,630 $ 2,644 $ 2,521
Mortgage-backed securities -- -- -- --
Mutual funds ............. 670 672 616 616
------- ------- ------- -------
Total securities
available-for-
sale ................... $ 2,299 $ 2,302 $ 3,260 $ 3,137
------- ------- ------- -------
Securities held-
to-maturity:
U.S. government
and agency
securities ............. $ 2,995 $ 3,016 $ 4,799 $ 4,635
Mortgage-backed
securities ............. 274 274 319 334
------- ------- ------- -------
Total securities
held-to-maturity ......... $ 3,269 $ 3,290 $ 5,118 $ 4,969
======= ======= ======= =======
</TABLE>
(1) The net unrealized gain (loss) at December 31, 1998 and 1997 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.
16
<PAGE>
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, 1998.
<TABLE>
<CAPTION>
After One Year Through After Five Years Through
One Year or Less Five Years Ten Years After Ten Years
--------------------- --------------------- ----------------------- ----------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits
in other financial
institutions $ 4,406 4.90% $ - -% $ - -% $ - -%
Securities available-
for-sale:
Obligations of states
and political
subdivisions(1) $ - -% $ 386 4.73% $ 378 4.25% $ - -%
Mortgage backed securities - - - - - - 9,662 5.79
Total securities
available-for-sale $ - -% $ 386 4.73% $ 378 4.25% $ 9,662 5.79%
Securities held-to-
maturity:
U.S. government and
agency securities $ 748 6.35% $ - -% $ - -% $ - -%
Mortgage-backed
securities - - - - - - 1,744 7.24
Total securities
held-to-maturity $ 748 6.35% $ - -% $ - -% $ 1,744 7.24%
Total investments, at
carrying value $ 748 6.35% $ 386 4.73% $ 378 4.25% $ 11,406 6.01%
Total interest-bearing
deposits and
investments $ 5,154 5.11% $ 386 4.73% $ 378 4.25% $ 11,406 6.01%
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Total
----------------------
Weighted
Carrying Average
Value Yield
----- -----
<S> <C> <C>
Interest-bearing deposits
in other financial
institutions $ 4,406 4.90%
Securities available-
for-sale:
Obligations of states
and political
subdivisions(1) $ 764 4.49%
Mortgage backed securities 9,662 5.79
Total securities
available-for-sale $ 10,426 5.69%
Securities held-to-
maturity:
U.S. government and
agency securities $ 748 6.37%
Mortgage-backed
securities 1,744 7.24
Total securities
held-to-maturity $ 2,492 6.98%
Total investments, at
carrying value $ 12,918 5.94%
Total interest-bearing
deposits and
investments $ 17,324 5.68%
</TABLE>
(1) Yields on obligations of sates and political subdivisions are not calculated
on a tax-equivalent basis.
17
<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 $24.0 million at December 31, 1998 with the FHLB of
Atlanta.
Deposits. On December 31, 1998, 1997 and 1996, the Bank's deposits
totaled $73.2 million, $67.0 million and $66.5 million, respectively.
The following table sets forth information relating to the Bank's
deposit flows during the periods shown and total deposits at the end of the
periods shown.
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
----------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
Total deposits at
beginning of period $ 66,973 $ 66,564 $ 73,035 $ 69,140 $ 64,282
Net increase (decrease)
before interest credited 3,823 (2,713) (9,518) 914 3,021
Interest credited 2,380 3,122 3,047 2,981 1,837
------------ ------------ ------------ ------------ --------------
Total deposits at end of
period $ 73,176 $ 66,973 $ 66,564 $ 73,035 $ 69,140
============ ============ ============ ============ ==============
</TABLE>
The Bank attracts both short-term and long-term deposits from the
general public by offering a variety of accounts and rates. The Bank offers
passbook and statement 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.
18
<PAGE>
The following table sets forth certain information regarding the Bank's
savings deposits at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
------------------------------ ----------------------------- -----------------------------
1998 1997 1996
------------------------------ ----------------------------- -----------------------------
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 $ 8,696 2.84% 12.26% $ 9,189 3.00% 13.72% $11,377 3.00% 16.06%
NOW accounts .................. 4,367 .54 5.90 2,242 .61 3.35 1,514 0.73 2.14
Money market deposit accounts . 841 2.45 1.14 2,463 2.46 3.68 2,416 2.45 3.41
------- ---- ------ ------- ---- ------ ------- ---- ------
Total demand deposits .... 13,904 2.09 19.30 13,894 2.61 20.75 15,307 2.69 21.61
------- ---- ------ ------- ---- ------ ------- ---- ------
Time Deposits:
Certified accounts with
original maturities of:
3 months or less ......... 599 4.67 1.54 1,348 4.80 2.01 3,786 4.86 5.34
3-6 months ............... 13,502 4.90 18.22 7,894 5.33 11.79 9,205 5.23 12.99
11-12 months ............. 13,853 5.38 18.69 14,924 5.53 22.28 17,089 5.40 24.13
13 months ................ 10,128 5.72 13.66 3,494 5.94 5.22
18 months ................ 3,658 5.49 4.93 4,908 5.74 7.33 5,183 5.59 7.32
24 months ................ 3,171 5.64 4.28 3,508 5.70 5.24 3,483 5.98 4.92
25 months ................ 2,035 5.94 2.75 2,017 5.84 3.01
30 months ................ 12,197 5.75 16.46 14,986 5.7 22.37 16,781 6.16 23.69
36 months ................ 129 5.00 .17 -- --
------- ---- ------ ------- ---- ------ ------- ---- ------
Total certificates ..... 59,272 5.44 80.70 53,079 5.62 79.25 55,527 5.62 78.39
------- ---- ------ ------- ---- ------ ------- ---- ------
Total deposits ...... $73,176 4.80% 100.00% $66,973 4.88% 100.00% $70,834 4.99% 100.00%
======= ==== ====== ======= ==== ====== ======= ==== ======
</TABLE>
19
<PAGE>
As of December 31, 1998, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $8.3 million.
<TABLE>
<CAPTION>
Amount
-----------
(In Thousands)
<S> <C> <C>
3 Months or less $ 958
Over three months through 6 months 1,065
Over 6 months through 12 months 1,831
Over 12 months 4,419
-----------
Total $ 8,273
===========
</TABLE>
Borrowings. The FHLB system functions in a reserve credit capacity for
savings institutions. As a member, the Bank is required to own capital stock in
the FHLB of Atlanta and is authorized to apply for advances from the FHLB of
Atlanta on the security of that stock and a floating lien on certain of its real
estate secured loans and other assets. Each credit program has its own interest
rate and range of maturities. Depending on the program, limitations on the
amount of advances are based either on a fixed percentage of an institution's
net worth or on the FHLB of Atlanta's assessment of the institution's
creditworthiness. At December 31, 1998 the Bank had outstanding borrowings from
the FHLB of Atlanta totaling $23,967,000.
The following table sets forth information relating to the weighted
average rates and the maturities of the borrowings at December 31, 1998:
<TABLE>
<CAPTION>
Amount
------------
(In thousands)
<S> <C>
5.78% due on or before December 31, 1999 $ 6,967
5.52% due on or before August 2, 2003 2,000
5.09% due on or before August 28, 2008 15,000
------------
Total $ 23,967
============
</TABLE>
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
<PAGE>
has also faced additional significant competition for investors' funds for
short-term money market securities and other corporate and government
securities. At December 31, 1998 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, 1998, the
Bank had a deposit market share of approximately 25.14% 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
20
<PAGE>
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, 1998, the Bank had 22 full-time employees. All
full-time employees of the Bank are covered as a group for basic
hospitalization, including major medical, dental, accidental death and
dismemberment insurance as well as life and long term disability insurance.
Optional medical and dental insurance is available for dependents which must be
partially paid by the employee. In addition, in connection with the Conversion,
the Bank adopted an employment stock ownership plan which will provide benefits
to the Bank's employees.
Employees are not represented by any union or collective bargaining
group, and the Bank considers its employee relations to be good.
Federal Income Taxation
Savings institutions such as the Bank are subject to the taxing
provisions of the Code, for corporations, as modified by certain provisions
specifically applicable for financial or thrift institutions. Income is reported
using the accrual method of accounting. The maximum corporate federal income tax
rate is 34%.
For fiscal years beginning prior to December 31, 1995, thrift
institutions which qualified under certain definitional tests and other
conditions of the Code were permitted certain favorable provisions regarding
their deductions from taxable income for annual additions to their bad debt
reserve. A reserve could be established for bad debts on qualifying real
property loans (generally loans secured by interests in real property improved
or to be improved) under (i) a method based on a percentage of the institution's
taxable income as adjusted (the "percentage of taxable income method") or (ii) a
method based on actual loss experience (the "experience method"). The reserve
for nonqualifying loans was computed using the experience method.
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 1998 and
1997 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.
<PAGE>
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 1998, 1997 and 1996.
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
21
<PAGE>
and simultaneously recognize the amount as an item of taxable income increased
by the amount of income tax imposed on the inclusion. Dividends not in excess of
earnings and profits accumulated since December 31, 1951 will not require
inclusion 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,
1998 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, 1998, 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.
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 7.25% 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 7.00% in 1999 and
6.90% thereafter.
<PAGE>
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.
22
<PAGE>
Additionally, the BHCA prohibits the Company from engaging in, or
acquiring ownership or control of, more than 5% of the outstanding voting stock
of any company engaged in nonbanking business unless such business is determined
by the Federal Reserve to be so closely related to banking as to be properly
incident thereto. The BHCA generally does not place territorial restrictions on
the activities of such nonbanking related activities.
Similarly, Federal Reserve approval (or, in certain cases,
non-disapproval) must be obtained prior to any person acquiring control of the
Company. Control is conclusively presumed to exist if, among other things, a
person acquired more than 25% of any class of voting stock of the holding
company or controls in any manner the election of a majority of the directors of
the holding company. Control is presumed to exist if a person acquires more than
10% of any class of voting stock and the stock is registered under Section 12 of
the Exchange Act or the acquiror will be the largest shareholder after the
acquisition.
There are a number of obligations and restrictions imposed on bank
holding companies and their depository institution subsidiaries by law and
regulatory policy that are designed to minimize potential loss to the depositors
of such depository institutions and the FDIC insurance funds in the event the
depository institution becomes in danger of default or in default. For example,
under the 1991 Banking Law, to avoid 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 ("FDA") 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.
<PAGE>
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
23
<PAGE>
sheet activities, such as standby letters of credit) is 8%. At least half of the
total capital is required to be "Tier I capital," principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock, and a
limited amount of cumulative perpetual preferred stock, less certain goodwill
items and other intangible assets.
The remainder ("Tier II capital") may consist of a limited amount of
subordinated debt, certain hybrid capital instruments and other debt securities,
perpetual preferred stock, and a limited amount of the general loan loss
allowance. In addition to the risk-based capital guidelines, the Federal Reserve
has adopted a minimum Tier I capital (leverage) ratio, under which a bank
holding company must maintain a minimum level of Tier I capital to average total
consolidated assets of at least 3% in the case of a bank holding company which
has the highest regulatory examination rating and is not contemplating
significant growth or expansion. All other bank holding companies are expected
to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the
stated minimum.
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.
<PAGE>
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
24
<PAGE>
Transfers), Regulation O (Loans to Executive Officers, Directors and Principal
Shareholders), Regulation Z (Truth in Lending), Regulation CC (Availability of
Funds) and Regulation DD (Truth in Savings). As creditors of loans secured by
real property and as owners of real property, financial institutions, including
the Bank, may be subject to potential liability under various statutes and
regulations applicable to property owners generally, including statutes and
regulations relating to the environmental condition of real property.
The FDIC has extensive enforcement authority over North Carolina
state-chartered savings banks, including the Bank. This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease and desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated in response to violations of
laws and regulations and unsafe or unsound practices.
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
<PAGE>
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
25
<PAGE>
("well capitalized," "adequately capitalized" or "undercapitalized"), which are
defined in the same 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 provided 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
<PAGE>
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 all
26
<PAGE>
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, 1998,
the Bank had a leverage ratio of 21.35%.
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, 1998, 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.
<PAGE>
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
amount up to 50% of net worth.
27
<PAGE>
As of December 31, 1998, the largest aggregate amount of loans which
the Bank had to any one borrower was $1.2 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, 1998, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of approximately
$1,569,800.
FIRREA has had the effect of reducing the dividends that the Bank
receives on its stock in the FHLB of Atlanta. During fiscal 1998 and 1997, the
Bank recorded dividend income of $79,449 and $52,600 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, 1998, 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.
<PAGE>
For three years following completion of the Conversion, North Carolina
conversion regulations require the prior written approval of the Administrator
before any person may directly or indirectly offer to acquire or acquire the
beneficial ownership of more than 10% of any class of an equity security of the
Bank. If any person were to so acquire the beneficial ownership of more than 10%
of any class of any equity security without prior written approval, the
securities beneficially owned in excess of 10% would not be counted as shares
entitled to vote and would not be voted or counted as voting shares in
connection with any matter submitted to stockholders for a vote. Approval is not
required for (i) any offer with a view toward public resale made exclusively to
the bank or its underwriters or the selling group acting on its behalf or (ii)
any offer to acquire or acquisition of beneficial ownership of more than 10% of
the common stock of the Bank by a corporation whose ownership is or will be
substantially the same as the ownership of the Bank, provided that the offer or
acquisition is made more than one year following the consummation of the
Conversion. The regulation provides that within one year following the
Conversion, the Administrator would approve the acquisition of more than 10% of
beneficial ownership only to
28
<PAGE>
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, 1998, the Bank's liquidity
ratio, calculated in accordance with North Carolina regulations, was
approximately 11.39%.
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
<PAGE>
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, 1998, 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 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
29
<PAGE>
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.
<PAGE>
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 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.
30
<PAGE>
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
<PAGE>
institution is of doubtful character or when he otherwise deems it prudent. The
Administrator is empowered to order the revocation of the license of an
institution if he finds that it has violated or is in violation of any North
Carolina law or regulation and that revocation is necessary in order to preserve
the assets of the institution and protect the interests of its depositors. The
Administrator has the power to issue cease and desist orders if any person or
institution is engaging in, or has engaged in, and unsafe or unsound practice or
unfair and discriminatory practice in the conduct of its business or in
violation of any other law, rule or regulation.
A North Carolina-chartered savings bank must maintain net worth,
computed in accordance with the Administrator's requirements, of 5% of total
assets and liquidity of 10% of total assets, as discussed above. Additionally, a
North Carolina-chartered savings bank is required to maintain general valuation
allowances and specific loss reserves in the same amounts as required by the
FDIC.
31
<PAGE>
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 statutory 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, 1998, 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,
1998. All properties are owned by the Company.
<TABLE>
<CAPTION>
Net Book Value Deposits
Address of Property (In Thousands)
------- ----------- --------------
<S> <C> <C>
Mocksville: $ 44,875 $ 57,279
232 South Main Street
Mocksville, North Carolina 27028
Advance: $ 591,613 $ 15,897
5361 U.S. Highway 158
Advance, North Carolina 27006
</TABLE>
The Bank's management considers the property to be in very good
condition. The total net book value of the Bank's furniture, fixtures, equipment
and vehicles on December 31, 1998 was $258,690.
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
In the opinion of management, neither the Company nor the Bank is
involved in any pending legal proceedings other than routine, non-material
proceedings occurring in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's stockholders during
the quarter ended December 31, 1998.
32
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
See the information under the section captioned "Capital Stock" in the
Company's 1998 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 1998 Annual Report which is
incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
OPERATING RESULTS
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------ -------
<S> <C> <C> <C> <C> <C>
Return on Average Assets (Net income divided
by average total assets) 1.37% 1.45% 1.43% .88% 1.40%
Return on Average Equity (Net income divided
by average shareholders' equity) 4.97% 4.52% 4.48% 6.00% 9.78%
Average Equity to Average Assets Ratio
(Average shareholders' equity divided by
average total assets) 27.53% 32.07% 31.88% 14.64% 14.34%
Interest Rate Spread for the Period 3.20% 3.16% 2.62% 2.86% 3.59%
Average Interest-Earning Assets to Average
Interest-Bearing Liabilities 133.32% 147.04% 147.90% 117.49% 114.11%
Net Interest Margin 4.48% 4.77% 4.32% 3.62% 4.12%
</TABLE>
See also the information set forth under Item 1 above and the
information set forth under the section captioned "Management's Discussion and
Analysis" on pages 4 through 16 in the Company's 1998 Annual Report which
section is incorporated herein by reference.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See also the information set forth under Item 1 above and the
information set forth under the section captioned "Management's Discussion and
Analysis" on pages 4 through 16 in the Company's 1998 Annual Report which
section is incorporated herein by reference.
<PAGE>
Interest Rate Risk Management
The Company's net income is dependent on its net interest income. Net
interest income is susceptible to interest rate risk to the degree that
interest-bearing liabilities mature or reprice on a different basis than
interest-earning assets. When interest-bearing liabilities mature or reprice
more quickly than interest-earning assets in a given period, a significant
increase in market rates of interest could adversely affect net interest income.
Similarly,
33
<PAGE>
when interest-earning assets mature or reprice more quickly than
interest-bearing liabilities, falling interest rates could result in a decrease
in net income.
In an attempt to manage its exposure to changes in interest rates,
management monitors the Company's interest rate risk. Management meets monthly
to review the Company's interest rate risk position and profitability, and to
recommend adjustments for consideration by the Board of Directors. Management
also reviews the Bank's securities portfolio, formulates investment strategies,
and oversees the timing and implementation of transactions to assure attainment
of the Board's objectives in the most effective manner. Notwithstanding the
Company's interest rate risk management activities, the potential for changing
interest rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company's asset/liability position, the Board and
management attempt to manage the Company's interest rate risk while enhancing
net interest margins. At times, depending on the level of general interest
rates, the relationship between long and short-term interest rates, market
conditions and competitive factors, the Board and management may determine to
increase the Company's interest rate risk position somewhat in order to increase
its net interest margin. The Company's results of operations and net portfolio
values remain vulnerable to increases in interest rates and to fluctuations in
the difference between long-and short-term interest rates.
Consistent with the asset/liability management philosophy described
above, the Company has taken several steps to manage its interest rate risk.
First, the Company has structured the security portfolio to shorten the lives of
its interest-earning assets. The Company recently purchased securities, includes
$9.7 million of adjustable rate mortgage-backed securities. At December 31,
1998, the Company had securities totaling $12.9 million, of which $10.4 million
either have adjustable rates or mature in five years of less. Mortgage-backed
securities amortize and experience prepayments of principal; the Company has
received average cash flows from principal paydowns, sales, maturities of
securities of $2.6 million annually over the past three fiscal years. The
Company also controls interest rate risk reduction by emphasizing
non-certificate depositor accounts. The Board and management believe that such
accounts carry a lower cost than certificate accounts, and that a material
portion of such accounts may be more resistant to changes in interest rates than
are certificate accounts. At December 31, 1998, the Company had $8.7 million of
regular savings accounts, and $5.2 million of money market, demand and NOW
accounts representing 1.90% of total depositor accounts.
The Company does not currently engage in trading activities or use
derivative instruments to control interest rate risk. Even though such
activities may be permitted with the approval of the Board of Directors, the
Company does not intend to engage in such activities in the immediate future.
Interest rate risk is the most significant market risk affecting the Company.
Other types of market risk, such as foreign currency exchange rate risk and
commodity price risk, do not arise in the normal course of the Company's
business activities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The consolidated financial statements of the Bank set forth on pages 17
through 39 of the Company's 1998 Annual Report are incorporated herein by
reference.
<PAGE>
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, 1998 and
subsequent interim period.
34
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item regarding directors and executive
officers of the Company is set forth under the sections captioned "Proposal 1
Election of Directors-General" and "Executive Officers" contained in the Proxy
Statement, which sections are incorporated herein by reference.
The information required by this Item regarding compliance with Section
16(a) of the Securities Exchange Act of 1934 is set forth under the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy
Statement, which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION AND TRANSACTIONS
The information required by this Item is set forth under the sections
captioned "Proposal 1 - Election of Directors - Directors' Compensation" and
"Executive Compensation" contained in the Proxy Statement, which sections are
incorporated herein by reference.
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
1998 Annual Report attached hereto as Exhibit (13) and
incorporated herein by reference
(a) Independent Auditors' Report
(b) Consolidated Balance Sheets as of December 31, 1998 and
1997
(c) Consolidated Statements of Income for the Years Ended
December 31, 1998, 1997 and 1996
(d) Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1998, 1997 and 1996
(e) Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996
(f) Notes to Consolidated Financial Statements
<PAGE>
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.
35
<PAGE>
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 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 1998 Annual Report to Security
Holders
Exhibit (23) Consent of Independent Certified Public
Accountants
Exhibit (21) Subsidiaries of the Registrant
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, 1998.
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 29, 1999 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 29, 1999
- ------------------- and Director
J. Charles Dunn
/s/ Allen W. Carter Senior Vice President March 29, 1999
- ------------------
Allen W. Carter
/s/ Marjorie D. Foster Vice President and Controller March 29, 1999
- ----------------------
Marjorie D. Foster
/s/ Robert B. Hall Director March 29, 1999
- ------------------
Robert B. Hall
/s/ William F. Junker Director March 29, 1999
- ---------------------
William F. Junker
/s/ Donald G. Bowles Director March 29, 1999
- --------------------
Donald G. Bowles
/s/ Claude R. Horn, Jr. Director March 29, 1999
- -----------------------
Claude R. Horn, Jr.
<PAGE>
/s/ George W. Martin Director March 29, 1999
- --------------------
George W. Martin
/s/ Terry Bralley Director March 29, 1999
Terry B. Bralley
/s/ Ronald H. Vogler Director March 29, 1999
- --------------------
Ronald H. Vogler
37
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
Exhibit (11) Statement Regarding Computation of Per Share Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) 1998 Annual Report
Exhibit (21) Subsidiary of the Registrant
Exhibit (23) Consent of Independent Certified Public Accountants
Exhibit (27) Financial Data Schedule
38
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 1998 and 1997 were
$1,813,850 and $1,875,451, respectively. 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.
STATEMENT REGARDING COMPUTATION OF RATIOS
The averages used in computing the performance ratios provided in Item
6 represent average daily balances.
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA
Year Ended December 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- --------- --------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Summary of Operations:
Interest income $ 9,268 $ 8,353 $ 8,008 $ 6,602 $ 5,996
Interest expense 4,270 3,491 3,610 3,607 2,862
---------- ---------- --------- --------- ----------
Net interest income 4,998 4,862 4,398 2,995 3,134
Provision for loan losses 180 60 50 350 26
---------- ---------- --------- --------- ----------
Net interest income after provision for
loan losses 4,818 4,802 4,348 2,645 3,108
Other income 163 145 114 127 111
Other expenses (1) 2,428 2,514 2,123 1,605 1,495
---------- ---------- --------- --------- ----------
Income before tax expense 2,553 2,433 2,339 1,167 1,724
Income tax expense 945 901 858 430 617
---------- ---------- --------- --------- ----------
Net income $ 1,608 $ 1,532 $ 1,481 $ 737 $ 1,107
========== ========== ========= ========= ==========
Selected Year-End Balances:
Total assets $ 127,273 $ 108,092 $ 105,807 $ 87,751 $ 81,560
Loans receivable, net 102,549 92,967 82,992 75,097 65,973
Investments (2) 18,134 11,483 18,945 8,884 12,693
Deposits 73,176 66,973 66,564 73,035 69,140
FHLB Advances 23,967 7,800 - 1,000 -
Stockholders' equity 28,490 31,076 37,368 12,562 11,729
Average Balance Sheet Data:
Total assets $ 117,567 $ 105,617 $ 103,874 $ 83,921 $ 78,890
Total earning assets 111,633 101,909 102,336 83,058 76,125
Loans receivable, net 98,675 87,489 78,797 70,397 61,301
Investments (2) 12,021 13,696 22,907 12,481 14,825
Deposits 68,600 66,520 68,684 70,541 66,713
FHLB Advances 15,134 2,788 83 167 -
Stockholders' equity 32,368 33,869 33,115 12,283 11,317
Selected Financial Ratios:
Return on average assets 1.37% 1.45% 1.43% .88% 1.40%
Return on average equity 4.97% 4.52% 4.48% 6.00% 9.78%
Average equity to average assets 27.53% 32.07% 31.88% 14.64% 14.34%
Interest rate spread (tax equivalent basis) 3.20% 3.16% 2.62% 2.86% 3.59%
Net interest margin (tax equivalent basis) 4.48% 4.77% 4.32% 3.62% 4.12%
Dividend payout ratio 51.12 55.22 54.32 N/A N/A
Cash dividends declared per common share (3) $ 0.46 $ 4.45 $ 0.44 N/A N/A
Earnings per share - basic (4) $ 0.89 $ 0.82 $ 0.82 N/A N/A
Earnings per share - diluted (4) $ 0.89 $ 0.82 $ 0.82 N/A N/A
</TABLE>
<PAGE>
(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 1998 was calculated using
weighted average shares outstanding of 1,813,850 shares. Earnings per share
for 1997 was computed 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 Stone Street Bank & Trust
(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 1998 the Company completed an exceptional year once again with record
earnings. Net income increased to $1.61 million for the year ended December 31,
1998 compared to $1.53 million in 1997 and $1.48 million in 1996. Growth in net
interest income combined with an increase in other income combined with a
decrease in other expense made 1998 a very 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 $136,000 or 2.8% in
1998 to $5.0 million from $4.9 in 1997. Tax equivalent net interest income in
1997 was $4.9 million as compared to $4.4 million in 1996, an increase of
$464,000 or 10.6%. 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 1998 as compared to 1997 was
primarily the result of the increase in the average balances in 1998 combined
with an increase in the weighted average yields. Average loans increased by
$11.2 million or 12.8% to $98.7 million. Average investments decreased by $1.3
million or 13.2% as matured investment proceeds were used to fund the loan
growth. The weighted average yield on interest-earning assets increased by 10
basis points in 1998. In 1997, tax-equivalent interest income rose 4.3%
primarily due to increases in the weighted average yield on interest-earning
assets from 7.87% to 8.20% combined with an increase in average balances.
Interest expense increased by $779,000 in 1998 due primarily to the increase in
FHLB borrowings The balance of average interest-bearing liabilities increased
$14.4 million or 20.8% primarily due to the $12.3 million increase in average
balance of borrowings from the FHLB combined with $2.1 million increase in
average deposits. The increased balances of interest bearing liabilities were
used to fund loan demands.
<PAGE>
Interest expense decreased by only $119,000 in 1997. Average interest-bearing
liabilities increased $541,000 or .79% in 1997 while the average rate paid on
those liabilities decreased by 21 basis points. As a result, the decrease in
interest expense in 1997 was due primarily to decreases in average rates.
Interest rate spread (on a tax equivalent basis) increased to 3.20% in 1998 from
3.16% in 1997 due to the increase in the yield on interest earning assets net of
an increase in the average rate on interest bearing liabilities. Net interest
margin decreased to 4.48% in 1998 from 4.77% in 1997. Interest rate spread
increased to 3.16% in 1997 from 2.62% in 1996. Net interest margin (on a tax
equivalent basis) increased to 4.77% in 1997 from 4.32% in 1996.
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 1998 and
1997 while increases in net interest income in 1996 were primarily due to volume
changes.
Table 1: NET INTEREST INCOME ANALYSIS-TAX EQUIVALENT
<TABLE>
<CAPTION>
1998 1997
-------------------------------- -------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable (1) $ 98,675 $ 8,457 8.57% $ 87,489 $ 7,490 8.56%
Investment securities (2) 8,263 461 5.58% 9,517 519 5.45%
Interest-bearing deposits 3,758 271 7.21% 4,179 291 6.96%
FHLB common stock 937 79 8.43% 724 53 7.32%
--------- --------- ------ --------- --------- -------
Total interest-earning assets 111,633 9,268 8.30% 101,909 8,353 8.20%
Non-interest-earning assets 5,934 3,708
--------- ---------
TOTAL $ 117,567 $ 105,617
========= =========
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts $ 68,600 $ 3,426 4.99% $ 66,520 $ 3,345 5.03%
FHLB advances 15,134 844 5.58% 2,788 146 5.24%
--------- --------- ------ --------- --------- -------
Total interest-bearing liabilities 83,734 4,270 5.10% 69,308 3,491 5.04%
Non-interest-bearing liabilities 1,465 2,440
Stockholders' equity 32,368 33,869
--------- ---------
TOTAL 117,567 $ 105,617
========= =========
Net interest income and interest
rate spread $ 4,998 3.20% $ 4,862 3.16%
========= ========= ========= =========
Net interest- earning assets
and net interest margin $ 27,899 4.48% $ 32,601 4.77%
========= ========= ========= =========
Ratio of interest-earning assets
to interest bearing liabilities 133.32% 147.04%
========= =========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1996
--------------------------------
Average
Average Yield/
Balance Interest Rate
------- -------- ----
<S> <C> <C> <C>
Assets:
Interest-earning assets:
Loans receivable (1) $ 78,797 $ 6,662 8.45%
Investment securities (2) 7,617 607 6.75%
Interest-bearing deposits 14,645 692 4.72%
FHLB common stock 645 47 7.29%
-------- --------- ------
Total interest-earning assets 101,704 8,008 7.87%
Non-interest-earning assets 2,170
--------
TOTAL $103,874
========
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts $ 68,684 3,604 5.24%
FHLB advances 83 6 8.43%
-------- --------- ------
Total interest-bearing liabilities 68,767 3,610 5.25%
Non-interest-bearing liabilities 1,992
Stockholders' equity 33,115
--------
TOTAL $103,874
========
Net interest income and interest
rate spread $ 4,398 2.62%
========== ========
Net interest- earning assets
and net interest margin $ 32,937 4.32%
======== ========
Ratio of interest-earning assets
to interest bearing liabilities 147.90%
=======
</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 1998 of 7.25%, 1997 of 7.50% and 1996 of 7.75%, respectively and
reduced by the nondeductible portion of interest expense.
<PAGE>
Table 2: RATE/VOLUME ANALYSIS
<TABLE>
<CAPTION>
1998 vs 1997 1997 vs 1996
--------------------------------------- ---------------------------------------
Rate/ Rate/
Volume Rate Volume Net Volume Rate Volume Net
------- ------ ------ ------ ------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income
(tax-equivalent) on:
Loans $ 958 $ 8 $ 1 $ 967 $ 734 $ 86 $ 8 $ 828
Investment securities (68) 12 (2) (58) 151 (191) (48) (88)
Interest-bearing deposits (29) 10 (1) (20) (494) 328 (235) (401)
FHLB common stock 16 8 2 26 6 - - 6
------- ------ ------ ------ ------- ------ ------- ------
Total interest income 877 38 - 915 397 223 (275) 345
------- ------ ------ ------ ------- ------ ------- ------
Deposit accounts 105 (23) (1) 81 (113) (151) 5 (259)
FHLB advances 647 9 42 698 228 (3) (85) 140
------- ------ ------ ------ ------- ------ ------- ------
Total interest expense 752 (14) 41 779 115 (154) (80) (119)
------- ------ ------ ------ ------- ------ ------- ------
Increase (decrease) in
net interest income $ 125 $ 52 $ (41) $ 136 $ 282 $ 377 $ (195) $ 464
======= ====== ====== ====== ======= ====== ======= ======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<CAPTION>
1996 vs 1995
---------------------------------------------
Rate/
Volume Rate Volume Net
------- ------- ------- ------
<S> <C> <C> <C> <C>
Interest income
(tax-equivalent) on:
Loans $ 714 $ (31) $ (4) $ 679
Investment securities (45) 306 (37) 224
Interest-bearing deposits 687 (43) (150) 494
FHLB common stock 6 - - 6
------- ------- ------- ------
Total interest income 1,362 232 (191) 1,403
------- ------- ------- ------
Deposit accounts (95) 92 - (3)
FHLB advances 7 - - 7
------- ------- ------- ------
Total interest expense (88) 92 - 4
------- ------- ------- ------
Increase (decrease) in
net interest income $ 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 $180,000 in 1998 compared to $60,000
in 1997, and $50,000 in 1996. 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. In 1998, the allowance for
loan loss was increased due to expansion into more commercial lending as a
result of increased market demand.
Other Income
Other income increased from $145,000 in 1997 to $163,000 in 1998, and was
$114,000 in 1996. The increase in other income was primarily in customer service
charges and other fees which increased $9,000 in 1998 from the 1997 level. Other
income in 1997 increased $31,000 over the 1996 amount. This increase was
primarily in customer service charges and other fees which increased $30,000 in
1997.
Other Expenses
Other expenses decreased by 3.4% in 1998 compared to an increase of
18.4% in 1997. As a percent of average assets, other expense for 1998 was 2.1%
as compared to 2.4% in 1997 and 2.04% in 1996.
Other expenses totaled $2,428,000 in 1998 compared to $2,514,000 and $2,123,000
in 1997 and 1996, respectively. This was primarily attributable to a decrease in
the compensation expense recognized in the second quarter of 1998 related to MRP
plan of the Company combined with a reduction in the ESOP compensation expense
in 1998. 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.
Other expenses in 1998 which totaled $2,428,000, compared to 1997 total without
the effect of the non-recurring portion of ESOP-related compensation expense
would have totaled $2,343,000, an $85,000 increase in 1998. Compensation and
fringe benefits, excluding non-recurring items, increased by $49,000 to
$1,631,000 compared to $1,582,000 in 1997, primarily related to annual salary
increases and additional employees. The recurring portion of ESOP-related
compensation expense for 1998 totaled $190,000 compared to $180,000 recorded for
1997 and $175,000 for 1996. Also included in compensation expense was $273,000
in 1998 and $353,000 in 1997 of amortization of deferred compensation associated
with the MRP plan.
<PAGE>
Within other expenses the 'other' expense category increased $5,000 to $395,000
in 1998 from $390,000 in 1997 due to increases in marketing expenses,
shareholder reporting expenses, and franchise tax expenses. These increased
expenses are mitigated to a degree by a $3,000 decrease in FDIC-insurance
premiums to $43,000 for 1998 from $46,000 for 1997. In 1996 FDIC insurance
premiums 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 $61,000 or 23.4% in 1998 over 1997
as the Bank changed its data processing service bureau and continued to improve
its customer information technology. Professional fees decreased $27,000 from
1997 because there were no additional costs related to assistance with
conversion, regulatory filings or employee benefit programs incurred in 1998.
6
<PAGE>
ANALYSIS OF FINANCIAL CONDITION
---------------
Other expenses increased by $391,000 or 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.
Compensation and fringe benefits in 1997 representing over 69.7% of total other
expenses increased by $740,000 or 73.1% over 1996. The large increase in
compensation and related benefits is due to the implementation of the Company's
MRP and ESOP plans. The costs associated with these employee benefit programs in
1997 was $351,000 for the ESOP plan and $353,000 for the MRP plan. In 1996 the
only cost incurred by the Company was an ESOP contribution expense of $175,000.
Occupancy and equipment expense increased by $45,000 in 1997 over 1996. Reasons
for the increase in 1997 included investments in technology primarily the costs
associated with an ATM machine and additional computer costs. Deposit insurance
premiums decreased $535,000 from the 1996 level due to the special one time
assessment by the FDIC incurred by the Company in September, 1996 of $456,000.
Professional fees increased by $28,000 in 1997 compared to 1996 as the Company
obtained assistance in implementing the employee benefit program related to the
ESOP and MRP plans as well as regulatory filings.
Management continues to look for ways to improve cost efficiency while offering
new services to its customers.
Income Tax Expense
Income tax expense increased $44,000 or 4.9% to $945,000 in 1998 from
$901,000 in 1997. The effective tax rate was 37.0% in 1998 and 1997. Income tax
expense totaled $858,000 in 1996, and the effective tax rate was 36.7%. 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 now Stone Street Bank
& Trust (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.
<PAGE>
At December 31, 1998, the net loan portfolio totaled $102.5 million and
represented 80.6% of total assets. During 1998, loans increased by $9.6 million
or 10.3%. Loan originations increased from $27.6 million in 1997 to $43.0
million in 1998, 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, 1998. Table 3 sets forth the composition of the loan portfolio at
the dates indicated.
7
<PAGE>
Table 3: TYPES OF LOANS
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------------------------------------
1998 1997 1996 1995
-------------------- -------------------- --------------------- --------------------
Amount Percentage Amount Percentage Amount Percentage Amount Percentage
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Percentage
Real estate loans: (dollars in thousands)
Residential 1-4 family $ 84,094 82.00% $ 76,894 82.71% $ 67,844 81.75% $ 63,329 84.33%
Nonresidential real estate 9,619 9.38 9,541 10.26 5,716 6.88 4,260 5.67
Home equity and other
second mortgage 2,477 2.42 2,675 2.88 2,473 2.98 2,185 2.91
Construction 12,670 12.35 8,571 9.22 12,492 15.05 11,735 15.63
--------- ------ -------- ------ --------- ------- --------- ------
Total real estate loans 108,860 106.15 97,681 105.07 88,525 106.66 81,509 108.54
Other installment loans 1,265 1.23 632 .68 372 .45 222 .30
Less:
Unearned fees 1,212 1.18 1,058 1.14 1,009 1.22 962 1.29
Loans in process 5,614 5.47 3,718 4.00 4,385 5.28 5,211 6.94
Allowance for loan losses 750 .73 570 .61 511 .61 462 .61
--------- ------ -------- ------ --------- ------ --------- ------
Total reductions 7,576 7.38 5,346 5.75 5,905 7.11 6,635 8.84
--------- ------ -------- ------ --------- ------ --------- ------
Total loans, net $ 102,549 100.00% $ 92,967 100.00% $ 82,992 100.00% $ 75,096 100.00%
========= ====== ======== ====== ========= ====== ========= ======
<CAPTION>
December 31,
-----------------------
1994
-----------------------
Amount Percentage
------ ----------
<S> <C> <C>
Percentage
Real estate loans:
Residential 1-4 family $ 54,321 82.34%
Nonresidential real estate 4,987 7.56
Home equity and other
second mortgage 1,423 2.16
Construction 11,589 17.56
--------- ------
Total real estate loans 72,320 109.62
Other installment loans 197 0.30
Less:
Unearned fees 1,095 1.66
Loans in process 5,334 8.09
Allowance for loan losses 115 0.17
--------- ------
Total reductions 6,544 9.92
--------- ------
Total loans, net $ 65,973 100.00%
========= ======
</TABLE>
<PAGE>
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, 1998. 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 4: LOAN MATURITIES
<TABLE>
<CAPTION>
December 31, 1998
------------------------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or Less 3 Years 5 Years 10 Years Years Total
--------- --------- --------- ---------- ---------- -----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Fixed rate 1-4 family $ 22 $ 1,134 $ 4,246 $ 38,953 $ 44,249 $ 88,604
Adjustable rate 1-4 family 1,455 - - - - 1,455
Adjustable home equity 2,356 - - - - 2,356
Fixed rate-nonresidential 46 515 313 3,397 5,348 9,619
Other loans 1,265 - - - - 1,265
Less:
Allowance for loan losses (750) - - - - (750)
--------- --------- --------- ---------- ---------- -----------
Total Loans $ 4,394 $ 1,649 $ 4,559 $ 42,350 $ 49,597 $ 102,549
========= ========= ========= ========== ========== ===========
</TABLE>
9
<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
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
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 $ 243 $ 295 $ 423 $ 201 $ 280
========= ========= ========= ========= =========
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 $127,273 $108,092 $ 105,807 $ 87,751 $ 81,560
Total loans, net $102,549 $ 92,967 $ 82,992 $ 75,097 $ 65,973
</TABLE>
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.
<PAGE>
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 $180,000 in 1998 compared to $60,000
in 1997, and $50,000 in 1996. 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. During 1998 the
provision was increased as the Company increased its lending in the commercial
real estate market.
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
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period $ 570 $ 511 $ 462 $ 115 $ 89
Provision for loan losses 180 60 50 350 26
Charge-offs - 1 1 3 -
Recoveries - - - -
--------- --------- --------- -------- --------
Balance, end of period $ 750 $ 570 $ 511 $ 462 $ 115
========= ========= ========= ========= ========
Allowance as a percentage of loans .73% .61% .62% .62% .17%
</TABLE>
Table 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Residential 1-4 family $ 188 $ 154 $ 138 $ 127 $ 45
Nonresidential real estate 263 171 153 138 23
Home equity and other second mortgage 53 58 52 46 12
Construction 188 143 128 115 24
--------- --------- --------- --------- --------
Total real estate loans 692 526 471 426 104
Other loans 58 44 40 36 11
--------- --------- --------- --------- --------
Total allowance for loan losses $ 750 $ 570 $ 511 $ 462 $ 115
========= ========= ========= ========= ========
</TABLE>
The allocation of the allowance for loan losses to the respective loan
classifications is not necessarily indicative of future losses or future
allocations. Refer to Table 3 for percentages of loans in each category to total
loans.
<PAGE>
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, FHLMC and SBA which are
secured by mortgage-backed securities guaranteed by the GNMA, FHLMC or SBA.
Interest bearing deposits totaled $4.4 million at December 31, 1998, an increase
of $1.7 million from 1997. This increase is attributable to the increase in
deposits during 1998. The Company also had $878,000 of federal funds sold at
December 31, 1998, a decrease of $156,000 from the 1997 level of $1,034,000.
10
<PAGE>
Investment securities totaled $12.9 million at December 31, 1998, an increase of
$5.2 million from $7.7 million at December 31, 1997. The increase is
attributable to the growth in deposits in 1998. At December 31, 1998, net
unrealized losses of $67,788 were included in the carrying value of securities
classified available-for-sale compared to net unrealized gains of $4,678 on such
securities at December 31, 1997. 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, 1998 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, 1998, 1997 and 1996 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
-------------------- --------------------- ---------------------- ----------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Held-to-Maturity:
U.S. government and agency ... $ 748 6.35% $ -- --% $ -- --% $ -- --
Mortgage-backed securities (1) -- -- -- -- -- -- 1,744 7.24%
------- ----- ------ ---- ------- ------- ------- -----
Total held-to-maturity .... $ 748 6.35% $ -- --% $ -- --% $ 1,744 7.24%
------- ----- ----- ---- ------- ------- ------- -----
Available-for-sale:
State and local government (2) $ -- -- $ 386 6.81% $ 378 6.01% $ -- --%
Mortgage-backed securities (1) -- -- -- -- -- -- 9,662 5.79
------- ----- ----- ---- ------- ------- ------- -----
Total available-for-sale .. -- -- 386 6.81% 378 6.01% 9,662 5.79%
------- ----- ----- ---- ------- ------- ------- -----
Total investments
at carrying value ......... $ 748 6.35% $ 386 6.81% $ 378 6.01% $11,406 6.01%
======= ===== ===== ==== ======= ======= ======= =====
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Total
----------------------
Weighted
Carrying Average
Value Yield
------- ----
<S> <C> <C>
Held-to-Maturity:
U.S. government and agency ... $ 748 6.35%
Mortgage-backed securities (1) 1,744 7.24
------- ----
Total held-to-maturity .... $ 2,492 6.97%
------- ----
Available-for-sale:
State and local government (2) $ 764 6.45%
Mortgage-backed securities (1) 9,662 --
------- ----
Total available-for-sale .. 10,426 5.79%
------- ----
Total investments
at carrying value ......... $12,918 6.05%
======= ====
</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, 1998.
(2) Yields are stated on taxable equivalent basis assuming statutory tax rates
of 34% for federal and 7.25% for state purposes. Book yields without regard to
tax-equivalent adjustments are: one year or less, 6.37%; two to five years,
4.73%; six to ten years, 4.25%; more than ten year, 6.01%; total, 5.94%.
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. A ready market does not exist for such stock, which is
carried at cost. The Bank however, can redeem the stock at cost with the FHLB.
As of December 31, 1998, the Company's investment in stock of the FHLB of
Atlanta was $1,570,000.
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 $73.2 million at December 31, 1998, compared to $67.0
million at December 31, 1997, an increase of approximately $6.2 million. 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>
1998 1997 1996
-------------------- ------------------- -------------------
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 $ 4,698 1.53% $ 4,260 1.71% $ 3,996 1.80%
Savings account 9,218 2.84 11,928 3.00 9,270 3.51
Certificates of deposit 54,684 5.61 50,332 5.79 55,418 5.84
-------- ----- --------- ------ --------- -----
Total deposits $ 68,600 4.99% $ 66,520 5.03% $ 68,684 5.24%
======== ====== ======== ====== ========= =====
</TABLE>
As of December 31, 1998, the Company had outstanding $8,273,195 in time
certificates of deposit of $100,000 or more. Maturities of certificates of
deposits of $100,000 or more at December 31, 1998 were as follows: three months
or less, $958,362; over three months through six months, $1,064,877, over six
months through twelve months $1,831,165; and over one year through twenty-four
months, $4,418,791.
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, 1998, the Company had outstanding FHLB advances
totaling $23,967,000, compared to $7,800,000 outstanding at December 31, 1997.
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.
The total available line of credit from the FHLB is $37.0 million. At December
31, 1998, the Bank had an additional $13.0 million of credit available from the
<PAGE>
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, 1998 which are projected to reprice or mature in each of the future time
periods shown. At December 31, 1998, the Company had a negative cumulative one
year asset-sensitive gap position of $48.3 million or 39.26% 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. Loans with thirty year amortizations have a ten year call
provision which enables the Company to adjust the interest rate given market
conditions. 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, 1998, management realizes its
need to improve the Company's interest rate exposure and has developed
strategies to address this issue.
<PAGE>
Table 10: INTEREST SENSITIVITY
<TABLE>
<CAPTION>
December 31, 1998
---------------------------------------------------------------------------
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
-------- ------- ---------- --------- --------- ------- -------
Interest earning assets ................ (dollars in thousands)
<S> .................................... <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Fixed rate residential 1-4 family .... $ -- $ 22 $ 1,134 $ 4,246 $ 38,953 $ 44,249 $ 88,604
Adjustable rate residential 1-4 family -- 1,455 -- -- -- -- 1,455
Adjustable home equity ............... 2,356 -- -- -- -- -- 2,356
Fixed rate-nonresidential ............ -- 46 515 313 3,397 5,348 9,619
-------- -------- -------- -------- -------- -------- --------
Total mortgage loans ................ 2,356 1,523 1,649 4,559 42,350 49,597 102,034
Other loans .......................... 1,265 -- -- -- -- -- 1,265
-------- -------- -------- -------- -------- -------- --------
Total loans ......................... 3,621 1,523 1,649 4,559 42,350 49,597 103,299
Interest-bearing deposits(2) ........... 5,284 -- -- -- -- -- 5,284
Investment securities (1) .............. 10,410 0 386 378 -- 1,744 12,918
FHLB common stock ...................... 1,570 -- -- -- -- -- 1,570
-------- -------- -------- -------- -------- -------- --------
Total interest-earning assets ....... $ 20,885 $ 1,523 $ 2,035 $ 4,937 $ 42,350 $ 51,341 $123,071
-------- -------- -------- -------- -------- -------- --------
Interest-bearing liabilities
Deposits:
Fixed maturity deposits .............. $ 13,668 $ 36,185 $ 9,419 $ -- $ -- $ -- $ 59,272
NOW accounts money market accounts ... 5,208 -- -- -- -- -- 5,208
Savings accounts ..................... 8,696 -- -- -- -- -- 8,696
-------- -------- -------- -------- -------- -------- --------
Total deposits ...................... 27,572 36,185 9,419 -- -- -- 73,176
FHLB advances ........................ -- 6,967 -- 2,000 15,000 -- 23,967
-------- -------- -------- -------- -------- -------- --------
Total interest-bearing liabilities .. $ 27,572 $ 43,152 $ 9,419 $ 2,000 $ 15,000 $ -- $ 97,143
-------- -------- -------- -------- -------- -------- --------
Interest sensitivity gap per period $ (6,687) $(41,629) $ (7,384) $ 2,937 $ 27,350 $ 51,341 $ 25,928
Cumulative interest-sensitivity gap $ (6,687) $(48,316) $(55,700) $(52,763) $(25,413) $ 25,928 $ 25,928
Cumulative gap as a percentage of
total interest-earning assets (5.43)% (39.26)% (45.26)% (42.87)% (20.65)% 21.07% 21.07%
Cumulative interest-earning assets as a
percentage of interest-bearing liabilities 75.75% 31.68% 30.50% 35.77% 73.84% 126.69% 126.69%
</TABLE>
(1) Includes investments and mortgage-backed securities
(2) Includes interest-bearing deposits and federal funds
13
<PAGE>
Capital Resources
----------
Stockholders' equity decreased from $31.1 million at December 31, 1997 to
$28.5 million at December 31, 1998, due to the purchase of $3,692,000 in
treasury stock during 1998.
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, 1998 and 1997, 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.
<PAGE>
Table 11: REGULATORY CAPITAL
<TABLE>
<CAPTION>
At December 31,
----------------------------
1998 1997
----------- ----------
<S> <C> <C>
Risk-Based and Leverage Capital (dollars in thousands) Tier I capital:
Common stockholders' equity .......................................... $ 27,083 $ 26,030
Unrealized holding loss (gain) on securities available-for-sale ...... (39) (3)
----------- ----------
Total Tier I leverage capital ......................................... 27,044 26,027
Tier II Capital:
Qualifying allowances for loan losses
Tier II capital additions ...................................... 750 570
----------- ----------
Total risk-based capital .............................................. $ 27,794 $ 26,597
Risk-weighted assets .................................................. 71,217 61,531
Fourth quarter average assets ......................................... 126,388 102,598
Risk-based capital ratios:
Tier-I capital as a percent of risk-weighted assets .................. 36.01% 42.30%
Minimum Required Tier I capital ...................................... 4.00% 4.00%
Total risk-based capital as a percent of risk-weighted assets ........ 37.01% 43.23%
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 21.35% 25.37%
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 22.00% 25.92%
Minimum required North Carolina capital .............................. 5.00% 5.00%
</TABLE>
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,
1998 that will affect the Company's future reporting.
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
adopted the SFAS 130 is fiscal year 1998 without any significant 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 15, 1997 and in the initial year
of application, comparative information for earlier years is to be restated. The
Company adopted SFAS 131 in fiscal year 1998 without any significant impact on
its consolidated financial statements.
The FASB has issued SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, which the Company has not been required to adopt as of
December 31, 1998. This Statement, which is effective for fiscal years beginning
after June 15, 1998, established accounting and reporting standards for
derivative instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
<PAGE>
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated as (a) a hedge of the exposure
to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows
of a forecasted transaction, or (c) a hedge of the foreign currency exposure of
a net investment in a foreign operation an unrecognized firm commitment, an
available for sale security, or a foreign currency denominated forecasted
transaction. This Statement is not expected to have a significant impact on the
Company.
The FASB has issued SFAS No. 134, Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise, an amendment of FASB Statement No. 65, which the
Company has not been required to adopt as of December 31, 1998. Statement No.
65, as amended by FASB Statements No. 115, Accounting for Certain Investments in
Debt and Equity Securities, and No 125, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities, requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed security as a trading
security.
15
<PAGE>
This Statement further amends Statement No. 65 to require that after the
securitization of mortgage loans held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed securities or other
retained interests based on its ability and intent to sell or hold those
investments. This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a nonmortgage banking enterprise.
This Statement is effective for fiscal years beginning after December 15, 1998,
and is not expected to have a significant impact on the Company.
Year 2000 Issue
------------
The Year 2000 challenge touches many facets of the financial activity of
a business. It affects mainframe computer systems, networks and desktop personal
computers. The problem even effects security and maintenance, because most
modern offices rely on computerized systems. Stone Street Bank and Trust (Stone
Street) and the Company considers the Year 2000 issue a top customer priority.
The issue has received a lot of public attention because of concern about how
businesses plan to meet this challenge. At Stone Street we began discussing the
issue more than two years ago and started executing a plan for the challenge in
1997. To help us address this issue in a methodical, comprehensive manner, we
created our Year 2000 Strategic Project Plan, designed to protect and inform our
business partners and customers.
At first glance, the challenge may seem simple. For example, many computer
programs and computer chips store the calendar year portion of the date as two
digits rather than four digits. These software programs and chips record the
year 1999 as "99". This approach works until the year 2000 when the "00" may be
interpreted as the year 1900 instead of the year 2000. Banks use computer
systems to perform financial calculations, transfer funds, record deposits and
loan payments, run security systems and vaults and a myriad of other functions.
Because banks rely heavily on their computer systems, the Federal Financial
Institutions Examination Council ("FFIEC") has placed significant emphasis on
the problems surrounding the year 2000 issues and has required financial
institutions to document the assessment, testing and corrections made to ready
their computer systems and programs for the year 2000 date change. The FFIEC has
strict regulations, guidelines and milestones in place that each FDIC insured
financial institution must follow in order to remain operational. The Company's
board of directors has remained informed of the Company's position and progress
in its year 2000 project.
The Company's year 2000 project remains on schedule according to the guidelines
set forth by the FFIEC. The Company's most critical external exposure to year
2000 system problems is with its data processing provider, Fiserv. Fiserv
renovated its systems in June 1998 and conducted a full test of the system in
November, 1998. Fiserv has responded to the Company that renovation of its
program is virtually complete and a final test is scheduled in April, 1999.
In addition, the Company has contacted its major customers and vendors to
inquire about their progress in addressing the year 2000 program and does not
believe that the problems of such customers and vendors will have a material
adverse effect on the Company or its operations. The Company completed a
scheduled upgrade to its computer terminals and software at a cost of $155,000
<PAGE>
during 1998 due to the aging of previous systems that were not considered
directly related to the year 2000. Costs directly associated with resolving any
year 2000 issues during 1999 is estimated to cost $15,000. The Company will
continue to monitor the progress of these parties in addressing the year 2000
problem as the new millennium approaches.
The year 2000 problems can affect the Company's operation in a number of ways
but the mission critical issue is maintaining customers' account information
including tracking deposits, interest accruals and loan payments. The Company is
dependent upon electricity, telephone lines, computer hardware and Fiserv's data
processing capability. The Company is in contact with its electric utility and
phone company, and assurances have been given that no major problems exist and
that both companies will have all year 2000 problems addressed well before
December 31, 1999.
Banking, like other interconnected industries, relies on relationships with
outside partners to provide services to our customers. We are working with card
processors, ATM networks and others to help ensure a smooth transition on
January 1, 2000; however, we cannot ensure compatibility with non-Stone Street
networks and services. We are not responsible for failures due to circumstances
beyond our control. We do not, therefore, provide guarantees or warranties
beyond those we normally provide to our customers.
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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three year
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/Weir Smith Jones Miller & Elliott
- ------------------------------------
Weir Smith Jones Miller & Elliott
Statesville, North Carolina
January 30, 1999
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31, 1998 and 1997
1998 1997
--------- ---------
(dollars in thousands)
<S> <C> <C>
ASSETS
Cash ...................................................... $ 2,404 $ 968
Federal funds sold ........................................ 878 1,034
Interest-bearing deposits in other financial institutions . 4,406 2,701
Investment securities (note 2)
Held-to-maturity (Market value: $2,491 in 1998
and $5,940 in 1997) ..................................... 2,492 5,889
Available-for-sale (Cost: $10,426 in 1998
and $1,854 in 1997) ..................................... 10,358 1,859
Loans receivable (net of allowance
for loan losses of
$750 in 1998 and $570 in 1997) (note 3) .................. 102,549 92,967
Federal Home Loan Bank stock at cost ...................... 1,570 741
Premises and equipment (note 4) ........................... 909 824
Accrued interest receivable ............................... 670 284
Deferred income tax (note 8) .............................. 627 412
Refundable income tax ..................................... 116 126
Prepaid expenses and other assets ......................... 102 141
Cash surrender value of life insurance .................... 192 146
--------- ---------
Total assets ........................................... $ 127,273 $ 108,092
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (note 5):
Savings accounts ......................................... $ 8,696 $ 9,190
NOW and MMDA ............................................. 5,208 4,704
Other certificates of deposit ............................ 50,999 47,565
Certificates of deposit, $100,000 and over ............... 8,273 5,514
Total deposits ......................................... 73,176 66,973
--------- ---------
Advances from the Federal Home Loan Bank (note 6) ......... 23,967 7,800
Amounts payable under remittance service agreement .... 358 1,175
Accrued interest payable .................................. 296 144
Accrued expenses and other liabilities .................... 986 924
--------- ---------
Total liabilities .................................. 98,783 77,016
--------- ---------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
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 shares issued and 1,898,052 and 1,692,352
outstanding, respectively (note 1) ...................... 18,433 20,611
Unearned ESOP shares ...................................... (1,859) (1,948)
Unamortized deferred compensation ......................... (1,245) (1,518)
Retained earnings, substantially restricted (notes 7 and 8) 13,200 13,928
Accumulated other comprehensive income, net ............... (39) 3
--------- ---------
Total stockholders' equity ............................. 28,490 31,076
--------- ---------
Commitments and contingencies (notes 3 and 9)
Total liabilities and stockholders' equity ......... $ 127,273 $ 108,092
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED FINANCIAL STATEMENTS OF INCOME
-------------------------------------------
Years ended December 31, 1998, 1997 and 1996
1998 1997 1996
------ ------ ------
(dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Interest on loans ..................................... $8,457 $7,490 $6,662
Interest on deposits in other financial institutions .. 271 291 692
Interest and dividends on investment securities:
Taxable .............................................. 489 486 563
Non-taxable .......................................... 51 86 91
------ ------ ------
Total interest income ............................... 9,268 8,353 8,008
------ ------ ------
Interest expense:
Interest on deposits (note 5) ......................... 3,426 3,345 3,604
Interest on borrowings ................................ 844 146 6
------ ------ ------
Total interest expense .............................. 4,270 3,491 3,610
------ ------ ------
Net interest income .................................... 4,998 4,862 4,398
Provision for loan losses (note 3) ..................... 180 60 50
------ ------ ------
Net interest income after provision for loan losses . 4,818 4,802 4,348
------ ------ ------
Other income:
Loan fees and charges ................................. 55 49 45
Customer service and other fees ....................... 95 86 56
Other ................................................. 13 10 13
------ ------ ------
Total other income .................................. 163 145 114
------ ------ ------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Other expenses:
Compensation and related benefits (note 9) ............ 1,631 1,753 1,013
Deposit insurance premiums ............................ 43 46 581
Occupancy and equipment expense ....................... 322 261 216
Professional fees ..................................... 37 64 36
Other ................................................. 395 390 277
------ ------ ------
Total other expenses ................................ 2,428 2,514 2,123
------ ------ ------
Income before income tax expense .................... 2,553 2,433 2,339
Income tax expense (note 8) ............................ 945 901 858
------ ------ ------
Net income ............................................. $1,608 $1,532 $1,481
====== ====== ======
Net income per share - basic (note 1) .................. $ 0.89 $ 0.82 $ 0.82
====== ====== ======
Net income per share - diluted (note 1) ................ $ 0.89 $ 0.82 $ 0.82
====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
For the Years ended December 31, 1998, 1997 and 1996
Unearned Unamortized Compre-
Shares Common ESOP Deferred Retained hensive
Outstanding Shares Shares Compensation Earnings Income
----------- ------ ------ ------------ -------- ------
(in thousands, except shares outstanding)
<S> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1995 - $ - $ - $ - $ 12,563
Net income - - - - 1,481 1,481
Net proceeds from issuance
of no par common stock 1,825,050 26,333 - - -
Common stock acquired
by ESOP - - (2,198) - -
Cash dividends declared
($.44 per share) - - - - (803)
Change in unrealized
holding gains (losses)
net of income taxes of $3 - - - - - (7)
-------
Total comprehensive income $ 1,474
=======
Balance at
December 31, 1996 1,825,050 26,333 (2,198) - 13,241
Net income 1,532 1,532
Common stock acquired
by ESOP (329)
Release of ESOP shares 579
Cash dividends declared
($4.45 per share)** (7,593) (845)
Issuance of restricted stock 73,002 1,871 (1,871)
Amortization of earned
compensation 353
Change in unrealized
holding gains (losses),
net of income taxes of $4 11
-------
Total comprehensive income $ 1,543
=======
Balance at
December 31, 1997 1,898,052 20,611 (1,948) (1,518) 13,928
Net income 1,608 1,608
Purchase of Treasury Stock (205,700) (2,178) (1,514)
Release of ESOP shares 89
Cash dividends
($.45 per share) ** (822)
Amortization of unearned
compensation 273
Change in unrealized
holding gains (losses)
net of income taxes of $28
Total comprehensive income (42)
-------
Balance at
December 31, 1998 1,692,352 $ 18,433 $ (1,859) $ (1,245) $ 13,200
========= ========= ========= ======== =========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Accumulated
Other Total
Comprehensive Stockholders'
Income Equity
------ ------
<S> <C> <C>
Balance at
December 31, 1995 (1) $ 12,562
Net income - 1,481
Net proceeds from issuance
of no par common stock - 26,333
Common stock acquired
by ESOP - (2,198)
Cash dividends declared
($.44 per share) - (803)
Change in unrealized
holding gains (losses)
net of income taxes of $3 (7) (7)
Total comprehensive income
---- -----------
Balance at
December 31, 1996 (8) 37,368
Net income 1,532
Common stock acquired
by ESOP (329)
Release of ESOP shares 579
Cash dividends declared
($4.45 per share)** (8,438)
Issuance of restricted stock
Amortization of earned
compensation 353
Change in unrealized
holding gains (losses),
net of income taxes of $4 11 11
Total comprehensive income
---- -----------
Balance at
December 31, 1997 3 31,076
Net income 1,608
Purchase of Treasury Stock (3,692)
Release of ESOP shares 89
Cash dividends
($.45 per share) ** (822)
Amortization of unearned
compensation 273
Change in unrealized
holding gains (losses)
net of income taxes of $28
Total comprehensive income (42) (42)
---- -----------
Balance at
December 31, 1998 $ (39) $ 28,490
====== ============
</TABLE>
** Includes $4.00 special return of capital dividend paid on July 11, 1997. See
accompanying notes to consolidated financial statements.
20
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the Years ended December 31, 1998, 1997 and 1996
1998 1997 1996
-------- -------- --------
Operating activities: (dollars in thousands)
<S> <C> <C> <C>
Net income ................................................................ $ 1,608 $ 1,532 $ 1,481
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation ............................................................ 96 86 96
Provision for loan losses ............................................... 180 60 50
Deferred income taxes ................................................... (215) (36) (42)
Contributions allowing the release of ESOP shares ....................... 89 579
Compensation earned under the Management Recognition Plan ............... 273 353
Decrease (increase) in accrued interest receivable ...................... (386) 26 (206)
Increase in cash surrender value of life insurance ...................... (46) (18) (64)
Decrease (increase) in refundable income taxes .......................... 10 (49) (56)
Increase (decrease) in amounts payable under remittance
service agreement ...................................................... (817) 539 41
(Increase) decrease in other assets ..................................... 39 (48) 44
Increase (decrease) in accrued interest payable ......................... 152 (26) 23
Increase (decrease) in accrued cash dividends payable .................. -- (402) 402
Increase (decrease) in other liabilities ................................ 62 257 281
-------- -------- --------
Net cash provided by operating activities ........................... 1,045 2,853 2,050
-------- -------- --------
Investing activities:
Net increase in loans held for investment ................................. (9,762) (10,035) (7,996)
Principal collected on mortgage-backed securities ......................... -- 597 108
Purchase of investment securities classified as available-for-sale ........ (8,541) -- (860)
Purchase of investment securities classified as held-to-maturity .......... -- (750) (2,760)
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 ........ 3,397 2,000 500
Purchase of FHLB Stock .................................................... (829) (74) (91)
Purchase of premises and equipment ...................................... (181) (10) (47)
Net cash used by investing activities ................................... (15,916) (7,397) (13,005)
-------- -------- --------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Financing activities:
Net increase (decrease) in deposits ....................................... 6,203 409 (6,471)
Proceeds from borrowings .................................................. 16,167 7,800
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 ....................................... (822) (8,438) (803)
Purchase of treasury stock ................................................ (3,692) -- --
Net cash provided by financing activities ................................. 17,856 (558) 15,861
-------- -------- --------
Increase (decrease) in cash and cash equivalents .................. 2,985 (5,102) 4,906
Cash and cash equivalents at beginning of period ........................... 4,703 9,805 4,899
-------- -------- --------
Cash and cash equivalents at end of period ................................. $ 7,688 $ 4,703 $ 9,805
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ................................................................. $ 4,118 $ 3,517 $ 3,587
======== ======== ========
Income taxes ............................................................. $ 935 $ 949 $ 914
======== ======== ========
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on available-for-sale securities, net of deferred
taxes (benefit) of $(28) for 1998 and $2 for 1997 ........................ $ (39) $ 3 $ 8
======== ======== ========
Dividends declared but unpaid ............................................. $ - $ -- $ 402
======== ======== ========
</TABLE>
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 now Stone Street
Bank & Trust (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.
<PAGE>
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, 1998, 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, 1998, the Bank owned 15,698 shares
of the FHLB's $100 par value capital stock. A ready market does not exist
for such stock, which is carried at cost. The Bank however, can redeem
this stock at cost with the FHLB.
<PAGE>
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 for 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 market price not exceeding the exercise price during the
period, both basic and diluted earnings per share are the same. Weighted
average shares outstanding for 1998 and 1997 were 1,813,850 and 1,872,451,
respectively, 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, 1998 that will affect the Company's future reporting.
The FASB has issued SFAS No. 130, Reporting Comprehensive Income, which
the Company adopted during 1998. The Statement, which is effective for
fiscal years beginning after December 15, 1997, establishes standards for
reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general-purpose
financial statements. This statement requires that all items that are
recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the
same prominence as other financial statements. All required disclosures
are included in the 1998 financial statements.
The FASB has issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, which the Company has adopted during
1998. This Statement, which is effective for fiscal years beginning after
December 15, 1997, requires that a public business enterprise report
financial and descriptive information about its reportable operating
segments. Operating segments are components of an enterprise about which
separate financial information is available that is evaluated regularly by
the chief operating decision maker in deciding how to allocate resources
and in assessing performance. Generally, financial information is required
to be reported on the basis that it is used internally for evaluating
segment performance and deciding how to allocate resources to segments.
This statement did not have a significant impact on the Company.
<PAGE>
The FASB has issued SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, which the Company has not been required to adopt
as of December 31, 1998. This Statement, which is effective for fiscal
years beginning after June 15, 1998, established accounting and reporting
standards for derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as (a) a hedge of the exposure to changes in
the fair value of a recognized asset or liability or an unrecognized firm
commitment, (b) a hedge of the exposure to variable cash flows of a
forecasted transaction, or (c) a hedge of the foreign currency exposure of
a net investment in a foreign operation, an unrecognized firm commitment,
an available for sale security, or a foreign currency denominated
forecasted transaction. This Statement is not expected to have a
significant impact on the Company.
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
----------------------------------------------------
The FASB has issued SFAS No. 134, Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for
Sale by a Mortgage Banking Enterprise, an amendment of FASB Statement No.
65, which the Company has not been required to adopt as of December 31,
1998. Statement No. 65, as amended by FASB Statements No. 115, Accounting
for Certain Investments in Debt and Equity Securities, and No. 125,
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, requires that after the securitization of
a mortgage loan held for sale, an entity engaged in mortgage banking
activities classify the resulting mortgage-backed security as a trading
security. This statement further amends Statement No. 65 to require that
after the securitization of mortgage loans held for sale, an entity
engaged in mortgage banking activities classify the resulting
mortgage-backed securities or other retained interests based on its
ability and intent to sell or hold those investments. This Statement
conforms the subsequent accounting for securities retained after the
securitization of mortgage loans by a mortgage banking enterprise with the
subsequent accounting for securities retained after the securitization of
other types of assets by a nonmortgage banking enterprise. This Statement
is effective for fiscal years beginning after December 15, 1998, and is
not expected to have a significant impact on the Company.
Reclassifications
Certain reclassifications have been made for 1997 and 1996 to conform with
the 1998 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:
<TABLE>
<CAPTION>
December 31, 1998
-------------------------------------------------
(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 $ 748 $ 2 $ - $ 750
Mortgage-backed securities (a) 1,744 6 9 1,741
----------- ------------ ----------- ----------
Total securities held-to-maturity 2,492 8 9 2,491
=========== ============ =========== ==========
Securities available-for-sale:
States and local governments $ 764 $ 19 $ - $ 783
Mortgage-backed securities 9,662 - 87 9,575
----------- ------------ ----------- ----------
Total securities available-for-sale $ 10,426 $ 19 $ 87 $ 10,358
=========== ============ =========== ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
December 31, 1997
-------------------------------------------------
(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 $ 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
=========== ============ =========== ==========
</TABLE>
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
----------------------------------------------------
(2) Investment Securities, Continued
--------------------------------
<TABLE>
<CAPTION>
December 31, 1996
(in thousands)
--------------------------------------------------
Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
Securities held-to-maturity:
US government and agency securities $ 4,753 $ 21 $ 18 $ 4,756
Mortgage-backed securities (a) 2,983 41 - 3,024
----------- ------------ ----------- ----------
Total securities held-to-maturity $ 7,736 $ 62 $ 18 $ 7,780
=========== ============ =========== ==========
Securities available-for-sale
State and local governments $ 2,019 $ 4 $ 12 $ 2,011
Mutual Funds 712 - - 712
----------- ------------ ----------- ----------
Total securities available-for-sale $ 2,731 $ 4 $ 12 $ 2,723
=========== ============ =========== ==========
</TABLE>
(a) At December 31, 1998 the Company owned mortgage-backed securities issued by
the General National Mortgage Association (GNMA), the Federal Home Loan
Mortgage Corporation (FHLMC) and the Small Business Association (SBA) with
an aggregate amortized cost of $11,406,000 and a market value of
$11,316,000. At December 31, 1997, the Company owned mortgage-backed
securities issued by GNMA and FHLMC with an aggregate amortized cost of
$2,400,000 and a market value of $2,446,000.
The aggregate amortized cost and approximate market value of the
available-for-sale and held-to-maturity securities portfolios at December
31, 1998, 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 agencies securities:
Due in 1 year or less $ $ $ 748 $ 750
Obligations of states and local governments:
Due 1 year through 5 years 386 400
Due after 5 through 10 years 378 383
Mortgage-backed securities 9,662 9,575 1,744 1,741
--------- --------- ------- ---------
Total securities $ 10,426 $ 10,358 $ 2,492 $ 2,491
========= ========= ======= =========
</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, 1998, 1997, and 1996.
(3) Loans Receivable
<TABLE>
<CAPTION>
December 31,
-------------------------
Loans receivable consist of the following: 1998 1997
----------- -----------
(in thousands)
<S> <C> <C>
Loans secured by first mortgages on real estate:
Mortgage loans held for investment, primarily one-to-four family $ 84,094 $ 76,894
Construction loans 12,670 8,571
Nonresidential real estate 9,619 9,541
----------- -----------
106,383 95,006
Home equity lines of credit 2,356 2,438
Other second mortgage loans 121 237
Other installment loans 1,265 632
----------- -----------
110,125 98,313
Undisbursed proceeds on loans in process (5,614) (3,718)
Deferred loan fees (1,212) (1,058)
Allowance for loan losses (750) (570)
----------- -----------
$ 102,549 $ 92,967
=========== =========
</TABLE>
An analysis of the allowance for loan losses follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- ----------
(in thousands)
<S> <C> <C> <C>
Balance at beginning of period $ 570 $ 511 $ 462
Provision for loan losses 180 60 50
Loans charged off - (1) (1)
Recoveries - - -
----------- ----------- ----------
Balance at end of period $ 750 $ 570 $ 511
=========== =========== ===========
</TABLE>
At December 31, 1998 and 1997, the Company had no loans which were in
nonaccrual status and $243,318 and $294,858 respectively, which were
contractually delinquent for 90 days or more and still accruing.
<PAGE>
At December 31, 1998, the Company had mortgage loan commitments outstanding
of $5,614,315 and preapproved but unused lines of credit totaled
$2,824,250. 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, 1998.
Balance at December 31, 1997 $ 2,028,952
New loans 445,500
Repayments (429,080)
-------------
Balance at December 31, 1998 $ 2,045,372
=============
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
----------------------------------------------------
(4) Premises and Equipment
Premises and equipment consist of the following:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
-------------------------------------- ------------------------------------
Accumulated Net book Accumulated Net book
Cost depreciation value Cost depreciation value
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Land $ 262 $ - $ 262 $ 258 $ - $ 258
Office buildings and
improvements 847 461 386 834 423 411
Furniture, fixtures and
equipment 574 327 247 507 371 136
Vehicles 26 12 14 26 7 19
-------- ------- ------- -------- ------ -----
$ 1,709 $ 800 $ 909 $ 1,625 $ 801 $ 824
======== ======= ======= ======== ====== =====
</TABLE>
(5) Deposits
Time deposits of $100,000 or more totaled $8,273,195 and $5,514,098 at
December 31, 1998 and 1997, respectively.
Interest expense on deposits includes $324,288, $196,905 and $343,000 for
the years ended December 31, 1998, 1997 and 1996, respectively, on time deposits
of $100,000 or more.
Contractual maturities of time deposits at December 31, 1998 are as
follows:
Total
Year Ending December 31, Maturities
(dollars in thousands)
1999 $ 49,853
2000 7,965
2001 1,454
------------
Total time deposits $ 59,272
============
(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:
<PAGE>
<TABLE>
<CAPTION>
December 31,
------------------------------
1998 1997
------------ -----------
(in thousands)
<S> <C> <C>
6.50% due on or before December 31, 1998 $ - $ 7,800
5.78% due on or before December 31, 1999 6,967 -
5.52% due on or before August 2, 2003 2,000 -
5.09% due on or before August 28, 2008 15,000 -
------------ -----------
$ 23,967 $ 7,800
============ ===========
</TABLE>
The Bank has a total available line of credit of $37.0 million with the
FHLB. At December 31, 1998, the Bank had additional credit availability
from the Federal Home Loan Bank of $13.0 million.
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, 1998 and 1997, there were
1,692,352 and 1,898,052 shares of common stock issued and outstanding,
respectively. The decrease is attributable to the Company purchasing
$3,692,443 in treasury stock during 1998.
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, 1998 or 1997. 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.
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.
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
<PAGE>
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 $754,138 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").
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
----------------------------------------------------
(7) Stockholders' Equity - Continued
--------------------------------
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.
As of December 31, 1998, 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 Capitalized Under
Capital Amount Ratio Adequacy Prompt Corrective
1998 1997 1998 1997 Purposes Action Provisions
--------- --------- ---- ---- -------- ------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31:
Tier I Capital (ratio to risk-weighted assets): $ 27,044 $ 26,027 36.01% 42.30% 4.00% 6.00%
Tier Capital - Tier II capital (ratio to risk-
weighted assets): 27,794 26,597 37.01% 43.23% 8.00% 10.00%
Leverage - Tier I capital (ratio to average
Assets): 27,044 26,027 21.35% 25.92% 4.00% 5.00%
</TABLE>
At December 31, 1998 and 1997, the Bank was in compliance with all of the
aforementioned capital requirements.
<PAGE>
(8) Income Taxes
------------
The components of income tax expense (benefit) were as follows:
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------
(in thousands)
1998 1997 1996
------- -------- -------
<S> <C> <C> <C>
Currently payable:
Federal $ 913 $ 798 $ 757
State 167 145 139
------- -------- -------
1,080 943 896
------- -------- -------
Deferred:
Federal (91) (34) (31)
State (44) (8) (7)
------- -------- -------
(135) (42) (38)
------- -------- -------
$ 945 $ 901 $ 858
======= ======== =======
</TABLE>
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:
<TABLE>
<CAPTION>
December 31,
--------------
1998 1997
---- ----
(in thousands)
<S> <C> <C>
Allowance for loan losses (net) ......................... $308 $229
Deferred loan origination fees, net of deferred costs . 497 424
---- ----
Gross deferred tax assets .......................... 805 653
Accelerated depreciation ............................... 12 0
Valuation allowance .................................... 0 0
---- ----
Gross deferred tax assets .......................... 817 653
---- ----
Accelerated depreciation ............................... -- 46
FHLB stock dividends ............................... 180 180
Other temporary differences creating deferred tax assets 10 15
---- ----
Gross deferred tax liabilities ..................... 190 241
---- ----
Net deferred tax asset ............................. $627 $412
==== ====
</TABLE>
The Company has no valuation allowance at December 31, 1998 or 1997 because
it has sufficient taxable income in the carryback period to support the
realizability of the net deferred tax asset.
The reconciliation of income taxes at statutory tax rates to income tax
expense reported in the statements of income follows:
<TABLE>
<CAPTION>
December 31,
--------------------------------------
1998 1997 1996
------- -------- --------
(in thousands)
<S> <C> <C> <C>
Income taxes at the statutory federal tax rate $ 868 $ 827 $ 798
State income taxes less federal benefit 118 120 120
Tax exempt interest (15) (29) (38)
Other (26) (17) (22)
------- -------- --------
Total tax expense $ 945 $ 901 $ 858
======= ======== ========
</TABLE>
<PAGE>
Retained earnings at December 31, 1998 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 is permitted to take
deductions for bad debts, but is required to compute such deductions using
an experience method.
(9) Employee and Director Benefit Plans
-----------------------------------
401(k) PLAN
-----------
During 1994, the Bank implemented a 401(k) plan that covers all eligible
employees. The Bank may elect to match 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, and $1,900 in 1996.
There was no company matching in 1998.
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
----------------------------------------------------
(9) Employee and Director Benefit Plans - Continued
-----------------------------------------------
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 1998, the Bank made a $257,162 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 9,207 shares to
individual participant accounts. At December 31, 1998, a total of 40,029
shares have been released and allocated to participants and 105,975 shares
remain unallocated. Total compensation expense associated with the ESOP for
the years ended December 31, 1998 and 1997 was $190,000 and $180,000,
respectively. At December 31, 1998, there were 105,975 unallocated ESOP
shares with a total fair value of approximately $1,510,144. 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, 1998 and 1997, 9,207 and 23,617 shares respectively were
considered committed to be released to ESOP participants, and compensation
expense of $190,000 and $180,000, respectively 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, 1998 and 1997 was
$273,000 and $353,000, respectively.
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. No
stock options were granted in 1998.
A summary of the Company's stock option activity and related information
for the year ended December 31, 1998 follows:
<TABLE>
<CAPTION>
Outstanding Exercisable
---------------------- ----------------------
Weighted Weighted
Average Average
Option Exercise Option Exercise
Shares Price Shares Price
------- --------- ------- ---------
<S> <C> <C> <C> <C>
At December 31, 1997 ......... 172,244 $ 21.75 78,241 $ 21.75
Granted ...................... -- -- 23,439 21.75
Exercised .................... -- -- -- --
Forfeited .................... 1,287 -- 456 --
------- --------- ------- ---------
At December 31, 1998 ......... 170,957 $ 21.75 101,224 $ 21.75
======= ========= ======= =========
</TABLE>
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 using the Black-Scholes option pricing model with
the following assumptions: a risk free interest rate of 6.75%, expected
lives of 7 years, expected volatility of 30% and expected dividends of $.45
per year. The weighted average fair value per share of options granted
amounted to $6.26. The effects of applying the provisions of SFAS 123 in
1998 and 1997 are not necessarily indicative of future effects.
<PAGE>
<TABLE>
<CAPTION>
1998 1997
----------- ----------
(in thousands, except per share data)
<S> <C> <C>
Net income
As reported ......................... $ 1,608 $ 1,532
Pro forma ........................... 1,608 1,498
Net income per share
As reported ......................... $ 0.89 $ 0.82
Pro forma ........................... 0.89 0.80
</TABLE>
33
<PAGE>
NOTES TO FINANCIAL STATEMENTS - Continued
-----------------------------------------
(9) Employee and Director Benefit Plans - Continued
-----------------------------------------------
DIRECTOR'S DEFERRED COMPENSATION PLAN: The Bank has a deferred
compensation plan for its directors under which the directors would be paid
specified amounts during the ten year period following the date that the
director becomes 65 years of age. The Bank has purchased life insurance
policies with the Bank named as beneficiary to fund the benefits. Total
expense related to these plans was approximately $78,208 for 1998, $123,271
for 1997 and $48,000 for 1996.
EMPLOYMENT AGREEMENTS: In connection with the Conversion, the Bank entered
into an employment agreement with its chief executive officer in order to
ensure a stable and competent management base. The agreement provides for a
three-year term, but upon each anniversary, the agreement automatically
extends so that the remaining term shall always be three years. The
agreement provides that the nature of the covered employee's compensation,
duties or benefits cannot be diminished following a change in control of
the Company.
SEVERANCE PLAN: In connection with the Conversion, the Bank adopted a
Severance Plan for the benefit of its employees. The Plan provides for
severance pay benefits in the event of a change in control which results in
the termination of such employees or diminished compensation, duties, or
benefits within two years of a change in control. The employees covered
would be entitled to a severance benefit of the greater of (a) the amount
equal to two weeks salary at the existing salary rate multiplied by the
employee's number of completed years of service or (b) the amount of one
month's salary at the employee's salary rate at the time of termination,
subject to a maximum payment equal to two times the employee's annual
salary.
SPECIAL TERMINATION AGREEMENTS: In order to assure the continued employment
of Allen W. Carter and Marjorie D. Foster, the Bank entered into special
termination agreements with each of them to provide benefits in the event
of a change in control of the Bank or the Company. Such agreements are
intended to ensure that the Bank will be able to maintain a stable and
competent employee base. The continued success of the Bank depends, to a
significant degree, on the skill and competence of its employees.
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
----------------------------------------------------
(10) Quarterly Financial Data (Unaudited)
------------------------------------
Summarized unaudited quarterly financial data for the year ended December
31, 1998 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 $ 2,190 $ 2,253 $ 2,360 $ 2,465
Interest expense 952 975 1,121 1,222
-------- ---------- ---------- ---------
Net interest income 1,238 1,278 1,239 1,243
Provision for loan losses 30 30 30 90
Net interest income after provision for loan losses 1,208 1,248 1,209 1,153
Other income 34 36 31 62
Other expenses 493 798 551 586
--------- ---------- ---------- ---------
Income before income tax expense 749 486 689 629
Income taxes 286 185 263 211
--------- ---------- ---------- ---------
Net income 463 301 426 418
Per Share Data:
Net income per share - basic .25 .16 .24 .24
Net income per share - diluted .25 .16 .24 .24
Cash dividends declared .1150 .1150 .1150 .1150
Dividend payout 46.69 70.94 43.35 46.62
Book value per share 16.47 16.64 16.68 16.83
Selected Average Balances:
Assets $ 109,518 $ 111,599 $ 118,175 $ 125,684
Investment securities 10,910 9,674 13,153 17,715
Loans, net 94,344 96,931 99,589 101,794
Interest-bearing deposits 67,365 68,291 68,827 71,003
FHLB advances 31,025 30,824 29,665 28,572
</TABLE>
35
<PAGE>
NOTES TO FINANCIAL STATEMENTS - Continued
(10) Quarterly Financial Data (Unaudited) - (Continued)
--------------------------------------------------
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 91,490 65,553 66,414
FHLB advances - - 3,390 6,555
Stockholders' equity 37,587 34,212 30,799 31,027
</TABLE>
36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
------------------------------------------------------
(11) Parent Company Financial Data
-----------------------------
Condensed financial information for Stone Street Bancorp, Inc. (Parent
Company) is as follows:
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
------------- -------------
Condensed Balance Sheet (in thousands)
<S> <C> <C>
Assets:
Cash on deposit with bank subsidiary $ 931 $ 3,957
Interest bearing deposits 473 204
Investment securities available for sale at market value:
Obligations of states and local governments, cost $860,000 - 859
Investment in bank subsidiary 27,046 26,030
Other assets 164 118
------------- -------------
Total assets $ 28,614 $ 31,168
============= ============
Liabilities and stockholders' equity:
Accrued expenses and other liabilities $ 124 $ 92
Stockholders' equity, net 28,490 31,076
------------- -------------
Total liabilities and stockholders' equity $ 28,614 $ 31,168
============= =============
<CAPTION>
Year Ended December 31,
1998 1997
------------- -------------
Condensed Statement of Income (in thousands)
<S> <C> <C>
Dividends from bank subsidiary $ 725 $ 619
Interest income from bank subsidiary 92 203
Interest on interest bearing deposits 20 149
Interest on loan from bank subsidiary ESOP 167 182
Interest on investment securities 15 33
------------- -------------
Total income 1,019 1,186
Operating expenses 131 241
------------- -------------
Income before income taxes 888 945
Income tax expense 63 120
------------- -------------
Income before equity in undistributed net income of subsidiary 825 825
Equity in undistributed net income of bank subsidiary 783 707
------------- -------------
Net income $ 1,608 $ 1,532
============= =============
</TABLE>
37
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
------------------------------------------------------
(11) Parent Company Financial Data - Continued
-----------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
1998 1997
------------ -------------
Condensed Statement of Cash Flows (in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,608 $ 1,532
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary (783) (707)
Payments on ESOP loan receivable from bank subsidiary 89 579
(Increase) (decrease) in other assets 46 47
Increase in other liabilities (32) (326)
------------ -------------
Net cash provided by operating activities 928 1,125
------------- -------------
Cash flows from investing activities:
Maturity of available for sale securities 829 -
------------- -------------
Net cash provided by investing activities 829 -
Cash flows from financing activities:
Proceeds of issuance of no par common stock - -
Loan to ESOP for purchase of common stock - (329)
Capital contribution to bank subsidiary - -
Cash dividends paid to stockholders (822) (8,438)
Purchase of treasury stock (3,692) -
------------ -------------
Net cash provided by financing activities (4,514) (8,767)
------------ -------------
Net increase in cash and cash equivalents (2,757) (7,642)
Cash and cash equivalents at beginning of year 4,161 11,803
------------- -------------
Cash and cash equivalents at end of year $ 1,404 $ 4,161
============= =============
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 95 $ 149
============= =============
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on securities available for sale
net of deferred tax benefit of $1 in each year $ (39) $ (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 $ 0 $ 4
============= =============
Dividends declared but unpaid $ - $ -
============= =============
</TABLE>
38
<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, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------------------------ ------------------------
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 $ 7,688 $ 7,688 $ 4,703 $ 4,703
Investment securities:
Available-for-sale 10,426 10,358 1,854 1,859
Held-to-maturity 2,492 2,491 5,889 5,940
Net loans 102,549 103,574 92,967 92,549
Federal Home Loan Bank stock 1,570 1,570 741 741
Financial liabilities:
Deposits 73,176 73,468 66,973 67,106
Advance from FHLB 23,967 23,967 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, 1998, 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.
39
<PAGE>
CORPORATE INFORMATION
----------------
BOARD OF DIRECTORS
Robert B. Hall, Chairman of the Board Claude R. Horn, Jr.
Retired Pharmacist President of Horn Oil Co.
William F. Junker, Vice Chairman
President of Featherlite Trailer George W. Martin
Attorney and Partner
Donald G. Bowles in Martin, VanHoy,
Certified Public Accountant Smith & Raisbeck
J. Charles Dunn Ronald H. Vogler
President of the Company and Stone Street Bank Financial Consultant
with Paine Webber
Terry Bralley since 1993, formerly
Town Manager with Merrill Lynch
Mocksville, North Carolina
EXECUTIVE OFFICERS
J. Charles Dunn Allen W. Carter
President and Chief Executive Officer Senior Vice President
of The Company and Bank of the Company and Bank
Marjorie D. Foster
Vice President
and Controller of The
Company and Bank
CORPORATE OFFICE INDEPENDENT CERTIFIED
STONE STREET BANCORP, INC. PUBLIC ACCOUNTANTS
232 South Main Street Weir Smith Jones Miller & Elliott
Mocksville, NC 27028 310 West Broad Street
(336) 751-5936 Statesville, NC 28677
STOCK TRANSFER AGENT FORM 10-K
Registrar and Transfer Company A copy of the Form 10-K as filed with
10 Commerce Drive the Securities and Exchange Commission
Cranford, New Jersey 07016-3572 will be furnished without charge to
stockholders upon written request to:
SPECIAL LEGAL COUNSEL Marjorie D. Foster
Brooks, Pierce, McLendon, Humphrey and Leonard Stone Street Bancorp, Inc.
Post Office Box 26000 232 South Main Street
Greensboro, NC 27420 Mocksville, NC 27028
<PAGE>
ANNUAL MEETING
The 1999 Annual Meeting of stockholders of Stone Street Bancorp, Inc. will be
held at 5:00 p.m. on April 20, 1999 at the Davie County Public Library,
Mocksville, North
Carolina.
40
<PAGE>
CAPITAL STOCK
--------------
Stone Street Bancorp's common stock is traded on the American Stock
Exchange under the symbol "SSM". As of December 31, 1998, there were
1,692,352 shares outstanding and 667 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
<TABLE>
<CAPTION>
Stock Price Dividends Declared, Per Share
-------------------------- -----------------------------
High Low
1998:
<S> <C> <C> <C>
First Quarter ended March 31 $ 22 1/4 $ 19 3/4 $ .1150
Second Quarter ended June 30 21 19 1/8 .1150
Third Quarter ended September 30 19 3/4 15 1/4 .1150
Fourth Quarter ended December 31 15 3/8 14 .1150
1997:
First Quarter ended March 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 a regular cash dividend of $.1125 per share and a return of capital
dividend of $4.00 per share.
41
SUBSIDIARY OF THE REGISTRANT
The registrant has one subsidiary, Stone Street Bank and Trust
(formerly Mocksville Savings Bank, Inc., SSB), a North Carolina corporation. The
subsidiary does business under its corporate name "Stone Street Bank", and Stone
Street Bank and Trust. Stone Street Bank and Trust has a wholly-owned
subsidiary, Stone Street Financial Services, Inc., a North Carolina Corporation.
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, 1999 relating to the consolidated balance sheets of Stone
Street Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997 and the
related consolidated statements of income, stockholders' equity and cash flows
for the years then ended, which report appears in the Company's 1998 annual
report on Form 10-K.
/s/Weir Smith Jones Miller & Elliott
- ------------------------------------
Weir Smith Jones Miller & Elliott
Statesville, North Carolina
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,404
<INT-BEARING-DEPOSITS> 4,406
<FED-FUNDS-SOLD> 878
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 10,358
<INVESTMENTS-CARRYING> 2,492
<INVESTMENTS-MARKET> 2,491
<LOANS> 102,549
<ALLOWANCE> 750
<TOTAL-ASSETS> 127,273
<DEPOSITS> 73,176
<SHORT-TERM> 6,967
<LIABILITIES-OTHER> 1,640
<LONG-TERM> 17,000
0
0
<COMMON> 18,433
<OTHER-SE> 10,057
<TOTAL-LIABILITIES-AND-EQUITY> 127,273
<INTEREST-LOAN> 8,457
<INTEREST-INVEST> 540
<INTEREST-OTHER> 271
<INTEREST-TOTAL> 9,268
<INTEREST-DEPOSIT> 3,426
<INTEREST-EXPENSE> 844
<INTEREST-INCOME-NET> 4,998
<LOAN-LOSSES> 180
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,428
<INCOME-PRETAX> 2,553
<INCOME-PRE-EXTRAORDINARY> 2,553
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,608
<EPS-PRIMARY> .89
<EPS-DILUTED> .89
<YIELD-ACTUAL> 4.48
<LOANS-NON> 0
<LOANS-PAST> 243
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 570
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 750
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 750
</TABLE>
