SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended June 30, 1997 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-28446
MITCHELL BANCORP, INC.
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(Exact name of registrant as specified in its charter)
North Carolina 56-1966011
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
210 Oak Avenue, Spruce Pine, North Carolina 28777
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (704) 765-7324
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to
Section 12(g) of the Act: Common Stock, par value $.01 per share
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(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 .
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Indicate by check mark whether disclosure of delinquent filers
pursuant to Item 405 of Regulation S-B is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
other information statements incorporated by reference in Part III of this Form
10-KSB or any amendments to this Form 10-KSB. YES X NO .
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The Registrant's revenues for the fiscal year ended June 30, 1997
were $2,666,000.
As of September 2, 1997, there were issued and outstanding 930,902
shares of the Registrant's Common Stock. The Registrant's voting stock is
traded over-the-counter and is listed on the Nasdaq Smallcap Market under
the symbol "MBSP." Based on the closing price for the Common Stock on
September 2, 1997, the aggregate value of the Common Stock outstanding held by
nonaffiliates of the registrant was $14.0 million (852,511 shares at $16.375
per share). For purposes of this calculation, officers and directors of the
Registrant are considered nonaffiliates of the Registrant.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Shareholders for the Fiscal
Year Ended June 30, 1997 ("Annual Report") (Parts I and II).
2. Portions of Definitive Proxy Statement for the 1997 Annual
Meeting of Stockholders (Part III).
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PART I
Item 1. Business
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General
Mitchell Bancorp, Inc. ("Corporation"), a North Carolina corporation, was
organized on February 28, 1996 for the purpose of becoming the holding company
for Mitchell Savings Bank, Inc., SSB ("Savings Bank") upon the Savings Bank's
conversion from a North Carolina-chartered mutual to a North Carolina-chartered
stock savings bank ("Conversion"). The Conversion was completed on July 12,
1996. The Corporation has not engaged in any significant activity other than
holding the stock of the Savings Bank. Accordingly, the information set forth
in this report, including financial statements and related data, relates
primarily to the Savings Bank and its subsidiary.
The Savings Bank was established in 1924 as "Mitchell County Building and
Loan Association," a North Carolina-chartered mutual savings and loan
association, located in Spruce Pine, North Carolina, approximately 50 miles
Northeast of Asheville, North Carolina. In 1992, the Savings Bank converted to
a North Carolina-chartered savings bank and adopted its current title. The
Savings Bank is regulated by the Administrator, Savings Institutions Division,
North Carolina Department of Commerce ("Administrator"), its primary regulator,
and the Federal Deposit Insurance Corporation ("FDIC"), the insurer of its
deposits. The Savings Bank's deposits are federally insured by the FDIC under
the Savings Association Insurance Fund ("SAIF"). The Savings Bank is a member
of the Federal Home Loan Bank ("FHLB") System.
The Savings Bank is a traditional, community oriented financial
institution that is engaged primarily in the business of attracting deposits
from the general public and using these funds to originate for its portfolio
fixed-rate one- to four- family residential mortgage loans within the Savings
Bank's market area, and, to a significantly lesser extent, loans secured by
multi-family properties, land, churches, and selected commercial properties,
and consumer loans.
Market Area
Spruce Pine, North Carolina, is a community of approximately 2,000 people
located in Mitchell County, approximately 50 miles northeast of Asheville,
North Carolina. The Savings Bank focuses primarily on serving customers
located in Mitchell and Yancey counties, North Carolina and to a limited
extent, customers in Avery and McDowell counties, North Carolina. The
population within the zip code encompassing Spruce Pine, which covers much of
the Savings Bank's primary market area, is approximately 15,000. Because it
operates in a relatively small market area, the Savings Bank's loan and deposit
growth prospects are limited. The major employers in the Savings Bank's market
area include the Mitchell County Board of Education, Mitchell County
Government, Blue Ridge Hospital System, Inc., Henredon Furniture, and Felspar
Mining. The Savings Bank faces intense competition from many financial
institutions for deposits and loan originations. See "-- Competition."
Selected Financial Data
This information is incorporated by reference from page 3 of the 1997
Annual Report to Stockholders ("Annual Report").
Yields Earned and Rates Paid
This information is incorporated by reference from page 7 of the Annual
Report.
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Lending Activities
General. The principal lending activity of the Savings Bank is the
origination of mortgage loans to enable borrowers to purchase existing one- to
four-family homes. To a significantly lesser extent, the Savings Bank also
originates loans secured by multi-family properties, land, churches, selected
commercial properties, and consumer loans. The Savings Bank's net loans
receivable totalled approximately $28.2 million at June 30, 1997, representing
approximately 85.3% of consolidated total assets.
Loan Portfolio Analysis. The following table sets forth the composition
of the Savings Bank's loan portfolio at the dates indicated.
At June 30,
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1996 1997
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Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
Residential one- to four-family. . . . . . . $19,751 82.47% $23,909 83.22%
Commercial real estate . . . . . . . . . . . 2,810 11.73 3,661 12.74
Multi-family . . . . . . . . . . . . . . . . 157 0.66 20 .07
Land . . . . . . . . . . . . . . . . . . . . 1,078 4.50 1,013 3.53
------- ------ ------- -----
Total mortgage loans . . . . . . . . . . . 23,796 100.00% 28,603 99.56%
Consumer loans . . . . . . . . . . . . . . . 154 0.64 126 .44
------- ------ ------- ------
Total loans. . . . . . . . . . . . . . . . 23,950 100.00% 28,729 100.00%
======= ====== ======= ======
Less:
Undisbursed portion
of loans in process. . . . . . . . . . . . 62 135
Unamortized loan origination
fees, net or direct costs. . . . . . . . . 124 160
Allowance for loan losses . . . . . . . . . 152 176
Allowance for uncollected interest. . . . . 44 55
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Total loans receivable, net . . . . . . . $23,568 $28,203
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Residential One- to Four-Family Lending. The primary lending activity of
the Savings Bank is the origination of mortgage loans to enable borrowers to
purchase existing one- to four-family homes. Management believes that this
policy of focusing on one- to four-family residential mortgage loans located in
its market area has been successful in contributing to interest income while
keeping delinquencies and losses to a minimum. At June 30, 1997, $23.9
million, or 83.2%, of the Savings Bank's total gross loan portfolio, consisted
of loans secured by one- to four-family residential real estate. As of such
date, the average balance of the Savings Bank's permanent residential one- to
four-family mortgage loans was approximately $37,500. The Savings Bank
presently originates for retention in its portfolio fixed-rate mortgage loans
with terms of 16 years. The Savings Bank charges a 1% origination fee on its
residential one- to four-family mortgage loans.
Virtually all of the Savings Bank's residential mortgage loans are not
readily saleable in the secondary market because they are not originated in
accordance with the purchase requirements of the Federal Home Loan Mortgage
Corporation ("FHLMC") or the Federal National Mortgage Association ("FNMA").
Although such loans satisfy the Savings Bank's underwriting requirements, they
are "non-conforming" because they do not satisfy minimum loan amount
requirements, acreage limits, or various other requirements imposed by the
FHLMC and FNMA. Accordingly, the Savings Bank's non-conforming loans could be
sold only after incurring certain costs and/or discounting the purchase price.
The Savings Bank currently does not intend to sell its loans. The Savings Bank
has historically found that its origination of non-conforming loans has not
resulted in a materially higher
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amount of nonperforming loans. In addition, the Savings Bank believes that
these loans satisfy a need in the Savings Bank's local community. As a result,
the Savings Bank intends to continue to originate such non-conforming loans.
While fixed-rate, single-family residential real estate loans are normally
originated with 16 year terms, such loans typically 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. In addition, substantially all mortgage loans in the Savings
Bank's loan portfolio contain due-on-sale clauses providing that the Savings
Bank may declare the unpaid amount due and payable upon the sale of the
property securing the loan. Typically, the Savings Bank enforces these
due-on-sale clauses to the extent permitted by law and as business judgment
dictates. 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 Savings Bank requires fire and extended coverage casualty insurance be
maintained on all of its real estate secured loans.
The Savings Bank's lending policies generally limit the maximum
loan-to-value ratio on mortgage loans secured by owner-occupied properties to
66-2/3% of the lesser of the appraised value or the purchase price. Loans
originated by the Savings Bank on new one- to four-family properties which are
less than five years old may have an increased loan-to-value ratio of 80% of
the lesser of the purchase price. The maximum loan-to-value ratio on mortgage
loans secured by non-owner-occupied properties is generally 66-2/3%.
Commercial Real Estate Lending. Historically, the Savings Bank has
engaged in limited amounts of commercial real estate lending in its primary
market area and expects to continue that practice. Commercial real estate
loans are made for terms up to 15 years, amortized monthly, and at fixed
interest rates. Loan-to-value ratios generally do not exceed 50% of appraised
property value. At June 30, 1997, such loans totalled $3.7 million, or 12.7%,
of total gross loans.
At June 30, 1997, a commercial real estate loan relationship of $1.2
million represented the Savings Bank's largest loan-to-one borrower
relationship at that date. The relationship consisted of a loan made to the
corporate owner and operator of a local commercial property. At June 30, 1997,
this loan relationship was performing according to its terms.
At June 30, 1997, the second and third largest commercial real estate
loans had outstanding balances of $525,000 and $404,000, respectively, and were
secured by first mortgages on commercial properties located in the Savings
Bank's market area. Each loan was performing according to its terms at June
30, 1997.
Loans secured by commercial real estate generally involve larger principal
balances and greater risks than one- to four-family residential mortgage loans.
Payments on such loans often depend on the successful operation or management
of the underlying properties and may be subject to a greater extent to adverse
conditions in the real estate market or the economy. The Savings Bank seeks to
minimize these risks in a variety of ways, including limiting the size of such
loans and the maximum loan-to-value ratio to 50%, and strictly scrutinizing the
financial condition of the borrower, the quality of the collateral, and the
management of the property securing the loan. The Savings Bank also obtains
loan guarantees from financially capable parties based on a review of personal
financial statements. All of the properties securing the Savings Bank's
commercial real estate loans are inspected by the Savings Bank's lending
personnel before origination. The Savings Bank also obtains appraisals on each
property in accordance with applicable regulations and, if applicable, an
environmental audit.
At June 30, 1997, the Savings Bank had two commercial real estate loans
outstanding secured by local properties used in petroleum-related activities.
Although the Savings Bank is unaware of any underground petroleum contamination
at such properties, no assurances can be given that such contamination does
not, in fact, exist or that it will not arise in the future. Under current
law, the Savings Bank could be liable for the cleanup costs associated with
such contamination should it have to foreclose on the properties or take other
actions in the event of borrower
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default. Such costs, if any, often exceed the value of the collateral
property. See "REGULATION -- The Savings Bank -- Environmental Issues
Associated With Real Estate Lending." Such loans were performing according to
their terms at June 30, 1997.
Multi-family Real Estate Lending. The Savings Bank has historically
engaged in a limited amount of multi-family real estate lending. The Savings
Bank does not actively solicit multi-family real estate loans as there are a
limited number multi-family properties in its market area. At June 30, 1997,
the Savings Bank had one multi- family loans in the amount of $20,000. The
risks associated with multi-family lending are substantially the same as those
associated with commercial lending discussed above.
Land Lending. The Savings Bank originates loans secured by farm
residences and combinations of farm residences and farm real estate. The
Savings Bank also originates loans for the acquisition of land upon which the
purchaser can then build or upon which the purchaser makes improvements
necessary to build upon or to sell as improved lots. At June 30, 1997, the
Savings Bank's land loan portfolio totalled $1.0 million, or 3.5%, of total
gross loans.
Loans secured by farm real estate generally involve greater risks than
one- to four-family residential mortgage loans. Payments on loans secured by
such properties, in some instances, may depend on farm income from the
properties. To address this risk, the Savings Bank does not consider farm
income when qualifying borrowers. In addition, such loans are more difficult
to evaluate. If the estimate of value proves to be inaccurate, in the event of
default and foreclosure, the Savings Bank may be confronted with a property the
value of which is insufficient to assure full repayment.
Consumer Lending. Consumer lending has traditionally been a small part of
the Savings Bank's business. Consumer loans generally have shorter terms to
maturity and higher interest rates than mortgage loans. At June 30, 1997, the
Savings Bank's consumer loan portfolio consisted entirely of loans secured by
deposit accounts, which totalled $126,000, or 0.4%, of total gross loans. The
interest rate charged on such loans is generally 2% above the interest rate
earned on the underlying deposit account. Deposit account loans are payable in
monthly payments of principal and interest or in a single payment.
Maturity of Loan Portfolio. The following table sets forth certain
information at June 30, 1997 regarding the dollar amount of loans maturing in
the Savings Bank's portfolio based on their contractual terms to maturity.
Demand loans, loans having no stated schedule of repayments and no stated
maturity, and overdrafts are reported as due in one year or less. Loan
balances do not include undisbursed loan proceeds, unearned discounts, unearned
income and allowance for loan losses.
After After After
Due at June 30, 3 Years 5 Years 10 Years
-------------------- Through Through Through
1998 1999 2000 5 Years 10 Years 15 Years Total
---- ---- ---- ------- -------- -------- -----
(In thousands)
Residential
one- to four-
family. . . . . . $ 5 $39 $73 $234 $2,567 $20,991 $23,909
Commercial real
estate. . . . . . -- -- 5 62 504 3,090 3,661
Multi- family. . . -- -- -- -- 20 -- 20
Land loans . . . . -- -- -- 11 122 880 1,013
Consumer loans . . 126 -- -- -- -- -- 126
---- --- --- ---- ------ ------- -------
Total loans . . . $131 $39 $78 $307 $3,213 $24,961 $28,729
==== === === ==== ====== ======= =======
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The following table sets forth the dollar amount of all loans due after
June 30, 1998, all of which have fixed interest rates. The Savings Bank does
not originate adjustable rate loans.
Fixed
Rates
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(In thousands)
Residential one- to
four-family. . . . . . . . . . . . $23,904
Commercial real estate . . . . . . . 3,661
Multi-family . . . . . . . . . . . . 20
Land loans . . . . . . . . . . . . . 1,013
Consumer loans . . . . . . . . . . . --
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Total . . . . . . . . . . . . . $28,598
=======
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Savings Bank the right to declare loans
immediately due and payable in the event, among other things, that the borrower
sells the real property subject to the mortgage and the loan is not repaid.
The average life of mortgage loans tends to increase, however, when current
mortgage loan market rates are substantially higher than rates on existing
mortgage loans and, conversely, decrease when rates on existing mortgage loans
are substantially higher than current mortgage loan market rates.
Loan Solicitation and Processing. Loan originations are obtained from a
variety of sources, including walk-in customers, and referrals from attorneys,
builders and realtors. Upon receipt of a loan application from a prospective
borrower, a credit report and other data are obtained to verify specific
information relating to the loan applicant's employment, income and credit
standing. An appraisal of the real estate offered as collateral generally is
undertaken by an appraiser retained by the Savings Bank and certified by the
State of North Carolina.
All loans are approved by the President, Calvin F. Hall, Mr. Ballew and
Mrs. Wilson, and subsequently reviewed and ratified by the Board of Directors.
Interest rates are subject to change if the approved loan is not closed within
the time of the commitment. Management of the Savings Bank believes its local
decision-making capabilities and the accessibility of its senior officers are
attractive qualities to customers within its market area. The Savings Bank's
loan approval process allows consumer loans to be approved in one or two days
and mortgage loans to be approved in approximately 14 days and closed in 30
days.
Loan Originations. Consistent with its asset/liability management
strategy, the Savings Bank's policy has been to retain in its portfolio all of
the loans that it originates.
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The following table sets forth total loans originated and repaid during
the periods indicated. No loans were purchased or sold during the periods
indicated.
Year Ended June 30,
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1996 1997
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(In thousands)
Total mortgage loans at beginning of period. . . . . $22,575 $23,796
Loans originated:
Residential one- to four-family . . . . . . . . . . 5,526 8,677
Commercial real estate. . . . . . . . . . . . . . . 323 1,353
Land loans. . . . . . . . . . . . . . . . . . . . . 68 401
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Total loans originated. . . . . . . . . . . . . . 5,917 10,431
------- -------
Mortgage loan principal repayments . . . . . . . . . (4,696) (5,572)
Other. . . . . . . . . . . . . . . . . . . . . . . . -- (52)
Net loan activity. . . . . . . . . . . . . . . . . . 1,221 4,807
------- -------
Total gross mortgage loans
at end of period . . . . . . . . . . . . . . . . . $23,796 $28,603
======= =======
Loan Origination and Other Fees. The Savings Bank, in some instances,
receives loan origination fees. Loan fees are a percentage of the principal
amount of the mortgage loan which are charged to the borrower for funding the
loan. The amount of fees charged by the Savings Bank is generally 1%, except
on loans made to churches for which the Savings Bank does not charge any loan
origination fees. Current accounting standards require fees received (net of
certain loan origination costs) for originating loans to be deferred and
amortized into interest income over the contractual life of the loan. Net
deferred fees or costs associated with loans that are prepaid are recognized as
income at the time of prepayment. The Savings Bank had $160,000 of net
deferred mortgage loan fees at June 30, 1997.
Nonperforming Assets and Delinquencies. The Savings Bank does not assess
late fees or penalty charges on delinquent loans. All loan payments are due on
the first day of the month; however, the borrower is given the entire month to
make the loan payment. When a mortgage loan borrower fails to make a required
payment when due, the Savings Bank institutes collection procedures. The first
notice is mailed to the borrower 30 days after the date the payment is due and,
if necessary, a second written notice follows within 30 days thereafter giving
the borrower 15 days to respond and correct the delinquency. Attempts to
contact the borrower by telephone generally begin soon after the first notice
is mailed to the borrower. If a satisfactory response is not obtained,
continuous follow-up contacts are attempted until the loan has been brought
current. Before the 90th day of delinquency, attempts to interview the
borrower, preferably in person, are made to establish (i) the cause of the
delinquency, (ii) whether the cause is temporary, (iii) the attitude of the
borrower toward the debt, and (iv) a mutually satisfactory arrangement for
curing the default.
If by the 91st day of delinquency, or sooner if the borrower is
chronically delinquent and all reasonable means of obtaining payment on time
have been exhausted, foreclosure is initiated according to the terms of the
security instrument and applicable law. Interest income on loans is reduced by
the full amount of accrued and uncollected interest.
When a consumer loan borrower fails to make a required payment on a
consumer loan by the payment due date, the Savings Bank institutes the same
collection procedures as for its mortgage loan borrowers.
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The Savings Bank's Board of Directors is informed monthly as to the status
of all mortgage and consumer loans that are delinquent more than 30 days, the
status on all loans currently in foreclosure, and the status of all foreclosed
and repossessed property owned by the Savings Bank.
The following table sets forth information with respect to the Savings
Bank's non-performing assets at the dates indicated.
At June 30,
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1996 1997
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(Dollars in thousands)
Loans accounted for on a nonaccrual basis:
Real estate:
Residential one- to four-family. . . . . . $690 $561
Commercial . . . . . . . . . . . . . . . . 9 9
Multi-family . . . . . . . . . . . . . . . -- --
Land . . . . . . . . . . . . . . . . . . . 135 11
Consumer . . . . . . . . . . . . . . . . . . . -- --
---- ----
Total. . . . . . . . . . . . . . . . . . . 834 581
---- ----
Accruing loans which are contractually past
due 90 days or more . . . . . . . . . . . . . . -- --
---- ----
Total of nonaccrual and 90 days
past due loans . . . . . . . . . . . . . . . 834 581
Real estate owned. . . . . . . . . . . . . . . . 99 91
---- ----
Total nonperforming assets. . . . . . . . . . $933 $672
==== ====
Total loans delinquent 90 days or more to
net loans. . . . . . . . . . . . . . . . . . . 3.54% 2.06%
Total loans delinquent 90 days or more to
total assets . . . . . . . . . . . . . . . . . 2.27% 1.76%
Total nonperforming assets to total assets . . . 2.54% 2.03%
Interest income, which would have been recorded for the year ended June
30, 1997 had nonaccruing loans been current in accordance with their original
terms, amounted to approximately $37,000. The amount of interest included in
the results of operations on such loans for the year ended June 30, 1997
amounted to approximately $8,000.
Real Estate Owned. Real estate acquired by foreclosure or by deed-in-lieu
of foreclosure is classified as real estate owned until sold. When property is
acquired it is recorded at the lower of its cost, which is the unpaid principal
balance of the related loan plus foreclosure costs, or fair market value.
Subsequent to foreclosure, the property is carried at the lower of the
foreclosed amount or fair value, less estimated selling costs.
At June 30, 1997, the Savings Bank had $91,000 of real estate owned, with
no allowance for losses, consisting of two one- to four-family residences.
Asset Classification. Applicable regulations require that each insured
institution review and classify its assets on a regular basis. In addition, in
connection with examinations of insured institutions, regulatory examiners have
authority to identify problem assets and, if appropriate, require them to be
classified. There are three
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classifications for problem assets: substandard, doubtful and loss.
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss.
An asset classified as loss is considered uncollectible and of such little
value that continuance as an asset of the institution is not warranted. 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 balances of the asset. The Savings Bank's determination as
to the classification of its assets and the amount of its valuation allowances
is subject to review by the FDIC and the Administrator which can order the
establishment of additional loss allowances.
The aggregate amounts of the Savings Bank's classified assets (as
determined by the Savings Bank), and of the Savings Bank's general and specific
loss allowances and charge-offs for the dates indicated, were as follows:
At June 30,
-------------------------
1996 1997
---- ----
(In thousands)
Loss . . . . . . . . . . . . . . . . . . . $ 55 $ 55
Doubtful . . . . . . . . . . . . . . . . . -- --
Substandard assets . . . . . . . . . . . . 878 617
Special mention. . . . . . . . . . . . . . -- --
General loss allowances. . . . . . . . . . 152 176
Specific loss allowances(1). . . . . . . . 15 --
Charge-offs(1) . . . . . . . . . . . . . . -- 15
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(1) Real estate owned.
Allowance for Loan Losses. The Savings Bank has established a systematic
methodology for the determination of provisions for loan losses. The
methodology is set forth in a formal policy and takes into consideration the
need for an overall general valuation allowance as well as specific allowances
assigned to individual loans.
In originating loans, the Savings Bank recognizes that 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, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. The Savings Bank increases its allowance
for loan losses by charging provisions for loan losses against income.
The general valuation allowance is maintained to cover losses inherent in
the portfolio of performing loans and is generally based on mortgage loans
which consist primarily of single-family residences. Management reviews the
adequacy of the allowance at least quarterly based on management's assessment
of current economic conditions, past loss and collection experience, and risk
characteristics of the loan portfolio. Specific valuation allowances are
established to absorb losses on loans for which full collectibility may not be
reasonably assured. The amount of the allowance is based on the estimated
value of the collateral securing the loan and other analyses pertinent to each
situation. No allowance is maintained for consumer loans since the only
non-mortgage loans held by the Savings Bank are on savings accounts.
Generally, a provision for losses is charged against income quarterly to
maintain the allowances.
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At June 30, 1997, the Savings Bank had an allowance for loan losses of
$176,000. Management believes that the amount maintained in the allowances
will be adequate to absorb losses inherent in the portfolio. Although
management believes that it uses the best information available to make such
determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations.
While the Savings Bank believes it has established its existing allowance
for loan losses in accordance with GAAP, there can be no assurance that
regulators, in reviewing the Savings Bank's loan portfolio, will not request
the Savings Bank to increase significantly its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing allowance
for loan losses is adequate or that substantial increases will not be necessary
should the quality of any loans deteriorate as a result of the factors
discussed above. Any material increase in the allowance for loan losses may
adversely affect the Savings Bank's financial condition and results of
operations.
The following table sets forth an analysis of the gross allowance for
possible loan losses for the periods indicated. Where specific loan loss
reserves have been established, any difference between the loss reserve and the
amount of loss realized has been charged or credited to current income.
Year Ended June 30,
-----------------------
1996 1997
---- ----
(Dollars in thousands)
Allowance at beginning of period . . . . . . $92 $152
Provision for loan losses. . . . . . . . . . 60 24
Recoveries . . . . . . . . . . . . . . . . . -- --
Charge-offs. . . . . . . . . . . . . . . . . -- --
---- ----
Balance at end of period . . . . . . . . $152 $176
==== ====
Ratio of allowance to total
loans outstanding at the end
of the period . . . . . . . . . . . . . . . 0.63% 0.61%
Ratio of net charge-offs to
average loans outstanding
during the period . . . . . . . . . . . . . -- --
Ratio of allowance to
non-performing loans. . . . . . . . . . . . 18.23 30.29
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The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not necessarily indicative of
future losses and does not restrict the use of the allowance to absorb losses
in any other category.
At June 30,
-------------------------------------------------
1996 1997
------------------------ -----------------------
% of % of
Loans Loans
in in
As a % Cate- As a % Cate-
of Out- gory of Out- gory
standing to standing to
Loans in Total Loans in Total
Amount Category Loans Amount Category Loans
------ -------- ----- ------ -------- -----
(Dollars in thousands)
Real estate -- mortgage:
Residential one- to-
four family . . . . . . $ 95 0.48% 82.47% $100 0.42% 83.22%
Commercial . . . . . . . 57 2.03 11.73 76 2.08 12.74
Multi-family . . . . . . -- -- 0.66 -- -- 0.07
Land . . . . . . . . . . -- -- 4.50 -- -- 3.53
Consumer . . . . . . . . . -- -- 0.64 -- -- .44
------ ---- ------ ---- ---- ------
Total allowance
for loan losses. . . . . $ 152 100.00% $176 100.00%
====== ====== ==== ======
Investment Activities
The Savings Bank is permitted under federal and state law to invest in
various types of liquid assets, including U.S. Treasury obligations, securities
of various federal agencies and of state and municipal governments, deposits at
the FHLB-Atlanta, certificates of deposit of federally insured institutions,
certain bankers' acceptances and federal funds. Subject to various
restrictions, the Savings Bank may also invest a portion of its assets in
commercial paper and corporate debt securities. Savings institutions like the
Savings Bank are also required to maintain an investment in FHLB-Atlanta stock.
The Savings Bank is required under North Carolina regulations to maintain
a minimum amount of liquid assets. At June 30, 1997, the Savings Bank's
regulatory liquidity was 7%. See "REGULATION -- The Savings Bank --
Liquidity." The Corporation's consolidated liquidity was 12% at June 30, 1997.
As of June 30, 1997, the Savings Bank's investment securities portfolio
consisted entirely of interest-earning deposits at other banks, FHLB-Atlanta
stock and FHLMC stock. At June 30, 1997, the Savings Bank's investment in
FHLMC stock and FHLB-Atlanta stock totalled $13,000 and $291,000, respectively.
The market value of the Savings Bank's investment portfolio amounted to
$576,000 and $758,000 at June 30, 1996 and 1997, respectively.
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of the
Savings Bank's funds for lending and other investment purposes. Scheduled loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are influenced significantly by general interest
rates and money market conditions. Borrowings through the FHLB-Atlanta may be
used on a short-term basis to compensate for reductions in the availability of
funds from other sources; however, the Savings Bank has never borrowed any
funds from the FHLB-Atlanta.
Deposit Accounts. Substantially all of the Savings Bank's depositors are
residents of North Carolina. Deposits are attracted from within the Savings
Bank's market area through the offering of a broad selection of
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deposit instruments, including money market deposit accounts, regular savings
accounts and certificates of deposit. Deposit account terms vary, according to
the minimum balance required, the time periods the funds must remain on deposit
and the interest rate, among other factors. In determining the terms of its
deposit accounts, the Savings Bank considers current market interest rates,
profitability to the Savings Bank, matching deposit and loan products and its
customer preferences and concerns.
The Savings Bank has recently adopted a strategy to extend the term of its
liabilities in the form of longer term certificate accounts and maintain
adequate liquidity levels to address its interest rate risk exposure. The
implementation of such strategy, however, is not reflected in the Savings
Bank's recent financial data as most of its liabilities are still in the form
of short term certificate accounts.
At June 30, 1997 the Savings Bank had $14.1 million of certificates of
deposit. The Savings Bank does not solicit brokered deposits and believes that
its jumbo certificates of deposit, which represented 21.45% of total deposits
at June 30, 1997, present similar interest rate risk to its other deposit
products.
In the unlikely event the Savings Bank is liquidated, depositors will be
entitled to full payment of their deposit accounts prior to any payment being
made to the Corporation, as the sole stockholder of the Savings Bank.
The following table sets forth information concerning the Savings Bank's
time deposits and other interest-bearing deposits at June 30, 1997.
Weighted
Average Percentage
Interest Minimum of Total
Rate Term Checking and Savings Deposits Amount Balance Deposits
- ---- ---- ----------------------------- ------ ------- --------
(In thousands)
2.87% -- Money market accounts $ 1,000 $ 1,443 8.17%
2.25 -- Savings accounts 25 2,117 11.98
Certificates of Deposit
-----------------------
6.50 -- Fixed-term, fixed-rate (1) -- 11 0.06
7.50 -- Fixed-term, fixed-rate (1) -- 29 0.16
8.00 -- Fixed-term, fixed-rate (1) -- 20 0.11
5.11 6 months Fixed-term, fixed-rate 2,500 3,298 18.66
5.11 12 months Fixed-term, fixed-rate 2,500 3,010 17.03
5.15 18 months Fixed-term, fixed-rate 500 735 4.16
6.38 30 months Fixed-term, fixed-rate 500 1,060 6.00
6.92 48 months Fixed-term, fixed-rate 2,500 2,159 12.22
Negotiable Fixed-term, fixed-rate 100,000 3,790 21.45
------- ------
$17,672 100.00%
======= ======
- --------------
(1) No longer offered.
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The following table indicates the amount of jumbo certificates of deposit
by time remaining until maturity as of June 30, 1997. Jumbo certificates of
deposit require minimum deposits of $100,000, and have negotiable interest
rates.
Maturity Period Amount
--------------- --------------
(In thousands)
Less than three months............................ $ 827
Three through six months.......................... 620
More than six through twelve months............... 1,244
Over twelve months................................ 1,099
------
Total $3,790
======
Deposit Flow
The following table sets forth the balances of savings deposits in the
various types of savings accounts offered by the Savings Bank at the dates
indicated.
At June 30,
-------------------------------------------------
1996 1997
----------------- ----------------------------
Percent Percent
of of Increase
Amount Total Amount Total (Decrease)
------ ----- ------ ----- ----------
(Dollars in thousands)
Regular savings accounts . . $ 2,184 10.73% $ 2,117 11.98% $ (67)
Money market deposit . . . . 1,581 7.77 1,443 8.17 (138)
Fixed-rate certificates
which mature in the
year ended in(1):
Within 1 year. . . . . . . 12,257 60.24 10,917 61.78 (1,340)
After 1 year,
but within 2 years. . . . 2,456 12.07 1,947 11.02 (509)
After 2 years,
but within 5 years. . . . 1,868 9.18 1,248 7.05 (620)
------- ------ ------- ------ -------
Total . . . . . . . . . $20,346 100.00% $17,672 100.00% $(2,674)
======= ====== ======= ====== ========
_____________
(1) At June 30, 1996 and 1997, jumbo certificates amounted to $4.8 million and
$3.8 million, respectively.
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Time Deposits by Rates and Maturities
The following table sets forth the certificates of deposit in the Savings
Bank classified by rates at the dates indicated.
At June 30,
---------------------------
1996 1997
---- ----
(In Thousands)
2.00 - 3.99% . . . . . . . . . . $ 37 $ 6
4.00 - 5.99% . . . . . . . . . . 11,859 10,202
6.00 - 7.99% . . . . . . . . . . 4,372 3,566
8.00% and over . . . . . . . . . 313 338
------- -------
Total . . . . . . . . . . . . . $16,581 $14,112
======= =======
The following table sets forth the amount and maturities of certificates
of deposit at June 30, 1997.
Amount Due
------------------------------------
More
More More than
than Two Three
One Years Years Percent
Less Year to to After of Total
Than to Two Three Four 4 Certificate
One Year Years Years Years Years Total Accounts
-------- ------ ----- ----- ----- ------- --------
(In thousands)
2.00 - 3.99% . . . . . $ 6 $ -- $ -- $ -- $ -- $ 6 0.04%
4.00 - 5.99% . . . . . 8,850 1,036 316 -- -- 10,202 72.29
6.00 - 7.99% . . . . . 2,061 1,211 294 -- -- 3,566 25.27
8.00% and over . . . . -- 260 78 -- $ -- 338 2.40
------- ------ ---- ---- ---- ------- ------
Total . . . . . . . . $10,917 $2,507 $688 $ -- $ -- $14,112 100.00%
======= ====== ==== ==== ==== ======= ======
Deposit Activities
The following table sets forth the deposit activities of the Savings Bank
for the periods indicated.
Year Ended June 30,
---------------------
1996 1997
---- ----
(In thousands)
Beginning balance. . . . . . . . $20,940 $20,346
------- -------
Net decrease
before interest credited . . . (1,768) (3,639)
Interest credited. . . . . . . . 1,174 965
------- -------
Net decrease
in savings deposits. . . . . . (594) (2,674)
------ -------
Ending balance . . . . . . . . . $20,346 $17,672
======= =======
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Borrowings
Savings deposits are the primary source of funds for the Savings Bank's
lending and investment activities and for general business purposes. The
Savings Bank has the ability to use advances from the FHLB-Atlanta to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB-Atlanta functions as a central reserve bank providing
credit for savings and loan associations and certain other member financial
institutions. As a member of the FHLB-Atlanta, the Savings Bank is required to
own capital stock in the FHLB- Atlanta and is authorized to apply for advances
on the security of such stock and certain of its mortgage loans and other
assets (principally securities which are obligations of, or guaranteed by, the
U.S. Government) provided certain creditworthiness standards have been met.
Advances are made pursuant to several different credit programs. Each credit
program has its own interest rate and range of maturities. Depending on the
program, limitations on the amount of advances are based on the financial
condition of the member institution and the adequacy of collateral pledged to
secure the credit. At June 30, 1997, and during the two years ended June 30,
1997, the Savings Bank had no borrowings from the FHLB-Atlanta.
Competition
The Savings Bank operates in an intensely competitive market for the
attraction of savings deposits (its primary source of lendable funds) and in
the origination of loans. Historically, its most direct competition for
savings deposits has come from three large commercial banks in its market area.
Particularly in times of high interest rates, the Savings Bank has faced
additional significant competition for investors' funds from short-term money
market securities and other corporate and government securities. The Savings
Bank's competition for loans comes principally from mortgage bankers and
commercial banks. Such competition for deposits and the origination of loans
may limit the Savings Bank's future growth and earnings prospects.
Subsidiary Activities
The Savings Bank has one wholly-owned subsidiary, Mitchell Mortgage and
Investment Co., Inc., which was formed to hold stock in the Savings Bank's data
processing servicer. This subsidiary has been inactive for the past five
years. At June 30, 1997, the Savings Bank's investment in the subsidiary was
$15,000.
REGULATION
The Savings Bank
General. As a state-chartered, federally insured savings bank, the
Savings Bank is subject to extensive regulation. Lending activities and other
investments must comply with various statutory and regulatory requirements,
including prescribed minimum capital standards. The Savings Bank is regularly
examined by the FDIC and the Administrator and files periodic reports
concerning the Savings Bank's activities and financial condition with its
regulators. The Savings Bank's relationship with depositors and borrowers also
is regulated to a great extent by both federal law and the laws of North
Carolina, especially in such matters as the ownership of savings accounts and
the form and content of mortgage documents.
Federal and state banking laws and regulations govern all areas of the
operation of the Savings Bank, including reserves, loans, mortgages, capital,
issuance of securities, payment of dividends and establishment of branches.
Federal and state bank regulatory agencies also have the general authority to
limit the dividends paid by insured banks and bank holding companies if such
payments should be deemed to constitute an unsafe and unsound practice. The
respective primary federal regulators of the Corporation and the Savings Bank
have authority to impose penalties, initiate civil and administrative actions
and take other steps intended to prevent banks from engaging in unsafe or
unsound practices.
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State Regulation and Supervision. As a North Carolina-chartered savings
bank, the Savings 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-chartered 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 Savings Bank maintain federal deposit
insurance as a condition of doing business. Under state law, savings banks in
North Carolina with deposits insured by the SAIF are generally 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.
The Administrator conducts regular examinations of North
Carolina-chartered savings banks. The purpose of such examinations is to
assure that institutions are being operated in compliance with applicable North
Carolina law and regulations and in a safe and sound manner. These
examinations are usually conducted on a joint basis with the FDIC. In
addition, the Administrator is required to conduct an examination of any
institution when he has good reason to believe that the standing and
responsibility of the institution is of doubtful character or when he otherwise
deems it prudent. The Administrator is empowered to order the revocation of
the license of an institution if he finds that it has violated or is in
violation of any North Carolina law or regulation and that revocation is
necessary in order to preserve the assets of the institution and protect the
interests of its depositors. The Administrator has the power to issue cease
and desist orders if any person or institution is engaging in, or has engaged
in, any unsafe or unsound practice or unfair and discriminatory practice in the
conduct of its business or in violation of any other law, rule or regulation.
A North Carolina-chartered savings bank must maintain net worth, computed
in accordance with the Administrator's requirements, of 5% of total assets, and
liquidity of 10% of total assets. See "-- Capital Requirements" and "--
Liquidity." Additionally, a North Carolina-chartered savings bank is required
to maintain general valuation allowances and specific loss reserves in the same
amounts as required by the FDIC.
Subject to limitation by the Administrator, North Carolina-chartered
savings banks may make any loan or investment or engage in any activity which
is permitted to federally chartered institutions. However, a North
Carolina-chartered savings bank cannot invest more than 15% of its total assets
in business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutorily permitted
investments, including but not limited to (i) obligations of the United States,
or those guaranteed by it; (ii) obligations of the State of North Carolina;
(iii) bank demand or time deposits; (iv) stock or obligations of the federal
deposit insurance fund or a FHLB; (v) savings accounts of any savings
institution as approved by the board of directors; and (vi) stock or
obligations of any agency of the State of North Carolina or of the United
States or of any corporation doing business in North Carolina whose principal
business is to make education loans.
North Carolina law provides a procedure by which savings institutions may
consolidate or merge, subject to approval of the Administrator. The approval
is conditioned upon findings by the Administrator that, among other things,
such merger or consolidation will promote the best interests of the members or
stockholders of the merging institutions. North Carolina law also provides for
simultaneous mergers and conversions and for supervisory mergers conducted by
the Administrator.
Deposit Insurance. The FDIC insures deposits at the Savings Bank to the
maximum extent permitted by law. The Savings Bank currently 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 which are
based solely on the level of an institution's capital --"well
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capitalized," "adequately capitalized," and "undercapitalized" -- which are
defined in the same manner as the regulations establishing the prompt
corrective action system under the Federal Deposit Insurance Act ("FDIA"), as
discussed below. These three groups are then divided into three subgroups
which reflect varying levels of supervisory concern, from those which are
considered to be healthy to those which are considered to be of substantial
supervisory concern. The Savings Bank's assessments expensed for the year
ended June 30, 1997 equaled $155,000 (including the FDIC SAIF assessment of
$137,000).
Pursuant to the Deposit Insurance Fund ("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, including the Savings Bank, paying 0%.
This assessment schedule is the same as that for the BIF, which reached its
designated reserve ratio in 1995. In addition, since January 1, 1997, SAIF
members are charged an assessment of 0.065% of SAIF-assessable deposits for the
purpose of paying interest on the obligations issued by the Financing
Corporation ("FICO") in the 1980s to help fund the thrift industry cleanup.
BIF-assessable deposits will be charged an assessment to help pay interest on
the FICO bonds at a rate of approximately .013% until the earlier of December
31, 1999 or the date upon which the last savings association ceases to exist,
after which time the assessment will be the same for all insured deposits.
The DIF Act provides for the merger of the BIF and the SAIF into the
Deposit Insurance Fund on January 1, 1999, but only if no insured depository
institution is a savings association on that date. The DIF Act contemplates
the development of a common charter for all federally chartered depository
institutions and the abolition of separate charters for national banks and
federal savings associations. It is not known what form the common charter may
take and what effect, if any, the adoption of a new charter would have on the
operation of the Savings 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 which could
result in termination of the deposit insurance of the Savings Bank.
Prompt Corrective Action. Each federal banking agency is required to
implement a system of prompt corrective action for institutions which it
regulates. The federal banking agencies have promulgated substantially similar
regulations to implement this system of prompt corrective action. Under the
regulations, an institution shall be deemed to be: (i) "well capitalized" if it
has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based
capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or
more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized"
if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized;" (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances); (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of
tangible equity to total assets that is equal to or less than 2.0%.
A federal banking agency may, after notice and an opportunity for a
hearing, reclassify a well capitalized institution as adequately capitalized
and may require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category if the institution is in an unsafe
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or unsound condition or engaging in an unsafe or unsound practice. (The FDIC
may not, however, reclassify a significantly undercapitalized institution as
critically undercapitalized.)
An institution generally must file a written capital restoration plan
which meets specified requirements, as well as a performance guaranty by each
company that controls the institution, with the appropriate federal banking
agency within 45 days of the date that the institution receives notice or is
deemed to have notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. Immediately upon becoming
undercapitalized, an institution shall become subject to the provisions of the
FDIA, which sets forth various mandatory and discretionary restrictions on its
operations.
At June 30, 1997, the Savings Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the FDIC.
Standards for Safety and Soundness. The FDIA requires the federal banking
regulatory agencies to prescribe, by regulation, standards for all insured
depository institutions relating to: (i) internal controls, information systems
and internal audit systems; (ii) loan documentation; (iii) credit underwriting;
(iv) interest rate risk exposure; (v) asset growth; and (vi) compensation, fees
and benefits. The federal banking agencies recently adopted final regulations
and Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") to implement safety and soundness standards required by the
FDIA. The Guidelines set forth the safety and soundness standards that the
federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. The agencies also
proposed asset quality and earnings standards which, if adopted in final, would
be added to the Guidelines. Under the final regulations, if the FDIC
determines that the Savings Bank fails to meet any standard prescribed by the
Guidelines, the agency may require the Savings Bank to submit to the agency an
acceptable plan to achieve compliance with the standard, as required by the
FDIA. The final regulations establish deadlines for the submission and review
of such safety and soundness compliance plans.
Capital Requirements. The FDIC's minimum capital standards applicable to
FDIC-regulated banks and savings banks require the most highly-rated
institutions to meet a "Tier 1" leverage capital ratio of at least 3% of total
assets. Tier 1 (or "core capital") consists of common stockholders' equity,
noncumulative perpetual preferred stock and minority interests in consolidated
subsidiaries minus all intangible assets other than limited amounts of
purchased mortgage servicing rights and certain other accounting adjustments.
All other banks must have a Tier 1 leverage ratio of at least 100-200 basis
points above the 3% minimum. The FDIC capital regulations establish a minimum
leverage ratio of not less than 4% for banks that are not the most highly rated
or are anticipating or experiencing significant growth.
The FDIC's capital regulations require higher capital levels for banks
which exhibit more than a moderate degree of risk or exhibit other
characteristics which necessitate that higher than minimum levels of capital be
maintained. Any insured bank with a Tier 1 capital to total assets ratio of
less than 2% is deemed to be operating in an unsafe and unsound condition
pursuant to the FDIA unless the insured bank enters into a written agreement,
to which the FDIC is a party, to correct its capital deficiency. Insured banks
operating with Tier 1 capital levels below 2% (and which have not entered into
a written agreement) are subject to an insurance removal action. Insured banks
operating with lower than the prescribed minimum capital levels generally will
not receive approval of applications submitted to the FDIC. Also, inadequately
capitalized state nonmember banks will be subject to such administrative action
as the FDIC deems necessary.
FDIC regulations also require that banks meet a risk-based capital
standard. The risk-based capital standard requires the maintenance of total
capital (which is defined as Tier 1 capital and Tier 2 or supplementary
capital) to risk weighted assets of 8% and Tier 1 capital to risk-weighted
assets of 4%. In determining the amount of risk- weighted assets, all assets,
plus certain off balance sheet items, are multiplied by a risk-weight of 0% to
100%, based on the risks the FDIC believes are inherent in the type of asset or
item. The components of Tier 1 capital are equivalent to those discussed above
under the 3% leverage requirement. The components of supplementary capital
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<PAGE>
currently include cumulative perpetual preferred stock, adjustable-rate
perpetual preferred stock, mandatory convertible securities, term subordinated
debt, intermediate-term preferred stock and allowance for possible loan and
lease losses. Allowance for possible loan and lease losses includable in
supplementary capital is limited to a maximum of 1.25% of risk-weighted assets.
Overall, the amount of capital counted toward supplementary capital cannot
exceed 100% of Tier 1 capital. Beginning in September 1995, the FDIC will
include in its evaluation of a bank's capital adequacy an assessment of the
exposure to declines in the economic value of the bank's capital due to changes
in interest rates. However, no measurement framework for assessing the level
of a bank's interest rate risk exposure has been codified. In the future, the
FDIC will issue a proposed rule that would establish an explicit minimum
capital charge for interest rate risk, based on the level of a bank's measured
interest rate risk exposure.
An undercapitalized, significantly undercapitalized, or critically
undercapitalized institution is required to submit an acceptable capital
restoration plan to its appropriate federal banking agency. The plan must
specify (i) the steps the institution will take to become adequately
capitalized, (ii) the capital levels to be attained each year, (iii) how the
institution will comply with any regulatory sanctions then in effect against
the institution and (iv) the types and levels of activities in which the
institution will engage. The banking agency may not accept a capital
restoration plan unless the agency determines, among other things, that the
plan "is based on realistic assumptions, and is likely to succeed in restoring
the institution's capital" and "would not appreciably increase the risk...to
which the institution is exposed." Under the FDIA, a bank holding company must
guarantee that a subsidiary depository institution meet its capital restoration
plan, subject to certain limitations. The obligation of a controlling bank
holding company under the FDIA to fund a capital restoration plan is limited to
the lesser of 5.0% of an undercapitalized subsidiary's assets and the amount
required to meet regulatory capital requirements.
The FDIA provides that the appropriate federal regulatory agency must
require an insured depository institution that is significantly
undercapitalized or its undercapitalized and either fails to submit an
acceptable capital restoration plan within the time period allowed or fails in
any material respect to implement a capital restoration plan accepted by the
appropriate federal banking agency to take one or more of the following
actions: (i) sell enough shares, including voting shares, to become adequately
capitalized; (ii) merge with (or be sold to) another institution (or holding
company), but only if grounds exist for appointing a conservator or receiver;
(iii) restrict certain transactions with banking affiliates as if the "sister
bank" requirements of Section 23A of the Federal Reserve Act ("FRA") did not
exist; (iv) otherwise restrict transactions with bank or non-bank affiliates;
(v) restrict interest rates that the institution pays on deposits to
"prevailing rates" in the institution's region; (vi) restrict asset growth or
reduce total assets; (vii) alter, reduce or terminate activities; (viii) hold a
new election of directors; (ix) dismiss any director or senior executive
officer who held office for more than 180 days immediately before the
institution became undercapitalized; (x) employ "qualified" senior executive
officers; (xi) cease accepting deposits from correspondent depository
institutions; (xii) divest certain non-depository affiliates which pose a
danger to the institution; (xiii) be divested by a parent holding company; and
(xiv) take any other action which the agency determines would better carry out
the purposes of the Prompt Corrective Action provisions. See "-- Prompt
Corrective Action."
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 June 30, 1997, the Savings Bank
had a Tier 1 leverage capital ratio of 34.5% and net worth of 34.2% of total
assets.
The FDIC has adopted the Federal Financial Institutions Examination
Council's recommendation regarding the adoption of SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." Specifically, the
agencies determined that net unrealized holding gains or losses on available
for sale debt and equity securities should not be included when calculating
core and risk-based capital ratios.
FDIC capital requirements are designated as the minimum acceptable
standards for banks whose overall financial condition is fundamentally sound,
which are well-managed and have no material or significant financial
weaknesses. The FDIC capital regulations state that, where the FDIC determines
that the financial history or condition, including off-balance sheet risk,
managerial resources and/or the future earnings prospects of a bank are not
adequate and/or a bank has a significant volume of assets classified
substandard, doubtful or loss or otherwise
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criticized, the FDIC may determine that the minimum adequate amount of capital
for that bank is greater than the minimum standards established in the
regulation.
The Savings Bank's management believes that, under the current
regulations, the Savings Bank will continue to meet its minimum capital
requirements in the foreseeable future. However, events beyond the control of
the Savings Bank, such as a downturn in the economy in areas where the Savings
Bank has most of its loans, could adversely affect future earnings and,
consequently, the ability of the Savings Bank to meet its capital requirements.
Activities and Investments of Insured State-Chartered Banks. The FDIA
generally limits the activities and equity investments of FDIC-insured,
state-chartered banks to those that are permissible for national banks. Under
regulations dealing with equity investments, an insured state bank generally
may not directly or indirectly acquire or retain any equity investment of a
type, or in an amount, that is not permissible for a national bank. An insured
state bank is not prohibited from, among other things, (i) acquiring or
retaining a majority interest in a subsidiary, (ii) investing as a limited
partner in a partnership the sole purpose of which is direct or indirect
investment in the acquisition, rehabilitation or new construction of a
qualified housing project, provided that such limited partnership investments
may not exceed 2% of the bank's total assets, (iii) acquiring up to 10% of the
voting stock of a company that solely provides or reinsures directors',
trustees' and officers' liability insurance coverage or bankers' blanket bond
group insurance coverage for insured depository institutions, and (iv)
acquiring or retaining the voting shares of a depository institution if certain
requirements are met.
In addition, an insured state bank (i) that is located in a state which
authorized as of September 30, 1991 investment in common or preferred stock
listed on a national securities exchange ("listed stock") or shares of a
registered investment company ("registered shares"), and (ii) which during the
period beginning September 30, 1990 through November 26, 1991 ("measurement
period") made or maintained investments in listed stocks and registered shares,
may retain whatever shares that were lawfully acquired or held prior to
December 19, 1991 and continue to acquire listed stock and registered shares,
provided that the bank does not convert its charter to another form or undergo
a change in control. In order to acquire or retain any listed stock or
registered shares, however, the bank must file a one-time notice with the FDIC
which meets specified requirements and which sets forth the bank's intention to
acquire and retain stocks or shares, and the FDIC must determine that acquiring
or retaining the listed stocks or registered shares will not pose a significant
risk to the deposit insurance fund of which the bank is a member.
FDIC regulations implementing the FDIA provide that an insured
state-chartered bank may not, directly, or indirectly through a subsidiary,
engage as "principal" in any activity that is not permissible for a national
bank unless the FDIC has determined that such activities would pose no risk to
the insurance fund of which it is a member and the bank is in compliance with
applicable regulatory capital requirements. Any insured state-chartered bank
directly or indirectly engaged in any activity that is not permitted for a
national bank must cease the impermissible activity.
Loans-to-One-Borrower. The Savings Bank is subject to the Administrator's
loan-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 institution 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 institution's net worth, provided
that (i) the purchase price of each single-family dwelling in the development
does not exceed $500,000; (ii) the savings institution is in compliance with
its fully phased-in capital requirements; (iii) the loans comply with
applicable loan-to-value requirements; (iv) the aggregate amount of loans made
under this authority does not exceed 150% of net worth; and (v) the
institution's regulator issued an order permitting the savings institution to
use this higher limit. These limits also authorize a savings bank to make
loans-to-one-borrower to finance the sale of real property acquired in
satisfaction of debts in an amount up to 50% of net worth.
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At June 30, 1997 the Savings Bank's loans-to-one-borrower limit was
approximately $1.6 million. At June 30, 1997, the largest aggregate amount of
loans by the Savings Bank to any one borrower was approximately $1.2 million,
which was a loan made to the corporate owner and operator of a local commercial
property. See "-- Lending Activities -- Commercial Real Estate Lending."
Environmental Issues Associated With Real Estate Lending. The
Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), a federal statute, generally imposes strict liability on, among
other things, all prior and present "owners and operators" of hazardous waste
sites. However, the U.S. Congress created a safe harbor provision for secured
creditors by providing that the term "owner and operator" excludes a person
who, without participating in the management of the site, holds indicia of
ownership primarily to protect its security interest in the site. Since the
enactment of the CERCLA, this "secured creditor exemption" has been the subject
of judicial interpretations which have left open the possibility that lenders
could be liable for cleanup costs on contaminated property that the hold as
collateral for a loan.
In response to the uncertainty created by judicial interpretations, in
April 1992, the United States Environmental Protection Agency ("EPA"), an
agency within the Executive Branch of the government, promulgated a regulation
clarifying when and how secured creditors could be liable for cleanup costs
under the CERCLA. Generally, the regulation protected a secured creditor that
acquired full title to collateral property through foreclosure as long as the
creditor did not participate in the property's management before foreclosure
and undertook certain due diligence efforts to divest itself of the property.
However, in February 1994, the U.S. Court of Appeals for the District of
Columbia Circuit held that the EPA lacked authority to promulgate such
regulation on the grounds that Congress meant for decisions on liability under
the CERCLA to be made by the courts and not the Executive Branch. In January
1995, the U.S. Supreme Court denied to review the U.S. Court of Appeal's
decision. In light of this adverse court ruling, in October 1995 the EPA
issued a statement entitled "Policy on CERCLA Enforcement Against Lenders and
Government Entities that Acquire Property Involuntarily" explaining that as an
enforcement policy, the EPA intended to apply as guidance the provisions of the
EPA lender liability rule promulgated in 1992.
To the extent that legal uncertainty exists in this area, all creditors,
including the Savings Bank, that have made loans secured by properties with
potential hazardous waste contamination (such as petroleum contamination) could
be subject to liability for cleanup costs, which costs often substantially
exceed the value of the collateral property.
Federal Reserve System. All depository institutions that maintain
transaction accounts or nonpersonal time deposits must maintain reserve
requirements (under "Regulation D") imposed by the Federal Reserve. These
reserves may be in the form of cash or non-interest-bearing deposits with the
regional Federal Reserve Bank. NOW accounts and other types of accounts that
permit payments or transfers to third parties fall within the definition of
transaction accounts and are subject to Regulation D reserve requirements, as
are any nonpersonal time deposits at a bank. Under Regulation D, a bank must
establish reserves equal to 3% of the first $54.0 million of transaction
accounts, of which the first $4.2 million is exempt, and 10% on the remainder.
The reserve requirement on nonpersonal time deposits with original maturities
of less than 1-1/2 years is 0%. As of June 30, 1997, the Savings Bank met its
reserve requirements.
Liquidity. The Savings 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 investment with
maturities in excess of five years. At June 30, 1997, the Savings Bank's
liquidity ratio calculated in accordance with North Carolina regulations, was
approximately 7%. The Savings Bank is taking the appropriate action subsequent
to year end to restore its liquidity ratio to the required level.
Affiliate Transactions. The Corporation and the Savings Bank are legal
entities separate and distinct. Various legal limitations restrict the Savings
Bank from lending or otherwise supplying funds to the Corporation (an
"affiliate"), generally limiting such transactions with the affiliate to 10% of
the bank's capital and surplus and
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limiting all such transactions to 20% of the bank's capital and surplus. Such
transactions, including extensions of credit, sales of securities or assets and
provision of services, also must be on terms and conditions consistent with
safe and sound banking practices, including credit standards, that are
substantially the same or at least as favorable to the bank as those prevailing
at the time for transactions with unaffiliated companies.
Federally insured banks are subject, with certain exceptions, to certain
restrictions on extensions of credit to their parent holding companies or other
affiliates, on investments in the stock or other securities of affiliates and
on the taking of such stock or securities as collateral from any borrower. In
addition, such banks are prohibited from engaging in certain tie-in
arrangements in connection with any extension of credit or the providing of any
property or service.
Community Reinvestment Act. Banks are also subject to the provisions of
the Community Reinvestment Act of 1977 ("CRA"), which requires the appropriate
federal bank regulatory agency, in connection with its regular examination of a
bank, to assess the bank's record in meeting the credit needs of the community
serviced by the bank, including low and moderate income neighborhoods. The
regulatory agency's assessment of the bank's record is made available to the
public. Further, such assessment is required of any bank which has applied,
among other things, to establish a new branch office that will accept deposits,
relocate an existing office or merge or consolidate with, or acquire the assets
or assume the liabilities of, a federally regulated financial institution. The
Savings Bank received a "satisfactory" rating during its most recent CRA
examination.
Dividends. Dividends from the Savings Bank constitute the major source of
funds for dividends which may be paid by the Corporation. The amount of
dividends payable by the Savings Bank to the Corporation will depend upon the
Savings Bank's earnings and capital position, and is limited by federal and
state laws, regulations and policies. According to North Carolina law, the
Savings Bank may not declare or pay a cash dividend on its capital stock if it
would cause its net worth to be reduced below (i) the amount required for the
liquidation account established in connection with the Conversion and (ii) 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.
The amount of dividends actually paid during any one period are strongly
affected by the Savings Bank's management policy of maintaining a strong
capital position. Federal law further provides that no insured depository
institution may make any capital distribution (which would include a cash
dividend) if, after making the distribution, the institution would be
"undercapitalized," as defined in the prompt corrective action regulations.
Moreover, the federal bank regulatory agencies also have the general authority
to limit the dividends paid by insured banks if such payments should be deemed
to constitute an unsafe and unsound practice.
The Corporation
General. The Corporation, as the sole shareholder of the Savings Bank, is
a bank holding company and is registered as such with the Board of Governors of
the Federal Reserve System ("Federal Reserve"). Bank holding companies are
subject to comprehensive regulation by the Federal Reserve under the Bank
Holding Company Act of 1956, as amended ("BHCA") and the regulations of the
Federal Reserve. As a bank holding company, the Corporation will be required
to file with the Federal Reserve annual reports and such additional information
as the Federal Reserve may require and will be subject to regular examinations
by the Federal Reserve. The Federal Reserve also has extensive enforcement
authority over bank holding companies, including, among other things, the
ability to assess civil money penalties, to issue cease and desist or removal
orders and to require that a holding company divest subsidiaries (including its
bank subsidiaries). In general, enforcement actions may be initiated for
violations of law and regulations and unsafe or unsound practices.
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Under the BHCA, a bank holding company must obtain Federal Reserve
approval before: (1) acquiring, directly or indirectly, ownership or control of
any voting shares of another bank or bank holding company if, after such
acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or (3)
merging or consolidating with another bank holding company.
Any direct or indirect acquisition by a bank holding company or its
subsidiaries of more than 5% of the voting shares of, or substantially all of
the assets of, any bank located outside of the state in which the operations of
the bank holding company's banking subsidiaries are principally conducted, may
not be approved by the Federal Reserve unless the laws of the state in which
the bank to be acquired is located specifically authorize such an acquisition.
Most states have authorized interstate bank acquisitions by out-of-state bank
holding companies on either a regional or a national basis, and most such
statutes require the home state of the acquiring bank holding company to have
enacted a reciprocal statute. North Carolina law permits out-of-state bank
holding companies to acquire banks or bank holding companies located in North
Carolina so long as the laws of the state in which the acquiring bank holding
company is located permit bank holding companies located in North Carolina to
acquire banks or bank holding companies in the acquiror's state and the North
Carolina bank sought to be acquired has been in existence for at least three
years. Beginning September 30, 1995, federal law permits well capitalized and
well managed bank holding companies to acquire control of an existing bank in
any state.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company that is not a bank or bank holding company and
from engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries.
Under the BHCA, the Federal Reserve is authorized to approve the ownership of
shares by a bank holding company in any company, the activities of which the
Federal Reserve has determined to be so closely related to the business of
banking or managing or controlling banks as to be a proper incident thereto.
The list of activities determined by regulation to be closely related to
banking within the meaning of the BHCA includes, among other things: operating
a savings institution, mortgage company, finance company, credit card company
or factoring company; performing certain data processing operations; providing
certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing property
on a full-payout, non-operating basis; selling money orders, travelers' checks
and U.S. Savings Bonds; real estate and personal property appraising; providing
tax planning and preparation services; and, subject to certain limitations,
providing securities brokerage services for customers.
Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 ("Interstate Banking Act") permits adequately
capitalized bank and savings bank holding companies to acquire control of banks
and savings banks in any state beginning on September 29, 1995, one year after
the effectiveness of the Interstate Banking Act. 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 specifically legislated a higher deposit cap. States are free to
legislate stricter deposit caps and, at present, 18 states have deposit caps
lower than 30%.
The Interstate Banking Act also provides for interstate branching. The
McFadden Act of 1927 established state lines as the ultimate barrier to
geographic expansion of a banking network by branching. The Interstate Banking
Act withdraws these barriers, effective June 1, 1997, allowing interstate
branching in all states, provided that a particular state has not specifically
prohibited interstate branching by legislation prior to such time. Unlike
interstate acquisitions, a state may prohibit 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 interstate
branching transactions.
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The Interstate Banking Act also modifies the controversial safety and
soundness provisions contained in the 1991 Banking Law which required the
banking regulatory agencies to promulgate regulations governing such topics as
internal controls, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation and fees and other matters those agencies
determine to be appropriate. The legislation exempts bank holding companies
from these provisions and requires the agencies to prepare guidelines, as
opposed to regulations, dealing with these areas. It also gives more
discretion to the banking regulatory agencies in prescribing standards for
banks' asset quality, earnings and stock valuation.
The Interstate Banking Act also expanded exemptions from the requirement
that banks be examined on a 12-month cycle. Exempted banks are inspected every
18 months. Other provisions address paperwork reduction and regulatory
improvements, small business and commercial real estate loan securitization,
truth-in-lending amendments regarding high cost mortgages, strengthening of the
independence of certain financial regulatory agencies, money laundering, flood
insurance reform and extension of certain statutes of limitations.
Dividends. The Federal Reserve has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the
Federal Reserve's view that a bank holding company should pay cash dividends
only to the extent that the company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earning retention
that is consistent with the company's capital needs, asset quality and overall
financial condition. The Federal Reserve also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow
funds to pay dividends. Furthermore, under the prompt corrective action
regulations adopted by the Federal Reserve pursuant to FDICIA, the Federal
Reserve may prohibit a bank holding company from paying any dividends if the
holding company's bank subsidiary is classified as "undercapitalized" under the
prompt corrective action regulations.
Bank holding companies, except for certain "well-capitalized" bank holding
companies, are required to give the Federal Reserve prior written notice of any
purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding
12 months, is equal to 10% or more of their consolidated net worth. The
Federal Reserve may disapprove such a purchase or redemption of it determines
that the proposal would constitute an unsafe or unsound practice or would
violate any law, regulation, Federal Reserve order, or any condition imposed
by, or written agreement with, the Federal Reserve.
Capital Requirements. The Federal Reserve has established capital
adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for the Savings Bank. The Federal Reserve
regulations provide that capital standards will be applied on a consolidated
basis in the case of a bank holding company with $150 million or more in total
consolidated assets. For bank holding companies with less than $150 million in
consolidated assets, such as the Savings Bank, 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 subject to the Federal Reserve's capital adequacy
guidelines are required to comply with the Federal Reserve's risk-based capital
regulations. Under these regulations, the minimum ratio of total capital to
risk-weighted assets (including certain off-balance sheet activities, such as
standby letters of credit) is 8%. At least half of the total capital is
required to be Tier 1 capital, principally consisting of common stockholders'
equity, noncumulative perpetual preferred stock, and a limited amount of
cumulative perpetual preferred stock, less certain goodwill items. The
remainder, Tier II capital, may consist of a limited amount of subordinated
debt, certain hybrid capital instruments and other debt securities, perpetual
preferred stock, and a limited amount of the general loan loss allowance. In
addition to the risk-based capital guidelines, the Federal Reserve has adopted
a minimum Tier I (leverage) capital ratio, under which a bank holding company
must maintain a minimum level of Tier 1 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 1 (leverage) capital ratio of at least 1% to 2% above the state minimum.
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TAXATION
Federal Taxation
General. The Holding Company and the Savings Bank report their income on
a calendar year basis using the accrual method of accounting and are subject to
federal income taxation in the same manner as other corporations with some
exceptions. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Savings Bank or the Holding Company.
Tax Bad Debt Reserves. Historically, savings institutions such as the
Savings Bank which met certain definitional tests primarily related to their
assets and the nature of their business ("qualifying thrift") were permitted to
establish a reserve for bad debts and to make annual additions thereto, which
may have been deducted in arriving at their taxable income. The Savings Bank's
deductions with respect to "qualifying real property loans," which are
generally loans secured by certain interest in real property, were computed
using an amount based on the Savings Bank's actual loss experience, or a
percentage equal to 8% of the Savings Bank's taxable income, computed with
certain modifications and reduced by the amount of any permitted additions to
the non-qualifying reserve. Due to the Savings Bank's loss experience, the
Savings Bank generally recognized a bad debt deduction equal to 8% of taxable
income.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." The new
rules eliminate the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all thrifts for tax years beginning after December
31, 1995. These rules also require that all institutions recapture all or a
portion of their bad debt reserves added since the base year (last taxable year
beginning before January 1, 1988). The Savings Bank has previously recorded a
deferred tax liability equal to the bad debt recapture and as such the new
rules will have no effect on the net income or federal income tax expense. For
taxable years beginning after December 31, 1995, the Savings Bank's bad debt
deduction will be determined under the experience method using a formula based
on actual bad debt experience over a period of years or, if the Savings Bank is
a "large" association (assets in excess of $500 million) on the basis of net
charge-offs during the taxable year. The new rules allow an institution to
suspend bad debt reserve recapture for the 1996 and 1997 tax years if the
institution's lending activity for those years is equal to or greater than the
institutions average mortgage lending activity for the six taxable years
preceding 1996 adjusted for inflation. For this purpose, only home purchase or
home improvement loans are included and the institution can elect to have the
tax years with the highest and lowest lending activity removed from the average
calculation. If an institution is permitted to postpone the reserve recapture,
it must begin its six year recapture no later than the 1998 tax year. The
unrecaptured base year reserves will not be subject to recapture as long as the
institution continues to carry on the business of banking. In addition, the
balance of the pre-1988 bad debt reserves continue to be subject to provisions
of present law referred to below that require recapture in the case of certain
excess distributions to shareholders.
Distributions. To the extent that the Savings Bank makes "nondividend
distributions" to the Corporation that are considered as made: (i) from the
reserve for losses on qualifying real property loans, to the extent the reserve
for such losses exceeds the amount that would have been allowed under the
experience method; or (ii) from the supplemental reserve for losses on loans
("Excess Distributions"), then an amount based on the amount distributed will
be included in the Savings Bank's taxable income. Nondividend distributions
include distributions in excess of the Savings Bank's current and accumulated
earnings and profits, distributions in redemption of stock, and distributions
in partial or complete liquidation. However, dividends paid out of the Savings
Bank's current or accumulated earnings and profits, as calculated for federal
income tax purposes, will not be considered to result in a distribution from
the Savings Bank's bad debt reserve. Thus, any dividends to the Corporation
that would reduce amounts appropriated to the Savings Bank's bad debt reserve
and deducted for federal income tax purposes would create a tax liability for
the Savings Bank. The amount of additional taxable income attributable to an
Excess Distribution is an amount that, when reduced by the tax attributable to
the income, is equal to the amount of the distribution. Thus, if the Savings
Bank makes a "nondividend distribution," then approximately one and one-half
times the amount so used would be includable in gross income for federal income
tax purposes, assuming a 35% corporate income tax rate (exclusive of state and
local taxes). See "REGULATION -- The Savings Bank --
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Dividends" for limits on the payments of dividends by the Savings Bank. The
Savings Bank does not intend to pay dividends that would result in a recapture
of any portion of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as
amended ("Code") imposes a tax on alternative minimum taxable income ("AMTI")
at a rate of 20%. The excess of the tax bad debt reserve deduction using the
percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. In addition, only 90% of AMTI can be offset by
net operating loss carryovers. AMTI is increased by an amount equal to 75% of
the amount by which the Savings Bank's adjusted current earnings exceeds its
AMTI (determined without regard to this preference and prior to reduction for
net operating losses). For taxable years beginning after December 31, 1986,
and before January 1, 1996, an environmental tax of .12% of the excess of AMTI
(with certain modification) over $2.0 million is imposed on corporation,
including the Savings Bank, whether or not an Alternative Minimum Tax ("AMT")
is paid.
Dividends-Received Deduction and Other Matters. The Corporation may
exclude from its income 100% of dividends received from the Savings Bank as a
member of the same affiliated group of corporations. The corporate
dividends-received deduction is generally 70% in the case of dividends received
from unaffiliated corporations with which the Corporation and the Savings Bank
will not file a consolidated tax return, except that if the Corporation or the
Savings Bank owns more than 20% of the stock of a corporation distributing a
dividend, then 80% of any dividends received may be deducted.
Audits. The Corporation's and the Savings Bank's Federal income tax
returns have not been audited during the last five years.
State and Local Taxation
The North Carolina corporate income tax is 7.75% of federal taxable income
as computed under the Code, subject to certain prescribed adjustments. In
addition, for tax years beginning in 1991, 1992, 1993 and 1994, corporate
taxpayers were required to pay a surtax equal to 4%, 3%, 2% and 1%,
respectively, of the state income tax otherwise payable by it. An annual state
franchise tax is imposed a rate of 0.15% applied to the greater of the
institution's (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 Corporation's and the Savings Bank's North Carolina income tax returns
have not been audited during the last five years.
Personnel
As of June 30, 1997, the Savings Bank had six full-time employees and one
part-time employee. The employees are not represented by a collective
bargaining unit and the Savings Bank believes its relationship with its
employees is good.
Item 2. Description of Property
- --------------------------------
The Savings Bank has no branch offices. The Savings Bank owns its main
office located at 210 Oak Avenue, Spruce Pine, North Carolina 28777. The
office was opened in 1957 and the square footage is approximately 5,400 feet.
At June 30, 1997, the net book value of the property (including land and
building) and the Savings Bank's fixtures, furniture and equipment was $65,000.
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Item 3. Legal Proceedings
- --------------------------
Periodically, there have been various claims and lawsuits involving the
Savings Bank, such as claims to enforce liens, condemnation proceedings on
properties in which the Savings Bank holds security interests, claims involving
the making and servicing of real property loans and other issues incident to
the Savings Bank's business. The Savings Bank is not a party to any pending
legal proceedings that it believes would have a material adverse effect on the
financial condition or operations of the Savings Bank.
Item 4. Submission of Matters to a Vote of Security-Holders
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended June 30, 1997.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
- -----------------------------------------------------------------
The information contained in the section captioned "Common Stock
Information" in the Annual Report is incorporated herein by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
- ------------------------------------------------------------------
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
the Annual Report is incorporated herein by reference.
Item 7. Financial Statements
- -----------------------------
Independent Auditors Report*
(a) Consolidated Balance Sheets, June 30, 1996 and 1997*
(b) Consolidated Statements of Income For the Years Ended June 30,
1996 and 1997*
(c) Consolidated Statements of Stockholders' Equity For the Years
Ended June 30, 1996 and 1997*
(d) Consolidated Statements of Cash Flows For the Years Ended June
30, 1996 and 1997*
(e) Notes to Consolidated Financial Statements*
* Contained in the Annual Report filed as an exhibit hereto and
incorporated herein by reference. All schedules have been omitted as
the required information is either inapplicable or contained in the
Consolidated Financial Statements or related Notes contained in the
Annual Report.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
- -------------------------------------------------------------------------
None.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
- ----------------------------------------------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors" in the Proxy Statement is incorporated herein by
reference.
The following table sets forth certain information with respect to the
executive officers of the Corporation and the Savings Bank.
26
<PAGE>
<PAGE>
Age at
June 30,
Name 1997 Position
- ---- ------- -----------------------------------------
Corporation Savings Bank
------------------- -------------------
Calvin F. Hall 68 President President
Edward Ballew, Jr. 75 Executive Executive
Vice President Vice President
and Chief Executive and Chief Executive
Officer Officer
Emma Lee M. Wilson 61 Assistant Managing Assistant Managing
Officer, Secretary Officer, Secretary
and Treasurer and Treasurer
The principal occupation of each executive officer of the Corporation is
set forth below. All of the officers listed above have held positions with or
been employed by the Corporation for five years unless otherwise stated. All
executive officers reside in Spruce Pine, North Carolina. There are no family
relationships among or between the executive officers, unless otherwise stated.
Calvin F. Hall is President and an agent of Fortner Insurance Agency,
Inc., with which he has been affiliated with for over 38 years. Mr. Hall was
appointed President of the Savings Bank in January 1995 to succeed the retiring
President S.W. Enloe. Mr. Hall is a member of the Spruce Pine Rotary Club.
Edward Ballew, Jr. has been employed as an executive officer by the
Savings Bank since 1947 and serves as Executive Vice President and Chief
Executive Officer.
Emma Lee M. Wilson has been employed by the Savings Bank since 1958 and
has served in various capacities during that time. Mrs. Wilson is the
Assistant Managing Officer, Secretary and Treasurer of the Savings Bank.
Compliance with Section 16(a) of the Exchange Act
The information contained under the section captioned "Compliance With
Section 16(a) of the Exchange Act" in the Proxy Statement is incorporated
herein by reference.
Item 10. Executive Compensation
- --------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors" in the Proxy Statement is incorporated herein by
reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein
by reference to the section captioned "Voting Securities
and Security Ownership of Certain Beneficial Owners and
Management" of the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein
by reference to the sections captioned "Voting Securities
and Security Ownership of Certain Beneficial Owners and
Management" and "Proposal I - Election of Directors" of
the Proxy Statement.
27
<PAGE>
<PAGE>
(c) Changes in Control
The Corporation is not aware of any arrangements,
including any pledge by any person of securities of the
Corporation, the operation of which may at a subsequent
date result in a change in control of the Corporation,
except for the following:
Jerome H. Davis and Susan B. Davis, Greenwich,
Connecticut, have filed with the Securities and
Exchange Commission a Schedule 13D dated July 19, 1996,
as subsequently amended on November 19, 1996 and May 7,
1997, with respect to the Corporation's common stock. The
Schedule 13D discloses that Mr. Davis and Mrs. Davis
beneficially own an aggregate of 93,000 shares of common
stock, or 9.99% of the outstanding shares. Item 4 of the
Schedule 13D, entitled "Purpose of Transaction," states in
part "Mr. and Mrs. Davis now believe that Mitchell must
consider several options which will enhance shareholder
value, including a merger transaction."
Item 12. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors -- Certain
Transactions."
PART IV
Item 13. Exhibits List and Reports on Form 8-K
- -----------------------------------------------
(a) Exhibits
3.1 Certificate of Incorporation of Mitchell Bancorp, Inc.*
3.2 Bylaws of Mitchell Bancorp, Inc.*
10.1 Employment Agreement with Emma Lee M. Wilson*
10.2 Employment Agreement with Edward Ballew, Jr.*
10.2 Mitchell Savings Bank, Inc., SSB 1996 Employee Stock
Ownership Plan*
10.3 Mitchell Bancorp, Inc. 1996 Stock Option Plan**
10.4 Mitchell Bancorp, Inc. 1996 Management Recognition and
Development Plan**
13 1997 Annual Report to Shareholders
23 Consent of Independent Auditors
21 Subsidiaries of Registrant
27 Financial Data Schedule
(b) The Corporation did not file any Reports on Form 8-K during the quarter
ended June 30, 1997.
_________________
* Incorporated by reference to the Corporation's Registration Statement on
Form S-1 (File No. 333-1888).
** Incorporated by reference to the Corporation's Annual Meeting Proxy
Statement dated December 16, 1996.
28
<PAGE>
<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.
MITCHELL BANCORP, INC.
Date: September 26, 1997 By: /s/Edward Ballew, Jr.
------------------------------------
Edward Ballew, Jr.
Executive Vice President and Chief
Executive Officer
Pursuant to 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.
SIGNATURES TITLE DATE
---------- ----- ----
/S/ Edward Ballew, Jr. Executive Vice President, Chief September 26, 1997
- -----------------------
Edward Ballew, Jr. Executive Officer and
Director (Principal
Executive Officer)
/s/ Emma Lee M. Wilson Assistant Managing Officer, September 26, 1997
- -----------------------
Emma Lee M. Wilson Secretary, Treasurer and
Director (Principal Financial
and Accounting Officer)
/s/ Calvin F.Hall President and Director September 26, 1997
- -----------------------
Calvin F. Hall
/s/ Baxter D. Johnson Director September 26, 1997
- -----------------------
Baxter D. Johnson
/s/ Lloyd Hise, Jr. Director September 26, 1997
- -----------------------
Lloyd Hise, Jr.
<PAGE>
<PAGE>
EXHIBIT 13
1997 Annual Report to Shareholders<PAGE>
MITCHELL BANCORP, INC.
1997 ANNUAL REPORT
<PAGE>
<PAGE>
TABLE OF CONTENTS
Page
----
Letter to Shareholders . . . . . . . . . . . . . . . . . . 2
Selected Consolidated Financial Data . . . . . . . . . . . 3
Management's Discussion and Analysis . . . . . . . . . . . 5
Independent Auditor's Report . . . . . . . . . . . . . . . 15
Consolidated Financial Statements. . . . . . . . . . . . . 16
Notes to Consolidated Financial Statements . . . . . . . . 20
Common Stock Information . . . . . . . . . . . . . . . . . 36
Directors and Officers . . . . . . . . . . . . . . . . . . 37
Corporate Information. . . . . . . . . . . . . . . . . . . 37
__________
BUSINESS OF THE COMPANY
Mitchell Bancorp, Inc. ("Mitchell Bancorp" or the "Company"), a North
Carolina corporation, was organized on February 28, 1996 and became the holding
company for Mitchell Savings Bank, Inc., SSB ("Savings Bank") on July 12, 1996
in connection with the Savings Bank's conversion from a North Carolina-
chartered mutual to a North Carolina-chartered stock savings bank. The Company
is engaged primarily in the business of directing, planning and coordinating
the business activities of the Savings Bank.
The Savings Bank was established in 1924 as "Mitchell County Building and
Loan Association," a North Carolina-chartered mutual savings and loan
association, located in Spruce Pine, North Carolina, approximately 50 miles
Northeast of Asheville, North Carolina. In 1992, the Savings Bank converted to
a North Carolina-chartered savings bank and adopted its current title. The
Savings Bank is regulated by the Administrator, Savings Institutions Division,
North Carolina Department of Commerce ("Administrator"), its primary regulator,
and the Federal Deposit Insurance Corporation ("FDIC"), the insurer of its
deposits. The Savings Bank's deposits are federally insured by the FDIC under
the Savings Association Insurance Fund ("SAIF"). The Savings Bank is a member
of the Federal Home Loan Bank ("FHLB") System.
The Savings Bank is a traditional, community oriented financial
institution that is engaged primarily in the business of attracting deposits
from the general public and using these funds to originate fixed-rate one- to
four- family residential mortgage loans within the Savings Bank's market area,
and, to a significantly lesser extent, loans secured by multi-family
properties, land, churches, and selected commercial properties, and consumer
loans. The Savings Bank originates loans for its portfolio.
-1-
<PAGE>
<PAGE>
Dear Fellow Shareholders:
On behalf of the Board of Directors, Officers and employees of Mitchell
Bancorp, Inc. and its wholly-owned subsidiary, Mitchell Savings Bank, Inc.,
S.S.B., we are pleased to present to you our Annual Report for the year ended
June 30, 1997.
In its first full year of operations Mitchell Bancorp, Inc. posted solid
operating results for the year ended June 30, 1997. Increases in net interest
income and net income coupled with decreases in non-interest expense all
contributed favorably to the Company's performance in fiscal 1997.
Net income for fiscal 1997 was $471,000, or $.53 per share. Also, the
Company paid its first semi-annual dividend in February 1997 of $.20 per share.
Higher capital levels resulting from the Company's initial stock offering
in July 1996 continue to keep the return on average equity at lower than
desired levels. Management of the Company's high capital levels is a top
priority, with the Company repurchasing 48,995 shares of its common stock at an
average price of $16.00 per share during fiscal 1997.
Our primary focus continues to be directed toward being a community
oriented financial institution that provides affordable financial services and
products. We are committed to enhancing long-term shareholder value and
deploying our capital to take advantage of growth opportunities consistent with
our operating philosophy.
Thank you for your continued interest in and support of Mitchell Bancorp,
Inc.
Sincerely,
/s/Edward Ballew, Jr.
Edward Ballew, Jr.
Executive Vice President
and Chief Executive Officer
-2-
<PAGE>
<PAGE>
SELECTED CONSOLIDATED FINANCIAL CONDITION, OPERATING AND OTHER DATA
The following tables set forth certain information concerning the
consolidated financial position and results of operations of the Corporation
and its subsidiary at the dates and for the periods indicated.
At June 30,
-------------------------------------------
1993 1994 1995 1996 1997
----- ---- ---- ---- ----
(In thousands)
FINANCIAL CONDITION DATA:
Total assets . . . . . . $26,399 $28,109 $27,596 $36,776 $33,059
Loans receivable, net. . 20,785 21,843 22,463 23,568 28,203
Cash, interest-earning
deposits and investment
securities . . . . . . 4,945 5,710 4,254 12,414 4,073
FHLB stock . . . . . . . 280 291 291 291 291
Deposits . . . . . . . . 21,050 22,195 20,940 20,346 17,672
Total stockholders'
equity . . . . . . . . 5,182 5,694 6,078 14,634 14,325
For the Years Ended June 30,
-------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(In thousands)
OPERATING DATA:
Interest income. . . . . $2,331 $2,193 $2,259 $2,271 $2,659
Interest expense . . . . 962 903 962 1,161 975
------ ------ ------ ------ ------
Net interest income . . 1,369 1,290 1,297 1,110 1,684
Provision for loan
losses. . . . . . . . . 12 24 24 60 24
------ ------ ------ ------ ------
Net interest income
after provision
for loan losses . . . . 1,357 1,266 1,273 1,050 1,660
Non-interest income. . . 20 5 45 6 7
Non-interest expenses. . 417 452 953 930 907
------ ------ ------ ------ ------
Income before income
taxes and cumulative
effect adjustments . . 960 819 365 126 760
Income tax expense . . . 375 317 112 35 289
------ ------ ------ ------ ------
Income before cumulative
effect adjustment . . . 585 502 253 91 471
Cumulative effect on prior
years for accounting
change . . . . . . . . -- -- 11 -- --
------ ------ ------ ------ ------
Net income . . . . . . . $ 585 $ 513 $ 253 $ 91 $ 471
====== ====== ====== ====== ======
-3-
<PAGE>
<PAGE>
At June 30,
-------------------------------------------
1993 1994 1995 1996 1997
----- ---- ---- ---- ----
OTHER DATA:
Number of:
Real estate loans
outstanding(1). . . . 675 639 656 660 718
Deposit accounts. . . . 1,601 1,603 1,584 1,603 1,444
Full service offices. . 1 1 1 1 1
At or for the Year Ended June 30,
-------------------------------------------
1993 1994 1995 1996 1997
----- ---- ---- ---- ----
KEY FINANCIAL RATIOS:
Return on average assets
(net income divided by
average assets) . . . . 2.26% 1.89% 0.92% 0.32% 1.37%
Return on average equity
(net income divided by
average equity) . . . . 11.89 9.39 4.24 1.53 3.21
Average equity to average
assets . . . . . . . . 19.00 20.17 21.71 20.73 42.59
Interest rate spread (dif-
ference between average
yield on interest- earning
assets and average cost of
interest-bearing
liabilities) . . . . . 4.50 3.97 3.79 2.81 2.73
Net interest margin (net
interest income as a
percentage of average
interest-earning
assets) . . . . . . . . 5.37 4.82 4.77 3.96 5.05
Non-interest expense to
average assets. . . . . 1.61 1.67 3.45 3.23 2.64
Average interest-earning
assets to interest-
bearing liabilities . . 123.10 125.02 127.87 127.83 179.46
Allowance for loan losses
to total loans at end
of period . . . . . . . 0.21 0.31 0.40 0.63 0.61
Net charge offs to average
out-standing loans
during the period . . . -- -- -- -- --
Ratio of nonperforming
assets to total assets
at period end . . . . . 1.19 1.12 1.43 2.54 2.03
- -----------
(1) All real estate loans have fixed-rates of interest.
-4-
<PAGE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
Management's discussion and analysis of financial condition and results of
operations is intended to assist in understanding the financial condition and
results of operations of the Company. Since the operations of the Savings Bank
significantly impact those of the Company, the following discussion will
include references to both the Company and the Savings Bank. The information
contained in this section should be read in conjunction with the Consolidated
Financial Statements and accompanying Notes thereto.
Operating Strategy
The business of the Savings Bank consists principally of attracting
deposits from the general public and using such deposits to originate
fixed-rate mortgage loans secured primarily by one- to four-family residences.
The Savings Bank also invests in overnight deposits. The Savings Bank plans to
continue to fund its assets primarily with deposits.
The Savings Bank's profitability depends primarily on its net interest
income, which is the difference between the income it receives on its loan and
investment portfolio and its cost of funds, which consists of interest paid on
deposits. Net interest income is also affected by the relative amounts of
interest-earning assets and interest-bearing liabilities. When
interest-earning assets equal or exceed interest-bearing liabilities, any
positive interest rate spread will generate net interest income. The Savings
Bank's profitability is also affected by the level of other income and
expenses. Other income consists of service charges on loan charges and other
fees, insurance commissions and net real estate owned income (expense). Other
expenses include compensation and employee benefits, occupancy expenses,
deposit insurance premiums, equipment and data servicing expenses, professional
fees and other operating costs. The Savings Bank's results of operations are
also significantly affected by general economic and competitive conditions,
particularly changes in market interest rates, government legislation and
policies concerning monetary and fiscal affairs, housing and financial
institutions and the attendant actions of the regulatory authorities.
The Savings Bank strives to operate a conservative, well capitalized,
profitable thrift dedicated to financing home ownership and other consumer
needs, and to provide quality service to its customers. The Savings Bank
believes that it has established a market niche by serving moderate-income
borrowers and making smaller loans and loans that do not satisfy the standards
of the secondary market, which are considered less desirable by competing
lenders. The Savings Bank believes that it has successfully implemented its
strategy by: (i) maintaining a strong capital level; (ii) maintaining what
management believes are conservative underwriting standards; (iii) emphasizing
local loan origination; and (iv) emphasizing high quality customer service with
a competitive fee structure.
Financial Condition
Total assets decreased from $36.8 million at June 30, 1996 to $33.1
million at June 30, 1997 primarily as a result of a $2.7 million net withdrawal
of savings deposits and the payment of stock oversubcribers and accrued
conversion costs. Loans receivable increased by $4.6 million and has been
funded with cash flow provided by operations and principal repayments on the
existing loan portfolio. Deposits decreased from $20.3 million at June 30,
1996 to $17.7 million at June 30, 1997.
-5-
<PAGE>
<PAGE>
Results of Operations
The operating results of the Company depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets, primarily loans, and interest expense on interest-bearing liabilities,
primarily deposits. The Company's net income is also affected by the
establishment of provisions for loan losses and the level of its non-interest
expenses and income tax provisions.
Comparison of Operating Results for the Year Ended June 30, 1996 and 1997
General. Net income increased $380,000, or 417% from $91,000 for the year
ended June 30, 1996 to $471,000 for the year ended June 30, 1997. This
increase was mainly attributable to a $574,000 increase in net interest income
which was primarily attributable to a $3.6 million increase in average loans
outstanding.
Interest Income. Total interest income increased by $388,000 in 1997 to
$2.7 million primarily as a result of an increase in average outstanding loans
of $3.6 million offset by a decrease in the average yield on those loans of 23
basis points. Interest income on earning deposits increased $135,000 in 1997
as the result of proceeds from the public offering being deposited in overnight
funds. Interest income on investments had minimal change in fiscal 1997
compared to fiscal 1996.
Interest Expense. Savings deposit interest expense decreased $186,000
for the year ended June 30, 1997 as compared to the same period in 1996. The
decrease was attributable to a decrease in the cost of these liabilities as the
weighted average rate paid on deposits decreased four basis points from 5.29%
during the year ended June 30, 1996 to 5.25% during the year ended June 30,
1997. The decrease in deposit rates was attributable primarily to a decrease
in rates paid on certificates of deposits, which decreased from 6.04% in 1996
to 5.83% in 1997, along with a corresponding decrease in average balances of
certificates of deposits of $2.4 million from $17.3 million to $14.9 million
between the periods. The Savings Bank did not have any FHLB-Atlanta advances
or other borrowings outstanding during these periods.
Provision for Loan Losses. The provisions for loan losses were $60,000
and $24,000 during the years ended June 30, 1996 and 1997, respectively. At
June 30, 1997, the allowance for loan losses was equal to 26.2% of
non-performing assets compared to 16.3% at June 30, 1996. The ratio of the
allowance to total loans outstanding at June 30, 1997 was .61% compared to .63%
at June 30, 1996.
Non-Interest Income. Non-interest income increased $1,000 from $6,000 for
the year ended June 30, 1996 to $7,000 for the year ended June 30, 1997.
Non-Interest Expense. Non-interest expense decreased by $23,000 from
$930,000 for the year ending June 30, 1996 to $907,000 for 1997 as a result of
lower employee benefit expenses offset by additional operating expense as a
public company, by increased compensation expense associated with the
recognition of allocated Employee Stock Ownership Plan ("ESOP") shares at fair
market value and by the recognition of the SAIF recapitalization special
assessment. During fiscal 1997, the Company recognized $73,000 of compensation
expense related to the ESOP and $137,000 for additional deposit insurance
premiums. Employee benefits decreased in 1997 by $276,000 as expenses related
to the supplemental executive retirement plans and post-retirement executive
health care agreements decreased. In 1996, both of these employee benefits
reflected significant expense as a result of initial adoption and plan
amendments. Other non-interest expense increased from related expenses of
being a public company. Non-interest expense will increase in future periods
as a result of the implementation of the Company's Management Recognition Plan.
Provision for Income Tax. The provisions for income taxes increased
$254,000 for the year ended June 30, 1997 compared with the prior year,
primarily as a result of a $634,000 increase in income before income taxes.
-6-
<PAGE>
<PAGE>
Average Balances, Interest and Average Yields/Cost
The following table sets forth certain information for the periods
indicated regarding average balances of assets and liabilities as well as the
total dollar amounts of interest income from average interest-earning assets
and interest expense on average interest-bearing liabilities and average yields
and costs. Such yields and costs for the periods indicated are derived by
dividing income or expense by the average monthly balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from month-end balances. Management does not believe that the use of
month-end balances instead of daily balances has caused any material difference
in the information presented.
At
Year Ended June 30, June
-------------------------------------------------------- 30,
1996 1997 1997
--------------------------- ---------------------------- ----
Interest Average Interest Average
Average and Yield/ Average and Yield/
Balance Dividends Cost Balance Dividends Cost
------- --------- ---- ------- --------- ----
(Dollars in thousands)
Interest-
earning
assets:
Mortgage
loans. . . . . $22,863 $1,994 8.72% $26,470 $2,248 8.49% 8.34%
Consumer
loans. . . . . 170 12 7.06 143 9 6.29 6.21
------- ------ ------- ------
Total net
loans . . . . 23,033 2,006 8.71 26,613 2,257 8.48 8.33
FHLMC
stock(1) . . . 13 4 30.77 13 6 46.15 38.46
Daily
interest
- -bearing
deposits. . . . 4,705 240 5.10 6,419 375 5.84 5.40
FHLB stock. . . 292 21 7.19 292 21 7.19 7.22
------- ------ ------- ------
Total
interest
-earning
assets. . . . 28,043 $2,271 8.10 33,337 $2,659 7.98 8.02
====== ======
Non-interest
- -earning
assets:
Office
properties
and
equipment,
net. . . . . 71 67
Real estate,
net. . . . . 89 72
Non-
interest
-earning
assets . . . 557 939
------- -------
Total
assets. . . $28,760 $34,415
======= =======
Interest-
bearing
liabilities:
Passbook
accounts . . $ 2,935 66 2.25 $ 2,129 60 2.82 2.25
Money
market
accounts . . 1,712 50 2.92 1,544 46 2.98 2.87
Certificates
of deposit . 17,290 1,045 6.04 14,903 869 5.83 5.78
------- ------ ------- ------
Total
interest
-bearing
liabil-
ities. . . 21,937 1,161 5.29 18,576 975 5.25 5.12
Non-interest
-bearing
liabilities . 861 1,181
------- -------
Total
liabilities. 22,798 19,757
Stockholders'
equity. . . 5,962 14,658
------- -------
Total
liabil-
ities and
stockholders'
equity. . . $28,760 $34,415
======= =======
Net interest
income . . . $1,110 $1,684
====== ======
Interest rate
spread (2) . 2.81% 2.73% 2.90%
===== ===== ======
Net interest
margin (3) . 3.96% 5.05%
===== =====
Ratio of
average
interest
-earning
assets
to average
interest-
bearing
liabil-
ities. . . . 127.83% 179.46%
======= =======
- ---------------------
(1) Stated at amortized cost.
(2) Interest rate spread represents the difference between the average
yield on interest-earning assets and the average cost of
interest-bearing liabilities.
(3) Net yield in interest-earning assets represents net interest income
divided by average interest-earning assets.
-7-
<PAGE>
<PAGE>
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes
on net interest income of the Savings Bank. Information is provided with
respect to (i) effects on interest income attributable to changes in volume
(changes in volume multiplied by prior rate); (ii) effects on interest income
attributable to changes in rate (changes in rate multiplied by prior volume);
and (iii) changes in rate/volume (change in rate multiplied by change in
volume).
Year Ended June 30, 1996 Year Ended June 30, 1997
Compared to June 30, 1995 Compared to June 30, 1996
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------- ----------------------------
Rate/ Rate/
Rate Volume Volume Net Rate Volume Volume Net
---- ------ ------ --- ---- ------ ------ ---
(In thousands)
Interest-
earning
assets:
Mortgage
loans. . . $ (53) $ 81 $ (2) $ 26 $ (54) $315 $ (7) $254
Consumer
loans. . . 1 (2) -- (1) (1) (2) -- (3)
----- ---- ---- ---- ----- ---- ---- ----
Total
loans. . (52) 79 (2) 25 (55) 313 (7) 251
Invest-
ment
secur-
ities. . . 1 -- -- 1 2 -- -- 2
Daily
interest
-earning
deposits . (16) 1 -- (15) 35 87 13 135
FHLB
stock. . 1 -- -- 1 -- -- -- --
----- ---- ---- ---- ----- ---- ---- ----
Total
interest
-earning
assets . . (66) 80 (2) 12 (18) 400 6 388
----- ---- ---- ---- ----- ---- ---- ----
Interest
expense:
Interest-
bearing
deposits. 161 32 6 199 (36) (144) (6) (186)
----- ---- ---- ---- ----- ---- ---- ----
Total
interest
-bearing
liabil-
ities . . 161 32 6 199 (36) (144) (6) (186)
----- ---- ---- ---- ----- ---- ---- ----
Net change
in net
interest
income . . $(227) $ 48 $ (8) $(187) $ 18 $544 $ 12 $574
====== ==== ===== ====== ===== ==== ==== ====
Asset and Liability Management and Interest Rate Risk
General. The ability to maximize net interest income depends largely upon
achieving a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Interest rate sensitivity is a
measure of the difference between amounts of interest-earning assets and
interest-bearing liabilities which either reprice or mature within a given
period of time. The difference, or the interest rate repricing "gap," provides
an indication of the extent to which an institution's interest rate spread will
be affected by changes in interest rates. A gap is considered positive when
the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities, and is considered negative when the amount
of interest-rate sensitive liabilities exceeds the amount of interest-rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap within shorter maturities would result in a decrease in net
interest income. Conversely, during a period of falling interest rates, a
negative gap within shorter maturities would result in an increase in net
interest income.
The Savings Bank has perceived its market niche to be that of a
traditional thrift lender that originates fixed rate residential loans for its
portfolio and uses its capital position to absorb the adverse consequences of
the increased interest rate risk associated with this strategy. As an integral
part of this strategy, the Savings Bank has historically
-8-
<PAGE>
<PAGE>
concentrated its lending activity on the origination of long-term, fixed-rate,
residential one- to four-family mortgage loans and commercial real estate and
multi-family loans. As of June 30, 1997, all of the Savings Bank's total
loans, net of loans in process and non-performing loans, were fixed rate loans.
The mismatch between maturities and interest rate sensitivities of balance
sheet items results in interest rate risk. The Savings Bank has a high level
of interest rate risk, compared to many similar sized thrift institutions, as a
result of its policies to make fixed-rate, residential one- to four-family real
estate loans, which are longer term in nature than the short-term
characteristics of its liabilities for customer deposit accounts.
The extent of interest rate risk to which the Savings Bank is subject is
monitored by management through an analysis of the institution's interest
sensitivity gap (the difference between the amounts of interest-earning assets
and interest-bearing liabilities repricing during a given time), as well as by
other means. At June 30, 1997, the Savings Bank's interest-bearing liabilities
that were estimated to mature or reprice within one year exceeded its
interest-earning assets with the same characteristics by $6.9 million for
cumulative one-year negative gap to total rate sensitive assets of 118%. An
institution with a significant negative gap, like the Savings Bank, could
expect adverse effects on liquidity, net interest margin and net interest
income during a period of rising interest rates. The Savings Bank has recently
adopted a strategy to extend the term of its liabilities in the form of longer
term certificate accounts and maintain adequate liquidity levels to address its
interest rate risk exposure, however, most of its liabilities are still short
term certificate accounts and as a result does not reflect the implementation
of this new strategy. The Savings Bank's one year interest sensitivity gap as
a percentage of total rate sensitive assets on June 30, 1997 was negative 118%.
At June 30, 1997, the Savings Bank's three year cumulative interest rate
sensitivity gap as a percentage of total interest-earning assets was negative
37% and its five year cumulative interest rate sensitivity gap as a percentage
of total interest-earning assets was negative 4%.
-9-
<PAGE>
<PAGE>
<TABLE>
The following table presents the Savings Bank's interest sensitivity gap between interest-earning assets
and interest-bearing liabilities at June 30, 1997.
Within Over Over
Six 6 Months 1-3 3-5 5-10
Months to One Year Years Years Years Total
------ ----------- ----- ----- ----- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Residential
one- to
four-family loans . . . . $ 2,038 $ 1,865 $ 6,043 $ 4,359 $ 8,855 $ 23,160
Commercial
real estate . . . . . . . 91 96 426 503 2535 3,651
Multi-family . . . . . . . -- -- -- -- 20 20
Land . . . . . . . . . . . -- -- -- -- 1,002 1,002
Consumer loans . . . . . . 126 -- -- -- -- 126
Investment securities and
interest-bearing
deposits. . . . . . . . . 1,635 -- -- -- -- 1,635
------- ------- ------- ------- -------- --------
Total rate sensitive
assets. . . . . . . . . $ 3,890 $ 1,961 $ 6,469 $ 4,862 $ 12,412 $ 29,594
======= ======= ======= ======= ======== ========
Interest-bearing liabilities:
Deposits:
Regular savings. . . . . $ 188 $ 171 $ 546 $ 356 $ 854 $ 2,115
Money market deposit
accounts. . . . . . . . 782 358 159 76 69 1,444
Certificates of
deposit . . . . . . . . 4,455 6,717 2,430 511 -- 14,113
Other borrowings . . . . 84 -- 1,018 -- 638 1,740
------- ------- ------- ------- -------- --------
Total rate sensitive
liabilities. . . . . . $ 5,509 $ 7,246 $ 4,153 $ 943 $ 1,561 $ 19,412
======= ======= ======= ======= ======== ========
Excess (deficiency) of
interest sensitivity
assets over interest
sensitivity liabilities . $(1,619) $(5,285) $ 2,316 $ 3,919 $ 10,851 $ 10,182
======= ======= ======= ======= ======== ========
Cumulative excess
(deficiency) of
interest sensitivity
assets. . . . . . . . . . $(1,619) $(6,904) $(4,588) $ (669) $ 10,182 $ 10,182
======= ======= ======= ======= ======== ========
Cumulative ratio of
interest-earning assets
to interest-bearing
liabilities . . . . . . . 71% 46% 73% 96% 152% 152%
Interest sensitivity gap
to total assets . . . . . (5)% (22)% (15)% (2)% 33% 33%
Ratio of interest-earning
assets to interest-bearing
liabilities . . . . . . . 71% 27% 156% 516% 795% 152%
Ratio of cumulative gap to
total assets. . . . . . . (5)% (22)% (15)% (2)% 33% 33%
Interest sensitivity gap to
total rate sensitive
assets. . . . . . . . . . (42)% (270)% 36% 81% 87% 34%
Ratio of cumulative gap to
total rate sensitive
assets. . . . . . . . . . (42)% (118)% (37)% (4)% 34% 34%
-10-
</TABLE>
<PAGE>
<PAGE>
Rate/Volume Analysis
The Savings Bank's analysis of its interest-rate sensitivity, as
illustrated in the preceding table, incorporates certain assumptions regarding
the amortization of loans and other interest-earning assets and the withdrawal
of deposits. The Savings Bank's interest-rate sensitivity analysis, as
illustrated in the foregoing table, could vary substantially if different
assumptions were used or if actual experience differs from the assumptions
used. The assumptions used in preparing the table are based on market loan
prepayment rates and market deposit decay rates observed by the FHLB-Atlanta on
or about June 30, 1997. The Savings Bank believes that the FHLB-Atlanta
assumptions are a realistic representation of its own portfolio.
Net Portfolio Value and Net Interest Income Analysis. In addition to the
interest rate gap analysis as discussed above, management monitors the Savings
Bank's interest rate sensitivity through the use of a model which estimates the
change in NPV (net portfolio value) and net interest income in response to a
range of assumed changes in market interest rates. NPV is the present value of
expected cash flows from assets, liabilities, and off-balance sheet items. The
model estimates the effect on the Savings Bank's NPV and net interest income of
instantaneous and permanent 200 and 400 basis point increases and decreases in
market interest rates. The Savings Bank's Board of Directors has established
maximum acceptable decreases in NPV and net interest income for the various
rate scenarios. The following information is presented as of June 30, 1997.
Change in Net Portfolio Value
Interest Rates ---------------------------------------------
in Basis Points
(Rate Shock) Amount $ Change % Change Limit
--------------- ------ -------- -------- -----
(Dollars in thousands)
400 $ 7,273 $(3,778) (34)% 110%
200 9,229 (1,822) (16) 60
0 11,051 -- -- --
(200) 12,035 984 9 65
(400) 12,880 1,829 16 130
Interest Rate Sensitivity of Net Portfolio Value. The table below
measures interest rate risk by estimating the change in market value of the
Savings Bank's assets, liabilities, and off-balance sheet contracts in response
to an instantaneous change in the general level of interest rates. The
procedure for measuring interest rate risk was developed to replace the "gap"
analysis (the difference between interest-earning assets and interest-bearing
liabilities that mature or reprice within a specific time period). The model
first estimates the level of the Savings Bank's NPV (market value of assets,
less market value of liabilities, plus or minus the market value of any
off-balance sheet items) under the current rate environment. In general,
market values are estimated by discounting the estimated cash flows of each
instrument by appropriate discount rates. The model then recalculates the
Savings Bank's NPV under different interest rate scenarios. The change in NPV
under the different interest rate scenarios provides a measure of the Savings
Bank's exposure to interest rate risk. The data presented is as of June 30,
1997.
-11-
<PAGE>
<PAGE>
-400 -200 +200 +400
Basis Basis No Basis Basis
Points Points Change Points Points
------ ------ ------ ------ ------
(Dollars in thousands)
ASSETS
Mortgage loans . . . . . . $ 30,694 $ 29,449 $ 27,995 $ 25,775 $ 23,475
Non-mortgage loans . . . . 126 126 126 126 126
Cash, deposits and
securities. . . . . . . . 2,197 2,152 2,107 2,062 2,018
Nonperforming loans and
real estate . . . . . . . 535 517 496 464 431
Premises and equipment . . 65 65 65 65 65
Other assets . . . . . . . 587 586 585 583 580
-------- -------- -------- -------- --------
TOTAL ASSETS . . . . . . . $ 34,204 $ 32,895 $ 31,374 $ 29,075 $ 26,695
======== ======== ======== ======== ========
LIABILITIES
Deposits . . . . . . . . . $ 18,194 $ 17,912 $ 17,524 $ 17,143 $ 16,791
Borrowings . . . . . . . . 2,117 1,932 1,773 1,634 1,512
Other liabilities. . . . . 1,035 1,035 1,035 1,035 1,035
-------- -------- -------- -------- --------
TOTAL LIABILITIES. . . . . $ 21,346 $ 20,879 $ 20,332 $ 19,812 $ 19,338
======== ======== ======== ======== ========
Net portfolio value. . . . $ 12,858 $ 12,016 $ 11,042 $ 9,263 $ 7,357
Percent change . . . . . . 16% 9% -- (16)% (33)%
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan repayments and deposit decay, and should not be relied upon as
indicative of actual results. Further, the computations do not reflect any
actions management may undertake in response to changes in interest rates.
In the event of a 200 basis point decrease in interest rates, the Savings
Bank would be expected to experience an 8.9% increase in NPV and a .95%
increase in net interest income. In the event of a 200 basis point increase in
interest rates, a 16.5% decrease in NPV and a 6.04% decrease in net interest
income would be expected. Based upon the modelling described above, the
Savings Bank's asset and liability structure results in increases in NPV and in
net interest income in a declining interest rate scenario and decreases in NPV
and in net interest income in a rising interest rate scenario. However, the
amount of change in value of specific assets and liabilities due to changes in
rates is not the same in a rising rate environment as in a falling rate
environment.
As with any method of measuring interest rate risk, certain shortcomings
are inherent in the method of analysis presented in the foregoing table. 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. Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates.
Additionally, certain assets have features which restrict changes in interest
rates on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates, expected rates of prepayments on loans and
early withdrawals from certificates could likely deviate significantly from
those assumed in calculating the table.
-12-
<PAGE>
<PAGE>
Liquidity and Capital Resources
The Savings Bank's primary sources of funds are customer deposits and
proceeds from principal and interest payments on loans. While maturities and
scheduled amortization of loans are a predictable source of funds, deposit
flows and mortgage prepayments are greatly influenced by general interest
rates, economic conditions and competition.
The primary investing activity of the Savings Bank is the origination of
fixed-rate mortgage loans. During the years ended June 30, 1996 and 1997 and
the Savings Bank originated mortgage loans in the amounts of $5.9 million and
$10.4 million, respectively. Other investing activities include the purchase
of overnight deposits.
The Savings Bank must maintain an adequate level of liquidity to ensure
the availability of sufficient funds to support loan growth and deposit
withdrawals, to satisfy financial commitments and to take advantage of
investment opportunities. During fiscal years 1996 and 1997, the Savings Bank
used its liquidity primarily to fund deposit withdrawals and loan originations.
From June 30, 1996 to June 30, 1997, deposits at the Savings Bank
decreased from $20.3 million to $17.7 million. Management believes that
deposits decreased during this period as a result of large certificate of
deposit withdrawals for estate payout, movement of deposits to trust accounts
at other institutions, and general movement of deposits to other investment
vehicles. Because of its high level of liquidity, the Savings Bank does not
believe that a moderate decrease in deposits will have a significant impact on
its financial condition and results of operations. However, the Savings Bank
plans to develop strategies to attract new deposits.
At June 30, 1997, certificates of deposit amounted to $14.1 million, or
79.9%, of the Savings Bank's total deposits, including $10.9 million which were
scheduled to mature by June 30, 1998. Historically, the Savings Bank has been
able to retain a significant amount of its maturing deposits. Management of
the Savings Bank believes it can adjust the interest rates of savings
certificates to retain deposits in changing interest rate environments.
The Savings Bank is required to maintain specific amounts of capital
pursuant to FDIC requirements. As of June 30, 1997, the Savings Bank was in
compliance with all regulatory capital requirements which were effective as of
such date with a Tier 1 leverage capital ratio of 34.5%.
Impact of New Accounting Pronouncements
Accounting for Stock-Based Compensation. In October 1995, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation," establishing
financial accounting and reporting standards for stock-based employee
compensation plans. SFAS No. 123 encourages all entities to adopt a new method
of accounting to measure compensation cost of all employee stock compensation
plans based on the estimated fair value of the award at the date it is granted.
Companies are, however, allowed to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting, which
generally does not result in compensation expense recognition for most plans.
Companies that elect to remain with the existing accounting are required to
disclose in a footnote to the financial statements pro forma net income and, if
presented, earnings per share, as if this statement had been adopted. The
accounting requirements of this statement are effective for transactions
entered into in fiscal years that begin after December 15, 1995; however,
companies are required to disclose information for awards granted in their
first fiscal year beginning after December 15, 1994. At June 30, 1997, the
Company did not have any stock-based compensation plans in effect that required
reporting under SFAS No. 123.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with GAAP, which require the
measurement of financial position and operating results in terms of
-13-
<PAGE>
<PAGE>
historical dollars, without considering the change in the relative purchasing
power of money over time due to inflation. The primary impact of inflation is
reflected in the increased cost of the Company's operations. Unlike most
industrial companies, virtually all the assets and liabilities of a financial
institution are monetary in nature. As a result, interest rates generally have
a more significant impact on a financial institution's performance than do
general levels of inflation. Interest rates do not necessarily move in the
same direction or to the same extent as the prices of goods and services.
-14-
<PAGE>
<PAGE>
CRISP
CH
HUGHES
---- & CO., L.L.P. ----
CERTIFIED PUBLIC ACCOUNTANTS AND CONSULTANTS
- Independent Auditors' Report -
Board of Directors
Mitchell Bancorp, Inc. and Subsidiary
Spruce Pine, North Carolina
We have audited the accompanying consolidated balance sheets of Mitchell
Bancorp, Inc. and Subsidiary ("Company") as of June 30, 1996 and 1997, and the
related consolidated statements of income, stockholders' equity, and cash flows
for the years then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Mitchell Bancorp, Inc. and
Subsidiary as of June 30, 1996 and 1997, and the results of their operations
and their cash flows for the years then ended, in conformity with generally
accepted accounting principles.
/s/CRISP, HUGHES & CO., L.L.P.
CRISP, HUGHES & CO., L.L.P.
Asheville, North Carolina
August 7, 1997
32 Orange Street - P.O. Box 3049 - Asheville, North Carolina 28802 -
(704) 254-2254 - FAX (704) 254-6859
Other Offices: Boone, Burnsville, Sylvia, NC and Greenville, SC
Member of The American Institute of Certified Public Accountants, The
Continental Association of CPA Firms, Inc. The Intercontinental Accounting
Associates and The North Carolina and South Carolina Associates of CPAs
-15-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(in thousands, except share data)
June 30,
-----------------------------
Assets 1996 1997
------ ---- ----
Cash on hand $ 133 $ 211
Interest earning deposits 11,996 3,395
Investment securities:
Available for sale (amortized cost of $13
in 1996 and 1997) 285 467
Loans receivable, net 23,568 28,203
Real estate owned 84 91
Premises and equipment, net 70 65
Federal Home Loan Bank stock 291 291
Accrued interest receivable 5 7
Deferred income taxes 230 164
Prepaid expenses and other assets 114 165
---------- ----------
Total assets $ 36,776 $ 33,059
========== ==========
Liabilities and Stockholders' Equity
------------------------------------
Deposits $ 20,346 $ 17,672
Accounts payable--conversion cost 347 -
Stock oversubscription 523 -
Accrued interest payable 60 63
Accrued expenses and other liabilities 818 845
Current income taxes payable 48 154
---------- ----------
Total liabilities 22,142 18,734
---------- ----------
Stockholders' equity:
Preferred stock ($.01 par
value, 500,000 shares authorized;
none outstanding) - -
Common stock ($.01 par value,
3,000,000 shares authorized;
979,897 issued; 979,897 and
930,902 shares outstanding at
June 30, 1996 and 1997, respectively) 10 10
Paid-in capital 9,204 9,225
Retained earnings, substantially restricted 6,038 6,329
Treasury stock, at cost (48,995 shares at - (784)
June 30,1997)
Unrealized gain on securities available for
sale, net of income taxes 166 277
Unearned compensation:
Employee stock ownership plan (784) (732)
---------- ----------
Total stockholders' equity 14,634 14,325
---------- ----------
Total liabilities and stockholders' equity $ 36,776 $ 33,059
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
-16-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
(in thousands, except per share data)
For Years Ended June 30,
-----------------------------
1996 1997
---- ----
Interest income:
Loans $ 2,006 $ 2,257
Investments 25 27
Interest earning deposits 240 375
---------- ----------
Total interest income 2,271 2,659
Interest expense:
Deposits 1,161 975
---------- ----------
Net interest income 1,110 1,684
Provision for loan losses 60 24
---------- ----------
Net interest income after provision for
loan losses 1,050 1,660
Non-interest income:
Gain on real estate owned 2 3
Other 4 4
---------- ----------
Total non-interest income 6 7
---------- ----------
Non-interest expenses:
Compensation 269 318
Other employee benefits 435 159
Net occupancy expense 27 27
Deposit insurance premiums 48 155
Data processing 28 27
Provision for real estate losses 10 -
Other 113 221
---------- ----------
Total non-interest expenses 930 907
---------- ----------
Income before income taxes 126 760
Income tax expense 35 289
---------- ----------
Net income $ 91 $ 471
========== ==========
Net income per common share N/A $ .53
The accompanying notes are an integral part of these consolidated financial
statements.
-17-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
(in thousands)
Unreal-
ized Unearned
Gain on Compen-
Common Paid-In Retained Treasury Secur- sation
Stock Capital Earnings Stock ities for ESOP Total
----- ------- -------- ----- ------- -------- -----
Balance at
June 30, $ - $ - $ 5,947 $ - $ 131 $ - $ 6,078
1995
Net income - - 91 - - - 91
Unrealized
gain on
securities
available
for sale,
net of
income
taxes - - - - 35 - 35
Sale of
common
stock
(979,897
shares) 10 9,204 - - - (784) 8,430
-------- -------- -------- -------- -------- -------- --------
Balance
at June
30, 10 9,204 6,038 - 166 (784) 14,634
1996
Net income - - 471 - - - 471
Dividends
paid
($.20 - - (180) - - - (180)
per share)
Unrealized
gain on
securities
available
for sale,
net of
income
taxes - - - - 111 - 111
Earned - 21 - - - 52 73
compen-
sation--
ESOP
Repurchase
of common
stock
(48,995
shares) - - - (784) - - (784)
-------- -------- -------- -------- -------- -------- --------
Balance
at June
30, $ 10 $ 9,225 $ 6,329 $ (784)$ 277 $ (732) $ 14,325
1997 ======== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-18-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(in thousands)
Years Ended June 30,
------------------------
1996 1997
---- ----
Operating activities:
Net income $ 91 $ 471
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 11 11
Provision for loan losses 60 24
Provision for losses on real estate 10 -
Amortization of ESOP compensation - 73
Increase (decrease) in reserve for uncollected 36 11
interest
Deferred income taxes (benefit) (153) (5)
Net increase in deferred loan fees 8 36
Gain on real estate owned (2) (3)
(Increase) decrease in accrued interest receivable - 2
(Increase) decrease in prepaid expenses and other (5) (27)
assets
Increase (decrease) in accrued interest payable (13) 3
Increase in accrued expenses and other liabilities 361 133
-------- --------
Net cash provided by operating activities 404 729
-------- --------
Investing activities:
Net increase in loans (1,193) (4,714)
Purchase of premises and equipment (7) (6)
Proceeds from sale of real estate owned 3 -
Investment in life insurance cash surrender value (25) (24)
-------- ---------
Net cash used by investing activities (1,222) (4,744)
-------- ---------
Financing activities:
Net decrease in deposits (594) (2,674)
Proceeds from sale of common stock 8,430 -
Repurchase of common stock - (784)
Dividends paid - (180)
Proceeds (repayment) from stock oversubscriptions 523 (523)
Accrued (paid) conversion cost 347 (347)
-------- ---------
Net cash provided (used) by financing activities 8,706 (4,508)
-------- ---------
Increase (decrease) in cash and cash equivalents 7,888 (8,523)
Cash and cash equivalents at beginning of year 4,241 12,129
-------- --------
Cash and cash equivalents at end of year $ 12,129 $ 3,606
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 1,174 $ 972
Income taxes 147 196
======== ========
Noncash transactions:
Real estate acquired in satisfaction of mortgage $ 17 $ 74
loans
Loans to facilitate sale of real estate owned 33 70
Unrealized gain on securities available for sale,
net of deferred tax liability of $21 and $71
in 1996 and 1997, respectively 35 111
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-19-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1996 and 1997
(tabular amounts in thousands)
1. Organization
------------
Mitchell Bancorp, Inc. ("Bancorp") is a bank holding company organized in
February 1996 to become the holding company for Mitchell Savings Bank, Inc.
S.S.B. ("Savings Bank"). Bancorp became the holding company of the Savings
Bank upon the conversion of the Savings Bank from a North Carolina-chartered
mutual savings bank to a North Carolina-chartered stock savings bank (see Note
14).
Mitchell Mortgage and Investment Co., Inc. ("MMI") is wholly owned by the
Savings Bank. MMI was organized in September of 1980 and has had no
significant business activity.
Bancorp, Savings Bank, and MMI are herein collectively referred to as the
"Company".
2. Summary of Significant Accounting Policies
------------------------------------------
The following is a description of the more significant accounting and reporting
policies which the Company follows in preparing and presenting its consolidated
financial statements.
Principles of Consolidation - The accompanying consolidated financial
- ---------------------------
statements include the accounts of Bancorp, Savings Bank, and MMI. All
significant intercompany balances and transactions have been eliminated in
consolidation.
Estimates - The preparation of consolidated 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 at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Loans Receivable - Loans receivable are carried at their unpaid principal
- ----------------
balance less, where applicable, undisbursed funds, net deferred loan fees, and
allowance for losses. Additions to the allowance for loan losses are based on
management's evaluation of the loan portfolio under current economic conditions
and such other factors which, in management's judgment, deserve recognition in
estimating loan losses. Interest accrual is discontinued when a loan becomes 90
days delinquent unless, in management's opinion, the loan is well secured and
in process of collection. Interest income on impaired loans is
-20-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
subsequently recognized on a cash basis, until such time that, in management's
opinion, the borrower will be able to meet payments as they become due.
The Savings Bank's policy on single-family mortgage loans is to lend within its
primary market area which is defined as Mitchell County and the surrounding
counties in Western North Carolina. It is the Savings Bank's general policy to
limit an individual single-family mortgage loan to 80% of the appraised value
of the property securing the loan.
The Savings Bank's multi-family and commercial real estate loans consist of
properties located in its primary market. The general policy is to limit loans
on multi-family residential complexes and commercial real estate to 50% of the
appraised value of the property securing the loan.
Loan Origination Fees - Loan fees result from the Savings Bank
- ---------------------
originating mortgage loans. Such fees and certain direct incremental costs
related to origination of such loans are deferred ("net deferred loan fees")
and reflected as a reduction of the carrying value of mortgage loans. The net
deferred fees (or costs) are amortized using the interest method over the
contractual lives of the loans. Unamortized net deferred loan fees on loans
sold prior to maturity are credited to income at the time of sale.
Investment Securities - All of the Company's investments which consist
- ---------------------
solely of FHLMC stock have been identified as available for sale and recorded
at market value. The unrealized gains are reported as a component of
stockholders' equity. Gains or losses on sales of securities available for sale
are based on the specific identification method.
Premises and Equipment - Premises and equipment are carried at cost less
- ----------------------
accumulated depreciation. Depreciation is provided using the straight-line
method over estimated useful lives. The cost of maintenance and repairs is
charged to expense as incurred while expenditures which materially increase
property lives are capitalized.
Federal Home Loan Bank Stock - Investment in stock of a Federal Home Loan
- ----------------------------
Bank is required by law of every federally insured savings and loan or savings
bank. The investment is carried at cost. No ready market exists for the stock,
and it has no quoted market value.
Real Estate Owned - Real estate acquired through, or in lieu of, loan
- -----------------
foreclosure is carried at the lower of fair value minus estimated costs to sell
or cost, which is redefined as the fair value at the time of foreclosure. If
fair value minus estimated costs to sell is less than cost, a valuation
allowance is recognized. If the fair value less estimated costs to sell
subsequently increases, the valuation allowance is reduced, but not below zero.
Increases or decreases in the valuation allowance are charged or credited to
income. Gains on sales of real estate owned are deferred to the extent that
gains are not received in cash. Deferred gains are taken into income in the
same ratio as the loan balances are reduced.
-21-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
Income Taxes - The Company utilizes the liability method of computing
- ------------
income taxes. Under the liability method, deferred tax liabilities and assets
are established for future tax return effects of temporary differences between
the stated value of assets and liabilities for financial reporting purposes and
their tax basis. The focus is on accruing the appropriate balance sheet
deferred tax amount, with the statement of earnings effect being the result of
changes in balance sheet amounts from period to period. Current income tax
expense is provided based upon the actual tax liability incurred for tax return
purposes.
Cash Flow Information - As presented in the consolidated statements of
- ---------------------
cash flows, cash and cash equivalents include cash on hand and interest-earning
deposits.
Earnings Per Share - Earnings per share is computed based on weighted
- ------------------
average number of shares for common stock and common stock equivalents assumed
to be outstanding during the period. Unreleased ESOP shares are not considered
outstanding for the earnings per share computations. Earnings per share for
1996 was not calculated as no shares were outstanding during the year ending
June 30, 1996. There were no dilutive common stock equivalents outstanding
during 1997.
2. Loans Receivable
----------------
Loans receivable are summarized as follows:
June 30,
---------------------------
1996 1997
---- ----
Real estate mortgage loans:
One-to-four family residential $ 19,751 $ 23,909
Commercial real estate 2,810 3,661
Multi-family residential 157 20
Land 1,078 1,013
---------- ----------
Total real estate loans 23,796 28,603
Consumer loans:
Loans secured by deposit accounts 154 126
---------- ----------
Total loans 23,950 28,729
---------- ----------
Less:
Undisbursed portion of loans in process (62) (135)
Allowance for loan losses (152) (176)
Deferred loan fees (124) (160)
Reserve for uncollected interest (44) (55)
---------- ----------
(382) (526)
$ 23,568 $ 28,203
========== ==========
-22-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
At June 30, 1996 and 1997 loans which were contractually past due ninety days
or more totaled approximately $834,000 and $581,000, respectively. All of these
loans would be categorized as homogeneous loans and therefore excluded from
consideration for impairment in accordance with Statement of Financial
Accounting Standards (SFAS) No. 114. The Savings Bank had no loans considered
impaired as defined under SFAS No. 114 for 1996 and 1997. A summary of the
activity in the allowance for loan losses is summarized as follows:
Years Ended June 30,
---------------------------
1996 1997
---- ----
Beginning balance $ 92 $ 152
Provision for losses charged to income 60 24
---------- ----------
Ending balance $ 152 $ 176
========== ==========
Management of the Savings Bank believes that its allowances for losses on its
loan portfolio are adequate. However, the estimates used by management in
determining the adequacy of such allowances are susceptible to significant
changes due primarily to changes in economic and market conditions. In
addition, various regulatory agencies periodically review the Savings Bank's
allowance for losses as an integral part of their examination processes. Such
agencies may require the Savings Bank to recognize additions to the allowances
based on their judgments of information available to them at the time of their
examinations.
3. Real Estate Owned
-----------------
Real estate owned is summarized as follows:
June 30,
---------------------------
1996 1997
---- ----
One-to-four family residential $ 52 $ 91
Commercial real estate 47 -
Allowance for losses on real estate (15) -
---------- --------
$ 84 $ 91
========== ========
-23-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
A summary of activity in the valuation allowance for losses on real
estate is summarized as follows:
Years Ended June 30,
---------------------------
1996 1997
---- ----
Beginning balance $ 5 $ 15
Chargeoffs - (15)
Provision for losses charged to income 10 -
--------- --------
Ending balance $ 15 $ -
========= ========
4. Premises and Equipment
----------------------
Premises and equipment is summarized as follows:
June 30,
---------------------------
1996 1997
---- ----
Land $ 16 $ 16
Office building and improvements 83 84
Furniture and equipment 186 191
---------- ----------
285 291
Less accumulated depreciation 215 226
---------- ----------
$ 70 $ 65
========== ==========
5. Deposits
--------
Deposits are summarized as follows:
JUNE 30,
--------------------------------------------------
1996 1997
------------------------ ------------------------
Weighted Weighted
Average Average
Rage Amount Rage Amount
---- ------ ---- ------
Passbook 2.50% $ 2,184 2.25% $ 2,117
Money market 3.02% 1,581 2.87% 1,443
Certificates of 5.93% 16,581 5.78% 14,112
deposit --------- ---------
Total deposits
$ 20,346 $ 17,672
========= =========
Weighted average cost of 5.33% 5.12%
deposits ==== ====
-24-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
Contractual maturities of certificates of deposit are as follows:
June 30,
---------------------------
1996 1997
---- ----
12 months or less $ 12,257 $ 10,917
1-2 years 2,456 1,947
2-3 years 1,359 738
3-5 years 509 510
---------- ----------
$ 16,581 $ 14,112
========== ==========
Interest expense on deposits is summarized as follows:
Years Ended June 30,
---------------------------
1996 1997
---- ----
Passbook $ 66 $ 60
Money market 50 46
Certificates of deposit 1,045 869
---------- ----------
$ 1,161 $ 975
========== ==========
Certificates of deposit with balances of $100,000 or more totaled approximately
$5,052,000 and $3,891,000 at June 30, 1996 and 1997, respectively.
6. Income Taxes
------------
The components of income tax expense (benefit) are as follows:
Years Ended June 30,
---------------------------
1996 1997
---- ----
Current $ 188 $ 294
Deferred (benefit) (153) (5)
---------- ----------
Total $ 35 $ 289
========== ==========
-25-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
The differences between actual income tax expense and the amount computed by
applying the federal statutory income tax rate of 34% to income before income
taxes are reconciled as follows:
Years Ended June 30,
---------------------------
1996 1997
---- ----
Computed income tax expense $ 43 $ 259
Increase (decrease) resulting from:
State income tax net of federal tax (6) 22
benefits
Other (2) 8
---------- ----------
Actual income tax expense $ 35 $ 289
========== ==========
The components of the net deferred income tax assets are as follows:
June 30,
---------------------------
1996 1997
---- ----
Deferred tax assets, principally deferred
compensation expenses $ 396 $ 402
Valuation allowance - -
---------- --------
396 402
Deferred tax liabilities, principally
unrealized gain on securities available
for sale 166 238
---------- --------
Net deferred income tax asset $ 230 $ 164
========== ========
The Savings Bank's annual addition to its reserve for bad debts allowed under
the Internal Revenue Code may differ significantly from the bad debt experience
used for financial statement purposes. Such bad debt deductions for income tax
purposes are included in taxable income of later years only if the bad debt
reserves are used for purposes other than to absorb bad debt losses. Since the
Savings Bank does not intend to use the reserve for purposes other than to
absorb losses, no deferred income taxes have been provided on the amount of bad
debt reserves for tax purposes that arose in tax years beginning before
December 31, 1987, in accordance with SFAS No. 109. Therefore, retained income
at June 30, 1996 and 1997, includes approximately $1.1 million representing
such bad debt deductions for which no deferred income taxes have been provided.
7. Pension Plan
------------
The Company has a defined benefit pension plan covering all full-time employees
over the age of twenty and one-half who have completed six months of continuous
employment.
-26-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
The following is a summary of the components of pension cost:
Years Ended June 30,
---------------------------
1996 1997
---- ----
Service cost--benefits earned during the $ 7 $ 16
year
Interest cost on projected benefit 10 14
obligation
Actual return on plan assets (7) (10)
Net amortization of initial transition
liability and deferral of subsequent
gains under SFAS No. 87 1 1
Net amortization of loss not reflected in
market related value 1 3
---------- ----------
$ 12 $ 24
========== ==========
A summary of the plan's funding status is as follows:
June 30,
---------------------------
1996 1997
---- ----
Actuarial present value of benefit obligations:
Vested benefits $ 123 $ 138
Non-vested benefits - 1
---------- ----------
Accumulated benefit obligation $ 123 $ 139
========== ==========
Projected benefit obligations for services
rendered to date $ 136 $ 207
Plan assets at fair value, primarily cash
and contracts with insurance companies 101 135
---------- ----------
Deficit of plan assets over projected
benefit obligations 35 72
Unrecognized transition asset (20) (19)
Minimum liability adjustment 38 25
Unrecognized net loss (30) (74)
---------- ----------
Accrued pension expense $ 23 $ 4
========== ==========
The weighted average discount rate and rate of increase in future
compensation levels in determining the actuarial present value of the projected
benefit obligation for 1996 and 1997 were 5% and 8%. The expected long-term
rate of return on assets was 8%.
-27-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
8. Compensation Benefit Agreements
-------------------------------
The Savings Bank has established nonqualified compensation agreements with its
directors providing for fixed benefits payable monthly over a ten year period.
The benefits are payable to those directors beginning upon attainment of age 62
or, in the event of their death, to their designated beneficiary. The expense
before income tax effect associated with these agreements was approximately
$12,000 and $17,000 for the years ending June 30, 1996 and 1997, respectively.
The Savings Bank also has established nonqualified compensation agreements with
certain key executives providing for benefits payable monthly over a ten year
period beginning at retirement and to their designated beneficiary in the event
of death. The expense before income tax effect recognized on these agreements
was approximately $273,000 and $84,000 for the years ending June 30, 1996 and
1997, respectively.
The Company has purchased life insurance contracts with respect to directors
and key executives covered by these agreements. The Company is the owner and
beneficiary of the insurance contracts. The directors and key executives are
general creditors of the Company with respect to these benefits. The cash
surrender value of the Company-owned life insurance is reflected in other
assets on the accompanying consolidated balance sheets. The liability for the
benefits have been accrued at the balance sheet dates at the net present value
of the expected benefits. Annual expense is based on the increase in the
present value of expected future benefits.
9. Postretirement Benefits Other Than Pensions
-------------------------------------------
Effective December 31, 1995, the Company adopted an unfunded postretirement
health care benefit plan covering certain executive officers and their spouses
for life beginning at their date of retirement. The Company plans to provide
health insurance coverage under their existing group plan for these retirees.
The benefits are recordedin accordance with SFAS No. 106, "Employers Accounting
for Postretirement Benefits Other Than Pensions". Under SFAS No. 106, the
Company is required to accrue the estimated cost of retiree benefit payments
during the employee's active service period. Based on the full eligibility of
the covered executive officers, the Company has accrued the expected
postretirement benefit obligation of approximately $73,000 at June 30, 1996 and
1997. This liability consists entirely of unrecognized prior service cost.
-28-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
10. Employment and Change of Control Agreements
-------------------------------------------
The Company entered into three year employment agreements with certain key
officers which may be extended by the Board for an additional year at each
anniversary date so that the remaining terms shall be three years. The
agreements provide for severance payments and other benefits in the event of
involuntary termination of employment in connection with any change in control
of the employers. The severance payments will equal 2.99 times the executive
officer's average annual compensation during the preceding five years. The
employment agreements provide for termination by the Company for just cause at
any time. The Company has not accrued any benefits under these postemployment
agreements.
11. Regulatory Matters
------------------
The Savings Bank is subject to various regulatory capital requirements
administered by the Federal Deposit Insurance Company ("FDIC"). Failure
to meet minimum capital requirements can initiate certain mandatory, and
possible additional discretionary, actions by regulators that, if undertaken,
could have a direct material effect on the Company's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Savings Bank must meet specific capital guidelines that
involve quantitative measures of the Savings Bank's assets, liabilities, and
certain off- balance sheet items as calculated under regulatory accounting
practices. The Savings Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. In addition, the Savings Bank is subject to a
North Carolina Savings Institution (State) capital requirement of at least 5%
of total assets.
Quantitative measures established by regulation to ensure capital adequacy
require the Savings Bank to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital to average assets ( as
defined). Management believes, as of June 30, 1997, that the Savings Bank meet
all capital adequacy requirements to which it is subject.
As of June 30, 1997, the most recent notification from the FDIC categorized the
Savings Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Savings Bank must
maintain minimum total risked-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the following table. There are no conditions or event
since the notification that management believes have changed the Savings Bank's
category.
-29-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
Following are the required and actual capital amounts and ratios for the
Savings Bank:
TO BE WELL
CAPITALIZED
UNDER
PROMPT
CORRECTIVE
FOR CAPITAL ACTION
ACTUAL ADEQUACY PURPOSES PROVISIONS
----------------- ----------------- --------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
As of June 30, 1997:
Tier 1 Capital (to
average assets) $10,328 34.5% $ 1,198 >4.0% $ 1,497 >5%
-
Tier 1 Capital (to risk-
weighted assets) $10,328 56.9% $ 726 >4.0% $ 907 >6%
-
Total Capital (to risk-
weighted assets) $10,504 57.9% $ 1,451 >8.0% $ 1,814 >10%
- -
As of June 30, 1996:
Tier 1 Capital (to
average assets) $ 9,862 29.9% $ 1,757 >4.0% $ 2,197 >5%
- -
Tier 1 Capital (to risk-
weighted assets) $ 9,862 71.6% $ 551 >4.0% $ 827 >6%
Total Capital (to risk-
weighted assets) $10,014 72.7% $ 1,101 >8.0% $ 1,376 >10%
- -
12. Financial Instruments with Off-Balance-Sheet Risk
-------------------------------------------------
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit. Those
instruments involve, to varying degrees, elements of credit and interest-rate
risk in excess of the amount recognized in the accompanying consolidated
balance sheet. The contract or notional amounts of those instruments reflect
the extent of the Company's involvement in particular classes of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The
Company uses the same credit policies in making commitments as it does for
on-balance-sheet instruments.
The Company had outstanding commitments to originate fixed rate mortgage loans
of approximately $1,512,000 and $563,000 at June 30, 1996 and 1997,
respectively. The commitments to originate loans at June 30, 1996, had interest
rates ranging from 7.75% to 8.00% with terms ranging from 15 to 16 years. The
commitments to originate loans at June 30, 1997, had interest rates ranging
from 8.00% to 8.50% with terms ranging from 15 to 16 years.
-30-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
13. Deposit Insurance Premiums
--------------------------
The Savings Bank recorded an expense in 1997 for the one-time special
assessment levied by the omnibus appropriation bill to recapitalize the Savings
Association Insurance Fund (SAIF). The special assessment for deposit insurance
premiums of approximately $137,000 has been reflected in income for the year
ending June 30, 1997, with an after tax impact on net income of approximately
$87,000. Effective January 1, 1997, the Savings Bank began paying reduced
premium assessments in accordance with the new SAIF assessment schedule.
14. Stockholders' Equity
--------------------
Bancorp was incorporated under North Carolina law in February 1996 to acquire
and hold all the outstanding common stock of the Savings Bank, as part of the
Savings Bank's conversion from a North Carolina-chartered mutual savings bank
to a North Carolina-chartered stock savings bank. In connection with the
conversion which was consummated on July 12, 1996, Bancorp issued and sold
979,897 shares of common stock at a price of $10.00 per share for total net
proceeds of approximately $9.2 million after conversion expenses of
approximately $585,000. Bancorp retained one-half of the net proceeds and used
the remaining net proceeds to purchase the newly issued capital stock of the
Savings Bank. The net conversion proceeds of approximately $9.2 million and
over-subscription proceeds of approximately $523,000 were held in withdrawable
accounts at the Savings Bank at June 30, 1996. Since, the conversion was
essentially consummated prior June 30, 1996, the conversion was accounted for
as being effective as of June 30, 1996, with the net conversion offering
proceeds of approximately $9.2 million shown on the statements of stockholders'
equity as proceeds from the sale of common stock and stock oversubscription
proceeds of approximately $523,000 recorded as a liability. The
oversubscription proceeds were refunded, with accrued interest, by July 12,
1996.
The Savings Bank may not declare or pay a cash dividend if the effect thereof
would cause its net worth to be reduced below either the amounts required for
the liquidation account discussed below or the regulatory capital requirements
imposed by federal and state regulations.
At the time of conversion, the Savings Bank established a liquidation account
in an amount equal to its retained earnings as reflected in the latest
consolidated balance sheet used in the final conversion prospectus. The
liquidation account will be maintained for the benefit of eligible account
holders who continue to maintain their deposit accounts in the Savings Bank
after conversion. In the event of a complete liquidation of the Savings Bank
(and only in such an event), eligible depositors who continue to maintain
accounts shall be entitled to receive a distribution from the liquidation
account before any liquidation may be made with respect to common stock.
-31-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
In January 1997, the stockholders ratified the approval of the 1996 stock
option plan and the 1996 management recognition and development plan (MRP) to
become effective in July 1997. The options and MRP shares, when granted under
these plans, will be included in the computation of earnings per share and thus
dilute the interest of existing stockholders.
15. Employee Stock Ownership Plan
-----------------------------
As part of the conversion discussed in Note 14, an Employee Stock Ownership
Plan (ESOP) was established and the ESOP borrowed approximately $784,000 from
Bancorp to purchase 78,391 shares of common stock issued by Bancorp. The loan
will be repaid principally from the Savings Bank's discretionary contributions
to the ESOP over a period of 15 years. On June 30, 1997, the loan had an
outstanding balance of approximately $740,000 and an interest rate of 8.25%.
The unearned compensation for unallocated shares is recorded as a reduction of
the Company's stockholders' equity. Contributions to the ESOP and shares
released from the suspense account are allocated to the participants on the
basis of compensation in the year of allocation. Benefits become fully vested
at the end of seven years of service. Since Savings Bank's annual contributions
are discretionary, benefits payable under the ESOP cannot be estimated.
Compensation expense is recognized to the extent of the fair value of shares
committed to be released. No shares were release in 1996 and therefore no
expense recognized. In 1997, compensation expense of approximately $73,000 was
recorded for the release of 5,226 shares. At June 30, 1997, there remains
73,165 shares in suspense.
16. Financial Instruments
---------------------
The approximate stated and estimated fair value of certain financial
instruments are summarized below:
1996 1997
----------------------- ------------------------
Stated Estimated Stated Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Loans receivable, $ 23,568 $ 23,860 $ 28,203 $ 27,950
net ========= ========= ========= =========
Financial liabilities:
Deposits:
Demand deposits $ 3,765 $ 3,765 $ 3,560 $ 3,560
Certificates of
deposit 16,581 16,761 14,112 14,130
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments" (SFAS 107), requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. The
following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
-32-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
Fair value approximates book value for the following financial instruments due
to the short-term nature of the instruments: Cash, interest earning deposits,
accrued interest receivable, accrued expenses and stock oversubscriptions.
Fair values for loans held for investment are estimated by segregating the
portfolio by type of loan and discounting scheduled cash flows using interest
rates currently being offered for loans with similar terms, reduced by an
estimate of credit losses inherent in the portfolio. A prepayment assumption is
used as an estimate of the portion of loans that will be repaid prior to their
scheduled maturity.
Fair values for demand deposits with no fixed maturity date is equal to the
carrying value. The fair value of certificates of deposit are estimated by
discounting the amounts payable at the certificate rates using the rates
currently offered for deposits of similar remaining maturities.
Fair value estimates are made at a specific point of time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from
offering for sale the Company's entire holdings of a particular financial
instrument. Because no active market exists for a significant portion of the
Company's financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions, current
interest rates and prepayment trends, 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 any of these assumptions used in
calculating fair value also would affect significantly the estimates. Further,
the fair value estimates were calculated as of June 30, 1996 and 1997. Changes
in market interest rates and prepayment assumptions could change significantly
the estimated fair value.
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. For example, the Company has significant assets and
liabilities that are not considered financial assets or liabilities including
deposit franchise value, loan servicing portfolio, real estate, deferred tax
assets, and premises and equipment. In addition, the tax ramifications related
to the realization of the unrealized gains and losses can have a significant
effect on fair value estimates and have not been considered in any of these
estimates.
17. Parent Company Financial Information
------------------------------------
Condensed financial information at and as of June 30, 1996 and 1997, for
Mitchell Bancorp, Inc. is presented and should be read in conjunction with the
consolidated financial statements and the notes thereto:
-33-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
June 30, June 30,
STATEMENTS OF FINANCIAL CONDITION 1996 1997
---- ----
Assets
------
Cash and cash equivalents $ 4,693 $ 1,965
Equity investment in net assets of 10,027 10,607
savings bank
Loans receivable 784 1,740
Prepaid expenses and other assets - 20
---------- ----------
Total assets $ 15,504 $ 14,332
========== ==========
Liabilities and Stockholders' Equity
------------------------------------
Stock oversubscriptions $ 523 $ -
Accrued conversion cost 347 7
---------- ----------
Total liabilities 870 7
---------- ----------
Stockholders' equity 14,634 14,325
---------- ----------
Total liabilities and stockholders' $ 15,504 $ 14,332
equity ========== ==========
For the
Period Ended
June 30,
Statement of Income 1997
----
Interest income $ 228
Non-interest expenses (109)
Income taxes (42)
Equity in undistributed income of savings bank 394
----------
Net income $ 471
==========
There was no income or expense for the period ending June 30, 1996. No
dividends have been paid from the Savings Bank to the parent for the periods
ending June 30, 1996 and 1997.
-34-
<PAGE>
<PAGE>
MITCHELL BANCORP, INC.
AND SUBSIDIARY Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------
For the Period Ending
STATEMENTS OF CASH FLOWS June 30,
---------------------------
1996 1997
---- ----
Operating activities:
Net income $ - $ 471
Equity earnings of Savings Bank - (394)
Other, net - (15)
---------- ----------
- 62
---------- ----------
Investing activities:
Loan to savings bank - (1,000)
Repayments on loans receivable - 44
Investment in savings bank (4,607) -
---------- ----------
Net cash used by investing activities (4,607) (956)
---------- ----------
Financing activities:
Proceeds from sale of common stock 8,430 -
Repurchase of common stock - (784)
Dividends paid - (180)
Proceeds from stock oversubscription 523 (523)
Accrued conversion cost 347 (347)
---------- ----------
Net cash provided by financing 9,300 (1,834)
activities ---------- ----------
Net increase in cash and cash 4,693 (2,728)
equivalents
Cash and cash equivalents at beginning of - 4,693
period ---------- ----------
Cash and cash equivalents at end of period $ 4,693 $ 1,965
========== ==========
-35-
<PAGE>
<PAGE>
COMMON STOCK INFORMATION
The common stock of Mitchell Bancorp is traded in the over-the counter
market as reported on The Nasdaq Smallcap Market under the symbol "MBSP." As
of September 2, 1997, there were approximately 311 shareholders of record.
Declarations or payments of dividends will be subject to determination by
the Corporation's Board of Directors, which will take into account the
Corporation's financial condition, results of operations, tax considerations,
capital requirements, industry standards, economic conditions and other
factors, including the regulatory restrictions which affect the payment of
dividends by the Savings Bank to the Corporation. Under current North Carolina
regulations, the Corporation could not declare or pay a cash dividend if the
effect thereof would be to reduce its net worth to an amount which is less than
the minimum required by the FDIC and the Administrator. In addition, for a
period of five years after the consummation of the Conversion, the Corporation
will be required, under existing regulations, to obtain the 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. No assurances can be
given that dividends will continue.
The stock prices shown below reflect the initial public offering ("IPO")
price and the high and low prices by quarter as reported by The Nasdaq Stock
Market from July 12, 1996, the initial offering date, through the year ended
June 30, 1997.
Cash
Market Price Dividends Paid
--------------
High Low Per Share
---- --- --------------
IPO. . . . . . . . . $10.00 $10.00 $ --
September 30, 1996 . 12.75 10.125 --
December 31, 1996. . 14.25 12.125 --
March 31, 1997 . . . 16.00 13.75 .20
June 30, 1997. . . . 16.75 15.25 --
-36-
<PAGE>
<PAGE>
DIRECTORS AND OFFICERS
MITCHELL BANCORP, INC. MITCHELL SAVINGS BANK, INC., SSB
Calvin F. Hall Calvin F. Hall
President and Director of the Company. President of the Savings Bank.
President and an agent of Fortner President and an agent of
Insurance Agency, Inc. Fortner Insurance Agency, Inc.
Edward Ballew, Jr. Edward Ballew, Jr.
Executive Vice President, Chief Executive Executive Vice President, Chief
Officer and Director. Executive Officer and Director.
Emma Lee M. Wilson Emma Lee M. Wilson
Assistant Managing Officer, Secretary, Assistant Managing Officer,
Treasurer and Director. Secretary, Treasurer and
Director.
Baxter D. Johnson Baxter D. Johnson
Owner of Johnson Electric in Spruce Pine, Owner of Johnson Electric in
North Carolina. Spruce Pine, North Carolina.
Lloyd Hise, Jr. Lloyd Hise, Jr.
Practicing attorney in Spruce Pine, North Practicing attorney in Spruce
Carolina. Pine, North Carolina.
Michael B. Thomas Michael B. Thomas
Salesman for Buck Stove, Inc., Spruce Pine, Salesman for Buck Stove, Inc.,
North Carolina Spruce Pine, North Carolina
CORPORATE INFORMATION
Corporate Headquarters Transfer Agent
210 Oak Avenue Registrar and Transfer Co.
Spruce Pine, North Carolina 28777 10 Commerce Drive
Cranford, New Jersey 07016
Independent Auditors Common Stock
Crisp, Hughes & Co., LLP Traded Over-the-Counter/
Asheville, North Carolina Nasdaq Smallcap Market
Nasdaq Symbol: MBSP
Special Counsel 10-KSB Information
Breyer & Aguggia A copy of the Form 10-KSB will
Washington, D.C. be furnished without charge to
shareholders of record upon
written request to the
Secretary, Mitchell Bancorp,
Inc., 210 Oak Avenue, Spruce
Pine, North Carolina 28777.
ANNUAL MEETING
The Annual Meeting of Shareholders will be held October 22, 1997, at 2:00
p.m., local time, at the main office of Mitchell Savings Bank, Inc., SSB
located at 210 Oak Street, Spruce Pine, North Carolina.
-37-
PAGE
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
Percentage Jurisdiction or
Subsidiaries (1) Owned State of Incorporation
- ---------------- ---------- ----------------------
Mitchell Savings Bank, Inc., SSB 100% North Carolina
Mitchell Mortgage and Investment
Co., Inc. (2) 100% North Carolina
- ---------------------
(1) The operations of the Corporation's subsidiaries are included in the
Corporation's consolidated financial statements.
(2) Wholly-owned subsidiary of Mitchell Savings Bank, Inc., SSB.
<PAGE>
<PAGE>
EXHIBIT 23
Consent of Independent Auditors<PAGE>
CRISP
CH
HUGHES
---- & CO., L.L.P. ----
CERTIFIED PUBLIC ACCOUNTANTS AND CONSULTANTS
CONSENT OF INDEPENDENT AUDITORS
We have issued our report dated August 7, 1997, accompanying the
Consolidated Financial Statements included in the Annual Report of Mitchell
Bancorp, Inc. on Form 10-KSB for the year ending June 30, 1997. We hereby
consent to the incorporation by reference of said reports in the Registration
Statement of Mitchell Bancorp, Inc. on Form S-8 (File No. 333-31253, effective
July 14, 1997).
/s/Crisp Hughes & Co., L.L.P.
CRISP HUGHES & CO., L.L.P.
Asheville, North Carolina
September 23, 1997
32 Orange Street - P.O. Box 3049 - Asheville, North Carolina 28802 -
(704) 254-2254 - FAX (704) 254-6859
Other Offices: Boone, Burnsville, Sylvia, NC and Greenville, SC
Member of The American Institute of Certified Public Accountants, The
Continental Association of CPA Firms, Inc. The Intercontinental Accounting
Associates and The North Carolina and South Carolina Associates of CPAs
<PAGE>
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