<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended September 30, 1997
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Commission file number 0-21083
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SOUTH STREET FINANCIAL CORP.
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(Exact name of registrant as specified in its charter)
North Carolina 56-1973261
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
155 West South Street
Albemarle, North Carolina 28001
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (704) 982-9184
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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, no par value
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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 if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing.
$75,232,433 common stock, no par value, based on the closing price of such
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common stock on December 9, 1997.
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Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 4,676,360 shares of common
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stock, no par value, outstanding at December 9, 1997.
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<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report of South Street Financial Corp. for the year ended
September 30, 1997, are incorporated by reference into Part I, Part II and
Part IV.
Portions of the Proxy Statement for the 1998 Annual Meeting of Shareholders of
South Street Financial Corp. to be held on February 9, 1998, are incorporated by
reference into Part III.
2
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PART I
ITEM 1. BUSINESS
General
Prior to October 2, 1996, Home Savings Bank of Albemarle, Inc., S.S.B.
(the "Bank") operated as a mutual North Carolina-chartered savings bank. On
October 2, 1996, the Bank converted from a North Carolina-chartered mutual
savings bank to a North Carolina-chartered stock savings bank (the
"Conversion"). In connection with the Conversion, all of the issued and
outstanding capital stock of the Bank was acquired by South Street Financial
Corp., a North Carolina corporation (the "Company") which was organized to
become the holding company for the Bank. At that time, the Company had an
initial public offering of its common stock, no par value (the "Common Stock").
The Company is a bank holding company registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve") under the Bank
Holding Company Act of 1956, as amended (the "BHCA") and the savings bank
holding company laws of North Carolina. The Company's office is located at 155
West South Street, Albemarle, North Carolina. The Company's activities consist
of investing the proceeds of its initial public offering which were retained at
the holding company level, holding the indebtedness outstanding from the Home
Savings Bank of Albemarle, Inc., SSB Employee Stock Ownership Plan (the "ESOP")
and owning the Bank. The Company's principal sources of income are earnings on
its investments and interest payments received from the ESOP with respect to the
ESOP loan. In addition, the Company will receive any dividends which are
declared and paid by the Bank on its capital stock.
The Bank was originally chartered in 1911. It has been a member of
the Federal Home Loan Bank ("FHLB") system since 1954 and its deposits are
federally insured up to allowable limits.
The Bank is engaged primarily in the business of attracting retail
deposits from the general public and using such deposits to make mortgage loans
secured by real estate. The Bank makes mortgage loans secured by residential
real property, including one-to-four family residential real estate loans, home
equity line of credit loans and other subordinate lien loans, loans secured by
improved nonresidential real property, loans secured by undeveloped real
property and construction loans. The Bank also makes a limited number of loans
which are not secured by real property, such as loans secured by savings
accounts. The Bank's primary source of revenue is interest income from its
lending activities. The Bank's other major sources of revenue are interest and
dividend income from investments and mortgage-backed securities, interest income
from its interest-bearing deposit balances in other depository institutions and
fee income from its lending and deposit activities. The major expenses of the
Bank are interest on deposits and noninterest expenses such as compensation and
fringe benefits, federal deposit insurance premiums, data processing expenses
and branch occupancy and related expenses.
The operations of the Bank and depository institutions in general are
significantly influenced by general economic conditions and by related monetary
and fiscal policies of depository institution regulatory agencies, including the
Federal Reserve, the Federal Deposit Insurance Corporation (the "FDIC") and the
North Carolina Administrator, Savings Institutions Division, North Carolina
Department of Commerce (the "Administrator"). Deposit flows and cost of funds
are influenced by interest rates on competing investments and general market
rates of interest. Lending activities are affected by the demand for financing
of real estate and other types of loans, which in turn are affected by the
interest rates at which such financing may be offered and other factors
affecting local demand and availability of funds.
At September 30, 1997, the Company had total assets of $241.1 million,
net loans of $112.0 million, deposits of $141.8 million, investment securities
of $123.0 million and stockholders' equity of $61.7 million.
At September 30, 1997, the Company and the Bank had a total of 38
employees, all of whom are full-time.
3
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The Company has no operations and conducts no business of its own
other than owning the Bank, investing its portion of the net proceeds received
in the Conversion and lending funds to the ESOP. Accordingly, the discussion of
the business which follows in the Form 10-K concerns the business conducted by
the Bank, unless otherwise indicated.
Market Area
The Bank's primary market area is Stanly County, North Carolina. The
Bank's principal office is in Albemarle, North Carolina and it has one full-
service branch in Locust, North Carolina. Stanly County is located in south
central North Carolina; Albemarle is approximately 30 miles from Charlotte,
North Carolina.
The Bank's loans and deposits are primarily generated from the areas
where its offices are located. It does not solicit deposits and loans outside
its primary market area and does not use brokers to obtain deposits.
Approximately 87% of the Bank's deposits are at the Albemarle office. Stanly
County is largely rural with a population of 56,000. Its economy is diversified
among manufacturing, trade and services. Major area employers include
Wiscassett Mills Company, Collins and Aikman Corporation, Michelin Aircraft Tire
Company and Alcoa Aluminum Company. Within the past five years several large
manufacturing companies have closed operations in Stanly County, resulting in
the loss of approximately 2,000 jobs. Over the past five years the local
economy has weakened as a result of layoffs and plant closings by local
employers. The North Carolina Department of Commerce has declared Stanly a
"distressed county" entitling it to use state grants and tax credits to lure
industry to the area. Population and household growth, and median and per
capita income levels for Stanly County are generally lower than comparable
levels for North Carolina and the nation, while unemployment levels are
generally higher. Management regards the Stanly County market area as a low
growth area in which there is significant competition among financial services
providers for market share. Management believes that opportunities for future
earnings growth in the Bank's primary market area are limited in light of these
factors.
Lending Activities
General. The Bank's primary source of revenue is interest and fee
income from its lending activities, consisting primarily of mortgage loans for
the purchase or refinancing of one-to-four family residential real property
located in its primary market area. The Bank also makes loans secured by
improved nonresidential real estate, construction loans, loans secured by
undeveloped real estate and savings account loans. Approximately 99% of the
Bank's net loan portfolio is secured by real estate. As of September 30, 1997,
all of the loans in the Bank's real estate loan portfolio were secured by
properties in North Carolina. On September 30, 1997, the Bank's largest single
outstanding loan had a balance of approximately $1.1 million. This loan was
performing in accordance with its original terms. In addition to interest
earned on loans, the Bank receives fees in connection with loan originations,
loan servicing, loan modifications, late payments, loan assumptions and other
miscellaneous services.
Loan Portfolio Composition. The Bank's net loan portfolio totaled
approximately $112.0 million at September 30, 1997 representing 46.5% of the
Bank's total assets at such date. At September 30, 1997, 85.7% of the Bank's
net loan portfolio was composed of one-to-four family residential mortgage
loans. Home equity loans, all of which have adjustable rates, represented 3.0%
of the Bank's net loan portfolio, and nonresidential real estate loans
represented 3.4% of the Bank's net loan portfolio on such date.
The Bank no longer originates adjustable rate mortgage loans,
excluding home equity loans, but continues to hold a small number of adjustable
rate loans in its portfolio. As of September 30, 1997, 3.2% of the loans in the
Bank's loan portfolio, excluding home equity loans, had adjustable interest
rates.
The following table sets forth the composition of the Bank's loan
portfolio by type of loan at the dates indicated.
4
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<TABLE>
<CAPTION>
At September 30,
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1997 1996 1995 1994 1993
----------------- ----------------- ----------------- ----------------- -------------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential
1-4 family $ 95,984 85.71% $ 93,275 84.90% $ 94,036 86.60% $ 91,674 85.80% $100,437 85.80%
Residential
multi-family 555 0.50% 695 0.63% 840 0.77% 870 0.81% 731 0.62%
Nonresidential
real estate 3,774 3.37% 4,038 3.67% 3,013 2.77% 3,157 2.95% 3,655 3.12%
Residential
construction 8,394 7.50% 4,720 4.30% 5,368 4.94% 6,015 5.63% 6,644 5.68%
Land 6,091 5.44% 6,304 5.74% 4,890 4.50% 4,998 4.68% 4,960 4.24%
Line of credit 3,328 2.96% 3,786 3.45% 3,875 3.58% 4,056 3.81% 3,715 3.17%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate
loans: 118,126 105.48% 112,818 102.69% 112,022 103.16% 110,770 103.68% 120,142 102.63%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Consumer loans:
Share 488 0.44% 196 0.18% 110 0.10% 105 0.10% 290 0.25%
Credit reserve 96 0.08% 470 0.43% 221 0.20% 176 0.16% 102 0.09%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total consumer
loans 584 0.52% 666 0.61% 331 0.30% 281 0.26% 392 0.34%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Less:
Unearned fees
and discounts 636 0.57% 582 0.53% 519 0.48% 465 0.44% 440 0.38%
Loans in process 5,655 5.05% 2,616 2.38% 3,100 2.85% 3,602 3.37% 2,895 2.47%
Allowance for
loan losses 429 0.38% 428 0.39% 137 0.13% 140 0.13% 144 0.12%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total reductions 6,720 6.00% 3,626 3.30% 3,756 3.46% 4,207 3.94% 3,479 2.97%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans
receivable, net $111,990 100.00% $109,858 100.00% $108,597 100.00% $106,844 100.00% $117,055 100.00%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
</TABLE>
The following table sets forth the time to contractual maturity of the
Bank's loan portfolio at September 30, 1997. Loans which have adjustable rates
are shown as being due in the period during which rates are next subject to
change while fixed rate and other loans are shown as due over the contractual
maturity. Demand loans, loans having no stated maturity and overdrafts are
reported as due in one year or less. The table does not include prepayments,
however, it does include scheduled principal repayments. Prepayments and
scheduled repayments in the loan portfolio totaled $24.8 million, $20.2 million,
and $16.2 million in fiscal years ended September 30, 1997, 1996 and 1995,
respectively. Amounts in the table are net of loans in process and are net of
unamortized loan fees.
5
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<TABLE>
<CAPTION>
At September 30, 1997
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Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or Less 3 Years 5 Years 10 Years Years Total
--------- --------- --------- --------- --------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Adjustable rate 1-4 family
residential $ 6,441 $ - $ - $ - $ - $ 6,441
Fixed rate 1-4 family
residential 2,063 468 1,379 57,609 35,863 97,382
Other adjustable rate
real estate loans 427 - - - - 427
Other fixed rate real
estate loans 630 41 227 6,270 417 7,585
Other loans 234 350 - - - 584
Less:
Allowance for loan losses (429) - - - - (429)
--------- --------- --------- --------- --------- ---------
$ 9,366 $ 859 $ 1,606 $ 63,879 $ 36,280 $ 111,990
========= ========= ========= ========= ========= =========
</TABLE>
The following table sets forth the dollar amount at September 30, 1997
of all loans maturing or repricing on or after September 30, 1998 which have
fixed or adjustable interest rates.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
----------- ----------
(In Thousands)
<S> <C> <C>
Mortgage loans $ 102,274 $ -
Other loans
350 -
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$ 102,624 $ -
=========== ==========
</TABLE>
Origination of Loans. Historically, the Bank has not originated its
one-to-four family residential mortgage or other loans with the intention that
they will be sold in the secondary market. Accordingly, the Bank originates
fixed rate one-to-four family residential real estate loans which satisfy the
Bank's underwriting requirements and are tailored to its local community, but do
not necessarily satisfy various technical FHLMC and FNMA underwriting
requirements and purchase requirements not related to documentation.
Although the Bank believes that many of its nonconforming loans are
saleable in the secondary market, some of such nonconforming loans could be sold
only after the Bank incurred certain costs and/or discounted the purchase price.
As a result, the Bank's loan portfolio is less liquid than would be the case if
it was composed entirely of loans originated in conformity with secondary market
requirements. In addition, certain types of nonconforming loans are generally
thought to have greater risks of default and nonperformance. However, such loans
generally produce a higher yield than would be produced by conforming loans, and
the Bank has historically found that its origination of such loans
6
<PAGE>
has not resulted in a high level of nonperforming assets. These nonconforming
loans satisfy a need in the Bank's local community, and the Bank intends to
continue to originate nonconforming loans.
Substantially all of the one-to-four family residential mortgage loans
originated by the Bank have a fixed rate of interest because there is very
little demand for adjustable rate loans in the Bank's market area. As a result,
the Bank offers 30-year fixed rate residential real estate loans but prices its
loans to encourage shorter terms of 10 to 15 years.
The Bank has instituted a new marketing program in which all of the
Bank's loan officers visit local realtors to promote the Bank's residential
mortgage products.
The table below sets forth the Bank's loan origination, purchase
activity and loan portfolio repayment experience during the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------
1997 1996 1995
--------- --------- ---------
(In Thousands)
<S> <C> <C> <C>
Loans receivable, net,
beginning of period $ 109,858 $ 108,597 $ 106,844
--------- --------- ---------
Loan originations:
Residential 1-4 family 17,998 13,773 10,190
Residential multifamily -- -- 58
Nonresidential real estate 524 -- 333
Residential construction 9,898 5,704 6,282
Line of credit 1,248 747 626
Consumer 321 1,141 454
--------- --------- ---------
Total loan originations 29,989 21,365 17,943
Principal repayments (24,763) (20,234) (16,192)
Other changes, net (1) (3,094) 130 2
--------- --------- ---------
Increase in loans receivable 2,132 1,261 1,753
--------- --------- ---------
Loans receivable, net, end of period $ 111,990 $ 109,858 $ 108,597
========= ========= =========
</TABLE>
- --------------------
(1) Includes changes in deferred loan fees, allowance for loan losses and
undisbursed portion of construction loans.
Residential Real Estate Lending. The Bank's primary lending activity,
which it intends to continue to emphasize, is the origination of fixed-rate
mortgage loans to enable borrowers to purchase or refinance one-to-four family
residential real property. Consistent with the Bank's emphasis on being a
community-oriented financial institution, it is and has been the Bank's strategy
to focus its lending efforts in Stanly County, North Carolina and in contiguous
counties. On September 30, 1997, approximately 85.7% of the Bank's total net
real estate loan portfolio consisted of one-to-four family residential real
estate loans. These include both loans secured by detached single-family
residences and condominiums and loans secured by housing containing not more
than four separate dwelling units. Of such loans, excluding home equity loans,
2.8% had adjustable interest rates.
7
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The Bank also originates fixed-rate mortgage loans secured by owner
occupied property having terms generally ranging from 10 to 30 years in amounts
of up to 90% of the lesser of the value or purchase price. Private mortgage
insurance is always required if the loan amount exceeds 80% of the value of the
property. In addition, the Bank makes fixed-rate loans secured by non-owner
occupied residential real estate generally having terms of 15 to 20 years in
amounts of up to 80% of the value of the property. Substantially all of the
fixed-rate loans in the Bank's mortgage loan portfolio have due on sale
provisions allowing the Bank to declare the unpaid balance due and payable in
full upon the sale or transfer of an interest in the property securing the loan.
While one-to-four family residential loans are normally originated for
10 to 30 year terms, such loans customarily remain outstanding for substantially
shorter periods because borrowers often prepay their loans in full upon sale of
the property pledged as security or upon refinancing the original loan. Thus,
average loan maturity is a function of, among other factors, the level of
purchase and sale activity in the real estate market, prevailing interest rates,
and the interest rates payable on outstanding loans. The thrift and mortgage
banking industries have generally used 12-year and 7-year average loan lives in
calculations calling for prepayment assumptions for 30-year residential loans
and 15-year residential loans, respectively. Management believes that the Bank's
recent loan prepayment experience has been shorter than these assumed average
loan lives due to recent periods of low interest rates and resulting high levels
of refinancing.
The Bank requires title insurance for its one-to-four family
residential loans. The Bank also requires that fire and extended coverage
casualty insurance (and, if appropriate, flood insurance) be maintained in an
amount at least equal to the loan amount or replacement cost of the improvements
on the property securing the loans, whichever is greater.
Residential Multifamily. At September 30, 1997, the Bank had
approximately $555,000 in outstanding loans secured by multifamily residential
real estate, comprising approximately .50% of its loan portfolio as of that
date. Substantially all of the Bank's loans secured by multifamily residential
real estate have fixed rates. Such loans are typically made to a maximum of 80%
of the lesser of the purchase price or appraised value of the property for a
maximum term of 20 years. All such loans are personally guaranteed by
individuals.
Nonresidential Real Estate Lending. On September 30, 1997, the Bank had
$3.8 million in outstanding loans secured by nonresidential real estate,
including undeveloped land, comprising approximately 3.4% of its net loan
portfolio as of that date. Most of these loans are secured by office, retail,
other commercial real estate, as well as church properties. Loans secured by
undeveloped land generally do not exceed 65% of the appraised value of the real
estate securing the loans; loans secured by commercial real estate generally do
not exceed 80% of the appraised value of the real estate securing the loans.
Loans secured by commercial real estate and undeveloped land generally are
larger than one-to-four family residential loans and involve a greater degree of
risk. Payments on these loans depend to a large degree on results of operations
and management of the properties and may be affected to a greater extent by
adverse conditions in the real estate market or the economy in general. As of
September 30, 1997, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $1.1 million. This loan was performing in accordance with
the original loan contract.
Home Equity Lines of Credit. At September 30, 1997, the Bank had
approximately $3.3 million in home equity line of credit loans, representing
approximately 3.0% of its net loan portfolio. These loans are often originated
at the time of the closing of a one-to-four family residential real estate loan
secured by the same property. The Bank's home equity lines of credit have
adjustable interest rates tied to prime interest rates plus a margin. The home
equity lines of credit require monthly payments until the loan is paid in full.
Home equity lines of credit are generally secured by subordinate liens against
residential real property. The Bank requires that fire and extended coverage
casualty insurance (and, if appropriate, flood insurance) be maintained in an
amount at least sufficient to cover its loan. Home equity loans are generally
limited so that the amount of such loans, along with any senior indebtedness,
does not exceed 80% of the value of the real estate security. Because home
equity loans involve revolving lines of credit which can be drawn over a period
of time, the Bank faces risks associated with changes in the borrower's
financial condition. Because home equity loans have adjustable interest rates
with no rate caps (other than usury limitations), increased delinquencies could
occur if interest rate increases occur and borrowers are unable to satisfy
higher payment requirements. The Bank
8
<PAGE>
intends to continue to emphasize its home equity program. The presence of home
equity loans in the Bank's portfolio allows the institution to manage the
interest sensitivity of its assets and liabilities because home equity lines of
credit have adjustable rates which are subject to change monthly and without any
significant rate caps.
Construction Lending. The Bank makes construction loans primarily for
the construction of single-family dwellings. The aggregate outstanding balance
of such loans on September 30, 1997 was approximately $8.4 million, representing
approximately 7.5% of the Bank's net loan portfolio. Most of these loans were
made to persons who are constructing properties for the purpose of occupying
them. Loans made to individual property owners are "construction-permanent"
loans which generally provide for the payment of interest only during a
construction period, after which the loans convert to a permanent loan at fixed
rates having terms similar to other one-to-four family residential loans.
Construction loans to persons who intend to occupy the finished premises
generally have a maximum loan-to-value ratio of 90%.
Construction loans are generally considered to involve a higher degree
of risk than long-term financing secured by real estate which is already
occupied. A lender's risk of loss on a construction loan is dependent largely
upon the accuracy of the initial estimate of the property's value at the
completion of construction and the estimated cost (including interest) of
construction. If the estimate of construction costs proves to be inaccurate, the
lender may be required to advance funds beyond the amount originally committed
in order to permit completion of construction. If the estimate of anticipated
value proves to be inaccurate, the lender may have security which has value
insufficient to assure full repayment.
Consumer Loans. In addition to the loans described above, the Bank
provides overdraft lines of credit in amounts of up to $2,000. Payments are
required in amounts of 5% of the outstanding balance or $10, whichever is
greater. In addition, the Bank offers loans secured by savings accounts. As of
September 30, 1997, the Bank had approximately $584,000 of such loans
outstanding, representing approximately .5% of its net loan portfolio.
Loan Solicitation, Processing and Underwriting. Loan originations are
derived from a number of sources such as referrals from real estate brokers,
present depositors and borrowers, builders, attorneys, walk-in customers and in
some instances, other lenders.
During its loan approval process, the Bank assesses the applicant's
ability to make principal and interest payments on the loan and the value of the
property securing the loan. The Bank obtains detailed written loan applications
to determine the borrower's ability to repay and verifies responses on the loan
application through the use of credit reports, financial statements, and other
confirmations. Under current practice, the loan officer of the Bank analyzes the
loan application and the property involved, and an appraiser inspects and
appraises the property. The Bank requires independent fee appraisals on all
loans originated primarily on the basis of real estate collateral. The Bank also
obtains information concerning the income, financial condition, employment and
the credit history of the applicant.
Mortgage loans of up to $300,000 are approved by the Bank's loan
committee which is composed of its President, Executive Vice President and one
other member of the Board of Directors. All loans in excess of $300,000 must be
approved by the entire Board of Directors.
Normally, upon approval of a residential mortgage loan application, the
Bank gives a commitment to the applicant that it will make the approved loan at
a stipulated rate any time within a 30-day period. The loan is typically funded
at such rate of interest and on other terms which are based on market conditions
existing as of the date of the commitment. As of September 30, 1997, the Bank
had $7.1 million in such unfunded mortgage loan commitments. In addition, on
such date the Bank had $2.8 million in unfunded commitments for unused lines of
credit and letters of credit.
Interest Rates, Terms, Points and Fees. Interest rates and fees charged
on the Bank's loans are affected primarily by the market demand for loans,
competition, the supply of money available for lending purposes and the Bank's
cost of funds. These factors are affected by, among other things, general
economic conditions and the policies of the federal government, including the
Federal Reserve, tax policies and governmental budgetary matters.
9
<PAGE>
In addition to earning interest on loans, the Bank receives fees in
connection with originating loans. Fees for loan servicing, loan modifications,
late payments, loan assumptions and other miscellaneous services in connection
with loans are also charged by the Bank.
Nonperforming Assets and Asset Classification. When a borrower fails to
make a required payment on a loan and does not cure the delinquency promptly,
the loan is classified as delinquent. Delinquencies on all loans are reviewed
monthly by the Board of Directors. The normal procedure followed by the Bank
once a loan is classified as delinquent is to make contact with the borrower at
prescribed intervals in an effort to bring the loan to a current status, and
late charges are assessed as allowed by law. In most cases, delinquencies are
cured promptly. If a delinquency is not cured, the Bank normally, subject to any
required prior notice to the borrower, commences foreclosure proceedings. If the
loan is not reinstated within the time permitted for reinstatement, or the
property is not redeemed prior to sale, the property may be sold at a
foreclosure sale. In foreclosure sales, the Bank may acquire title to the
property through foreclosure, in which case the property so acquired is offered
for sale and may be financed by a loan involving terms more favorable to the
borrower than those normally offered. Any property acquired as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until such time as it is sold or otherwise disposed of by the Bank to recover
its investment. As of September 30, 1997, the Bank had two pieces of
single-family property classified as real estate owned. These properties were
recorded on the Bank's books at $18,000, the unpaid principal balance of loans
secured by such property. The appraised value of these properties exceeded their
unpaid principal balances. Real estate acquired through, or in lieu of, loan
foreclosure is initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. After foreclosure, valuations are periodically
performed by management, and the real estate is carried at the lower of cost or
fair value minus costs to sell. Revenue and expenses from holding the properties
and additions to the valuation allowance are included in operations.
The Bank continues to accrue interest on loans delinquent 90 days or
more. However, these loans are effectively placed on nonaccrual status as all
such interest income is reversed by the establishment of a reserve for
uncollected interest. Loans are returned to earning status when management
determines, based upon an evaluation of the underlying collateral, together with
the borrower's payment record and financial condition, that the borrower has the
capability and intent to meet the contractual obligations of the loan agreement.
Interest on loans placed on nonperforming status is charged off when management
determines it is not collectible. The allowance is established by a charge to
interest income equal to all interest previously accrued, and income is
subsequently recognized only to the extent cash payments are received until the
loan is returned to performing status. For the fiscal year ended September 30,
1997, interest income that would have been recorded net of interest income
actually recognized on nonperforming loans under the original terms of such
loans was $29,000.
The following table sets forth information with respect to
nonperforming assets identified by the Bank, including nonperforming loans and
real estate owned at the dates indicated.
10
<PAGE>
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Total nonaccrual loans
Mortgage loans delinquent 90 days or more $ 490 $ 631 $ 923 $ 910 $ 762
Consumer loans delinquent 90 days or more 20 23 58 36 82
Real estate owned 18 18 135 176 119
-------- -------- -------- -------- --------
Total non-performing assets $ 528 $ 672 $ 1,116 $ 1,122 $ 963
======== ======== ======== ======== ========
Non-performing loans to total gross loans 0.43% 0.58% 0.87% 0.85% 0.70%
Non-performing assets to total assets 0.22% 0.31% 0.70% 0.76% 0.61%
Total assets $241,061 $217,954 $159,863 $147,837 $157,909
Total gross loans $118,710 $113,484 $112,353 $111,051 $120,534
</TABLE>
Applicable regulations require the Bank to "classify" its own assets on
a regular basis. In addition, in connection with examinations of savings
institutions, regulatory examiners have authority to identify problem assets
and, if appropriate, classify them. Problem assets are classified as
"substandard,""doubtful" or "loss," depending on the presence of certain
characteristics as discussed below.
An asset is considered "substandard" if not adequately protected by the
current net worth and paying capacity of the obligor or the collateral pledged,
if any. "Substandard" assets include those characterized by the "distinct
possibility" that the insured institution will sustain "some loss" if the
deficiencies are not corrected. Assets classified as "doubtful" have all of the
weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable". Assets classified "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a loss reserve is not warranted.
As of September 30, 1997, the Bank had approximately $975,000 of loans
internally classified as "substandard", and no loans classified as "doubtful" or
"loss". The Bank also identifies assets which possess credit deficiencies or
potential weaknesses deserving close attention by management. These assets may
be considered "special mention" assets and do not yet warrant adverse
classification. At September 30, 1997, the Bank had approximately $1.0 million
of loans in the "special mention" category.
When an insured institution classifies problem assets as either
substandard or doubtful, it is required to establish general allowances for loan
losses in an amount deemed prudent by management. These allowances represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities and the risks associated with particular
problem assets. When an insured institution classifies problem assets as "loss,"
it charges off the balance of the asset. The Bank's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the FDIC and the Administrator which can order the
establishment of additional loss allowances.
11
<PAGE>
The following table sets forth at September 30, 1997, the Bank's
aggregate carrying value of the assets classified as substandard, doubtful, loss
or "special mention":
<TABLE>
<CAPTION>
Special Mention List Substandard Doubtful Loss
-------------------- -------------------- --------------------- ---------------------
Number Amount Number Amount Number Amount Number Amount
------ ------ ------ ------ ------ ------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family 30 $1,004 33 $ 944 -- $ -- -- $ --
Residential real estate -- -- -- -- -- -- -- --
Nonresidential real estate -- -- -- -- -- -- -- --
Residential construction -- -- -- -- -- -- -- --
Land -- -- -- -- -- -- -- --
Line of credit -- -- 3 28 -- -- -- --
---- ----- ---- ----- ---- ------ ---- ----
Total real estate loans 30 1,004 36 972 -- -- -- --
---- ----- ---- ----- ---- ------ ---- ----
Consumer loans:
Share -- -- -- -- -- -- -- --
Credit reserve -- -- 3 3 -- -- -- --
Total consumer loans -- -- 3 3 -- -- -- --
---- ----- ---- ----- ---- ------ ---- ----
Total 30 $1,004 39 $ 975 $ -- $ -- $ -- $ --
==== ===== ==== ===== ==== ====== ==== ====
</TABLE>
Allowance for Loan Losses. In originating loans, the Bank recognizes
that credit losses will be experienced and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan and, in the case of a secured loan, the
quality of the security for the loan as well as general economic conditions. It
is management's policy to maintain an adequate allowance for loan losses based
on, among other things, the Bank's historical loan loss experience, evaluation
of economic conditions and regular reviews of delinquencies and loan portfolio
quality. Specific allowances are provided for individual loans when ultimate
collection is considered in doubt by management after reviewing the current
status of loans which are contractually past due and considering the fair value
of the security for the loans.
Management continues to actively monitor the Bank's asset quality, to
charge off loans against the allowance for loan losses when appropriate and to
provide specific loss reserves when necessary. Although management believes it
uses the best information available to make determinations with respect to the
allowance for loan losses, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations. During the fiscal year ended
September 30, 1997, the Bank maintained its level of allowance for loan losses
which management believes is adequate based on the risks inherent in the loan
portfolio.
12
<PAGE>
The following table describes the activity related to the Bank's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- --------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period $ 428 $ 137 $ 140 $ 144 $ 144
Provision for loan losses - 300 - - -
Charge-offs:
Residential 1-4 family (1) (8) (3) (3) -
Line of credit - (10) - (1) (1)
Recoveries:
Residential 1-4 family 2 6 - - -
Line of credit - 3 - - 1
------ ------ ------ ------ ------
Balance, end of period $ 429 $ 428 $ 137 $ 140 $ 144
====== ====== ====== ====== ======
Net charge-offs (recoveries) as a % of average loans (0.001%) 0.008% 0.003% 0.004% -
outstanding
Allowance at period end as a % of nonperforming loans 84.12% 65.44% 13.97% 14.80% 17.06%
Allowance at period end as a % of nonperforming assets 81.25% 63.69% 12.28% 12.48% 14.95%
Allowance at period end as a % of total gross loans 0.36% 0.38% 0.12% 0.13% 0.12%
</TABLE>
The following table sets forth the composition of the allowance for
loan losses by type of loan at the dates indicated. The allowance is allocated
to specific categories of loans for statistical purposes only, and may be
applied to loan losses incurred in any loan category.
13
<PAGE>
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
Amount of Amount of Amount of
Amount of Loans to Amount of Loans to Amount of Loans to
Allowance Gross Loans Allowance Gross Loans Allowance Gross Loans
--------- ----------- --------- ----------- --------- -----------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $ 262 80.86% $ 243 82.19% $ 125 83.70%
Residential multi-family 1 0.47% 1 0.61% -- 0.75%
Nonresidential real estate 4 3.18% 4 3.56% 3 2.68%
Residential construction -- 7.07% -- 4.16% -- 4.78%
Land 4 5.13% 6 5.56% -- 4.35%
Line of credit 7 2.80% 10 3.34% 8 3.45%
------- ------- ------ ------- ----- -------
Total real estate loans 278 99.51% 264 99.42% 136 99.71%
------- ------- ------ ------- ----- -------
Consumer loans:
Share -- 0.41% -- 0.17% -- 0.10%
Credit reserve -- 0.08% -- 0.41% 1 0.19%
------- ------- ------ ------- ----- -------
Total consumer loans -- 0.49% -- 0.58% 1 0.29%
------- ------- ------ ------- ----- -------
Unallocated 151 -- 164 -- -- --
------- ------- ------ ------- ----- -------
Total allowance for loan losses $ 429 100.00% $ 428 100.00% $ 137 100.00%
======= ======= ====== ======= ===== =======
At September 30,
--------------------------------------------------------
1994 1993
----------------- -----------------
Amount of Amount of
Amount of Loans to Amount of Loans to
Allowance Gross Loans Allowance Gross Loans
--------- ----------- --------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $ 77 82.60% $ 129 83.33%
Residential multi-family -- 0.78% -- 0.61%
Nonresidential real estate 4 2.83% 6 3.03%
Residential construction -- 5.41% -- 5.51%
Land -- 4.50% -- 4.12%
Line of credit -- 3.64% -- 3.08%
------- ------- ------ -------
Total real estate loans 81 99.76% 135 99.68%
------- ------- ------ -------
Consumer loans:
Share -- 0.09% -- 0.08%
Credit reserve -- 0.15% -- 0.24%
------- ------- ------ -------
Total consumer loans -- 0.24% -- 0.32%
------- ------- ------ -------
Unallocated 59 -- 9 --
------- ------- ------ -------
Total allowance for loan losses $ 140 100.00% $ 144 100.00%
======= ======= ====== =======
</TABLE>
<PAGE>
Investment Securities
Interest and dividend income from investment securities generally
provides the second largest source of income to the Bank after interest on
loans. In addition, the Bank receives interest income from deposits in other
financial institutions. On September 30, 1997, the carrying value of the Bank=s
investment securities portfolio totaled approximately $123.0 million and
consisted of interest-bearing deposits, U.S. government and agency securities,
mortgage-backed securities, FHLMC stock, stock in the FHLB of Atlanta and in
Central Service Corporation. The investment securities portfolio includes
interest-bearing deposits of $25.2 million at September 30, 1997. The
mortgage-backed securities consist of mortgage-backed securities issued by the
GNMA, FNMA and FHLMC.
Investments in mortgage-backed securities involve a risk that, because
of changes in the interest rate environment, actual prepayments may be greater
than estimated prepayments over the life of the security, which may require
adjustments to the amortization of any premium or accretion of any discount
relating to such instruments, thereby reducing the net yield on such securities.
There is also reinvestment risk associated with the cash flows from such
securities. In addition, the market value of such securities may be adversely
affected by changes in interest rates.
The FASB has issued Statement of Financial Accounting Standards No. 115
("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities"
which addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values and for all investments in
debt securities. These investments are to be classified in three categories and
accounted for as follows: (1) debt securities that the entity has the positive
intent and ability to hold to maturity are classified as held-to-maturity and
reported at amortized cost; (2) debt and equity securities that are bought and
held principally for the purpose of selling them in the near term are classified
as trading securities and reported at fair value, with net unrealized gains and
losses included in earnings; and (3) debt securities not classified as either
held-to-maturity or trading securities and equity securities not classified as
trading securities are classified as securities available-for-sale and reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of equity. The Bank has no trading securities.
See Notes 3 and 4 of "Notes to Financial Statements".
The amortized cost of securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest income
from investments. Realized gains and losses, and declines in value judged to be
other than temporary are included in net securities gains (losses).
The cost of securities sold is based on the specific identification method.
As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in stock of the FHLB of Atlanta equal to the greater of 1% of the
Bank's outstanding home loans or 5% of its outstanding advances from the FHLB of
Atlanta. No ready market exists for such stock, which is carried at cost.
As of September 30, 1997, the Bank's investment in stock of the FHLB of Atlanta
was $2.3 million.
North Carolina regulations require the Bank to maintain a minimum
amount of liquid assets which may be invested in specified short-term
securities. The Bank is also permitted to make certain other securities
investments. The Bank's current investment policy states that the Bank's
investments will be limited to U.S. Treasury obligations, federal agency
securities, corporate notes and time deposits in the FHLB.
Investment decisions are made by authorized officers of the Bank under
policies established by the Board of Directors. Such investments are managed in
an effort to produce the highest yield consistent with maintaining safety of
principal and compliance with regulations governing the savings industry.
The following table sets forth certain information regarding the Bank's
interest-bearing deposits and the amortized cost and market values of the Bank's
investment and mortgage-backed securities portfolios at the dates indicated.
15
<PAGE>
<TABLE>
<CAPTION>
At September 30,
------------------------------------------------------------------------------------
1997 1996 1995
------------------------ ----------------------- ------------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
---------- --------- ---------- --------- ---------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits(2) $ 25,187 $ 25,187 $ 59,348 $ 59,348 $ 8,622 $ 8,622
--------- --------- --------- --------- ---------
Mortgage-backed securities, held to
maturity 21,661 21,561 5,496 5,511 4,529 4,642
--------- --------- --------- --------- --------- ---------
Investment Securities:
Available for sale:
U.S. Treasury and agency securities 68,556 68,639 34,827 34,769 30,907 30,959
Mortgage-backed securities 4,901 4,932 - - - -
Non-marketable equity securities:
Federal Home Loan Bank stock 2,250 2,250 1,346 1,346 1,346 1,346
Other 315 315 15 15 15 15
--------- --------- --------- --------- --------- ---------
76,022 76,136 36,188 36,130 32,268 32,320
======== ========= ========= ========= ========= =========
Unrealized gain (loss) on securities
available for sale(1) 114 - (58) - 52 -
--------- --------- --------- --------- --------- ---------
Total $ 122,984 $ 122,884 $ 100,974 $ 100,989 $ 45,471 $ 45,584
========= ========= ========= ========= ========= =========
</TABLE>
(1) The net unrealized gain (loss) at September 30, 1997, 1996 and 1995
relates to available for sale securities in accordance with SFAS No.
115. The net unrealized gain (loss) is presented in order to reconcile
the "Amortized Cost" of the Bank's securities portfolio in the
"Carrying Cost," as reflected in the Statements of Financial Condition.
(2) Includes interest-bearing cash and federal funds sold.
The following table sets forth certain information regarding the
carrying value, weighted average yields and contractual maturities of the Bank's
interest-bearing deposits, investment and mortgage-backed securities as of
September 30, 1997.
<TABLE>
<CAPTION>
After One Through After Five Through
One Year or Less Five Years Ten Years After Ten Years Total
------------------- ------------------- ------------------ ------------------ -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- ------- -------- -------- -------- --------
(Dollars in Thousands)
Interest-bearing
deposits $ 25,187 5.58% $ - - $ - - $ - - $ 25,187 5.58%
Mortgage-backed
securities held to
maturity - - - - - - 21,661 8.03% 21,661 8.03%
Available-for-sale
securities 15,513 5.60% 38,432 6.06% 10,806 7.14% 8,820 7.64% 73,571 6.31%
Federal Home Loan
Bank Stock (1) - - - - - - 2,250 6.71% 2,250 6.71%
Other (1) - - - - - - 315 - 315 -
-------- ----- -------- ----- -------- ----- -------- ----- ------- -----
Total $ 40,700 5.59% $ 38,432 6.06% $ 10,806 7.14% $ 33,046 7.76% $122,984 6.45%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
</TABLE>
(1) Nonmarketable equity security; substantially all required to be maintained
and assumed to mature in period greater than 10 years.
16
<PAGE>
Deposits and Borrowings
General. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank
derives funds from loan principal repayments, loan interest income, the stock
offering, investment income, interest-bearing deposit income, interest income
from mortgage-backed securities and otherwise from its operations. Loan
repayments are a relatively stable source of funds while deposit inflows and
outflows may be significantly influenced by general interest rates and money
market conditions. Borrowings may be used on a short-term basis to compensate
for reductions in the availability of funds from other sources. They may also
be used on a longer term basis for general business purposes. The Bank has
$35.0 million in borrowings outstanding from the FHLB of Atlanta at September
30, 1997.
Deposits. On September 30, 1997, 1996 and 1995, the Bank's deposits
totaled $141.8 million, $146.4 million, and $137.6 million, respectively.
The following table sets forth information relating to the Bank's
deposit flows during the periods shown and total deposits at the end of the
periods shown.
<TABLE>
<CAPTION>
At or For the Year Ended September 30,
---------------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(In Thousands)
<S> <C> <C> <C> <C> <C>
Total deposits at $ 146,398 $ 137,647 $ 127,312 $ 139,685 $ 138,753
beginning of period
Net increase (decrease) (11,998) 976 4,355 (17,346) (5,105)
before interest credited
Interest credited 7,355 7,775 5,980 4,973 6,037
--------- --------- --------- --------- ---------
Total deposits at end of
period $ 141,755 $ 146,398 $ 137,647 $ 127,312 $ 139,685
========= ========= ========= ========= =========
</TABLE>
The Bank attracts both short-term and long-term deposits from the
general public by offering a variety of accounts and rates. The Bank offers
statement savings accounts, negotiable order of withdrawal accounts, money
market accounts, and fixed interest rate certificates with varying maturities.
All deposit flows are greatly influenced by economic conditions, the general
level of interest rates, competition, and other factors, including the
restructuring of the thrift industry. The Bank's savings deposits traditionally
have been obtained primarily from its primary market area. The Bank utilizes
traditional marketing methods to attract new customers and savings deposits,
including print media advertising, local radio, local cable television and
direct mailings. The Bank does not advertise for deposits outside of its local
market area or utilize the services of deposit brokers. The vast majority of
the Bank's depositors are residents of North Carolina. In the unlikely event
the Bank is liquidated following the Conversion, depositors will be entitled to
full payment of their deposit accounts prior to any payment being made to
stockholders.
17
<PAGE>
The following table sets forth certain information regarding the
Bank's savings deposits at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------- --------------------------------- ---------------------------------
Weighted Weighted Weighted
Average % of Average % of Average % of
Amount Rate Deposits Amount Rate Deposits Amount Rate Deposits
-------- -------- -------- -------- --------- --------- -------- --------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Demand Accounts: (1)
Passbook savings $ 15,311 3.00% 10.80% $ 17,953 3.00% 12.26% $ 15,490 3.00% 11.25%
NOW accounts 7,307 2.32% 5.15% 6,369 2.59% 4.35% 6,331 3.02% 4.60%
Money market deposit
accounts 6,266 3.00% 4.42% 6,674 3.00% 4.56% 7,809 3.25% 5.67%
Noninterest bearing
accounts 689 -- 0.49% 819 -- 0.56% 562 -- 0.41%
------ ------ ----- ------ ------ ----- ------ ----- -----
Total demand deposits 29,573 2.76% 20.86% 31,815 2.84% 21.73% 30,192 3.01% 21.93%
------ ----- ------ ------ ----- ------ ------ ----- ------
Certificates of Deposit 111,957 5.85% 78.98% 114,307 5.96% 78.08% 107,280 6.10% 77.94%
------- ----- ------ ------- ----- ------ ------- ----- ------
Accrued Interest 225 0.16% 276 0.19% 175 0.13%
------ ------ ------ ------ --- -----
Total Deposits........... $141,755 5.20% 100.00% $146,398 5.21% 100.00% $137,647 5.43% 100.00%
======== ===== ======= ======== ===== ======= ======== ====== =======
</TABLE>
(1) In addition, the Bank had deposits received for the stock
offering totaling $46.6 million with a weighted average rate of 3.00%
outstanding at September 30, 1996.
As of September 30, 1997, the aggregate amount of time
certificates of deposit in amounts greater than or equal to $100,000
was $13.3 million. (Some of these deposits were deposits of state and
local governments which are subject to rebidding from time to time and
to securitization requirements.) The following table presents the
maturity of these time certificates of deposit at the dates indicated.
<TABLE>
<CAPTION>
At
September 30, 1997
------------------
(In Thousands)
<S> <C>
3 Months or less $3,485,000
Over 3 months through 6 months 3,636,000
Over 6 months through 12 months 2,504,000
Over 12 months 3,703,000
---------
Total $13,328,000
===========
</TABLE>
Borrowings. The FHLB system functions in a reserve credit
capacity for savings institutions. As a member, the Bank is required to
own capital stock in the FHLB of Atlanta and is authorized to apply for
advances from the FHLB of Atlanta on the security of that stock and a
floating lien on certain of its real estate secured loans and other
assets. Each credit program has its own interest rate and range of
maturities. Depending on the program, limitations on the amount of
advances are based either on a fixed percentage of an institution's net
worth or on the FHLB of Atlanta's assessment of the institution's
creditworthiness. The Bank had $35.0 million outstanding borrowings
from the FHLB of Atlanta at September 30, 1997.
18
<PAGE>
Subsidiaries
The Company has no subsidiaries other than the Bank. The Bank has no
subsidiaries.
Competition
The Bank faces strong competition both in attracting deposits and
making real estate and other loans. Its most direct competition for deposits
has historically come from other savings institutions, credit unions and
commercial banks located in its primary market area, including large financial
institutions which have greater financial and marketing resources available to
them. The Bank has also faced additional significant competition for investors'
funds from short-term money market securities and other corporate and
government securities. At September 30, 1997, there were at least 7 other
commercial banks, credit unions and mortgage companies as well as numerous
other financial services providers located in the Bank's market area. At
September 30, 1997, the Bank had a deposit market share of approximately 23% in
Stanly County. The ability of the Bank to attract and retain savings deposits
depends on its ability to generally provide a rate of return, liquidity and
risk comparable to that offered by competing investment opportunities.
The Bank experiences strong competition for real estate loans from
other savings institutions, commercial banks, and mortgage banking companies.
The Bank competes for loans primarily through the interest rates and loan fees
it charges, the efficiency and quality of services it provides borrowers, and
its more flexible underwriting standards. Competition may increase as a result
of the continuing reduction of restrictions on the interstate operations of
financial institutions.
Employees are not represented by any union or collective bargaining
group, and the Bank considers its employee relations to be good.
Federal Income Taxation
Savings institutions such as the Bank are subject to the taxing
provisions of the Code, for corporations, as modified by certain provisions
specifically applicable for financial or thrift institutions. Income is
reported using the accrual method of accounting. The maximum corporate federal
income tax rate is 35%.
For fiscal years beginning prior to December 31, 1995, thrift
institutions which qualified under certain definitional tests and other
conditions of the Code were permitted certain favorable provisions regarding
their deductions from taxable income for annual additions to their bad debt
reserve. A reserve could be established for bad debts on qualifying real
property loans (generally loans secured by interests in real property improved
or to be improved) under (i) a method based on a percentage of the
institution's taxable income, as adjusted (the "percentage of taxable income
method") or (ii) a method based on actual loss experience (the "experience
method"). The reserve for nonqualifying loans was computed using the experience
method.
The percentage of taxable income method was limited to 8% of taxable
income. This method could not raise the reserve to exceed 6% of qualifying real
property loans at the end of the year. Moreover, the additions for qualifying
real property loans, when added to nonqualifying loans, could not exceed 12% of
the amount by which total deposits or withdrawable accounts exceed the sum of
surplus, undivided profits and reserves at the beginning of the year. This
limitation precluded the Bank from taking a bad debt deduction in its 1996 and
1995 tax returns. The experience method was the amount necessary to increase
the balance of the reserve at the close of the year to the greater of (i) the
amount which bore the same ratio to loans outstanding at the close of the year
as the total net bad debts sustained during the current and five preceding
years bore to the sum of the loans outstanding at the close of such six years
or (ii) the balance in the reserve account at the close of the last taxable
year beginning before 1988 (assuming that the loans outstanding have not
declined since such date).
In order to qualify for the percentage of income method, an
institution had to have at least 60% of its assets as "qualifying assets" which
generally included, cash, obligations of the United States government or an
agency or
19
<PAGE>
instrumentality thereof or of a state or political subdivision, residential
real estate-related loans, or loans secured by savings accounts and property
used in the conduct of its business. In addition, it had to meet certain other
supervisory tests and operate principally for the purpose of acquiring savings
and investing in loans.
Institutions which became ineligible to use the percentage of income
method had to change to either the reserve method or the specific charge-off
method that applied to banks. Large thrift institutions, those generally
exceeding $500 million in assets, had to convert to the specific charge-off
method. In computing its bad debt reserve for federal income taxes, the Bank
used the reserve method in fiscal years 1997, 1996 and 1995.
Bad debt reserve balances in excess of the balance computed under the
experience method or amounts maintained in a supplemental reserve built up
prior to 1962 ("excess bad debt reserve") require inclusion in taxable income
upon certain distributions to its stockholders. Distributions in redemption or
liquidation of stock or distributions with respect to its stock in excess of
earnings and profits accumulated in years beginning after December 31, 1951,
are treated as a distribution from the excess bad debt reserve. When such a
distribution takes place and it is treated as from the excess bad debt reserve,
the thrift is required to reduce its reserve by such amount and simultaneously
recognize the amount as an item of taxable income increased by the amount of
income tax imposed on the inclusion. Dividends not in excess of earnings and
profits accumulated since December 31, 1951 will not require inclusion of part
or all of the bad debt reserve in taxable income. The Bank has accumulated
earnings and profits since December 31, 1951 and has an excess in its bad debt
reserve. Distributions in excess of current and accumulated earnings and
profits will increase taxable income. Net retained earnings at September 30,
1997 includes approximately $2.9 million for which no provision for federal
income tax has been made. See Note 13 to "Notes to Financial Statements".
Legislation passed by the U.S. Congress and signed by the President in
August 1996 contains a provision that repeals the percentage of taxable income
method of accounting for thrift bad debt reserves for tax years beginning after
December 31, 1995. The legislation will trigger bad debt reserve recapture for
post-1987 excess reserves over a six-year period. At September 30, 1997, the
Bank's post-1987 excess reserves amounted to approximately $1.0 million. A
special provision suspends recapture of post-1987 excess reserves for up to two
years if, during those years, the institution satisfies a "residential loan
requirement." This requirement will be met if the principal amount of the
institution's residential loans exceeds a base year amount, which is determined
by reference to the average of the institution's residential loans during the
six taxable years ending before January 1, 1996. However, notwithstanding this
special provision, recapture will begin no later than the first taxable year
beginning after December 31, 1997. The Bank met the requirement at September
30, 1997.
The Bank may also be subject to the corporate alternative minimum tax
("AMT"). This tax is applicable only to the extent it exceeds the regular
corporate income tax. The AMT is imposed at the rate of 20% of the
corporation's alternative minimum taxable income ("AMTI") subject to applicable
statutory exemptions. AMTI is calculated by adding certain tax preference items
and making certain adjustments to the corporation's regular taxable income.
Preference items and adjustments generally applicable to financial institutions
include, but are not limited to, the following: (i) the excess of the bad debt
deduction over the amount that would have been allowable on the basis of actual
experience; (ii) interest on certain tax-exempt bonds issued after August 7,
1986; and (iii) 75% of the excess, if any, of a corporation's adjusted earnings
and profits over its AMTI (as otherwise determined with certain adjustments).
Net operating loss carryovers, subject to certain adjustments, may be utilized
to offset up to 90% of the AMTI. Credit for AMT paid may be available in future
years to reduce future regular federal income tax liability. The Bank has not
been subject to the AMT in recent years.
The Bank's federal income tax returns have not been audited in over 10
years.
State Taxation
Under North Carolina law, the corporate income tax is 7.50% of federal
taxable income as computed under the Code, subject to certain prescribed
adjustments. 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
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otherwise payable by it. An annual state franchise tax is imposed at a rate of
0.15% applied to the greatest of the institutions (i) capital stock, surplus
and undivided profits, (ii) investment in tangible property in North Carolina
or (iii) appraised valuation of property in North Carolina.
The North Carolina corporate tax rate will drop to 7.25% in 1998,
7.00% in 1999 and 6.90% thereafter.
SUPERVISION AND REGULATION
Regulation of the Company
General. The Company was organized for the purpose of acquiring and
holding all of the capital stock of the Bank to be issued in the Conversion. As
a bank holding company subject to the Bank Holding Company Act of 1956, as
amended ("BHCA"), the Company is subject to certain regulations of the Federal
Reserve. Under the BHCA, the Company's activities and those of its subsidiaries
are limited to banking, managing or controlling banks, furnishing services to
or performing services for its subsidiaries or engaging in any other activity
which the Federal Reserve determines to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto. The BHCA
prohibits the Company from acquiring direct or indirect control of more than 5%
of the outstanding voting stock or substantially all of the assets of any bank
or savings bank or merging or consolidating with another bank holding company
or savings bank holding company without prior approval of the Federal Reserve.
Additionally, the BHCA prohibits the Company from engaging in, or
acquiring ownership or control of, more than 5% of the outstanding voting stock
of any company engaged in a nonbanking business unless such business is
determined by the Federal Reserve to be so closely related to banking as to be
properly incident thereto.
Similarly, Federal Reserve approval (or, in certain cases,
non-disapproval) must be obtained prior to any person acquiring control of the
Company. Control is conclusively presumed to exist if, among other things, a
person acquires more than 25% of any class of voting stock of the holding
company or controls in any manner the election of a majority of the directors
of the holding company. Control is presumed to exist if a person acquires more
than 10% of any class of voting stock and the stock is registered under Section
12 of the Exchange Act or the acquiror will be the largest shareholder after
the acquisition.
There are a number of obligations and restrictions imposed on bank
holding companies and their depository institution subsidiaries by law and
regulatory policy that are designed to minimize potential loss to the
depositors of such depository institutions and the FDIC insurance funds in the
event the depository institution becomes in danger of default or in default.
For example, to avoid receivership of an insured depository institution
subsidiary, a bank holding company is required to guarantee the compliance of
any insured depository institution subsidiary that may become
"undercapitalized" with the terms of any capital restoration plan filed by such
subsidiary with its appropriate federal banking agency up to the lesser of (i)
an amount equal to 5% of the institution's total assets at the time the
institution became undercapitalized or (ii) the amount which is necessary (or
would have been necessary) to bring the institution into compliance with all
acceptable capital standards as of the time the institution fails to comply
with such capital restoration plan. Under a policy of the Federal Reserve with
respect to bank holding company operations, a bank holding company is required
to serve as a source of financial strength to its subsidiary depository
institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. The Federal Reserve
under the BHCA also has the authority to require a bank holding company to
terminate any activity or to relinquish control of a nonbank subsidiary (other
than a nonbank subsidiary of a bank) upon the Federal Reserve's determination
that such activity or control constitutes a serious risk to the financial
soundness and stability of any bank subsidiary of the bank holding company.
In addition, the "cross-guarantee" provisions of the Federal Deposit
Insurance Act, as amended ("FDIA") require insured depository institutions
under common control to reimburse the FDIC for any loss suffered by either the
Savings Association Insurance Fund (the "SAIF") or the Bank Insurance Fund (the
"BIF") as a result of the default of a commonly controlled insured depository
institution or for any assistance provided by the FDIC to a commonly controlled
insured depository institution in danger of default. The FDIC may decline to
enforce the cross-guarantee
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provisions if it determines that a waiver is in the best interest of the SAIF
or the BIF or both. The FDIC's claim for damages is superior to claims of
stockholders of the insured depository institution or its holding company but
is subordinate to claims of depositors, secured creditors and holders of
subordinated debt (other than affiliates) of the commonly controlled insured
depository institutions.
Federal regulations require that the Company must notify the Federal
Reserve Bank of Richmond prior to repurchasing Common Stock in excess of 10% of
its net worth during a rolling 12 month period. As a result of the Company's
ownership of the Bank, the Company will be registered under the savings bank
holding company laws of North Carolina. Accordingly, the Company is also
subject to regulation and supervision by the Administrator.
Capital Adequacy Guidelines for Holding Companies. The Federal Reserve
has adopted capital adequacy guidelines for bank holding companies and banks
that are members of the Federal Reserve system and have consolidated assets of
$150 million or more. For bank holding companies with less than $150 million in
consolidated assets, the guidelines are applied on a bank-only basis unless the
parent bank holding company (i) is engaged in nonbank activity involving
significant leverage or (ii) has a significant amount of outstanding debt that
is held by the general public.
Bank holding companies are required to comply with the Federal
Reserve's risk-based capital guidelines. Under these regulations, the minimum
ratio of total capital to risk-weighted assets (including certain off-balance
sheet activities, such as standby letters of credit) is 8%. At least half of
the total capital is required to be "Tier I capital," principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock, and a
limited amount of cumulative perpetual preferred stock, less certain goodwill
items. The remainder ("Tier II capital") may consist of a limited amount of
subordinated debt, certain hybrid capital instruments and other debt
securities, perpetual preferred stock, and a limited amount of the general loan
loss allowance. In addition to the risk-based capital guidelines, the Federal
Reserve has adopted a minimum Tier I capital (leverage) ratio, under which a
bank holding company must maintain a minimum level of Tier I capital to average
total consolidated assets of at least 3% in the case of a bank holding company
which has the highest regulatory examination rating and is not contemplating
significant growth or expansion. All other bank holding companies are expected
to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the
stated minimum.
Federal Securities Law. The Company has registered its Common Stock
with the SEC pursuant to Section 12(b) of the Exchange Act and will not
deregister the Common Stock for a period of three years following the
completion of the Conversion. As a result of such registration, the proxy and
tender offer rules, insider trading reporting requirements, annual and periodic
reporting and other requirements of the Exchange Act are applicable to the
Company.
The registration under the Securities Act of the Offerings of the
Common Stock does not cover the resale of such shares. Shares of the Common
Stock purchased by persons who are not affiliates of the Company may be resold
without registration. Shares purchased by an affiliate of the Company are
subject to the resale provisions of Rule 144 under the Securities Act. So long
as the Company meets the current public information requirements of Rule 144
under the Securities Act, each affiliate of the Company who complies with the
other conditions of Rule 144 (including those that require the affiliate's sale
to be aggregated with those of certain other persons) will be able to sell in
the public market, without registration, a number of shares not to exceed, in
any three-month period, the greater of (i) 1% of the outstanding shares of the
Company or (ii) the average weekly volume of trading in such shares during the
preceding four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under the
Securities Act under certain circumstances. There are currently no demand
registration rights outstanding. However, in the event the Company at some
future time determines to issue additional shares from its authorized but
unissued shares, the Company might offer registration rights to certain of its
affiliates who want to sell their shares.
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Regulation of the Bank
General. Federal and state legislation and regulation have
significantly affected the operations of federally insured savings institutions
and other federally regulated financial institutions in the past several years
and have increased competition among savings institutions, commercial banks and
other providers of financial services. In addition, federal legislation has
imposed new limitations on investment authority, and higher insurance and
examination assessments on savings institutions and has made other changes that
may adversely affect the future operations and competitiveness of savings
institutions with other financial institutions, including commercial banks and
their holding companies. The operations of regulated depository institutions,
including the Bank, will continue to be subject to changes in applicable
statutes and regulations from time to time.
The Bank is a North Carolina-chartered savings bank, is a member of
the FHLB system, and its deposits are insured by the FDIC through the SAIF. It
is subject to examination and regulation by the FDIC and the Administrator and
to regulations governing such matters as capital standards, mergers,
establishment of branch offices, subsidiary investments and activities, and
general investment authority. Generally, North Carolina state chartered savings
banks whose deposits are issued by the SAIF are subject to restrictions with
respect to activities and investments, transactions with affiliates and
loans-to-one borrower similar to those applicable to SAIF insured savings
associations. Such examination and regulation is intended primarily for the
protection of depositors and the federal deposit insurance funds.
The Bank is subject to various regulations promulgated by the Federal
Reserve including, without limitation, Regulation B (Equal Credit Opportunity),
Regulation D (Reserves), Regulation E (Electronic Fund Transfers), Regulation O
(Loans to Executive Officers, Directors and Principal Shareholders), Regulation
Z (Truth in Lending), Regulation CC (Availability of Funds) and Regulation DD
(Truth in Savings). As creditors of loans secured by real property and as
owners of real property, financial institutions, including the Bank, may be
subject to potential liability under various statutes and regulations
applicable to property owners generally, including statutes and regulations
relating to the environmental condition of real property.
The FDIC has extensive enforcement authority over North
Carolina-chartered savings banks, including the Bank. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated in
response to violations of laws and regulations and unsafe or unsound practices.
The grounds for appointment of a conservator or receiver for a North
Carolina savings bank on the basis of an institution's financial condition
include: (i) insolvency, in that the assets of the savings bank are less than
its liabilities to depositors and others; (ii) substantial dissipation of
assets or earnings through violations of law or unsafe or unsound practices;
(iii) existence of an unsafe or unsound condition to transact business; (iv)
likelihood that the savings bank will be unable to meet the demands of its
depositors or to pay its obligations in the normal course of business; and (v)
insufficient capital or the incurring or likely incurring of losses that will
deplete substantially all of the institution's capital with no reasonable
prospect of replenishment of capital without federal assistance.
Transactions with Affiliates. Under current federal law, transactions
between the Bank and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of the Bank is any company or entity that
controls, is controlled by or is under common control with the savings bank.
Generally, subsidiaries of a bank, other than a bank subsidiary, and certain
other types of companies are not considered to be affiliates. Generally,
Sections 23A and 23B (i) limit the extent to which the Bank or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal
to 10% of such the Bank's capital stock and surplus, and contain an aggregate
limit on all such transactions with all affiliates to an amount equal to 20% of
such capital stock and surplus and (ii) require that all such transactions be
on terms substantially the same, or at least as favorable, to the Bank or the
subsidiary as those provided to a nonaffiliate. The term "covered transaction"
includes the making of loans or other extensions of credit to an affiliate, the
purchase of assets from an affiliate, the purchase of, or an investment in, the
securities of an affiliate, the acceptance of securities of an affiliate as
collateral for a loan or extension of credit to any person, or issuance of a
guarantee, acceptance or letter of credit on behalf of an affiliate.
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Further, current federal law has extended to savings banks the
restrictions contained in Section 22(h) of the Federal Reserve Act with respect
to loans to directors, executive officers and principal stockholders. Under
Section 22(h), loans to directors, executive officers and stockholders who,
directly or indirectly, own more than 10% of any class of voting securities of
a savings bank, and certain affiliated entities of any of the foregoing, may
not exceed, together with all other outstanding loans to such person and
affiliated entities, the savings bank's loans-to-one borrower limit as
established by federal law (as discussed below). Section 22(h) also prohibits
loans above amounts prescribed by the appropriate federal banking agency to
directors, executive officers or stockholders who own more than 10% of a
savings bank, and their respective affiliates, unless such loan is approved in
advance by a majority of the disinterested directors of the board of directors
of the savings bank and the Company. Any "interested" director may not
participate in the voting. The Federal Reserve has prescribed the loan amount
(which includes all other outstanding loans to such person), as to which such
prior board of director approval is required, as being the greater of $25,000
or 5% of unimpaired capital and unimpaired surplus (up to $500,000). Further,
pursuant to Section 22(h) the Federal Reserve requires that loans to directors,
executive officers, and principal stockholders be made on terms substantially
the same as offered in comparable transactions to other persons and not involve
more than the normal risk of repayment or present other unfavorable features.
Section 22(h) also generally prohibits a depository institution from paying the
overdrafts of any of its executive officers or directors.
Deposit Insurance. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is
determined by the institution's capital level and supervisory evaluations.
Based on the data reported to regulators for the date closest to the last day
of the seventh month preceding the semi-annual assessment period, institutions
are assigned to one of three capital groups -- well capitalized, adequately
capitalized or undercapitalized -- using the same percentage criteria as in the
prompt corrective action regulations. See "-- Regulation of the Bank - Prompt
Corrective Regulatory Action." Within each capital group, institutions are
assigned to one of three subgroups on the basis of supervisory evaluations by
the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund. Subgroup A consists of
financially sound institutions with only a few minor weaknesses. Subgroup B
consists of institutions that demonstrate weaknesses which, if not corrected,
could result in significant deterioration of the institution and increased risk
of loss to the deposit insurance fund. Subgroup C consists of institutions that
pose a substantial probability of loss to the deposit insurance fund unless
effective corrective action is taken. The assessment rate for SAIF members had
ranged from 0.23% of deposits for well capitalized institutions in Subgroup A
to 0.31% of deposits for undercapitalized institutions in Subgroup C while
assessments for over 90% of the BIF members had been the statutory minimum of
$2,000. The Bank's federal deposit insurance premium expense was $70,000 and
$318,000, not including a one-time special SAIF assessment incurred for the
year ended September 30, 1996, for the years ended September 30, 1997 and 1996,
respectively.
Legislation provided for a one-time assessment of 65.7 basis points
for the year ended September 30, 1996 of insured deposits as of March 31, 1995,
that fully capitalized the SAIF and had the effect of reducing future SAIF
assessments. Accordingly, although the special assessment resulted in a
one-time charge to the Bank of approximately $838,000 pre-tax, the
recapitalization of the SAIF had the effect of reducing the Bank's future
deposit insurance premiums to the SAIF. Under the recently enacted legislation,
both BIF and SAIF members will be assessed an amount for the Financing
Corporation Bond payments. BIF members will be assessed approximately 1.3 basis
points while the SAIF rate will be approximately 6.4 basis points until January
1, 2000. At that time, BIF and SAIF members will begin pro rata sharing of the
payment at an expected rate of 2.43 basis points.
Community Reinvestment Act. The Bank, like other financial
institutions, is subject to the Community Reinvestment Act, as amended ("CRA").
A purpose of this Act is to encourage financial institutions to help meet the
credit needs of its entire community, including the needs of low- and
moderate-income neighborhoods. During the Bank's last compliance examination
the Bank received a "satisfactory" rating with respect to CRA compliance. The
Bank's rating with respect to CRA compliance would be a factor to be considered
by the Federal Reserve and FDIC in considering applications submitted by the
Bank to acquire branches or to acquire or combine with other financial
institutions and take other actions and could result in the denial of such
applications.
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The federal banking regulatory agencies have issued a rewrite of the
CRA regulations, which became effective on January 1, 1996, to implement a new
evaluation system that rates institutions based on their actual performance in
meeting community credit needs. Under the regulations, a savings bank will be
evaluated and rated under three categories: a lending test, an investment test
and a service test. For each of these three tests, the savings bank will be
given a rating of either "outstanding," "high satisfactory," "low
satisfactory," "needs to improve" or "substantial non-compliance." A set of
criteria for each rating has been developed and is included in the regulation.
If an institution disagrees with a particular rating, the institution has the
burden of rebutting the presumption by clearly establishing that the
quantitative measures do not accurately present its actual performance, or that
demographics, competitive conditions or economic or legal limitations peculiar
to the service area should be considered. The ratings received under the three
tests will be used to determine the overall composite CRA rating. The composite
ratings will be the same as those that are currently given: "outstanding,"
"satisfactory," "needs to improve" or "substantial non-compliance."
Capital Requirements Applicable To The Bank. The FDIC requires the
Bank to have a minimum leverage ratio of Tier I capital (principally consisting
of common stockholders' equity, noncumulative perpetual preferred stock and
minority interests in consolidated subsidiaries, less certain intangible items,
goodwill items, identified losses and investments in securities subsidiaries)
to total assets of at least 3%; provided, however that all institutions, other
than those (i) receiving the highest rating during the examination process and
(ii) not anticipating or experiencing any significant growth, are required to
maintain a ratio of 1% or 2% above the stated minimum, with an absolute minimum
leverage ratio of not less than 4%. The FDIC also requires the Bank to have a
ratio of total capital to risk-weighted assets, including certain off-balance
sheet activities, such as standby letters of credit, of at least 8%. At least
half of the total capital is required to be Tier I capital. The remainder
("Tier II capital") may consist of a limited amount of subordinated debt,
certain hybrid capital instruments, other debt securities, certain types of
preferred stock and a limited amount of loan loss allowance.
An institution which fails to meet minimum capital requirements may be
subject to a capital directive which is enforceable in the same manner and to
the same extent as a final cease and desist order, and must submit a capital
plan within 60 days to the FDIC. If the leverage ratio falls to 2% or less, the
bank may be deemed to be operating in an unsafe or unsound condition, allowing
the FDIC to take various enforcement actions, including possible termination of
insurance or placement of the institution in receivership. At September 30,
1997, the Bank had a leverage ratio of 18.91%.
The Administrator requires that net worth equal at least 5% of total
assets. Intangible assets must be deducted from net worth and assets when
computing compliance with this requirement.
At September 30, 1997, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.
Each federal banking agency is required to establish risk-based
capital standards that take adequate account of interest rate risk,
concentration of credit risk, and the risk of nontraditional activities, as
well as reflect the actual performance and expected risk of loss on multifamily
mortgages.
On August 2, 1995, the federal banking agencies issued a joint notice
of adoption of final risk based capital rules to take account of interest rate
risk. The final regulation required an assessment of the need for additional
capital on a case-by-case basis, considering both the level of measured
exposure and qualitative risk factors. The final rule also stated an intent to,
in the future, establish an explicit minimum capital charge for interest rate
risk based on the level of a bank's measured interest rate risk exposure.
Effective June 26, 1996, the federal banking agencies issued a joint
policy statement announcing the agencies' election not to adopt a standardized
measure and explicit capital charge for interest rate risk at that time.
Rather, the policy statement (i) identifies the main elements of sound interest
rate risk management, (ii) describes prudent principles and practices for each
of those elements, and (iii) describes the critical factors affecting the
agencies'
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evaluation of a bank's interest rate risk when making a determination of
capital adequacy. The joint policy statement is not expected to have a material
impact on Bank's management of interest rate risk.
Loans-To-One-Borrower. The Bank is subject to the Administrator's
loans-to-one-borrower limits. Under these limits, no loans and extensions of
credit to any borrower outstanding at one time and not fully secured by readily
marketable collateral shall exceed 15% of the net worth of the savings bank.
Loans and extensions of credit fully secured by readily marketable collateral
may comprise an additional 10% of net worth. These limits also authorize
savings banks to make loans-to-one-borrower, for any purpose, in an amount not
to exceed $500,000. A savings bank also is authorized to make
loans-to-one-borrower to develop domestic residential housing units, not to
exceed the lesser of $30 million or 30% of the savings bank's net worth,
provided that the purchase price of each single-family dwelling in the
development does not exceed $500,000 and the aggregate amount of loans made
under this authority does not exceed 150% of net worth. These limits also
authorize a savings bank to make loans-to-one-borrower to finance the sale of
real property acquired in satisfaction of debts in an amount up to 50% of net
worth.
As of September 30, 1997, the largest aggregate amount of loans which
the Bank had to any one borrower was $1.1 million. The Bank had no loans
outstanding which management believes violate the applicable
loans-to-one-borrower limits. The Bank does not believe that the
loans-to-one-borrower limits will have a significant impact on its business,
operations and earnings.
Federal Home Loan Bank System. The FHLB system provides a central
credit facility for member institutions. As a member of the FHLB of Atlanta,
the Bank is required to own capital stock in the FHLB of Atlanta in an amount
at least equal to the greater of 1% of the aggregate principal amount of its
unpaid residential mortgage loans, home purchase contracts and similar
obligations at the end of each calendar year, or 5% of its outstanding advances
(borrowings) from the FHLB of Atlanta. On September 30, 1997, the Bank was in
compliance with this requirement with an investment in FHLB of Atlanta stock of
$2.3 million.
Each FHLB is required to contribute at least 10% of its reserves and
undivided profits to fund the principal and a portion of the interest on
certain bonds and certain other obligations which are used to fund the
resolution of troubled savings association cases, and to transfer a percentage
of its annual net earnings to the Affordable Housing Program. These
contributions continue to reduce the FHLB of Atlanta's earnings and the Bank's
dividends on its FHLB of Atlanta stock.
Federal Reserve System. Federal Reserve regulations require savings
banks, not otherwise exempt from the regulations, to maintain reserves against
their transaction accounts (primarily negotiable order of withdrawal accounts)
and certain nonpersonal time deposits. The reserve requirements are subject to
adjustment by the Federal Reserve. As of September 30, 1997, the Bank was in
compliance with the applicable reserve requirements of the Federal Reserve.
Restrictions on Acquisitions. Federal law generally provides that no
"person," acting directly or indirectly or through or in concert with one or
more other persons, may acquire "control," as that term is defined in FDIC
regulations, of a state savings bank without giving at least 60 days' written
notice to the FDIC and providing the FDIC an opportunity to disapprove the
proposed acquisition. Pursuant to regulations governing acquisitions of
control, control of an insured institution is conclusively deemed to have been
acquired by, among other things, the acquisition of more than 25% of any class
of voting stock. In addition, control is presumed to have been acquired,
subject to rebuttal, upon the acquisition of more than 10% of any class of
voting stock. Such acquisitions of control may be disapproved if it is
determined, among other things, that (i) the acquisition would substantially
lessen competition; (ii) the financial condition of the acquiring person might
jeopardize the financial stability of the savings bank or prejudice the
interests of its depositors; or (iii) the competency, experience or integrity
of the acquiring person or the proposed management personnel indicates that it
would not be in the interest of the depositors or the public to permit the
acquisitions of control by such person.
Liquidity. The Bank is subject to the Administrator's requirement that
the ratio of liquid assets to total assets equal at least 10%. The computation
of liquidity under North Carolina regulation allows the inclusion of
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mortgage-backed securities and investments which, in the judgment of the
Administrator, have a readily marketable value, including investments with
maturities in excess of five years. On September 30, 1997, the Bank's liquidity
ratio, calculated in accordance with North Carolina regulations, was
approximately 43%.
Additional Limitations on Activities. Recent FDIC law and regulations
generally provide that the Bank may not engage as principal in any type of
activity, or in any activity in an amount, not permitted for national banks, or
directly acquire or retain any equity investment of a type or in an amount not
permitted for national banks. The FDIC has authority to grant exceptions from
these prohibitions (other than with respect to non-service corporation equity
investments) if it determines no significant risk to the insurance fund is
posed by the amount of the investment or the activity to be engaged in and if
the Bank is and continues to be in compliance with fully phased-in capital
standards. National banks are generally not permitted to hold equity
investments other than shares of service corporations and certain federal
agency securities. Moreover, the activities in which service corporations are
permitted to engage are limited to those of service corporations for national
banks.
Savings banks are also generally prohibited from directly or
indirectly acquiring or retaining any corporate debt security that is not of
investment grade (generally referred to as "junk bonds"). State savings banks
are also required to notify the FDIC at least 30 days prior to the
establishment or acquisition of any subsidiary, or at least 30 days prior to
conducting any such new activity. Any such activities must be conducted in
accordance with the regulations and orders of the FDIC and the Administrator.
Prompt Corrective Regulatory Action. Federal law provides the federal
banking agencies with broad powers to take corrective action to resolve
problems of insured depository institutions. The extent of these powers depends
upon whether the institutions in question are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized," or
"critically undercapitalized." Under the FDIC regulations applicable to the
Bank, an institution is considered "well capitalized" if it has (i) a total
risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital
ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not
subject to any order or written directive to meet and maintain a specific
capital level for any capital measure. An "adequately capitalized" institution
is defined as one that has (i) a total risk-based capital ratio of 8% or
greater, (ii) a Tier I risk-based capital ratio of 4% or greater and (iii) a
leverage ratio of 4% or greater (or 3% or greater in the case of an institution
with the highest examination rating and which is not experiencing or
anticipating significant growth). An institution is considered (A)
"undercapitalized" if it has (i) a total risk-based capital ratio of less than
8%, (ii) a Tier I risk-based capital ratio of less than 4% or (iii) a leverage
ratio of less than 4% (or 3% in the case of an institution with the highest
examination rating and which is not experiencing or anticipating significant
growth); (B) "significantly undercapitalized" if the institution has (i) a
total risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based
capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and (C)
"critically undercapitalized" if the institution has a ratio of tangible equity
to total assets equal to or less than 2%.
Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Banking Act"), effective September 29,
1995, permits adequately capitalized bank and savings bank holding companies to
acquire control of banks and savings banks in any state. The states may
specifically permit interstate acquisitions prior to September 29, 1995, by
enacting legislation that provides for such transactions. North Carolina
adopted nationwide reciprocal interstate acquisition legislation in 1994.
Such interstate acquisitions are subject to certain restrictions.
States may require the bank or savings bank being acquired to have been in
existence for a certain length of time but not in excess of five years. In
addition, no bank or saving bank may acquire more than 10% of the insured
deposits in the United States or more than 30% of the insured deposits in any
one state, unless the state has specifically legislated a higher deposit cap.
States are free to legislate stricter deposit caps.
The Interstate Banking Act also provides for interstate branching,
effective June 1, 1997, allowing interstate branching in all states, provided
that a particular state has not specifically denied interstate branching by
legislation prior to such time. Unlike interstate acquisitions, a state may
deny interstate branching if it specifically elects to do so by June 1, 1997.
States may choose to allow interstate branching prior to June 1, 1997 by
opting-in to a group of
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states that permits these transactions. These states generally allow interstate
branching via a merger of an out-of-state bank with an in-state bank, or on a
de novo basis. North Carolina has enacted legislation permitting branching
transactions.
It is anticipated that the Interstate Banking Act will increase
competition within the markets in which the Bank now operates, although the
extent to which such competition will increase in such markets or the timing of
such increase cannot be predicted.
Restrictions on Dividends and Other Capital Distributions. A North
Carolina-chartered stock savings bank may not declare or pay a cash dividend
on, or repurchase any of, its capital stock if the effect of such transaction
would be to reduce the net worth of the institution to an amount which is less
than the minimum amount required by applicable federal and state regulations.
In addition, a North Carolina-chartered stock savings bank, for a period of
five years after its conversion from mutual to stock form, must obtain the
written approval from the Administrator before declaring or paying a cash
dividend on its capital stock in an amount in excess of one-half of the greater
of (i) the institution's net income for the most recent fiscal year end, or
(ii) the average of the institution's net income after dividends for the most
recent fiscal year end and not more than two of the immediately preceding
fiscal year ends, if applicable. Under FDIC regulations, stock repurchases may
be made by the savings bank only upon receipt of FDIC approval.
Also, without the prior written approval of the Administrator, a North
Carolina-chartered stock savings bank, for a period of five years after its
conversion from mutual to stock form, may not repurchase any of its capital
stock. The Administrator will give approval to repurchase only upon a showing
that the proposed repurchase will not adversely affect the safety and soundness
of the institution.
In addition, the Bank is not permitted to declare or pay a cash
dividend on or repurchase any of its capital stock if the effect thereof would
be to cause its net worth to be reduced below the amount required for the
liquidation account established in connection with the Bank's conversion from
mutual to stock ownership.
The Company paid cash dividends totaling $0.38 per share during the
year ended September 30, 1997, and subsequent to September 30, 1997, declared a
special return of capital dividend of $6.00 per share to be paid on January 8,
1998 to shareholders of record as of December 17, 1997.
Other North Carolina Regulations. As a North Carolina-chartered
savings bank, the Bank derives its authority from, and is regulated by, the
Administrator. The Administrator has the right to promulgate rules and
regulations necessary for the supervision and regulation of North Carolina
savings banks under his jurisdiction and for the protection of the public
investing in such institutions. The regulatory authority of the Administrator
includes, but is not limited to, the establishment of reserve requirements; the
regulation of the payment of dividends; the regulation of stock repurchases,
the regulation of incorporators, stockholders, directors, officers and
employees; the establishment of permitted types of withdrawable accounts and
types of contracts for savings programs, loans and investments; and the
regulation of the conduct and management of savings banks, chartering and
branching of institutions, mergers, conversions and conflicts of interest.
North Carolina law requires that the Bank maintain federal deposit insurance as
a condition of doing business.
The Administrator conducts regular 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.
28
<PAGE>
A North Carolina-chartered savings bank must maintain net worth,
computed in accordance with the Administrator's requirements, of 5% of total
assets and liquidity of 10% of total assets, as discussed above. Additionally,
a North Carolina-chartered savings bank is required to maintain general
valuation allowances and specific loss reserves in the same amounts as required
by the FDIC.
Subject to limitation by the Administrator, North Carolina-chartered
savings banks may make any loan or investment or engage in any activity which
is permitted to federally chartered institutions. However, a North
Carolina-chartered savings bank cannot invest more than 15% of its total assets
in business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutorily permitted
investments, including but not limited to (i) obligations of the United States,
or those guaranteed by it; (ii) obligations of the State of North Carolina;
(iii) bank demand or time deposits; (iv) stock or obligations of the federal
deposit insurance fund or a FHLB; (v) savings accounts of any savings
institution as approved by the board of directors; and (vi) stock or
obligations of any agency of the State of North Carolina or of the United
States or of any corporation doing business in North Carolina whose principal
business is to make education loans.
North Carolina law provides a procedure by which savings institutions
may consolidate or merge, subject to approval of the Administrator. The
approval is conditioned upon findings by the Administrator that, among other
things, such merger or consolidation will promote the best interests of the
members or stockholders of the merging institutions. North Carolina law also
provides for simultaneous mergers and conversions and for supervisory mergers
conducted by the Administrator.
Future Requirements. Statutes and regulations are regularly introduced
which contain wide-ranging proposals for altering the structures, regulations
and competitive relationships of financial institutions. It cannot be predicted
whether or what form any proposed statute or regulation will be adopted or the
extent to which the business of the Company and the Bank may be affected by
such statute or regulation.
ITEM 2. PROPERTIES
Properties
The following table sets forth the location of the Bank's principal
office in Albemarle, North Carolina and its full service branch office in
Locust, North Carolina, as well as certain other information relating to these
offices as of September 30, 1997. The Bank owns both the Albemarle and Locust
offices. The Bank also owns two vacant lots which are adjacent to its Albemarle
office, but has no plans for these lots at the present time.
<TABLE>
<CAPTION>
Net Book Value Deposits
Address of Property (In Thousands)
------- -------------- --------------
<S> <C> <C>
Albemarle: $593,000 $120,892
155 West South Street
Albemarle, North Carolina 28001
Two (2) Vacant Lots $26,000
South Second Street
Albemarle, North Carolina 28001
Locust: $231,000 $20,863
406 West Main Street
Locust, North Carolina 28097
$850,000 $141,755
======== ========
</TABLE>
29
<PAGE>
The Bank's management considers the property to be in good condition.
The total net book value of the Bank's furniture, fixtures and equipment on
September 30, 1997 was $308,000.
ITEM 3. LEGAL PROCEEDINGS
In the opinion of management, neither the Company nor the Bank is
involved in any pending legal proceedings other than routine, non-material
proceedings occurring in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's stockholders during
the quarter ended September 30, 1997.
30
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
See the information under the section captioned "Common Stock
Information" on page 54 in the Company's 1997 Annual Report, which section is
incorporated herein by reference. See "Item 1. DESCRIPTION OF
BUSINESS--Regulation of the Bank--Restrictions on Dividends and Other Capital
Distributions" above for regulatory restrictions which limit the ability of the
Bank to pay dividends to the Company.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth in the table
captioned "Selected Consolidated Financial Data" on page 1 of the Company's
1997 Annual Report which is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The table below sets forth certain performance ratios for the Company
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------
1997 1996 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
Return on Average Assets (Net income divided by average total
assets) 1.24% 0.30% 1.23% 1.63%
Return on Average Equity (Net income divided by average
shareholders' equity 4.70% 2.45% 9.50% 14.22%
Average Equity to Average Assets Ratio (Average shareholders'
equity divided by average total assets) 26.40% 12.23% 12.97% 11.45%
Interest Rate Spread for the Period 2.02% 2.52% 3.59% 4.38%
Average Interest-Earning Assets to Average Interest-Bearing
Liabilities 136.08% 112.00% 112.74% 110.19%
Net Interest Margin 3.46% 3.09% 4.11% 4.72%
Loan Loss Allowance to Nonperforming Assets at Period End 81.25% 63.69% 12.28% 12.48%
</TABLE>
See also the information set forth under Item 1 above and the
information set forth under the section captioned "Management's Discussion and
Analysis of Financial Condition and Results of Operation" on pages 3 through 17
in the Company's 1997 Annual Report which section is incorporated herein by
reference.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Pages 4 and 5 of the attached 1997 Annual Report to Stockholders are
herein incorporated by reference.
31
<PAGE>
Interest Rate Risk Management
The Company's net income is dependent on its net interest income. Net
interest income is susceptible to interest rate risk to the degree that
interest-bearing liabilities mature or reprice on a different basis than
interest-earning assets. When interest-bearing liabilities mature or reprice
more quickly than interest-earning assets in a given period, a significant
increase in market rates of interest could adversely affect net interest
income. Similarly, when interest-earning assets mature or reprice more quickly
than interest-bearing liabilities, falling interest rates could result in a
decrease in net income.
In an attempt to manage its exposure to changes in interest rates,
management monitors the Company's interest rate risk. Management meets monthly
to review the Company's interest rate risk position and profitability, and to
recommend adjustments for consideration by the Board of Directors. Management
also reviews the Bank's securities portfolio, formulates investment strategies,
and oversees the timing and implementation of transactions to assure attainment
of the Board's objectives in the most effective manner. Notwithstanding the
Company's interest rate risk management activities, the potential for changing
interest rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company's asset/liability position, the Board and
management attempt to manage the Company's interest rate risk while enhancing
net interest margins. At times, depending on the level of general interest
rates, the relationship between long and short-term interest rates, market
conditions and competitive factors, the Board and management may determine to
increase the Company's interest rate risk position somewhat in order to
increase its net interest margin. The Company's results of operations and net
portfolio values remain vulnerable to increases in interest rates and to
fluctuations in the difference between long- and short-term interest rates.
Consistent with the asset/liability management philosophy described
above, the Company has taken several steps to manage its interest rate risk.
First, the Company has structured the security portfolio to shorten the lives
of its interest-earning assets. The Company's recent purchases of securities,
including mortgage-backed securities have had short or medium terms to
maturity. At September 30, 1997, the Company had securities totaling $123.0
million, of which $79.1 million have contractual maturities of five years or
less. Mortgage-backed securities amortize and experience prepayments of
principal; the Company has received average cash flows from principal paydowns,
sales, maturities and calls of securities of $15.4 million annually over the
past three fiscal years. The Company also controls interest rate risk reduction
by emphasizing non-certificate depositor accounts. The Board and management
believe that such accounts carry a lower cost than certificate accounts, and
that a material portion of such accounts may be more resistant to changes in
interest rates than are certificate accounts. At September 30, 1997, the
Company had $15.3 million of regular savings accounts, and $14.3 million of
money market, demand and NOW accounts, representing 20.9% of total depositor
accounts.
The Company does not currently engage in trading activities or use
derivative instruments to control interest rate risk. Even though such
activities may be permitted with the approval of the Board of Directors, the
Company does not intend to engage in such activities in the immediate future.
Interest rate risk is the most significant market risk affecting the Company.
Other types of market risk, such as foreign currency exchange rate risk and
commodity price risk, do not arise in the normal course of the Company's
business activities.
32
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and supplementary
data set forth on pages 19 through 51 of the Company's 1997 Annual Report are
incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
N/A.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item regarding directors and
executive officers of the Company is set forth under the sections captioned
"Proposal 1 - Election of Directors - General" on pages 6 and 7 of the Proxy
Statement and "Proposal 1 - Election of Directors - Executive Officers" on page
11 of the Proxy Statement, which sections are incorporated herein by reference.
The information required by this Item regarding compliance with
Section 16(a) of the Securities Exchange Act of 1934 is set forth under the
section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" set
forth on page 5 of the Proxy Statement, which is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the sections
captioned "Proposal 1 - Election of Directors - Directors' Compensation" on
pages 8 through 11 and "- Executive Compensation" on pages 11 through 16 of
the Proxy Statement, which sections are incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference
from the section captioned "Security Ownership of Certain Beneficial Owners"
on pages 3 through 5 of the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There have been no reportable transactions during the two most recent
fiscal years nor are any reportable transactions proposed as of the date of
this Form 10-K. See also the section captioned "Proposal 1 - Election of
Directors - Certain Indebtedness and Transactions of Management" on page 19 of
the Proxy Statement, which section is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
14(a)1. Consolidated Financial Statements (contained in the Bank's 1997 Annual
Report attached hereto as Exhibit (13) and incorporated herein by
reference)
(a) Independent Auditors' Report
33
<PAGE>
(b) Statements of Financial Condition as of September 30, 1997 and
1996
(c) Statements of Income for the Years Ended September 30, 1997,
1996 and 1995
(d) Statements of Equity for the Years Ended September 30, 1997,
1996 and 1995
(e) Statements of Cash Flows for the Years Ended September 30,
1997, 1996 and 1995
(f) Notes to Financial Statements
14(a)2. Financial Statement Schedules
All schedules have been omitted as the required information is either
inapplicable or included in the Notes to Consolidated Financial
Statements.
<TABLE>
<CAPTION>
14(a)3. Exhibits
<C> <C> <S>
Exhibit (3)(i) Certificate of Incorporation, incorporated
herein by reference to Exhibit (3)(i) to the
Registration Statement on Form S-1, Registration
No. 333-04509, dated May 24, 1996, and amended
on July 25, 1996
Exhibit (3)(ii) Bylaws, incorporated herein by reference to
Exhibit (3)(ii) to the Registration Statement on
Form S-1, Registration No. 333-04509, dated May
24, 1996, and amended on July 25, 1996
Exhibit (4) Specimen Stock Certificate, incorporated
herein by reference to Exhibit (4) to the
Registration Statement on Form S-1, Registration
No. 333-04509, dated May 24, 1996, and amended
on July 25, 1996
Exhibit (10)(i) Employment Agreement between Carl M. Hill and
Home Savings Bank of Albemarle, Inc., S.S.B.,
incorporated herein by reference to the Form 10-
K dated September 30, 1996
Exhibit (10)(ii) Employment Agreement between R. Ronald Swanner
and Home Savings Bank of Albemarle, Inc.,
S.S.B., incorporated herein by reference to the
Form 10-K dated September 30, 1996
Exhibit (10)(iii) 1985 Retirement Payment Agreements with Carl M.
Hill, R. Ronald Swanner, Caldwell A. Holbrook,
Jr. and Joel A. Huneycutt, incorporated herein
by reference to the Form 10-K dated September
30, 1996
Exhibit (10)(v) 1995 Retirement Payment Agreements with Carl M.
Hill, R. Ronald Swanner, Caldwell A. Holbrook,
Jr., Joel A. Huneycutt, Douglas Dwight Stokes
and Greg E. Underwood, incorporated herein by
reference to the Form 10-K dated September 30,
1996
Exhibit (10)(vi) Directors Retirement Plan Agreements with Carl
M. Hill, R. Ronald Swanner, Caldwell A.
Holbrook, Jr., Joel A. Huneycutt, Douglas Dwight
Stokes and Greg E. Underwood, incorporated
herein by reference to the Form 10-K dated
September 30, 1996
</TABLE>
34
<PAGE>
<TABLE>
<C> <C> <S>
Exhibit (10)(vii) 1985 Supplemental Income Agreements with Carl M.
Hill and R. Ronald Swanner, incorporated herein
by reference to the Form 10-K dated September
30, 1996
Exhibit (10)(viii) 1995 Supplemental Income Agreements with Carl M.
Hill and R. Ronald Swanner, incorporated herein
by reference to the Form 10-K dated September
30, 1996
Exhibit (10)(ix) South Street Financial Corp. Stock Option Plan
Exhibit (10)(x) Home Savings Bank of Albemarle, Inc., SSB
Management Recognition Plan and Trust Agreement
Exhibit (11) Statement Regarding Computation of Per Share
Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) 1997 Annual Report to Security Holders
Exhibit (21) See Item 1. Business for discussion of
subsidiaries
Exhibit (27) Financial Data Schedule
14(b) The Company filed no reports on Form 8-K during the last quarter of
the fiscal year ended September 30, 1997.
</TABLE>
35
<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.
SOUTH STREET FINANCIAL CORP.
Date: December 22, 1997 By: /s/ Carl M. Hill
---------------------
Carl M. Hill
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Carl M. Hill President, Chief Executive December 22, 1997
----------------------------------- Officer and Director
Carl M. Hill
/s/ R. Ronald Swanner Executive Vice President, December 22, 1997
----------------------------------- Secretary and Director
R. Ronald Swanner
/s/ Christopher F. Cranford Controller and Treasurer December 22, 1997
-----------------------------------
Christopher F. Cranford
/s/ Caldwell A. Holbrook, Director December 22, 1997
----------------------------------
Caldwell A. Holbrook, Jr.
/s/ Joel A. Huneycutt Director December 22, 1997
----------------------------------
Joel A. Huneycutt
/s/ Douglas Dwight Stokes Director December 22, 1997
----------------------------------
Douglas Dwight Stokes
/s/ Greg E. Underwood Director December 22, 1997
----------------------------------
Greg E. Underwood
</TABLE>
36
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
Exhibit (3)(i) Certificate of Incorporation, incorporated herein by
reference to Exhibit (3)(i) to the Registration
Statement on Form S-1, Registration No. 333-04509,
dated May 24, 1996, and amended on July 25, 1996
Exhibit (3)(ii) Bylaws, incorporated herein by reference to Exhibit
(3)(ii) to the Registration Statement on Form S-1,
Registration No. 333-04509, dated May 24, 1996, and
amended on July 25, 1996
Exhibit (4) Specimen Stock Certificate, incorporated herein by
reference to Exhibit (4) to the Registration
Statement on Form S-1, Registration No. 333-04509,
dated May 24, 1996, and amended on July 25, 1996
Exhibit (10)(i) Employment Agreement between Carl M. Hill and Home
Savings Bank of Albemarle, Inc., S.S.B., incorporated
herein by reference to the Form 10-K dated September
30, 1996
Exhibit (10)(ii) Employment Agreement between R. Ronald Swanner and
Home Savings Bank of Albemarle, Inc., S.S.B.,
incorporated herein by reference to the Form 10-K
dated September 30, 1996
Exhibit (10)(iii) 1985 Retirement Payment Agreements with Carl M. Hill,
R. Ronald Swanner, Caldwell A. Holbrook, Jr. and Joel
A. Huneycutt, incorporated herein by reference to the
Form 10-K dated September 30, 1996
Exhibit (10)(v) 1995 Retirement Payment Agreements with Carl M. Hill,
R. Ronald Swanner, Caldwell A. Holbrook, Jr., Joel A.
Huneycutt, Douglas Dwight Stokes and Greg E.
Underwood, incorporated herein by reference to the
Form 10-K dated September 30, 1996
Exhibit (10)(vi) Directors Retirement Plan Agreements with Carl M.
Hill, R. Ronald Swanner, Caldwell A. Holbrook, Jr.,
Joel A. Huneycutt, Douglas Dwight Stokes and Greg E.
Underwood, incorporated herein by reference to the
Form 10-K dated September 30, 1996, incorporated
herein by reference to the Form 10-K dated September
30, 1996
Exhibit (10)(vii) 1985 Supplemental Income Agreements with Carl M. Hill
and R. Ronald Swanner, incorporated herein by
reference to the Form 10-K dated September 30, 1996
Exhibit (10)(viii) 1995 Supplemental Income Agreements with Carl M. Hill
and R. Ronald Swanner
Exhibit (10)(ix) South Street Financial Corp. Stock Option Plan
Exhibit (10)(x) Home Savings Bank of Albemarle, Inc., SSB Management
Recognition Plan and Trust Agreement
Exhibit (11) Statement Regarding Computation of Per Share Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) 1997 Annual Report to Security Holders
</TABLE>
37
<PAGE>
<TABLE>
<S> <C>
Exhibit (21) See Item 1. Business for discussion of subsidiaries
Exhibit (27) Financial Data Schedule
14(b) The Company filed no reports on Form 8-K during the
last quarter of the fiscal year ended September 30,
1997.
</TABLE>
38
<PAGE>
SOUTH STREET FINANCIAL CORP.
STOCK OPTION PLAN
THIS IS THE STOCK OPTION PLAN ("Plan") of South Street Financial Corp. (the
"Corporation"), a North Carolina corporation, with its principal office in
Albemarle, Stanly County, North Carolina, adopted by the Board of Directors of
the Corporation and effective upon the approval of the Plan by the shareholders
of the Corporation, under which options may be granted from time to time to
eligible directors and employees of the Corporation, Home Savings Bank of
Albemarle, Inc., SSB (the "Bank") and of any corporation or other entity of
which either the Corporation or the Bank owns, directly or indirectly, not less
than fifty percent (50%) of any class of equity securities (a "Subsidiary"), to
purchase shares of common stock of the Corporation ("Common Stock"), subject to
the provisions set forth below:
1. PURPOSE OF THE PLAN. The purpose of the Plan is to aid the Corporation,
-------------------
the Bank and any Subsidiary in attracting and retaining capable directors and
employees and to provide a long range incentive for directors, employees and
others to remain in the management and service of the Corporation, the Bank or
any Subsidiary, to perform at increasing levels of effectiveness and to acquire
a permanent stake in the Corporation with the interest and outlook of an owner.
These objectives will be promoted through the granting of options to acquire
shares of Common Stock pursuant to the terms of this Plan.
2. ADMINISTRATION. The Plan shall be administered by a committee (the
--------------
"Committee"), which shall consist of not less than two members of the Board of
Directors of the Corporation (the "Board") who are "Non-Employee Directors" as
defined in Rule 16b-3(b)(3) of the Rules and Regulations under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Members of the Committee
shall serve at the pleasure of the Board. In the absence at any time of a duly
appointed Committee, this Plan shall be administered by the Board. The Committee
may designate any officers or employees of the Corporation, the Bank or any
Subsidiary to assist in the administration of the Plan and to execute documents
on behalf of the Committee and perform such other ministerial duties as may be
delegated to them by the Committee.
Subject to the provisions of the Plan, the determinations or the
interpretation and construction of any provision of the Plan by the Committee
shall be final and conclusive upon all persons affected thereby. By way of
illustration and not of limitation, the Committee shall have the discretion (a)
to construe and interpret the Plan and all options granted hereunder and to
determine the terms and provisions (and amendments thereof) of the options
granted under the Plan (which need not be identical); (b) to define the terms
used in the Plan and in the options granted hereunder; (c) to prescribe, amend
and rescind the rules and regulations relating to the Plan; (d) to determine the
individuals to whom and the time or times at which such options shall be
granted, the number of shares to be subject to each option, the option price,
and the determination of leaves of absence which may be granted to participants
without constituting a termination of their employment for the purposes of the
Plan; and (e) to make all other determinations necessary or advisable for the
administration of the Plan.
<PAGE>
It shall be in the discretion of the Committee to grant options which qualify
as "incentive stock options," as that term is defined in Section 422 of the
Internal Revenue Code of 1986, as amended ("Incentive Stock Options") or which
do not qualify as Incentive Stock Options ("Nonqualified Stock Options") (herein
referred to collectively as "Options;" however, whenever reference is
specifically made only to "Incentive Stock Options" or "Nonqualified Stock
Options," such reference shall be deemed to be made to the exclusion of the
other). Any options granted which fail to satisfy the requirements for
Incentive Stock Options shall become Nonqualified Stock Options.
3. STOCK AVAILABLE FOR OPTIONS. In the discretion of the Committee, the
---------------------------
stock to be subject to Options under the Plan shall be authorized but unissued
shares of Common Stock which are issued directly to optionees upon exercise of
options and/or shares of Common Stock which are acquired by the Plan or the
Corporation in the open market. The total number of shares of Common Stock for
which Options may be granted under the Plan is 449,650 shares, which is ten
percent (10%) of the total number of shares of Common Stock issued by the
Corporation in connection with the conversion of the Bank from a North Carolina
mutual savings bank to a North Carolina stock savings bank on October 2, 1996
(the "Conversion"). Such number of shares is subject to any capital adjustments
as provided in Section 16. In the event that an Option granted under the Plan
is forfeited, released, expires or is terminated unexercised as to any shares
covered thereby, such shares thereafter shall be available for the granting of
Options under the Plan; however, if the forfeiture, expiration, release or
termination date of an Option is beyond the term of existence of the Plan as
described in Section 21, then any shares covered by forfeited, unexercised,
released or terminated options shall not reactivate the existence of the Plan
and therefore may not be available for additional grants under the Plan. The
Corporation, during the term of the Plan, will reserve and keep available a
number of shares of Common Stock sufficient to satisfy the requirements of the
Plan. In the discretion of the Committee, the shares of Common Stock necessary
to be delivered to satisfy exercised options may be from authorized and unissued
shares of Common Stock or may be purchased in the open market.
4. ELIGIBILITY. Options shall be granted only to individuals who meet all
-----------
of the following eligibility requirements:
(a) Such individual must be an employee or a member of the Board of
Directors of the Corporation, the Bank or a Subsidiary. For this purpose, an
individual shall be considered to be an "employee" only if there exists
between the Corporation, the Bank or a Subsidiary and the individual the
legal and bona fide relationship of employer and employee. In determining
whether such relationship exists, the regulations of the United States
Treasury Department relating to the determination of such relationship for
the purpose of collection of income tax at the source on wages shall be
applied.
(b) Such individual must have such knowledge and experience in financial
and business matters that he or she is capable of evaluating the merits and
risks of the investment involved in the exercise of the Options.
(c) Such individual, being otherwise eligible under this Section 4, shall
have been selected by the Committee as a person to whom an Option shall be
granted under the Plan.
<PAGE>
In determining the directors and employees to whom Options shall be granted
and the number of shares to be covered by each Option, the Committee shall take
into account the nature of the services rendered by respective directors and
employees, their present and potential contributions to the success of the
Corporation, the Bank and any Subsidiary and such other factors as the Committee
shall deem relevant. A director or employee who has been granted an Option
under the Plan may be granted an additional Option or Options under the Plan if
the Committee shall so determine.
If, pursuant to the terms of the Plan, it is necessary that the percentage of
stock ownership of any individual be determined, stock ownership in the
Corporation or of a related corporation which is owned (directly or indirectly)
by or for such individual's brothers and sisters (whether by the whole or half
blood), spouse, ancestors, and lineal descendants or by or for any corporation,
partnership, estate or trust of which such employee is a shareholder, partner or
beneficiary shall be considered as owned by such director or employee.
5. OPTION AGREEMENT Subject to the provisions of this Plan, Options shall
----------------
be awarded to the directors and employees in such amounts as are determined by
the Committee. The proper officers on behalf of the Corporation and each
Optionee shall execute a Stock Option Grant and Agreement (the "Option
Agreement") which shall set forth the total number of shares of Common Stock to
which it pertains, the exercise price, whether it is a Nonqualified Stock Option
or an Incentive Stock Option, and such other terms, conditions, restrictions and
privileges as the Committee in each instance shall deem appropriate, provided
they are not inconsistent with the terms, conditions and provisions of this
Plan. Each Optionee shall receive a copy of his executed Option Agreement. Any
Option granted with the intention that it will be an Incentive Stock Option but
which fails to satisfy a requirement for Incentive Stock Options shall continue
to be valid and shall be treated as a Nonqualified Stock Option.
6. OPTION PRICE.
------------
(a) The option price of each Option granted under the Plan shall be not
less than one hundred percent (100%) of the market value of the stock on the
date of grant of the Option. In the case of incentive stock options granted to
a shareholder who owns stock possessing more than 10 percent (10%) of the
total combined voting power of all classes of stock of the Corporation, the
Bank or a Subsidiary (a "ten percent shareholder"), the option price of each
Option granted under the Plan shall not be less than one hundred and ten
percent (110%) of the market value of the stock on the date of grant of the
Option. If the Common Stock is listed on a national securities exchange
(including for this purpose the Nasdaq Stock Market, Inc. National Market) on
the date in question, then the market value per share shall be not less than
the average of the highest and lowest selling price on such exchange on such
date, or if there were no sales on such date, then the market price per share
shall be equal to the average between the bid and asked price on such date. If
the Common Stock is traded otherwise than on a national securities exchange
(including for this purpose the Nasdaq Stock Market, Inc. National Market) on
the date in question, then the market price per share shall be equal to the
average between the bid and asked price on such date, or, if there is no bid
and asked price on such date, then on the next prior business day on which
there was a bid and asked price. If no such bid and asked price is available,
then the market value per share shall be its fair market value as determined
by the Committee, in its sole and
<PAGE>
absolute discretion. The Committee shall maintain a written record of its
method of determining such value.
(b) The option price shall be payable to the Corporation either (i) in
cash or by check, bank draft or money order payable to the order of the
Corporation, or (ii) at the discretion of the Committee, through the delivery
of shares of the common stock of the Corporation owned by the optionee with a
market value (determined in a manner consistent with (i) above) equal to the
option price, or (iii) at the discretion of the Committee by a combination of
(i) and (ii) above. No shares shall be delivered until full payment has been
made.
7. EXPIRATION OF OPTIONS. The Committee shall determine the expiration date
---------------------
or dates of each Option, but such expiration date shall be not later than ten
(10) years after the date such Option is granted. In the event an Incentive
Stock Option is granted to a ten percent shareholder, the expiration date or
dates of each Option shall be not later than five (5) years after the date such
Option is granted. The Committee, in its discretion, may extend the expiration
date or dates of an Option after such date was originally set; however, such
expiration date may not exceed the maximum expiration date described in this
Section 7.
8. TERMS AND CONDITIONS OF OPTIONS.
-------------------------------
(a) All Options must be granted within ten (10) years of the Effective
Date of this Plan as defined in Section 20.
(b) The Committee may grant Options which are intended to be Incentive
Stock Options and Nonqualified Stock Options, either separately or jointly, to
an eligible employee.
(c) The grant of Options shall be evidenced by a written instrument (an
Option Agreement) containing terms and conditions established by the Committee
consistent with the provisions of this Plan.
(d) Not less than 100 shares may be purchased at any one time unless the
number purchased is the total number at that time purchasable under the Plan.
(e) The recipient of an Option shall have no rights as a shareholder with
respect to any shares covered by his Option until payment in full by him for
the shares being purchased. No adjustment shall be made for dividends
(ordinary or extraordinary, whether in cash, securities or other property) or
distributions or other rights for which the record date is prior to the date
such stock is fully paid for, except as provided in Section 16.
(f) The aggregate fair market value of the stock (determined as of the
time the Option is granted) with respect to which Incentive Stock Options are
exercisable for the first time by any participant during any calendar year
(under all benefit plans of the Corporation, the Bank or any Subsidiary, if
applicable) shall not exceed $100,000; provided, however, that such $100,000
limit of this subsection (f) shall not apply to the grant of Nonqualified
Stock Options. The Committee may grant Options which are
<PAGE>
exercisable in excess of the foregoing limitations, in which case Options
granted which are exercisable in excess of such limitation shall be
Nonqualified Stock Options.
(g) All stock obtained pursuant to an option which qualifies as an
Incentive Stock Option shall be held in escrow for a period which ends on the
later of (i) two (2) years from the date of the granting of the Option or (ii)
one (1) year after the transfer of the stock pursuant to the exercise of the
Option. The stock shall be held by the Corporation or its designee. The
employee who has exercised the Option shall during such holding period have
all rights of a shareholder, including but not limited to the rights to vote,
receive dividends and sell the stock. The sole purpose of the escrow is to
inform the Corporation of a disqualifying disposition of the stock within the
meaning of Section 422 of the Internal Revenue Code of 1986, as amended, and
it shall be administered solely for that purpose.
9. EXERCISE OF OPTIONS.
-------------------
(a) Unless otherwise set forth in the Option Agreement, all Options
granted to an optionee by virtue of his position as a nonemployee director of
the Corporation or the Bank (as stated in the Option Agreement) shall be fully
vested, exercisable and nonforfeitable immediately at the time of the grant.
(b) Options granted to an optionee by virtue of his position as an
employee (as stated in the Option Agreement) shall become vested and
exercisable at the times, at the rate and subject to such limitations as may
be set forth in the Option Agreement executed in connection therewith;
provided, however, that all outstanding and nonforfeited options shall be
exercisable, if not sooner, on the day prior to the expiration date thereof.
(c) Notwithstanding the foregoing, Options shall become exercisable with
respect to all of the shares subject thereto upon the optionee's death,
retirement or disability within the meaning of Section 22(e)(3) of the
Internal Revenue Code of 1986, as amended, and in the event of a change in
control as set forth in Section 13 of this Plan.
(d) Any right to exercise Options in annual installments shall be
cumulative and any vested installments may be exercised, in whole or in part,
at the election of the optionee. The exercise of any Option must be evidenced
by written notice to the Corporation that the optionee intends to exercise his
Option.
(e) In no event shall an Option be deemed granted by the Corporation or
exercisable by a recipient prior to the mutual execution by the Corporation
and the recipient of an Option Agreement which comports with the requirements
of Section 5 and Section 8(c).
(f) The inability of the Corporation or Bank to obtain approval from any
regulatory body or authority deemed by counsel to be necessary to the lawful
issuance and sale of any shares of Common Stock hereunder shall relieve the
Corporation and the Bank of any liability in respect of the non-issuance or
sale of such shares. As a condition to the exercise of an option, the
Corporation may require the person exercising the Option to make such
representations and warranties as may be necessary to assure
<PAGE>
the availability of an exemption from the registration requirements of federal
or state securities laws.
(g) The Committee shall have the discretionary authority to impose in the
Option Agreements such restrictions on shares of Common Stock as it may deem
appropriate or desirable, including but not limited to the authority to impose
a right of first refusal or to establish repurchase rights or both of these
restrictions.
(h) Notwithstanding anything to the contrary herein, an optionee
receiving the grant of an Option by virtue of his or her position as a
director or as an employee of the Corporation, the Bank or a Subsidiary (as
stated in the Option Agreement), shall be required to exercise his or her
Options within the periods set forth in Sections 10, 11 and 12 below.
10. TERMINATION OF EMPLOYMENT - EXCEPT BY DISABILITY, RETIREMENT OR DEATH.
---------------------------------------------------------------------
If any optionee receiving the grant of an Option by virtue of his position as a
director (as stated in the Option Agreement) ceases to be a director of at least
one of the Corporation, the Bank or any Subsidiary for any reason other than
death, retirement (as defined in Section 11) or disability (as defined in
Section 11) or if any optionee receiving the grant of an Option by virtue of his
position as an employee (as stated in the Option Agreement) ceases to be an
employee of at least one of the Corporation, the Bank and any Subsidiary for any
reason other than death, retirement (as defined in Section 11) or disability (as
defined in Section 11), he may, (i) at any time within three (3) months after
his date of termination, but not later than the date of expiration of the
Option, exercise any Option designated in the Option Agreement as an Incentive
Stock Option and (ii) at any time prior to the date of expiration of the Option,
exercise any option designated in the Option Agreement as a Nonqualified Stock
Option. However, in either such event the optionee may exercise any Option only
to the extent it was vested and he or she was entitled to exercise the Option on
the date of termination. Any Options or portions of Options of terminated
optionees not so exercised shall terminate and be forfeited.
11. TERMINATION OF EMPLOYMENT - DISABILITY OR RETIREMENT. If any optionee
----------------------------------------------------
receiving the grant of an Option by virtue of his position as a director (as
stated in the Option Agreement) ceases to be a director of at least one of the
Corporation, the Bank or any Subsidiary due to his becoming disabled within the
meaning of Section 22(e)(3) of the Internal Revenue Code of 1986, as amended, or
if any employee receiving the grant of an Option by virtue of his position as an
employee (as stated in the Option Agreement) ceases to be employed by at least
one of the Corporation, the Bank and any Subsidiary due to his becoming disabled
within the meaning of Section 22(e)(3) of the Internal Revenue Code of 1986, as
amended, all unvested and forfeitable Options of such optionee shall immediately
become vested and nonforfeitable and he may, (i) at any time within 12 months
after his date of termination, but not later than the date of expiration of the
Option, exercise any option designated in the Option Agreement as an Incentive
Stock Option with respect to all shares subject thereto and (ii) at any time
prior to the date of expiration of the Option, exercise any Option designated in
the Option Agreement as a Nonqualified Stock Option with respect to all shares
subject thereto. Any portions of Options of optionees who are terminated
because they become disabled which are not so exercised shall terminate.
If any optionee receiving the grant of an Option by virtue of his position as
a director (as stated in the Option Agreement) ceases to be a director of at
least one of the Corporation, the
<PAGE>
Bank or any Subsidiary due to his retirement, or if any employee receiving the
grant of an Option by virtue of his position as an employee (as stated in the
Option Agreement) ceases to be employed by at least one of the Corporation, the
Bank and any Subsidiary due to his retirement, all unvested and forfeitable
Options of such optionee shall immediately become vested and nonforfeitable and
he may, at any time prior to the date of expiration of the Option, exercise such
Option; provided, however, that if the Option is exercised more than three
months after such retirement, the Option may be treated as a Nonqualified Stock
Option. Any portions of Options of retired directors or employees not so
exercised shall terminate. For purposes of this Plan, the term "retirement," as
it relates to any optionee receiving a grant of an Option as a result of his or
her position as an employee of the Corporation, the Bank or any Subsidiary,
shall mean (i) the termination of the optionee's employment under conditions
which would constitute retirement under any tax qualified retirement plan
maintained by the Corporation, the Bank or a Subsidiary, or (ii) termination of
employment after attaining age 65. The term "retirement," as it relates to any
optionee receiving a grant of an Option as a result of his or her position as a
director shall mean the cessation of membership on such board of directors (i)
with the approval of such board of directors, at any time after such optionee
reaches age 65, or (ii) at the election of the optionee at any time after not
less than 25 years of service as a member of the such board of directors, as
applicable.
12. TERMINATION OF EMPLOYMENT - DEATH. If an optionee receiving the grant of
---------------------------------
an option by virtue of his position as a director (as stated in the Option
Agreement) dies while a director of the Corporation, the Bank or any Subsidiary
or if any employee receiving the grant of an option by virtue of his position as
an employee (as stated in the Option Agreement) dies while in the employment of
the Corporation, the Bank or a Subsidiary, all unvested and forfeitable Options
of such optionee shall immediately become vested and nonforfeitable and the
person or persons to whom the Option is transferred by will or by the laws of
descent and distribution may exercise the Option at any time until the term of
the Option has expired, with respect to all shares subject thereto, to the same
extent and upon the same terms and conditions the optionee would have been
entitled to do so had he lived. Any Options or portions of options of deceased
directors or employees not so exercised shall terminate.
13. CHANGE IN CONTROL. In the event that an optionee ceases to be an
-----------------
employee, a director of the Corporation, the Bank or a Subsidiary (which
position resulted in his or her receipt of an option pursuant to this Plan) for
any reason after the occurrence of a "change in control" and prior to the time
that all shares allocated to him or her would be 100% vested, nonforfeitable and
exercisable in accordance with Sections 9 and 10 above, then, notwithstanding
Sections 9 and 10 above, all Options granted to such optionee shall immediately
become fully vested and nonforfeitable. For purposes of this Plan, a "change in
control" shall mean (i) a change in control of a nature that would be required
to be reported by the Corporation in response to Item 1 of the Current Report on
Form 8-K, as in effect on the date hereof, pursuant to Section 13 or 15(d) of
the Exchange Act; (ii) such time as any "person" (as such term is used in
Sections 13(d) and 14(d) of the Exchange Act) is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of securities of the Corporation or Bank representing 25 percent or
more of the combined voting power of the outstanding Common Stock of the
Corporation or outstanding common stock of the Bank, as applicable; or (iii)
individuals who constitute the Board or the board of directors of the Bank on
the date hereof (the "Incumbent Board" and "Incumbent Bank Board," respectively)
cease for any reason to constitute at least a majority thereof, provided that
any person becoming a director subsequent to the date hereof whose election was
approved by a vote of at least three-quarters of
<PAGE>
the directors comprising the Incumbent Board or Incumbent Bank Board, as
applicable, or whose nomination for election by the Corporation's or Bank's
shareholders was approved by the Corporation's or Bank's Board of Directors or
Nominating Committee, shall be considered as though he or she were a member of
the Incumbent Board or Incumbent Bank Board, as applicable; or (iv) either the
Corporation or the Bank consolidates or merges with or into another corporation,
association or entity or is otherwise reorganized, where neither the Corporation
nor the Bank, respectively, is the surviving corporation in such transaction; or
(v) all or substantially all of the assets of either the Corporation or the Bank
are sold or otherwise transferred to or are acquired by any other entity or
group.
As set forth in Section 10, in the event of such a termination after a change
in control, the Optionee must exercise any Incentive Stock Options within three
(3) months after his date of termination and may exercise any Nonqualified Stock
Options at any time prior to the date of expiration of the Option.
14. STOCK APPRECIATION RIGHTS.
-------------------------
(a) General Terms and Conditions. The Committee may, but shall not be
obligated to, grant rights to optionees to surrender an exercisable Option, or
any portion thereof, in consideration for the payment by the Corporation of an
amount equal to the excess of the market value (determined as set forth in
Section 6 above) of the shares of Common Stock subject to the Option, or
portion thereof, surrendered over the exercise price of the Option with
respect to such shares (any such authorized surrender and payment being
hereinafter referred to as a "Stock Appreciation Right"). Such payment, at the
discretion of the Committee, may be made in shares of Common Stock valued at
the then market value thereof (determined as set forth in Section 6 above), or
in cash, or partly in cash and partly in shares of Common Stock.
The terms and conditions set with respect to a Stock Appreciation Right
may include (without limitation), subject to other provisions of this Section
14 and this Plan, the period during which, date by which or event upon which
the Stock Appreciation Right may be exercised (which shall be on the same
terms as the Option to which is related); the method for valuing shares of
Common Stock for purposes of this Section 14; a ceiling on the amount of
consideration which the Corporation may pay in connection with exercise of the
Stock Appreciation Right; and arrangements for income tax withholding. The
Committee shall have complete discretion to determine whether, when and to
whom Stock Appreciation Rights may be granted.
(b) Time Limitations. A Stock Appreciation Right may be exercised only
within the period, if any, within which the Option to which it relates may be
exercised. Notwithstanding the foregoing, any election by an optionee to
exercise Stock Appreciation Rights shall be made during the period beginning
on the third business day following the release for publication of quarterly
or annual financial information required to be prepared and disseminated by
the Corporation pursuant to the requirements of the Exchange Act and ending on
the twelfth business day following such date. The required release of
information shall be deemed to have been satisfied when the specified
financial data appears on or in a wire service, financial news service or
newspaper of general circulation or is otherwise first made publicly
available.
<PAGE>
(c) Effects of Exercise of Stock Appreciation Rights or Options. Upon
the exercise of a Stock Appreciation Right, the number of shares of Common
Stock available under the Option to which it relates shall decrease by a
number equal to the number of shares for which the Stock Appreciation Right
was exercised. Upon the exercise of an Option, any related Stock Appreciation
Right shall terminate as to any number of shares of Common Stock subject to
the Stock Appreciation Right that exceeds the total number of shares for which
the Option remains unexercised.
(d) Time of Grant. A Stock Appreciation Right granted in connection with
an Incentive Stock Option must be granted concurrently with the Option to
which is relates, while a Stock Appreciation Right granted in connection with
a Nonqualified Stock Option may be granted concurrently with the Option to
which it relates or at any time thereafter prior to the exercise or expiration
of such Option. No optionee shall have any Stock Appreciation Rights unless
(i) in the case of Incentive Stock Options and Nonqualified Stock Options, the
Stock Option Agreement shall so state or (ii) in the case of Nonqualified
Stock Options, the Committee shall have executed an amendment to the Stock
Option Agreement so stating.
(e) Non-Transferable. A Stock Appreciation Right may not be transferred
or assigned except in connection with a transfer of the Option to which it
relates.
15. RESTRICTIONS ON TRANSFER. An Option granted under this Plan may not be
------------------------
transferred except by will or the laws of descent and distribution and, during
the lifetime of the optionee to whom it was granted, may be exercised only by
such optionee.
16. CAPITAL ADJUSTMENTS AFFECTING COMMON STOCK.
------------------------------------------
(a) If the outstanding shares of Common Stock of the Corporation are
increased, decreased, changed into or exchanged for a different number or kind
of shares or other securities of the Corporation or another entity as a result
of a recapitalization, reclassification, stock dividend, stock split,
amendment to the Corporation's Certificate of Incorporation, reverse stock
split, merger or consolidation, an appropriate adjustment shall be made in the
number and/or kind of securities allocated to the Options and Stock
Appreciation Rights previously and subsequently granted under the Plan,
without change in the aggregate purchase price applicable to the unexercised
portion of the outstanding Options but with a corresponding adjustment in the
price for each share or other unit of any security covered by the Options.
(b) In the event that the Corporation shall declare and pay any dividend
with respect to the Common Stock (other than a dividend payable in shares of
the Corporation's Common Stock or a regular quarterly cash dividend),
including a dividend which results in a nontaxable return of capital to the
holders of shares of Common Stock for federal income tax purposes, or
otherwise than by dividend makes distribution of property to the holders of
its shares of Common Stock, the Committee, in its discretion applied uniformly
to all outstanding Options, may adjust the exercise price per share of
outstanding Options in such a manner as the Committee may determine to be
necessary to reflect the effect of the dividend or other distribution on the
fair market value of a share of Common Stock.
<PAGE>
(c) To the extent that the foregoing adjustments described in Sections
16(a) and (b) above relate to particular Options or to particular stock or
securities of the Corporation subject to Option under this Plan, such
adjustments shall be made by the Committee, whose determination in that
respect shall be final and conclusive.
(d) The grant of an Option or Stock Appreciation Right pursuant to this
Plan shall not affect in any way the right or power of the Corporation to make
adjustments, reclassifications, reorganizations or changes of its capital or
business structure or to merge or to consolidate or to dissolve, liquidate or
sell, or transfer all or any part of its business or assets.
(e) No fractional shares of stock shall be issued under the Plan for any
such adjustment.
(f) Any adjustment made pursuant to this Section 16, shall be made, to
the extent practicable, in such manner as not to constitute a modification of
any outstanding Incentive Stock Options within the meaning of Section 424(h)
of the Internal Revenue Code of 1986, as amended.
17. INVESTMENT PURPOSE. At the discretion of the Committee, any Option
------------------
Agreement may provide that the optionee shall, by accepting the Option,
represent and agree, for himself and his transferees by will or the laws of
descent and distribution, that all shares of stock purchased upon the exercise
of the Option will be acquired for investment and not for resale or
distribution, and that upon each exercise of any portion of an Option, the
person entitled to exercise the same shall furnish evidence of such facts which
is satisfactory to the Corporation. Certificates for shares of stock acquired
under the Plan may be issued bearing such restrictive legends as the Corporation
and its counsel may deem necessary to ensure that the optionee is not an
"underwriter" within the meaning of the regulations of the Securities Exchange
Commission.
18. APPLICATION OF FUNDS. The proceeds received by the Corporation from the
--------------------
sale of Common Stock pursuant to Options will be used for general corporate
purposes.
19. NO OBLIGATION TO EXERCISE. The granting of an Option or Stock
-------------------------
Appreciation Right shall impose no obligation upon the optionee to exercise such
Option or Stock Appreciation Right.
20. EFFECTIVE DATE OF PLAN. The Plan will become effective upon the approval
----------------------
of the Plan by the shareholders of the Corporation and receipt of any necessary
regulatory approvals.
21. TERM OF PLAN. Options and Stock Appreciation Rights may be granted
------------
pursuant to this Plan from time to time within ten (10) years from the effective
date of the Plan.
22. TIME OF GRANTING OF OPTIONS. Nothing contained in the Plan or in any
---------------------------
resolution adopted or to be adopted by the Committee or the shareholders of the
Corporation and no action taken by the Committee shall constitute the granting
of any Option or Stock Appreciation Right hereunder. The granting of an Option
and Stock Appreciation Right pursuant to the Plan shall take place only when an
Option Agreement shall have been duly executed and delivered by and on behalf of
the Corporation at the direction of the Committee.
<PAGE>
23. CASH PAYMENTS. At the time of the payment of any dividend or other
-------------
distribution with respect to the Common Stock, in the absolute discretion of,
and upon direction of the Board, the Corporation shall cause to be paid to
existing directors and employees of the Corporation, the Bank or any Subsidiary
who hold nonforfeited, unexercised Options under this Plan, regardless of
whether or not such Options are vested and nonforfeitable, a cash amount equal
to the number of shares of Common Stock subject to nonforfeited, unexercised
options held by such optionee multiplied by the amount of any dividends or other
distributions paid per share of Common Stock outstanding. The Board shall have
the discretion to approve cash payments at the time of some dividends or
distributions but not others. Notwithstanding the foregoing, no amounts shall
be paid to optionees pursuant to this Section 23 with respect to any dividend or
distribution if at the time of such dividend or distribution, the exercise price
of the Options shall have been reduced pursuant to Section 16(b) above.
If any director or employee of the Corporation, the Board or any Subsidiary
shall receive any cash payment from the Company, the Board or any Subsidiary
pursuant to this Section 23 with respect to an Option which is not vested and
exercisable, and if such Option shall be forfeited, then within 30 days after
the effective date of such forfeiture, the optionee shall pay to the
Corporation, the Bank or the Subsidiary (as applicable) an amount equal to the
cash payment received by such optionee with respect to such forfeited Option.
In the alternative, at the option of the Corporation, the Bank or the Subsidiary
(as applicable) the amount to be repaid may be withheld from the final
compensation payable to the optionee.
24. WITHHOLDING TAXES. Whenever the Corporation proposes or is required to
-----------------
cause to be issued or transferred shares of stock, cash or other assets pursuant
to this Plan, the Corporation shall have the right to require the optionee to
remit to the Corporation an amount sufficient to satisfy any federal, state
and/or local withholding tax requirements prior to the issuance of any
certificate or certificates for such shares or delivery of such cash or other
assets. Alternatively, the Corporation may issue or transfer such shares of
stock or make other distributions of cash or other assets net of the number of
shares or other amounts sufficient to satisfy the withholding tax requirements.
For withholding tax purposes, the shares of stock, cash and other assets to be
distributed shall be valued on the date the withholding obligation is incurred.
25. TERMINATION AND AMENDMENT. The Board may at any time alter, suspend,
-------------------------
terminate or discontinue the Plan, subject to any applicable regulatory
requirements and any required stockholder approval or any stockholder approval
which the Board may deem advisable for any reason, such as for the purpose of
obtaining or retaining any statutory or regulatory benefits under tax,
securities or other laws or satisfying applicable stock exchange or quotation
system listing requirements. The Board may not, without the consent of the
holder of an Option or Stock Appreciation Right previously granted, make any
alteration which would deprive the optionee of his rights with respect thereto.
26. CAPTIONS AND HEADINGS; GENDER AND NUMBER. Captions and paragraph
----------------------------------------
headings used herein are for convenience only, do not modify or affect the
meaning of any provision herein, are not a part, and shall not serve as a basis
for interpretation or construction of, this Plan. As used herein, the masculine
gender shall include the feminine and neuter, and the singular number shall
include the plural, and vice versa, whenever such meanings are appropriate.
<PAGE>
27. COST OF PLAN; EXCULPATION AND INDEMNIFICATION. All costs and expenses
---------------------------------------------
incurred in the operation and administration of the Plan shall be borne by the
Corporation, the Bank and the Subsidiaries. In connection with this Plan, no
member of the Board, no member of the Board of Directors of the Bank, and no
member of the Board of Directors of any Subsidiary, and no member of the
Committee shall be personally liable for any act or omission to act, nor for any
mistake in judgment made in good faith, unless arising out of, or resulting
from, such person's own bad faith, willful misconduct or criminal acts. To the
extent permitted by applicable law and regulation, the Corporation shall
indemnify, defend and hold harmless the members of the Board, the members of the
Board of Directors of the Bank and the members of the Board of Directors of any
Subsidiary, and members of the Committee, and each other officer or employee of
the Bank, the Corporation or of any Subsidiary to whom any power or duty
relating to the administration or interpretation of this Plan may be assigned or
delegated, from and against any and all liabilities (including any amount paid
in settlement of a claim with the approval of the Board), and any costs or
expenses (including counsel fees) incurred by such persons arising out of or as
a result of, any act or omission to act, in connection with the performance of
such person's duties, responsibilities and obligations under this Plan, other
than such liabilities, costs, and expenses as may arise out of, or result from
the bad faith, willful misconduct or criminal acts of such persons.
28. GOVERNING LAW. Without regard to the principles of conflicts of laws,
-------------
the laws of the State of North Carolina shall govern and control the validity,
interpretation, performance, and enforcement of this Plan.
29. INSPECTION OF PLAN. A copy of this Plan, and any amendments thereto,
------------------
shall be maintained by the Secretary of the Corporation and shall be shown to
any proper person making inquiry about it.
30. OTHER PROVISIONS. The Option Agreements authorized under this
----------------
Plan shall contain such other provisions not inconsistent with the foregoing,
including, without limitation, increased restrictions upon the exercise of
options, as the Committee may deem advisable.
<PAGE>
EXHIBIT A
---------
STOCK OPTION GRANT AND AGREEMENT
THIS STOCK OPTION GRANT AND AGREEMENT ("Agreement"), being made according to
and subject to the terms and conditions of the STOCK OPTION PLAN of South
Street Financial Corp. ("Plan"), a copy of which is attached hereto as Annex A
and is hereby incorporated by reference and made a part of this Agreement, is
herein executed and effective the _______ day of _______________, _____, between
South Street Financial Corp. (the "Corporation") and ____________________
("Optionee"):
1. Grant. As of the above date, the Corporation hereby grants to the
-----
Optionee (applicable provisions are marked):
[_] an Incentive Stock Option [as that term is defined in Section 422
of the Internal Revenue Code of 1986, as amended (the "Code")] to
purchase ________ shares of Common Stock of the Corporation at the
price stated in this Agreement;
[_] a Nonqualified Stock Option to purchase __________ shares of
Common Stock of the Corporation at the price stated in this Agreement.
The Optionee [_] shall [_] shall not have Stock Appreciation Rights in
connection with the Options granted hereby, in accordance with Section
14 of the Plan.
The Option(s) and any Stock Appreciation Rights granted under this
section and as described in this Agreement is (are) in all respects
subject to and conditioned by the terms, definitions, and provisions
of this Agreement and of the Plan. Capitalized terms in this
Agreement which are not otherwise defined but which are defined in the
Plan shall have the same meaning given to those terms in the Plan.
The Optionee has been granted Options under the Plan as a result of
the Optionee's position as a [_] director [_] employee of the
Corporation, the Bank or a Subsidiary.
2. Price. The Option price is $_____________ for each share.
-----
3. Exercise of Option. The Option(s) granted under this Agreement shall
------------------
be exercisable pursuant to the terms and conditions of the Plan and as
set forth below:
(a) Right to Exercise: In addition to the terms and conditions
-----------------
imposed on the Optionee's right to exercise his Options and any Stock
Appreciation Rights imposed in the Plan, the following terms and
conditions are applicable:
<PAGE>
- --------------------------------------------------------------------------------
(b) [_] (Marked if applicable) Annual Installments: Subject to the terms and
-------------------
conditions of the Plan, the Incentive Stock Options can be exercised in annual
installments as follows:
__________________ shares beginning on __________________, 19__
__________________ shares beginning on __________________, 19__
__________________ shares beginning on __________________, 19__
__________________ shares beginning on __________________, 19__
__________________ shares beginning on __________________, 19__
Subject to the terms and conditions of the Plan, the Nonqualified
Options can be exercised in annual installments as follows:
__________________ shares beginning on __________________, 19__
__________________ shares beginning on __________________, 19__
__________________ shares beginning on __________________, 19__
__________________ shares beginning on __________________, 19__
__________________ shares beginning on __________________, 19__
The right to exercise the Option(s) in annual installments shall be
cumulative. In addition, the option(s) shall be exercisable upon
disability, death, retirement and a change in control as set forth in
the Plan.
(c) [_] (Marked if applicable) Immediate Vesting: Subject to the
-----------------
terms and conditions of the Plan, all of the Options are vested,
nonforfeitable and exercisable.
(d) Method of Exercise: The Options and any Stock Appreciation
------------------
Rights granted under this Agreement shall be exercisable by a written
notice to the Secretary of the Corporation which shall:
(1) State the election to exercise the Option or the election to
surrender an exercisable Option and exercise Stock Appreciation
Rights, the number of shares in respect of which the Option or
Stock Appreciation Right is being exercised, the person in whose
name any stock certificate or certificates for such shares of
Common Stock is to be registered or to whom any cash is to be
paid, his or her address, and social security number;
(2) Contain any such representation and agreements as to
Optionee's investment intent with respect to shares of Common
Stock as may be required by the Committee;
<PAGE>
(3) Be signed by the person entitled to exercise the Option and,
if the Option is being exercised by any person or persons other
than the Optionee, be accompanied by proof, satisfactory to the
Corporation, of the right of such person or persons to exercise
the Option or Stock Appreciation Rights in accordance with the
Plan; and
(4) Be accompanied by payment of the purchase price of any shares
with respect to which the Option is being exercised which payment
shall be in form acceptable to the Committee pursuant to Section
6(b) of the Plan.
(e) Representations and Warranties: In order to exercise an Option
------------------------------
or Stock Appreciation Right, the person exercising the Option or Stock
Appreciation Right must make the representations and warranties to the
Corporation as may be required by any applicable law or regulation, or
as may otherwise be required pursuant to the Plan.
(f) Approvals. In order for an Option or Stock Appreciation Right to
---------
be exercised, all filings and approvals required by applicable law and
regulations or pursuant to the Plan must have been made and obtained.
4. Non-transferability. Neither any Option nor any Stock Appreciation
-------------------
Rights may be transferred in any manner otherwise than by will or the laws of
descent and distribution and such Option and any Stock Appreciation Rights may
be exercised during the life of the Optionee only by him or her.
5. Investment Purpose. This Option and any Stock Appreciation Rights may
------------------
not be exercised if the issuance of shares or payment of cash upon such exercise
would constitute a violation of any applicable federal or state securities law
or other law or valid regulation.
6. Expiration. This Option and any corresponding Stock Appreciation
----------
Rights shall expire on _____________, _________.
7. Escrow. All stock purchased pursuant to an Incentive Stock Option
------
shall be held in escrow for a period which ends on the later of (i) two (2)
years from the date of the granting of the option or (ii) one (1) year after the
transfer of the stock pursuant to the exercise of the Option. The stock shall be
held by the Corporation or its designee. The Optionee who has exercised the
Option shall have all rights of a stockholder, including, but not limited to,
the rights to vote, receive dividends and sell the stock. The sole purpose of
the escrow is to inform the Corporation of a disqualifying disposition of the
stock within the meaning of Section 422 of the Code, and it shall be
administered solely for this purpose.
8. Repayment of Cash Payments. If the Optionee hereunder forfeits any
--------------------------
Options pursuant to the Plan, the Optionee shall, within 30 days after the
effective date of such forfeiture, pay the Corporation, the Bank or a Subsidiary
(as applicable) an amount equal to the cash payments received by the Optionee
from the Corporation, the Bank or any Subsidiary with respect to such forfeited
Options pursuant to Section 23 of the Plan. In the alternative, at the option of
the Corporation, the Bank or a Subsidiary, the amount to be repaid may be
withheld by
<PAGE>
the Corporation, the Bank or a Subsidiary from the final compensation or fees
payable to the Optionee. Each acceptance by an Optionee of cash payments
pursuant to such Section 23 with respect to Options still subject to forfeiture
shall constitute a reaffirmation of the agreements set forth in this
paragraph 8.
9. Tax Withholding. All stock, cash and other assets distributed pursuant
---------------
to this Agreement shall be subject to applicable federal, state and local
withholding for taxes. The Optionee expressly acknowledges and agrees to such
withholding. The Optionee acknowledges and agrees to the tax withholding
provisions which are set forth in the Plan.
10. Resolution of Disputes. Any dispute or disagreement which should arise
----------------------
under, or as a result of, or in any way relate to, the interpretation,
construction, or application of this Agreement or the Plan will be determined by
the Committee designated in Section 2 of the Plan. Any determination made by
such Committee shall be final, binding, and conclusive for all purposes.
11. Construction Controlled by Plan. The Options and any corresponding Stock
-------------------------------
Appreciation Rights evidenced hereby shall be subject to all of the
requirements, conditions and provisions of the Plan. This Agreement shall be
construed so as to be consistent with the Plan; and the provisions of the Plan
shall be deemed to be controlling in the event that any provision should appear
to be inconsistent therewith.
12. Severability. Whenever possible, each provision of this Agreement shall
------------
be interpreted in such a manner as to be valid and enforceable under applicable
law, but if any provision of this Agreement is determined to be unenforceable,
invalid or illegal, the validity of any other provision or part thereof shall
not be affected thereby and this Agreement shall continue to be binding on the
parties hereto as if such unenforceable, invalid or illegal provision or part
thereof had not been included herein.
13. Modification of Agreement; Waiver. This Agreement may be modified,
---------------------------------
amended, suspended or terminated, and any terms, representations or conditions
may be waived, but only by a written instrument signed by each of the parties
hereto and only subject to the limitations set forth in the Plan. No waiver
hereunder shall constitute a waiver with respect to any subsequent occurrence or
other transaction hereunder or of any other provision.
14. Captions and Headings; Gender and Number. Captions and paragraph
----------------------------------------
headings used herein are for convenience only, do not modify or affect the
meaning of any provision herein, are not a part, and shall not serve as a basis
for interpretation or construction, of this Agreement. As used herein, the
masculine gender shall include the feminine and neuter, and the singular number
shall include the plural, and vice versa, whenever such meanings are
appropriate.
15. Governing Law; Venue and Jurisdiction. Without regard to the principles
-------------------------------------
of conflicts of laws, the laws of the State of North Carolina shall govern and
control the validity, interpretation, performance, and enforcement of this
Agreement.
16. Binding Effect. This Agreement shall be binding upon and shall inure to
--------------
the benefit of the Corporation, and its successors and assigns, and shall be
binding upon and inure to
<PAGE>
the benefit of the Optionee, and his or her heirs, legatees, personal
representative, executor, administrator and permitted assigns.
17. Entire Agreement. This Agreement and the Plan constitute and embody the
----------------
entire understanding and agreement of the parties hereto and, except as
otherwise provided hereunder, there are no other agreements or understandings,
written or oral, in effect between the parties hereto relating to the matters
addressed herein.
18. Counterparts. This Agreement may be executed in any number of
------------
counterparts, each of which when executed and delivered shall be deemed an
original, but all of which taken together shall constitute one and the same
instrument.
IN WITNESS WHEREOF, the parties have set their hands and seals the day and
year first above written.
ATTEST: SOUTH STREET FINANCIAL CORP.
By:
- ---------------------------------- -------------------------------
(Corporate Seal) President
----------------------
OPTIONEE:
-----------------------------------
(SEAL)
<PAGE>
This page intentionally left blank
<PAGE>
HOME SAVINGS BANK OF ALBEMARLE, INC., SSB
MANAGEMENT RECOGNITION PLAN AND TRUST AGREEMENT
Home Savings Bank of Albemarle, Inc., SSB, a North Carolina chartered savings
bank (the "Bank"), does herein set forth the terms of its Management Recognition
Plan (the "Plan") and Trust (the "Trust") and the Trustees hereby accept this
Trust and agree to hold the Trust assets existing on the date of the Agreement
and all additions and accretions thereto upon the terms and conditions
hereinafter stated.
Section 1. Purpose of this Plan. The purpose of this Plan is to provide to
---------- --------------------
the directors, officers and employees (the "Participants") of the Bank and of
any corporation or other entity of which the Bank owns, directly or indirectly,
not less than fifty percent (50%) of any class of the equity securities thereof
(a "Subsidiary"), an ownership interest in the Bank's parent holding company,
South Street Financial Corp. (the "Corporation") by making awards (hereinafter
referred to as "Awards" or singularly, "Award") of shares of common stock of the
Corporation (the "Common Stock"). The Board of Directors of the Bank (the
"Board") and the Board of Directors of the Corporation believe that
participation in the ownership of the Corporation will induce Participants to
continue to serve the Bank or any Subsidiary as directors, officers and/or
employees and encourage them to contribute to the future growth and profits of
the Bank and the Corporation. In addition, the existence of this Plan will make
it possible for the Bank and its Subsidiaries to attract capable individuals to
serve as directors or officers of the Bank and its Subsidiaries. The Board
believes that the existence of this Plan will provide incentives to the
directors, officers and employees of the Bank and any Subsidiaries which will
contribute materially to the success of such companies.
Section 2. Administration of this Plan.
---------- ---------------------------
(a) This Plan shall be administered by a committee of the Board (the
"Committee") which shall consist of not less than two members of the Board who
are "Non-Employee Directors" as defined in Rule 16 b-3(b)(3) of the Rules and
Regulations under the Securities Exchange Act of 1934 (the "Exchange Act"). In
the absence of a duly appointed Committee, the Plan shall be administered by the
Board. The Committee shall have full power and authority to construe, interpret
and administer this Plan. All actions, decisions, determinations, or
interpretations of the Committee shall be final, conclusive, and binding upon
all parties. Members of the Committee shall serve at the pleasure of the Board.
(b) The Committee shall decide (i) to whom Awards shall be made under
this Plan, (ii) the number of shares of Common Stock subject to each award,
(iii) the number of additional shares, if any, to be purchased or allocated for
the purposes of this Plan, (iv) the determination of leaves of absence which may
be granted to Participants without constituting a termination of their
employment for purposes of the Plan and (v) such additional terms and conditions
for Awards as the Committee shall deem appropriate, including, without
limitation, any determinations as to the restrictions or conditions on transfer
of shares of Common Stock that are necessary or appropriate to satisfy all
applicable securities laws, rules, regulations, and listing requirements.
<PAGE>
(c) The Committee may designate any officers or employees of the Bank or
of any Subsidiary to assist in the administration of this Plan. The Committee
may authorize such individuals to execute documents on its behalf and may
delegate to them such other ministerial and limited discretionary duties as the
Committee may see fit.
(d) Any shares of Common Stock held under this Plan, including without
limitation unallocated, undistributed and forfeited shares, shall be held by the
Trust.
(e) The Trustees shall be appointed by the Board.
Section 3. Contributions to Trust.
---------- ----------------------
(a) The Board shall determine the amount (or the method of computing the
amount) and timing of any contributions by the Bank and any Subsidiaries to the
Trust established under this Plan. Such amounts may be paid in cash or in
shares of Common Stock and shall be paid to the Trust at the designated time of
contribution. No contributions by Participants shall be permitted.
(b) Subject to Section 9 hereof, the Trustees shall invest all of the
Trust's assets primarily in Common Stock. The Trust shall acquire, in the
aggregate, 179,860 shares of Common Stock, which is equal to four percent (4%)
of the shares of Common Stock issued in connection with the conversion of the
Bank from a North Carolina chartered mutual savings bank to a North Carolina
chartered stock savings bank on October 2, 1996 (the "Conversion"). Such shares
of Common Stock may be purchased by the Trust in the open market, or, subject to
approval of the Board of Directors of the Corporation, may be acquired through
the issuance by the Corporation to the Trust of authorized but unissued shares
of Common Stock on such terms as may be approved by the Committee and the Board
of Directors of the Corporation. Such shares (the "Plan Shares") shall be held
by the Trust until they have been awarded and distributed pursuant to the terms
of this Plan. In the event that the Trust receives cash pursuant to receipt of
dividends on Common Stock held by the Trust which has not been awarded to
participants, including the receipt of a special cash dividend or return of
capital with respect to such shares, then such funds may be used by the Trustees
to purchase additional shares of Common Stock available for future award under
this Plan or the Trustees may distribute such cash received by the Trust along
with the Common Stock upon which it was earned upon the award of such previously
unallocated shares.
(c) The principal of the Trust, and any earnings thereon, shall be held
separate and apart from other funds of the Bank and shall be used exclusively
for the uses and purposes of Participants and general creditors as herein set
forth. Participants and their beneficiaries shall have no preferred claim on,
or any beneficial ownership interest in, any assets of the Trust. Any rights
created under the Plan and the Trust shall be mere unsecured contractual rights
of Participants and their beneficiaries against the Bank. Any assets held by
the Trust will be subject to the claims of the Bank's general creditors under
federal and state law in the event of insolvency or bankruptcy, as defined in
Section 9(e) herein.
Section 4. Eligibility and Award of Plan Shares.
---------- ------------------------------------
(a) The Participants in this Plan to whom Awards may be made shall be the
following: members of the Board, members of the Board of Directors of any
Subsidiary, and
<PAGE>
such officers and employees of the Bank and/or of any Subsidiary as may be
designated by the Committee.
(b) As promptly as practicable after a determination is made that an
Award of Plan Shares is to be made, the Committee shall notify the Participant
in writing of the grant of the Award, the number of Plan Shares covered by the
Award, and the terms upon which the Plan Shares subject to the Award shall vest
and be distributed to the Participant. Awards of Plan Shares under this Plan
shall be effective upon execution and delivery of the Stock Grant Agreement
which sets forth the terms and conditions of the Award of Plan Shares (the
"Stock Grant Agreement").
(c) Notwithstanding anything to the contrary contained in Sections 4(a)
and 4(b) above, no Participant shall have any right or entitlement to receive a
Plan Share Award hereunder, such awards being at the total discretion of the
Committee.
Section 5. Vesting and Distribution of Plan Shares.
---------- ---------------------------------------
(a) Shares granted under this Plan shall vest and the right of a
Participant to the Plan Shares shall be nonforfeitable as determined by the
Committee and as set forth in the Stock Grant Agreement.
(b) In determining the number of shares vested under any applicable
vesting schedule, a Participant shall not receive fractional shares. If the
product resulting from multiplying the vested percentage times the allocated
shares results in a fractional share, then a Participant's vested right shall be
rounded down to the nearest whole number of shares.
(c) In the event any Participant shall no longer be either a director or
an employee of the Bank or any Subsidiary for any reason (whichever position
resulted in the award, as set forth in the Stock Grant Agreement), other than as
provided in Sections 5(d) and 5(e) below, and such Participant does not have a
100% vested interest in his or her shares under the Plan, then any shares which
are not vested based upon the applicable schedule set forth in the Stock Grant
Agreement shall be forfeited and, provided this Plan has not terminated pursuant
to Section 16 below, shall be available again for Awards to Participants as may
be determined by the Committee.
(d) In the event that a Participant shall no longer be an employee or a
director of the Bank or any Subsidiary (whichever position resulted in the
award, as set forth in the Stock Grant Agreement), because of such Participant's
disability, death or retirement, prior to the date when all shares allocated to
him or her would be 100% vested in accordance with the schedule set forth in the
Stock Grant Agreement, then, notwithstanding such vesting schedule, all shares
allocated to such Participant shall immediately become fully vested and
nonforfeitable. For purposes of this Plan, the term "retirement" shall be
defined in the same manner as such term is defined in Section 22(e)(3) of the
Internal Revenue Code of 1986, as amended (the "Code"). For purposes of this
Plan, the term "retirement", as it relates to any Participant receiving an award
as a result of his or her position as an employee of the Bank or any Subsidiary,
shall mean (i) the termination of the Participant's employment under conditions
which would constitute retirement under any tax qualified retirement plan
maintained by the Corporation, the Bank or a Subsidiary, or (ii) termination of
employment after attaining age 65. The term "retirement," as it relates to any
Participant receiving an award as a result of his or her position as a member of
the
<PAGE>
Board or the board of directors of any Subsidiary, shall mean the cessation of
membership on the Board or such board of directors (i) with the approval of the
Board or other board of directors, as applicable, at any time after such
Participant reaches age 65, or (ii) at the election of the Participant at any
time after not less than twenty-five (25) years of service as a member of the
Board or such other board of directors, as applicable.
(e) In the event that a Participant ceases to be an employee or a
director of the Bank or a Subsidiary (whichever position resulted in the award,
as set forth in the Stock Grant Agreement), for any reason after the occurrence
of a "change in control" and prior to the time that all shares allocated to him
or her would be 100% vested in accordance with the schedule set forth in the
Stock Grant Agreement, then, notwithstanding such vesting schedule, all shares
allocated to such Participant shall immediately become fully vested and
nonforfeitable. For purposes of this Plan, a "change in control" shall mean (i)
a change in control of a nature that would be required to be reported by the
Corporation in response to Item 1 of the Current Report on Form 8-K, as in
effect on the date hereof, pursuant to Section 13 or 15(d) of the Exchange Act;
(ii) such time as any "person" (as such term is used in Sections 13(d) and 14(d)
of the Exchange Act) other than the Corporation is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of securities of the Corporation or Bank representing 25% or more of
the combined voting power of the outstanding Common Stock of the Corporation or
outstanding common stock of the Bank, as applicable; or (iii) individuals who
constitute the board of directors of the Corporation or the Board on the date
hereof (the "Incumbent Board" and "Incumbent Bank Board," respectively) cease
for any reason to constitute at least a majority thereof, provided that any
person becoming a director subsequent to the date hereof whose election was
approved by a vote of at least three-quarters of the directors comprising the
Incumbent Board or Incumbent Bank Board, as applicable, or whose nomination for
election by the Corporation's or Bank's shareholders was approved by the
Corporation's or Bank's Board of Directors or Nominating Committee, shall be
considered as though he or she were a member of the Incumbent Board or Incumbent
Bank Board, as applicable; or (iv) either the Corporation or the Bank
consolidates or merges with or into another corporation, association or entity
or is otherwise reorganized, where neither the Corporation nor the Bank,
respectively, is the surviving corporation in such transaction; or (v) all or
substantially all of the assets of either the Corporation or the Bank are sold
or otherwise transferred to or are acquired by any other entity or group.
(f) Plan Shares which have vested shall be distributed to the Participant
or any transferee permitted by Section 11 (a "Permitted Transferee"), as the
case may be, as soon as practicable after such Plan Shares have vested in
accordance with the schedule contained in the Stock Grant Agreement.
(g) The Trustees, the Corporation, the Bank and any Subsidiary shall have
the right to require any Participant or Permitted Transferee to remit to the
Corporation, the Bank or any Subsidiary an amount sufficient to satisfy any
federal, state and/or local withholding tax requirements prior to the delivery
or release of any certificate or certificates for Plan Shares or delivery of any
cash or other assets with respect to Plan Shares or otherwise pursuant to this
Plan. Alternatively, the Trustees, Corporation, Bank and any Subsidiary may
deliver or release Shares or make other distributions of cash or other assets
net of the number of shares or cash sufficient to satisfy the withholding tax
requirements. For withholding tax purposes, the shares of stock, cash and other
assets to be distributed shall be valued on the date the withholding obligation
is incurred.
<PAGE>
(h) Each Participant receiving an Award of Plan Shares under this Plan
shall deliver to the Bank a Stock Grant Agreement, which shall be signed by such
Participant.
Section 6. Restrictions on Selling of Plan Shares. Plan Share Awards may not
---------- --------------------------------------
be sold, assigned, pledged or otherwise disposed of prior to the time that they
are vested and distributed pursuant to the terms of this Plan. The Board of
Directors or the Committee may require the Participant or his Permitted
Transferee, as the case may be, to agree not to sell or otherwise dispose of his
distributed Plan Shares except in accordance with all then applicable federal
and state securities laws, and the Board of Directors or the Committee may cause
a legend to be placed on the stock certificate(s) representing the distributed
Plan Shares in order to restrict the transfer of the distributed Plan Shares for
such period of time or under such circumstances as the Board of Directors or the
Committee, upon the advice of counsel, may deem appropriate.
Section 7. Effect of Award on Status of Participant. The fact that an Award
---------- ----------------------------------------
is made to a Participant under this Plan shall not confer on such Participant
any right to continued service on the Board or on the Board of Directors of any
Subsidiary, nor any right to continued employment with the Bank or any
Subsidiary; nor shall it limit the right of the Bank, the Corporation, or any
Subsidiary to remove such Participant from any such boards, or to terminate his
or her employment at any time.
Section 8. Voting Rights; Dividends; Other Distributions. After an Award of
---------- ---------------------------------------------
Plan Shares has been made, the Participant or Permitted Transferee shall be
entitled to direct the Trustees as to the voting of the Plan Shares which are
covered by the Award and which are not yet vested and distributed to him,
subject to rules and procedures adopted by the Committee for this purpose. All
shares of Common Stock held by the Trust which have not been awarded under an
Award of Plan Shares and shares which have been awarded as to which Participants
or Permitted Transferees have not directed the voting shall be voted by the
Trustees in the same proportion as the trustees of the Bank's Employee Stock
Ownership Plan votes Common Stock held in trust associated therewith, and in the
absence of any such voting, shall be voted in the manner directed by the Board
of Directors.
Any cash dividends or other cash or noncash distributions (including special
large and nonrecurring dividends and including one that has the effect of a
return of capital to the Corporation's stockholders) or stock dividends declared
in respect of each unvested Plan Share will be held by the Trustees for the
benefit of the Participant or Permitted Transferee on whose behalf such Award is
then held by the Trust and such dividends, including any interest thereon, will
be paid out proportionately by the Trust to the Participant or Permitted
Transferee thereof as soon as practicable after the Plan Shares become vested in
accordance with the Stock Grant Agreement, or otherwise. Any cash dividends,
cash or noncash distributions or stock dividends declared in respect of each
vested Plan Share held by the Trust will be paid by the Trust, as soon as
practicable after the Trust's receipt thereof, to the Participant or Permitted
Transferee on whose behalf such Plan Share is then held by the Trust. In the
event that the Trust receives cash pursuant to receipt of dividends or other
distributions on Common Stock held by the Trust and unallocated to participants
(including the receipt of a special cash dividend or return of capital) then
such funds may be used by the Trust to purchase additional shares of Common
Stock available for future award under this Plan, or the Committee or Board may
distribute such cash
<PAGE>
received by the Trust along with the Common Stock upon which it was earned upon
the award of such previously unallocated shares.
Section 9. Trust.
---------- -----
(a) The Trustees shall receive, hold, administer, invest and make
distributions and disbursements from the Trust in accordance with the provisions
of this Plan and Trust and the applicable directions, rules, regulations,
procedures and policies established by the Board of Directors or the Committee
pursuant to the Plan.
(b) It is the intent of this Plan and Trust that the Trustees shall have
complete authority and discretion with respect to the arrangement, control and
investment of the Trust, and that the Trustees shall invest all assets of the
Trust in Common Stock to the fullest extent practicable, except to the extent
that the Trustees determine that the holding of monies in cash or cash
equivalents is necessary to meet the obligations of the Trust. In performing
their duties, the Trustees shall have the power to do all things and execute
such instruments as may be deemed necessary or proper, including the following
powers;
(i) To invest up to one hundred percent (100%) of all Trust assets
in Common Stock without regard to any law now or hereafter in force limiting
investments for trustees or other fiduciaries. The investment authorized herein
may constitute the only investment of the Trust, and in making such investment,
the Trustees are authorized to purchase Common Stock from the Corporation or
from any other source, and such Common Stock so purchased may be outstanding,
newly issued, or treasury shares.
(ii) To invest any Trust assets not otherwise invested in accordance
with (a) above, in deposit accounts and certificates of deposit at the Bank or
in obligations of the United States Government or its agencies or such other
investments as shall be considered the equivalent of cash.
(iii) To sell, exchange or otherwise dispose of any property at any
time held or acquired by the Trust.
(iv) To cause stocks, bonds or other securities to be registered in
the name of a nominee, without the addition of words indicating that such
security is an asset of the Trust (but accurate records shall be maintained
showing that such security is an assets of the Trust).
(v) To hold cash without interest in such amounts as may in the
opinion of the Trustees be reasonable for the proper operation of the Plan and
Trust.
(vi) To employ brokers, agents, custodians, consultants and
accountants.
(vii) To hire counsel to render advice with respect to their rights,
duties and obligations hereunder, and such other legal services or
representation as the Trustees deem desirable.
<PAGE>
(viii) To hold funds and securities representing the amounts to be
distributed to a Recipient or his Beneficiary as a consequence of a dispute as
to the disposition thereof, whether in a segregated account or held in common
with other assets of the Trust.
Notwithstanding anything herein contained to the contrary, the Trustees shall
not be required to make any inventory, appraisal or settlement or report to any
court, or to secure any order of court for the exercise of any power herein
contained, or give bond.
(c) The Trustees shall maintain accurate and detailed records and
accounts of all transactions of the Trust, which shall be available at all
reasonable times for inspection by any legally entitled person or entity to the
extent required by applicable law, or by any other person determined by the
Board of Directors or the Committee.
(d) Notwithstanding anything to the contrary in this Plan or Trust, the
assets of the Plan and Trust are subject to the payment of the claims of
creditors of the Bank in the event of its insolvency or bankruptcy. The Bank is
insolvent or bankrupt if it is the subject of a proceeding under the Bankruptcy
Code, 11 U.S.C. Section 101 et seq. or is unable to pay its debts. The Board of
Directors or the chief executive officer of the Bank must give written notice to
the Trustees of the Corporation's bankruptcy or insolvency as soon as
practicable following the occurrence of such event. Upon receipt of such notice
or other written allegations of the Bank's bankruptcy or insolvency, or in the
case of the Trustees' actual knowledge of or determination of the Bank's
bankruptcy or insolvency, the Trustees shall discontinue delivery of Trust
assets to the Participants or the Bank and shall hold the assets of the Trust
for the benefit of the Bank's general creditors and, upon a determination that
the Bank is bankrupt or insolvent, shall distribute such assets to or for the
benefit of the general creditors. The Trustees shall resume delivery of Trust
assets to the Participants or the Bank only after it is determined that the Bank
is no longer bankrupt or insolvent. Determination of the bankruptcy or
insolvency shall be determined by a court of competent jurisdiction or by an
arbitrator selected by and pursuant to rules of the American Arbitration
Association upon petition by an interested party.
Section 10. Adjustment Upon Changes in Capitalization; Dissolution or
----------- ---------------------------------------------------------
Liquidation. In the event of a change in the number or type of shares of Common
- -----------
Stock outstanding, or in the event shares of Common Stock are decreased, changed
into or exchanged for securities of a different entity, by reason of a
reclassification, recapitalization, reorganization, other similar capital
adjustment; by reason of a merger or consolidation of the Corporation; by
reason of the sale by the Corporation of all or a substantial portion of its
assets; or by reason of the occurrence of any other event which could affect
the implementation of this Plan and the realization of its objectives, the
number or kind of shares subject to Awards which have occurred, or could occur,
under this Plan shall be proportionately and equitably adjusted by the
Committee.
Section 11. Non-Transferability.
----------- -------------------
Prior to the time Plan Share Awards become vested and are distributed by the
Trustees, Plan Share Awards may not be sold, pledged, assigned, hypothecated,
transferred or disposed of in any manner other than by will or by the laws of
descent and distribution. Notwithstanding the foregoing, or any other provision
of this Plan, a Participant who holds Plan Share Awards may transfer such awards
to his or her spouse, lineal ascendants, lineal descendants, or to a duly
established trust for the benefit of one or more of these individuals. Plan
Share Awards so transferred may thereafter be transferred only to the
Participant who originally received the grant
<PAGE>
or to an individual or trust to whom the Participant could have initially
transferred the awards pursuant to this Section 11. Plan Share Awards which are
transferred pursuant to this Section 11 shall be subject to the same terms and
conditions as applied to the Participant. In addition, such shares may be
tendered in response to a tender offer for or a request or invitation to tenders
of greater than fifty percent (50%) of the outstanding Common Stock and may be
surrendered in a merger, consolidation or share exchange involving the
Corporation; provided, however, in each case, that except as otherwise provided
herein, the securities or other consideration received in exchange therefor
shall thereafter be subject to the restrictions and conditions set forth in this
Plan.
Section 12. Impact of Award on Other Benefits of Participant. The value
----------- ------------------------------------------------
of any Award, either on the date of the Award or at the time such shares become
vested, shall not be includable as compensation or earnings for purposes of any
other benefit plan offered by the Bank, the Corporation or any Subsidiary other
than any qualified employee benefit plan which provides that such value shall be
included as compensation or earnings for purposes of such plan.
Section 13. Corporate Action. The making of an Award under this Plan
----------- ----------------
shall not affect in any way the right or power of the Corporation or its
shareholders or the Bank or its shareholders or any Subsidiary or its
shareholders to make or authorize any adjustment, recapitalization,
reorganization, or other change in the Corporation's, the Bank's or any
Subsidiary's capital structure or its business, or any merger or consolidation
of the Corporation, the Bank or any Subsidiary, or the issuance of any bonds,
debentures, preferred or other capital stock or rights with respect thereto, or
the dissolution or liquidation of the Corporation, the Bank or any Subsidiary,
or any sale or transfer of all or any part of the Corporation's, the Bank's or
any Subsidiary's assets or business.
Section 14. Exculpation and Indemnification. In connection with this
----------- -------------------------------
Plan, no member of the Board, no member of the Board of Directors of the
Corporation, no member of the Committee and no Trustee shall be personally
liable for any act or omission to act in his capacity as a member of the Board,
the Board of Directors of the Corporation or the Committee or as Trustees, nor
for any mistake in judgment made in good faith, unless arising out of, or
resulting from, such person's own bad faith, willful misconduct, or criminal
acts. To the extent permitted by applicable law and regulation, the Bank shall
indemnify, defend and hold harmless the members of the Board, the members of the
Board of Directors of the Corporation, the members of the Board of Directors of
any Subsidiary, the Committee and each Trustee and each other officer or
employee of the Bank, the Corporation or of any Subsidiary to whom any duty or
power relating to the administration or interpretation of this Plan may be
assigned or delegated, from and against any and all liabilities (including any
amount paid in settlement of a claim with the approval of the Board) and any
costs or expenses (including counsel fees) incurred by such persons arising out
of, or as a result of, any act or omission to act in connection with the
performance of such person's duties, responsibilities, and obligations under
this Plan, other than such liabilities, costs, and expenses as may arise out of,
or result from, the bad faith, willful misconduct, or criminal acts of such
persons.
Section 15. Amendment and Modification of this Plan. The Board may at any
----------- ---------------------------------------
time, and from time to time, amend or modify this Plan (including the form of
Stock Grant Agreement) in any respect, subject to any applicable regulatory
requirements and any required stockholder approval or any stockholder approval
which the Board may deem advisable for any reason, such as for the purpose of
obtaining or retaining any statutory or regulatory benefits
<PAGE>
under tax, securities or other laws or satisfying applicable stock exchange or
quotation system listing requirements. However, any amendment or modification
of this Plan shall not in any manner affect any Award of shares theretofore made
to a Participant under this Plan without the consent of such Participant or any
Permitted Transferee of such Participant.
Section 16. Termination and Expiration of this Plan. This Plan may be
----------- ---------------------------------------
abandoned, suspended, or terminated, in whole or in part, at any time by the
Board; provided, however, that abandonment, suspension, or termination of this
Plan shall not affect any Award theretofore made under this Plan. Unless sooner
terminated, this Plan shall terminate at the close of business on the day that
is the tenth (10th) anniversary of the date of approval of the Plan by the
shareholders of the Corporation; and no Award of shares may be made under this
Plan thereafter. Such termination shall not effect any Award of shares
theretofore made. In the event that the Board terminates this Plan in whole,
any shares held by the Trust which have not been allocated to eligible
Participants, together with any other assets held by the Trust, shall revert to
the Bank.
17. Tax Status of Trust. It is intended that the trust established hereby be
-------------------
treated as a Grantor Trust of the Corporation under the provisions of Section
671 et seq. of the Code, as the same may be amended from time to time.
-- ---
18. Miscellaneous.
-------------
(a) This Plan has been adopted by the Board to be effective as of the
date of approval of the Plan by the shareholders of the Corporation.
(b) Captions and paragraph headings used herein are for convenience only,
do not modify or affect the meaning of any provision herein, are not a part
hereof, and shall not serve as a basis for interpretation or construction of
this Plan or Trust. As used herein, the masculine gender shall include the
feminine and neuter, and the singular number shall include the plural, and vice
versa, whenever such meanings are appropriate.
(c) All costs and expenses incurred in the operation and administration
of this Plan shall be borne by the Bank or by a Subsidiary, or in the discretion
of the Bank, the Trust.
(d) Without regard to the principles of conflicts of laws, the laws of
the State of North Carolina shall govern and control the validity,
interpretation, performance, and enforcement of this Plan and Trust.
(e) A copy of this Plan, and any amendments thereto, shall be maintained
by the Secretary of the Bank and shall be shown to any proper person making
inquiry about it.
<PAGE>
STATE OF NORTH CAROLINA
COUNTY OF STANLY STOCK GRANT AGREEMENT
THIS STOCK GRANT AGREEMENT (the "Agreement") is made and entered into as of
the ____ of ___________________, _______ (the "Effective Date"), by and among
Home Savings Bank of Albemarle, Inc., SSB (the "Bank"), a North Carolina
corporation, _______________________ (the "Participant") and
______________________, ___________________ and ____________________ (the
"Trustees").
WHEREAS, a Management Recognition Plan (the "Plan") was adopted by the Board
of Directors of the Bank (the "Bank") and approved by the Board of Directors and
by the shareholders of South Street Financial Corp., the holding company of the
Bank (the "Corporation") on ________________, 1997.
WHEREAS, it has been determined that it is desirable and in the best interest
of the Bank to make an award (the "Award") of certain shares of the Common Stock
of the Corporation, under the Plan, to the Participant, subject to certain
restrictions as specified below; and
WHEREAS, capitalized terms not otherwise defined herein shall have the same
meaning given to such terms in the Plan.
NOW, THEREFORE, the Parties agree as follows:
1. Date of Award. The date of making the Award under this Agreement is the
-------------
_____ day of _________________, ______. This Award has been made in recognition
of the Participant's status and service as a ____________________ of
_____________________________________________. The Participant is ____ or _____
is not a director or executive officer of the Bank.
2. Award of Plan Shares. The Participant is awarded, in the aggregate,
--------------------
___________________________ (__________) shares of Common Stock (the "Plan
Shares"), which shares become vested and nonforfeitable pursuant to paragraph 5
of this Agreement.
3. Investment Representation and Transfer Restrictions.
---------------------------------------------------
(a) Investment Representation. Participant makes and agrees to the
-------------------------
investment representation, if any, attached hereto as Annex A, and the Committee
may cause a legend to be placed on any certificate representing any of the Plan
Shares to make appropriate reference to such representation, as necessary.
(b) Securities Law and Regulations. The Participant agrees that the Plan
-------------------------------
Shares shall be subject to such stop-transfer orders and other restrictions as
the Committee may deem advisable under the rules, regulations, and other
requirements of the Securities and Exchange Commission, any stock exchange or
interdealer quotation system upon which the Common Stock is then listed and any
other applicable federal or state securities laws, rules or regulations, and the
Committee may cause a legend or legends to be placed on any certificate
representing any of the Plan Shares to make appropriate reference to such
restrictions.
<PAGE>
(c) Other Transfer Restrictions. (Intentionally omitted.)
---------------------------
4. Receipt by the Trustees. The Trustees acknowledge and agree that the
-----------------------
Plan Shares shall be held by the Trustees and distributed or transferred in
accordance with the Plan and as set forth herein.
5. Vesting and Delivery of Plan Shares by the Trustees.
---------------------------------------------------
(a) Periodic Vesting. Plan Shares shall vest and become nonforfeitable
----------------
in accordance with the following schedule:
_________ shares on ___________________, 19___
_________ shares on ___________________, 19___
_________ shares on ___________________, 19___
_________ shares on ___________________, 20___
_________ shares on ___________________, 20___
In addition, Plan Shares shall become vested and nonforfeitable upon disability,
death, retirement and a change in control as set forth in the Plan.
(b) Delivery of Vested Plan Shares to the Participant. After the date on
-------------------------------------------------
which the Plan Shares have become vested as provided in this Agreement and in
the Plan, the Committee shall instruct the Trustees to deliver to the
Participant, the Participant's designee, such other person as shall have been
designated as Participant's beneficiary in accordance with this Agreement, or
any other permitted recipient pursuant to the Plan, as applicable, certificates
representing the Plan Shares which have become vested and nonforfeitable, as the
Committee shall determine, free from any restrictions imposed by this Agreement
other than such restrictions and conditions as may be deemed necessary by the
Committee pursuant to paragraph 3 above.
(c) Delivery of Forfeited Plan Shares. If the Plan Shares, or any of
---------------------------------
them, are forfeited pursuant to the Plan, the Committee shall instruct the
Trustees concerning the disposition of such forfeited shares. Thereafter such
forfeited shares shall cease to be subject to this Agreement.
6. Payment of Dividends. As soon as practicable after the Plan Shares have
--------------------
become vested and delivered, the Trustees shall pay to the Participant, the
Participant's designee, such other person as shall have been designated as
Participant's beneficiary in accordance with the Agreement or any other
permitted recipient pursuant to the Plan, the proportional amount of any cash or
stock dividend, or other cash or noncash distributions, including any interest
earned thereon, declared in respect of such vested Plan Shares, which had been
held in the Trust for the benefit of the above-named person(s).
7. Designation of Beneficiary. The Participant hereby designates the
--------------------------
person(s) described on Annex B as the beneficiary or beneficiaries who shall be
entitled to receive the Plan Shares and other assets, if any, distributable to
the Participant upon his death. The Participant may, from time to time, revoke
or change his beneficiary designation without the consent of any prior
beneficiary, if any, by filing a new designation with the Committee. The last
such
<PAGE>
designation received by the Committee shall be controlling; provided, however,
that no designation, or change or revocation thereof, shall be effective unless
received by the Committee prior to the Participant's death, and in no event
shall it be effective as of a date prior to such receipt.
If no such beneficiary designation is in effect at the time of the
Participant's death, or if no designated beneficiary survives the Participant,
or if such designation conflicts with law, the Participant's estate shall be
deemed to have been designated his beneficiary and shall receive the Plan Shares
and other assets, if any, distributable to the Participant upon his death. If
the Committee is in doubt as to the right of any person to receive such
distribution, the Committee may direct the Trustees to retain the Plan Shares
and other assets, without liability for any interest in respect thereof, until
the rights thereto are determined, or the Committee may direct the transfer of
such Plan Shares into any court of appropriate jurisdiction and such transfer
shall be deemed a complete discharge of the obligations of the Bank, the
Corporation, the Committee and Trustees hereunder.
8. Effect of Award on Status of Participant. The fact that an Award has
----------------------------------------
been made to the Participant under this Plan shall not confer on the Participant
any right to continued service on the Board, on the board of directors of the
Corporation or on the board of directors of any Subsidiary, nor to continued
employment with the Bank, the Corporation or any Subsidiary; nor shall it limit
the right of the Bank, the Corporation or of any Subsidiary to remove the
Participant from any such boards, or to terminate his employment at any time
without prior notice.
9. Impact of Award on Other Benefits of Participant. The value of the Plan
------------------------------------------------
Shares on the date of the Award or at the time the Plan Shares becomes vested,
shall not be includable as compensation or earnings for purposes of any other
benefit plan offered by the Bank, the Corporation or any Subsidiary other than
any qualified employee benefit plan which provides that such value shall be
included as compensation or earnings for purposes of such plans.
10. Tax Withholding. All Plan Shares distributed pursuant to this Agreement
---------------
shall be subject to applicable federal, state and local withholding for taxes.
The Participant expressly acknowledges and agrees to such withholding without
regard to whether the Plan Shares may then be sold or otherwise transferred by
the Participant. The Participant acknowledges and agrees to the tax withholding
provisions which are set forth in the Plan.
11. Notices. Any notices or other communications required or permitted to be
-------
given under this Agreement shall be in writing and shall be deemed to have been
sufficiently given if delivered personally or three business days after deposit
in the United States mail by Certified Mail, return receipt requested, properly
addressed and postage prepaid, if to the Bank, the Committee or the Trustees at
the Bank's principal office address at 155 West South Street, Albemarle, North
Carolina 28002; and, if to the Participant, at his last address appearing on the
books of the Bank. The Bank and the Participant may change their address or
addresses by giving written notice of such change as provided herein. Any
notice or other communication hereunder shall be deemed to have been given on
the date actually delivered or as of the third (3rd) business day following the
date mailed as set forth above, as the case may be.
12. Construction Controlled by Plan. The Plan, a copy of which is attached
-------------------------------
hereto as Annex C, is incorporated herein by reference. The Award of Restricted
Shares shall be
<PAGE>
subject to the terms and conditions of the Plan, and the Participant hereby
assumes and agrees to comply with all of the obligations imposed upon the
Participant in the Plan. This Agreement shall be construed so as to be
consistent with the Plan; and the provisions of the Plan shall be deemed to be
controlling in the event that any provision hereof should appear to be
inconsistent therewith.
13. Severability. Whenever possible, each provision of this Agreement shall
------------
be interpreted in such a manner as to be valid and enforceable under applicable
law, but if any provision of this Agreement is determined to be unenforceable,
invalid or illegal, the validity of any other provision or part thereof shall
not be affected thereby and this Agreement shall continue to be binding on the
parties hereto as if such unenforceable, invalid or illegal provision or part
thereof had not been included herein.
14. Governing Law. Without regard to the principles of conflicts of laws,
-------------
the laws of the State of North Carolina shall govern and control the validity,
interpretation, performance, and enforcement of this Agreement.
15. Modification of Agreement; Waiver. This Agreement may be modified,
---------------------------------
amended, suspended or terminated, and any terms, representations or conditions
may be waived, but only by a written instrument signed by each of the parties
hereto or their successors in interest. No waiver hereunder shall constitute a
waiver with respect to any subsequent occurrence or other transaction hereunder
or of any other provision hereof.
16. Binding Effect. This Agreement shall be binding upon and shall inure to
--------------
the benefit of the parties hereto, and their respective heirs, legatees,
personal representatives, executors, and administrators, successors and assigns.
17. Entire Agreement. This Agreement and the Plan constitute and embody the
----------------
entire understanding and agreement of the parties hereto and, except as
otherwise provided hereunder, there are no other agreements or understandings,
written or oral, in effect between the parties hereto relating to the matters
addressed herein.
18. Counterparts. This Agreement may be executed in any number of
------------
counterparts, each of which when executed and delivered shall be deemed an
original, but all of which taken together shall constitute one and the same
instrument.
19. Substitution of Trustees. In the event any new trustee is substituted
------------------------
for any Trustee pursuant to the Plan, such substitute trustee shall also be
substituted as a Trustee hereunder.
<PAGE>
IN WITNESS WHEREOF, the Bank has caused this instrument to be executed in its
corporate name by its President, or one of its Vice Presidents, and attested by
its Secretary or one of its Assistant Secretaries, and its corporate seal to be
hereto affixed, all by, authority of its Board of Directors first duly given;
and each individual party hereto has hereunto set his hand and adopted as his
seal the typewritten word "SEAL" appearing beside his name, all done this the
day and year first above written.
HOME SAVINGS BANK OF ALBEMARLE,
INC., SSB
By:
-----------------------------------------------
President
------------------
ATTEST:
- -----------------------------
Secretary
- -------------------
[Corporate Seal]
PARTICIPANT
--------------------(SEAL)
--------------------(SEAL)
TRUSTEE
--------------------(SEAL)
TRUSTEE
--------------------(SEAL)
TRUSTEE
<PAGE>
ANNEX A
Investment Representation
-------------------------
<PAGE>
ANNEX B
Management Recognition Plan
---------------------------
Beneficiary Designation Form
----------------------------
As Beneficiary to receive any shares of stock distributable on my behalf
pursuant to the Home Savings Bank of Albemarle, Inc., SSB Management Recognition
Plan, I hereby designate the following:
Name Address Relationship
Primary Beneficiary:
------------------------------------------------------------
------------------------------------------------------------
------------------------------------------------------------
Contingent Beneficiary:
(if any)
------------------------------------------------------------
------------------------------------------------------------
------------------------------------------------------------
If more than one primary beneficiary is named, shares will be paid in equal
shares to surviving primary beneficiaries. Should the contingent beneficiaries
be eligible to receive the benefits (i.e., all primary beneficiaries are
deceased), such benefits will be paid in equal shares to such surviving
contingent beneficiaries.
Name of Spouse if not given above:
----------------------------------------------
- --------------------------------- ------------------------------------
Witness Participant
------------------------------------
Date
<PAGE>
ANNEX C
Management Recognition Plan
---------------------------
<PAGE>
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
Earnings per share: The earnings per share computation for the year ended
------------------
September 30, 1997 is based on net income earned divided by the weighted average
number of shares outstanding from the beginning of the fiscal year to the end of
the fiscal year. For purposes of this computation, the number of shares of
common stock purchased by the Bank's employee stock ownership plan which have
not been allocated to participant accounts are not assumed to be outstanding.
<PAGE>
STATEMENT REGARDING COMPUTATION OF RATIOS
The averages used in computing the performance ratios provided in Item 7
represent average monthly balances. Management does not believe the use of
month-end balances has caused a material difference in the information provided.
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
Page
- ------------------------------------------------------------------------------------------------
<S> <C>
Selected Consolidated Financial Data 1
Report to Stockholders 2
Management's Discussion and Analysis 3 - 17
Independent Auditor's Report 19
Consolidated Financial Statements:
Statements of financial condition at September 30, 1997 and 1996 20
Statements of income for the years ended September 30, 1997, 1996 and 1995 21
Statements of stockholders' equity for the years ended September 30, 1997, 1996 22 - 23
and 1995 24 - 26
Statements of cash flows for the years ended September 30, 1997, 1996 and 1995
Notes to Consolidated Financial Statements 27 - 51
Corporate Information 53 - 54
</TABLE>
This annual report to stockholders contains certain forward-looking statements
consisting of estimates with respect to the financial condition, results of
operations and other business of South Street Financial Corporation that are
subject to various factors which could cause actual results to differ materially
from those estimates. Factors which could influence the estimates include
changes in the national, regional and local market conditions, legislative and
regulatory conditions, and an adverse interest rate environment.
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
At September 30,
-------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- ---------
(Dollars in Thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
Financial Condition Data:
Total assets $ 241,061 $ 217,954 $ 159,863 $ 147,837 $ 157,909
Investment securities (1) 122,984 100,974 45,471 35,600 34,383
Loans receivable, net (2) 111,990 109,858 108,597 106,844 117,055
Deposits 141,755 146,398 137,647 127,312 139,685
Deposits, stock offering - 46,601 - - -
Advances from Federal Home Loan Bank 35,000 - - - -
Stockholders' equity (3) 61,694 20,867 20,426 18,311 16,503
Book value per share (3) 13.72 - - - -
<CAPTION>
Year Ended September 30,
-------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- ---------
(Dollars in Thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
Operating Data:
Interest income $ 16,712 $ 12,869 $ 11,980 $ 11,994 $ 13,044
Interest expense 8,846 7,775 5,980 4,973 6,037
--------- --------- --------- --------- ---------
Net interest income 7,866 5,094 6,000 7,021 7,007
Provision for loan losses - 300 - - -
--------- --------- --------- --------- ---------
Net interest income after provision
for loan losses 7,866 4,794 6,000 7,021 7,007
--------- --------- --------- --------- ---------
Non-interest income 169 126 126 147 206
--------- --------- --------- --------- ---------
Non-interest expense:
Compensation and employee benefits 2,384 1,905 1,867 1,324 1,018
Other 1,167 2,341 1,343 1,833 1,126
--------- --------- --------- --------- ---------
Total noninterest expense 3,551 4,246 3,210 3,157 2,144
--------- --------- --------- --------- ---------
Income before income taxes 4,484 674 2,916 4,011 5,069
Income tax expense 1,616 164 1,055 1,498 1,765
--------- --------- --------- --------- ---------
Income before cumulative effect of a change in
accounting principle 2,868 510 1,861 2,513 3,304
Cumulative effect on prior years of changing to a
different method of accounting for income taxes - - - 485 -
--------- --------- --------- --------- ---------
Net income $ 2,868 $ 510 $ 1,861 $ 2,028 $ 3,034
========= ========= ========= ========= =========
Earnings per share (3) $ 0.69 - - - -
Dividends per share (3) 0.38 - - - -
Dividend payout ratio (9) 55.07% - - - -
<CAPTION>
At or For the Year Ended September 30,
-------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- ---------
(Dollars in Thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
Selected Other Data: (4)
Return on average assets (5) 1.24% 0.30% 1.23% 1.63% 2.12%
Return on average equity (5) 4.70% 2.45% 9.50% 14.22% 22.25%
Average equity to average assets 26.40% 12.23% 12.97% 11.45% 9.54%
Stockholders' equity to end-of-period assets 25.59% 9.59% 12.76% 12.53% 10.45%
Interest rate spread for period (6) 2.02% 2.52% 3.59% 4.38% 4.21%
Average interest-earning assets to
average interest-bearing liabilities 136.08% 112.00% 112.74% 110.19% 109.77%
Net interest margin (7) 3.46% 3.09% 4.11% 4.72% 4.61%
Non-performing assets to total assets
at period end (8) 0.22% 0.31% 0.70% 0.76% 0.61%
Non-performing loans to total loans
at period end 0.43% 0.59% 0.87% 0.85% 0.70%
Allowance for loan losses to non-performing
loans at period end 84.12% 65.44% 13.97% 14.80% 17.06%
Net interest income, after provision for
loan losses to non-interest expense 221.52% 112.91% 186.92% 223.39% 326.82%
Non-interest expense to average assets 1.53% 2.49% 2.12% 2.05% 1.38%
Deposit accounts 14,037 16,486 17,988 17,152 18,416
Loan accounts 3,204 3,283 3,316 3,433 3,734
Number of full service banking offices 2 2 2 2 2
</TABLE>
(1) Includes interest-bearing deposits, federal funds sold, Federal Home Loan
Bank stock, and investment securities.
(2) Loans, net, represents gross loans less net deferred loan fees and allowance
for loan losses.
(3) South Street Financial Corporation completed it's stock offering on October
2, 1996 and then acquired all of the common stock of Home Savings of
Albemarle, S.S.B.
(4) Ratios other than period-end ratios are based on monthly balances.
Management does not believe the use of month end balances has caused a
material difference in the information provided.
(5) Income before cumulative effect of changes in accounting principle is used
to calculate return on average assets and return on average equity ratios.
(6) The interest rate spread represents the difference between the weighted-
average yield on interest-earning assets and the weighted-average cost of
interest-bearing liabilities.
(7) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(8) Non-performing assets include mortgage loans and consumer loans 90 days or
more delinquent, and real estate acquired in settlement of loans.
(9) The dividend payout ratio represents dividends per share as a percent of
earnings per share.
1
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND OPERATING RESULTS
The following discussion and analysis is intended to assist readers in
understanding the results of operations in 1997, 1996 and 1995, and changes in
financial position for the years ended September 30, 1997 and 1996,
respectively. This discussion and analysis is intended to compliment, and
should be read in conjunction with the audited financial statements of the
Company and related notes appearing elsewhere in this annual report to
stockholders.
Description of Business
South Street Financial Corp. (the "Company") was incorporated under laws of the
State of North Carolina for the purpose of becoming the bank holding company of
Home Savings Bank of Albemarle, Inc., S.S.B. (the "Bank," "Home Savings" or
"Home") in connection with the Bank's conversion from a state chartered mutual
savings bank to a state chartered stock savings bank (the "Conversion"),
pursuant to its Plan of Conversion. The Company was organized to acquire all of
the common stock of Home Savings upon its conversion to stock form. A
subscription and community offering of the Company's shares closed on October 2,
1996, at which time the Company acquired all of the shares of the Bank and
commenced operations.
In accordance with the Plan of Conversion, the Company issued 4,496,500 shares
of common stock at the price of $10 per share which resulted in proceeds of
$43,645,000, net of conversion costs. The Company transferred $19,558,000 of
the net proceeds to Home Savings for the purchase of all of the capital stock of
the Bank.
The Company has no operations and conducts no business of its own other than
owning Home Savings, investing its portion of the net proceeds received in the
conversion, and lending funds to the Employee Stock Ownership Plan (the "ESOP")
which was formed in connection with the Conversion. The principal business of
the Bank is accepting deposits from the general public and using those deposits
and other sources of funds to make loans secured by real estate and other forms
of collateral located in the Bank's primary market area of Stanly County, North
Carolina.
Home Savings' results of operations depend primarily on its net interest income,
which is the difference between interest income from interest-earning assets and
interest expense on interest-bearing liabilities. The Bank's operations are
also affected by noninterest income, such as miscellaneous income from loans,
customer deposit account service charges, and other sources of revenue. The
Bank's principal operating expenses, aside from interest expense, consist of
compensation and associated benefits, federal deposit insurance premiums,
occupancy costs, and other general and administrative expenses.
The Company did not commence operations until October 2, 1996; therefore, the
following discussion and analysis contains the financial results for the Company
and Home Savings for the year ended September 30, 1997, and for Home Savings for
the years ended September 30, 1996 and 1995. Because the Company has no
operations and conducts no business other than as described above, the
discussion contained in this "Management's Discussion and Analysis" concerns
primarily the business of the Bank. However, for ease of reading and because
the financial statements are presented on a consolidated basis, the Company and
the Bank are collectively referred to herein as the "Company" unless otherwise
noted.
3
<PAGE>
Market Risk
The tables below provide information about the Company's financial instruments
that are sensitive to changes in interest rates.
(A) For loans receivable the table presents principle cash flows by fixed and
adjustable rate. The table includes contractual maturities including
scheduled principal repayments adjusted for estimated prepayments. The
table presents fair values at September 30, 1997 and weighted average
interest rates by maturity dates.
(B) For investment securities, including securities available for sale,
securities held to maturity, and nonmarketable equity securities, the table
presents contractual maturities, including scheduled principal repayments
for mortgage-backed securities, adjusted for estimated prepayments.
Interest-bearing cash and federal funds sold are due on demand financial
instruments and are presented in the due in one year category.
Nonmarketable equity securities have no contractual maturity and are placed
in the longest expected maturity date. The table presents fair values at
September 30, 1997 and weighted average interest rates by maturity dates .
(C) For deposits and advances from Federal Home Bank the table presents
principle cash flows and weighted average interest rates by expected
maturity dates. The table utilizes anticipated decay rates on deposits and
present fair values at September 30, 1997.
4
<PAGE>
<TABLE>
<CAPTION>
Loans Receivable
Expected Maturity Date
Years Ending September 30,
-----------------------------------------------------------------
1998 1999 2000 2001 2002
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C>
Fixed Rate $ 2,927 $ 472 $ 387 $ 883 $ 723
Average interest rate 9.57 % 9.09 % 9.07 % 8.69 % 8.69 %
Variable Rate $ 8 $ 62 $ 50 $ 349 $ 285
Average interest rate 9.98 % 12.42 % 8.60 % 8.60 % 8.60 %
<CAPTION>
Loans Receivable
Expected Maturity Date
Years Ending September 30,
------------------------------------------
Fair
Thereafter Total Value
<S> <C> <C> <C>
Fixed Rate 100,159 $ 105,551 $ 105,406
Average interest rate 8.11 %
Variable Rate 6,114 $ 6,868 $ 6,868
Average interest rate 8.57 %
<CAPTION>
Investment Securities
Expected Maturity Date
Year Ending September 30,
--------------------------------------------------------------------
1998 1999 2000 2001 2002
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C>
Interest-bearing cash $ 19,257 $ - $ - $ - $ -
Average interest rate 5.58 % - % - % - % - %
Federal Fund sold $ 5,930 $ - $ - $ - $ -
Average interest rate 5.58 % - % - % - % - %
Securities available for sale $ 15,601 $ 27,011 $ 1,638 $ 4,154 $ 6,196
Average interest rate 5.61 % 5.46 % 6.48 % 6.54 % 7.12 %
Securities held to maturity $ 2,973 $ 1,732 $ 1,904 $ 2,016 $ 1,991
Average interest rate 7.31 % 7.31 % 7.31 % 7.31 % 7.31 %
Nonmarketable equity securities $ - $ - $ - $ - $ -
Average interest rate - % - % - % - % - %
<CAPTION>
-----------------------------------------
Fair
Thereafter Total Value
<S> <C> <C> <C>
Interest-bearing cash $ - $ 19,257 $ 19,257
Average interest rate - %
Federal Fund sold $ - $ 5,930 $ 5,930
Average interest rate - %
Securities available for sale $ 18,971 $ 73,571 $ 73,571
Average interest rate 7.35 %
Securities held to maturity $ 11,045 $ 21,661 $ 21,561
Average interest rate 7.31 %
Nonmarketable equity securities $ 2,565 $ 2,565 $ 2,565
Average interest rate - %
<CAPTION>
Debt Obligations
Expected Maturity Date
Years Ending September 30,
-------------------------------------------------------------------------------
1998 1999 2000 2001 2002
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C>
Deposits $ 83,090 $ 16,199 $ 10,828 $ 9,532 $ 2,680
Average interest rate 3.43 % 4.38 % 3.56 % 4.45 % 3.87 %
Advances from Federal Home Loan Bank $ 35,000 $ - $ - $ - $ -
Average interest rate 5.87 % - % - % - % - %
<CAPTION>
---------------------------------------------
Fair
Thereafter Total Value
<S> <C> <C> <C>
Deposits $ 19,201 $ 141,530 $ 141,901
Average interest rate 3.95 %
Advances from Federal Home Loan Bank $ - $ 35,000 $ 35,000
Average interest rate - %
</TABLE>
5
<PAGE>
Changes in Financial Condition
Total assets of the Company amounted to $241.1 million at September 30, 1997,
which is an increase of $23.1 million or 10.6% from total assets at September
30, 1996. The Company's total assets at September 30, 1996 increased by $58.1
million, or 36.3% from total assets of $159.9 million at September 30, 1995.
The growth from September 30, 1995 to September 30, 1997 can primarily be
attributed to the increase in cash and cash equivalents and investment
securities, funded by proceeds from the Conversion and savings deposit growth.
The principal category of earnings assets is loans receivable which amounted to
$112.0 million, $109.9 million and $108.6 million at September 30, 1997, 1996
and 1995, respectively. Home was able to increase the size of its loan
portfolio during 1997 and 1996 primarily through its marketing efforts in the
origination of permanent residential 1-4 family mortgages and residential
construction during a time period in which loan prepayments stabilized. All
other categories of Home's loan portfolio have remained fairly consistent from
1995 to 1997. Loan originations for the year ended September 30, 1997 totaled
$30.0 million and were funded primarily by loan principal repayments of $24.8
million as the loan portfolio increased by $2.1 million. Loan originations for
the year ended September 30, 1996 totaled $21.4 million while principal
repayments totaled $20.1 million for a net increase in the loan portfolio of
$1.3 million over 1995. The growth was primarily in the residential 1-4 family
category. Management believes that its marketing efforts, competitive rates and
contacts within its community contributed to the increased loan demand. The
Bank maintains underwriting and credit standards designed to maintain the
quality of the loan portfolio. Nonperforming loans at September 30, 1997, 1996
and 1995 totaled $510,000, $654,000 and $981,000, respectively, and were 0.43%,
0.58% and 0.87% of total loans, respectively.
In addition to loans, the Company invests in U. S. Treasury and Government
agency securities. Management does not engage in the practice of trading
securities, rather, the Company's investment portfolio consists primarily of
securities designated as available for sale. Investment securities, excluding
interest-bearing deposits, federal funds sold and Federal Home Loan Bank
("FHLB") stock, at September 30, 1997, 1996 and 1995 totaled $95.5 million,
$40.3 million and $35.5 million, respectively. The securities portfolio
increased by $55.2 million for the year ended September 30, 1997 from September
30, 1996 as $13.3 million in securities matured, $8.7 million of securities were
sold and $77.1 million in new securities were purchased. Proceeds received in
the Conversion and FHLB advances funded the securities growth in 1997. The
securities portfolio increased by $4.8 million for the year ended September 30,
1996 from September 30, 1995 as $13.9 million of securities matured, $3.0 of
securities were sold and $21.7 million of new securities were purchased. The
stock offering deposits and deposit growth funded the securities growth in 1996.
Cash and cash equivalents totaled $27.6 million, $62.1 million and $5.8 million
at September 30, 1997, 1996 and 1995, respectively. The fluctuations are a
direct result of the Conversion, as the proceeds received from the stock
offering in 1996 were temporarily invested in interest-bearing deposits and
then reinvested during 1997 in longer term investment securities, and as the
Company sought to increase liquidity to have funds available for future expanded
loan growth.
Savings deposits amounted to $141.8 million at September 30, 1997, which is a
decrease of $4.6 million from $146.4 million at September 30, 1996. At
September 30, 1996, deposits increased by $8.8 million from $137.6 million at
September 30, 1995. The decrease in 1997 is due to customers using their
deposits to purchase stock issued in the Conversion. Additionally, the Bank
received $46.6 million in
6
<PAGE>
deposits from the stock offering during 1996 which were utilized to purchase
stock during 1997. Home priced its deposits in a fashion to be at or near the
top of the market because of its dependence on the local market for funds
availability.
The Company borrowed a total of $35.0 million from the Federal Home Loan Bank
during 1997. These advances are due during fiscal 1998. The proceeds were used
for liquidity requirements, to fund loan growth and to purchase investment
securities.
Stockholders' equity during 1997 increased by $43.6 million from the proceeds
received in the Conversion, less $4.5 million for the issuance of the note
receivable to the ESOP. Additionally, equity increased by $270,000 for
principal payments received on the ESOP note and by $39,000 for the ESOP
contribution. Cash dividends of $0.38 per share were paid, which decreased
equity by $1.6 million. Lastly, stockholders' equity increased due to net
income of $2.9 million, $510,000 and $1.9 million for the years ending September
30, 1997, 1996 and 1995, respectively. The unrealized gain (loss) on securities
available for sale, net of tax, amounted to $69,000, $(35,000) and $34,000 at
September 30, 1997, 1996 and 1995, respectively. The change in the unrealized
gain (loss) reflected through stockholders' equity was $104,000, $(69,000) and
$254,000 for the years ended September 30, 1997, 1996 and 1995, respectively.
Comparison of Operating Results for the Years Ended September 30, 1997, 1996,
and 1995
Net Income
- ----------
Net income for the years ended September 30, 1997, 1996, and 1995 was $2.9
million, $510,000 and $1.9 million, respectively. Net income increased in 1997
from 1996 primarily due to a substantial increase in net interest income, as
proceeds received in the Conversion were placed into the investment portfolio.
Additionally, non-interest expense decreased in 1997 due to a one time special
assessment of $838,000 that occurred in 1996 as a result of the legislation to
recapitalize the Savings Association Insurance Fund ("SAIF"). Net income
decreased in 1996 from 1995 primarily due to a decrease in net interest income
caused by a decrease in the interest rate spread from 1995 to 1996 and due to
the SAIF assessment discussed above. Additionally, Home provided additional
provisions for loan losses and incurred an increase in other noninterest
expenses.
Net Interest Income
- -------------------
Net interest income amounted to $7.9 million, $5.1 million and $6.0 million
during the years ended September 30, 1997, 1996, and 1995, respectively. The
average outstanding balance of interest-earning assets in excess of interest-
bearing liabilities increased by a net of $42.6 million during 1997 and $1.2
million in 1996 to $60.3 million in 1997 and $17.7 million in 1996. However,
the Company's interest rate spread decreased from 3.59% in 1995 to 2.52% in 1996
and to 2.02% in 1997 as a result of an increase in the Company's cost of funds
coupled with a slight decrease in the yield on interest earning assets. The
higher balance of interest-earning assets in 1997 more than offset the decrease
in the Company's interest rate spread, resulting in higher net interest income.
The narrowing of the Company's spread in 1996 had a negative impact on net
interest income and more than offset the higher balance of net interest-earning
assets outstanding during 1996.
See the table on page 8 which analyzes the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. The table distinguishes between (i) changes
attributable to volume (changes in volume multiplied by the prior period's
rate); (ii) changes attributable to rate (changes in rate multiplied by the
prior period's volume); and (iii) mixed changes (changes in volume multiplied by
changes in rate).
7
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30, Year Ended September 30,
1997 vs. 1996 1996 vs. 1995
-----------------------------------------------------------------------------------------------------
Increase (Decrease) Attributable to Increase (Decrease) Attributable to
-----------------------------------------------------------------------------------------------------
Rate/ Rate/
Volume Rate Volume Net Volume Rate Volume Net
-----------------------------------------------------------------------------------------------------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income on:
Interest-bearing deposits $ 26 $ 100 $ 3 $ 139 $ 838 $ (65) $ (201) $ 572
Investments 2,394 96 113 2,603 316 107 22 445
Mortgage-backed securities 1,499 (85) (309) 1,105 40 (20) (2) 18
Loans receivable 235 (233) (6) (4) (44) (102) - (146)
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
Total interest income on
interest-earning assets 4,154 (112) (199) 3,843 1,150 (80) (181) 889
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
Interest expense on:
Passbook savings 21 - - 21 (15) 18 (1) 2
NOW and money market 4 (59) - (55) (39) (53) 4 (88)
Certificates of deposit (152) (174) 4 (322) 797 882 138 1,817
Deposits, stock offering (64) - - (64) 64 - - 64
FHLB Advances 1,491 - - 1,491 - - - -
-------- ---------- ---------- --------- --------- ---------- ---------- ---------
Total interest expense on
interest-bearing liabilities 1,300 (233) 4 1,071 807 847 141 1,795
--------- ---------- ---------- --------- --------- ---------- ---------- ---------
Increase (decrease) in net
Interest income $ 2,854 $ 121 $ (203) $ 2,772 $ 343 $ (927) $ (322) $ (906)
========= ========== ========== ========= ========= ========== ========== =========
<CAPTION>
Year Ended September 30,
1995 vs. 1994
-------------------------------------------------
Increase (Decrease) Attributable to
-------------------------------------------------
Rate/
Volume Rate Volume Net
-------------------------------------------------
<S> <C> <C> <C> <C>
Interest income on:
Interest-bearing deposits $ (237) $ 276 $ (166) $ (127)
Investments 330 26 7 363
Mortgage-backed securities (90) 19 (4) (75)
Loans receivable (96) (80) 1 (175)
--------- ---------- ---------- ---------
Total interest income on
interest-earning assets (93) 241 (162) (14)
--------- ---------- ---------- ---------
Interest expense on:
Passbook savings (64) 1 - (63)
NOW and money market (90) 8 (1) (83)
Certificates of deposit (7) 1,162 (2) 1,153
Deposits, stock offering - - - -
FHLB Advances - - - -
--------- ---------- ---------- ---------
Total interest expense on
interest-bearing liabilities (161) 1,171 (3) 1,007
--------- ---------- ---------- ---------
Increase (decrease) in net
interest income $ 68 $ (930) $ (159) $ (1,021)
========= ========== ========== =========
</TABLE>
8
<PAGE>
Interest Income
- ---------------
Interest income amounted to $16.7 million, $12.9 million and $12.0 million for
the years ended September 30, 1997, 1996, and 1995, respectively. The Company's
average yield on interest-earning assets decreased from 8.20% in 1995 to 7.80%
in 1996 and to 7.35% in 1997. The primary interest- earning asset is loans,
which experienced a slight decrease in average yield during 1997 and 1996, a
slight increase in the average outstanding balance during 1997 and a slight
decrease during 1996. Loan income in 1997 was flat compared to 1996, as the
increase in the average outstanding balance was offset by the decrease in the
average yield. The other primary interest-earning asset is investment
securities, which is the primary reason for the increase in interest income
during 1997, as the average balance increased $59.3 million to $98.6 million in
1997, due to investing of the funds received in the Conversion. The decline in
loan income in 1996 was offset by increases in investment income due to
increases in average outstanding balances in interest-bearing deposits and an
increase in the average outstanding balances and average yield in investment
securities.
Interest Expense
- ----------------
Interest expense amounted to $8.8 million, $7.8 million and $6.0 million for the
years ended September 30, 1997, 1996 and 1995, respectively. Interest expense
increased $1.0 million in 1997 primarily due to an increase in average
outstanding borrowings from the FHLB of $25.4 million, which was offset by a
decrease in interest expense related to core deposits and certificates of
deposit, as customers used portions of deposits to purchase stock in the
Conversion. The change in the overall cost of funds from 1996 to 1997 was not
significant. Interest expense increased $1.8 million in 1996 due to the
increase in the Bank's average balance of outstanding deposits of $17.6 million
and an increase in the average cost of funds from 4.61% in 1995 to 5.28% in
1996. The increase in cost of funds was primarily in certificates of deposit
which increased from 5.16% during 1995 to 6.05% during 1996. The increase in
outstanding average balances was primarily due to certificates of deposits and
deposits received from the stock offering, while core deposits of passbook, NOW
and money market accounts declined as customers have shifted funds into longer
term certificates of deposit. Management believes the Bank's cost of funds was
indicative of changes in overall market rates.
See the table on page 10 for additional information concerning the Company's
yields on interest-earning assets and cost of funds on interest-bearing
liabilities for the years ended September 30, 1997, 1996 and 1995.
Provision for Loan Losses and Asset Quality
Home's provision for loan losses amounted to $-0-, $300,000 and $-0- in 1997,
1996 and 1995. The provision, which is charged to operations, and the resulting
loan loss allowances are amounts Home's management believes will be adequate to
absorb potential losses on existing loans that may become uncollectible. Loans
are charged off against the allowance when management believes that
collectibility is unlikely. The evaluation to increase or decrease the
provision and resulting allowances is based both on prior loan loss experience
and other factors, such as changes in the nature and volume of the loan
portfolio, overall portfolio quality, and current economic conditions. During
the year ended September 30, 1996 management determined that its allowance for
loan losses should be increased to more closely reflect peer group banks' levels
of outstanding reserves and for increased risk in the loan portfolio resulting
from the economic environment of the market area and manufacturing plant
closings.
9
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended September 30,
------------------------------------------------------------------------------------
At September 30, 1997 1996 1995
1997 -------------------------- --------------------------- ---------------------------
Average Average Average Average
Yield/ Average Yield/ Average Yield/ Average Yield/
Rate (5) Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- ------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest earning assets:
Interest bearing deposits 5.58% $ 18,124 $ 981 5.41% $ 17,583 $ 842 4.79% $ 4,283 $ 270 6.30%
Investments (1) 6.54% 73,836 4,633 6.27% 33,884 2,030 5.99% 28,250 1,585 5.61%
Mortgage-backed securities 8.03% 24,720 1,517 6.14% 5,330 412 7.73% 4,842 394 8.14%
Loans receivable, net (4) 8.26% 110,775 9,581 8.65% 108,126 9,585 8.86% 108,755 9,731 8.95%
--------- -------- --------- -------- ---------
Total interest-earning assets 7.41% 227,455 $ 16,712 7.35% 164,923 $ 12,869 7.80% 146,130 $ 11,980 8.20%
-------- -------- --------
Non-interest-earning assets 3,899 5,608 5,004
--------- --------- ---------
Total $ 231,354 $ 170,531 $ 151,134
========= ========= =========
Liabilities and retained earnings:
Interest-bearing liabilities:
Passbook savings 3.00% $ 16,446 $ 486 2.96% $ 15,720 $ 465 2.96% $ 16,261 $ 463 2.85%
NOW and money market 2.62% 14,869 353 2.37% 14,716 408 2.77% 15,975 496 3.10%
Certificates of deposits 5.85% 110,429 6,516 5.90% 112,939 6,838 6.05% 97,382 5,021 5.16%
Deposits, stock offering -- -- -- -- 3,883 64 3.00% -- -- --
FHLB advances 5.87% 25,400 1,491 5.87% -- -- -- -- -- --
--------- -------- --------- -------- --------- --------
Total interest-bearing liabilities 5.33% 167,144 $ 8,846 5.29% 147,258 $ 7,775 5.28% 129,618 $ 5,980 4.61%
-------- -------- --------
Non-interest-bearing liabilities 3,144 2,418 1,918
Stockholders' equity 61,066 20,855 19,598
--------- --------- ---------
Total $ 231,354 $ 170,531 $ 151,134
========= ========= =========
Net interest income and interest
rate spread (2) 2.08% $ 7,866 2.02% $ 5,094 2.52% $ 6,000 3.59%
-------- -------- --------
Net yield on interest-earning
assets (3) 3.46% 3.09% 4.11%
Ratio of interest-earning assets
to interest-bearing liabilities 136.08% 112.00% 112.74%
</TABLE>
(1) Includes investment securities available for sale and FHLB of Atlanta
common stock.
(2) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Net Yield on interest-earning assets represents net interest income divided
by average interest-earning assets.
(4) Loans placed on nonperforming status have been included in the computation
of average balances
(5) The weighted average rate represents the coupon associated with each asset
and liability, weighted by the principle balance associated with each asset
and liability.
<PAGE>
Home's level of nonperforming loans, defined as loans past due 90 days or more,
has historically been low as a percentage of total loans outstanding. Loans
outstanding which were delinquent more than 90 days were approximately $510,000,
$654,000 and $981,000 at September 30, 1997, 1996 and 1995, respectively.
Foreclosures or real estate transfers in lieu of foreclosures amounted to
$91,000, $162,000 and $209,000 in 1997, 1996 and 1995, respectively. Home
Savings has adopted policies which it believes provides for prudent and adequate
levels of loan loss allowances. At September 30, 1997, Home's level of general
valuation allowances for loan losses amounted to $429,000, which management
believes is adequate to absorb potential losses in its loan portfolio.
Noninterest Income
- ------------------
Noninterest income amounted to $169,000, $126,000 and $126,000 for the years
ended September 30, 1997, 1996 and 1995, respectively. Noninterest income
consists primarily of service charges and fees associated with the Bank's
checking accounts.
Noninterest Expense
- -------------------
Noninterest expense consists primarily of operating expenses for compensation
and employee benefits, occupancy, federal deposit insurance premiums, data
processing charges and other operating expense. Noninterest expense amounted to
$3.6 million, $4.2 million and $3.2 million for the years ended September 30,
1997, 1996 and 1995, respectively. Compensation increased $479,000, $38,000 and
$543,000 for the years ended September 30, 1997, 1996, and 1995, respectively.
The Company incurred $309,000 of expense related to the ESOP in 1997, which is
included in compensation expense. Other slight increases in 1997 were due to
additional personnel, and inflationary increases. The 1995 increase in compen-
sation were due to inflationary increases, additional supplemental income
agreements and additional deferred compensation agreements. Home incurred
$838,000 in expense due to the special SAIF assessment in 1996. Occupancy
expenses and data processing increased nominally during the years ended
September 30, 1997, 1996 and 1995. Federal insurance premium expense decreased
$248,000 during 1997 as the SAIF assessment incurred in 1996 resulted in lower
regular premiums for the following year. Charitable contributions increased
$181,000 during 1996 primarily due to the Bank's funding of one-time prior
commitments to Wingate University ($40,000), Boy Scouts ($10,000), Stanly
Community College ($20,000) and Pfeiffer College ($80,000).
Income Taxes
- ------------
The Company's effective income tax rate was 36.0%, 24.3% and 36.2% for the years
ended September 30, 1997, 1996 and 1995, respectively. The decline in the 1996
effective income rate was due to a permanent difference and incurring a net
operating loss for state tax purposes. The effective rates for 1997 and 1995
reflect normal expected rates on taxable income.
Capital Resources and Liquidity
The Company paid regular cash dividends of $.38 per share during the year ended
September 30, 1997. Although the Company anticipates that it will continue to
declare cash dividends on a regular basis, the Board of Directors will continue
to review its policy on the payment of dividends on an ongoing basis, and such
payments will be subject to future earnings, cash flows, capital needs and
regulatory restrictions.
The objective of Home's liquidity management is to ensure the availability of
sufficient cash flows to meet all of its financial commitments. Liquidity
management addresses Home's ability to meet deposit withdrawals either on demand
or at contractual maturity, to repay borrowings, if any, as they mature and to
originate new loans and make investments as opportunities arise.
11
<PAGE>
Significant liquidity sources for Home are cash provided by new savings
deposits, operating activities, sale or maturity of investment and the ability
to raise equity capital. Cash flows from investing activities typically are
dependent on the level of loan demand and the amount of new savings deposits
that the Bank is able to generate. During the year ending September 30, 1997, a
decline in savings deposits of $7.5 million and proceeds from FHLB advances of
$35.0 million were the main causes of a net inflow of $26.3 million. Operating
activities provided $1.4 million, while investing activities generated a net
outflow of cash amounting to $62.2 million, as Conversion proceeds were used to
purchase investment securities and fund the ESOP note. During 1997, loan demand
increased the Bank's cash out flows on the loan portfolio by approximately $2.1
million. During the year ended September 30, 1996 new savings deposits provided
$8.7 million in net cash inflow while operating activities provided funds
totaling $1.5 million and stock offering deposits provided $46.6 million. These
funds were used primarily to increase liquidity by investing in interest-earning
deposits, purchase additional investments and fund increases in the loan
portfolio in 1996. During 1995, new savings deposits provided $10.3 million in
funds and operating activities provided $1.5 million, while investing activities
generated a net outflow of cash amounting to $6.5 million, with the excess cash
generated being invested in short term interest-earning deposits. During 1995,
loan demand increased the Bank's portfolio by $1.8 million.
These cash outflows were funded by operating and financing activities. Cash
provided by operations, deposit growth and advances from the FHLB are the
primary sources for its liquidity needs.
Levels of deposit accounts are impacted primarily by overall market rates and
the pricing policies that Home sets to attract or maintain its deposits, which
are affected by Home's demand for loans and its other liquidity needs.
Approximately 73% of Home's certificates of deposit outstanding at September 30,
1997 are scheduled to mature within the next year. Management believes that
substantially all of these deposits will be renewed and intends to price such
deposits at competitive rates in order to ensure that these deposits are
renewed. Home does not hold brokered deposits or significant levels of public
deposits which are less likely to renew if a higher rate of interest can be
obtained elsewhere. Liquidity levels and Home's operations would be
significantly hindered should a sizable portion of these deposits not be
renewed.
Cash provided by operating and financing activities has historically been used
by the Company to make new loans to its customers. Excess cash will be used in
the future to make new loans as demand warrants and to maintain the Company's
liquid investment portfolios by offsetting maturities which are timed to provide
needed cash flows to meet anticipated short term liquidity requirements.
As a state chartered savings bank, Home must meet certain liquidity requirements
which are established by the Administrator of the North Carolina Savings
Institutions Division. Home's liquidity ratio at September 30, 1997, as
computed under such regulations, was in excess of such requirements. Given its
excess liquidity and its ability to borrow from the FHLB of Atlanta, Home
believes that it will have sufficient funds available to meet anticipated future
loan commitments, unexpected deposit withdrawals, or other cash requirements.
Asset/Liability Management
Home's asset/liability management, or interest rate risk management, is focused
primarily on evaluating and managing Home's net interest income given various
risk criteria. Factors beyond Home's control, such as the effects of changes in
market interest rates and competition, may also have an impact on the management
of interest rate risk.
12
<PAGE>
In the absence of other factors, Home's overall yield on interest-earning assets
will increase as will its cost of funds on its interest-bearing liabilities when
market rates increase over an extended period of time. Inversely, Home's yields
and cost of funds will decrease when market rates decline. Home is able to
manage these swings to some extent by attempting to control the maturity or rate
adjustments of its interest-earning assets and interest-bearing liabilities over
given periods of time. Home's "gap" is typically described as the difference
between the amounts of such assets and liabilities which reprice within a period
of time. In a declining interest rate environment, a negative gap, or a
situation where Home's interest-bearing liabilities subject to repricing exceed
the level of interest-earning assets which will mature or reprice, will have a
favorable impact on Home's net interest income. At September 30, 1997, Home had
a one-year sensitivity gap of negative 29.7%. Conversely, an increase in
general market rates over a sustained period of time will tend to affect Home's
net interest income adversely.
In order to minimize the potential effects of adverse material and prolonged
increases or decreases in market interest rates on the Bank's operations,
management has implemented an asset/liability program designed to stabilize the
Bank's interest rate gap. The program emphasizes the investment of excess cash
in short or intermediate term interest-earning assets, the solicitation of
transaction deposit accounts which are less sensitive to changes in interest
rates and can be repriced rapidly, and to a lesser extent, the origination of
adjustable rate mortgage loans.
In addition to shortening the average repricing period of its assets, Home has
sought to lengthen the average maturity of its liabilities by adopting a tiered
pricing program for its certificates of deposit, which provides higher rates of
interest on its longer term certificates in order to encourage depositors to
invest in certificates with longer maturities.
Although Home's asset/liability management program has generally helped to
decrease the exposure of its earnings to interest rate increases, Home continues
to have a negative gap position which will be adversely impacted during
prolonged periods of rising interest rates and positively affected during
prolonged periods of interest rate declines. The Bank's interest-earning assets
less interest-bearing liabilities maturing or repricing within three years as a
percentage of total interest-earning assets was a negative 30.3%.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 1997, which are
projected to reprice or mature in each of the future time periods shown. The
computations were made without using assumptions for loan prepayments or deposit
decline. Except as stated below, the amounts of assets and liabilities shown
which reprice or mature within a given period were determined in accordance with
contractual terms of the assets or liabilities. In making the computations, all
adjustable rate loans were considered to be due at the end of the next upcoming
adjustment period. Fixed rate loans are reflected at their contractual
maturities with consideration given to scheduled payments. Marketable equity
securities and savings accounts with no stated maturities are subject to
immediate repricing and availability and have been classified in the earliest
category. FHLB of Atlanta stock must be maintained at certain regulatory levels
and is classified in the more than ten category. The interest rate sensitivity
of Home's assets and liabilities illustrated in the following table would vary
substantially if different assumptions were used or if actual experience differs
from that indicated by such assumptions.
13
<PAGE>
<TABLE>
<CAPTION>
At September 30, 1997
---------------------------------------------------------------------------------
Less than More than More than More than More than
3 3 Months 1 Year to 3 Years to 5 Years to More than
Months to 1 Year 3 Years 5 Years 10 Years 10 Years Total
--------- --------- --------- ---------- ---------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets (1):
Loans Receivable:
Adjustable rate 1-4 family residential $ 3,323 $ 3,118 $ - $ - $ - $ - $ 6,441
Fixed rate 1-4 family residential 9 2,054 468 1,379 57,609 35,863 97,382
Other adjustable rate real estate loans - 427 - - - - 427
Other fixed rate real estate loans 486 144 41 227 6,270 417 7,585
Other loans - 234 350 - - - 584
------- ------- -------- --------- --------- -------- -------
Total loans 3,818 5,977 859 1,606 63,879 36,280 112,419
Interest-bearing deposits 25,187 - - - - - 25,187
Investment securities
Available for sale - 6,389 27,983 10,449 19,930 8,820 73,571
Nonmarketable equity securities - - - - - 2,565 2,565
Mortgage-backed securities held to maturity (2) - - - - - 21,661 21,661
------- ------- -------- --------- --------- -------- -------
Total interest-earning assets $ 29,005 $ 12,366 $ 28,842 $ 12,055 $ 83,809 $ 69,326 $235,403
======= ======= ======== ========= ========= ======== =======
Interest-bearing liabilities:
Deposits:
Certificates of deposit $ 27,070 $ 54,657 $ 30,215 $ - $ 15 $ - $111,957
Money market deposit accounts 6,266 - - - - - 6,266
NOW and commercial checking accounts 7,996 - - - - - 7,996
Passbook savings 15,311 - - - - - 15,311
Total deposits 56,643 54,657 30,215 - 15 - 141,530
------- ------- -------- --------- --------- -------- -------
Total interest-bearing liabilities $ 56,643 $ 54,657 $ 30,215 $ - $ 15 $ - $141,530
======= ======= ======== ========= ========= ======== =======
Interest sensitivity gap per report $(27,638) $(42,291) $ (1,373) $ 12,055 $ 83,794 $ 69,326
Cumulative interest sensitivity gap (27,638) (69,929) (71,302) (59,247) 24,547 93,873
Cumulative gap as a percentage of
total interest-earning assets -11.74% -29.71% -30.29% -25.17% 10.43% 39.88%
Cumulative interest-earning assets
as a percentage of interest-bearing liabilities 51.21% 37.17% 49.62% 58.13% 117.34% 166.33%
</TABLE>
(1) Interest-earning assets are included in the period in which the balances are
expected to be redeployed and/or repriced as a result of anticipating
prepayments, scheduled rate adjustments and contractual maturities.
(2) Based upon contractual maturities.
14
<PAGE>
Impact of Inflation and Changing Prices
The financial statements and accompanying footnotes have been prepared in
accordance with generally accepted accounting principles ("GAAP"), which
require the measurement of financial position and operating results in terms of
historical dollars without consideration for changes in the relative purchasing
power of money over time due to inflation. The assets and liabilities of the
Company are primarily monetary in nature and changes in market interest rates
have a greater impact on it's performance than do the effects of inflation.
Impact of New Accounting Standards
The Company's stockholders approved the Company's stock option plan on October
15, 1997. The FASB has issued SFAS No. 123, "Accounting for Awards of Stock-
Based Compensation to Employees," which will be implemented by the Company to
account for the plan. The statement defines a fair value-based method of
accounting for an employee stock option or similar equity instrument and
encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. However, it also allows an entity to
continue to measure compensation cost for those plans using the intrinsic value-
based method of accounting prescribed by APB Opinion No. 25, "Accounting for
Stock Issued to Employees" ("Opinion 25"). Under the fair value-based method,
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period, which is usually the vesting period.
Under the intrinsic value-based method, compensation cost is the excess, if any,
of the quoted market price of the stock at the grant date or other measurement
date over the amount an employee must pay to acquire the stock. Most fixed
stock option plans - the most common type of stock compensation plan - have no
intrinsic value at grant date, and under Opinion 25 no compensation cost is
recognized for them. Compensation cost is recognized for other types of stock-
based compensation plans under Opinion 25, including plans with variable,
usually performance-based, features. This statement requires that an employer's
financial statements include certain disclosures about stock-based employee
compensation arrangements regardless of the method used to account for them.
The Statement is not expected to have a significant effect on the Company's
financial statements because management is expected to elect to continue to use
the accounting and reporting permitted by APB Opinion No. 25 and will disclose
the differences, if any, as proforma effects in the notes to the financial
statements of not utilizing the fair value method prescribed in SFAS No. 123.
The FASB has issued SFAS No. 128, "Earnings Per Share," which the Company has
not been required to adopt as of September 30, 1997. The Statement, which will
be effective for the Company's interim period ending after December 15, 1997,
specifies the computation, presentation and disclosure requirements for earnings
per share. The Company does not anticipate the effect of adoption of SFAS No.
128 to significantly impact earnings per share presentation.
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income," which the
Company has not been required to adopt as of September 30, 1997. The Statement,
which is effective for fiscal years beginning after December 15, 1997,
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of general-
purpose financial statements. This statement requires that all items that are
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements.
15
<PAGE>
Deposit Insurance/SAIF Recapitalization
For 1996, SAIF-insured institutions paid deposit insurance assessment rates of
$0.23 to $0.31 per $100 of deposits. In contrast, institutions insured by the
FDIC's Bank Insurance Fund (the "BIF") that were well capitalized and without
any significant supervisory concerns paid the minimum annual assessment of
$2,000, and all other BIF-insured institutions paid deposit insurance assessment
rates of $0.03 to $0.27 per $100 of deposits. In response to the SAIF/BIF
assessment disparity, the Deposit Funds Insurance Act of 1996 (the "Funds Act")
was enacted into law on September 30, 1996.
The Funds Act authorized the FDIC to impose a special assessment on all
institutions with SAIF-assessable deposits in the amount necessary to
recapitalize the SAIF. As implemented by the FDIC, institutions with SAIF-
assessable deposits will pay a special assessment, subject to adjustment, of
65.7 basis points per $100 of the SAIF-assessable deposits held at March 31,
1995. Based on the foregoing, the Bank charged $838,000 against pretax earnings
for the year ended September 30, 1996. This assessment is deductible in the
taxable year paid.
Due to the recapitalization of the SAIF, the FDIC proposed on October 8, 1996 to
reduce the assessment rate for SAIF-assessable deposits for periods beginning on
October 1, 1996. The proposed assessment rates would range from 18 to 27 basis
points per $100 of deposits for the last calendar quarter of 1996 and would
range from -0- to 27 basis points per $100 of deposits for subsequent assessment
periods. However, the Funds Act also provides that the FDIC cannot assess
regular insurance assessments for an insurance fund unless required to maintain
or achieve the designated reserve ratio of 1.25% per $100 of deposits, except
for institutions that are not classified as "well capitalized" or that have
moderately severe or unsatisfactory financial, operational, or compliance
weaknesses as determined by the FDIC. The Bank has not been so classified.
Accordingly, assuming the designated reserve ratio is maintained by the SAIF
after collection of the special assessment, the Bank will pay substantially
lower regular SAIF assessments compared to those paid by the Bank in recent
years, as long as it maintains its current regulatory status.
In addition, the Funds Act expanded the assessment base for the payment of
interest on FICO bonds, which were issued in the late 1980's by the Financing
Corporation to recapitalize the now defunct Federal Savings and Loan Insurance
Corporation, to include the deposits of both BIF and SAIF insured institutions
beginning January 1, 1997. Until December 31, 1999, or until such earlier date
on which the last savings association ceases to exist, the rate of assessment
for BIF insured deposits will be one-fifth of the rate imposed on SAIF-
assessable deposits. The current estimate of the assessment rate for the
payment of the FICO interest is approximately 1.3 basis points for BIF-
assessable deposits and 6.4 basis points for SAIF-assessable deposits.
The Funds Act also provides for the merger of the BIF and SAIF on January 1,
1999, assuming the prior elimination of the thrift charter. The Secretary of
the Treasury was required to conduct a study of the relevant factors for the
development of a common charter for banks and thrifts and report conclusions and
findings to Congress.
16
<PAGE>
Recapture of Tax Bad Debt Reserves
Prior to the enactment of the Small Business Job Protection Act of 1996 (the
"1996 Act") on August 20, 1996, thrift institutions which met certain
definitional tests, were permitted to establish tax reserves for bad debts and
to deduct annual additions to such reserves in arriving at taxable income. The
Bank was permitted to compute the annual bad debt deduction based upon an
experience method or a percentage equal to 8.0% of the Bank's taxable income
(the "PTI Method") before such bad debt deduction, subject to certain
limitations. Under the 1996 Act, the PTI Method was repealed and the Bank will
be required to use the experience method for computing its annual bad debt
deduction for taxable years beginning on or after October 1, 1996.
The Bank will also have to recapture its tax bad debt reserves which have
accumulated since 1987 amounting to approximately $1,023,000 over a six year
period. The tax associated with the recaptured reserves is approximately
$350,000. The recapture is scheduled to begin with the Bank's 1997 year, but
can be delayed up to two years if the Bank originates a certain level of
residential mortgage loans over the next two years. The Bank was able to meet
the requirements and deferred recapture for 1997. Deferred income taxes have
been previously established for the taxes associated with the recaptured
reserves and the ultimate payment of the taxes will not result in a charge to
earnings.
17
<PAGE>
(This page intentionally left blank)
18
<PAGE>
[LOGO OF MCGLADREY & PULLEN, LLP APPEARS HERE]
MCGLADREY & PULLEN, LLP
-----------------------
Certified Public Accountants and Consultants
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
South Street Financial Corporation
Albemarle, North Carolina
We have audited the accompanying consolidated statements of financial condition
of South Street Financial Corporation and subsidiary as of September 30, 1997
and 1996, and the related consolidated statements of income, stockholders'
equity and cash flows for each of the years in the three year period ended
September 30, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of South Street
Financial Corporation and subsidiary as of September 30, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three year period ended September 30, 1997 in conformity with generally accepted
accounting principles.
/s/ McGladrey & Pullen, LLP
Charlotte, North Carolina
November 6, 1997
19
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents:
Noninterest-bearing deposits (Note 2) $ 2,457,000 $ 2,787,000
Interest-bearing deposits 19,257,000 59,348,000
Federal funds sold 5,930,000 -
Securities held to maturity, fair value 1997, $21,561,000;
1996, $5,511,000 (Note 4) 21,661,000 5,496,000
Securities available for sale (Note 3) 73,886,000 34,784,000
Federal Home Loan Bank stock, at cost 2,250,000 1,346,000
Loans receivable, net (Note 5) 111,990,000 109,858,000
Real estate acquired in settlement of loans 18,000 18,000
Accrued interest receivable (Note 6) 1,903,000 1,165,000
Office properties and equipment, net (Note 7) 1,158,000 1,238,000
Prepaid expenses and other assets (Notes 8 and 13) 551,000 1,914,000
-----------------------------------
Total assets $ 241,061,000 $ 217,954,000
===================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------------------------------------
Liabilities:
Deposits (Note 9) $ 141,755,000 $ 146,398,000
Deposits, stock offering (Note 9) - 46,601,000
Special SAIF assessment (Note 10) - 838,000
Advances from Federal Home Loan Bank (Note 11) 35,000,000 -
Advance payments by borrowers for taxes and insurance 131,000 115,000
Accounts payable and other liabilities (Note 13) 2,189,000 2,148,000
Checks outstanding on disbursement account 292,000 987,000
-----------------------------------
Total liabilities 179,367,000 197,087,000
-----------------------------------
Commitments (Notes 12 and 16)
Stockholders' equity: (Note 14)
Preferred stock, no par value, authorized 5,000,000 shares;
no shares issued - -
Common stock, no par value, authorized 20,000,000 shares;
issued 4,496,500 in 1997; issued -0- shares in 1996 - -
Additional paid-in capital 43,684,000 -
Unrealized gain (loss) on securities available for sale net (Note 3) 69,000 (35,000)
Note receivable, ESOP (Note 15) (4,258,000) -
Retained earnings, substantially restricted (Notes 13 and 14) 22,199,000 20,902,000
-----------------------------------
Total stockholders' equity 61,694,000 20,867,000
-----------------------------------
Total liabilities and stockholders' equity $ 241,061,000 $ 217,954,000
===================================
</TABLE>
See Notes to Consolidated Financial Statements.
20
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans $ 9,581,000 $ 9,585,000 $ 9,731,000
Mortgage-backed securities 1,517,000 412,000 394,000
Securities 4,633,000 2,030,000 1,585,000
Other interest-bearing deposits 981,000 842,000 270,000
-----------------------------------------------------------
16,712,000 12,869,000 11,980,000
-----------------------------------------------------------
Interest expense:
Deposits (Note 9) 7,355,000 7,775,000 5,980,000
FHLB advances (Note 11) 1,491,000 - -
-----------------------------------------------------------
8,846,000 7,775,000 5,980,000
-----------------------------------------------------------
Net interest income 7,866,000 5,094,000 6,000,000
Provision for loan losses (Note 5) - 300,000 -
-----------------------------------------------------------
Net interest income after
provision for loan losses 7,866,000 4,794,000 6,000,000
-----------------------------------------------------------
Noninterest income 169,000 126,000 126,000
-----------------------------------------------------------
Noninterest expenses:
Compensation and benefits (Notes 8 and 12) 2,384,000 1,905,000 1,867,000
Net occupancy 291,000 291,000 256,000
Federal insurance premium expenses 70,000 318,000 295,000
Special SAIF assessment (Note 10) - 838,000 -
Data processing 213,000 210,000 205,000
Contributions 18,000 227,000 46,000
Other 575,000 457,000 541,000
-----------------------------------------------------------
3,551,000 4,246,000 3,210,000
-----------------------------------------------------------
Income before income taxes 4,484,000 674,000 2,916,000
Income taxes (Note 13) 1,616,000 164,000 1,055,000
-----------------------------------------------------------
Net income $ 2,868,000 $ 510,000 $ 1,861,000
===========================================================
Earnings per share (Note 1) $ 0.69 $ n/a $ n/a
===========================================================
Weighted average number of shares outstanding $ 4,143,444 $ n/a $ n/a
===========================================================
Dividends declared per share $ 0.38 $ n/a $ n/a
===========================================================
</TABLE>
See Notes to Consolidated Financial Statements.
21
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Unrealized
Additional Gain (Loss) Note
Paid-in on Securities Receivable,
Capital Available for Sale ESOP
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at September 30, 1994 $ - $ (220,000) $ -
Net income - - -
Net change in unrealized gain (loss) on
securities available for sale, net - 254,000 -
----------------------------------------------------------------------------------
Balance at September 30, 1995 - 34,000 -
Net income - - -
Net change in unrealized gain (loss) on
securities available for sale, net - (69,000) -
----------------------------------------------------------------------------------
Balance at September 30, 1996 - (35,000) -
Net proceeds from issuance of common stock 43,645,000 - -
Purchase of common stock by the ESOP - - (4,528,000)
Principal payment on note receivable
from the ESOP - - 270,000
ESOP contribution 39,000 - -
Cash dividends - - -
Net change in unrealized gain (loss) on
securities available for sale, net - 104,000 -
Net income - - -
----------------------------------------------------------------------------------
Balance at September 30, 1997 $43,684,000 $ 69,000 $ (4,258,000)
==================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
22
<PAGE>
<TABLE>
<CAPTION>
Retained
Earnings, Total
Substantially Stockholders'
Restricted Equity
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at September 30, 1994 $ 18,531,000 $ 18,311,000
Net income 1,861,000 1,861,000
Net change in unrealized gain (loss) on
securities available for sale, net - 254,000
-------------------------------------------
Balance at September 30, 1995 20,392,000 20,426,000
Net income 510,000 510,000
Net change in unrealized gain (loss) on
securities available for sale, net - (69,000)
-------------------------------------------
Balance at September 30, 1996 20,902,000 20,867,000
Net proceeds from issuance of common stock
Purchase of common stock by the ESOP - 43,645,000
Principal payment on note receivable - (4,528,000)
from the ESOP - 270,000
ESOP contribution - -
Cash dividends - 39,000
Net change in unrealized gain (loss) on
securities available for sale, net (1,571,000) (1,571,000)
Net income - 104,000
2,868,000 2,868,000
-------------------------------------------
Balance at September 30, 1997 $ 22,199,000 $ 61,694,000
===========================================
</TABLE>
23
<PAGE>
SOUTH STREET FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income $ 2,868,000 $ 510,000 $ 1,861,000
Adjustments to reconcile net income
to net cash provided by
operating activities:
Provision for loan losses - 300,000 -
Net accretion of premiums and
discounts on securities (56,000) (59,000) (19,000)
Amortization of deferred loan fees (152,000) (146,000) (73,000)
Gain on sale of real estate acquired
in settlement of loans (7,000) (5,000) (3,000)
Provision for depreciation 119,000 116,000 104,000
Deferred income taxes 285,000 (490,000) (75,000)
(Gain) loss on sale of office properties
and equipment (4,000) 3,000 -
ESOP contribution 39,000 - -
(Increase) decrease in assets:
Accrued interest receivable (738,000) (15,000) (123,000)
Prepaid and other assets 1,363,000 (338,000) (137,000)
Increase (decrease) in liabilities:
Accounts payable and other
liabilities (762,000) 227,000 190,000
Interest payable (51,000) 101,000 63,000
Accrued special SAIF assessment (838,000) 838,000 -
Checks outstanding on
disbursement account (695,000) 498,000 (294,000)
-------------------------------------------------------------
Net cash provided by
operating activities 1,371,000 1,540,000 1,494,000
-------------------------------------------------------------
</TABLE>
(Continued)
24
<PAGE>
SOUTH STREET FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Investing Activities
Purchases of securities held to maturity $ (19,307,000) $ (1,954,000) $ -
Purchases of securities available for sale (57,754,000) (19,815,000) (11,987,000)
Proceeds from sales of securities
available for sale 8,700,000 3,000,000 -
Proceeds from maturities and recalls of
securities available for sale 10,263,000 12,960,000 6,500,000
Principal collected on securities
held to maturity 3,059,000 981,000 790,000
Loan originations and principal
payments on loans, net (2,058,000) (1,391,000) (1,751,000)
Proceeds from sale of equipment 31,000 - -
Purchase of equipment (66,000) (63,000) (211,000)
Proceeds from sale of real estate aquired
in settlement of loans 85,000 114,000 115,000
Purchase of FHLB stock (904,000) - -
Loan to ESOP for purchase of stock (4,528,000) - -
Principal payment received on ESOP note 270,000 - -
------------------------------------------------------------
Net cash used in
investing activities (62,209,000) (6,168,000) (6,544,000)
------------------------------------------------------------
Cash Flows from Financing Activities
Net increase (decrease) in deposits (4,592,000) 8,650,000 10,272,000
Deposits, stock offering (2,956,000) 46,601,000 -
Payment of dividends (1,121,000) - -
Proceeds from FHLB borrowings 35,000,000 - -
Net increase (decrease) in advance
payments by borrowers for taxes
and insurance 16,000 18,000 (377,000)
------------------------------------------------------------
Net cash provided by
financing activities 26,347,000 55,269,000 9,895,000
------------------------------------------------------------
</TABLE>
25
<PAGE>
SOUTH STREET FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Increase (decrease) in cash
and cash equivalents $ (34,491,000) $ 50,641,000 $ 4,845,000
Cash and cash equivalents:
Beginning 62,135,000 11,494,000 6,649,000
----------------------------------------------------------------
Ending $ 27,644,000 $ 62,135,000 $ 11,494,000
================================================================
Supplemental Schedule of Cash and
Cash Equivalents:
Interest-bearing deposits $ 2,457,000 $ 59,348,000 $ 8,622,000
Noninterest-bearing deposits 19,257,000 2,787,000 2,872,000
Federal funds sold 5,930,000 - -
----------------------------------------------------------------
$ 27,644,000 $ 62,135,000 $ 11,494,000
================================================================
Supplemental Disclosures of Cash
Flow Information:
Cash payments for:
Interest $ 8,897,000 $ 7,674,000 $ 5,917,000
Income taxes 1,386,000 702,000 1,346,000
Supplemental Disclosures of Noncash
Transactions
Transfer of loans to real estate acquired
in settlement of loans 91,000 162,000 209,000
Loans originated to finance the sale
of real estate acquired in settlement
of loans 13,000 178,000 138,000
Net change in unrealized (gain) loss on
securities available for sale, net of
deferred taxes (credits) (104,000) 69,000 (254,000)
Prepaid conversion costs - 1,089,000 -
Dividends accrued 450,000 - -
Stock offering deposits used to purchase
common stock in conversion 43,645,000 - -
</TABLE>
See Notes to Consolidated Financial Statements.
26
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Summary of Significant Accounting Policies
Conversion and organization of holding company: On October 2, 1996, pursuant to
- ----------------------------------------------
a Plan of Conversion which was approved by its members and regulators, Home
Savings Bank of Albemarle, S.S.B. ("Home Savings" or the "Bank") converted from
a North Carolina-chartered mutual savings bank to a North Carolina-chartered
stock savings bank (the "Conversion"), and became a wholly-owned subsidiary of
South Street Financial Corp. (the "Company"). The Company was formed to acquire
all of the common stock of the Bank upon its conversion to stock form. The
Company has no operations and conducts no business of its own other than owning
Home Savings, investing its portion of the net proceeds received in the
Conversion, and lending funds to the Employee Stock Ownership Plan (the "ESOP")
which was formed in connection with the Conversion.
Nature of business: Home Savings is primarily engaged in the business of
- ------------------
obtaining savings deposits and originating single-family residential loans
within its primary lending area of Stanly County, North Carolina. The Bank's
underwriting policies require such loans to be made 80% loan-to-value based upon
appraised values unless private mortgage insurance is obtained. These loans are
secured by the underlying properties. The Bank's primary regulators are the
Federal Deposit Insurance Company ("FDIC") and the Administrator of the North
Carolina Savings Institutions Division (the "NC Administrator"). The Bank's
deposits are insured by the Savings Association Insurance Fund ("SAIF") of the
FDIC.
The following is a description of the significant accounting policies used in
the preparation of the accompanying financial statements:
Principles of consolidation: The consolidated financial statements include the
- ---------------------------
accounts of South Street Financial Corporation and its wholly-owned subsidiary,
Home Savings Bank of Albemarle, for the year ended September 30, 1997. South
Street Financial Corporation was capitalized on October 2, 1996, therefore, the
consolidated financial statements for the years ended September 30, 1996 and
1995 include the operations of the Bank only. All significant intercompany
transactions and balances have been eliminated in consolidation.
Basis of financial statement presentation: The accounting and reporting policies
- -----------------------------------------
of the Company conform to generally accepted accounting principles and general
practices within the financial services industry. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities as of the date of the financial statements and the
reported revenues and expenses for the period. Actual results could differ from
those estimates.
Cash and cash equivalents: For purposes of reporting the statements of cash
- -------------------------
flows, the Company includes cash on hand, demand deposits at other financial
institutions and federal funds sold as cash equivalents. From time to time, the
Company maintains deposits with financial institutions which are in excess of
the federally-insured amounts. The Company has not experienced any losses in
such amounts.
27
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Summary of Significant Accounting Policies
(Continued)
Investment in debt securities and accounting change: The Company has investments
- ---------------------------------------------------
in debt securities. Debt securities consist primarily of obligations of the U.
S. Government and federal agencies and mortgage-backed securities.
Management classifies all securities as trading, available for sale, or held to
maturity on the date of purchase and the appropriateness of such classification
be reassessed at each statement of financial condition date. Since the Company
does not buy investment securities in anticipation of short-term fluctuations in
market prices, none of the investment securities are classified as trading in
accordance with SFAS No. 115. All securities have been classified as either
available for sale or held to maturity.
Securities available for sale: Securities classified as available for sale are
- -----------------------------
those securities that the Company intends to hold for an indefinite period of
time but not necessarily to maturity. Any decision to sell a security classified
as available for sale would be based on various factors, including significant
movements in interest rates, changes in the maturity mix of the Company's assets
and liabilities, liquidity needs, regulatory capital consideration, and other
similar factors. Securities available for sale are carried at fair value.
Unrealized gains or losses are reported as increases or decreases in equity, net
of the related deferred tax effect. Realized gains or losses, determined on the
basis of the cost of specific securities sold, are included in income.
Securities held to maturity: Securities classified as held to maturity are those
- ---------------------------
securities the Company has both the intent and ability to hold to maturity
regardless of changes in market conditions, liquidity needs or changes in
general economic conditions. These securities are carried at cost adjusted for
amortization of premium and accretion of discount, computed by the interest
method over their contractual lives. Based on the Company's financial position
and liquidity, management believes the Company has the ability to hold these
securities to maturity.
Investment in Federal Home Loan Bank stock: The Bank, as a member of the Federal
- ------------------------------------------
Home Loan Bank system (FHLB), is required to maintain an investment in capital
stock of the FHLB in an amount equal to the greater of 1% of its outstanding
home loans or 5% of advances from the FHLB. No ready market exists for the FHLB
stock, and it has no quoted market value.
Loans receivable: Loans receivable are stated at unpaid principal balances, less
- ----------------
the allowance for loan losses, the undisbursed portion of construction loans,
and net deferred loan origination fees. The Bank's loan portfolio consists
principally of mortgage loans collateralized by first trust deeds on single
family residences, other residential property, commercial property and land.
Allowance for loan losses: The allowance for loan losses is increased by charges
- -------------------------
to income and decreased by charge-offs (net of recoveries). Management's
periodic evaluation of the adequacy of the allowance is based on the Bank's past
loan loss experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower's ability to pay, the estimated value of
any underlying collateral, and current economic conditions. While management
uses the best information to make evaluations, future adjustments may be
necessary, if economic or other conditions differ substantially from the
assumptions used.
28
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Summary of Significant Accounting Policies
(Continued)
Impaired loans: SFAS No. 114 requires that the Bank establish specific loan loss
- --------------
allowances on impaired loans if it is doubtful that all principal and interest
due, according to the loan terms, will be collected. An allowance on an impaired
loan is required if the present value of the future cash flows discounted using
the loan's effective interest rate is less than the carrying value of the loan.
An impaired loan can also be valued based upon its fair value in the market
place or on the basis of its underlying collateral if the loan is collateral
dependent. If foreclosure is imminent, and the loan is collateral dependent, the
loan must be valued based upon the fair value of the underlying collateral. The
Bank had no loans outstanding during the years ended September 30, 1997 and 1996
which it considered to be impaired. Therefore, there is no SFAS No. 114
allowance for unpaid loans at September 30, 1997 and September 30, 1996.
Interest Income: The Bank recognizes interest income on loans using the interest
- ---------------
method over the contractual life of the loans. The Bank continues to accrue
interest on loans, including loans delinquent 90 days or more when the
collection of interest is not in doubt. At the time a loan becomes
nonperforming, the loan is placed on nonaccrual status by establishing an
allowance for uncollected interest. If and when management determines that the
collectibility of principal and interest is no longer in doubt, the loan is
returned to performing status and the reserve for uncollected interest is
reversed. The Bank anticipates that it will account for interest on impaired
loans in a similar fashion in the future if and when it has impaired loans.
Loan origination fees: Loan fees and certain direct loan origination costs are
- ---------------------
deferred, and the net fee or cost is recognized as an adjustment to interest
income using the interest method over the contractual life of the loans,
adjusted for actual prepayments.
Real estate acquired in settlement of loans: Real estate acquired in settlement
- -------------------------------------------
of loans is initially recorded at estimated fair value at the date of
foreclosure, establishing a new cost basis. Based on periodic evaluations by
management, the carrying values are reduced where they exceed fair value minus
estimated costs to sell. Costs relating to the development and improvement of
the property are capitalized, while holding costs of the property are charged to
expense in the period incurred.
Office properties and equipment: Office properties and equipment are stated at
- -------------------------------
cost less accumulated depreciation which is computed principally by the
straight-line method over the estimated useful lives.
Benefit plans: The Bank provides a noncontributory pension plan covering
- -------------
substantially all of the Bank's employees who are eligible as to age and length
of service. The Bank's funding policy is to make the maximum annual contribution
that is deductible for income tax purposes. The Bank also has an ESOP which
covers substantially all of its employees. Contributions to the plan are based
upon the amortization requirements of the ESOP's debt to the Company, subject to
compensation limitations, and are expensed in accordance with the AICPA's
Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership
Plans. Additionally, the Bank has entered into deferred compensation agreements
for certain directors and supplemental income agreements for certain executive
officers. The present value of the liability for the benefits is being accrued
over the service life of the agreements.
29
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Summary of Significant Accounting Policies
(Continued)
Advance payments by borrowers for taxes and insurance: Certain borrowers make
- -----------------------------------------------------
monthly payments, in addition to principal and interest, in order to accumulate
funds from which the Bank can pay the borrowers' property taxes and insurance
premiums.
Income taxes: Deferred taxes are provided on a liability method whereby deferred
- ------------
tax assets are recognized for deductible temporary differences and operating
loss and tax credit carryforwards and deferred tax liabilities are recognized
for taxable temporary differences. Temporary differences are the differences
between the reported amounts of assets and liabilities and their tax bases.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized. Deferred tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on the date of
enactment.
Earnings per share: The earnings per share computation for the year ended
- ------------------
September 30, 1997 is based on net income earned divided by the weighted average
number of shares outstanding from the beginning of the fiscal year to the end of
the fiscal year. For purposes of this computation, the number of shares of
common stock purchased by the Bank's employee stock ownership plan which have
not been allocated to participant accounts are not assumed to be outstanding.
Off-statement of financial condition risk: The Bank is a party to financial
- -----------------------------------------
instruments with off statement of financial condition risk such as commitments
to extend credit and lines of credit. Management assesses the risk related to
these instruments for potential losses on an ongoing basis.
Fair value of financial instruments: The estimated fair values required under
- -----------------------------------
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, have been
-----------------------------------------------------
determined by the Company using available market information and appropriate
valuation methodologies; however, considerable judgment is required to develop
the estimates of fair value. Accordingly, the estimates presented for the fair
value of the Company's financial instruments are not necessarily indicative of
the amounts the Company could realize in a current market exchange. The use of
different market assumptions or estimation methodologies may have a material
effect on the estimated fair market value amounts.
The fair value estimates presented are based on pertinent information available
to management as of September 30, 1997 and 1996. Although management is not
aware of any factors that would significantly affect the estimated fair value
amount, such amounts have not been comprehensively revalued for purposes of
these financial statements since these dates and therefore, current estimates of
fair value may differ significantly from the amounts presented in these
financial statements.
Note 2. Cash
Noninterest-bearing cash amounting to approximately $8,000 and $16,000 was held
by a trustee at September 30, 1997 and 1996, respectively, and was required to
be used to repay loan principal and interest and taxes and insurance for the
related loans due to the Federal National Mortgage Association.
30
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 3. Securities Available for Sale
Amortized cost and fair values of securities available for sale as of September
30, are summarized as follows:
<TABLE>
<CAPTION>
1997
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Government and federal
agencies obligations $ 68,556,000 $ 190,000 $ (107,000) $ 68,639,000
Mortgage-backed securities 4,901,000 31,000 - 4,932,000
Other security 315,000 - - 315,000
----------------------------------------------------------
$ 73,772,000 $ 221,000 $ (107,000) $ 73,886,000
==========================================================
<CAPTION>
1996
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
---------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Government and federal
agencies obligations $ 34,827,000 $ 61,000 $ (119,000) $ 34,769,000
Other security 15,000 - 15,000
---------------------------------------------------------
$ 34,842,000 $ 61,000 $ (119,000) $ 34,784,000
=========================================================
</TABLE>
The amortized cost and fair values of securities available for sale as of
September 30, 1997 by contractual maturity are shown below. The contractual
maturities of mortgage-backed securities are not disclosed because the actual
maturities may differ from contractual maturities because the mortgages
underlying the securities may be prepaid without a penalty. The other security
has no contractual maturity.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
----------------------------
<S> <C> <C>
Due in one year or less $ 15,477,000 $ 15,513,000
Due after one year through five years 38,382,000 38,432,000
Due after five years through ten years 10,738,000 10,806,000
Due after ten years 3,959,000 3,888,000
Mortgage-backed securities 4,901,000 4,932,000
Other security 315,000 315,000
----------------------------
$ 73,772,000 $ 73,886,000
============================
</TABLE>
Proceeds from the sales of securities available for sale for the years ended
September 30, 1997, 1996, and 1995 were $8,700,000, $3,000,000, and $-0-,
respectively. Gross proceeds from maturities and recalled securities available
for sale for the years ended September 30, 1997, 1996, and 1995 were
$10,263,000, $12,960,000 and $6,500,000, respectively. There were no realized
gains or losses from sales, maturities or recalls of securities available for
sale for the years ended September 30, 1997, 1996 and 1995.
31
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 3. Securities Available for Sale and Accounting Change (Continued)
The change in net unrealized gains and losses shown as a separate component of
equity for the years ended September 30, 1997 and 1996 is as shown below:
<TABLE>
<CAPTION>
1997 1996
---------------------------
<S> <C> <C>
Balance in equity component, beginning $ (35,000)$ 34,000
Change in unrealized gains (losses) 172,000 (110,000)
Change in deferred income taxes (68,000) 41,000
---------------------------
Balance in equity component, ending $ 69,000 $ (35,000)
===========================
</TABLE>
Note 4. Securities Held to Maturity
Carrying amounts and fair values of securities being held to maturity as of
September 30, 1997 and 1996 are summarized as follows:
<TABLE>
<CAPTION>
1997
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities
and related securities $ 21,661,000 $ 202,000 $ (302,000) $ 21,561,000
==========================================================
<CAPTION>
1996
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
----------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities
and related securities $ 5,496,000 $ 119,000 $ (104,000) $ 5,511,000
==========================================================
</TABLE>
There were no sales, maturities or recalls of investment securities held to
maturity during the years ended September 30, 1997, 1996 and 1995.
32
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Securities Held to Maturity (Continued)
The contractual maturities of securities held to maturity are not disclosed
because the actual maturities of mortgage-backed securities may differ from
contractual maturities because the mortgages underlying the securities may be
prepaid without a penalty.
Mortgage-backed securities and related securities consist of the following at
September 30:
<TABLE>
<CAPTION>
1997 1996
----------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Government National Mortgage Association
(GNMA) securities $ 3,541,000 $ 3,626,000 $ 3,894,000 $ 3,885,000
Federal National Mortgage Association
(FNMA) securities 11,890,000 11,950,000 882,000 882,000
Federal Home Loan Mortgage Corporation
(FHLMC) securities 6,202,000 5,957,000 689,000 713,000
Small Business Administration 28,000 28,000 31,000 31,000
----------------------------------------------------------------
$ 21,661,000 $ 21,561,000 $ 5,496,000 $ 5,511,000
================================================================
</TABLE>
Note 5. Loans Receivable
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
September 30,
----------------------------------------------
1997 1996
----------------------------------------------
<S> <C> <C>
Principal balances:
First mortgage loans (principally conventional):
Secured by one-to-four family residences $ 95,984,000 $ 93,275,000
Secured by other properties 10,420,000 11,037,000
Construction loans 8,394,000 4,720,000
Home equity 3,328,000 3,786,000
----------------------------------------------
118,126,000 112,818,000
----------------------------------------------
Other loans 584,000 666,000
----------------------------------------------
Allowance for loan losses (429,000) (428,000)
Undisbursed portion of construction loans (5,655,000) (2,616,000)
Net deferred loan origination fees (636,000) (582,000)
----------------------------------------------
(6,720,000) (3,626,000)
----------------------------------------------
$111,990,000 $109,858,000
==============================================
</TABLE>
Certain qualifying first mortgage loans secured by one-to-four family residences
are pledged as collateral for the Federal Home Loan Bank advances discussed in
note 11.
33
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 5. Loans Receivable (Continued)
The following is an analysis of the allowance for loan losses:
<TABLE>
<CAPTION>
Years Ended
September 30,
-----------------------------------------------
1997 1996 1995
-----------------------------------------------
<S> <C> <C> <C>
Balance, beginning $ 428,000 $ 137,000 $ 140,000
Provision charged to operations - 300,000 -
Loans charged off (1,000) (18,000) (3,000)
Recoveries 2,000 9,000 -
-----------------------------------------------
Balance, ending $ 429,000 $ 428,000 $ 137,000
===============================================
</TABLE>
SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by
------------------------------------------------
SFAS No. 118, Accounting by Creditors for Impairment of a Loan-Income
-------------------------------------------------------
Recognition and Disclosures, requires that the Bank establish a specific
- ---------------------------
allowance on impaired loans and disclosure of the Bank's method of accounting
for interest income on impaired loans. The Bank assesses loans delinquent more
than 90 days for impairment. Such loans amounted to approximately $510,000 and
$654,000 at September 30, 1997 and 1996, respectively, and had an average
outstanding balance of approximately $714,000 and $1,075,000 for the year ended
September 30, 1997 and 1996, respectively. These loans are primarily collateral
dependent and management has determined that the underlying collateral is in
excess of the carrying amounts. As a result, the Bank has determined that
specific allowances on these loans is not required.
Nonperforming loans for which interest has been reduced totaled approximately
$510,000, and $654,000 at September 30, 1997, and 1996, respectively. The
differences between interest income that would have been recorded under the
original terms of such loans and the interest income actually recognized totaled
$29,000, $40,000, and $7,000 for the years ended September 30, 1997, 1996 and
1995, respectively.
Mortgage loans serviced for others consist of FNMA loans and are not included in
the accompanying statements of financial condition. The unpaid principal
balances of these loans totaled $460,000 and $715,000 at September 30, 1997 and
1996, respectively. Custodial escrow balances maintained in connection with the
foregoing loan servicing was approximately $8,000 and $16,000 at September 30,
1997 and 1996, respectively.
Officers and directors of the Company were indebted to the Bank for loans made
in the ordinary course of business. The following is an analysis of the loans
to officers and directors for the year ended September 30:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------
<S> <C> <C>
Balance, beginning $ 1,256,000 $ 984,000
Originations 570,000 374,000
Payments received (219,000) (102,000)
-------------------------------------
Balance, ending $ 1,607,000 $ 1,256,000
=====================================
</TABLE>
34
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 6. Accrued Interest Receivable
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
September 30,
-------------------------------
1997 1996
-------------------------------
<S> <C> <C>
Securities $ 985,000 $ 440,000
Mortgage-backed securities 237,000 44,000
Loans receivable 681,000 681,000
-------------------------------
$ 1,903,000 $ 1,165,000
===============================
</TABLE>
Note 7. Office Properties and Equipment
Office properties and equipment consist of the following:
<TABLE>
<CAPTION>
September 30,
-------------------------------
1997 1996
-------------------------------
<S> <C> <C>
Land $ 138,000 $ 138,000
Buildings and improvements 1,343,000 1,321,000
Furniture and equipment 704,000 660,000
Automobiles - 45,000
-------------------------------
2,185,000 2,164,000
Less accumulated depreciation 1,027,000 926,000
-------------------------------
$ 1,158,000 $ 1,238,000
===============================
</TABLE>
Note 8. Employee Pension Plan
The Bank has a defined benefit plan covering substantially all employees. The
benefits are based on years of service and the employee's expected compensation
during five consecutive plan years within the last ten plan years that produce
the highest average. Total pension expense was $136,000, $139,000 and $108,000
for the years ended September 30, 1997, 1996 and 1995, respectively, and is
included in compensation and benefits in the accompanying statements of income.
35
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 8. Employee Pension Plan (Continued)
The following table sets forth the Plan's funded status and amounts recognized
in the statement of financial condition as of September 30, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
-------------------------------
<S> <C> <C>
Actuarial present value of benefit (obligations):
Accumulated benefit (obligation):
Vested $ (352,000) $ (276,000)
Nonvested (25,000) (12,000)
-------------------------------
(377,000) (288,000)
Effect of projected future compensation (610,000) (494,000)
-------------------------------
Projected benefit (obligation) for service rendered to date (987,000) (782,000)
Plan assets at fair value; primarily cash and short-term investments 384,000 234,000
-------------------------------
Projected benefit (obligation) in excess of plan assets (603,000) (548,000)
Unrecognized prior service cost 404,000 438,000
Unrecognized net (gain) loss 218,000 131,000
-------------------------------
Prepaid pension cost (included in prepaid and other assets) $ 19,000 $ 21,000
===============================
</TABLE>
The components of net pension expense for the years ended September 30, 1997,
1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------------------
<S> <C> <C> <C>
Service cost-benefits earned during the period $ 44,000 $ 39,000 $ 33,000
Interest cost on projected benefit obligation 70,000 60,000 43,000
Actual return on plan assets (24,000) (10,000) (2,000)
Net amortization and deferral 46,000 50,000 34,000
---------------------------------------------
Net pension expense $ 136,000 $ 139,000 $ 108,000
=============================================
</TABLE>
Assumptions used to develop the net periodic pension cost as of September
30, 1997 and 1996 were:
<TABLE>
<S> <C>
Discount rate 8.0%
Expected long-term rate of return on assets 8.0
Rate of increase in compensation levels 5.0
</TABLE>
36
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 9. Deposits
Deposits at September 30 are summarized as follows:
<TABLE>
<CAPTION>
Weighted
Average
Rate at 1997 1996
September 30, -------------------------------------------------------------------
1997 Amount Percent Amount Percent
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Demand and NOW accounts, including non-
interest-bearing deposits of $689,000 at
September 30, 1997 and $819,000 at
September 30, 1996 2.32 % $ 7,996,000 5.64 % $ 7,188,000 4.91 %
Money market 3.00 6,266,000 4.42 6,674,000 4.56
Passbook savings 3.00 15,311,000 10.80 17,953,000 12.26
-------------------------------------------------------------------
29,573,000 20.86 % 31,815,000 21.73 %
-------------------------------------------------------------------
Certificates of deposit:
2.00% to 3.99% 16,000 0.01 % $ 16,000 0.01 %
4.00% to 5.99% 59,037,000 41.65 59,286,000 40.5
6.00% to 7.99% 52,904,000 37.32 55,005,000 37.57
-------------------------------------------------------------------
5.85 % 111,957,000 78.98 % 114,307,000 78.08 %
-------------------------------------------------------------------
Accrued interest payable 225,000 0.16 % 276,000 0.19 %
-------------------------------------------------------------------
$ 141,755,000 100.00 % $ 146,398,000 100.00 %
===================================================================
Weighted average cost of savings deposits 5.20 % 5.21 %
=============== ===============
</TABLE>
The Bank received deposits from stock subscriptions totaling $46,601,000 at
September 30, 1996.
At September 30, 1997, the scheduled maturities of certificates of deposit are
as follows:
<TABLE>
<CAPTION>
Year Ending September 30, Amount
- ------------------------- -------------------
<S> <C>
1998 $ 81,727,000
1999 14,319,000
2000 10,828,000
2001 5,068,000
2002 and thereafter 15,000
-------------------
$ 111,957,000
===================
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $13,328,000 and $13,906,000 at
September 30, 1997 and 1996, respectively.
37
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 9. Deposits (Continued)
The aggregate amount of certificates of deposit by maturity with a minimum
denomination of $100,000 included in the above table is as follows:
<TABLE>
<CAPTION>
September 30,
1997
------------------
<S> <C>
Maturity Period:
Within 3 months or less $ 3,485,000
Over 3 months through 6 months 3,636,000
Over 6 months through 12 months 2,504,000
Over 12 months 3,703,000
------------------
$ 13,328,000
==================
</TABLE>
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
Years Ended September 30,
-----------------------------------------------------
1997 1996 1995
-----------------------------------------------------
<S> <C> <C> <C>
Passbook savings $ 486,000 $ 529,000 $ 492,000
NOW and money market 353,000 408,000 496,000
Certificates of deposit 6,516,000 6,838,000 4,992,000
-----------------------------------------------------
$ 7,355,000 $ 7,775,000 $ 5,980,000
=====================================================
</TABLE>
The Bank has pledged securities with an amortized cost of $1,000,000 at
September 30, 1997 as collateral for public deposits.
Eligible savings accounts are insured to $100,000 by the Savings Association
Insurance Fund (SAIF) which is administered by the Federal Deposit Insurance
Corporation (FDIC).
Note 10. Special SAIF Assessment
On September 30, 1996, The "Deposit Insurance Funds Act of 1996" was signed into
law. The legislation included a special assessment to capitalize the SAIF up to
a statutory goal of 1.25% of insured deposits. The assessment is equal to
approximately 65.7 basis points of the SAIF assessable deposit base as of March
31, 1995. Although the assessment was paid during the three month period ended
December 31, 1996, the Bank was required to accrue and expense the cost of the
assessment as of September 30, 1996. In addition, this assessment was not
deducted for income tax purposes until paid. The expense recorded for the
special SAIF assessment for the year ended September 30, 1996 was $838,000.
38
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 11. Advances from Federal Home Loan Bank
Advances from the Federal Home Loan Bank ("FHLB") at September 30, 1997 consist
of the following:
<TABLE>
<S> <C>
Advances due FHLB, due in quarterly interest only installments
at 5.98%, with accrued interest and principal due June 16, 1998 $ 15,000,000
Advances due FHLB, due in quarterly interest only installments
at 5.68%, with accrued interest and principal due December 16, 1997 10,000,000
Advances due FHLB, due in quarterly interest only installments
at 6.05%, with accrued interest and principal due March 18, 1998 6,000,000
Advances due FHLB, due in quarterly interest only installments
at 5.70%, with accrued interest and principal due October 20, 1997 4,000,000
-------------
$ 35,000,000
=============
</TABLE>
All advances are collateralized by the Bank's stock in the FHLB and qualifying
first mortgage loans secured by one-to-four family residences.
The average amount of borrowings outstanding was approximately $25,400,000
during the year ended September 30, 1997. The maximum amount of borrowings
outstanding amounted to $35,000,000 during the year ended September 30, 1997.
The weighted average interest rate of borrowings was 5.87% at September 30,
1997.
Interest expense on borrowed funds totaled $1,491,000, $-0- and $-0- for the
years ended September 30, 1997, 1996 and 1995, respectively.
Note 12. Deferred Compensation Agreements
The Bank has entered into unfunded deferred compensation agreements providing
retirement and death benefits for seven directors and supplemental retirement
and death benefits income agreements for two executive officers. Vested benefits
under the deferred compensation agreements are payable in monthly installments
over 10 and 15 year periods for the supplemental income agreements. The present
value of the liability for the benefits is being accrued over the service life
per the underlying agreements, which amounted to $1,342,000 and $1,082,000 at
September 30, 1997 and 1996, respectively. The total expense for the deferred
compensation agreements and supplemental income agreement amounted to $249,000,
$222,000, and $379,000 for the years ended September 30, 1997, 1996 and 1995,
respectively.
39
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 13. Income Tax Matters
Under the Internal Revenue Code, the Bank is allowed a special bad debt
deduction related to additions to tax bad debt reserves established for the
purposes of absorbing losses. Through 1996, the provisions of the Code permitted
the Bank to deduct from taxable income an allowance for bad debts based on 8% of
taxable income before such deduction or actual loss experience. The Bank was
unable to take a bad debt deduction in 1996 and 1995 due to limitations imposed
by the Code. In addition, legislation passed in 1996 eliminates the percentage
of taxable income method as an option for computing bad debt deductions in all
future years. The Bank will still be permitted to take deductions for bad debts,
but will be required to compute such deductions using an experience method.
The Bank will also have to recapture its tax bad debt reserves which have
accumulated since 1987 and amount to approximately $1,023,000 over a six year
period. The tax associated with the recaptured reserve is approximately
$350,000. The recapture was scheduled to begin with the Bank's 1997 year but is
being delayed up to two years as the Bank originates a certain level of mortgage
loans over this period. Deferred income taxes have been previously established
for the taxes associated with the recaptured reserves and the ultimate payment
of the taxes will not result in a charge to earnings.
Deferred taxes have been provided for certain increases in the Bank's tax bad
debt reserves subsequent to 1987 which are in excess of recorded book loan loss
allowances. At September 30, 1997, retained earnings contain certain historical
additions to bad debt reserves for income tax purposes of approximately
$2,870,000, the balance at September 30, 1988, for which no deferred taxes have
been provided because the Bank does not intend to use these reserves for
purposes other than to absorb losses. If amounts which qualified as bad debt
deductions are used for purposes other than to absorb losses or adjustments
arising from the carryback of net operating losses, income taxes may be imposed
at the then existing rates. The unrecorded deferred income tax liability on the
above amount was approximately $1,125,000 as of September 30, 1997. In the
future, if the Bank does not meet the income tax requirements necessary to
permit the deduction of an allowance for bad debts, the Bank's effective tax
rate would increase to the maximum percent under existing law.
40
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 13. Income Tax Matters (Continued)
The tax effects of temporary differences that gave rise to significant portions
of the net deferred tax asset (liability) (classified with prepaid expenses and
other assets and accounts payable and other liabilities) in the Statement of
Financial Condition at September 30 are as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------------
<S> <C> <C>
Deferred tax assets:
Net deferred loan fees and costs $ 1,000 $ 45,000
Deferred compensation and supplemental income 455,000 414,000
Federal Insurance Premium - 328,000
Reserve for uncollected interest 10,000 -
Unrealized loss on securities available for sale - 23,000
Allowance for loan losses 146,000 187,000
---------------------------
612,000 997,000
---------------------------
Deferred tax liabilities:
FHLB dividends 232,000 232,000
Reserve for bad debts 350,000 400,000
Unrealized gain on securities available for sale 45,000
Property and equipment 43,000 70,000
---------------------------
670,000 702,000
---------------------------
Net deferred tax asset (liability) $ (58,000)$ 295,000
===========================
</TABLE>
A valuation allowance was not recorded for deferred tax assets at September 30,
1997 or 1996.
Income tax expense (credits) consist of the following for the years ended
September 30:
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------
<S> <C> <C> <C>
Current $ 1,331,000 $ 654,000 $ 1,130,000
Deferred 285,000 (490,000) (75,000)
-----------------------------------------
Total $ 1,616,000 $ 164,000 $ 1,055,000
=========================================
</TABLE>
The following is a reconciliation of the federal income tax rate of 34% to the
effective tax rate:
<TABLE>
<CAPTION>
Year Ended
September 30,
------------------------------------------
1997 1996 1995
------------------------------------------
<S> <C> <C> <C>
Statutory federal income tax rate 34.0 % 34.0 % 34.0 %
Increase (decrease) in taxes resulting from:
State income taxes, net of federal benefit 1.4 - 2.2
Permanent differences - 0.2 -
Permanent differences and state net
operating loss - (9.5) -
Other 0.6 (0.4) -
------------------------------------------
36.0 % 24.3 % 36.2 %
==========================================
</TABLE>
41
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 14. Stockholders' Equity
On October 2, 1996, South Street Financial Corporation completed and closed its
stock offering. Gross proceeds from the sale of 4,496,500 shares amounted to
$44,965,000, which includes $4,528,000 in proceeds from shares purchased by the
ESOP, and reduced by conversion costs of $1,320,000. The Company transferred
$19,558,000 of the net proceeds to Home Savings for the purchase of all of the
common stock of the Bank, and retained the remaining net proceeds.
Concurrent with the Conversion, the Bank established a liquidation account in an
amount equal to its net worth as reflected in its latest statement of financial
condition contained in the definitive prospectus used in connection with the
Company's initial public offering. The liquidation account will be maintained
for the benefit of eligible deposit account holders and supplemental eligible
deposit account holders who continue to maintain their deposit accounts in the
Bank after the Conversion. Only in the event of a complete liquidation will
eligible deposit account holders and supplemental eligible deposit account
holders be entitled to receive a liquidation distribution from the liquidation
account in the amount of the then current adjusted sub-account balance for
deposit accounts then held before any liquidation distribution may be made with
respect to common stockholders. Dividends paid by the Bank subsequent to the
Conversion cannot be paid from this liquidation account.
Subject to applicable law, the Board of Directors of South Street Financial
Corporation or Home Savings may each provide for the payment of dividends.
Future declarations of cash dividends, if any, by the Company may depend upon
dividend payments by the Bank to the Company. Subject to regulations promulgated
by the NC Administrator, the Bank will not be permitted to pay dividends on its
common stock if its stockholder's equity would be reduced below the amount
required for the liquidation account or its capital requirement.
For a period of five years after its conversion from mutual to stock form, Home
Savings must obtain the written approval from the NC Administrator before
declaring or paying a cash dividend to South Street Financial Corporation on its
capital stock in an amount in excess of one-half of the greater of (i) the
Bank's net income for the most recent fiscal year end or (ii) the average of the
Bank's net income after dividends for the most recent fiscal year-end and not
more than two of the immediately preceding fiscal year ends. During 1997, the
Bank paid $826,000 in dividends to South Street Financial Corporation.
South Street Financial Corporation paid cash dividends totaling $0.38 per share
during the year ended September 30, 1997.
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory -- and possibly additional discretionary -- actions
by regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative regulatory accounting practices.
The Bank's capital amounts and classifications are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
42
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 14. Stockholders' Equity (Continued)
The FDIC requires the Bank to have a minimum leverage ratio of Tier I Capital
(principally consisting of retained earnings and any future common stockholders'
equity, less any intangible assets) to all assets of at least 3%, provided that
it receives the highest rating during the examination process. For institutions
that receive less than the highest rating, the Tier I capital requirement is 1%
to 2% above the stated minimum. The FDIC also requires the Bank to have a ratio
of total capital to risk-weighted assets of 8%, of which at least 4% must be in
the form of Tier I capital. The NC Administrator requires a net worth equal to
at least 5% of total assets. The Bank complied with all of the capital
requirements at September 30, 1997.
The following is a reconciliation of the Bank's capital in accordance with
generally accepted accounting principles (GAAP) to the components of regulatory
capital at September 30, 1997:
<TABLE>
<CAPTION>
Leverage N.C.
Ratio of Tier I Savings
Tier I Risk-Adjusted Risk-Based Bank
Capital Capital Capital Capital
------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
GAAP equity $ 41,789 $ 41,789 $ 41,789 $ 41,789
Supplemental capital items:
General valuation allowance - - 429 429
Unrealized gain on securities available
for sale (51) (51) (51) (51)
------------------------------------------------------
Regulatory capital 41,738 41,738 42,167 42,167
Minimum capital requirement 6,622 2,395 6,386 11,036
------------------------------------------------------
Excess regulatory capital $ 35,116 $ 39,343 $ 35,781 $ 31,131
======================================================
Total Bank assets at September 30, 1997 $ 220,726 $ 220,726
============= =============
Bank risk-weighted assets at
September 30, 1997 $ 79,819 $ 79,819
===========================
Capital as a percentage of assets:
Actual % 18.91 % 52.29 % 52.83 % 19.10%
Required 3.00 3.00 8.00 5.00
------------------------------------------------------
Excess % 15.91 % 49.29 % 44.83 % 14.10%
======================================================
</TABLE>
43
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 14. Stockholders' Equity (Continued)
As of September 30, 1997, the most recent notification from the FDIC categorized
corrective action. To be categorized as well capitalized, the Bank must maintain
total capital to risk weighted assets of 10%, Tier I Capital to risk weighted
assets of 6% and Tier I Capital to total assets of 5% or $7,982,000, $4,789,000,
and $11,036,000, respectively. There are no conditions or events since that
notification that management believes have changed the Bank's category.
Note 15. Employee Stock Ownership Plan
The Bank has established an employee stock ownership plan (ESOP) to benefit all
qualified employees. The ESOP purchased 359,720 shares of common stock in the
open market subsequent to the Conversion with proceeds received from a loan from
the Company.
The Company's note receivable is to be repaid based upon 15 annual installments
of principal and interest on September 30 of each year through September 30,
2011. Interest is based upon prime, which will be adjusted and paid annually.
The note may be prepaid without penalty. The unallocated shares of stock held by
the ESOP are pledged as collateral for the debt. The ESOP is funded by
contributions made by the Bank in amounts sufficient to retire the debt. At
September 30, 1997 the outstanding balance of the note receivable is $4,258,000,
and is presented as a reduction of stockholders' equity.
Shares are released as the debt is repaid and earnings from the common stock
held by the ESOP are allocated among participants on the basis of compensation
in the year of allocation. Benefits become 100% vested after five years of
credited service. Forfeitures of nonvested benefits will be reallocated among
remaining participating employees in the same proportion as contributions.
Dividends on unallocated shares may be used by the ESOP to repay the debt to the
Company and are not reported as dividends but as additional compensation expense
in the financial statements. Dividends on allocated or committed to be allocated
shares may also be used to repay the debt to the Company and are reported as
dividends in the financial statements.
Expenses of $309,000 have been incurred during 1997 in connection with the ESOP.
The expenses include, in addition to the cash contribution necessary to fund the
ESOP, $39,000 which represents the difference between the fair value of the
shares which have been released or committed to be released to participants, and
the cost of these shares to the ESOP. The Bank has credited this amount to
paid-in capital in accordance with the provisions of AICPA Statement of Position
93-6.
At September 30, 1997, 21,442 shares held by the ESOP have been released or
committed to be released to the plan's participants for purposes of computing
earnings per share. The fair value of the unallocated shares amounted to
approximately $6.6 million at September 30, 1997.
44
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 15. Employee Stock Ownership Plan (Continued)
The ESOP has a put option which requires the Company to repurchase its common
stock from participants in the ESOP who are eligible to receive benefits under
the terms of the plan and elect to receive cash in exchange for their common
stock. The potential commitment for the put option at September 30, 1997, based
on a fair value of the ESOP shares released of $19.50, is $2,756,000. This
commitment will fluctuate based on the fair value of the shares.
Note 16. Financial Instruments with Off-Statement of Financial Condition Risk
and Commitments
The Bank is a party to financial instruments with off-statement of financial
condition risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to extend credit.
These instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the statement of financial
condition. The contract or notional amounts of those instruments reflect the
extent of involvement the Bank has in particular classes of financial
instruments.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual or notional amount of these instruments. The Bank
uses the same credit policies in making commitments and conditional obligations
as it does for on-statement of financial condition instruments.
<TABLE>
<CAPTION>
September 30, 1997
-------------------------------
Fixed Rate Variable Rate
-------------------------------
<S> <C> <C>
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit, mortgage loans $ 7,079,000 $ -
Undisbursed lines of credit - 2,756,000
-------------------------------
$ 7,079,000 $ 2,756,000
===============================
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and many
require payment of a fee. The total commitment amounts do not necessarily
represent future requirements, since some may expire without being drawn upon.
The Bank evaluates each customer's credit worthiness on a case-by-case basis.
The Bank entered into employment agreements with two executive officers to
provide for their continued employment. The agreements provide for an initial
term of three years and can be extended an additional year annually.
45
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 17. Disclosures About Fair Value of Financial Instruments
The fair value of the Company's cash and cash equivalents, is estimated to be
equal to its recorded amount. For securities held to maturity and securities
available for sale, the fair value is estimated using quoted market values
obtained from independent pricing services. For Federal Home Loan Bank stock,
the fair value is the same as the recorded book value since the stock can be
redeemed at face value.
The fair value for all fixed rate loans has been estimated by discounting the
projected future cash flows using the rate at which similar loans would be made
to borrowers with similar credit ratings and for similar maturities. The
discount rate used has been adjusted by an estimated credit risk factor to
approximate the adjustment that would be applied in the marketplace for any
nonperforming loans. Certain prepayment assumptions have also been made
depending upon the original contractual lives of the loans. The fair value for
all adjustable rate loans has been estimated to be equal to their carrying
amounts because the repricing periods are relatively short-term in nature.
The fair value of deposits with no stated maturities, including checking
accounts and statement savings accounts, is estimated to be equal to the amount
payable on demand. The fair value of certificates of deposit is based upon the
discounted value of the contractual cash flows. The discount rates used in these
calculations approximate the current rates offered for deposits of similar
remaining maturities.
The fair values of checks outstanding on disbursement account, accrued interest
receivable, accrued interest payable and advance payments to borrowers for taxes
and insurance are presumed to be their recorded book values.
The fair value of the Federal Home Loan Bank advances is equal to the recorded
book value due to the market rates of interest and short-term nature of the
notes.
The estimated fair value of commitments to extend credit is estimated using fees
currently charged for similar arrangements adjusted for changes in interest
rates and credit risk that has occurred subsequent to origination. Because the
Bank believes that the credit risk associated with available but undisbursed
commitments would essentially offset fees that could be recognized under similar
arrangements, and because the commitments are either short term in nature or
subject to immediate repricing, no fair value has been assigned to these
off-statement of financial condition commitments.
46
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 17. Disclosures About Fair Value of Financial Instruments (Continued)
The recorded book value and estimated fair value of the Company's financial
assets and liabilities at September 30, are summarized below:
<TABLE>
<CAPTION>
1997 1996
---------------------------------------------------------------------
Recorded Estimated Recorded Estimated
Book Value Fair Value Book Value Fair Value
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents $ 27,644,000 $ 27,644,000 $ 62,135,000 $ 62,135,000
Securities held to maturity 21,661,000 21,561,000 5,496,000 5,511,000
Securities available for sale 73,866,000 73,866,000 34,784,000 34,784,000
Federal Home Loan Bank stock 2,250,000 2,250,000 1,346,000 1,346,000
Loans receivable, net 111,990,000 111,845,000 109,858,000 110,914,000
Accrued interest receivable 1,903,000 1,903,000 1,165,000 1,165,000
Financial Liabilities
Savings deposits with no stated maturities 29,573,000 29,573,000 31,815,000 31,815,000
Savings deposits with stated maturities 111,957,000 112,328,000 114,307,000 114,882,000
Deposits, stock offering - - 46,601,000 46,601,000
Checks outstanding on disbursement account 292,000 292,000 987,000 987,000
Accrued interest payable 225,000 225,000 276,000 276,000
Advance payments by borrowers for taxes
and insurance 131,000 131,000 115,000 115,000
Advances from Federal Home Loan Bank 35,000,000 35,000,000 - -
</TABLE>
47
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 18. Parent Company Financial Data
The following is a summary of the condensed financial statements of South Street
Financial Corporation as of and for the year ended September 30, 1997:
<TABLE>
<CAPTION>
Condensed Balance Sheet
September 30, 1997
<S> <C>
Assets:
Cash $ 858,000
Federal funds sold 5,930,000
Securities available for sale 13,384,000
Accrued interest receivable 168,000
Prepaid expenses and other assets 101,000
Investment in Home Savings Bank 41,789,000
--------------
$ 62,230,000
==============
Liabilities and Stockholders' Equity:
Liabilities:
Other liabilities $ 472,000
--------------
Stockholders' Equity:
Additional paid-in capital 43,784,000
Unrealized gain on securities available for sale,
net of tax 69,000
Note receivable, ESOP (4,258,000)
Retained earnings 22,163,000
--------------
61,758,000
--------------
$ 62,230,000
==============
Condensed Statement of Income
For the Year Ended September 30, 1997
Interest income $ 1,457,000
Equity in earnings of Home Savings Bank 1,964,000
Other expense (2,000)
Income tax expense (551,000)
--------------
Net Income $ 2,868,000
==============
</TABLE>
48
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 18. Parent Company Financial Data (Continued)
Condensed Statement of Cash Flows
For the Year Ended September 30, 1997
<TABLE>
<CAPTION>
<S> <C>
Cash Flows from Operating Activities:
Net income $ 2,868,000
Change in assets and liabilities:
Equity in earnings of Home Savings (1,964,000)
Increase in accrued interest receivable and other assets (269,000)
Increase in other liabilities 9,000
Other (35,000)
--------------
Net cash provided by operating activities 609,000
--------------
Cash Flows from Investing Activities:
Purchase of securities available for sale (15,081,000)
Proceeds from sales and repayments of
securities available for sale 1,763,000
Initial investment in Home Savings Bank (19,558,000)
Upstream dividend from Home Savings Bank 826,000
Loan to ESOP for purchase of common stock (4,528,000)
Principal payment received on note receivable from ESOP 270,000
--------------
Net cash used in investing activities (36,308,000)
--------------
Cash Flows from Financing Activities:
Net proceeds from common stock received in the Conversion 43,645,000
Payment of dividends (1,158,000)
--------------
Net cash provided by financing activities 42,487,000
--------------
Net increase in cash and cash equivalents 6,788,000
Cash and cash equivalents - beginning --
--------------
Cash and cash equivalents - ending $ 6,788,000
==============
Supplemental Disclosures of Cash Flow Information:
Cash payments for income taxes $ 541,000
Supplemental Disclosures of Noncash Investing and
Financing Activities
Change in unrealized gain on securities available for sale 31,000
Dividends accrued 450,000
</TABLE>
49
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 19. Future Reporting Requirements
The FASB has issued SFAS No. 123, Accounting for Stock-Based Compensation, which
will be in effect for the Company's interim period ending after December 15,
1997, will require that an entity account for stock based compensation plans
using a fair value based method which measures compensation cost at the grant
date based upon the value of the award, which is then recognized over the
service period, usually the vesting period. The accounting requirements of the
Statement apply to grants of awards entered into in fiscal years that begin
after December 15, 1995. The Statement allows entities to continue to use APB
Opinion No. 25 to measure compensation cost, but requires that the pro forma
effects on net income and earnings per share be disclosed to reflect the
difference between the compensation cost, if any, from applying APB Opinion No.
25 and the related cost measured by the fair value method defined in the
Statement. The Statement is not expected to have a material effect on the
Company's financial statements because management is expected to elect to
continue to use the accounting and reporting permitted by APB Opinion No. 25 and
will disclose the differences, if any, as pro forma effects in notes to the
financial statements of not utilizing the fair value method prescribed in SFAS
No. 123.
The FASB has issued SFAS No. 128, Earnings Per Share, which the Company has not
been required to adopt as of September 30, 1997. The Statement, which will be
effective for the Company's interim period ending after December 15, 1997,
specifies the computation, presentation and disclosure requirements for earnings
per share.
The FASB has issued SFAS No. 130, Reporting Comprehensive Income, which the
Company has not been required to adopt as of September 30, 1997. The Statement,
which is effective for fiscal years beginning after December 15, 1997,
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. This statement requires that all items
that are recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements.
Note 20. Subsequent Event
The Company's stockholders approved the Company's stock option plan and the
Bank's Management Recognition Plan (the "MRP") on October 15, 1997. The stock
option plan reserves for issuance up to 449,650 stock options to all officers,
directors, and employees at the time of the adoption either in the form of
incentive stock options or non-incentive stock options. The exercise price of
the stock options may not be less than the fair value of the Company's common
stock at date of grant. The options, which vest at the rate of 25% annually
beginning at the date of grant, were all granted upon the adoption of the plan
and expire on October 15, 2007. As permitted under the generally accepted
accounting principles, grants under the plan will be accounted for following the
provisions of APB Opinion No. 25 and its related interpretations. Accordingly,
no compensation cost will be recognized on the grant date of any options.
50
<PAGE>
SOUTH STREET FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 20. Subsequent Event (Continued)
The MRP reserved for issuance 179,860 shares of common stock to all officers,
directors, and employees at the time of the adoption. The Bank issued shares to
fund the MRP in October of 1997. The restricted common stock under the MRP vests
at the rate of 20% annually beginning at the date of grant.
Subsequent to year end, the Company declared a special return of capital
dividend of $6.00 per share to be paid on January 8, 1998 to shareholders of
record as of December 17, 1997.
51
<PAGE>
(This page intentionally left blank)
52
<PAGE>
CORPORATE INFORMATION
<TABLE>
<S> <C> <C>
EXECUTIVE OFFICERS
Carl M. Hill Christopher F. Cranford R. Ronald Swanner
President and CEO Traveler/Controller Executive Vice President/Secretary
DIRECTORS:
Carl M. Hill Caldwell A. Holbrook, Jr. R. Ronald Swanner
Chairman; President and CEO Partner, D.A. Holbrook Executive Vice President/
of Home Savings Secretary of Home Savings
Douglas D. Stokes Joel A. Honeycutt Greg E. Underwood
Owner and President, Stokes President, Locust Lumber Owner, Carolina Oil Company of
Construction Company Company Albemarle, Inc. and Barefoot Oil
Company of Albemarle, Inc.
</TABLE>
<TABLE>
<S> <C>
Stock Transfer Agent Annual Meeting
Registrar and Transfer Company The 1998 annual meeting of stockholders of
10 Commerce Drive South Street Financial Corp. will be held at 7:00 p.m.
Cranford, NJ 07016 on February 9, 1998 at the Company's corporate
office at 155 West South Street, Albemarle, NC.
Special Legal Counsel
Brooks, Pierce, McLendon, Form 10-K
Humphrey & Leonard, LLP A copy of Form 10-K as filed with the Securities and
2000 Renaissance Plaza Exchange Commission will be furnished without
230 North Elm Street charge to the Company's stockholders upon written
Greensboro, NC 27420 request to South Street Financial Corporation,
155 West South Street, P.O. Box 489,
Albemarle, NC 28002
Independent Auditors Corporate Office
McGladrey & Pullen, LLP 155 West South Street
One Morrocroft Centre P.O. Box 489
6805 Morrison Boulevard, Suite 200 Albemarle, NC 28002-0489
Charlotte, NC 28211
</TABLE>
53
<PAGE>
Common Stock Information
On October 2, 1996, the Company issued 4,496,500 shares of common stock. The
Company's common stock is listed on the NASDAQ National Market under the symbol
"SSFC" and began trading on October 3, 1996. At September 30, 1997, there were
approximately 734 shareholders of record, not including the number of persons or
entities where stock is held in nominee or "street" name through various
brokerage firms or banks. The following table reflects the stock trading and
dividend payment frequency of the Company for the year ended September 30, 1997.
<TABLE>
<CAPTION>
Stock Price
-----------------------
Dividends High Low
-------------------------------------
<S> <C> <C> <C>
First Quarter $ 0.08 $ 14.750 $ 10.000
Second Quarter 0.10 17.000 13.750
Third Quarter 0.10 16.750 15.125
Fourth Quarter 0.10 19.625 16.250
</TABLE>
54
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> SEP-30-1997 SEP-30-1996
<PERIOD-START> OCT-01-1996 OCT-01-1995
<PERIOD-END> SEP-30-1997 SEP-30-1996
<CASH> 2,457 2,787
<INT-BEARING-DEPOSITS> 19,257 59,348
<FED-FUNDS-SOLD> 5,930 0
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 76,136 36,130
<INVESTMENTS-CARRYING> 21,661 5,496
<INVESTMENTS-MARKET> 21,561 5,511
<LOANS> 111,990 109,858
<ALLOWANCE> 429 428
<TOTAL-ASSETS> 241,061 217,954
<DEPOSITS> 141,755 192,999
<SHORT-TERM> 35,000 0
<LIABILITIES-OTHER> 2,612 4,088
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 61,694 20,867
<TOTAL-LIABILITIES-AND-EQUITY> 241,061 217,954
<INTEREST-LOAN> 9,581 9,585
<INTEREST-INVEST> 6,150 2,442
<INTEREST-OTHER> 981 842
<INTEREST-TOTAL> 16,712 12,869
<INTEREST-DEPOSIT> 7,355 7,775
<INTEREST-EXPENSE> 1,491 0
<INTEREST-INCOME-NET> 7,866 5,094
<LOAN-LOSSES> 0 300
<SECURITIES-GAINS> 0 0
<EXPENSE-OTHER> 3,551 4,246
<INCOME-PRETAX> 4,484 674
<INCOME-PRE-EXTRAORDINARY> 4,484 674
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 2,868 510
<EPS-PRIMARY> 0.69 0
<EPS-DILUTED> 0.69 0
<YIELD-ACTUAL> 7.35 7.80
<LOANS-NON> 510 654
<LOANS-PAST> 0 0
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 428 137
<CHARGE-OFFS> 1 18
<RECOVERIES> 2 9
<ALLOWANCE-CLOSE> 429 428
<ALLOWANCE-DOMESTIC> 278 264
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 151 164
</TABLE>
