<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1999
--------------------------
Commission file number 0-21083
--------------------------
SOUTH STREET FINANCIAL CORP.
----------------------------------
(Exact name of registrant as specified in its charter)
North Carolina 56-1973261
- ----------------------------------------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
155 West South Street
Albemarle, North Carolina 28001
- ----------------------------------------- ----------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (704) 982-9184
--------------
Securities Registered Pursuant to Section 12(b) of the Act: None
--------
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, no par value
------------------------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _______
-------
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ 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.
$25,201,357.50 common stock, no par value, based on the closing price of such
- -----------------------------------------------------------------------------
common stock on December 22, 1999.
- ----------------------------------
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
3,665,652 shares of common stock, no par value, outstanding at December 22,
- ---------------------------------------------------------------------------
1999.
- -----
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to stockholders of South Street Financial Corp.
for the year ended September 30, 1999 ("1999 Annual Report"), are incorporated
by reference into Part I, Part II and Part IV.
Portions of the Proxy Statement for the 2000 Annual Meeting of Shareholders of
South Street Financial Corp. to be held on February 28, 2000, are incorporated
by reference into Part III.
================================================================================
<PAGE>
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.
In June 1998, Park Ridge Associates, a joint venture between the Bank and a
local real estate developer, acquired 25.6 acres of prime real estate located
within the city limits of Albemarle, North Carolina, with the intention of
developing the property into a premier residential subdivision. Eleven out of
twenty-seven of the subdivision lots have been committed to buyers, and the
property is currently being marketed; the expected completion date is December
1999. There can be no assurances that the development will be completed by the
expected completion date, or that the Bank will be successful in recovering its
investment in the joint venture, due to the uncertainty inherent in the
construction industry and in the real estate market.
In December 1998, the Bank joined the HONOR network (which merged into the
STAR network in 1999) and the CIRRUS network for ATMs and Point of Sale ("POS")
terminals, which allows the Bank's cardholders to enjoy the convenience and
accessability of approximately 324,000 ATMs and over 400,000 POS terminals
worldwide.
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,
2
<PAGE>
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, 1999, the Company had total assets of $174.5 million, net
loans of $125.5 million, deposits of $144.3 million, investment securities of
$41.5 million and stockholders' equity of $26.7 million. The Company
repurchased 578,208 shares of common stock in 1999 resulting in a decrease in
stockholders' equity of $4.5 million.
At September 30, 1999, the Company and the Bank had a total of 39
employees, all of whom are full-time. Employees are not represented by any union
or collective bargaining group, and the Bank considers its employee relations to
be good.
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
83% of the Bank's deposits are at the Albemarle office. Stanly County is largely
rural with a population of 54,000. Its economy is diversified among
manufacturing, trade and services. Major area employers include Wiscassett
Mills Company, Collins and Aikman Corporation, Michelin Aircraft Tire Company,
Oakwood Homes 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 98% of the Bank's loan
portfolio is secured by real estate. As of September 30, 1999, all of the loans
in the Bank's real estate loan portfolio were secured by properties in North
Carolina. On September 30, 1999, the Bank's largest single outstanding loan had
a balance of approximately $1.0 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 $125.5 million at September 30, 1999 representing 71.9% of the
Company's total assets at such date. At September 30, 1999, 83.7% of the Bank's
net loan portfolio was composed of one-to-four family residential mortgage
loans. Home equity loans, all of which have
3
<PAGE>
adjustable rates, represented 2.3% of the Bank's net loan portfolio, and
nonresidential real estate loans represented 3.0% 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, 1999, fewer than 1% of the loans in the
Bank's loan portfolio, excluding home equity loans, had adjustable interest
rates.
In December 1998, the Bank started a new consumer and commercial loan
department and began offering a full range of consumer and commercial products
and services. See "- Consumer Loans" below for a further discussion of the new
department, products and services.
Origination of Loans. Historically, the Bank has not originated its one-
to-four family residential mortgage or other loans with the intention that they
will be sold in the secondary market. Accordingly, the Bank originates fixed
rate one-to-four family residential real estate loans which satisfy the Bank's
underwriting requirements and are tailored to its local community, but do not
necessarily satisfy various technical FHLMC and FNMA underwriting requirements
and purchase requirements not related to documentation.
Although the Bank believes that many of its nonconforming loans are
saleable in the secondary market, some of such nonconforming loans could be sold
only after the Bank incurred certain costs and/or discounted the purchase price.
As a result, the Bank's loan portfolio is less liquid than would be the case if
it was composed entirely of loans originated in conformity with secondary market
requirements. In addition, certain types of nonconforming loans are generally
thought to have greater risks of default and nonperformance. However, such
loans generally produce a higher yield than would be produced by conforming
loans, and the Bank has historically found that its origination of such loans
has not resulted in a high level of nonperforming assets. These nonconforming
loans satisfy a need in the Bank's local community, and the Bank intends to
continue to originate nonconforming loans.
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 table below sets forth the Bank's loan origination, purchase activity
and loan portfolio repayment experience during the periods indicated.
4
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------
1999 1998 1997
---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C>
Loans receivable, net,
beginning of period $ 110,550 $ 111,990 $ 109,858
-------- ------- -------
Loan originations:
Residential 1-4 family 26,604 16,309 17,998
Nonresidential real estate 513 1,303 524
Residential construction 11,949 2,963 9,898
Line of credit 1,247 1,641 1,248
Commercial 5,739 -- --
Consumer 1,213 343 321
-------- ------- -------
Total loan originations 47,265 22,559 29,989
Principal repayments (227,948) (27,123) (24,763)
Other changes, net/(1)/ (4,374) 3,124 (3,094)
-------- ------- -------
Increase (decrease) in loans receivable 14,943 (1,440) 2,132
-------- ------- -------
Loans receivable, net, end of period $ 125,493 $ 110,550 $ 111,990
======== ======= =======
</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, 1999, approximately 83.7% 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, 2.4% had adjustable interest
rates.
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 95% 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
5
<PAGE>
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, 1999, the Bank had approximately
$620,000 in outstanding loans secured by multifamily residential real estate,
comprising approximately 0.49% of its net 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, 1999, the Bank had
$11.2 million in outstanding loans secured by nonresidential real estate,
including undeveloped land, comprising approximately 8.9% 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, 1999, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $1.0 million. This loan was performing in accordance with
the original loan contract.
Home Equity Lines of Credit. At September 30, 1999, the Bank had
approximately $2.9 million in home equity line of credit loans, representing
approximately 2.3% 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 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, 1999 was approximately $11.2 million, representing
approximately 9.0% 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%.
6
<PAGE>
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,
automobile loans and other secured and unsecured consumer loans. As of September
30, 1999, the Bank had approximately $2.6 million in consumer loans outstanding,
representing approximately 2.1% of its net loan portfolio.
In December 1998, the Bank started a new consumer and commercial loan
department and began offering a full range of consumer and commercial products
and services. To oversee the new department, the Bank hired a commercial banker
with over 21 years of experience in the local market. The Bank hired another
loan officer in August 1999 to assist in the growth of this line of service.
Management of the Bank believes that introducing consumer and commercial lending
to the Bank's existing line of products and services will enhance the Bank's net
interest margin while reducing the Bank's overall exposure to interest rate
risk. Management also feels that the addition of these products will help the
Bank grow while creating stronger ties to its existing customer base. As of
September 30, 1999, commercial loans, which are classified as nonresidential
real estate loans, totaled approximately $4.9 million, representing
approximately 3.9% of the Bank's 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 $500,000 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 $500,000 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, 1999, the Bank
had $8.5 million in such unfunded mortgage loan commitments. In addition, on
such date the Bank had $3.6 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.
7
<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, 1999, the Bank had one piece of single-
family property classified as real estate owned. The property was recorded on
the Bank's books at $18,000, the unpaid principal balance of loans secured by
such property. The appraised value of the property exceeded their its principal
balance. 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, 1999,
interest income that would have been recorded net of interest income actually
recognized on nonperforming loans under the original terms of such loans was
$12,000.
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, 1999, the Bank had approximately $291,000 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, 1999, the Bank had approximately $791,000 of
loans in the "special mention" category.
8
<PAGE>
When an insured institution classifies problem assets as either substandard
or doubtful, it is required to establish general allowances for loan losses in
an amount deemed prudent by management. These allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities and the risks associated with particular problem assets.
When an insured institution classifies problem assets as "loss," it charges off
the balance of the asset. The Bank's determination as to the classification of
its assets and the amount of its valuation allowances is subject to review by
the FDIC and the Administrator which can order the establishment of additional
loss allowances.
The following table sets forth at September 30, 1999, the Bank's aggregate
carrying value of the assets classified as substandard, doubtful, loss or
"special mention":
<TABLE>
<CAPTION>
Special Mention list Substandard Doubtful Loss
-------------------- -------------------- -------------------- --------------------
Number Amount Number Amount Number Amount Number Amount
------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in Thousand)
Real estate loans:
Residential 1-4 family 30 $791 11 $222 -- $ -- -- $ --
Residential real estate -- -- -- -- -- -- -- --
Nonresidential real estate -- -- -- -- -- -- -- --
Residential construction -- -- -- -- -- -- -- --
Land -- -- -- -- -- -- -- --
Line of credit -- -- 3 65 -- -- -- --
---- ---- ---- ---- ---- ---- ---- ----
Total real estate loans 30 791 14 287 -- -- -- --
---- ---- ---- ---- ---- ---- ---- ----
Consumer loans:
Share -- -- -- -- -- -- -- --
Credit reserve -- -- 4 4 -- -- -- --
---- ---- ---- ---- ---- ---- ---- ----
Total consumer loans -- -- 4 4 -- -- -- --
---- ---- ---- ---- ---- ---- ---- ----
Total 30 $791 18 $291 -- $ -- -- $ --
==== ==== ==== ==== ==== ==== ==== ====
</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, 1999, the Bank maintained its level of allowance for loan losses
which management believes is adequate based on the risks inherent in the loan
portfolio.
For information on loans receivable, see Note 4 of "Notes to Consolidated
Financial Statements" in the 1999 Annual Report.
Investment Securities
Interest and dividend income from investment securities generally provides
the second largest source of income to the Company after interest on loans. In
addition, the Company receives interest income from deposits in other
9
<PAGE>
financial institutions. On September 30, 1999, the carrying value of the
Company's investment securities portfolio totaled approximately $41.5 million
and consisted of interest-bearing deposits, federal funds sold, U.S. government
and agency securities, mortgage-backed securities, and stock in the FHLB of
Atlanta. The investment securities portfolio includes interest-bearing deposits
and federal funds sold of $2.3 million at September 30, 1999. 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 Company has no trading
securities. See Note 3 of "Notes to Consolidated Financial Statements" in the
1999 Annual Report.
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, 1999, the Bank's investment in stock of the FHLB of Atlanta was
$1.2 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.
See Note 3 of "Notes to Consolidated Financial Statements" in the 1999
Annual Report for further information on investment securities.
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
10
<PAGE>
significantly influenced by general interest rates and money market conditions.
Borrowings may be used on a short-term basis to compensate for reductions in the
availability of funds from other sources. They may also be used on a longer term
basis for general business purposes. The Bank had no borrowings outstanding from
other banks at September 30, 1999.
Deposits. On September 30, 1999, 1998 and 1997, the Bank's deposits
totaled, $144.3 million, $148.4 million, and $141.8 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,
---------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
(In Thousands)
Total deposits at $148,444 $141,755 $146,398 $137,647 $127,312
beginning of period
Net increase (decrease) (11,116) (614) (11,998) 976 4,355
before interest credited
Interest credited 6,944 7,303 7,355 7,775 5,980
-------- -------- -------- -------- --------
Total deposits at end of
period $144,272 $148,444 $141,755 $146,398 $137,647
======== ======== ======== ======== ========
</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 in accordance
with the regulations of the Administrator.
In December 1998, the Bank joined the HONOR network (which merged into the
STAR network in 1999) and the CIRRUS network for ATMs and Point of Sale ("POS")
terminals, which allows the Bank's cardholders to enjoy the convenience and
accessability of approximately 324,000 ATMs and over 400,000 POS terminals
worldwide.
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 no outstanding borrowings from the FHLB of
Atlanta at September 30, 1999. On January 8, 1998, the Company made a return of
capital distribution to its stockholders in the form of a special dividend of
$6.00 per share on all outstanding shares of Common Stock. To partially fund
this special dividend,
11
<PAGE>
the Company borrowed $18.0 million from an outside bank in fiscal year 1999. The
note was paid off on October 1, 1998
See Notes 8 and 9 of "Notes to Consolidated Financial Statements" in the
1999 Annual Report for further information on deposits and borrowings.
Subsidiaries
The Company has no subsidiaries other than the Bank. The Bank has a wholly-
owned subsidiary, South Street Development Corp. ("SSDC"), which is a 50% owner
of Park Ridge Associates, L.L.C. ("Park Ridge"). SSDC and Park Ridge do business
in the real estate development industry.
In June 1998, Park Ridge acquired 25.6 acres of prime real estate located
within the city limits of Albemarle, North Carolina. Park Ridge acquired the
real estate to develop it into a premier residential subdivision. The upscale
subdivision consists of 30 building lots of which 3 have been retained by the
sellers and 11 have been committed to buyers. As of December 1999 the project
was 99% completed, and was being marketed. There can be no assurances that the
development will be completed by the expected completion date, or that the Bank
will be successful in recovering its investment in the joint venture, due to the
uncertainty inherent in the construction industry and in the real estate market.
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, 1999, 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, 1999, the
Bank had a deposit market share of approximately 25% 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.
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
12
<PAGE>
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
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 1999, 1998 and 1997.
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. Retained earnings at September 30, 1999 includes
approximately $2.9 million for which no provision for federal income tax has
been made. See Note 12 to "Notes to Consolidated Financial Statements" in the
1999 Annual Report.
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, 1999, the
Bank's post-1987 excess reserves amounted to approximately $852,000. A special
provision suspended recapture of post-1987 excess reserves for two years
because, during those years, the institution satisfied a "residential loan
requirement." This requirement was met because the principal amount of the
institution's residential loans exceeded the base year amount, which was
measured by the average of the institution's residential loans during the six
taxable years ending before January 1, 1996. During the year ended September 30,
1999, the Bank recaptured $171,000 of the excess reserve.
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
13
<PAGE>
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 12
years.
State Taxation
Under North Carolina law, the corporate income tax is 7.25% of federal
taxable income as computed under the Code, subject to certain prescribed
adjustments. An annual state franchise tax is imposed at a rate of 0.15% applied
to the greatest of the institutions (i) capital stock, surplus and undivided
profits, (ii) investment in tangible property in North Carolina or (iii)
appraised valuation of property in North Carolina.
The North Carolina corporate tax rate will drop to 7.00% in 2000 and 6.90%
thereafter.
SUPERVISION AND REGULATION
Bank holding companies and state savings banks are extensively regulated
under both federal and state law. The following is a brief summary of certain
statutes and rules and regulations that affect or will affect the Company and
the Bank. This summary is qualified in its entirety by reference to the
particular statutes and regulatory provisions referred to below and is not
intended to be an exhaustive description of the statutes or regulations
applicable to the business of the Company and the Bank. Supervision, regulation
and examination of the Company and the Bank by the regulatory agencies are
intended primarily for the protection of depositors rather than shareholders of
the Company.
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
14
<PAGE>
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, require insured depository institutions under common
control to reimburse the FDIC for any loss suffered by either the Savings
Association Insurance Fund (the "SAIF") or the Bank Insurance Fund (the "BIF")
as a result of the default of a commonly controlled insured depository
institution or for any assistance provided by the FDIC to a commonly controlled
insured depository institution in danger of default. The FDIC may decline to
enforce the cross-guarantee provisions if it determines that a waiver is in the
best interest of the SAIF or the BIF or both. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
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(g) 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
15
<PAGE>
require the affiliate's sale to be aggregated with those of certain other
persons) will be able to sell in the public market, without registration, a
number of shares not to exceed, in any three-month period, the greater of (i) 1%
of the outstanding shares of the Company or (ii) the average weekly volume of
trading in such shares during the preceding four calendar weeks. Provision may
be made in the future by the Company to permit affiliates to have their shares
registered for sale under the Securities Act under certain circumstances. There
are currently no demand registration rights outstanding. However, in the event
the Company at some future time determines to issue additional shares from its
authorized but unissued shares, the Company might offer registration rights to
certain of its affiliates who want to sell their shares.
Regulation of the Bank
General. Federal and state legislation and regulation have significantly
affected the operations of federally insured savings institutions and other
federally regulated financial institutions in the past several years and have
increased competition among savings institutions, commercial banks and other
providers of financial services. In addition, federal legislation has imposed
new limitations on investment authority, and higher insurance and examination
assessments on savings institutions and has made other changes that may
adversely affect the future operations and competitiveness of savings
institutions with other financial institutions, including commercial banks and
their holding companies. The operations of regulated depository institutions,
including the Bank, will continue to be subject to changes in applicable
statutes and regulations 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
16
<PAGE>
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.
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 $87,000, $89,000, and $70,000, for
the years ended September 30, 1999, 1998 and 1997, respectively.
Under recently enacted legislation, both BIF and SAIF members are assessed
an amount for the Financing Corporation Bond payments. BIF members are assessed
approximately 1.3 basis points while the SAIF rate is 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
17
<PAGE>
rating with respect to CRA compliance would be a factor to be considered by the
Federal Reserve and FDIC in considering applications submitted by the Bank to
acquire branches or to acquire or combine with other financial institutions and
take other actions and could result in the denial of such applications.
The federal banking regulatory agencies have issued a rewrite of the CRA
regulations, which became effective on January 1, 1996, to implement a new
evaluation system that rates institutions based on their actual performance in
meeting community credit needs. Under the regulations, a savings bank will be
evaluated and rated under three categories: a lending test, an investment test
and a service test. For each of these three tests, the savings bank will be
given a rating of either "outstanding," "high satisfactory," "low satisfactory,"
"needs to improve" or "substantial 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,
1999, the Bank had a leverage ratio of 14.44%.
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, 1999, 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
18
<PAGE>
and practices for each of those elements, and (iii) describes the critical
factors affecting the agencies' evaluation of a bank's interest rate risk when
making a determination of capital adequacy. The joint policy statement is not
expected to have a material impact on 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, 1999, the largest aggregate amount of loans which the
Bank had to any one borrower was $1.3 million. The Bank had no loans outstanding
which management believes violate the applicable loans-to-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, 1999, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of $1.2 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, 1999, 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 mortgage-
backed securities and investments which, in the judgment of the Administrator,
have a readily marketable
19
<PAGE>
value, including investments with maturities in excess of five years. On
September 30, 1999, the Bank's liquidity ratio, calculated in accordance with
North Carolina regulations, was approximately 32%.
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 states that
20
<PAGE>
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 regular cash dividends totaling $0.40 per share during the
year ended September 30, 1999.
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.
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.
21
<PAGE>
Subject to limitation by the Administrator, North Carolina-chartered
savings banks may make any loan or investment or engage in any activity which is
permitted to federally chartered institutions. However, a North Carolina-
chartered savings bank cannot invest more than 15% of its total assets in
business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain 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, 1999. 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: $632,000 $119,231
155 West South Street
Albemarle, North Carolina 28001
Two (2) Vacant Lots $ 26,000
South Second Street
Albemarle, North Carolina 28001
Locust: $215,000 $ 25,041
406 West Main Street
Locust, North Carolina 28097
$873,000 $144,272
======= =======
</TABLE>
The Bank's management considers the property to be in good condition and is
of the opinion that it is adequately covered by insurance. The total net book
value of the Bank's furniture, fixtures and equipment on September 30, 1999 was
$292,000. 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, 1999, the Bank had recorded $18,000 for real estate acquired in settlement
of loans.
22
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
In the opinion of management, neither the Company nor the Bank is involved
in any pending legal proceedings other than routine, non-material proceedings
occurring in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's stockholders during the
quarter ended September 30, 1999.
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 65 in the Company's 1999 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 the inside cover of the Company's 1999
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,
-------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Return on Average Assets (Net income divided
by average total assets) 0.15% 0.35% 1.24% 0.30% 1.23%
Return on Average Equity (Net income divided
by average shareholders' equity 0.96% 1.89% 4.70% 2.45% 9.50%
Average Equity to Average Assets Ratio
(Average shareholders' equity divided by
average total assets) 16.12% 18.43% 26.40% 12.23% 12.97%
Interest Rate Spread for the Period 2.48% 1.97% 2.02% 2.52% 3.59%
Average Interest-Earning Assets to Average
Interest-Bearing Liabilities 118.68% 123.10% 136.08% 112.00% 112.74%
Net Interest Margin 3.24% 2.98% 3.46% 3.09% 4.11%
Loan Loss Allowance to Nonperforming Assets
at Period End 222.23% 135.76% 81.25% 63.69% 12.28%
</TABLE>
23
<PAGE>
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 4 through 21 in the
Company's 1999 Annual Report which section is incorporated herein by reference.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Pages 5 and 6 of the 1999 Annual Report are herein incorporated by
reference.
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, 1999, the Company had securities totaling $41.5 million, of
which $18.6 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 $39.9 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, 1999, the
Company had $14.6 million of regular savings accounts, and $14.5 million of
money market, demand and NOW accounts, representing 20.2% of total depositor
accounts.
The Company does not currently engage in trading activities or use
derivative instruments to control interest rate risk. Even though such
activities may be permitted with the approval of the Board of Directors, the
Company does not intend to engage in such activities in the immediate future.
Interest rate risk is the most significant market risk affecting the Company.
Other types of market risk, such as foreign currency exchange rate risk and
commodity price risk, do not arise in the normal course of the Company's
business activities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
24
<PAGE>
The consolidated financial statements of the Company and supplementary data
set forth on pages 23 through 65 of the Company's 1999 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 of the Proxy Statement
captioned "Proposal 1 - Election of Directors - General" of the Proxy Statement
and "Proposal - Election of Directors - Executive Officers," 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 Proxy
Statement section captioned "Section 16(a) Beneficial Ownership Reporting
Compliance," which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the Proxy
Statement sections captioned "Proposal -Election of Directors - Directors'
Compensation" and "- Executive Compensation," 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
Proxy Statement section captioned "Security Ownership of Certain Beneficial
Owners."
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 Proxy Statement section captioned "Proposal 1 -Election
of Directors - Certain Indebtedness and Transactions of Management," 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 1999
Annual Report attached hereto as Exhibit (13) and incorporated herein
by reference)
(a) Independent Auditor's Report
(b) Statements of Financial Condition as of September 30, 1999 and
1998
(c) Statements of Income and Comprehensive Income for the Years Ended
September 30, 1999, 1998 and 1997
25
<PAGE>
(d) Statements of Stockholders' Equity for the Years Ended September
30, 1999, 1998 and 1997
(e) Statements of Cash Flows for the Years Ended September 30, 1999,
1998 and 1997
(f) Notes to Consolidated Financial Statements
14(a)2. Financial Statement Schedules
All schedules have been omitted as the required information is either
inapplicable or included in the Notes to Consolidated Financial
Statements.
14(a)3. Exhibits
Exhibit (3)(i) 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
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
26
<PAGE>
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,
incorporated herein by reference to the Form 10-K
dated September 30, 1997
Exhibit (10)(x) Home Savings Bank of Albemarle, Inc., SSB
Management Recognition Plan and Trust Agreement,
incorporated herein by reference to the Form 10-K
dated September 30, 1997
Exhibit (11) Statement Regarding Computation of Per Share
Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) Portions of the 1999 Annual Report to Security
Holders
Exhibit (21) See Item 1. Business for discussion of subsidiaries
Exhibit (23) Consent of Independent Certified Public Accountants
Exhibit (27) Financial Data Schedule
14(b) The Company filed a report on Form 8-K on July 14, 1999, to disclose
that, on June 14, 1999, the Company's Board of Directors authorized
Management to repurchase up to 10% of common stock currently issued
and outstanding stock, which totaled 378,784 shares.
27
<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 28, 1999 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 28, 1999
- -----------------------------
Carl M. Hill Officer and Director
/s/ R. Ronald Swanner Executive Vice President, December 28, 1999
- -----------------------------
R. Ronald Swanner Secretary and Director
/s/ Christopher F. Cranford Controller and Treasurer December 28, 1999
- -----------------------------
Christopher F. Cranford
/s/ Caldwell A. Holbrook, Director December 28, 1999
- -----------------------------
Caldwell A. Holbrook, Jr.
/s/ Joel A. Huneycutt Director December 28, 1999
- -----------------------------
Joel A. Huneycutt
/s/ Douglas Dwight Stokes Director December 28, 1999
- -----------------------------
Douglas Dwight Stokes
/s/ Greg E. Underwood Director December 28, 1999
- -----------------------------
Greg E. Underwood
</TABLE>
28
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
Exhibit (11) Statement Regarding Computation of Per Share Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) 1999 Annual Report
Exhibit (23) Consent of Independent Certified Public Accountants
Exhibit (27) Financial Data Schedule
29
<PAGE>
EXHIBIT 11
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
See Note 16 of "Notes to the Consolidated Financial Statements" in the 1999
Annual Report.
<PAGE>
EXHIBIT 12
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>
<CAPTION>
Table of Contents
Page
- -------------------------------------------------------------------------------------------------------------
<S> <C>
Selected Consolidated Financial Data 1 - 2
Report to Stockholders 3
Management's Discussion and Analysis 4 - 22
Independent Auditor's Report 23
Consolidated Financial Statements:
Statements of financial condition at September 30, 1999 and 1998 24
Statements of income and comprehensive income for the years ended
September 30, 1999, 1998 and 1997 25 - 26
Statements of stockholders' equity for the years ended September 30, 1999, 1998
and 1997 27 - 28
Statements of cash flows for the years ended September 30, 1999, 1998 and 1997 29 - 31
Notes to Consolidated Financial Statements 32 - 63
Corporate Information 64 - 65
</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 Corp. 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>
<TABLE>
<CAPTION>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
SELECTED CONSOLIDATED FINANCIAL DATA
At September 30,
------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------------ ------------ ----------- ------------
(Dollars in Thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
Financial Condition Data:
Total assets $ 174,545 $ 201,945 $ 241,061 $ 217,954 $ 159,863
Investment securities (1) 41,490 84,110 122,984 100,974 45,471
Loans receivable, net (2) 125,493 110,550 111,990 109,858 108,597
Deposits 144,272 148,444 141,755 146,398 137,647
Deposits, stock offering - - - 46,601 -
Advances from Federal Home Loan Bank - - 35,000 - -
Note payable - 18,000 - - -
Stockholders' equity (3) 26,674 31,555 61,694 20,867 20,426
Book value per share (3) 7.07 7.25 13.72 - -
<CAPTION>
Year Ended September 30,
------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------------ ------------ ----------- ------------
(Dollars in Thousands, except per share amount)
<S> <C> <C> <C> <C> <C>
Operating Data:
Interest income $ 12,523 $ 15,661 $ 16,712 $ 12,869 $ 11,980
Interest expense 6,944 9,319 8,846 7,775 5,980
------------- ------------ ------------ ----------- ------------
Net interest income 5,579 6,342 7,866 5,094 6,000
Provision for loan losses - - - 300 -
------------- ------------ ------------ ----------- ------------
Net interest income after provision
for loan losses 5,579 6,342 7,866 4,794 6,000
------------- ------------ ------------ ----------- ------------
Noninterest income 220 353 169 126 126
------------- ------------ ------------ ----------- ------------
Noninterest expense:
Compensation and employee benefits 3,644 4,349 2,384 1,905 1,867
Other 1,378 1,271 1,167 2,341 1,343
------------- ------------ ------------ ----------- ------------
Total noninterest expense 5,022 5,620 3,551 4,246 3,210
------------- ------------ ------------ ----------- ------------
Income before income taxes 777 1,075 4,484 674 2,916
Income tax expense 499 312 1,616 164 1,055
------------- ------------ ------------ ----------- ------------
Net income $ 278 $ 763 $ 2,868 $ 510 $ 1,861
============= ============ ============ =========== ============
Basic earnings per share (3) $ 0.08 $ 0.19 $ 0.69 $ - $ -
Diluted earnings per share (3) 0.08 0.19 0.69 - -
Dividends per share (3) 0.40 0.40 0.38 - -
Return of capital dividends per share - 6.00 - - -
Dividend payout ratio (8) 500.00% 3368.42% 55.07% - -
</TABLE>
1
<PAGE>
<TABLE>
<CAPTION>
At or For the Year Ended September 30,
------------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Selected Other Data: (4)
Return on average assets 0.15% 0.35% 1.24% 0.30% 1.23%
Return on average equity 0.96% 1.89% 4.70% 2.45% 9.50%
Average equity to average assets 16.12% 18.43% 26.40% 12.23% 12.97%
Stockholders' equity to end-of-period assets 15.28% 15.63% 25.59% 9.59% 12.76%
Interest rate spread for period (5) 2.48% 1.97% 2.02% 2.52% 3.59%
Average interest-earning assets to
average interest-bearing liabilities 118.68% 123.10% 136.08% 112.00% 112.74%
Net interest margin (6) 3.24% 2.98% 3.46% 3.09% 4.11%
Nonperforming assets to total assets
at period end (7) 0.11% 0.16% 0.22% 0.31% 0.70%
Nonperforming loans to total loans
at period end 0.13% 0.22% 0.43% 0.58% 0.87%
Allowance for loan losses to non-peforming
loans at period end 245.14% 172.98% 84.12% 65.44% 13.97%
Net interest income, after provision for
loan losses to non-interest expense 111.09% 112.85% 221.52% 112.91% 186.92%
Noninterest expense to average assets 2.80% 2.56% 1.53% 2.49% 2.12%
Deposit accounts 12,908 13,218 14,037 16,486 17,988
Loan accounts 3,082 3,011 3,204 3,283 3,316
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 receivable, net," represents gross loans less net deferred loan
fees and allowance for loan losses.
(3) South Street Financial Corp. 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. Earnings per share has been calculated in accordance
with Statement of Financial Accounting Standards No. 128, "Earnings per
Share," and is based on net income for the year, divided by the weighted
average number of shares outstanding for the year. In accordance with
the ACIPA's SOP 93-6, unallocated ESOP shares were deducted from
outstanding shares used in the computation of earnings per share.
Diluted earnings per share includes the effect of dilutive common stock
equivalents in the weighted average number of shares outstanding.
(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) 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.
(6) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(7) Nonperforming assets include mortgage loans and consumer loans 90 days
or more delinquent and real estate acquired in the settlement of loans.
(8) The dividend payout ratio represents dividends per share as a percent of
basic earnings per share.
2
<PAGE>
<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 1999, 1998 and 1997, and changes in
financial position for the years ended September 30, 1999 and 1998,
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. 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.
During 1998, the Bank formed a wholly-owned subsidiary, South Street Development
Corporation ("SSDC") with a $1.8 million cash investment. SSDC then invested
$10,000 for a 50% interest in Park Ridge Associates, LLC ("Park Ridge"). The
other 50% interest in Park Ridge is owned by an outside individual. In June,
1998, Park Ridge Associates acquired 25.6 acres of prime real estate located
within the city limits of Albemarle, North Carolina. The joint venture was
created to acquire and develop the property into a premier residential
subdivision. As of December, 1999 the project was approximately 99% completed
and 11 of the 27 lots to be sold had been committed to buyers. There can be no
assurances that the development will be completed by the expected completion
date, or that the Bank will be successful in recovering its investment in the
joint venture.
4
<PAGE>
In December, 1998, the Bank started a new consumer and commercial loan
department and began offering a full range of consumer and commercial products
and services. To oversee the new department, the Bank hired a commercial banker
with over 21 years of experience in the local market. In addition, the Bank
hired another loan officer in August 1999 to assist in the growth of this line
of service. Management of the Bank believes that introducing consumer and
commercial lending to the Bank's existing line of products and services will
enhance the Bank's net interest margin while reducing the Bank's overall
exposure to interest rate risk. Management also feels that the addition of these
products will help the Bank grow while creating stronger ties to its existing
customer base. As of September 30, 1999, consumer and commercial loans totaled
approximately $7.5 million.
In December, 1998, the Bank joined the HONOR Network (which merged into the STAR
Network in 1999) and CIRRUS network for ATMs and Point of Sale (POS) terminals,
allowing the Bank's cardholders to enjoy the convenience and accessibility of
approximately 324,000 ATMs in 162 countries and over 400,000 POS terminals
worldwide.
The following discussion and analysis contains the consolidated financial
results for the Company, Home Savings, SSDC and Park Ridge for the year ended
September 30, 1999 and 1998, and the Company and Home Savings for the year ended
September 30, 1997. Because the Company has no operations and conducts no
business other than as described above and SSDC and Park Ridge assets are
primarily real estate held for investment and their operations have not
significantly impacted the consolidated financial statements for the years ended
September 30, 1999 and 1998, 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 and its subsidiaries are
collectively referred to herein as the "Company" unless otherwise noted.
Market Risk
The tables following provide information about the Company's financial
instruments that are sensitive to changes in interest rates.
(A) For loans receivable, the table presents principal cash flows by fixed
and adjustable rates for residential 1-4 family loans, commercial and
consumer loans. The table includes contractual maturities including
scheduled principal repayments. The table presents fair values at
September 30, 1999 and 1998 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. 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,
1999 and 1998 and weighted average interest rates by maturity dates.
(C) For deposits, the table presents principal 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, 1999 and 1998.
5
<PAGE>
<TABLE>
<CAPTION>
September 30, 1999
Loans Receivable
Expected Maturity Date
Years Ending September 30,
----------------------------------------------------------------------------------------------------
Fair
2000 2001 2002 2003 2004 Thereafter Total Value
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed Rate $ 65 $ 449 $ 600 $ 716 $ 1,851 $ 115,433 $ 119,114 $ 119,161
Average interest rate 10.21 % 8.68 % 8.86 % 8.25 % 7.06 % 7.45 %
Variable Rate $ 2,694 $ 271 $ 200 $ 96 $ 38 $ 3,509 $ 6,808 $ 6,808
Average interest rate 9.28 % 9.15 % 8.93 % 8.49 % 9.19 % 8.83 %
<CAPTION>
Investment Securities
Expected Maturity Date
Year Ending September 30,
----------------------------------------------------------------------------------------------------
Fair
2000 2001 2002 2003 2004 Thereafter Total Value
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-bearing cash $ 1,867 $ -- $ -- $ -- $ -- $ -- $ 1,867 $ 1,867
Average interest rate 5.50 % -- % -- % -- % -- % -- %
Federal Fund sold $ 430 $ -- $ -- $ -- $ -- $ -- $ 430 $ 430
Average interest rate 5.50 % -- % -- % -- % -- % -- %
Securities available for sale $ 999 $ 6,439 $ 8,876 $ -- $ -- $ 12,479 $ 28,793 $ 28,793
Average interest rate 5.75 % 5.48 % 5.67 % -- % -- % 6.31 %
Securities held to maturity $ -- $ -- $ -- $ -- $ -- $ 8,932 $ 8,932 $ 8,571
Average interest rate -- % -- % -- % -- % -- % 7.46 %
Nonmarketable equity securities$ -- $ -- $ -- $ -- $ -- $ 1,468 $ 1,468 $ 1,468
Average interest rate -- % -- % -- % -- % -- % 7.50 %
<CAPTION>
Debt Obligations
Expected Maturity Date
Years Ending September 30,
-----------------------------------------------------------------------------------------------------
Fair
2000 2001 2002 2003 2004 Thereafter Total Value
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Deposits $ 113,128 $ 25,376 $ 4,330 $ -- $ -- $ -- $ 142,834 $ 142,867
Average interest rate 4.39 % 5.30 % 5.48 % -- % -- % -- %
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
September 30, 1998
Loans Receivable
Expected Maturity Date
Years Ending September 30,
----------------------------------------------------------------------------------------
Fair
1999 2000 2001 2002 2003 Thereafter Total Value
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed Rate $ 38 $ 153 $ 241 $ 650 $ 974 $ 103,469 $ 105,525 $ 107,800
Average interest rate 9.30 % 9.00 % 8.60 % 8.50 % 7.60 % 7.80 %
Variable Rate $ 5,126 $ 328 $ -- $ -- $ -- $ -- $ 5,454 $ 5,454
Average interest rate 9.20 % 8.50 % -- % -- % -- % -- %
<CAPTION>
Investment Securities
Expected Maturity Date
Year Ending September 30,
----------------------------------------------------------------------------------------
Fair
1999 2000 2001 2002 2003 Thereafter Total Value
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-bearing cash $ 26,895 $ -- $ -- $ -- $ -- $ -- $ 26,895 $ 26,895
Average interest rate 5.75 % -- % -- % -- % -- % -- %
Federal Fund sold $ 3,010 $ -- $ -- $ -- $ -- $ -- $ 3,010 $ 3,010
Average interest rate 5.50 % -- % -- % -- % -- % -- %
Securities available for sale $ 18,024 $ 1,000 $ 10,581 $ 1,508 $ -- $ 7,730 $ 38,843 $ 38,843
Average interest rate 5.44 % 5.79 % 5.80 % 6.00 % -- % 7.00 %
Securities held to maturity $ -- $ -- $ -- $ -- $ -- $ 13,340 $ 13,340 $ 13,263
Average interest rate -- % -- % -- % -- % -- % 7.47 %
Nonmarketable equity securities $ -- $ -- $ -- $ -- $ -- $ 2,022 $ 2,022 $ 2,022
Average interest rate -- % -- % -- % -- % -- % 7.50 %
<CAPTION>
Debt Obligations
Expected Maturity Date
Years Ending September 30,
--------------------------------------------------------------------------------------------------
Fair
1999 2000 2001 2002 2003 Thereafter Total Value
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Deposits $90,065 $ 43,131 $ 13,638 $ -- $ -- $ -- $146,834 $147,319
Average interest rate 3.08 % 4.59 % 4.88 -- % -- % -- % %
Note payable $18,000 $ -- $ -- -- % $ -- $ -- $ 18,000 $18,000
Average interest rate 7.75 % -- % -- -- % -- % -- % %
</TABLE>
<PAGE>
Changes in Financial Condition
Total assets of the Company amounted to $174.5 million at September 30, 1999,
which is a decrease of $27.4 million or 13.6% from total assets at September 30,
1998. The Company's total assets at September 30, 1998 decreased by $39.1
million, or 16.2% from total assets of $241.1 million at September 30, 1997. The
decrease in total assets from September 30, 1997 to September 30, 1998 was
primarily attributable to a decrease in liquidity and investment securities
which were used to repay advances from the Federal Home Loan Bank (the "FHLB").
In addition, the Company paid a return of capital in the form of a special
dividend to their shareholders during 1998 in the amount of $28.1 million ($6
per share). Eighteen million dollars of the special dividend was financed
through outside borrowings. The repayment of the outside borrowings was the
primary reason for the decrease in total assets from September 30, 1998 to
September 30, 1999.
The principal category of earning assets is loans receivable which amounted to
$125.5 million, $110.6 million and $112.0 million at September 30, 1999, 1998
and 1997, respectively. Home was able to increase the size of its loan portfolio
during 1997 primarily through its marketing efforts in the origination of
permanent residential 1-4 family mortgages and residential construction loans
during a time period in which loan prepayments stabilized. Loans for residential
construction and land then decreased slightly during 1998. In 1999, residential
mortgage and construction loans increased again sparked by anticipation of
rising interest rates. In addition, commercial and consumer loans increased when
the Bank hired a commercial loan officer to build this side of the loan
portfolio. Loan originations for the year ended September 30, 1999 totaled $47.3
million and were funded primarily by loan principal repayments of $27.9 million
and liquidation of investments as the loan portfolio increased by $14.9 million.
Loan originations for the year ended September 30, 1998 totaled $22.6 million
and were funded primarily by loan principal repayments of $27.1 million as the
loan portfolio decreased by $1.4 million. 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, 1999, 1998 and 1997 totaled $175,000, $248,000 and $510,000,
respectively, and were 0.13%, 0.22% and 0.43% of total loans, respectively.
In addition to loans, the Company invests in U.S. Treasury and Government agency
securities and mortgage-backed 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 FHLB
stock, at September 30, 1999, 1998 and 1997 totaled $38.0 million, $52.5 million
and $95.5 million, respectively. The securities portfolio decreased by $14.5
million for the year ended September 30, 1999 from September 30, 1998 as $32.2
million in securities matured or were called and $4.3 million of repayments were
made on securities held to maturity. The decrease was offset by $23.0 million in
purchases of new securities. For the year ended September 30, 1998, the
securities portfolio decreased by $43.0 million from September 30, 1997, as
$44.4 million in securities matured or were called, $8.5 million of securities
were sold and $18.1 million in new securities were purchased. The decrease in
securities in 1998 was due to liquidation of investments used to repay FHLB
advances.
8
<PAGE>
Cash and cash equivalents totaled $4.9 million, $32.8 million and $27.6 million
at September 30, 1999, 1998 and 1997, respectively. The decrease in cash was due
primarily to the repayment of $18 million of outside borrowings. In addition,
cash was used to fund loan originations and cash decreased due to the decrease
in deposit accounts.
Savings deposits amounted to $144.3 million at September 30, 1999, a decrease of
$4.1 million from September 30, 1998. At September 30, 1998, deposits increased
$6.6 million to $148.4 million from $141.8 million at September 30, 1997. The
decrease in 1999 was a result of the Bank lowering rates on most accounts to be
more reflective of market rate changes. The decrease was offset by the addition
of a Premium Savings Account which offers a higher rate for savings accounts
greater than $10,000. The increase in 1998 was primarily in NOW and money market
accounts and certificates of deposits. Customers moved funds out of savings
accounts due to additional service charges along with a lowering of interest
rates. 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 $18.0 million from an outside bank in 1998 to partially
fund the return of capital dividend paid during the year. This note was paid off
on October 1, 1998. The Company borrowed a total of $35.0 million from the FHLB
during 1997, which was paid off in 1998. The proceeds from advances were used
for liquidity requirements, to fund loan growth and to purchase investment
securities.
Stockholders' equity decreased by $4.9 million during 1999 due primarily to
repurchasing 578,208 shares of outstanding stock for $4.5 million. Equity also
decreased by $1.4 million for quarterly cash dividends totaling $.40 per share
and $109,000 for the ESOP contribution. Increases in equity were due to $408,000
in payments received on the ESOP debt, additional vesting of the management
recognition program in the amount of $798,000 and $144,000 for amortization of
the return of capital dividends paid on ESOP shares. Stockholders' equity
decreased by $30.1 million during 1998 primarily due to a special return of
capital dividend of $6 per share and by $1.7 million for regular quarterly cash
dividends paid of $.40 per share in the aggregate. The Company repurchased
325,300 shares of common stock in 1998 to decrease stockholders' equity by $3.0
million and implemented a management recognition plan which increased
stockholders' equity by $1.6 million due to 50% of the restricted stock awards
vesting during 1998. Equity also increased by $178,000 for principal payments
received on the ESOP note and $142,000 for the ESOP contribution. Lastly,
stockholders' equity increased due to net income of $278,000, $763,000, and $2.9
million for the years ending September 30, 1999, 1998 and 1997, respectively.
The unrealized gain (loss) on securities available for sale, net of tax,
amounted to $(519,000), $26,000 and $69,000 at September 30, 1999, 1998 and
1997, respectively. The change in the unrealized gain (loss) reflected through
stockholders' equity was $(545,000), $(43,000) and $104,000 for the years ended
September 30, 1999, 1998 and 1997, respectively.
9
<PAGE>
Comparison of Operating Results for the Years Ended September 30, 1999, 1998 and
1997
Net Income
- ----------
Net income for the years ended September 30, 1999, 1998 and 1997 was $278,000,
$763,000 and $2.9 million, respectively. The decrease in net income from 1998 to
1999 was primarily due to decrease in interest income from securities as
proceeds from investments that matured were used to repay debt. Net income
decreased in 1998 from 1997 due to an increase in interest expense on
outstanding debt and a decrease in interest income as investment securities were
liquidated to pay off FHLB advances. In addition, noninterest expenses increased
with the implementation of a management recognition plan during the 1998 fiscal
year. Net income increased in 1997 from 1996 primarily due to a substantial
increase in net interest income, as proceeds received in the Conversion were
utilized to increase the investment portfolio. Additionally, noninterest 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 Interest Income
- -------------------
Net interest income amounted to $5.6 million, $6.3 million and $7.9 million
during the years ended September 30, 1999, 1998 and 1997, respectively. The
average outstanding balance of interest-earning assets in excess of
interest-bearing liabilities decreased by a net of $12.8 million during 1999 and
$20.4 million during 1998 and increased by a net of $42.6 million during 1997.
The Company's interest rate spread was $2.48%, 1.97% and 2.02% in 1999, 1998 and
1997, respectively. The increase in 1999 is a result of a decrease in the
Company's cost of funds. The decrease in 1998 is a result of a slight increase
in the Company's cost of funds.
See the table on page 11 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), with any rate/volume variances allocated based on their
absolute values.
10
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30, Year Ended September 30,
1999 vs. 1998 1998 vs. 1997
------------------------------------- ------------------------------------
Increase (Decrease) Attributable to Increase (Decrease) Attributable to
------------------------------------- ------------------------------------
Rate/ Rate/
Volume Rate Volume Net Volume Rate Volume Net
--------------------------------------------------------------------------
Interest income on:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits $ (736) $ (219) $ 93 $ (862) $ 721 $ 22 $ 14 $ 757
Investments (1,911) (101) 63 (1,949) (1,831) 406 (165) (1,590)
Mortgage-backed securities (163) 91 (10) (82) 77 (94) (3) (20)
Loans receivable 339 (563) (21) (245) (16) (188) 6 (198)
------------------------------------- ----------------------------------
Total interest income on
interest-earning assets (2,471) (792) 125 (3,138) (1,049) 146 (148) (1,051)
------------------------------------- ----------------------------------
Interest expense on:
Passbook savings (29) (115) 8 (136) (42) (30) 4 (68)
NOW and money market 20 (101) (6) (87) (41) (2) 1 (42)
Certificates of deposit 136 (266) (6) (136) 266 (199) (9) 58
Deposits, stock offering - - - - - - - -
FHLB advances (936) - - (936) (565) 18 (8) (555)
Note payable (1,080) - - (1,080) 1,080 - - 1,080
------------------------------------- ----------------------------------
Total interest expense on
interest-bearing liabilities (1,889) (482) (4) (2,375) 698 (213) (12) 473
------------------------------------- ----------------------------------
Increase (decrease) in net
interest income $ (582) $ (310) $ 129 $ (763) $ (1,747) $ 359 $(136) $(1,524)
========= ======= ====== ======== ========= ======= ====== ========
</TABLE>
Year Ended September 30,
1997 vs. 1996
--------------------------------------
Increase (Decrease) Attributable to
--------------------------------------
Rate/
Volume Rate Volume Net
(Dollars in Thousands)
Interest income on:
Interest-bearing deposits $ 26 $ 110 $ 3 $ 139
Investments 2,394 96 113 2,603
Mortgage-backed securities 1,499 (85) (309) 1,105
Loans receivable 235 (233) (6) (4)
---------------------------------------
Total interest income on
interest-earning assets 4,154 (112) (199) 3,843
---------------------------------------
Interest expense on:
Passbook savings 21 - - 21
NOW and money market 4 (59) - (55)
Certificates of deposit (152) (174) 4 (322)
Deposits, stock offering (64) - - (64)
FHLB advances 1,491 - - 1,491
Note payable - - - -
---------------------------------------
Total interest expense on
interest-bearing liabilities 1,300 (233) 4 1,071
---------------------------------------
Increase (decrease) in net
interest income $ 2,854 $ 121 $ (203) $ 2,772
======== ======= ======== ========
<PAGE>
Interest Income
- ---------------
Interest income amounted to $12.5 million, $15.7 million and $16.7 million for
the years ended September 30, 1999, 1998, and 1997, respectively. The Company's
average yield on interest-earning assets increased slightly from 7.35% in 1997
to 7.36% in 1998 and decreased to 7.26% in 1999. The primary interest-earning
asset is loans, which experienced a decrease in average yield from 1997 through
1999. In addition, a slight decrease in the average outstanding balance occurred
during 1998. The reduction in interest income on loans in 1999 was due to the
decrease in average yield as rates declined during the year. The decrease in
average yield was offset, in part, by a $4.0 million increase in the average
outstanding loan balance. Interest income on loans was down in 1998 due to the
decreases in both average outstanding balance and average yield.
The other primary interest-earning asset is investment securities, defined as
investment securities available for sale, mortgage-backed securities and FHLB
stock, which is the primary cause of the decreases in interest income during
1999 and 1998 and the increase in 1997. The average balance of investment
securities decreased $30.9 million to $39.7 million in 1999. As investments were
called or matured, the Company utilized most of the proceeds to fund loan
originations and stock repurchases. In 1998, the average balance of investment
securities decreased $27.9 million to $70.6 due to liquidation of investments to
repay FHLB advances. In 1997, the average balance increased $59.3 million to
$98.6 million due to investing of the funds received in the Conversion. Interest
income from interest-bearing deposits, including federal funds sold decreased
$862,000 in 1999 due to a decrease in both average outstanding balance and
yield. In 1998, the increase of interest income of $757,000 to $1.7 million was
a result of a $13.3 million increase in average outstanding balance and a slight
increase in average yield during the year. This increase helped to offset the
decreases in interest income from loans and investments.
Interest Expense
- ----------------
Interest expense amounted to $6.9 million, $9.3 million and $8.8 million for the
years ended September 30, 1999, 1998 and 1997, respectively. Interest expense
decreased in 1999 as there were no outstanding borrowings throughout the entire
year. In addition, interest expense on deposit accounts decreased with the
decrease in the average outstanding deposits balance and average yield. The
increase in interest expense in 1998 was due to the Company obtaining a note
payable for which proceeds from the borrowing were used to help fund the return
of capital dividend paid during the year. Interest of $1.1 million for the note
payable was partially offset by a decrease of $555,000 for interest expense
associated with FHLB advances. In addition, interest expense relating to core
deposits decreased due to a decrease in both average outstanding balances and a
decrease in average yield paid during 1998. Interest expense on certificates of
deposits increased slightly due to an increase in the average outstanding
balance, although the average yield was down during 1998. In 1997, the $1.0
million increase in interest expense was 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. Management believes the Bank's cost of funds was indicative of
changes in overall market rates.
See the table on page 13 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, 1999, 1998 and 1997.
12
<PAGE>
<TABLE>
<CAPTION>
For the year ended September 30,
------------------------------------------------------------------
At September 30, 1999 1998
1999 -------------------------------- --------------------------------
Average Average Average
Yield/ Average Yield/ Average Yield/
Rate (5) Balance (6) Interest Rate Balance (6) Interest Rate
--------------- ----------- -------- ------- ----------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest earning assets:
Interest-bearing deposits 5.50% $ 18,129 $ 876 4.83% $ 31,446 $ 1,738 5.53%
Investments (1) 5.62% 16,601 1,094 6.59% 44,639 3,043 6.82%
Mortgage-backed securities 6.76% 23,146 1,415 6.11% 25,977 1,497 5.76%
Loans receivable, net (4) 7.57% 114,577 9,138 7.98% 110,586 9,383 8.48%
----------- ----------- ----------- -----------
Total interest-earning assets 7.23% 172,453 $ 12,523 7.26% 212,648 $ 15,661 7.36%
----------- -----------
Non interest-earning assets 7,043 6,921
----------- -----------
Total $ 179,495 $ 219,569
=========== ===========
Liabilities and stockholders' equity
Interest-bearing liabilities:
Passbook savings 2.10% $ 13,990 $ 282 2.02% $ 15,041 $ 418 2.78%
NOW and money market 1.44% 14,011 224 1.60% 13,158 311 2.36%
Certificates of deposit 5.32% 117,306 6,438 5.49% 114,935 6,574 5.72%
FHLB advances - - - - 15,769 936 5.94%
Note payable - - - - 13,846 1,080 7.80%
----------- ----------- ----------- -----------
Total interest-bearing liabilities 4.59% 145,307 $ 6,944 4.78% 172,749 $ 9,319 5.39%
----------- -----------
Non-interest-bearing liabilities 5,255 6,360
Stockholders' equity 28,933 40,460
----------- -----------
Total $ 179,495 $ 219,569
=========== ===========
Net interest income and interest
rate spread (2) 2.64% $ 5,579 2.48% $ 6,342 1.97%
========== ===========
Net yield on interest-
earning assets (3) 3.24% 2.98%
Ratio of interest-earning assets
to interest-bearing liabilities 118.68% 123.10%
</TABLE>
For the year ended September 30,
--------------------------------
1997
--------------------------------
Average
Average Yield/
Balance (6) Interest Rate
-------------------- -------
(Dollars in Thousands)
Assets:
Interest earning assets:
Interest-bearing deposits 18,124 $ 981 5.41%
Investments (1) 73,836 4,633 6.27%
Mortgage-backed securities 24,720 1,517 6.14%
Loans receivable, net (4) 110,775 9,581 8.65%
----------- ----------
Total interest-earning assets 227,455 $ 16,712 7.31%
----------
Non interest-earning assets 3,899
-----------
Total 231,354
===========
Liabilities and stockholders' equity
Interest-bearing liabilities:
Passbook savings 16,446 $ 486 2.96%
NOW and money market 14,869 353 2.37%
Certificates of deposit 110,429 6,516 5.90%
FHLB advances 25,400 1,491 5.87%
Note payable - - -
----------- ----------
Total interest-bearing liabilities 167,144 $ 8,846 5.29%
----------
Non-interest-bearing liabilities 3,144
Stockholders' equity 61,066
-----------
Total 231,354
===========
Net interest income and interest
rate spread (2) $ 7,866 2.02%
==========
Net yield on interest-
earning assets (3) 3.46%
Ratio of interest-earning assets
to interest-bearing liabilities 136.08%
(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 principal balance associated with each asset
and liability.
(6) Average balances are based on monthly balances. Management does not believe
the use of month end balances has caused a material difference in the
information provided.
<PAGE>
Provision for Loan Losses and Asset Quality
- -------------------------------------------
No provisions for loan losses were made in 1999, 1998 or 1997. No provisions
were made in each of the three years due to a steady decrease in nonperforming
loans as noted below, and there being very minimal net charge-offs in the same
periods. There have also been no changes in the methods or assumptions used in
determining the loan loss allowances during the past three years. The 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.
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 $175,000,
$248,000 and $510,000 at September 30, 1999, 1998 and 1997, respectively. Real
estate acquired in the settlement of loans amounted to $18,000 and $68,000 at
September 30, 1999 and 1998, respectively. Home Savings has adopted policies
which it believes provides for prudent and adequate levels of loan loss
allowances. At September 30, 1999 and 1998, 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 $220,000, $353,000 and $169,000 for the years
ended September 30, 1999, 1998 and 1997, respectively. Noninterest income
consists primarily of service charges and fees associated with the Bank's
checking accounts. During 1998, the Company realized gains of $88,000 from the
sale or call of investments available for sale to contribute to the increase in
noninterest income for the year. Realized gains from the call of investments
available for sale for 1999 amounted to $3,000.
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 expenses. Noninterest expense amounted to
$5.0 million, $5.6 million and $3.6 million for the years ended September 30,
1999, 1998 and 1997, respectively. Compensation decreased $705,000 for the year
ended September 30, 1999 and increased $2.0 million and $479,000 for the years
ended September 30, 1998 and 1997 respectively. The significant increase during
1998 was due to the implementation of the management recognition plan in October
of 1997. During 1998, 50% of the restricted stock awards allocated to directors,
officers and employees under the plan vested, bringing approximately $1.6
million into compensation expense. The expense related to the restricted stock
awards in 1999 was approximately $798,000, as another 25% of the awards vested.
In addition, the Company incurred $462,000, $459,000 and $309,000 of expense
related to the ESOP in 1999, 1998 and 1997, respectively, which is included in
compensation expense. Other slight increases from 1997 through 1999 were due to
additional personnel, and inflationary increases. Occupancy, data processing and
federal insurance premium expenses changed nominally during the years ended
September 30, 1999, 1998 and 1997.
14
<PAGE>
Income Taxes
- ------------
The Company's effective income tax rate was 64.2%, 29.0% and 36.0% for the years
ended September 30, 1999, 1998 and 1997, respectively. The effective rate for
1999 is higher than expected due to permanent nondeductible income tax
differences, primarily a portion of the expenses related to the MRP. The
effective rate for 1998 was lower than expected due to permanent taxable
differences and incurring a net operating loss for state tax purposes.
Capital Resources and Liquidity
- -------------------------------
The Company paid regular quarterly cash dividends of $.40 per share in the
aggregate during 1999 and 1998, a special return of capital dividend of $6.00
during 1998, and quarterly regular cash dividends of $.38 per share in the
aggregate during 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.
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 ended September 30, 1999,
cash inflow was provided by proceeds from maturities, calls and principal
repayments on securities of $36.5 million and cash provided by operating
activities of $809,000. Significant cash outflows during 1999 included a net
decrease in deposits of $4.2 million, repayments on a note payable of $18.0
million, repurchase of common stock for $4.5 million, purchases of securities
available for sale of $23.0 million and net loan originations of $14.5 million.
During the year ended September 30, 1998, cash inflow was provided by a net
increase in deposits of $6.8 million and proceeds from borrowings on a note
payable of $18.0 million. In addition, proceeds from the sale, maturity or call
of securities provided $61.7 million and operating activities provided $3.7
million in cash inflow. Significant cash outflows during 1998 included $18.1
million for the purchase of securities, $29.8 million in payment of dividends,
$35.0 million in repayment of FHLB advances and $3.0 million for the repurchase
of common stock. 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.
15
<PAGE>
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 74% of Home's certificates of deposit outstanding at September 30,
1999 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. The
Company also intends to use excess cash to continue to repurchase up to 30% of
the original amount of outstanding common stock.
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, 1999, 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.
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, 1999, Home had
a one-year sensitivity gap of negative 63.96%. 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.
16
<PAGE>
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 five years as a
percentage of total interest-earning assets was a negative 70.0%.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 1999, 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.
17
<PAGE>
<TABLE>
<CAPTION>
At September 30, 1999
--------------------------------------------------------
More than More than
1 Year 1 Year to 5 Years to More than
or Less 5 Years 10 Years 10 Years Total
----------- ---------- ---------- --------- ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets (1):
Loans Receivable:
Adjustable rate 1-4 family residential $ 5 $ 107 $ 231 $ 827 $ 1,170
Fixed rate 1-4 family residential 34 1,849 26,969 78,707 107,559
Other adjustable rate real estate loans 2,387 496 1,316 1,337 5,536
Other fixed rate real estate loans 7 1,226 1,245 6,609 9,087
Other loans 326 543 912 789 2,570
----------- ---------- ---------- --------- ---------
Total loans 2,759 4,221 30,673 88,269 125,922
Interest-bearing deposits 2,297 - - - 2,297
Investment securities
Available for sale 999 15,315 - - 16,314
Available for sale mortgage-backed securities (2) - - - 12,479 12,479
Nonmarketable equity securities - - - 1,468 1,468
Mortgage-backed securities held to maturity (2) - - 1,005 7,927 8,932
----------- ---------- ---------- --------- ---------
Total interest-earning assets $ 6,055 $ 19,536 $ 31,678 $110,143 $167,412
=========== ========== ========== ========= =========
Interest-bearing liabilities:
Deposits:
Certificates of deposit $ 85,339 $ 29,706 $ - $ - $115,045
Money market deposit accounts 5,803 - - - 5,803
NOW and commercial checking accounts 7,424 - - - 7,424
Passbook savings 14,562 - - - 14,562
----------- ---------- ---------- --------- ---------
Total deposits 113,128 29,706 - - 142,834
----------- ---------- ---------- --------- ---------
Total interest-bearing liabilities $ 113,128 $ 29,706 $ - $ - $142,834
=========== ========== ========== ========= =========
Interest sensitivity gap per report $(107,073) $ (10,170) $ 31,678 $110,143
Cumulative interest sensitivity gap (107,073) (117,243) (85,565) 24,578
Cumulative gap as a percentage of
total interest-earning assets -63.96% -70.03% -51.11% 14.68%
Cumulative interest-earning assets
as a percentage of interest-bearing liabilities 5.35% 17.92% 40.09% 117.21%
</TABLE>
(1) Interest-earning assets are included in th period in which the balances are
expected to be redeployed and/or repriced as a result of anticipated
prepayments, scheduled rate adjustments and contractual maturities.
(2) Based upon contractual maturities.
<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 its 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 was implemented by the Company to account for
the plan when the options were granted. 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. 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 did not have a significant effect on the Company's financial
statements because management elected to continue to use the accounting and
reporting permitted by APB Opinion No. 25 and disclose the differences as pro
forma 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. 130, Reporting Comprehensive Income, which the
Company adopted during the year ended September 30, 1999. The Statement
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.
19
<PAGE>
The FASB has issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, which the Company has not been required to adopt as of
September 30, 1999. This Statement, which is effective for fiscal years
beginning after June 15, 2000, establishes accounting and reporting standards
for derivative instruments embedded in other contracts, (collectively referred
to as derivatives) and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (a) a hedge
of the exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available for sale security, or a foreign currency denominated
forecasted transaction. This Statement is not expected to have a significant
impact on the Company.
The FASB has issued SFAS No. 134, Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise, an amendment of FASB Statement No. 65, which the Company has
not been required to adopt as of September 30, 1999. Statement No. 65, as
amended by FASB Statements No. 115, Accounting for Certain Investments in Debt
and Equity Securities, and No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed security as a trading
security. This Statement further amends Statement No. 65 to require that after
the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments. This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a nonmortgage banking enterprise.
This Statement is effective for fiscal years beginning after December 15, 1998,
and is not expected to have a significant impact on the Company.
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, over a six year period, its tax bad debt
reserves which have accumulated since 1987 and amount to approximately
$1,023,000. The tax associated with the recaptured reserve is approximately
$350,000. The recapture was scheduled to begin with the Bank's 1997 year but was
delayed two years as the Bank originated 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. During the year ended September
30, 1999, the Bank has recaptured $171,000 of this reserve, resulting in a
reduction to the deferred tax asset of $58,000.
20
<PAGE>
Year 2000
A lot of attention has been given to the impact that the year 2000 date change
will have on businesses, utilities and other organizations that rely on
computerized systems to help run their operations. The year 2000 date change can
affect any system that uses computer software or computer chips including
automated equipment and machinery. For example, many computer programs and
computer chips store the calendar year portion of the date as two digits rather
than four digits. These software programs and chips record the year 1999 as
"99". This approach works until the year 2000 when the "00" may be interpreted
as the year 1900 instead of the year 2000.
Banks use computer systems to perform financial calculations, transfer funds,
record deposits and loan payments, run financial security systems and vaults and
a myriad of other functions. Because banks rely heavily on their computer
systems, the Federal Financial Institutions Examination Council ("FFIEC") has
placed significant emphasis on the problems surrounding the year 2000 issues and
has required financial institutions to document the assessment, testing and
corrections made to ready their computer systems and programs for the year 2000
date change. The FFIEC has strict regulations, guidelines, and milestones in
place that each FDIC insured financial institution must follow in order to
remain operational. The Company's board of directors has remained informed of
the Company's position and progress in its year 2000 project.
The Company's year 2000 project remains on schedule according to the guidelines
set forth by the FFIEC. The Company's most critical external exposure to year
2000 system problems is with its data processing provider, Fiserv. Fiserv
renovated its systems in June 1998 and has tested its remediation efforts.
Fiserv has responded to the Company that renovation of its program is complete
and is able to operate in the 2000 environment.
In addition, the Company has contacted its major customers and vendors to
inquire about their progress in addressing the year 2000 problem and does not
believe that the problems of such customers and vendors will have a material
adverse effect on the Company or its operations. The Company will continue to
monitor the progress of these parties in addressing the year 2000 problem as the
new millennium approaches. Management replaced the computer hardware and
software with year 2000 compliant equipment during 1999 at a total cost of
approximately $250,000.
The year 2000 problems can affect the Company's operation in a number of ways
but the mission critical issue is maintaining customers' account information
including tracking deposits, interest accruals and loan payments. The Company is
dependent upon electricity, telephone lines, computer hardware and Fiserv's date
processing capability.
The Company is in contact with its electric utility and phone company, and
assurances have been given that no major problems exist and that both companies
have all year 2000 problems addressed. A new telephone system was also installed
in the second quarter of fiscal 1999 that is year 2000 compliant.
To prevent difficulties in the event there is an unforeseen interruption in
either telephone or electrical service when the year changes, the Company will
print hard copies of all account information. In addition, the Company will
download all account information into programs on the Company's hardware that
will allow bank personnel to extract customer information without regard to
outside sources.
21
<PAGE>
The Company's loan portfolio consists primarily of residential mortgage loans to
individuals. These individuals generally are not affected by year 2000 failures.
A limited number of the Company's commercial borrowers are being contacted to
assure that timely payments will be made in January 2000. The Company intends to
amend its underwriting policies to address loan payment problems associated with
a borrower as a result of a disruption in income or a commercial borrower's
inability to make a timely payment.
22
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
South Street Financial Corp.
Albemarle, North Carolina
We have audited the accompanying consolidated statements of financial condition
of South Street Financial Corp. and subsidiary as of September 30, 1999 and
1998, and the related consolidated statements of income and comprehensive
income, stockholders' equity and cash flows for each of the years in the three
year period ended September 30, 1999. 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 Corp. and subsidiary as of September 30, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three year period ended September 30, 1999 in conformity with generally accepted
accounting principles.
/s/ McGLADREY & PULLEN, LLP
Charlotte, North Carolina
November 10, 1999
23
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED Statements of Financial Condition
September 30, 1999 and 1998
<TABLE>
<CAPTION>
ASSETS 1999 1998
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents:
Noninterest-bearing deposits (Note 2) $ 2,598,000 $ 2,891,000
Interest-bearing deposits 1,867,000 26,895,000
Federal funds sold 430,000 3,010,000
Securities held to maturity, fair value 1999, $8,571,000;
1998, $13,263,000 (Note 3) 8,932,000 13,340,000
Securities available for sale (Note 3) 29,108,000 39,158,000
Federal Home Loan Bank stock, at cost 1,153,000 1,707,000
Loans receivable, net (Note 4) 125,493,000 110,550,000
Real estate acquired in settlement of loans 18,000 68,000
Real estate held for investment 1,212,000 960,000
Accrued interest receivable (Note 5) 1,084,000 1,302,000
Office properties and equipment, net (Note 6) 1,288,000 1,106,000
Prepaid expenses and other assets (Notes 7 and 12) 1,362,000 ,958,000
-----------------------------
Total assets $ 174,545,000 $ 201,945,000
=============================
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
- ----------------------------------------------------------------------------------------------------------
Liabilities:
Deposits (Note 8) $ 144,272,000 $ 148,444,000
Note payable (Note 9) -- 18,000,000
Advance payments by borrowers for taxes and insurance 123,000 125,000
Minority interest in Park Ridge Associates, LLC 10,000 10,000
Accounts payable and other liabilities (Note 10 and 12) 2,846,000 3,250,000
Checks outstanding on disbursement account 620,000 561,000
-----------------------------
Total liabilities 147,871,000 170,390,000
=============================
Commitments (Notes 7, 10 and 15)
Stockholders' equity: (Note 14)
Common stock, no par value, authorized 20,000,000 shares;
issued 3,772,852 in 1999; issued 4,351,060 shares in 1998 -- --
Additional paid-in capital 13,348,000 17,930,000
Accumulated other comprehensive income (loss) (Note 3) (519,000) 26,000
Unearned ESOP (Note 14) (3,672,000) (4,080,000)
Deferred management recognition plan (Note 11) (798,000) (1,596,000)
Unearned compensation (Note 14) (1,846,000) (1,990,000)
Retained earnings, substantially restricted (Notes 12 and 13) 20,161,000 21,265,000
-----------------------------
Total stockholders' equity 26,674,000 31,555,000
-----------------------------
Total liabilities and stockholders' equity $ 174,545,000 $ 201,945,000
=============================
</TABLE>
See Notes to Consolidated Financial Statements.
24
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Years Ended September 30, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans $ 9,138,000 $ 9,383,000 $ 9,581,000
Mortgage-backed securities 1,415,000 1,497,000 1,517,000
Securities 1,094,000 3,043,000 4,633,000
Other interest-bearing deposits 876,000 1,738,000 981,000
--------------------------------------
12,523,000 15,661,000 16,712,000
--------------------------------------
Interest expense:
Deposits (Note 8) 6,944,000 7,303,000 7,355,000
FHLB advances (Note 9) -- 936,000 1,491,000
Note payable (Note 9) -- 1,080,000 --
--------------------------------------
6,944,000 9,319,000 8,846,000
--------------------------------------
Net interest income 5,579,000 6,342,000 7,866,000
Provision for loan losses (Note 4) -- -- --
--------------------------------------
Net interest income after
provision for loan losses 5,579,000 6,342,000 7,866,000
--------------------------------------
Noninterest income:
Gain on sale or call of investment securities 3,000 88,000 --
Other 217,000 265,000 169,000
--------------------------------------
220,000 353,000 169,000
--------------------------------------
Noninterest expenses:
Compensation and benefits (Notes 7, 10, 11 and 14) 3,644,000 4,349,000 2,384,000
Net occupancy 318,000 270,000 291,000
Federal insurance premium expenses 87,000 89,000 70,000
Data processing 211,000 210,000 213,000
Contributions 31,000 26,000 18,000
Other 731,000 676,000 575,000
--------------------------------------
5,022,000 5,620,000 3,551,000
--------------------------------------
Income before income taxes 777,000 1,075,000 4,484,000
Income taxes (Note 12) 499,000 312,000 1,616,000
--------------------------------------
Net income 278,000 763,000 2,868,000
--------------------------------------
</TABLE>
(Continued)
25
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE
INCOME (CONTINUED)
Years Ended September 30, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) arising during
the year, net of tax 1999 $(348,000); $ (543,000) $ 11,000 $ 104,000
1998 $6,000, 1997 $68,000
Less reclassification adjustment for realized gains
included in income, net of tax 1999 $1,000;
1998 $34,000; 1997 $-0- (2,000) (54,000) --
-----------------------------------------
Other comprehensive income (loss) (545,000) (43,000) 104,000
-----------------------------------------
Comprehensive income (loss) $ (267,000) $ 720,000 $ 2,972,000
=========================================
Basic earnings per share (Note 16) $ 0.08 $ 0.19 $ 0.69
=========================================
Diluted earnings per share (Note 16) $ 0.08 $ 0.19 $ 0.69
=========================================
dividends declared per share $ 0.40 $ 0.40 $ 0.38
=========================================
Return of capital dividend declared per share $ -- $ 6.00 $ --
=========================================
</TABLE>
See Notes to Consolidated Financial Statements.
26
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended September 30, 1999, 1998 and 1997
<TABLE>
<CAPTION>
Accumulated
Additional Other
Paid-in Comprehensive Unearned
Capital Income (Loss) ESOP
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
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)
Principal payment on note receivable
from the ESOP -- -- 178,000
ESOP contribution 142,000 -- --
Retirement of 325,300 shares of common
stock repurchased (3,021,000) -- --
Adoption of management recognition plan 3,193,000 -- --
Vesting of management recognition plan -- -- --
Return of capital dividend (26,068,000) -- --
Cash dividends -- -- --
Net change in unrealized gain (loss) on
securities available for sale, net -- (43,000) --
Net income -- -- --
------------------------------------------------
Balance at September 30, 1998 17,930,000 26,000 (4,080,000)
Principal payment on note receivable
from the ESOP -- -- 408,000
ESOP contribution (109,000) -- --
Retirement of 578,208 shares of common
stock repurchased (4,473,000) -- --
Vesting of management recognition plan -- -- --
Cash dividends -- -- --
Net change in unrealized gain (loss) on
securities available for sale, net -- (545,000) --
Amortization of return of capital dividend -- -- --
Net income -- -- --
---------------------------------------------------
Balance at September 30, 1999 $ 13,348,000 $ (519,000) $ (3,672,000)
===================================================
</TABLE>
See Notes to Consolidated Financial Statements.
27
<PAGE>
Deferred Retained
Management Earnings, Total
Recognition Unearned Substantially Stockholders'
Plan Compensation Restricted Equity
- -------------------------------------------------------------------
$ -- $ -- $ 20,902,000 $ 20,867,000
-- -- -- 43,645,000
-- -- -- (4,528,000)
-- -- -- 270,000
-- -- -- 39,000
-- -- (1,571,000) (1,571,000)
-- -- -- 104,000
-- -- 2,868,000 2,868,000
- -------------------------------------------------------------------
-- -- 22,199,000 61,694,000
-- -- -- 178,000
-- -- -- 142,000
-- -- -- (3,021,000)
(3,193,000) -- -- --
1,597,000 -- -- 1,597,000
-- (1,990,000) -- (28,058,000)
-- -- (1,697,000) (1,697,000)
-- -- -- (43,000)
-- -- 763,000 763,000
- -------------------------------------------------------------------
(1,596,000) (1,990,000) 21,265,000 31,555,000
-- -- -- 408,000
-- -- -- (109,000)
-- -- -- (4,473,000)
798,000 -- -- 798,000
-- -- (1,382,000) (1,382,000)
-- -- -- (545,000)
-- 144,000 -- 144,000
-- -- 278,000 278,000
- -------------------------------------------------------------------
$ (798,000) $ (1,846,000) $ 20,161,000 $ 26,674,000
===================================================================
28
<PAGE>
SOUTH STREET FINANCIAL CORP. and subsidiary
CONSOLIDATED Statements of Cash Flows
Years Ended September 30, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income $ 278,000 $ 763,000 $ 2,868,000
Adjustments to reconcile net income
to net cash provided by
operating activities:
Net accretion (amortization) of
premiums and discounts on securities 59,000 10,000 (56,000)
Amortization of deferred loan fees (387,000) (254,000) (152,000)
Gain on sale of real estate acquired
in settlement of loans (8,000) -- (7,000)
Provision for depreciation 155,000 112,000 119,000
Deferred income taxes (125,000) (387,000) 285,000
Gain on sale of office properties and
equipment -- -- (4000)
Gain on sale or call of investments
available for sale (3,000) (88,000) --
ESOP contribution (109,000) 142,000 39,000
Vesting of management recognition plan 798,000 1,597,000 --
Amortization of unearned compensation 144,000 -- --
(Increase) decrease in assets:
Accrued interest receivable 218,000 601,000 (738,000)
Prepaid expenses and other assets 70,000 (71,000) 274,000
Increase (decrease) in liabilities:
Accounts payable and other liabilities (348,000) 1,155,000 327,000
Interest payable on deposits 8,000 (117,000) (51,000)
Accrued special SAIF assessment -- -- (838,000)
Checks outstanding on disbursement
account 59,000 269,000 (695,000)
--------------------------------------------
Net cash provided by
operating activities 809,000 3,732,000 1,371,000
--------------------------------------------
</TABLE>
(Continued)
29
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended September 30, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Investing Activities
Purchases of securities held to maturity $ -- $ -- $ (19,307,000)
Purchases of securities available for sale (23,034,000) (18,081,000) (57,754,000)
Proceeds from sales of securities
available for sale -- 8,463,000 8,700,000
Proceeds from maturities and calls of
securities available for sale 32,197,000 44,427,000 10,263,000
Principal collected on securities
held to maturity 4,345,000 8,247,000 3,059,000
Loan originations and principal
payments on loans, net (14,498,000) 1,644,000 (2,058,000)
Proceeds from sale of equipment -- -- 31,000
Purchase of equipment (337,000) (60,000) (66,000)
Proceeds from sale of real estate acquired
in settlement of loans -- -- 85,000
Purchase of real estate held for investment (493,000) (960,000) --
Proceeds from sale of real estate held
for investment 241,000 -- --
Purchase of FHLB stock -- -- (904,000)
Proceeds from the sale of FHLB stock 554,000 543,000 --
------------------------------------------------
Net cash provided by (used in)
investing activities (1,025,000) 44,223,000 (57,951,000)
------------------------------------------------
Cash Flows from Financing Activities
Net increase (decrease) in deposits (4,180,000) 6,806,000 (4,592,000)
Decrease in deposits, stock offering -- -- (2,956,000)
Payment of dividends (1,438,000) (29,770,000) (1,121,000)
Retirement of stock repurchased (4,473,000) (3,021,000) --
Minority interest contribution in LLC -- 10,000 --
Proceeds from FHLB borrowings -- -- 35,000,000
Repayments on FHLB borrowings -- (35,000,000) --
Proceeds from borrowings on note payable -- 18,000,000 --
Repayments on note payable (18,000,000) -- --
Loan to ESOP for purchase of stock -- -- (4,528,000)
Principal payment received on ESOP note 408,000 178,000 270,000
Net increase (decrease) in advance payments
by borrowers for taxes and insurance (2,000) (6,000) 16,000
------------------------------------------------
Net cash provided by (used in)
financing activities (27,685,000) (42,803,000) 22,089,000
------------------------------------------------
(Continued)
</TABLE>
30
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended September 30, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Increase (decrease) in cash
and cash equivalents $ (27,901,000) $ 5,152,000 $ (34,491,000)
Cash and cash equivalents:
Beginning 32,796,000 27,644,000 62,135,000
----------------------------------------------
Ending $ 4,895,000 $ 32,796,000 $ 27,644,000
==============================================
Supplemental Schedule of Cash and
Cash Equivalents:
Interest-bearing deposits $ 1,867,000 $ 2,891,000 $ 2,457,000
Noninterest-bearing deposits 2,598,000 26,895,000 19,257,000
Federal funds sold 430,000 3,010,000 5,930,000
---------------------------------------------
$ 4,895,000 $ 32,796,000 $ 27,644,000
=============================================
Supplemental Disclosures of Cash
Flow Information:
Cash payments for:
Interest $ 7,304,000 $ 9,227,000 $ 8,897,000
Income taxes 980,000 314,000 1,386,000
Supplemental Disclosures of Noncash
Transactions
Transfer of loans to real estate acquired
in settlement of loans 42,000 50,000 91,000
Loans originated to finance the sale
of real estate acquired in settlement
of loans 100,000 -- 13,000
Net change in unrealized (gain) loss on
securities available for sale, net of
deferred taxes (credits) 545,000 (43,000) (104,000)
Prepaid conversion costs -- -- (1,089,000)
Change in dividends accrued (56,000) (15,000) 450,000
Stock offering deposits used to purchase
common stock in conversion -- -- 43,645,000
Adoption of management recognition plan -- 3,193,000 --
</TABLE>
See Notes to Consolidated Financial Statements.
31
<PAGE>
SOUTH STREET FINANCIAL CORP. 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 polices require such loans to be made with a loan-to-value ratio of
at least 80% 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.
During 1998, the Bank formed a wholly-owned subsidiary, South Street Development
Corporation ("SSDC") with a $1.8 million cash investment. SSDC then invested
$10,000 for a 50% interest in Park Ridge Associates, LLC ("Park Ridge"). The
other 50% interest in Park Ridge is owned by an outside individual.
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 Corp. and its wholly-owned subsidiary, Home
Savings Bank of Albemarle, S.S.B., the Bank's wholly-owned subsidiary, South
Street Development Corporation, and SSDC's majority-owned subsidiary, Park Ridge
Associates, LLC. 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.
32
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Summary of Significant Accounting Policies
(Continued)
Cash, cash equivalents and cash flows: 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 with regard to concentration. Cash flows from loans and deposits are
reported net.
Investment in debt securities: The Company has investments in debt securities
- ------------------------------
which 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 is 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.
Premiums and discounts are amortized using the interest method over the
securities' contractual lives. 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. Declines in the fair value of
individual securities classified as either available for sale or held to
maturity below their amortized cost that are determined to be other than
temporary result in write-downs of the individual securities to their fair value
with the resulting write-downs included in current earnings as realized losses.
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. For presentation purposes, such stock
is assumed to have a market value which is equal to cost.
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.
33
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Summary of Significant Accounting Policies
(Continued)
Allowance for loan losses: The allowance for loan losses is increased by charges
- --------------------------
to income and decreased by charge-offs (net of recoveries). The allowance is an
amount that management believes will be adequate to absorb estimated losses on
existing loans. 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. The loan portfolio is further analyzed by each loan type
and delinquency status to determine the risk category for each loan that is used
in calculating the allowance for loan losses. Loans delinquent greater than 90
days are evaluated individually for loss exposure, while other loans are
evaluated aggregately by type. Allocated an unallocated portions are determined
in the same manner. 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.
Impaired loans: The Bank assesses loans delinquent greater than 90 days for
- ---------------
impairment. 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.
Interest income: The Bank recognizes interest income on loans using the interest
- ----------------
method over the contractual life of the loan. 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 and related costs: 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.
Real estate held for investment: Real estate held for investment is stated at
- --------------------------------
the lower of cost or market value.
34
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Summary of Significant Accounting Policies
(Continued)
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 assets' 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 has deferred compensation, supplemental income and retirement plan
agreements for the benefit of certain officers of the Company and members of the
Board of Directors. The plans are funded in part through life insurance policies
held by the Bank and the liabilities are being accrued over the terms indicated
in the plan agreements. 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 Company has implemented a qualified stock option plan
authorizing the grant of up to 449,650 stock options to certain directors,
officers and employees at the time of the adoption, either in the form of
incentive stock options or non-incentive stock options. The Company has also
implemented a management recognition plan by acquiring in trust 179,860 shares
of stock for issuance to certain directors, officers and employees at the time
of adoption.
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 an asset and 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: SFAS No. 128 requires the presentation of earnings per share
- ------------------
by all entities that have common stock or potential common stock, such as
options, warrants and convertible securities, outstanding that trade in a public
market. Those entities that have only common stock outstanding are required to
present basic earnings per-share amounts. Basic per-share amounts are computed
by dividing net income (the numerator) by the weighted-average number of common
shares outstanding (the denominator). All other entities are required to present
basic and diluted per-share amounts. Diluted per-share amounts assume the
conversion, exercise or issuance of all potential common stock instruments
unless the effect is to reduce the loss or increase the income per common share
from continuing operations. For both computations, 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.
35
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. Nature of Business and Summary of Significant Accounting Policies
(Continued)
Comprehensive income: SFAS No. 130, Reporting Comprehensive Income, 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.
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, 1999 and 1998. 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 $5,000 and $4,000 was held
by a trustee at September 30, 1999 and 1998, 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.
The Bank is required to maintain a minimum balance of $225,000 with the Federal
Reserve Bank for transactions clearing through that account.
36
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 3. Securities
Amortized cost and fair values of securities as of September 30, are summarized
as follows:
<TABLE>
<CAPTION>
1999
------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. Government and federal
agencies obligations $ 16,496,000 $ - $ (182,000) $ 16,314,000
Mortgage-backed securities 13,148,000 - (669,000) 12,479,000
Other security 315,000 - - 315,000
-------------------------------------------------------------------
$ 29,959,000 $ - $ (851,000) $ 29,108,000
===================================================================
Securities held to maturity:
Mortgage-backed securities
and related securities $ 8,932,000 $ 84,000 $ (445,000) $ 8,571,000
===================================================================
Other investments:
Interest-earning deposits $ 1,867,000 $ - $ - $ 1,867,000
Federal funds sold 430,000 - - 430,000
Federal Home Loan Bank
stock 1,153,000 - - 1,153,000
-------------------------------------------------------------------
$ 3,450,000 $ - $ - $ 3,450,000
===================================================================
<CAPTION>
1998
-------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. Government and federal
agencies obligations $ 30,975,000 $ 138,000 $ - $ 31,113,000
Mortgage-backed securities 7,825,000 - (95,000) 7,730,000
Other security 315,000 - - 315,000
-------------------------------------------------------------------
$ 39,115,000 $ 138,000 $ (95,000) $ 39,158,000
===================================================================
Securities held to maturity:
Mortgage-backed securities
and related securities $ 13,340,000 $ 206,000 $ (283,000) $ 13,263,000
===================================================================
Other investments:
Interest-earning deposits $ 26,895,000 $ - $ - $ 26,895,000
Federal funds sold 3,010,000 - - 3,010,000
Federal Home Loan Bank
stock 1,707,000 - - 1,707,000
------------------------------------------------------------------
$ 31,612,000 $ - $ - $ 31,612,000
==================================================================
</TABLE>
37
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 3. Securities (Continued)
<TABLE>
<CAPTION>
1997
-----------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Securities available for sale:
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
=============================================================================
Securities held to maturity:
Mortgage-backed securities
and related securities $ 21,661,000 $ 202,000 $ (302,000) $ 21,561,000
=============================================================================
Other investments:
Interest-earning deposits $ 19,257,000 $ -- $ -- $ 19,257,000
Federal funds sold 5,930,000 -- -- 5,930,000
Federal Home Loan Bank
stock 2,250,000 -- -- 2,250,000
-----------------------------------------------------------------------------
$ 27,437,000 $ -- $ -- $ 27,437,000
=============================================================================
</TABLE>
The amortized cost and fair values of securities as of September 30, 1999 by
contractual maturity are shown
Amortized Fair
Cost Value
-----------------------------------
Securities available for sale:
Due in one year or less $ 1,000,000 $ 999,000
Due after one year through five years 15,496,000 15,315,000
Due after ten years 13,463,000 12,794,000
-----------------------------------
$29,959,000 $29,108,000
===================================
Securities held to maturity:
Due after five years through ten years $ 1,005,000 $ 1,048,000
Due after ten years 7,927,000 7,523,000
---------------------------------
$ 8,932,000 $ 8,571,000
=================================
Proceeds from the sales of securities available for sale for the years ended
September 30, 1999, 1998 and 1997 were $-0-, $8,463,000 and $8,700,000,
respectively. Gross proceeds from maturities and recalled securities available
for sale for the years ended September 30, 1999, 1998 and 1997 were $32,194,000,
$44,427,000 and $10,263,000, respectively. Realized gains from sales, maturities
or recalls of securities available for sale for the years ended September 30,
1999, 1998 and 1997 were $3,000, $88,000 and $-0-, respectively. There were no
sales, maturities or recalls of investment securities held to maturity during
the years ended September 30, 1999, 1998 and 1997.
38
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 3. Securities (Continued)
The change in accumulated other comprehensive income, which consists of
unrealized gains and losses for the years ended September 30, 1999 and 1998 is
as shown below:
1999 1998
---------------------------------------
Balance, beginning $ 26,000 $ 69,000
Change in unrealized losses (894,000) (71,000)
Change in deferred income taxes 349,000 28,000
---------------------------------------
Balance, ending $(519,000) $ 26,000
=======================================
The following table sets forth certain information regarding the carrying value
and contractual maturities of the Company's investment portfolio at September
30, 1999:
<TABLE>
<CAPTION>
Carrying Value
---------------------------------------------------------------------------------------------
After One After Five
Year Through Years Through After
One Year Five Years Ten Years Ten Years Total
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Securities available for sale:
Federal Home Loan Bank bonds $ 999,000 $15,315,000 $ -- $ -- $16,314,000
Mortgage-backed securities -- -- -- 12,479,000 12,479,000
Other -- -- -- 315,000 315,000
Securities held to maturity:
Mortgage-backed securities -- -- 1,005,000 7,927,000 8,932,000
Other investments:
Interest-earning deposits 1,867,000 -- -- -- 1,867,000
Federal funds sold 430,000 -- -- -- 430,000
Federal Home Loan Bank stock -- -- -- 1,153,000 1,153,000
---------------------------------------------------------------------------------------------
$ 3,296,000 $15,315,000 $ 1,005,000 $21,874,000 $41,490,000
=============================================================================================
</TABLE>
The following table sets forth the weighted average yield by maturity of the
Company's investment portfolio at Sepetember 30, 1999:
<TABLE>
<CAPTION>
After One After Five
Year Through Years Through After
One Year Five Years Ten Years Ten Years Total
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Securities available for sale:
Federal Home Loan Bank bonds 5.75% 5.59% -- -- 5.60%
Mortgage-backed securities -- -- -- 6.31% 6.31%
Other -- -- -- -- --
Securities held to maturity:
Mortgage-backed securities -- -- 8.34% 7.34% 7.46%
Other investments:
Interest-earning deposits 5.50% -- -- -- 5.50%
Federal funds sold 5.50% -- -- -- 5.50%
Federal Home Loan Bank stock -- -- -- 7.50% 7.50%
---------------------------------------------------------------------------------------------
5.58% 5.59% 8.34% 6.63% 6.20%
=============================================================================================
</TABLE>
39
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Loan Receivable
Loans receivable at September 30 are summarized below:
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------------------------------------------------------------
Amount % of Total Amount % of Total Amount % of Total
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $104,994,000 83.67% $ 96,218,000 87.04% $ 95,984,000 85.71%
Residential multi-family 620,000 0.49% 464,000 0.42% 555,000 0.50%
Nonresidential real estate 3,791,000 3.02% 3,777,000 3.42% 3,774,000 3.37%
Residential construction 11,225,000 8.95% 4,427,000 4.00% 8,394,000 7.50%
Land 2,489,000 1.98% 5,507,000 4.98% 6,091,000 5.44%
Line of credit 2,854,000 2.27% 3,167,000 2.86% 3,328,000 2.96%
Commercial loans 4,920,000 3.92% -- --% -- --
---------------------------------------------------------------------------------
Total real estate loans 130,893,000 104.30% 113,560,000 102.72% 118,126,000 105.48%
---------------------------------------------------------------------------------
Consumer loans:
Share and other 2,468,000 1.97% 201,000 0.18% 488,000 0.44%
Credit reserve 102,000 0.08% 385,000 0.35% 96,000 0.08%
---------------------------------------------------------------------------------
Total consumer loans 2,570,000 2.05% 586,000 0.53% 584,000 0.52%
---------------------------------------------------------------------------------
Less:
Net deferred loan fees 564,000 0.45% 591,000 0.53% 636,000 0.57%
Loans in process 6,977,000 5.56% 2,576,000 2.33% 5,655,000 5.05%
Allowance for loan losses 429,000 0.34% 429,000 0.39% 429,000 0.38%
---------------------------------------------------------------------------------
Total reductions 7,970,000 6.35% 3,596,000 3.25% 6,720,000 6.00%
---------------------------------------------------------------------------------
Total loans receivable, net $125,493,000 100.00% $110,550,000 100.00% $111,990,000 100.00%
=================================================================================
<CAPTION>
1996 1995
-------------------------------------------------------
Amount % of Total Amount % of Total
-------------------------------------------------------
<S> <C> <C> <C> <C>
Real estate loans:
Residential 1-4 family $ 93,275,000 84.90% $ 94,036,000 86.60%
Residential multi-family 695,000 0.63% 840,000 0.77%
Nonresidential real estate 4,038,000 3.67% 3,013,000 2.77%
Residential construction 4,720,000 4.30% 5,368,000 4.94%
Land 6,304,000 5.74% 4,890,000 4.50%
Line of credit 3,786,000 3.45% 3,875,000 3.58%
------------------------------------------------------
Total real estate loans 112,818,000 102.69% 112,022,000 103.16%
------------------------------------------------------
Consumer loans:
Share 196,000 0.18% 110,000 0.10%
Credit reserve 470,000 0.43% 221,000 0.20%
------------------------------------------------------
Total consumer loans 666,000 0.61% 331,000 0.30%
------------------------------------------------------
Less:
Net deferred loan fees 582,000 0.53% 519,000 0.48%
Loans in process 2,616,000 2.38% 3,100,000 2.85%
Allowance for loan losses 428,000 0.39% 137,000 0.13%
------------------------------------------------------
Total reductions 3,626,000 3.30% 3,756,000 3.46%
------------------------------------------------------
Total loans receivable, net $109,858,000 100.00% $108,597,000 100.00%
======================================================
</TABLE>
40
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Loans Receivable (Continued)
The following table sets forth the time to contractual maturity of the Bank's
loan portfolio at September 30, 1999. Loans which have adjustable rates are
shown as being due in the period during which rates are next subject to change,
while fixed rate and other loans are shown as due in the period of contractual
maturity. Demand loans, loans having no stated maturity and overdrafts, are
reported as due in one year or less. The table does not include prepayments or
scheduled principal repayments. Amounts in the table are net of loans in process
and are net of unamortized loan fees.
<TABLE>
<CAPTION>
At September 30, 1999
----------------------------------------------------------------
More than Greater
One Year 1 Year to than
or Less 5 Years 5 Years Total
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Adjustable rate residential 1-4 family $ 5,000 $ 107,000 $ 1,058,000 $ 1,170,000
Fixed rate residential 1-4 family 34,000 1,849,000 105,676,000 107,559,000
Other real estate loans - adjustable 2,387,000 496,000 2,653,000 5,536,000
Other real estate loans - fixed 7,000 1,226,000 7,854,000 9,087,000
Other loans 326,000 543,000 1,701,000 2,570,000
Allowance for loan losses (429,000) -- -- (429,000)
-------------------------------------------------------------
Totals $ 2,330,000 $ 4,221,000 $ 118,942,000 $ 125,493,000
==============================================================
</TABLE>
The following table sets forth the dollar amount at September 30, 1999 of all
loans maturing or repricing on or after September 30, 2000 which have fixed or
adjustable interest rates.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
------------------------------------
<S> <C> <C>
Real estate loans $ 116,605,000 $ 4,314,000
Other 2,244,000 --
------------------------------------
$ 118,849,000 $ 4,314,000
====================================
</TABLE>
41
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Loans Receivable (Continued)
The following is an analysis of the allowance for loan losses:
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------
1999 1998 1997 1996 1995
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, beginning of period $429,000 $ 429,000 $ 428,000 $137,000 $ 140,000
Provision for loan losses - - - 300,000 -
Charge-offs:
Residential 1-4 family - (1,000) (1,000) (8,000) (3,000)
Line of credit - - - (10,000) -
Recoveries:
Residential 1-4 family - 1,000 2,000 6,000 -
Line of credit - - - 3,000 -
---------------------------------------------------------------
Balance, end of period $429,000 $ 429,000 $ 429,000 $428,000 $ 137,000
===============================================================
Net charge-offs (recoveries) as a
percent of average loans 0.000% 0.000% (0.001)% 0.008% 0.003%
Allowance at period end as a
percent of nonperforming loans 245.14% 172.98% 84.12% 65.44% 13.97%
Allowance at period end as a
percent of nonperforming assets 222.28% 135.76% 81.25% 63.69% 12.28%
Allowance at period end as a
percent of total gross loans 0.32% 0.38% 0.36% 0.38% 0.12%
</TABLE>
42
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Loans Receivable (Continued)
The allocation of the allowance for loan losses applicable to each category of
loans at September 30 is as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------------------
Percent of Percent Percent of Percent
Allowance to of Loans Allowance of Loans
Amount of Total to Total Amount of to Total to Total
Allowance Allowance Loans Allowance Allowance Loans
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One-to-four family
residential $ 175,000 40.79% 82.97% $203,000 47.31% 84.30%
Multi-family residential 1,000 0.23% 0.49% 1,000 0.23% 0.41%
Nonresidential real estate 2,000 0.47% 2.99% -- -- 3.31%
Residential construction -- -- 3.37% -- -- 3.88%
Land 4,000 0.93% 1.97% -- -- 4.82%
Home equity 11,000 2.57% 2.27% 6,000 1.40% 2.77%
Commercial loans 5,000 1.17% 3.91% -- -- --
---------------------------------------------------------------------------
Total real estate loans 198,000 46.16% 97.97% 210,000 48.94% 99.49%
---------------------------------------------------------------------------
Consumer loans:
Share and other loans 1,000 0.23% 1.95% -- -- 0.43%
Credit reserve -- 0.00% 0.08% -- -- 0.08%
---------------------------------------------------------------------------
Total consumer loans 1,000 0.23% 2.03% -- -- 0.51%
---------------------------------------------------------------------------
Unallocated 230,000 53.61% -- 219,000 51.06% --
---------------------------------------------------------------------------
$ 429,000 100.00% 100.00% $429,000 100.00% 100.00%
===========================================================================
<CAPTION>
1997 1996
---------------------------------------------------------------------------
Percent of Percent Percent of Percent
Allowance to of Loans Allowance of Loans
Amount of Total to Total Amount of to Total to Total
Allowance Allowance Loans Allowance Allowance Loans
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One-to-four family $ 262,000 61.07% 80.86% $243,000 56.78% 82.19%
residential
Multi-family residential 1,000 0.23% 0.47% 1,000 0.23% 0.61%
Nonresidential real estate 4,000 0.94% 3.18% 4,000 0.93% 3.56%
Residential construction -- -- 7.07% -- -- 4.16%
Land 4,000 0.93% 5.13% 6,000 1.40% 5.56%
Home equity 7,000 1.63% 2.80% 10,000 2.34% 3.34%
---------------------------------------------------------------------------
Total real estate loans 278,000 64.80% 99.51% 264,000 61.68% 99.42%
---------------------------------------------------------------------------
Consumer loans:
Share loans -- -- 0.41% -- -- 0.17%
Credit reserve -- -- 0.08% -- -- 0.41%
---------------------------------------------------------------------------
Total consumer loans -- -- 0.49% -- -- 0.58%
---------------------------------------------------------------------------
Unallocated 151,000 35.20% -- 164,000 38.32% --
---------------------------------------------------------------------------
$ 429,000 100.00% 100.00% $428,000 100.00% 100.00%
===========================================================================
</TABLE>
43
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Loans Receivable (Continued)
1995
---------------------------------------
Percent of Percent
Allowance of Loans
Amount of to Total to Total
Allowance Allowance Loans
---------------------------------------
Real estate loans:
One-to-four family residential $ 125,000 91.24% 83.70%
Multi-family residential -- -- 0.75%
Nonresidential real estate 3,000 2.19% 2.68%
Residential construction -- -- 4.78%
Land -- -- 4.35%
Home equity 8,000 5.84% 3.45%
---------------------------------------
Total real estate loans 136,000 99.27% 99.71%
---------------------------------------
Consumer loans:
Share loans -- -- 0.10%
Credit reserve 1,000 0.73% 0.19%
---------------------------------------
Total consumer loans 1,000 0.73% 0.29%
---------------------------------------
Unallocated -- -- --
---------------------------------------
$ 137,000 100.00% 100.00%
=======================================
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 $175,000 and
$248,000 at September 30, 1999 and 1998, respectively, and had an average
outstanding balance of approximately $279,000 and $373,000 for the years ended
September 30, 1999 and 1998, respectively. These loans are primarily collateral
dependent and management has determined that the underlying collateral value 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
$175,000 and $248,000 at September 30, 1999, and 1998, 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
$12,000, $14,000 and $29,000 for the years ended September 30, 1999, 1998 and
1997, respectively.
44
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Loans Receivable (Continued)
The following table sets forth information with respect to nonperforming assets
identified by the Bank, including nonaccrual loans.
<TABLE>
<CAPTION>
At September 30,
------------------------------------------------
1999 1998 1997
------------------------------------------------
<S> <C> <C> <C>
Nonaccrual loans $ 175,000 $ 248,000 $ 510,000
Foreclosed real estate 18,000 68,000 18,000
------------------------------------------------
Total non-performing assets $ 193,000 $ 316,000 $ 528,000
================================================
Non-performing loans to total gross loans 0.13 % 0.22 % 0.43 %
================================================
Non-performing assets to total assets 0.11 % 0.16 % 0.22 %
================================================
Total assets $ 174,545,000 $ 201,945,000 $ 241,061,000
Total gross loans $ 133,463,000 $ 114,146,000 $ 118,710,000
</TABLE>
<TABLE>
<CAPTION>
At September 30,
--------------------------------
1996 1995
--------------------------------
<S> <C> <C>
Nonaccrual loans $ 654,000 $ 981,000
Foreclosed real estate 18,000 135,000
Total non-performing assets $ 672,000 $ 1,116,000
================================
Non-performing loans to total gross loans 0.58 % 0.87 %
================================
Non-performing assets to total assets 0.31 % 0.70 %
================================
Total assets $ 217,954,000 $ 159,863,000
Total gross loans $ 113,484,000 $ 112,353,000
</TABLE>
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 $47,000 and $265,000 at September 30, 1999 and
1998, respectively. Custodial escrow balances maintained in connection with the
foregoing loan servicing was approximately $6,000 at September 30, 1999 and
1998.
45
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. Loans Receivable (Continued)
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:
1999 1998
-------------------------------
Balance, beginning $ 1,436,000 $ 1,607,000
Originations 1,632,000 526,000
Payments received (277,000) (697,000)
-------------------------------
Balance, ending $ 2,791,000 $ 1,436,000
===============================
Note 5. Accrued Interest Receivable
Accrued interest receivable is summarized as follows:
September 30,
-------------------------------
1999 1998
-------------------------------
Securities $ 266,000 $ 503,000
Mortgage-backed securities 160,000 164,000
Loans receivable 658,000 635,000
-------------------------------
$ 1,084,000 $ 1,302,000
===============================
Note 6. Office Properties and Equipment
September 30,
-------------------------------
1999 1998
-------------------------------
Land $ 138,000 $ 138,000
Buildings and improvements 1,425,000 1,343,000
Furniture and equipment 957,000 763,000
-------------------------------
2,520,000 2,244,000
Less accumulated depreciation 1,232,000 1,138,000
-------------------------------
$ 1,288,000 $ 1,106,000
===============================
46
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 7. 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 $173,000, $165,000 and $136,000
for the years ended September 30, 1999, 1998 and 1997, respectively, and is
included in compensation and benefits in the accompanying statements of income.
The Company adopted FASB Statement No. 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits, during 1998. The Statement revises
employers' disclosures about pensions, but does not change the measurement or
recognition criteria.
The following table sets forth the Plan's funded status and amounts recognized
in the statement of financial condition as of September 30, 1999 and 1998:
1999 1998
===============================
Change in benefit obligation:
Benefit obligation, beginning $ 1,283,000 $ 987,000
Service cost 56,000 52,000
Interest cost 109,000 91,000
Actuarial gain 77,000 153,000
Distributions (4,000) --
-------------------------------
Benefit obligation, ending 1,521,000 1,283,000
-------------------------------
Change in plan assets:
Fair value of plan assets, beginning 593,000 384,000
Actual return on plan assets 45,000 34,000
Employer contribution 150,000 175,000
Distributions (4,000) --
-------------------------------
Fair value of plan assets, ending 784,000 593,000
-------------------------------
Funded status (737,000) (690,000)
Unrecognized net actuarial loss 425,000 358,000
Unrecognized prior service cost 336,000 370,000
-------------------------------
Prepaid benefit cost (included in prepaid expenses
and other assets) $ 24,000 $ 38,000
===============================
The components of net periodic benefit cost for the years ended September 30,
1999, 1998 and 1997 are as follows:
1999 1998 1997
---------------------------------------------
Service cost $ 56,000 $ 52,000 $ 44,000
Interest cost 109,000 91,000 70,000
Expected return on plan assets (54,000) (37,000) (27,000)
Amortization of prior service cost 34,000 34,000 34,000
Recognized net actuarial loss 28,000 25,000 15,000
---------------------------------------------
Net periodic benefit cost $ 173,000 $ 165,000 $ 136,000
=============================================
47
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 7. Employee Pension Plan (Continued)
Weighted-average assumptions used to develop the net periodic pension cost as of
September 30, 1999, 1998 and 1997 were:
Discount rate 8.0 %
Expected rate of return on plan assets 8.0
Rate of compensation increase 5.0
Note 8. Deposits
Deposits at September 30 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average % of Average % of Average % of
Amount Rate deposits Amount Rate deposits Amount Rate deposits
-------------------------------------------------------------------------------------
Demand Accounts: (Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Passbook savings $ 14,562 2.10% 10.09% $13,766 2.00% 9.27% 15,311 3.00% 10.80%
NOW accounts 7,424 1.00% 5.15% 7,875 1.00% 5.31% 7,307 2.32% 5.15%
Money market 5,803 2.00% 4.02% 6,512 2.50% 4.39% 6,266 3.00% 4.42%
Noninterest bearing
accounts 1,322 - 0.92% 1,502 - 1.01% 689 - 0.49%
-------------------------------------------------------------------------------------
Total demand
deposits 29,111 1.67% 20.18% 29,655 1.74% 19.98% 29,573 2.76% 20.86%
-------------------------------------------------------------------------------------
Certificates of deposit
1.00% to 1.99% 65 0.04% - - - -
2.00% to 3.99% 7,372 5.11% - - 16 0.01%
4.00% to 5.99% 55,096 38.19% 57,616 38.81% 59,037 41.65%
6.00% to 7.99% 52,512 36.40% 61,065 41.14% 52,904 37.32%
-------------------------------------------------------------------------------------
115,045 5.32% 79.74% 118,681 5.65% 79.95% 111,957 5.85% 78.98%
-------------------------------------------------------------------------------------
Accrued interest payable 116 0.08% 108 0.07% 225 0.16%
-------------------------------------------------------------------------------------
Total Deposits $ 144,272 4.59% 100.00% $148,444 4.87% 100.00% 141,755 5.20% 100.00
=====================================================================================
</TABLE>
48
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 8. Deposits (Continued)
At September 30, 1999, the scheduled maturities of certificates of deposit are
as follows:
Year Ending September 30, Amount
- ------------------------- ----------------
2000 $ 85,339,000
2001 25,376,000
2002 4,330,000
----------------
$ 115,045,000
================
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $16,186,000 and $17,194,000 at
September 30, 1999 and 1998, respectively.
The aggregate amount of certificates of deposit by maturity with a minimum
denomination of $100,000 included in the above table is as follows:
September 30,
1999
----------------
Maturity Period:
Within 3 months or less $ 2,120,000
Over 3 months through 6 months 5,001,000
Over 6 months through 12 months 5,506,000
Over 12 months 3,559,000
----------------
$ 16,186,000
================
Interest expense on deposits is summarized as follows:
Years Ended September 30,
----------------------------------------------
1999 1998 1997
----------------------------------------------
Passbook savings $ 282,000 $ 418,000 $ 486,000
NOW and money market 224,000 311,000 353,000
Certificates of deposit 6,438,000 6,574,000 6,516,000
----------------------------------------------
$ 6,944,000 $ 7,303,000 $ 7,355,000
==============================================
The Bank has pledged securities with an amortized cost of $1,000,000 as
collateral for public deposits and pledged securities with an amortized cost of
$500,000 as collateral on treasury tax and loan account at September 30, 1999.
Eligible savings accounts are insured to $100,000 by the SAIF which is
administered by the FDIC.
49
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 9. Advances from Federal Home Loan Bank and Note Payable
Note payable consists of the following at September 30:
1999 1998
-------------------
Note payable, due in quarterly interest only installments
at prime rate (8.25% at September 30, 1998) less .50%,
with accrued interest and principal paid October 1, 1998.
Collateralized by the Company's common stock. $ - $ 18,000,000
===================
The average amount of FHLB advances and notes payable outstanding was
approximately $-0- and $29,615,000 and had a weighted average interest rate of
0% and 6.81% during the years ended September 30, 1999 and 1998, respectively.
The maximum amount of borrowings outstanding amounted to $-0- and $53,000,000
during the years ended September 30, 1999 and 1998, respectively. There were no
FHLB advances on notes payable outstanding at September 30, 1999 and 1998.
Interest expense on FHLB advances totaled $-0-, $936,000 and $1,491,000 for the
years ended September 30, 1999, 1998 and 1997, respectively. Interest expense on
the note payable totaled $-0-, $1,080,000 and $-0- for the years ended September
30, 1999, 1998 and 1997, respectively.
On October 26, 1999, the Bank borrowed $4,000,000 in an advance from the FHLB.
The advance bears interest at 6.30% and is due in quarterly interest only
installments with accrued interest and principal due on October 26, 2000.
Note 10. Deferred Compensation Agreements
The Bank has entered into unfunded deferred compensation agreements providing
retirement and death benefits for seven directors and supplemental income
agreements for two executive officers. Vested benefits under these agreements
are payable in monthly installments over 10 and 15 year periods. The present
value of the liability for the benefits is being accrued over the service life
per the underlying agreements, which amounted to $1,883,000 and $1,609,000 at
September 30, 1999 and 1998, respectively. The total expense for the deferred
compensation agreements and supplemental income agreements amounted to $273,000,
$272,000 and $249,000 for the years ended September 30, 1999, 1998 and 1997,
respectively.
50
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 11. Management Recognition Plan and Stock Option Plan
The Company's stockholders approved the Company's Stock Option Plan and the
Bank's Management Recognition Plan and Trust (the "MRP") on October 15, 1997.
The Stock Option Plan reserves for issuance up to 449,650 stock options to
certain officers, directors, and employees 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 granted to employees, which vest at the rate of 25% annually
beginning at the date of grant, were all granted in 1998 and expire in 2008.
Options granted to non-employee directors vested immediately on the date of
grant. The weighted average fair value of the options on the grant date was
$12.00 per share. 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 has been recognized for grants made to date. Had compensation
cost been determined based on the fair value method prescribed in FASB Statement
No. 123, the pro forma effect on reported net income would be as follows for the
years ended September 30:
1999 1998
------------------------------
Net income (loss)
As reported $ 278,000 $ 763,000
Pro forma (35,000) 136,000
Earnings (loss) per share
As reported
Basic $ 0.08 $ 0.19
Diluted 0.08 0.19
Pro forma
Basic (0.01) 0.03
Diluted (0.01) 0.03
In determining the fair value of the option grant as prescribed in Statement No.
123, the Black-Scholes option pricing model was used with the following
assumptions: a risk-free interest rate of 5.00%, expected lives of 10 years,
expected volatility of 29.55% and expected dividends of $0.40 per year.
At September 30, 1999, all options have been granted at an exercise price of
$12.00, of which 269,789 options are currently exercisable. No options have been
exercised to date and all options granted are outstanding at September 30, 1999.
The MRP reserved for issuance 179,860 shares of common stock to certain
officers, directors, and employees at the time of the adoption. The Company
issued shares to fund the MRP on October 15, 1997. The restricted common stock
under the MRP vests at the rate of 25% annually beginning at the date of grant.
The expense related to the vesting of the MRP totaled $798,000 and $1,597,000
for the years ended September 30, 1999 and 1998, respectively.
51
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 12. 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. 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 over a six year period its tax bad debt
reserves which have accumulated since 1987 and amount to approximately
$1,023,000. The tax associated with the recaptured reserve is approximately
$350,000. The recapture was scheduled to begin with the Bank's 1997 year but was
delayed two years as the Bank originated 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. During the year ended September
30, 1999, the Bank recaptured $171,000 of this reserve, resulting in a reduction
to the deferred tax asset of $59,000.
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, 1999, 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 loan 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, 1999. 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.
52
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 12. Income Tax Matters (Continued)
The tax effects of temporary differences that gave rise to significant portions
of the net deferred tax asset (classified with prepaid expenses and other assets
in the Statement of Financial Condition at September 30 are as follows:
1999 1998
---------------------------
Deferred tax assets:
Net deferred loan fees and costs $ 22,000 $ 31,000
Unrealized loss on securities available for sale 332,000 --
Deferred compensation and supplemental income 631,000 534,000
Accrued management recognition plan 271,000 271,000
Reserve for uncollected interest 4,000 5,000
Allowance for loan losses 146,000 146,000
State NEL carryforward 332,000 308,000
---------------------------
1,738,000 1,295,000
Less valuation allowance 332,000 308,000
---------------------------
1,406,000 987,000
---------------------------
Deferred tax liabilities:
FHLB dividends 229,000 232,000
Reserve for bad debts 291,000 350,000
Unrealized gain on securities available for sale -- 17,000
Property and equipment 55,000 31,000
---------------------------
575,000 630,000
---------------------------
Net deferred tax asset $ 831,000 $ 357,000
===========================
Income tax expense (credits) consist of the following for the years ended
September 30:
1999 1998 1997
----------------------------------------------
Current $ 624,000 $ 699,000 $ 1,331,000
Deferred (125,000) (387,000) (285,000)
----------------------------------------------
Total $ 499,000 $ 312,000 $ 1,616,000
=============================================
The following is a reconciliation of the federal income tax rate of 34% to the
effective tax rate:
Year Ended
---------------------------------
1999 1998 1997
---------------------------------
Statutory federal income tax rate 34.0 % 34.0 % 34.0 %
Increase (decrease) in taxes resulting from:
State income taxes, net of federal benefit 5.1 (0.9) 1.4
Permanent differences 7.8 (2.1) --
Other, primarily prior year underaccrual 17.3 (2.0) 0.6
---------------------------------
64.2 % 29.0 % 36.0 %
=================================
53
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 13. Stockholders' Equity
On October 2, 1996, South Street Financial Corp. 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 the Company 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
stockholders' 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 the Company 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 1999 and 1998, the Bank paid
$19,239,000 and $1,173,000, respectively, in dividends to the Company.
The Company paid cash dividends totaling $.40 and $6.40 (including a return of
capital dividend of $6.00 per share in 1998) per share during the years ended
September 30, 1999 and 1998, respectively.
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.
54
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 13. Stockholders' Equity (Continnued)
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, 1999 and 1998.
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, 1999 and 1998:
<TABLE>
<CAPTION>
September 30, 1999
------------------------------------------------------
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 $ 24,522 $ 24,522 $ 24,522 $ 24,522
Supplemental capital items:
General valuation allowance - - 429 429
Unrealized loss on securities
available for sale 443 443 443 443
------------------------------------------------------
Regulatory capital 24,965 24,965 25,394 25,394
Minimum capital requirement 5,188 2,537 6,765 8,646
------------------------------------------------------
Excess regulatory capital $ 19,777 $ 22,428 $ 18,629 $ 16,748
======================================================
Total Bank assets at
September 30, 1999 $ 172,928 $ 172,928
=========== ===============
Bank risk-weighted assets at
September 30, 1999 $ 84,568 $ 84,568
==========================
Capital as a percentage of assets:
Actual 14.44 % 29.52 % 30.03 % 14.68 %
Required 3.00 3.00 8.00 5.00
------------------------------------------------------
Excess 11.44 % 26.52 % 22.03 % 9.68 %
======================================================
</TABLE>
55
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
Notes to CONSOLIDATED Financial Statements
- --------------------------------------------------------------------------------
Note 13. Stockholders' Equity (Continnued)
<TABLE>
<CAPTION>
September 30, 1998
------------------------------------------------------
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 $ 43,270 $ 43,270 $ 43,270 $ 43,270
Supplemental capital items:
General valuation allowance - - 429 429
Unrealized gain on securities
available for sale (61) (61) (61) (61)
------------------------------------------------------
Regulatory capital 43,209 43,209 43,638 43,638
Minimum capital requirement 5,893 2,340 6,241 9,822
------------------------------------------------------
Excess regulatory capital $ 37,316 $ 40,869 $ 37,397 $ 33,816
======================================================
Total Bank assets at
September 30, 1998 $196,434 $ 196,434
========== ================
Bank risk-weighted assets at
September 30, 1998 $ 78,012 $ 78,012
=========================
Capital as a percentage of assets:
Actual 22.00 % 55.39 % 55.94 % 22.21 %
Required 3.00 3.00 8.00 5.00
------------------------------------------------------
Excess 19.00 % 52.39 % 47.94 % 17.21 %
======================================================
</TABLE>
As of September 30, 1999, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
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 $8,457,000, $5,074,000
and $8,646,000, respectively. There are no conditions or events since that
notification that management believes have changed the Bank's category.
56
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 14. 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 ESOP purchased 168,448 additional shares with proceeds received
from the return of capital dividend paid by the Company in 1998.
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, 1999 the outstanding balance of the note receivable is $3,672,000,
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. Special return of capital dividends paid
on 331,742 unallocated ESOP shares totaled $1,990,000 on September 30, 1998 and
are being amortized as compensation expense in subsequent periods as ESOP shares
are released to the participants. During the year ended September 30, 1999,
$144,000 was amortized as compensation expense.
Expenses of $462,000 and $459,000 have been incurred during 1999 and 1998,
respectively, in connection with the ESOP. The expenses include, in addition to
the cash contribution necessary to fund the ESOP, $(109,000) and $142,000 for
1999 and 1998, respectively, 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
(debited) this amount to paid-in capital in accordance with the provisions of
AICPA Statement of Position 93-6.
At September 30, 1999, 129,470 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 $2.7 million at September 30, 1999.
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, 1999, based
on a fair value of the ESOP shares released or committed to be released of
$6.6875, is $866,000. The fair value of the unallocated shares is $2,666,000 at
September 30, 1999. This commitment will fluctuate based on the fair value of
the shares.
57
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 15. 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>
<S> <C>
September 30, 1999
------------------------------
Fixed Rate Variable Rate
------------------------------
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit, mortgage loans $ 8,525,000 $ --
Undisbursed lines of credit -- 3,598,000
------------------------------
$ 8,525,000 $ 3,598,000
==============================
</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.
58
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 16. Earnings Per Share
Earnings per share has been calculated in accordance with Financial Accounting
Standards Board Statement No. 128, Earnings Per Share, and Statement of Position
93-6, Employers' Accounting for Employee Stock Ownership Plans. 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. Stock-based compensation grants have
not been included in the diluted earnings per share since they are antidilutive.
The following are reconciliations of the amounts used in the per share
calculations:
For the Year Ended September 30, 1999
-----------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-----------------------------------------------
Basic and Diluted EPS $ 278,000 3,500,840 $ 0.08
===============================================
For the Year Ended September 30, 1998
-----------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-----------------------------------------------
Basic and Diluted EPS $ 763,000 4,092,339 $ 0.19
===============================================
For the Year Ended September 30, 1997
-----------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-----------------------------------------------
Basic and Diluted EPS $ 2,868,000 4,143,444 $ 0.69
===============================================
Note 17. 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 FHLB 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.
59
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTE TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 17. Fair Value of Financial Instruments (Continued)
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 FHLB advances and note payable 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.
The recorded book value and estimated fair value of the Company's financial
assets and liabilities at September 30, are summarized below:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------
Recorded Estimated Recorded Estimated
Book Value Fair Value Book Value Fair Value
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Assets:
Interest-earning deposits $ 2,297,000 $ 2,297,000 $ 29,905,000 $ 29,905,000
Securities held to maturity 8,932,000 8,571,000 13,340,000 13,263,000
Securities available for sale 29,108,000 29,108,000 39,158,000 39,158,000
Federal Home Loan Bank stock 1,153,000 1,153,000 1,707,000 1,707,000
Loans receivable, net 125,493,000 125,540,000 110,550,000 112,825,000
Accrued interest receivable 1,084,000 1,084,000 1,302,000 1,302,000
Financial Liabilities:
Interest-bearing deposits with
no stated maturities 27,789,000 27,789,000 28,153,000 28,153,000
Interest-bearing deposits
with stated maturities 115,045,000 115,078,000 118,681,000 119,166,000
Checks outstanding on
disbursement account 620,000 620,000 561,000 561,000
Accrued interest payable 116,000 116,000 108,000 108,000
Advance payments by borrowers
for taxes and insurance 123,000 123,000 125,000 125,000
Note payable -- -- 18,000,000 18,000,000
</TABLE>
60
<PAGE>
SOUTH STREET FINANCIAL CORP. 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 Corp. as of and for the years ended September 30, 1999 and 1998:
Condensed Balance Sheets
September 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
---------------------------------
<S> <C> <C>
Assets:
Cash $ 131,000 $ 389,000
Federal funds sold 430,000 3,010,000
Securities available for sale 1,474,000 3,092,000
Accrued interest receivable 331,000 371,000
Prepaid expenses and other assets 165,000 226,000
Investment in Home Savings Bank 24,522,000 43,270,000
---------------------------------
$ 27,053,000 $ 50,358,000
=================================
Liabilities and Stockholders' Equity:
Liabilities:
Other liabilities $ 379,000 $ 803,000
Note payable -- 18,000,000
------------------------------------
379,000 18,803,000
------------------------------------
Stockholders' Equity:
Additional paid-in capital 13,348,000 17,930,000
Unrealized gain (loss) on securities
available for sale, net of tax (519,000) 26,000
Unearned ESOP (3,672,000) (4,080,000)
Deferred management recognition plan (798,000) (1,596,000)
Unearned compensation (1,846,000) (1,990,000)
Retained earnings (20,161,000) 21,265,000
------------------------------------
26,674,000 31,555,000
------------------------------------
$ 27,053,000 $ 50,358,000
====================================
</TABLE>
Condensed Statements of Income
For the Years Ended September 30, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------------------------------
<S> <C> <C> <C>
Interest income $ 562,000 $ 1,065,000 $ 1,457,000
Interest expense -- (1,080,000) --
Equity in earnings of Home Savings Bank (50,000) 780,000 1,964,000
Net gain on sale of investments available for sale -- 4,000 --
Other expense (25,000) (30,000) (2,000)
Income tax (expense) benefit (209,000) 24,000 (551,000)
---------------------------------------------------
Net income $ 278,000 $ 763,000 $ 2,868,000
===================================================
</TABLE>
61
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 18. Parent Company Financial Data (Continued)
Condensed Statements of Cash Flows
For the Years Ended September 30, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income $ 278,000 $ 763,000 $ 2,868,000
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Gain on sale of investments available for sale -- (4,000) --
Change in assets and liabilities:
Equity in earnings of Home Savings 50,000 (780,000) (1,964,000)
(Increase) decrease in accrued interest
receivable and other assets 127,000 (471,000) (269,000)
Increase (decrease) in other liabilities (579,000) 346,000 9,000
Other -- -- (35,000)
------------------------------------------------
Net cash provided by (used in)
operating activities (124,000) (146,000) 609,000
------------------------------------------------
Cash Flows from Investing Activities:
Purchase of securities available for sale -- -- (1,5081,000)
Proceeds from sales and repayments of
securities available for sale 1,550,000 10,209,000 1,763,000
Initial investment in Home Savings Bank -- -- (19,558,000)
Upstream dividend from Home Savings Bank 19,239,000 1,173,000 826,000
------------------------------------------------
Net cash provided by (used in)
investing activities 20,789,000 11,382,000 (32,050,000)
------------------------------------------------
Cash Flows from Financing Activities:
Net proceeds from common stock received
in the Conversion -- -- 43,645,000
Proceeds from borrowings on notes payable -- 18,000,000 --
Repayments on note payable (18,000,000) -- --
Retirement of stock purchased (4,473,000) (3,021,000) --
Payment of dividends (1,438,000) (29,782,000) (1,158,000)
Loan to ESOP for purchase of common stock -- -- (4,528,000)
Principal payment received on note
receivable from ESOP 408,000 178,000 270,000
------------------------------------------------
Net cash provided by (used in)
financing activities (23,503,000) (14,625,000) 38,229,000
------------------------------------------------
Net increase (decrease) in cash
and cash equivalents (2,838,000) (3,389,000) 6,788,000
Cash and cash equivalents:
Beginning 3,399,000 6,788,000 --
------------------------------------------------
Ending $ 561,000 $ 3,399,000 $ 6,788,000
================================================
</TABLE>
(Continued)
62
<PAGE>
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 18. Parent Company Financial Data (Continued)
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------------
<S> <C> <C> <C>
Supplemental Disclosures of Cash Flow
Information
Cash payments for income taxes $ 118,000 $ 132,000 $ 541,000
Cash payments for interest 368,000 -- --
Supplemental Disclosures of Noncash Investing
and Financing
Change in unrealized gain (loss) on
securities available for sale, net 545,000 (43,000) 31,000
Change in dividends accrued (56,000) (15,000) 450,000
Adoption of management recognition plan -- 3,193,000 --
</TABLE>
Note 19. Future Reporting Requirements
The FASB has issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, which the Company has not been required to adopt as of
September 30, 1999. This Statement, which is effective for fiscal years
beginning after June 15, 2000, establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available for sale security, or a
foreign currency denominated forecasted transaction. This Statement is not
expected to have a significant impact on the Company.
The FASB has issued SFAS No. 134, Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise, an amendment of FASB Statement No. 65, which the Company has
not been required to adopt as of September 30, 1999. Statement No. 65, as
amended by FASB Statements No. 115, Accounting for Certain Investments in Debt
and Equity Securities, and No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed security as a trading
security. This Statement further amends Statement No. 65 to require that after
the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments. This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a nonmortgage banking enterprise.
This Statement is effective for fiscal years beginning after December 15, 1998,
and is not expected to have a significant impact on the Company.
63
<PAGE>
<TABLE>
<CAPTION>
CORPORATE INFORMATION
<S> <C> <C>
EXECUTIVE OFFICERS:
Carl M. Hill Christopher F. Cranford R. Ronald Swanner
President and CEO Treasurer/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 and and Sons Secretary of Home Savings
the Company and the Company
Douglas D. Stokes Joel A. Huneycutt 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>
Stock Transfer Agent
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016
Annual Meeting
The 1999 annual meeting of stockholders of
South Street Financial Corp. will be held at 4:00 p.m
on February 28, 2000 at the Company's corporate
office at 155 West South Street, Albemarle, NC.
Special Legal Counsel
Brooks, Pierce, McLendon,
Humphrey & Leonard, LLP
2000 Renaissance Plaza
230 North Elm Street
Greensboro, NC 27420
Form 10-K
A copy of Form 10-K as filed with the Securities and
Exchange Commission will be furnished without
charge to the Company's stockholders upon written
request to South Street Financial Corp., 155 West
South Street, P.O. Box 489, Albemarle, NC 28002.
Independent Auditors
McGladrey & Pullen, LLP
One Morrocroft Centre
6805 Morrison Boulevard, Suite 200
Charlotte, NC 28211
Corporate Office
155 West South Street
P.O. Box 489
Albemarle, NC 28002-0489
64
<PAGE>
Common Stock Information
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, 1999, there
were approximately 693 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 years ended September 30,
1999 and 1998.
1999 Dividends Stock Price
--------------------------------------------------
Regular Special High Low
--------------------------------------------------
First Quarter $ 0.10 $ - $ 8.625 $ 7.500
Second Quarter 0.10 - 8.000 7.438
Third Quarter 0.10 - 7.625 6.875
Fourth Quarter 0.10 - 7.563 6.594
1998 Dividends Stock Price
--------------------------------------------------
Regular Special High Low
--------------------------------------------------
First Quarter $ 0.10 $ 6.00 $ 20.000 $ 17.125
Second Quarter 0.10 - 19.000 11.750
Third Quarter 0.10 - 11.875 8.625
Fourth Quarter 0.10 - 10.250 8.250
65
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the incorporation by reference into all Registration
Statements on Form 10-K of South Street Financial Corp. of our report dated
November 10, 1999, relating to the consolidated statements of financial
condition of South Street Financial Corp. and subsidiary as of September 30,
1999 and 1998, and the related consolidated statements of income and
comprehensive income, stockholders' equity and cash flows for each of the years
in the three year period then ended, which report appears in the Company's 1999
annual report on Form 10-K.
/s/ McGLADREY & PULLEN, LLP
Charlotte, North Carolina
December 28, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> SEP-30-1999 SEP-30-1998
<PERIOD-START> OCT-01-1998 OCT-01-1997
<PERIOD-END> SEP-30-1999 SEP-30-1998
<CASH> 2,598 2,891
<INT-BEARING-DEPOSITS> 1,867 26,895
<FED-FUNDS-SOLD> 430 3,010
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 29,108 39,158
<INVESTMENTS-CARRYING> 10,085 15,047
<INVESTMENTS-MARKET> 9,724 14,970
<LOANS> 125,922 110,979
<ALLOWANCE> 429 429
<TOTAL-ASSETS> 174,545 201,945
<DEPOSITS> 144,272 148,444
<SHORT-TERM> 0 18,000
<LIABILITIES-OTHER> 3,599 3,946
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 26,674 31,555
<TOTAL-LIABILITIES-AND-EQUITY> 174,545 201,945
<INTEREST-LOAN> 9,138 9,383
<INTEREST-INVEST> 2,509 4,540
<INTEREST-OTHER> 876 1,738
<INTEREST-TOTAL> 12,523 15,661
<INTEREST-DEPOSIT> 6,944 7,303
<INTEREST-EXPENSE> 6,944 9,319
<INTEREST-INCOME-NET> 5,579 6,342
<LOAN-LOSSES> 0 0
<SECURITIES-GAINS> 3 88
<EXPENSE-OTHER> 5,022 5,620
<INCOME-PRETAX> 777 1,075
<INCOME-PRE-EXTRAORDINARY> 777 1,075
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 278 763
<EPS-BASIC> .08 .19
<EPS-DILUTED> .08 .19
<YIELD-ACTUAL> 7.26 7.36
<LOANS-NON> 175 248
<LOANS-PAST> 175 248
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 429 429
<CHARGE-OFFS> 0 1
<RECOVERIES> 0 1
<ALLOWANCE-CLOSE> 429 429
<ALLOWANCE-DOMESTIC> 199 210
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 230 219
</TABLE>
