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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1998
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Commission file number 000-21701
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CAROLINA FINCORP, INC.
(Name of small business issuer in its charter)
NORTH CAROLINA 56-1978449
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
115 SOUTH LAWRENCE STREET
ROCKINGHAM, NORTH CAROLINA 27380-1597
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(Address of principal executive offices) (Zip Code)
(910) 997-6245
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(Issuer's telephone number)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, NO PAR VALUE NASDAQ SMALLCAP MARKET
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(Title of class) (Name of each exchange on which registered)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
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Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year $9,252,098
State the aggregate market value of the voting stock held by non-affiliates
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 the past 60
days.
Common Stock, no par value -- $13,626,856 (based on the price at which the stock
was sold on September 11, 1998).
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Common Stock, no par value 1,905,545
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(Class) (Outstanding at September 11, 1998)
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended June 30, 1998
(the "1998 Annual Report"), are incorporated by reference into Part I and Part
II.
Portions of the Proxy Statement for the Annual Meeting of Stockholders to be
held on November 18, 1998 (the "Proxy Statement"), are incorporated by reference
into Part III.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE): Yes No X
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Prior to November 22, 1996, Richmond Savings, Inc., SSB (the "Bank")
operated as a mutual North Carolina-chartered savings bank. On November 22,
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 Carolina Fincorp, Inc., a North Carolina corporation (the
"Company"), which was organized to become the Bank's holding company and
incorporated on June 5, 1996. At that time, the Company had an initial public
offering of its common stock, no par value (the "Common Stock").
The Company is a bank holding company registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve") under the Bank
Holding Company Act of 1956, as amended (the "BHCA") and the savings bank
holding company laws of North Carolina. The Company's and the Bank's principal
office is located at 115 South Lawrence Street, Rockingham, North Carolina. The
Company's activities consist of holding the indebtedness outstanding from the
Richmond Savings Bank, Inc., SSB Employee Stock Ownership Plan (the "ESOP"),
investing any remaining proceeds of the Conversion which were retained at the
holding company level, and owning the Bank. The Company's principal sources of
income are interest payments received from the ESOP with respect to the ESOP
loan, earnings on capital retained by the Company, and dividends paid by the
Bank to the Company, if any.
The Bank was organized in 1906, and has been a member of the Federal Home
Loan Bank (the "FHLB") system and its deposits have been federally insured since
1957. The deposits of the Bank are insured by the Savings Association Insurance
Fund (the "SAIF") of the Federal Deposit Insurance Corporation (the "FDIC") to
the maximum amount permitted by law.
The Bank conducts business through two full service offices in Rockingham
and full services offices in Southern Pines and Ellerbe, North Carolina. In
addition, the Bank has a loan origination office in Laurinburg, North Carolina
which is intends to expand into a full service office in September, 1998. The
Bank's primary market area consists of Richmond, Moore and Scotland counties in
North Carolina. At June 30, 1998, the Company had total assets of $113.9
million, net loans of $83.6 million, deposits of $93.4 million, investment
securities of $18.1 million and stockholders' equity of $15.4 million.
At June 30, 1998, the Company and the Bank had a total of 41 full-time
employees and 3 part-time employees.
The Company has no operations and conducts no business of its own other
than owning the Bank, lending funds to the ESOP, and investing its portion of
the net proceeds received in the Conversion. Accordingly, the discussion of the
business which follows in this Form 10-KSB concerns the business conducted by
the Bank, unless otherwise indicated.
LENDING ACTIVITIES
The Bank is engaged primarily in the business of attracting deposits from
the general public and using such deposits to make mortgage loans secured by
real estate. The Bank's primary source of revenue is interest 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 home equity loans and loans secured by
multi-family and commercial properties, construction loans, home improvement
loans, savings accounts loans and various types of consumer loans. Over 91% of
the Bank's loan portfolio, before net items, is secured by real estate. On June
30, 1998, the Bank's largest single outstanding loan had a balance of
approximately $1.4 million. This loan
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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. Adjustable rate loans are generally originated with the
intention that they be held in the Bank's portfolio. Fixed rate one-to-four
family residential loans are generally originated in conformity with secondary
market purchase requirements and sold in the secondary market. During fiscal
1998, 1997 and 1996, the Bank sold $6.4 million, $1.0 million, and $1.4 million,
respectively, of fixed rate loans in order to better manage its interest rate
risk.
The Bank's net loan portfolio totaled approximately $83.6 million at June
30, 1998 representing 73.4% of the Bank's total assets at such date. At June
30, 1998, 73.7% of the Bank's loan portfolio, before net items, was composed of
one-to-four family residential mortgage loans. Home equity and home improvement
loans represented 10.7% of the Bank's loan portfolio, before net items, and
multi-family residential and commercial and construction loans represented 15.1%
of the Bank's loan portfolio, before net items, on such date. As of June 30,
1998, 76.3% of the loans in the Bank's loan portfolio had adjustable interest
rates. Loans maturing or repricing on or after June 30, 1999, consist of fixed
rate real estate loans of $12.6 million, adjustable rate real estate loans of
$32.3 million, other fixed rate loans of $6.3 million and other adjustable rate
loans of $434,000. See Note C - Loans Receivable to the Financial Statements
Contained in the 1998 Annual Report.
INVESTMENT SECURITIES
Interest and dividend income from other investment securities provide the
second largest source of income to the Bank after distribution from the Bank.
Interest and dividend income from investment securities also generally provide
the second largest source of income to the Company after interest on loans. In
addition, the Company and the Bank receive interest income from deposits in
other financial institutions. At June 30, 1998, the Company and Bank's
investment securities portfolio totaled approximately $24.5 million and
consisted of U.S. government and agency securities, mortgage-backed securities,
municipal bonds, interest-earning deposits in other financial institutions,
stock of the FHLB of Atlanta, and investments in corporate debt securities of a
large financial institution and IBM corporation.
Investments in mortgage-backed securities involve a risk that, because of
changes in the interest rate environment, actual prepayments will 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. See Note B - Investment Securities to
the Financial Statements Contained in the 1998 Annual Report.
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 June 30, 1998, the Bank's investment in stock of the FHLB of Atlanta was
$735,000.
North Carolina regulations require the Bank to maintain a minimum amount of
liquid assets which may be invested in specified short-term securities. See "--
Regulation of the Bank - Liquidity." The Bank is also permitted to make certain
other securities investments.
DEPOSITS AND BORROWINGS
DEPOSITS. Deposits are the primary source of the Bank's funds for lending
and other investment purposes. The Bank attracts both short-term and long-term
deposits from the general public by offering a variety of accounts and rates.
The Bank offers passbook savings accounts, statement savings accounts,
negotiable order of withdrawal accounts, individual retirement accounts, and
fixed rate certificates with varying maturities. At June 30, 1998, 12.8% of the
Bank's deposits consisted of passbook and statement savings accounts, 11.6%
consisted of interest-bearing transaction accounts and 3.2% consisted of
noninterest-bearing transaction accounts. Although the vast majority of the
Bank's deposits are authentic deposit accounts, management of the Bank believes
that it has been successful in maintaining a
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high percentage of demand deposit and transaction accounts which are generally
considered to be less interest rate sensitive than certificated accounts. This
is consistent with the Bank's asset/liability management strategies. 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 and direct mailings. The Bank does not advertise for deposits
outside of its local market area or utilize the services of deposit brokers. See
Note G - Deposit Accounts to the Financial Statements contained in the 1998
Annual Report.
In addition to deposits, the Bank derives funds from loan principal
repayments, interest payments, investment income and principal repayments,
interest from its own interest-earning deposits, interest income and repayments
from mortgage-backed securities and otherwise from its operations. Loan
repayments are a relatively stable source of funds while deposit inflows and
outflows may be significantly influenced by general interest rates and money
market conditions.
BORROWINGS. 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. Although it has not
done so in several years, the Bank may obtain advances from the FHLB of Atlanta
to supplement its liquidity needs. 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. As of June 30, 1998, the Bank had no
outstanding advances from the FHLB of Atlanta. However, as of June 30, 1998, in
order to pay the return of capital dividend to its shareholders, the Company had
outstanding to another financial institution a note payable in the principal
amount of $3,200,000, which was repaid on July 3, 1998. See Note F - Advances
from Federal Home Loan Bank and Other Borrowed Funds contained in the 1998
Annual Report.
RESULTS OF OPERATIONS
The Bank's results of operations are dependent primarily on net interest
income, which is the difference between the income earned on its interest-
earning assets, such as loans and investments, and the cost of its interest-
bearing liabilities, consisting of deposits. The Bank's operations are affected
to a much lesser degree by non-interest income, such as transaction and other
service fee income, and other sources of income. The Bank's net income is also
affected by, among other things, provisions for loan losses and operating
expenses. The Bank's principal operating expenses, aside from interest
expense, consist of compensation and employee benefits, office occupancy costs,
data processing expenses and federal deposit insurance premiums. The Bank's
results of operations are also significantly affected by general economic and
competitive conditions, particularly changes in market interest rates,
government legislation and policies concerning monetary and fiscal affairs,
housing and financial institutions and the attendant actions of regulatory
authorities.
MARKET AREA
The Bank's primary market area consists of Richmond, Moore and Scotland
Counties in North Carolina. Richmond County, which contains Rockingham, is
located in south central North Carolina near the North Carolina-South Carolina
boundary, and is the home of the North Carolina Motor Speedway, location of two
Winston-Cup stock car races annually. Moore County, which is immediately north
of Richmond County, is the home of several retirement communities and golf
resorts, including Pinehurst and Southern Pines. Scotland County, which
includes Laurinburg, is located east of Richmond County. Richmond and Scotland
Counties have experienced relatively slow growth during the last five (5) years.
Moore County, which includes the resort and retirement communities of Pinehurst
and Southern Pines, has experienced greater growth. The economy of the Bank's
primary market area is largely rural, with
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employment diversified among manufacturing, agricultural, retail and wholesale
trade, government, services and utilities. Major area employers include UCO
Fabrics, Burlington Industries, Sara Lee Hosiery, Perdue Farms, Inc., Richmond
Memorial Hospital, Firsthealth Moore Regional Hospital, Gullistan Carpets,
Resorts of Pinehurst, Campbell Soup Company, WestPoint Stevens and Abbott
Laboratories.
SUBSIDIARIES
The Bank is the only subsidiary of the Company. As a North Carolina
chartered savings bank, the Bank is able to invest up to 10% of its total assets
in subsidiary service corporations. However, any investment in service
corporation which would cause the Bank to exceed an investment of 3% of assets
must receive prior approval of the FDIC.
The Bank has one wholly-owned subsidiary, Richmond Investment Services,
Inc., a North Carolina corporation ("R.I.S."). R.I.S. acts as an agent in the
sale of annuities, Medicare and Medicaid supplements, and major medical and life
insurance policies, and it provides certain investment brokerage services
through UVEST Investment Services. In addition, R.I.S. owns certain real
property. Regulations of the Administrator and FDIC place limitations upon the
activities of subsidiaries of North Carolina-chartered savings banks. The total
assets of R.I.S. at June 30, 1998 were $208,000 , and the net income for that
subsidiary for the year ended June 30, 1998 was $25,000.
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 governmental
securities. 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 its
charges, the efficiency and quality of service 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.
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 statute 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 savings 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
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voting stock or substantially all of the assets of any bank or savings bank or
merging or consolidating with another bank holding company or savings bank
holding company without prior approval of the Federal Reserve.
Additionally, the BHCA prohibits the Company from engaging in, or acquiring
ownership or control of, more than 5% of the outstanding voting stock of any
company engaged in a nonbanking business unless such business is determined by
the Federal Reserve to be so closely related to banking as to be properly
incident thereto.
Similarly, Federal Reserve approval (or, in certain cases, non-disapproval)
must be obtained prior to any person acquiring control of the Company. Control
is conclusively presumed to exist if, among other things, a person acquires more
than 25% of any class of voting stock of the holding company or controls in any
manner the election of a majority of the directors of the holding company.
Control is presumed to exist if a person acquires more than 10% of any class of
voting stock and the stock is registered under Section 12 of the Exchange Act or
the acquiror will be the largest shareholder after the acquisition.
There are a number of obligations and restrictions imposed on bank holding
companies and their depository institution subsidiaries by law and regulatory
policy that are designed to minimize potential loss to the depositors of such
depository institutions and the FDIC insurance funds in the event the depository
institution becomes in danger of default or in default. For example, to avoid
receivership of an insured depository institution subsidiary, a bank holding
company is required to guarantee the compliance of any insured depository
institution subsidiary that may become "undercapitalized" with the terms of any
capital restoration plan filed by such subsidiary with its appropriate federal
banking agency up to the lesser of (i) an amount equal to 5% of the
institution's total assets at the time the institution became undercapitalized
or (ii) the amount which is necessary (or would have been necessary) to bring
the institution into compliance with all acceptable capital standards as of the
time the institution fails to comply with such capital restoration plan. Under
a policy of the Federal Reserve with respect to bank holding company operations,
a bank holding company is required to serve as a source of financial strength to
its subsidiary depository institutions and to commit resources to support such
institutions in circumstances where it might not do so absent such policy. The
Federal Reserve under the BHCA also has the authority to require a bank holding
company to terminate any activity or to relinquish control of a nonbank
subsidiary (other than a nonbank subsidiary of a bank) upon the Federal
Reserve's determination that such activity or control constitutes a serious risk
to the financial soundness and stability of any bank subsidiary of the bank
holding company.
In addition, insured depository institutions under common control are
required to reimburse the FDIC for any loss suffered by either 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 ten
percent of its net worth during a rolling twelve month period. As a result of
the Company's ownership of the Bank, the Company is 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.
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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 Securities Exchange Act of 1934 (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.
REGULATION OF THE BANK
GENERAL. Federal and state legislation and regulation significantly affect
the operations of federally insured savings institutions and other federally
regulated financial institutions. The operations of regulated depository
institutions, including the Bank, is subject to changes in applicable statutes
and regulations from time to time. Such changes may or may not be favorable to
the Bank.
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
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practices; (iii) existence of an unsafe or unsound condition to transact
business; (iv) likelihood that the savings bank will be unable to meet the
demands of its depositors or to pay its obligations in the normal course of
business; and (v) insufficient capital or the incurring or likely incurring of
losses that will deplete substantially all of the institution's capital with no
reasonable prospect of replenishment of capital without federal assistance.
TRANSACTIONS WITH AFFILIATES. Under current federal law, transactions
between the Bank and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of the Bank is any company or entity that
controls, is controlled by or is under common control with the savings bank.
Generally, subsidiaries of a bank, other than a bank subsidiary, and certain
other types of companies are not considered to be affiliates. Generally,
Sections 23A and 23B (i) limit the extent to which the Bank or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal
to 10% of such the Bank's capital stock and surplus, and contain an aggregate
limit on all such transactions with all affiliates to an amount equal to 20% of
such capital stock and surplus and (ii) require that all such transactions be on
terms substantially the same, or at least as favorable, to the Bank or the
subsidiary as those provided to a nonaffiliate. The term "covered transaction"
includes the making of loans or other extensions of credit to an affiliate, the
purchase of assets from an affiliate, the purchase of, or an investment in, the
securities of an affiliate, the acceptance of securities of an affiliate as
collateral for a loan or extension of credit to any person, or issuance of a
guarantee, acceptance or letter of credit on behalf of an affiliate.
Further, current federal law has extended to savings banks the restrictions
contained in Section 22(h) of the Federal Reserve Act and its implementing
regulations with respect to loans to directors, executive officers and principal
stockholders. Under Section 22(h), loans to directors, executive officers and
stockholders who own more than 10% 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 and all loans to such
persons may not exceed the institution's unimpaired capital and unimpaired
surplus. Section 22(h) also prohibits loans above amounts prescribed by the
appropriate federal banking agency to directors, executive officers and
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. Recently enacted legislation provided for a one-time assessment of 65.7
basis points
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of insured deposits as of March 31, 1995, that fully capitalized the SAIF and
had the effect of reducing future SAIF assessments. Accordingly, although the
special assessment resulted in a one-time charge to the Bank of approximately
$519,000 pre-tax, the recapitalization of the SAIF had the effect of reducing
the Bank's future deposit insurance premiums to the SAIF. Under the recently
enacted legislation, both BIF and SAIF members will be assessed an amount for
the Financing Corporation Bond payments. BIF members will be assessed
approximately 1.3 basis points while the SAIF rate will be approximately 6.4
basis points until January 1, 2000. At that time, BIF and SAIF members will
begin pro rata sharing of the payment at an expected rate of 2.43 basis points.
COMMUNITY REINVESTMENT ACT. The Bank, like other financial institutions, is
subject to the Community Reinvestment Act, as amended ("CRA"). A purpose of this
Act is to encourage financial institutions to help meet the credit needs of its
entire community, including the needs of low- and moderate-income neighborhoods.
During the Bank's last compliance examination the Bank received a "satisfactory"
rating with respect to CRA compliance. The Bank's rating with respect to CRA
compliance would be a factor to be considered by the Federal Reserve and FDIC in
considering applications submitted by the Bank to acquire branches or to acquire
or combine with other financial institutions and take other actions and could
result in the denial of such applications.
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 June 30, 1998,
the Bank had a leverage ratio of 16.0%.
The Administrator requires that net worth equal at least 5% of total
assets. Intangible assets must be deducted from net worth and assets when
computing compliance with this requirement.
At June 30, 1998, the Bank complied with each of the capital requirements
of the FDIC and the Administrator.
8
<PAGE>
Each federal banking agency is required to establish risk-based capital
standards that take adequate account of interest rate risk, concentration of
credit risk, and the risk of nontraditional activities, as well as reflect the
actual performance and expected risk of loss on multifamily mortgages.
On August 2, 1995, the federal banking agencies issued a joint notice of
adoption of final risk based capital rules to take account of interest rate
risk. The final regulation required an assessment of the need for additional
capital on a case-by-case basis, considering both the level of measured exposure
and qualitative risk factors. The final rule also stated an intent to, in the
future, establish an explicit minimum capital charge for interest rate risk
based on the level of a bank's measured interest rate risk exposure.
Effective June 26, 1996, the federal banking agencies issued a joint policy
statement announcing the agencies' election not to adopt a standardized measure
and explicit capital charge for interest rate risk at that time. Rather, the
policy statement (i) identifies the main elements of sound interest rate risk
management, (ii) describes prudent principles and practices for each of those
elements, and (iii) describes the critical factors affecting the agencies'
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 June 30, 1998, the largest aggregate amount of loans which the Bank
had to any one borrower was $1.4 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 June 30, 1998, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of $735,000.
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 June 30, 1998, the Bank was in
compliance with the applicable reserve requirements of the Federal Reserve.
9
<PAGE>
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 value, including investments with maturities in excess
of five years. On June 30, 1998, the Bank's liquidity ratio, calculated in
accordance with North Carolina regulations, was approximately 21.7%.
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%.
10
<PAGE>
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.
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 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.
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.
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
11
<PAGE>
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.
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. DESCRIPTION OF PROPERTY
The following table sets forth the location of the Bank's headquarters in
Rockingham, North Carolina, its three full-service branch offices, its loan
origination office, and one vacant lot owned by the Bank as well as certain
other information relating to these offices and vacant lots as of June 30, 1998:
12
<PAGE>
<TABLE>
<CAPTION>
Net Book Value
of Property and
Improvements Own or Lease Lease Expiration Date
--------------- ------------ ---------------------
<S> <C> <C> <C>
Headquarters Office:
115 South Lawrence Street
Rockingham, NC $227,536 Owned N/A
*Full-Service Branch Offices:
Rockingham Road Office
1222 Rockingham Road
Rockingham, NC $492,575 Owned N/A
Southern Pines Office
495 Pinehurst Avenue
Southern Pines, NC $703,788 Owned N/A
Ellerbe Office
115 West Sunset Avenue
Ellerbe, NC $335,945 Owned N/A
*Loan Origination Office:
800-C Atkinson Street
Laurinburg, NC - Leased Month to Month basis
Vacant Lot:
**Corner of Highway 5 and
Trotter Drive
Pinehurst, NC $207,097 Owned N/A
**410 South Main Street
Laurinburg, NC $ 89,466 Owned N/A
</TABLE>
*On August 1, 1998, the month to month lease for the Laurinburg Office at 800-E
Atkinson Street was terminated, and the loan origination office was moved to a
leased facility 103 McRay Street, Laurinburg, North Carolina. The Bank intends
to expand the McRay Street location to a full-service branch office in late
September, 1998.
**The Laurinburg lot is owned by Richmond Investment Services, Inc., a wholly
owned subsidiary of the Bank, and it may be purchased by the Bank in the future.
Both the Pinehurst and Laurinburg lots may be branch locations in the future.
The Bank's management considers each of these properties 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 at June 30,
1998 was $316,574. 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 in an effort to recover its
investment. As of June 30, 1998, the Bank owned no real estate acquired in
settlement of loans.
13
<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 litigation that is
incidental to the 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 June 30, 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
See the information under the section captioned "Common Stock Information"
on page 42 of the Company's 1998 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. MANAGEMENT'S DISCUSSION AND ANALYSIS
See the information set forth under ITEM 1 above and the information set
forth under the section captioned "Management's Discussion and Analysis" on
pages 3 through 13 in the Company's 1998 Annual Report, which section is
incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of the Company set forth on pages 15
through 41 in the Company's 1998 Annual Report are incorporated herein by
reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
N/A.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH 16(A) OF THE EXCHANGE ACT
The information required by this Item regarding directors and executive
officers of the Company is set forth under the sections captioned "Proposal 1 -
Election of Directors" beginning on page 7 of the Proxy Statement and "Executive
Officers" beginning on page 10 of the Proxy Statement, which sections are
incorporated herein by reference.
The information required by this Item regarding compliance with
Section 16(a) of the Securities Exchange Act of 1934 is set forth under the
section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" set
forth on page 7 of the Proxy Statement, which is incorporated herein by
reference.
14
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the sections
captioned "Proposal 1 - Election of Directors - Directors Compensation" on pages
9 and 10 and "- Executive Compensation" on pages 10 through 15 of the Proxy
Statement, which sections are incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from the
section captioned "Security Ownership of Certain Beneficial Owners" on pages 4
through 6 of the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See also the section captioned "Certain Indebtedness and Transactions of
Management" on page 16 of the Proxy Statement, which section is incorporated
herein by reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
(3)(i) Articles of Incorporation, incorporated herein by reference to
Exhibit 3.1 to the Registration Statement on Form S-1,
Registration No. 333-6855, dated July 26, 1996 and amended on
September 10, 1996.
(3)(ii) Bylaws, incorporated herein by reference to Exhibit 3.2 to the
Registration Statement on Form S-1, Registration No. 333-6855,
dated July 26, 1996 and amended on September 10, 1996.
(4) Specimen Stock Certificate incorporated herein by reference to
Exhibit 4.1 to the Registration Statement on Form S-1,
Registration No. 333-6855, dated July 26, 1996 and amended on
September 10, 1996.
10(a) Employment Agreement with R. Larry Campbell incorporated herein
by reference to Exhibit 10(a) to the Annual Report on Form 10-KSB
for the 1997 fiscal year end.
10(b) Employment Agreement with John W. Bullard incorporated herein by
reference to Exhibit 10(b) to the Annual Report on Form 10-KSB
for the 1997 fiscal year end.
10(c) Nonqualified Supplemental Retirement Plan with R. Larry Campbell
incorporated herein by reference to Exhibit 10(c) to the Annual
Report on Form 10-KSB for the 1997 fiscal year end.
10(d) Nonqualified Supplemental Retirement Plan with John W. Bullard
incorporated herein by reference to Exhibit 10(d) to the Annual
Report on Form 10-KSB for the 1997 fiscal year end.
(11) Statement Regarding Computation of Per Share Earnings
(13) Portions of 1998 Annual Report to Stockholders
15
<PAGE>
(21) See ITEM 1. - "DESCRIPTION OF BUSINESS --Subsidiaries." for
discussion of subsidiaries
(27) Financial Data Schedule
REPORTS ON FORM 8-K
The Company filed no reports on Form 8-K during the last quarter of the
fiscal year ended June 30, 1998. There have been no reportable transactions
during the two most recent fiscal years nor are there any reportable
transactions proposed as of the date of this Form 10-KSB.
16
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CAROLINA FINCORP, INC.
Date: September 23, 1998 By: /s/ R. Larry Campbell
------------------------------------------
R. Larry Campbell
President and Chief Executive Officer
In accordance with the Exchange Act, 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/ R. Larry Campbell President, Chief Executive September 23, 1998
- ------------------------------ Officer and Director
R. Larry Campbell
/s/ John W. Bullard Executive Vice-President September 23, 1998
- ------------------------------ and Chief Operations Officer
John W. Bullard
/s/ Winston G. Dwyer Treasurer and Chief Financial September 23, 1998
- ------------------------------ Officer
Winston G. Dwyer
/s/ J. Stanley Vetter Chairman of the Board of September 23 1998
- ------------------------------ Directors
J. Stanley Vetter
/s/ John T. Page, Jr. Vice Chairman of the September 23, 1998
- ------------------------------ Board of Directors
John T. Page, Jr.
/s/ Russell E. Bennett, Jr. Director September 23 1998
- ------------------------------
Russell E. Bennett, Jr.
/s/ Buena Vista Coggin Director September 23 1998
- ------------------------------
Buena Vista Coggin
/s/ Joe M. McLaurin Director September 23 1998
- ------------------------------
Joe M. McLaurin
/s/ W. Jesse Spencer Director September 23, 1998
- ------------------------------
W. Jesse Spencer
/s/ E.E. Vuncannon, Jr. Director September 23, 1998
- ------------------------------
E.E. Vuncannon, Jr.
</TABLE>
17
<PAGE>
1998 ANNUAL REPORT TO SECURITY HOLDERS
The 1998 Annual Report to Security Holders which is Exhibit (13) to this
Form 10-KSB is separately bound.
<PAGE>
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
Net income per common share of $0.61 for the year ended June 30, 1998 was
calculated by dividing net income of $1,069,480 for the year ended June 30, 1998
by the weighted average number of common shares outstanding of 1,763,678. Net
income per common share of $0.46 for the year ended June 30, 1997 was calculated
by dividing net income of $831,586 for the year ended June 30, 1997 by the
weighted average number of common shares outstanding of 1,790,311. Because the
conversion was not effective until November 22, 1996, earnings per share data
for the year ended June 30, 1997 is comprised of the earnings for the post-
Conversion period. The number of shares purchased by the ESOP which have not
been allocated or committed to be released to participant accounts are not
assumed to be outstanding in calculating the weighted average number of common
shares outstanding.
<PAGE>
CAROLINA FINCORP, INC.
1998 ANNUAL REPORT
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
Page No.
--------
Report to Shareholders.......................................... 1
Selected Financial and Other Data............................... 2
Management's Discussion and Analysis............................ 3
Independent Auditors' Report.................................... 13
Consolidated Financial Statements
Consolidated Statements of Financial Condition................. 15
Consolidated Statements of Operations.......................... 16
Consolidated Statements of Stockholders' Equity................ 17
Consolidated Statements of Cash Flows.......................... 18
Notes to Consolidated Financial Statements..................... 20
Corporate Information........................................... 42
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 Carolina Fincorp, Inc. and its wholly-owned
subsidiaries 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 national, regional and local market conditions,
legislative and regulatory conditions, and the interest rate environment.
<PAGE>
REPORT TO SHAREHOLDERS
Dear Shareholders:
The Board of Directors and Management are pleased to present the second annual
report of Carolina Fincorp, Inc. (the "Company") to our Shareholders, marking
another year of continued progress for the Company and its subsidiary, Richmond
Savings Bank, Inc., SSB (the "Bank").
The Company paid a total of $11.9 million in dividends to its shareholders
during the year, consisting of $.24 per share in quarterly dividends and a one
time special (return of capital) dividend of $6.00 per share. In keeping with
the Board of Directors' commitment to enhance shareholder value, a decision to
pay the return of capital dividend was reached after analyzing other investment
alternatives and recommendations of the Company's financial advisors.
The Company's stock, which trades on the National Stock Exchange (NASDAQ) under
the symbol "CFNC," closed on June 30, 1998 at $10.50 per share. This represents
a 162.5% increase in market value to initial investors since the initial public
offering on November 25, 1996 (each share having a $4.00 cost basis from the
$10.00 initial offering price after the $6.00 return of capital in June 1998).
To implement the Company's expansion strategy, action was initiated during the
year to convert the Bank's loan production office in Laurinburg, North Carolina
to a full service branch office. Regulatory authority has been received, new
office space leased, and we anticipate opening the new branch office for
business in late September 1998. The Bank has purchased land in Pinehurst, North
Carolina for possible future expansion of our branch operations in Moore County.
Consumer and small business products and services were expanded and enhanced
with the implementation of MasterCard/VISA Merchants Processing program and
development of Debit Card and Telephone Banking programs which we intend to
place in service in October 1998. Richmond Investment Services, Inc., a wholly
owned subsidiary of the Bank, has executed agreements with UVEST and has on
staff a licensed stockbroker, along with an independent agent, to market and
sell nonbank investment products and services such as mutual funds, fixed and
variable annuities, life insurance, etc. to our customers and the general
public.
The Company has adopted an aggressive business and strategic plan for the next
fiscal year which the Board of Directors currently expects will continue to
produce growth and improve earnings as well as franchise and shareholder values.
We look forward to the future challenges and opportunities facing our industry.
We would like to thank our customers and shareholders for their support and the
Company's staff for their hard work and dedication.
Sincerely,
/s/ R. Larry Campbell
R. Larry Campbell
President and Chief Executive Officer
-1-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
SELECTED FINANCIAL AND OTHER DATA
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
At or for the Year Ended June 30,
--------------------------------------------------------
1998 1997 1996 1995 1994
---------- ------------ ---------- -------- --------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Financial Condition Data:
Total assets $113,911 $111,503 $ 94,110 $91,410 $87,504
Investments/(1)/ 24,511 27,259 21,782 18,540 16,034
Loans receivable, net 83,623 78,674 68,358 68,745 67,680
Deposits 93,415 83,760 83,715 81,437 78,315
Stockholders' equity 15,388 25,448 8,641 8,128 7,414
Book value per common share 8.08 13.74 - - -
Operating Data:
Interest income $ 8,628 $ 7,645 $ 6,836 $ 6,378 $ 6,128
Interest expense 4,122 3,887 3,949 3,271 2,934
-------- -------- --------- ------- -------
Net interest income 4,506 3,758 2,887 3,107 3,194
Provision for loan losses 92 70 36 36 36
-------- -------- --------- ------- -------
Net interest income after provision
for loan losses 4,414 3,688 2,851 3,071 3,158
Non-interest income 624 561 532 430 586
Non-interest expense 3,385 3,094 2,493 2,452 2,392
-------- -------- --------- ------- -------
Income before income taxes 1,653 1,155 890 1,049 1,352
Income tax expense 584 402 299 329 492
-------- -------- --------- ------- -------
Net income $ 1,069 $ 753 $ 591 $ 720 $ 860
======== ======== ========= ======= =======
Per Common Share Data:
Net income, basic/(2),(3)/ $ 0.61 $ 0.46/(3)/ - - -
Net income, diluted 0.61 - - - -
Regular cash dividends 0.24 0.05 - - -
Dividend payment ratio/(4)/ 39.58% 10.87% - - -
Special return of capital dividend $ 6.00 - - - -
Selected Other Data:
Return on average assets 0.93% 0.72% 0.64% 0.81% 0.98%
Return on average equity 4.24% 3.93% 7.01% 9.30% 12.27%
Average equity to average assets 21.84% 18.43% 9.12% 8.71% 7.98%
Interest rate spread 3.23% 3.01% 2.77% 3.24% 3.48%
Net yield on average interest-earning assets 4.12% 3.78% 3.26% 3.64% 3.79%
Average interest-earning assets to average
interest-bearing liabilities 123.79% 119.76% 110.90% 110.33% 108.93%
Ratio of non-interest expense to average total
assets 2.93% 2.98% 2.70% 2.76% 2.72%
Nonperforming assets to total assets 0.13% 0.18% 0.06% 0.08% 0.13%
Nonperforming loans to total loans 0.15% 0.26% 0.04% 0.11% 0.17%
Allowance for loan losses to total loans 0.51% 0.52% 0.57% 0.53% 0.47%
Allowance for loan losses to nonperforming loans 352.42% 194.17% 1,296.67% 484.00% 282.14%
</TABLE>
/(1)/Includes interest-bearing deposits, federal funds sold, FHLB stock and
investment securities.
/(2)/On November 22, 1996, Richmond Savings Bank, Inc., SSB converted from a
state-chartered mutual savings bank to a state-chartered stock savings bank
and became a wholly-owned subsidiary of Carolina Fincorp, Inc.
/(3)/Earnings per share is based on unaudited earnings from November 22, 1996 to
June 30, 1997 divided by the weighted average number of shares outstanding
during the same period.
/(4)/The dividend payment ratio represents regular cash dividends per share as a
percentage of earnings per share and excludes the special nonrecurring
$6.00 return of capital dividend during the year ended June 30, 1998.
-2-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Management's discussion and analysis is intended to assist readers in the
understanding and evaluation of the financial condition and results of
operations of Carolina Fincorp, Inc. and Subsidiaries. It should be read in
conjunction with the audited consolidated financial statements and accompanying
notes included in this report and the supplemental financial data appearing
throughout this discussion and analysis.
DESCRIPTION OF BUSINESS
Carolina Fincorp, Inc. ("Carolina" or "Parent") was incorporated under the laws
of the State of North Carolina for the purpose of becoming the bank holding
company of Richmond Savings Bank, Inc., SSB (the "Bank" or "Richmond Savings")
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. Carolina was organized to acquire all of the common stock of
Richmond Savings upon its conversion to stock form. A subscription and community
offering (the "Offering") of Carolina's common stock closed on November 22,
1996, at which time Carolina acquired all of the outstanding common stock of the
Bank and commenced operations.
In accordance with the Plan of Conversion, Carolina issued common stock with a
value of $18.5 million in the Offering and received proceeds of $17.6 million,
net of Conversion costs. Carolina transferred a portion of the net proceeds to
Richmond Savings for the purchase of all of the outstanding common stock of the
Bank.
Carolina has no operations and conducts no business of its own other than owning
Richmond Savings, investing its portion of the net proceeds received in the
Conversion, and lending funds to the Richmond Savings Bank, Inc., SSB 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 located in the Bank's primary market area of Richmond,
Moore and Scotland counties in North Carolina. On June 30, 1998, approximately
91% of the Bank's net loan portfolio was composed of real estate loans.
Carolina's principal sources of income have been capital retained by Carolina,
interest earned from the loan to the ESOP, and dividends paid by the Bank to
Carolina. Revenues of Richmond Savings are derived primarily from interest on
loans. Richmond Savings also receives interest income from its investment
securities and interest-earning deposit balances and various types of non-
interest income. The major expenses of Richmond Savings are interest on deposits
and general and administrative expenses such as salaries, employee benefits,
federal deposit insurance premiums, data processing and occupancy and related
expenses.
Richmond Investment Services, Inc. is a wholly-owned subsidiary of Richmond
Savings whose principal business activity is that of an agent for various
insurance products and non-bank investment products and services.
Carolina and its subsidiaries are collectively referred to herein as the
"Company."
-3-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
- --------------------------------------------------------------------------------
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk primarily stems from interest rate risk, the potential
economic loss due to future changes in interest rates, which is inherent in
lending and deposit gathering activities. The Company's objective is to manage
the mix of interest-sensitive assets and liabilities to moderate interest rate
risk and stabilize the net interest margin while enhancing profitability.
ASSET/LIABILITY AND INTEREST RATE RISK MANAGEMENT
The Company's asset/liability management, or interest rate risk management,
program is focused primarily on evaluating and managing the composition of its
assets and liabilities in view of various interest rate scenarios. Factors
beyond the Company's control, such as market interest rates and competition, may
also have an impact on the Company's interest income and interest expense.
In the absence of other factors, the yield or return associated with the
Company's earning assets generally will increase from existing levels when
interest rates rise over an extended period of time, and, conversely, interest
income will decrease when interest rates decrease. In general, interest expense
will increase when interest rates rise over an extended period of time, and,
conversely, interest expense will decrease when interest rates decrease.
INTEREST RATE GAP ANALYSIS. As a part of its interest rate risk management
policy, the Company calculates an interest rate "gap." Interest rate "gap"
analysis is a common, though imperfect, measure of interest rate risk, which
measures the relative dollar amounts of interest-earning assets and interest-
bearing liabilities which reprice within a specific time period, either through
maturity or rate adjustment. The "gap" is the difference between the amounts of
such assets and liabilities that are subject to repricing. A "negative" gap for
a given period means that the amount of interest-bearing liabilities maturing or
otherwise repricing within that period exceeds the amount of interest-earning
assets maturing or otherwise repricing within the same period. Accordingly, in a
declining interest rate environment, an institution with a negative gap would
generally be expected, absent the effects of other factors, to experience a
smaller decrease in the yield of its assets relative to the decrease in the cost
of its liabilities, and, as a result, its income should be positively affected.
Conversely, the cost of funds for an institution with a negative gap would
generally be expected to increase more quickly than the yield on its assets in a
rising interest rate environment, and, as a result, such institution's net
interest income would generally be expected to be adversely affected by rising
interest rates. Changes in interest rates generally have the opposite effect on
an institution with a "positive gap."
The Company's one-year interest sensitivity gap as a percentage of total
interest-earning assets at June 30, 1998 was negative 30.74%. At June 30, 1998,
the Company's three-year and five-year cumulative interest sensitivity gaps as a
percentage of total interest-earning assets were negative 24.29% and negative
6.86%, respectively.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1998 which are projected to
reprice or mature in each of the future time periods shown. Except as stated
below, the amounts of assets and liabilities shown which reprice or mature
within a particular period were determined in accordance with the contractual
terms of the assets or liabilities. Loans with adjustable rates are shown as
being due at the end of the next upcoming adjustment period. Passbook accounts,
money market deposit accounts and negotiable order of
-4-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
- --------------------------------------------------------------------------------
withdrawal or other transaction accounts are assumed to be subject to immediate
repricing and depositor availability and have been placed in the shortest
period. In making the gap computations, none of the assumptions sometimes made
regarding prepayment rates and deposit decay rates have been used for any other
interest-earning assets or interest-bearing liabilities. In addition, the table
does not reflect scheduled principal payments which will be received throughout
the lives of the loans. The interest rate sensitivity of the Company's assets
and liabilities illustrated in the following table would vary substantially if
different assumptions were used or if actual experience differs from that
indicated by such assumptions.
<TABLE>
<CAPTION>
Terms to Repricing at June 30, 1998
---------------------------------------------------------
More Than More Than
1 Year 1 Year to 3 Years to More Than
or Less 3 Years 5 Years 5 Years Total
--------- ---------- ----------- ---------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans receivable:
Real estate loans:
Residential 1-4 family
Adjustable $ 16,441 $ 12,926 $13,510 $ 3,091 $ 45,968
Fixed 268 245 1,019 10,771 12,303
Multi-family residential and commercial
Adjustable 1,279 1,248 1,443 48 4,018
Fixed 128 14 35 520 697
Construction
Adjustable 4,778 - - - 4,778
Home equity credit lines
Adjustable 8,909 - - - 8,909
Other loans:
Adjustable 28 21 35 378 462
Fixed 644 1,227 1,433 3,621 6,925
Interest-earning balances in other banks 7,811 - - - 7,811
Investments 3,498 9,906 2,316 245 15,965
FHLB common stock/(1)/ - - - 735 735
-------- -------- ------- ------- --------
Total interest-earning assets $ 43,784 $ 25,587 $19,791 $19,409 $108,571
======== ======== ======= ======= ========
INTEREST-BEARING LIABILITIES:
Deposits:
Passbook and statement accounts $ 11,944 $ - $ - $ - $ 11,944
NOW and VIP checking accounts 10,804 - - - 10,804
Non-interest-bearing accounts 2,951 - - - 2,951
Certificate accounts 48,263 18,586 867 - 67,716
Other borrowed funds 3,200 - - - 3,200
-------- -------- ------- ------- --------
Total interest-bearing liabilities $ 77,162 $ 18,586 $ 867 $ - $ 96,615
======== ======== ======= ======= ========
INTEREST SENSITIVITY GAP PER PERIOD $(33,378) $ 7,001 $18,924 $19,409 $ 11,956
CUMULATIVE INTEREST SENSITIVITY GAP $(33,378) $(26,377) $(7,453) $11,956 $ 11,956
CUMULATIVE GAP AS A PERCENTAGE OF TOTAL INTEREST-EARNING ASSETS (30.74)% (24.29)% (6.86)% 11.01% 11.01%
CUMULATIVE INTEREST-EARNING
ASSETS AS A PERCENTAGE OF
INTEREST-BEARING LIABILITIES 56.74% 72.45% 92.29% 112.37% 112.37%
</TABLE>
/(1)/Nonmarketable equity security; substantially all required to be maintained
and assumed to mature in periods greater than 10 years.
-5-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
- --------------------------------------------------------------------------------
In addition to the traditional gap analysis, the Company also uses a computer
based interest rate risk simulation model. This comprehensive model includes
rate sensitivity gap analysis, rate shock net interest margin analysis, and
asset/liability term and rate analysis. The Company uses this model to monitor
interest rate risk on a quarterly basis and to detect trends that may affect
overall interest income. As a result, this analysis more accurately predicts the
risk to net interest income over the upcoming twelve month period. The Company
has a policy establishing the maximum allowable risk to net interest income
caused by changes in interest rates. The modeling results indicate that the
Company is within the established parameters of the interest rate risk policy.
NET INTEREST INCOME
Net interest income represents the difference between income derived from
interest-earning assets and interest expense incurred on interest-bearing
liabilities. Net interest income is affected by both (i) the difference between
the rates of interest earned on interest-earning assets and the rates paid on
interest-bearing liabilities ("interest rate spread") and (ii) the relative
amounts of interest-earning assets and interest-bearing liabilities ("net
earning balance"). The following table sets forth information relating to
average balances of the Company's assets and liabilities for the years ended
June 30, 1998 and 1997. For the periods indicated, the table reflects the
average yield on interest-earning assets and the average cost of interest-
bearing liabilities (derived by dividing income or expense by the monthly
average balance of interest-earning assets or interest-bearing liabilities,
respectively) as well as the net yield on interest-earning assets (which
reflects the impact of the net earning balance). Nonaccruing loans were included
in the computation of average balances.
<TABLE>
<CAPTION>
Year Ended June 30, 1998 Year Ended June 30, 1997
----------------------------- -----------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- -------- -------- --------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Interest-earning balances $ 3,964 $ 227 5.73% $ 5,323 $ 387 7.27%
Investments 23,088 1,491 6.46% 21,537 1,356 6.30%
Loans 82,222 6,910 8.40% 72,440 5,902 8.15%
-------- -------- ------
Total interest-earning assets 109,274 8,628 7.90% 99,300 7,645 7.70%
Other assets 6,266 4,682
-------- --------
Total assets $115,540 $103,982
======== ========
Interest-bearing liabilities:
Deposits $ 88,070 4,108 4.66% $ 82,857 3,884 4.69%
Borrowings 203 14 6.90% 56 3 5.36%
-------- ------ -------- ------
Total interest-bearing liabilities 88,273 4,122 4.67% 82,913 3,887 4.69%
------ ------
Other liabilities 2,037 1,904
Stockholders' equity 25,230 19,165
-------- --------
Total liabilities and stockholders' equity $115,540 $103,982
======== ========
Net interest income and interest rate spread $4,506 3.23% $3,758 3.01%
====== ==== ====== ====
Net yield on average interest-earning assets 4.12% 3.78%
==== ====
Ratio of average interest-earning assets to
average interest-bearing liabilities 123.79% 119.76%
======== ========
</TABLE>
-6-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
- --------------------------------------------------------------------------------
RATE/VOLUME ANALYSIS
The following table 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) net change (the sum of the previous columns). The change attributable
to both rate and volume (changes in rate multiplied by changes in volume) has
been allocated equally to both the changes attributable to volume and the
changes attributable to rate.
Year Ended June 30, 1998 vs. 1997
------------------------------------
Increase (Decrease) Due To
------------------------------------
Volume Rate Total
------------ ---------- ----------
(Dollars in thousands)
Interest income:
Interest-earning balances $ (87) $ (73) $ (160)
Investments 100 35 135
Loans 817 191 1,008
------------ ---------- ----------
Total interest income 830 153 983
------------ ---------- ----------
Interest expense:
Deposits 243 (19) 224
Borrowings 10 1 11
------------ ---------- ----------
Total interest expense 253 (18) 235
------------ ---------- ----------
Net interest income $ 577 $ 171 $ 748
============ ========== ==========
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1998 AND 1997
Consolidated total assets increased during the year by $2.4 million, from $111.5
million at June 30, 1997 to $113.9 million at June 30, 1998. The growth in total
assets would have been larger were it not for the payment during the fourth
quarter of the current fiscal year of a special nonrecurring $6.00 per share
return of capital dividend which aggregated $11.4 million, reducing both total
assets and stockholders' equity by that amount. This special dividend was funded
principally by maturing investment securities of $7.7 million held by the
Holding Company and by borrowings of $3.2 million of the Holding Company.
Deposit accounts increased by $9.6 million during the year, from $83.8 million
at June 30, 1997 to $93.4 million at June 30, 1998. This growth, which was
divided almost equally between demand and certificate accounts, was the primary
source of funding for the increases of $4.9 million in loans receivable and 5.9
million in interest-earning balances in other banks.
-7-
<PAGE>
Carolina Fincorp, Inc. and Subsidiaries
Management's Discussion and Analysis (Continued)
================================================================================
Total stockholders' equity was $15.4 million at June 30, 1998 as compared with
$25.4 million at June 30, 1997, a decrease of $10.0 million which resulted from
the special return of capital dividend discussed above. Net income for the year
was $1.1 million, while regular quarterly dividends aggregated $424,000 or $.24
per share. At June 30, 1998, both the Holding Company and the Bank continued to
significantly exceed all applicable regulatory capital requirements.
ASSET QUALITY
Non-performing assets include non-accrual loans, accruing loans contractually
past due 90 days or more, restructured loans, other real estate and other real
estate under contract for sale. Loans are placed on non-accrual status when
management has concerns relating to the ability to collect the loan principal
and interest, and generally when such loans are 90 days or more past due. While
non-performing assets represent potential losses to the Company, management does
not anticipate any aggregate material losses since most loans are believed to be
adequately secured. Management believes the allowance for loan losses is
sufficient to absorb known risks in the portfolio. No assurance can be given
that economic conditions will not adversely affect borrowers and result in
increased losses. The following table summarizes non-performing assets by type
at the dates indicated. Other than the amounts listed, there were no other loans
that (i) represent or result from trends or uncertainties which management
reasonably expects will materially impact future operating results, liquidity or
capital resources or (ii) represent material credits about which management has
information that causes them to have serious doubts as to the ability of such
borrowers to comply with the loan repayment terms.
SCHEDULE OF NON-PERFORMING ASSETS
At June 30,
------------------
1998 1997
-------- --------
Non-accrual loans $ 124 $ 206
Loans past due 90 days or more and still accruing - -
Other real estate 20 -
Renegotiated troubled debt - -
-------- --------
Total non-performing assets $ 144 $ 206
======== ========
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1998 AND 1997
NET INCOME
The Company earned consolidated net income of $1.1 million, or $.61 per share,
during the year ended June 30, 1998 as compared with net income of $753,000
during the prior year, an increase of $316,000. This increase resulted primarily
from the absence of the special SAIF deposit insurance assessment of $519,000
which, net of an income tax benefit of $176,000, decreased net income for
-8-
<PAGE>
Carolina Fincorp, Inc. and Subsidiaries
Management's Discussion and Analysis (Continued)
================================================================================
the year ended June 30, 1997 by approximately $343,000. An increase of $748,000
in net interest income was largely offset by increased personnel costs of
$720,000.
NET INTEREST INCOME
Net interest income increased to $4.5 million during the year ended June 30,
1998 as compared with $3.8 million during the previous year. This increase of
$748,000 resulted both from an increase in net interest-earning assets and from
higher yields. Average interest-earning assets exceeded average interest-bearing
liabilities by $21.0 million during the year ended June 30, 1998, and by $16.4
million during the year ended June 30, 1997. Substantially all of the growth in
average interest-earning assets was in higher yielding loans receivable. As a
result of loan growth over the last two years, the average balance of loans
receivable increased from $72.4 million during fiscal 1997 to $82.2 million
during fiscal 1998. In addition, the average yield on loans receivable increased
by 25 basis points to 8.40% for the year ended June 30, 1998, resulting in an
overall increase in the yield to total interest-earning assets of 20 basis
points, from 7.7% to 7.9%.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $92,000 and $70,000 for the years ended
June 30, 1998 and 1997, respectively. Management believes that the provision for
loan losses and the resulting loan loss allowance at June 30, 1998 will be
adequate to absorb losses on existing loans. There were $55,000 in net loan
charge-offs during the year ended June 30, 1998 as compared with net charge-offs
of $59,000 during the year ended June 30, 1997. Nonaccrual loans aggregated
$124,000 at June 30, 1998.
OTHER INCOME
Other income increased from $561,000 to $624,000, principally as a result of
increased gains of $82,000 from the sales of loans.
OTHER EXPENSES
Exclusive of the special SAIF assessment explained under the caption "Net
Income," (also see Note I to the consolidated financial statements) of $519,000
that was incurred during the year ended June 30, 1997, other expenses increased
by $810,000 from $2,575,000 during the year ended June 30, 1997 to $3,385,000
during the year ended June 30, 1998. This increase was primarily due to an
increase of $720,000 in personnel costs, $441,000 of which represents a non-
recurring charge to expense from distribution of shares of common stock under
the Company's new Management Recognition Plan ("MRP") which was approved by
shareholder vote at the last annual meeting, and $68,000 of which represents
recurring MRP costs charged to expense during the last six months of the fiscal
year. In addition, expenses of the Company's ESOP, which was in effect for the
full year, increased by $82,000.
PROVISION FOR INCOME TAXES
The provision for income taxes, as a percentage of income before income taxes,
was 35.3% and 34.8% for the years ended June 30, 1998 and 1997, respectively.
-9-
<PAGE>
Carolina Fincorp, Inc. and Subsidiaries
Management's Discussion and Analysis (Continued)
================================================================================
LIQUIDITY AND CAPITAL RESOURCES
Carolina Fincorp, Inc. paid regular quarterly cash dividends totaling $.24 a
share during fiscal 1998. The Company also paid a special nonrecurring return of
capital dividend of $6.00 per share during the last quarter of 1998. Although
Carolina anticipates that it will continue to declare cash dividends on a
quarterly basis, the Board of Directors will continue to review its policy on
the payment of dividends on an ongoing basis, and such payment will be subject
to future earnings, cash flows, capital needs, and regulatory restrictions.
Maintaining adequate liquidity while managing interest rate risk is the primary
goal of Carolina's asset and liability management strategy. Liquidity is the
ability to fund the needs of the Bank's borrowers and depositors, pay operating
expenses, and meet regulatory liquidity requirements. Maturing investments, loan
and mortgage-backed security principal repayments, deposits and income from
operations are the main sources of liquidity. The Bank's primary uses of
liquidity are to fund loans and to make investments.
As of June 30, 1998, liquid assets (cash and cash equivalents, and marketable
investment securities) were approximately $24.7 million, which represents 26.5%
of deposits. As a North Carolina-chartered savings bank, Richmond Savings is
required to maintain liquid assets equal to at least 10% of its total assets.
For purposes of this requirement, liquid assets consist of cash and readily
marketable investment securities. At June 30, 1998, this liquidity ratio, based
on North Carolina regulations, was 21.7%. Management considers current liquidity
levels to be adequate to meet the Company's foreseeable needs.
At June 30, 1998, outstanding mortgage loan commitments were $2.1 million,
available line of credit balances were $12.3 million, and the undisbursed
portion of construction loans was $2.4 million. Funding for these commitments is
expected to be provided from deposits, loan and mortgage-backed securities
principal repayments, maturing investments and income generated from operations.
Under federal capital regulations, Carolina and Richmond Savings must satisfy
certain minimum leverage ratio requirements and risk-based capital requirements.
Failure to meet such requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on Richmond Savings' financial statements. At June 30,
1998 and 1997, Carolina and Richmond Savings exceeded all such requirements.
(See Note K to the consolidated financial statements.)
ACCOUNTING AND REGULATORY MATTERS
Management is not aware of any known trends, events, uncertainties or current
recommendations by regulatory authorities that will have or that are reasonably
likely to have a material effect on the Company's liquidity, capital resources,
or other operations.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and notes thereto presented herein have been prepared
in accordance with generally accepted accounting principles, which require the
measurement of financial position and operating results in terms of historical
dollars without considering the change in the relative purchasing power of money
over time and due to inflation. The impact of inflation is reflected in the
increased cost
-10-
<PAGE>
Carolina Fincorp, Inc. and Subsidiaries
Management's Discussion and Analysis (Continued)
================================================================================
of the Company's operations. Unlike most industrial companies, nearly all the
Company's assets and liabilities are monetary in nature. As a result, interest
rates have a greater impact on the Company's performance than do the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the price of goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130. This Statement establishes standards
of reporting and display of comprehensive income and its components in a full
set of general-purpose financial statements. In addition to net income, as has
been historically determined, comprehensive income for the Company would include
unrealized holding gains and losses on available for sale securities. This
Statement will be effective for the Company's fiscal year ending June 30, 1999,
and the Company does not intend to early adopt. Had the Company early-adopted
this Statement, it would have reported comprehensive income of $1,137,347 and
$800,867 for the years ended June 30, 1998 and 1997, respectively.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. This statement establishes standards for the
way that public business enterprises report information about operating segments
and certain other information in annual financial statements and requires that
those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. This Statement will be
effective for the Company's fiscal year ending June 30, 1999.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 standardizes the accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts. Under this standard, entities are required to carry all
derivative instruments in the statement of financial position at fair value. The
accounting for changes in the fair value (i.e., gains or losses) of a derivative
instrument depends on whether it has been designated and qualifies as part of a
hedging relationship and, if so, on the reason for holding it. If certain
conditions are met, entities may elect to designate a derivative instrument as a
hedge of exposure to changes in fair values, cash flows, or foreign currencies.
If the hedged exposure is a fair value exposure, the gain or loss on the
derivative instrument is recognized in earnings in the period of change together
with the offsetting loss or gain on the hedged item attributable to the risk
being hedged. If the hedged exposure is a cash flow exposure, the effective
portion of the gain or loss on the derivative instrument is reported initially
as a component of other comprehensive income (outside earnings) and subsequently
reclassified into earnings when the forecasted transaction affects earnings. Any
amounts excluded from the assessment of hedge effectiveness as well as the
ineffective portion of the gain or loss is reported in earnings immediately.
Accounting for foreign currency hedges is similar to accounting for fair value
and cash flow hedges. If the derivative instrument is not designated as a hedge,
the gain or loss is recognized in earnings in the period of change. Management
anticipates that this statement will have no effect on the Company's
consolidated financial statements.
-11-
<PAGE>
Carolina Fincorp, Inc. and Subsidiaries
Management's Discussion and Analysis (Continued)
================================================================================
YEAR 2000 COMPLIANCE
The "Year 2000" issue confronting the Company and its suppliers, customers,
customers' suppliers and competitors centers on the inability of computer
systems to recognize the Year 2000. Many existing computer programs and systems
were originally programmed with six digit dates that provided only two digits to
identify the calendar year in the date field, without considering the upcoming
change in the century. With the impending new millennium, these programs and
computers will recognize "00" as the year 1900 rather than the year 2000. Like
most financial service providers, the Company and its operations may be
significantly affected by the Year 2000 issue due to its dependence on computer
generated financial information. Software, hardware, and equipment both within
and outside the Company's direct control and with whom the Company
electronically or operationally interfaces (e.g. third party vendors providing
data processing, information system management, maintenance of computer systems,
and credit bureau information) are likely to be affected. Furthermore, if
computer systems are not adequately changed to identify the Year 2000, many
computer applications could fail or create erroneous results. As a result, many
calculations which rely on date field information, such as interest, payment or
due dates and other operating functions, could generate results which are
significantly misstated, and the Company could experience a temporary inability
to process transactions, prepare statements or engage in similar normal business
activities. In addition, under certain circumstances, failure to adequately
address the Year 2000 issue could adversely affect the viability of the
Company's suppliers and creditors and the creditworthiness of its borrowers.
Thus, if not adequately addressed, the Year 2000 matter could result in a
significant adverse impact on products, services and the competitive condition
of the Company.
Financial institution regulators have recently increased their focus upon Year
2000 compliance issues, issuing guidance concerning the responsibilities of
senior management and directors. The Federal Financial Institutions Examination
Council ("FFIEC") has issued several interagency statements on Year 2000 Project
Management Awareness. These statements require financial institutions to, among
other things, examine the Year 2000 implications of reliance on vendors, data
exchange and potential impact on customers, suppliers and borrowers. These
statements also require each federally regulated financial institution to survey
its exposure, measure its risk and prepare a plan in order to solve the Year
2000 issue. In addition, the federal banking regulators have issued safety and
soundness guidelines to be followed by insured depository institutions, such as
the Bank, to assure resolution of any Year 2000 problems. The federal banking
agencies have asserted that Year 2000 testing and certification is a key safety
and soundness issue in conjunction with regulatory exams, and thus an
institution's failure to appropriately address the Year 2000 issue could result
in supervisory action, including such enforcement actions as the reduction of
the institution's supervisory ratings, the denial of applications for approval
of a merger or acquisition, or the imposition of civil money penalties.
In order to address the Year 2000 issue and to minimize its potential adverse
impact, management is engaged in a process to identify areas that will be
affected by the Year 2000, assess their potential impact on operations, monitor
the progress of third party software vendors in addressing the matter, test
changes provided by these vendors, and develop contingency plans for any
critical systems which are not effectively reprogrammed. The plan is divided
into the five phases: (1) awareness, (2) assessment, (3) renovations, (4)
validation, and (5) implementation.
-12-
<PAGE>
Carolina Fincorp, Inc. and Subsidiaries
Management's Discussion and Analysis (Continued)
================================================================================
The Company has substantially completed the first two phases of the plan and is
currently working internally and with external vendors on the final three
phases. The Company outsources its item processing operations to a service
provider. The Company's Year 2000 compliance is being closely coordinated with
that of the service provider.
The Company does not currently expect that the cost of its Year 2000 compliance
program will be material to its financial condition or results of operations,
and expects that it will satisfy such compliance program without material
disruption of its operations. In the event that the Company's significant
suppliers do not successfully and timely achieve Year 2000 compliance, the
Company's business, results of operations or financial condition could be
adversely affected.
-13-
<PAGE>
[LETTERHEAD OF DIXON ODOM PLLC CERTIFIED PUBLIC ACCOUNTANTS APPEARS HERE]
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Carolina Fincorp, Inc.
Rockingham, North Carolina
We have audited the accompanying consolidated statements of financial condition
of Carolina Fincorp, Inc. and Subsidiaries as of June 30, 1998 and 1997 and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated 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 Carolina Fincorp,
Inc. and Subsidiaries at June 30, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ Dixon Odom PLLC
Southern Pines, North Carolina
July 27, 1998
-14-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 1998 and 1997
================================================================================
<TABLE>
<CAPTION>
ASSETS 1998 1997
------------- -------------
<S> <C> <C>
Cash on hand and in banks $ 961,184 $ 1,789,958
Interest-earning balances in other banks 7,810,843 1,862,462
Investment securities available for sale, at fair value (amortized cost of
$10,256,498 and $17,779,550 at June 30, 1998
and 1997, respectively) (Note B) 10,295,194 17,713,835
Investment securities held to maturity, at amortized cost (fair
value of $5,729,533 and $6,911,620 at June 30, 1998 and 1997,
respectively) (Note B) 5,669,953 6,948,232
Loans held for sale 1,057,045 -
Loans receivable, net (Note C) 83,622,584 78,674,342
Accrued interest receivable 582,838 702,489
Premises and equipment, net (Note D) 2,076,418 2,118,184
Real estate acquired in settlement of loans 20,000 -
Stock in the Federal Home Loan Bank, at cost 734,700 734,700
Other assets 1,080,209 958,323
------------- -------------
TOTAL ASSETS $ 113,910,968 $ 111,502,525
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposit accounts (Note G) $ 93,414,753 $ 83,759,560
Advances from the Federal Home Loan Bank (Note F) - 500,000
Other borrowed funds (Note F) 3,200,000 -
Accrued interest payable 152,182 178,583
Advance payments by borrowers for property taxes and insurance 418,746 456,094
Accrued expenses and other liabilities 1,336,881 1,160,244
------------- -------------
TOTAL LIABILITIES 98,522,562 86,054,481
------------- -------------
Commitments and contingencies (Notes C and L)
STOCKHOLDERS' EQUITY (Note K)
Preferred stock, no par value, 5,000,000 shares authorized, no
shares issued and outstanding - -
Common stock, no par value, 20,000,000 shares
authorized; 1,905,545 and 1,851,500 issued and
outstanding at June 30, 1998 and 1997, respectively 7,852,262 17,585,611
Deferred management recognition plan (Note H) (477,504) -
ESOP note receivable (1,392,166) (1,491,000)
Unearned ESOP compensation (Note H) (661,000) -
Retained earnings, substantially restricted 10,041,662 9,396,148
Unrealized holding gains (losses) 25,152 (42,715)
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 15,388,406 25,448,044
------------- -------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 113,910,968 $ 111,502,525
============= =============
</TABLE>
See accompanying notes.
-15-
<PAGE>
<TABLE>
<CAPTION>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended June 30, 1998 and 1997
======================================================================================================================
1998 1997
------------- -------------
<S> <C> <C>
INTEREST INCOME
Loans $ 6,910,296 $ 5,902,020
Investments and deposits in other banks 1,717,474 1,743,151
------------- -------------
TOTAL INTEREST INCOME 8,627,770 7,645,171
------------- -------------
INTEREST EXPENSE
Deposit accounts (Note G) 4,107,881 3,884,049
Borrowings 14,149 3,371
------------- -------------
TOTAL INTEREST EXPENSE 4,122,030 3,887,420
------------- -------------
NET INTEREST INCOME 4,505,740 3,757,751
PROVISION FOR LOAN LOSSES (Note C) 92,000 70,000
------------- -------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 4,413,740 3,687,751
------------- -------------
OTHER INCOME
Transaction and other service fee income 350,779 368,413
Gain on sale of loans 90,526 8,059
Gain on sale of investment securities 1,157 -
Gain on sale of premises and equipment - 52,267
Other income 181,866 132,407
------------- -------------
TOTAL OTHER INCOME 624,328 561,146
------------- -------------
OTHER EXPENSES
Personnel costs 2,110,772 1,391,054
Occupancy 143,841 152,888
Equipment rental and maintenance 196,239 177,735
Marketing 64,599 61,797
Data processing and outside service fees 304,323 285,027
Federal and other insurance premiums (Note I) 89,230 628,966
Supplies, telephone and postage 126,511 132,953
Other 349,800 263,725
------------- -------------
TOTAL OTHER EXPENSES 3,385,315 3,094,145
------------- -------------
INCOME BEFORE INCOME TAXES 1,652,753 1,154,752
INCOME TAX EXPENSE (Note J) 583,273 402,248
------------- -------------
NET INCOME $ 1,069,480 $ 752,504
============= =============
NET INCOME PER COMMON SHARE (Note A)
Basic and diluted $ 0.61 $ 0.46
============= =============
Weighted average shares outstanding 1,763,678 1,790,311
============= =============
DIVIDENDS PER COMMON SHARE
Regular dividends per common share $ 0.24 $ 0.05
============= =============
Special nonrecurring return of capital dividend per common share $ 6.00 $ -
============= =============
</TABLE>
See accompanying notes.
-16-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30, 1998 and 1997
================================================================================
<TABLE>
<CAPTION>
Deferred
management ESOP
Common stock recognition note
Shares Amount plan receivable
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Balance at June 30, 1996 -- $ -- $ -- $ --
Net income -- -- -- --
Net proceeds from issuance of no par
value common stock 1,851,500 17,585,611 -- --
Purchase of 112,000 shares of common
stock by the ESOP -- -- -- (1,549,551)
Principal payments on note receivable
from ESOP -- -- -- 58,551
Cash dividends paid ($.05 per share) -- -- -- --
Change in unrealized holding gains
(losses), net of income taxes of $42,314 -- -- -- --
------------ ------------ ------------- ------------
Balance at June 30, 1997 1,851,500 17,585,611 -- (1,491,000)
Net income -- -- -- --
Cash dividends paid ($.24 per share) -- -- -- --
Return of capital dividend ($6.00 per share) --
(10,761,270) -- --
Adoption of deferred management recognition plan 54,045 986,321 (986,321) --
Deferred management recognition plan shares earned -- -- 508,817 --
Principal payments on note receivable from ESOP -- -- -- 98,834
ESOP contribution -- 41,600 -- --
Change in unrealized holding gains
(losses), net of income taxes of $36,544 -- -- -- --
------------ ------------ ------------- ------------
Balance at June 30, 1998 1,905,545 $ 7,852,262 $ (477,504) $ (1,392,166)
============ ============ ============= ============
<CAPTION>
Unearned Unrealized Total
ESOP Retained holding stockholders'
compensation earnings gains (losses) equity
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Balance at June 30, 1996 $ -- $ 8,731,804 $ (91,078) $ 8,640,726
Net income -- 752,504 -- 752,504
Net proceeds from issuance of no par
value common stock -- -- -- 17,585,611
Purchase of 112,000 shares of common
stock by the ESOP -- -- -- (1,549,551)
Principal payments on note receivable
from ESOP -- -- -- 58,551
Cash dividends paid ($.05 per share) -- (88,160) -- (88,160)
Change in unrealized holding gains
(losses), net of income taxes of $42,314 -- -- 48,363 48,363
------------ ------------ ------------- ------------
Balance at June 30, 1997 -- 9,396,148 (42,715) 25,448,044
Net income -- 1,069,480 -- 1,069,480
Cash dividends paid ($.24 per share) -- (423,966) -- (423,966)
Return of capital dividend ($6.00 per share)
(661,000) -- -- (11,422,270)
Adoption of deferred management recognition plan -- -- -- --
Deferred management recognition plan shares earned -- -- -- 508,817
Principal payments on note receivable from ESOP -- -- -- 98,834
ESOP contribution -- -- -- 41,600
Change in unrealized holding gains
(losses), net of income taxes of $36,544 -- -- 67,867 67,867
------------ ------------ ------------- ------------
Balance at June 30, 1998 $ (661,000) $ 10,041,662 $ 25,152 $ 15,388,406
</TABLE>
See accompanying notes.
-17-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 1998 and 1997
================================================================================
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,069,480 $ 752,504
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 176,877 152,699
Amortization, net (86,269) 50,872
Gain on sale of assets, net (91,683) (54,801)
Origination of loans held for sale (7,373,876) (990,203)
Proceeds from sale of loans held for sale 6,407,357 998,262
ESOP contribution expense 41,600 -
Vesting of deferred management recognition plan 508,817 -
Provision for loan losses 92,000 70,000
Deferred income taxes (152,652) (21,497)
Deferred compensation 108,022 107,828
Change in assets and liabilities
(Increase) decrease in accrued interest receivable 119,651 (124,911)
(Increase) decrease in other assets 13,944 (160,201)
Decrease in accrued interest payable (26,401) (32,240)
Increase (decrease) in accrued expenses and other liabilities 45,923 (26,103)
------------- -------------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 852,790 722,209
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net (increase) decrease in interest-earning balances in other banks (5,948,381) 2,823,121
Purchases of:
Available for sale investment securities (19,523,928) (11,510,273)
Held to maturity investment securities (502,920) (515,000)
Proceeds from maturities and calls of:
Available for sale investment securities 25,200,000 2,250,000
Held to maturity investment securities 1,773,125 1,527,431
Proceeds from sales of:
Available for sale investment securities 1,989,688 -
Net increase in loans (5,162,085) (10,484,302)
Purchase of premises and equipment (132,141) (951,990)
Proceeds from sale of premises and equipment - 86,010
Proceeds from sale of real estate acquired in settlement of loans 55,223 98,186
Capital expenditures for real estate acquired in settlement of loans (588) (520)
------------- -------------
NET CASH USED BY
INVESTING ACTIVITIES (2,252,007) (16,677,337)
------------- -------------
</TABLE>
See accompanying notes.
-18-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 1998 and 1997
================================================================================
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in demand accounts $ 4,620,070 $ (1,026,113)
Net increase in certificates of deposit 5,035,123 1,070,744
Decrease in advance payments by borrowers for
taxes and insurance (37,348) (13,509)
Proceeds from other borrowings 3,200,000 -
Net increase (decrease) in advances from Federal
Home Loan Bank (500,000) 500,000
Net proceeds from issuance of common stock - 17,585,611
Loan to ESOP for purchase of common stock - (1,549,551)
Principal payment received on note receivable from ESOP 98,834 58,551
Regular cash dividends paid (423,966) (88,160)
Special return of capital dividend (11,422,270) -
------------- -------------
NET CASH PROVIDED
BY FINANCING ACTIVITIES 570,443 16,537,573
------------- -------------
NET INCREASE (DECREASE) IN
CASH ON HAND AND IN BANKS (828,774) 582,445
CASH ON HAND AND IN BANKS, BEGINNING 1,789,958 1,207,513
------------- -------------
CASH ON HAND AND
IN BANKS, ENDING $ 961,184 $ 1,789,958
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 4,148,431 $ 3,919,660
============= =============
Income taxes $ 454,814 $ 425,621
============= =============
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Loans receivable transferred to real estate acquired in
settlement of loans $ 74,635 $ 68,592
============= =============
Unrealized holding gain on available for sale investment
securities, net of deferred income taxes $ 67,867 $ 48,363
============= =============
Adoption of deferred management recognition plan $ 986,321 $ -
============= =============
</TABLE>
See accompanying notes.
-19-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
Organization and Operations
- ---------------------------
In November 1996, pursuant to a Plan of Conversion which was approved by its
members and regulators, Richmond Savings Bank, Inc., SSB ("Richmond Savings" or
"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 Carolina Fincorp, Inc. ("Carolina" or "Parent"). Carolina
was formed to acquire all of the common stock of Richmond Savings upon its
conversion to stock form. Carolina has no operations and conducts no business on
its own other than owning Richmond 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
- ------------------
Richmond Savings maintains its offices and conducts its primary business in
Richmond, Moore and Scotland counties, North Carolina. The Bank is primarily
engaged in the business of attracting deposits from the general public and using
such deposits to make mortgage loans secured by one-to-four family residential
real estate located in its primary market area. The Bank also makes home equity
line of credit loans, multi-family residential loans, commercial loans,
construction loans, loans secured by deposit accounts, and various types of
consumer loans. Richmond Savings has been and intends to continue to be a
community-oriented financial institution offering a variety of financial
services to meet the needs of the communities it serves. Richmond Investment
Services, Inc. is a wholly-owned subsidiary of Richmond Savings whose principal
business activity is that of an agent for various insurance products and non-
bank investment products and services.
Basis of Presentation
- ---------------------
The accompanying consolidated financial statements include the accounts of the
Parent, the Bank and the Bank's wholly-owned subsidiary, together referred to as
the "Company." All significant intercompany transactions and balances are
eliminated in consolidation.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly sensitive to significant change relate
to the determination of the allowance for losses on loans and the valuation of
real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowances for losses on
loans and foreclosed real estate, management obtains independent appraisals for
significant properties.
-20-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Use of Estimates (Continued)
- ---------------------------
A majority of the Bank's loan portfolio consists of single-family residential
loans in its market area. The regional economy is currently stable and consists
of various types of industry. Real estate prices in this market are also stable;
however, the ultimate collectibility of a substantial portion of the Bank's loan
portfolio can be affected by changes in local market conditions.
While management uses available information to recognize losses on loans and
foreclosed real estate, future additions to the allowances may be necessary
based on changes in local economic conditions. In addition, regulatory agencies,
as an integral part of their examination process, periodically review the Bank's
allowances for losses on loans and foreclosed real estate. Such agencies may
require the Bank to recognize additions to the allowances based on their
judgments about information available to them at the time of their examination.
Investment Securities
- ---------------------
The Company classifies its securities in one of three categories: trading,
available for sale, or held to maturity. There were no trading securities at
June 30, 1998 or 1997. Securities held to maturity are those securities for
which the Company has the ability and intent to hold to maturity. All other
securities are classified as available for sale.
Available for sale securities consist of investment securities not classified as
trading securities or held to maturity securities and are recorded at fair
value. Held to maturity securities are recorded at cost, adjusted for the
amortization or accretion of premiums or discounts. Unrealized holding gains and
losses, net of the related tax effect, on securities available for sale are
excluded from earnings and are reported as a separate component of stockholders'
equity until realized. Transfers of securities between categories are recorded
at fair value at the date of transfer. Unrealized holding gains or losses
associated with transfers of securities from held to maturity to available for
sale are recorded as a separate component of stockholders' equity.
A decline in the market value of any available for sale or held to maturity
investment below cost that is deemed other than temporary is charged to earnings
and establishes a new cost basis for the security.
Premiums and discounts are amortized or accreted over the life of the related
security as an adjustment to the yield. Realized gains and losses are included
in earnings and the costs of securities sold are derived using the specific
identification method.
Loans Held for Sale
- -------------------
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate. Net
unrealized losses are recognized through a valuation allowance by charges to
income.
-21-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loans Receivable
- ----------------
Loans receivable are stated at unpaid balances, less the allowance for loan
losses and net deferred loan fees.
Loan origination and commitment fees, as well as certain direct origination
costs, are deferred and amortized as a yield adjustment over the lives of the
related loans using the interest method. Amortization of deferred loan fees is
discontinued when a loan is placed on nonaccrual status.
Loans are placed on nonaccrual when a loan is specifically determined to be
impaired or when principal or interest is delinquent for 90 days or more.
Interest income generally is not recognized on specific impaired loans unless
the likelihood of further loss is remote. Interest payments received on such
loans are applied as a reduction of the loan principal balance. Interest income
on other nonaccrual loans is recognized only to the extent of interest payments
received.
The Bank accounts for impaired loans in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of
a Loan, amended by SFAS No. 118, Accounting by Creditors for Impairment of a
Loan - Income Recognition and Disclosure. A loan is impaired when, based on
current information and events, it is probable that all amounts due according to
the contractual terms of the loan agreement will not be collected. Impaired
loans are measured based on the present value of expected future cash flows,
discounted at the loan's effective interest rate, or at the loan's observable
market price, or the fair value of the collateral of the loan if the loan is
collateral dependent. Interest income from impaired loans is recognized using
the cash basis method of accounting during the time within that period in which
the loans were impaired.
Allowance for Loan Losses
- -------------------------
The Bank provides for loan losses on the allowance method. Accordingly, all loan
losses are charged to the related allowance and all recoveries are credited to
it. Additions to the allowance for loan losses are provided by charges to
operations based on various factors which, in management's judgment, deserve
current recognition in estimating possible losses. Such factors considered by
management include the market value of the underlying collateral, growth and
composition of the loan portfolio, the relationship of the allowance for loan
losses to outstanding loans, delinquency trends, and economic conditions.
Management evaluates the carrying value of loans periodically and the allowance
is adjusted accordingly. While management uses the best information available to
make evaluations, future adjustments to the allowance may be necessary if
conditions differ substantially from the assumptions used in making the
evaluations.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to recognize additions to the allowance based
on their judgments of information available to them at the time of their
examination.
-22-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Premises and Equipment
- ----------------------
Bank premises and equipment are stated at cost less accumulated depreciation.
Depreciation of premises and equipment is recorded on a straight-line basis over
the estimated useful lives of the related assets.
Expenditures for maintenance and repairs are charged to expense as incurred,
while those for improvements are capitalized. The costs and accumulated
depreciation relating to premises and equipment retired or otherwise disposed of
are eliminated from the accounts, and any resulting gains or losses are credited
or charged to earnings.
Investment in Federal Home Loan Bank Stock
- ------------------------------------------
As a requirement for membership, the Bank invests in stock of the Federal Home
Loan Bank of Atlanta ("FHLB"). This investment is carried at cost.
Real Estate Acquired In Settlement of Loans
- -------------------------------------------
Real estate acquired in settlement of loans is carried at the lower of cost or
fair value less estimated costs to dispose. Generally accepted accounting
principles define fair value as the amount that is expected to be received in a
current sale between a willing buyer and seller other than in a forced or
liquidation sale. Fair values at foreclosure are based on appraisals. Losses
arising from the acquisition of foreclosed properties are charged against the
allowance for loan losses. Subsequent writedowns are provided by a charge to
operations through the allowance for losses on other real estate in the period
in which the need arises.
Income Taxes
- ------------
Deferred tax assets and liabilities are recorded for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Future tax
benefits are recognized to the extent that realization of such benefits is more
likely than not. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which the assets
and liabilities are expected to be recovered or settled. The effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income tax
expense in the period that includes the enactment date.
In the event the future tax consequences of differences between the financial
reporting bases and the tax bases of the Company's assets and liabilities result
in deferred tax assets, applicable accounting standards require an evaluation of
the probability of being able to realize the future benefits indicated by such
assets. A valuation allowance is provided when it is more likely than not that
some portion or all of the deferred tax assets will not be realized. In
assessing the realizability of the deferred tax assets, management considers the
scheduled reversals of deferred tax liabilities, projected future taxable
income, and tax planning strategies.
-23-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes (Continued)
- -----------------------
A deferred tax liability is not recognized for portions of the allowance for
loan losses for income tax purposes in excess of the financial statement
balance, as described in Note J. Such a deferred tax liability will only be
recognized when it becomes apparent that those temporary differences will
reverse in the foreseeable future.
Net Income Per Common Share
- ---------------------------
Effective with the year ended June 30, 1998, the Company has implemented
Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per
Share. This Statement simplifies the standards for computing earnings per share
previously found in Accounting Principles Board ("APB") Opinion No. 15, Earnings
Per Share, and makes them comparable to international earnings per share ("EPS")
standards. It replaces the presentation of primary EPS with the presentation of
basic EPS. It also requires dual presentation of basic and diluted EPS on the
face of the statement of operations for all entities with complex capital
structures. It also requires a reconciliation of the numerator and the
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. Basic EPS excludes dilution and it is computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. For the years ended
June 30, 1998 and 1997, basic and diluted earnings per share are the same
amounts.
Net income per common share for the year ended June 30, 1997 is based on
unaudited net income earned from the date of Conversion, November 22, 1996, to
the end of the fiscal year, divided by the weighted average number of shares
outstanding during that period. Net income per common share for the year ended
June 30, 1998 is based on net income earned divided by the weighted average
number of shares outstanding during the year. For purposes of this computation,
the number of shares of common stock purchased by the Bank's ESOP and MRP which
have not been allocated to participant accounts are not assumed to be
outstanding.
Recent Accounting Pronouncements
- --------------------------------
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. This
Statement establishes standards of reporting and display of comprehensive income
and its components in a full set of general-purpose financial statements. In
addition to net income as has been historically determined, comprehensive income
for the Company would include unrealized holding gains and losses on available
for sale securities. This Statement will be effective for the Company's fiscal
year ending June 30, 1999, and the Company does not intend to early adopt. Had
the Company early-adopted this Statement, it would have reported comprehensive
income of $1,137,347 and $800,867 for the years ended June 30, 1998 and 1997,
respectively.
-24-
<PAGE>
CAROLINA FINCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recent Accounting Pronouncements (Continued)
- --------------------------------
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. This Statement establishes standards for the
way that public business enterprises report information about operating segments
and certain other information in annual financial statements and requires that
those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. This Statement will be
effective for the Company's fiscal year ending June 30, 1999.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 standardizes the accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts. Under this standard, entities are required to carry all
derivative instruments in the statement of financial position at fair value. The
accounting for changes in the fair value (i.e., gains or losses) of a derivative
instrument depends on whether it has been designated and qualifies as part of a
hedging relationship and, if so, on the reason for holding it. If certain
conditions are met, entities may elect to designate a derivative instrument as a
hedge of exposure to changes in fair values, cash flows, or foreign currencies.
If the hedged exposure is a fair value exposure, the gain or loss on the
derivative instrument is recognized in earnings in the period of change together
with the offsetting loss or gain on the hedged item attributable to the risk
being hedged. If the hedged exposure is a cash flow exposure, the effective
portion of the gain or loss on the derivative instrument is reported initially
as a component of other comprehensive income (outside earnings) and subsequently
reclassified into earnings when the forecasted transaction affects earnings. Any
amounts excluded from the assessment of hedge effectiveness as well as the
ineffective portion of the gain or loss is reported in earnings immediately.
Accounting for foreign currency hedges is similar to accounting for fair value
and cash flow hedges. If the derivative instrument is not designated as a hedge,
the gain or loss is recognized in earnings in the period of change. Management
anticipates that this statement will have no effect on its consolidated
financial statements.
NOTE B - INVESTMENT SECURITIES
The following is a summary of the securities portfolios by major classification:
<TABLE>
<CAPTION>
June 30, 1998
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ------------- ---------- -----------
<S> <C> <C> <C> <C>
Securities available for sale:
U. S. government securities and obligations
of U. S. government agencies $10,256,498 $ 41,233 $ 2,537 $10,295,194
=========== ============= ========== ===========
Securities held to maturity:
U. S. government securities and obligations
of U. S. government agencies $ 3,507,667 $ 16,852 $ 1,574 $ 3,522,945
Mortgage-backed securities 1,168,232 24,955 - 1,193,187
Corporate debt securities 994,054 19,347 - 1,013,401
----------- ------------- ---------- -----------
$ 5,669,953 $ 61,154 $ 1,574 $ 5,729,533
=========== ============= ========== ===========
</TABLE>
-25-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE B - INVESTMENT SECURITIES (CONTINUED)
<TABLE>
<CAPTION>
June 30, 1997
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ------------- ---------- -----------
<S> <C> <C> <C> <C>
Securities available for sale:
U. S. government securities and obligations
of U. S. government agencies $17,779,550 $ 16,485 $ 82,200 $17,713,835
=========== ============= ========== ===========
Securities held to maturity:
U. S. government securities and obligations
of U. S. government agencies $ 4,013,745 $ 3,790 $ 39,195 $ 3,978,340
Mortgage-backed securities 1,441,497 17,101 14,953 1,443,645
Corporate debt securities 1,492,990 5,000 8,355 1,489,635
----------- ------------- ---------- -----------
$ 6,948,232 $ 25,891 $ 62,503 $ 6,911,620
=========== ============= ========== ===========
</TABLE>
Gross realized gains and gross realized losses on sales of available for sale
securities were $2,108 and $951, respectively, during the year ended June 30,
1998. There were no sales of investment securities available for sale during the
year ended June 30, 1997.
The amortized cost and fair values of securities available for sale and held to
maturity at June 30, 1998 by contractual maturity are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
Securities Available for Sale Securities Held to Maturity
----------------------------- ---------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Due within one year $ 2,499,260 $ 2,497,533 $1,001,518 $1,001,875
Due after one year through five years 6,495,762 6,530,917 3,373,793 3,407,623
Due after five years through ten years 1,261,476 1,266,744 1,049,075 1,060,331
Due after ten years - - 245,567 259,704
----------- ----------- ---------- ----------
$10,256,498 $10,295,194 $5,669,953 $5,729,533
=========== =========== ========== ==========
</TABLE>
For purposes of the maturity table, mortgage-backed securities, which are not
due at a single maturity date, have been allocated over maturity groupings based
on the weighted-average contractual maturities of underlying collateral. The
mortgage-backed securities may mature earlier than their weighted-average
contractual maturities because of principal prepayments.
Securities with a carrying value of $738,102 and $1,320,992 and a fair value of
$760,164 and $1,322,358 at June 30, 1998 and 1997, respectively, were pledged to
secure public monies on deposit as required by law.
-26-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE B - INVESTMENT SECURITIES (CONTINUED)
The following table sets forth certain information regarding the carrying
values, weighted average yields and contractual maturities of the Company's
investment portfolio at June 30, 1998. FHLB common stock, a nonmarketable
equity security, substantially all of which is required to be maintained, is
assumed to mature in periods greater than ten years.
<TABLE>
<CAPTION>
Carrying Value
-------------------------------------------------------------
After After
One Year Five Years
One Year Through Through After Ten
or Less Five Years Ten Years Years Total
--------- ----------- --------------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Securities available for sale:
U. S. government and agency securities $ 2,497 $ 6,531 $ 1,267 $ - $ 10,295
Securities held to maturity:
U. S. government and agency securities 1,001 1,501 1,006 - 3,508
Mortgage-backed securities 880 43 245 1,168
Corporate bonds - 994 - - 994
Other:
Interest-earning balances in other banks 7,811 - - - 7,811
Federal Home Loan Bank stock - - - 735 735
--------- ----------- --------------- ---------- --------
Total $ 11,309 $ 9,906 $ 2,316 $ 980 $ 24,511
========= =========== =============== ========== ========
</TABLE>
<TABLE>
<CAPTION>
Average Yield
------------------------------------------------------------
After After
One Year Five Years
One Year Through Through After Ten
or Less Five Years Ten Years Years Total
-------- ---------- ---------- --------- -----
<S> <C> <C> <C> <C> <C>
Securities available for sale:
U. S. government and agency securities 5.43% 6.26% 7.06% - 6.16%
Securities held to maturity:
U. S. government and agency securities 5.70% 6.39% 7.40% - 6.48%
Mortgage-backed securities - 6.88% 9.00% 8.50% 8.58%
Corporate bonds - 6.59% - - 6.59%
Other:
Interest-earning balances in other banks 5.48% - - - 5.48%
Federal Home Loan Bank stock - - - 7.25% 7.25%
Weighted average 5.49% 6.37% 7.24% 7.56% 6.09%
</TABLE>
-27-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE C - LOANS RECEIVABLE
Loans receivable consist of the following:
<TABLE>
<CAPTION>
1998 1997
-------------------------- --------------------------
Percentage Percentage
Amount of Total Amount of Total
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Type of loan:
Real estate loans:
One-to-four family residential $58,270,874 69.68% $59,063,396 75.07%
Multi-family residential and commercial 4,714,574 5.64% 3,979,061 5.06%
Construction 7,195,787 8.61% 6,276,804 7.98%
Home equity lines of credit 8,908,799 10.65% 7,951,066 10.11%
----------- ---------- ----------- ----------
Total real estate loans 79,090,034 94.58% 77,270,327 98.22%
----------- ---------- ----------- ----------
Other loans:
Consumer loans 6,416,354 7.67% 4,152,974 5.28%
Home improvement loans 367,550 0.44% 570,853 0.73%
Loans secured by deposits 603,993 0.72% 545,661 0.69%
----------- ---------- ----------- ----------
Total other loans 7,387,897 8.83% 5,269,488 6.70%
----------- ---------- ----------- ----------
Total loans 86,477,931 103.41% 82,539,815 104.92%
Less:
Construction loans in process 2,417,928 2.89% 3,465,422 4.40%
Allowance for loan losses 437,419 0.52% 400,051 0.52%
----------- ---------- ----------- ----------
$83,622,584 100.00% $78,674,342 100.00%
=========== ========== =========== ==========
</TABLE>
<TABLE>
<CAPTION>
The allowance for loan losses is summarized as follows:
1998 1997
----------- -----------
<S> <C> <C>
Balance at beginning of year $ 400,051 $ 389,358
----------- -----------
Loans charged off:
Real estate - -
Other (60,263) (60,521)
----------- -----------
Total loans charged off (60,263) (60,521)
----------- -----------
Recoveries:
Real estate - -
Other 5,631 1,214
----------- -----------
Total loan recoveries 5,631 1,214
----------- -----------
Provision for loan losses 92,000 70,000
----------- -----------
Balance at end of year $ 437,419 $ 400,051
=========== ===========
</TABLE>
-28-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE C - LOANS RECEIVABLE (Continued)
The allocation of the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
-------------------------------- -------------------------------
Percent of Percent Percent of Percent
Allowance of Loans Allowance of Loans
Amount of to Total to Gross Amount of to Total to Gross
Allowance Allowance Loans Allowance Allowance Loans
--------- ---------- -------- --------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One-to-four family residential $ 67,000 15.32% 67.38% $ 63,000 15.75% 71.56%
Multi-family residential and commercial 39,000 8.92% 5.45% 37,000 9.25% 4.82%
Construction 23,000 5.26% 8.32% 11,000 2.75% 7.60%
Home equity lines of credit 45,000 10.28% 10.30% 40,000 10.00% 9.64%
-------- -------- ------ -------- -------- --------
Total real estate loans 174,000 39.78% 91.45% 151,000 37.75% 93.62%
-------- -------- ------ -------- -------- --------
Other loans:
Consumer loans 151,000 34.52% 7.42% 124,000 31.00% 5.03%
Home improvement loans 9,000 2.06% 0.43% 17,000 4.25% 0.69%
Loans secured by deposits - - 0.70% - 0.00% 0.66%
-------- -------- ------ -------- -------- --------
Total other loans 160,000 36.58% 8.55% 141,000 35.25% 6.38%
-------- -------- ------ -------- -------- --------
Unallocated 103,419 23.64% - 108,051 27.00% 0.00%
-------- -------- ------ -------- -------- --------
Total allowance for loan losses $437,419 100.00% 100.00% $400,051 100.00% 100.00%
======== ======== ====== ======== ======== ========
</TABLE>
Nonaccrual loans, which consisted of loans on which principal or interest was
delinquent for 90 days or more, totaled approximately $124,000 and $206,000 at
June 30, 1998 and 1997, respectively. Such loans had the effect of reducing
interest income by approximately $4,000 and $7,000 during the years ended June
30, 1998 and 1997, respectively.
Loans serviced for other investors amounted to $6,602,000 and $8,164,000 at June
30, 1998 and 1997, respectively.
At June 30, 1998, the Bank had mortgage loan commitments outstanding of
$2,110,000 and pre-approved but unused lines of credit totaling $12,332,000. In
management's opinion, these commitments, and undisbursed proceeds on
construction loans in process reflected above, represent no more than normal
lending risk to the Bank and will be funded from normal sources of liquidity.
The Bank has had loan transactions with its directors and executive officers.
Such loans were made in the ordinary course of business and also on
substantially the same terms and collateral as those comparable transactions
prevailing at the time and did not involve more than the normal risk of
collectibility or present other unfavorable features. A summary of related party
loan transactions is as follows:
1998 1997
------------ ------------
Balance at beginning of year $ 81,395 $ 101,408
Additional borrowings - -
Loan repayments (11,731) (20,013)
----------- -----------
Balance at end of year $ 69,664 $ 81,395
=========== ===========
-29-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE D - PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
1998 1997
----------- -----------
Land $ 648,069 $ 648,069
Building and improvements 1,721,168 1,682,308
Furniture and equipment 1,127,611 1,034,330
Leasehold improvements - -
----------- -----------
3,496,848 3,364,707
Accumulated depreciation (1,420,430) (1,246,523)
----------- -----------
$ 2,076,418 $ 2,118,184
=========== ===========
NOTE E - FEDERAL INSURANCE OF DEPOSITS
Eligible deposit accounts are insured up to $100,000 by the Federal Deposit
Insurance Corporation.
NOTE F - ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWED FUNDS
Advances from the Federal Home Loan Bank of Atlanta, with weighted average
interest rates, are as follows:
June 30,
--------------------
1998 1997
-------- --------
5.92% due on August 21, 1997 $ - $500,000
======== ========
At June 30, 1998, Richmond Savings also had $12,000,000 available on a line of
credit from the Federal Home Loan Bank. All advances are secured by a blanket
floating lien on the Bank's one-to-four family residential mortgage loans.
Other borrowed funds at June 30, 1998 consist of a note payable to another bank
for $3,200,000 which bears interest at 8% (prime minus 0.5%). This note was
repaid on July 3, 1998.
-30-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE G - DEPOSIT ACCOUNTS
A comparative summary of deposit accounts at June 30, 1998 and 1997 follows:
<TABLE>
<CAPTION>
1998 1997
----------------------- ---------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
----------- ---------- -------------- -----------
<S> <C> <C> <C> <C>
Demand accounts:
Passbook and statement accounts $11,944,115 2.94% $10,669,197 2.96%
NOW accounts 6,481,463 1.98% 5,664,210 1.98%
VIP checking accounts 4,321,827 3.57% 2,520,810 3.10%
Non-interest bearing accounts 2,951,146 - 2,224,264 -%
----------- -----------
25,698,551 2.47% 21,078,481 2.40%
Certificates of deposit 67,716,202 5.39% 62,681,079 5.55%
----------- -----------
Total deposit accounts $93,414,753 4.59% $83,759,560 4.76%
=========== ===========
</TABLE>
The weighted average cost of deposit accounts was 4.59% and 4.76% at June
30, 1998 and 1997, respectively.
A summary of certificate accounts by maturity as of June 30, 1998 follows:
<TABLE>
<CAPTION>
Less than $100,000
$100,000 or More Total
-------- ------------- ----------
(In thousands)
<S> <C> <C> <C>
Three months or less $ 19,100 $ 4,216 $ 23,316
Over three months through twelve months 22,124 2,823 24,947
Over one year through three years 15,257 3,329 18,586
Over three years 367 500 867
-------- ----------- ----------
Total certificate accounts $ 56,848 $ 10,868 $ 67,716
======== =========== ==========
</TABLE>
Interest expense on deposits for the years ended June 30 is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Passbook and statement account $ 330,016 $ 344,120
NOW and VIP checking accounts 245,927 217,251
Certificates of deposit 3,543,836 3,329,862
----------- ----------
4,119,779 3,891,233
Penalties for early withdrawal 11,898 7,184
----------- ----------
$ 4,107,881 $3,884,049
=========== ==========
</TABLE>
-31-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE H - EMPLOYEE AND DIRECTOR BENEFIT PLANS
Management Recognition and Stock Option Plans
- ---------------------------------------------
At the Company's annual meeting which was held on November 27, 1997, the
stockholders approved the Carolina Fincorp, Inc. Stock Option Plan (the "SOP")
and the Richmond Savings Bank, Inc., SSB Management Recognition Plan (the
"MRP"). The SOP provides for the issuance to directors, officers and employees
of the Bank options to purchase up to 185,150 shares of the Company's common
stock. The MRP provides for the award of up to 74,060 shares of the Company's
common stock to directors, officers and employees of the Bank. The Company may
elect to fund the plans through the issuance of authorized but unissued shares,
or by purchasing shares in the open market.
During January of 1998, 54,045 of newly issued common shares were awarded under
the MRP at a value of $18.25 per share at the date of grant. Personnel costs for
year ended June 30, 1998 include $508,817 which represents the value of MRP
shares earned through that date. To date no options have been issued under the
SOP.
Employee Stock Ownership Plan
- -----------------------------
The Bank has established an ESOP to benefit all qualified employees. The ESOP
purchased 112,000 shares of common stock in the Conversion with proceeds
received from a loan of $1,549,551 from the Parent. The loan is to be repaid
over fifteen years in quarterly installments of principal and interest. Interest
is based upon the prime rate and will be adjusted annually. The loan may be
prepaid without penalty. The unallocated shares of stock held by the ESOP are
pledged as collateral for the loan. The ESOP is funded by contributions made by
the Bank in amounts sufficient to retire the debt. At June 30, 1998 and 1997,
the outstanding balance of the loan is $1,392,166 and $1,491,000, respectively,
and is presented as a reduction of stockholders' equity.
Shares released as the debt is repaid and earnings from the common stock held by
the ESOP are allocated among active participants on the basis of compensation in
the year of allocation. Benefits become 100% vested after seven 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 loan to the
Company and are not reported as dividends in the financial statements. Dividends
on allocated or committed to be allocated shares are credited to the accounts of
the participants and reported as dividends in the financial statements. Special
return of capital dividends on unallocated ESOP shares totaling $661,000 are
recorded as unearned compensation and reported as a separate component of
stockholders' equity. These funds will be used by the ESOP to purchase
additional shares of the Company's common stock, which may result in the ESOP
owning a larger percentage of the outstanding common stock than was originally
anticipated at the time of the Conversion.
-32-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE H - EMPLOYEE AND DIRECTOR BENEFIT PLANS (CONTINUED)
Employee Stock Ownership Plan (Continued)
- -----------------------------------------
Expense of $140,434 and $58,551 during the years ended June 30, 1998 and 1997,
respectively, has been incurred in connection with the ESOP. The expense for the
year ended June 30, 1998 includes, in addition to the cash contribution
necessary to fund the ESOP, $41,600, which represents the difference between the
fair value of the shares which have been released or committed to be released to
participants, and the cost of these shares to the ESOP. The Bank has credited
this amount to common stock.
At June 30, 1998, 13,657 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
$1,130,000 at June 30, 1998.
Deferred Compensation Plans
- ---------------------------
The Bank has deferred compensation plans for certain directors and officers.
These plans provide benefits upon disability, death or attainment of a certain
age. The Bank has made current provisions for future payments under these plans,
and the related liabilities and deferred income tax benefits are included in the
accompanying consolidated financial statements. Expenses associated with these
plans were $108,022 and $107,828 for the years ended June 30, 1998 and 1997,
respectively.
Defined Contribution Plan
- -------------------------
The Bank had a defined contribution retirement plan which covered substantially
all the Bank's employees. Contributions to the plan were discretionary, but were
generally made in amounts which were estimated to be sufficient to provide a
target retirement benefit based on a percentage of the employee's eligible
compensation. This plan was terminated on October 18, 1996. Contributions to the
plan totaled $-0- and $45,067 for the years ended June 30, 1998 and 1997,
respectively.
401(k) Retirement Plan
- ----------------------
The Bank maintains for the benefit of its eligible employees a 401(k) plan.
Under the plan, the Bank does not make contributions. It does, however, match
fifty percent of eligible employee contributions, but the amount matched shall
not exceed three percent of compensation The plan eligibility requirement is
completion of one year's full time service for employees who have attained the
age of twenty-one. At June 30, 1998 and 1997, substantially all full-time
employees are eligible and are covered by the plan. Provisions for contributions
to the plan totaled $21,273 and $15,285 for the years ended June 30, 1998 and
1997, respectively.
-33-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE H - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)
Employment Agreements
- ---------------------
The Bank has entered into employment agreements with its chief executive officer
and one other executive officer to ensure a stable and competent management
base. The agreements provide for a three-year term, but the agreements may be
extended for an additional year at the end of the initial term and annually
thereafter. The agreements provide for benefits as spelled out in the contracts
and cannot be terminated by the Board of Directors, except for cause, without
prejudicing the officers' rights to receive certain vested rights, including
compensation. In the event of a change in control of the Bank, as defined in the
agreements, the acquirer will be bound to the terms of the contracts.
Severance Plan
- --------------
The Bank has also adopted a severance plan for the benefit of its employees in
the event of a change in control of the Bank which provides for varying
severance benefits for employees based on their salaries and length of service
with the Bank.
NOTE I - SPECIAL SAIF ASSESSMENT
On September 30, 1996, the Deposit Insurance Funds Act of 1996 was signed into
law. The legislation included a special assessment to recapitalize the SAIF
insurance fund up to its statutory goal of 1.25% of insured deposits. The
assessment required the Bank to pay an amount equal to 65.7 basis points of its
SAIF-assessable deposit base as of March 31, 1995, which resulted in a charge to
income during the year ended June 30, 1997 of $519,463.
NOTE J - INCOME TAXES
The components of income tax expense are as follows for the years ended June 30,
1998 and 1997:
1998 1997
---------- ---------
Current tax expense $ 735,925 $423,745
Net deferred benefit included in operations (152,652) (21,497)
--------- --------
$ 583,273 $402,248
========= ========
The differences between the provision for income taxes and the amount computed
by applying the statutory federal income tax rate of 34% to income before income
taxes were as follows for the years ended June 30, 1998 and 1997:
1998 1997
--------- --------
Income tax at federal statutory rate $561,936 $392,616
State income tax, net of federal tax benefit 21,401 5,579
Other (64) 4,053
-------- --------
$583,273 $402,248
======== ========
-34-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE J - INCOME TAXES (Continued)
Deferred tax assets and liabilities arising from temporary differences at June
30, 1998 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Deferred tax assets relating to:
Deferred compensation $ 401,755 $ 286,654
Unrealized losses on investment securities
available for sale - 23,000
--------- ---------
Gross deferred tax assets 401,755 309,654
Valuation allowance - -
--------- ---------
Net deferred tax assets 401,755 309,654
--------- ---------
Deferred tax liabilities relating to:
Unrealized gains on investment securities available for sale (14,000) -
Allowance for loan losses (64,264) (78,838)
Premises and equipment (42,475) (55,910)
FHLB stock dividends (135,948) (135,948)
Loan fees and costs (44,117) (54,115)
--------- ---------
Total deferred tax liabilities (300,804) (324,811)
--------- ---------
Net deferred tax asset (liability) $ 100,951 $ (15,157)
========= =========
</TABLE>
Retained earnings at June 30, 1998 includes approximately $1,400,000 for which
no deferred income tax liability has been recognized. This amount represents an
allocation of income to bad debt deductions for income tax purposes only.
Reductions of the amount so allocated for purposes other than tax bad debt
losses or adjustments arising from carryback of net operating losses would
create income for tax purposes only, which would be subject to the then current
corporate income tax rate.
During 1996, Congress enacted certain tax legislation that exempted thrift
institutions from being taxed on these pre-1987 bad debt reserves. Further, the
use of the reserve method is now required for all thrifts. The Bank will be
recapturing $580,000 of its bad debt reserve created in prior years by using the
percentage of taxable income method, requiring payment of additional income
taxes of approximately $225,000. Deferred income taxes have been previously
established for the taxes arising from the reserve recapture, and thus the
ultimate payment of the taxes will not result in a charge to earnings.
-35-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE K - REGULATORY RESTRICTIONS
Capital Requirements
- --------------------
The Parent is regulated by the Board of Governors of the Federal Reserve System
and is subject to securities registration and public reporting regulations of
the Securities and Exchange Commission. The Bank is regulated by the Federal
Deposit Insurance Corporation ("FDIC") and the Savings Institutions Division,
North Carolina Department of Commerce (the "Administrator").
The Bank is subject to the capital requirements of the FDIC and the
Administrator. The FDIC requires the Bank to maintain minimum ratios of Tier 1
capital to risk-weighted assets and total capital to risk-weighted assets of 4%
and 8%, respectively. Tier 1 capital consists of total shareholders' equity
calculated in accordance with generally accepted accounting principles less
intangible assets, and total capital is comprised of Tier 1 capital plus certain
adjustments, the only one of which applies to the Bank is the allowance for
possible loan losses. Risk-weighted assets refer to the on- and off-balance
sheet exposures of the Bank adjusted for their relative risk levels using
formulas set forth in FDIC regulations. The Bank is also subject to an FDIC
leverage capital requirement, which calls for a minimum ratio of Tier 1 capital
(as defined above) to quarterly average total assets of 3% to 5%, depending on
the institution's composite ratings as determined by its regulators. The
Administrator requires a net worth equal to at least 5% of total assets.
At June 30, 1998, the Bank was in compliance with all of the aforementioned
capital requirements as shown below:
<TABLE>
<CAPTION>
Leverage Tier 1 Risk
Ratio Adjusted Risk-Based N. C. Savings
Tier 1 Capital Capital Capital Bank Capital
--------------- ------------ ------------ --------------
<S> <C> <C> <C> <C>
Consolidated stockholders' equity $15,388,406 $15,388,406 $15,388,406 $15,388,406
Additional equity of the Bank 2,857,094 2,857,094 2,857,094 2,857,094
Unrealized (gain) loss on securities (25,152) (25,152) (25,152) (25,152)
Loan loss allowance - - 437,419 437,419
----------- ----------- ----------- -----------
Regulatory capital 18,220,348 18,220,348 18,657,767 18,657,767
Minimum capital requirement 3,363,000 2,502,000 5,004,000 5,700,000
----------- ----------- ----------- -----------
Excess regulatory capital $14,857,348 $15,718,348 $13,653,767 $12,957,767
=========== =========== =========== ===========
</TABLE>
-36-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
NOTE K - REGULATORY RESTRICTIONS (Continued)
Liquidation Account
- -------------------
At the time of Conversion, the Bank established a liquidation account in an
amount equal to its net worth at June 30, 1996. The liquidation account will be
maintained for the benefit of eligible deposit account holders who continue to
maintain their deposit accounts in the Bank after Conversion. Only in the event
of a complete liquidation will each eligible deposit account holder be entitled
to receive a liquidation distribution from the liquidation account in the amount
of the then current adjusted subaccount balance for deposit accounts then held
before any liquidation distribution may be made from the Bank to the Parent.
Dividends cannot be paid from this liquidation account.
Dividends
- ---------
Subject to applicable law, the Boards of Directors of the Bank and the Parent
may each provide for the payment of dividends. Future declarations of cash
dividends, if any, by the Parent may depend upon dividend payments by the Bank
to the Parent. Subject to regulations of the Administrator, the Bank may not
declare or pay a cash dividend on or repurchase any of its common stock if its
stockholders' equity would thereby be reduced below either the aggregate amount
then required for the liquidation account or the minimum regulatory capital
requirements imposed by federal and state regulations. In addition, for a period
of five years after the Conversion, the Bank will be required, under existing
North Carolina regulations, to obtain prior written approval of the
Administrator before it can declare and pay a cash dividend on its capital stock
in an amount in excess of one-half of the greater of (i) its net income for the
most recent fiscal year, or (ii) the average of its net income after dividends
for the most recent fiscal year and not more than two of the immediately
preceding fiscal years, if applicable.
During the year ended June 30, 1997, the Bank paid dividends of $200,000 to the
Parent. During the year ended June 30, 1998, the Bank did not pay any dividends
to Carolina Fincorp, Inc. However, subsequent to year-end, with the permission
of the NC Administrator, the Bank paid $3,100,000 in dividends to the Company.
Carolina Fincorp, Inc. paid regular quarterly cash dividends totaling $.24 and
$.05 per share during the years ended June 30, 1998 and 1997, respectively, and
a special nonrecurring return of capital dividend of $6.00 per share during the
year ended June 30, 1998.
NOTE L - CONCENTRATION OF CREDIT RISK AND OFF-BALANCE SHEET RISK
The Bank generally originates single-family residential loans within its primary
lending area of Richmond County. The Bank's underwriting policies require such
loans to be made at no greater than 80% loan-to-value based upon appraised
values unless private mortgage insurance is obtained. These loans are secured by
the underlying properties.
-37-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE L - CONCENTRATION OF CREDIT RISK AND OFF-BALANCE SHEET RISK (CONTINUED)
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit on mortgage loans,
standby letters of credit and equity lines of credit. Those instruments involve,
to varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the consolidated statements 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.
A summary of the approximate contract amount of the Bank's exposure to off-
balance sheet risk as of June 30, 1998 is as follows:
<TABLE>
<S> <C>
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit, mortgage loans $ 2,110,000
Undisbursed construction loans 2,418,000
Undisbursed lines of credit 12,332,000
</TABLE>
NOTE M - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company has implemented Statement of Financial Accounting Standards No. 107,
Disclosures about Fair Value of Financial Instruments ("SFAS 107"), which
requires disclosure of the estimated fair values of the Company's financial
instruments whether or not recognized in the balance sheet, where it is
practical to estimate that value. Such instruments include cash and interest-
earning balances in other banks, investment securities, loans held for sale,
loans receivable, stock in the Federal Home Loan Bank of Atlanta, deposit
accounts, advances from the Federal Home Loan Bank, and other borrowed funds.
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Company's entire holdings of a particular financial
instrument. Because no active market readily exists for a portion of the
Company's financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
-38-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE M - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
CASH AND INTEREST-EARNING BALANCES IN OTHER BANKS
The carrying amounts for cash and interest-earning balances in other banks
approximate fair value because of the short maturities of those
instruments.
INVESTMENT SECURITIES
Fair value for investment securities equals quoted market price if such
information is available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities.
LOANS HELD FOR SALE
Fair value for loans held for sale is determined by available market
prices.
LOANS RECEIVABLE
For certain homogenous categories of loans, such as residential mortgages,
fair value is estimated using the quoted market prices for securities
backed by similar loans, adjusted for differences in loan characteristics.
The fair value of other types of loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities.
STOCK IN FEDERAL HOME LOAN BANK OF ATLANTA
The fair value for FHLB stock is its carrying value, since this is the
amount for which it could be redeemed. There is no active market for this
stock, and the Bank is required to maintain a minimum balance based on the
unpaid principal of home mortgage loans.
DEPOSIT LIABILITIES
The fair value of demand deposits is the amount payable on demand at the
reporting date. The fair value of certificates of deposit is estimated
using the rates currently offered for deposits of similar remaining
maturities.
-39-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE M - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWED FUNDS
The fair values of these advances and borrowings are based upon the
discounted value using current rates at which borrowings of similar
maturity could be obtained.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
With regard to financial instruments with off-balance sheet risk discussed
in Note L, it is not practicable to estimate the fair value of future
financing commitments.
The carrying amounts and estimated fair values of the Company's financial
instruments, none of which are held for trading purposes, are as follows at June
30, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------------------------ ------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
--------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and interest-earning balances in
other banks $ 8,772,027 $ 8,772,027 $ 3,652,420 $ 3,652,420
Investment securities 15,965,147 16,024,727 24,662,067 24,625,455
Loans held for sale 1,057,045 1,074,545 - -
Loans receivable 83,622,584 86,222,000 78,674,342 80,611,473
Stock in FHLB of Atlanta 734,700 734,700 734,700 734,700
Financial liabilities:
Deposits 93,414,753 92,528,000 83,759,560 82,127,429
Advances from Federal Home Loan Bank - - 500,000 501,350
Other borrowed funds 3,200,000 3,193,000 - -
</TABLE>
-40-
<PAGE>
CAROLINA FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
================================================================================
NOTE N - PARENT COMPANY FINANCIAL DATA
Following are condensed financial statements of Carolina Fincorp, Inc. as of and
for the periods ended June 30, 1998 and 1997:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Assets:
Cash $ 423,285 $ 814,741
Investment securities available for sale - 7,736,990
Investment in Richmond Savings Bank, Inc., SSB 18,220,348 16,804,111
Accrued interest receivable - 88,637
Other assets 5,480 4,415
----------- -----------
$18,649,113 $25,448,894
=========== ===========
Liabilities and Stockholders' Equity:
Liabilities:
Accounts payable $ - $ 850
Accrued expenses and other liabilities 60,707 -
Other borrowed funds 3,200,000 -
----------- -----------
Total liabilities 3,260,707 850
----------- -----------
Stockholders' equity:
Common stock 7,852,262 17,585,611
Deferred management recognition plan (477,504) -
ESOP note receivable (1,392,166) (1,491,000)
Unearned compensation (661,000) -
Retained earnings 10,041,662 9,372,546
Unrealized holding gain (loss), net of tax 25,152 (19,113)
----------- -----------
15,388,406 25,448,044
----------- -----------
$18,649,113 $25,448,894
=========== ===========
</TABLE>
CONDENSED STATEMENTS OF OPERATIONS
YEAR ENDED JUNE 30, 1998 AND PERIOD FROM NOVEMBER 22, 1996 TO JUNE 30, 1997
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Equity in earnings of subsidiaries $ 779,260 $ 620,503
Interest income 596,019 362,693
Operating expenses (134,306) (37,052)
Interest expense (9,956) -
Income taxes (161,537) (114,558)
---------- ---------
Net income $1,069,480 $ 831,586
========== =========
</TABLE>
-41-
<PAGE>
CAROLINA FINCORP, INC.
COMMON STOCK
================================================================================
The Company's stock began trading on November 25, 1996. There are 1,905,545
shares of common stock outstanding which were held by approximately 660
stockholders of record (excluding shares held in street name) on June 30, 1998.
The Company's common stock is quoted on the NASDAQ National Market under the
symbol "CFNC." The following table reflects the stock trading and dividend
payment frequency of the Company for the year ended June 30, 1998 and 1997.
<TABLE>
<CAPTION>
Stock price Dividends, per share
-------------- --------------------
High Low Regular Special
------ ------ --------- ---------
<S> <C> <C> <C> <C>
For the year ended June 30, 1998:
First quarter ending September 30 $17.88 $15.00 $0.06 $ -
Second quarter ending December 31 $18.50 $17.25 $0.06 $ -
Third quarter ending March 31 $18.75 $17.13 $0.06 $ -
Fourth quarter ending June 30 $19.75 $ 9.50 $0.06 $6.00
For the year ended June 30, 1997:
First quarter ending September 30 $ - $ - $ - $ -
Second quarter ending December 31 $13.75 $12.50 $ - $ -
Third quarter ending March 31 $15.25 $13.25 $ - $ -
Fourth quarter ending June 30 $15.38 $14.00 $0.05 $ -
</TABLE>
-42-
<PAGE>
CAROLINA FINCORP, INC.
CORPORATE INFORMATION
================================================================================
Executive Officers
R. Larry Campbell John W. Bullard
President and CEO Vice President and COO
Winston G. Dwyer
Treasurer and CFO
Directors
J. Stanley Vetter - Chairman Joe M. McLaurin
Physician Retired Corporate Executive
John T. Page, Jr. - Vice Chairman Russell E. Bennett, Jr.
Retired Attorney Retired Corporate Executive
E.E. Vuncannon, Jr. W. Jesse Spencer
President - E.E. Vuncannon, Inc. Certified Public Accountant
Buena Vista Coggin R. Larry Campbell
Retired Corporate Executive President - Carolina Fincorp, Inc.
<TABLE>
<CAPTION>
STOCK TRANSFER AGENT ANNUAL MEETING
<S> <C>
Registrar and Transfer Company The 1998 annual meeting of stockholders of Carolina Fincorp, Inc. will be
10 Commerce Drive held at 1:00 p.m. on November 18, 1998 at the Calvin Little Room, Thomas
Cranford, NJ 07016 H. Leath Memorial Library, 412 East Franklin Street, Rockingham, NC
SPECIAL LEGAL COUNSEL FORM 10-KSB
Brooks, Pierce, McLendon, A COPY OF FORM 10-KSB AS FILED WITH THE SECURITIES AND EXCHANGE
Humphrey & Leonard, L.L.P. COMMISSION WILL BE FURNISHED WITHOUT CHARGE TO THE COMPANY'S STOCKHOLDERS
2000 Renaissance Plaza FOR THE COMPANY'S MOST RECENT FISCAL YEAR UPON WRITTEN REQUEST TO R.
230 North Elm Street LARRY CAMPBELL, PRESIDENT, CAROLINA FINCORP, INC., 115 SOUTH LAWRENCE
Greensboro, NC 27420 STREET, ROCKINGHAM, NC 28379.
INDEPENDENT AUDITORS Corporate Office
Dixon Odom PLLC 115 South Lawrence Street
6 Turnberry Wood Rockingham, NC 28379
Southern Pines, NC 28387
</TABLE>
This annual report has not been reviewed or confirmed for accuracy or relevance
by the Federal Deposit Insurance Corporation.
-43-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 961
<INT-BEARING-DEPOSITS> 7,811
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 10,295
<INVESTMENTS-CARRYING> 5,670
<INVESTMENTS-MARKET> 5,730
<LOANS> 85,117
<ALLOWANCE> 437
<TOTAL-ASSETS> 113,911
<DEPOSITS> 93,415
<SHORT-TERM> 3,200
<LIABILITIES-OTHER> 1,908
<LONG-TERM> 0
0
0
<COMMON> 7,852
<OTHER-SE> 7,536
<TOTAL-LIABILITIES-AND-EQUITY> 113,911
<INTEREST-LOAN> 6,910
<INTEREST-INVEST> 1,718
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 8,628
<INTEREST-DEPOSIT> 4,108
<INTEREST-EXPENSE> 4,122
<INTEREST-INCOME-NET> 4,506
<LOAN-LOSSES> 92
<SECURITIES-GAINS> 1
<EXPENSE-OTHER> 3,385
<INCOME-PRETAX> 1,653
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,069
<EPS-PRIMARY> .61
<EPS-DILUTED> .61
<YIELD-ACTUAL> 4.12
<LOANS-NON> 124
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 37
<ALLOWANCE-OPEN> 400
<CHARGE-OFFS> 60
<RECOVERIES> 5
<ALLOWANCE-CLOSE> 437
<ALLOWANCE-DOMESTIC> 334
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 103
</TABLE>
