UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(NO FEE REQUIRED EFFECTIVE OCTOBER 7, 1996)
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
Commission File Number: 333-12373
SOUTHERN COMMUNITY BANCSHARES, INC.
(Exact name of small business issuer as specified in its charter)
Delaware 63-1176408
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
325 2nd Street, S.E., Cullman, AL 35055
(Address of principal executive offices) (Zip Code)
The registrant's telephone number, including area code: (256) 734-4863
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
par value $0.01 per share
The registrant (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 and (2) has been subject to such filing requirements for the
past 90 days.
Disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is not contained in this form, and disclosure will not be
contained, to the best of the registrant's knowledge, in the
definitive proxy statement incorporated by reference in Part III of
this Form 10-KSB.
The registrant's revenues for its most recent fiscal year were
$5,416,000.
The aggregate market value of the registrant's outstanding common
stock held by non-affiliates of the registrant at September 30, 1998
was approximately $5,459,474 (based on 408,185 shares at the most
recent trading price of which management was aware ($13.375 on
December 18, 1998) (for this purpose, the registrant's directors and
executive officers and stock benefit plans and trusts have not been
deemed to be non-affiliates).
The total number of outstanding shares of the registrant's common
stock at September 30, 1998 was 1,080,482.
Transitional small business disclosure format: No.
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
The following portions of the Southern Community Bancshares, Inc.
Annual Report to Shareholders for the fiscal year ended September 30,
1998, are incorporated by reference into Part II of this Form 10-KSB:
1. Market Price of Common Shares and Related Shareholder Matters;
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations; and
3. Consolidated Financial Statements.
The following portions of the definitive Proxy Statement for the 1998
Annual Meeting of Shareholders of Southern Community Bancshares, Inc.
are incorporated by reference into Part III of this Form 10-KSB:
1. Voting Securities and Ownership of Certain Beneficial Owners
and Management.
<PAGE>
ITEM 1.--DESCRIPTION OF BUSINESS
General
The Holding Company is a Delaware corporation organized at the
direction of the Association for the purpose of purchasing all of the
capital stock of the Association to be issued in connection with the
Conversion. Before the conversion, the Holding Company did not engage
in any material operations. The Holding Company is a unitary savings
and loan holding company, the principal assets consist of the capital
stock of the Association and the investments made with the net
proceeds retained from the sale of Common Shares in connection with
the Conversion. The office of the Holding Company is located at 325
2nd Street, S.E., Cullman, Alabama, and its telephone number is
(256) 734-4863.
The Association is a federal stock savings and loan association which
was organized in 1905. As a federal savings and loan association, the
Association is subject to supervision and regulation by the OTS. The
Association is a member of the Federal Home Loan Bank (the "FHLB") of
Atlanta, and the deposit accounts of the Association are insured up to
applicable limits by the FDIC in the Savings Association Insurance
Fund (the "SAIF"). The Association conducts business from its offices
in Cullman County, Alabama, and its executive office is located at 325
2nd Street, S.E., Cullman, Alabama. At September 30, 1998, the
Association had $66,8 million of total assets, $55.7 million of total
liabilities, including $55.6 million of deposits, and $11.1 million of
equity.
The Association is principally engaged in the business of originating
mortgage loans secured by first mortgages on one-to-four family
residential real estate located in Cullman County, Alabama, the
Association's primary market area. Such loans account for $28.0
million and $25.6 million at September 30, 1998 and 1997,
respectively. The Association also originates loans for the
construction of residential real estate and construction and permanent
mortgage loans secured by multifamily real estate (over four units)
and nonresidential real estate in its primary market area. Such loans
account for $12.3 million and $13.5 million of total loans,
respectively. In addition to real estate lending, the Association
originates a limited number of commercial loans and secured and
unsecured consumer loans. The stated loans account for $7.3 million
and $5.6 million of total loans, respectively. For liquidity and
interest rate risk management purposes, the Association invests in
interest-bearing deposits in other financial institutions, U.S.
Government and agency obligations, mortgage-backed securities, and
other investments permitted by applicable law. As of September 30,
1998, the carrying value of investments that management has the intent
and ability to hold until maturity was $1.8 million and the carrying
value of investments that were available for sale was $8.6_ million.
In addition, as of that same date, the Association's aggregate cash
and interest-bearing deposits in other banks totaled $9.6 million.
Funds for lending and other investment activities are obtained
primarily from savings deposits, which are insured up to applicable
limits by the FDIC, and loan principal repayments.
Historically, the Association has operated as a traditional savings
and loan association, emphasizing the origination of loans secured by
single-family residences. The Association has recently focused on
increasing consumer and commercial lending.
Interest on loans and investments is the Association's primary source
of income. The Association's principal expense is interest paid on
deposit accounts. Operating results are dependent to a significant
degree on the net interest income of the Association, which is the
difference between interest income earned on loans, mortgage-backed
securities and other investments, and interest paid on deposits and
borrowings. Like most thrift institutions, the Association's interest
income and interest expense are significantly affected by general
economic conditions and by the policies of various regulatory
authorities.
Market Area
The Association conducts business from its office in Cullman, Alabama.
The Association's primary market area for lending and deposit activity
is Cullman County, Alabama.
Cullman County's economy is principally agricultural, light industry,
and manufacturing. Cullman County is among the largest poultry
producing counties in the United States. For the period 1994 to 1999,
the population of Cullman County is projected to grow by 5.20% and the
City of Cullman's population is projected to grow by 7.73%. The
projected population growth of 5.20% for the county is projected to be
above that of Alabama at 3.47% and level with the United States at
5.28%. The projected population growth for the City at 7.73% exceeds
the projections for the United States, Alabama, and Cullman County.
Income levels in Cullman County are below averages for the State of
Alabama and the United States according to demographic statistics.
For 1994, average per capita income for Cullman County was 12% below
and 30% below, respectively, average per capita income for Alabama and
the United States, respectively. For 1999, average per capita income
for Cullman County is projected to be 12% and 31% below, respectively,
average per capita income for Alabama and the United States, respectively.
Cullman County has no single, dominant employer. The largest employer
in the county is the Wal-Mart Distribution Center with approximately
1,500 employees.
The Association is one of two thrift institutions based in Cullman
County and had a 42% share of the County's thrift deposits and a .74%
share of all deposits in the county, as of Sept. 30, 1998.
Lending Activities
General. The Association's principal lending activity is the
origination of conventional real estate loans, including construction
loans, secured by one- to four-family homes located in the
Association's primary market area. Loans secured by multifamily
properties containing five units or more and by nonresidential real
estate and loans for the construction of residences and other
properties are also offered by the Association. In addition to real
estate lending, the Association originates commercial loans and
consumer loans, including loans secured by deposit accounts,
automobile loans, and a limited number of other secured and unsecured
loans.
Since the enactment of FIRREA in 1989, a savings association generally
may not make loans to one borrower and related entities in an amount
which exceeds 15% of its unimpaired capital and surplus, although
loans in an amount equal to an additional 10% of unimpaired capital
and surplus may be made to a borrower if the loans are fully secured
by readily marketable securities. At September 30, 1998, the
Association's loans-to-one borrower limit was $1.7 million and its
five largest loans or groups of loans-to-one borrower, including
related entities, were $1,454,000, $1,130,000, $697,000, $552,000 and
$525,000. Each of these loans is secured by real estate, a
substantial portion of which is rental property. All of these loans
or groups of loans were performing in accordance with their terms at
September 30, 1998.
<PAGE>
Loan Portfolio Composition. The following table sets forth the
composition of the Association loan portfolio by type of loan at the
dates indicated:
<TABLE>
<CAPTION>
September 30,
-----------------------------------------
1998 1997
----------------- ------------------
Amount % Amount %
------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans:
One-to four-family $27,972 61.01% $25,617 59.58%
Nonresidential 8,384 18.29 8,077 18.78
Multifamily 2,514 5.48 4,172 9.70
Construction 1,358 2.96 1,267 2.95
------- ------- ------- -------
Total real estate loans 40,228 87.74 39,133 91.01
------- ------- ------- -------
Commercial loans 3,658 7.98 2,294 5.34
------- ------- ------- -------
Consumer loans:
Automobile loans 1,477 3.22 1,535 3.57
Loans on deposits 518 1.13 518 1.20
Other consumer loans 1,608 3.51 1,311 3.05
------- ------- ------- -------
Total consumer loans 3,603 7.86 3,364 7.82
------- ------- ------- -------
Total loans 47,489 103.58 44,791 104.17
------- ------- ------- -------
Less:
Undisbursed portion of loans
in progress 691 1.51 816 1.90
Unearned and deferred income 162 0.35 170 .40
Allowances for loan losses 790 1.72 806 1.87
------- ------- ------- -------
Net loans $45,846 100.00% $42,999 100.00%
======= ======= ======= =======
</TABLE>
<PAGE>
Contractual Principal Repayments and Interest Rates. The following
table sets forth certain information at September 30, 1998 regarding
the dollar amount of loans maturing in the Association's portfolio,
based on the contractual terms to maturity, before giving effect to
net items. Demand loans, loans having no stated schedule of
repayments and no stated maturity and overdrafts are reported as due
in one year.
<TABLE>
<CAPTION>
Over
Due in 1 Year
1 Year Through Over
or Less 5 Years 5 Years Total
------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C>
Mortgage Loans:
Adjustable $ 7,219 $ 5,881 $ 2,376 $15,476
Fixed 628 6,985 17,139 24,752
Consumer 1,957 1,646 0 3,603
Commercial 1,838 554 1,266 3,658
------- ------- ------- -------
Total $11,642 $15,066 $20,781 $47,489
======= ======= ======= =======
</TABLE>
The following table sets forth the dollar amount of all loans, before
net items, due after one year from September 30, 1998 which have fixed
interest rates or which have adjustable interest rates.
Fixed Rates
(In thousands)
Fixed rates of interest $27,590
Adjustable rates of interest 8,257
--------
Total $35,847
========
Scheduled contractual amortization of loans does not reflect the
actual term of the Association's loan portfolio. The average life of
loans is substantially less than their contractual terms because of
prepayments and due-on-sale clauses, which give the Association the
right to declare a conventional loan immediately due and payable in
the event, among other things, that the borrower sells the real
property subject to the mortgage.
Loan Solicitation and Processing. Loan originations are developed
from a number of sources, including continuing business with
depositors, other borrowers and real estate developers, solicitations
by the Association's lending staff and walk-in customers.
Loan applications for permanent real estate loans are taken by loan
personnel at the Association's office. The Association typically
obtains a credit report, verification of employment, and other
documentation concerning the creditworthiness of the borrower. An
appraisal of the fair market value of the real estate which will be
given as security for the loan is prepared by an appraiser approved by
the Board of Directors. Upon the completion of the appraisal and the
receipt of information on the credit history of the borrower, the
application for a loan is submitted for review in accordance with the
Association's underwriting guidelines. All real estate loans are
approved by the Loan Committee of the Association (the Loan Committee
is comprised of two members, Mr. Eston Jones and Mr. Daniel Keel).
Loans not secured by real estate may be approved by the President or
the Vice President-Lending of the Association for amounts less than
$20,000. Loans not secured by real estate in amounts in excess of
$20,000 require approval of the Loan Committee. Any loan in an amount
in excess of $250,000 requires the approval of the full Board of
Directors of the Association.
If a mortgage loan application is approved, the Association typically
obtains an attorney's opinion of title. The Association obtains title
insurance on only approximately 5% of its loans secured by real
estate. Borrowers are required to carry satisfactory fire and
casualty insurance and flood insurance, if applicable, and to name the
Association as an insured mortgagee.
The procedure for approval of construction loans is the same as for
permanent real estate loans, except that an appraiser evaluates the
building plans, construction specifications, and estimates of
construction costs. The Association also evaluates the feasibility of
the proposed construction project and the experience and record of the
builder. Once approved, the construction loan is disbursed in
portions based upon periodic inspections of construction progress.
Consumer loans are underwritten on the basis of the borrower's credit
history and an analysis of the borrower's income and expenses, ability
to repay the loan, and the value of the collateral, if any.
Loan Originations. The Association currently originates a variety of
mortgage loans, including adjustable and fixed rate loans. The
Association is an approved seller/servicer for the Federal Home Loan
Mortgage Corporation (FHLMC) and as such, originates loans for the
various programs of FHLMC. Further, the Association originates
certain first and second mortgage loans secured by single family
dwellings which are nonconforming.
At September 30, 1998, the Association owns loan participation
interests in 10 loans with an aggregate outstanding balance of
approximately $4.5 million. These loans consist of both adjustable
and fixed rate loans. The Association is the lead lender on one loan
of the 10, which loan has an outstanding balance of $279,000 at
September 30, 1998. The remaining 9 loans are serviced by other
lending institutions. All participation loans are performing and
secured by first mortgages. The participation loans are secured by
various types of properties, including multifamily residences,
shopping centers, office buildings, and a country club, some of which
are outside of the Association's primary market area. The Association
does not currently intend to originate or purchase additional loan
participations outside their market area.
The following table shows total loans originated, loan reductions, and
the net increase in the Association's loan portfolio during the
periods indicated:
<TABLE>
<CAPTION>
Year Ended
September 30,
1998 1997
--------- ---------
(In thousands)
<S> <C> <C>
Loans originated:
One-to-four family residential $ 10,876 $ 8,626
Multifamily residential 573 568
Nonresidential 2,061 660
Construction 2,590 1,758
Commercial 1,947 1,674
Consumer 2,658 3,093
--------- ---------
Total loans originated 20,705 16,379
Principal repayments (18,007) (13,504)
Increase (decrease) in other items, net (1) 149 523
--------- ---------
Net increase (decrease) $ 2,847 $ 3,398
========= =========
(1) Other items consist of deferred loan fees, allowance for loan
losses and the undisbursed portion of construction loans.
</TABLE>
Loans Secured by One- to Four-Family Residences. The principal
lending activity of the Association is the origination of conventional
loans secured by first mortgages on one- to four-family residences,
primarily single-family residences located within the Association's
primary market area. At September 30, 1998, the Association's one- to
four-family residential loans totaled approximately $28.0 million, or
61.0% of total loans.
OTS regulations limit the amount which the Association may lend in
relationship to the appraised value at the time of loan origination of
the real estate and improvements which will secure the loan (the
"LTV"). In accordance with such regulations and laws, and as a matter
of policy established by the Board of Directors of the Association,
the Association makes loans secured by one- to four-family residences
for not more than a 85% LTV.
ARMs are currently offered by the Association for terms of up to 20
years. On ARMs currently offered by the Association, the interest
rate adjustment periods are one year and rates are adjusted in
accordance with the weekly average yield on United States Treasury
securities adjusted to a constant maturity of one year. The new
interest rate at each change date is determined by adding a margin of
2.75% to the prevailing index. On ARMs currently offered by the
Association, the maximum allowable adjustment at each adjustment date
is 2.0% and the maximum allowable adjustment over the term of the loan
is 6.0%.
Although ARMs decrease the Association's interest rate risk, such
loans involve other risks. As interest rates rise, for example, the
payment by the borrower increases to the extent permitted by the terms
of the loan. Such increases in the payment may increase the potential
for default. Moreover, the marketability of the underlying property
may be adversely affected by a general increase in interest rates.
The Association believes that such risks have not had a material
adverse effect on the Association to date.
The Association currently offers fixed rate loans for terms of 15, 20,
and 30 years. The fixed-rate loans are competitively priced based on
market conditions and the Association's cost of funds.
Loans Secured by Multifamily Residences. In addition to loans on one-
to four-family properties, the Association originates loans secured by
multifamily properties which contain more than four units. At
September 30, 1998, loans secured by multifamily residences totaled
approximately $2.5 million, or 5.5% of total loans. At September 30,
1998, the largest single loan secured by a multifamily residence was
$1.4 million and was performing in accordance with its terms.
Multifamily loans are offered with adjustable or fixed rates for terms
of up to 20 years and have LTVs up to 80%.
Multifamily lending is generally considered to involve a higher degree
of risk than one- to four-family residential lending because the
borrower typically depends upon income generated by the project to
cover operating expenses and debt service. The profitability of a
project can be affected by economic conditions, government policies,
and other factors beyond the control of the borrower. The Association
attempts to reduce the risk associated with multifamily lending by
evaluating the creditworthiness of the borrower and the projected
income from the project and by obtaining personal guarantees on loans
made to corporations and partnerships.
Loans Secured by Nonresidential Real Estate. The Association also
originates loans for the purchase of nonresidential real estate. At
September 30, 1998, approximately $8.4 million, or 18.3%, of the
Association's total loans were secured by mortgages on nonresidential
real estate. At such date, the largest single loan secured by
nonresidential real estate was $1.5 million and was performing in
accordance with its terms. The Association's nonresidential real
estate loans have adjustable rates or fixed rates, terms of up to 30
years, and LTVs of up to 80%. The Association also makes loans for
the construction of nonresidential real estate.
Although loans secured by nonresidential real estate have higher
interest rates than one- to four-family residential real estate loans,
nonresidential real estate lending is generally considered to involve
a higher degree of risk than residential lending due to the relatively
larger loan amounts and the effects of general economic conditions on
the successful operation of income-producing properties. The
Association has endeavored to reduce such risk by evaluating the
credit history and past performance of the borrower, the location of
the real estate, the financial condition of the borrower, the quality
and characteristics of the income stream generated by the property,
and appraisals supporting the property's valuation.
Construction Loans. The Association makes loans for the construction
of single-family houses, multifamily properties, and nonresidential
real estate projects. Of the loans made by the Association for
construction of single-family residences, all are made to
owner-occupants or to professional builders.
Construction loans are offered with adjustable or fixed rates for
terms of up to one year. At September 30, 1998, the Association's
loan portfolio included $1.4 million in construction loans, or 3.0% of
total loans. The majority of construction loans were for construction
of residential properties.
Construction loans, particularly loans involving nonresidential real
estate, generally involve greater underwriting and default risks than
do loans secured by mortgages on existing properties. Loan funds are
advanced upon the security of the project under construction, which is
more difficult to value before the completion of construction.
Moreover, because of the uncertainties inherent in estimating
construction costs, it is relatively difficult to evaluate accurately
the LTV and the total loan funds required to complete a project. In
the event a default on a construction loan occurs and foreclosure
follows, the Association would have to take control of the project and
attempt either to arrange for completion of construction or dispose of
the unfinished project.
All of the Association's loans are secured by property in the
Association's primary market area.
Commercial Loans. The Association makes commercial loans to
businesses in its primary market area. Such loans are typically
secured by a security interest in equipment, nonresidential real
estate, or other assets of the borrower. At September 30, 1998, the
Association's commercial loan portfolio totaled $3.7 million, or 8.0%
of total loans.
Consumer Loans. The Association makes various types of consumer
loans, including loans made to depositors on the security of their
deposit accounts, automobile loans, home improvement loans, and other
secured loans and unsecured personal loans. Consumer loans are made
at variable or fixed rates of interest and for varying terms based on
the type of loan. At September 30, 1998, the Association had
approximately $3.6 million, or 7.9% of total loans, invested in
consumer loans.
Consumer loans, particularly consumer loans which are unsecured or are
secured by depreciating assets such as automobiles, may entail greater
risk than residential real estate loans. Repossessed collateral for a
defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance. The risk of default on
consumer loans increases during periods of recession, high
unemployment, and other adverse economic conditions.
Loan Origination and Other Fees. The Association realizes loan
origination fees and other fee income from its lending activities and
also realizes income from late payment of charges, application fees,
and fees for other miscellaneous services.
Loan origination fees and other fees are a volatile source of income,
varying with the volume of lending, loan repayments, and general
economic conditions. All nonrefundable loan origination fees and
certain direct loan origination costs are deferred and recognized in
accordance with SFAS No. 91 as an adjustment to yield over the life of
the related loan. At September 30, 1998, the Association had $162,000
of net loan fees which had been deferred and are being recognized as
income over the estimated maturities of the related loans.
Non-performing Assets. Non-performing assets include nonaccruing
loans, real estate acquired by foreclosure or by deed-in-lieu thereof,
in-substance foreclosures, and repossessed assets. The Association
ceases to accrue interest on real estate loans if the collateral value
is not adequate, in the opinion of management, to cover the
outstanding principal and interest. Prior to 1997, the Association
reviewed loans which were 90 days or more delinquent and made a
determination, based upon its estimation of collectibility, whether to
continue to accrue, or to cease accruing, interest on such loan.
During 1997, the Association implemented a new policy ceasing the
accrual of interest on all loans which were 90 days or more
delinquent.
Real estate acquired by the Association as a result of foreclosure
proceedings is classified as real estate owned ("REO") until it is
sold. When property is so acquired, such property is recorded by the
Association at the fair value of the real estate, less estimated
selling expenses, at the date of acquisition and any write-down
resulting therefrom is charged to the allowance for loan losses. All
costs incurred in maintaining REO property are expenses from the date
the property is acquired. Costs relating to the development and
improvement of the property are capitalized to the extent of fair
value
As of September 30, 1998, the Association's total non-performing loans
amounted to $103,000, or 0.2% of total net loans, compared to
$265,000, or 0.6% of total net loans at September 30, 1996.
The following table sets forth information with respect to the accrual
and nonaccrual status of the Association's loans and other
non-performing assets at the dates indicated:
<TABLE>
<CAPTION>
September 30,
1998 1997
------- -------
(In thousands)
<S> <C> <C>
Accruing loans delinquent 90+ days $ 0 $ 0
Loans accounted for on a nonaccrual basis:
Real estate:
One- to four-family 103 263
Multifamily 0 0
Nonresidential 0 0
Consumer 0 2
------- -------
Total nonaccrual loans 103 265
------- -------
Total non-performing loans 103 265
------- -------
Real estate owned (1) 3 0
------- -------
Total non-performing assets $ 106 $ 265
======= =======
Allowance for loan losses $ 790 $ 806
======= =======
Non-performing assets as a percent of total loans 0.2% 0.6%
======= =======
Non-performing loans as a percent of total loans 0.2% 0.6%
======= =======
Allowance for loan losses as a percent of
non-performing loans 767.0% 304.2%
======= =======
(1) Consists of real estate acquired by foreclosures.
</TABLE>
Interest income foregone on non-accrual loans was not significant for
any period shown.
Classified Assets. The Association classifies its own assets on a
quarterly basis in accordance with federal regulations and Association
policy. Problem assets are classified as "substandard," "doubtful,",
or "loss." "Substandard" assets have one or more defined weaknesses
and are characterized by the distinct possibility that the Association
will sustain some loss if the deficiencies are not corrected.
"Doubtful" assets have the same weaknesses as "substandard" assets,
with the additional characteristics that (i) the weaknesses make
collection or liquidation in full, on the basis of currently existing
facts, conditions, and values, questionable and (ii) there is a high
possibility of loss. An asset classified "loss" is considered
uncollectible and of such little value that its continuance as an
asset of the Association is not warranted.
The aggregate amounts of the Association's classified loans at the
dates indicated were as follows:
September 30,
1998 1997
(In thousands)
Classified loans:
Substandard $112 $281
Doubtful 0 0
Loss 96 97
---- -----
Total classified loans $208 $378
==== =====
The Association establishes general allowances for loan losses for any
loan classified as substandard or doubtful. If an asset, or portion
thereof, is classified as a loss, the Association establishes specific
allowances for losses in the amount of 100% of the portion of the
asset classified loss. Generally, the Association charges off the
portion of any real estate loan deemed to be uncollectible.
The Association analyzes each classified asset on a quarterly basis to
determine whether changes in the classifications are appropriate under
the circumstances. Such analysis focuses on a variety of factors,
including the amount of any delinquency and the reasons for the
delinquency, if any, the use of the real estate securing the loan, the
status of the borrower, and the appraised value of the real estate.
As such factors change, the classification of the asset will change
accordingly.
Allowance for Loan Losses. Senior management, with oversight by the
Board of Directors, reviews on a quarterly basis the allowance for
loan losses as it relates to a number of relevant factors, including,
but not limited to, trends in the level of delinquent and
nonperforming assets and classified loans, current and anticipated
economic conditions in the primary lending area, past loss experience,
and possible losses arising from specific problem assets. To a lesser
extent, management also considers loan concentrations to single
borrowers and changes in the composition of the loan portfolio. While
management believes that it uses the best information available to
determine the allowance for loan losses, unforeseen market conditions
could result in adjustments and net income could be significantly
affected if circumstances differ substantially from the assumptions
used in making the final determination. The amounts in the provisions
for loan losses shown in the table below for 1996 through 1998 were
determined based upon past loan experience, a review of individual
specific problem loans, if any, the estimated value of the underlying
collateral, and the prevailing economic conditions.
At September 30, 1998, the Association's allowance for loan losses was
$790,000 compared to $806,000 at September 30, 1997. The following
table sets forth an analysis of the Association's allowance for loan
losses for the periods indicated:
<TABLE>
<CAPTION>
1998 1997 1996
------ ----- -----
(In thousands)
<S> <C> <C> <C>
Balance at beginning of period $806 $802 $624
Charge-offs (24) (56) (20)
Recoveries 8 60 8
------ ----- -----
Net (charge-offs) recoveries 16 4 (12)
Provision for loan losses 0 190
------ ----- -----
Balance at end of year $790 $806 $802
====== ===== =====
Ratio of net (charge-offs) recoveries
to average loans outstanding during
the period (.04)% (.01)% .03%
====== ===== =====
Ratio of allowance for loan losses to
total loans 1.72% 1.87 % 1.95%
====== ===== =====
</TABLE>
The following table presents the allocation of the allowance for loan
losses to the total amount of net loans in each category listed at the
dates indicated.
<TABLE>
<CAPTION>
September 30,
-----------------------------------------------
1998 1997
-------------------- ----------------------
% of Loans % of Loans
in Each in Each
Category to Category to
Amount Total Loans Amount Total Loans
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Real estate loans $343 87.7% $ 41 91.0%
Commercial loans 127 8.0 100 5.3
Consumer loans 90 7.9 84 7.8
Unallocated 230 0 288 0
---- ------ ---- ------
Total $790 103.6% $806 104.2%
==== ====== ==== ======
</TABLE>
Securities
The Association accounts for its investments in accordance with the
provisions of Statement of Financial Accounting Standards ("SFAS")
No. 115, Accounting for Certain Investments in Debt and Equity
Securities. Securities classified as held-to-maturity are stated at
cost, adjusted for amortization of premiums and accretion of discounts
on the constant effective yield method. The Association has the
positive intent and ability to hold these securities to maturity.
Available-for-sale securities are carried at fair value and include
all debt and equity securities not classified as held-to-maturity or
trading. Trading securities are those held principally for the
purpose of selling in the near future and are carried at fair value.
The Association does not currently have any trading securities.
Unrealized holding gains and losses for trading securities are
included in earnings. Unrealized holding gains and losses for
available-for-sale securities are excluded from earnings and reported,
net of any income tax effect, as a separate component of retained
earnings. Realized gains and losses for securities classified as
either available-for-sale or held-to-maturity are reported in earnings
based on the adjusted cost of the specific security sold.
The Company's securities portfolio includes mortgage-backed securities
which are insured or guaranteed by the FHLMC, GNMA, or the FNMA, all
of which are backed by FHLMC, GNMA, and FNMA securities.
Mortgage-backed securities increase the quality of the Company's
assets by virtue of the guarantees that back them, are more liquid
than individual mortgage loans and may be used to collateralize
borrowings or other obligations of the Company. Investments in
mortgage-backed securities as well as investments in other investment
securities are managed by the Company's Investment Committee in
accordance with the Company's Portfolio and Investment Policy.
The following table sets forth the carrying value of the Company's
investment portfolio at the dates indicated:
<TABLE>
<CAPTION>
September 30,
1998 1997
--------- --------
(In thousands)
<S> <C> <C>
Available for sale (1):
U.S. Treasury and federal agencies $ 1,984 $ 6,983
Equity securities 140,000 0
Federal Home Loan Bank stock 430 430
--------- --------
Investment securities 2,554 7,413
Mortgage-backed securities 6,039 5,583
--------- --------
Total $ 8,593 $ 12,996
========= ========
Held to maturity (2):
U.S. Treasury and federal agencies $ 849 $ 1,348
Obligations of state and political subdivisions 150 150
--------- --------
Investment securities 999 1,498
Mortgage-backed securities 837 2,027
--------- --------
Total $ 1,836 $ 3,525
========= ========
(1) The carrying value is the approximate fair value of the security at each
reporting date.
(2) The carrying value is the amortized cost of the security at each
reporting date.
</TABLE>
<PAGE>
<TABLE>
The following table sets forth information regarding the scheduled maturities, amortized costs, fair value and weighted average
yields for the Association's securities at September 30, 1998:
<CAPTION>
One Year or Less One to Five Years Five to Ten Years After Ten Years Total
------------------- ------------------- ------------------- ------------------ ----------------- Fair
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Market
Value Yield Value Yield Value Yield Value Yield Value Yield Value
---------- ------ ---------- ------ -------- ------ ---------- ----- ---------- ----- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Available for sale:
U.S. Treasury and
federal agencies $1,249,212 6.05% $ 728,756 5.95% $ 0 0.00% $ 0 0.00% $1,977,968 6.02% $1,984,287
Equities and
Federal Home Loan
Bank stock
569,800 3.60% 569,800 3.60 569,800
Mortgage-backed
securities 140,932 5.20% 3,040,618 5.88% 303,880 5.93% 2,532,889 6.02 6,018,319 5.93 6,038,694
---------- ---- ---------- ---- -------- ---- ---------- ---- ---------- ---- ----------
Total $1,390,144 5.97% $3,769,374 5.90% $303,880 5.93% $3,102,689 5.58% $8,566,087 5.79% $8,592,781
========== ==== ========== ==== ======== ==== ========== ==== ========== ==== ==========
Held-to-maturity:
U.S. Treasury and
federal agencies $ 350,000 5.35% $ 499,042 5.33% $ 0 0.00% $ 0 0.00% $ 849,042 5.34% $ 848,641
Obligations of
state and
political
subdivisions 0 0.00 150,000 6.60 0 0.00 0 0.00 150,000 6.59 155,475
Mortgage-backed
securities 511,453 5.22 133,199 5.28 106,533 5.52 86,039 9.37 837,224 5.69 854,528
---------- ---- ---------- ---- -------- ---- ---------- ---- ---------- ---- ----------
Total $ 861,453 5.27% $ 782,241 5.57% $106,533 5.52% $ 86,039 9.37% $1,836,266 5.60% $1,858,644
========== ==== ========== ==== ======== ==== ========== ==== ========== ==== ==========
</TABLE>
<PAGE>
Cash and Interest-Bearing Deposits in Other Banks
The Association also had cash on hand and cash due from and on deposit
with other banks amounting to $9.6 million and $9.9 million at
September 30, 1998 and 1997, respectively.
Deposits and Borrowings
General. Deposits have traditionally been the primary source of the
Association's funds for use in lending and other investment
activities. In addition to deposits, the Association derives funds
from interest payments and principal repayments on loans and income on
earning assets. Loan payments are a relatively stable source of
funds, while deposit inflows and outflows fluctuate in response to
general interest rates and money market conditions. The Association
has the ability to use FHLB advances as an alternative source of funds
but has not utilized such source in the recent past.
Deposits. The Company's deposits are attracted principally from
within the Company's primary market area through the offering of a
wide selection of deposit instruments, including NOW accounts, money
market accounts, regular passbook savings accounts, and term
certificate accounts. Included among these deposit products are
individual retirement account certificates of approximately $4.0
million at September 30, 1998. Deposit account terms vary, with the
principal differences being the minimum balance required, the time
periods the funds must remain on deposit and the interest rate. As of
September 30, 1998, the certificates of deposit with principal amounts
of $100,000 or more totaled to $7.2 million.
Interest rates paid, maturity terms, service fees and withdrawal
penalties are established by the Association on a periodic basis.
Determination of rates and terms are predicated on funds acquisition
and liquidity requirements, rates paid by competitors, growth goals
and federal regulations.
<PAGE>
<TABLE>
The following table sets forth the dollar amount of deposits in the
various types of deposit programs offered at the dates indicated:
<CAPTION>
1998 1997
------------------ -------------------
Percent Percent
of Total of Total
Amount Deposits Amount Deposits
-------- -------- -------- ---------
(In thousands)
<S> <C> <C> <C> <C>
Transaction accounts:
NOW accounts (1) $10,376 18.7% $10,561 18.9%
Passbook savings accounts (2) 9,035 16.3 9,286 16.6
Money market accounts (3) 1,074 1.9 1,094 2.0
-------- -------- -------- ---------
Total transaction accounts 20,485 36.9 20,941 37.5
-------- -------- -------- ---------
Certificates of deposit:
4.01--6.00% 32,376 58.3 32,295 57.7
6.01--8.00% 2,546 4.6 2,489 4.5
8.01--10.00% 150 0.3 150 .3
-------- -------- -------- ---------
Total certificates of deposit (4) 35,072 63.1 34,934 62.5
-------- -------- -------- ---------
Total deposits $55,557 100.0% $55,875 100.0%
======== ======== ======== =========
(1) The weighted average rate on NOW accounts at September 30, 1998 was 2.22%.
(2) The weighted average rate on passbook savings accounts at September 30, 1998 was 1.96%.
(3) The weighted average rate on money market accounts at September 30, 1998 was 1.96%.
(4) The weighted average rate on all certificates of deposit, including IRA accounts,
at September 30, 1998 was 4.3%.
</TABLE>
<TABLE>
The following table sets forth the amount and maturities of the
Association's certificates of deposit at September 30, 1998.
<CAPTION>
Over One Over Two Over Three
One Year Year Years Through Years Over
or Less Through Three Years Through Four Years Totals
Two Years Four Years
------- --------- -------------- ----------- ---------- -------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
4.00%--6.00% $23,412 $4,929 $2,961 $522 $552 $32,376
6.01%--8.00% 761 803 817 100 65 2,546
8.01%--10.00% 150 0 0 0 0 150
------- ------ ------ ---- ---- -------
$24,323 $5,732 $3,778 $622 $617 $35,072
======= ====== ====== ==== ==== =======
</TABLE>
<TABLE>
The following table sets forth the Association's deposit account
balance activity for the periods indicated:
<CAPTION>
Year Ended
September 30,
1998 1997
-------- --------
(In thousands)
<S> <C> <C>
Beginning balance $55,875 $57,138
Net increase (decrease) in deposits before
interest credited (1,757) (2,763)
Interest credited 1,439 1,500
Ending balance 55,557 55,875
-------- --------
Net increase (decrease) $ (318) $ 1,263
======== ========
</TABLE>
<TABLE>
The following table sets forth the change in dollar and amount of
deposits in the various types of accounts offered by the Association
between the dates indicated:
<CAPTION>
Increase
(Decrease)
Balance at from Balance at
September 30, % of September 30, September 30, % of
1998 Deposit 1997 1997 Deposits
------------- ------- ------------- ------------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-bearing and
noninterest bearing
demand deposits $11,450 20.61% $(205) $11,655 20.86%
Passbook savings 9,035 16.26 (251) 9,286 16.62
Certificates of deposit 35,072 63.13 138 34,934 62.52
------- ------- ------ ------- -------
Total $55,557 100.00% $(318) $55,875 100.00%
======= ======= ====== ======= =======
</TABLE>
<TABLE>
The following table sets forth the maturities of the Association's
certificates of deposit having principal amounts of $100,000 or more
at September 30, 1998:
<CAPTION>
Certificate of Deposit
Maturing in Quarter Ending: Amount
- --------------------------------------------------- -----------
(In thousands)
<S> <C>
December 31, 1998 $ 813
March 31, 1999 2,478
June 30, 1999 563
September 30, 1999 517
After September 30, 1999 2,780
-------
Total certificates of deposit with balances of
$100,000 or more $ 7,151
=======
</TABLE>
Borrowings. The FHLB system functions as a central reserve bank
providing credit for its member institutions and certain other
financial institutions. As a member in good standing of the FHLB of
Atlanta, the Association is authorized to apply for advances from the
FHLB of Atlanta, provided certain standards of creditworthiness have
been met. Under current regulations, an association must meet certain
qualifications to be eligible for FHLB advances. The extent to which
an association is eligible for such advances will depend upon whether
it meets the Qualified Thrift Lender Test (the "QTL Test"). If an
association meets the QTL Test, the Association will be eligible for
100% of the advances it would otherwise be eligible to receive. If an
association does not meet the QTL Test, the Association will be
eligible for such advances only to the extent it holds specified QTL
Test assets. At September 30, 1998, the Association was in compliance
with the QTL Test and had no advances from the FHLB.
Competition
The Association competes for deposits with other savings and loan
associations, savings banks, commercial banks, and credit unions and
with issuers of commercial paper and other securities, including
shares in money market mutual funds. The primary factors in
competition for deposits are customer service and convenience of
office location. In making loans, the Association competes with other
savings banks, savings and loan associations, commercial banks,
mortgage brokers, consumer finance companies, credit unions, leasing
companies, and other lenders. The Association competes for loan
originations primarily through the interest rates and loan fees it
charges and through the efficiency and quality of services it provides
to borrowers. Competition is intense and is affected by, among other
things, the general availability of lendable funds, general and local
economic conditions, current interest rate levels, and other factors
which are not readily predictable. The Association does not offer all
of the products and services offered by some of its competitors,
particularly commercial banks. The Association monitors the product
offerings of its competitors and adds new products when it can do so
competitively and cost effectively.
REGULATION
The Company
General. The Holding Company is a savings and loan holding company
within the meaning of the Home Owners Loan Act, as amended (the
"HOLA"). Consequently, the Holding Company is subject to regulation,
examination, and oversight by the OTS and is required to submit
periodic reports thereto. Because the Holding Company is a
corporation organized under Delaware law, the Holding Company is also
subject to the provisions of the Delaware General Corporation Law
applicable to Delaware corporations generally.
Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one
subsidiary savings institution. However, if the Director of the OTS
determines that there is reasonable cause to believe that the
continuation by a savings and loan holding company of an activity
constitutes a serious risk to the financial safety, soundness or
stability of its subsidiary savings institution, the Director may
impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings
institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that
might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings institution.
Notwithstanding the above rules as to permissible business activities
of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet a
QTL test, then such unitary holding company also shall become
subject to the activities restrictions applicable to multiple savings
and loan holding companies and, unless the savings institution
requalifies as a QTL within one year thereafter, shall register as,
and become subject to the restrictions applicable to, a bank holding
company.
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the
Association, the Company would thereupon become a multiple savings and
loan holding company. Except where such acquisition is pursuant to
the authority to approve emergency thrift acquisitions and where each
subsidiary savings institution meets the QTL test, as set forth below,
the activities of the Company and any of its subsidiaries (other than
the Savings Bank or other subsidiary savings institutions) would
thereafter be subject to further restrictions. Among other things, no
multiple savings and loan holding company or subsidiary thereof which
is not a savings institution shall commence or continue for a limited
period of time after becoming a multiple savings and loan holding
company or subsidiary thereof which is not a savings institution shall
commence or continue for a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof any
business activity, upon prior notice to, and no objection by the OTS,
other than: (i) furnishing or performing management services for a
subsidiary savings institution; (ii) conducting an insurance agency or
escrow business; (iii) holding, managing, or liquidating assets owned
by or acquired from a subsidiary savings institution; (iv) holding or
managing properties used or occupied by a subsidiary savings
institution; (v) acting as trustee under deeds of trust; (vi) those
activities authorized by regulation as of March 5, 1987 to be engaged
in by multiple savings and loan holding companies; or (vii) unless the
Director of the OTS by regulation prohibits or limits such activities
for savings and loan holding companies, those activities authorized by
the Federal Reserve Board as permissible for bank holding companies.
Those activities described in (vii) above also must be approved by the
Director of the OTS prior to being engaged in by a multiple savings
and loan holding company.
Limitations on Transactions with Affiliates. Transactions between
savings institutions and any affiliate are governed by Sections 23A
and 23B of the Federal Reserve Act. An affiliate of a savings
institution is any company or entity which controls, is controlled by
or is under common control with the savings institution. In a holding
company context, the parent holding company of a savings institution
(such as the Company) and any companies which are controlled by such
parent holding company are affiliates of the savings institution.
Generally, Sections 23A and 23B (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered
transactions: with any one affiliate to an amount equal to 10% of such
institution'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 institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of
loans, purchase of assets, issuance of a guarantee and similar other
types of transactions. In addition to the restrictions imposed by
Sections 23A and 23B, no savings institution may (i) loan or otherwise
extend credit to an affiliate, except for any affiliate which engages
only in activities which are permissible for bank holding companies,
or (ii) purchase or invest in any stocks, bonds, debentures, notes or
similar obligations of any affiliate, except for affiliates which are
subsidiaries of the savings institution.
In addition, Sections 22(h) and (g) of the Federal Reserve Act place
restrictions on loans to execute officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive
officer and to a greater than 10% stockholder of a savings
institution, and certain affiliated interests of either, may not
exceed, together with all other outstanding loans to such person and
affiliated interests, the institution's loan to one borrower limit
(generally equal to 15% of the institution's unimpaired capital and
surplus). Section 22(h) also requires that loans to directors,
executive officers and principal stockholders be make on terms
substantially the same as offered in comparable transactions to other
persons and also requires prior board approval for certain loans. In
addition, the aggregate amount of extensions of credit by a savings
institution to all insiders cannot exceed the institution's unimpaired
capital and surplus. Furthermore, Section 22(g) places additional
restrictions on loans to executive officers. At September 30, 1997,
the Savings Bank was in compliance with the above restrictions.
Restrictions on Acquisitions. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring,
without prior approval of the Director of the OTS, (i) control of any
other savings institution or savings and loan holding company or
substantially all the assets thereof or (ii) more than 5% of the
voting shares of a savings institution or holding company thereof
which is not a subsidiary. Except with the prior approval of the
Director of the OTS, no director or officer of a savings and loan
holding company or person owning or controlling by proxy or otherwise
more than 25% of such company's stock, may acquire control of any
savings institution, other than a subsidiary savings institution, or
of any other savings and loan holding company.
The Director of the OTS may only approved acquisitions resulting in
the formation of a multiple savings and loan holding company which
controls savings institutions in more than one state if (i) the
multiple savings and loan holding company involved controls a savings
institution which operated a home or branch office located in the
state of the institution to be acquired as of March 5, 1987; (ii) the
acquirer is authorized to acquire control of the savings institution
pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in
which the institution to be acquired is located specifically permit
institutions to be acquired by the state-chartered institutions or
savings and loan holding companies located in the state where the
acquiring entity is located (or by a holding company that controls
such state-chartered savings institutions).
The FIRREA amended provisions of the Bank Holding Company Act of 1956
to specifically authorize the Federal Reserve Board to approve an
application by a bank holding company to acquire control of a savings
institution. FIRREA also authorized a bank holding company that
controls a savings institution to merge or consolidate the assets and
liabilities to, any subsidiary bank which is a member of the BIF with
the approval of the appropriate federal banking agency and the Federal
Reserve Board. As a result of these provisions, there have been a
number of acquisitions of savings institutions by bank holding
companies in recent years.
Federal Securities Laws. The Company is registered with the
Securities and Exchange Commission ("SEC") under the Securities
Exchange Act of 1934, as amended (the "Securities Exchange Act"), and
under OTS regulations. Generally, the Common Stock may not be
deregistered for at least three years after the Conversion. The
Company is subject to the information, proxy solicitation, insider
trading restrictions and other requirements of the Securities Exchange
Act.
The Association
General. The OTS has extensive authority over the operations of
federally chartered savings institutions. As part of this authority
savings institutions are required to file periodic reports with the
OTS and are subject to periodic examinations by the OTS and the FDIC.
The investment and lending authority of savings institutions are
prescribed by federal laws and regulations, and such institutions are
prohibited from engaging in any activities not permitted by such laws
and regulations. Those laws and regulations generally are applicable
to all federally chartered savings institutions and may also apply to
state-chartered savings institutions. Such regulation and supervision
is primarily intended for the protection of depositors.
The OTS' enforcement authority over all savings institutions was
substantially enhanced by FIRREA. 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 for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed
with the OTS. FIRREA significantly increased the amount of the ground
for civil money penalties.
On December 19, 1991, the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") was enacted into law. The FDICIA
provides for, among other things, the recaptilization of the BIF; the
authorization of the FDIC to make emergency special assessments under
certain circumstances against BIF members and members of the SAIF; the
establishment of risk-based deposit insurance premiums; and improved
examinations and reporting requirements. The FDICIA also provides for
enhanced federal supervision of depository institutions based on,
among other things, an institution's capital level.
Deposit Insurance
The FDIC is an independent federal agency that insures the deposits,
up to prescribed statutory limits, of banks and thrifts and safeguards
the safety and soundness of the banking and thrift industries. The
FDIC administers two separate insurance funds, the BIF for commercial
banks and state savings banks and the SAIF for savings associations
and banks that have acquired deposits from savings associations. The
FDIC is required to maintain designated levels of reserves in each
fund. The reserves of the SAIF are currently below the level required
by law, primarily because a significant portion of the assessments
paid into the SAIF have been used to pay the cost of prior thrift
failures while the reserves of the BIF met the level required by law
in May 1995. Thrifts are generally prohibited from converting from
one insurance fund to the other until the SAIF meets its designated
reserve level, except with the prior approval of the FDIC in certain
limited cases, and provided certain fees are paid. The insurance fund
conversion provisions do not prohibit a SAIF member from converting to
a bank charter or merging with a bank during the moratorium as long as
the resulting bank continues to pay the applicable insurance
assessments to the SAIF during such period and as long as certain
other conditions are met.
The Association is a member of the SAIF and its deposit accounts are
insured by the FDIC up to the prescribed limits. The FDIC has
examination authority over all insured depository institutions,
including the Association, and has authority to initiate enforcement
actions against federally insured savings associations if the FDIC
does not believe the OTS has taken appropriate action to safeguard
safety and soundness and the deposit insurance fund.
The FDIC is authorized to establish separate annual assessment rates
for deposit insurance for members of the BIF and members of the SAIF.
The FDIC may increase assessment rates for either fund if necessary to
restore the fund's ratio of reserves to insured deposits to the target
level within a reasonable time and may decrease such rates if such
target level has been met. The FDIC has established a risk-based
assessment system for both SAIF and BIF members. Under this system,
assessments vary depending on the risk the institution poses to its
deposit insurance fund. Such risk level is determined based on the
institution's capital level and the FDIC's level of supervisory
concern about the institution.
Both the SAIF and the BIF are required by law to attain and thereafter
maintain a reserve ratio of 1.25% of insured deposits. The BIF has
achieved the required reserve rate, and, as discussed below, the FDIC
recently substantially reduced the average deposit insurance premium
paid by BIF-insured banks to a level substantially below the average
premium paid by savings institutions.
The deposits of the Association are currently insured by the SAIF.
Both the SAIF and the Bank Insurance Fund ("BIF"), the federal deposit
insurance fund that covers the deposits of state and national banks
and certain state savings banks, are required by law to attain and
thereafter maintain a reserve ratio of 1.25% of insured deposits. The
BIF has achieved the required reserve rate, and, as discussed below,
during the past year the FDIC reduced the average deposit insurance
premium paid by BIF-insured banks to a level substantially below the
average premium paid by savings institutions.
On November 4, 1995, the FDIC approved a final rule regarding deposit
insurance premiums. That rule reduced deposit insurance premiums for
BIF member institutions to zero basis points (subject to a $2,000
minimum) for institutions in the lowest risk category, while holding
deposit insurance premiums for SAIF members at their current levels 23
basis points for institutions in the lowest risk category). The
reduction was effective with respect to the semiannual premium
assessment beginning January 1, 1996.
Banking legislation was enacted September 30, 1996 to eliminate the
premium differential between SAIF-insured institutions and BIF-insured
institutions. The FDIC Board of Directors met October 8, 1996 and
approved a rule that, except for the possible impact of certain
exemptions for de novo and "weak" institutions, established the
special assessment necessary to recapitalize the SAIF at 65.7 basis
points of SAIF assessable deposits held by affected institutions as of
March 31, 1995. The legislation provides that all SAIF member
institutions pay a special one-time assessment to recapitalize the
SAIF, which in the aggregate is sufficient to bring the reserve ratio
in the SAIF to 1.25% of insured deposits It is anticipated that after
recapitalization of the SAIF, premiums paid by SAIF-insured
institutions will be reduced to match those currently being assessed
by BIF-insured commercial banks. The legislation also provides for
the merger of the BIF and the SAIF, with such merger being conditioned
upon the prior elimination of the thrift charter.
Based upon its level of SAIF deposits as of March 31, 1995, the
Association paid a special assessment of approximately $370,000, or
$237,000 net of related tax benefits. Accordingly, an accrual for
that amount was provided in the quarter ended September 30, 1996.
Regulatory Capital Requirements. Federal insured savings institutions
are required to maintain minimum levels of regulatory capital.
Pursuant to FIRREA, the OTS has established capital standards
applicable to all savings institutions. These standards generally
must be as stringent as the comparable capital requirements imposed on
national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual institutions
on a case-by-case basis.
Current OTS capital standards require savings institutions to satisfy
three different capital requirements. Under these standards, savings
institutions must maintain "tangible" capital equal to at least 1.5%
of adjusted total assets, "core" capital equal to at least 3% of
adjusted total assets and "total" capital (a combination of core and
"supplementary" capital) equal to at least 8.0% of "risk-weighted"
assets. For purposes of the regulation, core capital generally
consists of common equity (including retained earnings), noncumulative
perpetual preferred stock and related surplus, minority interests in
the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying
supervisory goodwill." Tangible capital is given the same definition
as core capital but does not include qualifying supervisory goodwill
and is reduced by the amount of all the savings institution's
intangible assets, with only a limited exception for purchased
mortgage servicing rights. The Association had no goodwill or other
intangible assets at September 30, 1997. Both core and tangible
capital are further reduced by an amount equal to a savings
institution's debt and equity investments in subsidiaries engaged in
activities not permissible to national banks (other than subsidiaries
engaged in activities undertaken as agent for customers or in mortgage
banking activities and subsidiary depository institutions or their
holding companies). These adjustments do not affect the Association's
regulatory capital. Supplementary capital generally consists of
hybrid capital instruments; perpetual preferred stock which is not
eligible to be included as core capital; subordinated debt and
intermediate-term preferred stock; and general allowances for loan
losses up to a maximum of 1.25% of risk-weighted assets.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to include both core capital and
supplementary capital in its total capital, provided that the amount
of supplementary capital included does not exceed the savings
institution's core capital. In determining the required amount of
risk-based capital, total assets, including certain off-balance sheet
items, are multiplied by a risk weight based on the risks inherent in
the type of assets. The risk weight assigned by the OTS for principal
categories of assets are (i) 0% for cash and securities issued by the
U. S. Government or unconditionally backed by the full faith and
credit of the U. S. Government; (ii) 20% for securities (other than
equity securities) issued by U. S. Government-sponsored agencies and
mortgage-backed securities issued by, or fully guaranteed as to
principal and interest by, the FNMA or the FHLMC, except for those
classes with residual characteristics or stripped mortgage-related
securities; (iii) 50% for prudently underwritten permanent one-to-four
family first lien mortgage loans not more than 90 days delinquent and
having a loan-to-value ratio of not more than 80% at origination
unless insured to such ratio by an insurer approved by the FNMA or the
FHLMC, qualifying residential bridge loans made directly for the
construction of one-to-four family residences and qualifying
multi-family residential loans; and (iv) 100% for all other loans and
investments, including consumer loans, commercial loans, and
single-family residential real estate loans more than 90 days
delinquent, and for repossessed assets.
At September 30, 1998, the Association exceeded all of its regulatory
capital requirements. The following table sets forth the Association's
compliance with applicable regulatory capital requirements at
September 30, 1998:
<TABLE>
<CAPTION>
For To Be Well
Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
------------------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------- ------ ------- ------ ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
September 30, 1998:
Total capital (to risk weighted assets) $11,288 29.5% $3,064 8.0% $3,830 10.0%
Tier 1 (core) capital (to risk weighted assets) 10,809 28.2 N/A N/A 2,298 6.0
Tier 1 (core) capital (to adjusted total assets) 10,809 15.8 2,048 3.0 3,413 5.0
Tangible capital (to adjusted total assets) 10,809 15.8 1,024 1.5 N/A N/A
September 30, 1997:
Total capital (to risk weighted assets) $10,699 30.4% $2,817 8.0% $3,522 10.0%
Tier 1 (core) capital (to risk weighted assets) 10,259 29.1 N/A N/A 2,113 6.0
Tier 1 (core) capital (to adjusted total assets) 10,259 15.1 2,044 3.0 3,407 5.0
Tangible capital (to adjusted total assets) 10,259 15.1 1,022 1.5 N/A N/A
</TABLE>
<TABLE>
The following table is a reconciliation of the Association's
stockholder's equity to tangible, Tier 1, and risk-based capital as
required by the OTS:
<CAPTION>
1998 1997
-------- -------
(In thousands)
<S> <C> <C>
Stockholder's equity $10,827 $10,222
Unrealized loss on securities available for sale (18) 37
-------- --------
Tangible and Tier 1 capital 10,809 10,259
Allowance for loan losses 479 440
------- -------
Total risk based capital $11,288 $10,699
======= =======
Total assets $67,285 $68,112
Adjusted total assets 67,267 68,149
Total risk weighted assets 38,297 35,218
</TABLE>
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation.
Under the rule, an institution with a greater than "normal" level of
interest rate risk is subject to a deduction of its interest rate risk
component from total capital for purposes of calculating its
risk-based capital. As a result, such an institution is required to
maintain additional capital in order to comply with the risk-based
capital requirement. An institution with a greater than "normal"
interest rate risk is defined as an institution that would suffer a
loss of net portfolio value exceeding 2.0% of the estimated economic
value of its assets in the event of a 200 basis point increase or
decrease (with certain minor exceptions) in interest rates. The
interest rate risk component is calculated, on a quarterly basis, as
one-half of the difference between an institution's measured interest
rate risk and 2.0% multiplied by the economic value of its assets.
The rule also authorizes the Director of the OTS, or his designee, to
waive or defer an institution's interest rate risk component on a
case-by-case basis. The final rule was effective as of January 1,
1994, subject however to a three quarter "lag" time between the
reporting date of the data used to calculate an institution's interest
rate risk and the effective date of each quarter's interest rate risk
component. Recently the OTS postponed the interest rate risk capital
deduction in order to provide sufficient time to implement and
evaluate the OTS appeals process as well as get a better sense of the
direction that the other federal banking agencies may take in their
implementation of Section 305 of FDICIA.
Prompt Corrective Action. Under Section 39 of the FDIA, as added by
the FDICIA, each federal banking agency was required to implement a
system of promptly corrective action for institutions which it
regulates. The federal banking agencies, including the OTS, adopted
substantially similar regulations to implement Section 38 of the FDIA,
effective as of December 19, 1992. Under the regulations, an
institution is deemed to be (i) "well capitalized" if it has total
risk-based capital of 10.0% or more, than a Tier 1 risk-based capital
ratio of 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or
more and is not subject to any order or final capital directive to
meet and maintain a specific capital level for any capital measure,
(ii) "adequately capitalized" if it has a total risk-based capital
ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or
more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under
certain circumstances) and does not meet the definition of "well
capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier 1 risk-based capital
ratio that is less than 4.0% or a Tier 1 leverage capital ratio that
is less than 4.0% (3.0% under certain circumstances), (iv)
"significantly undercapitalized" if it has a total risk-based capital
ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that
is less than 3.0% or a Tier 1 leverage capital ratio that is less than
3.0%, and (v) "critically undercapitalized" if it has a ratio of
tangible equity to total assets that is equal to or less than 2.0%.
Section 38 of the FDIA and the regulations promulgated thereunder also
specify circumstances under which a federal banking agency may
reclassify a well capitalized institution as adequately capitalized
and may require an adequately capitalized institution or an
undercapitalized institution to comply with supervisory actions as if
it were in the next lower category (except that the FDIC may not
reclassify a significantly undercapitalized institution as critically
undercapitalized).
An institution generally must file a written capital restoration plan
which meets specified requirements with an appropriate federal banking
agency with 45 days of the date that the institution receives notice
or is deemed to have notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. A federal banking
agency must provide the institution with written notice of approval or
disapproval with 60 days after receiving a capital restoration plan,
subject to extensions by the agency.
An institution which is required to submit a capital restoration plan
must concurrently submit a performance guaranty by each company that
controls the institution. Such guaranty shall be limited to the
lesser of (i) an amount equal to 5.0% of the institution's total
assets at the time the institution was notified or deemed to have
notice that it was undercapitalized or (ii) the amount necessary to
restore the relevant capital measures of the institution to the levels
required for the institution to be classified as adequately
capitalized. Such a guarantee shall expire after the federal banking
agency notifies the institution that it has remained adequately
capitalized for each of four consecutive calendar quarters. An
institution which fails to submit a written capital restoration plan
with the requisite period, including any required performance guarantee(s),
or fails in any material respect to implement a capital restoration plan,
shall be subject to the restrictions in Section 38 of the FDIA which are
applicable to significantly undercapitalized institutions.
Immediately upon becoming undercapitalized, an institution shall
become subject to the provisions of Section 38 of the FDIA (i)
restricting payment of capital distributions and management fees, (ii)
requiring that the appropriate federal banking agency monitor the
condition of the institution and its efforts to restore its capital,
(iii) requiring submission of a capital restoration plan, (iv)
restricting the growth of the institution's assets and (v) requiring
prior approval of certain expansion proposals. The appropriate
federal banking agency for an undercapitalized institution also may
take any number of discretionary supervisory actions if the agency
determines that any of these actions is necessary to resolve the
problem of the institution at the least possible long-term cost to the
deposit insurance fund, subject in certain cases to specified
procedures. These discretionary supervisory actions include requiring
the institution to raise additional capital; restricting transactions
with affiliates; restricting interest rates paid by the institution on
deposits; requiring replacement of senior executive officers and
directors; restricting the activities of the institution and its
affiliates; requiring divestiture of the institution or the sale of
the institution to a willing purchaser; and any other supervisory
action that the agency deems appropriate. These and additional
mandatory and permissive supervisory actions may be taken with respect
to significantly undercapitalized and critically undercapitalized
institutions.
At September 30, 1998, the Association was deemed a "well capitalized"
institution for purpose of the above regulations and as such was not
subject to the above mentioned restrictions.
Safety and Soundness. On November 18, 1993, a joint notice of
proposed rulemaking was issued by the OTS, the Office of the
Comptroller of the Currency and the Federal Reserve Board
(collectively, the "agencies") concerning standards for safety and
soundness required to be prescribed by regulation pursuant to
Section 39 of the FDIA. In general, the standards relate to (1)
operational and managerial matters; (2) asset quality and earnings;
and (3) compensation. The operational and managerial standards cover
(a) internal controls and information systems, (b) internal audit
system, (c) loan documentation, (d) credit underwriting, (e) interest
rate risk exposure, (f) asset growth, and (g) compensation, fees and
benefits. Under the proposed asset quality and earnings standards,
the Association would be required to maintain (1) a maximum ratio of
classified assets (assets classified substandard, doubtful and to the
extent that related losses have not been recognized, assets classified
loss) to total capital of 1.0%, and (2) minimum earnings sufficient to
absorb losses without impairing capital. The last ratio concerning
market value to book value was determined by the agencies not to be
feasible. Finally, the proposed compensation standard states that
compensation will be considered excessive if it is unreasonable or
disproportionate to the services actually performed by the individual
being compensated. If an insured depository institution or its
holding company fail to meet any of the standards promulgated by
regulation, then such institution or company will be required to
submit a plan within 30 days to the FDIC specifying the steps it will
take to correct the deficiency. In the event that an institution or
company fails to submit or fails in any material respect to implement
a compliance plan within the time allowed by the agency, Section 39 of
the FDIA provides that the FDIC must order the institution or company
to correct the deficiency and may (1) restrict asset growth; (2)
require the institution or company to increase its ratio of tangible
equity to assets; (3) restrict the rates of interest that the
institution or company may pay; or (4) take any other action that
would better carry out the purpose of prompt corrective action. The
Association believes that it will be in compliance with each of the
standards if they are adopted as proposed.
Liquidity Requirements. Each savings institution is required to
maintain an average daily balance of liquid assets equal to a certain
percentage of the sum of its average daily balance of net withdrawable
deposit accounts and borrowing payable in one year or less. The
liquidity requirement may vary from time to time (between 4% and 10%)
depending upon economic conditions and savings flows of all savings
institutions. At the present time, the required minimum liquid asset
ratio is 5%. At September 30, 1998, the Association's liquidity ratio
was in excess of the required minimum.
Capital Distributions. OTS regulations govern capital distributions
by savings institutions, which include cash dividends, stock
redemptions or repurchases, cash-out mergers, interest payments on
certain convertible debt and other transactions charged to the capital
account of a savings institution to make capital distributions.
Generally, the regulation creates a safe harbor for specified levels
of capital distributions from institutions meeting at least their
minimum capital requirements, so long as such institutions notify the
OTS and receive no objection to the distribution from the OTS.
Savings institutions and distributions that do not qualify for the
safe harbor are required to obtain prior OTS approval before making
any capital distributions.
Generally, a savings institution that before and after the proposed
distribution meets or exceeds its fully phased-in capital requirements
(Tier 1 institutions) may make capital distributions during any
calendar year equal to the higher of (i) 100% of net income for the
calendar year-to-date plus 50% of its "surplus capital ratio" at the
beginning of the calendar year or (ii) 75% of net income over the most
recent four-quarter period. The "surplus capital ratio" is defined to
mean the percentage by which the institution's ratio of total capital
to assets exceeds the ratio of its fully phased-in capital
requirement: is defined to mean an institution's capital requirements
under the statutory and regulatory standards applicable on
December 31, 1994, as modified to reflect any applicable individual
minimum capital requirement imposed upon the institution. Failure to
meet fully phased-in or minimum capital requirements will result in
further restrictions on capital distributions, including possible
prohibition without explicit OTS approval.
Tier 2 institutions, which are institutions that before and after the
proposed distribution meet or exceed their minimum capital
requirements, may make capital distributions up to 75% of their net
income over the most recent four quarter period.
In order to make distributions under these safe harbors, Tier 1 and
Tier 2 institutions must submit 30 days written notice to the OTS
prior to making the distribution. The OTS may object to the
distribution during that 30-day period based on safety and soundness
concerns. In addition, a Tier 1 institution deemed to be in need of
more than normal supervision by the OTS may be downgraded to a Tier 2
or Tier 3 institution as a result of such a determination.
Tier 3 institutions, which are institutions that do not meet current
minimum capital requirements, or that have capital in excess of either
their fully phased-in capital requirement or minimum capital
requirement but which have been notified by the OTS that it will be
treated as a Tier 3 institution because they are in need of more than
normal supervision, cannot make any capital distribution without
obtaining OTS approval prior to making such distributions.
At September 30, 1998, the Association was a Tier 1 institution for
purposes of this regulation.
Loans to One Borrower. FIRREA imposed limitations on the aggregate
amount of loans that a savings institution could make to any one
borrower, including related entities. Under FIRREA, the permissible
amount of loans-to-one borrower now follows the national bank standard
for all loans made by savings institutions, as compared to the
pre-FIRREA rule that applied that standard only to commercial loans
made by federally chartered savings institutions. The regulations
promulgated pursuant to FIRREA generally do not permit loans-to-one
borrower to exceed the greater of $500,000 or 15% of unimpaired
capital and surplus. Loans in an amount equal to an additional 10% of
unimpaired capital and surplus also may be made to a borrower if the
loans are fully secured by readily marketable securities.
Branching by Federal Savings Institutions. Effective May 11, 1992,
the OTS amended its Policy Statement on Branching by Federal Savings
Institutions to permit interstate branching to the full extent
permitted by statute (which is essentially unlimited). Prior policy
permitted interstate branching for federal savings institutions only
to the extent allowed for state-chartered institutions in the states
where the institution's home office is located and where the branch is
sought. Prior policy also permitted healthy out-of-state federal
institutions to branch into another state, regardless of the law in
that state, provided the branch office was the result of a purchase of
an institution that was in danger of default.
Generally, federal law prohibits federal savings institutions from
establishing, retaining or operating a branch outside the state in
which the federal institution has its home office unless the
institution meets the IRS's domestic building and loan test
(generally, 60% of a thrift's assets must be housing-related) ("IRS
Test"). The IRS Test requirement does not apply if: (i) the
branch(es) result(s) from an emergency acquisition of a troubled
savings institution (however, if the troubled savings institution is
acquired by a bank holding company, does not have its home office in
the state of the bank holding company bank subsidiary and does not
qualify under the IRS Test, its branching is limited to the branching
laws for state-chartered banks in the state where the savings
institution is located); (ii) the law of the state where the branch
would be located would permit the branch to be established if the
federal savings institution were chartered by the state in which its
home office is located; or (iii) the branch was operated lawfully as a
branch under state law prior to the savings institution's conversion
to a federal charter.
Furthermore, the OTS will evaluate a branching applicant's record of
compliance with the Community Reinvestment Act of 1977 ("CRA"). An
unsatisfactory CRA record may be the basis for denial of a branching
application.
Qualified Thrift Lender Test. All savings institutions are required
to meet a QTL test set forth in Section 10(m) of the HOLA and
regulations of the OTS thereunder to avoid certain restrictions on
their operations. A saving institution that does not meet the QTL
test set forth in the HOLA and implementing regulations must either
convert to a bank charter or comply with the following restrictions on
its operations: (i) the institution may not engage in any new activity
or make any new investment, directly or indirectly, unless such
activity or investment is permissible for a national bank; (ii) the
branching powers of the institution shall be restricted to those of a
national bank; (iii) the institution shall not be eligible to obtain
any advances from its FHLB; and (iv) payment of dividends
by the institution shall be subject to the rules regarding payment of
dividends by a national bank. Upon the expiration of three years from
the date the savings institution ceases to be a QTL, it must cease any
activity and not retain any investment not permissible for a national
bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations).
Currently, the QTL test requires that 65% of an institution's
"portfolio assets" (as defined) consist of certain housing and
consumer-related assets on a monthly average basis in nine out of
every 12 months. Assets that qualify without limit for inclusion as
part of the 65% requirement are loans made to purchase, refinance,
construct, improve or repair domestic residential housing and
manufactured housing; home equity loans; mortgage-backed securities
(where the mortgages are secured by domestic residential housing or
manufactured housing); stock issued by the FHLB of Dallas; and direct
or indirect obligations of the FDIC. In addition, the following
assets, among others, may be included in meeting the test subject to
an overall limit of 20% of the savings institution's portfolio assets:
50% of residential mortgage loans originated and sold within 90 days
of origination; 100% of consumer and educational loans (limited to 10%
of total portfolio assets); and stock issued by the FHLMC or the FNMA.
Portfolio assets consist of total assets minus the sum of (i) goodwill
and other intangible assets, (ii) property used by the savings
institution to conduct its business, and (iii) liquid assets up to 20%
of the institution's total assets. At September 30, 1998, the
qualified thrift investments of the Association were substantially in
excess of 20%.
Accounting Requirements. FIRREA requires the OTS to establish
accounting standards to be applicable to all savings institutions for
purposes of complying with regulations, except to the extent otherwise
specified in the capital standards. Such standards must incorporate
GAAP to the same degree as is prescribed by the federal banking
agencies for banks or may be more stringent than such requirements.
Effective October 2, 1992, the OTS amended a number of its accounting
regulations and reporting requirements to adopt the following
standards: (i) regulatory reports will incorporate GAAP when GAAP is
used by federal banking agencies; (ii) savings institution
transactions, financial condition and regulatory capital must be
reported and disclosed in accordance with OTS regulatory reporting
requirements that will be at least as stringent as for national banks;
and (iii) the Director of the OTS may prescribe regulatory reporting
requirements more stringent than GAAP wherever the Director determines
that such requirements are necessary to ensure the safe and sound
reporting and operation of savings institutions.
Effective February 10, 1992, the OTS adopted a statement of policy
("Statement") set forth in Thrift Bulletin 52 concerning (i)
procedures to be used in the selection of a securities dealer, (ii)
the need to document and implement prudent policies and strategies for
securities, whether held for investment, trading or for sale, and to
establish systems and internal controls to ensure that securities
activities are consistent with the financial institution's policies
and strategies, (iii) securities trading and sales practices that may
be unsuitable in connection with securities held in an investment
portfolio, (iv) high-risk mortgage securities that are not suitable
for investment portfolio holdings for financial institutions, and (v)
disproportionately large holdings of long-term, zero-coupon bonds that
may constitute an imprudent investment practice. The Statement
applies to investment securities, high-yield, corporate debt
securities, loans, mortgage-backed securities and derivative
securities, and provides guidance concerning the proper classification
of and accounting for securities held for investment, sale and
trading. Securities held for investment, sale or trading may be
differentiated based upon an institution's desire to earn an interest
yield (held for investment), to realize a holding gain from assets
held for indefinite periods of time (held for sale), or to earn a
dealer's spread between the bid and asked prices (held for trading).
Depository institution investment portfolios are maintained to provide
earnings consistent with the safety factors of quality, maturity,
marketability and risk diversification. Securities that are purchased
to accomplish these objectives may be reported at their amortized cost
only when the depository institution has both the intent and ability
to hold the assets for long-term investment purposes. Securities held
for investment purposes may be accounted for at amortized cost,
securities held for sale are to be accounted for at the lower of cost
or market, and securities held for trading are to be accounted for at
market. The Association believes that its investment activities have
been and will continue to be conducted in accordance with the
requirements of OTS policies and GAAP.
Federal Home Loan Banks. The FHLBs provide credit to their members in
the form of advances. The Association is a member of the FHLB of
Atlanta and must maintain an investment in the capital stock of the
FHLB of Atlanta in an amount equal to the greater of 1% of the
aggregate outstanding principal amount of the Association's
residential mortgage loans, home purchase contracts, and similar
obligations at the beginning of each year, and 5% of its advances from
the FHLB. The Association is in compliance with this requirement with
an investment in stock of the FHLB of Atlanta of $428,800 at
September 30, 1998.
FHLB advances to members such as the Association who meet the QTL Test
are generally limited to the lower of (i) 25% of the member's assets
and (ii) 20 times the member's investment in FHLB stock. The granting
of advances is subject also to the FHLB's collateral and credit
underwriting guidelines. Upon the origination or renewal of a loan or
advance, the FHLB of Atlanta is required by law to obtain and maintain
a security interest in collateral in one or more of the following
categories: fully disbursed, whole first mortgage loans on improved
residential property or securities representing a whole interest in
such loans; securities issued, insured, or guaranteed by the U.S.
Government or an agency thereof; deposits in any FHLB; or other real
estate related collateral up to 30% of the member association's
capital) acceptable to the applicable FHLB, if such collateral has a
readily ascertainable value and the FHLB perfects its security
interest in the collateral.
Each FHLB is required to establish standards of community investment
or service that its members must maintain for continued access to
long-term advances from the FHLBs. The standards take into account a
member's performance under the Community Reinvestment Act and its
record of lending to first-time home buyers. All long-term advances
by each FHLB must be made only to provide funds for residential
housing finance. The FHLBs have established an "Affordable Housing
Program" to subsidize the interest rate of advances to member
associations engaged in lending for long-term, low-, and
moderate-income, owner-occupied and affordable rental housing at
subsidized rates. The FHLB of Atlanta reviews and accepts proposals
for subsidies under that program twice a year. The Association has
not participated in such program.
Federal Reserve System. The Federal Reserve Board requires all
depository institutions to maintain average daily reserves equal to
various percentages against their accounts. The percentages are
subject to adjustment by the Federal Reserve Board. At September 30,
1998, the Association met its reserve requirement. Because required
reserves must be maintained in the form of vault cash or a
non-interest-bearing account at a Federal Reserve Bank, the effect of
this reserve requirement is to reduce an institution's earning assets.
Taxation
Federal Taxation. The Holding Company is subject to the federal tax
laws that apply to corporations generally. With certain exceptions,
the Association is also subject to the federal tax laws and
regulations which apply to corporations generally.
In addition to the regular income tax, the Association is subject to a
minimum tax. An alternative minimum tax is imposed at a minimum tax
rate of 20% on "alternative minimum taxable income" (which is the sum
of a corporation's regular taxable income, with certain adjustments
and tax preference items), less any available exemption. Such tax
preference items include (i) 100% of the excess of a thrift
institution's bad debt deduction over the amount that would have been
allowable based on actual experience and (ii) interest on certain
tax-exempt bonds issued after August 7, 1986. In addition, 75% of the
amount by which a corporation's "adjusted current earnings" exceeds
its alternative minimum taxable income computed without regard to this
preference item and prior to reduction by net operating losses, is
included in alternative minimum taxable income. Net operating losses
can offset no more than 90% of alternative minimum taxable income.
The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax. Payments of alternative minimum tax
may be used as credits against regular tax liabilities in future
years.
If the Association distributes cash or property to its stockholders,
and the distribution is treated as being from its accumulated bad debt
reserves, the distribution will cause the Association to have
additional taxable income. A distribution is deemed to have been made
from accumulated bad debt reserves to the extent that (a) the reserves
exceed the amount that would have been accumulated on the basis of
actual loss experience, and (b) the distribution is a "nonqualified
distribution." A distribution with respect to stock is a nonqualified
distribution to the extent that, for federal income tax purposes, (i)
it is in redemption of shares, (ii) it is pursuant to a liquidation of
the institution, or (iii) in the case of a current distribution,
together with all other such distributions during the taxable year, it
exceeds the institution's current and post-1951 accumulated earnings
and profits. The amount of additional taxable income created by a
nonqualified distribution is an amount that when reduced by the tax
attributable to it is equal to the amount of the distribution.
The tax returns of the Association have been closed by statute or
audited through 1994. In the opinion of management, any examination
of open returns would not result in a deficiency which could have a
material adverse effect on the financial condition of the Association.
Alabama and Delaware Taxation. The State of Alabama imposes a 6.0%
excise tax on the earnings of financial institutions such as the
Association. The 6.0% excise tax also would apply to the Holding
Company. In addition to the excise taxes, the State of Alabama
imposes an annual state franchise tax for domestic and foreign
corporations. A domestic corporation, including a federally chartered
stock savings bank domiciled in Alabama, is assessed a domestic
franchise tax of approximately 1.0% based on the par value of its
common stock. Foreign corporations, such as the Holding Company which
is incorporated in Delaware, are assessed a foreign franchise tax of
0.3% based on a total of capital (as determined by statute) deemed to
be employed in the state of Alabama. The foreign corporation's
investment in the capital of an Alabama corporation is excluded from
the taxable base. The Holding Company will also be subject to the
Delaware franchise tax.
The Company was organized in the State of Delaware, and therefore it
will be required to file a franchise tax return with the State of
Delaware. The Company will also be required to file an income tax
return in the State of Delaware if it derives income from business
activities carried on in the State of Delaware. Currently, the
Company does not have any business activities in the State of
Delaware.
Delaware law provides two methods to calculate the Delaware Franchise
Tax. One method is based on the Company's authorized number of shares
and the second method is based on the Company's "assumed no-par
capital" with respect to no par shares and on the Company's "assumed
par value capital" with respect to par value shares. The lesser
result under both methods is then used to determine the franchise tax
liability in the State of Delaware.
Under the first method the franchise tax is calculated at a base rate
of $90 on the first 10,000 shares, plus $50.00 per each additional
10,000 shares or part thereof.
The second method is based on "assumed no-par capital" with respect to
no-par shares and an "assumed par-value capital" with respect to par
value shares as follows:
1. The "assumed no-par capital" is the authorized number of
shares without par value multiplied by $100. The tax on the
"assumed no-par capital" is $30.00 for each $300,000 or less
and is graduated as follows: (i) $50.00 for over $300,000
but not over $500,000; (ii) $90.00 for over $500,000 but not
over $1,000,000; and (iii) $90 for over $1,000,000, plus
$50.00 per each additional $1,000,000 or part thereof.
2. The tax on par value is $200 for each $1,000,000, or fraction
thereof of an "assumed par-value capital." The "assumed
par-value capital" is found as follows: (i) ascertain
average asset value per share by dividing total gross assets
by the total number of issued shares, including shares
without par value; (ii) if average asset value is more than
par value; it is multiplied by the total number of authorized
par value shares; if average assets value is less than par
value of any class of authorized shares, such shares must be
taken at their par value. Where it is necessary to use
average asset value for one class of shares and par value of
any other class or classes, the "assumed par-value capital"
is the sum of the products of the multiplications.
If a corporation has both no-par shares and par-value shares, the
no-par shares are taxed as calculated above upon a share basis which
is added to the tax calculated above on the par value shares.
Executive Officers of Association Who Are Not Directors
Presented below is certain information regarding the executive
officers of the Association who are not directors:
Name Age Position
Beth B. Knight 36 Vice President-Finance and Chief
Financial Officer
Raymond A. Williams 45 Vice President-Lending and Chief
Lending Officer
Beth B. Knight. Ms. Knight has a BS in accounting from the University
of Alabama and she is a Certified Public Accountant. She joined the
Association in 1992 and has served in her current capacity since
joining the Association.
Raymond A. Williams. Mr. Williams worked for a major commercial bank
for 15 years prior to joining the Association in 1995 as chief lending
officer.
Employees
The Association had 16 full time employees and five part-time
employees at September 30, 1998. None of the employees is represented
by a collective bargaining agreement.
<PAGE>
ITEM 2.--PROPERTIES.
The following table sets forth information regarding the Association's
offices at September 30, 1998:
Owned or Date Net Book
Location Leased Acquired Value
325 Second Street SE Owned 1968 $115,000
Cullman, AL
(Main Office)
1602 Second Ave., SW Leased (1) 1979 15,660
Cullman, AL
(Branch)
(1) Lease expires March 31, 2000.
The net book value of the Company's investment in furnishings and
equipment totaled $298,000 at September 30, 1998.
ITEM 3.--LEGAL PROCEEDINGS.
Neither the Holding Company nor the Association is presently involved
in any material legal proceedings. From time to time, the Association
is a party to legal proceedings incidental to its business to enforce
its security interest in collateral pledged to secure loans made by
the Association.
ITEM 4.--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5.--MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The information contained in the 1998 Annual Report to Shareholders
(the "Annual Report") under the caption "Common Stock Data", a copy of
which is attached as exhibit 13.
ITEM 6.--SELECTED FINANCIAL DATA
The information called for by item 6 is set forth in the Annual Report
for the year ended September 30, 1998 under the heading "Selected
Financial Information and Other Data" and is attached under exhibit 13.
ITEM 7.--MANAGEMENT'S DISCUSSIN AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The information called for by Item 7 is set forth in the Annual Report
for the year ended September 30, 1998 under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
and is incorporated herein by reference.
<PAGE>
<TABLE>
ITEM 8.--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
(Dollars in Thousands Except Per Share Amounts)
<CAPTION>
1998
First Second Third Fourth Total
------ ------ ------ ------- ------
<S> <C> <C> <C> <C> <C>
Interest revenue $1,316 $1,347 $1,309 $1,264 $5,236
Interest expense 608 613 603 604 2,426
------ ------ ------ ------- ------
Net interest revenue 710 734 706 660 2,810
Provision for loan losses 0 0 0 0 0
Non-interest revenue 49 45 55 31 180
Non-interest expense 422 509 379 391 1,701
------ ------ ------ ------- ------
Income before income taxes 337 270 382 300 1,289
Income tax expense 121 116 107 122 466
------ ------ ------ ------- ------
Net income $ 216 $ 154 $ 275 $ 178 $ 823
====== ====== ====== ====== ======
Basic earnings per share $ 0.22 $ 0.17 $ 0.31 $ 0.22 $ 0.92
====== ====== ====== ====== ======
Diluted earnings per share $ 0.22 $ 0.16 $ 0.29 $ 0.20 $ 0.87
====== ====== ====== ====== ======
<CAPTION>
1997
First Second Third Fourth Total
------ ------ ------ ------- ------
<S> <C> <C> <C> <C> <C>
Interest revenue $1,204 $1,234 $1,248 $1,362 $5,048
Interest expense 643 605 510 677 2,435
------ ------ ------ ------- ------
Net interest revenue 561 629 738 685 2,613
Provision for loan losses 0 5 0 (5) 0
Non-interest revenue 65 40 76 7 188
Non-interest expense 382 354 484 352 1,572
------ ------ ------ ------- ------
Income before income taxes 244 310 330 345 1,229
Income tax expense 84 106 119 128 437
------ ------ ------ ------- ------
Net income $ 160 $ 204 $ 211 $ 217 $ 792
====== ====== ====== ====== ======
Basic and diluted earnings per share (1) $ 0.15 $ 0.20 $ 0.21 $ 0.23 $ 0.66
====== ====== ====== ====== ======
(1) Net income per share for the first quarter is for the period
from the date of the conversion, December 31, 1997, to
December 31, 1998. Net income per share for the year is for the
period from the date of conversion to September 30, 1998.
Other information called for by Item 8, is set forth in the Company's
Annual Report for the year ended September 30, 1998 and is
incorporated herein by reference.
</TABLE>
<PAGE>
ITEM 9.--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
<PAGE>
PART III
ITEM 10.--DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
The information contained in the definitive Proxy Statement for the
1998 Annual Meeting of Shareholders of Southern Community Bancshares,
Inc. (the "Proxy Statement"), is incorporated herein by reference.
ITEM 11.--EXECUTIVE COMPENSATION
The information contained in the Proxy Statement is incorporated
herein by reference.
ITEM 12.--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information contained in the Proxy Statement is incorporated
herein by reference.
ITEM 13.--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the Proxy Statement is incorporated
herein by reference.
<PAGE>
PART IV
ITEM 14.--EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(a) EXHIBITS
3(a) Certificate of Incorporation Incorporated by reference to the
Form SB-2
3(b) Bylaws Incorporated by reference to the
Form SB-2
13 Annual Report to Shareholders
21 Subsidiaries of the Registrant
27 Financial Data Schedule
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1923,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
SOUTHERN COMMUNITY BANCSHARES INC.
Date: 12/23/98 By: /s/ William R. Faulk
William R. Faulk
President and Chief
Executive Officer
Date: 12/23/98 By: /s/ Beth Knight
Beth Knight
Secretary and Treasurer
EXHIBIT 13
<TABLE>
Selected Financial Information and Other Data:
<CAPTION>
At September 30,
1998 1997 1996
------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Total amount of:
Assets $66,820 $70,885 $63,861
Cash and interest-bearing time deposits in banks 9,591 9,887 3,868
Investment securities 3,553 8,911 9,945
Mortgage-backed securities 6,876 7,610 8,450
Loans receivable, net 45,846 42,999 39,601
Deposits 55,557 55,875 57,138
Equity 11,101 14,470 5,685
</TABLE>
<TABLE>
Summary of Earnings:
<CAPTION>
Year Ended September 30,
1998 1997 1996
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Interest income $ 5,236 $ 5,048 $ 4,642
Interest expense 2,426 2,435 2,574
------- ------- -------
Net interest income 2,810 2,613 2,068
Provision for loan losses 0 0 190
------- ------- -------
Net interest income after provision for loan losses 2,810 2,613 1,878
Non-interest income, net 180 188 242
Non-interest expense, net 1,701 1,572 1,781
------- ------- -------
Income before provision for income taxes 1,289 1,229 339
Income tax expense 466 437 118
------- ------- -------
Net income $ 823 $ 792 $ 221
======= ======= =======
</TABLE>
<PAGE>
<TABLE>
Selected Financial Ratios:
<CAPTION>
Year Ended September 30,
1998 1997 1996
------- ------- ------
(Dollars in thousands)
<S> <C> <C> <C>
Performance ratios:
Return on average assets 1.2% 1.1% .3%
Return on average equity 6.8 5.8 3.9
Interest rate spread (1) 3.4 3.0 3.0
Net interest margin (2) 4.1 3.8 3.3
Ratio of noninterest expenses to average assets 2.4 2.2 2.8
Average equity to average assets 17.3 19.1 9.0
Average interest-earning assets to average
interest-bearing liabilities 120.3 121.7 107.3
Assets quality ratios:
Nonperforming assets to total assets (3) .2 .4 .2
Nonperforming loans to total loans (3) .2 .6 .4
Allowance for loan losses to total loans 1.7 1.9 1.9
Allowance for loan losses to nonperforming loans (3) 763.9 304.2 524.2
(1) Interest rate spread represents the difference between the weighted
average yield on interest-earning assets and weighted average rate paid
on interest-bearing liabilities.
(2) Net interest margin represents annualized net interest income as a
percentage of average interest-earning assets.
(3) Nonperforming loans consist of nonaccrual loans and accruing loans 90 days
or more delinquent and nonperforming assets consist of nonperforming loans
and real estate owned.
</TABLE>
<PAGE>
COMMON STOCK DATA
The Company's common stock began trading on the NASDAQ on December 23,
1996, under the symbol "SCBS." At September 30, 1998, there were
1,080,482 shares of the common stock outstanding and approximately 350
stockholders of record. The following table sets forth information as
to high and low sales prices of the Company's common stock and cash
dividends per share of common stock for the calendar quarters
indicated.
<TABLE>
<CAPTION>
Price Per Share Dividends Per Share
---------------- -------------------
High Low Regular Special
------ ------ -------- --------
<S> <C> <C> <C> <C>
Fiscal 1998:
First quarter 19.00 17.00 0.075 0.00
Second quarter 20.00 17.50 0.000 2.50
Third quarter 19.75 14.75 0.075 0.00
Fourth quarter 17.75 14.75 0.075 0.00
Fiscal 1997:
First quarter 13.75 12.25 0.000 0.00
Second quarter 13.50 13.00 0.075 0.00
Third quarter 14.63 13.50 0.075 0.00
Fourth quarter 16.75 14.75 0.075 0.00
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The principal business of the Association consists of accepting
deposits from the general public and investing those funds in loans
secured by one- to four-family residential properties located in the
Association's primary market area and loans for other general purposes
to individuals and businesses. The Association's securities portfolio
consists primarily of U.S. Treasury notes and government agency
securities and mortgage-backed securities.
The Association's earnings are primarily dependent upon its net
interest income, the difference between interest income and interest
expense. Interest income is a function of the balances of loans and
investments outstanding during a given period and the yield earned on
such loans and investments. Interest expense is a function of the
amount of deposits outstanding during the same period and interest
rates paid on such deposits. The Association's earnings are also
affected by provisions for loan losses, service charges, and other
noninterest income, operating expenses, and income taxes.
The Association is significantly affected by prevailing economic
conditions, as well as government policies and regulations concerning,
among other things, monetary and fiscal affairs, housing, and
financial institutions. Deposit flows are influenced by a number of
factors, including interest rates paid on competing investments,
account maturities, and the level of personal income and savings
within the Association's market. In addition, deposit growth is
affected by how customers perceive the stability of the financial
services industry amid various current events such as regulatory
changes, failures of other financial institutions, and financing of
the deposit insurance fund. Lending activities are influenced by the
demand for and supply of housing lenders, the availability and cost of
funds, and various other items. Sources of funds for lending
activities of the Association include deposits and income provided
from operations.
Changes in Financial Condition
At September 30, 1998, the Company's assets totaled $66.8 million, as
compared to $70.9 million at September 30, 1997. Total assets
decreased by $4.1 million, or 5.7%, from September 30, 1997 to
September 30, 1998. The decrease in total assets during this period
resulted from funding of a $2.2 million special dividend in the form
of a return of capital, $1.3 million in stock purchased for benefit
plan trusts and contributions to benefit plan trusts, and the purchase
of $800,000 in treasury stock. This was reflected in decreases in
interest bearing deposits of $2.4 million, mortgage-backed securities
of $700,000 and investment securities of $5.4 million. The decreases
in investment and mortgage-backed securities were primarily due to
maturities and significant prepayments due to the decreasing rate
environment. These decreases were partially offset by a $1.0 million
increase in fed funds sold and a $2.8 million increase in loans. The
increase in loans reflected the Company's continued emphasis to invest
excess funds in loans, especially one-to-four family residential
loans.
During the fiscal year ended September 30, 1998, total deposits
remained relatively constant, decreasing by only $300,000, or 0.6%, to
$55.6 million. Total equity decreased by $3.4 million, primarily as a
result of the special dividend, the contribution to benefit plan
trusts and the purchase of treasury stock.
Results of Operations for the Years Ended September 30, 1998, 1997,
and 1996
The Company had net income of $823,000 for the year ended
September 30, 1998 compared to net income of $792,000 for fiscal 1997.
The $823,000 in net income represented a 4.0% increase over fiscal
1997. The Company's net income of $792,000 for the fiscal year ended
September 30, 1997 represented an increase of $571,000 or 258.3%, from
fiscal 1996. This increase from fiscal 1996 to fiscal 1997 was
primarily the result of the SAIF assessment during 1996.
Total interest income increased by $197,000, or 7.5%, in fiscal year
ended September 1998 compared to fiscal year ended September 30, 1997.
The increase was primarily the result of an increase in the average
yield on interest earning assets, primarily on loans.
Interest income increased by $735,000, or 39.2%, during the fiscal
year ended September 1997 compared to fiscal 1996. Such increase was
due primarily to an increase in interest income as a result of
investing the stock offering proceeds in the average balance of
deposits. The decrease in deposits was the result of withdrawals from
deposit accounts maintained with the association for payment of the
Company's common stock during the stock offering.
Provision for Loan Losses
The Association did not record a provision for loan losses during the
fiscal year ended September 30, 1998 or 1997 compared to a $190,000
provision during fiscal 1996. The provision in fiscal 1996 was made
in order to adjust the allowance for the increased volume of mortgage
loans as well as the expansion of consumer and commercial lending.
Favorable charge-off experience since that time has not warranted
additions to the allowance. Commercial and consumer loans
traditionally have higher rates of default and are secured by
collateral that often depreciates or is less liquid than the real
estate securing mortgage loans.
The Association's methodology for evaluating the adequacy of its
allowance for loan losses, which conforms with GAAP, considers
collateral valuation, changes in the loan portfolio mix, and certain
economic indicators, causing it to be a leading indicator of inherent
risk in the loan portfolio. Accordingly, it is not necessarily
reflective of past trends in charge-offs and other factors. The
methodology incorporates economic indicators such as growth in
personal income and unemployment rates as well as other economic
indicators affecting the Association's market area and considers
higher risk loan groups, including growth in the Association's
consumer and multi-family and non-residential loan portfolios.
Non-Interest Income
Non-interest income declined slightly to $180,000 in fiscal 1998.
Non-interest income amounted to $187,000 for the fiscal year ended
September 30, 1997 compared to $242,000 for fiscal 1996. The primary
differences in non-interest income between fiscal 1998 and fiscal 1997
and between fiscal 1997 and fiscal 1996 were from reductions in fees
from deposit accounts.
Non-Interest Expenses
Non-interest expenses amounted to $1.7 million during the fiscal year
ended September 30, 1998, a $129,000, or 8.2%, increase over the $1.6
million of non-interest expenses during the year ended September 30,
1997. The primary reason for the increase in non-interest expenses in
fiscal 1998 compared to fiscal 1997 was implementation of the
Management Retention Plan ("MRP") during fiscal 1998. The primary
reason for the decrease in non-interest expenses in fiscal 1997
compared to fiscal 1996 was the 1996 one-time special assessment of
$370,000 on SAIF insured deposits as of March 31, 1996 which was
partially offset by the $150,000 increase in compensation and benefits
which resulted from increased personnel, merit raises, and $95,000 in
ESOP expense which was new in fiscal 1997.
Income Taxes
The provisions for income taxes were $466,000, $437,000, and $118,000
in fiscal 1998, 1997, and 1996, respectively. The changes in such
respective amounts primarily reflect the fluctuations in levels of
income before income taxes of the Company during those fiscal years of
$1,289,000, $1,229,000, and $339,000, respectively.
Net Interest Income
The Company's net interest income is determined by its interest rate
spread (i.e., the difference between the yields earned on its
interest-earning assets and the rates paid on its interest-bearing
liabilities) and the relative amounts of interest-earning assets and
interest-bearing liabilities.
Total interest income increased by $188,000, or 3.7%, in the fiscal
year ended September 30, 1998 compared to fiscal 1997. The increase
was due primarily to an increase in interest on loans of $479,000
resulting from an increase in loan volume. Interest income from other
interest earning assets decreased $291,000 as the average balances
decreased.
Total interest income increased by $406,000, or 8.8%, in the fiscal
year ended September 30, 1997 compared to fiscal 1996. The increase
was due primarily to an increase in income and dividends on securities
held to maturity and securities available for sale (including
mortgage-backed securities and investment securities) increased
$156,000, or 14.9% resulting from an increase in the average balances
resulting from investing the stock offering proceeds. Interest income
from other interest earning assets increased $159,000, or 77.9%, as
the average balance increased due to investing the proceeds from the
stock offering.
Liquidity and Capital Resources
The Association is required under applicable federal regulations to
maintain specified levels of "liquid" investments in qualifying types
of United States Government, federal agency, and other investments
having maturities of five years or less. Current OTS regulations
require that a savings association maintain liquid assets of not less
than 5% of its average daily balance of net withdrawable deposit
accounts and borrowings payable in one year or less, of which
short-term liquid assets must consist of not less than 1%. Monetary
penalties may be imposed for failure to meet applicable liquidity
requirements. At September 30, 1998, the Association's liquidity, as
measured for regulatory purposes, was in excess of the minimum OTS
requirement.
Cash was generated by the Association's operating activities during
the years ended September 30, 1998 and 1997 primarily as a result of
net income. The adjustments to reconcile net income to cash provided
by operating activities during the periods presented consisted
primarily of amortization of premiums and discounts, proceeds from the
sale of loans, and increases or decreases in interest and dividends
receivable, prepaid income taxes, accrued interest payable, and
accrued expenses and other liabilities. The primary investing
activity of the Association is lending, which is funded with cash
provided by operations, as well as principal collections and
maturities of interest-bearing deposits in banks. For additional
information about cash flows from the Association's operating,
financing, and investing activities, see the Statements of Cash Flows
included in the Consolidated Financial Statements.
At September 30, 1998, the Association had outstanding $691,000 in
undisbursed portion of mortgage loans. At the same date, the total
amount of certificates of deposit which are scheduled to mature by
September 30, 1999 was $24.3 million. The Association believes that
it has adequate resources to fund commitments as they arise and that
it can adjust the rate on savings certificates to retain deposits in
changing interest rate environments. If the Association requires
funds beyond its internal funding capabilities, advances from the FHLB
of Atlanta are available as an additional source of funds.
The Association is required to maintain specified amounts of capital
pursuant to the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 ("FIRREA") and regulations promulgated
thereunder by the OTS. The capital standards generally require the
maintenance of regulatory capital sufficient to meet a tangible
capital requirement, a core capital requirement, and a risk-based
requirement. At September 30, 1998, the Association's tangible and
core capital totaled $10.8 million, or 15.8% of adjusted total assets,
which exceeded the respective minimum requirements at that date by
approximately $9.8 million and $8.8 million, respectively, or 14.3%
and 12.8%, respectively. The Association's risk-based capital totaled
$11.3 million at September 30, 1998, or 29.5% of risk-weighted assets,
which exceeded the current requirement of 8% by approximately
$8.2 million, or 21.5% of risk-weighted assets.
Impact of Inflation and Changing Prices
The financial statements and related financial data presented herein
have been prepared in accordance with GAAP, which requires the
measurement of financial position and operating results in terms of
historical dollars, without considering changes in relative purchasing
power over time due to inflation.
Unlike most industrial companies, virtually all of the Association's
assets and liabilities are monetary in nature. As a result, interest
rates generally have a more significant impact on a financial
institution's performance than does the effect of inflation.
Year 2000 Problem
A great deal of information has been disseminated about the global
computer crash that may occur in the year 2000. Many computer
programs that can only distinguish the final two digits of the year
entered (a common programming practice in earlier years) are expected
to read entries for the year 2000 as the year 1900. All of the
significant data processing of the Association that could be affected
by this problem is provided by a third party service bureau. The
service bureau of the Association has advised the Association that it
expects to resolve this potential problem before the year 2000.
However, if the service bureau is unable to resolve this potential
problem in time, the Association would likely experience significant
data processing delays, mistakes, or failures. These delays,
mistakes, or failures could have a material adverse impact on the
financial condition and results of operations of the Association.
Risks to the Company if its computer system are not year 2000
compliant include the inability to process customer deposits or checks
drawn on the Association, inaccurate interest accruals, and maturity
dates of loans and time deposits, and the inability to update accounts
for daily transactions. Other risks to the Company exist if certain
of its vendors', suppliers', and customers' computer systems are not
Year 2000 compliant. These risks include the inability of the
Association to communicate with its third party service bureau if
phone systems are not working, the interruption of business in the
event of power outages, the inability of loan customers to comply with
repayment terms if their businesses are interrupted, the inability to
make payment for checks drawn on the Association, receive payment for
checks deposited by the Association's customers, or invest excess
funds if the Federal Home Loan Bank or correspondent banks are not
Year 2000 compliant. The Company's most important mission critical
system is the software and hardware responsible for maintaining and
processing general ledger, deposits, and loan accounts. The Company's
Year 2000 Compliance and Contingency Plans are structured in
accordance with the OTS and the FFIEC guidelines. Remediation and
testing efforts relating to the Year 2000 are on schedule and are
expected to be completed by December 1998. The Company has contacted
its key vendors, suppliers, and customers to determine their Year 2000
compliance. The Company estimates that the cost of testing and
updating its systems for Year 2000 compliance will not be material.
Average Balance, Interest, and Average Yields and Rates
The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities
and reflects the average yield on assets and the average cost of liabilities
for the periods and at the date indicated. Such yields and costs are
derived by dividing income or expense by the average monthly balance of
assets or liabilities, respectively, for the periods indicated.
The table also presents information for the periods indicated and at
September 30, 1998 with respect to the difference between the weighted
average yield earned on interest-earning assets and the weighted average
rate paid on interest-bearing liabilities, or "interest rate spread,"
which savings institutions have traditionally used as an indicator of
profitability. Another indicator of an institution's net interest income
is its "net yield on interest-earning assets." which is its net interest
income divided by the average balance of interest-earning assets. Net
interest income is affected by the interest rate spread and by the relative
amounts of interest-earning assets and interest-bearing liabilities. When
interest-earning assets approximate or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest income.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------------------
1998 1997
------------------------------ -----------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
-------- -------- ------- -------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits in other financial institutions $ 9,445 $ 483 5.12% $ 7,540 $ 363 4.81%
Investment securities and FHLB stock 7,082 414 5.84 13,134 731 5.57
Mortgage-backed securities 6,521 381 5.85 8,035 475 5.91
Loans receivable 45,478 3,958 8.70 40,609 3,479 8.57
-------- -------- -------- --------
Total interest-earning assets 68,526 5,236 7.64 69,318 $5,048 7.28
Non-interest-earning assets 1,325 1,859
-------- --------
Total assets $ 69,851 $ 71,177
======== ========
Interest-bearing liabilities $ 56,949 2,426 4.26 $ 56,950 2,435 4.28
Non-interest-bearing liabilities 839 648
-------- --------
Total liabilities 57,788 57,598
-------- --------
Equity 12,063 13,579
-------- --------
Total liabilities and retained earnings $ 69,851 $ 71,177
======== -------- ======== ------
Net interest income $ 2,810 $2,613
======== ======
Interest rate spread 3.38% 3.00%
======= =======
Net interest margin (net interest income as a percentage
of average interest-earning assets) 4.10% 3.77%
======= =======
Average interest-earning assets to average interest-bearing
liabilities 120.33% 121.72%
======= =======
</TABLE>
Rate/Volume Analysis
The table below sets forth certain information regarding changes in
interest income and interest expense of the Association for the
periods indicated. For each category of interest-earning asset and
interest-bearing liability, information is provided on changes
attributable to: (i) changes in volume (changes in volume multiplied
by prior period rate) and (ii) changes in rates (change in rate
multiplied by prior period volume). Changes in rate-volume (changes
in rate multiplied by changes in volume) are allocated proportionately
between changes in volume and changes in rates.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------------------------
1998 Compared to 1997 1997 Compared to 1996
------------------------------------ ----------------------------------------
Increase Increase Increase Increase
(Decrease) (Decrease) Total (Decrease) (Decrease) Total
Due to Due to Increase Due to Due to Increase
Rate Volume (Decrease) Rate Volume (Decrease)
-------- -------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income attributable to:
Interest-bearing deposits in other
financial institutions $ 24 $ 96 $ 120 $ (4) $163 $ 159
Investment securities 38 (355) (317) (2) 151 149
Mortgage-backed securities (5) (89) (94) (2) 9 7
Loans receivable 56 423 479 1 90 91
----- ------- ------ ------- ------ -------
Total interest income 113 75 188 (7) 413 406
----- ------- ------ ------- ------ -------
Interest expense attributable to:
Deposits (9) 0 (9) (103) (36) (139)
----- ------- ------ ------- ------ -------
Increase (decrease) in net interest income $122 $ 75 $ 197 $ 96 $449 $ 545
===== ======= ====== ======= ====== =======
</TABLE>
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Southern Community Bancshares, Inc.:
We have audited the accompanying consolidated statements of financial
condition of SOUTHERN COMMUNITY BANCSHARES, INC. (a Delaware
corporation) AND SUBSIDIARY as of September 30, 1998 and 1997, and the
related consolidated statements of income, stockholders' equity, and
cash flows for each of the three years in the period ended
September 30, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated
financial position of Southern Community Bancshares, Inc. and
subsidiary as of September 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the
period ended September 30, 1998, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Birmingham, Alabama
November 4, 1998
<PAGE>
<TABLE>
SOUTHERN COMMUNITY BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 1998 AND 1997
<CAPTION>
ASSETS
1998 1997
------------- -------------
<S> <C> <C>
CASH AND DUE FROM BANKS $ 1,614,385 $ 579,544
INTEREST BEARING DEPOSITS IN BANKS 7,976,978 9,307,720
INVESTMENT SECURITIES AVAILABLE-FOR-SALE, at fair value 2,554,087 7,412,925
MORTGAGE-BACKED SECURITIES AVAILABLE-FOR-SALE, at fair value 6,038,694 5,583,924
INVESTMENT SECURITIES HELD-TO-MATURITY, fair value of $1,004,116
and $1,492,141, respectively 999,042 1,498,407
MORTGAGE-BACKED SECURITIES HELD-TO-MATURITY, fair value
of $854,528 and $2,033,126, respectively 837,224 2,026,416
LOANS RECEIVABLE, net 45,846,372 42,998,875
ACCRUED INTEREST RECEIVABLE 406,034 469,453
PREMISES AND EQUIPMENT, net 297,708 545,564
INCOME TAXES RECEIVABLE 203,275 185,579
OTHER ASSETS 46,420 276,604
------------- -------------
Total assets $ 66,820,219 $ 70,885,011
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS $ 55,557,060 $ 55,874,668
ACCRUED INTEREST PAYABLE 90,261 102,304
ACCRUED EXPENSES AND OTHER LIABILITIES 72,371 437,922
------------- -------------
Total liabilities 55,719,692 56,414,894
------------- -------------
COMMITMENTS AND CONTINGENCIES
PREFERRED STOCK, par value $.01, no shares issued, 100,000 shares authorized 0 0
COMMON STOCK, par value $.01 per share, 3,000,000 shares authorized,
1,137,350 shares issued and outstanding 11,374 11,374
ADDITIONAL PAID-IN CAPITAL 10,807,847 10,786,689
RETAINED EARNINGS, substantially restricted 4,865,649 6,445,252
TREASURY STOCK, at cost, 56,868 shares (830,891) 0
UNEARNED COMPENSATION (3,771,076) (2,736,893)
UNREALIZED GAIN (LOSS) ON AVAILABLE-FOR-SALE SECURITIES, net of deferred taxes 17,624 (36,305)
------------- -------------
Total stockholders' equity 11,100,527 14,470,117
------------- -------------
Total liabilities and stockholders' equity $ 66,820,219 $ 70,885,011
============= =============
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
<PAGE>
<TABLE>
SOUTHERN COMMUNITY BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED SEPTEMBER 30, 1998, 1997, AND 1996
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans $3,958,307 $3,479,134 $3,387,699
Interest and dividends on investment securities 413,368 730,798 581,317
Interest on mortgage-backed and related securities 381,347 475,408 468,809
Other interest income 483,187 362,505 203,800
---------- ---------- ----------
Total interest income 5,236,209 5,047,845 4,641,625
INTEREST EXPENSE--DEPOSITS 2,426,019 2,434,567 2,573,461
---------- ---------- ----------
Net interest income before provision
for loan losses 2,810,190 2,613,278 2,068,164
PROVISION FOR LOAN LOSSES 0 0 190,170
---------- ---------- ----------
Net interest income after provision
for loan losses 2,810,190 2,613,278 1,877,994
---------- ---------- ----------
NONINTEREST INCOME:
Service charges on deposit accounts 175,677 182,225 234,963
Income (loss) from real estate operations, net 0 0 838
Gain on sale of premises and equipment 1,313 0 1,500
Other 2,807 5,224 4,958
---------- ---------- ----------
Total non-interest income 179,797 187,449 242,259
---------- ---------- ----------
NONINTEREST EXPENSE:
Compensation and benefits 1,015,113 869,414 719,704
Occupancy and equipment 173,374 171,158 180,007
SAIF deposit insurance 35,565 50,310 498,942
Data processing 140,541 119,329 118,208
Professional fees 54,854 55,564 45,243
Other 281,630 306,388 219,137
---------- ---------- ----------
Total non-interest expense 1,701,077 1,572,163 1,781,241
---------- ---------- ----------
Income before income taxes 1,288,910 1,228,564 339,012
INCOME TAX EXPENSE 465,510 436,723 118,024
---------- ---------- ----------
Net income $ 823,400 $ 791,841 $ 220,988
========== ========== ==========
BASIC EARNINGS PER SHARE $.91 $.66 N/A
========== ========== ==========
DILUTED EARNINGS PER SHARE $.87 $.66 N/A
========== ========== ==========
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
<PAGE>
<TABLE>
SOUTHERN COMMUNITY BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 1998, 1997, AND 1996
<CAPTION>
Unrealized
Gain (Loss)
on
Available
for Sale
Securities,
Additional Net of
Common Paid-In Retained Unearned Treasury Deferred
Stock Capital Earnings Compensation Stock Taxes Total
------- ----------- ---------- ----------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, September 30, 1995 $ 0 $ 0 $ 5,650,521 $ 0 $ 0 $ (44,934) $ 5,605,587
Net income 0 0 220,988 0 0 0 220,988
Change in net unrealized gain
(loss) on securities
available-for-sale, net 0 0 0 0 0 (141,794) (141,794)
------- ----------- ---------- ----------- --------- ---------- ----------
BALANCE, September 30, 1996 0 0 5,871,509 0 0 (186,728) 5,684,781
Net income 0 0 791,841 0 0 0 791,841
Change in unrealized gain (loss)
on securities
available-for-sale, net 0 0 0 0 0 150,423 150,423
Issuance of common stock 11,374 10,752,273 0 (909,880) 0 0 9,853,767
Amortization of unearned
compensation 0 34,416 60,824 0 95,240
Repurchase of stock for stock
plan trusts 0 0 (1,878,680) 0 0 (1,878,680)
Contribution to plan trust 0 0 0 (9,157) 0 0 (9,157)
Dividends declared ($.225 per share) 0 (218,098) 0 (218,098)
------- ----------- ---------- ----------- --------- ---------- ----------
BALANCE, September 30, 1997 11,374 10,786,689 6,445,252 (2,736,893) 0 (36,305) 14,470,117
Net income 0 0 823,400 0 0 0 823,400
Change in unrealized gain (loss)
on securities
available-for-sale, net 0 0 0 0 0 53,929 53,929
Amortization of unearned
compensation 0 21,158 0 225,213 0 0 246,371
Repurchase of stock for stock
plan trusts 0 0 0 (563,120) 0 0 (563,120)
Purchase of treasury stock 0 0 0 0 (830,891) 0 (830,891)
Contribution to plan trust 0 0 0 (696,276) 0 0 (696,276)
Dividends declared ($2.725 per share) 0 0 (2,403,003) 0 0 0 (2,403,003)
------- ----------- ----------- ----------- --------- ---------- ----------
BALANCE, September 30, 1998 $11,374 $10,807,847 $ 4,865,649 $(3,771,076) $(830,891) $ 17,624 $11,100,527
======= =========== =========== =========== ========= ========== ==========
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
<PAGE>
<TABLE>
SOUTHERN COMMUNITY BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 1998, 1997, AND 1996
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 823,400 $ 791,841 $ 220,988
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 84,746 82,388 82,388
Amortization and accretion on securities 39,634 (35,252) (49,120)
Amortization of unearned ESOP 246,371 95,240 0
Amortization of net deferred loan origination fees and costs (70,023) (47,407) (42,452)
Provision (benefit) for deferred income taxes (57,499) 122,904 (198,635)
Provision for loan losses 0 0 190,170
Loss on sale of foreclosed real estate, net 0 0 291
Gain on sale of premises and equipment, net (1,313) 0 (1,500)
Change in assets and liabilities:
Increase (decrease) in income taxes receivable/payable 7,781 (81,822) (98,442)
Increase (decrease) in accrued interest receivable 63,419 (37,443) (48,029)
Decrease (increase) in other assets 230,184 363,435 (536,612)
Decrease in accrued interest payable (12,043) (6,461) (4,513)
Increase (decrease) in accrued expenses and other liabilities (280,250) (576,802) 693,579
------------ ------------ ------------
Total adjustments 251,007 (121,220) (12,875)
------------ ------------ ------------
Net cash provided by operating activities 1,074,407 670,621 208,113
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities/calls of investment securities available-for-sale 4,950,000 3,620,636 1,000,000
Proceeds from maturities/calls of investment securities held-to-maturity 500,000 2,760,000 3,950,497
Purchases of investment securities available-for-sale 0 (5,272,915) (4,102,853)
Purchases of investment securities held-to-maturity 0 0 0
Net loan repayments (originations) (2,777,474) (3,350,673) (1,217,051)
Proceeds from maturities of mortgage-backed securities available-for-sale 1,647,192 1,072,607 672,582
Proceeds from maturities of mortgage-backed securities held-to-maturity 1,183,680 474,148 650,497
Purchases of mortgage-backed securities available-for-sale (2,141,930) (500,825) (4,492,120)
Capital expenditures (35,007) (24,674) (84,678)
Proceeds from sale of foreclosed real estate 0 0 43,924
Proceeds from sale of fixed assets 199,430 0 1,500
------------ ------------ ------------
Net cash provided by (used in) investing activities 3,525,891 (1,221,696) (3,577,702)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in deposits (317,608) (1,263,034) 1,129,732
Net proceeds from public stock offering 0 9,853,767 0
Repurchase of stock for stock plan trusts (563,120) (1,878,680) 0
Contributions to plan trusts (696,276) (9,157) 0
Payment of dividends (2,488,304) (132,797) 0
Purchase of treasury stock (830,891) 0 0
------------ ------------ ------------
Net cash provided by (used in) financing activities (4,896,199) 6,570,099 1,129,732
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (295,901) 6,019,024 (2,239,857)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 9,887,264 3,868,240 6,108,097
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 9,591,363 $ 9,887,264 $ 3,868,240
============ ============ ============
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest on deposits $ 2,438,062 $ 2,341,955 $ 2,577,974
Income taxes 510,979 339,991 418,241
Transfers from loans to real estate acquired through foreclosure 7,306 0 38,771
============ ============ ============
CHANGE IN UNREALIZED NET LOSS ON SECURITIES AVAILABLE-
FOR-SALE, net of deferred taxes $ 53,929 $ 150,423 $ 141,794
============ ============ ============
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
<PAGE>
SOUTHERN COMMUNITY BANCSHARES, INC. AND SUBSIDIARY
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization, Nature of Operations, and Principles of
Consolidation
Southern Community Bancshares, Inc. (the "Company") was incorporated
in the State of Delaware in July 1996, for the purpose of becoming a
holding company to own all of the outstanding capital stock of First
Federal Savings and Loan Association of Cullman (the "Association")
upon the Association's conversion from a federally chartered mutual
savings association to a federally chartered stock savings association
(the "Conversion"). The accounting for the conversion is in a manner
similar to that utilized in a pooling of interests.
The Association received its federal charter in 1905 and was converted
to a federally chartered stock organization on December 23, 1996
through the sale of all of its common stock to the Company. The
Association is primarily engaged in the business of obtaining funds in
the form of various savings deposit products and investing those funds
in mortgage loans or single family real estate and, to a lesser
extent, in consumer loans. The Association operates from its two
offices in the primary market area of Cullman County, Alabama.
The accompanying consolidated financial statements include the
accounts of the Company, and the Association. All significant
intercompany balances and transactions have been eliminated in
consolidation.
Use of Estimates
The accounting principles and reporting policies of the Company, and
the methods of applying these principles, conform with generally
accepted accounting principles ("GAAP") and with general practices
within the thrift industry. In preparing the financial statements,
management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of the date of the
balance sheet and revenues and expenses for the period. Actual
results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant
changes in the near-term relate to the determination of the allowance
for loan losses 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 loan losses
and real estate owned, management obtains independent appraisals for
significant properties, evaluates the overall portfolio
characteristics and delinquencies and monitors economic conditions.
A substantial portion of the Company's loans are secured by real
estate in its primary market area. Accordingly, the ultimate
collectibility of a substantial portion of the Company's loan
portfolio and the recovery of a portion of the carrying amount of
foreclosed real estate are susceptible to changes in economic
conditions in the Company's primary market areas.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash on hand, amounts due from banks, interest-bearing
deposits in banks, and federal funds sold. Federal funds are
generally purchased and sold for one-day periods.
Investment and Mortgage-Backed Securities
Securities classified as held-to-maturity are stated at cost, adjusted
for amortization of premiums and accretion of discounts on the
constant effective yield method. Management has the positive intent
and the Company has the ability to hold these securities to maturity.
Available-for-sale securities are carried at fair value, except for
FHLB required stock holding which are carried at cost, and include all
equity securities and debt not classified as held-to-maturity or
trading. Trading securities are those held principally for the
purpose of selling in the near future and are carried at fair value.
The Company does not currently have any trading securities.
Unrealized gains and losses for trading securities are included in
earnings. Unrealized gains and losses for available-for-sale
securities are excluded from earnings and reported, net of any income
tax effect, as a separate component of retained earnings. Realized
gains and losses for securities classified as either
available-for-sale or held-to-maturity are reported in earnings based
on the adjusted cost of the specific security sold.
Loans Receivable
Loans receivable are stated at their unpaid balances, less the
allowance for loan losses and net deferred loan origination fees and
discounts.
The Company ceases accrual of interest on substantially all loans when
payment on a loan is in excess of 90 days past due. An allowance is
established by a charge to interest income equal to all interest
previously accrued but unpaid. Interest income is subsequently
recognized only to the extent that cash payments are received until,
in management's judgment, the borrower's ability to make periodic
interest and principal payments is in accordance with the terms of the
loan agreement; in which case the loan is returned to accrual status.
The allowance for loan losses is increased by charges to income and
decreased by loan charge-offs, net of recoveries. The allowance for
loan losses is maintained at a level which management considers
adequate to absorb losses inherent in the loan portfolio at each
reporting date. Management's estimation of this amount includes a
review of all loans for which full collectibility is not reasonably
assured and considers, among other factors, prior years' loss
experience, economic conditions, distribution of portfolio loans by
risk class, and the estimated value of the underlying collateral.
Though management believes the allowance for loan losses to be
adequate, ultimate losses may vary from their estimates. However,
estimates are reviewed periodically, and as adjustments become
necessary, they are reported in earnings in periods in which they
become known. In addition, various regulatory agencies, as an
integral part of their examination process periodically review the
Company's allowance for losses on loans and the carrying value of
foreclosed real estate. Such agencies may require the Company to
recognize additions to the allowances based on their judgments about
information available to them at the time of their examinations.
Losses on individually identified impaired loans are measured based on
the present value of expected future cash flows discounted at each
loan's original effective interest rate. As a practical expedient,
impairment may be measured based on the loan's observable market price
or the fair value of the collateral if the loan is collateral
dependent. When the measure of the impaired loan is less than the
recorded investment in the loan, the impairment is recorded through a
provision added to the allowance for loan losses. Because on the
Company's loan portfolio primarily consists of one-to-four family
residential mortgages and consumer installment loans that are
evaluated collectively for impairment, the Company had no loans
designated as impaired under the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 114 at September 30, 1998 or 1997.
Loan Origination Fees and Related Costs
Loan origination fees and certain direct origination costs are
capitalized and recognized as an adjustment of the yield of the
related loan over the remaining period to contractual maturity.
Foreclosed Real Estate
Real estate acquired through, or in lieu of, loan foreclosure is
initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. Costs to maintain or hold the property
are expensed and amounts incurred to improve the property, to the
extent that fair value is not exceeded, are capitalized. Valuations
are periodically performed by management, and an allowance for losses
is established by a charge to income if the carrying value of a
property exceeds its fair value less the estimated costs to sell.
Premises and Equipment
Land is carried at cost. Buildings, leasehold improvements, and
furniture, fixtures and equipment are carried at cost, less
accumulated depreciation and amortization. Depreciation is provided
using the straight-line and accelerated methods over the estimated
useful lives of the assets. The cost of leasehold improvements is
amortized using the straight-line method over the life of the lease.
The estimated useful lives of furniture, fixtures, and equipment range
from 5 to 15 years and for building and improvements range from 5 to
33 years.
Income Taxes
The Company accounts for income taxes through the use of the asset and
liability method. Under the asset and liability method, deferred
taxes are recognized for the tax consequences of temporary differences
by applying enacted statutory rates applicable to future years to
differences between the financial statement carrying amounts and the
tax bases of existing assets and liabilities. The effect on deferred
taxes of a change in tax rates would be recognized in income in the
period that includes the enactment date.
Treasury Stock
Treasury stock purchases and sales are accounted for using the cost
method.
Pending Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, Reporting of Comprehensive Income, which establishes
standards for reporting and display of comprehensive income and its
components (revenues expenses, gains, and losses) in a full set of
financial statements. This statement also requires that all items
that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other
financial statements.
This statement is effective for fiscal years beginning after
December 15, 1997. Earlier application is permitted.
Reclassification of financial statements for earlier periods provided
for comparative purposes is required. Management will provide this
additional disclosure in the coming year.
In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments
of an Enterprise and Related Information, which establishes standards
for the way that public business enterprises report information about
operating segments in annual financial statements and also establishes
standards for related disclosures about products and services,
geographic areas, and major customers. This statement is effective
for financial statements for periods beginning after December 15,
1997. Management believes there will be no material effect on the
consolidated financial statements from the adoption of this
pronouncement.
The AICPA has issued Statements of Position 98-1, Accounting for the
Cost of Computer Software Developed or Obtained for Internal Use.
This statement requires capitalization of external direct costs of
materials and services; payroll and payroll-related costs for
employees directly associated; and interest costs during development
of computer software for internal use (planning and preliminary costs
should be expensed). Also, capitalized costs of computer software
developed or obtained for internal use should be amortized on a
straight-line basis unless another systematic and rational basis is
more representative of the software's use. This statement is
effective for financial statements for fiscal years beginning after
December 15, 1998 (prospectively) and is not expected to have a
material effect on the consolidated financial statements.
The FASB has issued SFAS No. 133, Accounting for Derivative
Instruments for Hedging Activities. The statement requires
derivatives to be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement also requires
that changes in the derivatives' fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. This
statement is effective for fiscal years beginning after June 15, 1999
(prospectively) and is not expected to have a material effect on the
consolidated financial statements.
Financial Statement Reclassification
The financial statements for prior years have been reclassified in
order to conform with the 1998 financial statement presentation. The
reclassification did not change total assets or net income in the
prior year.
2. EARNINGS PER SHARE
In 1998, the Company adopted SFAS No. 128, Earnings Per Share,
effective December 15, 1997. Basic earnings per share were computed
by dividing net income by the weighted average number of shares of
common stock outstanding during the years ended September 30, 1998,
and 1997. Common stock outstanding consists of issued shares less
unallocated ESOP shares, and shares owned by the MRP and Stock Option
Plan Trust. Earnings per share for the period from December 23, 1996,
the date of Conversion, to September 30, 1997, have been computed
based on the earnings during that period and on the weighted average
number of shares of common stock and common stock equivalents
outstanding during that period. The weighted average number of shares
used for the period from December 23, 1996 through September 30, 1997,
was 975,727. Diluted earnings per share for this period was the same
as basic earnings per share because there were no dilutive securities
outstanding during the period.
The following table represents the earnings per share calculations for
the years ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
Per
Share
Income Shares Amount
<S> <C> <C> <C>
September 30, 1998:
Net income $823,400
Basic earnings per share:
Income available to common shareholders 823,400 909,123 $.91
====
Dilutive securities 0 37,005
-------- -------
Diluted earnings per share $823,400 946,128 $.87
======== ======= ====
September 30, 1997:
Net income for the period December 23,
1996 to September 30, 1997 $623,652
Basic earnings per share:
Income available to common shareholders 643,652 975,727 $.66
====
Dilutive securities 0 0
-------- -------
Diluted earnings per share $643,652 975,727 $.66
======== ======= ====
</TABLE>
<PAGE>
3. INVESTMENT AND MORTGAGE-BACKED SECURITIES
Details of securities are as follows:
<TABLE>
<CAPTION>
September 30, 1998
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------ -------- --------- ------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Treasury and federal agencies $ 1,977,968 $ 6,319 $ 0 $ 1,984,287
Equity securities 140,000 0 0 140,000
Federal Home Loan Bank stock 429,800 0 0 429,800
------------ -------- --------- ------------
Investment securities 2,547,768 6,319 0 2,554,087
Mortgage-backed securities 6,018,319 20,375 0 6,038,694
------------ -------- --------- ------------
Total $ 8,566,087 $26,694 $ 0 $ 8,592,781
============ ======== ========= ============
Held-to-maturity:
U.S. Treasury and federal agencies $ 849,042 $ 0 $ (401) $ 848,641
Obligations of state and political subdivisions 150,000 5,475 0 155,475
------------ -------- --------- ------------
Investment securities 999,042 5,475 (401) 1,004,116
Mortgage-backed securities 837,224 17,304 0 854,528
------------ -------- --------- ------------
Total $ 1,836,266 $22,779 $ (401) $ 1,858,644
============ ======== ========= ============
<CAPTION>
September 30, 1997
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------ -------- --------- ------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Treasury and federal agencies $ 6,980,741 $ 2,384 $ 0 $ 6,983,125
Equity securities 0 0 0 0
Federal Home Loan Bank stock 429,800 0 0 429,800
------------ -------- --------- ------------
Investment securities 7,410,541 2,384 0 7,412,925
Mortgage-backed securities 5,643,733 4,503 (64,312) 5,583,924
------------ -------- --------- ------------
Total $13,054,274 $ 6,887 $(64,312) $12,996,849
============ ======== ========= ============
Held-to-maturity:
U.S. Treasury and federal agencies $ 1,348,407 $ 0 $(14,869) $ 1,333,538
Obligations of state and political subdivisions 150,000 8,603 0 158,603
------------ -------- --------- ------------
Investment securities 1,498,407 8,603 (14,869) 1,492,141
Mortgage-backed securities 2,026,416 20,084 (13,374) 2,033,126
------------ -------- --------- ------------
Total $ 3,524,823 $28,687 $(28,243) $ 3,525,267
============ ======== ========= ============
</TABLE>
<PAGE>
The amortized cost and estimated fair value of securities, by contractual
maturity, are shown below. Expected maturities will differ from contractual
maturity because borrowers may have the right to call or prepay obligations:
<TABLE>
<CAPTION>
September 30, 1998
Available-for-Sale Held-to-Maturity
------------------------ --------------------------
Amortized Amortized
Cost Fair Value Cost Fair Value
---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Due in one year or less $1,249,212 $1,253,744 $ 350,000 $ 349,891
Due after one year through five years 753,756 755,543 649,042 654,225
Due after five years through ten years 0 0 0 0
Due after ten years 544,800 544,800 0 0
---------- ---------- ----------- -----------
2,547,768 2,554,087 999,042 1,004,116
Mortgage-backed securities 6,018,319 6,038,694 837,224 854,528
---------- ---------- ----------- -----------
Total $8,566,087 $8,592,781 $1,836,266 $1,858,644
========== ========== =========== ===========
</TABLE>
All mortgage-backed securities were issued by either U.S. government
agencies (Government National Mortgage Association) or
government-sponsored enterprises (Federal Home Loan Mortgage
Corporation or Freddie Mac). The mutual funds are backed primarily by
Federal Home Loan Mortgage Association mortgage-backed securities and
private issuer mortgage-backed securities.
During the year ended September 30, 1998, the Company sold mutual
funds with a book and fair value of $1,870,636 with no gain or loss.
There were no other sales of securities during the years ended
September 30, 1998 and 1997.
<PAGE>
4. LOANS RECEIVABLE, NET
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
------------ ------------
<S> <C> <C>
Mortgage loans:
Principal balances:
Secured by 1-4 family residences $27,972,399 $25,617,086
Secured by nonresidential properties 8,384,027 8,077,000
Secured by multifamily properties 2,514,375 4,172,496
Construction loans 1,357,500 1,266,600
------------ ------------
40,228,301 39,133,182
Less:
Undisbursed portion of mortgage loans (691,229) (815,502)
Net deferred loan origination fees (161,971) (169,738)
------------ ------------
Total mortgage loans 39,375,101 38,147,942
Commercial loans 3,658,012 2,293,540
Consumer loans:
Principal balances:
Loans secured by automobiles 1,477,235 1,534,822
Loans secured by savings accounts 518,366 518,173
Other 1,607,372 1,310,362
------------ ------------
Total consumer loans 3,602,973 3,363,357
------------ ------------
Total loans 46,636,086 43,804,839
Less allowance for loan losses 789,714 805,964
------------ ------------
Loans receivable, net $45,846,372 $42,998,875
============ ============
</TABLE>
In the ordinary course of business, the Company makes loans to
officers, directors, employees, and other related parties of the
Company. Management believes that these loans are made on
substantially the same terms as those prevailing for comparable
transactions with others and that they do not involve more than normal
risk of collectibility nor do they present other unfavorable features.
The amounts of such related party loans and commitments at
September 30, 1998 and 1997 were $1,020,000 and $1,035,000,
respectively. During the year ended September 30, 1998, new loans
totaled $423,000 and repayments were $438,000.
Activity in the allowance for loan losses is summarized as follows:
1998 1997 1996
--------- -------- ---------
Balance at beginning of year $805,964 $802,034 $623,638
Provision charged to income 0 0 190,170
Charge-offs (23,917) (55,878) (20,141)
Recoveries 7,667 59,808 8,367
--------- -------- ---------
Balance at end of year $789,714 $805,964 $802,034
========= ======== =========
The Company had loans on nonaccrual status of approximately $103,000
and $265,000 at September 30, 1998 and 1997, respectively. Interest
income foregone on these nonaccrual loans was not significant for
fiscal years 1998 and 1997.
5. LOAN SERVICING
The Company originates and services mortgage loans for Freddie Mac.
Mortgage loans serviced for Freddie Mac are not included in the
accompanying statements of financial condition. Unpaid principal
balances of serviced loans totaled $4,202,781 at September 30, 1998
and $1,723,251 at September 30, 1997. The serviced loans were sold
without recourse.
6. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable at September 30 is summarized as follows:
1998 1997
-------- --------
Investment securities $ 62,816 $116,948
Mortgage-backed securities 36,206 41,333
Loans receivable 307,012 311,172
-------- --------
Total $406,034 $469,453
======== ========
7. PREMISES AND EQUIPMENT
A summary of premises and equipment at September 30 is as follows:
<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
Land $ 62,500 $ 163,081
Buildings and improvements 567,700 768,216
Leasehold improvements 30,166 30,166
Furniture, fixtures, and equipment 771,374 736,366
------------ -----------
1,431,740 1,697,829
Less accumulated depreciation and amortization 1,134,032 1,152,265
------------ -----------
Net premises and equipment $ 297,708 $ 545,564
============ ===========
</TABLE>
8. DEPOSITS
<TABLE>
Deposits are summarized as follows:
<CAPTION>
September 30, 1998 September 30, 1997
Amount Percent Amount Percent
----------- ------- ----------- -------
<S> <C> <C> <C> <C>
Demand and NOW accounts, including
noninterest-bearing deposits of
$104,527 in 1998 and $93,914 in 1997 $10,375,612 18.7% $10,561,301 18.9%
Money market accounts 1,074,189 1.9 1,093,499 2.0
Passbook savings 9,035,095 16.2 9,286,230 16.6
----------- ------ ----------- ------
20,484,896 36.8 20,941,030 37.5
Certificates of deposit, rates from 2.51%
to 6.60% in 1998 and 1997 35,072,164 63.2 34,933,638 62.5
----------- ------ ----------- ------
Total $55,557,060 100.0% $55,874,668 100.0%
=========== ====== =========== ======
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was $7,150,843 at September 30, 1998 and
$6,578,414 at September 30, 1997. Deposits in excess of $100,000
are not federally insured.
Scheduled maturities of certificates of deposit are as follows:
Years Ending
September 30 Amount
1999 $24,322,553
2000 5,732,301
2001 3,778,514
2002 621,550
2003 617,246
-----------
$35,072,164
===========
Interest expense on deposits at September 30 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
NOW accounts $ 252,214 $ 250,614 $ 247,313
Money market accounts 55,839 58,778 55,289
Passbook savings 216,857 250,510 240,093
Certificates of deposit 1,903,411 1,877,771 2,033,947
Withdrawal penalties (2,302) (3,106) (3,181)
----------- ----------- -----------
Total $2,426,019 $2,434,567 $2,573,461
=========== =========== ===========
</TABLE>
The Company has pledged U.S. government and government agency
obligations totaling $1,235,000 and $1,120,000 at September 30,
1998 and 1997, respectively, as collateral against certain large deposits.
9. INCOME TAXES
The provisions for income taxes for the years ended September 30
are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ----------
<S> <C> <C> <C>
Current:
Federal $431,664 $260,611 $ 286,824
State 91,345 53,208 29,835
--------- --------- ----------
523,009 313,819 316,659
Deferred:
Federal (47,805) 104,083 (180,222)
State (9,694) 18,821 (18,413)
--------- --------- ----------
(57,499) 122,904 (198,635)
--------- --------- ----------
Total $465,510 $436,723 $ 118,024
========= ========= ==========
</TABLE>
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 at September 30
were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Expected income tax expense at
statutory federal tax rate $438,229 $417,712 $115,264
Increase (decrease) resulting from:
State income tax, net of federal benefit 53,890 47,539 7,539
Tax-exempt interest income (23,302) (41,063) (2,639)
Other, net (3,307) 12,535 (2,140)
--------- --------- ---------
$465,510 $436,723 $118,024
========= ========= =========
Effective rate 36% 36% 36%
========= ========= =========
</TABLE>
Temporary differences between the financial statement carrying amounts
and tax bases of assets and liabilities at September 30 that give rise
to significant portions of the net deferred tax asset relate to the
following:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Deferred loan fees, net $ 4,167 $ 8,333
Allowance for loan losses for financial reporting 296,753 296,753
Unrealized loss on securities available for sale 0 18,703
Other 53,007 47,913
----------- -----------
Deferred tax asset 353,927 371,702
Allowance for loan losses for the tax reserve in
excess of base year (42,546) (56,881)
Depreciation (15,091) (47,341)
Unrealized gain on securities available for sale (9,070) 0
Other (35,419) (45,405)
----------- -----------
Deferred tax liability (102,126) (149,627)
----------- -----------
Net deferred tax asset $ 251,801 $ 222,075
=========== ===========
</TABLE>
Thrift institutions, in determining taxable income, have historically
been allowed special bad debt deductions based on specified experience
formulae or on a percentage of taxable income before such deductions.
On August 2, 1996, Congress passed the Small Business Job Protection
Act that repealed the tax bad debt reserve method for thrifts
effective for taxable years which began after December 31, 1996. As a
result, thrifts must recapture into taxable income the amount of their
post-1987 tax bad debt reserves over a six-year period beginning after
1995. The Association is expected to recapture approximately
$115,000; $43,000 tax effected, of its tax bad debt reserves into
taxable income over the remaining four-year period as a result of this
new law. The recapture has no effect on the Association's financial
statements because the related tax expense has already been accrued.
The portion of a thrift's tax bad debt reserve that is not recaptured
under this new law is only subject to recapture at a later date under
similar circumstances. These include stock repurchases redemptions by
the thrift or if the thrift converts to a type of institution (such as
a credit union) that is not considered a bank for tax purposes.
However, no further recapture would be allowed if the thrift converted
to a commercial bank charter or was acquired by a bank. The
Association does not anticipate engaging in any transactions at this
time that would require the recapture of its remaining tax bad debt
reserves.
10. REGULATORY MATTERS
The Association is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Association's financial
statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Association must meet
specific capital guidelines that involve quantitative measures of the
Association's assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. The
Association's capital amounts and classifications are also subject to
qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Association to maintain minimum amounts and
ratios (set forth in the table which follows) of total and Tier 1
capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier 1 capital (as defined) to average assets (as
defined). Management believes, as of September 30, 1998 and 1997, the
Association meets all capital adequacy requirements to which it is
subject.
As of September 30, 1998 and 1997, the most recent notification from
the regulatory authorities categorized the Association as well
capitalized under the regulatory framework for prompt corrective
action. To be categorized as well capitalized, the Association must
maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage
ratios as set forth in the table which follows.
Actual capital amounts and ratios are presented in the table below for
the Association:
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------ ------------------ -----------------
Amount Ratio Amount Ratio Amount Ratio
------- ------ -------- ------- ------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
September 30, 1998:
Total capital (to risk weighted assets) $11,288 29.5% $3,064 8.0% $3,830 10.0%
Tier 1 (core) capital (to risk weighted assets) 10,809 28.2 N/A N/A 2,298 6.0
Tier 1 (core) capital (to adjusted total assets) 10,809 15.8 2,048 3.0 3,413 5.0
Tangible capital (to adjusted total assets) 10,809 15.8 1,024 1.5 N/A N/A
September 30, 1997:
Total capital (to risk weighted assets) $10,699 30.4% $2,817 8.0% $3,522 10.0%
Tier 1 (core) capital (to risk weighted assets) 10,259 29.1 N/A N/A 2,113 6.0
Tier 1 (core capital (to adjusted total assets) 10,259 15.1 2,044 3.0 3,407 5.0
Tangible capital (to adjusted total assets) 10,259 15.1 1,022 1.5 N/A N/A
</TABLE>
The following table is a reconciliation of the Association's
stockholder's equity to tangible, Tier 1, and risk-based capital as
required by the OTS:
<TABLE>
<CAPTION>
1998 1997
-------- --------
(In thousands)
<S> <C> <C>
Stockholder's equity $10,827 $10,222
Net unrealized loss (gain) on debt securities
available for sale (18) 37
-------- --------
Tangible and Tier 1 capital 10,809 10,259
Allowance for loan losses 479 440
-------- --------
Total risk based capital $11,288 $10,699
======== ========
Total assets $67,285 $68,112
Adjusted total assets 67,267 68,149
Total risk weighted assets 38,297 35,218
</TABLE>
Pursuant to OTS regulations, an institution that exceeds fully
phased-in capital requirements before and after a proposed capital
distribution and has not been advised by the OTS that it is in need of
more than the normal supervision can, after prior notice but without
the approval of the OTS, make capital distributions during a calendar
year equal to the greater of (i) 100% of its net income to date during
the calendar year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in
capital requirements) at the beginning of the calendar year, or (ii)
75% of its net income over the most recent four-quarter period. Any
additional capital distributions require prior regulatory approval.
The Company's principal source of funds for dividend payments is
dividends from the Association. Certain restrictions exist regarding
the ability of the Association to pay dividends to the Company. At
July 1, 1997, dividend payments by the Association were subject to
regulatory approval.
11. COMMITMENTS AND CONTINGENCIES
Lease Commitment
The Association leases property utilized as a branch office under a
long-term lease expiring March 31, 2000, at an annual rental of
$15,409 plus taxes and maintenance. The Association has three 5-year
options to renew with rentals adjusted to the consumer price index.
Rent expense under this lease totaled $15,409 for the year ended
September 30, 1998.
At September 30, 1998, projected minimum lease payments for years
ending September 30 are as follows:
1999 $15,409
2000 7,705
2001 0
2002 0
2003 0
-------
Total $23,114
=======
Financial Instruments With Off-Balance-Sheet Risk
The Association does not engage in transactions involving options,
standby letters of credit, financial guarantees, interest-rate swaps,
and forward and future contracts. Further, the Association does not
routinely issue loan commitments, other than undisbursed portions of
construction loans, and had none outstanding at September 30, 1998 and
1997.
Significant Group Concentrations of Credit Risk
The majority of the Association's business activity is with customers
located in Cullman County and surrounding areas. While this area is
heavily involved in agribusiness activities, there is significant
diversified industry with no heavy concentration in any one industry.
FDIC Assessment
The deposits of the Association are currently insured by the Savings
Association Insurance Fund ("SAIF"). Both the SAIF and the Bank
Insurance Fund ("BIF"), the federal deposit insurance fund that covers
the deposits of state and national banks and certain state savings
banks, are required by law to attain and thereafter maintain a reserve
ratio of 1.25% of insured deposits. The BIF achieved the required
reserve rate, and, as discussed below, the FDIC reduced the average
deposit insurance premium paid by BIF-insured banks to a level
substantially below the average premium paid by savings institutions.
Banking legislation was enacted September 30, 1996 to eliminate the
premium differential between SAIF-insured institutions and BIF-insured
institutions. The FDIC Board of Directors established a special
assessment necessary to recapitalize the SAIF at 65.7 basis points of
SAIF assessable deposits held by affected institutions as of March 31,
1995. Based upon its level of SAIF deposits as of March 31, 1995, the
Association paid a special assessment of approximately $370,000 during
the fiscal year ended September 30, 1997. Upon recapitalization of
the SAIF, premiums paid by SAIF-insured institutions were reduced.
The legislation also provides for the merger of the BIF and the SAIF,
with such merger being conditioned upon the prior elimination of the
thrift charter.
Litigation
The Company is a defendant in certain claims and legal actions arising
in the ordinary course of business. In the opinion of management,
after consultation with legal counsel, the ultimate disposition of
these matters is not expected to have a material adverse effect on the
financial position of the Company.
12. EMPLOYEE RETIREMENT AND SAVINGS PLANS
Employee Stock Ownership Plan
In connection with the Conversion, the Association established an ESOP
for eligible employees. The ESOP purchased 90,988 shares of the
Company's common stock with the proceeds of a $909,880 note payable
from the Association and secured by the Common Stock owned by the
ESOP. Principal payments under the note are due in equal and annual
installments through 2006. Impact of this financing is eliminated in
the consolidated financial statement presentation.
Expense related to the ESOP was approximately $160,000 and $61,000 for
1998 and 1997, respectively. Unearned compensation related to the
ESOP was approximately $1.2 million and $930,000 at June 30, 1998 and
1997, respectively, and is shown as a reduction of stockholders'
equity in the accompanying consolidated statements of financial
condition. Unearned compensation is amortized into compensation
expense based on employee services rendered in relation to shares
which are committed to be released.
Management Recognition Plan
During fiscal 1998, the Association established a MRP which purchased
45,494 shares of the Company's common stock on the open market
subsequent to the Conversion. The MRP provides for awards of common
stock to directors and officers of the Association. The aggregate
fair market value of the shares purchased by the MRP is considered
unearned compensation at the time of purchase and compensation is
earned ratably over the stipulated vesting period. The expense
related to the MRP was approximately $134,000 for 1998. Unearned
compensation related to the MRP was approximately $600,000 for 1998
and is shown as a reduction to stockholders' equity in the
accompanying consolidated statements of financial condition.
13. STOCK-BASED COMPENSATION PLANS
The Company has a stockholder approved Option Plan. The Option Plan
provides for the grant of incentive stock options ("ISO's") to
employees and nonincentive stock options ("non-ISO's") to nonemployee
directors. The Company utilizes the intrinsic value method of
accounting for stock option grants. As the option price is considered
to be equal to the fair value of the stock at the date of grant, no
compensation cost is recognized.
The Company has adopted the disclosure requirements of SFAS No. 123,
Accounting for Stock-Based Compensation. This Statement establishes
financial accounting and reporting standards for stock-based employee
compensation plans. Those plans include all arrangements by which
employees receive shares of stock or other equity instruments of the
employer or the employer incurs liabilities to employees in amounts
based on the price of the employer's stock. Examples are stock
purchase plans, stock options, restricted stock, and stock
appreciation rights.
Under the Option Plan, the Company may grant options up to 113,735
shares and during 1998 granted options shares through September 30,
1998. Under the Option Plan, the options vest 20% per year and become
exercisable upon the participant's completion of each of five years of
service
Had compensation costs for these plans been determined consistent with
SFAS No. 123, the Company's net income and earnings per share would
have been reduced to the following pro forma amounts for the year
ended September 30, 1998:
Net income:
As reported $823,400
Pro forma 748,620
Earnings per share:
As reported:
Basic $.91
Diluted .82
Pro forma:
Basic .87
Diluted .79
Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to October 5, 1995, the resulting pro forma
compensation costs may not be representative of that to be expected in
future years.
Unearned compensation related to the Option Plan was approximately
$2.0 million at September 30, 1998 and is shown as a reduction of
stockholders' equity in the accompanying statements of financial
condition. A summary of the status of the Company's stock option plan
at September 30, 1998 and the changes during the year then ended is as
follows:
<TABLE>
<CAPTION>
Weighted
Average Option
Exercise Price
Shares Price Per Share
------- -------- ---------
<S> <C> <C> <C>
Outstanding at beginning of year 0 $ 0.00 $ 0.00
Granted 107,298 15.50 15.50
Forfeitures 0 0.00 0.00
Exercised 0 0.00 0.00
------- ------ ------
Outstanding at end of year 107,298 $15.50 $15.50
======= ====== ======
Exercisable at end of year 0 N/A
======= ======
Weighted average fair value of the
options granted $5.92
=======
</TABLE>
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1998: risk-free
interest rate of 5.56%; expected life of the options is seven years
from the date of grant and expected volatility and dividend yields of
17% and 2.99%, respectively.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosure of fair value information about financial
instruments, whether or not recognized in the statement of condition,
for which it is practicable to estimate that value. In cases where
quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. In
that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be
realized in immediate settlement of the instrument. The use of
different market assumptions and/or estimation methodologies may have
a material effect on the estimated fair value amounts. Also, the fair
value estimates presented herein are based on pertinent information
available to Management as of September 30, 1998. Such amounts have
not been comprehensively revalued for purposes of these financial
statements since those dates and, therefore, current estimates of fair
value may differ significantly from the amounts presented herein.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Investment Securities
Fair values for investment securities are primarily based on quoted
market prices. If a quoted market price is not available, fair value
is estimated using market prices for similar securities.
Loans
For equity lines and other loans with short-term or variable rate
characteristics, the carrying value reduced by an estimate for credit
losses inherent in the portfolio is a reasonable estimate of fair
value. The fair value of all other loans is estimated by discounting
their future cash flows using interest rates currently being offered
for loans with similar terms, reduced by an estimate of credit losses
inherent in the portfolio. The discount rates used are commensurate
with the interest rate and prepayment risks involved for the various
types of loans.
Deposits
The fair value disclosed for demand deposits (e.g., interest and
noninterest bearing demand, savings, and money market savings), are,
as required by SFAS No. 107, equal to the amounts payable on demand at
the reporting date (i.e., their carrying amounts). Fair values for
certificates of deposits are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated monthly maturities.
Commitments to Extend Credit
The value of these unrecognized financial instruments is estimated
based on the fee income associated with the commitments which, in the
absence of credit exposure, is considered to approximate their
settlement value. As no significant credit exposure exists and
because such fee income is not material to the Company's financial
statements at September 30, 1998 and 1997, the fair value of these
commitments is not presented.
Many of the Company's assets and liabilities are short-term financial
instruments whose carrying amounts reported in the statement of
condition approximate fair value. These items include cash and due
from banks, interest-bearing bank balances, accrued interest
receivable and payable, and similar assets. The estimated fair values
of the Company's remaining on-balance sheet financial instruments as
of September 30, 1998, are summarized below:
<TABLE>
<CAPTION>
1998 1997
-------------------------- -------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Financial Assets:
Investment securities available for sale $ 2,554,087 $ 2,554,087 $ 7,412,925 $ 7,412,925
Mortgage backed and related securities
available for sale 6,038,694 6,038,694 5,583,924 5,583,924
Investment securities held-to-maturity 999,042 1,004,116 1,498,407 1,492,141
Mortgage backed and related securities
held-to-maturity 837,224 854,528 2,026,416 2,033,126
Loans, net 45,846,372 46,065,901 42,998,875 43,413,865
Financial Liabilities:
Deposits 55,557,060 54,765,479 55,874,668 55,982,666
</TABLE>
SFAS No. 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. The
disclosures also do not include certain intangible assets, such as
customer relationships, deposit base intangibles and goodwill.
Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company.
15. STOCK CONVERSION
On December 23, 1996, the Conversion of the Bank from a federally
chartered mutual institution to a federally chartered stock savings
bank through amendment of its charter and issuance of common stock to
the Company was completed. Related thereto, the Company sold
1,137,350 shares of common stock, par value $.01 per share, at an
initial price of $10 per share in subscription and community
offerings. Costs associated with the Conversion were approximately
$575,000, including underwriting fees. These conversion costs were
deducted from the gross proceeds of the sale of the common stock.
In connection with the Offering, the Association established a
liquidation account in an amount equal to its regulatory capital as of
the latest practicable date prior to consummation of the Offering.
The Company's ability to pay dividends will be largely dependent upon
dividends to the Company from the Association. Pursuant to Office of
Thrift Supervision ("OTS") regulations, the Association will not be
permitted to pay dividends on its capital stock or repurchase shares
of its stock if its stockholders' equity would be reduced below the
amount required for the liquidation account or if stockholders' equity
would be reduced below the amount required by the OTS.
<PAGE>
16. PARENT COMPANY FINANCIAL STATEMENTS
Separate condensed financial statements of Southern Community
Bancshares, Inc. (the "Parent Company") as of and for the years ended
September 30, 1998 and 1997 are presented below:
<TABLE>
Statements of Financial Condition
September 30, 1998 and 1997
(Dollar amounts in thousands)
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
ASSETS:
Cash and cash equivalents $ 393 $ 753
Securities available for sale 100 1,750
Investment in subsidiary 10,827 10,222
Due from subsidiary 0 1,888
Other assets 12 26
--------- ---------
Total assets $ 11,332 $ 14,639
========= =========
LIABILITIES:
Other liabilities $ 0 $ 169
Due to subsidiary 231 0
STOCKHOLDERS' EQUITY:
Common stock 11 11
Additional paid-in capital 10,808 10,787
Retained earnings 4,866 6,445
Treasury stock, at cost (831) 0
Unearned compensation (3,771) (2,737)
Unrealized gain on securities available for
sale, net 18 (36)
--------- ---------
Total stockholders' equity 11,101 14,470
--------- ---------
Total liabilities and stockholders' equity $ 11,332 $ 14,639
========= =========
</TABLE>
<PAGE>
<TABLE>
Statements of Income
For the Years Ended September 30, 1998 and 1997
(Dollar amounts in thousands)
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
INTEREST INCOME $ 86 $ 143
OPERATING EXPENSE 158 151
------ ------
LOSS BEFORE INCOME TAXES AND EQUITY IN
UNDISTRIBUTED CURRENT YEAR SUBSIDIARY
EARNINGS (72) (8)
INCOME TAX (BENEFIT) EXPENSE (5) 3
------ ------
LOSS BEFORE EQUITY IN UNDISTRIBUTED CURRENT
YEAR SUBSIDIARY EARNINGS (77) (5)
EQUITY IN UNDISTRIBUTED CURRENT YEAR
SUBSIDIARY EARNINGS 900 797
------ ------
Net income $ 823 $ 792
====== ======
</TABLE>
<PAGE>
<TABLE>
Statements of Cash Flows
For the Years Ended September 30, 1998 and 1997
(Dollar amounts in thousands)
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 823 $ 792
Equity in undistributed current year earnings of subsidiary 900 797
-------- --------
(77) (5)
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization of discounts on securities 0 (1)
Other changes in equity of subsidiary 32 0
(Increase) decrease in other assets 14 (26)
Net change in due to/from subsidiary 2,119 (1,888)
Increase in other liabilities (83) 169
-------- --------
Net cash provided by (used in) operating activities 2,005 (1,836)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available for sale 0 (3,250)
Proceeds from maturity of securities available for sale 1,650 1,500
-------- --------
Net cash provided by (used in) investing activities 1,650 (1,750)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 0 9,854
Purchase of Bank's common stock 0 (5,373)
Repurchase of treasury stock (831) 0
Contributions to plan trusts of the Association (696) (9)
Dividends paid (2,488) (133)
-------- --------
Net cash provided by (used in) financing activities (4,015) 4,339
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 360 753
CASH AND CASH EQUIVALENTS, beginning of year 753 0
-------- --------
CASH AND CASH EQUIVALENTS, end of year $ 393 $ 753
======== ========
</TABLE>
EXHIBIT 21
LIST OF SUBSIDIARIES
NAME OF BUSINESS STATE OF INCORPORATION
First Federal Savings and Loan Alabama
Association of Cullman
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,614
<INT-BEARING-DEPOSITS> 7,977
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 8,593
<INVESTMENTS-CARRYING> 1,836
<INVESTMENTS-MARKET> 1,859
<LOANS> 46,636
<ALLOWANCE> 790
<TOTAL-ASSETS> 66,820
<DEPOSITS> 55,557
<SHORT-TERM> 0
<LIABILITIES-OTHER> 163
<LONG-TERM> 0
0
0
<COMMON> 11
<OTHER-SE> 11,089
<TOTAL-LIABILITIES-AND-EQUITY> 66,820
<INTEREST-LOAN> 3,958
<INTEREST-INVEST> 794
<INTEREST-OTHER> 483
<INTEREST-TOTAL> 5,236
<INTEREST-DEPOSIT> 2,426
<INTEREST-EXPENSE> 2,426
<INTEREST-INCOME-NET> 2,810
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,701
<INCOME-PRETAX> 1,289
<INCOME-PRE-EXTRAORDINARY> 1,289
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 823
<EPS-PRIMARY> .91
<EPS-DILUTED> .87
<YIELD-ACTUAL> 4.10
<LOANS-NON> 103
<LOANS-PAST> 0
<LOANS-TROUBLED> 87
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 806
<CHARGE-OFFS> 24
<RECOVERIES> 8
<ALLOWANCE-CLOSE> 790
<ALLOWANCE-DOMESTIC> 560
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 230
</TABLE>
