SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1997
OR
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 0-22219
NEWSOUTH BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Delaware 56-1999749
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
1311 Carolina Avenue, Washington, North Carolina 27889-2047
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (919) 946-4178
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant was required to
file such reports) and (2) has been subject to such filing requirements for the
past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of December 9, 1997, the aggregate market value of the 2,329,993 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $67.6 million based on the closing sale price of
$29.00 per share of the registrant's Common Stock as listed on the Nasdaq
National Market System. For purposes of this calculation, it is assumed that
directors, executive officers and beneficial owners of more than 5% of the
registrant's outstanding voting stock are affiliates.
Number of shares of Common Stock outstanding as of December 9, 1997: 2,909,500.
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:
1. Portions of the Annual Report to Stockholders for the fiscal year
ended September 30, 1997. (Parts I, II and IV)
2. Portions of Proxy Statement for 1998 Annual Meeting of Stockholders.
(Part III)
<PAGE>
PART I
Item 1. Business
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General
NewSouth Bancorp, Inc. (the "Company") was incorporated under the laws of
the State of Delaware in October 1996 at the direction of the Board of Directors
of Home Savings Bank, SSB (the "Savings Bank") for the purpose of serving as the
holding company of the Savings Bank upon completion of its conversion from
mutual to stock form (the "Stock Conversion"), and then as a bank holding
company of NewSouth Bank (the "Bank") following the conversion of the Savings
Bank from a North Carolina-chartered savings bank to a commercial bank (the
"Bank Conversion"). The Stock Conversion and the Bank Conversion were completed
in April 1997 and the Company is now the holding company for the Bank. The
Company's principal business is overseeing the business of the Bank and
investing the portion of the net Stock Conversion proceeds retained by it.
NewSouth Bank. The Bank is a North Carolina-chartered commercial bank
headquartered in Washington, North Carolina and serves eastern North Carolina.
The Bank was chartered by the State of North Carolina in 1902 under the name The
Home Building and Loan Association. The Bank received federal insurance of its
deposits in 1959. In 1992, the Bank converted to a North Carolina-chartered
savings bank, at which time it adopted the name Home Savings Bank, SSB. Upon
completion of the Bank Conversion in April 1997, the Bank became a North
Carolina-chartered commercial bank and adopted its present name.
The Bank's principal business consists of attracting deposits from the
general public and investing these funds in loans secured by first mortgages on
owner-occupied, single-family residences in the Bank's market area, commercial
real estate loans, commercial business loans and consumer loans.
The Bank derives its income principally from interest earned on loans and
investments and, to a lesser extent, loan servicing and other fees and gains on
the sale of loans and investments. The Bank's principal expenses are interest
expense on deposits and borrowings and noninterest expense such as compensation
and employee benefits, office occupancy expenses and other miscellaneous
expenses. Funds for these activities are provided principally by deposits,
repayments of outstanding loans and investments and operating revenues.
Market Area
Although the Company makes loans and obtains deposits throughout eastern
North Carolina, the Company's primary market area consists of Beaufort, Craven,
Lenoir, Nash, Pasquotank and Pitt Counties in North Carolina, which are the
counties in which the Bank's offices are located. As of September 30, 1997,
management estimates that more than 95% of deposits and 90% of loans came from
its primary market area.
The economy of the Company's primary market area is diversified, with
employment distributed among manufacturing, agriculture and non-manufacturing
activities. Major employers in the area include Weyerhaeuser Company, Dupont,
Abbott Laboratories, East Carolina University and Pitt Memorial Hospital. The
unemployment rate in the Company's market area is below the national average,
though higher than the unemployment rate for the State of North Carolina.
According to data provided by a private marketing firm, the Company
estimates the population of its primary market area to be approximately 430,000.
This compares to a population of approximately 400,000 in 1990. The median
household income of the Company's primary market area is $23,256, as compared to
$26,647 for North Carolina as a whole.
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<PAGE>
Lending Activities
General. The Company's gross loan portfolio totaled $214.5 million at
September 30, 1997, representing 86.0% of total assets at that date. It is the
Company's policy to concentrate its lending within its market area. At September
30, 1997, $68.0 million, or 31.7% of the Company's gross loan portfolio,
consisted of single-family, residential mortgage loans. The Company's
construction loans totaled $33.2 million, or 15.5% of the Company's gross loan
portfolio, at September 30, 1997. The Company also originates a significant
amount of commercial real estate loans. At September 30, 1997, commercial real
estate loans amounted to $46.0 million, or 21.4% of the Company's gross loan
portfolio. In recent years, the Company has sought to increase originations of
commercial business loans and consumer loans. At September 30, 1997, commercial
business loans totaled $16.4 million, or 7.7% of the Company's gross loan
portfolio, and consumer loans totaled $49.9 million, or 23.3% of the Company's
gross loan portfolio. To a lesser extent, the Company also originates
multi-family residential real estate loans and commercial real estate loans. At
September 30, 1997, multi-family residential real estate loans amounted to
$946,000, or .4% of the Company's gross loan portfolio.
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<PAGE>
Loan Portfolio Composition. The following table sets forth selected data
relating to the composition of the Company's loan portfolio by type of loan at
the dates indicated. At September 30, 1997, the Company had no concentrations of
loans exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At September 30,
1997 1996 1995 1994 1993
-------------------------------------------------------------------------------------------
Amount % Amount % Amount % Amount % Amount %
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
(Dollars in thousands)
Residential mortgage loans:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Single-family residential.......... $ 67,959 31.7% $ 58,576 33.7% $ 67,736 43.0% $ 74,364 49.8% $ 76,692 58.0%
Multi-family residential........... 946 .4 998 .6 2,315 1.5 2,412 1.6 2,508 1.9
Construction....................... 33,249 15.5 35,240 20.3 32,062 20.4 31,663 21.2 23,723 17.9
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total residential mortgage loans. 102,154 47.6 94,814 54.6 102,113 64.9 108,439 72.6 102,923 77.8
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial loans:
Commercial real estate............. 45,990 21.4 31,168 17.9 21,890 13.9 17,098 11.4 8,157 6.2
Commercial business................ 16,449 7.7 10,328 6.0 3,698 2.4 1,777 1.2 162 .1
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total commercial loans........... 62,439 29.1 41,496 23.9 25,588 16.3 18,875 12.6 8,319 6.3
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer loans:
Automobile......................... 4,611 2.2 4,185 2.4 2,532 1.6 1,986 1.3 2,148 1.6
Savings account loans.............. 617 .3 549 .3 661 .4 454 .3 389 .3
Home equity loans.................. 21,665 10.1 17,949 10.3 15,514 9.9 11,930 8.0 10,231 7.7
Other.............................. 22,996 10.7 14,740 8.5 10,977 6.9 7,767 5.2 8,323 6.3
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans............. 49,889 23.3 37,423 21.5 29,684 18.8 22,137 14.8 21,091 15.9
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total.......................... 214,482 100.00% 173,733 100.00% 157,385 100.00% 149,451 100.00% 132,333 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Loans in process................... 12,717 15,245 10,626 11,506 11,766
Deferred fees and discounts........ 731 456 341 289 188
Allowance for loan losses.......... 3,249 2,351 1,877 1,977 1,843
-------- -------- -------- -------- --------
Total............................ $197,785 $155,681 $144,541 $135,679 $118,536
======== ======== ======== ======== ========
</TABLE>
4
<PAGE>
Loan Maturities. The following table sets forth certain information at
September 30, 1997 regarding the dollar amount of loans maturing in the
Company's portfolio based on their contractual terms to maturity, including
scheduled repayments of principal. Demand loans, loans having no stated schedule
of repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table does not include any estimate of prepayments which
significantly shorten the average life of mortgage loans and may cause the
Company's repayment experience to differ from that shown below. Loan balances
are net of loans in process.
<TABLE>
<CAPTION>
Due After Due After
1 Through 5 or More
Due One Year 5 Years After Years After
or Less, September 30, 1997 September 30, 1997 Total
------------------ ------------------ ------------------ ------
(In thousands)
<S> <C> <C> <C> <C>
Residential mortgage loans.......... $ 21,539 $ 11,692 $ 58,531 $ 91,762
Commercial (1)...................... 9,540 46,053 4,756 60,349
Consumer............................ 5,230 21,969 22,456 49,655
---------- ---------- ---------- ----------
Total.......................... $ 36,309 $ 79,714 $ 85,743 $ 201,766
========== ========== ========== ==========
</TABLE>
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(1) Includes commercial real estate and commercial business loans.
The following table sets forth at September 30, 1997 the dollar amount of
all loans due one year or more after September 30, 1997 which have predetermined
interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
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(In thousands)
<S> <C> <C>
Residential mortgage loans......................... $ 35,182 $ 35,041
Commercial (1)..................................... 19,642 31,167
Consumer........................................... 18,526 25,899
----------- -----------
Total.......................................... $ 73,350 $ 92,107
=========== ===========
</TABLE>
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(1) Includes commercial real estate and commercial business loans.
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans can be substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare a loan immediately
due and payable in the event, among other things, that the borrower sells the
real property subject to the mortgage and the loan is not repaid. The average
life of mortgage loans tends to increase when current mortgage loan market rates
are substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
Originations, Purchases and Sales of Loans. The Bank generally has
authority to originate and purchase loans secured by real estate located
throughout the United States. Consistent with its emphasis on being a
community-oriented financial institution, the Bank concentrates its lending
activities in its market area.
The Bank's loan originations are derived from a number of sources,
including referrals from depositors and borrowers, repeat customers,
advertising, calling officers as well as walk-in customers. The Bank's
solicitation programs consist of advertisements in local media, in addition to
participation in various community organizations and events. Real estate loans
are originated by the Bank's loan personnel. All of the Bank's loan personnel
are salaried, and though the Bank does not compensate loan personnel on a
commission basis for loans originated, it does pay an incentive percentage of
closed mortgage loan volume once a defined threshold has been achieved by the
participant. With the
5
<PAGE>
exception of applications for boat or recreational vehicle loans, which may be
originated on an indirect basis through an arrangement with dealers, loan
applications are accepted at the Bank's offices. In addition, the Bank has
several salaried loan originators who travel to meet prospective borrowers and
take applications. In all cases, the Bank has final approval of the application.
Historically, the Bank generally has not purchased loans. However, the Bank may
in the future consider making limited loan purchases, including purchases of
commercial loans.
In recent years, the Bank has sold or exchanged for mortgage-backed
securities a significant amount of fixed-rate, single-family mortgage loans that
it originated. During the years ended September 30, 1997, 1996 and 1995, these
transactions totaled $31.7 million, $53.2 million and $43.9 million,
respectively. Such loans are sold to or exchanged with the Federal Home Loan
Mortgage Corporation ("FHLMC"). The Bank generally retains servicing on loans
sold or exchanged.
Loan Underwriting Policies. The Bank's lending activities are subject to
the Bank's written, non-discriminatory underwriting standards and to loan
origination procedures prescribed by the Bank's Board of Directors and its
management. Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. All mortgage loans are presented weekly to a loan committee of
the Board of Directors of the Bank made up of three outside directors who serve
on a rotating basis. Neither the President nor the Chairman of the Board serves
on the loan committee. Individual officers of the Bank have been granted
authority by the Board of Directors to approve consumer and commercial loans up
to varying specified dollar amounts, depending upon the type of loan. In
addition, committees of loan officers have loan authorities greater than
individual authorities. These authorities are based on aggregate borrowings of
an individual or entity. All loans to a single borrower aggregating in excess of
$500,000 must be approved by the full Board of Directors. On a monthly basis,
the full Board of Directors reviews the actions taken by the loan committee.
Applications for single-family real estate loans are underwritten and
closed in accordance with the standards of FHLMC. Generally, upon receipt of a
loan application from a prospective borrower, a credit report and verifications
are ordered to verify specific information relating to the loan applicant's
employment, income and credit standing. If a proposed loan is to be secured by a
mortgage on real estate, an appraisal of the real estate is usually undertaken
either by an appraiser approved by the Bank and licensed by the State of North
Carolina or by qualified Bank personnel. In the case of single-family
residential mortgage loans, except when the Bank becomes aware of a particular
risk of environmental contamination, the Bank generally does not obtain a formal
environmental report on the real estate at the time a loan is made. A formal
environmental report may be required in connection with nonresidential real
estate loans.
It is the Bank's policy to record a lien on the real estate securing a loan
and to obtain title insurance which insures that the property is free of prior
encumbrances and other possible title defects. Borrowers must also obtain hazard
insurance policies prior to closing and, when the property is in a flood plain
as designated by the Department of Housing and Urban Development, pay flood
insurance policy premiums.
With respect to single-family residential mortgage loans, the Bank makes a
loan commitment of between 15 and 30 days for each loan approved. If the
borrower desires a longer commitment, the commitment may be extended for good
cause and upon written approval. Fees of between $175 and $425 are charged in
connection with the issuance of a commitment letter. The interest rate is
guaranteed for the commitment period.
If the amount of a residential loan originated or refinanced exceeds 80% of
the lessor of the appraised value or contract price, the Bank's policy generally
is to obtain private mortgage insurance at the borrower's expense on that
portion of the principal amount of the loan that exceeds 80%. The Bank will make
a single-family residential mortgage loan with up to a 95% loan-to-value ratio
if the required private mortgage insurance is obtained. The Bank generally
limits the loan-to-value ratio on commercial real estate mortgage loans to 80%,
although the loan-to-value ratio on commercial real estate loans in limited
circumstances has been as high as 85%. The Bank limits the loan-to-value ratio
on multi-family residential real estate loans to 80%.
6
<PAGE>
The Bank is subject to regulation which limits the amount the Bank can lend
to one borrower. See " -- Regulation -- Limits on Loans to One Borrower." Under
these limits, the Bank's loan-to-one-borrower were limited to $6.0 million at
September 30, 1997. At that date the Bank had no lending relationships in excess
of the loans-to-one-borrower limit.
Interest rates charged by the Bank on loans are affected principally by
competitive factors, the demand for such loans and the supply of funds available
for lending purposes. These factors are, in turn, affected by general economic
conditions, monetary policies of the federal government, including the Federal
Reserve Board, legislative tax policies and government budgetary matters.
Single-Family Residential Real Estate Lending. The Bank historically has
been and continues to be an originator of single-family, residential real estate
loans in its market area. At September 30, 1997, single-family, residential
mortgage loans, excluding home improvement loans, totaled $67.9 million, or
31.7% of the Company's gross loan portfolio.
The Bank originates fixed-rate mortgage loans at competitive interest
rates. At September 30, 1997, $41.4 million, or 19.3%, of the Company's gross
loan portfolio was comprised of fixed-rate mortgage loans. Generally, the
Company retains fixed-rate mortgages with maturities 15 years or less while
fixed-rate loans with longer maturities may be retained in portfolio or sold in
the secondary market. The Bank also offers FHA and VA mortgage loans in its
market area, which are underwritten and closed by a correspondent lender.
The Bank also offers adjustable-rate residential mortgage loans. The
adjustable-rate loans currently offered by the Bank have interest rates which
adjust every one, three or five years from the closing date of the loan or on an
annual basis commencing after an initial fixed-rate period of one, three or five
years in accordance with a designated index (the primary index utilized by the
Bank is the weekly average yield on U.S. Treasury securities adjusted to a
constant comparable maturity equal to the loan adjustment period, as made
available by the Federal Reserve Board (the "Treasury Rate")), plus a stipulated
margin. The Bank offers adjustable-rate loans that meet FHLMC standards, as well
as loans that do not meet such standards. The Bank's adjustable-rate
single-family residential real estate loans that do not meet FHLMC standards
have a cap of generally 2% on any increase in the interest rate at any
adjustment date, and include a cap on the maximum interest rate over the life of
the loan, which cap generally is 3% to 4.5% above the initial rate. In return
for providing a relatively low cap on interest rate increases over the life of
the loan, the Bank's adjustable-rate loans provide for a floor on the minimum
interest rate over the life of the loan, which floor generally is .125% below
the initial rate. Further, the Bank generally does not offer "teaser" rates
i.e., initial rates below the fully indexed rate, on such loans. The
adjustable-rate mortgage loans offered by the Bank that do conform to FHLMC
standards have a cap of 6% above the initial rate over the life of a loan but do
not include a floor, may be offered with a teaser rate and have a 25 basis point
lower margin above the index on which the interest rate is based. All of the
Bank's adjustable-rate loans require that any payment adjustment resulting from
a change in the interest rate of an adjustable-rate loan be sufficient to result
in full amortization of the loan by the end of the loan term and, thus, do not
permit any of the increased payment to be added to the principal amount of the
loan, or so-called negative amortization. At September 30, 1997, $50.4 million,
or 23.5%, of the Company's residential mortgage loans were adjustable-rate
loans.
The retention of adjustable-rate loans in the Company's portfolio helps
reduce the Company's exposure to increases or decreases in prevailing market
interest rates. However, there are unquantifiable credit risks resulting from
potential increases in costs to borrowers in the event of upward repricing of
adjustable-rate loans. It is possible that during periods of rising interest
rates, the risk of default on adjustable-rate loans may increase due to
increases in interest costs to borrowers. Further, although adjustable-rate
loans allow the Company to increase the sensitivity of its interest-earning
assets to changes in interest rates, the extent of this interest sensitivity is
limited by the initial fixed-rate period before the first adjustment and the
lifetime interest rate adjustment limitations. Accordingly, there can be no
assurance that yields on the Company's adjustable-rate loans will fully adjust
to compensate for increases in the Company's cost of funds.
7
<PAGE>
Construction Lending. The Bank also offers residential and commercial
construction loans, with a substantial portion of such loans originated to date
being for the construction of owner-occupied, single-family dwellings in the
Bank's primary market area. Residential construction loans are offered primarily
to individuals building their primary or secondary residence, as well as to
selected local developers to build single-family dwellings. Generally, loans to
owner/occupants for the construction of owner-occupied, single-family
residential properties are originated in connection with the permanent loan on
the property and have a construction term of six to 18 months. Such loans are
offered on a fixed-rate or adjustable-rate basis. Interest rates on residential
construction loans made to the owner/occupant have interest rates during the
construction period of 1% above the rate offered by the Bank on the permanent
loan product selected by the borrower. Upon completion of construction, the
permanent loan rate will be set at the rate then offered by the Bank on that
permanent loan product, except that if the permanent loan rate would be above
the construction loan rate then the borrower can maintain the same rate as on
the construction loan. Interest rates on residential construction loans to
builders are set at the prime rate plus a margin of between .50% and 1% or at
the Treasury Rate plus a margin of between 3% and 4.5%, and adjust annually.
Interest rates on commercial construction loans are based on the prime rate plus
a negotiated margin of between 0% and 1% and adjust annually, with construction
terms generally not exceeding 18 months. Advances are made on a percentage of
completed basis. At September 30, 1997, $33.2 million, or 15.5%, of the
Company's gross loan portfolio consisted of construction loans, virtually all of
which was secured by single-family residences.
Prior to making a commitment to fund a loan, the Bank requires both an
appraisal of the property by appraisers approved by the Board of Directors and a
study of the feasibility of the proposed project. The Bank also reviews and
inspects each project at the commencement of construction and either weekly or
biweekly during the term of the construction loan. The Bank generally charges a
.50% to 1% construction loan fee for speculative builder loans. For construction
loans to owner-occupants, the Bank generally charges a 1% construction loan fee
and a $425 commitment fee.
Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate. Risk
of loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. During
the construction phase, a number of factors could result in delays and cost
overruns. If the estimate of construction costs proves to be inaccurate and the
borrower is unable to meet the Bank's requirements of putting up additional
funds to cover extra costs or change orders, then the Bank will demand that the
loan be paid off and, if necessary, institute foreclosure proceedings, or
refinance the loan. If the estimate of value proves to be inaccurate, the Bank
may be confronted, at or prior to the maturity of the loan, with collateral
having a value which is insufficient to assure full repayment. The Bank has
sought to minimize this risk by limiting construction lending to qualified
borrowers (i.e., borrowers who satisfy all credit requirements and whose loans
satisfy all other underwriting standards which would apply to the Bank's
permanent mortgage loan financing for the subject property) in the Bank's market
area. On loans to builders, the Bank works only with selected builders with whom
it has experience and carefully monitors the creditworthiness of the builders.
Multi-Family Residential and Commercial Real Estate Lending. The Bank
originates commercial real estate loans, as well as a limited amount of
multi-family residential real estate loans, generally limiting such originations
to loans secured by properties in its primary market area and to borrowers with
whom it has other loan relationships. The Company's multi-family residential
loan portfolio consists primarily of loans secured by small apartment buildings,
and the commercial real estate loan portfolio includes loans to finance the
acquisition of small office buildings and commercial and industrial buildings.
Such loans generally range in size from $1.0 million to $3.4 million. At
September 30, 1997, multi-family residential and commercial real estate loans
totaled $1.0 million and $46.0 million, respectively, which amounted to .5% and
21.4%, respectively, of the Company's gross loan portfolio. Multi-family and
commercial real estate loans are originated either for 15 year terms with
interest rates that adjust every one, three or five years based on either the
prime rate as quoted in The Wall Street Journal plus a negotiated margin of
between 0% and 1% for shorter term loans or, for longer term loans, or the
Treasury Rate plus a negotiated margin of between 3% and
8
<PAGE>
4.5%, or on a fixed-rate basis with interest calculated on a 15 year
amortization schedule with a balloon payment due after five years.
Multi-family residential and commercial real estate lending entails
significant additional risks as compared with single-family residential property
lending. Multi-family residential and commercial real estate loans typically
involve larger loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans typically is dependent on the successful
operation of the real estate project, retail establishment or business. These
risks can be significantly affected by supply and demand conditions in the
market for office, retail and residential space, and, as such, may be subject to
a greater extent to adverse conditions in the economy generally. To minimize
these risks, the Bank generally limits itself to its market area or to borrowers
with which it has prior experience or who are otherwise known to the Bank. It
has been the Bank's policy to obtain annual financial statements of the business
of the borrower or the project for which commercial or multi-family residential
real estate loans are made. In addition, in the case of commercial mortgage
loans made to a partnership or a corporation, the Bank seeks, whenever possible,
to obtain personal guarantees and annual financial statements of the principals
of the partnership or corporation.
Commercial Lending. The Company's commercial loans consist of loans secured
by commercial real estate and commercial business loans, which are not secured
by real estate. For a discussion of the Company's commercial real estate lending
see "-- Multi-Family and Commercial Real Estate Lending."
In recent years, the Bank has emphasized commercial business lending. The
Bank originates commercial business loans to small and medium sized businesses
in its market area. The Bank's commercial borrowers are generally small
businesses engaged in manufacturing, distribution or retailing, or professionals
in healthcare, accounting and law. Commercial business loans are generally made
to finance the purchase of inventory, new or used equipment or commercial
vehicles and for short-term working capital. Such loans generally are secured by
equipment and inventory, and, if possible, cross-collateralized by a real estate
mortgage, although commercial business loans are sometimes granted on an
unsecured basis. Such loans generally are made for terms of five years or less,
depending on the purpose of the loan and the collateral, with loans to finance
operating expenses made for one year or less, with interest rates that adjust at
least annually at a rate equal to the prime rate as stated in The Wall Street
Journal plus a margin of between 0% and 2%. Generally, commercial loans are made
in amounts ranging between $5,000 and $250,000. At September 30, 1997,
commercial business loans totaled $16.4 million, or 7.6% of the Company's gross
loan portfolio.
The Bank underwrites its commercial business loans on the basis of the
borrower's cash flow and ability to service the debt from earnings rather than
on the basis of underlying collateral value, and the Bank seeks to structure
such loans to have more than one source of repayment. The borrower is required
to provide the Bank with sufficient information to allow the Bank to make its
lending determination. In most instances, this information consists of at least
two years of financial statements, a statement of projected cash flows, current
financial information on any guarantor and any additional information on the
collateral. For loans with maturities exceeding one year, the Bank requires that
borrowers and guarantors provide updated financial information at least annually
throughout the term of the loan.
The Bank's commercial business loans may be structured as term loans or as
lines of credit. Commercial business term loans are generally made to finance
the purchase of assets and have maturities of five years or less. Commercial
business lines of credit are typically made for the purpose of providing working
capital and are usually approved with a term of 12 months and are reviewed at
that time to see if extension is warranted. The Bank also offers both commercial
and standby letters of credit for its commercial borrowers. Commercial letters
of credit are written for a maximum term of one year. The terms of standby
letters of credit generally do not exceed one year.
Commercial business loans are often larger and may involve greater risk
than other types of lending. Because payments on such loans are often dependent
on successful operation of the business involved, repayment of such loans may be
subject to a greater extent to adverse conditions in the economy. The Bank seeks
to minimize these risks through its underwriting guidelines, which require that
the loan be supported by adequate cash flow of the borrower, profitability of
the business, collateral and personal guarantees of the individuals in the
business. In addition, the Bank
9
<PAGE>
limits this type of lending to its market area and to borrowers with which it
has prior experience or who are otherwise well known to the Bank.
Consumer Lending. In recent years, the Bank has been successful in its
strategy of increasing its portfolio of consumer loans. The consumer loans
originated by the Bank include automobile loans, certificate of deposit loans,
home equity loans and miscellaneous other consumer loans, including unsecured
loans. At September 30, 1997, consumer loans totaled $49.9 million, or 23.3% of
the Company's gross loan portfolio.
The Bank's automobile loans are generally underwritten in amounts up to 90%
of the lesser of the purchase price of the automobile or, with respect to used
automobiles, the loan value as published by the National Automobile Dealers
Association. The terms of most such loans do not exceed 60 months. The Bank
requires that the vehicles be insured and the Bank be listed as loss payee on
the insurance policy.
The Bank makes certificate of deposit loans for up to 90% of the
depositor's account balance. The interest rate is normally 3% above the annual
percentage yield paid on the account and the account must be pledged as
collateral to secure the loan. Interest generally is billed on a quarterly
basis. At September 30, 1997, loans on certificates of deposit totaled $617,000,
or 0.3% of the Company's total loan portfolio.
At September 30, 1997, the Company had approximately $21.7 million in home
equity line of credit loans, representing approximately 10.1% of its gross loan
portfolio. The Company's home equity lines of credit have adjustable interest
rates tied to the prime interest rate plus a margin. The home equity lines of
credit require monthly payments until the loan is paid in full. Home equity
lines of credit are generally secured by subordinate liens against residential
real property. The Bank requires that fire and extended coverage casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least sufficient to cover its loan. Home equity loans are generally limited so
that the amount of such loans, along with any senior indebtedness, does not
exceed 85% of the value of the real estate security.
The Company offers credit card loans through its participation as a Visa
and MasterCard issuer. Management believes that providing credit card services
to its customers helps the Bank remain competitive by offering customers an
additional service, and the Bank does not actively solicit credit card business
beyond its customer base and market area. The rate currently charged by the Bank
on its credit card loans ranges from 11.5% to 17.5%, and the Bank is permitted
to change the interest rate on 30 days notice. Processing of bills and payments
is contracted to an outside servicer. At September 30, 1997, the Company had a
commitment to fund an aggregate of $2.2 million of credit card loans, which
represented the aggregate credit limit on credit cards, and had $479,000 of
credit card loans outstanding, representing 0.2% of its gross loan portfolio.
The Company intends to continue and expand credit card lending, but estimates
that at current levels of credit card loans, it makes little or no monthly
profit net of service expenses and write-offs.
Consumer lending affords the Company the opportunity to earn yields higher
than those obtainable on single-family residential lending. However, consumer
loans entail greater risk than do residential mortgage loans, particularly in
the case of loans which are unsecured (as is the case with credit card loans) or
secured by rapidly depreciable assets such as automobiles. Repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower. In addition,
consumer and credit card loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by events such as job loss, divorce, illness or personal bankruptcy.
Further, the application of various state and federal laws, including federal
and state bankruptcy and insolvency law, may limit the amount which may be
recovered. In underwriting consumer loans, the Bank considers the borrower's
credit history, an analysis of the borrower's income and ability to repay the
loan, and the value of the collateral.
10
<PAGE>
Loan Fees and Servicing. The Bank receives fees in connection with late
payments and for miscellaneous services related to its loans. The Bank also
charges fees in connection with loan originations. These fees can consist of
origination, discount, construction and/or commitment fees, depending on the
type of loan. The Bank generally does not service loans for others except as set
forth below and except for mortgage loans originated and sold by the Bank with
servicing retained.
In addition, the Bank has developed a program to originate loans for a
local credit union. The Bank receives a $600 origination fee for each loan as
well as an annual servicing fee of .375% of the loan amount. All of these loans
are funded and closed in the name of the credit union. The Bank has explored the
possibility of developing similar arrangements with other institutions, although
none are currently planned.
Nonperforming Loans and Other Problem Assets. It is management's policy to
continually monitor its loan portfolio to anticipate and address potential and
actual delinquencies. When a borrower fails to make a payment on a loan, the
Bank takes immediate steps to have the delinquency cured and the loan restored
to current status. Loans which are delinquent more than 15 days incur a late fee
of 4% of the monthly payment of principal and interest due. As a matter of
policy, the Bank will contact the borrower after the loan has been delinquent 15
days. If payment is not promptly received, the borrower is contacted again, and
efforts are made to formulate an affirmative plan to cure the delinquency.
Generally, after any loan is delinquent 45 days or more, a default letter is
sent to the borrower. If the default is not cured after 30 days, formal legal
proceedings are commenced to collect amounts owed.
Loans generally are placed on nonaccrual status, and accrued but unpaid
interest is reversed, when, in management's judgment, it is determined that the
collectibility of interest, but not necessarily principal, is doubtful.
Generally, this occurs when payment is delinquent in excess of 90 days. Consumer
loans are generally charged off, or any expected loss is reserved for, after
they become more than 120 days past due. All other loans are charged off when
management concludes that they are uncollectible. See Note 1 of Notes to
Financial Statements.
Real estate acquired by the Bank as a result of foreclosure is classified
as real estate acquired through foreclosure until such time as it is sold and is
recorded at the lower of the estimated fair value of the underlying real estate
or the carrying amount of the loan. Costs relating to holding or improving such
real estate are charged against income in the current period. Any required
write-down of the loan to its fair value less estimated selling costs upon
foreclosure is charged against the allowance for loan losses. See Note 1 of
Notes to Financial Statements.
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. At the dates shown, the Bank had no
restructured loans within the meaning of Statement of Financial Accounting
Standards No. 15.
<TABLE>
<CAPTION>
At September 30,
------------------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis:
<S> <C> <C> <C> <C> <C>
Residential mortgage:
Single-family............................ $ 298 $ 376 $ 413 $ 286 $ 806
Construction............................. 916 647 248 -- 200
Commercial real estate..................... 16 -- -- -- --
Commercial business........................ 14 8 -- -- --
Consumer................................... 18 3 20 53 34
------- ------- ------- ------- -------
Total nonperforming loans................ $ 1,262 $ 1,034 $ 681 $ 339 $ 1,040
======= ======= ======= ======= =======
Percentage of total loans, net............... .64% .66% .47% .25% .88%
======= ======= ======= ======= =======
Real estate owned............................ $ 358 $ 179 $ 69 $ 180 $ 115
======= ======= ======= ======= =======
</TABLE>
11
<PAGE>
During the year ended September 30, 1997, gross interest income of
approximately $48,000 would have been recorded on loans accounted for on a
nonaccrual basis if the loans had been current throughout this period. Interest
on such loans included in income during the period amounted to approximately
$9,000.
At September 30, 1997, the Bank had no loans not classified as non-accrual,
90 days past due or restructured where known information about possible credit
problems of borrowers caused management to have serious concerns as to the
ability of the borrowers to comply with present loan repayment terms and may
result in disclosure as non-accrual, 90 days past due or restructured.
There were no loans accruing interest which were contractually past due 90
days or more at the end of any reported period.
At September 30, 1997, an analysis of the Bank's portfolio did not reveal
any impaired loans that needed to be classified under SFAS No. 114 or 118.
At September 30, 1997, the Company had $1.3 million of nonaccrual loans,
which consisted of six single-family residential real estate loans totaling
$298,000, six single-family residential construction loans totaling $916,000,
one commercial real estate loan totaling $16,000, two commercial business loans
totaling $14,000, and three consumer totaling $18,000.
At September 30, 1997, the Bank had $358,000 of real estate owned, which
consisted of four single-family residences.
Classified Assets. Federal regulations require that the Bank classify its
assets on a regular basis. In addition, in connection with examinations of
insured institutions, examiners have authority to identify problem assets and if
appropriate, classify them in their reports of examination. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts,
conditions and values, questionable, and there is a high possibility of loss. An
asset classified loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. Assets classified
as substandard or doubtful require a bank to establish general allowances for
loan losses. If an asset or portion thereof is classified loss, a bank must
either establish a specific allowance for loss in the amount of the portion of
the asset classified loss, or charge off such amount. The Bank regularly reviews
its assets to determine whether any assets require classification or
re-classification. At September 30, 1997, the Company had $2.2 million in
classified assets, including $1.2 million in assets classified as special
mention, $937,000 million in assets classified as substandard, no assets
classified as doubtful and $36,000 in assets classified as loss.
Allowance for Loan Losses. The Company's policy is to establish reserves
for estimated losses on delinquent loans when it determines that losses are
expected to be incurred on such loans. The allowance for losses on loans is
maintained at a level believed adequate by management to absorb potential losses
in the portfolio. Management's determination of the adequacy of the allowance is
based on an evaluation of the portfolio, past loss experience, current economic
conditions, volume, growth and composition of the portfolio, and other relevant
factors. The allowance is increased by provisions for loan losses which are
charged against income.
Although management believes it uses the best information available to make
determinations with respect to the allowances for losses and believes such
allowances are adequate, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations. Management anticipates that the
Company's allowance for loan losses will increase in the future as it implements
the Board of Directors' strategy of continuing existing lines of business while
gradually expanding
12
<PAGE>
commercial business and consumer lending, which loans generally entail greater
risks than single-family residential mortgage loans.
The following table sets forth an analysis of the Company's allowance for
loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period........ $ 2,351 $ 1,877 $ 1,977 $ 1,843 $ 1,350
--------- --------- --------- --------- ---------
Loans charged-off:
Residential mortgage:
Single-family..................... $ -- $ 44 $ 20 $ 10 $ --
Commercial real estate.............. -- -- 76 -- --
Consumer............................ 72 19 26 68 56
--------- --------- --------- --------- ---------
Total charge-offs..................... 72 63 122 78 56
--------- --------- --------- --------- ---------
Recoveries:
Residential real estate mortgage:
Single-family residential......... 33 25 -- -- --
Consumer............................ 6 1 2 2 1
--------- --------- --------- --------- ---------
Total recoveries...................... 39 26 2 2 1
--------- --------- --------- --------- ---------
Net loans charged-off................. 33 37 120 76 55
--------- --------- --------- --------- ---------
Provision for loan losses............. 931 511 20 210 548
--------- --------- --------- --------- ---------
Balance at end of period.............. $ 3,249 $ 2,351 $ 1,877 $ 1,977 $ 1,843
========= ========= ========= ========= =========
Ratio of net charge-offs to average
loans outstanding during the period. .02% .02% .09% .06% .02%
========= ========= ========= ========= =========
</TABLE>
13
<PAGE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At September 30,
----------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------ ------------------ ------------------ ------------------ ------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Category to Category to Category to Category to Category to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential mortgage................ $1,070 47.6% $1,037 54.6% $1,041 64.9% $1,137 72.6% $1,147 82.3%
Commercial (1)...................... 1,456 23.3 879 23.9 517 16.3 497 12.6 417 15.9
Consumer............................ 723 29.1 435 21.5 319 18.8 343 14.8 279 1.8
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance for loan losses $3,249 100.00% $2,351 100.00% $1,877 100.00% $1,977 100.00% $1,843 100.00%
====== ====== ====== ======= ====== ====== ====== ====== ====== ======
</TABLE>
- ---------------
(1) Includes commercial real estate and commercial business loans.
14
<PAGE>
Investment Activities
General. Interest income from mortgage-backed securities and investment
securities generally provides the second largest source of income to the Company
after interest on loans. The Bank's Board of Directors has authorized investment
in U.S. Government and agency securities, state government obligations,
municipal securities, obligations of the Federal Home Loan Bank ("FHLB"),
mortgage-backed securities. The Bank's objective is to use such investments to
reduce interest rate risk, enhance yields on assets and provide liquidity. At
September 30, 1997, the Company's mortgage-backed securities and investment
securities portfolio amounted to $24.8 million and $3.1 million, respectively.
At such date, the Company had an unrealized gain of $300,318, net of deferred
taxes, with respect to its securities, all of which are classified as available
for sale.
Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in the Bank's investment
policy. The Bank performs analyses on mortgage-backed securities and investment
securities prior to forming mortgage pools and on an ongoing basis to determine
the impact on earnings and market value under various interest rate and
prepayment conditions. Securities purchases are subject to the oversight of the
Bank's Investment Committee consisting of four directors and are reviewed by the
Board of Directors on a monthly basis. The Bank's President has authority to
make specific investment decisions within the parameters determined by the Board
of Directors.
Mortgage-Backed Securities. At September 30, 1997, the Company's
mortgage-backed securities amounted to $24.8 million, or 10.0% of total assets.
Mortgage-backed securities represent a participation interest in a pool of
single-family or multi-family mortgages, the principal and interest payments on
which are passed from the mortgage originators through intermediaries that pool
and repackage the participation interest in the form of securities to investors
such as the Bank. Such intermediaries may include quasi-governmental agencies
such as FHLMC, FNMA and GNMA which guarantee the payment of principal and
interest to investors. Mortgage-backed securities generally increase the quality
of the Bank's assets by virtue of the guarantees that back them, are more liquid
than individual mortgage loans and may be used to collaterize borrowings or
other obligations of the Bank. At September 30, 1997, all of the Company's
mortgage-backed securities were backed by loans originated by the Bank and
swapped with the FHLMC in exchange for such mortgage-backed securities.
The FHLMC is a public corporation chartered by the U.S. Government and
owned by the 12 FHLBs and federally insured savings institutions. The FHLMC
issues participation certificates backed principally by conventional mortgage
loans. The FHLMC guarantees the timely payment of interest and the ultimate
return of principal on participation certificates. FHLMC securities are not
backed by the full faith and credit of the United States, but because the FHLMC
is not a U.S. Government-sponsored enterprise, these securities are considered
to be among the highest quality investments with minimal credit risks. The
maximum loan limit for FNMA and FHLMC currently is $207,000.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and having varying maturities. The
underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate loans. As a result, the risk characteristics of the underlying
pool of mortgages, (i.e., fixed-rate or adjustable-rate) as well as prepayment
risk, are passed on to the certificate holder. The life of a mortgage-backed
pass-through security thus approximates the life of the underlying mortgages.
Mortgage-backed securities generally yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which offer nominal credit risk. In addition, mortgage-backed
securities are more liquid than individual mortgage loans and may be used to
collateralize borrowings of the Bank in the event that the Bank determined to
utilize borrowings as a source of funds. Mortgage-backed securities issued or
guaranteed by the FHLMC (except interest-only securities or the residual
interests in CMOs) are weighted at no more than 20% for risk-based capital
purposes, compared to a weight of 50% to 100% for residential loans. See
"Regulation -- Regulation of the Bank -- Capital Requirements."
15
<PAGE>
At September 30, 1997, mortgage-backed securities with an amortized cost of
$24.4 million and a carrying value of $24.8 million were held as available for
sale, and no mortgage-backed securities were classified as held to maturity.
Mortgage-backed securities which are held to maturity are carried at cost,
adjusted for the amortization of premiums and the accretion of discounts using a
method which approximates a level yield. Mortgage-backed securities classified
as available for sale are carried at fair value. Unrealized gains and losses on
available for sale mortgage-backed securities are recognized as direct increases
or decreases in equity, net of applicable income taxes. See Notes 1 and 4 of the
Notes to Consolidated Financial Statements. At September 30, 1997, the Bank's
mortgage-backed securities had a weighted average yield of 7.37%.
At September 30, 1997, the average contractual maturity of the Company's
fixed-rate mortgage-backed securities was approximately 19 years. The actual
maturity of a mortgage-backed security varies, depending on when the mortgagors
prepay or repay the underlying mortgages. Prepayments of the underlying
mortgages may shorten the life of the investment, thereby adversely affecting
its yield to maturity and the related market value of the mortgage-backed
security. The yield is based upon the interest income and the amortization of
the premium or accretion of the discount related to the mortgage-backed
security. Premiums and discounts on mortgage-backed securities are amortized or
accreted over the estimated term of the securities using a level yield method.
The prepayment assumptions used to determine the amortization period for
premiums and discounts can significantly affect the yield of the mortgage-backed
security, and these assumptions are reviewed periodically to reflect the actual
prepayment. The actual prepayments of the underlying mortgages depend on many
factors, including the type of mortgage, the coupon rate, the age of the
mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates. The
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates is an important determinant in the rate of
prepayments. During periods of falling mortgage interest rates, prepayments
generally increase, and, conversely, during periods of rising mortgage interest
rates, prepayments generally decrease. If the coupon rate of the underlying
mortgage significantly exceeds the prevailing market interest rates offered for
mortgage loans, refinancing generally increases and accelerates the prepayment
of the underlying mortgages. Prepayment experience is more difficult to estimate
for adjustable-rate mortgage-backed securities.
Investment Securities. The Company's investment securities consist
primarily of securities issued by the U.S. Treasury and federal and state
government agency obligations. At September 30, 1997, the Company's entire
portfolio of investment securities was classified available for sale and
amounted to $3.1 million, including gross unrealized gains of $83,000. The
Company attempts to maintain a high degree of liquidity in its investment
securities portfolio by choosing those that are readily marketable. As of
September 30, 1997, the estimated average life of the Company's investment
securities portfolio was approximately 2 years. In addition, at September 30,
1997, the Company had $1.3 million of FHLB stock.
16
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
amortized cost and average yields for the Company's investment securities and
mortgage-backed securities portfolio at September 30, 1997.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years
---------------- ----------------- ----------------- -------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
------- ----- ------- ----- ------- ----- ------- -----
(Dollars in thousands)
Securities available for sale:
<S> <C> <C> <C> <C> <C> <C> <C> <S>
U.S. government and agency
securities............... $ -- --% $ 3,083 7.13% $ -- --% $ -- --%
Mortgage-backed securities.. -- -- -- -- 4,270 7.10 20,548 7.42
Securities held to maturity:
FHLB stock (1).............. -- -- -- -- -- -- 1,288 7.25
------- ----- ------- ----- -------- ----- ------- -----
Total.................... $ -- --% $ 3,083 7.13% $ 4,270 7.10% $21,836 7.41%
======= ===== ======= ===== ======= ===== ======= =====
</TABLE>
Total Investment Portfolio
--------------------------
Carrying Amortized Average
Value Cost Yield
------- ------- -----
(Dollars in thousands)
Securities available for sale:
U.S. government and agency
securities............... $ 3,083 $ 3,001 7.13%
Mortgage-backed securities.. 24,818 24,407 7.37
Securities held to maturity:
FHLB stock (1).............. 1,288 1,288 7.25
------- ------- -----
Total.................... $29,189 $28,696 7.34%
======= ======= =====
- ---------------
(1) As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in FHLB stock, which has no stated maturity.
17
<PAGE>
The following table sets forth the carrying value of the Company's
investment securities and mortgage-backed securities portfolio at the dates
indicated.
<TABLE>
<CAPTION>
At September 30,
------------------------------------------
1997 1996 1995
------ ------ ------
(In thousands)
Securities available for sale:
<S> <C> <C> <C>
U.S. government and agency securities....................... $ 3,083 $ 5,107 $ --
State government obligations................................ -- 3,000 --
Mortgage-backed securities.................................. 24,818 14,797 9,072
-------- -------- --------
Total 27,901 22,904 9,072
Securities held to maturity:
U.S. government and agency securities and other............. -- -- 3,002
FHLB stock.................................................. 1,288 1,288 1,288
Mortgage-backed securities.................................. -- -- 13,213
-------- -------- --------
Total.................................................... 1,288 1,288 17,503
-------- -------- --------
Total.................................................. $ 29,189 $ 24,192 $ 26,575
======== ======== ========
</TABLE>
Deposit Activity and Other Sources of Funds
General. Deposits are the primary source of the Bank's funds for lending,
investment activities and general operational purposes. In addition to deposits,
the Bank derives funds from loan principal and interest repayments, maturities
of investment securities and mortgage-backed securities and interest payments
thereon. Although loan repayments are a relatively stable source of funds,
deposit inflows and outflows are significantly influenced by general interest
rates and money market conditions. Borrowings may be used on a short-term basis
to compensate for reductions in the availability of funds, or on a longer term
basis for general operational purposes. The Bank has access to borrow from the
FHLB of Atlanta.
Deposits. The Bank attracts deposits principally from within its market
area by offering a variety of deposit instruments, including checking accounts,
money market accounts, statement and passbook savings accounts, Individual
Retirement Accounts, and certificates of deposit which range in maturity from
seven days to five years. Deposit terms vary according to the minimum balance
required, the length of time the funds must remain on deposit and the interest
rate. Maturities, terms, service fees and withdrawal penalties for its deposit
accounts are established by the Bank on a periodic basis. The Bank reviews its
deposit pricing on a weekly basis. In determining the characteristics of its
deposit accounts, the Bank considers the rates offered by competing
institutions, lending and liquidity requirements, growth goals and federal
regulations. Management believes it prices its deposits comparably to rates
offered by its competitors. The Bank does not accept brokered deposits.
The Bank attempts to compete for deposits with other institutions in its
market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers. Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially, all of the
Bank's depositors are North Carolina residents. To provide additional
convenience, the Bank participates in the HONOR Automatic Teller Machine network
at locations throughout the United States, through which customers can gain
access to their accounts at any time. To better serve its customers, the Bank
has installed automatic teller machines at four office locations.
18
<PAGE>
The following tables set forth the distribution of the Bank's deposit
accounts at the dates indicated, the weighted average interest rates and the
change in dollar amounts for each category of deposits presented. Management
does not believe that the use of year-end balances instead of average balances
resulted in any material difference in the information presented.
<TABLE>
<CAPTION>
For the Year Ended September 30,
------------------------------------------------------------------------------
1997 1996 1995
---------------------- ----------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
(Dollars in thousands)
Demand accounts:
<S> <C> <C> <C> <C> <C> <C>
Checking....................................... $ 22,788 .61% $ 17,079 .61% $ 11,752 .93%
Money market................................... 14,712 4.19 10,256 4.20 4,201 2.87
Savings accounts................................. 6,456 2.00 7,020 2.00 6,890 2.43
--------- ------ --------- ------ --------- ------
Total....................................... 43,956 2.01 34,355 1.96 22,843 1.74
Certificate accounts:
Less than 12 months (1)........................ 41,814 5.28 52,962 5.32 41,397 5.81
12 - 14 months (1)............................. 27,384 5.14 39,525 5.29 53,004 6.05
14 - 72 months (1)............................. 61,962 5.89 44,371 6.02 36,213 6.06
--------- ------ --------- ------ --------- ------
Total....................................... 131,160 5.53 136,858 5.54 130,614 5.98
--------- ------ --------- ------ --------- ------
Total deposits................................... $ 175,116 4.65% $ 171,213 4.82% $ 153,457 5.35%
========= ====== ========= ====== ========= ======
</TABLE>
- ---------------
(1) Original term.
19
<PAGE>
The following table indicates the amount of the Company's certificates of
deposit of $100,000 or more (in thousands) by time remaining until maturity as
of September 30, 1997. At such date, such deposits represented 9.8% of total
deposits and had a weighted average rate of 5.83%.
Maturity Period
---------------
Three months or less....................... $ 6,328
Over three through six months.............. 2,852
Over six through 12 months................. 6,206
Over 12 months............................. 1,711
----------
Total.................................. $ 17,097
==========
At September 30, 1997, mortgage-backed securities with a carrying value of
$1.6 million were pledged as collateral for deposits from public entities.
Borrowings. Savings deposits historically have been the primary source of
funds for the Bank's lending, investment and general operating activities. The
Bank is authorized, however, to use advances from the FHLB of Atlanta to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB of Atlanta functions as a central reserve bank providing
credit for savings institutions and certain other member financial institutions.
As a member of the FHLB System, the Bank is required to own stock in the FHLB of
Atlanta and is authorized to apply for advances. Advances are pursuant to
several different programs, each of which has its own interest rate and range of
maturities. The Bank has a Blanket Agreement for advances with the FHLB under
which the Bank may borrow up to 25% of assets subject to normal collateral and
underwriting requirements. Advances from the FHLB of Atlanta are secured by the
Bank's stock in the FHLB of Atlanta and other eligible assets. During the years
ended September 30, 1997, 1996 and 1995, the Bank's borrowings consisted of FHLB
advances and, during the year ended September 30, 1997, retail repurchase
agreements.
The Bank also utilized retail repurchase agreements to a limited extent
during fiscal 1996 and 1997. Retail repurchase agreements represent agreements
to sell securities under terms which require the Bank to repurchase the same or
substantially similar securities by a specified date. The Bank did not have any
such agreements at September 30, 1995. The Bank did not utilize such agreements
during fiscal 1995.
The following table sets forth certain information regarding short-term
borrowings by the Company at the dates and for the periods indicated:
<TABLE>
<CAPTION>
At or for the
Year Ended September 30,
-----------------------------------------------
1997 1996 1995
--------- --------- --------
(In thousands)
Amounts outstanding at end of period:
<S> <C> <C> <C>
FHLB advances.............................................. $ 11,000 $ -- $ 4,000
Federal funds purchased and securities
sold under repurchase agreements......................... $ 1,621 $ 1,040 --
Weighted average rate paid on:
FHLB advances.............................................. 6.17% -- 7.27%
Federal funds purchased and securities sold under
agreements to repurchase................................. 4.67% 4.31% --
Maximum amount of borrowings outstanding at any month end:
FHLB advances.............................................. $ 13,000 $ 7,000 $ 21,000
Federal funds purchased and securities
sold under repurchased agreements........................ 1,645 1,040 --
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
At or for the
Year Ended September 30,
-----------------------------------------------
1997 1996 1995
--------- --------- --------
(In thousands)
Approximate average short-term borrowings
outstanding with respect to:
<S> <C> <C> <C>
FHLB advances...................................... $ 3,400 $ 2,250 $ 11,833
Federal funds purchased and securities
sold under repurchase agreements................. 1,218 582 --
Approximate weighted average rate paid on: (1)
FHLB advances...................................... 5.78% 6.83% 6.54%
Federal funds purchased and securities
sold under agreements to repurchase.............. 4.56% 4.44% --%
</TABLE>
- -------------------
(1) Based on month-end balances.
Subsidiary Activities
In prior years, the Bank had one subsidiary, Tidewater Financial Services
Corporation, a North Carolina corporation, which had been inactive during the
past three years. This subsidiary was dissolved effective September 30, 1996.
Competition
The Company faces strong competition in originating real estate, commercial
business and consumer loans and in attracting deposits. The Bank competes for
real estate and other loans principally on the basis of interest rates, the
types of loans it originates, the deposit products it offers and the quality of
services it provides to borrowers. The Bank also competes by offering products
which are tailored to the local community. Its competition in originating real
estate loans comes primarily from other commercial banks, savings institutions,
mortgage bankers and mortgage brokers. Commercial banks, credit unions and
finance companies provide vigorous competition in consumer lending. Competition
may increase as a result of the recent reduction of restrictions on the
interstate operations of financial institutions.
The Bank attracts its deposits through its branch offices primarily from
the local communities. Consequently, competition for deposits is principally
from other commercial banks, savings institutions, credit unions and brokers in
the Bank's primary market area. The Bank competes for deposits and loans by
offering what it believes to be a variety of deposit accounts at competitive
rates, convenient business hours, a commitment to outstanding customer service
and a well-trained staff. The Bank believes it has developed strong
relationships with local realtors and the community in general.
Management considers its primary market area for gathering deposits and
originating loans to be Beaufort, Craven, Lenoir, Nash, Pasquotank and Pitt
Counties in eastern North Carolina, which are the counties in which the Bank's
offices are located. The Bank originates loans throughout eastern North
Carolina.
Employees
As of September 30, 1997, the Bank had 113 full-time and 7 part-time
employees, none of whom were represented by a collective bargaining agreement.
Management considers the Bank's relationships with its employees to be good.
21
<PAGE>
REGULATION
Depository Institution Regulation
General. The Bank is a North Carolina-chartered commercial bank and its
deposit accounts are insured by the Savings Association Insurance Fund ("SAIF")
of the FDIC. The Bank is subject to supervision, examination and regulation by
the Commissioner and the FDIC and to North Carolina and federal statutory and
regulatory provisions governing such matters as capital standards, mergers,
subsidiary investments and establishment of branch offices. The FDIC also has
the authority to conduct special examinations. The Bank is required to file
reports with the Commissioner and the FDIC concerning its activities and
financial condition and will be required to obtain regulatory approval prior to
entering into certain transactions, including mergers with, or acquisitions of,
other depository institutions.
As a federally insured depository institution, the Bank is subject to
various regulations promulgated by the Board of Governors of the Federal Reserve
System ("Federal Reserve Board"), including Regulation B (Equal Credit
Opportunity), Regulation D (Reserve Requirements), Regulations E (Electronic
Fund Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of
Funds and Collection of Checks) and Regulation DD (Truth in Savings).
The system of regulation and supervision applicable to the Bank establishes
a comprehensive framework for the operations of the Bank, and is intended
primarily for the protection of the FDIC and the depositors of the Bank. Changes
in the regulatory framework could have a material effect on the Bank that in
turn, could have a material effect on the Company.
Capital Requirements. The Federal Reserve Board and the FDIC have
established guidelines with respect to the maintenance of appropriate levels of
capital by bank holding companies with consolidated assets of $150 million or
more and state non-member banks, respectively. The regulations impose two sets
of capital adequacy requirements: minimum leverage rules, which require bank
holding companies and state non-member banks to maintain a specified minimum
ratio of capital to total assets, and risk-based capital rules, which require
the maintenance of specified minimum ratios of capital to "risk-weighted"
assets. The regulations of the FDIC and the Federal Reserve Board require bank
holding companies and state non-member banks, respectively, to maintain a
minimum leverage ratio of "Tier 1 capital" to total assets of 3.0%. Tier 1
capital is the sum of common stockholders' equity, certain perpetual preferred
stock (which must be noncumulative with respect to banks), including any related
surplus, and minority interests in consolidated subsidiaries; minus all
intangible assets (other than certain purchased mortgage servicing rights and
purchased credit card receivables), identified losses and investments in certain
subsidiaries. As a SAIF-insured, state-chartered bank, the Bank must also deduct
from Tier 1 capital an amount equal to its investments in, and extensions of
credit to, subsidiaries engaged in activities that are not permissible for
national banks, other than debt and equity investments in subsidiaries engaged
in activities undertaken as agent for customers or in mortgage banking
activities or in subsidiary depository institutions or their holding companies.
Although setting a minimum 3.0% leverage ratio, the capital regulations state
that only the strongest bank holding companies and banks, with composite
examination ratings of 1 under the rating system used by the federal bank
regulators, would be permitted to operate at or near such minimum level of
capital. All other bank holding companies and banks are expected to maintain a
leverage ratio of at least 1% to 2% above the minimum ratio, depending on the
assessment of an individual organization's capital adequacy by its primary
regulator. Any bank or bank holding companies experiencing or anticipating
significant growth would be expected to maintain capital well above the minimum
levels. In addition, the Federal Reserve Board has indicated that whenever
appropriate, and in particular when a bank holding company is undertaking
expansion, seeking to engage in new activities or otherwise facing unusual or
abnormal risks, it will consider, on a case-by-case basis, the level of an
organization's ratio of tangible Tier 1 capital to total assets in making an
overall assessment of capital.
In addition to the leverage ratio, the regulations of the Federal Reserve
Board and the FDIC require bank holding companies and state-chartered nonmember
banks to maintain a minimum ratio of qualifying total capital to risk-weighted
assets of at least 8.0% of which at least four percentage points must be Tier 1
capital. Qualifying total capital consists of Tier 1 capital plus Tier 2 or
supplementary capital items which include allowances for loan losses in an
amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and
preferred stock with a maturity of 20 years or more and certain other capital
instruments. The includible amount of Tier 2 capital cannot exceed the
22
<PAGE>
institution's Tier 1 capital. Qualifying total capital is further reduced by the
amount of the bank's investments in banking and finance subsidiaries that are
not consolidated for regulatory capital purposes, reciprocal cross-holdings of
capital securities issued by other banks and certain other deductions. The
risk-based capital regulations assign balance sheet assets and the credit
equivalent amounts of certain off-balance sheet items to one of four broad risk
weight categories. The aggregate dollar amount of each category is multiplied by
the risk weight assigned to that category based principally on the degree of
credit risk associated with the obligor. The sum of these weighted values equals
the bank holding company or the bank's risk-weighted assets.
The federal bank regulators, including the FDIC, have proposed to revise
their risk-based capital requirements to ensure that such requirements provide
for explicit consideration of interest rate risk. Under the proposed rule, a
bank's interest rate risk exposure would be quantified using either the
measurement system set forth in the proposal or the bank's internal model for
measuring such exposure, if such model is determined to be adequate by the
bank's examiner. If the dollar amount of a bank's interest rate risk exposure,
as measured under either measurement system, exceeds 1% of the bank's total
assets, the bank would be required under the proposed rule to hold additional
capital equal to the dollar amount of the excess. Management has not determined
what effect, if any, the proposed interest rate risk component would have on the
Bank's capital if adopted as proposed. The FDIC has adopted a regulation that
provides that the FDIC may take into account whether a bank has significant
risks from concentrations of credit or nontraditional activities in determining
the adequacy of its capital. The Bank has not been advised that it will be
required to maintain any additional capital under this regulation. The proposed
interest rate risk component would not apply to bank holding companies on a
consolidated basis.
In addition to FDIC regulatory capital requirements, the North Carolina
Bank Commissioner requires that the Bank have adequate capitalization which is
determined based upon each Bank's particular set of circumstances. The Bank is
subject to the Commissioner's capital surplus regulation which requires
commercial banks to maintain a capital surplus of at least 50% of common
capital. Common capital is defined as the total of the par value of shares times
the number of shares outstanding.
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. A
"significantly undercapitalized" institution may be subject to regulatory
demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution could also
be required to divest the institution or the institution could be required to
divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior regulatory approval and the institution is prohibited
from making payments of principal or interest on its subordinated debt. If an
institution's ratio of tangible capital to total assets falls below a "critical
capital level," the institution will be subject to conservatorship or
receivership within 90 days unless periodic determinations are made that
forbearance from such action would better protect the deposit insurance fund.
The federal banking regulators has adopted regulations implementing the
prompt corrective action provisions of FDICIA. Under these regulations, the
federal banking regulators will generally measure a depository institution's
capital adequacy on the basis of the institution's total risk-based capital
ratio (the ratio of its total capital to risk-weighted assets), Tier 1
risk-based capital ratio (the ratio of its core capital to risk-weighted assets)
and leverage ratio (the ratio of its core capital to adjusted total assets).
Under the regulations, an institution that is not subject to an order or written
directive by its primary federal regulator to meet or maintain a specific
capital level will be deemed "well capitalized" if it also has: (i) a total
risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital
ratio of 6.0% or greater;
23
<PAGE>
and (iii) a leverage ratio of 5.0% or greater. An "adequately capitalized"
depository institution is an institution that does not meet the definition of
well capitalized and has: (i) a total risk-based capital ratio of 8.0% or
greater; (ii) a Tier 1 risk-based capital ratio of 4.0% or greater; and (iii) a
leverage ratio of 4.0% or greater (or 3.0% or greater if the depository
institution has a composite 1 CAMEL rating). An "undercapitalized institution"
is a depository institution that has (i) a total risk-based capital ratio less
than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii)
a leverage ratio of less than 4.0% (or less than 3.0% if the institution has a
composite 1 CAMEL rating). A "significantly undercapitalized" institution is
defined as a depository institution that has: (i) a total risk-based capital
ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than
3.0%; or (iii) a leverage ratio of less than 3.0%. A "critically
undercapitalized" institution is defined as a depository institution that has a
ratio of "tangible equity" to total assets of less than 2.0%. Tangible equity is
defined as core capital plus cumulative perpetual preferred stock (and related
surplus) less all intangibles other than qualifying supervisory goodwill and
certain purchased mortgage servicing rights. The FDIC may reclassify a well
capitalized depository institution as adequately capitalized and may require an
adequately capitalized or undercapitalized institution to comply with the
supervisory actions applicable to institutions in the next lower capital
category (but may not reclassify a significantly undercapitalized institution as
critically under-capitalized) if it determines, after notice and an opportunity
for a hearing, that the institution is in an unsafe or unsound condition or that
the institution has received and not corrected a less-than-satisfactory rating
for any CAMEL rating category. As of September 30, 1997, the Bank was classified
as "well capitalized" under FDIC regulations.
Safety and Soundness Guidelines. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each federal banking agency was required to establish safety and soundness
standards for institutions under its authority. The interagency guidelines
require depository institutions to maintain internal controls and information
systems and internal audit systems that are appropriate for the size, nature and
scope of the institution's business. The guidelines also establish certain basic
standards for loan documentation, credit underwriting, interest rate risk
exposure, and asset growth. The guidelines further provide that depository
institutions should maintain safeguards to prevent the payment of compensation,
fees and benefits that are excessive or that could lead to material financial
loss, and should take into account factors such as comparable compensation
practices at comparable institutions. If the appropriate federal banking agency
determines that a depository institution is not in compliance with the safety
and soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines. A depository institution must
submit an acceptable compliance plan to its primary federal regulator within 30
days of receipt of a request for such a plan. Failure to submit or implement a
compliance plan may subject the institution to regulatory sanctions. Management
believes that the Bank already substantially meets all the standards adopted in
the interagency guidelines.
Community Reinvestment Act. The Bank, like other financial institutions, is
subject to the Community Reinvestment Act ("CRA"). The purpose of the CRA is to
encourage financial institutions to help meet the credit needs of their entire
communities, including the needs of low-and moderate-income neighborhoods.
During the Bank's last compliance examination, the Bank received an
"outstanding" rating with respect to CRA compliance. The Bank's rating with
respect to CRA compliance would be a factor to be considered by the Federal
Reserve Board and the FDIC in considering applications submitted by the Bank to
acquire branches or to acquire or combine with other financial institutions and
take other actions and, if such rating was less than "satisfactory," could
result in the denial of such applications.
The federal banking regulatory agencies have issued a revision of the CRA
regulations, which became effective on January 1, 1996, to implement a new
evaluation system that rates institutions based on their actual performance in
meeting community credit needs. Under the regulations, a bank will first be
evaluated and rated under three categories: a lending test, an investment test
and a service test. For each of these three tests, the savings bank will be
given a rating of either "outstanding," "high satisfactory," "low satisfactory,"
"needs to improve," or "substantial non-compliance." A set of criteria for each
rating has been developed and is included in the regulation. If an institution
disagrees with a particular rating, the institution has the burden of rebutting
the presumption by clearly establishing that the quantitative measures do not
accurately present its actual performance, or that demographics, competitive
conditions or economic or legal limitations peculiar to its service area should
be considered. The ratings received under the three tests will be used to
determine the overall composite CRA rating. The composite ratings will be the
same as those that are currently given: "outstanding," "satisfactory," "needs to
improve" or "substantial non-compliance."
24
<PAGE>
Federal Home Loan Bank System. The FHLB System consists of 12 district
FHLBs subject to supervision and regulation by the Federal Housing Finance Board
("FHFB"). The FHLBs provide a central credit facility primarily for member
institutions. As a member of the FHLB of Atlanta, the Bank is required to
acquire and hold shares of capital stock in the FHLB of Atlanta in an amount at
least equal to 1% of the aggregate unpaid principal of its home mortgage loans,
home purchase contracts, and similar obligations at the beginning of each year,
or 1/20 of its advances (borrowings) from the FHLB of Atlanta, whichever is
greater. The Bank was in compliance with this requirement with investment in
FHLB of Atlanta stock at September 30, 1997, of $1.3 million. The FHLB of
Atlanta serves as a reserve or central bank for its member institutions within
its assigned district. It is funded primarily from proceeds derived from the
sale of consolidated obligations of the FHLB System. It offers advances to
members in accordance with policies and procedures established by the FHFB and
the Board of Directors of the FHLB of Atlanta. Long-term advances may only be
made for the purpose of providing funds for residential housing finance.
Reserves. Pursuant to regulations of the Federal Reserve Board, the Bank
must maintain average daily reserves against their transaction accounts. No
reserves are required to be maintained on the first $4.3 million of transaction
accounts, reserves equal to 3% must be maintained on the next $52.0 million of
transaction accounts, plus 10% on the remainder. This percentage is subject to
adjustment by the Federal Reserve Board. Because required reserves must be
maintained in the form of vault cash or in a noninterest bearing account at a
Federal Reserve Bank, the effect of the reserve requirement is to reduce the
amount of the institution's interest-earning assets. As of September 30, 1997,
the Bank met its reserve requirements.
The Bank is also subject to the reserve requirements of North Carolina
commercial banks. North Carolina law requires state non-member banks to
maintain, at all times, a reserve fund in an amount set by the State Commission.
Deposit Insurance. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken. The
assessment rate for SAIF members had ranged from 0.23% of deposits for well
capitalized institutions in Subgroup A to 0.31% of deposits for undercapitalized
institutions in Subgroup C while assessments for over 90% of the Bank Insurance
Fund ("BIF") members had been the statutory minimum of $2,000. Recently enacted
legislation provided for a one-time assessment of 65.7 basis points of insured
deposits as of March 31, 1995, that fully capitalized the SAIF and had the
effect of reducing future SAIF assessments. Accordingly, although the special
assessment resulted in a one-time charge to the Bank of approximately $946,000
pre-tax, accrued during the quarter ended September 30, 1997, the
recapitalization of the SAIF had the effect of reducing the Bank's future
deposit insurance premiums to the SAIF. Under the recently enacted legislation,
both BIF and SAIF members will be assessed an amount for Financing Corporation
Bond payments. BIF members will be assessed approximately 1.3 basis points while
the SAIF rate will be approximately 6.4 basis points until January 1, 2000. At
that time, BIF and SAIF members will begin pro rata sharing of the payment at an
expected rate of 2.43 basis points.
Although the Bank, as a North Carolina commercial bank, would qualify for
insurance of deposits by the BIF of the FDIC, substantial entrance and exit fees
apply to conversions from SAIF to BIF insurance. Accordingly, following the Bank
Conversion, the Bank remained a member of the SAIF, which insures the deposits
of the Bank to a maximum of $100,000 for each depositor.
25
<PAGE>
Liquidity Requirements. FDIC policy requires that banks maintain an average
daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances and specified United States government, state, or federal agency
obligations) in an amount which it deems adequate to protect safety and
soundness of the bank. The FDIC currently has no specific level which it
requires. Under the FDIC's calculation method, management calculated the Bank's
liquidity ratio as 16.0% of total assets at September 30, 1997, which management
believes is adequate.
North Carolina banks must maintain a reserve fund in an amount and/or ratio
set by the Banking Commission to account for the level of liquidity necessary to
assure the safety and soundness of the State banking system. As of September 30,
1997, the Bank's liquidity ratio was in excess of the North Carolina
regulations.
Dividend Restrictions. Under FDIC regulations, the Bank is prohibited from
making any capital distributions if after making the distribution, the Bank
would have: (i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier
1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less
than 4.0%.
Earnings of the Bank appropriated to bad debt reserves and deducted for
Federal income tax purposes are not available for payment of cash dividends or
other distributions to stockholders without payment of taxes at the then current
tax rate by the Bank on the amount of earnings removed from the pre-1988
reserves for such distributions. The Bank intends to make full use of this
favorable tax treatment and does not contemplate use of any earnings in a manner
which would create federal tax liabilities.
Limits on Loans to One Borrower. The Bank generally is subject to both FDIC
regulations and North Carolina law regarding loans to any one borrower,
including related entities. Under applicable law, with certain limited
exceptions, loans and extensions of credit by a state chartered non-member bank
to a person outstanding at one time and not fully secured by collateral having a
market value at least equal to the amount of the loan or extension of credit
shall not exceed 15% of the unimpaired capital of the bank. Loans and extensions
of credit fully secured by readily marketable collateral having a market value
may comprise shall not exceed 10% of the unimpaired capital fund of the bank.
Under these limits, the Bank's loans to one borrower were limited to $6.0
million at September 30, 1997. At that date, the Bank had no lending
relationships in excess of the loans-to-one-borrower limit. Notwithstanding the
statutory loans-to-one-borrower limitations, the Bank has a self imposed
loans-to-one-borrower limit, which currently is $3.5 million. At September 30,
1997, the Bank's largest lending relationship was a $3.3 million relationship
consisting of four commercial real estate loans. All loans within this
relationship were current and performing in accordance with their terms at
September 30, 1997.
Transactions with Related Parties. Transactions between a state non-member
bank and any affiliate are governed by Sections 23A and 23B of the Federal
Reserve Act. An affiliate of a state non-member bank is any company or entity
which controls, is controlled by or is under common control with the state
non-member bank. In a holding company context, the parent holding company of a
state non-member bank (such as the Company) and any companies which are
controlled by such parent holding company are affiliates of the savings
institution or state non-member bank. Generally, Sections 23A and 23B (i) limit
the extent to which an 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 state non-member bank 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 state non-member
bank.
State non-member banks also are subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve's Regulation O
thereunder on loans to executive officers, directors and principal stockholders.
Under Section 22(h), loans to a director, executive officer and to a greater
than 10% stockholder of a state non-member bank and certain affiliated interests
of such persons, may not exceed, together with all other outstanding
26
<PAGE>
loans to such person and affiliated interests, the institution's
loans-to-one-borrower limit and all loans to such persons may not exceed the
institution's unimpaired capital and unimpaired surplus. Section 22(h) also
prohibits loans, above amounts prescribed by the appropriate federal banking
agency, to directors, executive officers and greater than 10% stockholders of a
savings institution, and their respective affiliates, unless such loan is
approved in advance by a majority of the board of directors of the institution
with any "interested" director not participating in the voting. Regulation O
prescribes the loan amount (which includes all other outstanding loans to such
person) as to which such prior board of director approval is required as being
the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further,
Section 22(h) requires that loans to directors, executive officers and principal
stockholders be made on terms substantially the same as offered in comparable
transactions to other persons. Section 22(h) also generally prohibits a
depository institution from paying the overdrafts of any of its executive
officers or directors.
State non-member banks also are subject to the requirements and
restrictions of Section 22(g) of the Federal Reserve Act on loans to executive
officers and the restrictions of 12 U.S.C. ss. 1972 on certain tying
arrangements and extensions of credit by correspondent banks. Section 22(g) of
the Federal Reserve Act requires loans to executive officers of depository
institutions not be made on terms more favorable than those afforded to other
borrowers, requires approval by the board of directors of a depository
institution for extension of credit to executive officers of the institution,
and imposes reporting requirements for and additional restrictions on the type,
amount and terms of credits to such officers. Section 1972 (i) prohibits a
depository institution from extending credit to or offering any other services,
or fixing or varying the consideration for such extension of credit or service,
on the condition that the customer obtain some additional service from the
institution or certain of its affiliates or not obtain services of a competitor
of the institution, subject to certain exceptions, and (ii) prohibits extensions
of credit to executive officers, directors, and greater than 10% stockholders of
a depository institution by any other institution which has a correspondent
banking relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
Additionally, North Carolina statutes set forth restrictions on loans to
executive officers of state-chartered banks, which provide that no bank may
extend credit to any of its executive officers nor a firm or partnership of
which such executive officers is a member, nor a company in which such executive
officer owns a controlling interest, unless the extension of credit is made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions by the bank with persons who
are not employed by the bank, and provided further that the extension of credit
does not involve more than the normal risk of repayment.
Restrictions on Certain Activities. Under FDICIA, state-chartered
non-member banks with deposits insured by the FDIC are generally prohibited from
acquiring or retaining any equity investment of a type or in an amount that is
not permissible for a national bank. The foregoing limitation, however, does not
prohibit FDIC-insured state banks from acquiring or retaining an equity
investment in a subsidiary in which the bank is a majority owner.
State-chartered banks are also prohibited from engaging as principal in any type
of activity that is not permissible for a national bank and subsidiaries of
state-chartered, FDIC-insured state banks may not engage as principal in any
type of activity that is not permissible for a subsidiary of a national bank
unless in either case the FDIC determines that the activity would pose no
significant risk to the appropriate deposit insurance fund and the bank is, and
continues to be, in compliance with applicable capital standards.
The FDIC has adopted regulations to clarify the foregoing restrictions on
activities of FDIC-insured state-chartered banks and their subsidiaries. Under
the regulations, the term activity refers to the authorized conduct of business
by an insured state bank and includes acquiring or retaining any investment
other than an equity investment. An activity permissible for a national bank
includes any activity expressly authorized for national banks by statute or
recognized as permissible in regulations, official circulars or bulletins or in
any order or written interpretation issued by the Office of the Comptroller of
the Currency ("OCC"). In its regulations, the FDIC indicates that it will not
permit state banks to directly engage in commercial ventures or directly or
indirectly engage in any insurance underwriting activity other than to the
extent such activities are permissible for a national bank or a national bank
subsidiary or except for certain other limited forms of insurance underwriting
permitted under the regulations. Under the regulations, the
27
<PAGE>
FDIC permits state banks that meet applicable minimum capital requirements to
engage as principal in certain activities that are not permissible to national
banks including guaranteeing obligations of others, activities which the Federal
Reserve Board has found by regulation or order to be closely related to banking
and certain securities activities conducted through subsidiaries.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank, is a bank
holding company and is registered with the Federal Reserve Board. Bank holding
companies are subject to comprehensive regulation by the Federal Reserve Board
under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and the
regulations of the Federal Reserve Board. As a bank holding company, the Company
is required to file with the Federal Reserve Board annual reports and such
additional information as the Federal Reserve Board may require, and is subject
to regular examinations by the Federal Reserve Board. The Federal Reserve Board
also has extensive enforcement authority over bank holding companies, including,
among other things, the ability to assess civil money penalties, to issue cease
and desist or removal orders and to require that a holding company divest
subsidiaries (including its bank subsidiaries). In general, enforcement actions
may be initiated for violations of law and regulations and unsafe or unsound
practices.
Under the BHCA, a bank holding company must obtain Federal Reserve Board
approval before: (i) acquiring, directly or indirectly, ownership or control of
any voting shares of another bank or bank holding company if, after such
acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (ii) acquiring all or
substantially all of the assets of another bank or bank holding company; or
(iii) merging or consolidating with another bank holding company, (satisfactory
financial condition, particularly with respect to capital adequacy, and a
satisfactory CRA rating generally are prerequisites to obtaining federal
regulatory approval to make acquisitions).
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company which is not a bank or bank holding company, or
from engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by Federal Reserve Board regulation or order, have been
identified as activities closely related to the business of banking or managing
or controlling banks. The list of activities permitted by the Federal Reserve
Board includes, among other things, operating a savings institution, mortgage
company, finance company, credit card company or factoring company; performing
certain data processing operations; providing certain investment and financial
advice; underwriting and acting as an insurance agent for certain types of
credit-related insurance; leasing property on a full-payout, non-operating
basis; selling money orders, travelers' checks and United States Savings Bonds;
real estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing securities
brokerage services for customers. The Company has no present plans to engage in
any of these activities.
The Federal Reserve Board has adopted guidelines regarding the capital
adequacy of bank holding companies, which require bank holding companies to
maintain specified minimum ratios of capital to total assets and capital to
risk-weighted assets. See " -- Depository Institution Regulation -- Capital
Requirements."
Acquisition of Bank Holding Companies and Banks. Under the BHCA, any
company must obtain approval of the Federal Reserve Board prior to acquiring
control of the Company or the Bank. For purposes of the BHCA, "control" is
defined as ownership of more than 25% of any class of voting securities of the
Company or the Bank, the ability to control the election of a majority of the
directors, or the exercise of a controlling influence over management or
policies of the Company or the Bank. In addition, the Change in Bank Control Act
and the related regulations of the Federal Reserve Board require any person or
persons acting in concert (except for companies required to make application
under the BHCA), to file a written notice with the Federal Reserve Board before
such person or persons may acquire control of the Company or the Bank. The
Change in Bank Control Act defines "control" as the power, directly or
indirectly, to vote 25% or more of any voting securities or to direct the
management or policies of a bank holding company or an insured bank.
28
<PAGE>
Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Act") was enacted to ease restrictions on
interstate banking. Effective September 29, 1995, the Act allows the Federal
Reserve Board to approve an application of an adequately capitalized and
adequately managed bank holding company to acquire control of, or acquire all or
substantially all of the assets of, a bank located in a state other than such
holding company's home state, without regard to whether the transaction is
prohibited by the laws of any state. The Federal Reserve Board may not approve
the acquisition of bank that has not been in existence for the minimum time
period (not exceeding five years) specified by the statutory law of the host
state. The Act also prohibits the Federal Reserve Board from approving an
application if the applicant (and its depository institution affiliates)
controls or would control more than 10% of the insured deposits in the United
States or 30% or more of the deposits in the target bank's home state or in any
state in which the target bank maintains a branch. The Act does not affect the
authority of states to limit the percentage of total insured deposits in the
state which may be held or controlled by a bank or bank holding company to the
extent such limitation does not discriminate against out-of-state banks or bank
holding companies. Individual states may also waive the 30% state-wide
concentration limit contained in the Act.
Additionally, the Act authorizes the federal banking agencies to approve
interstate merger transactions without regard to whether such transaction is
prohibited by the law of any state, unless the home state of one of the banks
opts out of the Act by adopting a law after the date of enactment of the Act and
prior to June 1, 1997 that applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks. North
Carolina has enacted legislation permitting interstate banking transactions.
Interstate acquisitions of branches will be permitted only if the law of the
state in which the branch is located permits such acquisitions. Interstate
mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
The Act authorizes the FDIC to approve interstate branching de novo by
state banks only in states which specifically allow for such branching. The
Riegle-Neal Act also requires the appropriate federal banking agencies to
prescribe regulations by June 1, 1997 which prohibit any out-of-state bank from
using the interstate branching authority primarily for the purpose of deposit
production. These regulations must include guidelines to ensure that interstate
branches operated by an out-of-state bank in a host state are reasonably helping
to meet the credit needs of the communities which they serve.
Dividends. The Federal Reserve Board has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the Federal
Reserve Board's view that a bank holding company should pay cash dividends only
to the extent that the company's net income for the past year is sufficient to
cover both the cash dividends and a rate of earning retention that is consistent
with the company's capital needs, asset quality and overall financial condition.
The Federal Reserve Board also indicated that it would be inappropriate for a
company experiencing serious financial problems to borrow funds to pay
dividends. Furthermore, under the prompt corrective action regulations adopted
by the Federal Reserve Board pursuant to FDICIA, the Federal Reserve Board may
prohibit a bank holding company from paying any dividends if the holding
company's bank subsidiary is classified as "undercapitalized". See "--
Depository Institution Regulation -- Prompt Corrective Regulatory Action."
Bank holding companies are required to give the Federal Reserve Board prior
written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of the their
consolidated retained earnings. The Federal Reserve Board may disapprove such a
purchase or redemption if it determines that the proposal would constitute an
unsafe or unsound practice or would violate any law, regulation, Federal Reserve
Board order, or any condition imposed by, or written agreement with, the Federal
Reserve Board.
The Federal Reserve Board has adopted guidelines regarding the capital
adequacy of bank holding companies, which require bank holding companies to
maintain specified minimum ratios of capital to total assets and capital to
risk-weighted assets. See " -- Depository Institution Regulation -- Capital
Requirements."
29
<PAGE>
TAXATION
General
The Bank files a federal income tax return based on a fiscal year ending
September 30.
Federal Income Taxation
The Bank is subject to the provisions of the Internal Revenue Code of 1986,
as amended (the "Internal Revenue Code") in the same general manner as other
corporations. In its form as a savings bank until April 1997, through tax years
beginning before December 31, 1995, institutions such as the Bank which met
certain definitional tests and other conditions prescribed by the Internal
Revenue Code benefitted from certain favorable provisions regarding their
deductions from taxable income for annual additions to their bad debt reserve.
For purposes of the bad debt reserve deduction, loans are separated into
"qualifying real property loans," which generally are loans secured by interests
in certain real property, and "nonqualifying loans", which are all other loans.
The bad debt reserve deduction with respect to nonqualifying loans must be based
on actual loss experience. The amount of the bad debt reserve deduction with
respect to qualifying real property loans may be based upon actual loss
experience (the "experience method") or a percentage of taxable income
determined without regard to such deduction (the "percentage of taxable income
method"). Under the experience method, the bad debt deduction for an addition to
the reserve for qualifying real property loans was an amount determined under a
formula based generally on the bad debts actually sustained by a savings
institution over a period of years. Under the percentage of taxable income
method, the bad debt reserve deduction for qualifying real property loans was
computed as 8% of a savings institution's taxable income, with certain
adjustments. The Bank generally elected to use the method which has resulted in
the greatest deductions for federal income tax purposes in any given year.
Legislation that became effective for tax years beginning after December
31, 1995 requiring the Bank to recapture into taxable income over a six taxable
year period the portion of the tax loan reserve that exceeds the pre-1988 tax
loan loss reserve. The Bank will no longer be allowed to use the reserve method
for tax loan loss provisions, but would be allowed to use the experience method
of accounting for bad debts. There will be no future effect on net income from
the recapture because the taxes on these bad debts reserves has already been
accrued as a deferred tax liability.
The Bank's federal income tax returns have been audited through the year
ended September 30, 1992.
State Income Taxation
Under North Carolina law, the corporate income tax currently is 7.50% of
federal taxable income as computed under the Internal Revenue Code, subject to
certain prescribed adjustments. This rate will be reduced to 7.25% for 1998,
7.00% for 1999 and 6.9% for 2000 and thereafter. An annual state franchise tax
is imposed at a rate of .15% applied to the greatest of the institutions (i)
capital stock, surplus and undivided profits, (ii) investment in tangible
property in North Carolina or (iii) appraised valuation of property in North
Carolina.
For additional information regarding taxation, see Notes 1 and 10 of Notes
to Consolidated Financial Statements.
30
<PAGE>
Item 2. Properties
- -------------------
The following table sets forth the location and certain additional
information regarding the Bank's offices at September 30, 1997.
<TABLE>
<CAPTION>
Book Value at
Year Owned or September 30, Approximate
Opened Leased 1997 Square Footage
------ -------- ------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Main Office:
1311 Carolina Avenue
Washington, NC 27889 1986 Owned $ 627 10,200
Branch Offices:
300 North Market Street
Washington, NC 27889 1959 Owned 117 4,680
301 E. Arlington Blvd.
Greenville, NC 27835 1993 Owned 314 2,600
604 E. Ehringhaus Street
Elizabeth City, NC 27906 1980 Owned 180 2,500
827 Hardee Road
Kinston, NC 28501 1996 Leased -- 2,000
1725 Glenburnie Road
New Bern, NC 28561 1990 Owned 339 2,600
202 Craven Street
New Bern, NC 28560 1995 Leased 34 2,500
300 Sunset Avenue
Rocky Mount, NC 27804 1994 Owned 330 4,948
Loan Production Office:
6800 Wrightsville Avenue
Suite 23 1995 Leased -- 692
Wilmington, NC 28406
Operations Center:
239 West Main Street
Washington, NC 27889 1994 Owned 334 7,600
Future Branch Sites:
Cypress Landing
Chocowinity, NC Owned 126
Taberna
New Bern, NC Owned 176
</TABLE>
The book value of the Bank's investment in premises and equipment was $2.8
million at September 30, 1997. See Note 6 to Consolidated Financial Statements.
31
<PAGE>
Item 3. Legal Proceedings.
- --------------------------
From time to time, the Company and/or the Bank is a party to various legal
proceedings incident to their business. At September 30, 1997, there were no
legal proceedings to which the Company or the Bank was a party, or to which any
of their property was subject, which were expected by management to result in a
material loss to the Company or the Bank. There are no pending regulatory
proceedings to which the Company or the Bank is a party or to which either of
their properties is subject which are currently expected to result in a material
loss.
Item 4. Submission of Matters to Vote of Security Holders.
- -----------------------------------------------------------
Not applicable.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholders'
- --------------------------------------------------------------------------------
Matters
-------
The information contained under the sections captioned "Market Information"
in the Company's Annual Report to Stockholders for the Fiscal Year Ended
September 30, 1997 (the "Annual Report") filed as Exhibit 13 hereto is
incorporated herein by reference.
Item 6. Selected Financial Data
- --------------------------------
The information contained in the table captioned "Selected Consolidated
Financial and Other Data" on page 2 in the Annual Report is incorporated herein
by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
-------------
The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" on pages 3
through 13 in the Annual Report is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
The information contained under the sections captioned "Interest Rate
Sensitivity Analysis" on page 5 in the Annual Report is incorporated herein be
reference.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
The Consolidated Financial Statements, Notes to Consolidated Financial
Statements, Independent Auditors' Report and Selected Financial Data contained
on pages 14 through 30 in the Annual Report, which are listed under Item 14
herein, are incorporated herein by reference.
Item 9. Changes in and Disagreements With Accountants on Accounting and
- --------------------------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
32
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The information contained under the sections captioned "Proposal I --
Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive proxy statement for the Company's 1998
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.
Item 11. Management Remuneration
- ---------------------------------
The information contained under the sections captioned "Proposal I --
Election of Directors," "-- Compensation Committee Interlocks and Insider
Participation," "-- Compensation Committee Report on Executive Compensation," "
- -- Comparative Stock Performance Graph," " -- Executive Compensation" and
"--Director Compensation" " in the Proxy Statement is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners. Information required
by this item is incorporated herein by reference to the section
captioned "Voting Securities and Security Ownership" in the Proxy
Statement.
(b) Security Ownership of Management. Information required by this item is
incorporated herein by reference to the sections captioned "Voting
Securities and Security Ownership" and "Proposal I -- Election of
Directors" in the Proxy Statement.
(c) Changes in Control. Management of the Company knows of no
arrangements, including any pledge by any person of securities of the
Company, the operation of which may at a subsequent date result in a
change in control of the registrant.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors -- Transactions
with Management" in the Proxy Statement.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
- --------------------------------------------------------------------------
(a) List of Documents Filed as Part of this Report
----------------------------------------------
(1) Financial Statements. The following consolidated financial statements
are incorporated by reference from Item 8 hereof (see Exhibit 13):
Independent Auditors' Report
Consolidated Statements of Financial Condition as of September 30, 1997 and
1996
Consolidated Statements of Operations for the Years Ended September 30,
1997, 1996 and 1996
Consolidated Statements of Stockholders Equity for the Years Ended
September 30, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended September 30,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
33
<PAGE>
(2) Financial Statement Schedules. All schedules for which provision is
made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.
(3) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-K and is also the Exhibit Index.
No. Description
--- -----------
3.1 Certificate of Incorporation of NewSouth Bancorp, Inc.
(Incorporated herein by reference from Exhibit 3.1 to the
Company's Registration Statement on Form S-1 (File No.
333-16335))
3.2 Bylaws of NewSouth Bancorp, Inc. (Incorporated herein by
reference from Exhibit 3.2 to the Company's Registration
Statement on Form S-1 (File No. 333-16335))
4 Form of Common Stock Certificate of NewSouth Bancorp, Inc.
(Incorporated herein by reference from Exhibit 1 to the
Company's Registration Statement on Form 8-A))
10.1(a) Employment Agreement between NewSouth Bancorp, Inc. and Thomas
A. Vann (Incorporated herein by reference from Exhibit 10.3(a)
to the Company's Registration Statement on Form S-1 (File No.
333-16335))
10.1(b) Employment Agreement between Home Savings Bank, SSB and Thomas
A. Vann (Incorporated herein by reference from Exhibit 10.3(b)
to the Company's Registration Statement on Form S-1 (File No.
333-16335))
10.2 Change in Control Protective Agreements between Home Savings
Bank, SSB, NewSouth Bancorp, Inc. and Mary R. Boyd, Sherry L.
Correll, Kristie W. Hawkins, Walter P. House and William R.
Outland (Incorporated herein by reference from Exhibit 10.4 to
the Company's Registration Statement on Form S-1 (File No.
333-16335))
10.3 Supplemental Income Agreements as Amended and Restated
December 14, 1995 between Home Savings Bank, SSB and Sherry L.
Correll, William R. Outland and Thomas A. Vann and the 1996
Amendment Thereto (Incorporated herein by reference from
Exhibit 10.5 to the Company's Registration Statement on Form
S-1 (File No. 333-16335))
10.4 Supplemental Income Plan Agreements as Amended and Restated
December 14, 1995 between Home Savings Bank, SSB and James F.
Buckman, Walter P. House, Thomas A. Vann and William L. Wall
and the 1996 Amendment Thereto (Incorporated herein by
reference from Exhibit 10.6 to the Company's Registration
Statement on Form S-1 (File No. 333-16335))
10.5 Home Savings Bank, SSB Director's Deferred Compensation Plan
Agreements as Amended and Restated December 14, 1995 with
Edmund T. Buckman, Jr., Linley H. Gibbs, Jr., Frederick N.
Holscher, Frederick H. Howdy, Charles E. Parker, Jr., Marshall
T. Singleton and Thomas A. Vann and the 1996 Amendment Thereto
(Incorporated herein by reference from Exhibit 10.7 to the
Company's Registration Statement on Form S-1 (File No.
333-16335))
10.6 Home Savings Bank, SSB Director's Retirement Plan Agreements
as Amended and Restated December 14, 1995 with Edmund T.
Buckman, Jr., Linley H. Gibbs, Jr., Frederick N. Holscher,
Frederick H. Howdy, Charles E. Parker, Jr. and Thomas A. Vann
and the 1996 Amendment Thereto (Incorporated herein by
reference from Exhibit 10.8 to the Company's Registration
Statement on Form S-1 (File No. 333-16335))
10.7 Home Savings Bank, SSB Director's Retirement Payment
Agreements as Amended and Restated December 14, 1995 with
Edmund T. Buckman, Jr., Linley H. Gibbs, Jr., Frederick N.
Holscher, Frederick H. Howdy, Charles E. Parker, Jr., and
Thomas A. Vann and the 1996 Amendment Thereto (Incorporated
herein by reference from Exhibit 10.9 to the Company's
Registration Statement on Form S-1 (File No. 333-16335))
10.8 Home Savings Bank, SSB Directors Retirement Plan Agreement
with Marshall Singleton (Incorporated herein by reference from
Exhibit 10.10 to the Company's Registration Statement on Form
S-1 (File No. 333-16335))
34
<PAGE>
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant
27 Financial Data Schedule
(b) Reports on Form 8-K. During the quarter ended September 30, 1997, the
--------------------
Registrant did not file any Current Reports on Form 8-K.
(c) Exhibits. The exhibits required by Item 601 of Regulation S-K are
---------
either filed as part of this Annual Report on Form 10-K or incorporated by
reference herein.
(d) Financial Statements and Schedules Excluded from Annual Report. There
----------------------------------------------------------------
are no other financial statements and financial statement schedules which were
excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b) which
are required to be included herein.
35
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NEWSOUTH BANCORP, INC.
December 19, 1997
By: /s/ Thomas A. Vann
-------------------------
Thomas A. Vann
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Thomas A. Vann December 19, 1997
- --------------------------------------------
Thomas A. Vann
President and Director
(Principal Executive Officer)
/s/ William L. Wall December 19, 1997
- --------------------------------------------
William L. Wall
Executive Vice President, Chief Financial
Officer and Secretary
(Principal Financial and Accounting Officer)
/s/ Edmund T. Buckman, Jr. December 19, 1997
- --------------------------------------------
Edmund T. Buckman, Jr.
Director
/s/ Linley H. Gibbs, Jr. December 19, 1997
- --------------------------------------------
Linley H. Gibbs, Jr.
Director
/s/ Frederick N. Holscher December 19, 1997
- --------------------------------------------
Frederick N. Holscher
Director
/s/ Frederick H. Howdy December 19, 1997
- --------------------------------------------
Frederick H. Howdy
Director
/s/ Charles E. Parker, Jr. December 19, 1997
- --------------------------------------------
Charles E. Parker, Jr.
Director
/s/ Marshall T. Singleton December 19, 1997
- --------------------------------------------
Marshall T. Singleton
Director
1997 Annual Report
NewSouth Bancorp
- ----------------
<PAGE>
TABLE OF CONTENTS
Letter to Stockholders 1
Selected Consolidated Financial Information and Other Data 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations 3
Report of Independent Accountants 14
Consolidated Statements of Financial Condition 15
Consolidated Statements of Operations 16
Consolidated Statements of Stockholders' Equity 17
Consolidated Statements of Cash Flows 18
Notes to Consolidated Financial Statements 19
Board of Directors 31
Executive Officers 31
NewSouth Bank Office Locations 31
Stockholder Information 32
<PAGE>
LETTER TO STOCKHOLDERS
To Our Stockholders:
This was a landmark year in the history of NewSouth Bank. We celebrated our 95th
anniversary and converted to a publicly-held company. The public offering of 2.9
million shares marked the beginning of NewSouth Bancorp, now the holding company
of NewSouth Bank. The enthusiastic response to the stock offering was
encouraging and, as a community bank, the interest from local investors in
eastern North Carolina was impressive. We are proud to have our new investors
join our depositors, directors and employees as members of NewSouth Bank.
We converted to a public company because your Board of Directors and management
team recognized that in order to be properly positioned in the marketplace,
NewSouth Bank needed to become a community bank. With the banking industry
consolidating more and more each day, NewSouth Bank recognized that an
opportunity was unfolding to serve its customers and at the same time position
itself for future success.
While the conversion to a publicly-held company was undoubtedly our most
significant event of the past year, our commitment to community banking
continued unabated. At year-end September 30, 1997, our assets were $249
million, loans receivable totaled $198 million and deposits totaled $175
million. We are also proud to report that our capital exceeded $57 million.
Consumer and commercial lending has become increasingly important to NewSouth
Bank. As a community bank, we have focused our attention on lending and other
services where we think the greatest opportunities exist for community
businesses. We have expanded the number of personnel involved in consumer and
commercial lending in order to better serve our customers.
Total consumer and commercial loan portfolios grew this year from $79 million to
$112 million, an increase of 42%. Again, much of this increase is attributable
to our approach to relationship business.
New deposit product lines such as free checking for individuals over fifty and
expanded business checking accounts helped us experience remarkable growth in
customer checking accounts. Checking accounts grew by $10 million or 37%.
As we look into the future, we believe the opportunities are vast. As we take up
the challenge of growing NewSouth Bank, excellent service and a broad range of
competitive products as well as a direct involvement in our communities will
continue to guide our endeavors. The course set this past year provides a solid
foundation for the future of NewSouth Bank.
With gratitude for the support of investors and customers as well as a
recognition of the significant commitment of our employees, officers and
directors, we look forward with confidence and a determination to become eastern
North Carolina's premier community bank.
Sincerely,
/s/Tom Vann
Tom Vann
President
1
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(In thousands)
Selected Financial Condition Data
- ---------------------------------
<S> <C> <C> <C> <C> <C>
Total assets $249,281 $194,139 $177,704 $165,996 $146,012
Loans receivable, net 197,785 155,681 144,541 135,679 118,536
Cash and investment securities 18,856 16,684 4,788 5,817 6,477
Mortgage-backed securities 24,818 14,797 22,285 18,535 16,083
Deposits 175,116 171,213 153,457 131,592 103,645
Borrowings 12,621 1,040 4,000 16,500 26,500
Stockholders' equity 57,856 18,347 17,688 15,620 13,383
Selected Operations Data
- ------------------------
Interest income $ 18,515 $ 15,349 $ 14,385 $ 11,811 $ 10,462
-------- -------- -------- -------- --------
Interest expense 8,346 8,105 7,344 5,204 4,524
Net interest income 10,169 7,244 7,041 6,607 5,938
Provision for loan losses 931 511 20 210 548
Noninterest income 1,685 1,833 1,502 1,652 3,006
Noninterest expenses 6,941 7,295 5,660 4,801 3,738
-------- -------- -------- -------- --------
Income before income taxes 3,982 1,271 2,863 3,248 4,658
Income taxes 1,719 451 998 1,011 2,065
-------- -------- -------- -------- --------
Net income $ 2,263 $ 820 $ 1,865 $ 2,237 $ 2,593
======== ======== ======== ======== ========
Earnings per share (1) $ .53 $ -- $ -- $ -- $ --
======== ======== ======== ======== ========
Dividends declared per share $ .20 $ -- $ -- $ -- $ --
======== ======== ======== ======== ========
Selected Financial Ratios and Other Data
- ----------------------------------------
Performance Ratios:
Return on average assets 1.00% .45% 1.07% 1.28% 1.93%
Return on average equity 6.57 4.45 11.17 13.38 19.17
Interest rate spread 4.10 3.72 3.84 4.25 4.67
Net interest margin 4.67 4.12 4.21 4.48 4.46
Average earning assets to average
interest-bearing liabilities 115.00 108.52 108.40 106.58 107.44
Ratio of noninterest expense to average
total assets 3.06 3.97 3.26 3.08 2.56
Quality Ratios:
Nonperforming assets to total assets .53% .62% .42% .31% .62%
Nonperforming loans to total loans .49 .66 .47 .25 .77
Loan loss reserves to total loans 1.64 1.51 1.30 1.46 1.56
Loan loss reserves to nonperforming
loans 337.03 227.37 275.62 583.19 202.30
Provision for loan losses to total loans .47 .32 .01 .15 .46
Capital Ratios:
Equity to total assets, end of period 23.23% 9.45% 9.95% 9.41% 9.17%
Average equity to average assets 15.17 10.05 9.61 9.54 9.10
Other Data:
Full service offices 8 8 8 6 6
Loans serviced for others $253,647 $253,682 $229,635 $205,141 $161,674
</TABLE>
- --------------------
(1) Applies to net income of $1,395,899 earned for the period April 8, 1997 to
September 30, 1997.
2
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Prior to April 7, 1997 NewSouth Bancorp, Inc. (the "Company") had no assets
or liabilities and engaged in no business activities. The Company was formed for
the purpose of issuing common stock and owning 100% of the stock of NewSouth
Bank (the "Bank") and operating through the Bank a commercial banking business.
Subsequent to the stock conversion, the Company has engaged in no significant
activity other than holding the stock of the Bank, therefore, this discussion
relates to the consolidated financial condition and results of operations of the
Company and the Bank.
The business of the Bank consists principally of attracting deposits from
the general public and using them to originate secured and unsecured commercial
and consumer loans, permanent mortgage and construction loans secured by
single-family residences, credit cards and other loans. The Bank's earnings
depend primarily on its net interest income, which is the difference between
interest earned on interest-earning assets and interest paid on interest-bearing
liabilities. The Bank's earnings are also affected by the level of its
noninterest income and expenses.
The operations of the Bank are affected by prevailing economic conditions
as well as policies of federal and state regulatory authorities. The Bank's cost
of funds is influenced by interest rates paid on competing investments, rates
offered on deposits by other financial institutions in the Bank's market area
and by general market interest rates. Lending activities are affected by the
demand for financing of real estate and various types of commercial and consumer
loans, which are influenced by interest rates at which such financing may be
offered.
The Bank's business emphasis is to operate as a well-capitalized,
profitable and independent community oriented financial institution dedicated to
providing quality customer service and meeting the financial needs of the
communities it serves. Management believes that the Bank can be more effective
in servicing its customers than many of its nonlocal competitors because of the
Bank's ability to quickly and effectively provide responses to customer needs
and inquiries. The Bank's ability to provide these services is enhanced by the
stability of the Bank's senior management team.
Liquidity and Capital Resources
As a state chartered commercial bank, the Bank must meet certain liquidity
requirements established by the State of North Carolina Office of The
Commissioner of Banks (the "Commissioner"). Savings banks which convert to
commercial banks are required to have at least 15% liquidity pursuant to the
conversion guidelines adopted by the Commissioner. The Bank's liquidity ratio at
September 30, 1997, as computed under such regulations, was 16.0%. Prior to
converting to a commercial bank, the Bank was required to maintain liquid assets
equal to at least 10% of total assets. The Bank's liquidity ratio was 13.6% for
the year ended September 30, 1996.
The Bank's primary sources of funds are deposits, principal and interest
payments on loans, proceeds from the sale of loans and advances from the Federal
Home Loan Bank of Atlanta (the "FHLB"). While maturities and scheduled
amortization of loans are predictable sources of funds, deposit flows and
mortgage prepayments are greatly influenced by general interest rates, economic
conditions and local competition.
The primary investing activities of the Bank have been the origination of
loans and the purchase of investment securities. During the years ended
September 30, 1997 and 1996, the Bank had loan originations of $143.7 million
and $130.2 million, respectively. During the years ended September 30, 1997 and
1996, the Bank purchased investment securities of $2.0 million and $6.0 million,
respectively. The primary financing activities of the Bank are the attraction of
savings deposits and obtaining FHLB advances.
The Bank's most liquid assets are cash and cash equivalents. The levels of
these assets are dependent on the Bank's operating, financing, lending and
investing activities during any given period. At September 30, 1997 and 1996,
cash and cash equivalents totaled $15.8 million and $8.6 million, respectively.
The Bank has other sources of liquidity if a need for additional funds arises.
During the years ended September 30, 1997 and 1996, the Bank sold loans totaling
$31.7 million and $53.0 million, respectively. At September 30, 1997, the Bank
had $11.0 million
3
<PAGE>
of FHLB advances, compared to no advances at September 30, 1996. At September
30, 1997, the Bank had $1.6 million of retail repurchase agreements, compared to
$1.0 million at September 30, 1996. Other sources of liquidity include
investment and mortgage-backed securities designated as available for sale,
which totaled $27.9 million at September 30, 1997 and $22.9 million at September
30, 1996.
At September 30, 1997 stockholders' equity was $57.8 million compared to
$18.3 million at September 30, 1996, reflecting current earnings and net
proceeds received from the stock conversion. On April 7, 1997 the Company issued
2,909,500 shares of common stock and received net proceeds of $42.5 million,
including $3.5 million in shares purchased by the Employee Stock Ownership Plan
("ESOP"). Net income for the year ended September 30, 1997 was $2.3 million,
compared to $820,000 for the year ended September 30, 1996.
As a North Carolina chartered commercial bank and a Federal Deposit
Insurance Corporation (the "FDIC") insured institution, the Bank is required to
meet various capital standards by its state and federal banking regulatory
agencies. The Bank's stand-alone equity was $39.9 million at September 30, 1997,
which is substantially in excess of all such regulatory requirements. The
Commissioner requires the Bank at all times to maintain a capital surplus of not
less than 50% of common capital stock. The FDIC requires the Bank to meet a
minimum leverage capital requirement of Tier I capital (consisting of retained
earnings and common stockholders' equity, less any intangible assets) to assets
ratio of at least 4% and a total capital to risk-weighted assets ratio of 8%, of
which 4% must be in the form of Tier I capital. The Bank was in compliance with
all of the capital requirements of both the Commissioner and the FDIC at
September 30, 1997.
Asset/Liability Management
The Bank strives to achieve consistent net interest income and reduce its
exposure to adverse changes in interest rates by matching the terms to repricing
of its interest-sensitive assets and liabilities. Factors beyond the Bank's
control, such as market interest rates and competition, may also have an impact
on the Bank's interest income and interest expense.
In the absence of any other factors, the overall yield on the Bank's
earning assets generally will increase from existing levels when interest rates
rise over an extended period of time, and conversely interest income will
decrease when interest rates decrease. In general, interest expense will
increase when interest rates rise over an extended period of time, and
conversely interest expense will decrease when interest rates decrease.
Therefore, by controlling the increases and decreases in its interest income and
interest expense which are caused by changes in market interest rates, the Bank
can significantly influence its net interest income.
The President of the Bank reports to the Board of Directors on a regular
basis on interest rate risk and trends, as well as liquidity and capital ratios
and requirements. The Board of Directors reviews the maturities of the Bank's
assets and liabilities and establishes policies and strategies designed to
regulate the Bank's flow of funds and to coordinate the sources, uses and
pricing of such funds. The first priority in structuring and pricing the Bank's
assets and liabilities is to maintain an acceptable interest rate spread while
reducing the net effects of changes in interest rates. The Bank's management is
responsible for administering the policies and determinations of the Board of
Directors with respect to the Bank's asset and liability goals and strategies.
Management's principal strategy in managing the Bank's interest rate risk
has been to increase interest rate sensitive assets such as commercial business
loans and consumer loans. At September 30, 1997, the Bank had $16.4 million of
commercial business loans and $49.9 million of consumer loans, which amounted to
7.7% and 23.3%, respectively, of the Bank's gross loan portfolio, compared to
6.0% and 21.5%, respectively, at September 30, 1996. In managing its portfolio
of investment and mortgage-backed securities, the Bank has emphasized the
purchase of short-term securities, to reduce it's exposure to increases in
interest rates. At September 30, 1997, the Bank had $25.1 million of loans held
for sale, compared to $21.6 million at September 30, 1996. The Bank had $27.9
million of investment and mortgage-backed securities classified as available for
sale at September 30, 1997, compared to $22.9 million at September 30, 1996. The
Bank is holding these loans, investment and mortgage-backed securities as
available for sale so that they may be sold if needed for liquidity or asset and
liability management purposes.
The Bank has shortened the average repricing period of its assets by
emphasizing the origination of short-term fixed-rate or adjustable-rate
residential mortgage loans. At September 30, 1997, the Bank held approximately
$50.4 million of adjustable-rate residential mortgage loans, which represented
approximately 23.5% of the Bank's
4
<PAGE>
gross loan portfolio, compared to $45.6 million at September 30, 1996. Depending
on conditions existing at a given time, as part of its interest rate risk
management strategy, the Bank may sell newly originated fixed-rate residential
mortgage loans in the secondary market.
Interest Rate Sensitivity Analysis
Management measures the Bank's interest rate risk by computing estimated
changes in net interest income and the net portfolio value ("NPV") of its cash
flows from assets, liabilities and off-balance sheet items in the event of a
range of assumed changes in market interest rates. The Bank's exposure to
interest rates is reviewed on a quarterly basis by senior management and the
Board of Directors. Exposure to interest rate risk is measured with the use of
interest rate sensitivity analysis to determine the change in NPV in the event
of hypothetical changes in interest rates, while interest rate sensitivity gap
analysis is used to determine the repricing characteristics of the Bank's assets
and liabilities. If estimated changes to NPV and net interest income are not
within the limits established by the Board, the Board may direct management to
adjust the Bank's asset and liability mix to bring interest rate risk within
Board approved limits.
NPV represents the market value of portfolio equity and is equal to the
market value of assets minus the market value of liabilities, with adjustments
made for off-balance sheet items. This analysis assesses the risk of loss in
market risk sensitive instruments in the event of a sudden and sustained 1% to
4% increases and decreases in market interest rates. The Bank's Board of
Directors has adopted an interest rate risk policy which establishes maximum
increases in NPV of 17%, 36%, 56% and 83% and decreases in NPV of 15%, 36%, 61%
and 90% in the event of sudden and sustained 1% to 4% increases or decreases in
market interest rates. Table 1 below presents the Bank's projected change in NPV
for the various rate shock levels at September 30, 1997.
Table 1 - Projected Change in NPV
Net Portfolio Value
Change ------------------------------------------
in Rates $ Amount $ Change % Change
- -------- -------- -------- --------
(Dollars in thousands)
+ 400 bp $ 52,361 $(13,527) (20.5)%
+ 300 bp 56,048 (9,840) (14.9)
+ 200 bp 59,735 (6,153) (9.3)
+ 100 bp 62,812 (3,076) (4.7)
Base 65,888 -- --
- - 100 bp 67,682 1,794 2.7
- - 200 bp 69,475 3,587 5.4
- - 300 bp 71,058 5,170 7.8
- - 400 bp 72,640 6,752 10.2
Table 1 indicates that at September 30, 1997, in the event of sudden and
sustained increases in prevailing market interest rates, the Bank's estimated
NPV would be expected to decrease, and that in the event of sudden and sustained
decreases in prevailing market interest rates, the Bank's estimated NPV would be
expected to increase. At September 30, 1997, the Bank's estimated changes in NPV
were within the targets established by the Board of Directors.
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay rates, and should not be relied upon
as indicative of actual results. Further, the computations do not contemplate
any actions the Bank may undertake in response to changes in interest rates. The
NPV calculation is based on the net present value of discounted cash flows
utilizing market prepayment assumptions and market rates of interest provided by
surveys performed during each quarterly period, with adjustments made to reflect
the shift in the Treasury yield curve between the survey date and the quarter
end date.
Certain shortcomings are inherent in the method of analysis presented in
the computation of estimated NPV. Actual values may differ from those
projections set forth in Table 1 should market conditions vary from assumptions
used in preparing the table. Certain assets such as adjustable-rate loans have
features which restrict changes in interest rates on a short-term basis and over
the life of the asset. In addition, the proportion of adjustable-rate loans
5
<PAGE>
in the Bank's portfolio could decrease in future periods if market interest
rates remain at or decrease below current levels due to refinance activity.
Further, in the event of a change in interest rates, prepayment and early
withdrawal levels would likely deviate from those assumed in the table. Finally,
the ability of many borrowers to repay their adjustable-rate debt may decrease
in the event of an increase in interest rates.
In addition, the Bank uses interest rate sensitivity gap analysis to
monitor the relationship between the maturity and repricing of its
interest-earning assets and interest-bearing liabilities, while maintaining an
acceptable interest rate spread. Interest rate sensitivity gap is defined as the
difference between the amount of interest-earning assets maturing or repricing
within a specific time period and the amount of interest-bearing liabilities
maturing or repricing within that time period. A gap is considered positive when
the amount of interest-rate-sensitive assets exceeds the amount of
interest-sensitive-liabilities, and is considered negative when the amount of
interest-rate- sensitive liabilities exceeds the amount of
interest-rate-sensitive assets. Generally, during a period of rising interest
rates, a negative gap would adversely affect net interest income, while a
positive gap would result in an increase in net interest income. Conversely,
during a period of falling interest rates, a negative gap would result in an
increase in net interest income, while a positive gap would negatively affect
net interest income. The Bank's goal is to maintain a reasonable balance between
exposure to interest rate fluctuations and earnings.
Rate/Volume Analysis
Net interest income can also be analyzed in terms of the impact of changing
interest rates on average interest-earning assets and average interest-bearing
liabilities and the changing volume or amount of these assets and liabilities.
Table 2 below represents the extent to which changes in interest rates and
changes in the volume of average interest-earning assets and average
interest-bearing liabilities have affected the Bank's interest income and
interest expense during the periods indicated. For each category of average
interest-earning asset and average interest-bearing liability, information is
provided on changes attributable to: (i) changes in volume (changes in volume
multiplied by old rate); (ii) changes in rate (change in rate multiplied by old
volume); (iii) changes in rate-volume (changes in rate multiplied by the changes
in volume); and (iv) net change (total of the previous columns).
Table 2 - Rate/Volume Analysis
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------------------
1997 vs. 1996 1996 vs. 1995
------------------------------ -----------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
------------------------------ -----------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ---- ------ ----- ------ ---- ------ -----
(In thousands)
Interest income:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable ............... $2,509 $ 133 $ 24 $2,666 $ 660 $ 246 $ 13 $ 919
Investment securities .......... 3 12 -- 15 215 (19) (28) 168
Mortgage-backed securities ..... 292 (15) (3) 274 (184) 21 (3) (166)
Other interest-earning assets .. 668 (161) (297) 210 57 (12) (2) 43
------ ----- ----- ------ ----- ----- ---- ------
Total interest-earning assets 3,472 (31) (276) 3,165 748 236 (20) 964
------ ----- ----- ------ ----- ----- ---- ------
Interest expense:
Deposits ....................... 1,261 (958) (154) 149 791 481 57 1,329
FHLB advances .................. 74 (11) (6) 57 (591) 32 (26) (585)
Other interest-bearing
liabilities .................. 20 8 7 17 48 (2) (29) 17
------ ----- ----- ------ ----- ----- ---- ------
Total interest-bearing
liabilities ............... 1,355 (961) (153) 241 248 511 2 761
------ ----- ----- ------ ----- ----- ---- ------
Change in net interest income .... $2,117 $ 930 $(123) $2,924 $ 500 $(275) $(22) $ 203
====== ===== ===== ====== ===== ===== ==== ======
</TABLE>
6
<PAGE>
TABLE 3 - YIELD/COST ANALYSIS
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------------------------------------------
1997 1996 1995
-------------------------- ------------------------- -------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable $176,311 $16,097 9.13% $148,538 $13,431 9.04% $141,088 $12,511 8.87%
Investment securities 5,287 326 6.17 5,236 311 5.94 2,090 143 6.84
Mortgage-backed securities 20,832 1,521 7.30 16,881 1,247 7.39 19,404 1,413 7.28
Other interest-earning assets 15,249 571 3.75 5,349 361 6.75 4,539 318 7.01
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest-earning assets 217,679 18,515 8.51 176,004 15,350 8.72 167,121 14,385 8.61
------- ------- -------
Non-interest-earning assets 9,311 7,579 6,587
-------- -------- --------
Total assets $226,990 $183,583 $173,708
======== ======== ========
Interest-bearing liabilities:
Deposits $184,672 8,088 4.38 $159,304 7,939 4.98 $142,283 6,610 4.65
FHLB advances 3,400 202 5.94 2,250 145 6.44 11,833 730 6.17
Other interest-bearing liabilities 1,218 56 4.60 629 21 3.34 48 4 8.33
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest-bearing liabilities 189,290 8,346 4.41 162,183 8,105 5.00 154,164 7,344 4.76
------- ------- -------
Non-interest-bearing liabilities 3,265 2,958 2,848
-------- -------- --------
Total liabilities 192,555 165,141 157,012
Stockholders' equity 34,435 18,442 16,696
-------- -------- --------
Total liabilities and retained income $226,990 $183,583 $173,708
======== ======== ========
Net interest income $10,169 $ 7,245 $ 7,041
======= ======= =======
Interest rate spread (1) 4.10% 3.72% 3.85%
==== ==== ====
Net yield on interest-earning assets (2) 4.67% 4.12% 4.21%
==== ==== ====
Ratio of average interest-earning assets
to average interest bearing liabilities 115.00% 108.52% 108.40%
====== ====== ======
</TABLE>
- -----------------------------------------
(1) Represents the difference between the average yield on interest-earning
assets and the average cost of interest bearing liabilities.
(2) Represents the net interest income divided by average interest-earning
assets.
7
<PAGE>
Analysis of Net Interest Income
Net interest income represents the difference between income derived from
interest-earning assets and the interest expense on interest-bearing
liabilities. Net interest income is affected by both the difference between
rates of interest earned on interest-earning assets and rates paid on
interest-bearing liabilities ("interest rate spread") and the relative volume of
interest-earning assets and interest-bearing liabilities.
Table 3 above sets forth certain information relating to the Bank's
statements of financial condition and statements of income for the three years
ended September 30, 1997, 1996, and 1995 and reflects the yield on average
interest-earning assets and the cost of average interest-bearing liabilities for
the periods indicated. Average balances are derived from month end balances and
the Bank does not believe that the use of month end balances instead of average
daily balances has caused any material difference in the information presented.
Results of Operations
Comparison of Financial Condition at September 30, 1997 and 1996
Total assets increased 28.4% to $249.3 million at September 30, 1997 from
$194.1 million at September 30, 1996. Assets invested in mortgage, consumer and
commercial loans (net of loans-in-process, deferred fees and loan loss reserves)
increased by 27.0%, to $197.8 million at September 30, 1997 from $155.7 million
at September 30, 1996. Investment securities and mortgage-backed securities
increased by 21.8% between the periods, to $27.9 million at September 30, 1997
from $22.9 million at September 30, 1996. The increase in assets was supported
by the net proceeds received from the stock conversion. On April 7, 1997 the
Company issued 2,909,500 shares of common stock and received $42.5 million,
which represents the actual net proceeds from the stock offering, including $3.5
million in shares purchased by the ESOP.
In order to take advantage of generally higher loan yields as well as
shorter terms, the Bank has increased its emphasis on the origination of both
secured and unsecured commercial and consumer loans. Prior to 1994, a majority
of the loans originated by the Bank were mortgage loans secured by single-family
residences. From time to time, the Bank sells selected mortgage loans in the
secondary market in order to reduce interest rate and credit risk, while
retaining servicing to generate additional fee income.
Total residential real estate mortgage loans increased 7.8% to $102.2
million at September 30, 1997 from $94.8 million at September 30, 1996. Consumer
loans increased 33.4% to $49.9 million at September 30, 1997 from $37.4 million
at September 30, 1996. Commercial real estate loans increased 47.4% to $46.0
million at September 30, 1997 from $31.2 million at September 30, 1996, and
commercial business loans increased 59.2% to $16.4 million at September 30, 1997
from $10.3 million at September 30, 1996. During fiscal 1997, the Bank
originated $66.9 million of residential real estate mortgage loans, compared to
$76.3 million during fiscal 1996. The Bank sold $31.7 million of real estate
loans during fiscal 1997, compared to $53.0 million during fiscal 1996. Loans
serviced for others was $253.6 million at September 30, 1997, compared to $253.7
million at September 30, 1996. Commercial real estate, commercial business and
consumer loan originations increased 42.8% to $76.8 million during fiscal 1997
from $53.8 million during fiscal 1996, as the Bank continues to place an
emphasis on structuring itself as a commercial banking entity.
Deposits for the current fiscal year increased by 2.3%, to $175.1 million
at September 30, 1997 from $171.2 million at September 30, 1996. During the year
ended September 30, 1997, approximately $11.8 million of deposits were withdrawn
by depositors to purchase shares of the Company's common stock subscribed for in
the stock conversion. While total deposits experienced a marginal increase
during the year ended September 30, 1997, checking accounts increased by $10.2
million, or 37.4%, to $37.5 million at September 30, 1997 from $27.3 million at
September 30, 1996, reflecting the Bank's efforts to increase lower cost core
checking accounts. Total borrowings increased to $12.6 million at September 30,
1997 from $1.0 million at September 30, 1996, to support the growth in earning
assets and banking operations during the period.
Stockholders' equity increased by $39.5 million, or 215.8%, to $57.8
million at September 30, 1997 from $18.3 million at September 30, 1996,
reflecting the infusion of the net proceeds of the stock conversion and the
consolidated earnings of the Company for the year ended September 30, 1997. At
September 30, 1997, the ratio of equity to total assets increased to 23.2% from
9.5% at September 30, 1996, and the ratio of average equity to
8
<PAGE>
average assets increased to 15.2% for the year ended September 30,1997 from
10.1% for the year ended September 30, 1996. During the year ended September 30,
1997, the Company declared two quarterly cash dividends at $0.10 each, totaling
$582,000. Future quarterly dividends will be determined at the discretion of the
Board of Directors based upon earnings, the capital and financial condition of
the Company and general economic conditions.
The Company's note receivable from the ESOP was $3.1 million at September
30, 1997 and is reported as a reduction of stockholders's equity. The note
requires an annual $349,000 principal payment plus interest at prime plus one
percent. Although repayment of the note is secured solely by 232,760 shares of
common stock of the Company purchased by the ESOP (8% of the shares issued in
the stock conversion), the Bank expects to make discretionary contributions to
the ESOP in amounts at least equal to the principal and interest payments on the
ESOP note.
During the year ended September 30, 1997, the Management Recognition Plan
Trust ("MRP") established for the benefit of directors and officers of the
Company and the Bank, purchased 77,700 shares of the Company's common stock in
the open market at a $26.39 average cost per share totaling $2.1 million. These
shares are being held in trust for future awards and are reported as a reduction
in stockholders' equity. The MRP is expected to purchase up to 116,380 shares of
the Company's common stock (4% of the shares issued in the stock conversion) in
the open market.
Comparison of Operating Results for the Years Ended September 30, 1997 and 1996
Net Income. Net income increased by $1.4 million to $2.3 million for the
year ended September 30, 1997 from $820,000 for the year ended September 30,
1996. The principal reasons for this increase are the results of investing the
net proceeds of the stock conversion into earning assets, as average
interest-earning assets increased by $41.7 million, or 23.7% during fiscal 1997,
which is discussed below.
Interest Income. Interest income increased by $3.2 million, or 20.9%, to
$18.5 million for fiscal 1997 from $15.3 million for fiscal 1996. The increase
in interest income on loans and investments during 1997 is a result of the
increase in the volume of average interest-earning assets . Interest on loans
increased by $2.7 million, or 20.1%, to $16.1 million in fiscal 1997 from $13.4
million in fiscal 1996. This increase was due primarily to a $27.8 million
increase in the average balance of loans outstanding between fiscal 1997 and
1996, and an increase in the average yield on loans to 9.13% for fiscal 1997
from 9.04% for fiscal 1996. The average yield on total average interest-earning
assets of $217.7 million was 8.5% for 1997 compared to an 8.7% average yield on
$176.0 million of total average interest- earning assets for 1996.
Interest Expense. Interest expense for the year ended September 30, 1997
increased by $241,000, or 3.0%, to $8.3 million, from $8.1 million for fiscal
1996. This resulted principally from an increase in the volume of average
interest-bearing liabilities. Average deposits increased by $25.4 million, or
15.9%, to $184.7 million for fiscal 1997 from $159.3 million for fiscal 1996.
The average cost of interest-bearing liabilities decreased to 4.4% for 1997 from
5.0% for 1996. Total average interest-bearing liabilities increased to $189.3
million for fiscal 1997 from $162.2 million for fiscal 1996. As previously
discussed, approximately $11.8 million of deposits were withdrawn by depositors
to purchase shares of the Company's common stock.
Net Interest Income. Net interest income increased by $3.0 million, or
41.7%, to $10.2 million for the year ended September 30, 1997, from $7.2 million
for the year ended September 30, 1996.
Provision for Loan Losses. The Bank maintains an allowance for losses on
loans based upon management's evaluation of risks in the loan portfolio, the
Bank's past loan loss experience, and current and expected future economic
conditions. The Bank provided $931,000 and $511,000 for loan losses during the
years ended September 30, 1997 and 1996, respectively. The increased provisions
were necessary to support the growth and risks associated with the emphasis
placed upon commercial and consumer lending. The allowance for loan losses was
$3.2 million at September 30, 1997 compared to $2.4 million at September 30,
1996, which the Bank believes is adequate to absorb potential losses in its loan
portfolio. The ratio of the allowance for loan losses to total loans, net of
loans in process and deferred loan fees, was 1.6% at September 30, 1997 compared
to 1.5% at September 30, 1996.
The Bank uses a systematic approach in determining the adequacy of its loan
loss allowance and the necessary provision for loan losses, through a
classification of assets program, whereby the loan portfolio is reviewed
9
<PAGE>
generally and delinquent loan accounts are analyzed individually, on a quarterly
basis. Consideration is given to the account status, payment history, ability to
repay and probability of repayment, and loan-to-value percentages. As a result
of this review and analysis, loans are classified in the appropriate categories
applicable to their circumstances. After reviewing current economic conditions,
changes in delinquency status, and actual loan losses incurred by the Bank,
management establishes an appropriate reserve percentage applicable to each
category of assets, and provision for loan losses is recorded when necessary to
bring the allowance to a level consistent with this analysis. The ratio of
nonperforming loans to total loans was 0.5% at September 30, 1997 and 0.7% at
September 30, 1996.
Noninterest Income. Noninterest income totaled $1.7 million for the year
ended September 30, 1997 and $1.8 million for the year ended September 30, 1996.
Noninterest income consists of fees and service charges earned on loans, service
charges on deposit accounts, gains from sales of loans, and other miscellaneous
income. Loan fees and service charges increased to $752,000 for fiscal 1997 from
$552,000 for fiscal 1996, reflecting the growth in the loan portfolio during
1997. Gains from sales of loans decreased to $124,000 for fiscal 1997 from
$423,000 for fiscal 1996, as the volume of loans sold during 1997 decreased to
$31.7 million for 1997 from $53.0 million for 1996. Servicing fee income on
loans serviced for others was $613,000 for 1997 compared to $632,000 for 1996.
Noninterest Expense. Noninterest expenses decreased 5.5% in fiscal 1997 to
$6.9 million, from $7.3 million in fiscal 1996. The ratio of these expenses to
gross income decreased to 34.4% for fiscal 1997 from 42.4% for fiscal 1996. The
largest single component of these expenses, compensation and fringe benefits,
increased to $4.6 million for fiscal 1997 from $3.6 million for fiscal 1996.
This increase is a result of approximately $614,000 in benefits expense incurred
with the establishment of the ESOP and growth in personnel and management
required to support the 28.4% growth in assets from September 30, 1996 to
September 30, 1997.
Federal deposit insurance premiums decreased to $88,000 for the year ended
September 30, 1997 from $1.3 million for the year ended September 30, 1996.
During 1996, the Bank incurred a one-time FDIC assessment of $946,000 to
capitalize the SAIF insurance fund. Pursuant to the Deposit Insurance Funds Act
of 1996, the Bank's deposit insurance premium rate has declined to 6.4 cents per
$100 of deposits for 1997 from 23 cents per $100 of deposits for 1996. This
revised deposit insurance rate structure has enabled the Bank to recognize a
substantial reduction in deposit insurance premiums.
Premises and equipment expense decreased to $377,000 for fiscal 1997 from
$798,000 for fiscal 1996. During the year ended September 30, 1996 the Bank
recognized accelerated depreciation of $225,000 on certain fixed assets with no
future value due to obsolescence or excessive use.
Income Taxes. The provision for income taxes increased to $1.7 million for
fiscal 1997 from $451,000 for fiscal 1996. The increase in provision for income
taxes is the result of the increased pretax earnings to $4.0 million for fiscal
1997 from $1.3 million for fiscal 1996 and the effective income tax rates then
in effect.
Comparison of Financial Condition at September 30, 1996 and 1995
Total assets increased 9.2% to $194.1 million at September 30, 1996 from
$177.7 million at September 30, 1995. Assets invested in mortgage, consumer and
commercial loans (net of loans-in-process, deferred fees and loan loss reserves)
increased by 7.7%, to $155.7 million at September 30, 1996 from $144.5 million
at September 30, 1995. Investment securities and mortgage-backed securities
decreased by 9.5% between the periods, to $22.9 million at September 30, 1996
from $25.3 million at September 30, 1995.
Total residential real estate mortgage loans decreased 7.1% to $94.8
million at September 30, 1996 from $102.1 million at September 30, 1995.
Consumer loans increased 26.1% to $37.4 million at September 30, 1996 from $29.7
million at September 30, 1995. Commercial real estate loans increased 42.4% to
$31.2 million at September 30, 1996 from $21.9 million at September 30, 1995,
and commercial business loans increased 179.3% to $10.3 million at September 30,
1996 from $3.7 million at September 30, 1995. During fiscal 1996, the Bank
originated $76.3 million of residential real estate mortgage loans, compared to
$59.2 million of such originations during fiscal 1995. The Bank sold $53.0
million of real estate loans during fiscal 1996, compared to $43.6 million
during fiscal 1995. Loans serviced for others increased to $253.7 million at
September 30, 1996 from $229.6 million at September 30, 1995. Commercial real
estate, commercial business and consumer loan originations increased 57.5% to
$53.8 million during fiscal 1996 from $34.2 million during fiscal 1995.
10
<PAGE>
Deposits for the period increased by 11.6%, to $171.2 million at September
30, 1996 from $153.5 million at September 30, 1995. The number of deposit
accounts grew to 15,404 at September 30, 1996 from 13,794 at September 30, 1995.
Total capital for the period increased by 3.7%, to $18.3 million at September
30, 1996 from $17.7 million at September 30, 1995. At September 30, 1996, the
ratio of capital to total assets was 9.5%, compared to 10.0% at September 30,
1995.
Comparison of Operating Results for the Years Ended September 30, 1996 and 1995
Net Income. Net income decreased by $1.0 million to $820,000 for the year
ended September 30, 1996 from $1.9 million for the year ended September 30,
1995. The principal reasons for this decrease are the results of a special
assessment on deposit insurance premiums, increased provisions for possible loan
losses and accelerated depreciation on certain fixed assets, all of which are
discussed below.
Interest Income. Interest income increased $964,000, or 6.7%, to $15.3
million for fiscal 1996 from $14.4 million for fiscal 1995. This increase
resulted from an increase in interest income on loans and investments and higher
yields due to a rising interest rate environment. Interest on loans increased by
$920,000, or 7.2%, to $13.4 million in fiscal 1996 from $12.5 million in fiscal
1995. This increase was due to a 17 basis point increase in the average yield on
loans to 9.04% for fiscal 1996 from 8.87% for fiscal 1995. In addition, there
was an increase of $7.5 million in the average balance of loans outstanding
between the two periods. The average yield on total average interest-earning
assets of $176.0 million was 8.7% for 1996 compared to an 8.6% average yield on
$167.1 million of total average interest earning assets for 1995.
Interest Expense. Interest expense for the year ended September 30, 1996
increased by $761,000, or 10.4%, to $8.1 million, from $7.3 million for fiscal
1995. The increase resulted from a rise in general market interest rates and was
also influenced by an increase in the volume of deposits. Average deposits
increased $17.0 million, or 11.9%, to $159.3 million for fiscal 1996 from $142.3
million for fiscal 1995. The average cost of interest-bearing liabilities
increased to 5.0% for 1996 from 4.8% for 1995, and average interest-bearing
liabilities increased to $162.2 million for fiscal 1996 from $154.2 million for
fiscal 1995.
Net Interest Income. Net interest income increased by $203,000, or 2.9%, to
$7.2 million for the year ended September 30, 1996, from $7.0 million for the
year ended September 30, 1995.
Provision for Loan Losses. The Bank maintains an allowance for losses on
loans based upon management's evaluation of risks in the loan portfolio, the
Bank's past loan loss experience, and current and expected future economic
conditions. The Bank provided $511,000 and $20,000 for loan losses during the
years ended September 30, 1996 and 1995, respectively. The allowance for loan
losses was $2.4 million at September 30, 1996 compared to $1.9 million at
September 30, 1995. The ratio of the allowance for loan losses to total loans,
net of loans in process and deferred loan fees, was 1.5% at September 30, 1996
compared to 1.3% at September 30, 1995. The increased provisions were necessary
to support the growth and risks associated with the emphasis placed upon
commercial and consumer lending. The ratio of nonperforming loans to total loans
was 0.7% at September 30, 1996 and 0.5% at September 30, 1995.
Noninterest Income. Noninterest income totaled $1.8 million for the year
ended September 30, 1996 and $1.5 million for the year ended September 30, 1995.
Noninterest income consists of fees and service charges earned on loans, service
charges on deposit accounts, gains for sale of loans, and other miscellaneous
income. Gains from sales of loans increased to $423,000 for fiscal 1996 from
$312,000 for fiscal 1995, as the volume of loans sold increased to $53.0 million
for 1996 from $43.6 million for 1995. Servicing fee income on loans serviced for
others increased to $632,000 for fiscal 1996 from $582,000 for fiscal 1995.
Noninterest Expense. Noninterest expenses increased 28.9% in fiscal 1996 to
$7.3 million, from $5.7 million in fiscal 1995. The ratio of these expenses to
gross income was 42.4% in fiscal 1996 compared to 35.6% in fiscal 1995. The
largest single component of these expenses, compensation and fringe benefits,
increased 4.0% in fiscal 1996 to $3.6 million from $3.4 million for fiscal 1995.
These increases are a result of the growth in personnel and management required
to support the 16.9% growth in assets from September 30, 1994 to September 30,
1996.
11
<PAGE>
Federal deposit insurance premiums increased by $995,000 to $1.3 million
for the year ended September 30, 1996 from $305,000 for the year ended September
30, 1995. During the year ended September 30, 1996, the Bank incurred a one-time
FDIC assessment of $946,000 to capitalize the SAIF insurance fund up to required
reserve ratios. The assessment was based upon 65.7 cents per $100 of SAIF
deposits as of March 31, 1995. During fiscal 1996, the Bank has also paid
continuing SAIF insurance premiums at a rate of 23 cents per $100 of SAIF
deposits. However, that rate will drop to 6.4 cents per $100 effective January
1, 1997 through December 31, 1999 and to 2.4 cents per $100 thereafter. This
revised deposit insurance rate structure will enable the Bank to recognize a
substantial reduction in deposit insurance premiums going forward.
Premises and equipment expense increased by $255,000 to $798,000 for the
year ended September 30, 1996 from $543,000 for September 30, 1995. During the
year ended September 30, 1996 the Bank recognized accelerated depreciation of
$225,000 on certain fixed assets with no future value due to obsolescence or
excessive use.
Income Taxes. The provision for income taxes decreased to $451,000 for
fiscal 1996 from $998,000 for fiscal 1995. The Bank's effective income tax rate
was 35.4% for the year ended September 30, 1996 and 34.9% for the year ended
September 30, 1995.
Impact of Inflation and Changing Prices
The financial statements of the Bank and accompanying footnotes have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time and due to inflation. The impact of inflation is
reflected in the increased cost of the Bank's operations. Unlike most industrial
companies, nearly all the assets and liabilities of the Bank are monetary. As a
result, interest rates have a greater impact on the Bank's performance than do
the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the price of goods and
services.
Impact of Recent Accounting Standards
The Company prepares its consolidated financial statements and related
disclosures in conformity with standards established by, among others, the
Financial Accounting Standards Board ("FASB"). The FASB frequently issues new
rules and proposed new rules for companies to apply to their reporting
activities. The following discussion addresses such changes as of September 30,
1997 that will affect the Company's future reporting.
The Accounting Standards Division of the AICPA approved SOP 93-6,
"Employers' Accounting for Employee Stock Ownership Plans," which applies to
shares of capital stock of sponsoring employers acquired by ESOP plans. SOP 93-6
changed the measure of compensation recorded by employers from the cost of ESOP
shares to the fair value of employee stock ownership plan shares. To the extent
that the fair value of the ESOP shares, committed to be released directly to
compensate employees, differs from the cost of such shares, compensation
expenses and a related charge or credit to additional paid-in capital will be
reported in the Company's financial statements.
The FASB has issued Statement of Financial Accounting Standards No. 125
('SFAS No. 125"), "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities". SFAS No. 125 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
December 31, 1996 and is applied prospectively. This statement requires, among
other things, the Company to record at fair value, assets and liabilities
resulting from a transfer of financial assets. In December 1996, SFAS No. 127
was issued which deferred the effective date of certain provisions of SFAS No.
125 related to repurchase agreements, securities lending and similar
transactions until January 1, 1998. The Company adopted the provisions of SFAS
No. 125 as of January 1, 1997 and the adoption did not have a material effect on
the Company's reported financial condition or results of operations.
The FASB has issued SFAS No. 128, "Earnings Per Share", which is effective
for financial statements issued for periods ending after December 15, 1997. SFAS
No. 128 establishes standards for computing and presenting earnings per share
("EPS") and replaces the presentation of primary EPS with a presentation of
basic EPS. It requires dual presentation of basic and diluted EPS on the face of
the consolidated statement of income and the reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator
12
<PAGE>
of the diluted EPS computation. Earlier application is not permitted but
disclosure of pro forma EPS amounts computed using the standards established by
SFAS No. 128 is permitted in the notes to financial statements for periods
ending prior to the effective date. See Note l to the Notes to Consolidated
Financial Statements for additional information.
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income",
effective for the fiscal year ending September 30, 1999. SFAS No. 130
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general-purpose financial statements. Management has
not yet determined the effect, if any, of adopting SFAS No. 130.
The FASB has issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information", effective for the fiscal year ending
September 30, 1999. SFAS No. 131 specifies revised guidelines for determining an
entity's operating segments and the type and level of financial information to
be disclosed. Management does not expect that the adoption of SFAS No. 131 will
have a material impact on the Company's consolidated financial statements.
13
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
NewSouth Bancorp, Inc.
Washington, North Carolina
We have audited the accompanying consolidated statements of financial condition
of NewSouth Bancorp, Inc. and Subsidiary as of September 30, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended September 30, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in all
material respects, the consolidated financial position of NewSouth Bancorp, Inc.
and Subsidiary at September 30, 1997 and 1996, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended September 30, 1997, in conformity with generally accepted accounting
principles.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
Raleigh, North Carolina
October 17, 1997
14
<PAGE>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
NewSouth Bancorp, Inc. and Subsidiary
September 30, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
---- ----
<S> <C> <C>
Cash and due from banks $ 3,027,271 $ 2,811,326
Interest-bearing deposits in financial institutions 12,744,980 5,765,251
Investment securities - available for sale 3,083,422 8,106,581
Mortgage-backed securities - available for sale 24,818,412 14,797,424
Loans receivable, net:
Held for sale 25,055,845 21,627,590
Held for investment 172,729,060 134,053,705
Premises and equipment, net 2,818,167 2,900,421
Income taxes receivable - 385,373
Deferred income taxes 821,863 223,983
Real estate owned 357,503 178,509
Federal Home Loan Bank of Atlanta stock, at cost
which approximates market 1,287,500 1,287,500
Accrued interest receivable 1,847,346 1,382,569
Prepaid expenses and other assets 689,828 618,921
------------ ------------
Total assets $249,281,197 $194,139,153
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand $ 37,500,216 $ 27,334,469
Savings 6,455,357 7,019,797
Time 131,160,215 136,859,020
------------ ------------
Total deposits 175,115,788 171,213,286
Borrowed money 12,621,120 1,039,608
Accrued interest payable 91,915 67,939
Income taxes payable 457,498 -
Advance payments by borrowers for property taxes and insurance 182,731 383,517
Other liabilities 2,956,558 3,088,232
------------ ------------
Total liabilities 191,425,610 175,792,582
Commitments and contingencies (Notes 4, 9, 10, 13 and 16)
Common stock, $.01 par value, 8,000,000 shares authorized,
2,909,500 shares issued and outstanding 29,095 -
Additional paid-in capital 42,654,054 -
Retained earnings, substantially restricted 20,041,635 18,306,036
Unearned ESOP shares, 207,932 shares (3,118,984) -
Unawarded MRP shares, at cost (2,050,531) -
Unrealized gain on available for sale securities, net 300,318 40,535
------------ ------------
Total stockholders' equity 57,855,587 18,346,571
------------ ------------
Total liabilities and stockholders' equity $249,281,197 $194,139,153
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
15
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
NewSouth Bancorp, Inc. and Subsidiary
years ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
Interest income:
<S> <C> <C> <C>
Interest and fees on loans $16,096,914 $13,430,797 $12,511,035
Interest and dividends on investments and deposits 2,418,451 1,918,876 1,874,173
----------- ----------- -----------
Total interest income 18,515,365 15,349,673 14,385,208
----------- ----------- -----------
Interest expense:
Interest on deposits 8,088,144 7,939,014 6,610,023
Interest on borrowings 258,084 166,438 733,993
----------- ----------- -----------
Total interest expense 8,346,228 8,105,452 7,344,016
----------- ----------- -----------
Net interest income before provision for loan losses 10,169,137 7,244,221 7,041,192
Provision for loan losses 931,078 511,000 20,000
----------- ----------- -----------
Net interest income 9,238,059 6,733,221 7,021,192
----------- ----------- -----------
Other income:
Loan fees and service charges 752,470 552,169 402,054
Loan servicing fees 613,353 631,866 581,844
Gain on sale of real estate, net 32,190 33,628 64,513
Gain on sale of mortgage loans and mortgage-backed securities 124,066 423,113 312,325
Other income 162,893 191,768 141,613
----------- ----------- -----------
Total other income 1,684,972 1,832,544 1,502,349
----------- ----------- -----------
General and administrative expenses:
Compensation and fringe benefits 4,603,764 3,569,144 3,431,537
Federal insurance premiums 88,165 353,585 304,802
Insurance fund special assessment - 946,020 -
Premises and equipment 377,468 798,119 542,840
Advertising 181,016 102,762 93,634
Payroll and other taxes 311,290 286,949 259,786
Other 1,379,348 1,238,180 1,027,622
----------- ----------- -----------
Total general and administrative expenses 6,941,051 7,294,759 5,660,221
----------- ----------- -----------
Income before income taxes 3,981,980 1,271,006 2,863,320
Income taxes 1,719,350 450,517 998,080
----------- ----------- -----------
Net income $ 2,262,630 $ 820,489 $ 1,865,240
=========== =========== ===========
Net income per common share (1) $ .53
===========
Weighted average shares outstanding (1) 2,641,289
===========
</TABLE>
(1) Calculated from date of conversion, see Notes 1 and 2.
The accompanying notes are an integral part of the consolidated financial
statements.
16
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDER EQUITY
NewSouth Bancorp, Inc. and Subsidiary
years ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Unrealized
gain on
Retained Available
Additional Earnings Unearned Unawarded For Sale
Common Paid-in Substantially ESOP MRP Securities
Stock Capital Restricted Shares Shares net Total
------- ----------- ----------- ----------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1994 $ - $ - $15,620,307 $ - $ - $ - $15,620,307
Adjustment to October 1, 1994 balance for
change in method of accounting
for securities, net of taxes - - - - - 46,431 46,431
Change in unrealized gains on securities
available-for sale, net of taxes - - - - - 156,091 156,091
Net income as restated - - 1,865,240 - - - 1,865,240
------- ----------- ----------- ----------- ----------- -------- -----------
Balance at September 30, 1995 - - 17,485,547 - - 202,522 17,688,069
Change in unrealized gains on securities
available-for-sale, net of taxes - - - - - (161,987) (161,987)
Net income - - 820,489 - - - 820,489
------- ----------- ----------- ----------- ----------- -------- -----------
Balance at September 30, 1996 - - 18,306,036 - - 40,535 18,346,571
Issuance of shares of common stock 29,095 42,423,041 - (3,491,400) - - 38,960,736
Net income - - 2,262,630 - - - 2,262,630
Change in unrealized gains on securities
available-for-sale, net of taxes - - - - - 259,783 259,783
Acquisition of shares for MRP - - - - (2,050,531) - (2,050,531)
Dividends ($.20 per share) - - (527,031) - - - (527,031)
Release of ESOP shares - 231,013 - 372,416 - - 603,429
------- ----------- ----------- ----------- ----------- -------- -----------
Balance September 30, 1997 $29,095 $42,654,054 $20,041,635 $(3,118,984) $(2,050,531) $300,318 $57,855,587
======= =========== =========== =========== =========== ======== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
17
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
NewSouth Bancorp, Inc. and Subsidiary
years ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
Operating activities:
<S> <C> <C> <C>
Net income $ 2,262,630 $ 820,489 $ 1,865,240
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses 931,078 511,000 20,000
Depreciation 147,927 449,104 228,684
ESOP compensation 603,429 - -
Accretion of discounts on securities 24,263 19,918 123
Provision for deferred income taxes (765,372) (440,704) (241,196)
Gain on disposal of premises and equipment and
real estate acquired in settlement of loans (33,506) (36,293) (64,432)
Gain on sale of mortgage loans and
mortgage-backed securities (139,405) (423,113) (312,325)
Originations of loans held for sale, net (35,004,100) (55,047,196) (47,101,448)
Proceeds from sale of loans held for sale 13,190,353 51,656,899 37,707,880
Other operating activities (248,415) 636,375 560,847
------------ ------------ ------------
Net cash used in operating activities (19,031,118) (1,853,521) (7,336,627)
------------ ------------ ------------
Investing activities:
Proceeds from maturities of securities available for sale 7,000,000 - -
Purchases of investment securities (2,000,000) (6,043,438) (3,001,857)
Proceeds from principal repayments and sales of
mortgage-backed securities available-for-sale 8,914,741 8,832,521 2,877,591
Loan originations, net of principal repayments of
loans held for investment (40,566,654) (9,827,513) (5,580,606)
Proceeds from maturities of securities held-to-maturity - 1,000,000 1,000,000
Proceeds from disposal of premises and equipment and
real estate acquired in settlement of loans 815,117 238,564 282,474
Redemptions (purchases) of FHLB stock - - (38,400)
Purchases of premises and equipment (66,057) (351,588) (594,301)
------------ ------------ ------------
Net cash used in investing activities (25,902,853) (6,151,454) (5,055,099)
------------ ------------ ------------
Financing activities:
Net increase in deposit accounts 3,902,502 17,756,258 21,864,747
Proceeds from FHLB borrowings 49,000,000 24,000,000 42,000,000
Repayments of FHLB borrowings (38,000,000) (28,000,000) (54,500,000)
Net proceeds from issuance of stock 38,960,736 - -
MRP funding (2,050,531) - -
Cash dividends paid (264,574) - -
Net change in repurchase agreements 581,512 1,039,608 -
------------ ------------ ------------
Net cash provided by financing activities 52,129,645 14,795,866 9,364,747
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents 7,195,674 6,790,891 (3,026,979)
Cash and cash equivalents, beginning of year 8,576,577 1,785,686 4,812,665
------------ ------------ ------------
Cash and cash equivalents, end of year $ 15,772,251 $ 8,576,577 $ 1,785,686
============ ============ ============
Supplemental disclosures:
Real estate acquired in settlement of loans $ 960,221 $ 296,690 $ 110,636
Exchange of loans for mortgage-backed securities $ 18,524,209 $ 1,545,859 $ 6,288,164
Transfers to securities available-for-sale $ - $ 16,140,485 $ -
Cash paid for interest $ 8,322,252 $ 8,100,128 $ 7,384,085
Cash paid for income taxes $ 1,673,000 $ 1,327,315 $ 904,222
Dividends declared, not paid $ 262,457 $ - $ -
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NewSouth Bancorp Inc. and Subsidiary
Note 1 - Basis of Presentation and Accounting Policies
Organization and Nature of Operations
NewSouth Bancorp, Inc. (the "Company") is a bank holding company incorporated in
October, 1996 under the laws of the State of Delaware. NewSouth Bank (the
"Bank"), the wholly-owned subsidiary of the Company, is organized and
incorporated under the laws of the state of North Carolina (See Note 2). The
Bank is regulated by the Federal Deposit Insurance Corporation and the Office of
The Commissioner of Banks of the state of North Carolina.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, the Bank. All significant intercompany balances and
transactions have been eliminated in consolidation.
The accounting and reporting policies of the Company and the Bank follow
generally accepted accounting principles and general practices within the
financial services industry.
The significant policies are summarized below:
Investments and Mortgage-Backed Securities
Investments in certain securities are classified into three categories and
accounted for as follows: (1) debt securities that the entity has the positive
intent and the ability to hold to maturity are classified as held-to-maturity
and reported at amortized cost; (2) debt and equity securities that are bought
and held principally for the purpose of selling them in the near term are
classified as trading securities and reported at fair value, with unrealized
gains and losses included in earnings; (3) debt and equity securities not
classified as either held-to-maturity securities or trading securities are
classified as available-for-sale securities and reported at fair value, with
unrealized gains and losses excluded from earnings and reported as a separate
component of equity. As of September 30, 1997, the Bank has classified all
investments as available-for-sale.
Premiums and discounts on debt securities are recognized in interest income on
the level interest yield method over the period to maturity.
Mortgage-backed securities represent participating interests in pools of
long-term first mortgage loans originated and serviced by the issuers of the
securities. Premiums and discounts are amortized using the interest method over
the remaining period to contractual maturity, adjusted for anticipated
prepayments.
Gains and losses on the sale of securities are determined by using the specific
identification method.
Loans Receivable and Allowance for Loan Losses
Loans receivable held for investment are stated at the amount of unpaid
principal, reduced by an allowance for loan losses and net deferred origination
fees. Interest on loans is accrued based on the principal amount outstanding and
is recognized on a level yield method. The accrual of interest is discontinued,
and accrued but unpaid interest is reversed when, in management's judgment, it
is determined that the collectibility of interest, but not necessarily
principal, is doubtful. Generally, this occurs when payment is delinquent in
excess of ninety days.
Loan origination fees are deferred, as well as certain direct loan origination
costs. Such costs and fees are recognized as an adjustment to yield over the
contractual lives of the related loans utilizing the interest method.
Commitment fees to originate or purchase loans are deferred, and if the
commitment is exercised, recognized over the life of the loan as an adjustment
of yield. If the commitment expires unexercised, commitment fees are recognized
in income upon expiration of the commitment. Fees for originating loans for
other financial institutions are recognized as loan fee income.
A loan is considered impaired, based on current information and events, if it is
probable that the Bank will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Uncollateralized loans are measured for impairment based on the
present value of expected future cash flows discounted at the historical
effective interest rate, while all collateral-dependent loans are measured for
impairment based on the fair value of the collateral. At September 30, 1997 and
1996 and during the years then ended there were no loans material to the
consolidated financial statements which were defined as impaired.
The Bank uses several factors in determining if a loan is impaired. The internal
asset classification procedures include a thorough review of significant loans
and lending relationships and include the accumulation of related data. This
data includes loan payment status, borrowers' financial data and borrowers'
operating factors such as cash flows, operating income or loss, etc.
19
<PAGE>
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries). Management's periodic evaluation of the
adequacy of the allowance is based on the Bank's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay, the estimated value of any underlying
collateral, and current economic conditions. While management believes that it
has established the allowance in accordance with generally accepted accounting
principles and has taken into account the views of its regulators and the
current economic environment, there can be no assurance that in the future the
Bank's regulators or its economic environment will not require further increases
in the allowance.
Loans Held for Sale
Loans originated and intended for sale are carried at the lower of cost or
aggregate estimated market value. Net unrealized losses are recognized in a
valuation allowance by charges to income. Gains and losses on sales of whole or
participating interests in real estate loans are recognized at the time of sale
and are determined by the difference between net sales proceeds and the Bank's
basis of the loans sold, adjusted for the recognition of any servicing assets
retained.
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well-secured and in the process of
collection. If a loan or a portion of a loan is classified as doubtful or is
partially charged off, the loan is generally classified as nonaccrual. Loans
that are on a current payment status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is in
doubt.
Loans may be returned to accrual status when all principal and interest amounts
contractually due (including arrearages) are reasonably assured of repayment
within an acceptable period of time, and there is a sustained period of
repayment performance (generally a minimum of six months) by the borrower, in
accordance with the contractual terms of interest and principal.
While a loan is classified as nonaccrual and the future collectibility of the
recorded loan balance is doubtful, collections of interest and principal are
generally applied as a reduction to principal outstanding, except in the case of
loans with scheduled amortization where the payment is generally applied to the
oldest payment due. When the future collectibility of the recorded loan balance
is expected, interest income may be recognized on a cash basis limited to that
which would have been recognized on the recorded loan balance at the contractual
interest rate. Receipts in excess of that amount are recorded as recoveries to
the allowance for loan losses until prior charge-offs have been fully recovered.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed by the straight-line
and accelerated methods based on estimated service lives of assets. Useful lives
range from 10 to 40 years for substantially all premises and from 3 to 20 years
for equipment and fixtures.
Real Estate Owned
Assets acquired through loan foreclosure are recorded as real estate owned
("REO") at the lower of the estimated fair value of the property less estimated
costs to sell at the date of foreclosure or the carrying amount of the loan plus
unpaid accrued interest. The carrying amount is subsequently reduced by
additional allowances which are charged to earnings if the estimated fair value
declines below its initial value plus any capitalized costs. Costs related to
the improvement of the property are capitalized, whereas costs related to
holding the property are expensed.
Investment in Federal Home Loan Bank Stock
The Bank is required to invest in stock of the Federal Home Loan Bank of Atlanta
(FHLB) in the amount of 1% of its outstanding home loans or 5% of its
outstanding advances from the FHLB, whichever is greater. At both September 30,
1997 and 1996, the Bank owned 12,875 shares of the FHLB's $100 par value capital
stock.
Income Taxes
Deferred tax asset and liability balances are determined by application to
temporary differences of the tax rate expected to be in effect when taxes will
become payable or receivable. Temporary differences are differences between the
tax basis of assets and liabilities and their reported amounts in the financial
statements that will result in taxable or deductible amounts in future years.
The effect on deferred taxes of a change in tax rates is recognized in income in
the period that includes the enactment date.
Cash and Cash Equivalents
Cash and cash equivalents include demand and time deposits (with remaining
maturities of ninety days or less at time of purchase) at other financial
institutions and federal funds sold. Generally, federal funds are purchased and
sold for one-day periods.
20
<PAGE>
Net Income Per Common Share
Net income per common share is computed on the basis of weighted average number
of shares of common stock outstanding, excluding unallocated ESOP shares and
unawarded MRP shares. Net income per common share for 1997 of $.53 is calculated
by dividing net income for the period April 8, 1997 to September 30, 1997,
$1,395,900, by the number of weighted average shares of common stock
outstanding.
The Company will adopt Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings Per Share", on October 1, 1997. SFAS No. 128 requires the Company
to change its method of computing, presenting and disclosing earnings per share
information. Upon adoption, all prior periods data presented will be restated to
conform to the provisions of SFAS No. 128. If the Company had adopted SFAS No.
128 for the period ending September 30, 1997, there would have been no effect on
earnings per share, as the Company had no common stock equivalents or
convertible securities outstanding during the period.
Reclassifications
Certain items included in the 1996 and 1995 financial statements have been
reclassified to conform to the 1997 presentation. These reclassifications have
no effect on the net income or retained earnings previously reported.
New Accounting Pronouncements
The Company adopted SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" on January 1, 1997. The
impact of adopting this statement is not material to the Company's consolidated
financial statements.
The Company will adopt SFAS No. 130, "Reporting Comprehensive Income" on October
1, 1998. SFAS No. 130 establishes standards for reporting and displaying
comprehensive income and its components in a full set of general-purpose
financial statements.
The Company will adopt SFAS No. 131, "Disclosure About Segments of an Enterprise
and Related Information" on October 1, 1998. SFAS No. 131 specifies revised
guidelines for determining an entity's operating segments and the type and level
of financial information to be disclosed.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Note 2 - Conversion to Commercial Bank
NewSouth Bancorp, Inc., was incorporated in October, 1996 under the laws for the
State of Delaware for the purpose of becoming the holding company for Home
Savings Bank, SSB. On April 7, 1997, Home Savings Bank, SSB converted from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank to be known as Home Savings Bank, Inc., SSB, ("Converted Bank"), in
connection with an initial public offering of common stock. Immediately
following completion of the stock conversion, the Converted Bank converted from
a North Carolina-chartered stock savings bank to a North Carolina commercial
bank known as "NewSouth Bank." In connection with the conversion, the Company
issued 2,909,500 shares of common stock, including 232,760 issued to the
Employee Stock Ownership Plan ("ESOP"), par value $.01 per share, for $15 per
share. The sale of common stock generated proceeds of $38,960,736, net of
conversion costs of $1,190,364 and ESOP shares of $3,491,400. NewSouth Bank
opened for business the first day under that name on April 8, 1997. The common
stock of the Company began trading on the NASDAQ National Market System under
the symbol "NSBC" on April 8, 1997.
At the time of the conversion, the Bank established a liquidation account in an
amount equal to the Bank's net worth, or approximately $19,200,000, for the
benefit of eligible account holders at that time. The liquidation account will
be reduced annually to the extent that eligible account holders have reduced
their eligible deposits, shall cease upon the closing of the accounts, and shall
never be increased. In the event of the liquidation of the Bank, all remaining
eligible deposit account holders shall be entitled, after all payments to
creditors, to a distribution from the liquidation account before any
distribution to stockholders. Dividends paid by the Company cannot be paid from
the liquidation account.
21
<PAGE>
Note 3 - Investment Securities
Investment securities at September 30, 1997 and 1996 are classified as available
for sale according to management's intent and summarized as follows:
Gross Unrealized Estimated
Amortized --------------------- Market
Cost Gains Losses Value
---------- -------- -------- ----------
1997:
U.S. Treasury notes $3,000,897 $ 82,525 $ - $3,083,422
========== ======== ======== ==========
1996:
U.S. Treasury notes $5,025,160 $ 81,421 $ - $5,106,581
State and political
Subdivisions 3,000,000 - - 3,000,000
---------- -------- -------- ----------
$8,025,160 $ 81,421 $ - $8,106,581
========== ======== ======== ==========
All investment securities at September 30, 1997 will mature after one year
through five years.
Investment securities with a carrying value of $5,000,000 were sold during 1997,
resulting in no realized gain or loss.
Note 4 - Mortgage-Backed Securities
Mortgage-backed securities at September 30, 1997 and 1996 are classified as
available for sale according to management's intent and summarized as follows:
Gross Unrealized Estimated
Amortized -------------------- Market
Cost Gains Losses Value
----------- -------- -------- -----------
1997:
FHLMC participation
certificates, maturing
from years 2003 to 2027 $24,406,887 $463,942 $ 52,417 $24,818,412
=========== ======== ======== ===========
1996:
FHLMC participation
certificates, maturing
from years 2006 to 2022 $14,812,070 $143,156 $157,802 $14,797,424
=========== ======== ======== ===========
Mortgage-backed securities at September 30, 1997 will contractually mature on
the following schedule:
Estimated
Amortized Market
Cost Value
----------- -----------
Due after five years through ten years $ 4,221,949 $ 4,269,920
Due after ten years 20,184,938 20,548,492
----------- -----------
$24,406,887 $24,818,412
=========== ===========
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
Mortgage-backed securities with a carrying value of $6,607,924, $5,566,420 and
$776,757 were sold during the years ended September 30, 1997, 1996, and 1995,
respectively. Gross gains realized on the sales of mortgage-backed securities
were $688, $146,723 and $6,112 during 1997, 1996 and 1995, respectively. Gross
realized losses on sales of mortgage-backed securities were $15,339, $0 and $0
during 1997, 1996 and 1995, respectively.
Mortgage-backed securities with a carrying value of approximately $1,594,000 and
$2,089,000 were pledged as collateral for deposits from public entities at
September 30, 1997 and 1996, respectively.
22
<PAGE>
Note 5 - Loans Receivable
Loans receivable at September 30, 1997 and 1996 are summarized as follows:
1997 1996
---- ----
Mortgage loans $102,154,361 $ 94,813,285
Consumer loans 49,889,347 37,422,945
Commercial loans 62,438,748 41,496,450
------------ ------------
Total 214,482,456 173,732,680
Less:
Loans in process (12,716,819) (15,244,463)
Allowance for loan losses (3,249,352) (2,351,309)
Deferred loan fees (731,380) (455,613)
------------ ------------
Loans receivable, net $197,784,905 $155,681,295
============ ============
At September 30, 1997, the Bank had entered into a security agreement with a
blanket floating lien pledging its eligible real estate loans to secure actual
or potential borrowings from the Federal Home Loan Bank of Atlanta (See Note 9).
During 1997, 1996 and 1995, the Bank exchanged loans with outstanding principal
balances of $18,524,209, $1,545,859 and $6,288,164, respectively, with the
Federal Home Loan Mortgage Corporation ("FHLMC") for mortgage-backed securities
of equal value.
The Bank originates mortgage loans for portfolio investment or sale in the
secondary market. During the period of origination, mortgage loans are
designated as either held for sale or investment purposes. Transfers of loans
held for sale to the investment portfolio are recorded at the lower of cost or
market value on the transfer date. Loans receivable held for sale at September
30, 1997 and 1996, are fixed rate mortgage loans with an estimated market value
of approximately $25,100,000 and $21,600,000, respectively.
Net gains on sales of loans receivable held for sale amounted to $138,717,
$276,390 and $306,213 during the years ended September 30, 1997, 1996 and 1995,
respectively.
The changes in the allowance for loan losses for the years ended September 30,
1997, 1996 and 1995 are as follows:
1997 1996 1995
---- ---- ----
Balance at beginning of year $2,351,309 $1,876,954 $1,977,327
Provisions for loan losses 931,078 511,000 20,000
Loans charged off (71,904) (62,559) (122,000)
Recoveries 38,869 25,914 1,627
---------- ---------- ----------
Balance at end of year $3,249,352 $2,351,309 $1,876,954
========== ========== ==========
The following is a summary of the principal balances of loans on nonaccrual
status and loans past due ninety days or more:
1997 1996
---- ----
Loans contractually past due 90 days or more
and/or on nonaccrual status:
Residential $1,214,189 $1,022,521
Consumer and commercial 48,233 11,358
---------- ----------
Balance at end of year $1,262,422 $1,033,879
========== ==========
During the years ended September 30, 1997, 1996 and 1995, interest income of
approximately $48,000, $44,000 and $23,000, respectively, was not recorded
related to loans accounted for on a nonaccrual basis.
23
<PAGE>
Note 6 - Premises and Equipment
Premises and equipment at September 30, 1997 and 1996 consist of the following:
1997 1996
---- ----
Land $ 935,560 $ 935,560
Office buildings 2,488,976 2,488,976
Furniture, fixtures and equipment 1,067,858 1,073,120
Vehicles 225,041 174,343
---------- ----------
4,717,435 4,671,999
Less accumulated depreciation 1,899,268 1,771,578
---------- ----------
Total $2,818,167 $2,900,421
========== ==========
Note 7 - Employee Benefit Plans
The Company participates in a multiemployer defined benefit pension plan which
covers substantially all employees. Expenses of the plan for the years ended
September 30, 1997, 1996 and 1995 were $96,000, $137,000 and $123,154,
respectively.
Effective July 1, 1995, the Company participates in a multiemployer defined
contribution plan which covers substantially all employees. Under the plan,
employees may contribute from 1% to 15% of compensation, subject to an annual
maximum as determined by the Internal Revenue Code. The Company makes matching
contributions of 50% of employees' contributions up to 6% of the employees'
salaries. The plan provides that employees' contributions are 100% vested at all
times and the Bank's contributions vest 25% for each year of service. Prior to
July 1, 1995, the Company maintained a profit sharing 401(k) plan. The expenses
related to the Company's contributions to these plans for the years ended
September 30, 1997, 1996 and 1995 were $52,253, $46,171 and $37,074,
respectively.
Directors and certain officers participate in deferred compensation plans. These
plans generally provide for fixed payments beginning at retirement. These
payments are earned over service periods of up to ten years, and can include
provisions for deferral of current payments. The expense related to these plans
during the years ended September 30, 1997, 1996 and 1995 aggregated $515,435,
$463,250 and $582,022, respectively. The plans generally include provisions for
forfeitures of unvested portions of payments, and vesting in the event of death
or disability. During 1996 it was discovered that the accrual for these plans
was understated as of September 30, 1995. The effect of this understatement was
that other liabilities were understated by $270,000, deferred tax assets were
understated by $100,000, income taxes payable were overstated by $30,000 and
income was overstated by $140,000 as of September 30, 1995. The previously
reported financial results for the year ended September 30, 1995 have been
restated for the effect of this error.
In conjunction with the initial public offering, the Company's Board of
directors approved a Management Recognition Plan for director and key employees.
The Company is authorized to fund the acquisition and award of up to 116,380
shares (4% of shares issued in the stock conversion) to be awarded by a
committee of the board of directors. Compensation expense will be based on the
fair market value of the shares at the award date and recognized during any
vesting period. As of September 30, 1997, 77,700 shares have been acquired at an
aggregate cost of $2,050,531, and no shares have been awarded.
Note 8 - Employee Stock Ownership Plan
The Company's Board of Directors has adopted an employee stock ownership plan
("ESOP"), effective October 1, 1996. Employees of the Company and its
subsidiaries who have attained age 21 and completed one year of service are
eligible to participate in the ESOP, provided that any employee who was employed
full-time on the closing date of the Stock Conversion automatically became a
participant on October 1, 1996. The ESOP is to be funded by contributions made
by the Company or the Bank in cash or shares of Common Stock. Allocations to
participants' accounts occur annually on September 30. Shares are committed to
be released for financial statement purposes when the Bank makes scheduled
payments on the ESOP note payable and will be allocated to employees for
services rendered in the current accounting period. Employees vest in their
allocated ESOP shares over three years. The number of shares legally released
and allocated is based on the ratio of the actual principal payments amount to
the remaining total principal payments for the ESOP note payable. The Bank
expects to contribute sufficient funds to the ESOP to repay the note payable
over a ten-year period, plus such other amounts as the Company's Board of
Directors may determine in its discretion.
Initially, the ESOP acquired 232,760 shares of the Company's common stock
financed by $3,491,400 in borrowings by the ESOP from the Company. This loan
will be secured by the shares of Common Stock purchased and earnings thereon. At
September 30, 1997, 24,828 shares have been allocated to participants' accounts
and 207,932 shares, with an estimated market value of $6,237,960, remain
unallocated. All allocated shares are considered outstanding for earning per
share purposes, while the unallocated shares are not included in the
calculation.
24
<PAGE>
The principal balance of the ESOP loan was $3,118,984 at September 30, 1997. The
Bank is using the dividends declared on shares held by the ESOP to reduce the
outstanding debt. Dividends on allocated shares are treated as a reduction of
retained earnings. Dividends on unallocated shares are treated only as debt
service, and there is no reduction of retained earnings. Compensation expense
related to the ESOP is based on the average fair market value of shares during
the period since the prior allocation date through the dates shares are
committed to be released. The financial statements for the years ended September
30, 1997 include compensation expense of $603,429 related to the ESOP.
Note 9 - Borrowed Money
Borrowed money represents advances from the Federal Home Loan Bank of Atlanta
and repurchase agreements. Advances from the Federal Home Loan Bank had a
weighed average rate of 6.17% and 0.0% and totaled $11,000,000 and $0 at
September 30, 1997 and 1996, respectively.
At September 30, 1997 and 1996, repurchase agreements outstanding had a rate of
4.67% and 4.31% and totaled $1,621,120 and $1,039,608, respectively.
Repurchase agreements are collateralized by U.S. government agency obligations
with a principal balance of $2,000,000.
The Company has pledged all of its stock in the Federal Home Loan Bank of
Atlanta and certain loans secured by one to four family residential mortgages as
collateral for actual or potential borrowings from the FHLB. At September 30,
1997, the Company had an additional $14,000,000 of credit available with the
Federal Home Loan Bank of Atlanta.
Note 10 - Income Taxes
The components of income taxes for the years ended September 30, 1997, 1996 and
1995 are as follows:
1997 1996 1995
---- ---- ----
Current:
Federal $1,908,576 $ 766,558 $1,034,106
State 576,146 124,663 205,170
---------- --------- ----------
Total current 2,484,722 891,221 1,239,276
---------- --------- ----------
Deferred:
Federal (617,976) (360,903) (211,224)
State (147,396) (79,801) (29,972)
---------- --------- ----------
Total deferred (765,372) (440,704) (241,196)
---------- --------- ----------
Total $1,719,350 $ 450,517 $ 998,080
========== ========= ==========
Reconciliations of expected income tax at the statutory Federal rate of 34% with
income tax expense for the years ended September 30, 1997, 1996 and 1995 are as
follows:
1997 1996 1995
---- ---- ----
Expected income tax expense $1,353,873 $432,142 $973,529
State income taxes net of federal
income tax benefit 147,000 26,671 115,631
Non-deductible ESOP and other expenses 206,000 - -
Rehabilitation credit - - (28,666)
Other 12,477 (8,296) (62,414)
---------- -------- --------
$1,719,350 $450,517 $998,080
========== ======== ========
25
<PAGE>
The components of the net deferred income tax liability and asset are as
follows:
1997 1996
---- ----
Deferred income tax assets:
Deferred directors' fees $ 346,328 $ 317,186
Bad debt reserve 782,302 331,007
Deferred employee benefits 363,925 263,009
Other 26,382 -
---------- ---------
1,518,937 911,202
---------- ---------
Deferred income tax liabilities:
Loans mark-to-market adjustment (235,757) (405,771)
Depreciation and amortization (91,306) (85,354)
Unrealized gains on securities available-for-sale (193,732) (26,240)
Deferred loan origination fees and costs (76,929) (47,519)
FHLB stock (99,350) (99,434)
Other - (22,901)
---------- ---------
(697,074) (687,219)
---------- ---------
Net deferred income tax asset (liability) $ 821,863 $ 223,983
========== =========
Retained income at September 30, 1997, includes approximately $1,850,000 for
which no deferred income tax liability has been recognized. This amount
represents an allocation of income to bad debt deductions for income tax
purposes only. Reductions of the amount so allocated for purposes other than tax
bad debt losses or adjustments arising from carryback of net operating losses
would create income for tax purposes only, which would be subject to the then
current corporate income tax rate.
During 1996, Congress enacted certain tax legislation that exempted thrift
institutions from being taxed on pre-1987 bad debt reserves, however the Bank
will be recapturing a portion of its post-1987 bad debt reserve created by using
the percentage of taxable income method. The Bank has previously recorded
deferred tax liabilities related to these excess reserves. Additionally, the
Bank is now required to use the experience method.
Note 11 - Regulatory Capital Requirements
Dividend payments made by the Company are subject to regulatory restrictions
under Federal Reserve Board policy as well as to limitations under applicable
provisions of Delaware corporate law. The Federal Reserve Board may prohibit a
bank holding company from paying any dividends if the holding company's bank
subsidiary is classified as "undercapitalized". Under Delaware law, dividends
may be paid out of surplus or, if there is no surplus, out of net profits for
the fiscal year in which the dividend is declared and for the preceding fiscal
year. Furthermore, under FDIC regulations, the Bank is prohibited from making
any capital distributions if after making the distribution, the Bank would have:
(i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based
capital ratio of less than 4.0%; or (iii) a leverage ratios of less than 4.0%.
The Bank is subject to various regulatory capital requirements administered by
the federal and state banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Quantitative measures
established by regulation to ensure capital adequacy require the Bank to
maintain minimum amounts and ratios, as set forth in the table below. Management
believes, as of September 30, 1997, that the Bank meets all capital adequacy
requirements to which it is subject.
As of September 30, 1997, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must maintain
minimum amounts and ratios, as set forth in the table below. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
26
<PAGE>
The Company's actual capital amounts and ratios as of September 30, 1997 and
1996 are also presented in the table below (dollars in thousands).
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt
Actual Adequacy Purposes Action Provisions
--------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
1997:
Total Capital (to Risk Weighted
<S> <C> <C> <C> <C> <C> <C>
Weighted Assets) $59,684 34.8% $13,719 8.0% $17,149 10.0%
Tier I Capital (to Risk Weighted
Weighted Assets) 57,527 33.6% 6,859 4.0% 10,289 6.0%
Tier I Capital (to Average
Assets) 57,527 23.8% 9,679 4.0% 12,099 5.0%
1996:
Total Capital (to Risk Weighted
Weighted Assets) $19,954 15.2% $10,484 8.0% $13,155 10.0%
Tier I Capital (to Risk Weighted
Weighted Assets) 18,306 9.6% 7,625 4.0% 7,893 6.0%
Tier I Capital (to Average
Assets) 18,306 14.0% 5,242 4.0% 9,534 5.0%
</TABLE>
Note 12 - Mortgage Banking Activities
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of condition. The unpaid principal balances of mortgage
loans serviced for others was $253,646,909 and $253,681,978 at September 30,
1997 and 1996, respectively. Servicing loans for others generally consists of
collecting mortgage payments, maintaining escrow accounts, disbursing payment to
investors and foreclosure processing. Loan servicing income is recorded on the
accrual basis and includes servicing fees from investors and certain charges
collected from borrowers, such as late payment fees.
Effective January 1, 1997, the Company adopted SFAS No. 125 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishements of
Liabilities". At September 30, 1997, mortgage servicing rights reported in the
consolidated statements of condition, net of amortization, were equal to
$57,525.
Note 13 - Financial Instruments With Off-Balance Sheet Risk and Significant
Group Concentration of Credit Risk
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit and involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the balance sheet.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Company uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The Company evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Company upon extension of credit, is based on management's credit
evaluation of the borrower.
A summary of the contractual amounts of the Company's exposure to off-balance
sheet risk as of September 30, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
Commitments to extend credit:
<S> <C> <C>
Commitments to originate loans $13,070,715 $ 9,179,693
Undrawn balances on lines of credit and undrawn
balances on credit reserves (overdraft protection) 19,889,495 16,899,367
----------- -----------
$32,960,210 $26,079,060
=========== ===========
</TABLE>
27
<PAGE>
Included in the commitments to originate loans as of September 30, 1997 and 1996
are fixed interest rate loan commitments of $6,722,340 and $7,367,788,
respectively. The shorter duration of interest-sensitive liabilities, to the
extent they are used to fund these fixed-rate loans, indicates that the Company
is exposed to interest rate risk because, in a rising rate environment,
liabilities will be repricing faster at higher interest rates, thereby reducing
the market value of fixed-rate long-term assets and net interest income.
The Company's lending is concentrated primarily in Beaufort, Craven, Nash,
Lenoir, Pasquotank, Pitt and surrounding counties in North Carolina. Credit has
been extended to certain of the Company's customers through multiple lending
transactions.
Note 14 - Parent Company Financial Data
The Company's principal asset is its investment in the Bank. Condensed financial
statements for the parent company as of September 30, 1997 and for the year
ended September 30, 1997 are as follows:
Condensed Balance Sheet
Cash $ 23,383
Due from subsidiary 18,220,854
Investment in wholly-owned subsidiary 39,941,603
------------
Total assets $ 58,185,840
============
Deferred income taxes $ 57,800
Other liabilities 300,946
Shareholders' equity 57,827,094
------------
Total liabilities and shareholders' equity $ 58,185,840
============
Condensed Statement of Income
Interest income, net $ 159,006
Other income 1,570,050
Miscellaneous expenses 333,156
------------
Net income $ 1,395,900
============
Condensed Statement of Cash Flows
Operating activities:
Net income $ 1,395,900
Adjustments to reconcile net income to
net cash provided by operating activities:
Deferred income taxes 57,800
ESOP compensation 603,429
Increase in other liabilities 300,946
------------
Net cash provided by operating activities 2,358,075
------------
Investing activities:
Investment in, and advances to, subsidiary (38,980,323)
------------
Net cash used by investing activities (38,980,323)
------------
Financing activities:
Net proceeds from issuance of stock 38,960,736
MRP funding (2,050,531)
Dividends (264,574)
------------
Net cash provided by financing activities 36,645,631
------------
Net increase in cash 23,383
Cash at beginning of the year 0
------------
Cash at the end of year $ 23,383
============
28
<PAGE>
Note 15 - Quarterly Financial Data (Unaudited)
Summarized unaudited quarterly financial data for the year ended September 30,
1997 is as follows:
1997
----------------------------------------------
Fourth Third Second First
---------- ---------- ---------- ----------
Interest income $5,165,935 $4,910,713 $4,355,804 $4,082,913
Interest expense 2,149,529 1,985,807 2,123,907 2,086,985
Provision for loan losses 183,500 541,000 100,000 106,578
Noninterest income 458,623 484,603 366,550 370,209
Noninterest expense 1,960,736 1,642,952 1,864,310 1,468,066
Income tax expense 613,650 546,800 248,600 310,300
---------- ---------- ---------- ----------
Net income $ 717,143 $ 678,757 $ 385,537 $ 481,193
========== ========== ========== ==========
Net income per common share $ 0.27 $ 0.25 N/A N/A
========== ==========
Note 16 - Fair Values of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments" (SFAS No. 107), requires the disclosure of
estimated fair values for financial instruments. Quoted market prices, if
available, are utilized as an estimate of the fair value of financial
instruments. Because no quoted market prices exist for a significant part of the
Company financial instruments, the fair value of such instruments has been
derived based on management's assumptions with respect to future economic
conditions, the amount and timing of future cash flows and estimated discount
rates. Different assumptions could significantly affect these estimates.
Accordingly, the net realizable value could be materially different from the
estimates presented below. In addition, the estimates are only indicative of
individual financial instruments' values and should not be considered an
indication of the fair value of the Company taken as a whole.
Fair values have been estimated using data which management considered the best
available, and estimation methodologies deemed suitable for the pertinent
category of financial instrument. The estimation methodologies, resulting fair
values, and recorded carrying amounts at September 30, 1997 and 1996, were as
follows:
Cash and cash equivalents are by definition short-term and do not present
any unanticipated credit issues. Therefore, the carrying amount is a
reasonable estimate of fair value. The estimated fair values of investment
securities and mortgage backed securities are provided in Notes 2 and 3 to
the financial statements. These are based on quoted market prices, when
available. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
The fair value of the net loan portfolio has been estimated using the
present value of expected cash flows, discounted at an interest rate
adjusted for servicing costs and giving consideration to estimated
prepayment risk and credit loss factors, as follows:
1997 1996
-------------------------- --------------------------
Estimated Carrying Estimated Carrying
Fair Value Amount Fair Value Amount
------------ ------------ ------------ ------------
1 - 4 family mortgages $ 92,301,373 $ 90,080,092 $ 80,982,405 $ 80,190,043
Consumer 48,442,139 48,942,499 36,263,680 36,595,184
Non-residential 58,762,314 58,762,314 38,896,068 38,896,068
------------ ------------ ------------ ------------
$199,505,826 $197,784,905 $156,142,153 $155,681,295
============ ============ ============ ============
The fair value of deposit liabilities with no stated maturities has been
estimated to equal the carrying amount (the amount payable on demand),
totaling $43,955,573 and $34,354,266 in 1997 and 1996, respectively. Under
Statement 107, the fair value of deposits with no stated maturity is equal
to the amount payable on demand. Therefore, the fair value estimates for
these products do not reflect the benefits that the Bank receives from the
low-cost, long-term funding they provide. These benefits are considered
significant.
29
<PAGE>
The fair value of certificates of deposits and advances from the Federal
Home Loan Bank is estimated by discounting the future cash flows using the
current rates offered for similar deposits and advances with the same
remaining maturities. The carrying value and estimated fair values of
certificates of deposit and Federal Home Loan Bank advances at September
30, 1997 and 1996 are as follows:
1997 1996
---- ----
Certificates of deposits:
Carrying amount $131,160,215 $136,859,020
Estimated fair value 131,780,748 137,735,084
Advances from Federal Home Loan Bank:
Carrying amount $ 11,000,000 -
Estimated fair value 11,000,595 -
The carrying amount of repurchase agreements approximates the fair value.
The interest rate on these agreements is a floating rate based on the
Federal funds daily rate.
There is no material difference between the carrying amount and estimated
fair value of off-balance sheet items totaling $32,962,010 in 1997 and
$26,079,060 in 1996, which are primarily comprised of unfunded loan
commitments.
The Company's remaining assets and liabilities are not considered financial
instruments.
30
<PAGE>
<TABLE>
<CAPTION>
BOARD OF DIRECTORS
<S> <C> <C>
Dr. Frederick H. Howdy Linley H. Gibbs, Jr. Edmund T. Buckman, Jr.
Chairman Vice Chairman Retired
President Retired Washington, NC
Drs. Freshwater and Howdy, P.A. Washington, NC
Washington, NC
Frederick N. Holscher Charles E. Parker, Jr. Marshall T. Singleton
Partner Vice President Co-Owner
Rodman, Holscher, Francisco & Robinson Insurance Agency B. E. Singleton & Sons
Peck, P.A. New Bern, NC Washington, NC
Washington, NC
Thomas A. Vann
President
NewSouth Bank
Washington, NC
<CAPTION>
EXECUTIVE OFFICERS
<S> <C> <C>
Thomas A. Vann John B. Burgess William L. Wall
President Executive Vice President Executive Vice President
Credit Administration Chief Financial Officer/Secretary
Jack L. Ashley Mary R. Boyd Sherry L. Correll
Vice President Vice President Vice President
Branch Administration and Loan Servicing Deposit Administration
Operations
Kristie W. Hawkins Walter P. House William R. Outland
Treasurer Vice President Vice President
Controller Mortgage Operations Consumer Lending
<CAPTION>
NEWSOUTH BANK OFFICE LOCATIONS
<S> <C> <C>
Corporate Office Kinston Washington
1311 Carolina Avenue 827 Hardee Road 1311 Carolina Avenue
Washington, NC 27889 919-522-9466 919-946-4178
919-946-4178
New Bern 300 North Market Street
Full-Service Branch Offices 202 Craven Street 919-946-4178
919-636-2997
Elizabeth City Operations Center
604 East Ehringhaus Street 1725 Glenburnie Road 239 West Main Street
919-335-0848 919-636-2997 919-946-4178
Greenville Rocky Mount Mortgage Origination Office
301 East Arlington Blvd. 300 Sunset Avenue
919-321-2600 919-972-9661 Wilmington
6800 Wrightsville Avenue
910-256-3626
</TABLE>
31
<PAGE>
STOCKHOLDER INFORMATION
Corporate Headquarters
NewSouth Bancorp, Inc.
1311 Carolina Avenue
Washington, NC 27889
Telephone: (919) 946-4178
Fax: (919) 946-3873
Stock Listing Information
The Company's common stock trades on the Nasdaq Stock Market under the symbol
NSBC.
Stock Price Information
The following table sets forth the high and low trade price information and
dividends declared per share for the periods indicated. The Company's common
stock began trading on April 8, 1997.
Quarter Ended High Low Dividends Declared
------------- ---- --- ------------------
June 30, 1997 $25.00 $20.00 $.10
September 30, 1997 $31.125 $24.50 $.10
Registrar and Transfer Agent
Inquiries regarding stock transfer, registration, lost certificates or changes
in name and address should be directed to the stock registrar and transfer
agent:
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
(800) 866-1340
Form 10-K
The Company's annual report on Form 10-K, filed with the Securities and Exchange
Commission, is available to shareholders without charge by writing:
William L. Wall
Chief Financial Officer
NewSouth Bancorp, Inc.
P.O. Box 2047
Washington, NC 27889
Investor Information
Shareholders, investors, and analysts interested in additional information may
contact William L. Wall, Chief Financial Officer, NewSouth Bancorp, Inc.
Annual Meeting
The Annual Meeting of shareholders of NewSouth Bancorp, Inc. will be held
Thursday, February 12, 1998 at 10:00 a.m. at the main office of NewSouth Bank,
1311 Carolina Avenue, Washington, North Carolina.
<TABLE>
<S> <C> <C>
General Counsel Special Counsel Independent Auditors
Rodman, Holscher, Francisco & Housley, Kantarian & Bronstein, P.C. Coopers & Lybrand L.L.P.
Peck, P.A. Suite 700 Suite 2300
320 North Market Street 1220 19th Street, N.W. 150 Fayetteville Street Mall
Washington, NC 27889 Washington, DC 20036 Raleigh, NC 27601
</TABLE>
32
<PAGE>
NewSouth Bancorp
----------------
1311 Carolina Avenue
P.O. Box 2047
Washington, North Carolina 27889
(919) 946-4178 Fax (919) 946-3873
EXHIBIT 21
Subsidiaries of the Registrant
State or Other
Jurisdiction of Percentage
Incorporation Ownership
Parent ------------- ---------
- ------
NewSouth Bancorp, Inc. Delaware 100%
Subsidiary
NewSouth Bank North Carolina 100%
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-START> OCT-01-1996
<PERIOD-END> SEP-30-1997
<CASH> 3,027,271
<INT-BEARING-DEPOSITS> 12,744,980
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 27,901,834
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 201,034,257
<ALLOWANCE> 3,249,352
<TOTAL-ASSETS> 249,281,197
<DEPOSITS> 175,115,788
<SHORT-TERM> 12,621,120
<LIABILITIES-OTHER> 3,688,702
<LONG-TERM> 0
0
0
<COMMON> 57,826,492
<OTHER-SE> 29,025
<TOTAL-LIABILITIES-AND-EQUITY> 249,281,197
<INTEREST-LOAN> 16,096,914
<INTEREST-INVEST> 2,418,451
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 18,515,365
<INTEREST-DEPOSIT> 8,088,144
<INTEREST-EXPENSE> 8,346,228
<INTEREST-INCOME-NET> 10,169,137
<LOAN-LOSSES> 931,078
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 6,941,051
<INCOME-PRETAX> 3,981,980
<INCOME-PRE-EXTRAORDINARY> 3,981,980
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,981,980
<EPS-PRIMARY> .53
<EPS-DILUTED> .53
<YIELD-ACTUAL> 4.67
<LOANS-NON> 1,262,422
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 36,414
<ALLOWANCE-OPEN> 2,351,309
<CHARGE-OFFS> 71,904
<RECOVERIES> 38,869
<ALLOWANCE-CLOSE> 3,249,352
<ALLOWANCE-DOMESTIC> 3,249,352
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
