SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1999
OR
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission File No. 0-22219
NEWSOUTH BANCORP, INC.
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(Exact Name of Registrant as Specified in Its Charter)
Virginia 56-1999749
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1311 Carolina Avenue, Washington, North Carolina 27889-2047
- ------------------------------------------------ -------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (252) 946-4178
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
(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 14, 1999, the aggregate market value of the 2,651,941 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $48.4 million based on the closing sale price of
$18.25 per share of the registrant's Common Stock as listed on the Nasdaq
National Market. 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 14, 1999: 3,509,228.
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, 1999. (Parts II and IV)
2. Portions of Proxy Statement for 2000 Annual Meeting of Stockholders. (Part
III)
<PAGE>
PART I
ITEM 1. BUSINESS
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General
NewSouth Bancorp, Inc. (the "Company") is a Virginia corporation that
serves as the holding company for NewSouth Bank, a North Carolina chartered
commercial bank (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.
RECENT REGULATORY AND LEGISLATIVE CHANGES
On November 12, 1999, the Gramm-Leach-Bliley Act was signed into law. The
Act calls for the modernization of the banking system and could have
far-reaching effects on the financial services industry and the Company's and
the Bank's operations. For additional information on the provisions of this
legislation, see "Depository Institution Regulation -- Recently Enacted
Legislation."
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, 1999,
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.
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LENDING ACTIVITIES
General. The Company's gross loan portfolio totaled $229.0 million at
September 30, 1999, representing 78.3% of total assets at that date. It is the
Company's policy to concentrate its lending within its market area. At September
30, 1999, $62.4 million, or 27.2% of the Company's gross loan portfolio,
consisted of single-family, residential mortgage loans. The Company's
construction loans totaled $25.8 million, or 11.3% of the Company's gross loan
portfolio, at September 30, 1999. The Company also originates a significant
amount of commercial real estate loans. At September 30, 1999, commercial real
estate loans amounted to $68.4 million, or 29.9% 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, 1999, commercial
business loans totaled $21.1 million, or 9.2% of the Company's gross loan
portfolio, and consumer loans totaled $50.8 million, or 22.2% of the Company's
gross loan portfolio. To a lesser extent, the Company also originates
multi-family residential and commercial real estate loans.
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, 1999, the Company had no concentrations of
loans exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------- ---------------- ---------------- ---------------- ----------------
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 ........ $ 62,422 27.2% $ 91,546 37.8% $ 67,959 31.7% $ 58,576 33.7% $ 67,736 43.0%
Multi-family residential ......... 379 .2 848 .4 946 .4 998 .6 2,315 1.5
Construction ..................... 25,809 11.3 27,817 11.5 33,249 15.5 35,240 20.3 32,062 20.4
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total residential mortgage loans 88,610 38.7 120,211 49.7 102,154 47.6 94,814 54.6 102,113 64.9
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial loans:
Commercial real estate ........... 68,403 29.9 51,480 21.3 45,990 21.4 31,168 17.9 21,890 13.9
Commercial business .............. 21,106 9.2 21,823 9.0 16,449 7.7 10,328 6.0 3,698 2.4
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total commercial loans ......... 89,509 39.1 73,303 30.3 62,439 29.1 41,496 23.9 25,588 16.3
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer loans:
Automobile ....................... 4,291 1.9 4,575 1.9 4,611 2.2 4,185 2.4 2,532 1.6
Savings account loans ............ 620 .3 470 .2 617 .3 549 .3 661 .4
Home equity loans ................ 23,795 10.4 22,898 9.5 21,665 10.1 17,949 10.3 15,514 9.9
Other ............................ 22,141 9.6 20,443 8.4 22,996 10.7 14,740 8.5 10,977 6.9
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans ........... 50,847 22.2 48,386 20.0 49,889 23.3 37,423 21.5 29,684 18.8
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total ........................ 228,966 100.00% 241,900 100.00% 214,482 100.00% 173,733 100.00% 157,385 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Loans in process ................. 13,102 12,930 12,717 15,245 10,626
Deferred fees and discounts ...... 513 606 731 456 341
Allowance for loan losses ........ 3,297 3,365 3,249 2,351 1,877
-------- -------- -------- -------- --------
Total .......................... $212,054 $224,999 $197,785 $155,681 $144,541
======== ======== ======== ======== ========
</TABLE>
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Loan Maturities. The following table sets forth certain information at
September 30, 1999 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, 1999 September 30, 1999 Total
------------------ ------------------ ------------------ --------
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans................... $ 66,610 $ 67,801 $ 41,483 $ 175,894
Commercial.......................... 17,369 10,613 816 28,798
Other............................... 5,445 5,241 486 11,172
---------- ---------- ---------- ----------
Total.......................... $ 89,424 $ 83,655 $ 42,785 $ 215,864
========== ========== ========== ==========
</TABLE>
The following table sets forth at September 30, 1999 the dollar amount of
all loans due one year or more after September 30, 1999 which have predetermined
interest rates and have floating or adjustable interest rates.
Predetermined Floating or
Rate Adjustable Rates
------------- ----------------
(In thousands)
Real estate loans.................. $ 79,731 $ 29,553
Commercial......................... 8,889 2,540
Other.............................. 5,521 206
----------- -----------
Total.......................... $ 94,141 $ 32,299
=========== ===========
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 state of North Carolina and 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 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 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.
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<PAGE>
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, 1999, 1998 and 1997, these
transactions totaled $86.1 million, $54.1 million and $31.7 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 loans are presented weekly by the management loan committee
to a loan committee of the Board of Directors of the Bank, made up of three
outside directors who serve on a rotating basis. The President does not serve on
the loan committee of the Board of Directors. 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 97% 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%.
The Bank is subject to regulations that limit the amount the Bank can lend
to one borrower. See A -- Depository Institution Regulation -- Limits on Loans
to One Borrower. Under these limits, the Banks loans-to-one-borrower were
limited to $4.1 million at September 30, 1999. At that date the Bank had no
lending relationships in excess of the loans-to-one-borrower limit.
5
<PAGE>
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, 1999, single-family, residential
mortgage loans, excluding home improvement loans, totaled $62.4 million, or
27.2% of the Company's gross loan portfolio.
The Bank originates fixed-rate mortgage loans at competitive interest
rates. At September 30, 1999, $27.5 million, or 12.0%, of the Company's gross
loan portfolio was comprised of fixed-rate residential 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 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, 1999, $34.9 million, or 15.2%,
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.
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
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<PAGE>
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, 1999, $25.8 million, or 11.3%, 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.
Builder relationships are analyzed and underwritten annually by the Banks credit
administration department.
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 $100,000 to $2.0 million. At September
30, 1999, multi-family residential and commercial real estate loans totaled
$379,000 and $68.4 million, respectively, which amounted to .2% and 29.9%,
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 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,
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<PAGE>
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 to support trading assets. 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, 1999,
commercial business loans totaled $21.1 million, or 9.2% 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 short-term loans,
term loans or as lines of credit. Short-term commercial business loans are for
periods of 12 months or less and are generally self-liquidating from asset
conversion cycles. 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 supporting
trading assets and providing working capital. Such loans 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 standby letters of credit for its commercial
borrowers. The terms of standby letters of credit generally do not exceed one
year, and they are underwritten as stringently as any commercial loan and
generally are of a performance nature.
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 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, 1999, consumer loans totaled $50.8 million, or 22.2% of
the Company's gross loan portfolio.
8
<PAGE>
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, 1999, loans on certificates of deposit totaled $620,000,
or .3% of the Company's total loan portfolio.
At September 30, 1999, the Company had approximately $23.8 million in home
equity line of credit loans, representing approximately 10.4% 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, 1999, the Company had a
commitment to fund an aggregate of $5.3 million of credit card loans, which
represented the aggregate credit limit on credit cards, and had $955,000 of
credit card loans outstanding, representing .4% 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.
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
9
<PAGE>
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 5 of Notes to
Financial Statements included in the Annual Report to Stockholders for the
Fiscal Year Ended September 30, 1999 (the "Annual Report").
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 5 of
Notes to Financial Statements in the Annual Report.
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,
------------------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
(Dollars in thousands)
Loans accounted for on a nonaccrual basis:
Residential mortgage:
<S> <C> <C> <C> <C> <C>
Single-family............................ $ 486 $ 323 $ 298 $ 376 $ 413
Construction............................. -- 406 916 647 248
Commercial real estate..................... -- -- 16 -- --
Commercial business........................ 48 25 14 8 --
Consumer................................... 33 48 18 3 20
------- ------- ------- ------- -------
Total nonperforming loans................ $ 567 $ 802 $ 1,262 $ 1,034 $ 681
======= ======= ======= ======= =======
Percentage of total loans, net............... .27% .36% .64% .66% .47%
======= ====== ======= ======= =======
Real estate owned............................ $ 591 $ 412 $ 358 $ 179 $ 69
======= ======= ======= ======= =======
</TABLE>
During the year ended September 30, 1999, additional gross interest income
of approximately $9,000 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
$8,000.
At September 30, 1999, the Bank had no loans not classified as non-accrual,
90 days past due or restructured loans where known information about possible
credit problems of borrowers caused management to have serious
10
<PAGE>
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, 1999, an analysis of the Bank's portfolio did not reveal
any impaired loans that needed to be classified under SFAS No. 114 or 118. 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 and interest when due according to the contractual terms of the loan
arrangement. 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. 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 payments status, borrowers financial data and borrowers operating factors
such as cash flows, operating income or loss, and various other matters.
At September 30, 1999, the Company had $567,000 of nonaccrual loans, which
consisted of five single-family residential real estate loans totaling $486,000,
two commercial business loans totaling $48,000, and six consumer loans totaling
$33,000.
At September 30, 1999, the Bank had $591,000 of real estate owned, which
consisted of five 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, 1999, the Company had $7.4 million in
classified assets, including $6.2 million in assets classified as special
mention, $1.1 million in assets classified as substandard, no assets classified
as doubtful and $176,000 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
11
<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,
----------------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period........ $ 3,365 $ 3,249 $ 2,351 $ 1,877 $ 1,977
--------- --------- --------- --------- ---------
Loans charged-off:
Residential mortgage:
Single-family..................... -- -- -- 44 20
Commercial real estate.............. -- -- -- -- 76
Commercial business................. 206 128 -- -- --
Consumer............................ 58 74 72 19 26
--------- --------- --------- --------- ---------
Total charge-offs..................... 264 202 72 63 122
--------- --------- --------- --------- ---------
Recoveries:
Residential real estate mortgage:
Single-family residential......... -- -- 33 25 --
Commercial.......................... 65 -- -- -- --
Consumer............................ 11 8 6 1 2
--------- --------- --------- --------- ---------
Total recoveries...................... 76 8 39 26 2
--------- --------- --------- --------- ---------
Net loans charged-off................. 188 194 33 37 120
--------- --------- --------- --------- ---------
Provision for loan losses............. 120 310 931 511 20
--------- --------- --------- --------- ---------
Balance at end of period.............. $ 3,297 $ 3,365 $ 3,249 $ 2,351 $ 1,877
========= ========= ========= ========= =========
Ratio of net charge-offs to average
loans outstanding during the period. .08% .09% .02% .02% .09%
======== ========= ========= ========= =========
</TABLE>
12
<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,
--------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------- ---------------- ---------------- ---------------- ----------------
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 .............. $ 1,071 38.7% $ 1,071 49.7% $ 1,070 47.6% $ 1,037 54.6% $ 1,041 64.9%
Commercial (1) .................... 1,577 39.1 1,598 30.3 1,456 29.1 879 23.9 517 16.3
Consumer .......................... 649 22.2 696 20.0 723 23.3 435 21.5 319 18.8
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total allowance for loan losses $ 3,297 100.00% $ 3,365 100.00% $ 3,249 100.00% $ 2,351 100.00% $ 1,877 100.00%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) Includes commercial real estate and commercial business loans.
13
<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") and
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, 1999, the Company's mortgage-backed securities and investment
securities portfolio amounted to $56.3 million and $3.0 million, respectively.
At such date, the Company had an unrealized loss of $893,000, 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, 1999, the Company's
mortgage-backed securities amounted to $56.3 million, or 19.3% 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, 1999, 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 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 $240,000.
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
"Depository Institution Regulation -- Capital Requirements."
14
<PAGE>
At September 30, 1999, mortgage-backed securities with an amortized cost of
$57.8 million and a carrying value of $56.3 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 3 of the
Notes to Consolidated Financial Statements in the Annual Report. At September
30, 1999, the Bank's mortgage-backed securities had a weighted average yield of
6.6%.
At September 30, 1999, the average contractual maturity of the Company's
fixed-rate mortgage-backed securities was approximately 21 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. At September 30, 1999, the
Company's entire portfolio of investment securities was classified available for
sale and amounted to $3.0 million, including gross unrealized gains of $24,000.
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, 1999, the estimated average life of the Company's investment
securities portfolio was approximately one year. In addition, at September 30,
1999, the Company had $1.5 million of FHLB stock.
15
<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, 1999.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years Total Investment Portfolio
----------------- ----------------- ----------------- ------------------- --------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Amortized Average
Value Yield Value Yield Value Yield Value Yield Value Cost Yield
------- ----- ------- ----- ------- ----- ------- ----- ------- ----- -------
(Dollars in thousands)
Securities available for sale:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government and
agency securities ..... $ 3,024 7.13% $ -- --% $ -- --% $ -- --% $ 3,024 $ 3,000 7.13%
Mortgage-backed securities -- -- 1,272 6.83 4,705 6.61 50,349 6.75 56,326 57,849 6.59
Securities held to maturity:
FHLB stock (1) ........... -- -- -- -- -- -- 1,460 7.50 1,460 1,460 7.50
------- ----- ------- ----- ------- ----- ------- ----- ------- ------- -----
Total ................ $ 3,024 7.13% $ 1,272 6.83% $ 4,705 6.61% $51,809 6.77% $60,810 $62,309 6.64%
======= ===== ======= ===== ======= ===== ======= ===== ======= ======= =====
</TABLE>
- ---------------
(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.
16
<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,
---------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
Securities available for sale:
<S> <C> <C> <C>
U.S. government and agency securities........ $ 3,024 $ 3,108 $ 3,083
Mortgage-backed securities................... 56,326 27,017 24,818
-------- -------- --------
Total..................................... 59,350 30,125 27,901
Securities held to maturity:
FHLB stock................................... 1,460 1,364 1,288
-------- -------- --------
Total..................................... 1,460 1,364 1,288
-------- -------- --------
Total................................... $ 60,810 $ 31,489 $ 29,189
======== ======== ========
</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 can 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 STAR 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 seven office locations.
17
<PAGE>
The following tables set forth the distribution of the Bank's deposit
accounts at the dates indicated and the weighted average interest rates 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>
At September 30,
-----------------------------------------------------------------
1999 1998 1997
------------------- ------------------- -------------------
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 .............. $ 31,151 .28% $ 26,494 .42% $ 22,788 .61%
Money market .......... 22,375 3.92 16,379 3.62 14,712 4.19
Savings accounts ........ 7,220 1.50 6,398 1.78 6,456 2.00
-------- ------ -------- ------ -------- ------
Total .............. 60,746 1.76 49,271 1.66 43,956 2.01
Certificate accounts:
Less than 12 months (1) 50,671 5.05 30,155 4.89 41,814 5.28
12 - 14 months (1) .... 82,655 5.06 66,064 5.70 27,384 5.14
15 - 72 months (1) .... 40,546 5.44 59,145 5.71 61,962 5.89
-------- ------ -------- ------ -------- ------
Total .............. 173,872 5.15 155,364 5.54 131,160 5.53
-------- ------ -------- ------ -------- ------
Total deposits .......... $234,618 4.27% $204,635 4.58% $175,116 4.65%
======== ====== ======== ====== ======== ======
</TABLE>
- ---------------
(1) Original term.
18
<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, 1999. At such date, such deposits represented 13.38% of total
deposits and had a weighted average rate of 5.13%.
Maturity Period
---------------
(In thousands)
Three months or less....................... $ 104
Over three through six months.............. 3,790
Over six through 12 months................. 19,889
Over 12 months............................. 7,616
----------
Total.................................. $ 31,399
==========
At September 30, 1999, mortgage-backed securities with a carrying value of
$2.0 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, 1999, 1998 and 1997, the Bank's borrowings consisted of FHLB
advances and retail repurchase agreements. 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 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,
-------------------------------
1999 1998 1997
------- ------- -------
(Dollars in thousands)
Amounts outstanding at end of period:
<S> <C> <C> <C>
FHLB advances .......................................... $ -- $ 9,500 $11,000
Federal funds purchased and securities
sold under repurchase agreements ..................... $ 1,318 $ 2,432 $ 1,621
Weighted average rate at end of period:
FHLB advances .......................................... --% 6.00% 6.17%
Federal funds purchased and securities sold under
agreements to repurchase ............................. 3.13% 3.33% 4.67%
Maximum amount of borrowings outstanding at any month end:
FHLB advances .......................................... $19,000 $10,000 $13,000
Federal funds purchased and securities
sold under repurchased agreements .................... 2,374 2,652 1,645
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
At or for the
Year Ended September 30,
-------------------------------
1999 1998 1997
------- ------- -------
(In thousands)
Approximate average short-term borrowings outstanding with respect to:
<S> <C> <C> <C>
FHLB advances........................................... $10,558 $ 1,071 $ 3,400
Federal funds purchased and securities
sold under repurchase agreements...................... 1,773 1,918 1,218
Approximate weighted average rate paid on: (1)
FHLB advances........................................... 5.19% 5.90% 5.78%
Federal funds purchased and securities
sold under agreements to repurchase................... 2.69% 3.98% 4.56%
</TABLE>
- -------------------
(1) Based on month-end balances.
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, 1999, the Bank had 123 full-time and nine 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.
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.
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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.
Recently Enacted Legislation. On November 12, 1999, President Clinton
signed legislation which could have a far-reaching impact on the financial
services industry. The Gramm-Leach-Bliley (G-L-B) Act authorizes affiliations
between banking, securities and insurance firms and authorizes bank holding
companies and national banks to engage in a variety of new financial activities.
Among the new activities that will be permitted to bank holding companies are
securities and insurance brokerage, securities underwriting, insurance
underwriting and merchant banking. The Federal Reserve Board, in consultation
with the Department of Treasury, may approve additional financial activities.
National bank subsidiaries will be permitted to engage in similar financial
activities but only on an agency basis unless they are one of the 50 largest
banks in the country. National bank subsidiaries will be prohibited from
insurance underwriting, real estate development and merchant banking. The G-L-B
Act, however, prohibits future acquisitions of existing unitary savings and loan
holding companies by firms that are engaged in commercial activities and
prohibits the formation of new unitary holding companies.
The G-L-B Act imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the
G-L-B Act. The G-L-B Act directs the federal banking agencies, the National
Credit Union Administration, the Secretary of the Treasury, the Securities and
Exchange Commission and the Federal Trade Commission, after consultation with
the National Association of Insurance Commissioners, to promulgate implementing
regulations within six months of enactment. The privacy provisions will become
effective six months thereafter.
The G-L-B Act contains significant revisions to the Federal Home Loan Bank
System. The G-L-B Act imposes new capital requirements on the Federal Home Loan
Banks and authorizes them to issue two classes of stock with differing dividend
rates and redemption requirements. The G-L-B Act expands the permissible uses of
Federal Home Loan Bank advances by community financial institutions (under $500
million in assets) to include funding loans to small businesses, small farms and
small agri-businesses.
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee. The G-L-B Act reduces the
frequency of Community Reinvestment Act examinations for smaller institutions
and imposes certain reporting requirements on depository institutions that make
payments to non-governmental entities in connection with the Community
Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and
authorizes a federal savings association that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.
The Company is unable to predict the impact of the G-L-B Act on its
operations at this time. Although the G-L-B Act reduces the range of companies
with which the Company may affiliate, it may facilitate affiliations with
companies in the financial services industry.
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<PAGE>
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 CAMELS under the rating system used by the federal bank
regulators, are permitted to operate at or near such minimum level of capital.
All other bank holding companies and banks must maintain a leverage ratio of at
least 4%. 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
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
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<PAGE>
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; 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 CAMELS 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 CAMELS 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 CAMELS rating category. As of
September 30, 1999, the Bank was classified as "well capitalized" under FDIC
regulations.
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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."
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, 1999, of $1.5 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.
Reserves equal to 3% must be maintained on transaction accounts between $5.0
million and $44.3 million, 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
24
<PAGE>
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, 1999, 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 ranges from zero for well capitalized
institutions in Subgroup A to 0.27% of deposits for undercapitalized
institutions in Subgroup C. Both BIF and SAIF members are assessed an amount for
Financing Corporation Bond payments. BIF members are assessed approximately 1.3
basis points while the SAIF rate is approximately 6.4 basis points until January
1, 2000. At that time, BIF and SAIF members will begin pro rata sharing of the
payment at an expected rate of 2.43 basis points.
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, the Bank has
remained a member of the SAIF, which insures the deposits of the Bank to a
maximum of $100,000 for each depositor.
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 22.9% of total assets at September 30, 1999, 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,
1999, 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
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<PAGE>
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 $6.4
million at September 30, 1999. 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 $4.1 million. At September 30,
1999, the Bank's largest lending relationship was a $3.7 million relationship
consisting of two commercial real estate loans. All loans within this
relationship were current and performing in accordance with their terms at
September 30, 1999.
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 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. '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
26
<PAGE>
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 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).
27
<PAGE>
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.
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.
28
<PAGE>
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."
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. For fiscal years beginning prior to December 31, 1995, thrift
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.
As a result of changes in law, thrift institutions were required to change
to either the reserve method or the specific charge-off method that applied to
banks. Legislation passed in August 1996 contained a provision that repeals
29
<PAGE>
the percentage of taxable income method of accounting for thrift bad debt
reserves for tax years beginning after December 31, 1995. The legislation will
trigger bad debt reserve recapture for post 1987 excess reserves over a six year
period.
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 7.25% of
federal taxable income as computed under the Internal Revenue Code, subject to
certain prescribed adjustments. For the tax years beginning in 1998, 1999 and
2000, this rate will be reduced to 7.25%, 7.00% and 6.90%, respectively. 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 11 of Notes
to Consolidated Financial Statements in the Annual Report.
30
<PAGE>
ITEM 2. PROPERTIES
- ------------------
The following table sets forth the location and certain additional
information regarding the Bank's offices at September 30, 1999.
<TABLE>
<CAPTION>
Book Value at
Year Owned or September 30, Approximate
Opened Leased 1999 Square Footage
------ -------- ------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
MAIN OFFICE:
1311 Carolina Avenue
Washington, NC 27889 1986 Owned $ 795 10,200
BRANCH OFFICES:
300 North Market Street
Washington, NC 27889 1959 Owned 222 4,680
301 E. Arlington Blvd.
Greenville, NC 27835 1993 Owned 404 2,600
604 E. Ehringhaus Street
Elizabeth City, NC 27906 1980 Owned 421 2,500
827 Hardee Road
Kinston, NC 28501 1996 Leased 62 2,000
1725 Glenburnie Road
New Bern, NC 28561 1990 Owned 414 2,600
202 Craven Street
New Bern, NC 28560 1995 Leased 62 2,500
300 Sunset Avenue
Rocky Mount, NC 27804 1994 Owned 407 4,948
OPERATIONS CENTER:
239 West Main Street
Washington, NC 27889 1994 Owned 485 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 $3.6
million at September 30, 1999. 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, 1999, 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, 1999 (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 "Market Risk" on
page 5 in the Annual Report is incorporated herein be reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------
The Independent Auditors Report, Consolidated Financial Statements, Notes
to Consolidated Financial Statements and Selected Financial Data contained on
pages 14 through 39 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 ASection 16(a) Beneficial Ownership Reporting
Compliance in the Company's definitive proxy statement for the Company's 2000
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 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, 1999 and
1998
Consolidated Statements of Operations for the Years Ended September 30,
1999, 1998 and 1997
Consolidated Statements of Stockholders Equity for the Years Ended
September 30, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the Years Ended September 30,
1999, 1998 and 1997
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>
10.9 NewSouth Bancorp, Inc. Management Recognition Plan
(Incorporated herein by reference from Exhibit 99.1 to the
Company's Registration Statement on Form S-8 (File No.
333-49759))
10.10 NewSouth Bancorp, Inc. 1997 Stock Option Plan (Incorporated
herein by reference from Exhibit 99.2 to the Company's
Registration Statement on Form S-8 (File No. 333-49759)) and
1999 Amendment to NewSouth Bancorp, Inc. 1997 Stock Option Plan
10.11 Employment Agreements between NewSouth Bank and H.D. Reaves,
Jr., Allen Lloyd and Anthony R. Strickland
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of PricewaterhouseCoopers LLP
27 Financial Data Schedule
(B) REPORTS ON FORM 8-K. On September 22, 1999, the Company filed a Current
Report on Form 8-K reporting under Item 5 that the Company had completed the
previously announced 5% stock repurchase program and had adopted a program to
repurchase an additional 5% of its issued and outstanding shares of Common
Stock.
On August 16, 1999, the Company filed a Current Report on Form 8-K
reporting under Item 5 that the Company had signed an agreement to acquire Green
Street Financial Corp, the holding company for Home Federal Savings and Loan
Association.
(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 27, 1999
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 27, 1999
- --------------------------------------------
Thomas A. Vann
President and Director
(Principal Executive Officer)
/s/ William L. Wall December 27, 1999
- --------------------------------------------
William L. Wall
Executive Vice President, Chief Financial
Officer and Secretary
(Principal Financial and Accounting Officer)
/s/ Edmund T. Buckman, Jr. December 27, 1999
- --------------------------------------------
Edmund T. Buckman, Jr.
Director
/s/ Linley H. Gibbs, Jr. December 27, 1999
- --------------------------------------------
Linley H. Gibbs, Jr.
Director
/s/ Frederick N. Holscher December 27, 1999
- --------------------------------------------
Frederick N. Holscher
Director
/s/ Frederick H. Howdy December 27, 1999
- --------------------------------------------
Frederick H. Howdy
Director
/s/ Charles E. Parker, Jr. December 27, 1999
- --------------------------------------------
Charles E. Parker, Jr.
Director
/s/ Marshall T. Singleton December 27, 1999
- --------------------------------------------
Marshall T. Singleton
Director
/s/ H. D. Reaves, Jr. December 27, 1999
- --------------------------------------------
H. D. Reaves, Jr.
Director
EXHIBIT 13
1999 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 40
Executive Officers 40
NewSouth Bank Office Locations 40
Stockholder Information 41
MISSION STATEMENT
"Our mission is to become the premier community bank in eastern North Carolina.
We will enhance shareholder value by serving the personal and business needs of
our markets, providing superior customer service, investing in the communities
that we serve, and enriching the lives of our employees."
<PAGE>
LETTER TO STOCKHOLDERS
To Our Stockholders:
The year ended September 30, 1999 was the best in NewSouth's history. We met our
projected financial results and accomplished all of our strategic objectives.
Record earnings per share were achieved, the cash dividend payment rate was
increased by 42.9%, and excellent growth was achieved in our commercial loan
portfolio. The company continued to leverage its capital by signing a definitive
agreement to acquire Green Street Financial Corp, the holding company of Home
Federal Savings and Loan Association in Fayetteville, NC. We are pleased with
the results achieved during 1999 and are encouraged about the company's future.
Net income for the year ending September 30, 1999 was $3.2 million, compared to
$3.1 million for 1998. Diluted earnings per share increased 13.8% to $0.91 per
share for 1999, from $0.80 per share for 1998.
On August 9, 1999, NewSouth announced the signing of a definitive agreement to
acquire Home Federal Savings and Loan Association. With approximately $161
million in assets, this acquisition, which is expected to occur during the
fourth quarter of 1999, will allow us to leverage our capital through a purchase
acquisition. This acquisition will give us an important entrance into
southeastern North Carolina and the cities of Fayetteville and Lumberton. Home
Federal and NewSouth share the same philosophy of customer and community service
and safe and sound banking operations. The company should blend quickly and
produce greater opportunities for NewSouth.
In conjunction with the Home Federal acquisition, NewSouth Bank will change its
name to First South Bank. This change will reflect our expanded market area and
also reflect our desire to be first in community banking. We look forward to
this change.
While energy and attention is focused on the acquisition and merger of the two
institutions, NewSouth is continuing to expand. We are pleased to announce that
the Bank's ninth full service branch office in Chocowinity, NC will open during
the fourth quarter of 1999. This office will compliment our other Beaufort
County offices and serve as an additional base for developing customer
relationships and meeting the banking needs of our growing market. Additional
branch offices are being planned and we will continue to grow both internally
and through acquisitions that will enhance our franchise value.
Many of our future strategies are focused on enhancing our franchise value
through dependable customer service, the development of a more effective banking
operation and our commitment to becoming the best community bank in eastern and
southeastern North Carolina. During the coming year, we will develop and
implement a web page, expanded 24 hour banking services, establish an SBA loan
department, implement commercial sweep accounts and leasing services and offer
more products and services to meed the needs or our growing customer base.
Our people are our greatest asset and resource. Our performance is dependant on
their intelligence, teamwork and their individual efforts to make us a
successful company. I want to thank them for their efforts in making NewSouth so
successful.
Each member of your Board of Directors along with our officers and employees
join me in thanking you for your continued support of NewSouth Bancorp. As
always, your comments or suggestions are welcome and we look forward to your
continued support.
Sincerely,
Tom Vann
President
1
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
<TABLE>
<CAPTION>
September 30,
--------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands)
Selected Financial Condition Data
- ---------------------------------
<S> <C> <C> <C> <C> <C>
Total assets $ 292,305 $ 281,479 $ 249,281 $ 194,139 $ 177,704
Loans receivable, net 212,054 224,999 197,785 155,681 144,541
Cash and investment securities 12,435 20,119 18,856 16,684 4,788
Mortgage-backed securities 56,326 27,017 24,818 14,797 22,285
Deposits 234,618 204,635 175,116 171,213 153,457
Borrowings 1,318 11,933 12,621 1,040 4,000
Stockholders' equity 48,763 56,714 57,856 18,347 17,688
Selected Operations Data
- ------------------------
Interest income $ 23,129 $ 21,867 $ 18,515 $ 15,349 $ 14,385
Interest expense 9,979 9,240 8,346 8,105 7,344
--------- --------- --------- --------- ---------
Net interest income 13,150 12,627 10,169 7,244 7,041
Provision for loan losses 120 310 931 511 20
Noninterest income 2,874 2,646 1,685 1,833 1,502
Noninterest expenses 10,255 9,940 6,941 7,295 5,660
--------- --------- --------- --------- ---------
Income before income taxes 5,649 5,023 3,982 1,271 2,863
Income taxes 2,453 1,900 1,719 451 998
--------- --------- --------- --------- ---------
Net income $ 3,196 $ 3,123 $ 2,263 $ 820 $ 1,865
========= ========= ========= ========= =========
Earnings per share (1)(2) $ .91 $ .80 $ .35 $ -- $ --
========= ========= ========= ========= =========
Dividends per share (2) $ .31 $ .27 $ .13 $ -- $ --
========= ========= ========= ========= =========
Selected Financial Ratios and Other Data
- ----------------------------------------
Performance Ratios:
Return on average assets 1.09% 1.19% 1.00% .45% 1.07%
Return on average equity 6.03 5.40 6.57 4.45 11.17
Interest rate spread 3.95 4.03 4.10 3.72 3.84
Net interest margin 4.69 5.05 4.67 4.12 4.21
Average earning assets to average
interest-bearing liabilities 121.04 127.57 115.00 108.52 108.40
Noninterest expense to average assets 3.50 3.80 3.06 3.97 3.26
Dividend payout ratio 34.07 33.75 37.14 -- --
Quality Ratios:
Nonperforming assets to total assets .41% .43% .65% .62% .42%
Nonperforming loans to total loans .27 .36 .64 .66 .47
Loan loss reserves to total loans 1.53 1.50 1.64 1.51 1.30
Loan loss reserves to nonperforming
loans 581.48 419.45 257.45 227.37 275.62
Provision for loan losses to total loans .06 .14 .47 .32 .01
Capital Ratios:
Equity to total assets, end of period 16.69% 19.95% 23.23% 9.45% 9.95%
Average equity to average assets 18.09 22.14 15.17 10.05 9.61
Other Data:
Full service offices 9 8 8 8 8
Loans serviced for others $ 275,255 $ 250,202 $ 253,647 $ 253,682 $ 229,635
</TABLE>
- ----------------------------
(1) Applies to net income of $1,395,900 earned for the period April 8, 1997 to
September 30, 1997.
(2) Adjusted for three-for-two stock split on August 19, 1998.
2
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
NewSouth Bancorp, Inc. (the "Company") was formed on April 7, 1997 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. Prior
to the stock conversion, the Company had no assets or liabilities and engaged in
no business activities. Subsequent to the stock conversion, the Company has
engaged in no significant activities 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 the Bank can be more effective in
serving its customers than many larger competitors, because of its ability to
quickly and effectively respond 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 North Carolina Office of The Commissioner of
Banks (the "Commissioner"). Savings banks which convert to commercial banks are
required to maintain 15% liquidity pursuant to the conversion guidelines adopted
by the Commissioner. The Bank's liquidity ratio, as computed under these
guidelines, was 22.9% at September 30, 1999 compared to 15.1% at September 30,
1998.
The Bank's primary sources of funds are deposits, principal and interest
payments on loans, proceeds from loan sales 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 interest rates, economic conditions and
local competition.
The primary investing activity of the Bank is the origination of
commercial, consumer and mortgage loans. During the years ended September 30,
1999 and 1998, the Bank had loan originations of $177.5 million and $173.1
million, respectively. The primary financing activities of the Bank are the
attraction of checking, certificate and 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, 1999 and 1998,
cash and cash equivalents totaled $9.4 million and $17.0 million, respectively.
The Bank has other sources of liquidity if a need for additional funds arises.
During the years ended September 30, 1999 and 1998, the Bank sold and exchanged
real estate loans totaling $86.1 million and $54.1 million, respectively. At
September 30, 1999, the Bank had no outstanding FHLB advances, compared to $9.5
million at September 30, 1998. At September 30, 1999, the Bank had $1.3 million
of retail repurchase agreements, compared to $1.9 million at September 30, 1998.
Other sources of liquidity include investment and mortgage-backed securities
designated as available for sale, which totaled $59.4 million at September 30,
1999 and $30.1 million at September 30, 1998.
3
<PAGE>
At September 30, 1999 stockholders' equity was $48.8 million compared to
$56.7 million at September 30, 1998. At September 30, 1999 the Company had
3,550,541 shares of common stock outstanding, net of 813,503 treasury shares.
Net income for the year ended September 30, 1999 was $3.2 million, compared to
$3.1 million for the year ended September 30, 1998.
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 regulatory agencies. The
Bank's stand-alone equity was $42.6 million at September 30, 1999, compared to
$42.0 million at September 30, 1998, 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 capital requirements of both the
Commissioner and the FDIC at September 30, 1999 and September 30, 1998.
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.
A principal strategy in managing the Bank's interest rate risk has been to
increase interest rate sensitive assets such as commercial and consumer loans.
At September 30, 1999, the Bank had $89.5 million of commercial loans and $50.8
million of consumer loans, or 41.5% and 23.6%, respectively, of the Bank's gross
loan portfolio, compared to $73.3 million and $48.4 million, respectively, at
September 30, 1998. At September 30, 1999, the Bank had $13.5 million of loans
held for sale, compared to $38.4 million at September 30, 1998. Depending on
conditions existing at a given time, as part of its interest rate risk
management strategy, the Bank may sell fixed-rate residential mortgage loans in
the secondary market.
In managing its portfolio of investment securities, the Bank has emphasized
the purchase of short-term securities to reduce it's exposure to increases in
interest rates. The Bank had $59.4 million of investment and mortgage-backed
securities classified as available for sale at September 30, 1999, compared to
$30.1 million at September 30, 1998. The Bank is holding these 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.
4
<PAGE>
MARKET RISK
Market risk reflects the risk of economic loss resulting from changes in
market prices and interest rates. The risk of loss can be reflected in
diminished current market values and/or reduced potential net interest income in
future periods. The Bank's market risk arises primarily from interest rate risk
inherent in its lending and deposit taking activities. The Bank does not
maintain a trading account for any class of financial instruments, nor does it
engage in hedging activities or purchase high-risk derivative instruments.
Furthermore, the Bank is not subject to foreign currency exchange risk or
commodity price risk.
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
3% 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% and 56% and decreases in NPV of 15%, 36% and 61% in
the event of sudden and sustained 1% to 3% 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, 1999.
TABLE 1 - PROJECTED CHANGE IN NPV AND NET INTEREST INCOME
Net Portfolio Value Net Interest Income
Change ------------------------------- ------------------------------
in Rates $ Amount $ Change % Change $ Amount $ Change % Change
- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
+ 300 bp $ 42,653 $(12,790) (23.1)% $ 11,024 $ (466) (4.1)%
+ 200 bp 47,065 (8,378) (15.1) 11,231 (259) (2.3)
+ 100 bp 51,339 (4,104) (7.4) 11,377 (113) (1.0)
Base 55,443 -- -- 11,490 -- --
- - 100 bp 59,070 3,627 6.5 11,561 71 .6
- - 200 bp 61,995 6,552 11.8 11,647 157 1.4
- - 300 bp 63,691 8,248 14.9 11,732 242 2.1
Table 1 indicates that at September 30, 1999, in the event of sudden and
sustained increases in market interest rates, the Bank's estimated net interest
income and NPV would be expected to decrease, and that in the event of sudden
and sustained decreases in market interest rates, estimated net interest income
and NPV would be expected to increase. At September 30, 1999, 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.
5
<PAGE>
Certain shortcomings are inherent in the method of analysis presented in
Table 1. For example, although certain assets and liabilities may have similar
maturities to repricing, they may react in differing degrees to changes in
market interest rates. The interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates. 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 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. Also, 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-rate-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,
------------------------------------------------------------------------------------
1999 vs. 1998 1999 vs. 1998
---------------------------------------- ----------------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
---------------------------------------- ----------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ---- ------ ----- ------ ---- ------ -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable ............... $ 1,338 $ (902) $ (62) $ 374 $ 2,670 $ 104 $ 17 $ 2,791
Investment securities .......... 5 3 -- 8 (54) 47 (8) (15)
Mortgage-backed securities ....... 1,066 (89) (42) 935 784 (10) (5) 769
Other interest-earning assets .. 30 (79) (6) (55) (250) 101 (44) (193)
------- ------- ------- ------- ------- ------- ------- -------
Total interest-earning assets 2,439 (1,067) (110) 1,262 3,150 242 (40) 3,352
------- ------- ------- ------- ------- ------- ------- -------
Interest expense:
Deposits ....................... 1,207 (813) (110) 284 369 610 29 1,008
FHLB advances .................. 587 (10) (92) 485 (138) 1 (1) (138)
Other interest-bearing
liabilities ................. (5) (27) 2 (30) 33 (6) (3) 24
------- ------- ------- ------- ------- ------- ------- -------
Total interest-bearing
liabilities ................. 1,789 (850) (200) 739 264 605 25 894
------- ------- ------- ------- ------- ------- ------- -------
Change in net interest income ..... $ 650 $ (217) $ 90 $ 523 $ 2,886 $ (363) $ (65) $ 2,458
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
6
<PAGE>
TABLE 3 - YIELD/COST ANALYSIS
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- ------------------------- -------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in thousands)
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable (1) $220,123 $19,262 8.75% $205,587 $18,888 9.19% $176,311 $16,097 9.13%
Investment securities 4,484 319 7.11 4,410 311 7.05 5,287 326 6.17
Mortgage-backed securities 46,279 3,225 6.97 31,565 2,290 7.25 20,832 1,521 7.30
Other Interest-earning assets 9,248 323 3.49 8,570 378 4.41 15,249 571 3.75
-------- ------- ---- -------- ------- ---- ------- ------ ----
Total interest-earning assets 280,134 23,129 8.26 250,132 21,867 8.74 217,679 18,515 8.51
------- ---- ------ ---- ------ ----
Non-interest-earning assets 13,026 11,278 9,311
-------- -------- --------
Total assets $293,160 $261,410 $226,990
======== ======== ========
Interest-bearing liabilities:
Deposits $218,742 9,380 4.29 $193,061 9,096 4.71 $184,672 8,088 4.38
FHLB advances 10,885 549 5.04 1,071 64 5.98 3,400 202 5.94
Other interest-bearing liabilities 1,815 50 2.75 1,944 80 4.12 1,218 56 4.60
-------- ------- ---- ------- ------ ---- -------- ------- ----
Total interest-bearing liabilities 231,442 9,979 4.31 196,076 9,240 4.71 189,290 8,346 4.41
------- ---- ----- ---- ------- ----
Non-interest-bearing liabilities 8,688 7,445 3,265
-------- ------- -------
Total liabilities 240,130 203,521 192,555
Stockholders' equity 53,030 57,889 34,435
-------- ------- -------
Total liabilities and retained income $293,160 $261,410 $226,990
======== ======== ========
Net interest income $13,150 $12,627 $10,169
======= ======= =======
Interest rate spread (2) 3.95% 4.03% 4.10%
==== ==== ====
Net yield on interest-earning assets (3) 4.69% 5.05% 4.67%
==== ====
Ratio of average interest-earning assets
to average interest bearing liabilities 121.04% 127.57% 115.00%
====== ====== ======
</TABLE>
- -------------------------------------------------------
(1) Includes non-performing loans.
(2) Represents the difference between the average yield on interest-earning
assets and the average cost of interest bearing liabilities.
(3) 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 operations for the three
years ended September 30, 1999, 1998, and 1997 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, 1999 and 1998
Total assets increased 3.8% to $292.3 million at September 30, 1999, from
$281.5 million at September 30, 1998. Loans receivable (net of loans-in-process,
deferred fees and loan loss reserves) decreased 5.7% to $212.1 million at
September 30, 1999, from $225.0 million at September 30, 1998. Investment
securities and mortgage-backed securities increased 97.0% to $59.4 million at
September 30, 1999, from $30.1 million at September 30, 1998.
In recent years, the Bank has increased its emphasis on the origination of
both secured and unsecured commercial and consumer loans in order to take
advantage of generally higher yields as well as shorter terms to maturity. Prior
thereto, 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.
Commercial loans increased 22.1% to $89.5 million at September 30, 1999,
from $73.3 million at September 30, 1998, while consumer loans increased 5.1% to
$50.8 million at September 30, 1999 from $48.4 million at September 30, 1998,
reflecting the Bank's emphasis of structuring itself as a commercial banking
entity. Residential real estate mortgage loans decreased 29.6% to $75.5 million
at September 30, 1999, from $107.3 million at September 30, 1998. During fiscal
1999, the Bank originated $91.2 million of residential real estate mortgage
loans, compared to $95.7 million during fiscal 1998. The Bank sold and exchanged
$86.1 million of real estate loans during fiscal 1999, compared to $54.1 million
during fiscal 1998. Loans serviced for others was $275.3 million at September
30, 1999, compared to $250.2 million at September 30, 1998. Commercial and
consumer loan originations increased to $86.3 million during fiscal 1999, from
$77.4 million during fiscal 1998.
Deposits increased 14.7% to $234.6 million at September 30, 1999, from
$204.6 million at September 30, 1998. Certificates of deposit increased 11.9% to
$173.9 million at September 30, 1999, from $155.4 million at September 30, 1998.
The Bank continued its efforts of attracting lower cost core deposits, as
checking accounts increased 24.8% to $53.5 million at September 30, 1999, from
$42.9 million at September 30, 1998. Total borrowings were $1.3 million at
September 30, 1999 compared to $11.9 million at September 30, 1998, supporting
the Bank's banking operations and liquidity requirements during the periods.
Stockholders' equity was $48.8 million at September 30, 1999, compared to
$56.7 million at September 30, 1998. The ratio of equity to total assets at
September 30, 1999 decreased to 16.7% from 19.9% at September 30, 1998. During
the years ended September 30, 1999 and 1998, the Company declared four quarterly
cash dividends each, totaling $1.1 million and $1.0 million respectively,
reflecting dividend payout ratios of 34.1% and 33.8% respectively. 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 Employee Stock Ownership Plan
("ESOP") declined to $2.3 million at September 30, 1999, from $2.7 million at
September 30, 1998, reflecting the release of 42,359 shares to ESOP
participants. The note is reported as a reduction of stockholders' equity and
requires an annual $349,000 principal payment plus interest at prime plus one
percent. Although the ESOP note is secured solely by shares of common
8
<PAGE>
stock of the Company, the Bank expects to make discretionary contributions to
the ESOP in amounts at least equal to the required principal and interest
payments. At September 30, 1999, 226,350 unallocated shares remained in the
ESOP, compared to 268,709 at September 30, 1998.
During fiscal 1998, the Company's stockholders approved the Management
Recognition Plan ("MRP"), representing 174,570 shares (4% of outstanding
shares), costing $3.3 million. This deferred stock awards plan was established
for the benefit of directors and officers of the Company and the Bank, and the
vesting schedule provides that one-third of the shares are earned and become
non-forfeitable on April 8, 1998, 1999, and 2000. During 1999, 58,187 of the
awarded shares were vested. At September 30, 1999, the remaining 58,187 of the
awarded shares are being held in trust for future vesting, and reported as a
reduction in stockholders' equity as deferred stock awards.
Pursuant to stock repurchase programs adopted by the Company during fiscal
years 1999 and 1998, the Company acquired 595,301 and 218,202 shares of its
common stock, respectively, through open market and private purchases. Shares
acquired under the repurchase program are being held as treasury stock, at cost.
At September 30, 1999, treasury shares were 813,503 totaling $15.8 million,
compared to 218,202 shares totaling $4.9 million at September 30, 1998. The
Company believes the repurchase of its outstanding common stock will improve
liquidity in the market for its common stock, increase per share earnings and
book value, provide an attractive investment for the Company's excess funds and
decrease the potential dilutive effect caused by the future exercise of stock
options.
Comparison of Operating Results for the Years Ended September 30, 1999 and 1998
Net Income. Net income increased to $3.2 million for the year ended
September 30, 1999, from $3.1 million for the year ended September 30, 1998.
Basic and diluted earnings per share increased 13.8% to $0.91 per share for the
year ended September 30, 1999, compared to $0.80 per share for the year ended
September 30, 1998. The average number of shares outstanding (net of unearned
ESOP, MRP and treasury shares) was 3,530,811 and 3,876,813, respectively, for
the years ended September 30, 1999 and 1998, reflecting the impact of the stock
repurchases.
Interest Income. Interest income increased 5.8% to $23.1 million for fiscal
1999, from $21.9 million for fiscal 1998. The increase in interest income on
loans and investments during 1999 results principally from the increased volume
of average interest-earning assets. The average balance of interest-earning
assets increased 12.0% to $280.1 million for fiscal 1999, from $250.1 million
for fiscal 1998. The yield on average interest-earning assets declined to 8.3%
for 1999, from 8.7% for 1998, reflecting the general decline in interest rates
during 1999.
Interest Expense. Interest expense increased 8.0% to $9.9 million for
fiscal 1999, from $9.2 million for fiscal 1998. The increase in interest expense
on deposits and borrowings during 1999 results principally from the increased
volume of average interest-bearing liabilities. The average balance of
interest-bearing liabilities increased 18.0% to $231.4 million for fiscal 1999,
from $196.1 million for fiscal 1998. The cost of interest-bearing liabilities
declined to 4.3% for 1999, from 4.7% for 1998, also reflecting the general
decline in interest rates during 1999.
Net Interest Income. Net interest income increased 4.1% to $13.2 million
for fiscal 1999, from $12.6 million for fiscal 1998. The increase in net
interest income is primarily due to the combination of the increases in both the
volume of average interest-earning assets and interest-bearing liabilities,
offset by the general decline in interest rates during 1999, as discussed above.
The net yield on interest-earning assets (net interest income divided by average
interest-earning assets) declined to 4.7% for fiscal 1999, from 5.0% for 1998.
See Table 2 (Rate/Volume Analysis) and Table 3 (Yield/Cost Analysis) above for
additional information on interest income, interest expense, net interest
income, average balances and yield/cost ratios.
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 $120,000 and $310,000 for loan losses during the
years ended September 30, 1999 and 1998, respectively. These 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 $3.3
million at September 30, 1999, compared to $3.4 million at September 30, 1998,
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 1.5% at September 30, 1999 and
1998.
9
<PAGE>
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
generally, and delinquent loans are analyzed individually, on a quarterly basis.
Consideration is given to the loan status, payment history, ability to repay,
probability of repayment, and loan-to-value percentages. As a result of this
review and analysis, loans are classified in 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 0.2% at September 30, 1999 and 0.4% at September 30,
1998.
Other Income. Other income increased 8.6% to $2.9 million for fiscal 1999,
from $2.6 million for fiscal 1998. Other 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 28.5% to $1.3 million for fiscal 1999, from $985,000 for fiscal 1998,
reflecting the growth in the commercial and consumer loan portfolios and
checking accounts during 1999. Gains from sales of loans and mortgage-backed
securities declined to $560,000 for fiscal 1999 from $796,000 for fiscal 1998.
The volume of loans and mortgage-backed securities sold during 1999 was $46.0
million, compared to $45.1 million for 1998, reflecting more competitive pricing
in the secondary mortgage market. Servicing fee income on loans serviced for
others increased to $762,000 for 1999 from $637,000 for 1998, as loans serviced
for others increased 9.2% to $275.3 million at September 30, 1999, from $250.2
million at September 30, 1998.
General and Administrative Expenses. General and administrative expenses
increased 3.2% to $10.3 million for fiscal 1999, from $9.9 million in fiscal
1998. The Company's efficiency ratio (noninterest expenses divided by net
interest income plus noninterest income) improved to 63.9% for fiscal 1999, from
65.1% for fiscal 1998.
The largest single component of these expenses, compensation and fringe
benefits, declined 4.4% to $6.9 million for fiscal 1999, from $7.2 million for
fiscal 1998. During fiscal 1999, the benefits expense for the MRP plan declined
29.4% to $1.3 million, compared to $1.9 million for fiscal 1998. The Bank
recorded $854,000 in benefits expense for the ESOP in fiscal 1999, compared to
$826,000 in fiscal 1998. Other noninterest expenses including deposit insurance
premiums, premises and equipment, advertising and office expenses sustained
marginal incremental increases from 1998 to 1999, supporting a 17.3% growth in
assets from September 30, 1997 to September 30, 1999.
Income Taxes. The provision for income taxes increased to $2.5 million for
fiscal 1999 from $1.9 million for fiscal 1998. The increase in provision for
income taxes is the result of the increased pretax earnings to $5.6 million for
fiscal 1999, from $5.0 million for fiscal 1998, and the effective income tax
rates for each period.
Comparison of Financial Condition at September 30, 1998 and 1997
Total assets increased 12.9% to $281.5 million at September 30, 1998, from
$249.3 million at September 30, 1997. Loans receivable (net of loans-in-process,
deferred fees and loan loss reserves) increased 13.8%, to $225.0 million at
September 30, 1998 from $197.8 million at September 30, 1997. Investment
securities and mortgage-backed securities increased 8.0%, to $30.1 million at
September 30, 1998, from $27.9 million at September 30, 1997.
Commercial loans increased 17.4% to $73.3 million at September 30, 1998,
from $62.4 million at September 30, 1997, while consumer loans declined 3.0% to
$48.4 million at September 30, 1998, from $49.9 million at September 30, 1997.
Residential real estate mortgage loans increased 17.6% to $120.2 million at
September 30, 1998, from $102.2 million at September 30, 1997. During fiscal
1998, the Bank originated $95.7 million of residential real estate mortgage
loans, compared to $66.9 million during fiscal 1997. The Bank sold and exchanged
$54.1 million of real estate loans during fiscal 1998, compared to $31.7 million
during fiscal 1997. Loans serviced for others was $250.2 million at September
30, 1998, compared to $253.7 million at September 30, 1997. Commercial real
estate, commercial business and consumer loan originations increased to $77.4
million during fiscal 1998, from $76.8 million during fiscal 1997.
Deposits increased 16.9%, to $204.6 million at September 30, 1998, from
$175.1 million at September 30, 1997. Certificates of deposits increased 18.4%
to $155.4 million at September 30, 1998, from $131.2 million at September 30,
1997, and checking accounts increased 16.8% to $42.9 million at September 30,
1998, from $37.5
10
<PAGE>
million at September 30, 1997. Total borrowings were $12.0 million at September
30, 1998, compared to $12.6 million at September 30, 1997, supporting the growth
in earning assets and banking operations during the periods.
Stockholders' equity was $56.7 million at September 30, 1998, compared to
$57.9 million at September 30, 1997. The ratio of equity to total assets at
September 30, 1998 declined to 19.9%, from 23.2% at September 30, 1997. During
the year ended September 30, 1998, the Company declared four quarterly cash
dividends totaling $1.0 million, reflecting a dividend payout ratio of 33.8%.
The Company's note receivable from the ESOP declined to $2.7 million at
September 30, 1998, from $3.1 million at September 30, 1997, reflecting the
release of 43,189 shares to ESOP participants. At September 30, 1998, 268,709
unallocated shares remained in the ESOP.
During the year ended September 30, 1998, 58,195 of the shares awarded to
MRP participants were vested, and 116,374 of the awarded shares were being held
in trust for future vesting, and reported as a reduction in stockholders' equity
as deferred stock awards.
Comparison of Operating Results for the Years Ended September 30, 1998 and 1997
Net Income. Net income increased 38.0% to $3.1 million for the year ended
September 30, 1998, from $2.3 million for the year ended September 30, 1997. The
increase in net income is attributable to a 28.8% increase in net interest
income and other income, offset in part by a 43.2% increase in general and
administrative expenses.
Interest Income. Interest income increased 18.1% to $21.9 million for
fiscal 1998, from $18.5 million for fiscal 1997. The increase in interest income
on loans and investments during 1998 results from the increased volume of
average interest-earning assets. Interest on loans increased 17.3% to $18.9
million in fiscal 1998, from $16.1 million in fiscal 1997, due primarily to a
$29.3 million increase in the average balance of loans receivable between fiscal
1998 and 1997, and an increase in the average yield on loans to 9.19% for fiscal
1998 from 9.13% for fiscal 1997. The yield on average interest-earning assets
was 8.7% for 1998, compared to 8.5% for 1997.
Interest Expense. Interest expense for fiscal 1998 increased 10.7% to $9.2
million, from $8.3 million for fiscal 1997. This resulted principally from an
increase in the rates paid on average interest-bearing liabilities. Total
deposits increased 16.9% to $204.6 million for fiscal 1998, from $175.1 million
for fiscal 1997. The average cost of interest-bearing liabilities increased to
4.7% for 1998, from 4.4% for 1997. The average balance of interest-bearing
liabilities increased 3.6% to $196.1 million for fiscal 1998, from $189.3
million for fiscal 1997.
Net Interest Income. Net interest income increased 24.2% to $12.6 million
for the year ended September 30, 1998, from $10.2 million for the year ended
September 30, 1997.
Provision for Loan Losses. The Bank provided $310,000 and $931,000 for loan
losses during the years ended September 30, 1998 and 1997, respectively. The
allowance for loan losses was $3.4 million at September 30, 1998, compared to
$3.2 million at September 30, 1997, which the Bank believes was 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
1.5% at September 30, 1998, compared to 1.6% at September 30, 1997. The ratio of
nonperforming loans to total loans was 0.4% at September 30, 1998 and 0.6% at
September 30, 1997.
Other Income. Other income increased 57.0% to $2.7 million for fiscal 1998,
from $1.7 million for fiscal 1997. Other 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 $985,000 for fiscal 1998 from $752,000 for fiscal 1997, reflecting
the growth in the loan portfolio during 1998. Gains from sales of loans and
mortgage-backed securities increased to $796,000 for fiscal 1998, from $124,000
for fiscal 1997, as the volume of loans and mortgage-backed securities sold
during 1998 increased to $45.1 million, from $19.8 million for 1997. Servicing
fee income on loans serviced for others was $637,000 for 1998, compared to
$613,000 for 1997.
General and Administrative Expenses. General and administrative expenses
increased 43.2% to $9.9 million for fiscal 1998, from $6.9 million in fiscal
1997. The Company's efficiency ratio increased to 65.1% for fiscal 1998, from
58.6% for fiscal 1997.
11
<PAGE>
The largest single component of these expenses, compensation and fringe
benefits, increased to $7.2 million for fiscal 1998 from $4.6 million for fiscal
1997. During fiscal 1998 the Bank recorded $1.9 million of benefits expense for
the MRP plan, compared to no expense MRP expense in fiscal 1997. In addition,
the Bank recorded $826,000 in benefits expense for the ESOP in fiscal 1998,
compared to $603,000 in fiscal 1997. This increase is also a result of the
growth in personnel and management required to support the 45.0% growth in
assets from September 30, 1996 to September 30, 1998. Other noninterest expenses
including deposit insurance premiums, premises and equipment, advertising and
zoffice expenses remained relatively constant from period to period.
Income Taxes. The provision for income taxes increased to $1.9 million for
fiscal 1998 from $1.7 million for fiscal 1997. The increase in provision for
income taxes is the result of the increased pretax earnings to $5.0 million for
fiscal 1998, from $4.0 million for fiscal 1997 and the effective income tax
rates then in effect.
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.
YEAR 2000
A great deal of information has been disseminated about the global computer
crash that may occur in the year 2000 ("Y2K"). Many computer programs that can
only distinguish the final two digits of the year entered (a common programming
practice in earlier years) are expected to read entries for the year 2000 as the
year 1900 and compute payment, interest or delinquency based on the wrong date
or are expected to be unable to compute payment, interest or delinquency. Rapid
and accurate data processing is essential to the operations of the Bank, most
other financial institutions and many other companies.
In compliance with regulatory guidelines, the Bank has formed a Y2K
committee to review the effects the century date change may have on all current
operating systems and to assess the potential risks associated with the Y2K
issue. Formal Y2K strategic contingency plans have been developed to address the
necessary steps to insure that problems and disruptions related to the Y2K issue
are minimized.
All material data processing functions of the Bank that could be impacted
by the Y2K issue are provided by a national third party service bureau, Bisys,
Inc. Bisys has dedicated significant resources in assuring its systems are Y2K
compliant. In doing so, Bisys developed a comprehensive testing and verification
program, in which the Bank participated.
The Bank has successfully completed an extensive series of simulated date
testing on the Bisys host system, including the century date rollover from
December 31, 1999 to January 3, 2000 for all system applications. All Bank user
departments have successfully completed testing their system applications and
business resumption contingency plans, assuring validation of the century date
changes and system readiness. Additional testing has also taken place with all
other external mission critical information systems and relationships with which
the Bank exchanges data or information.
The Bank has implemented an aggressive customer awareness campaign aimed at
educating its customers on both the Y2K issue and the Bank's Y2K plans. In the
event of any real or perceived Y2K concerns, a cash contingency plan has been
developed to deal with any potential increase in currency demand. Throughout the
remainder of 1999, the Bank will continue to implement its customer awareness
campaign. In addition, the Bank will continue to monitor and refine its Y2K
preparedness to insure it is ready for this unprecedented event.
In addressing the Y2K issue, the Bank has used its current internal
staffing with little reliance on outside resources. Bisys has provided
remediated host system software at no expense to the Bank and major system is
12
<PAGE>
expected to be replaced in the near future. As a result, estimated Y2K related
expenses of $70,000 were accrued fiscal year 1999, compared to less than $5,000
for fiscal 1998. The Bank believes the cost of addressing the Y2K issue going
forward will have no material impact on its results of operations, liquidity,
capital resources, or uncertainty that would cause its reported financial
condition not to be necessarily indicative of future operating results or
financial condition.
FORWARD LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 states that the
disclosure of forward looking information is desirable for investors and
encourages such disclosure by providing a safe harbor for forward looking
statements by corporate management. This Annual Report, including the Letter to
Stockholders and Management's Discussion and Analysis of Financial Condition and
Results of Operations, contains forward looking statements that involve risk and
uncertainty. In order to comply with the terms of the safe harbor, the Company
notes that a variety of risks and uncertainties could cause its actual results
and experience to differ materially from the anticipated results or other
expectations expressed in the Company's forward looking statements. The risks
and uncertainties that may affect the operations, performance, development,
growth projections and results of the Company's business include, but are not
limited to, economic growth, interest rate movements, timely development of
technology enhancements for products, services and operating systems, the impact
of competitive products, services and pricing, customer requirements, regulatory
changes and similar matters. Readers of this report are cautioned not to place
undue reliance on forward looking statements that are subject to influence by
these risk factors and unanticipated events. Accordingly, actual results may
differ materially from management's expectations.
SIGNIFICANT ACTIVITIES AND SUBSEQUENT EVENTS
On August 9, 1999, the Company signed an Agreement and Plan of Merger (the
"Plan") with Green Street Financial Corp ("Green Street"). The Plan provided
that the Company acquire Green Street for a cash purchase price of $59.2
million, representing $15.25 per share of Green Street common stock. The merger
was consummated on November 30, 1999, and was accounted for using the purchase
method of accounting. Summary financial information related to Green Street as
of September 30, 1999 and for the year then ended is as follows (unaudited):
Total assets $160,819,000
Total deposits 100,806,000
Stockholders' equity 58,599,000
Total revenue 11,877,000
Net income 2,480,000
Concurrently with the Green Street acquisition, the Bank changed its name
to First South Bank.
On December 10, 1999, the Company signed a Purchase and Assumption
Agreement (the "Agreement") with Centura Bank and Triangle Bank to acquire six
of Triangle's branch offices located in Rocky Mount, North Carolina and Tarboro,
North Carolina, subject to regulatory approval and certain other conditions.
Under terms of the Agreement, the Bank will assume the deposits of six of
Triangle's branch offices for a premium of approximately 4.0% of the assumed
deposits, and purchase the loans, fixed assets and certain other assets
associated with the branch offices. At October 31, 1999, the deposits of the six
branch offices totaled approximately $147.0 million.
Five of the six branch offices are expected to become branch offices of the
Bank, while one of the branch offices is expected to be closed with the deposits
and loans to be serviced out of a nearby, existing branch office of the Bank.
The transaction is expected to be completed in the first quarter of 2000.
13
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
NewSouth Bancorp, Inc.
Washington, North Carolina
In our opinion, the accompanying consolidated statements of financial condition
and the related consolidated statements of operations, of stockholders' equity
and of cash flows present fairly, in all material respects, the financial
position of NewSouth Bancorp, Inc. and Subsidiary at September 30, 1999 and 1998
and the results of their operations and their cash flows for each of the three
years in the period ended September 30, 1999, in conformity with generally
accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
November 2, 1999
14
<PAGE>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
SEPTEMBER 30, 1999 AND 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1999 1998
<S> <C> <C>
Cash and due from banks $ 5,375,856 $ 5,243,853
Interest-bearing deposits in financial institutions 4,034,076 11,767,988
Investment securities - available for sale 3,024,531 3,107,545
Mortgage-backed securities - available for sale 56,325,868 27,016,679
Loans receivable, net:
Held for sale 13,481,714 38,406,628
Held for investment 198,572,216 186,592,403
Premises and equipment, net 3,575,974 3,558,836
Deferred income taxes 2,314,930 569,604
Real estate owned 591,144 411,938
Federal Home Loan Bank of Atlanta stock, at cost
which approximates market 1,460,200 1,363,800
Accrued interest receivable 2,022,055 1,935,490
Prepaid expenses and other assets 1,526,907 1,504,689
------------- -------------
Total assets $292,305,471 $281,479,453
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand $ 53,525,231 $ 42,873,230
Savings 7,220,337 6,397,856
Large denomination certificates of deposit 31,399,212 25,587,798
Other time 142,473,215 129,776,201
------------- -------------
Total deposits 234,617,995 204,635,085
Borrowed money 1,318,340 11,932,919
Accrued interest payable 81,081 62,707
Income taxes payable 67,779 -
Advance payments by borrowers for property taxes and insurance 89,067 451,860
Other liabilities 7,368,176 7,682,912
------------- -------------
Total liabilities 243,542,438 224,765,483
Commitments and contingencies (Notes 10 and 14)
Common stock, $.01 par value, 8,000,000 shares authorized,
4,364,044 shares issued and outstanding 43,640 43,640
Additional paid-in capital 44,232,010 43,801,987
Retained earnings, substantially restricted 24,197,767 22,091,243
Treasury stock at cost, 813,503 and 218,202 shares at September 30,
1999 and 1998, respectively (15,770,962) (4,895,754)
Unearned ESOP shares, 226,350 and 268,709 shares at September 30, 1999
and 1998, respectively (2,263,500) (2,687,093)
Deferred stock awards (783,392) (2,126,299)
Accumulated other comprehensive income (loss), net (892,530) 486,246
------------- -------------
Total stockholders' equity 48,763,033 56,713,970
------------- -------------
Total liabilities and stockholders' equity $292,305,471 $281,479,453
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
15
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Interest income:
Interest and fees on loans $ 19,261,766 $ 18,888,253 $ 16,096,914
Interest and dividends on investments and deposits 3,867,259 2,978,655 2,418,451
------------ ------------ ------------
Total interest income 23,129,025 21,866,908 18,515,365
------------ ------------ ------------
Interest expense:
Interest on deposits 9,379,641 9,096,290 8,088,144
Interest on borrowings 599,422 143,342 258,084
------------ ------------ ------------
Total interest expense 9,979,063 9,239,632 8,346,228
------------ ------------ ------------
Net interest income before provision for loan losses 13,149,962 12,627,276 10,169,137
Provision for loan losses 120,000 310,000 931,078
------------ ------------ ------------
Net interest income 13,029,962 12,317,276 9,238,059
------------ ------------ ------------
Other income:
Loan fees and service charges 1,265,974 985,439 752,470
Loan servicing fees 762,125 637,480 613,353
Gain on sale of real estate, net 61,027 28,478 32,190
Gain on sale of mortgage loans and mortgage-backed
securities 560,469 796,004 124,066
Other income 224,118 198,647 162,893
------------ ------------ ------------
Total other income 2,873,713 2,646,048 1,684,972
------------ ------------ ------------
General and administrative expenses:
Compensation and fringe benefits 6,924,085 7,239,911 4,603,764
Federal insurance premiums 123,431 113,646 88,165
Premises and equipment 501,270 356,550 377,468
Advertising 137,806 134,978 181,016
Payroll and other taxes 520,656 417,140 311,290
Other 2,047,568 1,677,841 1,379,348
------------ ------------ ------------
Total general and administrative expenses 10,254,816 9,940,066 6,941,051
------------ ------------ ------------
Income before income taxes 5,648,859 5,023,258 3,981,980
Income taxes 2,452,713 1,899,900 1,719,350
------------ ------------ ------------
Net income $ 3,196,146 $ 3,123,358 $ 2,262,630
Other comprehensive income (loss), net (1,378,776) 185,928 259,783
------------ ------------ ------------
Comprehensive income $ 1,817,370 $ 3,309,286 $ 2,522,413
============ ============ ============
Net income per common share:
Basic $ .91 $ .80 $ .35 (1)
============ ============ ============
Diluted $ .91 $ .80 $ .35 (1)
============ ============ ============
</TABLE>
(1) Calculated from date of conversion, see Note 2
The accompanying notes are an integral part of these consolidated financial
statements.
16
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
RETAINED
ADDITIONAL EARNINGS, UNEARNED
COMMON PAID-IN SUBSTANTIALLY TREASURY ESOP
STOCK CAPITAL RESTRICTED STOCK SHARES
----------- -------------- --------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
BALANCE, SEPTEMBER 30, 1996 $ - $ - $ 18,306,036 $ - $ -
Issuance of shares of common stock 29,095 42,423,041 - - (3,491,400)
Net income - - 2,262,630 - -
Other comprehensive income, net of taxes - - - - -
Acquisition of shares for MRP - - - - -
Dividends ($.13 per share) - - (527,031) - -
Release of ESOP shares - 231,013 - - 372,416
----------- -------------- --------------- --------------- --------------
BALANCE, SEPTEMBER 30, 1997 29,095 42,654,054 20,041,635 - (3,118,984)
Three for two stock split effected in the
form of a 50% stock dividend 14,545 - (14,545) - -
Net income - - 3,123,358 - -
Fractional shares paid - - (4,652) - -
Other comprehensive income, net of taxes - - - - -
Acquisition of shares for MRP - - - - -
Change in market value of deferred stock - 753,959 - - -
MRP amortization - - - - -
Acquisition of treasury shares - - - (4,895,754) -
Dividends ($.27 per share) - - (1,054,553) - -
Release of ESOP shares - 393,974 - - 431,891
----------- -------------- --------------- --------------- --------------
BALANCE, SEPTEMBER 30, 1998 43,640 43,801,987 22,091,243 (4,895,754) (2,687,093)
Net income - - 3,196,146 - -
Other comprehensive loss, net of taxes - - - - -
MRP amortization - - - - -
Acquisition of treasury shares - - - (10,875,208) -
Dividends ($.31 per share) - - (1,089,622) - -
Release of ESOP shares - 430,023 - - 423,593
----------- -------------- --------------- --------------- --------------
BALANCE, SEPTEMBER 30, 1999 $ 43,640 $ 44,232,010 $ 24,197,767 $ (15,770,962) $ (2,263,500)
=========== ============== =============== =============== ==============
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997 (continued)
- --------------------------------------------------------------------------------
ACCUMULATED
OTHER
DEFERRED COMPREHENSIVE
STOCK INCOME (LOSS),
AWARDS NET TOTAL
------------- ------------- --------------
<S> <C> <C> <C>
BALANCE, SEPTEMBER 30, 1996 $ - $ 40,535 $ 18,346,571
Issuance of shares of common stock - - 38,960,736
Net income - - 2,262,630
Other comprehensive income, net of taxes - 259,783 259,783
Acquisition of shares for MRP (2,050,531) - (2,050,531)
Dividends ($.13 per share) - - (527,031)
Release of ESOP shares - - 603,429
------------- ------------- --------------
BALANCE, SEPTEMBER 30, 1997 (2,050,531) 300,318 57,855,587
Three for two stock split effected in the
form of a 50% stock dividend - - -
Net income - - 3,123,358
Fractional shares paid - - (4,652)
Other comprehensive income, net of taxes - 185,928 185,928
Acquisition of shares for MRP (1,224,768) - (1,224,768)
Change in market value of deferred stock (753,959) - -
MRP amortization 1,902,959 - 1,902,959
Acquisition of treasury shares - - (4,895,754)
Dividends ($.27 per share) - - (1,054,553)
Release of ESOP shares - - 825,865
------------- ------------- --------------
BALANCE, SEPTEMBER 30, 1998 (2,126,299) 486,246 56,713,970
Net income - - 3,196,146
Other comprehensive loss, net of taxes - (1,378,776) (1,378,776)
MRP amortization 1,342,907 - 1,342,907
Acquisition of treasury shares - - (10,875,208)
Dividends ($.31 per share) - - (1,089,622)
Release of ESOP shares - - 853,616
------------- ------------- --------------
BALANCE, SEPTEMBER 30, 1999 $ (783,392) $ (892,530) $ 48,763,033
============= ============= ==============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
17
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Operating activities:
Net income $ 3,196,146 $ 3,123,358 $ 2,262,630
Adjustments to reconcile net income to net cash
used in operating activities:
Provision for loan losses 120,000 310,000 931,078
Depreciation 289,150 172,844 147,927
ESOP compensation 853,616 825,865 603,429
MRP compensation 1,342,907 1,902,959 -
Accretion of discounts on securities 371 372 24,263
Provision for (benefit from) deferred income taxes (825,748) 132,438 (765,372)
Gain on disposal of premises and equipment and
real estate acquired in settlement of loans (64,373) (34,259) (33,506)
Gain on sale of mortgage loans and mortgage-
backed securities (560,469) (796,004) (124,066)
Originations of loans held for sale, net (60,777,625) (66,892,933) (35,004,100)
Proceeds from sale of loans held for sale 40,597,010 36,106,871 13,175,014
Other operating activities (337,366) 3,327,998 (50,297)
------------ ------------- -------------
Net cash used in operating activities (16,166,381) (21,820,491) (18,833,000)
------------ ------------- -------------
Investing activities:
Proceeds from maturities of investment securities
available for sale - - 7,000,000
Purchases of investment securities - - (2,000,000)
Proceeds from principal repayments and sales of
mortgage-backed securities available for sale 14,141,098 16,314,270 8,914,741
Originations of loans held for investment, net
of principal repayments (12,863,836) (14,631,404) (40,566,654)
Proceeds from disposal of premises and equipment
and real estate acquired in settlement of loans 655,821 441,237 815,117
Purchases of FHLB stock (96,400) (76,300) -
Purchases of premises and equipment (312,919) (916,865) (66,057)
------------ ------------- -------------
Net cash provided by (used in) investing
activities 1,523,764 1,130,938 (25,902,853)
------------ ------------- -------------
Financing activities:
Net increase in deposit accounts 29,982,910 29,519,297 3,902,502
Proceeds from FHLB borrowings 61,000,000 46,000,000 49,000,000
Repayments of FHLB borrowings (70,500,000) (47,500,000) (38,000,000)
Net proceeds from issuance of stock - - 38,960,736
Purchase of treasury shares (10,875,208) (4,895,754) -
MRP funding - (1,224,768) (2,050,531)
Cash paid for fractional shares - (4,652) -
Cash dividends paid (1,089,622) (1,045,908) (264,574)
Net change in escrow accounts (362,793) 269,129 (198,118)
Net change in repurchase agreements (1,114,579) 811,799 581,512
------------ ------------- -------------
Net cash provided by financing activities 7,040,708 21,929,143 51,931,527
------------ ------------- -------------
Increase (decrease) in cash and cash equivalents (7,601,909) 1,239,590 7,195,674
Cash and cash equivalents, beginning of year 17,011,841 15,772,251 8,576,577
------------ ------------- -------------
Cash and cash equivalents, end of year $ 9,409,932 $ 17,011,841 $ 15,772,251
============ ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF OPERATIONS
NewSouth Bancorp, Inc. (the "Company") is a bank holding company
incorporated under the laws of the State of Virginia. NewSouth Bank (the
"Bank"), the wholly-owned subsidiary of the Company, is organized and
incorporated under the laws of the state of North Carolina. The Bank is
regulated by the Federal Deposit Insurance Corporation and the North
Carolina Office of the Commissioner of Banks.
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 as summarized below.
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.
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 accumulated other comprehensive income, a separate
component of equity. As of September 30, 1999 the Bank has classified all
investments as available for sale.
Premiums and discounts on debt securities are recognized in interest income
using the interest method over the period to maturity.
Mortgage-backed securities represent participating interests in pools of
long-term first mortgage loans. 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.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
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 using the interest 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, as well certain direct loan origination costs, are
deferred. 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, 1999 and 1998 and during the
years then ended there were no individual 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.
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 risks in its
portfolio 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.
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
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.
MORTGAGE SERVICING RIGHTS
The Company accounts for its mortgage servicing assets in accordance with
SFAS No. 125 "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities". Impairments of servicing assets are
evaluated through an assessment of the fair value of those assets using a
disaggregated, discounted cash-flows method under which the assets are
disaggregated into various strata, based on predominant risk
characteristics. The net carrying value of each stratum, based on
predominant risk characteristics, is compared to its discounted estimated
future net cash flows to determine whether adjustments should be made to
carrying values or amortization schedules. Impairment of a servicing asset
is recognized through a valuation allowance and a charge to current-period
earnings if it is considered to be temporary, or, through a direct
write-down of the asset and a charge to current-period earnings if it is
considered other than temporary. The predominant risk characteristics of
the underlying loan that are used to satisfy the servicing assets and
liabilities for measurement purposes generally include the (1) loan
origination date, (2) loan rate, (3) loan type and size and (4) loan
maturity date.
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.
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
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 September
30, 1999 and 1998, respectively the Bank owned 14,602 and 13,638 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.
STOCK SPLIT
On July 16, 1998 the Company declared at three-for-two stock split, in the
form of a 50% stock dividend, payable August 19, 1998 to stockholders of
record on July 31, 1998. Stockholders received one additional share of
common stock for every two shares held on the record date. All prior period
share and per share data have been adjusted for the split.
RECLASSIFICATIONS
Certain items included in the 1998 financial statements have been
reclassified to conform to the 1999 presentation. These reclassifications
have no effect on the net income or stockholders' equity previously
reported.
COMPREHENSIVE INCOME
The Company adopted 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.
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
As required by SFAS No. 130, prior year information has been modified to
conform with the new presentation. The Company's only components of other
comprehensive income relate to unrealized gains (losses) on available for
sale securities. Information concerning the Company's other comprehensive
income (loss) for the years ended September 30, 1999, 1998 and 1997 is as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Unrealized gains (losses) on securities
available for sale $(2,159,473) $ 578,471 $ 411,520
Reclassification of net (gains) losses
recognized in net income (138,881) (272,724) 14,651
Income tax (expense) benefit relating to
unrealized gains (losses) on available
for sale securities 919,578 (119,819) (166,388)
----------- ----------- -----------
Other comprehensive income (loss), net $(1,378,776) $ 185,928 $ 259,783
=========== =========== ===========
</TABLE>
SEGMENT INFORMATION
The Company adopted 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. The
adoption of SFAS No. 131 did not have a material effect on the Company's
financial statements, as management has determined that the bank operates
in one business segment.
EMPLOYERS DISCLOSURES ABOUT PENSION AND OTHER POSTRETIREMENT BENEFITS
The Company has adopted the provisions of Financial Accounting Standards
No. 132, "Employers Disclosures about Pensions and Other Postretirement
benefits", effective for fiscal years beginning after December 15, 1997.
This Statement revises employees' disclosures about pension and other
postretirement benefit plans. It does not change the measurement or
recognition of those plans. The adoption of SFAS No. 132 did not have a
material effect on the Company's financial statements.
MORTGAGE-BACKED SECURITIES
Statement of Financial Accounting Standards No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage
Loans Held for Sale by a Mortgage Banking Enterprise", was issued in
October 1998. This Statement amends existing classification and accounting
treatment of mortgage-backed securities, retained after mortgage loans held
for sale are securitized, for entities engaged in mortgage banking
activities. These securities previously were classified and accounted for
as trading and now may be classified as held-to-maturity or
available-for-sale, also. This Statement is effective for the first fiscal
quarter beginning after December 15, 1998. SFAS No. 134 did not have a
material effect on the Company's financial statements.
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
The Company will adopt the provisions of SFAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities", as amended, effective with
the fiscal quarter beginning July 1, 2000. This Statement establishes
accounting and reporting standards for derivative instruments and for
hedging activities. It requires that derivatives be recognized as either
assets or liabilities in the statement of financial position and be
measured at fair value. The accounting for changes in the fair value of a
derivative depends on the intended use of the derivative and whether or not
the derivative is designated as a hedging instrument. SFAS No. 133 is not
expected to have a material effect on the Company's financial statements.
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.
2. SIGNIFICANT ACTIVITIES
NewSouth Bancorp, Inc. was formed 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 4,364,250
shares of $.01 par value per share common stock, including 349,140 issued
to the Employee Stock Ownership Plan ("ESOP"), for $10 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.
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.
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
On August 9, 1999, the Company signed an Agreement and Plan of Merger with
Green Street Financial Corp ("Green Street"). The Plan calls for each Green
Street share to be converted into the right to receive a cash payment of
$15.25 upon completion of the merger. The merger will be accounted for
using the purchase method of accounting and is expected to be completed by
December 31, 1999. Information related to Green Street as of September 30,
1999 and for the year then ended is as follows (unaudited):
Total assets $160,819,000
Total revenue 11,877,000
Net income 2,480,000
Concurrently with the Green Street acquisition, the Bank will change its
name to First South Bank.
3. INVESTMENT SECURITIES
Investment securities at September 30, 1999 and 1998 are classified as
available for sale according to management's intent and summarized as
follows:
GROSS UNREALIZED ESTIMATED
AMORTIZED -------------------- MARKET
COST GAINS LOSSES VALUE
---------- ---------- ------- ----------
1999:
U.S. Treasury Notes $3,000,155 $ 24,376 $ -- $3,024,531
========== ========== ======= ==========
1998:
U.S. Treasury Notes $3,000,526 $ 107,019 $ -- $3,107,545
========== ========== ======= ==========
U.S. Treasury notes at September 30, 1999 with amortized cost of $3,000,155
and estimated market value of $3,024,531 are contractually scheduled to
mature in one year or less.
4. MORTGAGE-BACKED SECURITIES
Mortgage-backed securities at September 30, 1999 and 1998 are classified as
available for sale according to management's intent and summarized as
follows:
<TABLE>
<CAPTION>
GROSS UNREALIZED ESTIMATED
AMORTIZED ------------------------- MARKET
COST GAINS LOSSES VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1999:
FHLMC participation certificates,
maturing from years 2003 to 2029 $57,848,801 $ 47,196 $(1,570,127) $56,325,868
=========== =========== =========== ===========
1998:
FHLMC participation certificates,
maturing from years 2003 to 2028 $26,323,899 $ 692,780 $ -- $27,016,679
=========== =========== =========== ===========
</TABLE>
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
Mortgage-backed securities at September 30, 1999 are contractually
scheduled to mature as follows:
ESTIMATED
AMORTIZED MARKET
COST VALUE
----------- -----------
Due after one year through five years $ 1,269,296 $ 1,271,842
Due after five years through ten years 4,760,395 4,704,570
Due after ten years 51,819,110 50,349,456
----------- -----------
$57,848,801 $56,325,868
=========== ===========
Expected maturities may differ from contractual maturities because
borrowers have the right to call or prepay obligations with or without call
or prepayment penalties.
Mortgage-backed securities with a carrying value of $5,520,194, $9,016,982
and $6,607,924 were sold during the years ended September 30, 1999, 1998,
and 1997, respectively. Gross realized gains on the sales of
mortgage-backed securities were $138,881, $272,724 and $688 during 1999,
1998 and 1997, respectively. Gross realized losses on sales of
mortgage-backed securities were $15,339 during 1997. There were no gross
realized losses during 1999 and 1998.
Mortgage-backed securities with a carrying value of approximately
$2,119,192 and $3,619,011 were pledged as collateral for deposits from
public entities at September 30, 1999 and 1998, respectively.
5. LOANS RECEIVABLE
Loans receivable at September 30, 1999 and 1998 are summarized as follows:
1999 1998
Mortgage loans $ 75,508,130 $ 107,280,800
Consumer loans 50,846,947 48,385,965
Commercial loans 89,509,323 73,303,016
------------- -------------
Total 215,864,400 228,969,781
Less:
Allowance for loan losses (3,297,256) (3,364,588)
Deferred loan fees (513,214) (606,162)
------------- -------------
Loans receivable, net $ 212,053,930 $ 224,999,031
============= =============
The Bank has pledged its eligible real estate loans to collateralize actual
or potential borrowings from the Federal Home Loan Bank of Atlanta (See
Note 10).
During 1999, 1998 and 1997, the Bank exchanged loans with outstanding
principal balances of $45,527,117, $17,958,559 and $18,524,209,
respectively, with the Federal Home Loan Mortgage Corporation ("FHLMC") for
mortgage-backed securities of equal value.
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
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 for 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, 1999 and 1998, are fixed rate mortgage loans with an
estimated market value of approximately $13,500,000 and $ 38,400,000,
respectively.
Net gains on sales of loans receivable held for sale amounted to $303,324,
$523,280 and $138,717 during the years ended September 30, 1999, 1998 and
1997, respectively.
The changes in the allowance for loan losses for the years ended September
30, 1999, 1998 and 1997 are as follows:
1999 1998 1997
Balance at beginning of year $ 3,364,588 $ 3,249,352 $ 2,351,309
Provisions for loan losses 120,000 310,000 931,078
Loans charged off (265,384) (202,543) (71,904)
Recoveries 78,052 7,779 38,869
----------- ----------- -----------
Balance at end of year $ 3,297,256 $ 3,364,588 $ 3,249,352
=========== ============ ===========
The following is a summary of the principal balances of loans on nonaccrual
status and loans past due ninety days or more:
1999 1998
Loans contractually past due 90 days or more
and/or on nonaccrual status:
Residential $486,714 $728,856
Consumer and commercial 80,631 73,544
-------- --------
$567,345 $802,400
======== ========
During the years ended September 30, 1999, 1998 and 1997, interest income
of approximately $9,000, $18,000 and $48,000, respectively, was not
recorded related to loans accounted for on a nonaccrual basis.
6. PREMISES AND EQUIPMENT
Premises and equipment at September 30, 1999 and 1998 consist of the
following:
1999 1998
Land $1,081,952 $1,081,952
Office buildings 2,499,579 2,499,579
Furniture, fixtures and equipment 1,840,334 1,706,207
Vehicles 241,061 249,748
---------- ----------
5,662,926 5,537,486
Less accumulated depreciation 2,086,952 1,978,650
---------- ----------
Total $3,575,974 $3,558,836
---------- ----------
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
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, 1999, 1998 and 1997 were $133,000, $168,500 and
$96,000, respectively.
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. The expenses related to the Company's contributions to these plans
for the years ended September 30, 1999, 1998 and 1997 were $76,985, $76,386
and $52,253, 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, 1999, 1998 and 1997
aggregated $516,985, $562,478 and $515,435, respectively. The plans
generally include provisions for forfeitures of unvested portions of
payments, and vesting in the event of death or disability.
On April 8, 1998, the Company's Stockholders approved a Management
Recognition Plan ("MRP") for directors and key employees. The Company is
authorized to fund the acquisition of and award up to 174,570 shares (4% of
shares issued in the stock conversion) to be awarded by a committee of the
Board of Directors. The Company completed the acquisition of MRP shares
during fiscal 1998. On April 8, 1998, 174,570 shares (market value of
$4,029,258 and aggregate cost of $3,275,299) were awarded to certain
officers and employees. The vesting schedule provides that 33-1/3% of the
shares shall be earned and become non-forfeitable on April 8, 1998, 1999
and 2000.
The shares issued to the MRP plan have been recorded as outstanding shares,
and the unvested portion has been recorded as unearned compensation through
a contra equity account. The consolidated statements of operations for the
years ended September 30, 1999 and 1998 include compensation expense of
$1,342,907 and $1,902,959 relating to the scheduled vesting of MRP shares.
8. EMPLOYEE STOCK OWNERSHIP PLAN
The Company's Board of Directors 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
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
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 349,140 shares of the Company's common stock
financed by $3,491,400 in borrowings by the ESOP from the Company. This
loan is secured by the shares of Common Stock purchased and earnings
thereon. At September 30, 1999 and 1998, 122,790 and 80,431 shares,
respectively, have been allocated to participants' accounts and 226,350 and
268,709 shares, with an estimated market value of $4,031,973 and
$5,844,420, remain unallocated. All allocated shares are considered
outstanding for earning per share purposes, while the unallocated shares
are not included in the calculation.
The principal balance of the ESOP loan was $2,263,500 and $2,687,093 at
September 30, 1999 and 1998, respectively. 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, 1999, 1998 and 1997, include compensation expense of
$853,616, $825,865, and $603,429, respectively, related to the ESOP.
9. STOCK OPTION PLAN
On April 8, 1998, the Shareholders of the Company approved the NewSouth
Bancorp, Inc. 1997 Stock Option Plan (the "Plan"). The purpose of this Plan
is to advance the interests of the Company through providing selected key
employees and Directors of the Bank and the Company with the opportunity to
purchase shares. The Plan reserves 436,425 shares for grant within ten
years of the effective date. The option price is required to be 100% of the
stock's fair market value as defined, with an exception for any shareholder
with more than a 10% ownership interest in the Company. The exercise price
is required to be 110% of the stock's fair market value for these options
holders. Vesting is determined on the date of the grant. Options have a 10
year life, however, there are additional limitations for shareholders with
more than a 10% ownership interest in the Company. The Plan also has a
change of control provision under which all shares immediately vest if a
change of control, as defined, occurs.
The Company has adopted SFAS No. 123, "Accounting for Stock Based
Compensation". As permitted by SFAS No. 123, the Company has chosen to
apply APB Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations. Accordingly, no compensation cost has been
recognized for options granted under the Option Plan. Had compensation cost
for the Company's Option Plan been determined based on the fair value at
the grant dates for awards under the Option Plan consistent with the method
of SFAS No. 123, the Plan's net income and net income per share would have
been reduced to the pro forma amounts indicated below. The Company did not
grant any options during the year ended September 30, 1997, therefore,
there are no pro forma amounts for this period.
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
--------------------------- ---------------------------
AS AS
REPORTED PRO FORMA REPORTED PRO FORMA
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net income $ 3,196,146 $ 3,138,174 $ 3,123,358 $ 1,829,801
Earnings per common share - basic $ .91 $ .89 $ .80 $ .47
Earnings per common share - diluted $ .91 $ .89 $ .80 $ .47
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1999 and 1998, respectively; dividend growth
rate of 15% and 0%, expected volatility of 20.8% and 6.1%; risk-free
interest rates of 7.1% and 5.3%; and expected lives of 7 years.
A summary of the status of the Plan as of September 30, 1999 and 1998 and
changes during the years then ended is presented below:
1999 1998
-------------------- -------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
-------- --------- ------- ---------
Outstanding at beginning of year 398,303 $ 18.25 -- $ --
Granted 6,000 $ 17.75 398,303 $ 18.25
------- -------
Outstanding at year end 404,303 $ 18.24 398,303 $ 18.25
======= =======
Weighted-average fair value of
options granted during the year $ 5.04 $ 5.59
========= ==========
The following table summarizes additional information about the Option Plan
at September 30, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ---------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICE AT 9/30/99 LIFE PRICE AT 9/30/99 PRICE
- -------------- ---------- ----------- ---------- ---------- ---------
$17.75 - 18.25 404,303 8.5 years $ 18.24 376,053 $ 18.25
10. 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 6.00% and totaled $9,500,000 at September 30,
1998. There were no advances outstanding from the Federal Home Loan Bank at
September 30, 1999.
At September 30, 1999 and 1998, repurchase agreements outstanding had
average rates of 3.13% and 3.33% and totaled $1,318,340 and $2,432,919,
respectively.
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
At September 30, 1999, repurchase agreements were collateralized by U.S.
government agency obligations with a principal balance of $3,000,000. 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, 1999, the Company had an additional $65,000,000 of credit
available with the Federal Home Loan Bank of Atlanta.
11. INCOME TAXES
The components of income tax expense (benefit) for the years ended
September 30, 1999, 1998 and 1997 are as follows:
1999 1998 1997
Current:
Federal $ 2,712,909 $ 1,422,845 $ 1,908,576
State 565,552 344,617 576,146
----------- ----------- -----------
3,278,461 1,767,462 2,484,722
----------- ----------- -----------
Deferred:
Federal (719,993) 115,458 (617,976)
State (105,755) 16,980 (147,396)
----------- ----------- -----------
(825,748) 132,438 (765,372)
----------- ----------- -----------
Total $ 2,452,713 $ 1,899,900 $ 1,719,350
=========== =========== ===========
A reconciliation of the expected income tax expense at statutory tax rates,
with income tax expense reported in the statements of operations for the
years ended September 30, 1999, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Expected income tax expense at 34% $ 1,920,612 $ 1,707,908 $ 1,353,873
State income taxes net of federal income tax 270,298 239,220 147,000
Non-deductible ESOP, other expenses and
other adjustments 261,803 (47,228) 218,477
----------- ----------- -----------
$ 2,452,713 $ 1,899,900 $ 1,719,350
=========== =========== ===========
</TABLE>
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
The components of deferred income tax assets and liabilities are as
follows:
1999 1998
Deferred income tax assets:
Deferred directors' fees $ 379,283 $ 365,384
Allowance for loan losses 1,000,686 931,514
Employee benefits 878,390 483,382
Unrealized losses on securities available for sale 606,025 --
Other 79,602 108,765
---------- ----------
2,943,986 1,889,045
---------- ----------
Deferred income tax liabilities:
Loans mark-to-market 266,793 665,254
Depreciation and amortization 173,055 134,905
Unrealized gains on securities available for sale -- 313,553
Deferred loan origination fees and costs 90,696 106,379
FHLB stock 98,512 99,350
---------- ----------
629,056 1,319,441
---------- ----------
Net deferred income tax asset $2,314,930 $ 569,604
========== ==========
Retained earnings at September 30, 1999 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 for tax bad debt losses or adjustments arising from carryback of net
operating losses could create taxable income, in certain remote instances,
which would be subject to the then current corporate income tax rate.
12. 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 Virginia 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 Virginia 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, 1999, that the Bank meets
all capital adequacy requirements to which it is subject.
32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
As of September 30, 1999, the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank
must maintain 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.
The Bank's actual capital amounts and ratios as of September 30, 1999 and
1998 are presented in the table below (dollars in thousands):
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT
ACTUAL ADEQUACY PURPOSE ACTION PROVISIONS
----------------- ---------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
1999:
Total Capital (to Risk Weighted Assets) $51,989 24.8% $16,750 8.0% $20,938 10.0%
Tier I Capital (to Risk Weighted Assets) 48,691 23.3% 8,375 4.0% 12,563 6.0%
Tier I Capital (to Average Assets) 48,691 16.2% 12,041 4.0% 15,052 5.0%
1998:
Total Capital (to Risk Weighted Assets) $58,169 28.9% $16,125 8.0% $20,156 10.0%
Tier I Capital (to Risk Weighted Assets) 55,650 27.6% 8,063 4.0% 12,094 6.0%
Tier I Capital (to Average Assets) 55,650 20.2% 11,066 4.0% 13,758 5.0%
</TABLE>
13. EARNINGS PER SHARE
The Company adopted SFAS No. 128 "Earnings Per Share" on October 1, 1997.
As required, all prior period earnings per share have been restated to
conform with the provisions of the statement.
The following table provides a reconciliation of income available to common
stockholders and the average number of shares outstanding (less unearned
ESOP shares, unearned deferred stock awards and treasury shares) for the
years ended September 30, 1999 and 1998. Options to purchase 404,303 and
398,303 shares of common stock were outstanding during the years ended
September 30, 1999 and 1998, respectively, but were not included in the
computation of diluted EPS because the options' exercise price was greater
than the average market price of common shares for each of the years.
1999 1998 1997
Net income (numerator) $3,196,146 $3,123,358 $1,395,900 (1)
========== ========== ==========
Weighted average shares outstanding
for basic EPS (denominator) 3,530,811 3,876,813 3,961,933 (1)
Dilutive effect of stock options -- -- --
---------- ---------- ----------
Adjusted shares for diluted EPS 3,530,811 3,876,813 3,961,933
========== ========== ==========
(1) Calculated from date of conversion, April 7, 1997.
33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
14. MORTGAGE BANKING ACTIVITIES
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal
balances of mortgage loans serviced for others was $275,255,000 and
$250,202,000 at September 30, 1999 and 1998, 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.
At September 30, 1999 and 1998, mortgage servicing rights reported in the
consolidated statements of financial condition, net of amortization, were
$209,090 and $184,433, respectively.
15. FINANCIAL INSTRUMENT 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 non-performance 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, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Commitments to extend credit:
Commitments to originate loans $33,769,607 $14,887,234
Undrawn balances on lines of credit and undrawn
balances on credit reserves (overdraft protection) 28,341,602 18,626,163
----------- -----------
$62,111,209 $33,513,397
=========== ===========
</TABLE>
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
Included in the commitments to originate loans as of September 30, 1999 and
1998 are fixed interest rate loan commitments of $9,118,636 and $5,821,488,
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.
Since many of the commitments are expected to expire without being drawn
upon, amounts reported do not necessarily represent future cash
requirements.
16. PARENT COMPANY FINANCIAL INFORMATION
The Company's principal asset is its investment in the Bank. Condensed
financial statements of the parent company as of September 30, 1999 and
1998 and for the three years ended September 30, 1999 are as follows:
1999 1998
CONDENSED BALANCE SHEET
Cash $ 1,151,744 $ 959,617
Due from subsidiary 5,368,089 13,485,534
Investment in wholly-owned subsidiary 42,563,204 41,960,610
Other assets 12,115 579,311
----------- -----------
Total assets $49,095,152 $56,985,072
=========== ===========
Other liabilities $ 332,119 $ 271,102
Shareholders' equity 48,763,033 56,713,970
----------- -----------
Total liabilities and shareholders' equity $49,095,152 $56,985,072
=========== ===========
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
CONDENSED STATEMENT OF INCOME
Interest income, net $ 234,242 $ 291,950 $ 159,006
Equity in earnings of subsidiary 3,121,370 3,007,978 1,570,050
Miscellaneous expenses 159,466 176,570 333,156
------------ ------------ ------------
Net income $ 3,196,146 $ 3,123,358 $ 1,395,900
============ ============ ============
35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
1999 1998 1997
CONDENSED STATEMENT OF CASH FLOWS
Operating activities:
Net income $ 3,196,146 $ 3,123,358 $ 1,395,900
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed earnings of subsidiary (3,121,370) (3,007,978) (1,570,050)
Deferred income taxes -- (57,800) 57,800
ESOP compensation 853,616 825,865 603,429
MRP compensation 1,342,907 1,902,959 --
Other operating activities 628,213 (589,308) 1,870,996
------------ ------------ ------------
Net cash provided by operating activities 2,899,512 2,197,096 2,358,075
------------ ------------ ------------
Investing activities:
Investment in, and advances to, subsidiary -- -- (38,980,323)
Repayments of advances to subsidiary 9,257,445 5,910,220 --
------------ ------------ ------------
Net cash provided by investing activities 9,257,445 5,910,220 (38,980,323)
------------ ------------ ------------
Financing activities:
Net proceeds from issuance of stock -- -- 38,960,736
MRP funding -- (1,224,768) (2,050,531)
Purchase of treasury shares (10,875,208) (4,895,754) --
Cash paid for fractional shares -- (4,652) --
Dividends paid (1,089,622) (1,045,908) (264,574)
------------ ------------ ------------
Net cash used in financing activities (11,964,830) (7,171,082) 36,645,631
------------ ------------ ------------
Net increase in cash 192,127 936,234 23,383
Cash at beginning of the year 959,617 23,383 --
------------ ------------ ------------
Cash at the end of year $ 1,151,744 $ 959,617 $ 23,383
============ ============ ============
</TABLE>
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized unaudited quarterly financial data for the years ended September
30, 1999 and 1998 is as follows (in thousands):
FOURTH THIRD SECOND FIRST
------ ------ ------ ------
1999:
Interest income $5,918 $5,935 $5,629 $5,647
Interest expense 2,610 2,500 2,450 2,419
Provision for loan losses 70 -- -- 50
Noninterest income 644 685 735 810
Noninterest expense 2,546 2,574 2,553 2,582
Income tax expense 532 762 561 598
------ ------ ------ ------
Net income $ 804 $ 784 $ 800 $ 808
====== ====== ====== ======
Net income per common share:
Basic and diluted $ .24 $ .23 $ .22 $ .22
====== ====== ====== ======
36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
FOURTH THIRD SECOND FIRST
------ ------ ------ ------
1998:
Interest income $5,694 $5,603 $5,330 $5,240
Interest expense 2,417 2,357 2,262 2,204
Provision for loan losses 100 110 -- 100
Noninterest income 647 678 732 589
Noninterest expense 2,524 2,564 2,558 2,294
Income tax expense 483 467 476 474
------ ------ ------ ------
Net income $ 817 $ 783 $ 766 $ 757
====== ====== ====== ======
Net income per common share:
Basic and diluted $ .21 $ .20 $ .20 $ .19
====== ====== ====== ======
18. 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 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 considers as
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, 1999
and 1998, were as follows:
Cash and cash equivalents are by definition short-term and do not prevent
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 3 and 4 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.
37
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
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:
<TABLE>
<CAPTION>
1999 1998
--------------------------- ---------------------------
ESTIMATED CARRYING ESTIMATED CARRYING
FAIR VALUE AMOUNT FAIR VALUE AMOUNT
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
1 - 4 family mortgages $ 74,868,715 $ 74,822,333 $107,101,833 $105,059,149
Consumer 49,641,554 50,263,344 47,905,877 48,414,917
Non-residential 86,968,253 86,968,253 71,524,965 71,524,965
------------ ------------ ------------ ------------
$211,478,522 $212,053,930 $226,532,675 $224,999,031
============ ============ ============ ============
</TABLE>
The fair value of deposit liabilities with no stated maturities has been
estimated to equal the carrying amount (the amount payable on demand),
totaling $60,745,568 and $50,271,086 at September 30 1999 and 1998,
respectively. 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.
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, 1999 and 1998 are as follows:
1999 1998
Certificates of deposits:
Carrying amount $173,872,427 $155,363,999
Estimated fair value $174,479,131 $156,426,259
Advances for Federal Home Loan Bank:
Carrying amount $ -- $ 9,500,000
Estimated fair value $ -- $ 9,500,000
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 $62,111,209 in 1999 and
$33,513,397 in 1998, which are primarily comprised of unfunded loan
commitments.
The Company's remaining assets and liabilities are not considered financial
instruments.
38
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
19. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the years ended September 30, 1999,
1998, and 1997 is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Real estate acquired in settlement of loans $ 764,023 $ 458,061 $ 960,221
Exchange of loans for mortgage-backed
securities $45,527,117 $17,958,559 $18,524,209
Cash paid for interest $ 9,960,689 $ 9,268,840 $ 8,322,252
Cash paid for income taxes $ 2,787,000 $ 2,637,000 $ 1,673,000
Dividends declared, not paid $ 332,119 $ 271,102 $ 262,457
</TABLE>
39
<PAGE>
BOARD OF DIRECTORS
DR. FREDERICK H. HOWDY LINLEY H. GIBBS, JR. EDMUND T. BUCKMAN, JR.
CHAIRMAN VICE CHAIRMAN Retired
President Retired Washington, NC
Drs. Freshwater and Washington, NC
Howdy, P.A.
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
EXECUTIVE OFFICERS
THOMAS A. VANN JACK L. ASHLEY JOSEPH C. DUNN
President Executive Vice President Executive Vice President
Branch Administration and Credit Administration
Operations
WALTER P. HOUSE WILLIAM L. WALL MARY R. BOYD
Executive Vice President Executive Vice President Senior Vice President
Mortgage Operations Chief Financial Officer Loan Servicing
and Secretary
SHERRY L. CORRELL KRISTIE W. HAWKINS WILLIAM R. OUTLAND
Senior Vice President Treasurer Senior Vice President
Deposit Administration Controller Consumer Lending
NEWSOUTH BANK OFFICE LOCATIONS
BANKING OFFICES
CHOCOWINITY NEW BERN WASHINGTON
2999 Highway 17 South 202 Craven Street 1311 Carolina Avenue
252-946-4178 252-636-2997 252-946-4178
ELIZABETH CITY 1725 Glenburnie Road 300 North Market Street
604 East Ehringhaus Street 252-636-2997 252-946-4178
252-335-0848
GREENVILLE ROCKY MOUNT Corporate Office
301 East Arlington Blvd 300 Sunset Avenue 1311 Carolina Avenue
252-321-2600 252-972-9661 252-946-4178
KINSTON Operations Center
827 Hardee Road 239 West Main Street
252-522-9466 252-946-4178
40
<PAGE>
STOCKHOLDER INFORMATION
CORPORATE HEADQUARTERS
NewSouth Bancorp, Inc. Telephone: 252-946-4178
1311 Carolina Avenue Fax: 252-946-3873
Washington, NC 27889 E-mail: [email protected]
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.
Quarter Ended High Low Dividends
------------- ---- --- ---------
December 31, 1997 (1) $22.417 $19.25 $ .067
March 31, 1998 (1) 23.167 19.333 .067
June 30, 1998 (1) 23.667 21.333 .067
September 30, 1998 (1) 23.333 21.25 .07
December 31, 1998 22.00 16.50 .07
March 31, 1999 18.25 17.00 .07
June 30, 1999 18.50 17.00 .07
September 30, 1999 18.625 16.00 .10
(1) Adjusted for three-for-two stock split on August 19, 1998.
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 17, 2000 at 11:00 a.m., at the main office of NewSouth Bank,
1311 Carolina Avenue, Washington, North Carolina.
GENERAL COUNSEL SPECIAL COUNSEL INDEPENDENT ACCOUNTANTS
Rodman, Holscher, Housley, Kantarian & PricewaterhouseCoopers LLP
Francisco & Peck, P.A. Bronstein, P.C. Suite 2300
320 North Market Street Suite 700 150 Fayetteville Street Mall
Washington, NC 27889 1220 19th Street, N.W. Raleigh, NC 27601
Washington, DC 20036
41
<PAGE>
NEWSOUTH BANCORP
================
1311 Carolina Avenue
P.O. Box 2047
Washington, NC 27889
(252)946-4178 Fax (252)946-3873
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
State or Other
Jurisdiction of Percentage
Incorporation Ownership
------------- ---------
Parent
- ------
NewSouth Bancorp, Inc. Virginia 100%
Subsidiary
- ----------
NewSouth Bank North Carolina 100%
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
NewSouth Bancorp, Inc. on Form S-8 (File number 333-49759) of our report dated
November 2, 1999, on our audits of the consolidated financial statements of
NewSouth Bancorp, Inc. as of September 30, 1999 and 1998, and for each of the
three years in the period ended September 30, 1999, which report has been
included in this Annual Report on Form 10-K.
PRICEWATERHOUSECOOPERS LLP
Raleigh, North Carolina
December 27, 1999
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