<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transaction period from ___________________ to ______________________
Commission File Number: 0-23971
GASTON FEDERAL BANCORP, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Federal 56-2063438
- ------------------------------- ---------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
245 West Main Avenue, Gastonia, NC 28053
- --------------------------------------- ------------------
(Address of Principal Executive Office) (Zip Code)
(704) 868-5200
---------------------------------------------------
(Registrant's Telephone Number including area code)
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 $1.00 per share
---------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file reports) and (2) has been subject to such
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-B 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-KSB or any amendments to
this Form 10-KSB. [_]
The registrant's revenues for the fiscal year ended September 30, 1998 were
$14.9 million.
As of September 30, 1998, there were issued and outstanding 4,496,500
shares of the Registrant's Common Stock. The aggregate value of the voting stock
held by non-affiliates of the Registrant, computed by reference to the closing
price of the Common Stock as of November 30, 1998 ($14.125) was $25.0 million.
DOCUMENTS INCORPORATED BY REFERENCE
1. Sections of Annual Report to Stockholders for the fiscal year ended
September 30, 1998 (Parts II and IV).
<PAGE>
PART I
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ITEM 1. Business
- --------------------
Gaston Federal Bancorp, Inc.
Gaston Federal Bancorp, Inc. (the "Company") was formed on March 18, 1998
for the purpose of acting as the holding Company for Gaston Federal Bank (the
"Bank"). The Company's assets consist primarily of the outstanding capital stock
of the Bank and cash and investments of $8.4 million, representing a portion of
the net proceeds from the Company's stock offering completed April 9, 1998 in
connection with the mutual holding company reorganization of the Bank. At
September 30, 1998, 2,113,355 shares of the Company's common stock, par value
$1.00 per share, were held by the public, and 2,383,145 shares were held by
Gaston Federal Holdings, MHC the Company's parent mutual holding company. The
Company's principal business is overseeing and directing the business of the
Bank and investing the net stock offering proceeds retained by it.
At September 30, 1998, the Company had consolidated total assets of $208.0
million, consolidated total deposits of $143.9 million and consolidated total
equity of $41.6 million.
The Company's executive office is located at 245 West Main Avenue, P.O. Box
2249, Gastonia, North Carolina 28053-2249. Its telephone number at this address
is (704) 868-5200.
Gaston Federal Bank
The Bank was organized in 1904 as a state chartered building and loan
association. The Bank's deposits are insured by the Savings Association
Insurance Fund (the "SAIF"), as administered by the FDIC, up to the maximum
amount permitted by law. The Bank is a community-oriented savings bank engaged
primarily in the business of offering FDIC-insured deposits to customers through
its branch offices and investing those deposits, together with funds generated
from operations and borrowings, in one- to four-family residential, multifamily
residential and commercial real estate loans, commercial business loans,
construction loans and consumer loans, and investment and mortgage-backed
securities.
The Bank's executive office is located at 245 West Main Avenue, P. O. Box
2249, Gastonia, North Carolina 28053-2249. Its telephone number at that address
is (704) 868-5200.
Market Area
All of the Bank's offices are located in the County of Gaston. The main
office and two branches are located in the City of Gastonia, and one branch is
located in the City of Mount Holly. Gaston County is located on the I-85
corridor in the Southern Piedmont region of North Carolina, not far from the
regional banking center of Charlotte, North Carolina, and the South Carolina
state line. Gaston County is bounded by the North Carolina Counties of
Mecklenburg, Lincoln and Cleveland, and the South Carolina County of York. The
Bank considers Gaston and these contiguous counties to be its primary market
area.
Gaston County has a population of approximately 183,000, and has an economy
based on manufacturing, especially textiles, apparel, fabricated metals,
machinery, chemicals, and automotive transportation equipment, and has developed
a strong base in service industries, especially construction and retail trade.
Twenty-one Fortune 500 companies operate in Gaston County. Among the largest
employers in Gaston County are Freightliner, Firestone, Parkdale Mills, Pharr
Yarns, Dana Corporation, Gaston Memorial Hospital and Gaston College.
<PAGE>
Lending Activities
General. At September 30, 1998, the Bank's net loans receivable totaled
$136.5 million, or 65.6% of total assets at that date. The Bank has
traditionally concentrated its lending activities on conventional first mortgage
loans secured by one- to four-family properties, with such loans amounting to
$105.5 million, or 73.5% of total loans receivable at September 30, 1998. In
addition, the Bank originates construction loans, commercial real estate loans,
multifamily residential real estate loans, land loans, commercial business loans
and consumer loans. A substantial portion of the Bank's loan portfolio is
secured by real estate, either as primary or secondary collateral, located in
its primary market area.
2
<PAGE>
Loan Portfolio Analysis. The following table sets forth the composition of
the Bank's loan portfolio at the dates indicated. The Bank had no concentration
of loans exceeding 10% of total gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At September 30,
---------------------------------------------------------------------------------------
1998 1997 1996
--------------------------- --------------------------- ---------------------------
Amount Percent Amount Percent Amount Percent
---------- --------- ---------- ---------- --------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family................. $ 105,526 73.50% $ 106,422 76.50% $ 104,363 76.72%
Construction........................ 10,573 7.36 5,869 4.22 6,827 5.02
Commercial.......................... 8,076 5.63 7,318 5.26 6,458 4.75
Multifamily residential............. 3,771 2.63 6,514 4.68 6,843 5.03
------------ ----------- ------------ ----------- ------------ -----------
Total real estate loans.......... 127,946 89.12 126,123 90.66 124,491 91.52
Commercial business loans.............. 6,629 4.62 5,558 4.00 5,160 3.79
Consumer loans:
Home equity lines of credit......... 6,764 4.71 5,651 4.06 4,747 3.49
Loans on deposits................... 1,052 0.73 688 0.49 709 0.52
Other............................... 1,173 0.82 1,091 0.78 923 0.68
------------ ----------- ------------ ----------- ------------ -----------
Total consumer loans............. 8,989 6.26 7,430 5.34 6,379 4.69
------------ ----------- ------------ ----------- ------------ -----------
Total loans......................... 143,564 100.00% 139,111 100.00% 136,030 100.00%
=========== =========== ===========
Less:
Loans in process.................... 5,152 2,990 3,812
Deferred loan origination fees...... 501 520 526
Allowance for loan losses........... 1,411 1,110 830
------------ ------------ ------------
Total loans, net....................... $ 136,500 $ 134,491 $ 130,862
============ ============ ============
<CAPTION>
At September 30,
---------------------------------------------------------
1995 1994
--------------------------- ---------------------------
Amount Percent Amount Percent
------------ --------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
One- to four-family................. $ 93,694 75.74% $ 88,619 76.14%
Construction........................ 5,667 4.58 6,567 5.64
Commercial.......................... 5,051 4.08 4,694 4.03
Multifamily residential............. 7,367 5.96 6,806 5.85
------------ ----------- ------------ -----------
Total real estate loans.......... 111,779 90.36 106,686 91.67
Commercial business loans.............. 6,030 4.87 4,717 4.05
Consumer loans:
Home equity lines of credit......... 4,154 3.36 3,649 3.14
Loans on deposits................... 672 0.54 530 0.46
Other............................... 1,075 0.87 801 0.69
------------ ----------- ------------ -----------
Total consumer loans............. 5,901 4.77 4,980 4.28
------------ ----------- ------------ -----------
Total loans......................... 123,710 100.00% 116,383 100.00%
=========== ===========
Less:
Loans in process.................... 2,994 4,094
Deferred loan origination fees...... 422 422
Allowance for loan losses........... 786 726
------------ ------------
Total loans, net....................... $ 119,508 $ 111,141
============ ============
</TABLE>
3
<PAGE>
One- to Four-Family Real Estate Lending. Historically, the Bank has
concentrated its lending activities on the origination of loans secured by a
first mortgage on existing one- to four-family residences located in its primary
market area. At September 30, 1998, $105.5 million, or 73.5% of the Bank's total
loans receivable, consisted of one- to four-family residential real estate
loans. The Bank originated $21.3 million, $12.6 million and $18.5 million of
one- to four-family residential mortgage loans during the fiscal years ended
September 30, 1998, 1997 and 1996, respectively.
Generally, the Bank's fixed-rate one- to four-family mortgage loans have
maturities ranging from ten to 30 years and are fully amortizing with monthly
and bi weekly payments sufficient to repay the total amount of the loan with
interest by the end of the loan term. Generally, they are originated under
terms, conditions and documentation which permit them to be sold to U.S.
Government sponsored agencies such as FHLMC ("Freddie Mac"). The Bank's
fixed-rate loans customarily include "due on sale" clauses, which give the Bank
the right to declare a loan immediately due and payable in the event the
borrower sells or otherwise disposes of the real property subject to the
mortgage and the loan is not paid.
Management implemented a residential wholesale correspondent lending
program in 1998. This program enables the Bank to purchase one- to four-family
residential mortgage loans from private mortgage bankers. The bank intends to
confine this practice to select mortgage banking companies located only in North
Carolina. The purpose of this program is to provide an additional medium by
which the Bank can invest its new capital in conservative interest sensitive
assets such as residential loan products with three, five, seven and ten year
rate adjustments or shorter-term 15-year fixed rate loans.
The Bank offers ARM loans at rates and terms competitive with market
conditions. At September 30, 1998, $44.7 million, or 31.1% of the Bank's total
loan portfolio, were subject to periodic interest rate adjustments.
Substantially all of the Bank's ARM loan originations meet the underwriting
standards of Freddie Mac even though the Bank originates ARM loans primarily for
its own portfolio. The Bank's ARM loans typically provide for an interest rate
which adjusts every year based on the one year Treasury constant maturity index
and are typically based on a 30-year amortization schedule. For loans with a
loan to value ratio of 80% or less, the Bank qualifies the borrowers on its ARM
loans based on the initial rate. For loans with a loan to value ratio of more
than 80%, the Bank qualifies the borrowers on its ARM loans based on the initial
rate plus 2%. The Bank's current ARM loans do not provide for negative
amortization. The Bank's ARM loans generally provide for annual and lifetime
interest rate adjustment limits of 2% and 5%, respectively. The Bank offers
discounted or "teaser" initial interest rates that may be more than 2% below the
interest rate to which the loan would adjust after the first year based on the
market rates of interest at the time the loan was originated.
Borrower demand for ARM loans versus fixed-rate mortgage loans is a
function of the level of interest rates, the expectations of changes in the
level of interest rates and the difference between the initial interest rates
and fees charged for each type of loan. The relative amount of fixed-rate
mortgage loans and ARM loans that can be originated at any time is largely
determined by the demand for each in a competitive environment.
The retention of ARM loans in the Bank's loan portfolio helps reduce the
Bank's exposure to changes in interest rates. There are, however, unquantifiable
credit risks resulting from the potential of increased costs due to changed
rates to be paid by the customer. It is possible that during periods of rising
interest rates the risk of default on ARM loans may increase as a result of
repricing and the increased payments required by the borrower. In addition,
although ARM loans allow the Bank to increase the sensitivity of its asset base
to changes in the interest rates, the extent of this interest sensitivity is
limited by the annual and lifetime interest rate adjustment limits. Because of
these considerations, the Bank has no assurance that yields on ARM loans will be
sufficient to offset increases in the Bank's cost of funds. The Bank believes
these risks, which have not had a material adverse effect on the Bank to date,
generally are less than the risks associated with holding fixed-rate loans in
portfolio during a rising interest rate environment.
The Bank generally requires title insurance insuring the status of
its lien or an acceptable attorney's opinion on all loans where real estate is
the primary source of security. The Bank also requires that fire and casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least equal to the outstanding loan balance.
4
<PAGE>
Pursuant to underwriting guidelines adopted by the Bank's Board of
Directors, the Bank can lend up to 95% of the appraised value of the property
securing a one- to four-family residential loan. For loans of up to 80% of the
appraised value of the property, the Bank does not require private mortgage
insurance, for loans of more than 80% to up to 95% of the appraised value of the
property, the Bank requires private mortgage insurance for between 20% and 30%
of the amount of the loan.
Construction Lending. The Bank originates residential construction
loans to local home builders, generally with whom it has an established
relationship, and to individuals who have a contract with a builder for the
construction of their residence. The Bank's construction loans are generally
secured by property located in the Bank's primary market area. At September 30,
1998, construction loans amounted to $10.6 million, or 7.36% of the Bank's total
loan portfolio.
The Bank's construction loans to home builders generally have fixed
interest rates and are for a term of twelve months. Construction loans to
individuals are typically made in connection with the granting of the permanent
financing on the property. Construction loans to individuals convert to a fully
amortizing adjustable- or fixed-rate loan at the end of the six month
construction term; if the construction is not complete after six months, the
Bank will generally modify the loan so that the term is for a period necessary
to complete construction. Construction loans to builders are typically
originated with a maximum loan to value ratio of 80%. Construction loans to
individuals are generally originated pursuant to the same policy regarding loan
to value ratios as are used in connection with loans secured by one- to
four-family residential real estate.
The Bank's construction loans to builders are made on either a
pre-sold or speculative (unsold) basis. However, the Bank generally limits the
number of outstanding loans on unsold homes under construction to individual
builders, with the amount dependent on the financial strength of the builder,
the present exposure of the builder, the location of the property and prior
sales of homes in the development. At September 30, 1998, speculative
construction loans amounted to $2.8 million.
Prior to making a commitment to fund a construction loan, the Bank
requires an appraisal of the property by an independent state-licensed and
qualified appraiser approved by the Board of Directors. The Bank's staff or an
independent appraiser retained by the Bank, reviews and inspects each project
prior to disbursement of funds during the term of the construction loan. Loan
proceeds are disbursed after inspection of the project based on a percentage of
completion. Monthly payment of accrued interest is required, with all accrued
interest collected at maturity.
Construction lending affords the Bank the opportunity to charge
higher interest rates with shorter terms to maturity relative to single-family
permanent mortgage lending. Construction lending, however, is generally
considered to involve a higher degree of risk than single-family permanent
mortgage lending because of the inherent difficulty in estimating both a
property's value at completion of the project and the estimated cost of the
project. The nature of these loans is such that they are generally more
difficult to evaluate and monitor. If the estimate of construction cost proves
to be inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the project. If the estimate of
value upon completion proves to be inaccurate, the Bank may be confronted at or
prior to the maturity of the loan with a project the value of which is
insufficient to assure full repayment. Projects may also be jeopardized by
disagreements between borrowers and builders and by the failure of builders to
pay subcontractors. Loans to builders to construct homes for which no purchaser
has been identified carry more risk because the payoff for the loan is dependent
on the builder's ability to sell the property prior to the time that the
construction loan is due. The Bank has attempted to minimize the foregoing risks
by, among other things, limiting its construction lending primarily to
residential properties and generally requiring personal guarantees from the
principals of its corporate borrowers.
Commercial Real Estate Lending. The Bank originates mortgage loans
for the acquisition and refinancing of commercial real estate properties. At
September 30, 1998, $8.1 million, or 5.63% of the Bank's total loan portfolio
consisted of loans secured by commercial real estate properties. The majority of
the Bank's commercial real estate properties are secured by office buildings,
churches, and retail shops, which are generally located in the Bank's primary
market area. The interest rates for the Bank's commercial real estate loans
generally have interest rates that adjust at either one-, three-, or five-year
intervals, based on the constant maturity Treasury index, with annual and
lifetime interest rate adjustment limits of 2% and 5%, respectively, and are
originated to amortize in a maximum of 20 years.
5
<PAGE>
The Bank requires appraisals of all properties securing commercial
real estate loans. Appraisals are performed by an independent appraiser
designated by the Bank, all of which are reviewed by management. The Bank
considers the quality and location of the real estate, the credit of the
borrower, the cash flow of the project and the quality of management involved
with the property.
Loan to value ratios on the Bank's commercial real estate loans are
generally limited to 80% of the appraised value of the secured property. As part
of the criteria for underwriting commercial real estate loans, the Bank
generally imposes a debt coverage ratio (the ratio of net cash from operations
before payment of debt service to debt service) of not less than 1.25. It is
also the Bank's policy to obtain personal guarantees from the principals of its
corporate borrowers on its commercial real estate loans.
Commercial real estate lending affords the Bank an opportunity to
receive interest at rates higher than those generally available from one- to
four-family residential lending. However, loans secured by such properties
usually have higher balances and are more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family residential
mortgage loans. If the estimate of value proves to be inaccurate, in the event
of default and foreclosure the Bank may be confronted with a property the value
of which is insufficient to assure full repayment. Because payments on such
loans are often dependent on the successful development, operation and
management of the properties, repayment of such loans may be affected by adverse
conditions in the real estate market or the economy. The Bank seeks to minimize
these risks by limiting the maximum loan-to-value ratio and strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The Bank also
obtains loan guarantees from financially capable parties based on a review of
personal financial statements.
Multifamily Residential Real Estate Lending. The Bank originates
mortgage loans secured by multifamily dwelling units (more than four units). At
September 30, 1998, $3.8 million, or 2.6% of the Bank's total loan portfolio
consisted of loans secured by multifamily residential real estate. The majority
of the Bank's multifamily residential real estate loans are secured by apartment
buildings located in the Bank's primary market area. The interest rates for the
Bank's multifamily residential real estate loans generally have interest rates
that adjust at either one-, three-, or five-year intervals, based on the
constant maturity Treasury index, with annual and lifetime interest rate
adjustment limits of 2% and 5%, respectively, and are originated to amortize in
a maximum of 20 years.
The Bank requires appraisals of all properties securing multifamily
residential real estate loans. Appraisals are performed by an independent
appraiser designated by the Bank, all of which are reviewed by management. The
Bank considers the quality and location of the real estate, the credit of the
borrower, the cash flow of the project and the quality of management involved
with the property.
Loan-to-value ratios on the Bank's multifamily residential real
estate loans are generally limited to 80%. As part of the criteria for
underwriting multifamily residential real estate loans, the Bank generally
imposes a debt coverage ratio (the ratio of net cash from operations before
payment of debt service to debt service) of not less than 1.25. It is also the
Bank's policy to obtain personal guarantees from the principals of its corporate
borrowers on its multifamily residential real estate loans.
Multifamily residential real estate lending affords the Bank an
opportunity to receive interest at rates higher than those generally available
from one- to four-family residential lending. However, loans secured by such
properties usually have higher balances and are more difficult to evaluate and
monitor and, therefore, involve a greater degree of risk than one- to
four-family residential mortgage loans. If the estimate of value proves to be
inaccurate, in the event of default and foreclosure the Bank may be confronted
with a property the value of which is insufficient to assure full repayment.
Because payments on such loans are often dependent on the successful operation
and management of the properties, repayment of such loans may be affected by
adverse conditions in the real estate market or the economy. The Bank seeks to
minimize these risks by limiting the maximum loan-to-value ratio and strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The Bank also
obtains loan guarantees from financially capable parties based on a review of
personal financial statements.
Consumer Lending. The Bank originates a variety of consumer loans
primarily on a secured basis. Consumer loans include home equity lines of
credit, loans secured by savings accounts, automobiles, recreational vehicles
and
6
<PAGE>
second mortgages, and unsecured personal loans. The Bank's home equity lines of
credit are secured by a first or second mortgage on residential property, have
variable interest rates that are tied to The Wall Street Journal prime lending
rate (the "Prime Rate") and may adjust monthly, and generally mature in 15
years. Other consumer loans are made with fixed interest rates and have terms
that generally do not exceed five years. At September 30, 1998, consumer loans
amounted to $9.0 million, or 6.3% of the total loan portfolio.
At September 30, 1998, the largest component of the consumer loan
portfolio consisted of home equity lines of credit, which totaled $6.8 million,
or 4.7% of the total loan portfolio. At September 30, 1998, unused commitments
to extend credit under home equity lines of credit totaled $7.7 million.
The majority of the Bank's consumer loans are made to existing
customers, although the Bank actively promotes consumer loans by contacting
existing customers and by other promotions and advertising directed at existing
and prospective customers. The Bank's consumer loans are originated on a secured
and unsecured basis, and the secured loans on rare occasions may have loan
balances that exceed the value of the collateral.
The Bank views consumer lending as an important part of its business
because consumer loans generally have shorter terms and higher yields, thus
reducing exposure to changes in interest rates. In addition, the Bank believes
that offering consumer loans helps to expand and create stronger ties to its
customer base. Subject to market conditions, the Bank intends to continue
emphasizing consumer lending. Consumer loans entail greater risk than do
residential mortgage loans, particularly in the case of consumer loans that are
unsecured or secured by rapidly depreciating assets. In such cases, any
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 beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and are more likely
to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Furthermore, the application of various federal and state laws, including
federal and state bankruptcy and insolvency laws, may limit the amount that can
be recovered on such loans. The Bank believes that these risks are not as
prevalent in the case of the Bank's consumer loan portfolio because a large
percentage of the portfolio consists of home equity lines of credit that are
underwritten in a manner such that they result in credit risk that is
substantially similar to one- to four-family residential mortgage loans.
Nevertheless, home equity lines of credit have greater credit risk than one- to
four-family residential mortgage loans because they often are secured by
mortgages subordinated to the existing first mortgage on the property, which may
or may not be held by the Bank. At September 30, 1998, the Bank had no consumer
loans that were delinquent in excess of 90 days.
The Bank employs strict underwriting procedures for consumer loans.
These procedures include an assessment of the applicant's credit history and the
ability to meet existing and proposed debt obligations. Although the applicant's
creditworthiness is the primary consideration, the underwriting process also
includes a comparison of the value of the security, if any, to the proposed loan
amount. The Bank generally underwrites and originates its consumer loans
internally, which the Bank believes limits its exposure to credit risks
associated with loans underwritten or purchased from brokers and other external
sources.
Commercial Business Loans. The Bank also originates commercial
business loans, generally to customers who are well known to the Bank.
Commercial business loans are frequently secured by real estate, although the
decision to grant a commercial business loan depends primarily on the
creditworthiness and cash flow of the borrower (and any guarantors) and
secondarily on the value of and ability to liquidate the collateral. The Bank
generally requires annual financial statements from its corporate borrowers and
personal guarantees from the corporate principals. The Bank also generally
requires an appraisal of any real estate that secures the loan. In addition, the
Bank's portfolio of commercial business loans as of September 30, 1998 includes
residential acquisition and development loans ("A&D loans"), all of which were
made to builders with whom the Bank has a longstanding relationship and are
secured by real estate located in Gaston County. At September 30, 1998, the Bank
had $6.6 million of commercial business loans which represented 4.6% of the
total loan portfolio. As of September 30, 1998, unsecured commercial business
loans totaled $659,000.
The Bank's A&D loans are originated to local developers for the
purpose of developing land for sale by, for example, installing roads, sewers,
water and other utilities. A&D loans are secured by a lien on the property,
and
7
<PAGE>
are typically made for a period of three years with interest rates that are tied
to the Prime Rate. The Bank requires monthly interest payments during the term
of the loan. The Bank's A&D loans are structured so that the Bank is repaid in
full upon the sale by the borrower of approximately 75% of the available lots.
All of the Bank's A&D loans are secured by property located in its primary
market area. In addition, the Bank obtains personal guarantees from the
principals of its corporate borrowers and generally originates A&D loans to
developers with whom its has established relationships.
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential and commercial real estate lending. Real estate
lending is generally considered to be collateral based, with loan amounts based
on predetermined loan to collateral values and liquidation of the underlying
real estate collateral is viewed as the primary source of repayment in the event
of borrower default. Although commercial business loans may be collateralized by
equipment or other business assets, the liquidation of collateral in the event
of a borrower default is often an insufficient source of repayment because
equipment and other business assets may be obsolete or of limited use, among
other things. Accordingly, the repayment of a commercial business loan depends
primarily on the creditworthiness of the borrower (and any guarantors), while
liquidation of collateral is a secondary and often insufficient source of
repayment.
Maturity of Loan Portfolio. The following table sets forth certain
information at September 30, 1998 regarding the dollar amount of loans maturing
in the Bank's portfolio based on their contractual terms to maturity, but does
not include scheduled payments or potential prepayments. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as becoming due within one year. Loan balances do not include
undisbursed loan proceeds, unearned discounts, unearned income and allowance for
loans losses.
<TABLE>
<CAPTION>
Real Estate Loans
------------------------------------------------------------------
One- to Four- Multi- Commercial
Family Family Business and
Residential Construction Commercial Residential Consumer Total
------------- ------------ ---------- ----------- ------------ ------------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Amounts Due:
Within 1 year......... $ 604 $ 2,530 $ 0 $ 0 $ 3,359 $ 6,493
Over 1 to 2 years..... 85 482 13 0 654 1,234
Over 2 to 3 years..... 307 0 188 0 1,521 2,016
Over 3 to 5 years..... 1,687 0 618 31 2,313 4,649
Over 5 to 10 years.... 17,783 0 962 879 168 19,792
Over 10 to 20 years... 41,983 3,721 6,295 2,861 7,603 62,463
Over 20 years......... 43,077 3,840 0 0 0 46,917
------------ ------------ ------------ ------------ ------------ ------------
Total amount due...... $ 105,526 $ 10,573 $ 8,076 $ 3,771 $ 15,618 $ 143,564
============ ============ ============ ============ ============ ============
</TABLE>
The following table sets forth the dollar amount of all loans for
which final payment is not due until after September 30, 1999. The table also
shows the amount of loans which have fixed rates of interest and those which
have adjustable rates of interest.
<TABLE>
<CAPTION>
Fixed Rates Adjustable Rates Total
------------- ------------------ ------------
(In Thousands)
<S> <C> <C> <C>
Real Estate Loans:
One- to four-family residential... $ 85,838 $ 19,084 $ 104,922
Construction...................... 7,983 60 8,043
Commercial real estate............ 376 7,700 8,076
Multifamily residential........... 0 3,771 3,771
---------- ---------- ----------
Total real estate loans.............. 94,197 30,615 124,812
Commercial and consumer.............. 3,120 9,139 12,259
---------- ---------- ----------
Total loans....................... $ 97,317 $ 39,754 $ 137,071
========== ========== ==========
</TABLE>
Scheduled contractual principal repayments of loans do not reflect
the actual life of such assets. The average life of a loan is substantially less
than its contractual terms because of prepayments. In addition, due-on-sale
clauses on
8
<PAGE>
loans generally give the Bank the right to declare loans 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, however, when current mortgage loan market
rates are substantially higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgage loans are substantially
higher than current mortgage loan market rates. Furthermore, management believes
that a significant number of the Bank's residential mortgage loans are
outstanding for a period less than their contractual terms because of the
transitory nature of many of the borrowers who reside in its primary market
area.
Loan Solicitation and Processing. The Bank's lending activities are
subject to the written, non-discriminatory, underwriting standards and loan
origination procedures established by the Bank's Board of Directors and
management. Loan originations come from a number of sources. The customary
sources of loan originations are real estate agents, home builders, walk-in
customers, referrals and existing customers. The Bank also advertises its loan
products by television and newspaper. In its marketing, the Bank emphasizes its
community ties, customized personal service and an efficient underwriting and
approval process. The Bank uses professional fee appraisers for most residential
real estate loans and construction loans and all commercial real estate and land
loans. The Bank requires hazard, title and, to the extent applicable, flood
insurance on all security property.
Mortgage loan applications are initiated by loan officers. All loans
of $500,000 or more must be approved by the Board of Directors. Loans of less
than $500,000 may be approved by the Bank's Loan Committee, a management
committee consisting of the Bank's President and three senior lending officers.
In addition, individual lending officers have lending authority up to limits
established by the Board of Directors.
Loan Originations, Sales and Purchases. The following table sets
forth total loans originated and repaid during the periods indicated.
<TABLE>
<CAPTION>
For the Years Ended
September 30,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
(In Thousands)
<S> <C> <C> <C>
Total loans receivable at beginning of period........ $ 139,111 $ 136,030 $ 123,710
Total loan originations:
One- to four-family residential................... 21,282 12,608 18,466
Construction...................................... 10,701 7,536 8,645
Commercial real estate............................ 1,265 1,747 1,235
Multifamily....................................... -- -- 2,513
Commercial business and consumer.................. 19,456 9,430 10,360
----------- ----------- -----------
Total loans originated............................... 52,704 31,321 41,219
Loans purchased...................................... 8,835 -- 254
Principal repayments................................. (57,086) (28,240) (29,153)
----------- ----------- -----------
Net loan activity.................................... 4,453 3,081 12,320
----------- ----------- -----------
Total loans receivable at end of period.............. $ 143,564 $ 139,111 $ 136,030
=========== =========== ===========
</TABLE>
Loan Commitments. The Bank issues commitments for mortgage loans
conditioned upon the occurrence of certain events. Such commitments are made in
writing on specified terms and conditions and are honored for up to 60 days from
approval, depending on the type of transaction. At September 30, 1998, the Bank
had loan commitments (excluding undisbursed portions of interim construction
loans of $5.2 million) of $890,000 and unused lines of credit of $15.1 million.
Loan Fees. In addition to interest earned on loans, the Bank
receives income from fees in connection with loan originations, loan
modifications, late payments and for miscellaneous services related to its
loans. Income from these activities varies from period to period depending upon
the volume and type of loans made and competitive conditions.
The Bank charges loan origination fees which are calculated as a
percentage of the amount borrowed. In accordance with applicable accounting
procedures, loan origination fees and discount points in excess of loan
origination costs are deferred and recognized over the contractual remaining
lives of the related loans on a level yield basis. Discounts and premiums on
loans purchased are accreted and amortized in the same manner. The Bank
recognized
9
<PAGE>
$231,000, $172,000 and $131,000 of deferred loan fees during the fiscal years
ended September 30, 1998, 1997 and 1996, respectively, in connection with loan
refinancings, payoffs, sales and ongoing amortization of outstanding loans.
Nonperforming Assets and Delinquencies. When a borrower fails to
make a required payment on a loan, the Bank attempts to cure the deficiency by
contacting the borrower and seeking the payment. Computer generated late notices
are mailed 15 days after a payment is due. In most cases, deficiencies are cured
promptly. If a delinquency continues, additional contact is made either through
a notice or other means and the Bank will attempt to work out a payment schedule
and actively encourage delinquent borrowers to seek home ownership counseling.
While the Bank generally prefers to work with borrowers to resolve such
problems, the Bank will institute foreclosure or other proceedings, as
necessary, to minimize any potential loss.
Loans are placed on nonaccrual status generally if, in the opinion
of management, principal or interest payments are not likely in accordance with
the terms of the loan agreement, or when principal or interest is past due 90
days or more. Interest accrued but not collected at the date the loan is placed
on nonaccrual status is reversed against income in the current period. Loans may
be reinstated to accrual status when payments are under 90 days past due and, in
the opinion of management, collection of the remaining past due balances can be
reasonably expected.
The Bank's Board of Directors is informed monthly of the status of
all mortgage loans delinquent more than 60 days, all consumer and commercial
business loans delinquent more than 30 days, all loans in foreclosure and all
foreclosed and repossessed property owned by the Bank.
The following table sets forth information with respect to the
Bank's nonperforming assets at the dates indicated. As of such dates, the Bank
had no restructured loans within the meaning of SFAS No. 15.
<TABLE>
<CAPTION>
At September 30,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Loans accounted for on a nonaccrual basis:
Real estate loans:
One- to four-family residential....................... $ 970 $ 876 $ 1,053 $ 778 $ 904
Multifamily residential............................... 177 183 141 -- --
Commercial real estate................................ 91 -- -- -- --
Commercial business and consumer........................... -- -- -- -- --
Total nonaccrual loans..................................... 1,238 1,059 1,194 778 904
Accruing loans which were contractually past
due 90 days or more...................................... -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Total nonperforming loans.................................. 1,238 1,059 1,194 778 904
Real estate owned.......................................... 247 247 258 426 535
----------- ----------- ----------- ----------- -----------
Total nonperforming assets................................. $ 1,485 $ 1,306 $ 1,452 1,204 1,439
=========== =========== =========== =========== ===========
Nonaccrual loans and loans 90 days past due as a
percentage of net loans............................... 0.91% 0.79% 0.91% 0.65% 0.81%
Nonaccrual loans and loans 90 days past due as a
percentage of total assets............................ 0.86% 0.76% 0.88% 0.63% 0.78%
Total nonperforming assets as a percentage of total assets. 0.71% 0.75% 0.84% 0.73% 0.95%
</TABLE>
Interest income that would have been recorded for the fiscal years
ended September 30, 1998, 1997 and 1996 had nonaccruing loans been current in
accordance with their original terms amounted to $77,000, $42,000 and $46,000,
respectively. The Bank did not include any interest income on such loans for
such periods.
Real Estate Acquired in Settlement of Loans. Real estate acquired by
the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is
classified as real estate acquired in settlement of loans until sold. Pursuant
to American Institute of Certified Public Accountants ("AICPA") Statement of
Position ("SOP") 92-3, which provides guidance on determining the balance sheet
treatment of foreclosed assets in annual financial statements for periods ended
on or after December 15, 1992, there is a rebuttable presumption that
foreclosed assets are held for sale and such assets are recommended to be
carried at fair value minus estimated cost to sell the property. After the date
of acquisition, all costs incurred in maintaining the property are expensed and
costs incurred for the improvement or development of such property are
capitalized up to the extent of their net realizable value. The Bank's
accounting for its real estate acquired in settlement of loans complies with SOP
92-3. At September 30, 1998, the Bank had $247,000 of real estate acquired in
settlement of loans.
10
<PAGE>
Restructured Loans. Under Generally Accepted Accounting Principals
("GAAP"), the Bank is required to account for certain loan modifications or
restructuring as a "troubled debt restructuring." In general, the modification
or restructuring of a debt constitutes a troubled debt restructuring if the Bank
for economic or legal reasons related to the borrower's financial difficulties
grants a concession to the borrowers that the Bank would not otherwise consider.
Debt restructurings or loan modifications for a borrower do not necessarily
always constitute troubled debt restructurings, however, and troubled debt
restructurings do not necessarily result in nonaccrual loans. The Bank had no
restructured loans as of September 30, 1998.
Asset Classification. The OTS has adopted various regulations
regarding problem assets of savings institutions. The regulations require that
each insured institution review and classify its assets on a regular basis. In
addition, in connection with examinations of insured institutions, OTS examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. 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 as loss is considered uncollectible and
of such little value that continuance as an asset of the institution is not
warranted. If an asset or portion thereof is classified as loss, the insured
institution establishes specific allowances for loan losses for the full amount
of the portion of the asset classified as loss. All or a portion of general loan
loss allowances established to cover possible losses related to assets
classified substandard or doubtful can be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital. Assets that do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are designated "special mention" and monitored by the Bank.
As of September 30, 1998, the aggregate amount of the Bank's assets
classified as substandard was $2.1 million, no assets were classified as
doubtful or loss, and the aggregate amount not classified but designated special
mention was $384,000. As of September 30, 1997, the aggregate amount of the
Bank's assets classified as substandard was $2.3 million, no assets were
classified as doubtful or loss, and the aggregate amount not classified but
designated special mention was $312,000. As of September 30, 1996, the aggregate
amount of the Bank's assets classified as substandard was $2.3 million, no
assets were classified as doubtful or loss, and the aggregate amount not
classified but designated special mention was $432,000.
Allowance for Loan Losses. The Bank has established a systematic
methodology for the determination of provisions for loan losses. The methodology
is set forth in a formal policy and takes into consideration the need for an
overall general valuation allowance as well as specific allowances that are tied
to individual loans.
In originating loans, the Bank recognizes that losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. The Bank increases its allowance for loan
losses by charging provisions for loan losses against the Bank's income.
The general valuation allowance is maintained to cover losses
inherent in the loan portfolio. 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. Specific valuation allowances are established
to absorb losses on loans for which full collectibility cannot be reasonably
assured. The amount of the allowance is based on the estimated value of the
collateral securing the loan and other analyses pertinent to each situation.
Generally, a provision for losses is charged against income monthly to maintain
the allowances.
At September 30, 1998, the Bank had an allowance for loan losses of
$1.4 million. Management believes that the amount maintained in the allowance at
September 30, 1998 will be adequate to absorb losses inherent in the portfolio.
Although management believes that it uses the best information available to make
such determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and
11
<PAGE>
adversely affected if circumstances differ substantially from the assumptions
used in making the determinations. Furthermore, while the Bank believes it has
established its existing allowance for loan losses in accordance with GAAP,
there can be no assurance that regulators, in reviewing the Bank's loan
portfolio, will not request the Bank to increase significantly its allowance for
loan losses. In addition, because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
the existing allowance for loan losses is adequate or that substantial increases
will not be necessary should the quality of any loans deteriorate as a result of
the factors discussed above. Any material increase in the allowance for loan
losses may adversely affect the Bank's financial condition and results of
operations.
The following table sets forth an analysis of the Bank's allowance
for loan losses.
<TABLE>
<CAPTION>
At and For the Fiscal Years
Ended September 30,
---------------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Total loans outstanding........................... $ 143,564 $ 139,111 $ 136,030 $ 123,710 $ 116,383
========= ========= ========= ========= =========
Average loans outstanding......................... $ 143,555 $ 137,149 $ 131,671 $ 119,527 $ 113,902
========= ========= ========= ========= =========
Allowance at beginning of period.................. 1,110 $ 830 $ 786 726 426
Provision......................................... 300 293 47 60 300
Recoveries........................................ 6 -- -- -- --
Charge-offs:
Consumer loans.................................. 5 13 3 -- --
--------- --------- --------- --------- ---------
Allowance at end of period........................ $ 1,411 $ 1,110 $ 830 $ 786 $ 726
========= ========= ========= ========= =========
Allowance for loan losses as a percentage
of total loans outstanding...................... 1.03% 0.83% 0.63% 0.66% 0.65%
========= ========= ========= ========= =========
Net loans charged off as a percentage of total
loans outstanding............................... --% 0.01% --% --% --%
========= ========= ========= ========= =========
Ratio of allowance to nonperforming loans......... 113.97% 104.82% 69.51% 101.03% 80.31%
========= ========= ========= ========= =========
</TABLE>
12
<PAGE>
The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. 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 other category.
<TABLE>
<CAPTION>
At September 30,
----------------------------------------------------------------------------------------
Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
-------- ----------- -------- ----------- -------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family residential...... $ 699 73.5% $ 643 76.50% $ 450 76.72%
Construction......................... 125 7.36 55 4.22 50 5.02
Commercial........................... 200 5.63 105 5.26 88 4.75
Multifamily residential.............. 75 2.63 100 4.68 75 5.03
Commercial and consumer................ 312 10.88 207 9.34 167 8.48
------- ------- ------- ------- ------- -------
Total allowance for loan losses........ $ 1,411 100.00% $ 1,110 100.00% $ 830 100.00%
======= ======= ======= ======= ======= =======
<CAPTION>
At September 30,
-------------------------------------------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Amount Total Loans Amount Total Loans
-------- ----------- -------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
One- to four-family residential....... $ 436 75.74% $ 400 76.14%
Construction.......................... 50 4.58 50 5.64
Commercial............................ 75 4.08 70 4.03
Multifamily residential............... 75 5.96 70 5.85
Commercial and consumer................. 150 9.64 136 8.33
------- ------- ------- -------
Total allowance for loan losses......... $ 786 100.00% $ 726 100.00%
======= ======= ======= =======
</TABLE>
13
<PAGE>
Investment Activities
The Bank is permitted under federal law to invest in various types
of liquid assets, including U.S. Treasury obligations, securities of various
federal agencies and of state and municipal governments, deposits at the
FHLB-Atlanta, certificates of deposit of federally insured institutions, certain
bankers' acceptances and federal funds. Subject to various restrictions, the
Bank may also invest a portion of its assets in commercial paper and corporate
debt securities. Savings institutions like the Bank are also required to
maintain an investment in FHLB stock. The Bank is required under federal
regulations to maintain a minimum amount of liquid assets. See "Regulation" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The Bank purchases investment securities with excess liquidity
arising when investable funds exceed loan demand. The Bank's investment
securities purchases typically have been limited to U.S. Government and agency
securities generally with contractual maturities of between one and five years.
The Bank's investment policies generally limit investments to U.S.
Government and agency securities, municipal bonds, certificates of deposit,
marketable corporate debt obligations, mortgage-backed securities and certain
types of mutual funds. The Bank's investment policy does not permit engaging
directly in hedging activities or purchasing high risk mortgage derivative
products or non-investment grade corporate bonds. Mutual funds held by the Bank
may periodically engage in hedging activities and invest in derivative
securities. Investments are made based on certain considerations, which include
the interest rate, yield, settlement date and maturity of the investment, the
Bank's liquidity position, and anticipated cash needs and sources (which in turn
include outstanding commitments, upcoming maturities, estimated deposits and
anticipated loan amortization and repayments). The effect that the proposed
investment would have on the Bank's credit and interest rate risk and risk-based
capital is also considered.
14
<PAGE>
The following table sets forth the amortized cost and fair value of our
investment and mortgage-backed securities, at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
-----------------------------------------------------------------------
1998 1997
---------------------------------- ---------------------------------
Amortized Unrealized Fair Amortized Unrealized Fair
Cost Gain(Loss) Value Cost Gain(Loss) Value
--------- ---------- -------- --------- ---------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment Securities:
U.S. Government and agency securities held to maturity.. $ 15,228 $ 371 $ 15,599 $ 10,407 $ 18 $ 10,425
U.S. Government and agency securities available for sale 15,047 156 15,203 1,988 22 2,010
--------- -------- -------- -------- -------- --------
Total investment securities................................ $ 30,275 $ 527 $ 30,802 $ 12,395 $ 40 $ 12,435
========= ======== ======== ======== ======== ========
Mortgage-backed securities:
FHLMC held to maturity.................................. $ 3,039 $ 72 $ 3,111 $ 5,238 $ 94 $ 5,332
FNMA held to maturity................................... 2,353 27 2,380 3,588 (18) 3,570
GNMA held to maturity................................... 966 43 1,009 1,261 30 1,291
FNMA available for sale................................. 1,483 (2) 1,481 -- -- --
GNMA available for sale................................. 4,866 (12) 4,854 -- -- --
SBA available for sale.................................. 2,010 5 2,015 -- -- --
--------- -------- -------- -------- -------- --------
Total mortgage-backed securities........................... $ 14,717 $ 133 $ 14,850 $ 10,087 $ 106 $ 10,193
========= ======== ======== ======== ======== ========
Other Investments:
US League Asset Management Fund available for sale...... $ 1,459 $ 37 $ 1,496 $ 1,375 $ 14 1,38
Federated Government Trust available for sale........... 1,163 135 1,298 3,036 228 3,264
FHLMC stock available for sale.......................... 44 2,184 2,228 44 1,542 1,586
Municipal Bonds available for sale...................... 1,040 15 1,063 -- -- --
Municipal Bonds held to maturity........................ 660 8 368 -- -- --
--------- -------- -------- -------- -------- --------
Total other investments.................................... $ 3,709 $ 2,379 $ 6,085 $ 4,455 $ 1,784 $ 6,239
========= ======== ======== ======== ======== ========
<CAPTION>
At September 30,
---------------------------------
1996
---------------------------------
Amortized Unrealized Fair
Cost Gain(Loss) Value
--------- ---------- --------
(Dollars in Thousands)
<S> <C> <C> <C>
Investment Securities:
U.S. Government and agency securities held to maturity........ $ 14,751 $ (88) $ 14,663
U.S. Government and agency securities available for sale...... -- -- --
-------- -------- --------
Total investment securities...................................... $ 14,751 $ (88) $ 14,663
======== ======== ========
Mortgage-backed securities:
FHLMC held to maturity........................................ $ 6,813 $ 15 $ 6,828
FNMA held to maturity......................................... 4,663 (94) 4,569
GNMA held to maturity......................................... 1,442 7 1,449
-------- -------- --------
FNMA available for sale....................................... -- -- --
GNMA available for sale....................................... -- -- --
SBA available for sale........................................ -- -- --
-------- -------- --------
Total mortgage-backed securities................................. $ 12,918 $ (72) $ 12,846
======== ======== ========
Other Investments:
US League Asset Management Fund available for sale............ 1,295 $ 9 $ 1,304
Federated Government Trust available for sale................. 2,861 183 3,044
FHLMC stock available for sale................................ 44 1,073 1,117
Municipal Bonds available for sale............................ 50 -- 50
Municipal Bonds held to maturity.............................. -- -- --
-------- -------- --------
Total other investments.......................................... $ 4,250 $ 1,265 $ 5,515
======== ======== ========
</TABLE>
The following table sets forth information regarding the scheduled
maturities, carrying values, approximate fair values, and weighted average
yields for our investment securities portfolio at September 30, 1998 by
contractual maturity. The following table does not take into consideration the
effects of scheduled repayments or the effects of possible prepayments.
15
<PAGE>
<TABLE>
<CAPTION>
At September 30, 1998
-----------------------------------------------------------------------------------------
Less than 1 year 1 to 5 years Over 5 to 10 years Over 10 years
-------------------- -------------------- -------------------- --------------------
Weighed Weighed Weighed Weighed
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield(1) Value Yield(1) Value Yield(1) Value Yield(1)
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government securities.......... $ 1,500 6.22% $ 994 6.50% $ -- --% -- --%
U.S. Agency securities.............. 2,748 5.70 10,033 6.10 15,000 6.32 -- --
------- ------ ------- ------ ------- ------ ------- ------
Total............................... $ 4,248 5.88% $11,027 6.14% $15,000 6.32% $ -- --%
======= ====== ======= ====== ======= ====== ======= ======
</TABLE>
At September 30, 1998
-------------------------------
Total Securities
-------------------------------
Weighed
Carrying Average Market
Value Yield(1) Value
(Dollars in Thousands)
U.S. Government securities.......... $ 2,494 6.33% $ 2,530
U.S. Agency securities.............. 27,781 6.18 28,272
------- ------ -------
Total............................... $30,275 6.19% $30,802
======= ====== =======
- -----------------------------
(1) Yields on tax exempt obligations have been computed on a tax equivalent
basis.
16
<PAGE>
Deposit Activities and Other Sources of Funds
General. Deposits are the major external source of funds for the Bank's
lending and other investment activities. In addition, the Bank also generates
funds internally from loan principal repayments and prepayments and maturing
investment securities. Scheduled loan repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and money market conditions. Borrowings
from the FHLB-Atlanta may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources. Presently, the Bank
has no other borrowing arrangements.
Deposit Accounts. The Bank's deposit products include a broad selection of
deposit instruments, including NOW accounts, demand deposit accounts, money
market accounts, regular passbook savings, statement savings accounts and term
certificate accounts. Deposit account terms vary with the principal difference
being the minimum balance deposit, early withdrawal penalties and the interest
rate. The Bank reviews its deposit mix and pricing weekly. The Bank does not
utilize brokered deposits, nor has it aggressively sought jumbo certificates of
deposit.
The Bank believes it is competitive in the type of accounts and interest
rates it offers on its deposit products. The Bank does not seek to pay the
highest deposit rates but a competitive rate. The Bank determines the rates paid
based on a number of conditions, including rates paid by competitors, rates on
U.S. Treasury securities, rates offered on various FHLB-Atlanta lending
programs, and the deposit growth rate the Bank is seeking to achieve.
From time to time, the Bank may use premiums to attract new checking
accounts, particularly in conjunction with new branch openings. Should they be
used, these premium offers would be reflected in an increase in the Bank's
advertising and promotion expense, as well as its cost of funds. The Bank also
seeks business checking accounts and promotes individual retirement accounts
("IRAs") and Self Employment Plan retirement accounts to businesses.
17
<PAGE>
The following table sets forth information concerning the Bank's time
deposits and other interest-bearing deposits at September 30, 1998.
<TABLE>
<CAPTION>
At September 30, 1998 At September 30, 1997 At September 30, 1996
--------------------- --------------------- ---------------------
Interest Interest Interest
Category Balance Rate Balance Rate Balance Rate
------- -------- ------- -------- ------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Noninterest bearing demand $ 5,868 --% $ 3,023 --% $ 2,088 --%
Interest bearing demand 22,842 2.80 25,906 2.90 23,716 2.90
Savings accounts 20,557 3.20 14,197 2.90 14,082 2.90
Certificates of deposit 94,623 5.40 102,318 5.60 106,089 5.80
-------- -------- -------- -------- -------- --------
Total Deposits $143,900 4.50% $145,444 4.60% $145,975 5.00%
======== ======== ======== ======== ======== ========
</TABLE>
The following table indicates the amount of the Bank's certificate accounts
with a principal balance greater than $100,000 by time remaining until maturity
as of September 30, 1998.
Maturity Period Certificates of Deposit
- --------------- -----------------------
(In Thousands)
Within three months......................... $ 4,368
Three to six months......................... 4,824
Six through twelve months................... 3,972
Over twelve months.......................... 4,744
-----------
Total jumbo certificates of deposit...... $ 17,908
===========
Time Deposits by Rates. The following table sets forth the amount of
time deposits in the Bank categorized by rates at the dates indicated.
As of September 30,
------------------------------------------
1998 1997 1996
----------- ---------- -----------
(In Thousands)
Interest Rate
- -------------
2.00-4.00%................... $ 399 $ 172 $ 24
4.01-6.00%................... 91,641 92,311 84,163
6.01-8.00%................... 2,583 9,835 21,902
----------- ---------- -----------
$ 94,623 $ 102,318 $ 106,089
=========== ========== ===========
Time Deposits by Maturities. The following table sets forth the amount of
time deposits in the Bank categorized by rates and maturities at September 30,
1998.
<TABLE>
<CAPTION>
After
Interest Rate September 30, 1999 September 30, 2000 September 30, 2001 September 30, 2001 Total
- ------------- ------------------ ------------------ ------------------ ------------------ ---------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
2.01-4.0%......... $ 399 $ -- $ -- $ -- $ 399
4.01-6.0%......... 70,075 16,171 5,089 305 91,640
6.01-8.0%......... 622 1,066 665 231 2,584
---------- ---------- ---------- ---------- ----------
Total............. $ 71,096 $ 17,237 $ 5,754 $ 536 $ 94,623
========== ========== ========== ========== ==========
</TABLE>
18
<PAGE>
Deposit Activity. The following table set forth the deposit activity of the
Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Beginning balance................................... $ 145,444 $ 145,975 $ 141,432 $ 129,681 $ 129,600
Net increase (decrease) before interest credited.... (8,216) (7,386) (2,751) 5,649 (4,368)
Interest credited................................... 6,672 6,855 7,294 6,102 4,449
--------- --------- --------- --------- ---------
Net increase (decrease) in savings deposits......... (1,544) (531) 4,543 11,751 81
---------- --------- --------- --------- ---------
Ending balance...................................... $ 143,900 $ 145,444 $ 145,975 $ 141,432 $ 129,681
========= ========= ========= ========= =========
</TABLE>
Borrowings. Savings deposits are the primary source of funds for the Bank's
lending and investment activities and for its general business purposes. The
Bank has the ability to use advances from the FHLB-Atlanta to supplement its
supply of lendable funds and to meet deposit withdrawal requirements. The
FHLB-Atlanta functions as a central reserve bank providing credit for savings
associations and certain other member financial institutions. As a member of the
FHLB-Atlanta, the Bank is required to own capital stock in the FHLB-Atlanta and
is authorized to apply for advances on the security of such stock and certain of
its mortgage loans and other assets (principally securities that are obligations
of, or guaranteed by, the U.S. Government) provided certain creditworthiness
standards have been met. Advances are made pursuant to several different credit
programs. Each credit program has its own interest rate and range of maturities.
Depending on the program, limitations on the amount of advances are based on the
financial condition of the member institution and the adequacy of collateral
pledged to secure the credit. The maximum outstanding balances of the Bank's
FHLB advances for the fiscal years ended September 30, 1998, 1997 and 1996 were
$19.5 million, $3.8 million and $3.8 million, respectively, the average balances
outstanding were $ 7.9 million, $2.3 million and $1.4 million, respectively, and
the weighted average interest rates were 5.50%, 6.28% and 4.36%, respectively.
The Bank's outstanding balances of FHLB advances as of September 30, 1998, 1997
and 1996, were $19.5 million, $3.5 million and $3.8 million, respectively.
Management of Market Risk
Generally. The Bank's most significant form of market risk is interest-rate
risk, as the majority of the Bank's assets and liabilities are sensitive to
changes in interest rates. The principal objective of the Bank's interest rate
risk management is to evaluate the interest rate risk inherent in the Bank's
assets and liabilities, determine the level of risk appropriate given the Bank's
business strategy, operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with the guidelines
approved by the Board of Directors. Through such management, the Bank seeks to
reduce the vulnerability of its operations to changes in interest rates. The
Bank's Asset/Liability Committee comprises the Bank's senior management under
the direction of the Board of Directors, with senior management responsible for
reviewing with the Board of Directors its activities and strategies, the effect
of those strategies on the Bank's net interest margin, the fair value of the
portfolio and the effect that changes in interest rates will have on the Bank's
portfolio and the Bank's exposure limits. See "Risk Factors--Potential Effects
of Changes in Interest Rates and the Current Interest Rate Environment."
In recent years, the Bank has utilized the following strategies to manage
interest rate risk: (1) emphasizing the origination and retention of one- to
four-family residential ARM loans and fixed-rate loans with maturities of 15
years or less, (2) emphasizing the origination and retention of commercial and
multifamily residential real estate loans and commercial business loans with
adjustable interest rates, and (3) emphasizing the origination of home equity
lines of credit that have adjustable interest rates and mature in 15 years or
less and other consumer loans that mature in five years or less, and (4)
investing in shorter term securities which generally bear lower yields as
compared to longer term investments, but which better position the Bank for
increases in market interest rates. Management recognizes that the long-term
effect of interest rate changes on the Bank's income can be substantial.
Accordingly, management has increased the attractiveness of its 10 to 15 year
mortgage loans with below-market rates. In addition, the Bank aggressively
markets shorter term nonmortgage loans and adjustable rate home equity lines of
credit.
Net Portfolio Value. In recent years, The Bank has measured its interest
rate sensitivity by computing the "gap" between the assets and liabilities which
were expected to mature or reprice within certain time periods, based on
assumptions regarding loan prepayment and deposit decay rates formerly provided
by the OTS. However, the OTS now requires the computation of amounts by which
the net present value of an institution's cash flow from assets, liabilities and
off balance sheet items (the institution's net portfolio value or "NPV") would
change in the event of a range of
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<PAGE>
assumed changes in market interest rates. These computations estimate the effect
on an institution's NPV from instantaneous and permanent 1% to 4% (100 to 400
basis points) increases and decreases in market interest rates.
The following table presents our NPV at September 30, 1998, as calculated
by the OTS, which is based upon quarterly information voluntarily provided to
the OTS by the Bank.
Percentage Change in Net Portfolio Value
----------------------------------------
Changes Board
in Market Projected Policy
Interest Rates Change (1) Limit (2)
-------------- ---------- ---------
(basis points)
+ 400 (36.00)% (65.00)%
+ 300 (27.00)% (45.00)%
+ 200 (17.00)% (30.00)%
+ 100 (8.00)% (15.00)%
0 0.00% 0.00%
(100) 6.00% (15.00)%
(200) 12.00% (30.00)%
(300) 20.00% (45.00)%
(400) 28.00% (65.00)%
- -------------------------
(1) Calculated as the amount of change in the estimated NPV divided by the
estimated NPV assuming no change in interest rates.
(2) Limits are established by the Bank's Board of Directors.
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurement. Modeling changes in NPV requires the making of
certain assumptions which may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. In this regard,
the NPV table presented assumes that the composition of the Bank's interest
sensitive assets and liabilities existing at the beginning of a period remains
constant over the period being measured and also assumes that a particular
change in interest rates is reflected uniformly across the yield curve
regardless of the duration to maturity or repricing of specific assets and
liabilities. Accordingly, although the NPV table provides an indication of the
Bank's interest rate risk exposure at a particular point in time, such
measurements are not intended to and do not provide a precise forecast of the
effect of changes in market interest rates on the Bank's net interest income and
will differ from actual results.
Employees
As of September 30, 1998, the Bank had 53 full-time and 6 part-time
employees, none of whom is represented by a collective bargaining unit. The Bank
believes its relationship with its employees is good.
REGULATION
As a federally chartered SAIF-insured stock savings bank, the Bank is
subject to examination, supervision and extensive regulation by the OTS and the
FDIC. The Bank is a member of the Federal Home Loan Bank ("FHLB") system. This
regulation and supervision establishes a comprehensive framework of activities
in which an institution can engage and is intended primarily for the protection
of the insurance fund and depositors. The Bank also is subject to regulation by
the Board of Governors of the Federal Reserve System (the "Federal Reserve
Board") governing reserves to be maintained against deposits and certain other
matters. The OTS examines the Bank and prepares reports for the consideration of
the Bank's Board of Directors on any deficiencies that they may find in the
Bank's operations. The FDIC also examines the Bank in its role as the
administrator of the SAIF. The Bank's relationship with its depositors and
borrowers also is regulated to a great extent by both federal and state laws,
especially in such matters as the ownership of savings accounts and the form and
content of the Bank's mortgage documents. Any change in such regulation, whether
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<PAGE>
by the FDIC, OTS, or Congress, could have a material adverse impact on
the Company, the Bank, Gaston Federal Holdings, MHC (the "Mutual Company"), the
Company's parent mutual holding company, and their operations.
Federal Regulation of Savings Institutions
Business Activities. The activities of savings institutions are governed
by the Home Owners' Loan Act, as amended (the "HOLA") and, in certain respects,
the Federal Deposit Insurance Act (the "FDI Act") and the regulations issued by
the agencies to implement these statutes. These laws and regulations delineate
the nature and extent of the activities in which savings association may engage.
The description of statutory provisions and regulations applicable to savings
associations set forth herein does not purport to be a complete description of
such statutes and regulations and their effect on the Bank.
Loans to One Borrower. Under the HOLA, savings institutions are generally
subject to the national bank limits on loans to a single or related group of
borrowers. Generally, this limit is 15% of the Bank's unimpaired capital and
surplus, and an additional 10% of unimpaired capital and surplus if such loan is
secured by readily-marketable collateral, which is defined to include certain
financial instruments and bullion. The OTS by regulation has amended the loans
to one borrower rule to permit savings associations meeting certain requirements
to extend loans to one borrower in additional amounts under circumstances
limited essentially to loans to develop or complete residential housing units.
Qualified Thrift Lender Test. In general, savings associations are
required to maintain at least 65% of their portfolio assets in certain qualified
thrift investments (which consist primarily of loans and other investments
related to residential real estate and certain other assets). A savings
association that fails the qualified thrift lender test is subject to
substantial restrictions on activities and to other significant penalties.
Recent legislation has expanded the qualified thrift lender test to provide
savings associations with greater authority to lend and diversify their
portfolios. In particular, credit card and education loans may now be made by
savings associations without regard to any percentage-of-assets limit, and
commercial loans may be made in an amount up to 10 percent of total assets, plus
an additional 10 percent for small business loans. Loans for personal, family
and household purposes (other than credit card, small business and educational
loans) are now included without limit with other assets that, in the aggregate,
may account for up to 20% of total assets. The Bank satisfied the qualified
thrift lender test at September 30, 1998.
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to stockholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution, such as the
Bank, that exceeds all fully phased-in capital requirements before and after a
proposed capital distribution ("Tier 1 Association") and has not been advised by
the OTS that it is in need of more than normal supervision, could, after prior
notice but without the approval of the OTS, make capital distributions during a
calendar year equal to the greater of: (i) 100% of its net earnings to date
during the calendar year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in capital
requirements) at the beginning of the calendar year; or (ii) 75% of its net
earnings for the previous four quarters; provided that the institution would not
be undercapitalized, as that term is defined in the OTS Prompt Corrective Action
regulations, following the capital distribution. Any additional capital
distributions would require prior regulatory approval. In the event the Bank's
capital fell below its fully-phased in requirement or the OTS notified it that
it was in need of more than normal supervision, the Bank's ability to make
capital distributions could be restricted. In addition, the OTS could prohibit
a proposed capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such distribution would
constitute an unsafe or unsound practice.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable deposit accounts plus
borrowings payable in one year or less. Monetary penalties may be imposed for
failure to meet these liquidity requirements. The Bank's average liquidity
ratio for the quarter ended September 30, 1998 which exceeded the then
applicable requirements. The Bank has never been subject to monetary penalties
for failure to meet its liquidity requirements.
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<PAGE>
Community Reinvestment Act and Fair Lending Laws. Savings association
share a responsibility under the Community Reinvestment Act ("CRA") and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act (together, the "Fair Lending Laws")
prohibit lenders from discriminating in their lending practices on the basis of
characteristics specified in those statutes. An institution's failure to comply
with the provisions of CRA could, at a minimum, result in regulatory
restrictions on its activities, and failure to complete with the Fair Lending
Laws could result in enforcement actions by the OTS, as well as other federal
regulatory agencies and the Department of Justice. The Bank received a
satisfactory CRA rating under the current CRA regulations in its most recent
federal examination by the OTS.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with an institution, including the Stock
Company and any nonsavings institution subsidiaries) or to make loans to certain
insiders, is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA").
Section 23A limits the aggregate amount of transactions with any individual
affiliate to 10% of the capital and surplus of the savings institution and also
limits the aggregate amount of transactions with all affiliates to 20% of the
savings institution's capital and surplus. Certain transactions with affiliates
are required to be secured by collateral in an amount and of a type described in
Section 23A and the purchase of low quality assets from affiliates is generally
prohibited. Section 23B provides that certain transactions with affiliates,
including loans and asset purchases, must be on terms and under circumstances,
including credit standards, that are substantially the same or at least as
favorable to the institution as those prevailing at the time for comparable
transactions with nonaffiliated companies.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring
enforcement action against all "institution-related parties," including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors of the institutions, receivership, conservatorship or the termination
of deposit insurance. Civil penalties cover a wide range of violations and
actions, and range up to $25,000 per day, unless a finding of reckless disregard
is made, in which case penalties may be as high as $1 million per day. Under
the FDI Act, the FDIC has the authority to recommend to the Director of OTS that
enforcement action be taken with respect to a particular savings institution.
If action is not taken by the Director, the FDIC has authority to take such
action under certain circumstances.
Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies adopted a final regulation and Interagency Guidelines
Prescribing Standards for Safety and Soundness ("Guidelines") to implement the
safety and soundness standards required under the FDI Act. The Guidelines set
forth the safety and soundness standards that the federal banking agencies use
to identify and address problems at insured depository institutions before
capital becomes impaired. The Guidelines address internal controls and
information systems; internal audit systems; credit underwriting; loan
documentation; interest rate risk exposure; asset growth; and compensation, fees
and benefits. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard, as required by the FDI Act. The final
regulations establish deadlines for the submission and review of such safety and
soundness compliance plans.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three capital standards: a 1.5% tangible capital standard,
a 3% leverage (core capital) ratio and an 8% risk based capital standard. Core
capital is defined as common stockholder's equity (including retained earnings),
certain noncumulative perpetual preferred stock and related surplus, minority
interests in equity accounts of consolidated subsidiaries less intangibles other
than certain mortgage servicing rights ("MSRs"), and credit card relationships.
The OTS regulations require that, in meeting the leverage ratio, tangible and
risk-based capital standards institutions generally must deduct investments in
and loans to subsidiaries engaged in activities not permissible for a national
bank. In addition, the OTS prompt corrective action regulation provides that a
savings institution that has a leverage capital ratio of less than 4% (3% for
institutions receiving
22
<PAGE>
the highest CAMEL examination rating) will be deemed to be "undercapitalized"
and may be subject to certain restrictions. See "--Prompt Corrective Regulatory
Action."
The risk-based capital standard for savings institutions requires the
maintenance of total capital (which is defined as core capital and supplementary
capital) to risk-weighted assets of 8%. In determining the amount of risk-
weighted assets, all assets, including certain off-balance sheet assets, are
multiplied by a risk-weight of 0% to 100%, as assigned by the OTS capital
regulation based on the risks OTS believes are inherent in the type of asset.
The components of core capital are equivalent to those discussed earlier under
the 3% leverage standard. The components of supplementary capital currently
include cumulative preferred stock, long-term perpetual preferred stock,
mandatory convertible securities, subordinated debt and intermediate preferred
stock and, within specified limits, the allowance for loan and lease losses.
Overall, the amount of supplementary capital included as part of total capital
cannot exceed 100% of core capital.
The OTS has incorporated an interest rate risk component into its
regulatory capital rule. The final interest rate risk rule also adjusts the
risk-weighting for certain mortgage derivative securities. Under the rule,
savings associations with "above normal" interest rate risk exposure would be
subject to a deduction from total capital for purposes of calculating their
risk-based capital requirements. A savings association's interest rate risk is
measured by the decline in the net portfolio value of its assets (i.e., the
difference between incoming and outgoing discounted cash flows from assets,
liabilities and off-balance sheet contracts) that would result from a
hypothetical 200-basis point increase or decrease in market interest rates
divided by the estimated economic value of the association's assets, as
calculated in accordance with guidelines set forth by the OTS. A savings
association whose measured interest rate risk exposure exceeds 2% must deduct an
interest rate component in calculating its total capital under the risk-based
capital rule. The interest rate risk component is an amount equal to one-half
of the difference between the institution's measured interest rate risk and 2%,
multiplied by the estimated economic value of the association's assets. That
dollar amount is deducted from an association's total capital in calculating
compliance with its risk-based capital requirement. Under the rule, there is a
two quarter lag between the reporting date of an institution's financial data
and the effective date for the new capital requirement based on that data. A
savings association with assets of less than $300 million and risk-based capital
ratios in excess of 12% is not subject to the interest rate risk component,
unless the OTS determines otherwise. The rule also provides that the Director
of the OTS may waive or defer an association's interest rate risk component on a
case-by-case basis. The OTS has postponed the date that the component will
first be deducted from an institution's total capital to provide it with an
opportunity to review the interest rate risk approaches taken by the other
federal banking agencies. At September 30, 1998, the Bank met each of its
capital requirements, in each case on a fully phased-in basis.
Thrift Charter. Congress has been considering legislation in various forms
that would require federal thrifts, such as the Bank, to convert their charters
to national or state bank charters. The Company cannot determine whether, or in
what form, such legislation may eventually be enacted and there can be no
assurance that any legislation that is enacted would not adversely affect the
Bank and the Company.
Prompt Corrective Regulatory Action
Under the OTS Prompt Corrective Action regulations, the OTS is required to
take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of capitalization.
Generally, a savings institution that has total risk-based capital of less than
8.0% or a leverage ratio or a Tier 1 core capital ratio that is less than 4.0%
is considered to be undercapitalized. A savings institution that has total
risk-based capital of less than 6.0%, a Tier 1 core risk-based capital ratio of
less than 3.0% or a leverage ratio that is less than 3.0% is considered to be
"significantly undercapitalized," and a savings institution that has a tangible
capital to assets ratio equal to or less than 2.0% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the banking regulator is
required to appoint a receiver or conservator for an institution that is
"critically undercapitalized." The regulation also provides that a capital
restoration plan must be filed with the OTS within 45 days of the date an
institution receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." In addition, numerous
mandatory supervisory actions become immediately applicable to the institution,
including, but not limited to, restrictions on growth, investment activities,
capital distributions, and affiliate transactions. The OTS may also take any
one of a number of discretionary supervisory actions, including the issuance of
a capital directive and the replacement of senior executive officers and
directors.
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<PAGE>
Insurance of Deposit Accounts
The FDIC has adopted a risk-based insurance assessment system. The FDIC
assigns an institution to one of three capital categories based on the
institution's financial information, as of the reporting period ending seven
months before the assessment period, consisting of (1) well capitalized, (2)
adequately capitalized or (3) undercapitalized, and one of three supervisory
subcategories within each capital group. The supervisory subgroup to which an
institution is assigned is based on a supervisory evaluation provided to the
FDIC by the institution's primary federal regulator and information which the
FDIC determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. An institution's assessment rate
depends on the capital category and supervisory category to which it is
assigned. The FDIC is authorized to raise the assessment rates in certain
circumstances. The FDIC has exercised this authority several times in the past
and may raise insurance premiums in the future. If such action is taken by the
FDIC, it could have an adverse effect on the earnings of the Bank.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB, is required to acquire and
hold shares of capital stock in that FHLB in an amount at least equal to 1% of
the aggregate principal amount of its unpaid residential mortgage loans and
similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. As of September 30, 1998, the
Bank was in compliance with this requirement. The FHLBs are required to provide
funds for the resolution of insolvent thrifts and to contribute funds for
affordable housing programs. These requirements could reduce the amount of
dividends that the FHLBs pay to their members and could also result in the FHLBs
imposing a higher rate of interest on advances to their members.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain noninterest-earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). At September 30, 1998, the Bank
was in compliance with these reserve requirements. The balances maintained to
meet the reserve requirements imposed by the FRB may be used to satisfy
liquidity requirements imposed by the OTS.
Holding Company Regulation
Generally. The Mutual Company and the Company are nondiversified mutual
savings and loan holding companies within the meaning of the HOLA, as amended.
As such, the Mutual Company and the Company are registered with the OTS and are
subject to OTS regulations, examinations, supervision and reporting
requirements. In addition, the OTS has enforcement authority over the Mutual
Company and the Company and any nonsavings institution subsidiaries. Among other
things, this authority permits the OTS to restrict or prohibit activities that
are determined to be a serious risk to the subsidiary savings institution. As
federal corporations, the Company and the Mutual Company are generally not
subject to state business organizations law.
Permitted Activities. Pursuant to Section 10(o) of the HOLA and OTS
regulations and policy, a mutual holding company and a federally chartered mid-
tier holding company such as the Company may engage in the following activities:
(i) investing in the stock of a savings association; (ii) acquiring a mutual
association through the merger of such association into a savings association
subsidiary of such holding company or an interim savings association subsidiary
of such holding company; (iii) merging with or acquiring another holding
company; one of whose subsidiaries is a savings association; (iv) investing in a
corporation, the capital stock of which is available for purchase by a savings
association under federal law or under the law of any state where the subsidiary
savings association or associations share their home offices; (v) furnishing or
performing management services for a savings association subsidiary of such
company; (vi) holding, managing or liquidating assets owned or acquired from a
savings subsidiary of such company; (vii) holding or managing properties used or
occupied by a savings association subsidiary of such company properties used or
occupied by a savings association subsidiary of such company; (viii) acting as
trustee under deeds of trust; (ix) any other activity (A) that the Federal
Reserve Board, by regulation, has determined to be permissible for bank holding
companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the
Director, by regulation, prohibits or limits any such activity for
24
<PAGE>
savings and loan holding companies; or (B) in which multiple savings and loan
holding companies were authorized (by regulation) to directly engage on March 5,
1987; and (x) purchasing, holding, or disposing of stock acquired in connection
with a qualified stock issuance if the purchase of such stock by such savings
and loan holding company is approved by the Director. If a mutual holding
company acquires or merges with another holding company, the holding company
acquired or the holding company resulting from such merger or acquisition may
only invest in assets and engage in activities listed in (i) through (x) above,
and has a period of two years to cease any nonconforming activities and divest
of any nonconforming investments.
The HOLA prohibits a savings and loan holding company, including the Stock
Company and the Mutual Company, directly or indirectly, or through one or more
subsidiaries, from acquiring another savings institution or holding company
thereof, without prior written approval of the OTS. It also prohibits the
acquisition or retention of, with certain exceptions, more than 5% of a
nonsubsidiary savings institution, a nonsubsidiary holding company, or a
nonsubsidiary company engaged in activities other than those permitted by the
HOLA; or acquiring or retaining control of an institution that is not federally
insured. In evaluating applications by holding companies to acquire savings
institutions, the OTS must consider the financial and managerial resources,
future prospects of the company and institution involved, the effect of the
acquisition on the risk to the insurance fund, the convenience and needs of the
community and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies, and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
Waivers of Dividends by the Mutual Company. OTS regulations require the
Mutual Company to notify the OTS of any proposed waiver of its right to receive
dividends. The OTS' reviews dividend waiver notices on a case-by-case basis,
and, in general, does not object to any such waiver if: (i) the mutual holding
company's board of directors determines that such waiver is consistent with such
directors' fiduciary duties to the mutual holding company's members; (ii) for as
long as the savings association subsidiary is controlled by the mutual holding
company, the dollar amount of dividends waived by the mutual holding company are
considered as a restriction to the retained earnings of the savings association,
which restriction, if material, is disclosed in the public financial statements
of the savings association as a note to the financial statements; (iii) the
amount of any dividend waived by the mutual holding company is available for
declaration as a dividend solely to the mutual holding company, and, in
accordance with SFAS 5, where the savings association determines that the
payment of such dividend to the mutual holding company is probable, an
appropriate dollar amount is recorded as a liability; (iv) the amount of any
waived dividend is considered as having been paid by the savings association in
evaluating any proposed dividend under OTS capital distribution regulations; and
(v) in the event the mutual holding company converts to stock form, the
appraisal submitted to the OTS in connection with the conversion application
takes into account the aggregate amount of the dividends waived by the mutual
holding company.
Conversion of the Mutual Company to Stock Form. OTS regulations permit the
Mutual Company to convert from the mutual to the capital stock form of
organization (a "Conversion Transaction"). In a Conversion Transaction a new
holding company would be formed as the successor to the Company (the "New
Holding Company"), the Mutual Company's corporate existence would end, and
certain depositors of the Bank would receive the right to subscribe for
additional shares of the New Holding Company. In a Conversion Transaction, each
share of Common Stock held by the Company's public stockholders ("Minority
Stockholders") would be automatically converted into a number of shares of
common stock of the New Holding Company determined pursuant an exchange ratio
that ensures that after the Conversion Transaction, subject to the Dividend
Waiver Adjustment described below and any adjustment to reflect the receipt of
cash in lieu of fractional shares, the percentage of the to-be outstanding
shares of the New Holding Company issued to Minority Stockholders in exchange
for their Common Stock would be equal to the percentage of the outstanding
shares of Common Stock held by Minority Stockholders immediately prior to the
Conversion Transaction. The total number of shares held by Minority
Stockholders after the Conversion Transaction would also be affected by any
purchases by such persons in the offering that would be conducted as part of the
Conversion Transaction.
The Dividend Waiver Adjustment would decrease the percentage of the to-be
outstanding shares of common stock of the New Holding Company issued to Minority
Stockholders in exchange for their shares of Common Stock to
25
<PAGE>
reflect (i) the aggregate amount of dividends waived by the Mutual Company and
(ii) assets other than Common Stock held by the Mutual Company. Pursuant to the
Dividend Waiver Adjustment, the percentage of the to-be outstanding shares of
the New Holding Company issued to Minority Stockholders in exchange for their
shares of Common Stock would be equal to the percentage of the outstanding
shares of Common Stock held by Minority Stockholders multiplied by the Dividend
Waiver Fraction. The Dividend Waiver Fraction is equal to the product of (a) a
fraction, of which the numerator is equal to the Stock Company's stockholders'
equity at the time of the Conversion Transaction less the aggregate amount of
dividends waived by the Mutual Company and the denominator is equal to the Stock
Company's stockholders' equity at the time of the Conversion Transaction, and
(b) a fraction, of which the numerator is equal to the appraised pro forma
market value of the New Holding Company minus the value of the Mutual Company's
assets other than Common Stock and the denominator is equal to the pro forma
market value of the New Holding Company.
Federal Securities Laws
Shares of the Company's Common Stock are registered with the SEC under
Section 12(g) of the Exchange Act. The Company is also subject to the proxy
rules, tender offer rules, insider trading restrictions, annual and periodic
reporting, and other requirements of the Exchange Act.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank are subject to federal income taxation
in the same general manner as other corporations, with some exceptions discussed
below. The following discussion of federal taxation is intended only to
summarize certain pertinent federal income tax matters and is not a
comprehensive description of the tax rules applicable to the Bank.
Method of Accounting. For federal income tax purposes, the Bank currently
reports its income and expenses on the accrual method of accounting and uses a
tax year ending September 30 for filing its consolidated federal income tax
returns. The Small Business Protection Act of 1996 (the "1996 Act") eliminated
the use of the reserve method of accounting for bad debt reserves by savings
institutions, effective for taxable years beginning after 1995.
Bad Debt Reserves. Prior to the 1996 Act, the Bank was permitted to
establish a reserve for bad debts and to make annual additions to the reserve.
These additions could, within specified formula limits, be deducted in arriving
at the Bank's taxable income. As a result of the 1996 Act, the Bank must use
the specific charge off method in computing its bad debt deduction beginning
with its 1996 federal tax return. In addition, the federal legislation requires
the recapture (over a six year period) of the excess of tax bad debt reserves at
September 30, 1996 over those established as of September 30, 1988. The amount
of such reserve subject to recapture as of September 30, 1998, was approximately
$940,000.
Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt
reserves created prior to January 1, 1988 were subject to recapture into taxable
income should the Bank fail to meet certain thrift asset and definitional tests.
New federal legislation eliminated these thrift related recapture rules.
However, under current law, pre-1988 reserves remain subject to recapture should
the Bank make certain nondividend distributions or cease to maintain a bank
charter. At September 30, 1998, the Bank's total federal pre-1988 reserve was
approximately $4.8 million. This reserve reflects the cumulative effects of
federal tax deductions by the Bank for which no federal income tax provision has
been made.
Minimum Tax. The Code imposes an alternative minimum tax ("AMT") at a
rate of 20% on a base of regular taxable income plus certain tax preferences
("alternative minimum taxable income" or "AMTI"). The AMT is payable to the
extent such AMTI is in excess of an exemption amount. Net operating losses can
offset no more than 90% of AMTI. Certain payments of alternative minimum tax
may be used as credits against regular tax liabilities in future years. The Bank
has not been subject to the alternative minimum tax and has no such amounts
available as credits for carryover.
26
<PAGE>
Net Operating Loss Carryovers. A financial institution may carry back net
operating losses to the preceding two taxable years and forward to the
succeeding 20 taxable years. This provision applies to losses incurred in
taxable years beginning after 1986. At September 30, 1998, the Bank had no net
operating loss carryforwards for federal income tax purposes.
Corporate Dividends-Received Deduction. The Stock Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. Following completion of the Reorganization
and Offering, the Mutual Company will own less than 80% of the outstanding
Common Stock. As such, the Mutual Company will not be permitted to file a
consolidated federal income tax return with the Stock Company and the Bank. The
corporate dividends-received deduction is 80% in the case of dividends received
from corporations with which a corporate recipient does not file a consolidated
return, and corporations which own less than 20% of the stock of a corporation
distributing a dividend may deduct only 70% of dividends received or accrued on
their behalf.
Status of Examination. The Bank's federal income tax returns have been
audited by the IRS, and are closed, through the fiscal year ended September 30,
1994. The IRS has not notified the Bank of any intention to audit the Bank's
federal income tax returns for any subsequent year.
State Taxation
State of North Carolina. Under North Carolina law, the corporate income
tax is 7.50% of federal taxable income as computed under the Code, subject to
certain prescribed adjustments. In addition, for tax years beginning in 1991,
1992, 1993 and 1994, corporate taxpayers were required to pay a surtax equal to
4%, 3%, 2% and 1%, respectively, of the state income tax otherwise payable by
it. An annual state franchise tax is imposed at a rate of 0.15% applied to the
greatest of the institution's (i) capital stock, surplus and undivided profits,
(ii) investment in tangible property in North Carolina or (iii) 55% of the
appraised valuation of property in North Carolina.
ITEM 2. Properties
- ------- ----------
The following table sets forth certain information regarding the Bank's
offices at September 30, 1998, all of which are owned by the Bank.
<TABLE>
<CAPTION>
Location Year Opened Approximate Square Feet Deposits
- -------- ----------- ----------------------- --------
<S> <C> <C> <C>
245 West Main Avenue 1971 12,400 $40.0 million
Gastonia, NC 28052-4140
1670 Neal Hawkins Road 1987 5,322 21.4 million
Gastonia, NC 28056-6429
1535 Burtonwood Drive 1976 2,372 46.0 million
Gastonia, NC 28054-4011
233 South Main Street 1990 4,739 35.5 million
Mount Holly, NC 28120-1620
</TABLE>
At September 30, 1998, the net book value of the Bank's office properties
and the Bank's fixtures, furniture, and equipments was $2.2 million.
ITEM 3. Legal Proceedings
- ------- -----------------
Periodically, there have been various claims and lawsuits involving the
Bank, such as claims to enforce liens, condemnation proceedings on properties in
which the Bank holds security interests, claims involving the making and
servicing of real property loans and other issues incident to the Bank's
business. The Bank is not a party to any pending legal proceedings that it
believes would have a material adverse effect on the financial condition or
operations of the Bank.
27
<PAGE>
ITEM 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
No matters were submitted to a vote of stockholders during the fourth
quarter of the year under report.
PART II
ITEM 5. Market for Company's Common Stock and Related Security Holder Matters
- ------- ---------------------------------------------------------------------
The "Market for Common Stock" section of the Company's Annual Report to
Stockholders is incorporated herein by reference.
ITEM 6. Selected Financial Data
- ------- -----------------------
The selected financial information for the year ended September 30, 1998 is
filed as part of the Company's Annual Report to Stockholders and is incorporated
by reference.
ITEM 7. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
The "Management's Discussion and Analysis of Financial Condition and
Results of Operations" section of the Company's Annual Report to Stockholders is
incorporated herein by reference.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
- -------- ----------------------------------------------------------
The information required by this item is set forth under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Annual Report to Stockholders which is incorporated herein by
reference.
ITEM 8. Financial Statements and Supplementary Data
- ------- -------------------------------------------
The financial statements are contained in the Company's Annual Report to
Stockholders and is incorporated herein by reference.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
- ------- ---------------------------------------------------------------
Financial Disclosure
--------------------
None.
PART III
--------
ITEM 10. Directors and Executive Officers of the Company
- -------- -----------------------------------------------
The Company's Board of Directors is currently composed of nine members.
The Company's bylaws provide that approximately one-third of the Directors are
to be elected annually. Directors of the Company are generally elected to serve
for a three-year period or until their respective successors shall have been
elected and shall qualify. Three Directors will be elected at the Company's
Annual Meeting of Stockholders to serve for a three-year period and until their
respective successors shall have been elected and shall qualify. The Board of
Directors has nominated to serve as Directors, Martha B. Beal, James J. Fuller
and Charles D. Massey.
28
<PAGE>
The table below sets forth certain information, as of September 30, 1998,
regarding members of the Company's Board of Directors, including the terms of
office of Board members. It is intended that the proxies solicited on behalf of
the Board of Directors (other than proxies in which the vote is withheld as to
the nominee) will be voted at the Meeting for the election of the nominee
identified below. If the nominee is unable to serve, the shares represented by
all such proxies will be voted for the election of such substitute as the Board
of Directors may recommend. At this time, the Board of Directors knows of no
reason why the nominee might be unable to serve, if elected. Except as
indicated herein, there are no arrangements or understandings between the
nominee and any other person pursuant to which such nominee was selected.
<TABLE>
<CAPTION>
Position(s) Held With Director Current Beneficially Percent of
Name the Company Age Since/(1)/ Term Expires Owned Class
- ---------------------- --------------------- -------- ---------- ------------ ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
NOMINEES
Martha B. Beal Director 67 1993 1999 23,752 *
James J. Fuller Director 55 1972 1999 6,872 *
Charles D. Massey Director 61 1971 1999 13,000 *
<CAPTION>
OTHER BOARD MEMBERS
<S> <C> <C> <C> <C> <C> <C>
Senator David W. Hoyle Chairman 59 1975 2000 36,107 *
Ben R. Rudisill, II Vice Chairman 55 1977 2000 16,730 *
Robert W. Williams, Sr. Director 70 1975 2000 16,362 *
William H. Keith Director 70 1991 2001 3,000 *
Eugene R. Matthews, II Director 41 1998 2001 5,591 *
Kim S. Price President, Chief 42 1997 2001 11,946 *
Executive
Officer and
Director
<CAPTION>
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
<S> <C> <C> <C> <C> <C> <C>
Gary F. Hoskins Vice President, 35 N/A N/A 7,733 *
Treasurer and
Chief Financial
Officer
Paul L. Teem, Jr. Executive Vice 50 N/A N/A 12,154 *
President, Chief
Operations
Officer and
Secretary
</TABLE>
- -----------------
* Less than 1%
/(1)/ Reflects initial appointment to the Board of Directors of Gaston Federal
Bank or its predecessors.
The business experience for the past five years for each of the Company's
directors and executive officers is as follows:
Martha B. Beal was the Vice President, Secretary and Financial Officer of
Chelsea House, Inc., a manufacturer of decorative arts, accessories and
furniture from 1973 until her retirement in 1998.
James J. Fuller is the President of Mount Holly Furniture Company, Inc.,
and has served in that position since 1972.
Charles D. Massey is the Director of Information Services of The Massey
Company, Inc., a wholesale industrial distributor and has served in various
positions with The Massey Company, Inc. since 1957.
Senator David W. Hoyle is a North Carolina State Senator and has served in
that position since 1993. Prior to that, Senator Hoyle was a self-employed real
estate developer and investor.
Ben R. Rudisill, II is the President of Rudisill Enterprises, Inc., a
wholesale beverage distributor and has served in that position since 1976.
29
<PAGE>
Robert W. Williams, Sr. served as President and Chief Executive Officer of
Gaston Federal Savings and Loan Association from 1975 to August 1997 and served
as Vice Chairman of the Board of Directors from August 1997 to March 31, 1998.
William H. Keith is retired and was a Senior Vice President and Area
Executive for First Union National Bank of North Carolina from 1959 to 1988.
Eugene R. Matthews, II is a Senior Vice President of Belk, Inc., a
department store chain, and has served in that position since 1980.
Kim S. Price is the President and Chief Executive Officer of Gaston
Federal Bank and has served in that position since August 1997. From 1991 to
1997 Mr. Price served as Vice President for Loan Production for First National
Bank of Shelby.
Gary F. Hoskins has served as Vice President, Treasurer and Chief Financial
Officer of the Bank since August 1997. Prior to that Mr. Hoskins served as a
Senior Vice President, Secretary, Treasurer and Chief Financial Officer of
Cherryville Federal Savings and Loan Association from 1995 to 1997. From 1986
to 1995, Mr. Hoskins served as a Thrift Examiner for the OTS.
Paul L. Teem, Jr. has served as Executive Vice President, Secretary and
Chief Operations Officer of the Bank since 1983.
ITEM 11. Executive Compensation
- -------- ----------------------
Summary Compensation Table
The following table sets forth for the year ended September 30, 1998,
certain information as to the total remuneration paid by the Bank to the Chief
Executive Officer of the Company.
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
----------------------------------- -----------------------------------------------------------
Awards Payouts
---------------------- --------------------------------
Other
Year Annual Restricted Options/ All Other
Name and Ended Compensation Stock SARS LTIP Compensation
Principal Position 9/30/(1)/ Salary/(2)/ Bonus/(3)/ /(4)/ Awards /(5)/ Payouts /(5)/
- ------------------ --------- ----------- ---------- ------------ ---------- -------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Kim S. Price 1998 $107,664 $25,000 -- -- -- -- $ 1,786
</TABLE>
- -----------------------------------------------
/(1)/ In accordance with the rules on executive officer and director
compensation disclosure adopted by the SEC, Summary Compensation
information is excluded for the fiscal years ended September 30, 1997 and
1996, as the Bank was not a public company during such periods.
/(2)/ Includes compensation deferred at the election of executives pursuant to
the 401(k) plan of the Bank.
/(3)/ Includes bonuses deferred at the election of executives pursuant to the
401(k) plan of the Bank.
/(4)/ The Bank provides certain members of senior management with certain other
personal benefits, the aggregate value of which did not exceed the lesser
of $50,000 or 10% of the total annual salary and bonus reported for each
officer. The value of such persons/benefits is not included in this table.
/(5)/ Includes employer contributions to the Bank's 401(k) Plan on behalf of
Named Executive Officers.
Employment Agreement
The Bank has entered into an employment agreement with President and Chief
Executive Officer, Kim S. Price, which provides for a term of 36 months. On
each anniversary date, the agreement may be extended for an additional 12
months, so that the remaining term shall be 36 months. If the agreement is not
renewed, the agreement will expire 36 months following the anniversary date. At
October 1, 1998, the Base Salary for Mr. Price was $120,000. The Base Salary
may be increased but not decreased. In addition to the Base Salary, the
agreement provides for, among other things, participation in stock benefit plans
and other employee and fringe benefits applicable to executive personnel. The
30
<PAGE>
agreement provides for termination by the Bank for cause at any time. In the
event the Bank terminates the executive's employment for reasons other than for
cause, or in the event of the executive's resignation from the Bank upon (i)
failure to re-elect the executive to his current offices, (ii) a material change
in the executive's functions, duties or responsibilities, or relocation of his
principal place of employment by more than 30 miles, (iii) liquidation or
dissolution of the Bank, or (iv) a breach of the agreement by the Bank, the
executive, or in the event of death, his beneficiary would be entitled to
severance pay in an amount equal to three times the annual rate of Base Salary
(which includes any salary deferred at the election of Mr. Price) at the time of
termination, plus the highest annual cash bonus paid to him during the prior
three years. The Bank would also continue the executive's life, health, dental
and disability coverage for the remaining unexpired term of the agreement. In
the event the payments to the executive would include an "excess parachute
payment" as defined by Code Section 280G (relating to payments made in
connection with a change in control), the payments would be reduced in order to
avoid having an excess parachute payment.
The executive's employment may be terminated upon his attainment of normal
retirement age (i.e., age 65) or in accordance with any retirement policy
established by the Bank (with Mr. Price's consent with respect to him). Upon
Mr. Price's retirement, he will be entitled to all benefits available to him
under any retirement or other benefit plan maintained by the Bank. In the event
of the executive's disability for a period of six months, the Bank may terminate
the agreement provided that the Bank will be obligated to pay the executive his
Base Salary for the remaining term of the agreement or one year, whichever is
longer, reduced by any benefits paid to the executive pursuant to any disability
insurance policy or similar arrangement maintained by the Bank. In the event of
the executive's death, the Bank will pay his Base Salary to his named
beneficiaries for one year following his death, and will also continue medical,
dental, and other benefits to his family for one year.
The employment agreement provides that, following termination of
employment, the executive will not compete with the Bank for a period of one
year, provided, however, that in the event of a termination in connection with a
change in control within the meaning of Home Owners' Loan Act, as amended, and
the rules and regulations thereunder, the noncompete provisions will not apply.
Compensation of Directors
Fees. During the fiscal year ended September 30, 1998, nonemployee
Directors of the Bank received a retainer fee of $12,000 ($15,600 for the
Chairman), plus a fee of $300 per Board meeting attended, $400 per meeting for
attendance at Executive Committee meetings and $300 per meeting for all other
committee meetings.
Deferred Compensation and Income Continuation Agreement. In May 1986 the
Bank entered into nonqualified deferred compensation agreements ("DCA") for the
benefit of Directors Hoyle, Williams, Rudisill, Fuller, Massey and former
Director B. Frank Matthews, II. The DCAs provide each director with the
opportunity to defer up to $20,000 of their usual compensation into the DCA. In
the event of a director's termination of employment, amounts credited to his
account under the DCA will be paid to him in 120 equal monthly installments
beginning not later than the sixth month following the end of the Bank's year in
which the director reaches age 70. In the event of death, amounts under the DCA
will be paid to the director's designated beneficiaries. The DCA is an unfunded
plan for tax purposes and for purposes of ERISA. All obligations arising under
the DCA are payable from the general assets of the Bank. In October 1998, Mr.
Matthews and Mr. Williams will receive the first of what will be 120 monthly
payments of $1,026 each under the DCA.
Supplemental Executive Retirement Plan. In February 1992 the Bank entered
into nonqualified supplemental retirement agreements ("SRA") for Directors
Keith, Williams, Massey, Hoyle, Fuller, Rudisill, and former Director Matthews.
The SRAs directors provide for an annual benefit that ranges from $1,275 to
$5,100. Monthly benefits are provided for designated beneficiaries of directors
who die before or after age 70. Amounts not paid to the director, beneficiaries
or spouse are paid to the estate of the director in a lump sum. Benefits under
the SRA are forfeited if the director's service is terminated for cause. The
SRA is considered an unfunded plan for tax and ERISA purposes. All obligations
arising under the SRA are payable from the general assets of the Bank. In
November 1997 Mr. Matthews received the first of what will be 180 monthly
payments of $1,300 under the SRA. In January 1998, Mr. Williams received the
first of what will be 180 monthly payments of $297.50 under the SRA. In July
1998, Mr. Keith received the first of what will be 180 monthly payments of
$106.25 under the SRA.
31
<PAGE>
Defined Benefit Pension Plan
The Bank maintains the Financial Institutions Retirement Fund, which is a
qualified, tax-exempt defined benefit plan ("Retirement Plan"). All employees
age 20 or older who have worked at the Bank for a period of 5 months are
eligible for membership in the Plan for vesting purposes; however, only
employees that have been credited with 1,000 or more hours of service with the
Bank during the year are eligible to accrue benefits under the Retirement Plan.
The Bank annually contributes an amount to the Retirement Plan necessary to
satisfy the actuarially determined minimum funding requirements in accordance
with the Employee Retirement Income Security Act ("ERISA").
The regular form of all retirement benefits (normal, early or disability)
is guaranteed for the life of the retiree, but not less than 120 monthly
installments. An optional form of benefit may be selected. These optional
forms include various annuity forms as well as a lump sum payment after age 55.
Benefits payable upon death may be made in a lump sum, installments over 10
years, or a lifetime annuity. For a married participant, the normal form of
benefit is a joint and survivor annuity where, upon the participant's death, the
participant's spouse is entitled to receive a benefit equal to 50% of that paid
during the participant's lifetime.
The normal retirement benefit payable at age 65 with 25 years of service,
is an amount equal to 45% of a participant's average compensation based on the
average of the five years providing the highest average. A reduced benefit is
payable upon retirement at age 65 with less than 25 years of service and at or
after completion of five years of service. For the plan year ended June 30,
1997, the Bank made a contribution to the Retirement Plan of $75,700.
The following table indicates the annual retirement benefit that would be
payable under the Retirement Plan upon retirement at age 65 in calendar year
1998, expressed in the form of a single life annuity for the average salary and
benefit service classifications specified below.
<TABLE>
<CAPTION>
Highest Five-Year Years of Service and Benefit Payable at Retirement(1)
Average ------------------------------------------------------
Compensation 15 20 25 30 35 40
------------ ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
$50,000 $13,500 $18,000 $22,500 $22,500 $22,500 $22,500
$75,000 $20,300 $27,000 $33,800 $33,800 $33,800 $33,800
$100,000 $27,000 $36,000 $45,000 $45,000 $45,000 $45,000
$125,000 $33,800 $45,000 $56,300 $56,300 $56,300 $56,300
$150,000 $40,500 $54,000 $67,500 $67,500 $67,500 $67,500
</TABLE>
____________________________
(1) No additional credit is received for years of service in excess of 25,
however, increases in compensation after 25 years will generally cause an
increase in benefits.
As of September 30, 1998, Mr. Kim S. Price had one year of credited service
(i.e., benefit service), under the plan. In May 1998, Mr. Robert W. Williams
received a lump sum benefit of $427,122 under the plan.
Supplemental Executive Retirement Plan
The Bank entered into a nonqualified supplemental retirement agreement
("SRA") with Mr. Robert W. Williams, as an executive of the Bank. The SRA for
Mr. Williams provides an annual retirement benefit of $5,249 payable in equal
monthly installments over a period of 180 months, commencing on or after age 70.
Monthly benefits are provided for Mr. Williams' designated beneficiary(ies) if
he dies before or after age 70. Amounts not paid to Mr. Williams, his
beneficiary(ies) or spouse are paid to his estate in a lump sum. Benefits under
the SRA are forfeited if Mr. Williams' service is terminated for cause. The SRA
is considered an unfunded plan for tax and ERISA purposes. All obligations
arising under the SRA are payable from the general assets of the Bank. In
January 1998, Mr. Williams received the first of what will be 180 monthly
payments of $437.42 under this SRA.
32
<PAGE>
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
- -------- --------------------------------------------------------------
The Common Stock of the Company is registered with the Securities and
Exchange Commission (the "SEC") pursuant to Section 12(g) of the Securities
Exchange Act of 1934 (the "Exchange Act"). The officers and directors of the
Company and beneficial owners of greater than 10% of the Company's Common Stock
("10% beneficial owners") are required to file reports on Forms 3,4 and 5 with
the SEC disclosing beneficial ownership and changes in beneficial ownership of
the Common Stock. SEC rules require disclosure in the Company's Proxy Statement
or Annual Report on Form 10-K of the failure of an officer, director or 10%
beneficial owner of the Company's Common Stock to file a Form 3, 4, or 5 on a
timely basis. All of the Company's officers and directors filed these reports
on a timely basis.
ITEM 13. Certain Relationships and Related Transactions
- -------- ----------------------------------------------
The Company offers to directors, officers, and employees real estate
mortgage loans secured by their principal residence. All loans to the Company's
directors, officers and employees are made on substantially the same terms,
including interest rates and collateral as those prevailing at the time for
comparable transactions, and do not involve more than minimal risk of
collectibility.
PART IV
-------
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- -------- ----------------------------------------------------------------
(a)(1) Financial Statements
--------------------
The exhibits and financial statement schedules filed as a part of this Form
10-KSB are as follows:
(A) Report of Independent Auditors
(B) Consolidated Statements of Condition
(C) Consolidated Statements of Operations
(D) Consolidated Statements of Changes in Equity
(E) Consolidated Statements of Cash Flows
(F) Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
-----------------------------
All financial statement schedules have been omitted as the required
information is inapplicable or has been included in the Notes to
Consolidated Financial Statements.
(b) Reports on Form 8-K
-------------------
The Company has not filed a Current Report on Form 8-K during the fourth
quarter of the fiscal year ended September 30, 1998.
33
<PAGE>
(c) Exhibits
--------
3.1 Stock Holding Company Charter of Gaston Federal Bancorp,
Inc. (incorporated herein by reference to the Company's
registration statement on SB-2, file No. 333-42951 (the "SB-
2"))
3.2 Bylaws of Gaston Federal Bancorp, Inc. (incorporated herein
by reference to the Company's SB-2)
4 Form of Stock Certificate of Gaston Federal Bancorp, Inc.
(incorporated herein by reference to the Form SB-2)
10.1 Employment Agreement with Kim S. Price (incorporated herein
by reference to the Company's SB-2)
10.2 Deferred Compensation and Income Continuation Agreement
(incorporated herein by reference to the Company's SB-2)
10.3 Employee Stock Ownership Plan (incorporated herein by
reference to the Company's SB-2)
10.4 Supplemental Executive Retirement Plan (incorporated herein
by reference to the Company's SB-2)
13 Annual Report to Stockholders
21 Subsidiaries of the Company
27 EDGAR Financial Data Schedule
<PAGE>
Signatures
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Company has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Gaston Federal Bancorp, Inc.
Date: December 24, 1998 By: /s/ Kim S. Price
-----------------------------------
Kim S. Price
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange 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.
By: /s/ Kim S. Price By: /s/ Gary F. Hoskins
--------------------------- -----------------------------------
Kim S. Price Gary F. Hoskins
President, Chief Executive Vice President, Treasurer and
Officer and Director Chief Financial Officer
(Principal Executive Officer) (Principal Financial and Accounting
Officer)
Date: December 24, 1998 Date: December 24, 1998
By: /s/ David W. Hoyle By: /s/ Ben R. Rudisill, II
--------------------------- -----------------------------------
David W. Hoyle Ben R. Rudisill, II
Chairman Vice Chairman
Date: December 24, 1998 Date: December 24, 1998
By: /s/ Martha B. Beal By: /s/ Charles D. Massey
--------------------------- -----------------------------------
Martha B. Beal Charles D. Massey
Director Director
Date: December 24, 1998 Date: December 24, 1998
By: /s/ James J. Fuller By: /s/ Eugene R. Matthews, II
--------------------------- -----------------------------------
James J. Fuller Eugene R. Matthews, II
Director Director
Date: December 24, 1998 Date: December 24, 1998
By: /s/ William H. Keith By: /s/ Robert W. Williams, Sr.
--------------------------- -----------------------------------
William H. Keith Robert W. Williams, Sr.
Director Director
Date: December 24, 1998 Date: December 24, 1998
<PAGE>
EXHIBIT 13
ANNUAL REPORT TO STOCKHOLDERS
<PAGE>
1998 ANNUAL REPORT TO STOCKHOLDERS
GASTON FEDERAL BANCORP, INC.
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following tables set forth certain financial and other data of Gaston
Federal Bancorp, Inc. (the "Company"), or, prior to April 9, 1998, Gaston
Federal Bank (the "Bank") at the dates and for the periods indicated. For
additional information about the Company, reference is made to "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements of the Company and related notes included
elsewhere herein.
<TABLE>
<CAPTION>
At September 30,
-------------------------------
1998 1997 1996
--------- --------- --------
(In Thousands)
<S> <C> <C> <C>
Selected Consolidated Financial Condition Data
Total assets.......................................................................... $208,003 $173,470 $171,953
Loans receivable, net................................................................. 136,501 134,491 130,862
Mortgage-backed securities............................................................ 14,707 10,087 12,918
United States government and agency securities held to maturity....................... 15,228 10,407 14,751
United States government and agency securities available for sale..................... 15,203 2,009 --
Other investments available for sale.................................................. 5,716 6,239 5,515
Deposits.............................................................................. 143,900 145,444 145,975
Borrowed funds........................................................................ 19,500 3,500 3,750
Total equity.......................................................................... 41,570 20,868 19,084
<CAPTION>
Year Ended September 30,
-------------------------------
1998 1997 1996
-------- --------- --------
(In Thousands)
<S> <C> <C> <C>
Selected Consolidated Operating Data:
Interest income....................................................................... $ 13,927 $ 12,936 $12,518
Interest expense...................................................................... 7,126 6,952 7,381
-------- -------- -------
Net interest income................................................................... 6,801 5,984 5,137
Provision for loan losses............................................................. 300 293 47
-------- -------- -------
Net interest income after provision for losses........................................ 6,501 5,691 5,090
Noninterest income.................................................................... 956 516 417
Noninterest expense................................................................... 4,567 3,956 4,646/(1)/
-------- -------- -------
Income before income taxes............................................................ 2,890 2,251 861
Income tax expense.................................................................... 1,004 819 351
-------- -------- -------
Net income............................................................................ $ 1,886 $ 1,432 $ 510
======== ======== =======
<CAPTION>
At and For the Years
Ended September 30,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Performance Ratios:
Return on average assets (net income divided by average total assets)................. 0.98% 0.84% 0.30%
Return on average equity (net income divided by average equity)....................... 6.47 7.38 2.76
Net interest rate spread.............................................................. 3.16 3.24 2.82
Net interest margin................................................................... 3.54 3.50 3.03
Average interest-earning assets to average interest-bearing liabilities............... 114.01 109.02 108.29
Noninterest expense to total assets................................................... 2.20 2.28 2.70
Noninterest expense to average total assets........................................... 2.38 2.31 2.74
Asset Quality Ratios:
Nonperforming assets to total assets.................................................. 0.71 0.75 0.84
Nonperforming loans to total loans.................................................... 0.91 0.76 0.88
Nonperforming loans to total assets................................................... 0.60 0.61 0.69
Allowance for loan losses to total loans at the end of period......................... 1.03 0.80 0.61
Allowance for loan losses to nonperforming loans...................................... 113.97 104.82 69.51
Net interest income after provision for loan losses to total noninterest expense...... 142.35 143.82 109.58
Capital Ratios:
Ratio of average equity to average total assets....................................... 15.16 11.34 10.92
Equity to assets at period end........................................................ 19.99 12.03 11.10
Other Data:
Number of real estate loans outstanding............................................... 2,099 1,999 2,060
Number of deposit accounts............................................................ 14,120 14,368 14,315
Number of full service offices........................................................ 4 4 4
- -----------------------
</TABLE>
/(1)/ Includes a nonrecurring expense of $867 for the year ended September 30,
1996 for a one-time premium to recapitalize the Savings Association
Insurance Fund.
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
In addition to historical information, this document contains forward-
looking statements. The forward looking statements contained in the following
sections are subject to certain risks and uncertainties that could cause actual
results to differ materially from those projected in the forward-looking
statements. Important factors that might cause such a difference include, but
are not limited to, those discussed. Readers should not place undue reliance on
these forward-looking statements, as they reflect management's analysis as of
the date of this report. The Company has no obligation to update or revise
these forward-looking statements to reflect events or circumstances that occur
after the date of this report. Readers should carefully review the risk factors
described in other documents the Company files from time to time with the SEC,
including quarterly reports on Form 10-QSB and current reports filed on Form
8-K.
General
The Company's results of operations are dependent primarily on net interest
income, which is the difference between the income earned on its loan and
securities portfolios and its cost of funds, consisting primarily of the
interest paid on deposits and borrowings. Results of operations are also
affected by the Company's provision for loan losses, securities sales, and
service charges on its deposit accounts. The Company's noninterest expense
primarily consists of salaries and employee benefits, occupancy expense, federal
deposit insurance premiums, advertising and other expenses. Results of
operations are also significantly affected by general economic and competitive
conditions, particularly changes in interest rates, government policies and
actions of regulatory authorities.
Management of Market Risk
Generally. The Company's most significant form of market risk is interest-
rate risk, as the majority of the Company's assets and liabilities are sensitive
to changes in interest rates. The principal objective of the Company's interest
rate risk management is to evaluate the interest rate risk inherent in the
Bank's assets and liabilities, determine the level of risk appropriate given the
Company's business strategy, operating environment, capital and liquidity
requirements and performance objectives, and manage the risk consistent with the
guidelines approved by the Board of Directors. Through such management, the
Company seeks to reduce the vulnerability of its operations to changes in
interest rates. The Company's Asset/Liability Committee is comprised of the
Company's senior management and members of the Board of Directors. Senior
management is responsible for reviewing with the Board of Directors its
activities and strategies, the effect of those strategies on the Company's net
interest margin, the fair value of the portfolio and the effect that changes in
interest rates will have on the Company's portfolio and the Company's exposure
limits.
In recent years, the Company has utilized the following strategies to
manage interest rate risk: (1) emphasizing the origination and retention of one-
to four-family residential ARM loans and fixed-rate loans with maturities of 15
years or less, (2) emphasizing the origination and retention of commercial real
estate loans and commercial business loans with shorter maturities and/or
adjustable interest rates, and (3) emphasizing the origination of home equity
lines of credit that have adjustable interest rates, and (4) investing in
shorter term securities which better position the Company for increases in
market interest rates.
Net Portfolio Value. The Office of Thrift Supervision ("OTS") requires the
computation of amounts by which the net present value of an institution's cash
flow from assets, liabilities and off balance sheet items
4
<PAGE>
(the institution's net portfolio value or "NPV") would change in the event of a
range of assumed changes in market interest rates. These computations estimate
the effect on an institution's NPV from instantaneous and permanent 1% to 4%
(100 to 400 basis points) increases and decreases in market interest rates.
The following table presents our NPV at September 30, 1998, as calculated
by the OTS, which is based upon quarterly information that is voluntarily
provided to the OTS.
Percentage Change in Net Portfolio Value
----------------------------------------
Changes Board
in Market Projected Policy
Interest Rates Change /(1)/ Limit /(2)/
-------------- ------------ -----------
(basis points)
+ 400 (36)% (65.00)%
+ 300 (27)% (45.00)%
+ 200 (17)% (30.00)%
+ 100 (8)% (15.00)%
0 -- --
(100) 6% (15.00)%
(200) 12% (30.00)%
(300) 20% (45.00)%
(400) 28% (65.00)%
- -------------------------
/(1)/ Calculated as the amount of change in the estimated NPV divided by the
estimated NPV assuming no change in interest rates.
/(2)/ Limits are established by our Board of Directors.
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurement. Modeling changes in NPV require the making of
certain assumptions which may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. Accordingly,
although the NPV table provides an indication of the Bank's interest rate risk
exposure at a particular point in time, such measurements are not intended to
and do not provide a precise forecast of the effect of changes in market
interest rates on the Bank's net interest income and will differ from actual
results.
Comparison of Financial Condition
Assets. Total assets for the fiscal year ended September 30, 1998,
increased by $34.5 million, or 19.9%, from $173.5 million to $208.0 million.
This increase in assets was primarily due to the $18.5 million in net proceeds
received from the Company's stock offering completed April 9, 1998 as part of
the Bank's mutual holding company reorganization (the "Reorganization") and a
$16.0 million increase in investment and mortgage-backed securities that were
funded by Federal Home Loan Bank advances. In addition to the increase in
assets, there were also material changes in the Company's asset portfolio mix.
Cash and cash equivalents increased $9.2 million, or 198.3%, from $4.6 million
to $13.8 million. This increase was primarily due to the receipt of $9.7
million from the sale of long-term fixed rate loans in August 1998. Also, non-
mortgage loans increased by $2.4 million, or 18.5%, from $13.0 million to $15.4
million. This increase
5
<PAGE>
was due to an overall change in management philosophy that emphasizes shorter-
term, higher-yielding non-mortgage loans. The mortgage loan portfolio remained
stable at $121.1 million.
Total assets for the fiscal year ended September 30, 1997, increased by
$1.5 million, or 0.9%, from $172.0 million to $173.5 million. While the
increase in total assets was moderate, there were significant changes in the
overall asset portfolio mix during the fiscal year. Cash and cash equivalents
increased by $2.4 million, or 109.1%, from $2.2 million to $4.6 million.
Investments and mortgage-backed securities decreased by $4.5 million, or 13.6%,
from $33.2 million to $28.7 million. Also, total loans increased by $3.6
million, or 2.8%, from $130.9 million to $134.5 million. This change in asset
mix was due, in part, to the declining interest rate environment which resulted
in higher loan demand, increased prepayments on mortgage-backed securities, and
increased calls on U.S. Government Agency callable securities.
Liabilities. Total liabilities for the fiscal year ended September 30,
1998, increased $13.8 million, or 9.0% , from $152.6 million to $166.4 million.
This change in liabilities was primarily due to a $16.0 million increase in
borrowed money from $3.5 million to $19.5 million. The borrowed money was used
to purchase investment and mortgage backed securities. Also, as part of the
Reorganization, depositors withdrew approximately $8.4 million in existing Bank
deposits to purchase stock in the Company. A significant portion of these
deposits has been replaced as a result of aggressive marketing. Total deposits
decreased by $1.5 million, or 1.1%, from $145.4 million to $143.9 million.
Total liabilities for the fiscal year ended September 30, 1997, decreased
by $300,000, or 0.2%, from $152.9 million to $152.6 million. This slight
decrease was primarily due to a $600,000 decrease in deposits from $146.0
million to $145.4 million which resulted, in part, from the increased
competition in the Bank's local market area. Also during the period, Federal
Home Loan Bank advances decreased by $250,000 to $3.5 million.
Equity. Total equity for the fiscal year ended September 30, 1998,
increased by $20.7 million, or 99.2%, from $20.9 million to $41.6 million. The
primary reasons for the increase in equity are the receipt of $18.5 million in
net proceeds from the Reorganization and the $1.9 million in net income for the
fiscal year.
Total equity for the fiscal year ended September 30, 1997, increased by
$1.9 million, or 8.2%, from $19.1 million to $20.9 million. The increase in
total equity was due to the transfer of $1.4 million in net income to retained
earnings and a $400,000 increase in the unrealized gain on securities held as
available for sale.
6
<PAGE>
Analysis of Results of Operations
Net Interest Income. Net interest income represents the difference between
income on interest-earning assets and expense on interest-bearing liabilities.
Net interest income also depends on the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rate earned or paid on
them, respectively. The following table sets forth certain information relating
to the Company for the years ended September 30, 1998, 1997 and 1996. For the
periods indicated the total dollar amount of interest income from average
interest-earning assets and the resultant yields, as well as the interest
expense on average interest-bearing liabilities, is expressed both in dollars
and rates. No tax equivalent adjustments were made.
<TABLE>
<CAPTION>
For The Years Ended September 30,
------------------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------- --------------------------------- ---------------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
------------ --------- ------- ------------ --------- -------- ------------ -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable /(1)/..... $136,491 $ 11,020 8.07% $132,529 $ 10,826 8.17% $126,503 $10,218 8.08%
Investment securities /(2)/ 24,058 1,482 6.16 18,226 1,232 6.76 18,501 1,265 6.84
Interest-earning deposits.. 13,376 802 6.00 1,049 89 8.48 1,817 96 5.28
Mortgage-backed securities. 9,692 623 6.43 11,612 789 6.79 13,528 939 6.94
-------- -------- ------ -------- -------- ------ -------- ------- ----
Total interest-earning
assets..................... 183,617 $ 13,927 7.58 163,416 12,936 7.92 160,349 12,518 7.81
========
Noninterest-earning assets.. 8,608 7,751 9,144
-------- -------- --------
Total assets................ $192,225 $171,167 $169,493
-------- -------- ========
Interest-bearing
liabilities:
Demand deposits and money
market demand accounts.... 37,188 861 2.32 27,201 672 2.47 25,773 685 2.66
Savings accounts........... 19,607 663 3.38 14,037 387 2.76 13,695 394 2.88
Certificates of deposit.... 96,400 5,170 5.36 105,119 5,746 5.47 107,196 6,215 5.80
Borrowed funds............. 7,852 432 5.50 2,309 147 6.37 1,403 88 6.27
-------- -------- ------ -------- -------- ------ -------- ------- ----
Total interest-bearing
liabilities................ 161,047 7,126 4.42% 148,666 6,952 4.68% 148,067 7,382 4.99%
======== -------- -------
Noninterest-bearing
liabilities................ 2,032 3,098 2,912
-------- -------- --------
Total liabilities........... 163,079 151,764 150,979
Total equity................ 29,146 19,403 18,514
-------- -------- --------
Total liabilities and
retained earnings.......... $192,225 $171,167 $169,493
======== -------- ========
Net interest income......... $ 6,801 $5,984 $5,136
-------- ======== -------
Interest rate spread/(2)/.. 3.16% 3.24% 2.82%
====== ====== ======
Net yield on
interest-earning
assets /(3)/............... 3.70% 3.66% 3.20%
====== ====== ======
Ratio of average
interest-earning
assets to interest-bearing
liabilities................ 114.01% 109.92% 108.29%
====== ====== ======
</TABLE>
/(1)/ Average balances include nonaccrual loans.
/(2)/ Interest rate spread represents the difference between the average yield
on interest-earning assets and the average cost of interest-bearing
liabilities.
/(3)/ Net yield on interest-earning assets represents net interest income as a
percentage of average interest-earning assets.
7
<PAGE>
The table below sets forth information regarding changes in our interest
income and interest expense for the periods indicated. For each category of our
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (changes in volume
multiplied by old rate); (ii) changes in rate (changes in rate multiplied by old
volume); (iii) changes in rate-volume (changes in rate multiplied by the change
in volume).
<TABLE>
<CAPTION>
For The Year Ended For the Year Ended
September 30, 1998 vs September 30, 1997 September 30, 1997 to September 30, 1996
Increase (Decrease) Increase (Decrease)
Due to 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:
Securities and other
interest earning assets..... $1,245 $(145) $(137) $ 963 $ (69) $ 31 $(2) $ (40)
Mortgage-backed and related
securities.................. (130) (43) 7 (166) (133) (20) 3 (150)
Loan portfolio............... 324 (126) (4) 194 486 116 6 608
------ ----- ----- ----- ----- ------ --- -----
Total interest-income... 1,438 (313) (133) 991 284 127 7 418
------ ----- ----- ----- ----- ------ --- -----
Interest expense:
Deposits..................... 318 (410) (19) (111) (16) (474) 1 (489)
Borrowed funds............... 353 (20) (48) 285 57 1 1 59
------ ----- ----- ----- ----- ------ --- -----
Total interest-expense.... 671 (429) (68) 174 41 (473) 2 (430)
------ ----- ----- ----- ----- ------ --- -----
Net interest income............ $ 767 $ 115 $ (65) $ 817 243 600 5 848
====== ===== ===== ===== ===== ===== === =====
</TABLE>
Results of Operations
General. The earnings of the Company depend primarily on its level of net
interest income, which is the difference between interest earned on the
Company's interest-earning assets, consisting primarily of real estate loans,
commercial business loans, consumer loans, investment securities and mortgage-
backed securities, and the interest paid on interest-bearing liabilities,
consisting primarily of deposits and borrowed funds. Net interest income is a
function of the Company's interest rate spread, which is the difference between
the average yield earned on interest-earning assets and the average rate paid on
interest-bearing liabilities, as well as a function of the average balance of
interest-earning assets as compared to interest-bearing liabilities. The
Company's earnings also are affected by its level of service charges and gains
on sale of assets, as well as its level of noninterest expenses, including
salaries and benefits, occupancy, deposit insurance, advertising, professional
services and other noninterest expenses.
Net Income. Net income for the fiscal year ended September 30, 1998,
increased by $454,000, or 30.3%, from $1.4 million to $1.9 million. The
increase was primarily due to a $866,000 increase in net interest income and an
increase of $391,000 in non-interest income. The effects of these increases
were partially offset by a $610,000 increase in non-interest expenses.
Net income for the fiscal year ended September 30, 1997 increased by
$922,000, to $1.4 million for the fiscal year ended September 30, 1997 from
$510,000 for the prior fiscal year. The increase was primarily due to an
$847,000 increase in net interest income, a $690,000 decrease in noninterest
expenses (primarily do to a special assessment to recapitalize the Savings
Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation
("FDIC") as discussed below in "--Noninterest Expenses"), and a $99,000 increase
in noninterest income. The effects of these increases were partially offset by
a $246,000 increase in the provision for loan losses and a $468,000 increase in
the provision for income taxes.
8
<PAGE>
Interest Income. Interest income for the fiscal year ended September 30,
1998, increased by $1.0 million, or 7.8%, from $12.9 million to $13.9 million.
This increase was due to a $963,000 increase in income from investment
securities and a $243,000 increase in income from loans, the effects of which
were partially offset by a $166,000 decrease in income from mortgage-backed
securities. The increase in income from investment securities was partly
attributable to an $18.1 million, or 93.8%, increase in the average balance of
investment securities from $19.3 million to $37.4 million, the effects of which
were offset by a 75 basis point decrease in the average yield from 6.85% to
6.10%. The increase in the Company's investment portfolio was due, in part, to
the purchase of $26.2 million in investment securities using proceeds received
from the stock conversion and Federal Home Loan Bank advances. The sale and
maturity of $8.1 million in investment securities offset this increase. The
decrease in the yield on investments was primarily due to the fact that many
higher-yielding investments have either matured or were called, while additional
securities were purchased in a lower interest rate environment. The decrease in
income from mortgage-backed securities was attributable to a $1.9 million, or
16.4%, decrease in the average balance of mortgage backed securities from $11.6
million to $9.7 million. The decrease in the average balance of mortgage backed
securities was primarily the result of prepayments due to falling interest
rates. The decrease in market rates also resulted in a 36 basis point decrease
in the yield on mortgage-backed securities from 6.79% to 6.43%.
Interest income from the Company's loan portfolio increased by $243,000, or
2.2%, from $10.8 million to $11.0 million. This increase was primarily due to a
$4.0 million, or 3.0%, increase in the average balance of loans from $132.5
million to $136.5 million, the effects of which were partially offset by a 10
basis point reduction in the yield to 8.07% from 8.17%. The decrease in yield
was primarily due to the lower interest rate environment. During the fiscal
year, mortgage loans increased by $1.9 million, or 1.6%, to $121.9 million and
non-mortgage loans increased by $2.1 million, or 16.6%, to $18.2 million. The
Company's strategy is to continue to prudently grow its loan portfolio with a
strong emphasis on higher yielding, shorter-term non-mortgage loans.
Interest income increased by $418,000, or 3.3%, to $12.9 million for the
fiscal year ended September 30, 1997 from $12.5 million for the prior fiscal
year. The increase was due to a $608,000 increase in income from loans, the
effects of which were partially offset by a $40,000 decrease in income from
investment securities, a slight decrease in income from interest-earning
deposits, and a $150,000 decrease in income from mortgage-backed securities.
The increase in income from loans was attributable to a $6.0 million, or 4.8%,
increase in the average balance of loans to $132.5 million from $126.5 million
and a 9 basis point increase in the average yield on loans to 8.17% from 8.08%.
The increase in the Company's average loan portfolio was attributable to $21.9
million of loan originations resulting in increases in the Company's portfolio
of one- to four-family residential and commercial real estate loans, commercial
business loans and home equity lines of credit. The increase in yield on loans
receivable resulted, in part, from a change in the composition of the Company's
loan portfolio from lower yielding residential mortgage loans to higher yielding
commercial loans and nonmortgage loans. During the fiscal year, commercial
mortgage loans increased from $6.5 million to $7.3 million, or from 4.8% to 5.3%
of the Company's total loan portfolio. Also, nonmortgage loans increased from
$11.6 million to $13.0 million, or from 8.5% to 9.3% of the Bank's total loan
portfolio. The yield also increased due to repricing of teaser rate ARMs which
were originated during the fiscal year ended September 30, 1996.
Interest income from the Company's investment securities decreased by
$40,000, or 2.9%, to $1.32 million from approximately $1.36 million. The
decrease in interest income from investment securities resulted from a $275,000
decrease in average investment securities to $18.2 million from $18.5 million,
and an 8 basis point decrease in the yield on average investment securities to
6.76% from 6.84%. Interest income on mortgage-backed securities decreased by
$150,000, or 16.0%, to $789,000 from $939,000. The decrease
9
<PAGE>
in income from mortgage-backed securities resulted from a $1.9 million, or 14.1%
decrease in average mortgage-backed securities to $11.6 million from $13.5
million, and a 15 basis point decrease in the yield on average mortgage-backed
securities to 6.79% from 6.94%. In addition, income from interest-earning
deposits decreased slightly. The changes in average balances of the Company's
investment securities and mortgage-backed securities resulted from an increase
in calls on U.S. Government Agency callable securities and an increase in
prepayments on mortgage-backed securities due to an overall decrease in interest
rates during the fiscal year. This decrease in market interest rates also
resulted in an 8 basis point decrease in the average yield on the Company's
investment securities and mortgage-backed securities portfolio.
Interest expense. Interest expense increased by $174,000, or 2.5%, to $7.1
million for the fiscal year ended September 30, 1998 from $6.9 million for the
prior fiscal year. This increase was due to the net effect of a $285,000
increase in interest expense on borrowings and a $111,000 decrease in interest
expense on deposits. The increased expense on borrowed money was primarily due
a $5.4 million increase in the average balance of borrowings from $2.3 million
to $7.9 million, the effects of which were offset by an 87 basis point reduction
in the rate paid on borrowings from 6.37% to 5.50%. Management's strategy is to
continue to use borrowings as a tool to leverage the Company's capital and
improve the Company's return on equity until such time as the increased equity
can be prudently invested in loans. Interest expense on deposits decreased
as a result of a 28 basis point decrease in the rate paid on deposits from 4.65%
to 4.37%. The benefit of the lower cost of deposits was offset by a $6.8
million increase in the average balance of deposit accounts. Management's
strategy is to use lower-costing demand deposit accounts rather than higher-
costing certificates of deposit to fund future loan growth.
Interest expense decreased by $429,000, or 5.8%, to $7.0 million for the
fiscal year ended September 30, 1997 from $7.4 million for the prior fiscal
year. This decrease was the result of a decrease in the Company's average cost
of funds, the effects of which were partially offset by a slight increase in the
Company's average interest bearing liabilities. The increase in average
interest-bearing liabilities resulted from increases in the average balances of
demand deposits and money market demand accounts, passbook savings and borrowed
funds, partially offset by a decrease in the Company's certificates of deposit.
The decrease in the average cost of the Company's interest-bearing liabilities
resulted from an overall decrease in market interest rates during the fiscal
year and a change in the portfolio mix of the Company's deposits. From September
30, 1996 to September 30, 1997, higher-costing certificates of deposit decreased
from $106.1 million to $102.3 million, or from 72.7% to 70.3% of the Company's
total deposit portfolio, respectively. This was offset by a corresponding
increase in lower-costing NOW accounts and passbook savings accounts which
increased from $39.9 million to $43.1 million, or from 27.3% to 29.7% of the
Company's total deposits.
Provision for Loan Losses. The Company establishes provisions for loan
losses, which are charged to operations, in order to maintain the allowance for
loan losses at a level which is deemed appropriate to absorb future charge-offs
of loans deemed uncollectible. In determining the appropriate level of the
allowance for loan losses, management considers past and anticipated loss
experience, evaluations of real estate collateral, current and anticipated
economic conditions, volume and type of lending and the levels of nonperforming
and other classified loans. The amount of the allowance is based on estimates
and the ultimate losses may vary from such estimates. Management of the Company
assesses the allowance for loan losses on a quarterly basis and makes provisions
for loan losses monthly in order to maintain the adequacy of the allowance.
The Company provided $300,000 and $293,000 in loan loss provisions during
the fiscal years ended September 30, 1998 and 1997, respectively. The increase
was primarily due to the strong loan volume during the year. At September 30,
1998 and 1997 the Company's allowance for loan losses was $1.4 million and $1.1
million, respectively, and the Company's nonperforming loans were $1.2 million
and $1.1 million,
10
<PAGE>
respectively. The Company's allowance for loan losses as a percentage of total
nonperforming loans at September 30, 1998 and 1997 was 114.0% and 104.8%,
respectively. While management uses available information to recognize losses on
loans, future loan loss provisions may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the allowance for loan losses and
may require the Company to recognize additional provisions based on their
judgment of information available to them at the time of their examination.
The Company provided $293,000 and $47,000 in loan loss provisions during
the fiscal years ended September 30, 1997 and 1996, respectively. The increase
was primarily due to the growth in our portfolio of higher-yielding
construction, commercial real estate, and commercial business loans. At
September 30, 1997 and 1996 the Company's allowance for loan losses was $1.1
million and $830,000, respectively, and the Company's nonperforming loans were
$1.1 million and $1.2 million, respectively. The Company's allowance for loan
losses as a percentage of total nonperforming loans at September 30, 1997 and
1996 was 104.8% at and 69.5%, respectively.
Noninterest Income. Noninterest income is composed of service charges on
deposit accounts, gain on sale of securities and other income. Noninterest
income increased by $440,000, or 85.3%, to $956,000 for the fiscal year ended
September 30, 1998 from $516,000 for the prior fiscal year. The primary reasons
for the increase were a $114,000 increase in the gain on sale of assets, a
$52,000 increase in service charges on deposit accounts, and a $274,000 increase
in other income which includes, in part, miscellaneous loan fees and commissions
on the sale of mutual funds and annuities. The increase in deposit fees
resulted, in part, from management's emphasis on fee generating demand deposit
accounts rather than certificates of deposits which generally do not generate
fee income. The increase in the gain on sale of assets was primarily due to the
sale of $9.7 million of long-term fixed rate loans at a gain of $80,000 in order
to reduce the Bank's interest rate risk. Other income increased due to a higher
level of loan demand due to falling interest rates and increased sales of
securities products.
Noninterest income increased by $99,000, or 23.7%, to $516,000 for the
fiscal year ended September 30, 1997, from $417,000 for the prior fiscal year,
as service charges on deposit accounts increased by $20,000, gain on sale of
securities increased by $52,000, and other income increased by $27,000.
Noninterest expenses. Noninterest expenses increased by $600,000, or
15.0%, to $4.6 million for the fiscal year ended September 30, 1998 from $4.0
million for the prior fiscal year. The increase was primarily due to a $248,000
increase in compensation and benefits and a $324,000 increase in other
noninterest expenses. The increase in compensation and benefits was primarily
due to an increase in the number of personnel in order to operate the Company
more like a commercial bank. Other noninterest expenses increased, in part, due
to the addition of three automated teller machines, the implementation of a
debit card program, branch office improvements, and increased expenditures for
computers and technology.
Noninterest expenses decreased by $688,000, or 14.8%, to $4.0 million for
the fiscal year ended September 30, 1997 from $4.6 million for the prior fiscal
year. The decrease was primarily due to a $1.1 million decrease in deposit
insurance as a result of legislation, enacted in September 1996, to recapitalize
the SAIF by a one-time assessment on all SAIF-insured deposits held as of March
31, 1995. The effect of the decrease in deposit insurance was partially offset
by a $252,000, or 12.8%, increase in salaries and benefits to $2.2 million for
the fiscal year ended September 30, 1997 from $2.0 million for the prior fiscal
year. The SAIF assessment was 65.7 basis points per $100 in deposits, payable
on November 30, 1996. For
11
<PAGE>
the Company, the assessment amounted to $867,000 (or approximately $552,000 when
adjusted for taxes), based on the Company's SAIF-insured deposits as of March
31, 1995.
Provision for Income Taxes. The Company's provision for income taxes was
$1.0 million and $819,000 for the fiscal years ended September 30, 1998 and
1997. The increase was due to a $600,000 increase in income before taxes and a
reduction in the effective tax rate from 36.4% to 34.8%. The effective tax rate
decreased due to the $16.2 million increase in state tax-exempt investments and
the $1.0 million increase in bank-qualified tax-exempt municipal securities.
These securities were primarily funded from the net proceeds of the stock
offering.
The Company's provision for income taxes was $819,000 and $351,000 for the
fiscal years ended September 30, 1997 and 1996. The higher provision for the
fiscal year ended September 30, 1997 related primarily to an increase in income
before income taxes. The Company's effective tax rate decreased to 36.4% for
the fiscal year ended September 30, 1997 from 40.8% for the fiscal year ended
September 30, 1996 primarily due to the effects of certain nondeductible
expenses incurred in 1996.
Capital Resources and Liquidity
The Company's liquidity management objective is to ensure the availability
of sufficient cash flows to meet all financial commitments and to capitalize on
opportunities for expansion. Liquidity management addresses the ability to meet
deposit withdrawals on demand or at contractual maturity, to repay borrowings as
they mature, and to fund new loans and investments as opportunities arise. The
Company's primary sources of internally generated funds are principal and
interest payments on loans receivable, cash flows generated from operations, and
cash flows generated by investments. External sources of funds include
increases in deposits and advances from the FHLB of Atlanta.
The Company is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of United States
Government, federal agency and other investments having maturities of five years
of less. Current OTS regulations require that a savings association maintain
liquid assets of not less than 4% of its average daily balance of net
withdrawable deposit accounts and borrowings payable in one year or less.
Monetary penalties may be imposed for failure to meet applicable liquidity
requirements. At September 30, 1998, the Company's liquidity, as measured for
regulatory purposes, was in excess of the minimum OTS requirement.
At September 30, 1998, the Company had loan commitments (excluding
undisbursed portions of interim construction loans of $5.2 million) of $890,000
and unused lines of credit of $15.1 million. The Company believes that it has
adequate resources to fund loan commitments as they arise. If the Company
requires funds beyond its internal funding capabilities, additional advances
from the FHLB of Atlanta are available. At September 30, 1998, approximately
$71.1 million of time deposits scheduled to mature within a year, and the
Company expects that a portion of these time deposits will not be renewed upon
maturity.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and related Notes have been prepared
in accordance with generally accepted accounting principles ("GAAP"), which
generally 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 due to inflation. The impact of inflation
is reflected in the increased cost of the Company's operations. Nearly all the
assets and liabilities of the Company are financial, unlike
12
<PAGE>
most industrial companies. As a result, the Company's performance is directly
impacted by changes in interest rates, which are indirectly influenced by
inflationary expectations. The Company's ability to match the interest
sensitivity of its financial assets to the interest sensitivity of it financial
liabilities in its asset/liability management may tend to minimize the effect of
changes in interest rates on the Company's performance. Changes in interest
rates do not necessarily move to the same extent as changes in the price of
goods and services. In the current interest rate environment, liquidity and the
maturity structure of the Company's assets and liabilities are critical to the
maintenance of acceptable performance levels.
Impact of New Accounting Standards
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128 "Earnings Per Share." SFAS No. 128 supersedes APB Opinion No. 15
"Earnings Per Share" and specifies the computation, presentation and disclosure
requirements for earnings per share ("EPS") for entities with publicly held
stock or potential publicly held Common Stock. Essentially, this standard
replaces the primary EPS and fully diluted EPS presentations under APB Opinion
No. 15 with a basic EPS and diluted EPS presentation. SFAS No. 128 has been
adopted for interim periods following the mutual holding company reorganization
of the Bank and the formation of the Company in April 1998. EPS data for the
years ended September 30, 1998 and 1997 have not been presented because such
data would not be meaningful given the short period of time during which common
stock was outstanding.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
The comprehensive income and related cumulative equity impact of comprehensive
income items will be required to be disclosed prominently as part of the notes
to the financial statements. Only the impact of unrealized gains or losses on
securities available for sale is expected to be disclosed as an additional
component of the Bank's income under the requirements of SFAS No. 130. The
Company will adopt the provisions of the SFAS No. 130 during the first quarter
of fiscal 1998-1999.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which changes the way public companies
report information about segments of their business on their annual financial
statements and requires them to report selected segment information in their
quarterly reports issued to shareholders. It also requires entity wide
disclosures about the products and services an entity provides, the foreign
countries in which it holds assets and reports revenues, and its major
customers. This statement is effective for fiscal years beginning after
December 15, 1997. The adoption of the provisions of SFAS No. 131 are not
expected to have significant impact on the Company's financial statements.
In June, 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which, establishes accounting and reporting
requirements for derivative instruments, including derivative instruments
imbedded other contracts. The provisions of the Statement are effective for
fiscal years beginning after June 15, 1999. The Company is still assessing the
impact of adopting the provisions of SFAS No. 133.
Year 2000 Considerations
Like many financial institutions, the Bank relies upon computers for
conducting its daily operations. There is concern among industry experts that on
January 1, 2000, computers will be unable to "read" the new year and, as a
consequence, there may be widespread computer malfunctions. Since the Bank
processes all of its loan, deposit, and accounting operations on an internal
data processing system, the Year 2000 issue
13
<PAGE>
could have a material adverse effect on the operations of the Bank if proper
modifications and conversions are not made in a timely manner.
Failure to resolve year 2000 issues presents the following risks to the
Bank: (1) the Bank could lose customers to other financial institutions,
resulting in a loss of revenue, if the Bank is unable to properly process
customer and other transactions; (2) governmental agencies, such as the Federal
Home Loan Bank, and correspondent institutions could fail to provide funds to
the Bank, which could materially impair the Bank's liquidity and affect the
Bank's ability to fund loans and deposit withdrawals; (3) concern on the part of
depositors that year 2000 issues could impair access to their deposit account
balances could result in the Bank experiencing deposit outflows prior to
December 31, 1999; and (4) the Bank could incur increased personnel costs if
additional staff is required to perform functions that inoperative systems
would have otherwise performed. Management believes that it is not possible to
estimate the potential lost revenue due to the year 2000 issue, as the extent
and longevity of any potential problem cannot be predicted.
As a result of the Year 2000 issue, Management has conducted a
comprehensive review of its computer systems to identify systems that could be
affected by the Year 2000, and has developed a Year 2000 Plan to modify or
replace the affected systems and test them for Year 2000 readiness. To date, the
Company has taken the following actions to mitigate the potential effects of the
Year 2000 issue:
. The Bank has upgraded its mainframe computer system (including hardware and
software) to be Year 2000 ready. Management is currently testing the new
computer system to ensure that there are no material Year 2000 problems;
. The Board of Directors has adopted a Year 2000 Plan that Management is
currently implementing. The Plan addresses the overall status of the Year
2000 project, details the Bank's contingency plan, describes mission
critical systems and non-mission critical systems, and identifies test
dates. The Company also has a written Year 2000 Business Resumption
Contingency Plan which contains all mission critical systems and services
and details policy, public relations statements, and workaround procedures
for each system. A general contingency plan will be developed for
non-mission critical systems;
. The Board of Directors has engaged an outside technology consultant to
assist Management in identifying any and all exposures that the Bank may
have and help make all appropriate changes necessary to allow a smooth
transition to the new millennium. The technology consultant will also
coordinate the Bank's Year 2000 contingency planning;
. The Company has established a Year 2000 Committee consisting of members of
senior management that currently meets on a weekly basis to discuss
progress on the Year 2000 Plan, and
. A Year 2000 budget has been developed which estimates the cost associated
with Year 2000 readiness to be less than $200,000. To date, the Company
has expended approximately $150,000 on Year 2000 readiness, including
$125,000 for a new mainframe computer system (hardware and software) which
is being depreciated over a three-year period.
There can be no assurances that the Bank's year 2000 plan will effectively
address the year 2000 issue, that the Bank's estimates of the timing and costs
of completing the plan will ultimately be accurate or that the impact of any
failure of the Bank to be year 2000 compliant will not have a material adverse
effect on the Bank's business, financial condition or results of operations.
Stock Repurchase Plan to Repurchase Up to 105,668 Shares of Common Stock
On October 9, 1998, the Company authorized a plan to repurchase up to
105,668 shares, or approximately 5.0% of its publicly held common stock, as a
part of its capital management strategy. As of November 30, 1998, the Company
had repurchased approximately 15,000 shares of its common stock. The Company
has and will utilize available cash to effect any further repurchases.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of selected financial data for the years ended September 30, 1998
and 1997 is as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------------------------------------
(In Thousands Except Per Share Data)
Fiscal 1998
- -----------
Interest income.............. $3,277 $3,410 $3,655 $3,585
Net interest income.......... 1,540 1,573 1,937 1,751
Provision for losses......... 75 75 90 60
Income before provision for
14
<PAGE>
income taxes................. 597 660 921 712
Net income................... 378 428 609 471
Earnings per common share.... n/a n/a $ 0.14 $ 0.10
Fiscal 1997
- -----------
Interest income.............. $3,181 $3,133 $3,216 $3,406
Net interest income.......... 1,411 1,413 1,489 1,671
Provision for losses......... 59 59 59 116
Income before provision
for income taxes............. 633 584 669 365
Net income................... 375 341 395 321
Earning per common share..... n/a n/a n/a n/a
COMMON STOCK AND RELATED MATTERS
The Company's common stock is listed on the Nasdaq National Market under
the symbol "GBNK." As of November 2, 1998, the Company had seven registered
market makers, 1,156 stockholders of record (excluding the number of persons or
entities holding stock in street name through various brokerage firms), and
4,496,500 shares outstanding. As of such date, Gaston Federal Holdings, MHC
(the "Mutual Company"), the Company's mutual holding company, held 2,383,145
shares of common stock and stockholders other than the Mutual Company held
2,113,355 shares.
The following table sets forth market price and dividend information for
the Common Stock since the completion of the Bank's reorganization into the two-
tier mutual holding company structure, which was completed on April 9, 1998.
Fiscal Year Ended Cash Dividends
September 30, 1998 High Low Declared
-------------------- -------- -------- ----------------
Third quarter $20 $10 $0.05/share
Fourth quarter $15 1/2 $10 6/8 $0.05/share
Payment of dividends on the Company's common stock is subject to
determination and declaration by the Board of Directors and depends upon a
number of factors, including capital requirements, regulatory limitations on the
payment of dividends, the Company's results of operations and financial
condition, tax considerations and general economic conditions. No assurance can
be given that dividends will be declared or, if declared, what the amount of
dividends will be, or whether such dividends, once declared, will continue.
OTS regulations impose limitations upon all "capital distributions" by
savings institutions, including cash dividends, payments by a savings
institution to repurchase or otherwise acquire its stock, payments to
stockholders of another savings institution in a cash-out merger, and other
distributions charged against capital. The regulations establish a three-tiered
system of regulation, with the greatest flexibility being afforded to well-
capitalized or Tier 1 savings associations. As of the date hereof, the Bank was
a Tier 1 institution. Accordingly, under the OTS capital distribution
regulations, the Bank would be permitted to pay dividends during any calendar
year up to 100 percent of its net income during that calendar year, plus the
amount that would reduce by one-half its surplus capital ratio at the beginning
of the calendar year.
In addition to the foregoing, 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 reserves for such distributions. The Bank intends to make full
use of this favorable tax
15
<PAGE>
treatment and does not contemplate any distribution by the Bank in a manner that
would limit the Bank's bad debt deduction or create federal tax liability.
The Mutual Company has accepted all dividends paid by the Company. OTS
regulations require the Mutual Company to notify the OTS of any proposed waiver
of the right to receive dividends. It is the OTS' recent practice to review
dividend waiver notices on a case-by case-basis, and, in general, not object to
any such waiver if: (i) the mutual holding company's board of directors
determines that such a waiver is consistent with such directors' fiduciary
duties to the mutual holding company's members; (ii) for as long as the savings
association subsidiary is controlled by the mutual holding company, the dollar
amount of dividends waived by the mutual holding company are considered as a
restriction on the retained earnings of the savings association as a note to the
financial statements; (iii) the amount of any dividend waived by the mutual
holding company is available for declaration as a dividend solely to the mutual
holding company, and, in accordance with SFAS 5, where the savings association
determines that the payment of such dividend to the mutual holding company is
probable, an appropriate dollar amount is recorded as a liability; (iv) the
amount of any waived dividend is considered as having been paid by the savings
association (and the savings association's capital ratios adjusted accordingly)
in evaluating any proposed dividend under OTS capital distribution regulations;
and (v) in the event the mutual holding company converts to stock form, the
appraisal submitted to the OTS in connection with the conversion application
takes into account the aggregate amount of the dividends waived by the mutual
holding company.
16
<PAGE>
STOCKHOLDER INFORMATION
Annual Meeting Independent Auditors
Cherry, Bekaert & Holland, L.L.P.
The Annual Meeting of Stockholders 2020 Remount Road
will be held at 10:30 A.M. on Post Office Box 1064
Monday, April 12, 1999, in Gastonia, Gastonia, NC 28053-1064
North Carolina.
Stock Listing Transfer Agent and Registrar
ChaseMellon Shareholder Services, L.L.C.
The Company's Common Stock trades 85 Challenger Road, Overpeck Centre
over-the-counter on the Nasdaq Ridgefield Park, NJ 07660
National Market under the symbol Phone (800) 370-1163
"GBNK."
Special Counsel Annual Report on Form 10-KSB
Luse Lehman Gorman Pomerenk & Schick, A copy of the Company's Form 10-KSB
P.C. for the fiscal year ended September
5335 Wisconsin Avenue, N.W., Suite 400 30, 1998, will be furnished without
Washington, D.C. 20015 charge to stockholders as of November
2, 1998, upon written request to the
Secretary, Gaston Federal Bancorp,
Inc., 245 West Main Avenue, P.O. Box
2249, Gastonia, North Carolina
28053-2249.
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Contents
Page
Report of Independent Auditors F-2
Consolidated Statements of Condition F-3
Consolidated Statements of Operation F-4
Consolidated Statements of Changes in Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7 - F-21
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Gaston Federal Bancorp, Inc.
We have audited the accompanying consolidated statements of condition of Gaston
Federal Bancorp, Inc. and subsidiaries as of September 30, 1998 and 1997 and the
related consolidated statements of operations, changes in equity and cash flows
for the years then ended. These financial statements are the responsibility of
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Gaston Federal
Bancorp, Inc. and subsidiaries as of September 30, 1998 and 1997 and the results
of their operations and their cash flows for the years then ended, in conformity
with generally accepted accounting principles.
/s/ Cherry, Bekaert & Holland, L.L.P.
Gastonia, North Carolina
October 29, 1998
F-2
<PAGE>
GASTON FEDERAL BANCORP, INC. and SUBSIDIARIES
Consolidated Statements of Condition
<TABLE>
<CAPTION>
September 30
1998 1997
------------------ ------------------
Assets
<S> <C> <C>
Cash and due from banks $ 2,697,028 $ 2,422,301
Interest-earning bank balances 11,100,936 2,203,314
------------------ ------------------
Cash and cash equivalents 13,797,964 4,625,615
Investment securities
Available-for-sale 20,919,033 8,248,173
Held-to-maturity (fair value $15,967,677 in 1998
and 10,425,353 in 1997) 15,588,173 10,407,029
Mortgage-backed securities
Available-for-sale 8,350,179 -
Held-to-maturity (fair value $6,499,498 in 1998
and $10,193,711 in 1997) 6,357,370 10,087,081
Loans, net 136,500,519 134,491,057
Premises and equipment 2,247,437 2,139,497
Accrued interest receivable 1,238,225 981,313
Federal Home Loan Bank stock 1,300,121 1,276,000
Other assets 1,704,466 1,214,683
------------------ ------------------
Total assets $ 208,003,487 $ 173,470,448
================== ==================
Liabilities and Equity
Deposits $ 143,900,772 $ 145,443,500
Advances from borrowers for taxes and insurance 728,061 1,042,360
Accrued interest payable 428,868 412,234
Advances from Federal Home Loan Bank 19,500,000 3,500,000
Deferred income taxes 415,589 424,000
Other liabilities 1,460,068 1,780,358
------------------ ------------------
Total liabilities 166,433,358 152,602,452
Commitments and contingencies
Stockholders' Equity:
Preferred stock, 10,000,000 shares authorized, none issued - -
Common stock, $1.00 par value, 20,000,000 shares -
authorized, issued and outstanding 4,496,500 in 1998 4,496,500
Additional paid in capital 15,721,070 -
Unallocated common stock held by Employee Stock
Ownership Plan (1,615,539) -
Retained earnings, substantially restricted 21,430,004 19,769,045
Unrealized gain on securities available-for-sale,
net of tax 1,538,094 1,098,951
------------------ ------------------
Total equity 41,570,129 20,867,996
------------------ ------------------
Total liabilities and equity $ 208,003,487 $ 173,470,448
================== ==================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
GASTON FEDERAL BANCORP, INC. and SUBSIDIARIES
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Year Ended September 30
1998 1997
-----------------------------------
<S> <C> <C>
Interest income
Loans $ 11,019,814 $ 10,825,661
Investment securities 2,284,625 1,321,451
Mortgage-backed and related securities 623,003 788,872
-------------- --------------
Total interest income 13,927,442 12,935,984
Interest expense
Deposits 6,694,335 6,804,918
Borrowed funds 432,240 146,956
-------------- --------------
Total interest expense 7,126,575 6,951,874
-------------- --------------
Net interest income 6,800,867 5,984,110
Provision for loan losses 300,000 292,652
-------------- --------------
Net interest income after provision for loan losses 6,500,867 5,691,458
Noninterest income
Service charges on deposit accounts 260,543 208,566
Gain on sale of securities 184,213 52,261
Other income 511,041 255,521
-------------- --------------
Total noninterest income 955,797 516,348
Noninterest expense
Salaries and benefits 2,476,633 2,228,466
Occupancy expense 500,232 465,300
Deposit insurance 109,360 138,631
Computer expense 122,817 139,455
Advertising 255,223 219,695
Professional services 197,209 183,847
Other 905,406 581,564
-------------- --------------
Total noninterest expense 4,566,880 3,956,958
-------------- --------------
Income before income taxes 2,889,784 2,250,848
Provision for income taxes 1,004,000 819,000
-------------- --------------
Net income $ 1,885,784 $ 1,431,848
============== ==============
</TABLE>
See notes to consolidated financial statements.
<PAGE>
GASTON FEDERAL BANCORP, INC. and SUBSIDIARIES
Consolidated Statements of Changes in Equity
<TABLE>
<CAPTION>
Unrealized
Unallocated Gain (Loss)
Retained Common on Securities
Additional Earnings Stock Available
Preferred Common Paid-In- Substantially Held By for Total
Stock Stock Capital Restricted ESOP Sale, net Equity
----------- ---------- ----------- ----------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance September 30, 1996 $ - $ - $ - $18,337,197 $ - $ 746,482 $19,083,679
Net income - - 1,431,848 - - 1,431,848
Unrealized gain on securities
available-for-sale, net of tax - - - - - 352,469 352,469
----------- ---------- ----------- ----------- ----------- ---------- -----------
Balance September 30, 1997 - - - 19,769,045 - 1,098,951 20,867,996
Net Income - - - 1,885,784 - - 1,885,784
Issuance of 2,113,355 shares of $1.00
par value common stock in the initial
public offering at $10.00 per share - 2,113,355 18,104,215 - - - 20,217,570
Issuance of 2,383,145 shares of $1.00
par value common stock to Gastonia
Federal Holdings, MHC - 2,383,145 (2,383,145) - - - -
Loan to ESOP for purchase of
common stock - - - - (1,690,680) - (1,690,680)
Allocation from shares purchased with
loan to ESOP - - - - 75,141 - 75,141
Change in net unrealized gain on
securities available-to-sale, net of
tax - - - - - 439,143 439,143
Cash dividends declared on common stock - - - (224,825) - - (224,825)
----------- ---------- ----------- ----------- ----------- ---------- -----------
Balance September 30, 1998 $ - $4,496,500 $15,721,070 $21,430,004 $(1,615,539) $1,538,094 $41,570,129
=========== ========== =========== =========== =========== ========== ===========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
GASTON FEDERAL BANCORP, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year Ended September 30
1998 1997
------------- ------------
<S> <C> <C>
Operating Activities
Net income $ 1,885,784 $ 1,431,848
Adjustments to reconcile net income to
net cash provided by operating activities
Provision for loan losses 300,000 292,652
Depreciation 401,789 280,879
Deferred income tax expense (benefit) (213,000) 12,000
Gain on sale of investments available-for-sale (184,213) (52,261)
Gain on sale of equipment - (4,059)
Gain on sale of real estate owned - (90,604)
Gain on sale of loans (80,148) -
Deferred loan origination fees (20,050) (5,754)
(Increase) decrease in interest receivable (281,033) 14,089
(Increase) in prepaid expenses (424,783) (256,326)
(Decrease) in accounts payable (392,541) (325,772)
Increase in accrued interest payable 16,634 4,667
Increase (decrease) in accrued / prepaid income taxes (65,000) 575,107
------------- ------------
Net cash provided by operating activities 943,439 1,876,466
Investing Activities
Net (increase) in loans made to customers (11,809,490) (3,915,498)
Sales of investments available-for-sale 2,628,000 601,210
Maturities and prepayments of investments held-to-maturity 6,700,000 9,100,000
Maturities and prepayments of mortgage-backed securities 4,414,063 2,830,854
Purchases of investments available-for-sale (14,420,877) (2,742,786)
Purchases of investments held-to-maturity (11,881,144) (4,755,783)
Purchases of mortgage-backed securities (9,012,318) -
Purchase of FHLB stock - (14,900)
Purchases of premises and equipment (509,729) (103,157)
Proceeds from sale of loans 9,600,226
Proceeds from sales of premises and equipment - 14,000
Proceeds from sales of real estate owned - 102,090
------------- ------------
Net cash provided by (used for) investing activities (24,291,269) 1,116,030
Financing Activities
Dividends to stockholders (224,825) -
Proceeds from common stock issuance 18,602,031 -
Net (decrease) in deposits (1,542,728) (531,592)
Advances from FHLB 16,000,000 8,000,000
Repayment of advances from FHLB - (8,250,000)
Increase (decrease) in advances from borrowers
for insurance and taxes (314,299) 251,137
-------------
------------
Net cash provided by (used for) financing activities 32,520,179 (530,455)
------------- ------------
Net increase in cash and cash equivalents 9,172,349 2,462,041
Cash and cash equivalents at beginning of year 4,625,615 2,163,574
------------- ------------
Cash and cash equivalents at end of year $ 13,797,964 $ 4,625,615
============= ============
</TABLE>
See notes to consolidated financial statements.
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 1 - Summary of Significant Accounting Policies
Gaston Federal Bancorp, Inc. (the Company) is a stock holding company whose
activities are primarily limited to holding the stock of Gaston Federal Bank
(the Bank). The Bank is a community-oriented Federal stock savings bank engaged
primarily in the business of offering deposits to customers through its branch
offices and investing those deposits, together with funds generated from
operations and borrowings, in residential, commercial and consumer loans. The
Bank's wholly-owned subsidiary, Gaston Financial Services, Inc. (doing business
as Gaston Federal Investment Services) acts as an independent agent selling
various financial products.
The accounting and reporting policies of Gaston Federal Bancorp, Inc. and its
subsidiaries follow generally accepted accounting principles and policies within
the financial services industry. The following is a summary of the more
significant policies.
Principles of Consolidation - The consolidated financial statements include the
accounts of Gaston Federal Bancorp, Inc. (the Company), its wholly-owned
subsidiary, Gaston Federal Bank (the Bank), and the Bank's wholly-owned
subsidiary, Gaston Financial Services, Inc. All significant intercompany
accounts and transactions have been eliminated.
Use of Estimates - The financial statements are prepared in accordance with
generally accepted accounting principles which require management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Cash and Cash Equivalents - The Company considers cash on hand, cash due from
banks, which are maintained in financial institutions, and interest-earning
deposits, which are maintained with the Federal Home Loan Bank, as cash and cash
equivalents.
Securities - Management determines the appropriate classification of securities
at the time of purchase. Securities are classified as held-to-maturity when the
Company has the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost.
Securities classified as available-for-sale are carried at fair value. Such
securities are used to execute asset/liability management and to manage
liquidity. Adjustments for unrealized gains or losses, net of related income tax
effect, are reported as a separate component of equity.
The Company has no trading portfolio.
Amortization of premiums and accretion of discounts are included in interest
income over the life of the related security, or in the case of mortgage-backed
securities, the estimated life of the security. Gains or losses on the sale of
securities are recognized on a specific identification, trade date basis.
Loans and Allowance for Loan Losses - Loans are carried at their principal
amount outstanding. Income on loans is accrued based upon the outstanding
principal balance. Generally, loans are classified as nonaccrual, and the
accrual of interest is discontinued, when the contractual payment of principal
and interest has become 90 days past due or when, in management's judgment,
principal or interest is not collectible in accordance with the terms of the
obligation. Cash receipts on nonaccrual loans are applied to principal. The
accrual of interest resumes when the loan returns to performing status.
F-7
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 1 - Summary of Significant Accounting Policies (Continued)
The allowance for loan losses is maintained at a level believed by management to
be adequate 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 loan loss experience, current economic conditions, volume,
growth, and composition of the loan portfolio, and other risks inherent in the
portfolio. Loans are charged to the allowance at the time they are determined to
be losses. Subsequent recoveries are credited to the allowance.
Concentrations of Credit Risk - The Company makes loans to individuals and small
businesses primarily in Gaston County, North Carolina, and surrounding counties.
The Company has a diversified loan portfolio, and the borrowers' ability to
repay their loans is not dependent upon any specific economic segment.
Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
computed over the estimated useful lives of the assets (from 3 to 30 years)
primarily by the straight-line method. Leasehold improvements are amortized on a
straight-line basis over the shorter of the estimated useful life of the
improvement or the lease term.
Other Real Estate Owned - Other real estate owned, included in other assets, is
comprised of real estate properties acquired in partial or total satisfaction of
problem loans. The properties are recorded at the lower of cost or fair value
less estimated costs to sell at the date acquired. Losses arising at the time of
acquisition of such properties are charged against the allowance for loan
losses. Subsequent write-downs that may be required to the carrying value of
these properties are charged to noninterest expenses. Gains and losses realized
from the sale of other real estate owned are included in noninterest income.
Loan Origination Fees - Origination fees received and direct costs incurred are
amortized to interest income over the contractual lives of the loans, using the
level yield method.
Income Taxes - Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Amounts
provided for deferred income taxes relate primarily to differences between tax
and financial reporting for unrealized gains and losses on securities
available-for-sale, allowances for loan losses, depreciation, and deferred
compensation.
Advertising - Advertising costs are expensed as incurred.
Reclassifications - Certain of the prior year amounts have been reclassified or
restated to conform to current year presentation; such reclassifications and
restatements are immaterial to the financial statements.
Earnings Per Share - Earnings per share data have not been presented because
such data would not be meaningful given the short period during which common
stock was outstanding. Presentations of earnings per share amounts will follow
the provisions of Statement of Financial Accounting Standards (SFAS) No. 128,
Earnings Per Share. As the Company has not presented earnings per share amounts
prior to conversion to a stock institution, the adoption of the provisions of
this Statement has no impact on comparative information.
F-8
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 1 - Summary of Significant Accounting Policies (Continued)
Impact of Recently Issued Accounting Standards - SFAS No. 130, Reporting
Comprehensive Income, establishes standards for reporting and display of
comprehensive income in financial statements. The only item expected to be
disclosed as an additional item of comprehensive income in the Company's
financial statements is the change in unrealized gains or losses on securities
available for sale. The Company will adopt the provisions of SFAS No. 130 during
the first quarter of fiscal 1998-1999.
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
issued in June 1998, establishes accounting and reporting requirements for
derivative instruments, including derivative instruments imbedded in other
contracts. The provisions of the Statement are effective for fiscal years
beginning after June 15, 1999. The Company is still assessing the impact of
adopting the provisions of SFAS No. 133.
Note 2 - Conversion to Stock Form of Ownership
On July 14, 1997, the Board of Directors of Gaston Federal Savings and Loan
Association (now known as "Gaston Federal Bank") adopted the Gaston Federal
Savings and Loan Association Plan of Reorganization from Mutual Savings
Association to Mutual Holding Company and Stock Issuance Plan (the "Plan of
Reorganization"). Pursuant to the Plan of Reorganization, on April 9, 1998, the
Bank converted from a federally chartered mutual savings and loan association to
a federally chartered stock savings bank and became the wholly-owned subsidiary
of Gaston Federal Bancorp, Inc., a Federal corporation (the "Reorganization").
The Company was incorporated on March 18, 1998, to serve as the Bank's holding
company, and prior to April 9, 1998, had no operations and insignificant assets
and liabilities. In addition, pursuant to the Plan of Reorganization, the
Company sold 2,113,355 shares of its common stock to the Bank's customers for
$10.00 per share (the "Offering"), and issued 2,383,145 shares of its common
stock to Gaston Federal Holdings, MHC (the "Mutual Holding Company"), a federal
mutual holding company formed as part of the Reorganization. At the conclusion
of the Offering, the Mutual Holding Company owned 53.0% of the Company's
outstanding shares of common stock and purchasers in the Offering owned 47.0%.
Gross proceeds of the Offering totaled $21,133,550, expenses totaled
approximately $916,000, and purchases by the Bank's employee stock ownership
plan formed in connection with the Offering, funded with a loan from the
Company, totaled $1,690,680 for net proceeds of approximately $18,527,000.
Subsequent to the Conversion, the Bank may not declare or pay cash dividends on
or repurchase any of its shares of common stock if the effect thereof would
cause stockholder's equity to be reduced below applicable regulatory capital
maintenance requirements or if such declaration and payment would otherwise
violate regulatory requirements. The Company, unlike the Bank, is not subject to
the same restrictions regarding the declaration or payment of dividends to its
shareholders, although the source of the Company's dividends may depend upon the
Bank's ability to pay dividends.
F-9
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 3 - Investment Securities
The aggregate book and fair values, as well as gross unrealized gains and
losses, of investment securities as of September 30 were as follows:
<TABLE>
<CAPTION>
September 30, 1998
----------------------------------------------------------------------------------
Book Unrealized Unrealized Fair
Value Gains Losses Value
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-Sale
- ------------------
Federated U.S. Government Fund $ 1,162,998 $ 134,735 $ - $ 1,297,733
Asset Management Fund 1,459,188 36,803 - 1,495,991
FHLMC Stock 43,967 2,184,170 - 2,228,137
U.S. Treasury and other agencies 15,046,698 156,003 - 15,202,701
Municipals 680,000 14,471 - 694,471
================ ================= ============== =================
$ 18,392,851 $ 2,526,182 $ - $ 20,919,033
================ ================= ============== =================
Mortgage-backed securities Available-for-Sale
- ---------------------------------------------
FNMA $ 1,482,570 $ - $ (1,276) $ 1,481,294
GNMA 4,866,382 - (12,078) 4,854,304
SBA's 2,009,810 4,771 - 2,014,581
================ ================= ============== =================
Total mortgage-backed securities $ 8,358,762 $ 4,771 $ (13,354) $ 8,350,179
================ ================= ============== =================
Held-to-Maturity
- ----------------
U.S. Treasury and other agencies $ 15,228,173 $ 371,223 $ - $ 15,599,396
Municipals 360,000 8,281 - 368,281
---------------- ----------------- -------------- -----------------
Total Held-to-Maturity $ 15,588,173 $ 379,504 $ - $ 15,967,677
================ ================= ============== =================
Mortgage-backed securities Held-to-Maturity
- -------------------------------------------
FHLMC $ 3,038,585 $ 22,103 $ - $ 3,060,688
FNMA 2,352,782 26,879 - 2,379,661
GNMA 966,003 42,526 - 1,008,529
================ ================= ============== =================
Total mortgage-backed securities $ 6,357,370 $ 91,508 $ - $ 6,448,878
================ ================= ============== =================
<CAPTION>
September 30, 1997
-----------------------------------------------------------------------------------
Book Unrealized Unrealized Fair
Value Gains Losses Value
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-Sale
- ------------------
Federated U.S. Government Fund $ 3,036,073 $ 227,513 $ - $ 3,263,586
Asset Management Fund 1,375,086 14,490 - 1,389,576
FHLMC Stock 43,967 1,541,533 - 1,585,500
U.S. Treasuries and other agencies 1,987,935 21,576 - 2,009,511
================ ================= ============== =================
Total Available-for-sale $ 6,443,061 $ 1,805,112 $ - $ 8,248,173
================ ================= ============== =================
</TABLE>
F-10
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 3 - Investment Securities (Continued)
<TABLE>
<CAPTION>
September 30, 1997
-----------------------------------------------------------------------------------
Book Unrealized Unrealized Fair
Value Gains Losses Value
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Held-to-Maturity
- ----------------
US Treasury and other agencies $ 10,407,029 $ 24,100 $ (5,776) $ 10,425,353
================ ================= ============== ================
Mortgage-backed securities Held-to-Maturity
- -------------------------------------------
FHLMC $ 5,238,150 $ 112,845 $ (18,967) $ 5,332,028
FNMA 3,588,454 4,131 (22,176) 3,570,409
GNMA 1,260,477 33,322 (2,525) 1,291,274
================ ================= ============== =================
Total mortgage-backed securities $ 10,087,081 $ 150,298 $ (43,668) $ 10,193,711
================ ================= ============== =================
</TABLE>
The mutual fund investments are in funds that invest primarily in obligations of
the U.S. government or its agencies.
The book value and estimated fair value of debt securities at September 30,
1998, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
September 30, 1998
--------------------------------------------
Book Fair
Value Value
--------------------------------------------
<S> <C> <C>
Available-for-Sale
- ------------------
Due in one year or less $ 3,999,817 $ 4,025,000
Due after one year through five years 8,187,807 8,306,040
Due after five years through ten years 3,538,974 3,566,132
Mutual funds 2,622,186 2,793,724
Equity securities 43,967 2,228,137
------------------- -------------------
$ 18,392,751 $ 20,919,033
=================== ===================
Mortgage-backed securities $ 8,358,762 $ 8,350,179
=================== ===================
Held-to-maturity
- ----------------
Due in one year or less $ 1,246,773 $ 1,250,469
Due after one year through five years 2,342,962 2,379,702
Due after five years through ten years 11,998,438 12,337,506
Due after ten years - -
=================== ===================
$ 15,588,173 $ 15,967,677
=================== ===================
Mortgage-backed securities $ 6,357,370 $ 6,448,878
=================== ===================
</TABLE>
F-11
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 4 - Loans and Allowance for Loan Losses
The following is a summary of loans outstanding by category at September 30:
1998 1997
--------------------------------------
Real estate:
One-to-four family residential $ 105,526,044 $ 106,422,243
Multi-family residential 3,771,000 6,514,000
Commercial mortgage 8,076,000 7,318,055
Construction 10,572,620 5,868,907
Commercial 6,629,452 5,558,332
Consumer 8,988,997 7,429,841
-------------- --------------
Gross loans 143,564,113 139,111,378
Less:
Loans in process 5,151,824 2,989,750
Deferred loan fees, net 500,521 520,571
Allowance for loan losses 1,411,249 1,110,000
-------------- --------------
Net loans $ 136,500,519 $ 134,491,057
============== ==============
The Company evaluates impairment of its residential mortgage and consumer loans
on a collective basis. Commercial loans individually evaluated and considered
impaired under SFAS No. 114 at September 30, 1998 and 1997 were immaterial.
Changes in the allowance for loan losses for the two years ended September 30,
1998 were as follows:
1998 1997
-----------------------------------
Balance at beginning of year $ 1,110,000 $ 830,000
Provision for loan losses 300,000 292,652
Recoveries on loans previously charged off 6,453 -
Loans charged off (5,204) (12,652)
------------ --------------
Balance at end of year $ 1,411,249 $ 1,110,000
============ ==============
Directors, executive officers, and associates of such persons were customers of
and had transactions with the Bank in the ordinary course of business. Included
in such transactions are outstanding loans and commitments, all of which were
made under normal credit terms and did not involve more than normal risk of
collection. The aggregate amount of these loans was $1,988,197 and $760,128 at
September 30, 1998 and 1997, respectively. During 1998, new loans of $1,444,735
were made and payments totaled $216,666. During 1997, new loans of $71,632 were
made and payments totaled $142,634.
During 1998, the Bank sold a group of loans with a book value of $9,588,145 at a
gain of $80,148. As of September 30, 1998, the Bank held no other loans for
sale.
F-12
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 5 - Premises and Equipment
Premises and equipment at September 30 are summarized as follows:
1998 1997
-------------------------------
Land $ 604,704 $ 604,704
Buildings 1,725,332 1,650,767
Land improvements 103,071 99,738
Furniture and equipment 2,067,050 1,681,655
------------ ------------
4,500,157 4,036,864
Less accumulated depreciation 2,252,720 1,897,367
------------ ------------
$ 2,247,437 $ 2,139,497
============ ============
Note 6 - Deposits
Deposit balances as of September 30 and interest expense and average rates paid
for the years then ended are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
---------------------------------------------------------------------------------------------
Balance Interest Paid Rate Balance Interest Paid Rate
------------ ------------- ------ ------------ ------------- -----
<S> <C> <C> <C> <C> <C> <C>
Noninterest bearing $ 5,878,000 $ - - $ 3,023,000 - -
Interest bearing demand $ 22,842,000 $ 861,000 3.7% $ 25,906,000 $ 672,000 2.9%
Passbook savings $ 20,557,000 $ 664,000 3.2% $ 14,197,000 $ 387,000 2.9%
Savings certificates $ 94,623,000 $ 5,169,000 5.4% $102,317,000 $ 5,746,000 5.8%
------------ ------------ ------------ ------------
$143,900,000 $ 6,694,000 4.7% $145,443,000 $ 6,805,000 5.0%
============ ============ ========= ============ ============ =========
</TABLE>
Contractual maturities of savings certificates as of September 30, 1998 are as
follows:
Under 1 year $ 71,555,000
1 to 2 years 17,314,000
2 to 3 years 5,754,000
-------------
$ 94,623,000
=============
Certificates of deposit in excess of $100,000 totaled $17,908,000 and
$17,611,000 at September 30,1998 and 1997, respectively. Interest paid on
deposits and other borrowings was $7,126,575 and $6,951,874 for the years ended
September 30, 1998 and 1997, respectively.
Note 7 - Advances from the Federal Home Loan Bank
Advances from the Federal Home Loan Bank of Atlanta are pursuant to lines of
credit and are collateralized by a lien on qualifying first mortgage loans in an
amount necessary to satisfy outstanding indebtedness plus accrued interest.
Advances had interest rates ranging from 4.97% to 5.75% at September 30, 1998
and 5.66% to 6.69% at September 30, 1997. The unused portion of the line of
credit available to the Company at September 30, 1998 was $15,500,000.
F-13
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 7 - Advances from the Federal Home Loan Bank (Continued)
Maturities of advances at September 30 are as follows:
1998 1997
-----------------------------------
Advances from FHLB due:
Less than 1 year $ - $ 1,500,000
1 to 2 years - -
2 to 3 years - -
3 to 4 years 2,000,000 -
4 to 5 years 1,500,000 2,000,000
5 to 10 years 16,000,000 -
------------ ------------
$ 19,500,000 $ 3,500,000
============ ============
Note 8 - Income Taxes
The provision for income taxes is summarized below:
1998 1997
-----------------------------------
Currently payable
Federal $ 1,123,000 $ 728,000
State 94,000 79,000
------------ ------------
1,217,000 807,000
Deferred
Federal (172,000) 10,000
State (41,000) 2,000
------------ ------------
(213,000) 12,000
------------ ------------
Total income taxes $ 1,004,000 $ 819,000
============ ============
The reasons for the difference between consolidated income tax expense and the
amount computed by applying the statutory federal income tax rate of 34% to
income before income taxes were as follows:
1998 1997
-------------------------------
Federal income taxes at statutory rate $ 973,000 $ 765,000
State income taxes, net of federal benefit 35,000 53,000
Other (4,000) 1,000
------------ -----------
$ 1,004,000 $ 819,000
============ ===========
Effective tax rate 34.7% 36.4%
============ ===========
Income taxes recoverable (payable) are included in other assets (liabilities)
and were $65,000 and $(385,975), at September 30, 1998 and 1997, respectively.
Income taxes paid for the years ended September 30, 1998 and 1997 were
$1,693,000 and $296,753, respectively.
F-14
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 8 - Income Taxes (Continued)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities at September 30 are as follows:
1998 1997
--------------------------------
Deferred tax assets
Deferred compensation $ 207,823 $ 188,000
Deferred loan fees 195,804 207,000
Allowance for loan losses 184,242 -
SAIF premium - -
Other 70,150 91,000
----------- -----------
Gross deferred tax assets 658,019 486,000
Deferred tax liabilities
Allowance for loan losses - 25,000
Unrealized gain on securities
available-for-sale 985,990 706,000
Depreciation 19,665 47,000
Other 67,953 132,000
----------- -----------
Gross deferred tax liabilities 1,073,608 910,000
----------- -----------
Net deferred tax liability $ (415,589) $ (424,000)
=========== ===========
The Company, in accordance with SFAS No. 109, did not record a deferred tax
liability of approximately $1,870,000 as of September 30, 1997 related to the
cumulative special bad debt deduction for savings and loan associations
recognized for income tax reporting prior to September 30, 1988, Gaston
Federal's base year.
Management believes that the Company will fully realize deferred tax assets
based on future taxable temporary differences, refundable income taxes from
carryback years, and current levels of operating income.
Note 9 - Commitments to Extend Credit
Commitments to extend credit are agreements to lend 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. Since commitments may expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Commitments to extend credit as of September 30 are as follows:
1998 1997
--------------------------------
Loan commitments $ 889,995 $ 5,047,000
Unused lines of credit
Commercial 6,654,000 2,418,000
Consumer 8,389,000 7,131,000
F-15
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 9 - Commitments to Extend Credit (Continued)
All loan commitments at September 30, 1998 are at fixed rates ranging from
6.125% to 7.125%. Commitment periods are typically 60 days.
Note 10 - Regulatory Capital Requirements
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Under the capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of assets, liabilities,
and certain commitments as calculated under regulatory accounting practices. The
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors. Failure to
meet minimum capital requirements can initiate certain mandatory, and possibly
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements.
The Bank is required to maintain: tangible capital of at least 1.5% of adjusted
total assets; core capital of at least 3.0% of adjusted total assets; and total
capital of at least 8.0% of risk weighted assets. At September 30, 1998, The
Bank's tangible capital and core capital were both $31,671,000, or 15.4% of
tangible assets, and total capital was $34,142,000, or 31.53% of risk-weighted
assets. The Company's primary regulator, the Office of Thrift Supervision,
informed the Bank that it was in the well-capitalized category as of the most
recent regulatory examinations, and management is not aware of any events that
have occurred since that would have changed its classification.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
Prompt Corrective
Adequacy Purposes
Actual For Capital Action Provisions
------------------------------- -------------------------------- -------------------------------
Amount Ratio Amount Ratio Amount Ratio
---------------------- ------- ---------------------- ------- ---------------------- -------
(dollars in thousands) (dollars in thousands) (dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1998
Total Risk-Based Capital
(To Risk-Weighted Assets) 34,142 31.53% 8,663 8.00% 10,829 10.00%
Tier 1 Capital
(To Risk-Weighted Assets) 31,671 29.25% 4,332 4.00% 6,498 6.00%
Tier 1 Capital
(To Adjusted Total Assets) 31,671 15.44% 8,207 4.00% 10,256 5.00%
Tangible Capital
(To Adjusted Total Assets) 31,671 15.44% 3,078 1.50% 6,155 3.00%
As of September 30, 1997
Total Risk-Based Capital
(To Risk-Weighted Assets) 20,800 21.40% 7,786 8.000% 9,733 10.00%
Tier 1 Capital
(To Risk-Weighted Assets) 19,890 20.44% 2,920 3.00% 5,840 6.00%
Tier 1 Capital
(To Adjusted Total Assets) 19,890 11.52% 5,179 3.00% 8,632 5.00%
Tangible Capital
(To Adjusted Total Assets) 19,890 11.52% 2,590 1.50% 5,179 3.00%
</TABLE>
F-16
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 10 - Regulatory Capital Requirements (Continued)
The deposits of the Bank are insured by the Savings Association Insurance Fund
(SAIF), one of two funds administered by the FDIC. The Bank previously paid
annual premiums of approximately $.23 per $100 of deposits. On September 30,
1996, the Deposit Insurance Funds Act of 1996 was signed, which authorized the
FDIC to impose a special assessment on certain deposits held by thrift
institutions. This special assessment, which was based on $.657 per $100 of
outstanding deposits at March 31, 1995, was intended to recapitalize the SAIF.
Accordingly, the Bank recorded a one time pre-tax charge of approximately
$867,000 at September 30, 1996, which was paid prior to December 31, 1996. The
Bank's annual SAIF premium rates were reduced to $.0648 per $100 of deposits
beginning January 1, 1997.
Note 11 - Employee Benefit Plans
The Bank contributes to the Financial Institutions Retirement Fund, a
multi-employer, qualified, noncontributory defined benefit pension plan that
covers substantially all employees of the Bank meeting age and service
requirements. The plan provides pension benefits based on the employee's length
of credited service and final average compensation as defined in the plan. The
plan requires employers to fund amounts necessary to meet ERISA minimum funding
requirements. Total expense relating to this plan was $3,338 in 1998 and $75,693
in 1997. Separate company information relating to the Bank is not available.
The Bank also provides supplemental benefits to substantially all employees
through a 401(k) savings plan. Eligible participants may contribute up to 15% of
base salary, with the Bank providing matching contributions of 25% of employee
contributions. The plan also provides for discretionary employer contributions.
Total expense relating to this plan was $90,961 in 1998 and $123,443 in 1997.
The Bank also maintains nonqualified deferred compensation and supplemental
retirement plans for its directors. Total expense for the plans were $67,623 in
1998 and $64,260 in 1997. The accrued liabilities for the plans were $531,236
and $480,000 at September 30, 1998 and 1997, respectively.
Employee Stock Ownership Plan - In connection with the Conversion, the Bank
established an ESOP. The ESOP is a tax-qualified retirement plan designed to
invest primarily in the Company's common stock. All full-time employees of the
Bank who have completed one year of service with the Bank will be eligible to
participate in the ESOP. The ESOP utilized funds borrowed from the Company
totaling $1,690,680, to purchase approximately 8%, or 169,068 shares of the
Company's common stock issued in the Conversion. The loan to the ESOP will be
primarily repaid with contributions from the Bank to the ESOP over a period not
to exceed 15 years. Under the terms of the ESOP, the Bank makes contributions to
the ESOP sufficient to cover all payments of principal and interest as they
become due. At September 30, 1998, the loan had an outstanding balance of
$1,690,680 million and an interest rate equal to the Bank's prime rate (8.25% as
of September 30, 1998).
F-17
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 11 - Employee Benefit Plans (Continued)
Shares purchased with the loan proceeds are held in a suspense account by the
trustee of the plan for future allocation among participants as the loan is
repaid. Contributions to the ESOP and shares released from the suspense account
are allocated among participants on the basis of compensation as described in
the plan. The number of shares released to participants will be determined based
upon the percentage of principal and interest payments made during the year
divided by the total remaining principal and interest payments including the
current year's payment. Participants will vest in the shares allocated to their
respective accounts over a period not to exceed 5 years. Any forfeited shares
are allocated to the then remaining participants in the same proportion as
contributions. At September 30, 1998, no shares have been allocated to
participants and 169,068 shares remain unallocated. The Company recognizes
compensation expense attributable to the ESOP ratably over the fiscal year based
upon the estimated number of ESOP shares to be allocated each December 31st. For
the year ended September 30, 1998, the Company recognized $75,000 as
compensation expense.
The trustee for the ESOP must vote all allocated shares held in the ESOP trust
in accordance with the instructions of the participants. Unallocated shares held
by the ESOP trust are voted by the trustee in a manner calculated to most
accurately reflect the results of the allocated ESOP shares voted, subject to
the requirements of the Employee Retirement Income Security Act of 1974, as
amended (ERISA).
Note 12 - Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments. In cases where quoted market
prices are not available, fair values are based on estimates using present value
or other valuation techniques. The estimates are significantly affected by the
assumptions used, including discount rates and estimates of future cash flows.
These estimates may differ substantially from amounts that could be realized in
an immediate sale or settlement of the instrument.
Fair value approximates book value for the following financial instruments due
to their short-term nature: cash and due from banks, interest-earning bank
balances, and advances from customers for taxes and insurance.
Fair values for investment securities and mortgage-backed securities are based
on quoted market prices. If a quoted market price is not available, fair value
is estimated using market prices for similar securities.
Fair value for variable rate loans that reprice frequently is based on the
carrying value reduced by an estimate of credit losses inherent in the
portfolio. Fair value for all other loans is estimated by discounting their
future cash flows using interest rates currently being offered for loans of
comparable terms and credit quality.
Fair value for demand deposit accounts and interest-bearing accounts with no
fixed maturity is equal to the carrying value. Certificate of deposit fair
values are estimated by discounting cash flows from expected maturities using
interest rates currently being offered for similar instruments.
Fair values for the advances from the Federal Home Loan Bank Board is based on
discounted cash flows using current interest rates.
F-18
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 12 - Fair Value of Financial Instruments (Continued)
At September 30, 1998 and 1997, The Company had outstanding unfunded commitments
to extend credit offered in the normal course of business. Fair values of these
commitments are based on fees currently charged for similar instruments. At
September 30, 1998 and 1997, the carrying amounts and fair values of these
off-balance sheet financial instruments were immaterial.
The Company has used management's best estimates of fair values of financial
instruments based on the above assumptions. This presentation does not include
certain financial instruments, nonfinancial instruments or certain intangible
assets such as customer relationships, deposit base intangibles, or goodwill.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company. The estimated fair values of financial
instruments as of September 30 were as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets
Cash and due from banks $ 2,697,028 $ 2,697,028 $ 2,422,301 $ 2,422,301
Interest-earning bank balances 11,100,936 11,100,936 2,203,314 2,203,314
Investments and mortgage-
backed securities 51,214,755 51,685,767 45,080,068 45,168,698
Loans 136,500,519 138,444,000 134,491,057 135,227,000
Financial liabilities
Deposits 143,900,772 144,324,000 145,443,500 145,287,000
Advances from FHLB 19,500,000 19,677,000 3,500,000 3,421,000
</TABLE>
Note 13 - Parent-Only Financial Information
The earnings of the Bank are recognized by Gaston Federal Bancorp, Inc. using
the equity method of accounting. Accordingly, undistributed earnings of the Bank
are recorded as increases in the Company's investment in the Bank. The following
are the condensed financial statements of the Company as of and for the year
ended September 30, 1998 (although the Company did not commence operations until
April 9, 1998, the full year results have been presented).
Condensed Statement of Financial Condition
- ------------------------------------------
September 30, 1998
Assets
Cash and cash equivalents $ 6,874,046
Investment in securities available for sale 1,514,219
Investment in subsidiary 33,200,213
Other assets 33,300
----------------
Total assets $ 41,621,778
===============
F-19
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 13 - Parent-Only Financial Information (Continued)
September 30, 1998
Liabilities and Stockholders' Equity
Liabilities $ 51,649
Stockholders' equity 41,570,129
------------
Total liabilities and stockholders' equity $ 41,621,778
===========
Condensed Statement of Operations
- ---------------------------------
Interest income $ 467,092
Interest expense (227,282)
Other operating expenses (108,126)
------------
Income before income taxes and undistributed
earnings from subsidiaries 131,684
Income taxes (51,397)
------------
Income before undistributed earnings
from subsidiaries 80,287
Equity in undistributed earnings of
subsidiaries 1,805,497
------------
Net income $ 1,885,784
===========
Condensed Statement of Cash Flows
- ---------------------------------
Operating activities
Net income $ 1,885,784
Adjustments to reconcile net income to net cash
provided by operating activities
Equity in undistributed earnings of subsidiaries (1,805,497)
Increase in other operating assets (33,300)
Increase in other operating liabilities 46,562
------------
Net cash provided by operating activities 93,549
Investing activities
Purchase of investments available for sale (1,500,000)
Investment in subsidiary (10,096,709)
------------
Net cash used in investing activities (11,596,709)
Financing activities
Proceeds from common stock issuance 18,602,031
Dividends to stockholders (224,825)
------------
Net cash provided by financing activities 18,377,206
------------
Net increase in cash and cash equivalents 6,874,046
Cash and cash equivalents, beginning of period -
------------
Cash and cash equivalents, end of period $ 6,874,046
===========
F-20
<PAGE>
GASTON FEDERAL BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Note 14 - Subsequent event
On October 9, 1998, the Company's Board of Directors announced the authorization
to repurchase of up to 105,668 shares of outstanding common stock. The
repurchases are authorized to be made from time to time during the six-month
period following the announcement at management's discretion. The number of
shares authorized to be repurchased represent approximately 5% of the Company's
outstanding common stock held by stockholders other than Gaston Federal
Holdings, MHC.
F-21
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
Company Percent Owned
- ------- -------------
Gaston Federal Bank 100% Owned by the Company
Gaston Financial Services, Inc. 100% Owned by the Bank
(dba Gaston Federal Investment Services)
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,697
<INT-BEARING-DEPOSITS> 11,101
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 29,269
<INVESTMENTS-CARRYING> 21,945
<INVESTMENTS-MARKET> 22,467
<LOANS> 136,501
<ALLOWANCE> 1,411
<TOTAL-ASSETS> 208,003
<DEPOSITS> 143,901
<SHORT-TERM> 5,000
<LIABILITIES-OTHER> 3,033
<LONG-TERM> 14,500
0
0
<COMMON> 20,217
<OTHER-SE> 21,353
<TOTAL-LIABILITIES-AND-EQUITY> 208,003
<INTEREST-LOAN> 11,020
<INTEREST-INVEST> 2,907
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 13,927
<INTEREST-DEPOSIT> 6,467
<INTEREST-EXPENSE> 7,127
<INTEREST-INCOME-NET> 6,801
<LOAN-LOSSES> 300
<SECURITIES-GAINS> 184
<EXPENSE-OTHER> 4,567
<INCOME-PRETAX> 2,890
<INCOME-PRE-EXTRAORDINARY> 2,890
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,886
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<YIELD-ACTUAL> 2.9
<LOANS-NON> 1,238
<LOANS-PAST> 0
<LOANS-TROUBLED> 247
<LOANS-PROBLEM> 384
<ALLOWANCE-OPEN> 1,110
<CHARGE-OFFS> 6
<RECOVERIES> 5
<ALLOWANCE-CLOSE> 1,411
<ALLOWANCE-DOMESTIC> 1,411
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
