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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period ______ to _______
Commission File Number 000-24553
CNBT BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
United States 76-0575815
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
5320 Bellaire Boulevard
Bellaire, Texas 77401
(Address of principal executive offices, including zip code)
(713) 661-4444
(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 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
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The aggregate market value of the voting stock held by non-affiliates of the
registrant at March 11, 1999 was approximately $38,949,000. The aggregate
market value was computed by using the closing price of the stock as of that
date on the Nasdaq National Market. (For purposes of calculating this amount
only, all directors and executive officers of the registrant have been treated
as affiliates.)
Number of shares of Common Stock, $1.00 par value, outstanding at March 11,
1999: 4,911,117.
Documents Incorporated by Reference:
Part III -- Portions of the registrant's definitive proxy statement to be issued
in connection with registrant's annual stockholders' meeting to be held on
May 18, 1999.
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TABLE OF CONTENTS
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PART I Page
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Item 1. Business........................................................ 3
Item 2. Properties...................................................... 14
Item 3. Legal Proceedings............................................... 14
Item 4. Submission of Matters to a Vote of Security Holders............. 14
Item 4A Executive Officers of the Registrant............................ 15
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters................................... 17
Item 6. Selected Consolidated Financial Data............................ 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 19
Item 7A Quantitative and Qualitative Disclosure About Market Risk....... 43
Item 8. Financial Statements and Supplementary Data..................... 43
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure........................... 44
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 45
Item 11. Executive Compensation.......................................... 45
Item 12. Security Ownership of Certain Beneficial
Owners and Management......................................... 45
Item 13. Certain Relationships and Related Transactions.................. 45
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K........................................... 46
Signatures...................................................... 47
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Forward-Looking Statements
In the normal course of its business, the Company, in an effort to keep its
stockholders and the public informed about the Company's operations, may from
time to time issue certain statements, either in writing or orally, that contain
or may contain forward-looking information. In addition to historical
information, this Annual Report contains forward-looking statements. Generally,
these statements relate to business plans or strategies, acquisitions made or to
be made by the Company, and other aspects of the Company's operating results.
Forward looking statements are not guarantees of future performance and are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those reflected in the forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
those discussed in the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Factors That May Affect Future
Results and Market Price of Stock." The Company undertakes no obligation to
publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof. Readers should carefully review
the risk factors described in other documents the Company files from time to
time with the Securities and Exchange Commission including the Quarterly Reports
on Form 10-Q to be filed by the Company in 1999 and any Current Reports on
Form 8-K filed by the Company.
PART I
Item 1. Business.
General
CNBT Bancshares, Inc. (the "Company") is a Texas corporation and bank
holding company, which owns and derives substantially all of its income from the
operation of its wholly-owned subsidiary, Citizens National Bank of Texas
(together with its wholly-owned subsidiary, the "Bank"). The Bank is a national
banking association that provides a full range of traditional retail and
commercial banking services primarily to individual consumers and small
businesses in the Houston metropolitan area. The Bank was founded in October
1983 in the City of Bellaire, an incorporated city within the city limits of
Houston, by a group of experienced bankers who had been senior officers with
other commercial banks in the Bank's primary market area. Over its sixteen-year
history, the Bank has demonstrated a consistent record of growth and
profitability. The Bank has increased its assets and net income in each year of
operation, even during the period of adverse economic conditions in Texas in the
mid-to-late 1980s. At December 31, 1998, the Company had $377.9 million in total
assets, $330.9 million in total deposits and total stockholders' equity of $33.4
million.
The Company was incorporated under the laws of Texas on April 8, 1998, to
serve as a holding company for the Bank. The reorganization of the Bank into a
holding company structure was effective on July 2, 1998, at which time the
holders of common stock of the Bank became stockholders of the Company and the
Bank became a subsidiary of the Company.
The Company's main office is located at 5320 Bellaire Boulevard, Bellaire,
Texas 77401 and its telephone number is (713) 661-4444.
Management of the Company adheres to a community banking philosophy that
emphasizes accessible, service-oriented, relationship banking. Management
believes that this commitment, together with
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the Bank's conservative lending and prudent investment policies, are important
factors in its success and growth. The Bank's high quality personal service and
responsiveness to customer needs has attracted numerous customers from larger
regional and multi national banks. Management believes that the continued
acquisitions of local banks by out-of-state organizations present additional
opportunities to attract customers who prefer to work with a local community
bank or who have experienced a decline in personal service from the out-of-state
banks. The quality of service provided by the Bank and the development of long-
term customer relationships has been facilitated by the continuity of service of
officers and staff. The Bank's eight senior lending officers average more than
25 years of experience in the Bank's primary market areas. In addition, of the
Bank's 23 current executive officers and directors, 11 were in the founding
group.
As a full service commercial bank, the Bank offers an array of lending and
deposit services to its retail and commercial customers. The primary lending
focus of the Bank is on small business, commercial and residential real estate,
and consumer loans. The Bank generally seeks a mix of 50% consumer loans, 25%
small business loans, and 25% real estate loans. Loan demand and maturities may
cause the actual percentage of the Bank's loans in any category to vary from the
proposed mix. As a service to its customers, the Bank also offers home computer
banking, provides on-site access to conventional mortgage loans through its
subsidiary CNB Mortgage Company, and check printing, which permits almost
immediate turnaround on check orders.
The Bank maintains a strong community orientation by, among other things,
supporting the active participation of its officers and employees in local
charitable, civic, school, and religious activities. Three of the Bank's senior
officers are past Presidents of the Bellaire Chamber of Commerce. In 1989, the
Bank founded the Leisure Club for customers 50 years of age and over. Leisure
Club members are eligible for a package of special services from the Bank and
participate in community activities and various local, national, and
international trips and tours. At December 31, 1998, the Leisure Club had more
than 4,310 members and accounted for more than $144.5 million in deposits in the
Bank. The Bank has renovated an office building adjacent to its main office
which serves as the office and activity center for the Leisure Club and is also
available to other community organizations free of charge. The Bank currently
has three full-time employees and one part-time employee dedicated to the
Leisure Club's activities.
Management believes that the Houston metropolitan area offers significant
growth opportunities for the Bank. Houston is the fourth largest city in the
United States with an estimated metropolitan area population in 1996 of
approximately 3.8 million. The Company's primary markets are centered in the
City of Bellaire, approximately seven miles southwest of the Houston central
business district, northwest Houston, and in rapidly growing suburban northeast
Fort Bend County, which is approximately 15 miles southwest of the Houston
central business district. The Bank's main office is located in the City of
Bellaire, an established community in the center of southwest Houston. This area
is attractive to residents because of its convenience to the Houston central
business district, the Texas Medical Center, the Galleria area, local museums,
and Rice University. According to U.S. Census Bureau estimates, Fort Bend County
ranked as the second fastest growing county in Texas and the fourth fastest
growing urban county in the United States between 1990 and 1995, based on per
capita population. According to private research estimates, Fort Bend County
also ranked sixth in the nation in economic strength and employment growth for
counties with populations of 150,000 or more and is predicted to have the sixth
fastest rate of employment growth of any county in the U.S. from 1995 to 2005.
In May 1998, the Bank established a temporary branch office and began
construction of a permanent branch office and drive through facility in
northwest Houston.
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The Company has grown through a combination of internal growth and the
opening of new community banking offices. The Bank opened its first two branch
offices in 1992 in supermarkets in Fort Bend County, Texas, and a third in 1997,
which afforded the Bank with a relatively inexpensive means of entering this new
market. In addition to providing the Bank with an opportunity to diversify its
deposit base, this area was attractive because of its growth characteristics. In
December 1995, the Bank opened a free-standing office in Sugar Land, an affluent
section of Fort Bend County. This office is managed by a senior banking officer
with 15 years of experience in the Fort Bend market area. At December 31, 1998,
the Fort Bend County branches accounted for approximately $56.2 million of the
Bank's deposits, of which $31.9 million were at the free-standing Sugar Land
office.
The Company's strategy is to increase its presence in existing markets by
targeting individuals and small owner-operated businesses and to expand into new
areas of the greater Houston metropolitan area that complement its existing or
targeted customer base by opening new branch offices or acquiring existing
financial institutions. In pursuing its expansion strategy, the Bank intends to
seek both an attractive location and one or more senior banking officers with
experience in the local community to staff the office. Currently, the Bank is
actively pursuing expansion into the west and northwest suburban areas of the
greater Houston metropolitan area either by establishing a new branch office or
acquiring one or more existing branches. There can be no assurance that the Bank
can successfully establish new branch offices or acquire existing institutions
and failure to do so may limit the Bank's growth potential. The Bank plans to
have its permanent free-standing branch office in northwest Houston completed in
September 1999, and is exploring an additional sight in west Houston for a
possible branch office.
Competition
The banking business is highly competitive and the profitability of the
Company depends principally upon the Company's ability to compete in the Houston
metropolitan area. In addition to competing with other commercial and savings
banks and savings and loan associations, the Company competes with credit
unions, finance companies, mutual funds, insurance companies, brokerage and
investment banking firms, asset-based non-bank lenders, and certain other non-
financial entities, including retail stores that may maintain their own credit
programs, and governmental organizations that may offer subsidized financing at
lower rates than those offered by the Company. Many of the Company's competitors
have significantly greater financial and other resources and larger lending
limits than the Company. The Company has been able to compete effectively with
other financial institutions by emphasizing customer service, including local
office decision-making on loans, establishing long-term customer relationships,
and building customer loyalty.
The success of the Company is also highly dependent upon general economic
conditions in the Houston metropolitan area. Significant deterioration in the
local economy or economic problems in the greater Houston area could
substantially impact the Company's performance. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors That May
Affect Future Results and Market Price of Stock."
Employees
As of December 31, 1998, the Company had 110 full-time equivalent
employees, 31 of whom were officers. The Company provides medical and
hospitalization insurance and a 401(k) profit sharing plan to its full-time
employees. The Company considers its relations with its employees to be
excellent.
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Supervision and Regulation
The federal banking laws contain numerous provisions affecting various
aspects of the business and operations of the Company. The following description
of references herein to applicable statutes and regulations, which are not
intended to be complete descriptions of these provisions or their effects on the
Company and the Bank, are brief summaries and are qualified in their entirety by
reference to such statutes and regulations.
General. The Company is subject to the Bank Holding Company Act of 1956, as
amended (the "BHCA"), and to regulation and supervision by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"). The Bank
is a national bank under the National Bank Act of 1864, as amended (the
"National Bank Act"). As a national banking association, the Bank is supervised,
examined, and regulated principally by the Office of the Comptroller of the
Currency (the "OCC"). The OCC regularly examines such areas as capital adequacy,
reserves, loan portfolio, investments, and management practices. The Bank must
also furnish quarterly and annual reports to the OCC, and the OCC may exercise
cease and desist and other enforcement powers over the Bank if its actions
represent unsafe or unsound practices or violations of law. Since the deposits
of the Bank are insured by the Bank Insurance Fund ("BIF") of the Federal
Deposit Insurance Corporation (the "FDIC"), the Bank is also subject to
regulation and supervision by the FDIC. Because the Bank is a member of the
Federal Reserve System, the Federal Reserve Board also has supervisory authority
over certain operations and activities of the Bank.
Bank Holding Company Act of 1956. The BHCA requires the Company to secure
prior approval of the Federal Reserve Board before acquiring control, directly
or indirectly, of more than five percent of the voting shares or substantially
all of the assets of any institution, including another bank. In addition, a
bank holding company is prohibited from engaging in or acquiring direct or
indirect control of more than five percent of the voting shares of any company
engaged in non-banking activities unless the Federal Reserve Board, by order or
regulation, has found such activities to be so closely related to banking,
managing, or controlling banks as to be a proper incident thereto. In making
this determination, the Federal Reserve Board considers whether these activities
offer benefits to the public that outweigh any possible adverse effects.
As a bank holding company, the Company is required to file an annual and
quarterly report with the Federal Reserve Board as well as any additional
information that the Federal Reserve Board may require pursuant to the BHCA. The
Federal Reserve Board may also make examinations of the Company and any or all
of its subsidiaries. Further, under Section 106 of the 1970 amendments to the
BHCA and the Federal Reserve Board's regulations, a bank holding company and its
subsidiaries are prohibited from engaging in certain tie-in arrangements in
connection with any extensions of credit or provision of credit or provision of
any property or services. The so-called "anti-tie-in" provisions state generally
that a bank may not extend credit, lease, sell property or furnish any service
to a customer on the condition that the customer provide additional credit or
service to the bank, to its bank holding company or to any other subsidiary of
its bank holding company or on the condition that the customer not obtain other
credit or service from a competitor of the bank, its bank holding company or any
subsidiary of its bank holding company.
Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act on any extensions of credit to
the bank holding company or any of its subsidiaries, on investments in the stock
or other securities of the bank holding company and on taking of such stock or
securities as collateral for loans to any borrower.
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Permitted Activities of Bank Holding Companies. The Federal Reserve Board
permits bank holding companies to engage in activities so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
While the types of permissible activities are subject to change by the Federal
Reserve Board, the following list comprises the principal activities that
presently may be conducted by a bank holding company.
1) Making, acquiring or servicing loans and other extensions of credit
for its own account or for the account of others, such as would be
made by the following types of companies: consumer finance, credit
card, mortgage, commercial finance and factoring.
2) Operating as an industrial bank, Morris Plan or industrial loan
company in the manner authorized by state law so long as the
institution does not both accept demand deposits and make commercial
loans.
3) Operating as a trust company in the manner authorized by federal or
state law so long as the institution does not make certain types of
loans or investments or accept deposits, except as may be permitted by
the Federal Reserve Board.
4) Subject to certain limitations, acting as an investment or financial
advisor to investment companies and other persons.
5) Leasing personal and real property or acting as agent, broker, or
advisor in leasing property, provided that it is reasonably
anticipated that the transaction will compensate the lessor for not
less than the lessor's full investment in the property.
6) Making equity and debt investments in corporations or projects
designed primarily to promote community welfare.
7) Providing to other financially oriented data processing or bookkeeping
services.
8) Subject to certain limitations, acting as an insurance agent or broker
in relation to insurance for itself and its subsidiaries or for
insurance directly related to extensions of credit by the bank holding
company system.
9) Subject to certain limitations, acting as underwriter for credit life
insurance and credit accident and health insurance that is directly
related to extensions of credit by the bank holding company system.
10) Providing courier services of a limited character.
11) Subject to certain limitations, providing management consulting advice
to nonaffiliated banks and nonbank depository institutions.
12) Selling money orders having a face value of $1,000.00 or less,
travelers' checks and United States savings bonds.
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13) Performing appraisals of real estate.
14) Subject to certain conditions, acting as intermediary for the
financing of commercial or industrial income-producing real estate by
arranging for the transfer of the title, control and risk of such a
real estate project to one or more investors.
15) Providing securities brokerage services, related securities credit
activities pursuant to Federal Reserve Board Regulation T and
incidental activities such a offering custodial services, individual
retirement accounts and cash management services, if the securities
brokerage services are restricted to buying and selling securities
solely as agent for the account of customers and do not include
securities underwriting or dealing or investment advice or research
services.
16) Underwriting and dealing in obligations of the United States, general
obligations of states and their political subdivisions and other
obligations such as bankers' acceptances and certificates of deposit.
17) Subject to certain limitations, providing by any means, general
information and statistical forecasting with respect to foreign
exchange markets; advisory services designed to assist customers in
monitoring, evaluating and managing their foreign exchange exposures;
and certain transactional services with respect to foreign exchange.
18) Subject to certain limitations, acting as a futures commission
merchant in the execution and clearance on major commodity exchanges
of futures contracts and options on futures contracts for bullion,
foreign exchange, government securities, certificates of deposit and
other money market instruments.
19) Subject to certain limitations, providing commodity trading and
futures commission merchant advice.
20) Providing consumer financial counseling that involves counseling,
educational courses and distribution of instructional materials to
individuals on consumer-oriented financial management matters,
including debt consolidation, mortgage applications, bankruptcy,
budget management, real estate tax shelters, tax planning, retirement
and estate planning, insurance and general investment management, so
long as this activity does not include the sale of specific products
or investments.
21) Providing tax planning and preparation advice such as strategies
designed to minimize tax liabilities and includes, for individuals,
analysis of the tax implications of retirement plans, estate planning
and family trusts. For corporations, tax planning includes the
analysis of the tax implications of mergers and acquisitions,
portfolio mix, specific investments, previous tax payments and year-
end tax planning. Tax preparation involves the preparation of tax
forms and advice concerning liability based on records and receipts
supplied by the client
22) Providing check guaranty service to subscribing merchants.
23) Subject to certain limitations, operating a collection agency and
credit bureau.
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24) Acquiring and operating thrift institutions, including savings and
loan associations, building and loan associations and FDIC-insured
savings banks.
25) Operating a credit bureau, subject to certain limitations.
Permissible Activities of National Banks. The National Bank Act sets forth
the rights, privileges, and powers of national banks and defines the activities
in which national banks may engage. National banks may engage in the following
activities: to make, arrange, purchase, or sell loans or extensions of credit
secured by liens or interests in real estate; to purchase, hold, and convey real
estate under certain conditions; to offer certain trust services to the public;
to deal in investment securities in certain circumstances; and, more broadly, to
engage in the "business of banking" and activities that are "incidental" to
banking. The following are a few of the activities deemed incidental to the
business of banking: the borrowing and lending of money; receiving deposits,
including deposits of public funds; holding or selling stock or other property
acquired in connection with security on a loan; discounting and negotiating
evidences of debt; acting as guarantor, if the bank has a "substantial interest
in the performance of the transaction;" issuing letters of credit to or on
behalf of its customers; operating a safe deposit business; providing check
guarantee plans; issuing credit cards; operating a loan production office;
selling loans under repurchase agreements; selling money orders at offices other
than bank branches; providing consulting services to banks; and verifying and
collecting checks.
In general, statutory restrictions on the activities of banks are aimed at
protecting the safety and soundness of banking practices. Many of the statutory
restrictions limit the participation of national banks in the securities and
insurance markets. These restrictions do not affect the Bank because it is not
currently involved in the types of activities covered by the restrictions.
Branching. National banks may establish a branch anywhere in Texas provided
that the branch is approved in advance by the OCC, which considers a number of
factors, including financial history, capital adequacy, earnings prospects,
character of management, needs of the community, and consistency with corporate
powers. The Interstate Banking Act, which expanded the authority of bank holding
companies and banks to engage in interstate bank acquisitions and interstate
banking, allows each state the option of "opting out" of the interstate
branching (but not banking) provisions. The Texas Legislature opted out of the
interstate branching provisions in 1995. Interstate banking was effective on
September 25, 1995, and interstate branching would have become effective in
Texas in June 1997, if Texas had not elected to opt out. The Texas "opt-out"
legislation prohibiting interstate branching is effective until September 1999.
Restrictions on Transactions with Affiliates and Insiders. The Company and
the Bank are subject to certain provisions of the Federal Deposit Insurance
Corporation Improvements Act of 1991 ("FDICIA") limiting transactions with the
Company and its nonbanking affiliates. One set of restrictions is found in
Section 23A of the Federal Reserve Act, which affects loans or other credit
extensions to, asset purchases with, and investments in affiliates of, the
Company and the Bank. Such transactions with the Company, the Bank, or any of
their nonbanking subsidiaries are limited in amount to ten percent of the
Company's capital and surplus and, with respect to the Bank and all of its
nonbanking subsidiaries together, to an aggregate of 20% of the Bank's capital
and surplus. Furthermore, such loans and extensions of credit, as well as
certain other transactions, are required to be secured in specified amounts.
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Another set of restrictions is found in Section 23B of the Federal Reserve
Act. Among other things, Section 23B requires that certain transactions between
the Company, its subsidiaries (including the Bank), and its affiliates must be
on terms substantially the same, or at least as favorable to the Company or its
subsidiaries, as those prevailing at the time for comparable transactions with
or involving other nonaffiliated persons. In the absence of such comparable
transactions, any transaction between the Company and its affiliates must be on
terms and under circumstances, including credit standards, that in good faith
would be offered to or would apply to nonaffiliated persons. The Bank is also
subject to certain prohibitions against any advertising that indicates the Bank
is responsible for the obligations of its affiliates. The Company did not have
any nonbanking affiliates as of December 31, 1998.
The restrictions on loans to directors, executive officers, principal
stockholders, and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O now apply to
all insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such loans can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the OCC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
Interest Rate Limits. Interest rate limitations for the Bank are primarily
governed by the National Bank Act which generally defers to the laws of the
state where the bank is located. Under the laws of the State of Texas, the
maximum annual interest rate that may be charged on most loans made by the Bank
is based on doubling the average auction rate, to the nearest 0.25%, for United
States Treasury Bills, as computed by the Office of the Consumer Credit
Commissioner of the State of Texas. However, the maximum rate does not decline
below 18% or rise above 24% (except for loans in excess of $250,000 that are
made for business, commercial, investment or other similar purposes (excluding
agricultural loans), in which case the maximum annual rate may not rise above
28%, rather than 24%). On fixed rate closed-end loans, the maximum non-usurious
rate is to be determined at the time the rate is contracted, while on floating
rate and open-end loans (such as credit cards), the rate varies over the term of
the indebtedness. State usury laws (but not late charge limitations) have been
preempted by federal law for loans secured by a first lien on residential real
property.
Examinations. The OCC periodically examines and evaluates national banks.
Based upon such an evaluation, the OCC may revalue the assets of a national bank
and require that it establish specific reserves to compensate for the difference
between the OCC-determined value and the book value of such assets. Onsite
examinations are to be conducted every 12 months, except that certain well-
capitalized banks may be examined every 18 months. FDICIA authorizes the OCC to
assess the institution for its costs of conducting the examinations.
Prompt Corrective Action. In addition to the capital adequacy guidelines
(see "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Financial Condition--Capital Resources"), FDICIA requires the OCC to
take "prompt corrective action" with respect to any national bank that does not
meet specified minimum capital requirements. The applicable regulations
establish five capital levels, ranging from "well-capitalized" to "critically
undercapitalized," which authorize, and in certain cases require, the OCC to
take certain specified supervisory action. Under regulations implemented under
FDICIA, a national bank is considered well-capitalized if it has a total risk-
based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of
6.0% or greater, and a leverage ratio of 5.0% or greater, and it is not subject
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to an order, written agreement, capital directive, or prompt corrective action
directive to meet and maintain a specific capital level for any capital measure.
A national bank is considered adequately capitalized if it has a total risk-
based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of at
least 4%, and leverage capital ratio of 4.0% or greater (or a leverage ratio of
3.0% or greater if the institution is rated composite 1 in its most recent
report of examination, subject to appropriate federal banking agency
guidelines), and the institution does not meet the definition of an
undercapitalized institution. A national bank is considered undercapitalized if
it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-
based capital ratio that is less than 4.0%, or a leverage ratio that is less
than 4.0% (or a leverage ratio that is less than 3.0% if the institution is
rated composite 1 in its most recent report of examination, subject to
appropriate federal banking agency guidelines). A significantly undercapitalized
institution is one which has a total risk-based capital ratio that is less than
6.0%, a Tier 1 risk-based capital ratio that is less than 3.0%, or a leverage
ratio that is less than 3.0%. A critically undercapitalized institution is one
which has a ratio of tangible equity to total assets that is equal to or less
than 2.0%. Under certain circumstances, a well capitalized, adequately
capitalized, or undercapitalized institution may be treated as if the
institution were in the next lower capital category if it receives an
unsatisfactory examination rating.
With certain exceptions, national banks are prohibited from making capital
distributions to their stockholders if the payment of such distributions will
cause them to become undercapitalized. Furthermore, undercapitalized national
banks are required to file capital restoration plans with the OCC. Such a plan
will not be accepted unless, among other things, the banking institution's
stockholders guarantee the plan up to a certain specified amount. Any such
guarantee from a depository institution's stockholders is entitled to a priority
of payment in bankruptcy. Undercapitalized national banks also are subject to
restrictions on growth, acquisitions, branching and engaging in new lines of
business unless they have an approved capital plan that permits otherwise. The
OCC also may, among other things, require an undercapitalized national bank to
issue shares or obligations, which could be voting stock, to recapitalize the
institution or, under certain circumstances, to divest itself of any subsidiary.
The OCC is authorized by the legislation to take various enforcement
actions against any significantly undercapitalized national bank and any
national bank that fails to submit an acceptable capital restoration plan or
fails to implement a plan accepted by the OCC. These powers include, among other
things, requiring the institution to be recapitalized, prohibiting asset growth,
restricting interest rates paid, requiring divestiture by the institution of its
subsidiaries, requiring new election of directors, and requiring the dismissal
of directors and officers.
Significantly and critically undercapitalized national banks may be subject
to more extensive control and supervision. The OCC may prohibit any such
institution from, among other things, entering into any material transaction not
in the ordinary course of business, amending its charter or bylaws, or engaging
in certain transactions with affiliates. In addition, critically
undercapitalized institutions generally will be prohibited from making payments
of principal or interest on outstanding subordinated debt. Within 90 days of a
national bank becoming critically undercapitalized, the OCC must appoint a
receiver or conservator unless certain findings are made with respect to the
prospect for the institution's continued viability.
Banks with capital ratios below the required minimum are subject to certain
administrative actions by the FDIC, including the termination of deposit
insurance upon notice and hearing or a temporary suspension of insurance without
a hearing in the event the bank has no tangible capital.
As of December 31, 1998, the Bank met the capital requirements of a "well-
capitalized" institution.
11
<PAGE>
Dividends. Federal Reserve Board policy requires a bank holding company to
serve as a source of financial strength to its banking subsidiaries and commit
resources to their support. The Federal Reserve Board has required bank holding
companies to contribute cash to their troubled bank subsidiaries based upon this
"source of strength" regulation, which could have the effect of decreasing funds
available for distributions to stockholders.
It is the policy of the Federal Reserve Board that bank holding companies
should pay cash dividends to common stock only out of income available over the
past year and only if prospective earnings retention is consistent with the
organization's expected future needs and financial condition. The policy
provides that bank holding companies should not maintain a level of cash
dividends that undermines the bank holding company's ability to serve as a
source of strength to its banking subsidiaries.
The Company's principal source of funds to pay dividends on its shares will
be cash dividends from the Bank. The payment of dividends by the Bank to the
Company is subject to restrictions imposed by federal banking laws, regulations
and authorities. Without approval of the OCC, dividends may not be paid by the
Company in an amount in any calendar year which exceeds the Company's net income
for that year, plus its retained net income for the preceding two years, less
any required transfers to capital surplus. In addition, a national bank may not
pay dividends in excess of its undivided profits. In some cases, the OCC may
find a dividend payment that meets these statutory requirements to be an unsafe
or unsound practice. Under FDICIA, the Bank cannot pay a dividend if it will
cause the Bank to be "undercapitalized." See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Dividend History
and Restrictions on Ability to Pay Dividends."
The National Banking Act also provides that until the surplus fund of a
bank equals its common stock, no dividend may be declared unless there has been
carried to the surplus fund not less than 10% of the bank's net income of the
preceding half-year in the case of quarterly or semi-annual dividends, or not
less than 10% of the bank's net income for the preceding year in the case of
annual dividends.
Deposit Insurance. The deposits of the Bank are insured by the FDIC through
the BIF to the extent provided by law. Under the FDIC's risk-based insurance
system, BIF-insured institutions are currently assessed premiums of between zero
and twenty seven cents per $100 of eligible deposits, depending upon the
institution's capital position and other supervisory factors. Congress recently
enacted legislation that, among other things, provides for assessments against
BIF-insured institutions that will be used to pay certain Financing Corporation
("FICO") obligations. In addition to any BIF insurance assessments, BIF-insured
banks are expected to make payments for the FICO obligations equal to an
estimated $0.0129 per $100 of eligible deposits each year during 1997 through
1999, and an estimated $0.024 per $100 of eligible deposits thereafter.
Conservator and Receivership Powers. FDICIA significantly expanded the
authority of the federal banking regulators to place depository institutions
into conservatorship or receivership to include, among other things, appointment
of the FDIC as conservator or receiver of an undercapitalized institution under
certain circumstances. In the event the Bank is placed into conservatorship or
receivership, the FDIC is required, subject to certain exceptions, to choose the
method for resolving the institution that is least costly to the BIF, such as
liquidation. In any event, if the Bank was placed into conservatorship or
receivership, because of the cross-guarantee provisions of the Federal Deposit
Insurance Act, as amended, the stockholders of the Bank would likely lose their
investment in the Bank.
12
<PAGE>
Brokered Deposit Restrictions. The Financial Institutions Reform, Recovery
and Enforcement Act of 1989 ("FIRREA") and FDICIA generally limit institutions
that are not well capitalized from accepting brokered deposits. In general,
undercapitalized institutions may not solicit, accept, or renew brokered
deposits. Adequately capitalized institutions may not solicit, accept, or renew
brokered deposits unless they obtain a waiver from the FDIC. Even in that event,
they may not pay an effective yield of more than 75 basis points over the
effective yield paid on deposits of comparable size and maturity in the
institution's normal market area for deposits accepted from within that area, or
the national rate paid on deposits of comparable size and maturity for deposits
accepted from outside the institution's normal market area.
Consumer Laws and Regulations. In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth-in-Lending Act, the Truth-in-Savings Act, the Electronic Funds
Transfer Act, the Expedited Funds Availability Act, the Community Reinvestment
Act, the Equal Credit Opportunity Act, and the Fair Housing Act, among others.
These laws and regulations mandate certain disclosure requirements and regulate
the manner in which financial institutions must deal with customers when taking
deposits or making loans to such customers. The Bank must comply with the
applicable provisions of these consumer protection laws and regulations as part
of their ongoing customer relations.
Changing Regulatory Structure. Various legislation, including proposals to
overhaul the bank regulatory system, expand the powers of banking institutions
and bank holding companies, and limit the investments that a depositary
institution may make with insured funds, is from time-to-time introduced in
Congress. Other legislative and regulatory proposals regarding changes in
banking and regulations of banks, thrifts, and other financial institutions, are
being considered by the executive branch of the federal government, Congress,
and various state governments, including Texas. Certain of these proposals, if
adopted, could significantly change the regulation of banks and the financial
services industry and the operating environment of the Bank in substantial and
unpredictable ways. The Bank cannot predict accurately whether any of these
proposals will be adopted or, if adopted, how these proposals, or implementing
regulations with respect thereto, will affect the financial condition or results
of operation of the Bank.
Expanding Enforcement Authority. One of the major effects of FDICIA was the
increased ability of banking regulators to monitor the activities of banks and
their holding companies. In addition, the Federal Reserve Board, the OCC, and
the FDIC have extensive authority to police unsafe or unsound practices and
violations of applicable laws and regulations by depository institutions and
their holding companies. For example, the FDIC may terminate the deposit
insurance of any institution which it determines has engaged in an unsafe or
unsound practice. The agencies can also assess civil money penalties, issue
cease and desist or removal orders, seek injunctions, and publicly disclose such
actions.
Effect on Economic Environment. The policies of regulatory authorities,
including the monetary policy of the Federal Reserve Board, have a significant
effect on the operating results of bank holding companies and their
subsidiaries. Among the means available to the Federal Reserve Board to affect
the money supply are open market operations in U.S. Government securities,
changes in the discount rate on member bank borrowings, and changes in reserve
requirements against member bank deposits. These means are used in varying
combinations to influence overall growth and distribution of bank loans,
investments and deposits, and their use may affect interest rates charged on
loans or paid for deposits.
13
<PAGE>
Federal Reserve Board monetary policies have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect of
such policies on the business and earnings of the Bank and its subsidiaries
cannot be predicted.
Item 2. Properties.
The Company currently has six banking offices. The Company owns its main
office, an adjacent drive-in banking facility, and an adjacent office building,
which has been converted to a community activity center and offices for the
Leisure Club. The Company currently leases the real estate where its main office
is located pursuant to a ten-year lease expiring in 2001 with an option to renew
or purchase the property. The Company also owns the building and land for its
free-standing Sugar Land branch and the new Northwest Houston branch. The Bank
leases space in three grocery stores from The Kroger Co. under leases that
expire in 2000, 2000, and 2002, respectively. The following table sets forth
specific information on each branch, each of which offers full service banking.
<TABLE>
<CAPTION>
Branch Deposits at
Branch Location December 31, 1998
- -------------------------------- ---------------------- ------------------
(In thousands)
<S> <C> <C>
Bellaire/Main Office............ 5320 Bellaire Blvd. $267,110
Sugar Land...................... Highway 59
at Williams Trace 31,914
Sugar Land - First Colony (1)... 3665 Highway 6 9,424
Stafford (1).................... 220 FM 1092 11,671
Sugar Land - Sweetwater (1)..... 4825 Sweetwater Blvd 3,240
Northwest (2)................... 13150 FM 529, Ste. 106 7,558
</TABLE>
(1) Located in Kroger store.
(2) Opened May 1998
Item 3. Legal Proceedings.
The Bank is a party to miscellaneous legal proceedings, which arose in the
ordinary course of business. While the outcome of these claims cannot be
predicted with certainty, management believes that the ultimate resolution of
these matters will not have a material adverse impact on the Company's financial
condition or results of operation.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
14
<PAGE>
Item 4A. Executive Officers of the Registrant.
The executive officers of the Bank are as follows:
Name Office(s)
---- ---------
Frank G. Cook............. Chairman of the Board
B. Ralph Williams ........ President, Chief Executive Officer, and Director
Randall W. Dobbs.......... Executive Vice President, Cashier, Chief Operations
Officer, and Advisory Director
Joseph E. Ives............ Executive Vice President and Director
Mary A. Walker............ Senior Vice President and Director
John M. James............. Senior Vice President and Advisory Director
Sheila J. Duffy........... President of Sugar Land Office and Advisory Director
Robert J. Kramer.......... President of Northwest Office and Advisory Director
Frank G. Cook. Mr. Cook was a founder of the Bank in 1983, was President
from 1983 until 1986, when he was elected Chairman of the Board, and was Chief
Executive Officer from 1983 until 1992. Prior to joining the Bank, Mr. Cook was
Executive Vice President and Cashier of First National Bank of Bellaire where he
was employed from 1979 until 1981. From 1950 until 1979, Mr. Cook was employed
by First State Bank of Bellaire, having advanced to the position of Executive
Vice President and Cashier and Secretary to the Board of Directors at the time
he left the bank.
B. Ralph Williams. Mr. Williams was a founder of the Bank in 1983 and has
been President since 1986 and Chief Executive Officer since 1992. Prior to
joining the Bank, Mr. Williams was employed by East Texas National Bank of
Palestine as a Vice President, Loan Officer, and Compliance Officer from 1981 to
1983. He was associated with First National Bank of Bellaire as Senior Vice
President from 1979 to 1981, and with First State Bank of Bellaire from 1963
until 1979, initially as a teller, and in various capacities advancing to Senior
Vice President. Mr. Williams was with Houston National Bank from 1958 to 1963.
Randall W. Dobbs. Mr. Dobbs joined the Bank as its first Cashier in 1983,
became Chief of Operations in 1992, and Executive Vice President and Chief of
Operations in 1996, and was elected an advisory director in 1995. Prior to
joining the Bank, Mr. Dobbs was employed by Texas Bank & Trust from 1981 until
1983 and First National Bank of Bellaire from 1974 until 1981.
Joseph E. Ives. Mr. Ives joined the Bank as Senior Vice President and was
elected a Director in 1984 and Executive Vice President in 1986. Prior to
joining the Bank, Mr. Ives was a Senior Vice President with Texas Commerce Bank
- - Stafford from 1981 to 1984. Prior to 1981, Mr. Ives was a loan officer with
First National Bank of Bellaire and First State Bank of Bellaire.
Mary A. Walker. Ms. Walker joined the Bank as Vice President in 1983 and
was elected a Director of the Bank in 1986 and a Senior Vice President in 1986.
Prior to joining the Bank, Ms. Walker was employed with First National Bank of
Bellaire as a Vice President and loan officer from 1979 to 1983.
John M. James. Mr. James joined the Bank as a Senior Vice President in
1993. From 1985 to 1992, he served as President of First City National Bank of
Bellaire. From 1978 to 1985, Mr. James was employed
15
<PAGE>
by First City National Bank in its corporate office in Houston. From 1973 to
1978, he was employed by the Federal Reserve Bank of Dallas in its bank holding
company examination division.
Sheila J. Duffy. Ms. Duffy joined the Bank as President of the Sugar Land
office in 1995 and was elected an Advisory Director in November 1997. From
February 1988 to July 1995, she was employed by Park National Bank - Stafford as
a Vice President. From 1982 to 1988 she was employed by American National Bank,
which was acquired by Park National Bank in 1988.
Robert J. Kramer. Mr. Kramer joined the Bank as President of the Northwest
office and as an Advisory Director in April 1998. From July 1985 to March 1998,
he was employed by the Independence Bank - Houston, Texas, as President and CEO.
From January 1983 to June 1985, he served as President and CEO of the Mont
Belvieu State Bank, Mont Belvieu, Texas.
16
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's Common Stock is approved for quotation on the Nasdaq Stock
Market (the "NSM") under the symbol "CNBT." Shares began trading on October 1,
1997. The following table sets forth the range of the high and low per share
closing sale prices for the Common Stock as reported by the NSM, and cash
dividends declared for the period indicated.
<TABLE>
<CAPTION>
Low Sale Price High Sale Price Cash Dividend
--------------- --------------- -------------
<S> <C> <C> <C>
1998
----
First Quarter............................ $ 12.250 $ 16.625 $ 0.09
Second Quarter........................... 13.875 17.000 0.09
Third Quarter............................ 10.125 14.875 0.09
Fourth Quarter........................... 9.625 12.125 0.10
1999
----
First Quarter (through March 11, 1999)... $ 9.813 $ 11.250 --
</TABLE>
On March 11, 1999, the closing sale price as reported on the NSM was $11.25
per share. The number of holders of record of Common Stock based on the transfer
records of the Company at March 12, 1999, was 441. Based on security position
listings, the Bank believes it has in excess of 1,900 beneficial owners.
The Bank has paid cash dividends to its stockholders since 1986. The Bank
paid a special cash dividend of $0.10 on May 30, 1997, and declared a year-end
dividend of $0.30 on December 31, 1997, payable on January 15, 1998. The Bank
also declared a 10% stock dividend in April 1997. In 1998 the Bank declared
cash dividends on a quarterly basis that amounted to $0.37 for the year.
Commencing in March 1998, the Company began paying dividends on a quarterly
basis. The declaration and payment of dividends on the Common Stock depends upon
the earnings and financial condition of the Company and the Bank liquidity and
capital requirements, the general economic and regulatory climate, the Company's
ability to service any equity or debt obligations senior to the Common Stock,
and other factors deemed relevant by the Company's Board of Directors. As of
January 1, 1999, approximately $2.8 million was available, under applicable
restrictions without regulatory approval, for payment of dividends by the Bank
to the Company. Regulatory authorities could impose stricter limitations on the
ability of the Company to pay dividends if such limits were deemed appropriate
to preserve certain capital adequacy requirements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Factors That
May Affect Future Results and Market Price of Stock."
17
<PAGE>
Item 6. Selected Consolidated Financial Data.
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements of the Company and the
Notes thereto, appearing elsewhere in the Annual Report, and the information
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operations." The selected historical consolidated financial data as
of the end of and for each of the five years in the period ended December 31,
1998, are derived from the Company's Consolidated Financial Statements which
have been audited by independent public accountants.
<TABLE>
<CAPTION>
As of and for the
Year Ended December 31,
---------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Interest income............................ $ 23,777 $ 19,941 $ 17,372 $ 14,705 $ 12,582
Interest expense........................... 11,068 9,075 7,902 6,895 4,993
-------- -------- -------- -------- --------
Net interest income...................... 12,709 10,866 9,470 7,810 7,589
Provision for loan losses.................. 612 877 655 200 126
-------- -------- -------- -------- --------
Net interest income after provision for
loan losses.......................... 12,097 9,989 8,815 7,610 7,463
Noninterest income......................... 2,862 2,507 2,322 2,053 1,866
Noninterest expenses....................... 9,352 7,644 6,949 6,108 5,892
-------- -------- -------- -------- --------
Income before taxes...................... 5,607 4,852 4,188 3,555 3,437
Provision for income taxes................. 1,122 1,154 1,035 683 668
-------- -------- -------- -------- --------
Net income................................. $ 4,485 $ 3,698 $ 3,153 $ 2,872 $ 2,769
======== ======== ======== ======== ========
Per Share Data:
Net income, basic (1)..................... $ 0.89 $ 0.89 $ 0.81 $ 0.74 $ 0.71
Net income, fully diluted (2)(3).......... 0.88 0.88 0.80 0.73 0.70
Book value................................ 6.80 6.27 4.60 4.35 3.56
Cash dividends............................ 0.37 0.40 0.36 0.30 0.29
Weighted average common shares
outstanding, basic....................... 5,024 4,161 3,886 3,886 3,886
Weighted average common shares
outstanding, fully diluted................ 5,105 4,224 3,941 3,938 3,936
Balance Sheet Data (4):
Total assets.............................. $377,930 $295,606 $258,150 $231,779 $206,379
Securities................................ 244,524 169,831 147,505 148,294 134,029
Loans..................................... 111,360 102,875 91,284 67,875 58,996
Allowance for loan losses................. 1,183 1,009 687 484 522
Total deposits............................ 330,917 260,907 238,059 208,749 185,579
Total stockholders' equity................ 33,386 31,647 17,871 16,921 13,815
Performance Ratios:
Return on average assets.................. 1.33% 1.34% 1.30% 1.34% 1.40%
Return on average common equity........... 13.89 16.89 18.43 19.10 20.51
Net interest margin....................... 4.01 4.22 4.18 3.89 4.11
Dividend payout ratio, basic.............. 41.57 44.94 44.44 40.54 40.85
Efficiency ratio (5)...................... 61.03 58.31 60.12 63.45 63.31
Asset Quality Ratios (4):
Nonperforming assets to loans
and other real estate.................... 0.46% 1.31% 0.57% 0.67% 0.92%
Nonperforming assets to total assets...... 0.13 0.46 0.20 0.20 0.26
Net charge-offs to average loans.......... 0.41 0.57 0.55 0.39 0.34
Allowance for loan losses to total loans.. 1.06 0.98 0.75 0.71 0.88
Allowance for loan losses to
nonperforming loans (6).................. 261.15 74.80 131.61 105.68 95.78
Capital Ratios (4):
Leverage ratio............................ 9.37% 11.10% 7.27% 7.43% 7.22%
Average stockholders' equity to
average total assets.................... 9.55 7.96 7.05 7.03 6.84
Tier 1 risk-based capital ratio........... 20.44 21.42 13.87 15.22 15.39
Total risk-based capital ratio............ 21.20 22.13 14.41 15.68 15.96
- ------------------------
</TABLE>
(1) Basic earnings per share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period.
Shares have been restated in accordance with FASB 128.
(footnotes continued on following page)
18
<PAGE>
(2) Fully diluted earnings per share is calculated by dividing net income
by the weighted average number of common shares outstanding plus the
common stock equivalents computed using the treasury stock method.
Shares have been restated in accordance with FASB 128.
(3) Outstanding shares have been adjusted for all periods presented for a
2-for-1 stock split declared in May 1994 and 10% stock dividends
declared in March 1997 and April 1996.
(4) At period end, except net charge-offs to average loans and average
stockholders' equity to average total assets.
(5) Calculated by dividing total noninterest expenses by net interest
income plus noninterest income, excluding securities gains and losses.
(6) Nonperforming loans consist of nonaccrual loans and loans contractually
past due 90 days or more.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Management's Discussion and Analysis of Financial Condition and Results of
Operations analyzes the major elements of the Company's balance sheets and
statements of income and reviews the Company's operations for the three years
ended December 31, 1998, and should be read in conjunction with the Company's
Consolidated Financial Statements and related notes thereto and Selected
Consolidated Financial Data.
Overview
Total assets at December 31, 1998, 1997, and 1996, were $377.9 million,
$295.6 million, and $258.2 million, respectively. This growth was a result of a
strong local economy, expansion of the Company's services in northwest Houston
and Fort Bend County, and the Company's style of accessible, service-oriented,
relationship banking. Loans were $111.4 million at December 31, 1998, an
increase of $8.5 million or 8.3% from $102.9 million at the end of 1997. Loans
were $91.3 million at year end 1996. Deposits also experienced significant
growth, increasing to $330.9 million at year end 1998 from $260.9 million at
year end 1997, and $238.1 million at year end 1996. Stockholders' equity was
$33.4 million, $31.6 million, and $17.9 million at December 31, 1998, 1997, and
1996, respectively. The increase in stockholders' equity in 1997 is primarily
attributable to the sale of 1,150,000 shares of common stock in October 1997,
which increased capital by approximately $11.1 million.
Net income was $4.5 million, $3.7 million, and $3.2 million for 1998, 1997,
and 1996, respectively. Basic earnings per share was $0.89, $0.89, and $0.81 and
fully diluted earnings per share was $0.88, $0.88, and $0.80 for the years ended
1998, 1997, and 1996, respectively. The increase in net income was primarily the
result of strong loan growth, maintenance of strong asset quality, and expense
control. The return on average assets was 1.33%, 1.34%, and 1.30% and returns on
average common equity was 13.89%, 16.89%, and 18.43% for the years ended 1998,
1997, and 1996, respectively. These ratios and the earnings per share amounts
were relatively flat from 1997 to 1998 because of the 30% increase in shares
outstanding as a result of the Company's public offering in the fourth quarter
of 1997.
The Company declared dividends of $0.37, $0.40, and $0.36 per share for the
years ended 1998, 1997, and 1996, respectively, which resulted in a dividend
payout ratio (basic) of 41.6%, 44.9%, and 44.4% for the years ended 1998, 1997,
and 1996, respectively.
19
<PAGE>
Results of Operations
Net Interest Income
Net interest income represents the amount by which interest income on
interest-earning assets, including securities and loans, exceeds interest
expense incurred on interest-bearing liabilities, including deposits and other
borrowed funds. Net interest income is the principal source of the Company's
earnings. Interest rate fluctuations, as well as changes in the amount and type
of earning assets and liabilities combine to affect net interest income.
1998 versus 1997. Net interest income for 1998 was $12.7 million, an
increase of $1.8 million or 16.5% from $10.9 million for 1997. The Bank's net
interest spread was 2.91% and 3.23% and the net interest margin was 4.01% and
4.22% for the years ended December 31, 1998, and 1997, respectively.
The decrease in net interest margin resulted from an decrease in net
interest income relative to the increase in total average interest earnings
assets. There was a decrease in the yield on total interest earning assets of
0.24%, as well as an increase of 0.08% in the rate paid on interest earnings
liabilities which resulted in a decrease in net interest spread.
The increase in net interest income resulted from increases in the
Company's loan and securities portfolios. Interest income from loans increased
to $10.8 million in 1998 from $9.6 million in 1997, an increase of $1.2 million
or 12.5%. The yield on the loan portfolio increased to 10.01% for 1998 from
9.90% for 1997. Interest income from the securities portfolio increased to $13.0
million for 1998 from $10.4 million for 1997, a $2.6 million or 25.0% increase.
This was due primarily to a 30.20% increase in average securities held by the
Bank and offset slightly by a decrease in yield from 6.46% in 1997 to 6.20% for
1998. Partially offsetting the interest income growth was an increase in
interest expense, which grew to $11.1 million for 1998, compared to $9.1 million
for 1997. This increase was the result of strong growth in average deposits, in
particular, money market and savings deposits and certificates of deposit.
1997 versus 1996. Net interest income totaled $10.9 million in 1997
compared to $9.5 million in 1996, an increase of $1.4 million or 14.7%. This
resulted in net interest margins of 4.22% and 4.18% and net interest spreads of
3.23% and 3.28% for 1997 and 1996, respectively.
The primary reason for higher net interest income was strong growth in
outstanding loans. Yields on the loan portfolio increased to 9.90% from 9.89%.
Interest and fees on loans increased by $1.5 million or 18.4% while interest on
investment securities increased $1.1 million or 11.7%. Offsetting these
increases was a large increase in interest expense due to the growth in savings
and money market account balances and certificates of deposit and an increase in
the rate paid to 4.51% from 4.39% for the year ended 1997 versus 1996.
20
<PAGE>
The following table presents, for the periods indicated, the total dollar
amount of average balances, interest income from average interest-earning assets
and the resulting yields, as well as the interest expense on average interest-
bearing liabilities, expressed both in dollars and rates. No tax equivalent
adjustments were made and all average balances are daily average balances.
Nonaccruing loans have been included in the table as loans carrying a zero
yield.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------------- -------------------------------- ------------------------------
Average Interest Average Average Interest Average Average Interest Average
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>
Assets
Interest-earning assets:
Loans........................... $107,749 $10,787 10.01% $ 96,655 $ 9,572 9.90% $ 81,746 $ 8,084 9.89%
Securities...................... 208,058 12,904 6.20 159,798 10,320 6.46 143,832 9,243 6.43
Federal funds sold and
other Earning assets........... 1,230 86 6.99 1,030 49 4.76 878 45 5.13
-------- ------- -------- ------- -------- -------
Total interest-earning
Assets....................... 317,037 23,777 7.50 257,483 19,941 7.74 226,456 17,372 7.67
Less allowance for
loan losses..................... 1,072 746 548
-------- -------- --------
Total earning assets,
net of Allowance................ 315,965 256,737 225,908
Nonearning assets................ 22,128 18,634 16,794
-------- -------- --------
Total assets.................. $338,093 $275,371 $242,702
======== ======== ========
Liabilities and
Stockholders' equity
Interest-bearing liabilities:
Interest-bearing
demand Deposits............... $ 21,005 $ 359 1.71% $ 19,348 $ 341 1.76% $ 17,862 $ 317 1.77%
Savings and money
market Accounts................ 82,926 3,126 3.77 71,742 2,645 3.69 65,721 2,296 3.49
Certificates of deposit......... 125,883 6,984 5.55 105,347 5,835 5.54 92,610 5,098 5.50
Repurchase agreements
and Borrowed funds............. 11,086 599 5.40 4,582 254 5.54 3,676 191 5.20
-------- ------- -------- ------- -------- -------
Total interest-bearing
Liabilities.................. 240,900 11,068 4.59 201,019 9,075 4.51 179,869 7,902 4.39
------- ------- -------
Noninterest-bearing liabilities:
Noninterest-bearing
demand Deposits................ 62,446 50,759 44,274
Other liabilities............... 2,466 1,693 1,455
-------- -------- --------
Total liabilities.............. 305,812 253,471 225,598
Stockholders' equity............. 32,281 21,900 17,104
-------- -------- --------
Total liabilities and
Stockholders' equity.......... $338,093 $275,371 $242,702
======== ======== ========
Net interest income.............. $12,709 $10,866 $ 9,470
======= ======= =======
Net interest spread (1).......... 2.91% 3.23% 3.28%
Net interest margin (2).......... 4.01% 4.22% 4.18%
</TABLE>
________________
(1) The interest rate spread is the difference between the average yield on
interest-earning assets and the average rate paid on interest-bearing
liabilities.
(2) The net interest margin is equal to net interest income divided by
average interest-earning assets.
21
<PAGE>
The following table presents, for the periods indicated, the dollar amount
of changes in interest income and interest expense for the major components of
interest-earning assets and interest-bearing liabilities and distinguishes
between the increase (decrease) related to higher outstanding balances and the
volatility of interest rates. For purposes of this table, changes attributable
to both rate and volume which can not be segregated have been allocated.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------
1998 vs. 1997 1997 vs. 1996
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------- -------------------------
Volume Rate Total Volume Rate Total
------ ------- ------ ------ ------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans........................................... $1,099 $ 116 $1,215 $1,474 $ 14 $1,488
Securities...................................... 3,117 (533) 2,584 1,025 52 1,077
Other earning assets............................ 10 27 37 8 (4) 4
------ ----- ------ ------ ----- ------
Total increase (decrease) in interest income... 4,226 (390) 3,836 2,507 62 2,569
------ ----- ------ ------ ----- ------
Interest-bearing liabilities:
Interest-bearing demand deposits................ 29 (11) 18 26 (2) 24
Savings and money market accounts............... 412 69 481 210 139 349
Certificates of deposit......................... 1,138 11 1,149 702 35 737
Borrowed funds.................................. 361 (16) 345 47 16 63
------ ----- ------ ------ ----- ------
Total increase (decrease) in interest
expense.................................... 1,940 53 1,993 985 188 1,173
------ ----- ------ ------ ----- ------
Increase (decrease) in net interest income...... $2,286 $(443) $1,843 $1,522 $(126) $1,396
====== ===== ====== ====== ===== ======
</TABLE>
Provisions for Loan Losses
The 1998 provision for loan losses decreased to $612,000 from $877,000 in
1997, a decrease of $265,000 or 30.22%. The provision for year ended 1997
increased to $877,000 from $655,000 in 1996, an increase of $222,000 or 33.89%.
The lower provision in 1998 and the increase in 1997 relate to the Company's
methodology for determining the appropriate provision amount which includes an
analysis of loan portfolio and economic trends and other portfolio risks. In
addition, a significant portion of the increase from 1996 to 1997 was
attributable to a provision for losses in the Company's credit card portfolio,
which the Company sold in July 1998.
Noninterest Income
Noninterest income for the year ended December 31, 1998, was $2.9 million,
an increase of $355,000 or 14.16% over the same period in 1997. Noninterest
income of $2.5 million earned in the year ended December 31, 1997, represented
an increase of $185,000 or 7.97% over the same period in 1996. The following
table presents for the periods indicated the major components of noninterest
income:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
1998 1997 1996
--------- ---------- ----------
<S> <C> <C> <C>
(Dollars in thousands)
Service fees.................................................. $2,036 $1,950 $1,816
Net realized gains on sale of available-for-sale securities... 248 263 233
Other operating income........................................ 578 294 273
------ ------ ------
Total noninterest income..................................... $2,862 $2,507 $2,322
====== ====== ======
</TABLE>
22
<PAGE>
Service fees were $2.0 million for the year ended December 31, 1998,
comparable to the $2.0 million earned for the year ended December 31, 1997. From
1996 to 1997 service fees increased $200,000 or 11.1%. This increase is
primarily attributable to an increase in the number of deposit accounts from
21,871 at December 31, 1996, to 23,144 at December 31, 1997, to 25,972 at
December 31, 1998.
Noninterest Expenses
For the year ended December 31, 1998, noninterest expenses totaled $9.4
million, an increase of $1.8 million or 23.7% from $7.6 million in 1997, which
had increased $695,000 or 10.0% from $6.9 million in 1996. The increase in
noninterest expenses during these periods was due primarily to increases in
salaries and benefits, general and administrative expenses, data processing and
professional fees. The efficiency ratio was 61.03% in 1998, 58.31% in 1997, and
60.12% in 1996. The percentage increase from 1997 to 1998 was due primarily to
an increase in staff to accommodate the Company's growth which included the
opening of a new full service branch office in northwest Houston.
Salary and benefits, general and administrative expenses for the year ended
December 31, 1998, were $6.1 million, an increase of $1.1 million or 22.0% from
$5.0 million for the year ended December 31, 1997. Salary, general and
administrative, and benefit expenses for the year ended December 31, 1997, were
up $485,000 or 10.7% from the same period in 1996. The increase in both years
was due primarily to the hiring of additional personnel required to accommodate
the Bank's growth. Total full-time equivalent employees at December 31, 1998,
1997, and 1996 were 110, 99, and 83, respectively.
Net occupancy and equipment maintenance expenses increased $148,000 and
$45,000 or 14.2% and 4.5% in 1998 and 1997, respectively. This increase in
expenses is attributable to the Sugar Land (Sweetwater) office which began
operations in June 1997 and the Northwest office which opened in 1998. Major
categories included within occupancy expense are building lease expense,
depreciation expense, and maintenance expense. Depreciation expense increased
$18,000 and $6,000 or 4.4% and 1.4% in 1998 and 1997, respectively. These
increases were due primarily to depreciation on equipment provided to new
employees and expenses related to technology upgrades throughout the Bank.
Maintenance expense for equipment and building for the year ended December 31,
1998, was $285,000, an increase of $53,000 or 22.8% compared to $232,000 in 1997
and $204,000 in 1996.
Data processing expenses during 1998 were $899,000, an increase of $104,000
or 13.1% from $795,000 during 1997, which had increased $92,000 or 13.1% from
$703,000 during 1996. This increase was primarily due to a renegotiation of the
Bank's contract for data processing services which are handled by a third party
vendor and the increase in the number of the Bank's deposit accounts.
Postage and printing expense during 1998 increased to $485,000 from
$414,000 in 1997, an increase of 17.1%. Proxies related to the stockholders
meeting in May 1998, along with the growth in deposit accounts primarily
influenced this increase. From 1996 to 1997, postage and printing decreased
$22,000, or 5.0%.
Professional fees during 1998 increased to $621,000 from $353,000 in 1997,
a difference of $268,000 or 75.9%. This increase is attributed to professional,
accounting and legal fees related to the formation of the Company,
reorganization into a holding company, quarterly reporting, and audit expenses.
Also, fees related to an efficiency expert, transfer agent fees, and
professional fees associated with CRA can
23
<PAGE>
also be attributed to this increase. Professional fees during 1997 increased to
$353,000 from $285,000 during 1996, an increase of $68,000 or 23.9%.
Deposit insurance premiums paid by the Bank totaled $32,000 for 1998
compared to $29,000 for 1997. Deposit insurance premiums were increased
effective as of January 1, 1997, to $0.013 per $100 of deposits from $500 per
quarter in 1996. See "Business -- Supervision and Regulation."
Income taxes
The income tax provision includes both federal current and deferred income
tax amounts using the statutory rates currently in effect. The amount of federal
income tax expense is influenced by the amount of taxable income, the amount of
tax-exempt income, the amount of nondeductible interest expense, and the amount
of other nondeductible expenses. In 1998, income tax expense was $1.1 million, a
decrease of $100,000 or 8.3% from $1.2 million in 1997. In 1997, income tax
expense was $1.2 million, an increase of $119,000 or 11.5% from the $1.0 million
of income tax expense in 1996. The effective tax rates for 1998, 1997, and 1996,
respectively, were 20.0%, 23.8%, and 24.7%.
Impact of Inflation
The effects of inflation on the local economy and on the Company's
operating results have been relatively modest for the past several years. Since
substantially all of the Company's assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. The Company tries to
control the impact of interest rate fluctuations by managing the relationship
between its interest rate sensitive assets and liabilities. See "Financial
Condition -- Interest Rate Sensitivity and Liquidity" below.
Financial Condition
Loan Portfolio
Total loans increased by $8.5 million or 8.3% to $111.4 million at
December 31, 1998. During 1997, total loans increased $11.6 million or 12.7% to
$102.9 million from $91.3 million at December 31, 1996. The increase in 1998 is
net of the sale of the Company's credit card program, which accounted for $2.0
million in the loan portfolio.
At December 31, 1998, total loans represented 33.7% of deposits and 29.5%
of total assets. Total loans as a percentage of deposits were 39.4% at
December 31, 1997, as compared to 38.3% at December 31, 1996. Total loans as a
percentage of total assets were 34.8% at December 31, 1997, as compared with
35.4% at December 31, 1996.
24
<PAGE>
The following table summarizes the loan portfolio of the Bank by major
category as of the dates indicated:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------- ------------------- ------------------- ------------------- -------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- --------- -------- --------- -------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Commercial and industrial $ 23,836 21.4% $ 25,230 24.5% $22,717 24.9% $18,180 26.8% $15,564 26.4%
Real estate:
Construction and land
development............ 11,144 10.0 10,673 10.4 6,285 6.9 3,240 4.8 3,301 5.6
1-4 family residential.. 11,161 10.0 10,808 10.5 11,245 12.3 8,329 12.3 7,913 13.4
Commercial owner
occupied............... 25,760 23.1 17,846 17.3 15,998 17.5 9,912 14.6 7,280 12.3
Other................... 643 0.6 378 0.4 340 0.4 100 0.1 123 0.2
Consumer................. 38,816 34.9 37,940 36.9 34,699 38.0 28,114 41.4 24,815 42.1
-------- --------- -------- --------- -------- --------- -------- --------- -------- ---------
Total loans............ $111,360 100.0% $102,875 100.0% $91,284 100.0% $67,875 100.0% $58,996 100.0%
======== ========= ======== ========= ======== ========= ======== ========= ======== =========
</TABLE>
The primary lending focus of the Company is on small commercial businesses,
commercial and residential real estate, and consumer loans. The Company offers a
variety of commercial lending products including term loans, lines of credit,
and equipment financing. A broad range of short and medium-term commercial
loans, both collateralized and uncollateralized, are made available to
businesses for working capital (including inventory and receivables), business
expansion (including acquisitions of real estate and improvements), and the
purchase of equipment and machinery. The purpose of a particular loan generally
determines its structure. While the Company's lending limit is approximately
$5.0 million, its largest currently outstanding loan is approximately $2.3
million, and the average size of its 20 largest loans is approximately $887,000.
The Company generally seeks a mix of 50% consumer loans, 25% small business
loans, and 25% real estate loans although the mix will vary from time-to-time
due to market conditions and the Company's policy allows for a variance of up to
10% in any category.
The Company seeks credit risks of good quality within its target markets
that display stable operating histories and cash flows and secondary sources of
repayment from tangible collateral and personal guarantees. Generally, the
Company's commercial loans are underwritten in the Company's primary market area
on the basis of the borrower's ability to service such debt from income. The
Company maintains rigorous credit approval and credit quality assurance
policies. Under these policies, all loans in excess of $50,000 that are not
collateralized by a certificate of deposit, a deposit account, or vehicles must
be approved by the Company's loan committee, which includes four outside
directors. The loan committee meets on an as needed basis in order to provide
prompt response to customer's loan requests. As a general practice, the Company
takes as collateral a lien on any available real estate, equipment, or other
assets and personal guarantees. Working capital loans are primarily
collateralized by short-term assets whereas term loans are primarily
collateralized by long-term assets. Business loans secured by assets other than
real estate generally range from $20,000 to $100,000 with the largest such loan
being $500,000.
A substantial portion of the Company's real estate loans consists of loans
collateralized by real estate and other assets of commercial customers. Real
estate loans range from $3,000 to $2.3 million. The Company originates single-
family residential mortgage loans collateralized by owner-occupied properties
through the Company's subsidiary CNB Mortgage Company. At its main office, the
Company accepts mortgage applications, gathers necessary information and
documentation, processes applications, and approves applicants in accordance
with the underwriting guidelines of the purchasers of the mortgages. The
25
<PAGE>
Company currently sells all residential mortgages it originates at closing and
does not service any residential mortgages.
Loans collateralized by single-family residential real estate generally
have been originated in amounts of no more than 80% of appraised value. The
Company requires mortgage title insurance and hazard insurance in the amount of
the loan. Although the contractual loan payment periods for single-family
residential real estate loans are generally for a three to seven-year period,
such loans often remain outstanding for significantly shorter periods than their
contractual terms.
Consumer loans made by the Company include automobile loans, recreational
vehicle loans, boat loans, home improvement loans, personal loans
(collateralized and uncollateralized), and deposit account collateralized loans.
The terms of these loans typically range from 12 to 84 months and vary based
upon the nature of collateral and size of loan. Consumer loans typically range
from $5,000 to $25,000 with the largest consumer loan being $148,000.
The contractual maturity ranges of the commercial and industrial, real
estate mortgage, and real estate construction loan portfolio and the amount of
such loans with fixed interest rates and floating rates in each maturity range
as of December 31, 1998, are summarized in the following table:
<TABLE>
<CAPTION>
December 31, 1998
-----------------------------------------
After One After
One Year Through Five
or Less Five Years Years Total
-------- ---------- ------- -------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Commercial and industrial............. $11,103 $12,615 $ 118 $23,836
Real estate mortgage.................. 6,468 15,190 15,906 37,564
Real estate construction.............. 6,292 2,875 1,977 11,144
------- ------- ------- -------
Total................................ $23,863 $30,680 $18,001 $72,544
======= ======= ======= =======
Loans with a fixed interest rate...... $16,935 $24,127 $13,725 $54,787
Loans with a floating interest rate... 6,928 6,553 4,276 17,757
------- ------- ------- -------
Total................................ $23,863 $30,680 $18,001 $72,544
======= ======= ======= =======
</TABLE>
Nonperforming Assets
The Company has well developed procedures in place to maintain a high
quality loan portfolio. These procedures include credit quality policies that
begin with approval of lending policies and underwriting guidelines by the Board
of Directors, an independent loan review conducted by outside parties, low
individual lending limits for officers, Loan Committee approval for large credit
relationships, and quality loan documentation procedures. The Company's lending
officers and loan personnel identify and analyze weaknesses in the portfolio and
report credit risk changes on a monthly basis to the Bank's Board of Directors.
The Company also maintains a well-developed monitoring process for credit
extensions in excess of $50,000. The Company performs monthly and quarterly
concentration analyses based on collateral types, business lines, large credit
sizes, and officer portfolio loads. The Company has established underwriting
guidelines to be followed by its officers. The Company also monitors its
delinquency levels for any negative or adverse trends. There can be no
assurance, however, that the Company's loan portfolio will not become subject to
increasing pressures from deteriorating borrower credit due to general economic
conditions.
26
<PAGE>
The Company generally places a loan on nonaccrual status and ceases
accruing interest when loan payment performance is deemed unsatisfactory. All
loans past due 90 days, however, are placed on nonaccrual status, unless the
loan is both well collateralized and in the process of collection. Cash payments
received while a loan is classified as nonaccrual are recorded as a reduction of
principal as long as doubt exists as to collection. The Company is sometimes
required to revise a loan's interest rate or repayment terms in a troubled debt
restructuring.
The Company's conservative lending approach has resulted in strong asset
quality. Nonperforming assets at December 31, 1998, were $507,000, compared with
$1.3 million at December 31, 1997, $522,000 at December 31, 1996, and $458,000
at December 31, 1995. This resulted in a ratio of nonperforming assets to loans
plus other real estate of 0.46%, 1.31% and 0.57% at December 31, 1998, 1997, and
1996, respectively. The increase at December 31, 1997 was due to a number of 1-4
family construction loans that were in the process of being converted from
construction loans to permanent loans and sold but had not been converted at
year-end. $624,000 of these loans were converted and sold in January 1998, which
reduced total nonperforming assets to approximately $725,000, resulting in a
ratio of nonperforming loans to loans plus other real estate of 0.70% and a
ratio of nonperforming assets to total assets of 0.25%.
Loans listed as nonaccrual and restructured loans are not considered to be
material. If interest had been accrued on nonaccrual loans, such income would
have been approximately $17,000, $30,000 and $21,000 for the years ended
December 31, 1998, 1997, and 1996, respectively.
The following table presents information regarding nonperforming assets as
of December 31, 1994 through 1998:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1998 1997 1996 1995 1994
------ ------- ------ ------ ------
<S> <C> <C> <C> <C> <C>
(Dollars in thousands)
Nonaccrual loans................................ $ 239 $ 279 $ 301 $ 323 $ 398
Accruing loans 90 or more days past due......... 174 1,016 191 97 84
Restructured loans.............................. 40 54 30 38 63
Other real estate and foreclosed property....... 54 -- -- -- --
----- ------ ----- ----- -----
Total nonperforming assets.................... $ 507 $1,349 $ 522 $ 458 $ 545
===== ====== ===== ===== =====
Nonperforming assets to total loans and other
real estate.................................... 0.46% 1.31% 0.57% 0.67% 0.92%
Nonperforming assets to total assets............ 0.13 0.46 0.20 0.20 0.26
</TABLE>
27
<PAGE>
Allowance for Loan Losses
The allowance for loan losses is a reserve established through charges to
earnings in the form of a provision for loan losses. Based on an evaluation of
the loan portfolio, management presents a monthly review of the allowance for
loan losses to the Board of Directors, indicating any changes in the allowance
since the last review and any recommendations as to adjustments in the
allowance. In making its evaluation, management considers the diversification by
industry of the Company's commercial loan portfolio, the effect of changes in
the local real estate market on collateral values, the results of recent
regulatory examinations, the effects on the loan portfolio of current economic
indicators and their probable impact on borrowers, the amount of charge-offs for
the period, the amount of nonperforming loans and related collateral security,
the evaluation of its loan portfolio by the loan review function, and the annual
examination of the Company's financial statements by its independent auditors.
Charge-offs occur when loans are deemed to be uncollectible.
In order to determine the adequacy of the allowance for loan losses,
management considers the risk classification or delinquency status of loans and
other factors, such as collateral value, portfolio composition, trends in
economic conditions, and the financial strength of borrowers. Management
establishes specific allowances for loans which management believes require
reserves greater than those allocated according to their classification or
delinquent status. An unallocated allowance is also established based on the
Company's historical charge-off experience. The Company then charges to
operations a provision for loan losses determined on an annualized basis to
maintain the allowance for loan losses at an adequate level determined according
to the foregoing methodology.
Management believes that the allowance for loan losses at December 31,
1998, is adequate to cover losses inherent in the portfolio as of such date.
There can be no assurance, however, that the Company will not sustain losses in
future periods, which could be greater than the size of the allowance at
December 31, 1998.
The following table presents, for the periods indicated, an analysis of the
allowance for loan losses and other related data for the years ended
December 31, 1994 through 1998:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Allowance for loan losses at
January 1....................... $ 1,009 $ 687 $ 484 $ 522 $ 577
Provision for loan losses......... 612 877 655 200 126
Charge-offs....................... (569) (636) (478) (271) (225)
Recoveries........................ 131 81 26 33 44
------- ------ ------- ------- ------
Allowance for loan losses at
December 31..................... $ 1,183 $1,009 $ 687 $ 484 $ 522
======= ====== ======= ======= ======
Allowance to period-end loans..... 1.06% 0.98% 0.75% 0.71% 0.88%
Net charge-offs (recoveries) to
average loans................... 0.41 0.57 0.55 0.39 0.34
Allowance to period-end
nonperforming loans............. 261.15 74.80 131.61 105.68 95.78
</TABLE>
28
<PAGE>
The following tables describe the allocation of the allowance for loan
losses among various categories of loans and certain other information as of the
dates indicated. The allocation is made for analytical purposes and is not
necessarily indicative of the categories in which future loan losses may occur.
The total allowance is available to absorb losses from any segment of loans.
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1998 1997
------------------ ------------------
Percent Percent
of Loans of Loans
to Total to Total
Amount Loans Amount Loans
------ --------- ------ ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance of allowance for loan losses
applicable to:
Commercial and industrial............ $ 200 21.4% $ 287 24.5%
Real estate.......................... 0 43.7 41 38.6
Consumer............................. 382 34.9 547 36.9
Unallocated.......................... 601 134
------ ------
Total allowance for loan losses........ $1,183 $1,009
====== ======
</TABLE>
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------
1996 1995 1994
----------------- ----------------- -----------------
Percent Percent Percent
of Loans of Loans of Loans
to Total to Total to Total
Amount Loans Amount Loans Amount Loans
------ -------- ------ -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance of allowance for loan losses
applicable to:
Commercial and industrial............ $ 194 24.9% $ 121 26.8% $ 176 26.4%
Real estate.......................... 48 37.1 51 31.8 94 31.5
Consumer............................. 354 38.0 312 41.4 218 42.1
Unallocated.......................... 91 -- 34
------ ------ ------
Total allowance for loan losses........ $ 687 $ 484 $ 522
====== ====== ======
</TABLE>
Effective January 1, 1995, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 114, "Accounting for Creditors for Impairment
of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment
of a Loan -- Income Recognition and Disclosure." Under SFAS No. 114, as amended,
a loan is considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. The measurement of impaired loans is based on the present value of
expected future cash flows discounted at the loan's effective interest rate or
the loan's observable market price or based on the fair value of the collateral
if the loan is collateral-dependent. The adoption of SFAS No. 114 did not result
in any additional provision for loan losses.
29
<PAGE>
Securities
In accordance with SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," at the date of purchase, the Company is required to
classify debt and equity securities into one of three categories: held-to-
maturity, trading or available-for-sale. Investments in debt securities are
classified as held-to-maturity and measured at amortized cost in the financial
statements only if management has the intent and ability to hold those
securities to maturity. Securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading and measured
at fair value in the financial statements with unrealized gains and losses
included in earnings. Securities not classified as either held-to-maturity or
trading are classified as available-for-sale and measured at fair value in the
financial statements with unrealized gains and losses reported, net of tax, in a
separate component of stockholders' equity until realized. Gains and losses on
sales of securities are determined using the specific-identification method.
In November 1995, the Financial Accounting Standards Board issued "A Guide
to Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities" which provided a one-time reassessment of the
appropriateness of the classifications of all securities. Based on such
reassessment, the Company transferred a portion of its securities in the held-
to-maturity portfolio to the available-for-sale portfolio in November 1995. The
transferred securities had an amortized cost of approximately $27.1 million and
net unrealized gains of approximately $930,000. The transfer resulted in an
increase of approximately $614,000 to stockholders' equity net of deferred
income tax of $316,000. Such reassessment does not change management's intent to
hold other debt securities to maturity in the future. At this time,
classification of all securities as available-for-sale allows the Company to
manage its investment portfolio more effectively and to enhance the average
yield on the portfolio.
In November 1998, the Bank adopted SFAS No. 133, Accounting for Derivative
Investments and Hedging Activities, which at the time of adoption provided for
the reassessment of the appropriateness of the classification of all securities
based upon the assessment of various hedging transactions and/or market
interest-rate risk. Such transfers from the held-to-maturity category to the
available-for-sale category at the date of initial adoption shall not call into
question an entity's intent to hold other debt securities to maturity in the
future. At initial adoption, the Bank transferred $41 million from the held-to-
maturity category into the available-for-sale category which had a market value
of $41.6 million with the unrealized portion being recognized as a separate
component of stockholders' equity.
The following table summarizes the amortized cost of securities held by the
Company as of the dates shown:
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
U.S. Government and agency
Securities......................... $ 71,812 $ 66,140 $ 66,632 $ 72,809 $ 67,880
Mortgage-backed securities........... 112,051 50,497 52,600 48,748 45,294
Obligations of state and political
Subdivisions....................... 55,315 48,884 25,962 23,992 28,199
Other securities..................... 2,682 2,508 1,794 958 918
-------- -------- -------- -------- --------
Total securities................... $241,860 $168,029 $146,988 $146,507 $142,291
======== ======== ======== ======== ========
</TABLE>
30
<PAGE>
The following table summarizes the carrying value and classification of
securities as of the dates shown:
<TABLE>
<CAPTION>
December 31,
------------------------------
1998 1997 1996
-------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C>
Available-for-sale... $164,796 $ 93,036 $ 79,109
Held-to-maturity..... 79,728 76,795 68,396
-------- -------- --------
Total securities..... $244,524 $169,831 $147,505
======== ======== ========
</TABLE>
The following tables present the amortized cost of securities classified as
available-for-sale and their approximate values at December 31, 1998,
December 31, 1997, and December 31, 1996:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------------------------------------- ----------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Cost Gain Loss Value Cost Gain Loss Value
--------- ---------- ----------- -------- --------- ---------- ----------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government and agency
Securities................. $ 62,078 $ 927 $ -- $ 63,005 $17,085 $ 262 $ (1) $17,346
Mortgage-backed securities... 42,057 172 (132) 42,097 22,757 259 -- 23,016
Obligations of state and
political subdivisions...... 55,315 1,757 (60) 57,012 48,884 1,363 (81) 50,166
Other securities............. 2,682 -- -- 2,682 2,508 -- -- 2,508
-------- ------ ----- -------- --------- ---------- ---------- -------
Total securities............ $162,132 $2,856 $(192) $164,796 $91,234 $1,884 $ (82) $93,036
======== ====== ===== ======== ========= ========== ========== =======
</TABLE>
December 31, 1996
----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
--------- ---------- ---------- -------
(Dollars in thousands)
U.S. Government and agency
Securities.................. $30,058 $ 174 $ (86) $30,146
Mortgage-backed securities... 20,778 109 (230) 20,657
Obligations of state and
political subdivisions...... 25,962 555 (5) 26,512
Other securities............. 1,794 -- -- 1,794
--------- ---------- ---------- -------
Total securities............ $78,592 $ 838 $(321) $79,109
========= ========== ========== =======
The following tables present the amortized cost of securities classified as
held-to-maturity and their approximate fair values at December 31, 1998,
December 31, 1997, and December 31, 1996:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------------------------------- ----------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Cost Gain Loss Value Cost Gain Loss Value
--------- ---------- ----------- ------- --------- ---------- ----------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government and agency
Securities................ $ 9,734 $ 44 $ (30) $ 9,748 $49,055 $ 982 $ (24) $50,013
Mortgage-backed securities... 69,994 188 (215) 69,967 27,740 195 (379) 27,556
------- ---- ----- ------- ------- ------ ----- -------
Total securities........... $79,728 $232 $(245) $79,715 $76,795 $1,177 $(403) $77,569
======= ==== ===== ======= ======= ====== ===== =======
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
December 31, 1996
----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
--------- ---------- ----------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
U.S. Government and agency securities... $36,574 $446 $(251) $36,769
Mortgage-backed securities.............. 31,822 217 (470) 31,569
------- ---- ----- -------
Total securities....................... $68,396 $663 $(721) $68,338
======= ==== ===== =======
</TABLE>
U.S. Government and agency securities are primarily securities issued by
the Federal National Mortgage Association ("FNMA"), Federal Home Loan Bank
("FHLB"), and Federal Home Loan Mortgage Corporation ("FHLMC"). Mortgage-backed
securities are securities that have been developed by pooling a number of real
estate mortgages and are principally issued by federal agencies such as the
FNMA, FHLMC and the Governmental National Mortgage Association. These securities
have high credit ratings, and minimum regular monthly cash flows of principal
and interest are guaranteed by the agencies. The Company has no mortgage-backed
securities that have been issued by non-agency entities.
At December 31, 1998, securities totaled $244.5 million, an increase of
$74.7 million from $169.8 million at December 31, 1997. The increase occurred
primarily in mortgage-backed securities. During 1997, securities increased $22.3
million from $147.5 million at December 31, 1996. The yield on the securities
portfolio for 1998 was 6.20% while the yield was 6.46% in 1997 and 6.43% in
1996.
At December 31, 1998, 25.80% of the mortgage-backed securities held by the
Company had final maturities of more than 10 years. At December 31, 1998,
approximately $36.9 million of the Company's mortgage-backed securities earned
interest at floating rates and repriced within one year, and, accordingly, were
less susceptible to declines in value should interest rates increase.
The following table summarizes the contractual maturity of investments on
an amortized cost basis (including securities and interest-bearing deposits) and
their weighted average yields at December 31, 1998 (the yields on tax exempt
obligations have not been adjusted to their tax equivalent basis):
<TABLE>
<CAPTION>
December 31, 1998
--------------------------------------------------------------------------------------------
After One After Five
Year but Years but
Within Within Within
One Year Five Years Ten Years After Ten Years
--------------- ---------------- ---------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield Total Yield
------ ------ ------- ------ ------- ------ ------- ------ -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government and agency
Securities............... $3,019 7.16% $ 6,998 5.74% $44,389 6.92% $17,406 7.03% $ 71,812 6.85%
Mortgage-backed securities... 3,970 8.40 44,624 6.21 34,546 6.45 28,911 5.87 112,051 6.28
Obligations of states and
political subdivisions.... 2,606 4.68 4,250 4.86 1,167 4.95 47,292 5.25 55,315 7.86
Other securities............. -0- -- -0- -- -0- -- 2,682 6.42 2,682 6.42
Interest-bearing deposits.... 224 4.76 -0- -- -0- -- -0- -- 224 4.76
------ ---- ------- ---- ------- ---- ------- ---- -------- ----
Total securities........... $9,819 6.94% $55,872 6.05% $80,102 6.69% $96,291 5.79% $242,084 6.81%
====== ==== ======= ==== ======= ==== ======= ==== ======== ====
</TABLE>
Deposits
The Company offers a variety of deposit accounts having a wide range of
interest rates and terms. The Company's deposits consist of demand, savings, NOW
accounts, money market, and time accounts. The Company relies primarily on
advertising, competitive pricing policies, and customer service to attract and
retain these deposits. As of December 31, 1998, the Company has no deposits
classified as brokered funds.
32
<PAGE>
Deposits provide generally all the funding for the Company's lending and
investment activities and the interest paid for deposits must be managed
carefully to control the level of interest expense.
The Company's ratio of average demand deposits to average total deposits
for the years ended December 31, 1998, 1997, and 1996 were 21.4%, 20.4%, and
20.0%, respectively.
Average total deposits during 1998 increased to $292.3 million from $246.9
million in 1997, an increase of $45.4 million or 18.4%. In addition, average
noninterest-bearing deposits increased to $62.4 million in 1998 from $50.8
million in 1997 due to the increase in the number of deposit accounts. Average
deposits in 1997 rose to $246.9 million from $220.4 million in 1996, an increase
of $26.5 million or 12.0%.
The daily average balances and weighted average rates paid on deposits for
each of the years ended December 31, 1998, 1997 and 1996 are presented below:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------
1998 1997 1996
---------------- ---------------- ----------------
Amount Rate Amount Rate Amount Rate
-------- ----- -------- ----- -------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
NOW accounts....................... $ 21,005 1.71% $ 19,348 1.76% $ 17,862 1.77%
Regular savings.................... 7,429 2.18 6,731 2.24 6,437 2.35
Money market....................... 75,497 3.93 65,010 3.84 59,284 3.62
CDs less than $100,000............. 70,862 5.50 61,097 5.53 54,550 5.50
CDs $100,000 and over.............. 35,103 5.59 27,544 5.52 24,040 5.54
IRAs & QRPs........................ 19,918 5.67 16,706 5.62 14,020 5.49
-------- ---- -------- ---- -------- ----
Total interest-bearing deposits... 229,814 4.49% 196,436 4.38% 176,193 4.38%
Noninterest-bearing deposits....... 62,446 -- 50,759 -- 44,274 --
-------- ---- -------- ---- -------- ----
Total deposits.................... $292,260 3.58% $247,195 3.57% $220,467 3.50%
======== ==== ======== ==== ======== ====
</TABLE>
The following table sets forth the maturity and repricing of the Company's
certificates of deposit that are $100,000 or greater as of the dates indicated:
<TABLE>
<CAPTION>
December 31,
---------------------------
1998 1997 1996
------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C>
3 months or less............... $10,462 $ 9,000 $11,368
Between 3 months and 1 year... 25,520 15,110 14,443
Over 1 year.................... 6,126 7,063 3,372
------- ------- -------
Total CDs $100,000 and over... $42,108 $31,173 $29,183
======= ======= =======
</TABLE>
33
<PAGE>
Borrowings
Other borrowings generally represent borrowings from the FHLB. FHLB
advances may be utilized from time to time as either a short-term funding source
(maturities ranging from one to thirty-five days) or a longer-term funding
source. Information relating to these borrowings is summarized as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
(Dollars in thousands)
Other borrowings:
Average................................. $11,086 $ 4,582 $3,676
Year-end................................ 11,100 --(1) -- (1)
Maximum month-end balance during year... 21,669 15,100 7,500
Interest rate:
Average................................. 5.40% 5.53% 5.20%
Year-end (weighted)..................... 5.38% -- --
- --------------------
</TABLE>
(1) There were no borrowings at year-end.
Interest Rate Sensitivity and Liquidity
The nature of the banking business, which involves paying interest on
deposits at varying rates and terms and charging interest on loans and earning
interest on investments at other rates and terms, creates interest rate risk. As
a result, earnings of the Company are subject to fluctuations that arise due to
changes in the level and directions of interest rates.
Asset and liability management is concerned with the timing and magnitude
of repricing assets compared to liabilities. It is the objective of the Company
to generate stable growth in net interest income and to attempt to control risks
associated with interest rate movements. In general, management's strategy is to
reduce the impact of changes in interest rates on its net interest income by
maintaining a favorable match between the maturities or repricing dates of its
interest-earning assets and interest-bearing liabilities. The Company's asset
and liability management strategy is formulated and monitored by the Bank's
Investment-Asset/Liability Committee, which is composed of senior officers and
directors of the Bank, in accordance with policies approved by the Bank's Board
of Directors. This Committee meets regularly to review, among other things, the
sensitivity of the Bank's assets and liabilities to interest rate changes, the
book and market values of assets and liabilities, unrealized gains and losses,
purchase and sale activity, and maturities of investments and borrowings. The
Investment-Asset/Liability Committee also approves and establishes pricing and
funding decisions with respect to the Bank's overall asset and liability
composition. The Committee reviews the Bank's liquidity, cash flow flexibility,
maturities of investments, deposits and borrowings, deposit activity, current
market conditions, and interest rates on both a local and national level.
The Company manages its interest rate risk by structuring its balance sheet
in the ordinary course of business. During 1998 and 1997 the Company did not and
does not currently enter into derivative financial instruments such as leveraged
derivatives, structured notes, interest rate swaps, caps or floors, financial
options, financial futures contracts, or forward delivery contracts for the
purpose of reducing its exposure to interest rate risks.
34
<PAGE>
One traditional test of interest rate sensitivity is the interest rate
sensitivity gap ("GAP"), which is defined as the difference between interest-
earning assets and interest-bearing liabilities maturing or repricing within a
given time period. A GAP is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
GAP is considered negative when the amount of interest rate sensitive
liabilities exceeds interest rate sensitive assets. During a period of rising
interest rates, a negative GAP would tend to adversely affect net interest
income, while a positive GAP would tend to result in an increase in net interest
income. During a period of falling interest rates, a negative GAP would tend to
result in an increase in net interest income, while a positive GAP would tend to
affect net interest income adversely. While the interest rate sensitivity GAP is
a useful measurement and contributes toward effective asset and liability
management, it is difficult to predict the effect of changing interest rates
solely on that measure. Because different types of assets and liabilities with
the same or similar maturities may react differently to changes in overall
market rates or conditions, changes in interest rates may affect net interest
income positively or negatively even if an institution were perfectly matched in
each maturity category.
The following table sets forth an interest rate sensitivity analysis for
the Company as of December 31, 1998:
<TABLE>
<CAPTION>
Volumes Subject to Repricing Within
---------------------------------------------------------------
After
0-30 31-180 181-360 One
Days Days Days Year Total
-------- ---------- ----------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Securities and interest-earning funds....... $ 5,638 $ 18,158 $ 31,430 $186,858 $242,084
Loans....................................... 30,392 6,551 6,541 67,548 111,032
Overdrafts.................................. 328 -- -- -- 328
--------- --------- --------- -------- --------
Total interest-earning assets............ 36,358 24,709 37,971 254,406 353,444
Interest-bearing liabilities:
Demand, money market and savings
Deposits................................... $ 116,658 $ -- $ -- $ -- $116,658
Certificates of deposit,
other time deposits and borrowings......... 22,656 44,893 45,858 39,214 152,621
--------- --------- --------- -------- --------
Total interest-bearing liabilities......... 139,314 44,893 45,858 39,214 269,279
--------- --------- --------- -------- --------
Period GAP................................... $(102,956) $ (20,184) $ (7,887) $215,192 $ 84,165
Cumulative GAP............................... $(102,956) $(123,140) $(131,027) $ 84,165
Period GAP to total assets................... (27.24)% (5.34)% (2.09)% 56.94%
Cumulative GAP to total assets............... (27.24)% (32.58)% (34.67)% 22.27%
Cumulative interest-earning assets to
cumulative interest-bearing liabilities... 26.09% 33.15% 43.05% 131.26%
</TABLE>
35
<PAGE>
The preceding table reflects a one-year cumulative GAP position at
December 31, 1998, of negative $131 million or 34.67% of assets and a cumulative
liability-sensitive balance sheet over a one-year time frame that likely will
more positively affect net interest income if rates fall than if they rise.
However, while the GAP analysis is widely used in the industry, it is unable to
capture other factors affecting the sensitivity of the balance sheet, such as
time lags required for certain assets and liabilities to reprice because of
their varying sensitivity to changes in market interest rates. Furthermore,
included in the total for rate sensitive liabilities are $31.6 million in
savings and NOW accounts. While immediately repricable, the rates paid on these
deposit accounts will not change in direct correlation with changes in the
general level of short-term interest rates. For example, if the Bank's base
lending rate declines by 100 basis points, the interest rate paid on these
deposits will not immediately decline by the full 100 basis points. Conversely,
if lending rates increase by the same amount, the rates paid on these deposits
will likewise not increase immediately or by the full 100 basis points.
Shortcomings are inherent in any GAP analysis because certain assets and
liabilities may not move proportionally as interest rates change. Consequently,
in addition to GAP analysis, the Company uses a simulation model and shock
analysis to test the interest rate sensitivity of net interest income and the
balance sheet, respectively. Based on the Company's December 31, 1998,
simulation analysis, the Company estimates that a 200 basis point rise in
interest rates over the next twelve-month period would result in a 9.5% decline
in net interest income. This is a result of the Company maintaining a
significant portion of its interest earning assets in fixed rate securities
rather than adjustable rate securities or loans tied to a prime lending rate
that adjusts as interest rates change.
The Investment-Asset/Liability Committee regularly reviews interest rate
risk exposure by forecasting the impact of alternative interest rate
environments on net interest income. The Company adjusts interest sensitivity
accordingly during the year through changes in the mix of assets and
liabilities. In the fourth quarter of 1997, the Bank's Investment-
Asset/Liability Committee adopted specific investment policies directed at
reducing the length of maturity of securities that it purchases and shifting a
portion of the securities portfolio to adjustable rate securities.
Liquidity involves the Company's ability to raise funds to support asset
growth or reduce assets to meet deposit withdrawals and other payment
obligations, to maintain reserve requirements, and otherwise to operate the
Company on an ongoing basis. During 1998, the Company's liquidity needs were
primarily met by growth in deposits, as previously discussed. Access to borrowed
funds from the FHLB is available and has been utilized to take advantage of
investment opportunities. The Company's cash position, supplemented by
amortizing securities and loan portfolios, has generally created an adequate
liquidity position.
FHLB advances may be utilized from time to time as either a short-term
funding source or a long-term funding source. FHLB advances can be particularly
attractive as a long-term funding source to balance interest rate sensitivity
and reduce interest rate risk. These borrowing programs are available as either
a short-term financing arrangement (usually with maturities ranging from 1-35
days) or as a long-term financing arrangement. Under either of these two
arrangements, the Company is required to hold a certain amount of FHLB stock.
Generally, FHLB borrowings are limited to a maximum of 75% of the Company's 1-4
family mortgage loans before specific collateral is required. A secondary source
of collateral is the delivery of eligible securities. At December 31, 1998, the
Company had approximately $156 million in eligible securities maintained in
safekeeping at the FHLB. In addition, the Company may deliver other collateral
which includes credit card and installment loans and are usually assigned a
loan-to-value ratio of approximately 90%. With regards to the above, total
advances are limited to 50% of assets or total eligible
36
<PAGE>
collateral, whichever is less. At December 31, 1998, the Company had total
potential borrowings (without purchasing addition stock) of $23 million.
Operating Risk Management
The Company, like all businesses of any size, is exposed to many types of
operating risks, including the risk of fraud by employees or outsiders,
unauthorized transactions by employees, and errors relating to computer and
telecommunications systems. The Company maintains a system of controls that is
designed to keep operating risk at appropriate levels in view of the financial
strength of the Company, the characteristics of the businesses and markets in
which the Company operates, competitive circumstances, and regulatory
considerations. However, from time to time in the past, the Company has suffered
losses from operating risk and there can be no assurance that the Company will
not suffer such losses in the future.
Capital Resources
Stockholders' equity increased to $33.4 million at December 31, 1998, from
$31.6 million at December 31, 1997, an increase of $1.8 million, or 5.7%. This
increase was primarily the result of net income of $4.5 million, a net change in
comprehensive income of $600,000, dividends declared of $1.9 million and $1.6
million in the repurchase of common stock. During 1997, stockholders' equity
increased by $13.8 million, or 77.1%, from $17.9 million at December 31, 1996
due to the sale of 1,150,000 shares of Common Stock in October 1997, in the
amount of $11.1 million.
Capital management consists of providing equity to support both current and
future operations. The Company is subject to capital adequacy requirements
imposed by the OCC. The OCC has adopted risk-based capital requirements for
assessing bank capital adequacy. These standards define capital and establish
minimum capital requirements in relation to assets and off-balance sheet
exposure, adjusted for credit risk. The risk-based capital standards currently
in effect are designed to make regulatory capital requirements more sensitive to
differences in risk profiles among bank holding companies and banks, to account
for off-balance sheet exposure and to minimize disincentives for holding liquid
assets. Assets and off-balance sheet items are assigned to broad risk
categories, each with appropriate relative risk weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and off-
balance sheet items.
Bank regulatory authorities in the United States have issued risk-based
capital standards by which all bank holding companies and banks are evaluated in
terms of capital adequacy. The risk-based capital guidelines issued by the OCC
apply to the Bank. These guidelines relate a financial institution's capital to
the risk profile of its assets. The risk-based capital standards require all
financial organizations to have "Tier 1 capital" of at least 4.0% of risk-
adjusted assets and "total risk-based" capital (Tier 1 and Tier 2) of at least
8.0% of risk-adjusted assets. "Tier 1 capital" includes, generally, common
stockholders' equity and qualifying perpetual preferred stock, together with
related surpluses and retained earnings, qualifying perpetual preferred stock,
and minority interest in equity accounts of consolidated subsidiaries less
deductions for goodwill and various other intangibles. "Tier 2 capital" may
consist of a limited amount of intermediate-term preferred stock, a limited
amount of subordinated debt, certain hybrid capital instruments and other debt
securities, perpetual preferred stock not qualifying as Tier 1 capital, and a
limited amount of the general valuation allowance for loan losses ("Tier 2
capital"). The sum of Tier 1 capital and Tier 2 capital is "total risk-based
capital."
The OCC has also adopted guidelines which supplement the risk-based capital
guidelines with a minimum leverage ratio of Tier 1 capital to average total
consolidated assets ("leverage ratio") of 3.0% for
37
<PAGE>
institutions with well diversified risk, including no undue interest rate
exposure; excellent asset quality; high liquidity; good earnings; and that are
generally considered to be strong banking organizations, rated composite 1 under
applicable federal guidelines, and that are not experiencing or anticipating
significant growth. Other banking organizations are required to maintain a
leverage ratio of at least 4.0% to 5.0%. These rules further provide that
banking organizations experiencing internal growth or making acquisitions will
be expected to maintain capital positions substantially above the minimum
supervisory levels and comparable to peer group averages, without significant
reliance on intangible assets.
The following table provides a comparison of the Bank's leverage and risk-
weighted capital ratios as of December 31, 1998, to the minimum regulatory
standards:
<TABLE>
<CAPTION>
Well
Capitalized
Minimum Minimum Bank
Required Required Ratio
------------ --------- ------
<S> <C> <C> <C>
Leverage ratio.................... 3.00% (1) 5.00% 9.37%
Tier 1 risk-based capital ratio... 4.00% 6.00% 20.44%
Risk-based capital ratio.......... 8.00% 10.00% 21.20%
- --------------------
</TABLE>
(1) The OCC has the authority to require the Bank to maintain a leverage ratio
of up to 200 basis points above the required minimum.
Pursuant to the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA"), each federal banking agency revised its risk-based capital
standards to ensure that those standards take adequate account of interest rate
risk, concentration of credit risk and the risks of nontraditional activities,
as well as reflect the actual performance and expected risk of loss on
multifamily mortgages. Also pursuant to FDICIA, each federal banking agency has
promulgated regulations setting the levels at which an insured institution would
be considered "well-capitalized," "adequately-capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized." Under the
Federal Reserve Board's regulations, the Company is classified "well-
capitalized" for purposes of prompt corrective action. See "Supervision and
Regulation."
Year 2000
The Year 2000 issue is the result of many existing computer programs using
two digits rather than four to identify a year in a date field. These programs
were designed and developed without considering the impact of the upcoming
change in the century. Computer hardware, date-driven automated equipment, and
computer software may recognize a date using "00" as the year 1900 rather than
the year 2000. If not corrected, many computer systems could fail or create
erroneous results causing disruptions of operations, including a temporary
inability to process transactions or engage in normal business activities. The
Year 2000 issue affects virtually all companies and organizations.
In May 1997, the OCC issued an advisory letter to all national banks
concerning the Year 2000 issue. The OCC has directed that all national banks
must largely complete all software code enhancements and revisions, hardware
upgrades, and other associated changes by December 31, 1998. Between January 1,
1999 and the end of the year, banks must test and implement their Year 2000
conversion projects. In addition, the OCC is conducting an examination of each
bank's Year 2000 preparedness.
38
<PAGE>
The Company has completed an internal review of all computer hardware,
date-sensitive automated equipment, and software. Some of the Company's software
will require modification or replacement so that applications and computer
systems will properly use dates beyond December 31, 1999. The Company is using
both internal and external resources to correct or replace and test in-house
code to ensure uninterrupted customer service. The Company believes that through
modifications to existing software and conversion to new software, the Year 2000
issue will be adequately addressed. The Company is also working with its third
party data processing vendor to coordinate their Year 2000 activities with the
Company's to ensure Year 2000 readiness, as well as working with significant
customers, venders, and business parties to monitor the progress of their Year
2000 efforts.
The Company plans to complete its Year 2000 readiness project by August
1999 and began testing of programs during the third quarter of 1998. The Company
currently expects to incur approximately $100,000 in programming and equipment
costs in connection with the Year 2000 project which is being funded through
operating cash flows, will be expensed or capitalized as incurred during 1999
and is not expected to have any material adverse effect on the Company's results
of operations.
The Company's Year 2000 readiness project costs include the estimated costs
and time associated with the impact of the Company's primary third party data
processing vendor's Year 2000 issues and are based on presently available
information. The costs associated with the Year 2000 readiness project and the
date on which the Company plans to complete the project are based on
management's best estimates, which were derived using assumptions of future
events including the availability of certain resources, third party vendors Year
2000 plans, and other factors. There is no assurance that the Company's
estimates will be realized and actual results could differ materially. Specific
factors that might cause such a material difference include the availability and
cost of trained programming personnel and the ability to locate and correct all
relevant computer code. In addition, there can be no assurance that the systems
and applications of other companies on which the Bank's systems and applications
rely will be timely converted, that a failure to convert by another company, or
that a conversion that is incompatible with the Company's systems and
applications would not have a material adverse impact on the Company.
Other Accounting Pronouncements
Effective October 1, 1997, the Company adopted SFAS No. 123, Accounting for
Stock-based Compensation. This statement requires expanded disclosures of stock-
based compensation arrangements with employees and encourages, but does not
require, companies to record compensation cost for stock-based employee
compensation plans at fair value. As permitted by this statement, the Company
continues to follow the rules to measure compensation as outlined in Accounting
Principles Bulletin No. 25, but the Company is now required to disclose pro
forma amounts of net income and earnings per share that would have been reported
under the fair value recognition provisions of SFAS No. 123. The adoption of
SFAS No. 123 had no material impact on the results of operations or financial
condition of the Company.
Effective January 1, 1997, the Company adopted SFAS No. 125, Accounting for
Transfers and Servicing of Assets and Extinguishments of Liabilities. This
statement requires that accounting and reporting standards for the transfer and
servicing of financial assets and extinguishments of liabilities be based on
consistent application of financial components approach that focuses on control.
Under this approach, after a transfer of financial assets, the Company
recognizes the financial and servicing assets it controls and the liabilities it
has incurred, derecognizes financial assets when control had been surrendered,
and derecognizes liabilities when extinguished. This statement provides
consistent standards for distinguishing transfers of
39
<PAGE>
financial assets that are sales from transfers that are secured borrowings.
Provisions of SFAS No. 125 that deal with securities lending, repurchase and
dollar repurchase agreements, and the recognition of collateral were not adopted
until January 1, 1998, as provided by SFAS No. 127 which allows the deferral of
these items.
Effective December 15, 1997, the Company adopted SFAS No. 129, Disclosure
of Information about Capital Structure. This statement establishes standards for
disclosing information about the Company's capital structure. This statement
does not change any previous disclosures but consolidates them in this statement
for ease of retrieval and for greater visibility.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
This statement establishes standards for reporting and disclosure of
comprehensive income and its components. Comprehensive income is defined as the
change in equity during a period. Comprehensive income includes net income and
other comprehensive income which refers to unrealized gains and losses that
under generally accepted accounting principles are excluded from net income. For
all periods presented in the audited financial statements, the Bank has included
a comprehensive income statement.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. This statement establishes standards and
requirements for public enterprises regarding information about operating
segments in annual financial statements. This statement also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. Operating segments are components of an enterprise that are
evaluated regularly by the chief executive officer in deciding how to allocate
resources and in assessing performance.
In June 1998, the FASB issued SFAS. No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes standards and
reporting requirements for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. It requires
that the Bank recognize all derivatives as other assets or liabilities in the
financial statements and to measure these instruments at fair value. The
accounting for changes in the fair value of a derivative depends on the intended
use of the derivative and the resulting designation.
The adoption of these statements will impact the disclosures in the
Company's financial statements, however, management does not believe that
adoption of these statements will have a material impact on the Company's
financial condition or results of operation.
Factors that May Affect Future Results and Market Price of Stock
In addition to historical and factual statements, the information discussed
in this Annual Report contains forward-looking statements, which can be
identified by the use of forward-looking phrases such as "believes," "expects,"
"may," "should," "projected," "contemplates," or "anticipates" or the negative
thereof or comparable words that involve risks and uncertainties. The Company
operates in an environment that involves numerous risks, uncertainties, and
other influences, many of which are beyond the Company's control, and any one of
which, or a combination of which, could materially affect the Company's results
of operation and the market price of its Common Stock. The Company's actual
results may differ materially from the results discussed in the forward-looking
statements.
The following discussion highlights some of the risks the Company faces and
includes cautionary statements identifying important factors with respect to
forward-looking statements, including certain risks
40
<PAGE>
and uncertainties, that could cause actual results to vary materially from the
future results discussed in such forward-looking statements.
Interest Rate Risk. The Company's earnings depend to a substantial extent
on "rate differentials", i.e., the differences between the income the Company
earns on loans, securities, and other earning assets, and the interest expense
it pays to obtain deposits and other liabilities. These rates are highly
sensitive to many factors that are beyond the Company's control, including
general economic conditions and the policies of various governmental and
regulatory authorities. Increases in the discount rate by the Federal Reserve
Board usually lead to rising interest rates, which affect the Company's interest
income, interest expense, and securities portfolio. Also, governmental policies,
such as the creation of a tax deduction for individual retirement accounts, can
increase savings and affect the Company's cost of funds. From time to time,
maturities of assets and liabilities are not balanced and a rapid increase in
interest rates could have an adverse effect on the net interest margin and
results of operations of the Company. To the extent that the Company maintains a
significant percentage of its assets in investment securities, a rapid increase
or decrease in interest rates could have a greater adverse effect on the
Company's net interest margin and results of operation. The nature, timing, and
effect of any future changes in federal monetary and fiscal policies on the
Company and its results of operations are not predictable. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Financial Condition--Interest Rate Sensitivity and Liquidity."
Exposure to Local Economic Conditions. The Company's success is dependent
to a significant extent upon general economic conditions in the Houston
metropolitan area. The banking industry in Texas and Houston is affected by
general economic conditions such as inflation, recession, unemployment, and
other factors beyond the Company's control. During the mid-1980's, severely
depressed oil and gas and real estate prices materially and adversely affected
the Texas and Houston economies, causing recession and unemployment in the
region and resulting in excess vacancies in the Houston real estate market and
elsewhere in the State. Since 1987, the local economy has improved in part due
to its expansion into non-energy related industries. As the Houston economy has
diversified away from the energy industry, however, it has become more
susceptible to adverse effects resulting from recession in the national economy.
Economic recession over a prolonged period of time in the Houston area could
cause significant increases in nonperforming assets, thereby causing operating
losses, impairing liquidity, and eroding capital. There can be no assurance that
future adverse changes in the local economy would not have a material adverse
effect on the Company's financial condition, results of operations or cash
flows.
Competition. The banking business is highly competitive and the
profitability of the Company depends principally upon the Company's ability to
compete in the Houston metropolitan area. In addition to competing with other
commercial and savings banks and savings and loan associations, the Company
competes with credit unions, finance companies, mutual funds, insurance
companies, brokerage and investment banking firms, asset-based non-bank lenders,
and certain other non-financial entities, including retail stores that may
maintain their own credit programs, and governmental organizations that may
offer subsidized financing at lower rates than those offered by the Company.
Many of such competitors have significantly greater financial and other
resources and higher lending limits than the Company. Although the Company has
been able to compete effectively in the past, no assurance can be given that the
Company will continue to be able to compete effectively in the future. Various
legislative acts in recent years have led to increased competition among
financial institutions. There can be no assurance that Congress or the Texas
legislature will not enact legislation that may further increase competitive
pressures on the Company. Competition from both financial and non-financial
institutions is expected to continue. See "Business -- Competition."
41
<PAGE>
Supervision and Regulation. Banks operate in a highly regulated environment
and are subject to extensive supervision and examination by federal and state
regulatory agencies. The Company, as a national banking association, is subject
to regulation and supervision by the OCC and, as a result of the insurance of
its deposits, the FDIC. These regulations are intended primarily for the
protection of depositors and customers, rather than for the benefit of
investors. The Company is subject to changes in federal and state law, as well
as changes in regulation and governmental policies, income tax laws and
accounting principles. The effects of any potential changes cannot be predicted
but could adversely affect the business and operations of the Company in the
future. See "Business--Supervision and Regulation."
Dividend History and Restrictions on Ability to Pay Dividends. While the
Company has paid dividends on the Common Stock each year since 1986 and in the
future plans to pay dividends based on its earnings and capital requirements,
there is no assurance that the Company will pay dividends in the future. The
payment of dividends by the Company is subject to restrictions imposed by
federal banking laws, regulations, and authorities. Without approval of the OCC,
dividends from the Bank to the Company in any calendar year may not exceed the
Bank's net income for that year, plus its retained net income for the preceding
two years, less any required transfers to capital surplus or to a fund for the
retirement of any preferred stock. In addition, a dividend may not be paid in
excess of a bank's undivided profits. Under these restrictions, as of January 1,
1999, approximately $2.8 million was available for payment of dividends (without
prior regulatory approval) by the Bank to the Company.
The federal banking statutes also prohibit a national bank from making any
capital distribution (including a dividend payment) if, after making the
distribution, the institution would be "undercapitalized," as defined by
statute. In addition, the relevant federal regulatory agencies also have
authority to prohibit a national bank from engaging in an unsafe or unsound
practice as determined by the agency in conducting its business. The payment of
dividends could be deemed to constitute such an unsafe or unsound practice,
depending upon the financial condition of the Bank. Regulatory authorities could
also impose administratively stricter limitations on the ability of the Bank to
pay dividends if such limits were deemed appropriate by such regulatory
authorities to preserve the Bank's capital. See "Market for Registrant's Common
Stock and Related Stockholder Matters" and "Business--Supervision and
Regulation."
Dependence on Key Personnel. The Bank is dependent on certain key
personnel, including Frank G. Cook, B. Ralph Williams, Randall W. Dobbs, Joseph
E. Ives, Mary A. Walker, Sheila J. Duffy, Robert J. Kramer and John M. James,
each of whom has relationships with customers of the Bank that the Company
considers important to its business. The loss of such individuals or other
members of senior management could have an adverse effect on the Company's
growth and profitability. See "Executive Officers of the Registrant."
Certain Charter and Bylaw Provisions. The Company's Certificate of
Incorporation and Bylaws contain certain provisions that could delay, discourage
or prevent an attempted acquisition or change of control of the Company. These
provisions include a provision establishing certain advance notice procedures
for nomination of candidates for election as directors and for stockholder
proposals to be considered at an annual meeting of stockholders.
42
<PAGE>
Management's Ownership Interest and Possible Effects. The Company's
directors and executive officers beneficially own approximately 29.51% of the
outstanding shares of Common Stock. Accordingly, such persons will be able to
influence, to a significant extent, the outcome of matters required to be
submitted to the Company's stockholders for approval, including decisions
relating to the election of directors of the Company, the determination of day-
to-day management policies of the Company, and other significant transactions,
which may include taking actions that may be inconsistent with the interests of
non-affiliated stockholders.
Regulation of Control. Any person (individual or entity), alone or acting
in concert, seeking to acquire 25% or more of any class of voting securities of,
or otherwise to acquire "control" of, the Company is required to seek the prior
approval of the Federal Reserve Board under the Change in Bank Control Act and
regulations issued by the Federal Reserve Board. It is presumed, unless
rebutted, that an acquisition or other disposition of voting securities of the
Company through which any person alone or acting in concert with other persons,
proposes to acquire ownership of, or the power to vote, 10% or more of a class
of voting securities of the Company constitutes the acquisition of "control" of
the Company. In such event, such acquiring person or persons would be required
to obtain the approval of the Federal Reserve Board. See "Business --
Supervision and Regulation."
Possible Volatility of Stock Price. The market price of the Company's
Common Stock could be subject to significant fluctuations in response to
variations in the Company's quarterly operating results and other factors. The
market price of the Common Stock may be significantly affected by such factors
as the announcement of a proposed acquisition, the proposed sale of additional
shares of Common Stock or other securities by the Company, the Company's results
of operations, changes in earnings estimates by market analysts, speculation in
the press or analyst community, and general market conditions or market
conditions specific to particular industries. From time to time in recent years,
the securities markets have experienced significant price and volume
fluctuations that have often been unrelated or disproportionate to the operating
performance of particular companies. These broad fluctuations may adversely
affect the market price of the Common Stock.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
The Company's primary market risk exposure is interest rate risk. For
information regarding the interest rate risk exposure of the Company's financial
instruments, see "Management's Discussion and Analysis of Financial Condition
and Results of Operation - Interest Rate Sensitivity and Liquidity" beginning on
page 34. The Company's financial instruments generally are not subject to market
risks associated with foreign currency exchange rate risk, commodity price risk,
or other market risks or price risks (such as equity price risk). The Company
did not use derivative financial instruments (such as futures, forwards, swaps,
options, and other financial instruments with similar characteristics) to manage
its interest rate risk during the years ended December 31, 1997, and 1998.
Item 8. Financial Statements and Supplementary Data.
Consolidated Quarterly Financial Information
The following tables present certain unaudited financial information
concerning the Company's results of operations for each of the two years ended
December 31, 1998. The information should be read in conjunction with the
Consolidated Financial Statements of the Company and notes thereto included
elsewhere in this Annual Report.
43
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended 1998
------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ ------- --------
<S> <C> <C> <C> <C>
(Dollars in Thousands)
Interest income........................... $6,285 $6,226 $5,835 $5,431
Interest expense.......................... 2,964 2,977 2,723 2,404
------ ------ ------ ------
Net interest income....................... 3,321 3,249 3,112 3,027
Provision for loan losses................. 180 100 167 165
------ ------ ------ ------
Net interest income after provision for
loan losses............................. 3,141 3,149 2,945 2,862
Non-interest income....................... 631 805 806 620
Non-interest expense...................... 2,478 2,377 2,350 2,147
------ ------ ------ ------
Income before income taxes................ 1,294 1,577 1,401 1,335
Applicable income taxes................... 44 407 346 325
------ ------ ------ ------
Net income................................ $1,250 $1,170 $1,055 $1,010
====== ====== ====== ======
Earnings per share:
Basic.................................... $ 0.20 $ 0.21 $ 0.23 $ 0.25
Fully diluted............................ 0.20 0.20 0.23 0.25
</TABLE>
<TABLE>
<CAPTION>
Quarter Ended 1997
------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ ------- --------
<S> <C> <C> <C> <C>
(Dollars in Thousands)
Interest income........................... $5,385 $5,059 $4,837 $4,660
Interest expense.......................... 2,318 2,395 2,250 2,112
------ ------ ------ ------
Net interest income....................... 3,067 2,664 2,587 2,548
Provision for loan losses................. 370 180 167 160
------ ------ ------ ------
Net interest income after provision for
loan losses............................. 2,697 2,484 2,420 2,388
Non-interest income....................... 701 703 563 540
Non-interest expense...................... 2,092 1,916 1,868 1,768
------ ------ ------ ------
Income before income taxes................ 1,306 1,271 1,115 1,160
Applicable income taxes................... 192 358 308 296
------ ------ ------ ------
Net income................................ $1,114 $ 913 $ 807 $ 864
====== ====== ====== ======
Earnings per share:
Basic.................................... $ 0.22 $ 0.21 $ 0.23 $ 0.22
Fully diluted............................ 0.22 0.20 0.23 0.22
</TABLE>
The other information required by this title is contained in the financial
statements and schedules set forth in Item 14(a) under the captions
"Consolidated Financial Statements" and "Financial Statement Schedules" as a
part of this report.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
44
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information regarding directors required by Item 10 is incorporated by
reference from the Company's definitive proxy statement for its annual meeting
of stockholders to be held May 18, 1999.
Item 11. Executive Compensation.
The information regarding directors required by Item 11 is incorporated by
reference from the Company's definitive proxy statement for its annual meeting
of stockholders to be held May 18, 1999. The information specified in
Item 402(k) and (l) of Regulation S-K and set forth in the Company's definitive
proxy statement for its annual stockholders' meeting to be held on May 18, 1999,
is not incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information regarding directors required by Item 12 is incorporated by
reference from the Company's definitive proxy statement for its annual meeting
of stockholders to be held on May 18, 1999.
Item 13. Certain Relationships and Related Transactions.
The information regarding directors required by Item 13 is incorporated by
reference from the Company's definitive proxy statement for its annual meeting
of stockholders to be held on May 18, 1999.
45
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a)(1) Financial Statements:
The following financial statements are filed as part of this report:
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report..................................................... F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997..................... F-3
Consolidated Statements of Income for the Years Ended December 31,
1998, 1997 and 1996........................................................... F-4
Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 1998, 1997 and 1996.............................................. F-5
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996.............................................. F-6
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1997, and 1996.......................................................... F-7
Notes to Consolidated Financial Statements....................................... F-8
</TABLE>
(a)(2) Financial Statement Schedules:
All Financial Statement Schedules have been omitted since the required
information is not present or not present in amounts sufficient to
require submission of the schedule, or because the information
required is included in the consolidated financial statements or the
notes thereto.
(a)(3) Exhibits:
The following exhibits are filed herewith or are incorporated by
reference to exhibits previously filed with the Securities and
Exchange Commission. The Company will furnish copies of exhibits for a
reasonable fee (covering the expense of furnishing copies) upon
request.
Exhibit
Number Description
- ------ -----------
3.1 Composite Articles of Association of the Company [Incorporated by
reference to Exhibit 3.1 to the Form S-1 Registration Statement
filed August 28, 1997, File No., as amended].
3.2 Amended and Restated Bylaws of the Company. [Incorporated by reference
to Exhibit 3.2 to the Form S-1 Registration Statement filed
August 28, 1997, File No., as amended].
10.1* 1992 Stock Option Plan.[Incorporated by reference to Exhibit 10.1 to
the Form S-1 Registration Statement filed August 28, 1997, File No.,
as amended].
10.2* 1994 Stock Option Plan.[Incorporated by reference to Exhibit 10.2 to
the Form S-1 Registration Statement filed August 28, 1997, File No.,
as amended].
10.3* Form of Stock Option Agreement under option plans. [Incorporated by
reference to Exhibit 10.3 to the Form S-1 Registration Statement
filed August 28, 1997, File No., as amended].
46
<PAGE>
Exhibit
Number Description
- ------ -----------
10.4* Form of Executive Severance Agreement.
21.1 Subsidiaries of the Bank.
* Indicates management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 12, 1999.
CITIZENS NATIONAL BANK OF TEXAS
By: /s/ B. Ralph Williams
-------------------------------------
B. Ralph Williams, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dated indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
Name Title Date
---- ----- ----
/s/ Frank G. Cook Chairman of the Board (Chief March 12, 1999
- ------------------------------ Financial Officer)
Frank G. Cook
/s/ B. Ralph Williams President, Chief Executive March 12, 1999
- ------------------------------ Officer, and Director
B. Ralph Williams
/s/ Randall W. Dobbs Executive Vice President, Chief March 12, 1999
- ------------------------------ Operations Officer, and Director
Randall W. Dobbs (Chief Accounting Officer)
/s/ Joe E. Ives Executive Vice President and March 12, 1999
- ------------------------------ Director
Joe E. Ives
/s/ Mary Walker Senior Vice President and March 12, 1999
- ----------------------------- Director
Mary Walker
/s/ John B. Barnes Director March 12, 1999
- ------------------------------
John B. Barnes
/s/ Williams H. Bruecher, Jr. Director March 12, 1999
- ------------------------------
William H. Bruecher, Jr.
</TABLE>
47
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ C. Joe Chapman Director March 12, 1999
- ------------------------------
C. Joe Chapman
/s/ Robert C. Dawson Director March 12, 1999
- ------------------------------
Robert C. Dawson
/s/ James B. Earthman, III Director March 12, 1999
- ------------------------------
James B. Earthman, III
/s/ Lura M. Griffith Director March 12, 1999
- ------------------------------
Lura M. Griffin
/s/ Alton L. Hollis Director March 12, 1999
- ------------------------------
Alton L. Hollis
/s/ Larry L. January Director March 12, 1999
- ------------------------------
Larry L. January
/s/ I.W. Marks Director March 12, 1999
- ------------------------------
I.W. Marks
/s/ David E. Preng Director March 12, 1999
- ------------------------------
David E. Preng
/s/ James K. Chancelor Director March 12, 1999
- ------------------------------
James K. Chancelor
/s/ Al Kochran Director March 12, 1999
- ------------------------------
Al Kochran
</TABLE>
48
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
C O N T E N T S
---------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report............................................................. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997............................. F-3
Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 and 1996... F-4
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 1998,
1997 and 1996.......................................................................... F-5
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996....................................................... F-6
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997
and 1996............................................................................... F-7
Notes to Consolidated Financial Statements............................................... F-8
Financial Statement Schedules:
All schedules have been omitted since the required information is not present or not
present in amounts sufficient to require submission of the schedule, or because the
information required is included in the consolidated financial statements or the notes
thereto.
</TABLE>
F-1
<PAGE>
[MANN FRANKFORT STEIN & LIPP LETTERHEAD APPEARS HERE]
INDEPENDENT AUDITORS' REPORT
----------------------------
To the Board of Directors of
CNBT Bancshares, Inc. and Subsidiaries
Bellaire, Texas
We have audited the accompanying consolidated balance sheets of CNBT Bancshares,
Inc. and wholly-owned subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, comprehensive income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of CNBT
Bancshares, Inc. and wholly-owned subsidiaries as of December 31, 1998 and 1997,
and the consolidated results of its operations and its cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
As described in Note A to the consolidated financial statements, CNBT
Bancshares, Inc. and wholly-owned subsidiaries adopted certain new accounting
standards during 1998 as required by the Financial Accounting Standards Board.
/s/ Mann Frankfort Stein & Lipp, P.C.
- -------------------------------------
Houston, Texas
February 5, 1999
F-2
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31,
-------------------
ASSETS 1998 1997
-------- --------
<S> <C> <C>
Cash and due from banks $ 13,070 $ 12,099
Due from banks - interest bearing overnight funds 224 3,177
Investment securities available-for-sale 164,796 93,036
Investment securities held-to-maturity (approximate market
value of $79,715 and $77,569, respectively) 79,728 76,795
Loans, net 110,177 101,866
Bank premises and equipment, net 5,913 5,384
Other assets 4,022 3,249
-------- --------
TOTAL ASSETS $377,930 $295,606
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Demand $ 72,738 $ 54,598
NOW 24,020 20,209
Savings 7,620 6,932
Money market 85,018 68,786
Time, $100,000 and over 42,108 31,173
Other time 99,413 79,209
-------- --------
TOTAL DEPOSITS 330,917 260,907
Other borrowed funds 11,100 -
Accrued interest and other liabilities 1,689 2,483
Federal income taxes payable - 35
Deferred income taxes 838 534
-------- --------
TOTAL LIABILITIES 344,544 263,959
COMMITMENTS AND CONTINGENT LIABILITIES - -
STOCKHOLDERS' EQUITY
Common stock, $1.00 and $2.03 par value in 1998 and 1997,
respectively; 30,000,000 shares authorized, 5,065,601
shares issued and 4,910,201 shares outstanding in 1998
and 5,044,181 shares issued and outstanding in 1997 5,065 10,242
Surplus 21,899 16,656
Retained earnings 6,264 3,637
Accumulated other comprehensive income; net unrealized
gains on available-for-sale securities, net of deferred
income taxes of $838 and $573, respectively 1,719 1,112
-------- --------
34,947 31,647
Less: treasury stock, 155,400 shares at cost (1,561) -
-------- --------
TOTAL STOCKHOLDERS' EQUITY 33,386 31,647
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $377,930 $295,606
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $10,787 $ 9,572 $ 8,084
Interest on investment securities:
Available-for-sale:
Taxable 3,698 3,406 3,435
Non-taxable 2,807 1,957 1,263
------- ------- -------
6,505 5,363 4,698
Held-to-maturity, taxable 6,485 5,006 4,590
------- ------- -------
Total interest on investment securities 12,990 10,369 9,288
------- ------- -------
TOTAL INTEREST INCOME 23,777 19,941 17,372
INTEREST EXPENSE
Interest on deposits 10,469 8,821 7,711
Interest on Federal Home Loan Borrowings 599 254 191
------- ------- -------
Total interest expense 11,068 9,075 7,902
------- ------- -------
Net interest income 12,709 10,866 9,470
PROVISION FOR LOAN LOSSES 612 877 655
------- ------- -------
Net interest income after provision for
loan losses 12,097 9,989 8,815
OTHER INCOME
Service fees 2,036 1,950 1,816
Net realized gains on sale of available-for-sale
securities 248 263 233
Other operating income 578 294 273
------- ------- -------
TOTAL OTHER INCOME 2,862 2,507 2,322
OTHER EXPENSES
Salaries and employee benefits 4,759 3,899 3,459
General and administrative 1,369 1,115 1,070
Data processing 899 795 703
FDIC assessments 32 29 2
Occupancy expenses, net 603 523 540
Equipment maintenance 584 516 454
Postage and printing fees 485 414 436
Professional fees 621 353 285
------- ------- -------
TOTAL OTHER EXPENSES 9,352 7,644 6,949
------- ------- -------
INCOME BEFORE FEDERAL INCOME
TAXES 5,607 4,852 4,188
Applicable federal income taxes 1,122 1,154 1,035
------- ------- -------
NET INCOME $ 4,485 $ 3,698 $ 3,153
======= ======= =======
Earnings per share:
Basic $0.89 $0.89 $0.81
===== ===== =====
Fully diluted $0.88 $0.88 $0.80
===== ===== =====
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1998 1997 1996
------ ------ -------
<S> <C> <C> <C>
NET INCOME $4,485 $3,698 $3,153
OTHER COMPREHENSIVE INCOME, NET OF TAX:
UNREALIZED GAINS ON SECURITIES:
Unrealized holding gains (losses) arising during
period 443 698 (944)
Reclassification adjustment for gains included
in net income 164 174 154
------ ------ ------
607 872 (790)
------ ------ ------
COMPREHENSIVE INCOME $5,092 $4,570 $2,363
====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Accumulated
Other
Common Stock Compre-
----------------------- Treasury Retained hensive
Shares Par Value Stock Surplus Earnings Income Total
---------- ---------- --------- ------- --------- ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 3,886,491 $ 4,817 $ - $ 5,219 $ 5,855 $1,030 $16,921
Par value change - 1,486 - 1,084 (2,570) - -
Cash dividends - - - - (1,413) - (1,413)
Comprehensive income:
Unrealized losses on investment
securities available-for-sale, net of
deferred income tax benefit of $406 - - - - - (790) (790)
Net income - - - - 3,153 - 3,153
-------
Total comprehensive income 2,363
--------- --------- -------- ------- ------- ----------- -------
Balance, December 31, 1996 3,886,491 6,303 - 6,303 5,025 240 17,871
Par value change - 1,590 - 1,594 (3,184) - -
Proceeds from exercise of stock options 7,690 14 - 9 - - 23
Cash dividends - - - - (1,902) - (1,902)
Net proceeds from issuance of stock
through initial public offering 1,150,000 2,335 - 8,750 - - 11,085
Comprehensive income:
Unrealized gains on investment
securities available-for-sale, net of
deferred income taxes of $449 - - - - - 872 872
Net income - - - - 3,698 - 3,698
-------
Total comprehensive income 4,570
--------- --------- -------- ------- ------- ----------- -------
Balance, December 31, 1997 5,044,181 10,242 - 16,656 3,637 1,112 31,647
Par value change - (5,220) - 5,220 - - -
Proceeds from exercise of stock options 21,420 43 - 23 - - 66
Cash dividends - - - - (1,858) - (1,858)
Repurchase of stock (155,400) - (1,561) - - - (1,561)
Comprehensive income:
Unrealized gains on investment
securities available-for-sale, net of
deferred income taxes of $312 - - - - - 607 607
Net income - - - - 4,485 - 4,485
-------
Total comprehensive income 5,092
--------- --------- -------- ------- ------- ----------- -------
Balance, December 31, 1998 4,910,201 $ 5,065 $(1,561) $21,899 $ 6,264 $1,719 $33,386
========= ========= ======== ======= ======= =========== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,485 $ 3,698 $ 3,153
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 430 412 406
Premium amortization net of discount accretion 105 (43) 46
Provision for loan losses 612 877 655
Net realized gains on available-for-sale securities (248) (263) (233)
Loss on disposal of bank premises and equipment
and other assets 99 43 90
Provision (benefit) for deferred taxes (8) (39) (18)
Changes in assets and liabilities:
Accrued interest receivable (668) (861) 118
Other assets (46) 33 49
Accrued expenses 19 62 (155)
Accrued interest payable 209 131 130
Federal income taxes payable/receivable (49) (223) 258
-------- -------- --------
455 129 1,346
-------- -------- --------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 4,940 3,827 4,499
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities (66,856) (36,387) (33,908)
Proceeds from sales of available-for-sale securities 28,008 21,359 29,311
Proceeds from maturities of available-for-sale securities 9,263 2,678 1,972
Purchases of held-to-maturity securities (84,599) (34,840) (18,080)
Proceeds from maturities of held-to-maturity securities 40,553 26,490 20,495
Loans originated, net of principal collected (9,231) (12,258) (24,169)
Proceeds from sales of other real estate and repossessed
assets 176 122 169
Cash paid for bank premises and equipment (971) (611) (170)
Proceeds from sales of bank premises and equipment - - 83
-------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES (83,657) (33,447) (24,297)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, NOW, savings, and
money market accounts 38,871 12,665 14,810
Proceeds from sales of time deposits, net of payments
for maturing time deposits 31,139 10,183 14,502
Net change in other borrowings 11,100 - (3,900)
Net proceeds from issuance of common stock 66 11,108 -
Purchase of common stock (1,561) - -
Dividends paid (2,880) (1,449) (1,221)
-------- -------- --------
NET CASH PROVIDED BY FINANCING
ACTIVITIES 76,735 32,507 24,191
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (1,982) 2,887 4,393
CASH AND CASH EQUIVALENTS AT JANUARY 1 15,276 12,389 7,996
-------- -------- --------
CASH AND CASH EQUIVALENTS AT DECEMBER 31 $ 13,294 $ 15,276 $ 12,389
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of CNBT Bancshares, Inc. (a Texas corporation), and its wholly-owned
subsidiaries (collectively referred to as the "Bank"). CNBT Bancshares, Inc.
was incorporated under the laws of the State of Texas during April 1998,
primarily to serve as a holding company for Citizens National Bank of Texas
which was initially formed in 1983. The reorganization into the holding company
structure was effective July 1998 and was accounted for in a manner similar to a
pooling of interests due to its common ownership. All significant intercompany
transactions and balances have been eliminated upon consolidation.
Basis of Accounting: The accounting and reporting policies of the Bank conform
to generally accepted accounting principles and prevailing practices within the
banking industry.
Nature of Operations: CNBT Bancshares, Inc. and its wholly-owned subsidiaries
provide a variety of banking services to local individuals and businesses
through its six locations in Houston and Sugar Land, Texas. Its primary deposit
products are demand deposits, certificates of deposit, and IRA's, and its
primary lending products are commercial business, real estate mortgage, and
installment loans.
Use of Estimates: The preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Investment Securities: Bonds, notes, and debentures for which the Bank has the
positive intent and ability to hold to maturity are classified as held-to-
maturity and are carried at cost. The initial premiums and discounts incurred
to acquire the investment are recognized in interest income using methods
approximating the interest method.
Securities to be held for indefinite periods of time, including securities that
management intends to use as part of its asset/liability strategy, or that may
be sold in response to changes in interest rates, changes in prepayment risk,
the need to increase regulatory capital or other similar factors, are classified
as available-for-sale and are carried at fair value. Fair values of securities
are estimated based on available market quotations.
Unrealized holding gains and losses, net of tax, on available-for-sale
securities are reported as a net amount in a separate component of stockholders'
equity until realized. Realized gains and losses on the sale of available-for-
sale securities and held-to-maturity securities, if any, are determined using
the specific-identification method. The Bank reviews its financial position,
liquidity and future plans in evaluating the criteria for classifying investment
securities. Securities are classified among categories at the time the
securities are purchased. Declines in the fair value of individual held-to-
maturity and available-for-sale securities below their cost that are other than
temporary will result in the write-down of the individual securities to their
fair value. The related write-downs, if any, would be included in earnings as
realized losses. The Bank believes that none of the unrealized losses should be
considered other than temporary. The initial premiums and discounts incurred to
acquire the investment are recognized in interest income using the interest
method over the period of maturity. The Bank does not maintain a trading
portfolio.
Investments in Federal Home Loan Bank (the "FHLB") stock and Federal Reserve
Bank stock are considered restricted investments and classified as other
securities in the available-for-sale category. These investments are carried at
their acquisition cost which approximates fair value. Institutions that are
members of the Federal Reserve system and the FHLB system are required to
maintain a certain level of investment in these stocks and may be required to
purchase additional stock if a certain level of borrowings are reached with
these institutions.
Pursuant to the Bank's adoption of Statement of Financial Accounting Standards
("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities,
the Bank elected to transfer certain securities from the held-to-maturity
category to the available-for-sale category as part of a reassessment of
interest-rate risk. See Note B for further discussion.
F-8
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Bank Premises and Equipment: Bank premises and equipment are carried at original
cost less accumulated depreciation. Depreciation is computed on the straight-
line basis over the estimated useful lives of 5 to 40 years for the Bank
building and improvements and 4-7 years for the other equipment. Costs incurred
for repairs and maintenance are expensed in the period incurred.
Loans and Allowance for Loan Losses: Installment loans are made on a discount
basis. The unearned discount applicable to such loans is taken into income
monthly, using the sum-of-the-period-balance method. Subsequent to 1998, all
new loans originated will be calculated using the simple interest method on
daily balances of the principal amount outstanding. Interest on all other loans
is calculated by using the simple interest method on daily balances of the
principal amount outstanding. The allowance for loan losses is maintained at a
level considered adequate to provide for potential loan losses. The allowance
is increased by provisions charged to operating expense and reduced by net
charge-offs. The level of the allowance is based on management's evaluation of
potential losses in the loan portfolio, as well as prevailing and anticipated
economic conditions. The evaluation of the adequacy of loan collateral is often
based upon estimates and appraisals. Because of changing economic conditions,
the valuation determined from such estimates and appraisals may also change.
Accordingly, the Bank may ultimately incur losses which vary from management's
current estimates. Adjustments to the allowance for loan losses will be
reported in the period such adjustments become known or are reasonably
estimable. Accrual of interest is discontinued on a loan when management
believes, after considering economic and business conditions and collection
efforts, that the borrower's financial condition is such that collection of
interest is doubtful.
Effective January 1, 1995, the Bank adopted SFAS No. 114, Accounting for
Creditors for Impairment of a Loan, as amended by SFAS No. 118. Under SFAS No.
114, as amended, a loan is considered impaired, based on current information and
events, if it is probable that the Bank will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. A loan is not considered impaired during a period of delay
in payment if the Bank expects to collect all amounts due, including interest
past due. The Bank generally considers a period of delay in payment to include
delinquency up to 90 days. Accordingly, for purposes of applying SFAS No. 114,
impaired loans have been defined as all nonaccrual loans. The measurement of
impaired loans is based on the present value of expected future cash flows
discounted at the loan's effective interest rate or the loan's observable market
price or based on the fair value of the collateral if the loan is collateral-
dependent. If the measure of the impaired loan is less than the recorded
investment in the loan, an impairment is recognized through a valuation
allowance and a corresponding charge to operations.
Loans Held for Sale: Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated market value in
the aggregate. Net unrealized losses, if any, are recognized through a
valuation allowance by charges to income.
Federal Income Taxes: The liability method is used in accounting for income
taxes, whereby tax rates are applied to cumulative temporary differences based
on when and how they are expected to affect future tax returns. Deferred tax
assets and liabilities are adjusted for tax rate changes in the year changes are
enacted. The realizability of deferred tax assets are evaluated annually and a
valuation allowance is provided if it is more likely than not that the deferred
tax assets will not give rise to future benefits in the Bank's tax returns. The
Bank files its federal income tax return on a consolidated basis.
Other Real Estate Owned: Real estate acquired by foreclosure is carried in other
assets at the lower of recorded investment in the property or its fair value.
Prior to foreclosure, the value of the underlying loan is written down to the
fair market value of the real estate to be acquired by a charge to the allowance
for loan losses, if necessary. Any subsequent writedowns are charged against
operating expenses. Operating expenses of such properties, net of related
income and gains and losses on their disposition are included in other expenses.
F-9
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Long-Lived Assets: The Bank assesses other-than-temporary impairments of its
long-lived assets on a quarterly basis whenever changes or events indicate that
the carrying amount of an asset is not recoverable. Impairment is measured
based upon the present value of expected cash flows of the asset and its
eventual disposition. During the years ended December 31, 1998, 1997 and 1996,
no impairments of long-lived assets were considered necessary by management.
Employee Stock Options: The Bank has a stock option plan. This plan reserves
shares for the granting of options to key employees of the Bank to purchase
common stock at a price which may be less than the fair market value on the date
of grant.
Earnings Per Share: Effective December 15, 1997, the Bank adopted FASB No. 128,
Earnings per Share, which changes the manner in which earnings per share (EPS)
amounts are calculated and presented. Basic earnings per common share is
calculated by dividing net income by the weighted average number of common
shares outstanding during the period presented. Fully dilutive earnings per
common share is calculated by dividing net income by the weighted average number
of common shares and common share equivalents. Stock options are regarded as
common stock equivalents and are computed using the treasury stock method.
Stock options will have a dilutive effect under the treasury stock method only
when the average market price of the common stock during the period exceeds the
exercise price of the stock options.
Reclassifications: For comparable purposes, certain amounts at December 31, 1997
and 1996 have been reclassified to conform with classifications at December 31,
1998.
Other Accounting Pronouncements: Effective October 1, 1997, the Bank adopted
SFAS No. 123, Accounting for Stock-based Compensation, which requires expanded
disclosures of stock-based compensation arrangements with employees and
encourages, but does not require, companies to record compensation cost for
stock-based employee compensation plans at fair value. As permitted by this
statement, the Bank continues to follow the rules to measure compensation as
outlined in Accounting Principles Bulletin No. 25, but the Bank is now required
to disclose pro forma amounts of net income and earnings per share that would
have been reported under the fair value recognition provisions of SFAS No. 123.
The adoption of SFAS No. 123 had no material impact on the results of operations
or financial condition of the Bank.
Effective January 1, 1997, the Bank adopted SFAS No. 125, Accounting for
Transfers and Servicing of Assets and Extinguishments of Liabilities. This
statement requires that accounting and reporting standards for the transfer of
and servicing of financial assets and extinguishments of liabilities be based on
consistent application of financial-components approach that focuses on control.
Under this approach, after a transfer of financial assets, the Bank recognizes
the financial and servicing assets it controls and the liabilities it has
incurred, derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. This statement provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. Provisions of SFAS No. 125 that deal
with securities lending, repurchase and dollar repurchase agreements and the
recognition of collateral were adopted January 1, 1998 as provided by SFAS No.
127 which allowed for the deferral of these items.
Effective December 15, 1997, the Bank adopted SFAS No. 129, Disclosure of
Information about Capital Structure, which establishes standards for disclosing
information about the Bank's capital structure. This statement does not change
any previous disclosures but consolidates them in this statement for ease of
retrieval and for greater visibility.
F-10
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Effective for 1998, the Bank adopted SFAS No. 130, Reporting Comprehensive
Income, which establishes standards for reporting and disclosure of
comprehensive income and its components. Comprehensive income is defined as the
change in equity during a period. Comprehensive income includes net income and
other comprehensive income which refers to unrealized gains and losses that
under generally accepted accounting principles are excluded from net income.
Effective for 1998, the Bank adopted SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information, which establishes standards and
requirements for public enterprises regarding information about operating
segments in annual financial statements. This statement also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. Operating segments are components of an enterprise that
are evaluated regularly by the chief executive officer in deciding how to
allocate resources and in assessing performance.
Effective November 30, 1998, the Bank adopted SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. It requires
that the Bank recognize all derivatives as either assets or liabilities in the
statements and to measure these instruments at fair value. The accounting for
changes in the fair value of a derivative depends on the intended use of the
derivative and the resulting designation.
Statements of Cash Flows: For purposes of the Consolidated Statements of Cash
Flows, cash equivalents include all cash and amounts due from depository
institutions, and interest-bearing deposits in other banks, all of which have
maturities of three months or less.
Cash and cash equivalents include the following:
<TABLE>
<CAPTION>
December 31,
----------------------------
1998 1997 1996
------- ------- --------
<S> <C> <C> <C>
Cash and due from banks $13,070 $12,099 $10,154
Due from banks - interest bearing overnight
funds 224 3,177 2,235
------- ------- -------
Cash and cash equivalents $13,294 $15,276 $12,389
======= ======= =======
The following is supplemental information with respect to the Consolidated Statements of Cash Flows:
Year Ended December 31,
---------------------------
1998 1997 1996
------- ------- -------
Cash paid for:
Interest $10,859 $ 8,944 $ 7,772
Income taxes $ 1,180 $ 1,416 $ 795
Non-cash activity:
Loans transferred to other real
estate or repossessed assets $ 308 $ 112 $ 308
Par value adjustment to common
stock $ 5,220 $ 3,184 $ 2,570
Transfer of held-to-maturity
securities to available-for-sale
securities $41,090 $ - $ -
Change in unrealized gain (loss)
on available-for-sale securities $ 862 $ 1,285 $(1,270)
</TABLE>
F-11
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE B - INVESTMENT SECURITIES
The amortized cost and estimated market values of investments in debt and other
securities at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Available-for-Sale Securities
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Government and agency securities $ 62,078 $ 927 $ - $ 63,005
Mortgage-backed securities 42,057 172 132 42,097
Obligations of state and political
subdivisions 55,315 1,757 60 57,012
Other securities 2,682 - - 2,682
-------- ------ ---- --------
Totals $162,132 $2,856 $192 $164,796
======== ====== ==== ========
Held-to-Maturity Securities
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
U.S. Government and agency securities $ 9,734 $ 44 $ 30 $ 9,748
Mortgage-backed securities 69,994 188 215 69,967
-------- ------ ---- --------
Totals $ 79,728 $ 232 $245 $ 79,715
======== ====== ==== ========
The amortized cost and estimated market values of investments in debt and other securities at December 31, 1997 are as follows:
Available-for-Sale Securities
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
U.S. Government and agency securities $17,085 $ 262 $ 1 $17,346
Mortgage-backed securities 22,757 259 - 23,016
Obligations of state and political
subdivisions 48,884 1,363 81 50,166
Other securities 2,508 - - 2,508
------- ------ ---------- -------
Totals $91,234 $1,884 $82 $93,036
======= ====== ========== =======
</TABLE>
F-12
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE B - INVESTMENT SECURITIES (CONTINUED)
<TABLE>
<CAPTION>
Held-to-Maturity Securities
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Government and agency securities $49,055 $ 982 $ 24 $50,013
Mortgage-backed securities 27,740 195 379 27,556
------- ------ ---- -------
Totals $76,795 $1,177 $403 $77,569
======= ====== ==== =======
</TABLE>
The amortized cost and estimated market value of securities held-to-maturity and
securities available-for-sale at December 31, 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>
Available-for-Sale Securities Held-to-Maturity Securities
----------------------------- ---------------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Due in one year or less $ 6,635 $ 6,689 $ 2,960 $ 3,006
Due after one year through five years 24,922 25,061 30,950 30,914
Due after five years through ten years 56,347 57,267 23,755 23,797
Due after ten years 71,546 73,097 22,063 21,998
Other securities 2,682 2,682 - -
-------- -------- ------- ------------
Totals $162,132 $164,796 $79,728 $79,715
======== ======== ======= ============
</TABLE>
Gross realized gains and losses on sales of available-for-sale
securities were:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1998 1997 1996
-------- ------- ------------
<S> <C> <C> <C>
Gross realized gains:
U.S. Government and agency securities $ - $ 72 $ -
Obligations of state and political subdivisions 248 204 268
Mortgage-backed securities - - 105
-------- ------- ------------
$ 248 $ 276 $ 373
======== ======= ============
Gross realized losses:
U.S. Government and agency securities $ - $ - $ 93
Obligations of state and political subdivisions - - 38
Mortgage-backed securities - 13 9
-------- ------- ------------
$ - $ 13 $ 140
======== ======= ============
</TABLE>
F-13
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE B - INVESTMENT SECURITIES (CONTINUED)
In November 1998, the Bank adopted SFAS No. 133, Accounting for Derivative
Investments and Hedging Activities, which at the time of adoption provided for
the reassessment of the appropriateness of the classification of all securities
based upon the assessment of various hedging transactions and/or market
interest-rate risk. Such transfers from the held-to-maturity category to the
available-for-sale category at the date of initial adoption shall not call into
question an entity's intent to hold other debt securities to maturity in the
future. At initial adoption, the Bank transferred $41,090 from the held-to-
maturity category into the available-for-sale category which had a market value
of $41,589 with the unrealized portion being recognized as a separate component
of stockholders' equity.
At December 31, 1998 and 1997, investment securities with a carrying value of
$3,392 and $3,436 and a market value of $3,436 and $3,503, respectively, were
pledged to secure public deposits and for other purposes required or permitted
by law.
NOTE C - LOANS
Major classifications of loans are as follows:
<TABLE>
<CAPTION>
December 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Commercial and industrial $ 23,836 $ 25,230
Real estate - construction 11,144 10,673
Real estate - 1-4 family 11,161 10,808
Real estate - other 26,403 18,224
Consumer 42,767 41,711
-------- --------
115,311 106,646
Unearned discount (3,951) (3,771)
-------- --------
111,360 102,875
Allowance for loan losses (1,183) (1,009)
-------- --------
$110,177 $101,866
======== ========
</TABLE>
Changes in the allowance for loan losses account are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------
1998 1997 1996
------ -------- --------
<S> <C> <C> <C>
Balance at beginning of year $1,009 $ 687 $ 484
Provision charged to operations 612 877 655
Recoveries 131 81 26
Loans charged off (569) (636) (478)
------ -------- --------
Balance at end of year $1,183 $ 1,009 $ 687
====== ======== ========
</TABLE>
For income tax purposes, $438 and $495 at December 31, 1998 and 1997,
respectively, has been accumulated in the allowance for loan losses. This
amount is based on the Internal Revenue Code formula.
At December 31, 1998 and 1997, the Bank had loans totaling $239 and $279,
respectively, on which the accrual of interest had been discontinued. The Bank
does not consider these amounts to be material. If interest on these loans had
been accrued, such income would have amounted to $17 and $30 for the years ended
December 31, 1998 and 1997, respectively.
F-14
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE D - BANK PREMISES AND EQUIPMENT
Major classifications of bank premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
December 31,
---------------
1998 1997
------ ------
<S> <C> <C>
Land $2,105 $1,542
Building and improvements 3,191 3,072
Equipment 3,187 2,922
Automobiles 24 19
------ ------
8,507 7,555
Less: accumulated depreciation 2,594 2,171
------ ------
Total bank premises and equipment $5,913 $5,384
====== ======
</TABLE>
Depreciation expense totaled $430, $412 and $406 for the years ended December
31, 1998, 1997 and 1996, respectively, and are included in occupancy expense and
equipment maintenance in the Consolidated Statements of Income.
NOTE E - DEPOSITS
<TABLE>
<CAPTION>
Scheduled maturities of time deposits are summarized as follows: December 31,
-------------------
1998 1997
-------- --------
<S> <C> <C>
Maturity:
Zero to one year $112,436 $ 82,624
One year to two years 18,491 20,721
Two years to three years 5,754 1,134
Three years to four years 2,451 3,419
Four years to five years 2,354 2,484
Thereafter 35 -
-------- --------
$141,521 $110,382
======== ========
</TABLE>
NOTE F - APPLICABLE FEDERAL INCOME TAXES
Total income tax provision (benefit) in the Consolidated Statements of Income
are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Current $1,130 $1,193 $1,053
Deferred (8) (39) (18)
------ ------ ------
$1,122 $1,154 $1,035
====== ====== ======
</TABLE>
Applicable income tax expense of $50, $63 and $58 for the years ending December
31, 1998, 1997 and 1996, respectively, on security gains is included in the
provision for income taxes.
F-15
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE F - APPLICABLE FEDERAL INCOME TAXES (CONTINUED)
The types of temporary differences between the tax bases of assets and
liabilities and their financial reporting amounts that give rise to deferred
income tax assets (and allowance, if applicable) and liabilities and their
approximate tax effects are as follows:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------------- ----------------------
Temporary Tax Temporary Tax
Differences Effect Differences Effect
------------ -------- ------------ -------
<S> <C> <C> <C> <C>
Premises and equipment $ - $ - $ 21 $ 7
Allowance for loan losses 745 253 514 175
------- ------- ------- -----
Deferred income tax assets $ 745 253 $ 535 182
======= =======
Premises and equipment $ (27) (9) $ - -
Unrealized gain on securities
available-for-sale (2,604) (885) (1,685) (573)
Accretion of discount on treasury
and tax exempt securities (578) (197) (422) (143)
------- ------- ------- -----
Deferred income tax liabilities $(3,209) (1,091) $(2,107) (716)
======= ------- ======= -----
Net deferred income tax liabilities $ (838) $(534)
======= =====
</TABLE>
Applicable federal income taxes for financial reporting purposes differ from the
amount computed by applying the statutory federal income tax rate for the
reasons noted in the table below:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Income taxes at statutory rate (34%) $1,906 $1,650 $1,424
Nontaxable investment income (954) (655) (398)
Other 170 159 9
------ ------ ------
Applicable federal income taxes $1,122 $1,154 $1,035
====== ====== ======
</TABLE>
NOTE G - COMMITMENTS AND CONTINGENT LIABILITIES
The Bank is committed under a long-term contractual agreement for its data
processing services. The agreement, expiring in 2001, contains certain
escalation charges allowing the service bureau to increase its fees if the Bank
sustains a certain level of growth. Lease payments are based upon the level of
activity with the service bureau without provisions for minimum payments.
The Bank is committed under a lease for the land for their premises which
expires February 2001. The Bank has the option to renew the lease at certain
points in time and also has the option to purchase the land for fair market
value at the end of the lease term.
The Bank also leases three facilities for its branch locations under
noncancellable operating leases, which have expiration dates through June 2002.
F-16
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE G - COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Minimum future rental payments under these noncancellable operating leases and
agreements which have initial or remaining terms in excess of one year as of
December 31, 1998, for each of the next five years and in the aggregate are:
<TABLE>
<CAPTION>
Year Ending December 31,
- ------------------------
<S> <C>
1999 $138
2000 119
2001 40
2002 15
2003 -
Thereafter -
----
Total future minimum payments $312
====
</TABLE>
Total rent expense amounted to $169, $135 and $121 for the years ended December
31, 1998, 1997 and 1996, respectively.
The Bank is party to miscellaneous legal proceedings, which arise in the
ordinary course of business. While the outcomes cannot be predicted with
certainty, management believes that the ultimate resolution will not have a
material adverse impact on the Bank's financial condition or results of
operation.
NOTE H - RELATED PARTY TRANSACTIONS
At December 31, 1998 and 1997, certain officers, directors and certain officers'
and directors' companies in which they have ten percent or more beneficial
ownership in those companies, were indebted to the Bank in the amount of $1,510
and $675 for loans and in the amount of $123 and $100 for unfunded commitments,
respectively.
Following is an analysis of activity with respect to such loans:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Balance at beginning of period $ 675 $1,171
New loans 1,204 465
Repayments (369) (961)
------ ------
Balance at end of period $1,510 $ 675
====== ======
</TABLE>
Additionally, at December 31, 1998 and 1997, these certain officers, directors
and certain officers' and directors' companies had deposits in the Bank in the
aggregate totaling $4,037 and $5,034, respectively.
F-17
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE I - OTHER BORROWED FUNDS
Other borrowings generally represent borrowings from the Federal Home Loan Bank
(the "FHLB"). FHLB advances may be utilized from time to time as either a
short-term funding source (maturities ranging from one to thirty-five days) or a
longer-term funding source and are secured by any of the following: specific
investment securities, blanket pledge on investments, a percentage of mortgage
loans or FHLB stock. Information relating to these borrowings is summarized as
follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997 1996
-------- -------- -------
<S> <C> <C> <C>
Other borrowings:
Average $11,086 $ 4,582 $3,676
Period-end 11,100 - -
Maximum month-end balance during period 21,669 15,100 7,500
Interest rate:
Average 5.40% 5.53% 5.20%
Period-end (weighted) 5.38% - -
</TABLE>
Interest expense on borrowings totaled $599, $254 and $191 for the years ended
December 31, 1998, 1997 and 1996, respectively. The year end balance of $11,100
is comprised of short-term borrowings of $1,100 at a fixed rate of 5.55% and two
long-term borrowings of $5,000 each at fixed rates of 5.335% and 5.385%,
respectively, due March 2003 and secured by investments and a percentage of 1-4
family real estate loans.
NOTE J - INCENTIVE STOCK OPTION PLAN
The Bank has an incentive stock option plan under which shares of common stock
are reserved for the purpose of granting stock options to certain key employees
at the discretion of the Board of Directors. These stock options can be
exercised at a price ranging from $2.75 to $10.50 per share and expire at
various periods through the year 2008.
The Bank has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB No. 25") and related
interpretations in accounting for its stock-based compensation arrangements as
opposed to the alternative fair value accounting provided for under SFAS No.
123, Accounting for Stock-Based Compensation. Under APB No. 25, no compensation
expense is recognized because the exercise price of the Bank's employee stock
options equals the market price of the underlying stock on the date of grant.
The following is a summary of changes in total options outstanding (all option
amounts have been restated for the stock split and stock dividends, as discussed
in Note M):
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Options outstanding at January 1, 1996 96,140 $ 2.75 to $ 6.20
Granted -
-------
Options outstanding at December 31, 1996 96,140 $ 2.75 to $ 6.20
Granted 95,000 $ 9.00
Exercised (7,690) $ 2.75 to $ 3.03
Canceled (2,500) $ 9.00
-------
Options outstanding at December 31, 1997 180,950 $ 2.75 to $ 9.00
Granted 10,000 $10.50
Exercised (21,420) $ 2.75 to $ 5.79
Canceled -
-------
Options outstanding at December 31, 1998 169,530 $ 2.75 to $10.50
=======
</TABLE>
F-18
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE J - INCENTIVE STOCK OPTION PLAN (CONTINUED)
Of the 169,530 outstanding options at December 31, 1998, 50,090 options were
exercisable with the remaining 119,440 options vesting over a period of up to 10
years.
While the Bank will continue to use APB No. 25, proforma information regarding
net income and earnings per shares is required by SFAS No. 123, which also
requires that the information be determined as if the Bank has accounted for its
employee stock options granted subsequent to December 31, 1994 under the fair
value method prescribed by SFAS No. 123.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, the model requires the input of highly subjective
assumptions including the expected stock price volatility. Because the Bank's
employee stock options have characteristics different from those of traded
options, and because changes in input assumptions can materially affect the fair
value estimate, the existing model may not necessarily provide the only measure
of fair value for the employee stock options. The fair value for these options
was estimated at the date of grant using the following weighted-average
assumptions: risk-free interest rates of 5.66%; 4.71% dividend yield; a
volatility factor of the expected market price of the Bank's common stock of
11.46%; and a weighted-average expected life of the options of 10 years.
Compensation cost actually charged to operations for those individuals was
$1,526, $1,252 and $573 for the years ended December 31, 1998, 1997 and 1996,
respectively. The impact of applying and recognizing compensation costs
pursuant to SFAS No. 123 is immaterial to the Bank's financial position and
results of operations and did not change the earning per share amounts currently
disclosed.
NOTE K - COMPENSATION AGREEMENTS
The Company has severance agreements with six key employees. The agreement
promises severance benefits to the specified employees if, following a change or
potential change in control, the employees are terminated without cause or
resign for good reason during the term of the agreement. Severance benefits
include 1) a lump sum payment equal to 2.99 times the employee's annual base
salary in effect when employment ends or, if higher, annual base salary in
effect immediately prior to change or potential change in control, and 2)
entitlement to any COBRA rights for group insurance benefit continuation for
employees and employees' dependents at employees' own expense.
NOTE L - BENEFIT PLAN
The Bank has a 401(k) and profit sharing plan (the "Plan") that covers all
employees who meet certain age and service requirements. Employees may provide
contributions to the Plan through salary deferrals. Additionally, the Bank may
provide voluntary contributions at their discretion. The Bank made
contributions to the Plan of $200, $180 and $128 for the years ended December
31, 1998, 1997 and 1996, respectively. Subsequent to the year ended December
31, 1998, the Bank amended the Plan to be participant directed.
F-19
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE M - DIVIDEND AND STOCK TRANSACTIONS
Certain banking regulations may limit the amount of dividends that may be paid
without prior approval of the Bank's regulatory agency. All dividends were
within the specified limits.
During July 1998, the Board of Directors with the approval of the stockholders
granted the formation of two bank holding companies. With the formation of
these holding companies, the Bank's $2.03 par value shares were exchanged for
shares of the bank holding companies at $1.00 par value. This change in par
value was accomplished through a corresponding transfer of approximately $5,220
between common stock and surplus.
During the year ended December 31, 1998, cash dividends were authorized as
follows: a dividend of $.09 per share was declared to stockholders of record on
April 2, 1998 and paid April 15, 1998, totaling $455. A dividend of $.09 per
share was declared to stockholders of record on June 30, 1998 and paid July 15,
1998, totaling $456. A dividend of $.09 per share was declared to stockholders
of record on September 30, 1998 and paid October 15, 1998, totaling $456. A
dividend of $.10 per share was declared to stockholders of record on December
31, 1998 and paid January 15, 1999, totaling $491.
During the period October through December 1998, the Bank repurchased 155,400
common stock shares for approximately $1,561.
During July 1997, the Board of Directors authorized an increase in the
authorized shares available for issuance from 5,000,000 shares to 30,000,000
shares.
During the year ended December 31, 1997, a dividend of $.10 per share was
declared to stockholders of record on May 15, 1997 and paid May 30, 1997,
totaling $389. A dividend of $.30 per share was declared to stockholders of
record on December 31, 1997 and paid January 15, 1998, totaling $1,513. On
March 25, 1997, the Board of Directors authorized a 10% stock dividend
representing 353,797 shares of common stock was declared to stockholders of
record on April 30, 1997 and also authorized an increase in the par value of
common stock from $1.622 (after effect of stock dividend) to $2.03 per share
which effectively increased common stock by $1,590 and surplus by $1,594, with a
corresponding charge to retained earnings of $3,184.
During the year ended December 31, 1996, a dividend of $.09 per share was
declared to stockholders of record on June 3, 1996 and paid June 15, 1996,
totaling $353. A dividend of $.27 per share was declared to shareholders of
record on December 31, 1996 and paid January 15, 1997, totaling $1,060. In
April 1996, the Board of Directors authorized an increase in the par value of
common stock from $1.50 to $1.622 (after effect of stock dividend) per share
which effectively increased common stock by $1,486 and surplus by $1,084, with a
corresponding charge to retained earnings of $2,570. Additionally, during the
year ended December 31, 1996, a 10% stock dividend representing 321,098 shares
of common stock was declared to stockholders of record on April 30, 1996.
All references in the accompanying financial statements to the number of common
shares and per share amounts have been restated to reflect any stock splits
and/or stock dividends.
NOTE N - INITIAL PUBLIC OFFERING
The Bank filed a registration statement with the Office of the Comptroller of
the Currency in October 1997 to register the sale of 1,150,000 shares of its
common stock. The net proceeds to the Bank from the sale of the shares offered
by the Bank (after deducting underwriting commissions and other expenses of
$990) were $11,085. The proceeds from the offering are to be used for expansion
of existing facilities and establishments of new locations and for other working
capital purposes.
F-20
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE O - EARNINGS PER COMMON SHARE
Earnings per common share were computed as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net income $ 4,485 $ 3,698 $ 3,153
========== ========== ==========
Divided by weighted average common shares and
common share equivalents:
Weighted average common shares 5,024,329 4,161,432 3,886,491
Weighted average common share equivalents 80,571 62,612 54,693
---------- ---------- ----------
Total average common share and common share
equivalents 5,104,900 4,224,044 3,941,184
========== ========== ==========
Basic earnings per common share $ .89 $ .89 $ .81
========== ========== ==========
Fully dilutive earnings per common share $ .88 $ .88 $ .80
========== ========== ==========
</TABLE>
NOTE P - COMPREHENSIVE INCOME
In June 1997, SFAS No. 130, Reporting Comprehensive Income was issued.
Comprehensive income is comprised of net income and all changes to stockholders'
equity, except those due to investments by owners (changes in paid-in- capital)
and distributions to owners (dividends). This statement is effective for fiscal
years beginning after December 15, 1997. For the years ended December 31, 1998,
1997 and 1996, unrealized holding gain (losses) on debt and equity securities
available-for-sale is the Bank's only other comprehensive income component.
Prior periods have been reclassified to reflect the application of the
provisions of SFAS No. 130. The following table sets forth the amounts of other
comprehensive income included in equity along with the related tax effect for
the years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------------
1998 1997 1996
--------------------------- --------------------------- -----------------------------
Tax Net Tax Net Tax Net
Expense of Tax Expense of Tax Expense of Tax
Pretax (Benefit) Amount Pretax (Benefit) Amount Pretax (Benefit) Amount
------ --------- ------ ------ --------- ------ ------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net unrealized gain (loss)
on securities available-
for-sale $671 $(228) $443 $1,058 $(360) $698 $(617) $(327) $(944)
Reclassification adjustment
for net gain (loss)
realized in net income 248 (84) 164 263 (89) 174 233 (79) 154
---- ----- ------ ------ -------- ------ ------ -------- ------
Other comprehensive income $919 $(312) $607 $1,321 $(449) $872 $(384) $(406) $(790)
==== ===== ====== ====== ======== ====== ====== ======== ======
</TABLE>
F-21
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE Q - REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to risk-
weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes that the Bank meets all capital
adequacy requirements to which it is subject.
As of December 31, 1997 (the most recent review), the Office of the Comptroller
of the Currency categorized the Bank as well-capitalized under the regulatory
framework for prompt corrective action as of its most recent notification. To
be categorized as well-capitalized the Bank must maintain minimum total risk-
based, Tier I risk-based, and Tier I leverage ratios as set forth in the table.
As of December 31, 1998, there are no conditions or events since that
notification that management believes have changed the institution's category.
<TABLE>
<CAPTION>
The Bank's actual capital amounts and ratios are also presented in the table.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------- -------------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
---------- --------- --------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total Capital
(to Risk Weighted Assets) $32,850 21.20% $12,395 *8.0% $15,494 *10.0%
Tier I Capital
(to Risk Weighted Assets) 31,667 20.44% 6,197 *4.0% 9,296 *6.0%
Tier I Capital
(to Average Assets) 31,667 9.37% 13,524 *4.0% 16,905 *5.0%
As of December 31, 1997:
Total Capital
(to Risk Weighted Assets) $31,543 22.13% $11,404 *8.0% $14,255 *10.0%
Tier I Capital
(to Risk Weighted Assets) 30,535 21.42% 5,702 *4.0% 8,553 *6.0%
Tier I Capital
(to Average Assets) 30,535 11.10% 11,004 *4.0% 13,755 *5.0%
- -------------
* [Greater Than Or Equal To]
</TABLE>
NOTE R - CONCENTRATION OF CREDIT RISK
The Bank's operations are affected by various risk factors, including interest-
rate risk, credit risk and risk from geographic concentration of lending
activities. Management attempts to manage interest-rate risk through various
asset/liability management techniques designed to match maturities of assets and
liabilities. Loan policies and administration are designed to provide assurance
that loans will only be granted to credit-worthy borrowers, although credit
losses are expected to occur because of subjective factors and factors beyond
the control of the Bank. In addition, the Bank is a community bank and, as
such, is mandated by the Community Reinvestment Act and other regulations to
conduct most of its lending activities within the geographic area where it is
located. As a result, the Bank and its borrowers may be especially vulnerable
to the consequences of changes in the local economy.
F-22
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE S - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Bank is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers and to
reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit and standby letters of credit.
Those instruments involve, to varying degrees, elements of credit and interest-
rate risk in excess of the amount recognized in the Consolidated Balance Sheets.
The contract or notional amounts of those instruments reflect the extent of
involvement the Bank has in particular classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual notional amount of those
instruments. The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments.
Unless noted otherwise, the Bank does not require collateral or other security
to support financial instruments with credit risk.
Commitments to Extend Credit. Commitments to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Bank evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained if deemed necessary by the Bank upon extension of
credit is based on management's credit evaluation of the counterparty.
Collateral held varies, but may include accounts receivable, inventory,
property, plant, equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements, including
commercial paper, bond financing, and similar transactions. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. The Bank holds marketable securities
and certificates of deposit as collateral supporting those commitments for which
collateral is deemed necessary. The extent of collateral held for those
commitments varies from 0 percent to 100 percent.
NOTE T - FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair Values of Financial Instruments: Disclosure about fair value of financial
instruments provided below is the information required by SFAS No. 107,
Disclosures about Fair Value of Financial Instruments. These amounts represent
estimates of fair values at a point in time. Significant estimates regarding
economic conditions, loss experience, risk characteristics associated with
particular financial instruments and other factors were used for the purposes of
this disclosure. These estimates are subjective in nature and involve matters
of judgment. Therefore, they cannot be determined with precision. Changes in
the assumptions could have a material impact on the amounts estimated.
While the estimated fair value amounts are designed to represent estimates of
the amounts at which these instruments could be exchanged in a current
transaction between willing parties, many of the Bank's financial instruments
lack an available trading market as characterized by willing parties engaging in
an exchange transaction. In addition, it is the Bank's intent to hold most of
its financial instruments to maturity and, therefore, it is not probable that
the fair values shown will be realized in a current transaction.
The estimated fair values disclosed do not reflect the value of assets and
liabilities that are not considered financial instruments. In addition, the
value of long-term relationships with depositors (core deposit intangibles) and
other customers is not reflected. The value of these items is significant.
F-23
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE T - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
Because of the wide range of valuation techniques and the numerous estimates
which must be made, it may be difficult to make reasonable comparisons of the
Bank's fair value information to that of other financial institutions. It is
important that the many uncertainties discussed above be considered when using
the estimated fair value disclosures and to realize that because of these
uncertainties, the aggregate fair value amount should in no way be construed as
representative of the underlying value of the Bank.
The following methods and assumptions were used by the Bank in estimating its
fair values of financial instruments as disclosed herein:
CASH AND DUE FROM BANKS: The carrying amounts reported in the Consolidated
Balance Sheets for cash and due from banks approximate those assets' fair
values.
HELD-TO-MATURITY AND AVAILABLE-FOR-SALE SECURITIES: Fair values for
investment securities, excluding restricted equity securities, are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments. The carrying values of restricted equity securities approximate
fair values.
LOANS RECEIVABLE: For variable-rate loans that reprice frequently and have no
significant change in credit risk, fair values are based on carrying amounts.
The fair values for other loans (for example, fixed rate commercial real
estate and rental property mortgage loans and commercial and industrial
loans) are estimated using discounted cash flow analyses, using interest
rates currently being offered for loans with similar terms to borrowers of
similar credit quality. Loan fair value estimates include judgments
regarding future expected loss experience and risk characteristics. Fair
value for impaired loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable.
DEPOSIT LIABILITIES: The fair values disclosed for demand deposits (for
example, interest-bearing checking accounts) are, by definition, equal to the
amount payable on demand at the reporting date (that is, their carrying
amounts). The fair values for certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated contractual maturities on
such time deposits.
OTHER BORROWED FUNDS: The carrying amount of short-term borrowings
approximates the fair values. The long-term borrowings with fixed rates and
fair values are estimated by discounting the remaining payments due on the
loans and is calculated using the Bank's incremental borrowing rate for
similar obligations.
ACCRUED INTEREST: The carrying amounts of accrued interest approximate their
fair values.
OFF-BALANCE-SHEET INSTRUMENTS: Fair values for off-balance-sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counterparties.
F-24
<PAGE>
CNBT BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(Dollars in thousands, except per share amounts)
NOTE T - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values of the Bank's financial instruments are as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------
1998 1997
------------------------ ------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $ 13,294 $ 13,294 $ 15,276 $ 15,276
Investment securities
available-for-sale 164,796 164,796 93,036 93,036
Investment securities
held-to-maturity 79,728 79,715 76,795 77,569
Loans, net of allowance for
loan losses 110,177 114,063 101,866 103,546
Accrued interest receivable 3,776 3,776 3,108 3,108
Financial liabilities:
Deposits (330,917) (333,551) (260,907) (262,442)
Other borrowed funds (11,100) (10,285) - -
Accrued interest and other
liabilities (1,689) (1,689) (2,483) (2,483)
Off-balance sheet assets (liabilities):
Commitments to extend credit - 18,226 - 12,331
Credit card arrangements - - - 6,692
Standby letters of credit - 683 - (303)
</TABLE>
A summary of the contract or notional amounts (used and unused) of the Bank's
financial instruments with off-balance-sheet risk follows:
<TABLE>
<CAPTION>
Contract or Notional Amount
---------------------------
December 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Commitments to extend credit $36,948 $30,626
Credit card arrangements - 9,161
Standby letters of credit 683 303
</TABLE>
F-25
<PAGE>
EXHIBIT 21.1
Subsidiaries
Citizens National Bank of Texas
CNB Mortgage Company
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF CNBT BANCSHARES, INC., AT DECEMBER 31, 1998, AND 1997,
AND FOR THE YEARS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 13,070 12,099
<INT-BEARING-DEPOSITS> 224 3,177
<FED-FUNDS-SOLD> 0 0
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 164,796 93,036
<INVESTMENTS-CARRYING> 79,728 76,795
<INVESTMENTS-MARKET> 79,715 77,569
<LOANS> 111,360 102,875
<ALLOWANCE> 1,183 1,009
<TOTAL-ASSETS> 377,930 295,606
<DEPOSITS> 330,917 260,907
<SHORT-TERM> 1,100 0
<LIABILITIES-OTHER> 2,527 3,052
<LONG-TERM> 10,000 0
0 0
0 0
<COMMON> 5,065 10,242
<OTHER-SE> 28,321 21,405
<TOTAL-LIABILITIES-AND-EQUITY> 377,930 295,606
<INTEREST-LOAN> 10,787 9,572
<INTEREST-INVEST> 12,990 10,369
<INTEREST-OTHER> 0 0
<INTEREST-TOTAL> 23,777 19,941
<INTEREST-DEPOSIT> 10,469 8,821
<INTEREST-EXPENSE> 11,068 9,075
<INTEREST-INCOME-NET> 12,709 10,866
<LOAN-LOSSES> 612 877
<SECURITIES-GAINS> 248 263
<EXPENSE-OTHER> 9,352 7,644
<INCOME-PRETAX> 5,607 4,852
<INCOME-PRE-EXTRAORDINARY> 5,607 4,852
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 4,485 3,698
<EPS-PRIMARY> 0.89 0.89
<EPS-DILUTED> 0.88 0.88
<YIELD-ACTUAL> 7.50 7.74
<LOANS-NON> 239 279
<LOANS-PAST> 174 1,016
<LOANS-TROUBLED> 94 54
<LOANS-PROBLEM> 507 1,349
<ALLOWANCE-OPEN> 1,009 687
<CHARGE-OFFS> 569 636
<RECOVERIES> 131 81
<ALLOWANCE-CLOSE> 1,183 1,009
<ALLOWANCE-DOMESTIC> 582 875
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 601 134
</TABLE>
