<PAGE>
U. S. Securities and Exchange Commission
Washington, DC 20549
Form 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended September 30, 1999
------------------
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
For the transition period from __________ to ___________
Commission file number 333-63363
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INNES STREET FINANCIAL CORPORATION
----------------------------------
(Exact name of small business issuer in its charter)
NORTH CAROLINA 56-2101799
-------------- ----------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
401 WEST INNES STREET
SALISBURY, NC 28144
-------------------
(Address of principal executive offices)
(704) 633-2341
--------------
(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act:
None
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Securities registered under Section 12(g) of the Exchange Act:
Common shares, without par value
----------------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 -
---
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of the Form 10-KSB
or any amendment to the Form 10-KSB. [X]
-
The issuer's revenues for its most recent fiscal year were $14,320,279.
Based upon information regarding the average of the bid and asked price
provided by The NASDAQ Small-Cap Market, the aggregate market value of the
voting shares held by nonaffiliates of the registrant on November 30, 1999, was
$22,139,540.
As of November 30, 1999, there were 2,135,838 shares of the Registrant's
common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held February 1, 2000 are incorporated by reference into Part III.
<PAGE>
Part I
------
Item 1. Description of Business
General
Innes Street Financial Corporation. Innes Street Financial Corporation
(the "Company") was incorporated on July 6, 1998 to serve as the holding company
for Citizens Bank, FSB ("Citizens Bank" or the "Bank") upon the Bank's
conversion from a federally chartered mutual savings bank to a federally
chartered stock savings bank ("Conversion"). The Company completed the
Conversion on December 28, 1998 through the sale and issuance of 2,248,250
shares of common stock. Since the Conversion, the Company has had no significant
assets other than the outstanding capital stock of Citizens Bank, a portion of
the net proceeds of the Conversion, investment securities and a note payable
from the Bank's employee stock ownership plan ("ESOP"). The Company's principal
business has been the business of Citizens Bank. Information set forth in this
report relating to periods prior to the Conversion, including financial
statements and related data relates to the Bank.
The Company is classified as a unitary savings institution by the Office
of Thrift Supervision ("OTS"). As long as the Company remains a unitary savings
institution holding company, the Company currently may diversify its activities
is such a manner as to include any activities allowed by law or regulation to a
unitary savings institution holding company. For additional information, see
""Regulation of the Company."
The Company's executive offices are located at 401 West Innes Street,
Salisbury, North Carolina 28144; the telephone number is (704) 633-2341.
Citizens Bank, FSB. The Bank has served the Salisbury, North Carolina
area for over ninety years. The deposits of the Bank are insured up to
applicable limits by the Federal Deposit Insurance Corporation (the "FDIC") in
the Savings Association Insurance Fund (the "SAIF"). The Bank is a member of the
Federal Home Loan Bank (the "FHLB") of Atlanta and is subject to regulation and
supervision by the OTS.
The Bank is engaged primarily in the business of attracting deposits
from the general public and using such deposits to make mortgage loans secured
by real estate. The Bank makes one-to-four family residential real estate loans
and, to a lesser extent, multi-family residential loans, nonresidential loans,
construction and development loans, home equity loans, commercial and consumer
loans. However, in the past year the Bank has increased its production of multi-
family residential loans, nonresidential loans, construction and development
loans and home equity loans. The Bank's primary source of revenue is interest
income from its lending activities. The Bank's other major sources of revenue
are interest and dividend income from investments, interest income from its
interest-earning deposit balances in other depository institutions, and
transaction and fee income from its lending and deposit activities. The major
expenses of the Bank are interest on deposits and general and administrative
expenses such as employee compensation and benefits, federal deposit insurance
premiums, data processing, advertising expenses and occupancy expenses.
Market Area
The Bank's primary market area consists of the communities in an
approximately a 10-mile radius around its offices in Salisbury, Rockwell, and
Statesville, North Carolina. These areas are located within Rowan and Iredell
Counties. All three offices are in proximity of Charlotte, North Carolina and
the market area has been and will continue to be affected by this major
metropolitan area.
Based on 1998 FDIC comparative data, the Bank had approximately 12.1% of
the deposits in Salisbury and approximately 11.3% of the deposits in Rowan
County. The Bank had approximately 7.2% of the deposits in Statesville and
approximately 4.2% in Iredell County at the same date.
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Lending Activities
General. The Bank's primary source of revenue is interest income from its
lending activities, consisting primarily of mortgage loans for the purchase or
refinance of one-to-four family residential real property located in its primary
market area. The Bank also makes home equity loans, multi-family residential
loans, nonresidential loans, construction and development loans, commercial and
consumer loans. Over 99% of the Bank's loan portfolio, before net items, is
secured by real estate. In addition to interest earned on loans, the Bank
receives fees in connection with loan originations, loan servicing, loan
modifications, late payments, loan assumptions and other miscellaneous services.
Adjustable rate loans are generally originated with the intention that they
will be held in the Bank's loan portfolio. Fixed rate one-to-four family
residential loans are generally originated to conform with secondary market
purchase requirements and sold in the secondary market. During fiscal 1999,
1998, and 1997, the Bank sold $8.2 million, $5.6 million, and $5.5 million,
respectively, of fixed rate loans in order to better manage its interest rate
risk.
Loan Portfolio Composition. The Bank's net loan portfolio totaled
approximately $167.9 million on September 30, 1999 which represented 84.8% of
the Bank's total assets. One-to-four family residential mortgage loans comprised
77.0% of the Bank's loan portfolio, before net items. Home equity loans
represented 11.8% of the loan portfolio, before net items, and loans secured by
construction and development property, multi-family residential property,
nonresidential property, secured commercial loans, and personal loans comprised
the remaining 11.2%.
3
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As of September 30, 1999, 53% of the loans in the Bank's loan portfolio had
adjustable interest rates. The following table sets forth the composition of
the Bank's loan portfolio by type of loan at the date indicated.
<TABLE>
<CAPTION>
At September 30,
----------------------------------------------------------------------------------
1999 1998 1997
---------------------- ---------------------- ----------------------
Amount % of Total Amount % of Total Amount % of Total
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of loan:
Real estate loans:
1-4 family $ 134,823 80.31% $ 136,279 85.58% $ 140,797 88.30%
Home equity 20,705 12.33% 17,171 10.78% 11,063 6.94%
Construction and development 13,211 7.87% 4,118 2.59% 5,639 3.54%
Nonresidential 2,387 1.42% 1,618 1.02% 2,220 1.39%
Multi-family 3,652 2.18% 1,312 0.82% 1,592 1.00%
---------- -------- ---------- -------- ---------- --------
Total real estate loans 174,778 104.11% 160,498 100.79% 161,311 101.17%
---------- -------- ---------- -------- ---------- --------
Other loans:
Commercial 23 0.01% 1,422 0.89% 1,629 1.02%
Consumer 216 0.13% 245 0.15% 349 0.22%
---------- -------- ---------- -------- ---------- --------
Total other loans 239 0.14% 1,667 1.04% 1,978 1.24%
---------- -------- ---------- -------- ---------- --------
Total gross loans 175,017 104.25% 162,165 101.83% 163,289 102.41%
---------- -------- ---------- -------- ---------- --------
Less:
Construction loans in process 5,714 3.40% 1,540 0.96% 2,447 1.53%
Deferred loan origination fees 205 0.12% 93 0.06% 57 0.04%
Unearned income - - 60 0.04% 104 0.07%
Allowance for loan losses 1,224 0.73% 1,224 0.77% 1,223 0.77%
---------- -------- ---------- -------- ---------- --------
Total reductions 7,143 4.25% 2,917 1.83% 3,831 2.41%
---------- -------- ---------- -------- ---------- --------
Total loans receivable, net $ 167,874 100.00% $ 159,248 100.00% $ 159,458 100.00%
========== ======== ========== ======== ========== ========
</TABLE>
The following table sets forth the time to contractual maturity of the Bank's
loan portfolio at September 30, 1999. Loans which have adjustable rates are
shown as being due in the period during which rates are next subject to change,
while fixed rate and other loans are shown as due in the period of contractual
maturity. Overdrafts on checking accounts are reported as due in one year or
less. The table does not include prepayments or scheduled principal repayments.
Amounts in the table are net of loans in process and are net of unamortized loan
fees.
4
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<TABLE>
<CAPTION>
At September 30, 1999
--------------------------------------------------
More than 1
1 Year or Year to 5 More than
Less Years 5 Years Total
----------- ----------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
1-4 family - fixed $ 151 $ 611 $ 69,253 $ 70,015
1-4 family - adjustable 33,206 30,312 628 64,146
Home Equity - fixed - 103 1,060 1,163
Home Equity - adjustable 19,892 - - 19,892
Construction and Development - Fixed 1,520 214 1,688 3,422
Construction and Development - adjustable 2,311 1,770 101 4,182
Nonresidential - fixed - 40 1,990 2,030
Nonresidential - adjustable 218 59 80 357
Residential multi-family - fixed - 9 2,458 2,467
Residential multi-family - adjustable 672 114 399 1,185
Commercial - fixed - 23 - 23
Consumer loans 214 2 - 216
Less:
Allowance for loan losses (1,224) - - (1,224)
---------- ---------- --------- ----------
Totals $ 56,960 $ 33,257 $ 77,657 $ 167,874
========== ========== ========= ==========
</TABLE>
The following table sets forth the dollar amount at September 30, 1999 of
all loans maturing or repricing on or after September 30, 2000, which have fixed
or adjustable interest rates.
<TABLE>
<CAPTION>
Fixed Adjustable
Rates Rates
--------- ----------
(In Thousands)
<S> <C> <C>
Real estate loans $ 77,426 $ 33,463
Commercial loans 23 -
Other loans 2 -
--------- ---------
Totals $ 77,451 $ 33,463
========= =========
</TABLE>
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of a loan is substantially less
than its contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare loans immediately
due and payable in the event, among other things, that the borrower sells the
real property subject to the mortgage and the loan is not repaid. The
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average life of mortgage loans tends to increase, however, when current mortgage
loan market rates are substantially higher than rates on existing mortgage loans
and, conversely, decrease when rates on existing mortgage loans are
substantially higher than current mortgage loan market rates. Furthermore,
management believes that a significant number of the Bank's residential mortgage
loans are outstanding for a period less than their contractual terms because of
the transitory nature of many of the borrowers who reside in its primary market
area.
Origination, Purchase, and Sale of Loans. The Bank generally has originated
loans in Rowan and Iredell Counties. Some loans have been originated in Cabarrus
and Mecklenburg Counties, which are contiguous with the Bank's primary market
area of Rowan and Iredell Counties.
During the year ended September 30, 1999, the Bank purchased $7.7 million
of loans. These loans were fifteen year fixed one-to-four family, construction
acquisition and development, and nonresidential.
The Bank originates fixed rate conventional, conforming single-family loans
with the intent of selling those loans in the secondary market to reduce
interest rate risk exposure.
The following table sets forth the Bank's loan origination, purchase and
sale activity and loan portfolio repayment experience during the periods
indicated.
6
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------
1999 1998 1997
---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C>
Loans receivable, net, beginning of period $ 159,248 $ 159,458 $ 159,491
---------- ---------- ----------
Loan originations/(1)/:
1-4 family 35,706 39,040 21,554
Home equity 13,846 8,416 3,317
Construction and development 11,000 5,259 6,692
Nonresidential 1,608 - -
Multi-family 5,322 - -
Commercial - - -
Consumer 182 193 343
---------- ---------- ----------
Total loan originations 67,664 52,908 31,906
---------- ---------- ----------
Loans purchased/(1)/ 7,748 - -
Loan sales (8,190) (5,594) (5,508)
Principal repayments (58,544) (47,531) (26,392)
Other changes, net/(2)/ (52) 7 (39)
---------- ---------- ----------
Loans receivable, net, end of period $ 167,874 $ 159,248 $ 159,458
========== ========== ==========
</TABLE>
(1) Construction loans and equity lines of credit are shown at commited
amount.
(2) Includes changes in deferred loan fees and the allowance for loan
losses.
One-to-Four Family Residential Real Estate Lending. The Bank's primary
lending activity, which it intends to continue to emphasize, is the origination
of fixed and adjustable rate first mortgage loans to enable borrowers to
purchase or refinance one-to-four family residential real property. Consistent
with the Bank's emphasis on being a community-oriented financial institution, it
is and has been the Bank's strategy to focus its lending efforts in its primary
market. On September 30, 1999, approximately 77.0% of the Bank's real estate
loan portfolio, before net items, consisted of one-to-four family residential
real estate loans. These include both loans secured by detached single-family
residences and condominiums and loans secured by housing containing not more
than four separate dwelling units. Of such loan amounts, 48% had adjustable
interest rates.
The Bank originates conventional mortgage loans secured by owner-
occupied property having terms of up to 30 years in amounts of up to 95% of the
value of the property. Bank policy requires private mortgage insurance on the
amount of the loan which exceeds 80% of the value of the property. The loans
have both fixed and adjustable rates. The fixed rate loans are generally
originated for sale. Some of such loans are sold "servicing retained" and others
are sold "servicing released." The interest rates on adjustable rate loans are
generally adjustable every year after a period of one, three, or five years and
are tied to the average weekly yield on the
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United States Treasury securities adjusted to a constant maturity or the 11th
District Cost of Funds. The loans have rate caps which limit the amount of
change at the time of each adjustment and over the life of each loan.
The Bank generally requires title insurance for its one-to-four family
residential loans and requires that fire and extended coverage casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least equal to the loan amount or replacement cost of the improvements on the
property securing the loans, whichever is greater.
Home Equity Lending. At September 30, 1999, the Bank had approximately
$21 million in home equity line of credit loans, representing approximately
11.8% of its portfolio, before net items. In addition, at such date, the Bank
had unfunded home equity lines of credit totaling $17.3 million. The Bank's home
equity lines of credit have adjustable interest rates tied to the Wall Street
Journal Prime plus a margin. The home equity lines of credit require the payment
of interest monthly, and all outstanding amounts must be paid in full at the end
of 15 years. Home equity lines of credit are generally secured by subordinate
liens against residential real property. The Bank requires that fire and
extended coverage casualty insurance (and, if appropriate, flood insurance) be
maintained in an amount at least sufficient to cover its loan. Home equity lines
are generally limited so that the amount of such loans, along with any senior
indebtedness, does not exceed 90% of the value of the real estate security to
borrowers with excellent credit history. Under certain circumstances, the Bank
will provide lines of credit up to 100% of the value of the real estate security
to borrowers with excellent credit history.
The Bank had approximately $1.15 million in closed-end home equity
loans on September 30, 1999. These loans have maximum terms of 15 years and are
usually made for home improvements. These loans represent 0.7% of the Bank's
loan portfolio, before net items.
Construction Lending. The Bank makes construction loans for the
construction of single-family dwellings. The aggregate outstanding balance of
such loans on September 30, 1999 was approximately $3.7 million, representing
approximately 2.1% of the Bank's loan portfolio, before net items. Some of these
loans were made to persons who are constructing properties for the purpose of
occupying them; others were made to builders who were constructing properties
for sale. Loans made to builders are generally "pure construction" loans which
require the payment of interest during the construction period of generally one
year or less and the payment of the principal in full at the end of the
construction period. Loans made to individual property owners are both pure
construction loans and "construction-permanent" loans which generally provide
for the payment of interest only during a construction period, after which the
loans convert to a permanent loan at fixed or adjustable interest rates having
terms similar to one-to-four family residential loans.
Construction loans for one-to-four family real estate to be occupied
by the borrower generally have a maximum loan-to-value ratio of 80% of the
appraised value of the property. Title insurance is generally required for
construction loans. In addition, the Bank generally requires builders risk or
casualty insurance (and, if appropriate, flood insurance) on such loans.
The Bank occasionally makes or purchases loans for the development of
land in preparation for the construction of single-family properties. The
aggregate outstanding balance of such loans on September 30, 1999, was $2.7
million, representing 1.54% of the Bank's loan portfolio, before net items. The
maximum loan-to-value for this type loan is 65%. Full Board approval is required
for all loans exceeding 65% loan-to-value.
The Bank purchased $2.3 million of loans for the construction of
nonresidential property. These loans have terms of up to 15 years.
Nonresidential Lending. On September 30, 1999, the Bank had $2.39
million outstanding in loans secured by nonresidential properties, comprising
approximately 1.4% of its loan portfolio, before net items. These loans are
secured by office, retail, and other commercial real estate and by church
properties in the Bank's primary market area and have either fixed or adjustable
interest rates. These loans generally do not exceed 75% of the appraised value
of the real estate securing the loans. These loans have terms of up to 15 years.
The adjustable rate
8
<PAGE>
loans generally use the index and rate change limitations as are used in one-to-
four family residential lending. See "--One-to-Four Family Residential Lending."
The Bank generally requires title insurance in connection with its
nonresidential real estate loans. The Bank also requires that fire and extended
coverage casualty insurance (and, if appropriate, flood insurance) be maintained
in an amount at least equal to the loan amount or the replacement cost of the
improvements on the property securing the loans, whichever is greater.
The Board of Directors is currently evaluating the opportunities
available in the market area for nonresidential lending. The Board may increase
efforts in this area to diversify the loan portfolio. Because of competition
from other financial institutions and economic conditions in the Bank's market
area, there can be no assurance that the Board's efforts to diversify will be
successful.
Multi-family Residential Lending. On September 30, 1999, the Bank had
$3.65 million outstanding in loans secured by multi-family residential
properties, comprising approximately 2.09% of its loan portfolio, before net
items. These loans are secured by apartments and have fixed and adjustable
interest rates. These loans generally do not exceed 75% of the appraised value
of the real estate securing the loans. Multi-family residential loans have terms
of up to 15 years. The loans generally use the same index and rate change
limitations as are used in one-to-four family residential lending. See "-- One-
to-Four Family Residential Real Estate Lending."
The Bank generally requires title insurance in connection with its
multi-family residential real estate loans. The Bank also requires that fire and
extended coverage casualty insurance (and, if appropriate, flood insurance) be
maintained in an amount at least equal to the loan amount or the replacement
cost of the improvements on the property securing the loans, whichever is
greater.
The Board of Directors is currently evaluating the opportunities
available in the market area for multi-family residential lending. The Board may
increase efforts in this area to diversify the loan portfolio. Because of
competition from other financial institutions and economic conditions in the
Bank's market area, there can be no assurance that the Board's efforts to
diversify will be successful.
Commercial Lending. Although infrequent, the Bank has made commercial
loans. Those loans generally require publicly-traded common stock as security
and are limited to a margin of 60%. The Board of Directors is currently
evaluating the opportunities available in the market area for commercial
lending. The Board may increase efforts in this area to diversify the loan
portfolio. Because of competition from other financial institutions and economic
conditions in the Bank's market area, there can be no assurance that the Board's
efforts to diversify will be successful.
Consumer Lending. At September 30, 1999, the Bank's consumer loan
portfolio amounted to $216,000, or 0.12% of gross loans outstanding, before net
items. The Board of Directors is currently evaluating the opportunities
available in the market area for consumer lending. The Board may increase
efforts in this area to diversify the loan portfolio. Because of competition
from other financial institutions and economic conditions in the Bank's market
area, there can be no assurance that the Board's efforts to diversify will be
successful.
Loan Solicitation, Processing and Underwriting. Loan originations are
derived from a number of sources such as referrals from real estate brokers, the
Bank's depositors and borrowers, builders, attorneys, walk-in customers and in
some instances, other lenders.
During its loan approval process, the Bank assesses the applicant's
ability to make principal and interest payments on the loan and the value of the
property securing the loan. The Bank obtains detailed written loan applications
to determine the borrower's ability to repay and verifies responses on the loan
application through the use of credit reports, financial statements, and other
confirmations. The Bank also obtains information concerning the income,
financial condition, employment and the credit history of the applicant. Under
current practice, the responsible officer or loan officer of the Bank analyzes
the loan application and the property involved, and an
9
<PAGE>
appraiser inspects and appraises the property. The Bank generally requires an
independent fee appraisal on loans secured by a first mortgage on real estate.
In some instances, tax value is used for second lien position loans.
All real estate loans, except certain home equity loans, must be
approved by a Bank underwriter. All loans and lending relationships in excess of
$250,000 must receive full Board approval. All loan originations for the month
are reported monthly to the Board of Directors.
Normally, upon approval of a residential mortgage loan application,
the Bank gives a commitment to the applicant that it will make the approved loan
at a stipulated rate any time within 45 days of the commitment date. The loan is
typically funded at such rate of interest and on other terms which are based on
market conditions existing as of the date of the commitment. No points are
charged unless the loan is actually closed. Approximately 15 percent of
commitments that are issued expire without the loan being closed.
Interest Rates, Terms, Points and Fees. Interest rates and fees
charged on the Bank's loans are affected primarily by the market demand for
loans, competition, the supply of money available for lending purposes and the
Bank's cost of funds. These factors are affected by, among other things, general
economic conditions and the policy of the federal government, including the
Federal Reserve, tax policies and governmental budgetary matters. In addition to
earning interest on loans, the Bank receives fees in connection with originating
loans. The Bank also charges fees for loan modifications, late payments, loan
assumptions and other miscellaneous services in connection with loans.
Nonperforming Assets and Asset Classification. When a borrower fails
to make a required payment on a loan and does not cure the delinquency promptly,
the loan is classified as delinquent. In this event, the normal procedure
followed by the Bank is to make contact with the borrower at prescribed
intervals in an effort to bring the loan to a current status, and late charges
are assessed as allowed by law. Interest on loans is recorded as borrowers'
monthly payments become due. Accrual of interest on loans is suspended when
interest becomes 90 days past due or earlier when, in management's judgment,
doubts exist as to the collectibility of additional interest. Interest is
reserved by establishing an allowance for uncollected interest when a loan
becomes delinquent 90 days or more or earlier. Loans are returned to accrual
status when all the principal and interest amounts contractually due are brought
current or future payments are reasonably assured. In most cases, delinquencies
based on management's judgment regarding collectibility are cured promptly. If a
delinquency is not cured, the Bank normally, subject to any required prior
notice to the borrower, commences foreclosure proceedings. If the loan is not
reinstated within the time permitted for reinstatement, or the property is not
redeemed prior to sale, the property may be sold at a foreclosure sale. In
foreclosure sales, the Bank may acquire title to the property through
foreclosure, in which case the property so acquired is offered for sale and may
be financed by the Bank at prevailing market terms. Any property acquired as a
result of foreclosure, or by deed in lieu of foreclosure, is classified as real
estate owned until such time as it is sold or otherwise disposed of by the Bank
to recover its investment. As of September 30, 1999, the Bank had $107,450 in
real estate acquired in settlement of loans. Real estate acquired through, or in
lieu of, loan foreclosure is initially recorded at the lower of cost or fair
value at the date of foreclosure, establishing a new cost basis. After
foreclosure, valuations are periodically performed by an independent appraiser,
and the real estate is carried at the lower of cost or fair value minus costs to
sell. Costs relating to the development and improvement of the property are
capitalized, and costs relating to holding the property are charged to expenses.
The following table sets forth information with respect to
nonperforming assets by the Bank, including nonaccrual loans and foreclosed real
estate at the dates indicated.
10
<PAGE>
<TABLE>
<CAPTION>
At September 30,
----------------------------------------
1999 1998 1997
---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C>
Nonaccrual loans $ 492 $ 200 $ 348
Accruing loans past due 90 days or more - - -
Foreclosed real estate 107 - -
---------- ---------- ----------
Total nonperforming assets $ 599 $ 200 $ 348
========== ========== ==========
---------- ---------- ----------
Nonperforming loans to total gross loans 0.28% 0.12% 0.21%
========== ========== ==========
---------- ---------- ----------
Nonperforming assets to total assets 0.30% 0.11% 0.17%
========== ========== ==========
Total assets $ 198,001 $ 190,058 $ 199,616
Total gross loans $ 175,017 $ 162,165 $ 163,289
</TABLE>
During the years ended September 30, 1999 and 1998, gross interest
income of $45,958 and $21,512, respectively, would have been recorded on these
loans accounted for on a nonaccrual basis if the loans had been current
throughout the year. The amount of gross interest income actually recorded on
such nonperforming assets during the periods was $16,911 and $15,536,
respectively.
Applicable regulations require the Bank to "classify" its own assets
on a regular basis. In addition, in connection with examinations of savings
institutions, regulatory examiners have authority to identify problem assets
and, if appropriate, classify them. Problem assets are classified as
"substandard," "doubtful" or "loss," depending on the presence of certain
characteristics as discussed below. The Bank also identifies assets which
possess credit deficiencies or potential weaknesses deserving close attention by
management. These assets are listed as "special mention" and do not warrant
adverse classification. At September 30, 1999, the Bank had seven loans with an
aggregate outstanding balance of $649,298 classified as "special mention."
An asset is considered "substandard" if not adequately protected by
the current net worth and paying capacity of the obligor or the collateral
pledged, if any. "Substandard" assets include those characterized by a well-
defined weakness with possible risk of loss if the deficiency is not corrected.
Assets classified as "doubtful" have all of the weaknesses inherent in those
classified "substandard" with the added characteristic that the weaknesses
present make "collection or liquidation in full," on the basis of currently
existing facts, conditions, and values, "highly questionable." Assets classified
"loss" are those considered "uncollectible" and of such little value that their
continuance as assets without the establishment of a loss reserve is not
warranted.
As of September 30, 1999, the Bank had $613,085 loans internally
classified as "substandard," no loans classified as "doubtful" and no loans
classified as "loss." Total classified loans as of September 30, 1998 and 1997
were approximately $376,000 and $348,000, respectively.
11
<PAGE>
The following table sets forth at September 30, 1999, the Bank's aggregate
carrying value of the assets classified as "substandard," "doubtful," "loss," or
criticized as "special mention."
<TABLE>
<CAPTION>
Special Mention List Substandard Doubtful Loss
-------------------- ------------------ --------------------- ---------------------
Number Amount Number Amount Number Amount Number Amount
---------- -------- -------- -------- --------- ---------- -------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
1-4 family 6 $ 606 11 $ 601 - $ - - $ -
Home equity 1 43 1 12 - - - -
Construction and development - - - - - - - -
Nonresidential - - - - - - - -
Multi-family - - - - - - - -
------ ------ ------ ------- ------- -------- ------- --------
Total real estate loans 7 649 12 613 - - - -
------ ------ ------ ------- ------- -------- ------- --------
Other loans:
Commercial - - - - - - - -
Consumer - - - - - - - -
------ ------ ------ ------- ------- -------- ------- --------
Total other loans - - - - - - - -
------ ------ ------ ------- ------- -------- ------- --------
Total 7 $ 649 12 $ 613 - $ - - $ -
====== ====== ====== ======= ======= ======== ======= ========
</TABLE>
Allowance for Loan Losses. In originating loans, the Bank recognizes that
credit losses will be experienced and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan and, in the case of a secured loan, the
quality of the security for the loan as well as general economic conditions. It
is management's policy to maintain an allowance for loan losses based on, among
other things, the Bank's historical loan loss experience, evaluation of economic
conditions and regular reviews of delinquencies and loan portfolio quality.
Specific allowances are provided for individual loans when ultimate collection
is considered questionable by management after reviewing the current status of
loans which are contractually past due and considering the net realizable value
of the security for the loans.
Management continues to actively monitor the Bank's asset quality, to
charge off loans against the allowance for loan losses when appropriate and to
provide specific loss reserves when necessary. Although management believes it
uses the best information available to make determinations with respect to the
allowance for loan losses, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations.
The following table describes the activity related to the Bank's allowance
for loan losses for the periods indicated.
12
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------
1999 1998 1997
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Balance, beginning of period $ 1,224 $ 1,223 $ 1,216
Charge-offs - - -
Provision - - -
Recoveries - 1 7
-------- -------- --------
Balance, end of period $ 1,224 $ 1,224 $ 1,223
======== ======== ========
</TABLE>
The following table sets forth the composition of the allowance for loan
losses by type of loan at the dates indicated. The allowance is allocated to
specific categories of loans for statistical purposes only, and may be applied
to loan losses incurred in any loan category.
13
<PAGE>
<TABLE>
<CAPTION>
At September 30,
----------------------------------------------------------------------------------
1999 1998
----------------------------------------- ----------------------------------------
Percent of Amount of Percent of Amount of
Allowance to Loans to Allowance to Loans to
Amount of Total Gross Amount of Total Gross
Allowance Allowance Loans Allowance Allowance Loans
------------ -------------- ----------- ----------- -------------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of loan:
Real estate loans:
1-4 family $ 135 11.03% 77.04% $ 135 11.03% 84.03%
Home equity 621 50.74% 11.83% 514 41.99% 10.59%
Construction and development 312 25.49% 7.55% 103 8.42% 2.54%
Nonresidential 24 1.96% 1.36% 47 3.84% 1.00%
Multi-family 15 1.23% 2.09% 40 3.27% 0.81%
-------- ------- ------- -------- ------- -------
Total real estate loans 1,107 90.45% 99.87% 839 68.55% 98.97%
-------- ------- ------- -------- ------- -------
Other loans:
Commercial 1 0.08% 0.01% 43 3.51% 0.88%
Consumer 1 0.08% 0.12% 1 0.08% 0.15%
-------- ------- ------- -------- ------- -------
Total other loans 2 0.16% 0.13% 44 3.59% 1.03%
-------- ------- ------- -------- ------- -------
Unallocated 115 9.39% - 341 27.86% -
-------- ------- ------- -------- ------- -------
Total allowance for loan losses $ 1,224 100.00% 100.00% $ 1,224 100.00% 100.00%
======== ======= ======= ======== ======= =======
<CAPTION>
-----------------------------------------
1997
-----------------------------------------
Percent of Amount of
Allowance to Loans to
Amount of Total Gross
Allowance Allowance Loans
------------ -------------- -----------
<S> <C> <C> <C>
Type of loan:
Real estate loans:
1-4 family $ 396 32.38% 86.23%
Home equity - - 6.78%
Construction and development 109 8.91% 3.45%
Nonresidential 16 1.31% 1.36%
Multi-family 4 0.33% 0.97%
-------- ------- -------
Total real estate loans 525 42.93% 98.79%
-------- ------- -------
Other loans:
Commercial - - 1.00%
Consumer 96 7.85% 0.21%
-------- ------- -------
Total other loans 96 7.85% 1.21%
-------- ------- -------
Unallocated 602 49.22% -
-------- ------- -------
Total allowance for loan losses $ 1,223 100.00% 100.00%
======== ======= =======
</TABLE>
14
<PAGE>
Investment Securities
Interest and dividend income from investment securities generally provides the
second largest source of income to the Company and the Bank, on a consolidated
basis (the "Consolidated Entity") after interest on loans. In addition, the
Consolidated Entity receives interest income from deposits in other financial
institutions. At September 30, 1999 the Consolidated Entity's investment
portfolio totaled $22.6 million and consisted of U.S. government and agency
securities, interest-earning deposits in other financial institutions and stock
of the FHLB of Atlanta.
Investments are classified in three categories and accounted for as
follows: (1) debt securities that the entity has the positive intent and ability
to hold to maturity are classified as held-to-maturity and reported at amortized
cost; (2) debt and equity securities that are bought and held principally for
the purpose of selling them in the near term are classified as trading
securities and reported at fair value, with net unrealized gains and losses
included in earnings; and (3) debt and equity securities not classified as
either held-to-maturity or trading securities are classified as securities
available-for-sale and reported at fair value, with unrealized gains and losses,
net of taxes, reported as a separate component of equity. Net unrealized
securities gains on the securities available-for-sale of $32,837, net of related
deferred tax assets of $20,805, are reported as a separate component of equity
in the Consolidated Entity's financial statements at September 30, 1999. The
Bank established a trading account to satisfy the investment requirements of a
rabbi trust related to a deferred compensation plan. These amounts are
classified as other assets in the statement of condition.
The amortized cost of securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization or accretion is accounted for as an
adjustment to interest income from investments. Interest and dividends are
included in interest income from investments. Realized gains and losses, and
declines in value judged to be other than temporary are included in net
securities gains (losses). The cost of securities sold is based on the specific
identification method.
As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in stock of the FHLB of Atlanta equal to the greater of 1% of the
Bank's outstanding residential mortgage loans and similar obligations or 5% of
its outstanding advances from the FHLB of Atlanta. No ready market exists for
such stock, accordingly, the stock is carried at cost. As of September 30, 1999,
the Bank was in compliance with this requirement with an investment in stock of
the FHLB of Atlanta of $1.6 million.
OTS regulations require the Bank to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable deposit accounts plus short-
term borrowings. The Bank's average liquidity ratio for the quarter ended
September 30, 1999 was 15.30% which exceeded the applicable requirements.
The Bank's current investment policy provides that investment decisions
will be made jointly by Ronald E. Bostian, President and Chief Executive
Officer, and Dianne Hawkins, Vice President, Controller and Treasurer, and
reviewed monthly by the Board of Directors. The investment policy provides that
the objectives of the investment portfolio are to: (i) establish an acceptable
level of interest rate and credit risk for all investments; (ii) generate an
acceptable rate of return on investments; (iii) provide for adequate levels of
liquidity for the Bank; and (iv) provide guidance from the Board of Directors to
management on the investments desired for the Bank.
Permitted investments include FHLB daily time deposits, FHLB term deposits,
insured certificates of deposit, government securities and government agency
securities.
15
<PAGE>
The following table sets forth certain information regarding the
Consolidated Entity's investment portfolio at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
---------------------------------------
1999 1998 1997
--------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C>
Securities available for sale:
U.S. government and agencies $ 16,024 $ 7,228 $ 10,335
Securities held to maturity:
U.S. government and agencies 715 1,565 2,328
Other:
Interest-earning deposits 4,268 11,637 14,164
Term Federal Funds - 2,000 6,100
Federal Home Loan Bank stock 1,607 1,825 1,825
--------- --------- ---------
Total $ 22,614 $ 24,255 $ 34,752
========= ========= =========
</TABLE>
The following table sets forth certain information regarding the carrying
value, weighted average yields and contractual maturities of the Consolidated
Entity's investment portfolio as of September 30, 1999. Mortgage-backed
securities are not due at a single maturity date; therefore, the table does not
consider prepayment of the underlying loans.
16
<PAGE>
<TABLE>
<CAPTION>
After One Year After Five Years
One Year or Less Through Five Years Through Ten Years
------------------------ ------------------------ ----------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
---------- ----------- ---------- ----------- ---------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agencies $ 9,987 5.11% $ 2,071 5.42% $ 108 9.00%
Securities held to maturity:
U.S. government and agencies - - 244 6.79% - -
Other:
Interest-earning deposits 4,268 5.55% - - - -
Term Federal Funds - - - - - -
Federal Home Loan Bank stock - - - - - -
--------- ------ -------- ------ ------ ------
Total $ 14,255 5.24% $ 2,315 5.56% $ 108 9.00%
========= ====== ======== ====== ====== ======
<CAPTION>
After Ten Years Total
------------------------ ------------------------
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agencies $ 3,858 6.98% $ 16,024 5.63%
Securities held to maturity:
U.S. government and agencies 471 7.62% 715 7.34%
Other:
Interest-earning deposits - - 4,268 5.55%
Term Federal Funds - - - -
Federal Home Loan Bank stock 1,607 7.50% 1,607 7.50%
--------- ------ -------- ------
Total $ 5,936 7.17% $ 22,614 5.80%
========= ====== ======== ======
</TABLE>
17
<PAGE>
Deposits and Borrowings
General. Deposits are one of the primary sources of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank derives
funds from loan principal payments and prepayments, interest payments,
investment income and principal payments and prepayments, interest from its own
interest-earning deposits, interest income and advances from the FHLB of Atlanta
and otherwise from its operations. Loan repayments are a relatively stable
source of funds while deposit inflows and outflows may be significantly
influenced by general interest rates and money market conditions. Borrowings may
be used on a short-term basis to compensate for reductions in the availability
of funds from other sources. They may also be used on a longer term basis for
general business purposes.
Deposits. The Bank attracts both short-term and long-term deposits from the
general public by offering a variety of accounts and rates. The Bank offers
passbook savings accounts, negotiable order of withdrawal accounts, money market
demand accounts, non-interest-bearing accounts, and fixed interest rate
certificates with varying maturities. At September 30, 1999, 71.5% of the Bank's
deposits consisted of certificate accounts, 22.5% consisted of savings accounts,
5.3% consisted of interest-bearing transaction accounts and 0.68% consisted of
noninterest-bearing transaction accounts. Deposit flows are greatly influenced
by economic conditions, the general level of interest rates, competition, and
other factors. The Bank utilizes traditional marketing methods to attract new
customers and savings deposits, including print, television advertising and
direct mailings. The Bank plans to emphasize savings and checking accounts as a
source of lower cost funds. The Bank recently began issuing ATM cards to its
customers as a way of increasing the number and balances of such accounts.
The following table sets forth information relating to the Bank's deposit
flows and total deposits as follows:
<TABLE>
<CAPTION>
At or for the Year
Ended September 30,
---------------------------------------
1999 1998 1997
--------- --------- ---------
(In Thousands)
<S> <C> <C> <C>
Total deposits at beginning of year $ 161,549 $ 160,493 $ 146,450
Net increase (decrease) before interest
credited (6,520) (4,998) 8,048
Interest credited 5,781 6,054 5,995
--------- --------- ---------
Total deposits at end of year $ 160,810 $ 161,549 $ 160,493
========= ========= =========
</TABLE>
The following table sets forth certain other information regarding the
Bank's savings deposits at the dates indicated.
18
<PAGE>
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------------- ------------------------------ --------------------------------
Weighted Weighted Weighted
Average % of Average % of Average % of
Amount Rate Deposits Amount Rate Deposits Amount Rate Deposits
---------- ---------- ----------- -------- --------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Deposit accounts:
Savings accounts $ 36,126 4.16% 22.47% $ 40,131 4.53% 24.84% $ 31,395 4.52% 19.56%
NOW accounts 6,572 0.96% 4.09% 5,893 1.43% 3.65% 5,248 1.35% 3.27%
Money market deposit accounts 2,014 2.34% 1.25% 2,454 2.50% 1.52% 3,125 2.50% 1.95%
Non-interest bearing accounts 1,086 - 0.68% 1,331 - 0.82% 1,550 - 0.97%
-------- ----- ------- -------- ----- ------- -------- ----- -------
Total demand deposits 45,798 3.52% 28.49% 49,809 3.94% 30.83% 41,318 3.79% 25.75%
-------- ----- ------- -------- ----- ------- -------- ----- -------
Certificates of deposit 115,012 5.22% 71.51% 111,740 5.52% 69.17% 119,175 5.66% 74.25%
-------- ----- ------- -------- ----- ------- -------- ----- -------
Total deposits $160,810 4.74% 100.00% $161,549 5.03% 100.00% $160,493 5.18% 100.00%
======== ===== ======= ======== ===== ======= ======== ===== =======
</TABLE>
19
<PAGE>
The following table presents the maturities by rates paid on all certificates of
deposit as of September 30, 1999.
<TABLE>
<CAPTION>
Amount Due During The Year Ending September 30,
-------------------------------------------------------------------------------------------
2004 and
2000 2001 2002 2003 thereafter Total
------------ ---------- ----------- ----------- ------------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Certificates of deposit
2.00% to 3.99% $ 1,423 $ - $ - $ - $ - 1,423
4.00% to 5.99% 91,485 13,843 1,041 254 2 106,625
6.00% to 7.99% 6,256 179 143 43 123 6,744
8.00% to 9.99% 42 178 - - - 220
------------ ---------- ----------- ----------- ------------- -----------
Total $ 99,206 $ 14,200 $ 1,184 $ 297 $ 125 $ 115,012
============ ========== =========== =========== ============= ===========
</TABLE>
As of September 30, 1999, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 outstanding was
approximately $21.01 million, representing 18.27% of all certificates of deposit
on such date. Management believes that most of these deposits are held by long-
time, local customers of the Bank. The Bank also holds deposits of state and
local governments which are subject to rebidding from time to time and to
securitization requirements. The following table presents the maturity of these
time certificates of deposit greater than or equal to $100,000 at such date.
<TABLE>
<CAPTION>
At September 30,
1999
----------------
(In Thousands)
<S> <C>
3 Months or less $ 6,038
Over 3 months through 6 months 5,833
Over 6 months through 12 months 6,747
Over 12 months 2,390
----------------
Total $ 21,008
================
</TABLE>
Return on Equity and Assets. The following table presents the return on
equity and assets for the Company.
<TABLE>
<CAPTION>
For the Year Ended September 30,
--------------------------------
1999 1998 1997
--------- ---------- --------
<S> <C> <C> <C>
Return on average assets 0.84% 0.69% 0.49%
Return on average equity 5.34% 8.50% 6.70%
Average equity to average assets 15.73% 8.11% 7.30%
Dividend payout ratio 18.07% N/A N/A
</TABLE>
Borrowings. The Bank's principal source of long-term borrowings are
advances from the FHLB of Atlanta. The FHLB system functions in a reserve credit
capacity for savings institutions. As a member, the Bank is required to own
capital stock in the FHLB of Atlanta and is authorized to apply for advances
from the FHLB of Atlanta on the security of that stock and a floating lien on
certain of its real estate secured loans and other assets. Each credit program
has its own interest rate and range of maturities. Depending on the program,
limitations on the
20
<PAGE>
amount of advances are based either on a fixed percentage of an institution's
net worth or on the FHLB of Atlanta's assessment of the institution's
creditworthiness. The Bank had no advances from the FHLB of Atlanta on September
30, 1999, and had advances of $10.0 million at September 30, 1998.
Competition
The Bank has operated in the Salisbury community for more than 90 years.
It faces strong competition both in attracting deposits and making real estate
and other loans. Its most direct competition for deposits has historically come
from other savings institutions, credit unions, brokerage firms and commercial
banks located in its primary market area, including large financial institutions
which have greater financial and marketing resources available to them.
The Bank has also faced additional significant competition for investors'
funds from short-term money market securities and other corporate and government
securities. While the Bank's market share of deposits has decreased in recent
years, its deposit base has grown principally due to economic growth in the
Bank's market area. The ability of the Bank to attract and retain savings
deposits depends on its ability to generally provide a rate of return, liquidity
and risk comparable to that offered by competing investment opportunities.
The Bank experiences strong competition for real estate loans from other
savings institutions, commercial banks, and mortgage banking companies. The
Bank competes for loans primarily through the interest rates and loan fees it
charges and the efficiency and quality of services it provides borrowers.
Competition may increase as a result of the continuing reduction of restrictions
on the interstate operations of financial institutions.
Employees
As of September 30, 1999, the Bank had 41 full-time employees and 5 part-
time employees. Employees are not represented by any union or collective
bargaining group, and the Bank considers its employee relations to be good.
TAXATION
Federal Income Taxation
General. The Company and the Bank are subject to the taxing provisions of
the Internal Revenue Code of 1986, as amended (the "Code"), for corporations and
will file separate federal income tax returns on a September 30 fiscal year
basis. The maximum corporate federal income tax rate is 35%. The Company and
the Bank will report their income using the accrual method of accounting and
will be subject to federal income taxation on a basis consistent with the Bank's
prior years. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Company and the Bank.
Tax Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Code were permitted certain favorable provisions regarding
their deductions from taxable income for annual additions to their bad debt
reserve. A reserve could be established for bad debts on qualifying real
property loans (generally loans secured by interests in real property improved
or to be improved) under (i) a method based on a percentage of the institution's
taxable income, as adjusted (the "percentage of taxable income method") or (ii)
a method based on actual loss experience (the "experience method"). The reserve
for nonqualifying loans was computed using the experience method.
The addition to the bad debt reserve under the percentage of taxable income
method was limited to 8% of the institution's taxable income. This method could
not raise the reserve for losses on qualifying real property loans to exceed 6%
of qualifying real property loans at the end of the year. Moreover, the current
year addition to the reserve for losses on qualifying loans, when added to the
experience method deduction for nonqualifying loans, could not exceed the amount
by which 12% of total deposits and withdrawable accounts at the close of the tax
year exceeded the sum of surplus, undivided profits and reserves at the
beginning of the year. The experience method amount was the amount necessary to
increase the balance of the reserve at the close of the year to the greater of
(i) the amount which bore the same ratio to loans outstanding at the close of
the year as the total net bad debts sustained during the current and five
preceding years bore to the sum of the loans outstanding at the close of such
21
<PAGE>
six years or (ii) the balance in the reserve account at the close of the last
taxable year beginning before 1988 (assuming that the loans outstanding have not
declined since such date).
In order to qualify for the percentage of taxable income method, an
institution had to have at least 60% of its assets as "qualifying assets," which
generally included, cash, obligations of the United States government or certain
agencies or instrumentalities thereof or of a state or political subdivision,
residential real estate-related loans, or loans secured by savings accounts and
property used in the conduct of its business. In addition, it had to meet
certain other supervisory tests and operate principally for the purpose of
acquiring savings and investing in loans.
Institutions which became ineligible to use the percentage of taxable
income method had to change to either the reserve method or the specific charge-
off method that applied to banks. Large thrift institutions, those generally
exceeding $500 million in assets, had to convert to the specific charge-off
method. In computing its bad debt reserve for federal income taxes, the Bank
used the reserve method in fiscal years 1997, 1998, and 1999.
Bad debt reserve balances as of the close of the last taxable year
beginning before January 1, 1988 or amounts maintained in a supplemental reserve
built up prior to 1962 ("excess bad debt reserve") must be included in taxable
income upon certain distributions to shareholders. Distributions in redemption
of stock or in partial or complete liquidation or distributions with respect to
its stock in excess of earnings and profits accumulated in years beginning after
December 31, 1951, are treated as a distribution from the excess bad debt
reserve. When such a distribution takes place, the thrift is required to reduce
its reserve by such distribution plus the income tax resulting from
simultaneously recognizing the distribution as an item of taxable income
increased by the amount of income tax imposed on the inclusion. Dividends not
in excess of earnings and profits accumulated since December 31, 1951 will not
require inclusion of part or all of the bad debt reserve in taxable income. The
Bank has accumulated earnings and profits since December 31, 1951 and has an
excess bad debt reserve. Distributions in excess of current and accumulated
earnings and profits will increase taxable income. Net retained earnings at
September 30, 1999 includes approximately $3.7 million for which no provision
for federal income tax has been made.
Legislation passed by the U.S. Congress and signed by the President in
August 1996 contains a provision that repealed the percentage of taxable income
method of accounting for thrift bad debt reserves for tax years beginning after
December 31, 1995. The legislation requires bad debt reserve recapture for
post-1987 excess reserves over a six-year period. At September 30, 1996, the
Bank's post-1987 excess reserves amounted to approximately $567,000. A special
provision suspended recapture of post-1987 excess reserves for up to two years,
the two tax years beginning after December 31, 1995, if, during one or both of
those years, the institution satisfied a "residential loan requirement." This
requirement was met if the principal amount of the institution's residential
loans originated during the year exceeded a base year amount, which was
determined by reference to the average of the institution's residential loans
originated during the six most recent taxable years beginning on or before
December 31, 1995. The Bank did not meet the residential loan requirement for
its 1996 or 1997 tax year and recaptured one-sixth of the excess reserves in
each of those years. However, notwithstanding this special provision, recapture
was required to begin no later than the first taxable year beginning after
December 31, 1997. At September 30, 1999, the Bank's post-1987 excess reserves
amounted to approximately $283,000.
Corporate Alternative Minimum Tax. The Company and the Bank may also be
subject to the corporate alternative minimum tax ("AMT"). This tax is
applicable only to the extent it exceeds the regular corporate income tax. The
AMT is imposed at the rate of 20% of the corporation's alternative minimum
taxable income ("AMTI") subject to applicable statutory exemptions. AMTI is
calculated by adding certain tax preference items and making certain adjustments
to the corporation's regular taxable income. Preference items and adjustments
generally applicable to financial institutions include, but are not limited to,
the following: (i) the excess of the bad debt deduction for reasonable bad debt
reserves over the amount that would have been allowed had the institution
maintained a reserve for all tax years on the basis of actual experience; (ii)
interest on certain tax-exempt bonds issued after August 7, 1986; and (iii) 75%
of the excess, if any, of a corporation's adjusted current earnings over its
AMTI (as otherwise determined with certain adjustments). Net operating loss
carryovers, subject to certain adjustments, may be utilized to offset up to 90%
of the AMTI. Credit for AMT paid may be available in future years to reduce
future regular federal income tax liability to the extent it exceeds the year's
AMT. The Bank has not been subject to the AMT in recent years.
Dividends Received Deduction. The Company may exclude from its income 100%
of dividends received from the Bank as a member of the same affiliated group of
corporations.
22
<PAGE>
Audits. The Bank's federal income tax returns were audited by the IRS for
the 1994 tax year. There were no findings.
State and Local Taxation
Under North Carolina law, the corporate income tax for tax years beginning
in 1997 is 7.5% of federal taxable income as computed under the Code, subject to
certain prescribed adjustments. Prior to 1997, the corporate income tax rate
was 7.75%. In addition, for tax years beginning in 1991, 1992, 1993 and 1994,
corporate taxpayers were required to pay a surtax equal to 4%, 3%, 2% and 1%,
respectively, of the state income tax otherwise payable by it. An annual state
franchise tax is imposed at a rate of 0.15% applied to the greatest of the
institutions (i) capital stock, surplus and undivided profits, (ii) investment
in tangible property in North Carolina or (iii) appraised valuation of property
in North Carolina.
The North Carolina corporate tax rate will drop to 7.25% for tax years
beginning in 1998, 7.0% in 1999, and 6.9% thereafter.
Supervision and Regulation-Bank
General
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its chartering agency, and the FDIC, as the deposit insurer. The
Bank is a member of the FHLB System. The Bank's deposit accounts are insured up
to applicable limits by the SAIF managed by the FDIC. The Bank must file
reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other financial
institutions. There are periodic examinations by the OTS and the FDIC to test
the Bank's compliance with various regulatory requirements. This regulation and
supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such policies, whether by
the OTS, the FDIC or the Congress, could have a material adverse impact on the
Company, the Bank and their operations. The Company, as a savings and loan
holding company, is also required to file certain reports with, and otherwise
comply with the rules and regulations of the OTS and of the SEC under the
federal securities laws.
Any change in the regulatory structure or the applicable statutes or
regulations, whether by the OTS, the FDIC or the Congress, could have a material
impact on the Company and or the Bank. The repeal of the Glass-Stegall Act may
have a material impact on the Company and the Bank. However, at present the
impact cannot be determined.
Federal Regulation of the Bank
Business Activities. The activities of federal savings institutions are
governed by the Home Owners' Loan Act, as amended (the "HOLA") and, in certain
respects, the Federal Deposit Insurance Act ("FDI Act") and the regulations
issued by the agencies to implement these statutes. These laws and regulations
delineate the nature and extent of the activities in which federal associations
may engage. In particular, many types of lending authority for federal
associations, e.g., commercial, nonresidential real property loans and consumer
loans, are limited to a specified percentage of the institution's capital or
assets.
Loans-to-One Borrower. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans-to-one borrower. Generally, this
limit is 15% of the Bank's unimpaired capital and surplus, plus an additional
10% of unimpaired capital and surplus, if such loan is secured by readily-
marketable collateral, which is defined to include certain financial instruments
and bullion. At September 30, 1999, the Bank's general limit on loans-to-one
borrower was $4.04 million. At September 30, 1999, the Bank's largest aggregate
amount of loans-to-one borrower was $2.3 million.
23
<PAGE>
Qualified Thrift Lender Test ("QTL"). The HOLA requires savings
institutions to meet a QTL test. Under the QTL test, a savings association is
required to maintain at least 65% of its "portfolio assets" (total assets less:
(i) specified liquid assets up to 20% of total assets; (ii) intangibles,
including goodwill; and (iii) the value of property used to conduct business) in
certain "qualified thrift investments" (primarily residential mortgages and
related investments, including certain mortgage-backed and related securities)
in at least 9 months out of each 12-month period. A savings association that
fails the QTL test must either convert to a bank charter or operate under
certain restrictions. As of September 30, 1999, the Bank maintained 96.46% of
its portfolio assets in qualified thrift investments and, therefore, met the QTL
test. Recent legislation has expanded the extent to which education loans,
credit card loans and small business loans may be considered as "qualified
thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by a savings institution, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in regulatory capital requirements before and after a proposed
capital distribution ("Tier 1 Bank") and has not been advised by the OTS that it
is in need of more than normal supervision, could, after prior notice to, but
without the approval of the OTS, make capital distributions during a calendar
year equal to the greater of: (i) 100% of its net earnings to date during the
calendar year plus the amount that would reduce by one-half its "surplus capital
ratio" (the excess capital over its fully phased-in capital requirements) at the
beginning of the calendar year; or (ii) 75% of its net earnings for the previous
four quarters. Any additional capital distributions would require prior OTS
approval. In the event the Bank's capital fell below its capital requirements
or the OTS notified it that it was in need of more than normal supervision, the
Bank's ability to make capital distributions could be restricted. In addition,
the OTS could prohibit a proposed capital distribution by any institution, which
would otherwise be permitted by the regulation, if the OTS determines that such
distribution would constitute an unsafe or unsound practice.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable deposit accounts plus short-
term borrowings. Monetary penalties may be imposed for failure to meet these
liquidity requirements. The Bank's average liquidity ratio for the quarter
ended September 30, 1999 was 15.30%, which exceeded the applicable requirements.
The Bank has never been subject to monetary penalties for failure to meet its
liquidity requirements.
Assessments. Savings institutions are required by regulation to pay
assessments to the OTS to fund the agency's operations. The general assessment,
paid on a semi-annual basis, is based upon the savings institution's total
assets, including consolidated subsidiaries, as reported in the Bank's latest
quarterly Thrift Financial Report. The assessment paid to the OTS for the fiscal
year ended September 30, 1999 was $36,914.
Branching. OTS regulations permit federally-chartered savings associations
to branch nationwide under certain conditions. Generally, federal savings
associations may establish interstate networks and geographically diversify
their loan portfolios and lines of business. The OTS authority preempts any
state law purporting to regulate branching by federal savings associations.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with an institution, including the Company
and any non-savings institution subsidiaries that the Company may establish) is
limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A
restricts the aggregate amount of covered transactions with any individual
affiliate to 10% of the capital and surplus of the savings institution and also
limits the aggregate amount of transactions with all affiliates to 20% of the
savings institution's capital and surplus. Certain transactions with affiliates
are required to be secured by collateral in an amount and of a type described in
Section 23A and the purchase of low quality assets from affiliates is generally
prohibited. Section 23B generally requires that certain transactions with
affiliates, including loans and asset purchases, must be on terms and under
circumstances, including credit standards, that are substantially the same or at
least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders, and any
attorneys, appraisers and accountants who knowingly or recklessly participate in
wrongful action likely to
24
<PAGE>
have an adverse effect on an insured institution. Formal enforcement action may
range from the issuance of a capital directive or cease and desist order to
removal of officers or directors, receivership, conservatorship or termination
of deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or $1 million per day in especially egregious cases.
Under the FDI Act, the FDIC has the authority to recommend to the Director of
the OTS that enforcement action be taken with respect to a particular savings
institution. If action is not taken by the Director, the FDIC has authority to
take such action under certain circumstances. Federal and state law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Establishing Standards for Safety and Soundness ("Guidelines") to
implement these safety and soundness standards. The Guidelines set forth the
safety and soundness standards that the federal banking agencies use to identify
and address problems at insured depository institutions before capital becomes
impaired. The Guidelines address internal controls and information systems;
internal audit system; credit underwriting; loan documentation; interest rate
risk exposure; asset growth; asset quality; earnings; and compensation, fees and
benefits. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard, as required by the FDI Act. The final
regulations establish deadlines for the submission and review of such safety and
soundness compliance plans.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three capital standards: a 1.5% tangible capital standard,
a 3% leverage (core capital) ratio and an 8% risk based capital standard. Core
capital is defined as common stockholder's equity (including retained earnings),
certain non-cumulative perpetual preferred stock and related surplus, minority
interests in equity accounts of consolidated subsidiaries less intangibles other
than certain mortgage servicing rights ("MSRs") and credit card relationships.
The OTS regulations require that, in meeting the leverage ratio, tangible and
risk-based capital standards institutions generally must deduct investments in
and loans to subsidiaries engaged in activities not permissible for a national
bank. In addition, the OTS prompt corrective action regulation provides that a
savings institution that has a leverage capital ratio of less than 4% (3% for
institutions receiving the highest CAMEL examination rating) will be deemed to
be "undercapitalized" and may be subject to certain restrictions.
The risk-based capital standard for savings institutions requires the
maintenance of total capital (which is defined as core capital and supplementary
capital) to risk-weighted assets of 8%. In determining the amount of risk-
weighted assets, all assets, including certain off-balance sheet assets, are
multiplied by a risk-weight of 0% to 100%, as assigned by the OTS capital
regulation based on the risks OTS believes are inherent in the type of asset.
The components of core capital are equivalent to those discussed earlier under
the 3% leverage standard. The components of supplementary capital currently
include cumulative preferred stock, long-term perpetual preferred stock,
mandatory convertible securities, subordinated debt and intermediate preferred
stock and, within specified limits, the allowance for loan and lease losses.
Overall, the amount of supplementary capital included as part of total capital
cannot exceed 100% of core capital.
The OTS has adopted an interest rate risk component into its regulatory
capital requirements; however, the OTS has postponed indefinitely any adjustment
to capital which would be required by such interest rate risk component. The
OTS interest rate risk rule as written would also adjust the risk-weighting for
certain mortgage derivative securities. Under the rule as written, savings
associations with "above normal" interest rate risk exposure would be subject to
a deduction from total capital for purposes of calculating their risk-based
capital requirements. A savings association's interest rate risk would be
measured by the decline in the net portfolio value of its assets (i.e., the
difference between incoming and outgoing discounted cash flows from assets,
liabilities and off-balance sheet contracts) that would result from a
hypothetical 200-basis point increase or decrease in market interest rates
divided by the estimated economic value of the Bank's assets, as calculated in
accordance with guidelines set forth by the OTS. A savings association whose
measured interest rate risk exposure exceeds 2% would be required to deduct an
interest rate component in calculating its total risk-based capital. The
interest rate risk component would be an amount equal to one-half of the
difference between the institution's measured interest rate risk and 2%,
multiplied by the estimated economic value of the Bank's assets. That dollar
amount would be deducted from an association's total capital in calculating
compliance with its risk-based capital requirement. Under the rule as
25
<PAGE>
written, there is a two quarter lag between the reporting date of an
institution's financial data and the effective date for the new capital
requirement based on that data. A savings association with assets of less than
$300 million and risk-based capital ratios in excess of 12% would be not subject
to the interest rate risk component, unless the OTS determined otherwise. The
rule also provides that the Director of the OTS may waive or defer an
association's interest rate risk component on a case-by-case basis. No
prediction can be made when such interest rate risk component requirement will
be implemented, or if it ever will be implemented.
At September 30, 1999, the Bank met each of its capital requirements, in
each case on a fully phased-in basis. The table below presents certain
information relating to the Bank's regulatory capital compliance at September
30, 1999.
<TABLE>
<CAPTION>
Percent of
Amount Assets(1)
-------- ----------
(Dollars in Thousands)
<S> <C> <C>
Tier 1 $ 26,907 14.0 %
Tier 1 Capital Requirement (7,694) (4.0)%
-------- ----------
Excess $ 19,213 10.0 %
======== ==========
Total Capital $ 28,131 25.4 %
Risk-Based Capital Requirement (8,852) (8.0)%
-------- ----------
Excess $ 19,279 17.4 %
======== ==========
</TABLE>
(1) Adjusted total assets were used for the Tier 1 calculation and risk-weighted
assets were used for the Risk-Based Capital calculation.
Prompt Corrective Regulatory Action
Under the OTS prompt corrective action regulations, the OTS is required to
take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of capitalization.
Generally, a savings institution that has a total risk-based capital of less
than 8.0% or a leverage ratio or a Tier 1 capital ratio that is less than 4.0%
is considered to be undercapitalized. A savings institution that has a total
risk-based capital less than 6.0%, a Tier 1 risk-based capital ratio of less
than 3.0% or a leverage ratio that is less than 3.0% is considered to be
"significantly undercapitalized" and a savings institution that has a tangible
capital to assets ratio equal to or less than 2.0% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the Banking regulator is
required to appoint a receiver or conservator for an institution that is
critically undercapitalized. The regulation also provides that a capital
restoration plan must be filed with the OTS within 45 days of the date an
association receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding company. In addition, numerous
mandatory supervisory actions may become immediately applicable to the
institution depending upon its category, including, but not limited to,
increased monitoring by regulators, restrictions on growth, and capital
distributions and limitations on expansion. The OTS could also take any one of
a number of discretionary supervisory actions, including the issuance of a
capital directive and the replacement of senior executive officers and
directors.
26
<PAGE>
Insurance of Deposit Accounts
The FDIC has adopted a risk-based insurance assessment system. The FDIC
assigns an institution to one of three capital categories based on the
institution's financial information, as of the reporting period ending seven
months before the assessment period, consisting of (1) well capitalized, (2)
adequately capitalized or (3) undercapitalized, and one of three supervisory
subcategories within each capital group. The supervisory subgroup to which an
institution is assigned is based on a supervisory evaluation provided to the
FDIC by the institution's primary federal regulator and information which the
FDIC determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. An institution's assessment rate
depends on the capital category and supervisory category to which it is
assigned. Assessment rates for SAIF member institutions currently range from 0
basis points to 27 basis points. The FDIC is authorized to raise the assessment
rates in certain circumstances. The FDIC has exercised this authority several
times in the past and may raise insurance premiums in the future. If such
action is taken by the FDIC, it could have an adverse effect on the earnings of
the Bank. The Bank's assessment rate for the years ended September 30, 1999,
1998 and 1997 was .059%, 0.061% and 0.093% of assessable deposits, respectively.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
OTS. The management of the Bank does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB, is required to acquire and
hold shares of capital stock in the FHLB in an amount at least equal to 1% of
the aggregate principal amount of its unpaid residential mortgage loans and
similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. The Bank was in compliance
with this requirement with an investment in FHLB stock at September 30, 1999 of
$1.6 million. FHLB advances must be secured by specified types of collateral
and all long-term advances may only be obtained for the purpose of providing
funds for residential housing finance. At September 30, 1999, the Bank had no
FHLB advances.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the fiscal years ended September 30, 1999, 1998
and 1997, cash dividends from the FHLB to the Bank amounted to $129,507,
$134,585 and $132,207, respectively. If dividends were reduced, the Bank's net
interest income would likely also be reduced. Further, there can be no
assurance that the impact of recent or future legislation on the FHLBs will not
also cause a decrease in the value of the FHLB stock held by the Bank.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts. The
Federal Reserve Board regulations generally require that reserves be maintained
against aggregate transaction accounts as follows: for accounts aggregating
$47.8 million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement is 3%; and for accounts greater than $47.8 million, the
reserve requirement is $1.4 million plus 10% (subject to adjustment by the
Federal Reserve Board between 8% and 14%) against that portion of total
transaction accounts in excess of $47.8 million. The first $4.7 million of
otherwise reservable balances (subject to adjustment by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with the foregoing requirements. Because required reserves must be maintained
in the form of either vault cash, a non-interest-bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets. FHLB System members are also authorized to borrow from the Federal
Reserve "discount window," but Federal Reserve Board regulations require
institutions to exhaust all FHLB sources before borrowing from a Federal Reserve
Bank.
27
<PAGE>
Supervision and Regulation of the Company
The Company is a non-diversified unitary savings and loan holding company
within the meaning of the HOLA. As such, the Company is subject to OTS
regulations, examinations, supervision and reporting requirements. In addition,
the OTS has enforcement authority over the Company and its non-savings
institution subsidiaries. Among other things, this authority permits the OTS to
restrict or prohibit activities that are determined to be a serious risk to the
subsidiary savings institution. The Bank must notify the OTS 30 days before
declaring any dividend to the Company.
As a unitary savings and loan holding company, the Company generally will
not be restricted under existing laws as to the types of business activities in
which it may engage, provided that the Bank continues to be a QTL. See
"--Federal Regulation of the Bank--QTL Test" for a discussion of the QTL
requirements. Upon any non-supervisory acquisition by the Company of another
savings association, the Company would become a multiple savings and loan
holding company (if the acquired institution is held as a separate subsidiary)
and would be subject to extensive limitations on the types of business
activities in which it could engage. The HOLA limits the activities of a
multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the Bank Holding Company Act, as amended (the "BHC
Act"), subject to the prior approval of the OTS, and to other activities
authorized by OTS regulation.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution, or holding company thereof,
without prior written approval of the OTS; from acquiring or retaining, with
certain exceptions, more than 5% of a non-subsidiary holding company or savings
association. The HOLA also prohibits a savings and loan holding company from
acquiring more than 5% of a company engaged in activities other than those
authorized for savings and loan holding companies by the HOLA, or acquiring or
retaining control of a depository institution that is not insured by the FDIC.
In evaluating applications by holding companies to acquire savings institutions,
the OTS must consider the financial and managerial resources and future
prospects of the company and institution involved, the effect of the acquisition
on the risk to the insurance funds, the convenience and needs of the community
and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, except: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies, and (ii) the acquisition of
a savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions. The states vary in
the extent to which they permit interstate savings and loan holding company
acquisitions.
Federal Securities Laws
The Company filed with the SEC a registration statement under the
Securities Act for the registration of the common stock to be issued pursuant to
the Conversion and has registered the Company's common stock with the SEC under
Section 12 (g) of the Exchange Act. Consequently, the Company is subject to the
information, proxy solicitation, insider trading restrictions and other
requirements under the Exchange Act.
The registration under the Securities Act of shares of the common stock
issued in the Conversion does not cover the resale of such shares. Shares of
the common stock purchased by persons who are not affiliates of the Company may
be resold without registration. Shares purchased by an affiliate of the Company
will be subject to the resale restrictions of Rule 144 under the Securities Act.
If the Company meets the current public information requirements of Rule 144
under the Securities Act, each affiliate of the Company who complies with the
other conditions of Rule 144 (including those that require the affiliate's sale
to be aggregated with those of certain other persons) would be able to sell in
the public market, without registration, a number of shares not to exceed, in
any three-month period, the greater of (i) 1% of the outstanding shares of the
Company or (ii) the average weekly volume of trading in such shares during the
preceding four calendar weeks.
28
<PAGE>
Item 2. Description of Property
The following table sets forth the location of the Bank's headquarters
office in Salisbury, and branch offices in Statesville and Rockwell, North
Carolina, as well as certain other real property owned or leased by the Bank and
information relating to such real estate as of September 30, 1999:
<TABLE>
<CAPTION>
Net Book
Value of
Property or Owned or
Improvements Leased
------------ ---------
<S> <C> <C>
401 West Innes Street $340,706 Owned
Salisbury, North Carolina 28144-4232
427 West Innes Street 289,173 Owned
Salisbury, North Carolina 28144
307 North Center Street 394,518 Owned
Statesville, North Carolina 28677
106 West Main Street 37,232 Owned
Rockwell, North Carolina 28138
649 Brawley School Road 435,471 Owned
Mooresville, North Carolina 28117
</TABLE>
The total net book value of the Company's furniture, fixtures and equipment
and automobile at September 30, 1999 was $650,906. The properties are
considered by the Company's management to be in good condition and to be
adequately covered by insurance.
Any property acquired as a result of foreclosure or by deed in lieu of
foreclosure is classified as real estate owned until such time as it is disposed
of by the Bank in an effort to recover its investment. As of September 30,
1999, the Bank had $107,450 in real estate acquired in settlement of loans.
Item 3. Legal Proceedings
From time to time, the Bank and the Company are parties to legal
proceedings which arise in the ordinary course of its business. Most commonly,
such proceedings are commenced by the Bank to enforce obligations owed to it.
From time to time, claims are asserted against the Bank directly or as defenses
and counterclaims in actions filed by the Bank. At this time, the Bank is not a
party to any legal proceeding which is expected to have a material effect on its
financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
Part II
-------
Item 5. Market for Common Equity and Related Stockholders Matters
Price information with respect to the Company's common shares is listed on
The NASDAQ Small-Cap Market("NASDAQ") under the symbol of ISFC. The following
table sets forth the range of high and low bid information for the common shares
of the Company, as quoted by NASDAQ, together with the dividends declared per
common share for each quarter ended during the fiscal year ended September 30,
1999.
29
<PAGE>
<TABLE>
9/99 6/99 3/99 12/98
----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Dividend Declared $ 0.05 $ 0.05 $ 0.05 $ 0.00
High Bid During Quarter $13.6875 $13.2500 $13.6250 $14.0000
Low Bid During Quarter 12.1875 11.2500 11.1250 12.6250
Last Bid of Quarter 12.3750 13.0625 11.3750 13.2500
</TABLE>
The sources of income to the Company consists mainly of earnings on the
capital retained by the Company from the Conversion and dividends paid by the
Bank to the Company, if any. Consequently, future declarations of cash dividends
by the Company may depend upon dividend payments by the Bank to the Company,
which payments are subject to various restrictions. The Bank, like all savings
banks regulated by the OTS, is subject to certain restrictions on the payment of
dividends based on its net income, its capital in excess of the regulatory
capital requirements and the amount of regulatory capital required for the
liquidation account to be established in connection with the Conversion.
At December 1, 1999, there were approximately 530 stock holders of record,
not including the number of persons or entities where stock is held in nominee
or "street" name through various brokerage firms or banks.
Item 6. Management's Discussion and Analysis
General
Management's discussion and analysis of financial condition and results of
operations is intended to assist in understanding the financial condition and
changes therein and results of operations of the Consolidated Entity.
The Company was incorporated under North Carolina law on July 6, 1998 at
the direction of the Bank for the purpose of acquiring and holding all of the
outstanding stock of the Bank to be issued in the Conversion has been. The
Company's principal business activities since the Conversion have been conducted
mainly through the Bank.
The Consolidated Entity's results of operations depend primarily on net
interest income, which is the difference between interest income from interest-
earning assets and interest expense on interest-bearing liabilities. The
Consolidated Entity's operations are affected to a much lesser degree by non-
interest income, such as transaction and other service fee income, and other
sources of income. The Consolidated Entity's principal operating expenses,
aside from interest expense, consist of compensation and employee benefits,
office occupancy costs, data processing, advertising expenses and federal
deposit insurance premiums.
Net Interest Income
Net interest income represents the difference between income derived from
interest-earning assets and interest expense incurred on interest-bearing
liabilities. Net interest income is affected by both (i) the difference between
the rates of interest earned on interest-earning assets and the rates paid on
interest-bearing liabilities ("interest rate spread") and (ii) the relative
amounts of interest-earning assets and interest-bearing liabilities ("net
earning balance"). The following table sets forth information relating to
average balances of the Consolidated Entity's assets and liabilities for the
years ended September 30, 1999, 1998 and 1997. For the periods indicated, the
table reflects the average yield on interest-earning assets and the average cost
of interest-bearing liabilities (derived by dividing income or expense by the
monthly average balance of interest-earning assets or interest-bearing
liabilities, respectively) as well as the net yield on interest-earning assets
(which reflects the impact of the net earning balance). Monthly average
balances are derived from daily balances.
30
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended September 30,
-------------------------------------------------------------------------
At
September 30,
1999 1999 1998
------------- ------------------------------------ ------------------------------------
Average Average Average
Rate(5) Average Balance Interest Yield/ Rate Average Balance Interest Yield/ Rate
------------- --------------- -------- ----------- --------------- -------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets
Interest-earning deposits 5.55% $ 22,004 $ 1,159 5.27% $ 10,676 $ 664 6.22%
Investments (1) 5.86% 15,839 952 6.01% 18,791 1,182 6.29%
Loans receivable, net (4) 7.48% 158,005 11,876 7.52% 158,013 12,068 7.64%
--------------- -------- --------------- --------
Total interest-earning assets 7.28% 195,848 $ 13,987 7.14% 187,480 $ 13,914 7.42%
-------- --------
Non-interest-earning assets 6,999 6,056
--------------- ---------------
Total $ 202,847 $ 193,536
=============== ===============
Liabilities and equity
Interest-bearing liabilities:
NOW and Money
market accounts 1.28% $ 8,924 $ 119 1.33% $ 8,531 $ 152 1.78%
Savings accounts 4.16% 37,852 1,519 4.01% 35,522 1,625 4.57%
Certificates of deposit 5.22% 113,742 6,098 5.36% 113,730 6,341 5.58%
--------------- -------- --------------- --------
Total deposits 4.77% 160,518 7,736 4.82% 157,783 8,118 5.15%
FHLB advances - 6,249 431 6.90% 15,518 1,069 6.89%
--------------- -------- --------------- --------
Total interest-bearing liabilities 4.77% 166,767 $ 8,167 4.90% 173,301 $ 9,187 5.30%
-------- --------
Non-interest-bearing liabilities 4,163 4,545
Equity 31,917 15,690
--------------- ---------------
Total $ 202,847 $ 193,536
=============== ===============
Net interest income and interest
rate spread (2)
$ 5,820 2.24% $ 4,727 2.12%
======== ========
Net yield on interest-earning
assets (3) 2.97% 2.52%
Ratio of interest-earning assets to
interest-bearing liabilities 117.44% 108.18%
<CAPTION>
------------------------------------
1997
------------------------------------
Average
Yield/
Average Balance Interest Rate
--------------- -------- -----------
<S> <C> <C> <C>
Assets:
Interest-earning assets
Interest-earning deposits $ 9,152 $ 537 5.87%
Investments (1) 23,014 1,438 6.25%
Loans receivable, net (4) 160,597 11,927 7.43%
--------------- --------
Total interest-earning assets 192,763 $ 13,902 7.21%
--------
Non-interest-earning assets 4,934
---------------
Total $ 197,697
===============
Liabilities and equity
Interest-bearing liabilities:
NOW and Money
market accounts $ 8,125 $ 157 1.93%
Savings accounts 29,254 1,319 4.51%
Certificates of deposit 116,148 6,623 5.70%
--------------- --------
Total deposits 153,527 8,099 5.28%
FHLB advances 25,751 1,773 6.89%
--------------- --------
Total interest-bearing liabilities 179,278 $ 9,872 5.51%
--------
Non-interest-bearing liabilities 3,986
Equity 14,433
---------------
Total $ 197,697
===============
Net interest income and interest
rate spread (2)
$ 4,030 1.70%
========
Net yield on interest-earning
assets (3) 2.09%
Ratio of interest-earning assets to
interest-bearing liabilities 107.52%
</TABLE>
________________________________________________________________________________
(1) Includes investment securities, term fed funds and FHLB of Atlanta stock.
(2) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Net yield on interest-earning assets represents net interest income divided
by average interest-earning assets.
(4) Loans placed on nonperforming status have been included in the computation
of average balances.
(5) The weighted average rate represents the coupon associated with each asset
and liability, weighted by the principal balance associated with each asset
and liability.
31
<PAGE>
Rate/Volume Analysis
- --------------------
The following table analyzes the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. The table distinguishes between (i) changes
attributable to rate (changes in rate multiplied by the prior period's volume),
(ii) changes attributable to volume (changes in volume multiplied by the prior
period's rate), and (iii) net change (the sum of the previous columns). The
change attributable to both rate and volume (changes in rate multiplied by
changes in volume) has been allocated equally to both the changes attributable
to volume and the changes attributable to rate.
32
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30, Year Ended September 30, Year Ended September 30,
1999 vs. 1998 1998 vs. 1997 1997 vs. 1996
---------------------------------- ---------------------------------- ----------------------------------
Increase(Decrease) Attributable to Increase(Decrease) Attributable to Increase(Decrease) Attributable to
---------------------------------- ---------------------------------- ----------------------------------
Rate Volume Net Rate Volume Net Rate Volume Net
--------- ---------- ---------- --------- ---------- ---------- --------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income
Interest-earning deposits $ (115) $ 610 $ 495 $ 34 $ 93 $ 127 $ (4) $ 11 $ 7
Investments (51) (179) (230) 10 (266) (256) (26) 70 44
Loans receivable, net (191) (1) (192) 335 (194) 141 146 15 161
---------- ---------- ----------
Total interest income on
interest-earning assets 73 12 212
---------- ---------- ----------
Interest expense
NOW and Money Market
accounts (40) 7 (33) (13) 8 (5) (18) 1 (17)
Savings accounts (208) 102 (106) 21 285 306 49 256 305
Certificates of deposit (244) 1 (243) (147) (135) (282) (150) (160) (310)
FHLB advances 2 (640) (638) - (704) (704) (3) (86) (89)
---------- ---------- ----------
Total interest expense on
interest-bearing
liabilities (1,020) (685) (111)
---------- ---------- ----------
Increase(decrease) in net
interest income $ 1,093 $ 697 $ 323
========== ========== ==========
</TABLE>
33
<PAGE>
Financial condition
Total assets increased $7.9 million from $190.1 million at September 30,
1998 to $198.0 million at September 30, 1999.
Loans receivable, net, increased $8.7 million from $159.2 million at
September 30, 1998 to $167.9 million at September 30, 1999. This increase was a
result of the purchase of $8.7 million of loans and an increase in the Bank's
own production, net of loan sales.
Cash and cash equivalents decreased to $6.8 million at September 30, 1999
from $13.3 million at September 30, 1998, a decrease of $6.5 million, or 48.9%.
This decrease was a result of repaying $10.0 million in FHLB advances this year,
purchases of $12.0 million of investment securities and increasing loans
receivable, net by $8.7 million. This decrease of $30.7 million was offset by
approximately $21 million received from the Conversion.
Premises and equipment increased $1.0 million from $1.2 million at
September 30, 1998 to $2.2 million at September 30, 1999, a 83.3% increase. This
increase resulted from the Consolidated Entity installing a local area network
and upgrading its computer hardware to accommodate the requirements of its
service bureau's software. The new hardware is year 2000 compliant. Also, the
Consolidated Entity purchased $0.5 million in land for future expansion of its
branch network.
In connection with the Conversion, 121,978 shares of the Company's stock
were purchased by certain employees and directors in conjunction with the
respective nonqualified deferred compensation plans. The purchase price of the
shares, and corresponding liability, have been recorded in shareholders' equity.
The result was a decrease in other assets and other liabilities of $1,219,780 at
September 30, 1999 compared to September 30, 1998.
During the year, the Bank repaid $10.0 million in advances from the FHLB in
accordance with the debt agreement. This repayment was made from part of the
proceeds from the stock offering. At September 30, 1999, the Bank had no
advances from FHLB.
Paid in capital resulted from the issuance 2,248,250 shares of common
stock, no par value, at $10 per share as part of the Conversion. During the
quarter ended September 30, 1999, the Company repurchased 112,412 shares of its
own stock at $13.50 per share. This repurchase decreased paid in capital by
approximately $1.5 million. These shares were retired from issued and
outstanding.
Unallocated ESOP stock was the result of the establishing an ESOP on behalf
of the Bank's eligible employees. Unallocated ESOP stock will decrease in the
future as the shares acquired by the ESOP are allocated to its eligible
employees.
Retained earnings increased from $15.9 million at September 30, 1998 to
$17.3 million at September 30, 1999, a $1.4 million increase or 8.8%. This
increase was a result of $1.7 million in earnings offset by $0.3 million paid to
stockholders in the form of dividends.
Results of Operations
Net Income. Net income was $1,705,254 for the year ended September 30,
1999 compared to $1,333,701 for the year ended September 30, 1998, a 27.9%
increase. This increase was primarily a result of an increase in net interest
income offset by an increase in non-interest expense.
Net Interest Income. Net interest income was $5.82 million for the year
ended September 30, 1999 compared to $4.73 million for the year ended September
30, 1998, an increase of 23.0%. The decrease in interest expense on borrowings
was the primary cause for the improved net interest margin. Interest expense on
borrowings decreased as a result of a $9.3 million decrease in average
borrowings outstanding during the respective periods.
34
<PAGE>
This planned decrease was a result of the Company repaying $10.0 million of FHLB
advances since September 30, 1998.
Provision for Loan Losses. No provision for loan losses was made in either
the year ended September 30, 1999 or the year ended September 30, 1998.
Other Income. Other income decreased from $420,953 for the year ended
September 30, 1998 to $333,593 for the year ended September 30, 1999,due to a
decrease in gains on sales of loans and a decrease in loan servicing fees.
Operating Expenses. Operating expenses increased from $3.06 million for
the year ended September 30, 1998 to $3.44 million for the year ended September
30, 1999. Increases in compensation and benefits and other during the year ended
September 30, 1999 account for the majority of this increase. The increase in
compensation and benefits was a result of an increase in the number of
employees, normal annual increases in salaries of existing employees and ESOP
expenses. Also, professional fees increased as a result of the Conversion.
Occupancy and equipment increased during the year ended September 30, 1999 due
to the installation of a local area network and the upgrading of the Bank's
computer hardware to accommodate the requirements of its service bureau's
software.
Income Taxes. The provision for income taxes increased from $758,545 for
the year ended September 30, 1998 to $1,011,840 for the year ended September 30,
1999 as a result of the higher income.
Year 2000 Compliance
As the year 2000 approaches, an important business issue has emerged
regarding how existing application software programs and operating systems can
accommodate this date value. Some of the existing application software products
were designed to accommodate only two-digits. For example, "99" is stored on
the system and represents 1999. The Consolidated Entity has identified
potential problems associated with the "Year 2000" issue and has implemented a
plan designed to ensure that all software used in connection with the
Consolidated Entity's business will manage and manipulate data involving the
transition from 1999 to 2000 without functional or data abnormality and without
inaccurate results related to such data.
The Consolidated Entity has prepared a critical issues schedule with a time
line and assigned responsibilities to address the Year 2000 problem. In
addition, the Consolidated Entity recognizes that its ability to be Year 2000
compliant is dependent upon the cooperation of its vendors. The Consolidated
Entity is requiring its computer systems and software vendors to represent that
the products provided are or will be Year 2000 compliant and has tested for
compliance. The Consolidated Entity has completed all phases outlined in the
Federal Financial Institutions Examinations Council (FFIEC). The FFIEC requires
all banks to develop plans with five critical phases: awareness, assessment,
renovation, validation and implementation. The awareness phase defined the Year
2000 issue for the Bank and made employees and departments aware of potential
challenges associated with the date change. In the assessment phase of our plan,
extensive inventories were taken of hardware, software and facilities that could
be a problem when January 1, 2000 arrives. Through testing and correspondence
with service providers, corrective actions were determined. The Bank's customer
accounts reside with one of the largest and most proactive computer service
providers in the financial services industry. The Bank's renovation phase was
greatly enhanced by its decision to replace all existing personal computers and
printers. Although this decision was primarily made to improve customer service,
it has provided the additional benefit of helping to prepare for the Year 2000.
All systems were in place for testing with the data processing company in April
1999. The test was performed in a Year 2000 environment meaning the dates were
changed on our personal computers as well as the computer processing company.
This provided our validation for the new computers, local area network and most
importantly the accurate processing of loan, checking and savings transactions.
The fifth phase is implementation; whereby the bank introduces successfully
tested systems into the production environment. All internal mission critical
and mission necessary systems have been renovated, tested and implemented.
The Consolidated Entity has also prepared contingency plans in the event
there are any system interruptions. These plans have been tested and our staff
is continuing to be trained to implement them. The Consolidated Entity's
contingency plan is designed to ensure continued operation even in the event of
a power
35
<PAGE>
failure. Telephone capability is being analyzed in conjunction with vendors. The
same analysis and monitoring is being performed on the provider of security
services. The Consolidated Entity's vaults are mechanical and not subject to
time or calendar failure. There can be no assurances however, that the
contingency plan or the performance of the Consolidated Entity's vendors will be
effective to remedy all potential problems. To the extent the Consolidated
Entity's systems are not fully Year 2000 compliant, there can be no assurance
that potential systems interruptions or the cost necessary to update software
would not have material adverse effect on the Consolidated Entity's business,
financial condition, results of operations and business prospects.
The Consolidated Entity's external costs related to Year 2000 through
September 30, 1999 have been approximately $17,000. The Consolidated Entity
expects the remaining external costs will be minimal. The Consolidated Entity's
internal Year 2000 costs have been primarily payroll costs that have not been
tracked.
The risks associated with not being Year 2000 compliant include financial
and legal risks. Legal risks include the failure to meet contractual service
agreements, leading to possible punitive actions including those of a regulatory
nature. Financial risks concern the possibility of lost revenues or even
business failure. Major risks associated with the date change event include a
shut down of voice and data communication systems due to failure by switching
systems, satellites, or telephone companies; excessive cash withdrawal activity;
cash couriers delayed or not available; and government offices or facilities not
opening or operating.
The Consolidated Entity's loan portfolio consists primarily of residential
mortgage loans to individuals. These individuals generally are not affected by
Year 2000 failures. The limited number of the Consolidated Entity's commercial
borrowers are being contacted to assure that timely payments will be made in
January 2000. The Consolidated Entity has amended its underwriting policies to
address loan payment problems associated with a borrower as a result of a
disruption in income or a commercial borrower's inability to make a timely
payment.
Impact of Inflation and Changing Prices
The Financial Statements and Notes thereto presented herein have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time and due to inflation. The impact of inflation is
reflected in the increased cost of the Bank's operations. Unlike most
industrial companies, nearly all the assets and liabilities of the Bank are
monetary in nature. As a result, interest rates have a greater impact on the
Bank's performance than do the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or to the same extent as the
price of goods and services.
Impact of New Reporting and Accounting Standards
Reporting Comprehensive Income. In June 1997, Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130),
was issued and establishes standards for reporting and displaying comprehensive
income and its components. SFAS 130 requires comprehensive income and its
components, as recognized under accounting standards, to be displayed in a
financial statement with the same prominence as other financial statements. The
Bank adopted the standard, as required in fiscal 1998.
Disclosures about Segments of an Enterprise and Related Information. In
June 1997, Statements of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information," was issued and
establishes new standards for public companies to report information about
operating segments in annual and interim financial statements. The standard
also requires descriptive information about the way the operating segments are
determined, the products and services provided by the segments and the nature of
differences between reportable segment measurements and those used for the
consolidated enterprise. The Consolidated Entity adopted the standard, as
required in fiscal 1998. Management has determined that the Consolidated Entity
has only one segment, Consumer Banking.
Employers' Disclosures about Pensions and Other Postretirement Benefits.
In February 1998, Statement of Financial Accounting Standards No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits" (SFAS
No. 132) which revises employers' disclosures about pension and other
36
<PAGE>
postretirement benefit plans was issued. The standard does not change the
measurement or recognition of those plans. SFAS No. 132 standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable, requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis, and eliminates certain disclosures that are no longer viewed as useful
to the reader. The Bank adopted the standard, as required, in fiscal 1998.
Accounting for Derivative Instruments and Hedging Activities. In June
1998, the FASB issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (FASB 133). FASB
133 establishes new accounting and reporting requirements for derivative
instruments, including certain derivative instruments embedded in other
contracts and hedging activities. The standard requires all derivatives to be
measured at fair value and recognized as either assets or liabilities in the
statement of condition. Under certain conditions, a derivative may be
specifically designated as a hedge. Accounting for the changes in the fair
value of a derivative depends on the intended use of the derivative and the
resulting designation. The Statement, which is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000, will not affect the
Bank's financial position or its results of operations.
The Bank does not intend to early adopt SFAS No. 133 or to reclassify
any of its financial instruments as a result of this Statement.
Item 7. Financial Statements
37
<PAGE>
Consolidated Financial Statements
Innes Street Financial Corporation
Years ended September 30, 1999 and 1998
with Report of Independent Auditors
38
<PAGE>
Innes Street Financial Corporation
Consolidated Financial Statements
Years ended September 30, 1999 and 1998
Contents
<TABLE>
<S> <C>
Report of Independent Auditors............................................. 42
Audited Consolidated Financial Statements
Consolidated Balance Sheets................................................ 43
Consolidated Statements of Income.......................................... 44
Consolidated Statements of Shareholders' Equity............................ 45
Consolidated Statements of Cash Flows...................................... 46
Notes to Consolidated Financial Statements................................. 47
</TABLE>
39
<PAGE>
Report of Independent Auditors
The Board of Directors
Innes Street Financial Corporation
We have audited the accompanying consolidated balance sheets of Innes Street
Financial Corporation as of September 30, 1999 and 1998, and the related
consolidated statements of income, shareholders' equity, and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Innes Street
Financial Corporation at September 30, 1999 and 1998, and the consolidated
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
Ernst & Young LLP
Winston-Salem, North Carolina
November 12, 1999
40
<PAGE>
Innes Street Financial Corporation
Consolidated Balance Sheets
<TABLE>
<CAPTION>
September 30
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Assets
Cash and due from banks $ 3,667,346 $ 8,927,380
Federal funds sold-overnight 3,122,000 4,355,000
------------ ------------
Cash and cash equivalents 6,789,346 13,282,380
Federal funds sold-term - 2,000,000
Investment securities available-for-sale 16,023,687 7,227,783
Investment securities held-to-maturity (fair value of $727,555 and $1,614,024
at September 30, 1999 and 1998, respectively) 715,216 1,564,791
Loans receivable, net 167,874,234 159,248,042
Premises and equipment, net 2,173,006 1,178,903
Other 4,425,138 5,556,336
------------ ------------
Total assets $198,000,627 $190,058,235
============ ============
Liabilities and equity
Deposit accounts $160,809,797 $161,548,502
Advances from the Federal Home Loan Bank - 10,000,000
Other 1,509,048 2,537,357
----------- ------------
Total liabilities 162,318,845 174,085,859
Commitments and contingencies (Note 10)
Preferred Stock, no par value:
authorized - 5,000,000 shares; none issued and
outstanding - -
Common stock, no par value:
Authorized - 20,000,000 shares; issued and
outstanding - 2,135,838 shares - -
Paid in capital 20,106,106 -
Retained earnings (substantially restricted) 17,251,509 15,856,214
Unearned compensation relating to the ESOP (1,708,670) -
Accumulated other comprehensive income 32,837 116,162
----------- ------------
Total equity 35,681,782 15,972,376
------------ ------------
Total liabilities and equity $198,000,627 $190,058,235
============ ============
</TABLE>
See accompanying notes.
41
<PAGE>
Innes Street Financial Corporation
Consolidated Statements of Income
<TABLE>
<CAPTION>
Year ended September 30
-----------------------------------------
1999 1998
------------- -------------
<S> <C> <C>
Interest and fee income:
Loans receivable $11,876,172 $12,067,605
Investments 789,316 698,460
Other interest-earning assets 1,321,198 1,148,476
------------- -------------
Total interest income 13,986,686 13,914,541
Interest expense:
Deposits 7,736,427 8,118,049
Borrowings 430,878 1,069,177
------------- -------------
Total interest expense 8,167,305 9,187,226
------------- -------------
Net interest income 5,819,381 4,727,315
Provision for loan losses - -
------------- -------------
Net interest income after provision for
loan losses 5,819,381 4,727,315
Non-interest income:
Loan servicing fees 138,422 207,032
Gain on sales of loans, net 98,271 102,207
Other 96,900 111,714
------------- -------------
Total non-interest income 333,593 420,953
Non-interest expense:
Compensation and benefits 1,727,259 1,550,713
Occupancy and equipment 465,301 377,013
Advertising and promotion 133,871 198,112
Data processing 216,797 187,307
Deposit insurance premium 94,835 111,055
Other 797,816 631,822
------------- -------------
Total non-interest expense 3,435,879 3,056,022
------------- -------------
Income before income taxes 2,717,095 2,092,246
Provision for income taxes 1,011,841 758,545
------------- ------------
Net income $1,705,254 $ 1,333,701
============= =============
Basic and diluted earnings per share $ 0.83 N/A
Weighted average shares outstanding 2,066,326 N/A
</TABLE>
See accompanying notes.
42
<PAGE>
Innes Street Financial Corporation
Consolidated Statements of Shareholders' Equity
<TABLE>
<CAPTION>
Unearned Accumulated
Shares of Deferred Compensation Other Total
Common Paid in Retained Compensation Relating to the Comprehensive Shareholders'
Stock Capital Earnings Plans ESOP Income Equity
--------- ----------- ----------- ------------ --------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1997 $14,522,513 $ 106,383 $14,628,896
Net income 1,333,701 1,333,701
Change in unrealized appreciation
on securities available for sale,
net of taxes of $5,624 9,779 9,779
-----------
Comprehensive income 1,343,480
----------- ---------- -----------
Balance at September 30, 1998 15,856,214 116,162 15,972,376
Net income 1,705,254 1,705,254
Change in unrealized appreciation
on securities available for sale,
net of taxes of ($53,307) (83,325) (83,325)
-----------
Comprehensive income 1,621,929
Dividends paid ($.15 per share) (309,959) (309,959)
Net proceeds from Initial Public
Offering 2,248,250 $21,598,347 $ (1,798,600) 19,799,747
Shares purchased and held in rabbi
trusts $ 1,238,118 1,238,118
Deferred compensation obligation (1,238,118) (1,238,118)
Commitment of ESOP shares
(8,993 shares) 89,930 89,930
Repurchase of common stock (112,412) (1,492,241) (1,492,241)
--------- ----------- ----------- ------------ --------------- ------------- -------------
Balance at September 30, 1999 2,135,838 $20,106,106 $17,251,509 $ - $ (1,708,670) $ 32,837 $35,681,782
========= =========== =========== ============ =============== ============= =============
</TABLE>
See accompanying notes.
43
<PAGE>
Innes Street Financial Corporation
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year ended September 30
---------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Operating activities
Net income $ 1,705,254 $ 1,333,701
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation 203,923 173,378
Amortization of deferred loan fees 47,005 77,338
Commitment of ESOP shares 89,930 -
Deferred income taxes (128,934) 17,569
Gain on sales of loans, net (98,273) (102,207)
Other, net 982,931 (1,566,637)
------------ ------------
Net cash provided by (used in) operating activities 2,801,836 (66,858)
Investing activities
Purchases of federal funds sold-term - (7,000,000)
Proceeds from maturity of federal funds sold-term 2,000,000 11,100,000
Purchases of investments available-for-sale (11,989,500) -
Principal repayment of mortgage-backed securities 3,908,310 3,879,129
Net increase in loans (10,190,843) (5,365,533)
Purchases of loans (6,572,367) -
Proceeds from sales of loans 8,188,286 5,600,682
Proceeds from the sale of FHLB stock 218,200 -
Proceeds from sales of foreclosed real estate 110,516 -
Purchases of premises and equipment (1,198,005) (16,372)
------------ ------------
Net cash (used in) provided by investing activities (15,525,403) 8,197,906
Financing activities
Net (decrease) increase in deposit amounts (738,705) 1,055,938
Repayment of FHLB advances (10,000,000) (12,000,000)
Net (decrease) increase in mortgage escrow funds (1,028,309) 43,224
Net proceeds from issuance of common stock 19,799,747 -
Repurchase of common stock (1,492,241) -
Dividends paid (309,959) -
------------ ------------
Net cash provided by (used in) financing activities 6,230,533 (10,900,838)
------------ ------------
Net decrease in cash and cash equivalents (6,493,034) (2,769,790)
Cash and cash equivalents at beginning of year 13,282,380 16,052,170
------------ ------------
Cash and cash equivalents at end of year $ 6,789,346 $ 13,282,380
============ ============
Supplemental disclosure of cash flow data:
Cash paid during the year for:
Interest $ 8,222,055 $ 9,298,263
Taxes $ 1,189,524 $ 844,818
Transfers from loans to foreclosed real estate $ 214,356 $ -
</TABLE>
See accompanying notes.
44
<PAGE>
Innes Street Financial Corporation
Notes to Consolidated Financial Statements
September 30, 1999
1. Accounting Policies
Basis of Presentation and Consolidation
The consolidated financial statements include the accounts of Innes Street
Financial Corporation and its wholly-owned subsidiary, Citizens Bank, FSB
(together "the Company"). All significant intercompany balances and
transactions have been eliminated in consolidation.
Business
Innes Street Financial Corporation was incorporated on July 6, 1998 to serve as
the holding company for Citizens Bank, FSB (the "Bank") upon the Bank's
conversion from a federally chartered mutual savings bank to a federally
chartered stock savings bank (the "Conversion"). Innes Street Financial
Corporation completed the Conversion on December 28, 1998 through the sale and
issuance of 2,248,250 shares of common stock. The Bank offers full service
banking to those within Salisbury and the surrounding communities. The Office of
Thrift Supervision is the Company's primary regulator.
Use of Estimates
In preparing consolidated financial statements in conformity with generally
accepted accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
date of the balance sheet and reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. The
material estimate that is particularly susceptible to significant change in the
near term relates to the determination of the allowance for loan losses.
Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, and
overnight federal funds sold. The Company considers all highly liquid debt
instruments purchased with an original maturity of three months or less to be
cash equivalents.
45
<PAGE>
1. Accounting Policies (continued)
Investment Securities
Management determines the appropriate classification of securities at the time
of purchase. Securities are classified as held to maturity when the Company has
the positive intent and ability to hold the securities to maturity. Held to
maturity securities are stated at amortized cost.
Securities not classified as held to maturity are classified as available for
sale. Available for sale securities are stated at fair value, with the
unrealized gains and losses, net of tax, included in comprehensive income, a
separate component of shareholders' equity.
The amortized cost of investment securities is adjusted for amortization of
premiums and accretion of discounts over the estimated life of the security.
Such amortization is included in interest income from investments. The cost of
securities sold is based on the specific identification method.
Loans Receivable
The Company grants primarily mortgage loans to customers. A substantial portion
of the loan portfolio is represented by mortgage loans in Salisbury and the
surrounding communities. The loans typically do not exceed 80% of the appraised
value of the security property. Pursuant to underwriting guidelines adopted by
the Board of Directors, the Company can lend up to 95% of the appraised value of
the property securing a one-to-four family residential loan; however, the
Company generally obtains private mortgage insurance on the portion of the
principal amount that exceeds 80% of the appraised value of the security
property. The ability of the Company's debtors to honor their contracts is
dependent upon the real estate and general economic conditions of this area.
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or pay-off generally are reported at their outstanding
unpaid principal balances adjusted for charge-offs, the allowance for loan
losses, and any deferred fees or costs on originated loans. Interest income is
accrued on the unpaid principal balance. Loan origination fees, net of certain
direct origination costs, are deferred and recognized as an adjustment of the
related loan yield using the interest method.
The accrual of interest on loans is discontinued at the time the loan is 90 days
delinquent. In all cases, loans are placed on nonaccrual or charged-off at an
earlier date if collection of principal or interest is considered doubtful.
46
<PAGE>
1. Accounting Policies (continued)
The Company provides a reserve for uncollected interest on all nonaccrual loans.
Interest income is subsequently recognized on impaired loans only to the extent
cash payments in excess of past due principal amounts are received. The interest
reserve is a reduction of accrued interest receivable for financial reporting
purposes. Loans are returned to accrual status when all the principal and
interest amounts contractually due are brought current or future payments are
reasonably assured.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
Management considers the Company's loan portfolio to be homogeneous in nature,
accordingly, the Company does not separately identify individual consumer and
residential loans for impairment disclosures.
Foreclosed Real Estate
Foreclosed real estate acquired in settlement of loans is carried at the lower
of cost or the fair value minus estimated costs to sell. Costs relating to the
development and improvement of property are capitalized to the extent of the
property's net realizable value, whereas those relating to holding the property
are charged to expense.
Premises and Equipment
Premises and equipment is stated at cost. Depreciation is computed by the
straight-line method over the assets' estimated useful lives, which range from
three to thirty years, for financial reporting purposes.
47
<PAGE>
1. Accounting Policies (continued)
Income Taxes
The Company accounts for income taxes using the liability method in accordance
with Financial Accounting Standards Board ("FASB") Statement No. 109, Accounting
for Income Taxes, which requires an asset and liability approach to accounting
for income taxes. Under Statement No. 109, deferred income taxes reflect the
net tax effects of temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and the amounts used for income
tax purposes.
Earnings Per Share
The earnings per share calculation is not applicable for the year ended
September 30, 1998 as the Company was not publicly held until December 28, 1998.
For purposes of calculating earnings per share for the year ended September 30,
1999, the shares issued on December 28, 1998 have been assumed to be outstanding
as of October 1, 1998. The Company had no potentially dilutive securities
during the year ended September 30, 1999, accordingly, basic earnings per share
and diluted earnings per share are the same.
Segment Reporting
In June 1997, the FASB issued Statement No. 131, Disclosures about Segments of
an Enterprise and Related Information. This statement establishes new standards
for reporting information about operating segments in annual and interim
financial statements. The Company adopted this statement effective December 28,
1998, as the requirement is applicable only to publicly held corporations.
Management has determined that as of September 30, 1999, it operates in only one
segment, Consumer Banking. Accordingly, the financial results of the Company
consist only of this one segment.
Derivatives
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes new accounting
and reporting requirements for derivative instruments, including certain
derivative instruments embedded in other contracts and hedging activities.
Currently, the Company has no derivative instruments that fall within the
definition of a derivative as defined by the statement. The Company does not
anticipate that the adoption of this statement on October 1, 2000 will
significantly impact the financial results of the Company.
48
<PAGE>
1. Accounting Policies (continued)
Reclassifications
Certain prior period amounts have been reclassified to conform to the current
year presentation.
2. Investment Securities
The amortized cost, gross unrealized gains, gross unrealized losses and market
values of investment securities are as follows:
<TABLE>
<CAPTION>
September 30, 1999
----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Securities Available-for Sale
FHLB bonds and notes $11,995,180 $ - $ (38,523) $ 11,956,657
Mortgage-backed securities 3,974,865 92,165 - 4,067,030
----------- ------------- ---------- ------------
Total securities available-for-sale $15,970,045 $ 92,165 $ (38,523) $ 16,023,687
=========== ============= ========== ============
Securities Held-to-Maturity
Mortgage-backed securities $ 715,216 $ 12,339 $ - $ 727,555
----------- ------------- ---------- ------------
Total securities held-to-maturity $ 715,216 $ 12,339 $ - $ 727,555
=========== ============= ========== ============
<CAPTION>
September 30, 1998
---------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Securities Available-for-Sale
Mortgage-backed securities $ 7,037,509 $ 190,274 $ - $ 7,227,783
-------------- ----------- --------- ------------
Total securities available-for-sale $ 7,037,509 $ 190,274 $ - $ 7,227,783
============== =========== ========= ============
Securities Held-to-Maturity
Mortgage-backed securities $ 1,564,791 $ 49,233 $ - $ 1,614,024
-------------- ----------- --------- ------------
Total securities held-to-maturity $ 1,564,791 $ 49,233 $ - $ 1,614,024
============== =========== ========= ============
</TABLE>
49
<PAGE>
2. Investment Securities (continued)
The amortized cost and fair value of debt securities by contractual maturity
at September 30, 1999 follows:
<TABLE>
<CAPTION>
Available-for-Sale
-------------------------------------------
Amortized Cost Fair
Value
-------------------------------------------
<S> <C> <C>
Within 1 year $ 9,995,180 $ 9,972,515
Over 1 year through 5 years 2,000,000 1,984,142
-------------------------------------------
$11,995,180 $11,956,657
===========================================
</TABLE>
Mortgage-backed securities are not due at a single maturity date. Hence, there
is no contractual maturity for mortgage-backed securities as of September 30,
1999. All mortgage-backed securities are backed by either FNMA, GNMA, or FHLMC.
Securities carried at $1,769,854 and $1,680,435 at September 30, 1999 and 1998,
respectively, were designated as security for deposits and public funds.
50
<PAGE>
3. Loans Receivable, Net
Loans receivable, net consisted of the following:
<TABLE>
<CAPTION>
September 30
---------------------------------------
1999 1998
-------------- -------------
<S> <C> <C>
1-4 family $134,822,329 $136,279,370
Home equity 20,704,877 17,171,204
Construction and development 13,211,376 4,117,777
Nonresidential 2,386,697 1,617,422
Multi-family 3,652,435 1,311,782
------------ ------------
Mortgage loans 174,777,714 160,497,555
Other loans 239,493 1,667,113
------------ ------------
175,017,207 162,164,668
Less:
Allowance for loan losses 1,223,627 1,223,627
Loans in process 5,713,721 1,539,951
Deferred fees, net 205,625 93,481
Unearned income - 59,567
7,142,973 2,916,626
------------ ------------
$167,874,234 $159,248,042
============ ============
</TABLE>
Mortgage loans at September 30, 1999 and 1998, are net of participations and
whole loans serviced for others, in the amounts of $48,386,833 and $55,462,955,
respectively. Custodial escrow balances maintained in connection with loans
serviced for others were $292,513 and $372,745, at September 30, 1999 and 1998,
respectively.
Changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
Year ended September 30
------------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Balance at beginning of year $ 1,223,627 $ 1,222,675
Provision for loan losses - -
Charge-offs - -
Recoveries - 952
------------ -----------
Balance at end of year $ 1,223,627 $ 1,223,627
============ ===========
</TABLE>
51
<PAGE>
4. Deposit Accounts
<TABLE>
<CAPTION>
September 30
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Demand $ 1,086,097 $ 1,331,049
NOW 6,572,501 5,892,705
Money market 2,014,150 2,453,688
Passbook savings 36,125,534 40,131,039
Certificates of deposit 115,011,515 111,740,021
------------ ------------
Total deposits $160,809,797 $161,548,502
============ ============
</TABLE>
Demand deposits are non-interest bearing. All other deposit types bear interest.
The aggregate amount of certificates of deposit with a minimum denomination in
excess of $100,000 was $15,407,874 and $14,559,420 at September 30, 1999 and
1998, respectively. Deposits which exceed $100,000 are not federally insured.
At September 30, 1999, scheduled maturities of certificates of deposit are as
follows:
<TABLE>
<S> <C>
Year ending September 30:
2000 $ 99,206,151
2001 14,200,252
2002 1,183,153
2003 297,012
2004 2,042
Thereafter 122,905
------------
$115,011,515
============
</TABLE>
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
Year ended September 30
------------------------------
1999 1998
----------- -----------
<S> <C> <C>
NOW $ 61,182 $ 81,210
Money market 58,251 70,343
Passbook savings 1,519,230 1,625,099
Certificates of deposit 6,097,764 6,341,397
----------- -----------
$ 7,736,427 $ 8,118,049
=========== ===========
</TABLE>
The Company had on deposit amounts from certain directors and executive officers
of $933,070 and $1,051,663 as of September 30, 1999 and 1998, respectively.
52
<PAGE>
5. Advances from the Federal Home Loan Bank
Pursuant to collateral agreements with the Federal Home Loan Bank (FHLB),
advances are secured by stock in the FHLB and qualifying first mortgage loans.
The carrying value of qualifying first mortgage loans was $137,879,871 as of
September 30, 1998. Interest rates on FHLB advances are fixed, and the weighted
average interest rate was 6.89% at September 30, 1998.
The Company had available credit with the FHLB of $39,356,000 and $30,000,000 as
of September 30, 1999 and 1998, respectively.
6. Employee Benefit and Deferred Compensation Plans
On March 31, 1998, The Board of Directors of the Company terminated its non-
contributory defined benefit pension plan effective July 31, 1998. At the time
the pension plan was terminated, it was fully funded. The benefits accrued by
employees under the plan have been transferred, at the election of each
employee, to the Company's new 401(k) retirement plan.
The Company implemented a 401(k) retirement plan effective July 1, 1998. All
eligible employees may elect to contribute a percentage of their compensation to
the plan each year, subject to certain maximums imposed by federal law. The
Company will match 50% of each participant's contribution, up to 3% of
participant's compensation. The Company also intends to make discretionary
contributions to the plan, expected to equal approximately 3% each year.
Participants are fully vested in the amounts they contribute to the plan.
Participants will be fully vested in employer matching contributions after one
year of service. Contribution expense related to this plan was $76,987 and
$18,318 for the years ended September 30, 1999 and 1998, respectively.
On December 28, 1998, the Company established an employee stock ownership plan
(ESOP) for the benefit of all eligible employees based upon years of service
with the Company. In conjunction with the establishment of the ESOP, an off-
balance sheet ESOP trust was established and funded by the Company, by way of a
loan to the trust, in order to purchase 179,860 shares of the Company's stock.
The trust expects to pay down the loan over the fifteen year term principally
from discretionary contributions and dividends on allocated shares. An equal
amount of unallocated ESOP stock was recorded as a reduction of shareholders'
equity. As the ESOP trust pays down the loan, shares are allocated to
participants, on the basis of relative compensation in the year of allocation,
reducing the unallocated shares amount recorded in shareholders' equity. The
expense associated with the ESOP, in the form of discretionary contributions and
dividends on unallocated shares, was $142,231 for the year ended September 30,
1999. Unallocated shares are not included in weighted average outstanding shares
for purposes of computing earnings per share. As of September 30, 1999, there
were 176,832 weighted average uncommitted shares related to the ESOP plan.
53
<PAGE>
6. Employee Benefit and Deferred Compensation Plans (continued)
The Company maintains four non-qualified deferred compensation plans, a
diversified and a non-diversified plan, for the benefit of certain key
executives and the board of directors. The eligible employees may defer a
portion of their compensation and the directors may defer a portion of their
directors fees. The deferred assets are maintained in rabbi trusts which are
included in the assets of the Company. The deferred compensation amounts
directed to the diversified plans are included in Other Assets in the
consolidated balance sheets. The assets are accounted for at market value in
accordance with FASB Statement No. 115, Accounting for Certain Investments in
Debt and Equity Securities, with the resulting gains or losses in value recorded
as an adjustment to the fair value of the deferred compensation obligation. The
assets of the non-diversified rabbi trusts consist only of Company stock,
therefore the value of the stock, at cost, and the corresponding deferred
compensation have been recorded in shareholders' equity.
The fair value of the assets in the rabbi trusts established for the diversified
plans and the deferred compensation obligation associated with the diversified
plans was $231,269 and $1,275,485 at September 30, 1999 and 1998, respectively.
54
<PAGE>
7. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are summarized as follows.
<TABLE>
<CAPTION>
September 30
------------------------
1999 1998
---------- --------
<S> <C> <C>
Deferred tax assets:
Deferred compensation $ 525,935 $434,982
Allowance for loan losses 361,049 329,055
ESOP expense 45,343 -
Depreciation 32,611 43,007
Loans to facilitate sales of foreclosed real estate 30,167 31,320
Other 11,253 51,557
---------- --------
Total deferred tax assets 1,006,358 889,921
Deferred tax liabilities:
Deferred fees 260,609 260,946
FHLB stock dividends 173,536 197,944
Mortgage loan servicing rights 44,754 27,534
Net unrealized appreciation on securities available-for-sale 20,805 74,112
Other 281 5,253
---------- --------
Total deferred tax liabilities 499,985 565,789
---------- --------
Net deferred tax asset $ 506,373 $324,132
========== ========
</TABLE>
The following is a summary of provision for income taxes:
<TABLE>
<CAPTION>
Year ended September 30
-------------------------
1999 1998
---------- ---------
<S> <C> <C>
Current:
Federal $ 999,925 $652,320
State 140,850 88,656
---------- --------
Total current 1,140,775 740,976
Deferred:
Federal (107,073) 11,152
State (21,861) 6,417
---------- --------
Total deferred (128,934) 17,569
---------- --------
$1,011,841 $758,545
========== ========
</TABLE>
55
<PAGE>
7. Income Taxes (continued)
The Company's effective tax rate differs from that computed at the statutory
federal income tax rate, as follows:
<TABLE>
<CAPTION>
Year ended September 30
-------------------------
1999 1998
---------- --------
<S> <C> <C>
Tax at statutory rate $ 923,812 $711,363
State income tax, net of federal income tax benefit 80,778 58,325
Other 7,251 (11,143)
---------- --------
$1,011,841 $758,545
========== ========
Statutory federal tax rate 34% 34%
========== ========
Effective tax rate 37% 36%
========== ========
</TABLE>
Savings and loan associations which met certain definitional tests and operating
requirements prescribed by the Internal Revenue Code were allowed a special bad
debt deduction, extended expiration dates for net operating loss carryforwards
and other special tax provisions.
The special bad debt deduction was based on either specified experience formulas
or a specified percentage of taxable income before such deduction. The deduction
was subject to certain limitations based on the aggregate loans, savings account
balances and retained earnings at year end. Gains and losses on sales of
repossessed property and provisions for losses on loans and real estate
foreclosed were generally adjustments to the tax bad debt reserve and not
included in the computation of taxable income before this deduction. Effective
October 1, 1996 this deduction was no longer allowed. In addition, a portion of
the tax bad debt reserve is required to be recaptured over six years. The Bank
recaptured $93,548 and $93,638 into income for income tax purposes for the years
ended September 30, 1999 and 1998, respectively.
Retained earnings at year end include tax bad debt reserves of approximately
$3,735,000, for which no provision for federal income tax has been made. If, in
the future, these amounts are used for any purpose other than to absorb bad debt
losses, or the Company ceases to be qualified as a savings bank, they may be
subject to federal income tax at the then prevailing corporate tax rate. If
federal income taxes had been provided the deferred tax liability would have
been approximately $1,270,000.
56
<PAGE>
8. Regulatory Matters
The Bank is subject to various regulatory capital requirements administered by
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 1 capital (as defined in the regulations) to risk-
weighted assets (as defined), and of Tier 1 capital (as defined) to adjusted
assets (as defined). Management believes, as of September 30, 1999, that the
Bank meets all capital adequacy requirements to which it is subject.
As of September 30, 1999, the most recent notification from the Office of Thrift
Supervision (OTS) categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Bank must maintain minimum Tier 1 and total capital ratios as set forth in
the table. The amounts and ratios as of September 30, 1999 and 1998 were set
forth under the criteria established by the OTS. There are no conditions or
events since that notification that management believes have changed the
institution's category.
57
<PAGE>
8. Regulatory Matters (continued)
(Dollars in thousands)
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
Minimum For Capital Promt Corrective
Actual Adequacy Purposes Action Provisions
-------------------- -------------------- ----------------------
Ratio Amount Ratio Amount Ratio Amount
-------------------- -------------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1999:
Equity and ratio to total assets 14.01% $ 26,956
Unrealized appreciation of securities
available for sale (49)
-----------
Tier 1 (Core) and ratio to adjusted
total assets 13.99% $ 26,907 4.00% $ 7,694 5.00% $ 9,618
=========== ======== =========
Tier 1 (Core) and ratio to risk-
weighted assets 24.32% 26,907 4.00% $ 4,426 6.00% $ 6,639
======= =========
Allowance for loan losses 1,224
-----------
Total Risk-Based Capital and ratio to
risk-weighted assets 25.42% $ 28,131 8.00% $ 8,852 10.00% $ 11,065
=========== ======== =========
Total assets $ 192,436
===========
Adjusted total assets $ 192,355
===========
Risk-weighted assets $ 110,647
===========
</TABLE>
58
<PAGE>
8. Regulatory Matters (continued)
(Dollars in thousands)
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
Minimum For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------- ----------------------- --------------------
Ratio Amount Ratio Amount Ratio Amount
---------------------- ----------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1998:
Equity and ratio to total assets 8.40% $ 15,972
Unrealized appreciation of securities
available for sale (116)
--------
Tier 1 (Core) and ratio to adjusted
total assets 8.35% $ 15,856 4.00% $7,595 5.00% $ 9,494
======== ====== =======
Tier 1 (Core) and ratio to risk-
weighted assets 15.59% 15,856 4.00% $4,068 6.00% $ 6,102
====== =======
Allowance for loan losses 1,224
--------
Total Risk-Based Capital and ratio to
risk-weighted assets 16.79% $ 17,080 8.00% $8,136 10.00% $10,170
======== ====== =======
Total assets $190,058
========
Adjusted total assets $189,883
========
Risk-weighted assets $101,698
========
</TABLE>
The OTS places certain restrictions on dividends paid by the Bank to the
Company. The total amount of dividends which may be paid at any date is
generally limited to the retained earnings of the Bank. In addition, dividends
paid by the Bank to the Company would be prohibited if the effect thereof would
cause the Bank's capital to be reduced below applicable minimum capital
requirements.
59
<PAGE>
9. Other Non-interest Expense
Other non-interest expense amounts are summarized as follows:
Year ended September 30
--------------------------
1999 1998
----------- -------------
Printing, postage and supplies $156,113 $134,647
Professional and legal fees 245,115 135,009
Insurance premiums 35,131 31,439
Telephone 60,142 48,185
Other 301,315 282,542
-------- --------
$797,816 $631,822
======== ========
10. Commitments and Contingencies
In conjunction with its lending activities, the Company enters into various
commitments to extend credit. Loan commitments (unfunded loans and unused lines
of credit) are issued to accommodate the financing needs of the Bank's
customers. Loan commitments are agreements by the Company to lend at a future
date, so long as there are no violations of any conditions established in the
agreement.
Financial instruments (primarily equity lines), where the contract amount
represents the Company's credit risk included unused lines of credit of
$17,499,579 and $15,053,671 at September 30, 1999 and 1998, respectively.
These loan commitments are subject to the same credit policies and reviews as
loans on the statement of condition. Collateral, both the amount and nature, is
obtained based upon management's assessment of the credit risk. Since many of
the extensions of credit are expected to expire without being drawn, the total
commitment amounts do not necessarily represent future cash requirements.
Outstanding commitments on mortgage loans not yet closed amounted to $3,374,375
and $7,256,700 at September 30, 1999 and 1998, respectively. Approximately 47%
and 88% of these commitments were at fixed interest rates as of September 30,
1999 and 1998, respectively. The fixed rates ranged from 6.597% to 9.00% and
5.875% to 10.75% at September 30, 1999 and 1998, respectively. Such commitments,
which are funded subject to certain limitations, extend over varying periods of
time with the majority being funded within a six-month period.
60
<PAGE>
11. Fair Value of Financial Instruments
FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments,
requires disclosure of fair value information about financial instruments,
whether or not recognized in the balance sheet, for which it is practicable to
estimate that value. In cases where quoted market prices are not available, fair
values are based on estimates using present value of expected cash flows or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rates and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts. The fair value estimates presented herein are
based on pertinent information available to management. Such amounts have not
been comprehensively revalued for purposes of these financial statements since
that date and, therefore, current estimates of fair value may differ
significantly from the amounts presented herein.
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
Investment Securities
---------------------
Fair values for investment securities are based on quoted market prices.
For purposes of determining the fair value of Federal Home Loan Bank stock,
for which quoted market prices are not available, the carrying amount of
the stock has been considered the fair value.
Loans Receivable
----------------
The fair value of all categories of loans is estimated by discounting their
expected future cash flows using interest rates currently being offered for
loans with similar terms, reduced by an estimate of credit losses inherent
in the portfolio.
Deposit Accounts
----------------
The fair value of demand deposits (e.g., interest and non-interest bearing
and money market accounts) is assumed to be their carrying amount. The fair
value of savings certificates is estimated using a discounted cash flow
calculation that applies rates currently being offered on instruments with
similar remaining maturities.
61
<PAGE>
11. Fair Value of Financial Instruments (continued)
Advances from the Federal Home Loan Bank
----------------------------------------
The fair value of advances from the Federal Home Loan Bank is estimated
using discounted cash flow analysis based upon rates currently available to
the Company on similar instruments.
Off-Balance Sheet Instruments
-----------------------------
Fair values of the Company's commitments to extend credit and stand-by
letters of credit are nominal since they have short maturities, and the
committed rates approximate current rates offered for commitments with
similar rate and maturity characteristics.
Many of the Company's assets and liabilities are short-term financial
instruments whose carrying amounts reported in the statement of condition
approximate fair value. These items include cash and due from banks, accrued
interest receivable and the financial instruments included in other assets and
liabilities. The estimated fair values of the Company's remaining on-balance
sheet financial instruments are summarized as follows:
<TABLE>
<CAPTION>
September 30, 1999
--------------------------------------
Carrying Estimated
Value Fair Value
-------------- -------------------
<S> <C> <C>
Financial assets:
Investment securities available-for-sale $ 16,023,687 $ 16,023,687
Investment securities held-to-maturity 715,216 727,555
Loans receivable 167,874,234 165,405,414
Federal Home Loan Bank stock 1,606,600 1,606,600
Financial liabilities:
Deposit accounts 160,809,797 157,735,000
</TABLE>
62
<PAGE>
11. Fair Value of Financial Instruments (continued)
<TABLE>
<CAPTION>
September 30, 1998
------------------------------------
Carrying Estimated
Value Fair Value
-------------- --------------
<S> <C> <C>
Financial assets:
Investment securities available-for-sale $ 7,227,783 $ 7,227,783
Investment securities held-to-maturity 1,564,791 1,614,024
Loans receivable 159,248,042 162,224,193
Federal Home Loan Bank stock 1,824,800 1,824,800
Financial liabilities:
Deposit accounts 161,548,502 162,240,481
Advances from the Federal Home Loan Bank 10,000,000 10,104,000
</TABLE>
Statement No. 107 excludes certain financial instruments and all non-financial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
12. Plan of Conversion
Effective September 2, 1998, the Bank converted from a North Carolina chartered
mutual savings bank to a federally chartered mutual savings bank. On September
10, 1998, the Board of Directors of the Bank adopted a Plan of Conversion (the
Plan) under which the Bank converted from a federally chartered mutual savings
bank to a federally chartered stock savings bank. As part of the Plan, the Bank
became a wholly-owned subsidiary of a holding company, Innes Street Financial
Corporation, formed in connection with the conversion. The holding company
issued common stock to be sold in the conversion and used a portion of the net
proceeds to purchase the capital stock of the Bank. The Plan was approved by
regulatory authorities and by the members of the Bank at a special meeting. The
shares of the holding company began trading on December 28, 1998.
At the time of the conversion, the Bank established a liquidation account in the
amount equal to its regulatory capital as of the latest practicable date before
the conversion at which such regulatory capital can be determined. The
liquidation account was maintained for the benefit of eligible depositors who
continued to maintain their accounts at the Bank after the conversion. The
liquidation account will be reduced annually to the extent that eligible
depositors have reduced their qualifying deposits. Subsequent increases will not
restore an eligible account holder's interest in the liquidation account. In the
event of a complete liquidation, each eligible depositor will be entitled to
receive a distribution from the liquidation account in an amount proportionate
to the current adjusted qualifying balances for accounts then held. The Bank may
63
<PAGE>
12. Plan of Conversion (continued)
not pay dividends that would reduce shareholders' equity below the required
liquidation account balance. Under OTS regulations, limitations have been
imposed on all "capital distributions" by savings institutions, including cash
dividends. The regulation establishes a three-tiered system of restrictions,
with the greatest flexibility afforded to thrifts that are both well capitalized
and given a favorable qualitative examination rating by the OTS.
13. Condensed Financial Statements of Parent Company
The following condensed financial information pertains only to Innes Street
Financial Corporation. The parent company commenced operations December 28,
1998.
<TABLE>
<CAPTION>
Condensed Balance Sheet
September 30
1999
----------------
<S> <C>
Assets
Cash and cash equivalents $ 1,502,728
Investment securities available-for-sale 6,970,717
Investment in subsidiary 28,194,721
Other 1,953,906
----------------
Total assets $ 38,622,072
================
Liabilities and equity
Accrued liabilities $ 160,202
Other 2,780,088
Shareholders' equity 35,681,782
----------------
Total liabilities and equity $ 38,622,072
================
</TABLE>
64
<PAGE>
13. Condensed Financial Statements of Parent Company (continued)
Condensed Statement of Income
<TABLE>
<CAPTION>
Period from December
28, 1998 to September
30, 1999
------------
<S> <C>
Income:
Dividends from subsidiary $ 337,238
Investments 208,352
Other 249,056
-----------
Total income 794,646
Operating expenses 103,017
-----------
Income before income taxes and equity in
undistributed net income of subsidiary 691,629
Provision for income taxes 137,450
-----------
Equity in undistributed net income of
subsidiary 1,151,075
-----------
Net income $ 1,705,254
===========
</TABLE>
65
<PAGE>
13. Condensed Financial Statements of Parent Company (continued)
Condensed Statement of Cash Flows
<TABLE>
<CAPTION>
Period from December 28, 1998
to September 30,
1999
------------
<S> <C>
Operating activities
Net income $ 1,705,254
Adjustments to reconcile net income to net
cash (used in) provided by operating activities:
Equity in undistributed net income of
subsidiary (1,151,075)
Commitment of ESOP shares 89,930
Increase in other assets (1,946,475)
Increase in accrued liabilities 160,202
Increase in other liabilities 2,780,088
------------
Cash provided by operating activities 1,637,924
Investing activities
Purchase of Bank common stock (9,899,875)
Purchases of investment securities (6,994,750)
------------
Cash used in investing activities (16,894,625)
Financing activities
Net proceeds from issuance of common stock 19,799,747
Purchase of common stock held by rabbi trust (1,238,118)
Repurchase of common stock (1,492,241)
Dividends paid (309,959)
------------
Net cash provided by financing activities 16,759,429
------------
Net increase in cash and cash equivalents 1,502,728
Cash and cash equivalents at beginning of period -
------------
Cash and cash equivalents at end of year $ 1,502,728
============
</TABLE>
66
<PAGE>
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
Not Applicable
Part III
--------
Item 9. Directors, Executive Officers, Promoters and Control Persons,
Compliance with Section 16(a) of the Exchange Act
The information required by this Item regarding directors and
executive officers of the Company and the Bank is set forth under the sections
captioned "Proposal 1 - Election of Directors" on pages 5 through 7 of the Proxy
Statement and "-Executive Officers" on page 5 of the Proxy Statement, which
sections are incorporated herein by reference.
The information required by this Item regarding compliance with
Section 16 (a) of the Securities Exchange Act of 1934 is set forth under the
section captioned "Section 16 (a) Beneficial Ownership Reporting Compliance" set
forth on page 5 of the Proxy Statement, which is incorporated herein by
reference.
Item 10. Executive Compensation
The information required by this Item is set forth under the sections
captioned "Proposal 1 -Election of Directors-Director Compensation" on page 7
and "-Executive Compensation" on pages 9 through 11 of the Proxy Statement,
which sections are incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is incorporated by reference
from the section captioned "Security Ownership of Certain Beneficial Owner" on
pages 3 through 5 of the Proxy Statement.
Item 12. Certain Relationships and Related Transactions
There have been no reportable transactions during the two most recent
fiscal years nor are any reportable transactions proposed as of the date of this
Form 10-KSB.
Item 13. Exhibits and Reports on Form 8-K
13(a) Exhibits
(3)(i) Articles of Incorporation, incorporated herein by reference
to Exhibit (3)(i) to the Registration Statement on Form S-1,
Registration No. 333-63363, dated September 14, 1998, as
amended by Pre-Effective Amendment No. 1, dated November 2,
1998, Pre-Effective Amendment No. 2, dated November 10, 1998
and Pre-Effective Amendment No. 3, dated November 12, 1998.
(3)(ii) Bylaws, incorporated herein by reference to Exhibit (3)(ii)
to the Registration Statement on Form S-1, Registration No.
333-63363, dated September 14, 1998, as amended by Pre-
Effective Amendment No. 1, dated November 2, 1998, Pre-
Effective Amendment No. 2, dated November 10, 1998 and Pre-
Effective Amendment No. 3, dated November 12, 1998.
(4) Specimen Stock Certificate, incorporated herein by reference
to Exhibit (4) to the Registration Statement on Form S-1,
Registration No. 333-63363, dated September 14, 1998, as
amended by Pre-Effective Amendment No. 1, dated November 2,
1998, Pre-Effective Amendment No. 2, dated November 10, 1998
and Pre-Effective Amendment No. 3, dated November 12, 1998.
10(a) Employment agreement between Citizen Bank, FSB and Ronald E.
Bostian
67
<PAGE>
10(c) Innes Street Financial Corporation Stock Option Plan
10(d) Citizens Bank, FSB Management Recognition Plan and Trust
10(e) Severance Agreement, incorporated herein by reference to
Exhibit 10(e) to the Registration Statement on Form S-1,
Registration No. 333-63363, dated September 14, 1998, as
amended by Pre-Effective Amendment No. 1, dated November 2,
1998, Pre-Effective Amendment No. 2, dated November 10, 1998
and Pre-Effective Amendment No. 3, dated November 12, 1998.
10(f) Amended and Restated Nonqualified Deferred Compensation
Plan, incorporated herein by reference to Exhibit 10(f) to
the Registration Statement on Form S-1, Registration No.
333-63363, dated September 14, 1998, as amended by Pre-
Effective Amendment No. 1, dated November 2, 1998, Pre-
Effective Amendment No. 2, dated November 10, 1998 and Pre-
Effective Amendment No. 3, dated November 12, 1998.
10(g) Amended and Restated Directors Deferred Compensation Plan,
incorporated herein by reference to Exhibit 10(g) to the
Registration Statement on Form S-1, Registration No. 333-
63363, dated September 14, 1998, as amended by Pre-Effective
Amendment No. 1, dated November 2, 1998, Pre-Effective
Amendment No. 2, dated November 10, 1998 and Pre-Effective
Amendment No. 3, dated November 12, 1998.
10(h) Second Directors' Deferred Compensation Plan of Citizens
Bank, FSB, incorporated by reference to Exhibit 10(i) to the
Form 10-QSB dated May 13, 1999.
10(i) Second Nonqualified Deferred Compensation Plan for Key
Employees of Citizens Bank, FSB, incorporated by reference
to Exhibit 10(ii) to the Form 10-QSB dated May 13, 1999.
(11) Statement Regarding Computation of Per Share Earnings.
(21) See Item 1. Description of Business for discussion of
subsidiaries.
(27) Financial Data Schedule
13(b) The Company filed no reports on Form 8-K during the last quarter of the
fiscal year covered by this report.
68
<PAGE>
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INNES STREET FINANCIAL CORPORATION
Date: By: /s/ Ronald E. Bostian
-----------------------------------
Ronald E. Bostian
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 dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Ronald E. Bostian President, Chief Executive December 20, 1999
- -------------------------------
Ronald E. Bostian Officer and Chairman of the Board
/s/Dianne E. Hawkins Treasurer and Controller December 20, 1999
- -------------------------------
Dianne E. Hawkins
/s/ Malcolm B. Blankenship, Jr. Director December 20, 1999
- -------------------------------
Malcolm B. Blankenship, Jr.
/s/ James W. Duke Director December 20, 1999
- -------------------------------
James W. Duke
/s/ Harold C. Earnhardt Vice Chairman December 20, 1999
- -------------------------------
Harold C. Earnhardt
/s/ K.V. Epting, Jr. Director December 20, 1999
- -------------------------------
K.V. Epting, Jr.
/s/ Gordon P. Hurley Director December 20, 1999
- -------------------------------
Gordon P. Hurley
/s/ Bobby A. Lomax Director December 20, 1999
- -------------------------------
Bobby A. Lomax
</TABLE>
69
<PAGE>
Exhibit (11)
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
See Note 1 to the Financial Statements contained in Item 7. Financial
Statements.
70
<PAGE>
CITIZENS BANK, FSB
EMPLOYMENT AGREEMENT
THIS AGREEMENT entered into as of December 28, 1999, by and between
Citizens Bank, FSB, a federally chartered stock savings bank (hereinafter
referred to as the "Bank") with its principal administrative office at 401 West
Innes Street, Salisbury, North Carolina, and Ronald E. Bostian (hereinafter
referred to as the "Officer"). Any reference to "Holding Company" herein shall
mean Innes Street Financial Corporation, the parent holding company of the Bank.
WHEREAS, the Officer has heretofore been employed by the Bank as its
President and Chief Executive Officer; and
WHEREAS, the Bank is a federally chartered, stock-owned savings
association, chartered under the provisions of the Home Owners' Loan Act of
1934, and the wholly-owned subsidiary of the Holding Company; and
WHEREAS, the Bank desires to retain the services of the Officer as the
President and Chief Executive Officer of the Bank upon the terms and conditions
set forth herein; and
WHEREAS, the services of the Officer, his experience and knowledge of the
affairs of the Bank, and his reputation and contacts in the industry and the
local community are extremely valuable to the Bank; and
WHEREAS, the Bank wishes to attract and retain such well-qualified
executives and it is in the best interest of the Bank and of the Officer to
secure the continued services of the Officer; and
WHEREAS, the Bank considers the establishment and maintenance of a sound
and vital management to be part of its overall corporate strategy and to be
essential to protecting and enhancing the best interests of the Bank and its
stockholders; and
<PAGE>
WHEREAS, the parties desire to enter into this Agreement in order to set
forth the terms and conditions of the Officer's employment relationship with the
Bank.
NOW, THEREFORE, for and in consideration of the premises and mutual
promises, covenants and conditions hereinafter set forth and other good and
valuable considerations, the receipt and sufficiency of which hereby are
acknowledged, the parties hereby do agree as follows:
1. Employment. The Bank hereby agrees to employ the Officer and the
----------
Officer hereby agrees to accept employment, upon the terms and conditions stated
herein, as the President and Chief Executive Officer of the Bank. The Officer
shall render such administrative and management services to the Bank as are
customarily performed by persons situated in a similar executive capacity. The
Officer shall promote the business of the Bank and perform such other duties as
shall, from time to time, be reasonably prescribed by the Board of Directors of
the Bank (the "Board"). During the term of this Agreement, Officer also agrees
to serve, if elected, as an officer and director of the Holding Company or any
subsidiary of the Bank.
2. Compensation. The Bank shall pay the Officer during the term of this
------------
Agreement, as compensation for all service rendered by him to the Bank, a base
salary at the rate of $147,528 per annum, payable in cash not less frequently
than monthly; provided that the rate of such salary shall be reviewed by the
Board not less often than annually. Such rate of salary, or increased rate of
salary, as the case may be, may be further increased from time to time in such
amounts as the Board, in its discretion, may decide. In determining salary
increases, the Board shall compensate the Officer for increases in the cost of
living and may also provide for performance or merit increases. Participation
in incentive compensation, deferred compensation, discretionary bonus, profit-
sharing, retirement, stock option and other employee benefit plans that the Bank
or the
2
<PAGE>
Holding Company have adopted, or may from time to time adopt, and participation
in any fringe benefits, shall not reduce the salary payable to the Officer under
this Section. Any compensation provided to the Officer for his service as a
member of the Board or the Board of Directors of the Holding Company shall not
reduce the salary payable to the Officer under this Section or any benefit
payable under any other section of this Agreement. The Officer will be entitled
to such customary fringe benefits, vacation and sick leave as are consistent
with the normal practices and established policies of the Bank.
3. Raises and Discretionary Bonuses. During the term of this Agreement,
--------------------------------
no later than in December or January of each annual period, the Officer shall be
evaluated by the non-employee members of the Board and such Board members shall
determine whether the Officer's base salary should be increased and whether
payment of a performance bonus is justified. The performance of the Officer
shall be evaluated by such Board members in the following areas: capital
adequacy, asset quality, liquidity risk, interest rate risk, earnings, strategic
planning and progress, and contributions to shareholder values. The Board shall
also consider compensation provided for similarly situated officers at similarly
situated companies with the objective that the Officer will be compensated at or
above levels of compensation provided by peer companies for their chief
executive officers. No other compensation provided for in this Agreement shall
be deemed a substitute for the Officer's right to discretionary bonuses when and
as declared by the Board under this Section.
4. Participation in Retirement and Employee Benefit Plans; Fringe
--------------------------------------------------------------
Benefits.
- --------
(a) The Officer shall be entitled to participate in any plan relating to
deferred compensation, stock awards, stock options, stock purchases, pension,
thrift, profit sharing, group life insurance, medical coverage, disability
coverage, education, or other retirement or employee benefits
3
<PAGE>
that the Bank or the Holding Company have adopted, or may, from time to time
adopt, for the benefit of their executive employees and for employees generally,
whether such plans are qualified or non-qualified, subject to the eligibility
rules of such plans.
(b) The Officer shall also be entitled to participate in any other fringe
benefits which are now or may be or become applicable to the Officer or the
Bank's other executive employees, including the payment of reasonable expenses
for attending annual and periodic meetings of trade associations, and any other
benefits which are commensurate with the duties and responsibilities to be
performed by the Officer under this Agreement. Additionally, the Officer shall
be entitled to such vacation and sick leave as shall be established under
uniform employee policies promulgated by the Board. The Bank shall reimburse
the Officer for all out-of-pocket reasonable and necessary business expenses
which the Officer may incur in connection with his services on behalf of the
Bank.
(c) The Bank agrees to provide the Officer with one automobile of an
appropriate class and quality owned or leased by the Bank for use in connection
with the Officer's duties hereunder.
(d) The Bank agrees to provide at the Bank's expense a membership in the
Country Club of Salisbury for the use of the Officer and his family.
5. Term. The initial term of employment under this Agreement shall be
----
for a period of three years commencing as of the date of this Agreement (the
"Effective Date") subject to earlier termination as provided herein. Beginning
on the first anniversary of the Effective Date, and continuing at each
anniversary date thereafter, subject to the Board's review of the Officer's
performance, the term of this Agreement shall be extended for an additional year
such that the remaining term shall be three years, unless the Board has given
sixty (60) days prior written notice to the Officer that the term of this
Agreement shall not be extended further. Prior to the sixty (60)
4
<PAGE>
day notice period the Board shall conduct a comprehensive performance evaluation
and review of the officer for the purpose of determining whether to extend the
Agreement. The results of the Board's consideration shall be included in the
minutes of the Board's meeting. Reference herein to the term of this Agreement
shall refer to both such initial term and any such extended terms.
6. Loyalty.
-------
(a) The Officer shall devote his full efforts and entire business time to
the performance of his duties and responsibilities under this Agreement.
(b) The Officer agrees that he will hold in confidence all knowledge or
information of a confidential nature with respect to the respective businesses
of the Holding Company, the Bank or of their subsidiaries, if any, received by
him during the term of this Agreement and will not disclose or make use of such
information without the prior written consent of the Holding Company or the
Bank.
7. Standards. The Officer shall perform his duties and responsibilities
---------
under this Agreement in accordance with such reasonable standards expected of
employees with comparable positions in comparable organizations and as may be
established from time to time by the Board. The Bank will provide the Officer
with the working facilities and staff customary for similar executives and
necessary for him to perform his duties.
8. Termination and Termination Pay.
-------------------------------
The Officer's employment hereunder may be terminated under the following
circumstances:
(a) Death. The Officer's employment under this Agreement shall terminate
-----
upon his death during the term of this Agreement, in which event the Officer's
estate shall be entitled to
5
<PAGE>
receive the compensation due the Officer through the last day of the calendar
month in which his death occurred and for a period of one month thereafter.
(b) Disability. In the event the Officer is unable to perform his duties
----------
under this Agreement on a full-time basis for a period of six (6) consecutive
months by reason of illness or other physical or mental disability, the Bank may
terminate this Agreement, provided that the Bank shall continue to be obligated
to pay the Officer his then-current salary for the remaining term of the
Agreement, or one year, whichever is the longer period of time, and provided
further that any amounts actually paid to the Officer pursuant to any disability
insurance or other similar such program which the Bank has provided or may
provide on behalf of its employees or pursuant to any workman's or social
security disability program shall reduce the compensation to be paid to the
Officer pursuant to this Section 8(b).
(c) For Just Cause. The Board may, by written notice to the Officer,
--------------
immediately terminate his employment at any time, for Just Cause. The Officer
shall have no right to receive compensation or other benefits for any period
after termination for Just Cause. Termination for "Just Cause" shall mean
termination because of, in the good faith determination of the Board, the
Officer's personal dishonesty, incompetence, willful misconduct, breach of
fiduciary duty involving personal profit, intentional failure to perform stated
duties, willful violation of any law, rule, regulation (other than traffic
violations or similar offenses) or final cease-and-desist order, or material
breach of any provisions of this Agreement. Notwithstanding the foregoing, the
Officer shall not be deemed to have been terminated for Just Cause unless there
shall have been delivered to the Officer a copy of the resolution duly adopted
by the affirmative vote of not less than three-fourths of the entire membership
of the Board (excluding the Officer if a member of the Board) at a meeting of
the Board
6
<PAGE>
called and held for that purpose (after reasonable notice to the Officer and an
opportunity for the Officer (together with counsel) to be heard before the
Board), finding that in the good faith opinion of the Board the Officer was
guilty of conduct justifying termination for Just Cause and specifying the
particulars thereof in detail.
(d) Without Just Cause. The Board may, by written notice to the Officer,
------------------
immediately terminate his employment at any time for any reason; provided that,
if such termination is for any reason other than pursuant to Sections 8(a), (b)
or (c) above, the Officer shall be entitled to receive the following
compensation and benefits: (i) the salary provided pursuant to Section 2 hereof,
up to the date of expiration of the term (including any renewal term then in
effect) of this Agreement (the "Termination Date") and (ii) the cost to the
Officer of obtaining all health, life, disability and other benefits (excluding
any bonus, stock option or other compensation benefits) in which the Officer
would have been eligible to participate through the Termination Date based upon
the benefit levels substantially equal to those that the Bank provided for the
Officer at the date of termination of employment. Said sum shall be paid, at
the option of the Officer, either (I) in periodic payments over the remaining
term of this Agreement, as if the Officer's employment had not terminated, or
(II) in one lump sum within ten (10) days of such termination.
(e) For Good Reason. The Officer may terminate his employment for Good
---------------
Reason upon not less than thirty (30) days advance written notice to the Bank
(the "Termination Notice") and the Officer shall be entitled to receive the same
compensation and benefits for the same period and on the same terms and
conditions as provided in (d) above. "Good Reason" shall mean termination by
the Officer based on:
7
<PAGE>
(i) Without the Officer's express written consent, failing to elect
or re-elect or appoint or re-appoint the Officer to the offices of
President and Chief Executive Officer of the Bank or a material
adverse change made by the Bank or the Holding Company in the
Officer's functions, duties or responsibilities as President and Chief
Executive Officer of the Bank; or
(ii) Without the Officer's express written consent, reducing the
Officer's base salary as the same may be increased from time to time;
or
(iii) Without the Officer's express written consent, reducing in
level, scope or coverage or eliminating Officer's life insurance,
medical or hospitalization insurance, disability insurance, profit
sharing plans, stock option plans, stock purchase plans, deferred
compensation plans, management retention plans, retirement plans or
similar plans or benefits being provided by the Bank or the Holding
Company to the Officer in effect on the date of the Termination
Notice; or
(iv) Without the Officer's express written consent, transferring the
Officer to a location which is greater than thirty-five (35) miles
from his principal work location at the Effective Date; or
(v) The liquidation or dissolution of the Bank or Company other
than liquidations or dissolutions that are caused by reorganizations
that do not affect the status of the Officer; or
(vi) Any breach of this Agreement by the Bank or the Holding
Company.
(f) In the event any dispute shall arise between the Officer and the Bank
as to the terms or interpretation of this Agreement, including this Section 8,
whether instituted by formal legal proceedings or otherwise, including any
action taken by the Bank, the Bank shall reimburse the Officer for all costs and
expenses incurred in such proceedings or actions, including attorney's fees, in
the event the Officer prevails in any such action.
9. Additional Regulatory Requirements.
----------------------------------
8
<PAGE>
(a) If the Officer is suspended and/or temporarily prohibited from
participating in the conduct of the Bank's affairs by a notice served under
Section 8(e)(3) or Section 8(g)(1) of the Federal Deposit Insurance Act (12
U.S.C. 1818(e)(3) and (g)(1)), the Bank's obligations under this Agreement shall
be suspended as of the date of service, unless stayed by appropriate
proceedings. If the charges in the notice are dismissed, the Bank may, in its
discretion, (i) pay the Officer all or part of the compensation withheld while
its contract obligations were suspended and (ii) reinstate (in whole or in part)
any of its obligations which were suspended.
(b) If the Officer is removed and/or permanently prohibited from
participating in the conduct of the Bank's affairs by an order issued under
Section 8(e)(4) of Section 8(g)(1) of the Federal Deposit Insurance Act (12
U.S.C. 1818(e)(4) and (g)(1)), all obligations of the Bank under this Agreement
shall terminate as of the effective date of the order, but vested rights of the
contracting parties shall not be affected.
(c) If the Bank is in default as defined in Section 3(x)(1) of the Federal
Deposit Insurance Act (12 U.S.C. (S) 1818(x)(1)), all obligations under this
Agreement shall terminate as of the date of default, but this paragraph shall
not affect any vested rights of the contracting parties.
(d) All obligations under this Agreement shall be terminated, except to
the extent determined that continuation of the Agreement is necessary for the
continued operation of the Bank, (i) by the Director of the Office of Thrift
Supervision ("Director") or the Director's designee, at the time the Federal
Deposit Insurance Corporation (the "Corporation") enters into an agreement to
provide assistance to or on behalf of the Bank under the authority contained in
Section 13(c) of the Federal Deposit Insurance Act (12 U.S.C. (S) 1818(c)); or
(ii) by the Director, or the Director's designee, at the time the Director or
such designee approves a supervisory merger to resolve
9
<PAGE>
problems related to operation of the Bank or when the Bank is determined by the
Director to be in an unsafe or unsound condition. Any rights of the parties that
have already vested, however, shall not be affected by such action.
(e) Any payments made to the Officer pursuant to this Agreement, or
otherwise, are subject to and conditioned upon their compliance with 12 U.S.C.
(S) 1828(k) and any regulations promulgated thereunder.
(f) If any of the provisions of this Agreement conflict with the
requirements of 12 C.F.R. (S) 563.39, the latter shall control.
10. No Mitigation. The Officer shall not be required to mitigate the
-------------
amount of any payment provided for in this Agreement by seeking other employment
or otherwise, and no such payment shall be offset or reduced by the amount of
any compensation or benefits provided to the Officer in any subsequent
employment.
11. Successors and Assigns.
----------------------
(a) This Agreement shall inure to the benefit of and be binding upon any
corporate or other successor of the Bank which shall acquire, directly or
indirectly, by conversion, merger, consolidation, purchase or otherwise, all or
substantially all of the assets of the Holding Company or the Bank, and the Bank
shall require any successor or assignee, whether direct or indirect, by
purchase, merger, consolidation or otherwise, to all or substantially all the
business or assets of the Bank or the Holding Company, expressly and
unconditionally to assume and agree to perform the Bank's obligations under this
Agreement, in the same manner and to the same extent that the Bank would be
required to perform if no such succession or assignment had taken place.
10
<PAGE>
(b) Since the Bank is contracting for the unique and personal skills of
the Officer, the Officer shall be precluded from assigning or delegating his
rights or duties hereunder without first obtaining the written consent of the
Bank.
12. Indemnification.
---------------
(a) The Bank and the Holding Company shall provide the Officer (including
his heirs, executors and administrators) with coverage under a standard
directors' and officers' liability insurance policy at its expense and shall
indemnify the Officer (and his heirs, executors and administrators) as permitted
under federal law against all expenses and liabilities reasonably incurred by
him in connection with or arising out of any action, suit or proceeding in which
he may be involved by reason of his having been a director or officer of the
Bank (whether or not he continues to be a director or officer at the time of
incurring such expenses or liabilities), such expenses and liabilities to
include, but not be limited to, judgments, court costs and attorneys' fees and
the cost of reasonable settlements.
(b) Any payments made to the Officer pursuant to this Section are subject
to and conditioned upon compliance with 12 U.S.C. Section 1828(k), 12 C.F.R.
Part 359 and 12 C.F.R. Section 545.121 and any rules or regulations promulgated
thereunder.
13. Modification; Waiver; Amendments. No provision of this Agreement may
--------------------------------
be modified, waived or discharged unless such waiver, modification or discharge
is agreed to in writing, signed by the Officer and on behalf of the Bank by such
officer as may be specifically designated by the Board. No waiver by either
party hereto, at any time, of any breach by the other party hereto of, or
compliance with, any condition or provision of this Agreement to be performed by
such other party shall be deemed a waiver of similar or dissimilar provisions or
conditions at the same or at any
11
<PAGE>
prior or subsequent time. No amendments or additions to this Agreement shall be
binding unless in writing and signed by both parties, except as herein otherwise
provided.
14. Applicable Law. This Agreement shall be governed in all respects
--------------
whether as to validity, construction, capacity, performance or otherwise, by the
laws of North Carolina, except to the extent that federal law shall be deemed to
apply.
15. Severability. The provisions of this Agreement shall be deemed
------------
severable and the invalidity or unenforceability of any provision shall not
affect the validity or enforceability of the other provisions hereof.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first hereinabove written.
CITIZENS BANK, FSB
By:__________________________________
Authorized Member of the Board
[Corporate Seal]
S/S
-------------------------------------
(SEAL)
Ronald E. Bostian
12
<PAGE>
APPENDIX A
----------
INNES STREET FINANCIAL CORPORATION
STOCK OPTION PLAN
THIS IS THE STOCK OPTION PLAN ("Plan") of Innes Street Financial
Corporation (the "Corporation"), a North Carolina corporation, with its
principal office in Salisbury, Rowan County, North Carolina, adopted by the
Board of Directors of the Corporation and effective upon the approval of the
Plan by the shareholders of the Corporation, under which options may be granted
from time to time to eligible directors and employees of the Corporation,
Citizens Bank, FSB (the "Bank") and of any corporation or other entity of which
either the Corporation or the Bank owns, directly or indirectly, not less than
fifty percent (50%) of any class of equity securities (a "Subsidiary"), to
purchase shares of common stock of the Corporation ("Common Stock"), subject to
the provisions set forth below:
1. PURPOSE OF THE PLAN. The purpose of the Plan is to aid the
-------------------
Corporation, the Bank and any Subsidiary in attracting and retaining capable
directors and employees and to provide a long range incentive for directors,
employees and others to remain in the management and service of the Corporation,
the Bank or any Subsidiary, to perform at increasing levels of effectiveness and
to acquire a permanent stake in the Corporation with the interest and outlook of
an owner. These objectives will be promoted through the granting of options to
acquire shares of Common Stock pursuant to the terms of this Plan.
2. ADMINISTRATION. The Plan shall be administered by a committee (the
--------------
"Committee"), which shall consist of not less than two members of the Board of
Directors of the Corporation (the "Board") who are "Non-Employee Directors" as
defined in Rule 16b-3(b)(3) of the Rules and Regulations under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Members of the Committee
shall serve at the pleasure of the Board. In the absence at any time of a duly
appointed Committee, this Plan shall be administered by the Board. The Committee
may designate any officers or employees of the Corporation, the Bank or any
Subsidiary to assist in the administration of the Plan and to execute documents
on behalf of the Committee and perform such other ministerial duties as may be
delegated to them by the Committee.
Subject to the provisions of the Plan, the determinations or the
interpretation and construction of any provision of the Plan by the Committee
shall be final and conclusive upon all persons affected thereby. By way of
illustration and not of limitation, the Committee shall have the discretion (a)
to construe and interpret the Plan and all options granted hereunder and to
determine the terms and provisions (and amendments thereof) of the options
granted under the Plan (which need not be identical); (b) to define the terms
used in the Plan and in the options granted hereunder; (c) to prescribe, amend
and rescind the rules and regulations relating to the Plan; (d) to determine the
individuals to whom and the time or times at which such options shall be
granted, the number of shares to be subject to each option, the option price,
and the determination of leaves of absence which may be granted to participants
without constituting a termination of their employment for the purposes of the
Plan; and (e) to make all other determinations necessary or advisable for the
administration of the Plan.
<PAGE>
It shall be in the discretion of the Committee to grant options which
qualify as "incentive stock options," as that term is defined in Section 422 of
the Internal Revenue Code of 1986, as amended ("Incentive Stock Options") or
which do not qualify as Incentive Stock Options ("Nonqualified Stock Options")
(herein referred to collectively as "Options;" however, whenever reference is
specifically made only to "Incentive Stock Options" or "Nonqualified Stock
Options," such reference shall be deemed to be made to the exclusion of the
other). Any options granted which fail to satisfy the requirements for
Incentive Stock Options shall become Nonqualified Stock Options.
3. STOCK AVAILABLE FOR OPTIONS. In the discretion of the Committee, the
---------------------------
stock to be subject to Options under the Plan shall be authorized but unissued
shares of Common Stock which are issued directly to optionees upon exercise of
options and/or shares of Common Stock which are acquired by the Plan or the
Corporation in the open market. The total number of shares of Common Stock for
which Options may be granted under the Plan is 224,825 shares, which is ten
percent (10%) of the total number of shares of Common Stock issued by the
Corporation in connection with the conversion of the Bank from a federally-
chartered mutual savings bank to a federally-chartered stock savings bank on
December 28, 1998 (the "Conversion"). Such number of shares is subject to any
capital adjustments as provided in Section 16. In the event that an Option
granted under the Plan is forfeited, released, expires or is terminated
unexercised as to any shares covered thereby, such shares thereafter shall be
available for the granting of Options under the Plan; however, if the
forfeiture, expiration, release or termination date of an Option is beyond the
term of existence of the Plan as described in Section 21, then any shares
covered by forfeited, unexercised, released or terminated options shall not
reactivate the existence of the Plan and therefore may not be available for
additional grants under the Plan. The Corporation, during the term of the Plan,
will reserve and keep available a number of shares of Common Stock sufficient to
satisfy the requirements of the Plan. In the discretion of the Committee, the
shares of Common Stock necessary to be delivered to satisfy exercised options
may be from authorized and unissued shares of Common Stock or may be purchased
in the open market.
4. ELIGIBILITY. Options shall be granted only to individuals who meet
-----------
all of the following eligibility requirements:
(a) Such individual must be an employee or a member of the Board of
Directors of the Corporation, the Bank or a Subsidiary. For this purpose,
an individual shall be considered to be an "employee" only if there exists
between the Corporation, the Bank or a Subsidiary and the individual the
legal and bona fide relationship of employer and employee. In determining
whether such relationship exists, the regulations of the United States
Treasury Department relating to the determination of such relationship for
the purpose of collection of income tax at the source on wages shall be
applied.
(b) Such individual must have such knowledge and experience in
financial and business matters that he or she is capable of evaluating the
merits and risks of the investment involved in the exercise of the Options.
2
<PAGE>
(c) Such individual, being otherwise eligible under this Section 4,
shall have been selected by the Committee as a person to whom an Option
shall be granted under the Plan.
In determining the directors and employees to whom Options shall be granted
and the number of shares to be covered by each Option, the Committee shall take
into account the nature of the services rendered by respective directors and
employees, their present and potential contributions to the success of the
Corporation, the Bank and any Subsidiary and such other factors as the Committee
shall deem relevant. A director or employee who has been granted an Option
under the Plan may be granted an additional Option or Options under the Plan if
the Committee shall so determine.
If, pursuant to the terms of the Plan, it is necessary that the percentage
of stock ownership of any individual be determined, stock ownership in the
Corporation or of a related corporation which is owned (directly or indirectly)
by or for such individual's brothers and sisters (whether by the whole or half
blood), spouse, ancestors, and lineal descendants or by or for any corporation,
partnership, estate or trust of which such employee is a shareholder, partner or
beneficiary shall be considered as owned by such director or employee.
5. OPTION AGREEMENT Subject to the provisions of this Plan, Options
----------------
shall be awarded to the directors and employees in such amounts as are
determined by the Committee. The proper officers on behalf of the Corporation
and each Optionee shall execute a Stock Option Grant and Agreement (the "Option
Agreement") which shall set forth the total number of shares of Common Stock to
which it pertains, the exercise price, whether it is a Nonqualified Stock Option
or an Incentive Stock Option, and such other terms, conditions, restrictions and
privileges as the Committee in each instance shall deem appropriate, provided
they are not inconsistent with the terms, conditions and provisions of this
Plan. Each Optionee shall receive a copy of his executed Option Agreement. Any
Option granted with the intention that it will be an Incentive Stock Option but
which fails to satisfy a requirement for Incentive Stock Options shall continue
to be valid and shall be treated as a Nonqualified Stock Option.
6. OPTION PRICE.
------------
(a) The option price of each Option granted under the Plan shall be
not less than one hundred percent (100%) of the market value of the stock
on the date of grant of the Option. In the case of incentive stock options
granted to a shareholder who owns stock possessing more than 10 percent
(10%) of the total combined voting power of all classes of stock of the
Corporation, the Bank or a Subsidiary (a "ten percent shareholder"), the
option price of each Option granted under the Plan shall not be less than
one hundred and ten percent (110%) of the market value of the stock on the
date of grant of the Option. If the Common Stock is listed on a national
securities exchange (including for this purpose the Nasdaq Stock Market,
Inc. National Market) on the date in question, then the market value per
share shall be not less than the average of the highest and lowest selling
price on such exchange on such date, or if there were no sales on such
date, then the market price per share shall be equal to the average between
the bid and asked price on such date. If the Common Stock is traded
otherwise than on a national securities exchange (including for this
purpose the Nasdaq Stock Market, Inc.
3
<PAGE>
National Market) on the date in question, then the market price per share
shall be equal to the average between the bid and asked price on such date,
or, if there is no bid and asked price on such date, then on the next prior
business day on which there was a bid and asked price. If no such bid and
asked price is available, then the market value per share shall be its fair
market value as determined by the Committee, in its sole and absolute
discretion. The Committee shall maintain a written record of its method of
determining such value.
(b) The option price shall be payable to the Corporation either (i) in
cash or by check, bank draft or money order payable to the order of the
Corporation, or (ii) at the discretion of the Committee, through the
delivery of shares of the common stock of the Corporation owned by the
optionee with a market value (determined in a manner consistent with (i)
above) equal to the option price, or (iii) at the discretion of the
Committee by a combination of (i) and (ii) above. No shares shall be
delivered until full payment has been made.
7. EXPIRATION OF OPTIONS. The Committee shall determine the expiration
---------------------
date or dates of each Option, but such expiration date shall be not later than
ten (10) years after the date such Option is granted. In the event an Incentive
Stock Option is granted to a ten percent shareholder, the expiration date or
dates of each Option shall be not later than five (5) years after the date such
Option is granted. The Committee, in its discretion, may extend the expiration
date or dates of an Option after such date was originally set; however, such
expiration date may not exceed the maximum expiration date described in this
Section 7.
8. TERMS AND CONDITIONS OF OPTIONS.
-------------------------------
(a) All Options must be granted within ten (10) years of the Effective
Date of this Plan as defined in Section 20.
(b) The Committee may grant Options which are intended to be Incentive
Stock Options and Nonqualified Stock Options, either separately or jointly,
to an eligible employee.
(c) The grant of Options shall be evidenced by a written instrument
(an Option Agreement) containing terms and conditions established by the
Committee consistent with the provisions of this Plan.
(d) Not less than 100 shares may be purchased at any one time unless
the number purchased is the total number at that time purchasable under the
Plan.
(e) The recipient of an Option shall have no rights as a shareholder
with respect to any shares covered by his Option until payment in full by
him for the shares being purchased. No adjustment shall be made for
dividends (ordinary or extraordinary, whether in cash, securities or other
property) or distributions or other rights for which the record date is
prior to the date such stock is fully paid for, except as provided in
Section 16.
4
<PAGE>
(f) The aggregate fair market value of the stock (determined as of the
time the Option is granted) with respect to which Incentive Stock Options
are exercisable for the first time by any participant during any calendar
year (under all benefit plans of the Corporation, the Bank or any
Subsidiary, if applicable) shall not exceed $100,000; provided, however,
that such $100,000 limit of this subsection (f) shall not apply to the
grant of Nonqualified Stock Options. The Committee may grant Options which
are exercisable in excess of the foregoing limitations, in which case
Options granted which are exercisable in excess of such limitation shall be
Nonqualified Stock Options.
(g) All stock obtained pursuant to an option which qualifies as an
Incentive Stock Option shall be held in escrow for a period which ends on
the later of (i) two (2) years from the date of the granting of the Option
or (ii) one (1) year after the transfer of the stock pursuant to the
exercise of the Option. The stock shall be held by the Corporation or its
designee. The employee who has exercised the Option shall during such
holding period have all rights of a shareholder, including but not limited
to the rights to vote, receive dividends and sell the stock. The sole
purpose of the escrow is to inform the Corporation of a disqualifying
disposition of the stock within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended, and it shall be administered solely for
that purpose.
9. EXERCISE OF OPTIONS.
-------------------
(a) Unless otherwise set forth in the Option Agreement, all Options
granted to an optionee by virtue of his position as a nonemployee director
of the Corporation or the Bank (as stated in the Option Agreement) shall be
fully vested, exercisable and nonforfeitable immediately at the time of the
grant.
(b) Options granted to an optionee by virtue of his position as an
employee (as stated in the Option Agreement) shall become vested and
exercisable at the times, at the rate and subject to such limitations as
may be set forth in the Option Agreement executed in connection therewith;
provided, however, that all outstanding and nonforfeited options shall be
exercisable, if not sooner, on the day prior to the expiration date
thereof.
(c) Notwithstanding the foregoing, Options shall become exercisable
with respect to all of the shares subject thereto upon the optionee's
death, retirement or disability within the meaning of Section 22(e)(3) of
the Internal Revenue Code of 1986, as amended, and in the event of a change
in control as set forth in Section 13 of this Plan.
(d) Any right to exercise Options in annual installments shall be
cumulative and any vested installments may be exercised, in whole or in
part, at the election of the optionee. The exercise of any Option must be
evidenced by written notice to the Corporation that the optionee intends to
exercise his Option.
(e) In no event shall an Option be deemed granted by the Corporation
or exercisable by a recipient prior to the mutual execution by the
Corporation and the
5
<PAGE>
recipient of an Option Agreement which comports with the requirements of
Section 5 and Section 8(c).
(f) The inability of the Corporation or Bank to obtain approval from
any regulatory body or authority deemed by counsel to be necessary to the
lawful issuance and sale of any shares of Common Stock hereunder shall
relieve the Corporation and the Bank of any liability in respect of the
non-issuance or sale of such shares. As a condition to the exercise of an
option, the Corporation may require the person exercising the Option to
make such representations and warranties as may be necessary to assure the
availability of an exemption from the registration requirements of federal
or state securities laws.
(g) The Committee shall have the discretionary authority to impose in
the Option Agreements such restrictions on shares of Common Stock as it may
deem appropriate or desirable, including but not limited to the authority
to impose a right of first refusal or to establish repurchase rights or
both of these restrictions.
(h) Notwithstanding anything to the contrary herein, an optionee
receiving the grant of an Option by virtue of his or her position as a
director or as an employee of the Corporation, the Bank or a Subsidiary (as
stated in the Option Agreement), shall be required to exercise his or her
Options within the periods set forth in Sections 10, 11 and 12 below.
10. TERMINATION OF EMPLOYMENT - EXCEPT BY DISABILITY, RETIREMENT OR DEATH.
---------------------------------------------------------------------
If any optionee receiving the grant of an Option by virtue of his position as a
director (as stated in the Option Agreement) ceases to be a director of at least
one of the Corporation, the Bank or any Subsidiary for any reason other than
death, retirement (as defined in Section 11) or disability (as defined in
Section 11) or if any optionee receiving the grant of an Option by virtue of his
position as an employee (as stated in the Option Agreement) ceases to be an
employee of at least one of the Corporation, the Bank and any Subsidiary for any
reason other than death, retirement (as defined in Section 11) or disability (as
defined in Section 11), he may, (i) at any time within three (3) months after
his date of termination, but not later than the date of expiration of the
Option, exercise any Option designated in the Option Agreement as an Incentive
Stock Option and (ii) at any time prior to the date of expiration of the Option,
exercise any option designated in the Option Agreement as a Nonqualified Stock
Option. However, in either such event the optionee may exercise any Option only
to the extent it was vested and he or she was entitled to exercise the Option on
the date of termination. Any Options or portions of Options of terminated
optionees not so exercised shall terminate and be forfeited.
11. TERMINATION OF EMPLOYMENT - DISABILITY OR RETIREMENT. If any optionee
----------------------------------------------------
receiving the grant of an Option by virtue of his position as a director (as
stated in the Option Agreement) ceases to be a director of at least one of the
Corporation, the Bank or any Subsidiary due to his becoming disabled within the
meaning of Section 22(e)(3) of the Internal Revenue Code of 1986, as amended, or
if any employee receiving the grant of an Option by virtue of his position as an
employee (as stated in the Option Agreement) ceases to be employed by at least
one of the Corporation, the Bank and any Subsidiary due to his becoming disabled
within the meaning of Section 22(e)(3) of the Internal Revenue Code of 1986, as
6
<PAGE>
amended, all unvested and forfeitable Options of such optionee shall immediately
become vested and nonforfeitable and he may, (i) at any time within 12 months
after his date of termination, but not later than the date of expiration of the
Option, exercise any option designated in the Option Agreement as an Incentive
Stock Option with respect to all shares subject thereto and (ii) at any time
prior to the date of expiration of the Option, exercise any Option designated in
the Option Agreement as a Nonqualified Stock Option with respect to all shares
subject thereto. Any portions of Options of optionees who are terminated
because they become disabled which are not so exercised shall terminate.
If any optionee receiving the grant of an Option by virtue of his position
as a director (as stated in the Option Agreement) ceases to be a director of at
least one of the Corporation, the Bank or any Subsidiary due to his retirement,
or if any employee receiving the grant of an Option by virtue of his position as
an employee (as stated in the Option Agreement) ceases to be employed by at
least one of the Corporation, the Bank and any Subsidiary due to his retirement,
all unvested and forfeitable Options of such optionee shall immediately become
vested and nonforfeitable and he may, at any time prior to the date of
expiration of the Option, exercise such Option; provided, however, that if the
Option is exercised more than three months after such retirement, the Option may
be treated as a Nonqualified Stock Option. Any portions of Options of retired
directors or employees not so exercised shall terminate. For purposes of this
Plan, the term "retirement," as it relates to any optionee receiving a grant of
an Option as a result of his or her position as an employee of the Corporation,
the Bank or any Subsidiary, shall mean (i) the termination of the optionee's
employment under conditions which would constitute retirement under any tax
qualified retirement plan maintained by the Corporation, the Bank or a
Subsidiary, or (ii) termination of employment after attaining age 65. The term
"retirement," as it relates to any optionee receiving a grant of an Option as a
result of his or her position as a director shall mean the cessation of
membership on such board of directors (i) with the approval of such board of
directors, at any time after such optionee reaches age 65, or (ii) at the
election of the optionee at any time after not less than 25 years of service as
a member of the such board of directors, as applicable.
12. TERMINATION OF EMPLOYMENT - DEATH. If an optionee receiving the grant
---------------------------------
of an option by virtue of his position as a director (as stated in the Option
Agreement) dies while a director of the Corporation, the Bank or any Subsidiary
or if any employee receiving the grant of an option by virtue of his position as
an employee (as stated in the Option Agreement) dies while in the employment of
the Corporation, the Bank or a Subsidiary, all unvested and forfeitable Options
of such optionee shall immediately become vested and nonforfeitable and the
person or persons to whom the Option is transferred by will or by the laws of
descent and distribution may exercise the Option at any time until the term of
the Option has expired, with respect to all shares subject thereto, to the same
extent and upon the same terms and conditions the optionee would have been
entitled to do so had he lived. Any Options or portions of options of deceased
directors or employees not so exercised shall terminate.
13. CHANGE IN CONTROL. In the event that an optionee ceases to be an
-----------------
employee, a director of the Corporation, the Bank or a Subsidiary (which
position resulted in his or her receipt of an option pursuant to this Plan) for
any reason after the occurrence of a "change in control" and prior to the time
that all shares allocated to him or her would be 100% vested, nonforfeitable and
exercisable in accordance with Sections 9 and 10 above, then,
7
<PAGE>
notwithstanding Sections 9 and 10 above, all Options granted to such optionee
shall immediately become fully vested and nonforfeitable. For purposes of this
Plan, a "change in control" shall mean (i) a change in control of a nature that
would be required to be reported by the Corporation in response to Item 1 of the
Current Report on Form 8-K, as in effect on the date hereof, pursuant to Section
13 or 15(d) of the Exchange Act; (ii) such time as any "person" (as such term is
used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly
or indirectly, of securities of the Corporation or Bank representing 25 percent
or more of the combined voting power of the outstanding Common Stock of the
Corporation or outstanding common stock of the Bank, as applicable; or (iii)
individuals who constitute the Board or the board of directors of the Bank on
the date hereof (the "Incumbent Board" and "Incumbent Bank Board," respectively)
cease for any reason to constitute at least a majority thereof, provided that
any person becoming a director subsequent to the date hereof whose election was
approved by a vote of at least three-quarters of the directors comprising the
Incumbent Board or Incumbent Bank Board, as applicable, or whose nomination for
election by the Corporation's or Bank's shareholders was approved by the
Corporation's or Bank's Board of Directors or Nominating Committee, shall be
considered as though he or she were a member of the Incumbent Board or Incumbent
Bank Board, as applicable; or (iv) either the Corporation or the Bank
consolidates or merges with or into another corporation, association or entity
or is otherwise reorganized, where neither the Corporation nor the Bank,
respectively, is the surviving corporation in such transaction; or (v) all or
substantially all of the assets of either the Corporation or the Bank are sold
or otherwise transferred to or are acquired by any other entity or group.
As set forth in Section 10, in the event of such a termination after a
change in control, the Optionee must exercise any Incentive Stock Options within
three (3) months after his date of termination and may exercise any Nonqualified
Stock Options at any time prior to the date of expiration of the Option.
14. STOCK APPRECIATION RIGHTS.
-------------------------
(a) General Terms and Conditions. The Committee may, but shall not be
obligated to, grant rights to optionees to surrender an exercisable Option,
or any portion thereof, in consideration for the payment by the Corporation
of an amount equal to the excess of the market value (determined as set
forth in Section 6 above) of the shares of Common Stock subject to the
Option, or portion thereof, surrendered over the exercise price of the
Option with respect to such shares (any such authorized surrender and
payment being hereinafter referred to as a "Stock Appreciation Right").
Such payment, at the discretion of the Committee, may be made in shares of
Common Stock valued at the then market value thereof (determined as set
forth in Section 6 above), or in cash, or partly in cash and partly in
shares of Common Stock.
The terms and conditions set with respect to a Stock Appreciation
Right may include (without limitation), subject to other provisions of this
Section 14 and this Plan, the period during which, date by which or event
upon which the Stock Appreciation Right may be exercised (which shall be on
the same terms as the Option to which is related); the method for valuing
shares of Common Stock for purposes of this Section 14; a ceiling on the
amount of consideration which the Corporation may pay in
8
<PAGE>
connection with exercise of the Stock Appreciation Right; and arrangements
for income tax withholding. The Committee shall have complete discretion to
determine whether, when and to whom Stock Appreciation Rights may be
granted.
(b) Time Limitations. A Stock Appreciation Right may be exercised
only within the period, if any, within which the Option to which it relates
may be exercised. Notwithstanding the foregoing, any election by an
optionee to exercise Stock Appreciation Rights shall be made during the
period beginning on the third business day following the release for
publication of quarterly or annual financial information required to be
prepared and disseminated by the Corporation pursuant to the requirements
of the Exchange Act and ending on the twelfth business day following such
date. The required release of information shall be deemed to have been
satisfied when the specified financial data appears on or in a wire
service, financial news service or newspaper of general circulation or is
otherwise first made publicly available.
(c) Effects of Exercise of Stock Appreciation Rights or Options. Upon
the exercise of a Stock Appreciation Right, the number of shares of Common
Stock available under the Option to which it relates shall decrease by a
number equal to the number of shares for which the Stock Appreciation Right
was exercised. Upon the exercise of an Option, any related Stock
Appreciation Right shall terminate as to any number of shares of Common
Stock subject to the Stock Appreciation Right that exceeds the total number
of shares for which the Option remains unexercised.
(d) Time of Grant. A Stock Appreciation Right granted in connection
with an Incentive Stock Option must be granted concurrently with the Option
to which is relates, while a Stock Appreciation Right granted in connection
with a Nonqualified Stock Option may be granted concurrently with the
Option to which it relates or at any time thereafter prior to the exercise
or expiration of such Option. No optionee shall have any Stock
Appreciation Rights unless (i) in the case of Incentive Stock Options and
Nonqualified Stock Options, the Stock Option Agreement shall so state or
(ii) in the case of Nonqualified Stock Options, the Committee shall have
executed an amendment to the Stock Option Agreement so stating.
(e) Non-Transferable. A Stock Appreciation Right may not be
transferred or assigned except in connection with a transfer of the Option
to which it relates.
15. RESTRICTIONS ON TRANSFER. An Option granted under this Plan may not
------------------------
be transferred except by will or the laws of descent and distribution and,
during the lifetime of the optionee to whom it was granted, may be exercised
only by such optionee.
16. CAPITAL ADJUSTMENTS AFFECTING COMMON STOCK.
------------------------------------------
(a) If the outstanding shares of Common Stock of the Corporation are
increased, decreased, changed into or exchanged for a different number or
kind of shares or other securities of the Corporation or another entity as
a result of a recapitalization, reclassification, stock dividend, stock
split, amendment to the Corporation's Certificate of Incorporation, reverse
stock split, merger or consolidation, an appropriate adjustment
9
<PAGE>
shall be made in the number and/or kind of securities allocated to the
Options and Stock Appreciation Rights previously and subsequently granted
under the Plan, without change in the aggregate purchase price applicable
to the unexercised portion of the outstanding Options but with a
corresponding adjustment in the price for each share or other unit of any
security covered by the Options.
(b) In the event that the Corporation shall declare and pay any
dividend with respect to the Common Stock (other than a dividend payable in
shares of the Corporation's Common Stock or a regular quarterly cash
dividend), including a dividend which results in a nontaxable return of
capital to the holders of shares of Common Stock for federal income tax
purposes, or otherwise than by dividend makes distribution of property to
the holders of its shares of Common Stock, the Committee, in its discretion
applied uniformly to all outstanding Options, may adjust the exercise price
per share of outstanding Options in such a manner as the Committee may
determine to be necessary to reflect the effect of the dividend or other
distribution on the fair market value of a share of Common Stock.
(c) To the extent that the foregoing adjustments described in Sections
16(a) and (b) above relate to particular Options or to particular stock or
securities of the Corporation subject to Option under this Plan, such
adjustments shall be made by the Committee, whose determination in that
respect shall be final and conclusive.
(d) The grant of an Option or Stock Appreciation Right pursuant to
this Plan shall not affect in any way the right or power of the Corporation
to make adjustments, reclassifications, reorganizations or changes of its
capital or business structure or to merge or to consolidate or to dissolve,
liquidate or sell, or transfer all or any part of its business or assets.
(e) No fractional shares of stock shall be issued under the Plan for
any such adjustment.
(f) Any adjustment made pursuant to this Section 16, shall be made, to
the extent practicable, in such manner as not to constitute a modification
of any outstanding Incentive Stock Options within the meaning of Section
424(h) of the Internal Revenue Code of 1986, as amended.
17. INVESTMENT PURPOSE. At the discretion of the Committee, any Option
------------------
Agreement may provide that the optionee shall, by accepting the Option,
represent and agree, for himself and his transferees by will or the laws of
descent and distribution, that all shares of stock purchased upon the exercise
of the Option will be acquired for investment and not for resale or
distribution, and that upon each exercise of any portion of an Option, the
person entitled to exercise the same shall furnish evidence of such facts which
is satisfactory to the Corporation. Certificates for shares of stock acquired
under the Plan may be issued bearing such restrictive legends as the Corporation
and its counsel may deem necessary to ensure that the optionee is not an
"underwriter" within the meaning of the regulations of the Securities Exchange
Commission.
10
<PAGE>
18. APPLICATION OF FUNDS. The proceeds received by the Corporation from
--------------------
the sale of Common Stock pursuant to Options will be used for general corporate
purposes.
19. NO OBLIGATION TO EXERCISE. The granting of an Option or Stock
-------------------------
Appreciation Right shall impose no obligation upon the optionee to exercise such
Option or Stock Appreciation Right.
20. EFFECTIVE DATE OF PLAN. The Plan will become effective upon the
----------------------
approval of the Plan by the shareholders of the Corporation and receipt of any
necessary regulatory approvals.
21. TERM OF PLAN. Options and Stock Appreciation Rights may be granted
------------
pursuant to this Plan from time to time within ten (10) years from the effective
date of the Plan.
22. TIME OF GRANTING OF OPTIONS. Nothing contained in the Plan or in any
---------------------------
resolution adopted or to be adopted by the Committee or the shareholders of the
Corporation and no action taken by the Committee shall constitute the granting
of any Option or Stock Appreciation Right hereunder. The granting of an Option
and Stock Appreciation Right pursuant to the Plan shall take place only when an
Option Agreement shall have been duly executed and delivered by and on behalf of
the Corporation at the direction of the Committee.
23. CASH PAYMENTS. At the time of the payment of any dividend or other
-------------
distribution with respect to the Common Stock, in the absolute discretion of,
and upon direction of the Board, the Corporation shall cause to be paid to
existing directors and employees of the Corporation, the Bank or any Subsidiary
who hold nonforfeited, unexercised Options under this Plan, regardless of
whether or not such Options are vested and nonforfeitable, a cash amount equal
to the number of shares of Common Stock subject to nonforfeited, unexercised
options held by such optionee multiplied by the amount of any dividends or other
distributions paid per share of Common Stock outstanding. The Board shall have
the discretion to approve cash payments at the time of some dividends or
distributions but not others. Notwithstanding the foregoing, no amounts shall
be paid to optionees pursuant to this Section 23 with respect to any dividend or
distribution if at the time of such dividend or distribution, the exercise price
of the Options shall have been reduced pursuant to Section 16(b) above.
If any director or employee of the Corporation, the Board or any Subsidiary
shall receive any cash payment from the Company, the Board or any Subsidiary
pursuant to this Section 23 with respect to an Option which is not vested and
exercisable, and if such Option shall be forfeited, then within 30 days after
the effective date of such forfeiture, the optionee shall pay to the
Corporation, the Bank or the Subsidiary (as applicable) an amount equal to the
cash payment received by such optionee with respect to such forfeited Option.
In the alternative, at the option of the Corporation, the Bank or the Subsidiary
(as applicable) the amount to be repaid may be withheld from the final
compensation payable to the optionee.
24. WITHHOLDING TAXES. Whenever the Corporation proposes or is required
-----------------
to cause to be issued or transferred shares of stock, cash or other assets
pursuant to this Plan, the Corporation shall have the right to require the
optionee to remit to the Corporation an amount sufficient to satisfy any
federal, state and/or local withholding tax requirements prior to the
11
<PAGE>
issuance of any certificate or certificates for such shares or delivery of such
cash or other assets. Alternatively, the Corporation may issue or transfer such
shares of stock or make other distributions of cash or other assets net of the
number of shares or other amounts sufficient to satisfy the withholding tax
requirements. For withholding tax purposes, the shares of stock, cash and other
assets to be distributed shall be valued on the date the withholding obligation
is incurred.
25. TERMINATION AND AMENDMENT. The Board may at any time alter, suspend,
-------------------------
terminate or discontinue the Plan, subject to any applicable regulatory
requirements and any required stockholder approval or any stockholder approval
which the Board may deem advisable for any reason, such as for the purpose of
obtaining or retaining any statutory or regulatory benefits under tax,
securities or other laws or satisfying applicable stock exchange or quotation
system listing requirements. The Board may not, without the consent of the
holder of an Option or Stock Appreciation Right previously granted, make any
alteration which would deprive the optionee of his rights with respect thereto.
26. CAPTIONS AND HEADINGS; GENDER AND NUMBER. Captions and paragraph
----------------------------------------
headings used herein are for convenience only, do not modify or affect the
meaning of any provision herein, are not a part, and shall not serve as a basis
for interpretation or construction of, this Plan. As used herein, the masculine
gender shall include the feminine and neuter, and the singular number shall
include the plural, and vice versa, whenever such meanings are appropriate.
27. COST OF PLAN; EXCULPATION AND INDEMNIFICATION. All costs and expenses
---------------------------------------------
incurred in the operation and administration of the Plan shall be borne by the
Corporation, the Bank and the Subsidiaries. In connection with this Plan, no
member of the Board, no member of the Board of Directors of the Bank, and no
member of the Board of Directors of any Subsidiary, and no member of the
Committee shall be personally liable for any act or omission to act, nor for any
mistake in judgment made in good faith, unless arising out of, or resulting
from, such person's own bad faith, willful misconduct or criminal acts. To the
extent permitted by applicable law and regulation, the Corporation shall
indemnify, defend and hold harmless the members of the Board, the members of the
Board of Directors of the Bank and the members of the Board of Directors of any
Subsidiary, and members of the Committee, and each other officer or employee of
the Bank, the Corporation or of any Subsidiary to whom any power or duty
relating to the administration or interpretation of this Plan may be assigned or
delegated, from and against any and all liabilities (including any amount paid
in settlement of a claim with the approval of the Board), and any costs or
expenses (including counsel fees) incurred by such persons arising out of or as
a result of, any act or omission to act, in connection with the performance of
such person's duties, responsibilities and obligations under this Plan, other
than such liabilities, costs, and expenses as may arise out of, or result from
the bad faith, willful misconduct or criminal acts of such persons.
28. GOVERNING LAW. Without regard to the principles of conflicts of laws,
-------------
the laws of the State of North Carolina shall govern and control the validity,
interpretation, performance, and enforcement of this Plan.
12
<PAGE>
29. INSPECTION OF PLAN. A copy of this Plan, and any amendments thereto,
------------------
shall be maintained by the Secretary of the Corporation and shall be shown to
any proper person making inquiry about it.
30. OTHER PROVISIONS. The Option Agreements authorized under this Plan
----------------
shall contain such other provisions not inconsistent with the foregoing,
including, without limitation, increased restrictions upon the exercise of
options, as the Committee may deem advisable.
13
<PAGE>
APPENDIX B
----------
CITIZENS BANK, FSB
MANAGEMENT RECOGNITION PLAN AND TRUST AGREEMENT
Citizens Bank, FSB, a federally-chartered savings bank (the "Bank"), does
herein set forth the terms of its Management Recognition Plan (the "Plan") and
Trust (the "Trust") and the Trustees hereby accept this Trust and agree to hold
the Trust assets existing on the date of the Agreement and all additions and
accretions thereto upon the terms and conditions hereinafter stated.
Section 1. Purpose of this Plan. The purpose of this Plan is to provide
---------- --------------------
to the directors, officers and employees (the "Participants") of the Bank and of
any corporation or other entity of which the Bank owns, directly or indirectly,
not less than fifty percent (50%) of any class of the equity securities thereof
(a "Subsidiary"), an ownership interest in the Bank's parent holding company,
Innes Street Financial Corporation (the "Corporation") by making awards
(hereinafter referred to as "Awards" or singularly, "Award") of shares of common
stock of the Corporation (the "Common Stock"). The Board of Directors of the
Bank (the "Board") and the board of directors of the Corporation believe that
participation in the ownership of the Corporation will induce Participants to
continue to serve the Bank or any Subsidiary as directors, officers and/or
employees and encourage them to contribute to the future growth and profits of
the Bank and the Corporation. In addition, the existence of this Plan will make
it possible for the Bank and its Subsidiaries to attract capable individuals to
serve as directors or officers of the Bank and its Subsidiaries. The Board
believes that the existence of this Plan will provide incentives to the
directors, officers and employees of the Bank and any Subsidiaries which will
contribute materially to the success of such companies.
Section 2. Administration of this Plan.
---------- ---------------------------
(a) This Plan shall be administered by a committee of the Board (the
"Committee") which shall consist of not less than two members of the Board who
are "Non-Employee Directors" as defined in Rule 16 b-3(b)(3) of the Rules and
Regulations under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). In the absence of a duly appointed Committee, the Plan shall be
administered by the Board. The Committee shall have full power and authority to
construe, interpret and administer this Plan. All actions, decisions,
determinations, or interpretations of the Committee shall be final, conclusive,
and binding upon all parties. Members of the Committee shall serve at the
pleasure of the Board.
(b) The Committee shall decide (i) to whom Awards shall be made under
this Plan, (ii) the number of shares of Common Stock subject to each award,
(iii) the number of additional shares, if any, to be purchased or allocated for
the purposes of this Plan, (iv) the determination of leaves of absence which may
be granted to Participants without constituting a termination of their
employment for purposes of the Plan and (v) such additional terms and conditions
for Awards as the Committee shall deem appropriate, including, without
limitation, any determinations as to the restrictions or conditions on transfer
of shares of Common Stock that are necessary or appropriate to satisfy all
applicable securities laws, rules, regulations, and listing requirements.
(c) The Committee may designate any officers or employees of the Bank
or of any Subsidiary to assist in the administration of this Plan. The
Committee may authorize such individuals to execute documents on its behalf and
may delegate to them such other ministerial and limited discretionary duties as
the Committee may see fit.
<PAGE>
(d) Any shares of Common Stock held under this Plan, including
without limitation unallocated, undistributed and forfeited shares, shall be
held by the Trust.
(e) The Trustees shall be appointed by the Board.
Section 3. Contributions to Trust.
---------- ----------------------
(a) The Board shall determine the amount (or the method of
computing the amount) and timing of any contributions by the Bank and any
Subsidiaries to the Trust established under this Plan. Such amounts may be paid
in cash or in shares of Common Stock and shall be paid to the Trust at the
designated time of contribution. No contributions by Participants shall be
permitted.
(b) Subject to Section 9 hereof, the Trustees shall invest all of
the Trust's assets primarily in Common Stock. The Trust shall acquire, in the
aggregate, 89,930 shares of Common Stock, which is equal to four percent (4%) of
the shares of Common Stock issued in connection with the conversion of the Bank
from a federally-chartered mutual savings bank to a federally-chartered stock
savings bank on December 28, 1998 (the "Conversion"). Such shares of Common
Stock may be purchased by the Trust in the open market, or, subject to approval
of the board of directors of the Corporation, may be acquired through the
issuance by the Corporation to the Trust of authorized but unissued shares of
Common Stock on such terms as may be approved by the Committee and the board of
directors of the Corporation. Such shares (the "Plan Shares") shall be held by
the Trust until they have been awarded and distributed pursuant to the terms of
this Plan. In the event that the Trust receives cash pursuant to receipt of
dividends on Common Stock held by the Trust which has not been awarded to
participants, including the receipt of a special cash dividend or return of
capital with respect to such shares, the Trustees may distribute such cash
received by the Trust along with the Common Stock upon which it was earned upon
the award of such previously unallocated shares.
(c) The principal of the Trust, and any earnings thereon, shall be
held separate and apart from other funds of the Bank and shall be used
exclusively for the uses and purposes of Participants and general creditors as
herein set forth. Participants and their beneficiaries shall have no preferred
claim on, or any beneficial ownership interest in, any assets of the Trust. Any
rights created under the Plan and the Trust shall be mere unsecured contractual
rights of Participants and their beneficiaries against the Bank. Any assets held
by the Trust will be subject to the claims of the Bank's general creditors under
federal and state law in the event of insolvency or bankruptcy, as defined in
Section 9(e) herein.
Section 4. Eligibility and Award of Plan Shares.
---------- ------------------------------------
(a) The Participants in this Plan to whom Awards may be made shall
be the following: members of the Board, members of the board of directors of any
Subsidiary, and such officers and employees of the Bank and/or of any Subsidiary
as may be designated by the Committee. Notwithstanding the foregoing, no member
of the Committee is eligible to receive any grants or any Awards under this Plan
during the one-year period prior to serving on the Committee or during such
2
<PAGE>
service, except for the initial Awards of Plan Shares which will be distributed
after the Plan is approved by a majority of the shareholders of the Corporation.
Such initial Awards shall be made pursuant to the provisions of Section 4(b).
(b) As promptly as practicable after a determination is made that
an Award of Plan Shares is to be made, the Committee shall notify the
Participant in writing of the grant of the Award, the number of Plan Shares
covered by the Award, and the terms upon which the Plan Shares subject to the
Award shall vest and be distributed to the Participant. Awards of Plan Shares
under this Plan shall be effective upon execution and delivery of the Stock
Grant Agreement which sets forth the terms and conditions of the Award of Plan
Shares (the "Stock Grant Agreement").
(c) Notwithstanding anything to the contrary contained in Sections
4(a) and 4(b) above, no Participant shall have any right or entitlement to
receive a Plan Share Award hereunder, such awards being at the total discretion
of the Committee.
Section 5. Vesting and Distribution of Plan Shares.
---------- ---------------------------------------
(a) Shares granted under this Plan shall vest and the right of a
Participant to the Plan Shares shall be nonforfeitable as determined by the
Committee and as set forth in the Stock Grant Agreement.
(b) In determining the number of shares vested under any applicable
vesting schedule, a Participant shall not receive fractional shares. If the
product resulting from multiplying the vested percentage times the allocated
shares results in a fractional share, then a Participant's vested right shall be
rounded down to the nearest whole number of shares.
(c) In the event any Participant shall no longer be either a
director or an employee of the Bank or any Subsidiary for any reason (whichever
position resulted in the award, as set forth in the Stock Grant Agreement),
other than as provided in Sections 5(d) and 5(e) below, and such Participant
does not have a 100% vested interest in his or her shares under the Plan, then
any shares which are not vested based upon the applicable schedule set forth in
the Stock Grant Agreement shall be forfeited and, provided this Plan has not
terminated pursuant to Section 16 below, shall be available again for Awards to
Participants as may be determined by the Committee.
(d) In the event that a Participant shall no longer be an employee
or a director of the Bank or any Subsidiary (whichever position resulted in the
award, as set forth in the Stock Grant Agreement), because of such Participant's
disability or death, prior to the date when all shares allocated to him or her
would be 100% vested in accordance with the schedule set forth in the Stock
Grant Agreement, then, notwithstanding such vesting schedule, all shares
allocated to such Participant shall immediately become fully vested and
nonforfeitable. For purposes of this Plan, the term "disability" shall be
defined in the same manner as such term is defined in Section 22(e)(3) of the
Internal Revenue Code of 1986, as amended (the "Code").
3
<PAGE>
(e) In the event that a Participant ceases to be an employee or a
director of the Bank or a Subsidiary (whichever position resulted in the award,
as set forth in the Stock Grant Agreement), for any reason after the occurrence
of a "change in control" and prior to the time that all shares allocated to him
or her would be 100% vested in accordance with the schedule set forth in the
Stock Grant Agreement, then, notwithstanding such vesting schedule, all shares
allocated to such Participant shall immediately become fully vested and
nonforfeitable. For purposes of this Plan, a "change in control" shall mean (i)
a change in control of a nature that would be required to be reported by the
Corporation in response to Item 1 of the Current Report on Form 8-K, as in
effect on the date hereof, pursuant to Section 13 or 15(d) of the Exchange Act;
(ii) such time as any "person" (as such term is used in Sections 13(d) and 14(d)
of the Exchange Act) other than the Corporation is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of securities of the Corporation or Bank representing 25 percent or
more of the combined voting power of the outstanding Common Stock of the
Corporation or outstanding common stock of the Bank, as applicable; or (iii)
individuals who constitute the board of directors of the Corporation or the
Board on the date hereof (the "Incumbent Board" and "Incumbent Bank Board,"
respectively) cease for any reason to constitute at least a majority thereof,
provided that any person becoming a director subsequent to the date hereof whose
election was approved by a vote of at least three-quarters of the directors
comprising the Incumbent Board or Incumbent Bank Board, as applicable, or whose
nomination for election by the Corporation's or Bank's shareholders was approved
by the Corporation's or Bank's Board of Directors or Nominating Committee, shall
be considered as though he or she were a member of the Incumbent Board or
Incumbent Bank Board, as applicable; or (iv) either the Corporation or the Bank
consolidates or merges with or into another corporation, association or entity
or is otherwise reorganized, where neither the Corporation nor the Bank,
respectively, is the surviving corporation in such transaction; or (v) all or
substantially all of the assets of either the Corporation or the Bank are sold
or otherwise transferred to or are acquired by any other entity or group.
(f) Plan Shares which have vested shall be distributed to the
Participant or any transferee permitted by Section 11 (a "Permitted
Transferee"), as the case may be, as soon as practicable after such Plan Shares
have vested in accordance with the schedule contained in the Stock Grant
Agreement.
(g) The Trustees, the Corporation, the Bank and any Subsidiary
shall have the right to require any Participant or Permitted Transferee to remit
to the Corporation, the Bank or any Subsidiary an amount sufficient to satisfy
any federal, state and/or local withholding tax requirements prior to the
delivery or release of any certificate or certificates for Plan Shares or
delivery of any cash or other assets with respect to Plan Shares or otherwise
pursuant to this Plan. Alternatively, the Trustees, Corporation, Bank and any
Subsidiary may deliver or release Shares or make other distributions of cash or
other assets net of the number of shares or cash sufficient to satisfy the
withholding tax requirements. For withholding tax purposes, the shares of stock,
cash and other assets to be distributed shall be valued on the date the
withholding obligation is incurred.
(h) Each Participant receiving an Award of Plan Shares under this
Plan shall deliver to the Bank a Stock Grant Agreement, which shall be signed by
such Participant.
4
<PAGE>
Section 6. Restrictions on Selling of Plan Shares. Plan Share Awards may
---------- --------------------------------------
not be sold, assigned, pledged or otherwise disposed of prior to the time that
they are vested and distributed pursuant to the terms of this Plan. The Board or
the Committee may require the Participant or his Permitted Transferee, as the
case may be, to agree not to sell or otherwise dispose of his distributed Plan
Shares except in accordance with all then applicable federal and state
securities laws, and the Board or the Committee may cause a legend to be placed
on the stock certificate(s) representing the distributed Plan Shares in order to
restrict the transfer of the distributed Plan Shares for such period of time or
under such circumstances as the Board or the Committee, upon the advice of
counsel, may deem appropriate.
Section 7. Effect of Award on Status of Participant. The fact that an
---------- ----------------------------------------
Award is made to a Participant under this Plan shall not confer on such
Participant any right to continued service on the Board or on the board of
directors of any Subsidiary, nor any right to continued employment with the Bank
or any Subsidiary; nor shall it limit the right of the Bank, the Corporation, or
any Subsidiary to remove such Participant from any such boards, or to terminate
his or her employment at any time.
Section 8. Voting Rights; Dividends; Other Distributions. After an Award
---------- ---------------------------------------------
of Plan Shares has been made, the Participant or Permitted Transferee shall be
entitled to direct the Trustees as to the voting of the Plan Shares which are
covered by the Award and which are not yet vested and distributed to him,
subject to rules and procedures adopted by the Committee for this purpose. All
shares of Common Stock held by the Trust which have not been awarded under an
Award of Plan Shares and shares which have been awarded as to which Participants
or Permitted Transferees have not directed the voting shall be voted by the
Trustees in the same proportion as the trustees of the Bank's Employee Stock
Ownership Plan votes Common Stock held in trust associated therewith, and in the
absence of any such voting, shall be voted in the manner directed by the Board.
Any cash dividends or other cash or noncash distributions (including
special large and nonrecurring dividends and including one that has the effect
of a return of capital to the Corporation's stockholders) or stock dividends
declared in respect of each unvested Plan Share will be held by the Trustees for
the benefit of the Participant or Permitted Transferee on whose behalf such
Award is then held by the Trust and such dividends, including any interest
thereon, will be paid out proportionately by the Trust to the Participant or
Permitted Transferee thereof as soon as practicable after the Plan Shares become
vested in accordance with the Stock Grant Agreement, or otherwise. Any cash
dividends, cash or noncash distributions or stock dividends declared in respect
of each vested Plan Share held by the Trust will be paid by the Trust, as soon
as practicable after the Trust's receipt thereof, to the Participant or
Permitted Transferee on whose behalf such Plan Share is then held by the Trust.
In the event that the Trust receives cash pursuant to receipt of dividends or
other distributions on Common Stock held by the Trust and unallocated to
participants (including the receipt of a special cash dividend or return of
capital) then such funds may be used by the Trust to purchase additional shares
of Common Stock available for future award under this Plan, or the Committee or
Board may distribute such cash received by the Trust along with the Common Stock
upon which it was earned upon the award of such previously unallocated shares.
5
<PAGE>
Section 9. Trust.
---------- -----
(a) The Trustees shall receive, hold, administer, invest and make
distributions and disbursements from the Trust in accordance with the provisions
of this Plan and Trust and the applicable directions, rules, regulations,
procedures and policies established by the Board or the Committee pursuant to
the Plan.
(b) It is the intent of this Plan and Trust that the Trustees shall
have complete authority and discretion with respect to the arrangement, control
and investment of the Trust, and that the Trustees shall invest all assets of
the Trust in Common Stock to the fullest extent practicable, except to the
extent that the Trustees determine that the holding of monies in cash or cash
equivalents is necessary to meet the obligations of the Trust. In performing
their duties, the Trustees shall have the power to do all things and execute
such instruments as may be deemed necessary or proper, including the following
powers;
(i) To invest up to one hundred percent (100%) of all Trust
assets in Common Stock without regard to any law now or hereafter in force
limiting investments for trustees or other fiduciaries. The investment
authorized herein may constitute the only investment of the Trust, and in
making such investment, the Trustees are authorized to purchase Common
Stock from the Corporation or from any other source, and such Common Stock
so purchased may be outstanding, newly issued, or treasury shares.
(ii) To invest any Trust assets not otherwise invested in
accordance with (i) above, in deposit accounts and certificates of deposit
at the Bank or in obligations of the United States Government or its
agencies or such other investments as shall be considered the equivalent of
cash.
(iii) To sell, exchange or otherwise dispose of any property
at any time held or acquired by the Trust.
(iv) To cause stocks, bonds or other securities to be
registered in the name of a nominee, without the addition of words
indicating that such security is an asset of the Trust (but accurate
records shall be maintained showing that such security is an asset of the
Trust).
(v) To hold cash without interest in such amounts as may in
the opinion of the Trustees be reasonable for the proper operation of the
Plan and Trust.
(vi) To employ brokers, agents, custodians, consultants and
accountants.
(vii) To hire counsel to render advice with respect to their
rights, duties and obligations hereunder, and such other legal services or
representation as the Trustees deem desirable.
6
<PAGE>
(viii) To hold funds and securities representing the amounts to
be distributed to a Recipient or his Permitted Transferee as a consequence
of a dispute as to the disposition thereof, whether in a segregated account
or held in common with other assets of the Trust.
Notwithstanding anything herein contained to the contrary, the Trustees
shall not be required to make any inventory, appraisal or settlement or report
to any court, or to secure any order of any court for the exercise of any power
herein contained, or give bond.
(c) The Trustees shall maintain accurate and detailed records and
accounts of all transactions of the Trust, which shall be available at all
reasonable times for inspection by any legally entitled person or entity to the
extent required by applicable law, or by any other person determined by the
Board or the Committee.
(d) Notwithstanding anything to the contrary in this Plan or Trust,
the assets of the Plan and Trust are subject to the payment of the claims of
creditors of the Bank in the event of its insolvency or bankruptcy. The Bank is
insolvent or bankrupt if it is the subject of a proceeding under the Bankruptcy
Code, 11 U.S.C. Section 101 et seq. or is unable to pay its debts. The Board or
the chief executive officer of the Bank must give written notice to the Trustees
of the Bank's bankruptcy or insolvency as soon as practicable following the
occurrence of such event. Upon receipt of such notice or other written
allegations of the Bank's bankruptcy or insolvency, or in the case of the
Trustees' actual knowledge of or determination of the Bank's bankruptcy or
insolvency, the Trustees shall discontinue delivery of Trust assets to the
Participants or the Bank and shall hold the assets of the Trust for the benefit
of the Bank's general creditors and, upon a determination that the Bank is
bankrupt or insolvent, shall distribute such assets to or for the benefit of the
general creditors. The Trustees shall resume delivery of Trust assets to the
Participants or the Bank only after it is determined that the Bank is no longer
bankrupt or insolvent. Determination of the bankruptcy or insolvency shall be
determined by a court of competent jurisdiction or by an arbitrator selected by
and pursuant to rules of the American Arbitration Association upon petition by
an interested party.
Section 10. Adjustment Upon Changes in Capitalization; Dissolution or
----------- ---------------------------------------------------------
Liquidation. In the event of a change in the number or type of shares of Common
- -----------
Stock outstanding, or in the event shares of Common Stock are decreased, changed
into or exchanged for securities of a different entity, by reason of a
reclassification, recapitalization, reorganization, other similar capital
adjustment; by reason of a merger or consolidation of the Corporation; by reason
of the sale by the Corporation of all or a substantial portion of its assets; or
by reason of the occurrence of any other event which could affect the
implementation of this Plan and the realization of its objectives, the number or
kind of shares subject to Awards which have occurred, or could occur, under this
Plan shall be proportionately and equitably adjusted by the Committee.
Section 11. Non-Transferability. Prior to the time Plan Share Awards
----------- -------------------
become vested and are distributed by the Trustees, Plan Share Awards may not be
sold, pledged, assigned, hypothecated, transferred or disposed of in any manner
other than by will or by the laws of descent and distribution. Notwithstanding
the foregoing, or any other provision of this Plan, a Participant who holds Plan
Share Awards may transfer such awards to his or her spouse, lineal ascendants,
lineal descendants, or to a duly established trust for the benefit of one or
more of these individuals. Plan Share Awards so transferred
7
<PAGE>
may thereafter be transferred only to the Participant who originally received
the grant or to an individual or trust to whom the Participant could have
initially transferred the awards pursuant to this Section 11. Plan Share Awards
which are transferred pursuant to this Section 11 shall be subject to the same
terms and conditions as applied to the Participant. In addition, such shares may
be tendered in response to a tender offer for or a request or invitation to
tenders of greater than fifty percent (50%) of the outstanding Common Stock and
may be surrendered in a merger, consolidation or share exchange involving the
Corporation; provided, however, in each case, that except as otherwise provided
herein, the securities or other consideration received in exchange therefor
shall thereafter be subject to the restrictions and conditions set forth in this
Plan.
Section 12. Impact of Award on Other Benefits of Participant. The value
----------- ------------------------------------------------
of any Award, either on the date of the Award or at the time such shares become
vested, shall not be includable as compensation or earnings for purposes of any
other benefit plan offered by the Bank, the Corporation or any Subsidiary other
than any qualified employee benefit plan which provides that such value shall be
included as compensation or earnings for purposes of such plan.
Section 13. Corporate Action. The making of an Award under this Plan
----------- ----------------
shall not affect in any way the right or power of the Corporation or its
shareholders or the Bank or its shareholders or any Subsidiary or its
shareholders to make or authorize any adjustment, recapitalization,
reorganization, or other change in the Corporation's, the Bank's or any
Subsidiary's capital structure or its business, or any merger or consolidation
of the Corporation, the Bank or any Subsidiary, or the issuance of any bonds,
debentures, preferred or other capital stock or rights with respect thereto, or
the dissolution or liquidation of the Corporation, the Bank or any Subsidiary,
or any sale or transfer of all or any part of the Corporation's, the Bank's or
any Subsidiary's assets or business.
Section 14. Exculpation and Indemnification. In connection with this
----------- -------------------------------
Plan, no member of the Board, no member of the board of directors of the
Corporation, no member of the Committee and no Trustee shall be personally
liable for any act or omission to act in his capacity as a member of the Board,
the board of directors of the Corporation or the Committee or as Trustees, nor
for any mistake in judgment made in good faith, unless arising out of, or
resulting from, such person's own bad faith, willful misconduct, or criminal
acts. To the extent permitted by applicable law and regulation, the Bank shall
indemnify, defend and hold harmless the members of the Board, the members of the
board of directors of the Corporation, the members of the board of directors of
any Subsidiary, the Committee and each Trustee and each other officer or
employee of the Bank, the Corporation or of any Subsidiary to whom any duty or
power relating to the administration or interpretation of this Plan may be
assigned or delegated, from and against any and all liabilities (including any
amount paid in settlement of a claim with the approval of the Board) and any
costs or expenses (including counsel fees) incurred by such persons arising out
of, or as a result of, any act or omission to act in connection with the
performance of such person's duties, responsibilities, and obligations under
this Plan, other than such liabilities, costs, and expenses as may arise out of,
or result from, the bad faith, willful misconduct, or criminal acts of such
persons.
Section 15. Amendment and Modification of this Plan. The Board may at
----------- ---------------------------------------
any time, and from time to time, amend or modify this Plan (including the form
of Stock Grant Agreement) in any respect, subject to any applicable regulatory
requirements and any required stockholder approval or any
8
<PAGE>
stockholder approval which the Board may deem advisable for any reason, such as
for the purpose of obtaining or retaining any statutory or regulatory benefits
under tax, securities or other laws or satisfying applicable stock exchange or
quotation system listing requirements. However, any amendment or modification of
this Plan shall not in any manner affect any Award of shares theretofore made to
a Participant under this Plan without the consent of such Participant or any
Permitted Transferee of such Participant.
Section 16. Termination and Expiration of this Plan. This Plan may be
----------- ---------------------------------------
abandoned, suspended, or terminated, in whole or in part, at any time by the
Board; provided, however, that abandonment, suspension, or termination of this
Plan shall not affect any Award theretofore made under this Plan. Unless sooner
terminated, this Plan shall terminate at the close of business on the day that
is the tenth (10th) anniversary of the date of approval of the Plan by the
shareholders of the Corporation; and no Award of shares may be made under this
Plan thereafter. Such termination shall not effect any Award of shares
theretofore made. In the event that the Board terminates this Plan in whole, any
shares held by the Trust which have not been allocated to eligible Participants,
together with any other assets held by the Trust, shall revert to the Bank.
17. Tax Status of Trust. It is intended that the trust established
-------------------
hereby be treated as a Grantor Trust of the Corporation under the provisions of
Section 671 et seq. of the Code, as the same may be amended from time to time.
-- ---
18. Miscellaneous.
-------------
(a) This Plan has been adopted by the Board to be effective as of the date
of approval of the Plan by the shareholders of the Corporation.
(b) Captions and paragraph headings used herein are for convenience only,
do not modify or affect the meaning of any provision herein, are not a part
hereof, and shall not serve as a basis for interpretation or construction of
this Plan or Trust. As used herein, the masculine gender shall include the
feminine and neuter, and the singular number shall include the plural, and vice
versa, whenever such meanings are appropriate.
(c) All costs and expenses incurred in the operation and administration of
this Plan shall be borne by the Bank or by a Subsidiary, or in the discretion of
the Bank, the Trust.
(d) Without regard to the principles of conflicts of laws, the laws of the
State of North Carolina shall govern and control the validity, interpretation,
performance, and enforcement of this Plan and Trust.
(e) A copy of this Plan, and any amendments thereto, shall be maintained
by the Secretary of the Bank and shall be shown to any proper person making
inquiry about it.
9
<PAGE>
[INNES STREET FINANCIAL CORPORATION'S LETTERHEAD]
December 20, 1999
Branch Chief
Division of Corporate Finance
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Re: Innes Street Financial Corporation Form 10-KSB
Dear Sir or Madam:
The financial statements contained in the Form 10-KSB reflect no changes from
the preceding year in any accounting principles or practices, or in the method
of applying any such principles or practices. During 1999, the Company applied
the disclosure requirement under accounting pronouncement, SFAS No.131,
Disclosures about Segments of an Enterprise and Related Information.
Sincerely,
/s/ Ronald E. Bostian
Ronald E. Bostian
Chairman, President and Chief Executive Officer
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