SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended June 30, 1999
Commission File No.: 0-24479
AF BANKSHARES, INC.
(Exact name of small business issuer as specified in its charter)
Federally Chartered 56-0125319
State of Incorporation IRS Employer Number
206 South Jefferson Avenue
P.O. Box 26
West Jefferson, North Carolina 28694
(Address of Principal Executive Offices)
Issuer's telephone, including area code: (336) 246-4344
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, par value $0.01 per share
Title of Class
Indicate by check mark whether the issuer (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the issuer
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark there is no disclosure of delinquent filers
pursuant to Item 405 of Regulation S-B contained herein or any amendment to this
Form 10-KSB. [ ]
The revenues for the issuer's fiscal year ended June 30, 1999 are
$9,084,938.
The issuer had 1,053,678 shares of common stock outstanding as of
August 18, 1999. The aggregate value of the voting stock held by non-affiliates
of the issuer, computed by reference to the price at which the common stock was
sold on August 18, 1999 ($11.25) was $4,287,128.
Transitional Small Business Disclosure Format. Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Annual Report to Stockholders for the year ended June
30, 1999 are incorporated by reference into Part I and II of this Form 10-KSB.
Portions of the Proxy Statement for the 1999 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-KSB.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I
<S> <C> <C>
ITEM 1. DESCRIPTION OF BUSINESS................................................1
ITEM 2. PROPERTIES............................................................29
ITEM 3. LEGAL PROCEEDINGS.....................................................30
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................30
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS...............30
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS..................................30
ITEM 7. FINANCIAL STATEMENTS..................................................30
ITEM 8. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..............................................31
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS..........31
ITEM 10. EXECUTIVE COMPENSATION................................................31
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........31
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................31
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K...............................31
SIGNATURES.................................................................................33
</TABLE>
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
AF Bankshares, Inc. (the "Company") is a federally chartered stock
holding company which owns 100% of the common stock of AF Bank (the "Bank"),
formerly Ashe Federal Bank, AF Insurance Services, Inc. and AF Brokerage, Inc.
The Company has no operations and conducts no business of its own other than
ownership of its subsidiaries and investing in securities. The Bank is a
federally chartered stock savings bank which conducts business from its main
office located in West Jefferson, North Carolina, branches in West Jefferson,
Jefferson and Warrensville, North Carolina operating under the trade name Ashe
Federal Bank, one branch in Allegheny County, North Carolina operating under the
trade name Allegheny First Bank and one branch in Watauga County, North Carolina
operating under the trade name Appalachian First Bank. The Bank was founded in
1939 as a building and loan association. In the early 1980s, the Bank converted
from a North Carolina chartered building and loan to a federally chartered
mutual savings and loan association, and in August of 1995 converted to a
federally chartered mutual savings bank. During fiscal year 1997, the Bank
converted from a federally chartered mutual savings bank to a federally
chartered stock savings bank which is majority owned by AsheCo, M.H.C., a mutual
holding company. On June 16, 1998, the Bank completed its reorganization into a
two-tier mutual holding company and became a wholly owned subsidiary of the
Company. See "Management's Discussion and Analysis -- The Reorganization." The
Bank's deposits are insured by the Savings Association Insurance Fund ("SAIF")
of the Federal Deposit Insurance Corporation (the "FDIC") to the maximum extent
permitted by law. At June 30, 1999, the Bank had total assets of $109.9 million,
total deposits of $93.1 million and equity of $12.2 million.
The historical operations of the Company have been that of a portfolio
mortgage lender, providing fixed rate loans for the residents of Ashe County,
North Carolina. Management has recently expanded the market area of the Company
to include Allegheny and Watauga counties and has diversified its product lines
by engaging in non-mortgage lending and offering non-traditional financial
services, such as insurance and brokerage products. More specifically, since
1996, the Company has made a major commitment to small business commercial
lending and consumer lending as a means to increase the yield on its loan
portfolio and attract lower cost deposit accounts. As a result of this
commitment, commercial loans increased by 359% and consumer loans have increased
by 47% since June 30, 1998. In addition, since July 1997, the Company has
offered traditional property and casualty, life and health insurance products
through AF Insurance Services, Inc., a wholly-owned subsidiary of the Company,
which operates under the trade name AF Ashelande Insurance Service in West
Jefferson, AF Brown Insurance Agency in Wilkesboro, AF Blair Insurance Agency in
Lenoir and AF Insurance Services, Inc. in Sparta, West Jefferson and Jefferson,
North Carolina. In August of 1998, the Company also began offering various
uninsured investment products, including fixed-rate and variable annuities and
mutual funds through a relationship with a third-party broker-dealer. The
Company believes that its strategy of expanding its market area and diversifying
its product lines will enhance its franchise value and strengthen earnings in
the future.
The Company's operating results are primarily dependent upon net
interest income, fees and charges and insurance commissions. Net interest income
is the difference between interest earned on loans, investments and
interest-earning deposits at other financial institutions and the interest paid
on savings deposits and borrowings of the company. The primary interest-earning
asset of the Company is its mortgage loan portfolio representing 65.3% of total
loans, with approximately 50% of portfolio mortgage loans at fixed rates at June
30, 1999. The net interest income of the Company is affected by changes in
economic conditions that influence market interest rates. This exposure to
changes in interest rates contributes to a moderate degree of interest rate risk
because of the negative impact of increasing rates to the Bank's earnings and to
the net market value of its assets and liabilities. Additionally, the Company
receives fee income primarily from loan origination fees, late loan payment
fees, commissions from the sale of credit life, accident and health insurance,
insurance commissions generated from the insurance agency subsidiary and in
payment for other services provided to the customer by the Company. The major
non-interest costs to the Company include compensation and benefits, occupancy
and equipment and data processing costs. Other external factors that affect the
operating results of the Company include changes in
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government and accounting regulations, costs of implementing information
technology, and changes in the competition's emphasis within the Company's
market.
As of June 30, 1999, $57.2 million, or 65.3% of the Bank's total loan
portfolio consisted of real estate loans. Total loans at June 30, 1999 were
$87.6 million of which $48.4 million or 55.3% were secured by one-to-four
family residences. Total mortgage loans, including construction loans, totaled
$57.2 million as of June 30, 1999. Of that amount, approximately 50% were
adjustable rate loans. This change in the composition of the mortgage loan
portfolio results from the Company's strategy of selling long term, fixed-rate
mortgages while retaining the servicing. The reduction in the level of fixed
rate mortgages has served to reduce the Company's exposure to interest rate
risk.
The Bank also invests in consumer loans and commercial loans. As of
June 30, 1999, the Bank's consumer loans and commercial loan portfolios were
$30.4 million, or 34.7% of total loans. Commercial loans totaled $18.3 million,
or 20.9% of the Bank's total loan portfolio. The Bank invests a portion of its
assets in equity securities issued by the FHLB and the Federal Home Loan
Mortgage Corporation (the "FHLMC") and began investing in mortgage-backed
securities during fiscal 1996. Mortgage-backed securities totaled $4.7 million
or 4.3% of total assets at June 30, 1999, and FHLB, Federal Farm Credit Bank and
FHLMC securities investments totaled $5.3 million, or 4.9%, of total assets at
June 30, 1999.
REORGANIZATION
On October 4, 1996, the Bank reorganized into the mutual holding
company form of organization. Members of the mutual holding company consist of
depositors of the Bank, who have the sole authority to elect the board of
directors of the mutual holding company for as long as it remains in mutual
form. Initially, the mutual holding company's principal assets are the shares of
the Bank's common stock received in the reorganization and on its initial
capitalization of $100,000 in cash. The mutual holding company, which by law
must own in excess of 50% of the stock of the Bank, was issued stock in the
Reorganization resulting in a majority ownership interest of 53.8% of the Bank.
The remaining shares of common stock of the Bank were sold to the depositors and
borrowers of the Bank. By virtue of its ownership of a majority of the
outstanding shares of the Bank, the mutual holding company can generally control
the outcome of most matters presented to the stockholders of the Bank for
resolution by vote except for certain matters related to stock compensation
plans, a vote regarding conversion of the mutual holding company to stock form,
or others matters which require a vote only by the minority stockholders. The
mutual holding company has registered as a savings and loan holding company and
its subject to regulation, examination, and supervision by the Office of Thrift
Supervision (OTS).
On June 16, 1998, the Bank completed its reorganization into a two-tier
mutual holding company, pursuant to the agreement and plan of reorganization
approved by the Bank's shareholders on December 8, 1997. Under the
reorganization, the Bank became the wholly-owned subsidiary of AF Bankshares,
Inc., a newly formed stock holding company (the "Company") and holders of the
Bank's common stock became holders of the Company's common stock, on an equal
share for shares exchange.
MARKET AREA AND COMPETITION
Previously, the Bank's market area for deposit gathering and lending
has been concentrated in Ashe County, North Carolina. However, management
believes that the Company must expand its market base to build value for the
Company and its shareholders. In March 1998, the Company opened a branch of AF
Bank in Allegheny County and operates the branch under the trade name Allegheny
First Bank. At the same time, an insurance agency branch of AF Insurance
Services, Inc., was opened in the same location. The staff of Allegheny First
came from the local banking community and is attuned to the needs and habits of
Allegheny citizens. The insurance agency personnel direct their attention to the
special needs of Allegheny County citizens as well. On March 1, 1999, the Bank
also opened a branch office in Boone, North Carolina operating under the trade
name Appalachian First Bank. The Company also added an insurance agency in
Lenoir, North Carolina operating under the name AF Blair Insurance Agency. Entry
into the Boone and Allegheny markets significantly expands the Company's
potential to market its banking, insurance and noninsured investment products to
a larger and more
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diverse market. Management now believes that it is delivering the same
personalized customer service to Allegheny and Watauga counties that it has
historically delivered to Ashe County. Management believes that penetration into
other markets increases the opportunity to deliver products from all of the
Company's subsidiaries to a broader market and will make the insurance and
brokerage subsidiaries more profitable investments by increasing the economies
of scale and adding to the products that are available for delivery to the
Company's customers. The Company continues to seek opportunities to increase its
market penetration for its services.
Management believes that the Company's customers perceive "financial
services" to include three elements: funds transfer, including loans, checking
accounts and savings instruments, insurance and securities brokerage. Further,
management believes that failure to offer insurance and brokerage services will
impair the Company's growth and make retention of existing customers more
difficult. During the year ended June 30, 1999, the Company established a
securities brokerage subsidiary, AF Brokerage, Inc., which has applied to become
a member of the National Association of Securities Dealers, Inc. ("NASD"). The
Company currently conducts brokerage services as a branch of a third party
broker/dealer but will operate independently once its regulatory applications
are approved. The Company expects to be accepted into membership in the NASD
within the first quarter of the fiscal year ending June 30, 2000. Management
continues to evaluate acquisitions and business opportunities that it believes
will provide access to customers and markets that enhance the Company's value
and earnings potential in the long term.
The Bank faces substantial competition for both the deposits it accepts
and the loans it makes. Management believes that the Bank has the second largest
deposit base in Ashe County, and the second largest deposit base in the part of
Ashe County which comprises its primary zip code, 28694. Located within Ashe
County are branches of six other depository institutions, four of which are
commercial banks and two of which are credit unions. The Bank competes for
deposits by offering a variety of customer services and deposit accounts at
competitive interest rates. The Bank, like its competitors, is affected by
general economic conditions, particularly changes in market interest rates, real
estate market values, government policies and regulatory authorities' actions.
Changes in the ratio of the demand for loans relative to the availability of
credit may affect the level of competition from financial institutions which may
have greater resources than the Bank, but which have not generally engaged in
lending activities in the Bank's market area in the past, and from credit unions
that can expand into the Bank's market area and compete for customers without
the level of taxation experienced by the Company. Competition may also increase
as a result of the lifting of restrictions on the interstate operations of
financial institutions. See "--Regulation."
LENDING ACTIVITIES
Loan Portfolio Composition. The Bank's loan portfolio consists
primarily of mortgage loans. The Bank also makes consumer and commercial loans.
The types of loans that the Bank may originate are subject to federal
and state laws and regulations. Interest rates charged by the Bank on loans are
affected by the demand for such loans, the supply of money available for lending
purposes and the rates offered by competitors. These factors are in turn
affected by, among other things, economic conditions, monetary policies of the
federal government, including the Federal Reserve Board (the "FRB"), and
legislative tax policies.
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The following table sets forth the composition of the Bank's mortgage
and other loan portfolios in dollar amounts and percentages at the dates
indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
-----------------------------------------------------------------------------------------------
1999 1998 1997
----------------------------- ----------------------------- ---------------------------
% OF % OF % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
--------- --------- ---------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Mortgage loans:
One- to four-family...... $ 48,433 59.68% $ 55,462 76.36% $ 53,903 76.75%
Multi-family............. 316 0.39% 668 0.92% 742 1.06%
Non-residential.......... 2,068 2.55% 1,418 1.95% 2,804 3.99%
Land..................... 1,258 1.55% 2,424 3.34% 1,586 2.26%
Construction............. 5,082 6.26% 3,477 4.79% 1,562 2.22%
--------- --------- ---------- --------- --------- ---------
Total mortgage loans.... 57,157 70.43% 63,449 87.36% 60,597 86.28%
--------- --------- ---------- --------- --------- ---------
Other loans:
Commercial............... 18,261 22.50% 3,975 5.48% 4,182 5.95%
Consumer loans........... 12,144 14.96% 8,282 11.40% 7,705 10.97%
--------- --------- ---------- --------- --------- ---------
Total other loans....... 30,405 37.46% 12,257 16.88% 11,887 16.92%
--------- --------- ---------- --------- --------- ---------
Gross loans.............. 87,562 107.89% 75,706 104.24% 72,484 103.20%
--------- --------- ---------- --------- --------- ---------
Less:
Undisbursed loan funds... 5,033 6.20% 1,598 2.20% 759 1.08%
Deferred loan fees....... 249 0.31% 316 0.44% 458 0.65%
Allowance for loan losses 1,123 1.38% 1,164 1.60% 1,031 1.47%
--------- --------- ---------- --------- --------- ---------
6,405 7.89% 3,078 4.24% 2,248 3.20%
--------- --------- ---------- --------- --------- ---------
Loans, net.............. $ 81,157 100.00% $ 72,628 100.00% $ 70,236 100.00%
========= ========= ========== ========= ========= =========
Loans serviced for others:
One- to four-family and
cooperative apartment. $ 20,657 100.00% $ 8,511 100.00% $ 383 100.00%
--------- --------- ---------- --------- --------- ---------
Total loans serviced
for others....... $ 20,657 100.00% $ 8,511 100.00% $ 383 100.00%
========= ========= ========== ========= ========= =========
</TABLE>
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Loan Maturity. The following table shows the maturity or period to
repricing of the Bank's loan portfolio at June 30, 1999. Loans that have
adjustable rates are shown using scheduled principal amortization. The table
does not consider estimated prepayments of principal. Prepayments and scheduled
principal amortization on the Bank's loan portfolio, excluding loan portfolio
held for sale, totaled $47.9 million for the year ended June 30, 1999, and $24.8
million and $18.9 million for the years ended June 30, 1998 and 1997,
respectively.
<TABLE>
<CAPTION>
AT JUNE 30, 1999
-------------------------------------------------------------------------------------------
MORTGAGE LOANS
---------------------------------------------------------
ONE- TO
FOUR- MULTI- NON- COMMERCIAL CONSUMER TOTAL
FAMILY FAMILY RESIDENTIAL LAND CONSTRUCTION LOANS LOANS LOANS
------- ------ ----------- ------- ------------ ---------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Amount due:
One year or less................ $ 3,291 $ 0 $ 0 $ 0 $ 5,082 $ 5,649 $ 1,312 $15,334
------- ------- ------- ------- ------- ------- ------- -------
After one year:
One to three years............ 1,889 8 385 311 0 2,839 2,331 7,763
More than three years to five
years........................ 2,711 0 39 219 0 3,804 6,660 13,433
More than five years to ten
years........................ 8,239 80 615 92 0 2,509 1,458 12,993
More than ten years to
twenty years................. 15,173 228 606 636 0 3,220 384 20,247
Over twenty years............. 17,129 0 423 0 0 240 0 17,792
------- ------- ------- ------- ------- ------- ------- -------
Total due or repricing after one
year.......................... 45,141 316 2,068 1,258 0 12,612 10,833 72,228
Total amounts due or repricing, ------- ------- ------- ------- ------- ------- ------- -------
gross......................... $48,432 $ 316 $ 2,068 $ 1,258 $ 5,082 $18,261 $12,145 $87,562
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
The following table sets forth the dollar amounts in each loan category
at June 30, 1999 that are due after June 30, 2000, and whether such loans have
fixed or adjustable interest rates.
<TABLE>
<CAPTION>
DUE AFTER JUNE 30, 2000
--------------------------------------------------------
FIXED ADJUSTABLE TOTAL
----------- ---------- -----------
<S> <C> <C> <C>
(IN THOUSANDS)
Mortgage loans: $ 23,048 $ 22,093 $ 45,141
One- to four-family....................... 160 156 316
Multi-family.............................. 1,855 213 2,068
Non-residential........................... 640 618 1,258
Land...................................... 4,008 8,604 12,612
Commercial loans............................ 8,359 2,474 10,833
----------- ---------- ----------
Consumer loans.............................. $ 38,070 $ 34,158 $ 72,228
=========== ========== ==========
</TABLE>
Origination, Purchase, Sale and Servicing of Loans. The Bank's lending
activities are conducted through its branches in Ashe, Allegheny and Watauga
counties, North Carolina. The Bank originates both adjustable-rate loans and
fixed-rate mortgage loans for portfolio and for sale in the secondary market.
Adjustable-rate mortgage loans carried in portfolio and fixed-rate mortgage
loans carry maximum maturities of 30 years and 15 years, respectively. Fixed
rate loans originated for sale in the secondary market have maximum maturities
of 30 years. Historically, the Bank held for its portfolio all loans it
originated. The Bank now sells all qualified fixed-rate loans to Fannie Mae, but
retains the servicing rights. The determination to sell loans is based upon
management's efforts to reduce interest rate risk. At June 30, 1999, the Bank
serviced approximately $20.7 million of loans for Fannie Mae.
One- to Four-Family Mortgage Lending. The Bank offers both fixed-rate
and adjustable-rate mortgage loans, with maturities up to 30 years, which are
secured by one- to four-family residences, which generally are owner-occupied.
Fixed-rate loans held in the Bank's portfolio have higher interest rates and
shorter terms than those loans sold to Fannie Mae. Most are secured by property
located in Ashe and Allegheny counties, North Carolina. Loan originations are
generally obtained from existing or past customers and members of the local
communities. See "--Origination, Purchase, Sale and Servicing of Loans."
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The Bank offers three to five year call loans, which are either called
or modified based on the Bank's interest rates currently in effect at the call
date. These loans are similar to adjustable rate loans in that the loans
generally amortize over terms of up to 30 years but are not indexed to any
widely recognized rate, such as the one year U.S. Treasury securities rate, and
do not have interest rate caps or floors. Instead, the majority of such loans
are modified at the call date and the rate is adjusted to the Bank's current
rate offered for similar loans being originated on such dates. For purposes of
the tabular presentations throughout this document, such loans are considered to
be adjustable.
In view of its operating strategy, the Bank adheres to its Board
approved underwriting guidelines for loan originations, which, though prudent in
approach to credit risk and evaluation of collateral, allow management
flexibility with respect to documentation of certain matters and certain credit
requirements. As a result, such underwriting guidelines in certain lending
situations are less rigid than comparable Fannie Mae underwriting guidelines.
The Bank's loans are typically originated under terms, conditions and
documentation which permit them to be sold to U.S. government sponsored agencies
such as Fannie Mae. The Bank sells all qualifying fixed-rate loans to Fannie
Mae, while retaining servicing rights. The Bank's policy is to originate one- to
four-family residential mortgage loans in amounts up to 80% of the lower of the
appraised value or the selling price of the property securing the loan. The Bank
offers products with a higher loan-to-value ratio in conjunction with private
mortgage insurance. Mortgage loans originated by the Bank generally include
due-on-sale clauses which provide the Bank with the contractual right to deem
the loan immediately due and payable in the event the borrower transfers
ownership of the property without the Bank's consent. Due-on-sale clauses are an
important means of adjusting the rates on the Bank's fixed-rate mortgage loan
portfolio and the Bank has generally exercised its rights under these clauses.
Construction Lending. The Bank originates construction loans primarily
to finance construction of one- to four-family homes to the individuals who will
be the owners and occupants upon completion of construction in the Bank's market
area. At June 30, 1999, that Bank's portfolio contained approximately $5.1
million, or 5.8%, of construction loans. The Bank's policy is to disburse loan
proceeds as construction progresses and as periodic inspections warrant. These
loans are made primarily to the individuals who will ultimately occupy the home,
and are structured to guarantee the permanent financing to the Bank as well.
Thus construction loans typically "roll" into permanent financing. Construction
loans are made for a maximum of 12 months, by which time permanent financing
must be obtained.
Construction lending is generally considered to involve a higher degree
of credit risk than long-term financing of residential properties. The Bank's
risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction or
development and the estimated cost of construction. If the estimate of
construction cost proves to be inaccurate, the Bank may be compelled to advance
additional funds to complete construction.
Non-Residential Mortgage Lending. The Bank originates commercial real
estate mortgage loans that are generally secured by properties used for business
purposes and retail facilities, such as small office buildings and church loans.
The Bank's underwriting procedures provide that non-residential mortgage loans
may be made, based on debt service coverage or in amounts up to the lesser of
(i) 80% of the lesser of the appraised value or purchase price of the property
or (ii) the Bank's current loans-to-one-borrower limit. These loans are
generally originated as three to five year call loans with amortization periods
of up to 15 years. The Bank considers factors such as the borrower's expertise,
credit history, profitability, cash flow, and the value of the collateral while
underwriting these loans. At June 30, 1999, the Bank's non-residential mortgage
loan portfolio was $2.1 million, or 2.4% of total loans outstanding. The largest
non-residential mortgage loan in the Bank's portfolio at June 30, 1999 was
approximately $750,000 and is secured by a commercial property.
<PAGE>
Mortgage loans secured by non-residential properties can be larger and
therefore may involve a greater degree of credit risk than one- to four-family
residential mortgage loans. This risk is attributable to the uncertain
realization of projected income-producing cash flows which are affected by
vacancy rates, the ability to maintain rent levels against competitively-priced
properties and the ability to collect rent from tenants on a timely basis.
Because payments on loans secured by non-residential properties are often
dependent on the successful operation
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<PAGE>
or management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Bank seeks to minimize these risks through its underwriting standards, which
require such loans to be qualified on the basis of the property's income and
debt service ratio.
Other Mortgage Lending. The Bank also offers loans secured by land and
multi-family residences. Land loans generally consist of residential building
lots for which the borrower intends to ultimately construct residential
properties, but may also include tracts purchased for agricultural use and a
minor amount for speculative purposes. Multi-family loans generally consist of
residential properties with more than four units, typically small apartment
complexes, located in the Bank's primary lending area. At June 30, 1999, the
Bank's total land loan portfolio was $1.3 million or 1.4% of total loans and its
multi-family loan portfolio was $316,000 or 0.36% of total loans.
The Bank requires appraisals of all mortgage loans. Appraisals are
performed by independent appraisers designated by the Bank. The appraisals of
such properties are then reviewed by the Bank's management. The independent
appraisers used by the Bank are reviewed annually by management and the Board of
Directors.
The Bank originates multi-family residential loans with both fixed and
adjustable interest rates which vary as to maturity. Such loans are typically
income-producing investment loans. Loan to value ratios on the Bank's
multi-family residential loans are generally limited to 80%. As part of the
criteria for underwriting these loans, the Bank's general policy is to require
principals of corporate borrowers to become co-borrowers or to obtain personal
guarantees from the principals of corporate borrowers.
Multi-family residential lending generally entails significant
additional risks as compared with single-family residential property lending.
Such loans typically involve large loan balances to single borrowers or groups
of related borrowers. The payment experience on such loans is typically
dependent on the successful operation of the real estate project. The success of
such projects is sensitive to changes in supply and demand, conditions in the
market for multi-family residential properties as well as to regional and
economic conditions generally.
Consumer Loans. Subject to the restrictions contained in federal laws
and regulations, the Bank also is authorized to make loans for a wide variety of
personal or consumer purposes. As of June 30, 1999, $12.1 million, or 13.9%, of
the Bank's total loan portfolio consisted of consumer loans (including home
equity credit line loans and second mortgage loans). The primary component of
the Bank's consumer loan portfolio was $4.8 million of home equity credit lines.
Consumer loans are available at fixed or variable interest rates.
Consumer loans generally involve more credit risk than mortgage loans
because of the type and nature of the collateral. In addition, consumer lending
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness, and
personal bankruptcy. In many cases, any repossessed collateral resulting from a
defaulted consumer loan will not provide an adequate source of repayment of the
outstanding loan balance because of depreciation and improper repair and
maintenance of the underlying security.
As of June 30, 1999, the Bank had $8,000 of non-performing consumer
loans. Charge-offs for consumer loans totaled $37,000, $13,000 and $69,000 for
the years ended June 30, 1999, 1998 and 1997, respectively.
The Bank also offers loans secured by savings accounts at the Bank.
Interest rates charged on such loans are tied to the prime rate and are
available in amounts up to 90% of the value of the account. Savings account
loans are reviewed and approved in conformity with standards approved by the
Bank's Board of Directors. At June 30, 1999, the Bank's savings account loan
portfolio totaled $302,000 or 0.34% of the total loans outstanding.
The Bank offers adjustable rate home equity credit lines tied to the
prime interest rate. The home equity portfolio amounted to $4.8 million or 5.4%
of the total loan portfolio as of June 30, 1999. The home equity credit line is
available on any owner-occupied one-to-four family home, townhouse, or
condominium in the Bank's lending area provided the homeowner meets the Bank's
lending criteria. A home equity loan is an adjustable rate mortgage which is
based on the equity in the home, and is generally secured by a first or second
mortgage on the
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residence. The current maximum term is 180 months. The Bank may offer home
equity loans up to 100% of the value of the collateral to certain customers
meeting a higher level of credit criteria.
Commercial Business Loans. The Bank offers commercial business loans
that are generally provided to various types of closely held businesses located
in the Bank's primary market area. Commercial business loans generally have
terms of three years or less and interest rates which float in accordance with
the prime rate although the Bank occasionally originates commercial business
loans with fixed rates of interest. The Bank performs a cash flow analysis in
underwriting these loans. The Bank's commercial loans generally are secured by
equipment, machinery or other corporate assets including real estate and
receivables. The Bank requires principals of corporate borrowers to become
co-borrowers or obtains personal guarantees from the principals of the borrower
with respect to all commercial business loans.
Commercial business lending generally entails significantly greater
credit risk than residential real estate lending. The repayment of commercial
business loans typically is dependent on the successful operations and income of
the borrower. Such risks can be significantly affected by economic conditions.
In addition, commercial business lending generally requires substantially
greater oversight efforts compared to residential real estate lending.
As of June 30, 1999, the Bank had no non-performing commercial business
loans. The Bank had no charge-offs with respect to commercial business loans in
the years ended June 30, 1999, 1998 or 1997.
Loan Approval Procedures and Authority. The Board of Directors
establishes the lending policies of the Bank. The Board of Directors has
established the following lending authority: the Bank's Chief Executive Officer
and lending officers may approve loans in amounts within assigned lending
limits, and the Loan Committee, comprised of the Board of Directors may approve
loans up to the Bank's loans-to-one-borrower limit. In addition, the staff loan
committee, comprised of the chief executive officer, chief financial officer,
chief lending officer, collection officer and compliance officer, meets twice a
week to review all loan applications, except for secured consumer loan
applications for less than $25,000 that meet all lending policy criteria. The
staff loan committee can approve lending relationships up to $750,000. Larger
amounts must be approved by the Executive Committee of the Board of Directors.
The foregoing lending limits are reviewed annually and, as needed, revised by
the Board of Directors. The Board generally ratifies all loans on a monthly
basis.
For all loans originated by the Bank, upon receipt of a completed loan
application from a prospective borrower, a credit report is ordered and certain
other information supporting the borrower's ability to repay is required. An
appraisal performed by a Bank approved independent appraiser is required for all
real property intended to secure the proposed loan. The Board annually approves
the independent appraisers used by the Bank and approves the Bank's appraisal
policy. It is the Bank's policy to obtain title insurance on all real estate
loans of $50,000 or more and hazard insurance on all improved real estate loans.
In connection with a borrower's request for a renewal of a mortgage loan, the
Bank evaluates both the borrower's ability to service the renewed loan applying
an interest rate that reflects prevailing market conditions and the customer's
payment history, as well as the value of the underlying collateral property.
ASSET QUALITY
Non-Performing Loans. Loans are considered non-performing if they are
in foreclosure or are 90 or more days delinquent. Management and the Board of
Directors perform a monthly review of all delinquent loans. The actions taken by
the Bank with respect to delinquencies vary depending on the nature of the loan
and period of delinquency. The Bank's policies generally provide that delinquent
mortgage loans be reviewed and that a written late charge notice be mailed no
later than the 17th day of delinquency. The Bank's policies provide that
telephone contact and further written notification will be attempted to
ascertain the reasons for delinquency and the prospects of repayment. When
contact is made with the borrower at any time prior to foreclosure, the Bank
attempts to obtain full payment or work out a repayment schedule with the
borrower to avoid foreclosure.
8
<PAGE>
It is the Bank's general policy to reserve all accrued interest due on
all loans that are 90 days or more past due.
Real Estate Owned. Property acquired by the Bank as a result of
foreclosure on a mortgage loan is classified as real estate owned ("REO"). At
June 30, 1999, the Bank held $59,000 in REO, while non-performing loans, defined
as loans that are 90 days or more delinquent, totaled $60,000. The Bank's REO is
initially recorded at the fair value of the related assets at the date of
foreclosure. Thereafter, if there is a further deterioration in value, the Bank
provides an REO valuation allowance and charges operations for the diminution in
value less cost to sell. It is the policy of the Bank to obtain an appraisal on
all real estate acquired through foreclosure as soon as practicable after it
determines that foreclosure is imminent. The Bank generally reassesses the value
of REO at least annually thereafter. The policy for loans is to establish loss
reserves in accordance with the Bank's asset classification process, based on
Generally Accepted Accounting Principles ("GAAP").
9
<PAGE>
Non-performing Assets. The following table sets forth information
regarding the Bank's non-performing assets at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
---------------------------------------------------------
1999 1998 1997
---------------------- --------------------- ------------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Non-accrual mortgage loans:
One- to four-family....................... $ 52 $ -- $ --
Multi-family.............................. -- -- --
Non-residential........................... -- -- --
Land...................................... -- -- --
Construction.............................. -- -- --
------------ ------------ ------------
Total mortgage loans.................. 52 -- --
------------ ------------ ------------
Commercial................................ -- -- --
Consumer Loans............................ 8 -- --
------------ ------------ ------------
Total non-accruing loans................ $ 60 $ -- $ --
------------ ------------ ------------
Loans delinquent 90 or more days for which
interest is fully reserved and still
accruing:
One- to four-family....................... $ -- $ 18 $ 119
Multi-family.............................. -- -- --
Non-residential........................... -- -- --
Land...................................... -- -- --
Construction.............................. -- -- --
------------ ------------ ------------
Total mortgage loans................... -- 18 119
------------ ------------ ------------
Commercial................................ -- -- --
Consumer Loans............................ -- 6 12
------------ ------------ ------------
Total loans delinquent 90 or more days for
which interest has been fully reserved........ -- 24 131
------------ ------------ ------------
Total non-performing loans.................... $ 60 $ 24 $ 131
------------ ------------ ------------
Total real estate owned....................... 59 38 --
------------ ------------ ------------
Total non-performing assets............... $ 119 $ 62 $ 131
============ ============ ============
Total non-performing loans to loans, gross.... 0.07% 0.03% 0.18%
Total non-performing assets to total assets... 0.11% 0.06% 0.16%
</TABLE>
Classified Assets. Federal regulations and the Bank's Classification of
Assets Policy require the Bank to use an internal asset classification system as
a means of reporting problem and potential problem assets. The Bank has
incorporated the OTS internal asset classifications as a part of its credit
monitoring system. The Bank currently classifies problem and potential problem
assets as "Special Mention," "Substandard," "Doubtful" or "Loss" assets. An
asset is considered "Substandard" if it is inadequately protected by the current
equity and paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the insured institution will sustain "some loss" if the deficiencies are
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
10
<PAGE>
facts, conditions, and values, "highly questionable and improbable." Assets
classified as "Loss" are those considered "uncollectible" and of such little
value that their continuance as assets without the establishment of a specific
loss reserve is not warranted. Assets which do not currently expose the insured
institution to sufficient risk to warrant classification in one of the
aforementioned categories but possess weaknesses are required to be designated
"Special Mention."
The Bank's management reviews and classifies the Bank's assets monthly
and reports the results to the Bank's Board of Directors on a monthly basis. The
Bank classifies assets in accordance with the management guidelines described
above. At June 30, 1999, the Bank had $68,000 of assets classified as
Substandard, $6,000 of assets classified as Special Mention, $0 of assets
classified as Loss and $6,000 of assets classified as Doubtful.
Allowance for Loan Losses. The Allowance for Loan Losses ("ALL") is
established through a provision for loan losses based on management's evaluation
of the risks inherent in the Bank's loan portfolio and the general economy. The
ALL is maintained at an amount management considers adequate to cover loan
losses which are deemed probable and estimable. The allowance is based upon a
number of factors, including asset classifications, economic trends, industry
experience and trends, industry and geographic concentrations, estimated
collateral values, management's assessment of the credit risk inherent in the
portfolio, historical loan loss experience, and the Bank's underwriting
policies. At June 30, 1999, the Bank's ALL was $1.1 million, or 1.3% of total
loans, as compared to $1.2 million or 1.5%, at June 30, 1998. The Bank had
non-performing loans of $60,000 and $24,000 at June 30, 1999 and June 30, 1998,
respectively. The Bank will continue to monitor and modify its ALL as conditions
dictate. Various regulatory agencies, as an integral part of their examination
processes, periodically review the Bank's ALL. These agencies may require the
Bank to establish additional valuation allowances, based on their judgments of
the information available at the time of the examination.
11
<PAGE>
The following table sets forth activity in the Bank's ALL at or for the
dates indicated.
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED JUNE 30,
----------------------------------------------------
1999 1998 1997
------------------- ------------------- ------------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Total loans outstanding at end of period............ $ 87,562 $ 75,706 $ 72,484
Average total loans outstanding..................... 76,597 74,095 69,332
Balance at beginning of year........................ 1,164 1,031 1,096
------------- ------------- -------------
Provision for loan losses........................... 20 (25) 20
------------- ------------- -------------
Charge-offs:
One- to four-family residential.................. (4) -- (20)
Multi-family residential......................... -- -- --
Non-residential and land......................... (33) -- --
Construction..................................... -- -- --
Commercial....................................... -- -- --
Consumer loans................................... (37) (13) (69)
-------------- ------------- -------------
Total charge-offs.............................. (74) (13) (89)
-------------- ------------- -------------
Recoveries.......................................... 13 171 4
------------- ------------- -------------
Balance at end of year.............................. $ 1,123 $ 1,164 $ 1,031
============= ============= =============
Allowance for loan losses to total loans
at end of period.................................. 1.28% 1.54% 1.42%
============= ============= =============
Allowance for loan losses to total non-performing
assets at end of period........................... 943.70% 1,877.42% 787.02%
============= ============= =============
Allowance for loan losses to total non-performing
loans at end of period........................... 1,871.14% 4,851.00% 787.02%
============= ============= =============
Ratio of net charge-offs during the period
To average loans outstanding during period....... 0.08% 0.02% 0.13%
============= ============= =============
</TABLE>
12
<PAGE>
The following table sets forth the Bank's ALL allocated by loan
category and the percent of loans in each category to total loans at the dates
indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
---------------------------------------------------------------------------------------------------------
1999 1998 1997
---------------------------------- ------------------------------- -----------------------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN LOANS IN LOANS IN
PERCENT OF EACH PERCENT OF EACH PERCENT OF EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY ALLOWANCE CATEGORY
ALLOWANCE TO TOTAL TO TOTAL ALLOWANCE TO TOTAL TO TOTAL ALLOWANCE TO TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
-------- ----------- ----------- --------- --------- --------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Mortgage loans:
One- to four-family.. $ 456 40.61% 55.32% $ 634 54.47% 73.26% $ 543 52.67% 74.37%
Multi-family......... 10 0.89% 0.36% 8 0.69% 0.88% 7 0.68% 1.02%
Non-residential and 61 5.43% 3.80% 58 4.98% 5.07% 42 4.07% 6.06%
land................
Construction......... 14 1.25% 5.80% 7 0.60% 4.59% 5 0.48% 2.15%
Other:
Consumer............. 442 39.36% 13.87% 457 39.26% 10.94% 434 42.10% 10.63%
Commercial........... 140 12.46% 20.85% -- -- 5.26% -- -- 5.77%
-------- ------ ------ ------- ------ ------ ------- ------ ------
Total................ $ 1,123 100.00% 100.00% $ 1,164 100.00% 100.00% $ 1,031 100.00% 100.00%
======== ====== ====== ======= ====== ====== ======= ====== ======
</TABLE>
INVESTMENT ACTIVITIES
The Bank's investment policy permits it to invest in U.S. government
obligations, certain securities of various government-sponsored agencies and
municipal obligations, including mortgage-backed securities issued/guaranteed by
Fannie Mae, the FHLMC and the Government National Mortgage Association ("GNMA"),
certificates of deposit of insured banks and savings institutions, federal
funds, mutual funds and overnight deposits at the FHLB. At June 30, 1999, the
Bank held $11.8 million in investment securities.
The following table sets forth activity in the Bank's investment
securities portfolio for the periods indicated:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED JUNE 30,
---------------------------------------------------
1999 1998 1997
---------------- --------------- ---------------
<S> <C> <C> <C>
(IN THOUSANDS)
Amortized cost at beginning of period................... $ 8,533 $ 6,362 $ 5,272
Purchases, net.......................................... 4,122 2,609 1,390
Principal payments from mortgage backed securities...... (1,333) (731) (316)
Gain on sales........................................... 166 306 --
Premium and discount amortization, net.................. (24) (13) 16
-------------- ------------- -------------
Amortized cost at end of period......................... 11,464 8,533 6,362
Net unrealized gain(1).................................. 334 484 575
------------- ------------- -------------
Total securities, net................................... $ 11,798 $ 9,017 $ 6,937
============= ============= =============
</TABLE>
(1) The net unrealized gain at June 30, 1999, 1998 and 1997 relates to
available for sale securities in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 115. The net unrealized gain is
presented in order to reconcile the "Amortized Cost" of the Bank's
securities portfolio in the "Carrying Cost," as reflected in the
Statements of Financial Condition.
13
<PAGE>
The following table sets forth the amortized cost and fair value of the
Bank's securities at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
-----------------------------------------------------------------------------
1999 1998 1997
----------------------- ---------------------- -----------------------
AMORTIZED AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
---------- ---------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Mortgage-backed securities:
Fannie Mae and Government
National Mortgage Association... $ 4,626 $ 4,672 $ 2,174 $ 2,235 $ 1,375 $ 1,440
-------- -------- -------- --------
Other debt securities:
U.S. Treasury and Agency........ 4,624 4,589 5,530 5,522 4,200 4,177
Other........................... 480 459 198 198 198 198
-------- -------- -------- -------- -------- --------
Total debt securities............. 5,104 5,048 5,728 5,720 4,398 4,375
-------- -------- -------- -------- -------- --------
Equity securities(1).............. 1,210 1,554 7 438 13 546
Federal Home Loan Bank Stock...... 524 524 624 624 576 576
Net unrealized gain(2)............ 334 -- 484 -- 575 --
-------- -------- -------- -------- -------- --------
Total securities, net............. $ 11,798 $ 11,798 $ 9,017 $ 9,017 $ 6,937 $ 6,937
======== ======== ======== ======== ======== ========
</TABLE>
(1) Equity securities consist of FHLMC common stock and mutual funds.
(2) The net unrealized gain at June 30, 1999, 1998 and 1997 relates to
available for sale securities in accordance with SFAS No.115. The net
unrealized gain is presented in order to reconcile the "Amortized Cost" of
the Bank's securities portfolio in the "Carrying Cost," as reflected in the
Statements of Financial Condition.
The following table sets forth the amortized cost and fair value of the
Bank's securities, by accounting classification and by type of security, at the
dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
---------------------------------------------------------------------------
1999 1998 1997
---------------------- ------------------------ ------------------------
AMORTIZED AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Held to Maturity
Other debt securities............. $ 100 $ 100 $ 100 $ 100 $ 100 $ 100
------- ------- ------- ------- ------- -------
Total held to maturity...... 100 100 100 100 100 100
------- ------- ------- ------- ------- -------
Available-for-Sale:
Mortgage-backed securities........ 4,626 4,672 2,174 2,235 1,375 1,440
Other debt securities:............ 4,806 4,750 5,430 5,422 4,100 4,077
Equity securities................. 1,210 1,554 7 438 13 546
Net unrealized gain(1)............ 334 -- 484 -- 575 --
------- ------- ------- ------- ------- -------
Total available-for-sale.... 10,976 10,976 8,095 8,095 6,063 6,063
------- ------- ------- ------- ------- -------
Certificates of deposit.............. 198 198 198 198 198 198
------- ------- ------- ------- ------- -------
Federal Home Loan Bank Stock......... 524 524 624 624 576 576
------- ------- ------- ------- ------- -------
Total securities, net............. $11,798 $11,798 $ 9,017 $ 9,017 $ 6,937 $ 6,937
======= ======= ======= ======= ======= =======
</TABLE>
(1) The net unrealized gains at June 30, 1999, 1998 and 1997 relate to
available for sale securities in accordance with SFAS No. 115. The net
unrealized gain is presented in order to reconcile the "Amortized Cost"
of the Bank's securities portfolio in the "Carrying Cost," as reflected
in the Statements of Financial Condition.
14
<PAGE>
The following table sets forth certain information regarding the
amortized cost, fair value and weighted average yield of the Bank's debt
securities at June 30, 1999, by remaining period to contractual maturity. With
respect to mortgage-backed securities, the entire amount is reflected in the
maturity period that includes the final security payment date and, accordingly,
no effect has been given to periodic repayments or possible prepayments.
<TABLE>
<CAPTION>
AT JUNE 30, 1999
-------------------------------------------------------------------------------
HELD-TO-MATURITY AVAILABLE FOR SALE
-------------------------------------------------------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
--------- ------ --------- --------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Debt Securities
Mortgaged-backed securities:
Due within 1 year..................... $ -- $ -- $ --% $ -- $ -- $ --%
Due after 1 year but within 5 years -- -- -- 66 66 7.29
Due after 5 years but within 10
years............................... -- -- -- -- -- --
Due after 10 years.................... -- -- -- 4,560 4,606 6.76
------- -------
Total -- -- -- 4,626 4,672 6.77
U.S. Treasury and Agency:
Due within 1 year..................... 100 100 5,83 -- -- --
Due after 1 year but within 5 years -- -- -- 2,880 2,849 5.75
Due after 5 years but within 10
years................................ -- -- -- 1,017 1,018 7.53
Due after 10 years.................... -- -- -- 627 622 5.80
------- -------
Total 100 100 5.83 4,524 4,489 6.16
------ ----- ------- ------- -------
Corporate & Other:
Due within 1 year..................... 99 99 5.10 -- -- --
Due after 1 year but within 5 years 99 99 7.25 -- -- --
Due after 5 years but within 10
years................................ -- -- -- -- -- --
Due after 10 years.................... -- -- -- 282 261 4.60
-------
198 198 6.18 282 261 4.60
-------
Equity Securities:.................... -- -- -- 1,210 1,554 --
-------
Total:
Due within 1 year................... 199 199 5.47 -- -- --
Due after 1 year but within 5 years 99 99 7.25 2,946 2,915 5.79
Due after 5 years but within 10
years.............................. -- -- -- 1,017 1,018 7.53
Due after 10 years.................. -- -- -- 5,469 5,489 6.54
Equity Securities................... -- -- -- 1,210 1.554 --
------- -------
298 298 6.06 10,642 10,976 6.41
--- --- ------- -------
Federal Home Loan Bank Stock....... 524 524 -- -- -- --
------ ----- -------- ------- ------- ------
$ 822 $ 822 6.06% $10,642 $10,976 6.41%
====== ===== ======== ======= =======
</TABLE>
15
<PAGE>
SOURCES OF FUNDS
General. Deposits, loan and security repayments and prepayments,
proceeds of refinanced loans sold to Fannie Mae and cash flows generated from
operations are the primary sources of the Bank's funds for use in lending and
for other general purposes.
Deposits. The Bank offers a variety of deposit accounts with a range of
interest rates and terms. The Bank's deposits consist of regular (passbook)
savings accounts, checking accounts, money market deposit accounts, statement
savings accounts, IRAs and certificates of deposit. In recent years, the Bank
has offered certificates of deposit with maturities of up to 48 months. At June
30, 1999, the Bank's core deposits (which the Bank considers to consist of
checking accounts, regular savings accounts and statement savings accounts)
constituted 44.2% of total deposits. The flow of deposits is influenced
significantly by general economic conditions, changes in money market rates,
prevailing interest rates and competition. The Bank's deposits are obtained
predominantly from Ashe, Allegheny and Watauga counties. The Bank relies
primarily on customer service and long-standing relationships with customers to
attract and retain these deposits; however, market interest rates and rates
offered by competing financial institutions significantly affect the Bank's
ability to attract and retain deposits.
The following table presents the deposit activity of the Bank for the
periods indicated.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED JUNE 30,
---------------------------------------------------------
1999 1998 1997
--------------------- -------------------- ------------
<S> <C> <C> <C>
(IN THOUSANDS)
Total deposits at beginning of period,
including accrued interest.................. $ 82,488 $ 68,218 $ 63,468
Net increase before interest credited......... 6,848 10,728 1,554
Interest credited............................. 3,770 3,542 3,196
--------- --------- ----------
Total deposits at end of period............... $ 93,106 $ 82,488 $ 68,218
========= ========= ==========
</TABLE>
At June 30, 1999, the Bank had approximately $13.9 million in Jumbo
certificate of deposits (accounts in amounts over $100,000) maturing as follows:
<TABLE>
<CAPTION>
WEIGHTED
AMOUNT AVERAGE RATE
-------- -------------
<S> <C> <C>
(IN THOUSANDS)
Maturity Period
Within three months..................................... $ 4,975 5.25%
After three but within six months....................... 3,393 4.76%
After six but within 12 months.......................... 4,232 4.97%
After 12 months......................................... 1,310 4.92%
----------
Total........................................ $ 13,910 5.01%
==========
</TABLE>
16
<PAGE>
The following table sets forth the distribution of the Bank's deposit
accounts and the related weighted average interest rates at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
--------------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------------- --------------------------------- ------------------------------
PERCENT WEIGHTED PERCENT WEIGHTED PERCENT WEIGHTED
OF TOTAL AVERAGE OF TOTAL AVERAGE OF TOTAL AVERAGE
AMOUNT DEPOSITS RATE AMOUNT DEPOSITS RATE AMOUNT DEPOSITS RATE
-------- -------- --------- ------ -------- -------- ------ -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Noninterest bearing
checking accounts...... $ 3,914 4.20% --% $ 3,469 4.21% --% $ 901 1.33% --
Interest bearing
checking / Money Market 15,425 16.57% 2.28% 10,321 12.51% 3.13% 11,347 16.63% 3.38%
accounts..............
Passbook savings...... 21,841 23.46% 3.05% 16,729 20.28% 4.25% 10,672 15.64% 4.03%
Certificates of deposit 51,788 55.62% 4.94% 51,801 62.80% 5.52% 45,133 66.16% 5.52%
Accrued interest...... 138 0.15% -- 168 0.20% -- 165 0.24% --
-------- ------- ------ -------- ------- -------- ------- ------- -------
Totals $ 93,106 100.00% 4.29% $ 82,488 100.00% 4.94% $68,218 100.00% 4.96%
======== ======= ====== ======== ======= ======== ======= ======= =======
</TABLE>
The following table presents, by interest rate ranges, the amount of
certificate accounts outstanding at June 30, 1999 and the period to maturity.
<TABLE>
<CAPTION>
PERIOD TO MATURITY AT JUNE 30, 1999
- ------------------------------------------------------------------------------------------------------------
LESS THAN ONE TO FOUR TO
INTEREST RATE RANGE ONE YEAR THREE YEARS FIVE YEARS TOTAL
- -------------------------------- ------------------- ------------------- --------------- ------------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
4.00% to 5.99% $ 42,693 $ 5,577 $ 1,219 $ 49,489
6.01% to 7.99%.................. 1,964 272 63 2,299
Total............. $ 44,657 $ 5,849 $ 1,282 $ 51,788
============== ============= ============= =============
</TABLE>
Borrowings. The Bank historically has not used borrowings as a source
of funds. However, the Bank may obtain advances from the FHLB as an alternative
to retail deposit funds and may do so in the future as part of its operating
strategy. These advances would be collateralized primarily by certain of the
Bank's mortgage loans and secondarily by the Bank's investment in capital stock
of the FHLB. See "Regulation--Regulation of Federal Savings Banks--Federal Home
Loan Bank System." Such advances may be made pursuant to several different
credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time to time in accordance
with the policies of the OTS and the FHLB. As of June 30, 1999, the maximum
amount of FHLB advances available to the Bank was $16.0 million. The Bank had
short term advances of $2.6 million at June 30, 1999 from the FHLB. Interest is
payable at rates ranging from 5.68% to 6.87%. $912,500 of the advances are due
by August of 2002, $1.5 million are due by September of 2002, with the remaining
$152,000 due January 2007.
SUBSIDIARY ACTIVITIES
AF Insurance Services, Inc., a wholly owned subsidiary of the Company,
was formed in July 1997 upon the purchase of two independent insurance agencies
for the sole purpose of selling traditional property and casualty, life and
health insurance. An additional insurance agency was purchased in April of 1999.
AF Insurance Services, Inc. offers these services in a segregated location at
the Bank's executive offices, Sparta, Lenoir, Jefferson and North Wilkesboro,
North Carolina.
17
<PAGE>
AF BROKERAGE, INC.
AF Brokerage, Inc., a wholly owned subsidiary of the Company, was
formed in August 1998 for the purpose of selling brokerage and investment
products through a third-party vendor. AF Brokerage, Inc. offers these services
in a segregated location at the Bank's executive offices and branch locations.
PERSONNEL
As of June 30, 1999, the Company had 70 full-time employees. The
employees are not represented by a collective bargaining unit and the Company
considers its relationship with its employees to be good. See "Executive
Compensation" for a description of certain compensation and benefit programs
offered to the Bank's employees.
REGULATION
GENERAL
The Company and the Bank are subject to extensive regulation,
examination and supervision by the OTS, as their chartering agency. The Bank's
deposit accounts are insured up to applicable limits by the FDIC and it is a
member of the FHLB of Atlanta. The Bank must file reports with the OTS
concerning its activities and financial condition and it must obtain regulatory
approvals prior to entering into certain transactions, such as mergers with, or
acquisitions of, other depository institutions. The OTS conducts periodic
examinations to assess the Bank's compliance with various regulatory
requirements. This regulation and supervision establishes a comprehensive
framework of activities in which a savings institution can engage and is
intended primarily for the protection of the insurance fund and depositors. The
Company and the Holding Company, as savings and loan holding companies, are
required to file certain reports with, and otherwise comply with, the rules and
regulations of the OTS.
The OTS has significant 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 or the Congress, could have a material adverse impact on the Holding
Company, the Company or the Bank.
The following discussion is intended to be a summary of the material
statutes and regulations applicable to savings institutions and their holding
companies, and it does not purport to be a comprehensive description of all such
statutes and regulations.
REGULATION OF FEDERAL SAVINGS BANKS
Business Activities. The Bank derives its lending and investment powers
from the Home Owner's Loan Act ("HOLA") and the regulations of the OTS
thereunder. Under these laws and regulations, the Bank may invest in mortgage
loans secured by residential and non-residential real estate, commercial and
consumer loans, certain types of debt securities and certain other assets. The
Bank may also establish service corporations that may engage in activities not
otherwise permissible for the Bank, including certain real estate equity
investments and securities and insurance brokerage. These investment powers are
subject to various limitations, including (a) a prohibition against the
acquisition of any corporate debt security that is not rated in one of the four
highest rating categories; (b) a limit of 400% of an association's capital on
the aggregate amount of loans secured by non-residential real estate property;
(c) a limit of 20% of an association's assets on commercial loans; (d) a limit
of 35% of an association's assets on the aggregate amount of consumer loans and
acquisitions of certain debt securities; (e) a limit of 5% of assets on
non-conforming loans (loans in excess of the specific limitations of HOLA); and
(f) a limit of the greater of 5% of assets or an association's capital on
certain construction loans made for the purpose of financing what is or is
expected to become residential property.
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Loans to One Borrower. Under HOLA, savings associations are generally
subject to the same limits on loans to one borrower as are imposed on national
banks. Generally, under these limits, a savings institution may not make a loan
or extend credit to a single or related group of borrowers in excess of 15% of
the association's unimpaired capital and surplus. Additional amounts may be
lent, not exceeding 10% of the association's unimpaired capital and surplus, if
such loans and extensions of credit are fully secured by readily-marketable
collateral. Such collateral is defined to include certain debt and equity
securities and bullion, but generally does not include real estate. At June 30,
1999, the Bank's limit on loans to one borrower was approximately $1.8 million.
At June 30, 1999, the Bank's largest aggregate amount of loans to one borrower
was $1.5 million and is secured by a mix of one- to four-family, multifamily and
commercial properties. The second largest borrower had an aggregate balance of
approximately $1.4 million, secured by an apartment complex. At June 30, 1999,
all of the loans in both of these lending relationships were performing in
accordance with their terms.
QTL Test. HOLA requires a savings institution to meet a Qualified
Thrift Lender ("QTL") test. A savings institution may satisfy the QTL test by
maintaining at least 65% of its "portfolio assets" in certain "qualified thrift
investments" in at least 9 months of the most recent 12-month period. "Portfolio
assets" means, in general, an association's total assets less the sum of (a)
specified liquid assets up to 20% of total assets, (b) certain intangibles,
including goodwill and credit card and purchased mortgage servicing rights and
(c) the value of property used to conduct the association's business. The term
"qualified thrift investments" includes various types of loans made for
residential and housing purposes, investments related to such purposes,
including certain mortgage-backed and related securities, and loans for
personal, family, household and certain other purposes up to a limit of 20% of
an association's portfolio assets. Recent legislation broadened the scope of
"qualified thrift investments" to include 100% of an institution's credit card
loans, education loans, and small business loans. A savings association may also
satisfy the QTL test by qualifying as a Adomestic building and loan association@
as defined in the Internal Revenue Code of 1986. At June 30, 1999, the Bank
maintained 89.8% of its portfolio assets in qualified thrift investments. The
Bank had also satisfied the QTL test in each of the prior 12 months and,
therefore, was a qualified thrift lender.
A savings institution that fails the QTL test must either operate under
certain restrictions on its activities or convert to a bank charter. The initial
restrictions include prohibitions against (a) engaging in any new activity not
permissible for a national bank, (b) paying dividends not permissible under
national bank regulations, (c) obtaining new advances from any FHLB and (d)
establishing any new branch in a location not permissible for a national bank in
the association's home state. In addition, within one year of the date a savings
institution ceases to meet the QTL test, any company controlling the association
would have to register under, and become subject to the requirements of, the
Bank Holding Company Act of 1956, as amended ("BHC Act"). If the savings
institution does not requalify under the QTL test within the three-year period
after it failed the QTL test, it would be required to terminate any activity and
to dispose of any investment not permissible for a national bank and would have
to repay as promptly as possible any outstanding advances from an FHLB. A
savings institution that has failed the QTL test may requalify under the QTL
test and be free of such limitations, but it may do so only once.
Capital Requirements. The OTS regulations require savings associations
to meet three minimum capital standards: a tangible capital ratio requirement of
1.5% of total assets as adjusted under the OTS regulations, a leverage ratio
requirement of 3% of core capital to such adjusted total assets and a risk-based
capital ratio requirement of 8% of core and supplementary capital to total
risk-weighted assets. The OTS and the federal banking regulators have proposed
amendments to their minimum capital regulations to provide that the minimum
leverage capital ratio for a depository institution that has been assigned the
highest composite rating of 1 under the Uniform Financial Institutions Ratings
System will be 3% and that the minimum leverage capital ratio for any other
depository institution will be 4%, unless a higher leverage capital ratio is
warranted by the particular circumstances or risk profile of the depository
institution. In determining compliance with the risk-based capital requirement,
a savings association must compute its risk-weighted assets by multiplying its
assets and certain off-balance sheet items by risk-weights, which range from 0%
for cash and obligations issued by the United States Government or its agencies
to 100% for consumer and commercial loans, as assigned by the OTS capital
regulation based on the risks OTS believes are inherent in the of asset.
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Tangible capital is defined, generally, as common stockholders' equity
(including retained earnings), certain non-cumulative perpetual preferred stock
and related earnings and minority interests in equity accounts of fully
consolidated subsidiaries, less intangibles (other than certain mortgage
servicing rights) and investments in and loans to subsidiaries engaged in
activities not permissible for a national bank. Core capital is defined
similarly to tangible capital, but core capital also includes certain qualifying
supervisory goodwill and certain purchased credit card relationships.
Supplementary capital currently includes cumulative and other perpetual
preferred stock, mandatory convertible securities, subordinated debt and
intermediate preferred stock and the allowance for loan and lease losses. The
allowance for loan and lease losses includable in supplementary and capital is
limited to a maximum of 1.25% of risk-weighted assets, and the amount of
supplementary capital that may be included as total capital cannot exceed the
amount of core capital.
The OTS has promulgated a regulation that requires a savings
association with "above normal" interest rate risk, when determining compliance
with its risk-based capital requirement, to hold additional capital to account
for its "above normal" interest rate risk. A savings association's interest rate
risk is measured by the decline in the net portfolio value of its assets (i.e.,
the difference between incoming and outgoing discounted cash flows from assets,
liabilities and off-balance sheet contracts) resulting from a hypothetical 2%
increase or decrease in market rates of interest, divided by the estimated
economic value of the association's assets, as calculated in accordance with
guidelines set forth by the OTS. At the times when the 3-month Treasury bond
equivalent yield falls below 4%, an association may compute its interest rate
risk on the basis of a decrease equal to one-half of that Treasury rate rather
than on the basis of 2%. A savings association whose measured interest rate risk
exposure exceeds 2% would be considered to have "above normal" risk. The
interest rate risk component is an amount equal to one-half of the difference
between the association's measured interest rate risk and 2%, multiplied by the
estimated economic value of the association's assets. That dollar amount is
deducted from an association's total capital in calculating compliance with its
risk-based capital requirement. Any required deduction for interest rate risk
becomes effective on the last day of the third quarter following the reporting
date of the association's financial data on which the interest rate risk was
computed. The OTS has indefinitely deferred the implementation of the interest
rate risk component in the computation of an institution's risk-based capital
requirements. The OTS continues to monitor the interest rate risk of individual
institutions and retains the right to impose additional capital requirements on
individual institutions. At June 30, 1999, the Bank was not required to maintain
any additional risk-based capital under this rule. At June 30, 1999, the Bank
met each of its capital requirements.
The table below presents the Bank's regulatory capital as compared to
the OTS regulatory capital requirements at June 30, 1999:
<TABLE>
<CAPTION>
CAPITAL EXCESS
AMOUNT REQUIREMENTS CAPITAL
--------- -------------- ----------
<S> <C> <C> <C>
(IN THOUSANDS)
Core capital........................... $ 10,897 $ 3,256 $ 7,641
Risk-based capital..................... 11,901 5,484 6,417
</TABLE>
A reconciliation between regulatory capital and GAAP capital at June
30, 1999 in the accompanying financial statements is presented below:
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<TABLE>
<CAPTION>
RISK-
CORE BASED
CAPITAL CAPITAL
------------ -----------
<S> <C> <C>
GAAP capital.................................... $ 11,063 $ 11,063
Net unrealized gain on available for
sale investment securities, net of tax........ (166) (166)
Allowance for loan losses included as
supplementary capital......................... -- 856
Goodwill and other nonincludible assets......... -- 148
------------ -----------
Regulatory capital.............................. $ 10,897 $ 11,901
============ ===========
</TABLE>
Limitation on Capital Distributions. Effective April 1, 1999, the OTS
amended its capital distribution regulations to reduce regulatory burdens on
savings associations. The regulations being replaced, which were effective
throughout 1998, established limitations upon capital distributions by savings
associations, such as cash dividends, payments to repurchase or otherwise
acquire its shares, payments to shareholders of another institution in a cashout
merger, and other distributions charged against capital. At least 30-days
written notice to the OTS was required for a proposed capital distribution by a
savings association, and capital distributions in excess of specified earnings
or by certain institutions were subject to approval by the OTS. An association
that had capital in excess of all fully phased in regulatory capital
requirements before and after a proposed capital distribution and that was not
otherwise restricted in making capital distributions, could, after prior notice
but without the approval of the OTS, make capital distributions during a
calendar year equal to the greater of (a) 100% of its net earnings to date
during the calendar year plus the amount that would reduce by half its "surplus
capital ratio" (the excess capital over its fully phased in capital
requirements) at the beginning of the calendar year, or (b) 75% of its net
earnings for the previous four quarters. Any additional capital distributions
would require prior OTS approval. Under the amendments adopted by the OTS,
certain savings associations will be permitted to pay capital distributions
during a calendar year that do not exceed the association's net income for that
year plus its retained net income for the prior two years, without notice to, or
the approval of, the OTS. However, a savings association subsidiary of a savings
and loan holding company, such as the Bank, will continue to have to file a
notice unless the specific capital distribution requires an application. In
addition, the OTS can prohibit a proposed capital distribution, otherwise
permissible under the regulation, if the OTS has determined that the association
is in need of more than normal supervision or if it determines that a proposed
distribution by an association would constitute an unsafe or unsound practice.
Furthermore, under the OTS prompt corrective action regulations, the Bank would
be prohibited from making any capital distribution if, after the distribution,
the Bank failed to meet its minimum capital requirements, as described above.
See "--Prompt Corrective Regulatory Action."
Liquidity. The Bank is required to maintain an average daily balance of
liquid assets (cash, certain time deposits, bankers' acceptances, specified
United States Government, state or federal agency obligations, shares of certain
mutual funds and certain corporate debt securities and commercial paper) equal
to a monthly average of not less than a specified percentage of its net
withdrawable deposit accounts plus short-term borrowings. This liquidity
requirement may be changed from time to time by the OTS to any amount within the
range of 4% to 10% depending upon economic conditions and the savings flows of
member institutions, and is currently 4%. Monetary penalties may be imposed for
failure to meet these liquidity requirements. The Bank's average liquidity ratio
for the month ended June 30, 1999 was approximately 19.7% which exceeded the
applicable requirements. The Bank has never been subject to monetary penalties
for failure to meet its liquidity requirements.
Assessments. The OTS has adopted amendments to its regulations,
effective January 1, 1999, that are intended to assess savings associations on a
more equitable basis. The new regulations will base the assessment for an
individual savings association on three components: the size of the association,
on which the basic assessment would be based; the association's supervisory
condition, which would result in an additional assessment based of a percentage
of the basic assessment for any savings institution with a composite rating
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<PAGE>
of 3, 4 or 5 in its most recent safety and soundness examination; and the
complexity of the association's operations, which would result in an additional
assessment based of a percentage of the basic assessment for any savings
association that managed over $1.0 billion in trust assets, serviced for others
loans aggregating more than $1.0 billion, or had certain off-balance sheet
assets aggregating more than $1.0 billion. In order to avoid a disproportionate
impact on the smaller savings institutions, which are those whose total assets
never exceeded $100.0 million, the new regulations provide that the portion of
the assessment based on asset size will be the lesser of the assessment under
the amended regulations or the regulations before the amendment. Management
believes that any change in its rate of OTS assessments under the amended
regulations will not be material.
Branching. Subject to certain limitations, HOLA and the OTS regulations
permit federally chartered savings institutions to establish branches in any
state of the United States. The authority to establish such a branch is
available (a) in states that expressly authorize branches of savings
institutions located in another state and (b) to an association that either
satisfies the "QTL" test for a qualified thrift lender or qualifies as a
"domestic building and loan association" under the Internal Revenue Code of 1986
(the "Code"), which imposes qualification requirements similar to those for a
"qualified thrift lender" under HOLA. See "--QTL Test." The authority for a
federal savings institution to establish an interstate branch network would
facilitate a geographic diversification of the association's activities. This
authority under HOLA and the OTS regulations preempts any state law purporting
to regulate branching by federal savings institutions.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"),
as implemented by OTS regulations, a savings institution has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the OTS, in connection with its examination of a savings institution,
to assess the association's record of meeting the credit needs of its community
and to take such record into account in its evaluation of certain applications
by such association. The CRA also requires all institutions to make public
disclosure of their CRA ratings. The Bank received a "Satisfactory" CRA rating
in its most recent examination on January 20, 1998.
The CRA regulations establish an assessment system that bases an
association's rating on its actual performance in meeting community needs. In
particular, the assessment system focuses on three tests: (a) a lending test, to
evaluate the institution's record of making loans in its assessment areas; (b)
an investment test, to evaluate the institution's record of investing in
community development projects, affordable housing, and programs benefitting low
or moderate income individuals and businesses; and (c) a service test, to
evaluate the institution's delivery of services through its branches, ATMs, and
other offices.
Transactions with Related Parties. The Bank's authority to engage in
transactions with its "affiliates" is limited by the OTS regulations and by
Sections 23A and 23B of the Federal Reserve Act ("FRA"). In general, an
affiliate of the Bank is any company that controls the Bank or any other company
that is controlled by a company that controls the Bank, excluding the Bank's
subsidiaries other than those that are insured depository institutions. The OTS
regulations prohibit a savings institution (a) from lending to any of its
affiliates that is engaged in activities that are not permissible for bank
holding companies under Section 4(c) of the BHC Act and (b) from purchasing the
securities of any affiliate other than a subsidiary. Section 23A limits the
aggregate amount of transactions with any individual affiliate to 10% of the
capital and surplus of the savings institution and also limits the aggregate
amount of transactions with all affiliates to 20% of the savings institution's
capital and surplus. Extensions of credit to affiliates are required to be
secured by collateral in an amount and of a type described in Section 23A, and
the purchase of low quality assets from affiliates is generally prohibited.
Section 23B provides that certain transactions with affiliates, including loans
and asset purchases, must be on terms and under circumstances, including credit
standards, that are substantially the same or at least as favorable to the
association as those prevailing at the time for comparable transactions with
non-affiliated companies. In the absence of comparable transactions, such
transactions may only occur under terms and circumstances, including credit
standards, that in good faith would be offered to or would apply to
non-affiliated companies.
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The Bank's authority to extend credit to its directors, executive
officers, and 10% shareholders, as well as to entities controlled by such
persons, is currently governed by the requirements of Sections 22(g) and 22(h)
of the FRA and Regulation O of the FRB thereunder. Among other things, these
provisions require that extensions of credit to insiders (a) be made on terms
that are substantially the same as, and follow credit underwriting procedures
that are not less stringent than, those prevailing for comparable transactions
with unaffiliated persons and that do not involve more than the normal risk of
repayment or present other unfavorable features and (b) not exceed certain
limitations on the amount of credit extended to such persons, individually and
in the aggregate, which limits are based, in part, on the amount of the
association's capital. In addition, extensions of credit in excess of certain
limits must be approved by the association's board of directors.
Enforcement. Under the Federal Deposit Insurance Act ("FDI Act"), the
OTS has primary enforcement responsibility over savings institutions and has the
authority to bring enforcement action against all "institution-affiliated
parties," including any controlling stockholder or any shareholder, attorney,
appraiser or accountant who knowingly or recklessly participates in any
violation of applicable law or regulation or breach of fiduciary duty or certain
other wrongful actions that causes or is likely to cause a more than a minimal
loss or other significant adverse effect on an insured savings institution.
Civil penalties cover a wide range of violations and actions and range from
$5,000 for each day during which violations of law, regulations, orders, and
certain written agreements and conditions continue, up to $1 million per day for
such violations if the person obtained a substantial pecuniary gain as a result
of such violation or knowingly or recklessly caused a substantial loss to the
institution. Criminal penalties for certain financial institution crimes include
fines of up to $1 million and imprisonment for up to 30 years. In addition,
regulators have substantial discretion to take enforcement action against an
institution that fails to comply with its regulatory requirements, particularly
with respect to its capital requirements. Possible enforcement actions range
from the imposition of a capital plan and capital directive to receivership,
conservatorship, or the termination of deposit insurance. Under the FDI Act, the
FDIC has the authority to recommend to the Director of OTS that enforcement
action be taken with respect to a particular savings institution. If action is
not taken by the Director of the OTS, the FDIC has authority to take such action
under certain circumstances.
Standards for Safety and Soundness. Pursuant to the FDI Act, as amended
by Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and
the Riegle Community Development and Regulatory Improvement Act of 1994
("Community Development Act"), the OTS, together with the other federal bank
regulatory agencies, adopted a set of guidelines prescribing safety and
soundness standards. The guidelines establish general standards relating to
internal controls and information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, asset
quality, earnings standards, and compensation, fees and benefits. In general,
the guidelines require, among other things, appropriate systems and practices to
identify and manage the risks and exposures specified in the guidelines. The
guidelines prohibit excessive compensation as an unsafe and unsound practice and
describe compensation as excessive when the amounts paid are unreasonable or
disproportionate to the services performed by an executive officer, employee,
director or principal shareholder. The OTS and the other agencies determined
that stock valuation standards were not appropriate. In addition, the OTS
adopted regulations that authorize, but do not require, the OTS to order an
institution that has been given notice by the OTS that it is not satisfying any
of such safety and soundness standards to submit a compliance plan. If, after
being so notified, an institution fails to submit an acceptable compliance plan
or fails in any material respect to implement an accepted compliance plan, the
OTS must issue an order directing action to correct the deficiency and may issue
an order directing other actions of the types to which an undercapitalized
association is subject under the "prompt corrective action" provisions of
FDICIA. If an institution fails to comply with such an order, the OTS may seek
to enforce such order in judicial proceedings and to impose civil money
penalties.
Real Estate Lending Standards. The OTS and the other federal banking
agencies adopted regulations to prescribe standards for extensions of credit
that (a) are secured by real estate or (b) are made for the purpose of financing
the construction of improvements on real estate. The OTS regulations require
each savings institution to establish and maintain written internal real estate
lending standards that are consistent with safe and sound banking practices and
appropriate to the size of the association and the nature and scope of its real
estate lending activities. The standards also must be consistent with
accompanying OTS guidelines, which include loan-to-value
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<PAGE>
ratios for the different types of real estate loans. Banks are also permitted to
make a limited amount of loans that do not conform to the proposed loan-to-value
limitations so long as such exceptions are reviewed and justified appropriately.
The guidelines also list a number of lending situations in which exceptions to
the loan-to-value standards are justified.
Prompt Corrective Regulatory Action. Under the OTS prompt corrective
action regulations, the OTS is required to take certain, and is authorized to
take other, supervisory actions against undercapitalized savings institutions.
For this purpose, a savings institution would be placed in one of five
categories based on the association's capital. Generally, a savings institution
is treated as "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10.0%, its ratio of core capital to risk-weighted assets is
at least 6.0%, its ratio of core capital to total assets is at least 5.0%, and
it is not subject to any order or directive by the OTS to meet a specific
capital level. A savings institution will be treated as "adequately capitalized"
if its ratio of total capital to risk-weighted assets is at least 8.0%, its
ratio of core capital to risk-weighted assets is at least 4.0%, and its ratio of
core capital to total assets is at least 4.0% (3.0% if the association receives
the highest rating on the CAMEL financial institutions rating system). 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% (3.0% leverage ratio if
the association receives the highest rating on the CAMEL financial institutions
rating system) is considered to be "undercapitalized." A savings institution
that has a total risk-based capital of less than 6.0% or a Tier 1 risk-based
capital ratio or a leverage ratio of less than 3.0% is considered to be
"significantly undercapitalized." A savings institution that has a tangible
capital to assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." The elements of an association's capital for purposes of the
prompt corrective action regulations are defined generally as they are under the
regulations for minimum capital requirements. See "--Capital Requirements." At
June 30, 1999, the Bank met the criteria for being considered
"well-capitalized."
Where appropriate, the OTS can impose corrective action by a savings
and loan holding company under the "prompt corrective action" provisions of
FDICIA.
Insurance of Deposit Accounts. The Bank is a member of the SAIF, and
the Bank pays its deposit insurance assessments to the SAIF. The FDIC also
maintains another insurance fund, the Bank Insurance Fund (the "BIF"), which
primarily insures the deposits of banks and state chartered savings banks.
Pursuant to FDICIA, the FDIC established a new risk-based assessment
system for determining the deposit insurance assessments to be paid by insured
depository institutions. Under the 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. The three capital categories consist of (a) well capitalized,
(b) adequately capitalized, or (c) undercapitalized. The FDIC also assigns an
institution to 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 that 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. Under the regulation, there are
nine assessment risk classifications (i.e., combinations of capital groups and
supervisory subgroups) to which different assessment rates are applied.
Assessment rates currently range from 0.0% of deposits for an institution in the
highest category (i.e., well-capitalized and financially sound, with no more
than a few minor weaknesses) to 0.27% of deposits for an institution in the
lowest category (i.e., undercapitalized and substantial supervisory concern).
The FDIC is authorized to raise the assessment rates as necessary to maintain
the required reserve ratio of 1.25%. As a result of the Deposit Insurance Funds
Act of 1996 (the "Funds Act"), both the BIF and the SAIF currently satisfy the
reserve ratio requirement. If the FDIC determines that assessment rates should
be increased, institutions in all risk categories could be affected. The FDIC
has exercised this authority several times in the past and could raise insurance
assessment rates in the future. If such action is taken by the FDIC, it could
have an adverse effect on the earnings of the Bank.
The Funds Act also amended the FDIA to expand the assessment base for
the payments on the FICO bonds. Beginning January 1, 1997, the assessment base
for the FICO bonds included the deposits of both BIF-
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and SAIF-insured institutions. Until December 31, 1999, or such earlier date on
which the last savings association ceases to exist, the rate of assessment for
BIF-assessable deposits shall be one-fifth of the rate imposed on
SAIF-assessable deposits. The annual rate of assessments for the payments on the
FICO bonds for the first, second, third and fourth quarters of fiscal year 1999
were 0.0622%, 0.0610%, 0.0582% and 0.061%, 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 of
Atlanta, which is one of the regional FHLBs composing the FHLB System. Each FHLB
provides a central credit facility primarily for its member institutions. The
Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares
of capital stock in the FHLB of Atlanta in an amount equal to 1% of the
aggregate principal amount of its unpaid residential mortgage loans, home
purchase contracts and similar obligations, but not less than $500. The Bank was
in compliance with this requirement with an investment in FHLB of Atlanta stock
at June 30, 1999, of $524,000. Any advances from a FHLB must be secured by
specified types of collateral, and all long-term advances may be obtained only
for the purpose of providing funds for residential housing finance.
For the fiscal years ended June 30, 1999, 1998 and 1997, dividends from
the FHLB of Atlanta to the Bank amounted to $45,000, $43,000 and $38,000,
respectively. If dividends were reduced, or interest on future FHLB advances
increased, the Bank's net interest income would likely also be reduced.
Federal Reserve System. The Bank is subject to provisions of the FRA
and the FRB's regulations pursuant to which depositary institutions may be
required to maintain non-interest-earning reserves against their deposit
accounts and certain other liabilities. Currently, reserves must be maintained
against transaction accounts (primarily NOW and regular checking accounts). The
FRB regulations generally require that reserves be maintained in the amount of
3% of the aggregate of transaction accounts up to $46.5 million. The amount of
aggregate transaction accounts in excess of $46.5 million are currently subject
to a reserve ratio of 10%, which ratio the FRB may adjust between 8% and 12%.
The FRB regulations currently exempt $4.9 million of otherwise reservable
balances from the reserve requirements, which exemption is adjusted by the FRB
at the end of each year. The Bank is in compliance with the foregoing reserve
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 FRB, the effect of this reserve
requirement is to reduce the Bank's interest-earning assets. The balances
maintained to meet the reserve requirements imposed by the FRB may be used to
satisfy liquidity requirements imposed by the OTS. FHLB System members are also
authorized to borrow from the Federal Reserve "discount window," but FRB
regulations require such institutions to exhaust all FHLB sources before
borrowing from a Federal Reserve Bank.
REGULATION OF THE HOLDING COMPANY
General. The Holding Company and the Company are holding companies
chartered pursuant to Section 10(o) of the HOLA. As such, the Holding Company
and the Company are registered with and subject to OTS examination and
supervision as well as certain reporting requirements. In addition, the OTS has
enforcement authority over the Company and the Holding Company and any of 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 financial safety, soundness, or stability of a subsidiary savings
institution. Unlike bank holding companies, federal mutual holding companies are
not subject to any regulatory capital requirements or to supervision by the
Federal Reserve System.
Restrictions Applicable to Activities of Mutual Holding Companies.
Pursuant to Section 10(o) of the HOLA, a mutual holding company may engage only
in the following activities: (i) investing in the stock of a savings
institution; (ii) acquiring a mutual association through the merger of such
association into a savings
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<PAGE>
institution subsidiary of such holding company or an interim savings institution
subsidiary of such holding company; (iii) merging with or acquiring another
holding company, one of whose subsidiaries is a savings institution; (iv)
investing in a corporation the capital stock of which is available for purchase
by a savings institution under federal law or under the law of any state where
the subsidiary savings institution or associations have their home offices; (v)
furnishing or performing management services for a savings institution
subsidiary of such holding company; (vi) holding, managing, or liquidating
assets owned or acquired from a savings institution subsidiary of such company;
(vii) holding or managing properties used or occupied by a savings institution
subsidiary of such company; (viii) acting as trustee under a deed of trust; (ix)
any other activity (a) that the FRB, by regulation, has determined to be
permissible for bank holding companies under Section 4(c) of the BHC Act, unless
the Director of the OTS, by regulation, prohibits or limits any such activity
for savings and loan holding companies, or (b) in which multiple savings and
loan holding companies were authorized by regulation to directly engage on March
5, 1987; and (x) purchasing, holding, or disposing of stock acquired in
connection with a qualified stock issuance if the purchase of such stock by such
holding company is approved by the Director of the OTS. If a mutual holding
company acquires or merges with another holding company, the holding company
acquired or the holding company resulting from such merger or acquisition may
only invest in assets and engage in activities listed above, and it has a period
of two years to cease any non-conforming activities and divest any
non-conforming investments.
Restrictions Applicable to All Savings and Loan Holding Companies. The
HOLA prohibits a savings and loan holding company, including a federal mutual
holding company, directly or indirectly, from acquiring (i) control (as defined
under HOLA) of another savings institution (or a holding company parent thereof)
without prior OTS approval; (ii) more than 5% of the voting shares of another
savings institution (or holding company parent thereof) that is not a
subsidiary, subject to certain exceptions; (iii) through merger, consolidation,
or purchase of assets, another savings institution or a holding company thereof,
or acquiring all or substantially all of the assets of such institution (or a
holding company thereof) without prior OTS approval; or (iv) control of any
depository institution not insured by the FDIC (except through a merger with and
into the holding company's savings institution subsidiary that is approved by
the OTS).
A savings and loan holding company may not acquire as a separate
subsidiary an insured institution that has a principal office outside of the
state where the principal office of its subsidiary institution is located,
except (i) in the case of certain emergency acquisitions (as defined under HOLA)
approved by the FDIC; (ii) if such holding company controls a savings
institution subsidiary that operated a home or branch office in such additional
state as of March 5, 1987, and (iii) if the laws of the state in which the
savings institution to be acquired is located specifically authorize a savings
institution chartered by that state to be acquired by a savings institution
chartered by the state where the acquiring savings institution or savings and
loan holding company is located or by a holding company that controls such a
state chartered association. The conditions imposed upon interstate acquisitions
by those states that have enacted authorizing legislation vary. Some states
impose conditions of reciprocity, which have the effect of requiring that the
laws of both the state in which the acquiring holding company is located (as
determined by the location of its subsidiary savings institution) and the state
in which the association to be acquired is located, have each enacted
legislation allowing its savings institutions to be acquired by out-of-state
holding companies on the condition that the laws of the other state authorize
such transactions on terms no more restrictive than those imposed on the
acquirer by the state of the target association. Some of these states also
impose regional limitations, which restrict such acquisitions to states within a
defined geographic region. Other states allow full nationwide banking without
any condition of reciprocity. Some states do not authorize interstate
acquisitions of savings institutions. In evaluating an application by a holding
company to acquire a savings institution, the OTS must consider the financial
and managerial resources and future prospects of the company and savings
institution involved, the effect of the acquisition on the risk to the insurance
funds, the convenience and needs of the community, and competitive factors.
If the savings institution subsidiary of a federal mutual holding
company fails to meet the QTL test set forth in Section 10(m) of the HOLA and
regulations of the OTS, the holding company must register with the FRB as a bank
holding company under the BHC Act within one year of the savings institution's
failure to so qualify. For additional information in this regard, see "--
Regulation of Federal Savings Banks -- QTL Test."
26
<PAGE>
For a description of certain restrictions on transactions between the
Bank and its affiliates, including, without limitation, the Holding Company, see
"--Regulation of Federal Savings Banks -- Transactions with Related Parties."
THE YEAR 2000 PROBLEM
Financial institution regulators have recently increased their focus
upon Year 2000 issues, issuing guidance concerning the responsibilities of
senior management and directors. The Federal Financial Institutions Examination
Council ("FFIEC") has issued several interagency statements on Year 2000 Project
Management Awareness. These statements require financial institutions to, among
other things, examine the Year 2000 implications of reliance on vendors, data
exchange and potential impact on customers, suppliers and borrowers. These
statements also require each federally regulated financial institution to survey
its exposure, measure its risk and prepare a plan in order to solve the Year
2000 Problem. In addition, the FDIC and the other federal banking regulators
have issued safety and soundness guidelines to be followed by insured depository
institutions, such as the Bank, to assure resolution of any Year 2000 problems.
The federal banking agencies have asserted that Year 2000 testing and
certification is a key safety and soundness issue in conjunction with regulatory
exams, and thus an institution's failure to address appropriately the Year 2000
problem could result in supervisory action, including such enforcement actions
as the reduction of the institution's supervisory ratings, the denial of
applications for approval of a merger or acquisition, or the imposition of civil
money penalties.
The Company's Year 2000 project remains on schedule according to the
guidelines set forth by the FFIEC. The Company replaced all of its computer
systems with Year 2000 compliant systems in the fall of 1997. The Company's
internal software remediation, replacement and testing efforts are complete. The
Company is also monitoring the progress of its customers and vendors in becoming
Year 2000 compliant. See "Management Discussion and Analysis - Impact of the
Year 2000."
REGULATION OF INSURANCE ACTIVITIES
The Company offers various insurance products through AF Insurance
Services, Inc., a wholly owned subsidiary of the Company. AF Insurance Services,
Inc. is licensed and regulated by the North Carolina Department of Insurance
(the "Department"). As such AF Insurance Services, Inc. is subject to the
supervision, examination and reporting requirements of the Department and its
activities are governed by the laws and regulations of the State of North
Carolina.
REGULATION OF SECURITIES BROKERAGE ACTIVITIES
The Company offers brokerage and investment products through AF
Brokerage, Inc., a wholly owned subsidiary of the Company. AF Brokerage, Inc. is
a North Carolina corporation which is registered as a broker-dealer under
Section 15 of the Securities Exchange Act of 1934, as amended, and has applied
for membership in the National Association of Securities Dealers, Inc. (the
"NASD"). As such, AF Brokerage, Inc. is subject to the supervision, examination
and reporting requirements of the SEC, the NASD and the various states in which
it conducts business.
FEDERAL SECURITIES LAWS
The Common Stock of the Company is registered with the SEC under the
Exchange Act. The Company is subject to the information, proxy solicitation,
insider trading restrictions and other requirements of the SEC under the
Exchange Act.
27
<PAGE>
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
General. The following discussion is intended only as a summary and
does not purport to be a comprehensive description of the tax rules applicable
to the Bank, Mutual Company or Stock Company. The Bank has not been audited for
the last seven years.
For federal income tax purposes, the Bank reports its income on the
basis of a taxable year ending June 30, using the accrual method of accounting,
and is subject to federal income taxation in the same manner as other
corporations with some exceptions, including particularly the Bank's tax reserve
for bad debts, discussed below. The Bank and Stock Company constitute an
affiliated group of corporations and, therefore, are eligible to report their
income on a consolidated basis. Because the Mutual Company will own less than
80% of the Common Stock, it will not be a member of such affiliated group and
will report its income on a separate return.
Bad Debt Reserves. The Bank, as a "small bank" (one with assets having
an adjusted tax basis of $500 million or less) is permitted to maintain a
reserve for bad debts with respect to "qualifying loans," which, in general, are
loans secured by certain interests in real property, and to make, within
specified formula limits, annual additions to the reserve which are deductible
for purposes of computing the Bank's taxable income. Pursuant to the Small
Business Job Protection Act of 1996, the Bank is now recapturing (taking into
income) over a multi-year period a portion of the balance of its bad debt
reserve as of June 30, 1996. Since the Bank has already provided a deferred tax
liability equal to the amount of such recapture, the recapture will not
adversely impact the Bank's financial condition or results of operations.
Distributions. To the extent that the Bank makes "non-dividend
distributions" to shareholders, such distributions will be considered to result
in distributions from the Bank's "base year reserve," i.e., it reserve as of
June 30, 1999, to the extent thereof and then from its supplemental reserve for
losses on loans, and an amount based on the amount distributed will be included
in the Bank's taxable income. Non-dividend distributions include distributions
in excess of the Bank's current and accumulated earnings and profits,
distributions in redemption of stock and distributions in partial or complete
liquidation. However, dividends paid out of the Bank's current or accumulated
earnings and profits, as calculated for federal income tax purposes, will not
constitute non-dividend distributions and, therefore, will not be included in
the Bank's income.
The amount of additional taxable income created from a non-dividend
distribution is equal to the lesser of the Bank's base year reserve and
supplemental reserve for losses on loans; or an amount that, when reduced by the
tax attributable to the income, is equal to the amount of the distribution.
Thus, in certain situations approximately one and one-half times the
non-dividend distribution would be includable in gross income for federal income
tax purposes, assuming a 34% federal corporate income tax rate.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986,
as amended (the "Code"), imposes a tax ("AMT") on alternative minimum taxable
income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net
operating loss carryovers of which the Bank currently has none. AMTI is also
adjusted by determining the tax treatment of certain items in a manner that
negates the deferral of income resulting from the regular tax treatment of those
items. Thus, the Bank's AMTI is increased by an amount equal to 75% of the
amount by which the Bank's adjusted current earnings exceeds its AMTI
(determined without regard to this adjustment and prior to reduction for net
operating losses). Although the corporate environmental tax of 0.12% of the
excess of AMTI (with certain modifications) over $2.0 million has expired, under
current Administration proposals, such tax will be retroactively reinstated for
taxable years beginning after December 31, 1996 and before January 2008.
Elimination of Dividends; Dividends Received Deduction. The Stock
Company may exclude from its income 100% of dividends received from the Bank as
a member of the same affiliated group of corporations. Because, following
completion of the Reorganization, Mutual Company will not be a member of such
affiliated group, it will not qualify for such 100% dividends exclusion, but
will be entitled to deduct 80% of the dividends it receives from Stock Company
so long as it owns more than 20% of the Common Stock.
28
<PAGE>
STATE TAXATION
Under North Carolina law, the corporate income tax is 7.25% of federal
taxable income as computed under the Code, subject to certain prescribed
adjustments. An annual state franchise tax is imposed at a rate of .0015 applied
to the greatest of the institution's (i) capital stock, surplus and undivided
profits, (ii) investment in tangible property in North Carolina or (iii) 55% of
the appraised valuation of property in North Carolina.
ITEM 2. PROPERTIES
The Company conducts its business through its main office, located in
West Jefferson, North Carolina, and its branches located in Warrensville,
Jefferson, Sparta, Wilkesboro, Lenoir and Boone, North Carolina. The Company
owns the main office, corporate offices and the Jefferson Branch, with net book
value for property of $195,000, $599,000 and $519,000, respectively, as of June
30, 1999. Management believes that the Bank's current facilities are adequate to
meet the present and immediately foreseeable needs of the Bank and the Holding
Company.
<TABLE>
<CAPTION>
DATE LEASE NET BOOK
LEASED OR LEASED OR EXPIRATION VALUE AT
OWNED ACQUIRED DATE JUNE 30, 1999
------------------ -------------------- -------------------- -----------------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Corporate Offices............ Owned 06/30/97 -- $ 599
206 S. Jefferson Avenue
West Jefferson, NC 28694
West Jefferson Branch Owned 06/30/63 -- 195
205 S. Jefferson Avenue
West Jefferson, NC 28694
Jefferson Branch............. Owned 05/18/94 -- 519
840 E. Main Street
Jefferson, NC 28640
Warrensville Branch.......... Leased 08/31/98 08/31/2000* --
4951 NC Hwy. 88 West
Warrensville, NC 28693
Allegheny First.............. Leased 01/09/98 12/31/2000** --
403 South Main Street
Sparta, NC 28675
Appalachian First............ Leased 02/26/99 2/26/2003*** --
285 Hwy 105 Ext.
Boone, NC 28607
AF Brown Insurance........... Leased 09/01/97 8/31/1999**** --
1347 West D Street
Wilkesboro, NC 28659
AF Blair..................... Leased 04/01/99 03/31/2004 --
324 Morganton Blvd., SW
Lenior, NC 28645
</TABLE>
29
<PAGE>
- -------------
* Option to renew for two additional five-year periods.
** Option to renew for an additional three-year period.
*** Option to renew two additional one-year periods.
**** Option to renew for three additional one-year periods.
ITEM 3. LEGAL PROCEEDINGS
At June 30, 1999, there were no material legal proceedings to which the
Company or any of its subsidiaries was a party or to which any of its property
was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Information relating to the market for Registrant's common equity and
related stockholder matters appears under "Common Stock" and "Market for the
Common Stock" in the Registrant's 1999 Annual Report to Stockholders on page 56,
and is incorporated herein by reference.
Information relating to the payment of dividends by the Registrant appears
under "Common Stock" and "Market for the Common Stock" in the Registrant's 1999
Annual Report to Stockholders on page 56, and is incorporated herein by
reference. A dividend declared by the Board of Directors of the Bank is
considered a capital distribution from the Bank to the stockholders, including
AsheCo, M.H.C., its mutual holding company. Under the requirements of the OTS,
there are certain restrictions on the ability of the Bank to pay a capital
distribution. See "Regulation--Limitation on Capital Distributions."
The Bank paid cash dividends totaling $0.20 per share during the years
ended June 30, 1999 and 1998, respectively.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
Certain of the above-captioned information appears under "Selected
Financial and Other Data of the Company" "Management's Discussion and Analysis"
and in the Registrant's 1999 Annual Report to Stockholders on pages 1 and 2, and
5 through 18 and is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
The Financial Statements of AF Bankshares, Inc., together with the report
thereon by McGladrey & Pullen, LLP appears in the Registrant's 1999 Annual
Report to Stockholders on pages 19 through 53 and are incorporated herein by
reference.
<TABLE>
<CAPTION>
Page(s) in
Annual Report
-------------
<S> <C>
o Independent Auditor's Report......................................... 19
o Consolidated Statements of Financial Condition, 20
June 30, 1999 and 1998..............................................
o Consolidated Statements of Income and Comprehensive Income 21
Years Ended June 30, 1999 and 1998..................................
o Consolidated Statements of Stockholders' Equity, 22-23
Years Ended June 30, 1999 and 1998..................................
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
o Consolidated Statements of Cash Flows, 24-25
Years Ended June 30, 1999 and 1998.................................
o Notes to Consolidated Financial Statements........................... 26-53
</TABLE>
ITEM 8. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The information relating to Directors and Executive Officers of the Company
is incorporated herein by reference to the Company's Proxy Statement for the
Annual Meeting of Stockholders to be held on November 1, 1999.
ITEM 10. EXECUTIVE COMPENSATION
The information relating to executive compensation is incorporated herein
by reference to the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on November 1, 1999.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership of certain beneficial owners
and management is incorporated herein by reference to the Company's Proxy
Statement for the Annual Meeting of Stockholders to be held on November 1, 1999.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related transactions
is incorporated herein by reference to the Company's Proxy Statement for the
Annual Meeting of Stockholders to be held on November 1, 1999.
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Agreement and Plan of Reorganization dated September 15, 1997 by and
among Ashe Federal Bank, AF Bankshares, Inc. and Ashe Interim Savings
Bank (incorporated by reference to the Registration Statement on Form
8-A, as filed with the SEC on June 16, 1998 (the "Form 8-A")).
3.1 Federal Stock Charter of the Company (Incorporated by reference to
Exhibit 3.1 of the Form 8-A).
3.2 Bylaws of the Company (Incorporated by reference to Exhibit 3.2 of the
Form 8-A).
4.1 Common Stock Certificate of the Company (Incorporated by reference to
Exhibit 4.3 of the Form 8-A).
10.1 Employment Agreement with James A. Todd, President and Chief Executive
Officer (incorporated by reference to the 10-KSB for the year ended
June 30, 1998).
10.2 Employment Agreement with Melanie Paisley Miller, Executive Vice
President, Chief Financial Officer, Secretary and Treasurer
(incorporated by reference to the 10-KSB for the year ended June 30,
1998).
31
<PAGE>
10.3 Employment Agreement with Martin G. Little, Senior Vice President and
Chief Lending Officer (incorporated by reference to the 10-KSB for the
year ended June 30, 1998).
10.4 Employee Stock Ownership Plan of Ashe Federal Bank (incorporated by
reference to the Company's Annual Report on Form 10-KSB for the year
ended June 30, 1998).
13.1 1999 Annual Report to Stockholders, is filed herewith.
21.1 Subsidiary Information is incorporated herein by reference to "Part I
- Subsidiary Activities."
27.1 Financial Data Schedule.*
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of the
fiscal year ended June 30, 1999.
*Filed in electronic format only.
32
<PAGE>
SIGNATURES
Pursuant to the Requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Bank has duly caused this report to be signed on its
behalf by the undersigned, thereto duly authorized.
AF BANKSHARES, INC.
(Small Business Issuer)
Date: September 27 By: /s/ James A. Todd
------------------------------- -------------------------------------
James A. Todd
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Date
----
/s/ James A. Todd September 27, 1999
- --------------------------------------- -------------------------
James A. Todd
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Melanie Paisley Miller September 27, 1999
- --------------------------------------- -------------------------
Melanie Paisley Miller
Executive Vice President, Secretary,
Treasurer and Chief Financial Officer
(Principal Financial Officer)
/s/ Jan R. Caddell September 27, 1999
- --------------------------------------- -------------------------
Jan R. Caddell - Director
/s/ Kenneth R. Greene September 27, 1999
- --------------------------------------- -------------------------
Kenneth R. Greene - Director
/s/ William O. Ashley, Jr. September 27, 1999
- --------------------------------------- -------------------------
William O. Ashley, Jr. - Director
/s/ Wayne R. Burgess September 27, 1999
- --------------------------------------- -------------------------
Wayne R. Burgess - Director
33
<PAGE>
/s/ Frank E. Roland September 27, 1999
- --------------------------------------- -------------------------
Frank E. Roland - Director
/s/ Jerry L. Roten September 27, 1999
- --------------------------------------- -------------------------
Jerry L. Roten - Director
/s/ John D. Weaver September 27, 1999
- --------------------------------------- -------------------------
John D. Weaver - Director
34
EXHIBIT 13.1
CONTENTS
<TABLE>
<S> <C>
Selected Financial Data 1 - 2
President's Message 3 - 4
Management's Discussion and Analysis of Financial Condition and
Results of Operations 5 - 18
Independent Auditor's Report 19
Financial Statements 20 - 53
Corporate Information 54 - 56
</TABLE>
<PAGE>
SELECTED FINANCIAL AND OTHER DATA OF THE COMPANY
The following tables set forth certain information concerning the financial
position and results of the Company at the dates and for the years indicated.
The selected financial condition data and the selected operating data for the
years then ended were derived from the audited financial statements of the
Company. The information should be read in conjunction with the Financial
Statements of the Company presented elsewhere.
<TABLE>
<CAPTION>
AT JUNE 30,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ ------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL CONDITION DATA:
Total assets $ 109,931 $ 100,074 $ 82,024 $ 72,318 $ 65,440
Loans receivable, net (1) 81,157 72,628 70,236 62,485 58,294
Investment securities (2) 11,798 9,017 6,937 5,560 2,754
Cash and cash equivalents (3) 12,395 14,789 2,533 1,830 2,469
Savings deposits 93,106 82,488 68,218 63,468 58,496
FHLB advances 2,564 4,116 1,654 1,250 --
Equity 12,218 11,486 10,979 7,238 6,768
Book value per share 11.64 10.90 10.98 N/A N/A
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED JUNE 30,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ------------- ------------- ------------- ------------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING DATA:
Interest income and dividends $ 7,879 $ 7,356 $ 6,213 $ 5,683 $ 5,108
Interest expense 3,967 3,795 3,245 3,204 2,630
----------- ------------- ------------- ------------- ------------
Net interest income 3,912 3,561 2,968 2,479 2,478
Provision for (recovery of) loan losses 20 (25) 20 57 204
----------- ------------- ------------- ------------- ------------
Net interest income after provision for
(recovery of) loan losses 3,892 3,586 2,948 2,422 2,274
Noninterest income 1,206 991 169 142 126
Noninterest expense 4,349 3,488 2,556 1,809 1,507
----------- ------------- ------------- ------------- ------------
Income before income taxes 749 1,089 561 755 893
Income tax expense 235 381 218 301 347
----------- ------------- ------------- ------------- ------------
Net income 514 708 343 454 546
Other comprehensive income (loss), net of tax (91) (56) 175 16 30
----------- ------------- ------------- ------------- ------------
Comprehensive income $ 423 $ 652 $ 518 $ 470 $ 576
=========== ============= ============= ============= ============
Basic earnings per share (4) $ 0.52 $ 0.73 $ 0.44 $ N/A $ N/A
=========== ============= ============= ============= ============
Diluted earnings per shares (4) $ 0.52 $ 0.72 $ 0.44 $ N/A $ N/A
=========== ============= ============= ============= ============
Dividends per share $ 0.20 $ 0.20 $ 0.10 $ N/A $ N/A
=========== ============= ============= ============= ============
</TABLE>
(1) Loans receivable, net is comprised of total loans less allowance for loan
losses, undisbursed loan funds, and deferred loan fees.
(2) Includes FHLB stock, certificates of deposit and investment securities.
(3) Includes interest-earning deposit balances of $4.2 million, $11.8
million, $1.2 million, $840,000, and $1.5 million at June 30, 1999, 1998,
1997, 1996 and 1995 respectively.
(4) Earnings per share has been calculated in accordance with the Statement
of Financial Accounting Standards No. 128, Earnings Per Share, and is
based on net income for the year, divided by the weighted average number
of shares outstanding for the year. In accordance with the AICPA's SOP
93-6, unallocated ESOP shares were deducted from outstanding shares used
in the computation of earnings per share. Diluted earnings per share
includes the effect of dilutive common stock equivalents in the weighted
average number of shares outstanding.
1
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED JUNE 30,
---------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL RATIOS AND OTHER DATA: (1)
PERFORMANCE RATIOS:
Return on average assets 0.49% 0.77% 0.44% 0.65% 0.86%
Return on average equity 4.47% 6.31% 3.64% 6.50% 8.66%
Average equity to average assets 11.02% 12.21% 12.10% 10.05% 9.91%
Equity to total assets at end of period 11.11% 11.48% 13.39% 10.01% 10.34%
Interest rate spread (2) 3.64% 3.64% 3.34% 3.38% 3.68%
Average interest-earning assets to
to average interest-bearing liabilities 110.20% 111.95% 114.40% 107.79% 108.94%
Net interest margin (3) 4.06% 4.17% 3.96% 3.76% 4.06%
Noninterest expense to average assets 4.17% 3.80% 3.28% 2.62% 2.37%
Efficiency ratio (4) 84.97% 76.63% 81.48% 69.20% 57.87%
Dividend payout ratio (6) 38.46% 27.40% 22.73% N/A N/A
REGULATORY CAPITAL RATIOS (5):
Tangible capital 10.00% 10.90% 12.90% 9.80% 10.10%
Core capital 10.00% 10.90% 12.90% 9.80% 10.10%
Total risk-based capital 17.40% 20.40% 26.30% 19.80% 21.60%
ASSET QUALITY RATIOS AND OTHER DATA:
Ratios:
Nonperforming loans to total loans 0.07% 0.03% 0.18% 0.27% 1.12%
Nonperforming loans and real estate owned
to total assets 0.11% 0.06% 0.16% 0.24% 1.08%
Allowance for loan losses to:
Nonperforming loans 1871.14% 851.10% 787.02% 629.89% 179.38%
Total loans 1.28% 1.54% 1.42% 1.70% 2.00%
Number of full service branches 5 4 3 3 2
</TABLE>
(1) With the exception of end of period ratios, all ratios are based on
average monthly or quarterly balances during the indicated periods, and
are annualized where appropriate. Asset Quality Ratios and Regulatory
Capital Ratios are end of period ratios.
(2) The interest rate spread represents the difference between the
weighted-average yield on interest-bearing assets and the
weighted-average cost of interest-bearing liabilities.
(3) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(4) The efficiency ratio represents noninterest expense as a percentage of
the sum of net interest income and noninterest income.
(5) For definitions and further information relating to the Bank's regulatory
capital requirements, see "Note 7 of the Notes to Consolidated Financial
Statements.
(6) The dividend payout ratio represents dividends per share as a percentage
of basic earnings per share. Earnings per share has been calculated in
accordance with the Statement of Financial Accounting Standards No. 128,
Earnings Per Share, and is based on net income for the year, divided by
the weighted average number of shares outstanding for the year. In
accordance with the AICPA's SOP 93-6, unallocated ESOP shares were
deducted from outstanding shares used in the computation of earnings per
share.
2
<PAGE>
PRESIDENT'S MESSAGE
Dear Shareholder,
As the cover of this report indicates, your Company celebrated its 60th birthday
this year. And it is my pleasure to report to you that we begin our next 60
years doing business on the same basis our founders had in mind more than half a
century ago -- "Neighbors Helping Neighbors."
These are exciting times in the financial services industry, and this past year
was especially exciting for your company.
Total assets as of June 30, 1999 stood at $110 million, a 10% increase over the
$100 million level reported at June 30, 1998. Stockholders' equity grew $700,000
to $12.2 million on June 30, 1999, compared to $11.5 million on June 30, 1998.
Net income for the year ended June 30, 1999 was $514,000 or $.52 per share,
versus $708,000 for the prior year ended June 30, 1998.
The slight decline in net income reflects a strong belief on the part of your
board of directors and management that now is the time to make significant
investments in the long-term growth and success of the Company. These
investments are expensive in the short-term; however, they significantly expand
our future earnings capacity and viability in the long run.
During the year, your Company established a securities brokerage subsidiary, AF
Brokerage, Inc., which has applied to become a member of the National
Association of Securities Dealers, Inc. The Company currently conducts brokerage
services as a branch of a third party broker/dealer. Once all its regulatory
applications are accepted, AF Brokerage will operate independently.
Your Company also added an insurance agency in Lenior, North Carolina, operating
under the name AF Blair Insurance Agency; and a bank office in Boone, North
Carolina, operating under the name Appalachian First.
We entered Alleghany and Watauga Counties because we were able to attract
experienced people who were attuned to the needs of those markets and knew
potential customers there for our services. Their knowledge and commitment have
enabled the Company to expand its banking, insurance and brokerage businesses
into new areas offering us added prospects for growth, while better leveraging
our equity. Your management and board remain committed to pursuing sound
business opportunities that will lead to increases in both shareholder and
customer value.
The complete array of financial services and products we offer are all designed
to meet, and surpass the specific needs and wants of our customers. As those
needs and wants change, we endeavor to develop new services to better meet our
customers changing demands. For example, in the year just ended we've added
24-hour telephone access to account information for our banking customers. Plus,
we are well on the way to introducing full-service on-line banking.
Our delivery system is centered on employees who provide a level of customer
service that exceeds our customers' expectations. To enhance the overall quality
of our customer service, we implemented a customer support training system that
included: building product knowledge for employees awareness of Company
products; learning how to listen to customers to determine the customers'
desires; and developing a level of confidence in the products that encourages
all employees to refer customers to areas in the Company that address all
customers' needs and desires.
3
<PAGE>
Customer concerns about the changing of the millennium ("Y2K") and the rather
overblown coverage by the news media have consumed considerable resources during
the past year. We have upgraded and tested all our equipment to ensure that our
systems will work on January 1, 2000 -- and beyond. I am pleased to be able to
frankly tell you, "We are ready." Our offices will open as normal for business
on Monday, January 3, 2000.
All told, indeed it was an exciting year. As a result, your Company is solidly
positioned to take advantage of future opportunities, increase our market share,
and successfully meet the challenges of competing in the financial services
industry in the 21st Century.
On behalf of the board of directors, management, and staff of AF Bankshares,
Inc., thank you for your business, your support, and your confidence throughout
the year. Please know that everyone here is dedicated to serving the financial
needs of our communities in an exceptionally personalized manner, perhaps best
described as "Neighbors Helping Neighbors."
Sincerely,
James A. Todd
President & CEO
P.S. Contrary to popular opinion, it feels great to be sixty!
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
This discussion contains certain forward-looking statements consisting of
estimates with respect to the financial condition, results of operations and
other business of the Company that are subject to various factors which could
cause actual results to differ materially from those estimates. Factors which
could influence the estimates include changes in general and local market
conditions, legislative and regulatory conditions and an adverse interest rate
environment. The information contained in this section should be read in
conjunction with the Financial Statements, the accompanying Notes to the
Financial Statements and the other sections contained in this document.
REORGANIZATION
AF Bankshares, Inc. (the "Company") is a federally chartered stock holding
company for AF Bank (the "Bank") which conducts business from its main office
located in West Jefferson, North Carolina, branches in West Jefferson, Jefferson
and Warrensville, North Carolina operating under the trade name Ashe Federal
Bank, one branch in Alleghany County, North Carolina operating under the trade
name, Alleghany First Bank and one branch in Watauga County operating under the
trade name Appalachian First Bank. The Company has an insurance subsidiary
operating under the trade name AF Ashelande Insurance Service, in West
Jefferson, AF Brown Insurance Agency in Wilkesboro, AF Blair Insurance Agency in
Lenior, and AF Insurance Services, Inc. in Sparta, West Jefferson and Jefferson,
North Carolina. The Company has a brokerage service subsidiary, operating as AF
Brokerage, Inc., which serves Ashe, Alleghany, Wilkes and Watauga Counties.
On April 15, 1996, the Board of Directors of Ashe Federal Bank adopted a Plan of
Reorganization and the related Stock Issuance Plan pursuant to which the Bank
exchanged its federal mutual savings bank charter for a federal stock savings
bank charter, conducted a minority stock offering, and formed AsheCo, MHC, a
mutual holding company which by law must own more than 50% of the common stock
issued by the Bank. The Bank conducted its minority stock offering in July and
August of 1996 and the closing occurred on October 4, 1996. The Bank sold
461,779 shares of its common stock in the minority stock offering, which
includes 36,942 shares sold to its Employee Stock Ownership Plan (the "ESOP"),
and issued 538,221 shares to the mutual holding company.
At the Bank's annual meeting held on December 8, 1997, the shareholders of Ashe
Federal Bank approved the Ashe Federal Bank 1997 Stock Option Plan; the Ashe
Federal Bank 1997 Recognition and Retention Plan; a change in the Bank's federal
stock charter, changing the corporate name to AF Bank and approved a plan of
reorganization providing for the establishment of AF Bankshares, Inc., as a
federally chartered stockholding company parent of the Bank. On June 16, 1998,
the Bank completed its reorganization into a two-tier mutual holding company and
became a wholly owned subsidiary of the Company and the Company became a
majority owned subsidiary of AsheCo, MHC.
GENERAL
The Company had net income of $514,000 and $708,000 for the years ended June 30,
1999 and 1998, respectively. The Company's operating results are primarily
dependent upon net interest income, fees and charges, gain on sale of
investments and insurance commissions. Net interest income is the difference
between interest earned on loans, investments and interest-earning deposits at
other financial institutions and the interest-bearing savings deposits and with
other borrowings. The primary interest-earning asset of the Company is its
mortgage loan portfolio representing 64% of net loans, with approximately
one-half of portfolio mortgage loans at fixed rates at June 30, 1999. The net
interest income of the Company is affected by changes in economic conditions
that influence market interest rates. This exposure to changes in interest rates
contributes to a moderate degree of interest rate risk, because of the negative
impact of increasing rates to the Bank's earnings and to the net market value of
its assets and liabilities.
5
<PAGE>
Additionally, the Company receives fee income primarily from loan origination
fees, late loan payment fees, commissions from the sale of credit life, accident
and health insurance, insurance commissions generated from the insurance agency
subsidiary, income generated from the Company's brokerage subsidiary and for
payment of other services provided to the customer by the Company. The major
noninterest costs to the Company include compensation and benefits, occupancy
and equipment and data processing costs. Other external factors that affect the
operating results of the Company include changes in government and accounting
regulations, costs of implementing information technology, and changes in the
competition's emphasis within the Company.
MANAGEMENT STRATEGY
On March 18, 1998 the Bank opened a new office, Alleghany First Bank, in Sparta,
North Carolina. Additionally, the Bank's insurance agency subsidiary offers
property, casualty, health and life insurance products within the Alleghany
facility. On March 1, 1999, the Bank opened a new branch office, in Boone, North
Carolina, operating under the trade name Appalachian First Bank. Entry in the
Boone and Alleghany markets significantly expands the Company's potential to
market its banking, insurance and noninsured investment products to a larger and
more diverse market.
On April 1, 1999 the Company purchased an insurance agency in Lenior, North
Carolina to be operated under the trade name, AF Blair Insurance Agency.
Management believes that penetration into other markets increases the
opportunity to deliver products from all of the Company's subsidiaries to a
broader market and will make the insurance and brokerage subsidiaries more
profitable investments by increasing the economies of scale and adding to the
products that are available for delivery to the Company's customers. The Company
continues to seek opportunities to increase its market penetration for its
services.
Management believes that the Company's customers perceive "financial services"
to include three elements: funds transfer, including checking accounts and
savings instruments, insurance and securities brokerage. Further, management
believes that failure to offer insurance and brokerage services will impair the
Company's growth and make retention of existing customers more difficult. During
the year ended June 30, 1999, the Company established a securities brokerage
subsidiary, AF Brokerage, Inc., which has applied to become a member of the
National Association of Securities Dealers, Inc. ("NASD"). The Company currently
conducts brokerage services as a branch of a third party broker/dealer but will
operate independently once its regulatory applications are accepted. The Company
expects to be accepted into membership in the NASD within the first quarter of
the fiscal year ending June 30, 2000. Management continues to evaluate
acquisitions and business opportunities that it believes will provide access to
customers and markets that enhance the Company's value and earnings potential in
the long term.
The historical operations of the Company has been that of a portfolio mortgage
lender, providing fixed rate loans for the residents of Ashe County, North
Carolina. In the late 1980's adjustable rate mortgages (ARMs) were offered, and
at June 30, 1999, ARMs represented approximately one-half of portfolio mortgage
loans outstanding. This change in the composition of the mortgage loan portfolio
results from the Company's strategy of selling long term, fixed-rate mortgages
while retaining the servicing. The reduction in the level of fixed rate
mortgages has served to reduce the Company's exposure to interest rate risk.
During 1995, management introduced fixed rate mortgage loans with provisions
allowing the Company to "call the loan due" after three or five year periods,
thus reducing the period of time that the Company is exposed to a fixed rate of
interest in order to reduce interest rate risk. The call provision is now used
primarily where the fixed rate mortgage does not qualify for sale in the
secondary market and where the borrower has no desire for an ARM. At
approximately the same time, the Company began to offer consumer loans,
including automobile and home improvement loans. In June of 1998, the Company
began
6
<PAGE>
funding automobile loans originated by selected dealers in its market area where
the Company's loan officers have final underwriting authority to determine the
acceptability of the borrowers to the Company. At the end of June 1999, the
Company had closed approximately $3.9 million of these loans. At June 30, 1999,
consumer loans constituted approximately 13.9% of gross portfolio loans. In
1994, the Company began offering commercial loans to small businesses in Ashe
County and has expanded that business to include Alleghany County, and Watauga
County. At June 30, 1999 commercial loans constituted approximately 20.9% of
gross portfolio loans. Commercial loans generally have rates based on the prime
rate of interest that more closely reflects market interest rates. Additionally,
consumer and commercial loans generally have shorter terms and thus greater
interest rate sensitivity than mortgage loans. Management has pursued the above
mortgage and nonmortgage loan strategies as primary strategies to reduce the
level of interest rate risk inherent in the Company's loan portfolio and
maintain acceptable levels of credit risk. Funding for the loan originations has
been provided by aggressively marketing savings and checking accounts while
maintaining competitive pricing on certificates of deposits. Deposits increased
$10.6 million during the year ended June 30, 1999. Additionally, the Company was
able to lower the amount that was outstanding on the Federal Home Loan Bank
("FHLB") advances. At June 30, 1999 the Company had borrowed money totaling $2.6
million compared to $4.1 million at June 30, 1998.
In addition to loans, the Company invests in federal agency securities,
certificates of deposit (generally with terms of five years or less), overnight
deposits with the FHLB, equity securities in the Federal Home Loan Mortgage
Corporation (FHLMC), municipal bonds and mortgage-backed securities secured by
adjustable rate mortgages and issued by the Government National Mortgage
Association (GNMA) and Fannie Mae. Management does not engage in the practice of
trading securities, rather, the Company's investment portfolio consists
primarily of securities designated as available for sale. Management intends to
maintain investment securities as a supplement to its lending activities and as
a means to reduce interest rate risk and credit risk of its asset base in
exchange for lower rates of return than would typically be available with other
lending activities.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1999 AND 1998:
At June 30, 1999 and 1998, assets totaled $109.9 million and $100.1 million,
respectively. Total assets increased by $9.9 million or 9.8% from June 30, 1998
to June 30, 1999, primarily as a result of an increase of $8.5 million, or
11.7%, in net loans receivable and an increase of $2.9 million or 35.6% in
securities available for sale. Management believes that the increase in net
loans receivable is primarily a result of increased concentration in the
commercial market, which tends to yield larger loans, further enhanced by the
addition of the branch in Watauga County, a larger commercial market. The loan
growth was primarily funded by the increase in savings deposits. The Company's
deposits increased by $10.6 million from $82.5 million at June 30, 1998 to $93.1
million at June 30, 1999. Management believes that the increase in deposits is
attributable to its marketing efforts directed towards increasing balances in
savings and transaction accounts. The Company's level of advances from the FHLB
decreased $1.6 million from $4.1 million at June 30, 1998 to $2.6 million at
June 30, 1999. The Company's level of loans sold to the secondary market
increased significantly during the period ended June 30, 1999 to $20.7 million,
primarily due to lower interest rates on fixed rate originations.
The principal category of earning assets is loans and during the year ended June
30, 1999 loans receivable, net, increased by $8.5 million compared to a $2.4
million increase for the year ended June 30, 1998. The increase in net loans
receivable is typical for the Company, which operates in lending markets that
have had sustained loan demand over the past several years. Beginning in the
fiscal year ended June 30, 1997, the Company began actively soliciting banking
relationships with local commercial customers. As a result of this focus,
commercial loans receivable increased from $4.2 million at June 30, 1997 to
$18.3 million at June 30, 1999, an increase of $14.1 million or 336.7%. These
loans are a combination of real
7
<PAGE>
estate, secured, personal property and unsecured, and generally have prime based
pricing and have terms of three years or less. During 1997, 1998 and 1999 the
Company also emphasized home equity line of credit loans. Home equity loans
increased from $4.1 million at June 30, 1998 to $4.8 million at June 30, 1999,
an increase of $700,000.
The Company's level of non-performing assets, defined as loans past due 90 days
or more and repossessed assets, increased slightly from .06% of total assets at
June 30, 1998, to .11% of total assets at June 30, 1999. The low level of
non-performing assets is attributable to comprehensive lending policies and
exceptional collection efforts. The Company's level of non-performing loans has
remained consistently low in relation to prior periods and total loans
outstanding. The Company had net of charge off, of $62,000 during year ended
June 30, 1999 compared to net recoveries of $158,000 for the year ended June 30,
1998. As a result and based on management's analysis of its allowances, a
provision for additional loan loss allowance of $20,000 was made during the year
ended June 30, 1999.
The Company's net investment in office properties and equipment increased $1.2
million to $2.5 million at June 30, 1999 from $1.4 million at June 30, 1997, as
a result of acquiring and renovating a building located at 206 South Jefferson
Avenue in West Jefferson, acquiring equipment for the Alleghany First Bank and
Appalachian First Bank, leasehold improvements in the Alleghany and Watauga
facilities, equipment for AF Blair Insurance Agency and updating the Company's
data processing equipment. The building at 206 South Jefferson Avenue is
occupied by the Company's insurance agency subsidiary, a board meeting room that
also serves as a community meeting room and the corporate offices for the
Company. The Alleghany facility is occupied by the banking offices as well as an
insurance agency subsidiary office and a brokerage subsidiary office. The
Appalachian facility is occupied by the banking offices with room for an
insurance agency subsidiary office and a brokerage subsidiary office in the
future. The Company completed replacing all of its computer equipment during the
period with equipment that is compatible with the year 2000 environment.
At June 30, 1999 retained earnings increased $695,000 or 9.5% to $8.0 million,
from $7.3 million at June 30, 1998, as a result of earnings of $514,000, an
increase for a fair market value adjustment for ESOP stock in the amount of
$357,000 and offset by dividends of $205,000. Additional paid in capital
increased by $13,000 to $4.6 million at June 30, 1999 as a result of additional
shares issued under the ESOP. The unrealized gain on securities available for
sale decreased by $91,000 or 30.8% at June 30, 1999 primarily as a result of the
sale of 2,560 shares of stock in the FHLMC. At June 30, 1999 the Bank's
regulatory capital amounted to $10.9 million compared to $10.9 million at June
30, 1998, which as a percentage of total assets was 10.0% and was considerably
in excess of regulatory capital requirements at such date.
8
<PAGE>
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 volume (changes in volume multiplied by the prior period's rate)
(ii) changes attributable to rate (changes in rate multiplied by the prior
period's volume) and (iii) mixed changes (changes in volume multiplied by
changes in rate).
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
JUNE 30, 1999 JUNE 30, 1998
COMPARED TO COMPARED TO
YEAR ENDED YEAR ENDED
JUNE 30, 1998 JUNE 30, 1997
---------------------------------- ------------------------------
INCREASE/(DECREASE) INCREASE/(DECREASE)
DUE TO DUE TO
---------------------------------- ------------------------------
RATE/ RATE/
VOLUME RATE VOLUME NET VOLUME RATE VOLUME NET
------------------------------ ------------------------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Interest-bearing deposits $ 285 $ 9 $ 10 $304 $232 $(15) $(40) $ 177
Investment securities 171 (66) (26) 79 86 (33) (8) 45
Loans receivable 277 (132) (5) 140 488 400 33 921
------------------------------ ------------------------------
Total 733 (189) (21) 523 806 352 (15) 1,143
------------------------------ ------------------------------
LIABILITIES:
Interest-bearing liabilities:
Interest-bearing checking accounts 59 (95) (16) (52) 42 (29) (3) 10
Passbook savings 248 (61) (27) 160 117 3 2 122
Certificates of deposit 234 (105) (9) 120 190 22 3 215
Borrowed funds (66) 13 (3) (56) 196 1 6 203
------------------------------ ------------------------------
Total 475 (248) (55) 172 545 (3) 8 550
------------------------------ ------------------------------
Net interest income $ 258 $ 59 $ 34 $351 $261 $355 $(23) $ 593
============================== ==============================
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30, 1997
COMPARED TO
YEAR ENDED
JUNE 30, 1996
--------------------------------
INCREASE/(DECREASE)
DUE TO
--------------------------------
RATE/
VOLUME RATE VOLUME NET
--------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Interest-bearing deposits $(48) $ 18 $ (7) $ (37)
Investment securities 112 23 10 145
Loans receivable 691 (234) (35) 422
--------------------------------
Total 755 (193) (32) 530
--------------------------------
LIABILITIES:
Interest-bearing liabilities:
Interest-bearing checking accounts 64 (1) (1) 62
Passbook savings 75 (1) 0 74
Certificates of deposit (18) (125) (1) (144)
Borrowed funds 42 2 5 49
--------------------------------
Total 163 (125) 3 41
--------------------------------
Net interest income $592 $ (68) $(35) $ 489
================================
</TABLE>
9
<PAGE>
The following table provides information concerning the Company's yields on
interest-earning assets and cost of funds on interest-bearing liabilities over
the years ended June 30, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED JUNE 30,
------------------------------------------------------------------------------------
AT JUNE 30,
1999 1999 1998 1997
----------------- --------------------------- --------------------------- ----------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
ACTUAL YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE RATE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
------- ------- ------- -------- ------- -------- -------- ------- ------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning
assets:
Interest-bearing
deposits............ $ 4,173 5.32% $ 9,471 $ 571 5.86% $ 4,714 $ 267 5.66% $ 1,319 $ 90 6.82%
Investment
securities.......... 11,798 5.00% 9,975 501 5.02% 7,095 422 5.95% 5,774 377 6.53%
Loans receivable(1).. 81,157 8.39% 76,597 6,807 8.89% 73,544 6,667 9.07% 67,785 5,746 8.48%
-------- -------- ------ ------- ------ ------- ------
Total
interest-earning
assets............. 97,128 7.85% 96,313 $7,879 8.18% 85,353 $7,356 8.62% 74,878 $6,213 8.30%
------ ------ ------
Non-interest-earning
assets.............. 12,803 8,002 6,447 3,037
-------- -------- ------- -------
Total assets......... $109,931 $104,315 $91,800 $77,915
======== ======== ======= =======
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Interest-bearing
checking accounts... $ 15,425 2.28% $ 13,160 301 2.29% $11,265 353 3.13% $10,040 343 3.42%
Passbook savings..... 21,841 3.05% 19,257 698 3.62% 13,172 538 4.08% 10,279 416 4.05%
Certificates of
deposit............. 51,788 4.94% 51,995 2,771 5.33% 47,770 2,651 5.55% 44,313 2,436 5.50%
FHLB Advances and
notes payable....... 2,820 6.47% 2,988 197 6.59% 4,038 253 6.27% 818 50 6.11%
-------- -------- ------ ------- ------ ------- ------
Total
interest-bearing
liabilities........ 91,874 4.09% 87,400 3,967 4.54% 76,245 3,795 4.98% 65,450 3,245 4.96%
------ ------ ------
Other
non-interest-bearing
liabilities......... 5,839 5,424 4,343 3,038
Equity............... 12,218 11,491 11,212 9,427
-------- -------- ------- -------
Total liabilities
and equity ......... $109,931 $104,315 $91,800 $77,915
======== ======== ======= =======
Net interest
income and
interest rate
spread(2).............. 3.76% $3,912 3.64% $3,561 3.64% $2,968 3.34%
====== ====== ======
Net
interest-earning
assets and net
interest margin (3).... $ 5,254 $ 8,913 4.06% $ 9,108 4.17% $ 9,428 3.96%
======== ======== ======= =======
Ratio of interest-earning
assets to
interest-bearing
liabilities............ 105.72% 110.20% 111.95% 114.40%
</TABLE>
- -------------------------------
(1) Balance is net of deferred loan fees and loans in process. Non-accrual
loans are included in the balances.
(2) Average interest rate spread represents the difference between the yield on
average interest-earning assets and the cost of average interest-bearing
liabilities.
(3) Net interest margin represents net interest income divided by average total
interest-earning assets. With the exception of end of period ratios, all
ratios are based on monthly balances during the indicated years. Management
does not believe that the use of month end balances instead of daily
balances has caused a material difference in the information presented.
10
<PAGE>
COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED JUNE 30, 1999 AND
1998:
GENERAL. Net income for the years ended June 30, 1999 and 1998 was $514,000 and
$708,000, respectively. The decrease of $195,000 or 27.5% was primarily
attributable to the cost associated with establishing a bank branch in Watauga
County, costs associated with obtaining a broker/dealer license and costs to
acquire additional insurance agencies. Management believes that these costs are
indicative of growth and necessary in order to provide access to customers and
markets that enhance the Company's value and earnings potential in the long
term. In management's opinion, there has been an improvement in the level of
interest rate risk during the Company's most recent fiscal year.
NET INTEREST INCOME. Net interest income increased by $351,000 or 9.8% from $3.6
million for the year ended June 30, 1998 to $3.9 million for the year ended June
30, 1999. The increase is a result of increased average outstanding balances in
interest-earning assets, partially offset by the decline in the prime rate of
interest during the year. The decline in rates between June 30, 1998 and 1999
reduced interest income by approximately $189,000. Volume accounted for an
annualized increase in interest income of approximately $733,000. Interest
expense on deposits declined approximately $248,000 based on a reduction in
rates while interest expense increased by $475,000 based on an increase in
volume.
INTEREST INCOME. Interest income increased by $523,000, or 7.1%, from $7.4
million during the year ended June 30, 1998 to $7.9 million during the year
ended June 30, 1999. This increase was attributable to a change in the volume
and mix of the Company's loan portfolio and an increase in the average balance
of interest-bearing deposits.
INTEREST EXPENSE. Interest expense for the year ended June 30, 1999 increased
$172,000 to $4.0 million. The increase is the result of an increase in the
average outstanding balances in the level of deposits for the year ended June
30, 1999 as compared to the similar period in 1998. However, the average rate
for deposits was lower at June 30, 1999 than for the comparable period in 1998,
and was an offsetting factor to interest expense.
PROVISION FOR LOAN LOSSES. Management made additional provisions for loan losses
during the year ended June 30, 1999, of $20,000. The Company experienced net
charge offs of $62,000 during the year ended June 30, 1999. During the year
ended June 30, 1998, no provisions were made; however, the Company experienced
net recoveries of $158,000 that served to increase the level of loan loss
reserves. Provisions, which are charged to operations and resulting loan loss
allowances, are amounts that the Company's management believes will be adequate
to absorb potential losses on existing loans that may become uncollectible.
Loans are charged off against the allowance when management believes that
collectibility is unlikely. The evaluation to increase or decrease the
provisions and resulting allowances is based both on prior loan loss experience
and other factors, such as changes in the nature and volume of the loan
portfolio, overall portfolio quality and current economic conditions. The
Company's level of non-performing loans remained consistently low in relation to
prior periods and total loans outstanding during the year ended June 30, 1999.
At June 30, 1999 the Company's level of general valuation allowances for loan
losses amounted to $1.1 million which management believes is adequate to absorb
any losses that may exist in its loan portfolio.
NONINTEREST INCOME. Noninterest income increased by $214,000 or 21.6% during the
fiscal year 1999. The increase was primarily attributable to a gain on the sale
of FHLMC stock of $148,000, insurance commissions of $500,000 generated by the
insurance agency, and income generated by the Company's brokerage subsidiary.
NONINTEREST EXPENSE. Noninterest expense increased by $860,000 or 24.7% from
$3.5 million for the year ended June 30, 1998 to $4.3 million for the year ended
June 30, 1999. Increases for noninterest ex-
11
<PAGE>
pense are primarily attributable to compensation and employee benefit costs,
occupancy, data processing costs and legal expenses. Compensation costs
increased by $460,000 for the year ended June 30, 1999, primarily as the result
of additional insurance agency employees' salaries, the addition of Appalachian
First Bank employee salaries, and the addition of salaries paid to AF Brokerage,
Inc. Occupancy cost increased by $98,000 for the year ended June 30, 1999, due
to increased depreciation expense resulting from the new branch location in
Boone, computer equipment acquired for the new insurance office in Lenior and
for the brokerage subsidiary. Additional legal costs during the current period
were the result of applying for a broker/dealer registration.
INCOME TAXES. Income taxes resulted from applying normal, expected tax rates on
income earned during the year ended June 30, 1999 and 1998. Income tax expense
was $236,000 and $381,000, for the years ended June 30, 1999 and 1998. The
effective tax rate applied was slightly lower than the statutory tax rates,
primarily due to qualifying investment income that was exempt from state income
taxes. Legislated decreases are expected in the North Carolina corporate tax
rate in future periods, which would lower the overall effective tax rate.
IMPACT OF THE YEAR 2000. A lot of attention has been given to the impact that
the year 2000 date change will have on businesses, utilities and other
organizations that rely on computerized systems to help run their operations.
The year 2000 date change can affect any system that uses computer software or
computer chips including automated equipment and machinery. For example, many
computer programs and computer chips store the calendar year portion of the date
as two digits rather than four digits. These software programs and chips record
the year 1999 as "99". This approach works until the year 2000 when the "00" may
be interpreted as the year 1900 instead of the year 2000. Banks use computer
systems to perform financial calculations, transfer funds, record deposits and
loan payments, run security systems and vaults and a myriad of other functions.
Because banks rely heavily on their computer systems, the Federal Financial
Institutions Examination Council ("FFIEC") has placed significant emphasis on
the problems surrounding the year 2000 issues and has required financial
institutions to document the assessment, testing and corrections made to ready
their computer systems and programs for the year 2000 date change. The FFIEC and
OTS have strict regulations, guidelines, and milestones in place that each FDIC
insured financial institution must follow in order to remain operational. The
Company's board of directors has remained informed of the Company's position and
progress in its year 2000 project.
The Company's year 2000 project and contingency planning remain on schedule
according to the guidelines set forth by the FFIEC. The Company replaced all of
its computer systems in the fall of 1998 with year 2000 compliant systems. The
Company's internal software remediation, replacement, and testing efforts are
substantially complete. The Company's most critical external exposure to year
2000 lies with its data processing provider, Fiserv Orlando. Fiserv renovated
its systems in June 1998 and tested its remediation efforts in October 1998. The
test results revealed that there were two minor problems which have since been
corrected. The first problem occurred in the General Ledger portion of the
program, and the second problem occurred primarily due to the method of aging
the test loan accounts. The General Ledger corrections, which have already been
applied, were re-tested in February 1999, and no problems were found. The loan
test conditions are being modified and will be re-tested in October 1999. Fiserv
estimates that it has completed with it's remediation and testing efforts of the
Company's mission critical systems. In addition, the Company tested its systems
on-line with Fiserv's system in November 1998. One purpose was to test all
transactions using test data created in a test institution to validate Fiserv's
remediation efforts to date. The second purpose was to test the communication
hardware under the direct control of the testing parties. The test was
successful and correctly validated the testing objectives. In addition, the
Company has contacted its major customers and vendors to inquire about their
progress in addressing the year 2000 problem and does not believe that the
problems of such customers and vendors will have a material adverse effect on
the Company or its operations. The Company will continue to monitor the progress
of these parties in addressing the year 2000 problem as the new millennium
approaches.
12
<PAGE>
As noted, the Company has replaced all of its computers and printers at a cost
of $244,000. Software costs amounted to $101,000 and include internal software
for accounts payable, fixed assets, payroll and insurance agency management.
Management believes that all material costs to prepare for the year 2000 that
are under the direct control of the Company have been incurred. The remaining
costs are expected to amount to less than $5,000.
The year 2000 problems can affect the Company's operation in a number of ways
but the mission critical issue is maintaining customers' account information
including tracking deposits, interest accruals and loan payments. The Company is
dependent upon electricity, telephone lines, computer hardware and Fiserv
Orlando's data processing capacity.
The Company is in contact with its electric utility and the utility's staff
regularly updates the Company as to its progress. Assurances have been given
that no major problems exist and that the electric company will have all year
2000 problems addressed before June 30, 1999. The utility company has further
assured the Company that contingency plans are in place for any unforeseen
problems that may exist. The Company has installed a fixed generator with
sufficient capacity to run the system servers and workstations at the West
Jefferson branch office in case that the Company experiences power outages. The
generator was tested and performed as expected.
The Company uses two telephone utilities: Skyline Telephone Membership
Corporation and Sprint. Skyline Telephone has tested its system with the Company
and had no date related problems. Service between Fiserv Orlando and the Company
is the contractual responsibility of Fiserv Orlando.
To prevent difficulties in the event there is an unforeseen interruption in
either telephone or electrical service when the year changes, the Company will
print hard copies of all account information. In addition, the Company will
download all account information into programs on the Company's hardware that
will allow bank personnel to extract customer information without regard to
outside sources. Additionally, the Company stores customer information on
retrievable media in house. The insurance agency's computer hardware and
software has been tested, validated, and found to be year 2000 compliant.
Fiserv Orlando has responded to the Company that renovation of its program is
complete. In the event that Fiserv Orlando experiences some unforeseen problems
relating to the year 2000, the Company will convert its data to one of the other
Fiserv programs that is able to operate in the 2000 environment. The Company is
planning to attend a customer meeting in October of 1999 to review and comment
on Fiserv's Business Resumption Contingency Plan.
The Company is continuously evaluating its liquidity needs for the year 2000 and
believes that its plan provides for the sufficient funding to meet customers
demands. If additional funding needs become necessary due to unanticipated
customer cash demands, the Company has in place a borrowing agreement with the
FHLB and with the Federal Reserve Bank of Richmond, that management believes
will exceed any customer demands for cash.
13
<PAGE>
COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED JUNE 30, 1998 AND
1997:
GENERAL. Net income for the years ended June 30, 1998 and 1997 was $708,000 and
$343,000, respectively. The increase of $365,000 or 106.3% during the year ended
June 30, 1998 were primarily attributable lower FDIC premiums, and the absence
of the one time assessment from SAIF during the year ended June 30, 1997 and
from an increase in net interest income. In management's opinion, there has been
an improvement in the level of interest rate risk during 1998.
NET INTEREST INCOME. Net interest income increased by $594,000 or 20.0% from
$3.0 million for year ended June 30, 1997 to $3.6 million for the year ended
June 30, 1998. The increase is a result of increased average outstanding
balances in interest earning assets and an improved interest rate spread in
effect during the year. The Company's interest rate spread increased primarily
because the average yield on loans was higher during the year ended June 30,
1998 as compared to the year ended in 1997.
INTEREST INCOME. Interest income increase from $6.2 million to $7.4 million
during the year end June 30, 1998, or an 18.4% increase. This increase was
attributable to both an overall increase in the weighted average yield of the
Company's loan portfolio and by a change in the volume and mix of
interest-earning assets outstanding.
INTEREST EXPENSE. Interest expense for the year ended June 30, 1998 increased
$549,000 to $3.8 million. The increase is the result of an increase in the
average outstanding balances in the level of deposits and borrowings for the
year ended June 30, 1998 as compared to the similar period in 1997. However, the
increase was partially offset by a slightly lower average rate for deposits
during the year ended June 30, 1998 than for the comparable year ended 1997, and
was an offsetting factor to interest expense.
PROVISION FOR LOAN LOSSES. Management did not make additional provisions for
loan losses during the year ended June 30, 1998; however, the Company
experienced net recoveries of $158,000 that served to increase the level of loan
loss reserves. During the year ended June 30, 1997, provisions were made
totaling $20,000. Provisions, which are charged to operations and resulting loan
loss allowances, are amounts that the Company's management believes will be
adequate to absorb potential losses on existing loans that may become
uncollectible. Loans are charged off against the allowance when management
believes that collection is unlikely. The evaluation to increase or decrease the
provisions and resulting allowances is based both on prior loan loss experience
and other factors, such as changes in the nature and volume of the loan
portfolio, overall portfolio quality and current economic conditions. The
Company's level of non-performing loans remained consistently low in relation to
prior periods and total loans outstanding during the year ended June 30, 1998.
At June 30, 1998, the Company's level of general valuation allowances for loan
losses amounted to $1.2 million which management believes is adequate to absorb
any losses that may exist in its loan portfolio.
NONINTEREST INCOME. Noninterest income increased by $822,000 to $991,000 during
the fiscal year 1998. The increase was primarily attributable to a gain on the
sale of FHLMC stock of $306,000 and insurance commissions of $404,000 generated
by the insurance agency during the year ended June 30, 1998.
14
<PAGE>
NONINTEREST EXPENSE. Noninterest expense increased by $932,000 or 36.5% from
$2.6 million for the year ended June 30, 1997 to $3.5 million for the year ended
June 30, 1998. Increases for noninterest expense for the year ended June 30,
1998 are primarily attributable to compensation costs, occupancy, data
processing costs and legal expenses. Compensation costs increased by $866,000
for the year ended June 30, 1998, primarily as the result of the cost of the
Bank's Recognition and Retention Plan, insurance agency employees' salaries, and
Alleghany First employees' salaries. Occupancy cost increased by $110,000 for
the year ended June 30, 1998 because of increased depreciation expense resulting
from the addition of the new office facility at 206 South Jefferson Avenue, the
new branch location in Sparta, computer equipment acquired to address the year
2000 problem and one-time charges associated with changing data processing
providers from NCR to Fiserv Orlando in October 1997. Additional legal costs
during the current period were the result of obtaining shareholder and
regulatory approvals for a recognition and retention plan, a stock option plan,
and establishing a mid-tier holding company.
INCOME TAXES. Income taxes resulted from applying normal, expected tax rates on
income earned during the year ended June 30, 1998 and 1997. Income tax expense
was $381,000 and $218,000, for the years ended June 30, 1998 and 1997. The
effective tax rate applied was slightly lower than the statutory tax rates,
primarily due to qualifying investment income that was exempt from state income
taxes. Legislated decreases are expected in the North Carolina corporate tax
rate in future periods, which would lower the overall effective tax rate.
CAPITAL RESOURCES AND LIQUIDITY
The term "liquidity" generally refers to an organization's ability to generate
adequate amounts of funds to meet its need for cash. More specifically for
financial institutions, liquidity ensures that adequate funds are available to
meet deposit withdrawals, fund loan and capital expenditure commitments,
maintain reserve requirements, pay operating expenses, and provide funds for
debt service, dividends to stockholders, and other institutional commitments.
Funds are primarily provided through financial resources from operating
activities, expansion of the deposit base, borrowings, through the sale or
maturity of investments, the ability to raise equity capital, or maintenance of
shorter term interest earning deposits.
At June 30, 1999, cash and cash equivalents, a significant source of liquidity,
totaled $12.4 million. A significant portion of this is a direct result of the
Bank selling loans in the secondary market and retaining the proceeds in the
Bank's FHLB account.
As a federally chartered savings bank, the Bank must maintain a daily average
balance of liquid assets equal to at least 4% of withdrawable deposits and
short-term borrowings. During the year ended June 30, 1998 the OTS reduced the
required level of liquidity to 4% from 5%, eliminated the short term liquidity
requirement and imposed a new requirement that savings associations generally
maintain sufficient liquidity to ensure safe and sound operations. The Bank's
liquidity ratio at June 30, 1999, as computed under OTS regulations, was
considerably in excess of such requirements. Given its excess liquidity and its
ability to borrow from the FHLB, the Bank believes that it will have sufficient
funds available to meet anticipated future loan commitments, unexpected deposit
withdrawals, and other cash requirements.
15
<PAGE>
ASSET/LIABILITY MANAGEMENT
The Company's asset/liability management is focused primarily on evaluating and
managing the Company's net interest income in relation to various risk criteria.
Factors beyond the Company's control, such as the effects of changes in market
interest rates and competition, may also have an impact on the management of
interest rate risk.
In the absence of other factors, the Company's overall yield on interest-earning
assets will increase as will its cost of funds on its interest-bearing
liabilities when market rates increase over an extended period of time.
Inversely, the Company's yields and cost of funds will decrease when market
rates decline. The Company is able to manage these fluctuations to some extent
by attempting to control the maturity or rate adjustments of its
interest-earning assets and interest-bearing liabilities over given periods of
time. One of the Company's tools to monitor interest rate risk is the
measurement of sensitivity of its net portfolio value to changes in interest
rates.
In order to minimize the potential effects of adverse material and prolonged
increases in market interest rates on the Company's operations, management has
implemented an asset/liability program designed to improve the Company's
interest rate risk exposure. The program emphasizes that originations of
five-year fixed rate balloon mortgages, adjustable rate mortgages, selling long
term fixed rate loans to the secondary market, shorter term consumer and
commercial loans, the investment of excess cash in short or intermediate term
interest-earning assets, and the solicitation of deposit accounts that can be
repriced rapidly.
Although the Company's asset/liability management program has generally helped
to decrease the exposure of its earnings to interest rate increases, the Company
continues to be susceptible to increased levels of interest rates, which will
adversely affect earnings during prolonged periods of rising interest rates and
positively affect earnings during prolonged periods of interest rate declines.
NET PORTFOLIO VALUE
All federally regulated financial institutions are required to measure the
exposure to changes in interest rates. Institutions with assets of less than
$500 million may rely on outside sources of measurement such as that provided by
the OTS and the FHLB. The purpose is to determine how changes in interest rates
affect the estimated value or Net Portfolio Value ("NPV") of the insured
institution's statement of financial condition under several immediate or
"shock" changes in market rates. Since the timing of repricing opportunities for
interest-earning assets and interest-bearing liabilities are different, the
impact of shock changes will have a negative, neutral or positive impact on the
NPV of the bank based on the structure of the bank's assets and liabilities.
Thus, NPV is the difference between incoming and outgoing discounted cash flows
from assets, liabilities and off-balance sheet contracts. Generally, the level
of interest rate risk is measured in a 200 basis point shock environment that
has the most negative impact on the Company.
The Company's banking subsidiary, AF Bank, has historically been a mortgage
lender which means that it generally has longer terms before repricing its
assets than does its interest bearing liabilities or deposit accounts;
therefore, a rising rate environment will have the most negative impact on the
NPV of the Company. Management has implemented a strategy of limiting the terms
of mortgage loans that it cannot sell in the secondary market, increasing the
level of loans tied more closely to market interest rates such as the prime
rate, and generally reducing the terms of loans that the Company offers for
portfolio. The following table presents the Company's NPV at June 30, 1999, as
calculated by the OTS, based on information provided to the OTS by the Company.
16
<PAGE>
As a result of management's actions, at June 30, 1999, the estimated NPV
declined by 13% in a 300 basis point rising interest rate shock scenario
compared to a gain in NPV of 12% in a falling rate scenario. This compares to a
decline of 13% under a similar rise and a gain of 10% in a similar decline one
year earlier. The improvement in interest rate risk is further measured by the
basis point decline in the ratio of NPV to the PV of assets, defined as the
Sensitivity Measure by the OTS. At June 30, 1999, the decline of the sensitivity
measure was 128 basis points with a 300 basis point shock increase in rates
compared to a decline of 133 basis points at June 30, 1998.
<TABLE>
<CAPTION>
NPV as $ of PV (5)
Net Portfolio Value of Assets
- ---------------------------------------------------------- ---------------------
Changes in Rates $ Amount $ Change (1) % of Change (2) Ratio (3) Change (4)
- ---------------- -------- ------------ --------------- --------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
+300 bp 12,018 (1,757) (13.00)% 11.13% (128)
+200 bp 12,804 (971) (7.00)% 11.72% (68)
+100 bp 13,436 (339) (2.00)% 12.18% (22)
0 bp 13,775 12.40%
-100 bp 13,925 150 1.00% 12.47% 7
-200 bp 14,572 797 6.00% 12.92% 52
-300 bp 15,446 1,671 12.00% 13.54% 113
</TABLE>
(1) Represents the excess (deficiency) of NPV assuming the indicated change in
interest rates minus the estimated NPV assuming no change in interest
rates.
(2) Calculated as the amount of change in the estimated NPV divided by the
estimated NPV assuming no change in interest rates.
(3) Calculated as the estimated NPV divided by average total assets.
(4) Calculated as the excess (deficiency) of the NPV ratio assuming the
indicated change in interest rates over the estimated NPV ratio assuming no
change in interest rates.
(5) PV means present value.
The following chart provided by the OTS reflects further measures of the
Company's interest rate risk.
RISK MEASURES: 200BP RATE SHOCK: June 30, 1999 June 30, 1998
----------------------------
Pre-Shock NPV Ratio: NPV as a % of PV of Assets 12.40% 13.10%
Exposure Measure: Post Shock NPV Ratio 11.72% 12.44%
Sensitivity Measure: Change in NPV -68 bp -67 bp
Certain shortcomings are inherent in the methodology used in the above table.
Modeling changes in NPV requires the making of certain assumptions that may tend
to oversimplify the manner in which actual yields and costs respond to changes
in market interest rates. First, the models assume that the composition of the
Bank's interest sensitive assets and liabilities existing at the beginning of a
period remains constant over the period being measured. Second, the models
assume that a particular change in interest rates is reflected uniformly across
the yield curve regardless of the duration to maturity or repricing of specific
assets and liabilities. Accordingly, although the NPV measurements do provide an
indication of the Company's interest rate risk exposure at a particular point in
time, such measurements are not intended to provide a precise forecast of the
effect of changes in market interest rates on the Company's net interest income.
Furthermore, in times of decreasing interest rates, the value of fixed-rate
assets could increase in value and the lag in repricing of interest rate
sensitive assets could be expected to have a positive effect on the Company.
17
<PAGE>
Management believes that the NPV method of assessing the Company's exposure to
interest rate risk and potential reductions in net interest income is a useful
tool for measuring risk. Management also believes that the charts reflect the
positive impact of strategies to reduce interest rate risk as evidenced most
prominently by the relatively low level of interest rate sensitivity that
reflected a decline of 68 basis points and 67 basis points for the years ended
June 30, 1999 and 1998, respectively. The strategies that have reduced the level
of interest rate risk under an increasing rate assumption will continue to
reduce the impact or rising rates as long term mortgages are sold and replaced
with shorter term mortgage and nonmortgage loans with rates that can be adjusted
to more closely simulate market rates of interest. Management believes that a
strong equity capital position and the existence of the corporate authority to
raise additional capital as necessary act as valuable tools to absorb interest
rate risk.
FUTURE REPORTING REQUIREMENTS
The FASB has issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, which the Company has not been required to adopt as of June
30, 1999. This Statement, which is effective for fiscal years beginning after
June 15, 2000, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available for sale security, or a foreign
currency denominated forecasted transaction. This Statement is not expected to
have a significant impact on the Company.
The FASB has issued SFAS No. 134, Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise, an amendment of FASB Statement No. 65, which the Company has
not been required to adopt as of June 30, 1999. Statement No. 65, as amended by
FASB Statements No. 115, Accounting for Certain Investments in Debt and Equity
Securities, and No. 125, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed security as a trading
security. This Statement further amends Statement No. 65 to require that after
the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments. This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a nonmortgage banking enterprise.
This Statement is effective for fiscal years beginning after December 15, 1998,
and is not expected to have a significant impact on the Company.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and accompanying footnotes have been prepared in
accordance with GAAP, which require the measurement of financial position and
operating results in terms of historical dollars without consideration for
changes in the relative purchasing power of money over the time due to
inflation. The assets and liabilities of the Bank are primarily monetary in
nature and changes in the market interest rates have a greater impact on the
Company's performance than do the effects of inflation.
18
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
AF Bankshares, Inc. and Subsidiaries
West Jefferson, North Carolina
We have audited the accompanying consolidated statements of financial condition
of AF Bankshares, Inc. and Subsidiaries as of June 30, 1999 and 1998, and the
related consolidated statements of income and comprehensive income,
stockholders' 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 financial position of AF Bankshares, Inc. and
Subsidiaries as of June 30, 1999 and 1998, and the results of their operations
and their cash flows for the years then ended, in conformity with generally
accepted accounting principles.
Charlotte, North Carolina
July 30, 1999
19
<PAGE>
<TABLE>
<CAPTION>
AF BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 1999 AND 1998
ASSETS 1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents:
Interest-bearing deposits $ 4,173,311 $ 11,838,926
Noninterest-bearing deposits 8,221,749 2,949,842
Certificates of deposit, at cost 198,000 198,000
Securities held to maturity (fair value $100,000 in 1999 and
1998) (Note 2) 100,000 100,000
Securities available for sale (Note 2) 10,976,170 8,094,739
Federal Home Loan Bank stock (Notes 2 and 6) 523,600 624,000
Loans receivable, net (Notes 3 and 6) 81,156,766 72,627,870
Real estate owned 59,000 38,115
Office properties and equipment, net (Note 4) 2,544,777 2,160,783
Accrued interest receivable on loans 398,918 321,679
Accrued interest receivable on investment securities 97,598 87,880
Prepaid expenses and other assets 546,721 439,663
Deferred income taxes, net (Note 12) 425,100 307,294
Intangible assets, net of accumulated amortization of
$76,284 in 1999 and $34,990 in 1998 509,716 285,010
--------------------------------
TOTAL ASSETS $109,931,426 $100,073,801
================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------------------------------------
Liabilities:
Savings deposits (Note 5) $ 93,106,090 $ 82,488,216
Note payable - ESOP (Note 9 and 17) 255,420 295,420
Advances from Federal Home Loan Bank (Note 6) 2,564,358 4,115,596
Accounts payable and other liabilities (Note 10) 1,636,362 1,180,314
Redeemable common stock held by the ESOP, net of
unearned ESOP shares (Notes 9 and 17) 150,942 508,069
--------------------------------
TOTAL LIABILITIES 97,713,172 88,587,615
--------------------------------
Commitments and Contingencies (Notes 10 and 13)
Stockholders' equity: (Note 17)
Common stock, par value $.01 per share; authorized 5,000,000 shares;
1,053,678 issued and 1,049,378 outstanding shares
at 1999 and 1,053,678 issued and outstanding at 1998 (Note 7) 10,537 10,537
Additional paid-in capital 4,593,516 4,580,151
Retained earnings, substantially restricted (Notes 7 and 12) 7,974,373 7,279,694
Deferred recognition and retention plan (Note 11) (479,960) (678,576)
Accumulated other comprehensive income, unrealized gain
on securities available for sale (Note 2) 203,638 294,380
--------------------------------
12,302,104 11,486,186
Less cost of 4,300 shares of treasury stock (83,850)
--------------------------------
TOTAL STOCKHOLDERS' EQUITY 12,218,254 11,486,186
--------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $109,931,426 $100,073,801
================================
</TABLE>
See Notes to Consolidated Financial Statements.
20
<PAGE>
<TABLE>
<CAPTION>
AF BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED JUNE 30, 1999 AND 1998
1999 1998
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Loans $6,806,902 $6,667,587
Investment securities 501,410 421,609
Interest-bearing deposits 570,867 267,162
------------------------------
7,879,179 7,356,358
------------------------------
Interest expense:
Deposits (Note 5) 3,769,899 3,541,900
Federal Home Loan Bank advances (Note 6) 175,451 226,392
Note payable, ESOP 21,918 26,512
------------------------------
3,967,268 3,794,804
------------------------------
NET INTEREST INCOME 3,911,911 3,561,554
Provision for (recovery of) loan losses (Note 3) 20,000 (25,000)
------------------------------
NET INTEREST INCOME AFTER PROVISION FOR
(RECOVERY OF) LOAN LOSSES 3,891,911 3,586,554
------------------------------
Noninterest income
Insurance commissions 499,845 403,900
Gain on sale on investments available for sale 165,505 305,550
Other 540,409 281,846
------------------------------
1,205,759 991,296
------------------------------
Noninterest expenses
Compensation and employee benefits (Notes 8, 9, 10 and 11) 2,261,079 1,801,254
Occupancy and equipment 426,161 327,944
Deposit insurance premiums 48,918 43,696
Computer processing charges 209,018 138,511
Amortization 41,294 34,990
Other 1,361,826 1,141,797
------------------------------
4,348,296 3,488,192
------------------------------
INCOME BEFORE INCOME TAXES 749,374 1,089,658
Income taxes (Note 12) 235,540 381,255
------------------------------
NET INCOME 513,834 708,403
------------------------------
Other comprehensive loss, net of tax:
Unrealized loss on securities, net of tax 1999 ($82,485);
1998 ($101,568) (204,278) (254,370)
Less: reclassification adjustment for gains included in net income,
net of tax 1999 ($51,969); 1998 ($106,943) 113,536 198,607
------------------------------
Other comprehensive loss (90,742) (55,763)
------------------------------
COMPREHENSIVE INCOME $ 423,092 $ 652,640
==============================
Basic earning per share (Note 14) $ 0.52 $ 0.73
==============================
Diluted earnings per share (Note 14) $ 0.52 $ 0.72
==============================
Cash dividends per share $ 0.20 $ 0.20
==============================
</TABLE>
See Notes to Consolidated Financial Statements.
21
<PAGE>
<TABLE>
<CAPTION>
AF BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1999 AND 1998
Common Additional Retained
Stock Paid-In Capital Earnings
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, June 30, 1997 $10,000 $3,552,726 $7,065,824
Adoption of recognition and retention plan 537 992,506
Vesting of recognition and retention plan
Transfer to redeemable common stock
net of unearned ESOP shares (332,536)
ESOP contribution 34,919 37,000
Cash dividend, $.20 per share (198,997)
Net change in unrealized gain on securities
available for sale, net (Note 2)
Net income 708,403
----------------------------------------------
Balance, June 30, 1998 10,537 4,580,151 7,279,694
Vesting of recognition and retention plan
Transfer from redeemable common stock net of
unearned ESOP shares 357,127
ESOP contribution 13,365 33,723
Cash dividend, $.20 per share (205,105)
Purchase of common stock for treasury
Issuance of common stock from treasury (4,900)
Net change in unrealized gain on securities
available for sale, net (Note 2)
Net income 513,834
----------------------------------------------
Balance, June 30, 1999 $10,537 $4,593,516 $7,974,373
==============================================
</TABLE>
See Notes to Consolidated Financial Statements.
22
<PAGE>
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive
Income, Unrealized
Deferred Gain (Loss) on Total
Recognition and Securities Treasury Stockholders'
Retention Plan Available for Sale Stock Equity
- --------------------------------------------------------------------------------
<S> v <C> <C> <C>
$ $350,143 $ $10,978,693
(993,043)
314,467 314,467
(332,536)
71,919
(198,997)
(55,763) (55,763)
708,403
- --------------------------------------------------------------------------
(678,576) 294,380 11,486,186
198,616 198,616
357,127
47,088
(205,105)
(113,750) (113,750)
29,900 25,000
(90,742) (90,742)
513,834
- --------------------------------------------------------------------------
$ (479,960) $203,638 $ (83,850) $12,218,254
==========================================================================
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
AF BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1999 AND 1998
1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Operating Activities
Net income $ 513,834 $ 708,403
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for (recovery of) loan losses 20,000 (25,000)
Loss on disposal of office properties and equipment 607 9,146
Gain on sale of investments available for sale (165,505) (305,550)
Provision for depreciation 320,575 238,568
Amortization of goodwill and noncompete covenant 41,294 34,990
Amortization of deferred loan fees (156,603) (222,904)
Amortization of premium/discount on investments 23,823 12,687
Amortization of unearned ESOP shares 33,723 37,000
ESOP fair value adjustment 13,365 34,919
Vesting of recognition and retention plan 198,616 314,467
Stock compensation 25,000
Proceeds from sale of loans held for sale 12,133,119 8,091,901
Origination of loans held for sale (12,120,263) (8,084,101)
Gain on sale of loans held for sale (12,856) (7,800)
Deferred income taxes (59,165) (1,026)
Increase in operating assets:
Accrued interest receivable (86,957) (16,948)
Prepaid expenses and other assets (107,058) (159,378)
Increase (decrease) in liabilities:
Accrued interest payable (29,397) 2,630
Accounts payable and other liabilities 456,048 515,378
-------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,042,200 1,177,382
-------------------------------------
Cash Flows from Investing Activities
Purchases of securities available for sale (9,501,897) (5,922,587)
(Increase) decrease in FHLB stock 100,400 (48,300)
Proceeds from calls of securities available for sale 4,950,000 3,050,000
Proceeds from sale of securities available for sale 329,423 311,633
Principal payments received on securities available for sale 1,333,342 730,812
Net originations of loans receivable (8,467,343) (2,195,238)
Purchase of office properties and equipment (717,171) (1,036,924)
Proceeds from sale of properties and equipment 11,995 4,200
Proceeds from sale of real estate owned 54,165 12,827
Purchase of goodwill and noncompete agreement (266,000) (320,000)
-------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (12,173,086) (5,413,577)
-------------------------------------
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
AF BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED JUNE 30, 1999 AND 1998
1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Financing Activities
Net increase in savings deposits $ 10,647,271 $ 14,267,090
Net borrowings (payments) on FHLB advances (1,551,238) 2,461,365
Purchase of common stock for treasury (113,750)
Principal payments on borrowings (40,000) (37,000)
Cash dividends paid (205,105) (198,997)
-------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 8,737,178 16,492,458
-------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,393,708) 12,256,263
Cash and cash equivalents:
Beginning 14,788,768 2,532,505
-------------------------------------
Ending $ 12,395,060 $ 14,788,768
=====================================
Supplemental Schedule of Cash and Cash Equivalents
Interest-bearing deposits $ 4,173,311 $ 11,838,926
Noninterest-bearing 8,221,749 2,949,842
-------------------------------------
$ 12,395,060 $ 14,788,768
=====================================
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest $ 3,996,665 $ 3,792,174
Income taxes 335,333 485,178
Supplemental Disclosure of Noncash Investing and Financing
Activities
Net change in unrealized gain on securities available for sale,
net of tax $ (90,742) $ (55,763)
Transfer from loans receivable to real estate owned 104,563 50,942
Originations of loans to facilitate sale of real estate owned (29,513)
Fair value of ESOP shares in excess of unearned ESOP shares 323,404 295,536
Transfer (from) to retained earnings to redeemable
common stock 357,127 (332,536)
See Notes to Consolidated Financial Statements.
</TABLE>
25
<PAGE>
AF BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of business: AF Bankshares, Inc. (the "Company") is a bank holding
company which owns 100% of the common stock of AF Bank (the "Bank"), formerly
Ashe Federal Bank. The Company has no operations and conducts no business of its
own other than ownership of its subsidiaries and investing in securities. The
Bank is a federally chartered stock savings bank which conducts business from
its main office located in West Jefferson, North Carolina and four branches in
Sparta, Jefferson, Boone and Warrensville, North Carolina. The principal
activities of the Bank consist of obtaining savings deposits and providing
credit to customers in its primary market area, Ashe, Alleghany and Watauga
Counties. On April 15, 1996, the Board of Directors of the Bank adopted a Plan
of Reorganization and a related Stock Issuance Plan pursuant to which the Bank
exchanged its federal mutual savings bank charter for a federal stock savings
bank charter, conducted a minority stock offering, and formed AsheCo, M.H.C., a
mutual holding company which owned 53.8% of the common stock issued by the Bank.
The Bank conducted its minority stock offering in July and August of 1996 and
the closing occurred on October 4, 1996. The Bank sold 461,779 shares of common
stock in the minority stock offering, including 36,942 shares sold to its
Employee Stock Ownership Plan (the "ESOP"), and issued 538,221 shares to the
mutual holding company. See Note 17 for additional information concerning the
minority stock offering and the reorganization.
On June 16, 1998, the Board of Directors approved the formation of a mid-tier
holding company, AF Bankshares, Inc. which became a 100% owner of the Bank in a
stock swap with AsheCo, M.H.C., which was accounted for similar to a pooling of
interests. At June 30, 1998, AsheCo, M.H.C.'s ownership of AF Bankshares, Inc.
decreased to 51.10% due to the shares issued under the recognition and retention
plan discussed in Note 11. During the year ended June 30, 1999, AsheCo, M.H.C.'s
ownership of AF Bankshares, Inc. increased to 51.38% due to the purchase of
shares held in treasury.
On July 1, 1997, the Bank purchased two insurance agencies to form AF Insurance
Services, Inc., which became a wholly owned subsidiary of the Bank. A plan of
reorganization was completed during the year ended June 30, 1999 and AF
Insurance Services, Inc. became a wholly owned subsidiary of AF Bankshares, Inc.
On April 1, 1999, AF Insurance Services, Inc. purchased an additional insurance
agency. AF Insurance Services, Inc. operates from its main office in West
Jefferson, North Carolina and branch offices in Lenoir, North Wilkesboro,
Jefferson and Sparta, North Carolina. The transactions were recorded under the
purchase method of accounting. Revenues are not material to the financial
information.
On August 5, 1998, the Company formed AF Brokerage, Inc., which is a wholly
owned subsidiary of the Company. AF Brokerage, Inc. is in the process of
applying for a license to become a registered broker/dealer. Currently, AF
Brokerage, Inc. operates through the use of a third party clearing broker
pending approval of the application with NASD.
26
<PAGE>
NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
The following is a description of the significant accounting policies used in
the preparation of the accompanying financial statements.
Principles of consolidation: The consolidated financial statements include the
accounts of AF Bankshares, Inc. and its wholly owned subsidiaries, AF Bank, AF
Insurance Services, Inc. and AF Brokerage, Inc. All significant intercompany
transactions and balances have been eliminated in consolidation.
Basis of financial statement presentation: The accounting and reporting policies
of the Company conform to generally accepted accounting principles and general
practices within the financial services industry. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities as of the date of the financial statements and the
reported revenues and expenses for the period. Actual results could differ from
those estimates.
Cash and cash equivalents: For purposes of reporting the statements of cash
flows, the Company includes cash on hand and demand deposits at other financial
institutions with terms less than 90 days as cash and cash equivalents. The
Company maintains amounts due from banks which, at times, may exceed federally
insured limits. The Company has not experienced any losses in such accounts.
Investment securities: The Company and the Bank have investments in debt and
equity securities. Debt securities consist primarily of U.s. Treasury Notes,
Federal Farm Credit Notes, Federal Home Loan Bank bonds, Fannie Mae and
Government National Mortgage Association securities and certificates of deposit.
Equity securities consist of Federal Home Loan Mortgage Corporation (FHLMC)
stock and mutual funds.
Management classifies all debt securities and certain equity securities as
trading, available for sale, or held to maturity as individual investment
securities are acquired, and thereafter the appropriateness of such
classification is reassessed at each statement of financial condition date.
Because the Company does not buy investment securities in anticipation of
short-term fluctuations in market prices, none of the investment securities are
classified as trading in accordance with Statement 115. All securities have been
classified as either available for sale or held to maturity.
Securities available for sale: Securities classified as available for sale are
those securities that the Company intends to hold for an indefinite period of
time but, as in the case of debt securities, not necessarily to maturity. Any
decision to sell a security classified as available for sale would be based on
various factors, including significant movements in interest rates, changes in
the maturity mix of the Company's assets and liabilities, liquidity needs,
regulatory capital considerations, and other similar factors. Securities
available for sale are carried at fair value. Premiums and discounts are
amortized using the interest method over the securities' contractual lives.
Unrealized gains or losses are reported as increases or decreases in equity, net
of the related deferred tax effect. Realized gains or losses, determined on the
basis of the cost of specific securities sold, are included in income.
27
<PAGE>
NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
Securities held to maturity: Securities classified as held to maturity are those
securities for which the Company has both the intent and ability to hold to
maturity regardless of changes in market conditions, liquidity needs or changes
in general economic conditions. These securities are carried at cost adjusted
for amortization of premium and accretion of discount, computed by the interest
method over their contractual lives. Based on the Company's financial position
and liquidity, management believes the Company has the ability to hold these
securities to maturity.
Investment in Federal Home Loan Bank stock: The Bank, as a member of the Federal
Home Loan Bank (FHLB) system, is required to maintain an investment in capital
stock of the FHLB in an amount equal to the greater of 1% of its outstanding
home loans or 5% of advances from the FHLB. No ready market exists for the FHLB
stock, and it has no quoted market value.
Loans receivable: Loans receivable are stated at unpaid principal balances, less
the allowance for loan losses, the undisbursed portion of construction loans,
and net deferred loan-origination fees and costs. The Bank's loan portfolio
consists principally of mortgage loans collateralized by first trust deeds on
single family residences, other residential property, commercial property and
land.
Allowance for loan losses: The allowance for loan losses is increased by charges
to income and decreased by charge-offs (net of recoveries) based on the Bank's
evaluation of the potential and inherent risk of losses in its loan portfolio.
Management's periodic evaluation of the adequacy of the allowance is based on
the Bank's past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower's ability to repay, the
estimated value of any underlying collateral, and current economic conditions.
While management uses the best information available to make evaluations, future
adjustments may be necessary, if economic or other conditions differ or change
substantially from the assumptions used.
Impaired loans: SFAS No. 114, Accounting by Creditors for Impairment of a Loan,
requires that the Bank establish a specific loan allowance on an impaired loan
if the present value of the future cash flows discounted using the loan's
effective interest rate is less than the carrying value of the loan. An impaired
loan can also be valued based upon its fair value or the market value of the
underlying collateral if the loan is primarily collateral dependent. The Bank
assesses for impairment all loans delinquent more than 90 days. See Note 3 for a
further explanation of the Statement. No loans were impaired at June 30, 1999
and 1998, and there is no specific SFAS No. 114 allowance associated with the
portfolio.
Interest income: SFAS No. 118, Accounting by Creditors for Impairment of a
Loan--Income Recognition and Disclosures, which amended SFAS No. 114 requires
disclosure of the Bank's method of accounting for interest income on impaired
loans. The Bank generally continues to accrue interest on loans delinquent 90
days or more. However, all such accrued interest is reversed by the
establishment of a reserve for uncollected interest, if in the opinion of
management collectibility is uncertain. Such interest, if ultimately collected,
is credited to income in the period received. The Bank anticipates that it will
account for interest on impaired loans in a similar fashion in the future if and
when it has impaired loans.
28
<PAGE>
NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
Loan-origination fees and related costs: Loan fees and certain direct loan
origination costs are deferred, and the net fee or cost is recognized as an
adjustment to interest income using the interest method over the contractual
life of the loans, adjusted for actual prepayments.
Loans held for sale: Loans held for sale are those loans the Bank has the intent
to sell in the foreseeable future. They are carried at the lower of aggregate
cost or market value. Gains and losses on sales of loans are recognized at
settlement dates and are determined by the difference between the sales proceeds
and the carrying value of the loans. All sales are made without recourse. The
Bank has no loans held for sale at June 30, 1999 or 1998.
Real estate owned: Real estate owned is initially recorded at the estimated fair
value at the date of foreclosure, establishing a new cost basis. Subsequent to
foreclosure, valuations of the property are periodically performed by management
and the real estate is carried at the lower of cost or fair value minus
estimated costs to sell. Costs relating to improvement of the property are
capitalized, while holding costs of the property are charged to expense in the
period incurred.
Office properties and equipment: Office properties and equipment are stated at
cost less accumulated depreciation computed principally by the straight-line
method over estimated useful lives.
Intangible assets: Goodwill is the cost of investment in AF Insurance Services,
Inc. in excess of the fair value of net assets at the date of purchase and is
being amortized by the straight line method over a period of fifteen years.
Noncompete agreement is stated at cost less accumulated amortization computed by
the straight-line method over a period of seven years.
Pension plans: The Bank has a 401(k) retirement plan available to substantially
all employees. The Bank matches certain portions of voluntary contributions by
participating employees.
The Bank has deferred compensation and retirement plan agreements for the
benefit of the Board of Directors. Both plans are unfunded and the liabilities
are being accrued over the terms of active service of the directors. The Bank
also has an ESOP which covers substantially all of it's employees. Contributions
to the plan are based on amounts necessary to fund the amortization requirements
of the ESOP's debt to an unrelated third party financial institution, subject to
compensation limitations, and are expensed based on the AICPA's Statement of
Position 93-6, Employers' Accounting for Employee Stock Ownership Plans.
Additionally, the Company has implemented a qualified stock option plan
authorizing the grant of up to 21,322 stock options to certain officers and
directors at the time of the adoption, either in the form of incentive stock
options or non-incentive stock options. The Bank has also implemented a
recognition and retention plan by reserving 53,678 shares of common stock for
issuance to certain officers and directors at the time of adoption.
29
<PAGE>
NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
Income taxes: Deferred taxes are provided on a liability method whereby deferred
tax assets are recognized for deductible temporary differences and operating
loss and tax credit carryforwards, and deferred tax liabilities are recognized
for taxable temporary differences. Temporary differences are the differences
between the reported amounts of assets and liabilities and their tax bases.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized. Deferred tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on the date of
enactment.
Fair value of financial instruments: The estimated fair values required under
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, have been
determined by the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is required to develop
the estimates of fair value. Accordingly, the estimates presented for the fair
value of the Company's financial instruments are not necessarily indicative of
the amounts the Company could realize in a current market exchange. The use of
different market assumptions or estimation methodologies may have a material
effect on the estimated fair market value amounts.
The fair value estimates presented are based on pertinent information available
to management as of June 30, 1999 and 1998. Although management is not aware of
any factors that would significantly affect the estimated fair value amount,
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.
Off-statement of financial condition risk: The Bank is a party to financial
instruments with off-statement of financial condition risk such as commitments
to extend credit and home equity lines of credit. Management assesses the risk
related to these instruments for potential losses on an ongoing basis.
Earnings per share: SFAS No. 128, Earnings Per Share, requires the presentation
of earnings per share by all entities that have common stock or potential common
stock, such as options, warrants and convertible securities, outstanding that
trade in a public market. Those entities that have only common stock outstanding
are required to present basic earnings per-share amounts. Basic per-share
amounts are computed by dividing net income (the numerator) by the
weighted-average number of common shares outstanding (the denominator). All
other entities are required to present basic and diluted per-share amounts.
Diluted per-share amounts assume the conversion, exercise or issuance of all
potential common stock instruments unless the effect is to reduce the loss or
increase the income per common share from continuing operations.
Comprehensive income: SFAS No. 130, Reporting Comprehensive Income, establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general-purpose
financial statements. This statement requires that all items that are recognized
under accounting standards as components of comprehensive income be reported in
a financial statement that is displayed with the same prominence as other
financial statements.
30
<PAGE>
NOTE 1. DEBT AND EQUITY SECURITIES
Debt and equity securities have been classified in the statements of financial
condition according to management's intent. The carrying amount of securities
and approximate fair values at June 30 were as follows:
<TABLE>
<CAPTION>
1999
--------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Available for sale securities:
Debt securities:
U.S. Government agency securities $ 4,224,263 $ 3,125 $ (36,791) $ 4,190,597
Federal Farm Credit Notes 300,000 (2,438) 297,562
Fannie Mae and Government
National Mortgage Association 4,625,811 49,513 (3,080) 4,672,244
Municipals 281,977 (20,493) 261,484
Equity securities:
Mutual Funds 1,205,216 61,939 (45,792) 1,221,363
Federal Home Loan Mortgage
Corporation Common Stock 4,784 328,136 332,920
--------------------------------------------------------------
10,642,051 442,713 (108,594) 10,976,170
Held to maturity securities:
Debt securities:
Federal Home Loan Bank 100,000 100,000
Other securities:
Federal Home Loan Bank stock 523,600 523,600
--------------------------------------------------------------
$11,265,651 $442,713 $(108,594) $11,599,770
==============================================================
</TABLE>
31
<PAGE>
NOTE 2. DEBT AND EQUITY SECURITIES (CONTINUED)
<TABLE>
<CAPTION>
1998
--------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Available for sale securities:
Debt securities:
U.S. Government agency securities $5,029,967 $ 4,453 $(11,156) $5,023,264
Federal Farm Credit Notes 400,000 (1,062) 398,938
Fannie Mae and Government
National Mortgage Association 2,174,353 60,503 2,234,856
Equity securities:
Federal Home Loan Mortgage
Corporation Common Stock 6,917 430,764 437,681
--------------------------------------------------------------
7,611,237 495,720 (12,218) 8,094,739
Held to maturity securities:
Debt securities:
Student Loan Marketing
Association 100,000 100,000
Other securities:
Federal Home Loan Bank stock 624,000 624,000
--------------------------------------------------------------
$8,335,237 $495,720 $(12,218) $8,818,739
=============================================================-
</TABLE>
The amortized cost and estimated fair value of debt securities at June 30, 1999,
by contractual maturity are shown below. Fannie Mae and Government National
Mortgage Association securities are not included in the maturity categories
because they do not have a single maturity date. Additionally, equity securities
and mutual funds are not included in the maturity categories because they do not
have contractual maturities.
<TABLE>
<CAPTION>
Held to maturity securities: Available for sale securities:
--------------------------------------------------------------------
Amortized Amortized
Cost Fair Value Cost Fair Value
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due from one year to five years $100,000 $100,000 $2,880,000 $2,849,257
Due from five years to ten years 1,017,323 1,017,792
Due after ten years 908,917 882,594
Fannie Mae and Government
National Mortgage Association
debt securities 4,625,811 4,672,244
Mutual funds 1,205,216 1,221,363
Equity securities 4,784 332,920
-------------------------------------------------------------------
$100,000 $100,000 $10,642,051 $10,976,170
===================================================================
</TABLE>
32
<PAGE>
NOTE 2. DEBT AND EQUITY SECURITIES (CONTINUED)
Sales of securities are summarized as follows for the years ended June 30:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------
<S> <C> <C>
Proceeds from calls of securities available for sale $4,950,000 $3,050,000
Proceeds from sale of securities available for sale 329,423 311,633
--------------------------------------
5,279,423 3,361,633
Realized gain on sale of securities available for sale (165,505) (305,550)
--------------------------------------
Cost of securities sold $5,113,918 $3,056,083
======================================
</TABLE>
The change in accumulated other comprehensive income, which consists of
unrealized gains on securities available for sale for the years ended June 30,
are as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------
<S> <C> <C>
Balance, beginning $ 294,380 $350,143
Change in net unrealized gains (149,383) (91,589)
Change in deferred income taxes 58,641 35,826
--------------------------------------
Balance, ending $ 203,638 $294,380
======================================
</TABLE>
The Bank, as a member of the FHLB system, is required to maintain an investment
in capital stock of the FHLB in an amount equal to the greater of 1% of its
outstanding home loans or 5% of advances from the FHLB. No ready market exists
for the FHLB stock, and it has no quoted market value. For presentation
purposes, such stock is assumed to have a market value which is equal to cost.
NOTE 1. LOANS RECEIVABLE
Loans receivable at June 30, consist of the following:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------
<S> <C> <C>
One to four-family $48,432,985 $55,462,490
Multifamily 316,111 668,146
Non residential 2,068,070 1,417,513
Land 1,258,481 2,423,690
Construction loans 5,081,781 3,477,239
Commercial loans 18,261,202 3,974,669
Consumer loans 12,143,508 8,281,791
------------------------------------
87,562,138 75,705,538
Less:
Undisbursed loan funds (5,033,086) (1,597,657)
Deferred loan fees (249,605) (315,748)
Allowance for loan losses (1,122,681) (1,164,263)
------------------------------------
$81,156,766 $72,627,870
====================================
</TABLE>
33
<PAGE>
NOTE 3. LOANS RECEIVABLE (CONTINUED)
The following is an analysis of the allowance for loan losses for the years
ended June 30:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------
<S> <C> <C>
Balance, beginning $1,164,263 $1,031,182
Provisions (recoveries) charged to operations 20,000 (25,000)
Charge-offs (74,034) (12,936)
Recoveries 12,452 171,017
--------------------------------------
Balance, ending $1,122,681 $1,164,263
======================================
</TABLE>
SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by
SFAS No. 118 Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosure, requires that the Bank establish a specific allowance on
impaired loans and disclosure of the Bank's method of accounting for interest
income on impaired loans. The Bank assesses all loans delinquent more than 90
days for impairment and such loans amounted to approximately $60,000 and $24,000
at June 30, 1999 and 1998, respectively. Average balances for loans delinquent
more than 90 days totaled approximately $120,000 and $111,000 for the years
ended June 30, 1999 and 1998, respectively. These loans are primarily collateral
dependent and management has determined that the underlying collateral value is
in excess of the carrying amounts. As a result, the Bank has determined that
specific allowances on these loans are not required. Interest income foregone
during 1999 and 1998 was $4,313 and $509, respectively. The Bank established
reserves for uncollectible interest on mortgage and consumer loans totaling
$4,313 and $5,485 at June 30, 1999 and 1998, respectively.
Loan activity to officers and directors of the Company during the years ended
June 30, 1999 and 1998, is summarized as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------
<S> <C> <C>
Balance, beginning $ 943,194 $ 855,339
Disbursements 672,300 327,935
Payments received (79,890) (240,080)
--------------------------------------
Balance, ending $1,535,604 $ 943,194
======================================
</TABLE>
Mortgage loans serviced for others are not included in the accompanying
statements of financial condition. Mortgage loan portfolios serviced for Fannie
Mae were approximately $20,657,000 and $8,511,000 at June 30, 1999 and 1998,
respectively.
There were no loans held for sale or outstanding commitments to sell loans as of
June 30, 1999 or 1998.
34
<PAGE>
NOTE 1. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment at June 30 consist of the following:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------
<S> <C> <C>
Land and land improvements $ 308,329 $ 260,399
Buildings 1,421,055 1,239,304
Furniture and fixtures 1,434,791 1,065,993
Leasehold improvements 252,120 197,540
Automobiles 84,345 84,345
--------------------------------------
3,500,640 2,847,581
Accumulated depreciation (955,863) (686,798)
--------------------------------------
$2,544,777 $2,160,783
======================================
</TABLE>
NOTE 1. SAVINGS DEPOSITS
Savings deposits at June 30 consist of the following:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------
<S> <C> <C> <C> <C> <C>
Interest-bearing checking accounts at 2.25% (3.00% 1998) $13,831,977 $ 8,465,225
Commercial and free checking (noninterest bearing) 3,914,090 3,469,656
Passbook savings 3.05% (4.25% 1998) 21,840,801 16,729,421
Money market demand accounts 2.50% (3.75% 1998) 1,593,041 1,855,571
--------------------------------------
41,179,909 30,519,873
--------------------------------------
Certificates of Deposit:
weighted average rate of 4.94% (5.52% 1998)
4.00% to 5.99% 49,488,579 45,411,880
6.00% to 7.99% 2,299,181 6,388,645
--------------------------------------
51,787,760 51,800,525
--------------------------------------
Accrued interest payable 138,421 167,818
--------------------------------------
$93,106,090 $82,488,216
======================================
Weighted average cost of savings deposits 4.29% 4.94%
======================================
</TABLE>
At June 30, 1999, scheduled maturities of certificates of deposit are as
follows:
<TABLE>
<CAPTION>
2000 2001 2002 2003 After Total
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
4.00% to 5.99% $42,693,272 $3,619,452 $1,957,795 $1,202,194 $15,866 $49,488,579
6.00% to 7.99% 1,963,692 128,170 143,456 63,863 2,299,181
-------------------------------------------------------------------------------------------
$44,656,964 $3,747,622 $2,101,251 $1,266,057 $15,866 $51,787,760
===========================================================================================
</TABLE>
35
<PAGE>
NOTE 5. SAVINGS DEPOSITS (CONTINUED)
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was $13,910,406 and $13,894,135 at June 30, 1999 and
1998, respectively. At June 30, 1999, scheduled maturities of jumbo certificates
of deposit are as follows:
<TABLE>
<CAPTION>
Weighted
Amount Average Rate
--------------------------------------
<S> <C> <C>
Maturity period:
Within three months $ 4,975,364 5.25%
Three through six months 3,392,960 4.76
Six through twelve months 4,231,745 4.97
Over twelve months 1,310,337 4.92
--------------------------------------
$13,910,406 5.01%
======================================
</TABLE>
Eligible savings accounts are insured to $100,000 by the Savings Association
Insurance Fund (SAIF) which is administered by the Federal Deposit Insurance
Corporation (FDIC).
The Bank has pledged securities with a fair value of $100,000 at June 30, 1999
as collateral on treasury tax and loan account.
Interest expense on savings deposits consists of the following for the years
ended June 30:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------
<S> <C> <C>
Interest-bearing checking $ 300,521 $ 353,185
Passbook savings accounts 698,461 538,205
Certificate accounts 2,770,917 2,650,510
--------------------------------------
$3,769,899 $3,541,900
======================================
</TABLE>
NOTE 6. FEDERAL HOME LOAN BANK ADVANCES
The Bank had advances outstanding of $2,564,358 and $4,115,596 at June 30, 1999
and 1998, respectively, from the FHLB. Interest is payable at rates ranging from
5.68% to 6.87%. Pursuant to collateral agreements with the FHLB, advances are
collateralized by all the Bank's stock in the FHLB and qualifying first mortgage
loans. $912,500 of the advances are due by August of 2002, $1,500,000 are due by
September of 2002 and the remaining $151,858 is due January 2007. Interest
expense was $175,451 and $226,392 for the years ended June 30, 1999 and 1998,
respectively.
36
<PAGE>
NOTE 7. STOCKHOLDERS' EQUITY
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory -- and possibly additional discretionary -- actions
by regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative regulatory accounting practices.
The Bank's capital amounts and classifications are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
The Office of Thrift Supervision (OTS) regulations require institutions to have
a minimum regulatory tangible capital equal to 1.5% of total assets, a minimum
3% of total assets for the core capital ratio and 8% of risk-weighted assets for
the risk-based capital ratio. At June 30, 1999 and 1998, the Bank exceeded all
of the capital requirements.
The following is a reconciliation of the Bank's capital in accordance with
generally accepted accounting principles (GAAP) to the three components of
regulatory capital calculated under the requirements of the OTS at June 30, 1999
and 1998:
<TABLE>
<CAPTION>
June 30, 1999 Regulatory Capital
----------------------------------------------------------------------------------------
Percent Percent Percent
of of of
Tangible Tangible Core Tangible Risk-based Risk-based
Capital Assets Capital Assets Capital Assets
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GAAP capital $11,063,063 $11,063,063 $11,063,063
Unrealized gain on
securities
available for sale (165,855) (165,855) (165,855)
Equity investment
and other assets 147,661
Qualifying general
loan loss
allowance 856,113
-------------- ----------------- -----------------
Regulatory capital 10,897,208 10.0 % 10,897,208 10.0 % 11,900,982 17.4 %
Minimum capital
requirement 1,627,815 1.5 3,255,630 3.0 5,483,920 8.0
----------------------------------------------------------------------------------------
Excess regulatory
capital $9,269,393 8.5 % $ 7,641,578 7.0 % $ 6,417,062 9.4 %
========================================================================================
</TABLE>
37
<PAGE>
NOTE 7. STOCKHOLDERS' EQUITY (CONTINUED)
<TABLE>
<CAPTION>
June 30, 1998 Regulatory Capital
----------------------------------------------------------------------------------------
Percent Percent Percent
of of of
Tangible Tangible Core Tangible Risk-based Risk-based
Capital Assets Capital Assets Capital Assets
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GAAP capital $11,486,186 $11,486,186 $11,486,186
Goodwill and
other nonincludable
assets (285,010) (285,010) (300,010)
Unrealized gain on
securities
available for sale (294,380) (294,380) (294,380)
Qualifying general
loan loss
allowance 715,254
--------------- ----------------- ------------------
Regulatory capital 10,906,796 10.9 % 10,906,796 10.9 % 11,607,050 20.4 %
Minimum capital
requirement 1,494,270 1.5 2,988,540 3.0 4,543,304 8.0
----------------------------------------------------------------------------------------
Excess regulatory
capital $ 9,412,526 9.4 % $ 7,918,256 7.9 % $ 7,063,746 12.4 %
========================================================================================
</TABLE>
As of June 30, 1999, the most recent notification from the 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 total
capital to risk weighted assets of 10%, Tier I Capital to risk weighted assets
of 6% and Tier I Capital to total assets of 5% or $6,855,000, $4,113,000 and
$5,426,000, respectively. There are no conditions or events since that
notification that management believes have changed the Bank's category.
Under the conversion regulations the Bank may not declare or pay a cash dividend
on any of its stock if the effect thereof would cause the Bank's equity to be
reduced below (1) the amount required for the liquidation account; or (2) the
net worth requirements imposed by the OTS.
The Company paid cash dividends totaling $.20 per share during the years ended
June 30, 1999 and 1998. On July 19, 1999, the Company declared a $.05 per share
cash dividend for stockholders of record as of July 30, 1999 to be paid on
August 13, 1999. This dividend will be funded by an upstream dividend from the
Bank to the Company.
38
<PAGE>
NOTE 8. EMPLOYEE PENSION AND INCENTIVE PLANS
The Bank has a profit-sharing plan for the benefit of substantially all
employees. Contributions are discretionary and totaled $41,281 and $52,300 for
the years ended June 30, 1999 and 1998, respectively.
The Bank also has a discretionary bonus plan under which bonuses are paid to all
employees if approved by the Board of Directors each year. Expense related to
these incentives was $36,544 and $54,289 for the years ended June 30, 1999 and
1998, respectively.
In addition, the Bank implemented a 401(k) retirement plan during the year ended
June 30, 1998 which contains provisions for specified matching contributions by
the Bank. The Bank funds contributions as they accrue and 401(k) plan expense
amounted to $70,367 and $74,239 for the years ended June 30, 1999 and 1998,
respectively.
NOTE 9. EMPLOYEE STOCK OWNERSHIP PLAN
As part of the Reorganization, the Bank established an ESOP to benefit
substantially all employees. The ESOP purchased 36,942 shares of common stock
with the proceeds from a loan from a third party financial institution. The note
requires annual principal payments of 10% of the outstanding principal balance
plus interest at the lending institution's prime rate (7.75% at June 30, 1999)
less .5% with a balloon payment due June, 2002. The Bank is expected to make
quarterly contributions to the ESOP in amounts sufficient to allow the ESOP to
make its scheduled principal and interest payments on the note. The ESOP shares
are pledged as collateral for the debt. As the debt is repaid, shares are
released from collateral and allocated to active employees, based on proportion
of debt service paid in the year. The debt of the ESOP is recorded as debt in
the Company's accompanying statement of financial condition.
At June 30, 1999, future principal payments are due as follows:
Year Ending June 30: Amount
- -----------------------------------------------------------------------------
2000 $ 25,542
2001 22,988
2002 206,890
----------
$255,420
==========
Dividends on unallocated shares may be used by the ESOP to repay the debt to the
Bank and are not reported as dividends in the financial statements. Dividends on
allocated or committed to be allocated shares are credited to the accounts of
the participants and reported as dividends in the financial statements.
39
<PAGE>
NOTE 9. EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED)
Excluding interest, expense of $47,088 and $71,919 during 1999 and 1998,
respectively, has been incurred in connection with the ESOP. The expense
includes, in addition to the cash contribution necessary to fund the ESOP,
$13,365 in 1999 and $34,919 in 1998, which represents the difference between the
fair value of the shares which have been released or committed to be released to
participants, and the cost of these shares to the ESOP. The Bank has credited
this amount to paid-in capital in accordance with the provisions of AICPA
Statement of Position 93-6.
At June 30, 1999 and 1998, 11,400 and 7,400 shares held by the ESOP have been
released or committed to be released to the plan's participants for purposes of
computing earnings per share. The fair value of the unallocated shares amounted
to approximately $281,000 and $643,000 at June 30, 1999 and 1998, respectively.
The Bank has also recorded a liability for a put back option, which represents
the excess of the fair market value of the total number of ESOP shares over the
original cost of the unallocated ESOP shares. The liability recorded under the
put back option was $150,942 and $508,069 at June 30, 1999 and 1998,
respectively.
NOTE 10. DEFERRED COMPENSATION AND RETIREMENT PLAN AGREEMENTS
The Bank has an unfunded deferred compensation agreement providing retirement,
disability, and death benefits for directors. Vested benefits under the
agreements are payable in monthly installments over a ten-year period upon the
director's death, disability or retirement. The Bank has insured the lives of
the directors for amounts sufficient to discharge its obligations under the
agreements. The Bank also has a retirement plan for members of the Board of
Directors which the Plan states that outside directors with at least ten years
of service will receive an amount equal to their annual retainer for ten years
after their retirement from the Board. The liability for the benefits is being
accrued over the terms of active service of the directors. The amount charged to
expense under these plans amounted to $54,361 and $78,812 for the years ended
June 30, 1999 and 1998, respectively.
40
<PAGE>
NOTE 11. RECOGNITION AND RETENTION PLAN AND STOCK OPTION PLAN
The Bank's stockholders approved the Bank's Recognition and Retention Plan (the
"RRP") and the Bank's stock option plan on December 8, 1997. The stock option
plan provides for the issuance of up to 21,322 stock options to certain officers
and directors in the form of incentive stock options or non-incentive stock
options. The exercise price of the stock options may not be less than the fair
market value of the Company's common stock at the date of grant. Under the Plan
21,322 of options, which vest at the rate of 20% annually beginning at the date
of grant, were all granted on December 8, 1997 and expire on December 8, 2007.
As permitted under the generally accepted accounting principles, grants under
the plan are accounted for following the provisions of APB Opinion No. 25 and
its related interpretations. Accordingly, no compensation cost has been
recognized for grants made to date. Had compensation cost been determined based
on the fair value method prescribed in FASB Statement No. 123, the pro forma
effect on reported net income for the year ended June 30, 1999 and 1998 would be
as follows:
1999 1998
---------------------------
Net income
As reported $513,834 $708,403
Pro forma 485,179 679,748
Earnings per share
As reported
Basic $ 0.52 $ 0.73
Diluted 0.52 0.72
Pro forma
Basic 0.49 0.70
Diluted 0.49 0.69
In determining the fair value of the option grant as prescribed in Statement No.
123, the Black-Scholes option pricing model was used with the following
assumptions: a risk-free interest rate of 5.61%, expected lives of 10 years,
expected volatility of 17.19% and expected dividends of $0.20 per year.
At June 30, 1999, 21,322 options have been granted at an exercise price of
$18.50, of which 8,528 options are currently exercisable. No options have been
exercised to date and all options granted are outstanding at June 30, 1999.
The RRP reserved for issuance 53,678 shares of common stock to certain officers
and directors at the time of the adoption. The Bank issued shares to fund the
RRP in December of 1997. The restricted common stock under the RRP vests at the
rate of 20% annually beginning at the date of grant. The expense related to the
vesting of the RRP totaled $198,616 and $314,467 for the year ended June 30,
1999 and 1998, respectively.
41
<PAGE>
NOTE 12. INCOME TAX MATTERS
Under the Internal Revenue code, the Bank is allowed a special bad debt
deduction related to additions to tax bad debt reserves established for the
purpose of absorbing losses. Through 1996, the provisions of the Code permitted
the Bank to deduct from taxable income an allowance for bad debts based on 8% of
taxable income before such deduction or actual loss experience. Tax legislation
passed in 1996 eliminated the percentage of taxable income method as an option
for computing bad debt deductions in all future years. The Bank is still
permitted to take deductions for bad debts, but is required to compute such
deductions using an experience method.
In conjunction with the change in computing the tax bad debt deduction, the Bank
will also have to recapture its excess tax bad debt reserves which have
accumulated since 1988, amounting to approximately $92,000 over a six year
period. The tax associated with the recaptured reserves is approximately
$36,000. The recapture was scheduled to begin with the Bank's 1997 year, but was
delayed two years because the Bank originated a required minimum level of
mortgage loans. Deferred income taxes have been previously established for the
taxes associated with the recaptured reserves and the ultimate payment of the
related taxes will not result in a charge to earnings. The amount of reserve
recaptured and associated tax were approximately $15,000 and $6,000,
respectively, for each of the years ended June 30, 1999 and 1998.
Deferred taxes have been provided for certain increases in the Bank's tax bad
debt reserves subsequent to 1987 which are in excess of additions to recorded
loan loss allowances. At June 30, 1999, retained earnings contain certain
historical additions to bad debt reserves for income tax purposes of
approximately $870,000, the balance at June 30, 1987, for which no deferred
taxes have been provided because the Bank does not intend to use these reserves
for purposes other than to absorb losses. If amounts which qualified as bad debt
deductions are used for purposes other than to absorb bad debt losses or
adjustments arising from the carryback of net operating losses, income taxes may
be imposed at the then existing rates. The approximate amount of unrecorded
deferred tax liability associated with these historical additions is
approximately $340,000.
42
<PAGE>
NOTE 12. INCOME TAX MATTERS (CONTINUED)
The tax effects of temporary differences that gave rise to significant portions
of the net deferred tax asset as of June 30 were:
1999 1998
----------------------
Deferred tax assets:
Reserve for loan losses $435,431 $453,480
Reserve for uncollected interest 1,672 2,137
Deferred compensation 201,933 176,954
Recognition and retention plan 44,934 44,793
----------------------
683,970 677,364
----------------------
Deferred tax liabilities:
Reserve for loan losses 23,752 53,563
Unrealized gain on securities available for sale 130,483 189,124
Depreciation 37,602 44,319
FHLB stock dividends 60,427 60,949
Deferred loan fees 6,606 22,115
----------------------
258,870 370,070
----------------------
NET DEFERRED TAX ASSET $425,100 $307,294
======================
At June 30, 1999 and 1998, no valuation allowance was recorded on deferred tax
assets.
The provision for income taxes charged to operations for the years ended June
30, 1999 and 1998 consists of the following:
1999 1998
-------------------------------------
Current $294,705 $382,281
Deferred (59,165) (1,026)
--------------------------------------
$235,540 $381,255
======================================
A reconciliation of income taxes computed at the statutory federal income tax
rate to the income tax provision follows:
<TABLE>
<CAPTION>
1999 1998
---------------------------------------------------------------------------
Amount Percent Amount Percent
---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Tax at statutory rate $ 254,787 34.0% $ 370,484 34.0%
State tax, net of federal benefit 25,834 3.4 37,892 3.5
Municipal interest income (27,296) (3.6) (19,813) (1.8)
Other (17,785) (2.4) (7,308) (0.7)
---------------------------------------------------------------------------
Total 235,540 31.4% $ 381,255 35.0%
===========================================================================
</TABLE>
43
<PAGE>
NOTE 13. COMMITMENTS AND CONTINGENCIES
The Bank is a party to financial instruments with off-statement of financial
condition risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to extend credit
and equity lines of credit. Those instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the statement of financial condition. The contract or notional amounts of those
instruments reflect the extent of involvement the Bank has in particular classes
of financial instruments.
A summary of the contract amount of the Bank's exposure to off-statement of
financial condition risk, except for undisbursed construction loan funds, is as
follows at June 30, 1999:
Notional
Amount
-----------
Financial instruments whose contract amounts represent credit risk:
Undisbursed home equity lines of credit $5,981,090
Undisbursed commercial lines of credit 1,341,045
The Bank evaluates each customer's credit worthiness on a case-by-case basis.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Home equity
lines of credit have variable rates based on the prime rate of interest. Home
equity lines are reassessed every five years. Because many of the commitments
are expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The collateral obtained by
the Bank upon extension of credit is based on management's credit evaluation of
the customer. The collateral held is the underlying real estate. Undisbursed
commercial lines of credit have variable rates of prime plus two percent and are
reassessed on an annual basis. Prime at June 30, 1999 was 7.75%.
The Bank has entered into operating leases for the branch locations in
Warrensville, Sparta and Boone, North Carolina and the two insurance company
branches located in Wilkesboro and Lenoir, North Carolina. The minimum annual
lease payments are not significant to the Company's operations.
44
<PAGE>
NOTE 14. EARNINGS PER SHARE
Earnings per share has been calculated in accordance with Financial Accounting
Standards Board Statement No. 128, Earnings Per Share, and Statement of Position
93-6, Employers' Accounting for Employee Stock Ownership Plans. For purposes of
this computation, the number of shares of common stock purchased by the Bank's
employee stock ownership plan which have not been allocated to participant
accounts are not assumed to be outstanding. The following are reconciliations of
the amounts used in the per share calculations:
<TABLE>
<CAPTION>
For the Year Ended June 30, 1999
-------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-------------------------------------------------------
<S> <C> <C> <C>
BASIC AND DILUTED EPS
Income available to stockholders $513,834 995,301 $0.52
=======================================================
For the Year Ended June 30, 1998
-------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-------------------------------------------------------
BASIC EPS
Income available to stockholders $708,403 975,717 $0.73
===================
EFFECT OF DILUTIVE SECURITIES
RRP restricted stock awards @ 3,189
Stock options 1,854
------------------------------------
DILUTED EPS
Income available to stockholders $708,403 980,760 $0.72
=======================================================
</TABLE>
45
<PAGE>
NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table reflects a comparison of carrying amounts and the fair
values of the financial instruments as of June 30, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
----------------------------------------------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash
Interest-bearing $ 4,173,311 $ 4,173,311 $11,838,926 $11,838,926
Noninterest-bearing
deposits 8,221,749 8,221,749 2,949,842 2,949,842
Certificates of deposit 198,000 198,000 198,000 198,000
Investments 11,076,170 11,076,170 8,194,739 8,194,739
Loans receivable 81,156,766 79,796,954 72,627,870 72,297,027
Accrued interest receivable 496,516 496,516 409,559 409,559
FHLB stock 523,600 523,600 624,000 624,000
Financial liabilities:
Deposits 93,106,090 92,924,645 82,488,216 82,589,250
Advances from FHLB 2,564,358 2,564,358 4,115,596 4,115,596
Note payable, ESOP 255,420 255,420 295,420 295,420
</TABLE>
The fair values utilized in the table were derived using the information
described below for the group of instruments listed. It should be noted that the
fair values disclosed in this table do not represent market values of all assets
and liabilities of the Company and, thus, should not be interpreted to represent
the market or liquidation value of the Company.
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:
Cash and certificates of deposits: The carrying amounts for cash and short-term
instruments approximate their fair values.
Investment securities: Fair values for securities are based on quoted market
prices, where available. If quoted market prices are not available, fair values
are based on quoted market prices of similar securities.
Loans receivable: The fair value of fixed rate loans is estimated by discounting
the future cash flows using the current rates at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities. The fair value of variable rate loans approximates their carrying
value as these loans reprice frequently.
46
<PAGE>
NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Accrued interest receivable and accrued interest payable: The fair value of
accrued interest receivable and payable is the amount receivable or payable on
demand at the statement of financial condition date.
FHLB stock: The fair value of FHLB stock is the stated value by the FHLB.
Deposits: The fair value of demand deposits, savings accounts and certain money
market deposits is the amount payable on demand at the statement of financial
condition date. The fair value of fixed maturity certificates of deposit are
estimated based upon the discounted value of contractual cash flows using rates
currently offered for deposits with similar remaining maturities.
Advances from FHLB and Note payable, ESOP: The fair value of the Advances from
FHLB and Note payable, ESOP is equal to the carrying value of the liability.
Off-statement of financial condition instruments: Fair values for the Company's
off-statement of financial condition instruments (loan commitments) are based on
fees currently charged for similar agreements, taking into account the remaining
terms of the agreements and the counterparties' credit standings. The fair value
for such commitments is nominal.
NOTE 16. RECLASSIFICATION OF FINANCIAL STATEMENTS
Certain amounts in the financial statements for the year ended June 30, 1998
have been reclassified to conform with classifications adopted in the year ended
June 30, 1999. These reclassifications had no effect on net income or
stockholders' equity.
47
<PAGE>
NOTE 17. REORGANIZATION AND MINORITY STOCK OFFERING
On October 4, 1996, the Bank consummated its reorganization, as explained in
Note 1, and issued 461,779 shares in a minority stock offering (including 36,942
shares to the ESOP) which resulted in gross proceeds of $4,617,790, or
$3,917,389, net of conversion costs of $700,401. At closing, such costs were
netted against the stock proceeds received and shown as a reduction of
stockholders' equity. As a part of the reorganization, the Bank formed a mutual
holding company, AsheCo, M.H.C., which was issued 538,221 shares of the Bank's
common stock. Members of the mutual holding company consist of depositors of the
Bank, who have the sole authority to elect the board of directors of the mutual
holding company for as long as it remains in mutual form. Initially, the mutual
holding company's principal assets were the shares of the Bank's common stock
received in the reorganization and on its initial capitalization of $100,000 in
cash. The mutual holding company, which by law must own in excess of 50% of the
stock of the Bank, was issued stock in the reorganization resulting in an
ownership interest of 53.8% of the Bank. By virtue of its ownership of a
majority of the outstanding shares of the Bank, the mutual holding company can
generally control the outcome of most matters presented to the stockholders of
the Bank for resolution by vote except for certain matters related to stock
compensation plans, a vote regarding conversion of the mutual holding company to
stock form, or other matters which require a vote only by the minority
stockholders. The mutual holding company has registered as a savings and loan
holding company and is subject to regulation, examination, and supervision by
the OTS.
The Bank also established an ESOP which was issued 36,942 shares of common stock
in the reorganization. The funds used by the ESOP to acquire these shares were
obtained from borrowings from an unaffiliated third party lender. The loan is
reflected in the financial statements of the Bank which makes contributions to
the ESOP necessary to amortize the debt. Such contributions are expensed based
upon the fair value of the ESOP shares released or committed to be released from
restriction (or no longer debt financed). The total number of shares of common
stock issued as a result of the offering and reorganization were 1,000,000. On
June 16, 1998, the Board of Directors approved the formation of a mid-tier
holding company, AF Bankshares, Inc. which became a 100% owner of the Bank in a
stock swap with AsheCo, M.H.C., which was accounted for similar to a pooling of
interests. At June 30, 1998, AsheCo, M.H.C.'s ownership of AF Bankshares, Inc.
decreased to 51.1% due to the shares issued under the recognition and retention
plan discussed in Note 11. At June 30, 1999, AsheCo, M.H.C.'s ownership of AF
Bankshares, Inc. increased to 51.38% due to the purchase of shares held in
treasury.
Concurrent with the reorganization, the Bank has established a liquidation
account in an amount equal to its net worth as reflected in its latest statement
of financial condition used in its final offering circular. The liquidation
account will be maintained for the benefit of eligible deposit account holders
and supplemental eligible deposit account holders who continue to maintain their
deposit accounts in the Bank after the reorganization. Only in the event of a
complete liquidation will eligible deposit account holders and supplemental
eligible deposit account holders be entitled to receive a liquidation
distribution from the liquidation account in the amount of the then current
adjusted sub account balance for deposit accounts then held before any
liquidation distribution may be made with respect to common stock. Dividends
paid by the bank subsequent to the reorganization cannot be paid from this
liquidation account.
48
<PAGE>
NOTE 17. REORGANIZATION AND MINORITY STOCK OFFERING (CONTINUED)
The Bank may not declare or pay a cash dividend on its common stock if its
stockholders' equity would thereby be reduced below either the aggregate amount
then required for the liquidation account or the minimum regulatory capital
requirements imposed by federal regulations.
NOTE 18. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA
The mid-tier holding company, AF Bankshares, Inc., was formed on June 16, 1998.
At June 30, 1998, the Company's only asset was the investment in AF Bank and
Subsidiaries of $11,486,186. There were no significant operations from the date
of inception to June 30, 1998. The following are the condensed financial
statements of AF Bankshares, as of and for the year ended June 30, 1999:
AF Bankshares, Inc.
Condensed Balance Sheet
June 30, 1999
Assets:
Cash $ 232,410
Securities available for sale 267,155
Investment in AF Bankshares 11,063,063
Investment in AF Insurance Services, Inc. 744,851
Investment in AF Brokerage, Inc. 236,758
Other assets 111,930
------------
$12,656,167
============
Liabilities and Equity:
Liabilities:
Accounts payable $ 31,551
Note payable - ESOP 255,420
Redeemable common stock held by the ESOP, net of
unearned ESOP shares 150,942
------------
437,913
------------
Equity:
Common stock 10,537
Additional paid in capital 11,873,210
Retained earnings 694,679
Deferred recognition and retention plan (479,960)
------------
Accumulated other comprehensive income, unrealized
gain on securities available for sale, net 203,638
------------
12,302,104
Less cost of 4,300 shares of treasury stock (83,850)
-----------
12,218,254
------------
$12,656,167
============
49
<PAGE>
NOTE 18. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA (CONTINUED)
AF Bankshares, Inc.
Condensed Statement of Income
Year Ended June 30, 1999
Interest and investment income $ 18,305
Equity in earnings subsidiaries 645,031
Income tax credits 74,212
Other expense (223,714)
------------------
Net income $ 513,834
==================
AF Bankshares, Inc.
Condensed Statement of Cash Flows
Year Ended June 30, 1999
Cash Flows from Operating Activities:
Net income $ 513,834
Change in assets and liabilities:
Gain on sale of securities (17,400)
Stock compensation 25,000
Equity in earnings of subsidiaries (645,031)
Increase in accounts payable and other liabilities 608
Increase in other assets (111,930)
------------------
Net cash used in operating activities (234,919)
------------------
Cash Flows from Investing Activities:
Purchase of securities available for sale (367,001)
Proceeds from sales of securities available for sale 179,185
Upstream dividends from AF Bank 2,000,000
Purchase of insurance agency (276,000)
Capitalization of AF Brokerage, Inc. (250,000)
Investment in AF Insurance Services, Inc. (500,000)
------------------
Net cash provided by investing activities 786,184
------------------
Cash Flows from Financing Activities:
Cash dividends paid (205,105)
Purchase of common stock for treasury (113,750)
------------------
Net cash used in financing activities (318,855)
------------------
Net increase in cash 232,410
Cash - beginning
------------------
Cash - ending $ 232,410
==================
50
<PAGE>
NOTE 18. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA (CONTINUED)
The following are the condensed financial statements of the mutual holding
company, AsheCo, M.H.C., as of and for the years ended June 30, 1999 and 1998:
AsheCo, M.H.C.
Condensed Balance Sheets
June 30, 1999 and 1998
1999 1998
-------------------------
Assets:
Cash $ 222,503 $ 154,534
Investment in AA&G, Inc. and Subsidiary 66,828 38,004
Investment in AF Bankshares, Inc. and Subsidiaries 6,277,739 5,867,144
Other assets 26,086 19,409
-------------------------
$6,593,156 $6,079,091
=========================
Liabilities and Equity:
Liabilities:
Accrued expenses and other liabilities $ 1,000 $ 12,000
-------------------------
Equity:
Additional paid-in-capital 5,768,073 5,517,620
Retained earnings 824,083 549,471
-------------------------
6,592,156 6,067,091
-------------------------
$6,593,156 $6,079,091
=========================
AsheCo, M.H.C.
Condensed Statements of Income
Years Ended June 30, 1999 and 1998
1999 1998
-------------------------
Interest income $ 6,242 4,770
Equity in earnings subsidiaries 296,610 401,110
Income tax credits 14,212 12,048
Other expense (42,452) (71,055)
-------------------------
Net income $ 274,612 346,873
=========================
51
<PAGE>
NOTE 18. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA (CONTINUED)
AsheCo, M.H.C.
Condensed Statement of Cash Flows
Years Ended June 30, 1999 and 1998
1999 1998
----------------------
Cash Flows from Operating Activities:
Net income $ 274,612 $346,873
Change in assets and liabilities:
Equity in earnings of subsidiaries (296,610) (401,110)
Decrease in accounts payable (11,000) (2,838)
Increase in other assets (6,677) (19,409)
------------------------
Net cash used in operating activities (39,675) (76,484)
Cash Flows from Investing Activities:
Dividends from AF Bankshares, Inc. 107,644 107,644
------------------------
Net increase in cash 67,969 31,160
Cash - beginning 154,534 123,374
------------------------
Cash - ending $ 222,503 $154,534
========================
NOTE 19. RECENT ACCOUNTING PRONOUNCEMENTS
The FASB has issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, which the Company has not been required to adopt as of June
30, 1999. This Statement, which is effective for fiscal years beginning after
June 15, 2000, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available for sale security, or a foreign
currency denominated forecasted transaction. This Statement is not expected to
have a significant impact on the Company.
52
<PAGE>
NOTE 19. FUTURE REPORTING REQUIREMENTS (CONTINUED)
The FASB has issued SFAS No. 134, Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise, an amendment of FASB Statement No. 65, which the Company has
not been required to adopt as of June 30, 1999. Statement No. 65, as amended by
FASB Statements No. 115, Accounting for Certain Investments in Debt and Equity
Securities, and No. 125, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed security as a trading
security. This Statement further amends Statement No. 65 to require that after
the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments. This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a nonmortgage banking enterprise.
This Statement is effective for fiscal years beginning after December 15, 1998,
and is not expected to have a significant impact on the Company.
53
<PAGE>
AF BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
AF BANKSHARES, INC.
CORPORATE INFORMATION
<S> <C> <C>
OFFICERS
JAMES A. TODD MELANIE PAISLEY MILLER
President and Chief Executive Officer Executive Vice President, Secretary/Treasurer,
Chief Financial Officer
STEPHEN R. HOOKS JAMES R. WALKER
Executive Vice President Senior Vice President and Chief Information
Officer
LINDA D. MATEJ
Assistant Secretary
DIRECTORS
JAN R. CADDELL, Chairman KENNETH R. GREENE, Vice Chairman
JAMES A. TODD JOHN D. WEAVER
JERRY L. ROTEN WAYNE R. BURGESS
W. O. ASHLEY, JR. FRANK E. ROLAND
</TABLE>
54
<PAGE>
<TABLE>
<CAPTION>
CORPORATE INFORMATION (CONTINUED)
OFFICES
<S> <C>
Corporate Offices West Jefferson Office
206 S. Jefferson Avenue 205 S. Jefferson Avenue
West Jefferson, North Carolina 28694 West Jefferson, North Carolina 28694
Jefferson Office Warrensville Office
840 E. Main Street 4951 NC Hwy. 88 West
Jefferson, North Carolina 28640 Warrensville, North Carolina 28693
Sparta Office - d/b/a Alleghany First Bank North Wilkesboro Office - AF Brown Insurance
403 South Main Street 1347 West D Street
Sparta, NC 28675 North Wilkesboro, NC 28659
Boone Office - d/b/a Appalachian First Bank Lenoir Office - AF Blair Insurance
285 Highway 105 324 Morganton Blvd, SW
Boone, NC 28607 Lenoir, NC 28645
STOCK TRANSFER AGENT LEGAL COUNSEL
ChaseMellon Shareholders Services, LLC Vannoy & Reeves
Overpeck Centre 306 East Main Street
85 Challenger Road West Jefferson, North Carolina 28694
Ridgefield Park, New Jersey 07660
Thacher Proffitt & Wood
AUDITORS 1700 Pennsylvania Avenue
McGladrey & Pullen, LLP Washington, DC 20006
One Morrocroft Centre
6805 Morrison Boulevard, Suite 200 FORM 10-KSB
Charlotte, North Carolina 28211 A copy of Form 10-KSB as filed with the
Office of Thrift Supervision will be
ANNUAL MEETING furnished without charge to shareholders upon
The 1999 annual meeting of stockholders of written request to James A. Todd, President, AF
AF Bankshares, Inc. will be held on November 1, Bankshares, Inc., 206 S. Jefferson Avenue,
1999 at 6:00 p.m. at the Corporate Office, P. O. Box 26, West Jefferson, NC 28694.
206 S. Jefferson Avenue, West Jefferson,
North Carolina.
</TABLE>
55
<PAGE>
COMMON STOCK
The Company had 1,049,378 shares of common stock outstanding at August 31, 1999,
which are held by 439 shareholders of record. The majority of the outstanding
shares are held by the mutual holding company AsheCo, MHC. The remaining 515,457
shares are owned by minority shareholders including the Company's ESOP. Shares
are quoted on the OTC Electronic Bulletin Board under the symbol "ASFE."
MARKET FOR THE COMMON STOCK
There is no established market for the Company's common stock, excluding
occasional quotations, although the Company's common stock is quoted on the OTC
Electronic Bulletin Board. The table below reflects the stock trading and
dividend payment frequency of the Company for the years ended June 30, 1999 and
1998. For further information regarding the Company's dividend policy and
restrictions on dividends paid, please refer to note 7 of the notes to the
consolidated financial statements. Stock prices reflect bid prices between
broker/dealer, prior to any markups, markdowns or commissions, is based upon
information provided to management of the Company by certain securities firms
effecting transactions in the Company's stock on an ongoing basis, and may not
necessarily represent actual transactions.
STOCK PRICE
1999: DIVIDENDS HIGH LOW
- -------------------------------------------------------------------------
First Quarter $0.05 $22.00 $14.00
Second Quarter 0.05 19.00 11.50
Third Quarter 0.05 17.25 12.00
Fourth Quarter 0.05 13.50 9.50
STOCK PRICE
1998: DIVIDENDS HIGH LOW
- -------------------------------------------------------------------------
First Quarter $0.05 $17.00 $10.50
Second Quarter 0.05 19.00 16.50
Third Quarter 0.05 21.00 19.25
Fourth Quarter 0.05 22.00 20.00
DISCLAIMER: This statement has not been reviewed, or confirmed for accuracy or
relevance, by the Office of Thrift Supervision.
56
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0001064025
<NAME> AF BANKSHARES
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C> <C>
<PERIOD-TYPE> 12-MOS YEAR
<FISCAL-YEAR-END> JUN-30-1999 JUN-30-1999
<PERIOD-START> JUL-01-1998 JUL-01-1998
<PERIOD-END> JUN-30-1999 JUN-30-1999
<EXCHANGE-RATE> 1.000 1.000
<CASH> 8,222 2,950
<INT-BEARING-DEPOSITS> 4,173 11,839
<FED-FUNDS-SOLD> 0 0
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 10,976 8,075
<INVESTMENTS-CARRYING> 822 922
<INVESTMENTS-MARKET> 822 922
<LOANS> 82,280 73,792
<ALLOWANCE> 1,123 1,164
<TOTAL-ASSETS> 109,931 100,074
<DEPOSITS> 93,106 82,488
<SHORT-TERM> 0 0
<LIABILITIES-OTHER> 1,788 1,689
<LONG-TERM> 2,819 4,411
0 0
0 0
<COMMON> 11 11
<OTHER-SE> 12,207 11,475
<TOTAL-LIABILITIES-AND-EQUITY> 109,931 100,074
<INTEREST-LOAN> 6,807 6,667
<INTEREST-INVEST> 501 422
<INTEREST-OTHER> 571 267
<INTEREST-TOTAL> 7,879 7,356
<INTEREST-DEPOSIT> 3,770 3,542
<INTEREST-EXPENSE> 3,967 3,795
<INTEREST-INCOME-NET> 3,912 3,561
<LOAN-LOSSES> 20 (25)
<SECURITIES-GAINS> 166 306
<EXPENSE-OTHER> 4,348 3,488
<INCOME-PRETAX> 749 1,090
<INCOME-PRE-EXTRAORDINARY> 749 1,090
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 514 708
<EPS-BASIC> .52 .73
<EPS-DILUTED> .52 .72
<YIELD-ACTUAL> 8.18 8.62
<LOANS-NON> 60 0
<LOANS-PAST> 0 24
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 1,164 1,031
<CHARGE-OFFS> (74) (13)
<RECOVERIES> 13 171
<ALLOWANCE-CLOSE> 1,123 1,164
<ALLOWANCE-DOMESTIC> 1,123 1,164
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 0 0
</TABLE>
