<PAGE>
Filed Pursuant to Rule 424(b)(3)
Registration No. 333-63309
PROSPECTUS
VIRGINIA CAPITAL BANCSHARES, INC.
(PROPOSED HOLDING COMPANY FOR FREDERICKSBURG SAVINGS BANK)
12,144,000 SHARES OF COMMON STOCK
This offering is made as part of the plan of conversion of Fredericksburg
Savings and Loan Association, F.A., Fredericksburg, Virginia from a federally
chartered mutual savings and loan association to a federally chartered stock
savings bank to be known as Fredericksburg Savings Bank (Fredericksburg
Savings and Loan Association, F.A. and Fredericksburg Savings Bank are both
referred to herein as either the "Bank" or "Fredericksburg Savings"). In this
conversion, the Bank will become a wholly-owned subsidiary of Virginia Capital
Bancshares, Inc. (the "Company"). No shares will be sold if the minimum number
of shares are not subscribed for or if the necessary approvals from the
banking regulatory authorities and the members of the Bank are not received.
There is currently no public market for the common stock. The Company has
received conditional approval to have its common stock listed on the Nasdaq
National Market ("Nasdaq") under the symbol "VCAP" upon completion of the
Conversion.
----------------
INVESTING IN THE COMMON STOCK INVOLVES CERTAIN RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 16.
----------------
THESE SHARES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, THE OFFICE OF THRIFT SUPERVISION, OR ANY OTHER FEDERAL
AGENCY, NOR HAS SUCH COMMISSION, OFFICE OR OTHER AGENCY OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
----------------
THE SHARES ARE NOT SAVINGS ACCOUNTS OR DEPOSITS AND ARE NOT INSURED OR
GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE BANK INSURANCE
FUND, THE SAVINGS ASSOCIATION INSURANCE FUND OR ANY OTHER GOVERNMENT AGENCY
NOR ARE THEY INSURED OR GUARANTEED BY THE BANK OR THE COMPANY. THE COMMON
STOCK IS SUBJECT TO INVESTMENT RISK, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL
INVESTED.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MINIMUM MAXIMUM
MINIMUM MAXIMUM 8,976,000 12,144,000
PER SHARE PER SHARE SHARES SHARES
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Offering price................... $10.00 $10.00 $89,760,000 $121,440,000
- ------------------------------------------------------------------------------
Estimated underwriting commis-
sions and other expenses........ .23 .16 2,000,000 2,000,000
- ------------------------------------------------------------------------------
Estimated proceeds to Company.... 9.77 9.84 87,760,000 119,440,000
- ------------------------------------------------------------------------------
</TABLE>
- -------------------------------------------------------------------------------
The maximum number of shares to be sold may be increased up to the adjusted
maximum of 13,965,600 shares, a 15% increase above the maximum, if the
aggregate estimated pro forma market value of the common stock to be sold is
increased.
The shares are offered first in a Subscription Offering to persons who have
specified priorities of subscription rights based on their relationship with
the Bank. IN ORDER TO PURCHASE SHARES PURSUANT TO A SUBSCRIPTION RIGHT, YOU
MUST SUBMIT A PROPERLY COMPLETED SUBSCRIPTION ORDER FORM AND CERTIFICATION,
TOGETHER WITH FULL PAYMENT FOR THE SHARES, TO THE BANK PRIOR TO THE EXPIRATION
DATE, 12:00 NOON, EASTERN TIME, ON DECEMBER 15, 1998, UNLESS EXTENDED. All
funds received from subscribers will be held in an interest-bearing savings
account at the Bank until the completion or termination of the Conversion.
Funds will be returned promptly if the Conversion is terminated. If the
Conversion is not completed by January 29, 1999 and the Office of Thrift
Supervision consents to an extension of time to complete the Conversion,
subscribers will be given the right to increase, decrease or rescind their
orders. No single extension may exceed 90 days and such extensions may not go
beyond December 17, 2000.
To the extent sufficient shares to complete the conversion are not sold in
the Subscription Offering, the remaining shares will be offered for sale in a
Community Offering and, if necessary, other public offering.
Trident Securities, Inc. has agreed to assist the Company in selling the
shares, but does not guarantee that at least the minimum number of shares will
be sold.
TRIDENT SECURITIES, INC.
THE DATE OF THIS PROSPECTUS IS NOVEMBER 9, 1998.
<PAGE>
2
<PAGE>
SUMMARY
This summary highlights selected information from this document and does not
contain all the information that you need to know before making an informed
investment decision. To understand the stock offering fully, you should read
carefully this entire Prospectus, including the financial statements and the
notes to the financial statements of Fredericksburg Savings. References in this
document to the "Bank" or "Fredericksburg Savings" refer to Fredericksburg
Savings and Loan Association, F.A. when in mutual form and to Fredericksburg
Savings Bank upon conversion to stock form. References in this document to the
"Company" refer to Virginia Capital Bancshares, Inc.
VIRGINIA CAPITAL
BANCSHARES, INC. ......... The Company was recently organized as a Virginia
corporation to become a savings and loan holding
company and own all of the capital stock of the
Bank to be issued upon its conversion from mutual
to stock form. To date, the Company has not engaged
in any business.
The Company's office is located at 400 George
Street, Fredericksburg, Virginia and its telephone
number is (540) 899-5500. The Bank's executive
office has the same address and phone number.
FREDERICKSBURG SAVINGS
BANK...................... The Bank, which is currently a federally chartered
mutual savings and loan association, will become a
federally chartered stock savings bank known as
Fredericksburg Savings Bank in connection with its
conversion from mutual to stock form. At June 30,
1998, the Bank had total assets of $472.3 million,
total deposits of $373.7 million and total equity
capital of $83.5 million.
The Bank operates four banking offices, one in the
City of Fredericksburg, one in Stafford County and
two in Spotsylvania County, Virginia. The Bank
historically has operated as a community-oriented
banking institution primarily providing one- to
four-family residential mortgage loans and consumer
loans and a variety of retail deposit products in
its primary market area, which consists of the City
of Fredericksburg, and Stafford, Spotsylvania and
King George Counties, Virginia.
THE CONVERSION............ The Bank has adopted a Plan of Conversion (the
"Plan") which is subject to requirements of the
Office of Thrift Supervision (the "OTS"), the
primary federal banking regulator of the Bank. The
conversion, which hereafter is referred to as the
"Conversion," is governed by the Plan and has three
major components, as follows:
(i) The conversion of the Bank from mutual to
stock form;
(ii) The acquisition by the Company of all of the
outstanding capital stock of the Bank;
(iii) The sale by the Company of its common stock,
par value, $0.01 per share (the "Common
Stock").
The Conversion is subject to the approval of the
OTS, and approval of members of the Bank eligible
to vote at a special meeting to be held on December
17, 1998 (the "Special Meeting").
3
<PAGE>
FREDERICKSBURG SAVINGS
CHARITABLE FOUNDATION.... The Bank has established a charitable foundation,
Fredericksburg Savings Charitable Foundation, (the
"Foundation"). The Company intends to contribute to
the Foundation common stock up to 8% of the common
stock sold in the Conversion. The authority for the
affairs of the Foundation is vested in its Board of
Directors, the majority of whom are existing
Directors or officers of the Company and the Bank.
In this regard, the Foundation will reserve one
board seat for a period of five years for an
individual who is not an officer and/or director of
the Company or the Bank and who is a civic or
community leader within Fredericksburg, Virginia or
its neighboring communities and for that same
period of time will reserve one board seat for a
person who is an officer or director of the Bank.
TERMS OF THE OFFERING..... The shares of common stock are offered at a fixed
price of $10.00 per share in the Subscription
Offering pursuant to subscription rights in the
following order of priority to:
(i) Eligible Account Holders--holders of deposit
accounts, including all withdrawable deposits
in the Bank, including non-interest bearing
demand deposits, at the Bank totalling $50 or
more as of June 30, 1997;
(ii) the Employee Stock Ownership Plan of the
Company and the Bank (the "ESOP");
(iii) Supplemental Eligible Account Holders--
holders of deposit accounts at the Bank
totalling $50 or more as of September 30,
1998 who are not entitled to a first priority
subscription right; and
(iv) Other Members--holders of deposit accounts at
the Bank as of October 31, 1998 and borrowers
with loans outstanding as of September 2,
1986, which continue to be outstanding as of
October 31, 1998, who are not entitled to a
higher priority subscription right.
Shares of common stock not subscribed for by
persons having priority subscription rights will be
offered to certain members of the general public in
a Community Offering with preference given to
natural persons residing in the City of
Fredericksburg and Stafford and Spotsylvania
Counties.
EXPIRATION DATE OF
SUBSCRIPTION OFFERING.... Subscription rights will expire if not exercised
and all orders to purchase common stock in the
Subscription Offering must be received by 12:00
noon, Eastern time, on December 15, 1998, unless
extended (the "Expiration Date").
NONTRANSFERABILITY OF
SUBSCRIPTION RIGHTS...... The subscription rights are not transferable.
Persons found to be transferring such rights will
be subject to the forfeiture of such rights and
possible further sanctions and penalties imposed by
the OTS.
NUMBER OF SHARES
OFFERED.................. The Company is offering between a minimum of
8,976,000 shares and a maximum of 12,144,000 shares
of common stock, or up to an adjusted maximum of
13,965,600 shares if the maximum number of shares
is increased.
4
<PAGE>
The number of shares offered is based upon an
independent appraisal prepared by FinPro, Inc.
("FinPro") dated as of September 9, 1998, which
estimates that the aggregate pro forma market value
of the Company ranged from $89.8 million to $121.4
million. (This range is referred to as the
"Estimated Price Range"). FinPro is an independent
appraisal firm experienced in appraisals of savings
institutions. Establishing the Foundation in
connection with the Conversion will result in a
lower aggregate market valuation than if the
Conversion was completed without the Foundation.
The final aggregate estimated pro forma market
value of the Company will be determined at the time
of closing of the Subscription Offering, or if all
shares are not sold in the Subscription Offering,
the closing of the Community Offering or other
subsequent offering. Such estimated aggregate pro
forma market value is subject to change due to
changes in market and general financial and
economic conditions.
The maximum number of shares to be sold may be
increased up to the adjusted maximum, a 15%
increase over the maximum, if the aggregate
estimated pro forma market value of the common
stock to be sold is increased.
HOW TO ORDER STOCK........ If you have a subscription right, you may order
shares in the Subscription Offering by delivering
to the Bank a properly executed stock order and
certification form together with full payment for
the shares ordered on or prior to the Expiration
Date. ONCE TENDERED, SUBSCRIPTION ORDERS CANNOT BE
REVOKED OR MODIFIED WITHOUT THE CONSENT OF THE
BANK. Please make sure you review the Prospectus
carefully. To ensure that each purchaser receives a
prospectus at least 48 hours prior to the
Expiration Date in accordance with Rule 15c2-8 of
the Securities Exchange Act of 1934, no prospectus
will be mailed any later than five days prior to
the Expiration Date or hand delivered any later
than two days prior to such date. The Bank is not
obligated to accept subscriptions not submitted on
an original stock order form. To ensure that
subscription rights are properly identified,
persons must list all qualifying savings accounts,
as of the respective qualifying dates, on the stock
order form. Persons who do not list all qualifying
savings accounts may be subject to reduction or
rejection of their subscription.
Persons wishing to order shares offered in the
Community Offering also must submit a properly
executed stock order and certification form prior
to the expiration date to be set for the Community
Offering.
FORM OF PAYMENT FOR Payment for subscriptions may be made:
SHARES....................
(i) in cash (if delivered in person);
(ii) by check, bank draft or money order; or
(iii) by authorization of withdrawal from deposit
accounts maintained at the Bank.
ORDERS FOR COMMON STOCK IN THE SUBSCRIPTION
OFFERING WHICH AGGREGATE $50,000 OR MORE MUST BE
PAID BY OFFICIAL BANK OR CERTIFIED CHECK OR BY
WITHDRAWAL AUTHORIZATION FROM A DEPOSIT ACCOUNT AT
THE BANK. NO WIRE TRANSFERS WILL BE ACCEPTED.
5
<PAGE>
NUMBER OF SHARES THAT MAY
BE ORDERED................ Minimum: 25 shares ($250).
Maximum:
. No Eligible Account Holder, Supplemental
Eligible Account Holder or Other Member may
subscribe in the Subscription Offering for more
than $300,000 of common stock. In the event two
or more persons have an interest in an account
such as in the case of a joint account, the
aggregate amount all persons with an interest in
the account may subscribe for is $300,000 of
common stock.
. No person, together with associates or persons
acting in concert with such person, may purchase
in the Community Offering more than $300,000 of
common stock.
. No person, together with associates or persons
acting in concert with such person, may purchase
in the aggregate more than the overall maximum
purchase limitation of 1% ($1,214,400 at the
maximum) of the total number of shares of Common
Stock sold. However, the ESOP may purchase up to
10% of the Common Stock to be issued in
connection with the Conversion, including shares
issued to the Foundation. It is intended that
the ESOP will purchase 8% of the Common Stock
issued, including shares issued to the
Foundation.
USE OF PROCEEDS........... The Company will use 50% of the net proceeds from
the sale of common stock to purchase all of the
common stock of the Bank to be issued in the
Conversion. The portion of net proceeds retained by
the Company will be used for general business
activities, including the loan of funds to the ESOP
(to the extent such loan is not funded by a third
party) to enable the ESOP to purchase up to 8% of
the stock issued in connection with the Conversion,
including shares issued to the Foundation. The
Company intends initially to invest the remaining
net proceeds primarily in short-term U.S.
Government and Agency obligations, including
adjustable-rate mortgage-backed securities. The
Bank intends to utilize the net proceeds from the
sale of its stock to the Company for general
business purposes, including investment in loans
and to expand its market share through offering new
products and services. A primary goal of the Bank
is to offer retail products that attract more local
business customers to the Bank. The Bank also
intends to capitalize on its growing market to seek
opportunities to expand loan growth through the
origination of one- to four-family mortgage loans
as well as other loans, including home equity
loans. The Bank also intends to seek means to
attract more local businesses to the Bank for
retail checking, deposit and loan products. See
"Business of the Bank--Market Area and Competition"
and "--Lending Activities." Additionally, the Bank
intends to pursue means of expanding its market
share through offering new products and services
and through the acquisition of branch offices from
other financial institutions or through the
acquisition of other such companies. Although this
is a primary goal of the Bank, neither the Company
nor Bank have any specific plans with respect to
acquisitions at this time. See "Management's
Discussion and Analysis of Financial Condition and
Results of Operations--Management Strategy."
6
<PAGE>
DIVIDEND POLICY........... Upon Conversion, the Board of Directors of the
Company will have authority to declare dividends on
the Common Stock, subject to statutory and
regulatory requirements. Depending on market
conditions, the Company's Board of Directors
intends to pay cash dividends on the Common Stock;
however, no decision has been made regarding the
level of dividends or when they will be paid, and
no assurance can be given that dividends will
actually be paid. In addition, from time to time in
an effort to manage capital to a reasonable level,
the Board of Directors may determine to pay
periodic special cash dividends in addition to, or
in lieu of, regular cash dividends. Additionally,
in connection with the Conversion, the Company and
the Bank have committed to the OTS that during the
one-year period following the Conversion, the
Company will not take any action to further any
distribution to stockholders that, for federal tax
purposes, would be treated as a return of capital
without prior approval of the OTS and it is
unlikely the Company would take such action
following the one year period.
BENEFITS OF THE
CONVERSION TO
MANAGEMENT................ Among the benefits to the Bank and the Company
anticipated from the Conversion is the ability to
attract and retain personnel through the use of
stock options and other stock related benefit
programs. Subsequent to the Conversion, the Company
intends to adopt a Stock-Based Incentive Plan for
the benefit of directors, officers and employees of
the Company and Bank. If the Stock-Based Incentive
Plan is adopted within one year after the
Conversion, the plan will be subject to
stockholders' approval at a meeting of stockholders
which may not be held earlier than six months after
the Conversion. If adopted and approved by
stockholders, it is expected the benefits set forth
in the table below would be available for
distribution to employees and directors pursuant to
that plan.
Additionally, an ESOP, which is a tax qualified
plan, will be established in the Conversion to
provide retirement benefits to employees. Benefits
under that plan will be distributed to eligible
employees over an approximate twenty year period.
See the table below for the estimated value of such
benefits.
<TABLE>
<CAPTION>
PERCENTAGE OF
SHARES ISSUED,
ESTIMATED INCLUDING SHARES
VALUE OF ISSUED TO THE
SHARES(1) FOUNDATION
---------- ----------------
<S> <C> <C>
Employee Stock Ownership
Plan....................... $9,123,840 8.0%
Stock-Based Incentive Plan:
Stock Awards(2)............ 4,561,920 4.0
Stock Options.............. -- (3) 10.0
</TABLE>
--------
(1) Assumes shares are allocated to participants at
$10.00 per share and that shares are issued in
the Conversion at the midpoint of the Estimated
Price Range.
(2) Any Common Stock awarded under the Stock-Based
Incentive Plan will be awarded at no cost to
the recipients.
(3) Stock options will be granted with an exercise
price equal to the fair market value of the
Company's Common Stock on the day of grant.
Recipients of stock options realize value only
in the event of an increase in the price of the
Common Stock of the Company following the date
of grant of the stock options.
7
<PAGE>
In addition, the Company and Bank will enter into
employment agreements with the Company's and Bank's
two executive officers. Benefits under such
agreements would only be paid if the officer were
terminated without cause or if the officer
voluntarily retired under certain circumstances
following a Change in Control. The amounts payable
under these agreements will depend upon the
compensation paid to the officer in recent years
prior to termination. See "Management of the Bank--
Executive Compensation."
See "Management of the Bank" for more detail
regarding these and other benefits that are
currently available to employees or will be
following the Conversion.
PURCHASES BY OFFICERS AND
DIRECTORS................. Directors and executive officers of the Bank and
the Company expect to purchase approximately 2.07%
or 1.55% of shares of common stock to be issued in
the Conversion, including shares issued to the
Foundation, based on the estimated minimum and
maximum of such shares, respectively.
MARKET FOR STOCK..........
As a mutual institution, the Bank has never issued
capital stock and, consequently, there is no
existing market for the Common Stock. The Company
has received conditional approval to have its
Common Stock listed on the Nasdaq under the symbol
"VCAP" subject to the completion of the Conversion
and compliance with certain conditions.
NO BOARD The Bank's Board of Directors and the Company's
RECOMMENDATIONS........... Board of Directors make no recommendation to
depositors or other potential investors regarding
whether such persons should purchase the Common
Stock. An investment in the Common Stock must be
made pursuant to each investor's evaluation of his
or her best interests.
STOCK INFORMATION
CENTER.................... If you have any questions regarding the Conversion,
please call the Stock Information Center at (540)
368-1097, or toll free, at (800) 284-0198.
8
<PAGE>
SELECTED FINANCIAL AND OTHER DATA OF THE BANK
The selected financial and other data of the Bank set forth below is derived
in part from, and should be read in conjunction with, the Financial Statements
of the Bank and Notes thereto presented elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AT AT DECEMBER 31,
JUNE 30, --------------------------------------------
1998(1) 1997 1996(2) 1995 1994 1993
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
SELECTED FINANCIAL DATA:
Total Assets............ $472,280 $471,920 $469,917 $468,759 $451,035 $447,706
Loans receivable,
net(3)................. 415,986 413,032 405,145 390,541 371,269 375,229
Mortgage-backed
securities............. 1,190 1,291 1,502 1,879 2,109 2,640
Investment
securities(4).......... 30,928 31,151 31,979 49,257 52,361 49,629
Cash and cash
equivalents............ 9,031 11,287 15,937 11,980 11,088 6,772
Deposits................ 373,719 377,114 375,652 386,376 376,083 380,977
FHLB advances........... 8,000 8,000 15,000 8,000 8,000 8,000
Equity capital.......... 83,500 80,073 73,296 68,703 62,218 54,908
</TABLE>
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30, FOR THE YEAR ENDED DECEMBER 31,
------------------- ---------------------------------------
1998(1) 1997(1) 1997 1996(2) 1995 1994 1993
--------- --------- ------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
SELECTED OPERATING DATA:
Interest income......... $ 18,244 $ 18,072 $36,504 $35,998 $36,305 $33,234 $35,049
Interest expense........ 9,620 9,568 19,418 19,535 18,997 16,620 17,978
--------- --------- ------- ------- ------- ------- -------
Net interest income... 8,624 8,504 17,086 16,463 17,308 16,614 17,071
Provision for loan
losses................. 269 241 375 325 412 1,010 1,129
--------- --------- ------- ------- ------- ------- -------
Net interest income
after provision for
loan losses.......... 8,355 8,263 16,711 16,138 16,896 15,604 15,942
Total noninterest
income................. 249 205 460 409 283 256 3
Total noninterest
expense................ 3,069 3,059 6,794 9,565 6,451 6,850 7,326
--------- --------- ------- ------- ------- ------- -------
Income before income
taxes and cumulative
effect of change in
accounting principle... 5,535 5,409 10,377 6,982 10,728 9,010 8,619
Income tax expense...... 2,215 2,150 3,952 2,401 4,070 1,687 3,935
--------- --------- ------- ------- ------- ------- -------
Net income before
cumulative effect of
change in accounting
principle............ 3,320 3,259 6,425 4,581 6,658 7,323 4,684
Cumulative effect of
change in accounting
principle(5)........... -- -- -- -- -- -- 680
--------- --------- ------- ------- ------- ------- -------
Net income............ $ 3,320 $ 3,259 $ 6,425 $ 4,581 $ 6,658 $ 7,323 $ 5,364
========= ========= ======= ======= ======= ======= =======
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE SIX
MONTHS ENDED
JUNE 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------- --------------------------------------------
1998(1) 1997(1) 1997 1996(2) 1995 1994 1993
-------- -------- ------- --------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
SELECTED FINANCIAL
RATIOS AND OTHER
DATA(6)
PERFORMANCE RATIOS:
Return on average
assets................ 1.40% 1.39% 1.36% 0.98% 1.45% 1.62% 1.19%
Return on average
equity................ 8.12 8.71 8.39 6.42 10.17 12.61 10.26
Interest rate
spread(7)............. 2.88 2.96 2.93 2.89 3.19 3.25 3.44
Net interest
margin(8)............. 3.74 3.72 3.73 3.61 3.86 3.76 3.88
Yield on average-
interest earning
assets................ 7.90 7.92 7.97 7.90 8.11 7.81 7.97
Net interest income
after provisions for
loan losses, to total
noninterest expenses.. 272.24 270.12 245.97 168.72 261.91 227.80 217.61
Total noninterest
expense to average
assets................ 1.29 1.30 1.44 2.04 1.41 1.52 1.62
Efficiency ratio(9).... 34.58 35.12 38.72 56.69 36.67 40.60 42.91
REGULATORY CAPITAL
RATIOS(10):
Tangible capital....... 17.05% 15.77% 16.34% 14.97% 14.53% 13.33% 12.21%
Core capital........... 17.05 15.77 16.34 14.97 14.53 13.33 12.21
Risk-based capital..... 29.78 26.13 26.92 25.70 25.51 23.53 21.61
ASSET QUALITY RATIOS:
Non-performing loans to
total assets(11)(12).. 0.87% 1.48% 1.18% 1.91% 1.45% 2.34% 1.50%
Non-performing loans to
total loans(11)(12)... 0.94 1.61 1.29 2.10 1.64 2.67 1.68
Non-performing assets
to total assets(12)... 1.27 1.88 1.59 2.25 1.91 2.58 1.95
Allowance for loan
losses to non-
performing loans(12).. 137.81% 80.28% 98.60% 61.89% 80.60% 52.50% 79.66%
NUMBER OF FULL-SERVICE
BANKING FACILITIES..... 4 4 4 4 4 4 4
</TABLE>
- --------
(1) The data presented for the six months ended June 30, 1998 and 1997 was
derived from unaudited financial statements and reflect, in the opinion of
management, all adjustments (consisting only of normal recurring
adjustments) which are necessary to present fairly the results for such
interim periods. Interim results at and for the six months ended June 30,
1998 are not necessarily indicative of the results that may be expected for
the year ended December 31, 1998.
(2) Includes effect of the one-time special assessment of $2.5 million, on a
pre-tax basis, to recapitalize the Savings Association Insurance Fund
("SAIF"), which was recorded by the Bank in 1996.
(3) Loans receivable, net, consist of loans receivable minus the allowance for
loan losses, deferred loan fees and unadvanced loan funds. The allowance
for loan losses at June 30, 1998 and December 31, 1997, 1996, 1995, 1994
and 1993 was $5.6 million, $5.5 million, $5.5 million, $5.5 million, $5.5
million and $5.4 million, respectively.
(4) The Bank adopted Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities" as
of January 1, 1995. On December 31, 1995, a majority of the Bank's
portfolio was classified as "available-for-sale." Securities do not include
Federal Home Loan Bank of Atlanta ("FHLB-Atlanta" or "FHLB") stock of $3.5
million, $3.4 million, $3.2 million, $3.1 million, $4.1 million and $4.1
million at June 30, 1998 and December 31, 1997, 1996, 1995, 1994 and 1993,
respectively.
(5) Represents the cumulative effect, as of January 1, 1993, of the initial
application of Financial Accounting Standards Board Statement 109,
"Accounting for Income Taxes."
(6) Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average monthly balances during the indicated periods and are annualized
where appropriate.
(7) The interest rate spread represents the difference between the weighted
average yield on average interest-earning assets (which includes FHLB-
Atlanta stock and other equity securities) and the weighted average cost of
average interest-bearing liabilities.
(8) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(9) The efficiency ratio represents the ratio of noninterest expenses divided
by the sum of net interest income and noninterest income.
(10) For definitions and further information relating to the Bank's regulatory
capital compliance requirements, see "Regulation--Federal Savings
Institution Regulation--Capital Requirements." See "Regulatory Capital
Compliance" for the Bank's pro forma capital levels as a result of the
Offerings.
(11) Loans include total loans before the allowance for loan losses.
(12) Non-performing assets consist of non-performing loans and real estate
owned ("REO"). Non-performing loans consist of all loans 90 days or more
past due and other loans which have been identified by the Bank as
presenting uncertainty with respect to the collectibility of interest or
principal. It is the Bank's policy to cease accruing interest on loans 90
days or more past due. The Bank does, however, continue accruing interest
on loans 90 days or more past due that are in the process of being renewed
or extended. See "Business of the Bank."
10
<PAGE>
RECENT DEVELOPMENTS
The following tables set forth certain financial and other information of the
Bank for the periods and at the dates indicated. The selected financial data,
operating data and ratios and other data as of September 30, 1998 and for the
three and nine months ended September 30, 1998 and 1997 are derived from
unaudited financial statements. In the opinion of management, all adjustments
(consisting only of normal recurring accruals) considered necessary for the
fair presentation of financial data and operating data for the three and nine
months ended September 30, 1998 and 1997 are included. The results of
operations and ratios and other data presented for the three and nine months
ended September 30, 1998 are not necessarily indicative of the results of
operations for the year ending December 31, 1998.
<TABLE>
<CAPTION>
AT AT
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
SELECTED FINANCIAL DATA:
Total Assets......................................... $478,626 $471,920
Loans receivable, net(1)............................. 416,711 413,032
Mortgage-backed securities........................... 1,091 1,291
Investment securities(2)............................. 27,438 31,151
Cash and cash equivalents............................ 18,441 11,287
Deposits............................................. 376,695 377,114
Other borrowings..................................... 8,000 8,000
Equity capital....................................... 85,134 80,073
</TABLE>
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------- -------------------
1998 1997 1998 1997
---------- ---------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
SELECTED OPERATING DATA:
Interest income..................... $ 9,011 $ 9,237 $ 27,255 $ 27,309
Interest expense.................... 4,828 4,907 14,448 14,475
---------- ---------- --------- ---------
Net interest income................. 4,183 4,330 12,807 12,834
Provision for loan losses........... 146 128 415 369
---------- ---------- --------- ---------
Net interest income after provision
for loan losses.................... 4,037 4,202 12,392 12,465
Total noninterest income............ 85 111 334 316
Total noninterest expense........... 1,340 1,542 4,409 4,601
---------- ---------- --------- ---------
Income before income taxes.......... 2,782 2,771 8,317 8,180
Income tax expense.................. 1,085 1,105 3,300 3,255
---------- ---------- --------- ---------
Net income.......................... $ 1,697 $ 1,666 $ 5,017 $ 4,925
========== ========== ========= =========
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE AT OR FOR THE
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
SELECTED FINANCIAL RATIOS AND OTHER
DATA(3)
Performance Ratios:
Return on average assets........... 1.42% 1.41% 1.41% 1.40%
Return on average equity........... 8.05 8.62 8.10 8.67
Interest rate spread(4)............ 2.73 2.97 2.85 2.96
Net interest margin(5)............. 3.61 3.78 3.70 3.75
Yield on average-interest earning
assets............................ 7.77 8.06 7.87 7.97
Net interest income after
provisions for loan losses, to
total noninterest expenses........ 301.27 272.50 281.06 270.92
Total noninterest expense to
average assets.................... 1.13 1.31 1.24 1.31
Efficiency ratio(6)................ 31.40 34.72 33.55 34.99
REGULATORY CAPITAL RATIOS(7):
Tangible capital................... 17.17 16.03 17.17 16.03
Core capital....................... 17.17 16.03 17.17 16.03
Risk-based capital................. 28.68 26.97 28.68 26.97
ASSET QUALITY RATIOS:
Non-performing loans to total
assets(8)(9)...................... 1.07 1.30 1.07 1.30
Non-performing loans to total
loans(8)(9)....................... 1.18 1.42 1.18 1.42
Non-performing assets to total
assets(9)......................... 1.40 1.66 1.40 1.66
Allowance for loan losses to non-
performing loans(9)............... 110.68 92.64 110.68 92.64
NUMBER OF FULL-SERVICE BANKING
FACILITIES........................ 4 4 4 4
</TABLE>
- --------
(1) Loans receivable, net, consist of loans receivable minus the allowance for
loan losses, deferred loan fees and unadvanced loan funds. The allowance
for loan losses at September 30, 1998 and December 31, 1997 was $5.7
million and $5.5 million, respectively.
(2) The Bank adopted SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities" as of January 1, 1995. On December 31, 1995, a
majority of the Bank's portfolio was classified as "available-for-sale."
Securities do not include FHLB-Atlanta stock of $3.5 million, and $3.4
million, at September 30, 1998 and December 31, 1997, respectively.
(3) Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average monthly balances during the indicated periods and are annualized
where appropriate.
(4) The interest rate spread represents the difference between the weighted
average yield on average interest-earning assets (which includes FHLB-
Atlanta stock and other equity securities) and the weighted average cost of
average interest-bearing liabilities.
(5) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(6) The efficiency ratio represents the ratio of noninterest expenses divided
by the sum of net interest income and noninterest income.
(7) For definitions and further information relating to the Bank's regulatory
capital compliance requirements, see "Regulation--Federal Savings
Institution Regulation--Capital Requirements." See "Regulatory Capital
Compliance" for the Bank's pro forma capital levels as a result of the
Offerings.
(8) Loans include total loans before the allowance for loan losses.
(9) Non-performing assets consist of non-performing loans and REO. Non-
performing loans consist of all loans 90 days or more past due and other
loans which have been identified by the Bank as presenting uncertainty with
respect to the collectibility of interest or principal. It is the Bank's
policy to cease accruing interest on loans 90 days or more past due. The
Bank does, however, continue accruing interest on loans 90 days or more
past due that are in the process of being renewed or extended. See
"Business of the Bank."
12
<PAGE>
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
Assets totalled $478.6 million at September 30, 1998, an increase of $6.7
million, or 1.42% from total assets of $471.9 million at December 31, 1997. The
increase in assets during the nine month period was due primarily to a $3.7
million increase in the Bank's loan portfolio. Cash and cash equivalents
increased $7.2 million, offset by reductions in investment securities of $3.7
million and $200,000 in mortgage backed securities.
Loans. The increase in total loans was primarily due to increases in
residential real estate mortgage loans and construction and development loans,
partially offset by a decrease in non-residential real estate loans. Although
total residential real estate mortgage loans increased $9.9 million, or 2.76%,
total mortgage loans, as a percentage of total loans, remained relatively
stable from December 31, 1997, at 97.98% at September 30, 1998. Construction
and development loans increased from $16.0 million (3.72% of the portfolio) at
December 31, 1997 to $21.0 million (4.81% of the portfolio) at September 30,
1998. Non-residential real estate loans decreased by $7.1 million from $41.0
million at December 31, 1997 to $33.9 million at September 30, 1998. This was
the result of large loan payoffs in this portfolio. Undisbursed loan funds
increased from $5.0 million at December 31, 1997 to $8.1 million at September
30, 1998.
Allowance for Loan Losses. The allowance for loan losses increased from $5.5
million at December 31, 1997 to $5.7 million at September 30, 1998, an increase
of $217,000. The relatively stable allowance during this period reflects the
economic stability in the market area as well as improvement in net charged off
loans. The adequacy of the allowance for loan losses is evaluated monthly by
management based upon a review of significant loans, with particular emphasis
on nonperforming and delinquent loans that management believes warrant special
attention. At September 30, 1998, the allowance for loan losses provided
coverage of 110.68% of total nonperforming loans, an increase from 98.60% at
December 31, 1997. The balance of the allowance is maintained at a level which
is, in management's judgement, representative of the amount of risk inherent in
the loan portfolio. See "Business of the Bank--Allowance for Loan Losses."
Investment Securities. The balances of securities held-to-maturity and
available-for-sale decreased from $1.3 million and $31.2 million, respectively,
at December 31, 1997 to $1.1 million and $27.4 million, respectively, at
September 30, 1998. These decreases were primarily due to redemptions and
principal payments of these securities totalling approximately $5.2 million
during the nine months ended September 30, 1998. These repayments were offset
by purchases of securities totalling $1.5 million. Currently, management
intends to continue allowing the Bank's investment securities to mature and
paydown and to reinvest the proceeds primarily in securities to be classified
by the Bank as available-for-sale and in new loans.
Deposits. Total deposits decreased $419,000, or .11%, from 377.1 million at
December 31, 1997 to $376.7 million at September 30, 1998. While time deposits
increased $2.0 million, or .69%, during the period, savings accounts decreased
$161,000, or .42%, money market accounts decreased $2.5 million, or 5.48%, and
noninterest-bearing accounts increased $251,000, or 7.69%.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998
AND 1997
General. Net income was $1.7 million for both the three months ended
September 30, 1998 and 1997. Net interest income was $4.2 million for the three
months ended September 30, 1998, a decrease of $147,000 from $4.3 million for
the three months ended September 30, 1997.The Bank's return on average assets
("ROA") was 1.42% for the three months ended September 30, 1998, an increase
from 1.41% for the three months ended September 30, 1997. The Bank's return on
average equity ("ROE") was 8.05% for the three months ended September 30, 1998,
a decrease from 8.62% for the three months ended September 30, 1997.
Interest Income. Interest income for the three months ended September 30,
1998 was $9.0 million, a decrease of $226,000, or 2.5%, from $9.2 million for
the three months ended September 30, 1997. The decrease
13
<PAGE>
in interest income was primarily the result of a 29 basis point decrease in the
yield on average interest-earning assets from 8.06% for the three months ended
September 30, 1997, to 7.77% for the three months ended September 30, 1998. The
decline in the yield on average interest-earning assets was partially offset by
an increase in average interest-earning assets of $5.4 million from $458.3
million for the three months ended September 30, 1997 to $463.7 million for the
three months ended September 30, 1998.
Interest expense. Interest expense was $4.8 million for the three months
ended September 30, 1998, a decrease of $79,000, or 1.6%, from $4.9 million for
the three months ended September 30, 1997. The decrease in interest expense was
primarily the result of a 5 basis point decrease in the average cost of
interest-bearing liabilities from 5.09% for the three months ended September
30, 1997 to 5.04% for the three months ended September 30, 1998. In addition,
the decline in interest expense was furthered by a decrease in average
interest-bearing liabilities of $2.5 million from $385.7 million for the three
months ended September 30, 1997 to $383.2 million for the three months ended
September 30, 1998.
Net Interest Income. Net interest income for the three months ended September
30, 1998 was $4.2 million, a decrease of $147,000, or 3.4%, from $4.3 million
for the three months ended September 30, 1997. The decrease was the net result
of a $226,000 decrease in interest income and a $79,000 decrease in interest
expense. The Bank's interest rate spread was 2.73% for the three months ended
September 30, 1998, a decrease of 24 basis points from 2.97% for the three
months ended September 30, 1997. The Bank's net interest margin was 3.61% for
the three months ended September 30, 1998, a decrease of 17 basis points from
3.78% for the three months ended September 30, 1997.
Provision for Loan Losses. The provision for loan losses increased $18,000
from $128,000 for the three months ended September 30, 1997 to $146,000 for the
three months ended September 30, 1998. The increase is primarily the result of
increases in specific reserves for certain residential mortgage loans and land
development loans during the three months ended September 30, 1998. The bank
increased specific reserves for certain loans as a result of management's
determination that collateral had deteriorated in condition or value and/or a
determination that certain borrowers may be financially weak as a result of
their loans becoming 30 or more days past due. Management believes the specific
reserves established are adequate at this time.
Noninterest Income. Total noninterest income was $85,000 for the three months
ended September 30, 1998, a decrease of $26,000 from $111,000 for the three
months ended September 30, 1997. Noninterest income is composed primarily of
servicing fees and deposit account service charges.
Noninterest expense. Total noninterest expense was $1.3 million for the three
months ended September 30, 1998, a decrease of $202,000 from $1.5 million for
the three months ended September 30, 1997. This decrease consists of reductions
in compensation and benefits of $68,000, reductions in Federal deposit
insurance premiums of $48,000 and reductions in the net cost of foreclosed real
estate operations of $71,000.
Income Taxes. Income tax expense was $1.1 million for both the three months
ended September 30, 1998 and 1997. The consistent income tax expense from 1997
to 1998 was the result of consistent income before income taxes of $2.8 million
for both years.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
AND 1997
General. Net income for the nine months ended September 30, 1998 increased
$92,000 to $5.0 million compared to the nine months ended September 30, 1997.
This increase was primarily a result of a decrease in noninterest expense of
$192,000, which was partially offset by an increase in the provision for loan
losses of $46,000, a decrease in net interest income of $27,000 and an increase
in income tax expense of $45,000. The Bank's ROA was 1.41% for the nine months
ended September 30, 1998, up from 1.40% for the same period in 1997. The Bank's
ROE was 8.10% for the nine months ended September 30, 1998, down from 8.67% for
the nine months ended September 30, 1997.
Interest Income. Interest income for the nine months ended September 30, 1998
decreased $54,000 to $27.2 million, from $27.3 million for the comparable
period in 1997 primarily the result of a 10 basis point
14
<PAGE>
decrease in the yield on average interest-earning assets from 7.97% for the
nine months ended September 30, 1998, to 7.87% for the nine months ended
September 30, 1997. The decline in the yield on average interest-earning assets
was partially offset by an increase in average interest-earning assets of $5.4
million from $456.6 million for the nine months ended September 30, 1997 to
$462.0 million for the nine months ended September 30, 1998.
Interest Expense. Interest expense was $14.4 million for the nine months
ended September 30, 1998, a decrease of $27,000, or .19%, from 14.5 million for
the nine months ended September 30, 1997. The decrease in interest expense was
primarily the result of a decrease in the average balance of interest-bearing
liabilities of $1.7 million from $385.1 million for the nine months ended
September 30, 1997 to $383.4 million for the nine months ended September 30,
1998.
Net Interest Income. Net interest income was $12.8 million for both the nine
months ended September 30, 1998 and 1997. The Bank's interest rate spread was
2.85% for the nine months ended September 30, 1998, a decrease of 11 basis
points from 2.96% for the nine months ended September 30, 1997. The Bank's net
interest margin was 3.70% for the nine months ended September 30, 1998, a
decrease of 5 basis points from 3.75% for the nine months ended September 30,
1997.
Provision for Loan Losses. The provision for loan losses increased $46,000
from $369,000 for the nine months ended September 30, 1997 to $415,000 for the
nine months ended September 30, 1998. The increase is primarily the result of
increases in specific reserves for residential mortgage loans and land
development loans during the nine months ended September 30, 1998. The Bank
increased specific reserves for certain loans as a result of management's
determination that collateral had deteriorated in condition or value and/or a
determination that certain borrowers may be financially weak as a result of
their loans becoming 30 or more days past due. Management believes the specific
reserves established are adequate at this time.
Noninterest Income. Total noninterest income was $334,000 for the nine months
ended September 30, 1998, an increase of $18,000 from $316,000 for the same
period in 1997. Noninterest income is composed primarily of servicing fees and
deposit account service charges.
Noninterest Expense. Total noninterest expense was $4.4 million for the nine
months ended September 30, 1998, a decrease of $192,000 from $4.6 million for
the nine months ended September 30, 1997. Decreases in compensation and
benefits of $295,000 and net cost of foreclosed real estate operations of
$66,000 were offset by increases in other expenses totalling $185,000.
Income Taxes. Income tax expense was $3.3 million for both the nine months
ended September 30, 1998 and 1997. Income before income tax expense was $8.3
million for the year ended September 30, 1998 compared to $8.2 million for the
year ended September 30, 1997.
15
<PAGE>
RISK FACTORS
Investors should consider the following risk factors, in addition to those
discussed elsewhere in this Prospectus, before deciding whether to purchase
the Common Stock offered hereby.
SENSITIVITY TO CHANGES IN INTEREST RATES
The Bank's profitability, like that of most financial institutions, is
dependent to a large extent upon its net interest income, which is the
difference between its interest income on interest-earning assets, such as
loans and investments, and its interest expense on interest-bearing
liabilities, such as deposits and borrowings. Accordingly, the Bank's results
of operations and financial condition are largely dependent on movements in
market interest rates and its ability to manage its assets in response to such
movements.
The Bank attempts to manage its interest rate risk by seeking to originate
and retain adjustable-rate and shorter-term fixed-rate loans, and by
originating shorter-term, higher yielding consumer loans and investing in
securities with shorter stated or estimated maturities. However, in recent
years the Bank has originated primarily fixed-rate mortgage loans with terms
of 15 to 30 years, which the Bank retains in its portfolio. The Bank has done
this in response to very low customer demand for adjustable-rate loans and the
Bank's concern that failure to continue to originate loans in its primary
market area would adversely affect the Bank's ability to compete against other
financial services companies in its market area over the long term. Most
recently, while the Bank has continued to emphasize 15 year fixed-rate loans,
the Bank has primarily originated 30 year fixed-rate loans due to market
demand. This has resulted in the Bank becoming significantly vulnerable to
changes in interest rates. At June 30, 1998, the Bank's gross total loans had
an average weighted maturity of 17.4 years. At such date, $119.7 million, or
27.4% of the Bank's loans had adjustable interest rates with a weighted
average maturity of 20.0 years. At June 30, 1998, the Bank had $196.7 million
of certificates of deposit with maturities of less than one year and $45.3
million of certificates of deposit over $100,000 ("jumbo certificates of
deposit"). Such jumbo certificates of deposit tend to be less stable sources
of funding as compared to money market, savings and retail checking. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Management of Interest Rate Risk and Market Risk Analysis." At
June 30, 1998, the Bank's total interest-bearing liabilities maturing or
repricing within one year exceeded its total interest-earning assets maturing
or repricing in the same time period by $71.6 million, representing a
cumulative one-year interest sensitivity gap as a percentage of total assets
of negative 15.17%. To date, the Bank's policy of remaining competitive,
notwithstanding the potentially negative effects this strategy may have, has
not adversely affected the Bank. However, in a rapidly rising interest rate
environment, the cost of the Bank's interest-bearing liabilities will
generally increase at a rate faster than the yield on its interest-earning
assets thereby likely adversely affecting the Bank's net interest income. The
Bank's high level of capital and liquid assets could limit the effect of such
a change in interest rates, but the Bank would also be subject to other risks.
Specifically, increases in interest rates also could adversely affect the type
(fixed-rate or adjustable-rate) and amount of loans originated by the Bank
which, in turn, could adversely impact the yields earned on the Bank's loan
portfolios as well as the amount of secondary market activity in which the
Bank may engage.
Furthermore, increases in market interest rates would result in an increase
in the interest rates on the Bank's adjustable-rate loans, thereby causing
higher loan payment amounts by the borrowers which, in turn, may result in
elevated delinquencies on such loans. Increases in the level of interest rates
may also adversely affect the value of the Bank's investment securities and
other interest-earning assets and, in turn, its results of operations or
retained earnings. At June 30, 1998, the Bank's securities available-for-sale
had an estimated fair value of $30.9 million, which was $458,000 greater than
the amortized cost of $30.5 million. At the same date, the Bank's mortgage-
backed securities held-to-maturity had an estimated fair value of $1.2
million, which was $36,000 greater than their amortized cost. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Management of Interest Rate Risk and Market Risk Analysis,"
"Business of the Bank--Lending Activities--One- to Four-Family Lending" and
"--Investment Activities."
16
<PAGE>
POTENTIAL LOW RETURN ON EQUITY FOLLOWING THE CONVERSION
At June 30, 1998, the Bank's ratio of equity capital to total assets was
17.68%. The Company's equity position will be significantly increased as a
result of the Conversion. On a pro forma basis as of June 30, 1998, assuming
the sale of Common Stock at the midpoint of the Estimated Price Range, the
Company's ratio of stockholders' equity to total assets would have been 31.4%.
The Company's ability to deploy this new capital through investments in
interest-earning assets, such as loans and securities, which bear rates of
return comparable to its current investments, will be significantly affected
by industry competition for such investments. The Company currently
anticipates that it will take time to prudently deploy such capital. In
addition, although the Bank has operated extremely efficiently in the past and
management intends to continue to control costs, the Bank will incur
additional expenses operating as a public company. Furthermore, the addition
of new products and services may result in increased expense, including the
hiring of additional personnel. As a result of these factors, the Company's
return on equity initially is expected to be below its historical return on
equity and may be below peer group institutions after the Conversion.
Additionally, due to the implementation of stock-based benefit plans such as
the ESOP and the Stock-Based Incentive Plan, the Company's future compensation
expense will be increased, thereby, adversely affecting its net income and
return on equity.
MANAGEMENT DISCRETION IN INVESTMENT OF THE PROCEEDS
Assuming the sale of Common Stock at the midpoint of the Estimated Price
Range, the Company will have capital totalling approximately $177.0 million on
a pro forma basis following completion of the Offering. The ability of
management to invest the Company's capital will depend, among other things, on
market conditions at the time the Offering is closed and thereafter.
Management, in consultation with the Board, will have exclusive control over
how the Company's capital is invested. Although management currently intends
to initially invest the proceeds in new loans, U.S. Treasury and Agency
Obligations, and short-term investments which management believes bear
relatively low risk, a primary goal of management is to seek opportunities to
expand the Bank's market share through expansion of products and services, and
through the pursuit of acquisition opportunities, including, possibly, the
acquisition of a commercial bank; however, no current plans regarding
acquisitions exist. As a result, there can be no guarantee that management
will be successful in finding acquisition opportunities, and there can be no
assurance that the Bank will be successful in that regard. Inasmuch as
management has not attempted to allocate the proceeds to be received through
the Offering to any particular uses other than the general uses described
above, investment of the proceeds could be a lengthy process and the failure
of management to effectively deploy the capital in long-term investments that
provide for higher yields than will be received on short-term investments
could adversely affect the Company's future profitability and return on
equity. See "Use of Proceeds" and "Risk Factors--Potential Low Return on
Equity Following the Conversion."
LENDING RISKS ASSOCIATED WITH NON-RESIDENTIAL REAL ESTATE, CONSTRUCTION AND
DEVELOPMENT, MULTI-FAMILY, LAND AND LAND DEVELOPMENT AND CONSUMER LOANS
At June 30, 1998, the Bank's non-residential real estate, construction and
development, land and land development, multi-family and consumer loan
portfolios totalled $70.2 million, or 16.06%, of total loans. Of this amount,
$3.4 million, or 0.78%, consisted of multi-family loans, $20.0 million, or
4.57%, consisted of construction and development loans, $35.3 million, or
8.08%, consisted of non-residential real estate loans, which includes $12.1
million in loans to local churches, $2.3 million or 0.53% consisted of land
and land development and $9.2 million, or 2.10%, consisted of consumer loans.
These types of loans are generally viewed as exposing the lender to greater
risk of loss than one- to four-family residential loans and, with the
exception of consumer loans, frequently have higher principal amounts. The
specific risks associated with these types of loans are discussed in "Business
of the Bank--Lending Activities."
POTENTIAL NEGATIVE EFFECTS OF THE FOUNDATION
The Company intends to establish the Foundation and to contribute to it
shares of common stock equal to 8% of the shares to be sold in the Conversion.
Establishment of the Foundation is subject to the approval of the
17
<PAGE>
Bank's members at a Special Meeting. If approved by members, the establishment
of the Foundation will be dilutive to the voting and ownership interests of
stockholders and will have an adverse impact on the operating results of the
Company for its year ending December 31, 1998, possibly resulting in an
operating loss for that year.
Dilution of Stockholders' Interests. At the minimum, midpoint and maximum of
the Estimated Price Range, the contribution to the Foundation would be
718,080, 844,800, and 971,520 shares, with a value of $7,180,800, $8,448,000,
and $9,715,200, respectively, based on the public offering price of $10.00 per
share for the shares of common stock to be sold in the Conversion (the
"Purchase Price"). Upon completion of the Conversion and establishment of the
Foundation, the Company will have 13,115,520 shares issued and outstanding at
the maximum of the Estimated Price Range, of which the Foundation will own
971,520 shares, or 7.4% AS A RESULT, PERSONS PURCHASING SHARES IN THE
CONVERSION WILL HAVE THEIR OWNERSHIP AND VOTING INTERESTS IN THE COMPANY
DILUTED BY 7.4%. SEE "PRO FORMA DATA."
Negative Impact on Earnings. The Company will recognize an expense in the
amount of the contribution to the Foundation in the quarter in which it
occurs, which is expected to be the fourth quarter of 1998. Such expense will
reduce earnings and have a material adverse impact on the Company's earnings
for the fiscal year. The amount of the contribution will range from $7.2
million to $9.7 million, depending on the amount of common stock sold in the
Conversion. The contribution expense will be partially offset by the tax
deductibility of the expense. The Company has been advised by its independent
accountants that the contribution to the Foundation will be deductible for
federal income tax purposes, subject to a limitation based on 10% of the
Company's annual taxable income. Assuming a contribution of $8.4 million in
common stock, based on the mid-point of the Estimated Price Range, the Company
estimates a net tax effected expense of $5.2 million. If the Foundation had
been established at June 30, 1998, the Bank would have reported a net loss of
$1.9 million for the first six months of 1998 rather than reporting net income
of $3.3 million. In addition to the contribution to the Foundation, the Bank
may in the future continue to make ordinary charitable contributions within
its community.
Possible Nondeductibility of the Contribution. The Company estimates that
substantially all of the contribution to the Foundation should be deductible
for federal tax purposes over the permissible six-year period. However, no
assurance can be made that the Company will have sufficient pre-tax income
over the five-year period following the year in which the contribution is
initially made to fully utilize the carryover related to the excess
contribution. Furthermore, although the Company and the Bank have received an
opinion of their independent accountants that the Company will be entitled to
the deduction for the contribution to the Foundation, there can be no
assurance that the Internal Revenue Service ("IRS") will recognize the
Foundation as a Section 501(c)(3) exempt organization or that the deduction
will be permitted. In such event, there would be no tax benefit related to the
Foundation.
Potential Anti-Takeover Effect. If approved by the Bank's members, upon
completion of the Conversion, the Foundation will own 7.4% of the total shares
of the Company's common stock outstanding. However, pursuant to the terms of
the contribution as mandated by the OTS, the shares of common stock held by
the Foundation must be voted in the same ratio as all other shares of the
Company's common stock on all proposals considered by the stockholders of the
Company. As a result, the Company does not believe the Foundation will have an
anti-takeover effect on the Company. In the event, however, that the OTS were
to waive this voting restriction and not impose other restrictions and
requirements with respect to the Foundation, the Foundation's board of
directors would exercise sole voting power over such shares. See "The
Conversion--Establishment of the Charitable Foundation--Regulatory Conditions
Imposed on the Foundation." If the Foundation's shares are combined with
shares purchased directly by officers and directors of the Company, shares
held by proposed stock benefit plans, if approved by stockholders, and shares
held in the Bank's ESOP, the aggregate of such shares could exceed 20% of the
Company's outstanding common stock, which could enable management to defeat
stockholder proposals requiring 80% approval. Consequently, in the event the
voting restriction was waived, this potential voting control might preclude
takeover attempts that certain stockholders deem to be in their best interest,
and might tend to perpetuate management. Since the ESOP shares are allocated
to all eligible employees of the Bank, and any unallocated shares will be
voted by an independent trustee, and because awards under the
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<PAGE>
proposed stock benefit plans may be granted to employees other than executive
officers and directors, management of the Company does not expect to have
voting control of all shares held or allocated by the ESOP or other stock
benefit plans. See "--Certain Anti-Takeover Provisions Which May Discourage
Takeover Attempts--Voting Control of Officers and Directors."
There will be no agreements or understandings, written or tacit, with
respect to the exercise of either direct or indirect control over the
management or policies of the Company by the Foundation which may discourage
takeover attempts, including agreements related to voting, acquisition or
disposition of the Company's common stock. Finally, as the Foundation sells
its shares of common stock over time, its ownership interest and voting power
in the Company are expected to decrease.
Potential Challenges. The establishment and funding of a charitable
foundation as part of a conversion is innovative and has been done in only a
limited number of instances. As such, the Foundation may be subject to
potential challenges notwithstanding that the Boards of Directors of the
Company and the Bank have carefully considered the various factors involved in
the establishment of the Foundation. See "The Conversion--Establishment of the
Charitable Foundation--Purpose of the Foundation." If anyone were to institute
an action seeking to require that the Bank eliminate establishment of the
Foundation, no assurances can be made that the resolution of such action would
not result in a delay in the consummation of the Conversion or that any
objecting persons would not be ultimately successful in obtaining the
elimination of the Foundation or other equitable relief or monetary damages
against the Company or the Bank. Additionally, if the Company and the Bank are
forced to eliminate the Foundation, the Company may be required to resolicit
subscribers in the Offerings.
Approval of Members. Establishment of the Foundation is subject to the
approval of a majority of the total outstanding votes of the Bank's members
eligible to be cast at a Special Meeting. The Foundation will be considered as
a separate matter from approval of the Plan of Conversion. If the Bank's
members approve the Plan of Conversion, but not the establishment of the
Foundation, the Bank intends to complete the Conversion without the
establishment of the Foundation. Failure to approve the Foundation may
materially increase the aggregate pro forma market value of the common stock
to be sold in the Conversion since the estimate of such amount takes into
account the dilutive impact of the issuance of shares to the Foundation. If
the aggregate pro forma market value of the common stock without the
Foundation is either greater than $139.7 million or less than $89.8 million,
the Bank will establish a new Estimated Price Range and commence a
resolicitation of subscribers (i.e., subscribers will be permitted to continue
their orders, in which case they will need to affirmatively reconfirm their
subscriptions prior to the expiration of the resolicitation offering or their
subscriptions funds will be promptly refunded with interest at the Bank's
passbook rate of interest, or be permitted to increase, decrease, or cancel
their subscriptions). Any change in the Estimated Price Range must be approved
by the OTS. See "The Conversion--Stock Pricing." A resolicitation, if any,
following the conclusion of the Subscription and Community Offerings would not
exceed 45 days unless further extended by the OTS for periods of up to 90 days
not to extend beyond December 17, 2000.
FINANCIAL INSTITUTION REGULATION AND POSSIBLE LEGISLATION
The Bank is subject to extensive regulation and supervision as a federal
savings association. In addition, the Company, as a savings and loan holding
company, is subject to regulation and supervision. Such regulations, which
affect the Bank on a daily basis, may be changed at any time, and the
interpretation of the relevant law and regulations is also subject to change
by the authorities who examine the Bank and interpret those laws and
regulations. Any change in the regulatory structure or the applicable statutes
or regulations, whether by the OTS, the Federal Deposit Insurance Corporation
("FDIC") or the Congress, could have a material impact on the Company, the
Bank, its operations or the Bank's Conversion. See "Regulation."
LEGISLATIVE UNCERTAINTY
The Deposit Insurance Funds Act of 1996 (the "Funds Act"), which was enacted
in September 1996, provides that the BIF (the deposit insurance fund that
covers most commercial bank deposits) and the SAIF will
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<PAGE>
merge on January 1, 1999, if there are no more savings associations as of that
date. Several bills have been introduced in the current Congress that would
eliminate the federal thrift charter and the OTS. A bill originally reported
by the House Banking Committee would have required federal thrifts to become
national banks or state banks within two years of enactment or they would have
become national banks by operation of law. OTS would have been abolished and
its functions transferred to the bank regulatory agencies. The bill as passed
by the House of Representatives, however, did not provide for the elimination
of the federal thrift charter or OTS, but did provide that unitary savings and
loan holding companies existing or applied for after March 31, 1998 would not
have the ability to engage in unlimited activities but would be subject to the
activities restrictions applicable to multiple savings and loan holding
companies. Unitary holding companies existing or applied for before such date
would be grandfathered and could continue to engage in unlimited activities
and could transfer the grandfather rights to acquirors of the holding company.
The Senate has not acted on the legislation but if such legislation were
enacted, the Company would not qualify for unlimited activities but would be
subject to the activities restrictions applicable to multiple savings and loan
holding companies. The Bank is unable to predict whether the legislation will
be enacted or, given such uncertainty, determine the extent to which the
legislation, if enacted, would affect its business. The Bank is also unable to
predict whether the SAIF and BIF will eventually be merged or the federal
thrift charter eliminated, and what effect, if any, such legislation would
have on the Bank.
EXPENSES ASSOCIATED WITH ESOP AND THE STOCK-BASED INCENTIVE PLAN
If the ESOP and the Stock-Based Incentive Plan are implemented, the Bank
will recognize additional material employee compensation and benefit expenses
that stem from the shares purchased or granted to employees and executives
under those plans. The Bank cannot predict the actual amount of these new
expenses because applicable accounting practices require that they be based on
the fair market value of the shares of common stock when the expenses are
recognized. Expenses for the ESOP would be recognized when shares are
committed to be released to participants' accounts, and expenses for the
Stock-Based Incentive Plan would be recognized over the vesting period of
awards made to recipients. These expenses have been reflected in the pro forma
financial information under "Pro Forma Data" assuming the $10.00 per share
purchase price as fair market value. Actual expenses, however, will be based
on the fair market value of the common stock at the time of recognition, which
may be higher or lower than $10.00. For further discussion of these plans, see
"Management of the Bank--Benefits--Employee Stock Ownership Plan and Trust"
and "--Benefits--Stock-Based Incentive Plan."
POSSIBLE DILUTIVE EFFECT OF STOCK-BASED INCENTIVE PLAN
Following the Conversion, the Stock-Based Incentive Plan will acquire an
amount of shares equal to 4% of the shares of common stock issued in the
Conversion, including shares issued to the Foundation, either through open
market purchases or the issuance of authorized but unissued shares of common
stock from the Company. If the Stock-Based Incentive Plan is funded by the
issuance of authorized but unissued shares, the voting interests of existing
stockholders at that time will be diluted by 3.8%. Also following the
Conversion, directors, officers and employees will be granted stock options
under the Stock-Based Incentive Plan in an amount up to 10% of the Common
Stock issued in the Conversion, including shares issued to the Foundation. The
exercise of such stock options may be satisfied by the issuance of authorized
but unissued shares. If all of the stock options were to be exercised using
authorized but unissued common stock and the stock awards granted under the
Stock-Based Incentive Plan were funded with authorized but unissued shares,
the voting interests of existing stockholders at that time would be diluted at
that time by 12.3%.
VOTING CONTROL OF EXECUTIVE OFFICERS AND DIRECTORS.
Directors and executive officers of the Bank and the Company expect to
purchase approximately 2.07% or 1.55% of the shares of Common Stock to be
issued in the Conversion, including shares issued to the Foundation, based
upon the minimum and the maximum of the Estimated Price Range, respectively.
The ESOP may be viewed as giving directors, officers and employees the
potential to control the voting of an additional 8% of the Company's common
stock. In addition, the Foundation will be funded with a contribution by the
Company up to
20
<PAGE>
8% of the common stock sold in the Conversion. If a waiver of the voting
restriction imposed on such common stock is obtained from the OTS and the OTS
does not impose other restrictions, the Foundation shares may be voted as
determined by the directors of the Foundation who also will be directors or
officers of the Company and Bank. Management's potential voting control could,
together with additional stockholder support, defeat stockholder proposals
requiring 80% approval of stockholders. As a result, this potential voting
control may preclude takeover attempts that certain stockholders deem to be in
their best interest and may tend to perpetuate existing management. See
"Restrictions on Acquisition of the Company and the Bank--Restrictions in the
Company's Articles of Incorporation and Bylaws."
CERTAIN ANTI-TAKEOVER PROVISIONS IN THE COMPANY'S AND THE BANK'S GOVERNING
INSTRUMENTS WHICH MAY DISCOURAGE TAKEOVER ATTEMPTS
Certain provisions of the Company's Articles of Incorporation and Bylaws and
the Bank's Stock Articles of Incorporation and Bylaws, as well as certain
federal regulations and state laws, may assist the Company in maintaining its
status as an independent publicly owned corporation. These provisions provide
for, among other things, supermajority voting on certain matters, staggered
boards of directors, non-cumulative voting for directors, limits on the
calling of special meetings, limits on voting shares in excess of 10% of
outstanding shares, and certain uniform price provisions for certain business
combinations. These provisions in the Company's governing instruments may
discourage potential proxy contests and other potential takeover attempts,
particularly those which have not been negotiated with the Board of Directors,
and thus, generally may serve to perpetuate existing management. For a more
detailed discussion of these provisions, see "Restrictions on Acquisition of
the Company and the Bank."
ABSENCE OF MARKET FOR COMMON STOCK
The Company and the Bank have never issued capital stock. The Company has
received conditional approval to have its common stock listed on Nasdaq under
the symbol "VCAP" upon completion of the Conversion. However, there can be no
assurance that an active and liquid trading market for the common stock will
develop or, once developed, will continue, nor can there be any assurances
that purchasers of the common stock will be able to sell their shares at or
above the purchase price. The absence or discontinuance of a market for the
common stock would have an adverse impact on both the price and liquidity of
the common stock. See "Market for the Common Stock."
POSSIBLE INCREASE IN ESTIMATED PRICE RANGE AND NUMBER OF SHARES ISSUED
The number of shares to be issued in the Conversion, including shares issued
to the Foundation may be increased as a result of an increase in the Estimated
Price Range of up to 15% to reflect changes in market and financial conditions
following the commencement of the Subscription and Community Offerings. In the
event that the Estimated Price Range is so increased, it is expected that the
Company will issue up to 13,965,600 shares of common stock for an aggregate
purchase price of up to $139.7 million. An increase in the number of shares
issued will decrease a subscriber's pro forma net earnings per share and
stockholders' equity per share and will increase the Company's pro forma
consolidated stockholders' equity and net earnings. Such an increase will also
increase the purchase price as a percentage of pro forma stockholders' equity
per share and net earnings per share.
YEAR 2000 COMPLIANCE
As the year 2000 approaches, an important business issue has emerged
regarding how existing application software programs and operating systems can
accommodate this date value. Many existing application software products were
designed to accommodate only two-digits. For example, "96" is stored on the
system and represents 1996. The Bank has conducted a comprehensive review of
its systems to identify applications that could be affected by the "Year 2000"
issue and has developed an implementation plan to address the issue. The Bank
has already begun testing on its own systems. The Bank has been told that its
primary service providers
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<PAGE>
anticipate all reprogramming efforts will be complete by December 31, 1998,
allowing the Bank significant time for testing. The Bank believes that its
costs related to Year 2000 will be approximately $200,000. There can be no
assurances, however, that the performance by the Bank's vendors will be
effective to remedy all potential problems. To the extent the Company's
systems are not fully Year 2000 compliant, there can be no assurance that
potential systems interruptions or the cost necessary to update software would
not have a materially adverse effect on the Company's business, financial
condition, results of operations and business prospects. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Year
2000 Compliance.
COMPETITION
Due to the significant growth in the Fredericksburg area in recent years,
the Bank has encountered a significant increase in competition for both loan
origination and attracting deposits. The Bank's primary market area is highly
competitive and the Bank faces direct competition from a significant number of
financial institutions, many with a state-wide or regional presence and, in
some cases, a national presence. Many of these financial institutions are
significantly larger and have greater financial resources than the Bank. The
Bank's competition for loans comes principally from commercial banks, savings
banks, credit unions, mortgage brokers, mortgage banking companies, and
insurance companies, and most recently, from one- to four-family home builders
who not only finance their own projects, but also arrange permanent financing
for purchasers. Its most direct competition for deposits has historically come
from savings, cooperative and commercial banks and credit unions. In addition,
the Bank faces significant competition for deposits from non-bank institutions
such as brokerage firms and insurance companies in such instruments as short-
term money market funds, corporate and government securities funds, mutual
funds and annuities. Competition may also increase as a result of the lifting
of restrictions on the interstate operations of financial institutions. The
Bank has also experienced significant competition from credit unions which
have a competitive advantage as they do not pay state or federal income taxes.
Such competitive advantage has placed increased pressure on the Bank with
respect to its loan and deposit pricing.
VIRGINIA CAPITAL BANCSHARES, INC.
The Company was organized under Virginia law in September 1998 at the
direction of the Board of Directors of the Bank for the purpose of acquiring
all of the capital stock to be issued by the Bank in the Conversion. The
Company has applied to the OTS to become a savings and loan holding company
and, upon approval, will be subject to regulation by the OTS. Upon
consummation of the Conversion, the Company will conduct business initially as
a unitary savings and loan holding company. See "Regulation--Holding Company
Regulation." After completion of the Conversion, the Company's assets will
consist of all of the outstanding shares of the Bank's capital stock issued to
the Company in the Conversion and that portion of the net proceeds of the
Offerings retained by the Company. The Company intends to use part of the net
proceeds it retains to loan funds to the ESOP to enable the ESOP to purchase
8% of the Common Stock issued in the Conversion, including shares issued to
the Foundation. Based on certain regulatory and market conditions, the Company
and Bank may, however, alternatively choose to fund the ESOP's stock purchases
through a loan by a third-party financial institution. The Company intends to
initially invest any remaining proceeds in federal funds and short-term U.S.
Government and agency obligations. See "Use of Proceeds." Immediately after
the Conversion, the Company will have no significant liabilities. Initially,
the Company will neither own nor lease any property, but will instead use the
premises, equipment and furniture of the Bank. The management of the Company
is set forth under "Management of the Company." At the present time, the
Company does not intend to employ any persons other than officers of the
Company who are also officers of the Bank, but will utilize the support staff
of the Bank from time to time. Additional employees will be hired as
appropriate to the extent the Company expands its business in the future.
Management believes that the holding company structure will provide the
Company with additional flexibility to diversify its business activities,
should it decide to do so, through existing or newly-formed
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<PAGE>
subsidiaries, or through acquisitions of other financial institutions and
financial services related companies. In addition, management believes that
the Company will be in a position after the Conversion, subject to regulatory
limitations and the Company's financial position, to take advantage of any
acquisition and expansion opportunities that may arise. There are no current
arrangements, understandings or agreements, written or oral, regarding any
such opportunities or transactions. The initial activities of the Company are
anticipated to be funded by the net proceeds retained by the Company and
earnings thereon or, alternatively, through dividends from the Bank.
The Company's executive offices are located at 400 George Street,
Fredericksburg, Virginia 22404 and the telephone number is (540) 899-5500.
FREDERICKSBURG SAVINGS
The Bank is a community-oriented savings institution whose business
primarily consists of accepting deposits from customers and investing those
funds primarily in mortgage loans secured by one- to four-family residences.
To a lesser extent, the Bank invests in multi-family, construction and
development, commercial real estate and consumer loans. The Bank originates
one- to four-family loans primarily for investment. At June 30, 1998, the
Bank's loans, net, totalled $415.9 million, or 88.1% of total assets. To a
significantly lesser extent, the Bank also invests in securities, primarily
consisting of U.S. Government and agency obligations and highly rated
corporate bonds. At June 30, 1998, the Bank's securities portfolio totalled
$32.1 million, or 6.8% of total assets, of which $30.9 million, or 96.3% of
total investment securities, were classified as available-for-sale. For the
six months ended June 30, 1998, the Bank's deposit accounts averaged $375.3
million, or 95.69% of total average liabilities, of which $83.1 million, or
21.2% of total average liabilities, were savings, money market and negotiable
order of withdrawal ("NOW") accounts (collectively, "core deposits"). The Bank
also uses advances from the FHLB-Atlanta as a source of funds. At June 30,
1998, such advances totalled $8.0 million, or 2.06% of total liabilities. See
"Business of the Bank."
The Bank's executive offices are located at 400 George Street,
Fredericksburg, Virginia 22404 and the telephone number is (540) 899-5500.
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<PAGE>
REGULATORY CAPITAL COMPLIANCE
At June 30, 1998, the Bank exceeded all regulatory capital requirements. See
"Regulation--Federal Savings Institution Regulation--Capital Requirements."
Set forth below is a summary of the Bank's compliance with the regulatory
capital standards as of June 30, 1998, on a historical and pro forma basis
assuming that the indicated number of shares were sold as of such date and
receipt by the Bank of 50% of the net proceeds. For purposes of the table
below, the amount expected to be borrowed by the ESOP and the cost of the
shares expected to be acquired by the Stock-Based Incentive Plan are deducted
from pro forma regulatory capital.
<TABLE>
<CAPTION>
FREDERICKSBURG SAVINGS
PRO FORMA AT JUNE 30, 1998 BASED UPON THE SALE
OF COMMON STOCK AT $10.00 PER SHARE
---------------------------------------------------------------------------
13,965,600
8,976,000 10,560,000 12,144,000 SHARES
SHARES SHARES SHARES (15% ABOVE
(MINIMUM OF (MIDPOINT OF (MAXIMUM OF MAXIMUM OF
HISTORICAL AT ESTIMATED ESTIMATED ESTIMATED ESTIMATED
JUNE 30, 1998 PRICE RANGE) PRICE RANGE) PRICE RANGE) PRICE RANGE)(1)
----------------- ------------------ ------------------ ------------------ ------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
OF OF OF OF OF
AMOUNT ASSETS(2) AMOUNT ASSETS(2) AMOUNT ASSETS(2) AMOUNT ASSETS(2) AMOUNT ASSETS(2)
------- --------- -------- --------- -------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
GAAP Capital............ $83,500 17.68% $115,747 22.94% $121,614 23.83% $127,482 24.69% $134,229 25.66%
Tangible Capital:
Capital Level.......... $79,903 17.05% $112,150 22.39% $118,017 23.29% $123,885 24.16% $130,632 25.15%
Requirement............ 7,031 1.50 7,514 1.50 7,602 1.50 7,691 1.50 7,792 1.50
------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Excess................. $72,872 15.55% $104,636 20.89% $110,415 21.79% $116,194 22.66% $122,840 23.65%
======= ===== ======== ===== ======== ===== ======== ===== ======== =====
Tier I Capital:
Capital Level.......... $79,903 17.05% $112,150 22.39% $118,017 23.29% $123,885 24.16% $130,632 25.15%
Requirement(3)......... 14,062 3.00 15,029 3.00 15,205 3.00 15,381 3.00 15,583 3.00
------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Excess................. $65,841 14.05% $ 97,121 19.39% $102,812 20.29% $108,504 21.16% $115,049 22.15%
======= ===== ======== ===== ======== ===== ======== ===== ======== =====
Risk-Based Capital:
Capital Level(4)(5).... $83,446 29.78% $115,693 39.05% $121,560 40.62% $127,428 42.17% $134,175 43.91%
Requirement............ 22,414 8.00 23,704 8.00 23,939 8.00 24,173 8.00 24,443 8.00
------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Excess................. $61,032 21.78% $ 91,989 31.05% $ 97,621 32.62% $103,255 34.17% $109,732 35.91%
======= ===== ======== ===== ======== ===== ======== ===== ======== =====
</TABLE>
- --------
(1) As adjusted to give effect to an increase in the number of shares which
could occur due to an increase in the Estimated Price Range of up to 15%
as a result of regulatory considerations or changes in market or general
financial and economic conditions following the commencement of the
Subscription Offering.
(2) Tangible capital levels are shown as a percentage of tangible assets. Tier
I capital levels are shown as a percentage of total adjusted assets. Risk-
based capital levels are shown as a percentage of risk-weighed assets.
(3) The current OTS core capital requirement for savings associations is 3% of
total adjusted assets. The OTS has proposed core capital requirements
which would require a core capital ratio of 3% of total adjusted assets
for thrifts that receive the highest supervisory rating for safety and
soundness and a 4% to 5% core capital ratio requirement for all other
thrifts. See "Regulation--Federal Savings Institution Regulation--Capital
Requirements."
(4) Assumes net proceeds are invested in assets that carry a 50% risk-
weighting.
(5) The difference between equity under generally accepted accounting
principles ("GAAP") and regulatory risk-based capital is attributable to a
portion of the general valuation allowance of $3.5 million and any
unrealized gains on available-for-sale securities at June 30, 1998.
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<PAGE>
USE OF PROCEEDS
Although the actual net proceeds from the sale of the Common Stock cannot be
determined until the Conversion is completed, it is presently anticipated that
the net proceeds from the sale of the Common Stock will be between $87.8
million and $119.4 million (or $137.7 million if the Estimated Price Range is
increased by 15%). See "Pro Forma Data" and "The Conversion--Stock Pricing" as
to the assumptions used to arrive at such amounts. The Company will be unable
to utilize any of the net proceeds of the Offerings until the consummation of
the Conversion.
The Company will purchase all of the outstanding capital stock of the Bank
to be issued upon Conversion in exchange for 50% of the net proceeds of the
Offerings, with the remaining net proceeds to be retained by the Company.
Based on net proceeds of $103.6 million, the Company expects to utilize $51.8
million of net proceeds to purchase the common stock of the Bank. Such portion
of net proceeds will be added to the Bank's general funds. Except as provided
herein, neither the Bank nor Company have specific plans regarding investment
of the funds. The Bank currently intends to utilize the funds for general
corporate purposes, including: investment in loans, particularly residential
real estate loans, non-residential real estate loans, including commercial
real estate loans in the Bank's primary market area, construction and
development loans and consumer loans, including home equity loans; investment
primarily in U.S. Treasury and Agency obligations, including short-term
adjustable-rate mortgage-backed securities; the repayment of FHLB advances;
funding of stock-based benefit plans; and, to a lesser extent, investment in
short-term high quality investments, such as highly rated corporate bonds and
municipal bonds. Management intends to invest the proceeds received to the
greatest extent possible in investments that will help reduce the Bank's
exposure to interest rate risk. Management also intends to seek means to
expand its products and market share. A primary goal of the Bank is to seek
opportunities to expand its products and services and examine opportunities to
expand its facilities and operations through acquisitions of other financial
institutions, including, possibly a commercial bank, branch offices or other
financial services companies; however, the Bank has no specific acquisition
plans at this time. See "Management's Discussion and Analysis--Management
Strategy." Although the Bank's capital currently exceeds regulatory
requirements (see "Regulatory Capital Compliance"), the Bank is pursuing the
mutual-to-stock conversion at this time to structure itself in the form used
by commercial banks, among other financial service companies. Fredericksburg
is a rapidly expanding market area and management believes converting at this
time is important to enable the Bank to position itself to take advantage of
future expansion opportunities and to remain competitive with other companies
in its market area that are already in the stock form with whom the Bank
directly competes. See "Business of the Bank--Market Area and Competition" and
"The Conversion--Purposes of Conversion."
The Company intends to use a portion of the net proceeds it retains to loan
funds to the ESOP to enable the ESOP to purchase 8% of the Common Stock issued
in the Conversion, including shares issued to the Foundation. Alternatively,
the Company and Bank may choose to fund the ESOP's stock purchases through a
loan by a third-party financial institution. The Company anticipates that the
remaining net proceeds retained by the Company will initially be invested in
short-term U.S. Treasury and Agency obligations. Based upon the sale of
8,976,000 shares or 12,144,000 shares at the minimum and maximum of the
Estimated Price Range and the issuance of shares to the Foundation, the amount
of the loan to the ESOP would be $7.8 million or $10.5 million, respectively
(or $12.1 million if the Estimated Price Range is increased by 15%) to be
repaid approximately over a twenty year period at the prevailing prime rate of
interest, which currently is 8.0%. At the minimum, midpoint and maximum of the
Estimated Price Range, total shares issued to the Foundation would be 718,080,
844,800 and 971,520 shares, with a value of $7,180,800, $8,448,000 and
$9,715,200, respectively, based upon a per share price of $10.00. See
"Management of the Bank--Benefits--Employee Stock Ownership Plan and Trust."
The net proceeds retained by the Company may also be used to support the
future expansion of operations through branch acquisitions, the establishment
of branch offices and the acquisition of financial institutions or their
assets, including those located within the Bank's market area, or
diversification into other banking related businesses. The Company has no
current arrangements, understandings or agreements regarding any such
opportunities or transactions. The Company, upon the Conversion, will be a
unitary savings and loan holding company, which under existing laws would
generally not be restricted as to the types of business activities in
25
<PAGE>
which it may engage, provided that the Bank continues to be a qualified thrift
lender ("QTL"). See "Regulation--Holding Company Regulation" for a description
of certain regulations applicable to the Company.
Upon completion of the Conversion, the Board of Directors of the Company
will have the authority to conduct stock repurchases, subject to statutory and
regulatory requirements. Unless approved by the OTS, the Company, pursuant to
OTS regulations, will be prohibited from repurchasing any shares of the Common
Stock for three years except (i) for an offer to all stockholders on a pro
rata basis, or (ii) for the repurchase of qualifying shares of a director.
Notwithstanding the foregoing and except as provided below, beginning one year
following completion of the Conversion, the OTS regulations permit the Company
to repurchase its Common Stock so long as: (i) the repurchases within the
following two years are part of an open-market program not involving greater
than 5% of its outstanding capital stock during a 12-month period; (ii) the
repurchases do not cause the Bank to become "undercapitalized" within the
meaning of the OTS prompt corrective action regulation; and (iii) the Company
provides to the Regional Director of the OTS no later than 10 days prior to
the commencement of a repurchase program written notice containing a full
description of the program to be undertaken and such program is not
disapproved by the Regional Director. See "Regulation--Prompt Corrective
Regulatory Action." In addition, under current OTS policies, repurchases may
be allowed in the first year following Conversion and in amounts greater than
5% in the second and third years following Conversion provided there are valid
and compelling business reasons for such repurchases and the OTS does not
object to such repurchases.
Based upon facts and circumstances following the Conversion and subject to
applicable regulatory requirements, the Board of Directors may determine to
repurchase stock in the future. Such facts and circumstances may include but
not be limited to: (i) market and economic factors such as the price at which
the stock is trading in the market, the volume of trading, the attractiveness
of other investment alternatives in terms of the rate of return and risk
involved in the investment, the ability to increase the book value and/or
earnings per share of the remaining outstanding shares and the opportunity to
improve the Company's return on equity; (ii) the avoidance of dilution to
stockholders by not having to issue additional shares to cover the exercise of
stock options or to fund employee stock benefit plans; and (iii) any other
circumstances in which repurchases would be in the best interests of the
Company and its shareholders. Although the Company has no current plans to
repurchase its stock, in the event the Company does determine to repurchase
stock, such repurchases may be made at market prices which may be in excess of
the Purchase Price in the Conversion.
Any stock repurchases will be subject to the determination of the Board of
Directors that both the Company and the Bank will be capitalized in excess of
all applicable regulatory requirements after any such repurchases and that
such capital will be adequate, taking into account, among other things, the
level of non-performing and other risk assets, the Company's and the Bank's
current and projected results of operations and asset/liability structure, the
economic environment, tax and other considerations. See "The Conversion--
Certain Restrictions on Purchase or Transfer of Shares after Conversion."
DIVIDEND POLICY
Upon Conversion, the Board of Directors of the Company will have the
authority to declare dividends on the Common Stock, subject to statutory and
regulatory requirements. Depending on market conditions, the Company's Board
of Directors intends to pay cash dividends on the Common Stock; however, no
decision has been made regarding the level of dividends that will actually be
paid. In addition, from time to time in an effort to manage capital to a
reasonable level, the Board of Directors may determine to pay periodic special
cash dividends in addition to, or in lieu of, regular cash dividends.
Declarations of dividends by the Board of Directors, if any, will depend upon
a number of factors, including the amount of net proceeds retained by the
Company in the Conversion, investment opportunities available to the Company
or the Bank, capital requirements, regulatory limitations, the Company's and
the Bank's financial condition and results of operations, tax considerations
and general economic conditions. No assurances can be given, however, that any
dividends will be paid or, if commenced, will continue to be paid.
26
<PAGE>
The Bank will not be permitted to pay dividends to the Company on its
capital stock if its stockholders' equity would be reduced below the amount
required for the liquidation account. See "The Conversion--Liquidation
Rights." For information concerning federal regulations which apply to the
Bank in determining the amount of proceeds which may be retained by the
Company and regarding a savings institution's ability to make capital
distributions, including payment of dividends to its holding company, see
"Federal and State Taxation--Federal Taxation--Distributions" and
"Regulation--Federal Savings Institution Regulation--Limitation on Capital
Distributions."
Unlike the Bank, the Company is not subject to OTS regulatory restrictions
on the payment of dividends to its stockholders, although the source of such
dividends will be dependent on the net proceeds retained by the Company and
earnings thereon and may be dependent, in part, upon dividends from the Bank.
The Company is subject, however, to the requirements of Virginia law, which
generally provide that a Virginia corporation may make distributions to its
stockholders unless, after giving effect to the distribution, (i) the
corporation would not be able to pay its debts as they become due in the usual
course of business, or (ii) the corporation's total assets would be less than
the sum of its total liabilities plus (unless the articles of incorporation
permit otherwise, which in the case of the Company they do not) the amount
that would be needed, if the corporation were to be dissolved at the time of
the distribution, to satisfy the preferential rights upon dissolution of
stockholders whose preferential rights are superior to those receiving the
distribution.
Additionally, in connection with the Conversion, the Company and Bank have
committed to the OTS that during the one-year period following the
consummation of the Conversion, the Company will not take any action to
further any distribution to stockholders which would be treated by recipient
stockholders as a tax-free return of capital for federal income tax purposes
without prior approval of the OTS and it is unlikely the Company would take
such action following the one year period.
MARKET FOR THE COMMON STOCK
The Company and Bank have not previously issued capital stock and,
consequently, there is no established market for the Common Stock. The Company
has received conditional approval to have its Common Stock listed on Nasdaq
under the symbol "VCAP" upon completion of the Conversion. Such approval is
subject to various conditions, including completion of the Conversion and the
satisfaction of applicable listing criteria. There can be no assurance that
the Common Stock will be able to meet the applicable listing criteria in order
to maintain its listing on Nasdaq or that an active and liquid trading market
will develop or, if developed, will be maintained. A public market having the
desirable characteristics of depth, liquidity and orderliness, however,
depends upon the presence in the marketplace of both willing buyers and
sellers of Common Stock at any given time, which is not within the control of
the Company. No assurance can be given that an investor will be able to resell
the Common Stock at or above the purchase price of the Common Stock after the
Conversion.
27
<PAGE>
CAPITALIZATION
The following table presents the unaudited historical consolidated
capitalization of the Bank at June 30, 1998 and the pro forma consolidated
capitalization of the Company after giving effect to the Conversion, including
the issuance of shares to the Foundation, based upon the sale of the number of
shares indicated in the table and the other assumptions set forth under "Pro
Forma Data."
<TABLE>
<CAPTION>
COMPANY PRO FORMA BASED UPON SALE OF COMMON STOCK
AT $10.00 PER SHARE
-------------------------------------------------
13,965,600
SHARES
8,976,000 10,560,000 12,144,000 (15% ABOVE
SHARES SHARES SHARES MAXIMUM OF
(MINIMUM OF (MIDPOINT OF (MAXIMUM ESTIMATED
BANK ESTIMATED ESTIMATED OF ESTIMATED PRICE
HISTORICAL PRICE RANGE) PRICE RANGE) PRICE RANGE) RANGE)(1)
---------- ------------ ------------ ------------ ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Deposits(2)............. $373,719 $373,719 $373,719 $373,719 $373,719
FHLB borrowings......... 8,000 8,000 8,000 8,000 8,000
-------- -------- -------- -------- --------
Total deposits and
borrowings............. $381,719 $381,719 $381,719 $381,719 $381,719
======== ======== ======== ======== ========
Stockholders' equity:
Preferred Stock, $.01
par value, 5,000,000
shares authorized;
none to be issued.... $ -- $ -- $ -- $ -- $ --
Common Stock, $.01 par
value, 75,000,000
shares authorized;
shares to be issued
as reflected......... -- 97 114 131 151
Additional paid-in
capital(3)............. -- 87,663 103,486 119,309 137,505
Retained earnings(4).... 83,216 83,216 83,216 83,216 83,216
Net unrealized gain on
available-for-sale
securities............. 284 284 284 284 284
Less:Expense of
contribution to the
Foundation, net of
taxes(5)............... -- (4,452) (5,238) (6,023) (6,927)
Plus:Shares issued to
the Foundation......... -- 7,181 8,448 9,715 11,172
Less: Common Stock
acquired by the
ESOP(6)........... -- (7,755) (9,124) (10,492) (12,066)
Common Stock acquired
by the Stock-Based
Incentive Plan(7).... -- (3,878) (4,562) (5,246) (6,033)
-------- -------- -------- -------- --------
Total stockholders'
equity................. $ 83,500 $162,356 $176,624 $190,894 $207,302
======== ======== ======== ======== ========
</TABLE>
- --------
(1) As adjusted to give effect to an increase in the number of shares which
could occur due to an increase in the Estimated Price Range of up to 15%
as a result of regulatory considerations or changes in market or general
financial and economic conditions following the commencement of the
Subscription Offering.
(2) Does not reflect withdrawals from deposit accounts for the purchase of
Common Stock in the Conversion. Such withdrawals would reduce pro forma
deposits by the amount of such withdrawals.
(3) No effect has been given to the issuance of additional shares of Common
Stock to the Foundation at a value of $10.00 per share or to the issuance
of additional shares pursuant to the Company's Stock-Based Incentive Plan
intended to be adopted by the Company. An amount equal to 10% of the
shares of Common Stock issued in the Conversion, including shares issued
to the Foundation, will be reserved for issuance upon the exercise of
options to be granted under the Stock-Based Incentive Plan. See "Risk
Factors--Possible Dilutive Effect of Stock-Based Incentive Plan," Footnote
4 to the tables under "Pro Forma Data" and "Management of the Bank--
Benefits--Stock-Based Incentive Plan."
(4) The retained earnings of the Bank will be substantially restricted after
the Conversion. See "The Conversion--Liquidation Rights" and "Regulation--
Federal Savings Institution Regulation--Limitations on Capital
Distributions."
(5) Represents the value of the contribution of Common Stock to the Foundation
at $10.00 per share reduced by the associated tax benefits $2.7 million,
$3.2 million, $3.7 million and $4.2 million at the minimum, midpoint,
maximum and 15% above the maximum of the Estimated Price Range,
respectively, based on an effective tax rate of 38%. The realization of
the federal tax benefit is limited annually to 10% of the Company's annual
taxable income, subject to the ability of the Company to carry forward any
unused portion of the deduction for five years following the year in which
the contribution is made. For state income tax purposes, the Bank will not
be able to utilize any such carry forward.
(6) Assumes that 8% of the shares issued in connection with the Conversion,
including shares issued to the Foundation, will be purchased by the ESOP
and that the funds used to acquire such shares will be borrowed from the
Company. See "Use of Proceeds." The Common Stock acquired by the ESOP is
reflected as a reduction of stockholders' equity. See "Management of the
Bank--Benefits--Employee Stock Ownership Plan and Trust."
(7) Assumes that subsequent to the Conversion, an amount equal to 4% of the
shares of Common Stock issued in the Conversion, including shares issued
to the Foundation, is purchased by the Stock-Based Incentive Plan through
open market purchases at the offering price of $10.00 per share. The
Common Stock purchased by the Stock-Based Incentive Plan is reflected as a
reduction of stockholders' equity. See "Risk Factors--Possible Dilutive
Effect of Stock-Based Incentive Plan," Footnote 3 to the tables under "Pro
Forma Data" and "Management of the Bank--Benefits--Stock-Based Incentive
Plan."
28
<PAGE>
PRO FORMA DATA
The actual net proceeds from the sale of the Common Stock cannot be
determined until the Conversion is completed. However, net proceeds are
currently estimated to be between $87.8 million and $119.4 million (or $137.7
million in the event the Estimated Price Range is increased by 15%) based upon
the following assumptions: (i) Trident will receive a fee of $525,000 for its
marketing services and financial advisory role in connection with the
Conversion; and (ii) other Conversion expenses, excluding the marketing fees
paid to Trident, will be approximately $1.5 million. Actual Conversion
expenses may vary from those estimated.
Pro forma consolidated net income of the Company for the six months ended
June 30, 1998, and for the year ended December 31, 1997, have been calculated
as if the Common Stock had been sold at the beginning of the respective
periods and the net proceeds had been invested at 5.41% and 5.41% which is
equivalent to the one year Treasury rate at June 30, 1998. The calculations
have been based on the one year Treasury rate, as opposed to the arithmetic
average of the average yield on the Bank's average interest earning assets and
the average cost of deposits, because the Bank will initially invest the
proceeds in short-term assets, at a lower yield, and will more effectively
invest the proceeds over time. The tables below do not reflect the effect of
withdrawals from deposit accounts for the purchase of Common Stock or the
effect of any possible use of the net Conversion proceeds. The pro forma
after-tax yields for the Company and the Bank are assumed to be 3.35% and
3.35% for the six months ended June 30, 1998 and for the year ended December
31, 1997, respectively. All calculations were based on an effective combined
federal and state income tax rate of 38%. Historical and pro forma net
earnings per share amounts have been calculated by dividing historical and pro
forma amounts by the indicated number of shares of Common Stock issued in the
Conversion, including shares issued to the Foundation, as adjusted to give
effect to unallocated and uncommitted shares held by the ESOP. Historical and
pro forma stockholders' equity per share amounts have been calculated by
dividing historical and pro forma amounts by the indicated number of shares of
Common Stock issued in the Conversion, including the issuance of shares to the
Foundation.
The following pro forma information may not be representative of the
financial effects of the Conversion at the date on which the Conversion
actually occurs and should not be taken as indicative of future results of
operations. Pro forma consolidated stockholders' equity represents the
difference between the stated amount of assets and liabilities of the Company.
The pro forma stockholders' equity is not intended to represent the fair
market value of the Common Stock and may be stated in an amount greater than
amounts that would be available for distribution to stockholders in the event
of liquidation.
The following tables summarize historical data of the Bank and pro forma
data of the Company at or for the six months ended June 30, 1998 and at or for
the year ended December 31, 1997, based on the assumptions set forth above and
in the table and should not be used as a basis for projections of market value
of the Common Stock following the Conversion. The tables below give effect to
the Stock-Based Incentive Plan, which is expected to be adopted by the Company
following the Conversion and presented to stockholders for approval at a
meeting of stockholders. See Footnote 3 to the tables and "Management of the
Bank--Benefits--Stock-Based Incentive Plan." No effect has been given in the
tables to the possible issuance of additional shares reserved for future
issuance pursuant to the Stock-Based Incentive Plan to be adopted by the Board
of Directors of the Company and presented to stockholders for approval at a
meeting of stockholders, nor does book value give any effect to the
liquidation account to be established for the benefit of Eligible Account
Holders and Supplemental Eligible Account Holders or, in the event of
liquidation of the Bank, to the tax effect of the bad debt reserve and other
factors. See Footnote 3 to the tables below, "The Conversion--Liquidation
Rights" and "Management of the Bank--Benefits--Stock-Based Incentive Plan."
THE FOLLOWING TABLES ASSUME THAT THE FOUNDATION IS APPROVED AS PART OF THE
CONVERSION AND THEREFORE GIVE EFFECT TO THE ISSUANCE OF AUTHORIZED BUT
UNISSUED SHARES OF THE COMPANY'S COMMON STOCK TO THE FOUNDATION CONCURRENTLY
WITH THE COMPLETION OF THE CONVERSION. THE VALUATION RANGE, AS SET FORTH
HEREIN AND IN THE TABLES BELOW, TAKES INTO ACCOUNT THE DILUTIVE IMPACT OF THE
ISSUANCE OF SHARES TO THE FOUNDATION.
29
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE SIX MONTHS ENDED JUNE 30, 1998
------------------------------------------------------
13,965,600
8,976,000 10,560,000 12,144,000 SHARES SOLD
SHARES SOLD SHARES SOLD SHARES SOLD AT $10.00
AT $10.00 AT $10.00 AT $10.00 PER SHARE
PER SHARE PER SHARE PER SHARE (15% ABOVE
(MINIMUM (MIDPOINT (MAXIMUM MAXIMUM OF
OF ESTIMATED OF ESTIMATED OF ESTIMATED ESTIMATED
PRICE RANGE) PRICE RANGE) PRICE RANGE) PRICE RANGE)(8)
------------ ------------ ------------ ---------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Gross proceeds.......... $ 89,760 $105,600 $121,440 $139,656
Plus:Shares issued to
Foundation (equal to 8%
of the stock sold in
the Conversion)........ 7,181 8,448 9,715 11,172
-------- -------- -------- --------
Pro forma market
capitalization....... $ 96,941 $114,048 $131,155 $150,828
======== ======== ======== ========
Gross proceeds.......... $ 89,760 $105,600 $121,440 $139,656
Less: Offering
expenses and
commission........... (2,000) (2,000) (2,000) (2,000)
-------- -------- -------- --------
Estimated net
proceeds........... 87,760 103,600 119,440 137,656
Less:Common Stock
acquired by the
ESOP................. (7,755) (9,124) (10,492) (12,066)
Common Stock to be
acquired by Stock-
Based Incentive
Plan............... (3,878) (4,562) (5,246) (6,033)
-------- -------- -------- --------
Estimated net
proceeds, as
adjusted........... $ 76,127 $ 89,914 $103,702 $119,557
======== ======== ======== ========
Consolidated net
earnings(1):
Historical............ $ 3,320 $ 3,320 $ 3,320 $ 3,320
Pro forma earnings on
net proceeds......... 1,275 1,506 1,737 2,003
Less:Pro forma ESOP
adjustment(2)........ (120) (141) (163) (187)
Pro forma Stock-
Based Incentive
Plan
adjustment(3)...... (240) (283) (325) (374)
-------- -------- -------- --------
Pro forma net
earnings........... $ 4,235 $ 4,402 $ 4,569 $ 4,762
======== ======== ======== ========
Per share net
earnings(1)(4):
Historical............ $ 0.37 $ 0.32 $ 0.27 $ 0.24
Pro forma earnings on
net proceeds......... 0.14 0.14 0.14 0.14
Less:Pro forma ESOP
adjustment(2)........ (0.01) (0.01) (0.01) (0.01)
Pro forma Stock-
Based Incentive
Plan
adjustment(3)...... (0.03) (0.03) (0.03) (0.03)
-------- -------- -------- --------
Pro forma net
earnings per
share.............. $ 0.47 $ 0.42 $ 0.37 $ 0.34
======== ======== ======== ========
Stockholders' equity:
Historical............ $ 83,500 $ 83,500 $ 83,500 $ 83,500
Estimated net
proceeds............. 87,760 103,600 119,440 137,656
Plus:Tax benefit of
Foundation(1)........ 2,729 3,210 3,692 4,245
Less:Common Stock
acquired by ESOP(2).. (7,755) (9,124) (10,492) (12,066)
Common Stock to be
acquired by Stock-
Based Incentive
Plan(3)............ (3,878) (4,562) (5,246) (6,033)
-------- -------- -------- --------
Pro forma
stockholders'
equity(3)(5)(6).... $162,356 $176,624 $190,894 $207,302
======== ======== ======== ========
Stockholders' equity per
share(7):
Historical............ $ 8.61 $ 7.32 $ 6.37 $ 5.54
Estimated net
proceeds............. 9.05 9.08 9.11 9.13
Plus:Tax benefit of
Foundation........... 0.28 0.28 0.28 0.28
Less:Common Stock
acquired by ESOP(2).. (0.80) (0.80) (0.80) (0.80)
Common Stock to be
acquired by Stock-
Based Incentive
Plan(3)............ (0.40) (0.40) (0.40) (0.40)
-------- -------- -------- --------
Pro forma
stockholders'
equity per
share(3)(5)(6)..... $ 16.74 $ 15.48 $ 14.56 $ 13.75
======== ======== ======== ========
Offering price as a
percentage of pro forma
stockholders' equity
per share.............. 59.74% 64.60% 68.68% 72.73%
Offering price to pro
forma net earnings per
share (annualized)..... 10.64 11.90 13.51 14.71
</TABLE>
(Footnotes on next page)
30
<PAGE>
- --------
(1) Does not give effect to the non-recurring expense that is expected to be
recognized in the fourth quarter of 1998 if the establishment of the
Foundation is approved. In that event, the Company will recognize an
after-tax expense for the amount of the contribution to the Foundation
which is expected to be $4.5 million, $5.2 million, $6.0 million and $6.9
million at the minimum, midpoint, maximum, and maximum as adjusted, of the
Estimated Price Range, respectively, based on an effective tax rate of
38%.
(2) It is assumed that 8% of the shares of Common Stock issued in the
Conversion, including shares issued to the Foundation, will be purchased
by the ESOP. For purposes of this table, the funds used to acquire such
shares are assumed to have been borrowed by the ESOP from the Company. See
"Use of Proceeds." The amount to be borrowed is reflected as a reduction
of stockholders' equity. The Bank intends to make annual contributions to
the ESOP in an amount at least equal to the principal and interest
requirement of the debt. The Bank's total annual payment of the ESOP debt
is based upon 20 equal annual installments of principal, with an assumed
interest rate at 8.5%. The pro forma net earnings assume: (i) that the
Bank's contribution to the ESOP is equivalent to the debt service
requirement for the six months ended June 30, 1998 and was made at the end
of the period; (ii) that 19,388, 22,810, 26,231 and 30,166 shares at the
minimum, midpoint, maximum and 15% above the maximum of the Estimated
Price Range, respectively, were committed to be released during the six
months ended June 30, 1998 at an average fair value of $10.00 per share in
accordance with Statement of Position ("SOP") 93-6; and (iii) only the
ESOP shares committed to be released were considered outstanding for
purposes of the net earnings per share calculations. A tax rate of 38% was
used for all calculations. See "Management of the Bank--Benefits--Employee
Stock Ownership Plan and Trust."
(3) Gives effect to the Stock-Based Incentive Plan expected to be adopted by
the Company following the Conversion, and assumes any necessary
stockholder or regulatory approval of the Stock-Based Incentive Plan has
been received. The Stock-Based Incentive Plan intends to acquire an amount
of Common Stock equal to 4% of the shares of Common Stock issued in the
Conversion, including shares issued to the Foundation, or 387,763,
456,192, 524,621 and 603,314 shares of Common Stock at the minimum,
midpoint, maximum and 15% above the maximum of the Estimated Price Range,
respectively, either through open market purchases, if permissible, or
from authorized but unissued shares of Common stock or treasury stock of
the Company, if any. Funds used by the Stock-Based Incentive Plan to
purchase the shares will be contributed to the Stock-Based Incentive Plan
by the Bank. In calculating the pro forma effect of the Stock-Based
Incentive Plan, it is assumed that the shares were acquired by the Stock-
Based Incentive Plan at the beginning of the period presented in open
market purchases at the Purchase Price and that 10% of the amount
contributed was an amortized expense during such period. The issuance of
authorized but unissued shares of the Company's Common Stock to the Stock-
Based Incentive Plan instead of open market purchases would dilute the
voting interests of existing stockholders by approximately 3.8% and pro
forma net earnings per share would be $0.46, $0.41, $0.37 and $0.34 at the
minimum, midpoint, maximum and 15% above the maximum of the range,
respectively, and pro forma shareholders' equity per share would be
$16.10, $14.89, $13.99 and $13.22 at the minimum, midpoint, maximum and
15% above the maximum of the range, respectively. There can be no
assurance that stockholder approval of the Stock-Based Incentive Plan will
be obtained, or that the actual purchase price of the shares will be equal
to the Purchase Price. A tax rate of 38% was used for all calculations.
See "Management of the Bank--Benefits--Stock-Based Incentive Plan."
(4) The number of shares used in the calculation of historical and pro forma
earnings per share was 8,937,942, 10,515,226, 12,092,509 and 13,906,386
shares at the minimum, midpoint, maximum and 15% above the maximum of the
Estimated Price Range, respectively.
(5) No effect has been given to the issuance of additional shares of Common
Stock pursuant to the Stock-Based Incentive Plan expected to be adopted by
the Company following the Conversion. An amount equal to 10% of the Common
Stock issued in the Conversion, including shares issued to the Foundation,
or 969,408, 1,140,480, 1,311,552 and 1,508,285 shares at the minimum,
midpoint, maximum and 15% above the maximum of the Estimated Price Range,
respectively, will be reserved for future issuance upon the exercise of
options to be granted under the Stock-Based Incentive Plan. The issuance
of Common Stock pursuant to the exercise of options under the Stock-Based
Incentive Plan will result in the dilution of existing stockholders'
interests. Assuming all options were exercised at the end of the period at
an exercise price of $10.00 per share, the pro forma net earnings per
share would be $0.43, $0.38, $0.34 and $0.31, respectively, and the pro
forma stockholders' equity per share would be $16.13, $14.99, $14.14 and
$13.40, respectively. See "Management of the Bank--Benefits--Stock-Based
Incentive Plan."
(6) The retained earnings of the Bank will continue to be substantially
restricted after the Conversion. See "Dividend Policy," "The Conversion--
Liquidation Rights" and "Regulation--Federal Savings Institution
Regulation--Limitation on Capital Distributions."
(7) The total number of shares, including shares issued to the Foundation,
used in the calculation of historical and pro forma stockholders' equity
per share was 9,694,080, 11,404,800, 13,115,520 and 15,082,848 shares at
the minimum, midpoint, maximum and 15% above the maximum of the Estimated
Price Range, respectively.
(8) As adjusted to give effect to an increase in the number of shares which
could occur due to an increase in the Estimated Price Range of up to 15%
as a result of regulatory considerations or changes in market or general
financial and economic conditions following the commencement of the
Subscription Offering.
31
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------
13,965,600
8,976,000 10,560,000 12,144,000 SHARES SOLD
SHARES SOLD SHARES SOLD SHARES SOLD AT $10.00
AT $10.00 AT $10.00 AT $10.00 PER SHARE
PER SHARE PER SHARE PER SHARE (15% ABOVE
(MINIMUM (MIDPOINT (MAXIMUM MAXIMUM OF
OF ESTIMATED OF ESTIMATED OF ESTIMATED ESTIMATED
PRICE RANGE) PRICE RANGE) PRICE RANGE) PRICE RANGE)(8)
------------ ------------ ------------ ---------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Gross proceeds.......... $ 89,760 $105,600 $121,440 $139,656
Plus:Shares issued to
Foundation (equal to 8%
of the stock sold in
the Conversion)........ 7,181 8,448 9,715 11,172
-------- -------- -------- --------
Pro forma market
capitalization..... $ 96,941 $114,048 $131,155 $150,828
======== ======== ======== ========
Gross proceeds.......... $ 89,760 $105,600 $121,440 $139,656
Less:Offering expenses
and commission....... (2,000) (2,000) (2,000) (2,000)
-------- -------- -------- --------
Estimated net
proceeds........... 87,760 103,600 119,440 137,656
Less:Common Stock
acquired by the
ESOP................. (7,755) (9,124) (10,492) (12,066)
Common Stock to be
acquired by Stock-
Based Incentive
Plan............... (3,878) (4,562) (5,246) (6,033)
-------- -------- -------- --------
Estimated net
proceeds, as
adjusted........... $ 76,127 $ 89,914 $103,702 $119,557
======== ======== ======== ========
Consolidated net
earnings(1):
Historical............ $ 6,425 $ 6,425 $ 6,425 $ 6,425
Pro forma earnings on
net proceeds......... 2,550 3,012 3,474 4,005
Less:Pro forma ESOP
adjustment(2)........ (240) (283) (325) (374)
Pro forma Stock-
Based Incentive
Plan
adjustment(3)...... (481) (566) (651) (748)
-------- -------- -------- --------
Pro forma net
earnings........... $ 8,254 $ 8,588 $ 8,923 $ 9,308
======== ======== ======== ========
Per share net
earnings(1)(4):
Historical............ $ 0.72 $ 0.61 $ 0.53 $ 0.46
Pro forma earnings on
net proceeds......... 0.28 0.29 0.29 0.29
Less:Pro forma ESOP
adjustment(2)........ (0.03) (0.03) (0.03) (0.03)
Pro forma Stock-
Based Incentive
Plan
adjustment(3)...... (0.05) (0.05) (0.05) (0.05)
-------- -------- -------- --------
Pro forma net
earnings per
share.............. $ 0.92 $ 0.82 $ 0.74 $ 0.67
======== ======== ======== ========
Stockholders' equity:
Historical............ $ 80,073 $ 80,073 $ 80,073 $ 80,073
Estimated net
proceeds............. 87,760 103,600 119,440 137,656
Plus:Tax benefit of
Foundation(1)........ 2,729 3,210 3,692 4,245
Less:Common Stock
acquired by ESOP(2).. (7,755) (9,124) (10,492) (12,066)
Common Stock to be
acquired by Stock-
Based Incentive
Plan(3)............ (3,878) (4,562) (5,246) (6,033)
-------- -------- -------- --------
Pro forma
stockholders'
equity(3)(5)(6).... $158,929 $173,197 $187,467 $203,875
======== ======== ======== ========
Stockholders' equity per
share(7):
Historical............ $ 8.26 $ 7.02 $ 6.11 $ 5.31
Estimated net
proceeds............. 9.05 9.08 9.11 9.13
Plus:Tax benefit of
Foundation........... 0.28 0.28 0.28 0.28
Less:Common Stock
acquired by ESOP(2).. (0.80) (0.80) (0.80) (0.80)
Common Stock to be
acquired by Stock-
Based Incentive
Plan(3)............ (0.40) (0.40) (0.40) (0.40)
-------- -------- -------- --------
Pro forma
stockholders'
equity per
share(3)(5)(6)..... $ 16.39 $ 15.18 $ 14.30 $ 13.52
======== ======== ======== ========
Offering price as a
percentage of pro forma
stockholders' equity
per share.............. 61.01% 65.88% 69.93% 73.96%
Offering price to pro
forma net earnings per
share.................. 10.87 12.20 13.51 14.93
</TABLE>
(Footnotes on next page)
32
<PAGE>
- --------
(1) Does not give effect to the non-recurring expense that will be recognized
in the fourth quarter of 1998 if the establishment of the Foundation is
approved. In that event, the Company will recognize an after-tax expense
for the amount of the contribution to the Foundation which is expected to
be $4.5 million, $5.2 million, $6.0 million and $6.9 million at the
minimum, midpoint, maximum, and maximum as adjusted, of the Estimated
Price Range, respectively, based on an effective tax rate of 38%.
(2) It is assumed that 8% of the shares of Common Stock issued in the
Conversion, including shares issued to the Foundation, will be purchased
by the ESOP. For purposes of this table, the funds used to acquire such
shares are assumed to have been borrowed by the ESOP from the Company. See
"Use of Proceeds." The amount to be borrowed is reflected as a reduction
of stockholders' equity. The Bank intends to make annual contributions to
the ESOP in an amount at least equal to the principal and interest
requirement of the debt. The Bank's total annual payment of the ESOP debt
is based upon 20 equal annual installments of principal, with an assumed
interest rate at 8.5%. The pro forma net earnings assume: (i) that the
Bank's contribution to the ESOP is equivalent to the debt service
requirement for the year ended December 31, 1997 and was made at the end
of the period; (ii) that 38,776, 45,619, 52,462 and 60,331 shares at the
minimum, the midpoint, maximum and 15% above the maximum of the Estimated
Price Range, respectively, were committed to be released during the year
ended December 31, 1997 at an average fair value of $10.00 per share in
accordance with SOP 93-6; and (iii) only the ESOP shares committed to be
released were considered outstanding for purposes of the net earnings per
share calculations. A tax rate of 38% was used for all calculations. See
"Management of the Bank--Benefits--Employee Stock Ownership Plan and
Trust."
(3) Gives effect to the Stock-Based Incentive Plan expected to be adopted by
the Company following the Conversion, and assumes any necessary
stockholder or regulatory approval of the Stock-Based Incentive Plan has
been received. The Stock-Based Incentive Plan intends to acquire an amount
of Common Stock equal to 4% of the shares of Common Stock issued in the
Conversion, including shares issued to the Foundation, or 387,763,
456,192, 524,621 and 603,314 shares of Common Stock at the minimum,
midpoint, maximum and 15% above the maximum of the Estimated Price Range,
respectively, either through open market purchases, if permissible, or
from authorized but unissued shares of Common stock or treasury stock of
the Company, if any. Funds used by the Stock-Based Incentive Plan to
purchase the shares will be contributed to the Stock-Based Incentive Plan
by the Bank. In calculating the pro forma effect of the Stock-Based
Incentive Plan, it is assumed that the shares were acquired by the Stock-
Based Incentive Plan at the beginning of the period presented in open
market purchases at the Purchase Price and that 20% of the amount
contributed was an amortized expense during such period. The issuance of
authorized but unissued shares of the Company's Common Stock to the Stock-
Based Incentive Plan instead of open market purchases would dilute the
voting interests of existing stockholders by approximately 3.8% and pro
forma net earnings per share would be $0.90, $0.80, $0.72 and $0.65 at the
minimum, midpoint, maximum and 15% above the maximum of the range,
respectively, and pro forma stockholders' equity per share would be
$15.76, $14.60, $13.74 and $13.00 at the minimum, midpoint, maximum, and
15% above the maximum of the range, respectively. There can be no
assurance that stockholder approval of the Stock-Based Incentive Plan will
be obtained, or that the actual purchase price of the shares will be equal
to the Purchase Price. A tax rate of 38% was used for all calculations.
See "Management of the Bank--Benefits--Stock-Based Incentive Plan."
(4) The number of shares used in the calculation of historical and pro forma
earnings per share was 8,957,330, 10,538,035, 12,118,740 and 13,936,551
shares at the minimum, midpoint, maximum and 15% above the maximum of the
Estimated Price Range, respectively.
(5) No effect has been given to the issuance of additional shares of Common
Stock pursuant to the Stock-Based Incentive Plan expected to be adopted by
the Company following the Conversion. An amount equal to 10% of the Common
Stock issued in the Conversion, including shares issued to the Foundation,
or 969,408, 1,140,480, 1,311,552 and 1,508,285 shares at the minimum,
midpoint, maximum and 15% above the maximum of the Estimated Price Range,
respectively, will be reserved for future issuance upon the exercise of
options to be granted under the Stock-Based Incentive Plan. The issuance
of Common Stock pursuant to the exercise of options under the Stock-Based
Incentive Plan will result in the dilution of existing stockholders'
interests. Assuming all options were exercised at the end of the period at
an exercise price of $10.00 per share, the pro forma net earnings per
share would be $0.83, $0.74, $0.66 and $0.60, respectively, and the pro
forma stockholders' equity per share would be $15.81, $14.71, $13.90 and
$13.20, respectively. See "Management of the Bank--Benefits--Stock-Based
Incentive Plan."
(6) The retained earnings of the Bank will continue to be substantially
restricted after the Conversion. See "Dividend Policy," "The Conversion--
Liquidation Rights" and "Regulation--Federal Savings Institution
Regulation--Limitation on Capital Distributions."
(7) The total number of shares, including shares issued to the Foundation,
used in the calculation of historical and pro forma stockholders' equity
per share was 9,694,080, 11,404,800, 13,115,520 and 15,082,848 shares at
the minimum, midpoint, maximum and 15% above the maximum of the Estimated
Price Range, respectively.
(8) As adjusted to give effect to an increase in the number of shares which
could occur due to an increase in the Estimated Price Range of up to 15%
as a result of regulatory considerations or changes in market or general
financial and economic conditions following the commencement of the
Subscription Offering.
33
<PAGE>
COMPARISON OF VALUATION AND PRO FORMA INFORMATION WITH NO FOUNDATION
If the Foundation were not being established as part of the Conversion,
FinPro has estimated that the pro forma market capitalization of the Bank
would be approximately $122.0 million at the midpoint, which is approximately
$8.0 million greater than the pro forma market capitalization of the Bank if
the Foundation is approved by members of the Bank and would result in
approximately a $16.4 million increase, or 15.5%, in the amount of Common
Stock offered for sale in the Conversion. The pro forma price to book ratio
and pro forma price to earnings ratio would be approximately the same under
both the current appraisal and the estimate of the value of the Company
without the Foundation. Further, assuming the midpoint of the Estimated Price
Range, pro forma stockholders' equity per share and pro forma earnings per
share would be essentially the same with the Foundation as without the
Foundation. This estimate by FinPro was prepared at the request of the OTS and
is solely for purposes of providing members with sufficient information with
which to make an informed decision on the Foundation. There is no assurance
that in the event the Foundation is not approved at the Special Meeting of
Members that the appraisal prepared at that time would conclude that the pro
forma market value of the Company would be the same as that estimated herein.
Any appraisal prepared at that time would be based on the facts and
circumstances existing at that time, including, among other things, market and
economic conditions.
For comparative purposes only, set forth below are certain pricing ratios
and financial data and ratios, at the minimum, midpoint, maximum and maximum,
as adjusted, of the Estimated Price Range, assuming the Conversion was
completed at June 30, 1998.
<TABLE>
<CAPTION>
AT THE MAXIMUM,
AT THE MINIMUM AT THE MIDPOINT AT THE MAXIMUM AS ADJUSTED
---------------------- ---------------------- ---------------------- ----------------------
WITH NO WITH NO WITH NO WITH NO
FOUNDATION FOUNDATION FOUNDATION FOUNDATION FOUNDATION FOUNDATION FOUNDATION FOUNDATION
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Estimated offering
amount................. $ 89,760 $103,700 $105,600 $122,000 $121,440 $140,300 $139,656 $161,345
Pro forma market
capitalization......... 96,941 103,700 114,048 122,000 131,155 140,300 150,828 161,345
Total assets............ 551,136 561,536 565,404 577,640 579,674 593,744 596,082 612,263
Total liabilities....... 388,780 388,780 388,780 388,780 388,780 388,780 388,780 388,780
Pro forma stockholders'
equity................. 162,356 172,756 176,624 188,860 190,894 204,964 207,302 223,483
Pro forma consolidated
net earnings........... 4,235 4,429 4,402 4,631 4,569 4,833 4,762 5,065
Pro forma stockholders'
equity per share....... 16.74 16.66 15.48 15.48 14.56 14.61 13.75 13.86
Pro forma consolidated
net earnings per
share.................. 0.47 0.47 0.42 0.42 0.37 0.38 0.34 0.34
Pro Forma Pricing
Ratios:
Offering price as a
percentage of pro
forma stockholders'
equity per share...... 59.74% 60.02% 64.60% 64.60% 68.68% 68.45% 72.73% 72.15%
Offering price to pro
forma net earnings per
share................. 10.64 x 10.64 x 11.90 x 11.90 x 13.51 x 13.16 x 14.71 x 14.71 x
Pro forma market
capitalization to
total assets.......... 17.59% 18.47% 20.17% 21.12% 22.63% 23.63% 25.30% 26.35%
Pro Forma Financial
Ratios:
Return on total
assets................ 1.54% 1.58% 1.56% 1.60% 1.58% 1.63% 1.60% 1.65%
Return on stockholders'
equity (annualized)... 5.22% 5.13% 4.98% 4.90% 4.79% 4.72% 4.59% 4.53%
Stockholders' equity to
total assets.......... 29.46% 30.76% 31.24% 32.70% 32.93% 34.52% 34.78% 36.50%
</TABLE>
34
<PAGE>
FREDERICKSBURG SAVINGS
STATEMENTS OF INCOME
The following Statements of Income for each of the years in the three-year
period ended December 31, 1997 have been audited by Cherry, Bekaert & Holland,
L.L.P., independent certified public accountants, whose report thereon is
included elsewhere in this Prospectus. With respect to the information for the
six months ended June 30, 1998 and 1997, which is unaudited, in the opinion of
management, all adjustments necessary for a fair presentation of such interim
periods have been included and are of a normal recurring nature. Results for
the six months ended June 30, 1998 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1998. These
Statements of Income should be read in conjunction with the Financial
Statements and notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEAR
ENDED JUNE 30, ENDED DECEMBER 31,
-------------------- -------------------------------
1998 1997 1997 1996 1995
--------- --------- -------------- ------- -------
(UNAUDITED) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest income:
Loans receivable:
Mortgage loans....... $ 16,473 $ 16,300 $32,879 $32,170 $31,561
Consumer and other
loans............... 383 330 696 543 611
Investment
securities........... 1,388 1,442 2,929 3,285 4,133
--------- --------- ------- ------- -------
Total interest
income............. 18,244 18,072 36,504 35,998 36,305
--------- --------- ------- ------- -------
Interest expense:
Deposit accounts...... 9,375 9,262 18,816 19,076 18,432
FHLB advances and
other borrowings..... 245 306 602 459 565
--------- --------- ------- ------- -------
Total interest
expense............ 9,620 9,568 19,418 19,535 18,997
--------- --------- ------- ------- -------
Net interest and
dividend income
before provision
for loan losses.... 8,624 8,504 17,086 16,463 17,308
Provision for loan
losses................. 269 241 375 325 412
--------- --------- ------- ------- -------
Net interest and
dividend income
after provision for
loan losses........ 8,355 8,263 16,711 16,138 16,896
--------- --------- ------- ------- -------
Noninterest income:
Fees and other service
charges.............. 147 155 318 240 198
Other income.......... 102 50 142 169 85
--------- --------- ------- ------- -------
Total noninterest
income............. 249 205 460 409 283
--------- --------- ------- ------- -------
Noninterest expense:
Compensation and
benefits............. 1,462 1,689 3,511 3,716 3,345
Occupancy and
equipment............ 343 343 717 762 608
Federal deposit
insurance premiums... 172 129 349 3,391 864
Net cost of foreclosed
real estate
operations........... 25 21 163 130 185
Other expense......... 1,067 877 2,054 1,566 1,449
--------- --------- ------- ------- -------
Total noninterest
expense............ 3,069 3,059 6,794 9,565 6,451
--------- --------- ------- ------- -------
Income before income
tax expense........ 5,535 5,409 10,377 6,982 10,728
--------- --------- ------- ------- -------
Income tax expense:
Current............... 2,280 2,527 3,990 2,943 4,508
Deferred.............. (65) (377) (38) (542) (438)
--------- --------- ------- ------- -------
Net income.......... $ 3,320 $ 3,259 $ 6,425 $ 4,581 $ 6,658
========= ========= ======= ======= =======
</TABLE>
(See notes to financial statements.)
35
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company has only recently been formed and, accordingly, has no results
of operations. The Bank's results of operations are dependent primarily on net
interest income, which is the difference between the income earned on its loan
and investment portfolios and its cost of funds, consisting of the interest
paid on deposits and borrowings. Results of operations are also affected by
the Bank's provision for loan losses and fees and other service charges. The
Bank's noninterest expense principally consists of compensation and employee
benefits, office occupancy and equipment expense, federal deposit insurance
premiums, the cost of foreclosed real estate operations, data processing,
advertising and business promotion and other expenses. Results of operations
are also significantly affected by general economic and competitive
conditions, particularly changes in interest rates, government policies and
actions of regulatory authorities. Future changes in applicable law,
regulations or government policies may materially impact the Bank.
FORWARD-LOOKING STATEMENTS
This Prospectus contains certain forward-looking statements which are based
on certain assumptions and describe future plans, strategies and expectations
of the Company. These forward-looking statements are generally identified by
use of the words "believe," "expect," "intend," "anticipate," "estimate,"
"project," or similar expressions. The Company's ability to predict results or
the actual effect of future plans or strategies is inherently uncertain.
Factors which could have a material adverse effect on the operations of the
Company and the subsidiaries include, but are not limited to, changes in:
interest rates, general economic conditions, legislative/regulatory changes,
monetary and fiscal policies of the U.S. Government, including policies of the
U.S. Treasury and the Federal Reserve Board, the quality or composition of the
loan or investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company's market area and
accounting principles and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements. The Company does not undertake--and
specifically disclaims any obligation--to publicly release the result of any
revisions which may be made to any forward-looking statements to reflect
events or circumstances after the date of such statements or to reflect the
occurrence of anticipated or unanticipated events.
MANAGEMENT STRATEGY
Traditionally, management's primary goal has been to control growth and
maintain the Bank's profitability, market share, asset quality and its capital
position by: (i) investing primarily in one- to four-family loans secured by
properties located in its primary market area; (ii) investing in non-
residential and construction and development loans secured by properties
located in the Bank's primary market area, to the extent that such loans meet
the Bank's general underwriting criteria including, but not limited to,
satisfaction of certain loan-to-value ("LTV") and debt service coverage ratios
and satisfaction that the borrower is experienced in these types of real
estate projects; (iii) investing in consumer loans; (iv) investing funds not
utilized for loan investments in short-term U.S. Treasury and agency
obligations, including mortgage-backed and mortgage-related securities as well
as highly rated corporate notes and municipal bonds; and (v) building capital
while controlling operating expenses. See "Business of the Bank--Lending
Activities" and "--Securities Investment Activities." In the future,
management intends to seek growth opportunities and intends to seek means of
lessening its exposure to interest rate risk while avoiding investments the
Bank's management believes bear risks inconsistent with the Bank's investment
policies. Management intends to grow by expanding the products and services it
offers, as necessary, in order to improve its market share in its primary
market area as well as seeking opportunities to expand its market share and
product line through acquisitions, including, possibly, the acquisition of a
commercial bank, although management has no current plans in that regard.
Currently, the Bank is seeking means to increase its total deposits,
particularly checking accounts, and has begun to implement 24 hour banking
services and, in the future, may expand its consumer retail products. Other
products and services are also being
36
<PAGE>
reviewed, including products that would attract more local business to the
Bank. Emphasis has been placed on increasing the number of transaction
accounts the Bank has through aggressive advertising and expanding the variety
of savings and checking accounts available. The Bank will also seek to expand
consumer loans, including home equity loan originations. Finally, depending
upon market conditions, management may implement leverage strategies to
enhance income. Such strategies would be to increase borrowings and invest the
borrowed funds in secured investments to enhance income from the spread
between the cost of the borrowed funds and the investment yield.
MANAGEMENT OF INTEREST RATE RISK AND MARKET RISK ANALYSIS
QUALITATIVE ANALYSIS
The principal objective of the Bank's interest rate risk management function
is to evaluate the interest rate risk included in certain balance sheet
accounts, determine the appropriate level of risk given the Bank's business
strategy, operating environment, capital and liquidity requirements and
performance objectives and manage the risk consistent with the Board of
Directors' approved guidelines. Through such management, the Bank seeks to
reduce the vulnerability of its operations to changes in interest rates, while
not subjecting the Bank to undue credit or investment risk. The Bank monitors
its interest rate risk as such risk relates to its operating strategies. The
Bank's Board of Directors has established an Asset/Liability Committee,
responsible for reviewing its asset/liability policies and interest rate risk
position, which meets on a regular basis, and reports trends and interest rate
risk position to the Board of Directors on a quarterly basis. The extent of
the movement of interest rates is an uncertainty that could have a negative
impact on the earnings of the Bank. See "Risk Factors--Sensitivity to Changes
in Interest Rates."
In recent years, the Bank has become subject to increasing risk in the event
interest rates begin to rise due to the substantial levels of fixed-rate loans
the Bank has been originating due to high customer demand for such products in
the Bank's primary market area. As discussed above, the Bank has sought to
offset the interest rate risk associated with originating primarily fixed-rate
loans in a low interest rate environment by investing in short-term U.S.
Treasury and agency obligations to enable the Bank to reinvest relatively
quickly in higher yielding investments if interest rates rise. In the future,
depending upon market conditions, the Bank intends to seek opportunities to
increase its investment in short-term adjustable rate mortgage-backed
securities and may evaluate opportunities to sell long-term fixed-rate loans
in the secondary market. Currently, management believes that the Bank's strong
capital position and level of liquidity coupled with low operating expenses
would enable the Bank to continue operating profitably in the event of a rapid
rise in interest rates, as it would be positioned to invest in higher yielding
investments to offset the negative impact its high fixed-rate loan portfolio
would have on the Bank's earnings; however, depending upon the magnitude of
any change in interest rates, the Bank may not be able to react quickly enough
to reinvest such funds and therefore may experience a decrease in earnings
following a significant increase in interest rates. The Bank may also increase
non-deposit borrowings which would further enable the Bank to invest in higher
yielding instruments in an increasing rate environment.
QUANTITATIVE ANALYSIS
Gap Analysis. The matching of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring a Bank's interest rate sensitivity "gap." An
asset and liability is said to be interest rate sensitive within a specific
time period if it will mature or reprice within that time period. The interest
rate sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period
and the amount of interest-bearing liabilities maturing or repricing within
that same time period. At June 30, 1998, the Bank's cumulative one year
interest rate gap (which is the difference between the amount of interest-
earning assets maturing or repricing within one year and interest-bearing
liabilities maturing or repricing within one year) as a percentage of total
assets, was negative 15.17%. A gap is considered positive when the amount of
interest rate sensitive assets exceeds the amount of interest rate sensitive
liabilities. A gap is considered negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets.
Accordingly, during a period of rising
37
<PAGE>
interest rates, an institution with a negative gap position would be in a
worse position to invest in higher yielding assets as compared to an
institution with a positive gap position which, consequently, may result in
the cost of its interest-bearing liabilities increasing at a rate faster than
its yield on interest-earning assets than if it had a positive gap. During a
period of falling interest rates, an institution with a negative gap position
would tend to have its interest-bearing liabilities repricing downward at a
faster rate than its interest-earning assets as compared to an institution
with a positive gap which, consequently, may tend to positively affect the
growth of its net interest income.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1998, which are
anticipated by the Bank, based upon certain assumptions, to reprice or mature
in each of the future time periods shown (the "Gap Table"). Except as stated
below, the amount of assets and liabilities shown which reprice or mature
during a particular period were determined in accordance with the earlier of
term to repricing or the contractual maturity of the asset or liability. The
table sets forth an approximation of the projected repricing of assets and
liabilities at June 30, 1998, on the basis of contractual maturities, and
scheduled rate adjustments within a one year period and subsequent selected
time intervals. The loan amounts in the table reflect principal balances
expected to be redeployed and/or repriced as a result of contractual
amortization of adjustable-rate loans and fixed-rate loans, and as a result of
contractual rate adjustments on adjustable-rate loans. Mortgage-backed
securities were assumed to prepay at 30% annually. Savings accounts were
assumed to decay at 20%, 20%, 20%, 20%, 20% and 0%, and money market savings
accounts were assumed to decay at 50%, 25%, 25%, 0%, 0% and 0%, for the
periods of one year or less, more than one year to two years, more than two
years to three years, more than three years to four years, more than four
years to five years, and more than five years, respectively. Certificate
accounts are reflected at actual dates of maturity. These assumptions are
generally based on the FDIC's deposit decay guidelines and the Bank's
historical experience. Prepayment and deposit decay rates can have a
significant impact on the Bank's estimated gap. While the Bank believes such
assumptions to be reasonable, there can be no assurance that assumed
prepayment rates and decay rates will approximate actual future loan
prepayment and deposit withdrawal activity. See "Business of the Bank--Lending
Activities," "--Investment Activities" and "--Sources of Funds."
38
<PAGE>
<TABLE>
<CAPTION>
MORE MORE
THAN MORE MORE THAN
1 YEAR THAN THAN 4 YEARS MORE
1 YEAR TO 2 YEARS TO 3 YEARS TO TO THAN TOTAL
OR LESS 2 YEARS 3 YEARS 4 YEARS 5 YEARS 5 YEARS AMOUNT
-------- --------- ---------- ---------- --------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Mortgage loans(1)...... $124,398 $ 5,457 $ 5,631 $ 3,186 $ 5,081 $280,640 $424,393
Consumer and other
loans................. 2,373 905 1,726 2,065 1,254 739 9,062
Mortgage-backed and
related securities.... 357 357 357 119 -- -- 1,190
Overnight and short
term investments...... 8,248 -- -- -- -- -- 8,248
Investments and
interest-earning
deposits.............. 20,019 4,537 4,320 1,019 1,796 2,776 34,467
-------- --------- --------- --------- --------- -------- --------
Total interest-earning
assets............... $155,395 $ 11,256 $ 12,034 $ 6,389 $ 8,131 $284,155 $477,360
======== ========= ========= ========= ========= ======== ========
INTEREST-BEARING LIABIL-
ITIES:
Money market deposit
accounts and other
transaction accounts.. 22,810 11,406 11,406 -- -- -- 45,622
Savings accounts....... 7,563 7,563 7,564 7,564 7,564 -- 37,818
Certificate accounts... 196,666 48,743 23,783 8,988 12,099 -- 290,279
-------- --------- --------- --------- --------- -------- --------
Total interest- bearing
deposits............... 227,039 67,712 42,753 16,552 19,663 -- 373,719
FHLB advances.......... -- 3,000 -- 5,000 -- -- 8,000
Total interest-bearing
liabilities........... $227,039 $ 70,712 $ 42,753 $ 21,552 $ 19,663 $ -- $381,719
======== ========= ========= ========= ========= ======== ========
Interest sensitivity
gap.................... $(71,644) $ (59,456) $ (30,719) $ (15,163) $ (11,532) $284,155 $ 95,641
======== ========= ========= ========= ========= ======== ========
Cumulative interest-rate
sensitivity gap........ $(71,644) $(131,100) $(161,819) $(176,982) $(188,514) $ 95,641
======== ========= ========= ========= ========= ========
Cumulative interest-rate
sensitivity gap as a
percentage of total
assets................. (15.17)% (27.76)% (34.26)% (37.47)% (39.92)% 20.25%
Cumulative interest-rate
gap as a percentage of
total interest-earning
assets................. (15.01)% (27.46)% (33.90)% (37.08)% (39.49)% 20.04%
Cumulative interest-
earning assets as a
percentage of
cumulative interest-
bearing liabilities.... 68.44 % 55.97 % 52.48 % 51.12 % 50.61 % 125.06%
</TABLE>
- --------
(1)Excludes nonaccrual loans.
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react differently to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict changes in interest rates both on a short-term basis
and over the life of the asset. Further, in the event of a change in interest
rates, prepayment and early withdrawal levels may deviate significantly from
those assumed in calculating the table. Finally, the ability of borrowers to
service their adjustable-rate loans may decrease in the event of an interest
rate increase.
39
<PAGE>
Net Portfolio Value. As part of its interest rate risk analysis, the Bank
uses an interest rate sensitivity model which generates estimates of the
change in the Bank's net portfolio value ("NPV") over a range of interest rate
scenarios and which is prepared by the OTS on a quarterly basis. NPV is the
present value of expected cash flows from assets, liabilities and off-balance
sheet contracts. The NPV ratio, under any interest rate scenario, is defined
as the NPV in that scenario divided by the market value of assets in the same
scenario. The OTS produces such analysis using its own model, based upon data
submitted on the Bank's quarterly Thrift Financial Reports, including
estimated loan prepayment rates, reinvestment rates and deposit decay rates.
See "Regulation--Federal Savings Institution Regulation." The following table
sets forth the Bank's NPV as of June 30, 1998 (the latest NPV analysis
prepared by the OTS), as calculated by the OTS.
<TABLE>
<CAPTION>
NPV AS % OF
PORTFOLIO VALUE
NET PORTFOLIO VALUE OF ASSETS
CHANGE IN INTEREST -------------------------- ----------------
RATES IN NPV
BASIS POINTS (RATE AMOUNT $ CHANGE % CHANGE RATIO CHANGE(1)
SHOCK) ------- -------- -------- ----- ---------
------------------ (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
+400........................... $39,029 $(42,383) (52.06)% 9.25% (803)
+300........................... 50,125 (31,287) (38.43) 11.53 (574)
+200........................... 61,264 (20,148) (24.75) 13.69 (358)
+100........................... 72,073 (9,339) (11.47) 15.66 (161)
Static......................... 81,412 -- -- 17.27 --
-100........................... 88,138 6,726 8.26 18.35 108
-200........................... 91,203 9,791 12.03 18.75 148
-300........................... 94,588 13,176 16.18 19.19 192
-400........................... 99,342 17,930 22.02 19.84 257
</TABLE>
--------
(1) Expressed in basis points.
As is the case with the Gap Table, certain shortcomings are inherent in the
methodology used in the above interest rate risk measurements. Modeling
changes in NPV require the making of certain assumptions which may or may not
reflect the manner in which actual yields and costs respond to changes in
market interest rates. In this regard, the NPV model presented assumes that
the composition of the Bank's interest sensitive assets and liabilities
existing at the beginning of a period remains constant over the period being
measured and also assumes that a particular change in interest rates is
reflected uniformly across the yield curve regardless of the duration to
maturity or repricing of specific assets and liabilities. Accordingly,
although the NPV measurements and net interest income models provide an
indication of the Bank's interest rate risk exposure at a particular point in
time, such measurements are not intended to and do not provide a precise
forecast of the effect of changes in market interest rates on the Bank's net
interest income and will differ from actual results.
ANALYSIS OF NET INTEREST INCOME
Net interest income represents the difference between income on interest-
earning assets and expense on interest-bearing liabilities. Net interest
income depends upon the relative amounts of interest-earning assets and
interest-bearing liabilities and the interest rate earned or paid on them.
Average Balance Sheets. The following tables set forth certain information
relating to the Bank at June 30, 1998, the six months ended June 30, 1998 and
1997 and for the years ended December 31, 1997, 1996 and 1995. The average
yields and costs are derived by dividing income or expense by the average
balance of interest-earning assets or interest-bearing liabilities,
respectively, for the periods shown except where noted otherwise and reflect
annualized yields and costs. Average balances are derived from month-end
balances. Management does not believe that the use of average monthly balances
instead of average daily balances has caused any material differences in the
information presented. The yields and costs include fees which are considered
adjustments to yields. Loan interest and yield data does not include any
accrued interest from non-accruing loans.
40
<PAGE>
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30,
-----------------------------------------------------
AT JUNE 30,
1998 1998 1997
---------------- -------------------------- --------------------------
AVERAGE AVERAGE
YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE COST BALANCE INTEREST COST BALANCE INTEREST COST
-------- ------ -------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning
assets:
Mortgage loans, net.... $406,890 8.10% $402,658 $16,473 8.18% $397,809 $16,300 8.18%
Consumer and other
loans, net............ 9,096 8.42 8,899 383 8.60 8,256 330 8.00
Mortgage-backed and
related securities.... 1,190 9.71 1,243 103 16.58 1,438 118 16.40
Overnight and short-
term deposits......... 9,031 4.71 13,848 329 4.76 12,970 294 4.54
Investment
securities(1)......... 34,467 4.96 34,234 956 5.58 35,158 1,030 5.86
-------- ---- -------- ------- ----- -------- ------- -----
Total interest-earning
assets............... 460,674 7.92% 460,882 $18,244 7.90% 455,631 $18,072 7.92%
---- ------- ----- ------- -----
Noninterest-earning
assets................ 11,606 13,127 13,186
-------- -------- --------
Total assets.......... $472,280 $474,009 $468,817
======== ======== ========
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Transaction accounts... $ 2,481 0.32% $ 3,524 $ 5 0.28% $ 3,113 $ 4 0.26%
Savings accounts....... 80,959 3.25 83,136 1,320 3.18 88,135 1,417 3.22
Certificates of
deposit............... 290,279 5.71 288,687 8,050 5.58 283,856 7,841 5.52
-------- ---- -------- ------- ----- -------- ------- -----
Total deposits........ 373,719 5.16 375,347 9,375 5.00 375,104 9,262 4.94
FHLB advances.......... 8,000 6.19 8,000 245 6.12 10,000 306 6.12
-------- ---- -------- ------- ----- -------- ------- -----
Total interest-bearing
liabilities.......... 381,719 5.16% 383,347 $ 9,620 5.02% 385,104 $ 9,568 4.96%
---- ------- ----- ------- -----
Other liabilities...... 7,061 8,902 8,839
-------- -------- --------
Total liabilities..... 388,780 392,249 393,943
Equity capital......... 83,500 81,760 74,874
-------- -------- --------
Total liabilities and
equity capital....... $472,280 $474,009 $468,817
======== ======== ========
Net interest income/Net
interest rate
spread(2)............. 2.76% $ 8,624 2.88% $ 8,504 2.96%
==== ======= ===== ======= =====
Net earning assets/Net
interest margin(3).... $ 78,955 3.74% $ 77,535 3.74% $ 70,527 3.72%
======== ==== ======== ===== ======== =====
Ratio of interest-
earning assets to
interest-bearing
liabilities........... 120.68% 120.23% 118.31%
======== ======== ========
</TABLE>
- --------
(1) Includes investment securities available-for-sale and stock in FHLB-
Atlanta.
(2) Net interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(3) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
41
<PAGE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------
1997 1996 1995
-------------------------- -------------------------- --------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
-------- -------- ------- -------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning
assets:
Mortgage loans, net.... $399,924 $32,879 8.22% $388,750 $32,170 8.27% $368,360 $31,561 8.56%
Consumer and other
loans, net............ 8,495 696 8.19 9,271 543 5.86 10,703 611 5.71
Mortgage-backed and
related securities.... 1,396 237 16.98 1,652 277 16.77 2,009 320 15.93
Overnight and short-
term deposits......... 13,076 623 4.76 14,685 661 4.50 12,304 659 5.36
Investment
securities(1)......... 34,851 2,069 5.94 40,868 2,347 5.74 53,907 3,154 5.85
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-earning
assets............... 457,742 $36,504 7.97% 455,226 $35,998 7.90% 447,283 $36,305 8.11%
------- ----- ------- ----- ------- -----
Noninterest-earning
assets................ 13,052 13,724 11,649
-------- -------- --------
Total assets.......... $470,794 $468,950 $458,932
======== ======== ========
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Transaction accounts... $ 3,329 $ 7 0.21% $ 3,609 $ 6 0.17% $ 891 $ 8 0.90%
Savings accounts....... 86,907 2,818 3.24 94,856 2,977 3.14 101,574 3,329 3.28
Certificates of
deposit............... 285,410 15,991 5.60 283,944 16,093 5.67 275,907 15,095 5.47
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total deposits........ 375,646 18,816 5.01 382,409 19,076 4.99 378,372 18,432 4.87
FHLB advances and other
borrowings............ 9,667 602 6.23 7,417 459 6.19 8,000 565 7.06
-------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-bearing
liabilities.......... 385,313 $19,418 5.04% 389,826 $19,535 5.01% 386,372 $18,997 4.92%
------- ----- ------- ----- ------- -----
Other liabilities...... 8,897 7,719 7,062
-------- -------- --------
Total liabilities..... 394,210 397,545 393,434
Equity capital......... 76,584 71,405 65,498
-------- -------- --------
Total liabilities and
equity capital....... $470,794 $468,950 $458,932
======== ======== ========
Net interest income/Net
interest rate
spread(2)............. $17,086 2.93% $16,463 2.89% $17,308 3.19%
======= ===== ======= ===== ======= =====
Net earning assets/Net
interest margin(3).... $ 72,429 3.73% $ 65,400 3.61% $ 60,911 3.86%
======== ===== ======== ===== ======== =====
Ratio of interest-
earning assets to
interest-bearing
liabilities........... 118.80% 116.78% 115.77%
======== ======== ========
</TABLE>
- --------
(1) Includes investment securities available-for-sale and stock in FHLB-
Atlanta.
(2) Net interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(3) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
42
<PAGE>
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in the volume of interest-earning assets
and interest-bearing liabilities have affected the Bank's interest income and
interest expense during the periods indicated. Information is provided in each
category with respect to: (i) changes attributable to changes in volume
(changes in volume multiplied by prior rate); (ii) changes attributable to
changes in rate (changes in rate multiplied by prior volume); and (iii) the
net change. The changes attributable to the combined impact of volume and rate
have been allocated on a proportional basis between changes in rate and
volume.
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED YEAR ENDED
JUNE 30, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
COMPARED TO COMPARED TO COMPARED TO
SIX MONTHS ENDED YEAR ENDED YEAR ENDED
JUNE 30, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
------------------- -------------------- ----------------------
INCREASE INCREASE INCREASE
(DECREASE) (DECREASE) (DECREASE)
DUE TO DUE TO DUE TO
------------- ------------- ---------------
VOLUME RATE NET VOLUME RATE NET VOLUME RATE NET
------ ----- ---- ------ ----- ----- ------ ------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Mortgage loans, net.... $ 386 $(213) $173 $1,194 $(485) $ 709 $1,746 $(1,137) $ 609
Consumer and other
loans................. 51 2 53 (45) 198 153 (82) 14 (68)
Mortgage-backed and
related securities.... (32) 17 (15) (43) 3 (40) (57) 14 (43)
Overnight and short
term deposits......... 40 (5) 35 (72) 34 (38) 128 (126) 2
Investment and
interest-earning
deposits.............. (54) (20) (74) (346) 68 (278) (763) (44) (807)
----- ----- ---- ------ ----- ----- ------ ------- -----
Total interest-earning
assets............... $ 391 $(219) $172 $ 688 $(182) $ 506 $ 972 $(1,279) $(307)
===== ===== ==== ====== ===== ===== ====== ======= =====
INTEREST-BEARING
LIABILITIES:
Transaction accounts... $ 1 $ -- $ 1 $ -- $ 1 $ 1 $ 24 $ (26) $ ( 2)
Savings accounts....... (161) 64 (97) (250) 91 (159) (220) (132) (352)
Certificate of
deposits.............. 267 (58) 209 83 (185) (102) 440 558 998
Total interest-bearing
deposits............. 107 6 113 (167) (93) (260) 244 400 644
FHLB advances.......... (122) 61 (61) 139 4 143 (41) (65) (106)
----- ----- ---- ------ ----- ----- ------ ------- -----
Total interest-bearing
liabilities.......... $ (15) $ 67 $ 52 $ (28) $ (89) $(117) $ 203 $ 335 $ 538
===== ===== ==== ====== ===== ===== ====== ======= =====
</TABLE>
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1998 AND DECEMBER 31, 1997
Assets totalled $472.3 million at June 30, 1998, an increase of $360,000, or
.08% from total assets of $471.9 million at December 31, 1997. The increase in
assets during the six month period was due primarily to a $3.0 million
increase in the Bank's loan portfolio, offset by reductions in cash and cash
equivalents of $2.3 million, investment securities of $223,000 and $101,000 in
mortgage-backed securities.
Loans. The increase in total loans was primarily due to increases in real
estate mortgage and consumer installment loans, partially offset by a decrease
in non-residential real estate loans. Although total mortgage loans increased
$5.9 million, total mortgage loans, as a percentage of total loans, remained
relatively stable at 97.90%, decreasing from 97.93% at December 31, 1997. The
growth in the Bank's real estate mortgage loan portfolio is primarily a result
of the Bank's decision to continue to originate and retain real estate loans
in its portfolio. Real estate construction loans increased from $16.0 million
(3.72% of the portfolio) at December 31, 1997 to $20.0 million (4.57% of the
portfolio) at June 30, 1998. Non-residential real estate loans decreased by
$5.6 million from $41.0 million at December 31, 1997 to $35.3 million at June
30, 1998. This was the result of large loan payoffs in this portfolio.
Undisbursed loan funds increased from $5.0 million at December 31, 1997 to
$8.7 million at June 30, 1998.
Allowance for Loan Losses. The allowance for loan losses increased from $5.5
million at December 31, 1997 to $5.6 million at June 30, 1998, an increase of
$161,000. The relatively stable allowance during this period reflects the
economic stability in the market area as well as improvement in net charged
off loans. The adequacy of the allowance for loan losses is evaluated monthly
by management based upon a review of significant loans, with particular
emphasis on nonperforming and delinquent loans that management believes
warrant special
43
<PAGE>
attention. At June 30, 1998, the allowance for loan losses provided coverage
of 137.81% of total nonperforming loans, an increase from 98.60% at December
31, 1997. The balance of the allowance is maintained at a level which is, in
management's judgment, representative of the amount of risk inherent in the
loan portfolio. See "Business of the Bank--Allowance for Loan Losses."
Investment Securities. The balances of securities held-to-maturity and
available-for-sale decreased from $1.3 million and $31.2 million,
respectively, at December 31, 1997 to $1.2 million and $30.9 million,
respectively, at June 30, 1998. These decreases were primarily due to
redemptions and principal payments of these securities totalling approximately
$4.1 million during the six months ended June 30, 1998. These repayments were
offset by purchases of securities totalling $3.7 million. Currently,
management intends to continue allowing the Bank's investment securities to
mature and paydown and to reinvest the proceeds primarily in securities to be
classified by the Bank as available-for-sale and in new loans.
Deposits. Total deposits decreased $3.4 million, or 0.9%, from $377.1
million at December 31, 1997 to $373.7 million at June 30, 1998. While time
deposits increased $1.0 million, or 0.34%, during the period, savings accounts
decreased $900,000, or 2.3%, money market accounts decreased $2.7 million, or
5.89%, and noninterest- bearing accounts decreased $800,000, or 24.04%.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1997 AND DECEMBER 31, 1996
Assets totalled $471.9 million at December 31, 1997, an increase of $2.0
million, or 0.43%, from $469.9 million at December 31, 1996. Most of this
increase was concentrated in the loan portfolio which increased $7.9 million
for the year ending December 31, 1997 to $413.0 million, which increase was
partially offset by a reduction in cash and cash equivalents of $4.7 million.
Total deposits increased by $1.4 million, from $375.7 million at December 31,
1996 to $377.1 million at December 31, 1997. FHLB advances decreased $7.0
million from $15.0 million at December 31, 1996 to $8.0 million at December
31, 1997.
Loans. The increase in total loans was primarily due to increases in
residential real estate loans and consumer loans, which were partially offset
by decreases in the Bank's construction and development loans and non-
residential real estate loans. Although, total real estate mortgage loans
increased $2.9 million, or 0.69%, total real estate mortgage loans as a
percentage of total loans decreased from 98.12% at December 31, 1996 to 97.93%
at December 31, 1997 due to the increase in consumer loans. Real estate
construction loans declined from $21.3 million, or 4.98% of the portfolio, at
December 31, 1996 to $16.0 million, or 3.72% of the portfolio, at December 31,
1997. The decline in real estate construction loans resulted from large
payoffs for this type of borrowing.
Allowance for Loan Losses. The allowance for loan losses decreased by
$65,000 to $5.5 million at December 31, 1997 from December 31, 1996. This
slight reduction reflects the economic stability in the market area as well as
improvements in net charged off loans. The adequacy of the allowance for loan
losses is evaluated monthly by management based upon a review of significant
loans, with particular emphasis on nonperforming and delinquent loans that
management believes warrant special attention. At December 31, 1997, the
allowance for loan losses provided coverage of 98.60% of total nonperforming
loans, up from 61.89% at December 31, 1996.
Investment Securities. The balances of securities held-to-maturity and
available-for-sale decreased from $1.5 million and $32.0 million,
respectively, at December 31, 1996 to $1.3 million and $31.2 million,
respectively, at December 31, 1997. These decreases were the result of
redemptions and principal payments of these securities, totalling
approximately $7.1 million during the year ended December 31, 1997. The
repayments were offset by purchases of securities totalling $5.4 million.
Deposits. Total deposits increased $1.5 million, or 0.40%, from $375.7
million at December 31, 1996 to $377.1 million at December 31, 1997. Of this
total increase, certificates of deposit increased $6.4 million, or 2.2%, and
noninterest-bearing accounts increased $815,000. These increases were
partially offset by decreases
44
<PAGE>
in money market accounts of $4.8 million and passbook accounts of $951,000.
FHLB advances decreased from $15.0 million at December 31, 1996 to $8.0
million at December 31, 1997, which was funded through net cash provided by
operations.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND
1997
General. Net income for the six months ended June 30, 1998 increased $61,000
to $3.3 million compared to the six months ended June 30, 1997. This increase
was primarily a result of an increase in net interest income of $120,000,
which was partially offset by an increase in the provision for loan losses of
$28,000, an increase in noninterest expense of $10,000 and an increase of
income tax expense of $65,000. The Bank's return on average assets (ROA) was
1.40% for the six months ended June 30, 1998, up from 1.39% for the same
period in 1997. The Bank's return on average equity (ROE) was 8.12% for the
six months ended June 30, 1998, down from 8.71% for the six months ended June
30, 1997.
Interest Income. Interest income for the six months ended June 30, 1998
increased $172,000 to $18.2 million, from $18.1 million for the comparable
period in 1997 primarily due to an increase in the average balance of mortgage
loans of $4.8 million to $402.7 million for the six months ended June 30,
1998, as compared to the same period in 1997. This increase was partially
offset by a decrease in the average yield on investment securities from 5.86%
to 5.58% and a decrease in the average balance of investment securities from
$35.2 million for the six months ended June 30, 1997 to $34.2 million for the
six months ended June 30, 1998.
Interest Expense. Interest expense increased by $52,000 during the six
months ended June 30, 1998 to $9.6 million. Interest paid on certificates of
deposit for the six months ended June 30, 1998 was $8.0 million, up from $7.8
million for the six months ended June 30, 1997, which was due primarily to an
increase in the average balance of time deposits, from $283.9 million for the
six months ended June 30, 1997 to $288.7 million for the six months ended June
30, 1998.
Net Interest Income. Net interest income for the six months ended June 30,
1998 increased $120,000 to $8.6 million from $8.5 million for the six months
ended June 30, 1997, which was primarily due to an increase in the average
balance of interest-earning assets from $455.6 million for the six months
ended June 30, 1997 to $460.9 million for the six months ended June 30, 1998,
the effect of which was partially offset by a decrease in the yield on average
interest-earning assets from 7.92% for the six months ended June 30, 1997 to
7.90% for the same period in 1998 and an increase in the cost of average
interest-bearing liabilities from 4.96% to 5.02%. The Bank's net interest
margin for the six months ended June 30, 1998 was 3.74%, up from 3.72% for the
six months ended June 30, 1997. As a result, the Bank's interest rate spread
decreased from 2.96% to 2.88%.
Provision for Loan Losses. The provision for loan losses increased from
$241,000 for the six months ended June 30, 1997 to $269,000 for the six months
ended June 30, 1998. This increase is primarily the result of increases in
reserves for commercial mortgage loans during the six months ended June 30,
1998 due to several individual lending relationships in addition to continued
growth in the Bank's loan portfolio. Although management believes the current
level of allowance for loan losses is adequate, there can be no assurance that
future losses will not exceed estimated amounts or that the provision for loan
losses will not increase in future periods. See "Business of the Bank--
Delinquent Loans, Classified Assets and Real Estate Owned--Allowance for Loan
Losses.
Noninterest Income. Total noninterest income increased $44,000 to $249,000
for the six months ended June 30, 1998 as compared to $205,000 for the same
period in 1997. Noninterest income is composed primarily of servicing fees and
deposit account service charges.
Noninterest Expense. Total noninterest expense was $3.1 million for both the
six months ended June 30, 1998 and 1997. Decreases in compensation and
benefits of $227,000 were offset by increases in Federal examination fees of
$43,000, and other expenses totalling $194,000. The decrease in compensation
expense is directly related to the Bank's attempts to increase the
efficiencies in branch and other operations. The increase in
45
<PAGE>
other expenses is the result of increased legal and accounting fees related to
litigation involving an employment matter which was settled in 1998.
Income Taxes. Income tax expense increased by $65,000 to $2.2 million for
the six months ended June 30, 1998. The increase is primarily the result of
the increase of $126,000 in income before income tax expense to $5.5 million
in 1998 from $5.4 million in 1997.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
General. Net income for the year ended December 31, 1997 increased by $1.8
million, or 40.3%, to $6.4 million compared to $4.6 million for the year ended
December 31, 1996. Net interest income for the years ended December 31, 1997
and 1996 was $17.1 million and $16.5 million, respectively, due to an increase
of $506,000 in interest income for 1997 coupled with a decrease in interest
expense of $117,000. Noninterest income increased by $51,000 in 1997. In
addition, noninterest expense decreased by $2.8 million to $6.8 million for
the year ended December 31, 1997 compared to $9.6 million for the prior year,
reflecting the one-time special SAIF assessment paid in 1996. The Bank's
return on average assets increased from 0.98% for the year ended December 31,
1996 to 1.36% for the year ended December 31, 1997. The Bank's return on
average equity also increased from 6.42% for the year ended December 31, 1996
to 8.39% for the year ended December 31, 1997.
Interest Income. Interest income for the year ended December 31, 1997 was
$36.5 million, an increase of $506,000 or 1.4% from $36.0 million for the year
ended December 31, 1996. The largest component of interest income is interest
on mortgage loans. Interest on mortgage loans increased from $32.2 million for
the year ended December 31, 1996 to $32.9 million for the year ended December
31, 1997. This increase of $709,000 or 2.2% is primarily the result of loan
volume increases. The average balance of mortgage loans increased $11.2
million to $399.9 million, while the yield on mortgage loans decreased 5 basis
points from 8.27% to 8.22%, partially offsetting the increase due to volume.
The increase in interest on loans was offset by a decrease in interest on
investment securities. Interest income on investment securities decreased
$356,000. Substantially all of the decrease in interest income on investment
securities is attributable to lower volume. The average balance of investment
securities decreased from $40.9 million for the year ended December 31, 1996
to $34.9 million for the year ended December 31, 1997. Average interest-
earning assets were $457.7 million for the year ended December 31, 1997, an
increase of $2.5 million, or 0.55%, from $455.2 million for the year ended
December 31, 1996. The average yield on earning assets increased 7 basis
points to 7.97% for the year ended December 31, 1997, from 7.90% for the year
ended December 31, 1996.
Interest Expense. Interest expense decreased during the year ended December
31, 1997 to $19.4 million, from $19.5 million for the year ended December 31,
1996. Substantially all of the Bank's interest expense is from interest-
bearing deposits. The largest category of interest-bearing deposits is
certificates of deposits. Interest on certificates of deposits for the year
ended December 31, 1997 was $16.0 million, down $102,000 from $16.1 million in
1996, which was primarily the result of an increase in the average balance of
certificates of deposits, from $283.9 million in 1996 to $285.4 million in
1997, offset by a decrease of 7 basis points in the rates paid on these
deposits from 5.67% in 1996 to 5.60% in 1997. Interest expense on savings
accounts decreased $159,000, from $3.0 million for the year ended December 31,
1996 to $2.8 million for the year ended December 31, 1997. This decrease is
attributable to a decrease in the average balance of savings accounts, which
decreased $7.9 million during 1997, partially offset by an increase of 10
basis points in the rates paid on these savings accounts, from 3.14% to 3.24%.
Interest expense on FHLB advances increased $143,000 from $459,000 for the
year ended December 31, 1996 to $602,000 for the year ended December 31, 1997.
This increase is primarily attributable to the increase in average advances
outstanding from $7.4 million for the year ended December 31, 1996 to $9.7
million for the year ended December 31, 1997. The factors contributing to a
decrease in interest expense were slightly offset by a 4 basis point increase
in the average cost of FHLB advances.
Net Interest Income. Net interest income for the year ended December 31,
1997 was $17.1 million, compared to $16.5 million for the year ended December
31, 1996. The increase was primarily due to a decrease
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<PAGE>
in average interest-bearing liabilities of $4.5 million coupled with an
increase in average interest-earning assets of $2.5 million. The yield on
average interest-earning assets increased from 7.90% to 7.97%, while the
average yield on interest-bearing liabilities increased from 5.01% for the
year ended December 31, 1996 to 5.04% for the year ended December 31, 1997. As
a result, the Bank's interest rate spread increased from 2.89% to 2.93% while
the net interest margin increased from 3.61% to 3.73%.
Provision for Loan Losses. The provision for loan losses increased from
$325,000 for the year ended December 31, 1996 to $375,000 for the year ended
December 31, 1997. This increase is primarily the result of an increase in net
charge-offs from $262,000 for the year ended December 31, 1996 to $440,000 for
the year ended December 31, 1997. The average impairment of loans decreased
from $11.9 million for the year ended December 31, 1996 to $9.8 million for
the year ended December 31, 1997, mitigating the need for additional
provisions for loan losses. See "Business of the Bank--Delinquent Loans,
Classified Assets and Real Estate Owned--Allowance for Loan Losses."
Noninterest Income. Total noninterest income increased $51,000, or 12.5% to
$460,000 for the year ended December 31, 1997, compared to $409,000 for the
same period in 1996. Noninterest income primarily consists of servicing fees
and deposit account service charges.
Noninterest Expense. Total noninterest expense decreased $2.8 million to
$6.8 million for the year ended December 31, 1997, down from $9.6 million for
the prior year. Decreases in compensation and benefits of $205,000, occupancy
and equipment of $45,000, and federal deposit insurance premium of $3.0
million (reflecting the one-time SAIF assessment paid in 1996) were offset by
an increase in the net cost of foreclosed real estate operations of $33,000
and increases in other expenses of $488,000.
The decrease in compensation expense to $3.5 million for the year ended
December 31, 1997 is directly related to the Bank's efforts to increase
efficiencies in branch-banking and other operations. The decrease in occupancy
and equipment expenses to $717,000 for the year ended December 31, 1997
reflects the reduction in depreciation expense for fully depreciated assets.
No significant acquisitions of hardware or software were made in the year
ended December 31, 1997. The increase in the net cost of foreclosed real
estate operations is the result of several factors. During the year ended
December 31, 1997, the Bank experienced a slight narrowing of the cost of
foreclosed property and the realized sale price. At the same time, the
condition of foreclosed property required additional reserves for deferred
maintenance, offset by decreased expenses in preparing foreclosed properties
for sale. The resulting net effect increased those expenses by $33,000 over
those experienced for the year ended December 31, 1996. The decrease in
federal deposit premiums was due primarily to the special SAIF assessment of
$2.5 million paid in 1996. The increase in other expenses is the result of
increased legal and accounting fees related to litigation regarding an
employment matter. This litigation has been settled and no further expenses
will be incurred.
Income Taxes. Income tax expense increased from $2.4 million for the year
ended December 31, 1996 to $3.9 million for the year ended December 31, 1997.
The increase is primarily the result of a change in deferred income tax from
$542,000 for the year ended December 31, 1996 to $38,000 for the year ended
December 31, 1997, offset by additional income before income tax expense of
$3.4 million or 48.6% in 1997 compared to 1996.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
General. Net income for the year ended December 31, 1996 decreased by $2.1
million or 31.2% to $4.6 million from $6.7 million for the year ended December
31, 1995. Net interest income was $16.5 million for the year ended December
31, 1996, compared to $17.3 million for the year ended December 31, 1995.
Noninterest expense was $9.6 million for the year ended December 31, 1996,
compared to $6.5 million for the year ended December 31, 1995.
Interest Income. Interest income for the year ended December 31, 1996
decreased $307,000 or 0.84% to $36.0 million, from $36.3 million for 1995. The
largest component of interest income is interest on mortgage loans. Interest
on mortgage loans increased by $609,000 or 1.9% from $31.6 million for the
year ended
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<PAGE>
December 31, 1995 to $32.2 million for the year ended December 31, 1996.
Interest income increased primarily due to an increase in the average balance
of interest-earning assets, the effect of which was partially offset by a
decrease in the average yield on such assets. The average balance of mortgage
loans increased $20.4 million to $388.7 million, while the average yield on
mortgage loans decreased 29 basis points from 8.56% to 8.27%. This decrease in
the yield earned on mortgage loans was driven primarily by decreases in the
rates on the fixed rate mortgage portfolio as refinances of higher rate
mortgages were experienced. See "Business of the Bank--Lending Activities."
The increase in interest on mortgage loans was partially offset by a decreases
in interest on investment securities coupled with a decrease in the balance of
investment securities. Interest income on investment securities declined
$807,000. In addition, the average balance of such securities declined by
$13.0 million. In addition, the average balance of mortgage-backed securities
decreased from $2.0 million for the year ended December 31, 1995 to $1.7
million for the year ended December 31, 1996. This decrease was partially
offset by an increase in the average yield on mortgage-backed securities from
15.9% to 16.8%. Average interest-earning assets were $455.2 million for the
year ended December 31, 1996, an increase of $7.9 million from $447.3 million
for the year ended December 31, 1995, while the average yield on interest-
earning assets was 7.9% for the year ended December 31, 1996, a decline of 21
basis points from 8.11% for 1995.
Interest Expense. Interest expense increased during the year ended December
31, 1996 by $538,000 to $19.5 million from $19.0 million for the year ended
December 31, 1995. The largest category of interest-bearing deposits is
certificates of deposit. Interest on certificates of deposits for the year
ended December 31, 1996 was $16.1 million, up $1.0 million from $15.1 million
in 1995. This increase is the result of an increase in the average balance of
certificates of deposit, from $275.9 million in 1995 to $283.9 million in
1996, combined with an increase of 20 basis points in the rates paid on these
deposits from 5.47% in 1995 to 5.67% in 1996. Interest expense on savings
accounts decreased $352,000 from $3.3 million in 1995 to $3.0 million in 1996.
This decrease resulted almost entirely from a $6.7 million decrease in the
average balances of savings accounts during this period from $101.6 million in
1995 to $94.9 million in 1996. Interest expense on FHLB advances decreased
$106,000 from 1995 to 1996, which was primarily attributed to lower interest
rates during the period. Fluctuations in interest expense on other categories
of interest-bearing liabilities were not significant.
Net Interest Income. Net interest income for the year ended December 31,
1996 was $16.5 million, down $845,000 or 4.9% from $17.3 million for the year
ended December 31, 1995. The decrease was primarily the result of the effects
of a 21 basis point decrease in the rates earned on earning assets from 8.11%
in 1995 to 7.90% in 1996. This reduction in yield was compounded by the
effects of a 9 basis point increase in the rates paid on average interest-
bearing liabilities, from 4.92% in 1995 to 5.01% in 1996. The Bank's net
interest margin for the year ended December 31, 1996 was 3.61%, down from
3.86% for the year ended December 31, 1995. The effect of the changes in rates
were partially offset by increases in volume. These increases were composed of
an increase in average interest-earning assets of $8.0 million, from $447.3
million in 1995 to $455.2 million for the year ended December 31, 1996, offset
by a $3.4 million increase in average interest-bearing liabilities from $386.4
million for the year ended December 31, 1995 to $389.8 million for the same
period in 1996.
Provision for Loan Losses. The provision for loan losses of $325,000 for the
year ended December 31, 1996 decreased $87,000 from the $412,000 provision in
the year ended December 31, 1995. This decrease resulted from reduced
chargeoffs of loan balances and an improving economy in the Bank's market
area.
Noninterest Income. Total noninterest income for the year ended December 31,
1996 was $409,000, an increase of $126,000 or 44.5% over noninterest income of
$283,000 for 1995. Increased income from loan servicing fees and deposit
account service charge increases aggregating $106,000 contributed to the
increase in noninterest income.
Noninterest Expense. Total noninterest expense increased $3.1 million or
48.3% to $9.6 million for the year ended December 31, 1996, up from $6.5
million for the year ended December 31, 1995. Increases in compensation and
benefits of $371,000 to $3.7 million, occupancy and equipment of $154,000, a
special SAIF assessment of $2.5 million, and other expenses of $117,000 were
partially offset by reductions in net cost of
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<PAGE>
foreclosed real estate operations of $55,000. The increase in compensation and
benefits is the result of a nonfunded termination agreement with the Bank's
former chief executive officer completed during the year ended December 31,
1996. The increase in occupancy and equipment was the result of transferring
data processing from an in-house system to a service bureau during 1996. The
conversion was completed in mid-year. The increase in the FDIC assessment is
the result of legislation which mandated that all thrift institutions pay a
special SAIF assessment.
Income Taxes. Income tax expense decreased from $4.1 million for the year
ended December 31, 1995 to $2.4 million for 1996. The decrease is primarily
the result of lower net income before income tax expense of $3.7 million in
1996 compared to 1995 and an increase in deferred taxes of $104,000.
LIQUIDITY AND CAPITAL RESOURCES
The Bank's primary sources of funds are deposits, principal and interest
payments on loans, mortgage-backed and investment securities and FHLB
advances. While maturities and scheduled amortization of loans are predictable
sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions and competition. The
Bank has continued to maintain the required levels of liquid assets as defined
by OTS regulations. This requirement of the OTS, which may be varied at the
direction of the OTS depending upon economic conditions and deposit flows, is
based upon a percentage of deposits and short-term borrowings. The Bank's
currently required liquidity ratio is 4.00%. At June 30, 1998 and December 31,
1997, the Bank's liquidity ratio was 8.58% and 9.58%, respectively.
Management's current strategy is to maintain liquidity as close as possible to
the minimum regulatory requirement and to invest any excess liquidity in
higher yielding interest-earning assets. The Bank manages its liquidity
position and demands for funding primarily by investing excess funds in short-
term investments and utilizing FHLB advances in periods when the Bank's
demands for liquidity exceed funding from deposit inflows.
The Bank's most liquid assets are cash and cash equivalents and securities
available-for-sale. The levels of these assets are dependent on the Bank's
operating, financing, lending and investing activities during any given
period. At June 30, 1998, cash and cash equivalents and securities available-
for-sale totalled $39.9 million, or 8.46% of total assets.
The Bank has other sources of liquidity if a need for additional funds
arises. At June 30, 1998, the Bank had $8.0 million in advances outstanding
from the FHLB and, at June 30, 1998, had an additional overall borrowing
capacity from the FHLB of $37.0 million. Depending on market conditions, the
pricing of deposit products and FHLB advances, the Bank may continue to rely
on FHLB borrowings to fund asset growth.
At June 30, 1998, the Bank had commitments to fund loans and unused
outstanding lines of credit, unused standby letters of credit and undisbursed
proceeds of construction mortgages totaling $36.2 million. The Bank
anticipates that it will have sufficient funds available to meet its current
loan origination commitments. Certificate accounts, including Individual
Retirement Accounts ("IRAs") and Keogh accounts, which are scheduled to mature
in less than one year from June 30, 1998, totalled $196.7 million. Based upon
experience, management believes the majority of maturing certificates of
deposit will remain with the Bank. In addition, management of the Bank
believes that it can adjust the rates offered on certificates of deposit to
retain deposits in changing interest rate environments. In the event that a
significant portion of these deposits are not retained by the Bank, the Bank
would be able to utilize FHLB advances to fund deposit withdrawals, which
would result in an increase in interest expense to the extent that the average
rate paid on such advances exceeds the average rate paid on deposits of
similar duration.
At June 30, 1998, the Bank exceeded all minimum regulatory capital
requirements with a tangible capital level of $79.9 million, or 17.05% of
total adjusted assets, which is above the required level of $7.0 million, or
1.5%; core capital of $79.9 million, or 17.05% of total adjusted assets, which
is above the required level of $14.1 million, or 3.00%; and risk-based capital
of $83.4 million, or 29.78% of risk-weighted assets, which is above the
required level of $22.4 million, or 8.00%. See "Regulatory Capital
Compliance."
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The primary investing activities of the Bank are the origination of
residential one- to four-family loans, non- residential real estate loans,
real estate construction and development loans, and the purchase of United
States Treasury and agency securities, mortgage-backed and mortgage-related
investment securities and other investment securities. During the six months
ended June 30, 1998 and 1997 and the years ended December 31, 1997, 1996 and
1995, the Bank's loan originations totalled $79.7 million, $51.9 million,
$112.5 million, $88.0 million, and $79.8 million, respectively. Purchases of
United States Treasury and agency securities, mortgage-backed and mortgage
related investment securities and other investment securities totalled $3.6
million, $2.6 million, $5.4 million, $8.3 million and $12.6 million for the
six months ended June 30, 1998 and 1997 and the years ended December 31, 1997,
1996 and 1995, respectively. These activities were funded primarily by
principal repayments on loans and mortgage-backed and mortgage related
investment securities and other investment securities, and to a minor extent
deposit growth.
The Bank experienced a net increase (decrease) in total deposits of ($3.4
million), $2.0 million, $1.5 million, ($10.7 million) and $10.2 million for
the six months ended June 30, 1998 and 1997 and the years ended December 31,
1997, 1996 and 1995, respectively. Deposit flows are affected by the level of
interest rates, the interest rates and products offered by local competitors,
interest rates offered by the Bank and other factors.
YEAR 2000 COMPLIANCE
The Bank conducted a comprehensive review of its computer systems in
September 1997 to identify applications that could be affected by the "Year
2000" issue, and developed an implementation plan to address the issue. The
Bank's data processing is performed under agreements with BISYS, Inc.
("BISYS"), a nationwide financial service bureau, and consequently the Bank
identified BISYS as its primary mission critical service provider. BISYS has
informed the Bank in writing that all reprogramming efforts have been
completed as of September 30, 1998. Bank personnel have attended four BISYS
workshops in 1998 to plan for User Validation Testing and Verification of Year
2000 Compliance as described in Year 2000 publications from the Federal
Financial Institutions Examination Council. With BISYS' September 1998
completion of The Remediation Phase and internal certification testing, User
Validation Testing is beginning in November 1998. Based on this information,
the Bank believes BISYS will be Year 2000 compliant by December 31, 1998.
However, the Bank will continue to review and test BISYS' applications. BISYS'
failure to demonstrate Year 2000 compliance by December 31, 1998 would result
in the Bank's implementation of its primary contingency plan, conversion to
another financial service vendor, who has indicated orally that they are Year
2000 compliant as of June 1998. The anticipated implementation time for the
conversion to this service provider would be six months with an estimated cost
of $40,000. In that the second vendor has stated they are compliant, the Bank
has not sought further contingency plans; however, would do so by March 31,
1999 if testing indicated there were any problems with the new vendor's
systems.
Of the other three mission critical systems identified by the Bank
(QuestPoint Item Processing Center, Federal Home Loan Bank of Atlanta, Federal
Reserve-Richmond), one (QuestPoint Item Processing Center) has completed Year
2000 reprogramming. The remaining two have indicated in writing that they
anticipate all Year 2000 reprogramming efforts will be completed by December
31, 1998, allowing the Bank adequate time for testing. If such systems are not
complete, services and information will be obtained by telephone.
Additionally, of the seven primary service vendors identified by the Bank,
four have completed Year 2000 reprogramming. The remaining three have
indicated in writing that they anticipate all Year 2000 reprogramming efforts
will be completed by December 31, 1998, allowing the Bank adequate time for
testing. If such systems are not complete, services will be handled manually
at the Bank and information will be obtained by telephone.
Certain other non-critical vendors have not yet responded to the Bank's Year
2000 inquiries; however, the Bank will pursue other options if it appears that
these vendors will be unable to comply.
The Bank estimates that its costs related to Year 2000 will be approximately
$200,000, and has incurred $42,600 through September 30, 1998. The Bank
expects the majority of these costs to consist of hardware and
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software replacements that will upgrade the Bank's computer systems in
addition to addressing Year 2000. Management does not expect these costs to
have a significant impact on the Bank's financial position or results of
operations. However, there can be no assurance that the vendors' systems will
be Year 2000 compliant; consequently, the Bank could incur incremental costs
to convert to another vendor.
The Bank has determined that Year 2000 non-compliance by any individual loan
customer would have no material impact on the Bank. The risks associated with
the Year 2000 issue, however, could go beyond the Bank's own ability to solve
Year 2000 problems. Should suppliers of critical services fail in their
efforts to be Year 2000 compliant, it could have significant adverse financial
results for the Bank. The Bank's risk management strategy for its mission-
critical systems focuses on its highest priority system, BISYS, the financial
service bureau.
IMPACT OF INFLATION AND CHANGING PRICES
The Financial Statements and Notes thereto presented herein have been
prepared in accordance with GAAP, which provide for the measurement of
financial position and operating results generally in terms of historical
dollar amounts without considering the changes in the relative purchasing
power of money over time due to inflation. The impact of inflation is
reflected in the increased cost of the Bank's operations. Unlike industrial
companies, nearly all of the assets and liabilities of the Bank are monetary
in nature. As a result, interest rates have a greater impact on the Bank's
performance than do the effects of general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the
prices of goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
Reporting Comprehensive Income. In June 1997, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive
Income." This Statement establishes standards for reporting and displaying
comprehensive income and its components within the financial statements.
Comprehensive income is defined in FASB Concepts Statement 6 as the "change in
equity of a business enterprise during a period from transactions and other
events and circumstances from nonowner sources. It includes all changes in
equity during a period except those resulting from investments by owners and
distributions to owners." The Statement is effective for fiscal years
beginning after December 15, 1997, and was adopted by the Bank during 1998.
The adoption of this Statement did not have a material effect on the Bank's
financial reporting.
Disclosure about Segments of an Enterprise and Related Information. In June
1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" which establishes standards for the way
that public business enterprises report information about operating segments
in annual financial statements. This Statement is effective for financial
statements for periods beginning after December 15, 1997, and was adopted by
the Bank during 1998. This Statement is a matter of disclosure only and does
not effect the determination of income and expense amounts. The adoption of
this Statement did not have a material effect on the Bank's financial
reporting.
Employers' Disclosures about Pensions and Other Postretirement Benefits. In
February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits" which standardizes the disclosure
requirements for pensions and other postretirement benefits. This Statement
supersedes FASB Statements No. 87, "Employers' Accounting for Pensions," No.
88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits," and No. 106, "Employers'
Accounting for Postretirement Benefits other than Pensions." This Statement is
effective for fiscal years beginning after December 15, 1997, and was adopted
by the Bank during 1998. The adoption of this Statement did not have a
material effect on the Bank's financial reporting.
Accounting for Derivative Instruments and Hedging Activities. In June 1998,
the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" which addresses the accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and
hedging
51
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activities. This Statement supersedes FASB Statements No. 80, "Accounting for
Futures Contracts," No. 105, "Disclosure of Information about Financial
Instruments with Off-Balance-Sheet Risk and Financial Instruments with
Concentrations of Credit Risk," and No. 119, "Disclosure about Derivative
Financial Instruments and Fair Value of Financial Instruments." It amends
Statement No. 107, "Disclosures about Fair Value of Financial Instruments" to
include in Statement 107 the disclosure provisions about concentrations of
credit risk from Statement 105. This Statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. Management of the Bank
is currently assessing the impact of this Statement on the Bank's financial
reporting process. Management does not expect to adopt this Statement early,
as permitted by the Statement. At the initial application of this Statement,
the Bank may elect to transfer any security classified by the Bank as held-to-
maturity to the available-for-sale or trading classification. In addition, the
Bank may elect to transfer any security classified as available-for-sale to
the trading classification. Presently, management does not expect to elect
these options.
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BUSINESS OF THE BANK
GENERAL
The Bank is a community oriented savings association whose principal
business has been and continues to be attracting retail deposits from the
general public in the areas surrounding its branch offices and investing those
deposits, together with funds generated from operations and borrowings,
primarily in one- to four-family residential mortgage loans. In recent years,
the Bank has originated primarily fixed-rate one- to four-family loans with
terms of 15 to 30 years. To a lesser extent, the Bank invests in non-
residential real estate loans, including loans to local churches, construction
and development loans, land and land development loans, and consumer loans.
The Bank operates through its four full service banking offices located in the
City of Fredericksburg and Stafford and Spotsylvania Counties, Virginia. The
Bank originates loans for investment. The Bank's revenues are derived
principally from interest on its mortgage loans and, to a lesser extent,
interest on its investments, which generally include short-term U.S. Treasury
bonds and U.S. Government Agency obligations, short-term, highly rated
corporate debt securities and municipal bonds and from loan fee income. The
Bank's primary sources of funds are deposits, principal and interest payments
on loans and investments.
MARKET AREA AND COMPETITION
The Bank is headquartered in Fredericksburg, Virginia and has been, and
intends to continue to be, a community oriented financial institution. The
Bank's primary market area is comprised of the City of Fredericksburg and
Spotsylvania, Stafford and King George Counties, Virginia, which are serviced
through the Bank's main office and three other full service banking offices.
The Bank's main office is located in Fredericksburg, two branch offices are
located in Spotsylvania County and one is in Stafford County. Based on the
most recent information available, the Bank had approximately one-third of the
total bank and thrift deposits in its market area.
The Bank's primary market area consists principally of suburban and rural
communities with service, wholesale/retail trade, government and manufacturing
serving as the basis of the local economy. Service jobs represent the largest
type of employment in the Bank's primary market area, with jobs in
wholesale/retail trade accounting for the second largest employment sector.
Fredericksburg and surrounding communities are located between Richmond,
Virginia and Washington, D.C. and are easily accessible from Interstate 95, a
major Interstate running north to south along the Eastern seaboard. The easy
accessability to the Fredericksburg area and its close proximity to these
large cities has resulted in the Fredericksburg area being among one of the
fastest growing areas in the country in recent years. Businesses that have
moved to the area in recent years and invested substantial capital into their
new locations include Capital One Financial Corp., Intuit, Inc., Dongsung
America, Inc., Mapei Corporation, Vulcan Materials Company, SEI Birchwood,
Inc. and Greenhost, Inc. In addition, GEICO insurance has significantly
expanded its presence in the area and currently employs over 2,000 people at
its Stafford County location. Management believes that its market area
continues to show economic growth with stable to moderately increasing real
estate values. Management hopes to capitalize on this high growth to expand
its market share.
The Bank faces significant competition both in generating loans and in
attracting deposits. The Bank's primary market area is highly competitive and
the Bank faces direct competition from a significant number of financial
institutions, many with a state-wide or regional presence and, in some cases,
a national presence. Many of these financial institutions are significantly
larger and have greater financial resources than the Bank. The Bank's
competition for loans comes principally from commercial banks, savings banks,
credit unions, mortgage brokers, mortgage banking companies and insurance
companies. In addition, the Bank has recently faced significant competition
for first mortgage loans on new home construction from builders who have been
offering financing for purchasers of new homes in the builders' development
projects. Its most direct competition for deposits has historically come from
savings, cooperative and commercial banks and credit unions. In addition, the
Bank faces significant competition for deposits from non-bank institutions
such as brokerage firms and insurance companies in such instruments as short-
term money market funds, corporate and government securities
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funds, mutual funds and annuities. Competition may also increase as a result
of the lifting of restrictions on the interstate operations of financial
institutions. The Bank has also experienced significant competition from
credit unions which have a competitive advantage as they do not pay state or
federal income taxes. Such competitive advantage has placed increased pressure
on the Bank with respect to its loan and deposit pricing.
LENDING ACTIVITIES
Loan Portfolio Composition. The Bank's loan portfolio consists primarily of
first mortgage loans secured by one- to four-family residences. At June 30,
1998, gross loans totalled $437.2 million, of which $367.0 million, or 83.94%
were one- to four-family, residential mortgage loans and home equity loans. At
such date, the remainder of the loan portfolio consisted of: $35.3 million of
non-residential loans, including church loans totalling $12.1 million, or
8.08% of total loans; $20.0 million of construction and development loans,
including unadvanced loan amounts, or 4.57% of total loans; $2.3 million of
land and land development loans or 0.53% of total loans; $3.4 million of
multi-family loans, or 0.78% of total loans; and $9.2 million of consumer
loans, or 2.10% of total loans.
The types of loans that the Bank may originate are subject to federal laws
and regulations. Interest rates charged by the Bank on loans are affected by
the demand for such loans and 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 and legislative tax
policies.
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The following table sets forth the composition of the Bank's loan portfolio
in dollar amounts and as a percentage of the portfolio at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
-----------------------------------------------------------------------------------------
AT JUNE 30, 1998 1997 1996 1995 1994 1993
----------------- ----------------- ----------------- ----------------- ----------------- -----------------
PERCENT PERCENT PERCENT PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Residential:
One- to four-
family (1)........ $367,041 83.94% $358,561 83.19% $345,799 80.94% $329,589 79.69% $312,933 79.09% $315,739 79.08%
Multi-family...... 3,396 0.78 3,455 0.80 3,453 0.81 2,340 0.57 4,407 1.11 9,315 2.33
Non-residential
real estate(2)..... 35,316 8.08 40,951 9.50 44,528 10.42 44,520 10.77 39,950 10.10 38,830 9.72
Land and land
development....... 2,321 0.53 3,091 0.72 4,136 0.97 6,398 1.55 4,375 1.12 5,454 1.37
Construction and
development....... 19,960 4.57 16,046 3.72 21,285 4.98 23,545 5.69 27,259 6.89 23,537 5.89
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage
loans........... 428,034 97.90 422,104 97.93 419,201 98.12 406,392 98.27 388,924 98.31 392,875 98.39
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer and other
loans.............. 9,192 2.10 8,913 2.07 8,046 1.88 7,159 1.73 6,601 1.69 6,409 1.61
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans......... 437,226 100.00% 431,017 100.00% 427,247 100.00% 413,551 100.00% 395,525 100.00% 399,284 100.00%
====== ====== ====== ====== ====== ======
Less:
Participating
interests.......... 3,319 4,217 5,450 6,543 8,126 9,261
Undisbursed loan
funds............. 8,743 4,978 8,064 8,132 7,829 6,539
Unearned discounts
and deferred loan
fees.............. 3,539 3,312 3,045 2,855 2,764 2,900
Allowance for loan
losses............ 5,639 5,478 5,543 5,480 5,537 5,355
-------- -------- -------- -------- -------- --------
Loans receivable,
net............... $415,986 $413,032 $405,145 $390,541 $371,269 $375,229
======== ======== ======== ======== ======== ========
</TABLE>
- ----
(1) Includes home equity lines of credit.
(2)Includes 36 loans to local churches totalling $12.1 million at June 30,
1998.
55
<PAGE>
Loan Maturity. The following table shows the remaining contractual maturity
of the Bank's loans at June 30, 1998. The table does not include the effect of
future principal prepayments.
<TABLE>
<CAPTION>
AT JUNE 30, 1998
-----------------------------------------------------------------------
ONE- TO CONSTRUCTION LAND AND
FOUR- MULTI- NON- AND LAND TOTAL
FAMILY FAMILY RESIDENTIAL DEVELOPMENT DEVELOPMENT CONSUMER LOANS
-------- ------ ----------- ------------ ----------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Amounts due:
One year or less....... $ 2,168 $ -- $ 7 $19,960(1) $1,651 $2,417 $ 26,203
After one year:
More than one year to
three years.......... 3,939 -- 49 -- 23 2,674 6,685
More than three years
to five years........ 6,111 -- 603 -- 130 3,340 10,184
More than five years
to ten years......... 46,811 809 6,940 -- 314 608 55,482
More than ten years to
twenty years......... 153,263 975 21,103 -- 135 153 175,629
More than twenty
years................ 154,749 1,612 6,614 -- 68 -- 163,043
-------- ------ ------- ------- ------ ------ --------
Total amount due..... $367,041 $3,396 $35,316 $19,960 $2,321 $9,192 437,226
======== ====== ======= ======= ====== ======
Less:
Participating interests.............................................................. 3,319
Allowance for loan losses............................................................ 8,743
Undisbursed loan funds............................................................... 3,539
Allowance for loan losses............................................................ 5,639
--------
Loans, net............................................................................ $415,986
========
</TABLE>
- --------
(1) Includes construction and development loans which will convert to one- to
four-family mortgage loans upon the completion of the construction.
The following tables set forth at June 30, 1998, the dollar amount of loans
contractually due after June 30, 1999 and whether such loans have fixed
interest rates or adjustable interest rates.
<TABLE>
<CAPTION>
DUE AFTER JUNE 30, 1999
----------------------------
FIXED ADJUSTABLE TOTAL
-------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Real estate loans:
One- to four-family.............................. $263,356 $101,517 $364,873
Multi-family..................................... 1,898 1,498 3,396
Non-residential.................................. 20,335 14,974 35,309
Construction and development..................... -- -- --
Land and land development........................ 557 113 670
-------- -------- --------
Total real estate loans......................... 286,146 118,102 404,248
Consumer and other loans.......................... 5,252 1,523 6,775
-------- -------- --------
Total loans....................................... $291,398 $119,625 $411,023
======== ======== ========
</TABLE>
Origination, Sale and Servicing of Loans. The Bank's mortgage lending
activities are conducted primarily by its loan personnel operating at its four
offices. In-market loan originations are generated by the Bank's marketing
efforts, which include print, radio and television advertising, lobby displays
and direct contact with local civic and religious organizations, as well as by
the Bank's present customers, walk-in customers and
56
<PAGE>
referrals from real estate agents, brokers and builders. Loans originated by
the Bank are underwritten by the Bank pursuant to the Bank's policies and
procedures and are generally underwritten in accordance with Fannie Mae
("FNMA") and Freddie Mac ("FHLMC") underwriting standards. The Bank originates
both adjustable-rate and fixed-rate loans. The Bank's ability to originate
fixed- or adjustable-rate loans is dependent upon the relative customer demand
for such loans, which is affected by the current and expected future level of
interest rates. In recent years, the Bank has originated primarily fixed-rate
loans as a result of low customer demand for adjustable-rate loans given the
prevailing low interest rate environment.
Generally, all loans originated by the Bank are held for investment,
although currently the Bank is exploring opportunities to sell fixed-rate
loans originated by the Bank through the secondary market. The Bank generally
does not originate mortgage loans insured by the Federal Housing
Administration ("FHA") and Department of Veterans Affairs ("VA").
During the years ended December 31, 1997 and December 31, 1996, the Bank
originated $85.1 million and $55.7 million of one- to four-family mortgage
loans, respectively, all of which were retained by the Bank. In the six months
ended June 30, 1998, the Bank originated $67.2 million of one- to four-family
mortgage loans. On January 1, 1996, the Bank implemented SFAS No. 122 pursuant
to which the value of servicing rights may be recognized as an asset of the
Bank. In the six months ended June 30, 1998 and in the year ended December 31,
1997, the fair value of servicing rights under SFAS No. 122 and SFAS No. 125
were not material and were not recognized in the financial statements for
those periods.
The following table sets forth the Bank's loan originations, purchases,
sales and principal repayments for the periods indicated:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30, FOR THE YEAR ENDED DECEMBER 31,
-------------------- -----------------------------------
1998 1997 1997 1996 1995
--------- --------- ----------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Mortgage loans (gross):
Beginning balance...... $ 422,104 $ 419,201 $ 419,201 $ 406,392 $ 388,924
Mortgage loans origi-
nated:
One- to four-family... 67,249 35,948 85,099 55,724 43,807
Multi-family.......... -- -- -- 1,440 --
Non-residential real
estate............... 138 733 1,763 2,384 628
Construction and
development.......... 9,225 11,930 19,333 21,772 24,386
Land and land
development.......... -- -- -- 503 3,473
--------- --------- ----------- ---------- ----------
Total mortgage loans
originated.......... 76,612 48,611 106,195 81,823 72,294
Transfer of mortgage
loans to foreclosed
real estate.......... (604) 479 (937) (4,815) --
Principal repayments.. (70,078) (44,127) (102,355) (64,199) (54,826)
--------- --------- ----------- ---------- ----------
Ending balance........ $ 428,034 $ 424,164 $ 422,104 $ 419,201 $ 406,392
========= ========= =========== ========== ==========
Consumer and other loans
(gross):
Beginning balance...... $ 8,913 $ 8,046 $ 8,046 $ 7,159 $ 6,601
Consumer and other
loans originated..... 3,098 3,288 6,323 6,130 7,512
Principal repayments.. (2,819) (2,570) (5,456) (5,243) (6,954)
--------- --------- ----------- ---------- ----------
Ending balance........ $ 9,192 $ 8,764 $ 8,913 $ 8,046 $ 7,159
========= ========= =========== ========== ==========
</TABLE>
One-to Four-Family Lending. The Bank currently offers both fixed-rate and
adjustable-rate mortgage ("ARM") loans with maturities of up to 30 years
secured by one- to four-family residences. Most of the residences securing
these loans are located in the Bank's primary market area. One- to four-family
mortgage loan originations are generally obtained from the Bank's in-house
loan representatives, from existing or past customers, and through referrals
from members of the Bank's local communities. At June 30, 1998, the Bank's
57
<PAGE>
one- to four-family mortgage loans totalled $367.0 million, or 83.94%, of
total loans. Of the one- to four-family mortgage loans outstanding at that
date, 72.34% were fixed-rate mortgage loans and 27.66% were ARM loans.
The Bank currently offers fixed-rate mortgage loans with terms from ten to
30 years. The Bank retains all of the fixed-rate residential loans that it
originates. The Bank is considering selling fixed-rate loans originated by the
Bank, but to date has not established a policy for such sales. The Bank does
not purchase one- to four-family mortgage loans.
The Bank currently offers one-year residential ARM loans with an interest
rate that adjusts annually based on the change in the relevant United States
Treasury index. The Bank also offers loans that bear fixed rates of interest
for specified periods of time and, thereafter, adjust on an annual basis.
These loans provide for up to a 2.0% periodic cap and a lifetime cap of 6.0%
over the initial rate. As a consequence of using caps, the interest rates on
these loans may not be as rate sensitive as the Bank's cost of funds.
Borrowers of one-year residential ARM loans are generally qualified at a rate
of 2.0% above the initial interest rate. The Bank also offers ARM loans that
are convertible into fixed-rate loans with interest rates based upon the then
current market rates. ARM loans generally pose greater credit risks than
fixed-rate loans, primarily because as interest rates rise, the required
periodic payment by the borrower rises, increasing the potential for default.
However, as of June 30, 1998, the Bank had not experienced higher default
rates on these loans relative to its other loans.
All one- to four-family mortgage loans are underwritten according to the
Bank's policies and guidelines. Generally, the Bank originates 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 and up
to 97% of the appraised value or selling price if private mortgage insurance
("PMI") is obtained. 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. The Bank requires fire,
casualty, title and, in certain cases, flood insurance on all properties
securing real estate loans made by the Bank.
Included in the Bank's one- to-four family loan portfolio are home equity
loans. The Bank originates home equity loans that are secured by a lien on the
borrower's residence and generally do not exceed $250,000. The Bank uses the
same underwriting standards for home equity loans as it uses for one- to four-
family residential mortgage loans. Home equity loans are generally originated
in amounts which, together with all prior liens on such residence, do not
exceed 80% of the appraised value of the property securing the loan. The
interest rates for home equity loans either float at a stated margin over the
prime rate or have fixed interest rates. As of June 30, 1998, the Bank had
$2.8 million, or 0.64% of the Bank's total loan portfolio outstanding, in home
equity loans.
Non-Residential and Multi-Family Lending. The Bank originates non-
residential real estate loans that are generally secured by properties used
for business purposes such as office buildings, schools, nursing homes, retail
stores and churches located in the Bank's primary market area. The Bank lends
to local churches to fund construction of or renovations to church facilities.
Such loans are generally fixed-rate loans with a maximum loan to value ratio
of 80%. The Bank currently has 36 church loans totalling $12.1 million in the
aggregate. All such loans are performing in accordance with their terms.
Multi-family loans are generally secured by 5 or more unit apartment buildings
located in the Bank's primary market area. The Bank's multi-family and non-
residential real estate underwriting policies provide that such real estate
loans may be made in amounts up to 75% of the appraised value of the property,
subject to the Bank's current internal loan-to-one-borrower limit, which at
June 30, 1998 was $2.5 million.
Non-residential real estate loans and multi-family loans generally have
adjustable rates and terms to maturity that do not exceed 25 years. The Bank's
current lending guidelines generally require that the property securing
commercial real estate loans and multi-family loans generate net cash flows of
at least 125% of debt service after the payment of all operating expenses,
excluding depreciation, and the loan-to-value ratio not to exceed 75% on loans
secured by such properties. As a result of a decline in the value of some
properties in the
58
<PAGE>
Bank's primary market area and due to economic conditions, the current loan-
to-value ratio of some non-residential real estate loans and multi-family
loans in the Bank's portfolio may exceed the initial loan-to-value ratio and
the current debt service ratio may exceed the initial debt service ratio.
Adjustable-rate non-residential real estate loans and multi-family loans
provide for interest at a margin over a designated index, often a designated
prime rate, with periodic adjustments, generally at frequencies of up to five
years. In underwriting non-residential real estate loans and multi-family
loans, the Bank analyzes the financial condition of the borrower, the
borrower's credit history, the reliability and predictability of the net
income generated by the property securing the loan and the value of the
property itself. The Bank generally requires personal guarantees of the
borrowers in addition to the security property as collateral for such loans.
Appraisals on properties securing non-residential real estate loans and multi-
family loans originated by the Bank are performed by independent appraisers
approved by the Board of Directors. At June 30, 1998, the Bank's largest non-
residential real estate loan was a $1.9 million loan secured by a local church
and was performing in accordance with its terms. At June 30, 1998, the Bank's
largest multi-family loan was a $1.4 million loan secured by an apartment
complex and was performing in accordance with its terms.
Non-residential real estate loans and multi-family loans generally present a
higher level of credit risk than loans secured by one- to four-family
residences. This greater credit risk is due to several factors, including the
concentration of principal in a limited number of loans and borrowers, the
effect of general economic conditions on income producing properties and the
increased difficulty of evaluating and monitoring these types of loans.
Furthermore, the repayment of loans secured by commercial real estate and
multi-family properties is typically dependent upon the successful operation
of the related real estate project. If the cash flow from the project is
reduced (for example, if leases are not obtained or renewed, or a bankruptcy
court modifies a lease term, or a major tenant is unable to fulfill its lease
obligations), the borrower's ability to repay the loan may be impaired and the
value of the property may be reduced. The Bank seeks to minimize these risks
through its underwriting standards.
Construction and Development and Land and Land Development Lending. The Bank
originates construction loans for the development of residential and
commercial property. Construction loans are offered primarily to experienced
local developers operating in the Bank's market area. The majority of the
Bank's construction loans are originated to finance the construction by
developers of one- to four-family residential real estate and, to a lesser
extent, multi-family and commercial real estate properties located in the
Bank's primary market area. Construction loans are generally offered with
terms of up to 12 months and may be made in amounts up to 75% of the appraised
value of the property on multi-family and commercial real estate construction
and 80% on one- to four-family residential construction. Land loans are made
in amounts up to 60% of the appraised value of the land securing the loan.
Construction loan proceeds are disbursed periodically in increments as
construction progresses and as inspections by the Bank's inspecting officers
warrant. At June 30, 1998, the Bank's largest construction and development
loan was a performing loan with a $1.0 million outstanding principal balance
secured by 19 units of single family construction located in Stafford and
Spotsylvania Counties.
Construction financing is generally considered to involve a higher degree of
credit risk than long-term financing on improved, owner-occupied real estate.
Risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction or
development compared to the estimated cost (including interest) of
construction and other assumptions, including the estimated time to sell
residential properties. If the estimated value proves to be inaccurate, the
Bank may be confronted with a property, when completed, having a value which
is insufficient to assure full repayment. The Bank seeks to minimize this risk
through its underwriting standards.
Consumer and Other Lending. Consumer loans at June 30, 1998 amounted to $9.2
million, or 2.1%, of the Bank's total loans and consisted primarily of
automobile loans (new and used) and loans secured by savings accounts. Such
loans are generally originated in the Bank's primary market area and generally
are secured by deposit accounts, personal property and automobiles. These
loans are typically shorter term and generally have higher interest rates than
one- to four-family mortgage loans. Historically, the Bank has not advertised
its consumer loans and has made these loans only to existing customers.
59
<PAGE>
Loans secured by rapidly depreciable assets such as automobiles or that are
unsecured entail greater credit risks than one- to four-family residential
mortgage loans. In such cases, repossessed collateral for a defaulted loan may
not provide an adequate source of repayment of the outstanding loan balance,
since there is a greater likelihood of damage, loss or depreciation of the
underlying collateral. Further, consumer loan collections on these loans are
dependent on the borrower's continuing financial stability and, therefore, are
more likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Finally, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered on such loans in the event of a default. At June
30, 1998, the Bank had 30 consumer loans 90 days or more delinquent, whose
balances totalled $113,000.
Loan Approval Procedures and Authority. The Board of Directors of the Bank
establishes the lending policies of the Bank. Such policies provide that the
Bank's President, Executive Vice President and Senior Lending Officer may
approve consumer loans up to $50,000. The Loan Committee approves all
residential loans up to $500,000. The Board approves loans in excess of
$500,000. All loans are submitted to the full Board of Directors for
ratification on a monthly basis.
DELINQUENT LOANS, CLASSIFIED ASSETS AND REAL ESTATE OWNED
Delinquencies and Classified Assets. Reports listing all delinquent accounts
are generated and reviewed by management on a monthly basis and the Board of
Directors performs a monthly review of all loans or lending relationships
delinquent 60 days or more and all REO. The procedures taken by the Bank with
respect to delinquencies vary depending on the nature of the loan and cause of
delinquency and whether the borrower is habitually delinquent. When a borrower
fails to make a required payment on a loan, the Bank takes a number of steps
to have the borrower cure the delinquency and restore the loan to current
status. The Bank generally sends the borrower a written notice of non-payment
after the loan is first past due. The Bank's guidelines provide that
telephone, written correspondence and/or face-to-face contact 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 usually attempts to obtain full payment, work out a
repayment schedule with the borrower to avoid foreclosure or, in some
instances, accept a deed in lieu of foreclosure. In the event payment is not
then received or the loan not otherwise satisfied, additional letters and
telephone calls generally are made. If the loan is still not brought current
or satisfied and it becomes necessary for the Bank to take legal action, which
typically occurs after a loan is 60 days or more delinquent, the Bank will
commence foreclosure proceedings against any real property that secures the
loan. If a foreclosure action is instituted and the loan is not brought
current, paid in full, or refinanced before the foreclosure sale, the property
securing the loan generally is sold at foreclosure and, if purchased by the
Bank, becomes real estate owned and is sold by the Bank as soon as possible.
Federal regulations and the Bank's Asset Classification Policy require that
the Bank utilize 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
"Substandard," "Doubtful" or "Loss" assets. An asset is considered
"Substandard" if it is inadequately protected by the current net worth 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 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."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, it is required to establish a general
valuation allowance for loan losses in an amount deemed prudent by
60
<PAGE>
management. General valuation allowances represent loss allowances which have
been established to recognize the inherent risk associated with lending
activities, but which, unlike specific allowances, have not been allocated to
particular problem assets. When an insured institution classifies one or more
assets, or portions thereof, as "Loss," it is required either to establish a
specific allowance for losses equal to 100% of the amount of the asset so
classified or to charge off such amount.
A savings institution's determination as to the classification of its assets
and the amount of its valuation allowances is subject to review by the OTS
which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
has adopted an interagency policy statement on the allowance for loan and
lease losses. The policy statement provides guidance for financial
institutions on both the responsibilities of management for the assessment and
establishment of adequate allowances and guidance for banking agency examiners
to use in determining the adequacy of general valuation guidelines. Generally,
the policy statement recommends that institutions have effective systems and
controls to identify, monitor and address asset quality problems; that
management has analyzed all significant factors that affect the collectibility
of the portfolio in a reasonable manner; and that management has established
acceptable allowance evaluation processes that meet the objectives set forth
in the policy statement. Although management believes that, based on
information currently available to it at this time, its allowance for loan
losses is adequate, actual losses are dependent upon future events and, as
such, further additions to the level of allowances for loan losses may become
necessary.
The Bank's Asset/Liability Committee reviews and classifies the Bank's
assets on a regular basis and the Board of Directors reviews the results of
the reports on a quarterly basis. The Bank classifies assets in accordance
with the management guidelines described above. At June 30, 1998, the Bank had
$7.8 million, or 1.65% of total assets, designated as Substandard. At such
date, no assets were classified as Doubtful or Loss (in accordance with OTS
regulations). As of June 30, 1998, the Bank had a total of $1.7 million, or
0.36% of total assets, classified loans designated as Special Mention. At June
30, 1998, all of the Bank's classified and Special Mention assets totalled
$9.5 million, representing 2.17% of loans.
The following table sets forth the delinquencies in the Bank's loan
portfolio as of the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30, 1998 AT DECEMBER 31, 1997
------------------------------------- -------------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
------------------ ------------------ ------------------ ------------------
PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL
NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
-------- --------- -------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
One- to four-family.... 11 $865 24 $1,253 13 $841 31 $1,596
Multi-family........... -- -- -- -- -- -- -- --
Non-residential real
estate................ -- -- -- -- -- -- 1 488
Construction and
development........... -- -- 3 580 -- -- 3 604
Land and land
development........... -- -- -- -- -- -- 1 1
---- ---- ---- ------ ---- ---- ---- ------
Total mortgage loans.. 11 865 27 1,833 13 841 36 2,689
Consumer and other
loans.................. 13 72 30 113 15 87 33 111
---- ---- ---- ------ ---- ---- ---- ------
Total loans............. 24 $937 57 $1,946 28 $928 69 $2,800
==== ==== ==== ====== ==== ==== ==== ======
Delinquent loans to
total loans............ 0.35% 0.21% 0.83% 0.45% 0.41% 0.22% 1.01% 0.65%
==== ==== ==== ====== ==== ==== ==== ======
</TABLE>
61
<PAGE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996 AT DECEMBER 31, 1995
------------------------------------- -------------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
------------------ ------------------ ------------------ ------------------
PRINCIPAL PRINCIPAL PRINCIPAL PRINCIPAL
NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE NUMBER BALANCE
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
-------- --------- -------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
One- to four-family.... 17 $1,578 74 $3,827 22 $1,464 8 $ 681
Multi-family........... -- -- 2 389 -- -- -- --
Non-residential real
estate................ 2 516 3 710 -- -- 2 265
Construction and
development........... -- -- 4 839 1 143 4 529
Land and land
development........... 1 301 1 37 1 179 1 237
---- ------ ---- ------ ---- ------ ---- ------
Total mortgage loans.. 20 2,395 84 5,802 24 1,786 15 1,712
Consumer and other
loans.................. 13 111 32 343 13 108 23 326
---- ------ ---- ------ ---- ------ ---- ------
Total loans............. 33 $2,506 116 $6,145 37 $1,894 38 $2,038
==== ====== ==== ====== ==== ====== ==== ======
Delinquent loans to
total loans............ 0.49% 0.59% 1.71% 1.44% 0.52% 0.46% 0.54% 0.49%
==== ====== ==== ====== ==== ====== ==== ======
</TABLE>
Non-Performing Assets and Impaired Loans. The following table sets forth
information regarding non-accrual loans and REO. At June 30, 1998, the Bank
had $1.9 million of REO net of a valuation allowance. It is the policy of the
Bank to cease accruing interest on loans 90 days or more past due and to
charge-off all accrued interest. The Bank does, however, continue accruing
interest on loans 90 days or more past due that are in the process of being
renewed or extended. Management of the Bank believes that all loans on
nonaccrual status are well secured and has provided, when necessary, for
allocated reserves to bring specific loans to their net realizable value. Each
nonaccruing loan at June 30, 1998 is in process of collection. For the six
months ended June 30, 1998 and the years ended December 31, 1997 and 1996, no
interest income was recorded on non-accrual loans. For the six months ended
June 30, 1998 and the years ended December 31, 1997 and 1996, the amount of
additional interest income that would have been recognized on non-accrual
loans if such loans had continued to perform in accordance with their
contractual terms was $114,000, $193,000 and $438,000, respectively. In 1993,
the Bank adopted SFAS No. 114 "Accounting by Creditors for Impairment of a
Loan" ("SFAS No. 114"), as amended by SFAS No. 118. There were $8.5 million
that met the definition of impaired loans, per SFAS 114 at June 30, 1998. This
compares to $10.7 million, $9.8 million, $11.9 million and $10.8 million for
June 30, 1997, December 31, 1997, 1996 and 1995, respectively.
62
<PAGE>
<TABLE>
<CAPTION>
AT JUNE 30, AT DECEMBER 31,
-------------- ----------------------------------------
1998 1997 1997 1996 1995 1994 1993
------ ------ ------ ------- ------ ------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Non-accrual loans(1):
Mortgage loans:
One- to four-family... $2,008 $4,328 $3,282 $ 5,366 $3,959 $ 5,211 $2,143
Non-residential real
estate............... 1,027 1,346 1,163 1,920 1,389 3,634 3,004
Construction and
development.......... -- -- -- 774 529 84 203
Land and development.. 606 528 493 558 653 1,332 1,165
Consumer and other
loans................. 130 125 136 135 269 284 207
------ ------ ------ ------- ------ ------- ------
Total non-accrual
loans................ 3,771 6,327 5,074 8,753 6,799 10,545 6,722
Loans 90 days or more
past due and accruing:
Construction and
development........... 186 507 -- 65 -- -- --
Land and land
development........... 135 138 482 138 -- -- --
------ ------ ------ ------- ------ ------- ------
Total accruing loans
90 days or more past
due.................. 321 645 482 203 -- -- --
------ ------ ------ ------- ------ ------- ------
Total non-performing
loans................. 4,092 6,972 5,556 8,956 6,799 10,545 6,722
Total foreclosed real
estate................. 1,883 1,882 1,959 1,611 2,135 1,082 2,030
------ ------ ------ ------- ------ ------- ------
Total non-performing
assets................. $5,975 $8,854 $7.515 $10,567 $8,934 $11,627 $8,752
====== ====== ====== ======= ====== ======= ======
Restructured loans...... $3,923 $2,914 $3,660 $ 2,546 $3,768 $ 2,239 $ 784
====== ====== ====== ======= ====== ======= ======
Non-performing loans to
total loans............ 0.94% 1.61% 1.29% 2.10% 1.64% 2.67% 1.68%
====== ====== ====== ======= ====== ======= ======
Non-performing assets to
total assets........... 1.27% 1.88% 1.59% 2.25% 1.91% 2.58% 1.95%
====== ====== ====== ======= ====== ======= ======
</TABLE>
- --------
(1) Loans are presented before allowance for loan losses.
Restructured loans totalled $3.9 million at June 30, 1998. Restructured
loans include loans that were modified while delinquent. Although the amount
due under these loans has not been modified from the terms of the loans when
originated, certain adjustments were made to these loans to help the borrower
make payments while the loans were delinquent and to enable the Bank to avoid
foreclosure proceedings. All outstanding restructured loans are single-family
loans with balances of less than $196,000 per loan. All restructured loans are
currently performing in accordance with their terms, however, there can be no
assurance that such loans will continue to be performing loans or that the
Bank will not experience losses on such loans in the future.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance
for loan losses is maintained at an amount management considers adequate to
cover estimated losses on loans which are deemed probable and estimable based
on information currently known to management. The allowance is based upon a
number of factors, including economic conditions, actual loss experience and
industry trends. In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the Bank's allowance for
loan losses. Such agencies may require the Bank to make additional provisions
for estimated loan losses based upon judgments different from those of
management. As of June 30, 1998, the Bank's allowance for loan losses was
1.36% of net loans as compared to 1.33% as of December 31, 1997. The Bank had
non-performing loans of $4.1 million and $5.6 million at June 30, 1998 and
December 31, 1997, respectively. The Bank will continue to monitor and modify
its allowances for loan losses as conditions dictate. While management
believes the Bank's allowance for loan losses is sufficient to cover losses
inherent in its loan portfolio at this time, no assurances can be given that
the Bank's level of allowance for loan losses will be sufficient to cover loan
losses incurred by the Bank or that future adjustments to the allowance for
loan losses will not be necessary if economic and other conditions differ
substantially from the economic and other conditions used by management to
determine the current level of the allowance for loan losses.
63
<PAGE>
The following table sets forth activity in the Bank's allowance for loan
losses for the periods as indicated.
<TABLE>
<CAPTION>
AT OR FOR THE
SIX
MONTHS ENDED AT OR FOR THE YEAR ENDED DECEMBER
JUNE 30, 31,
-------------- --------------------------------------
1998 1997 1997 1996 1995 1994 1993
------ ------ ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at beginning of
period................. $5,478 $5,543 $5,543 $5,480 $5,537 $5,355 $4,668
Provision for loan
losses................. 269 241 375 325 412 1,010 1,129
Charge-offs:
Mortgage loans:
One- to four-family... (79) (148) (260) (244) (17) (197) (412)
Non-residential real
estate............... -- -- -- -- -- (619) --
Construction and
development.......... -- (32) (148) -- (469) -- --
Consumer loans......... (29) (7) (32) (19) (3) (12) (38)
------ ------ ------ ------ ------ ------ ------
Total charge-offs..... (108) (187) (440) (263) (489) (828) (450)
Recoveries.............. -- -- -- 1 20 -- 8
------ ------ ------ ------ ------ ------ ------
Balance at end of
period................. $5,639 $5,597 $5,478 $5,543 $5,480 $5,537 $5,355
====== ====== ====== ====== ====== ====== ======
Ratio of net charge-offs
during the period to
average net loans
outstanding during the
period................. 0.03% 0.05% 0.11% 0.07% 0.13% 0.22% 0.12%
====== ====== ====== ====== ====== ====== ======
Ratio of allowance for
loan losses to net
loans receivable at the
end of the period...... 1.36% 1.36% 1.33% 1.37% 1.40% 1.49% 1.43%
====== ====== ====== ====== ====== ====== ======
Ratio of allowance for
loan losses to non-
performing loans at the
end of the period...... 137.81% 80.28% 98.60% 61.89% 80.60% 52.50% 79.66%
====== ====== ====== ====== ====== ====== ======
</TABLE>
The following tables set forth the Bank's percent of allowance for loan
losses to total allowance for loans losses and the percent of loans to total
loans in each of the categories listed at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30,
-----------------------------------------------------
1998 1997
-------------------------- --------------------------
PERCENT PERCENT
OF LOANS OF LOANS
PERCENT OF IN EACH PERCENT OF IN EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ ---------- -------- ------ ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
One-to four-family...... $1,663 29.48% 83.94% $1,884 33.66% 81.22%
Multi-family............ 34 0.60 0.78 36 0.64 0.82
Non-residential real
estate................. 682 12.10 8.08 1,014 18.12 10.24
Construction and
development............ 112 1.99 4.57 178 3.19 4.84
Land and land
development............ 200 3.54 0.53 145 2.59 0.86
Consumer and other
loans.................. 262 4.64 2.10 261 4.67 2.02
Unallocated general
allowance.............. 2,686 47.65 -- 2,079 37.13 --
------ ------ ------ ------ ------ ------
Total allowance....... $5,639 100.00% 100.00% $5,597 100.00% 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
64
<PAGE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
-----------------------------------------------------------------------------------------------------------
1997 1996 1995 1994
-------------------------- -------------------------- -------------------------- --------------------------
PERCENT PERCENT PERCENT PERCENT
OF LOANS OF LOANS OF LOANS OF LOANS
PERCENT OF IN EACH PERCENT OF IN EACH PERCENT OF IN EACH PERCENT OF IN EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY ALLOWANCE CATEGORY ALLOWANCE CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ ---------- -------- ------ ---------- -------- ------ ---------- -------- ------ ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One-to four-
family(1)....... $1,862 33.99% 83.19% $1,862 33.58% 80.94% $2,047 37.35% 79.69% $1,738 31.40% 79.09%
Multi-family..... 35 0.63 0.80 287 5.17 0.81 276 5.04 0.57 895 16.17 1.11
Non-residential
real estate..... 762 13.90 9.50 982 17.71 10.42 639 11.65 10.77 1,061 19.15 10.10
Construction and
development..... 80 1.46 3.72 116 2.09 4.98 194 3.55 5.69 148 2.68 6.89
Land and land
development..... 225 4.11 0.72 251 4.54 0.97 141 2.57 1.55 166 3.00 1.12
Consumer and
other loans..... 252 4.61 2.07 229 4.12 1.88 208 3.79 1.73 203 3.66 1.69
Unallocated
general
reserves........ 2,262 41.30 -- 1,816 32.79 -- 1,975 36.05 -- 1,326 23.94 --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total
allowance...... $5,478 100.00% 100.00% $5,543 100.00% 100.00% $5,480 100.00% 100.00% $5,537 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== ======
<CAPTION>
1993
--------------------------
PERCENT
OF LOANS
PERCENT OF IN EACH
ALLOWANCE CATEGORY
TO TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS
------ ---------- --------
<S> <C> <C> <C>
One-to four-
family(1)....... $1,529 28.56% 79.08%
Multi-family..... 1,180 22.04 2.33
Non-residential
real estate..... 810 15.12 9.72
Construction and
development..... 147 2.75 5.89
Land and land
development..... 117 2.18 1.37
Consumer and
other loans..... 204 3.81 1.61
Unallocated
general
reserves........ 1,368 25.54 --
------ ---------- --------
Total
allowance...... $5,355 100.00% 100.00%
====== ========== ========
</TABLE>
- ------
(1) Includes home equity lines of credit.
65
<PAGE>
Real Estate Owned. At December 31, 1997 and June 30, 1998, the Bank had $2.0
million and $1.9 million of REO, respectively. At June 30, 1998, REO consisted
of 25 one- to four-family properties, one parcel of land, one non-residential
property and one multi-family property. When the Bank acquires property
through foreclosure or by deed in lieu of foreclosure, it is initially
recorded at the lower of the recorded investment in the corresponding loan or
the fair value of the related assets at the date of foreclosure, less costs to
sell. Thereafter, if there is a further deterioration in value, the Bank
provides for a specific valuation allowance and charges operations for the
diminution in value. It is the policy of the Bank to have obtained an
appraisal on all real estate subject to foreclosure proceedings prior to the
time of foreclosure. It is the Bank's policy to require appraisals on a
periodic basis on foreclosed properties and conduct inspections on foreclosed
properties. The Bank seeks to sell its REO properties to the tenants of those
properties and encourages tenants to take advantage of this opportunity by
selling the properties at a favorable market value and with favorable loan
terms, including 100% financing. Management believes this type of lending
enhances the Bank's Community Reinvestment Act ("CRA") performance.
INVESTMENT ACTIVITIES
The Bank is authorized to invest in various types of liquid assets,
including United States Treasury obligations with terms of five years or less,
U.S. Agency obligations, including mortgage-backed securities with terms of
five years or less, municipal bonds with terms of five years or less rated by
a highly regarded rating service, such as Standard & Poors, as AA or better
and certain certificates of deposit of insured banks and savings institutions,
corporate obligations up to a maximum of 1% of the Bank's total assets that
have terms of five years or less and are rated by a highly regarded rating
service, such as Standard & Poors, as AA or better. The Bank is also
authorized to invest in mutual funds whose assets conform to the investments
that the Bank is otherwise authorized to make directly. At June 30, 1998, all
corporate obligations and state and local municipal obligations owned by the
Bank were in accordance with the types of investments the Bank is authorized
to invest in. In addition, at June 30, 1998, the Bank owned approximately $4.7
million of equity securities. These securities are held by the Bank for the
non-qualified deferred compensation plan established by the Bank. See Note 7
to the financial statements included in this prospectus for a further
description of this plan. At June 30, 1998, the equity securities consisted
primarily of investments in equities traded on national exchanges.
Generally, the investment policy of the Bank is to invest funds among
various categories of investments and maturities based upon the Bank's need
for liquidity, to achieve the proper balance between its desire to minimize
risk and maximize yield, and, to a much lesser extent, to provide collateral
for borrowings and to fulfill the Bank's asset/liability management policies.
To date, the Bank's investment strategy has been directed toward high-quality
assets (primarily U.S. Treasury obligations, federal agency obligations and
high grade corporate debt securities) with short and intermediate terms (five
years or less) to maturity. At June 30, 1998, the weighted average term to
maturity for investment securities available-for-sale and mortgage-backed and
related securities held-to-maturity was 1.93 years and 11.12 years,
respectively. See "Notes to Financial Statements" for information regarding
the maturities of the Bank's securities.
At June 30, 1998 the Bank had dual indexed consolidated bonds with a fair
value of $1.9 million, which was $587,000 below the Bank's amortized cost.
These instruments were purchased in 1993 and do not comply with the Bank's
current investment policy. The Bank does not intend to invest in this type of
instrument in the future and, based upon market conditions, intends to
evaluate opportunities to divest itself of these instruments. See "Notes to
Financial Statements" for information regarding dual indexed consolidated
bonds.
Management determines the appropriate classification of securities at the
time of purchase. If management has the intent and ability to hold debt
securities to maturity, they are stated at amortized cost. If securities are
purchased for the purpose of selling them in the near term, they are
classified as trading securities and are reported at fair value with
unrealized holding gains and losses reflected in current earnings. All other
debt and marketable equity securities are classified as securities available
for sale and are reported at fair value, with net unrealized gains or losses
reported, net of income taxes, as a separate component of equity. As a member
of the FHLB of Atlanta, the Bank is required to hold FHLB of Atlanta stock
which is carried at cost since there is no
66
<PAGE>
readily available market value. Historically, the Bank has not held any
securities considered to be trading securities.
The following table sets forth certain information regarding the amortized
cost and fair value of the Bank's securities at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
-----------------------------------------------------
AT JUNE 30, 1998 1997 1996 1995
----------------- ----------------- ----------------- -----------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
--------- ------- --------- ------- --------- ------- --------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Investment securities,
available-for-sale:(1)
U.S. Treasury and
agency obligations.... $16,814 $16,875 $19,812 $19,836 $20,823 $20,803 $30,943 $31,147
Corporate obligations.. 4,856 4,906 3,345 3,413 3,995 4,094 6,514 6,694
Equity securities...... 3,717 4,665 3,596 4,343 3,394 3,610 3,115 3,288
State and local
municipal bonds....... 1,290 1,301 350 371 350 373 350 381
Mutual funds........... 1,293 1,268 1,262 1,242 1,199 1,175 1,136 1,104
Duel indexed
consolidated bonds.... 2,500 1,913 2,500 1,946 2,500 1,924 7,500 6,643
------- ------- ------- ------- ------- ------- ------- -------
Total investment
securities............. $30,470 $30,928 $30,865 $31,151 $32,261 $31,979 $49,558 $49,257
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- --------
(1) On December 31, 1995, the Bank transferred all investment securities that
were classified as held-to-maturity to the available-for-sale category.
The amortized cost of the amounts transferred was $49.6 million with an
unrealized gain of $684,000, and an unrealized loss of $985,026. The Bank
made this transfer in response to a one-time reassessment opportunity
granted in a special report by the FASB regarding the implementation of
SFAS 115.
The following table sets forth certain information regarding the amortized
cost and fair values of the Bank's mortgage-backed and mortgage-related
securities, all of which were classified as held-to-maturity at the dates
indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------
AT JUNE 30, 1998 1997 1996 1995
---------------- ---------------- ---------------- ----------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE COST VALUE
--------- ------ --------- ------ --------- ------ --------- ------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed and
related securities
held-to-maturity:
Fixed rate:
FNMA pass through
securities............ $ 768 $ 768 $ 838 $ 838 $1,008 $1,008 $1,197 $1,197
GNMA certificates...... 422 458 453 497 494 537 682 741
------ ------ ------ ------ ------ ------ ------ ------
Total mortgage-backed
and related
securities............. $1,190 $1,226 $1,291 $1,335 $1,502 $1,545 $1,879 $1,938
====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
The following table sets forth the Bank's mortgage-backed and mortgage-
related securities activities for the periods indicated.
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30, FOR THE YEAR ENDED DECEMBER 31,
-------------------- ----------------------------------
1998 1997 1997 1996 1995
--------- --------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Mortgage-backed
securities:
At beginning of
period................ $ 1,291 $ 1,502 $ 1,502 $ 1,879 $ 2,109
Mortgage-backed
securities purchased.. -- -- -- -- --
Mortgage-backed
securities sold....... -- -- -- -- --
Amortization and
repayments............ (101) (98) (211) (377) (230)
--------- --------- ---------- ---------- ----------
Balance of mortgage-
backed and related
securities at end of
period................. $ 1,190 $ 1,404 $ 1,291 $ 1,502 $ 1,879
========= ========= ========== ========== ==========
</TABLE>
67
<PAGE>
The table below sets forth certain information regarding the carrying
amount, weighted average yields and contractual maturities of the Bank's
investment securities, and mortgage-related securities as of June 30, 1998.
<TABLE>
<CAPTION>
AT JUNE 30, 1998
--------------------------------------------------------------------------------------------------------------
ONE YEAR OR LESS ONE TO THREE YEARS THREE TO FIVE YEARS MORE THAN FIVE YEARS
----------------- --------------------- --------------------- ----------------------- AVERAGE
WEIGHTED WEIGHTED WEIGHTED WEIGHTED REMAINING
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE YEARS TO CARRYING
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD MATURITY AMOUNT
-------- -------- ---------- --------- ---------- --------- ----------- ---------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Investment
securities,
available-for-
sale:
U.S. Treasury and
agency
obligations...... $ 9,514 5.80% $ 6,300 6.16% $ 500 6.49% $ 500 6.14% 1.15 $16,814
Corporate
obligations...... 1,000 9.75 2,500 6.08 1,356 6.40 -- 4.93 1.79 4,856
Equity
securities....... 3,717 1.96 -- -- -- -- -- -- -- 3,717
State and local
municipal bonds.. -- -- -- -- 940 9.71 350 4.93 1.79 1,290
Mutual funds..... 1,293 2.40 -- -- -- -- -- -- 0.25 1,293
Duel indexed
consolidated
bonds............ -- -- -- -- -- -- 2,500 2.92 7.18 2,500
------- ---- ---------- -------- ---------- -------- ----------- --------- -------
Total investment
securities...... $15,524 4.85% $ 8,800 6.14% $ 2,796 7.53% $ 3,350 3.61% 1.93 $30,470
======= ==== ========== ======== ========== ======== =========== ========= =======
Mortgage-backed
and related
securities held-
to-maturity:
FNMA pass through
securities....... $ -- $ -- $ -- $ 768 9.60% 7.50 $ 768
GNMA
certificates..... -- -- -- 422 9.91 17.71 422
------- ---------- ---------- ----------- --------- -------
Total mortgage-
backed and related
securities........ $ -- $ -- $ -- $ 1,190 9.71% 11.12 $ 1,190
======= ========== ========== =========== ========= =======
<CAPTION>
TOTAL
----------------
WEIGHTED
MARKET AVERAGE
VALUE YIELD
------- --------
<S> <C> <C>
Investment
securities,
available-for-
sale:
U.S. Treasury and
agency
obligations...... $16,875 5.97%
Corporate
obligations...... 4,906 6.93
Equity
securities....... 4,665 1.96
State and local
municipal bonds.. 1,301 2.17
Mutual funds..... 1,268 2.40
Duel indexed
consolidated
bonds............ 1,913 2.92
------- --------
Total investment
securities...... $30,928 5.33%
======= ========
Mortgage-backed
and related
securities held-
to-maturity:
FNMA pass through
securities....... $ 768 9.60%
GNMA
certificates..... 458 9.91
------- --------
Total mortgage-
backed and related
securities........ $ 1,226 9.71%
======= ========
</TABLE>
68
<PAGE>
SOURCES OF FUNDS
General. Deposits, loan repayments and prepayments, maturities of securities
and cash flows generated from operations are the primary sources of the Bank's
funds for use in lending, investing 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 passbook and
statement savings accounts, money market accounts, transaction accounts and
time deposits currently ranging in terms from one to five years. At June 30,
1998, the balance of core deposits (savings and money market accounts)
represented 22.3% 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 the areas surrounding its branch offices. The Bank has
historically relied primarily on providing a higher level of customer service
and long-standing relationships with customers to attract and retain these
deposits and also relies on competitive pricing policies and advertising;
however, market interest rates and rates offered by competing financial
institutions significantly affect the Bank's ability to attract and retain
deposits. The Bank has become more susceptible to short-term fluctuations in
deposit flows, as customers have become more interest rate conscious. The Bank
manages the pricing of its deposits in keeping with its asset/liability
management, liquidity and profitability objectives. Based on its experience,
the Bank believes that its passbook and statement savings, money market
accounts and transaction accounts are relatively stable sources of deposits.
The Bank's time deposits have been a relatively stable source of funds as
well, including the $196.7 million of certificates of deposit maturing in one
year or less; however, the ability of the Bank to attract and maintain time
deposits and the rates paid on these deposits has been and will continue to be
significantly affected by market conditions. The Bank is seeking opportunities
to increase transaction deposit accounts through aggressive advertising,
offering ATM services, and offering interest on such accounts. The Bank also
intends to expand its deposit products to attract new customers, including
local businesses.
The following table presents the deposit activity of the Bank for the
periods indicated:
<TABLE>
<CAPTION>
FOR THE
SIX MONTHS ENDED FOR THE YEAR ENDED
JUNE 30, DECEMBER 31,
----------------- ---------------------------
1998 1997 1997 1996 1995
-------- ------- -------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net increase (decrease)
before interest
credited................. $(12,770) $(7,266) $(17,354) $(29,800) $(8,139)
Interest credited......... 9,375 9,262 18,816 19,076 18,432
-------- ------- -------- -------- -------
Net increase (decrease)
in deposits............ $ (3,395) $ 1,996 $ 1,462 $(10,724) $10,293
======== ======= ======== ======== =======
</TABLE>
At June 30, 1998, the Bank had $45.3 million in certificate accounts in
amounts of $100,000 or more maturing as follows:
<TABLE>
<CAPTION>
AMOUNT
--------------
(IN THOUSANDS)
<S> <C>
3 months or less............................................. $ 8,590
Over 3 through 6 months...................................... 8,190
Over 6 through 12 months..................................... 14,500
Over 12 months............................................... 14,066
-------
Total...................................................... $45,346
=======
</TABLE>
69
<PAGE>
The following table sets forth the distribution of the Bank's deposit
accounts as of the dates indicated and the weighted average interest rates on
each category of deposits presented.
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------------------------------------
AT JUNE 30, 1998 1997 1996 1995
-------------------------- -------------------------- -------------------------- --------------------------
PERCENT WEIGHTED PERCENT WEIGHTED PERCENT WEIGHTED PERCENT WEIGHTED
OF TOTAL AVERAGE OF TOTAL AVERAGE OF TOTAL AVERAGE OF TOTAL AVERAGE
BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Transaction
accounts......... $ 2,481 0.66% 0.32 $ 3,266 0.87% -- $ 2,451 0.65% -- $ 2,716 0.70% --
Savings.......... 80,959 21.67 3.25 84,547 22.42 3.25 90,255 24.03 3.25 97,696 25.29 3.25
-------- ------ -------- ------ -------- ------ -------- ------
Total........... 83,440 22.33 3.16 87,813 23.29 3.13 92,706 24.68 3.16 100,412 25.99 3.16
-------- ------ -------- ------ -------- ------ -------- ------
Certificate
accounts(1)(2):
Within 12
months.......... 196,666 52.62 5.60 192,592 51.07 5.74 206,995 55.10 5.57 193,460 50.07 5.63
Over 12 through
36 months....... 72,526 19.41 5.84 82,054 21.76 5.81 73,143 19.47 6.03 92,504 23.94 5.60
Over 36 months.. 21,087 5.64 6.29 14,655 3.88 6.32 2,808 0.75 6.21 -- -- 5.62
-------- ------ -------- ------ -------- ------ -------- ------
Total
certificate
accounts........ 290,279 77.67 5.71 289,301 76.71 5.79 282,946 75.32 5.70 285,964 74.01 5.62
-------- ------ -------- ------ -------- ------ -------- ------
Total deposits.. $373,719 100.00% 5.16 $377,114 100.00% 5.17 $375,652 100.00% 5.07 $386,376 100.00% 4.98
======== ====== ======== ====== ======== ====== ======== ======
</TABLE>
- ----
(1) Based on remaining maturity of certificates.
(2) Includes retirement accounts such as IRA and Keogh accounts.
70
<PAGE>
The following table presents by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at June 30, 1998.
<TABLE>
<CAPTION>
PERIOD TO MATURITY FROM
JUNE 30, 1998 AT DECEMBER 31,
------------------------ --------------------------
LESS ONE
THAN TO OVER
AT JUNE 30, ONE THREE THREE
1998 YEAR YEARS YEARS 1997 1996 1995
----------- -------- ------- ------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Certificate accounts:
0 to 4.00%............. $ -- $ -- $ -- $ -- $ -- $ 18 $ 575
4.01% to 5.00%......... 19,299 19,299 -- -- 17,303 42,404 40,990
5.01% to 6.00%......... 243,579 166,483 72,486 4,610 233,582 183,490 139,919
6.01% to 7.00%......... 24,239 7,722 40 16,477 32,589 51,217 99,017
7.01% to 8.00%......... 3,162 3,162 -- -- 5,827 5,817 5,386
8.01% to 9.00%......... -- -- -- -- -- -- 77
Over 9.01%............. -- -- -- -- -- -- --
-------- -------- ------- ------- -------- -------- --------
Total.................. $290,279 $196,666 $72,526 $21,087 $289,301 $282,946 $285,964
======== ======== ======= ======= ======== ======== ========
</TABLE>
Borrowings. As part of its operating strategy, the Bank has utilized
advances from the FHLB as an alternative to retail deposits to fund its
operations when borrowings are less costly and can be invested at a positive
interest rate spread or when the Bank needs additional funds to satisfy loan
demand. By utilizing FHLB advances, which possess varying stated maturities,
the Bank can meet its liquidity needs without otherwise being dependent upon
retail deposits and revising its deposit rates to attract retail deposits,
which have no stated maturities (except for certificates of deposit), which
are interest rate sensitive and which are subject to withdrawal from the Bank
at any time. These FHLB advances are collateralized primarily by certain of
the Bank's mortgage loans and secondarily by the Bank's investment in capital
stock of the FHLB. FHLB advances are 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
FHLB. See "Regulation--Federal Home Loan Bank System." At June 30, 1998, the
Bank had $8.0 million in outstanding advances from the FHLB as compared to
$8.0 million at December 31, 1997. The Bank has overnight borrowing capacity
at the FHLB of $45.0 million and additional borrowing capacity at June 30,
1998 of $37.0 million.
The following table sets forth certain information regarding the Bank's
borrowed funds at or for the periods ended on the dates indicated:
<TABLE>
<CAPTION>
AT OR FOR THE SIX AT OR FOR THE YEAR ENDED
MONTHS ENDED JUNE 30, DECEMBER 31,
----------------------- ----------------------------
1998 1997 1997 1996 1995
---------- ----------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
FHLB advances:
Average balance
outstanding
(monthly)............. $ 8,000 $ 10,000 $ 9,667 $ 7,417 $ 8,000
Maximum amount
outstanding at any
month-end during the
period................ 8,000 10,000 10,000 15,000 8,000
Balance outstanding at
end of period......... 8,000 10,000 8,000 15,000 8,000
Weighted average
interest rate during
the period............ 6.12% 6.12% 6.23% 6.19% 7.06%
Weighted average
interest rate at end
of period............. 6.19% 6.19% 6.19% 6.23% 7.16%
</TABLE>
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PROPERTIES
The Bank currently conducts its business through its four full service
banking offices including its main banking office. The Bank owns all four
branches. The following table sets forth information regarding the Bank's
properties.
<TABLE>
<CAPTION>
ORIGINAL NET BOOK VALUE TOTAL DEPOSITS
YEAR OF PROPERTY AT AT
LOCATION ACQUIRED JUNE 30, 1998 JUNE 30, 1998
-------- -------- -------------- --------------
(IN THOUSANDS)
<S> <C> <C> <C>
EXECUTIVE/BRANCH OFFICE:
400 George Street
Fredericksburg, VA 22404.............. 1962 $1,491 $244,106
BRANCH OFFICES:
Route Three Branch
3600 Plank Road
Fredericksburg, VA 22407.............. 1983 $1,007 42,239
Four Mile Fork Branch
4535 Lafayette Boulevard
Fredericksburg, VA 22408.............. 1972 $ 408 60,531
Aquia Branch
117 Garrisonville Road
P.O. Box 382
Stafford, VA 22555.................... 1978 $ 274 26,843
</TABLE>
The Bank also owns property for possible branch expansion located on Route
17 North, in Stafford County. The net book value of this property, as of June
30, 1998, was $333,390.
LEGAL PROCEEDINGS
The Bank is not involved in any pending legal proceedings other than routine
legal proceedings occurring in the ordinary course of business. Such routine
legal proceedings, in the aggregate, are believed by management to be
immaterial to the Company's financial condition or results of operations.
PERSONNEL
As of June 30, 1998, the Bank had 50 full-time employees and six part-time
employees. The employees are not represented by a collective bargaining unit
and the Bank considers its relationship with its employees to be good. See
"Management of the Bank--Benefits" for a description of certain compensation
and benefit programs offered to the Bank's employees.
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FEDERAL AND STATE TAXATION
FEDERAL TAXATION
General. The Company and the Bank will report their income on a fiscal year
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS or the Virginia
Department of Taxation ("DOT") in the past five years.
Bad Debt Reserve. Historically, savings institutions such as the Bank which
met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrifts") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have
been deducted in arriving at their taxable income. The Bank's deductions with
respect to "qualifying real property loans," which are generally loans secured
by certain interests in real property, were computed using an amount based on
the Bank's actual loss experience, or a percentage equal to 8% of the Bank's
taxable income, computed with certain modifications and reduced by the amount
of any permitted addition to the non-qualifying reserve. Due to the Bank's
loss experience, the Bank generally recognized a bad debt deduction equal to
8% of taxable income.
In August 1996, provisions repealing the current thrift bad debt rules were
passed by Congress as part of "The Small Business Job Protection Act of 1996."
The new rules eliminate the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also require that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base
year (last taxable year beginning before January 1, 1988). The Bank has
previously recorded a deferred tax liability equal to the bad debt recapture
and as such, the new rules will have no effect on net income or federal income
tax expense. For taxable years beginning after December 31, 1995, the Bank's
bad debt deduction will be equal to net charge-offs. The new rules allow an
institution to suspend the bad debt reserve recapture for the 1996 and 1997
tax years if the institution's lending activity for those years is equal to or
greater than the institution's average mortgage lending activity for the six
taxable years preceding 1996 adjusted for inflation. For this purpose, only
home purchase and home improvement loans are included and the institution can
elect to have the tax years with the highest and lowest lending activity
removed from the average calculation. If an institution is permitted to
postpone the reserve recapture, it must begin its six year recapture no later
than the 1998 tax year. The unrecaptured base year reserves will not be
subject to recapture as long as the institution continues to carry on the
business of banking. In addition, the balance of the pre-1988 bad debt
reserves continues to be subject to provision of present law referred to below
that require recapture in the case of certain excess distributions to
shareholders.
Distributions. To the extent that the Bank makes "non-dividend
distributions" to the Company that are considered as made (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for
such losses exceeds the amount that would have been allowed under the
experience method, or (ii) from the supplemental reserve for losses on loans
("Excess Distributions"), then 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 be considered to result in a distribution from the Bank's
bad debt reserve. Thus, any dividends to the Company that would reduce amounts
appropriated to the Bank's bad debt reserve and deducted for federal income
tax purposes would create a tax liability for the Bank. The amount of
additional taxable income created by an Excess Distribution is an amount that,
when reduced by the tax attributable to the income, is equal to the amount of
the distribution. Thus, if, after the Conversion, the Bank makes a "non-
dividend distribution," then approximately one and one-half times the amount
so used would be includable in gross income for federal income tax purposes,
presumably taxed at a 34% corporate income tax rate (exclusive of state and
local taxes). See "Regulation" and "Dividend Policy"
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<PAGE>
for limits on the payment of dividends of the Bank. The Bank does not intend
to pay dividends that would result in a recapture of any portion of its bad
debt reserve.
Corporate Alternative Minimum Tax ("AMT"). The Code imposes a tax 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 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 preference and prior to reduction for net operating losses). The Bank
does not expect to be subject to the AMT.
Dividends Received Deduction and Other Matters. The Company may exclude from
its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction
is generally 70% in the case of dividends received from unaffiliated
corporations with which the Company and the Bank will not file a consolidated
tax return, except that if the Company or the Bank owns more than 20% of the
stock of a corporation distributing a dividend then 80% of any dividends
received may be deducted.
STATE AND LOCAL TAXATION
Commonwealth of Virginia. The Commonwealth of Virginia imposes a tax at the
rate of 6.0% on the "Virginia taxable income" of the Bank and the Company.
Virginia taxable income is equal to federal taxable income with certain
adjustments. Significant modifications include the subtraction from federal
taxable income of interest or dividends on obligations or securities of the
United States that are exempt from state income taxes, and a recomputation of
the bad debt reserve deduction on reduced modified taxable income. Since the
Bank and the Company will recognize no taxable gain for federal tax purposes
as a result of the Conversion, the Bank and the Company will recognize no
Virginia taxable income as a result of the Conversion.
REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its chartering agency, and the FDIC, as the deposit insurer. The
Bank is a member of the FHLB System. The Bank's deposit accounts are insured
up to applicable limits by the SAIF managed by the FDIC. The Bank must file
reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other financial
institutions. There are periodic examinations by the OTS to test the Bank's
compliance with various regulatory requirements. In addition, the FDIC may
also conduct examinations of the Bank, at the FDIC's discretion. This
regulation and supervision establishes a comprehensive framework of activities
in which an institution can engage and is intended primarily for the
protection of the insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes. Any change in such
policies, whether by the OTS, the FDIC or the Congress, could have a material
adverse impact on the Company, the Bank and their operations. Assuming that
the holding company form of organization is utilized, the Company, as a
savings and loan holding company, will also be required to file certain
reports with and otherwise comply with the rules and regulations of the OTS
and of the Securities and Exchange Commission (the "SEC") under the federal
securities laws.
Any change in the regulatory structure or the applicable statutes or
regulations, whether by the OTS, the FDIC or the Congress, could have a
material impact on the Company, the Bank, their operations or the Bank's
Conversion. Congress has been considering the elimination of the federal
thrift charter and abolishment of the OTS. The results of such consideration,
including possible enactment of legislation is uncertain. Therefore, the
74
<PAGE>
Bank is unable to determine the extent to which the results of consideration
or possible legislation, if enacted, would affect its business. See "Risk
Factors--Financial Institution Regulation and Possible Legislation."
Certain of the regulatory requirements applicable to the Bank and to the
Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to savings associations set
forth in this Prospectus do not purport to be complete descriptions of such
statutes and regulations and their effects on the Bank and the Company and is
qualified in its entirety by reference to such statutes and regulations.
FEDERAL SAVINGS INSTITUTION REGULATION
Business Activities. The activities of federal savings institutions are
governed by the Home Owners' Loan Act, as amended (the "HOLA") and, in certain
respects, the Federal Deposit Insurance Act ("FDI Act") and the regulations
issued by the agencies to implement these statutes. These laws and regulations
delineate the nature and extent of the activities in which federal savings
associations may engage. In particular, certain lending authority for federal
savings associations, e.g., commercial, non-residential real property loans
and consumer loans, is limited to a specified percentage of the institution's
capital or assets.
Loans-to-One Borrower. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans-to-one borrower. Generally, this
limit is 15% of the Bank's unimpaired capital and surplus, plus an additional
10% of unimpaired capital and surplus, if such loan is secured by readily-
marketable collateral, which is defined to include certain financial
instruments and bullion. At June 30, 1998, the Bank's general limit on loans-
to-one borrower was $20.9 million. At June 30, 1998, the Bank's largest
aggregate amount of loans-to-one borrower consisted of one mortgage loan and
two installment loans to a local church with a combined carrying balance of
$2.0 million, of which $1.9 million was secured by real estate and $64,523 was
unsecured. Management believes that the Bank is in compliance with all
applicable loans-to-one borrower limitations.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under
the QTL test, a savings association is required to either qualify as a
"domestic building and loan association," as defined in the Code, or maintain
at least 65% of its "portfolio assets" (total assets less: (i) specified
liquid assets up to 20% of total assets; (ii) intangibles, including goodwill;
and (iii) the value of property used to conduct business) in certain
"qualified thrift investments" (primarily residential mortgages and related
investments, including certain mortgage-backed and related securities) in at
least 9 months out of each 12 month period. A savings association that fails
the QTL test must either convert to a bank charter or operate under certain
restrictions. As of June 30, 1998, the Bank maintained 99.99% of its portfolio
assets in qualified thrift investments and, therefore, met the QTL test.
Recent legislation has expanded the extent to which education loans, credit
card loans and small business loans may be considered as "qualified thrift
investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon
all capital distributions by a savings institution, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to
shareholders of another institution in a cash-out merger and other
distributions charged against capital. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level. An
institution that exceeds all fully phased-in regulatory capital requirements
before and after a proposed capital distribution ("Tier 1 Institution") and
has not been advised by the OTS that it is in need of more than normal
supervision, could, after prior notice to, but without the approval of the
OTS, make capital distributions during a calendar year equal to the greater
of: (i) 100% of its net earnings to date during the calendar year plus the
amount that would reduce by one-half its "surplus capital ratio" (the excess
capital over its fully phased-in capital requirements) at the beginning of the
calendar year; or (ii) 75% of its net earnings for the previous four quarters.
Any additional capital distributions would require prior OTS approval. In the
event the Bank's capital fell below its capital requirements or the OTS
notified it that it was in need of more than normal supervision, the Bank's
ability to make capital distributions could be restricted. In addition, the
OTS could prohibit a proposed capital distribution by any institution, which
would otherwise be permitted by the regulation, if the OTS determines that
such distribution would constitute an unsafe or unsound practice.
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<PAGE>
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a
specified percentage (recently lowered to 4%) of its net withdrawable deposit
accounts plus short-term borrowings. OTS regulations formerly required each
savings institution to maintain an average daily balance of short-term liquid
assets at 1% of the total of its net withdrawable deposit accounts and
borrowings payable in one year or less. However, this requirement was recently
eliminated. Monetary penalties may be imposed for failure to meet the
liquidity requirements. The Bank's average liquidity ratio for the six months
ended June 30, 1998 was 10.23%, which exceeded the applicable requirements.
The Bank has never been subject to monetary penalties for failure to meet its
liquidity requirements. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
Assessments. Savings institutions are required by regulation to pay
assessments to the OTS to fund the agency's operations. The general
assessment, paid on a semi-annual basis, is based upon the savings
institution's total assets, as reported in the Bank's latest quarterly Thrift
Financial Report. The assessments paid by the Bank for the year ended December
31, 1997 totalled $108,000.
Branching. OTS regulations permit federally chartered savings associations
to branch nationwide under certain conditions. Generally, federal savings
associations may establish interstate networks and geographically diversify
their loan portfolios and lines of business. The OTS authority preempts any
state law purporting to regulate branching by federal savings associations.
For a discussion of the impact of proposed legislation, see "Risk Factors--
Financial Institution Regulation and Possible Legislation."
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with an institution, including the Company
and any non-savings institution subsidiaries that the Company may establish)
is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section
23A restricts the aggregate amount of covered transactions with any individual
affiliate to 10% of the capital and surplus of the savings institution and
also limits the aggregate amount of transactions with all affiliates to 20% of
the savings institution's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
described in Section 23A and the purchase of low quality assets from
affiliates is generally prohibited. Section 23B generally requires that
certain transactions with affiliates, including loans and asset purchases,
must be on terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies.
The Bank's authority to extend credit to executive officers, directors and
10% shareholders ("insiders"), as well as entities such persons control, is
governed by Section 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Recent legislation created an exception for
loans to insiders made pursuant to a benefit or compensation program that are
widely available to all employees of the institution and do not give
preference to insiders over other employees. Regulation O also places
individual and aggregate limits on the amounts of loans the Bank may make to
insiders based, in part, on the Bank's capital position and requires that
certain board approval procedures be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders and any
attorneys, appraisers and accountants who knowingly or recklessly participate
in wrongful action likely to have an adverse effect on an insured institution.
Formal enforcement action may range from the issuance of a capital directive
or cease and desist order to removal of officers or directors, receivership,
conservatorship or termination of deposit insurance. Civil penalties cover a
wide range of violations and can amount to $25,000 per day, or $1 million per
day in especially egregious cases. Under the FDI Act, the FDIC has the
authority to recommend to the Director of the OTS that enforcement action be
taken with respect to a particular savings institution. If action is not taken
by the Director, the FDIC has authority to take such action under certain
circumstances. Federal and state law also establishes criminal penalties for
certain violations.
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<PAGE>
Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth and compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted regulations and Interagency Guidelines
Establishing Standards for Safety and Soundness ("Guidelines") to implement
these safety and soundness standards. The Guidelines set forth the safety and
soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired. The Guidelines address internal controls and information systems;
internal audit system; credit underwriting; loan documentation; interest rate
risk exposure; asset growth; asset quality; earnings; and compensation, fees
and benefits. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the
agency may require the institution to submit to the agency an acceptable plan
to achieve compliance with the standard, as required by the FDI Act. The
regulations establish deadlines for the submission and review of such safety
and soundness compliance plans.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three capital standards: a 1.5% tangible capital
standard, a 3% leverage (core capital to total assets) ratio and an 8% risk
based capital standard. Core capital is generally defined as common
stockholders' equity (including retained earnings), certain non-cumulative
perpetual preferred stock and related surplus and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
mortgage servicing rights ("MSRs") and certain purchased credit card
relationships. The OTS regulations require that, in meeting the leverage
ratio, tangible and risk-based capital standards institutions generally must
deduct investments in and loans to subsidiaries engaged in activities as
principal that are not permissible for a national bank. In addition, the OTS
prompt corrective action regulation provides that a savings institution that
has a leverage capital ratio of less than 4% (3% for institutions receiving
the highest examination rating) will be deemed to be "undercapitalized" and
may be subject to certain restrictions. See "--Prompt Corrective Regulatory
Action."
The risk-based capital standard for savings institutions requires the
maintenance of total capital (which is defined as core capital and
supplementary capital) to risk-weighted assets of at least 8%. In determining
the amount of risk-weighted assets, all assets, including certain off-balance
sheet assets, are multiplied by a risk-weight of 0% to 100%, as assigned by
the OTS capital regulation based on the risks OTS believes are inherent in the
type of asset. The components of core capital are equivalent to those
discussed above. The components of supplementary capital generally include
cumulative preferred stock, long-term perpetual preferred stock, mandatory
convertible securities, subordinated debt and intermediate preferred stock
and, within specified limits, the allowance for loan and lease losses.
Overall, the amount of supplementary capital included as part of total capital
cannot exceed 100% of core capital.
The OTS has incorporated an interest rate risk component into its regulatory
capital rule. The final interest rate risk rule also adjusts the risk-
weighting for certain mortgage derivative securities. Under the rule, savings
associations with "above normal" interest rate risk exposure would be subject
to a deduction from total capital for purposes of calculating their risk-based
capital requirements. A savings association's interest rate risk is measured
by the decline in the net portfolio value of its assets (i.e., the difference
between incoming and outgoing discounted cash flows from assets, liabilities
and off-balance sheet contracts) that would result from a hypothetical 200-
basis point increase or decrease in market interest rates divided by the
estimated economic value of the association's assets, as calculated in
accordance with guidelines set forth by the OTS. A savings association whose
measured interest rate risk exposure exceeds 2% must deduct an interest rate
component in calculating its total capital under the risk-based capital rule.
The interest rate risk component is an amount equal to one-half of the
difference between the institution's measured interest rate risk and 2%,
multiplied by the estimated economic value of the association's assets. That
dollar amount is deducted from an association's total capital in calculating
compliance with its risk-based capital requirement. Under the rule, there is a
two quarter lag between the reporting date of an institution's financial data
and the effective date for the new capital requirement based on that data. A
savings association with assets of less than $300 million and risk-based
capital
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<PAGE>
ratios in excess of 12% is not subject to the interest rate risk component,
unless the OTS determines otherwise. The rule also provides that the Director
of the OTS may waive or defer an association's interest rate risk component on
a case-by-case basis. The OTS has postponed indefinitely the date that the
component will first be deducted from an institution's total capital.
At June 30, 1998, the Bank met each of its capital requirements, in each
case on a fully phased-in basis. See "Regulatory Capital Compliance" for a
table which sets forth in terms of dollars and percentages the OTS tangible,
leverage and risk-based capital requirements, the Bank's historical amounts
and percentages at June 30, 1998 and pro forma amounts and percentages based
upon the issuance of the shares within the Estimated Price Range and assuming
that a portion of the net proceeds are retained by the Company.
PROMPT CORRECTIVE REGULATORY ACTION
Under the OTS prompt corrective action regulations, the OTS is required to
take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of capitalization.
Generally, a savings institution that has a total risk-based capital ratio of
less than 8.0% or a leverage ratio or a Tier 1 capital to risk-based assets
ratio that is less than 4.0% is considered to be undercapitalized. A savings
institution that has a total risk-based capital ratio less than 6.0%, a Tier 1
risk-based capital ratio of less than 3.0% or a leverage ratio that is less
than 3.0% is considered to be "significantly undercapitalized" and a savings
institution that has a tangible capital to assets ratio equal to or less than
2.0% is deemed to be "critically undercapitalized." Subject to a narrow
exception, the banking regulator is required to appoint a receiver or
conservator for an institution that is critically undercapitalized. The
regulation also provides that a capital restoration plan must be filed with
the OTS within 45 days of the date an association receives notice that it is
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Compliance with the plan must be guaranteed by any parent
holding company. In addition, numerous mandatory supervisory actions may
become immediately applicable to the institution depending upon its category,
including, but not limited to, increased monitoring by regulators,
restrictions on growth and capital distributions and limitations on expansion.
The OTS could also take any one of a number of discretionary supervisory
actions, including the issuance of a capital directive and the replacement of
senior executive officers and directors.
INSURANCE OF DEPOSIT ACCOUNTS
The FDIC has adopted a risk-based insurance assessment system. The FDIC
assigns an institution to one of three capital categories based on the
institution's financial information, as of the reporting period ending seven
months before the assessment period. The capital categories are (1) well
capitalized, (2) adequately capitalized or (3) undercapitalized. An
institution is also placed in 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 with the most well capitalized, healthy institutions receiving the
lowest rates.
Deposits of the Bank are presently insured by the SAIF. Both the SAIF and
the BIF are statutorily required to be recapitalized to a 1.25% of insured
reserve deposits ratio. Until recently, members of the SAIF and BIF were
paying average deposit insurance assessments of between 24 and 25 basis
points. The BIF met the required reserve in 1995, whereas the SAIF was not
expected to meet or exceed the required level until 2002 at the earliest. This
situation was primarily due to the statutory requirement that SAIF members
make payments on bonds issued in the late 1980s by the Financing Corporation
("FICO") to recapitalize the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted
a new assessment rate schedule of from 0 to 27 basis points under which 92% of
BIF members paid an annual premium of only $2,000. With respect to SAIF member
institutions, the FDIC adopted a final rule retaining the previously existing
assessment
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rate schedule applicable to SAIF member institutions of 23 to 31 basis points.
As long as the premium differential continued, it may have had adverse
consequences for SAIF members, including reduced earnings and an impaired
ability to raise funds in the capital markets. In addition, SAIF members, such
as the Bank could have been placed at a substantial competitive disadvantage
to BIF members with respect to pricing of loans and deposits and the ability
to achieve lower operating costs.
On September 30, 1996, the President of the United States signed into law
the Deposit Insurance Funds Act of 1996 (the "Funds Act") which, among other
things, imposed a special one-time assessment on SAIF member institutions,
including the Bank, to recapitalize the SAIF. As required by the Funds Act,
the FDIC imposed a special assessment of 65.7 basis points on SAIF assessable
deposits held as of March 31, 1995, payable November 27, 1996 (the "SAIF
Special Assessment"). The SAIF Special Assessment was recognized by the Bank
as an expense in the quarter ended September 30, 1996 and was generally tax
deductible. The SAIF Special Assessment recorded by the Bank amounted to $2.5
million on a pre-tax basis and $1.5 million on an after-tax basis.
The Funds Act also spread the obligations for payment of the FICO bonds
across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits
were assessed for a FICO payment of 1.3 basis points, while SAIF deposits pay
6.48 basis points. Full pro rata sharing of the FICO payments between BIF and
SAIF members will occur on the earlier of January 1, 2000 or the date the BIF
and SAIF are merged.
As a result of the Funds Act, the FDIC voted to effectively lower SAIF
assessments to 0 to 27 basis points as of January 1, 1997, a range comparable
to that of BIF members. Most recently, the FDIC determined to continue the 0
to 27 basis point range for the second half of 1998. SAIF members will also
continue to make the FICO payments described above. Management cannot predict
the level of FDIC insurance assessments on an on-going basis, whether the
federal thrift charter will be eliminated or whether the BIF and SAIF will
eventually be merged.
The Bank's assessment rate for 1997 ranged from 6.30 to 6.50 basis points
and the regular premium paid for this period was $240,000.
The FDIC is authorized to raise the assessment rates in certain
circumstances. The FDIC has exercised this authority several times in the past
and may raise insurance premiums in the future. If such action is taken by the
FDIC, it could have an adverse effect on the earnings of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is
in an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or
the OTS. The management of the Bank does not know of any practice, condition
or violation that might lead to termination of deposit insurance.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB, is required to acquire and
hold shares of capital stock in the FHLB in an amount at least equal to 1% of
the aggregate principal amount of its unpaid residential mortgage loans and
similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. The Bank was in compliance
with this requirement with an investment in FHLB stock at June 30, 1998 of
$3.5 million. FHLB advances must be secured by specified types of collateral
and all long-term advances may only be obtained for the purpose of providing
funds for residential housing finance. At June 30, 1998, the Bank had $8.0
million in FHLB advances.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to
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<PAGE>
their members and could also result in the FHLBs imposing a higher rate of
interest on advances to their members. For the years ended December 31, 1997,
1996 and 1995, dividends from the FHLB to the Bank amounted to approximately
$247,000, $232,000 and $240,000, respectively. If dividends were reduced, the
Bank's net interest income would likely also be reduced. Further, there can be
no assurance that the impact of recent or future legislation on the FHLBs will
not also cause a decrease in the value of the FHLB stock held by the Bank.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts. The
Federal Reserve Board regulations generally require that reserves be
maintained against aggregate transaction accounts as follows: for accounts
aggregating $47.8 million or less (subject to adjustment by the Federal
Reserve Board) the reserve requirement is 3%; and for accounts greater than
$47.8 million, the reserve requirement is $1.43 million plus 10% (subject to
adjustment by the Federal Reserve Board between 8% and 14%) against that
portion of total transaction accounts in excess of $47.8 million. The first
$4.7 million of otherwise reservable balances (subject to adjustment by the
Federal Reserve Board) are exempted from the reserve requirements. The Bank is
in compliance with the foregoing requirements. Because required reserves must
be maintained in the form of either vault cash, a non-interest-bearing account
at a Federal Reserve Bank or a pass-through account as defined by the Federal
Reserve Board, the effect of this reserve requirement is to reduce the Bank's
interest-earning assets. FHLB System members are also authorized to borrow
from the Federal Reserve discount window, but Federal Reserve Board
regulations require institutions to exhaust all FHLB sources before borrowing
from a Federal Reserve Bank.
HOLDING COMPANY REGULATION
The Company will be a non-diversified unitary savings and loan holding
company within the meaning of the HOLA. As such, the Company will be required
to register with the OTS and will be subject to OTS regulations, examinations,
supervision and reporting requirements. In addition, the OTS has enforcement
authority over the Company and its non-savings institution subsidiaries.
As a unitary savings and loan holding company, the Company generally will
not be restricted under existing laws as to the types of business activities
in which it may engage, provided that the Bank continues to be a QTL. See "--
Federal Savings Institution Regulation--QTL Test" for a discussion of the QTL
requirements. Upon any non-supervisory acquisition by the Company of another
savings association, the Company would become a multiple savings and loan
holding company (if the acquired institution is held as a separate subsidiary)
and would be subject to extensive limitations on the types of business
activities in which it could engage. The HOLA limits the activities of a
multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities authorized for bank holding companies
under Section 4(c)(8) of the Bank Holding Company Act, as amended (the "BHC
Act"), subject to the prior approval of the OTS, and to other activities
authorized by OTS regulation. No multiple savings and loan holding company may
acquire more than 5% of the voting stock of a company engaged in impermissible
activities. Proposed legislation would, subject to certain grandfathering,
limit the activities of unitary savings and loan companies to those
permissible for multiple savings and loan holding companies. See "Risk
Factors--Financial Institution Regulation and Possible Legislation."
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5%
of the voting stock of another savings institution, or holding company
thereof, without prior written approval of the OTS, and from acquiring or
retaining, with certain exceptions, more than 5% of a non-subsidiary holding
company or savings association. The HOLA also prohibits a savings and loan
holding company from acquiring or retaining control of a depository
institution that is not insured by the FDIC. In evaluating applications by
holding companies to acquire savings institutions, the OTS must consider the
financial and managerial resources and future prospects of the company and
institution involved, the effect of the acquisition on the risk to the
insurance funds, the convenience and needs of the community and competitive
factors.
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The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, except: (i) interstate supervisory acquisitions by
savings and loan holding companies and (ii) the acquisition of a savings
institution in another state if the laws of the state of the target savings
institution specifically permit such acquisitions. The states vary in the
extent to which they permit interstate savings and loan holding company
acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on
subsidiary savings institutions as described above. The Bank must notify the
OTS 30 days before declaring any dividend to the Company. In addition, the
financial impact of a holding company on its subsidiary institution is a
matter that is evaluated by the OTS and the agency has authority to order
cessation of activities or divestiture of subsidiaries deemed to pose a threat
to the safety and soundness of the institution.
THRIFT RECHARTERING
The Funds Act provides that the BIF and the SAIF will merge on January 1,
1999, if there are no more savings associations as of that date. Several bills
have been introduced in Congress that would eliminate the federal thrift
charter and the OTS. A bill originally reported by the House Banking Committee
would have regained federal thrifts to become national banks or state banks
within two years of enactment or they would have become national banks by
operation of law. OTS would have been abolished and its functions transferred
to the bank regulatory agencies. The bill as passed by the House of
Representatives, however, did not provide for the elimination of the federal
thrift charter or OTS, but did provide that unitary stock savings and loan
holding companies existing or applied for after March 31, 1998 would not have
the ability to engage in unlimited activities but would be subject to the
activities restrictions applicable to multiple savings and loan holding
companies. Unitary stock holding companies existing or applied for before 1998
would be grandfathered and could continue to engage in unlimited activities
and could transfer the grandfather rights to acquirors of the holding company.
The Bank is unable to predict whether the legislation will be enacted or,
given such uncertainty, determine the extent to which the legislation, if
enacted, would affect its business. The Bank is also unable to predict whether
the SAIF and BIF will eventually be merged or the federal thrift charter
eliminated, and what effect, if any, such legislation would have on the Bank.
FEDERAL SECURITIES LAWS
The Company has filed with the SEC a registration statement under the
Securities Act for the registration of the Common Stock to be issued pursuant
to the Conversion. Upon completion of the Conversion, the Company's Common
Stock will be registered with the SEC under the Exchange Act. The Company will
then be subject to the information, proxy solicitation, insider trading
restrictions and other requirements under the Exchange Act.
The registration under the Securities Act of shares of the Common Stock to
be issued in the Conversion does not cover the resale of such shares. Shares
of the Common Stock purchased by persons who are not affiliates of the Company
may be resold without registration. Shares purchased by an affiliate of the
Company will be subject to the resale restrictions of Rule 144 under the
Securities Act. If the Company meets the current public information
requirements of Rule 144 under the Securities Act, each affiliate of the
Company who complies with the other conditions of Rule 144 (including those
that require the affiliate's sale to be aggregated with those of certain other
persons) would be able to sell in the public market, without registration, a
number of shares not to exceed, in any three-month period, the greater of (i)
1% of the outstanding shares of the Company or (ii) the average weekly volume
of trading in such shares during the preceding four calendar weeks. Provision
may be made in the future by the Company to permit affiliates to have their
shares registered for sale under the Securities Act under certain
circumstances.
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MANAGEMENT OF THE COMPANY
The Board of Directors of the Company currently consists of nine members
each of whom is also a director of the Bank. The Board of Directors is divided
into three classes, each of which contains approximately one-third of the
Board. The directors shall be elected by the stockholders of the Company for
staggered three year terms, or until their successors are elected and
qualified. One class of directors, consisting of Messrs. Anderson, Beck and
Donahoe has a term of office expiring at the first annual meeting of
stockholders, a second class, consisting of Messrs. Ashby, Harding and Rowe
has a term of office expiring at the second annual meeting of stockholders and
a third class, consisting of Messrs. Hicks and McKann and Ms. Newman has a
term of office expiring at the third annual meeting of stockholders. Their
names and biographical information are set forth under "Management of the
Bank--Directors and Executive Officers."
The following individuals are the executive officers of the Company and hold
the offices set forth below opposite their names.
<TABLE>
<CAPTION>
EXECUTIVE POSITION(S) HELD WITH COMPANY
--------- ------------------------------------------
<S> <C>
Samuel C. Harding, Jr.............. President
Peggy J. Newman.................... Executive Vice President, Secretary and
Treasurer
</TABLE>
The executive officers of the Company are elected annually and hold office
until their respective successors have been elected and qualified or until
death, resignation or removal at the discretion of the Board of Directors.
Except for directors' meeting fees, since the formation of the Company, none
of the executive officers, directors or other personnel has received
remuneration from the Company. Information concerning the principal
occupations, employment and other information concerning the directors and
officers of the Company during the past five years is set forth under
"Management of the Bank--Biographical Information."
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MANAGEMENT OF THE BANK
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information regarding the Board of
Directors of the Bank.
<TABLE>
<CAPTION>
DIRECTOR TERM
NAME AGE POSITION(S) HELD WITH THE BANK SINCE EXPIRES
---- --- ------------------------------ -------- -------
<S> <C> <C> <C> <C>
H. Smith McKann......... 84 Chairman of the Board 1955 2001
Ronald G. Beck.......... 62 Vice Chairman of the Board 1988 1999
Samuel C. Harding, Jr... 56 Director and President 1987 2000
Peggy J. Newman......... 57 Director, Executive Vice President, 1988 2001
Secretary and Treasurer
William M. Anderson, 56 Director 1988 1999
Jr.....................
O'Conor Ashby........... 51 Director 1992 2000
Ernest N. Donahoe, Jr... 61 Director 1982 1999
DuVal Q. Hicks, Jr...... 78 Director 1958 2001
Charles S. Rowe......... 73 Director 1956 2000
</TABLE>
- --------
(1) As of June 30, 1998.
Each of the executive officers of the Bank will retain his or her office
after the Conversion until his or her re-election at the annual meeting of the
Board of Directors of the Bank, held immediately after the first annual
meeting of stockholders subsequent to the Conversion, and until their
successors are elected and qualified or until they are removed or replaced.
Officers are subject to re-election by the Board of Directors annually.
BIOGRAPHICAL INFORMATION
Directors and Executive Officers
H. Smith McKann is the President and owner of General Products Company,
Fredericksburg, Virginia. Mr. McKann has served as a director of the Bank
since 1955 and has been Chairman since 1996.
Ronald G. Beck is the President of Clayborne C. Beck & Sons, Inc.,
Fredericksburg, Virginia, which sells furniture grade lumber worldwide. Mr.
Beck has served as a director of the Bank since 1988 and currently serves as
Vice Chairman of the Board.
Samuel C. Harding, Jr. serves as President of the Bank and has held that
position since 1992. Mr. Harding has been with the Bank since 1972 and was
elected director in 1987.
Peggy J. Newman serves as Executive Vice President, Secretary and Treasurer
of the Bank and has held these positions since 1992. Ms. Newman has been with
the Bank for 33 years and was elected director in 1988.
William M. Anderson, Jr. was elected to the Board in 1988 and is currently
the President of Mary Washington College, Fredericksburg, Virginia. He has
served in that position since 1982.
O'Conor Ashby is a partner in the law firm of Willis & Ashby. He has been a
partner with that firm since 1975. Mr. Ashby, who has served on the Board of
the Bank since 1992 also is currently on the Board of Medicorp Services, Inc.
Ernest N. Donahoe, Jr. is an engineer and has been a partner with Sullivan,
Donahoe & Ingalls, P.C. since 1968. Mr. Donahoe has been a Board member of the
Bank since 1982.
DuVal Q. Hicks, Jr. is a retired attorney, formerly with Hicks, Baker and
Peterson. Mr. Hicks has been a director of the Bank since 1958.
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Charles S. Rowe is a retired Editor and Co-publisher of the Free Lance-Star,
Fredericksburg, Virginia and a former director of the Associated Press. He has
served as a director of the Bank since 1956.
COMMITTEES AND MEETINGS OF THE BOARD OF DIRECTORS OF THE BANK AND COMPANY
The Bank's Board of Directors meets twice per month and may have additional
special meetings called in the manner specified in the Bylaws. During 1997, no
current Director attended less than 75% of the aggregate of the total number
of Board meetings and the total number of committee meetings of the Board of
Directors on which they served.
The Board of Directors of the Bank has established the following committees:
The Executive Committee consists of Messrs. McKann, Beck and Harding, and
Ms. Newman. The purposes of this committee are to evaluate issues of major
importance to the Bank between regularly scheduled Board meetings. The
Executive Committee meets as the members deem necessary and met one time in
1997.
The Audit Committee consists of Messrs. Anderson, Ashby and Rowe. The
purpose of this committee is to oversee both internal and external audit
activities. The Audit Committee meets as the members deem necessary and met
one time in 1997.
The Loan Committee consists of Messrs. Beck, Donahoe and Harding. The
purpose of this committee is to review and approve all loan requests of less
than $500,000. The Loan Committee meets once a week.
Additionally, the Bank has a number of other management committees including
the Asset/Liability Committee, Advertising Committee, the Compensation
Committee, the Investment Committee, the Pension Committee and the Proxy
Committee.
The Board of Directors of the Company has established the following
committees: the Audit and Compliance Committee consisting of Messrs. Anderson,
Rowe and Ashby; the Pricing Committee consisting of the entire Board of
Directors; and the Compensation Committee consisting of Messrs. Beck, Hicks
and Harding.
COMPENSATION OF DIRECTORS OF THE BANK AND COMPANY
All directors of the Bank receive a monthly fee of $1,700 for the two
regularly scheduled meetings per month. Effective August 1, 1998, such monthly
fees were increased to $2,000. Messrs. Beck and Donohoe additionally receive
$400 per month for Loan Committee meetings attended.
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<PAGE>
EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth the cash
compensation paid by the Bank as well as other compensation paid or accrued
for services rendered in all capacities during the year ended December 31,
1997, to the Chief Executive Officer and the highest paid executive officer of
the Bank who received salary and bonus in excess of $100,000 ("Named Executive
Officers").
<TABLE>
<CAPTION>
ANNUAL COMPENSATION(1)
-----------------------------
OTHER
ANNUAL ALL OTHER
SALARY BONUS COMPENSATION COMPENSATION
NAME AND PRINCIPAL POSITIONS YEAR ($) ($) ($)(2) ($)(3)
---------------------------- ---- -------- ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Samuel C. Harding, Jr.......... 1997 $204,800 $20,000 -- $33,109
President (principal executive
officer)
Peggy J. Newman................ 1997 199,800 20,000 -- 37,884
Executive Vice President,
Secretary and Treasurer
(principal financial officer)
</TABLE>
- --------
(1) Under Annual Compensation, the column titled "Salary" includes directors'
fees for Mr. Harding and Ms. Newman.
(2) For 1997, there were no (a) perquisites over the lesser of $50,000 or 10%
of the individual's total salary and bonus for the year; (b) payments of
above-market preferential earnings on deferred compensation; (c) payments
of earnings with respect to long-term incentive plans prior to settlement
or maturation; (d) tax payment reimbursements; or (e) preferential
discounts on stock. For 1997, the Bank had no restricted stock or stock
related plans in existence.
(3) Includes deferred compensation of 28,612 and 33,387 for Mr. Harding and
Ms. Newman, respectively under the Management Security Plan. Also includes
matching contributions of 4,497 and 4,497 to the accounts of Mr. Harding
and Ms. Newman, respectively, under the Bank's 401(k) Plan.
EMPLOYMENT AGREEMENTS
Upon consummation of the Conversion, the Bank and the Company intend to
enter into employment agreements (collectively, the "Employment Agreements")
with Mr. Harding and Ms. Newman (individually, the "Executive"). The
Employment Agreements are subject to the review and approval of the OTS and
may be amended as a result of such OTS review. Review of compensation
arrangements by the OTS does not indicate, and should not be construed to
indicate, that the OTS has passed upon the merits of such arrangements. The
Employment Agreements are intended to ensure that the Bank and the Company
will be able to maintain a stable and competent management base after the
Conversion. The continued success of the Bank and the Company depends to a
significant degree on the skills and competence of both Mr. Harding and Ms.
Newman.
The Employment Agreements provide for a three-year term for each Executive
and shall become effective upon consummation of the Conversion. The Bank
Employment Agreements provide that, commencing on the first anniversary date
of the agreement and continuing each anniversary date thereafter, the Board of
Directors of the Bank may extend each of the agreements for an additional year
so that the remaining term shall be three years unless written notice of non-
renewal is given by the Board of Directors after conducting a performance
evaluation of the Executive. The terms of the Company Employment Agreements
shall be extended on a daily basis unless written notice of non-renewal is
given by the Board of Directors of the Company. The Bank and the Company
Employment Agreements provide that the Executive's base salary will be
reviewed annually. The base salaries, which will be effective for such
Employment Agreements for Mr. Harding and Ms. Newman will be $194,775 and
$189,525, respectively. In addition to the base salary, the Employment
Agreements provide for, among other things, participation in various employee
benefit plans and stock-based compensation programs, as well as furnishing
certain fringe benefits available to similarly situated executive personnel.
The Employment Agreements provide for termination by the Bank or the Company
for cause (as described in the agreements) at any time. In the event the Bank
or the Company chooses to terminate the Executive's employment for reasons
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<PAGE>
other than for cause, or in the event of the Executive's resignation from the
Bank and the Company upon (i) the failure to re-elect the Executive to his/her
current offices; (ii) a material change in the Executive's functions, duties
or responsibilities; (iii) a relocation of the Executive's principal place of
employment by more than 25 miles; (iv) liquidation or dissolution of the Bank
or the Company; or (v) a breach of the Employment Agreements by the Bank or
the Company; the Executive or, in the event of death, the Executive's
beneficiary would be entitled to receive an amount generally equal to the
remaining base salary and bonus payments that would have been paid to the
Executive during the remaining term of the Employment Agreements. In addition,
the Executive would receive a payment attributable to the contributions that
would have been made on the Executive's behalf to any employee benefit plans
of the Bank or the Company during the remaining term of the Employment
Agreements, together with the value of certain stock-based incentives
previously awarded to the Executive. The Bank and the Company would also
continue and pay for the Executive's life and disability coverage for the
remaining term of the Employment Agreement, as well as provide medical and
hospitalization coverage until the Executive at least attains eligible
Medicare age. Upon any termination of the Executive, the Executive is subject
to a covenant not to compete with the Company or the Bank for one year.
Under the agreements, if voluntary or involuntary termination follows a
change in control of the Bank or the Company, the Executive or, in the event
of the Executive's death, the Executive's beneficiary would be entitled to a
severance payment generally equal to the greater of: (i) the payments due for
the remaining terms of the agreement, including the value of certain stock-
based incentives previously awarded to the Executive; or (ii) three times the
average of the five preceding taxable years' annual compensation. The Bank and
the Company would also continue the Executive's life, health, and disability
coverage for thirty-six months (except medical and hospitalization would be
provided at least until the Executive attains eligible Medicare age).
Notwithstanding that both Employment Agreements provide for a severance
payment in the event of a change in control, the Executive would only be
entitled to receive a severance payment under one agreement. In the event of a
change in control of the Bank or the Company, the total amount of payments due
under the Agreements, based solely on the base salaries to be paid to Mr.
Harding and Ms. Newman effective upon the consummation of the Conversion, and
excluding any benefits under any employee benefit plan which may be payable,
and any other benefits that may be available under the employment contracts,
would equal approximately $1.2 million.
Payments to the Executive under the Bank Employment Agreement will be
guaranteed by the Company in the event that payments or benefits are not paid
by the Bank. Payment under the Company Employment Agreements would be made by
the Company. All reasonable costs and legal fees paid or incurred by the
Executive pursuant to any dispute or question of interpretation relating to
the Employment Agreements shall be paid by the Bank or Company, respectively,
if the Executive is successful on the merits pursuant to a legal judgment,
arbitration or settlement. The Employment Agreements also provide that the
Bank and Company shall indemnify the Executive to the fullest extent allowable
under federal and Virginia law, respectively.
EMPLOYEE SEVERANCE COMPENSATION PLAN
Upon consummation of the Conversion, the Bank's Board of Directors intends
to, upon consummation of the Conversion, establish the Fredericksburg Savings
Bank Employee Severance Compensation Plan (the "Severance Plan") which will
provide eligible employees with severance pay benefits in the event of a
change in control of the Bank or the Company. Management personnel with
Employment Agreements are not eligible to participate in the Severance Plan.
Generally, employees are eligible to participate in the Severance Plan if they
have completed at least six months of service with the Bank. Under the
Severance Plan, in the event of a change in control of the Bank or the
Company, eligible employees who are terminated from or terminate their
employment within one year after the change in control (for reasons specified
under the Severance Plan), will be entitled to receive a severance payment. A
participant, whose employment has terminated, will be entitled to a cash
severance payment equal to one-twelfth of his or her current annual
compensation for each year of service up to a maximum of 199% of current
annual compensation. In the event the provisions of the Severance Plan were
triggered, the total amount of payments that would be due thereunder, based
solely upon current salary levels, would equal approximately $2.1 million.
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<PAGE>
INSURANCE PLANS
All full-time employees of the Bank, upon completion of the applicable
introductory period, may elect coverage for comprehensive hospitalization,
including major medical, and are covered with long-term disability insurance.
BENEFITS
401(k) Plan. The Bank maintains the Fredericksburg Savings and Loan
Association, F.A. Salary Savings Plan (the "401(k) Plan"), a tax-qualified
profit sharing plan with a qualified cash or deferred arrangement under
Section 401(k) of the Code. The 401(k) Plan currently provides participants
with savings and retirement benefits based on employee deferrals of
compensation, as well as matching and other discretionary contributions made
by the Bank. Eligible employees may begin participating in the 401(k) Plan
upon the completion of one-half of one "Year of Service" (as defined in the
401(k) Plan) and attainment of age 21. Participants currently may make salary
reduction contributions to the 401(k) Plan up to the lesser of 20% of their
compensation or the legally permissible limit ($10,000 for 1998). A
participant is always 100% vested in his or her salary reduction contributions
to the 401(k) Plan. Participants become vested in employer contributions to
the 401(k) Plan at the rate of 33 1/3% per each completed year of service.
Participants also become 100% vested in their accounts under the 401(k) Plan
upon death or incurring disability (as described in the 401(k) Plan) or
attainment of their "Normal Retirement Age" (as defined in the 401(k) Plan).
Currently, participants may invest their accounts under the 401(k) Plan in
and among four funds. The Bank may add or eliminate investment options
available under the 401(k) Plan in the future.
Generally, distributions from the 401(k) Plan may commence upon a
participant's separation from service, death, or disability. However,
participants may request hardship withdrawals from the 401(k) Plan under
certain circumstances. Distributions from the 401(k) Plan are generally
subject to federal and state income taxes and distributions made prior to a
participant attaining age 59 1/2 are also generally subject to a federal
excise tax.
Pension Plan. The Bank also maintains a tax-qualified defined benefit
pension plan for its employees (the "Pension Plan"). Eligible employees begin
participating in the Pension Plan following the completion of one year of
service (as described in the Pension Plan) and attainment of the age 21. A
participant in the Pension Plan generally becomes vested in his accrued
benefit under the Pension Plan upon completing five years of service.
Participants also become 100% vested in their accrual benefit under the
Pension Plan upon incurring a disability (as described in the Pension Plan)
and upon the attainment of their "normal retirement age" (as described in the
Pension Plan). The Pension Plan is funded solely through contributions made by
the Bank.
A participant's accrued benefit under the Pension Plan is actuarially
determined based on his or her years of service with the Bank and his or her
average monthly compensation (as described in the Pension Plan), including
average monthly compensation in excess of an integration to the Social
Security Taxable Wage Base.
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<PAGE>
The table below reflects the annual pension benefit payable to a participant
in the Pension Plan, assuming various levels of "Average Monthly Compensation"
(as defined in the Pension Plan) and years of service credited as of the
participant's normal retirement age. As of January 1, 1998, Mr. Harding and
Ms. Newman had 25 and 32 years of service with the Bank, respectively, for
purposes of the Pension Plan.
<TABLE>
<CAPTION>
YEARS OF CREDITED SERVICE
AVERAGE ANNUAL --------------------------------------------------------------
EARNINGS(1) 15 20 25 30 35
-------------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
$ 50,000 $ 19,833 $ 26,444 $ 33,055 $ 33,055 $ 33,055
$ 75,000 $ 31,271 $ 41,694 $ 52,118 $ 52,118 $ 52,118
$100,000 $ 42,708 $ 56,944 $ 71,180 $ 71,180 $ 71,180
$125,000 $ 54,146 $ 72,194 $ 90,243 $ 90,243 $ 90,243
$150,000 $ 65,583 $ 87,444 $109,305 $109,305 $109,305
$175,000 $ 77,021 $102,694 $128,368 $128,368 $128,368
$200,000 $ 88,458 $117,944 $147,430 $147,430 $147,430
$250,000 $111,333 $148,444 $185,555 $185,555 $185,555
$300,000 $134,208 $178,944 $223,680 $223,680 $223,680
$350,000 $157,083 $209,444 $261,805 $261,805 $261,805
$400,000 $179,958 $239,944 $299,930 $299,930 $299,930
</TABLE>
- --------
(1) Code Section 401(a)(17) limits the amount of compensation the Bank may
consider in computing benefits under the Pension Plan to $150,000,
effective with respect to the Pension Plan for plan years beginning on or
after January 1, 1994, as periodically adjusted ($160,000 for 1998).
Employee Stock Ownership Plan and Trust. The Bank intends to establish a
tax-qualified employee stock ownership plan (the "ESOP") in connection with
the Conversion. Generally, eligible employees will become participants in the
ESOP upon the completion of one-half of one year of service with the Bank
(with credit given for service with the Bank prior to adoption of the plan)
and attainment of age 21. With the consent of the Bank, an affiliate of the
Bank may also adopt the ESOP for the benefit of its employees.
The Bank expects a committee of the Board of Directors to serve as the
administrative committee of the ESOP (the "ESOP Committee"). The ESOP
Committee will appoint an unrelated corporate trustee for the ESOP prior to
the Conversion. Among other matters, the ESOP Committee may generally instruct
the trustee regarding the investment of funds contributed to the ESOP, subject
to the terms of the plan document and the related trust agreement. The Bank
expects the ESOP to purchase 8% of the Common Stock issued in the Conversion.
As part of the Conversion, and in order to fund the ESOP's purchase of the
Common Stock issued in the Conversion, the ESOP will borrow 100% of the
aggregate purchase price of the Common Stock from either the Company or a
third-party lender.
The trustee of the ESOP will repay the loan principally from the Bank's
annual contributions to the ESOP over an expected period of 20 years. Subject
to receipt of any necessary regulatory approvals or opinions, the Bank may
make contributions to the ESOP for repayment of the loan since some
participants in the ESOP will be employees of the Bank or, alternatively, the
Bank may reimburse the Company for contributions made by the Company with
respect to employees of the Bank. The Bank expects the initial interest rate
(which may be fixed or variable) for the loan to be at or near the prime rate
on or about the date of Conversion.
The trustee of the ESOP will pledge the shares of Common Stock purchased by
the ESOP in connection with the Conversion as collateral for the loan and will
hold the shares in a suspense account under the plan. As the trustee repays
the loan, the trustee will release a portion of the shares from the suspense
account and allocate them to the accounts of active participants in the ESOP
based on each participant's compensation (as determined under the terms of the
plan) relative to all participants' compensation for the plan year. In the
event of a change in control of the Bank or the Company prior to complete
repayment of the loan, the ESOP trustee, in accordance with the terms of the
plan document, will sell enough shares of Common Stock held in the suspense
account to repay the loan in full. Upon repayment of the loan, the ESOP
trustee will then allocate all remaining shares of
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Common Stock held in the suspense account to the accounts of active
participants based on each participant's account balance as of a specific date
or based on some other method set forth in the plan document.
Participants will become vested in contributions made to the ESOP by the
Bank at the rate of 33 1/3% per year of service with the Bank (with credit
given for service with the Bank prior to its adoption of the ESOP).
Accordingly, participants will become fully vested in their accounts under the
ESOP after completing three years of vesting service. The Bank expects that
participants will also become fully vested in their accounts under the ESOP
upon the attainment of their normal retirement age while an employee of the
Bank, upon their death or incurring a disability, upon a change in control of
the Bank or the Company, or upon termination of the plan. Benefits generally
become distributable under the ESOP and potentially become subject to income
tax upon death, retirement, disability or other separation from service.
The ESOP trustee will vote all allocated shares held in the ESOP in
accordance with the instructions of the plan participants. The ESOP trustee,
subject to its fiduciary duties under ERISA, will vote the unallocated shares
(i.e., those held in the suspense account) and allocated shares for which it
receives no proper voting instructions in a manner calculated to most
accurately reflect the instructions it receives from participants regarding
the allocated stock. In the event no shares have been allocated under the ESOP
at the time such shares are to be voted, each participant shall be deemed to
have one share allocated to his or her account for voting purposes.
Supplemental Executive Retirement Plan. The Code limits the amount of
compensation the Bank may consider in providing benefits under its tax-
qualified retirement plans, such as the 401(k) Plan, the Pension Plan and the
ESOP. The Code further limits the amount of benefit accruals and annual
contributions under such plans on behalf of any employee. The Bank has
previously taken action to separately provide benefits to Mr. Harding and Ms.
Newman that would have accrued under the Pension Plan but for the limitation
on compensation the Bank may consider under the Pension Plan less benefits
that actually accrue under the Pension Plan for the benefit of Mr. Harding and
Ms. Newman. Upon Conversion, the Bank also intends to provide for similar
benefits with respect to the 401(k) Plan and ESOP, as well as benefits
otherwise limited by other provisions of the Code or the terms of the ESOP
loan.
To provide for such benefits, the Bank intends to implement a non-qualified
deferred compensation arrangement known as a "Supplemental Executive
Retirement Plan" ("SERP"). The SERP will generally provide benefits to
eligible individuals (designated by the Board of Directors of the Bank or its
affiliates) that cannot be provided under the Pension Plan, 401(k) Plan and/or
ESOP as a result of the limitations imposed by the Code, but that would have
been provided under the Pension Plan, 401(k) Plan and/or ESOP but for such
limitations. In addition to providing for benefits lost under tax-qualified
plans as a result of limitations imposed by the Code, the SERP will also make
up lost ESOP benefits to designated individuals who retire, who terminate
employment in connection with a change in control, or whose participation in
the ESOP ends due to termination of the ESOP in connection with a change in
control (regardless of whether the individual terminates employment) prior to
the complete scheduled repayment of the ESOP loan. Generally, upon the
retirement of an eligible individual or upon a change in control of the Bank
or the Company prior to complete repayment of the ESOP Loan, the SERP will
provide the individual with a benefit equal to what the individual would have
received under the ESOP had he remained employed throughout the term of the
ESOP or had the ESOP not been terminated prior to the scheduled repayment of
the ESOP loan less the benefits actually provided under the ESOP on behalf of
such individual. An individual's benefits under the SERP will generally become
payable upon the participant's retirement (in accordance with the standard
retirement policies of the Bank), upon the change in control of the Bank or
the Company or as determined under the applicable tax-qualified retirement
plans sponsored by the Bank.
The Bank may establish a grantor trust in connection with the SERP to
satisfy the obligations of the Bank with respect to the SERP. The assets of
the grantor trust would remain subject to the claims of the Bank's general
creditors in the event of the Bank's insolvency until paid to the individual
pursuant to the terms of the SERP.
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Management Security Plan. The Bank currently sponsors a non-tax qualified
deferred compensation arrangement for approximately ten employees, including
Mr. Harding and Ms. Newman, known as the Fredericksburg Savings and Loan
Association, F.A. Management Security Plan (the "Management Security Plan").
The Management Security Plan generally provides a payment to each covered
individual upon his or her death, disability, retirement, or termination of
employment after five or more years of service. Benefits under the Management
Security Plan are based on a flat dollar amount (specified for each individual
in a separate "Benefit Agreement") multiplied by the individual's years of
service with the Bank. Participants become fully vested in benefits under the
Management Security Plan after the completion of five years of service with
the Bank. The annual benefits for Mr. Harding and Ms. Newman are $3,685 and
$4,000, respectively, multiplied by each individual's respective years of
service with the Bank. As of January 1, 1998, Mr. Harding and Ms. Newman had
completed 27 and 33 years of service, respectively.
Stock-Based Incentive Plan. Following the Conversion, the Board of Directors
of the Company intends to adopt the Stock-Based Incentive Plan which will
provide for the granting of options to purchase Common Stock ("Stock
Options"), Common Stock ("Stock Awards"), Limited Option Rights and Limited
Stock Rights to eligible officers, employees, and directors of the Company and
Bank. The Company may provide such stock based benefits under the Stock-Based
Incentive Plan or may establish one or more separate plans which would provide
for the benefits described herein.
In the event the Stock-Based Incentive Plan (or any separate plan(s)) is
adopted within one year after conversion, OTS regulations require such plan to
be approved by a majority of the Company's stockholders at a meeting of
stockholders to be held no earlier than six months after the completion of the
Conversion. Under the Stock-Based Incentive Plan, the Company intends to grant
Stock Options in an amount equal to 10% of the shares of Common Stock issued
in the Conversion, including shares issued to the Foundation (1,311,552 shares
based upon the maximum of the Estimated Price Range), and intends to grant
Stock Awards in an amount equal to 4% of the shares of Common Stock issued in
the Conversion, including shares issued to the Foundation (524,621 shares
based upon the maximum of the Estimated Price Range). Any Common Stock awarded
under the Stock-Based Incentive Plan will be awarded at no cost to the
recipients. The plan may be funded through the purchase of Common Stock by a
trust established in connection with the Stock-Based Incentive Plan (or any
separate plan(s)) or from authorized but unissued shares. The Board intends to
appoint an independent fiduciary to serve as trustee of a trust to be
established in connection with the Stock-Based Incentive Plan. In the event
that additional authorized but unissued shares are acquired by the Stock-Based
Incentive Plan after the Conversion, the interests of existing shareholders
would be diluted. See "Pro Forma Data." Assuming the market value of the
Common Stock is $10.00 per share at the time stock awards are made under the
Stock-Based Incentive Plan, the estimated value of the total Stock Awards
available for grant under the Plan would be approximately $4.6 million,
assuming shares are issued at the midpoint of the Estimated Price Range in the
Conversion.
The grants of Stock Options and Stock Awards will be designed to attract and
retain qualified personnel in key positions, provide officers and key
employees with a propriety interest in the Company as an incentive to
contribute to the success of the Company and reward key employees for
outstanding performance. All employees of the Company and its subsidiaries,
including the Bank, will be eligible to participate in the Stock-Based
Incentive Plan. It is expected that the committee administering the plan will
determine the terms of awards granted to officers and employees. The committee
will also determine whether Stock Options will be Incentive or Non-Statutory
Stock Options, as defined below, the number of shares subject to each stock
option and Stock Award, the exercise price of each Non-Statutory Stock Option,
whether Stock Options may be exercised by delivering other shares of Common
Stock, and when Stock Options become exercisable or Stock Awards vest. Only
employees may receive grants of Incentive Stock Options. Therefore, under the
Stock-Based Incentive Plan, directors may receive only grants of Non-Statutory
Stock Options. If such plan is adopted within one year after conversion, OTS
regulations provide that no individual officer or employee of the Bank may
receive more than 25% of the stock options available under the Stock-Based
Incentive Plan (or any separate plan for officers and employees) and non-
employee directors may not receive more than 5% individually, or 30% in the
aggregate, of
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the stock options available under the Stock-Based Incentive Plan (or any
separate plan for directors). OTS regulations also provide that no individual
officer or employee of the Bank may receive more than 25% of the restricted
stock awards available under the Stock-Based Incentive Plan (or any separate
plan for officers and employees) and non-employee directors may not receive
more than 5% individually, or 30% in the aggregate, of the restricted stock
awards available under the Stock-Based Incentive Plan (or any separate plan
for directors).
The Stock-Based Incentive Plan will provide for the grant of: (i) Stock
Options intended to qualify as incentive Stock Options under Section 422 of
the Code ("Incentive Stock Options"); (ii) Stock Options that do not so
qualify ("Non-Statutory Stock Options"); and (iii) limited option rights
("Limited Option Rights"). Limited Option Rights are exercisable only upon a
change in control of the Bank or the Company. Subject to OTS regulations, upon
exercise of Limited Option Rights, the recipient will be entitled to receive a
lump sum cash payment equal to the difference between the exercise price of
any unexercised Stock Option, whether exercisable or unexercisable at such
time, and the fair market value of the shares of Common Stock subject to the
Stock Option on the date of exercise of the right in lieu of purchasing the
Common Stock underlying the Stock Option. It is anticipated that all Stock
Options granted contemporaneously with stockholder approval of the Stock-Based
Incentive Plan will qualify as Incentive Stock Options to the extent permitted
under Section 422 of the Code. Unless sooner terminated, the Stock-Based
Incentive Plan will be in effect for a period of ten years from the earlier of
adoption by the Board of Directors or approval by the Company's Stockholders.
Subject to stockholder approval, the Company intends to grant Stock Options
with Limited Option Rights under the plan at an exercise price equal to at
least the fair market value of the underlying Common Stock on the date of
grant.
An individual will not be deemed to have received taxable income upon the
grant or exercise of any Incentive Stock Option, provided that such shares
received through the exercise of such option are not disposed of by the
employee for at least one year after the date the stock is received in
connection with the stock option exercise and two years after the date of
grant of the stock option (a "disqualifying disposition"). No compensation
deduction will be available to the Company as a result of the grant or
exercise of Incentive Stock Options unless there has been a disqualifying
disposition. In the case of a Non-Statutory Stock Option and in the case of a
disqualifying disposition of an Incentive Stock Option, an individual will
realize ordinary income upon exercise of the stock option (or upon the
disqualifying disposition) in an amount equal to the amount by which the
exercise price exceeds the fair market value of the Common Stock purchased by
exercising the stock option on the date of exercise. The amount of any
ordinary income realized by an optionee upon the exercise of a Non-Statutory
Stock Option or due to a disqualifying disposition of an Incentive Stock
Option will be a deductible expense to the Company for tax purposes. In the
case of Limited Rights, the option holder will have to include the amount paid
to him or her upon exercise in his gross income for federal income tax
purposes in the year in which the payment is made and the Company will be
entitled to a deduction for federal income tax purposes of the amount paid.
The Stock-Based Incentive Plan will provide for the granting of Stock Awards
and Limited Stock Rights. Limited Stock Rights would be exercisable by
participants upon a change in control of the Company or Bank as described in
the plan. Subject to OTS regulations, upon the exercise of a Limited Stock
Right, the recipient will be entitled to receive a cash payment equal to the
fair market value of all unvested Stock Awards in exchange for any rights to
such unvested Stock Awards. Grants of Stock Awards and Limited Stock Rights to
officers and employees may be made in the form of base grants and/or
performance grants (the vesting of which would be contingent upon performance
goals established by the committee administering the plan). In establishing
any performance goals, the committee may utilize the annual financial results
of the Bank, actual performance of the Bank as compared to targeted goals such
as the ratio of the Bank's net worth to total assets, the Bank's return on
average assets, or such other performance standards as determined by the
committee with the approval of the Board of Directors.
When a participant becomes vested with respect to Stock Awards, the
participant will realize ordinary income equal to the fair market value of the
Common Stock at the time of vesting (unless the participant made an election
pursuant to Section 83(b) of the Code). The amount of income recognized by the
participants will be
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a deductible expense for tax purposes for the Bank. When restricted Stock
Awards become vested and shares of Common Stock are actually distributed to
participants, the participants would receive amounts equal to any accrued
dividends with respect thereto. Prior to vesting, recipients of Stock Awards
may direct the voting of the shares awarded to them. Shares not subject to
grants and shares allocated subject to the achievement of performance goals
will be voted by the trustee in proportion to the directions provided with
respect to shares subject to grants. Vested shares will be distributed to
recipients as soon as practicable following the day on which they vest.
The vesting periods for awards under the Stock-Based Incentive Plan will be
determined by the Committee administering the Plan. If the Stock-Based
Incentive Plan (or any separate plans for employees and directors) is adopted
within one year after conversion, awards would become vested and exercisable
subject to applicable OTS regulations, which such regulations require that any
awards begin vesting no earlier than one year from the date of shareholder
approval of the plan and, thereafter, vest at a rate of no more than 20% per
year and may not be accelerated except in the case of death or disability.
Stock Options could be exercisable for three months following the date on
which the employee or director ceases to perform services for the Bank or the
Company, except that in the event of death or disability, options accelerate
and become fully vested and could be exercisable for up to one year thereafter
or such longer period as determined by the Company. In the case of death or
disability, Stock Options may be exercised for a period of 12 months. However,
any Incentive Stock Options exercised more than three months following the
date the employee ceases to perform services as an employee would be treated
as a Non-Statutory Stock Option. In the event of retirement, if the optionee
continues to perform services as a director or consultant on behalf of the
Bank, the Company or an affiliate, unvested options would continue to vest in
accordance with their original vesting schedule until the optionee ceases to
serve as a consultant or director. In the event of death, disability or normal
retirement, the Company, if requested by the optionee, or the optionee's
beneficiary, could elect, in exchange for vested options, to pay the optionee,
or the optionee's beneficiary in the event of death, the amount by which the
fair market value of the Common Stock exceeds the exercise price of the
options on the date of the employee's termination of employment.
Subject to any applicable regulatory requirements, the Stock-Based Incentive
Plan (or any separate plans for employees and directors) may be amended
subsequent to the expiration of the one-year period to provide for accelerated
vesting of previously granted Stock Options or Stock Awards in the event of a
change in control of the Company or the Bank. A change in control would
generally be considered to occur when a person or group of persons acting in
concert acquires beneficial ownership of 20% or more of any class of equity
security of the Company or the Bank or in the event of a tender or exchange
offer, merger or other form of business combination, sale of all or
substantially all of the assets of the Company or the Bank or contested
election of directors which resulted in the replacement of a majority of the
Board of Directors by persons not nominated by the directors in office prior
to the contested election.
TRANSACTIONS WITH CERTAIN RELATED PERSONS
The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA")
requires that all loans or extensions of credit to executive officers and
directors must be made on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with the general public and must not involve more than the normal
risk of repayment or present other unfavorable features. In addition, loans
made to a director or executive officer in excess of the greater of $25,000 or
5% of the Bank's capital and surplus (up to a maximum of $500,000) must be
approved in advance by a majority of the disinterested members of the Board of
Directors.
Prior to FIRREA, the Bank made loans to its executive officers and Directors
which were secured by their primary residences. The rates of interest charged
by the Bank on such loans were the Bank's cost of funds. Pursuant to FIRREA,
in 1989, the Bank discontinued its practice of making such preferential loans
to its officers and Directors. However, all such pre-FIRREA preferential loans
were "grandfathered" under FIRREA. Since the enactment of FIRREA, the Bank has
not made any loans to its executive officers or Directors. The Bank intends to
implement a policy whereby it will begin to again offer loans to executive
officers and Directors. Such
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loans, as well as loans made to Bank employees, will be made on the same terms
and conditions offered to the general public. If the Bank implements a policy
of extending credit to executive officers and Directors, such policy will
provide that all such loans will be made in the ordinary course of business,
on substantially the same terms, including collateral, as those prevailing at
the time for comparable transactions with other persons and may not involve
more than the normal risk of collectibility or present other unfavorable
features. As of June 30, 1998, the Bank had $572,673 of loans to executive
officers or Directors all of which had balances of less than $60,000 as of
June 30, 1998 or were made by the Bank in the ordinary course of business with
no favorable terms and do not involve more than the normal risk of
collectibility or present unfavorable features.
The Company intends that all transactions in the future between the Company
and its executive officers, directors, holders of 10% or more of the shares of
any class of its common stock and affiliates thereof, will contain terms no
less favorable to the Company than could have been obtained by it in arm's
length negotiations with unaffiliated persons and will be approved by a
majority of independent outside directors of the Company not having any
interest in the transaction.
SUBSCRIPTIONS BY EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth the number of shares of Common Stock the
Bank's executive officers and directors propose to purchase, assuming shares
of Common Stock are issued at the minimum and maximum of the Estimated Price
Range, including the effect of shares issued to the Foundation, and that
sufficient shares will be available to satisfy their subscriptions. The table
also sets forth the total expected beneficial ownership of Common Stock as to
all directors and executive officers as a group.
<TABLE>
<CAPTION>
AT AT
THE MINIMUM THE MAXIMUM
OF THE ESTIMATED OF THE ESTIMATED
PRICE RANGE PRICE RANGE
----------------- -----------------
AS A AS A
NUMBER PERCENT NUMBER PERCENT
OF OF SHARES OF OF SHARES
NAME AMOUNT SHARES ISSUED SHARES ISSUED
---- ---------- ------- --------- ------- ---------
<S> <C> <C> <C> <C> <C>
H. Smith McKann................ $ 300,000 30,000 0.31% 30,000 0.23%
Ronald G. Beck................. 300,000 30,000 0.31 30,000 0.23
Samuel C. Harding, Jr.......... 300,000 30,000 0.31 30,000 0.23
Peggy J. Newman................ 300,000 30,000 0.31 30,000 0.23
O'Conor Ashby.................. 100,000 10,000 0.10 10,000 0.08
Ernest N. Donahoe, Jr.......... 100,000 10,000 0.10 10,000 0.08
DuVal Q. Hicks, Jr............. 300,000 30,000 0.31 30,000 0.23
Charles S. Rowe................ 300,000 30,000 0.31 30,000 0.23
William M. Anderson, Jr........ 10,000 1,000 0.01 1,000 0.01
---------- ------- ---- ------- ----
All Directors and Executive
Officers as a Group (9
persons)...................... $2,010,000 201,000 2.07% 201,000 1.55%
========== ======= ==== ======= ====
</TABLE>
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THE CONVERSION
THE BOARD OF DIRECTORS OF THE BANK AND THE OTS HAVE APPROVED THE PLAN OF
CONVERSION, SUBJECT TO APPROVAL BY THE MEMBERS OF THE BANK ENTITLED TO VOTE ON
THE MATTER AND THE SATISFACTION OF CERTAIN OTHER CONDITIONS. SUCH OTS
APPROVAL, HOWEVER, DOES NOT CONSTITUTE A RECOMMENDATION OR ENDORSEMENT OF THE
PLAN BY SUCH AGENCY. THE OTS NEITHER APPROVED NOR DISAPPROVED THE
ESTABLISHMENT OF THE FOUNDATION.
GENERAL
On July 14, 1998, the Bank's Board of Directors unanimously adopted the
Plan, which was subsequently amended, pursuant to which the Bank will be
converted from a federally-chartered mutual savings and loan association to a
federally-chartered capital stock savings bank. It is currently intended that
all of the outstanding capital stock of the Bank will be held by the Company,
which is incorporated under Virginia law. The Plan was approved by the OTS,
subject to, among other things, approval of the Plan by the Bank's members. A
special meeting of members has been called for this purpose to be held on
December 17, 1998.
The Company has received approval from the OTS to become a savings and loan
holding company and to acquire all of the common stock of the Bank to be
issued in the Conversion. The Company plans to purchase the shares of issued
and outstanding capital stock of the Bank in exchange for up to 50% of the net
proceeds and retain the remaining net proceeds. The Conversion will be
effected only upon completion of the sale of all of the shares of Common Stock
of the Company to be issued pursuant to the Plan.
The Plan provides generally that (i) the Bank will convert from a mutual
savings and loan association to a capital stock savings bank and (ii) the
Company will offer shares of Common Stock for sale in the Subscription
Offering to the Bank's Eligible Account Holders, the ESOP, Supplemental
Eligible Account Holders and Other Members. Upon completion of the
Subscription Offering, the Company will offer any shares of Common Stock not
subscribed for in the Subscription Offering in a Community Offering with
preference given to natural persons residing in the Bank's Local Community. It
is anticipated that shares not subscribed for in the Subscription and
Community Offerings will be offered for sale by the Company to the general
public in a Syndicated Community Offering. The Bank has the right to accept or
reject, in whole or in part, any orders to purchase shares of the Common Stock
received in the Community Offering or in the Syndicated Community Offering.
See "--Community Offering" and "--Syndicated Community Offering."
The aggregate price of the shares of Common Stock to be issued in the
Conversion within the Estimated Price Range, currently estimated to be between
$89.8 million and $121.4 million, will be determined based upon an independent
appraisal of the estimated pro forma market value of the Common Stock of the
Company. All shares of Common Stock to be issued and sold in the Conversion
will be sold at the same price. The independent appraisal will be affirmed or,
if necessary, updated at the completion of the Subscription Offering, if all
shares are subscribed for, or at the completion of the Community and/or the
Syndicated Community Offerings. The appraisal has been performed by FinPro, a
consulting firm experienced in the valuation and appraisal of savings
institutions. See "--Stock Pricing" for additional information as to the
determination of the estimated pro forma market value of the Common Stock.
THE FOLLOWING IS A BRIEF SUMMARY OF THE MATERIAL ASPECTS OF THE CONVERSION.
THE SUMMARY IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE PROVISIONS OF THE
PLAN. A COPY OF THE PLAN IS AVAILABLE FOR INSPECTION AT EACH OFFICE OF THE
BANK AND AT THE SOUTHEAST REGIONAL AND WASHINGTON, D.C. OFFICES OF THE OTS.
PURPOSES OF CONVERSION
The Bank, as a federally-chartered mutual savings and loan association, does
not have shareholders and has no authority to issue capital stock. By
converting to the capital stock form of organization, the Bank will be
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structured in the form used by commercial banks, other business entities and a
growing number of savings institutions. The Conversion will enhance the Bank's
ability to access capital markets, expand its current operations, acquire
other financial institutions or branch offices, provide affordable home
financing opportunities to the communities it serves or diversify into other
financial services to the extent allowable by applicable law and regulation.
The holding company form of organization will provide additional flexibility
to diversify the Bank's business activities through existing or newly formed
subsidiaries, or through acquisitions of or mergers with both mutual and stock
institutions, as well as other companies. Although there are no current
arrangements, understandings or agreements regarding any such opportunities,
the Company will be in a position after the Conversion, subject to regulatory
limitations and the Company's financial position, to take advantage of any
such opportunities that may arise.
The potential impact of the Conversion upon the Bank's capital base is
significant. At June 30, 1998, the Bank had retained earnings, determined in
accordance with GAAP, of $83.5 million, or 17.7% of total assets. Assuming
that the Company uses 50% of the net proceeds at the maximum of the Estimated
Price Range to purchase the capital stock of the Bank, the Bank's GAAP capital
will increase to $127.5 million or a ratio of GAAP capital to adjusted assets,
on a pro forma basis, of 24.7% after the Conversion. The investment of the net
proceeds from the sale of the Common Stock is expected to provide the Bank
with additional income to increase further its capital position.
After completion of the Conversion, the unissued common and preferred stock
authorized by the Company's Articles of Incorporation will permit the Company,
subject to market conditions and regulatory approval of an offering, to raise
additional equity capital through further sales of securities and to issue
securities in connection with possible acquisitions. At the present time, the
Company has no plans with respect to additional offerings of securities, other
than the issuance of additional shares upon exercise of stock options under
the Stock-Based Incentive Plan or the possible issuance of authorized but
unissued shares to fund the Stock-Based Incentive Plan. Following the
Conversion, the Company will also be able to use stock-based incentive
programs to attract and retain executive and other personnel for itself and
its subsidiaries. See "Management of the Bank--Executive Compensation."
ESTABLISHMENT OF THE CHARITABLE FOUNDATION
General. In furtherance of the Bank's long-standing commitment to its local
community, the Bank's Plan of Conversion provides for the establishment of a
charitable foundation in connection with the Bank's Conversion. The Plan
provides that the Bank and the Company will establish the Foundation, which
will be incorporated under Delaware law as a non-stock corporation, and will
fund the Foundation with Common Stock of the Company, as further described
below. The Company and the Bank believe that the funding of the Foundation
with Common Stock of the Company is a means of establishing a common bond
between the Bank and the communities in which the Bank operates and thereby
enables such communities to share in the potential growth and success of the
Company and the Bank over the long term. By further enhancing the Bank's
visibility and reputation in the communities in which it operates, the Bank
believes that the Foundation will enhance the long-term value of the Bank's
community banking franchise.
The Foundation will be dedicated to the promotion of charitable purposes
within the communities in which the Bank operates, including, but not limited
to, providing grants or donations to support housing assistance, not-for-
profit medical facilities, community groups and other types of organizations
or projects. Establishment of the Foundation is subject to the approval of a
majority of the total outstanding votes of the Bank's members eligible to be
cast at the Special Meeting. The Foundation will be considered as a separate
matter from approval of the Plan of Conversion. If the Bank's members approve
the Plan of Conversion, but not the Foundation, the Bank intends to complete
the Conversion without the establishment of the Foundation. Failure to approve
the establishment of the Foundation may materially affect the pro forma market
value of the Common Stock. See "Comparison of Valuation and Pro Forma
Information With No Foundation." In such an event, the Bank may
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establish a new Estimated Price Range and commence a resolicitation of
subscribers. In the event of a resolicitation, unless an affirmative response
is received within a specified period of time, all funds will be promptly
returned to investors, as described elsewhere herein. See "--Stock Pricing."
Purpose of the Foundation. The purpose of the Foundation is to provide
funding to support charitable purposes within the communities in which the
Bank operates. The Bank has long emphasized community lending and community
development activities and currently has a "Satisfactory" CRA rating. The
Foundation is being formed as a complement to the Bank's existing community
activities, not as a replacement for such activities. The Bank intends to
continue to emphasize community lending and community development activities
following the Conversion. However, such activities are not the Bank's sole
corporate purpose. The Foundation, conversely, will be completely dedicated to
community activities and the promotion of charitable causes and may be able to
support such activities in ways that are not presently available to the Bank.
The Bank believes that the Foundation will enable the Company and the Bank to
assist their local community in areas beyond community development and
lending. In this regard, the Board of Directors believes the establishment of
a charitable foundation is consistent with the Bank's commitment to community
service. The Boards of Directors of the Bank and Company also believe that the
funding of the Foundation with Common Stock of the Company is a means of
enabling the communities in which the Bank operates to share in the potential
growth and success of the Company long after completion of the Conversion. The
Foundation accomplishes that goal by providing for continued ties between the
Foundation and Bank, thereby forming a partnership with the Bank's community.
The establishment of the Foundation would also enable the Company and the Bank
to develop a unified charitable donation strategy and would centralize the
responsibility for administration and allocation of corporate charitable
funds. The Bank, however, does not expect the contribution to the Foundation
to take the place of the Bank's traditional community lending and charitable
activities. The Bank expects in future periods to continue making its ordinary
charitable contributions within its communities. Such ordinary contributions
typically range between $75,000 and $100,000 per year.
Structure of the Foundation. The Foundation will be incorporated under
Delaware law as a non-stock corporation. Pursuant to the Foundation's bylaws,
the Foundation's board of directors will be comprised of five members. For a
period of five years, the Foundation will reserve one board seat for an
individual who is not an officer and/or director of the Company or the Bank
and who is a civic or community leader within Fredericksburg, Virginia or its
neighboring communities and is not an associate of any officer or director of
the Company or the Bank and for that same period of time will reserve one seat
for a director or officer of the Bank. A person who is a director, officer or
employee of the Bank, or has the power to direct its management or policies,
or otherwise owes a fiduciary duty to the Bank, and who will also serve as a
director or employee of the Foundation would be subject to the requirements of
OTS Conflicts of Interest Regulations. Four of the five board seats will be
filled by Messrs. Anderson, Harding and Hicks and Ms. Newman. Such persons
intend to purchase 1,000, 30,000, 30,000 and 30,000 shares of Common Stock in
the Conversion, respectively. At the maximum of the Estimated Price Range,
such purchases equal 0.01%, 0.23%, 0.23% and 0.23%, respectively, or 0.70% in
the aggregate, of the total number of shares to be issued in the Conversion,
including shares issued to the Foundation. The remaining board seat will be
filled by a community member. On an on-going basis, a Nominating Committee of
the board of directors of the Foundation, will nominate individuals eligible
for election to the board of directors of the Foundation. The members of the
Foundation, who are comprised of its board members, will elect the directors
at the annual meeting of the Foundation from those nominated by the Nominating
Committee. Only persons serving as directors of the Foundation qualify as
members of the Foundation with voting authority. Directors will be divided
into three classes with each class appointed for three-year terms. The
certificate of incorporation of the Foundation provides that the corporation
is organized exclusively for charitable purposes as set forth in Section
501(c)(3) of the Code. The Foundation's certificate of incorporation further
provides that no part of the net earnings of the Foundation will inure to the
benefit of, or be distributable to its directors, officers or members.
The authority for the affairs of the Foundation will be vested in the board
of directors of the Foundation. The directors of the Foundation will be
responsible for establishing the policies of the Foundation with respect
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to grants or donations by the Foundation, consistent with the stated purposes
for which the Foundation was established. Although no formal policy governing
Foundation grants exists at this time, the Foundation's board of directors
will adopt such a policy upon establishment of the Foundation. The directors
will also be responsible for directing the assets of the Foundation. Pursuant
to the terms of the contribution as mandated by the OTS, all shares of Common
Stock held by the Foundation must be voted in the same ratio as all other
shares of the Company's Common Stock on all proposals considered by
stockholders of the Company; provided, however, that the OTS will waive this
voting restriction under certain circumstances if compliance with the
restriction would: (i) cause a violation of the law of the State of Delaware
and the OTS determines that federal law would not preempt the application of
the laws of the State of Delaware to the Foundation; (ii) cause the Foundation
to lose its tax-exempt status or otherwise have a material and adverse tax
consequence on the Foundation; or (iii) cause the Foundation to be subject to
an excise tax under Section 4941 of the Code. In order for the OTS to waive
such voting restriction, the Company's or the Foundation's legal counsel must
render an opinion satisfactory to OTS that compliance with the voting
restriction would have the effect described in clauses (i), (ii) or (iii)
above. Under those circumstances, the OTS will grant a waiver of the voting
restriction upon submission of such legal opinion(s) by the Company or the
Foundation. In the event that the OTS waived the voting restriction, the
directors would direct the voting of the Common Stock held by the Foundation.
However, a condition to the OTS approval of the Conversion provides that in
the event such voting restriction is waived or becomes unenforceable, the
Director of the OTS, or his designees, at that time may impose conditions on
the composition of the board of directors of the Foundation or such other
conditions or restrictions relating to the control of the Common Stock held by
the Foundation, any of which could limit the ability of the board of directors
of the Foundation to control the voting of the Common Stock held by the
Foundation. There will be no agreements or understandings with directors of
the Foundation regarding the exercise of control, directly or indirectly, over
the management or policies of the Company or the Bank, including agreements
related to voting, acquisition or disposition of the Company's stock. As
directors of a nonprofit corporation, directors of the Foundation will at all
times be bound by their fiduciary duty to advance the Foundation's charitable
goals, to protect the assets of the Foundation and to act in a manner
consistent with the charitable purpose for which the Foundation is
established.
The Company will provide office space and administrative support services to
the Foundation. Initially, the Foundation is expected to have no employees.
The board of directors of the Foundation will appoint such officers as may be
necessary to manage the operations of the Foundation. It is anticipated that
initially such officers will be selected from the board of directors of the
Foundation. Any transaction between the Bank and the Foundation will comply
with the affiliate transaction restrictions set forth in Sections 23A and 23B
of the Federal Reserve Act, as amended.
The Company and the Bank determined to fund the Foundation with Common Stock
rather than cash because it desired to form a bond with its community in a
manner that would allow the community to share in the potential growth and
success of the Company and the Bank over the long term. The funding of the
Foundation with stock also provides the Foundation with a potentially larger
endowment than if the Company contributed cash to the Foundation since, as a
shareholder, the Foundation will share in the potential growth and success of
the Company. As such, the contribution of stock to the Foundation has the
potential to provide a self-sustaining funding mechanism which reduces the
amount of cash that the Company, if it were not making the stock contribution,
would have to contribute to the Foundation in future years in order to
maintain a level amount of charitable grants and donations.
The Foundation will receive working capital from any dividends that may be
paid on the Common Stock in the future and, subject to applicable federal and
state laws, loans collateralized by the Common Stock or from the proceeds of
the sale of any of the Common Stock in the open market from time-to-time as
may be permitted to provide the Foundation with additional liquidity. As a
private foundation under Section 501(c)(3) of the Code, the Foundation will be
required to distribute annually in grants or donations, a minimum of 5% of the
average fair market value of its net investment assets. One of the conditions
imposed on the gift of Common Stock by the Company is that the amount of
Common Stock that may be sold by the Foundation in any one year shall not
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exceed 5% of the average market value of the assets held by the Foundation,
except where the board of directors of the Foundation determines that the
failure to sell an amount of Common Stock greater than such amount would
result in a long-term reduction of the value of the Foundation's assets or
would otherwise jeopardize the Foundation's capacity to carry out its
charitable purposes. While there may be greater risk associated with a one-
stock portfolio in comparison to a diversified portfolio, the Company believes
any such risk is mitigated by the ability of the Foundation's directors to
sell more than 5% of its stock in such circumstances. Upon completion of the
Conversion and the contribution of shares to the Foundation immediately
following the Conversion, the Company would have 9,694,080, 11,404,800 and
13,115,520 shares issued and outstanding at the minimum, midpoint and maximum,
respectively, of the Estimated Price Range. Because the Company will have an
increased number of shares outstanding, the voting and ownership interests of
shareholders in the Company's common stock would be diluted by 7.4%, as
compared to their interests in the Company if the Foundation was not
established. For additional discussion of the dilutive effect, see "Comparison
of Valuation and Pro Forma Information With No Foundation" and "Pro Forma
Data."
Comparison of Valuation and Other Factors Assuming the Foundation is Not
Established as Part of the Conversion. The Company proposes to capitalize the
Foundation with Common Stock in an amount up to 8% of the total amount of
Common Stock sold in connection with the Conversion. At the minimum, midpoint,
maximum and 15% above the maximum of the Estimated Price Range, the
contribution to the Foundation would equal 718,080, 844,800, 971,520 and
1,117,248 shares, respectively, which would have a market value of $7.2
million, $8.4 million, $9.7 million and $11.2 million, respectively, based on
the Purchase Price of $10.00 per share. Such contribution, once made, will not
be recoverable by the Company or the Bank. As a result of the establishment of
the Foundation, the Estimated Price Range, as estimated by FinPro, has
decreased and the amount of stock available for sale in the Offerings has also
correspondingly decreased. The amount of the decrease is 1,394,000, 1,640,000,
1,886,000 and 2,168,900 shares, or $13.9 million, $16.4 million, $18.9 million
and $21.7 million, at the minimum, midpoint, maximum and 15% above the maximum
of the Estimated Price Range, respectively. See "Pro Forma Data" and
"Comparison of Valuation and Pro Forma Data Information with No Foundation."
Tax Considerations. The Company and the Bank have been advised by their
independent accountants that an organization created for the above purposes
will qualify as a 501(c)(3) exempt organization under the Code and will be
classified as a private foundation rather than a public charity. A private
foundation typically receives its support from one person or one corporation
whereas a public charity receives its support from the public. The Foundation
will submit a request to the IRS to be recognized as an exempt organization
after approval of the Foundation by the Bank's members at the Special Meeting
being held to consider the Conversion. As long as the Foundation files its
application for tax-exempt status within 15 months from the date of its
organization and provided the IRS approves the application, the effective date
of the Foundation's status as a Section 501(c)(3) organization will be the
date of its organization.
A legal opinion of the OTS which addresses the establishment of charitable
foundations by savings associations opines that as a general rule funds
contributed to a charitable foundation should not exceed the deductible
limitations set forth in the Code and if an association's contributions exceed
the deductible limit, such action must be justified by the board of directors.
Under the Code, the Company may deduct up to 10% of its taxable income in any
one year and any contributions made by the Company in excess of the deductible
amount will be deductible for federal tax purposes over each of the five
succeeding taxable years. The Company and the Bank believe that the Conversion
presents a unique opportunity to establish and fund a charitable foundation
given the substantial amount of additional capital being raised in the
Conversion. In making such a determination, the Company and the Bank
considered the dilutive impact of the Foundation on the amount of Common Stock
available to be offered for sale in the Conversion. See "Comparison of
Valuation and Pro Forma Information with No Foundation." Based on such
consideration, the Company and Bank believe that the contribution to the
Foundation in excess of the 10% annual limitation is justified given the
Bank's capital position and its earnings, the substantial additional capital
being raised in the Conversion and the potential benefits of the Foundation to
the Bank's community. In this regard, assuming the sale of the Common Stock at
the midpoint of
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the Estimated Price Range, the Company would have pro forma consolidated
capital of $176.6 million, or 31.2% of consolidated assets and the Bank's pro
forma tangible, core and risk-based capital ratios would be 23.3%, 23.3% and
40.6%, respectively. See "Regulatory Capital Compliance," "Capitalization" and
"Comparison of Valuation and Pro Forma Information with No Foundation." Thus,
the amount of the contribution will not adversely impact the financial
condition of the Company and the Bank. The Company and the Bank therefore
believe that the amount of the charitable contribution is reasonable given the
Company's and the Bank's pro forma capital positions. As such, the Company and
the Bank believe that the contribution does not raise safety and soundness
concerns.
The Company and the Bank have received an opinion of their independent
accountants that the Company's contribution of its own stock to the Foundation
will not constitute an act of self-dealing and that the Company will be
entitled to a deduction in the amount of the fair market value of the stock at
the time of the contribution, subject to a limitation based on 10% of the
Company's annual taxable income. The Company, however, would be able to carry
forward any unused portion of the deduction for five years following the year
in which the contribution is made for federal tax purposes. Thus, while the
Company expects to receive a charitable contribution deduction of
approximately $850,000 in 1998, the Company is permitted under the Code to
carry over the excess contribution over a five-year period for federal income
tax purposes. Assuming the close of the Offerings at the midpoint of the
Estimated Price Range, the Company estimates that substantially all of the
deduction should be deductible over the six-year period. However, no
assurances can be made that the Company will have sufficient pre-tax income
over the five year period following the year in which the contribution is made
to fully utilize the carryover related to the excess contribution. Neither the
Company nor the Bank expect to make any further contributions to the
Foundation within the first five years following the initial contribution.
After that time, the Company and the Bank may consider future contributions to
the Foundation. Any such decisions would be based on an assessment of, among
other factors, the financial condition of the Company and the Bank at that
time, the interests of shareholders and depositors of the Company and the Bank
and the financial condition and operations of the Foundation.
Although the Company and the Bank have received an opinion of their
independent accountants that the Company is entitled to a deduction for the
charitable contribution, there can be no assurances that the IRS will
recognize the Foundation as a Section 501(c)(3) exempt organization or that
the deduction will be permitted. In such event, the Company's contribution to
the Foundation would be expensed without tax benefit, resulting in a reduction
in earnings in the year in which the IRS makes such a determination. See "Risk
Factors--Potential Negative Effects of the Foundation." In cases of willful,
flagrant or repeated acts or failures to act which result in violations of the
IRS rules governing private foundations, a private foundation's status as a
private foundation may be involuntarily terminated by the IRS. In such event,
the managers of a private foundation could be liable for excise taxes based on
such violations and the private foundation could be liable for a termination
tax under the Code. The Foundation's certificate of incorporation provides
that it shall have a perpetual existence. In the event, however, the
Foundation were subsequently dissolved as a result of a loss of its tax exempt
status, the Foundation would be required under the Code and its certificate of
incorporation to distribute any assets remaining in the Foundation at that
time for one or more exempt purposes within the meaning of Section 501(c)(3)
of the Code, or to distribute such assets to the federal government, or to a
state or local government, for a public purpose.
As a private foundation, earnings and gains, if any, from the sale of Common
Stock or other assets are exempt from federal and state corporate taxation.
However, investment income, such as interest, dividends and capital gains,
will be subject to a federal excise tax of 2.0%. The Foundation will be
required to make an annual filing with the IRS within four and one-half months
after the close of the Foundation's fiscal year to maintain its tax-exempt
status. The Foundation will be required to publish a notice that the annual
information return will be available for public inspection for a period of 180
days after the date of such public notice. The information return for a
private foundation must include, among other things, an itemized list of all
grants made or approved, showing the amount of each grant, the recipient, any
relationship between a grant recipient and the Foundation's managers and a
concise statement of the purpose of each grant.
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Regulatory Conditions Imposed on the Foundation. Establishment of the
Foundation is subject to the following conditions imposed by the OTS: (i) the
Foundation will be subject to examination by the OTS, at the Foundation's own
expense; (ii) the Foundation must comply with supervisory directives imposed
by the OTS; (iii) the Foundation will provide annual reports to the OTS
describing grants made and grant recipients; (iv) the Foundation will operate
in accordance with written policies adopted by the board of directors,
including a conflict of interest policy; (v) the Foundation will not engage in
self-dealing and will comply with all laws necessary to maintain its tax-
exempt status; (vi) any purchases of common stock by the Foundation following
the Conversion will be subject to OTS regulations on stock repurchases; and
(vii) any shares of Common Stock of the Company held by the Foundation must be
voted in the same ratio as all other shares of the Company's Common Stock on
all proposals considered by stockholders of the Company; provided, however,
that the OTS will waive this voting restriction under certain circumstances if
compliance with the voting restriction would: (a) cause a violation of the law
of the State of Delaware and the OTS determines the federal law does not
preempt the application of the laws of the State of Delaware to the
Foundation; (b) cause the Foundation to lose its tax-exempt status or
otherwise have a material and adverse tax consequence on the Foundation; or
(c) cause the Foundation to be subject to an excise tax under Section 4941 of
the Code. In order for the OTS to waive such voting restriction, the Company's
or the Foundation's legal counsel must render an opinion satisfactory to OTS
that compliance with the voting restriction would have the effect described in
clauses (a), (b) or (c) above. Under those circumstances, the OTS will grant a
waiver of the voting restriction upon submission of such opinion(s) by the
Company or the Foundation. There can be no assurances that either a legal or
tax opinion addressing these issues will be rendered, or if rendered, that the
OTS will grant an unconditional waiver of the voting restriction. In this
regard, a condition to the OTS approval of the Conversion provides that in the
event such voting restriction is waived or becomes unenforceable, the Director
of the OTS, or his designees, at that time may impose conditions on the
composition of the board of directors of the Foundation or such other
conditions or restrictions relating to the control of the Common Stock held by
the Foundation, any of which could limit the ability of the board of directors
of the Foundation to control the voting of Common Stock held by the
Foundation. In no event will the voting restriction survive the sale of shares
of the Common Stock held by the Foundation.
In addition, establishment of the Foundation is subject to the approval of a
majority of the total outstanding votes of the Bank's members eligible to be
cast at the special meeting being held to consider the Conversion. The
Foundation will be considered as a separate matter from approval of the Plan
of Conversion. If the Bank's members approve the Plan of Conversion, but not
the Foundation, the Bank intends to complete the Conversion without the
establishment of the Foundation. Failure to approve the Foundation may
materially increase the pro forma market value of the Common Stock being
offered for sale in the Offerings since the Valuation Range, as set forth
herein, takes into account the dilutive impact of the issuance of shares to
the Foundation. See "Comparison of Valuation and Pro Forma Information With No
Foundation."
EFFECTS OF CONVERSION
General. Each depositor in a mutual savings institution has both a deposit
account in the institution and a pro rata ownership interest in the net worth
of the institution based upon the balance in his or her account, which
interest may only be realized in the event of a liquidation of the institution
or in the event the institution declares a capital distribution to depositors,
subject to applicable regulations of the OTS. However, this ownership interest
is tied to the depositor's account and has no tangible market value separate
from such deposit account. Any depositor who opens a deposit account obtains a
pro rata ownership interest in the net worth of the institution without any
additional payment beyond the amount of the deposit. A depositor who reduces
or closes his account receives a portion or all of the balance in the account
but nothing for his ownership interest in the net worth of the institution,
which is lost to the extent that the balance in the account is reduced.
Consequently, mutual savings institution depositors normally have no way to
realize the value of their ownership interest, which has realizable value only
in the unlikely event that the mutual savings institution is liquidated or in
the event the institution declares a capital distribution to depositors,
subject to applicable regulations of the OTS. In such event, the depositors of
record at that time, as owners, would share pro rata in
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any residual surplus and reserves after other claims, including claims of
depositors to the amounts of their deposits, are paid.
When a mutual savings institution converts to stock form, permanent
nonwithdrawable capital stock is created to represent the ownership of the
institution's net worth. THE COMMON STOCK IS SEPARATE AND APART FROM DEPOSIT
ACCOUNTS AND CANNOT BE AND IS NOT INSURED BY THE FDIC OR ANY OTHER
GOVERNMENTAL AGENCY. Certificates are issued to evidence ownership of the
capital stock. The stock certificates are transferable and, therefore, the
stock may be sold or traded if a purchaser is available with no effect on any
account the seller may hold in the institution.
Continuity. While the Conversion is being accomplished, the normal business
of the Bank of accepting deposits and making loans will continue without
interruption. The Bank will continue to be subject to regulation by the OTS
and the FDIC. After the Conversion, the Bank will continue to provide services
for depositors and borrowers under current policies by its present management
and staff.
The Directors serving the Bank at the time of Conversion will serve
initially as Directors of the Bank after the Conversion. The Directors of the
Company will consist initially of individuals currently serving on the Board
of Directors of the Bank. All officers of the Bank at the time of Conversion
will retain their positions immediately after Conversion.
Effect on Deposit Accounts. Under the Plan, each depositor in the Bank at
the time of Conversion will automatically continue as a depositor after the
Conversion and each such deposit account will remain the same with respect to
deposit balance, interest rate and other terms. Each such account will be
insured by the FDIC to the same extent as before the Conversion (i.e., up to
$100,000 per depositor). Depositors will continue to hold their existing
certificates, passbooks and other evidences of their accounts.
Effect on Loans. No loan outstanding from the Bank will be affected by the
Conversion and the amount, interest rate, maturity and security for each loan
will remain as they were contractually fixed prior to the Conversion.
Effect on Voting Rights of Members. At present, all depositors and certain
borrowers of the Bank are members of, and have voting rights in, the Bank as
to all matters requiring membership action. Upon Conversion, depositors and
borrowers will cease to be members and will no longer be entitled to vote at
meetings of the Bank. Upon Conversion, all voting rights in the Bank will be
vested in the Company as the sole stockholder of the Bank. Exclusive voting
rights with respect to the Company will be vested in the holders of Common
Stock. Depositors and borrowers of the Bank will not have voting rights after
the Conversion except to the extent that they become stockholders of the
Company through the purchase of Common Stock.
Tax Effects. The Bank has received an opinion from Muldoon, Murphy &
Faucette with regard to federal income taxation and an opinion from Cherry,
Bekaert & Holland, L.L.P. with regard to Virginia taxation which provide that
the adoption and implementation of the Plan of Conversion set forth herein
will not be taxable for federal or Virginia tax purposes to the Bank, its
Eligible Account Holders, or its Supplemental Eligible Account Holders or the
Company, except as discussed below. See "--Tax Aspects."
Effect on Liquidation Rights. If a mutual savings institution were to
liquidate, all claims of creditors (including those of depositors, to the
extent of deposit balances) would be paid first. Thereafter, if there were any
assets remaining, depositors would be entitled to such remaining assets, pro
rata, based upon the deposit balances in their deposit accounts immediately
prior to liquidation. In the unlikely event that the Bank were to liquidate
after Conversion, all claims of creditors (including those of depositors, to
the extent of their deposit balances) would also be paid first, followed by
distribution of the "liquidation account" to certain depositors (see "--
Liquidation Rights"), with any assets remaining thereafter distributed to the
Company as the holder of the Bank's capital stock. Pursuant to the rules and
regulations of the OTS, a post-Conversion merger, consolidation, sale of bulk
assets or similar combination or transaction with another insured savings
institution
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would not be considered a liquidation and, in such a transaction, the
liquidation account would be assumed by the surviving institution.
STOCK PRICING
The Plan of Conversion requires that the aggregate purchase price of the
Common Stock must be based on the appraised pro forma market value of the
Common Stock, as determined on the basis of an independent valuation. The Bank
and the Company have retained FinPro to make such valuation. For its services
in making such appraisal, FinPro will receive a fee of $31,000, plus
reasonable expenses. The Bank and the Company have agreed to indemnify FinPro
and its employees and affiliates against certain losses (including any losses
in connection with claims under the federal securities laws) arising out of
its services as appraiser, except where FinPro liability results from its
negligence or willful misconduct.
An appraisal has been made by FinPro in reliance upon the information
contained in this Prospectus, including the Financial Statements. FinPro also
considered the following factors, among others: the present and projected
operating results and financial condition of the Company and the Bank and the
economic and demographic conditions in the Bank's existing marketing area;
certain historical, financial and other information relating to the Bank; a
comparative evaluation of the operating and financial statistics of the Bank
with those of other similarly situated publicly-traded savings banks and
savings institutions; the aggregate size of the offering of the Common Stock;
the impact of the Conversion on the Bank's net worth and earnings potential;
the proposed dividend policy of the Company and the Bank; and the trading
market for securities of comparable institutions and general conditions in the
market for such securities.
On the basis of the foregoing, FinPro has advised the Company and the Bank
that, in its opinion, dated September 9, 1998, the estimated pro forma market
value of the Common Stock being sold in connection with the Conversion ranged
from a minimum of $89.8 million to a maximum of $121.4 million with a midpoint
of $105.6 million. Based upon the Valuation Range and the Purchase Price of
$10.00 per share for the Common Stock established by the Board of Directors,
the Board of Directors has established the Estimated Price Range of $89.8
million to $121.4 million, with a midpoint of $105.6 million, based on the
issuance of 8,976,000 to 12,144,000 shares of Common Stock. The Board of
Directors of the Company and the Bank have reviewed the appraisal of FinPro
and in determining the reasonableness and adequacy of such appraisal
consistent with OTS regulations and policies, have reviewed the methodology
and reasonableness of the assumptions utilized by FinPro in the preparation of
such appraisal. The Estimated Price Range may be amended with the approval of
the OTS (if required), if necessitated by subsequent developments in the
financial condition of the Company or the Bank or market conditions generally.
SUCH APPRAISAL, HOWEVER, IS NOT INTENDED, AND MUST NOT BE CONSTRUED, AS A
RECOMMENDATION OF ANY KIND AS TO THE ADVISABILITY OF PURCHASING COMMON STOCK
IN THE OFFERINGS. FINPRO DID NOT INDEPENDENTLY VERIFY THE FINANCIAL STATEMENTS
AND OTHER INFORMATION PROVIDED BY THE BANK, NOR DID FINPRO VALUE INDEPENDENTLY
THE ASSETS OR LIABILITIES OF THE BANK. THE APPRAISAL CONSIDERS THE BANK AS A
GOING CONCERN AND SHOULD NOT BE CONSIDERED AS AN INDICATION OF THE LIQUIDATION
VALUE OF THE BANK. MOREOVER, BECAUSE SUCH APPRAISAL IS NECESSARILY BASED UPON
ESTIMATES AND PROJECTIONS OF A NUMBER OF MATTERS, ALL OF WHICH ARE SUBJECT TO
CHANGE FROM TIME-TO-TIME, NO ASSURANCE CAN BE GIVEN THAT PERSONS PURCHASING
COMMON STOCK IN THE CONVERSION WILL THEREAFTER BE ABLE TO SELL COMMON STOCK AT
PRICES AT OR ABOVE THE PURCHASE PRICE OR IN THE RANGE OF THE FOREGOING
VALUATION OF THE PRO FORMA MARKET VALUE THEREOF. SEE "RISK FACTORS--ABSENCE OF
MARKET FOR COMMON STOCK."
Prior to the completion of the Conversion, the maximum of the Estimated
Price Range may be increased up to 15% and the number of shares of Common
Stock to be issued in the Conversion may be increased to 13,965,600 shares due
to regulatory considerations, changes in the market and general financial and
economic conditions, without the resolicitation of subscribers. See "--
Limitations on Common Stock Purchases" as to the method of distribution and
allocation of additional shares that may be issued in the event of an increase
in the Estimated Price Range to fill unfilled orders in the Subscription
Offering.
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No sale of shares of Common Stock may be consummated unless, prior to such
consummation, FinPro confirms to the Bank and the OTS that, to the best of its
knowledge, nothing of a material nature has occurred which, taking into
account all relevant factors, would cause FinPro to conclude that the value of
the Common Stock at the price so determined is incompatible with its estimate
of the pro forma market value of the Common Stock at the conclusion of the
Conversion.
If the pro forma market value of the Common Stock is either more than 15%
above the maximum of the Estimated Price Range or less than the minimum of the
Estimated Price Range, the Bank and the Company, after consulting with the
OTS, may terminate the Plan and return all funds promptly with interest at the
Bank's passbook rate of interest on payments made by check, bank draft or
money order, extend or hold a new Subscription and/or Community Offering,
establish a new Estimated Price Range, commence a resolicitation of
subscribers or take such other actions as permitted by the OTS in order to
complete the Conversion. In the event that a resolicitation is commenced,
unless an affirmative response is received within a reasonable period of time,
all funds will be promptly returned to investors as described above. A
resolicitation, if any, following the conclusion of the Subscription Offering
would not exceed 45 days unless further extended by the OTS for periods of up
to 90 days not to extend beyond December 17, 2000.
If the minimum number of shares of Common Stock are not sold through the
Subscription Offering or Community Offering, then the Bank and the Company
expect to offer the remaining shares in a Syndicated Community Offering which
would occur as soon as practicable following the close of the Community
Offering. All shares of Common Stock will be sold at the same price per share
in the Syndicated Community Offering as in the Subscription and Community
Offerings. See "--Syndicated Community Offering."
No sale of shares of Common Stock may be consummated unless, prior to such
consummation, FinPro confirms to the Bank, the Company and the OTS that, to
the best of its knowledge, nothing of a material nature has occurred which,
taking into account all relevant factors, including those which would be
involved in a cancellation of the Syndicated Community Offering, would cause
FinPro to conclude that the aggregate value of the Common Stock at the
Purchase Price is incompatible with its estimate of the pro forma market value
of the Common Stock of the Company at the time of the Syndicated Community
Offering. Any change which would result in an aggregate purchase price which
is below or more than 15% above the Estimated Price Range would be subject to
OTS approval. If such confirmation is not received, the Bank may extend the
Conversion, extend, reopen or commence new Subscription Offering, Community
Offering or Syndicated Community Offering, establish a new Estimated Price
Range and commence a resolicitation of all subscribers with the approval of
the OTS or take such other actions as permitted by the OTS in order to
complete the Conversion, or terminate the Plan and cancel the Subscription and
Community Offerings and/or the Syndicated Community Offering. In the event
market or financial conditions change so as to cause the aggregate purchase
price of the shares to be below the minimum of the Estimated Price Range or
more than 15% above the maximum of such range and the Company and the Bank
determine to continue the Conversion, subscribers will be resolicited (i.e.,
be permitted to continue their orders, in which case they will need to
affirmatively reconfirm their subscriptions prior to the expiration of the
resolicitation offering or their subscription funds will be promptly refunded
with interest at the Bank's passbook rate of interest, or be permitted to
decrease or cancel their subscriptions). Any change in the Estimated Price
Range must be approved by the OTS. A resolicitation, if any, following the
conclusion of the Subscription Offering would not exceed 45 days, or if
following the Syndicated Community Offering, 90 days, unless further extended
by the OTS for periods up to 90 days not to extend beyond December 17, 2000.
If such resolicitation is not effected, the Bank will return all funds
promptly with interest at the Bank's passbook rate of interest on payments
made by check, bank draft or money order.
Copies of the appraisal report of FinPro, including any amendments thereto
and the detailed memorandum of the appraiser setting forth the method and
assumptions for such appraisal are available for inspection at the main office
of the Bank and the other locations specified under "Additional Information."
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NUMBER OF SHARES TO BE ISSUED
Depending upon market or financial conditions following the commencement of
the Subscription Offering, the total number of shares to be issued in the
Conversion may be increased or decreased without a resolicitation of
subscribers, provided that the product of the total number of shares times the
price per share is not below the minimum of the Estimated Price Range or more
than 15% above the maximum of the Estimated Price Range. Based on a fixed
purchase price of $10.00 per share and FinPro's estimate of the pro forma
market value of the Common Stock ranging from a minimum of $89.8 million to a
maximum, as increased by 15%, of $139.7 million, the number of shares of
Common Stock expected to be issued in the Conversion is between a minimum of
8,976,000 shares and a maximum, as adjusted by 15%, of 13,965,600 shares. The
actual number of shares issued between this range will depend on a number of
factors and shall be determined by the Bank and Company subject to OTS
approval, if necessary.
In the event market or financial conditions change so as to cause the
aggregate purchase price of the shares to be below the minimum of the
Estimated Price Range or more than 15% above the maximum of the Estimated
Price Range, if the Plan is not terminated by the Company and the Bank after
consultation with the OTS, purchasers will be resolicited (i.e., permitted to
continue their orders, in which case they will need to affirmatively reconfirm
their subscriptions prior to the expiration of the resolicitation offering or
their subscription funds will be promptly refunded, or be permitted to modify
or rescind their subscriptions). Any change in the Estimated Price Range must
be approved by the OTS. If the number of shares issued in the Conversion is
increased due to an increase of up to 15% in the Estimated Price Range to
reflect changes in market or financial condition, persons who subscribed for
the maximum number of shares will not be given the opportunity to subscribe
for an adjusted maximum number of shares, except for the ESOP which will be
able to subscribe for such adjusted amount. See "--Limitations on Common Stock
Purchases."
In the event the members of the Bank approve the establishment of the
Foundation, the number of shares to be issued and outstanding following the
Conversion will be increased by a number of shares up to 8% of the Common
Stock sold in the Conversion to fund the Foundation. Assuming the sale of
shares in the Offerings at the maximum of the Estimated Price Range, the
Company will issue 971,520 shares of its Common Stock from authorized but
unissued shares to the Foundation immediately following the completion of the
Conversion. In that event, the Company will have total shares of Common Stock
outstanding of 13,115,520 shares. Of that amount, the Foundation will own
7.4%. Funding the Foundation with authorized but unissued shares will have the
effect of diluting the ownership and voting interests of persons purchasing
shares in the Conversion by 7.4% since a greater number of shares will be
outstanding upon completion of the Conversion than would be if the Foundation
were not established. See "Pro Forma Data."
An increase in the number of shares to be issued in the Conversion as a
result of an increase in the estimated pro forma market value would decrease
both a subscriber's ownership interest and the Company's pro forma net
earnings and stockholders' equity on a per share basis while increasing pro
forma net earnings and stockholders' equity on an aggregate basis. A decrease
in the number of shares to be issued in the Conversion would increase both a
subscriber's ownership interest and the Company's pro forma net earnings and
stockholders' equity on a per share basis while decreasing pro forma net
earnings and stockholder's equity on an aggregate basis. For a presentation of
the effects of such changes, see "Pro Forma Data."
SUBSCRIPTION OFFERING AND SUBSCRIPTION RIGHTS
In accordance with the Plan of Conversion, rights to subscribe for the
purchase of Common Stock have been granted under the Plan of Conversion to the
following persons in the following order of descending priority: (1) holders
of deposit accounts including all withdrawable deposits in the Bank, including
non-interest bearing demand deposits in the Bank with a balance of $50 or more
as of June 30, 1997 ("Eligible Account Holders"); (2) the ESOP; (3) holders of
deposit accounts with a balance of $50 or more as of September 30, 1998
("Supplemental Eligible Account Holders"); and (4) members of the Bank,
consisting of depositors of the Bank as of October 31, 1998, the Voting Record
Date, and borrowers with loans outstanding as of September 2,
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1986, which continue to be outstanding as of the Voting Record Date other than
Eligible Account Holders and Supplemental Eligible Account Holders ("Other
Members"). All subscriptions received will be subject to the availability of
Common Stock after satisfaction of all subscriptions of all persons having
prior rights in the Subscription Offering and to the maximum and minimum
purchase limitations set forth in the Plan of Conversion and as described
below under "--Limitations on Common Stock Purchases."
Priority 1: Eligible Account Holders. Each Eligible Account Holder will
receive, without payment therefor, first priority, nontransferable
subscription rights to subscribe for in the Subscription Offering up to the
greater of the amount permitted to be purchased in the Community Offering
(currently $300,000 of Common Stock), one-tenth of one percent (.10%) of the
total offering of shares of Common Stock or fifteen times the product (rounded
down to the next whole number) obtained by multiplying the total number of
shares of Common Stock to be issued by a fraction of which the numerator is
the amount of the Eligible Account Holder's Qualifying Deposit (defined by the
Plan as any deposit account in the Bank with a balance of $50 or more as of
June 30, 1997) and the denominator is the total amount of Qualifying Deposits
of all Eligible Account Holders in each case on the Eligibility Record Date,
subject to the overall purchase limitation and exclusive of an increase in the
shares issued pursuant to an increase in the Estimated Price Range of up to
15%. See "--Limitations on Common Stock Purchases."
In the event that Eligible Account Holders exercise subscription rights for
a number of shares of Conversion Stock in excess of the total number of such
shares eligible for subscription, the shares of Conversion Stock shall be
allocated among the subscribing Eligible Account Holders so as to permit each
subscribing Eligible Account Holder, to the extent possible, to purchase a
number of shares sufficient to make his or her total allocation of Conversion
Stock equal to the lesser of 100 shares or the number of shares subscribed for
by the Eligible Account Holder. Any shares remaining after that allocation
will be allocated among the subscribing Eligible Account Holders whose
subscriptions remain unsatisfied in the proportion that the amount of the
Qualifying Deposit of each Eligible Account Holder whose subscription remains
unsatisfied bears to the total amount of the Qualifying Deposits of all
Eligible Account Holders whose subscriptions remain unsatisfied. If the amount
so allocated exceeds the amount subscribed for by any one or more Eligible
Account Holders, the excess shall be reallocated (one or more times as
necessary) among those Eligible Account Holders whose subscriptions are still
not fully satisfied on the same principle until all available shares have been
allocated or all subscriptions satisfied.
To ensure proper allocation of stock, each Eligible Account Holder must list
on his subscription order form all accounts in which he has an ownership
interest. Failure to list an account could result in less shares being
allocated than if all accounts had been disclosed. The subscription rights of
Eligible Account Holders who are also Directors or Officers of the Bank or
their associates will be subordinated to the subscription rights of other
Eligible Account Holders to the extent attributable to increased deposits in
the 12 months preceding June 30, 1997.
Priority 2: Employee Stock Ownership Plan. To the extent that there are
sufficient shares remaining after satisfaction of the subscriptions by
Eligible Account Holders, the ESOP will receive, without payment therefor,
second priority, nontransferable subscription rights to purchase, in the
aggregate, up to 10% of Common Stock issued in the Conversion, including
shares issued to the Foundation, and any increase in the number of shares of
Common Stock to be issued in the Conversion after the date hereof as a result
of an increase of up to 15% in the maximum of the Estimated Price Range. The
ESOP intends to purchase 8% of the shares to be issued in the Conversion,
including shares issued to the Foundation, or 775,526 shares and 1,049,242
shares, based on the issuance of 9,694,080 shares and 13,115,520 shares,
respectively. Subscriptions by the ESOP will not be aggregated with shares of
Common Stock purchased directly by or which are otherwise attributable to any
other participants in the Subscription and Community Offerings, including
subscriptions of any of the Bank's directors, officers, employees or
associates thereof. See "Management of the Bank--Benefits--Employee Stock
Ownership Plan and Trust."
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Priority 3: Supplemental Eligible Account Holders. Each Supplemental
Eligible Account Holder will receive, without payment therefor, third
priority, nontransferable subscription rights to subscribe for in the
Subscription Offering up to the greater of the amount permitted to be
purchased in the Community Offering (currently $300,000 of Common Stock), one-
tenth of one percent (.10%) of the total offering of shares of Common Stock or
fifteen times the product (rounded down to the next whole number) obtained by
multiplying the total number of shares of Common Stock to be issued by a
fraction of which the numerator is the amount of the Supplemental Eligible
Account Holder's Qualifying Deposit and the denominator is the total amount of
Qualifying Deposits of all Supplemental Eligible Account Holders, in each case
on the Supplemental Eligibility Record Date, subject to the overall purchase
limitation and exclusive of an increase in the shares issued pursuant to an
increase in the Estimated Price Range of up to 15%. See "--Limitations on
Common Stock Purchases."
In the event that Supplemental Eligible Account Holders exercise
subscription rights for a number of shares of Conversion Stock in excess of
the total number of such shares eligible for subscription, the shares of
Conversion Stock shall be allocated among the subscribing Supplemental
Eligible Account Holders so as to permit each subscribing Supplemental
Eligible Account Holder, to the extent possible, to purchase a number of
shares sufficient to make his or her total allocation of Conversion Stock
equal to the lesser of 100 shares or the number of shares subscribed for by
the Supplemental Eligible Account Holder. Any shares remaining after that
allocation will be allocated among the subscribing Supplemental Eligible
Account Holders whose subscriptions remain unsatisfied in the proportion that
the amount of the Qualifying Deposit of each Supplemental Eligible Account
Holder whose subscription remains unsatisfied bears to the total amount of the
Qualifying Deposits of all Supplemental Eligible Account Holders whose
subscriptions remain unsatisfied. If the amount so allocated exceeds the
amount subscribed for by any one or more Supplemental Eligible Account
Holders, the excess shall be reallocated (one or more times as necessary)
among those Supplemental Eligible Account Holders whose subscriptions are
still not fully satisfied on the same principle until all available shares
have been allocated or all subscriptions satisfied.
To ensure proper allocation of stock, each Supplemental Eligible Account
Holder must list on his subscription order form all accounts in which he has
an ownership interest. Failure to list an account could result in less shares
being allocated than if all accounts had been disclosed. The subscription
rights received by Eligible Account Holders will be applied in partial
satisfaction to the subscription rights to be received as a Supplemental
Eligible Account Holder.
Priority 4: Other Members. To the extent that there are sufficient shares
remaining after satisfaction of subscriptions by the Eligible Account Holders,
the ESOP and the Supplemental Eligible Account Holders, each Other Member will
receive, without payment therefor, fourth priority nontransferable
subscription rights to subscribe for Common Stock in the Subscription Offering
up to the greater of the amount permitted to be purchased in the Community
Offering (currently $300,000 of Common Stock), or one-tenth of one percent
(.10%) of the total offering of shares of Common Stock, subject to the overall
purchase limitation and exclusive of an increase in shares issued pursuant to
an increase in the Estimated Price Range of up to 15%.
In the event that Other Members subscribe for a number of shares of
Conversion Stock which, when added to the shares of Conversion Stock
subscribed for by the Eligible Account Holders, the Employee Plans and the
Supplemental Eligible Account Holders is in excess of the total number of
shares of Conversion Stock being issued, the subscriptions of such Other
Members will be allocated among the subscribing Other Members so as to permit
each subscribing Other Member, to the extent possible, to purchase a number of
shares sufficient to make his or her total allocation of Conversion Stock
equal to the lesser of 100 shares or the number of shares subscribed for by
the Other Member. Any shares remaining after that allocation will be allocated
among the subscribing Other Members whose subscriptions remain unsatisfied pro
rata in the same proportion that the number of votes of a subscribing Other
Member on the Voting Record Date bears to the total votes on the Voting Record
Date of all subscribing Other Members whose subscriptions remain unsatisfied.
If the amount so allocated exceeds the amount subscribed for by any one or
more remaining Other Members, the excess shall be reallocated (one or more
times as necessary) among those remaining Other Members whose subscriptions
are still not fully satisfied on the same principle until all available shares
have been allocated or all subscriptions satisfied.
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Expiration Date for the Subscription Offering. The Subscription Offering
will expire on December 15, 1998, at 12:00 noon, Eastern time, unless extended
for up to 45 days by the Bank or such additional periods with the approval of
the OTS. Subscription rights which have not been exercised prior to the
Expiration Date will become void.
The Bank will not execute orders until all shares of Common Stock have been
subscribed for or otherwise sold. If all shares have not been subscribed for
or sold within 45 days after the Expiration Date, unless such period is
extended with the consent of the OTS, all funds delivered to the Bank pursuant
to the Subscription Offering will be returned promptly to the subscribers with
interest and all withdrawal authorizations will be canceled. If an extension
beyond the 45 day period following the Expiration Date is granted, the Bank
will notify subscribers of the extension of time and of any rights of
subscribers to modify or rescind their subscriptions and have their funds
returned promptly with interest and of the time period within which
subscribers must affirmatively notify the Bank of their intention to confirm,
modify, or rescind their subscription. If an affirmative response to any
resolicitation is not received by the Company from a subscriber, such order
will be rescinded and all subscription funds will be promptly returned with
interest. Such extensions may not go beyond December 17, 2000.
COMMUNITY OFFERING
To the extent that shares remain available for purchase after satisfaction
of all subscriptions of the Eligible Account Holders, the ESOP, the
Supplemental Eligible Account Holders and Other Members, the Bank has
determined to offer shares pursuant to the Plan to certain members of the
general public. The Community Offering, if conducted, may begin concurrently
with, during or promptly after the Subscription Offering. In the event a
community offering is held, a preference will be given to natural persons
residing in the City of Fredericksburg and Stafford and Spotsylvania Counties,
subject to the right of the Company to accept or reject any such orders, in
whole or in part, in their sole discretion. Persons purchasing stock in the
Community Offering, together with associates of and persons acting in concert
with such persons, may purchase up to $300,000 of Common Stock subject to the
maximum purchase limitation and exclusive of shares issued pursuant to an
increase in the Estimated Price Range by up to 15%. See "--Limitations on
Common Stock Purchases." This amount may be increased to up to a maximum of 5%
or decreased to less than $300,000 at the sole discretion of the Company and
the Bank. THE OPPORTUNITY TO SUBSCRIBE FOR SHARES OF COMMON STOCK IN THE
COMMUNITY OFFERING CATEGORY IS SUBJECT TO THE RIGHT OF THE BANK AND THE
COMPANY, IN ITS SOLE DISCRETION, TO ACCEPT OR REJECT ANY SUCH ORDERS IN WHOLE
OR IN PART EITHER AT THE TIME OF RECEIPT OF AN ORDER OR AS SOON AS PRACTICABLE
FOLLOWING THE EXPIRATION DATE.
Subject to the foregoing, if the amount of stock remaining is insufficient
to fill the orders of Preferred Subscribers after completion of the
Subscription Offering and Community Offering, such stock will be allocated
first to each Preferred Subscriber whose order is accepted by the Bank, in an
amount equal to the lesser of 100 shares or the number of shares subscribed
for by each such Preferred Subscriber, if possible. Thereafter, unallocated
shares will be allocated among the Preferred Subscribers whose order remains
unsatisfied on a 100 shares per order basis until all such orders have been
filled or the remaining shares have been allocated. If there are any shares
remaining, shares will be allocated to other persons of the general public who
purchase in the Community Offering applying the same allocation described
above for Preferred Subscribers.
PERSONS IN NONQUALIFIED STATES OR FOREIGN COUNTRIES
The Company and the Bank will make reasonable efforts to comply with the
securities laws of all states in the United States in which persons entitled
to subscribe for stock pursuant to the Plan reside. However, the Plan provides
that the Bank and the Company are not required to offer stock in the
Subscription Offering to any person who resides in a foreign country or
resides in a state of the United States with respect to which both of the
following apply: (i) a small number of persons otherwise eligible to subscribe
for shares of Common Stock reside in such state; and (ii) the Company or the
Bank determines that compliance with the securities laws of such state would
be impracticable for reasons of cost or otherwise, including but not limited
to a request that the Company
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and the Bank or their officers, directors or trustees register as a broker,
dealer, salesman or selling agent, under the securities laws of such state, or
a request to register or otherwise qualify the subscription rights or Common
Stock for sale or submit any filing with respect thereto in such state. Where
the number of persons eligible to subscribe for shares in one state is small,
the Bank and the Company will base their decision as to whether or not to
offer the Common Stock in such state on a number of factors, including the
size of accounts held by account holders in the state, the cost of registering
or qualifying the shares or the need to register the Company, its officers,
directors or employees as brokers, dealers, salesmen or selling agents.
MARKETING AND UNDERWRITING ARRANGEMENTS
The Bank and the Company have engaged Trident as a consultant and financial
advisor in connection with the offering of the Common Stock and Trident has
agreed to use its best efforts to solicit subscriptions and purchase orders
for shares of Common Stock in the Offerings. Based upon negotiations between
the Bank and the Company concerning the fee structure, Trident will receive a
fixed fee of $525,000. In the event that a selected dealers agreement is
entered into in connection with a Syndicated Community Offering, the Bank will
pay a fee (to be negotiated at such time under such agreement) to Trident and
such selected dealers, any sponsoring dealers fees for shares sold by a
National Association of Securities Dealers, Inc. member firms pursuant to a
selected dealers agreement; provided, however, that the aggregate fees payable
to Trident and the selected dealers will not exceed 7% of the aggregate
Purchase Price of the Common Stock sold by selected dealers. Fees to Trident
and to any other broker-dealer may be deemed to be underwriting fees and
Trident and such broker-dealers may be deemed to be underwriters. Trident will
also be reimbursed for its reasonable out-of-pocket expenses incurred in its
capacity as consultant and financial advisor, as well as conversion agent,
including legal fees, in an amount not to exceed $55,000. Notwithstanding the
foregoing, in the event the Offerings are not consummated or Trident ceases,
under certain circumstances after the subscription solicitation activities are
commenced, to provide assistance to the Company, Trident will be reimbursed
for its reasonable out-of-pocket expenses as described above. The Company and
the Bank have agreed to indemnify Trident for reasonable costs and expenses in
connection with certain claims or liabilities, including certain liabilities
under the Securities Act. Trident has received advances towards its fees
totaling $10,000. See "Pro Forma Data" for the assumptions used to arrive at
these estimates.
Directors and executive officers of the Company and Bank may participate in
the solicitation of offers to purchase Common Stock. Questions of prospective
purchasers will be directed to executive officers or registered
representatives. Other employees of the Bank may participate in the Offering
in ministerial capacities or provide clerical work in effecting a sales
transaction. Such other employees have been instructed not to solicit offers
to purchase Common Stock or provide advice regarding the purchase of Common
Stock. The Company will rely on Rule 3a4-1 under the Exchange Act and sales of
Common Stock will be conducted within the requirements of Rule 3a4-1, so as to
permit officers, directors and employees to participate in the sale of Common
Stock. No officer, director or employee of the Company or the Bank will be
compensated in connection with his participation by the payment of commissions
or other remuneration based either directly or indirectly on the transactions
in the Common Stock.
PROCEDURE FOR PURCHASING SHARES IN SUBSCRIPTION OFFERING
To ensure that each purchaser receives a prospectus at least 48 hours before
the Expiration Date in accordance with Rule 15c2-8 of the Exchange Act, no
prospectus will be mailed any later than five days prior to such date or hand
delivered any later than two days prior to such date. Execution of the stock
order form and certification form will confirm receipt or delivery in
accordance with Rule 15c2-8. Stock order and certification forms will only be
distributed with a prospectus.
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To purchase shares in the Offerings, an executed stock order form and
certification form with the required payment for each share subscribed for, or
with appropriate authorization for withdrawal from the Bank's deposit account
(which may be given by completing the appropriate blanks in the stock order
form), must be received by the Bank at any of its offices by 12:00 noon,
Eastern Time, on December 15, 1998, with respect to the Subscription Offering,
or by the date set for the termination of the Community Offering, which date
shall be within 45 days after the close of the Subscription Offering, or
January 29, 1999, unless extended by the Bank and the Company with the
approval of the OTS, if necessary. Stock order forms which are not received by
such time or are executed defectively or are received without full payment (or
appropriate withdrawal instructions) are not required to be accepted.
Certificates representing shares of Common Stock purchased in the Subscription
Offering must be registered in the name of Eligible Account Holder or
Supplemental Eligible Account Holder, as the case may be. Joint stock
registration will be allowed only if the qualifying deposit account is so
registered. In addition, the Bank and Company are not obligated to accept
orders submitted on photocopied or facsimilied stock order forms and will not
accept stock order forms unaccompanied by an executed certification form.
Notwithstanding the foregoing, the Company shall have the right, in its sole
discretion, to permit institutional investors to submit irrevocable orders
together with a legally binding commitment for payment and to thereafter pay
for the shares of Common Stock for which they subscribe in the Community
Offering at any time prior to 48 hours before the completion of the
Conversion. The Company and the Bank have the right to waive or permit the
correction of incomplete or improperly executed forms, but do not represent
that they will do so. Once received, an executed stock order form may not be
modified, amended or rescinded without the consent of the Bank unless the
Conversion has not been completed within 45 days after the end of the
Subscription Offering, unless such period has been extended.
In order to ensure that Eligible Account Holders, Supplemental Eligible
Account Holders and Other Members are properly identified as to their stock
purchase priorities, depositors as of the Eligibility Record Date (June 30,
1997) and/or the Supplemental Eligibility Record Date (September 30, 1998)
and/or the Voting Record Date (October 31, 1998) must list all accounts on the
stock order form giving all names in each account and the account number.
Payment for subscriptions may be made (i) in cash if delivered in person at
any branch office of the Bank, (ii) by check, bank draft or money order, or
(iii) by authorization of withdrawal from deposit accounts maintained with the
Bank. Orders for Common Stock submitted by subscribers in the Subscription
Offering which aggregate $50,000 or more must be paid by official bank or
certified check, a check issued by a NASD-registered broker-dealer or by
withdrawal authorization from a deposit account of the Bank. No wire transfers
will be accepted. Interest will be paid on payments made by cash, check, bank
draft or money order at the Bank's passbook rate of interest from the date
payment is received until the completion or termination of the Conversion. If
payment is made by authorization of withdrawal from deposit accounts, the
funds authorized to be withdrawn from a deposit account will continue to
accrue interest at the contractual rates until completion or termination of
the Conversion, but a hold will be placed on such funds, thereby making them
unavailable to the depositor until completion or termination of the
Conversion.
If a subscriber authorizes the Bank to withdraw the amount of the purchase
price from his deposit account, the Bank will do so as of the effective date
of the Conversion. The Bank will waive any applicable penalties for early
withdrawal from certificate accounts. If the remaining balance in a
certificate account is reduced below the applicable minimum balance
requirement at the time that the funds actually are transferred under the
authorization, the certificate will be canceled at the time of the withdrawal,
without penalty, and the remaining balance will earn interest at the Bank's
passbook rate.
If the ESOP subscribes for shares during the Subscription Offering, the ESOP
will not be required to pay for the shares subscribed for at the time it
subscribes, but rather, may pay for such shares of Common Stock subscribed for
at the Purchase Price upon consummation of the Subscription Offering, if all
shares are sold, or upon consummation of the Community Offering or Syndicated
Community Offering if shares remain to be sold in such offerings; provided,
that there is in force from the time of its subscription until such time, a
loan
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commitment from an unrelated financial institution or the Company to lend to
the ESOP, at such time, the aggregate Purchase Price of the shares for which
it subscribed.
Owners of self-directed IRAs and Qualified Plans may use the assets of such
IRAs and Qualified Plans to purchase shares of Common Stock in the Offerings,
provided that such IRAs are not maintained at the Bank. Persons with IRAs and
Qualified Plans maintained at the Bank must have their accounts transferred to
an unaffiliated institution or broker to purchase shares of Common Stock in
the Offerings. In addition, the provisions of ERISA and IRS regulations
require that officers, directors and ten percent shareholders who use self-
directed IRA funds and Qualified Plans to purchase shares of Common Stock in
the Offerings, make such purchases for the exclusive benefit of the IRAs and
Qualified Plans.
Certificates representing shares of Common Stock purchased will be mailed to
purchasers at the address specified in properly completed stock order forms,
as soon as practicable following consummation of the sale of all shares of
Common Stock. Any certificates returned as undeliverable will be disposed of
in accordance with applicable law. Shares sold prior to the receipt of a stock
certificate are the responsibility of the purchaser.
RESTRICTIONS ON TRANSFER OF SUBSCRIPTION RIGHTS AND SHARES
Prior to the completion of the Conversion, the OTS conversion regulations
prohibit any person with subscription rights, including the Eligible Account
Holders, the ESOP, the Supplemental Eligible Account Holders and Other Members
of the Bank, from transferring or entering into any agreement or understanding
to transfer the legal or beneficial ownership of the subscription rights
issued under the Plan or the shares of Common Stock to be issued upon their
exercise. Such rights may be exercised only by the person to whom they are
granted and only for his account. Each person exercising such subscription
rights will be required to certify that he is purchasing shares solely for his
own account and that he has no agreement or understanding regarding the sale
or transfer of such shares. The regulations also prohibit any person from
offering or making an announcement of an offer or intent to make an offer to
purchase such subscription rights or shares of Common Stock prior to the
completion of the Conversion. For a discussion on post-Conversion restrictions
of directors and executive officers of the Bank, see "--Certain Restrictions
on Purchase or Transfer of Shares After Conversion."
THE BANK AND THE COMPANY WILL PURSUE ANY AND ALL LEGAL AND EQUITABLE
REMEDIES (INCLUDING FORFEITURE) IN THE EVENT THEY BECOME AWARE OF THE TRANSFER
OF SUBSCRIPTION RIGHTS AND WILL NOT HONOR ORDERS KNOWN BY THEM TO INVOLVE THE
TRANSFER OF SUCH RIGHTS.
SYNDICATED COMMUNITY OFFERING
As a final step in the Conversion, the Plan provides that, if feasible, all
shares of Common Stock not purchased in the Subscription and Community
Offerings, if any, will be offered for sale to the general public in a
Syndicated Community Offering through a syndicate of registered broker-dealers
to be formed and managed by Trident acting as agent of the Company to assist
the Company and the Bank in the sale of the Common Stock. The Company and the
Bank have the right to reject orders in whole or in part in their sole
discretion in the Syndicated Community Offering. Neither Trident nor any
registered broker-dealer shall have any obligation to take or purchase any
shares of the Common Stock in the Syndicated Community Offering, however,
Trident has agreed to use its best efforts in the sale of shares in the
Syndicated Community Offering.
The price at which Common Stock is sold in the Syndicated Community Offering
will be determined as described above under "--Stock Pricing." Subject to
overall purchase limitations, no person, together with any associate or group
of persons acting in concert, will be permitted to subscribe in the Syndicated
Community Offering for more than $300,000 of the Common Stock; provided,
however, that shares of Common Stock purchased in the Community Offering by
any persons, together with associates of or persons acting in concert with
such persons, will be aggregated with purchases in the Syndicated Community
Offering and be subject to an overall maximum purchase limitation of 1.0% of
the shares offered, exclusive of an increase in shares issued pursuant to an
increase in the Estimated Price Range by up to 15%.
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Payments made in the form of a check, bank draft, money order or in cash
will earn interest at the Bank's passbook rate of interest from the date such
payment is actually received by the Bank until completion or termination of
the Conversion.
In addition to the foregoing, if a syndicate of broker-dealers ("selected
dealers") is formed to assist in the Syndicated Community Offering, a
purchaser may pay for his shares with funds held by or deposited with a
selected dealer. If an order form is executed and forwarded to the selected
dealer or if the selected dealer is authorized to execute the order form on
behalf of a purchaser, the selected dealer is required to forward the order
form and funds to the Bank for deposit in a segregated account on or before
noon of the business day following receipt of the order form or execution of
the order form by the selected dealer. Alternatively, selected dealers may
solicit indications of interest from their customers to place orders for
shares. Such selected dealers shall subsequently contact their customers who
indicated an interest and seek their confirmation as to their intent to
purchase. Those indicating an intent to purchase shall execute order forms and
forward them to their selected dealer or authorize the selected dealer to
execute such forms. The selected dealer will acknowledge receipt of the order
to its customer in writing on the following business day and will debit such
customer's account on the third business day after the customer has confirmed
his intent to purchase (the "debit date") and on or before noon of the next
business day following the debit date will send order forms and funds to the
Bank for deposit in a segregated account. Although purchasers' funds are not
required to be in their accounts with selected dealers until the debit date in
the event that such alternative procedure is employed once a confirmation of
an intent to purchase has been received by the selected dealer, the purchaser
has no right to rescind his order.
Certificates representing shares of Common Stock purchased, together with
any refund due, will be mailed to purchasers at the address specified in the
order form, as soon as practicable following consummation of the sale of the
Common Stock. Any certificates returned as undeliverable will be disposed of
in accordance with applicable law.
The Syndicated Community Offering will terminate no more than 45 days
following the Expiration Date, unless extended by the Company with the
approval of the OTS. Such extensions may not go beyond December 17, 2000. See
"--Stock Pricing" above for a discussion of rights of subscribers, if any, in
the event an extension is granted.
LIMITATIONS ON COMMON STOCK PURCHASES
The Plan includes the following limitations on the number of shares of
Common Stock which may be purchased during the Conversion:
(1) No less than 25 shares;
(2) Each Eligible Account Holder may subscribe for and purchase in the
Subscription Offering up to the greater of the amount permitted to be
purchased in the Community Offering, currently $300,000 of Common Stock,
one-tenth of one percent (.10%) of the total offering of shares of Common
Stock or fifteen times the product (rounded down to the next whole number)
obtained by multiplying the total number of shares of Common Stock to be
issued by a fraction of which the numerator is the amount of the Qualifying
Deposit of the Eligible Account Holder and the denominator is the total
amount of Qualifying Deposits of all Eligible Account Holders in each case
on the Eligibility Record Date subject to the overall maximum purchase
limitation in (8) below;
(3) The ESOP is permitted to purchase in the aggregate up to 10% of the
shares of Common Stock issued in the Conversion, including shares issued to
the Foundation, including shares issued in the event of an increase in the
Estimated Price Range of 15% and intends to purchase 8% of the shares of
Common Stock issued in the Conversion, including shares issued to the
Foundation;
(4) Each Supplemental Eligible Account Holder may subscribe for and
purchase in the Subscription Offering up to the greater of the amount
permitted to be purchased in the Community Offering, currently $300,000 of
Common Stock, one-tenth of one percent (.10%) of the total offering of
shares of Common
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Stock or fifteen times the product (rounded down to the next whole number)
obtained by multiplying the total number of shares of Common Stock to be
issued by a fraction of which the numerator is the amount of the Qualifying
Deposit of the Supplemental Eligible Account Holder and the denominator is
the total amount of Qualifying Deposits of all Supplemental Eligible
Account Holders in such case on the Supplemental Eligibility Record Date
subject to the overall maximum purchase limitation in (8) below;
(5) Each Other Member may subscribe for and purchase in the Subscription
Offering up to the greater of the amount permitted to be purchased in the
Community Offering, currently $300,000 of Common Stock, or one-tenth of one
percent (.10%) of the total offering of shares of Common Stock subject to
the overall maximum purchase limitation in (8) below;
(6) Persons purchasing shares of Common Stock in the Community Offering,
together with associates of groups of persons acting in concert with such
persons, may purchase in the Community Offering up to $300,000 of Common
Stock subject to the overall maximum purchase limitation in (8) below;
(7) Persons purchasing shares of Common Stock in the Syndicated Community
Offering, together with associates of or persons acting in concert with
such persons, may purchase in the Syndicated Community Offering up to
$300,000 of Common Stock subject to the overall maximum purchase limitation
in (8) below, provided further that shares of Common Stock purchased in the
Community Offering by any persons, together with associates of and persons
acting in concert with such persons, will be aggregated with purchases in
the Syndicated Community Offering in applying the $300,000 purchase
limitation;
(8) Eligible Account Holders, Supplemental Eligible Account Holders and
Other Members may purchase stock in the Community Offering and Syndicated
Community Offering subject to the purchase limitations described in (6) and
(7) above, provided that, except for the ESOP, the overall maximum number
of shares of Common Stock subscribed for or purchased in all categories of
the Conversion by any person, together with associates of or groups of
persons acting in concert with such persons, shall not exceed 1.0%
($1,214,400 at the maximum) of the shares of Common Stock offered in the
Conversion and exclusive of an increase in the total number of shares
issued due to an increase in the Estimated Price Range of up to 15%; and
(9) No more than 25% of the total number of shares offered for sale in
the Conversion may be purchased by directors and officers of the Bank and
their associates in the aggregate, excluding purchases by the ESOP.
Subject to any required regulatory approval and the requirements of
applicable laws and regulations, but without further approval of the members
of the Bank, both the individual amount permitted to be subscribed for and the
overall maximum purchase limitation may be increased to up to a maximum of 5%
at the sole discretion of the Company and the Bank. If such amount is
increased, subscribers for the maximum amount will be, and certain other large
subscribers in the sole discretion of the Bank may be, given the opportunity
to increase their subscriptions up to the then applicable limit. In addition,
the Boards of Directors of the Company and the Bank may, in their sole
discretion, increase the maximum purchase limitation referred to above up to
9.99%, provided that orders for shares exceeding 5% of the shares being
offering in the Subscription Offering shall not exceed, in the aggregate, 10%
of the shares being offered in the Subscription Offering. Requests to purchase
additional shares of Common Stock under this provision will be determined by
the Boards of Directors and, if approved, allocated on a pro rata basis giving
priority in accordance with the priority rights set forth herein.
The overall maximum purchase limitation may not be reduced to less than 1.0%
but the individual amount permitted to be subscribed for may be reduced by the
Bank to less than 0.10%, subject to paragraphs (2), (4) and (5) above without
the further approval of members or resolicitation of subscribers. An
individual Eligible Account Holder, Supplemental Eligible Account Holder or
Other Member may not purchase individually in the Subscription Offering the
overall maximum purchase limit of 1.0% of the shares offered, but may make
such purchase, together with associates of and persons acting in concert with
such person, by also purchasing in other available categories of the
Conversion, subject to availability of shares and the overall maximum purchase
limit for purchases in the Conversion.
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In the event of an increase in the total number of shares offered in the
Conversion due to an increase in the Estimated Price Range of up to 15% (the
"Adjusted Maximum"), the additional shares will be allocated in the following
order of priority in accordance with the Plan: (i) to fill the ESOP's
subscription of 8% of the amount of Common Stock issued in the Conversion at
the Adjusted Maximum number of shares, including shares issued to the
Foundation; (ii) in the event that there is an oversubscription by Eligible
Account Holders, to fill unsatisfied subscriptions of Eligible Account
Holders, exclusive of the Adjusted Maximum; (iii) in the event that there is
an oversubscription by Supplemental Eligible Account Holders, to fill
unsatisfied subscriptions of Supplemental Eligible Account Holders, exclusive
of the Adjusted Maximum; (iv) in the event that there is an oversubscription
by Other Members, to fill unsatisfied subscriptions of Other Members exclusive
of the Adjusted Maximum; and (v) to fill unsatisfied subscriptions in the
Community Offering to the extent possible, exclusive of the Adjusted Maximum,
with preference to institutional investors then a preference to Preferred
Subscribers.
The term "associate" of a person is defined to mean: (i) any corporation or
organization (other than the Bank or a majority-owned subsidiary of the Bank)
of which such person is an officer, partner or directly or indirectly a 10%
stockholder; (ii) any trust or other estate in which such person has a
substantial beneficial interest or serves as a trustee or in a similar
fiduciary capacity; provided, however, such term shall not include any
employee stock benefit plan of the Bank in which such person has a substantial
beneficial interest or serves as a trustee or in a similar fiduciary capacity;
and (iii) any relative or spouse of such person, or any relative of such
spouse, who either has the same home as such person or who is a director or
officer of the Bank. Directors are not treated as associates of each other
solely because of their Board membership. For a further discussion of
limitations on purchases of a converting institution's stock at the time of
Conversion and subsequent to Conversion, see "Management of the Bank--
Subscriptions by Executive Officers and Directors," "--Certain Restrictions on
Purchase or Transfer of Shares After Conversion" and "Restrictions on
Acquisition of the Company and the Bank."
The term "Acting in Concert" means: (i) knowing participation in a joint
activity or interdependent conscious parallel action towards a common goal
whether or not pursuant to an express agreement; (ii) a combination or pooling
of voting or other interests in the securities of an issuer for a common
purpose pursuant to any contract, understanding, relationship, agreement or
other arrangement, whether written or otherwise; or (iii) a person or company
which acts in concert with another person or company ("other party") shall
also be deemed to be acting in concert with any person or company who is also
acting in concert with that other party, except that any tax-qualified
employee stock benefit plan will not be deemed to be acting in concert with
its trustee or a person who serves in a similar capacity solely for the
purpose of determining whether stock held by the trustee and stock held by the
plan will be aggregated.
LIQUIDATION RIGHTS
In the unlikely event of a complete liquidation of the Bank in its present
mutual form, each depositor would receive his pro rata share of any assets of
the Bank remaining after payment of claims of all creditors (including the
claims of all depositors to the withdrawal value of their accounts). Each
depositor's pro rata share of such remaining assets would be in the same
proportion as the value of his deposit account was to the total value of all
deposit accounts in the Bank at the time of liquidation. After the Conversion,
each depositor, in the event of a complete liquidation, would have a claim as
a creditor of the same general priority as the claims of all other general
creditors of the Bank. However, except as described below, his claim would be
solely in the amount of the balance in his deposit account plus accrued
interest. He would not have an interest in the value or assets of the Bank
above that amount.
The Plan provides for the establishment, upon the completion of the
Conversion, of a special "liquidation account" for the benefit of Eligible
Account Holders and Supplemental Eligible Account Holders in an amount equal
to the surplus and reserves of the Bank as of the date of its latest balance
sheet contained in the final prospectus used in connection with the
Conversion. Each Eligible Account Holder and Supplemental Eligible Account
Holder, if he were to continue to maintain his deposit account at the Bank,
would be entitled, on a
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complete liquidation of the Bank after the Conversion, to an interest in the
liquidation account prior to any payment to the stockholders of the Bank. Each
Eligible Account Holder and Supplemental Eligible Account Holder would have an
initial interest in such liquidation account for each deposit account,
including regular accounts, transaction accounts such as NOW accounts, money
market deposit accounts and certificates of deposit, with a balance of $50 or
more held in the Bank on June 30, 1997 and September 30, 1998, respectively.
Each Eligible Account Holder and Supplemental Eligible Account Holder will
have a pro rata interest in the total liquidation account based on the
proportion that the balance of his Qualifying Deposits on the Eligibility
Record Date or Supplemental Eligibility Record Date, respectively, bore to the
total amount of all Qualifying Deposits of all Eligible Account Holders and
Supplemental Eligible Account Holders in the Bank. For deposit accounts in
existence at both dates separate subaccounts shall be determined on the basis
of the Qualifying Deposits in such deposit accounts on such respective record
dates.
If, however, on any annual closing date subsequent to the Eligibility Record
Date or Supplemental Eligibility Record Date, the amount of the Qualifying
Deposit of an Eligible Account Holder or Supplemental Eligible Account Holder
is less than the amount of the Qualifying Deposit of such Eligible Account
Holder or Supplemental Eligible Account Holder as of the Eligibility Record
Date or Supplemental Eligibility Record Date, respectively, or less than the
amount of the Qualifying Deposits as of the previous annual closing date, then
the interest in the liquidation account relating to such Qualifying Deposit
would be reduced from time-to-time by the proportion of any such reduction and
such interest will cease to exist if such Qualifying Deposit accounts are
closed. In addition, no interest in the liquidation account would ever be
increased despite any subsequent increase in the related Qualifying Deposit.
Any assets remaining after the above liquidation rights of Eligible Account
Holders and Supplemental Eligible Account Holders are satisfied would be
distributed to the Company as the sole stockholder of the Bank.
TAX ASPECTS
Consummation of the Conversion is expressly conditioned upon the receipt by
the Bank of either a favorable ruling from the IRS or an opinion of counsel
with respect to federal income taxation and an opinion of an independent
accountant with respect to Virginia taxation, to the effect that the
Conversion will not be a taxable transaction to the Company, the Bank,
Eligible Account Holders, or Supplemental Eligible Account Holders except as
noted below. The federal and Virginia tax consequences will remain unchanged
in the event that a holding company form of organization is not utilized.
No private ruling will be received from the IRS with respect to the proposed
Conversion. Instead, the Bank has received an opinion of its counsel, Muldoon,
Murphy & Faucette, to the effect that for federal income tax purposes, among
other matters: (i) the Bank's change in form from mutual to stock ownership
will constitute a reorganization under section 368(a)(1)(F) of the Code and
neither the Bank nor the Company will recognize any gain or loss as a result
of the Conversion; (ii) no gain or loss will be recognized to the Bank or the
Company upon the purchase of the Bank's capital stock by the Company or to the
Company upon the purchase of its Common Stock in the Conversion; (iii) no gain
or loss will be recognized by Eligible Account Holders or Supplemental
Eligible Account Holders upon the issuance to them of Deposit Accounts in the
Bank in its stock form plus their interests in the liquidation account in
exchange for their deposit accounts in the Bank; (iv) the tax basis of the
depositors' accounts in the Bank immediately after the Conversion will be the
same as the basis of their deposit accounts immediately prior to the
Conversion; (v) the tax basis of each Eligible Account Holder's and
Supplemental Eligible Account Holder's interest in the liquidation account
will be zero; (vi) no gain or loss will be recognized by Eligible Account
Holders or Supplemental Eligible Account Holders upon the distribution to them
of nontransferable subscription rights to purchase shares of the Common Stock,
provided that the amount to be paid for the Common Stock is equal to the fair
market value of such stock; and (vii) the tax basis to the stockholders of the
Common Stock of the Company purchased in the Conversion will be the amount
paid therefor and the holding period for the shares of Common Stock purchased
by such persons will begin on the date on which their subscription rights are
exercised. Cherry, Bekaert & Holland, L.L.P. has opined that the Conversion
will not be a taxable transaction to the Company, the Bank, Eligible Account
Holders or Supplemental Eligible
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Account Holders for Virginia income and/or franchise tax purposes. Certain
portions of both the federal and the state and local tax opinions are based
upon the assumption that the subscription rights issued in connection with the
Conversion will have no economic value at the time of distribution or at the
time the subscriptions are exercised.
Unlike private rulings, an opinion of counsel or an opinion of an
independent accountant is not binding on the IRS or DOT and the IRS or DOT
could disagree with conclusions reached therein. In the event of such
disagreement, there can be no assurance that the IRS or DOT would not prevail
in a judicial or administrative proceeding.
FinPro has issued an opinion stating that, pursuant to its valuation, FinPro
is of the opinion that the subscription rights do not have any value, based on
the fact that such rights are acquired by the recipients without cost, are
nontransferable and of short duration and afford the recipients the right only
to purchase the Common Stock at a price equal to its estimated fair market
value, which will be the same price as the Purchase Price for the shares of
Common Stock sold in the Community Offering. Such valuation is not binding on
the IRS or DOT. If the subscription rights granted to Eligible Account Holders
or Supplemental Eligible Account Holders are deemed to have an ascertainable
value, receipt of such rights could be taxable to those Eligible Account
Holders or Supplemental Eligible Account Holders who receive and/or exercise
the subscription rights in an amount equal to such value and the Bank could
recognize gain on such distribution. Eligible Account Holders and Supplemental
Eligible Account Holders are encouraged to consult with their own tax advisor
as to the tax consequences in the event that such subscription rights are
deemed to have an ascertainable value.
INTERPRETATION AND AMENDMENT OF THE PLAN OF CONVERSION
To the extent permitted by law, all interpretations of the Plan by the Bank
will be final. The Plan provides that the Bank's Board of Directors shall have
the discretion to interpret and apply the provisions of the Plan to particular
circumstances and that such interpretation or application shall be final. This
includes any and all interpretations, applications and determinations made by
the Board of Directors on the basis of such information and assistance as was
then reasonably available for such purpose.
The Plan provides that, if deemed necessary or desirable by the Board of
Directors, the Plan may be substantively amended at any time prior to
solicitation of proxies from members to vote on the Plan by a two-thirds vote
of the Bank's Board of Directors. After submission of the proxy materials to
the members, the Plan may be amended by a two-thirds vote of the Board of
Directors at any time prior to the Special Meeting with the concurrence of the
OTS. The Plan may be amended at any time after the approval of members with
the approval of the OTS and no further approval of the members will be
necessary unless otherwise required by the OTS. By adoption of the Plan, the
Bank's members will be deemed to have authorized amendment of the Plan under
the circumstances described above.
The establishment of the Foundation will be considered as a separate matter
from approval of the Plan of Conversion. If the Bank's members approve the
Plan of Conversion, but not the creation of the Foundation, the Bank intends
to complete the Conversion without the Foundation. Failure to approve the
establishment of the Foundation may materially increase the pro forma market
value of the Common Stock since the Valuation Range, as set forth herein,
takes into account the dilutive impact of the issuance of shares to the
Foundation. In such an event, the Bank may establish a new Estimated Price
Range and commence a resolicitation of subscribers. In the event of a
resolicitation, unless an affirmative response is received within a specified
period of time, all funds will be promptly returned to investors, as described
elsewhere herein. See "--Stock Pricing."
CERTAIN RESTRICTIONS ON PURCHASE OR TRANSFER OF SHARES AFTER CONVERSION
All shares of Common Stock purchased in connection with the Conversion by a
director or an executive officer of the Bank will be subject to a restriction
that the shares not be sold for a period of one year following the Conversion,
except in the event of the death of such director or executive officer. Each
certificate for
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restricted shares will bear a legend giving notice of this restriction on
transfer and instructions will be issued to the effect that any transfer
within such time period of any certificate or record ownership of such shares
other than as provided above is a violation of the restriction. Any shares of
Common Stock issued at a later date as a stock dividend, stock split, or
otherwise, with respect to such restricted stock will be subject to the same
restrictions. The directors and executive officers of the Bank will also be
subject to the insider trading rules promulgated pursuant to the Exchange Act
and any other applicable requirements of the federal securities laws.
Purchases of outstanding shares of Common Stock of the Company by directors,
executive officers (or any person who was an executive officer or director of
the Bank after adoption of the Plan of Conversion) and their associates during
the three-year period following Conversion may be made only through a broker
or dealer registered with the SEC, except with the prior written approval of
the OTS. This restriction does not apply, however, to negotiated transactions
involving more than 1.0% of the Company's outstanding Common Stock or to the
purchase of stock pursuant to any stock option plan to be established after
the Conversion.
Unless approved by the OTS, the Company, pursuant to OTS regulations, will
be prohibited from repurchasing any shares of the Common Stock for three years
except: (i) for an offer to all stockholders on a pro rata basis; or (ii) for
the repurchase of qualifying shares of a director. Notwithstanding the
foregoing, beginning one year following completion of the Conversion the
Company may repurchase its Common Stock so long as: (i) the repurchases within
the following two years are part of an open-market program not involving
greater than 5% of its outstanding capital stock during a twelve-month period;
(ii) the repurchases do not cause the Company to become undercapitalized; and
(iii) the Company provides to the Regional Director of the OTS no later than
10 days prior to the commencement of a repurchase program written notice
containing a full description of the program to be undertaken and such program
is not disapproved by the Regional Director. In addition, under current OTS
policies, repurchases may be allowed in the first year following Conversion
and in amounts greater than 5% in the second and third years following
Conversion, provided there are valid and compelling business reasons for such
repurchases and the OTS does not object to such repurchases.
RESTRICTIONS ON ACQUISITION OF THE COMPANY AND THE BANK
GENERAL
The Bank's Plan of Conversion provides for the Conversion of the Bank from
the mutual to the stock form of organization and, in connection therewith, a
new Federal Stock Charter and Bylaws to be adopted by members of the Bank. The
Plan also provides for the concurrent formation of a holding company, which
form of organization may or may not be utilized at the option of the Board of
Directors of the Bank. See "The Conversion--General." In the event that the
holding company form of organization is utilized, as described below, certain
provisions in the Company's Articles of Incorporation and Bylaws and in its
management remuneration entered into in connection with the Conversion,
together with provisions of Virginia corporate law, may have anti-takeover
effects. In the event that the holding company form of organization is not
utilized, the Bank's Stock Charter and Bylaws and management remuneration
entered into in connection with the Conversion may have anti-takeover effects
as described below. In addition, regulatory restrictions may make it difficult
for persons or companies to acquire control of either the Company or the Bank.
RESTRICTIONS IN THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
A number of provisions of the Company's Articles of Incorporation and Bylaws
deal with matters of corporate governance and certain rights of stockholders.
The following discussion is a general summary of the material provisions of
the Company's Articles of Incorporation and Bylaws and certain other statutory
and regulatory provisions relating to stock ownership and transfers, the Board
of Directors and business combinations, which might be deemed to have a
potential "anti-takeover" effect. These provisions may have the effect of
discouraging a future takeover attempt which is not approved by the Board of
Directors but which individual Company stockholders may deem to be in their
best interests or in which shareholders may receive a
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substantial premium for their shares over then current market prices. As a
result, stockholders who might desire to participate in such a transaction may
not have an opportunity to do so. Such provisions will also render the removal
of the current Board of Directors or management of the Company more difficult.
The following description of certain of the provisions of the Articles of
Incorporation and Bylaws of the Company is necessarily general and reference
should be made in each case to such Articles of Incorporation and Bylaws,
which are incorporated herein by reference. See "Additional Information" as to
how to obtain a copy of these documents.
Limitation on Voting Rights. The Articles of Incorporation of the Company
provide that in no event shall any record owner of any outstanding Common
Stock which is beneficially owned, directly or indirectly, by a person who
beneficially owns in excess of 10% of the then outstanding shares of Common
Stock (the "Limit") be entitled or permitted to any vote in respect of the
shares held in excess of the Limit. Beneficial ownership is determined
pursuant to Rule 13d-3 of the General Rules and Regulations promulgated
pursuant to the Exchange Act and includes shares beneficially owned by such
person or any of his affiliates (as defined in the Articles of Incorporation),
shares which such person or his affiliates have the right to acquire upon the
exercise of conversion rights or options and shares as to which such person
and his affiliates have or share investment or voting power, but shall not
include shares beneficially owned by the ESOP or directors, officers and
employees of the Bank or Company or shares that are subject to a revocable
proxy and that are not otherwise beneficially owned, or deemed by the Company
to be beneficially owned, by such person and his affiliates. The Articles of
Incorporation of the Company further provide that this provision limiting
voting rights may only be amended upon the vote of 80% of the outstanding
shares of voting stock (after giving effect to the limitation on voting
rights).
Board of Directors. The Board of Directors of the Company is divided into
three classes, each of which shall contain approximately one-third of the
whole number of members of the Board. Each class shall serve a staggered term,
with approximately one-third of the total number of directors being elected
each year. The Company's Articles of Incorporation and Bylaws provide that the
size of the Board shall be determined by a majority of the directors. The
Articles of Incorporation and the Bylaws provide that any vacancy occurring in
the Board, including a vacancy created by an increase in the number of
directors or resulting from death, resignation, retirement, disqualification,
removal from office or other cause, shall be filled for the remainder of the
unexpired term exclusively by a majority vote of the directors then in office.
The classified Board is intended to provide for continuity of the Board of
Directors and to make it more difficult and time consuming for a stockholder
group to fully use its voting power to gain control of the Board of Directors
without the consent of the incumbent Board of Directors of the Company. The
Articles of Incorporation of the Company provide that a director may be
removed from the Board of Directors prior to the expiration of his term only
for cause, upon the vote of 80% of the outstanding shares of voting stock.
In the absence of these provisions, the vote of the holders of a majority of
the shares could remove the entire Board, with or without cause, and replace
it with persons of such holders' choice.
Cumulative Voting, Special Meetings and Action by Written Consent. The
Articles of Incorporation do not provide for cumulative voting for any
purpose. Moreover, special meetings of stockholders of the Company may be
called only by the Board of Directors of the Company. The Articles of
Incorporation also provide that any action required or permitted to be taken
by the stockholders of the Company may be taken only at an annual or special
meeting and prohibits stockholder action by written consent in lieu of a
meeting.
Authorized Shares. The Articles of Incorporation authorize the issuance of
75,000,000 shares of Common Stock and 5,000,000 shares of Preferred Stock. The
shares of Common Stock and Preferred Stock were authorized in an amount
greater than that to be issued in the Conversion to provide the Company's
Board of Directors with as much flexibility as possible to effect, among other
transactions, financings, acquisitions, stock dividends, stock splits and
employee stock options. However, these additional authorized shares may also
be used by the Board of Directors consistent with its fiduciary duty to deter
future attempts to gain control of the Company. The Board of Directors also
has sole authority to determine the terms of any one or more series of
Preferred Stock, including voting rights, conversion rates and liquidation
preferences. As a result of the ability to
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fix voting rights for a series of Preferred Stock, the Board has the power, to
the extent consistent with its fiduciary duty, to issue a series of Preferred
Stock to persons friendly to management in order to attempt to block a post-
tender offer merger or other transaction by which a third party seeks control
and thereby assist management to retain its position. The Company's Board of
Directors currently has no plans for the issuance of additional shares, other
than the issuance of shares in the Conversion, including shares contributed to
the Foundation, and the issuance of additional shares pursuant to the terms of
the Stock-Based Incentive Plan and upon exercise of stock options to be issued
pursuant to the terms of the Stock-Based Incentive Plan, which are to be
established and presented to stockholders at the first annual meeting after
the Conversion.
Stockholder Vote Required to Approve Business Combinations with Principal
Stockholders. The Articles of Incorporation require the approval of the
holders of at least 80% of the Company's outstanding shares of voting stock to
approve certain "Business Combinations," as defined therein, and related
transactions. Under Virginia law, absent this provision, Business
Combinations, including mergers, consolidations and sales of all or
substantially all of the assets of a corporation must, subject to certain
exceptions, be approved by the vote of the holders of only two-thirds of the
votes entitled to be cast. Under the Articles of Incorporation, at least 80%
approval of shareholders is required in connection with any transaction
involving an Interested Stockholder (as defined below) except (i) in cases
where the proposed transaction has been approved in advance by a majority of
those members of the Company's Board of Directors who are unaffiliated with
the Interested Stockholder and were directors prior to the time when the
Interested Stockholder became an Interested Stockholder or (ii) if the
proposed transaction meets certain conditions set forth therein which are
designed to afford the shareholders a fair price in consideration for their
shares in which case, if a stockholder vote is required, approval of only a
majority of the outstanding shares of voting stock would be sufficient. The
term "Interested Stockholder" is defined to include any individual, a group
acting in concert, corporation, partnership or other entity (other than the
Company or its subsidiaries) which owns beneficially or controls, directly or
indirectly, 10% or more of the outstanding shares of voting stock of the
Company. This provision of the Articles of Incorporation applies to any
"Business Combination," which is defined to include (i) any merger or
consolidation of the Company or any of its subsidiaries with or into any
Interested Stockholder or Affiliate (as defined in the Articles of
Incorporation) of an Interested Stockholder; (ii) any sale, lease, exchange,
mortgage, pledge, transfer, or other disposition to or with any Interested
Stockholder or Affiliate of 25% or more of the assets of the Company or
combined assets of the Company and its subsidiary; (iii) the issuance or
transfer to any Interested Stockholder or its Affiliate by the Company (or any
subsidiary) of any securities of the Company in exchange for any assets, cash
or securities the value of which equals or exceeds 25% of the fair market
value of the Common Stock of the Company; (iv) the adoption of any plan for
the liquidation or dissolution of the Company proposed by or on behalf of any
Interested Stockholder or Affiliate thereof; and (v) any reclassification of
securities, recapitalization, merger or consolidation of the Company which has
the effect of increasing the proportionate share of Common Stock or any class
of equity or convertible securities of the Company owned directly or
indirectly by an Interested Stockholder or Affiliate thereof. The directors
and executive officers of the Bank are purchasing in the aggregate
approximately 1.55% of the shares of the Common Stock at the maximum of the
Estimated Price Range. In addition, the ESOP intends to purchase 8% of the
Common Stock issued in connection with the Conversion including shares issued
to the Foundation. Additionally, if at a meeting of stockholders following the
Conversion stockholder approval of the proposed Stock-Based Incentive Plan is
received, the Company expects to acquire 4% of the Common Stock issued in
connection with the Conversion, including shares issued to the Foundation, on
behalf of the Stock-Based Incentive Plan and expects to issue an amount equal
to 10% of the Common Stock issued in connection with the Conversion, including
shares issued to the Foundation, under the Stock-Based Incentive Plan to
directors, officers and employees. As a result, assuming the Stock-Based
Incentive Plan is approved by Stockholders, directors, officers and employees
have the potential to control the voting of approximately 20.6% of the
Company's Common Stock, thereby enabling them to prevent the approval of the
transactions requiring the approval of at least 80% of the Company's
outstanding shares of voting stock described hereinabove.
Evaluation of Offers. The Articles of Incorporation of the Company further
provide that the Board of Directors of the Company, when evaluating any offer
of another "Person" (as defined therein) to (i) make a
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tender or exchange offer for any equity security of the Company, (ii) merge or
consolidate the Company with another corporation or entity, or (iii) purchase
or otherwise acquire all or substantially all of the properties and assets of
the Company, may, in connection with the exercise of its judgment in
determining what is in the best interest of the Company, the Bank and the
stockholders of the Company, give due consideration to all relevant factors,
including, without limitation, the social and economic effects of acceptance
of such offer on the Company's customers and the Bank's present and future
account holders, borrowers and employees; on the communities in which the
Company and the Bank operate or are located; and on the ability of the Company
to fulfill its corporate objectives as a savings and loan holding company and
on the ability of the Bank to fulfill the objectives of a federally-chartered
stock savings and loan association under applicable statutes and regulations.
By having these standards in the Articles of Incorporation of the Company, the
Board of Directors may be in a stronger position to oppose such a transaction
if the Board concludes that the transaction would not be in the best interest
of the Company, even if the price offered is significantly greater than the
then market price of any equity security of the Company.
Amendment of Articles of Incorporation and Bylaws. Amendments to the
Company's Articles of Incorporation must be approved by a majority vote of its
Board of Directors and also by a majority of the outstanding shares of its
voting stock; provided, however, that an affirmative vote of at least 80% of
the outstanding voting stock entitled to vote (after giving effect to the
provision limiting voting rights) is required to amend or repeal certain
provisions of the Articles of Incorporation, including the provision limiting
voting rights, the provisions relating to approval of certain business
combinations, calling special meetings, the number and classification of
directors, director and officer indemnification by the Company and amendment
of the Company's Bylaws and Articles of Incorporation. The Company's Bylaws
may be amended by its Board of Directors, or by a vote of 80% of the total
votes eligible to be voted at a duly constituted meeting of stockholders.
Certain Bylaw Provisions. The Bylaws of the Company also require a
stockholder who intends to nominate a candidate for election to the Board of
Directors, or to raise new business at a stockholder meeting to give at least
90 days advance notice to the Secretary of the Company. The notice provision
requires a stockholder who desires to raise new business to provide certain
information to the Company concerning the nature of the new business, the
stockholder and the stockholder's interest in the business matter. Similarly,
a stockholder wishing to nominate any person for election as a director must
provide the Company with certain information concerning the nominee and the
proposing stockholder.
ANTI-TAKEOVER EFFECTS OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
AND MANAGEMENT REMUNERATION ADOPTED IN CONVERSION
The provisions described above are intended to reduce the Company's
vulnerability to takeover attempts and certain other transactions which have
not been negotiated with and approved by members of its Board of Directors.
The provisions of the Employment Agreements, Employee Severance Compensation
Plan and Stock-Based Incentive Plan to be established may also discourage
takeover attempts by increasing the costs to be incurred by the Bank and the
Company in the event of a takeover. See "Management of the Bank--Employment
Agreements" and "--Benefits--Stock-Based Incentive Plan."
The Company's Board of Directors believes that the provisions of the
Articles of Incorporation, Bylaws and management remuneration plans to be
established are in the best interest of the Company and its stockholders. An
unsolicited non-negotiated proposal can seriously disrupt the business and
management of a corporation and cause it great expense. Accordingly, the Board
of Directors believes it is in the best interests of the Company and its
stockholders to encourage potential acquirors to negotiate directly with
management and that these provisions will encourage such negotiations and
discourage non-negotiated takeover attempts. It is also the Board of
Directors' view that these provisions should not discourage persons from
proposing a merger or other transaction at a price that reflects the true
value of the Company and that otherwise is in the best interest of all
stockholders.
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VIRGINIA CORPORATE LAW
The Commonwealth of Virginia has a statute designed to provide Virginia
corporations with additional protection against hostile takeovers. The
takeover statute, which is codified in Article 14 of the Virginia Stock
Corporation Act ("Article 14"), is intended to discourage certain takeover
practices by impeding the ability of a hostile acquiror to engage in certain
transactions with the target company.
In general, Article 14 provides that a "Person" (as defined therein) who
owns 10% or more of the outstanding voting stock of a Virginia corporation (an
"Interested Shareholder") may not consummate a merger or other affiliated
transaction with such corporation at any time during the three-year period
following the date such "Person" became an Interested Shareholder. The term
"affiliated transaction" is defined broadly to cover a wide range of corporate
transactions including mergers, share exchanges, dispositions of corporate
assets with an aggregate fair market value in excess of 5% of the
corporation's net worth, disposition of voting shares of the corporation with
an aggregate fair market value in excess of 5% of the aggregate fair market
value of all outstanding voting stock of the corporation, and any
reclassification of securities, including a reverse stock split,
recapitalization or merger of the corporation with its subsidiaries which
increases the percentage of voting shares owned beneficially by an Interested
Shareholder by more than 5%.
The statute exempts the following transactions from the requirements of
Article 14: (i) any affiliated transaction that is approved by a majority of
the disinterested directors (as defined therein) and by two-thirds of the
voting shares other than those shares beneficially owned by the Interested
Shareholder; or (ii) any affiliated transaction with an Interested Shareholder
whose acquisition of shares making such person an Interested Shareholder
receive prior approval of a majority of the corporation's disinterested
directors (as defined therein). A corporation may exempt itself from the
requirements of the statute by adopting an amendment to its Articles of
Incorporation or Bylaws electing not to be governed by Article 14. At the
present time, the Board of Directors does not intend to propose any such
amendment.
In addition, Virginia Stock Corporation Act, Article 14.1 ("Article 14.1")
limits the voting rights of shares acquired in "Control Share Acquisitions" by
providing that shares acquired in a transaction that would cause the acquiring
person's voting strength to meet or exceed any of three thresholds (one-fifth,
one-third or a majority of voting shares) have no voting rights unless granted
by a majority vote of shares not owned by the acquiring person or any officer
or employee-director of the Virginia corporation. A Virginia corporation may
exempt itself from the requirements of the statute by adopting an amendment to
its Articles of Incorporation or Bylaws electing not to be governed by Article
14.1. At the present time, the Board of Directors does not intend to propose
any such amendment.
RESTRICTIONS IN THE BANK'S NEW CHARTER AND BYLAWS
Although the Board of Directors of the Bank is not aware of any effort that
might be made to obtain control of the Bank after the Conversion, the Board of
Directors believes that it is appropriate to adopt certain provisions
permitted by federal regulations to protect the interests of the converted
Bank and its stockholders from any hostile takeover. Such provisions may,
indirectly, inhibit a change in control of the Company, as the Bank's sole
stockholder. See "Risk Factors--Certain Anti-Takeover Provisions in the
Company's and Bank's Governing Instruments Which May Discourage Takeover
Attempts."
The Bank's Federal Stock Charter will contain a provision whereby the
acquisition of or offer to acquire beneficial ownership of more than 10% of
the issued and outstanding shares of any class of equity securities of the
Bank by any person (i.e., any individual, corporation, group acting in
concert, trust, partnership, joint stock company or similar organization),
either directly or through an affiliate thereof, will be prohibited for a
period of five years following the date of completion of the Conversion. Any
stock in excess of 10% acquired in violation of the Federal Stock Charter
provision will not be counted as outstanding for voting purposes. This
limitation shall not apply to any transaction in which the Bank forms a
holding company without a change in the respective beneficial ownership
interests of its stockholders other than pursuant to the exercise of any
dissenter or appraisal
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rights. In the event that holders of revocable proxies for more than 10% of
the shares of the Common Stock of the Company seek, among other things, to
elect one-third or more of the Company's Board of Directors, to cause the
Company's stockholders to approve the acquisition or corporate reorganization
of the Company or to exert a continuing influence on a material aspect of the
business operations of the Company, which actions could indirectly result in a
change in control of the Bank, the Board of Directors of the Bank will be able
to assert this provision of the Bank's Federal Stock Charter against such
holders. Although the Board of Directors of the Bank is not currently able to
determine when and if it would assert this provision of the Bank's Federal
Stock Charter, the Board of Directors, in exercising its fiduciary duty, may
assert this provision if it were deemed to be in the best interests of the
Bank, the Company and its stockholders. It is unclear, however, whether this
provision, if asserted, would be successful against such persons in a proxy
contest which could result in a change in control of the Bank indirectly
through a change in control of the Company. Finally, for five years,
stockholders will not be permitted to call a special meeting of stockholders
relating to a change of control of the Bank or a charter amendment or to
cumulate their votes in the election of directors. Furthermore, the staggered
terms of the Board of Directors could have an anti-takeover effect by making
it more difficult for a majority of shares to force an immediate change in the
Board of Directors since only one-third of the Board is elected each year. The
purpose of these provisions is to assure stability and continuity of
management of the Bank in the years immediately following the Conversion.
Although the Bank has no arrangements, understandings or plans at the
present time, except as described in "Description of Capital Stock of the
Company--Preferred Stock," for the issuance or use of the shares of
undesignated Preferred Stock proposed to be authorized, the Board of Directors
believes that the availability of such shares will provide the Bank with
increased flexibility in structuring possible future financings and
acquisitions and in meeting other corporate needs which may arise. In the
event of a proposed merger, tender offer or other attempt to gain control of
the Bank of which management does not approve, it might be possible for the
Board of Directors to authorize the issuance of one or more series of
Preferred Stock with rights and preferences which could impede the completion
of such a transaction. An effect of the possible issuance of such Preferred
Stock, therefore, may be to deter a future takeover attempt. The Board of
Directors does not intend to issue any Preferred Stock except on terms which
the Board deems to be in the best interest of the Bank and its then existing
stockholders.
REGULATORY RESTRICTIONS
The Plan of Conversion prohibits any person, prior to the completion of the
Conversion, from transferring, or from entering into any agreement or
understanding to transfer, to the account of another, legal or beneficial
ownership of the subscription rights issued under the Plan or the Common Stock
to be issued upon their exercise. The Plan also prohibits any person, prior to
the completion of the Conversion, from offering, or making an announcement of
an offer or intent to make an offer, to purchase such subscription rights or
Common Stock.
For three years following the Conversion, OTS regulations prohibit any
person from acquiring or making an offer to acquire more than 10% of the stock
of any converted savings institution, except for: (i) offers that, if
consummated, would not result in the acquisition by such person during the
preceding 12-month period of more than 1% of such stock; (ii) offers for up to
25% in the aggregate by the ESOP or other tax qualified plans of the Bank or
the Company; or (iii) offers which are not opposed by the Board of Directors
of the Bank and which receive the prior approval of the OTS. Such prohibition
is also applicable to the acquisition of the stock of the Company. Such
acquisition may be disapproved by the OTS if it is found, among other things,
that the proposed acquisition (a) would frustrate the purposes of the
provisions of the regulations regarding conversions; (b) would be manipulative
or deceptive; (c) would subvert the fairness of the conversion; (d) would be
likely to result in injury to the savings institution; (e) would not be
consistent with economical home financing; (f) would otherwise violate law or
regulation; or (g) would not contribute to the prudent deployment of the
savings institution's conversion proceeds. In the event that any person,
directly or indirectly, violates this regulation, the securities beneficially
owned by such person in excess of 10% shall not be counted as shares entitled
to vote and shall not be voted by any person or counted as voting shares in
connection with any matters submitted to a vote of
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stockholders. The definition of beneficial ownership for this regulation
extends to persons holding revocable or irrevocable proxies for the Company's
stock under circumstances that give rise to a conclusive or rebuttable
determination of control under the OTS regulations. Persons holding revocable
or irrevocable proxies may be deemed to be beneficial owners of such
securities under OTS regulations and therefore prohibited from voting all or
the portion of such proxies in excess of the 10% aggregate beneficial
ownership limit. Such regulatory restrictions may prevent or inhibit proxy
contests for control of the Company or the Bank which have not received prior
regulatory approval.
In addition, the Change in Bank Control Act provides that no person, acting
directly or indirectly or through or in concert with one or more other
persons, may acquire control of a savings and loan holding company unless the
OTS has been given 60 days' prior written notice and has not objected to the
transaction. The HOLA provides that no company may acquire "control of a
savings and loan holding company without the prior approval of the OTS." Any
company that acquires such control becomes a "savings and loan holding
company" subject to registration, examination, and regulation by the OTS.
Pursuant to federal regulations, "control" of a savings and loan holding
company is conclusively deemed to have been acquired by, among other things,
the acquisition of more than 25% of any class of voting stock of the company
or irrevocable proxies representing more than 25% of any class of voting stock
of the company or the ability to control the election of a majority of the
directors. The regulations also establish a rebuttable presumption of
"control" upon the acquisition of more than 10% of any class of voting stock,
or of more than 25% of any class of stock, of a savings and loan holding
company, where certain enumerated "control factors" are also present in the
acquisition. The OTS may prohibit an acquisition by a person of "control" if
(i) it would result in a monopoly or substantially lessen competition, (ii)
the financial condition of the acquiring person might jeopardize the financial
stability of the institution, or (iii) the competence, experience, or
integrity of the acquiring person indicates that it would not be in the
interest of the depositors or the public to permit the acquisition of control
by such person or (iv) the proposed acquisition would have an adverse effect
on the deposit insurance funds. Applications by a company to acquire "control"
of a savings and loan holding company are evaluated by OTS based upon factors
such as the financial and managerial resources and future prospects of the
acquirer and the institution involved, competitive factors and the convenience
and needs of the community involved. The foregoing restrictions do not apply
to the acquisition of the Company's capital stock by one or more tax-qualified
employee stock benefit plans, provided that the plan or plans do not have
beneficial ownership in the aggregate of more than 25% of any class of equity
security of the Company.
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DESCRIPTION OF CAPITAL STOCK OF THE COMPANY
GENERAL
The Company is authorized to issue 75,000,000 shares of Common Stock having
a par value of $.01 per share and 5,000,000 shares of preferred stock having a
par value of $.01 per share (the "Preferred Stock"). Based on the sale of
Common Stock in connection with the Conversion and issuance of authorized but
unissued Common Stock in an amount up to 8% of the Common Stock issued in the
Conversion to the Foundation, the Company currently expects to issue up to
13,115,520 shares of Common Stock (or 15,082,848 in the event of an increase
of 15% in the Estimated Price Range) and no shares of Preferred Stock in the
Conversion. Except as discussed above in "Restrictions on Acquisition of the
Company and the Bank," each share of the Company's Common Stock will have the
same relative rights as, and will be identical in all respects with, each
other share of Common Stock. Upon payment of the Purchase Price for the Common
Stock, in accordance with the Plan, all such stock will be duly authorized,
fully paid and non-assessable.
THE COMMON STOCK OF THE COMPANY WILL REPRESENT NON-WITHDRAWABLE CAPITAL,
WILL NOT BE AN ACCOUNT OF AN INSURABLE TYPE AND WILL NOT BE INSURED BY THE
FDIC.
COMMON STOCK
Dividends. The Company can pay dividends out of statutory surplus or from
certain net profits if, as and when declared by its Board of Directors. The
payment of dividends by the Company is subject to limitations which are
imposed by law and applicable regulation. See "Dividend Policy" and
"Regulation." The holders of Common Stock of the Company will be entitled to
receive and share equally in such dividends as may be declared by the Board of
Directors of the Company out of funds legally available therefor. If the
Company issues Preferred Stock, the holders thereof may have a priority over
the holders of the Common Stock with respect to dividends.
Voting Rights. Upon Conversion, the holders of Common Stock of the Company
will possess exclusive voting rights in the Company. They will elect the
Company's Board of Directors and act on such other matters as are required to
be presented to them under Virginia law or the Company's Articles of
Incorporation or as are otherwise presented to them by the Board of Directors.
Except as discussed in "Restrictions on Acquisition of the Company and the
Bank," each holder of Common Stock will be entitled to one vote per share and
will not have any right to cumulate votes in the election of directors. If the
Company issues Preferred Stock, holders of the Preferred Stock may also
possess voting rights. Certain matters require an 80% shareholder vote. See
"Restrictions on Acquisition of the Company and the Bank."
As a federal mutual savings and loan association, corporate powers and
control of the Bank are vested in its Board of Directors, who elect the
officers of the Bank and who fill any vacancies on the Board of Directors as
it exists upon Conversion. Subsequent to Conversion, voting rights will be
vested exclusively in the owners of the shares of capital stock of the Bank,
which will be the Company, and voted at the direction of the Company's Board
of Directors. Consequently, the holders of the Common Stock will not have
direct control of the Bank.
Liquidation. In the event of any liquidation, dissolution or winding up of
the Bank, the Company, as holder of the Bank's capital stock, would be
entitled to receive, after payment or provision for payment of all debts and
liabilities of the Bank (including all deposit accounts and accrued interest
thereon) and after distribution of the balance in the special liquidation
account to Eligible Account Holders and Supplemental Eligible Account Holders
(see "The Conversion--Liquidation Rights"), all assets of the Bank available
for distribution. In the event of liquidation, dissolution or winding up of
the Company, the holders of its Common Stock would be entitled to receive,
after payment or provision for payment of all its debts and liabilities, all
of the assets of the Company available for distribution. If Preferred Stock is
issued, the holders thereof may have a priority over the holders of the Common
Stock in the event of liquidation or dissolution.
Preemptive Rights. Holders of the Common Stock of the Company will not be
entitled to preemptive rights with respect to any shares which may be issued.
The Common Stock is not subject to redemption.
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PREFERRED STOCK
None of the shares of the Company's authorized Preferred Stock will be
issued in the Conversion. Such stock may be issued with such preferences and
designations as the Board of Directors may from time-to-time determine. The
Board of Directors can, without stockholder approval, issue preferred stock
with voting, dividend, liquidation and conversion rights which could dilute
the voting strength of the holders of the Common Stock and may assist
management in impeding an unfriendly takeover or attempted change in control.
DESCRIPTION OF CAPITAL STOCK OF THE BANK
GENERAL
The Federal Stock Charter of the Bank, to be effective upon the Conversion,
authorizes the issuance of capital stock consisting of 18,000,000 shares of
common stock, par value $1.00 per share, and 2,000,000 shares of preferred
stock, par value $1.00 per share, which preferred stock may be issued in
series and classes having such rights, preferences, privileges and
restrictions as the Board of Directors may determine. Each share of common
stock of the Bank will have the same relative rights as, and will be identical
in all respects with, each other share of common stock. After the Conversion,
the Board of Directors will be authorized to approve the issuance of common
stock up to the amount authorized by the Federal Stock Charter without the
approval of the Bank's stockholders. Assuming that the holding company form of
organization is utilized, all of the issued and outstanding common stock of
the Bank will be held by the Company as the Bank's sole stockholder. THE
CAPITAL STOCK OF THE BANK WILL REPRESENT NON-WITHDRAWABLE CAPITAL, WILL NOT BE
AN ACCOUNT OF AN INSURABLE TYPE AND WILL NOT BE INSURED BY THE FDIC.
COMMON STOCK
Dividends. The holders of the Bank's common stock will be entitled to
receive and to share equally in such dividends as may be declared by the Board
of Directors of the Bank out of funds legally available therefor. See
"Dividend Policy" for certain restrictions on the payment of dividends and
"Federal and State Taxation--Federal Taxation" for a discussion of the
consequences of the payment of cash dividends from income appropriated to bad
debt reserves.
Voting Rights. Immediately after the Conversion, the holders of the Bank's
common stock will possess exclusive voting rights in the Bank. Each holder of
shares of common stock will be entitled to one vote for each share held,
subject to the right of shareholders to cumulate their votes for the election
of directors. During the five-year period after the effective date of the
Conversion, cumulation of votes will not be permitted. See "Restrictions on
Acquisition of the Company and the Bank--Anti-Takeover Effects of the
Company's Articles of Incorporation and Bylaws and Management Remuneration
Adopted in Conversion."
Liquidation. In the event of any liquidation, dissolution, or winding up of
the Bank, the holders of common stock will be entitled to receive, after
payment of all debts and liabilities of the Bank (including all deposit
accounts and accrued interest thereon) and distribution of the balance in the
special liquidation account to Eligible Account Holders and Supplemental
Eligible Account Holders, all assets of the Bank available for distribution in
cash or in kind. If preferred stock is issued subsequent to the Conversion,
the holders thereof may also have priority over the holders of common stock in
the event of liquidation or dissolution.
Preemptive Rights; Redemption. Holders of the common stock of the Bank will
not be entitled to preemptive rights with respect to any shares of the Bank
which may be issued. The common stock will not be subject to redemption. Upon
receipt by the Bank of the full specified purchase price therefor, the common
stock will be fully paid and non-assessable.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is Registrar and
Transfer Company, Crawford New Jersey.
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EXPERTS
The financial statements of the Bank and its subsidiary as of December 31,
1997 and 1996 and for each of the years in the three-year period ended
December 31, 1997, have been included in this Prospectus, in reliance upon the
report of Cherry, Bekaert & Holland, L.L.P., independent certified public
accountants, appearing elsewhere herein, and given on the authority of said
firm as experts in accounting and auditing.
FinPro has consented to the publication herein of the summary of its report
to the Bank and Company setting forth its opinion as to the estimated pro
forma market value of the Common Stock upon Conversion and its valuation with
respect to subscription rights.
LEGAL AND TAX OPINIONS
The legality of the Common Stock and the federal income tax consequences of
the Conversion will be passed upon for the Bank and the Company by Muldoon,
Murphy & Faucette, Washington, D.C., special counsel to the Bank and the
Company. The Commonwealth of Virginia tax consequences of the Conversion and
certain matters related to the Foundation will be passed upon for the Bank and
the Company by Cherry, Bekaert & Holland, L.L.P.
ADDITIONAL INFORMATION
The Company has filed with the SEC a registration statement under the
Securities Act with respect to the Common Stock offered hereby. As permitted
by the rules and regulations of the SEC, this Prospectus does not contain all
the information set forth in the registration statement. Such information can
be examined without charge at the public reference facilities of the SEC
located at 450 Fifth Street, N.W., Washington, D.C. 20549 and copies of such
material can be obtained from the SEC at prescribed rates. In addition, the
SEC maintains a web site (http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the SEC including the Company. This Prospectus contains a
description of the material terms and features of all material contracts,
reports or exhibits to the Registration Statement required to be described.
The statements contained in this Prospectus as to the contents of any contract
or other document filed as an exhibit to the registration statement are, of
necessity, brief descriptions thereof and are not necessarily complete; each
such statement is qualified by reference to such contract or document.
The Bank has filed an application for conversion with the OTS with respect
to the Conversion. Pursuant to the rules and regulations of the OTS, this
Prospectus omits certain information contained in that application. The
application may be examined at the principal office of the OTS, 1700 G Street,
N.W., Washington, D.C. 20552 and at the Office of the Regional Director of the
OTS located at 1475 Peachtree Street, NE, Atlanta, Georgia 30309.
In connection with the Conversion, the Company will register its Common
Stock with the SEC under Section 12(g) of the Exchange Act and, upon such
registration, the Company and the holders of its stock will become subject to
the proxy solicitation rules, reporting requirements and restrictions on stock
purchases and sales by directors, officers and greater than 10% stockholders,
the annual and periodic reporting and certain other requirements of the
Exchange Act. Under the Plan, the Company has undertaken that it will not
terminate such registration for a period of at least three years following the
Conversion. In the event that the Bank amends the Plan to eliminate the
concurrent formation of the Company as part of the Conversion, the Bank will
register its stock with the OTS under Section 12(g) of the Exchange Act and,
upon such registration, the Bank and the holders of its stock will become
subject to the same obligations and restrictions.
A copy of the Articles of Incorporation and the Bylaws of the Company and
the Federal Stock Charter and Bylaws of the Bank and the proposed Articles of
Incorporation and Bylaws of the Foundation are available without charge from
the Bank.
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FREDERICKSBURG SAVINGS AND LOAN
ASSOCIATION, F.A.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors............................................. F-l
Balance Sheets............................................................. F-2
Statements of Income....................................................... 35
Statements of Comprehensive Income......................................... F-3
Statements of Changes in Equity Capital.................................... F-4
Statements of Cash Flows................................................... F-5
Notes to Financial Statements.............................................. F-6
</TABLE>
Certain schedules required by OTS regulations and by Regulation S-X are not
included because they are not applicable or the required information has been
disclosed elsewhere.
Financial statements related to Virginia Capital Bancshares, Inc. are not
included as it has not begun operations.
F-0
<PAGE>
[CHERRY, BEKAERT & HOLLAND LOGO APPEARS HERE]
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Members
Fredericksburg Savings and Loan
Association, F.A.
Fredericksburg, Virginia
We have audited the accompanying balance sheets of Fredericksburg Savings
and Loan Association, F.A. as of December 31, 1997 and 1996, and the related
statements of income, comprehensive income, changes in equity capital, and
cash flows for each of the years in the three-year period ended December 31,
1997. These financial statements are the responsibility of the Association'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 Fredericksburg Savings and
Loan Association, F.A. as of December 31, 1997 and 1996, and the results of
its operations and its cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted
accounting principles.
/s/ CHERRY, BEKAERT & HOLLAND, L.L.P.
Richmond, Virginia
January 29, 1998, except to Note 16,
for which the date is August 14, 1998
F-1
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN F-2
ASSOCIATION, F.A.
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
JUNE 30,
1998 1997 1996
----------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents (includes interest-
bearing deposits of $8,248 at June 30, 1998;
$10,634 in 1997; $15,177 in 1996).............. $ 9,031 $ 11,287 $ 15,937
Investment securities
Held-to-maturity (fair value $1,226 at June
30, 1998; $1,335 in 1997; $1,545 in 1996).... 1,190 1,291 1,502
Available-for-sale (cost $30,470 at June 30,
1998; $30,865 in 1997; $32,261 in 1996)...... 30,928 31,151 31,979
Federal Home Loan Bank stock, restricted, at
cost........................................... 3,539 3,448 3,232
Loans receivable, net........................... 415,986 413,032 405,145
Accrued interest receivable
Loans......................................... 2,206 2,054 1,858
Investment securities......................... 508 543 588
Foreclosed real estate for sale, net............ 1,883 1,959 1,611
Property and equipment
Land.......................................... 1,115 1,115 1,120
Office properties and equipment, at cost, less
accumulated depreciation ($4,119 at June 30,
1998; $3,999 in 1997; $4,593 in 1996)........ 2,398 2,393 2,504
Other assets.................................... 183 269 813
Deferred tax asset.............................. 3,313 3,378 3,628
-------- -------- --------
Total assets................................ $472,280 $471,920 $469,917
======== ======== ========
LIABILITIES AND RETAINED EARNINGS
Liabilities
Deposits...................................... $373,719 $377,114 $375,652
Advances from Federal Home Loan Bank.......... 8,000 8,000 15,000
Retirement obligations........................ 5,593 5,480 4,934
Advances from borrowers for taxes and
insurance.................................... 1,234 936 844
Accrued expenses and other liabilities........ 234 317 191
-------- -------- --------
Total liabilities........................... 388,780 391,847 396,621
======== ======== ========
Commitments and contingencies
Retained earnings, substantially restricted..... 83,216 79,896 73,471
Unrealized gains (losses) on securities
available-for-sale, net of tax................. 284 177 (175)
-------- -------- --------
Total equity capital........................ 83,500 80,073 73,296
-------- -------- --------
Total liabilities and equity capital........ $472,280 $471,920 $469,917
======== ======== ========
</TABLE>
See notes to financial statements.
F-2
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN
ASSOCIATION, F.A.
STATEMENTS OF COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
------------------ ------------------------
1998 1997 1997 1996 1995
-------- -------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net income....................... $ 3,320 $ 3,259 $ 6,425 $ 4,581 $ 6,658
-------- -------- ------- ------- -------
Other comprehensive income-net of
tax:
Unrealized gains (losses) on
securities available for
sale.......................... 55 (199) 285 150 (192)
Less: reclassification
adjustment for gains (losses)
included in net income........ (52) (19) (67) 138 (19)
-------- -------- ------- ------- -------
Total other comprehensive
income...................... 107 (180) 352 12 (173)
-------- -------- ------- ------- -------
Comprehensive income............. $ 3,427 $ 3,079 $ 6,777 $ 4,593 $ 6,485
======== ======== ======= ======= =======
</TABLE>
See notes to financial statements.
F-3
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN
ASSOCIATION, F.A.
STATEMENTS OF CHANGES IN EQUITY CAPITAL
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
HOLDING GAINS
(LOSSES) OR
RETAINED AVAILABLE FOR
EARNINGS SALE SECURITIES TOTAL
-------- --------------- -------
<S> <C> <C> <C>
Balances at December 31, 1994................ $62,232 $ (14) $62,218
Net income................................. 6,658 -- 6,658
Changes in net unrealized gains/(losses) on
securities held available for sale, net of
reclassification adjustment............... -- (173) (173)
------- ----- -------
Balances at December 31, 1995................ 68,890 (187) 68,703
Net income................................. 4,581 -- 4,581
Changes in net unrealized gains/(losses) on
securities held available for sale, net of
reclassification adjustment............... -- 12 12
------- ----- -------
Balances at December 31, 1996................ 73,471 (175) 73,296
Net income................................. 6,425 -- 6,425
Changes in net unrealized gains/(losses) on
securities held available for sale, net of
reclassification adjustment............... -- 352 352
------- ----- -------
Balances at December 31, 1997................ 79,896 177 80,073
Net income (unaudited)..................... 3,320 -- 3,320
Changes in net unrealized gains/(losses) on
securities held available for sale, net of
reclassification adjustment (unaudited)... -- 107 107
------- ----- -------
Balances at June 30, 1998 (unaudited)........ $83,216 $ 284 $83,500
======= ===== =======
</TABLE>
See notes to financial statements.
F-4
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN
ASSOCIATION, F.A.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
------------------ ----------------------------
1998 1997 1997 1996 1995
-------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES
Net income.................. $ 3,320 $ 3,259 $ 6,425 $ 4,581 $ 6,658
Adjustments to reconcile net
income to net cash provided
by operating activities
Depreciation................ 172 181 371 377 385
Provision for loan losses... (269) (241) (375) (325) (412)
Increase (decrease) in
provision for loss on real
estate owned............... 54 (10) 87 (21) 18
Discount on mortgage-backed
securities................. (32) (29) (70) (79) (99)
Premium/discount on
investment securities...... 9 (10) 4 (29) 40
Loan fees deferred, net..... 110 226 266 192 90
(Increase) decrease in
deferred income taxes...... 8 (14) 34 (537) (332)
Loss on sale of property and
equipment.................. 29 5 16 7 5
(Gain) loss on sale of real
estate owned............... 2 (66) (5) 34 87
(Increase) decrease in
accrued interest
receivable................. (117) (244) (150) 358 (276)
(Increase) decrease in other
assets..................... 84 549 543 (590) (67)
Increase (decrease) in
advances by borrowers for
taxes and insurance........ 298 143 92 (35) 136
Increase in retirement
obligations................ 113 80 547 657 541
Increase (decrease) in other
liabilities................ (85) 163 125 (333) 269
-------- -------- -------- -------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES....... 3,696 3,992 7,910 4,257 7,043
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING
ACTIVITIES
Proceeds from maturities of
securities held-to-
maturity................... -- -- -- -- 15,450
Proceeds from sale of
securities available-for-
sale....................... -- -- -- 25,673 --
Proceeds from redemption of
securities available for
sale....................... 4,000 2,829 6,812 -- --
Purchases FHLB stock........ (91) (215) (215) (158) --
Proceeds from redemption of
FHLB stock................. -- -- -- -- 1,015
Purchase of securities held-
to-maturity................ -- -- -- -- (12,593)
Purchase of securities
available-for-sale......... (3,595) (2,621) (5,420) (8,347) (73)
Principal payments on
mortgage-backed securities
held to maturity........... 130 131 281 456 329
Loan originations and
principal payments, net.... (4,214) (7,640) (11,422) (17,487) (21,421)
Capital expenditures........ (181) (127) (271) (241) (464)
Proceeds from sale of real
estate owned............... 1,392 1,781 3,214 3,528 1,313
-------- -------- -------- -------- --------
NET CASH PROVIDED BY (USED
IN) INVESTING ACTIVITIES... (2,559) (5,862) (7,021) 3,424 (16,444)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING
ACTIVITIES
Net decrease in savings
accounts................... $ (4,370) $ (1,001) $ (4,894) $ (7,706) $(11,253)
Net increase (decrease) in
advance from Federal Home
Loan Bank.................. -- (5,000) (7,000) 7,000 --
Net increase (decrease) in
certificates of deposit.... 977 2,998 6,355 (3,018) 21,546
-------- -------- -------- -------- --------
NET CASH PROVIDED BY (USED
IN) FINANCING ACTIVITIES... (3,393) (3,003) (5,539) (3,724) 10,293
-------- -------- -------- -------- --------
NET INCREASE (DECREASE) IN
CASH AND CASH EQUIVALENTS... (2,256) (4,873) (4,650) 3,957 892
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD......... 11,287 15,937 15,937 11,980 11,088
-------- -------- -------- -------- --------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD............... $ 9,031 $ 11,064 $ 11,287 $ 15,937 $ 11,980
======== ======== ======== ======== ========
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION
Cash paid during the period
for interest............... $ 9,620 $ 9,569 $ 19,419 $ 19,534 $ 18,978
======== ======== ======== ======== ========
Cash paid during the period
for income taxes........... $ 2,165 $ 1,674 $ 3,591 $ 3,623 $ 4,166
======== ======== ======== ======== ========
SUPPLEMENTAL SCHEDULE OF NON-
CASH INVESTING ACTIVITIES
Loans transferred to real
estate owned............... $ 1,326 $ 1,779 $ 3,209 $ 3,512 $ 1,400
======== ======== ======== ======== ========
Investment securities
transferred to available-
for-sale, at fair value.... $ -- $ -- $ -- $ -- $ 49,257
======== ======== ======== ======== ========
Change in unrealized gain
(loss) in value of
securities available-for-
sale, net of tax effect.... $ 107 $ (180) $ 352 $ 12 $ (173)
======== ======== ======== ======== ========
</TABLE>
See notes to financial statements.
F-5
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN
ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Fredericksburg Savings & Loan
Association, F.A., "the Bank", are in accordance with generally accepted
accounting principles and conform to the general practices within the savings
institutions industry. The more significant of the principles used in
preparing the financial statements are briefly described below. Financial
statements and disclosures as of June 30, 1998 and for the six months ended
June 30, 1998 and 1997 are unaudited and, in the opinion of management of the
Bank, include all adjustments, consisting of normal recurring adjustments, for
a fair presentation of interim financial position and operating results.
Nature of operations
The Bank is a mutual savings and loan association with the primary business
of granting residential, commercial real estate and installment loans. As a
federally chartered savings institution, the Bank is subject to the regulation
of the Office of Thrift Supervision as well as the Federal Deposit Insurance
Corporation. The area served by the Bank is Fredericksburg, Virginia and the
surrounding counties. Services are provided at four business locations.
Reclassification of financial statement presentation
Certain of the prior year amounts have been reclassified or restated to
conform to the current presentation. Such reclassifications and restatements
are immaterial to the financial statements.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash equivalents
For purposes of reporting cash flows, the Bank considers all highly liquid
debt instruments with original maturities when purchased of three months or
less to be cash equivalents.
Investment securities and mortgage-backed securities
The Bank classifies its investment securities and its mortgage-backed
securities in one of three categories: held-to-maturity, available-for-sale,
and trading.
Securities held-to-maturity are purchased with the intent and ability to
hold to their maturity or call date. They are carried and reported at
amortized cost. The amortization of premium and accretion of discount are
recognized as adjustments to interest income. Securities available-for-sale
are those needed to meet liquidity needs, assist in portfolio restructuring,
or minimize interest rate market risk. They are carried at their fair value,
with unrealized gains and losses reported as a separate component of capital.
Securities that are bought and held principally for the purpose of selling
them in the near term are classified as trading securities. The Bank as a
matter of policy does not trade securities and, therefore, does not have
trading securities. Gains or losses on disposition of securities are computed
on the specific identification of the cost of each security.
Loans receivable and allowance for losses
Loans receivable are stated at the amount of unpaid principal, net of
participation or whole-loan interests owned by others, less the allowance for
loan losses, undisbursed loans in process, and net deferred loan
F-6
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
origination fees and discounts. The allowance for loan losses is increased by
charges to income and decreased by charge-offs (net of recoveries).
Management's periodic determination 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.
Impaired loans are measured based on the present value of expected cash
flows discounted at the loan's effective interest rate, or as a practical
expedient at the loan's observable market price or fair value of the
collateral if the loan is collateral dependent. Any change in fair value is
reported as bad debt expense in the same manner in which impairment initially
was recognized or as a reduction in the amount of bad debt expense that
otherwise would be reported.
Uncollectible interest on loans is charged off, or an allowance is
established based on management's periodic evaluation. The allowance is
established by a charge to interest income equal to all interest previously
accrued, and income is subsequently recognized only to the extent that cash
payments are received until, in management's judgment, the borrower's ability
to make periodic interest and principal payments is restored, in which case
the loan is returned to accrual status.
Loan sales
The Bank periodically generates additional funds for lending by selling
whole and/or participating interests in real estate loans. Gains or losses on
such sales are recognized at the time of sale and are determined by the
difference between the net sales proceeds and the unpaid principal balance of
the loans sold adjusted for any yield differential, servicing fees and
servicing cost applicable to future years. At each of the balance sheet dates
presented in the financial statements, the Bank was not holding any loans for
sale.
Loan origination fees and related costs
Fees charged on the origination of real estate loans and certain direct loan
origination costs are deferred and the net amount amortized as an adjustment
of the related loan's yield over the contractual life of the loan. Unamortized
fees on loans sold are recognized as adjustments to the basis of those loans
in the year of sale.
Foreclosed real estate
Real estate acquired in settlement of loans is classified as held for sale
and initially recorded at the lower of cost or fair value less estimated
selling costs at the date of foreclosure. Costs relating to development and
improvement of property are capitalized, whereas costs relating to the holding
of property are expensed. The portion of interest costs relating to the
development of real estate is capitalized.
Valuations are periodically performed by management, and an allowance for
losses is established by a charge to operations if the carrying value of a
property exceeds its fair value less estimated costs to sell.
Property and depreciation
The various classes of property and equipment are stated at cost less
accumulated depreciation computed principally by the straight-line method. The
costs of major improvements are capitalized, while the costs of maintenance
and repairs, which do not improve or extend the life of the respective
properties, are expensed
F-7
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
currently. The cost and accumulated depreciation on property are eliminated
from the accounts upon disposal, and any resulting gain or loss is included in
the determination of net income.
<TABLE>
<CAPTION>
ESTIMATED
USEFUL LIVES
------------
(YEARS)
<S> <C>
Land............................................................ --
Buildings....................................................... 5-39
Furniture, fixtures and equipment............................... 5- 7
</TABLE>
Income taxes
The Bank accounts for certain income and expense items differently for
financial reporting purposes than for purposes of computing income taxes
currently payable. Provisions for deferred taxes are made in recognition of
such timing differences.
The Bank has qualified under the provisions of the Internal Revenue Code
which permit it to deduct from taxable income an annual addition to the
reserve for bad debts based on the experience method. The tax bad debt reserve
is includible in taxable income of later years only if the bad debt reserves
are used subsequently for purposes other than to absorb bad debt losses. The
cumulative bad debt reserve, upon which no taxes have been paid, amounted to
$9,700 at June 30, 1998 and December 31, 1997.
Deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax
rates in effect for the year in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income tax expense in the period
that includes the enactment date.
New Accounting Pronouncements
The Statement of Financial Accounting Standards No. 131--Disclosure about
Segments of an Enterprise and Related Information
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information". SFAS No. 131 establishes standards for
reporting by public companies about operating segments of their business. SFAS
No. 131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. This Statement is effective
for periods beginning after December 15, 1997. At this time, management does
anticipate that the adoption of this Statement will significantly impact the
Bank's financial reporting.
The Statement of Financial Accounting Standards No. 132--Employers'
Disclosures about Pensions and Other Postretirement Benefits--an amendment of
FASB Statements N. 87, 88, and 106
In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures about
Pensions and Other Postretirement Benefits--an amendment of FASB Statements
No. 87, 88, and 106". SFAS No. 132 standardizes the disclosure requirements
for pensions and other postretirement benefits to the extent practicable,
requires additional information on changes in the benefit obligations and fair
value plan assets that will facilitate financial analysis, and eliminates
certain disclosures that are no longer useful as when Statements No. 87, 88,
and 106 were originally issued. SFAS 132 does not change the measurement
recognition of the plans. This statement is
F-8
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
effective for the periods beginning after December 15, 1997. At this time,
management does anticipate that the adoption of this Statement will
significantly impact the Bank's financial reporting.
The Statement of Financial Accounting Standards No. 133--Accounting for
Derivative Instruments and Hedging Activities
This Statement standardizes the accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, by
requiring that an entity recognize those items as assets or liabilities in the
statement of financial position and measure them at fair value. The bank is
evaluating the potential impact of adopting SFAS No. 133. Management does not
expect the adoption of SFAS No. 133 to have a material adverse impact on
financial condition or results of operation. The statement is effective for
all fiscal quarters of all fiscal years beginning after June 15, 1999.
Management does not expect to early adopt this Statement as permitted by the
Statement. At the initial application of this Statement, the Bank may elect to
transfer any security classified by the Bank as held-to-maturity to the
available-for-sale or trading classification. In addition, the Bank may elect
to transfer any security classified as available-for-sale to the trading
classification. Presently, management does not expect to elect these options.
NOTE 2--INVESTMENT SECURITIES
The amortized cost and estimated fair values of mortgage-backed securities
and investment securities are as follows as of June 30, 1998, and December 31,
1997 and 1996:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
SECURITIES HELD-TO-MATURITY
June 30, 1998 (unaudited)
Mortgage Backed Securities
FNMA pass-through securities....... $ 768 $ -- $ -- $ 768
GNMA certificates.................. 422 36 -- 458
------ ----- ----- ------
$1,190 $ 36 $ -- $1,226
====== ===== ===== ======
December 31, 1997
Mortgage Backed Securities
FNMA pass-through securities....... $ 838 $ -- $ -- $ 838
GNMA certificates.................. 453 44 -- 497
------ ----- ----- ------
$1,291 $ 44 $ -- $1,335
====== ===== ===== ======
December 31, 1996
Mortgage Backed Securities
FNMA pass-through securities....... $1,008 $ -- $ -- $1,008
GNMA certificates.................. 494 43 -- 537
------ ----- ----- ------
$1,502 $ 43 $ -- $1,545
====== ===== ===== ======
</TABLE>
F-9
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
FNMA pass-through securities are valued at net carrying value for fair value
purposes. Mortgage backed securities are not deemed to have a single maturity
date and no maturity grouping information has been presented.
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE-FOR-SALE
June 30, 1998 (unaudited)
U.S. Treasury and agency obliga-
tions............................. $16,814 $ 73 $ 12 $16,875
Corporate securities............... 4,856 62 12 4,906
State and local municipal bonds.... 1,290 34 23 1,301
Equity securities.................. 3,717 948 -- 4,665
Mutual fund........................ 1,293 -- 25 1,268
Dual Index Consolidated Bonds...... 2,500 -- 587 1,913
------- ------ ---- -------
$30,470 $1,117 $659 $30,928
======= ====== ==== =======
December 31, 1997
U.S. Treasury and agency obliga-
tions............................. $19,812 $ 82 $ 58 $19,836
Corporate securities............... 3,345 70 2 3,413
State and local municipal bonds.... 350 21 -- 371
Equity securities.................. 3,596 770 23 4,343
Mutual fund........................ 1,262 -- 20 1,242
Dual Index Consolidated Bonds...... 2,500 -- 554 1,946
------- ------ ---- -------
$30,865 $ 943 $657 $31,151
======= ====== ==== =======
December 31, 1996
U.S. Treasury and agency obliga-
tions............................. $20,823 $ 84 $104 $20,803
Corporate securities............... 3,995 99 -- 4,094
State and local municipal bonds.... 350 23 -- 373
Equity securities.................. 3,394 260 44 3,610
Mutual fund........................ 1,199 -- 24 1,175
Dual Index Consolidated Bonds...... 2,500 -- 576 1,924
------- ------ ---- -------
$32,261 $ 466 $748 $31,979
======= ====== ==== =======
</TABLE>
The mutual fund investments are in funds that invest primarily in obligations
of the U.S. Government or its agencies.
F-10
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
The amortized cost and estimated fair value of investment securities at June
30, 1998 and December 31, 1997 by contractual maturity, are shown below.
Expected maturities may differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
JUNE 30, 1998
(UNAUDITED) DECEMBER 31, 1997
------------------- -------------------
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
SECURITIES HELD-TO-MATURITY
Due after five years through ten
years................................ $ 768 $ 768 $ 838 $ 838
Due after ten years................... 422 458 453 497
------- ------- ------- -------
$ 1,190 $ 1,226 $ 1,291 $ 1,335
======= ======= ======= =======
SECURITIES AVAILABLE-FOR-SALE
Mutual Fund........................... $ 1,293 $ 1,268 $ 1,262 $ 1,242
Due in one year or less............... 14,231 12,717 14,593 15,351
Due after one year through five
years................................ 11,596 14,172 11,651 11,778
Due after five years through ten
years................................ 2,991 2,401 2,997 2,409
Due after ten years................... 359 370 362 371
------- ------- ------- -------
$30,470 $30,928 $30,865 $31,151
======= ======= ======= =======
</TABLE>
During 1993, the Bank acquired Dual Indexed Consolidated Bonds ("DICBs")
issued by the Federal Home Loan Bank ("FHLB"). DICBs' coupon rates are
determined by the difference between the designated Constant Maturity Treasury
("CMT") and the designated London Interbank Borrowing Rate ("LIBOR"). Interest
rates on DICBs are subject to reset annually at specified dates. This reset
may result in an interest rate less than those payable on conventional fixed
rate debt securities issued at the same time. These investments were acquired
as part of the interest rate risk management of the Bank.
The Secondary market for DICBs is affected by factors other than the credit
worthiness of the issuer. Such factors include other interest rates,
volatility of the two indices utilized, time remaining to maturity and the
amount of the outstanding bonds. Management of the Bank utilizes a third-party
investment advisory company to estimate the market value of the DICB's by
comparison to bid and asked prices of similar instruments. As these market
values are based on similar instruments, and are estimates, the actual value
the Bank would receive in a sale transaction is dependent upon the market for
these instruments at the time of disposition.
DICBs are classified by the Bank as available for sale and are recorded at
fair value with unrealized gains and losses included in Retained Earnings
Substantially Restricted. The DICBs were acquired at their face amount. The
consensus reached by the Emerging Issues Task Force ("EITF") Issue number 96-
12 requires interest income recognition for these instruments based upon the
retrospective interest method. The Bank recognizes interest income based on
the actual interest payments received. The difference between the
retrospective interest method and the method utilized is immaterial.
F-11
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
Disclosed below are the characteristics of each issue of DICBs, the indices
utilized and period-end coupon rates and market value. The Bank's exposure to
credit risk, on these instruments, is limited to the amount paid for each
DICB, if the FHLB fails to perform.
<TABLE>
<CAPTION>
JUNE 30, 1998
-------------
FACE INDEXING MARKET
ISSUER MATURITY AMOUNT FORMULA COUPON VALUE
------ -------- ------ ---------------------------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
FHLB................ 08/17/05 $1,000 (10 yr CMT+3.00%)-6 mo LIBOR 2.93% $ 766
FHLB................ 08/26/05 1,000 (10 yr CMT+3.00%)-6 mo LIBOR 3.03 772
FHLB................ 11/18/05 500 (10 yr CMT+2.75%)-6 mo LIBOR 2.68 375
------ ------
$2,500 $1,913
====== ======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1997 1996
-------------- --------------
FACE INDEXING MARKET MARKET
ISSUER MATURITY AMOUNT FORMULA COUPON VALUE COUPON VALUE
- ------ -------- ------ ---------------------------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
FHLB.. 08/17/05 $1,000 (10 yr CMT+3.00%)-6 mo LIBOR 3.408% $ 786 3.853% $ 765
FHLB.. 08/26/05 1,000 (10 yr CMT+3.00%)-6 mo LIBOR 3.472 788 3.940 771
FHLB.. 11/18/05 500 (10 yr CMT+2.75%)-6 mo LIBOR 2.764 372 3.499 369
------ ------ ------
$2,500 $1,946 $1,905
====== ====== ======
</TABLE>
NOTE 3--LOANS RECEIVABLE
Loans receivable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
JUNE 30,
1998 1997 1996
----------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Real estate mortgage loans
One to four family.......................... $367,041 $358,561 $345,799
Multi-family................................ 3,396 3,455 3,453
Non-residential real estate................. 35,316 40,951 44,528
Land and land development................... 2,321 3,091 4,136
-------- -------- --------
Total real estate mortgage loans.......... 408,074 406,058 397,916
Less: Amounts owned by holders of participat-
ing interests, net........................... (3,319) (4,217) (5,450)
-------- -------- --------
Net real estate mortgage loans............ 404,755 401,841 392,466
-------- -------- --------
Real estate construction and development
loans........................................ 19,960 16,046 21,285
Less: Undisbursed loan funds.................. (8,743) (4,978) (8,064)
-------- -------- --------
Net real estate construction loans........ 11,217 11,068 13,221
-------- -------- --------
Other loans
Consumer and other installment loans........ 9,192 8,913 8,046
-------- -------- --------
Total other loans......................... 9,192 8,913 8,046
-------- -------- --------
425,164 421,822 413,733
Less: Deferred loan fees...................... (3,539) (3,312) (3,045)
Allowance for loan losses................... (5,639) (5,478) (5,543)
-------- -------- --------
Net loans receivable........................ $415,986 $413,032 $405,145
======== ======== ========
</TABLE>
F-12
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
Amounts owned by holders of participating interests are not included in the
balance sheets. The unpaid principal balances of these loans are summarized as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
JUNE 30,
1998 1997 1996
----------- ------ ------
(UNAUDITED)
<S> <C> <C> <C>
FNMA, net of discount................................. $1,512 $2,222 $2,638
FHLMC................................................. 750 872 1,130
Other................................................. 1,057 1,123 1,682
------ ------ ------
$3,319 $4,217 $5,450
====== ====== ======
</TABLE>
Custodial escrow balances maintained in connection with the foregoing loan
servicing were $294 and $364 at June 30, 1998 and 1997, and $215, $130 and
$284 at December 31, 1997, 1996 and 1995, respectively.
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
-------------- ----------------------
1998 1997 1997 1996 1995
------ ------ ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period............ $5,478 $5,543 $5,543 $5,480 $5,537
Provision charged to operations....... 269 241 375 325 412
Loans charged off..................... (108) (187) (440) (263) (489)
Recoveries............................ -- -- -- 1 20
------ ------ ------ ------ ------
Balance, end of period.................. $5,639 $5,597 $5,478 $5,543 $5,480
====== ====== ====== ====== ======
</TABLE>
Impairment of loans having recorded investments of $8,476 at June 30, 1998,
$9,801 at December 31, 1997, $11,880 at December 31, 1996, and $10,756 at
December 31, 1995 have been recognized in conformity with FASB No. 114, as
amended by FASB No. 118. The average recorded investment in impaired loans
during 1998, 1997, 1996, and 1995 was $8,860, $10,466, $13,257, and $12,205,
respectively. The total allowance for loan losses related to these loans was
$659 on June 30, 1998, $669 and $729 on December 31, 1997 and 1996, and $807
on December 31, 1995, respectively. Interest income foregone associated with
these loans was $114 and $323 for the six months ended June 30, 1998 and 1997,
$193 for December 31, 1997 and $438 for December 31, 1996, and $198 for
December 31, 1995.
Loans having carrying values of $1,326, $3,209 , $3,512, and $2,471 were
transferred to foreclosed real estate in 1998, 1997, 1996, and 1995,
respectively.
The Bank is not committed to lend additional funds to debtors whose loans
have been modified.
Unspecified residential loans of approximately $208,000 at June 30, 1998 and
December 31, 1997, and approximately $199,000 at December 31, 1996 have been
pledged to the Federal Home Loan Bank under a floating blanket lien as
collateral for advances from that bank. See Note 6.
F-13
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 4--FORECLOSED REAL ESTATE FOR SALE
Foreclosed real estate consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
JUNE 30,
1998 1997 1996
----------- ------ ------
(UNAUDITED)
<S> <C> <C> <C>
Foreclosed real estate.............................. $2,063 $2,085 $1,650
Less allowance for losses........................... (180) (126) (39)
------ ------ ------
$1,883 $1,959 $1,611
====== ====== ======
</TABLE>
A summary of the foreclosed real estate operations is as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
-------------- ----------------------
1998 1997 1997 1996 1995
------ ------ ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Foreclosed real estate
Foreclosed real estate sales......... $1,392 $1,781 $3,214 $3,528 $1,313
Cost of sales........................ 1,326 1,779 3,209 3,512 1,400
Increase (decrease) in reserve....... 54 (11) 87 (21) 18
Selling and other expenses........... 37 34 81 167 79
------ ------ ------ ------ ------
Net loss........................... $ (25) $ (21) $ (163) $ (130) $ (184)
====== ====== ====== ====== ======
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Activity in the allowance for losses for real estate
owned is summarized as follows:
<CAPTION>
JUNE 30, DECEMBER 31,
------------- -----------------
1998 1997 1997 1996 1995
--------------------------- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period................. $ 126 $ 39 $ 39 $ 60 $ 42
Provision for losses......................... 95 3 167 122 112
Charge-offs.................................. (41) (13) (80) (143) (94)
------ ----- ---- ----- ----
Balance, end of period....................... $ 180 $ 29 $126 $ 39 $ 60
====== ===== ==== ===== ====
</TABLE>
NOTE 5--DEPOSITS
Deposits summarized by interest rates were as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
------------------- ----------------------------------
1998 1997 1996
------------------- ---------------- ----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- ------- -------- ------- -------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Passbook accounts
(weighted average rate
of 3.25% and 3.24%).... $ 37,818 10.10% $ 38,708 10.26% $ 39,659 10.56%
Non-interest bearing de-
posits................. 2,481 0.70 3,266 0.87 2,451 0.65
Money market accounts
(weighted average rate
of 3.25% and 3.26%).... 43,141 11.50 45,839 12.16 50,596 13.47
-------- ------ -------- ------ -------- ------
83,440 22.30 87,813 23.29 92,706 24.68
-------- ------ -------- ------ -------- ------
Certificates:
Up to 4.00%............. -- -- -- -- 18 0.01
4.01% to 5.00%.......... 19,299 5.16 17,303 4.58 42,404 11.28
5.01% to 6.00%.......... 243,579 65.18 233,582 61.94 183,490 48.85
6.01% to 7.00%.......... 24,239 6.49 32,589 8.64 51,217 13.63
7.01% to 8.00%.......... 3,162 0.87 5,827 1.55 5,817 1.55
-------- ------ -------- ------ -------- ------
290,279 77.70 289,301 76.71 282,946 75.32
-------- ------ -------- ------ -------- ------
Total deposits.......... $373,719 100.00% $377,114 100.00% $375,652 100.00%
======== ====== ======== ====== ======== ======
</TABLE>
F-14
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
The aggregate amount of short-term jumbo certificates of deposit with a
minimum denomination of $100 was approximately $45,346 at June 30, 1998, and
$21,270 and $39,805 at December 31, 1997 and 1996, respectively. Deposits in
excess of $100 are not federally insured.
The scheduled maturities of certificates of deposit are as follows:
<TABLE>
<CAPTION>
JUNE 30, 1998 DECEMBER 31,1997
------------- ----------------
(UNAUDITED)
<S> <C> <C>
One Year or Less.............................. $196,666 $192,592
Over One Through Two Years.................... 48,743 56,227
Over Two Through Three Years.................. 23,760 25,827
Over Three Through Four Years................. 8,988 3,645
Over Four Through Five Years.................. 12,122 11,011
-------- --------
$290,279 $289,302
======== ========
</TABLE>
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
------------- -----------------------
1998 1997 1997 1996 1995
------ ------ ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Passbook savings......................... $ 614 $ 614 $ 1,237 $ 1,336 $ 1,408
Money market............................. 726 822 1,619 1,692 1,921
NOW...................................... 4 3 6 7 7
Certificates of deposit.................. 8,031 7,823 15,954 16,041 15,096
------ ------ ------- ------- -------
$9,375 $9,262 $18,816 $19,076 $18,432
====== ====== ======= ======= =======
</TABLE>
NOTE 6--ADVANCES FROM FEDERAL HOME LOAN BANK
The advances to the Bank consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
INTEREST JUNE 30,
MATURITY DATE RATE 1998 1997 1996
------------- -------- ----------- ------ -------
(UNAUDITED)
<S> <C> <C> <C> <C>
January 6, 1997.......................... 6.53% $ -- $ -- $ 5,000
November 24, 1997........................ 5.66% -- -- 2,000
November 22, 1999........................ 6.09% 3,000 3,000 3,000
November 28, 2001........................ 6.25% 5,000 5,000 5,000
------ ------ -------
$8,000 $8,000 $15,000
====== ====== =======
</TABLE>
The Bank had approved borrowing capacity at the FHLB for $45 million as of
June 30, 1998, December 31, 1997 and 1996. The unused portion of this facility
aggregated $37 million at June 30, 1998 and December 31, 1997 and $30 million
at December 31, 1996.
NOTE 7--RETIREMENT OBLIGATIONS
Following is a description of each of the Bank's retirement plans. Total
retirement plan obligations of the Bank for all of the Plans was $5.6 million,
$5.5 million and $4.9 million at June 30, 1998, December 31, 1997 and December
31, 1996, respectively.
F-15
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
PENSION PLAN
The Bank has a qualified, noncontributory defined benefit plan covering
substantially all of its full-time employees. The benefits are based upon the
employee's average compensation during the last five years of employment. To
qualify initially, employees must have worked 1,000 hours in a twelve month
period. An employee becomes fully vested upon completion of 5 years of
qualifying service. The amounts of retirement plan expense recognized in the
Bank's statements of income for this plan totaled $169, and $108 for the six
months ended June 30, 1998 and 1997, respectively, $226 for 1997, $136 for
1996, and $426 for 1995. The Bank contributes to the plan the maximum
allowable amount in accordance with ERISA funding standards.
The Plan's assets are invested in managed stock and bond investment accounts
held by the Plan trustee and in certificates of deposit of $2,447 at June 30,
1998, $2,137 in 1997 and $2,055 in 1996 with the Bank.
The discount rate and rate of future compensation levels used in determining
the actuarial present value of the projected benefit obligation were 7.5% and
5.5%, respectively, and the expected long-term rates of return on assets used
in the computations was 7.00% at June 30, 1998, and 7.75% for 1997 and 1996.
The following sets forth the plan's funded status and amounts recognized in
the Bank's financial statements as of the actuarial dates of June 30, 1998,
December 31, 1997 and 1996.
<TABLE>
<CAPTION>
DECEMBER 31
----------------
JUNE 30,
1998 1997 1996
----------- ------- -------
(UNAUDITED)
<S> <C> <C> <C>
Accumulated benefit obligation, fully vested.... $ 2,709 $ 2,509 $ 2,627
======= ======= =======
Projected benefit obligation.................... $ 4,361 $ 4,061 $ 4,094
Market value of plan assets..................... 4,902 4,761 4,712
------- ------- -------
Excess of projected benefit obligation over mar-
ket value of plan assets....................... 541 700 618
Unrecognized net transition amount.............. 627 668 752
Unrecognized prior service cost................. (210) (219) (237)
Unrecognized net (gain) loss.................... (1,192) (1,573) (1,781)
------- ------- -------
Accrued pension liability (included in retire-
ment obligations).............................. $ (234) $ (424) $ (648)
======= ======= =======
</TABLE>
The components of net pension expense are as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
------------ -------------------
1998 1997 1997 1996 1995
----- ----- ----- ----- -----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Service cost--benefits earned during the
period.................................... $ 113 $ 106 $ 212 $ 201 $ 209
Interest cost on projected benefit obliga-
tion...................................... 137 138 277 313 268
Expected return on plan assets............. (181) (170) (341) (306) (516)
Net amortization and deferral.............. -- (6) (12) 28 301
----- ----- ----- ----- -----
Net pension expense........................ $ 69 $ 68 $ 136 $ 236 $ 261
===== ===== ===== ===== =====
</TABLE>
MANAGEMENT SECURITY PLAN
The Bank established a non-qualified deferred compensation plan in 1986 for
certain management personnel, known as the Fredericksburg Savings and Loan
Association, F.A. Management Security Plan. This
F-16
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
plan is structured to provide benefits upon retirement based on years of
service to the Bank. Participants are to receive benefits for life and are
eligible for retirement at age 55. If the participant passes away before the
age of 80, the benefits shall continue to be paid to the named beneficiary
until such time the participant would have reached such age. Deferred
compensation expense amounted to $216 for the six months ended June 30, 1998
and 1997, respectively, and $432, $297, and $426 for the years ended December
31, 1997, 1996, and 1995, respectively. At June 30, 1998, December 31, 1997
and 1996, the balance of their management security trust plan was
approximately $5,958, $4,342 and $3,376, respectively, which is included in
investment securities classified as available-for-sale. The use of these funds
is restricted to fulfilling the deferred compensation obligation, subject to
the claims of creditors in a bankruptcy proceeding. The Bank has recorded the
assets and liabilities for the non-qualified deferred compensation plan as
gross amounts in the balance sheet.
SUPPLEMENTAL RETIREMENT AGREEMENT
During 1996, the Bank entered into a non-funded supplemental retirement
agreement with its former chairman of the board. Deferred compensation expense
related to this agreement amounted to $56 for the six months ended June 30,
1998 and 1997, $112 for 1997, and $0 for 1996.
401(K) PLAN
The Bank maintains the Fredericksburg Savings and Loan Association, F.A.
Salary Savings Plan (the "401(k) Plan"), a tax-qualified profit sharing plan
with a qualified cash or deferred arrangement under Section 401(k) of the
Code. Eligible employees may begin participating in the 401(k) Plan upon the
completion of one-half of one "Year of Service" and attainment of age 21.
Participants may make contributions to the plan during the year, with certain
limitations placed on such contributions. The Bank is required to contribute
to the plan an amount equal to one-half the basic contribution made by a
participant to a maximum of 6% per participant. Expenses of the plan totaled
$31 and $25 for the six months ended June 30, 1998 and 1997, $58 for the year
ended December 31, 1997, $67 for the year ended December 31, 1996, and $62 for
the year ended December 31, 1995.
NOTE 8--RELATED PARTY TRANSACTIONS
The Bank has made loans to various officers and directors, collateralized by
the personal residences of the borrowers or their deposits in the Bank. Loans
outstanding to officers and directors totaled $2,136 at June 30, 1998, $2,302
at December 31, 1997 and $2,350 at December 31, 1996. New loans to officers
and directors for the first six months in 1998 were approximately $331 and
$225 in 1997.
Loans to executive officers and directors are generally made on the same
terms and conditions as for other loans. The Bank does not expect to incur any
losses with respect to these loans.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
JUNE 30,
1998 1997 1996 1995
----------- ---- ----- ----
(UNAUDITED)
<S> <C> <C> <C> <C>
Beginning balance............................. $ 493 $543 $ 690 $612
Additions..................................... 214 -- -- 157
Repayments.................................... (134) (50) (147) (79)
----- ---- ----- ----
Ending balance................................ $ 573 $493 $ 543 $690
===== ==== ===== ====
</TABLE>
F-17
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 9--REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory--and possibly discretionary--actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weighting, and other factors.
Qualitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management believes, as of June 30, 1998, that
the Bank meets all capital adequacy requirements to which it is subject.
As of June 30, 1998, the most recent notification from the Office of Thrift
Supervision categorized the Bank as well capitalized under the regulatory
framework for corrective action. To be categorized as well capitalized, the
Bank must maintain minimum total core capital, tangible capital, and risk-
based capital leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
The Bank's actual capital amounts and ratios are also presented in the
table.
<TABLE>
<CAPTION>
WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------- ------------------- ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ---------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1998
Core Capital (To total as-
sets).................... $79,903 17.05 $ 14,062 3.00 $ 23,610 5.00
Tangible Capital (To total
assets).................. 79,903 17.05 7,031 1.50 14,166 3.00
Risk-Based Capital (To
risk weighted assets).... 83,446 29.78 22,414 8.00 28,186 10.00
As of December 31, 1997
Core Capital (To total as-
sets).................... 26,518 16.34 14,109 3.00 23,515 5.00
Tangible Capital (To total
assets).................. 76,518 16.34 7,054 1.50 14,109 3.00
Risk-Based Capital (To
risk weighted assets).... 80,056 26.92 22,878 8.00 28,597 10.00
As of December 31, 1996
Core Capital (To total as-
sets).................... 71,843 14.97 14,049 3.00 23,414 5.00
Tangible Capital (To total
assets).................. 71,843 14.97 7,024 1.50 14,049 3.00
Risk-Based Capital (To
risk weighted assets).... 75,280 25.70 21,905 8.00 27,381 10.00
</TABLE>
F-18
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
The following is equity capital determined in accordance with GAAP
reconciled to core capital, tangible capital and risk-based capital at June
30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
JUNE 30, 1998 (UNAUDITED) DECEMBER 31, 1997
----------------------------- -----------------------------
CORE TANGIBLE RISK-BASED CORE TANGIBLE RISK-BASED
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
------- -------- ---------- ------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
GAAP equity capital..... $83,500 $83,500 $83,500 $80,073 $80,073 $80,073
Deferred tax asset...... (3,313) (3,313) (3,313) (3,378) (3,378) (3,378)
Unrealized losses
(gains) on available-
for-sale securities.... (284) (284) (284) (177) (177) (177)
Allowances for loan and
lease losses........... -- -- 3,543 -- -- 3,538
------- ------- ------- ------- ------- -------
$79,903 $79,903 $83,446 $76,518 $76,518 $80,056
======= ======= ======= ======= ======= =======
</TABLE>
NOTE 10--OFF BALANCE SHEET RISKS
Financial instruments with off-balance sheet risk include commitments to
extend credit made in the normal course of business. These commitments to
extend credit are not shown in the accompanying financial statements. The Bank
uses the same credit policies in making commitments, evaluates each customers'
credit worthiness on a case-by-case basis and requires collateral to support
financial instruments with credit risk. Collateral held varies, but generally
includes real estate, primarily single-family homes, and in some cases,
income-producing commercial properties. At June 30, 1998, the Bank had
commitments to originate loans of approximately $23,896 and approximately
$10,563 at December 31, 1997. Of these commitments, $23,341 and $10,307 were
fixed rate loan commitments at June 30, 1998 and December 31, 1997
respectively. The fixed rate loan commitments were at interest rates ranging
from 6.25% to 9.75% for both periods.
Standby letters of credit are conditional commitments issued by the Bank.
The credit risk involved in issuing letters of credit is essentially the same
as that involved in extending loans to customers. At June 30, 1998, the Bank
was conditionally committed under standby letters of credit aggregating
approximately $836 and at December 31, 1997 approximately $1,077. The Bank
does not expect to fund any of the letters of credit.
The amount of unfunded lines of credit for home equity loans was
approximately $3,020 at June 30, 1998 and $3,005 at December 31, 1997.
In the ordinary course of business, the Bank has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying financial statements. In addition, the Bank is a defendant in
certain claims and legal actions arising in the ordinary course of business.
In the opinion of management, after consultation with legal counsel, the
ultimate disposition of these matters is not expected to have a material
adverse effect on the financial condition of the Bank.
NOTE 11--MARKET CONCENTRATION
The Bank has a diversified loan portfolio consisting of commercial and
residential real estate and installment loans. Substantially all of the Bank's
customers are residents or operate business ventures in its market area
consisting of the Fredericksburg Standard Metropolitan Statistical Area
(SMSA). Therefore, a substantial portion of its debtors' ability to honor
their contracts is influenced by the economic conditions in this market area.
F-19
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 12--DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of financial instruments.
Cash and cash equivalents
Fair value of cash and cash equivalents is assumed to be book value.
Investment securities
For U.S. Treasury and Agency securities, fair values are based on market
prices or dealer quotes. For other investment securities, fair value equals
quoted market price if available.
Mortgage-backed securities
Fair value of mortgage securities is assumed to be net book value for FNMA
pass-through securities and quoted market prices for GNMA certificates.
Loans
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as commercial, residential
mortgage and consumer. Each loan category is further segmented into fixed and
adjustable rate interest terms and by performing and non-performing
categories.
The fair value of performing loans is calculated by discounting scheduled
cash flows through the estimated maturity using estimated market discount
rates that reflect the credit and interest rate risk inherent in the loan.
Deposits
Fair value of passbook and money market accounts is defined as the amounts
payable on demand at the reporting date. The fair value of fixed maturity
certificates of deposit is estimated based on the rates currently offered for
deposits of similar maturities
Advances
Fair value of advances outstanding is estimated based on the rates currently
available for advances of similar maturities.
Commitments to extend credit and standby letters of credit
The fair value of commitments is estimated using the fees currently charged
to enter into similar agreements, taking into account the remaining terms of
the agreements and the present credit-worthiness of the counter parties. All
commitments to extend credit and standby letters of credit are issued on a
short-term or floating rate basis. The fair value of these instruments is not
material.
The estimated fair values of the Bank's financial instruments are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------
JUNE 30,
1998 1997 1996
------------------ ------------------ ------------------
(UNAUDITED)
CARRYING EST. FAIR CARRYING EST. FAIR CARRYING EST. FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
-------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Financial assets
Cash.................. $ 9,031 $ 9,031 $ 11,287 $ 11,287 $ 15,937 $ 15,937
Investment
securities........... 30,470 30,928 30,865 31,151 32,261 31,979
Mortgage-backed
securities........... 1,190 1,226 1,291 1,335 1,502 1,545
Loans................. 415,986 421,646 413,032 416,508 405,145 405,540
Financial liabilities
Deposits.............. 373,719 372,237 377,114 376,181 375,652 374,753
Advances.............. 8,000 7,965 8,000 7,995 15,000 15,060
</TABLE>
F-20
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
NOTE 13--INCOME TAXES
Deferred income taxes result from timing differences in the recognition of
income and expense for income tax and financial reporting purposes. The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities at June 30, 1998 and December
31, 1997 and 1996 are summarized below:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
JUNE 30,
1998 1997 1996
----------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C>
Deferred tax assets
Allowance for loan losses....................... $2,270 $2,116 $2,108
Deferred compensation........................... 2,125 2,082 1,875
Other........................................... 31 31 361
------ ------ ------
Total gross deferred tax assets................... 4,426 4,229 4,344
------ ------ ------
Deferred tax liabilities
FHLB stock dividends............................ 480 480 480
Depreciation.................................... 250 250 236
Other........................................... 383 121 --
------ ------ ------
Total gross deferred tax liabilities.......... 1,113 851 716
------ ------ ------
Net deferred tax asset........................ $3,313 $3,378 $3,628
====== ====== ======
</TABLE>
The following is a reconciliation of the differences between the statutory
Federal income tax rate and the effective income tax rate for the six months
ended June 30, 1998 and the years ended December 31, 1997 and 1996.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
JUNE 30,
1998 1997 1996 1995
----------- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C>
Tax at expected rates........................... 34.0% 34.0% 34.0% 34.0%
Increases (decreases) in taxes resulting from
Tax exempt interest income..................... (2.2) (2.0) (2.8) (2.0)
State income tax, net of federal tax benefit.... 3.7 3.5 3.5 3.9
Other........................................... 4.5 2.6 4.8 2.0
---- ---- ---- ----
40.0% 38.1% 39.5% 37.9%
==== ==== ==== ====
</TABLE>
F-21
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
-------------- ----------------------
1998 1997 1997 1996 1995
------ ------ ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Current tax expense
U.S. Federal.......................... $2,143 $2,375 $3,437 $2,568 $4,093
State................................. 137 152 553 375 415
------ ------ ------ ------ ------
Total current....................... 2,280 2,527 3,990 2,943 4,508
------ ------ ------ ------ ------
Deferred tax expense
U.S. Federal.......................... (61) (354) (36) (509) (412)
State................................. (4) (23) (2) (33) (26)
------ ------ ------ ------ ------
Total deferred...................... (65) (377) (38) (542) (438)
------ ------ ------ ------ ------
Total expense....................... $2,215 $2,150 $3,952 $2,401 $4,070
====== ====== ====== ====== ======
</TABLE>
NOTE 14--COMPREHENSIVE INCOME
Effective January 1, 1998, the Bank adopted SFAS No. 130, "Reporting
Comprehensive Income". Statement No. 130 required the reporting of
comprehensive income in addition to net income from operations. Comprehensive
income is a more inclusive financial reporting methodology that includes
disclosure of certain financial information that historically has not been
recognized in the calculation of net income.
The Bank holds securities as "Available for Sale" and will sell securities,
or have securities redeemed, which give rise to comprehensive income.
F-22
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
The components of comprehensive income are detailed below, indicating the
tax effect to each item.
<TABLE>
<CAPTION>
TAX NET OF
BEFORE EXPENSE TAX
TAX (BENEFIT) AMOUNT
------ --------- ------
<S> <C> <C> <C>
For the period ended:
1995
Unrealized holding gains (losses) arising during the
period.............................................. $(310) $(118) $(192)
Less: reclassification adjustment for gains (losses)
realized in net income.............................. (31) (12) (19)
----- ----- -----
Net unrealized gains (losses)...................... (279) (106) (173)
----- ----- -----
Other comprehensive income............................. $(279) $(106) $(173)
===== ===== =====
1996
Unrealized holding gains (losses) arising during the
period.............................................. $ 242 $ 92 $ 150
Less: reclassification adjustment for gains (losses)
realized in net income.............................. 223 85 138
----- ----- -----
Net unrealized gains (losses)...................... 19 7 12
----- ----- -----
Other comprehensive income............................. $ 19 $ 7 $ 12
===== ===== =====
1997
Unrealized holding gains (losses) arising during pe-
riod................................................ $ 460 $ 175 $ 285
Less: reclassification adjustment for gains (losses)
realized in net income.............................. 108 41 67
----- ----- -----
Net unrealized gains (losses)...................... 568 216 352
----- ----- -----
Other comprehensive income............................. $ 568 $ 216 $ 352
===== ===== =====
June 30, 1997 (unaudited)
Unrealized holding gains (losses) arising during pe-
riod (unaudited).................................... $(321) $(122) $(199)
Less: reclassification adjustment for gains (losses)
realized in net income (unaudited).................. (31) (12) (19)
----- ----- -----
Net unrealized gains (losses) (unaudited).......... (290) (110) (180)
----- ----- -----
Other comprehensive income (unaudited)................. $(290) $(110) $(180)
===== ===== =====
June 30, 1998 (unaudited)
Unrealized holding gains (losses) arising during pe-
riod (unaudited).................................... $ 89 $ 34 $ 55
Less: reclassification adjustment for gains (losses)
realized in net income (unaudited).................. (84) (32) (52)
----- ----- -----
Net unrealized gains (losses) (unaudited).......... 173 66 107
----- ----- -----
Other comprehensive income (unaudited)................. $ 173 $ 66 $ 107
===== ===== =====
</TABLE>
NOTE 15--SUBSEQUENT EVENTS
On January 12, 1998, agreement was reached with an individual borrower to
accept deeds in lieu of foreclosure on sixteen properties collateralizing
mortgage loans. The outstanding principal balance of these loans aggregated
approximately $627 as of December 31, 1997. During the month of January 1998,
management obtained appraisals on the above referenced properties. These
appraisals indicated that sufficient loan to value of the underlying
properties existed to not require an addition to the allowance for losses.
F-23
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
On January 13, 1998, the Board of Directors granted approval to borrow an
additional $10,000 from the Federal Home Loan Bank at a 10 year term. Such
advances would be collateralized by certain qualifying real estate mortgage
loans under a blanket floating lien.
NOTE 16--PLAN OF CONVERSION
On July 14, 1998, the Board of Directors of the Bank adopted the Plan of
Conversion (the "Plan") pursuant to which the Bank will convert from a
federally chartered mutual savings bank to a federally chartered stock savings
bank. All of the outstanding common stock of the Bank will be acquired in
exchange for a portion of the net conversion proceeds (the "Conversion") by a
holding company formed expressly for such purpose (the "Company"). All of the
stock to be issued in the Conversion is being offered to eligible account
holders as of June 30, 1997.
The Bank plans to establish an ESOP for the benefit of eligible employees,
to become effective upon the Conversion. The ESOP intends to purchase up to 8%
of the Common Stock issued in the Conversion utilizing proceeds of a loan from
the Company or a third party lender. The loan will be repaid over a period of
20 years and the collateral for the loan will be the common stock purchased by
the ESOP.
Pursuant to the Plan, the Company intends to establish a Charitable
Foundation ("Foundation") in connection with the Conversion. The Plan provides
that the Bank and the Company will create the Foundation and donate an amount
of the Company's common stock equal to 8% of the common stock to be sold in
the Conversion. The Foundation will be dedicated to charitable purposes within
the communities in which the Bank operates and to complement the Bank's
existing community activities. Establishment of the Foundation is subject to
the approval of the Bank's members at the special meeting being held to vote
upon the Conversion.
The Foundation will submit a request to the Internal Revenue Service to be
recognized as a tax-exempt organization and would likely be classified as a
private foundation. A contribution of common stock to the Foundation by the
Company would be tax deductible, under Federal regulations, subject to a
limitation based on 10 percent of the Company's taxable income. The Company,
however, would be able to carry forward any unused portion of the deduction
for five years following the contribution. Upon funding the Foundation, the
Company will recognize an expense in the full amount of the contribution,
offset in part by the corresponding benefit for the tax deduction, during the
quarter in which the contribution is made.
The Bank may provide support services to the Foundation including, but not
limited to, employee time, office space and accounting support. The Bank
expects to provide these services without compensation, however, expenses
incurred on behalf of the Foundation are not expected to be significant to the
operations of the Bank.
At the time of Conversion, the Bank will establish a liquidation account in
an amount equal to its equity as reflected in the latest balance sheet used in
the final conversion prospectus. The liquidation account will be maintained
for the benefit of eligible account holders and supplemental eligible account
holders who continue to maintain their accounts at the Bank after the
Conversion. The liquidation account will be reduced annually to the extent
that eligible account holders and supplemental eligible account holders have
reduced their qualifying deposits as of each anniversary date. Subsequent
increases will not restore an eligible account holder's or supplemental
account holder's interest in the liquidation account. In the event of a
complete liquidation of the Bank, each eligible account holder and
supplemental eligible account holder will be entitled to receive a
distribution from the liquidation account in an amount proportionate to the
current adjusted qualifying balances for accounts then held.
F-24
<PAGE>
FREDERICKSBURG SAVINGS AND LOAN ASSOCIATION, F.A.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
The costs associated with Conversion will be deferred and will be deducted
from the proceeds upon the sale and issuance of stock. In the event the
Conversion is not consummated, costs incurred will be charged to expense. At
June 30, 1998, there were no deferred conversion costs.
After the conversion, the Bank may not declare or pay dividends on its stock
if such declaration and payment would violate statutory or regulatory
requirements.
NOTE 17--OTHER NONINTEREST EXPENSE
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
----------- --------------------
1998 1997 1997 1996 1995
------ ---- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Professional fees............................. $ 327 $118 $ 603 $ 115 $ 216
Data processing............................... 177 169 303 259 124
Printing and supplies......................... 80 63 153 90 110
Directors fees................................ 92 85 174 189 185
Charitable contributions...................... 73 57 95 92 96
Advertising................................... 47 63 115 167 160
Other non-interest expense.................... 271 322 611 654 558
------ ---- ------ ------ ------
$1,067 $877 $2,054 $1,566 $1,449
====== ==== ====== ====== ======
</TABLE>
F-25
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFOR-
MATION OR TO MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED IN THIS PROSPEC-
TUS IN CONNECTION WITH THE OFFERING MADE HEREBY, AND, IF GIVEN OR MADE, SUCH
OTHER INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AU-
THORIZED BY VIRGINIA CAPITAL BANCSHARES, INC., THE BANK OR TRIDENT SECURITIES,
INC. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF
AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON IN ANY JU-
RISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH
THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO
ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH
JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE HEREUNDER
SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF VIRGINIA CAPITAL BANCSHARES, INC. OR THE BANK SINCE
ANY OF THE DATES AS OF WHICH INFORMATION IS FURNISHED HEREIN OR SINCE THE DATE
HEREOF.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary.................................................................. 3
Selected Financial and Other Data of the Bank............................ 9
Recent Developments...................................................... 11
Risk Factors............................................................. 16
Virginia Capital Bancshares, Inc......................................... 22
Fredericksburg Savings................................................... 23
Regulatory Capital Compliance............................................ 24
Use of Proceeds.......................................................... 25
Dividend Policy.......................................................... 26
Market for the Common Stock.............................................. 27
Capitalization........................................................... 28
Pro Forma Data........................................................... 29
Comparison of Valuation and Pro Forma Information With No Foundation..... 34
Fredericksburg Savings Statements of Income.............................. 35
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 36
Business of the Bank..................................................... 53
Federal and State Taxation............................................... 73
Regulation............................................................... 74
Management of the Company................................................ 82
Management of the Bank................................................... 83
The Conversion........................................................... 94
Restrictions on Acquisition of the Company and the Bank.................. 116
Description of Capital Stock of the Company.............................. 123
Description of Capital Stock of the Bank................................. 124
Transfer Agent and Registrar............................................. 124
Experts.................................................................. 125
Legal and Tax Opinions................................................... 125
Additional Information................................................... 125
Index to Financial Statements............................................ F-0
</TABLE>
---------------
UNTIL DECEMBER 15, 1998 OR 25 DAYS AFTER COMMENCEMENT OF THE SYNDICATED COMMU-
NITY OFFERING, IF ANY, WHICHEVER IS LATER, ALL DEALERS EFFECTING TRANSACTIONS
IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBU-
TION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OB-
LIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND
WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
12,144,000 SHARES
VIRGINIA CAPITAL
BANCSHARES, INC.
(PROPOSED HOLDING COMPANY FOR
FREDERICKSBURG SAVINGS BANK)
COMMON STOCK
---------------
PROSPECTUS
---------------
NOVEMBER 9, 1998
TRIDENT SECURITIES, INC.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
