<PAGE>
As filed with the Securities and Exchange Commission on February 11, 1999
Registration No. 333-68091
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
PRE-EFFECTIVE
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-----------------------
1ST STATE BANCORP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C> <C>
Virginia 6035 [Applied for]
(State or other jurisdiction (Primary standard industrial (I.R.S. employer
of incorporation or organization) classification code number) identification number)
</TABLE>
445 S. Main Street
Burlington, North Carolina 27215
(336) 227-8861
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
JAMES C. McGILL
President and Chief Executive Officer
1st State Bancorp, Inc.
445 S. Main Street
Burlington, North Carolina 27215
(336) 227-8861
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
Copies to:
Gary R. Bronstein, Esquire
Joel E. Rappoport, Esquire
Housley Kantarian & Bronstein, P.C.
1220 19th Street, N.W., Suite 700
Washington, D.C. 20036
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this registration statement becomes effective.
If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933,
check the following box: [ ]
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
<TABLE>
<CAPTION>
Title of Each Class Amount Proposed Maximum Proposed Maximum Amount of
of Securities to be Offering Price Aggregate Offering Registration
to be Registered Registered Per Security Price (1) Fee
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value $.01 per share 3,163,125 (2) $16.00 (2) $50,610,000 (2) $14,069.58 (3)
==========================================================================================================================
</TABLE>
(1) Estimated solely for purposes of calculating the registration fee.
(2) Includes maximum number of shares to be sold to the public plus shares to
be contributed to a charitable foundation.
(3) Registration fee of $11,863.65 paid upon initial filing of Form S-1 on
November 30, 1998 and additional fee of $1,102.97 was paid upon the filing
of Pre-Effective Amendment No. 1 to Form S-1 on February 3, 1999.
Additional registration fee of $1,102.96 accompanies this Amendment No. 2
to account for the registration of additional shares.
<PAGE>
PROSPECTUS
Up to 3,163,125 Shares of Common Stock
1st STATE BANCORP, INC.
445 S. Main Street
Burlington, North Carolina 27215
(336) 227-8861
================================================================================
1st State Bank is converting from a mutual savings bank to a stock commercial
bank. As part of the transaction, 1st State Bank will become a subsidiary of 1st
State Bancorp, Inc., a corporation we recently formed to serve as our holding
company. As part of this process, we are offering shares of 1st State Bancorp,
Inc. common stock to the public.
================================================================================
TERMS OF THE OFFERING
We will sell between $30,600,000 and $47,610,000 of stock. We are offering a
minimum of 1,912,500 shares and a maximum, as adjusted, of 2,975,625 shares at
the purchase price of $16.00 per share. Based on these estimates, we are making
the following offering of shares of common stock:
<TABLE>
<CAPTION>
Per Share Total
--------------- ------------
<S> <C> <C>
. Purchase price: minimum to maximum, as adjusted $16.00 $30,600,000 to $47,610,000
. Offering expenses, including underwriting discounts
and commissions: minimum to maximum, as adjusted $.55 to $.43 $1,056,000 to $1,290,000
. Net proceeds: minimum to maximum, as adjusted $15.45 to $15.57 $29,544,000 to $46,320,000
</TABLE>
Please refer to Risk Factors beginning on page 1 of this document.
These securities are not deposits or accounts and are not insured or guaranteed
by the FDIC or any other government agency. The securities are subject to
investment risks, including possible loss of the principal invested.
Neither the Securities and Exchange Commission, the North Carolina Savings Bank
Administrator, the FDIC, nor any state securities commission has approved or
disapproved of these securities or determined if this prospectus is truthful or
complete. Any representation to the contrary is a criminal offense.
We have received conditional approval to list the common stock on the Nasdaq
National Market under the symbol "FSBC."
The underwriters, Trident Securities, Inc., must sell the minimum number of
securities (1,912,500 shares of common stock) if any are sold. The underwriters
are required to use only their best efforts to sell the maximum number of
securities offered (2,975,625 shares of common stock).
If you purchase stock through priority subscription rights we have granted you,
we must receive your order no later than 12:00 Noon, Eastern Time, on
__________, 1999. We may also offer shares to persons who do not have priority
subscription rights. We may terminate the offering to persons without
subscription rights at any time without notice. Pending completion or
termination of the offering, we will place funds we receive for stock purchases
in a segregated savings account at 1st State Bank, and we will pay interest at
our passbook rate on those funds for the period the funds are held until we
complete or terminate the offering.
For information on how to subscribe, call the Stock Information Center at (336)
___-____.
TRIDENT SECURITIES, INC.
______________, 1999
<PAGE>
[Inside front cover of Prospectus]
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Summary.........................................................................................(i)
Risk Factors.....................................................................................1
Selected Consolidated Financial Information and Other Data.......................................6
Recent Developments..............................................................................8
Proposed Management Purchases...................................................................11
Use of Proceeds.................................................................................12
Dividend Policy.................................................................................12
Market for the Common Stock.....................................................................13
Capitalization..................................................................................14
Historical and Pro Forma Regulatory Capital Compliance..........................................16
Pro Forma Data..................................................................................18
Comparison of Valuation and Pro Forma Information with No Foundation............................21
The Conversion..................................................................................22
Management's Discussion and Analysis of Financial Condition and Results of Operations...........40
Business of 1st State Bancorp, Inc..............................................................56
Business of 1st State Bank......................................................................56
Regulation......................................................................................80
Taxation........................................................................................91
Management of 1st State Bancorp.................................................................92
Management of 1st State Bank....................................................................92
Restrictions on Acquisition of 1st State Bancorp and 1st State Bank............................101
Anti-Takeover Provisions in Our Corporate Documents............................................103
Description of Capital Stock...................................................................109
Registration Requirements......................................................................110
Legal Matters..................................................................................111
Tax Opinions...................................................................................111
Experts........................................................................................111
Additional Information.........................................................................111
Index to Consolidated Financial Statements.....................................................112
</TABLE>
<PAGE>
[Map of our market area appears here. The map depicts all of North
Carolina, with Alamance County shaded, and also contains a larger view of
Alamance County depicting larger cities and towns and our office locations. The
map also sets forth the address of each of our offices.]
<PAGE>
SUMMARY
This summary highlights selected information from this document and may not
contain all the information that is important to you. To understand the stock
offering fully, you should read this entire document carefully, including the
consolidated financial statements and the notes to the consolidated financial
statements of 1st State Bank.
1st State Bancorp, Inc.
We formed 1st State Bancorp to be the holding company for 1st State Bank
following the conversion. 1st State Bancorp is not an operating company and has
not engaged in any significant business to date. 1st State Bancorp's executive
offices are located at 445 S. Main Street, Burlington, North Carolina 27215, and
its main telephone number is (336) 227-8861.
1st State Bank
Founded in 1914, we are a community and customer oriented North
Carolina-chartered savings bank headquartered in Burlington, North Carolina. We
have five full service branch offices located in north central North Carolina on
the Interstate 85 corridor between the Piedmont Triad and Research Triangle. We
conduct most of our business in Alamance County, North Carolina.
Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income, which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of the interest we
pay on deposits and borrowed funds. We also earn income from miscellaneous fees
related to our loans and deposits, mortgage banking income and commissions from
sales of annuities and mutual funds. At September 30, 1998, we had total assets
of $288.2 million, deposits of $235.7 million and total net worth of $26.0
million.
Our executive offices are located at 445 S. Main Street, Burlington, North
Carolina 27215, and our main telephone number is (336) 227-8861.
The Conversion
The conversion is a series of transactions by which we will convert from
our current status as a mutual savings bank to a North Carolina commercial bank.
Following the conversion, we will retain our current name "1st State Bank," but
we will be a subsidiary of 1st State Bancorp. As a commercial bank, we intend to
continue to follow our same business strategies, and we will be subject to the
regulation and supervision of the FDIC and the North Carolina Banking
Commission.
The Offering and the $2.4 Million to $3.0 Million Charitable Foundation
As part of the conversion process, we are offering between a minimum of
1,912,500 and a maximum of 2,587,500 shares of 1st State Bancorp common stock at
$16.00 per share. We may increase the number of shares to be sold by 15% to a
maximum, as adjusted of 2,975,625 shares without any further notice to you if
market or financial conditions change before we complete the conversion. If we
do not sell at least 1,912,500 shares, we may extend the offering. We are
permitted by regulation to extend the offering period by up to 90 days. If we
extend the offering period, you will have the opportunity to increase, decrease
or rescind your order. If we still have not sold at least 1,912,500 shares, we
will consult with our regulators to determine if we can find a way to complete
the conversion. If we cannot complete the conversion, we will terminate the
conversion and refund your money, with interest.
1
<PAGE>
Depositor and borrower members as of certain eligibility dates will receive
priority subscription rights to purchase shares in the offering. See "The
Conversion -- Subscription Rights" for a description of the priority categories.
We will offer any remaining shares to persons who do not receive priority
subscription rights, giving preference to residents of Alamance County, North
Carolina.
In furtherance of our long-standing commitment to our local community, we
will establish a charitable foundation which will be dedicated to charitable and
community service causes within our community. We will contribute to the
foundation up to 8% of the shares of common stock we sell in the offering, not
to exceed 187,500 shares. We expect to realize an after-tax expense of between
$1.6 million and $2.0 million during the quarter ended March 31 or June 30, 1999
as a result of our contribution to the foundation. We contributed $151,000 to
charity during the year ended September 30, 1998 and $106,000 during the year
ended September 30, 1997. See "Risk Factors -- The Expense and Dilutive Effect
of the Contribution of Shares to the Charitable Foundation" and "The Conversion
- -- Establishment of the Foundation" for an explanation on how a contribution to
the foundation might affect your ownership interest in 1st State Bancorp.
The following table sets forth the number of shares we are selling to the
public, the number that we will contribute to the foundation and the total
outstanding shares:
<TABLE>
<CAPTION>
Shares Total
Shares Sold Contributed to Outstanding
to Public Foundation Shares
<S> <C> <C> <C>
Minimum 1,912,500 153,000 2,065,500
Midpoint 2,250,000 180,000 2,430,000
Maximum 2,587,500 187,500 2,775,000
Maximum, as adjusted 2,975,625 187,500 3,163,125
</TABLE>
In this document, except where we have indicated otherwise, we calculated
outstanding shares and percentages based on outstanding shares by including the
shares we contribute to the foundation. In addition, when we refer to shares
issued or sold in the conversion, we are including the shares we will contribute
to the foundation.
How We Determined the Price Per Share and the Offering Range
The offering range is based on an independent appraisal of our pro forma
market value following the conversion by Ferguson & Company, an appraisal firm
experienced in appraisals of savings institutions. The pro forma market value is
our estimated market value assuming the sale of shares in this offering.
Ferguson & Company has estimated that in its opinion as of January 27, 1999 the
value was between $30.6 million and $41.4 million, with a midpoint of $36.0
million. The appraisal was based in part upon our financial condition and
operations and the effect of the additional capital we will raise from the sale
of common stock in this offering. The $16.00 price per share was determined by
our board of directors. Subject to regulatory approval, we may increase the
amount of common stock offered by up to 15%. Accordingly, at the purchase price
of $16.00 per share, we are offering a minimum of 1,912,500 shares of common
stock and a maximum, as adjusted, of 2,975,625 shares of common stock. The
appraisal will be updated prior to the completion of the conversion. If the pro
forma market value of the common stock at that time is either below $30.6
million or above $47.6 million, we will notify you, and you will have the
opportunity to modify or cancel your order. See "The Conversion -- Stock Pricing
and Number of Shares to be Issued" for a description of the factors and
assumptions used in determining the stock price and offering range.
Investment Ratios
Two of the measures many investors utilize to analyze whether a stock might
be a good investment are the ratio of the offering price to the issuer's "book
value" and the ratio of the offering price to the issuer's annual net
income.
2
<PAGE>
Ferguson & Company considered these ratios, among other factors, in preparing
its appraisal. Book value is the same as stockholders' equity, and represents
the difference between the issuer's assets and liabilities. The ratio of the
offering price to 1st State Bancorp's pro forma book value ranges from 63.1% to
75.3%, and the offering price represents between 10.1 and 14.3 times 1st State
Bancorp's pro forma earnings for the year ended September 30, 1998. See "Pro
Forma Data" for a description of the assumptions we made in making these
calculations. In preparing the appraisal, Ferguson & Company considered the
price to book ratios and price to earnings ratios of a group of 12 other
comparable entities. Ferguson & Company concluded that as of January 27, 1999,
the comparable group had an average price to book value ratio of 118.2% and a
median price to book ratio of 114.8%. At that date, the comparable group had an
average ratio of price to earnings of 16.9x and a median ratio of price to
earnings of 16.2x. We urge you to read Ferguson & Company's appraisal in its
entirety to understand the factors that Ferguson & Company considered in
determining to establish an appraised value for 1st State Bank that resulted in
our ratios of price to pro forma book value and price to pro forma earnings to
be below those for the comparable group. For information on how to obtain a copy
of the appraisal, see "Additional Information."
The Amount of Stock You May Purchase
The minimum purchase is 25 shares, which totals $400. You may purchase no
more than 62,500 shares, which totals $1,000,000. In determining whether you
have exceeded the maximum purchase limitation, we will include shares purchased
by individuals on joint accounts with you or having the same address as you on
our records, as well as shares purchased by your related interests or related
persons and those who are helping you acquire shares. We may decrease or
increase the maximum purchase limitation without notifying you.
Subscription Rights Are Not Transferable
You may not assign or sell your subscription rights. Any transfer of
subscription rights is prohibited by law. If you exercise subscription rights,
you will be required to certify that you are purchasing shares solely for your
own account and that you have no agreement or understanding regarding the sale
or transfer of shares. We intend to pursue any and all legal and equitable
remedies if we learn of the transfer of any subscription rights. We will reject
orders that we determine to involve the transfer of subscription rights.
How We Will Prioritize Orders If We Receive Orders for More Shares Than Are
Available
You might not receive any or all of the shares you order. If we receive
orders for more shares than are available, we will allocate stock to the
following persons or groups in order of priority.
. Eligible Account Holders - Depositors who had a deposit account with
us on December 31, 1994 with a balance of at least $50.00. Any
remaining shares will be offered to:
. Our employee stock ownership plan. Any remaining shares will be
offered to:
. Supplemental Eligible Account Holders - Depositors who had a deposit
account with us on December 31, 1998 with a balance of at least
$50.00. Any remaining shares will be offered to:
. Other Members - Other depositors and certain borrowers of ours, as of
__________, 1999.
If the above persons do not subscribe for all of the shares offered, we
will offer the remaining shares to the general public, giving preference to
people who live in Alamance County, North Carolina.
3
<PAGE>
Termination of the Offering
If you are purchasing stock through priority subscription rights we have
granted you, we must receive your order no later than 12:00 Noon, Eastern Time,
on __________, 1999. We may also offer remaining shares to persons who do not
have priority subscription rights. We may terminate the offering to those
persons at any time without notice. Pending completion or termination of the
offering, we will place funds we receive for stock purchases in a segregated
savings account at 1st State Bank, and we will pay interest at our passbook rate
on those funds for the period the funds are held until we complete or terminate
the offering.
Dividends
We intend to pay an annual cash dividend of $.32 per share, payable
quarterly at $.08 per share. We expect to begin paying dividends following the
first full quarter after the conversion. For a discussion of our anticipated
dividend policy, including restrictions on our ability to pay dividends, see
"Dividend Policy."
Market for the Common Stock
We have received conditional approval to list the common stock on the
Nasdaq National Market under the symbol AFSBC". For additional information about
the market and trading of the common stock, see "Market for the Common Stock."
Risks in Owning the Common Stock
Before you decide to purchase stock in the offering, you should read this
entire document, including the Risk Factors section beginning on page 1 of this
document.
The shares of common stock we are offering:
. Are not deposit accounts;
. Are not insured or guaranteed by the FDIC or any other government
agency; and
. Are not guaranteed by us.
The common stock is subject to investment risk, including the possible loss
of principal invested.
Why We Are Converting
With the holding company structure, we will have the ability to plan and
develop long-term growth opportunities and to access the capital markets more
easily in the future. The offering will increase our capital and the amount of
funds available to us for lending and investment. This will give us greater
flexibility to diversify operations and expand into other geographic markets, if
we choose to do so. If our earnings are sufficient in the future, you might also
receive dividends and benefit from the long-term appreciation of our stock
price. Conversion to a commercial bank charter will enable us to continue to
pursue our expanding lines of business by increasing our investment in
commercial real estate loans, commercial loans and consumer loans.
Use of Proceeds from the Sale of the Common Stock
We will use the net proceeds from the offering as follows:
. We will loan 8% to our employee stock ownership plan to fund its purchase
of common stock
. We will invest 46% in 1st State Bank
. 1st State Bancorp will retain 46% for general corporate purposes and may
use the proceeds to pay dividends to stockholders or to repurchase
stock
4
<PAGE>
The proceeds to be invested in 1st State Bank will be available for general
corporate purposes, including the continued expansion of our retail banking
franchise through continued growth in the loan portfolio, the opening of new
branches, deposit or bank acquisitions, and the purchase of investment
securities. See "Use of Proceeds" for a more specific discussion of our use of
the net proceeds.
Benefits to Management from the Offering
Our full-time employees will participate in the offering through the
purchase of stock by our employee stock ownership plan, which is a plan that
buys shares of stock and then allocates the stock to employees over a period of
time. You can find more information about our employee stock ownership plan by
reading the section of this document entitled "Management of 1st State Bank --
Executive Compensation -- Employee Stock Ownership Plan." Following the
conversion, we also intend to implement a restricted stock plan and a stock
option plan, which will benefit our officers and directors. These plans will not
be adopted until at least six months after the conversion. If we adopt a
restricted stock plan, our executive officers and directors will be awarded
shares of common stock at no cost to them. The following table summarizes the
benefits directors and management will receive from the conversion at the
midpoint of the offering range:
<TABLE>
<CAPTION>
Value of Shares
at Minimum and Pages in Prospectus
Individuals Eligible % of Outstanding Maximum, as Adjusted Where You Can Find
Plan to Receive Awards Shares of Offering Range Further Information
- ---- ----------------- --------------- ---------------------------- -------------------
<S> <C> <C> <C> <C>
Employee stock
ownership plan All employees 8% $2,643,840 to $4,048,800 95-96
Restricted stock plan Directors and officers 4% $1,321,920 to $2,024,400 99-100
Option plan Directors and officers 10% N/A 99
--- ------------------------
Total 22% $3,965,760 to $6,073,200
=== ========================
</TABLE>
Our directors and officers intend to purchase 546,875 shares. If they are
able to purchase all these shares and if we implement the benefit plans listed
on the above table, our directors, executive officers and employees could own
between 794,735 and 926,450 shares, which would represent up to between 29.3%
and 38.5% of our outstanding stock. At the $16.00 per share offering price,
these shares would have a value of between $12.7 million and $14.8 million.
We have entered into employment agreements with our three senior executive
officers. The agreements provide that the officers would receive severance
payments up to a total of $2.2 million if 1st State Bancorp is acquired and they
lose their jobs in the acquisition.
Obtaining Further Information
For further information, you may contact:
Stock Information Center
1st State Bancorp, Inc.
445 S. Main Street
Burlington, North Carolina 27215
(336) ___-____
5
<PAGE>
RISK FACTORS
In addition to the other information in this document, you should
consider carefully the following risk factors in deciding whether to invest in
the common stock.
We have relatively high amounts of commercial and consumer loans. These loans
have more credit risk than residential mortgage loans.
We generally invest a greater proportion of our assets in loans secured
by commercial real estate, commercial loans and consumer loans than typical
savings institutions that invest a greater proportion of their assets in loans
secured by single-family residences. Commercial real estate loans and commercial
loans generally involve a higher degree of credit risk than residential mortgage
lending due primarily to the large amounts loaned to individual borrowers.
Losses incurred on loans to a small number of borrowers could have a material
adverse impact on our income and financial condition. In addition, unlike
residential mortgage loans, commercial and commercial real estate loans depend
on the cash flow from the property or the business to service the debt. Cash
flow may be significantly affected by general economic conditions. Furthermore,
we continue to originate loans where repayment is based largely on the
liquidation of assets securing the loan, such as inventory and accounts
receivable. These loans carry an even higher incremental risk of loss, as their
repayment is often dependent solely on the financial performance of the persons
that owe money to our borrower. Consumer lending is riskier than residential
mortgage lending because consumer loans are either unsecured or secured by
assets that depreciate in value. See "Business -- Lending Activities" for
information as to the percentage of loans invested in commercial real estate,
commercial and consumer loans and the outstanding balances of our largest loans.
Our business plan calls for continued efforts to increase the percentage of our
assets invested in commercial real estate loans, commercial loans and consumer
loans.
Decreasing interest rates could hurt our profits.
Our ability to earn a profit, like that of most financial institutions,
depends on our net interest income, which is the difference between the interest
income we earn on our interest-earning assets, such as mortgage loans and
investments, and the interest expense we pay on our interest-bearing
liabilities, such as deposits. Our profitability depends on our ability to
manage our assets and liabilities during periods of changing market interest
rates.
A sustained decrease in market interest rates could adversely affect
our earnings. When interest rates decline, borrowers tend to refinance
higher-rate, fixed-rate loans at lower rates. Under those circumstances, we
would not be able to reinvest those prepayments in assets earning interest rates
as high as the rates on the prepaid loans or investment securities. In addition,
our commercial real estate and commercial loans, which carry interest rates that
adjust in accordance with changes in the prime rate, will adjust to lower rates.
After the conversion, we will have a low return on equity relative to our peers.
We may not be able to grow and thereby improve return on equity.
Net income divided by average equity, known as "return on average
equity" is a ratio many investors use to compare the performance of a financial
institution to its peers. We expect our return on equity to decrease as compared
to our performance in previous years until we are able to increase our balance
sheet by adding loans and deposits, thereby increasing net interest income. Our
return on equity will be reduced by increased equity from the conversion and
increased expenses due to added expense associated with our employee stock
ownership plan, the costs of being a public company and, later on, our
restricted stock plan.
To grow and thereby improve return on equity, we may seek to either
establish one or more new branches or acquire another financial institution or
branches of another financial institution. We cannot assure you that we will be
able to generate growth or identify attractive acquisition candidates, acquire
such candidates on favorable terms or successfully integrate any acquired
institutions or branches. Our ability to establish new branch offices depends on
whether we can identify advantageous branch office locations and generate new
deposits and loans from those locations that will create an acceptable level of
net income. New branches also typically entail start-up expenses. Our ability to
6
<PAGE>
acquire other financial institutions or branches depends on whether we can
identify, acquire and integrate such institutions or branches. There appear to
be few acquisition opportunities for us in Alamance County.
Contributing shares to a charitable foundation will hurt our profits and reduce
your ownership of 1st State Bancorp by between 5.9% and 7.4%.
We are establishing a charitable foundation and contributing to the
foundation up to 8% of the shares of common stock sold in the offering, not to
exceed 187,500 shares. The contribution to the foundation will reduce our
earnings in 1999, the fiscal year in which the foundation is to be established
and the contribution made, by between $1.6 million and $2.0 million. Assuming
the maximum contribution of 187,500 shares of common stock, if the foundation
had been established and the contribution made during the year ended September
30, 1998, we would have reported net income of approximately $541,000 rather
than reporting net income of approximately $2.5 million for the year ended
September 30, 1998. In addition, 1st State Bancorp stockholders will have their
ownership and voting interests diluted by between 5.9% and 7.4%. The number of
shares of common stock to be contributed to the foundation will equal between
7.4% and 5.9% of the shares that will be outstanding following the conversion.
See "The Conversion -- Establishment of the Foundation" for a more detailed
discussion of the effects the establishment of the foundation would have on
stockholders' interests and on our earnings.
An economic downturn in Alamance County could hurt our profits.
We conduct most of our business in Alamance County in North Carolina.
Despite recent diversification, the economy in Alamance County continues to be
heavily dependent on the textile industry. A downturn in the textile industry
could adversely affect the economy in Alamance County, which could adversely
affect our earnings and reduce the demand for loans and deposits. The NAFTA
legislation passed by Congress also appears to be having a negative impact on
the textile industry of Alamance County, affecting or potentially affecting
borrowers in the textile industry and borrowers employed by local textile
companies.
Strong competition in Alamance County could hurt our profits.
Competition in the banking and financial services industry is intense.
Our profitability depends upon our continued ability to successfully compete. We
compete in Alamance County with commercial banks, savings and loan associations,
credit unions, finance companies, mutual funds, insurance companies, and
brokerage and investment banking firms. Many of these competitors have
substantially greater resources and lending limits than we do and may offer
certain services that we do not or cannot provide.
Anti-takeover provisions in our corporate documents and voting control by
management may discourage takeover attempts and reduce our stock price.
Provisions in our corporate documents and in Virginia corporate law, as
well as certain federal regulations, may make it difficult, and expensive, to
pursue a tender offer, change in control or takeover attempt that our board of
directors opposes. As a result, you may not have an opportunity to participate
in such a transaction, and the trading price of our stock may not rise to the
level of other institutions that are more vulnerable to hostile takeovers.
Anti-takeover provisions include:
. restrictions on the acquisition of 1st State Bancorp's equity
securities and limitations on voting rights
. the classification of the terms of the members of the board of
directors
. certain provisions relating to meetings of stockholders
. denial of cumulative voting by stockholders in the election of
directors
. the ability to issue preferred stock and additional shares of
common stock without shareholder approval
7
<PAGE>
. super-majority voting provisions for the approval of certain
business combinations
These provisions also will make it more difficult for an outsider to remove our
current board of directors or management. See "Restrictions on Acquisition of
1st State Bancorp and 1st State Bank" and "Anti-takeover Provisions in Our
Corporate Documents" for a description of anti-takeover provisions in our
corporate documents and under Virginia law and federal regulations.
Also contributing to our ability to impede potential takeovers will be
the large amount of stock to be owned by our directors, executive officers and
employees. Our directors and executive officers, our employee stock ownership
plan and our restricted stock plan, if implemented, intend to purchase
approximately 838,475 shares, or 34.5% of the outstanding shares at the midpoint
of the offering range. In addition, the foundation will own between 5.9% and
7.4% of the outstanding common stock. The foundation must vote these shares in
the same proportion as all other outstanding shares are voted. These purchases,
along with potential purchases through future stock options, could make it
difficult to obtain majority support for stockholder proposals we oppose. In
addition, by voting these shares we could block the approval of transactions
requiring the approval of 80% of the stockholders. Examples of transactions we
could block are certain business combinations or amendments to our corporate
documents. For a description of our employee stock benefit plan, restricted
stock plan and stock option plan and the conditions governing the issuance of
stock under these plans, see "Management of 1st State Bank -- Executive
Compensation -- Employee Stock Ownership Plan," " -- Proposed Future Stock
Benefit Plans -- Stock Option Plan" and " -- Restricted Stock Plan."
The potential cost of future employee stock benefit plans may reduce our
profits.
We anticipate that our employee stock ownership plan will purchase 8%
of the common stock issued in the conversion with funds borrowed from 1st State
Bancorp. The cost of acquiring the employee stock ownership plan shares will be
between $2.6 million, and $4.0 million. We will record annual employee stock
ownership plan expenses in an amount equal to the fair value of shares committed
to be released to employees. If shares of common stock appreciate in value over
time, compensation expense relating to the employee stock ownership plan may
increase. In addition, it is possible that we will implement a restricted stock
plan, under which officers and directors could be awarded at no cost to them up
to an aggregate of 4% of the shares issued in the conversion. Assuming the
shares of common stock to be awarded under the plan cost $16.00 per share, the
reduction to stockholders' equity from the plan would be between $1.3 million
and $2.0 million.
Implementing employee stock benefit plans will reduce your ownership percentage.
If the conversion is completed and stockholders subsequently approve a
restricted stock plan and a stock option plan, we will issue stock to our
officers and directors through these plans. If the shares for the restricted
stock plan are issued from our authorized but unissued stock, your ownership
percentage could be diluted by up to approximately 4% and the trading price of
our stock may be reduced. See "Pro Forma Data" for data on the dilutive effect
of the restricted stock plan and "Management of 1st State Bank -- Proposed
Future Stock Benefit Plans -- Stock Option Plan" and "-- Restricted Stock Plan"
for a description of the plans. These plans will also involve additional
expense. See "-- Anticipated Low Return on Equity" for a more detailed
discussion of the increased expenses we will incur after the conversion and how
this increase could decrease our return on equity.
The appraisal does not predict the future stock price and the stock price could
decrease in the future.
We cannot assure you that if you purchase common stock in the offering
for $20.00 per share you will later be able to sell it at or above that price.
The final aggregate purchase price of the common stock in the conversion will be
based upon an independent appraisal. The appraisal is not intended, and should
not be construed, as a recommendation of any kind as to the advisability of
purchasing shares of common stock. The valuation is based on estimates and
projections of a number of matters, all of which are subject to change from time
to time. See "The Conversion -- How We Determined the $16.00 Price Per Share and
the Offering Range" for the assumptions Ferguson & Company used in determining
the appraisal.
Your subscription rights may be taxable.
8
<PAGE>
Should the Internal Revenue Service determine that the subscription
rights have ascertainable value, you could be taxed as a result of your exercise
of those rights in an amount equal to their value. Ferguson & Company has given
us their opinion that the subscription rights granted to eligible members in the
conversion have no value. This opinion is not binding on the Internal Revenue
Service, however.
Stock market volatility may cause fluctuations in the trading price of our
stock.
Due to possible continued market volatility and to other factors,
including certain Risk Factors discussed in this document, we cannot assure you
that, following the conversion, the trading price of our common stock will be at
or above the $16.00 per share initial offering price. Publicly traded stocks,
including stocks of financial institutions, have recently experienced
substantial market price volatility. These market fluctuations may be unrelated
to the operating performance of particular companies whose shares are traded. In
several cases, common stock issued by recently converted financial institutions
has traded at a price that is below the price at which the shares were sold in
the initial offerings of those companies. The purchase price of our common stock
in the offering is based on the independent appraisal by Ferguson & Company.
After our shares begin trading, the trading price of our common stock will be
determined by the marketplace, and may be influenced by many factors, including
prevailing interest rates, investor perceptions and general industry and
economic conditions.
Our stock sales agent has not given an opinion or recommendation as to whether
the stock is a good investment.
We have engaged Trident Securities to consult with and advise us with
respect to the conversion and to assist, on a best-efforts basis, in connection
with the solicitation of subscriptions and purchase orders for shares of common
stock in the offering. Trident Securities has not prepared or delivered any
opinion or recommendation with respect to the suitability of the common stock as
an investment or the appropriateness of the amount of common stock to be issued
in the conversion. Our engagement of Trident Securities and the work they
performed, including their due diligence investigation, should not be construed
by purchasers of the common stock as constituting an opinion or recommendation
relating to investment in the common stock offered by this document.
If our computer systems do not work properly on January 1, 2000, our operations
will be disrupted. We may be unable to upgrade our technology to match our
competition.
Our industry is experiencing rapid changes in technology. In addition
to improving customer services, effective use of technology increases efficiency
and enables financial institutions to reduce costs. Our future success will thus
depend in part on our ability to address our customers' needs by using
technology. We cannot assure you that we will be able to effectively develop new
technology-driven products and services or be successful in marketing these
products to our customers. Many of our competitors have far greater resources
than we have to invest in technology.
Our operations are also dependent on computers and computer systems,
whether we maintain them internally or they are maintained by a third party.
Systems that do not properly recognize the correct year could produce faulty
data or cause a system to fail. We cannot assure you that we, our customers and
our third party providers will be successful in making all necessary changes to
avoid computer system failures related to the year 2000. Such failures may
include, among other things, the inability to process and underwrite loan
applications, to credit deposits and withdrawals from customer accounts, to
credit loan payments or track delinquencies, to properly reconcile and record
daily activity or to engage in similar normal banking activities. Additionally,
if our commercial customers are not year 2000 compliant and suffer adverse
effects on their operations, their ability to meet their obligations to us could
be adversely affected. For a further discussion of our efforts to prepare for
Year 2000 issues, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Year 2000 Readiness Disclosure."
Regulatory changes could adversely affect our business.
We are subject to extensive government regulation, supervision and
examination. The regulatory authorities have extensive discretion in connection
with their supervisory and enforcement activities. Any change in regulation,
whether by the Commission, the FDIC, the Federal Reserve Board or the U.S.
Congress, could have a significant impact on us and our operations.
9
<PAGE>
There is legislation pending in the U.S. Congress that calls for the
modernization of the banking system and that would significantly affect the
operations and regulatory structure of the financial services industry. At this
time, we do not know what form the final legislation might take, but if enacted
into law, the legislation could affect our competitive environment as well as
our business and operations. See "Regulation --Depository Institution Regulation
- -- Proposed Legislative and Regulatory Changes" for a description of the
provisions of this proposed legislation.
You could lose some or all of your investment in our stock.
The shares of common stock offered by this document are not savings
accounts or deposits and are not insured or guaranteed by the FDIC, the Savings
Association Insurance Fund of the FDIC or any other governmental agency, and
involve investment risk, including the possible loss of principal.
Certain statements in this document are forward-looking and are
identified by the use of forward-looking words or phrases such as "intended,"
"will be positioned," "expects," is or are "expected," "anticipates," and
"anticipated" and other words and phrases of similar meaning. These
forward-looking statements are based on our current expectations. To the extent
any of the information contained in this document constitutes a forward-looking
statement, the risk factors set forth above are cautionary statements
identifying important factors that could cause actual results to differ
materially from those in the forward-looking statement.
10
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
The following summary consolidated financial information is derived
from our audited consolidated financial statements. The following information is
only a summary, and you should read it in conjunction with our consolidated
financial statements and the notes to our consolidated financial statements,
which you can find beginning on page F-1 of this Prospectus.
Selected Financial Condition Data
<TABLE>
<CAPTION>
At September 30,
-----------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------- -------- -------
(In thousands)
<S> <C> <C> <C> <C> <C>
Total assets.............................. $ 288,223 $ 258,509 $ 235,138 $ 222,916 $ 208,332
Loans receivable.......................... 196,782 197,122 173,849 171,093 154,195
Loans held for sale, at lower of
cost or fair value.................... 7,540 684 2,377 -- --
Cash and cash equivalents................. 31,077 14,990 9,754 7,550 4,858
Investment securities:
Available for sale.................... 9,858 11,320 16,024 16,307 19,004
Held to maturity...................... 30,195 23,482 21,685 17,649 18,197
Deposit accounts.......................... 235,694 229,341 209,707 200,769 188,309
Advances from Federal Home Loan Bank...... 20,000 1,000 1,000 -- 1,000
Net worth (1)............................. 25,966 23,277 20,629 19,151 16,530
</TABLE>
--------
(1) Consists of retained income, substantially restricted, and net unrealized
gains or losses on securities available for sale.
Selected Operating Data
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Total interest income.................. $ 20,708 $ 19,061 $ 17,395 $ 16,146 $ 13,374
Total interest expense................. 11,071 9,799 9,453 8,584 7,175
------------ ------------ ----------- ------------ ------------
Net interest income.................... 9,637 9,262 7,942 7,562 6,199
Provision for loan losses.............. 477 261 281 454 240
------------ ------------ ----------- ------------ ------------
Net interest income after
provision for loan losses............ 9,160 9,001 7,661 7,108 5,959
Other income........................... 1,497 1,468 1,179 1,600 295
Operating expenses..................... 6,774 6,473 6,403 5,006 4,316
------------ ------------ ----------- ------------ ------------
Income before income taxes............. 3,883 3,996 2,437 3,702 1,938
Income taxes........................... 1,362 1,447 841 1,378 686
------------ ------------ ----------- ------------ ------------
Net income............................. $ 2,521 $ 2,549 $ 1,596 $ 2,324 $ 1,252
============ ============ =========== ============ ============
</TABLE>
11
<PAGE>
Selected Financial Ratios and Other Data
<TABLE>
<CAPTION>
At or for the
Year Ended September 30,
--------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Performance Ratios:
Return on average assets (net income divided
by average total assets)........................................ 0.92% 1.03% 0.70% 1.07% 0.60%
Return on average net worth (net income
divided by average net worth)................................... 10.20 11.34 7.92 12.94 7.75
Interest rate spread (combined weighted average interest rate
earned less combined weighted average interest rate cost)....... 3.45 3.70 3.41 3.45 3.06
Net interest margin (net interest income divided by
average interest-earning assets)................................ 3.77 4.00 3.68 3.68 3.20
Ratio of average interest-earning assets
to average interest-bearing liabilities......................... 107.42 106.99 106.25 105.61 103.88
Ratio of operating expenses to average total assets................ 2.48 2.62 2.80 2.30 2.07
Asset Quality Ratios:
Nonperforming assets to total assets
at end of period................................................ 0.09 0.10 0.12 1.64 1.58
Nonperforming loans to total loans
at end of period................................................ 0.13 0.13 0.16 2.11 0.06
Allowance for loan losses to total
loans at end of period.......................................... 1.61 1.38 1.42 1.28 1.13
Allowance for loan losses to nonperforming
loans at end of period.......................................... 1,227.38 1,063.32 866.67 60.72 1,784.85
Provision for loan losses to total loans .......................... 0.24 0.13 0.16 0.26 0.15
Net charge-offs to average loans
outstanding..................................................... -- -- -- -- 0.01
Capital Ratios:
Net worth to total assets at
end of period................................................... 9.01 9.00 8.77 8.59 7.93
Average net worth to average assets................................ 9.05 9.10 8.80 8.25 7.75
<CAPTION>
At September 30,
-------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
Number of:
Loans outstanding.......................................... 6,253 6,410 6,404 6,675 6,848
Deposit accounts........................................... 26,066 26,924 27,187 27,850 27,399
Offices open (1)........................................... 6 6 6 5 5
</TABLE>
- --------
(1) All offices are full service offices.
12
<PAGE>
RECENT DEVELOPMENTS
The following consolidated financial information is only a summary
and you should read it in conjunction with our consolidated financial statements
and the notes to our consolidated financial statements, which you can find
beginning on page F-1 of this Prospectus. The selected financial condition data
at September 30, 1998 is derived from our audited consolidated financial
statements. All other data has been derived from unaudited financial statements.
In our opinion, the unaudited information reflects all adjustments, which
consist only of normal recurring adjustments, necessary for a fair presentation.
The operating data for the three months ended December 31, 1998 does not
necessarily predict the results we may achieve in the future.
Selected Financial Condition Data
<TABLE>
<CAPTION>
At At
December 31, September 30,
1998 1998
------------------ ------------------
(In thousands)
<S> <C> <C>
Total assets............................................ $ 291,249 $ 288,223
Loans receivable........................................ 189,142 196,782
Loans held for sale, at lower of cost or fair
value ............................................... 6,185 7,540
Cash and cash equivalents............................... 27,225 31,077
Investment securities:
Available for sale................................... 12,733 9,858
Held to maturity..................................... 42,935 30,195
Deposit accounts........................................ 237,394 235,694
Advances from Federal Home Loan Bank.................... 20,000 20,000
Net worth (1)........................................... 26,707 25,966
</TABLE>
- ----------------
(1) Consists of retained income, substantially restricted, and net unrealized
gains or losses on securities available for sale.
Selected Operating Data
<TABLE>
<CAPTION>
For the Three Months
Ended December 31,
-------------------------------------
1998 1997
------------ -----------
(In thousands)
<S> <C> <C>
Total interest income................................... $ 5,124 $ 4,983
Total interest expense.................................. 2,846 2,620
------------ -----------
Net interest income..................................... 2,278 2,363
Provision for loan losses............................... 60 60
------------ -----------
Net interest income after provisions for loan losses.... 2,218 2,303
Other income............................................ 665 391
Operating expenses...................................... 1,718 1,497
------------ -----------
Income before income taxes.............................. 1,165 1,197
Income taxes............................................ 414 439
------------ -----------
Net income.............................................. $ 751 $ 758
============ ===========
</TABLE>
13
<PAGE>
Selected Financial Ratios and Other Data
<TABLE>
<CAPTION>
At or for the Three
Months Ended December 31,
-----------------------------
1998 (1) 1997(1)
--------- ---------
<S> <C> <C>
Performance Ratios:
Return on average assets (net income divided
by average total assets)..................................... 1.04% 1.16%
Return on average net worth (net income
divided by average net worth)................................ 11.39 12.82
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost).................................. 2.96 3.53
Net interest margin (net interest income divided by
average interest-earning assets)............................. 3.36 3.88
Ratio of average interest-earning assets
to average interest-bearing liabilities...................... 109.50 108.26
Ratio of operating expenses to average total assets............. 2.38 2.29
Asset Quality Ratios:
Nonperforming assets to total assets at end of period........... 0.16 0.16
Nonperforming loans to total loans at end of period............. 0.24 0.21
Allowance for loan losses to total
loans at end of period....................................... 1.71 1.38
Allowance for loan losses to nonperforming
loans at end of period....................................... 723.72 675.39
Provision for loan losses to total loans ....................... 0.13 0.12
Net charge-offs to average loans outstanding.................... 0.03 --
Capital Ratios:
Net worth to total assets at end of period...................... 9.17 9.27
Average net worth to average assets............................. 9.12 9.06
</TABLE>
- ------------
(1) Annualized.
14
<PAGE>
Comparison of Financial Condition at December 31, 1998 and September 30, 1998
Total assets increased by $3.0 million, or 1.05% from $288.2 million at
September 30, 1998 to $291.2 million at December 31, 1998. Asset growth was
funded during the period by an increase of $1.7 million in deposits, as deposits
increased from $235.7 million at September 30, 1998 to $237.4 million at
December 31, 1998.
Investment securities, both available for sale and held to maturity,
increased a combined total of $15.6 million, or 39.0%, from $40.1 million at
September 30, 1998 to $55.7 million at December 31, 1998. During the quarter
ended December 31, 1998, we purchased $19.8 million of short-term government
agency securities to invest excess liquidity. The increased liquidity resulted
from loan sales during the quarter. Cash and cash equivalents decreased $3.9
million, or 12.4%, from $31.1 million at September 30, 1998 to $27.2 million at
December 31, 1998.
Interest rates continued to be low during the quarter, which encouraged
borrowers to refinance their mortgage loans into fixed-rate loans. As a result,
we originated $17.1 million in loans held for sale during the quarter. We sold
$19.1 million of loans held for sale during the quarter. As a result, our loans
held for sale decreased $1.4 million, or 18.0%, from $7.5 million at September
30, 1998 to $6.2 million at December 31, 1998. In addition, our loans
receivable, net decreased by $7.6 million, or 3.9%, from $196.8 million at
September 30, 1998 to $189.1 million at December 31, 1998.
Comparison of Operating Results for the Three Months Ended December 31, 1998 and
1997
Net Income. We had $751,000 of net income for the quarter ended December
31, 1998, compared to $758,000 of net income for the quarter ended December 31,
1997, representing a decrease of $7,000, or 0.9%. The principal reason for the
decrease was an $85,000 decrease in net interest income.
Interest Income. Total interest income was $5.1 million for the quarter
ended December 31, 1998, as compared to $5.0 million for the quarter ended
December 31, 1997, representing an increase of $141,000, or 2.8%. Average
interest-earning assets increased by $27.8 million, or 11.4%, from $243.8
million for the quarter ended December 31, 1997 to $271.6 for the quarter ended
December 31, 1998.
Interest Expense. Total interest expense was $2.8 million for the quarter
ended December 31, 1998, as compared to $2.6 million for the quarter ended
December 31, 1997, representing an increase of $226,000, or 8.6%. Average
interest-bearing liabilities increased $23.2 million, or 10.3%, from $224.8
million for the quarter ended December 31, 1997 to $248.0 million for the
quarter ended December 31, 1998.
Net Interest Income. Despite our increases in net earning assets of $4.6
million, our net interest rate spread decreased from 3.53% to 2.96% and the net
interest margin decreased from 3.88% to 3.36%. These decreases reflected our
increased level of investment securities and our decreased level of loans. Loans
generally carry higher interest rates than investment securities.
Provision for Loan Losses. We provided $60,000 for loan losses during each
of the quarters ended December 31, 1998 and 1997.
Other Income. Other income increased $274,000, or 70.1%, from $391,000 for
the quarter ended December 31, 1997 to $665,000 for the quarter ended December
31, 1998. As interest rates continued to remain low, we sold $19.1 million of
loans during the quarter to reduce our interest rate risk associated with
long-term fixed-rate mortgages. We recognized income of $337,000 from the
origination and sale of these loans. This is an increase of $290,000, or 617.0%,
from the same quarter in the prior year.
Operating Expenses. Total operating expenses increased $221,000, or 14.8%,
from $1.5 million for the quarter ended December 31, 1997 to $1.7 million for
the quarter ended December 31, 1998. Compensation expense increased $100,000, or
10.0%, from $1.0 million for the quarter ended December 31, 1997 to $1.1 million
for the quarter ended December 31, 1998.
15
<PAGE>
PROPOSED MANAGEMENT PURCHASES
The following table sets forth the approximate purchases of common stock by
each director and executive officer and their associates. The table assumes that
we will sell the midpoint of the offering range.
<TABLE>
<CAPTION>
Percent Approximate
Total of Total Aggregate
Name and Position Shares Outstanding Purchase Price
- ----------------- ------ ----------- --------------
<S> <C> <C> <C>
James A. Barnwell, Jr., Director 62,500 2.6% $ 1,000,000
Bernie C. Bean, Director 31,250 1.3 500,000
Richard C. Keziah, Chairman of the Board 59,375 2.4 950,000
James G. McClure, Director 62,500 2.6 1,000,000
James C. McGill, President, Chief Executive 62,500 2.6 1,000,000
Officer and Director
T. Scott Quakenbush, Director 62,500 2.6 1,000,000
Richard H. Shirley, Director 46,875 1.9 750,000
Virgil L. Stadler, Director 62,500 2.6 1,000,000
A. Christine Baker, Executive Vice President-
Chief Financial Officer 40,625 1.7 650,000
Fairfax C. Reynolds, Executive Vice President-
Commercial & Retail Banking 40,625 1.7 650,000
John D. Hansell, Manager-First Capital Services LLC 3,125 -- 50,000
Frank Gavigan, Senior Vice President-Senior
Credit Officer 12,500 .5 200,000
----------- ------ -----------
All directors and executive officers, as a
group (12 persons) and their associates 546,875 22.5 8,750,000
Employee stock ownership plan 194,400 8.0 3,110,400
Restricted stock plan(1) 97,200 4.0 1,555,200
Foundation 180,000(2) 7.4 N/A(2)
----------- ------ -----------
Total(3) 1,018,475 41.9% $13,415,600
=========== ====== ===========
</TABLE>
(1) Consists of shares that are expected to be awarded to participants in a
restricted stock plan, if implemented. The dollar amount of the common
stock to be purchased by the restricted stock plan is based on the purchase
price in the offering and does not reflect possible future increases or
decreases in the value of the stock. See "Management of 1st State Bank --
Proposed Future Stock Benefit Plans -- Restricted Stock Plan" for a
description of this plan. The shares awarded could be newly issued shares
or shares purchased in the open market in our sole discretion. In preparing
this table, we assumed that the shares are purchased in the open market.
Any sale of newly issued shares to the restricted stock plan would be
dilutive to existing stockholders. See "Risk Factors -- Possible Dilutive
Effect of Future Employee Stock Benefit Plans" describing how issuance of
stock under these plans may dilute stockholders= ownership interests.
(2) Shares will be donated to the foundation.
(3) Does not include shares that possibly would be purchased by participants in
a stock option plan, intended to be implemented, under which directors,
executive officers and other employees would be granted options to purchase
an aggregate amount of common stock equal to 10% of the shares issued in
the conversion at exercise prices equal to the market price of the common
stock on the date of grant. See "Management of 1st State Bank -- Proposed
Future Stock Benefit Plans -- Stock Option Plan" for a more detailed
discussion of the plan.
16
<PAGE>
USE OF PROCEEDS
We estimate that we will receive net proceeds from the sale of the common
stock of between $29.5 million at the minimum of the offering range and $46.3
million at the maximum, as adjusted of the offering range. Assuming the sale of
$36.0 million of common stock at the midpoint of the offering range and the
purchase of 8% of the shares by the employee stock ownership plan, the following
table sets forth the manner in which we will use the net proceeds:
Loan to employee stock ownership plan $ 3,110,400
Investment in 1st State Bank 15,879,800
1st State Bancorp working capital 15,879,800
--------------
Total $ 34,870,000
==============
The proceeds retained by 1st State Bancorp initially will be invested in
short-term and intermediate-term securities, including cash and cash equivalents
and U.S. Government and agency obligations. The proceeds will be available for a
variety of corporate purposes, including funding a restricted stock plan, if
implemented, future acquisitions and diversification of business, additional
capital contributions to 1st State Bank, dividends to stockholders and future
repurchases of common stock. We do not have any specific plans, intentions,
arrangements or understandings regarding acquisitions or capital contributions.
We have provided in our internal business plan that we will repurchase 5% of the
outstanding common stock in each of the second and third years following the
conversion. However, whether we actually repurchase stock depends on many
factors that may change during the next year or two. For example, we might not
repurchase any stock if the prevailing market price was too high or if we had a
better use for our excess liquid assets. In addition, we will have funds
available to loan to 1st State Bank, if necessary, in the event and to the
extent loan growth exceeds deposit growth or for other corporate purposes. We
may use a portion of the net proceeds to acquire shares of common stock pursuant
to a restricted stock plan, if implemented, or to purchase shares to be held by
a grantor trust for issuance to option holders upon the exercise of options in
the event a stock option plan is implemented. See "Management of 1st State Bank
- -- Proposed Future Stock Benefit Plans -- Stock Option Plan" and "-- Restricted
Stock Plan" for a description of those plans. We do not have any specific plans
regarding possible stock repurchases during the first year following the
conversion.
The proceeds we invest in 1st State Bank will become part of 1st State
Bank's general corporate funds to be used for business activities, including
making loans and investments. Initially, we expect that we will invest the
proceeds in short-term and intermediate-term securities, including cash and cash
equivalents and U.S. Government and agency obligations. We ultimately plan to
use the proceeds primarily to originate loans in the ordinary course of
business.
DIVIDEND POLICY
The board of directors will determine whether to pay dividends. The board
will take into account, among other things, our net income, capital and
financial condition, industry trends and general economic conditions, as well as
any restrictions required by law. We intend to pay an annual cash dividend of
$.32 per share, payable quarterly at $.08 per share. This would be a 2.0%
dividend rate based on the $16.00 per share purchase price. We expect to begin
paying dividends following the first full quarter after the conversion. In
addition, from time to time in an effort to manage capital to a reasonable
level, the board may determine if it is prudent to pay periodic special cash
dividends. Periodic special cash dividends, if paid, may be paid in addition to,
or in lieu of, regular cash dividends. We cannot assure you that we will pay
regular cash dividends or periodic special cash dividends. We could reduce or
eliminate the cash dividend at any time.
Dividend payments by 1st State Bancorp are subject to regulatory
restrictions under Federal Reserve Board policy and to limitations under
Virginia corporate law. The Federal Reserve Board has issued a policy statement
on the payment of cash dividends by bank holding companies, which expresses the
Federal Reserve Board's view that a
17
<PAGE>
bank holding company should pay cash dividends only to the extent that the
company's net income for the past year is sufficient to cover both the cash
dividends and a rate of earnings retention that is consistent with the company's
capital needs, asset quality and overall financial condition. The Federal
Reserve Board also indicated that it would be inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.
Furthermore, the Federal Reserve Board may prohibit a bank holding company from
paying any dividends if the holding company's bank subsidiary is classified as
"undercapitalized." See "Regulation -- Regulation of 1st State Bancorp Following
the Conversion -- Dividends" for the conditions on the payment on dividends
imposed on us after the conversion. Under Virginia law, dividends may be paid as
long as the payment of a dividend would not cause 1st State Bancorp to be unable
to pay its debts as they become due and would not result in total assets being
less than the sum of total liabilities plus any amount required to be paid to
holders of preferred stock in the event of liquidation of 1st State Bancorp.
We have agreed with the FDIC not to make a tax-free cash distribution to
stockholders for a period of one year following the conversion. In addition, we
have agreed with the FDIC not to file a private letter ruling request with the
Internal Revenue Service regarding the tax-free nature of a possible one-time
cash distribution to 1st State Bancorp stockholders for a period of one year
following the conversion.
Because 1st State Bancorp initially will have no significant source of
income other than dividends from 1st State Bank and earnings from investment of
the net offering proceeds it retains, to pay dividends to stockholders 1st State
Bancorp may need to receive dividends from 1st State Bank. 1st State Bank's
ability to pay dividends is subject to various tax and regulatory restrictions.
See "Regulation -- Depository Institution Regulation -- Dividend Restrictions"
for a description of these restrictions.
MARKET FOR THE COMMON STOCK
1st State Bancorp has never issued capital stock to the public.
Consequently, there is no established market for the common stock. We have
received conditional approval to have the common stock listed on the Nasdaq
National Market under the symbol "FSBC". For initial inclusion for listing on
Nasdaq, 1st State Bancorp must have three active and registered market makers.
Trident Securities has advised us that it will act as a market maker for the
common stock, and we expect that there will be additional market makers. The
development of a liquid public market depends on the existence of willing buyers
and sellers, the presence of which we cannot control, and the number of active
buyers and sellers of the common stock at any particular time may be limited.
Under these circumstances, you could have difficulty disposing of your shares
and should view the common stock as a long-term investment. We cannot assure you
that an active and liquid trading market for the common stock will develop, or,
if developed, that it will continue or that you will be able to sell your shares
at or above the $16.00 per share purchase price.
18
<PAGE>
CAPITALIZATION
The following table sets forth our historical capitalization, including
deposits, at September 30, 1998 and our pro forma consolidated capitalization
giving effect to the sale of the common stock in the offering based upon the
assumptions set forth under "Pro Forma Data" and below. Depending on market and
financial conditions, the total number of shares to be issued in the conversion
may be significantly increased or decreased above or below the midpoint of the
offering range. We may consummate the conversion without a resolicitation of
purchasers if the aggregate purchase price of the common stock sold in the
conversion is above the minimum of the offering range or less than the maximum,
as adjusted of the offering range. A change in the number of shares to be issued
in the conversion may materially affect our pro forma capitalization. See "Pro
Forma Data" and "The Conversion -- How We Determined the $16 Per Share Purchase
Price and the Offering Range" for the assumptions we used to calculate the
information below.
<TABLE>
<CAPTION>
Pro Forma Consolidated Capitalization of
1st State Bancorp at September 30, 1998
Based on the Sale of
-------------------------------------------------------
Maximum, as
Capitalization Minimum of Midpoint of Maximum of Adjusted of
of 1st State 1,912,500 2,250,000 2,587,500 2,975,625
Bank at Shares at Shares at Shares at Shares at
September $16.00 $16.00 $16.00 $16.00
30, 1998 Per Share Per Share Per Share Per Share
--------- --------- --------- --------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Deposits (1) ................................................. $ 235,694 $ 235,694 $ 235,694 $ 235,694 $ 235,694
FHLB advances ................................................ 20,000 20,000 20,000 20,000 20,000
--------- --------- --------- --------- ---------
Total deposits and borrowed funds ........................ $ 255,694 $ 255,694 $ 255,694 $ 255,694 $ 255,694
========= ========= ========= ========= =========
Capital stock
Preferred stock, $.01 par value per share:
authorized - 1,000,000 shares;
assumed outstanding - none ............................... $ -- $ -- $ -- $ -- $ --
Common stock, $.01 par value per share:
authorized - 7,000,000 shares;
shares to be outstanding - as shown, plus shares
issued to foundation ..................................... -- 21 24 28 32
Paid-in capital (2) ........................................ -- 31,971 37,726 43,168 49,288
Less: Common stock acquired by employee stock ownership
plan (5) .................................... -- (2,644) (3,110) (3,552) (4,049)
Common stock acquired by restricted stock plan (6) -- (1,322) (1,555) (1,776) (2,024)
Retained income (7) ........................................ 25,873 25,873 25,873 25,873 25,873
Less: Expense of contribution to foundation ................ -- (2,448) (2,880) (3,000) (3,000)
Plus: Tax benefit of contribution to foundation (4) ....... 833 979 1,020 1,020
Net unrealized gains on investment securities available
for sale ............................................... 93 93 93 93 93
--------- --------- --------- --------- ---------
Total stockholders' equity ............................... $ 25,966 $ 52,377 $ 57,150 $ 61,854 $ 67,233
========= ========= ========= ========= =========
</TABLE>
(footnotes on following page)
19
<PAGE>
(footnotes for table on previous page)
- ---------
(1) We have not included any withdrawals from savings accounts for the purchase
of stock. Any withdrawals will reduce pro forma capitalization by the
amount of the withdrawals.
(2) Based upon the estimated net proceeds from the sale of capital stock less
the par value of shares sold. Estimated offering expenses are $1,056,000,
$1,130,000, $1,204,000 and $1,290,000 at the minimum, midpoint, maximum and
maximum, as adjusted of the offering range. Does not reflect additional
shares of common stock that possibly could be purchased by participants in
a stock option plan, if implemented, under which directors, executive
officers and other employees could be granted options to purchase an
aggregate of up to 10% of the shares of common stock issued in the
conversion, including shares we contribute to the foundation, at exercise
prices equal to the market price of the common stock on the date of grant.
Implementation of the stock option plan within one year after the
conversion will require regulatory and stockholder approval. See
"Management of 1st State Bank -- Proposed Future Stock Benefit Plans --
Stock Option Plan" and "Risk Factors -- Possible Dilutive Effect of
Employee Stock Benefit Plans" for a description of these plans.
(3) Assumes the common stock contributed to the foundation has a value of
$16.00 per share. The number of shares of common stock we will contribute
to the foundation is 153,000, 180,000, 187,500 and 187,500 at the minimum,
midpoint, maximum and maximum, as adjusted, respectively, of the offering
range.
(4) Reflects the tax effect of the contribution based on a 34% marginal federal
tax rate. The realization of the deferred tax benefit is limited annually
to 10% of our annual taxable income, subject to our ability to carry
forward any unused portion of the deduction for five years following the
year in which the contribution is made.
(5) Assumes 8% of the shares of common stock to be sold in the offering are
purchased by the employee stock ownership plan and that the funds used to
purchase the shares are borrowed from 1st State Bancorp.
(6) Assumes that we will acquire for the restricted stock plan at $16.00 per
share a number of shares equal to 4% of the number of shares sold in the
offering. If the restricted stock plan were funded by authorized but
unissued shares, your interests would be diluted by approximately 4%.
Implementation of such a plan within one year of the conversion would
require regulatory and stockholder approval at a meeting of our
stockholders to be held no earlier than six months after the conversion.
See "Management of 1st State Bank -- Proposed Future Stock Benefit Plans --
Restricted Stock Plan" for a description of the plan.
(7) Our retained income is substantially restricted. All capital distributions
are subject to regulatory restrictions tied to our regulatory capital
level. In addition, after the conversion, we will be prohibited from paying
any dividend that would reduce our regulatory capital below the amount in
the liquidation account we will establish. See "Regulation -- Depository
Institution Regulation -- Dividend Restrictions" and "The Conversion -- How
the Conversion Will Affect Our Depositors and Borrowers -- Liquidation
Account" for information regarding the liquidation account. The liquidation
account is a memorandum account and will not appear in our financial
statements.
20
<PAGE>
HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE
We are subject to North Carolina law, which requires that our net worth,
computed in accordance with the requirements of the North Carolina Savings Bank
Administrator, equal or exceed 5% of total assets. In addition, we are subject
to the capital requirements of the FDIC. The FDIC requires that institutions
which receive the highest rating during their examination process and are not
experiencing or anticipating significant growth must maintain a leverage ratio
of Tier 1 capital to total assets of at least 3%. All other institutions are
required to maintain a ratio of 1% or 2% above the 3% minimum with an absolute
minimum leverage ratio of not less than 4%. The FDIC also imposes requirements
that:
. the ratio of Tier 1 capital to risk-weighted assets equal at least 4%,
and
. the ratio of total capital to risk-weighted assets equal at least 8%.
For a description of the regulatory capital standards we must meet, see
"Regulation -- Depository Institution Regulation -- Capital Requirements."
After the conversion, 1st State Bank will continue to be subject to the
FDIC's capital requirements and 1st State Bancorp will be required to satisfy
Federal Reserve Board capital requirements, which are similar but not identical
to the FDIC's capital requirements. The following table sets forth our
historical capital position relative to the various minimum North Carolina
Savings Bank Administrator and FDIC regulatory capital requirements to which we
are currently subject. The next table sets forth our historical capital position
and thereafter presents pro forma data relative to the FDIC capital requirements
to which 1st State Bank will be subject. For additional information regarding
our financial condition and the assumptions underlying the pro forma capital
calculations set forth below, see "Use of Proceeds," "Capitalization" and "Pro
Forma Data" and the consolidated financial statements and related notes, which
you can find beginning on page F-1 of this Prospectus.
<TABLE>
<CAPTION>
Historical at
September 30, 1998
-----------------------
Percent of
Amount Assets(1)
------ ---------
(Dollars in thousands)
<S> <C> <C>
Tier 1/leverage capital ........................... $25,873 9.13%
Tier 1/leverage capital requirement ............... 11,334 4.00
------- -------
Excess .......................................... $14,539 5.13%
======= =======
Tier 1 risk-based capital ......................... $25,873 14.53%
Tier 1 risk-based capital requirement ............. 7,124 4.00
------- -------
Excess .......................................... $18,749 10.53%
======= =======
Total risk-based capital .......................... $28,112 15.78%
Total risk-based capital requirement .............. 14,249 8.00
------- -------
Excess .......................................... $13,863 7.78%
======= =======
North Carolina regulatory capital ................. $28,112 9.75%
North Carolina regulatory capital requirement ..... 14,411 5.00
------- -------
Excess .......................................... $13,701 4.75%
======= =======
</TABLE>
- ---------------
(1) The ratio of leverage capital is based on quarterly average assets for the
year ended September 30, 1998. Tier 1 risk-based capital and total
risk-based capital are based on risk-weighted assets at September 30, 1998.
The North Carolina regulatory capital requirement is based on total assets
at September 30, 1998.
21
<PAGE>
<TABLE>
<CAPTION>
1st State Bank's
Historical Capital
at September 30, 1998
Assuming FDIC
Capital Requirements
-----------------------
Percent of
Amount Assets (2)
------- ----------
(Dollars in thousands)
<S> <C> <C>
Capital under generally accepted
accounting principles ........................... $25,966 9.0%
Tier 1 (core) to total assets ...................... $25,873 9.1%
Tier 1 (core) capital requirement (3) .............. 11,334 4.0
------- -------
Excess .......................................... $14,539 5.1%
Tier 1 (core) capital to risk-weighted
assets .......................................... $25,873 14.5%
Tier 1 (core) capital requirement .................. 7,124 4.0
------- -------
Excess .......................................... $18,749 10.5%
Total capital to risk-weighted assets .............. $28,112 15.8%
Total capital requirement .......................... 14,249 8.0
------- -------
Excess .......................................... $13,863 7.8%
NC Savings Bank capital ............................ $28,112 9.8%
Requirement ........................................ 14,411 5.0
------- -------
Excess ......................................... $13,701 4.8%
<CAPTION>
Pro Forma Capital of 1st State Bank as of September 30, 1998 Based on the Sale of(1)
----------------------------------------------------------------------------------------
Maximum,
Minimum of Midpoint of Maximum of as Adjusted of
1,912,500 Shares at 2,250,000 Shares at 2,587,500 Shares at 2,975,625 Shares
$16.00 Per Share $16.00 Per Share $16.00 Per Share at $16.00 Per Share
----------------------------------------------------------------------------------------
Percent of Percent of Percent of Percent of
Amount Assets(2) Amount Assets(2) Amount Assets(2) Amount Assets(2)
------- -------- ------ --------- ------ --------- ------ ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Capital under generally accepted
accounting principles .................. $39,416 13.1% $41,846 13.8% $44,288 14.4% $47,102 15.2%
Tier 1 (core) to total assets ............. $39,323 13.0% $41,753 13.7% $44,195 14.4% $47,009 15.2%
Tier 1 (core) capital requirement (3) ..... 12,063 4.0 12,160 4.0 12,258 4.0 12,371 4.0
------- ------ ------- ------- ------- ------ ------- ------
Excess ................................. $27,260 9.0% $29,593 9.7% $31,937 10.4% $34,638 11.2%
Tier 1 (core) capital to risk-weighted
assets ................................. $39,323 21.3% $41,753 22.4% $44,195 23.6% $47,009 24.9%
Tier 1 (core) capital requirement ......... 7,393 4.0 7,442 4.0 7,491 4.0 7,547 4.0
------- ------ ------- ------- ------- ------ ------- ------
Excess ................................. $31,930 17.3% $34,311 18.4% $36,704 19.6% $39,462 20.9%
Total capital to risk-weighted assets ..... $41,562 22.5% $43,992 23.6% $46,434 24.8% $49,248 26.1%
Total capital requirement ................. 14,787 8.0 14,884 8.0 14,982 8.0 15,094 8.0
------- ------ ------- ------- ------- ------ ------- ------
Excess ................................. $26,775 14.5% $29,108 15.6% $31,452 16.8% $34,154 18.1%
NC Savings Bank capital ................... $41,562 13.8% $43,992 14.5% $46,434 15.1% $49,248 15.9%
Requirement ............................... 15,084 5.0 15,205 5.0 15,327 5.0 15,468 5.0
------- ------ ------- ------- ------- ------ ------- ------
Excess ................................ $26,478 8.8% $28,787 9.5% $31,107 10.1% $33,780 10.9%
</TABLE>
----------------------
(1) Assumes we invest net proceeds initially in assets with a 50% risk-
weighting. The numbers of shares sold do not include the shares we
will contribute to the foundation.
(2) Based on our total assets for capital as determined under generally
accepted accounting principles and Tier 1 capital purposes, and risk-
weighted assets for the purpose of the risk-based capital
requirements.
(3) Assumes a core capital requirement of 4% adjusted total assets, though
that level may be increased by the FDIC to as high as 5%. See
"Regulation -- Depository Institution Regulation -- Capital
Requirements" for a description of the regulatory capital requirements
we must meet.
22
<PAGE>
PRO FORMA DATA
We will not know the actual net proceeds from the offering until the
offering is completed. We estimate that investable net proceeds will be between
$25.6 million at the minimum of the offering range and $40.2 million at the
maximum, as adjusted of the offering range. To arrive at this estimate, we made
the following assumptions:
. 8% of the sum of the shares sold plus shares donated to the
charitable foundation are sold to the employee stock ownership
plan
. directors, officers and employees purchase 546,875 shares
. conversion expenses, other than sales commissions, total
$768,000
We have prepared the following table, which sets forth our historical net
earnings and net worth prior to the conversion and our pro forma consolidated
net income and stockholders' equity following the conversion. In preparing this
table and in calculating pro forma data, we have made the following assumptions:
. For purposes of computing net income and net income per share,
the stock sale was completed on October 1, 1997 so that 1st State
Bancorp had use of the proceeds for the full year. Otherwise it
is assumed the stock sale was completed on September 30,
1998.
. Net proceeds were invested at 4.50%, which approximates the one-
year U.S. Treasury bill rate at September 30, 1998. Regulations
require us to estimate income on net proceeds by using the
arithmetic average of the average yield on interest-earning
assets and average rate paid on deposits. We used the one-year
U.S. Treasury bill rate instead because we believe that this is a
more accurate estimate of the rate that would be obtained on an
investment of the net proceeds from the offering.
. The effective blended federal and state tax rate was 36.0%,
resulting in an after-tax yield of 2.88%.
. We did not include any withdrawals from deposit accounts to
purchase shares in the offering.
. We did not include any earnings on the net proceeds in
calculating pro forma stockholders' equity.
. To calculate per share figures, we divided the appropriate
amounts by the indicated numbers of shares.
. We calculated historical and pro forma per share amounts by
dividing historical and pro forma amounts by the indicated number
of shares.
The following pro forma data relies on the assumptions we outlined above,
and this data does not represent the fair market value of the common stock, the
current value of assets or liabilities, or the amount of money that would be
distributed to stockholders if we liquidated 1st State Bancorp. The pro forma
data does not predict how much we will earn in the future. The following table
does not include the after-tax expense we will incur during the year ending
September 30, 1999 as a result of our contribution to the foundation.
23
<PAGE>
<TABLE>
<CAPTION>
At or for the Year Ended September 30, 1998
-----------------------------------------------------------
Maximum, as
Minimum of Midpoint of Maximum of Adjusted of
1,912,500 2,250,000 2,587,500 2,975,625
Shares Shares Shares Shares
at $16.00 at $16.00 at $16.00 at $16.00
Per Share Per Share Per Share Per Share
----------- ----------- ----------- -----------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Gross offering proceeds ............................................ $ 30,600 $ 36,000 $ 41,400 $ 47,610
Plus: Shares issued to foundation .................................. 2,448 2,880 3,000 3,000
----------- ----------- ----------- -----------
Pro Forma market capitalization ................................ $ 33,048 $ 38,880 $ 44,400 $ 50,610
=========== =========== =========== ===========
Gross offering proceeds ............................................ $ 30,600 $ 36,000 $ 41,400 $ 47,610
Less estimated offering expenses ................................... (1,056) (1,130) (1,204) (1,290)
----------- ----------- ----------- -----------
Estimated net offering proceeds ................................. 29,544 34,870 40,196 46,320
Less: Employee stock ownership plan funded by
1st State Bancorp ........................................ (2,644) (3,110) (3,552) (4,049)
Restricted stock plan ........................................ (1,322) (1,555) (1,776) (2,024)
----------- ----------- ----------- -----------
Estimated investable net proceeds ............................... $ 25,578 $ 30,205 $ 34,868 $ 40,247
=========== =========== =========== ===========
Net income:
Historical net income ........................................... $ 2,521 $ 2,521 $ 2,521 $ 2,521
Pro forma income on investable net proceeds ..................... 736 870 1,004 1,159
Pro forma employee stock ownership plan adjustment(1) ........... (169) (199) (227) (259)
Pro forma restricted stock plan adjustment(2) ................... (169) (199) (227) (259)
----------- ----------- ----------- -----------
Total ....................................................... $ 2,919 $ 2,993 $ 3,071 $ 3,162
=========== =========== =========== ===========
Net income per share:
Historical net income ........................................... $ 1.36 $ 1.16 $ 1.01 $ 0.89
Pro forma income on investable net proceeds ..................... 0.40 0.39 0.41 0.41
Pro forma employee stock ownership plan adjustment(1) ........... (0.09) (0.09) (0.09) (0.09)
Pro forma restricted stock plan adjustment(2) ................... (0.09) (0.09) (0.09) (0.09)
----------- ----------- ----------- -----------
Pro forma basic income per share ........................... $ 1.58 $ 1.37 $ 1.24 $ 1.12
=========== =========== =========== ===========
Pro forma diluted income per share ......................... $ 1.52 $ 1.33 $ 1.19 $ 1.08
=========== =========== =========== ===========
Weighted average number of shares outstanding
for basic income per share calculations(1) ...................... 1,850,688 2,177,280 2,486,400 2,834,160
=========== =========== =========== ===========
Weighted average number of shares outstanding
for diluted income per share calculations(1) .................... 1,916,784 2,255,040 2,575,200 2,935,380
=========== =========== =========== ===========
Stockholders' equity:(3)
Historical ..................................................... $ 25,966 $ 25,966 $ 25,966 $ 25,966
Estimated net proceeds(2)(4) ................................... 29,544 34,870 40,196 46,320
Plus: Shares issued to foundation .............................. 2,448 2,880 3,000 3,000
Less: Contribution to foundation ............................... (2,448) (2,880) (3,000) (3,000)
Plus: Tax benefit of the contribution to the foundation ........ 833 979 1,020 1,020
Less: Common stock acquired by employee stock
ownership plan(1) ..................................... (2,644) (3,110) (3,552) (4,049)
Common stock acquired by restricted stock
plan(2) ............................................... (1,322) (1,555) (1,776) (2,024)
----------- ----------- ----------- -----------
Total ....................................................... $ 52,377 $ 57,150 $ 61,854 $ 67,233
=========== =========== =========== ===========
Stockholders' equity per share: (3)
Historical ...................................................... $ 12.57 $ 10.69 $ 9.36 $ 8.21
Estimated net proceeds (2)(4) ................................... 14.30 14.35 14.49 14.64
Plus: Shares issued to foundation ............................... 1.19 1.19 1.08 0.95
Less: Contribution to foundation ................................ (1.19) (1.19) (1.08) (0.95)
Plus: Tax benefit of the contribution to the foundation ......... 0.41 0.40 0.36 0.33
Less: Common stock acquired by employee stock
ownership plan (1) ..................................... (1.28) (1.28) (1.28) (1.28)
Common stock acquired by restricted stock
plan (2) ............................................... (0.64) (0.64) (0.64) (0.64)
----------- ----------- ----------- -----------
Total ....................................................... $ 25.36 $ 23.52 $ 22.29 $ 21.26
=========== =========== =========== ===========
Number of shares outstanding for
stockholders' equity per share calculations ..................... 2,065,500 2,430,000 2,775,000 3,163,125
=========== =========== =========== ===========
Offering price as a percentage of pro forma
stockholders' equity per share .................................. 63.1% 68.0% 71.8% 75.3%
=========== =========== =========== ===========
Ratio of offering price to pro forma basic
income per share ............................................... 10.1x 11.7x 13.0x 14.3x
=========== =========== =========== ===========
</TABLE>
(Footnotes on succeeding page)
24
<PAGE>
- ------------------
(1) We assumed that the employee stock ownership plan purchases 8% of the
shares sold in the conversion, and that 1st State Bancorp lends the
employee stock ownership plan the funds to do so. The amount the employee
stock ownership plan will borrow is not reflected as a liability but is
reflected as a reduction of capital. Although repayment of the debt will be
secured solely by the shares purchased by the employee stock ownership
plan, 1st State Bank expects to make discretionary contributions to the
employee stock ownership plan in an amount at least equal to the principal
and interest payments on the employee stock ownership plan debt. We
adjusted pro forma net income for the contributions, based upon a fully
amortizing debt with a ten-year term. The offering price of $16.00 was
utilized to calculate the employee stock ownership plan expense. 1st State
Bank intends to record compensation expense related to the employee stock
ownership plan in accordance with accounting rule AICPA SOP No. 93-6. As a
result, if the value of the common stock appreciates over time,
compensation expense attributable to the employee stock ownership plan will
increase. SOP 93-6 and Statement of Financial Accounting Standards No. 128
require the earnings per share computations for companies with leveraged
employee stock ownership plans to include as outstanding only shares that
have been committed to be released to participants. We assumed that 10% of
the employee stock ownership plan shares were committed to be released. We
reduced the amount of employee stock ownership plan expense by an estimated
income tax benefit computed using a 36% blended federal and state effective
tax rate. See "Management of 1st State Bank -- Executive Compensation --
Employee Stock Ownership Plan" for a more detailed description of this
plan.
(2) We assumed a number of shares of common stock equal to 4% of the common
stock to be sold in the conversion will be purchased by a restricted stock
plan in the open market following the conversion. The dollar amount of the
common stock to be purchased by the restricted stock plan is based on the
$16.00 purchase price in the conversion and represents unearned
compensation and is reflected as a reduction of capital. This amount does
not reflect possible future increases or decreases in the value of the
common stock prior to the date we actually purchase the shares for this
plan. As 1st State Bank accrues compensation expense to reflect the vesting
of the shares as will be required by the restricted stock plan, the charge
against capital will be reduced accordingly. Statement of Financial
Accounting Standards No. 128 requires that unvested shares of the
restricted stock plan be excluded from the basic earnings per share
calculation but included in the diluted earnings per share calculation. We
assumed that 20% of the restricted stock plan shares were vested. Upon
vesting, restricted stock plan shares are included in calculating basic
earnings per share. Implementation of the restricted stock plan within one
year of the conversion would require stockholder approval at a meeting of
our stockholders. If the shares to be purchased by the restricted stock
plan were newly issued shares purchased from 1st State Bancorp by the
restricted stock plan at the $16.00 purchase price rather than shares
purchased in the open market, at the minimum, midpoint, maximum and
maximum, as adjusted of the offering range, pro forma stockholders' equity
per share would have been $25.00, $23.23, $22.05 and $21.05, respectively,
and pro forma diluted income per share would have been $1.46, $1.27, $1.14
and $1.63, respectively. If the restricted stock plan acquires authorized
but unissued shares from 1st State Bancorp, your ownership interests in 1st
State Bancorp would be diluted by approximately 4%. See "Management of 1st
State Bank -- Proposed Future Stock Benefit Plans -- Restricted Stock Plan"
and "Risk Factors -- Dilutive Effect of Restricted Stock Plan and Stock
Options" for additional details.
(3) Consolidated stockholders' equity represents the excess of the carrying
value of our assets over our liabilities. The amounts shown do not reflect
the federal income tax consequences of the potential restoration to income
of the bad debt reserves for income tax purposes, which would be required
in the event of liquidation or in certain other remote circumstances. The
amounts shown also do not reflect the amounts required to be distributed in
the event of liquidation to eligible depositors from the liquidation
account which will be established in the conversion.
(4) We did not make any allowance for shares that may be issued upon the
exercise of options that may be granted under a future stock option plan.
25
<PAGE>
COMPARISON OF VALUATION AND PRO FORMA INFORMATION WITH NO FOUNDATION
Had we not established the foundation as part of the conversion, Ferguson &
Company has estimated that our pro forma market capitalization would have been
approximately $42.0 million, at the midpoint of the offering range, which is
approximately $3.1 million greater than our pro forma market capitalization with
the foundation. This would result in approximately a $6.0 million increase in
the amount of common stock that we would offer for sale in the offering.
Further, at the midpoint of the offering range, pro forma stockholders' equity
per share and pro forma consolidated basic net income per share would be $23.52
and $1.37, respectively, with the foundation, as compared to $23.51 and $1.33,
respectively, without the foundation. At the midpoint of the offering range, the
pro forma price to book ratio and the pro forma price to earnings ratio are
68.0% and 11.7 times earnings, respectively, with the foundation, as compared to
68.1% and 12.0 times earnings, respectively, without the foundation. The
following table does not reflect the after-tax expense we will incur during the
year ending September 30, 1999 as a result of our contribution to the
foundation.
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 offering range, assuming the conversion was completed at
September 30, 1998.
<TABLE>
<CAPTION>
Minimum of Midpoint of
1,912,500 Shares at 2,250,000 Shares at
$16.00 Per Share $16.00 Per Share
---------------------------- ---------------------------
With No With No
Foundation Foundation Foundation Foundation
---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Estimated gross offering amount .......... $ 30,600 $ 35,700 $ 36,000 $ 42,000
Pro forma market capitalization .......... 33,048 35,700 38,880 42,000
Total assets ............................. 314,635 318,511 319,408 323,968
Total liabilities ........................ 262,258 262,258 262,258 262,258
Pro forma stockholders' equity ........... 52,377 56,253 57,150 61,710
Pro forma consolidated net earnings ...... 2,919 3,028 2,993 3,120
Pro forma stockholders' equity per share . 25.36 25.21 23.52 23.51
Pro forma consolidated basic income
per share .............................. 1.58 1.51 1.37 1.33
Pro forma consolidated diluted
income per share ....................... 1.52 1.46 1.33 1.28
Pro forma pricing ratios:
Offering price as a percentage of pro
forma stockholders' equity per share 63.1% 63.5% 68.0% 68.1%
Offering price to pro forma basic
income per share ................. 10.1 10.6 11.7 12.0
Offering price to assets per share .... 11.5% 11.2% 12.2% 13.0%
Pro forma financial ratios:
Return on assets ..................... 0.98% 1.00% 0.99% 1.01%
Return on stockholders' equity ....... 5.72% 5.51% 5.36% 5.17%
Stockholders' equity to assets ....... 16.6% 17.7% 17.9% 19.0%
<CAPTION>
Maximum of Maximum, as Adjusted of
2,587,500 Shares at 2,975,625 Shares at
$16.00 Per Share $16.00 Per Share
--------------------------- ----------------------------
With No With No
Foundation Foundation Foundation Foundation
---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Estimated gross offering amount .......... $ 41,400 $ 48,300 $ 47,610 $ 55,545
Pro forma market capitalization .......... 44,400 48,300 50,610 55,545
Total assets ............................. 324,112 329,425 329,491 335,701
Total liabilities ........................ 262,258 262,258 262,258 262,258
Pro forma stockholders' equity ........... 61,854 67,167 67,233 73,443
Pro forma consolidated net earnings ...... 3,071 3,213 3,162 3,320
Pro forma stockholders' equity per share . 22.29 22.25 21.26 21.16
Pro forma consolidated basic income
per share .............................. 1.24 1.19 1.12 1.07
Pro forma consolidated diluted
income per share ....................... 1.19 1.15 1.08 1.03
Pro forma pricing ratios:
Offering price as a percentage of pro
forma stockholders' equity per share 71.8% 71.9% 75.3% 75.6%
Offering price to pro forma basic
income per share ................. 13.0 13.4 14.3 15.0
Offering price to assets per share .... 13.7% 14.7% 15.4% 16.5%
Pro forma financial ratios:
Return on assets ..................... 1.00% 1.02% 1.01% 1.03%
Return on stockholders' equity ....... 5.07% 4.88% 4.80% 4.60%
Stockholders' equity to assets ....... 19.1% 20.4% 20.4% 21.9%
</TABLE>
26
<PAGE>
THE CONVERSION
Our board of directors and the North Carolina Savings Bank Administrator
have approved our Plan of Conversion, subject to approval by our members
entitled to vote on the matter and subject to certain other conditions. In
approving the Plan of Conversion, the North Carolina Savings Bank Administrator
does not recommend or endorse the Plan of Conversion.
General
On August 11, 1998, our board of directors unanimously adopted the Plan of
Conversion, subject to regulatory approval and the approval of our members. The
Plan of Conversion is the legal document that describes the terms and conditions
of the conversion. The North Carolina Savings Bank Administrator has approved
the Plan of Conversion subject to, among other conditions, approval by our
members. In addition, the FDIC has issued its conditional non-objection to the
Plan of Conversion and the conversion. A special meeting of our members to vote
on the Plan of Conversion will be held on ___________, 1999. As of the date of
this prospectus, we have received approval from the Commission, subject to
certain conditions, for the conversion, and 1st State Bancorp=s application to
the Federal Reserve Board for approval to control 1st State Bank following the
conversion is pending.
The following is a summary of material aspects of the conversion. Because
this is a summary, it does not contain all the information that may be important
to you, and you may wish to read the Plan of Conversion for complete
information. You may read the Plan of Conversion at any of our offices or at the
office of the North Carolina Savings Bank Administrator. The Plan of Conversion
also is filed as an exhibit to the Registration Statement of which this
Prospectus is a part. Copies of the Registration Statement may be obtained from
the Securities and Exchange Commission. For information on how to obtain a copy
of the Registration Statement without charge, see "Additional Information."
Business Purposes
The net proceeds from the offering will substantially increase our capital
position, which will in turn increase the amount of funds available for lending
and investment and provide greater resources to support current operations and
future expansion. We have no current agreements or understandings regarding
expansion.
We formed 1st State Bancorp, to serve as a holding company for 1st State
Bank after the conversion. We believe the holding company structure will provide
greater flexibility than 1st State Bank alone would have for diversification of
business activities and geographic expansion. We believe that this increased
capital and operating flexibility will enable us to compete more effectively
with other types of financial services organizations. In addition, the
conversion will enhance our future access to the capital markets.
We believe that operating as a commercial bank rather than a savings bank
will allow us to continue to pursue our expanding lines of business. We intend
to emphasize commercial real estate loans, commercial loans and consumer loans.
See "Risk Factors -- Risks Related to Commercial and Consumer Lending" for a
description of the higher credit risk inherent in these types of loans. We
believe we can pursue this strategy more effectively by operating as a North
Carolina commercial bank rather than a North Carolina-chartered savings bank. We
further believe that converting to a commercial bank will enhance our
marketability by allowing us to provide a broader range of services than we
currently are permitted under law to offer as a savings bank. For example, as a
commercial bank, we would be able to increase the percentage of our assets
invested in commercial real estate loans, commercial loans and consumer loans.
We believe that if we are able to increase our marketability in our community,
we will generate additional business, which we anticipate would increase the
value of our company's stock.
After the conversion we would be able to raise additional equity capital
through further sales of securities, subject to market conditions, and to issue
securities in connection with possible acquisitions. Presently, we do not have
27
<PAGE>
any plans to offer additional securities, other than to issue additional shares
under a restricted stock plan or a stock option plan, if implemented. Following
the conversion, we also will be able to use stock-related incentive programs to
attract and retain executive officers and other personnel. See "Management of
1st State Bank -- Future Proposed Stock Benefit Plans" for additional
information regarding these plans.
How the Conversion Will Affect Our Depositors and Borrowers
General. Each depositor in a mutual savings bank such as 1st State Bank has
both a deposit account and a proportionate ownership interest in the retained
earnings of that bank based on the balance in his or her deposit account.
However, this ownership interest is tied to the depositor's account and has no
tangible market value separate from the deposit account. Any other depositor who
opens a deposit account obtains a proportionate interest in the retained
earnings of the bank without any additional payment beyond the amount of the
deposit. A depositor who reduces or closes his or her account receives a portion
or all of the balance in the account but nothing for his or her ownership
interest, which is lost to the extent that the balance in the account is
reduced. Consequently, depositors normally do not have a way to earn the value
of their ownership interest, which has realizable value only in the unlikely
event that the mutual savings bank is liquidated. In that event, the depositors
at that time, as owners, would share proportionately in any residual retained
earnings after other claims are paid.
After the conversion, permanent nonwithdrawable capital stock will be
created to represent the ownership of the savings bank. The stock is separate
from deposit accounts and is not and cannot be insured by the FDIC. Transferable
certificates will be issued to evidence ownership of the stock, which will
enable the holder to sell or trade the stock with no effect on any account in
the savings bank. Under the Plan of Conversion, 1st State Bancorp will acquire
all of the capital stock of 1st State Bank in exchange for a portion of the net
proceeds from the sale of the common stock in the conversion. The common stock
we are selling to the public represents an ownership interest in 1st State
Bancorp.
Continuity. During the conversion process, our normal business of accepting
deposits and making loans will continue without interruption. 1st State Bank
will continue to be subject to regulation by the North Carolina Savings Bank
Administrator and the FDIC until we conclude the conversion. After the
conversion, 1st State Bank will be subject to regulation by the Commission and
the FDIC, and FDIC insurance of accounts will continue without interruption.
After the conversion, 1st State Bank will continue to provide services for
depositors and borrowers under current policies and by present management and
staff.
The board of directors of 1st State Bank at the time of the conversion will
serve as the board of directors of 1st State Bank after the conversion. The
board of directors of 1st State Bancorp will consist of the individuals
currently serving on the board of directors of 1st State Bank. All of our
officers at the time of the conversion will retain their positions with 1st
State Bank after the conversion.
Voting Rights. After the conversion, depositors and borrowers will have no
voting rights in 1st State Bank or 1st State Bancorp and, therefore, will not be
able to elect directors of 1st State Bank or 1st State Bancorp or to control
their affairs. Currently these rights are accorded to our depositors. Subsequent
to the conversion, the stockholders of 1st State Bancorp will have exclusive
voting rights. Each holder of common stock will be entitled to vote on any
matter to be considered by the stockholders of 1st State Bancorp, subject to the
provisions of 1st State Bancorp's articles of incorporation.
Deposit Accounts and Loans. Our deposit accounts, the balances of
individual accounts and existing federal deposit insurance coverage will not be
affected by the conversion. Furthermore, the conversion will not affect the loan
accounts, the balances of these accounts and the obligations of the borrowers
under their individual contractual arrangements with us.
28
<PAGE>
Tax Effects. We have received an opinion from our special counsel, Housley
Kantarian & Bronstein, P.C., Washington, D.C., as to the material federal income
tax consequences of the conversion to 1st State Bank and 1st State Bancorp, and
as to the generally applicable material federal income tax consequences of the
conversion to our account holders and to persons who purchase common stock in
the conversion. The opinion provides that the conversion will constitute one or
more reorganizations for federal income tax purposes under Section 368(a)(1)(F)
of the Internal Revenue Code. Among other things, the opinion also provides
that:
. No gain or loss will be recognized by us in our mutual or stock form
by reason of our conversion from mutual to stock form or from a
savings bank to a commercial bank.
. No gain or loss will be recognized by our account holders upon the
issuance to them of accounts in 1st State Bank in stock form
immediately after our conversion from mutual to stock form, in the
same dollar amounts and on the same terms and conditions as their
accounts with us immediately prior to the conversion.
. The tax basis of each account holder's interest in the liquidation
account will be equal to the value, if any, of that interest.
. The tax basis of the common stock purchased in the conversion will be
equal to the amount paid therefor increased, in the case of common
stock acquired pursuant to the exercise of subscription rights, by the
fair market value, if any, of the subscription rights exercised.
. The holding period for the common stock purchased in the conversion
will commence upon the exercise of such holder's subscription rights
and otherwise on the day following the date of that purchase.
. Gain or loss will be recognized to account holders upon the receipt of
liquidation rights or the receipt or exercise of subscription rights
in the conversion, to the extent such liquidation rights and
subscription rights are deemed to have value, as discussed below.
The opinion of Housley Kantarian & Bronstein, P.C. is based in part upon,
and subject to the continuing validity in all material respects through the date
of the conversion of, our various representations and upon certain assumptions
and qualifications, including that the conversion is consummated in the manner
and according to the terms provided in the Plan of Conversion. Such opinion also
is based upon the Internal Revenue Code, regulations now in effect or proposed,
current administrative rulings and practice and judicial authority, all of which
are subject to change, and such change may be made with retroactive effect.
Unlike private letter rulings received from the Internal Revenue Service, an
opinion is not binding upon the Internal Revenue Service and there can be no
assurance that the Internal Revenue Service will not take a position contrary to
the positions reflected in such opinion, or that such opinion will be upheld by
the courts if challenged by the Internal Revenue Service.
Housley Kantarian & Bronstein, P.C. has advised us that an interest in a
liquidation account has been treated by the Internal Revenue Service, in a
series of private letter rulings which do not constitute formal precedent, as
having nominal, if any, fair market value and therefore it is likely that the
interests in the liquidation account established by us as part of the conversion
will similarly be treated as having nominal, if any, fair market value.
Accordingly, it is likely that our depositors will not recognize any gain or
loss upon receipt of an interest in the liquidation account we will establish in
the conversion.
Housley Kantarian & Bronstein, P.C. has further advised us that the federal
income tax treatment of the receipt of subscription rights pursuant to the
conversion is uncertain, and recent private letter rulings issued by the
Internal Revenue Service have been in conflict. For instance, the Internal
Revenue Service adopted the position in one private ruling that subscription
rights will be deemed to have been received to the extent of the minimum pro
rata distribution
29
<PAGE>
of such rights, together with the rights actually exercised in excess of such
pro rata distribution, and with gain recognized to the extent of the combined
fair market value of the pro rata distribution of subscription rights plus the
subscription rights actually exercised. Under this analysis, persons who do not
exercise their subscription rights would recognize gain upon receipt of rights
equal to the fair market value of such rights, regardless of exercise, and would
recognize a corresponding loss upon the expiration of unexercised rights that
may be available to offset the previously recognized gain. Under another
Internal Revenue Service private ruling, subscription rights were deemed to have
been received only to the extent actually exercised. This private ruling
required that gain be recognized only if the holder of the rights exercised the
rights, and that no loss be recognized if the rights were allowed to expire
unexercised. There is no authority that clearly resolves this conflict among
these private rulings, which may not be relied upon for precedential effect.
However, based upon express provisions of the Internal Revenue Code and in the
absence of contrary authoritative guidance, Housley Kantarian & Bronstein, P.C.
has provided in its opinion that gain will be recognized upon the receipt rather
than the exercise of subscription rights. Further, also based upon a published
Internal Revenue Service ruling and consistent with recognition of gain upon
receipt rather than exercise of the subscription rights, Housley Kantarian &
Bronstein, P.C. has provided in its opinion that the subsequent exercise of the
subscription rights will not give rise to gain or loss. Regardless of the
position eventually adopted by the Internal Revenue Service, the tax
consequences of the receipt of the subscription rights will depend, in part,
upon their valuation for federal income tax purposes.
If the subscription rights are deemed to have a fair market value, the
receipt of such rights will be taxable to you if you exercise your subscription
rights, even though you would have received no cash from which to pay taxes on
such taxable income. We could also recognize a gain on the distribution of such
subscription rights in an amount equal to their aggregate value. In the opinion
of Ferguson & Company, whose opinion is not binding upon the Internal Revenue
Service, the subscription rights do not have any ascertainable market value,
based on the fact that such rights are acquired by the recipients without cost,
are non-transferable and of short duration and afford the recipients the right
only to purchase shares of the common stock at the same price as the price paid
by purchasers without subscription rights in the offering. We encourage you to
consult with your own tax advisors as to the tax consequences in the event that
the subscription rights are deemed to have a fair market value. Because the fair
market value, if any, of the subscription rights issued in the conversion
depends primarily upon the existence of certain facts rather than the resolution
of legal issues, Housley Kantarian & Bronstein, P.C. relied on the factual
opinion of Ferguson & Company in its opinion.
We have also obtained an opinion from KPMG LLP to the effect that the tax
effects of the conversion under North Carolina tax laws will be substantially
the same as described above with respect to federal income tax laws.
The federal and state income tax discussion set forth above does not
consider all aspects of federal and state income taxation which may be relevant
to each eligible account holder, supplemental eligible account holder and other
member entitled to special treatment under the Internal Revenue Code, such as
trusts, individual retirement accounts, other employee benefit plans, insurance
companies and eligible account holders, supplemental eligible account holders
and other members who are not citizens or residents of the United States. Due to
the individual nature of tax consequences, you are urged to consult your own tax
and financial advisor as to the effect of such federal and state income tax
consequences on your own particular facts and circumstances, including the
receipt and exercise of subscription rights, and also as to any other tax
consequences arising out of the conversion.
Liquidation Account. In the unlikely event of our complete liquidation in
our present mutual form, each holder of a deposit account in 1st State Bank
would receive his pro rata share of any of our assets remaining after payment of
claims of all creditors, including the claims of all depositors to the
withdrawal value of their accounts. His pro rata share of the remaining assets
would be the same proportion of the assets as the value of his deposit account
was to the total of the value of all deposit accounts in 1st State Bank at the
time of liquidation.
30
<PAGE>
After the conversion, in the event of liquidation, each deposit account
holder would have a claim of the same general priority as the claims of all
other general creditors of 1st State Bank. Therefore, except as described below,
his claim would be solely in the amount of the balance in his deposit account
plus accrued interest. He would have no interest in the value of 1st State Bank
above that amount.
The Plan of Conversion 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 our net worth as of September 30, 1998. An eligible Account Holder is
any person with a $50.00 or greater deposit account in 1st State Bank on
December 31, 1994, and a Supplemental Eligible Account Holder is any person with
a $50.00 or greater deposit account in 1st State Bank on December 31, 1998. Each
Eligible Account Holder and each Supplemental Eligible Account Holder would be
entitled, on our complete liquidation after the conversion, to an interest in
the liquidation account. Each Eligible Account Holder would have an initial
interest in such liquidation account for each $50 or greater deposit account
held on December 31, 1994 and each Supplemental Eligible Account Holder would
have an initial interest in the liquidation account for each $50 or greater
deposit account held on December 31, 1998. The interest as to each qualifying
deposit account would be in the same proportion of the total liquidation account
as the balance of the qualifying deposit account was to the balance in all
deposit accounts of Eligible Account Holders and Supplemental Eligible Account
Holders on such date. However, if the amount in the qualifying deposit account
on any September 30 subsequent to the relevant eligibility date is less than the
amount in the account on the relevant eligibility date, or any subsequent
September 30, then the Eligible Account Holder's or Supplemental Eligible
Account Holder's interest in the liquidation account would be reduced from time
to time by an amount proportionate to any reductions, and the interest would
cease if he ceases to maintain an account at 1st State Bank that has the same
Social Security number as appeared on his account(s) at the relevant eligibility
date. The interest in the liquidation account would never be increased,
notwithstanding any increase in the related deposit account after the
conversion.
Any assets remaining after the above liquidation rights of Eligible Account
Holders and Supplemental Eligible Account Holders were satisfied would be
distributed to stockholders at that time. The conversion will not be considered
a liquidation of 1st State Bank that would trigger the distribution of the
liquidation account.
A merger, consolidation, sale of bulk assets or similar combination or
transaction with an FDIC-insured institution in which we are not the surviving
insured institution would not be considered to be a "liquidation" under which
distribution of the liquidation account could be made. In such a transaction,
the liquidation account would be assumed by the surviving institution.
The creation and maintenance of the liquidation account will not restrict
the use or application of any of our capital accounts, except that we may not
declare or pay a cash dividend on, or repurchase any of, our capital stock if
the dividend or repurchase would cause our retained earnings to be reduced below
the aggregate amount then required for the liquidation account.
Subscription Rights
We issued at no cost nontransferable priority subscription rights to order
shares of common stock to all persons specified in our Plan of Conversion. The
amount of the common stock that these parties may order will be determined, in
part, by the total stock to be issued and the availability of stock for purchase
under the priority categories set forth in the Plan of Conversion.
Preference categories have been established for the allocation of common
stock, in the event we receive orders for more shares than are available. These
categories, in order of preference, are as follows:
First priority is reserved for our Eligible Account Holders, i.e., our
depositors on December 31, 1994 with balances of $50.00 or more, who,
including individuals on a joint account or having the same address on
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<PAGE>
our records, will each receive nontransferable subscription rights to
subscribe for up to $1,000,000 of common stock in the offering. If we
receive orders from Eligible Account Holders for more shares than are
available, we will allocate shares among subscribing Eligible Account
Holders so as to permit each Eligible Account Holder, to the extent
possible, to purchase 100 shares or the amount subscribed for, whichever is
less. We will allocate any remaining first priority shares among the
subscribing Eligible Account Holders on an equitable basis related to the
amounts of their respective qualifying deposits, as compared to the total
qualifying deposits of all subscribing Eligible Account Holders.
Subscription rights received by directors and officers of 1st State Bank
and their associates in this category based on their increased deposits in
1st State Bank in the one-year period preceding December 31, 1994 are
subordinated to the subscription rights of other Eligible Account Holders.
Second priority is reserved for our tax-qualified employee stock
benefit plans, i.e., the employee stock ownership plan, which will receive
nontransferable subscription rights to purchase in the aggregate up to 10%
of the shares issued in the conversion. We expect the employee stock
ownership plan to purchase 8% of the common stock issued in the conversion.
If all the shares of common stock offered are purchased by Eligible Account
Holders, then the employee stock ownership plan will purchase shares in the
open market following the conversion and will not purchase newly issued
shares from 1st State Bancorp.
Third priority is reserved for our Supplemental Eligible Account
Holders, i.e., our depositors with a balance of $50.00 or more on December
31, 1998 who, including individuals on a joint account or having the same
address on our records, will each receive nontransferable subscription
rights to subscribe for up to $1,000,000 of common stock. If we receive
orders for more shares than are available in this category, we will
allocate shares so as to permit each Supplemental Eligible Account Holder,
to the extent possible, to purchase 100 shares or the amount subscribed
for, whichever is less. We will allocate any remaining shares among the
subscribing Supplemental Eligible Account Holders on an equitable basis
related to the amounts of their respective qualifying deposits, as compared
to the total qualifying deposits of all subscribing Supplemental Eligible
Account Holders. We will fill subscriptions in this priority category only
to the extent that there are sufficient shares of common stock remaining
after satisfaction of subscriptions in the first two priority categories.
Subscription Category No. 4 is reserved for our Other Members, i.e.,
certain depositors and borrowers who are members of 1st State Bank as of
the voting record date for the special meeting of members to vote on the
conversion but who are not Eligible Account Holders or Supplemental
Eligible Account Holders. Other Members, including individuals on a joint
account or having the same address on our records, will receive
nontransferable subscription rights to subscribe for up to $1,000,000 of
common stock in the offering. If we receive orders for more share than are
available in this category, we will allocate any available shares
proportionately among subscribing Other Members on an equitable basis as we
determine.
To ensure a proper allocation of common stock, you must list on your stock
order form all accounts in which you have an ownership interest. If you fail to
list all your deposit accounts, we may not fill all or part of your order.
Neither 1st State Bancorp, 1st State Bank nor any of our agents will be
responsible for orders on which all deposit accounts have not been fully and
accurately disclosed. See "-- Limitations on Purchase of Shares" for information
on limitations placed on share purchases and guidelines and definitions that may
limit the number of shares you purchase.
We will make reasonable efforts to comply with the securities laws of all
states in the United States in which persons entitled to subscribe for the
common stock under the Plan of Conversion reside. However, you will not be
offered or allowed to purchase any common stock if you reside in a foreign
country or in a state of the United States where any or all of the following
apply:
32
<PAGE>
. A small number of persons otherwise eligible to subscribe for shares
under the Plan of Conversion reside in such state or foreign country.
. Granting subscription rights or offering or selling shares of common
stock to you would require us or our employees to register, under the
securities laws of your state, as a broker, dealer, salesman or agent
or to register or otherwise qualify our securities for sale in your
state or foreign country.
. Registration or qualification would be impracticable for reasons of
cost or otherwise.
We will not make any payments to you in lieu of granting subscription
rights to you if any of the above conditions apply.
Offering of Remaining Shares After Satisfaction of Subscription Rights
If shares are available after filling orders from all persons with
subscription rights, we will offer any remaining shares to members of the
general public to whom we deliver a copy of this Prospectus and a stock order
form. This offering, if one is held, will begin immediately after March __,
1999, but may begin at any time before that. We may terminate the offering to
persons without subscription rights without notice on or after March __, 1999,
but not later than ___________, 1999, unless further extended with the consent
of the FDIC and the North Carolina Savings Bank Administrator. We have the
absolute right to accept or reject any purchases in whole or in part in the
community offering in our sole discretion. We presently intend to terminate the
community offering, if any, as soon as we have received orders for all shares
available for purchase in the conversion.
If we receive orders for more shares than are available, we will allocate
the available shares in our discretion, giving preference to natural persons and
trusts of natural persons who are permanent residents of Alamance County, North
Carolina. The term "resident" as used in relation to the preference afforded
natural persons in Alamance County means any natural person who occupies a
dwelling within Alamance County, has an intention to remain within Alamance
County for a period of time as manifested by establishing a physical, ongoing,
nontransitory presence within Alamance County and continues to reside in
Alamance County at the time of the offering. We may utilize deposit or loan
records or any other evidence to determine whether a person is residing in
Alamance County. If the person is a corporation or other business entity, the
principal place of business or headquarters must be within Alamance County. If
the person is a personal benefit plan, the circumstances of the beneficiary will
apply. In the case of all other benefit plans, we will examine the circumstances
of the beneficiary. In all cases, however, we will have complete discretion in
determining whether a purchaser is a resident of Alamance County.
If we extend the offering period by more than 45 days, subscribers will
have the right to increase, decrease or rescind subscriptions for stock
previously submitted. Purchasers in the offering, together with their associates
and groups acting in concert, including individuals on joint accounts or having
the same address on our records, are eligible to purchase up to $1,000,000 of
common stock.
Except as noted below, we will place cash and checks received in the
offering in a segregated savings account. The account will be insured in the
aggregate by the FDIC up to the applicable $100,000 limit. We will pay interest
on orders made by check, in cash or by money order at our passbook rate from the
date we receive the payment until we complete or terminate the conversion. If
conversion is not completed for any reason, all funds submitted will be promptly
refunded with interest as described above.
If we determine that it is not feasible to sell the remaining shares in
this manner, we will immediately consult with the regulatory authorities to
determine the most viable alternative available to complete the conversion.
Should no viable alternative exist, we may terminate the conversion with the
concurrence of the FDIC and the North Carolina Savings Bank Administrator. Our
Plan of Conversion provides that the conversion must be completed within 12
months after approval of the Plan of Conversion at the special meeting, but that
time period may be extended up to an
33
<PAGE>
additional 12 months by amendment to the Plan of Conversion. If we do not
complete the conversion, we will remain a North Carolina-chartered mutual
savings bank, we will return all subscription funds to subscribers with interest
and all withdrawal authorizations will be canceled. Market conditions and other
factors beyond our control may affect our ability to complete the conversion. We
do not know how long it will take us to sell the stock and complete the
conversion after approval of the Plan of Conversion at the special meeting. If
we experience delays, our estimated pro forma market value, the offering price
and the net proceeds from the sale of the common stock may change significantly.
We also would incur substantial additional printing, legal and accounting
expenses to complete the conversion. If we terminate the conversion, we would
charge all conversion expenses against current income.
Syndicated Offering
As part of the offering to persons without subscription rights, shares may
be offered for sale to the general public in a syndicated offering through
selected dealers to be selected and managed by Trident Securities. We would
conduct the syndicated offering, if any, to achieve the widest distribution of
common stock subject to our right to reject orders in whole or in part in our
sole discretion. Neither Trident Securities nor any registered broker-dealer
will have any obligation to take or purchase any shares of the common stock in
the syndicated offering. We would sell common stock in the syndicated offering
at the same price as paid by other purchasers in the offering.
Selected dealers may only solicit indications of interest from their
customers to place orders to purchase stock with 1st State Bancorp as of a
certain date ("order date"). When and if Trident Securities and 1st State
Bancorp believe that enough indications and orders have been received in the
offerings to consummate the conversion, Trident Securities will request, as of
the order date, selected dealers to submit orders to purchase shares for which
they have received indications of interest from their customers. Selected
dealers will send confirmations of the orders to their customers on the next
business day after the order date. Selected dealers may debit the accounts of
their customers on a date which will be three business days from the order date
(known as the "settlement date"). Customers who authorize selected dealers to
debit their brokerage accounts are required to have the funds for payment in
their account on but not before the settlement date. On the settlement date,
selected dealers will remit funds to the account that 1st State Bancorp
established for each selected dealer. After we receive payment from selected
dealers, funds will earn interest at our passbook savings rate until we complete
the conversion. If we do not complete the conversion, we will return funds with
interest to the selected dealers, who, in turn, will promptly credit their
customers' brokerage accounts.
Establishment of the Foundation
General. We will establish a charitable foundation named 1st State Bank
Foundation, Inc. The foundation will be dedicated to charitable and educational
purposes within our market area. We will contribute shares of common stock to
fund the foundation. The number of shares of common stock we will contribute
will be up to 8% of the shares we sell in the offering, not to exceed 187,500
shares. We contributed $41,000 to charity during the year ended September 30,
1996, $151,000 during 1997 and $106,000 during 1998. These amounts are
significantly below the maximum of $3.0 million in common stock that we will
contribute to the foundation. By contributing common stock to the foundation, we
will dilute the interests of stockholders and materially reduce our earnings
during the fiscal year ending September 30, 1999, the year in which we will
establish the foundation.
Purposes of the Foundation. We are establishing the foundation to provide
funding to support charitable causes and community development activities. In
recent years, we have emphasized community lending and development activities
within the communities that we serve. We are forming the foundation as a
complement to our existing community reinvestment act activities and not as a
replacement for those activities. While we intend to continue to emphasize
community lending and development activities following the conversion, those
activities are not our sole corporate purpose. The foundation, conversely, will
be dedicated completely to community activities and the promotion of charitable
causes, and may be able to support those activities in ways that are not
currently available to us. We believe
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that the foundation will enable us to assist our local community in areas beyond
community lending and development. We believe the establishment of a charitable
foundation is consistent with our commitment to community service. We further
believe that the funding of the foundation with our common stock is a means of
enabling the communities we serve to share in our growth and success long after
the completion of the conversion. The foundation will accomplish that goal by
providing for continued ties between the foundation and 1st State Bank, thereby
forming a partnership with our community. The establishment of the foundation
also will enable us to develop a unified charitable donation strategy and will
centralize the responsibility for administration and allocation of corporate
charitable funds.
Structure of the Foundation. The foundation will be a North Carolina
nonprofit corporation. The foundation's board of directors will be comprised of
individuals who also serve as our directors or officers. The members of the
foundation, who are comprised of its directors, will elect the directors at the
annual meeting of the foundation. Directors will be elected annually. Directors
of the foundation will not receive any additional compensation for serving as
such. The foundation's corporate documents provide that the foundation is
organized exclusively for charitable purposes, including community development,
as set forth in Section 501(c)(3) of the Internal Revenue Code. The foundation's
corporate documents further provide that directors, officers or members of the
foundation may not receive or benefit from the net earnings of the foundation.
In addition, any person who is a director, officer or employee of 1st State
Bank, or has the power to direct our management or policies, or otherwise owes a
fiduciary duty to 1st State Bank, and will also serve as a director, officer or
employee of the foundation, is subject to conflicts of interest
regulations.
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 for grants or
donations by the foundation, consistent with the 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. 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. As a condition to receiving the
approval of the FDIC to the conversion, the foundation will be required to
commit to the FDIC that all shares of common stock held by the foundation will
be voted in the same ratio as all other shares of common stock on all proposals
considered by our stockholders; provided, however, that, consistent with such
condition, the FDIC would waive this voting restriction under certain
circumstances. See " -- Tax Considerations" for a description of these
circumstances.
The foundation's place of business will be located at our administrative
offices, and initially we expect the foundation will have no employees but will
utilize our staff. The board of directors of the foundation will appoint such
officers as they deem necessary to manage the operations of the foundation. In
this regard, we expect that we will be required to provide the FDIC with a
commitment that, to the extent applicable, we will comply with the Federal
Reserve Act restrictions governing transactions between us and the foundation.
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 from
the sale of any of the common stock in the open market from time to time. 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.
Dilution of Stockholders' Interests. We propose to contribute shares of
common stock to the foundation. The number of shares of common stock will equal
up to 8% of the shares sold in the offering, not exceed 187,500 shares. That
number represents between 7.4% of the number of shares of common stock that will
be outstanding following the conversion at the minimum of the offering range and
5.9% at the maximum, as adjusted of the offering range. As a result, your
ownership and voting interests in 1st State Bancorp will be diluted. See "Risk
Factors -- The Expense and Dilutive Effect of the Contribution of Shares to the
Charitable Foundation" for a discussion of the dilutive effect of the foundation
on stockholders.
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Impact on Earnings. Contributing common stock to the foundation will reduce
our earnings in the year in which we make the contribution. We will recognize
into income the full amount of the contribution in the quarter in which it
occurs, which is expected to be the quarter ending March 31 or June 30, 1999.
The amount of the contribution will be up to $3.0 million. The contribution
expense will be partially offset by the tax benefit related to the expense. We
anticipate that the contribution to the foundation will be tax deductible,
subject to an annual limitation based on 10% of annual taxable income. Assuming
a contribution of $3.0 million in common stock, we estimate an after tax expense
of $2.0 million based on a 34% marginal federal tax rate. If the foundation had
been established at September 30, 1998, assuming the maximum contribution of
187,500 shares, we would have reported net income of $541,000 for the year ended
September 30, 1998 rather than reporting net income of $2.5 million. We do not
expect in the future to make other than nominal charitable contributions within
the communities we serve. In addition, we do not currently anticipate making
additional contributions to the foundation within the first five years following
the initial contribution.
Tax Considerations. We anticipate that the foundation will qualify as a
Section 501(c)(3) exempt organization under the Internal Revenue Code and will
be classified as a private foundation. The foundation will submit a request to
the Internal Revenue Service to be recognized as an exempt organization.
Regulatory authorities require that common stock issued to the foundation
be voted in the same ratio as all other shares of our common stock on all
proposals considered by our stockholders. In the event that 1st State Bancorp or
the foundation receives an opinion of its legal counsel that compliance with the
voting restriction would have the effect of causing the foundation to lose its
tax-exempt status, or otherwise have a material and adverse tax consequence on
the foundation, or subject the foundation to an excise tax under Section 4941 of
the Code, the FDIC and the North Carolina Savings Bank Administrator will waive
the voting restriction upon submission of a legal opinion by 1st State Bancorp
or the foundation.
We further anticipate that we 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 an annual limitation based on 10% of annual taxable income. However, we would
be able to carry forward any unused portion of the deduction for five years
following the contribution. Thus, while we would receive a tax benefit of
approximately $1.0 million in the year ending September 30, 1999, based upon a
contribution of $3.0 million of common stock, we are permitted under the
Internal Revenue Code to carry over the excess contribution in the five
following years. We estimate that for federal income tax purposes we should be
able to deduct a substantial portion of the deduction over the six-year period.
Although we anticipate that we will be entitled to the deduction, we cannot
assure you that the Internal Revenue Service will recognize the foundation as a
Section 501(c)(3) exempt organization or that the deduction will be permitted.
If that happens, the tax benefit related to the foundation would have to be
fully expensed, resulting in further reduction in earnings in the year in which
the Internal Revenue Service makes such a determination.
Comparison of Valuation and Other Factors Assuming the Foundation is Not
Established as Part of the Conversion. Ferguson & Company considered the
establishment of the foundation in determining our estimated pro forma market
value. The number of shares of common stock we are offering and the purchase
price are based on the independent appraisal conducted by Ferguson & Company of
our estimated pro forma market value. The offering range is currently between
$30.6 million and $41.4 million, with a midpoint of $36.0 million. Ferguson &
Company has indicated that the establishment of the foundation reduced the
independent appraisal by $6.0 million at the midpoint of the offering range, and
that if we had not established the foundation in connection with the conversion
then the independent valuation would have been increased to a range of from
$35.7 million to $55.5 million with a midpoint of $42.0 million. The pro forma
price to book ratio and the pro forma price to annualized earnings ratio, at and
for the year ended September 30, 1998, are 68.0% and 11.7 times earnings,
respectively, at the midpoint of the offering range. If the conversion did not
include the foundation, Ferguson & Company has estimated that the independent
valuation would have been $42.0 million at the midpoint, which would have
resulted in a pro forma price to book ratio and a pro forma price to earnings
ratio of 68.1% and 12.0 times earnings, respectively. See "Comparison of
Valuation and Pro Forma Information with No Foundation" for a tabular comparison
of key ratios with and without the foundation.
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The decrease in the amount of common stock being offered as a result of
the contribution of common stock to the foundation will not have a significant
effect on 1st State Bancorp's or 1st State Bank's capital position. 1st State
Bank's regulatory capital significantly exceeds our regulatory capital
requirements and will further exceed such requirements following the conversion.
1st State Bank's leverage and total risk-based capital ratios at September 30,
1998 were 9.1% and 15.8%, respectively. Assuming the sale of shares at the
midpoint of the offering range, 1st State Bank's pro forma leverage and total
risk-based capital ratios at September 30, 1998 would be 13.7% and 23.6%,
respectively. On a consolidated basis, our pro forma stockholders' equity would
be $57.2 million, or approximately 17.9% of pro forma consolidated assets,
assuming the sale of shares at the midpoint of the offering range. Pro forma
stockholders' equity per share and pro forma basic income per share would be
$23.52 and $1.37, respectively, and pro forma diluted income per share would be
$1.33. If we were not establishing the foundation in the conversion, based on
Ferguson & Company's estimate, our pro forma stockholders' equity would be
approximately $61.7 million, or approximately 19.0% of pro forma consolidated
assets at the midpoint of the offering range, and pro forma stockholders' equity
per share and pro forma basic income per share would be $23.51 and $1.33,
respectively, and pro forma diluted income per share would be $1.28.
Regulatory Conditions Imposed on the Foundation. The foundation has agreed
to the following conditions imposed by regulatory authorities:
. The foundation will be subject to examination by the FDIC and the
North Carolina Savings Bank Administrator.
. The foundation must comply with supervisory directives imposed by the
FDIC and the North Carolina Savings Bank Administrator.
. The foundation will operate in accordance with written policies
adopted by the board of directors, including a conflict of interest
policy.
. Any shares of common stock held by the foundation must be voted in the
same ratio as all other outstanding shares of common stock on all
proposals considered by our stockholders.
The FDIC and the North Carolina Savings Bank Administrator would waive the
voting restriction under certain circumstances and subject to additional
conditions if compliance with the voting restriction would:
. cause a violation of the law of the State of North Carolina
. cause the foundation to lose its tax-exempt status or otherwise have a
material and adverse tax consequence on the foundation; or
. cause the foundation to be subject to an excise tax under Section 4941
of the Code. In order to obtain a waiver, the foundation's legal
counsel would be required to render an opinion satisfactory to the
FDIC and the North Carolina Savings Bank Administrator.
We cannot assure you that a legal opinion addressing these issues could be
rendered, or if rendered, that the FDIC and the North Carolina Savings Bank
Administrator would grant unconditional waivers of the voting restriction. The
voting restriction will lapse on any shares the foundation sells.
Subscriptions for Stock
Expiration Date. The offering to persons with subscription rights will
expire at 12:00 Noon, Eastern Time, on __________, 1999. We are permitted under
conversion regulations to extend this deadline for up to an additional 45 days,
to no later than _________, 1999. However, we are not required to extend this
deadline, and if we do not
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receive your order by__________, 1999, you will lose your priority rights to buy
stock. We may also offer shares to persons who do not have priority subscription
rights. We may terminate the offering to those persons at any time without
notice.
We will not execute orders until at least the minimum number of shares of
common stock we are offering have been subscribed for or sold. If we have not
received orders for the minimum number of shares we are offering within 45 days
of the end of the offering, unless that period is extended with consent of the
North Carolina Savings Bank Administrator, we will return all funds to
subscribers with interest, and we will rescind all charges to savings
accounts.
Use of Stock Order Forms and Certification Forms. You must complete a stock
order form and a certification form to exercise your subscription rights. If you
receive a stock order form and you desire to subscribe for shares of stock, you
must do so prior to _______________, 1999 by delivering by mail or in person to
any of our offices a properly executed and completed stock order form and
certification form, together with full payment for the shares you have ordered.
Make your checks or money orders payable to "1st State Bancorp, Inc." We will
not accept photocopies or faxes of stock order forms or payment by wire
transfer. All subscription rights under the Plan of Conversion will expire on
March __, 1999, whether or not we have been able to locate each person entitled
to subscription rights. Once tendered, subscription orders cannot be revoked.
We are required under federal regulations to obtain signed certification
forms from persons purchasing stock in the conversion, and that is why we
require that you sign it if you order stock. We presently have no intention to
ever assert the certification against you. However, we could use the
certification in a dispute with a banking or securities regulatory agency or
with you to prove that we informed you of the matters described in the
certification. By signing the certification form, you will not waive any of your
rights under the Securities Act of 1933, as amended.
Each subscription right may be exercised only by the person to whom it is
issued and only for his or her own account. The subscription rights granted
under the Plan of Conversion are not transferable. If you attempt to transfer
your subscription rights, you may lose the right to subscribe for stock in the
conversion and you may be subject to other sanctions and penalties imposed by
regulatory authorities. If you subscribe for shares, you will be required to
represent to us that you are purchasing the shares for your own account and that
you have no agreement or understanding with any other person for the sale or
transfer of your shares.
We will not honor your order and you may lose your subscription rights if
your stock order form:
. is not delivered and is returned to us by the United States Postal
Service or we are unable to locate the addressee,
. is not returned or is received after 12:00 Noon on March ____, 1999,
. is defectively completed or executed, or
. is not accompanied by the full required payment for the shares
subscribed for, including instances where a savings account or
certificate balance from which withdrawal is authorized is
insufficient to fund the amount of such required payment.
We may, but will not be required to, waive any irregularity on any stock
order form or require you to submit a corrected stock order form or to remit
full payment for subscribed shares by a date we specify. Our interpretation of
the terms and conditions of the Plan of Conversion and of the stock order form
will be final.
Payment for Shares. For your order to be accepted, you must enclose payment
for all shares of common stock you order. You may pay
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. in cash, if delivered in person,
. by check or money order, or
. by authorization of withdrawal from deposit accounts maintained with
us.
Appropriate means by which withdrawals may be authorized are provided in the
stock order form. Once a withdrawal has been authorized, you may not use any of
the designated withdrawal amount for any purpose other than to purchase stock
while the Plan of Conversion remains in effect. In the case of payments
authorized to be made through withdrawal from deposit accounts, all sums
authorized for withdrawal will continue to earn interest at the contract rate
until the date of the sale. Payments made in cash or by check or money order
will be placed in a single segregated savings account established specifically
for this purpose, with the account as a whole insured by the FDIC up to the
applicable $100,000 limit, and interest will be paid at our passbook rate from
the date payment is received until we complete or terminate the conversion.
Interest penalties for early withdrawal applicable to certificate accounts will
not apply to withdrawals authorized for the purchase of shares. If a partial
withdrawal results in a certificate account with a balance less than the
applicable minimum balance requirement, the certificate evidencing the remaining
balance will earn interest at our passbook rate subsequent to the withdrawal.
Once we receive your executed stock order form, you may not modify, amend or
rescind it without our consent, unless we do not complete the conversion within
45 days after the termination of the offering. If an extension of the period of
time to complete the conversion is approved by the North Carolina Savings Bank
Administrator, we will contact subscribers and each must affirmatively reconfirm
his order prior to the expiration of the resolicitation offering, or his
subscription funds will be promptly refunded. At that time, subscribers may also
modify or cancel their subscriptions. Interest will be paid on such funds at our
passbook rate during the 45-day period and any approved extension period.
If you own a self-directed individual retirement account, you may use the
assets of the individual retirement account to purchase shares of common stock
in the offering, provided that the self-directed individual retirement account
is not maintained with us. If you maintain an individual retirement account with
us, you must transfer your account to an unaffiliated institution or broker to
purchase shares of common stock in the offering. If you are interested in using
funds in a 1st State Bank individual retirement account to purchase common
stock, you must make arrangements with the Stock Information Center at (336)
___-____ no later than ___________, 1999 so that we may forward the necessary
forms for execution.
The employee stock ownership plan will not be required to pay for its
shares at the time it subscribes, but may pay for its shares at completion of
the offering.
Certificates for Shares Purchased. We will deliver certificates
representing shares of the common stock to purchasers as soon as practicable
after closing of the conversion. It will be your responsibility to deliver a
certificate if you sell your shares before you receive a stock certificate.
Plan of Distribution and Marketing Agent
Our officers are available to provide offering materials, to answer
questions and to receive completed stock order forms and certification forms.
None of our directors, officers or employees will receive any commissions or
other compensation for their efforts in connection with sales of shares of the
common stock. Although information regarding the stock offering is available at
our offices, an investment in the common stock is not a deposit, and the common
stock is not federally insured.
Our directors, officers and employees who will be involved in selling stock
are exempt from the requirement to register with the Securities and Exchange
Commission as broker-dealers within the meaning of Rule 3a4-1 under the
Securities Exchange Act of 1934, as amended. Such persons will qualify under the
safe harbor provisions of that rule on the basis of paragraphs (a)(4)(ii) and/or
(iii), i.e., we expect that such persons either will perform substantial
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duties for 1st State Bancorp in its business, will not otherwise be
broker-dealers and are not expected to participate in another offering in the
next twelve months or will limit their activities to preparing written
communications, responding to customer inquiries and/or performing
ministerial/clerical functions.
We have engaged Trident Securities as financial advisor to provide sales
assistance in connection with the offering. The services of Trident Securities
will include, but are not limited to,
. training and educating our employees who will be performing certain
ministerial functions in the offering regarding the mechanics and
regulatory requirements of the stock sales process and the
solicitation of proxies from members,
. providing employees to staff the Stock Information Center, assisting
our customers and interested stock purchasers and keeping records of
orders for shares of common stock, and
. supervising our sales efforts, including the preparation of marketing
materials.
For its services in the conversion, Trident Securities will receive a
commission equal to 1.50% of the aggregate dollar amount of common stock sold in
the offering, excluding any shares sold to our directors, executive officers and
employee stock ownership plan. Additionally, commissions will be excluded on
shares sold to associates of our directors and executive officers. If common
stock is sold by other National Association of Securities Dealers, Inc. member
firms under selected dealer's agreements, the aggregate commissions to be
received by Trident Securities and selected dealers will be agreed upon jointly
by us and Trident Securities to reflect market requirements at the time of the
stock allocation in the offering and will not exceed 6%. Trident Securities also
will be reimbursed for its reasonable out-of-pocket expenses in an amount not to
exceed $10,000 and its legal fees in an amount not to exceed $27,500. We have
agreed to indemnify Trident Securities for reasonable costs and expenses in
connection with certain claims or liabilities, including certain liabilities
under the Securities Act of 1933, as amended.
How We Determined the $16 Price Per Share and the Offering Range
We retained Ferguson & Company, which is experienced in the evaluation and
appraisal of savings institutions involved in the conversion process, to prepare
an appraisal of our estimated pro forma market value. Prior to the conversion,
we did not have any business relationship with Ferguson & Company. Ferguson &
Company will receive a fixed fee of $30,000 for its appraisal and other
services. We have agreed to indemnify Ferguson & Company under certain
circumstances against any losses, damages, expenses or liability arising out of
our engagement of Ferguson & Company for the appraisal.
Ferguson & Company has determined as of January 27, 1999 that the estimated
pro forma market value of the stock to be issued in the conversion was
$36,000,000. In determining the reasonableness and adequacy of the appraisal
submitted by Ferguson & Company, the Boards of Directors of 1st State Bank and
1st State Bancorp reviewed with Ferguson & Company the methodology and the
appropriateness of assumptions used by Ferguson & Company in preparing the
appraisal. In consultation with Trident Securities, we have determined to offer
the shares in the conversion at the purchase price of $16.00 per share. We
determined the price per share based on a number of factors, including the
market price per share of the stock of other financial institutions. With the
consent of the North Carolina Savings Bank Administrator and the FDIC, however,
the appraiser may establish a range of value for the stock of approximately 15%
on either side of the estimated value to allow for fluctuations in the aggregate
value of the stock due to changes in the market and other factors that may
occur. Accordingly, Ferguson & Company has established a range of value of from
$30,600,000 to $41,400,000 for the conversion. Ferguson & Company will either
confirm the continuing validity of its appraisal or provide an updated appraisal
immediately prior to the completion of the conversion.
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In preparing its appraisal, Ferguson & Company relied on the information in
this Prospectus, including our consolidated financial statements. Ferguson &
Company also considered the following factors, among others:
. our present and projected operating results and financial condition
and the economic and demographic conditions in our market area
. historical financial and other information
. a comparative evaluation of our operating and financial statistics
with those of other similarly situated savings institutions located in
North Carolina and other regions of the United States
. the aggregate size of the offering of common stock
. the effect of the conversion on 1st State Bank's and 1st State
Bancorp's net worth and earnings potential
. our proposed dividend policy and
. the trading market for securities of comparable institutions and
general securities market conditions.
If Ferguson & Company determines at the close of the offering that the
aggregate pro forma market value of the common stock is higher or lower than
$36.0 million, but is nonetheless within the offering range or within 15% above
the maximum of the range, we will make an appropriate adjustment by raising or
lowering the total number of shares issued within a range from 1,912,500 shares
to 2,975,625 shares. Unless we decide otherwise or unless required by the FDIC
or the North Carolina Savings Bank Administrator, we will not resolicit
subscribers and other purchasers because of any change in the number of shares
to be issued unless the aggregate purchase price of the common stock sold in the
conversion is below the minimum of the offering range or is more than the
maximum, as adjusted of the offering range. If the aggregate purchase price
falls outside the range of from $30,600,000 to $47,610,000, you will be
resolicited and given the opportunity to continue your orders, in which case you
will need to affirmatively reconfirm your subscriptions prior to the expiration
of the resolicitation, or we will promptly refund your subscription funds with
interest at our passbook rate. You also will be given the opportunity to
increase, decrease or rescind your orders. Any change in the offering range must
be approved by the North Carolina Savings Bank Administrator. We may set a new
price range without a resolicitation of votes from our members to approve the
Plan of Conversion.
The appraisal is not intended, and must not be construed, as a
recommendation of any kind as to the advisability of purchasing the common
stock. In preparing the valuation, Ferguson & Company relied upon and assumed
the accuracy and completeness of financial and statistical information provided
by us. Ferguson & Company did not independently verify the financial statements
and other information provided by us, nor did Ferguson & Company value
independently our assets and liabilities. The appraisal considers us only as a
going concern and should not be considered as an indication of our liquidation
value. Moreover, because the appraisal is based on estimates and projections of
a number of matters which are subject to change, the market price of the common
stock could decline below $16.00 per share. You can obtain a copy of the
appraisal report at the offices set forth under "Additional Information" or at
our offices. We will file any subsequent updated appraisal with the Securities
and Exchange Commission and make it available for inspection.
Limitations on Purchase of Shares
The Plan of Conversion sets limitations on share purchases in the
conversion. Each subscriber must subscribe for a minimum of 25 shares, which
totals $400. The employee stock ownership plan will purchase 8% of the shares of
the common stock to be issued in the conversion. Except for the employee stock
ownership plan, no person,
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including associates of and persons acting in concert with such person,
including individuals on a joint account or having the same address on our
records, may purchase more than 62,500 shares or 1,000,000, of common stock in
the conversion. Shares purchased by the employee stock ownership plan and
attributable to a participant will not be aggregated with shares purchased by
the participant or any other purchaser of common stock in the conversion. Our
directors are not deemed to be associates or a group acting in concert solely
because they are directors.
Subject to any required regulatory approval and the requirements of
applicable laws and regulations, but without further approval of our members, we
may change the purchase limitations at our sole discretion at any time. North
Carolina regulations authorize a plan of conversion to provide a maximum
purchase limitation of a percentage not to exceed 5% except for tax-qualified
employee stock benefit plans which may purchase in the aggregate not more than
10%. If we increase the purchase limitations, we will give subscribers for the
maximum amount the opportunity to increase their subscriptions up to the then
applicable limit, subject to the rights and preferences of any person who has
priority subscription rights. If we decrease the purchase limitation, we will
decrease the orders of any person who subscribed for the maximum number of
shares of common stock by the minimum amount necessary so that such person shall
be in compliance with the then maximum number of shares permitted to be
subscribed for by such person.
The term "associate" of a person is defined to mean:
. any corporation or organization other than 1st State Bank, 1st State
Bancorp, or a majority-owned subsidiary of 1st State Bank or 1st State
Bancorp of which such person is an officer or partner or is directly
or indirectly the beneficial owner of 10% or more of any equity
securities;
. any trust or other estate in which such person has a substantial
beneficial interest or as to which such person serves as a trustee or
in a similar fiduciary capacity, except that such term shall not
include any tax-qualified employee stock benefit plan of ours in which
such person has a substantial beneficial interest or serves as a
trustee or in a similar fiduciary capacity; and
. 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 of
1st State Bank or 1st State Bancorp or any of their subsidiaries.
Directors are not treated as associates solely because they serve as
directors.
The term "acting in concert" means:
. knowing participation in a joint activity or interdependent conscious
parallel action towards a common goal whether or not pursuant to an
express agreement; or
. 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. We may presume that certain persons are acting
in concert based upon, among other things, joint account
relationships, common addresses and the fact that such persons have
filed joint ownership reports with the Securities and Exchange
Commission with respect to other companies.
If you order more shares than you are permitted to buy, we will have the
right to purchase excess shares from you at the $16.00 per share purchase price.
If you have sold the shares, you must pay us the difference between the
aggregate purchase price you paid for the excess shares and the price at which
you sold the excess shares. We may assign these rights. In addition, you may be
subject to sanctions and penalties imposed by regulatory authorities.
Under guidelines of the National Association of Securities Dealers, Inc.,
members of the National Association of Securities Dealers, Inc. and their
associates are subject to certain restrictions on the transfer of securities
purchased in accordance with subscription rights and to certain reporting
requirements upon purchase of such securities.
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<PAGE>
Restrictions on Repurchase of Stock
After the conversion, our ability to repurchase our capital stock will be
governed by the Federal Reserve Board's regulations. Under the Federal Reserve
Board's regulations, any bank holding company that is not well-capitalized and
not in generally satisfactory condition must notify the Federal Reserve Board
before purchasing or redeeming its equity securities if the gross consideration
for the purchase or redemption, when aggregated with the net consideration paid
by the company for all purchases and redemptions during the preceding 12 months,
is equal to 10% or more of the company's consolidated net worth. The Federal
Reserve Board may disapprove a proposed purchase or redemption if it finds that
the proposal would constitute an unsafe or unsound practice or would violate any
directive of, condition imposed by or written agreement with, the Federal
Reserve Board. Under the Federal Reserve Board's regulations, no prior notice of
repurchases is required to be given by a bank holding company that has received
one of the two highest examination ratings at its most recent supervisory
inspection, is not the subject of any unresolved supervisory issues and is, and
after giving effect to the proposed repurchase will continue to be,
well-capitalized. We do not have any specific plans regarding possible stock
repurchases during the first year following the conversion. We have provided in
our internal business plan that we will repurchase 5% of the outstanding common
stock in each of the second and third years following the conversion. However,
whether we actually repurchase stock depends on many factors that may change
during the next year or two. For example, we might not repurchase any stock if
the prevailing market price was too high or if we had a better use for our
excess liquid assets.
Limitations on Resales by Management
Directors and executive officers of 1st State Bank may not sell shares
purchased in the conversion for a period of one year following completion of the
conversion, except in the event of the death of the original purchaser or in any
exchange of shares in connection with a merger or acquisition of 1st State
Bancorp approved by applicable regulatory authorities. Shares of common stock
issued to directors and executive officers will bear a legend giving appropriate
notice of this restriction. In addition, we will give appropriate instructions
to the transfer agent for the common stock with respect to the applicable
restriction for transfer of any restricted stock. This same limitation will
apply to any shares issued to directors and executive officers as a stock
dividend, stock split or otherwise with respect to restricted stock. Shares
acquired otherwise than in the conversion, such as under the stock option plan,
would not be subject to the restriction. If directors and executive officers are
deemed to be affiliates of 1st State Bancorp, all shares of common stock
acquired by them will be subject to certain resale restrictions and may be
resold pursuant to Rule 144 under the Securities Act of 1933, as amended. See
"Regulation -- Regulation of 1st State Bancorp -- Federal Securities Law" which
describes the provisions of Rule 144 in greater detail.
Limitations on Future Management Stock Purchases
During the first three years after the conversion, directors, executive
officers and their associates may purchase additional shares of common stock
only through a broker or dealer registered with the Securities and Exchange
Commission, except with the prior written approval of the North Carolina Savings
Bank Administrator and the FDIC. This restriction does not apply to negotiated
transactions involving more than 1% of the outstanding common stock or to
purchases of common stock by a stock benefit plan, such as the employee stock
ownership plan.
Interpretation and Amendment of the Plan of Conversion
To the extent permitted by law, our interpretations of the Plan of
Conversion will be final. The Plan of Conversion provides that our board of
directors will have sole discretion to interpret and apply the provisions of the
Plan of Conversion to particular facts and circumstances and to make all
determinations necessary or desirable to implement such provisions. Any and all
interpretations, applications and determinations we make in good faith and on
the basis of such information and assistance as was then reasonably available
for such purpose shall be conclusive and binding upon us and our members and
subscribers in the offering, subject to the authority of the FDIC and the North
Carolina Savings Bank Administrator.
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<PAGE>
The Plan of Conversion provides that we may amend the Plan of Conversion by
a two-thirds vote of the board of directors at any time prior to submission of
the Plan of Conversion and proxy materials to our members. After submission of
the Plan of Conversion and proxy materials to the members, we may amend the Plan
of Conversion by a two-thirds vote of the board of directors at any time prior
to the special meeting and at any time following the special meeting with the
concurrence of the FDIC and the North Carolina Savings Bank Administrator. In
our discretion, we may modify or terminate the Plan of Conversion upon the order
of the regulatory authorities without a resolicitation of proxies or another
special meeting. However, we would have to resolicit proxies and conduct another
meeting of members if we modify the Plan of Conversion to materially change the
terms of the conversion.
The Plan of Conversion further provides that if mandatory new regulations
pertaining to conversions are adopted by the FDIC, the North Carolina Savings
Bank Administrator, the Commission, the Federal Reserve Board or any successor
agency prior to completion of the conversion, the Plan of Conversion will be
amended to conform to those regulations without a resolicitation of proxies or
another special meeting. If new conversion regulations contain optional
provisions, we may amend the Plan of Conversion to utilize the optional
provisions in our discretion without a resolicitation of proxies or another
special meeting. By adoption of the Plan of Conversion, our members will be
deemed to have authorized amendment of the Plan of Conversion under the
circumstances described above.
Conditions and Termination
We may not complete the conversion unless the Plan of Conversion has been
approved by the affirmative vote of not less than a majority of the total
outstanding votes of our members and we sell at least the minimum of the
offering range within 12 months following approval of the Plan of Conversion by
the members. We may extend this time period by an additional 12 months by an
amendment to the Plan of Conversion. If these conditions are not satisfied, we
will terminate the Plan of Conversion and we will continue our business in the
mutual form of organization. The board of directors may terminate the Plan of
Conversion at any time prior to the special meeting and, with the approval of
the FDIC and the North Carolina Savings Bank Administrator, at any time after
the special meeting.
44
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
1st State Bancorp, Inc. has only recently been formed and, accordingly, has
no results of operations at this time. As a result, this discussion relates to
the financial condition and results of operations of 1st State Bank.
Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. Net interest income also is affected by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets approximate or exceed interest bearing liabilities,
any positive interest rate spread will generate net interest income. Our
profitability also is affected by the level of other income and operating
expenses. Other income consists of miscellaneous fees related to our loans and
deposits, mortgage banking income and commissions from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits,
occupancy related expenses, federal deposit insurance premiums, data processing,
advertising and other expenses.
Our operations are influenced significantly by local economic conditions
and by policies of financial institution regulatory authorities. Our cost of
funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. Lending activities are affected
by the demand for financing of real estate and other types of loans, which in
turn is affected by the interest rates at which such financing may be offered.
Our business emphasis has been to operate as a well-capitalized, profitable
and independent community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of
the communities in which we operate. We believe that we can be more effective
in servicing our customers than many of our nonlocal competitors because of our
ability to quickly and effectively provide senior management responses to
customer needs and inquiries. Our ability to provide these services is enhanced
by the stability of our senior management team.
Beginning in the late 1980's, we have sought to gradually increase the
percentage of our assets invested in commercial real estate loans, commercial
loans and consumer loans, which have higher interest rates and shorter terms and
adjust more frequently to changes in interest rates than single-family
residential mortgage loans. At September 30, 1998, commercial real estate,
commercial and consumer loans totaled $38.8 million, $25.2 million and $6.3
million, respectively, which represented 18.8%, 12.2% and 3.1%, respectively, of
gross loans. At September 30, 1998, $100.9 million, or 48.8% of gross loans,
consisted of residential real estate mortgage loans. Following the conversion,
we intend to continue to follow our current strategy of seeking growth
opportunities through increasing our portfolio of commercial real estate,
commercial and consumer loans while continuing to pursue single-family
residential mortgage loan origination activities.
Year 2000 Readiness Disclosure
The following information constitutes "Year 2000 Readiness Disclosure"
under the Year 2000 Information and Readiness Disclosure Act.
Our operations, like those of most financial institutions, are
substantially dependent upon computer systems for our lending and deposit
activities. We are addressing the potential problems associated with the
possibility that the computers which control our data processing activities,
facilities and networks may not be programmed to read
45
<PAGE>
four-digit dates and, upon the arrival of the year 2000, may recognize the two-
digit code "00" as the year 1900 rather than 2000. This could cause systems to
fail to function or generate erroneous information.
We formed a Year 2000 Committee early in 1998 with senior representatives
from every functional area of our Bank. At the direction of the Board, this
Committee is leading our efforts to ensure that we are ready for the Year 2000.
Our board of directors has approved 1st State Bank's five phase Year 2000 Plan
that was developed in accordance with the guidelines set forth by the Federal
Financial Institutions Examination Council.
The first phase, awareness, was intended to provide on-going information to
our employees, directors and customers of the impact of the Year 2000 issue. We
have conducted Year 2000 training for all directors and employees.
The second phase, assessment, required us to review all systems that we
believe to be potential risks in order to minimize any Year 2000 operating
difficulties. This review included all major computer and non-computer based
systems, such as vaults, security systems and telephone systems. In April 1998,
we converted to a new computer system for processing all loan, deposit and
general ledger transactions. In conjunction with this conversion, we purchased
and installed new hardware and software throughout 1st State Bank. The hardware
and software purchased are Year 2000 compliant or will be with minor
modifications or upgrades. The combined cost of this hardware and software was
$1.2 million, which was capitalized during the year ended September 30, 1998 in
accordance with our capitalization policy. This phase is virtually complete,
and we are following up on any remaining issues to complete our thorough
assessment.
We identified one vendor as mission critical. This vendor is Year 2000
compliant. We identified one system to be mission critical.
We have contacted all of our significant commercial borrowers and have
determined that they are progressing appropriately with their efforts on Year
2000 issues. We do not believe this poses a significant risk to us at this
time. In addition, we take into consideration a commercial loan applicant's
Year 2000 preparedness and will reject any application where the applicant's
Year 2000 preparedness could hinder sufficiently its ability to repay the loan.
The third phase, renovation and/or replacement, includes obtaining vendor
certification and/or the necessary upgrades and enhancements to ensure that our
existing systems are Year 2000 compliant. We are continuing to follow up with
third party vendors as necessary. At this time we have plans in place for all
mission critical systems to be compliant by December 31, 1998.
The fourth phase, testing, is currently underway. The hardware has been
successfully tested, and we have begun testing the software. We have received
representations from our mission critical third party vendors that they are Year
2000 compliant. All testing is expected to be completed by January 31, 1999 and
any problems would be remedied by March 31, 1999.
The last phase, implementation, will commence in the second quarter of
1999, ending with the first quarter of 2000. We are currently in the process of
developing contingency plans for processes that are not Year 2000 compliant. We
expect this contingency plan to be ready by March 31, 1999.
We estimate that the total future cost of Year 2000 compliance, excluding
internal staffing costs, will not exceed $15,000. This estimate includes the
cost of an independent consultant that has been retained to assist us in
evaluating our Year 2000 Plan and assist us in testing. We believe that our
policies, plans and actions are in compliance with regulatory guidelines and
milestone dates.
Our customers may also experience Year 2000 problems, which could adversely
affect their ability to comply with their obligations to us. We have assessed
all significant commercial loan customers to determine their Year 2000
readiness. Although Year 2000 readiness varies among our customers, we do not
expect that Year 2000 problems will have such a serious impact on our customers
as to cause them to suffer material adverse financial consequences.
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<PAGE>
We believe that the potential effects on our internal operations from Year
2000 issues can and will be addressed prior to the Year 2000. However, as
unforeseen circumstances arise, the Year 2000 issue could disrupt our normal
business operations. The most reasonably likely worst case Year 2000 scenarios
foreseeable at this time would include our not being able to systematically
process, in some combination, various types of customer transactions. This
could affect our ability to accept deposits or process withdrawals, originate
new loans or accept loan payments in the automated manner we currently utilize.
Depending upon how long this scenario lasted, this could have a material adverse
effect on our operations. Our contingency plan will address alternative methods
to enable us to continue to offer basic services to our customers. The costs of
our Year 2000 project and our benchmark dates are based on our best estimates,
which are based on a number of assumptions including future events. We cannot
guarantee that these estimates will be achieved at the cost disclosed or within
the time frames indicated.
Liquidity and Capital Resources
Following the conversion, 1st State Bancorp initially will have no business
other than that of 1st State Bank and investing the net conversion proceeds it
retains. We believe that the net proceeds to be retained by 1st State Bancorp,
earnings on those proceeds and principal and interest payments on the employee
stock ownership plan loan, together with dividends that may be paid from 1st
State Bank to 1st State Bancorp following the conversion, will provide
sufficient funds for its initial operations and liquidity needs; however, it is
possible that 1st State Bancorp may need additional funds in the future. We
cannot assure you, however, that 1st State Bancorp's sources of funds will be
sufficient to satisfy its liquidity needs in the future. 1st State Bank will be
subject to certain regulatory limitations on the payment of dividends to 1st
State Bancorp. For a discussion of these regulatory dividend limitations, see
"Dividend Policy" and "Regulation -- Depository Institution Regulation --
Dividend Restrictions." 1st State Bancorp intends to lend a portion of the net
proceeds retained from the conversion to the employee stock ownership plan to
fund the employee stock ownership plan's purchase of common stock in the
conversion. See "Use of Proceeds" for a more complete breakdown of our uses of
the net proceeds.
At September 30, 1998, we had net worth of $26.0 million, as compared to
$23.3 million at September 30, 1997. We reported net income for the year ended
September 30, 1998 of $2.5 million, as compared to $2.5 million and $1.6 million
for the years ended September 30, 1997 and 1996, respectively. At September 30,
1998 and 1997, we had a capital to total assets ratio of 14.5% and 14.1%,
respectively. At September 30, 1998, we had Tier 1 leverage capital, Tier 1
risk-based capital, and total risk-based capital of $25.9 million, $25.9 million
and $28.1 million, respectively.
At September 30, 1998, we exceeded all regulatory minimum capital
requirements. For a discussion of the North Carolina Savings Bank
Administrator's and the FDIC's regulatory capital requirements, see "Regulation
- -- Depository Institution Regulation -- Capital Requirements." For additional
information regarding our actual, pro forma and minimum required capital ratios
at September 30, 1998, see "Historical and Pro Forma Regulatory Capital
Compliance." As a result of the conversion, we will have substantially increased
capital.
Our primary sources of funds are deposits, principal and interest payments
on loans, proceeds from the sale of loans, and to a lesser extent, advances from
the FHLB of Atlanta. 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 local competition.
Our primary investing activities have been the origination of loans and the
purchase of investment securities. During the years ended September 30, 1998,
1997 and 1996, we had $105.4 million, $79.2 million and $62.9 million,
respectively, of loan originations. During the years ended September 30, 1998,
1997 and 1996, we purchased investment securities in the amounts of $34.6
million, $7.0 million and $16.4 million, respectively. Our primary financing
activities are the attraction of savings deposits and, during the year ended
September 30, 1998, obtaining FHLB advances.
The North Carolina Savings Bank Administrator's regulations require savings
banks to maintain liquid assets equal to at least 10% of total assets. The
computation of liquidity under the North Carolina Savings Bank Administrator's
regulations allows the inclusion of investments with
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<PAGE>
readily marketable value, including investments with maturities in excess of
five years. Our average liquidity ratios were 20.6%, 18.3%, and 19.4% for the
years ended September 30, 1998, 1997, and 1996, respectively. We have
maintained high liquidity ratios in recent years in anticipation of our
conversion to a commercial bank. Commercial banks are subject to higher
liquidity requirements than savings banks. Our most liquid assets are cash and
cash equivalents. The levels of these assets are dependent on our operating,
financing, lending and investing activities during any given period. At
September 30, 1998 and 1997, cash and cash equivalents totaled $31.1 million and
$15.0 million, respectively. We have other sources of liquidity should we need
additional funds. During the years ended September 30, 1998, 1997 and 1996, we
sold loans totaling $27.6 million, $9.2 million and $9.2 million, respectively.
Additional sources of funds include FHLB of Atlanta advances. During the year
ended September 30, 1998, we obtained $20.0 million of FHLB of Atlanta advances
with maturities matched to the repricing of a comparable amount of loans to
reduce our exposure to potentially rising interest rates. For more information
regarding this strategy, see " -- Asset/Liability Management." At September 30,
1998, we had $20.0 million of FHLB of Atlanta advances outstanding, compared to
$1.0 million at September 30, 1997. Other sources of liquidity include loans
and investment securities designated as available for sale, which totaled $7.5
million and $9.9 million, respectively, at September 30, 1998.
We anticipate that we will have sufficient funds available to meet our
current commitments. At September 30, 1998, we had $7.5 million in commitments
to originate new loans, $40.4 million in unfunded commitments to extend credit
under existing equity line and commercial lines of credit and $505,000 in
standby letters of credit. At September 30, 1998, certificates of deposit which
are scheduled to mature within one year totaled $116.5 million. We believe that
a significant portion of such deposits will remain with us. However, some of
these deposits may be used to buy stock in the offering.
Asset/Liability Management
Net interest income, the primary component of our net income, is derived
from the difference or "spread" between the yield on interest-earning assets and
the cost of interest-bearing liabilities. We strive to achieve consistent net
interest income and to reduce our exposure to changes in interest rates by
matching the terms to repricing of our interest-sensitive assets and
liabilities. The matching of our assets and liabilities may be analyzed by
examining the extent to which our assets and liabilities are interest rate
sensitive and by monitoring the expected effects of interest rate changes on our
net interest income. Factors beyond our control, such as market interest rates
and competition, may also have an impact on our interest income and interest
expense.
In the absence of any other factors, the overall yield or return associated
with our earning assets generally will increase from existing levels when
interest rates rise over an extended period of time, and conversely interest
income will decrease when interest rates decrease. In general, interest expense
will increase when interest rates rise over an extended period of time, and
conversely interest expense will decrease when interest rates decrease.
Therefore, by controlling the increases and decreases in its interest income and
interest expense which are brought about by changes in market interest rates, we
can significantly influence our net interest income.
Our President reports to our board of directors on a regular basis on
interest rate risk and trends, as well as liquidity and capital ratios and
requirements. The board of directors reviews the maturities of our assets and
liabilities and establishes policies and strategies designed to regulate our
flow of funds and to coordinate the sources, uses and pricing of such funds.
The first priority in structuring and pricing our assets and liabilities is to
maintain an acceptable interest rate spread while reducing the net effects of
changes in interest rates. Our management is responsible for administering the
policies and determinations of the board of directors with respect to our asset
and liability goals and strategies.
Our principal strategy in managing our interest rate risk has been to
increase interest rate sensitive assets such as commercial loans and consumer
loans. At September 30, 1998, we had $25.2 million of commercial loans and $6.3
million of consumer loans, which amounted to 12.2% and 3.1%, respectively, of
our gross loan portfolio, as compared
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to $22.9 million of commercial loans and $5.4 million of consumer loans,
respectively, at September 30, 1997, which amounted to 11.3% and 2.7%,
respectively, of our gross loan portfolio at that date. In addition, in managing
our portfolio of investment securities in recent periods we emphasized the
purchase of short-term securities so as to reduce our exposure to increases in
interest rates. In addition, at September 30, 1998, we had $7.5 million of loans
held for sale, and, pursuant to Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities", we had
investment securities with an aggregate amortized cost of $9.7 million and an
aggregate fair value of $9.9 million as available for sale. We are holding these
loans and investment securities as available for sale so that they may be sold
if needed for liquidity or asset and liability management purposes.
We also have shortened the average repricing period of our assets by
retaining in our portfolio single-family residential mortgage loans only in
cases where the loan carries an adjustable rate or the loan has an interest rate
that is sufficient to compensate us for the risk of maintaining long-term,
fixed-rate loans in our portfolio. During the past two years, we have sold a
significant portion of our fixed-rate, single-family residential mortgage loans
with terms of 15 years or more we have originated, and at September 30, 1998,
most of our single-family residential mortgage loans classified as held to
maturity were originated at least two years previously when market interest
rates were higher. At September 30, 1998, we held approximately $32.1 million
of adjustable-rate residential mortgage loans, which represented approximately
15.5% of our gross loan portfolio. Depending on conditions existing at any
given time, as part of our interest rate risk management strategy, we may sell
newly originated fixed-rate residential mortgage loans with original maturities
of 15 years or more in the secondary market.
In addition, in early 1998, as market interest rates were falling and our
yields on newly originated fixed-rate loans were decreasing, we became
increasingly concerned that if interest rates were to increase significantly
from the low rates then prevailing our cost of funds could be expected to
increase while we would continue to earn the same low yield on our fixed-rate
loans. To reduce our interest rate risk, in February 1998, we obtained $20.0
million in fixed-rate FHLB of Atlanta advances. These advances were structured
with maturities estimated to coincide with the expected repricing of
approximately $20.0 million of our loans. Through this strategy, we were able
to establish a positive interest rate spread on the $20.0 million of assets and
FHLB of Atlanta advances. The FHLB of Atlanta advances may not be prepaid, and
since the time the advances were obtained interest rates have declined, with the
result that we have been and currently are earning a lesser interest rate spread
than we would otherwise be earning had we not obtained the advances. However,
the strategy of obtaining FHLB advances with maturities matched to a comparably
sized portfolio of interest-earning assets has helped us to significantly reduce
our interest rate risk in times of rising interest rates with respect to that
portion of our assets and liabilities.
Interest Rate Sensitivity Analysis
One way to analyze the matching of assets and liabilities is to examine the
extent to which assets and liabilities reprice in response to changes in
interest rates. The interest rate 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 that will mature or
reprice within the same time period. At September 30, 1998 our cumulative one-
year interest rate gap as a percentage of total assets was a negative 2.4%. A
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities. Conversely, a gap is
considered negative when the interest rate sensitive liabilities exceed the
interest rate sensitive assets.
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The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 1998 which we
anticipate, based upon certain assumptions, to reprice or mature in each of the
future time periods shown.
<TABLE>
<CAPTION>
More than More than
3 months 4 to 12 1 year to 3 years Over
or less months 3 years to 5 years 5 years Total
--------- --------- ---------- ----------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
(Dollars In thousands)
Interest-earning assets:
Loans receivable (1).................. $73,237 $ 31,977 $ 32,288 $37,193 $29,627 $204,322
Investment securities (2)............. -- 3,992 9,484 7,000 20,923 41,399
Interest-bearing overnight deposits... 25,559 -- -- -- -- 25,559
------- -------- -------- ------- ------- --------
Total interest-earning assets........ 98,796 35,969 41,772 44,193 50,550 271,280
Interest-bearing liabilities:
Transaction accounts.................. 7,013 12,724 9,950 2,966 5,665 38,318
Passbook and statement................ 1,279 3,497 7,253 4,729 11,333 28,091
Certificates of deposit............... 38,881 78,156 35,406 8,218 -- 160,661
FHLB advances......................... -- -- -- -- 20,000 20,000
------- -------- -------- ------- ------- --------
Total interest-bearing liabilities... 47,173 94,377 52,609 15,913 36,998 247,070
Interest sensitivity gap............... $51,623 $(58,408) $(10,837) $28,280 $13,552 $ 24,210
======= ======== ======== ======= ======= ========
Cumulative interest sensitivity gap.... $51,623 $ (6,785) $(17,622) $10,658 $24,210
======= ======== ======== ======= =======
Ratio of cumulative gap to total
interest-earning assets............... 19.0% (2.5)% (6.5)% 3.9% 8.9%
======= ======== ======== ======= =======
Ratio of cumulative gap to total
assets................................ 17.9% (2.4)% (6.1)% 3.7% 8.4%
======= ======== ======== ======= =======
Ratio of interest-earning assets to
interest-bearing liabilities.......... 209.4% 38.1% 79.4% 277.7% 136.6%
======= ======== ======== ======= =======
</TABLE>
- -------------
(1) Includes nonaccrual loans and loans held for sale.
(2) Includes FHLB of Atlanta stock.
Market Risk
Market risk reflects the risk of economic loss resulting from adverse
changes in market prices and interest rates. The risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods.
Our market risk arises primarily from interest rate risk inherent in
our lending and deposit-taking activities. We do not maintain a trading account
for any class of financial instrument nor do we engage in hedging activities or
purchase high-risk derivative instruments. Furthermore, we are not subject to
foreign currency exchange rate risk or commodity price risk.
We measure our interest rate risk by computing estimated changes in
net interest income and the net portfolio value of cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed
changes in market interest rates. These computations estimate the effect on our
net interest income and net portfolio value of sudden and sustained 1% to 4%
increases and decreases in market interest rates. Our board of directors has
adopted an interest rate risk policy which establishes maximum decreases in our
estimated net interest income of 10%, 15%, 20% and 25% in the event of 1%, 2%,
3% and 4% increases and decreases in the market interest rates, respectively.
Limits have also been established for changes in net portfolio value of
decreases of 10%, 15%, 25% and 50% in the event of 1%, 2%, 3% and 4% increases
in market interest rates, respectively, and decreases of 5%, 10%, 15% and 20% in
the event of 1%, 2%, 3% and 4% decreases in market interest rates, respectively.
The following table presents the projected change in net interest income and net
portfolio value for the various rate shock levels at September 30, 1998.
50
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<TABLE>
<CAPTION>
Net Portfolio Value Net Interest Income
Change -------------------------------- --------------------------------
in Rates $ Amount $ Change % Change $ Amount $ Change % Change
- -------------- -------- --------- --------- -------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
+ 400 bp $28,281 $(5,254) (15.67)% $9,478 $ 1,012 11.95%
+ 300 bp 29,839 (3,696) (11.02) 9,240 774 9.13
+ 200 bp 31,397 (2,138) (6.37) 9,002 536 6.32
+ 100 bp 32,466 (1,069) (3.19) 8,734 268 3.16
Static 33,535 0 0.00 8,466 0 0.00
- - 100 bp 33,638 103 0.31 8,082 (384) (4.54)
- - 200 bp 33,742 207 0.62 7,697 (769) (9.09)
- - 300 bp 33,156 (379) (1.13) 7,265 (1,201) (14.19)
- - 400 bp 32,571 (964) (2.87) 6,832 (1,634) (19.30)
</TABLE>
The above table indicates that at September 30, 1998, in the event of
sudden and sustained increases in prevailing market interest rates, we would
expect our estimated net interest income to increase and our net portfolio value
to decrease, and that in the event of sudden and sustained decreases in
prevailing market interest rates, we would expect our estimated net interest
income and net portfolio value to decrease, except that we would expect our net
portfolio value to increase in the event of a sudden and sustained decrease in
interest rates of 100 or 200 basis points. Our board of directors reviews our
net interest income and net portfolio value position quarterly, and, if
estimated changes in net interest income and net portfolio value are not within
the targets established by the board, the board may direct management to adjust
the asset and liability mix to bring interest rate risk within board approved
targets. At September 30, 1998, our estimated changes in net interest income
and net portfolio value were within the targets established by the board of
directors.
Computations of prospective effects of hypothetical interest rate changes,
such as the above computations, are based on numerous assumptions, including
relative levels of market interest rates, loan prepayments and deposit decay,
and should not be relied upon as indicative of actual results. Further, the
computations do not contemplate any actions we may undertake in response to
changes in interest rates.
Certain shortcomings are inherent in the method of analysis presented in
the above tables. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in differing degrees
to changes in market interest rates. 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 on a short-term basis and over
the life of the asset. In addition, the proportion of adjustable-rate loans in
our portfolio could decrease in future periods if market interest rates remain
at or decrease below current levels due to refinance activity. Further, in the
event of a change in interest rates, prepayment and early withdrawal levels
would likely deviate significantly from those assumed in the table. Also,
borrowers may have difficulty in repaying their adjustable-rate debt if interest
rates increase.
51
<PAGE>
Analysis of Net Interest Income
Net interest income represents the difference between income derived from
interest-earning assets and the interest expense on interest-bearing
liabilities. Net interest income is affected by the difference between the rates
of interest earned on interest-earning assets and the rates paid on interest-
bearing liabilities known as "interest rate spread," and the relative volume of
interest-earning assets and interest-bearing liabilities.
The following table sets forth certain information relating to our
consolidated balance sheets at September 30, 1998 and our consolidated
statements of income for the years ended September 30, 1998, 1997, and 1996 and
reflects the average yield on assets and average cost of liabilities at the date
and for the periods indicated. We derived yields and costs by dividing income
or expense by the average balance of assets and liabilities, respectively, for
the periods shown. Average balances are derived from daily balances.
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------
At September 30, 1998 1998
--------------------- -----------------------------------
Average
Yield/ Average Yield/
Balance Cost Balance Interest Cost
------- ---------- ------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Assets:
Loans receivable (1).............................. $ 204,322 8.28% $ 199,203 $ 17,185 8.63%
Investment securities (2)......................... 41,399 6.26 35,938 2,320 6.46
Interest-bearing overnight deposits............... 25,559 5.75 20,409 1,203 5.89
--------- --------- --------
Total interest-earning assets................... 271,280 7.74 255,550 20,708 8.10
--------
Non-interest-earning assets......................... 16,943 17,499
--------- ---------
Total assets.................................... $ 288,223 $ 273,049
========= =========
Liabilities and net worth:
Deposits.......................................... $ 227,070 4.57 $ 224,334 10,331 4.61
FHLB advances..................................... 20,000 5.39 13,559 740 5.46
--------- --------- --------
Total interest-bearing liabilities.............. 247,070 4.63 237,893 11,071 4.65
------ -------- -------
Non-interest-bearing liabilities.................... 15,187 10,436
--------- ---------
Total liabilities............................... 262,257 248,329
Net worth........................................... 25,966 24,720
--------- ---------
Total liabilities and net worth................. $ 288,223 $ 273,049
========= =========
Net interest income................................. $ 9,637
========
Interest rate spread................................ 3.11% 3.45%
====== =======
Net interest margin (3)............................. 3.77%
=======
Ratio of average interest-earning assets
to average interest-bearing liabilities........... 109.80% 107.42%
====== =======
</TABLE>
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------------------------
1997 1996
-------------------------------- ------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
-------- -------- -------- -------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Loans receivable (1)....... $ 186,413 $ 16,167 8.67% $ 171,148 $ 14,620 8.54%
Investment securities (2).. 39,101 2,557 6.54 37,854 2,402 6.35
Interest-bearing overnight deposits 6,116 337 5.51 6,605 373 5.65
--------- -------- --------- --------
Total interest-earning assets 231,630 19,061 8.23 215,607 17,395 8.07
------- --------
Non-interest-earning assets.. 15,362 13,313
--------- ---------
Total assets............. $ 246,992 $ 228,920
========= =========
Liabilities and net worth:
Deposits................... $ 215,494 9,743 4.52 202,776 9,450 4.66
FHLB advances.............. 1,000 56 5.60 156 3 1.92
--------- -------- --------- --------
Total interest-bearing liabilities 216,494 9,799 4.53 202,932 9,453 4.66
-------- ------- -------- ------
Non-interest-bearing liabilities 8,026 5,842
--------- ---------
Total liabilities........ 224,520 208,774
Net worth.................... 22,472 20,146
--------- ---------
Total liabilities and
net worth............... $ 246,992 $ 228,920
========= =========
Net interest income.......... $ 9,262 $ 7,942
======== ========
Interest rate spread......... 3.70% 3.41%
======= ========
Net interest margin (3)...... 4.00% 3.68%
======= ========
Ratio of average interest-earning assets
to average interest-bearing liabilities 106.99% 106.25%
======= ========
</TABLE>
- --------------------
(1) Includes nonaccrual loans and loans held for sale.
(2) Includes FHLB of Atlanta stock.
(3) Represents net interest income divided by the average balance of interest-
earning assets.
52
<PAGE>
Rate/Volume Analysis
The table below sets forth certain information regarding changes in our
interest income and interest expense for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, we have
provided information on changes attributable to:
. changes in volume, which are changes in volume multiplied by old rate
. changes in rates, which are changes in rate multiplied by old volume
. changes in rate-volume, which are changes in rate multiplied by the
changes in volume and
. total change, which is the sum of the previous columns.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
----------------------------------------- -------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
----------------------------------------- -------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------- ------ ------ ----- ------ ---- ------ -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable (1).............. $ 1,109 $ (85) $ (6) $ 1,018 $ 1,304 $ 223 $ 20 $ 1,547
Investment securities (2)......... (207) (33) 3 (237) 79 74 2 155
Other interest-earning assets..... 788 23 55 866 (28) (9) 1 (36)
------- ------ ----- ------- ------- ----- ---- -------
Total interest-earning assets... 1,690 (95) 52 1,647 1,355 288 23 1,666
------- ------ ----- ------- ------- ----- ---- -------
Interest expense:
Deposits.......................... 400 181 7 588 593 (282) (18) 293
FHLB advances..................... 703 (1) (18) 684 16 6 31 53
------- ------ ----- ------- ------- ----- ---- -------
Total interest-bearing
liabilities................ 1,103 180 (11) 1,272 609 (276) 13 346
------- ------ ----- ------- ------- ----- ---- -------
Change in net interest income....... $ 587 $ (275) $ 63 $ 375 $ 746 $ 564 $ 10 $ 1,320
======= ====== ===== ======= ======= ===== ==== =======
</TABLE>
- ---------------
(1) Includes nonaccrual loans and loans held for sale.
(2) Includes FHLB of Atlanta stock.
Comparison of Financial Condition of September 30, 1998 and 1997
Total assets increased by $29.7 million, or 11.5%, from $258.5 million at
September 30, 1997 to $288.2 million at September 30, 1998. A significant
portion of the increase in assets was attributable to an increase in cash and
cash equivalents, which increased by $16.1 million, or 107.3%, from $15.0
million at September 30, 1997 to $31.1 million at September 30, 1998. Cash and
cash equivalents consist of cash and interest-bearing deposits in other banks
and are our most liquid assets. We increased our liquidity at September 30,
1998 due to:
. increased loan sales and prepayments of loans in connection with
refinancings as a result of declining interest rates during the year
ended September 30, 1998;
. our retention of cash from a $20.0 million FHLB of Atlanta advance; and
. an increase in deposits while loans receivable remained stable.
As a result of historically low prevailing interest rates during the year
ended September 30, 1998, we have increased our mortgage banking activities by
classifying as held for sale substantially all newly originated long-term,
fixed-rate single-family residential mortgage loans. As a result, our loans
held for sale increased from $684,000 at
53
<PAGE>
September 30, 1997 to $7.5 million at September 30, 1998. In addition, our loans
receivable, net decreased by $340,000, or .2%, from $197.1 million at September
30, 1997 to $196.8 million at September 30, 1998. While single-family
residential mortgage loans decreased by $7.5 million, or 6.9%, from $108.4
million at September 30, 1997 to $100.9 million at September 30, 1998, we were
able to increase our portfolio of construction loans by $6.0 million, or 47.6%,
from $12.6 million at September 30, 1997 to $18.6 million at September 30, 1998.
The increase in our portfolio of construction loans reflects our success in
obtaining several acquisition and development loans and loans to builders to
build unsold residences, as well as to an increase in the average size of loans
to individuals to build their primary residences.
Our investment securities held to maturity increased by $6.7 million, or
28.6%, from $23.5 million at September 30, 1997 to $30.2 million at September
30, 1998, as we used excess liquidity to purchase investment securities.
During the year ended September 30, 1998, we funded our asset growth partly
with increased deposit accounts but primarily with FHLB of Atlanta advances.
In February 1998, we obtained $20.0 million in FHLB of Atlanta advances. These
advances were structured with maturities estimated to coincide with the expected
repricing of approximately $20.0 million of our loans. See "-- Asset/Liability
Management" for more information about our use of FHLB of Atlanta advances in
reducing our interest rate risk. As a result, FHLB of Atlanta advances totaled
$20.0 million at September 30, 1998, as compared to $1.0 million at September
30, 1997. Deposit accounts increased by $6.4 million, or 2.8%, from $229.3
million at September 30, 1997 to $235.7 million at September 30, 1998. Of the
increase, $5.1 million was attributable to an increase in the transaction
accounts, which we have been promoting during the year. In addition, we have
had some success in cross-selling checking accounts and money market accounts to
our commercial borrowers.
Comparison of Operating Results for the Years Ended September 30, 1998 and 1997
Net Income. We had $2.5 million of net income for each of the years ended
September 30, 1998 and 1997. During the year ended September 30, 1998,
increases in net interest income and other income were offset by increases in
the provision for loan losses and operating expenses. We are establishing a
charitable foundation and contributing to the foundation up to 8% of the stock
we sell in the conversion, up to a maximum of 150,000 shares. The contribution
to the foundation will reduce our earnings in 1999, the fiscal year in which the
foundation is to be established and the contribution made, by up to $2.0
million. If the foundation had been established and the contribution made
during the year ended September 30, 1998, we would have reported net income of
approximately $541,000 rather than reporting net income of approximately $2.5
million, for the year ended September 30, 1998.
Net Interest Income. Net interest income was $9.6 million for the year
ended September 30, 1998, as compared to $9.3 million for the year ended
September 30, 1997, representing an increase of $375,000, or 4.1%. During the
year ended September 30, 1998, we were able to increase our net interest income
by leveraging our capital and increasing our levels of interest-earning assets
and interest-bearing liabilities. The average balance of interest-earning
assets increased by $23.9 million, or 10.3%, from $231.6 million for the year
ended September 30, 1997 to $255.6 million for the year ended September 30, 1998
primarily due to increases in the average balances of loans receivable and
interest-bearing overnight deposits. In addition, the average balance of
interest-bearing liabilities increased by $21.4 million, or 9.9%, from $216.5
million for the year ended September 30, 1997 to $237.9 million for the year
ended September 30, 1998 primarily due to increases in the average balances of
deposits and FHLB advances. The effect of the increases in the average balances
of assets and liabilities was offset in part by a decrease in our interest rate
spread from 3.70% for the year ended September 30, 1997 to 3.45% for year ended
September 30, 1998. In February 1998, we obtained $20.0 million in fixed-rate
FHLB of Atlanta advances. These advances were structured with maturities
estimated to coincide with the expected repricing of approximately $20.0 million
of our loans. Through this strategy, we were able to establish a positive
interest rate spread on the $20.0 million of assets and FHLB of Atlanta
advances. The proceeds of advances increased our cash and cash equivalents
pending deployment of the proceeds into loans. Since the time the advances were
obtained interest rates have declined, with the result that our cost of funds
has been
54
<PAGE>
negatively affected because the advances have a higher rate of interest than
other sources of funds while cash and cash equivalents have a lower yield than
our other interest-earning assets. As a result, we have been, and currently are,
earning a lesser interest rate spread than we would otherwise be earning had we
not obtained the advances. However, the strategy of obtaining FHLB advances with
maturities matched to a comparably sized portfolio of interest-earning assets
has helped us to significantly reduce our interest rate risk in times of rising
interest rates with respect to that portion of our assets and liabilities.
See "-- Asset/Liability Management" for our strategies in managing our interest
rate spread. However, during the year ended September 30, 1998, we continued our
efforts to increase the yield on interest-earning assets by increasing
originations of loans that are based on the prime rate, such as commercial loans
and home equity lines of credit, and to lower our cost of funds by successfully
attracting lower cost deposits such as checking accounts and money market
accounts.
Interest Income. Total interest income was $20.7 million for the year
ended September 30, 1998, as compared to $19.1 million for the year ended
September 30, 1997, representing an increase of $1.6 million, or 8.6%. Such
increase was due primarily to a $23.9 million, or 10.3%, increase in the average
balance of the interest-earning assets during such year and, offset in part by a
13 basis point decrease in the average yield on interest-earning assets.
Interest on loans receivable increased by $1.0 million, or 6.3%, from $16.2
million for the year ended September 30, 1997 to $17.2 million of the year ended
September 30, 1998. The increase was due primarily to an increase of $12.8
million, or 6.9%, in the average balance of loans receivable from $186.4 million
for the year ended September 30, 1997 to $199.2 million for the year ended
September 30, 1998, reflecting increased single-family residential mortgage loan
and commercial loan originations. The increase in the average balance of loans
receivable more than offset a 4 basis point decrease in the average yield on
loans receivable due to falling market interest rates during the year ended
September 30, 1998. Offsetting the decreased yield attributable to declining
market interest rates were our increased originations of commercial loans and
construction loans, which carry interest rates based on the prime rate, enabling
us earn a higher yield on interest-earning assets, as commercial loans generally
earn higher interest rates than single-family residential mortgage loans,
although those loans entail greater credit risk. For more information, see
"Business of 1st State Bank -- Lending Activities -- Commercial Lending."
Interest on investment securities decreased by $237,000, or 9.3%, from $2.6
million for the year ended September 30, 1997 to $2.3 million for the year ended
September 30, 1998. The decrease was attributable to a $3.2 million, or 8.1%,
decrease in the average balance of investment securities from $39.1 million for
the year ended September 30, 1997 to $35.9 million for the year ended September
30, 1998, combined with an 8 basis point decrease in the average yield on
investment securities. As market interest rates fell during the year ended
September 30, 1998, a higher than normal level of our investment securities were
called by the issuers.
Interest on interest-bearing overnight deposits increased by $867,000 from
$336,000 for the year ended September 30, 1997 to $1.2 million for the year
ended September 30, 1998. The increase was due primarily to a $14.3 million
increase in the average balance of other interest-earning assets from $6.1
million for the year ended September 30, 1997 to $20.4 million for the year
ended September 30, 1998, as a result of the $20.0 million of FHLB of Atlanta
advances obtained in February 1998, as well as to a 38 basis point increase in
the yield on other interest-earning assets.
Interest Expense. During the years ended September 30, 1997 and 1998,
interest expense consisted primarily of interest on deposit accounts. Interest
on deposit accounts increased by $588,000, or 6.0%, from $9.7 million for the
year ended September 30, 1997 to $10.3 million for the year ended September 30,
1998. The increase was due to an $8.8 million, or 4.1%, increase in the average
balance of deposits from $215.5 million for the year ended September 30, 1997 to
$224.3 million for the year ended September 30, 1998. In addition, there was a
9 basis point increase in the average cost of deposits. The increase in the
average cost of deposits reflected our decision to increase our deposit rates to
match competition in our market. In addition, during the year ended September
30, 1998, we had interest expense of $740,000 on our increased balance of FHLB
of Atlanta advances, as compared to $56,000 of interest expense during the year
ended September 30, 1997.
55
<PAGE>
Provisions for Loan Losses. We charge provisions for loan losses to
earnings to maintain the total allowance for loan losses at a level we consider
adequate to provide for probable loan losses, based on prior loss experience,
volume and type of lending we conduct, industry standards and past due loans in
our loan portfolio. Our policies require the review of assets on a regular
basis, and we appropriately classify loans as well as other assets if warranted.
See "Business of 1st State Bank -- Lending Activities -- Nonperforming Loans and
Other Problem Assets" and " -- Allowance for Loan Losses" for information as to
how we classify loans and establish loan loss reserves. We believe we use the
best information available to make a determination with respect to the allowance
for loan losses, recognizing that future adjustments may be necessary depending
upon a change in economic conditions. We provided $477,000 and $261,000 for
loan losses during the years ended September 1998 and 1997, respectively. The
allowance for loan losses was $3.2 million at September 30, 1998, as compared to
$2.8 million at September 30, 1997. The ratio for the allowance for loan losses
to total loans, net of loans in process and deferred loan fees was 1.61% and
1.38% at September 30, 1998 and 1997, respectively. The increased provision
during the year ended September 30, 1998 reflects the increased risk in our loan
portfolio attributable to the higher percentage of loans invested in commercial
loans, commercial real estate loans and construction loans. At September 30,
1998, commercial loans, commercial real estate loans and construction loans
totaled $25.2 million, $38.8 million and $18.6 million, respectively, which
amounted to 12.2%, 18.8% and 9.0%, respectively, of the gross loan portfolio.
Comparatively, at September 30, 1997, commercial loans, commercial real estate
loans and construction loans totaled $22.9 million, $34.3 million and $12.6
million, respectively, which amounted to 11.3%, 17.0% and 6.2%, respectively, of
the gross loan portfolio. Single-family residential real estate loans totaled
$100.9 million and $108.4 million at September 30, 1998 and 1997, respectively,
which represented 48.8% and 53.8%, respectively, of the gross loan portfolio at
such dates. Furthermore, we continued to originate asset-based loans, which are
loans where repayment is based largely on the liquidation of assets such as
inventory and accounts receivable. These loans carry an even higher incremental
risk of loss, as their repayment is often dependent on the financial performance
of the persons that owe money to our borrower. At September 30, 1998 and 1997,
we had $9.4 million and $8.1 million, respectively, we considered to be asset-
based loans.
In addition, changes in the economy during fiscal year 1998 have altered
the credit risk profile of some of our customers and as a result, we increased
our provision to reflect this additional credit risk. We believe that our
local economy may be nearing the end of a business cycle, which affects all of
our borrowers through a softening economy. We have been further affected by
this trend in that in recent years we have increased lending to smaller
businesses, churches and non-profit organizations, and we have increased the
origination of asset-based loans. We consider these borrowers to be more
vulnerable to changes in the economy than larger, more diversified companies
whose revenues are supported by customers in a variety of locations. The NAFTA
legislation passed by Congress also appears to be having a negative impact on
the textile industry of Alamance County, affecting or potentially affecting
borrowers in the textile industry and borrowers employed by local textile
companies. Finally, we believe increased consumer debt levels and rising
consumer bankruptcy rates nationally and in North Carolina have had a negative
effect on our consumer and mortgage loan portfolios during 1998. Collectively,
these factors prompted us to increase the allowance for loan losses during 1998.
Other Income. Total other income was $1.5 million for the years ended
September 30, 1998 and 1997. During the year ended September 30, 1998, mortgage
banking income, net increased by $256,000. As interest rates decreased during
the year, we decided to sell a greater volume of new residential mortgage loan
originations to reduce our exposure to interest rate risk. For most of these
transactions, we incurred a loss on the sale of the loan. During the years ended
September 30, 1998 and 1997, we recognized net losses on the sale of mortgage
loans of $119,000 and $16,000, respectively. These losses were offset by other
sources of income from mortgage banking transactions. For example, in many
cases, we elected to sell the rights to service the loan, resulting in the
collection of an additional premium to release the servicing rights. These
premiums, which amounted to $351,000 and $121,000 for the years ended September
30, 1998 and 1997, respectively, more than offset the aforementioned marketing
losses on the sale of the loans during these periods. In addition, during the
year ended September 30, 1998, commissions from sales of annuities and mutual
funds increased by $38,000 as customers shifted retirement funds into non-
insured investments. Also, customer service fees on loan and deposit accounts
increased by $65,000, or 13.1%, from $500,000 for the year ended September 30,
1997 to $566,000 for the year ended September 30, 1998 as a result of increased
levels of deposit and loan accounts.
56
<PAGE>
Offsetting these increases was a $269,000 securities loss during the year ended
September 30, 1998 from an other than temporary decline in the value of
marketable equity securities. During the mid 1980s, we made an investment in a
mutual fund which invests in mortgage-backed securities and U.S. Government and
agency securities. This investment is classified as available for sale, and in
prior years we have reflected a net unrealized loss on investment securities on
our consolidated balance sheets attributable to the then current unrealized loss
associated with this mutual fund investment. During the year ended September 30,
1998, we determined that the value of the investment in marketable equity
securities would not recover in the foreseeable future and we recognized an
expense attributable to the other than temporary decline in fair value. The fair
value of marketable equity securities depends largely on changes in interest
rates as the underlying securities are debt securities. Future changes in
interest rates could cause additional declines in value that are other than
temporary.
Operating Expenses. Total operating expenses increased by $302,000, or
4.7%, from $6.5 million for the year ended September 30, 1997 to $6.8 million
for the year ended September 30, 1998. Compensation and related benefits
increased by $267,000, or 6.2%, from $4.3 million for the year ended September
30, 1997 to $4.6 million for the year ended September 30, 1998, due to an
increase in expense attributable to normal salary increases and increases in the
number of employees. During the year ended September 30, 1998 and 1997, we
incurred $987,000 and $1.1 million, respectively, in compensation and related
expenses attributable to the implementation and vesting of a Deferred
Compensation Plan for directors and executive officers. The expense associated
with that plan is expected to approximate $200,000 annually beginning with the
year ended September 30, 1999. Occupancy and equipment expenses increased by
$105,000, or 11.1%, from $940,000 for the year ended September 30, 1997 to $1.0
million for the year ended September 30, 1998 due to an $85,000 write-down of
obsolete equipment. Deposit insurance premiums increased by $38,000, or 36.9%,
from $104,000 for the year ended September 30, 1997 to $142,000 for the year
ended September 30, 1998 due to increased levels of deposits. Our operating
expenses will increase in the future due to added expense associated with our
employee stock ownership plan, the costs of being a public company and, later
on, a restricted stock plan.
Income Taxes. Our income tax expense was $1.4 million for each of the
years ended September 30, 1998 and 1997. Our effective tax rate was 35.1% for
the year ended September 30, 1998 and 36.2% for the year ended September 30,
1997.
Comparison of Operating Results for the Years Ended September 30, 1997 and 1996
Net Income. We had $2.5 million of net income for the year ended September
30, 1997, compared to $1.6 million of net income for the year ended September
30, 1996, representing an increase of $952,000, or 59.7%. The principal reason
for the increase was a $1.3 million increase in net interest income.
Net Interest Income. Net interest income was $9.3 million for the year
ended September 30, 1997, as compared to $7.9 million for the year ended
September 30, 1996, representing an increase of $1.3 million, or 16.6%. The
increase was due to an increase in our interest rate spread from 3.41% for the
year ended September 30, 1996 to 3.70% for year ended September 30, 1997.
During the year ended September 30, 1997, we were able to increase the yield on
interest-earning assets by increasing loans that are based on the prime rate,
such as commercial loans and home equity lines of credit. Concurrently, we were
able to lower our cost of funds by increasing lower cost deposits such as
checking accounts and money market accounts. During the year ended September
30, 1997, we were able to increase our net interest income by leveraging our
capital and increasing our levels of interest-earning assets and interest-
bearing liabilities. The average balance of interest-earning assets increased
by $16.0 million, or 7.4%, from $215.6 million for the year ended September 30,
1996 to $231.6 million for the year ended September 30, 1997 primarily due to
increases in the average balance of loans receivable. In addition, the average
balance of interest-bearing liabilities increased by $13.6 million, or 6.7%,
from $202.9 million for the year ended September 30, 1996 to $216.5 million for
the year ended September 30, 1997 primarily due to increases in the average
balance of deposits.
57
<PAGE>
Interest Income. Total interest income was $19.1 million for the year
ended September 30, 1997, as compared to $17.4 million for the year ended
September 30, 1996, representing an increase of $1.7 million, or 9.6%. Such
increase was due primarily to a $16.0 million, or 7.4%, increase in the average
balance of the interest-earning assets during such year and, to a lesser extent,
to a 16 basis point increase in the average yield on interest-earning assets.
Interest on loans receivable increased by $1.5 million, or 10.6%, from
$14.6 million for the year ended September 30, 1996 to $16.2 million of the year
ended September 30, 1997. The increase was due primarily to an increase of
$15.3 million, or 8.9%, in the average balance of loans receivable from $171.1
million for the year ended September 30, 1996 to $186.4 million for the year
ended September 30, 1997, reflecting increased single-family residential
mortgage loan and commercial loan originations. The increase in interest on
loans receivable also reflected a 13 basis point increase in the average yield
on loans receivable. By increasing originations of commercial loans and home
equity lines of credit that carry interest rates based on the prime rate, we
were able to increase our average yield on interest-earning assets, as
commercial loans generally earn higher interest rates than single-family
residential mortgage loans, although those loans entail greater credit risk.
Interest on investment securities increased by $156,000, or 6.5%, from $2.4
million for the year ended September 30, 1996 to $2.6 million for the year ended
September 30, 1997. The increase was attributable to a $1.2 million, or 3.3%,
increase in the average balance of investment securities from $37.9 million for
the year ended September 30, 1996 to $39.1 million for the year ended September
30, 1997, as well as to a 19 basis point increase in the average yield on
investment securities. As market interest rates were rising during the year
ended September 30, 1997, we invested excess liquidity in short-term U.S.
government and agency securities to increase our yield on interest-earning
assets.
Interest Expense. During the years ended September 30, 1996 and 1997,
interest expense consisted almost entirely of interest on deposit accounts.
Interest on deposit accounts increased by $293,000, or 3.1%, from $9.5 million
for the year ended September 30, 1996 to $9.7 million for the year ended
September 30, 1997. The increase was due to a $12.7 million, or 6.3%, increase
in the average balance of deposits from $202.8 million for the year ended
September 30, 1996 to $215.5 million for the year ended September 30, 1997. The
increase in the average balance of deposits more than offset a 14 basis point
decrease in the average cost of deposits. The decrease in the average cost of
deposits reflected the increase in the percentage of our deposits comprised of
lower cost deposits such as checking accounts and money market accounts.
Provisions for Loan Losses. We provided $261,000 and $281,000 for loan
losses during the years ended September 1997 and 1996, respectively. The
allowance for loan losses was $2.8 million at September 30, 1997, as compared to
$2.5 million at September 30, 1996. The ratio for the allowance for loan losses
to total loans, net of loans in process and deferred loan fees was 1.38% at
September 30, 1997 and 1.42% at September 30, 1996.
Other Income. Total other income increased by $289,000 , or 24.5%, from
$1.2 million for the year ended September 30, 1996 to $1.5 million for the year
ended September 30, 1997. Of such increase, $113,000 was attributable to
increased commissions from sales of annuities and mutual funds, as customers
shifted retirement funds into noninsured investments, and $77,000 was
attributable to an increase in mortgage banking income, net. Also contributing
to the increase in other income was a $88,000, or 21.4%, increase in customer
service fees on loan and deposit accounts, which increased from $412,000 for the
year ended September 30, 1996 to $500,000 for the year ended September 30, 1997
as a result of increased levels of loan and deposit accounts.
Operating Expenses. Total operating expenses increased by $69,000, or
1.1%, from $6.4 million for the year ended September 30, 1996 to $6.5 million
for the year ended September 30, 1997. Compensation and related benefits
increased by $1.4 million, or 47.3%, from $2.9 million for the year ended
September 30, 1996 to $4.3 million for the year ended September 30, 1997, due to
an increase in expense attributable to the implementation and vesting of a
Deferred Compensation Plan for directors and executive officers. The increase
in compensation and related benefits offset a decrease in operating expenses as
a result of a $1.3 million expense incurred during the year ended September
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<PAGE>
30, 1996 as a result of a special assessment by the FDIC to recapitalize the
Savings Association Insurance Fund of the FDIC. During the year ended September
30, 1996, we paid a one-time special assessment in the amount of $1.3 million
assessed by the FDIC on all Savings Association Insurance Fund of the FDIC-
insured institutions to capitalize the Savings Association Insurance Fund of the
FDIC insurance fund of the FDIC up to required reserved ratio. Prior to such
special assessment, we paid continuing Savings Association Insurance Fund of the
FDIC insurance premiums at the rate of 23 cents per $100 of Savings Association
Insurance Fund of the FDIC deposits. However, the rate dropped to 6.4 cents per
$100 effective January 1, 1997 through September 30, 1999 and, based on our
current condition, will further decrease to 2.4 cents per $100 thereafter. This
revised deposit insurance rate structure enabled us to recognize the substantial
reduction in deposit insurance premiums during the year ended September 30,
1997. Deposit insurance premiums decreased from $465,000 for the year ended
September 30, 1996 to $104,000 for the year ended September 30, 1997.
Income Taxes. Our income tax expense was $841,000 and $1.4 million for the
years ended September 30, 1996 and 1997, respectively. Our effective tax rate
was 34.5% for the year ended September 30, 1996 and 36.2% for the year ended
September 30, 1997.
Impact of Inflation and Changing Prices
Our financial statements and the accompanying notes, which appear beginning
on page F-1 of this document, have been prepared in accordance with generally
accepted accounting principles, which require the measurement of financial
position and operating results in terms of historical dollars without
considering the change in the relative purchasing power of money over time and
due to inflation. The impact of inflation is reflected in the increased cost of
our operations. As a result, interest rates have a greater impact on our
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.
Accounting Matters
Accounting for Stock-Based Compensation. Statement of Financial Standards
No. 123, "Accounting for Stock-Based Compensation" ("Statement of Financial
Accounting Standards 123") was issued in October 1995 and defines the methods
and alternatives for recognizing compensation cost associated with stock-based
compensation. Because we are a mutually owned institution with no outstanding
common stock, Statement of Financial Accounting Standards 123 has not applied to
us. Effective with our conversion to a stock institution, we will become subject
to the requirements of Statement of Financial Accounting Standards 123 in
accounting for stock-based compensation. Statement of Financial Accounting
Standards 123 defines a fair value method of accounting for an employee stock
option or similar equity instrument and encourages all entities to adopt that
method of accounting for all of their employee stock compensation plans. It also
allows an entity to measure compensation cost for those plans using the
intrinsic value based method of accounting proscribed in Accounting Principles
Board Opinion Number 25 ("Accounting Principles Board 25"), "Accounting for
Stock Issued to Employees". Statement of Financial Accounting Standards 123
requires that an employers' financial statements include certain disclosures
about stock-based compensation arrangements regardless of the method used to
account for them. Entities electing to use the accounting in Accounting
Principles Board 25 must make pro forma disclosures of net income and, if
presented, earnings per share, as if the fair value based method of accounting
defined in Statement of Financial Accounting Standards 123 had been applied. We
will measure compensation cost using Accounting Principles Board 25, and
therefore we will make any pro forma disclosures required by Statement of
Financial Accounting Standards 123 of net income and earnings per share as if
the fair value based method of accounting defined in Statement of Financial
Accounting Standards 123 had been applied.
Earnings Per Share. Also upon conversion to a stock institution, we will
adopt Statement of Financial Accounting Standards No. 128, "Earnings per Share"
("Statement of Financial Accounting Standards 128"). This standard provides
guidance for computing and presenting earnings per share. Statement of Financial
Accounting Standards 128 provides for the disclosure of:
. basic earnings per share, or net income divided by weighted average
shares outstanding, and
. diluted earnings per share, or net income divided by weighted average
shares outstanding, as adjusted to include potential common stock
arising from the exercise of dilutive stock options.
. For a presentation of pro forma basic and diluted earnings per share and
the assumptions used to prepare those amounts, see "Pro Forma Data."
59
<PAGE>
Reporting Comprehensive Income. In June 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 130
("Statement of Financial Accounting Standards 130"), "Reporting Comprehensive
Income." Statement of Financial Accounting Standards 130 establishes standards
for reporting and displaying comprehensive income and its components of
revenues, expenses, gains, and losses in a full set of general-purpose financial
statements. This Statement requires that an enterprise classify items of other
comprehensive income by their nature in the financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in-capital in the equity section of a statement of
financial position. Statement of Financial Accounting Standards 130 is effective
for fiscal years beginning after December 15, 1997. Reclassification of
financial statements for earlier periods provided for comparative purposes is
required. We adopted Statement of Financial Accounting Standards 130 on October
1, 1998. Other comprehensive income consists of unrealized gains and losses on
certain investment securities and would have been $167,000 at September 30,
1998. Total comprehensive income would have been $2.7 million at September 30,
1998.
Disclosures Regarding Segments. In June 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 131
("Statement of Financial Accounting Standards 131"), "Disclosures about Segments
of an Enterprise and Related Information." Statement of Financial Accounting
Standards 131 establishes standards for the way that public businesses report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. This Statement is effective for financial statements for periods
beginning after December 15, 1997 and in the initial year of application,
comparative information for earlier years is to be restated. We adopted
Statement of Financial Accounting Standards 131 on October 1, 1998 without any
significant impact on our consolidated financial statements as we operate as one
segment.
Employers Disclosures About Pensions and Other Postretirement Benefits. In
February 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 132, "Employers Disclosures About Pension and
Other Postretirement Benefits," which standardizes disclosure requirements for
pensions and postretirement benefits. This Statement is effective for fiscal
years beginning after December 15, 1997. We do not believe that the adoption of
Statement of Financial Accounting Standards No. 132 will have a material effect
on our consolidated financial statements because we do not have a pension plan
or other postretirement benefits.
Accounting for Derivative Instruments and Hedging Activities. In June
1998, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 133. This Statement standardizes the accounting for
derivative instruments including certain derivative instruments embedded in
other contracts, by requiring that an entity recognize these items as assets or
liabilities in the statement of financial position and measure them at fair
value. This Statement generally provides for matching the timing of gain or loss
recognition on the hedging instrument with the recognition of the changes in the
fair value of the hedged asset or liability that are attributable to the hedged
risk or the earnings effect of the hedged forecasted transaction. The Statement,
which is effective for all fiscal quarters of all fiscal years beginning after
June 15, 1999, will not affect our financial position or our results of
operations because we do not have or intend to have derivative financial
instruments.
60
<PAGE>
BUSINESS OF 1st STATE BANCORP, INC.
We organized 1st State Bancorp in November 1998 to be the holding company
for 1st State Bank. 1st State Bancorp currently is not an operating company.
Following the conversion, 1st State Bancorp will engage primarily in the
business of directing, planning and coordinating the business activities of 1st
State Bank. In the future, 1st State Bancorp may conduct operations or acquire
or organize other operating subsidiaries, including other financial
institutions, though we have no current plans in this regard. Initially, 1st
State Bancorp will not maintain offices separate from those of 1st State Bank
nor employ any persons other than its officers who will not be separately
compensated for their service.
BUSINESS OF 1st STATE BANK
General
Our principal business is attracting deposits from the general public and
investing these funds in loans secured by single-family residential and
commercial real estate, secured and unsecured commercial loans and consumer
loans. We derive our income principally from interest earned on loans and
investments and, to a lesser extent, miscellaneous fees relating to our loans
and deposits, mortgage banking income and commissions from annuity and mutual
fund sales. Our principal expenses are interest expense on deposits and
borrowings and other expense such as compensation and related benefits,
occupancy and equipment expenses and other miscellaneous expenses. Funds for
these activities are provided principally by deposits, borrowings, repayments of
outstanding loans and investments and operating revenues.
Market Area
We conduct most of our business in Alamance County in north central North
Carolina, located on the Interstate 85 corridor between the Piedmont Triad and
Research Triangle. Historically, the Alamance County economy has been heavily
dependent on the textile industry. During the past 20 years, the economy has
diversified to some extent, with increasing employment in the areas of
insurance, banking, manufacturing and services. Major employers in the area
include LabCorp, Burlington Industries, Alamance County Schools, Glenraven Mills
and Alamance Health Services. Nevertheless, the economy in Alamance County
continues to be heavily dependent on the textile industry.
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<PAGE>
Lending Activities
Loan Portfolio Composition. At September 30, 1998, our gross loan
portfolio totaled $206.6 million and represented 71.7% of total assets. The
following table sets forth information relating to the composition of our loan
portfolio by type of loan at the dates indicated. At September 30, 1998, we had
no concentrations of loans exceeding 10% of gross loans other than as disclosed
below. Excluded from this table are mortgage loans held for sale, which are
presented separately on our consolidated balance sheets and in "Selected
Consolidated Financial Information and Other Data."
<TABLE>
<CAPTION>
At September 30,
---------------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- -------------------
Amount % Amount % Amount %
--------- -------- --------- -------- --------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
Single-family residential................. $100,891 48.84% $108,400 53.76% $100,247 55.70%
Commercial................................ 38,763 18.76 34,333 17.02 35,302 19.62
Home equity............................... 16,877 8.17 18,141 8.99 15,872 8.82
Construction.............................. 18,572 8.99 12,582 6.24 7,838 4.36
-------- ------- -------- ------- -------- -------
Total real estate....................... 175,103 84.76 173,456 86.01 159,259 88.50
Commercial................................. 25,190 12.19 22,870 11.34 16,989 9.44
Consumer................................... 6,310 3.05 5,354 2.65 3,706 2.06
-------- ------- -------- ------- -------- -------
206,603 100.00% 201,680 100.00% 179,954 100.00%
-------- ======= ------- ======= -------- =======
Less:
Loans in process.......................... (6,446) (1,660) (3,515)
Deferred fees and discounts............... (147) (144) (94)
Allowance for loan losses................. (3,228) (2,754) (2,496)
-------- -------- --------
Total.................................... $196,782 $197,122 $173,849
======== ======== ========
<CAPTION>
At September 30,
------------------------------------------------
1995 1994
-------------------- --------------------
Amount % Amount %
--------- -------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Single-family residential... $ 98,660 55.78% $ 91,094 57.51%
Commercial.................. 35,774 20.23 29,922 18.89
Home equity................. 16,409 9.28 15,326 9.67
Construction................ 7,084 4.01 5,675 3.58
-------- ------- -------- -------
Total real estate......... 157,927 89.30 142,017 89.65
Commercial................... 15,072 8.52 12,876 8.13
Consumer..................... 3,847 2.18 3,514 2.22
-------- ------- -------- -------
176,846 100.00% 158,407 100.00%
-------- ======= -------- =======
Less:
Loans in process............ (3,457) (2,446)
Deferred fees and discounts. (73) 1
Allowance for loan losses... (2,223) (1,767)
-------- --------
Total...................... $171,093 $154,195
======== ========
</TABLE>
62
<PAGE>
Loan Maturity Schedule
The following table sets forth certain information at September 30,
1998 regarding the dollar amount of loans maturing in our portfolio based on
their contractual terms to maturity, including scheduled repayments of
principal. Demand loans, loans having no stated schedule of repayments, such as
lines of credit, and overdrafts are reported as due in one year or less. The
table does not include any estimate of prepayments which significantly shorten
the average life of mortgage loans and may cause our repayment experience to
differ from that shown below.
<TABLE>
<CAPTION>
Due During the Year Ending Due After Due After Due After
September 30, 3 Through 5 Through 10 Through
---------------------------- 5 Years After 10 Years After 15 Years After
1999 2000 2001 September 30, 1998 September 30, 1998 September 30, 1998
------ ------ ------ -------------------- ------------------- ------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
Single-family.............. $ 3,140 $3,321 $ 1,530 $ 5,887 $12,368 $15,753
Commercial................. 3,020 1,581 1,851 15,314 7,028 7,431
Home equity................ 309 29 54 396 5,083 11,006
Construction............... 8,605 1,390 1,758 373 -- --
Commercial................... 12,181 2,495 4,236 4,727 790 761
Consumer..................... 2,024 690 1,347 2,056 193 --
------- ------ ------- ------- ------- -------
Total................... $29,279 $9,506 $10,776 $28,753 $25,462 $34,951
======= ====== ======= ======= ======= =======
<CAPTION>
Due After 15
Years After
September 30, 1998 Total
------------------ ---------
(In thousands)
<S> <C> <C>
Real estate loans:
Single-family.............. $58,892 $100,891
Commercial................. 2,538 38,763
Home equity................ -- 16,877
Construction............... -- 12,126
Commercial................... -- 25,190
Consumer..................... -- 6,310
------- --------
Total................... $61,430 $200,157
======= ========
</TABLE>
The following table sets forth at September 30, 1998, the dollar amount of
all loans due one year or more after September 30, 1998 which have predetermined
interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates Total
------------- ---------------- --------
(In thousands)
<S> <C> <C> <C>
Real estate loans:
Single-family residential... $ 66,846 $30,905 $ 97,751
Commercial.................. 22,485 13,258 35,743
Home equity................. 2,811 13,757 16,568
Construction................ 569 2,952 3,521
Commercial................... 4,199 8,810 13,009
Consumer..................... 4,205 81 4,286
-------- ------- --------
Total...................... $101,115 $69,763 $170,878
======== ======= ========
</TABLE>
63
<PAGE>
Scheduled contractual principal repayments of loans do not reflect the
actual life of the loans. The average life of loans can be substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give us the right to declare a loan immediately due
and payable in the event that, among other things, the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life
of mortgage loans tends to increase when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
Originations, Purchases and Sales of Loans. We generally have
authority to originate and purchase loans secured by real estate located
throughout the United States. Consistent with our emphasis on being a
community-oriented financial institution, we concentrate our lending activities
in Alamance County.
The following table sets forth certain information with respect to our
loan origination, purchase and sale activity for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------
1998 1997 1996
-------- ------- -------
(In thousands)
<S> <C> <C> <C>
Loans originated:
Real estate loans:
Single-family residential... $ 44,118 $27,731 $20,517
Commercial.................. 9,437 5,446 9,536
Home equity................. 7,351 6,340 5,083
Construction................ 19,158 17,082 12,912
-------- ------- -------
Total real estate loans.... 80,064 56,599 48,048
Commercial.................... 18,982 15,835 11,210
Consumer...................... 6,361 6,801 3,670
-------- ------- -------
Total loans originated... $105,407 $79,235 $62,928
======== ======= =======
Loans purchased:
Real estate loans............. $ 135 $ 96 $ 15
Other loans................... 18 -- --
-------- ------- -------
Total loans purchased...... $ 153 $ 96 $ 15
======== ======= =======
Loans sold: (1)................. $ 27,635 $ 9,166 $ 9,181
======== ======= =======
- ------------------
</TABLE>
(1) All loans sold were whole loans.
We obtain our loan originations from a number of sources, including
referrals from depositors and borrowers, repeat customers, advertising and
calling officers, as well as walk-in customers. We also advertise in local
media and participate in various community organizations and events. Real
estate loans are originated by our loan personnel. All of our loan personnel
are salaried and are eligible to receive commissions for loans originated. We
accept loan applications at our offices and do not originate loans on an
indirect basis such as through arrangements with automobile dealers. In all
cases, we have final approval of the application. Historically, we have
purchased limited quantities of loans. During the years ended September 30,
1998, 1997 and 1996, virtually all loans purchased were small participation
interests in multi-family residential real estate loans to finance low income
housing.
In recent years, and particularly during the year ended September 30,
1998, we have sold an increasing amount of fixed-rate, single-family mortgage
loans that we originated. During the years ended September 30, 1998, 1997 and
1996, we sold $27.6 million, $9.2 million and $9.2 million, respectively, of
such loans. Typically, in the current low interest rate environment, we have
been selling fixed-rate, single-family mortgage loans with terms of 15 years or
more
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<PAGE>
except in cases where the interest rate is sufficient to compensate us for the
risk of retaining a long-term, fixed-rate loan in our portfolio. Most loans have
been sold to private purchasers with servicing released. In addition, we sell a
smaller amount of loans in the secondary market to the Federal Home Loan
Mortgage Corporation. We retain servicing on loans sold to the Federal Home Loan
Mortgage Corporation.
Loan Underwriting Policies. We have established written, non-
discriminatory underwriting standards and loan origination procedures. We
obtain detailed loan applications to determine the borrower's ability to repay,
and verify the more significant items on these applications through the use of
credit reports, financial statements and confirmations. Individual officers
have been granted authority by the board of directors to approve mortgage,
consumer and commercial loans up to varying specified dollar amounts, depending
upon the type of loan. A loan committee consisting of our President, Executive
Vice President, Chief Financial Officer, senior credit officer and head of
mortgage lending has authority to approve any loan in an amount exceeding
individual lending authorities where our total loans to that borrower would not
exceed $350,000. Our executive committee, which consists of the Chairman of the
Board, the President, two additional board members that serve on a permanent
basis and one board member selected on a rotating basis that serves for a three-
month period, has authority to approve any loan where our total loans to that
borrower would not exceed $1.0 million. Loans above that amount may not be made
unless approved by the full board of directors. These authorities are based on
aggregate borrowings of an individual or entity. On a monthly basis, the full
board of directors reviews the actions taken by the loan committee and the
executive committee.
Applications for single-family real estate loans are underwritten and
closed in accordance with the standards of Federal Home Loan Mortgage
Corporation. Generally, upon receipt of a loan application from a prospective
borrower, we order a credit report and verifications to verify specific
information relating to the loan applicant's employment, income and credit
standing. If a proposed loan is to be secured by a mortgage on real estate, we
usually obtain an appraisal of the real estate from an appraiser approved by us
and licensed by the State of North Carolina. Except when we become aware of a
particular risk of environmental contamination, we generally do not obtain a
formal environmental report on real estate at the time a loan is made.
Our policy is to record a lien on the real estate securing a loan and
to obtain title insurance which insures that the property is free of prior
encumbrances and other possible title defects. Borrowers must also obtain
hazard insurance policies prior to closing and, when the property is in a flood
plain as designated by the Department of Housing and Urban Development, pay
flood insurance policy premiums.
On single-family residential mortgage loans, we make a loan commitment
of between 30 and 60 days for each loan approved. If the borrower desires a
longer commitment, we may extend the commitment for good cause. We guarantee
the interest rate for the commitment period.
We are permitted to lend up to 95% of the lesser of the appraised
value or the purchase price of the real property securing a mortgage loan.
However, if the amount of a residential loan originated or refinanced exceeds
80% of the appraised value, our policy generally is to obtain private mortgage
insurance at the borrower's expense on that portion of the principal amount of
the loan that exceeds 80% of the appraised value of the property. We will make
a single-family residential mortgage loan with up to a 95% loan-to-value ratio
if the required private mortgage insurance is obtained. We generally limit the
loan-to-value ratio on commercial real estate mortgage loans to 80%, although
the loan-to-value ratio on commercial real estate loans in limited circumstances
has been as high as 85%. We limit the loan-to-value ratio on multi-family
residential real estate loans to 80%.
Under applicable law, with certain limited exceptions, loans and
extensions of credit by a savings institution to a person outstanding at one
time and not fully secured by collateral having a market value at least equal to
the amount of the loan or extension of credit shall not exceed 15% of net worth
plus the general loan loss reserve. Loans and extensions of credit fully
secured by readily marketable collateral may comprise an additional 10% of net
worth. Applicable law additionally authorizes savings institutions to make
loans to one borrower, for any purpose:
. in an amount not to exceed $500,000;
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<PAGE>
. in an amount not to exceed the lesser of $30,000,000 or 30% of net
worth to develop residential housing, provided (a) the purchase price
of each single-family dwelling in the development does not exceed
$500,000 and (b) the aggregate amount of loans made under this
authority does not exceed 150% of net worth; or
. loans to finance the sale of real property in satisfaction of debts
previously contracted in good faith, not to exceed 50% of net worth.
Under these limits, our loans to one borrower were limited to $4.4 million
at September 30, 1998. At that date, we had no lending relationships in excess
of the loans-to-one-borrower limit. At September 30, 1998, our ten largest
lending relationships ranged in size from $2.4 million to $4.3 million.
Single-Family Residential Real Estate Lending. We historically have been
and continue to be an originator of single-family, residential real estate loans
in our market area. At September 30, 1998, single-family, residential mortgage
loans, excluding home equity loans, totaled $100.9 million, or 48.8% of our
gross loan portfolio.
We originate fixed-rate mortgage loans at competitive interest rates. At
September 30, 1998, $68.8 million, or 33.3%, of our gross loan portfolio was
comprised of fixed-rate, single-family mortgage loans. Generally, in the
currently low interest rate environment, we have been retaining fixed-rate
mortgages with maturities of ten years or less while fixed-rate loans with
longer maturities are being sold in the secondary market.
We also offer adjustable-rate residential mortgage loans. The adjustable-
rate loans we currently offer have interest rates which adjust every one, three
or five years from the closing date of the loan or on an annual basis commencing
after an initial fixed-rate period of three or five years in accordance with a
designated index, plus a stipulated margin. The primary index we utilize is the
weekly average yield on U.S. Treasury securities adjusted to a constant
comparable maturity equal to the loan adjustment period, as made available by
the Federal Reserve Board (the "Treasury Rate"). The maximum adjustment on the
bulk of our loans is 2% per adjustment period with a maximum aggregate
adjustment of 6% over the life of the loan. We offer adjustable-rate mortgage
loans that provide for initial rates of interest slightly below the rates that
would prevail when the index used for repricing is applied, i.e., "teaser"
rates. All of our adjustable-rate loans require that any payment adjustment
resulting from a change in the interest rate of an adjustable-rate loan be
sufficient to result in full amortization of the loan by the end of the loan
term and, thus, do not permit any of the increased payment to be added to the
principal amount of the loan, or so-called negative amortization. At September
30, 1998, $32.1 million, or 31.8%, of our single-family residential mortgage
loans were adjustable-rate loans.
The retention of adjustable-rate loans in our portfolio helps reduce our
exposure to increases or decreases in prevailing market interest rates.
However, there are unquantifiable credit risks resulting from potential
increases in costs to borrowers in the event of upward repricing of adjustable-
rate loans. It is possible that during periods of rising interest rates, the
risk of default on adjustable-rate loans may increase due to increases in
interest costs to borrowers. Further, although adjustable-rate loans allow us
to increase the sensitivity of our interest-earning assets to changes in
interest rates, the extent of this interest sensitivity is limited by the
initial fixed-rate period before the first adjustment and the lifetime interest
rate adjustment limitations. Accordingly, yields on our adjustable-rate loans
may not fully adjust to compensate for increases in our cost of funds.
Commercial Real Estate Lending. Our commercial real estate loan portfolio
includes loans secured by small office buildings, commercial and industrial
buildings and small apartment buildings. These loans generally range in size
from $100,000 to $3.3 million. At September 30, 1998, our commercial real
estate loans totaled $38.8 million, which amounted to 18.8%, of our gross loan
portfolio. We originate commercial real estate loans for terms of up to 15
years and with interest rates that adjust daily based on our prime rate plus a
negotiated margin typically up to 1% or that carry predetermined rates fixed for
one, three or five years.
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<PAGE>
Commercial real estate lending entails significant additional risks as
compared with single-family residential property lending. Commercial real
estate loans typically involve larger loan balances to single borrowers or
groups of related borrowers. The payment experience on such loans typically is
dependent on the successful operation of the real estate project, retail
establishment, apartment building or business. These risks can be significantly
affected by supply and demand conditions in the market for office, retail and
residential space, and, as such, may be subject to a greater extent to adverse
conditions in the economy generally. To minimize these risks, we generally
originate loans secured by collateral located in our market area or to borrowers
with which we have prior experience or who are otherwise known to us. It has
been our policy to obtain annual financial statements of the business of the
borrower or the project for which commercial real estate loans are made. In
addition, in the case of commercial mortgage loans made to a partnership or a
corporation, we seek, whenever possible, to obtain personal guarantees and
annual financial statements of the principals of the partnership or corporation.
Home Equity Loans. At September 30, 1998, we had approximately $16.9
million in home equity line of credit loans, representing approximately 8.2% of
our gross loan portfolio. Our home equity lines of credit generally have
adjustable interest rates tied to our prime interest rate plus a margin,
although we currently are offering a program where the interest rate on home
equity loans will be fixed for one or two years. Home equity lines of credit
must be repaid in 15 years or less and require monthly interest payments. Home
equity lines of credit generally are secured by subordinate liens against
residential real property. We require that fire and extended coverage casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least sufficient to cover the loan. Home equity loans generally are limited so
that the amount of such loans, along with any senior indebtedness, does not
exceed 80% of the value of the real estate security.
Construction Lending. We offer residential and commercial construction
loans, with a significant portion of such loans originated to date being for the
construction of owner-occupied, single-family dwellings in our market area.
Residential construction loans are offered primarily to individuals building
their primary or secondary residence, as well as to selected local developers to
build single-family dwellings. In addition, on occasion, we make acquisition
and development loans to local developers to acquire and develop land for sale
to builders who will construct single-family residences. At September 30,
1998, $18.6 million, or 9.0%, of our gross loan portfolio consisted of
construction loans.
Generally, we originate loans to owner/occupants for the construction of
owner-occupied, single-family residential properties in connection with the
permanent loan on the property, and these loans have a construction term of six
to 12 months. Loans are offered on an adjustable-rate basis. Interest rates on
residential construction loans made to the owner/occupant have interest rates
during the construction period equal to our prime rate. Upon completion of
construction, the loan is converted into a one-year adjustable-rate loan, and
the owner may lock in a fixed-rate loan at any time during the one-year period.
We make construction loans to builders on either a pre-sold or speculative
basis. However, we limit the number of outstanding loans on unsold homes under
construction to individual builders, with the amount dependent on the financial
strength of the builder, the present exposure of the builder, the location of
the property and prior sales of homes in the development. At September 30,
1998, speculative construction loans amounted to $5.8 million. At September 30,
1998, the largest amount of construction loans outstanding to one builder was
$600,000, all of which was for speculative construction. Interest rates on
residential construction loans to builders are set at our prime rate plus a
margin typically up to 1% and adjust with changes in the prime rate, and are
made for terms of up to 24 months.
Interest rates on commercial construction loans are based on the prime rate
plus a negotiated margin typically up to 1%, and adjust with changes in our
prime rate, and are made for terms of up to 24 months, with construction terms
generally not exceeding 12 months.
We make acquisition and development loans at a rate that adjusts monthly,
based on our prime rate plus a negotiated margin, for terms of up to three
years. Interest only is paid during the term of the loan, and the principal
balance of the loan is paid down as developed lots are sold to builders. For
more information regarding the higher
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degree of credit risk of these types of loans, see "Risk Factors -- Risks
Related to Commercial and Consumer Lending." At September 30, 1998, we had eight
such loans outstanding totaling $4.1 million. All acquisition and development
loans were performing in accordance with their terms at such date.
Prior to making a commitment to fund a construction loan, we require an
appraisal of the property by appraisers approved by our board of directors. We
also review and inspect each project at the commencement of construction and
either weekly or biweekly during the term of the construction loan. We may
charge a construction fee and/or an inspection fee on construction loans.
Advances are made on a percentage of completed basis.
We consider construction financing generally to involve a higher degree of
risk of loss than long-term financing on improved, 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 and the estimated cost, including interest, of construction. During
the construction phase, a number of factors could result in delays and cost
overruns. If the estimate of construction costs proves to be inaccurate and the
borrower is unable to meet our requirements of putting up additional funds to
cover extra costs or change orders, then we will demand that the loan be paid
off and, if necessary, institute foreclosure proceedings or refinance the loan.
If the estimate of value proves to be inaccurate, the collateral may not have
sufficient value to assure full repayment. We have sought to minimize this
risk by limiting construction lending to borrowers based in Alamance County and
who satisfy all credit requirements and whose loans satisfy all other
underwriting standards which would apply to our permanent mortgage loan
financing for the subject property. On loans to builders, we work only with
selected builders with whom we have experience and carefully monitor the
creditworthiness of the builders.
Commercial Lending. We originate commercial loans to small and medium
sized businesses in our market area. Our commercial borrowers are generally
small businesses engaged in manufacturing, distribution or retailing, or
professionals in healthcare, accounting and law. Commercial loans generally are
made to finance the purchase of inventory, new or used equipment or commercial
vehicles and for short-term working capital. Such loans generally are secured
by equipment and inventory, and, if possible, cross-collateralized by a real
estate mortgage, although commercial loans are sometimes granted on an unsecured
basis. Commercial loans generally are made for terms of five years or less,
depending on the purpose of the loan and the collateral, with loans to finance
operating expenses made for one year or less, with interest rates that adjust at
least annually at a rate equal to our prime rate plus a margin typically up to
2%. Generally, we make commercial loans in amounts ranging between $50,000 and
$1.0 million. At September 30, 1998, commercial loans totaled $25.2 million, or
12.2% of our gross loan portfolio.
We underwrite commercial loans on the basis of the borrower's cash flow and
ability to service the debt from earnings rather than on the basis of underlying
collateral value, and we seek to structure such loans to have more than one
source of repayment. The borrower is required to provide us with sufficient
information to allow us to make our lending determination. In most instances,
this information consists of at least two years of financial statements, a
statement of projected cash flows, current financial information on any
guarantor and any additional information on the collateral. For loans with
maturities exceeding one year, we require that borrowers and guarantors provide
updated financial information at least annually throughout the term of the loan.
Our commercial loans may be structured as term loans or as lines of credit.
Commercial term loans are generally made to finance the purchase of assets and
have maturities of five years or less. Commercial lines of credit are typically
made for the purpose of providing working capital and are usually reviewed on an
annual basis but may be called on demand. We also offer standby letters of
credit for commercial borrowers. Standby letters of credit are written for a
maximum term of one year.
Commercial loans are often larger and may involve greater risk than other
types of lending. Because payments on commercial loans are often dependent on
successful operation of the business involved, repayment of such loans may be
subject to a greater extent to adverse conditions in the economy. We seek to
minimize these risks through our underwriting guidelines, which require that the
loan be supported by adequate cash flow of the borrower, profitability
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<PAGE>
of the business, collateral and personal guarantees of the individuals in the
business. In addition, we limit this type of lending to our market area and to
borrowers with which we have prior experience or who are otherwise well known to
us.
Consumer Lending. In recent years, we have gradually increased our
portfolio of consumer loans. Our consumer loans include automobile loans,
savings account loans, unsecured lines of credit and miscellaneous other
consumer loans, including unsecured loans. At September 30, 1998, our consumer
loans totaled $6.3 million, or 3.1% of our gross loan portfolio.
We generally underwrite automobile loans in amounts up to 80% of the lesser
of the purchase price of the automobile or, with respect to used automobiles,
the loan value as published by the National Automobile Dealers Association. The
terms of most such loans do not exceed 72 months. We require that the vehicles
be insured and that we be listed as loss payee on the insurance policy.
We make savings account loans for up to 90% of the depositor's savings
account balance. The interest rate is normally 2.5% above the annual percentage
yield paid on the savings account. The account must be pledged as collateral to
secure the loan. Interest generally is paid on a monthly basis.
Consumer lending affords us the opportunity to earn yields higher than
those obtainable on single-family residential lending. However, consumer loans
entail greater risk than do residential mortgage loans, particularly in the case
of loans which are unsecured, as is the case with lines of credit, or secured by
rapidly depreciable assets such as automobiles. Repossessed collateral for a
defaulted consumer loan may not provide an adequate source of repayment of the
outstanding loan balance as a result of the greater likelihood of damage, loss
or depreciation. The remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by events such as job loss,
divorce, illness or personal bankruptcy. Further, the application of various
state and federal laws, including federal and state bankruptcy and insolvency
law, may limit the amount which may be recovered. In underwriting consumer
loans, we consider the borrower's credit history, an analysis of the borrower's
income and ability to repay the loan, and the value of the collateral.
Loan Fees and Servicing. We receive fees in connection with late payments
and for miscellaneous services related to our loans and deposits. We also
charge fees in connection with loan originations. These fees can consist of
origination, discount, construction and/or commitment fees, depending on the
type of loan. We generally do not service loans for others except for mortgage
loans we originate and sell with servicing retained. Mortgage servicing rights
were not material for any of the periods presented.
Nonperforming Loans and Other Problem Assets. We continually monitor our
loan portfolio to anticipate and address potential and actual delinquencies.
When a borrower fails to make a payment on a loan, we take immediate steps to
have the delinquency cured and the loan restored to current status. Loans which
are delinquent more than 15 days incur a late fee of 4% of the monthly payment
of principal and interest due. As a matter of policy, we will contact the
borrower after the loan has been delinquent 15 days. If payment is not promptly
received, we contact the borrower again, and we try to formulate an affirmative
plan to cure the delinquency. Generally, after any loan is delinquent 45 days
or more, we send a default letter to the borrower. If the default is not cured
after 30 days, we commence formal legal proceedings to collect amounts owed.
Generally we charge off or reserve through an allowance account interest on
loans, including impaired loans, that are contractually ninety days or more past
due. The allowance is established by a charge to interest income equal to all
interest previously accrued. In certain circumstances, interest on loans that
are contractually ninety days or more past due is not charged off or reserved
through an allowance account when we believe that the loan is both well secured
and in the process of collection. If amounts are received on loans for which
the accrual of interest has been discontinued, we decide whether payments
received should be recorded as a reduction of the principal balance or as
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<PAGE>
interest income depending on our analysis of the collectibility of principal.
The loan is returned to accrual status when we believe the borrower has
demonstrated the ability to make periodic interest and principal payments on a
timely basis.
We classify real estate acquired as a result of foreclosure as real estate
acquired in settlement of loans until such time as it is sold and is recorded at
the lower of the estimated fair value of the underlying real estate or the
carrying amount of the loan. Subsequent costs directly related to development
and improvement of property are capitalized, whereas costs related to holding
property are expensed. We charge any required write-down of the loan to its
fair value less estimated selling costs upon foreclosure against the allowance
for loan losses. See Note 1 of Notes to Consolidated Financial Statements.
The following table sets forth information with respect to our
nonperforming assets at the dates indicated. At the dates shown, we had no
restructured loans within the meaning of Statement of Financial Accounting
Standards No. 114, as amended.
<TABLE>
<CAPTION>
At September 30,
---------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Loans accounted for on a nonaccrual basis (1)..... $ 263 $ 259 $ 288 $ 3,661 $ 99
======== ======== ======== ======== ========
Accruing loans which are contractually past due
90 days or more................................. $ -- $ -- $ -- $ -- $ --
======== ======== ======== ======== ========
Total nonperforming loans..................... $ 263 $ 259 $ 288 $ 3,661 $ 99
======== ======== ======== ======== ========
Total loans....................................... $200,010 $199,876 $176,345 $173,316 $155,962
======== ======== ======== ======== ========
Percentage of total loans......................... 0.13% 0.13 % 0.16% 2.11% 0.06%
======== ======== ======== ======== ========
Other non-performing assets (2)................... $ -- $ -- $ 1 $ 1 $ 3,202
======== ======== ======== ======== ========
Loans modified in troubled debt restructuring..... $ -- $ -- $ -- $ -- $ --
======== ======== ======== ======== ========
- --------------------
</TABLE>
(1) Payments received on a non-accrual loan are either applied to the
outstanding principal balance or recorded as interest income, depending on
management's assessment of the collectibility of the loan.
(2) Other non-performing assets consist of property acquired through
foreclosure or repossession.
During the years ended September 30, 1998, 1997 and 1996, gross interest
income of $10,000, $27,000 and $26,000, respectively, would have been recorded
on loans accounted for on a nonaccrual basis if the loans had been current
throughout the year. Interest on such loans included in income during the years
ended September 30, 1998, 1997 and 1996 amounted to $15,000, $16,000 and
$12,000, respectively.
At September 30, 1998 there were no loans which are not currently
classified as non-accrual, 90 days past due or restructured but where known
information about possible credit problems of borrowers causes management to
have serious concerns as to the ability of the borrowers to comply with present
loan repayment terms and may result in disclosure as nonaccrual, 90 days past
due or restructured. See " -- Classified Assets" for information regarding
classified assets.
At September 30, 1998, an analysis of our portfolio did not reveal any
impaired loans that needed to be classified under Statement of Financial
Accounting Standards No. 114.
At September 30, 1998, we had $263,000 of nonaccrual loans, which consisted
of four single-family mortgage loans. At September 30, 1998, we did not have
any real estate owned.
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Classified Assets. Regulations require that we classify our assets on a
regular basis. In addition, in connection with examinations of insured
institutions, examiners have authority to identify problem assets and if
appropriate, classify them in their reports of examination. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts,
conditions and values, questionable, and there is a high possibility of loss.
An asset classified loss is considered uncollectible and of such little value
that continuance as an asset of the institution is not warranted. Assets
classified as substandard or doubtful require a savings institution to establish
general allowances for loan losses. If an asset or portion thereof is
classified loss, a savings institution must either establish a specific
allowance for loss in the amount of the portion of the asset classified loss, or
charge off such amount. 1st State Bank regularly reviews its assets to
determine whether any assets require classification or re-classification. At
September 30, 1998, we had $1.0 million in classified assets consisting of
$990,000 in assets classified as substandard, $20,000 in assets classified as
doubtful and no assets classified as loss.
In addition to regulatory classifications, we also classify as special
mention or watch assets that are currently performing in accordance with their
contractual terms but may be classified or nonperforming assets in the future.
At September 30, 1998 we have identified approximately $11.5 million in assets
classified as special mention or watch. Included in this amount are three loans
with an aggregate outstanding balance of $3.5 million at September 30, 1998 to a
company affiliated with one of our directors. In addition to the outstanding
balance on the loans, the borrower has the ability to borrow an additional
$256,000 from us under lines of credit. All the loans are secured by a first
lien on all company assets, including accounts receivable, inventory, equipment,
furniture and real property occupied by the borrower. In addition, the director
has personally guaranteed repayment of the loans. At September 30, 1998, such
loans were current with respect to their payment terms and, except for the
waiver of certain debt covenants by 1st State Bank, were performing in
accordance with the related loan agreements. Based on an analysis of the
borrower's current financial statements, management has concerns that the
borrower may have difficulty in complying with the present loan repayment terms
on an ongoing basis.
Allowance for Loan Losses. Our policy is to establish reserves for
estimated losses on delinquent loans when we determine that losses are expected
to be incurred on such loans. We maintain the allowance for losses on loans at
a level we believe to be adequate to absorb potential losses in the portfolio.
Our determination of the adequacy of the allowance is based on an evaluation of
the portfolio, past loss experience, current economic conditions, volume, growth
and composition of the portfolio, and other relevant factors. The allowance is
increased by provisions for loan losses which are charged against income.
Although we believe we use the best information available to make
determinations with respect to the allowance for losses and believe such
allowances are adequate, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations. We anticipate that our allowance for
loan losses will increase in the future as we implement the board of directors'
strategy of continuing existing lines of business while gradually expanding
commercial and consumer lending, which loans generally entail greater risks than
single-family residential mortgage loans.
During 1998 we increased our provision for loan losses to account for the
shift in the mix in our loan portfolio and to provide for certain changes in the
economy. During 1997 and to a greater extent in 1998, we increased commercial
and consumer loans. At September 30, 1998 and 1997, commercial loans comprised
12.19% and 11.34%, respectively, of total loans, and consumer loans comprised
3.05% and 2.65%, respectively, of total loans. These loans carry a higher
inherent credit risk than single family residential mortgage loans.
Furthermore, we continued to originate asset-based loans, which are loans whose
repayment is based largely on the liquidation of assets such as inventory and
accounts receivable. These loans carry an even higher incremental risk of loss,
as their repayment is often dependent solely on the financial performance of the
payer of the receivable. At September 30, 1998 and 1997, we had $9.4 million
and $8.1 million, respectively, of loans we considered to be asset-based loans.
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In addition, changes in the economy during fiscal year 1998 have altered
the credit risk profile of some of our customers and as a result, we increased
our provision to reflect this additional credit risk. We believe that our
local economy may be nearing the end of a business cycle, which affects all of
our borrowers through a softening economy. We have been further affected by
this trend in that in recent years we have increased lending to smaller
businesses, churches and non-profit organizations, and we have increased the
origination of asset-based loans. We consider these borrowers to be more
vulnerable to changes in the economy than larger, more diversified companies
whose revenues are supported by customers in a variety of locations. The NAFTA
legislation passed by Congress also appears to be having a negative impact on
the textile industry of Alamance County, affecting or potentially affecting
borrowers in the textile industry and borrowers employed by local textile
companies. Finally, we believe increased consumer debt levels and rising
consumer bankruptcy rates nationally and in North Carolina have had a negative
effect on our consumer and mortgage loan portfolios during 1998. Collectively,
these factors prompted us to increase the allowance for loan losses during 1998.
Banking regulatory agencies, including the FDIC, have adopted a policy
statement regarding maintenance of an adequate allowance for loan and lease
losses and an effective loan review system. This policy includes an arithmetic
formula for checking the reasonableness of an institution's allowance for loan
loss estimate compared to the average loss experience of the industry as a
whole. Examiners will review an institution's allowance for loan losses and
compare it against the sum of:
. 50% of the portfolio that is classified doubtful;
. 15% of the portfolio that is classified as substandard; and
. for the portions of the portfolio that have not been classified (including
those loans designated as special mention), estimated credit losses over
the upcoming 12 months given the facts and circumstances as of the
evaluation date.
This amount is considered neither a "floor" nor a "safe harbor" of the
level of allowance for loan losses an institution should maintain, but examiners
will view a shortfall relative to the amount as an indication that they should
review management's policy on allocating these allowances to determine whether
it is reasonable based on all relevant factors.
We have our own allowance for loan loss model which is similar to the FDIC
model. Our model indicated that the allowance for loan losses was adequate at
September 30, 1998.
The following table sets forth an analysis of our allowance for loan losses
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period.............. $ 2,754 $ 2,496 $ 2,223 $ 1,767 $ 1,540
-------- -------- -------- --------- --------
Loans charged off........................... 4 7 13 5 17
-------- -------- -------- --------- --------
Recoveries.................................. 1 4 5 7 4
-------- -------- -------- --------- --------
Net loans charged off....................... 3 3 8 (2) 13
-------- -------- -------- --------- --------
Provision for loan losses................... 477 261 281 454 240
-------- -------- -------- --------- --------
Balance at end of period.................... $ 3,228 $ 2,754 $ 2,496 $ 2,223 $ 1,767
======== ======== ======== ========= ========
Average loans outstanding................... $199,203 $186,413 $171,148 $ 165,347 $150,722
======== ======== ======== ========= ========
Ratio of net loans charged off to average
loans outstanding during the period....... 0.0015% 0.0016% 0.0047% (0.0012)% 0.0086%
======== ======== ======== ========= ========
</TABLE>
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<PAGE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At September 30,
----------------------------------------
1998 1997
---------------- ------------------
Percent Percent
of of
Loans in Loans in
Category Category
to to
Total Total
Amount Loans Amount Loans
------ -------- ------ ---------
(Dollars in thousands)
Real estate mortgage:................ <C> <C> <C> <C>
Single-family residential.......... $ 400 48.84% $ 376 53.76%
Commercial......................... 898 18.76 854 17.02
Home equity........................ 319 8.17 318 8.99
Construction....................... 458 8.99 380 6.24
Commercial........................... 815 12.19 540 11.34
Consumer............................. 338 3.05 286 2.65
------ ----- ------ ------
Total allowance for loan
losses.......................... $3,228 100.00% $2,754 100.00%
====== ====== ====== ======
<CAPTION>
At September 30,
------------------------------------------------------------
1996 1995 1994
------------------ ---------------- ------------------
Percent Percent Percent
of of of
Loans in Loans in Loans in
Category Category Category
to to to
Total Total Total
Amount Loans Amount Loans Amount Loans
------- -------- ------ -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate mortgage:
Single-family residential.......... $ 387 55.70% $ 326 55.78% $ 277 57.51%
Commercial......................... 882 19.62 788 20.23 583 18.89
Home equity........................ 303 8.82 272 9.28 233 9.67
Construction....................... 232 4.36 235 4.01 173 3.58
Commercial........................... 450 9.44 374 8.52 294 8.13
Consumer............................. 242 2.06 228 2.18 207 2.22
------ ------ ------ ------ ------ ------
Total allowance for loan
losses.......................... $2,496 100.00% $2,223 100.00% $1,767 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
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Investment Activities
General. Interest income from investment securities generally
provides our second largest source of income after interest on loans. Our board
of directors has authorized investment in U.S. Government and agency securities,
state government obligations, municipal securities, obligations of the FHLB,
mortgage-backed securities issued by Federal National Mortgage Association, the
Government National Mortgage Association and Federal Home Loan Mortgage
Corporation and any other securities authorized by the North Carolina Savings
Bank Administrator as permissible investments. Our objective is to use these
investments to reduce interest rate risk, enhance yields on assets and provide
liquidity. At September 30, 1998, the amortized cost of our investment
securities portfolio amounted to $39.9 million, which included $34.1 million of
U.S. Government and agency securities, $1.7 million of mortgage-backed
securities and $108,000 of collateralized mortgage obligations ("CMO's"). In
addition, at September 30, 1998, we had a $4.0 million investment in two mutual
funds that invest in U.S. Government and agency securities and mortgage-backed
securities. At that date, we had an unrealized gain of $93,000, net of deferred
taxes, with respect to our investment securities classified as available for
sale.
The board of directors has established an investment policy that sets
forth investment and aggregate investment limitations and credit quality
parameters of each class of investment security. Securities purchases are
subject to the oversight of our Executive Committee. The President has
authority to make specific investment decisions within the parameters determined
by the board of directors.
Pursuant to Statement of Financial Accounting Standards No. 115, we
had securities with an aggregate cost of $9.7 million and an approximate fair
value of $9.9 million at September 30, 1998 as available for sale. The impact on
our financial statements was an after-tax increase in net worth of approximately
$93,000 as of September 30, 1998. The unrealized gains at September 30, 1998 in
our portfolio of investment securities and mortgage-backed securities were due
to decreases in interest rates after we bought the securities. Upon acquisition,
we classify securities as to our intent. Securities designated as "held to
maturity" are those assets which we have the ability and intent to hold to
maturity. The held to maturity investment portfolio is not used for speculative
purposes and is carried at amortized cost. Securities designated as "available
for sale" are those assets which we may not hold to maturity and thus are
carried at fair value with unrealized gains or losses, net of tax effect,
recognized in net worth.
We periodically evaluate investment securities for other than
temporary declines in value and record any losses through an adjustment to
earnings. During the year ended September 30, 1998, we recognized a loss of
approximately $269,000 on the write-down of marketable equity securities for an
other than temporary decline in value.
At September 30, 1998, we had $4.0 million of U.S. Government and
agency securities classified as available for sale, which carry unrealized
after-tax gains of $26,000, and $30.1 million of U.S. Government and agency
securities classified as held to maturity. We attempt to maintain a high degree
of liquidity in our investment securities portfolio by choosing those that are
readily marketable. As of September 30, 1998, the estimated weighted average
life of our U.S. Government and agency securities was approximately 4 years, and
the average yield on our portfolio of U.S. Government and agency securities was
6.22%. In addition, at September 30, 1998, we had $1.3 million of FHLB of
Atlanta stock.
Mortgage-Backed and Related Securities. Included in our portfolio of
investment securities are mortgage-backed and mortgage-related securities.
Mortgage-backed securities represent a participation interest in a pool of
single-family or multi-family mortgages, the principal and interest payments on
which are passed from the mortgage originators through intermediaries that pool
and repackage the participation interest in the form of securities to investors.
Such intermediaries may include quasi-governmental agencies such as Federal Home
Loan Mortgage Corporation, Federal National Mortgage Association and Government
National Mortgage Association which guarantee the payment of principal and
interest to investors. Mortgage-backed securities generally increase the quality
of our assets by virtue of the guarantees that back them, are more liquid than
individual mortgage loans and may be used to collateralize borrowings or other
obligations.
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The Federal Home Loan Mortgage Corporation is a public corporation
chartered by the U.S. Government and owned by the 12 FHLBs and federally insured
savings institutions. The Federal Home Loan Mortgage Corporation issues
participation certificates backed principally by conventional mortgage loans.
The Federal Home Loan Mortgage Corporation guarantees the timely payment of
interest and the ultimate return of principal on participation certificates. The
Federal National Mortgage Association is a private corporation chartered by the
U.S. Congress with a mandate to establish a secondary market for mortgage loans.
The Federal National Mortgage Association guarantees the timely payment of
principal and interest on Federal National Mortgage Association securities.
Federal Home Loan Mortgage Corporation and The Federal National Mortgage
Association securities are not backed by the full faith and credit of the United
States, but because the Federal Home Loan Mortgage Corporation and the Federal
National Mortgage Association are U.S. Government-sponsored enterprises, these
securities are considered to be among the highest quality investments with
minimal credit risks.
The Government National Mortgage Association is a government agency
within the Department of Housing and Urban Development which is intended to help
finance government-assisted housing programs. Government National Mortgage
Association securities are backed by FHA-insured and VA-guaranteed loans, and
the timely payment of principal and interest on Government National Mortgage
Association securities is guaranteed by the Government National Mortgage
Association and backed by the full faith and credit of the U.S. Government.
Because the Federal Home Loan Mortgage Corporation, the Federal
National Mortgage Association and the Government National Mortgage Association
were established to provide support for low- and middle-income housing, there
are limits to the maximum size of loans that qualify for these programs. The
limit for Federal National Mortgage Association and Federal Home Loan Mortgage
Corporation currently is $227,150.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and having varying maturities. The
underlying pool of mortgages can be composed of either fixed-rate or adjustable-
rate loans. As a result, the risk characteristics of the underlying pool of
mortgages, whether fixed-rate or adjustable-rate, as well as prepayment risk,
are passed on to the certificate holder. The life of a mortgage-backed pass-
through security thus approximates the life of the underlying mortgages.
Mortgage-backed securities generally yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which offer nominal credit risk. In addition, mortgage-backed
securities are more liquid than individual mortgage loans and may be used to
collateralize borrowings in the event that we determined to utilize borrowings
as a source of funds. Mortgage-backed securities issued or guaranteed by the
Federal National Mortgage Association or the Federal Home Loan Mortgage
Corporation generally are weighted at no more than 20% for risk-based capital
purposes, compared to a weight of 50% to 100% for residential loans. See
"Regulation -- Depository Institution Regulation -- Capital Requirements" as to
how we assign a risk weight to assets under the risk-based capital
regulations.
Our mortgage-backed and related securities portfolio consists
primarily of seasoned fixed-rate and adjustable-rate, mortgage-backed and
related securities. We make these investments in order to manage cash flow,
diversify assets, obtain yield and to satisfy certain requirements for favorable
tax treatment.
At September 30, 1998, the weighted average contractual maturity of
our mortgage-backed securities, all of which carried fixed rates, was
approximately 5 years. The actual maturity of a mortgage-backed security
varies, depending on when the mortgagors prepay or repay the underlying
mortgages. Prepayments of the underlying mortgages may shorten the life of the
investment, thereby adversely affecting its yield to maturity and the related
market value of the mortgage-backed security. The yield is based upon the
interest income and the amortization of the premium or accretion of the discount
related to the mortgage-backed security. Premiums and discounts on mortgage-
backed securities are amortized or accreted over the estimated term of the
securities using a level yield method. The prepayment assumptions used to
determine the amortization period for premiums and discounts can significantly
affect the yield of the mortgage-backed security, and we review these
assumptions periodically to reflect the actual prepayment. The actual
prepayments of the underlying mortgages depend on many factors, including the
type of mortgage, the coupon rate, the age of the mortgages, the geographical
location of the underlying real estate collateralizing the mortgages and general
levels of market interest rates. The difference between the interest rates on
the underlying mortgages and the prevailing mortgage interest rates is an
important determinant in the rate of prepayments. During periods of falling
mortgage interest
75
<PAGE>
rates, prepayments generally increase, and, conversely, during periods of rising
mortgage interest rates, prepayments generally decrease. If the coupon rate of
the underlying mortgage significantly exceeds the prevailing market interest
rates offered for mortgage loans, refinancing generally increases and
accelerates the prepayment of the underlying mortgages.
At September 30, 1998, mortgage-backed securities with an amortized
cost of $1.7 million and a carrying value of $1.8 million were held as available
for sale. No mortgage-backed securities were classified as held to maturity.
Mortgage-backed securities classified as available for sale are carried at fair
value. Unrealized gains and losses on available for sale mortgage-backed
securities are recognized as direct increases or decreases in net worth, net of
applicable income taxes. See Notes 1 and 2 of the Notes to Consolidated
Financial Statements for a description of our accounting policies. At September
30, 1998, our mortgage-backed securities had a weighted average yield of 8.20%.
Mortgage-related securities, which include CMOs, are typically issued
by a special purpose entity, which may be organized in a variety of legal forms,
such as a trust, a corporation or a partnership. The entity aggregates pools of
pass-through securities, which are used to collateralize the mortgage-related
securities. Once combined, the cash flows can be divided into "tranches" or
"classes" of individual securities, thereby creating more predictable average
lives for each security than the underlying pass-through pools. Accordingly,
under this security structure, all principal paydowns from the various mortgage
pools are allocated to a mortgage-related securities' class or classes
structured to have priority until it has been paid off. These securities
generally have fixed interest rates, and, as a result, changes in interest rates
generally would affect the market value and possibly the prepayment rates of
such securities.
Some mortgage-related securities instruments are like traditional debt
instruments due to their stated principal amounts and traditionally defined
interest rate terms. Purchasers of certain other mortgage-related securities
instruments are entitled to the excess, if any, of the issuer's cash flows.
These mortgage-related securities instruments may include instruments designated
as residual interest and are riskier in that they could result in the loss of a
portion of the original investment. Cash flows from residual interests are very
sensitive to prepayments and, thus, contain a high degree of interest rate risk.
We do not purchase residual interests in mortgage-related securities.
At September 30, 1998, we had within our investment securities
portfolio CMOs with an amortized cost of $108,000, representing less than .1% of
total assets. Our CMOs had a weighted average yield of 6.57% at September 30,
1998.
The following table sets forth the carrying value of our investment
securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
---------------------------
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Securities available for sale:
U.S. government and agency securities.... $ 4,043 $ 4,012 $ 7,938
Federal Home Loan Mortgage Corporation... 662 1,564 2,131
Government National Mortgage Association. 1,147 1,754 1,981
Federal National Mortgage Association.... -- 29 58
Marketable equity securities (1)......... 4,006 3,961 3,916
------- ------- -------
Total................................ $ 9,858 $11,320 $16,024
======= ======= =======
Securities held to maturity:
U.S. government and agency securities... $30,087 $23,338 $21,317
CMOs.................................... 108 144 368
------- ------- -------
Total................................ $30,195 $23,482 $21,685
======= ======= =======
- -----------
</TABLE>
(1) Consists of an investment in two mutual funds.
76
<PAGE>
The following table sets forth the scheduled maturities, carrying
values, amortized cost and average yields for our investment securities and
mortgage-backed securities portfolio at September 30, 1998.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years
------------------- ------------------- -------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities available for
sale:
U.S. government and agency
securities............. $ -- --% $ 3,043 6.25% $1,000 6.23%
Mortgage-backed securities -- -- -- -- 251 7.81
Marketable equity
securities (1)........... -- -- 2,013 4.79 1,993 6.49
------ ------- ------
Total.................. $ -- -- $ 5,056 5.67 $3,244 6.51
====== ======= ======
Securities held to maturity:
U.S. government and agency
securities............. $3,992 6.13% $15,471 6.18% $9,624 6.22%
CMOs...................... -- -- -- -- -- --
------ ------- ------
Total................ $3,992 6.13 $15,471 6.18 $9,624 6.22
====== ======= ======
</TABLE>
<TABLE>
<CAPTION>
More than Ten Years Total Investment Portfolio
------------------- -----------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- -------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Securities available for
sale:
U.S. government and agency
securities............. $ -- --% $ 4,043 $ 4,043 6.25%
Mortgage-backed securities 1,558 8.26 1,809 1,809 8.20
Marketable equity
securities (1)........... -- -- 4,006 4,006 5.64
------ ------- -------
Total.................. $1,558 8.26 $ 9,858 $ 9,858 6.34
====== ======= =======
Securities held to maturity:
U.S. government and agency
securities............. $1,000 7.00% $30,087 $30,307 6.22%
CMOs...................... 108 6.57 108 108 6.57
------ ------- -------
Total................ $1,108 6.96 $30,195 $30,415 6.22
====== ======= =======
</TABLE>
_________
(1) Consists of an investment in two mutual funds.
77
<PAGE>
Deposit Activity and Other Sources of Funds
General. Deposits are our primary source of funds for lending,
investment activities and general operational purposes. In addition to
deposits, we derive funds from loan principal and interest repayments,
maturities of investment securities and interest payments thereon. Although
loan repayments are a relatively stable source of funds, deposit inflows and
outflows are significantly influenced by general interest rates and money market
conditions. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of funds, or on a longer term basis for general
operational purposes. We have access to FHLB of Atlanta advances. Following
the conversion, we will continue to have access to FHLB of Atlanta advances.
Deposits. We attract deposits principally from within Alamance County
by offering a variety of deposit instruments, including checking accounts, money
market accounts, passbook and statement savings accounts, Individual Retirement
Accounts, and certificates of deposit which range in maturity from seven days to
five years. Deposit terms vary according to the minimum balance required, the
length of time the funds must remain on deposit and the interest rate.
Maturities, terms, service fees and withdrawal penalties for our deposit
accounts are established by us on a periodic basis. We review our deposit
pricing on a weekly basis. In determining the characteristics of our deposit
accounts, we consider the rates offered by competing institutions, lending and
liquidity requirements, growth goals and applicable regulations. We believe we
price our deposits comparably to rates offered by our competitors. We do not
accept brokered deposits.
We compete for deposits with other institutions in our market area by
offering competitively priced deposit instruments that are tailored to the needs
of our customers. Additionally, we seek to meet customers' needs by providing
convenient customer service to the community, efficient staff and convenient
hours of service. Substantially all of our depositors are North Carolina
residents. To provide additional convenience, we participate in the HONOR and
CIRRUS Automatic Teller Machine networks at locations throughout the world,
through which customers can gain access to their accounts at any time. To
better serve our customers, we have installed automatic teller machines at five
office locations.
78
<PAGE>
Our savings deposits at September 30, 1998 consisted of the various
types of savings programs described below.
<TABLE>
<CAPTION>
Weighted
<S> <C> <C> <C> <C> <C>
Average
Interest Minimum Minimum Balance (in Percentage of
Rate Term Category Amount Thousands) Total Deposits
- ----------- ------------- ------------------------------------------- -------- ----------- --------------
-- None Non-interest-bearing checking accounts $ 100 $ 8,624 3.66%
2.29% None NOW accounts 300 25,080 10.64
2.84 None Savings Accounts 100 28,091 11.92
3.93 None Money Market Accounts 1,000 13,238 5.62
Certificates of Deposit
------------------------
4.26 3 months Fixed-term, fixed-rate 500 231 0.10
4.95 6 months Fixed-term, fixed-rate 500 7,098 3.01
4.94 7 months (1) Fixed-term, fixed-rate 5,000 44,862 19.04
5.23 9 months Fixed-term, fixed-rate 500 2,123 0.90
5.00 10 months Fixed-term, fixed-rate 5,000 4,910 2.08
5.35 12 months Fixed-term, fixed-rate 500 41,125 17.45
5.27 18 months Floating rate individual retirement account 50 1,089 0.46
5.49 18 months Fixed-term, fixed-rate 500 2,355 1.00
4.74 20 months Fixed-term, fixed-rate 500 33 0.01
5.41 24 months Fixed-term, fixed-rate 500 9,884 4.19
5.75 30 months Fixed-term, fixed-rate 500 17,610 7.47
5.45 36 months Fixed-term, fixed-rate 500 4,028 1.71
5.52 48 months Fixed-term, fixed-rate 500 4,553 1.93
5.58 60 months Fixed-term, fixed-rate 500 17,856 7.58
5.14 7 to 365 days Fixed-term, fixed-rate 100,000 2,904 1.23
-------- ------
$235,694 100.00%
======== ======
- --------------------
</TABLE>
(1) These certificates of deposit do not carry a penalty for early withdrawal.
As a result, we believe that should interest rates increase materially
after September 30, 1998, borrowers may withdraw funds invested in these
certificates prior to maturity, causing our cost of funds to increase.
79
<PAGE>
The following table sets forth the distribution of our deposit accounts at
the dates indicated and the change in dollar amount of deposits in the various
types of accounts we offer between the dates indicated.
<TABLE>
<CAPTION>
Balance at Balance at Balance at
September 30, % of Increase September 30, % of Increase September 30, % of
1998 Deposits (Decrease) 1997 Deposits (Decrease) 1996 Deposits
----------- --------- ---------- ----------- --------- ---------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand..... $ 8,624 3.66% $2,078 $ 6,546 2.85% $ 3,438 $ 3,108 1.48%
Interest-bearing checking...... 25,080 10.64 930 24,150 10.53 2,287 21,863 10.43
Money market accounts.......... 13,238 5.62 2,120 11,118 4.85 2,006 9,112 4.35
Passbook and savings........... 28,091 11.92 391 27,700 12.08 (764) 28,464 13.57
Certificates of deposit........ 160,661 68.16 834 159,827 69.69 12,667 147,160 70.17
-------- ------ ------ -------- ------ ------- -------- ------
$235,694 100.00% $6,353 $229,341 100.00% $19,634 $209,707 100.00%
======== ====== ====== ======== ====== ======= ======== ======
</TABLE>
80
<PAGE>
The following table sets forth the average balances and average
interest rates based on daily balances for various types of deposits at the
dates indicated for each category of deposits presented.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------
1998 1997 1996
------------------- ------------------ ------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand... $ 6,417 -- % $ 4,972 -- % $ 3,056 -- %
Interest-bearing checking.... 24,987 2.21 23,975 2.23 21,187 2.19
Money market accounts........ 12,277 3.82 10,638 3.42 9,883 3.10
Passbook and savings......... 28,017 2.85 28,650 2.85 29,051 2.85
Certificates of deposit...... 159,053 5.36 152,231 5.27 142,655 5.50
-------- -------- --------
Total.................... $230,751 4.48 $220,466 4.42 $205,832 4.59
======== ======== ========
</TABLE>
The following table sets forth our time deposits classified by rates
at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
-------------------------------
1998 1997 1996
--------- -------- --------
(In thousands)
<S> <C> <C> <C>
2 - 3.99%... $ -- $ 220 $ 294
4 - 5.99%... 149,064 147,667 129,549
6 - 7.99%... 11,496 11,843 17,228
8 - 9.99%... 101 97 89
-------- -------- --------
$160,661 $159,827 $147,160
======== ======== ========
</TABLE>
The following table sets forth the amount and maturities of our time
deposits at September 30, 1998.
<TABLE>
<CAPTION>
Amount Due
--------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
- ---- --------- --------- --------- ------- -----
(In thousands)
<S> <C> <C> <C> <C> <C>
4.00 - 5.99%....................... $108,512 $22,193 $10,390 $ 7,969 $149,064
6.00 - 7.99%....................... 8,016 3,020 253 207 11,496
8.00 - 9.99%....................... -- -- -- 101 101
-------- ------- ------- -------- --------
$116,528 $25,213 $10,643 $ 8,277 $160,661
======== ======== ======= ======== ========
</TABLE>
80
<PAGE>
The following table indicates the amount of our certificates of
deposit of $100,000 or more by time remaining until maturity as of September 30,
1998. At that date, such deposits represented 12.6% of total deposits and had a
weighted average rate of 5.41%.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- --------------
(In thousands)
<S> <C>
Three months or less............ $ 9,937
Over three through six months... 6,050
Over six through 12 months...... 9,276
Over 12 months.................. 4,437
-------
Total......................... $29,700
=======
</TABLE>
We estimate that more than $29 million of certificates of deposit in
amounts of $100,000 or more maturing within one year of September 30, 1998 were
held by our retail and commercial customers, while the remainder of such
deposits were from schools, municipalities and other public entities and were
obtained through competitive rate bidding. We believe certificates of deposits
held by our retail and commercial customers are more likely to be renewed upon
maturity than certificates of deposit obtained through competitive bidding.
The following table sets forth our savings activities for the periods
indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------
1998 1997 1996
-------- ------- ------
(In thousands)
<S> <C> <C> <C>
Net increase (decrease) before interest credited... $(3,026) $10,693 $ 163
Interest credited.................................. 9,379 8,941 8,775
------- ------- ------
Net increase in deposits....................... $ 6,353 $19,634 $8,938
======= ======= ======
</TABLE>
In the unlikely event 1st State Bank is liquidated after the
conversion, depositors will be entitled to full payment of their deposit
accounts prior to any payment being made to the sole stockholder of 1st State
Bank, which is 1st State Bancorp.
Borrowings. Savings deposits historically have been the primary
source of funds for our lending, investments and general operating activities.
We are authorized, however, to use advances from the FHLB of Atlanta to
supplement our supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB of Atlanta functions as a central reserve bank providing
credit for savings institutions and certain other member financial institutions.
As a member of the FHLB System, we are required to own stock in the FHLB of
Atlanta and are authorized to apply for advances. Advances are obtained
pursuant to several different programs, each of which has its own interest rate
and range of maturities. We have a Blanket Agreement for advances with the FHLB
under which we may borrow up to 25% of assets subject to normal collateral and
underwriting requirements. Advances from the FHLB of Atlanta are secured by our
stock in the FHLB of Atlanta and other eligible assets. We will remain as a
member of the FHLB system following the conversion.
In February 1998, we obtained $20.0 million in fixed-rate FHLB of
Atlanta advances. These advances were structured with maturities estimated to
coincide with the expected repricing of $20.0 million of loans. Through this
strategy, we were able to establish a positive interest rate spread on the $20.0
million of assets and FHLB of Atlanta
82
<PAGE>
advances. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Asset/Liability Management" for a more complete
discussion of this strategy.
The following table sets forth certain information regarding our
short-term borrowings at the dates and for the periods indicated:
<TABLE>
<CAPTION>
At or For the
Year Ended September 30,
-----------------------------------
1998 1997 1996
-------- -------------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Amounts outstanding at end of period:
FHLB advances.......................... $20,000 $1,000 $1,000
Weighted average rate paid on:
FHLB advances.......................... 5.39% 5.57% 5.48%
<CAPTION>
For the Year
Ended September 30,
----------------------------------------
1998 1997 1996
---------- ----------- -----------
(In thousands)
<S> <C> <C> <C>
Maximum amount of borrowings outstanding
at any month end:
FHLB advances........................... $21,000 $1,000 $2,000
<CAPTION>
For the Year
Ended September 30,
---------------------------------
1998 1997 1996
--------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C>
Average amounts outstanding:
FHLB advances.................................. $13,559 $1,000 $ 156
Approximate weighted average rate paid on: (1)
FHLB advances.................................. 5.46% 5.60% 1.92%
- -------------------------
</TABLE>
(1) Based on month-end balances.
Subsidiary Activities
In prior years, we had one subsidiary, First Capital Services, Inc., a
North Carolina corporation ("First Capital"), that engaged in sales of
annuities, mutual funds and insurance products on an agency basis. In September
1997, that corporation transferred its assets and liabilities to a newly formed
North Carolina limited liability company, First Capital Services Company, LLC
(the "LLC"), and the corporation was dissolved. 1st State Bank is the sole
member of the LLC, and since the transfer of assets and liabilities, the LLC has
conducted the activities previously conducted by First Capital. We earned
$262,000 and $232,000 on a pre-tax basis from the activities of the LLC and
First Capital during the years ended September 30, 1998 and 1997, respectively.
Competition
We face strong competition in originating real estate, commercial
business and consumer loans and in attracting deposits. We compete for real
estate and other loans principally on the basis of interest rates, the types of
loans we originate, the deposit products we offer and the quality of services we
provide to our customers. We also compete by offering products which are
tailored to the local community. Our competition in originating real estate
loans comes primarily from other savings institutions, commercial banks,
mortgage bankers and mortgage brokers. Commercial
83
<PAGE>
banks, credit unions and finance companies provide vigorous competition in
consumer lending. Competition may increase as a result of the continuing
reduction of restrictions on the interstate operations of financial
institutions.
We attract our deposits through our branch offices primarily from the
local communities. Consequently, competition for deposits is principally from
other savings institutions, commercial banks, credit unions and brokers in our
primary market area. We compete for deposits and loans by offering what we
believe to be a variety of deposit accounts at competitive rates, convenient
business hours, a commitment to outstanding customer service and a well-trained
staff. We believe we have developed strong relationships with local realtors
and the community in general.
We consider our primary market area for gathering deposits and
originating loans to be Alamance County in north central North Carolina, which
is the county in which our offices are located. Based on data provided by a
private marketing firm, we estimate that at June 30, 1997, we had 15.2% of
deposits held by all banks and savings institutions in our market area.
Offices and Other Material Properties
The following table sets forth the location and certain additional
information regarding our offices at September 30, 1998.
<TABLE>
<CAPTION>
Book Value at Deposits at
Year Owned or September 30, Approximate September 30,
Opened Leased 1998 (1) Square Footage 1998
------ ------- --------------- -------------- ------------
(Dollars in thousands)
Main Office:
<S> <C> <C> <C> <C> <C>
445 S. Main Street 1988 Owned $3,839 33,700 $101,149
Burlington, NC 27215
Branch Offices:
2294 N. Church Street 1984 Leased (2) 277 2,600 24,520
Burlington, NC 27215
503 Huffman Mill Road 1982 Owned 348 2,600 42,614
Burlington, NC 27215
102 S. 5th Street 1973 Owned 55 2,000 22,573
Mebane, NC 27302
221 N. Main Street 1974 Owned 110 2,700 32,226
Graham, NC 27253
3466 S. Church Street 1996 Owned 1,451 4,000 12,612
Burlington, NC 27215
</TABLE>
__________
(1) Land and building only.
(2) Land is leased. Lease expires on July 5, 2009, with options to extend for
three five-year periods.
The book value of our investment in premises and equipment was $7.5 million
at September 30, 1998. See Note 6 of Notes to Consolidated Financial Statements
elsewhere in this document.
Employees
As of September 30, 1998, we had 68 full-time and 11 part-time employees,
none of whom were represented by a collective bargaining agreement. We believe
that our relationship with our employees is good.
84
<PAGE>
Legal Proceedings
From time to time, we are a party to various legal proceedings incident to
its business. There currently are no legal proceedings to which we are a party,
or to which any of our property was subject, which were expected to result in a
material loss. There are no pending regulatory proceedings to which we are a
party or to which any of our properties is subject which are expected to result
in a material loss.
REGULATION
Depository Institution Regulation
General. We are a North Carolina-chartered savings bank and a member of
the FHLB of Atlanta and our deposits are insured by the FDIC through the Savings
Association Insurance Fund of the FDIC. As a North Carolina savings bank, we are
subject to regulation and supervision by the North Carolina Savings Bank
Administrator and the FDIC and to North Carolina and FDIC regulations governing
such matters as capital standards, mergers, establishment of branch offices,
subsidiary investments and activities and general investment authority. The
North Carolina Savings Bank Administrator and the FDIC periodically examine us
for compliance with various regulatory requirements and for safe and sound
operations. The FDIC also has the authority to conduct special examinations of
us because our deposits are insured by the Savings Association Insurance Fund of
the FDIC. We must file reports with the North Carolina Savings Bank
Administrator describing our activities and financial condition and must obtain
the approval from the Savings Association Insurance Fund of the FDIC
Administrator and the FDIC prior to entering into certain transactions, such as
mergers with, or acquisitions of, other depository institutions.
After the conversion, 1st State Bank will be a North Carolina commercial
bank, and our deposit accounts will continue to be insured by the Savings
Association Insurance Fund of the FDIC. 1st State Bank will be subject to
supervision, examination and regulation by the Commission, rather than the North
Carolina Savings Bank Administrator, and the FDIC and to North Carolina and
federal statutory and regulatory provisions governing such matters as capital
standards, mergers, subsidiary investments and establishment of branch offices,
and will remain subject to the FDIC's authority to conduct special examinations.
1st State Bank will be required to file reports with the Commission and the FDIC
concerning its activities and financial condition and will be required to obtain
regulatory approvals prior to entering into certain transactions, including
mergers with, or acquisitions of, other depository institutions.
As a federally insured depository institution, we are and 1st State Bank
will be, subject to various regulations promulgated by the Federal Reserve
Board, including Regulation B (Equal Credit Opportunity), Regulation D (Reserve
Requirements), Regulations E (Electronic Fund Transfers), Regulation Z (Truth in
Lending), Regulation CC (Availability of Funds and Collection of Checks) and
Regulation DD (Truth in Savings).
The system of regulation and supervision applicable to us establishes a
comprehensive framework for our operations and is intended primarily for the
protection of the FDIC and our depositors. Changes in the regulatory framework
could have a material effect on us and our respective operations that in turn,
could have a material effect on 1st State Bancorp.
Proposed Legislative and Regulatory Changes. On May 13, 1998, the U.S.
House of Representatives passed H.R. 10 (the "Act"), the Financial Services
Competition Act of 1998, "which calls for a sweeping modernization of the
banking system that would permit affiliations between commercial banks,
securities firms, insurance companies and, subject to certain limitations, other
commercial enterprises. The stated purposes of the Act are to enhance consumer
choice in the financial services marketplace, level the playing field among
providers of financial services and increase competition. H.R. 10 removed the
restrictions contained in the Glass-Steagall Act of 1933 and 1st State Bank
Holding Company Act of 1956, thereby allowing qualified financial holding
companies to control banks, securities firms, insurance companies, and other
financial firms. Conversely, securities firms, insurance companies and
financial firms would be allowed to own or affiliate with a commercial bank.
Under the new framework, the Federal Reserve would serve as an umbrella
regulator to oversee the new financial holding company structure. Securities
affiliates would be
85
<PAGE>
required to comply with all applicable federal securities laws, including
registration and other requirements applicable to broker-dealers. The Act also
provided that insurance affiliates be subject to applicable state insurance
regulations and supervision. The Act preserved the thrift charter and all
existing thrift powers, but restricted the activities of new unitary thrift
holding companies.
At the adjournment of Congress in October 1998, the Senate had not voted on
the legislation and the Act had been returned to the Senate Banking Committee
for further review A bill similar to the Act was introduced for consideration
by Congress in 1999. At this time, we do not know whether the Act will be
enacted, or if enacted, what form the final version of such legislation might
take.
Capital Requirements. The Federal Reserve Board and the FDIC have
established guidelines with respect to the maintenance of appropriate levels of
capital by bank holding companies with consolidated assets of $150 million or
more and state non-member banks, respectively. The regulations impose two sets
of capital adequacy requirements: minimum leverage rules, which require bank
holding companies and state non-member banks to maintain a specified minimum
ratio of capital to total assets, and risk-based capital rules, which require
the maintenance of specified minimum ratios of capital to "risk-weighted"
assets. The regulations of the FDIC and the Federal Reserve Board require bank
holding companies and state non-member banks, respectively, to maintain a
minimum leverage ratio of "Tier 1 capital" to total assets of 3%. Tier 1
capital is the sum of common stockholders' equity, certain perpetual preferred
stock, which must be noncumulative with respect to banks, including any related
surplus, and minority interests in consolidated subsidiaries; minus all
intangible assets other than certain purchased mortgage servicing rights and
purchased credit card receivables, identified losses and investments in certain
subsidiaries. As a Savings Association Insurance Fund of the FDIC-insured,
state-chartered bank, we must also deduct from Tier 1 capital an amount equal to
our investments in, and extensions of credit to, subsidiaries engaged in
activities that are not permissible for national banks, other than debt and
equity investments in subsidiaries engaged in activities undertaken as agent for
customers or in mortgage banking activities or in subsidiary depository
institutions or their holding companies. Although setting a minimum 3% leverage
ratio, the capital regulations state that only the strongest bank holding
companies and banks, with composite examination ratings of 1 under the rating
system used by the federal bank regulators, would be permitted to operate at or
near such minimum level of capital. All other bank holding companies and banks
are expected to maintain a leverage ratio of at least 1% to 2% above the minimum
ratio, depending on the assessment of an individual organization's capital
adequacy by its primary regulator. Any bank or bank holding companies
experiencing or anticipating significant growth would be expected to maintain
capital well above the minimum levels. In addition, the Federal Reserve Board
has indicated that whenever appropriate, and in particular when a bank holding
company is undertaking expansion, seeking to engage in new activities or
otherwise facing unusual or abnormal risks, it will consider, on a case-by-case
basis, the level of an organization's ratio of tangible Tier 1 capital to total
assets in making an overall assessment of capital.
In addition to the leverage ratio, the regulations of the Federal Reserve
Board and the FDIC require bank holding companies and state-chartered nonmember
banks to maintain a minimum ratio of qualifying total capital to risk-weighted
assets of at least 8% of which at least 4% must be Tier 1 capital. Qualifying
total capital consists of Tier 1 capital plus Tier 2 or "supplementary" capital
items which include allowances for loan losses in an amount of up to 1.25% of
risk-weighted assets, cumulative preferred stock and preferred stock with a
maturity of 20 years or more, certain other capital instruments and net
unrealized gains on equity securities. The includible amount of Tier 2 capital
cannot exceed the institution's Tier 1 capital. Qualifying total capital is
further reduced by the amount of the bank's investments in banking and finance
subsidiaries that are not consolidated for regulatory capital purposes,
reciprocal cross-holdings of capital securities issued by other banks and
certain other deductions. The risk-based capital regulations assign balance
sheet assets and the credit equivalent amounts of certain off-balance sheet
items to one of four broad risk weight categories. The aggregate dollar amount
of each category is multiplied by the risk weight assigned to that category
based principally on the degree of credit risk associated with the obligor. The
sum of these weighted values equals the bank holding company or the bank's risk-
weighted assets.
The federal bank regulators, including the Federal Reserve Board and the
FDIC, have revised their risk-based capital requirements to ensure that such
requirements provide for explicit consideration of interest rate risk. Under
the
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rule, a bank's interest rate risk exposure would be quantified using either the
measurement system set forth in the rule or the bank's internal model for
measuring such exposure, if such model is determined to be adequate by the
bank's examiner. If the dollar amount of a bank's interest rate risk exposure,
as measured under either measurement system, exceeds 1% of the bank's total
assets, the bank would be required under the rule to hold additional capital
equal to the dollar amount of the excess. We believe that the interest rate risk
component does not have a material effect on our capital. Further, the FDIC has
adopted a regulation that provides that the FDIC may take into account whether a
bank has significant risks from concentrations of credit or non-traditional
activities in determining the adequacy of its capital. We have not been advised
that we will be required to maintain any additional capital under this
regulation. The interest rate risk component does not apply to bank holding
companies on a consolidated basis.
In addition to FDIC regulatory capital requirements, the North Carolina
Savings Bank Administrator requires that net worth equal at least 5% of total
assets. Intangible assets must be deducted from net worth and assets when
computing compliance with this requirement.
At September 30, 1998, we complied with each of the capital requirements of
the FDIC and the North Carolina Savings Bank Administrator. For a description of
our required and actual capital levels on September 30, 1998, see "Historical
and Pro Forma Regulatory Capital Compliance."
Following the conversion, we will be subject to the Commission's capital
surplus regulation which requires commercial banks to maintain a capital surplus
of at least 50% of common capital. Common capital is defined as the total of
the par value of shares times the number of shares outstanding.
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure, known as an "undercapitalized institution," may be:
. subject to increased monitoring by the appropriate federal banking
regulator;
. required to submit an acceptable capital restoration plan within 45
days;
. subject to asset growth limits; and
. required to obtain prior regulatory approval for acquisitions,
branching and new lines of businesses.
A "significantly undercapitalized" institution may be subject to statutory
demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution could also
be required to divest the institution or the institution could be required to
divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior regulatory approval and the institution is prohibited
from making payments of principal or interest on its subordinated debt. If an
institution's ratio of tangible capital to total assets falls below a "critical
capital level," the institution will be subject to conservatorship or
receivership within 90 days unless periodic determinations are made that
forbearance from such action would better protect the deposit insurance fund.
Federal banking regulators have adopted regulations implementing the prompt
corrective action provisions of FDICIA. Under these regulations, the federal
banking regulators generally will measure a depository institution's capital
adequacy on the basis of:
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. the institution's total risk-based capital ratio;
. Tier 1 risk-based capital ratio; and
. leverage ratio.
Under the regulations, an institution that is not subject to an order or written
directive by its primary federal regulator to meet or maintain a specific
capital level will be deemed "well capitalized" if it also has:
. a total risk-based capital ratio of 10% or greater;
. a Tier 1 risk-based capital ratio of 6% or greater; and
. a leverage ratio of 5% or greater.
An "adequately capitalized" depository institution is an institution that does
not meet the definition of well capitalized and has:
. a total risk-based capital ratio of 8% or greater;
. a Tier 1 risk-based capital ratio of 4% or greater; and
. a leverage ratio of 4% or greater, or 3% or greater if the depository
institution has a composite 1 CAMELS rating.
An "undercapitalized institution" is a depository institution that has:
. a total risk-based capital ratio less than 8%; or
. a Tier 1 risk-based capital ratio of less than 4%; or
. a leverage ratio of less than 4%, or less than 3% if the institution
has a composite 1 CAMELS rating.
A "significantly undercapitalized" institution is defined as a depository
institution that has:
. a total risk-based capital ratio of less than 6%; or
. a Tier 1 risk-based capital ratio of less than 3%; or
. a leverage ratio of less than 3%.
A "critically undercapitalized" institution is defined as a depository
institution that has a ratio of "tangible equity" to total assets of less than
2%. Tangible equity is defined as core capital plus cumulative perpetual
preferred stock less all intangibles other than qualifying supervisory goodwill
and certain purchased mortgage servicing rights.
The appropriate federal banking agency may reclassify a well capitalized
depository institution as adequately capitalized and may require an adequately
capitalized or undercapitalized institution to comply with the supervisory
actions applicable to institutions in the next lower capital category, but may
not reclassify a significantly undercapitalized institution as critically under-
capitalized, if it determines, after notice and an opportunity for a hearing,
that the institution is in an unsafe or unsound condition or that the
institution has received and not corrected a
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less-than-satisfactory rating for any CAMELS rating category. At September 30,
1998, we were classified as "well capitalized" under FDIC regulations, and we
believe that we will, immediately after the conversion, also be classified as
"well-capitalized."
Safety and Soundness Guidelines. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each federal banking agency was required to establish safety and soundness
standards for institutions under its authority. The interagency guidelines
require depository institutions to maintain internal controls and information
systems and internal audit systems that are appropriate for the size, nature and
scope of the institution's business. The guidelines also establish certain
basic standards for loan documentation, credit underwriting, interest rate risk
exposure, and asset growth. The guidelines further provide that depository
institutions should maintain safeguards to prevent the payment of compensation,
fees and benefits that are excessive or that could lead to material financial
loss, and should take into account factors such as comparable compensation
practices at comparable institutions. If the appropriate federal banking agency
determines that a depository institution is not in compliance with the safety
and soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines. A depository institution must
submit an acceptable compliance plan to its primary federal regulator within 30
days of receipt of a request for such a plan. Failure to submit or implement a
compliance plan may subject the institution to regulatory sanctions. Management
believes that 1st State Bank meets all the standards adopted in the interagency
guidelines.
Community Reinvestment Act. 1st State Bank, like other financial
institutions, is subject to the Community Reinvestment Act ("CRA"). The purpose
of the CRA is to encourage financial institutions to help meet the credit needs
of their entire communities, including the needs of low- and moderate-income
neighborhoods. During our last compliance examination, we received a
"satisfactory" rating for CRA compliance. Our CRA rating would be a factor
considered by the Federal Reserve Board and the FDIC in considering applications
to acquire branches or to acquire or combine with other financial institutions
and take other actions and, if such rating was less than "satisfactory," could
result in the denial of such applications.
The federal banking regulatory agencies have implemented an evaluation
system that rates institutions based on their actual performance in meeting
community credit needs. Under the regulations, a bank will first be evaluated
and rated under three categories: a lending test, an investment test and a
service test. For each of these three tests, the savings bank will be given a
rating of either "outstanding," "high satisfactory," "low satisfactory," "needs
to improve," or "substantial non-compliance." A set of criteria for each rating
has been developed and is included in the regulation. If an institution
disagrees with a particular rating, the institution has the burden of rebutting
the presumption by clearly establishing that the quantitative measures do not
accurately present its actual performance, or that demographics, competitive
conditions or economic or legal limitations peculiar to its service area should
be considered. The ratings received under the three tests will be used to
determine the overall composite CRA rating. The composite ratings will be the
same as those that are currently given: "outstanding," "satisfactory," "needs to
improve" or "substantial non-compliance."
Federal Home Loan Bank System. The FHLB System consists of 12 district
FHLBs subject to supervision and regulation by the Federal Housing Finance Board
("FHFB"). The FHLBs provide a central credit facility primarily for member
institutions. As a member of the FHLB of Atlanta, we are required to acquire
and hold shares of capital stock in the FHLB of Atlanta in an amount at least
equal to 1% of the aggregate unpaid principal of home mortgage loans, home
purchase contracts, and similar obligations at the beginning of each year, or
1/20 of advances from the FHLB of Atlanta, whichever is greater. We were in
compliance with this requirement with investment in FHLB of Atlanta stock at
September 30, 1998 of $1.3 million. The FHLB of Atlanta serves as a reserve or
central bank for its member institutions within its assigned district. It is
funded primarily from proceeds derived from the sale of consolidated obligations
of the FHLB System. It offers advances to members in accordance with policies
and procedures established by the FHFB and the board of directors of the FHLB of
Atlanta. Long-term advances may only be made for the purpose of providing funds
for residential housing finance. At September 30, 1998, we had $20.0 million in
advances
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outstanding from the FHLB of Atlanta. Upon completion of the conversion, we will
continue to be a member of the FHLB of Atlanta.
Reserves. Under Federal Reserve Board regulations, we must maintain
average daily reserves against transaction accounts. Reserves equal to 3% must
be maintained on transaction accounts of between $4.9 million and $46.5 million,
plus 10% on the remainder. This percentage is subject to adjustment by the
Federal Reserve Board. Because required reserves must be maintained in the form
of vault cash or in a non-interest bearing account at a Federal Reserve Bank,
the effect of the reserve requirement is to reduce the amount of the
institution's interest-earning assets. As of September 30, 1998, we met our
reserve requirements.
After the conversion, we will be subject to the reserve requirements of
North Carolina commercial banks. North Carolina law requires state non-member
banks to maintain, at all times, a reserve fund in an amount set by regulation
of the Commission.
Deposit Insurance. We are required to pay assessments based on a percentage
of insured deposits to the FDIC for insurance of our deposits by the Savings
Association Insurance Fund of the FDIC. Under the FDIC's risk-based deposit
insurance assessment system, the assessment rate for an insured depository
institution depends on the assessment risk classification assigned to the
institution by the FDIC, which is determined by the institution's capital level
and supervisory evaluations. Based on the data reported to regulators for the
date closest to the last day of the seventh month preceding the semi-annual
assessment period, institutions are assigned to one of three capital groups --
well capitalized, adequately capitalized or undercapitalized -- using the same
percentage criteria as in the prompt corrective action regulations. See "--
Prompt Corrective Regulatory Action" for definitions and percentage criteria for
the capital group categories. Within each capital group, institutions are
assigned to one of three subgroups on the basis of supervisory evaluations by
the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund. Subgroup A consists of financially
sound institutions with only a few minor weaknesses. Subgroup B consists of
institutions that demonstrate weaknesses which, if not corrected, could result
in significant deterioration of the institution and increased risk of loss to
the deposit insurance fund. Subgroup C consists of institutions that pose a
substantial probability of loss to the deposit insurance fund unless effective
corrective action is taken. In 1996, the FDIC imposed a one-time assessment of
65.7 basis points of insured deposits as of March 31, 1995, that fully
capitalized the Savings Association Insurance Fund of the FDIC and had the
effect of reducing our future Savings Association Insurance Fund of the FDIC
assessments. Accordingly, although the special assessment resulted in a one-time
charge to us of approximately $1.3 million pre-tax, the recapitalization of the
Savings Association Insurance Fund of the FDIC had the effect of reducing our
future deposit insurance premiums to the Savings Association Insurance Fund of
the FDIC. Both Bank Insurance Fund of the FDIC and Savings Association Insurance
Fund of the FDIC members are assessed an amount for the Financing Corporation
Bond payments. Bank Insurance Fund of the FDIC members are assessed
approximately 1.3 basis points while the Savings Association Insurance Fund of
the FDIC rate is approximately 6.4 basis points until January 1, 2000. At that
time, Bank Insurance Fund of the FDIC and Savings Association Insurance Fund of
the FDIC members will begin pro rata sharing of the payment at an expected rate
of 2.43 basis points.
Although 1st State Bank, as a North Carolina commercial bank, would qualify
for insurance of deposits by the Bank Insurance Fund of the FDIC, substantial
entrance and exit fees apply to conversions from Savings Association Insurance
Fund of the FDIC to Bank Insurance Fund of the FDIC insurance. Accordingly,
following the conversion, we will remain a member of the Savings Association
Insurance Fund of the FDIC, which will insure our deposits to a maximum of
$100,000 for each depositor.
Liquidity Requirements. FDIC policy requires that banks maintain an average
daily balance of liquid assets in an amount which it deems adequate to protect
safety and soundness of the bank. Liquid assets include cash, certain time
deposits, bankers' acceptances and specified United States Government state or
federal agency obligations. The FDIC currently has no specific level which it
requires.
We also are subject to the North Carolina Savings Bank Administrator's
requirement that the ratio of liquid assets to total assets equal at least 10%.
The computation of liquidity under North Carolina regulations allows the
inclusion of mortgage-backed securities and investments which, in the judgment
of the North Carolina Savings Bank Administrator, have a readily ascertainable
market value, including
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investments with maturities in excess of five years. At September 30, 1998, our
liquidity ratio exceeded the North Carolina regulations.
Dividend Restrictions. Under FDIC regulations, we are prohibited from
making any capital distributions if after making the distribution, we would
have:
. a total risk-based capital ratio of less than 8%;
. a Tier 1 risk-based capital ratio of less than 4%; or
. a leverage ratio of less than 4%.
Our earnings appropriated to bad debt reserves and deducted for Federal
income tax purposes are not available for payment of cash dividends or other
distributions to stockholders without payment of taxes at the then current tax
rate on the amount of earnings removed from the pre-1988 reserves for such
distributions. We intend to make full use of this favorable tax treatment and
do not contemplate use of any earnings in a manner which would create federal
tax liabilities.
We may not pay dividends on our capital stock if our regulatory capital
would thereby be reduced below the amount then required for the liquidation
account established for the benefit of certain depositors at the time of the
conversion.
1st State Bancorp is subject to limitations on dividends imposed by the
Federal Reserve Board. See "-- Regulation of 1st State Bancorp Following the
Conversion -- Dividends" for more information.
Transactions with Related Parties. Transactions between a state non-member
bank and any affiliate are governed by Sections 23A and 23B of the Federal
Reserve Act. An affiliate of a state non-member bank is any company or entity
which controls, is controlled by or is under common control with the state non-
member bank. In a holding company context, the parent holding company of a
state non-member bank, such as 1st State Bancorp, and any companies which are
controlled by the parent holding company are affiliates of the savings
institution or state non-member bank. Generally, Sections 23A and 23B (i) limit
the extent to which an institution or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus and (ii) require that all such transactions be on terms
substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar other types of transactions. In addition to the restrictions imposed by
Sections 23A and 23B, no state non-member bank may (i) loan or otherwise extend
credit to an affiliate, except for any affiliate which engages only in
activities which are permissible for bank holding companies, or (ii) purchase or
invest in any stocks, bonds, debentures, notes or similar obligations of any
affiliate, except for affiliates which are subsidiaries of the state non-member
bank.
State non-member banks also are subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
Regulation O thereunder on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, executive officer and
to a greater than 10% stockholder of a state non-member bank and certain
affiliated interests of such persons, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the institution's
loans-to-one-borrower limit and all loans to such persons may not exceed the
institution's unimpaired capital and unimpaired surplus. Section 22(h) also
prohibits loans, above amounts prescribed by the appropriate federal banking
agency, to directors, executive officers and greater than 10% stockholders of a
savings institution, and their respective affiliates, unless such loan is
approved in advance by a majority of the board of directors of the institution
with any "interested" director not participating in the voting. Regulation O
prescribes the loan amount, which includes all other outstanding loans to such
person, as to which such
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prior board of director approval is required as being the greater of $25,000 or
5% of capital and surplus up to $500,000. Further, Section 22(h) requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons. Section 22(h) also generally prohibits a depository institution from
paying the overdrafts of any of its executive officers or directors.
State non-member banks also are subject to the requirements and
restrictions of Section 22(g) of the Federal Reserve Act on loans to executive
officers and the restrictions of 12 U.S.C. (S)1972 on certain tying arrangements
and extensions of credit by correspondent banks. Section 22(g) of the Federal
Reserve Act requires loans to executive officers of depository institutions not
be made on terms more favorable than those afforded to other borrowers, requires
approval by the board of directors of a depository institution for extension of
credit to executive officers of the institution, and imposes reporting
requirements for and additional restrictions on the type, amount and terms of
credits to such officers. Section 1972 (i) prohibits a depository institution
from extending credit to or offering any other services, or fixing or varying
the consideration for such extension of credit or service, on the condition that
the customer obtain some additional service from the institution or certain of
its affiliates or not obtain services of a competitor of the institution,
subject to certain exceptions, and (ii) prohibits extensions of credit to
executive officers, directors, and greater than 10% stockholders of a depository
institution by any other institution which has a correspondent banking
relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
Restrictions on Certain Activities. Under FDICIA, state-chartered banks
with deposits insured by the FDIC are generally prohibited from acquiring or
retaining any equity investment of a type or in an amount that is not
permissible for a national bank. The foregoing limitation, however, does not
prohibit FDIC-insured state banks from acquiring or retaining an equity
investment in a subsidiary in which the bank is a majority owner. State-
chartered banks are also prohibited from engaging as principal in any type of
activity that is not permissible for a national bank and subsidiaries of state-
chartered, FDIC-insured state banks may not engage as principal in any type of
activity that is not permissible for a subsidiary of a national bank unless in
either case the FDIC determines that the activity would pose no significant risk
to the appropriate deposit insurance fund and the bank is, and continues to be,
in compliance with applicable capital standards.
The FDIC has adopted regulations to clarify the foregoing restrictions on
activities of FDIC-insured state-chartered banks and their subsidiaries. Under
the regulations, the term activity refers to the authorized conduct of business
by an insured state bank and includes acquiring or retaining any investment
other than an equity investment. An activity permissible for a national bank
includes any activity expressly authorized for national banks by statute or
recognized as permissible in regulations, official circulars or bulletins or in
any order or written interpretation issued by the Office of the Comptroller of
the Currency ("OCC"). In its regulations, the FDIC indicates that it will not
permit state banks to directly engage in commercial ventures or directly or
indirectly engage in any insurance underwriting activity other than to the
extent such activities are permissible for a national bank or a national bank
subsidiary or except for certain other limited forms of insurance underwriting
permitted under the regulations. Under the regulations, the FDIC permits state
banks that meet applicable minimum capital requirements to engage as principal
in certain activities that are not permissible to national banks including
guaranteeing obligations of others, activities which the Federal Reserve Board
has found by regulation or order to be closely related to banking and certain
securities activities conducted through subsidiaries.
Subject to limitation by the North Carolina Savings Bank Administrator,
North Carolina-chartered savings banks may make any loan or investment or engage
in any activity which is permitted to federally chartered institutions. However,
a North Carolina-chartered savings bank cannot invest more than 15% of its total
assets in business, commercial, corporate and agricultural loans. In addition to
such lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutorily permitted
investments, including but not limited to:
. obligations of the United States, or those guaranteed by it;
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. obligations of the State of North Carolina;
. bank demand or time deposits;
. stock or obligations of the federal deposit insurance fund or a FHLB;
. savings accounts of any savings institution as approved by the board
of directors; and
. stock or obligations of any agency of the State of North Carolina or
of the United States or of any corporation doing business in North
Carolina whose principal business is to make education loans.
Regulation of 1st State Bancorp Following the Conversion
General. Following the conversion, 1st State Bancorp, as the sole
shareholder of 1st State Bank, will become a bank holding company and will
register as such with the Federal Reserve Board. Bank holding companies are
subject to comprehensive regulation by the Federal Reserve Board under the Bank
Holding Company Act of 1956, as amended (the "BHCA"), and the regulations of the
Federal Reserve Board. As a bank holding company, 1st State Bancorp will be
required to file with the Federal Reserve Board annual reports and such
additional information as the Federal Reserve Board may require, and will be
subject to regular examinations by the Federal Reserve Board. The Federal
Reserve Board also has extensive enforcement authority over bank holding
companies, including, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to require that a
holding company divest subsidiaries, including its bank subsidiaries. In
general, enforcement actions may be initiated for violations of law and
regulations and unsafe or unsound practices.
Under the BHCA, a bank holding company must obtain Federal Reserve Board
approval before:
. acquiring, directly or indirectly, ownership or control of any voting
shares of another bank or bank holding company if, after such
acquisition, it would own or control more than 5% of such shares
(unless it already owns or controls the majority of such shares);
. acquiring all or substantially all of the assets of another bank or
bank holding company; or
. merging or consolidating with another bank holding company.
Satisfactory financial condition, particularly with respect to capital adequacy,
and a satisfactory CRA rating generally are prerequisites to obtaining federal
regulatory approval to make acquisitions.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company which is not a bank or bank holding company, or
from engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non bank activities
which, by statute or by Federal Reserve Board regulation or order, have been
identified as activities closely related to the business of banking or managing
or controlling banks. The list of activities permitted by the Federal Reserve
Board includes, among other things:
. operating a savings institution, mortgage company, finance company,
credit card company or factoring company;
. performing certain data processing operations;
. providing certain investment and financial advice;
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. underwriting and acting as an insurance agent for certain types of
credit-related insurance;
. leasing property on a full-payout, non-operating basis;
. selling money orders, travelers' checks and United States Savings
Bonds;
. real estate and personal property appraising;
. providing tax planning and preparation services; and,
. subject to certain limitations, providing securities brokerage
services for customers.
Presently, we have no plans to engage in any of these activities.
Under the BHCA, any company must obtain approval of the Federal Reserve
Board prior to acquiring control of 1st State Bancorp or 1st State Bank. For
purposes of the BHCA, "control" is defined as ownership of more than 25% of any
class of voting securities of 1st State Bancorp or 1st State Bank, the ability
to control the election of a majority of the directors, or the exercise of a
controlling influence over management or policies of 1st State Bancorp or 1st
State Bank. In addition, the Change in Bank Control Act and the related
regulations of the Federal Reserve Board require any person or persons acting in
concert to file a written notice with the Federal Reserve Board before such
person or persons may acquire control of 1st State Bancorp or 1st State Bank.
The Change in Bank Control Act defines "control" as the power, directly or
indirectly, to vote 25% or more of any voting securities or to direct the
management or policies of a bank holding company or an insured bank.
The Federal Reserve Board has adopted guidelines regarding the capital
adequacy of bank holding companies, which require bank holding companies to
maintain specified minimum ratios of capital to total assets and capital to
risk-weighted assets. See " -- Depository Institution Regulation -- Capital
Requirements" for the regulatory capital requirements we must meet.
Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Reigle-Neal Act") was enacted to ease restrictions
on interstate banking. Effective September 29, 1995, the Act allows the Federal
Reserve Board to approve an application of an adequately capitalized and
adequately managed bank holding company to acquire control of, or acquire all or
substantially all of the assets of, a bank located in a state other than such
holding company's home state, without regard to whether the transaction is
prohibited by the laws of any state. The Federal Reserve Board may not approve
the acquisition of a bank that has not been in existence for a minimum of five
years, regardless of a longer minimum period specified by the statutory law of
the host state. The Reigle-Neal Act also prohibits the Federal Reserve Board
from approving an application if the applicant and its depository institution
affiliates control or would control more than 10% of the insured deposits in the
United States or 30% or more of the deposits in the target bank's home state or
in any state in which the target bank maintains a branch. The Reigle-Neal Act
does not affect the authority of states to limit the percentage of total insured
deposits in the state which may be held or controlled by a bank or bank holding
company to the extent such limitation does not discriminate against out-of-state
banks or bank holding companies. Individual states may also waive the 30%
statewide concentration limit contained in the Reigle-Neal Act.
Additionally, the federal banking agencies are authorized to approve
interstate merger transactions without regard to whether such transaction is
prohibited by the law of any state, unless the home state of one of the banks
opts out of the Reigle-Neal Act by adopting a law, which applies equally to all
out-of-state banks and expressly prohibits merger transactions involving out-of-
state banks, after the date of enactment of the Reigle-Neal Act and prior to
June 1, 1997. North Carolina has enacted legislation permitting interstate
banking transactions. Interstate acquisitions of branches will be permitted only
if the law of the state in which the branch is located permits such
acquisitions. Interstate
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mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
The Reigle-Neal Act authorizes the FDIC to approve interstate branching de
novo by state banks only in states which specifically allow for such branching.
Pursuant to the Riegle-Neal Act, the appropriate federal banking agencies have
adopted regulations which prohibit any out-of-state bank from using the
interstate branching authority primarily for the purpose of deposit production.
These regulations include guidelines to ensure that interstate branches operated
by an out-of-state bank in a host state are reasonably helping to meet the
credit needs of the communities which they serve.
Dividends. The Federal Reserve Board has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the Federal
Reserve Board's view that a bank holding company should pay cash dividends only
to the extent that the company's net income for the past year is sufficient to
cover both the cash dividends and a rate of earning retention that is consistent
with the company's capital needs, asset quality and overall financial condition.
The Federal Reserve Board also indicated that it would be inappropriate for a
company experiencing serious financial problems to borrow funds to pay
dividends. Furthermore, under the prompt corrective action regulations adopted
by the Federal Reserve Board pursuant to FDICIA, the Federal Reserve Board may
prohibit a bank holding company from paying any dividends if the holding
company's bank subsidiary is classified as "undercapitalized". For a definition
of "undercapitalized" institution, see "-- Depository Institution Regulation --
Prompt Corrective Regulatory Action."
Bank holding companies are required to give the Federal Reserve Board prior
written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of the their
consolidated retained earnings. The Federal Reserve Board may disapprove such a
purchase or redemption if it determines that the proposal would constitute an
unsafe or unsound practice or would violate any law, regulation, Federal Reserve
Board order, or any condition imposed by, or written agreement with, the Federal
Reserve Board. Bank holding companies whose capital ratios exceed the
thresholds for "well-capitalized" banks on a consolidated basis are exempt from
the foregoing requirement if they were rated composite 1 or 2 in their most
recent inspection and are not the subject of any unresolved supervisory issues.
Federal Securities Law
1st State Bancorp has filed with the Securities and Exchange Commission a
Registration Statement under the Securities Act of 1933, as amended, for the
registration of the common stock to be issued in the conversion. Following the
conversion, the common stock will be registered with the Securities and Exchange
Commission under the Securities Exchange Act of 1934, as amended. 1st State
Bancorp will then be subject to the information, proxy solicitation, insider
trading restrictions and other requirements of the Securities Exchange Act of
1934, as amended.
The registration under the Securities Act of 1933, as amended, of the
common stock does not cover the resale of such shares. Nonaffiliates may resell
shares without registration. Shares purchased by an affiliate of 1st State
Bancorp will be subject to the resale restrictions of Rule 144 under the
Securities Act of 1933, as amended. If 1st State Bancorp meets the current
public information requirements of Rule 144 under the Securities Act of 1933, as
amended, each affiliate of 1st State Bancorp who complies with the other
conditions of Rule 144 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 1% of the outstanding shares of 1st State Bancorp or the average
weekly volume of trading in such shares during the preceding four calendar
weeks. 1st State Bancorp may in the future permit affiliates to have their
shares registered for sale under the Securities Act of 1933, as amended, under
certain circumstances. There are currently no demand registration rights
outstanding. However, in the event 1st State Bancorp at some future time
determines to issue additional shares from its authorized but unissued shares,
1st State Bancorp might offer registration rights to certain of its affiliates
who want to sell their shares.
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TAXATION
General
1st State Bank files a federal income tax return based on a fiscal year
ending September 30.
Federal Income Taxation
Savings institutions such as 1st State Bank are subject to the provisions
of the Internal Revenue Code in the same general manner as other corporations.
Through tax years beginning before December 31, 1995, institutions such as 1st
State Bank which met certain definitional tests and other conditions prescribed
by the Internal Revenue Code benefitted from certain favorable provisions
regarding their deductions from taxable income for annual additions to their bad
debt reserve. For purposes of the bad debt reserve deduction, loans are
separated into "qualifying real property loans," which generally are loans
secured by interests in certain real property, and "nonqualifying loans", which
are all other loans. The bad debt reserve deduction with respect to
nonqualifying loans must be based on actual loss experience. The amount of the
bad debt reserve deduction with respect to qualifying real property loans may be
based upon actual loss experience (the "experience method") or a percentage of
taxable income determined without regard to such deduction (the "percentage of
taxable income method"). Under the experience method, the bad debt deduction
for an addition to the reserve for qualifying real property loans was an amount
determined under a formula based generally on the bad debts actually sustained
by a savings institution over a period of years. Under the percentage of
taxable income method, the bad debt reserve deduction for qualifying real
property loans was computed as 8% of a savings institution's taxable income,
with certain adjustments. We generally elected to use the method which has
resulted in the greatest deductions for federal income tax purposes in any given
year.
Legislation that is effective for tax years beginning after December 31,
1995 requires institutions to recapture into taxable income over a six taxable
year period the portion of the tax loan reserve that exceeds the pre-1988 tax
loan loss reserve. As a result of changes in the law, saving institutions were
required to change to either the reserve method or the specific charge-off
method that applied to banks.
We are not required to provide a deferred tax liability for the tax effect
of additions to the tax bad debt reserve through 1987, the base year. Retained
income at September 30, 1998 includes approximately $4.2 million for which no
provision for federal income tax has been made. These amounts represent
allocations of income to bad debt deductions for tax purposes only. Reduction
of such amounts for purposes other than tax bad debt losses could create income
for tax purposes in certain remote instances, which would be subject to the then
current corporate income tax rate.
Our federal income tax returns have not been audited since 1993.
For additional information on our policies regarding tax and accounting
matters, see our consolidated financial statements and related notes, which you
can find beginning on page F-1 of this document.
State Income Taxation
Under North Carolina law, the corporate income tax currently is 7.25% of
federal taxable income as computed under the Internal Revenue Code, subject to
certain prescribed adjustments. This rate will be reduced to 7.00% for 1999 and
6.9% for 2000 and thereafter. In addition, for tax years beginning in 1991,
1992, 1993 and 1994, corporate taxpayers were required to pay a surtax equal to
4%, 3%, 2% and 1%, respectively, of the state income tax otherwise payable. An
annual state franchise tax is imposed at a rate of .15% applied to the greatest
of the institution's (i) capital stock, surplus and undivided profits, (ii)
investment in tangible property in North Carolina, or (iii) appraised valuation
of property in North Carolina.
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For additional information regarding taxation, see Notes 1 and 10 of the
notes to the consolidated financial statements, which you can find beginning on
page F-1 of this document.
MANAGEMENT OF 1st STATE BANCORP, INC.
The board of directors of 1st State Bancorp consists of the same
individuals who serve as directors of 1st State Bank. Their biographical
information is set forth under "Management of 1st State Bank -- Directors." The
board of directors of 1st State Bancorp is divided into three classes. Directors
of 1st State Bancorp will serve for three year terms or until their successors
are elected and qualified, with approximately one-third of the directors being
elected at each annual meeting of stockholders, beginning with the first annual
meeting of stockholders following the conversion. Directors Bean, McGill and
Stadler have terms of office expiring at the 2000 annual meeting, Directors
Barnwell, McClure and Quakenbush have terms of office expiring at the 2001
annual meeting, and Directors Keziah and Shirley have terms of office expiring
at the 2002 annual meeting. Under 1st State Bancorp's bylaws, a person who is 75
years of age or older and who is not an employee of 1st State Bancorp or 1st
State Bank is not eligible for election, re-election, appointment, or re-
appointment to the board of directors, and a non-employee director may not serve
beyond the annual meeting of 1st State Bancorp immediately following the non-
employee director becoming 75.
The following individuals hold the offices in 1st State Bancorp set forth
below opposite their names.
Name Title
---- -----
James C. McGill President and Chief Executive Officer
A. Christine Baker Treasurer and Secretary
Fairfax C. Reynolds Vice President and Assistant Secretary
The executive officers of 1st State Bancorp are elected annually and hold
office until their respective successors have been elected and qualified or
until death, resignation or removal by the board of directors of 1st State
Bancorp.
Since the formation of 1st State Bancorp, none of the executive officers,
directors or other personnel have received remuneration from 1st State Bancorp.
Information concerning the principal occupations and employment of the directors
and executive officers of 1st State Bancorp during the past five years is set
forth under "Management of 1st State Bank -- Directors" and "-- Executive
Officers Who Are Not Directors." Executive officers and directors of 1st State
Bancorp will be compensated as described below under "Management of 1st State
Bank."
MANAGEMENT OF 1ST STATE BANK
Directors
Because we are a mutual savings bank, our members have elected our board of
directors. Following the conversion, the directors of 1st State Bank
immediately prior to the conversion will continue to serve as directors.
Currently, the term of each director is one year, and all of the members of the
board of directors stand for election each year. This will continue to be the
case for 1st State Bank following the conversion. Because 1st State Bancorp
will own all the issued and outstanding capital stock of 1st State Bank
following the conversion, the board of directors of 1st State Bancorp will elect
the directors of 1st State Bank.
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The following table sets forth information regarding the individuals who
serve currently as members of our board of directors. There are no arrangements
or understandings between us and any director by which such person has been
elected a director, and no director is related to any other director or
executive officer by blood, marriage or adoption. All directors' terms expire
in December 1999.
<TABLE>
<CAPTION>
Age at
September 30,
Name 1998 Director Since
- ---- ------------- --------------
<S> <C> <C>
James A. Barnwell, Jr. 58 1988
Bernie C. Bean 68 1978
Richard C. Keziah 66 1983
James G. McClure 53 1989
James C. McGill 57 1988
T. Scott Quakenbush 67 1978
Richard H. Shirley 51 1987
Virgil L. Stadler 62 1982
</TABLE>
Presented below is certain information concerning our directors.
Unless otherwise stated, all directors have held the positions indicated for at
least the past five years.
James A. Barnwell, Jr. is president of Huffman Oil Co., Inc., a
petroleum marketer in Burlington, North Carolina. He has served on the advisory
board of the Salvation Army Boys & Girls Club and the YMCA board.
Bernie C. Bean is retired. From 1988 to 1995 he was the national
sales manager of Craftique, Inc., a furniture manufacturer located in Mebane,
North Carolina.
Richard C. Keziah is president of Monarch Hosiery Mills, Inc. in
Burlington, North Carolina. He also serves on the board of directors of Elon
Homes for Children.
James G. McClure is president of Green & McClure, a retail furniture
store in Graham, North Carolina. He has served as president of the Graham Area
Business Association, on the zoning board for the city of Graham and is an Elder
at the Graham Presbyterian Church.
James C. McGill has been our President and Chief Executive Officer
since December 1988. He serves on the Boards of Hospice of Alamance and
Alamance Community College and in 1997 served as the chairman of the North
Carolina Bankers Association.
T. Scott Quakenbush retired in April 1997 from his position as vice
president and sales manager with Carolina Paper Box Company in Burlington, North
Carolina.
Richard H. Shirley is president of Dick Shirley Chevrolet, Inc., an
automobile dealership located in Burlington, North Carolina. He has served as
the president of the Alamance County YMCA and as a member and chairman of the
Economic Development Committee of the Burlington area Chamber of Commerce.
Virgil L. Stadler is the vice president of Stadler Country Hams, Inc.
in Elon College, North Carolina. He is active with the ACC Foundation, Elon
Homes for Children and the Burlington area Chamber of Commerce.
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Executive Officers Who Are Not Directors
The following sets forth information with respect to executive
officers of 1st State Bank who do not serve on the board of directors.
<TABLE>
<CAPTION>
Age at
September 30,
Name 1998 Title with 1st State Bank
- ---- ------------- -------------------------
<S> <C> <C>
A. Christine Baker 45 Executive Vice President - Chief Financial Officer,
Secretary and Treasurer
Fairfax C. Reynolds 45 Executive Vice President - Commercial and Retail
Banking
Frank Gavigan 40 Senior Vice President - Senior Credit Officer
John D. Hansell 61 Manager - First Capital Services, LLC
</TABLE>
A. Christine Baker has served as our Executive Vice President,
Secretary and Treasurer since April 1985. She has served as president and
director of the Burlington Rotary Club, director and treasurer of the local
chapter of the American Red Cross and director and vice president of the
Childcare Resource and Referral Service.
Fairfax C. Reynolds has served as our Executive Vice President in
charge of Retail and Commercial Banking since 1989. He serves on the board of
directors of YMCA of Alamance County, the Alamance County Arts Council, the
Alamance County Area Chamber of Commerce and the Alamance Country Club. He is
an Elder of the First Presbyterian Church.
Frank Gavigan has served as our Senior Vice President - Senior Credit
Officer since 1990. He has served as the budget director and on the executive
committee of the United Way, as Vice President and a director of Alamance County
Meals on Wheels, as President and a director of Alamance Prevention Alliance and
on the finance committee of Front Street United Methodist Church.
John D. Hansell has served since May 1987 as Manager of 1st Capital
Services Company, LLC and its predecessor, First Capital Services, Inc.,
entities we own that sell annuities, mutual funds and insurance products on an
agency basis. He has served on the small business council of the Alamance
Chamber of Commerce and on the board of directors of the International
Association of Financial Planners.
Committees of the Board of Directors
Our board of directors meets monthly and may have additional special
meetings. During the year ended September 30, 1998, the board met 12 times. No
director attended fewer than 75% in the aggregate of the total number of Board
meetings held during the year ended September 30, 1998 and the total number of
meetings held by committees on which he served during such fiscal year. The
board of directors has standing Audit and Executive Committees.
The board of directors' Audit Committee consists of Directors Keziah,
Quakenbush and Stadler, who serves as Chairperson. The Audit Committee met one
time during the year ended September 30, 1998. The function of the Audit
Committee is to examine and approve the audit report prepared by the independent
auditors, to review and recommend the independent auditors to be engaged by 1st
State Bank, to review the internal audit function and internal accounting
controls, and to review and approve audit policies.
The board of directors' Executive Committee consists of Directors
McGill, Barnwell, Shirley and Keziah and one additional director who serves on a
rotating basis for a three-month period. The Executive Committee, among other
things, evaluates the compensation and benefits of the directors, officers and
employees, recommends changes, and monitors and evaluates employee performance.
The Executive Committee reports its evaluations and findings to the
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full board of directors and all compensation decisions are ratified by the full
board of directors. Directors of 1st State Bank who also are officers of 1st
State Bank abstain from discussion and voting on matters affecting their
compensation. The Executive Committee also monitors the performance of our
investment portfolio and reviews loans. The Executive Committee is empowered to
exercise all of the authority of the board when the board is not in session. The
Executive Committee met 12 times during the fiscal year ended September 30,
1998.
Executive Compensation
The following table sets forth the cash and noncash compensation for
the last fiscal year awarded to or earned by the President and the four other
executive officers who earned salary and bonus in fiscal 1998 exceeding $100,000
for services rendered in all capacities to 1st State Bank.
<TABLE>
<CAPTION>
Annual Compensation
-----------------------------------------------------------------------
Name and Fiscal Other Annual All Other
Principal Position Year Salary Bonus Compensation (1) Compensation (2)
- ------------------ ------ -------- ------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
James C. McGill 1998 $175,000 $ 257,000 -- 107,352
President and Chief
Executive Officer
A. Christine Baker 1998 95,000 128,500 -- 44,469
Executive Vice President,
Treasurer and Secretary
Fairfax C. Reynolds 1998 95,000 128,500 -- 47,476
Executive Vice President
Frank Gavigan 1998 76,000 30,000 -- 10,260
Senior Vice President
John D. Hansell 1998 42,000 68,220(3) -- 5,460
Manager
</TABLE>
- ---------------------
(1) Executive officers receive indirect compensation in the form of certain
perquisites and other personal benefits. The amount of such benefits
received by the named executive officer in fiscal 1998 did not exceed 10%
of the executive officer's salary and bonus.
(2) Includes $4,800, $2,850, $2,850, $2,280 and $1,260 in matching
contributions under 1st State Bank's 401(k) Plan and $20,580, $10,830,
$10,830, $7,980 and $4,200 in accruals made pursuant to 1st State Bank's
Money Purchase Pension Plan for executive officers McGill, Baker,
Reynolds, Gavigan and Hansell, respectively. The Money Purchase Pension
Plan was terminated effective September 30, 1998. Also includes $81,972,
$30,789 and $33,766 accrued under our Deferred Compensation Plan for the
benefit of executive officers McGill, Baker and Reynolds, respectively,
for service as an employee during the year ended September 30, 1998.
Does not include amounts accrued pursuant to such plan during the year
ended September 30, 1998 for service in prior years.
(3) Consists of commissions.
Employee Stock Ownership Plan. We have established the employee stock
ownership plan for the exclusive benefit of our participating employees, to be
implemented upon the completion of the conversion. Participating employees are
employees who have completed one year of service with us, including at least
1,000 hours of service, and have attained the age of 21. An application for a
letter of determination as to the tax-qualified status of the employee stock
ownership plan will be submitted to the Internal Revenue Service. Although no
assurances can be given, we expect that the employee stock ownership plan will
receive a favorable letter of determination from the Internal Revenue Service.
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The employee stock ownership plan is to be funded by contributions made by
us in cash or common stock. Benefits may be paid either in shares of the common
stock or in cash. In accordance with the Plan, the employee stock ownership
plan may borrow funds to acquire up to 8% of the common stock issued in the
conversion. The employee stock ownership plan intends to borrow funds from 1st
State Bancorp. We expect the loan to be for a term of 10 years at an annual
interest rate equal to the prime rate, adjusted annually on each October 1st.
Presently, we anticipate that the employee stock ownership plan will purchase up
to 8% of the common stock to be issued in the offering, including shares
contributed to the foundation. This would total 194,400 shares at the midpoint
of the offering range. If we receive orders for more shares than are available,
the employee stock ownership plan will purchase shares in the open market after
the conversion. The loan will be secured by the shares purchased. Shares
purchased with such loan proceeds will be held in a suspense account for
allocation among participant accounts as the loan is repaid. We anticipate
contributing approximately $311,000 annually, based on a 194,400 share
purchase at $16.00 per share, to the employee stock ownership plan to meet
principal obligations under the employee stock ownership plan loan, as proposed.
It is anticipated that all such contributions will be tax-deductible. This loan
is expected to be fully repaid in approximately 10 years.
Contributions to the employee stock ownership plan and shares released from
the suspense account will be allocated among participant accounts on the basis
of each participant's annual wages subject to federal income tax withholding,
plus any amounts withheld under a plan qualified under Section 125 or 401(k) of
the Code and sponsored by us. All participants must be employed at least 500
hours in a plan year in order to receive an allocation. Participants will
become 20% vested in their employee stock ownership plan account balances
beginning in their third year for each year of service, up to a maximum of 100%
for seven years of service, with no more than five years of service credited for
employment before October 1, 1998. Vesting will be accelerated upon retirement,
death, disability, change in control of 1st State Bancorp, or termination of the
employee stock ownership plan. Forfeitures will be reallocated to participants
on the same basis as other contributions in the plan year. Benefits will be
payable in the form of a lump sum upon retirement, death, disability or
separation from service. Our contributions to the employee stock ownership plan
are discretionary and may cause a reduction in other forms of compensation.
Therefore, benefits payable under the employee stock ownership plan cannot be
estimated.
In the event of a change in control of 1st State Bancorp, the outstanding
balance of any loans used to finance the purchase of shares by the employee
stock ownership plan will be paid off through a transfer or sale of shares held
as collateral under such loan, with any remaining shares allocated to
participant accounts pro rata based on their account balances. Participants
terminating employment on or after the change in control will be entitled to
receive a cash payment from 1st State Bancorp or its successor equal to the
amount, if any, which would have been allocated to the participant's account
immediately following the change in control but was precluded from allocation
based on allocation limits applicable under federal tax laws.
The board of directors has appointed non-employee directors to the employee
stock ownership plan committee to administer the employee stock ownership plan
and to serve as the initial employee stock ownership plan trustees. The board
of directors or the employee stock ownership plan committee may instruct the
employee stock ownership plan trustees regarding investments of funds
contributed to the employee stock ownership plan. The employee stock ownership
plan trustees must vote all allocated shares held in the employee stock
ownership plan in accordance with the instructions of the participating
employees. Unallocated shares and allocated shares for which no timely
direction is received will be voted by the trustees as directed by the board of
directors or the employee stock ownership plan committee, subject to the
trustees' fiduciary duties.
401(k) Plan. Our 401(k) Plan has been amended to allow participants
initially and on an ongoing basis to direct that all or part of their account
balances be invested in our common stock. Participants will retain the right to
vote those shares held in trust for them under the 401(k) Plan.
Employment Agreements and Guaranty Agreements. 1st State Bank has entered
into employment agreements with James C. McGill, A. Christine Baker and Fairfax
C. Reynolds. The board believes that the employment agreements
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assure fair treatment of the employees in their careers with us by assuring them
of some financial security. The proposed employment agreements will require FDIC
approval prior to becoming effective.
The employment agreements will become effective on the date of the
conversion and will provide for a term of three years, with an annual base
salary equal to the employee's existing base salary rate in effect on the date
of conversion. On each anniversary date of the commencement of the employment
agreements, the term of the employee's employment will be extended for an
additional one-year period beyond the then effective expiration date upon a
determination by our board of directors that the performance of the employee has
met the required performance standards and that such employment agreements
should be extended. The employment agreements provide the employee with a
salary review by the board of directors not less often than annually, as well as
with inclusion in any discretionary bonus plans, retirement and medical plans,
vacation and sick leave and any fringe benefits that become available to senior
management, including for example, any stock option or incentive compensation
plans and any other benefits commensurate with their responsibilities. If the
board decides not to renew an employment agreement for any reason, and if the
employee remains an employee of 1st State Bank until the Agreement expires, 1st
State Bank must pay the employee an amount equal to two times total compensation
if the employee is later terminated.
The employment agreements terminate upon the employee's death, may
terminate upon the employee's disability and are determinable for just cause, no
severance benefits are available. If we terminate the employee without just
cause, the employee is entitled to receive three times total compensation as
well as continued medical and dental insurance under any group plan chosen by
the employee from the plans we maintain, unless that coverage is not permitted
by the terms of such plan, in which case we will remit to the employee, not less
frequently than monthly, the actual cost to the employee of equivalent
insurance. These provisions shall be in addition to, and not in lieu of, any
other rights that the employee has under the employment agreement, and shall
continue until the employee first becomes eligible for participation in
Medicare. If the employment agreements are terminated due to the employee's
"disability" as defined in the employment agreements, the employee will be
entitled to a continuation of his or her salary and benefits through the date of
termination, including any period prior to the establishment of the employee's
disability. In the event of the employee's death during the term of the
employment agreements, his or her estate will be entitled to receive three times
total compensation determined as of the date of death. Each employee is able
to voluntarily terminate his or her employment agreement by providing 90 days'
written notice to the board of directors, in which case the employee is entitled
to receive only his or her compensation, vested rights, and benefits up to the
date of termination.
We will pay a severance benefit equal to the difference between the product
of 2.99 and the employee's "base amount" as defined in the Internal Revenue Code
Section 280G(b)(3) and the sum of any other "parachute payments" as defined
under Code Section 280G(b)(2) that the employee receives on account of the
change in control, and (ii) provide long-term disability and medical insurance
for 18 months if any of the following occur:
. the employee's involuntary termination of employment other than for
"just cause" during the period beginning six months before a change in
control and ending on the later of the first anniversary of the change
in control or the expiration date of the employment agreements (the
"Protected Period");
. the employee's voluntary termination within 90 days of the occurrence
of certain specified events occurring during the Protected Period
which have not been consented to by the employee; or
. the employee's voluntary termination of employment for any reason
within the 30-day period beginning on the date of the change in
control.
The employee will be paid either in one lump sum within ten days of the
later of the date of the change in control and the employee's last day of
employment or if prior to the date which is 90 days before the date on which a
change in control occurs, the employee filed a duly executed irrevocable written
election, payment of such amount shall be made according to the elected
schedule. "Change in control" generally refers to the acquisition, by any
person or entity, of the ownership or power to vote more than 25% of our voting
stock, the control of the election of a majority
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of our directors, or the exercise of a controlling influence over our management
or policies. In addition, under the employment agreements, a change in control
occurs when, during any consecutive two-year period, directors of 1st State
Bancorp or 1st State Bank at the beginning of such period cease to constitute
two-thirds of the board of directors of 1st State Bancorp or 1st State Bank,
unless the election of replacement directors was approved by a two-thirds vote
of the initial directors then in office. The employment agreements provide that
within 10 business days of a change in control, we must deposit in a trust an
amount equal to the Internal Revenue Code Section 280G maximum. The payments
that would be made to Mr. McGill, Ms. Baker and Mr. Reynolds assuming
termination of employment under the foregoing circumstances at September 30,
1998 would have been approximately $1.1 million, $539,000 and $539,000,
respectively. These provisions may have an anti-takeover effect by making it
more expensive for a potential acquiror to obtain control of 1st State Bancorp.
For more information, see "Anti-Takeover Provisions in Our Corporate Documents
- --Benefit Plans." In the event that the employee prevails over us, or obtains a
written settlement, in a legal dispute as to the employment agreement, he or she
will be reimbursed for legal and other expenses.
In addition to the employment agreements, 1st State Bancorp has entered
into guaranty agreements with each of the employees. The guaranty agreements
provide that 1st State Bancorp will perform all covenants and honor all
obligations required to be performed or to which 1st State Bank is subject
pursuant to the employment agreements in the event that such covenants are not
performed or obligations are not honored by 1st State Bank, and that to the
extent permitted by law, 1st State Bancorp will be jointly and severally liable
with 1st State Bank for the payment of all amounts due under the employment
agreements. The guarantee agreements provide the employee with a salary review
by the board of directors not less often than annually, as well as with
inclusion in any discretionary bonus plans, retirement and medical plans,
customary fringe benefits, vacation and sick leave.
Director Compensation
Fees. Each non-employee member of 1st State Bank's board of directors
receives a monthly retainer fee based on the following schedule:
. the Chairman of the Board - $2,000;
. members of the Executive Committee - $1,750; and
. other directors - $1,500.
Officers who are directors are not compensated for their service as directors.
Directors also will participate in certain of our benefit plans. See " --
Proposed Future Stock Benefit Plans" for a description of the plans in which
directors will participate.
Deferred Compensation Plan. We adopted the 1st State Bank Deferred
Compensation Plan, effective September 24, 1997 for our directors and select
executive officers. Under the plan, before each fiscal year begins, each non-
employee director may elect to defer receipt of all or part of his future fees
and any other participant may elect to defer receipt of up to 25% of his or her
salary or 100% of his or her bonus compensation for the year. Deferred amounts
are credited at the end of the calendar year to bookkeeping accounts in the name
of each participant.
Under the plan, the accounts of directors Barnwell, Bean, Keziah, McClure,
Quakenbush, Shirley and Stadler were credited, on the plan's effective date,
with $79,152, $70,672, $90,460, $62,819, $70,672, $79,152 and $70,672,
respectively, with respect to prior years of service up to nine years. On each
September 30 after 1997, we will credit the accounts of directors Barnwell,
Bean, Keziah, McClure, Quakenbush, Shirley, and Stadler with $8,795, $7,852,
$10,051, $7,852, $7,852, $8,795 and $7,852, respectively, provided that such
annual credits shall not be made for the benefit of non-employee directors after
12 years of service credits. Similarly, the plan provides supplemental
executive retirement benefits for executive officers McGill, Baker and Reynolds
through initial credits of $737,729, $277,098 and $270,126, respectively, on
September 24, 1997 and, through annual credits, on each September 30th after
1997, of $81,972, $30,789 and $33,766, respectively. Each participant is fully
vested in his account balance under the plan.
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Until distributed in accordance with the terms of the plan, each
participant's account will be credited with a rate of return equal to our
highest rate of interest paid on our one-year certificates of deposit. After
the conversion, each participant may prospectively elect to instead have all or
part of his account credited with the total return on the common stock. Account
balances will normally be distributed in five substantially equal annual
installments beginning during the first quarter of the calendar year following
the calendar year in which the participant ceases to be a director or employee,
with any subsequent payments being made by the last day of the first quarter of
each subsequent calendar year until the participant has received the entire
amount of his or her account. Participants may, however, elect to receive their
distributions in a lump sum or in installments paid over a period of up to 10
years. In the event of a participant's death, the balance of his plan account
will be paid in a lump sum (unless the participant elects to continue the
previously designated distribution method) to his designated beneficiary, or if
none, his estate.
We have established a trust in order to hold assets with which to pay plan
benefits to participants. Trust assets are subject to claims of general
creditors. In the event a participant prevails over us in a legal dispute as to
the terms or interpretation of the plan, he or she would be reimbursed for his
legal and other expenses.
Proposed Future Stock Benefit Plans
Stock Option Plan. We intend to adopt a stock option plan following the
conversion, subject to approval by 1st State Bancorp's stockholders if required
by applicable law. We currently expect to implement this plan no sooner than
one year after the conversion. However, 1st State Bancorp may hold a
stockholders' meeting as soon as six months after the conversion to adopt the
option plan.
If the option plan is adopted during the first year following the
conversion, the option plan would be in compliance with the FDIC conversion
regulations in effect. For a list of the restrictions that the FDIC conversion
regulations would place on the option plan, see "-- Restrictions on Stock
Benefit Plans." If the option plan is implemented more than one year after the
conversion, which we expect, the option plan will comply with FDIC regulations
and policies that are applicable at that time. If the option plan is
implemented within one year after the conversion, in accordance with FDIC
regulations, a number of shares equal to 10% of the aggregate shares of common
stock to be issued in the offering, including shares contributed to the
foundation, would be reserved for issuance by 1st State Bancorp upon exercise of
stock options to be granted to our officers, directors and employees from time
to time under the option plan. The purpose of the option plan would be to
provide additional performance and retention incentives to certain officers,
directors and employees by facilitating their purchase of a stock interest in
1st State Bancorp. Under the FDIC regulations, the option plan would provide
for a term of 10 years after which no awards could be made, unless earlier
terminated by the board of directors pursuant to the option plan. The options
would vest over a five year period, beginning one year after the grant of the
option, if the option plan is implemented within one year of the conversion.
Options would expire no later than 10 years from the date granted and could
expire earlier in the event of termination of employment. Options would be
granted based upon several factors, including seniority, job duties and
responsibilities, job performance, our financial performance and a comparison of
awards given by other savings institutions converting from mutual to stock form.
1st State Bancorp would receive no monetary consideration for the granting
of stock options under the option plan. It would receive the option exercise
price for each share issued to optionees upon the exercise of such options.
Shares issued as a result of the exercise of options will be either authorized
but unissued shares or shares purchased in the open market by 1st State Bancorp.
The exercise of options and payment for the shares received would contribute to
the equity of 1st State Bancorp.
Restricted Stock Plan. We intend to adopt a restricted stock plan
following the conversion. The objective of the plan is to enable us to retain
personnel and directors of experience and ability in key positions of
responsibility. We expect to implement the restricted stock plan no sooner than
one year after the conversion, subject to any stockholder approval required by
law, but may elect instead to hold a stockholders' meeting as early as six
months after the conversion.
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If the restricted stock plan is implemented within one year or more after
the conversion, in accordance with applicable FDIC regulations, the shares
granted under the restricted stock plan will be in the form of restricted stock
vesting over a five-year period beginning one year after the date of grant of
the award. Additionally, the number of shares to be granted could not exceed 4%
of the shares sold in the conversion, including shares contributed to the
foundation, if the restricted stock plan is adopted during the first year
following conversion. If the restricted stock plan is implemented more than one
year after the conversion, the restricted stock plan will comply with FDIC
regulations and policies that are applicable at that time.
Compensation expense in the amount of the fair market value of the common
stock granted will be recognized pro rata over the years during which the shares
are payable. Until they have vested, shares may not be sold, pledged or
otherwise disposed of and are required to be held in escrow. Any shares not so
allocated would be voted by the restricted stock plan trustees. Awards would be
granted based upon a number of factors, including seniority, job duties and
responsibilities, job performance, our performance and a comparison of awards
given by other institutions converting from mutual to stock form. The
restricted stock plan would be managed by a committee of non-employee directors.
They would have the responsibility to invest all funds contributed by us to the
trust created for the restricted stock plan.
We expect to contribute sufficient funds to the restricted stock plan so
that the restricted stock plan trust can purchase, in the aggregate, up to 4% of
the amount of common stock that is sold in the conversion, including shares
contributed to the foundation. The shares purchased by the restricted stock plan
could be authorized but unissued shares or could be purchased in the open
market. Whether such shares will be purchased in the open market or newly issued
of 1st State Bancorp, and the timing of such purchases, will depend on market
and other conditions and the alternative uses of capital available. If the
market price of the common stock is greater than the per share conversion
offering price when awards are made, our contribution of funds will be
increased. Likewise, if the market price is lower than the per share conversion
offering price, our contribution will be decreased. In recognition of their
prior and expected services to us and 1st State Bancorp, as the case may be, the
officers, other employees and directors responsible for implementation of the
policies adopted by the board of directors and our profitable operation will,
without cost to them, be awarded stock under the restricted stock plan. Based on
the midpoint of the offering range, the restricted stock plan trust is expected
to purchase up to 97,200 shares of common stock.
Restrictions on Stock Benefit Plans. FDIC regulations provide that in the
event we implement stock option or management and/or employee stock benefit
plans within one year from the date of conversion, such plans must comply with
the following restrictions:
. the plans must be fully disclosed in the prospectus;
. all plans must be approved by a majority of the total votes eligible
to be cast at any duly called meeting of 1st State Bancorp's
stockholders held no earlier than six months following the conversion;
. for stock option plans, the exercise price must be at least equal to
the market price of the stock at the time of grant; and
. for restricted stock plans such as the restricted stock plan, no stock
issued in a conversion may be used to fund the plan.
In addition, the FDIC presumes that a stock option plan or restricted stock plan
that does not conform to applicable Office of Thrift Supervision percentage
limitations constitutes excessive insider benefits. These percentage
limitations are:
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. for stock option plans, the total number of shares for which options
may be granted may not exceed 10% of the shares issued in the
conversion;
. for restricted stock plans such as the restricted stock plan, the
shares may not exceed 3% of the shares issued in the conversion,
including shares issued to a charitable foundation, or 4% for
institutions with 10% or greater tangible capital;
. the aggregate amount of stock purchased by the employee stock
ownership plan in the conversion may not exceed 10%, or 8% for well-
capitalized institutions utilizing a 4% restricted stock plan, of
the shares issued in the conversion, including shares issued to a
charitable foundation;
. no individual employee may receive more than 25% of the available
awards under the option plan or the restricted stock plan;
. directors who are not employees may not receive more than 5%
individually or 30% in the aggregate of the awards under any plan;
and
. neither stock option awards nor restricted stock awards may vest
earlier than 20% as of one year after the date of stockholder approval
and 20% per year thereafter, and vesting may be accelerated only in
the case of disability or death or if not inconsistent with
applicable FDIC regulations in effect at such time, in the event of a
change in control.
Transactions with Management
We offer loans to our directors and officers. These loans were made in the
ordinary course of business on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with other persons and did not involve more than the normal risk of
collectibility or present other unfavorable features. Under current law, our
loans to directors and executive officers are required to be made on
substantially the same terms, including interest rates, as those prevailing for
comparable transactions with other persons and must not involve more than the
normal risk of repayment or present other unfavorable features. Furthermore,
all loans to such persons must be approved in advance by a disinterested
majority of our board of directors. At September 30, 1998, our loans to our
directors and executive officers and their affiliates totaled $7.5 million, or
29.0% of our net worth, at that date. See Note 3 of notes to consolidated
financial statements, which you can find beginning on page F-1 of this document.
RESTRICTIONS ON ACQUISITION OF
1ST STATE BANCORP, INC. AND 1ST STATE BANK
Conversion Regulations
North Carolina regulations provide that for a period of three years
following the conversion, the prior written approval of the North Carolina
Savings Bank Administrator will be required before any person may, directly or
indirectly, acquire beneficial ownership of or make any offer to acquire any
stock or other equity security of 1st State Bancorp if, after the acquisition or
consummation of such offer, such person would be the beneficial owner of more
than 10% of such class of stock or other class of equity security of 1st State
Bancorp. If any person were to so acquire the beneficial ownership of more than
10% of any class of any equity security without prior written approval, the
securities beneficially owned in excess of 10% would not be counted as shares
entitled to vote and would not be voted or counted as voting shares in
connection with any matter submitted to stockholders for a vote. Approval is not
required for any offer with a view toward public resale made exclusively to 1st
State Bancorp or its underwriters or the selling group acting on its behalf or
any offer to acquire or acquisition of beneficial ownership of more than 10% of
the common stock of 1st State Bancorp by a
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corporation whose ownership is or will be substantially the same as the
ownership of 1st State Bancorp, provided that the offer or acquisition is made
more than one year following the consummation of the conversion. The regulation
provides that within one year following the conversion, the North Carolina
Savings Bank Administrator would approve the acquisition of more than 10% of
beneficial ownership only to protect the safety and soundness of the
institution. During the second and third years after the conversion, the North
Carolina Savings Bank Administrator may approve such an acquisition upon a
finding that the acquisition is necessary to protect the safety and soundness of
1st State Bancorp and 1st State Bank or the board of directors of 1st State
Bancorp and 1st State Bank support the acquisition and the acquiror is of good
character and integrity and possesses satisfactory managerial skills, the
acquiror will be a source of financial strength to 1st State Bancorp and 1st
State Bank and the public interests will not be adversely affected.
Change in Bank Control Act and Bank Holding Company Act
The Change in Bank Control Act, together with North Carolina regulations,
require that the consent of the North Carolina Savings Bank Administrator and
Federal Reserve Board be obtained prior to any person or company acquiring
"control" of a North Carolina-chartered savings bank or a North Carolina-
chartered savings bank holding company. The consent of the Commission and the
Federal Reserve Board is required to be obtained prior to any person or company
acquiring "control" of a North Carolina-chartered commercial bank. Upon
acquiring control, such acquiror will be deemed to be a bank holding company.
Control is conclusively presumed to exist if, among other things, an individual
or company acquires the power, directly or indirectly, to direct the management
or policies of 1st State Bancorp or 1st State Bank or to vote 25% or more of any
class of voting stock. Control is rebuttably presumed to exist under the Change
in Bank Control Act if, among other things, a person acquires more than 10% of
any class of voting stock, and the issuer's securities are registered under
Section 12 of the Securities Exchange Act of 1934, as amended or the person
would be the single largest stockholder. Restrictions applicable to the
operations of bank holding companies and conditions imposed by the Federal
Reserve Board in connection with its approval of such acquisitions may deter
potential acquirors from seeking to obtain control of 1st State Bancorp. See
"Regulation -- Regulation of 1st State Bancorp Following the Conversion" for a
further discussion of regulations applicable to bank holding companies.
Virginia Stock Corporation Act
Virginia corporate law contains a statute designed to provide Virginia
corporations with additional protections against hostile takeovers. The
Virginia Affiliated Transactions Act restricts certain transactions between a
Virginia corporation and a holder of 10% or more of the corporation's
outstanding voting stock, together with affiliates or associates thereof,
defined as an "interested shareholder". For a period of three years following
the date that a stockholder becomes an interested shareholder, the Virginia
Affiliates Transactions Act generally prohibits the following types of
transactions between the corporation and the interested shareholder unless
certain conditions, described below, are met:
. mergers;
. sales, leases, exchanges, mortgages, pledges, transfers or other
dispositions (in one or a series of transactions) having a total
market value in excess of 5% of the corporation's consolidated net
worth;
. any guarantees of indebtedness of any interested shareholder in an
amount in excess of 5% of the corporation's consolidated net worth;
. sales or other dispositions by the corporation or any subsidiary
thereof of any voting shares of the corporation or any subsidiary
thereof having a market value of 5% or more of the total market value
of the outstanding voting shares of the corporation to any interested
shareholder or affiliate of any interested shareholder other than
pursuant to a stock dividend or the exercise of rights or warrants;
. the dissolution of the corporation if proposed by or on behalf of an
interested shareholder;
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. any reclassification of securities, including any reverse stock split,
or recapitalization of the corporation, or any merger of the
corporation with any of its subsidiaries or any distribution or other
transaction which has the effect directly or indirectly of increasing
by more than 5% the percentage of the outstanding voting shares of the
corporation or any of its subsidiaries beneficially owned by any
interested shareholder; and
. any share exchange in which an interested shareholder acquires a class
or series of the corporation's voting stock,
The affiliated transaction may occur if it is approved by a majority of the
disinterested directors and two-thirds of the disinterested voting shares.
Additionally, after the three-year prohibition on affiliated transactions has
expired, an affiliated transaction must be approved by two-thirds of the votes
cast by disinterested stockholders.
The foregoing voting requirements do not apply if the particular affiliated
transaction has been approved by a majority of the disinterested directors,
meets the rigorous fair price requirements of the Virginia Affiliated
Transactions Act, or qualifies for one of the statutory exemptions. A Virginia
corporation may exempt itself from the requirements of the statute in its
articles of incorporation. 1st State Bancorp has not exempted itself from the
provisions of the Virginia Affiliated Transactions Act. Additionally, the
Virginia Affiliated Transactions Act does not apply to corporations with less
than 300 shareholders of record.
The Virginia Control Share Acquisitions Act prohibits voting rights of
common stock of any person who acquires either one-fifth or more, but less than
one-third, of all voting power of the corporation, one-third or more, but less
than a majority, of the voting power of the corporation, or a majority or more
of the voting power of the corporation, unless such person has delivered an
acquiring person's statement to the corporation, and such voting rights are
approved by a majority of the disinterested shares of stock eligible to vote on
the election of directors. A Virginia corporation may include a provision in
its articles of incorporation or bylaws exempting the corporation from
Virginia's Control Share Acquisitions Statute. 1st State Bancorp, however, has
not exempted itself from the provisions of Virginia's Control Share Acquisitions
Statute. In addition, Virginia's Control Share Acquisitions Statute does not
apply to corporations with less than 300 shareholders.
ANTI-TAKEOVER PROVISIONS IN OUR CORPORATE DOCUMENTS
While the boards of directors of 1st State Bancorp and 1st State Bank are
not aware of any effort that might be made to obtain control of 1st State
Bancorp after the conversion, 1st State Bancorp's board of directors, as
discussed below, believes that it is appropriate to include certain provisions
as part of its articles of incorporation to protect the interests of 1st State
Bancorp and its stockholders from hostile takeovers which the board of directors
might conclude are not in the best interests of 1st State Bank, 1st State
Bancorp or 1st State Bancorp's stockholders. These provisions may have the
effect of discouraging a future takeover attempt which is not approved by the
board of directors but which individual stockholders may deem to be in their
best interests or in which stockholders may receive a 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. These provisions also will render the removal of our current board of
directors and management more difficult.
The following discussion is a general summary of certain provisions of the
articles of incorporation and bylaws of 1st State Bancorp which may be deemed to
have such an "anti-takeover" effect. The description of these provisions is
necessarily general and you should read the articles of incorporation and bylaws
of 1st State Bancorp for complete information. For information regarding how to
obtain a copy of these documents without charge, see "Additional Information."
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Classified Board of Directors and Related Provisions
1st State Bancorp's articles of incorporation provide that the board of
directors is to be divided into three classes which shall be as nearly equal in
number as possible. The directors in each class will hold office following
their initial appointment to office for terms of one year, two years and three
years, respectively, and, upon reelection, will serve for terms of three years
thereafter. Each director will serve until his or her successor is elected and
qualified. The articles of incorporation provide that a director may be removed
only for cause and only by the affirmative vote of the holders of at least 80%
of the outstanding shares entitled to vote.
A classified board of directors could make it more difficult for
stockholders, including those holding a majority of the outstanding shares, to
force an immediate change in the composition of a majority of the board of
directors. Since the terms of only one-third of the incumbent directors expire
each year, it requires at least two annual elections for the shareholders to
change a majority, whereas a majority of a non-classified board may be changed
in one year. In the absence of the provisions of the articles of incorporation
classifying the board, all of the directors would be elected each year.
We believe that the staggered election of directors tends to promote
continuity of management because only one-third of the board of directors is
subject to election each year. Staggered terms guarantee that in the ordinary
course approximately two-thirds of the directors, or more, at any one time have
had at least one year's experience as directors of 1st State Bancorp, and
moderate the pace of changes in the board of directors by extending the minimum
time required to elect a majority of directors from one to two years.
Stockholder Vote Required to Approve business combinations with Principal
Stockholders
1st State Bancorp's articles of incorporation require the approval of the
holders of at least 80% of 1st State Bancorp's outstanding shares of voting
stock, and at least a majority of 1st State Bancorp's outstanding shares of
voting stock, not including shares deemed beneficially owned by a "related
person," to approve certain "business combinations" as defined in the articles
of incorporation, and related transactions. Under Virginia law, in addition to
this provision, business combinations would be subject to the Virginia
Affiliated Transactions Act and, subject to certain exceptions, must be approved
by the vote of the holders of at least a two-thirds of the outstanding
disinterested shares of common stock. For a discussion of the Virginia
statutory voting and other requirements, see "Restrictions on Acquisition of 1st
State Bancorp and 1st State Bank -- Virginia Stock Corporation Act." The
increased voting requirements in 1st State Bancorp's articles of incorporation
apply in connection with business combinations involving a "related person,"
except in cases where the proposed transaction has been approved in advance by
two-thirds of those members of 1st State Bancorp's board of directors who are
unaffiliated with the related person and who were directors prior to the time
when the related person became a related person (the "continuing directors").
The term "related person" is defined to include any individual, corporation,
partnership or other entity or affiliate thereof which owns beneficially or
controls, directly or indirectly, 10% or more of the outstanding shares of
common stock of 1st State Bancorp. A "business combination" is defined to
include:
. any merger or consolidation of 1st State Bancorp with or into a
related person;
. any sale, lease exchange, transfer, or other disposition of more than
25% of 1st State Bancorp's assets to a related person;
. any merger or consolidation of a related person with or into 1st State
Bancorp or a subsidiary;
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. any sale, lease, exchange, transfer or other disposition of all or any
substantial part of the assets of a related person to 1st State
Bancorp or a subsidiary;
. the issuance of any securities of 1st State Bancorp or a subsidiary to
a related person;
. the acquisition by 1st State Bancorp or a subsidiary of any securities
of the related person;
. any reclassification of the common stock, or any recapitalization
involving the common stock; and
. any agreement, contract or other arrangement providing for any of the
above transactions.
Limitations on Call of Meetings of Stockholders
1st State Bancorp's articles of incorporation provide that special meetings
of stockholders may only be called by 1st State Bancorp's board of directors,
President or an appropriate committee appointed by the board of directors.
Stockholders are not authorized to call a special meeting, and stockholder
action may be taken only at a special or annual meeting of stockholders or if a
consent in writing setting forth the action taken is signed by all of the
stockholders entitled to vote on the matter.
Absence of Cumulative Voting
1st State Bancorp's articles of incorporation provide that there will not
be cumulative voting by stockholders for the election of 1st State Bancorp's
directors. The absence of cumulative voting rights effectively means that the
holders of a majority of the shares voted at a meeting of stockholders may, if
they so choose, elect all directors of 1st State Bancorp to be elected at that
meeting, thus precluding minority stockholder representation on 1st State
Bancorp's board of directors.
Restrictions on Acquisitions of Securities
The articles of incorporation provide that for a period of three years from
the effective date of the conversion, no person may directly or indirectly offer
to acquire or acquire the beneficial ownership of more than 10% of any class of
the equity security of 1st State Bancorp, unless such offer or acquisition shall
have been approved in advance by a two-thirds vote of 1st State Bancorp's
continuing directors. This provision does not apply to any employee stock
benefit plan of 1st State Bancorp or to an underwriter or member of an
underwriting or selling group involving the public sale or resale of securities
of 1st State Bancorp or a subsidiary; provided, that upon completion of the sale
or resale, no such underwriter or member of the selling group is a beneficial
owner of more than 10% of any class of equity securities of 1st State Bancorp.
In addition, during such three-year period, no shares beneficially owned in
violation of the foregoing percentage limitation, as determined by 1st State
Bancorp's board of directors, will be entitled to vote on any matter submitted
to stockholders for a vote. Additionally, the articles of incorporation provide
for further restrictions on voting rights of shares owned in excess of 10% of
any class of equity security of 1st State Bancorp beyond three years after the
conversion. Specifically, the articles of incorporation provide that if, at any
time after three years following the conversion to stock form, any person
acquires the beneficial ownership of more than 10% of any class of equity
security of 1st State Bancorp, then, with respect to each vote in excess of 10%,
the record holders of voting stock of 1st State Bancorp beneficially owned by
such person shall be entitled to cast only one-hundredth of one vote with
respect to each vote in excess of 10% of the voting power of the outstanding
shares of voting stock of 1st State Bancorp which such record holders would
otherwise be entitled to cast without giving effect to the provision, and the
aggregate voting power of such record holders shall be allocated proportionately
among such record holders. An exception from the restriction is provided if the
acquisition of more than 10% of the securities received the prior approval by a
two-thirds vote of 1st State Bancorp's continuing directors. Under 1st State
Bancorp's articles of incorporation, the restriction on voting shares
beneficially owned in violation of the foregoing limitations is imposed
automatically. In order to prevent the imposition of such restrictions, the
board of directors must take affirmative action approving in advance a
particular offer to acquire
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or acquisition. Unless the board took such affirmative action, the provision
would operate to restrict the voting by beneficial owners of more than 10% of
1st State Bancorp's common stock in a proxy contest.
Board Consideration of Certain Nonmonetary Factors in the Event of an Offer by
Another Party
The articles of incorporation of 1st State Bancorp permit the board of
directors, in evaluating a business combination or a tender or exchange offer,
to consider, in addition to the adequacy of the amount to be paid in connection
with any such transaction, certain specified factors and any other factors the
Board deems relevant, including
. the social and economic effects of the transaction on 1st State
Bancorp and its subsidiaries, employees, depositors, loan and other
customers, creditors and other elements of the communities in which
1st State Bancorp and its subsidiaries operate or are located;
. the business and financial condition and earnings prospects of the
acquiring person or entity; and
. the competence, experience and integrity of the acquiring person or
entity and its or their management.
By having the standards in the articles of incorporation of 1st State Bancorp,
the board of directors may be in a stronger position to oppose any proposed
business combination or tender or exchange offer if the board concludes that the
transaction would not be in the best interest of 1st State Bancorp, even if the
price offered is significantly greater than the then market price of any equity
security of 1st State Bancorp.
We feel a responsibility for maintaining the financial and business
integrity of 1st State Bancorp. Savings institutions and banks and their
holding companies occupy positions of special trust in the communities they
serve. They also provide opportunities for abuse by those who are not of
sufficient experience or competence or financial means to act professionally and
responsibly with respect to management of a financial institution. We want to
manage 1st State Bancorp in the interest of the communities that we serve and
that we and our subsidiary bank maintain our integrity as institutions.
One effect of this provision might be to encourage consultation by an
offeror with the board of directors prior to or after commencing a tender offer
in an attempt to prevent a contest from developing. This provision thus may
strengthen the board of directors' position in dealing with any potential
offeror which might attempt to effect a takeover of 1st State Bancorp. The
provision will not make a business combination regarded by the board of
directors as being in the interests of 1st State Bancorp more difficult to
accomplish, but it will permit the board of directors to determine whether a
business combination or tender or exchange offer is not in the interests of 1st
State Bancorp, and thus to oppose it, on the basis of various factors deemed
relevant.
Authorization of Preferred Stock
1st State Bancorp's articles of incorporation authorize us to issue up to
1,000,000 shares of preferred stock, which conceivably could represent an
additional class of stock required to approve any proposed acquisition. We are
authorized to issue preferred stock from time to time in one or more series
subject to applicable provisions of law, and the board of directors is
authorized to fix the powers, designations, preferences and relative,
participating, optional and other special rights of such shares, including
voting rights and conversion rights. Issuance of the preferred stock could
adversely affect the relative voting rights of holders of the common stock. In
the event of a proposed merger, tender offer or other attempt to gain control of
1st State Bancorp that the board of directors did not approve, it might be
possible for the board of directors to authorized the issuance of a series of
preferred stock with rights and preferences that would impede the completion of
such a transaction. An effect of the possible issuance of preferred stock,
therefore, may be to deter a future takeover attempt. We presently have no
plans or understandings to issue any preferred stock and do not intend to issue
any preferred stock except on terms which we deem to be in the best interests of
1st State
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Bancorp and its stockholders. This preferred stock, together with authorized but
unissued shares of common stock, also could represent additional capital
required to be purchased by the acquiror. The articles of incorporation
authorize the issuance of up to 7,000,000 shares of common stock.
Procedures for Stockholder Nominations
1st State Bancorp's articles of incorporation provide that any stockholder
desiring to make a nomination for the election of directors or a proposal for
new business at a meeting of stockholders must submit written notice to the
secretary of 1st State Bancorp not less than 30 or more than 60 days in advance
of the meeting. The articles of incorporation further provides that if a
stockholder seeking to make a nomination or a proposal for new business fails to
follow the prescribed procedures, the chairman of the meeting may disregard the
defective nomination or proposal. We believe that it is in the best interests
of 1st State Bancorp and our stockholders to provide sufficient time to enable
management to disclose to stockholders information about a dissident slate of
nominations for directors. This advance notice requirement may also give
management time to solicit its own proxies in an attempt to defeat any dissident
slate of nominations should management determine that doing so is in the best
interest of stockholders generally. Similarly, adequate advance notice of
stockholder proposals will give management time to study such proposals and to
determine whether to recommend to the stockholders that such proposals be
adopted.
Amendment of Bylaws
1st State Bancorp's articles of incorporation provides that 1st State
Bancorp's bylaws may be amended either by a two-thirds vote of 1st State
Bancorp's board of directors or by the affirmative vote of the holders of not
less than 80% of the outstanding shares of 1st State Bancorp's stock entitled to
vote generally in the election of directors. 1st State Bancorp's bylaws contain
numerous provisions concerning 1st State Bancorp's governance, such as fixing
the number of directors. By reducing the ability of a potential corporate
raider to make changes in 1st State Bancorp's bylaws and to reduce the authority
of the board of directors or impede its ability to manage 1st State Bancorp,
this provision could have the effect of discouraging a tender offer or other
takeover attempt where the ability to make fundamental changes through bylaw
amendments is an important element of the takeover strategy of the acquiror.
Amendment of Articles of Incorporation
1st State Bancorp's articles of incorporation provide that specified
provisions contained in the articles of incorporation may not be repealed or
amended except upon the affirmative vote of not less than 80% of the outstanding
shares of 1st State Bancorp's stock entitled to vote generally in the election
of directors, after giving effect to any limits on voting rights. This
requirement exceeds the two-thirds vote of the outstanding stock that would
otherwise be required by Virginia law for the repeal or amendment of a provision
of the articles of incorporation. The specific provisions are those:
. governing the calling of special meetings, the absence of cumulative
voting rights and the requirement that stockholder action be taken
only at annual or special meetings or by unanimous written consent,
. requiring written notice to 1st State Bancorp of nominations for the
election of directors and new business proposals,
. governing the number of 1st State Bancorp's directors, the filling of
vacancies on the board of directors and classification of the board
of directors,
. providing the mechanism for removing directors,
. limiting the acquisition of 10% or more of the capital stock of 1st
State Bancorp except, with the prior approval of the continuing
directors of 1st State Bancorp,
112
<PAGE>
. governing the requirement for the approval of certain business
combinations involving a "related person,"
. regarding the consideration of certain nonmonetary factors in the
event of an offer by another party,
. providing for the indemnification of directors, officers, employees
and agents of 1st State Bancorp,
. pertaining to the elimination of the liability of the directors to 1st
State Bancorp and its stockholders for monetary damages, with
certain exceptions, and
. governing the required stockholder vote for amending the articles of
incorporation or bylaws of 1st State Bancorp.
This provision is intended to prevent the holders of less than 80% of the
outstanding stock of 1st State Bancorp from circumventing any of the foregoing
provisions by amending the articles of incorporation to delete or modify one of
such provisions. This provision would enable the holders of more than 20% of
1st State Bancorp's voting stock to prevent amendments to 1st State Bancorp's
articles of incorporation or bylaws, even if such amendments were favored by the
holders of a majority of the voting stock.
Benefit Plans
In addition to the provisions of 1st State Bancorp's articles of
incorporation and bylaws described above, certain benefit plans of 1st State
Bancorp and 1st State Bank adopted in the conversion contain provisions which
also may discourage hostile takeover attempts which we might conclude are not in
the best interests of 1st State Bancorp, 1st State Bank or 1st State Bancorp's
stockholders. For a description of the benefit plans and the provisions of such
plans relating to changes in control of 1st State Bancorp or 1st State Bank, see
"Management of 1st State Bank -- Proposed Future Stock Benefit Plans."
The Purpose of and Anti-Takeover Effect of 1st State Bancorp's Articles of Our
Corporate Documents
We believe that the provisions described above reduce 1st State Bancorp's
vulnerability to takeover attempts and certain other transactions which have not
been negotiated with and approved by our board of directors. These provisions
will also assist us in the orderly deployment of the net proceeds of the
conversion into productive assets during the initial period after the
conversion. We believe these provisions are in the best interests of 1st State
Bank and of 1st State Bancorp and our stockholders. In our judgment, we are in
the best position to consider all relevant factors and to negotiate for what is
in the best interests of the stockholders and 1st State Bancorp's other
constituents. Accordingly, we believe that it is in the best interests of 1st
State Bancorp and its stockholders to encourage potential acquirors to negotiate
directly with our board of directors, and that these provisions will encourage
such negotiations and discourage nonnegotiated takeover attempts. It is also
our view that these provisions should not discourage persons from proposing a
merger or other transaction at prices reflective of our true value and which are
in the best interests of all stockholders.
Attempts to acquire control of financial institutions and their holding
companies have become increasingly common. Takeover attempts which have not
been negotiated with and approved by the board of directors present to
stockholders the risk of a takeover on terms which may be less favorable than
might otherwise be available. A transaction which is negotiated and approved by
the board of directors, on the other hand, can be carefully planned and
undertaken at an opportune time in order to obtain maximum value for 1st State
Bancorp and our stockholders, with due consideration given to matters such as
the management and business of the acquiring corporation and maximum strategic
development of our assets.
113
<PAGE>
An unsolicited takeover proposal can seriously disrupt the business and
management of a corporation and cause great expense. Although a tender offer or
other takeover attempt may be made at a price substantially above then current
market prices, such offers are sometimes made for less than all the outstanding
shares of a target company. As a result, stockholders may be presented with the
alternative of partially liquidating their investment at a time that may be
disadvantageous, or retaining their investment in an enterprise which is under
different management and whose objectives may not be similar to those of the
remaining stockholders. The concentration of control that could result from a
tender offer or other takeover attempt could also deprive our remaining
stockholders of certain protective provisions of the Exchange Act.
Despite our belief as to the benefits to stockholders of these provisions
of 1st State Bancorp's articles of incorporation and bylaws, these provisions
may also have the effect of discouraging a future takeover attempt which would
not be approved by 1st State Bancorp's board of directors but pursuant to which
the stockholders may receive a 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 any opportunity to do so. Such
provisions will also render the removal of 1st State Bancorp's board of
directors and management more difficult and may tend to stabilize 1st State
Bancorp's stock price, thus limiting gains which might otherwise be reflected in
price increases due to a potential merger or acquisition. We have, however,
concluded that the potential benefits of these provisions outweigh the possible
disadvantages. Pursuant to applicable regulations, at any annual or special
meeting of its stockholders after the conversion, 1st State Bancorp may adopt
additional articles of incorporation provisions regarding the acquisition of its
equity securities that would be permitted to a Virginia corporation. We do not
presently intend to propose the adoption of further restrictions on the
acquisition of 1st State Bancorp's equity securities.
DESCRIPTION OF CAPITAL STOCK
General
1st State Bancorp is authorized to issue 7,000,000 shares of common stock,
par value $.01 per share, and 1,000,000 shares of serial preferred stock, $.01
par value per share. We currently expect to sell between 1,912,500 and
2,975,625 shares of the common stock, and issue up to 187,500 shares of common
stock to the foundation, in the conversion depending upon whether the purchase
price is $15 per share or $20 per share. We will not issue any shares of serial
preferred stock in the conversion. If the option plan is adopted and
implemented, 1st State Bancorp will reserve for future issuance under the option
plan an amount of authorized but unissued shares of common stock equal to 10% of
the shares to be issued in the conversion, including shares to be contributed to
the foundation. THE CAPITAL STOCK OF 1ST STATE BANCORP WILL REPRESENT
NONWITHDRAWABLE CAPITAL, WILL NOT BE AN ACCOUNT OF AN INSURABLE TYPE, AND WILL
NOT BE INSURED BY THE FDIC OR ANY OTHER FEDERAL OR STATE GOVERNMENTAL AGENCY.
Common Stock
Voting Rights. Each share of the common stock will have the same relative
rights and will be identical in all respects with every other share of the
common stock. The holders of the common stock will possess exclusive voting
rights in 1st State Bancorp, except to the extent that shares of serial
preferred stock issued in the future may have voting rights, if any. Each
holder of shares of the common stock will be entitled to one vote for each share
held of record on all matters submitted to a vote of holders of shares of the
common stock. Stockholders are not permitted to cumulate votes in the election
of directors. For information regarding voting limitations, see "Anti-Takeover
Provisions in Our Corporate Documents -- Restrictions on Acquisitions of
Securities."
Dividends. 1st State Bancorp may, from time to time, declare dividends to
the holders of the common stock, who will be entitled to share equally in any
such dividends. For information as to cash dividends and restrictions on our
ability to pay dividends, see "Dividend Policy," "Regulation -- Depository
Institution Regulation -- Dividend Restrictions" and "Taxation."
114
<PAGE>
Liquidation. In the event of any liquidation, dissolution or winding up of
1st State Bank, 1st State Bancorp, as holder of all of 1st State Bank's capital
stock, would be entitled to receive all assets of 1st State Bank after payment
of all debts and liabilities of 1st State Bank and after distribution of the
balance in the liquidation account. In the event of a liquidation, dissolution
or winding up of 1st State Bancorp, each holder of shares of the common stock
would be entitled to receive, after payment of all debts and liabilities of 1st
State Bancorp, a pro rata portion of all assets of 1st State Bancorp available
for distribution to holders of the common stock. If any serial preferred stock
is issued, the holders thereof may have a priority in liquidation or dissolution
over the holders of the common stock. The conversion is not considered a
liquidation of 1st State Bank, and after the conversion 1st State Bank will
continue to maintain the liquidation account according to the same terms.
Restrictions on Acquisition of the Common Stock. For information regarding
limitations on acquisition of shares of the common stock, see "Restrictions on
Acquisition of 1st State Bancorp and 1st State Bank" and "Anti-Takeover
Provisions in Our Corporate Documents."
No Preemptive Rights. Holders of the common stock will not have preemptive
rights with respect to any additional shares of the common stock which may be
issued. Therefore, the board of directors may sell shares of capital stock of
1st State Bancorp without first offering such shares to existing shareholders of
1st State Bancorp.
Other Characteristics. The common stock is not subject to call for
redemption, and the outstanding shares of the common stock, when issued and upon
receipt by 1st State Bancorp of the full purchase price therefor, will be fully
paid and nonassessable.
Transfer Agent and Registrar. The transfer agent and registrar for the
common stock will be Registrar & Transfer Co., Cranford, New Jersey.
Serial Preferred Stock
None of the 1,000,000 authorized shares of serial preferred stock of 1st
State Bancorp will be issued in the conversion. After the conversion is
completed, the board of directors of 1st State Bancorp will be authorized to
issue serial preferred stock and to fix and state voting powers, designations,
preferences or other special rights of such shares and the qualifications,
limitations and restrictions thereof. The serial preferred stock may rank prior
to the common stock as to dividend rights or liquidation preferences, or both,
and may have full or limited voting rights. We presently have no intention to
issue any of the serial preferred stock. Should the board of directors of 1st
State Bancorp subsequently issue serial preferred stock, no holder of any such
stock shall have any preemptive right to subscribe for or purchase any stock or
any other securities of 1st State Bancorp other than such, if any, as the board
of directors, in its sole discretion, may determine and at such price or prices
and upon such other terms as the board of directors, in its sole discretion, may
fix.
REGISTRATION REQUIREMENTS
1st State Bancorp will register its common stock with the Securities
and Exchange Commission pursuant to the Securities Exchange Act of 1934, as
amended upon the completion of the conversion and will not deregister the shares
for a period of at least three years following the conversion. Upon
registration, the proxy and tender offer rules, insider trading reporting and
restrictions, annual and periodic reporting and other requirements of the
Securities Exchange Act of 1934, as amended will be applicable. 1st State
Bancorp intends to have a fiscal year end of September 30.
115
<PAGE>
LEGAL MATTERS
Housley Kantarian & Bronstein, P.C., Washington, D.C. will pass on the
legality of the common stock for 1st State Bancorp. Housley Kantarian &
Bronstein, P.C. has consented to the references in this document to its opinion.
Patton Boggs LLP, Washington, D.C., will pass on certain legal matters for
Trident Securities.
TAX OPINIONS
Housley Kantarian & Bronstein, P.C., Washington, D.C. will pass on the
federal income tax consequences of the conversion. Housley Kantarian &
Bronstein, P.C. has consented to the references in this document to its opinion.
KPMG LLP will pass on North Carolina income tax consequences of the conversion.
KPMG LLP has consented to the references in this document to its opinion.
EXPERTS
The consolidated financial statements of 1st State Bank and subsidiary as
of September 30, 1998 and 1997, and for each of the years in the three-year
period ended September 30, 1998, have been included herein and in the
registration statement in reliance upon the report of KPMG LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
Ferguson & Company has consented to the publication in this document of the
summary of its letter to us setting forth its opinion as to the estimated pro
forma aggregate market value of the common stock to be issued in the conversion
and the value of subscription rights to purchase the common stock and to the use
of its name and statements with respect to it appearing in this document.
ADDITIONAL INFORMATION
1st State Bancorp has filed with the Securities and Exchange Commission a
Registration Statement on Form S-1 under the Securities Act of 1933, as amended,
with respect to the common stock offered in this document. As permitted by the
rules and regulations of the Securities and Exchange Commission this document
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 Securities and Exchange Commission located at 450 Fifth
Street, N.W., Washington, D.C. 20549, and copies of such material can be
obtained from the Securities and Exchange Commission at prescribed rates. You
may obtain information on the operation of the Securities and Exchange
Commission's public reference room by calling the Securities and Exchange
Commission at 1-800-SEC-0330. The Securities and Exchange Commission also
maintains an internet address ("web site") that contains reports, proxy and
information statements and other information regarding registrants, including
1st State Bancorp, that file electronically with the Securities and Exchange
Commission. The address for this web site is "http: //www. sec. gov." The
statements contained in this document as to the contents of any contract or
other document filed as an exhibit to the Form S-1 describe the material
features of such contract or document are, of necessity, brief descriptions and
are not necessarily complete; each such statement is qualified by reference to
such contract or document.
We have filed an Application to Convert a Mutual Savings Bank to a Stock
Owned Savings Bank with the North Carolina Savings Bank Administrator. Pursuant
to the North Carolina conversion regulations, this Prospectus omits certain
information contained in that Application. The Application, which contains a
copy of Ferguson & Company's appraisal, may be inspected at the office of the
North Carolina Savings Bank Administrator, Savings Institutions Division, North
Carolina Department of Commerce, Tower Building, Suite 301, 1110 Navaho Drive,
Raleigh, North Carolina 27609. Copies of the Plan of Conversion, which includes
a copy of 1st State Bank's proposed Amended and Restated articles of
incorporation and bylaws, are available for inspection at each office of 1st
State Bank and may be obtained by writing to 1st State Bank at 445 S. Main
Street, Burlington, North Carolina 27815; Attention James C. McGill, President,
or by telephoning 1st State Bank at (336) 227-8861. A copy of Ferguson &
Company's independent appraisal is also available for inspection at the Stock
Information Center.
116
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report F-1
Consolidated Balance Sheets as of September 30, 1998 and 1997 F-2
Consolidated Statements of Income for the Years Ended F-3
September 30, 1998, 1997 and 1996
Consolidated Statements of Net Worth for the Years Ended F-4
September 30, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the Years Ended F-5
September 30, 1998, 1997 and 1996
Notes to Consolidated Financial Statements F-7
</TABLE>
Schedules - All schedules are omitted because the required information is not
applicable or is presented in the financial statements or accompanying notes.
All financial statements of 1st State Bancorp, Inc. have been omitted because
1st State Bancorp, Inc. has not yet issued any stock, has no assets and no
liabilities and has not conducted any business other than of an organizational
nature.
117
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
1st State Bank
Burlington, North Carolina
We have audited the accompanying consolidated balance sheets of 1st State Bank
and subsidiary as of September 30, 1998 and 1997 and the related consolidated
statements of income, net worth and cash flows for each of the years in the
three-year period ended September 30, 1998. These consolidated financial
statements are the responsibility of the Bank's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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 include
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of 1st State Bank and
subsidiary at September 30, 1998 and 1997, and the results of their operations
and their cash flows for each of the years in the three-year period ended
September 30, 1998, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
KPMG LLP
Greensboro, North Carolina
October 30, 1998
F-1
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Consolidated Balance Sheets
September 30, 1998 and 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
---------------- -----------------
<S> <C> <C>
Cash and cash equivalents $ 31,077,054 14,990,413
Investment securities (note 2):
Held to maturity (fair value of $30,415,447 and $23,539,770
at September 30, 1998 and 1997, respectively) 30,195,094 23,481,510
Available for sale (cost of $9,705,529 and $11,441,164 at
September 30, 1998 and 1997, respectively) 9,857,780 11,319,777
Loans held for sale, at lower of cost or fair value 7,539,919 684,438
Loans receivable (net of allowance for loan losses of $3,227,775
and $2,753,793 at September 30 1998 and 1997, respectively)
(notes 3, 4 and 8) 196,782,275 197,121,798
Federal Home Loan Bank stock, at cost (notes 5 and 8) 1,346,500 1,281,200
Premises and equipment (note 6) 7,513,347 6,771,800
Accrued interest receivable 1,807,588 1,556,828
Other assets (note 10) 2,103,659 1,301,640
---------------- -----------------
Total assets $ 288,223,216 258,509,404
================ =================
LIABILITIES AND NET WORTH
Liabilities:
Deposit accounts (note 7) $ 235,693,715 229,340,603
Advances from Federal Home Loan Bank (note 8) 20,000,000 1,000,000
Advance payments by borrowers for property taxes and
insurance 299,939 387,799
Other liabilities (notes 10 and 11) 6,263,957 4,503,659
---------------- -----------------
Total liabilities 262,257,611 235,232,061
---------------- -----------------
Commitments (notes 3 and 12)
Net worth (note 9):
Retained income - substantially restricted 25,872,605 23,351,343
Net unrealized gain (loss) on investment securities
available for sale (note 2) 93,000 (74,000)
---------------- -----------------
Total net worth 25,965,605 23,277,343
---------------- -----------------
Total liabilities and net worth $ 288,223,216 258,509,404
================ =================
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Consolidated Statements of Income
For the Years Ended September 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
---------------- ---------------- ----------------
<S> <C> <C> <C>
Interest income:
Interest and fees on loans $ 17,184,941 16,167,269 14,620,562
Interest and dividends on investments 2,319,980 2,557,133 2,401,615
Overnight deposits 1,203,594 336,426 372,900
---------------- ---------------- ----------------
Total interest income 20,708,515 19,060,828 17,395,077
---------------- ---------------- ----------------
Interest expense:
Deposit accounts (note 7) 10,330,999 9,743,038 9,450,414
Borrowings (note 8) 740,439 55,910 3,152
---------------- ---------------- ----------------
Total interest expense 11,071,438 9,798,948 9,453,566
---------------- ---------------- ----------------
Net interest income 9,637,077 9,261,880 7,941,511
Provision for loan losses (note 4) (477,017) (261,288) (280,550)
---------------- ---------------- ----------------
Net interest income after provision
for loan losses 9,160,060 9,000,592 7,660,961
---------------- ---------------- ----------------
Other income:
Loan servicing fees (note 3) 103,280 108,517 125,440
Customer service fees 565,693 500,216 411,936
Commission from sales of annuities and
mutual funds 436,568 399,058 285,891
Real estate operations, net (1,734) 19,808 32,216
Mortgage banking income, net 436,401 180,809 103,454
Securities losses, net (note 2) (246,259) -- --
Other 203,581 259,343 220,039
---------------- ---------------- ----------------
Total other income 1,497,530 1,467,751 1,178,976
---------------- ---------------- ----------------
Operating expenses:
Compensation and related benefits (note 11) 4,612,183 4,344,800 2,949,424
Occupancy and equipment (note 12) 1,044,147 939,544 845,799
Deposit insurance premiums 142,015 103,707 464,644
Other expenses 975,983 1,084,618 860,034
SAIF assessment (note 7) -- -- 1,283,320
---------------- ---------------- ----------------
Total operating expenses 6,774,328 6,472,669 6,403,221
---------------- ---------------- ----------------
Income before income taxes 3,883,262 3,995,674 2,436,716
Income taxes (note 10) 1,362,000 1,447,100 840,500
---------------- ---------------- ----------------
Net income $ 2,521,262 2,548,574 1,596,216
================ ================ ================
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Consolidated Statements of Net Worth
For the Years Ended September 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Net
Unrealized
Gain (Loss) on
Investment
Securities Total
Retained Available Net
Income for Sale Worth
-------------------- ------------------- -----------------
<S> <C> <C> <C>
Balance at September 30, 1995 $ 19,206,553 (56,000) 19,150,553
Net income 1,596,216 -- 1,596,216
Change in unrealized gain (loss) on investment --
securities available for sale, net of taxes -- (118,000) (118,000)
----------------- ------------------- -----------------
Balance at September 30, 1996 20,802,769 (174,000) 20,628,769
Net income 2,548,574 -- 2,548,574
Change in unrealized gain (loss) on investment --
securities available for sale, net of taxes -- 100,000 100,000
----------------- ------------------- -----------------
Balance at September 30, 1997 23,351,343 (74,000) 23,277,343
Net income 2,521,262 -- 2,521,262
Change in unrealized gain (loss) on investment --
securities available for sale, net of taxes -- 167,000 167,000
----------------- ------------------- -----------------
Balance at September 30, 1998 $ 25,872,605 93,000 25,965,605
================= =================== =================
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended September 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,521,262 2,548,574 1,596,216
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan losses 477,017 261,288 280,550
Depreciation 424,997 270,572 239,130
Deferred income tax expense (benefit) (601,000) 139,000 172,000
Amortization of premiums and discounts, net 24,419 (37,116) (2,112)
Loan origination fees and unearned discounts
deferred, net of current amortization 2,221 104,658 115,328
Net loss on sale of loans 118,633 15,520 122,309
Gain on sale of other real estate -- (21,288) (43,319)
Securities losses, net 246,259 -- --
Proceeds from loans held for sale 27,635,212 9,165,706 9,181,331
Originations of loans held for sale (34,609,326) (9,765,263) (11,695,278)
Decrease (increase) in other assets (307,657) 586,726 (227,523)
Increase in accrued interest receivable (250,760) (133,747) (101,534)
Increase in other liabilities 1,760,298 1,042,830 606,880
--------------- ---------------- ----------------
Net cash provided by (used in)
operating activities (2,558,425) 4,177,460 243,978
--------------- ---------------- ----------------
Cash flows from investing activities:
Purchase of FHLB stock (65,300) (35,500) (11,900)
Purchases of investment securities held to
maturity (32,614,244) (6,998,750) (12,379,167)
Purchases of investment securities available for
sale (2,002,500) -- (3,972,438)
Proceeds from sales of investment securities
available for sale 2,879,973 -- --
Proceeds from maturities of investment
securities available for sale 588,144 4,000,000 3,000,000
Proceeds from maturities of investment
securities held to maturity 25,900,000 6,107,200 9,407,696
Net increase in loans receivable (139,715) (21,361,303) (3,211,526)
Capital expenditures on real estate acquired in
settlement of loans -- -- (6,692)
Proceeds from disposal of real estate acquired in
settlement of loans -- 22,289 123,478
Purchases of premises and equipment (1,166,544) (355,006) (1,127,174)
--------------- ---------------- ----------------
Net cash used in investing activities (6,620,186) (18,621,070) (8,177,723)
--------------- ---------------- ----------------
</TABLE>
(Continued)
F-5
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Consolidated Statements of Cash Flows - Continued
Years ended September 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Cash flows from financing activities:
Net increase in deposits $ 6,353,112 19,633,862 8,937,737
Increase (decrease) in advance payments by
borrowers for property taxes and insurance (87,860) 45,819 199,939
Advances from Federal Home Loan Bank 20,000,000 -- 1,000,000
Repayments of advances from Federal Home
Loan Bank (1,000,000) -- --
---------------- ----------------- -----------------
Net cash provided by financing
activities 25,265,252 19,679,681 10,137,676
---------------- ----------------- -----------------
Net increase in cash and cash
equivalents 16,086,641 5,236,071 2,203,931
Cash and cash equivalents at beginning of year 14,990,413 9,754,342 7,550,411
---------------- ----------------- -----------------
Cash and cash equivalents at end
of year $ 31,077,054 14,990,413 9,754,342
================ ================= =================
Payments are shown below for the following:
Interest $ 10,947,338 9,777,417 9,455,792
================ ================= =================
Income taxes $ 2,301,000 866,300 1,657,500
================ ================= =================
Noncash investing and financing activities:
Transfer from loans to real estate acquired in
settlement of loans $ -- -- 73,468
================ ================= =================
Transfer from loans held for sale to loans
receivable $ -- 2,277,071 --
================ ================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
(1) SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The consolidated financial statements include the accounts of 1st
State Bank, SSB and its wholly-owned subsidiary, First Capital
Services Company, LLC (collectively referred to as "the Bank"). First
Capital Services Company, LLC is engaged primarily in the sale of
insurance products. Intercompany balances and transactions have been
eliminated.
(B) USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to
make estimates and assumptions that affect reported amounts of assets
and liabilities at the date of the financial statements and the
amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
(C) CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents
include cash and interest-bearing overnight deposits with the Federal
Home Loan Bank ("FHLB") of Atlanta. At September 30, 1998 and 1997,
interest-bearing overnight deposits were $25,558,925 and $7,813,209,
respectively.
(D) INVESTMENT SECURITIES
Investment securities that the Bank has the positive intent and
ability to hold to maturity are classified as held to maturity and
reported at amortized cost. Investment securities held for current
resale are classified as trading securities and reported at fair
value, with unrealized gains and losses included in earnings.
Investment securities not classified either as securities held to
maturity or trading securities are classified as available for sale
and reported at fair value, with net unrealized gains and losses net
of related taxes excluded from earnings and reported as a separate
component of net worth. The classification of investment securities as
held to maturity, trading or available for sale is determined at the
date of purchase.
Realized gains and losses from sales of investment securities are
determined based upon the specific identification method. Premiums and
discounts are amortized as an adjustment to yield over the remaining
lives of the securities using the level-yield method.
(Continued)
F-7
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
Management periodically evaluates investment securities for other than
temporary declines in value and records any losses through an
adjustment to earnings.
(E) LOANS HELD FOR SALE
Loans held for sale are carried at the lower of cost or fair value in
the aggregate as determined by outstanding commitments from investors
or current investor yield requirements. Gains and losses on loan sales
are determined by the difference between the selling price and the
carrying value of the loans sold.
(F) LOANS RECEIVABLE
Interest on loans, including impaired loans, that are contractually
ninety days or more past due is generally either charged off or
reserved through an allowance account. The allowance is established by
a charge to interest income equal to all interest previously accrued.
In certain circumstances, interest on loans that are contractually
ninety days or more past due is not charged off or reserved through an
allowance account when management determines that the loan is both
well secured and in the process of collection. If amounts are received
on loans for which the accrual of interest has been discontinued, a
determination is made as to whether payments received should be
recorded as a reduction of the principal balance or as interest income
depending on management's judgment as to the collectibility of
principal. The loan is returned to accrual status when, in
management's judgment, the borrower has demonstrated the ability to
make periodic interest and principal payments on a timely basis.
(G) LOAN ORIGINATION FEES AND RELATED COSTS
Loan origination fees and certain direct loan origination costs are
deferred, and the net fee or cost is recognized as an adjustment of
the loan yield using the level-yield method over the contractual life
of the related loans.
(H) ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through provisions for
loan losses charged against income. Loans deemed to be uncollectible
are charged against the allowance for loan losses, and subsequent
recoveries, if any, are credited to the allowance.
Management's evaluation of the adequacy of the allowance is based on a
review of individual loans, historical loan loss experience, the value
and adequacy of collateral, and economic conditions in the Bank's
market area. This evaluation is inherently subjective as it requires
material estimates, including the amounts and timing of future cash
flows expected to be
F-8 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
received on impaired loans that may be susceptible to significant
change. 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 recognize changes to the
allowance based on their judgments about information available to them
at the time of their examinations.
For all specifically reviewed loans for which it is probable that the
Bank will be unable to collect all amounts due according to the terms
of the loan agreement, the Bank determines impairment by computing a
fair value either based on discounted cash flows using the loans'
initial interest rate or the fair value of the collateral if the loan
is collateral dependent. Large groups of smaller balance homogenous
loans that are collectively evaluated for impairment (such as
residential mortgage and consumer installment loans) are excluded from
impairment evaluation, and their allowance for loan losses is
calculated in accordance with the allowance for loan losses policy
described above.
(I) REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS
Real estate acquired in settlement of loans by foreclosure or deed in
lieu of foreclosure is initially recorded at the lower of cost (unpaid
loan balance plus costs of obtaining title and possession) or fair
value less estimated costs to sell at the time of acquisition.
Subsequent costs directly related to development and improvement of
property are capitalized, whereas costs relating to holding property
are expensed.
When the carrying value of real estate exceeds its fair value, less
cost to sell, an allowance for loss on real estate is established and
a provision for loss on real estate is charged to other expenses. At
September 30, 1998 and 1997, the Bank had no real estate acquired in
settlement of loans.
(J) PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated
depreciation. Depreciation is computed generally by the straight-line
method over the estimated useful lives of the related assets.
Estimated lives are 15 to 50 years for buildings and 3 to 15 years for
furniture, fixtures and equipment.
(K) INCOME TAXES
Deferred income taxes are recognized for the future tax consequences
attributed 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
F-9 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
effect for the year in which the temporary differences are expected to
be recovered or settled. Deferred tax assets are reduced by a
valuation allowance if it is more likely than not that the tax
benefits will not be realized. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(L) RECLASSIFICATIONS
Certain amounts in the 1997 and 1996 consolidated financial statements
have been reclassified to conform with the presentation adopted in
1998. Such reclassifications did not change net income or net worth as
previously reported.
(2) INVESTMENT SECURITIES
Investment securities consist of the following:
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
SEPTEMBER 30, 1998
Held to maturity:
U.S. Government and agency
securities $ 30,087,456 219,742 -- 30,307,198
Collateralized mortgage
obligations 107,638 611 -- 108,249
--------------- ---------------- ---------------- ----------------
Total $ 30,195,094 220,353 -- 30,415,447
=============== ================ ================ ================
Available for sale:
U.S. Government and
agency securities 4,001,142 42,363 (232) 4,043,273
Marketable equity securities 3,993,081 13,120 -- 4,006,201
FHLMC mortgage-backed
securities 648,029 13,550 -- 661,579
GNMA mortgage-backed
securities 1,063,277 83,450 -- 1,146,727
--------------- ---------------- ---------------- ----------------
Total $ 9,705,529 152,483 (232) 9,857,780
=============== ================ ================ ================
</TABLE>
F-10 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
SEPTEMBER 30, 1997
Held to maturity:
U.S. Government and agency
securities $ 23,337,997 82,229 (26,750) 23,393,476
Collateralized mortgage
obligations 143,513 2,781 -- 146,294
--------------- ---------------- ---------------- ----------------
Total $ 23,481,510 85,010 (26,750) 23,539,770
=============== ================ ================ ================
Available for sale:
U.S. Government and
agency securities 3,993,052 18,949 -- 4,012,001
Marketable equity securities 4,262,331 -- (301,949) 3,960,382
FHLMC mortgage-backed
securities 1,507,153 60,679 (3,499) 1,564,333
GNMA mortgage-backed
securities 1,650,088 104,251 -- 1,754,339
FNMA mortgage-backed
securities 28,540 182 -- 28,722
--------------- ---------------- ---------------- ----------------
Total $ 11,441,164 184,061 (305,448) 11,319,777
=============== ================ ================ ================
</TABLE>
Following is a summary of investments in debt securities by maturity at
September 30, 1998. Marketable equity securities, mortgage-backed securities
and collateralized mortgage obligations do not have single maturity dates and
are not included below.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
---------------- ----------------
<S> <C> <C>
Held to maturity:
Within one year $ 3,992,563 4,014,606
After one but within five years 15,471,247 15,599,483
After five but within ten years 9,623,646 9,687,469
After ten years 1,000,000 1,005,640
---------------- ----------------
Total $ 30,087,456 30,307,198
================ ================
Available for sale:
After one but within five years $ 3,001,142 3,043,505
After five but within ten years 1,000,000 999,768
---------------- ----------------
Total $ 4,001,142 4,043,273
================ ================
</TABLE>
F-11 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
During the year ended September 30, 1998, the Bank recognized gross gains
on the sale of investment securities available for sale of approximately
$23,000. There were no sales in 1997 and 1996. The Bank also recognized a
loss of approximately $269,000 on the write-down of marketable equity
securities for an other than temporary decline in value during the year
ended September 30, 1998.
At September 30, 1998, U.S. Government securities with an amortized cost of
approximately $2,000,000 were pledged as collateral for certain deposit
accounts.
(3) LOANS RECEIVABLE
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998 1997
---------------- ----------------
<S> <C> <C>
Real estate loans:
One-to-four family residential $ 100,891,490 108,399,580
Commercial real estate and other properties 38,763,299 34,333,514
Home equity and property improvement 16,877,066 18,140,649
Construction loans 18,571,550 12,582,348
---------------- ----------------
Total real estate loans 175,103,405 173,456,091
---------------- ----------------
Other loans:
Commercial 25,189,613 22,869,834
Consumer 6,309,951 5,354,150
---------------- ----------------
Total other loans 31,499,564 28,223,984
---------------- ----------------
Less:
Loans in process (6,446,324) (1,660,110)
Net deferred loan origination fees (146,595) (144,374)
---------------- ----------------
Net loans receivable before allowance for loan losses 200,010,050 199,875,591
Allowance for loan losses (3,227,775) (2,753,793)
---------------- ----------------
Loans receivable, net $ 196,782,275 197,121,798
================ ================
</TABLE>
At September 30, 1998 and 1997 and during the years then ended there are no
loans considered to be impaired.
F-12 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
The Bank grants residential, residential construction, commercial real
estate, home equity and other loans to customers primarily throughout its
market area of Alamance County which includes the cities of Burlington,
Mebane and Graham. As reflected in the summary of loans receivable at
September 30, 1998, the largest component of the Bank's loan portfolio
consists of lower-risk, one-to-four family residential loans. The higher
risk components of the loan portfolio consist of real estate construction
loans, commercial real estate loans and commercial loans for which
repayment is dependent on the current real estate market and general
economic conditions. The consumer portfolio generally consists of smaller
loans to individuals in the Bank's primary market area and can also be
affected by general economic conditions.
The Bank's nonaccrual loans amount to approximately $263,000, $259,000 and
$288,000 at September 30, 1998, 1997 and 1996, respectively. If the Bank's
nonaccrual loans had been current in accordance with their original terms,
gross interest income of approximately $10,100, $27,300 and $25,800 would
have been recorded for the years ended September 30, 1998, 1997 and 1996,
respectively. Interest income on these loans included in net income was
approximately $15,000, $15,700 and $12,300 for 1998, 1997 and 1996,
respectively.
Loans serviced for others at September 30, 1998 and 1997 were approximately
$37,000,000 and $43,000,000, respectively. Mortgage servicing rights were
not material for any of the periods presented.
The Bank offers mortgage and consumer loans to its officers, directors, and
employees for the financing of their personal residences and for other
personal purposes. The Bank also offers commercial loans to companies
affiliated with directors. These loans are made in the ordinary course of
business and, in management's opinion, are made on substantially the same
terms, including interest rates and collateral, prevailing at the time for
comparable transactions with other persons and companies. Management does
not believe these loans involve more than the normal risk of collectibility
or present other unfavorable features, except for certain loans totaling
approximately $3.5 million to a company affiliated with a director. At
September 30, 1998, such loans were current with respect to their payment
terms and except for the waiver of certain debt covenants by the Bank, were
performing in accordance with the related loan agreements. Based on an
analysis of the affiliated company's current financial statements,
management has concerns that the borrower may have difficulty in complying
with the present loan repayment terms on an ongoing basis.
F-13 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
The following is a summary of the activity of loans outstanding to certain
executive officers, directors and their affiliates for the year ended September
30, 1998:
<TABLE>
<S> <C>
Balance at September 30, 1997 $ 7,495,243
New loans 1,412,420
Repayments 1,387,958
-----------------
Balance at September 30, 1998 $ 7,519,705
=================
</TABLE>
The Bank is a party to financial instruments with off-balance sheet risk
including commitments to extend credit under existing lines of credit and
commitments to sell loans. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets.
Off-balance sheet financial instruments whose contract amount represents credit
and interest rate risk are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998 1997
------------------- -------------------
<S> <C> <C>
Commitments to originate new loans $ 6,650,700 3,860,732
Commitments to originate new loans held for sale 833,411 224,863
Unfunded commitments to extend credit under existing equity
line and commercial lines of credit 40,444,057 34,593,971
Commercial letters of credit 505,000 874,709
Commitments to sell loans held for sale 1,863,591 684,438
</TABLE>
Commitments to originate new loans or to extend credit are agreements to lend to
a customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Bank upon extension of credit, is based on
management's credit evaluation of the borrower. The Bank's commitments to extend
credit under existing lines of credit relate principally to home equity lines of
credit which are secured by the borrower's primary residence.
Commitments to sell loans held for sale are agreements to sell loans to a third
party at an agreed upon price. At September 30, 1998, the aggregate fair value
of the commitments exceeded the cost of the loans to be sold.
F-14 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
(4) ALLOWANCE FOR LOAN LOSSES
The following is a summary of the activity in the allowance for loan
losses:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
1998 1997 1996
---------------- ---------------- ----------------
<S> <C> <C> <C>
Balance at beginning of year $ 2,753,793 2,495,677 2,222,765
Provision for loan losses 477,017 261,288 280,550
Charge-offs (3,731) (7,548) (12,477)
Recoveries 696 4,376 4,839
---------------- ---------------- ----------------
Net charge-offs (3,035) (3,172) (7,638)
---------------- ---------------- ----------------
Balance at end of year $ 3,227,775 2,753,793 2,495,677
================ ================ ================
</TABLE>
(5) INVESTMENT IN FHLB STOCK
As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in the stock of the FHLB. This stock is carried at cost since it
has no quoted fair value. See also note 8.
(6) PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998 1997
---------------- ----------------
<S> <C> <C>
Land $ 2,231,450 2,231,450
Building and improvements 5,166,911 5,166,911
Furniture and equipment 3,987,664 2,821,845
---------------- ----------------
11,386,025 10,220,206
Less accumulated depreciation (3,872,678) (3,448,406)
---------------- ----------------
Total $ 7,513,347 6,771,800
================ ================
</TABLE>
F-15 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
(7) DEPOSIT ACCOUNTS
A comparative summary of deposit accounts follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
-------------------------------------
WEIGHTED
BALANCE AVERAGE RATE
---------------- -----------------
<S> <C> <C>
Transactions accounts:
Noninterest bearing accounts $ 8,623,397 -- %
Interest bearing accounts:
Checking accounts 25,080,180 2.29%
Money market accounts 13,238,368 3.93%
Passbook and statement savings accounts 28,091,013 2.84%
Certificates of deposit 160,660,757 5.28%
---------------- -----------------
Total $ 235,693,715 4.40%
================ =================
<CAPTION>
SEPTEMBER 30, 1997
-------------------------------------
WEIGHTED
BALANCE AVERAGE RATE
---------------- -----------------
<S> <C> <C>
Transactions accounts:
Noninterest bearing accounts $ 6,546,032 -- %
Interest bearing accounts:
Checking accounts 24,149,622 2.32%
Money market accounts 11,117,680 3.64%
Passbook and statement savings accounts 27,699,834 2.84%
Certificates of deposit 159,827,435 5.33%
---------------- -----------------
Total $ 229,340,603 4.48%
================ =================
</TABLE>
Time deposits with balances of $100,000 or greater totaled approximately
$29,700,000 and $29,579,000 at September 30, 1998 and 1997, respectively.
F-16 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
At September 30, 1998, the scheduled maturities of certificate accounts
were as follows:
<TABLE>
<S> <C>
Year ending September 30,
1999 $ 116,528,391
2000 25,212,621
2001 10,643,247
2002 4,052,541
2003 4,188,260
2004 35,697
---------------
Total $ 160,660,757
===============
</TABLE>
Interest expense on deposit accounts is summarized below:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
1998 1997 1996
-------------- ------------- --------------
<S> <C> <C> <C>
Interest-bearing transaction accounts $ 1,004,155 898,330 770,911
Passbook and statement savings accounts 797,752 815,816 827,802
Certificate accounts 8,529,092 8,028,892 7,851,701
-------------- ------------- --------------
Total $ 10,330,999 9,743,038 9,450,414
============== ============= ==============
</TABLE>
On September 30, 1996, Congressional legislation was passed allowing a
special assessment to be levied by the FDIC to recapitalize the Savings
Association Insurance Fund ("SAIF"). The special assessment was based on
the level of SAIF deposits a financial institution had as of March 31, 1995
subject to a 20% reduction for certain qualifying deposits. The Bank's
special assessment in 1996 totaled $1,283,320.
(8) ADVANCES FROM FEDERAL HOME LOAN BANK OF ATLANTA
Advances from the FHLB of Atlanta at September 30, 1998 and 1997 totaled
$20,000,000 and $1,000,000, respectively, at an interest rate of 5.39% and
5.57%, respectively. These advances will mature on February 13, 2008.
At September 30, 1998 and 1997, the Bank had pledged all of its stock in
the FHLB (see note 5) and entered into a security agreement with a blanket
floating lien pledging all of its real estate loans to secure potential
borrowings. Under an agreement with the FHLB, the Bank must have
unencumbered collateral with principal balances, when discounted at 75% of
the unpaid principal, at least equal to 100% of the Bank's FHLB advances.
F-17 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
Interest expense on FHLB advances during the years ended September 30,
1998, 1997 and 1996 was $740,439, $55,910 and $3,152 respectively.
(9) NET WORTH AND REGULATORY MATTERS
At September 30, 1998, retained income-substantially restricted included
approximately $4,188,000 for which no provision for Federal income tax has
been made. This amount represents an allocation of income to bad debt
deductions for income tax purposes only. Reduction of such an amount for
purposes other than to absorb bad debt losses could create taxable income
in certain remote instances, which would be subject to the then current
corporate income tax rate.
The Bank is regulated by the Federal Deposit Insurance Corporation ("FDIC")
and the Administrator, Savings Institutions Division, North Carolina
Department of Commerce ("the Administrator"). The Bank must comply with the
capital requirements of the FDIC and the Administrator. The FDIC requires
the Bank to maintain minimum ratios of Tier I capital to risk-weighted
assets and total capital to risk-weighted assets of 4% and 8%,
respectively. To be "well capitalized," the FDIC requires ratios of Tier I
capital to risk-weighted assets and total capital to risk-weighted assets
of 6% and 10%, respectively. Tier I capital consists of total net worth
calculated in accordance with generally accepted accounting principles less
intangible assets, and total capital is comprised of Tier I capital plus
certain adjustments, the only one of which applicable to the Bank is the
allowance for loan losses. Risk-weighted assets reflect the Bank's on- and
off-balance sheet exposures after such exposures have been adjusted for
their relative risk levels using formulas set forth in FDIC regulations.
The Bank is also subject to a leverage capital requirement, which calls for
a minimum ratio of Tier I capital (as defined above) to quarterly average
total assets of 3%, and a ratio of 5% to be "well capitalized." The
Administrator requires a net worth equal to at least 5% of assets.
As summarized below, at September 30, 1998 and 1997, the Bank was in
compliance with all of the aforementioned capital requirements.
At September 30, 1998, the FDIC categorized the Bank as "well capitalized"
under the regulatory framework for prompt corrective action. There are no
events or conditions since the notification that management believes have
changed the Bank's category.
F-18 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
As of September 30:
<TABLE>
<CAPTION>
MINIMUM RATIOS
------------------------------------
TO BE "WELL
FOR CAPITAL CAPITALIZED" FOR
CAPITAL AMOUNT RATIO ADEQUACY PROMPT CORRECTIVE
--------------------- --------------------
1998 1997 1998 1997 PURPOSES ACTION PURPOSES
--------- ---------- --------- --------- --------------- -----------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Tier I Capital (to risk-
weighted assets) $ 25,873 23,049 14.53% 14.05% 4.00% 6.00%
Total Capital - Tier II
(to risk-weighted
assets) 28,112 25,108 15.78% 15.30% 8.00% 10.00%
Leverage - Tier I capital
(to average assets) 25,873 23,049 9.13% 9.02% 4.00% 5.00%
Total Capital - (to
fourth quarter
average assets) 28,112 25,108 9.92% 9.82% 3.00% 5.00%
</TABLE>
(10) INCOME TAXES
Components of income tax expense (benefit) consist of the following:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
1998 1997 1996
---------------- ---------------- ----------------
<S> <C> <C> <C>
Currently payable:
Federal $ 1,804,000 1,221,100 657,500
State 159,000 87,000 11,000
------------ -------------- --------------
1,963,000 1,308,100 668,500
------------ -------------- --------------
Deferred:
Federal (486,000) 139,000 172,000
State (115,000) -- --
------------ -------------- --------------
(601,000) 139,000 172,000
------------ -------------- --------------
Total $ 1,362,000 1,447,100 840,500
============ ============== ==============
</TABLE>
Other assets include current income taxes receivable of $251,000 at
September 30, 1998. Other liabilities include current income taxes payable
of $76,000 at September 30, 1997.
F-19 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
A reconciliation of reported income tax expense for the years ended September
30 1998 and 1997, to the amount of the income tax expense computed by
multiplying income before income taxes by the statutory federal income tax
rate of 34% follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Income tax expense at statutory rate $ 1,320,000 1,359,000 828,500
Increase in income taxes resulting from:
State income taxes, net of federal benefit 29,000 57,000 7,000
Other 13,000 31,100 5,000
--------- --------- ---------
Income tax expense $ 1,362,000 1,447,100 840,500
========= ========= =========
</TABLE>
The significant components of deferred tax assets (liabilities) which are
included in other assets, at September 30, 1998 and 1997, respectively, are:
<TABLE>
<CAPTION>
1998 1997
---------------- ----------------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $ 1,079,000 851,000
Loan fees deferred for financial reporting, net 52,000 49,000
Deferred compensation 750,000 369,000
Other than temporary declines in value of
securities available for sale 97,000 --
Unrealized gains on investments securities available for sale -- 47,000
Other 3,000 4,000
---------------- ----------------
Total gross deferred tax assets 1,981,000 1,320,000
---------------- ----------------
Less valuation allowance -- --
---------------- ----------------
Deferred tax assets net of valuation allowance 1,981,000 1,320,000
---------------- ----------------
Deferred tax liabilities:
Depreciable basis of fixed assets (288,000) (270,000)
Tax basis of FHLB stock (179,000) (168,000)
Loan fees (231,000) (158,000)
Unrealized losses on investment securities available for sale (59,000) --
Other (17,000) (12,000)
---------------- ----------------
Total gross deferred tax liabilities (774,000) (608,000)
---------------- ----------------
Net deferred tax asset $ 1,207,000 712,000
================ ================
</TABLE>
F-20 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
There is no valuation allowance for deferred tax assets as it is
management's contention that realization of the deferred tax assets is more
likely than not based upon the Bank's history of taxable income and
estimates of future taxable income.
The Bank is permitted under the Internal Revenue Code to deduct an annual
addition to a reserve for bad debts in determining taxable income, subject
to certain limitations. This addition differs significantly from the
provisions for loan and real estate owned losses for financial reporting
purposes. Under FASB 109, the Bank is not required to provide a deferred
tax liability for the tax effect of additions to the tax bad debt reserve
through 1987, the base year. Retained income at September 30, 1998,
includes approximately $4,188,000 for which no provision for federal income
tax has been made. These amounts represent allocations of income to bad
debt deductions for tax purposes only. Reductions of such amounts for
purposes other than tax bad debt losses could create income for tax
purposes in certain remote instances, which would be subject to the then
current corporate income tax rate.
(11) RETIREMENT PLANS
The Bank has two defined contribution retirement plans covering
substantially all of its employees. Retirement costs are funded as accrued.
Contributions to the plans are determined based upon specified percentages
of annual salaries. Retirement expense for the years ended September 30,
1998, 1997, and 1996 was approximately $191,000, $207,000 and $215,000,
respectively.
Directors and certain executive officers participate in a deferred
compensation plan which was approved by the Board of Directors on September
24, 1997. This plan generally provides for fixed payments beginning at age
62. The plan provides for past service credits of up to nine years, with
vesting of 100% and 60% at September 30, 1998 and 1997, respectively. In
addition, an annual amount will be credited to the participants accounts in
subsequent years which will be fully vested at all times. In future years,
directors may elect to defer directors' fees and executive officers may
defer 25% of their salary and 100% of bonus compensation. The expense
related to these plans for the years ended September 30, 1998 and 1997 was
$986,663 and $1,085,000, respectively, and is included in compensation
expense. The related liabilities at September 30, 1998 and 1997 of
approximately $1,085,000 and $2,072,000, respectively, are included in
other liabilities.
F-21
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
(12) LEASING ARRANGEMENTS
Rental expense was approximately $33,000 and $35,000 for the years ended
September 30, 1998 and 1997, respectively. All leases are accounted for as
operating leases. Minimum annual rents under noncancelable operating leases
with remaining terms in excess of one year at September 30, 1998 are as
follows:
<TABLE>
<CAPTION>
OFFICE
PROPERTIES
--------------
<S> <C>
Year ending September 30,
1999 $ 15,000
2000 17,250
2001 18,000
2002 18,000
2003 18,000
Thereafter 127,500
--------------
Total $ 213,750
==============
</TABLE>
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires a company to disclose the fair value of its financial instruments,
whether or not recognized in the balance sheet, where it is practical to
estimate that value.
The fair value estimates are made at a specific point in time based on
relevant market information about the financial instrument. These estimates
do not reflect any premium or discount that could result from offering for
sale at one time the Bank's entire holding of a particular financial
instrument. In cases where quoted market prices are not available, fair
value estimates are based on judgments regarding current economic
conditions, risk characteristics of various financial instruments, and
other factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and, therefore, cannot be
determined with precision. Changes in assumptions could significantly
affect the estimates. In addition, the tax ramifications related to the
realization of the unrealized gains and losses can have a significant
effect on fair value estimates and have not been considered in the
estimates. Finally, the fair value estimates presented herein are based on
pertinent information available to management as of September 30, 1998 and
1997, respectively. Such amounts have not been comprehensively revalued for
purposes of these financial statements since those dates and, therefore,
current estimates of fair value may differ significantly from the amounts
presented herein.
F-22 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
The following methods and assumptions were used by the Bank in estimating
its fair value disclosures for financial instruments:
(A) CASH AND CASH EQUIVALENTS
The carrying amounts reported in the balance sheet for cash and cash
equivalents approximate those assets' fair values.
(B) INVESTMENT SECURITIES
Fair values were based on quoted market prices, where available. If
quoted market prices were not available, fair values were based on
quoted market prices of comparable instruments.
(C) LOANS RECEIVABLE
The carrying values of variable-rate loans and other loans with short-
term characteristics were considered to approximate the fair values.
For other loans, the fair values were calculated using discounted cash
flow analyses, using interest rates currently being offered for loans
with similar terms and credit quality.
(D) DEPOSIT ACCOUNTS
The fair value of deposits with no stated maturity, such as
noninterest-bearing demand deposits, NOW, passbook, and money market
deposits, was, by definition, equal to the amount payable on demand as
of September 30, 1998 and 1997, respectively. The fair value of
certificates of deposit was estimated using discounted cash flow
analyses, using interest rates currently offered for deposits of
similar remaining maturities.
(E) ADVANCES FROM THE FHLB
The fair value of advances from the FHLB was estimated using
discounted cash flow analyses, using interest rates currently offered
for advances of similar remaining maturities.
F-23 (Continued)
<PAGE>
1ST STATE BANK AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 1998, 1997 and 1996
(With Independent Auditors' Report Thereon)
The estimated fair values of financial instruments are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------------------------
CARRYING ESTIMATED
VALUE FAIR VALUE
---------------- ----------------
<S> <C> <C>
Financial Assets:
Cash and cash equivalents $ 31,077,054 31,077,054
Investment securities 40,052,874 40,273,227
Loans held for sale 7,539,919 8,192,660
Loans receivable, net of allowance for loan losses 196,782,275 201,783,429
Federal Home Loan Bank stock 1,346,500 1,346,500
================ ================
Financial Liabilities:
Deposit accounts $ 235,693,715 235,904,989
Advances from the Federal Home Loan Bank 20,000,000 21,038,755
================ ================
<CAPTION>
SEPTEMBER 30, 1997
------------------------------------
CARRYING ESTIMATED
VALUE FAIR VALUE
---------------- ----------------
<S> <C> <C>
Financial Assets:
Cash and cash equivalents $ 14,990,413 14,990,413
Investment securities 34,801,287 34,859,547
Loans held for sale 684,438 684,438
Loans receivable, net of allowance for loan losses 197,121,798 197,864,510
Federal Home Loan Bank stock 1,281,200 1,281,200
================ ================
Financial Liabilities:
Deposit accounts $ 229,340,603 229,704,672
Advances from the Federal Home Loan Bank 1,000,000 1,000,000
================ ================
</TABLE>
At September 30, 1998 and 1997, the Bank had outstanding commitments to
originate new loans and to extend credit. These off-balance sheet financial
instruments were exercisable at the market rate prevailing at the date the
underlying transaction will be completed and, therefore, they were deemed to
have no current fair market value.
SFAS 107 excludes certain financial instruments and all non-financial
instruments from its disclosure requirements. The disclosures also do not
include premises and equipment and certain intangible assets, such as customer
relationships. Accordingly, the aggregate fair value amounts presented above do
not represent the underlying value of the Bank.
F-24
<PAGE>
No dealer, salesman or other person has been authorized to give any information
or to make any representations not contained in this document in connection with
the offering made hereby, and, if given or made, such information or
representations must not be relied upon as having been authorized by 1st State
Bank, 1st State Bancorp, or Trident Securities. This document does not
constitute an offer to sell, or the solicitation of an offer to buy, any of the
securities offered hereby to any person in any jurisdiction in which such offer
or solicitation would be unlawful. Neither the delivery of this document by 1st
State Bank, 1st State Bancorp, or Trident Securities nor any sale made hereunder
shall in any circumstances create an implication that there has been no change
in the affairs of 1st State Bank or 1st State Bancorp, since any of the dates as
of which information is furnished herein or since the date hereof.
1st STATE BANCORP, INC.
(Holding Company for 1st State Bank)
Up to 2,133,750 Shares
Common Stock
PROSPECTUS
TRIDENT SECURITIES, INC.
Dated __________, 1999
THESE SECURITIES ARE NOT DEPOSITS OR ACCOUNTS
AND ARE NOT FEDERALLY INSURED OR GUARANTEED.
DEALER PROSPECTUS DELIVERY OBLIGATION
UNTIL , 1999 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
-------- --
DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS
IS IN ADDITION TO THE DEALERS OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
<PAGE>
PART II: INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
<TABLE>
<S> <C> <C>
Legal Fees and Expenses......................... $ 160,000
Printing, Postage and Mailing................... 150,000
Appraisal and Business Plan Fees and Expenses... 35,000
Conversion Agent Fees and Expenses.............. 25,000
Transfer Agent Fees and Stock Certificates...... 15,000
Accounting Fees and Expenses.................... 125,000
Blue Sky Filing Fees and Expenses
(including counsel fees)...................... 15,000
Filing Fees (Administrator, Commissioner,
SEC, and NASD)............................... 50,000
* Underwriter's Fees and Expenses................. 399,600
Local Counsel................................... 5,000
Other Expenses.................................. 150,400
----------
Total........................................... $1,130,000 **
==========
- -------------------------
</TABLE>
* Calculation of Trident Securities' commissions assumes that the midpoint of
the offering range is sold in the conversion and 8% of the stock is
purchased by the employee stock ownership plan.
** Assumes sale of 2,250,000 shares (the midpoint of the offering range).
Item 14. Indemnification of Directors and Officers
Indemnification of Directors and Officers of the Company
The Amended and Restated Certificate of Incorporation of 1st State Bank
provides that, to the fullest extent permitted by the North Carolina Business
Corporation Act (the "NCBCA"), no person who serves as a director shall be
personally liable to the Savings Bank or any of its stockholders or otherwise
for monetary damages for breach of any duty as director.
In addition, Article IX of the Amended and Restated Bylaws of the Converted
Bank state that any individual who at any time serves or has served as a
director, officer, employee or agent of the Converted Bank, and any individual
who serves or has served at the request of the Converted Bank as a director,
officer, partner, trustee, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, or as a trustee or
administrator under an employee benefit plan, shall have a right to be
indemnified by the Converted Bank to the fullest extent permitted by law against
liability and litigation expense arising out of such status or activities in
such capacity. Article IX of the Amended and Restated Bylaws of the Commercial
Bank contain similar provisions.
Sections 55-8-50 through 55-8-58 of the NCBCA contain provisions prescribing
the extent to which directors and officers of the Converted Bank and the
Commercial Bank shall or may be indemnified. Section 55-8-51 of the NCBCA
permits a corporation, with certain exceptions, to indemnify a present or former
director against liability if (i) the director conducted himself in good faith,
(ii) the director reasonably believed (x) that the director's conduct in the
director's official capacity with the corporation was in its best interests and
(y) in all other cases the director's conduct was at least not opposed to the
corporation's best interests, and (iii) in the case of any criminal proceeding,
the director had no reasonable cause to believe the director's conduct was
unlawful. A corporation may not indemnify a director in connection with a
proceeding by or in the right of the corporation in which the director was
adjudged liable to the corporation or in connection with a proceeding charging
improper personal benefit to the director. The above standard
II-1
<PAGE>
of conduct is determined by a majority vote of a quorum of the board of
directors consisting of directors not at the time parties to the proceeding, or
majority vote of a duly designated committee of the board of directors, special
legal counsel, or the shareholders as prescribed in Section 55-8-55.
Sections 55-8-52 and 55-8-56 of the NCBCA require a corporation to indemnify a
director or officer in the defense of any proceeding to which the director or
officer was a party against reasonable expenses when the director or officer is
wholly successful in the director's or officer's defense, unless the articles of
incorporation provide otherwise. Upon application, the court may order
indemnification of the director or officer if the director or officer is
adjudged fairly and reasonably so entitled under Section 55-8-54.
In addition, Section 55-8-57 of the NCBCA permits a corporation to provide for
indemnification of directors, officers, employees or agents, in its articles of
incorporation or bylaws or by contract or resolution, against liability in
various proceedings and to purchase and maintain insurance policies on behalf of
these individuals. The Savings Bank currently maintains a directors and
officers liability insurance policy.
Directors, officers and employees of the Company may be entitled to benefit
from the indemnification provisions contained in the Virginia Stock Corporation
Act (the "VSCA") and the Holding Company's Articles of Incorporation. The
general effect of these provisions is summarized below.
In accordance with Sections 13.1-696 through 13.1-704 of the VSCA, a director
or officer of the Company generally shall be indemnified in the defense of a
proceeding if they are successful. A corporation may indemnify a director,
officer, employee or agent under the circumstances in the preceding sentence and
in other circumstances if (i) he conducted himself in good faith; and (ii) he
believed (x) that his conduct in his official capacity with the corporation was
in its best interests and (y) in all other cases his conduct was at least not
opposed to the corporation's best interests, and (iii) in the case of any
criminal proceeding, he had no reasonable cause to believe that his conduct was
unlawful. A corporation may not indemnify a director, officer, employee or
agent in connection with a proceeding by or in the right of the corporation in
which the individual was adjudged liable to the corporation or in connection
with a proceeding charging improper personal benefit to the individual. The
above standard of conduct is determined by a majority vote of a quorum of the
board of directors consisting of directors not at the time parties to the
proceeding, or majority vote of a duly designated committee of the board of
directors, special legal counsel, or the shareholders as prescribed in Section
13.1-701.
Sections 13.1-698 and 13.1-702 of the VSCA require a corporation to indemnify
a director or officer in the defense of any proceeding to which the director or
officer was a party against reasonable expenses when the director or officer is
wholly successful in the director's or officer's defense, unless the articles of
incorporation provide otherwise. Upon application, the court may order
indemnification of the director or officer if the director or officer is
adjudged fairly and reasonably so entitled under Section 13.1-700.1.
In addition, Section 13.1-704 of the VSCA permits a corporation to provide
for indemnification of directors, officers, employees or agents, in its articles
of incorporation or bylaws or by contract or resolution, against liability in
various proceedings and to purchase and maintain insurance policies on behalf of
these individuals, except an indemnity against willful misconduct or a knowing
violation of criminal law.
Article XVI of the Holding Company's Articles of Incorporation provides that
the Holding Company shall indemnify, to the fullest extent permissible under the
VSCA, any individual who is or was a director, officer, employee or agent of the
Holding Company, and any individual who serves or served at the Holding
Company's request as a director, officer, partner, trustee, employee or agent of
another corporation, partnership, joint venture, trust, other enterprise or
employee benefit plan, in any proceeding in which the individual is made a party
as a result of his service in such capacity. In addition, the Holding Company
must pay reasonable expenses incurred by any person identified in the preceding
sentence who is a party to a proceeding in advance of the final disposition of
the proceeding upon receipt by the Holding Company of: (i) a written
affirmation by such person of his good faith belief that the standard
II-2
<PAGE>
of conduct necessary for indemnification by the Holding Company as authorized in
Article XVI has been met; and (ii) a written undertaking by or on behalf of such
person to repay the amount if it shall ultimately be determined that the
standard of conduct has not been met.
Article XVI further provides that the Holding Company shall purchase and
maintain insurance on behalf of any person who holds or who has held any
position as a director or officer of the Holding Company against any liability
incurred by him or her in any such position, or arising out of his status as
such, whether or not the Corporation would have power to indemnify him or her
against such liability under Article XVI.
The engagement letter dated July 24, 1998, between the Savings Bank and
Ferguson provides for the indemnification of Ferguson and its employees under
certain circumstances, in connection with the appraisal services rendered under
the terms of that engagement letter. The engagement letter dated July 27, 1998,
between the Savings Bank and Trident Securities provides for the indemnification
of Trident Securities and its controlling persons under certain circumstances,
in connection with the Conversion and Trident Securities' engagement under the
engagement letter. The Sales Agency Agreement to be entered into between
Trident Securities and the Company will provide for the indemnification of
Trident Securities, its affiliates, and their respective officers, directors,
employees, agents and controlling persons under certain circumstances.
Item 15. Recent Sales of Unregistered Securities.
Not applicable.
Item 16. Exhibits and Financial Statement Schedules:
The exhibits and financial statement schedules filed as a part of this
registration statement are as follows:
(a) List of Exhibits
* 1.1 Engagement Letter with Trident Securities, Inc.
* 1.2 Form of Sales Agency Agreement with Trident Securities, Inc.
* 2 Plan of Conversion
* 3.1 Articles of Incorporation of 1st State Bancorp, Inc.
* 3.2 Bylaws of 1st State Bancorp, Inc.
* 4 Form of Common Stock Certificate of 1st State Bancorp, Inc.
* 5 Opinion of Housley Kantarian & Bronstein, P.C. regarding legality of
securities being registered
* 8.1 Federal Tax Opinion of Housley Kantarian & Bronstein, P.C.
* 8.2 State Tax Opinion of KPMG LLP
* 8.3 Opinion of Ferguson & Company as to the value of subscription rights
for tax purposes
II-3
<PAGE>
* 10.1 Proposed 1st State Bancorp, Inc. 1999 Stock Option and Incentive
Plan
* 10.2 Proposed 1st State Bancorp, Inc. Management Recognition Plan
* 10.3 Employment Agreements by and between 1st State Bank and James C.
McGill, A. Christine Baker and Fairfax C. Reynolds
* 10.4 Form of Guaranty Agreement by and between 1st State Bancorp, Inc.
and James C. McGill, A. Christine Baker and Fairfax C. Reynolds
* 10.5 1st State Bank Deferred Compensation Plan
* 23.1 Consent of Housley Kantarian & Bronstein, P.C. (contained in
opinions filed as Exhibits 5 and 8)
23.2 Consent of KPMG LLP
23.3 Consent of Ferguson & Company
24 Power of Attorney (reference is made to the signature page of the
Form S-1)
* 27 Financial Data Schedule
* 99.1
Form of Proposed Stock Order Form and Form of Certification
* 99.2 Proxy Statement for Special Meeting of Members of 1st State Bank;
Form of Proxy
99.3 Revised Miscellaneous Solicitation and Marketing Materials
99.4 Appraisal Report as of January 29, 1999
____________
* Previously filed.
(b) Financial Statement Schedules.
No financial statement schedules are filed because the required information is
not applicable or is included in the consolidated financial statements or
related notes.
Item 17. Undertakings
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
II-4
<PAGE>
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post-
effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any of
the securities being registered which remain unsold at the termination of the
offering.
The undersigned registrant hereby undertakes to provide to the underwriter at
the closing specified in the underwriting agreements, certificates in such
denominations and registered in such names as required by the underwriter to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the questions whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Burlington,
State of North Carolina, on February 11, 1999.
1ST STATE BANCORP, INC.
By: /s/ James C. McGill
-------------------------------
James C. McGill
President
Pursuant to the requirements of the Securities Act of 1933, as amended,
this registration statement has been signed below by the following persons in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
/s/James C. McGill President, Chief Executive Officer February 11, 1999
- ------------------------- and Director (Principal Executive Officer)
James C. McGill
/s/ A. Christine Baker Executive Vice President-Chief February 11, 1999
- ------------------------- Financial Officer, Secretary and
A. Christine Baker Treasurer (Principal Financial and
Accounting Officer)
* Chairman of the Board February 11, 1999
- -------------------------
Richard C. Keziah
* Director February 11, 1999
- -------------------------
James A. Barnwell, Jr.
* Director February 11, 1999
- -------------------------
Bernie C. Bean
* Director February 11, 1999
- -------------------------
James G. McClure
* Director February 11, 1999
- -------------------------
T. Scott Quakenbush
* Director February 11, 1999
- -------------------------
Richard H. Shirley
* Director February 11, 1999
- -------------------------
Virgil L. Stadler
* By: /s/ James C. McGill February 11, 1999
-------------------
James C. McGill
Attorney-in-fact
</TABLE>
II-6
<PAGE>
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
-----------------------------
Board of Directors
1st State Bank:
We consent to the use of our report included herein, and to the reference to our
firm under the heading "Experts" in the prospectus.
/s/ KPMG LLP
Greensboro, North Carolina
February 9, 1999
<PAGE>
EXHIBIT 23.3
FERGUSON & COMPANY LETTERHEAD APPEARS HERE
FEBRUARY 9, 1999
BOARD OF DIRECTORS
1st STATE BANK
445 S. MAIN STREET
BURLINGTON, NORTH CAROLINA 27215
DIRECTORS:
We hereby consent to the use of our firm's name in the applications
for conversion of 1st State Bank, Burlington, North Carolina, and any amendments
thereto, filed with the Division of Savings Institutions, North Carolina
Department of Commerce (the "Division"), and the FDIC, in the Form S-1
Registration Statement and any amendments thereto, and in the Acquisition
Application and the Holding Company Application for 1st State Bancorp, Inc. as
filed with the Division and the Federal Reserve Board, respectively. We also
hereby consent to the inclusion of, a summary of, and references to our
Appraisal Report and our opinion concerning subscription rights in such filings
including the Prospectus of 1st State Bancorp, Inc. and the Proxy Statement of
1st State Bank.
Sincerely,
/s/ Robin L. Fussell
Robin L. Fussell
Principal
<PAGE>
Exhibit 99.3
1st State Bancorp, Inc.
(Proposed Holding Company for
1st State Bank)
Burlington, North Carolina
Proposed Marketing Materials
February 5, 1999
<PAGE>
Marketing Materials for
1st State Bank
Table of Contents
-----------------
I. Press Release
A. Explanation
B. Schedule
C. Distribution List
D. Examples
II. Question and Answer Brochure
A. Explanation
B. Method of Distribution
C. Example
III. Officer and Director Brochure
A. Explanation
B. Method of Distribution
C. Example
IV. Counter Cards, Lobby Posters and a Tombstone Announcement
A. Explanation
B. Quantity
C. Examples
V. Community Meeting Materials and Prospect Letters
A. Explanation
B. Examples
VI. Cover Letters
A. Explanation
B. Method of Distribution
C. Examples
VII. IRA Mailing
A. Explanation
B. Quantity
C. Example
VIII. Proxygram
A. Explanation
B. Example
<PAGE>
I. Press Releases
A. Explanation
In an effort to assure that all customers, community members, and other
interested investors receive prompt accurate information in a simultaneous
manner, Trident Securities, Inc. advises 1st State Bank to forward press
releases to national and regional publications, newspapers, radio stations,
etc., at various points during the conversion process.
Only press releases approved by Conversion Counsel will be forwarded for
publication in any manner.
B. Press Releases
1. Approval of Conversion by the FDIC, Administrator, Savings
Institutions Division, North Carolina Department of Commerce and the
Securities and Exchange Commission
2. Close of Stock Offering
C. Distribution Lists (see attached)
D. Examples (see attached)
<PAGE>
C. National Media Distribution List
------------------------------------
American Banker
- ---------------
One State Street Plaza
New York, New York 10004
Michael Weinstein
Wall Street Journal
- -------------------
World Financial Center
200 Liberty
New York, New York 10004
SNL Securities
- --------------
Post Office Box 2124
Charlottesville, Virginia 22902
Barrons
- -------
Dow Jones & Company
Barron's Statistical Information
200 Burnett Road
Chicopee, Massachusetts 01020
Investors Business Daily
- ------------------------
12655 Beatrice Street
Post Office Box 661750
Los Angeles, California 90066
Local Media Distribution List
-----------------------------
(to be provided)
<PAGE>
Press Release
FOR IMMEDIATE RELEASE
---------------------
For More Information Contact:
James C. McGill, President
Telephone: (336) 227-8861
1st STATE BANK
--------------
STOCK SALE APPROVED
-------------------
Burlington, North Carolina - Mr. James C. McGill, President of 1st State
Bank, Burlington, North Carolina, announced today that 1st State Bank has
received approval from the FDIC and the Administrator, Savings Institution
Division, North Carolina Department of Commerce to convert from a North Carolina
mutual savings bank to a North Carolina stock savings bank and to become a
wholly-owned subsidiary of a newly-formed holding company, 1st State Bancorp,
Inc. (the "Company"). Following completion of the stock conversion, 1st State
Bank intends to convert from a North Carolina stock savings bank to a North
Carolina commercial bank to be known as "1st State Bank."
A Prospectus and Proxy Statement describing the Plan of Conversion will be
mailed to certain members of 1st State Bank on or about ___________, 1999.
Under the Plan of Conversion, the Company is offering an estimated 1,500,000
shares, subject to adjustment, of common stock at $20.00 per share. Certain of
1st State Bank's past and present depositors and borrowers will have the
opportunity to purchase stock through a subscription offering that closes on
________, 1999. Shares that are not subscribed for during the subscription
offering, if any, will be offered to the general public, with preference given
to natural persons and trusts of natural persons who are permanent residents of
Alamance County, North Carolina, in a community offering. The offerings are
being managed by Trident Securities, Inc., of Raleigh, North Carolina.
James C. McGill stated "1st State Bank remains committed to serving its
local market as a hometown community financial institution."
<PAGE>
1st State Bank is based in Burlington, North Carolina. The Bank was founded
in 1914. At September 30, 1998, 1st State Bank had total assets of $288.2
million and retained income of $26.0 million. Customers or interested members of
the community with questions concerning the stock offering should call the
institution at (336) _________ or visit 1st State Bank.
<PAGE>
Press Release FOR IMMEDIATE RELEASE
---------------------
For More Information Contact:
James C. McGill, President
Telephone: (336) 227-8861
1st STATE BANCORP, INC., HOLDING
--------------------------------
COMPANY FOR 1st STATE BANK,
---------------------------
COMPLETES INITIAL STOCK OFFERING
--------------------------------
Burlington, North Carolina - Mr. James C. McGill, President of 1st State
Bank, based in Burlington, North Carolina, announced today that 1st State
Bancorp, Inc., the holding company for 1st State Bank, has completed its initial
common stock offering. It is anticipated that the common stock of 1st State
Bancorp, Inc. will begin trading on the Nasdaq National Market System under the
symbol "____" on or about ___________, 1999. Trident Securities, Inc., Raleigh,
North Carolina and Atlanta, Georgia, will be a market maker. In addition,
following the stock conversion, the institution will convert to a North Carolina
commercial bank. 1st State Bancorp, Inc., will issue __________ shares of its
common stock.
The net proceeds contributed to 1st State Bank upon conversion will
substantially increase its capital. 1st State Bank ultimately intends to use
such funds for general corporate purposes, among them the origination of loans
and other investments. It is expected that in the interim all or part of the
proceeds will be invested in short-term and intermediate-term securities.
On __________, 1999, 1st State Bank's Plan of Conversion was approved by
1st State Bank's depositor and borrower members at a Special Meeting that was
held at the main office of the institution.
Mr. McGill indicated that the Officers and Board of Directors of 1st State
Bank want to express their thanks for the response by customers and the
community to the stock offering and that the Bank looks forward to serving the
needs of its customers as a stock institution.
<PAGE>
II. Question and Answer Brochure
A. Explanation
The Question and Answer brochure is an essential marketing piece in any
conversion. It serves to answer some of the most commonly asked questions
in "plain, everyday language." Although most of the answers are taken
verbatim from the Prospectus and Proxy Statement, it assists the individual
in finding answers to simple questions.
Conversion Counsel approves the language for each Question and Answer.
Trident Securities, Inc. and 1st State Bank will be responsible for any
introductory or concluding remarks, design, layout, color, and paper stock.
This will be coordinated through Trident Securities, Inc. in conjunction
with the financial printer.
B. Method of Distribution
There are three primary methods of distribution of the Question and Answer
brochure. However, regardless of the method, the brochure is always
accompanied by a Prospectus.
1. A Question and Answer brochure is sent out in the initial mailing to
all members of 1st State Bank.
2. Question and Answer brochures are available in 1st State Bank's
office.
3. Question and Answer brochures are sent out in a standard information
packet to all interested investors who phone the Stock Information
Center requesting information.
C. Example
<PAGE>
1st State Bank
Burlington, North Carolina
MUTUAL TO STOCK CONVERSION
--------------------------
1st State Bank's Board of Directors has unanimously voted to convert the savings
bank from its present mutual form to a stock institution, subject to approval of
the conversion by 1st State Bank's members and regulatory authorities, and,
immediately thereafter, to convert to a North Carolina commercial bank.
Complete details on the conversion, including reasons for conversion, are
contained in the Prospectus and Proxy Statement. We urge you to read them
carefully.
This brochure is provided to answer basic questions you might have about the
conversion. Remember, the conversion will not affect the rate on any of your
savings accounts, deposit certificates, or loans.
1. Q. What is a "Conversion"?
A. Conversion is a change in the legal form of organization. Following
completion of the conversion from a North Carolina mutual savings bank
to a North Carolina stock savings bank, 1st State Bank intends to
convert to a North Carolina commercial bank to be known as "1st State
Bank" (the "Bank"). 1st State Bank currently operates as a North
Carolina mutual savings bank with no shareholders. Through the
conversion, 1st State Bank will form a holding company, 1st State
Bancorp, Inc., which will ultimately own all of the outstanding stock
of the Bank. 1st State Bancorp, Inc. will issue stock in the
conversion, as described below, and will be a publicly-owned company.
2. Q. Why is 1st State Bank converting?
A. The stock form of ownership is used by most business corporations and
financial institutions. 1st State Bank has reached an important point
in its development with its decision to convert to the stock form of
ownership. 1st State Bank's management believes the continued
diversification of the institution's asset and deposit base and the
establishment of new banking services should enhance long-term
operating potential. The capital raised by issuing stock will:
* Enhance the Bank's capital position.
* Facilitate future access to the capital markets.
* Provide additional funds for increased lending and investment
opportunities.
* Support future growth by the Bank
<PAGE>
3. Q. Will the conversion have any effect on savings accounts,
certificates of deposit or loans with 1st State Bank?
A. No. The conversion will not change the amount, interest rate or
withdrawal rights of savings and checking accounts or certificates of
deposit. The rights and obligations of borrowers under their loan
agreements will not be affected. However, upon consummation of the
conversion, 1st State Bank's deposit account holders and borrowers
will no longer have voting rights unless they purchase common stock in
1st State Bancorp, Inc.
4. Q. Will the conversion cause any changes in personnel or management?
A. No. The conversion will not cause any changes in personnel or
management of 1st State. The normal day-to-day operations will
continue as before.
5. Q. Did the Board of Directors of 1st State Bank approve the conversion?
A. Yes. The Board of Directors unanimously adopted the Plan of Conversion
on ________.
THE SUBSCRIPTION AND COMMUNITY OFFERING
---------------------------------------
6. Q. Who is entitled to buy 1st State Bancorp, Inc. common stock?
A. Subscription rights to buy common stock will be given in order of
priority to (i) depositors of the Bank as of December 31, 1994 with a
$50.00 minimum deposit at that date (the "Eligible Account Holders");
(ii) the Company's employee stock ownership plan (the "ESOP"), a tax
qualified employee stock benefit plan; (iii) depositors of the Bank
with $50.00 or more on deposit as of December 31, 1998 (the
"Supplemental Eligible Account Holders"); and (iv) certain depositors
and borrowers as of ________ ("Other Members"), subject to the
purchase limitations set forth in the Plan of Conversion.
Shares that are not subscribed for during the subscription offering,
if any, may be offered to the general public through a community
offering with preference given to natural persons and trusts of
natural persons who are permanent residents of Alamance County, North
Carolina (the "Local Community"). It is anticipated that any shares
not subscribed for in the Subscription and Community Offerings will be
offered to certain members of the general public through a syndicate
of registered broker dealers pursuant to selected dealers agreements
in a Syndicated Community Offering.
7. Q. How do I subscribe for shares of stock?
A. Eligible customers wishing to exercise their subscription rights must
return the enclosed Stock Order Form to 1st State Bank. The Stock
Order Form must be completed and returned along with full payment or
appropriate instructions authorizing a withdrawal from a deposit
account at 1st State Bank on or prior to the close of the Subscription
Offering which is 12:00 noon, Eastern time, on ________, 1999, unless
extended.
<PAGE>
8. Q. How can I pay for my subscription?
A. First, you may pay for your stock in cash (if delivered in person to
1st State Bank) or by check or money order. These funds will earn
interest at 1st State Bank's passbook rate from the day we receive
them until the completion or termination of the conversion.
Second, you may authorize us to withdraw funds from your 1st State
Bank savings account or certificate of deposit without early
withdrawal penalty. These funds will continue to earn interest at the
rate in effect for your account until completion of the offering at
which time your funds will be withdrawn for your purchase. Funds
remaining in this account (if any) will continue at the contractual
rate unless the withdrawal reduces the account balance below the
applicable minimum in which case you will receive interest at the
passbook rate. A hold will be placed on your account for the amount
you specify for stock payment. You will not have access to these funds
from the day we receive your order until the completion or termination
of the conversion.
If you want to use Individual Retirement Account deposits held at 1st
State Bank to purchase stock, call our Stock Information Center at
________ for assistance. This transaction takes several days to
complete. Therefore, you must make arrangements to utilize 1st State
IRA funds no later than ________. There will be no early withdrawal or
IRS penalties incurred by these transactions, but additional paperwork
is necessary.
9. Q. When must I place my order for shares of stock?
A. To exercise subscription rights in the subscription offering, a Stock
Order Form must be received by 1st State Bank with full payment for
all shares subscribed for not later than 12:00 noon, Eastern time, on
________, 1999.
Non-customers desiring to order shares through the community offering,
if any, must order shares before the close of the community offering,
which will be no sooner than 12:00 noon, Eastern time on March 24,
1999, unless extended.
10. Q. How many shares of stock are being offered?
A. 1st State Bancorp, Inc. is offering 1,500,000 shares of common stock
at a price of $20.00 per share. The number of shares may be decreased
to 1,275,000 or increased to 1,983,750 in response to the independent
appraiser's final determination of the consolidated pro forma market
---------
value of the common stock issued in the conversion.
11. Q. What is the minimum and maximum number of shares that I can purchase
during the offering period?
A. The minimum number of shares that may be purchased is 25 shares. No
Stock Order Form will be accepted for less than $500.00. No person,
including associates of and persons acting in concert with such person
(other than the ESOP), including individuals on a joint account or
having the same address on the Bank's records, may purchase in the
Stock Conversion more than $1,000,000 or 50,000 shares of common
stock.
<PAGE>
12. Q. How was it determined that between 1,275,000 shares and 1,983,750
shares of stock would be issued at $20.00 per share?
A. The share range was determined through an appraisal of 1st State Bank
by Ferguson & Company, an independent appraisal firm specializing in
the thrift industry.
13. Q. Must I pay a commission on the stock for which I subscribe?
A. No. You will not pay a commission on stock purchased in the
Subscription Offering or the Community Offering or Syndicated
Community Offering, if any. Conversion expenses, including
commissions, will be deducted from the proceeds of the offering upon
completion of the conversion.
14. Q. Will I receive interest on funds I submit for stock purchases?
A. Yes. 1st State Bank will pay its current passbook rate from the date
funds are received (with a completed Stock Order Form) during the
subscription and community offerings until completion of the
conversion.
15. Q. If I have misplaced my Stock Order Form, what should I do?
A. 1st State Bank will mail you another order form or you may obtain one
from the 1st State Bank main office. If you need assistance in
obtaining or completing a Stock Order Form, a 1st State Bank employee
or Trident Securities, Inc. representative will be happy to help you.
16. Q. Will there be any dividends paid on the stock?
A. Subject to regulatory and other considerations, the Company intends to
establish a quarterly cash dividend following the Conversion of $.10
per share (or $0.40 per share annually) commencing during the first
full calendar quarter following the Stock Conversion. No assurance
can be given that dividends will be paid on the common stock or that,
if paid, such dividends will not be reduced or eliminated in future
periods.
17. Q. How much stock do the directors and officers of 1st State Bank intend
to purchase through the Subscription Offering?
A. Directors and executive officers and the honorary director intend to
purchase approximately $___ million (___% at the midpoint of the
offering) of the stock to be offered in the conversion. The purchase
price paid by directors and officers will be the same as that paid by
customers and the general public.
18. Q. Are the subscription rights transferable to another party?
A. No. Pursuant to federal regulations, subscription rights granted to
Eligible Account Holders, Supplemental Eligible Account Holders and
Other Members may be exercised only by the person(s) to whom they are
granted. Any person found to be transferring or selling subscription
rights will be subject to forfeiture of such rights and other
penalties.
<PAGE>
19. Q. I closed my account several months ago. Someone told me that I am
still eligible to buy stock. Is that true?
A. If you were an account holder on the Eligibility Record Date, December
31, 1994, or the Supplemental Eligibility Record Date, December 31,
1998, you are entitled to purchase stock without regard to whether you
continued to hold your 1st State Bank account.
20. Q. May I obtain a loan from 1st State Bank using stock as collateral to
pay for my shares?
A. No. Regulations do not allow 1st State Bank to make loans for this
purpose, but other financial institutions could make a loan for this
purpose.
21. Q. Will the FDIC (Federal Deposit Insurance Corporation) insure the
shares of stock?
A. No. The shares are not and may not be insured by the FDIC. However,
the Savings Association Insurance Fund of the FDIC will continue to
insure savings accounts and certificates of deposit up to the
applicable limits allowed by law.
22. Q. Will there be a market for the stock following the conversion?
A. Neither the Company nor the Bank has ever issued stock before, and
consequently there is no established market for the Company common
stock. The Company has received conditional approval to have the
common stock listed on the Nasdaq National Market System under the
symbol "____". Trident Securities intends to make a market in the
common stock of the Company. However, purchasers of common stock
should have a long-term investment intent and recognize that no
assurance can be given than an active and liquid trading market will
develop.
23. Q. Can I purchase stock using funds in a 1st State Bank IRA account?
A. Yes. 1st State Bank has arranged for Trident Securities, Inc. to
execute a trustee-to-trustee transfer of existing IRA funds held at
the Bank to purchase shares of Common Stock. If you elect Trident as
the third party custodian, the funds will be transferred to Trident
Securities, Inc. where the self-directed IRA will be maintained, with
Donaldson Lufkin & Jenrette as custodian. Through this arrangement,
only the principal amount of the IRA held at the Bank, as of February
12, 1999, the date of the Prospectus, may be directed to purchase
shares of Common Stock. No accrued interest or funds transferred to a
Bank IRA after February 12, 1999 may be directed for the purchase of
shares of stock. There are fees associated with this process and the
deadline for the receipt of the Trident Securities, Inc. self-directed
IRA order forms is March 9, 1999. If you wish to take advantage of
these arrangements or have any questions about the procedure please
call the Stock Information Center at (336)________. Other third party
custodian IRA orders, such as a brokerage firm self-directed IRA will
be accepted until 12:00 noon, March 16, 1999.
ABOUT VOTING "FOR" THE PLAN OF CONVERSION
24. Q. Am I eligible to vote at the Special Meeting of Members to be held to
consider the Plan of Conversion?
A. At the Special Meeting of Members to be held on ________, 1999, you
are eligible to vote if you are one of the "Voting Members," who are
holders of 1st State Bank's deposits
<PAGE>
or other authorized accounts or loans as of ________, 1999 (the
"Voting Record Date") for the Special Meeting. However, Bank members
of record as of the close of business on the Voting Record Date who
cease to be depositors or borrowers prior to the date of the Special
Meeting are no longer members and will not be entitled to vote at the
Special Meeting. If you are a Voting Member, you should have received
a proxy statement and proxy card with which to vote.
25. Q. How many votes do I have as a Voting Member?
A. Each account holder is entitled to one vote for each $100, or fraction
thereof, on deposit in such account. Each borrower who holds eligible
borrowings is entitled to cast one vote in addition to the number of
votes, if any, he or she is entitled to vote as an account holder. No
member may cast more than 1,000 votes.
26. Q. If I vote "against" the Plan of Conversion and it is approved, will I
be prohibited from buying stock during the subscription offering?
A. No. Voting against the Plan of Conversion in no way restricts you
from purchasing stock in either the subscription offering or the
community offering.
27. Q. What happens if 1st State Bank does not get enough votes to approve
the Plan of Conversion?
A. 1st State Bank's Conversion would not take place and 1st State Bank
would remain a mutual savings bank.
28. Q. As a qualifying depositor or borrower of 1st State Bank, am I required
to vote?
A. No. However, failure to return your proxy card will have the same
effect as a vote "Against" the Plan of Conversion.
29. Q. What is a Proxy Card?
A. A Proxy Card gives you the ability to vote without attending the
Special Meeting in person. You may attend the meeting and vote in
person, even if you have returned your proxy card, if you choose to do
so. However, if you are unable to attend, you would still be
represented by proxy.
30. Q. How does the conversion affect me?
A. The conversion is intended, among other things, to assist 1st State
Bank in maintaining and expanding its many services to 1st State
Bank's customers and community. By purchasing stock, you will also
have the opportunity to invest in 1st State Bancorp, Inc., the holding
company that will own the North Carolina-chartered commercial bank
into which 1st State Bank will convert. However, there is no
obligation to purchase stock; the purchase of stock is strictly
optional.
<PAGE>
31. Q. How can I get further information concerning the stock offering?
A. You may call the Stock Information Center, collect at (336) ________
for further information or an additional copy of the Prospectus, Stock
Order Form, Proxy Statement and Proxy Card.
Statements in this document concerning expectations for the future constitute
forward-looking statements. Such forward-looking statements contain known and
unknown risks and uncertainties. The Company's actual actions or results may
differ materially from those discussed in the forward-looking statements.
Specific factors that might cause such a difference include, but are not limited
to, the risks related to commercial and consumer lending, potentially adverse
impact of changes in interest rates, the uncertainty as to the existence of
growth opportunities, competition, local economic conditions in 1st state Bank's
market area, volatility in the stock markets, changes in the regulations
relating to financial institutions and general economic conditions in the United
States. See addition discussion in the Prospectus under "Risk Factor."
There shall be no sale of stock in any state in which any offer,
solicitation of an offer or sale of stock would be unlawful.
The common stock is not a deposit or account of 1st State Bank and is not
federally insured or guaranteed.
The securities are subject to investment risks, including possible loss of
the principal invested.
FOR YOUR CONVENIENCE
In order to assist you during the stock offering period, we have
established a Stock Information Center to answer your questions. Please call
collect:
(336) ________
<PAGE>
III. Officer and Director Brochure
A. Explanation
An Officer and Director Brochure merely highlights the intended stock
purchases shown in the Prospectus.
B. Method of Distribution
There are three primary methods of distribution of Officer and Director
Brochures. However, regardless of the method, they are always accompanied
by a Prospectus.
1. An Officer and Director Brochure may be sent out in the initial
mailing to all members of the Bank.
2. Officer and Director Brochures may be available in any of the Bank's
offices.
3. Officer and Director Brochures may be sent out in a standard
information packet to all interested investors who telephone the Stock
Information Center requesting information.
<PAGE>
OFFICER AND DIRECTOR STOCK PURCHASE COMMITMENTS
<TABLE>
<CAPTION>
Name and Position Amount Shares Percent at Midpoint
----------------- ------ ------ -------------------
<S> <C> <C> <C>
James A. Barnwell, Jr.,
Director
Bernie C. Bean,
Director
Richard C. Keziah,
Chairman of the Board
James C. McClure,
Director
James C. McGill,
President, CEO & Director
T. Scott Quakenbush,
Director
Richard H. Shirley,
Director
Virgil L. Stadler,
Director
A. Christine Baker,
EVP and CEO
Fairfax C. Reynolds,
EVP, Retail Administration
John D. Hansell,
Mgr. First Capital Services LLC
Frank Gavigan,
Senior VP, Senior Credit Officer
</TABLE>
All directors & executive officers,
as a group (12 persons) & their
associates
This information is neither an offer to sell nor a solicitation of an offer
to buy securities. The offer is made only by the Prospectus.
The common stock is not a deposit or account of 1st State Bank and is not
federally insured or guaranteed.
The securities are subject to investment risks, including possible loss of
the principal invested.
<PAGE>
IV. Counter Cards, Lobby Posters and the Tombstone Announcement
A. Explanation
Counter cards, lobby posters and the tombstone announcement serve three
-----
purposes: (1) As a notice to 1st State Bank's customers and members of the
local community that the stock sale is underway; (2) to remind the
customers of the end of the Subscription Offering; and (3) to invite
members of the community to an informational meeting, if applicable.
Trident has learned in the past that many people need reminding of the
deadline for subscribing and therefore we suggest the use of these simple
reminders.
B. Quantity
Approximately 3 - 4 counter cards will be used at the Bank's office, at
teller windows and on customer service representatives' desks. These
counter cards will be exact duplicates of the lobby poster and will be no
larger than 8-1/2" x 11".
Approximately 1 - 2 lobby posters will be used at the offices of the Bank.
These posters will be approximately 2' x 3'.
Tombstone announcements may be used for placement in local newspapers. The
advertisements will run no more than twice each in the local newspaper.
The ads will be no larger than 8-1/2" x 11".
C. Examples enclosed
<PAGE>
POSTER
1st State Bank
STOCK OFFERING MATERIALS
AVAILABLE HERE
Customer and Community Priority Rights for the Stock Offering
by 1st State Bancorp, Inc.
Expire on _______, 1999
<PAGE>
This announcement is neither an offer to sell nor a solicitation of an offer
to buy these securities. The offer is made only by the Prospectus. These shares
have not been approved or disapproved by the Securities and Exchange Commission,
Administrator Savings Institutions Division, North Carolina Department of
Commerce or Federal Deposit Insurance Corporation, nor has such Commission,
Office or Corporation passed upon the accuracy or adequacy of the Prospectus and
Proxy Statement. Any representation to the contrary is unlawful.
New Issue __________, 1999
- ---------
Up to 1,983,750 Shares
These shares are being offered pursuant
to a Plan of Conversion whereby
1st State Bank
of Burlington, North Carolina will convert from a
North Carolina mutual savings bank to a North Carolina stock
savings bank and, following completion of the offering, convert to a
North Carolina commercial bank and become the wholly-owned subsidiary of
1st State Bancorp, Inc.
Common Stock
__________
Price $20.00 per share
__________
Copies of the Prospectus may be obtained in any State in which this announcement
is circulated from such of the undersigned or other brokers and dealers
as may legally offer these securities in such state.
Trident Securities, Inc.
For a copy of the Prospectus call (336) ________.
<PAGE>
The Directors and Officers
of
1st State Bank
cordially invite you to attend a brief
presentation regarding the stock offering of
1st State Bancorp, Inc., our proposed holding Company
Please join us at the
Place
Address
Date
at 7:00 p.m.
for hors d'oeuvres
R.S.V.P.
(___) (Collect)
<PAGE>
V. Community Meeting Materials and Prospect Letters
A. Explanation
In order to educate the public about the stock offering, Trident suggests
holding Community meetings in various locations. In an effort to target a
group of interested investors, Trident requests that each Director of the
Bank submit a list of acquaintances that he or she would like to invite to
a Community meeting.
B. Method of Distribution of Invitations and Prospect Letters
Each Director submits his list of prospects.
Invitations are sent to each Director's prospects through the mail. All
invitations are preceded by a Prospectus and all attendees are given a
Prospectus at the meeting.
C. Examples enclosed
<PAGE>
The Directors and Officers
of
1st State Bank
cordially invite you to attend a brief
presentation regarding the stock offering of
1st State Bancorp, Inc., our proposed holding company
Please join us at the
Place
Address
Date
at 7:00 p.m.
for hors d'oeuvres
R.S.V.P.
(___) (Collect)
<PAGE>
Example
(Introductory Letter)
(1st State Bank Letterhead)
_______, 1999
Name
Address
City, State, Zip
Dear ______________:
You have probably read recently in the newspaper that 1st State Bank is
converting from mutual to stock form. This conversion is the biggest step in
the history of 1st State Bank in that it allows customers, community members,
employees and directors the opportunity to subscribe for common stock in our new
holding company, 1st State Bancorp, Inc.
I have enclosed a Prospectus and a stock order form which will allow you to
subscribe for shares and possibly become a charter stockholder of 1st State
Bancorp, Inc. In addition, we will be holding several presentations for friends
of 1st State Bank in order to explain the Conversion and review the merits of
possibly becoming a charter stockholder of 1st State Bancorp, Inc. You will
receive an invitation shortly.
I hope that if you have any questions you will feel free to call 1st State
Bank's Stock Information Center at (336)________. I look forward to seeing you
at our presentation.
Sincerely,
Director
The shares of common stock offered in the conversion are not savings
accounts or deposits and will not be insured by the Federal Deposit Insurance
Corporation or any other government agency.
This is not an offer to sell or a solicitation of an offer to buy stock.
The offer will be made only by the Prospectus. There shall be no sale of stock
in any state in which any offer, solicitation of an offer or sale of stock would
be unlawful.
The securities are subject to investment risks, including possible loss of
the principal invested
<PAGE>
Example
(Thank You Letter)
(1st State Bank Letterhead)
___________, 1999
Name
Address
City, State, Zip
Dear ______________:
On behalf of the Board of Directors and management of 1st State Bank, I
would like to thank you for attending our recent presentation regarding the
stock offering of 1st State Bancorp, Inc. We are enthusiastic about the stock
offering and look forward to completing the Subscription Offering on __________,
1999.
I hope that you will join me in being a charter stockholder, and once again
thank you for your interest.
Sincerely,
James C. McGill
President
The shares of common stock offered in the conversion are not savings
accounts or deposits and will not be insured by the Federal Deposit Insurance
Corporation or any other government agency.
This is not an offer to sell or a solicitation of an offer to buy stock.
The offer will be made only by the Prospectus. There shall be no sale of stock
in any state in which any offer, solicitation of an offer or sale of stock would
be unlawful.
The securities are subject to investment risks, including possible loss of
the principal invested
<PAGE>
Example
(Sorry You Were Unable to Attend)
(1st State Bank Letterhead)
____________, 1999
Name
Address
City, State, Zip
Dear ____________:
I am sorry you were unable to attend our recent presentation regarding 1st
State Bank's mutual to stock conversion. The Board of Directors and management
as a group intend to invest $_________ of our own funds in the common stock of
1st State Bancorp, Inc. We are enthusiastic about the stock offering and look
forward to completing the Subscription Offering on _______, 1999.
Enclosed is a Prospectus explaining the conversion process and stock
offering. We have established a Stock Information Center to answer any
questions regarding the stock offering. Should you require any assistance
between now and ________, 1999, I encourage you either to stop by or call our
Stock Information Center at _____________.
I hope you will join me in becoming a charter stockholder of 1st State
Bancorp, Inc.
Sincerely,
James C. McGill
President
The shares of common stock offered in the conversion are not savings
accounts or deposits and will not be insured by the Federal Deposit Insurance
Corporation or any other government agency.
This is not an offer to sell or a solicitation of an offer to buy stock.
The offer will be made only by the Prospectus. There shall be no sale of stock
in any state in which any offer, solicitation of an offer or sale of stock would
be unlawful.
The securities are subject to investment risks, including possible loss of
the principal invested
<PAGE>
Example
(Final Reminder Letter)
(1st State Bank Letterhead)
________, 1999
Name
Address
City, State, Zip
Dear ________________:
Just a quick note to remind you that the deadline is quickly approaching
for purchasing stock in 1st State Bancorp, Inc., the proposed holding company
for 1st State Bank. I hope you will join me in becoming a charter stockholder
in what will be North Carolina's newest publicly owned financial institution
holding company.
The deadline for subscribing for shares in the Subscription Offering is
_______, 1999. If you have any questions, I hope you will call our Stock
Information Center at _____________.
Once again, I look forward to having you join me as a stockholder of 1st
State Bancorp, Inc.
Sincerely,
James C. McGill
President
The shares of common stock offered in the conversion are not savings
accounts or deposits and will not be insured by the Federal Deposit Insurance
Corporation or any other government agency.
This is not an offer to sell or a solicitation of an offer to buy stock.
The offer will be made only by the Prospectus. There shall be no sale of stock
in any state in which any offer, solicitation of an offer or sale of stock would
be unlawful.
The securities are subject to investment risks, including possible loss of
the principal invested
<PAGE>
VI. Cover Letters
A. Explanation
Cover letters to accompany offering materials.
B. Method of Distribution
Enclosed with the initial mailing.
C. Examples
<PAGE>
(Trident Letterhead)
___________, 1999
To Members and Friends of 1st State Bank:
Trident Securities, Inc., member of the National Association of Securities
Dealers, Inc., is assisting 1st State Bank in its Conversion from a mutual
savings bank to a stock savings bank and the concurrent offering of common
shares by 1st State Bancorp, Inc. (the "Company"), a Virginia corporation
recently formed for the purpose of acquiring all of the stock of 1st State Bank.
At the request of 1st State Bank, we are enclosing a Prospectus and other
materials explaining the Conversion process and your right to subscribe for
common shares of the Company. Please read the enclosed offering materials
carefully before subscribing for stock.
If you have any questions, please call the Stock Information Center at
(336) ________.
Sincerely,
TRIDENT SECURITIES, INC.
Enclosures
The common shares offered in the Conversion are not savings accounts or deposits
and will not be insured by the Federal Deposit Insurance Corporation or any
other government agency.
This is not an offer to sell or a solicitation of an offer to buy the common
shares. The offer is made only by the Prospectus. There shall be no sale of
common shares in any state in which any offer, solicitation of an offer or sale
of stock would be unlawful.
The securities are subject to investment risks, including possible loss of
the principal invested
<PAGE>
(1st State Bank Letterhead)
___________, 1999
Dear Valued Member:
1st State Bank is pleased to announce that we have received regulatory
approval to proceed with our plan to convert from a mutual savings bank to a
stock savings bank (the "Conversion"), conditioned upon receipt of approval by
1st State Bank's members, among other things. This Conversion is a significant
event in the history of 1st State Bank in that it allows customers, directors
and employees an opportunity to subscribe for common shares of 1st State
Bancorp, Inc., the proposed holding company for 1st State Bank.
We want to assure you that the Conversion will not affect the terms,
balances, interest rates or existing FDIC insurance coverage on deposits at 1st
State Bank, or the terms or conditions of any loans to existing borrowers under
their individual contract arrangements with 1st State Bank. Let us also assure
you that the Conversion will not result in any changes in the management,
personnel or the Board of Directors of 1st State Bank.
A special meeting of the members of 1st State Bank will be held on
___________, 1999 at _______, Eastern Time, at 1st State Bank's main office to
consider and vote upon 1st State Bank's Plan of Conversion. Enclosed is a proxy
card. The Board of Directors of 1st State Bank solicits your vote "FOR" the Plan
of Conversion. A vote in favor of the Plan of Conversion does not obligate you
to purchase common shares of 1st State Bancorp, Inc. If you do not plan to
attend the special meeting, please sign and return your proxy card promptly.
Your vote is important to us.
As one of our valued members, you have the opportunity to invest in the
future of 1st State Bank by purchasing common shares of 1st State Bancorp, Inc.
during the Subscription Offering, without paying a sales commission.
If you decide to exercise your subscription rights to purchase shares, you
must return a properly completed stock order form together with full payment for
the subscribed shares so that it is received by 1st State Bank not later than
12:00 Noon, Eastern Time on _________, 1999.
We also have enclosed a Prospectus and Proxy Statement which fully
describes the Conversion and provides financial and other information about 1st
State Bancorp, Inc. and 1st State Bank. Please review these materials carefully
before you vote or invest. For your convenience we have established a Stock
Information Center. If you have any questions, please call the Stock Information
Center at (336) ________.
We look forward to continuing to provide quality financial services to you
in the future.
Sincerely,
James C. McGill
President
The common shares offered in the Conversion are not savings accounts or deposits
and will not be insured by the Federal Deposit Insurance Corporation or any
other government agency.
This is not an offer to sell or a solicitation of an offer to buy the common
shares. The offer is made only by the Prospectus. There shall be no sale of
common shares in any state in which any offer, solicitation of an offer or sale
of stock would be unlawful.
The securities are subject to investment risks, including possible loss of the
principal invested
<PAGE>
(Optional)
(1st State Bank Letterhead)
____________, 1999
Dear Interested Investor:
1st State Bank is pleased to announce that we have received regulatory
approval to proceed with our plan to convert from a mutual savings bank to a
stock savings bank (the "Conversion"), conditioned upon receipt of approval by
1st State Bank's members, among other things. This Conversion is a significant
event in the history of 1st State Bank in that it allows customers, community
members, directors and employees an opportunity to purchase common shares of 1st
State Bancorp, Inc., the proposed holding company for 1st State Bank.
We want to assure you that the Conversion will not result in any changes in
the management, personnel or the Board of Directors of 1st State Bank.
Enclosed is a Prospectus which fully describes 1st State Bancorp, Inc. and
1st State Bank, their management, board and financial condition. Please review
it carefully before you make an investment decision. If you decide to invest,
please return to 1st State Bank a properly completed stock order form together
with full payment for shares at your earliest convenience. For your convenience
we have established a Stock Information Center. If you have any questions,
please call the Stock Information Center at (336) ________.
Sincerely,
James C. McGill
President
Enclosures
The common shares offered in the Conversion are not savings accounts or deposits
and will not be insured by the Federal Deposit Insurance Corporation or any
other government agency.
This is not an offer to sell or a solicitation of an offer to buy the common
shares. The offer is made only by the Prospectus. There shall be no sale of
common shares in any state in which any offer, solicitation of an offer or sale
of stock would be unlawful.
The securities are subject to investment risks, including possible loss of the
principal invested
<PAGE>
(1st State Bank Letterhead)
____________, 1999
Dear Friend:
1st State Bank is pleased to announce that we have received regulatory
approval to proceed with our plan to convert from a mutual savings to a stock
savings bank (the "Conversion"), conditioned upon receipt of approval by 1st
State Bank's members, among other things. The Conversion is a significant event
in the history of 1st State Bank in that it allows customers, directors and
employees an opportunity to subscribe for common shares of 1st State Bancorp,
Inc., the proposed holding company for 1st State Bank.
We want to assure you that the Conversion will not affect the terms,
balances, interest rates or existing FDIC insurance coverage on deposits at 1st
State Bank, or the terms or conditions of any loans to existing borrowers under
their individual contract arrangements with 1st State Bank. Let us also assure
you that the Conversion will not result in any changes in the management,
personnel or the Board of Directors of 1st State Bank.
Our records indicate that you were a depositor of 1st State Bank on
December 31, 1994 or December 31, 1998. Therefore, under applicable law, you are
entitled to subscribe for common shares of 1st State Bancorp, Inc. in the
Subscription Offering. Orders submitted by you and others in the Subscription
Offering are contingent upon the current members' approval of the Plan of
Conversion at a special meeting of members to be held on __________, 1999, and
upon receipt of all required regulatory approvals.
If you decide to exercise your subscription rights to purchase shares, you
must return a properly completed stock order form together with full payment for
the subscribed shares so that it is received at 1st State Bank not later than
12:00 Noon, Eastern Time on __________, 1999.
Enclosed is a Prospectus which fully describes 1st State Bancorp, Inc. and
1st State Bank, their management, board and financial condition. Please review
it carefully before you invest. For your convenience, we have established a
Stock Information Center. If you have any questions, please call the Stock
Information Center at (336) ________.
Sincerely,
James C. McGill
President
Enclosures
The common shares offered in the Conversion are not savings accounts or deposits
and will not be insured by the Federal Deposit Insurance Corporation or any
other government agency.
This is not an offer to sell or a solicitation of an offer to buy the common
shares. The offer is made only by the Prospectus. There shall be no sale of
common shares in any state in which any offer, solicitation of an offer or sale
of stock would be unlawful.
The securities are subject to investment risks, including possible loss of the
principal invested
<PAGE>
(Optional)
(1st State Bank Letterhead)
___________, 1999
Dear Member:
As a qualified member of 1st State Bank, you have the right to vote upon
1st State Bank's proposed Plan of Conversion and also generally have the right
to subscribe for common shares of 1st State Bancorp, Inc., the proposed holding
company for 1st State Bank. However, the proposed Plan of Conversion provides
that 1st State Bancorp, Inc. will not offer shares in any state in which
compliance with the securities laws would be impracticable for reasons of cost
or otherwise. Unfortunately, the securities laws of your state would require 1st
State Bancorp, Inc. to register its common shares and /or its employees in order
to sell the common shares to you. Such registration would be prohibitively
expensive or otherwise impracticable in light of the few members residing in
your state.
You may vote on the proposed Plan of Conversion and we urge you to read the
enclosed Summary Proxy Statement and execute the enclosed Revocable Proxy.
Questions regarding the execution of the Revocable Proxy should be directed to
1st State Bank's Stock Information Center at (336) ________.
Sincerely,
James C. McGill
President
Enclosures
The common shares offered in the Conversion are not savings accounts or deposits
and will not be insured by the Federal Deposit Insurance Corporation or any
other government agency.
This is not an offer to sell or a solicitation of an offer to buy the common
shares. The offer is made only by the Prospectus. There shall be no sale of
common shares in any state in which any offer, solicitation of an offer or sale
of stock would be unlawful.
The securities are subject to investment risks, including possible loss of the
principal invested
<PAGE>
VII. IRA Mailing
A. Explanation
A special IRA mailing is proposed to be sent to all IRA customers of 1st
State Bank in order to alert the customers that funds held in an IRA can be
used to purchase stock. Since this transaction is not as simple as
designating funds from a certificate of deposit like a normal stock
purchase, this letter informs the customer that this process is slightly
more detailed and cannot be done through the mail.
B. Quantity
One IRA letter is proposed to be mailed to each IRA customer of 1st State
Bank. These letters would be mailed following OTS approval of the
Conversion and after each customer has received the initial mailing
containing a Proxy Statement and a Prospectus.
C. Example - Enclosed
<PAGE>
1st State Bank Letterhead
________, 1999
Dear Individual Retirement Account Participant:
As you know, 1st State Bank is in the process of converting from a North
Carolina chartered mutual savings bank to a North Carolina stock savings bank
and has formed 1st State Bancorp, Inc. to hold all of the stock of 1st State
Bank (the "Conversion"). Through the Conversion, certain current and former
depositors of 1st State Bank have the opportunity to purchase shares of common
stock of 1st State Bancorp, Inc. in a Subscription Offering. 1st State Bancorp,
Inc. currently is offering up to 1,983,750 common shares, subject to adjustment,
at a price of $20.00 per share.
As the holder of an individual retirement account ("IRA") at 1st State
Bank, you may use your IRA funds to subscribe for stock. If you desire to
purchase common shares of 1st State Bancorp, Inc. through your IRA, please
contact your broker or 1st State Bank can assist you in self-directing those
funds. This process can be done without an early withdrawal penalty and
generally without a negative tax consequence to your IRA.
1st State Bank has arranged for Trident Securities, Inc. to execute the
trustee-to-trustee transfer of existing IRA funds held at the Bank to purchase
shares of Common Stock. If you elect Trident as the third party custodian, the
funds will be transferred to Trident Securities, Inc. where the self-directed
IRA will be maintained, with Donaldson Lufkin & Jenrette as custodian. Through
this arrangement, only the principal amount of the IRA held at the Bank, as of
February 12, 1999, the date of the Prospectus, may be directed to purchase
shares of Common Stock. No accrued interest or funds transferred to a Bank IRA
after February 12, 1999 may be directed for the purchase of shares of stock.
There are fees associated with this process and the deadline for the receipt of
the Trident Securities, Inc. self-directed IRA order forms is March 9, 1999.
If you wish to take advantage of these arrangements or have any questions
about the procedure please call the Stock Information Center at (336)________.
Other third party custodian IRA orders, such as a brokerage firm self-directed
IRA will be accepted until 12:00 noon, March 16, 1999.
Sincerely,
James C. McGill
President
The common shares offered in the Conversion are not savings accounts or deposits
and will not be insured by the Federal Deposit Insurance Corporation or any
other government agency.
This is not an offer to sell or a solicitation of an offer to buy the common
shares. The offer is made only by the Prospectus. There shall be no sale of
common shares in any state in which any offer, solicitation of an offer or sale
of stock would be unlawful.
The securities are subject to investment risks, including possible loss of the
principal invested
<PAGE>
VIII. Proxy Reminder
A. Explanation
A proxygram is used when the majority of votes needed to adopt the Plan of
Conversion is still outstanding. The proxygram is mailed to those "target
vote" depositors who have not previously returned their signed proxy.
The target vote depositors are determined by the conversion agent.
B. Example enclosed
<PAGE>
B. Example
_______________________________________________________________________________
_______________________________________________________________________________
P R O X Y G R A M
(LOGO)
_______________________________________________________________________________
_______________________________________________________________________________
YOUR VOTE ON OUR PLAN OF CONVERSION HAS NOT BEEN RECEIVED.
---- --------
YOUR VOTE IS VERY IMPORTANT, PARTICULARLY SINCE FAILURE TO VOTE
- ---------------------------
IS EQUIVALENT TO VOTING AGAINST THE PLAN OF CONVERSION.
VOTING FOR THE PLAN OF CONVERSION WILL NOT AFFECT THE INSURANCE COVERAGE OF YOUR
ACCOUNTS. ALL ACCOUNTS WILL CONTINUE TO BE INSURED UP TO THE LEGAL LIMIT
--------------------------------
($100,000 PER ACCOUNT AS DEFINED BY LAW) BY THE SAVINGS ASSOCIATION INSURANCE
FUND OF THE FEDERAL DEPOSIT INSURANCE CORPORATION, AN AGENCY OF THE U.S.
GOVERNMENT.
REMEMBER, VOTING FOR THE PLAN OF CONVERSION DOES NOT OBLIGATE YOU TO BUY ANY
--------
SHARES.
PLEASE ACT PROMPTLY! SIGN THE ENCLOSED PROXY CARD AND MAIL OR DELIVER IT TO 1st
----------
STATE BANK
WE RECOMMEND THAT YOU VOTE "FOR" THE PLAN OF CONVERSION.
-----
THANK YOU!
_______________________________________________________________________________
_______________________________________________________________________________
THE BOARD OF DIRECTORS OF
1st STATE BANK
<PAGE>
Amended Conversion Valuation Report
Update
------------------------------------
Valued as of January 27, 1999
1ST STATE BANK
Burlington, North Carolina
Prepared By:
Ferguson & Company
Suite 305
860 West Airport Freeway
Hurst, Texas 76054
817/577-9558
<PAGE>
[LETTERHEAD OF FERGUSON & COMPANY]
February 5, 1999
Board of Directors
1st State Bank
445 S. Main Street
Burlington, North Carolina 27215
Dear Directors:
We have completed and hereby provide, as of January 27, 1999, an amended
updated independent appraisal of the estimated pro forma market value of 1st
State Bank, Burlington, North Carolina ("1st State" or the "Bank"), in
connection with the conversion of 1st State from the mutual to stock form of
organization ("Conversion"). This amended appraisal report update is furnished
pursuant to the filing of an amendment to the Holding Company's Registration
Statement and in response to comments received from the banking regulatory
authorities. Our original appraisal report, dated October 30, 1998, and our
previous appraisal update as of January 27, 1999, are incorporated herein by
reference.
In preparing this appraisal update, we reviewed our original appraisal and
earlier update and the various filings and applications filed with the Federal
Deposit Insurance Corporation ("FDIC"), Securities and Exchange Commission
("SEC"), Federal Reserve Board ("FRB"), and the Savings Institutions Division of
the North Carolina Department of Commerce ("Division"). We considered, among
other items, recent developments in stock market conditions. In addition, where
appropriate, we considered information based on other available published
sources that we believe is reliable; however, we cannot guarantee the accuracy
or completeness of such information. This updated appraisal also considered
comments and questions from the FDIC regarding the original appraisal report and
the earlier appraisal update.
Our appraisal update is based on the Bank's representation that the
information in the applications for conversion and additional evidence furnished
us by the Bank are accurate and complete. We did not independently verify the
financial statements and other information furnished by the Bank, nor did we
independently value its assets and liabilities. The appraisal update considers
the Bank as a going concern and should not be considered as an indication of its
liquidation value.
Our valuation is not intended, and must not be construed, as a recommendation
of any kind as to the advisability of purchasing shares of common stock in the
conversion. Moreover, because such valuation 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 who purchase
shares of common stock in the conversion will thereafter be able to sell such
shares at prices related to the foregoing estimate of the Bank's pro forma
market value. Ferguson & Company ("F&C") is not a seller of securities within
the meaning of any federal or state securities laws and any report prepared by
F&C shall not be used as an offer or solicitation with respect to the purchase
or sale of any securities.
<PAGE>
Board of Directors
February 5,1999
Page 2
Our earlier appraisal update utilizing market data as of January 27, 1999, was
issued under our letter dated February 1, 1999. After additional analysis, we
determined that the Bank's earnings level justified a higher appraisal, as the
pro forma price to earnings ratio was low relative to the comparative group,
North Carolina thrifts, southeast region thrifts, recent conversions, and all
publicly traded thrifts as a group.
In preparing the appraisal update, we looked at the most recent market
information available, which was as of February 4, 1999. The SNL index
increased 1.0% from 695.1 to 699.5 during the period from January 27, 1999, to
February 4, 1999. The average per share value of the comparative group did not
change--it was $18.51 on both dates. The median value of the comparative group
$17.47 on January 27, 1999, and $17.44 on February 4, 1999. Since there was no
appreciable change in market, we used the January 27, 1999, market information.
There were no changes in Exhibits I, II, III, IV, V, and IX. Therefore, they are
not included in this update.
Valuation Approach
- ------------------
Exhibit VI indicates the pro forma market valuation of 1st State versus the
comparative group and all publicly held thrifts. Pro forma pricing ratios for
1st State are based on the financial information shown in Exhibit VIII. Pro
forma earnings are based on currently available interest rates and pro forma
assets and book value information are taken from the December 31, 1998,
financial data included in the offering circular.
At the adjusted $36,000,000 midpoint of the range, 1st State is valued at
67.2% of pro forma book value, representing a discount of 43.1% from the mean
and 41.5% from the median of the comparative group. The midpoint price is 11.9
times pro forma earnings, representing a discount of 29.6% from the mean and a
discount of 26.5% from the median of the comparative group.
As compared to all publicly held thrifts, at the midpoint of the range, 1st
State's price earnings ratio represents a discount of 27.0% from the mean and a
22.7% discount from the median. 1st State's value of 67.2% of pro forma book
value is well below the mean of 131.4% and median of 119.2% of all publicly held
thrifts.
As compared to thrift conversions completed within the past six months, 1st
State's price to pro forma book of 67.2% represents a 1.5% discount from the
mean and a discount of 3.9% from the median. And its price earnings ratio of
11.9 represents a 32.8% discount from the mean and a 22.2% discount from the
median.
At the maximum, 1st State's price to book ratio of 70.9% represents a premium
of 4.0% over the mean 1.4% over the median, while, at the supermaximum, 1st
State's price to book ratio of 74.5% represents a premium of 9.2% over the mean
and 6.6% over the median of recent conversions. At the supermaximum, 1st
State's price earnings ratio is below but generally between a 5% to 15% discount
from all of the groups for comparison.
<PAGE>
Board of Directors
February 5,1999
Page 3
Conclusion
- ----------
In our opinion, 1st State's estimated pro forma market value at January 27,
1999, was $36,000,000, which increased $3,000,000, or 9.1% from our earlier
appraisal update as of January 27, 1999. The resulting valuation range is
$30,600,000 at the minimum to $41,400,000 at the maximum, based on a range of
15% below and 15% above the midpoint valuation. The supermaximum is $47,610,000
based on 1.15 times the maximum. Pro forma comparisons with the comparative
group are presented in Exhibit VI based on calculations shown in Exhibit VIII.
1st State will also contribute to a charitable foundation a number of shares of
its stock equal to 8% of the number of shares sold in the conversion, with the
contribution being subject to a maximum of $3,000,000 in value.
Our opinion is based upon circumstances as of the date hereof, including
current conditions in the United States securities markets. Events occurring
after the date hereof, including, but not limited to, changes affecting the
United States securities markets and subsequent results of operations of 1st
State, could materially affect the assumptions used in preparing this opinion.
Respectfully,
Ferguson & Company
/s/ Robin L. Fussell
Robin L. Fussell
Principal
<PAGE>
List of Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Title Page
- ---------- ------------------------------------- ------
<S> <C> <C>
VI Pro Forma Comparisons 1
VII Comparison of Pricing Ratios 3
VIII Pro Forma Assumptions 4
Pro Forma Effect of Conversion Proceeds 5
Pro Forma Analysis Sheet 9
</TABLE>
<PAGE>
FERGUSEN & COMPANY
EXHIBIT VI - Pro Forma Comparisons
As of January 27, 1999
<TABLE>
<CAPTION>
Ticker Name Price Mk Value PE P/Book P/TBook P/Assets Div Yld
($) ($Mil) (X) (%) (%) (%) (%)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1st State Bank
--------------
Before Conversion N/A N/A N/A N/A N/A N/A N/A
Pro Forma Supermaximum 20.000 47.61 14.7 74.5 74.5 15.3 2.00
Pro Forma Maximum 20.000 41.40 13.3 70.9 70.9 13.6 2.00
Pro Forma Midpoint 20.000 36.00 11.9 67.2 67.2 12.1 2.00
Pro Forma Minimum 15.000 30.60 10.4 62.2 62.2 10.4 2.00
Comparative Group
-----------------
Averages 18.511 46.18 16.9 118.2 120.0 15.8 2.59
Medians 17.469 36.39 16.2 114.8 118.5 14.5 2.55
North Carolina Thrifts
----------------------
Averages 13.235 33.43 15.2 98.7 99.0 18.9 3.66
Medians 13.250 24.56 15.6 92.2 92.2 19.1 4.09
Southeast Region Thrifts
------------------------
Averages 15.174 80.72 16.9 133.3 136.8 16.0 2.73
Medians 14.000 38.63 16.1 115.1 116.0 16.0 2.69
All Public Thrifts
------------------
Averages 17.055 284.24 16.3 131.4 139.0 14.2 2.28
Medians 15.063 45.56 15.4 119.2 125.9 13.3 2.34
Comparative Group
-----------------
ANA AcadianaBcshs-LA 18.188 33.57 15.2 105.0 105.0 14.3 2.42
ASBI AmerianaBancorp-IN 16.500 57.86 15.9 128.6 134.7 14.6 3.63
CBK CitizensFirst-IL 13.250 29.61 18.9 83.9 83.9 11.1 -
FFFD NorthCentral-IA 16.750 49.65 12.7 104.6 120.3 15.5 1.91
HBFW HomeBancorp-IN 29.500 64.46 22.9 162.1 162.1 17.9 1.08
HRBF HarborFedBncp-MD 19.500 35.04 18.9 120.7 120.7 15.4 2.67
JXVL Jacksonville-TX 15.938 37.73 11.6 107.1 107.1 14.5 3.14
MFBC MFBCorp-IN 22.000 32.21 15.3 103.0 103.0 9.6 1.55
MFFC MiltonFedFinl-OH 14.250 31.54 22.6 112.8 112.8 13.6 4.21
OHSL OHSLFinancial-OH 14.000 34.97 16.5 125.9 125.9 13.9 3.57
PFDC PeoplesBancorp-IN 20.375 66.45 15.9 147.9 147.9 21.0 2.36
SOPN FirstSvngsBncp-NC 21.875 81.09 16.6 116.7 116.7 28.2 4.57
</TABLE>
1
<PAGE>
FERGUSEN & COMPANY
EXHIBIT VI - Pro Forma Comparisons
<TABLE>
<CAPTION>
Ticker Name Assets Eq/A TEq/A EPS ROAA ROAE
($000) (%) (%) ($) (%) (%)
<S> <C> <C> <C> <C> <C> <C>
1st State Bank
--------------
Before Conversion 291,249 9.2 9.2 N/A 1.01 10.96
Pro Forma Supermaximum 331,496 20.5 20.5 1.36 1.09 5.17
Pro Forma Maximum 326,117 19.2 19.2 1.51 1.08 5.47
Pro Forma Midpoint 321,453 18.0 18.0 1.68 1.07 5.78
Pro Forma Minimum 316,827 16.8 16.8 1.45 1.06 6.16
Comparative Group
-----------------
Averages 291,538 13.8 13.7 1.09 1.07 7.36
Medians 294,542 13.4 12.9 1.21 0.92 7.24
North Carolina Thrifts
----------------------
Averages 182,962 19.6 19.6 0.96 1.22 6.14
Medians 141,130 17.9 17.9 0.77 1.23 5.79
Southeast Region Thrift
-----------------------
Averages 599,132 13.5 13.3 0.95 1.01 8.26
Medians 189,422 12.9 12.9 0.85 0.94 7.70
All Public Thrifts
------------------
Averages 1,787,317 11.9 11.6 1.15 0.99 9.32
Medians 359,430 10.0 10.0 1.02 0.94 8.46
Comparative Group
-----------------
ANA AcadianaBcshs-LA 298,148 14.7 14.7 1.17 1.05 6.48
ASBI AmerianaBancorp-IN 375,297 12.2 12.0 1.17 0.98 8.55
CBK CitizensFirst-IL 281,068 14.0 14.0 0.63 0.71 5.13
FFFD NorthCentral-IA 331,124 14.9 13.1 1.27 1.56 8.56
HBFW HomeBancorp-IN 360,286 11.9 11.9 1.25 0.85 6.84
HRBF HarborFedBncp-MD 227,562 12.8 12.8 1.03 0.79 6.25
JXVL Jacksonville-TX 242,673 14.5 14.5 1.26 1.33 9.13
MFBC MFBCorp-IN 290,936 11.4 11.4 1.29 0.80 6.44
MFFC MiltonFedFinl-OH 235,105 11.1 11.1 0.65 0.69 5.80
OHSL OHSLFinancial-OH 247,853 10.8 10.8 0.85 0.86 7.94
PFDC PeoplesBancorp-IN 304,320 15.0 15.0 1.26 1.45 9.56
SOPN FirstSvngsBncp-NC 304,088 22.9 22.9 1.30 1.76 7.64
</TABLE>
Note: Stock prices are closing prices or last trade. Pro
forma calculations for 1st State are based on sales at
$20 a share ($15 at the minimum) with a minimum of
$30,600,000, midpoint of $36,000,000, maximum of
$41,400,000, and supermaximum of $47,610,000.
Sources:1st State's audited and unaudited financial
Statements, SNL Securities, and F&C calculations.
2
<PAGE>
FERGUSON & COMPANY
- ------------------
Exhibit VII
Comparison of Pricing Ratios
<TABLE>
<CAPTION>
Group Percent Premium
Compared to (Discount) Versus
1st State ----------------------- ------------------------
Bank Average Median Average Median
------------ ---------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C>
Comparison of PE ratio at
midpoint to:
- ---------------------------------
Comparative group 11.9 16.9 16.2 (29.6) (26.5)
North Carolina thrifts 11.9 15.2 15.6 (21.7) (23.7)
Southeast Region thrifts 11.9 16.9 16.1 (29.6) (26.1)
All public thrifts 11.9 16.3 15.4 (27.0) (22.7)
Recent conversions 11.9 17.7 15.3 (32.8) (22.2)
Comparison of PE ratio at
maximum to:
- ---------------------------------
Comparative group 13.3 16.9 16.2 (21.3) (17.9)
North Carolina thrifts 13.3 15.2 15.6 (12.5) (14.7)
Southeast Region thrifts 13.3 16.9 16.1 (21.3) (17.4)
All public thrifts 13.3 16.3 15.4 (18.4) (13.6)
Recent conversions 13.3 17.7 15.3 (24.9) (13.1)
Comparison of PE ratio at
supermaximum to:
- ---------------------------------
Comparative group 14.7 16.9 16.2 (13.0) (9.3)
North Carolina thrifts 14.7 15.2 15.6 (3.3) (5.8)
Southeast Region thrifts 14.7 16.9 16.1 (13.0) (8.7)
All public thrifts 14.7 16.3 15.4 (9.8) (4.5)
Recent conversions 14.7 17.7 15.3 (16.9) (3.9)
Comparison of PB ratio at
midpoint to:
- ---------------------------------
Comparative group 67.2 118.2 114.8 (43.1) (41.5)
North Carolina thrifts 67.2 98.7 92.2 (31.9) (27.1)
Southeast Region thrifts 67.2 133.3 115.1 (49.6) (41.6)
All public thrifts 67.2 131.4 119.2 (48.9) (43.6)
Recent conversions 67.2 68.2 69.9 (1.5) (3.9)
Comparison of PB ratio at
maximum to:
- ---------------------------------
Comparative group 70.9 118.2 114.8 (40.0) (38.2)
North Carolina thrifts 70.9 98.7 92.2 (28.2) (23.1)
Southeast Region thrifts 70.9 133.3 115.1 (46.8) (38.4)
All public thrifts 70.9 131.4 119.2 (46.0) (40.5)
Recent conversions 70.9 68.2 69.9 4.0 1.4
Comparison of PB ratio at
supermaximum to:
- ---------------------------------
Comparative group 74.5 118.2 114.8 (37.0) (35.1)
North Carolina thrifts 74.5 98.7 92.2 (24.5) (19.2)
Southeast Region thrifts 74.5 133.3 115.1 (44.1) (35.3)
All public thrifts 74.5 131.4 119.2 (43.3) (37.5)
Recent conversions 74.5 68.2 69.9 9.2 6.6
</TABLE>
3
<PAGE>
FERGUSON & COMPANY Exhibit VIII
Pro Forma Assumptions
1. Net proceeds from the conversion were invested at the beginning of the
period at 4.60%, which was the approximate rate on the one-year treasury bill on
December 31, 1998. This rate was selected because it is considered more
representative of the rate the Bank is likely to earn.
2. 1st State's ESOP will acquire 8% of the conversion stock with loan proceeds
obtained from the Holding Company; therefore, there will be no interest expense.
We assumed that the ESOP expense is 10% annually of the initial purchase.
3. 1st State's RP will acquire 4% of the stock through open market purchases at
the same price per share as that paid for conversion stock and the expense is
recognized ratably over five years as the shares vest.
4. All pro forma income and expense items are adjusted for income taxes at a
combined state and federal rate of 36.0%, with the exception of thefoundation
contribution, on which the assumed tax benefit is 34.0%. The lower rate was used
because most of the benefit is expected to be realized during the carryforward
period, and the State of North Carolina does not permit contribution
carryforwards.
5. In calculating the pro forma adjustments to net worth, the ESOP and RP are
deducted in accordance with generally accepted accounting principles.
6. Earnings per share ("EPS") have been calculated simply by dividing pro forma
net income by the total shares assumed issued. The price earnings ("P/E") ratio
is simply total pro forma market capitalization (i.e., value of shares to be
sold plus the assigned value of shares issued to the charitable foundation)
divided by pro forma net income. Calculating EPS under AICPA SOP 93-6 and
assuming 10% of the ESOP shares are committed to be released at the beginning of
the period and under SFAS 128 assuming 20% of the RP shares are vested at the
beginning of the period, basic EPS would be $1.62, $1.88, $1.68, and $1.52,
diluted EPS would be $1.56, $1.81, $1.62, and $1.47, and the PE ratio based on
basic EPS would be 9.3, 10.6, 11.9, and 13.2, respectively, at the minimum,
midpoint, maximum, and supermaximum of the range.
4
<PAGE>
Exhibit VIII
Pro Forma Effect of Conversion Proceeds
At the Minimum of the Conversion Valuation Range
Valuation Date as of January 27, 1999
<TABLE>
<CAPTION>
1st State Bank, Burlington, NC
- ------------------------------------------------------
<S> <C>
1. Conversion Proceeds
Pro Forma Market Value $ 30,600,000
Less: Estimated Expenses (1,056,000)
-------------
Net Conversion Proceeds $ 29,544,000
2. Estimated Additional Income From Conversion
Proceeds
Net Conversion Proceeds $ 29,544,000
Less: ESOP Contributions (2,643,840)
RP Contributions (1,321,920)
-------------
Net Conversion Proceeds after ESOP & RP $ 25,578,240
Estimated Incremental Rate of Return(1) 2.94%
-------------
Estimated Additional Income $ 753,023
Less: ESOP Expense (169,206)
RP Expense (169,206)
-------------
$ 414,612
=============
3. Pro Forma Calculations
<CAPTION>
Before Conversion After
Period Conversion Results Conversion
-------------------------------------------------------------
<S> <C> <C> <C>
a. Pro Forma Earnings
Twelve Months Ended
December 31, 1998 $ 2,775,000 $ 414,612 $ 3,189,612
b. Pro Forma Net Worth
December 31, 1998 $ 26,707,000 $26,410,560 $ 53,117,560
c. Pro Forma Net Assets
December 31, 1998 $291,249,000 $25,578,240 $316,827,240
</TABLE>
(1) Assumes Proceeds can be reinvested at 4.60% and earnings taxed at a rate of
36.0 percent.
(2) Pro forma effect on capital includes tax effect related to contribution to
charitable foundation.
5
<PAGE>
Exhibit VIII
Pro Forma Effect of Conversion Proceeds
At the Midpoint of the Conversion Valuation Range
Valuation Date as of January 27, 1999
<TABLE>
<CAPTION>
1st State Bank, Burlington, NC
- ------------------------------------------------------------------------------------
<S> <C>
1. Conversion Proceeds
Pro Forma Market Valuation $ 36,000,000
Less: Estimated Expenses (1,130,000)
------------
Net Conversion Proceeds $ 34,870,000
2. Estimated Additional Income From Conversion Proceeds
Net Conversion Proceeds $ 34,870,000
Less: ESOP Contributions (3,110,400)
RP Contributions (1,555,200)
------------
Net Conversion Proceeds after ESOP & RP $ 30,204,400
Estimated Incremental Rate of Return(1) 2.94%
------------
Estimated Additional Income $ 889,218
Less: ESOP Expense (199,066)
RP Expense (199,066)
------------
$ 491,086
============
3. Pro Forma Calculations
<CAPTION>
Before Conversion After
Period Conversion Results Conversion
-------------------------------------------------------------
<S> <C> <C> <C>
a. Pro Forma Earnings
Twelve Months Ended
December 31, 1998 $ 2,775,000 $ 491,086 $ 3,266,086
b. Pro Forma Net Worth
December 31, 1998 $ 26,707,000 $31,183,600 $ 57,890,600
c. Pro Forma Net Assets
December 31, 1998 $291,249,000 $30,204,400 $321,453,400
</TABLE>
(1) Assumes Proceeds can be reinvested at 4.60% and earnings taxed at a rate of
36.0 percent.
(2) Pro forma effect on capital includes tax effect related to contribution to
charitable foundation.
6
<PAGE>
Exhibit VIII
Pro Forma Effect of Conversion Proceeds
At the Maximum of the Conversion Valuation Range
Valuation Date as of January 27, 1999
<TABLE>
<CAPTION>
1st State Bank, Burlington, NC
- -----------------------------------------------------------------------------
<S> <C> <C>
1. Conversion Proceeds
Pro Forma Market Valuation $ 41,400,000
Less: Estimated Expenses (1,204,000)
------------
Net Conversion Proceeds $ 40,196,000
2. Estimated Additional Income From Conversion Proceeds
Net Conversion Proceeds $ 40,196,000
Less: ESOP Contributions (3,552,000)
RP Contributions (1,776,000)
------------
Net Conversion Proceeds after ESOP & RP $ 34,868,000
Estimated Incremental Rate of Return(1) 2.94%
------------
Estimated Additional Income $ 1,026,514
Less: ESOP Expense (227,328)
RP Expense (227,328)
------------
$ 571,858
============
3. Pro Forma Calculations
<CAPTION>
Before Conversion After
Period Conversion Results Conversion
---------------------------------------------
<S> <C> <C> <C>
a. Pro Forma Earnings
Twelve Months Ended
December 31, 1998 $ 2,775,000 $ 571,858 $ 3,346,858
b. Pro Forma Net Worth
December 31, 1998 $ 26,707,000 $35,888,000 $ 62,595,000
c. Pro Forma Net Assets
December 31, 1998 $291,249,000 $34,868,000 $326,117,000
</TABLE>
(1) Assumes Proceeds can be reinvested at 4.60% and earnings taxed at a rate of
36.0 percent.
(2) Pro forma effect on capital includes tax effect related to contribution to
charitable foundation.
7
<PAGE>
Exhibit VIII
Pro Forma Effect of Conversion Proceeds
At the SuperMax of the Conversion Valuation Range
Valuation Date as of January 27, 1999
<TABLE>
<CAPTION>
1st State Bank, Burlington, NC
- --------------------------------------------------------------------------
<S> <C> <C>
1. Conversion Proceeds
Pro Forma Market Valuation $ 47,610,000
Less: Estimated Expenses (1,290,000)
------------
Net Conversion Proceeds $ 46,320,000
2. Estimated Additional Income
From Conversion Proceeds
Net Conversion Proceeds $ 46,320,000
Less: ESOP Contributions $ (4,048,800)
RP Contributions $ (2,024,400)
Net Conversion Proceeds after ESOP & RP $ 40,246,800
Estimated Incremental Rate of Return(1) 2.94%
------------
Estimated Additional Income $ 1,184,866
Less: ESOP Expense $ (259,123)
RP Expense $ (259,123)
------------
$ 666,619
============
3. Pro Forma Calculations
Before Conversion After
Period Conversion Results Conversion
---------------------------------------------
a. Pro Forma Earnings
Twelve Months Ended
December 31, 1998 $ 2,775,000 $ 666,619 $ 3,441,619
b. Pro Forma Net Worth
December 31, 1998 $ 26,707,000 $41,266,800 $ 67,973,800
c. Pro Forma Net Assets
December 31, 1998 $291,249,000 $40,246,800 $331,495,800
(1) Assumes Proceeds can be reinvested at 4.60% and earnings taxed at a rate of 36.0 percent.
(2) Pro forma effect on capital includes tax effect related to contribution to charitable foundation.
</TABLE>
8
<PAGE>
FERGUSON & COMPANY
- ------------------
<TABLE>
<CAPTION>
Exhibit VIII
Pro Forma Analysis Sheet
Name of Association: 1st State Bank, Burlington, NC
Date of Market Prices: January 27, 1999 N. Carolina Publicly All Publicly
Comparatives Held Thrifts Held Thrifts
---------------- -------------------- ----------------
Symbols Value Mean Median Mean Median Mean Median
------- ----- ---- ------ ---- ------ ---- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Price-Earnings Ratio P/E
- --------------------
Last Twelve Months N/A
At Minimum of Range 10.4
At Midpoint of Range 11.9 19.0 17.8 15.6 16.8 17.6 16.5
At Maximum of Range 13.3
At Supermax of Range 14.7
Price-Book Ratio P/B
- ----------------
At Minimum of Range 62.2%
At Midpoint of Range 67.2% 118.2 117.6 103.5 99.1 131.7 120.3
At Maximum of Range 70.9%
At Supermax of Range 74.5%
Price-Asset Ratio P/A
- -----------------
At Minimum of Range 10.4%
At Midpoint of Range 12.1% 16.2 15.1 19.6 18.2 14.7 13.8
At Maximum of Range 13.6%
At Supermax of Range 15.3%
Twelve Mo. Earnings Base Y $ 2,775,000
Period Ended December
31, 1998
Book Value B $ 26,707,000
As of December 31, 1998
Total Assets A $291,249,000
As of December 31, 1998
Return on Money (1) R 2.94%
Conversion Expense X $ 1,130,000
Underwriting Commission C 0.00%
Percentage Underwritten S 0.00%
Estimated Dividend
Dollar Amount DA $ 777,600
Yield DY 2.00%
ESOP Contributions P $ 3,110,400
RP Contributions I $ 1,555,200
ESOP Annual Expense E $ 199,066
RP Annual Contributions M $ 199,066
Cost of ESOP Borrowings F 0.00%
Charity Contribution CC $ 2,880,000
Tax Effect of Contribution TEC $ 979,200
After Tax Effect of Contri. ATEC $ 1,900,800
</TABLE>
(1) Assumes Proceeds can be reinvested at 4.60% and earnings taxed at a rate of
36.0 percent.
(2) Pro forma effect on capital includes tax effect related to contribution to
charitable foundation.
9
<PAGE>
FERGUSON & COMPANY
- ------------------
Exhibit VIII
Pro Forma Analysis Sheet
Calculation of Estimated Value (V) at Midpoint Value (including foundation
shares):
1. V= P/A(A-X-P-I-CC) $38,880,000
---------------------
1-P/A(1-(CxS))
2. V= P/B(B-X-P-I-ATEC) $38,880,000
---------------------
1-P/B(1-(CxX))
3. V= P/E(Y-R(X+P+I+CC)-(E+M)) $38,880,000
--------------------------
1-P/E(R(1-(CxX))
Calculation of Shares Being Offered for Sale (excluding foundation
shares):
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Value
Estimated Value Per Share Total Shares Date
------------------- ------------- ---------------- ----------------
$36,000,000 $20.00 1,800,000 January 27, 1999
</TABLE>
Range of Value
$36.0 million x 1.15 = $41.40 million or 2,070,000 shares at $20.00 per share
$36.0 million x 0.85 = $30.60 million or 2,040,000 shares at $15.00 per share
10
