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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998 Commission File No. 0-26486
Auburn National Bancorporation, Inc.
(Name of small business issuer in its charter)
Delaware 63-0885779
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
165 East Magnolia Avenue, Suite 203
Auburn, Alabama 36830
(334) 821-9200
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange
Title of each class on which registered
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None None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, Par Value, $.01 Per Share
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [ x ] No [ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ x ]
Issuer's revenues for its most recent fiscal year were $24,199,672.
The aggregate market value of the common stock held by non-affiliates of
registrant as of February 26, 1999, computed by reference to the price at which
the stock was sold as of such date, was $41,352,176.
As of February 26, 1999, there were issued and outstanding 3,924,573 shares of
the registrant's $.01 par value common stock.
Transitional Small Business Disclosure Format: Yes [ ] No [ x ]
Documents Incorporated by Reference
-----------------------------------
Portions of the definitive proxy statement for the Annual Meeting of
Shareholders to be held on May 11, 1999 are incorporated by reference into Part
III.
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PART I
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed under the caption "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and elsewhere in
this Annual Report are forward-looking statements for purposes of the Securities
Act of 1933, as amended (the "Securities Act") and the Securities Exchange Act
of 1934, as amended (the "Exchange Act"), and as such may involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements to differ from those expressed or implied
by such forward-looking statements. The Company's actual results may differ
materially from the results anticipated in these forward-looking statements
including those described under interest rate management, due to a variety of
factors, including, without limitation: the effects of future economic
conditions; governmental monetary and fiscal policies, as well as interest rate
risks; the effects of competition from other commercial banks, thrifts, mortgage
banking firms, consumer finance companies, credit unions, securities brokerage
firms, insurance companies, money market and other mutual funds and other
financial institutions operating in the Company's market area and elsewhere,
including institutions operating locally, regionally, nationally and
internationally, together with such competitors offering banking products and
services by mail, telephone, computer and the Internet; and the failure of
assumptions underlying the establishment of allowances for loan losses and
estimations of values of collateral and various financial assets and
liabilities. All forward-looking statements attributable to the Company are
expressly qualified in their entirety by these Cautionary Statements.
ITEM 1. BUSINESS
Auburn National Bancorporation, Inc. ("the Company") is a bank holding
company registered with the Board of Governors of the Federal Reserve System
(the "Federal Reserve") under the Bank Holding Company Act of 1956, as amended
(the "BHC Act"). The Company was incorporated in Delaware in 1990, and in 1994
it succeeded its Alabama predecessor as the bank holding company controlling
AuburnBank, an Alabama state bank with its principal office in Auburn, Alabama
(the "Bank"). The Company and its predecessor have controlled the Bank since
1984. As a bank holding company, the Company facilitates the Bank's ability to
serve its customers' requirements for financial services. The holding company
structure permits diversification by the Company into a broader range of
financial services and other business activities than currently are permitted to
the Bank under applicable law. The holding company structure also provides
greater financial and operating flexibility than is presently permitted to the
Bank.
The Bank has operated continuously since 1907 and conducts its business in
East Alabama, including Lee County and surrounding areas. In April 1995, in
order to gain flexibility and reduce certain regulatory burdens, the Bank
converted from a national bank to an Alabama state bank that is a member of the
Federal Reserve System (the "Charter Conversion"). Upon consummation of the
Charter Conversion, the Bank's primary regulator changed from the Office of the
Comptroller of the Currency (the "OCC") to the Federal Reserve and the Alabama
Superintendent of Banks (the "Alabama Superintendent"). The Bank has been a
member of the Federal Home Loan Bank of Atlanta (the "FHLB-Atlanta") since 1991.
General
The Company's business is conducted primarily through the Bank. The Bank's
business consists of (i) accepting demand, savings, and time deposits; (ii)
making loans to consumers, businesses, and other institutions; (iii) investments
of money market instruments, U.S. government and agency obligations, and state,
county, and
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municipal bonds; and (iv) other financial services. Although it has no immediate
plans to conduct any other business, the Company may engage directly or
indirectly in a number of activities which the Federal Reserve has determined to
be so closely related to banking or managing or controlling banks as to be a
proper incident thereto.
Services
The Bank offers checking, savings, negotiable order of withdrawal ("NOW")
accounts, money market deposit accounts ("MMDAs") and certificates of deposit,
and is an active residential mortgage lender in its primary service area
("PSA"). The Bank also offers commercial, financial, agricultural, real estate
construction and consumer loan products. During 1995, the Bank sold its credit
card portfolio and began providing credit cards, including MasterCard(R),
MasterCard Gold, Visa(R), and Visa Gold through an agent bank arrangement with
Columbus Bank & Trust Company in Columbus, Georgia. The Bank is one of the
largest providers of automated teller services in East Alabama with 15 locations
and was one of the nine original founders of Alabama Network, Inc. (Alert(R)),
an Alabama ATM network that processes more than 18 million transactions
annually. On January 1, 1997, Alert(R), Internet, Inc., and Southeast Switch,
Inc. merged to become Honor Technologies, Inc. ("Honor"). Pursuant to such
merger, the Company received an equity position in Honor equal to 0.3125% of
combined total equity and a 30 month waiver of certain fees in Honor. The Bank's
Tiger Teller ATM cards can be used internationally through the Cirrus(R)
network. In 1998, the Bank began offering VISA Checkcards, which are debit cards
with the VISA logo that work like checks but can be used anywhere VISA is
accepted, including ATMs.
Competition
The banking business in Alabama, including Lee County, is highly
competitive with respect to loans, deposits, and other services, and the area is
dominated by a number of major banks and bank holding companies which have
numerous offices and affiliates operating over wide geographic areas. The Bank
competes for deposits, loans, and other business with these banks, as well as
with credit unions, mortgage companies, insurance companies, and other local and
nonlocal financial institutions, including services offered through the mail, by
telephone and over the Internet. Among the advantages that certain of these
institutions have vis-a-vis the Bank are their ability to finance extensive
advertising campaigns and to allocate and diversify their assets among loans and
securities of the highest yield and in locations with the greatest demand.
Many of the major commercial banks operating in the Bank's service area, or
their affiliates, offer services, such as international banking and investment
services, which are not presently offered directly by the Bank. Such
competitors, because of their greater capitalization, also have substantially
higher lending limits than the Bank.
The Bank faces further competition for loans and deposits from a wide
variety of local and nonlocal financial institutions. As more and different
kinds of businesses enter the market for financial services, competition from
nonbank financial intermediaries such as thrifts, credit unions, mortgage
companies, insurance companies, and other financial institution intermediaries
may be expected to intensify further. Community banks also have experienced
significant competition for deposits from mutual funds, insurance companies, and
other investment companies, and money center banks' offerings of high-yield
investments and deposits. Certain of these competitors are not subject to the
same regulatory restrictions as the Bank. In addition, the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking
Act"), effective on September 29, 1995, repealed the prior statutory
restrictions on interstate acquisition of banks by bank holding companies, such
that any bank holding company located outside Alabama may presently acquire any
bank based in Alabama or any other state, regardless of state law to the
contrary, subject to certain deposit-percentage, aging requirements, and other
restrictions. Alabama has also opted in to the provisions of the Interstate
Banking Act which now permit national and state-chartered banks to branch
interstate through acquisitions of banks in other states. See "SUPERVISION AND
REGULATION."
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Selected Economic Data
The Bank's primary service area ("PSA") includes the cities of Auburn and
Opelika, Alabama and nearby surrounding areas in East Alabama, primarily in Lee
County. Lee County's population is approximately 98,000, which ranks it 11th in
the state. The 1996 per capita income in Lee County was $17,236, which ranked it
32nd in the state. Unemployment has been relatively low in Lee County, and
during 1998, the County had average unemployment of 2.2%, which is the 3rd
lowest unemployment rate in Alabama.
Approximately 71% of the land in Lee County is devoted to agriculture, with
91% comprised of forests. An estimated 10% is urban or developed. Timber and
timber products, greenhouses and horticulture, beef cattle, and cotton are the
major agricultural products. Principal manufactured products in the Company's
PSA include magnetic recording tapes, tires, textiles, small gasoline engines,
and hardware. The largest employers in the area are Auburn University, East
Alabama Medical Center, Quantegy Corporation, Uniroyal-Goodrich, West Point
Stevens, and Briggs & Straton.
Loans and Loan Concentrations
The Bank makes loans for commercial, financial, and agricultural purposes,
as well as for real estate mortgage, real estate construction, and consumer
purposes. While there are certain risks unique to each type of lending,
management believes that there is more risk associated with commercial, real
estate construction, agricultural, and consumer lending than with real estate
mortgage loans. To help manage these risks, the Bank has established
underwriting standards, which are substantially similar for each type of loan,
used in evaluating each extension of credit on an individual basis. These
standards include a review of the economic conditions affecting the borrower,
the borrower's financial strength and capacity to repay the debt, the underlying
collateral, and the borrower's past credit performance. These standards are used
to determine the creditworthiness of the borrower at the time a loan is made and
are monitored periodically throughout the life of the loan.
The Bank has loans outstanding to borrowers in all industries within its
PSA. Any adverse economic or other conditions affecting these industries would
also likely have an adverse effect on the local workforce, other local
businesses, and individuals in the community that have entered into loans with
the Bank. However, management believes that due to the diversified mix of
industries located within the Bank's PSA, adverse changes in one industry may
not necessarily affect other area industries to the same degree or within the
same time frame. Management realizes that the Bank's PSA is also subject to both
local and national economic fluctuations.
Employees
At December 31, 1998, the Company had 2 full-time equivalent employees,
both of which are officers, and the Bank had 106 full-time equivalent employees,
including 22 officers.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under federal
and state law. This discussion is qualified in its entirety by reference to the
particular statutory and regulatory provisions referred to below and is not
intended to be an exhaustive description of the status or regulations applicable
to the Company's and the Bank's business. Supervision, regulation, and
examination of the Company and the Bank and their respective subsidiary by the
bank regulatory agencies are intended primarily for the protection of depositors
rather than holders of Company capital stock. Any change in applicable law or
regulation may have a material effect on the Company's business.
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Bank Holding Company Regulation
The Company, as a bank holding company, is subject to supervision and
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve") under the BHC Act. The Company is required to file with the Federal
Reserve periodic reports and such other information as the Federal Reserve may
request. The Federal Reserve examines the Company, and may examine the Company's
Subsidiary. The State of Alabama does not regulate bank holding companies.
The BHC Act requires prior Federal Reserve approval for, among other
things, the acquisition by a bank holding company of direct or indirect
ownership or control of more than 5% of the voting shares or substantially all
the assets of any bank, or for a merger or consolidation of a bank holding
company with another bank holding company. With certain exceptions, the BHC Act
prohibits a bank holding company from acquiring direct or indirect ownership or
control of voting shares of any company which is not a bank or bank holding
company and from engaging directly or indirectly in any activity other than
banking or managing or controlling banks or performing services for its
authorized subsidiary. A bank holding company, may, however, engage in or
acquire an interest in a company that engages in activities which the Federal
Reserve has determined by regulation or order to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
The Company is a legal entity separate and distinct from the Bank and its
other subsidiary. Various legal limitations restrict the Bank from lending or
otherwise supplying funds to the Company or its non-bank subsidiary. The Company
and the Bank are subject to Section 23A of the Federal Reserve Act. Section 23A
defines "covered transactions", which include extensions of credit, and limits a
bank's covered transactions with any affiliate to 10% of such bank's capital and
surplus. All covered and exempt transactions between a bank and its affiliates
must be on terms and conditions consistent with safe and sound banking
practices, and banks and their subsidiary are prohibited from purchasing
low-quality assets from the bank's affiliates. Finally, Section 23A requires
that all of a bank's extensions of credit to an affiliate be appropriately
secured by acceptable collateral, generally United States government or agency
securities. The Company and the Bank also are subject to Section 23B of the
Federal Reserve Act, which generally limits covered and other transactions among
affiliates to terms and under circumstances, including credit standards, that
are substantially the same or at least as favorable to the bank or its
subsidiary as prevailing at the time for transactions with unaffiliated
companies.
The BHC Act, as amended by the Interstate Banking Act, repealed the prior
statutory restrictions on interstate acquisitions of banks by bank holding
companies, such that the Company and any other bank holding company located in
Alabama may now acquire a bank located in any other state, and any bank holding
company located outside Alabama may lawfully acquire any bank based in another
state, regardless of state law to the contrary, in either case subject to
certain deposit-percentage, age of bank charter requirements, and other
restrictions. The Interstate Banking Act also generally provides that, after
June 1, 1997, national and state-chartered banks may branch interstate through
acquisitions of banks in other states. By adopting legislation prior to that
date, a state has the ability to either "opt in" and accelerate the date after
which interstate branching is permissible or "opt out" and prohibit interstate
branching altogether. Alabama has adopted legislation opting into interstate
branching, effective May 31, 1997. Alabama has also adopted legislation, which
became effective on September 29, 1995, that allows Alabama banks to establish a
branch in any other state, territory, or country in accordance with federal law
or the law of such other state, territory, or country and upon prior approval of
the Alabama Superintendent.
Federal Reserve policy requires a bank holding company to act as a source
of financial strength and to take measures to preserve and protect bank
subsidiary in situations where additional investments in a troubled bank may not
otherwise be warranted. In addition, under the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA"), where a bank holding company
has more than one bank or thrift subsidiary, each of the bank holding company's
subsidiary depository institutions are responsible for any losses to the Federal
Deposit Insurance
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Corporation ("FDIC") as a result of an affiliated depository institution's
failure. As a result, a bank holding company may be required to loan money to
its subsidiary in the form of capital notes or other instruments which qualify
as capital under regulatory rules. However, any loans from the holding company
to such subsidiary banks likely will be unsecured and subordinated to such
bank's depositors and perhaps to other creditors of the bank.
The Federal Reserve has amended its Regulation Y to implement certain
provisions of The Economic Growth and Regulatory Paperwork Reduction Act of 1996
("EGRPRA"). Among other things, these amendments to Federal Reserve Regulation Y
reduced the notice and application requirements applicable to bank and nonbank
acquisitions and de novo expansion by well-capitalized and well-managed bank
holding companies; expanded the list of nonbanking activities permitted under
Regulation Y; reduced certain limitations on previously permitted activities;
and amended Federal Reserve anti-tying restrictions to allow banks greater
flexibility to package products and services with their affiliates.
Bank and Bank Subsidiary Regulation Generally
The Bank is subject to supervision, regulation, and examination by the
Federal Reserve and the Alabama Superintendent which monitors all areas of the
operations of the Bank, including reserves, loans, mortgages, issuances of
securities, payment of dividends, establishment of branches, capital adequacy,
and compliance with laws. The Bank is a member of the FDIC and, as such, its
deposits are insured by the FDIC to the maximum extent provided by law. See
"FDIC Insurance Assessments".
The powers of Alabama chartered banks include certain provisions designed
to provide such banks with competitive equality to the powers of national banks
regulated by the Office of the Comptroller of the Currency ("OCC").
In December 1996, the Federal Reserve adopted the Federal Financial
Institutions Examination Council's ("FFIEC") updated statement of policy
entitled "Uniform Financial Institutions Rating System" ("UFIRS"), effective
January 1, 1997. UFIRS is an internal rating system used by the federal and
state regulators for assessing the soundness of financial institutions on a
uniform basis and for identifying those institutions requiring special
supervisory attention. Under the previous UFIRS, each financial institution was
assigned a confidential composite rating based on an evaluation and rating of
five essential components of an institution's financial condition and operations
including Capital adequacy, Asset quality, Management, Earnings, and Liquidity.
The major changes include an increased emphasis on the quality of risk
management practices and the addition of a sixth component for Sensitivity to
market risk. For most institutions, the FFIEC has indicated that market risk
primarily reflects exposures to changes in interest rates. When regulators
evaluate this component, consideration is expected to be given to: management's
ability to identify, measure, monitor, and control market risk; the
institution's size; the nature and complexity of its activities and its risk
profile, and the adequacy of its capital and earnings in relation to its level
of market risk exposure. Market risk is rated based upon, but not limited to, an
assessment of the sensitivity of the financial institution's earnings or the
economic value of its capital to adverse changes in interest rates, foreign
exchange rates, commodity prices, or equity prices; management's ability to
identify, measure, monitor and control exposure to market risk; and the nature
and complexity of interest rate risk exposure arising from nontrading positions.
Community Reinvestment Act
The Company and the Bank are subject to the provisions of the Community
Reinvestment Act of 1977, as amended (the "CRA"), and the federal banking
agencies' regulations thereunder. Under the CRA, all banks and thrifts have a
continuing and affirmative obligation, consistent with their safe and sound
operation to help meet the credit needs for their entire communities, including
low and moderate income neighborhoods. The CRA does not establish specific
lending requirements or programs for financial institutions, nor does it limit
an institution's discretion to develop the types of products and services that
it believes are best suited to its particular community,
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consistent with the CRA. The CRA requires a depository institution's primary
federal regulator, in connection with its examination of the institution, to
assess the institution's record of assessing and meeting the credit needs of the
community served by that institution, including low- and moderate-income
neighborhoods. The regulatory agency's assessment of the institution's record is
made available to the public. Further, such assessment is required of any
institution which has applied to: (i) charter a national bank; (ii) obtain
deposit insurance coverage for a newly-chartered institution; (iii) establish a
new branch office that accepts deposits; (iv) relocate an office; or (v) merge
or consolidate with, or acquire the assets or assume the liabilities of, a
federally regulated financial institution. In the case of a bank holding company
applying for approval to acquire a bank or other bank holding company, the
Federal Reserve will assess the records of each subsidiary depository
institution of the applicant bank holding company, and such records may be the
basis for denying the application. A less than satisfactory CRA rating will
slow, if not preclude expansion of banking activities.
Current CRA regulations rate institutions based on their actual performance
in meeting community credit needs. CRA performance is evaluated by the Federal
Reserve, the Bank's primary federal regulator using a lending test, an
investment test, and a service test. The Federal Reserve also will consider: (i)
demographic data about the community; (ii) the institution's capacity and
constraints; (iii) the institution's product offerings and business strategy;
and (iv) data on the prior performance of the institution and similarly-situated
lenders.
The Bank is also subject to, among other things, the provisions of the
Equal Credit Opportunity Act (the "ECOA") and the Fair Housing Act (the "FHA"),
both of which prohibit discrimination based on race or color, religion, national
origin, sex, and familial status in any aspect of a consumer or commercial
credit or residential real estate transaction. The Department of Housing and
Urban Development, the Department of Justice (the "DJ"), and the federal banking
agencies in April 1994 issued an Interagency Policy Statement on Discrimination
in Lending in order to provide guidance to financial institutions in determining
whether discrimination exists, how the agencies will respond to lending
discrimination, and what steps lenders might take to prevent discriminatory
lending practices. The DJ has also increased its efforts to prosecute what it
regards as violations of the ECOA and FHA.
Payment of Dividends
The Company is a legal entity separate and distinct from its subsidiary.
The prior approval of the Federal Reserve and/or the Alabama Superintendent is
required if the total of all dividends declared by a state member bank (such as
the Bank) in any calendar year will exceed the sum of such bank's net profits
for the year and its retained net profits for the preceding two calendar years,
less any required transfers to surplus. Federal law also prohibits any state
member from paying dividends that would be greater than such bank's undivided
profits after deducting statutory bad debt in excess of such bank's allowance
for loan losses. During 1998, the Bank paid cash dividends of $385,000 to the
Company.
In addition, the Company and the Bank are subject to various general
regulatory policies and requirements relating to the payment of dividends,
including requirements to maintain adequate capital above regulatory minimums.
The appropriate federal regulatory and state authorities are authorized to
determine, under certain circumstances relating to the financial condition of a
state member bank or a bank holding company, that the payment of dividends would
be an unsafe or unsound practice and to prohibit payment thereof. The Federal
Reserve and the Alabama Superintendent have indicated that paying dividends that
deplete a state member bank's capital base to an inadequate level would be an
unsound and unsafe banking practice. The Federal Reserve and the Alabama
Superintendent have indicated that financial depository institutions should
generally pay dividends only out of current operating earnings.
Capital
The Federal Reserve has risk-based capital guidelines for bank holding
companies and state member banks, respectively. These guidelines require a
minimum ratio of capital to risk-weighted assets (including certain
off-
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balance-sheet activities, such as standby letters of credit) of 8%. At least
half of the total capital must consist of common equity, retained earnings and a
limited amount of qualifying preferred stock, less goodwill and certain core
deposit intangibles ("Tier 1 capital"). The remainder may consist of non-
qualifying preferred stock, qualifying subordinated, perpetual, and/or mandatory
convertible debt, term subordinated debt and intermediate term preferred stock,
up to 45% of pretax unrealized holding gains on available for sale equity
securities with readily determinable market values that are prudently valued,
and a limited amount of any loan loss allowance ("Tier 2 capital" and, together
with Tier 1 capital, "Total Capital").
In addition, the federal regulatory agencies have established minimum
leverage ratio guidelines for bank holding companies and state member banks,
which provide for a minimum leverage ratio of Tier 1 capital to adjusted average
quarterly assets ("leverage ratio") equal to 3%, plus an additional cushion of
1.0% - 2.0%, if the institution has less than the highest regulatory rating. The
guidelines also provide that institutions experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions substantially
above the minimum supervisory levels without significant reliance on intangible
assets. Higher capital may be required in individual cases, and depending upon a
bank holding company's risk profile. All bank holding companies and banks are
expected to hold capital commensurate with the level and nature of their risks
including the volume and severity of their problem loans. Lastly, the Federal
Reserve's guidelines indicate that the Federal Reserve will continue to consider
a "tangible Tier 1 leverage ratio" (deducting all intangibles) in evaluating
proposals for expansion or new activity. The Federal Reserve has not advised the
Company or the Bank of any specific minimum leverage ratio or tangible Tier 1
leverage ratio applicable to them.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), among other things, requires the federal banking agencies to take
"prompt corrective action" regarding depository institutions that do not meet
minimum capital requirements. FDICIA establishes five capital tiers: "well
capitalized", "adequately capitalized", "undercapitalized", "significantly
undercapitalized", and "critically undercapitalized". A depository institution's
capital tier will depend upon how its capital levels compare to various relevant
capital measures and certain other factors, as established by regulation.
All of the federal banking agencies have adopted regulations establishing
relevant capital measures and relevant capital levels. The relevant capital
measures are the Total Capital ratio, Tier 1 capital ratio, and the leverage
ratio. Under the regulations, a state member bank will be (i) well capitalized
if it has a Total Capital ratio of 10% or greater, a Tier 1 capital ratio of 6%
or greater, and is not subject to any written agreement, order, capital
directive, or prompt corrective action directive by a federal bank regulatory
agency to meet and maintain a specific capital level for any capital measure,
(ii) adequately capitalized if it has a Total Capital ratio of 8% or greater, a
Tier 1 capital ratio of 4% or greater, and a leverage ratio of 4% or greater (3%
in certain circumstances), (iii) undercapitalized if it has a Total Capital
ratio of less than 8%, a Tier 1 capital ratio of less than 4% (3% in certain
circumstances), or (iv) critically undercapitalized if its tangible equity is
equal to or less than 2% of average quarterly tangible assets.
As of December 31, 1998, the consolidated capital ratios of the Company and
the Bank were as follows:
Regulatory
Minimum Company Bank
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Tier 1 risk-based capital ratio 4.0% 13.33% 12.33%
Total risk-based capital ratio 8.0% 14.58% 13.58%
Tier 1 leverage ratio 3.0-5.0% 9.29% 8.57%
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would
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thereafter be undercapitalized. Undercapitalized depository institutions are
subject to growth limitations and are required to submit a capital restoration
plan for approval. For a capital restoration plan to be acceptable, the
depository institution's parent holding company must guarantee that the
institution comply with such capital restoration plan. The aggregate liability
of the parent holding company is limited to the lesser of 5% of the depository
institution's total assets at the time it became undercapitalized and the amount
necessary to bring the institution into compliance with applicable capital
standards. If a depository institution fails to submit an acceptable plan, it is
treated as if it is significantly undercapitalized. If the controlling holding
company fails to fulfill its obligations under FDICIA and files (or has filed
against it) a petition under the federal Bankruptcy Code, the claim would be
entitled to a priority in such bankruptcy proceeding over third party creditors
of the bank holding company. Significantly undercapitalized depository
institutions may be subject to a number of requirements and restrictions,
including orders to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total assets, and cessation of receipt of
deposits from correspondent banks. Critically undercapitalized institutions are
subject to the appointment of a receiver or conservator. Because the Company and
the Bank exceed applicable capital requirements, the respective managements of
the Company and the Bank do not believe that the provisions of FDICIA have had
any material impact on the Company and the Bank or their respective operations.
FDICIA
FDICIA directs that each federal banking regulatory agency prescribe
standards for depository institutions and depository institution holding
companies relating to internal controls, information systems, internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth compensation, a maximum ratio of classified assets to capital, minimum
earnings sufficient to absorb losses, a minimum ratio of market value to book
value for publicly traded shares, and such other standards as the federal
regulatory agencies deem appropriate.
FDICIA also contains a variety of other provisions that may affect the
operations of the Company and the Bank, including new reporting requirements,
regulatory standards for real estate lending, "truth in savings" provisions, the
requirement that a depository institution give 90 days prior notice to customers
and regulatory authorities before closing any branch, and a prohibition on the
acceptance or renewal of brokered deposits by depository institutions that are
not well capitalized or are adequately capitalized and have not received a
waiver from the FDIC.
Enforcement Policies and Actions
The Federal Reserve and the FDIC monitor compliance with laws and
regulations. Violations of laws and regulations, or other unsafe and unsound
practices, may result in these agencies imposing fines or penalties, cease and
desist orders, or taking other enforcement actions. Under certain circumstances,
these agencies may enforce these remedies directly against officers, directors,
employees and others participating in the affairs of a bank or bank holding
company.
Depositor Preference
The Omnibus Budget Reconciliation Act of 1993 provides that deposits and
certain claims for administrative expenses and employee compensation against an
insured depository institution would be afforded a priority over other general
unsecured claims against such an institution in the "liquidation or other
resolution" of such an institution by any receiver.
Fiscal and Monetary Policy
Banking is a business which depends on interest rate differentials. In
general, the difference between the interest paid by a bank on its deposits and
its other borrowings, and the interest received by a bank on its loans and
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securities holdings, constitutes the major portion of a bank's earnings. Thus,
the earnings and growth of the Company and the Bank are subject to the influence
of economic conditions generally, both domestic and foreign, and also to the
monetary and fiscal policies of the United States and its agencies, particularly
the Federal Reserve. The Federal Reserve regulates the supply of money through
various means, including open market dealings in United States government
securities, the discount rate at which banks may borrow from the Federal
Reserve, and the reserve requirements on deposits. The nature and timing of any
changes in such policies and their effect on the Company and the Bank cannot be
predicted.
FDIC Insurance Assessments
The Bank is subject to FDIC deposit insurance assessments. The Bank's
deposits are insured by the FDIC's Bank Insurance Fund ("BIF"), and it has no
deposit insured by the Savings Association Insurance Fund ("SAIF"). Prior to
January 1, 1996, the annual premiums ranged from $.04 to $.31 for every $100 of
BIF deposits. In 1996, the FDIC adopted a new risk-based premium schedule which
decreased the assessment rates for BIF depository institutions. Under this
schedule, which took effect for assessment periods beginning January 1, 1996,
the annual premiums range from zero to $.27 for every $100 of deposits. In
addition, the FDIC Board eliminated the $2,000 minimum annual assessment
previously imposed on all insured institutions. The Deposit Insurance Funds Act
of 1996 (the "Funds Act") authorized FICO to levy assessments on BIF-assessable
deposits at a rate equal to one-fifth of the FICO assessment rate that is
applied to deposits assessable by SAIF. The actual FICO 1998 annual assessment
rates on deposits were approximately 1.2 basis points for BIF-assessable
deposits.
Each financial institution is assigned to one of three capital groups -
well capitalized, adequately capitalized or undercapitalized - and further
assigned to one of three subgroups within a capital group, on the basis of
supervisory evaluations by the institution's primary federal and, if applicable,
state regulators and other information relevant to the institution's financial
condition and the risk posed to the applicable insurance fund. For the years
1996 and before the actual assessment rate applicable to a particular
institution will, therefore, depend in part upon the risk assessment
classification so assigned to the institution by the FDIC. During the years
ended December 31, 1998, 1997 and 1996 the Bank paid $0, $0 and $2,000,
respectively, in BIF deposit insurance premiums, and paid approximately $27,000
and $26,000 in FICO assessments during 1998 and 1997, respectively.
Legislative and Regulatory Changes
Various changes have been proposed with respect to restructuring and
changing the regulation of the financial services industry. FIRREA required a
study of the deposit insurance system. On February 5, 1991, the Department of
the Treasury released "Modernizing the Financial System; Recommendations for
Safer, More Competitive Banks". Among other matters, this study analyzed and
made recommendations regarding reduced bank competitiveness and financial
strength, overextension of deposit insurance, the fragmented regulatory system
and the under- capitalized deposit insurance fund. It proposed restoring
competitiveness by allowing banking organizations to participate in a full range
of financial services outside of insured commercial banks. Deposit insurance
coverage would be narrowed to promote market discipline.
The Interstate Banking Act also directed the Secretary of the Treasury to
take a broad look at the strengths and weaknesses of the United States'
financial services system. In June 1997, the Treasury Department proposed
legislation to eliminate what it deemed outmoded barriers to competition among
financial services providers. On November 17, 1997, the United States Department
of the Treasury released its study "American Finance for the 21st Century" which
considered changes in the financial services industry during the next 10 years
and beyond and reviewed the adequacy of existing statutes and legislation.
Other legislative and regulatory proposals regarding changes in banking,
and the regulation of banks, thrifts and other financial institutions and bank
and bank holding company powers are being considered by the
-10-
<PAGE>
executive branch of the Federal government, Congress and various state
governments. Among other items under consideration are the possible combination
of the BIF and SAIF, changes in or repeal of the Glass-Steagall Act which
separates commercial banking from investment banking, and changes in the BHC Act
to broaden the powers of "financial services" companies to own and control
depository institutions and engage in activities not closely related to banking.
The FDIC is considering possibly adding risk measures in determining deposit
insurance assessments. Certain of these proposals, if adopted, could
significantly change the regulation of banks and the financial services
industry. It cannot be predicted whether any of these proposals will be adopted,
and, if adopted, how these proposals will affect the Company and the Bank.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank conducts its business from its main office and four branches. The
main office is located in the center of Auburn, Alabama, in a 16,150 square foot
building that is owned by the Bank. The original building was constructed in
1964, and an addition was completed in 1981. Portions of the building have been
renovated within the last five years in order to accommodate growth and changes
in the Bank's operational structure and to adapt to technological changes. The
main office building is surrounded on two sides by paved areas that provide
parking for 84 vehicles, including four handicapped spaces.
The Bank's Kroger branch is located in the Kroger supermarket in the Corner
Village Shopping Center in Auburn, Alabama. On September 15, 1987, the Bank
entered into a 15-year lease agreement for approximately 300 square feet of
space in the supermarket. This branch offers the full line of the Bank's
services, with the exception of loans and safe deposit boxes.
The Opelika branch is located in Opelika, Alabama, in a 4,000 square foot
building. This branch is owned by the Bank and was built in 1991. This branch
offers the full line of the Bank's services and has drive-through windows and an
ATM. This branch offers parking for approximately 36 vehicles, including two
handicapped spaces.
The Bank's Winn-Dixie branch opened April 3, 1997, at the Winn Dixie
supermarket in the Tiger Crossing Shopping Center on the south side of Auburn,
Alabama. The Bank has a five year lease agreement for approximately 350 square
feet of space in the supermarket. This branch offers the full line of the Bank's
deposit and other services, except loans and safe deposit boxes.
The Bank's Wal-Mart branch was opened August 19, 1998 in the Wal-Mart
shopping center in Phenix City, Alabama, about 20 miles south of Auburn,
Alabama. The Bank has a five year lease agreement for approximately 600 square
feet of space in the Wal-Mart. This branch offers the full line of the Bank's
deposit and other services, except loans and safe deposit boxes.
The Bank owns a drive-in facility located directly across the street from
its main office. This drive-in facility was constructed in 1979 and has five
drive-through lanes and a walk-up window.
In addition, the Bank leases from the Company approximately 8,300 square
feet of space in the AuburnBank Center (the "Center"), which is located next to
the main office. This building, which has approximately 18,000 square feet of
space, is also leased to outside third parties. Leases between the Bank and the
Company are based on the same terms and conditions as leases to outside third
parties leasing space in the same building. The Bank's data processing
activities, as well as other operations, are located in this leased space. The
parking lot provides parking for approximately 120 vehicles, including
handicapped parking.
Directly behind the Center is an older home that is also owned by the
Company. This building is rented as housing to university students. The rear
portion of this property is used as a parking area for approximately 20 vehicles
of Bank employees.
-11-
<PAGE>
The Bank also owns a two-story building located directly behind the main
office. The first floor of this building is leased to unaffiliated third
parties.
The Company owns a commercial office building (the "Hudson Building")
located across the street from the main office in downtown Auburn. The Hudson
Building has two floors and a basement which contain approximately 14,395 square
feet of leasable space. Approximately 73.2% of this building is available for
rent by third-party tenants. The Bank occupies approximately 3,900 square feet,
which includes a portion of the basement level used for storage and office space
used to house certain bank functions. The Bank pays rent to the Company based on
current market rates for such space.
In 1994, the Bank acquired a piece of commercial real estate located in
Auburn on U.S. Highway 29. This property, which was acquired in satisfaction of
debt previously contracted, was formerly used by a floor covering business and
contained approximately 6,045 square feet of office, showroom, and warehouse
space. The Bank subsequently removed an underground storage tank ("UST")
containing petroleum products from the site. In March 1995, the Alabama
Department of Environmental Management ("ADEM") requested that the Bank submit a
Secondary Investigation Plan ("Secondary Investigation") as a result of
underground soil and water contamination of petroleum-based hydrocarbon
products. The Secondary Investigation was completed and submitted to ADEM by Roy
R. Weston, Inc. ("Weston"), an independent consultant hired by the Bank. The
Secondary Investigation indicated low concentrations of soil contamination on
site and elevated concentrations of gasoline constituents both on-site and
off-site. The Secondary Investigation indicated a low risk to human receptors,
and Weston recommended to ADEM initiation of a quarterly ground water monitoring
program for one year, at which time the program would be reassessed. In response
to ADEM's Letter of Requirement dated January 18, 1996, Weston prepared and
submitted, on behalf of the Bank, a Monitoring Only Corrective Action Plan on
February 20, 1996. Quarterly groundwater monitoring will continue in 1999 as
required by ADEM. Samples from the eight (8) existing monitoring wells will be
collected and analyzed by Roy F. Weston, Inc. The monitoring data will be
submitted by Weston to ADEM as required. It is estimated that the cost for
monitoring and providing reporting data to ADEM for 1999 will be approximately
$9,000 (unless the site is released by ADEM during the year). The extent and
cost of any further testing and remediation, if any, cannot be predicted at this
time.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of its business, the Company and the Bank from time to
time are involved in legal proceedings. The Company and Bank management believe
there are no pending or threatened legal proceedings which upon resolution are
expected to have a material adverse effect upon the Company's or the Bank's
financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1998.
-12-
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the Nasdaq SmallCap Market,
under the symbol AUBN. As of February 26, 1999, there were approximately
3,924,573 shares of the Company's Common Stock issued and outstanding, which
were held by approximately 450 shareholders of record. The following table sets
forth, for the indicated periods, the high and low closing sale prices for
Company's Common Stock as reported on the Nasdaq SmallCap Market.
Closing Cash
Price Dividends
Per Share (1)(2) Declared (2)
--------------------------- -------------------
High Low
1998
First Quarter $ 19.67 $ 12.77 $ 0.04
Second Quarter 24.00 18.17 0.05
Third Quarter 29.25 17.94 0.05
Fourth Quarter 17.50 15.88 0.05
1997
First Quarter 9.17 7.83 0.04
Second Quarter 8.67 7.67 0.04
Third Quarter 9.83 7.83 0.04
Fourth Quarter 13.83 11.33 0.04
- -------------
(1) The price information represents actual transactions.
(2) The price information for 1997 and the first quarter of 1998 is restated to
reflect the Company's three for one stock split in the form of a dividend
in June 1998.
On May 12, 1998, the Company's Board of Directors approved a three for one
stock split effected in the form of a dividend payable on June 25, 1998 to
shareholders of record on June 10, 1998. All share and per share information in
the accompanying financial statements has been restated to reflect the effect of
the additional shares outstanding resulting from the stock split. Common stock
and surplus have been restated also to reflect the stock split retroactively.
The Company has paid cash dividends on its capital stock since 1985. Prior
to this time, the Bank paid cash dividends since its organization in 1907,
except during the Depression years of 1932 and 1933. Holders of Common Stock are
entitled to receive such dividends as may be declared by the Company's Board of
Directors. The amount and frequency of cash dividends will be determined through
the judgment of the Company's Board of Directors based upon a number of factors,
including the Company's earnings, financial condition, capital requirements, and
other relevant factors. Company management presently intends to continue its
present dividend policies.
The amount of dividends payable by the Bank is limited by law and
regulation. The need to maintain adequate capital in the Bank also limits
dividends that may be paid to the Company. Although Federal Reserve policy could
restrict future dividends on Common Stock, such policy places no current
restrictions on such dividends. See "SUPERVISION AND REGULATION -- DIVIDENDS"
and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- CAPITAL RESOURCES."
-13-
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion and analysis is designed to provide a better
understanding of various factors related to the Company's results of operations
and financial condition. Such discussion and analysis should be read in
conjunction with "BUSINESS" and "FINANCIAL STATEMENTS AND RELATED NOTES."
The purpose of this discussion is to focus on significant changes in the
financial condition and results of the operations of the Company during the
three years ended December 31, 1998, 1997 and 1996. This discussion and analysis
is intended to supplement and highlight information contained in the
accompanying consolidated financial statements and the selected financial data
presented elsewhere herein.
Summary
Net earnings increased $359,000 (11.7%) to $3,439,000 during 1998 from
$3,080,000 for the year ended December 31, 1997. Basic income per share was
$0.88 and $0.79 for 1998 and 1997, respectively, an increase of 11.4%.
Comparatively, net earnings during 1997 increased $327,000 (11.9%) from the 1996
total of $2,753,000, while basic income per share showed a similar increase of
$0.09 per share for 1997 from a 1996 per share total of $0.70. The increase in
net earnings for 1998 is attributable to higher net interest income and higher
noninterest income offset by higher noninterest expense for the year. The
increase in 1997 was due to higher levels of net interest income offset by lower
noninterest income and higher noninterest expense compared to 1996. See
"FINANCIAL CONDITION -- CAPITAL RESOURCES" and the "CONSOLIDATED AVERAGE
BALANCES, INTEREST INCOME/EXPENSE AND YIELDS/RATES" tables.
Total assets at December 31, 1998 and 1997 were $307,874,000 and
$264,029,000, reflecting growth of $43,845,000 (16.6%). The Company's growth
during 1998 resulted primarily from the growth in loans. Deposits grew
$9,527,000 (4.3%) from $223,978,000 at year-end 1997 to $233,505,000 at year-end
1998. See "FINANCIAL CONDITION-DEPOSITS AND LOANS and LIQUIDITY."
Financial Condition
Investment Securities
Investment securities held to maturity were $8,094,000 and $14,364,000 at
December 31, 1998 and 1997, respectively. This decline of $6,270,000 (43.7%) in
1998 resulted entirely from scheduled paydowns, calls and maturities. The
securities available for sale portfolio was $63,586,000 and $40,446,000 at
December 31, 1998 and 1997, respectively. This increase of $23,140,000 (57.2%)
reflects purchases in the fourth quarter for approximately $10,000,000 to
pre-refund callable U.S. government agency securities which the Bank expects
will be called in the first quarter of 1999. In addition, proceeds from
held-to-maturity securities that were called or matured during 1998 were shifted
by management to available for sale securities to maintain flexibility in its
liquidity planning. See "-- LIQUIDITY."
The composition of the Company's total investment securities portfolio
reflects the Company's investment strategy to provide acceptable levels of
interest income from portfolio yields while maintaining an appropriate level of
liquidity to assist with controlling the Company's interest rate position. In
recent years, the Company has invested primarily in taxable securities due to
its inability to fully realize the benefits of the preferential treatment
afforded tax-exempt securities under the tax laws. Because of their liquidity,
credit quality and yield characteristics, the majority of the purchases of
taxable securities have been in investment grade mortgage-backed securities
("MBS") and collateralized mortgage obligations ("CMOs"). The yields, values,
and durations of such MBS and CMOs generally vary with interest rates,
prepayment levels, and general economic conditions, and as a result, the values
of such instruments may be more volatile than other instruments with similar
maturities. Such MBS and CMOs also may have longer stated maturities than other
securities, which may result in further price volatility.
-14-
<PAGE>
The following table indicates the amortized cost of the portfolio of
investment securities held to maturity at the end of the last three years:
<TABLE>
<CAPTION>
Amortized Cost
December 31,
------------------------------------------
1998 1997 1996
------ ------ ------
(In thousands)
Investment Securities Held to Maturity:
<S> <C> <C> <C>
U.S. government agency $ -- 3,216 2,028
State and political subdivisions 1,585 1,479 1,470
Mortgage-backed securities 6,509 9,470 13,663
Collateralized mortgage obligations -- 199 535
Other -- -- 207
----------- -------- --------
Total investment securities
held to maturity $ 8,094 14,364 17,903
=========== ======== ========
</TABLE>
The following table indicates the fair value of the portfolio of investment
securities available for sale at the end of the last three years:
<TABLE>
<CAPTION>
Cost and Unrealized Gain
December 31,
---------------------------------------------
1998 1997 1996
------ ------ ------
(In thousands)
Investment Securities Available for Sale:
<S> <C> <C> <C>
U.S. Government agency 17,340 12,097 17,873
State and political subdivisions 883 498 490
Mortgage-backed securities 17,711 7,990 363
Collateralized mortgage obligations 27,652 19,861 24,854
Mutual funds -- -- 447
-------- -------- --------
Total investment securities
available for sale $ 63,586 40,446 44,027
======== ======== ========
</TABLE>
At December 31, 1998, the Bank owned CMOs with a total amortized cost of
$27,525,000. All of the CMOs are rated AAA. The CMOs are all backed by federal
agency guaranteed mortgages, except for 2 issues in the amount of $427,000 which
are privately issued mortgage pass-through certificates. Fair values for the
private placement CMOs were estimated based on fair values for similar
instruments.
The MBS portfolio's total amortized cost of $24,140,000 at December 31,
1998, is a mixture of fixed rate mortgages, adjustable rate mortgages ("ARMs"),
and securities with balloon payments. At the time of purchase, the Bank looks at
various prepayment speeds and makes the purchase based on the ability to accept
the yield and average life based on both increasing and decreasing prepayment
speeds.
-15-
<PAGE>
The following tables present the maturities and weighted average yields of
investment securities at December 31, 1998:
<TABLE>
<CAPTION>
Maturities of Held-to-Maturity
Investment Securities
Amortized Cost
After one After five
Within through through After
one year five years 10 years 10 years
-------- ---------- -------- --------
(In thousands)
<S> <C> <C> <C> <C>
State and political subdivision securities $ 595 200 365 425
Mortgage-backed securities 21 184 4,780 1,524
--------- ---------- ------- ----------
Total investment securities
held to maturity $ 616 384 5,145 1,949
========= ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
Weighted Average Yields of Held-to-Maturity
Investment Securities
After one After five
Within through through After
one year five years 10 years 10 years
-------- ---------- --------- --------
<S> <C> <C> <C> <C>
State and political subdivision securities (1) 6.91% 5.91% 5.30% 7.25%
Mortgage-backed securities 9.33% 6.84% 6.39% 6.87%
----------- ------- --------- -------
Total weighted average yield 7.00% 6.35% 6.31% 6.96%
</TABLE>
(1) Weighted average yields have not been computed on a tax-equivalent basis.
<TABLE>
<CAPTION>
Maturities of Available for Sale
Investment Securities
Amortized Cost
After one After five
through through After
five years 10 years 10 years
---------- -------- --------
(In thousands)
<S> <C> <C> <C>
U.S. government agencies, excluding
mortgage-backed securities $ 9,985 7,041 --
State and political subdivision securities -- 848 --
Mortgage-backed securities 145 2,646 14,839
Collateralized mortgage obligations -- 555 26,970
---------- --------- --------
Total investment securities
available for sale $ 10,130 11,090 41,809
========== ======= =========
</TABLE>
-16-
<PAGE>
<TABLE>
<CAPTION>
Weighted Average Yields of Available for Sale
Investment Securities
After one After five
through through After
five years 10 years 10 years
---------- --------- --------
<S> <C> <C> <C>
U.S. government agencies, excluding
mortgage-backed securities 6.34% 6.04% --
State and political subdivision securities (1) -- 4.67% --
Mortgage-backed securities 6.79% 6.11% 6.01%
Collateralized mortgage obligations -- 8.66% 6.24%
---------- --------- --------
Total weighted average yield 6.35% 6.08% 6.16%
</TABLE>
(1) Weighted average yields have not been computed on a tax-equivalent basis.
Loans
Total loans, net of unearned income, were $218,687,000 at December 31,
1998, an increase of $33,194,000 (17.9%), over total loans, net of unearned
income, of $185,493,000 at December 31, 1997. The primary growth during 1998
occurred in the real estate mortgage and commercial, financial and agricultural
loan areas. The commercial, financial and agricultural portfolio increased
$14,746,000 (31.8%) to $61,075,000 at December 31, 1998 compared to $46,329,000
at December 31, 1997. The increase was due primarily to increased demand for
commercial credits. Commercial, financial and agricultural loans represented
27.9% and 25.0% of the total loans at December 31, 1998 and 1997, respectively.
The real estate mortgage loan component of the loan portfolio increased
$11,622,000 (10.2%) to $125,448,000 at December 31, 1998, over the 1997 balance
of $113,826,000 and represented 57.3% of the total loan portfolio at December
31, 1998, as compared to 61.3% at December 31, 1997. This growth in real estate
mortgage loans was attributable to the increase in commercial real estate
mortgages of $9,399,000 (18.2%) combined with an increase in residential real
estate mortgage loans of $2,223,000 (3.6%), reflecting lower rates to borrowers
and strong demand in the Bank's market for those products.
The respective increases in commercial real estate mortgage loans and
commercial, financial and agricultural loans also reflects management's focus on
balancing the composition of its loan portfolio by increasing the volume of
loans in these categories.
In addition to originating mortgage loans for its own portfolio, the
Company also originates residential mortgage loans which are sold in the
secondary market. In addition to selling real estate mortgage loans to the
Federal National Mortgage Association ("FNMA") with the Bank retaining the
servicing, the Bank has arranged with one mortgage servicing company to
originate and sell, without recourse, residential first mortgage real estate
loans, with servicing released. During 1998, the Bank sold mortgage loans
totaling approximately $24,662,000, to FNMA, with the Bank retaining the
servicing, and sold mortgage loans, totaling approximately $5,899,000, to the
mortgage servicing company, with servicing released. At December 31, 1998, the
Bank was servicing loans totaling approximately $65,661,000. The Bank collects
monthly servicing fees of 0.25% to 0.375% annually of the outstanding balances
of loans serviced for FNMA. See "- EFFECTS OF INFLATION AND CHANGING PRICES."
-17-
<PAGE>
The following table presents the composition of the loan portfolio by major
categories at the end of the last five years:
<TABLE>
<CAPTION>
Loan Portfolio Composition
December 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C> <C>
Commercial, financial and agricultural $ 61,075 46,329 39,213 35,800 32,443
Real estate - construction:
Commercial 8,112 3,172 3,572 945 1,076
Residential 4,544 3,583 3,068 2,323 1,657
Real estate - mortgage:
Commercial 61,113 51,714 42,827 33,593 33,517
Residential 64,335 62,112 58,530 54,384 50,677
Consumer installment 19,523 18,620 14,600 13,583 21,168
------ ------ ------ ------ ------
Total loans $ 218,702 185,530 161,810 140,628 140,538
Less:
Unearned income (15) (37) (91) (157) (210)
Allowance for loan losses (2,808) (2,125) (2,094) (2,012) (2,100)
--------- -------- -------- -------- --------
Loans, net $ 215,879 183,368 159,625 138,459 138,228
======== ======== ======== ======== ==========
</TABLE>
The following table presents maturities by major loan classifications and
the sensitivity of loans to changes in interest rates within each maturity
category at December 31, 1998:
<TABLE>
<CAPTION>
Loan Portfolio Maturing
After one
Within through After
one year five years five years Total
-------- ---------- ---------- -----
(In thousands)
<S> <C> <C> <C> <C>
Commercial, financial and agricultural $ 37,702 18,373 5,000 61,075
Real estate - construction 10,729 1,927 -- 12,656
Real estate - mortgage 14,211 14,248 96,989 125,448
Consumer installment 8,916 10,053 554 19,523
--------- ---------- ---------- ---------
Total loans 71,558 44,601 102,543 218,702
======== ======== ========= ========
Variable-rate loans 28,117 8,314 76,270 112,701
Fixed-rate loans 43,441 36,287 26,273 106,001
-------- -------- --------- ---------
Total loans $ 71,558 44,601 102,543 218,702
======== ======== ========= ========
</TABLE>
Allowance for Loan Losses and Risk Elements
Interest on loans is normally accrued from the date an advance is made. The
performance of loans is evaluated primarily on the basis of a review of each
customer relationship over a period of time and the judgment of lending officers
as to the ability of borrowers to meet the repayment terms of loans. If there is
reasonable doubt as to the repayment of a loan in accordance with the agreed
terms, the loan may be placed on a nonaccrual basis pending
-18-
<PAGE>
the sale of any collateral or a determination as to whether sources of repayment
exist. This action may be taken even though the financial condition of the
borrower or the collateral may be sufficient ultimately to reduce or satisfy the
obligation. Generally, when a loan is placed on a nonaccrual basis, all payments
are applied to reduce principal to the extent necessary to eliminate doubt as to
the repayment of the loan. Any interest income on a nonaccrual loan is
recognized only on a cash basis.
The Company's policy generally is to place a loan on nonaccrual status when
it is contractually past due 90 days or more as to payment of principal or
interest. A loan may be placed on nonaccrual status at an earlier date when
concerns exist as to the ultimate collections of principal or interest. At the
time a loan is placed on nonaccrual status, interest previously accrued but not
collected is reversed and charged against current earnings. Loans that are
contractually past due 90 days or more which are well secured or guaranteed by
financially responsible third parties and are in the process of collection
generally are not placed on nonaccrual status.
Lending officers are responsible for the ongoing review and administration
of each particular loan. As such, they make the initial identification of loans
which present some difficulty in collection or where circumstances indicate that
the possibility of loss exists. The responsibilities of the lending officers
include the collection effort on a delinquent loan. To strengthen internal
controls in the collection of delinquencies, senior management and the Loan
Committee are informed of the status of delinquent and "watch" or problem loans
on a monthly basis. Senior management reviews the allowance for loan losses and
makes recommendations to the Loan Committee as to loan charge-offs on a monthly
basis.
The allowance for loan losses represents management's assessment of the
risk associated with extending credit and its evaluation of the quality of the
loan portfolio. Management analyzes the loan portfolio to determine the adequacy
of the allowance for loan losses and the appropriate provision required to
maintain a level considered adequate to absorb anticipated loan losses. In
assessing the adequacy of the allowance, management reviews the size, quality
and risk of loans in the portfolio. Management also considers such factors as
the Bank's loan loss experience, the amount of past due and nonperforming loans,
specific known risk, the status and amount of nonperforming assets, underlying
collateral values securing loans, current and anticipated economic conditions
and other factors which affect the allowance for potential credit losses. An
analysis of the credit quality of the loan portfolio and the adequacy of the
allowance for loan losses is prepared by the Bank's Credit Administration area
and presented to the Loan Committee on a quarterly basis. In addition, the Bank
has engaged an outside loan review consultant, on a semi-annual basis, to
perform an independent review of the quality of the loan portfolio and adequacy
of the allowance.
The Bank's allowance for loan losses is also subject to regulatory
examinations and determinations as to adequacy, which may take into account such
factors as the methodology used to calculate the allowance for loan losses and
the size of the allowance for loan losses in comparison to a group of peer banks
identified by the regulators. During their routine examinations of banks, the
Federal Reserve and the Alabama Superintendent may require a bank to make
additional provisions to its allowance for loan losses when, in the opinion of
the regulators, credit evaluations and allowance for loan loss methodology
differ materially from those of management. See "SUPERVISION AND REGULATION."
While it is the Bank's policy to charge off in the current period loans for
which a loss is considered probable, there are additional risks of future losses
which cannot be quantified precisely or attributed to particular loans or
classes of loans. Because these risks include the state of the economy,
management's judgment as to the adequacy of the allowance is necessarily
approximate and imprecise.
-19-
<PAGE>
The following table summarizes the levels of the allowance for loan losses
at the end of the last five years and activity in the allowance during such
years:
<TABLE>
<CAPTION>
Allowance for Loan Loss Activity for year ended
December 31,
------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period $ 2,125 2,094 2,012 2,100 2,264
Provision for loan losses 891 285 80 -- 172
Charge-offs:
Commercial, financial, and agricultural 42 146 64 43 90
Real estate -- 1 1 1 164
Consumer 272 173 108 113 183
--- --- --- --- ---
Total charge-offs 314 320 173 157 437
Recoveries:
Commercial, financial and agricultural 7 15 100 4 7
Real estate 2 3 5 28 34
Consumer 97 48 70 88 60
-- -- -- -- --
Total recoveries 106 66 175 120 101
--- -- --- --- ---
Net charge-offs (recoveries) 208 254 (2) 37 336
Other adjustments (1) -- -- -- (51) --
-- -- -- ---- --
Balance at end of period $ 2,808 2,125 2,094 2,012 2,100
===== ===== ===== ===== =====
Ratio of allowance for loan losses to loans
outstanding, net of unearned discount 1.28% 1.15% 1.29% 1.43% 1.50%
Ratio of allowance for loan losses
to nonaccrual loans, renegotiated loans,
and other nonperforming assets 61.14% -- 1,957.01% 1,468.61% 156.72%
Ratio of net charge-offs (recoveries) to
average loans outstanding, net of
unearned income 0.10% 0.15% (0.001)% 0.03% 0.26%
</TABLE>
- -----------------
(1) In conjunction with the sale of its credit card portfolio in 1995, the Bank
reversed the portion of the allowance for loan losses that had been
maintained to absorb losses on credit card lines.
During 1998, the Company had loan charge-offs totaling $314,000 and
recoveries of $106,000, as compared to $320,000 in charge-offs and recoveries of
$66,000 in the prior year. Management believes that the $2,808,000 in allowance
for loan losses at December 31, 1998, (1.28% of total outstanding loans, net of
unearned income) is adequate to absorb known risks in the portfolio at such
date. However, no assurance can be given that adverse economic circumstances
will not result in increased losses in the Bank's loan portfolio. The Bank does
not currently allocate its allowance for loan losses among its various
classifications of loans. The substantial decrease in the ratio of the allowance
for loan and lease losses to nonperforming assets between year-end 1997 and
year-end 1998 was primarily due to the placement in nonaccrual status of the
impaired loan relationship discussed below. Management's assessment of the
credit quality of the loan portfolio during 1998 indicated deterioration of a
$4.098 million commercial credit such that management's estimate of the
necessary level of the allowance increased. This entire credit has been impaired
and included in nonaccrual loans since July 1998. The relationship continues to
be monitored as part of the Bank's overall credit administration procedures.
-20-
<PAGE>
While management recognizes that there is more risk traditionally
associated with commercial and consumer lending as compared to real estate
mortgage lending, the Bank currently has in place a tiered approach to determine
the adequacy of its allowance for loan losses. This methodology focuses on the
determination of the specific and potential loss allowance for certain loans
classified as problem credits and uses a three-year historical loss factor to
determine the loss allocation for the remainder of the loan portfolio as opposed
to allocations based on major loan categories. Level I includes specific
allowances that have been reserved for particular problem loans where management
has identified specific losses. Level II allowances are set aside to cover
potential losses associated with problem loans which possess more than a normal
degree of credit risk but where no specific losses have been identified. These
loans have been criticized or classified by the Bank's regulators, external loan
reviewers engaged by the Bank, or internally by management. The three-year
historical loss factors, subject to certain minimums, for Level II problem loans
are applied to the total Level II loans in determining the allocation. Level III
is the allowance for the balance of the loan portfolio. The loans in this tier
consist of all loans that are not classified as Level I or Level II problem
credits, and less risk-free loans. Risk-free loans are defined as loans fully
secured by cash or cash equivalents, readily marketable collateral, and portions
of the portfolio that are partially covered by a U.S. Government or government
agency guaranty. Adjustments are then made for local economic conditions. The
allocation for Level III is determined by applying the historical loss factor,
derived from the prior three years actual experience, to the adjusted
outstanding balance for this classification. The Company is currently expanding
its methodology to determine the adequacy of the allowance for loan losses by
major loan types. This change is not expected to have a material adverse effect
on the Company's consolidated financial condition or the results of operation.
On January 1, 1995, the Company adopted Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS No.
114") and Statement of Financial Accounting Standards No. 118, "Accounting by
Creditors for Impairment of a Loan-Income Recognition and Disclosures" ("SFAS
No. 118"), which amends SFAS No. 114, with no material effect on its financial
condition or results of operations. At December 31, 1998, the Company had
approximately $4,098,000 of impaired loans, which included 3 loans to the same
borrower with a total valuation allowance of approximately $564,000. This
valuation allowance was established following an independent evaluation of a
portion of the collateral securing all 3 loans. In comparison, at December 31,
1997, the Company had approximately $578,000 of impaired loans, which included 1
loan, totaling approximately $72,000 with a valuation allowance of approximately
$49,000. No valuation allowance was deemed necessary for the remaining $506,000
of impaired loans in 1997. This increase in impaired loans in 1998 resulted
mainly from the relationship mentioned previously.
Nonperforming Assets
Nonperforming assets consist of loans on nonaccrual status, loans that have
been renegotiated at terms more favorable to the borrower than those for similar
credits, real estate and other assets acquired in partial or full satisfaction
of loan obligations and accruing loans that are past due 90 days or more.
Nonperforming assets were $4,897,000, $276,000, and $219,000 at December
31, 1998, 1997, and 1996, respectively. These levels represent an increase of
$4,621,000 (1674.3%) for the year ended December 31, 1998, and an increase of
$57,000 (26.0%) for the year ended December 31, 1997. The increase in 1998 is
primarily due to the $4.078 million commercial loan relationship that is
classified as impaired. The increase in 1997 is mainly due to a overdrawn
checking account.
-21-
<PAGE>
An analysis of the components of nonperforming assets at the end of the
last five years is presented in the following table:
<TABLE>
<CAPTION>
Nonperforming Assets
December 31,
------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands)
<S> <C> <C> <C> <C> <C>
Nonaccrual loans $ 4,593 -- 107 73 27
Renegotiated loans -- -- -- -- --
Other nonperforming assets (primarily
other real estate) -- -- -- 64 1,313
Accruing loans 90 days or more past due 304 276 112 133 120
--- --- --- --- ---
Total nonperforming assets $ 4,897 276 219 270 1,460
===== === === === =====
Nonaccrual loans and renegotiated loans
as a % of total loans, net of unearned income 2.10% -- 0.07% 0.05% 0.02%
Nonaccrual loans, renegotiated loans and other
nonperforming assets as a percentage of total
loans, net of unearned income 2.10% -- 0.07% 0.10% 0.95%
Nonperforming assets as a percentage of
total loans, net of unearned income 2.24% 0.15% 0.14% 0.19% 1.03%
</TABLE>
If nonaccrual loans had performed in accordance with their original
contractual terms, interest income would have increased approximately $183,000,
$0, and $6,300 for the years ended December 31, 1998, 1997 and 1996
respectively. The amount of interest income earned and collected on nonaccrual
loans which is included in net income was $33,000 for 1998, $0 for 1997 and
$2,200 for 1996.
Other Potential Problem Loans
Potential problem loans consist of those loans where management has serious
doubts as to the borrower's ability to comply with the present loan repayment
terms. At December 31, 1998, the Company had identified 77 loans totaling
approximately $2,654,000 or 1.2% of total loans, net of unearned income were
considered potential problem loans. Such loans have been considered in the
determination of the Level II allowance previously discussed.
Deposits
Total deposits increased $9,527,000 (4.3%) to $233,505,000 at December 31,
1998, as compared to $223,978,000 at December 31, 1997. Noninterest-bearing
deposits were $34,724,000 and $32,638,000 while total interest-bearing deposits
were $198,781,000 and $191,340,000 at December 31, 1998 and 1997, respectively.
This trend is the result of management's decision to maintain a competitive
position in its deposit rate structure coupled with the Bank's marketing efforts
to attract local deposits and fund its loan growth. At December 31, 1998, as a
percentage of total deposits, noninterest-bearing accounts comprised
approximately 14.9%, while MMDAs, NOWs and regular savings made up approximately
31.9%, certificates of deposit under $100,000 comprised approximately 31.0%, and
certificates of deposit and other time deposits of $100,000 or more comprised
22.2%. At December 31, 1997, as a percentage of total deposits,
noninterest-bearing accounts comprised approximately 14.6%, while
-22-
<PAGE>
MMDAs, NOWs and regular savings made up approximately 37.1%, certificates of
deposit under $100,000 comprised approximately 31.8%, and certificates of
deposit and other time deposits of $100,000 or more comprised 16.5%.
The composition of total deposits for the last three years is presented in
the following table:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
% Change % Change % Change
from prior from prior from prior
Amount year end Amount year end Amount year end
------ ---------- ------ ---------- ------ ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Demand deposits $ 34,724 6.39% 32,638 14.89% 28,407 11.44%
Interest bearing deposits:
NOWs 21,606 (3.64)% 22,423 11.62% 20,089 (13.48)%
MMDAs 42,271 (16.59)% 50,678 18.81% 42,656 66.35%
Savings 10,536 3.12% 10,217 (0.39)% 10,257 (0.37)%
Certificates of deposit
under $100,000 72,425 1.81% 71,136 (4.49)% 74,477 (3.78)%
Certificates of deposit and
other time deposits of
$100,000 and over 51,943 40.82% 36,886 (9.68)% 40,841 71.95%
------ ------ ------- ------ ------- ------
Total interest bearing deposits 198,781 3.89% 191,340 16.04% 188,320 17.47%
------- ----- ------- ------ ------- ------
Total deposits $ 233,505 4.25% 223,978 3.35% 216,727 16.64%
======= ===== ======= ===== ======= ======
</TABLE>
The average balances outstanding and the average rates paid for certain
categories of deposits at the end of the last three years are disclosed in the
"Consolidated Average Balances, Interest Income/Expense and Yields/Rates" table
immediately following:
-23-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC. & SUBSIDIARIES
Consolidated Average Balances, Interest Income/Expense and Yields/Rates
Taxable Equivalent Basis
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1998
-----------------------------------------------
Average Yield/
ASSETS Balance Interest Rate
- --------------------- ======= ======== ====
(Dollars in thousands)
<S> <C> <C> <C>
Interest Earning Assets:
Loans, net of unearned income (1) $ 200,230 17,468 8.72%
Investment securities:
Taxable 59,450 3,787 6.37%
Tax-exempt (2) 1,875 164 8.76%
-------------------------------
Total investment securities 61,325 3,951 6.44%
Federal funds sold 4,200 236 5.62%
Interest bearing deposits with other banks 1,589 120 7.55%
-------------------------------
Total interest earning assets 267,344 21,775 8.14%
Allowance for loan losses (2,437)
Cash and due from banks 7,997
Premises and equipment 3,481
Rental property, net 1,795
Other assets 4,863
----------------
Total Assets $ 283,043
================
LIABILITIES & STOCKHOLDERS' EQUITY
- --------------------------------------------------------
Interest bearing liabilites:
Deposits:
Demand $ 20,646 428 2.07%
Savings and Money Market 58,461 2,531 4.33%
Certificates of deposits less than $100,000 71,616 4,411 6.16%
Certificates of deposit and other time
deposits of $100,000 or more 42,685 2,187 5.12%
-------------------------------
Total interest bearing deposits 193,408 9,557 4.94%
Federal funds purchased and securities sold under
agreements to repurchase 4,554 226 4.96%
Other short term borrowings 0 0 0.00%
Other borrowed funds 24,935 1,402 5.62%
Employee stock ownership plan debt 57 4 7.02%
-------------------------------
Total interest bearing liabilities 222,954 11,189 5.02%
Noninterest bearing demand deposits 30,292
Accrued expenses and other liabilities 1,737
Stockholders' equity 28,060
---------------
Total liabilities and stockholders' equity $ 283,043
===============
Net Interest Income $10,586
================
Net Yield on Total Interest Earning Assets 3.96%
=============
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1997
-----------------------------------------------
Average Yield/
ASSETS Balance Interest Rate
- --------------------- ======= ======== ====
(Dollars in thousands)
<S> <C> <C> <C>
Interest Earning Assets:
Loans, net of unearned income (1) 172,742 15,323 8.87%
Investment securities:
Taxable 59,829 3,933 6.57%
Tax-exempt (2) 2,031 188 9.28%
-------------------------------
Total investment securities 61,860 4,121 6.66%
Federal funds sold 6,778 388 5.72%
Interest bearing deposits with other banks 1,446 81 5.60%
-------------------------------
Total interest earning assets 242,826 19,913 8.20%
Allowance for loan losses (2,151)
Cash and due from banks 7,652
Premises and equipment 3,597
Rental property, net 1,859
Other assets 3,879
---------------
Total Assets 257,662
===============
<CAPTION>
LIABILITIES & STOCKHOLDERS' EQUITY
- ------------------------------------------------------
<S> <C> <C> <C>
Interest bearing liabilities:
Deposits:
Demand 20,143 426 2.11%
Savings and Money Market 59,098 2,660 4.50%
Certificates of deposits less than $100,000 71,933 4,495 6.25%
Certificates of deposit and other time
deposits of $100,000 or more 37,808 1,952 5.16%
-------------------------------
Total interest bearing deposits 188,982 9,533 5.04%
Federal funds purchased and securities sold under
agreements to repurchase 2,868 148 5.16%
Other short term borrowings 94 9 9.57%
Other borrowed funds 11,160 645 5.78%
Employee stock ownership plan debt 113 8 7.08%
-------------------------------
Total interest bearing liabilities 203,217 10,343 5.09%
Noninterest bearing demand deposits 27,941
Accrued expenses and other liabilities 2,070
Stockholders' equity 24,434
---------------
Total liabilities and stockholders' equity 257,662
===============
Net Interest Income $9,570
================
Net Yield on Total Interest Earning Assets 3.94%
=============
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1996
-----------------------------------------------
Average Yield/
ASSETS Balance Interest Rate
- --------------------- ======= ======== ====
(Dollars in thousands)
<S> <C> <C> <C>
Interest Earning Assets:
Loans, net of unearned income (1) 150,356 13,067 8.69%
Investment securities:
Taxable 61,814 4,075 6.59%
Tax-exempt (2) 1,861 180 9.72%
-------------------------------
Total investment securities 63,675 4,255 6.68%
Federal funds sold 6,249 337 5.39%
Interest bearing deposits with other banks 25 2 8.00%
-------------------------------
Total interest earning assets 220,305 17,661 8.02%
Allowance for loan losses (2,055)
Cash and due from banks 7,207
Premises and equipment 3,530
Rental property, net 1,954
Other assets 2,905
---------------
Total Assets 233,846
===============
LIABILITIES & STOCKHOLDERS' EQUITY
- ------------------------------------------------------
Interest bearing liabilites:
Deposits:
Demand 20,042 414 2.07%
Savings and Money Market 42,219 1,680 3.98%
Certificates of deposits less than $100,000 75,139 4,998 6.65%
Certificates of deposit and other time
deposits of $100,000 or more 28,972 1,592 5.49%
-------------------------------
Total interest bearing deposits 166,372 8,684 5.22%
Federal funds purchased and securities sold under
agreements to repurchase 7,784 425 5.46%
Other short term borrowings 602 30 4.98%
Other borrowed funds 9,003 513 5.70%
Employee stock ownership plan debt 171 12 7.02%
-------------------------------
Total interest bearing liabilities 183,932 9,664 5.25%
Noninterest bearing demand deposits 26,131
Accrued expenses and other liabilities 1,896
Stockholders' equity 21,887
---------------
Total liabilities and stockholders' equity 233,846
===============
Net Interest Income $7,997
================
Net Yield on Total Interest Earning Assets 3.63%
=============
</TABLE>
====================
(1) Loans on nonaccrual status have been included in the computation of average
balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent
basis using an income tax rate of 34%.
-24-
<PAGE>
The following table presents the maturities of certificates of deposit and
other time deposits of $100,000 or more at December 31, 1998:
Maturities of Time Deposits over $100,000
December 31, 1998
-----------------
(In thousands)
Three months or less....................... $ 25,276
After three within six months.............. 7,203
After six within twelve months............. 4,563
After twelve months........................ 14,901
----------
Total.................................. $ 51,943
==========
Weighted Average rate on time deposits
of $100,000 or more at period-end...... 5.40%
Schedule of Short-term Borrowings (1)
The following table shows the maximum amount of short-term borrowings and the
average and year-end amount of borrowings, as well as interest rates.
<TABLE>
<CAPTION>
Maximum Weighted
Year ended Outstanding at Average Interest Rate Ending Average Interest
December 31 any Month-end Balance During Year Balance Rate at Year-end
----------- ------------- ------- ----------- ------- ----------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
1998 $12,944 $4,554 4.96% $12,944 4.99%
1997 8,516 2,962 5.30% 1,274 5.29%
1996 12,774 8,386 5.42% 5,856 5.13%
</TABLE>
(1) Consists of federal funds purchased; treasury, tax and loan; securities sold
under agreements to repurchase; and borrowings from the FHLB-Atlanta that mature
either overnight or on a fixed maturity not to exceed three months.
Capital Resources
The Company's consolidated stockholders' equity was $28,943,000 and
$26,047,000 at December 31, 1998 and 1997, respectively, an increase of
$2,896,000 (11.1%) since year end 1997. The Company has funded its capital
growth primarily through retained earnings since its early 1995 sale of common
stock that raised approximately $1,234,000 of net proceeds to the Company.
On May 12, 1998, the Company's Board of Directors approved a three for one
stock split effected in the form of a dividend payable on June 25, 1998 to
shareholders of record on June 10, 1998. All share and per share information in
the accompanying financial statements has been restated to reflect the effect of
the additional shares outstanding resulting from the stock split. Common stock
and surplus have been restated also to reflect the stock split retroactively.
During 1998, cash dividends of $759,000 or $0.19 per share, were declared
on the Common Stock as compared to $627,000, or $0.16 per share, in 1997,
representing an increase of $132,000 (21.1%). The Company plans to continue a
dividend payout policy that provides cash returns to its investors and allows
the Company to maintain adequate capital to support future growth and capital
adequacy; however, the Company is dependent on dividends from the Bank as
discussed subsequently. Management believes that a strong capital position is
vital to the continued profitability of the Company and provides a foundation
for future growth as well as promoting depositor and investor confidence in the
institution. See "SUPERVISION AND REGULATION."
-25-
<PAGE>
Certain financial ratios for the Company for the last three years are
presented in the following table:
Equity and Asset Ratios
December 31,
----------------------------
1998 1997 1996
-------- -------- --------
Return on average assets 1.22% 1.20% 1.18%
Return on average equity 12.26% 12.61% 12.58%
Common dividend payout ratio 21.59% 20.25% 20.00%
Average equity to average asset ratio 9.91% 9.48% 9.36%
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory actions, and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct material effect
on the Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. The capital amounts and classification of the Bank are
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors. Management believes, as of December 31, 1998, that
the Bank meets all capital adequacy requirements to which it is subject. See
"SUPERVISION AND REGULATION."
The following table sets forth the Bank's actual capital levels and the
related required capital levels at December 31, 1998:
<TABLE>
<CAPTION>
Actual Required
Capital Actual Capital Required
Amount Ratio Amount Ratio
------ ----- ------ -----
<S> <C> <C> <C> <C>
Tier 1 Risk-Based Capital $ 26,173 12.33% $ 12,213 greater than or equal to 4%
Leverage Capital 26,173 8.57% 8,495 greater than or equal to 4%
Total Qualifying Capital 28,829 13.58% 16,988 greater than or equal to 8%
</TABLE>
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." This statement establishes standards for
reporting and displaying comprehensive income and its components in a full set
of general purpose financial statements. SFAS No. 130 requires all items that
are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed in
equal prominence with the other financial statements. The term "comprehensive
income" is used in the statement to describe the total of all components of
comprehensive income including net income. "Other comprehensive income" for the
Company consists of items recorded directly in stockholder's equity under SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Effective January 1, 1998, the Company also adopted the provisions of SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 establishes new standards for the disclosures made by public
business enterprises to report information about operating segments in annual
financial statements and requires those enterprises to 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. The Company does
not have any segments other than banking that are considered material.
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. This statement is effective for all
fiscal quarters of fiscal years
-26-
<PAGE>
beginning after June 15, 1999. The Company has not yet determined the impact of
SFAS No. 133 on the Company's financial statements upon adoption.
Liquidity
Liquidity is the Company's ability to convert assets into cash equivalents
in order to meet daily cash flow requirements, primarily for deposit
withdrawals, loan demand, and maturing liabilities. Without proper management,
the Company could experience higher costs of obtaining funds due to insufficient
liquidity, while excessive liquidity can lead to a decline in earnings due to
the cost of foregoing alternative higher-yielding investment opportunities.
At the Bank, asset liquidity is provided primarily through cash, the
repayment and maturity of investment securities, and the sale and repayment of
loans.
Sources of liability liquidity include customer deposits, federal funds
purchased and investment securities sold under agreements to repurchase.
Although deposit growth historically has been a primary source of liquidity,
such balances may be influenced by changes in the banking industry, interest
rates available on other investments, general economic conditions, competition
and other factors. The Bank has participated in the FHLB-Atlanta's advance
program to obtain funding for its growth. Advances include both fixed and
variable terms and are taken out with varying maturities. The Bank has a current
line of credit of $40,000,000. This line is collateralized by a blanket lien
against its one to four family residential mortgage loans. At December 31, 1998,
the Bank had credit available from FHLB-Atlanta of $9,242,000, and had
$30,758,000 in advances drawn down.
Overall, net cash provided from financing activities increased $37,896,000
(1576.4%) to $40,300,000 during 1998 from the previous year's total of
$2,404,000. Net cash provided by operating activities decreased $718,000 (18.5%)
to $3,174,000 from $3,892,000 for the year ended December 31, 1998. $48,878,000
of cash was used in investing activities during 1998.
The Company depends mainly on dividends, management fees and lease payments
from the Bank, for its liquidity. The Company only receives cash dividends from
the Bank if the cash flow from other sources is not sufficient to maintain a
positive cash flow, also giving consideration to regulatory restrictions.
Accordingly, the Bank paid the Company $385,000, $697,000, and $265,000 in cash
dividends for 1998, 1997, and 1996 respectively. The Company provides services
to the Bank for which it is paid a management fee comparable to a third party
vendor. The Bank paid the Company $314,000 and $295,000 in management fees and
$187,000 and $187,000 in lease payments for the years ended December 31, 1998
and 1997, respectively. These funds were used to pay operating expenses and fund
dividends to the Company's shareholders. In addition, the Bank makes transfers
to the Company, under its Tax Sharing Agreement, for payment of consolidated tax
obligations. The Tax Sharing Agreement calls for the allocation of the
consolidated tax liability or benefit between the Company and each Subsidiary
based on their individual tax positions as if each entity filed a separate tax
return.
Management has made the decision to allow the Bank's capital position to
grow to support its growth in capital adequacy.
Year 2000
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium ("Year 2000") approaches. The
Company has conducted a comprehensive review of its computer systems to identify
the systems that could be affected by the Year 2000 issue and has developed a
plan to resolve the mission critical modifications necessary in order to be
prepared for the new millennium. The Company has reviewed both information
technology (IT) systems and non-IT systems. All mission critical systems have
been upgraded, as needed, and tested. The majority of the remaining systems have
been tested, however, final modifications are expected to be completed by June
30, 1999. The Company has received certification of Year 2000 compliance from
their critical vendors used in the major operations of the Company. The Company
has followed the Federal Reserve guidelines for preparing for Year 2000. The
Company also reports quarterly to its Board of Directors the progress of the
Year 2000 project. Accordingly, the Company does not expect the Year 2000 issue
to
-27-
<PAGE>
pose any significant operational problems and has not discovered any Year 2000
problems with significant counter-parties that it believes will have material
effect on the financial position or results of operations of the Company.
However, the Company has not fully evaluated the effect of any Year 2000
problems on its loan and deposit customers. No assurance can be given that
potential Year 2000 problems of those with whom the Company does business will
not occur, and if they occur, that the consequences to the Company will not be
material.
The total cost of the Year 2000 project is estimated not to exceed
$250,000, of which $100,750 was expensed through 1998, and is estimated to be
funded through operating cash flows. Contingency Plans have been developed to
ensure direction in the event a non-compliant system or component is detected.
The Company currently has in place a disaster recovery plan. A business
resumption plan and a remediation plan have been developed based upon certain
circumstances. Part of the business resumption plan includes an agreement with a
third-party vendor which would enable the Bank to use the third-parties'
computer systems as a worst case scenario. These plans will provide the Company
direction in the event an unforeseen circumstance arises due to the Year 2000.
The Bank has held Y2K Customer Awareness Seminars, mailed Y2K information to all
customers, requested copies of the status of loan customers' Y2K plan and
examined all large loan customers for potential impacts on the customer's
creditworthiness. All plans will be finalized and implemented by September 30,
1999.
Interest Rate Sensitivity Management
An integral part of the funds management of the Company and the Bank is to
maintain a reasonably balanced position between interest rate sensitive assets
and liabilities. The Bank's Asset/Liability Management Committee ("ALCO") is
charged with the responsibility of managing, to the degree prudently possible,
its exposure to "interest rate risk," while attempting to provide earnings
enhancement opportunities. The dollar difference between rate sensitive assets
and liabilities for a given period of time is referred to as the rate sensitive
gap ("GAP"). A GAP ratio is calculated by dividing rate sensitive assets by rate
sensitive liabilities. Due to the nature of the Bank's balance sheet structure
and the market approach to pricing of liabilities, management and the Board of
Directors recognize that achieving a perfectly matched GAP position in any given
time frame would be extremely rare. ALCO has determined that an acceptable level
of interest rate risk would be for net interest income to fluctuate no more than
5.0% given a change in selected interest rates of up or down 200 basis points
over any 12-month period. Using an increase of 200 basis points and a decrease
of 200 basis points, the Bank's net interest income at December 31, 1998, would
decrease approximately 1.39% in a rising rate environment and increase
approximately 1.57% in a falling rate environment. Interest rate scenario models
are prepared on the Bank's Balance Sheet Information System created by Darling
Consulting Group.
For purposes of measuring interest rate sensitivity, Company management
assumes that the asset and liability balances remain constant over the 12-month
period. Deposit withdrawals are only considered in measuring liquidity. Although
demand and savings accounts are subject to immediate withdrawal, all passbook
savings and regular NOW accounts are reflected to reprice in over 5 years due to
their historically stable volume and limited repricing. High balance MMDAs and
NOW accounts are considered volatile and, as such, are shown as repricing in 1-3
months. Certificates of deposits are spread according to their contractual
maturity. Investment securities and loans reflect either the contractual
maturity, call date, repricing date, or in the case of mortgage related
products, a market prepayment assumption.
-28-
<PAGE>
<TABLE>
<CAPTION>
Interest Sensitivity Analysis
Over Five
One to Four to One to Years and
Three Twelve Five Non-rate
December 31, 1998 Immediate Months Months Years Sensitive Total
--------- ------ ------ ----- --------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Earning Assets:
Loans, net of unearned $ 42,778 24,157 32,737 100,122 18,893 218,687
Taxable investment securities -- 1,232 1,078 3,193 1,431 6,934
Tax-exempt investment securities -- 255 80 431 394 1,160
Investment securities available for sale -- 6,669 7,324 25,677 23,359 63,029
Federal funds sold and securities
purchased under agreements to resell 260 -- -- -- -- 260
Interest bearing deposits with other banks 134 -- -- -- -- 134
-------- -------- -------- --------- --------- --------
Total earning assets 43,172 32,313 41,219 129,423 44,077 290,204
------- -------- -------- --------- --------- --------
Interest bearing liabilities:
Demand deposits -- 1,829 -- -- 54,502 56,331
Savings and Money Market -- 42,270 -- -- 10,536 52,806
Certificates of deposit less than $100,000 -- 32,286 22,131 18,007 -- 72,424
Certificates of deposit and other
time deposits of $100,000 or more -- 24,862 11,766 15,316 -- 51,944
Federal funds purchased and securities
sold under agreements to repurchase -- 12,944 -- -- -- 12,944
Other short-term borrowings -- -- -- -- -- --
FHLB and other borrowings -- 24 72 10,537 20,367 31,000
--------- -------- ------- -------- ------- --------
Total interest bearing liabilities -- 114,215 33,969 43,860 85,405 277,449
Interest sensitivity gap 43,172 (81,902) 7,250 85,563 (41,328) 12,755
--------- --------- ------- -------- ------- ========
Cumulative interest sensitivity gap $ 43,172 (38,730) (31,480) 54,083 12,755
========= ========= ======== ======== =======
</TABLE>
The interest sensitive assets at December 31, 1998, that reprice or mature
within 12 months were $116,704,000 while the interest sensitive liabilities that
reprice or mature within the same time frame were $148,184,000. At December 31,
1998, the 12 month cumulative GAP position, including the effect of off-balance
sheet items, was a negative $31,480, resulting in a GAP ratio of 79.0%. This
negative GAP indicates that the Company has more interest-bearing liabilities
than interest-earning assets that reprice within the GAP period.
The Bank enters into interest rate protection contracts to help manage its
interest rate exposure. These contracts include interest rate swaps, caps and
floors. Interest rate swap transactions involve the exchange of fixed and
floating rate interest payment obligations based on the underlying notional
principal amounts. Interest rate caps and floors are purchased by the Bank for a
non-refundable fixed amount. The Bank receives interest based on the underlying
notional principal amount if the specified index rises above the cap rate or
falls below the floor strike rate. Notional principal amounts are used to
express the volume of these transactions, but because they are never exchanged,
the amounts subject to credit risk are much smaller. Risks associated with
interest rate contracts include interest rate risk and creditworthiness of the
counterparty. These risks are considered in the Bank's overall asset liability
management program. The Bank utilizes periodic financial statements issued by
the counterparty to analyze the creditworthiness of the counterparty prior to
entering into a contract and to monitor changes in the financial condition of
the counterparty throughout the term of the contract. Current contracts are
issued by a securities broker-dealer and were entered into with the purpose of
managing the Bank's interest rate exposure. Although none of the interest rate
protection agreements are traded on any organized exchange, an active secondary
market is available to the Company for such contracts.
The Bank's Asset Liability Management Policy states that establishing
limits on interest rate swaps, caps, and floors can be somewhat confusing or
misleading since the notional amount by which these instruments are expressed is
never exchanged between counterparties and therefore is not "at risk."
Furthermore, since they
-29-
<PAGE>
represent off-balance sheet tools used by ALCO to manage imbalances in the
Bank's balance sheet in a prudent and cost effective manner, the appropriate
volume of swaps for the Bank is not static; it changes with elements such as the
economic environment, the capital position, and the ability to efficiently
replicate hedging actions in the cash markets. The Bank endeavors to limit
outstanding notional value of off-balance sheet contracts executed for purposes
of managing net interest income to 25% of total assets as reported in the most
recent quarterly call report. Notional value of off-balance sheet contracts
executed with one counterparty are limited to 10% of total assets as reported in
the Bank's most recent quarterly call report.
The following table presents the Company's interest rate swaps and
floors position as of December 31, 1998:
<TABLE>
<CAPTION>
Weighted
Average
Weighted Remaining
Notional Carrying Estimated Average Rate (1) Life
Amount Value Fair Value Received Paid (Years)
------ ----- ---------- ------------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Swaps:
Receive fixed:
One year or less 10,000 -- 41 6.42% 5.88% 0.25
Floors
Purchased
Over two years through five years 10,000 6 20 -- -- 1.25
Over two years through five years 10,000 17 106 6.00% -- 1.25
---------- -- ---
$ 30,000 $ 23 $ 167
========== ===== =====
</TABLE>
----------------
(1) The weighted average rates received/paid are shown only for swaps and
floors for which net interest amounts were receivable or payable at the end
of each period. For floors when the index rate has not been reached, no
rate is shown. Interest rates on variable rate derivative products held by
the Bank are derived from the 3 month LIBOR rate.
As part of its overall interest rate risk management activities, the
Company utilizes off-balance sheet derivatives to modify the repricing
characteristics of on-balance sheet assets and liabilities. The primary
instruments utilized by the Company are interest rate swaps and interest rate
floor and cap agreements. The fair values of these off-balance sheet derivative
financial instruments are based on dealer quotes and third party financial
models. See "Results of Operations - Net Interest Income."
Interest rate swaps, floors and caps are accounted for on an accrual basis,
and the net interest differential, including premiums paid, if any, is
recognized as an adjustment to interest income or expense of the related
designated asset or liability. Changes in the fair values of the swaps, floors
and caps are not recorded in the consolidated statements of income because these
agreements are being treated as a synthetic alteration of the designated assets
or liabilities. The Company considers its interest rate swaps to be a synthetic
alteration of an asset or liability as long as (i) the swap is designated with a
specific asset or liability or finite pool of assets or liabilities; (ii) there
is a high correlation, at inception and throughout the period of the synthetic
alteration, between changes in the interest income or expense generated by the
swap and changes in the interest income or expense generated by the designated
asset or liability; (iii) the notional amount of the swap is less than or equal
to the principal amount of the designated asset or liability; and (iv) the swap
term is less than or equal to the remaining term of the designated asset or
liability. The criteria for consideration for a floor or cap as a synthetic
alteration of an asset or liability are generally the same as those for a swap
arrangement.
If the swap, floor or cap arrangements are terminated before their
maturity, the net proceeds received or paid are deferred and amortized over the
shorter of the remaining contract life or the maturity of the designated asset
-30-
<PAGE>
or liability as an adjustment to interest income or expense. If the designated
asset or liability is sold or matures, the swap agreement is marked to market
and the gain or loss is included with the gain or loss on the sale/maturity of
the designated asset or liability. Changes in the fair value of any undesignated
swaps, floors and caps are included in other income in the consolidated
statement of income.
Effects of Inflation and Changing Prices
Inflation generally increases the costs of funds and operating overhead,
and to the extent loans and other assets bear variable rates, the yields on such
assets. Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates generally have a more significant effect on the performance of a
financial institution than the effects of general levels of inflation. In
addition, inflation affects financial institutions' cost of goods and services
purchased, the cost of salaries and benefits, occupancy expense, and similar
items. Inflation and related increases in interest rates generally decrease the
market value of investments and loans held and may adversely affect liquidity,
earnings, and stockholders' equity. Mortgage originations and refinancings tend
to slow as interest rates increase, and likely will reduce the Company's volume
of such activities and the income from the sale of residential mortgage loans in
the secondary market.
Results of Operations
Net Income
Net income increased $359,000 (11.7%) to $3,439,000 during 1998 from
$3,080,000 for the year ended December 31, 1997. Basic income per share was
$0.88 and $0.79 for 1998 and 1997, respectively, an increase of 11.4%.
Comparatively, net income during 1997 increased $327,000 (11.9%) from the 1996
total of $2,753,000, while basic income per share showed a similar increase of
$0.09 per share for 1997 from a 1996 per share total of $0.70.
The increase in net income for 1998 is attributable to higher net interest
income and noninterest income offset by a higher noninterest expense. The
increase in 1997 was due to higher net interest income offset by lower
noninterest income and higher noninterest expense for the year.
Net Interest Income
Net interest income is the difference between the interest the Company
earns on its loans, investment securities and other earning assets and the
interest cost of its deposits, borrowed funds and other interest-bearing
liabilities. This is the primary component of the Company's earnings. Net
interest income was $10,531,000 for the year ended December 31, 1998. This
increase of $1,024,000 (10.8%) over 1997 is due to the increase in average
interest earning assets during 1998 and an increase in the net yield on total
interest earning assets of 2 basis points to 3.96%.
Net interest income for 1997 was $9,507,000, $1,570,000 (20.0%) higher than
1996 net interest income of $7,937,000. This increase over 1996 is due to the
increase in average interest earning assets during 1997 and an increase in the
net yield on total interest earning assets of 31 basis points to 3.94%.
The Company uses interest rate protection contracts, primarily interest
rate swaps, caps and floors, to protect the yields on earning assets and the
rates paid on interest-bearing liabilities. Such contracts act as hedges against
unfavorable rate changes. The income and expense associated with interest rate
swaps, caps and floors are ultimately reflected as adjustments to the net
interest income or expense of the underlying assets or liabilities. The effect
of such interest rate protection contracts resulted in a net increase in net
interest income of $93,194, $43,525 and $6,000 during 1998, 1997 and 1996,
respectively. It is the intention of the Company to continue to utilize interest
rate protection contracts to manage exposure to certain future changes in
interest rate environments. However, there can be no assurance that such
transactions will positively affect earnings. See "-- INTEREST RATE
-31-
<PAGE>
SENSITIVITY MANAGEMENT", the "CONSOLIDATED AVERAGE BALANCES, INTEREST
INCOME/EXPENSE AND YIELDS/RATES" table appearing elsewhere herein and the
"RATE/VOLUME VARIANCE ANALYSIS" tables immediately following.
<TABLE>
<CAPTION>
Rate/Volume Variance Analysis
Taxable-Equivalent Basis (1)(2) Change Due to
Years Ended December 31, Net Rate/
1998 Compared to 1997 change Rate Volume volume
------ ---- ------ ------
(In thousands)
<S> <C> <C> <C> <C>
Earning Assets:
Loans, net of unearned income $ 2,145 (293) 2,398 40
Investment securities:
Taxable (146) (121) (24) (1)
Tax-exempt (24) (10) (13) (1)
---- ---- ---- ---
Total investment securities (170) (131) (37) (2)
Federal funds sold (152) (4) (145) (3)
Interest bearing deposits with other banks 39 31 11 (3)
----- ----- ----- ----
Total earning assets $ 1,862 (397) 2,227 32
===== ===== ===== ====
Interest bearing liabilities:
Deposits:
Demand $ 2 (9) 11 --
Savings (129) (100) (28) (1)
Certificates of deposit less than $100,000 (84) (64) (20) --
Certificates of deposit and other time
deposits of $100,000 or more 235 (17) 250 2
--- ---- --- -
Total interest bearing deposits 24 (190) 213 1
Federal funds purchased and securities sold
under agreements to repurchase 78 (8) 83 (3)
Other short term borrowings (9) -- -- (9)
Other borrowed funds 753 (42) 772 23
--- ---- --- --
Total interest bearing liabilities $ 846 (240) 1,068 18
=== ===== ===== ==
</TABLE>
- -------------
(1) For analytical purposes, income for tax-exempt assets, primarily
securities issued by state and local governments or authorities, is
adjusted by an increment which equates tax-exempt income to interest from
taxable assets (assuming a 34% effective federal income tax rate).
(2) The change in interest due to rate is calculated by multiplying the
previous volume by the rate change and the change in interest due to
volume is calculated by multiplying the change in volume by the previous
rate. Changes attributable to both changes in rate and volume are
calculated by multiplying the change in volume by the change in rate.
-32-
<PAGE>
<TABLE>
<CAPTION>
Rate/Volume Variance Analysis
Taxable-Equivalent Basis (1)(2) Change Due to
Years Ended December 31, Net Rate/
1997 Compared to 1996 change Rate Volume volume
------ ---- ------ ------
(In thousands)
<S> <C> <C> <C> <C>
Earning Assets:
Loans, net of unearned income $ 2,256 310 1,986 (40)
Investment securities:
Taxable (142) (11) (131) --
Tax-exempt 8 (9) 16 1
- --- -- -
Total investment securities (134) (20) (115) 1
Federal funds sold 51 22 31 (2)
Interest bearing deposits with other banks 79 (35) 80 34
-- ---- -- --
Total earning assets $ 2,252 277 1,982 (7)
===== === ===== ===
Interest bearing liabilities:
Deposits:
Demand $ 12 10 2 --
Savings 980 308 760 (88)
Certificates of deposit less than $100,000 (503) (290) (200) (13)
Certificates of deposit and other time
deposits of $100,000 or more 360 (126) 457 29
--- ----- --- --
Total interest bearing deposits 849 (98) 1,019 (72)
Federal funds purchased and securities sold
under agreements to repurchase (277) (9) (253) (15)
Other short term borrowings (21) 4 (48) 23
Other borrowed funds 128 8 121 (1)
--- - --- ---
Total interest bearing liabilities $ 679 (95) 839 (65)
=== ==== === ====
</TABLE>
- -------------
(1) For analytical purposes, income for tax-exempt assets, primarily
securities issued by state and local governments or authorities, is
adjusted by an increment which equates tax-exempt income to interest from
taxable assets (assuming a 34% effective federal income tax rate).
(2) The change in interest due to rate is calculated by multiplying the
previous volume by the rate change and the change in interest due to
volume is calculated by multiplying the change in volume by the previous
rate. Changes attributable to both changes in rate and volume are
calculated by multiplying the change in volume by the change in rate.
Interest Income
Interest income is a function of the volume of interest earning assets and
their related yields. Interest income was $21,720,000, $19,849,000, and
$17,601,000 for the years ended December 31, 1998, 1997, and 1996, respectively.
Average interest earning assets increased $24,518,000 (10.0%) during 1998,
$22,521,000 (10.2%) during 1997, and $18,831,000 (9.4%) during 1996, while the
fully taxable equivalent yields on average earning assets decreased 6 basis
points in 1998 after increasing 18 basis points in 1997 and decreasing 4 basis
points in 1996. The combination of these factors resulted in increases in
interest income of $1,871,000 (9.4%), $2,248,000 (12.8%) and $1,439,000 (8.9%)
during 1998, 1997 and 1996, respectively. See "--CONSOLIDATED AVERAGE BALANCES,
INTEREST INCOME/EXPENSE AND YIELDS/RATES" and THE "RATE/VOLUME VARIANCE
ANALYSIS" tables.
Loans are the main component of the Bank's earning assets. Interest and
fees on loans were $17,468,000, $15,323,000, and $13,067,000 for the years ended
December 31, 1998, 1997, and 1996, respectively. These levels reflected
increases of $2,145,000 (14.0%) during 1998, $2,256,000 (17.3%) during
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<PAGE>
1997, and $949,000 (7.8%) during 1996 due to increases in the average volume
outstanding on loans over the past three years. While the level of average
balances has grown to $200,230,000 in 1998 from $172,742,000 and $150,356,000
for 1997 and 1996, respectively, the fully taxable equivalent yield on loans
decreased 15 basis points to 8.72% in 1998, and increased 18 basis points to
8.87% in 1997 from the 1996 average yield of 8.69%.
Interest income on investment securities decreased $161,000 (4.0%) to
$3,896,000 in 1998, following a decrease of $138,000 (3.3%) to $4,057,000 in
1997 and an increase of $500,000 (13.5%) to $4,195,000 in 1996. The 1998
decrease was due to the combination of a $535,000 decrease in average volume
outstanding and a 22 basis point decrease in the fully taxable equivalent yield
over 1997 levels. The 1997 decrease was due to the combination of a $1,815,000
decrease in average volume outstanding and a 2 basis point decrease in the fully
taxable equivalent yield over 1996 levels. The fully taxable equivalent yields
on investment securities were 6.44% in 1998, 6.66% in 1997, and 6.68% in 1996.
See "FINANCIAL CONDITION--INVESTMENT SECURITIES."
Interest Expense
Total interest expense was $11,189,000, $10,343,000 and $9,664,000 for the
years ended December 31, 1998, 1997 and 1996 respectively, representing
increases of $846,000 (8.2%), $679,000 (7.0%) and $806,000 (9.1%) during 1998,
1997, and 1996, respectively. Total average balances outstanding of
interest-bearing liabilities have continued an upward trend over the last three
years to $222,954,000 in 1998 from $203,217,000 in 1997 and $183,932,000 in
1996. The rates paid on these liabilities decreased 7 basis points in 1998 to
5.02% after decreasing 16 basis points to 5.09% during 1997, and decreasing 3
basis points to 5.25% during 1996.
Interest on deposits, the primary component of total interest expense,
increased $24,000 to $9,557,000 (0.3%) during 1998 from $9,533,000 in 1997,
which in turn represents a $849,000 (9.8%) increase from the 1996 level of
$8,684,000. The average balance outstanding of interest-bearing deposits has
increased steadily to the 1998 level of $193,408,000 as compared to $188,982,000
in 1997 and $166,372,000 in 1996. The 1998 increase is attributable to growth in
certificates of deposit over $100,000 accounts in the normal course of business,
while the 1997 increase was due to new deposit growth in money market deposit
accounts also in the normal course of business. The average rates paid on
interest-bearing deposits were 4.94%, 5.04%, and 5.22% for 1998, 1997, and 1996,
respectively.
Interest expense on borrowed funds, including both short term borrowings
and other borrowed funds, was $1,406,000 in 1998, $662,000 in 1997, and $555,000
in 1996. These levels represent an increase of $744,000 (112.4%) during 1998, an
increase of $107,000 (19.3%) during 1997, and a decrease of $95,000 (14.6%)
during 1996. The increase in 1998 is primarily due to increases in FHLB advances
of $19,882,000 compared to 1997.
Provision for Loan Losses
During 1998, the Company made a total provision for loan losses of $891,000
based on management's assessment of the risk in the loan portfolio, the growth
of the loan portfolio and historical loan loss trends, and an evaluation of
certain significant problem loans. During 1997 and 1996, the Company made total
provisions for loan losses of $285,000 and $80,000, respectively. See "FINANCIAL
CONDITION -- ALLOWANCE FOR LOAN LOSSES AND RISK ELEMENTS."
Noninterest Income
Noninterest income increased $408,000 (19.7%) to $2,479,000 for the year
ended December 31, 1998, from the 1997 total of $2,071,000, which in turn
represented a decrease of $337,000 (14.0%) from the total of $2,408,000 for
1996.
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<PAGE>
Service charges on deposit accounts increased $113,000 (13.1%) during 1998
and $64,000 (8.0%) in 1997 both primarily due to increases in nonsufficient
funds and overdraft charges.
During 1998, the Company experienced net gains of $14,000 on the sale, in
the ordinary course of business, of investment securities available for sale, as
compared to net losses of $60,000 in 1997 and net gains of $26,000 in 1996. See
"FINANCIAL CONDITION - INVESTMENT SECURITIES."
Other noninterest income increased $222,000 (17.6%) to $1,487,000 in 1998
from $1,265,000 in 1997. Comparatively, the 1997 total represented a decrease of
$316,000 (20.0%) from $1,581,000 in 1996. The increase in 1998 was due to a
$81,000 increase in Mastercard/VISA income mainly due to one merchant, a $64,000
increase in stock dividends resulting from additional shares purchased in
Southeastern Bankcard Association, Inc. and FHLB Atlanta stock, offset by a
$34,000 decrease in lease income due to lease expirations. The decrease in 1997
was due to a $30,000 decrease in rental income, an $18,000 increase in ATM
transaction fees and a $151,000 decrease in dividends from other companies
primarily due to the one time dividend of $150,000 paid in 1996 in connection
with the sale of Alert. See "Item 1 - Business - Services"
Noninterest Expense
Total noninterest expense was $6,838,000 for 1998, $6,385,000 for 1997, and
$6,007,000 for 1996 reflecting an increase of $453,000 (7.1%) for 1998, an
increase of $378,000 (6.3%) for 1997 and a decrease of $412,000 (6.4%) for 1996.
Salaries and benefits increased $94,000 (3.0%) to $3,237,000 for the year
ended December 31, 1998, and increased $202,000 (6.9%) to $3,143,000 for the
year ended December 31, 1997, from the 1996 total of $2,941,000. At December 31,
1998, the Company had 108 full-time equivalent employees, an increase of 4 over
the level at December 31, 1997. At December 31, 1997, the Company had 104
full-time equivalent employees, an increase of 2 over the level at December 31,
1996. The salary and benefit increases for 1998 and 1997 were primarily due to
new hires and merit raises and the cost of benefits associated with such
increases.
Net occupancy expense was $1,022,000, $972,000, and $817,000 for 1998, 1997
and 1996, respectively, representing increases of $50,000 (5.1%) in 1998 and
$155,000 (19.0%) in 1997 over the previous year's levels. The 1998 increase
resulted primarily from a $17,000 increase in furniture and equipment
depreciation due to the opening of the Wal-Mart branch, a $16,000 increase in
real estate rentals of the Wal-Mart branch, and a $16,000 increase in lease
payments for furniture and equipment due new leases on computer equipment. The
1997 increase resulted primarily from a $30,000 increase in property taxes, a
$24,000 increase in furniture and equipment depreciation, a $18,000 increase in
service contract expense, a $43,000 increase in leases payments due to the new
Winn Dixie branch and a $40,000 increase in equipment lease payments.
Other noninterest expense was $2,578,000 for 1998, $2,270,000 for 1997, and
$2,250,000 for 1996. These levels represent an increase of $308,000 (13.6%) in
1998 and an increase of $20,000 (0.9%) in 1997 over the respective previous
years. The 1998 increase resulted from a $54,000 increase in loan expenses,
including legal, loan review and administration, primarily related to the $4.078
million commercial loan classified as impaired, a $106,000 increase in
Mastercard/VISA expense due to the merchant mentioned above, a $44,000 increase
in ATM expense due to increases in ATM rent and courier expenses, a $37,000
increase in network expenses due to the Visa Checkcard that was launched in
1998, a $99,000 increase in professional fees due to management's development of
a strategic plan, a $20,000 increase in director's fees due to an increase in
board meeting fees, offset by a $27,000 decrease in computer software expense
due to fully amortized software, a $37,000 decrease in personnel, education and
training and a $37,000 decrease in marketing expense due to 1997 expenses for
the Winn Dixie branch opening and promotion for the Visa Checkcard.
The 1997 increase resulted from a $40,000 increase in electronic services
due to Mastercard/Visa processing expenses and ATM expenses, a $25,000 increase
in FICO assessments, $70,000 decrease in professional fees mainly due to
expenses in 1996 to set up the dividend reinvestment plan, and a $28,000
increase in marketing expenses due to the Winn Dixie branch opening and the
promotion of the Checkcard. See "SUPERVISION AND REGULATION-FDIC INSURANCE
ASSESSMENTS."
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<PAGE>
Income Taxes
The Company's income tax expense was $1,842,000, $1,828,000, and
$1,505,000 in 1998, 1997 and 1996, respectively. These levels represent an
effective tax rate on pre-tax earnings of 34.9% for 1998, 37.2% for 1997, and
35.3% for 1996. Details of the tax provision for income taxes are included in
Note 10, "Income Tax Expense" in the Notes to the Consolidated Financial
Statements included elsewhere herein.
ITEM 7. FINANCIAL STATEMENTS
See pages 38 to 72.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
Information required by this item is set forth under the heading
"Information about Nominees for Directors" on Pages 2 through 4 and under the
heading "Executive Officers" on Pages 5 and 6 of the definitive proxy statement
for the Company's Annual Meeting to be held on May 11, 1999, and is incorporated
herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
Information required by this item is set forth under the heading "Meetings
and Committees of the Board of Directors" on Pages 4 and 5 and under the heading
"Summary Compensation of Executive Officers" on Pages 6 and 7 of the definitive
proxy statement for the Company's Annual Meeting to be held on May 11, 1999, and
is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is set forth under the heading
"Information about Nominees for Directors" on Pages 2 through 4 of the
definitive proxy statement for the Company's Annual Meeting to be held on May
11, 1999, and is incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is set forth under the heading "Certain
Transactions and Business Relationships on Page 8 of the definitive proxy
statement for the Company's Annual Meeting to be held on May 11, 1999, and is
incorporated herein by reference.
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<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3. A. Certificate of Incorporation of Auburn National Bancorporation, Inc.
(incorporated by reference from Registrant's Registration Statement on
Form SB-2 (File No. 33-86180)).
B. Bylaws of Auburn National Bancorporation, Inc. (incorporated by
reference from Registrant's Registration Statement on Form SB-2 (File
No. 33-86180)).
10. Material Contracts
A. Auburn National Bancorporation, Inc. 1994 Long-Term Incentive Plan
(incorporated by reference from Registrant's Registration Statement on
Form SB-2 (File No. 33-86180)).
B. Lease and Equipment Purchase Agreement, dated September 15, 1987
(incorporated by reference from Registrant's Registration Statement on
Form SB-2 (File No. 33-86180)).
21. Subsidiaries of Registrant
23. Consent of Accountants
27. Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the fiscal
year ended December 31, 1998
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<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Financial Statements
December 31, 1998, 1997, and 1996
With Independent Auditors' Report Thereon
-38-
<PAGE>
Independent Auditors' Report
The Board of Directors
Auburn National Bancorporation, Inc. and Subsidiary:
We have audited the accompanying consolidated balance sheets of Auburn National
Bancorporation, Inc. and subsidiary (the Company) as of December 31, 1998 and
1997, and the related consolidated statements of earnings, stockholders' equity
and comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Auburn National
Bancorporation, Inc. and subsidiary as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles.
KPMG LLP
Atlanta, Georgia
February 4, 1999
-39-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
Assets 1998 1997
-------------------- ---------------------
<S> <C> <C>
Cash and due from banks (note 2) $ 9,220,225 12,268,412
Federal funds sold 260,000 2,615,000
-------------------- ---------------------
Cash and cash equivalents 9,480,225 14,883,412
-------------------- ---------------------
Interest-earning deposits with other banks 133,600 1,722,982
Investment securities held to maturity (fair value
of $8,227,385 and $14,401,723 for December 31, 1998
and 1997, respectively) (note 3) 8,094,283 14,364,262
Investment securities available for sale (note 3) 63,585,573 40,445,856
Loans:
Loans, less unearned income of $15,494 and $36,706
at December 31, 1998 and 1997, respectively 218,686,991 185,493,178
Less allowance for loan losses (2,808,307) (2,125,104)
-------------------- ---------------------
Loans, net (notes 4 and 8) 215,878,684 183,368,074
-------------------- ---------------------
Premises and equipment, net (note 5) 3,434,964 3,520,542
Rental property, net 1,760,294 1,807,359
Other assets (note 10) 5,506,649 3,916,190
-------------------- ---------------------
Total assets $ 307,874,272 264,028,677
==================== =====================
</TABLE>
See accompanying notes to consolidated financial statements.
-40-
<PAGE>
<TABLE>
<CAPTION>
Liabilities and Stockholders' Equity 1998 1997
------------------- ---------------------
<S> <C> <C>
Deposits:
Noninterest-bearing $ 34,724,182 32,638,352
Interest-bearing (note 6) 198,780,568 191,339,635
------------------- ---------------------
Total deposits 233,504,750 223,977,987
Securities sold under agreements to repurchase (note 7) 12,944,004 1,273,507
Other borrowed funds (note 8) 31,000,458 11,138,850
Accrued expenses and other liabilities 1,481,564 1,533,992
Employee Stock Ownership Plan debt (note 11) -- 56,934
------------------- ---------------------
Total liabilities 278,930,776 237,981,270
------------------- ---------------------
Stockholders' equity (notes 14 and 15):
Preferred stock of $.01 par value; authorized
200,000 shares; issued shares - none -- --
Common stock of $.01 par value; authorized 8,500,000
shares; issued 3,957,135 shares at December 31, 1998
and 1997 39,571 39,571
Additional paid-in capital 3,707,472 3,707,472
Retained earnings 25,077,126 22,396,461
Accumulated other comprehensive income 333,926 175,436
Less:
Treasury stock, 32,562 shares at December 31,
1998 and 1997, at cost (214,599) (214,599)
Employee Stock Ownership Plan debt -- (56,934)
------------------- ---------------------
Total stockholders' equity 28,943,496 26,047,407
Commitments and contingencies (note 12)
------------------- ---------------------
Total liabilities and stockholders' equity $ 307,874,272 264,028,677
=================== =====================
</TABLE>
-41-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Statements of Earnings
Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
1998 1997 1996
--------------- ----------------- -----------------
<S> <C> <C> <C>
Interest income:
Interest and fees on loans $ 17,467,725 15,323,433 13,067,275
--------------- ----------------- -----------------
Interest and dividends on investment securities:
Taxable 3,787,501 3,933,478 4,074,730
Tax-exempt 108,308 123,290 119,956
--------------- ----------------- -----------------
Total interest and dividends on investment
securities 3,895,809 4,056,768 4,194,686
Interest on federal funds sold 236,494 387,773 337,452
Interest on interest-earning deposits with other banks 120,268 81,421 1,550
--------------- ----------------- -----------------
Total interest income 21,720,296 19,849,395 17,600,963
--------------- ----------------- -----------------
Interest expense:
Interest on deposits (note 6) 9,557,171 9,532,606 8,684,432
Interest on federal funds purchased -- 86 11,040
Interest on securities sold under agreements
to repurchase (note 7) 225,524 148,216 413,650
Interest on other borrowings (note 8) 1,406,271 661,592 554,606
--------------- ----------------- -----------------
Total interest expense 11,188,966 10,342,500 9,663,728
--------------- ----------------- -----------------
Net interest income 10,531,330 9,506,895 7,937,235
Provision for loan losses (note 4) 891,030 285,245 80,102
--------------- ----------------- -----------------
Net interest income after provision
for loan losses 9,640,300 9,221,650 7,857,133
--------------- ----------------- -----------------
Noninterest income:
Service charges on deposit accounts 978,303 865,473 801,124
Investment securities gains (losses), net (note 3) 14,277 (59,876) 26,478
Other (note 16) 1,486,796 1,265,389 1,580,735
--------------- ----------------- -----------------
Total noninterest income 2,479,376 2,070,986 2,408,337
--------------- ----------------- -----------------
Noninterest expense:
Salaries and benefits (note 11) 3,237,336 3,142,740 2,940,791
Net occupancy expense 1,022,405 972,108 816,653
Other (note 16) 2,578,477 2,269,782 2,249,867
--------------- ----------------- -----------------
Total noninterest expense 6,838,218 6,384,630 6,007,311
--------------- ----------------- -----------------
Earnings before income taxes 5,281,458 4,908,006 4,258,159
Income tax expense (note 10) 1,842,041 1,827,963 1,504,805
--------------- ----------------- -----------------
Net earnings $ 3,439,417 3,080,043 2,753,354
=============== ================= =================
Basic income per share (note 1) $ .88 .79 .70
=============== ================= =================
Weighted-average shares outstanding (note 1) 3,924,573 3,916,446 3,914,226
=============== ================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
-42-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Years ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Common stock
---------------------- Additional
Comprehensive paid-in Retained
income Shares Amount capital earnings
------------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 3,957,135 $ 39,571 3,659,107 17,749,910
Comprehensive income:
Net earnings $ 2,753,354 -- -- 2,753,354
Other comprehensive income (loss) due to unrealized
gain (loss) on mutual funds and investment
securities available for sale, net (note 9) (237,303) -- -- -- --
------------
Total comprehensive income $ 2,516,051
============
Cash dividends paid ($0.14 per share) -- -- -- (560,284)
Payment of Employee Stock Ownership Plan debt -- -- -- --
Sale of Treasury stock (1,111 shares) -- -- 5,611 --
Purchase of Treasury stock (11,265 shares) -- -- -- --
---------- ---------- ---------- -----------
Balance at December 31, 1996 3,957,135 39,571 3,664,718 19,942,980
Comprehensive income:
Net earnings $ 3,080,043 -- -- -- 3,080,043
Other comprehensive income due to unrealized
gain (loss) on mutual funds and investment
securities available for sale, net (note 9) 321,964 -- -- -- --
------------
Total comprehensive income $ 3,402,007
============
Cash dividends paid ($0.16 per share) -- -- -- (626,562)
Payment of Employee Stock Ownership Plan debt -- -- -- --
Sale of Treasury stock (5,488 shares) -- -- 42,754 --
Purchase of Treasury stock (368 shares) -- -- -- --
---------- ---------- ---------- -----------
Balance at December 31, 1997 3,957,135 39,571 3,707,472 22,396,461
Comprehensive income:
Net earnings $ 3,439,417 -- -- -- 3,439,417
Other comprehensive income due to unrealized
gain (loss) on mutual funds and investment
securities available for sale, net (note 9) 158,490 -- -- -- --
------------
Total comprehensive income $ 3,597,907
============
Cash dividends paid ($0.19 per share) -- -- -- (758,752)
Payment of Employee Stock Ownership Plan debt -- -- -- --
---------- ---------- ---------- -----------
Balance at December 31, 1998 3,957,135 $ 39,571 3,707,472 25,077,126
========== ========== ========== ===========
<CAPTION>
Accumulated Employee
other stock
comprehensive ownership Treasury
income plan debt stock Total
------------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 90,775 (170,946) (99,755) 21,268,662
Comprehensive income:
Net earnings -- -- -- 2,753,354
Other comprehensive income (loss) due to unrealized
gain (loss) on mutual funds and investment
securities available for sale, net (note 9) (237,303) -- -- (237,303)
Total comprehensive income
Cash dividends paid ($0.14 per share) -- -- -- (560,284)
Payment of Employee Stock Ownership Plan debt -- 57,006 -- 57,006
Sale of Treasury stock (1,111 shares) -- -- 16,887 22,498
Purchase of Treasury stock (11,265 shares) -- -- (221,141) (221,141)
------------ ----------- ---------- -----------
Balance at December 31, 1996 (146,528) (113,940) (304,009) 23,082,792
Comprehensive income:
Net earnings -- -- -- 3,080,043
Other comprehensive income due to unrealized
gain (loss) on mutual funds and investment
securities available for sale, net (note 9) 321,964 -- -- 321,964
Total comprehensive income
Cash dividends paid ($0.16 per share) -- -- -- (626,562)
Payment of Employee Stock Ownership Plan debt -- 57,006 -- 57,006
Sale of Treasury stock (5,488 shares) -- -- 98,058 140,812
Purchase of Treasury stock (368 shares) -- -- (8,648) (8,648)
------------ ----------- ---------- -----------
Balance at December 31, 1997 175,436 (56,934) (214,599) 26,047,407
Comprehensive income:
Net earnings -- -- -- 3,439,417
Other comprehensive income due to unrealized
gain (loss) on mutual funds and investment
securities available for sale, net (note 9) 158,490 -- -- 158,490
Total comprehensive income
Cash dividends paid ($0.19 per share) -- -- -- (758,752)
Payment of Employee Stock Ownership Plan debt -- 56,934 -- 56,934
------------ ----------- ---------- -----------
Balance at December 31, 1998 333,926 -- (214,599) 28,943,496
============ =========== ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
-43-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 3,439,417 3,080,043 2,753,354
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation and amortization 606,127 524,338 519,063
Net (accretion) amortization of investment
discounts/premiums (89,505) (95,906) 46,623
Provision for loan losses 891,030 285,245 80,102
Deferred tax (benefit) expense (84,982) (76,861) 55,231
Loans originated for resale (31,294,332) (14,185,691) (13,730,694)
Proceeds from sale of loans originated for resale 30,561,484 14,184,327 12,480,598
(Gain) loss on sale of investment securities (14,277) 59,876 (26,478)
Increase in interest receivable (346,662) (261,171) (241,612)
(Increase) decrease in other assets (441,377) (493,632) 332,842
(Decrease) increase in interest payable (151,352) 129,857 (94,652)
Increase in accrued expenses and other liabilities 98,924 741,983 17,896
----------- ----------- -----------
Net cash provided by operating activities 3,174,495 3,892,408 2,192,273
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of investment securities available
for sale 4,970,085 11,288,950 3,871,059
Proceeds from maturities/calls/paydowns of investment
securities held to maturity 6,844,848 6,908,351 6,668,991
Purchases of investment securities held to maturity (425,000) (3,325,876) (17,800)
Proceeds from maturities/calls/paydowns of
investment securities available for sale 17,689,859 14,699,633 16,102,270
Purchases of investment securities available for sale (45,581,599) (21,907,663) (33,557,621)
Other net increase in loans (32,668,792) (24,092,861) (20,078,467)
Purchases of premises and equipment (359,187) (504,116) (224,636)
Proceeds from sale of other real estate -- 65,699 82,500
Additions to rental property (48,094) (1,670) (35,745)
with other banks 1,589,382 (1,716,628) 756
Increase in investment in FHLB stock (889,300) -- --
----------- ----------- -----------
Net cash used in investing activities (48,877,798) (18,586,181) (27,188,693)
----------- ----------- -----------
Cash flows from financing activities:
Net increase in noninterest-bearing deposits 2,085,830 4,231,406 2,915,890
Net increase in interest-bearing deposits 7,440,933 3,019,407 28,008,756
Net increase (decrease) in securities sold under
agreements to repurchase 11,670,497 (3,379,327) (2,357,264)
Borrowings from FHLB 25,000,000 251,261 5,000,000
Repayments to FHLB (5,118,256) -- (100,000)
Repayments of other borrowed funds (20,136) (20,749) (20,800)
Net (decrease) increase in other short-term borrowings -- (1,203,130) 730,935
Proceeds from sale of treasury stock -- 140,812 22,498
Purchase of treasury stock -- (8,648) (221,141)
Dividends paid (758,752) (626,562) (560,284)
----------- ----------- -----------
Net cash provided by financing activities 40,300,116 2,404,470 33,418,590
----------- ----------- -----------
Net (decrease) increase in cash and
cash equivalents (5,403,187) (12,289,303) 8,422,170
Cash and cash equivalents at beginning of year 14,883,412 27,172,715 18,750,545
----------- ----------- -----------
Cash and cash equivalents at end of year $ 9,480,225 14,883,412 27,172,715
=========== =========== ===========
</TABLE>
-44-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------- --------------------
(Continued)
<S> <C> <C> <C>
Supplemental information on cash payments:
Interest paid $ 11,340,318 10,212,643 9,758,380
================== =================== ====================
Income taxes paid $ 2,161,351 1,596,005 1,239,739
================== =================== ====================
Supplemental information on noncash transactions:
Loans transferred to other real estate $ -- 129,699 82,500
================== =================== ====================
Loans to facilitate the sale of other real estate $ -- 64,000 --
================== =================== ====================
</TABLE>
See accompanying notes to consolidated financial statements.
-45-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(1) Summary of Significant Accounting Policies
Auburn National Bancorporation, Inc. (the Company) provides a full range of
banking services to individual and corporate customers in Lee County,
Alabama and surrounding counties through its subsidiary, AuburnBank (the
Bank). The Company is subject to competition from other financial
institutions. The Company is also subject to the regulations of certain
federal and state agencies and undergoes periodic examinations by those
regulatory authorities.
The accounting policies followed by the Company and its subsidiary and the
methods of applying these principles conform with generally accepted
accounting principles and with general practice within the banking
industry. Certain principles which significantly affect the determination
of financial position, results of operations and cash flows are summarized
below.
(a) Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in conformity
with generally accepted accounting principles. In preparing the
financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and the disclosure of contingent assets and liabilities as of the date
of the balance sheet and revenues and expenses for the period. Actual
results could differ from those estimates.
Material estimates that are particularly susceptible to significant
change in the near-term relate to the determination of the allowance
for loan losses and the valuation of real estate acquired in
connection with foreclosures or in satisfaction of loans. In
connection with the determination of the allowances for loan losses
and foreclosed real estate owned, management obtains independent
appraisals for significant properties.
The Company's real estate loans are secured by real estate located
principally in Lee County, Alabama and surrounding areas. In addition,
the foreclosed real estate owned by the Company is located in this
same area. Accordingly, the ultimate collectibility of a substantial
portion of the Company's loan portfolio and the recovery of real
estate owned are susceptible to changes in market conditions in this
area.
Management believes that the allowances for losses on loans and real
estate owned are adequate. While management uses available information
to recognize losses on loans and real estate owned, future additions
to the allowances may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Company's
allowances for losses on loans and real estate owned. Such agencies
may require the Company to recognize additions to the allowances based
on their judgments about information available to them at the time of
their examination.
-46-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiary, AuburnBank. During the year ended December 31, 1997,
the Company merged its existing subsidiary, ANB Systems, Inc. into the
Company. All significant intercompany accounts and transactions have been
eliminated.
(c) Cash Equivalents
Cash equivalents include amounts due from banks and federal funds sold.
Federal funds are generally sold for one-day periods.
(d) Investment Securities
The Company accounts for investment securities under the provisions of
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for
Certain Investments in Debt and Equity Securities whereby investment
securities are classified in one of three portfolios: (i) trading account
securities, (ii) held-to-maturity securities, and (iii) securities
available for sale. Trading account securities are to be stated at fair
value. The Company does not have trading account securities. Investment
securities held to maturity are those for which the Company has both the
intent and ability to hold until maturity and are stated at cost adjusted
for amortization of premiums and accretion of discounts. Investment
securities available for sale are stated at fair value with any unrealized
gains and losses reported in a separate component of stockholders' equity,
net of tax effects, until realized.
Accretion of discounts and amortization of premiums are calculated on the
effective interest method over the anticipated life of the security, taking
into consideration prepayment assumptions. Gains and losses from the sale
of investment securities are computed under the specific identification
method.
A decline in the market value below cost of any available for sale or held
to maturity security that is deemed other than temporary results in a
charge to earnings and the establishment of a new cost basis for the
security.
The Company uses interest rate swaps, caps, and floors as part of its
overall interest rate risk management. Any premiums or discounts arising
from the use of interest rate contracts are deferred and amortized over the
lives of the underlying assets or liabilities as an adjustment to interest
income or expense. Interest income or expense related to interest rate
swaps, caps, and floors is recorded over the life of the agreement as an
adjustment to interest income or expense. Interest rates on variable rate
derivative products held by the Bank are derived from the three- month
LIBOR rate.
-47-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(e) Loans
Loans are stated at principal amounts outstanding, net of unearned income.
Interest on fixed rate precomputed installment loans is credited to income
based on a method which approximates the level-yield method. Interest on
all other loans is credited to income on the simple interest method.
It is the general policy of the Bank to discontinue the accrual of interest
when principal or interest payments become more than ninety days'
delinquent. When a loan is placed on a nonaccrual basis, any interest
previously accrued but not collected is reversed against current income
unless the collateral for the loan is sufficient to cover the accrued
interest. Income on such loans is then recognized only to the extent that
cash is received and where the future collection of principal is probable.
Interest accruals are recorded on such loans only when they are brought
fully current with respect to interest and principal and when, in the
judgment of management, the loans are estimated to be fully collectible as
to both principal and interest.
The Company accounts for impaired loans in accordance with SFAS 114,
Accounting by Creditors for Impairment of a Loan, as amended by SFAS 118,
Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures. Under the provisions of SFAS 114 and 118, management considers
a loan to be impaired when it is probable that the Company will be unable
to collect all amounts due according to the contractual terms of the loan
agreement. When a loan is considered impaired, the amount of impairment is
measured based on the present value of expected future cash flows
discounted at the note's effective interest rate. If the loan is
collateral-dependent, the fair value of the collateral is used to determine
the amount of impairment. Impairment losses are included in the allowance
for loan losses through the provision for loan losses. Impaired loans are
charged to the allowance when such loans are deemed to be uncollectible.
Subsequent recoveries are added to the allowance.
When a loan is considered impaired, cash receipts are applied under the
contractual terms of the loan agreement, first to principal and then to
interest income. Once the recorded principal balance has been reduced to
zero, future cash receipts are applied to interest income, to the extent
that any interest has not been recognized. Any further cash receipts are
recorded as recoveries of any amount previously charged off.
A loan is also considered impaired if its terms are modified in a troubled
debt restructuring. For those accruing impaired loans, cash receipts are
typically applied to principal and interest receivable in accordance with
the terms of the restructured loan agreement. Interest income is recognized
on these loans using the accrual method of accounting.
-48-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
The Bank originates mortgage loans to be held for sale only for loans that
have been pre-approved by the investor. The Bank bears minimal interest
rate risk on these loans. Such loans are stated at the lower of cost or
aggregate market.
(f) Allowance for Loan Losses
The amount of provision for loan losses charged to earnings is based on
actual loss experience and management's evaluation of the loan portfolio
under current economic conditions. In addition, loans are examined for
credit quality, documentation, and financial information annually by a
qualified non-employee loan review examiner. Such provisions, adjusted for
loan charge-offs and recoveries, comprise the allowance for loan losses.
Provision amounts are largely determined based on loan classifications
determined through credit quality review using estimated loss factors based
on historical loss experience. Such loss factors are adjusted periodically
based on changes in loss experience.
Loans are charged against the allowance when management determines such
loans to be uncollectible. Subsequent recoveries are credited to the
allowance.
(g) Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation.
Depreciation is computed on both the double-declining balance and
straight-line methods for buildings and principally on a straight-line
method for furniture, fixtures, and equipment over the estimated useful
lives of the assets, which range from three to 39 years.
(h) Rental Property
Rental property consists of land; buildings; and furniture, fixtures, and
equipment which are rented to the Bank and the general public. Rental
property is stated at cost less accumulated depreciation. Depreciation is
computed on both the double-declining balance and straight-line methods for
buildings and principally on a straight-line method for furniture,
fixtures, and equipment over the estimated useful lives of the assets.
(i) Other Real Estate
Real estate acquired through foreclosure or in lieu of foreclosure is
carried at the lower of cost or fair value, as determined by independent
appraisals, adjusted for estimated selling costs. Any write-down at the
time of foreclosure is charged to the allowance for loan losses. Subsequent
declines in fair value below acquisition cost and gains or losses on the
sale of these properties are credited or charged to earnings.
-49-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(j) Derivative Financial Instruments
The Bank uses derivative financial instruments to swap floating rate assets
or liabilities to fixed rate and to hedge the interest rate spread between
assets and liabilities. These transactions serve to better match the
repricing characteristics of various assets and liabilities, reduce spread
risk, adjust overall rate sensitivity and enhance net interest income.
Interest rate swaps, purchased floors, and purchased caps are accounted for
on an accrual basis, and the net interest differential, including premiums
paid, if any, is recognized as an adjustment to interest income or expense
of the related designated asset or liability. Changes in fair values of the
swaps, purchased floors, or purchased caps are not recorded in the
consolidated statements of income because these agreements are being
treated as a synthetic alteration of the designated assets or liabilities.
The Bank considers its interest rate swaps to be a synthetic alteration of
an asset or liability as long as (i) the swap is designated with a specific
asset or liability or finite pool of assets or liabilities; (ii) there is a
high correlation at inception and throughout the period of the synthetic
alteration, between changes in the interest income or expense generated by
the swap and changes in the interest income or expense generated by the
designated asset or liability; (iii) the notional amount of the swap is
less than or equal to the principal amount of the designated asset or
liability; and (iv) the swap term is less than or equal to the remaining
term of the designated asset or liability. The criteria for consideration
of a floor or cap as a synthetic alteration of an asset or liability are
generally the same as those for a swap arrangement.
If the swap, floor, or cap arrangements are terminated before their
maturity, the net proceeds received or paid are deferred and amortized over
the shorter of the remaining contract life or the maturity of the
designated asset or liability as an adjustment to interest income or
expense. If the designated asset or liability is sold or matures, the swap
agreement is marked to market and the gain or loss is included in the gain
or loss on the sale/maturity of the designated asset or liability.
(k) Income Taxes
Income taxes are accounted for under the asset and liability method,
whereby deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carry forward.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date.
The Company files its federal income tax returns on a consolidated basis.
-50-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(l) Earnings per Share
Basic income per share is computed on the weighted-average number of shares
outstanding in accordance with SFAS No. 128, Earnings Per Share. The
Company reserved 75,000 shares of common stock in May 1994 for issuance
under stock option plans; however, no options have been granted as of
December 31, 1998, thus there are no potential common shares that would
result in diluted earnings per share.
On May 14, 1998, the Company's Board of Directors approved a three-for-one
stock split effected in the form of a dividend payable on June 25, 1998 to
shareholders of record on June 10, 1998. All share and per share
information in the accompanying financial statements has been restated to
reflect the effect of the additional shares outstanding resulting from the
stock split.
(m) Comprehensive Income
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, Reporting Comprehensive Income. This statement establishes standards
for reporting and displaying comprehensive income and its components in a
full set of general purpose financial statements. SFAS No. 130 requires all
items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement
that is displayed in equal prominence with the other financial statements.
The term "comprehensive income" is used in the statement to describe the
total of all components of comprehensive income including net income.
"Other comprehensive income" for the Company consists of items recorded
directly in stockholders' equity under SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities.
(n) Segment Disclosures
Effective January 1, 1998, the Company also adopted the provisions of SFAS
No. 131, Disclosures about Segments of an Enterprise and Related
Information. SFAS No. 131 establishes new standards for the disclosures
made by public business enterprises to report information about operating
segments in annual financial statements and requires those enterprises to
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. The Company does not have any segments other than banking that
are considered material.
-51-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(o) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities. This
statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company has not yet determined the
impact of SFAS No. 133 on the Company's financial statements upon
adoption.
(p) Reclassifications
Certain of the 1997 and 1996 amounts have been reclassified to conform
to the 1998 presentation.
(2) Cash and Due from Banks
The Bank is required to maintain certain average cash reserve balances
in accordance with Federal Reserve Board requirements. The amounts of
those required balances as of December 31, 1998 and 1997 were
approximately $1,397,000 and $1,243,000, respectively.
(3) Investment Securities
The amortized cost and approximate fair value of investment securities at
December 31, 1998, were as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized unrealized unrealized Approximate
cost gains losses fair value
--------------- --------------- -------------- ------------
<S> <C> <C> <C> <C>
Investment securities held to maturity:
State and political subdivisions $ 1,585,000 29,911 -- 1,614,911
Mortgage-backed securities 6,509,283 103,418 227 6,612,474
--------------- --------------- -------------- -------------
$ 8,094,283 133,329 227 8,227,385
=============== =============== ============== =============
Investment securities available for sale:
U.S. government agencies excluding
mortgage-backed securities $ 17,025,648 313,834 -- 17,339,482
Mortgage-backed securities 17,630,259 91,407 10,619 17,711,047
Collateralized mortgage obligations 27,524,735 229,643 102,818 27,651,560
State and political subdivisions 848,388 35,096 -- 883,484
-------------- --------------- -------------- -------------
$ 63,029,030 669,980 113,437 63,585,573
=============== =============== ============== =============
</TABLE>
-52-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
The amortized cost and approximate fair value of investment securities at
December 31, 1998, by contractual maturity are shown below. Expected
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without prepayment
penalties.
<TABLE>
<CAPTION>
Amortized Approximate
cost fair value
----------------- ---------------------
Investment securities held to maturity:
<S> <C> <C>
Due in one year or less $ 595,000 602,048
Due after one year through five years 200,000 202,978
Due after five years through ten years 365,000 381,877
Due after ten years 425,000 428,008
----------------- ---------------------
Subtotal 1,585,000 1,614,911
Mortgage-backed securities 6,509,283 6,612,474
----------------- ---------------------
Total $ 8,094,283 8,227,385
================= =====================
Investment securities available for sale:
Due after one year through five years $ 9,984,690 10,119,482
Due after five years through ten years 7,889,346 8,103,484
----------------- ---------------------
Subtotal 17,874,036 18,222,966
Mortgage-backed securities 17,630,259 17,711,047
Collateralized mortgage obligations 27,524,735 27,651,560
----------------- ---------------------
$ 63,029,030 63,585,573
================= =====================
</TABLE>
The amortized cost and approximate fair value of investment securities at
December 31, 1997, were as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized unrealized unrealized Approximate
cost gains losses fair value
---------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Investment securities held to maturity:
U.S. government agencies excluding
mortgage-backed securities $ 3,216,614 -- 71,264 3,145,350
State and political subdivisions 1,478,866 41,216 -- 1,520,082
Mortgage-backed securities 9,469,748 67,907 -- 9,537,655
Collateralized mortgage obligations 199,034 -- 398 198,636
---------------- -------------- -------------- ---------------
$ 14,364,262 109,123 71,662 14,401,723
================ ============== ============== ===============
Investment securities available for sale:
U.S. government agencies excluding
mortgage-backed securities $ 12,056,107 41,107 -- 12,097,214
Mortgage-backed securities 7,957,596 32,576 -- 7,990,172
Collateralized mortgage obligations 19,659,759 234,443 33,519 19,860,683
State and political subdivisions 480,000 17,787 -- 497,787
---------------- -------------- -------------- ---------------
$ 40,153,462 325,913 33,519 40,445,856
================ ============== ============== ===============
</TABLE>
-53-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
There were no sales of investment securities held to maturity during any of
the years in the three-year period ended December 31, 1998. Proceeds from
sales of investment securities available for sale were $4,970,085,
$11,288,950, and $3,871,059 for the years ended December 31, 1998, 1997,
and 1996, respectively. Gross losses of $59,876 were realized on sales of
investment securities for the year ended December 31, 1997. Gross gains of
$14,277 and $26,478 were realized on sales for the years ended December 31,
1998 and 1996, respectively.
Investment securities with an aggregate carrying value of $65,826,237 and
$50,086,378 at December 31, 1998 and 1997, respectively, were pledged to
secure public and trust deposits as required by law and for other purposes.
The Company maintains a diversified investment portfolio, including
held-to-maturity and available-for-sale securities, with limited
concentration in any given region, industry, or economic characteristic.
Investments in municipal governments are made throughout the U.S. with no
concentration in any given state.
Included in other assets is stock in the Federal Home Loan Bank (FHLB) of
Atlanta. FHLB stock is carried at cost, has no contractual maturity, has no
quoted fair value, and no ready market exists; therefore, the fair value of
such stock is assumed to approximate cost. The investment in the stock is
required of every member of the FHLB system. The investment in the stock
was $1,788,900 and $899,600 at December 31, 1998 and 1997, respectively.
(4) Loans
At December 31, 1998 and 1997, the composition of the loan portfolio was as
follows:
<TABLE>
<CAPTION>
1998 1997
------------------ --------------------
<S> <C> <C>
Commercial, financial, and agricultural $ 61,074,779 46,328,523
Real estate - construction:
Commercial 8,112,199 3,172,382
Residential 4,543,748 3,582,534
Real estate - mortgage:
Commercial 61,113,412 51,713,918
Residential 60,135,660 58,645,606
Real estate - held for sale 4,199,818 3,466,970
Consumer installment 19,522,869 18,619,951
------------------ --------------------
Total loans 218,702,485 185,529,884
Less:
Unearned income (15,494) (36,706)
Allowance for loan losses (2,808,307) (2,125,104)
------------------ --------------------
Loans, net $ 215,878,684 183,368,074
================== ====================
</TABLE>
-54-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
During 1998 and 1997, certain executive officers and directors of the Company
and the Bank, including companies with which they are associated, were loan
customers of the Bank. Total loans outstanding to these persons at December 31,
1998 and 1997 amounted to $7,404,807 and $7,072,874, respectively. The change
from 1997 to 1998 reflects payments of $7,197,008 and advances of $7,528,941. In
management's opinion, these loans were made in the ordinary course of business
at normal credit terms, including interest rate and collateral requirements, and
do not represent more than normal credit risk.
A summary of the transactions in the allowance for loan losses for the years
ended December 31, 1998, 1997, and 1996 is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ -------------------
<S> <C> <C> <C>
Balance at beginning of year $ 2,125,104 2,093,682 2,012,133
Provision charged to earnings 891,030 285,245 80,102
Loan recoveries 105,901 66,224 174,050
Loans charged off (313,728) (320,047) (172,603)
------------------ ------------------ -------------------
Balance at end of year $ 2,808,307 2,125,104 2,093,682
================== ================== ===================
</TABLE>
At December 31, 1998 and 1997, the Company had $4,098,533 and $578,130,
respectively, of impaired loans. Impaired loans at December 31, 1998 consist of
one loan with a related valuation allowance of $564,313. Impaired loans at
December 31, 1997 include loans of $71,983 that had a related valuation
allowance of $49,450.
For the years ended December 31, 1998, 1997, and 1996, the average recorded
investment in the impaired loans was $2,370,393, $593,750, and $655,907,
respectively. The related amount of interest income recognized during 1998,
1997, and 1996 amounted to $110,367, $54,459, and $54,258, respectively.
Nonperforming loans, consisting of loans on nonaccrual status and accruing loans
past due greater than 90 days, amounted to $4,896,756 and $276,000 at December
31, 1998 and 1997, respectively. Nonaccrual loans were $4,593,108 at December
31, 1998. There were no nonaccrual loans at December 31, 1997. Interest that
would have been recorded on nonaccrual loans had they been in accruing status
was approximately $183,000 in 1998 and $6,000 in 1996. The amount of interest
collected and recorded on nonaccrual loans was approximately $33,000 in 1998 and
$2,000 in 1996.
The Company's loan servicing portfolio consisted of 869 loans with an
outstanding balance of $65,661,064, 832 loans with an outstanding balance of
$63,565,693, and 730 loans with an outstanding balance of $53,774,538, as of
December 31, 1998, 1997, and 1996, respectively.
-55-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(5) Premises and Equipment
Premises and equipment at December 31, 1998 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------------------ --------------------
<S> <C> <C>
Land $ 407,747 407,747
Buildings 2,730,244 2,713,251
Furniture, fixtures, and equipment 3,824,649 3,961,765
------------------ --------------------
Total premises and equipment 6,962,640 7,082,763
Less accumulated depreciation (3,527,676) (3,562,221)
------------------ --------------------
$ 3,434,964 3,520,542
================== ====================
</TABLE>
(6) Interest-Bearing Deposits
At December 31, 1998 and 1997, the composition of interest-bearing deposits was
as follows:
<TABLE>
<CAPTION>
1998 1997
------------------ --------------------
<S> <C> <C>
NOW, Super NOW, and Automatic Transfer Service $ 21,606,033 22,422,519
Money market 42,270,612 50,677,710
Savings 10,535,711 10,217,311
Certificates of deposit under $100,000 72,424,754 71,136,109
Certificates of deposit and other time
deposits of $100,000 and over 51,943,458 36,885,986
------------------ --------------------
$ 198,780,568 191,339,635
================== ====================
</TABLE>
Interest expense on certificates of deposit and other time deposits of $100,000
and over amounted to approximately $2,187,000, $1,972,000, and $1,592,000 in
1998, 1997, and 1996, respectively.
-56-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
The following table presents the maturities of certificates of deposit and
other time deposits of $100,000 or more at December 31, 1998.
Years ending December 31,
-------------------------
1999 $ 33,734,483
2000 11,880,153
2001 1,727,151
2002 1,226,908
2003 2,843,513
Thereafter 531,250
-----------------
$ 51,943,458
=================
(7) Securities Sold Under Agreements to Repurchase
The securities sold under agreements to repurchase at December 31, 1998 and
1997 are collateralized by obligations of the U.S. Government or its
corporations and agencies, state and municipal securities, or
mortgage-backed securities, which are held by independent trustees. The
following summarizes pertinent data related to the securities sold under
agreements to repurchase as of and for the years ended December 31, 1998,
1997, and 1996.
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ---------------- -----------------
<S> <C> <C> <C>
Weighted-average borrowing rate at year-end 4.99% 5.29 5.12
================= ================ =================
Weighted-average borrowing rate during
the year 4.96% 5.16 5.46
================= ================ =================
Average daily balance during the year $ 4,554,000 2,868,000 7,784,000
================= ================ =================
Maximum month-end balance during the year $ 12,944,004 8,516,000 12,067,000
================= ================ =================
</TABLE>
-57-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(8) Other Borrowed Funds
Other borrowed funds at December 31, 1998 and 1997 consisted of the
following:
<TABLE>
<CAPTION>
Maturity Interest
date rate 1998 1997
-------------------- ------------ ---------------- ----------------
<S> <C> <C> <C> <C>
Federal Home Loan Bank borrowings February 2017 6.64 $ 333,005 351,261
March 2003 5.79 425,000 525,000
January 2001 5.87 5,000,000 5,000,000
May 1998 5.63 -- 5,000,000
January 2008 5.46 5,000,000 --
March 2008 5.51 5,000,000 --
June 2008 5.51 10,000,000 --
October 2003 3.90 5,000,000 --
Small Business Administration debt June 2004 3.00 21,842 27,355
June 2004 5.08 220,611 235,234
---------------- ----------------
$ 31,000,458 11,138,850
================ ================
</TABLE>
The Bank has a $40,000,000 available line of credit from the FHLB which is
reviewed annually by the FHLB. The above advances are against this line of
credit. Interest expense on FHLB advances was $1,386,924, $630,494, and
$498,705 in 1998, 1997, and 1996, respectively. All interest rates on
outstanding advances are fixed interest rates. The advances and line of
credit are collateralized by the Bank's investment in the stock of the FHLB
and all first mortgage residential loans, which are sufficient to draw the
full line of credit.
-58-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(9) Other Comprehensive Income
The following table sets forth the amounts of other comprehensive income
included in stockholders' equity along with the related tax effect for the
years ended December 31, 1998, 1997, and 1996.
<TABLE>
<CAPTION>
Tax Net of
Pretax (expense) tax
amount benefit amount
------------------ ------------------ -----------------
<S> <C> <C> <C>
1998:
Net unrealized holding gains on
investment securities available
for sale arising during the year $ 278,426 (111,370) 167,056
Less reclassification adjustment
for net gains realized in net
income 14,277 (5,711) 8,566
------------------ ------------------ -----------------
Other comprehensive income $ 264,149 (105,659) 158,490
================== ================== =================
1997:
Net unrealized holding gains on
investment securities available
for sale arising during the year $ 447,549 (163,577) 283,972
Less reclassification adjustment for
net losses realized in net income (59,876) 21,884 (37,992)
------------------ ------------------ -----------------
Other comprehensive income $ 507,425 (185,461) 321,964
================== ================== =================
1996:
Net unrealized holding losses on
investment securities available
for sale arising during the year $ (342,683) 122,401 (220,282)
Less reclassification adjustment
for net gains realized in net
income 26,478 (9,457) 17,021
------------------ ------------------ -----------------
Other comprehensive income loss $ (369,161) 131,858 (237,303)
================== ================== =================
</TABLE>
-59-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(10) Income Tax Expense
Total income tax expense (benefit) for the years ended December 31, 1998,
1997, and 1996 was allocated as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ---------------- -----------------
<S> <C> <C> <C>
Income from continuing operations $ 1,842,041 1,827,963 1,504,805
================== ================ =================
Stockholders' equity, for accumulated other
comprehensive income $ 105,659 185,461 (131,858)
================== ================ =================
</TABLE>
For the years ended December 31, 1998, 1997, and 1996 the components of
income tax expense were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ---------------- -----------------
<S> <C> <C> <C>
Current income tax expense:
Federal $ 1,760,302 1,733,135 1,314,952
State 166,721 171,689 134,622
------------------ ---------------- -----------------
Total 1,927,023 1,904,824 1,449,574
------------------ ---------------- -----------------
Deferred income tax expense (benefit):
Federal (75,526) (68,833) 45,912
State (9,456) (8,028) 9,319
-----------------
------------------ ----------------
Total (84,982) (76,861) 55,231
------------------ ---------------- -----------------
$ 1,842,041 1,827,963 1,504,805
================== ================ =================
</TABLE>
-60-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
Total income tax expense differed from the amount computed by applying the
statutory federal income tax rate of 34 percent to pretax earnings as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ---------------- -----------------
<S> <C> <C> <C>
Income tax expense at statutory rate $ 1,795,696 1,668,722 1,447,774
Increase (decrease) resulting from:
Tax-exempt interest (36,625) (49,177) (59,513)
State income tax expense net of Federal
income tax benefit 103,795 108,016 95,001
Increase (decrease) in valuation allowance
for deferred tax assets (1,533) 7,956 --
Other (19,292) 92,446 21,543
------------------ ---------------- -----------------
$ 1,842,041 1,827,963 1,504,805
================== ================ =================
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 and 1997 are presented below:
<TABLE>
<CAPTION>
1998 1997
------------------ --------------------
Deferred tax assets:
<S> <C> <C>
Loans, principally due to allowance for loan losses $ 700,465 658,913
Principal amortization for leases being
depreciated for tax 92,677 77,487
Capital loss carry forward 6,423 7,956
Other 17,629 17,313
------------------ --------------------
Total gross deferred tax assets before
valuation allowance 817,195 761,669
Valuation allowance (6,423) (7,956)
------------------ --------------------
Total deferred tax assets 810,772 753,713
------------------ --------------------
Deferred tax liabilities:
Premises and equipment, principally due
to differences in depreciation 263,927 280,058
Investments, principally due to discount accretion 87,864 109,337
FHLB stock dividend 21,068 21,068
Prepaid expenses 64,800 69,952
Loans, principally due to differences in
deferred loan fees 57,151 42,681
Unrealized gain on investment securities
available for sale 222,617 116,958
Other 4,490 4,127
------------------ --------------------
Total deferred tax liabilities 721,917 644,181
------------------ --------------------
Net deferred tax asset $ 88,855 109,532
================== ====================
</TABLE>
-61-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected
future taxable income, and tax planning strategies in making this
assessment. Based upon the level of historical taxable income and
projection for future taxable income over the periods which the temporary
differences resulting in the deferred tax assets are deductible, management
believes it is more likely than not that the Company will realize the
benefits of these deductible differences, giving consideration to the
valuation allowance recorded.
(11) Retirement Plans
The Bank sponsored two retirement plans, the Auburn National
Bancorporation, Inc. Employee Incentive Plan and the Auburn National
Bancorporation, Inc. Employee Stock Ownership Plan (ESOP). In January 1994,
the two plans were merged into one plan, Auburn National Bancorporation,
Inc. 401(k) and Employee Stock Ownership Plan. The plan covers
substantially all employees. Participants become 20 percent vested in their
accounts after two years of service and 100 percent vested after six years
of service. Contributions to the plan are determined by the board of
directors. Company contributions to the plan amounted to $130,123,
$125,870, and $121,076 in 1998, 1997, and 1996, respectively.
During 1989, the ESOP borrowed $570,062 from an unrelated financial
institution to purchase 6,306 shares of common stock of the Company. The
remaining unallocated common stock acquired by the ESOP collateralizes the
loan. The note was payable in annual principal installments of $57,006 and
quarterly interest payments until December 31, 1998. The note was paid in
full as of December 31, 1998.
(12) Off-Balance-Sheet Risk and Contingent Liabilities
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend
credit, and standby letters of credit and financial guarantees. Such
instruments involve elements of credit risk in excess of the amounts
recognized in the consolidated financial statements.
The Company's exposure to credit loss in the event of nonperformance by the
other party to these financial instruments is represented by the
contractual amount of these instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
-62-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
The financial instruments whose contract amounts represent credit risk
as of December 31, 1998 are as follows:
Commitments to extend credit $ 4,065,000
Standby letters of credit 1,925,000
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements.
Standby letters of credit are commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees
are primarily issued to support public and private borrowing arrangements.
All guarantees expire within one year. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending
loan facilities to customers. The Company holds various assets as
collateral supporting those commitments for which collateral is deemed
necessary.
The Bank enters into interest rate protection contracts to help manage the
Bank's interest rate exposure. These contracts include interest rate swaps,
caps, and floors. Interest rate swap transactions generally involve the
exchange of fixed and floating rate interest payment obligations without
the exchange of the underlying principal amounts. Entering into interest
rate swap agreements involves not only the risk of dealing with
counterparties and their ability to meet the terms of the contracts but
also the risk associated with the movements in interest rates. Notional
principal amounts often are used to express the volume of these
transactions; however, the amounts potentially subject to credit risk are
much smaller. The notional principal amount related to these contracts was
$30,000,000 at December 31, 1998. Risks associated with interest rate
contracts include interest rate risk and creditworthiness of the
counterparty. These risks are considered in the Bank's overall asset
liability management program. The Bank utilizes periodic financial
statements issued by the counterparty to analyze the creditworthiness of
the counterparty prior to entering into a contract and to monitor changes
in the financial condition of the counterparty throughout the term of the
contract. Although none of the interest rate protection agreements are
traded on any organized exchange, the Company believes that an active
secondary market exists for such contracts.
In February 1995, the Bank entered into two interest rate floors with
respect to $20,000,000 in variable rate loans. These agreements allow the
Bank to receive interest payments based on three-month LIBOR should the
floor rate fall below 5.00% and 6.00%, respectively. The agreements
required the Bank to pay a fixed amount of $26,000 and $76,500,
respectively, upon consummation of the agreements. The purpose of these
contracts was to reduce interest rate exposure to variable assets in a low
interest rate environment.
-63-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
In May 1997, the Bank entered into an interest rate swap with respect to
$10,000,000 in two-year 6.25% certificates of deposit. This agreement
allows the Bank to receive fixed interest payments at 6.42% per annum and
to pay a variable rate equal to three-month LIBOR. The purpose of this
contract was to reduce the Bank's effective cost of funds to better match
the costs of funding variable rate loans.
The following table summarizes information on interest rate swaps and
floors at December 31, 1998:
<TABLE>
<CAPTION>
INTEREST RATE PROTECTION CONTRACTS
Thousands Weighted-average rate
--------------------------------------------- -------------------------
Weighted-
average
Notional Carrying Estimated remaining
amount value fair value Received Paid life (years)
---------- ------------ ------------- ------------ -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Swaps:
Receive fixed:
One year or less $ 10,000 -- 41 6.42% 5.88% .25
Floors:
Purchased:
Over two years through
five years 10,000 6 20 -- -- 1.25
Over two years through
five years 10,000 17 106 6.00% -- 1.25
---------- ------------ -------------
$ 30,000 23 167
========== ============ =============
</TABLE>
All interest rate protection contracts above reprice quarterly. The
weighted-average rates received/paid are shown only for swaps and floors
for which net interest amounts were receivable or payable at the end of
each period. For floors when the index rate has not been reached, no rate
is shown. Interest rates on variable rate derivative products held by the
Bank are derived from the three-month LIBOR rate.
The Company and the Bank are involved in various legal proceedings, arising
in connection with their business. In the opinion of management, based upon
consultation with legal counsel, the ultimate resolution of these
proceedings will not have a material adverse effect upon the financial
position or results of operations of the Company.
-64-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(13) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107 (SFAS 107), Disclosures
about Fair Value of Financial Instruments, requires disclosure of fair
value information about financial instruments, whether or not recognized on
the face of the balance sheet, for which it is practicable to estimate that
value. The assumptions used in the estimation of the fair value of the
Company's financial instruments are explained below. Where quoted market
prices are not available, fair values are based on estimates using
discounted cash flow and other valuation techniques. Discounted cash flows
can be significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. The following fair value
estimates cannot be substantiated by comparison to independent markets and
should not be considered representative of the liquidation value of the
Company's financial instruments, but rather a good-faith estimate of the
fair value of financial instruments held by the Company. SFAS 107 excludes
certain financial instruments and all nonfinancial instruments from its
disclosure requirements.
The following methods and assumptions were used by the Company in
estimating the fair value of its financial instruments:
(a) Cash, Cash Equivalents, and Interest-Bearing Deposits with Other Banks
Fair value equals the carrying value of such assets.
(b) Investment Securities
The fair value of investment securities is based on quoted market prices.
(c) Loans
The fair value of loans is calculated using discounted cash flows and
excludes lease financing arrangements. The discount rates used to determine
the present value of the loan portfolio are estimated market discount rates
that reflect the credit and interest rate risk inherent in the loan
portfolio. The estimated maturities are based on the Company's historical
experience with repayments adjusted to estimate the effect of current
market conditions. The carrying amount of accrued interest approximates its
fair value.
(d) Off-Balance-Sheet Instruments
Fair value of interest rate swaps, financial futures, and interest rate
caps and floors is based on quoted market prices. These values represent
the estimated amount the Company would receive or pay to terminate the
contracts or agreements, taking into account current interest rates and,
when appropriate, the creditworthiness of the counterparties.
-65-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(e) Deposits
As required by SFAS 107, the fair value of deposits with no stated
maturity, such as noninterest-bearing demand deposits, NOW accounts,
savings, and money market deposit accounts, is equal to the carrying value.
Certificates of deposit have been valued using discounted cash flows. The
discount rates used are based on estimated market rates for deposits of
similar remaining maturities.
(f) Short-term Borrowings
The fair value of federal funds purchased, securities sold under agreements
to repurchase, and other short-term borrowings approximates their carrying
value.
(g) Long-term Borrowings
The fair value of the Company's fixed rate long-term debt is estimated
using discounted cash flows based on estimated current market rates for
similar types of borrowing arrangements. The carrying amount of the
Company's variable rate long-term debt approximates its fair value.
The carrying value and estimated fair value of the Company's financial
instruments at December 31, 1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
------------------------------------ --------------------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
---------------- ---------------- ---------------- ------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and short-term investments $ 9,614 9,614 16,606 16,606
================ ================ ================ ==================
Investment securities $ 71,680 71,813 54,810 54,848
================ ================ ================ ==================
Loans, net of allowance
for loan losses $ 215,879 221,028 183,368 186,582
================ ================ ================ ==================
Financial liabilities:
Deposits $ 233,505 234,146 223,978 223,387
================ ================ ================ ==================
Short-term borrowings $ 12,944 12,944 1,274 1,274
================ ================ ================ ==================
Long-term borrowings $ 31,000 31,423 11,196 10,999
================ ================ ================ ==================
Off-balance sheet financial instruments:
Interest rate contracts:
Swaps $ -- 41 -- 76
Caps and floors 23 126 43 84
---------------- ---------------- ---------------- ------------------
$ 23 167 43 160
================ ================ ================ ==================
</TABLE>
-66-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(14) Common Stock and Capital Requirements
The Company and Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory -- and possibly
additional discretionary -- actions by regulators that, if undertaken,
could have a direct material effect on the Company's consolidated financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Company and Bank must meet specific
capital guidelines that involve quantitative measures of the Company's and
Bank's assets, liabilities, and certain off-balance- sheet items as
calculated under regulatory accounting practices. The Company's and Bank's
capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital
(as defined) to average assets (as defined). Management believes, as of
December 31, 1998, that the Company and Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 1998, based on its most recent notification, the Bank is
categorized as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the table. There are no conditions or events since
that notification that management believes have changed the Bank's capital
category.
-67-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
The actual capital amounts and ratios and the aforementioned minimums as of
December 31, 1998 and 1997 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
Minimum Minimum to be well
for capital capitalized under
adequacy prompt corrective
Actual purposes action provisions
-------------------------- ------------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ----------- ------------ -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Auburn National Bancorporation, Inc.
As of December 31, 1998
Total capital (to risk-weighted
assets) $ 31,294 14.58% $ 17,169 8% N/A N/A
Tier I risk-based capital (to risk-
weighted assets) 28,610 13.33 8,584 4 N/A N/A
Tier I leverage capital (to
average assets) 28,610 9.29 12,315 4 N/A N/A
As of December 31, 1997
Total capital (to risk-weighted
assets) $ 27,997 15.22% $ 14,717 8% N/A N/A
Tier I risk-based capital (to risk-
weighted assets) 25,872 14.06 7,359 4 N/A N/A
Tier I leverage capital (to
average assets) 25,872 9.80 10,561 4 N/A N/A
AuburnBank
As of December 31, 1998
Total capital (to risk-weighted
assets) $ 28,829 13.58% $ 16,988 8% $ 21,235 10%
Tier I risk-based capital (to risk-
weighted assets) 26,173 12.33 12,213 4 12,741 6
Tier I leverage capital (to
average assets) 26,173 8.57 8,495 4 15,266 5
As of December 31, 1997
Total capital (to risk-weighted
assets) $ 25,229 13.89% $ 14,529 8% $ 18,161 10%
Tier I risk-based capital (to risk-
weighted assets) 23,104 12.72 7,264 4 10,897 6
Tier I leverage capital (to
average assets) 23,104 8.84 10,453 4 13,066 5
</TABLE>
-68-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(15) Dividends from Subsidiary
Dividends paid by the Bank are a principal source of funds available to the
Company for payment of dividends to its stockholders and for other needs.
Applicable federal and state statutes and regulations impose restrictions
on the amounts of dividends that may be declared by the subsidiary bank.
State statutes restrict the Bank from declaring dividends in excess of the
sum of the current year's earnings plus the retained net earnings from the
preceding two years without prior approval. In addition to the formal
statutes and regulations, regulatory authorities also consider the adequacy
of the Bank's total capital in relation to its assets, deposits, and other
such items. Capital adequacy considerations could further limit the
availability of dividends from the Bank. At December 31, 1998, the Bank
could have declared dividends of approximately $8,253,000 without prior
approval of regulatory authorities. As a result of this limitation,
approximately $18,254,000 of the Company's investment in the Bank was
restricted from transfer in the form of dividends.
(16) Supplemental Information
Components of other noninterest income exceeding one percent of revenues
for any of the years in the three-year period ended December 31, 1998,
included merchant discounts and fees on MasterCard and Visa sales of
$391,315, $310,416, and $293,004 in 1998, 1997, and 1996, respectively;
and, gain on sale of mortgage loans of $134,715, $76,747, and $68,433 in
1998, 1997, and 1996, respectively. Also included were servicing fees of
$176,522, $166,538, and $163,820 in 1998, 1997, and 1996, respectively;
and, rental income of $150,623, $138,618, and $161,510 in 1998, 1997, and
1996, respectively.
Components of other noninterest expense exceeding one percent of revenues
for any of the years in the three-year period ended December 31, 1998,
included professional fees of $254,981, $155,635, and $225,036 in 1998,
1997, and 1996, respectively. Also included were marketing expenses of
$184,512, $221,504, and $191,553 in 1998, 1997, and 1996, respectively;
rental property expenses of $238,570, $239,192, and $236,206 in 1998, 1997,
and 1996, respectively; and, MasterCard and Visa processing fees of
$371,361, $254,863, and $231,432 in 1998, 1997, and 1996, respectively.
-69-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
(17) Parent Company Financial Information
The condensed financial information for Auburn National Bancorporation,
Inc. (Parent Company Only) is presented as follows:
<TABLE>
<CAPTION>
Parent Company Only
Condensed Balance Sheets
December 31, 1998 and 1997
Assets 1998 1997
------------------ --------------------
<S> <C> <C>
Cash and due from banks $ 170,713 474,460
Investment securities 642,228 693,221
Investment in bank subsidiary 26,506,602 23,280,149
Premises and equipment, net 44,346 68,194
Rental property 1,760,294 1,807,359
Other assets 152,346 154,238
------------------ --------------------
Total assets $ 29,276,529 26,477,621
================== ====================
Liabilities and Stockholders' Equity
Other borrowed funds $ 242,453 262,589
Accrued expenses and other liabilities 90,580 110,691
Employee Stock Ownership Plan debt -- 56,934
------------------ --------------------
Total liabilities 333,033 430,214
------------------ --------------------
Stockholders' equity:
Preferred stock of $.01 par value; authorized
200,000 shares; issued shares - none -- --
Common stock of $.01 par value; authorized
8,500,000 shares; issued 3,957,135
shares at December 31, 1998 and 1997 39,571 39,571
Additional paid-in capital 3,707,472 3,707,472
Retained earnings 25,077,126 22,396,461
Accumulated other comprehensive income 333,926 175,436
Less:
Employee Stock Ownership Plan debt -- (56,934)
Treasury stock, 10,854 shares in 1998 and 1997,
at cost (214,599) (214,599)
------------------ --------------------
Total stockholders' equity 28,943,496 26,047,407
------------------ --------------------
Total liabilities and stockholders' equity $ 29,276,529 26,477,621
================== ====================
</TABLE>
-70-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Parent Company Only
Condensed Statements of Earnings
Years Ended December 31, 1998, 1997, and 1996
1998 1997 1996
------------------ ------------------ -------------------
<S> <C> <C> <C>
Income:
Cash dividends from bank subsidiary $ 385,000 697,000 265,000
Interest on interest-earning deposits -- -- 7,306
Interest on investment securities:
Taxable 1,764 3,822 3,453
Tax-exempt 34,982 37,765 43,258
------------------ ------------------ -------------------
Total interest on investment
securities 36,746 41,587 46,711
------------------ ------------------ -------------------
Other income 640,358 612,970 819,286
------------------ ------------------ -------------------
Total income 1,062,104 1,351,557 1,138,303
------------------ ------------------ -------------------
Expense:
Interest on borrowed funds 19,347 22,450 26,197
Net occupancy expense 24,819 24,218 25,368
Salaries and benefits 332,685 357,186 322,750
Other 341,021 331,948 369,930
------------------ ------------------ -------------------
Total expense 717,872 735,802 744,245
------------------ ------------------ -------------------
Earnings before income tax
expense (benefit) and equity in
undistributed earnings (loss) of
subsidiaries 344,232 615,755 394,058
Applicable income tax expense (benefit) (27,222) (35,924) 10,917
------------------ ------------------ -------------------
Earnings before equity in
undistributed earnings (loss) of
subsidiaries 371,454 651,679 383,141
Equity in undistributed earnings (loss) of subsidiaries:
Bank 3,067,963 2,429,787 2,370,686
Other -- (1,423) (473)
------------------ ------------------ -------------------
Net earnings $ 3,439,417 3,080,043 2,753,354
================== ================== ===================
</TABLE>
-71-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Parent Company Only
Condensed Statements of Cash Flows
Years Ended December 31, 1998, 1997, and 1996
1998 1997 1996
---------------- --------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 3,439,417 3,080,043 2,753,354
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 119,007 116,919 124,980
Amortization of premium on investment
securities held to maturity -- -- 391
Net undistributed earnings of subsidiaries (3,067,963) (2,428,364) (2,370,213)
Decrease (increase) in other assets 1,892 142,437 (191,004)
(Decrease) increase in other liabilities (20,111) 18,740 17,929
---------------- --------------- ---------------
Net cash provided by operating activities 472,242 929,775 335,437
---------------- --------------- ---------------
Cash flows from investing activities:
Proceeds from paydowns of investment
securities held to maturity 5,993 9,554 11,155
Proceeds from calls of investment securities 45,000
held to maturity 45,000 95,000
Purchase of premises and equipment -- (83,488) --
Proceeds from sale of premises and equipment -- 47,444 11,554
Purchase of rental property (48,094) (1,978) (35,746)
---------------- --------------- ---------------
Net cash provided by investing activities 2,899 16,532 81,963
---------------- --------------- ---------------
Cash flows from financing activities:
Decrease in other borrowed funds (20,136) (20,749) (20,800)
Proceeds from sale of treasury stock -- 140,812 22,498
Purchase of treasury stock -- (8,648) (221,141)
Dividends paid (758,752) (626,562) (560,284)
---------------- --------------- ---------------
Net cash used in financing activities (778,888) (515,147) (779,727)
---------------- --------------- ---------------
Net (decrease) increase in cash and cash
equivalents (303,747) 431,160 (362,327)
Cash and cash equivalents at beginning of year 474,460 43,300 405,627
---------------- --------------- ---------------
Cash and cash equivalents at end of year $ 170,713 474,460 43,300
================ =============== ===============
</TABLE>
-72-
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Auburn, State of Alabama, on the 26th day of March,
1999.
AUBURN NATIONAL BANCORPORATION, INC.
(Registrant)
By: /s/ E. L. SPENCER, JR.
---------------------------
E. L. Spencer, Jr.
President
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Title Date
--------- ----- ----
/s/ E. L. SPENCER, JR. President, CEO and March 26, 1999
- ------------------------------ Director
E. L. Spencer, Jr.
/s/ LINDA D. FUCCI Chief Financial Officer March 26, 1999
- ------------------------------ and Chief Accounting
Linda D. Fucci Officer
/s/ TERRY W. ANDRUS Director March 26, 1999
- ------------------------------
Terry W. Andrus
/s/ ANNE M. MAY Director March 26, 1999
- ------------------------------
Anne M. May
/s/ EMIL F. WRIGHT, JR. Director March 26, 1999
- ------------------------------
Emil F. Wright, Jr.
-73-
<PAGE>
AUBURN NATIONAL BANCORPORATION, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Page
------ ----------- -------------
<S> <C> <C>
3.A. Certificate of Incorporation of Auburn National Bancorporation, Inc. * -
3.B. Bylaws of Auburn National Bancorporation, Inc. * -
4. Instruments Defining the Rights of Security Holders (See Certificate of
Incorporation and Bylaws). * -
10.A. Auburn National Bancorporation, Inc. 1994 Long-Term Incentive Plan. * -
10.B. Lease and Equipment Purchase Agreement, dated September 15, 1987. * -
21. Subsidiaries of Registrant 75
23. Consent of Accountants 76
27. Financial Data Schedule 77
</TABLE>
- ----------------------
* Incorporated by reference from Registrant's Registration Statement on Form
SB-2 (File No. 33-86180).
-74-
<PAGE>
Exhibit 21
AUBURN NATIONAL BANCORPORATION INC AND SUBSIDIARY
EXHIBIT 21 - SUBSIDIARIES
AuburnBank
<PAGE>
Exhibit 23
AUBURN NATIONAL BANCORPORATION INC AND SUBSIDIARY
EXHIBIT 23 - CONSENT OF ACCOUNTANTS
The Board of Directors
Auburn National Bancorporation, Inc.
We consent to the incorporation by reference in the registration statement (No.
333-03516) on Form S-3 of Auburn National Bancorporation, Inc. of our report
dated February 4, 1999, relating to the consolidated balance sheets of Auburn
National Bancorporation, Inc. and subsidiary as of December 31, 1998 and 1997,
and the consolidated statements of earnings, stockholders' equity and
comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 1998, which report appears in the December 31, 1998
annual report on Form 10-KSB of Auburn National Bancorporation, Inc.
KPMG LLP
Atlanta, Georgia
March 26, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 10-KSB
FOR DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 9,220
<INT-BEARING-DEPOSITS> 134
<FED-FUNDS-SOLD> 260
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 63,586
<INVESTMENTS-CARRYING> 8,094
<INVESTMENTS-MARKET> 8,227
<LOANS> 218,687
<ALLOWANCE> 2,808
<TOTAL-ASSETS> 307,874
<DEPOSITS> 233,505
<SHORT-TERM> 12,944
<LIABILITIES-OTHER> 1,482
<LONG-TERM> 31,000
0
0
<COMMON> 40
<OTHER-SE> 28,903
<TOTAL-LIABILITIES-AND-EQUITY> 307,874
<INTEREST-LOAN> 17,468
<INTEREST-INVEST> 3,896
<INTEREST-OTHER> 356
<INTEREST-TOTAL> 21,720
<INTEREST-DEPOSIT> 9,557
<INTEREST-EXPENSE> 11,189
<INTEREST-INCOME-NET> 10,531
<LOAN-LOSSES> 891
<SECURITIES-GAINS> 14
<EXPENSE-OTHER> 6,838
<INCOME-PRETAX> 5,281
<INCOME-PRE-EXTRAORDINARY> 5,281
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,439
<EPS-PRIMARY> 0.88
<EPS-DILUTED> 0.88
<YIELD-ACTUAL> 3.96
<LOANS-NON> 4,593
<LOANS-PAST> 304
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 2,654
<ALLOWANCE-OPEN> 2,125
<CHARGE-OFFS> 314
<RECOVERIES> 106
<ALLOWANCE-CLOSE> 2,808
<ALLOWANCE-DOMESTIC> 2,808
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
