<PAGE>
SECURITIES AND EXCHANGE COMMISSION SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 1996 Commission File Number: 0-24626
-----------
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Transition Period from _________________ to ________________
COOPERATIVE BANKSHARES, INC.
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(Exact name of registrant as specified in its charter)
North Carolina 56-1886527
- --------------------------------------------- ----------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
201 Market Street, Wilmington, North Carolina 28401
- --------------------------------------------- ----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (910) 343-0181
----------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
---------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. YES X NO .
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of February 7, 1997, the aggregate market value of the voting stock held by
non-affiliates of the registrant, based on the closing sales price of the
registrant's common stock as quoted on the National Association of Securities
Dealers, Inc. Automated Quotation National Market was $21,278,836 (1,037,992
shares at $20.50 per share). For purposes of this calculation, directors,
executive officers and beneficial owners of more than 5% of the registrant's
outstanding voting stock are treated as affiliates.
As of February 7, 1997 there were issued and outstanding 1,491,698 shares of the
registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended December
31, 1996. (Parts I and II)
2. Portions of Proxy Statement for the 1997 Annual Meeting of Stockholders.
(Part III)
<PAGE>
PART I
ITEM 1. BUSINESS
-----------------
GENERAL
THE COMPANY. Cooperative Bankshares, Inc. (the "Company") is a
registered savings bank holding company incorporated in North Carolina in
1994. The Company was formed for the purpose of serving as the holding
company for Cooperative Bank for Savings, Inc., SSB ("Cooperative Bank" or the
"Bank"), a North Carolina chartered savings bank. The Company's primary
activities consist of holding the stock of Cooperative Bank and operating the
business of the Bank. Accordingly, the information set forth in this report,
including financial statements and related data, relates primarily to
Cooperative Bank.
In December 1993, Cooperative Bank's Board of Directors approved a change
in the Bank's fiscal year end from March 31 to December 31. Accordingly, the
financial information in this report includes information for the nine-month
transition period ended December 31, 1994.
COOPERATIVE BANK. Cooperative Bank was organized as a North Carolina-
chartered building and loan association in 1898. The Bank has been a member
of the Federal Home Loan Bank System since 1933 and its deposits have been
federally insured since 1940. In August 1991, the Bank converted to a North
Carolina-chartered stock savings and loan association and on October 1, 1992,
the Bank converted from a North Carolina-chartered savings and loan
association to a North Carolina-chartered stock savings bank. The Bank's
deposit accounts are insured up to applicable limits by the Federal Deposit
Insurance Corporation ("FDIC"). At December 31, 1996, Cooperative Bank had
total assets of $341.3 million, deposits of $278.1 million and stockholders'
equity of $25.5 million.
The Bank is chartered under the laws of the state of North Carolina to
engage in general banking business. Cooperative Bank offers a wide range of
retail banking services including deposit services, banking cards and
alternative investments products. These funds are used for the extension of
credit through mortgage loans, savings account loans and other installment
credit such as home equity, auto and boat loans and check reserve.
Cooperative Bank conducts its operations through its main office in
Wilmington, North Carolina and 16 offices throughout eastern North Carolina.
The Bank's executive offices are located at 201 Market Street, Wilmington,
North Carolina 28401 and its telephone number is (910) 343-0181. The Bank
considers its primary market for deposits and lending activities to be the
communities of eastern North Carolina, extending from the Virginia to the
South Carolina borders.
Since opening its first branch office in 1954, the Bank has pursued a
strategy of steady, moderate growth through the promotion of banking services
in eastern North Carolina. In 1983, the Bank acquired Seaboard Savings and
Loan Association, a state-chartered stock savings association with assets of
approximately $60 million and with four offices located in northeastern North
Carolina, and thereby extended its market area to the northern border of North
Carolina.
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MARKET AREA
Cooperative Bank considers its primary market area to be the communities
of eastern North Carolina extending from the Virginia to the South Carolina
borders. The market is generally segmented into the coastal communities and
the inland areas. The economies of the coastal communities (concentrated in
Dare, Carteret, Currituck, Onslow, Pender, New Hanover and Brunswick Counties)
are seasonal and largely dependent on the summer tourism industry. The
economy of Wilmington (the largest city in the market area), a historic
seaport with a population of approximately 60,000, is also reliant upon summer
tourism but is diversified into the chemicals, shipping, aircraft engines,
nuclear fuels, and fiber optics industries. Wilmington also serves as a
regional retail center. The inland communities served by the Bank
(concentrated in Bladen, Brunswick, Columbus, Duplin, Hyde, Martin, Beaufort
and Pender Counties) are largely service areas for the agricultural activities
in eastern North Carolina.
LENDING ACTIVITIES
GENERAL. Cooperative Bank's lending activities are concentrated on the
origination of conventional mortgage loans for the purpose of constructing,
financing or refinancing one- to four family residential properties. As of
December 31, 1996, $258.7 million, or 93.2%, of the Bank's loan portfolio
consisted of loans secured by one-to-four family residential properties. At
that date, approximately 96.0% of the Bank's total loan portfolio consisted of
loans secured by residential real estate. To a lesser extent, the Bank
originates multi-family and nonresidential real estate loans, home equity
lines of credit loans and consumer loans. While continuing to place primary
emphasis on residential mortgage loans, the Bank has recently reactivated its
nonresidential real estate lending, involving loans secured by small
commercial properties with balances generally ranging from $100,000 to
$500,000. See " -- Loans Secured by Nonresidential Real Estate." The Bank's
primary emphasis is to originate adjustable rate loans with the fixed rate
loan as an option. As of December 31, 1996, before the loan loss reserve,
adjustable rate loans totaled $182.8 million, or 69.2%, and fixed rate loans
totaled $81.3 million, or 30.8%, of the Bank's total net loan portfolio.
2
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ANALYSIS OF LOAN PORTFOLIO. Set forth below is selected data relating to
the composition of the Bank's loan portfolio by type of loan and type of
security on the dates indicated.
<TABLE>
<CAPTION>
At December 31, At March 31,
------------------------------------------------------- --------------------------------------
1996 1995 1994 1994 1993
----------------- ----------------- ----------------- ------------------ ------------------
Amount % Amount % Amount % Amount % Amount %
-------- ------- -------- ------- -------- ------- --------- ------- --------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans secured by real
estate:
1-4 family residential
properties..................... $226,765 86.12% $203,577 87.00% $208,510 86.81% $186,165 86.39% $180,277 87.75%
Multi-family (5 or more)
residential
properties.................... 4,959 1.88 5,185 2.21 5,216 2.17 4,350 2.02 3,958 1.93
Nonresidential property......... 5,205 1.98 7,145 3.05 5,446 2.27 6,956 3.23 7,653 3.73
1-4 family residential
properties under
construction.................. 23,152 8.79 17,684 7.56 28,962 12.06 26,441 12.27 15,841 7.71
Multi-family (5 or more)
residential property
under construction............ 267 .10 -- -- -- -- -- -- -- --
Nonresidential properties under
construction................... 752 .29 698 .30 250 .10 370 .17 500 .24
Installment loans secured by real
estate:
1-4 family residential
properties (1)................. 8,820 3.35% 5,368 2.29 5,355 2.23 4,839 2.24 4,635 2.25
Multi-family (5 or more)
residential properties......... 212 .08 -- -- -- -- -- -- -- --
Nonresidential property......... 475 .18 -- -- -- -- -- -- -- --
1-4 family residential
properties under
construction.................. -- -- -- -- -- -- -- -- -- --
Multi-family (5 or more)
residential property
under construction............ 2,400 .91 -- -- -- -- -- -- -- --
Consumer loans, secured and
unsecured........................ 3,564 1.35 3,351 1.43 1,593 .66 1,428 .66 1,453 .71
Business loans, secured and
unsecured........................ 510 .19 -- -- -- -- -- -- -- --
Business and consumer loans,
secured and unsecured
under construction.............. 525 .20 -- -- -- -- -- -- -- --
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans................ 277,606 105.42 243,008 103.84 255,332 106.30 230,549 106.98 214,317 104.32
Less:
Undisbursed portion of
construction loans............. 12,205 4.63 6,958 2.97 12,830 5.34 12,954 6.01 7,107 3.47
Discounts and other............. 1,281 .49 1,305 .56 1,571 .65 1,361 .63 1,057 .51
Loan loss reserve............... 807 .30 737 .31 737 .31 737 .34 707 .34
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total....................... $263,313 100.00% $234,008 100.00% $240,194 100.00% $215,497 100.00% $205,446 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
</TABLE>
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(1) Includes residential 1-4 family home equity loans.
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RESIDENTIAL REAL ESTATE LOANS. The Bank's primary lending activity consists
of the origination of one-to four family residential mortgage loans secured by
property located in its market area. While a majority of the Bank's residential
real estate loans are secured by owner-occupied primary residences, the Bank's
portfolio also includes some second home and investor properties. The Bank also
originates residential lot loans secured by vacant lots located in approved
subdivisions.
The Bank's loan originations are generally for a term of 15 to 30 years,
amortized on a monthly basis, with principal and interest due each month.
Residential real estate loans often remain outstanding for significantly shorter
periods than their contractual terms. Borrowers may refinance or prepay loans
at their option.
The Bank has offered adjustable rate mortgage loans ("ARMs") since 1979 and
presently offers one year ARMs with rate adjustments tied to prime or the weekly
average yield on U.S. Treasury Securities adjusted to a constant maturity of one
year. The Bank offers introductory interest rates on ARMs which are not fully
indexed. The interest rates on these loans generally include a cap of 2% per
adjustment and 6% over the life of the loan. The Bank's underwriting policies
require that the borrower qualify for an ARM at the fully indexed rate. While
the proportion of fixed and adjustable rate loan originations in the Bank's
portfolio largely depends on the level of interest rates, the Bank has strongly
emphasized ARMs in recent years and has been relatively successful in
maintaining the level of one year ARM originations even during periods of
declining interest rates. In addition to the one year ARM, the Bank offers 3/1
and 5/1 ARM products. These loans adjust annually after the end of the first
three or five year period. A non-conforming fixed rate loan is offered at a
rate that is 1/2% higher than the conforming fixed rate loan. A "Low Doc"
program is available for the non-conforming loans.
Cooperative Bank also originates 15 to 30 year fixed rate mortgage loans on
one- to four-family units. The Bank generally charges a higher interest rate on
such loans if the property is not owner-occupied. The majority of fixed rate
loans are underwritten according to Federal Home Loan Mortgage Corporation
("FHLMC") or Federal National Mortgage Association ("FNMA") guidelines, so that
the loans qualify for sale in the secondary market. The Bank has sold fixed
rate loans in the secondary market from time to time when such sales were
consistent with the Bank's liquidity and asset/liability goals.
The Bank actively lends on the security of properties located in the Outer
Banks region of North Carolina. This region's economic base is seasonal and
driven by beach tourism, and a large number of the loans made by the Bank in
this area are secured by vacation rental properties. These loans are inherently
more risky than loans secured by the borrower's permanent residence, since the
borrower is typically dependent upon rental income to meet debt service
requirements, and repayment is therefore subject to a greater extent to adverse
economic, weather and other conditions affecting vacation rentals. Management
seeks to minimize these risks by employing what it believes are conservative
underwriting criteria.
The Bank's lending policies generally limit the maximum loan-to-value ratio on
conventional residential mortgage loans to 95% of the lesser of the appraised
value or purchase price, with the condition that private mortgage insurance is
required on loans with loan-to-value ratios in excess of 80%.
Cooperative Bank also originates loans secured by multi-family properties. At
December 31, 1996, the Bank had $7.8 million of such loans, representing 2.8% of
its mortgage loan portfolio. These loans are primarily secured by apartment
buildings located in the Bank's market area.
CONSTRUCTION LOANS. The Bank originates loans to finance the construction of
one- to four and multi-family dwellings, housing developments and condominiums.
Construction loans amounted to approximately $27.1 million, or 9.8%, of the
Bank's total loan portfolio at December 31, 1996. In recent years, the Bank has
emphasized the origination of construction loans in response to the significant
demand for such loans by borrowers engaged in building and development
activities in the growing communities of its market area. Substantially all of
the Bank's construction loans are structured to be converted to permanent loans
at the end of the construction phase. At the time the loan is converted to a
permanent loan and assumed by the ultimate purchaser, the Bank underwrites the
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creditworthiness of the ultimate purchaser prior to approving the assumption,
when the original borrower is released from liability. Construction/permanent
loans have either fixed or adjustable rates and have terms of up to 30 years.
Occasionally, the Bank will make short term construction loans which have fixed
rates and terms of up to 12 months. These loans are generally made in amounts
up to 80% of appraised value. Loan proceeds generally are disbursed in
increments as construction progresses and as inspections warrant.
Construction loans afford the Bank the opportunity to increase the interest
rate sensitivity of its loan portfolio. The Bank's risk of loss on a
construction loan is largely dependent upon the accuracy of the initial estimate
of the property's value at completion of construction and the bid price
(including interest) of construction. If the estimate of construction costs
proves to be inaccurate, the Bank may be required to advance funds beyond the
amount originally committed to permit completion of the project. If the
estimate of the value proves to be inaccurate, the Bank may be confronted, at or
prior to the maturity of the loan, with a project whose value is insufficient to
assure full repayment.
The Bank's underwriting criteria are designed to evaluate and minimize the
risks of each construction loan. Among other things, the Bank considers the
reputation of the borrower and the contractor, the amount of the borrower's
equity in the project, independent valuations and reviews of cost estimates,
pre-construction sale and leasing information, and cash flow projections of the
borrower. In addition, the Bank reviews the builder's current financial
reports, tax returns, credit reports and, if the builder has not previously
borrowed from Cooperative Bank, credit references. The Bank only makes
construction loans within its primary market area.
The Bank has in the past originated loans for the acquisition and development
of unimproved property to be used for residential purposes. Land development
lending is generally considered to involve a higher level of credit risk than
one- to four family residential lending due to the concentration of principal in
a limited number of loans and borrowers and the effects of general economic
conditions on development projects.
The following table sets forth certain information as of December 31, 1996
regarding the dollar amount of construction loans secured by real estate and
real estate mortgage loans maturing in the Bank's portfolio based on their
contractual terms to maturity. The majority of these loans have provisions to
convert to permanent loans upon completion of construction. For further
information, see Note 5 of Notes to Consolidated Financial Statements included
in the Company's Annual Report to Stockholders for the Fiscal Year Ended
December 31, 1996 (the "Annual Report").
<TABLE>
<CAPTION>
Due During the
Year Ended
December 31,
1997
---------------
(In thousands)
<S> <C>
Real estate - construction
Residential........................... $25,819
Nonresidential........................ 752
Business and Industrial............... 525
-------
Total.............................. $27,096
=======
</TABLE>
LOANS SECURED BY NONRESIDENTIAL REAL ESTATE. Loans secured by nonresidential
real estate constituted approximately $6.4 million, or 2.3%. of the Bank's total
mortgage loans at December 31, 1996. The Bank originates both construction
loans and permanent loans on nonresidential properties. Nonresidential real
estate loans are generally made in amounts up to 75% of the lesser of appraised
value or purchase price of the property and have generally been made in amounts
under $2.0 million. The Bank's permanent nonresidential real estate loans are
secured by improved property such as office buildings, retail centers,
warehouses, and other types of buildings located in the Bank's primary market
area. Nonresidential real estate loans are either fixed or variable rate. The
variable
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rate loans have interest rates tied to prime or the weekly average yield on U.S.
Treasury Securities adjusted to a constant maturity of one year.
Loans secured by nonresidential properties are generally larger and involve
greater risks than residential mortgage loans. Because payments on loans
secured by nonresidential properties are often dependent on successful operation
or management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Bank seeks to minimize these risks in a variety of ways, including limiting
the size of its nonresidential real estate loans, generally restricting such
loans to its primary market area and attempting to employ conservative
underwriting criteria.
CONSUMER LENDING. At December 31, 1996, the Bank's consumer loan portfolio
totaled approximately $3.6 million, representing 1.3% of the Bank's total net
loans receivable. Approximately $2.3 million was secured by the borrower's
savings deposits. Other consumer loans including automobile, home improvement,
boat and personal loans totaled approximately $1.3 million as of December 31,
1996. The Bank also offers home equity loans, which are made for terms of up to
15 years at adjustable interest rates. As of December 31, 1996, the Bank's home
equity loan portfolio totaled approximately $6.1 million, representing 2.2% of
its total loans receivable.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciable assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not
warrant further substantial collection efforts against the borrower. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Such loans may also give rise to claims and defenses by a consumer loan borrower
against an assignee of such loans such as the Bank, and a borrower may be able
to assert against such assignee claims and defenses which it has against the
seller of the underlying collateral.
NON-REAL ESTATE BUSINESS LENDING. In late 1996, the Bank initiated a program
for originating loans to small businesses in the Bank's market area which are
secured by various forms of non-real estate collateral or are unsecured. At
December 31, 1996, shortly following commencement of the program, these loans
totaled approximately $1.0 million, approximately $250,000 of which are
unsecured loans and the remainder of which are secured by various forms of
collateral, including savings accounts with the Bank. Management of Cooperative
Bank believes that these loans are attractive to the Bank in light of the
typically higher interest rate yields associated with them and the opportunity
they present for expanding the Bank's relationships with existing customers and
developing broader relationships with new customers. Accordingly, the Bank
plans to actively pursue this type of lending in the future in an effort to
maintain a profitable spread between the Bank's average loan yield and its cost
of funds.
Unlike residential mortgage loans, which generally are made on the basis of
the borrower's ability to make repayment from his or her employment and other
income and which are secured by real property whose value tends to be more
easily ascertainable, commercial business loans are of higher risk and typically
are made on the basis of the borrower's ability to make repayment from the cash
flow of the borrower's business. As a result, the availability of funds for the
repayment of commercial business loans may be substantially dependent on the
success of the business itself. Further, the collateral securing the loans may
depreciate over time, may be difficult to appraise and may fluctuate in value
based on the success of the business. Management of Cooperative Bank will seek
to minimize these risks as the Bank's commercial business loan portfolio grows
by attempting to employ conservative underwriting criteria.
LOAN SOLICITATION AND PROCESSING. Loan originations are derived from a number
of sources, including "walk-in" customers at the Bank's offices and
solicitations by Cooperative Bank employees. The Bank also has agreements with
third party solicitors who provide loan applications to the Bank.
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Loan applications are accepted at all full-service branches, and are reviewed
by a loan officer or branch manager. Upon receipt of a loan application,
central processing orders a credit report and verifications to verify specific
information relating to the applicant's employment, income and credit standing.
An appraisal of the real estate intended to secure the proposed loan is
undertaken by an internal appraiser or an outside appraiser approved by the
Bank. In the case of "Low Doc" loans a tax evaluation is acceptable.
Loan authorities and limits have been delegated by the Board of Directors to a
group of senior officers who function as the loan committee, except for consumer
loans, which may be approved by branch loan officers. Any loan exceeding
$700,000 is approved by the Bank's Board of Directors. Fire and casualty
insurance is required on all loans secured by improved real estate.
ORIGINATIONS, PURCHASES, AND SALES OF MORTGAGE LOANS. The Bank's general
policy is to originate loans under terms, conditions and documentation which
permit sale to the FHLMC, FNMA or private investors in the secondary market.
The Bank has from time to time sold fixed rate, long term mortgage loans in the
secondary market to meet liquidity requirements or as part of the
asset/liability management program. In connection with such sales, the Bank
generally retains the servicing of the loans (i.e., collection of principal and
interest payments), for which it generally receives a fee payable monthly of up
to 3/8% per annum of the unpaid balance of each loan. As of December 31, 1996,
the Bank was servicing approximately 1,700 loans for others aggregating
approximately $63 million.
The Bank does not generally purchase loans, and purchased no loans during the
last three fiscal years.
LOAN COMMITMENTS. The Bank issues loan origination commitments to qualified
borrowers primarily for the construction and purchase of residential real
estate. Such commitments are made on specified terms and conditions and are
typically for terms of up to 30 days. A non-refundable appraisal, flood
certificate and credit report fee is collected at the time of application.
Management estimates that historically, less than 20% of such commitments expire
unfunded. At December 31, 1996, the Bank had outstanding loan origination
commitments of approximately $12.9 million. For further information, see Note 5
of Notes to Consolidated Financial Statements included in the Annual Report.
LOAN ORIGINATION AND OTHER FEES. In addition to receiving interest at the
stated rate on loans, the Bank receives loan origination fees or "points" for
originating loans. Origination fees generally are calculated as a percentage of
the principal amount of the mortgage loan and are charged to the borrower for
creation of the loan account. Loan-origination fees and certain direct loan
origination costs are deferred, and the net fee or cost is recognized as an
adjustment to interest income over the contractual life of the related loan.
Loan origination and commitment fees are volatile sources of funds. Such fees
vary with the volume and type of loans and commitments made and purchased and
with competitive conditions in mortgage markets, which in turn respond to the
demand for and availability of money.
The Bank also recognizes other fees and service charges on loans. Other fees
and service charges consist of late fees, fees collected with a change in
borrower or other loan modifications.
DELINQUENCIES. The Bank's collection procedures provide that when a loan is
30 days past due, the borrower is contacted by mail, and payment is requested.
If the delinquency continues, subsequent efforts are made to contact the
borrower. If the loan continues in a delinquent status for 60 days or more,
the Bank generally initiates legal proceedings. At December 31, 1996, the Bank
owned approximately $42,000, net of valuation reserves, of property acquired as
the result of foreclosure or by deed in lieu of foreclosure and classified as
"real estate owned."
NON-PERFORMING ASSETS AND ASSET CLASSIFICATION. Loans are reviewed on a
regular basis and are placed on a non-accrual status when, in the opinion of
management, the collection of additional interest is doubtful. As of
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December 31, 1996, the Bank had seven single family loans in non-accrual status
totaling $787,000. Subsequent to December 31, 1996, three of these loans were
brought current and transferred to a new borrower, reducing the balance of non-
accrual loans to approximately $475,000.
Real estate acquired by the Bank as a result of foreclosure is classified as
real estate owned until such time as it is sold. When such property is
acquired, it is recorded at the lower of the unpaid principal balance plus
unpaid accrued interest of the related loan or its fair value. Any required
write-down of the loan to its fair market value is charged to the allowance for
loan losses. At December 31, 1996, the Bank had 12 loans in the process of
foreclosure and/or bankruptcy with a principal balance of approximately
$731,000.
The following table sets forth information with respect to the Bank's non-
performing assets for the periods indicated. During the periods shown, the Bank
had no restructured loans within the meaning of Statement of Financial
Accounting Standards ("SFAS") No. 15.
<TABLE>
<CAPTION>
At December 31, At March 31,
-------------------------- ---------------
1996 1995 1994 1994 1993
------- -------- ------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Residential real estate............... $ 787 $ 242 $ -- $ -- --
Accruing loans which are contractually
past due 90 days or more:
Real Estate:
Residential......................... 657 198 29 44 88
Nonresidential...................... 8 3 1 -- 12
------ ----- ----- ----- ------
Total............................ $1,452 $ 443 $ 30 $ 44 $ 100
====== ===== ===== ===== ======
Percentage of total loans............... .52% .18% .01% .02% .05%
====== ===== ===== ===== ======
Other non-performing assets (1)......... $ 42 $ 329 $ 462 $ 898 $2,536
====== ===== ===== ===== ======
Non-performing assets to total assets... .02% .25% .15% .30% .86%
====== ===== ===== ===== ======
</TABLE>
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(1) Other non-performing assets represents property acquired by the Bank
through foreclosure or repossession. This property is carried at fair
value less estimated costs of sale.
Except as set forth above, the Bank had no loans which were not classified as
non-accrual, 90 days past due or restructured but which may be so classified in
the near future because management has concerns as to the ability of borrowers
to comply with repayment terms. For further information, see Note 1d of Notes
to Consolidated Financial Statements in the Annual Report.
ALLOWANCE FOR LOAN LOSSES. In establishing the appropriate levels for the
provision and the allowance for possible loan losses, management considers a
variety of factors, in addition to the fact that an inherent risk of loss always
exists in the lending process. Consideration is given to, among other things,
the current and future impact of economic conditions, the diversification of the
loan portfolio, historical loss experience, the review of loans by the loan
review personnel, the individual borrower's financial and managerial strengths,
and the adequacy of underlying collateral. Consideration is also given to
examinations performed by regulatory authorities and the Bank's independent
certified public accountants.
8
<PAGE>
The following table analyzes activity in the Bank's allowance for possible
loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended Nine Months Years Ended
December 31, Ended March 31,
--------------------- December 31, --------------------
1996 1995 1994 1994 1993
--------- --------- ------------ --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
period.................... $ 737 $ 737 $ 737 $ 707 $ 682
Provision for possible
loan losses............... 156 3 -- 30 140
Loans charged-off.......... 86 3 -- -- 115
----- ----- ----- ----- -----
Balance at end of period... $ 807 $ 737 $ 737 $ 737 $ 707
===== ===== ===== ===== =====
Ratio of net charge-offs
to average loans
outstanding during the
period.................... .03% .001% --% --% .05%
===== ===== ===== ===== =====
Ratio of loan loss reserve
to total loans............ .29% .31% .31% .34% .33%
===== ===== ===== ===== =====
</TABLE>
Management believes that it has established the Bank's existing allowance for
loan losses in accordance with generally accepted accounting principles.
Additions to the allowance may be necessary, however, due to changes in economic
conditions, real estate market values, growth in the portfolio, and other
factors. In addition, bank regulators may require Cooperative Bank to make
additional provisions for losses in the course of their examinations based on
their judgments as to the value of the Bank's assets.
INVESTMENT ACTIVITIES. The Bank is required under applicable regulations to
maintain liquid assets equal to at least 10% of its total assets. For purposes
of this requirement, liquid assets consist of cash and readily marketable
investments. Cooperative Bank has generally maintained a liquidity portfolio in
excess of regulatory requirements. Liquidity levels may be increased or
decreased depending upon the yields on investment alternatives and upon
management's judgment as to the attractiveness of the yields then available in
relation to other opportunities and its expectation of the level of yield that
will be available in the future, as well as management's projections as to the
short term demand for funds to be used in the Bank's loan origination and other
activities.
The following table sets forth the carrying value of the Bank's investment
portfolio at the dates indicated. For additional information regarding the
Bank's investments, see Notes 2 and 3 of Notes to Consolidated Financial
Statements in the Annual Report.
<TABLE>
<CAPTION>
At December 31,
-------------------------
1996 1995 1994
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Interest-bearing deposits......................... $ 9,084 $ 8,203 $ 586
Securities:
Available for sale - at estimated market value.. 5,946 -- 13,766
Held to maturity................................ 21,054 21,063 21,073
Mortgage-backed and related securities:
Available for sale - at estimated market value.. 28,825 30,907 16,876
Held to maturity................................ -- -- 14,781
------- ------- -------
Total....................................... $64,909 $60,173 $67,082
======= ======= =======
</TABLE>
9
<PAGE>
From time to time, the Bank purchases mortgage-backed and related securities
guaranteed by the FHLMC, the Government National Mortgage Association ("GNMA")
or the FNMA. FHLMC and FNMA mortgage-backed securities are participation
certificates issued and guaranteed by the FHLMC or the FNMA which represent
interests in pools of conventional mortgages originated by savings institutions.
GNMA mortgage-backed securities are participation certificates issued and
guaranteed by the GNMA which represent interests in pools of mortgages insured
by the Federal Housing Administration or partially guaranteed by the Veterans
Administration. GNMA obligations are backed by the full faith and credit of the
United States. At December 31, 1996, the Bank held mortgage-backed securities,
classified as available for sale, with an amortized cost of approximately $29.4
million, which represented 8.6% of the Bank's total assets. At that date, the
estimated aggregate market value and carrying value of the mortgage-backed
securities was $28.8 million. Mortgage-backed securities increase the quality
of the Bank's assets by virtue of the insurance and guarantees that back them,
their greater degree of liquidity over individual mortgage loans, and their
capacity to be used to collateralize borrowings or other obligations of the
Bank. However, a portion of the Bank's mortgage-backed securities are long
term, fixed rate instruments and, in a rising interest rate environment, the
market value of such securities will decline. For further information regarding
the Bank's mortgage-backed securities portfolio, see "Management's Discussion &
Analysis" and Note 3 of Notes to Consolidated Financial Statements in the Annual
Report.
The Bank also invests in collateralized mortgage obligations ("CMOs"), which
are securities derived by reallocating the cash flows from mortgage-backed
securities or pools of mortgage loans in order to create multiple classes, or
tranches, of securities with coupon rates and average lives that differ from the
underlying collateral as a whole. Cooperative Bank invests in these securities
as an alternative to mortgage loans or mortgage-backed securities. See
"Management's Discussion & Analysis -- Liquidity" in the Annual Report.
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," requires that all
investments in debt securities and in equity securities that have readily
determinable fair values be classified into three categories. Debt securities
that management has the positive intent and ability to hold until maturity are
classified as held to maturity and are carried at amortized cost. Debt and
equity securities that are held principally to be sold in the near term are
classified as trading securities and are carried at market value. All other
securities are classified as available for sale and are carried at market value.
Unrealized holding gains and losses for available for sale securities are
reported as a separate component of stockholders' equity, net of related taxes.
For additional information regarding the Bank's investments, see Notes 2 and 3
of Notes to Consolidated Financial Statements in the Annual Report.
10
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Bank's investment portfolio at December
31, 1996.
<TABLE>
<CAPTION>
One Year One to Five to More than Total Investment
or Less Five Years Ten Years Ten Years Portfolio
---------------- ------------------ ------------------ ------------------ --------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Market Average
Value Yield Value Yield Value Yield Value Yield Value Value Yield
-------- -------- -------- -------- -------- -------- -------- -------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits. . $9,084 5.20% $ -- --% $ -- --% $ -- --% $ 9,084 $ 9,084 5.20%
U.S. government and
agency securities:
Available for sale...... . -- -- 5,946 6.12 -- -- -- -- 5,946 5,946 6.12
Held to maturity........ . -- -- -- -- 16,054 5.31 5,000 6.21 21,054 19,706 5.53
Mortgage-backed and related
securities:
Available for sale...... . -- -- 2,575 6.52 -- -- 26,250 6.77 28,825 28,825 6.75
Held to maturity........ . -- -- -- -- -- -- -- -- -- -- --
-------- -------- -------- -------- ------- -------
Total............... . $9,084 5.20% $8,521 6.24% $16,054 5.31% $31,250 6.68% $64,909 $63,561 6.08%
======== ======== ======== ======== ======= =======
</TABLE>
11
<PAGE>
SUBSIDIARY ACTIVITIES
As a North Carolina-chartered savings bank, the Bank is authorized to invest
up to 10% of its assets in subsidiary or service corporations engaged in
activities that are permissible to subsidiaries of federal savings associations.
Currently, subsidiaries of state-chartered savings banks generally may not
engage as principal in any activity that is not permissible for a subsidiary of
a national bank unless the FDIC determines that the activities do not pose a
significant risk to the appropriate insurance fund and the bank complies with
all applicable capital requirements.
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the major source of the Bank's funds for lending and
other investment purposes. In addition to deposits, Cooperative Bank derives
funds from interest payments, loan principal repayments, borrowed funds and
funds provided by operations. Scheduled loan repayments are a relatively stable
source of funds, while deposit inflows and outflows and loan prepayments are
significantly influenced by general interest rates and money market conditions.
Borrowings may be used on a short term basis to compensate for reductions in the
availability of funds from other sources. The Bank intends to fund its
activities primarily through deposits.
DEPOSITS. Deposits are attracted from within the Bank's primary market area
through the offering of a broad selection of deposit instruments including
checking, savings, money market deposit, and term certificate accounts
(including negotiated jumbo certificates in denominations of $100,000 or more)
as well as individual retirement plans. Deposit account terms vary according to
the minimum balance required, the time periods the funds must remain on deposit
and the interest rate, among other factors. The Bank does not obtain funds
through brokers, nor does it actively solicit funds outside of its primary
market area. For the various types of deposit accounts offered by the Bank and
the balances in these accounts at December 31, 1996, see Note 7 of Notes to
Consolidated Financial Statements in the Annual Report.
BORROWINGS. Deposits are the primary source of funds for Cooperative Bank's
lending and investment activities and for its general business purposes. If the
need arises, the Bank may obtain advances from the FHLB of Atlanta to supplement
its supply of loanable funds and to meet deposit withdrawal requirements.
Advances from the FHLB are typically secured by the Bank's stock in the FHLB and
a portion of the Bank's first mortgage loans. The Bank has utilized FHLB
advances in recent periods in order to meet a larger than typical loan demand in
the Bank's market area.
The FHLB of Atlanta functions as a central reserve bank providing credit for
the Bank and other member savings associations and financial institutions. As a
member, Cooperative Bank is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States), provided certain standards
related to creditworthiness have been met. Advances are made pursuant to
several different programs. Each credit program has its own interest rate and
range of maturities. Depending on the program, limitations on the amount of
advances are based either on a fixed percentage of a member institution's net
worth or on the FHLB's assessment of the institution's creditworthiness.
From time to time the Bank has borrowed funds under reverse repurchase
agreements and dollar rolls. Under a reverse repurchase agreement, the Bank
sells securities (generally government securities, mortgage-backed certificates
and FHLMC participation certificates) and agrees to repurchase them (or
substantially identical securities) at a specified price at a later date.
Reverse repurchase agreements are generally for terms of one week to one month,
are subject to renewal, and are deemed to be borrowings collateralized by the
securities sold. Generally, the cost of borrowed funds using reverse repurchase
agreements is less expensive than other borrowings with comparable terms.
Cooperative Bank had no reverse repurchase agreements or dollar rolls
outstanding during the fiscal year ended December 31, 1996. All reverse
repurchase agreements are contracted with registered broker-dealers. The dollar
rolls used by the Bank closely resemble reverse repurchase agreements, except
that with dollar rolls, the Bank agrees to repurchase securities similar to the
securities sold, rather than the same securities, as with reverse repurchase
agreements.
12
<PAGE>
For further information regarding the Bank's borrowings, see Note 8 of Notes
to Consolidated Financial Statements in the Annual Report.
The following tables set forth certain information regarding short term
borrowings by the Bank at the end of and during the periods indicated:
<TABLE>
<CAPTION>
During the During the
Year Ended Nine Months
December 31, Ended
--------------------- December 31,
1996 1995 1994
----------- -------- -------------
(Dollars in thousands)
<S> <C> <C> <C>
Maximum amount of short-term borrowings
outstanding at any month end:
Securities sold under agreements to repurchase.. $ -- $ 9,000 $26,322
FHLB advances................................... 35,145 27,000 22,000
Approximate average short-term borrowings
outstanding with respect to:
Securities sold under agreements to repurchase.. -- 1,446 14,163
FHLB advances................................... 14,839 9,468 14,365
Approximate weighted average rate paid on:
Securities sold under agreements to repurchase.. -- 5.65% 3.37%
FHLB advances................................... 6.47% 6.25% 3.85%
</TABLE>
COMPETITION
Cooperative Bank encounters strong competition both in the attraction of
deposits and in the making of real estate and other loans. Its most direct
competition for deposits has historically come from financial institutions in
its market area. Competition for deposits is also realized from brokerage firms
and credit unions. The Bank competes for deposits by offering depositors
competitive rates and a high level of personal service together with a wide
range of banking products and convenient office locations.
Competition for real estate and other loans comes principally from financial
institutions and mortgage companies. The Bank competes for loans primarily
through the interest rates and loan fees it charges, and the efficiency and
quality of services it provides borrowers. Factors which affect competition
include the general and local economic conditions, current interest rate levels
and volatility in the mortgage markets.
EMPLOYEES
At December 31, 1996, the Bank had 111 full-time employees and five part-time
employees. The employees are not represented by a collective bargaining unit.
The Bank believes its relationship with its employees to be good.
13
<PAGE>
EXECUTIVE OFFICERS
At December 31, 1996, the executive officers of the Bank who were not also
directors were as follows:
<TABLE>
<CAPTION>
Age at
Name December 31, 1996 Position
- ----------------------------------- ----------------- ----------------------------------------------
<S> <C> <C>
Daniel W. Eller 54 Senior Vice President and Corporate Secretary
Edward E. Maready 55 Senior Vice President and Treasurer, Principal
Financial and Accounting Officer
Eric R. Gray 54 Senior Vice President of Mortgage Lending
O.C. Burrell, Jr. 48 Senior Vice President of Retail Banking
</TABLE>
DANIEL W. ELLER was employed by the Bank in 1979 and served as the
Administrative Vice President until 1993, at which time he was appointed Senior
Vice President and Corporate Secretary. He is a member of the Board of the
Lower Cape Fear Water & Sewer Authority and has served on the boards of the
Southeastern Economic Development Commission, Downtown Area Revitalization
Effort (DARE), New Hanover County Recreation Advisory Committee, Cape Fear Area
United Way, and past president of Crimestoppers of New Hanover County. He also
is past president of the Wilmington Civitan Club and past chairman of the Board
of Child Development Center.
EDWARD E. MAREADY was employed by the Bank in 1977. He served as Controller
and Treasurer from 1977 until 1993. In 1993, Mr. Maready was appointed Senior
Vice President and Treasurer. He is a member of the Financial Managers'
Society, Inc. and serves as a member of various civic committees.
ERIC R. GRAY was employed by the Bank in 1971. He served as Vice President of
Mortgage Lending from 1984 until 1993, at which time he was elected Senior Vice
President of Mortgage Lending. He is past director of the Mortgage Banker's
Association of Wilmington, North Carolina, current member and past president and
director of the Wilmington East Rotary Club, and current member of the Single
Family FNMA/FHLMC of MBAC.
O. C. BURRELL, JR. was employed in May 1993 as Senior Vice President of Retail
Banking. Mr. Burrell has been in the banking industry since 1970 and has served
in leadership capacities in various civic and professional organizations. He is
active in the Wilmington Rotary Club and serves as a director of the Child
Development Center and a member of the Consumer Lending Committee of the North
Carolina Bankers Association.
14
<PAGE>
REGULATION
GENERAL. As a North Carolina savings bank with deposits insured by the SAIF,
Cooperative Bank is subject to extensive regulation by the Administrator of the
North Carolina Savings Banks Division (the "Administrator") and the FDIC. The
Company is also subject to extensive regulation under federal and state law.
The lending activities and other investments of Cooperative Bank must comply
with various federal regulatory requirements. The Administrator and the FDIC
periodically examine Cooperative Bank for compliance with various regulatory
requirements. The Bank must file reports with the Administrator and the FDIC
describing its activities and financial condition. The Bank is also subject to
certain reserve requirements promulgated by the Board of Governors of the
Federal Reserve System (the "Federal Reserve Board"). This supervision and
regulation is intended primarily for the protection of depositors. Certain of
these regulatory requirements are referred to below or appear elsewhere herein.
The following is a brief summary of certain statutes, rules and regulations
affecting the Company and the Bank. A number of other statutes and regulations
have an impact on their operations. The following summary of applicable
statutes and regulations does not purport to be complete and is qualified in its
entirety by reference to such statutes and regulations.
BANK HOLDING COMPANY REGULATION. The Company is registered as a bank holding
company under the Bank Holding Company Act of 1956, as amended (the "Holding
Company Act") and, as such, is subject to supervision and regulation by the
Federal Reserve Board. As a bank holding company, the Company is required to
furnish to the Federal Reserve Board annual and quarterly reports of its
operations at the end of each period and to furnish such additional information
as the Federal Reserve Board may require pursuant to the Holding Company Act.
The Company is also subject to regular examination by the Federal Reserve Board.
In addition, as a savings institution holding company, the Company is subject to
supervision by the Administrator under North Carolina law.
Under the Holding Company Act, a bank holding company must obtain the prior
approval of the Federal Reserve Board before (1) acquiring direct or indirect
ownership or control of any voting shares of any bank or bank holding company
if, after such acquisition, the bank holding company would directly or
indirectly own or control more than 5% of such shares; (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or (3)
merging or consolidating with another bank holding company. In addition to the
above restrictions under the Holding Company Act, the Company's investments are
limited under North Carolina law to those investments permitted for North
Carolina savings banks. See " -- State Law and Regulation."
The Holding Company Act prohibits the Federal Reserve Board from approving an
application by a bank holding company to acquire voting shares of a bank located
outside the state in which the operations of the holding company's bank
subsidiaries are principally conducted, unless such an acquisition is
specifically authorized by state law. The State of North Carolina has enacted
reciprocal interstate banking statutes that authorize banks and their holding
companies in North Carolina to be acquired by banks or their holding companies
in states that have also enacted reciprocal banking legislation, and permit
North Carolina banks and their holding companies to acquire banks in such other
states.
Under the Holding Company Act, any company must obtain approval of the Federal
Reserve Board prior to acquiring control of the Company or the Bank. For
purposes of the Holding Company Act, "control" is defined as ownership of more
than 25% of any class of voting securities of the Company or the Bank, the
ability to control the election of a majority of the directors, or the exercise
of a controlling influence over management or policies of the Company or the
Bank.
The Change in Bank Control Act and the regulations of the Federal Reserve
Board thereunder require any person or persons acting in concert (except for
companies required to make application under the Holding Company Act), to file a
written notice with the Federal Reserve Board before such person or persons may
acquire control of
15
<PAGE>
the Company or the Bank. The Change in Bank Control Act defines "control" as the
power, directly or indirectly, to vote 25% or more of any voting securities or
to direct the management or policies of a bank holding company or an insured
bank.
The Holding Company Act also prohibits, with certain exceptions, a bank
holding company from acquiring direct or indirect ownership or control of more
than 5% of the voting shares of a company that is not a bank or a bank holding
company, or from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities which, by statute or by Federal Reserve Board regulation or
order, have been identified as activities closely related to the business of
banking or managing or controlling banks. The activities of the Company are
subject to these legal and regulatory limitations under the Holding Company Act
and the Federal Reserve Board's regulations thereunder. Notwithstanding the
Federal Reserve Board's prior approval of specific nonbanking activities, the
Federal Reserve Board has the power to order a holding company or its
subsidiaries to terminate any activity, or to terminate its ownership or control
of any subsidiary, when it has reasonable cause to believe that the continuation
of such activity or such ownership or control constitutes a serious risk to the
financial safety, soundness or stability of any bank subsidiary of that holding
company.
The Federal Reserve Board has adopted guidelines regarding the capital
adequacy of bank holding companies, which require bank holding companies to
maintain specified minimum ratios of capital to total assets and capital to
risk-weighted assets. See " -- Capital Requirements."
The Federal Reserve Board has the power to prohibit dividends by bank holding
companies if their actions constitute unsafe or unsound practices. The Federal
Reserve Board has issued a policy statement on the payment of cash dividends by
bank holding companies, which expresses the Federal Reserve Board's view that a
bank holding company should pay cash dividends only to the extent that the
company's net income for the past year is sufficient to cover both the cash
dividends and a rate of earning retention that is consistent with the company's
capital needs, asset quality, and overall financial condition.
Bank holding companies generally are required to give the Federal Reserve
Board notice of any purchase or redemption of outstanding equity securities if
the gross consideration for the purchase or redemption, when combined with the
net consideration paid for all such purchases or redemptions during the
preceding 12 months, is equal to 10% or more of the Company's consolidated net
worth. The Federal Reserve Board may disapprove such a purchase or redemption
if it determines that the proposal would violate any law, regulation, Federal
Reserve Board order, directive, or any condition imposed by, or written
agreement with, the Federal Reserve Board. The requirement to receive prior
Federal Reserve Board approval for such purchases or redemption does not apply
to bank holding companies that are "well-capitalized," received one of the two
highest examination ratings at their last examination and are not the subject of
any unresolved supervisory issues.
CAPITAL REQUIREMENTS. The regulations of the Federal Reserve Board and the
FDIC require bank holding companies and state-chartered banks that are not
members of the Federal Reserve System to maintain a minimum leverage capital
requirement consisting of a ratio of Tier 1 capital to total assets of 3%.
Although setting a minimum 3% leverage ratio, the capital regulations state that
only the strongest bank holding companies and banks, with composite examination
ratings of 1 under the rating system used by the federal bank regulators, would
be permitted to operate at or near such minimum level of capital. For all but
the most highly rated institutions meeting the conditions set forth above, the
minimum leverage capital ratio is 3% plus an additional "cushion" amount of at
least 100 to 200 basis points. Any bank or bank holding company experiencing or
anticipating significant growth would be expected to maintain capital well above
the minimum levels. In addition, the Federal Reserve Board has indicated that
whenever appropriate, and in particular when a bank holding company is
undertaking expansion, seeking to engage in new activities or otherwise facing
unusual or abnormal rights, it will consider, on a case-by-case basis, the level
of an organization's ratio of tangible Tier 1 capital (after deducting all
intangibles) to total assets in making an overall assessment of capital. Tier 1
capital is the sum of common stockholders' equity, noncumulative perpetual
preferred stock (including any related surplus) and minority interests in
consolidated subsidiaries, minus all intangible
16
<PAGE>
assets (other than certain purchased mortgage servicing rights and purchased
credit card receivables), minus identified losses and minus investments in
certain subsidiaries. As a SAIF-insured, state-chartered bank, the Bank must
also deduct from Tier 1 capital an amount equal to its investments in, and
extensions of credit to, subsidiaries engaged in activities that are not
permissible to national banks, other than debt and equity investments in
subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities or in subsidiary depository institutions or their
holding companies.
The risk-based capital rules of the Federal Reserve Board and the FDIC require
bank holding companies and state non-member banks to maintain minimum regulatory
capital levels based upon a weighting of their assets and off-balance sheet
obligations according to risk. The risk-based capital rules have two basic
components: a core capital (Tier 1) requirement and a supplementary capital
(Tier 2) requirement. Core capital consists primarily of common stockholders'
equity, certain perpetual preferred stock (which must be noncumulative with
respect to banks), and minority interests in the equity accounts of consolidated
subsidiaries; less all intangible assets, except for certain purchased mortgage
servicing rights and purchased credit card relationships. Supplementary capital
elements include, subject to certain limitations, the allowance for losses on
loans and leases; perpetual preferred stock that does not qualify as Tier 1
capital and long-term preferred stock with an original maturity of at least 20
years from issuance; hybrid capital instruments, including perpetual debt and
mandatory convertible securities; and subordinated debt and intermediate-term
preferred stock.
The risk-based capital regulations assign balance sheet assets and credit
equivalent amounts of off-balance sheet obligations to one of four broad risk
categories based principally on the degree of credit risk associated with the
obligor. The assets and off-balance sheet items in the four risk categories are
weighted at 0%, 20%, 50% and 100%. These computations result in the total risk-
weighted assets.
The risk-based capital regulations require all banks and bank holding
companies to maintain a minimum ratio of total capital to total risk-weighted
assets of 8%, with at least 4% as core capital. For the purpose of calculating
these ratios: (i) supplementary capital will be limited to no more than 100% of
core capital; and (ii) the aggregate amount of certain types of supplementary
capital will be limited. In addition, the risk-based capital regulations limit
the allowance for loan losses includable as capital to 1.25% of total risk-
weighted assets.
The federal bank regulatory agencies, including the Federal Reserve Board and
the FDIC, have revised their risk-based capital requirements to ensure that such
requirements provide for explicit consideration by commercial banks of interest
rate risk. Under these requirements, a bank's interest rate risk exposure is
quantified using either the measurement system set forth in the rule or the
bank's internal model for measuring such exposure, if such model is determined
to be adequate by the bank's examiner. If the dollar amount of a bank's
interest rate risk exposure, as measured under either measurement system,
exceeds 1% of the bank's total assets, the bank is required to hold additional
capital equal to the dollar amount of the excess. Management of the Bank does
not believe that this interest rate risk component will have an adverse effect
on the Bank's capital.
Under North Carolina law, savings banks must maintain a net worth of not less
than 5% of assets. In computing its compliance with this requirement, the
savings bank must deduct intangible assets from both net worth and assets.
The Bank was in compliance with both the FDIC capital requirements and the
North Carolina net worth requirement at December 31, 1996.
LIQUIDITY. North Carolina savings banks must maintain cash and readily
marketable investments in an amount not less than 10% of the assets of the
savings banks. The Bank was in compliance with this requirement at December 31,
1996.
17
<PAGE>
PROMPT CORRECTIVE REGULATORY ACTION. The federal banking regulators are
required under applicable law to take prompt corrective action if an insured
depository institution fails to satisfy certain minimum capital requirements
including a leverage limit, a risk-based capital requirement, and any other
measure of capital deemed appropriate by the federal banking regulators for
measuring the capital adequacy of an insured depository institution. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees that would cause the
institution to fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of business. A significantly
undercapitalized institution, as well as any undercapitalized institution that
did not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution could also
be required to divest the institution or the institution could be required to
divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. If an
institution's ratio of tangible capital to total assets falls below a level
established by the appropriate federal banking regulator, which may not be less
than 2% nor more than 65% of the minimum tangible capital level otherwise
required (the "critical capital level"), the institution will be subject to
conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund.
The federal banking regulators measure a depository institution's capital
adequacy on the basis of the institution's total risk-based capital ratio (the
ratio of its qualifying total capital to risk-weighted assets), Tier 1 risk-
based capital ratio (the ratio of its Tier 1 capital to risk-weighted assets)
and leverage ratio (the ratio of its Tier 1 capital to adjusted total assets).
Under the regulations, a savings bank that is not subject to an order or written
directive to meet or maintain a specific capital level will be deemed "well
capitalized" if it also has: (i) a total risk-based capital ratio of 10% or
greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or greater; and (iii) a
leverage ratio of 5.0% or greater. An "adequately capitalized" institution is
an institution that does not meet the definition of well capitalized and has:
(i) a total risk-based capital ratio of 8.0% or greater; (ii) a Tier 1 capital
risk-based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or
greater (or 3.0% or greater if the institution has a composite 1 CAMEL rating).
An "undercapitalized institution" is an institution that has (i) a total risk-
based capital ratio less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of
less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the
institution has a composite 1 CAMEL rating). A "significantly undercapitalized"
institution is defined as an institution that has: (i) a total risk-based
capital ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of
less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A "critically
undercapitalized" institution is defined as an institution that has a ratio of
"tangible equity" to total assets of less than 2.0%. For purposes of the prompt
corrective action regulations, tangible equity is equivalent to Tier 1 capital
plus outstanding cumulative perpetual preferred stock (and related surplus)
minus all intangible assets other than certain purchased mortgage servicing
rights. The FDIC may reclassify a well capitalized institution as adequately
capitalized and may require an adequately capitalized or undercapitalized
institution to comply with the supervisory actions applicable to institutions in
the next lower capital category if the FDIC determines, after notice and an
opportunity for a hearing, that the savings institution is in an unsafe or
unsound condition or that the institution has received and not corrected a less-
than-satisfactory rating for any CAMEL rating category.
COMMUNITY REINVESTMENT ACT. The Bank, like other financial institutions, is
subject to the Community Reinvestment Act ("CRA"). The purpose of the CRA is to
encourage financial institutions to help meet the credit needs of their entire
communities, including the needs of low-and moderate-income neighborhoods.
During the Bank's last compliance examination, the Bank received a
"satisfactory" rating with respect to CRA compliance. The Bank's rating with
respect to CRA compliance would be a factor to be considered by the Federal
Reserve Board and the FDIC in considering applications submitted by the Bank to
acquire branches or to acquire or combine with other financial institutions and
take other actions and, if such rating was less than "satisfactory," could
result in the denial of such applications.
18
<PAGE>
The federal banking regulatory agencies have issued a revision of the CRA
regulations, which became effective on January 1, 1996, to implement a new
evaluation system that rates institutions based on their actual performance in
meeting community credit needs. Under the regulations, a bank will first be
evaluated and rated under three categories: a lending test, an investment test
and a service test. For each of these three tests, the savings bank will be
given a rating of either "outstanding," "high satisfactory," "low satisfactory,"
"needs to improve," or "substantial non-compliance." A set of criteria for each
rating has been developed and is included in the regulation. If an institution
disagrees with a particular rating, the institution has the burden of rebutting
the presumption by clearly establishing that the quantitative measures do not
accurately present its actual performance, or that demographics, competitive
conditions or economic or legal limitations peculiar to its service area should
be considered. The ratings received under the three tests will be used to
determine the overall composite CRA rating. The composite ratings will be the
same as those that are currently given: "outstanding," "satisfactory," "needs to
improve" or "substantial non-compliance."
DIVIDEND LIMITATIONS. The Bank may not pay dividends on its capital stock if
its regulatory capital would thereby be reduced below the amount then required
for the liquidation account established for the benefit of certain depositors of
the Bank at the time of its conversion to stock form.
Earnings of the Bank appropriated to bad debt reserves and deducted for
federal income tax purposes are not available for payment of cash dividends or
other distributions to stockholders without payment of taxes at the then current
tax rate by the Bank on the amount of earnings removed from the reserves for
such distributions. See "Taxation." The Bank intends to make full use of this
favorable tax treatment and does not contemplate use of any earnings in a manner
which would limit the Bank's bad debt deduction or create federal tax
liabilities.
Under applicable regulations, the Bank is prohibited from making any capital
distributions if after making the distribution, the Bank would have: (i) a total
risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital
ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.
DEPOSIT INSURANCE. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken. The
assessment rate for SAIF members had ranged from 0.23% of deposits for well
capitalized institutions in Subgroup A to 0.31% of deposits for undercapitalized
institutions in Subgroup C while assessments for over 90% of members of the Bank
Insurance Fund ("BIF") had been the statutory minimum of $2,000. Recently
enacted legislation provided for a one-time assessment of 65.7 basis points of
insured deposits as of March 31, 1995, that fully capitalized the SAIF and had
the effect of reducing future SAIF assessments. Accordingly, although the
special assessment resulted in a one-time charge to the Bank of approximately
$1.8 million pre-tax, the recapitalization of the SAIF had the effect of
reducing the Bank's future deposit insurance premiums to the SAIF. Under the
recently enacted legislation, both BIF and SAIF members will be assessed an
amount for the Financing Corporation Bond payments. BIF members will be
assessed approximately 1.3 basis points while the SAIF rate will be
approximately 6.4 basis points until January 1, 2000. At that time, BIF and
SAIF members will begin pro rata sharing of the payment at an expected rate of
2.43 basis points.
19
<PAGE>
RESTRICTIONS ON CERTAIN ACTIVITIES. Under applicable law, state-chartered
banks with deposits insured by the FDIC are generally prohibited from acquiring
or retaining any equity investment of a type or in an amount that is not
permissible for a national bank. The foregoing limitation, however, does not
prohibit FDIC-insured state banks from acquiring or retaining an equity
investment in a subsidiary in which the bank is a majority owner. State-
chartered banks are also prohibited from engaging as principal in any type of
activity that is not permissible for a national bank and subsidiaries of state-
chartered, FDIC-insured state banks have been prohibited from engaging as
principal in any type of activity that is not permissible for a subsidiary of a
national bank unless in either case the FDIC determines that the activity would
pose no significant risk to the appropriate deposit insurance fund and the bank
is, and continues to be, in compliance with applicable capital standards.
The FDIC has adopted regulations to clarify the foregoing restrictions on
activities of FDIC-insured state-chartered banks and their subsidiaries. Under
the regulations, the term activity refers to the authorized conduct of business
by an insured state bank and includes acquiring or retaining any investment
other than an equity investment. An activity permissible for a national bank
includes any activity expressly authorized for national banks by statute or
recognized as permissible in regulations, official circulars or bulletins or in
any order or written interpretation issued by the Office of the Comptroller of
the Currency ("OCC"). In its regulations, the FDIC indicates that it will not
permit state banks to directly engage in commercial ventures or directly or
indirectly engage in any insurance underwriting activity other than to the
extent such activities are permissible for a national bank or a national bank
subsidiary or except for certain other limited forms of insurance underwriting
permitted under the regulations. Under the regulations, the FDIC permits state
banks that meet applicable minimum capital requirements to engage as principal
in certain activities that are not permissible to national banks including
guaranteeing obligations of others, activities which the Federal Reserve Board
has found by regulation or order to be closely related to banking and certain
securities activities conducted through subsidiaries.
Subject to limitation by the Administrator, North Carolina-chartered savings
banks may make any loan or investment or engage in any activity which is
permitted to federally chartered institutions. However, a North Carolina-
chartered savings bank cannot invest more than 15% of its total assets in
business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutorily permitted
investments, including but not limited to (i) obligations of the United States,
or those guaranteed by it; (ii) obligations of the State of North Carolina;
(iii) bank demand or time deposits; (iv) stock or obligations of the federal
deposit insurance fund or a FHLB; (v) savings accounts of any savings
institution as approved by the board of directors; and (vi) stock or obligations
of any agency of the State of North Carolina or of the United States or of any
corporation doing business in North Carolina whose principal business is to make
education loans.
SAFETY AND SOUNDNESS STANDARDS. The federal banking regulatory agencies,
including the FDIC, have adopted standards for the safe and sound operation of
financial institutions, as mandated by the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"). These regulations require insured
depository institutions to maintain internal controls and information systems
and internal audit systems that are appropriate for the size, nature and scope
of the institution's business. The rules also require certain basic standards
to be observed in loan documentation, credit underwriting, interest rate risk
exposure, and asset growth. Depository institutions are also required to
maintain safeguards to prevent the payment of compensation, fees and benefits
that are excessive or that could lead to material financial loss, and to take
into account factors such as comparable compensation practices at comparable
institutions.
The regulations also require a depository institution to maintain a ratio of
classified assets to total capital and ineligible allowances that is no greater
than 1.0, and require that depository institutions have minimum earnings
sufficient to absorb losses without impairing capital. The FDIC may require
institutions to file safety and soundness plans to cure any deficiency. The FDIC
may issue orders directing an institution to correct a deficiency or to take or
refrain from taking actions prohibited by Section 39 of FDICIA, and may assess
civil money penalties or take other enforcement action if such an order is
violated.
20
<PAGE>
TRANSACTIONS WITH AFFILIATES. Transactions between savings banks and any
affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An
affiliate of a savings bank is any company or entity which controls, is
controlled by or is under common control with the savings bank. Generally,
Sections 23A and 23B (i) limit the extent to which the savings bank or its
subsidiaries may engage in "covered transactions" with any one affiliate to an
amount equal to 10% of such institution's capital stock and surplus, and contain
an aggregate limit on all such transactions with all affiliates to an amount
equal to 20% of such capital stock and surplus and (ii) require that all such
transactions be on terms substantially the same, or at least as favorable, to
the institution or subsidiary as those provided to a non-affiliate. A bank
holding company and its subsidiaries are considered "affiliates" of the bank
under Section 23A and 23B. The term "covered transaction" includes the making
of loans, purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
the Bank may not (i) lend or otherwise extend credit to an affiliate, except for
any affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the Bank.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB System, which
consists of 12 district FHLBs subject to supervision and regulation by the
Federal Housing Finance Board ("FHFB"). The FHLBs provide a central credit
facility primarily for member institutions. As a member of the FHLB of Atlanta,
the Bank is required to acquire and hold shares of capital stock in the FHLB of
Atlanta in an amount at least equal to 1% of the aggregate unpaid principal of
its home mortgage loans, home purchase contracts, and similar obligations at the
beginning of each year, or 1/20 of its advances (borrowings) from the FHLB of
Atlanta, whichever is greater. Cooperative Bank was in compliance with this
requirement with investment in FHLB of Atlanta stock at December 31, 1996 of
$2.4 million. The FHLB of Atlanta serves as a reserve or central bank for its
member institutions within its assigned region. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLB System.
It makes advances to members in accordance with policies and procedures
established by the FHFB and the Board of Directors of the FHLB of Atlanta. Long
term advances may only be made for the purpose of providing funds for
residential housing finance.
FEDERAL RESERVE BOARD REGULATION. Pursuant to regulations of the Federal
Reserve Board, all FDIC-insured depository institutions must maintain average
daily reserves against their transaction accounts. No reserves are required to
be maintained on the first $4.3 million of transaction accounts, reserves equal
to 3% must be maintained on the next $52.0 million of transaction accounts, and
a reserve of 10% must be maintained against all remaining transaction accounts.
These reserve requirements are subject to adjustment by the Federal Reserve
Board. Because required reserves must be maintained in the form of vault cash
or in a noninterest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's interest-
earning assets. At December 31, 1996, the Bank met its reserve requirements.
UNIFORM LENDING STANDARDS. Under FDIC regulations which became effective
March 19, 1993, banks must adopt and maintain written policies that establish
appropriate limits and standards for extensions of credit that are secured by
liens or interests in real estate or are made for the purpose of financing
permanent improvements to real estate. These policies must establish loan
portfolio diversification standards, prudent underwriting standards, including
loan-to-value limits, that are clear and measurable, loan administration
procedures and documentation, approval and reporting requirements. The real
estate lending policies must reflect consideration of the Interagency Guidelines
for Real Estate Lending Policies (the "Interagency Guidelines") that have been
adopted by the federal bank regulators.
The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits for real estate loans
that do not exceed the following supervisory limits: (i) for loans secured by
raw land, the supervisory loan-to-value limit is 65% of the value of the
collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%; (iii) for loans for the construction of commercial,
multifamily or other nonresidential property, the supervisory limit is 80%; (iv)
for loans for the construction of one-to four-family properties, the supervisory
limit is 85%; and (v) for loans secured by other improved property (e.g.,
farmland, completed commercial property and
21
<PAGE>
other income-producing property including non-owner-occupied one-to four-family
property), the limit is 85%. Although no supervisory loan-to-value limit has
been established for owner-occupied, one-to four-family and home equity loans,
the Interagency Guidelines state that for any such loan with a loan-to-value
ratio that equals or exceeds 90% at origination, an institution should require
appropriate credit enhancement in the form of either mortgage insurance or
readily marketable collateral.
The Interagency Guidelines state that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits, based on the support provided by other credit
factors. The aggregate amount of loans in excess of the supervisory loan-to-
value limits, however, should not exceed 100% of total capital and the total of
such loans secured by commercial, agricultural, multifamily and other non-one-to
four-family residential properties should not exceed 30% of total capital. The
supervisory loan-to-value limits do not apply to certain categories of loans
including loans insured or guaranteed by the U.S. government and its agencies or
by financially capable state, local or municipal governments or agencies, loans
backed by the full faith and credit of a state government, loans that are to be
sold promptly after origination without recourse to a financially responsible
party, loans that are renewed, refinanced or restructured without the
advancement of new funds, loans that are renewed, refinanced or restructured in
connection with a workout, loans to facilitate sales of real estate acquired by
the institution in the ordinary course of collecting a debt previously
contracted and loans where the real estate is not the primary collateral.
STATE LAW AND REGULATION. North Carolina law contains comprehensive
provisions for the regulation of a savings bank business in the State of North
Carolina, including the manner of chartering a savings bank, capital
requirements, the composition and qualifications of boards of directors, the
number and manner of selection of officers, and record keeping requirements.
The Bank derives its investment power from these laws and regulations and must
structure its lending policies and procedures to comply with the various
applicable provisions. Likewise, the investments by the Bank are regulated,
including investments in certain types of specific properties. The manner of
establishing savings accounts and evidencing the same is prescribed, as are the
obligations of the Bank with respect to withdrawals from savings accounts. As a
North Carolina savings bank, Cooperative Bank is also permitted to make any
investment permitted to a federal savings association.
North Carolina savings banks may conduct operations through branch offices
located in the State of North Carolina. The North Carolina Savings Banks
Commission of the Department of Commerce conducts hearings on all branch
applications, and any interested person may present evidence and argument.
Any plan adopted by the directors of a savings bank under which the savings
bank would reorganize or merge or consolidate with another savings bank must be
approved by the Administrator. The plan must also be approved by the members or
stockholders who are entitled to vote, at an annual or special meeting.
The Administrator is required to conduct a periodic examination of each
institution under his jurisdiction. The examination provides directors with an
independent assessment of the Bank's operations and compliance with applicable
law, regulations and prudent operating policies. The Administrator may make
such examination jointly with examiners of the FDIC.
TAXATION
Savings associations are subject to the provisions of the Internal Revenue
Code of 1986, as amended (the "Code") in the same general manner as other
corporations. Through tax years beginning before December 31, 1995, savings
associations such as Cooperative Bank which meet certain definitional tests and
other conditions prescribed by the Code benefitted from certain favorable
provisions regarding their deductions from taxable income for annual additions
to their bad debt reserve. For purposes of the bad debt reserve deduction,
loans are separated into "qualifying real property loans," which generally are
loans secured by interests in real property, and nonqualifying real property
loans, which are all other loans. The bad debt reserve deduction with respect
to nonqualifying loans
22
<PAGE>
must be based on actual loss experience. The amount of the bad debt reserve
deduction with respect to qualifying real property loans may be based upon
actual loss experience (the "experience method") or a percentage of taxable
income determined without regard to such deduction (the "percentage of taxable
income method"). The Bank generally elected to use the method which resulted in
the greatest deduction for federal income tax purposes in any given year.
Legislation that is effective for tax years beginning after December 31,
1995 requires institutions to recapture into taxable income over a six taxable
year period the portion of the tax loan reserve that exceeds the pre-1988 tax
loan loss reserve. The Bank will no longer be allowed to use the reserve method
for tax loan loss provisions, but would be allowed to use the experience method
of accounting for bad debts used by commercial banks under Code section 505.
There will be no future effect on net income from the recapture because the
taxes on these bad debt reserves has already been accrued as a deferred tax
liability.
The Bank's federal income tax returns were most recently audited in 1970.
For additional information regarding federal and state taxes, see Note 11
of Notes to Consolidated Financial Statements in the Annual Report.
STATE INCOME TAXATION
Under North Carolina law, the Bank is subject to an annual corporate
minimum tax of 7.75% of its federal taxable income as computed under the Code,
subject to certain prescribed adjustments. The North Carolina corporate income
tax will be reduced to 6.9% for years beginning on or after January 1, 2000.
This reduction is being phased in over a four year period with the tax rate
being reduced to 7.5% for taxable years beginning on or after January 1, 1997,
7.25% for 1998, and 7% for 1999. In addition to the state corporate income tax,
the Bank is subject to an annual state franchise tax, which is imposed at a rate
of .15% applied to the greatest of the Bank's (i) capital stock, surplus and
undivided profits, (ii) investment in tangible property in North Carolina or
(iii) appraised valuation of property in North Carolina. The filing of
consolidated returns is not permitted under North Carolina law.
23
<PAGE>
ITEM 2. PROPERTIES
- -------------------
The following table sets forth the location of the Bank's offices, as well
as certain additional information relating to these offices as of December 31,
1996.
<TABLE>
<CAPTION>
Year Net Book Square
Location Opened Value Footage Title Deposits
- -------------------------------------------- ------ -------------- ------- ------------ --------------
(In thousands) (In thousands)
<S> <C> <C> <C> <C> <C>
201 Market St., Wilmington, NC 1959 $2,075 27,976 Owned $36,378
24 N. Second St., Wilmington, NC (1) 1980 -- 4,176 Owned(1) --
827 New Bridge St., Jacksonville, NC 1954 15 4,213 Owned(2) 19,085
205 E. Main St., Wallace, NC 1954 134 2,880 Owned 39,964
922 E. Arendell St., Morehead City, NC 1958 62 1,984 Owned 17,736
Broad Street, Elizabethtown, NC 1961 58 2,016 Owned 17,369
4 E. Fifth St., Tabor City, NC 1980 163 3,880 Owned 25,887
3605 Oleander Dr., Wilmington, NC 1970 45 1,296 Owned(3) 23,702
2405 S. College Rd., Wilmington, NC 1974 179 2,000 Owned 27,092
1501 Live Oak St., Beaufort, NC 1975 14 1,685 Owned(4) 8,878
400 Western Blvd., Jacksonville, NC 1982 391 2,050 Owned 9,917
132 W. 2nd St., Washington, NC 1983 82 7,298 Owned(5) 19,337
Railroad St., Robersonville, NC 1983 60 2,500 Owned(5) 9,822
2007 Croatan Ave., Kill Devil Hills, NC 1983 120 2,337 Owned(5) 6,976
1296 John Small Ave., Washington, NC 1987 212 1,920 Owned 6,234
Corner By-pass, Business 264, Belhaven, NC 1989 357 1,482 Owned 8,189
821 Ocean Trail, Corolla, NC 1993 20 565 Leased(6) --
7028 Market Street, Wilmington, NC 1995 800 1,925 Owned 1,573
------- --------
$ 4,787 $278,139
======= ========
</TABLE>
- --------------------
(1) Operations center for the Bank. Net book value included in 201 Market
Street.
(2) Building is owned, but land is leased. Original lease dated 1958.
Current lease terminates 1998.
(3) Building is owned, but land is leased. Current lease terminates June
2000.
(4) Building is owned, but land is leased. Current lease terminates December
31, 1999.
(5) Acquired through merger.
(6) Loan production office. Current lease terminates May 1997.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
The Bank is a defendant in a lawsuit filed by a former borrower. The claim
seeks damages based on the Bank's disbursement of approximately $64,000 in the
borrower's funds for a residential construction loan. Based on its assessment
of all pertinent information, management believes that the claim is without
merit and does not expect the Bank to suffer a loss as a result of disposition
of the claim.
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, 1996.
24
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ------------------------------------------------------------------------------
The information contained under the section captioned "Corporate
Information" in the Annual Report is incorporated by reference.
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The information required by this item is incorporated herein by
reference to the tables captioned "Selected Financial and Other Data" in the
Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
-------------
The information contained in the section captioned "Management's
Discussion & Analysis" in the Annual Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The financial statements contained in the Annual Report which are
listed under Item 14 herein are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None, other than as previously reported.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
(a) Directors of the Registrant
The information contained under the section captioned "Proposal I --
Election of Directors" in the Proxy Statement for the 1997 Annual Meeting of
Stockholders (the "Proxy Statement") is incorporated herein by reference.
(b) Principal Officers of the Bank
The information contained under the caption "Executive Officers" under
Part I of this Form 10-K is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
- -------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors" in the Proxy Statement is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -----------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the sections captioned "Voting Securities and
Principal Holders Thereof" in the Proxy Statement.
25
<PAGE>
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the sections captioned "Proposal I -- Election of
Directors" in the Proxy Statement.
(c) Changes in Control
Management of the Bank knows of no arrangements, including any
pledge of any person of securities of the Bank, the operation of
which may at a subsequent date result in a change in control of the
Bank.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference to
the sections captioned "Proposal I -- Election of Directors" and "Voting
Securities and Principal Holders Thereof" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a) Contents. The following financial statements are filed as part of this
--------
Annual Report on Form 10-K.
(1) Consolidated Financial Statements*
1. Report of Independent Accountants
2. Consolidated Statements of Financial Condition as of December 31,
1996 and 1995
3. Consolidated Statements of Income for the Years Ended December
31, 1996 and 1995 and the Nine-Month Transition Period Ended
December 31, 1994
4. Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1996 and 1995 and the Nine-Month Transition
Period Ended December 31, 1994
5. Consolidated Statements of Cash Flows for the Year Ended
December 31, 1996 and 1995 and the Nine-Month Transition Period
Ended December 31, 1994
6. Notes to Consolidated Financial Statements
- --------------------
* Incorporated by reference to the Annual Report, attached hereto as
Exhibit 13.
(2) Financial Statement Schedules (All financial statement schedules
have been omitted as the required information is either inapplicable
or included in the Consolidated Financial Statements or related
notes.)
(b) No Current Reports on Form 8-K were filed by the Company during the final
quarter of the fiscal year ended December 31, 1996.
26
<PAGE>
(c) The following exhibits are either filed as part of this report or are
incorporated herein by reference:
<TABLE>
<CAPTION>
Page in
Sequentially
No. Description Numbered Copy
- ----------- ------------------------------------------------------------ -------------
<S> <C> <C>
3.1 Articles of Incorporation *
3.2 Bylaws *
10.1 Cooperative Bank for Savings, Inc. 1990 Stock *
Option Plan
10.2 Employment Agreement with Frederick Willetts, III *
10.3 Termination Agreements with Daniel W. Eller, Edward E. *
Maready, Eric R. Gray, Todd L. Sammons and O.C. Burrell, Jr.
10.4 Amendments to Severance Agreements with Daniel W. Eller, *
Edward E. Maready, Eric R. Gray, and Todd L. Sammons
10.5 Indemnity Agreement with Directors and Executive *
Officers
11 Statement re: computation of per share earnings -
Reference is made to the Bank's Consolidated
Statements of Operations attached hereto as Exhibit 13,
which are incorporated herein by reference
13 Annual Report to Stockholders for the year ended
December 31, 1996
21 Subsidiaries
23 Consent of Coopers & Lybrand L.L.P.
27 Financial Data Schedule
</TABLE>
- --------------------
* Incorporated by reference to the Registrant's Registration Statement on Form
S-4 (Reg. No. 33-79206).
27
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Cooperative Bankshares, Inc.
Date: February 20, 1997 By: /s/ Frederick Willetts, III
-------------------------------------
Frederick Willetts, III
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C>
By: /s/ Frederick Willetts, III Date: February 20, 1997
---------------------------------------------
Frederick Willetts, III
President, Chief Executive Officer and Direct
(Principal Executive Officer and Director)
By: /s/ Frederick Willetts, Jr. Date: February 20, 1997
----------------------------------------------
Frederick Willetts, Jr.
Senior Vice President, Chairman of the Board
By: /s/ Edward E. Maready Date: February 20, 1997
----------------------------------------------
Edward E. Maready
Senior Vice President and Treasurer
(Principal Financial and Accounting Officer)
By: /s/ James D. Hundley, M.D. Date: February 20, 1997
----------------------------------------------
James D. Hundley, M.D.
(Director)
By: /s/ O. Richard Wright, Jr. Date: February 20, 1997
----------------------------------------------
O. Richard Wright, Jr.
(Director)
By: /s/ Paul G. Burton Date: February 20, 1997
----------------------------------------------
Paul G. Burton
(Director)
By: /s/ H. Thompson King, III Date: February 20, 1997
----------------------------------------------
H. Thompson King, III
(Director)
By: /s/ F. Peter Fensel, Jr. Date: February 20, 1997
----------------------------------------------
F. Peter Fensel, Jr.
(Director)
By: /s/ William H. Wagoner Date: February 20, 1997
----------------------------------------------
William H. Wagoner
(Director)
By: /s/ Charles H. Boney Date: February 20, 1997
----------------------------------------------
Charles H. Boney
(Director)
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
INDEX TO EXHIBITS
<S> <C> <C>
Page Number
in Sequentially
Exhibit Description Numbered Copy
- --------------- ------------------------------------------------------------ ---------------
3.1 Articles of Incorporation *
3.2 Bylaws *
10.1 Cooperative Bank for Savings, Inc. 1990 Stock
Option Plan *
10.2 Employment Agreement with Frederick Willetts, III *
10.3 Termination Agreements with Daniel W. Eller, Edward E. *
Maready, Eric R. Gray, Todd L. Sammons and O.C. Burrell, Jr.
10.4 Amendments to Severance Agreements with Daniel W. Eller, *
Edward E. Maready, Eric R. Gray and Todd L. Sammons
10.5 Indemnity Agreement with Directors and Executive *
Officers
11 Statement re: computation of per share earnings -
Reference is made to the Bank's Consolidated
Statements of Operations attached hereto as Exhibit 13,
which are incorporated herein by reference
13 Annual Report to Stockholders for the year
ended December 31, 1996
21 Subsidiaries
23 Consent of Coopers & Lybrand, L.L.P.
27 Financial Data Schedule
</TABLE>
- --------------------
* Incorporated by reference to the Registrant's Registration Statement on Form
S-4 (Reg. No. 33-79206).
29
<PAGE>
EXHIBIT 13
<PAGE>
COOPERATIVE
BANKSHARES, INC.
ANNUAL REPORT
DECEMBER 31, 1996
<PAGE>
COOPERATIVE BANKSHARES, INC.
- -------------------------------------------------------------------------------
PROFILE Cooperative Bankshares, Inc., is the parent company of
Cooperative Bank For Savings, Inc., SSB. The Bank is
chartered under the laws of the state of North Carolina to
engage in general banking business. Cooperative offers a wide
range of retail banking services including deposit services,
banking cards and alternative investment products. These
funds are used for the extension of credit through mortgage
loans, consumer loans and other installment credit such as
home equity, auto, boat loans and check reserve.
Chartered in 1898, Cooperative's headquarters is located in
Wilmington, North Carolina. Cooperative operates 17 offices
throughout the coastal and inland communities of eastern
North Carolina from Corolla located on the Outer Banks of
North Carolina to Tabor City located on the South Carolina
border.
The common stock of Cooperative Bankshares, Inc., is traded
on the NASDAQ National Market under the symbol "COOP".
- -------------------------------------------------------------------------------
MISSION It is the mission of Cooperative to provide the maximum in
safety and security for our depositors, an equitable rate of
return for our stockholders, and excellent service for our
customers, and to do so while operating in a fiscally sound
and conservative manner, with fair pricing of our products
and services, good working conditions, outstanding training
and opportunities for our staff, along with a high level of
corporate citizenship.
- -------------------------------------------------------------------------------
TABLE OF CONTENTS Selected Financial and Other Data ..................... 2
President's Message ................................... 3
Management's Discussion & Analysis .................... 4-11
Report of Independent Accountants ..................... 12
Consolidated Statements of Financial Condition......... 13
Consolidated Statements of Operations ................. 14
Consolidated Statements of Stockholders' Equity ....... 15
Consolidated Statements of Cash Flows ................16-17
Notes to Consolidated Financial Statements ............18-36
Directors, Officers, and Office Locations ............. 38
Corporate Information ................................. 39
1
<PAGE>
SELECTED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
DECEMBER 31, December 31, December 31, March 31, March 31,
Financial Condition (Dollars in Thousands) 1996 1995 1994 1994 1993
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Assets $ 341,300 $ 311,843 $ 324,252 $ 312,513 $ 307,586
Loans receivable, net 263,313 234,008 240,194 215,497 205,446
Mortgage-backed and related securities 28,825 30,907 31,658 37,202 39,301
Cash, securities and other investments 40,942 35,540 40,320 47,039 48,872
Goodwill 0 3,602 3,894 4,113 4,405
Deposits 278,139 270,071 266,079 273,704 283,148
Borrowed funds 35,435 10,089 30,000 9,650 0
Stockholders' equity $ 25,470 $ 29,083 $ 26,923 $ 26,148 $ 21,639
- -----------------------------------------------------------------------------------------------------------------
<CAPTION>
Summary of Operations (Dollars in Thousands
except per share amounts)
YEAR ENDED Year ended 9 Mo. ended Year ended Year ended
DECEMBER 31, December 31, December 31, March 31, March 31,
1996 1995 1994 1994 1993
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest income $ 22,793 $ 21,904 16,610 22,079 24,189
Interest expense 13,630 13,701 8,302 10,565 12,648
Net interest income 9,163 8,203 8,308 11,514 11,541
Provision for loan losses 156 3 0 30 140
Non-interest income 570 620 502 1,538 636
Non-interest expenses (1) 12,251 7,121 4,967 6,269 5,871
Income (loss) before income taxes and
accounting change (2,674) 1,699 3,843 6,753 6,166
Income (loss) before accounting change (3,250) 1,024 2,487 4,032 3,927
Cumulative effect of a change in
accounting for income taxes 0 0 0 203 0
Net income (loss) $ (3,250) $ 1,024 $ 2,487 $ 4,235 $ 3,927
- -----------------------------------------------------------------------------------------------------------------
Other Selected Data
Return on average assets (2) (1.01)% 0.32% 1.01% 1.35% 1.28%
Return on average equity (2) (11.40)% 3.62% 12.28% 17.46% 19.88%
Stockholders' equity to total assets 7.46% 9.33% 8.30% 8.37% 7.04%
Non-performing assets to total assets 0.44% 0.25% 0.15% 0.30% 0.86%
Allowance for loan losses to total loans 0.29% 0.31% 0.31% 0.34% 0.33%
- -----------------------------------------------------------------------------------------------------------------
Per Share Data (3)
Net income (loss) $ (2.18) $ 0.65 $ 1.57 $ 2.69 $ 2.52
Tangible book value $ 17.07 $ 17.08 $ 15.44 $ 14.77 $ 11.55
Number of common shares outstanding 1,491,698 1,491,698 1,491,698 1,491,698 1,491,698
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes one time special assessment for deposit insurance of $1.8 million
and a charge-off of impaired goodwill of $3.4 million.
(2) Return on average assets and return on average equity for the nine months
ended December 31, 1994 have been annualized for comparative purposes.
(3) All per share amounts are adjusted for all stock dividends and splits.
2
<PAGE>
PRESIDENT'S MESSAGE
TO OUR STOCKHOLDERS:
The year 1996 was one marked by continued improvement in the overall
condition of Cooperative Bankshares, Inc. As the year progressed the Bank's net
interest margin, or the difference between interest from earning assets and
interest expense from liabilities, continued to widen. This allowed the Bank's
net income to increase steadily throughout the year as each quarter resulted in
improved earnings.
EARNINGS
Net income for the year ended December 31, 1996, rose 45% over the
previous year to $1,487,895 or $.94 per share, excluding a one time, special
assessment for deposit insurance of $1,782,810, and a charge-off of good will of
$3,359,791 related to an acquisition made in 1983. Income for the year ended
December 31, 1995, was $1,024,381, or $.65 per share. Net loss for 1996 after
the one time charges was $3,249,853 or $2.18 per share.
LOANS
During the year 696 mortgage loans were originated totaling $67,337,259,
a 51% increase over the level of originations in the previous year. Despite this
increase in the overall level of loan volume, we continue to adhere to strict
underwriting criteria. While we now make a wide range of loans, including
consumer and commercial loans, the primary focus during the past year has
continued to be on origination of one-to-four family residential loans. During
1995, the Bank consolidated its loan servicing and originating operations,
utilizing an automated system to better facilitate the origination and servicing
of our loans. I am pleased to report that this increase in overall loan volume
during 1996 has not caused any substantial increase in either personnel or other
overhead expense due to the previous consolidation of these operations, allowing
a more streamlined, cost efficient operation.
ASSET QUALITY
The quality of our assets remains a top priority for the Bank. As of
December 31, 1996, nonperforming loans and real estate owned, totaled
$1,494,394, or 0.44% of assets. The allowance for loan losses has been increased
to $807,539; and while this is considered to be adequate at the present time to
cover any potential loan loss exposure, the Bank is continuing to add to this
allowance to further protect our investment in loans.
RECENT DEVELOPMENTS
As previously mentioned, the Bank was assessed a one time special
assessment of $1,782,810 to recapitalize the SAIF insurance fund of the FDIC.
SAIF insured financial institutions throughout the country were assessed this
one time charge as of September 30, 1996. Going forward, this assessment will
have a positive effect on both the overall strength and condition of the SAIF
insurance fund, since it has been completely recapitalized. It will also
positively impact the earnings of Cooperative since we will now benefit from a
significant decrease in the premiums paid to the SAIF fund in the future. The
charge-off of $3,359,791 also positively affects the Bank's future earnings,
since the Bank was charging off goodwill over the next twelve years at the rate
of approximately $292,000 per year.
The Retail Banking Division continues to develop new products, and is
emphasizing currently a new commercial checking account called, "Strictly
Business". With the addition of this commercial checking account as well as
commercial, consumer, and personal loans and checking accounts, we are now truly
a full service community bank.
During the previous several years, the Bank had experienced a downturn
in earnings, largely due to a shrinkage in the Bank's net interest margin. I am
pleased to report that the net interest margin for the year ended December 31,
1996, had grown to 2.97% as compared to 2.67% at the same period in 1995. While
we anticipate that this margin will continue to expand in the future, it is also
important to note that the Bank has taken steps to reduce its exposure to
fluctuations in interest rates in the future.
SUMMARY
I am pleased that the Bank's performance during the past year
substantially exceeded that of the previous year, and am particularly proud of
the efforts put forward by our staff, officers, and Directors in bringing these
results to fruition. I am also pleased that we have the recapitalization of our
deposit insurance fund behind us and can anticipate enhanced earnings as a
result of a reduction in our deposit insurance premiums. Both the reduced SAIF
premium and the charge-off of goodwill should improve earnings of the Bank in
the future. I continue to remain optimistic about our future, and appreciate
your confidence and support.
Sincerely,
Frederick Willetts, III
President
3
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS
GENERAL
Cooperative Bankshares, Inc. (the "Company") is a registered
savings bank holding company incorporated in North Carolina in 1994. The Company
was formed for the purpose of serving as the holding company of Cooperative Bank
For Savings, Inc., SSB, ("Cooperative Bank" or the "Bank") a North Carolina
chartered stock savings bank. The Company's primary activities consist of
holding the stock of Cooperative Bank and operating the business of the Bank.
Accordingly, the information set forth in this report, including financial
statements and related data, relates primarily to Cooperative Bank.
Cooperative Bank is chartered under the laws of the state of North
Carolina to engage in general banking business. The Bank offers a wide range of
retail banking services including deposit services, banking cards and
alternative investment products. These funds are used for the extension of
credit through mortgage loans, savings account loans and other installment
credit such as home equity, auto and boat loans and check reserve.
The Company conducts its operations through its main office in
Wilmington, North Carolina and 16 offices throughout eastern North Carolina. The
Company considers its primary market for savings and lending activities to be
the communities of eastern North Carolina extending from the Virginia to the
South Carolina borders.
The Company's Board of Directors approved a change in the Company's
fiscal year end from March 31 to December 31, effective with the nine months
ended December 31, 1994. Accordingly, this report presents financial information
for the nine month transition period ended December 31, 1994, and the fiscal
years ended December 31, 1995 and 1996. The following management's discussion
and analysis is presented to assist in understanding the Company's financial
condition and results of operations. This discussion should be read in
conjunction with the consolidated financial statements and accompanying notes
presented in this report.
MANAGEMENT STRATEGY
It is the mission of the Company to provide the maximum in safety and
security for our depositors, an equitable rate of return for our stockholders,
excellent service for our customers, and to do so while operating in a fiscally
sound and conservative manner, with fair pricing of our products and services,
good working conditions, outstanding training and opportunities for our staff,
along with a high level of corporate citizenship.
Cooperative Bank's lending activities are concentrated on the
origination of conventional mortgage loans for the purpose of constructing,
financing or refinancing one-to four-family residential properties. As of
December 31, 1996, $258.7 million, or 93.2%, of the Bank's loan portfolio
consisted of loans secured by one- to four family residential properties. Also
at that date, approximately 96.0% of the Bank's total loan portfolio consisted
of loans secured by residential real estate. To a lesser extent, the Bank
originates multi-family, nonresidential real estate loans, home equity line of
credit loans, secured and unsecured consumer and business loans. While
continuing to place primary emphasis on residential mortgage loans, the Bank is
taking a more aggressive position in pursuing business lending, and
nonresidential real estate lending involving loans secured by small commercial
properties with balances generally ranging from $100,000 to $500,000. The Bank's
primary emphasis is to originate adjustable rate loans with the fixed rate loan
as an option. As of December 31, 1996, adjustable rate loans totaled $182.8
million, or 69.2%, and fixed rate loans totaled $81.3 million or 30.8% of the
Bank's total loan portfolio.
INTEREST RATE SENSITIVITY ANALYSIS
Interest rate sensitivity refers to the change in interest spread
resulting from changes in interest rates. To the extent that interest income and
interest expense do not respond equally to changes in interest rates, or that
all rates do not change uniformly, earnings will be affected. Interest rate
sensitivity, at a point in time, can be analyzed using a static gap analysis
that measures the match in balances subject to repricing between interest-
earning assets and interest-bearing liabilities.
4
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS
Gap is considered positive when the amount of interest rate sensitive assets
exceed the amount of interest rate sensitive liabilities. Gap is considered
negative when the amount of interest rate sensitive liabilities exceed the
amount of interest rate sensitive assets. At December 31, 1996, Cooperative had
a one-year negative gap position of 1.0%. During a period of rising interest
rates, a negative gap would tend to adversely affect net interest income, while
a positive gap would tend to result in an increase in net interest income.
During a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income while a positive gap would tend to
adversely affect net interest income. It is important to note that certain
shortcomings are inherent in static gap analysis.
Although certain assets and liabilities may have similar maturities or periods
of repricing, they may react in different degrees to changes in market interest
rates. For example, most of the Company's adjustable-rate mortgage loans are
indexed to the National Monthly Median Cost of Funds to SAIF-insured
institutions. This index is considered a lagging index that may lag behind
changes in market rates. The one-year or less interest-bearing liabilities also
include checking, savings, and money market deposit accounts. Experience has
shown that the Company sees relatively modest repricing of these transaction
accounts. Management takes this into consideration in determining acceptable
levels of interest rate risk.
The following table indicates the time periods in which interest-earning assets
and interest-bearing liabilities will mature or reprice in accordance with their
contractual terms. The table assumes prepayments and scheduled principal
amortization of fixed-rate loans and mortgages-backed securities, and assumes
that adjustable rate loans will reprice at contractual repricing intervals.
<TABLE>
<CAPTION>
INTEREST SENSITIVITY ANALYSIS
Over One Over Five
One Year Through Through Over Ten
December 31, 1996 or Less Five Years Ten Years Years Total
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Securities and other
interest-earning assets $ 16,528 $ 6,023 $11,010 $ 5,000 $ 38,561
Mortgage-backed and related 22,902 2,907 888 2,711 29,408
securities
Loan portfolio 169,485 53,254 20,805 19,781 263,325
------------------------------------------------------------------
Total $208,915 $ 62,184 $32,703 $27,492 $331,294
------------------------------------------------------------------
Interest-bearing liabilities:
Deposits (1) $200,926 $ 67,129 $10,057 $ 33 $278,145
Borrowed funds 10,208 25,101 24 102 35,435
------------------------------------------------------------------
Total $211,134 $ 92,230 $10,081 $ 135 $313,580
------------------------------------------------------------------
Interest rate sensitivity gap $ (2,219) $(30,046) $22,622 $27,357 $ 17,714
------------------------------------------------------------------
Cumulative interest rate sensitivity gap $ (2,219) $(32,265) $(9,643) $17,714
------------------------------------------------------------------
Cumulative ratio of interest-earning
assets to interest-bearing
liabilities 98.9% 89.4% 96.9% 105.6%
------------------------------------------------------------------
Ratio of cumulative gap to total assets (0.7%) (9.5%) (2.8%) 5.2%
------------------------------------------------------------------
</TABLE>
(1) Includes noninterest bearing checking accounts of $4,230,000
5
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS
LIQUIDITY
The Company's goal is to maintain adequate liquidity to meet potential
funding needs of loan and deposit customers, pay operating expenses, and meet
regulatory liquidity requirements. Maturing securities, principal repayments of
loans and securities, deposits, income from operations and borrowings are the
main sources of liquidity. Scheduled loan repayments are a relatively
predictable source of funds, unlike deposits and loan prepayments that are
significantly influenced by general interest rates, economic conditions and
competition.
At December 31, 1996, the estimated market value of liquid assets
(cash, cash equivalents, and marketable securities) was approximately $68.4
million, which represents 21.8% of deposits and borrowed funds as compared to
$65.3 million or 23.3% of deposits and borrowed funds at December 31, 1995. The
increase in liquid assets during the twelve months ended December 31, 1996, was
due to the purchase of $4.0 million in Federal Home Loan Bank bonds and $2.0
million in Federal Farm Credit Bank Bonds with a maturity ranging from two to
five years.
SECURITY PORTFOLIO
The Company's security portfolio consists of U.S. Government agency,
mortgage-backed and other permissible securities. The mortgage-backed
securities are guaranteed by the following agencies: Federal Home Loan Mortgage
Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA"), and the
Government National Mortgage Association ("GNMA"). Mortgage-backed securities
entitle the Company to receive a pro rata portion of the cash flows from an
identified pool of mortgages. Although mortgage-backed securities generally
offer lesser yields than the loans for which they are exchanged, they present
substantially lower credit risk by virtue of the guarantees that back them.
Mortgage-backed securities are more liquid than individual mortgage loans, and
may be used to collateralize borrowings or other obligations of the Company.
The Company's investment in mortgage-related securities includes
collateralized mortgage obligations ("CMO"). CMOs are securities derived by
reallocating the cash flows from mortgage-backed securities or pools of mortgage
loans in order to create multiple classes, or tranches, of securities with
coupon rates and average lives that differ from the underlying collateral as a
whole. At December 31, 1996, the Company's investment in CMOs totaled $15
million, or 25.7% of the securities portfolio. Of the $15 million, a $10
million CMO is guaranteed either directly or indirectly through mortgage-backed
securities underlying the obligations of FNMA. This FNMA CMO has a 30 year
term, floats at 155 basis points over the 30 day London Interbank Offered Rate
("LIBOR") on a monthly basis and has a lifetime interest rate cap of 8%. The
remaining $5 million CMO securities were issued by Chase Mortgage Finance
Corporation and represent a beneficial interest in a pool of fixed-rate one- to
four-family mortgage loans. The Chase CMO has a 30 year term, floats at 180
basis points over the 30 day LIBOR on a monthly basis and has a lifetime
interest rate cap of 8%.
The Company's investment in U. S. Government agency bonds includes $5
million in Federal Home Loan Banks' Dual Indexed Consolidated Bonds maturing
August 4, 2003. These bonds had an 8% interest rate from August 4, 1993,
through August 3, 1995, at which time the rate was adjusted to 3.485% based on
an indexing formula. Subsequent interest rates will also be based on an
indexing formula and will adjust annually on February 4 and August 4. The
indexing formula states that the interest rate per annum will be equal to a rate
determined by the 10-Year CMT less the 6 month LIBOR plus a margin of 2.9% for
August 4, 1995, increasing 30 basis points annually to 5.0% for August 4, 2005.
The mortgage-backed and related securities owned by the Company are
subject to repayment by the mortgagors of the underlying collateral at any
time. These repayments may be affected by a rising or declining interest rate
environment. During a rising or declining interest rate environment, repayments
and the interest rate caps may subject the Company's mortgage-backed and related
securities to yield and/or price volatility.
6
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS
The Company's primary uses of liquidity are to fund loans and to make
investments. At December 31, 1996, outstanding off-balance sheet commitments to
extend credit totaled $12.9 million, and the undisbursed portion of construction
loans was $12.2 million. Management considers current liquidity levels adequate
to meet the Company's cash flow requirements.
CAPITAL
Stockholders' equity at December 31, 1996, was $25.5 million, down
12.4% from $29.1 million at December 31, 1995. The total at December 31, 1996,
and December 31, 1995, includes $372 thousand and $298 thousand respectively,
net of tax, of unrealized losses on securities available for sale marked to
estimated fair market value under Statement of Financial Accounting Standards
No. 115, Accounting for Certain Investments in Debt and Equity Securities
("SFAS 115"). The reduction in equity was due to a one-time special assessment
for deposit insurance of $1.8 million and a charge-off of goodwill of $3.4
million.
Under the capital regulations of the FDIC, the Bank must satisfy
minimum leverage ratio requirements and risk-based capital requirements. Banks,
supervised by the FDIC, must maintain a minimum leverage ratio of core (Tier I)
capital to average adjusted assets ranging from 3% to 5%. At December 31, 1996,
the Bank's ratio of Tier I capital was 7.8%. The FDIC's risk-based capital
rules require banks supervised by the FDIC to maintain risk-based capital to
risk-weighted assets of at least 8.00%. Risk-based capital for the Bank is
defined as Tier 1 capital plus the balance of allowance for loan losses. At
December 31, 1996, the Bank had a ratio of qualifying total capital to risk-
weighted assets of 15.0%.
The Company, as a bank holding company, is also subject, on a
consolidated basis, to the capital adequacy guidelines of the Board of Governors
of the Federal Reserve (the "Federal Reserve Board"). The capital requirements
of the Federal Reserve Board are similar to those of the FDIC governing the
Bank.
The Company currently exceeds all of its capital requirements.
Management expects the Company to continue to exceed these capital requirements
without altering current operations or strategies. For further information, see
Note 9 of Notes to Consolidated Financial Statements.
OTHER INFORMATION
Pursuant to recently enacted legislation, the FDIC levied an assessment
on institutions with deposits insured by the Savings Association Insurance Fund
(the "SAIF") in order to recapitalize the SAIF. The assessment, set by the FDIC
at 0.657% of SAIF-insured deposits as of March 31, 1995, was paid on November
27, 1996. The effect of this assessment was to reduce the Company's net income,
before income taxes, for the year ended December 31, 1996, by $1.8 million. As
a result of this legislation, the Company's deposit insurance premiums declined
substantially commencing January 1, 1997.
In addition to numerous regulatory relief provisions contained in the
recent legislation, the legislation provides for a merger of the SAIF and the
Bank Insurance Fund effective January 1, 1999 if there are no insured savings
associations remaining on that date, and directs the Secretary of Treasury to
make recommendations to the Congress by March 31, 1997, with respect to
establishment of a common charter for banks and thrift institutions.
The Company has continually evaluated the realizability of its goodwill
relating to the 1983 purchase of a savings and loan. In September 1996, this
evaluation process indicated that the related branches were continuing to
experience decreased profitability that had permanently impaired the goodwill.
Due to this permanent impairment the Company recognized a charge-off of goodwill
of $3.4 million to non-interest expense during the year ended December 31, 1996.
In October 1995, the Company opened a new branch office in the Ogden
area of Wilmington, North Carolina. The capital investment in the new branch
increased the Company's non-earning assets by $840 thousand or 6.9% resulting in
a slight decrease in interest income. Due to the start-up cost of the new
branch office, other operating expenses increased slightly in 1996. The new
branch could have a negative effect on net income for a short period of time.
7
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS AT DECEMBER 31, 1996 COMPARED TO
DECEMBER 31, 1995
FINANCIAL CONDITION
The Company's total assets increased 9.5% to $341.3 million at December
31, 1996, as compared to $311.8 million at December 31, 1995. The two major
changes in the assets were the purchase of $6.0 million in available for sale
securities and the $29.3 million (12.5%) increase in loans receivable. The
securities were Federal Home Loan Bank bonds and Federal Farm Credit Bank bonds
with two and five year maturity dates. The security purchase and the increase
in loans during the current period were funded by retail deposits, borrowed
funds, and liquid assets. The Company concentrates its lending activities on
the origination of conventional mortgage loans for the purpose of the
construction, financing or refinancing of one- to four-family residential
properties. At December 31, 1996, over 93% of the Company's loan portfolio
consisted of loans secured by one- to four-family residential properties.
Of the $8.1 million increase in retail deposits during the twelve month
period ended December 31, 1996, $1.3 million was a deposit to a checking account
from a local municipality. The increase in retail deposits was used in part to
fund the increase in loans receivable. Borrowed funds, collateralized through an
agreement with the Federal Home Loan Bank ("FHLB") for advances, are secured by
the Company's investment in FHLB stock and qualifying first mortgage loans.
Borrowed funds at December 31, 1996, in the amount of $10.0 million, mature in
May 1997 with the remaining amount maturing in later years. For further
information, see Note 8 of Notes to Consolidated Financial Statements.
The Company's non-performing assets (loans 90 days or more delinquent
and foreclosed real estate) were $1.5 million, or 0.44% of assets, at December
31, 1996, compared to $772 thousand, or 0.25% of assets, at December 31, 1995.
An increase in delinquent single family loans caused non-performing assets to be
higher for the period ended December 31, 1996, as compared to December 31, 1995.
The Company takes an aggressive position in collecting delinquent loans to keep
non-performing assets down and continues to evaluate the loan and real estate
portfolios to provide loss reserves as considered necessary. In the opinion of
management, the allowance for loan losses of $807 thousand at December 31, 1996,
is adequate to cover potential losses. Subsequent to December 31, 1996, three
of the non-performing loans were brought current and transferred to a new
borrower, reducing the balance of non-performing assets by approximately $300
thousand.
RESULTS OF OPERATIONS
The net income of the Company depends primarily upon net interest
income. Net interest income is the difference between the interest earned on
loans and securities portfolios and the cost of funds, consisting principally of
the interest paid on deposits and borrowings. The Company's operations are
materially affected by general economic conditions, the monetary and fiscal
policies of the Federal government, and the policies of regulatory authorities.
NET INCOME (LOSS)
The net loss of $3.3 million for the year ended December 31, 1996, as
compared to $1.0 million in income for the same period a year ago, was the
direct result of one-time special charges. Pursuant to recently enacted
legislation, the FDIC levied an assessment on institutions with deposits insured
by the Savings Association Insurance Fund (the "SAIF") in order to recapitalize
the SAIF. The effect of this assessment was to reduce the Company's net income,
before income taxes, for the year ended December 31, 1996, by $1.8 million. As
a result of this legislation, the Company's deposit insurance premiums declined
substantially commencing January 1, 1997. As discussed earlier, the Company
recognized a charge-off of impaired goodwill of $3.4 million to non-interest
expense during the year ended December 31, 1996. Excluding the one-time special
assessment for deposit insurance and the charge-off of goodwill, net income for
the year ended December 31, 1996, would have been $1.5 million, compared to $1.0
million for the previous year.
8
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS
AVERAGE YIELD/COST ANALYSIS
The following table contains information relating to the Company's average
balance sheet and reflects the average yield on assets and average cost of
liabilities for the periods indicated. Such annualized yields and costs are
derived by dividing income or expense by the average balances of asset or
liabilities, respectively, for the periods presented.
<TABLE>
<CAPTION>
For the period ended
-------------------------------------------------------------------------------------------------------
December 31, 1996 December 31, 1995 December 31, 1994
-------------------------------- ------------------------------- ------------------------------------
(DOLLARS IN THOUSANDS) Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
-------------------------------- ------------------------------- ------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Securities and other
interest-earning
assets $ 32,511 $ 1,819 5.60% $ 37,046 $ 2,325 6.28% $ 46,304 $ 3,149 6.80%
Mortgage-backed and
related securities 30,397 2,048 6.74% 32,438 2,200 6.78% 37,906 2,381 6.28%
Loan portfolio 246,038 18,927 7.69% 237,431 17,379 7.32% 229,771 16,616 7.23%
-------- ------- -------- -------- -------- --------
Total interest-earning
assets 308,946 $22,794 7.38% 306,915 $21,904 7.14% 313,981 $22,146 7.05%
Noninterest-earning assets 11,956 12,454 13,435
-------- -------- --------
Total assets $320,902 $319,369 $327,416
======== ======== ========
Interest-bearing
liabilities:
Deposits 271,156 12,670 4.67% 269,468 12,642 4.69% 267,199 9,696 3.63%
Borrowed funds 14,839 960 6.47% 16,794 1,058 6.30% 28,527 1,373 4.81%
------- ------- ------- ------- -------- -------
Total interest-bearing
liabilities 285,995 $13,630 4.77% 286,262 $13,700 4.79% 295,726 $11,069 3.74%
Noninterest-bearing
liabilities 6,389 4,842 4,692
-------- --------- ---------
Total liabilities 292,384 291,104 300,418
Stockholders' equity 28,518 28,265 26,998
-------- --------- ---------
Total liabilities and
stockholders' equity $320,902 $319,369 $327,416
======== ======== ========
Net interest income $ 9,164 $ 8,204 $11,077
======= ======= =======
Interest rate spread 2.61% 2.35% 3.31%
====== ======= ======
Net yield on interest-earning assets 2.97% 2.67% 3.53%
====== ======= ======
Percentage of average interest-earning
assets to average interest-bearing
liabilities 108.0% 107.2% 106.2%
====== ======= =====
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
INTEREST INCOME
Interest income increased 4% for the year ended December 31, 1996, as
compared to the same period a year ago. The increase in income can be
principally attributed to an increase in yield and the average balance of the
loan portfolio as compared to the same period last year. This was partially
offset by decreases in both the average volume and rate of the other categories
of interest-earning assets. Overall the yield on average interest-earning
assets increased to 7.38% as compared to 7.14% for the same period a year ago,
and the average balance increased slightly.
INTEREST EXPENSE
Interest expense was essentially unchanged for the year ended December
31, 1996, as compared to the same period a year ago. The cost of interest-
bearing deposits decreased to 4.67% as compared to 4.69% for the same period
last year. Although there was a small reduction in average interest-bearing
liabilities, the higher interest rate paid on borrowed funds (6.47%) for the
current year as compared to 6.30% for last year had a negative effect on
interest expense.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
RATE/VOLUME ANALYSIS
The table below provides information regarding changes in interest income and
interest expense for the period indicated. For each category of interest-
earning asset and interest-bearing liabilities, information is provided on
changes attributable to (i) changes in volume (changes in volume multiplied by
old rate); (ii) changes in rates (change in rate multiplied by old volume); and
(iii) changes in rate-volume (changes in rate multiplied by changes in volume).
<TABLE>
<CAPTION>
DECEMBER 31, 1995 VS. DECEMBER 31, 1996 December 31, 1994 vs. December 31, 1995
INCREASE (DECREASE) Increase (Decrease)
DUE TO Due to
(Dollars in thousands) RATE/ Rate/
VOLUME RATE VOLUME TOTAL Volume Rate Volume Total
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Securities and other
interest-earning assets $(285) $(252) $31 $ (506) $(630) $ (243) $ 49 $ (824)
Mortgage-backed and
related securities (138) (14) 1 (151) (343) 190 (27) (180)
Loan portfolio 630 885 32 1,547 554 202 7 763
-----------------------------------------------------------------------------------------
Total interest-earning
assets 207 619 64 890 (419) 149 29 (241)
-----------------------------------------------------------------------------------------
Interest expense:
Deposits 79 (51) 0 28 82 2,840 24 2,946
Borrowed funds (123) 28 (3) (98) (565) 424 (174) (315)
-----------------------------------------------------------------------------------------
Total interest-bearing
liabilities (44) (23) (3) (70) (483) 3,264 (150) 2,631
-----------------------------------------------------------------------------------------
Net interest income $ 251 $ 642 $67 $ 960 $ 64 $(3,115) $ 179 $(2,872)
-----------------------------------------------------------------------------------------
</TABLE>
NET INTEREST INCOME
Net interest income for the year ended December 31, 1996, as compared
to the same period a year ago, increased 11.7%. A reduction in the Company's
one-year negative gap position in which interest-bearing liabilities reprice
faster than interest-earning assets had a positive effect on increasing the
interest rate margin. The one-year negative gap has been reduced to 1.0% at
December 31, 1996, as compared to 17.7% for the same period last year. During
the year ended December 31, 1996, the yield on average interest-earning assets
increased 24 basis points, while the cost of average interest-bearing
liabilities decreased 2 basis points, causing net interest income to increase.
The percentage of average interest-earning assets to average interest-bearing
liabilities increased to 108.0% for the year ended December 31, 1996, as
compared to 107.2% for the same period in 1995.
PROVISION FOR LOAN LOSSES
During the year ended December 31, 1996, the Company had charge-offs
against the allowance for loan losses of $86 thousand consisting of $22 thousand
for consumer loans and $64 thousand for loans on single family residential
property. The Company added $156 thousand to the allowance for loan losses for
the twelve month period ended December 31, 1996, bringing the balance up to $807
thousand. Management considers this level to be appropriate based on lending
volume, the current level of delinquencies and other non-performing assets,
overall economic conditions and other factors. Future increases to the allowance
may be necessary, however, due to changes in loan composition or loan volume,
changes in economic or market area conditions and other factors.
10
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS
NONINTEREST INCOME
The gain on sale of other investments of $52 thousand for the year ended
December 31, 1996, was the cash liquidation of equity securities. The
corporation in which the Company had invested was purchased by a third party and
the stock was redeemed at a gain of $46 thousand. The remaining $6 thousand was
from bonds with call options that were called during the year. During the twelve
month period ending December 31, 1995, the Company sold $14.7 million in
securities and $22.5 million in fixed rate mortgage loans at a gain of $23
thousand and $205 thousand, respectively. All of the securities and $13.9
million of the loans sold in 1995 were sold during the quarter ended June 30,
1995. The proceeds from the 1995 sales were used to repay short-term borrowed
funds, and improve the Company's interest rate sensitivity position by reducing
its one-year negative gap. Real estate owned expense and losses decreased by 75%
to $40 thousand as a result of management's commitment to disposing of these
properties in a timely manner. Loan fees for the year ended December 31, 1996,
as compared to last year decreased by 4.9% due to a decrease in servicing fees
on sold loans from repayments. Fee income from deposit operations increased due
to a more aggressive position in offering checking accounts.
OTHER OPERATING EXPENSES
As previously discussed, the Company recognized a charge-off of impaired
goodwill of $3.4 million to non-interest expense during the year ended December
31, 1996. Further, the FDIC levied an assessment on institutions with deposits
insured by the Savings Association Insurance Fund (the "SAIF") in 1996. The
effect of this assessment was to reduce the Company's income for the year ended
December 31, 1996, by $1.8 million. As a result of this legislation, the
Company's deposit insurance premiums declined substantially commencing January
1, 1997.
For the year ended December 31, 1996, compensation and related cost was
essentially unchanged as compared to the same period last year. Occupancy and
equipment expense increased 7.4% during the year ended December 31, 1996, as
compared to the same period a year ago. The major part of this increase can be
attributed to depreciation and operating cost of the new branch office opened in
October 1995. The decrease in Federal insurance premium can be attributed to the
recently enacted legislation that resulted in a reduction in the premium for the
fourth quarter of 1996. Advertising increased 1.6% for the twelve month period
ended December 31, 1996, as compared to the same period last year. Other
operating expense category was up 5.4% for the year ended December 31, 1996, as
compared to the same period last year. This was due to the new branch office
opened in October 1995 and normal increases in the purchase of paper, printing
and dues.
INCOME TAXES
The effective tax rates for the years ended December 31, 1996 and 1995
approximate the statutory rate after giving effect to nontaxable interest,
write-off of impaired goodwill, other permanent tax differences, and adjustments
to certain deferred tax liabilities.
11
<PAGE>
[LETTERHEAD OF COOPERS & LYBRAND L.L.P. APPEARS HERE]
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders
Cooperative Bankshares, Inc.
Wilmington, North Carolina
We have audited the accompanying consolidated statements of financial condition
of Cooperative Bankshares, Inc. and subsidiary as of December 31, 1996 and 1995,
and the related consolidated statements of operations, stockholders' equity and
cash flows for the years ended December 31, 1996 and 1995, and the nine months
ended December 31, 1994. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Cooperative
Bankshares, Inc. and subsidiary as of December 31, 1996 and 1995 and the
consolidated results of their operations and their cash flows for the years
ended December 31, 1996 and 1995, and the nine months ended December 31, 1994 in
conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
Raleigh, North Carolina
January 31, 1997
12
<PAGE>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995
----------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents........................................................ $ 11,507,283 $ 11,889,473
Securities:
Available for sale............................................................. 5,946,250 --
Held to maturity (estimated market value, 1996 - $19,705,629; 1995 -
$19,885,820).................................................................. 21,053,628 21,063,310
Mortgage-backed and related securities available for sale........................ 28,824,918 30,907,341
Other investments................................................................ 2,435,000 2,587,101
Loans receivable, net............................................................ 263,312,730 234,008,085
Real estate owned:
Foreclosed..................................................................... 42,146 329,338
Other.......................................................................... -- 206,885
Accrued interest receivable...................................................... 1,917,447 1,742,589
Premises and equipment, net...................................................... 4,786,292 5,025,587
Goodwill......................................................................... -- 3,602,189
Prepaid expenses and other assets................................................ 1,474,164 481,362
----------------------------
$341,299,858 $311,843,260
============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits......................................................................... $278,138,909 $270,070,661
Borrowed funds................................................................... 35,145,362 10,089,017
ESOP note payable................................................................ 289,160 --
Escrow deposits................................................................... 620,808 352,668
Accrued interest payable on deposits............................................. 351,295 862,377
Deferred income taxes, net....................................................... 1,075,883 857,500
Accrued expenses and other liabilities........................................... 208,891 528,147
----------------------------
Total liabilities.............................................................. 315,830,308 282,760,370
----------------------------
Commitments and contingencies (Notes 5 and 9)
Stockholders' Equity:
Preferred stock, $1 par value, 3,000,000 shares authorized, none issued
and outstanding............................................................... -- --
Common stock, $1 par value, 7,000,000 shares authorized, 1,491,698 issued
and outstanding............................................................... 1,491,698 1,491,698
Additional paid-in capital..................................................... 6,003,111 6,003,111
Unearned ESOP shares........................................................... (289,160) --
Net unrealized gain (loss) on securities available for sale.................... (372,265) (297,938)
Retained earnings.............................................................. 18,636,166 21,886,019
----------------------------
Total stockholders' equity .................................................. 25,469,550 29,082,890
----------------------------
$341,299,858 $311,843,260
============================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
13
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND THE
NINE MONTHS ENDED DECEMBER 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
-----------------------------------------------------------
<S> <C> <C> <C>
Interest Income:
Loans receivable......................................... $18,926,560 $17,379,495 $12,462,293
Mortgage-backed and related securities................... 2,048,268 2,199,582 1,786,026
Securities............................................... 1,818,629 2,324,569 2,361,966
-----------------------------------------------------------
Total interest income.................................. 22,793,457 21,903,646 16,610,285
-----------------------------------------------------------
Interest Expense:
Deposits................................................. 12,669,984 12,642,461 7,272,051
Borrowed funds........................................... 960,408 1,058,457 1,030,310
-----------------------------------------------------------
Total interest expense................................. 13,630,392 13,700,918 8,302,361
Net Interest Income........................................ 9,163,065 8,202,728 8,307,924
Provision for loan losses................................ 155,809 2,658 -
-----------------------------------------------------------
Net interest income after provision for loan losses.... 9,007,256 8,200,070 8,307,924
-----------------------------------------------------------
Noninterest Income:
Net gains on sale of securities......................... 52,496 22,629 153,939
Net gains on sale of loans and mortgage-backed and
related securities..................................... - 205,091 174,864
Real estate owned expenses and losses.................... (39,833) (159,546) (148,497)
Loan fees................................................ 295,625 310,783 202,178
Deposit and related fees................................. 257,011 232,353 159,500
Other income, net........................................ 4,217 9,151 (40,248)
------------------------------------------------------------
Total noninterest income............................... 569,516 620,461 501,736
------------------------------------------------------------
Other Operating Expenses:
Compensation and fringe benefits......................... 3,638,832 3,634,205 2,451,493
Occupancy and equipment.................................. 1,257,639 1,170,871 878,427
Federal insurance premiums............................... 543,526 658,706 467,107
Advertising.............................................. 348,356 343,020 188,364
Amortization of goodwill................................. 242,398 292,069 219,052
Other.................................................... 1,077,727 1,022,762 762,687
SAIF assessment.......................................... 1,782,810 - -
Goodwill impairment...................................... 3,359,791 - -
------------------------------------------------------------
Total other operating expenses......................... 12,251,079 7,121,633 4,967,130
------------------------------------------------------------
Income (loss) before income taxes.......................... (2,674,307) 1,698,898 3,842,530
Income tax expense......................................... 575,546 674,517 1,355,677
------------------------------------------------------------
Net income (loss).......................................... $ (3,249,853) $ 1,024,381 $ 2,486,853
============================================================
Earnings (loss) per:
Common share............................................. $(2.18)
================
Common and common share equivalent....................... $ .65 $ 1.57
============ ============
Common share - assuming full dilution.................... $ .64 $ 1.57
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
14
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
THE NINE MONTHS ENDED DECEMBER 31, 1994
<TABLE>
<CAPTION>
NET UNREALIZED
GAIN (LOSS) ON
ADDITIONAL UNEARNED SECURITIES TOTAL
COMMON PAID-IN ESOP AVAILABLE RETAINED STOCKHOLDERS'
STOCK CAPITAL SHARES FOR SALE EARNINGS EQUITY
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, March 31, 1994 $1,491,698 $6,003,111 $ -- $ 278,571 $18,374,785 $26,148,165
Change in unrealized gain (loss) on
securities available for sale, net
of income taxes -- -- -- (1,712,261) -- (1,712,261)
Net income for nine months -- -- -- -- 2,486,853 2,486,853
------------------------------------------------------------------------------------------
Balance, December 31, 1994 1,491,698 6,003,111 -- (1,433,690) 20,861,638 26,922,757
Change in unrealized gain (loss) on
securities available for sale, net
of income taxes -- -- -- 1,135,752 -- 1,135,752
Net income for year -- -- -- -- 1,024,381 1,024,381
------------------------------------------------------------------------------------------
Balance, December 31, 1995 1,491,698 6,003,111 -- (297,938) 21,886,019 29,082,890
Change in unrealized gain (loss) on
securities available for sale, net
of income taxes -- -- -- (74,327) -- (74,327)
Guarantee of ESOP borrowing -- -- (800,000) -- -- (800,000)
Release of ESOP shares -- -- 510,840 -- -- 510,840
Net loss for year -- -- -- -- (3,249,853) (3,249,853)
------------------------------------------------------------------------------------------
Balance, December 31, 1996 $1,491,698 $6,003,111 $(289,160) $ (372,265) $18,636,166 25,469,550
==========================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
15
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1996 and 1995 and the
nine months ended December 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
----------------------------------------------------------
<S> <C> <C> <C>
Operating Activities:
Net income (loss)........................................ $ (3,249,853) $ 1,024,381 $ 2,486,853
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Goodwill impairment.................................... 3,359,791 - -
Net accretion, amortization, and depreciation.......... 801,129 802,695 555,398
Net gains on sale of securities........................ (52,496) (22,629) (153,939)
Net gains on sale of loans and mortgage-backed and
related securities..................................... - (205,091) (174,864)
Provision (benefit) for deferred income taxes.......... 290,700 (151,600) 58,968
Loss on sales of premises and equipment................ 1,000 - -
Loss (gain) on sales of foreclosed real estate......... 13,266 48,972 (13,735)
Valuation losses on foreclosed real estate............. 76,566 86,836 145,893
Provision for loan losses.............................. 155,809 2,658 -
Changes in assets and liabilities:
Accrued interest receivable.......................... (174,858) 297,706 70,613
Prepaid expenses and other assets.................... (992,802) 160,020 386,884
Escrow deposits...................................... 268,140 (317,120) (326,372)
Accrued interest payable on deposits................. (511,082) 840,502 (18,061)
Accrued expenses and other liabilities............... (319,256) 237,247 (356,929)
----------------------------------------------------------
Net cash provided by (used in) operating
activities....................................... (333,946) 2,804,577 2,660,709
----------------------------------------------------------
Investing Activities:
Purchase of securities available for sale................ (9,997,883) - (29,516,981)
Proceeds from sale of securities available for sale...... - 14,698,750 31,523,312
Proceeds from maturity of securities available for sale.. 4,000,000 - -
Purchase of mortgage-backed and related securities
available for sale..................................... - - (5,148,000)
Proceeds from sale of mortgage-backed and related
securities available for sale.......................... - - 6,109,184
Proceeds from principal repayments of mortgage-backed
and related securities available for sale.............. 1,906,819 1,646,885 1,692,448
Proceeds from principal repayments of mortgage-backed
and related securities................................. - - 1,460,128
Proceeds from sales of loans............................. - 22,472,343 6,596,900
Loan originations, net of principal repayments........... (29,661,834) (16,219,011) (31,093,481)
Proceeds from disposals of foreclosed real estate........ 605,626 132,280 246,096
Purchases of premises and equipment...................... (241,238) (621,601) (779,103)
Proceeds from sale of premises and equipment............. 16,202 - -
Purchases of other investments........................... - (38,600) -
Proceeds from sales of other investments................. 199,471 - -
----------------------------------------------------------
Net cash provided by (used in) investing activities.. $(33,172,837) $ 22,071,046 $(18,909,497)
----------------------------------------------------------
</TABLE>
(continued)
16
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
AND THE NINE MONTHS ENDED DECEMBER 31, 1994
<TABLE>
<CAPTION>
1996 1995 1994
---------------------------------------------
<S> <C> <C> <C>
Financing Activities:
Net increase (decrease) in deposits................................ 8,068,248 3,991,578 (7,624,895)
Proceeds from FHLB advances........................................ 25,000,000 17,000,000 30,000,000
Principal payments on FHLB advances................................ - (28,000,000) (9,000,000)
Net decrease in other borrowings................................... - (9,000,000) (650,000)
Proceeds from FHLB program......................................... 56,345 89,017 -
---------------------------------------------
Net cash provided by (used in) financing activities............ 33,124,593 (15,919,405) 12,725,105
---------------------------------------------
Increase (decrease) in cash and cash equivalents..................... (382,190) 8,956,218 (3,523,683)
Cash and cash equivalents
Beginning of period................................................ 11,889,473 2,933,255 6,456,938
---------------------------------------------
End of period...................................................... $ 11,507,283 $ 11,889,473 $ 2,933,255
=============================================
Supplemental disclosures
Cash paid for:
Interest on deposits and borrowed funds.......................... $ 14,141,474 $ 12,860,416 $ 8,319,725
Income taxes..................................................... $ 836,685 $ 859,000 $ 1,476,000
Summary of noncash investing and financing activities:
Transfer of securities to available for sale:
Mortgage-backed and related securities........................... - $ 13,370,795 -
Change in unrealized gain (loss) on securities available
for sale, net of income taxes.................................... $ (74,327) $ 1,135,752 $ (1,712,261)
Transfer from loans to foreclosed real estate...................... $ 239,729 $ 333,594 $ 47,164
Loans to facilitate the sale of foreclosed real estate............. $ 38,348 $ 198,250 $ 150,150
Transfer from premises and equipment to real estate owned.......... $ - $ - $ 252,385
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The consolidated financial statements include the
accounts and transactions of Cooperative Bankshares, Inc. (the "Company"), a
bank holding company incorporated under the laws of the State of North
Carolina, and its wholly-owned subsidiary Cooperative Bank for Savings, Inc.,
SSB, and its wholly-owned subsidiary CS&L Services, Inc.
On July 29, 1994, the stockholders of the Bank approved a plan of corporate
reorganization under which the Bank became a wholly-owned subsidiary of the
Company. Pursuant to the reorganization, on August 9, 1994, the Company
issued 1,491,698 shares of its $1.00 par value common stock in exchange for
1,491,698 shares of the outstanding $1.00 par value common shares of the
Bank.
The reorganization was accounted for in a manner similar to a pooling-of-
interests. Accordingly, the nine months ended December 31, 1994 has been
restated as if the combination had occurred as of April 1, 1994.
The Company changed its fiscal year end from March 31 to December 31,
effective with the nine months ended December 31, 1994.
Nature of Operations - The Company operates 17 offices (including 16 full
service branches) in Eastern North Carolina and offers a wide range of
banking services including deposit services, banking cards, and alternative
investment products. The funds are used for the extension of credit through
mortgage loans, consumer loans, and other installment credit such as home
equity loans, auto and boat loans, and check reserves. The Company's primary
sources of revenue are its loan and securities portfolios.
Use of Estimates in the Preparation of Financial Statements - The preparation
of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at December 31, 1996 and 1995 and the reported amounts
of revenues and expenses during the periods ended December 31, 1996, 1995 and
1994. Actual results could differ from those estimates.
Significant Accounting Policies - The significant accounting policies of the
Company are summarized below:
a. Cash and Cash Equivalents - Cash and cash equivalents include demand and time
deposits (with original maturities of ninety days or less) at other
institutions. Interest-bearing deposits aggregated $9,084,216 and $8,202,722
at December 31, 1996 and 1995, respectively.
b. Securities and Mortgage-Backed and Related Securities - Investments in
certain securities are classified into three categories and accounted for as
follows: (1) debt securities that the entity has the positive intent and the
ability to hold to maturity are classified as held to maturity and reported
at amortized cost; (2) debt and equity securities that are bought and held
principally for the purpose of selling them in the near term are classified
as trading securities and reported at fair value, with unrealized gains and
losses included in earnings; (3) debt and equity securities not classified as
either held to maturity securities or trading securities are classified as
available for sale securities and reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component
of stockholders' equity.
Other investments are carried at cost, which approximates market value.
Premiums are amortized and discounts are accreted using the interest method
over the remaining terms of the related securities. Gains and losses on the
sales of securities are determined using the specific-identification method
and are included in noninterest income at the time of sale.
On December 29, 1995, the Company transferred mortgage-backed and related
securities with a carrying value of $13,370,795 and a market value of
$13,077,261 from the held to maturity category to the available for sale
category under a one time amnesty provision from Statement of Financial
Accounting Standards No. 115.
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
c. Loans Receivable and Allowance for Loan Losses - Loans receivable are stated
at the amount of unpaid principal, reduced by an allowance for loan losses,
unearned discounts and net deferred loan origination fees and costs.
Interest income on loans is recorded on the accrual basis based upon the
principal amount outstanding. Deferred loan fees and costs are amortized to
interest income over the contractual life of the loan using the interest
method.
The Company adopted Statement of Financial Accounting Standards No. 114
("SFAS 114"), "Accounting by Creditors for Impairment of a Loan", as amended
by Statement of Financial Accounting Standards No. 118 ("SFAS 118"),
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosure", on January 1, 1995. Under the new standards, a loan is
considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of
principal and interest when due according to the contractual terms of the
loan agreement. Uncollateralized loans are measured for impairment based on
the present value of expected future cash flows discounted at the original
contractual interest rate, while all collateral-dependent loans are measured
for impairment based on the fair value of the collateral. The adoption of
SFAS 114 and 118 did not result in any additional provision for credit losses
at January 1, 1995.
At December 31, 1996 and 1995, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS 114 totaled $1,064,261
and $173,616, respectively, with corresponding valuation allowances of
$70,385 and $0, respectively. For the year ended December 31, 1996 and 1995,
the average recorded investment in impaired loans was approximately $485,000
and $240,000, respectively. The amount of interest recognized on impaired
loans during the portion of the year that they were impaired was immaterial.
The Company uses several factors in determining if a loan is impaired. The
internal asset classification procedures include a thorough review of
significant loans and lending relationships and include the accumulation of
related data. This data includes loan payment status, borrowers' financial
data and borrowers' operating factors such as cash flows and operating income
or loss.
The allowance for loan losses is established through a provision for loan
losses charged to expense to reduce the recorded balance of loans to their
estimated net realizable value or fair value, as applicable. Loans are
charged against the allowance for loan losses when management believes that
the collectibility of the principal is unlikely. The allowance is an amount
that management believes will be adequate to absorb possible losses on
existing loans that may become uncollectible, based on the evaluations of the
collectibility of loans and prior loan loss experience. The evaluations take
into consideration such factors as changes in the nature and volume of the
loan portfolio quality, review of specific problem loans, and current
economic conditions and trends that may affect the borrowers' ability to pay.
d. Income Recognition on Impaired and Nonaccrual Loans - Loans, including
impaired loans, are generally classified as nonaccrual if they are past due
as to maturity or payment of principal or interest for a period of more than
90 days, unless such loans are well-secured and in the process of collection.
If a loan or a portion of a loan is classified as doubtful or is partially
charged off, the loan is generally classified as nonaccrual. Loans that are
on a current payment status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is
in doubt.
Loans may be returned to accrual status when all principal and interest
amounts contractually due (including arrearages) are reasonably assured of
repayment within an acceptable period of time, and there is a sustained
period of repayment performance (generally a minimum of six months) by the
borrower, in accordance with the contractual terms of interest and principal.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
d. Income Recognition on Impaired and Nonaccrual Loans (Continued) - While a
loan is classified as nonaccrual and the future collectibility of the
recorded loan balance is doubtful, collections of interest and principal are
generally applied as a reduction to the principal outstanding, except in the
case of loans with scheduled amortization where the payment is generally
applied to the oldest payment due. When the future collectibility of the
recorded loan balance is expected, interest income may be recognized on a
cash basis. In the case where a nonaccrual loan had been partially charged-
off, recognition of interest on a cash basis is limited to that which would
have been recognized on the recorded loan balance at the contractual interest
rate. Receipts in excess of that amount are recorded as recoveries to the
allowance for loan losses until prior charge-offs have been fully recovered.
e. Foreclosed Real Estate - Foreclosed real estate is recorded initially at the
lower of the loan balance plus unpaid accrued interest or estimated fair
value of the property less estimated costs to sell at the date of foreclosure
and subsequently reduced by additional allowances which are charged to
earnings if the estimated fair value declines below its initial value plus
any capitalized costs. Costs related to the improvement of the property are
capitalized, whereas those related to holding the property are expensed.
f. Premises and Equipment - Premises and equipment are carried at cost less
accumulated depreciation and amortization. The provision for depreciation is
computed using the straight-line method over the estimated useful lives of
the various classes of assets. Useful lives range from 15 to 40 years for
buildings and 5 to 10 years for furniture and equipment. The cost of
leasehold improvements is amortized on the straight-line method over the
lesser of the lives of the improvements or the terms of the leases. Repairs
and maintenance are charged to expense as incurred.
g. Income Taxes - Deferred tax asset and liability balances are determined by
application to temporary differences of the tax rate expected to be in effect
when taxes will become payable or receivable. Temporary differences are
differences between the tax basis of assets and liabilities and their
reported amounts in the consolidated financial statements that will result in
taxable or deductible amounts in future years.
The Company and its subsidiary file consolidated federal income tax returns.
h. Goodwill - Goodwill is amortized using the straight-line method over 25
years. The Company evaluates intangible assets for potential impairment by
analyzing the operating results, trends and prospects for the Company, as
well as by comparing them to their competitors. The Company also takes into
consideration recent acquisition patterns within the banking industry and any
other events or circumstances which might indicate potential impairment.
During fiscal year 1996, it was determined that the recorded investment in
goodwill was impaired. Accordingly, the carrying value was written down to
net realizable value through a charge to earnings of $3,359,791.
i. Earnings Per Share - Earnings per share is calculated by dividing net income
by the weighted average number of common shares and common share equivalents
of stock options outstanding during the period using the treasury stock
method.
The weighted average common shares outstanding for the year ended December
31, 1996 were 1,490,977. The weighted average common and common share
equivalents outstanding were 1,582,389 and 1,584,859 for the periods ended
December 31, 1995 and 1994, respectively. Weighted average common shares
assuming full dilution outstanding during the periods ended December 31, 1995
and 1994 were 1,593,385, and 1,587,418 respectively. Unearned ESOP shares are
not included in the computations of earnings per share.
j. New Accounting Pronouncement - Effective January 1, 1997, the Company will
adopt the applicable provisions of Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities". The impact of adopting this
statement is not expected to be material to the Company's consolidated
financial statements.
k. Reclassifications - Certain amounts in the 1995 and 1994 financial statements
have been reclassified to conform with the 1996 presentation with no effect
on previously reported stockholders' equity or net income.
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SECURITIES
Securities at December 31, 1996 and 1995 are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
1996
U.S. Government and agency securities:
Held to maturity ........................ $21,053,628 $ - $1,347,999 $19,705,629
Available for sale ...................... 6,003,733 1,250 58,733 5,946,250
-----------------------------------------------------------------
$27,057,361 $ 1,250 $1,406,732 $25,651,879
=================================================================
1995
U.S. Government and agency securities:
Held to maturity ........................ $21,063,310 - $1,177,490 $19,885,820
=================================================================
</TABLE>
Maturities of Securities at December 31, 1996 are summarized as follows:
<TABLE>
<CAPTION>
Estimated
Amortized Market
Cost Value
----------- -----------
<S> <C> <C>
Held to maturity:
After 5 years through 10 years .................. $16,053,628 $15,024,065
After 10 years .................................. 5,000,000 4,681,564
---------------------------
Total ..................................... $21,053,628 $19,705,629
===========================
Available for sale after 1 through 5 years ........ $ 6,003,733 $ 5,946,250
===========================
</TABLE>
Gross realized gains and losses on the sale of securities are summarized as
follows for the years ended December 31, 1996 and 1995 and the nine months
ended December 31, 1994:
<TABLE>
<CAPTION>
1996 1995 1994
----------------------------------------
<S> <C> <C> <C>
Gross realized gains ............ $52,496 $29,545 $377,704
Gross realized losses ........... - 6,916 223,765
</TABLE>
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. MORTGAGE-BACKED AND RELATED SECURITIES
Mortgage-backed and related securities available for sale at December 31,
1996 and 1995 are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
1996:
GNMA certificates ...................... $ 5,081,604 $ - $ 143,357 $ 4,938,247
FNMA certificates ...................... 6,720,961 19,185 166,425 6,573,721
FHLMC certificates ..................... 2,565,813 9,073 - 2,574,886
Collateralized mortgage obligations .... 15,038,140 - 300,076 14,738,064
------------------------------------------------------------------
Total .......................... $29,406,518 $ 28,258 $ 609,858 $28,824,918
==================================================================
1995:
GNMA certificates ...................... $ 5,150,278 $ - $ 134,100 $ 5,016,178
FNMA certificates ...................... 8,220,516 10,783 170,215 8,061,084
FHLMC certificates ..................... 2,990,845 37,267 - 3,028,112
Collateralized mortgage obligations .... 15,038,140 - 236,173 14,801,967
------------------------------------------------------------------
Total .......................... $31,399,779 $ 48,050 $ 540,488 $30,907,341
==================================================================
</TABLE>
There were no sales of mortgage-backed and related securities for the years
ended December 31, 1996 and 1995. The Company realized gains of $120,427 on
sales during the nine months ended December 31, 1994.
Expected maturities for mortgage-backed and related securities will differ
from contractual maturities because borrowers have the right to call or
prepay obligations with or without call or prepayment penalties.
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. OTHER INVESTMENTS
Other investments at December 31, 1996 and 1995 are summarized as follows:
<TABLE>
<CAPTION>
1996 1995
--------------------------
<S> <C> <C>
Federal Home Loan Bank of Atlanta ("FHLB") stock .... $2,435,000 $2,531,700
FNMA stock .......................................... - 401
US League Savings Insurance Group, Ltd. stock ....... - 55,000
--------------------------
Total .................................... $2,435,000 $2,587,101
==========================
</TABLE>
The Company, as member of the Federal Home Loan Bank System, is required to
maintain an investment in capital stock of the FHLB in an amount equal to the
greater of 1% of its outstanding home loans or 5% of its outstanding FHLB
advances. No ready market exists for the FHLB stock, and it has no quoted
market value.
5. LOANS RECEIVABLE
Loans receivable at December 31, 1996 and 1995 are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Mortgage loans collateralized by real estate:
1-4 family residential properties ............... $226,765 $203,577
Multi-family residential properties ............. 4,959 5,185
Non residential properties ...................... 5,205 7,145
1-4 family residential properties under
construction ................................... 23,152 17,684
Nonresidential properties under construction..... 752 698
Multi-family residential properties under
construction ................................... 267 -
Installment loans collateralized by real estate:
1-4 family residential properties ............... 8,820 5,368
Multi-family residential properties ............. 212 -
Nonresidential properties ....................... 475 -
Multifamily residential properties under
construction ................................... 2,400 -
Consumer loans ....................................... 3,564 3,351
Business loans ....................................... 510 -
Consumer and business loans under construction ....... 525 -
--------------------------
Total loans ............................. 277,606 243,008
Less:
Undisbursed portion of construction loans ....... 12,205 6,958
Discounts and other ............................. 1,281 1,305
Loan loss reserve ............................... 807 737
--------------------------
Net loans ............................... $263,313 $234,008
==========================
</TABLE>
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. LOANS RECEIVABLE (CONTINUED)
Activity in the allowance for loan losses for the year ended December 31,
1996 and 1995 and the nine months ended December 31, 1994 is summarized as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------------------------------------
<S> <C> <C> <C>
Balance at beginning of period ............. $737,000 $737,000 $737,000
Provision for loan losses .................. 155,809 2,658 -
Loans charged-off .......................... (85,270) (2,658) -
----------------------------------------
Balance at end of period ................... $807,539 $737,000 $737,000
========================================
</TABLE>
The following is a summary of nonperforming assets at December 31, 1996
and 1995 (in thousands):
<TABLE>
<CAPTION>
1996 1995
----------------------
<S> <C> <C>
Loans 90 days past due and still accruing interest ................ $ 665 $ 201
Nonaccrual loans .................................................. 787 242
Other real estate owned ........................................... 42 329
----------------------
$1,494 $ 772
======================
</TABLE>
In the normal course of business, the Company enters into off-balance sheet
commitments to extend credit. The Company maintains the same credit policies
in making off-balance sheet commitments as it does for its on-balance sheet
instruments. Commitments to extend credit are agreements to lend which
generally have fixed expiration dates or other termination clauses and may
require a fee.
The following table summarizes the Company's outstanding off-balance sheet
commitments to extend credit at December 31, 1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
1996 1995
----------------------
<S> <C> <C>
Undisbursed portion of home equity lines of credit
collateralized primarily by junior liens on 1-4
family properties .................................... $ 5,274 $4,585
Unsecured commitments and credit lines ................. 2,807 838
Fixed-rate mortgage loan commitments ................... 1,565 180
Adjustable-rate mortgage loan commitments .............. 3,287 1,117
----------------------
Total ..................................... $12,933 $6,720
======================
</TABLE>
The Company, through its normal lending activity, originates and maintains
loans receivable which are substantially concentrated in Eastern North
Carolina, where its offices are located. The Company's policy calls for
collateral or other forms of repayment assurance to be received from the
borrower at the time of loan originations. Such collateral or other form of
repayment assurance is subject to changes in economic value due to various
factors beyond the control of the Company and such changes could be
significant.
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. LOANS RECEIVABLE (CONTINUED)
The Company originates both adjustable and fixed interest rate loans. The
composition of these loans at December 31, 1996 and 1995 is summarized as
follows (in thousands):
<TABLE>
<CAPTION>
Fixed-rate Adjustable-rate
- ----------------------------------------------- --------------------------------------------------
Term to
Maturity 1996 1995 Rate Adjustment 1996 1995
- ------------------ ------- ------- ------------------ -------- --------
<S> <C> <C> <S> <C> <C>
1 month - 1 year $ 2,573 $ 2,573 1 month - 1 year $151,879 $134,792
1 year - 3 years 3,054 1,324 1 year - 3 years 17,936 36,140
3 years - 5 years 1,817 919 3 years - 5 years 11,574 629
5 years - 10 years 5,706 4,423 5 years - 10 years 1,419 -
Over 10 years 68,162 53,945 Over 10 years - -
- ----------------------------------------------- --------------------------------------------------
Total $81,312 $63,184 Total $182,808 $171,561
=============================================== ==================================================
</TABLE>
The adjustable-rate loans have interest rate adjustment limitations and are
indexed to various nationally recognized indexes or financial instruments.
Future market factors may affect the correlation of the interest rate
adjustment with rates the Company pays on the short term deposits that have
been primarily utilized to fund these loans.
Mortgage loans serviced for others were sold without recourse and
approximated $62,753,000 and $73,843,000 and $61,625,000 at December 31,
1996, 1995, and 1994, respectively.
On January 1, 1996 the Company adopted Statement of Financial Accounting
Standards No. 122, "Accounting for Mortgage Servicing Rights, an Amendment of
FASB Statement No. 65". This statement requires that enterprises recognize
as separate assets rights to service mortgage loans for others, however those
rights are acquired. As there were no purchases of servicing rights or sales
of loans during 1996, there is no recorded investment in mortgage servicing
rights at December 31, 1996.
Servicing loans for others generally consists of collecting mortgage
payments, maintaining escrow accounts, disbursing payments to investors and
foreclosure processing. Loan servicing income is recorded on the cash basis
and includes servicing fees from investors and certain charges collected from
borrowers, such as late payment fees.
6. PREMISES AND EQUIPMENT
Premises and equipment at December 31, 1996 and 1995 are summarized as
follows:
<TABLE>
<CAPTION>
1996 1995
---------------------------
<S> <C> <C>
Land................................................. $ 1,446,531 $ 1,446,531
Buildings ........................................... 4,785,996 4,797,041
Leasehold improvements .............................. 438,739 432,839
Furniture and equipment ............................. 3,486,791 3,964,894
---------------------------
10,158,057 10,641,305
Less accumulated depreciation and amortization ...... (5,371,765) (5,615,718)
---------------------------
Total ............................... $ 4,786,292 $ 5,025,587
===========================
</TABLE>
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. DEPOSITS
Deposits at December 31, 1996 and 1995, and their weighted average rates
("WAR"), are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
1996 1995
-------------------- --------------------
WAR BALANCE WAR Balance
-------------------- -------------------
<S> <C> <C> <C> <C>
NOW accounts, including non-
interest-bearing deposits of
$4,231 and $1,831, respectively 0.76% $17,104 1.27% $ 12,229
Money Market 2.14 7,670 2.14 8,347
Savings 2.00 35,782 2.15 37,287
Certificates of deposit:
3 month 4.44 6,788 4.84 9,530
6 month 4.87 31,565 5.43 51,567
7 month 5.55 22,188 - -
9 month 5.65 2,566 - -
12 month 5.23 54,292 5.95 89,331
13 month 5.89 39,719 - -
18 month 5.47 17,935 5.89 20,062
22 month 6.11 16,618 - -
24 month 5.86 18,435 5.97 32,965
30 month 5.52 2,757 5.19 3,178
36 month 5.42 4,720 5.08 5,575
-------- ---------
Total certificates of deposit 5.46% 217,583 5.74% 212,208
-------- ---------
Total deposits 4.63% $278,139 5.00% $270,071
======== =========
Total deposits - non-compounded
weighted average rate 4.51% 4.83%
</TABLE>
Certificates of deposit of $100,000 or more at December 31, 1996 and 1995
are summarized by maturity as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
-----------------------
<S> <C> <C>
3 months or less............................ $11,265 $ 8,492
Over 3 through 6 months..................... 9,198 8,031
Over 6 through 12 months.................... 15,948 14,220
Over 12 months.............................. 6,655 3,067
-----------------------
Total................................ $43,066 $33,810
=======================
</TABLE>
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. DEPOSITS (CONTINUED)
Interest expense on deposits for the years ended December 31, 1996 and 1995
and the nine months ended December 31, 1994 is summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------------------
<S> <C> <C> <C>
NOW accounts................................... $ 114,890 $ 136,114 $ 138,013
Money Market................................... 164,968 208,900 207,467
Savings........................................ 716,878 932,748 1,157,758
Certificates of deposit........................ 11,673,248 11,364,699 5,768,813
------------------------------------------
Total....................................... $12,669,984 $12,642,461 $7,272,051
==========================================
</TABLE>
8. BORROWED FUNDS
Borrowed funds at December 31, 1996 and 1995 are summarized
as follows:
<TABLE>
<CAPTION>
1996 1995
----------------------------
<S> <C> <C>
Advances from FHLB.............................................. $35,000,000 $10,000,000
Affordable housing Progarm advances from FHLB................... 145,362 89,017
----------------------------
Total.................................................. $35,145,362 $10,089,017
============================
</TABLE>
Pursuant to a collateral agreement with the FHLB, advances are secured by all
the Company's FHLB stock and qualifying first mortgage loans. This agreement
provides for an $82 million line of credit with the FHLB. The maximum month
end balances were $35 million, $27 million, and $22 million during the years
ended December 31, 1996 and 1995 and the nine months ended December 31, 1994,
respectively.
Annual principal maturities of Federal Home Bank advances for
each of the five years subsequent to December 31, 1996 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1997........................................................................................ $10,000,000
1998........................................................................................ 5,000,000
1999........................................................................................ 10,000,000
2000........................................................................................ -
2001........................................................................................ 10,000,000
-----------
Total $35,000,000
</TABLE>
The Affordable Housing Program advances are funds advanced by the FHLB for
the Company to re-lend to borrowers who might not otherwise qualify for a
home mortgage. These advances have an interest rate of 3.5% and mature at
various times between November 2015 and January 2016.
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. BORROWED FUNDS (CONTINUED)
Information concerning securities sold under agreement to repurchase for
the year ended December 31, 1995 and the nine months ended December 31,
1994 is summarized as follows:
<TABLE>
<CAPTION>
1995 1994
---------- ------------
<S> <C> <C>
Average balance during the period.................................... $1,446,000 $ 1,413,000
Maximum month end balance during the period.......................... 9,000,000 26,332,000
Weighted average interest rate....................................... 5.65% 3.37%
Mortgage-backed securities underlying the
agreement at end of period (carried at
market value)....................................................... $ - $ 9,281,000
</TABLE>
There were no securities sold under agreement to repurchase at December 31,
1995 or during the year ended December 31, 1996.
Interest expense on borrowed funds is summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------------------------------------
<S> <C> <C> <C>
Advances from FHLB........................................... $960,408 $ 976,707 $ 553,093
Securities sold under agreement to repurchase................ - 81,750 477,217
--------------------------------------
Total....................................... $960,408 $1,058,457 $1,030,310
======================================
</TABLE>
9. REGULATORY MATTERS AND CAPITAL REQUIREMENTS
The Company is subject to various regulatory capital requirements
administered by the federal and state 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 financial statements.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios, as set forth in
the table below. Management believes, as of December 31, 1996, that the
Company meets all capital adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification from the FDIC
categorized the Company as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized the
Company must maintain minimum amounts and ratios, as set forth in the table
below. There are no conditions or events since that notification that
management believes have changed the Company's category.
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. REGULATORY MATTERS AND CAPITAL REQUIREMENTS (CONTINUED)
The Company's actual capital amounts and ratios are also presented in the
table below (dollars in thousands):
<TABLE>
<CAPTION>
TO BE
WELL CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-----------------------------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-----------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996:
- ------------------------
Total Capital (to Risk Weighted Assets)............... $26,649 15.0% $14,215 8.0% $17,768 10.0%
Tier I Capital (to Risk Weighted Assets).............. 25,842 14.5 7,107 4.0 10,661 6.0
Tier I Capital (to Average Assets).................... 25,842 7.8 13,286 4.0 16,608 5.0
Total Tangible Capital (to Total Tangilbe Assets)..... 25,740 7.5 17,065 5.0 17,065 5.0
As of December 31, 1995:
- ------------------------
Total Capital (to Risk Weighted Assets)............... $26,516 17.2% $12,311 8.0% $15,389 10.0%
Tier I Capital (to Risk Weighted Assets).............. 25,779 16.8 6,156 4.0 9,234 6.0
Tier I Capital (to Average Assets).................... 25,779 8.3 12,425 4.0 15,531 5.0
Total Tangible Capital (to Total Tangilbe Assets)..... 25,481 8.3 15,412 5.0 15,412 5.0
</TABLE>
A liquidation account was established at the time of conversion to a stock
institution in an amount equal to the total net worth of the Bank as of March
31, 1991. Each eligible deposit account holder is entitled to a
proportionate share of this account in the event of a complete liquidation of
the Bank, and only in such an event . This share will be reduced if the
account holder's eligible deposits fall below the amount on the date of
record and will cease to exist if the account is closed. The liquidation
account will never be increased despite any increase after the conversion in
the related eligible deposit of an account holder. The liquidation account
was approximately $4,428,000 at December 31, 1996.
The Company may not declare or pay a cash dividend, or repurchase any of its
capital stock, if the effect would cause the regulatory net worth of the
Company to fall below the amount required for the liquidation account
established in connection with the conversion, or to an amount which is less
than the minimum required by the FDIC and the North Carolina Savings
Institutions Administrator ("N.C. Administrator"). A stock savings bank
which has been converted from mutual form for less than five years must
obtain the prior written approval of the N.C. Administrator before it can
declare and pay a cash dividend on its capital stock in an amount in excess
of one-half of the greater of (i) the net income for the most recent fiscal
year, or (ii) the average of the net income after dividends for the most
recent fiscal year and not more than two of the immediately preceding fiscal
years, if applicable.
During 1996, a memorandum of understanding with certain regulators was
entered into, complied with, and lifted.
On September 30, 1996, Congress passed into law a recapitalization plan for
the Savings Association Insurance Fund (the "SAIF"), the insurance fund
covering deposits of savings institutions. The approved plan provided for a
special assessment of 0.66% on certain deposits as of March 31, 1995. The
Company's assessment amounted to approximately $1,783,000. Future deposit
insurance premiums are expected to decrease to approximately .06% from the
.23% of deposits previously paid by the Company.
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. BENEFIT PLANS
The Company has a qualified, noncontributory defined-benefit retirement
plan (the "Plan") covering substantially all of its employees. The
benefits are based on each employee's years of service and the employee's
compensation during the last ten years of employment. The Company's
funding policy is to contribute annually the maximum amount that can be
deducted for federal income tax purposes. Contributions are intended to
provide not only for benefits attributed to service to date but also for
those expected to be earned in the future.
On October 25, 1996 the Plan was amended to change the Plan from a single
employer plan to a multi-employer plan. The effective date of the
amendment is January 1, 1996. All other provisions of the Plan remain
substantially the same, with the exception of Plan funding. Under the
multi-employer plan, the Company will be required to contribute its share
of the Plan's total pension liability as determined by the plan
administrator. There were no contributions required or made to the Plan
during 1996.
At December 31, 1995, the Company had accrued pension cost related to the
Plan of $300,784. Upon conversion to a multi-employer plan, the liability
was eliminated and recognized as a reduction of pension expense. The
Company recognized $139,350 and $132,246 as the net periodic pension cost
related to the Plan for the periods ended December 31, 1995 and 1994,
respectively.
The Company also maintains an Employee Stock Ownership Plan (the "ESOP")
for the exclusive benefit of participating employees with the Company.
Participating employees are full-time employees age 21 or older who have
completed one year of service. Contributions to the ESOP are allocated
among participants on the basis of total compensation paid each plan year.
Except for participants who retire, become disabled, or die during the
plan year, all other participants must be employed on the last day of the
plan year in order to receive an allocation.
Participant benefits become 100% vested after five years of service.
Vesting will be accelerated upon retirement, death, disability or
termination of the ESOP. Forfeitures are reallocated to participants on
the same basis as other contributions in the following plan year. Benefits
may be payable upon retirement, death, disability, or separation from
service. The Company's contributions to the ESOP are determined solely at
the discretion of the Board of Directors.
On December 23, 1996 the ESOP borrowed $800,000 from another financial
institution and purchased 42,187 shares of the Company's common stock from
the defined benefit plan at $18.92 per share. These shares purchased serve
as collateral for the loan and the loan is guaranteed by the Company.
Accordingly, the loan was recorded by the Company as a liability and the
shares recorded as a separate component of stockholders' equity.
On December 30, 1996, the Company contributed $510,000 to the ESOP to
repay a portion of the note. This released 27,000 shares from serving as
collateral for the loan. These shares were allocated to the participants
according to the plan specifications on December 31, 1996. At December 31,
1996 there are 15,187 unearned ESOP shares, with an estimated market value
of approximately $308,000, held in suspense.
The net expense incurred by the Company for these benefit plans, including
the effect of the change in the defined benefit plan noted earlier, was
$209,216, $179,350, and $148,246 for the periods ended December 31, 1996,
1995, and 1994, respectively.
On January 1, 1997 the ESOP will be merged into a combined ESOP and 401(k)
plan (the "KSOP"). The employees' ESOP accounts will be transferred to
their KSOP accounts on that date. Employees will be able to contribute up
to 15% of their eligible compensation, subject to Internal Revenue Service
limitations. The Company will match employee contributions up to a limit
determined annually by the Board of Directors, which for 1997 will be 6%
of employee contributions.
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. INCOME TAXES
Income tax expense consists of the following components for the years
ended December 31, 1996 and 1995 and the nine months ended December 31,
1994:
<TABLE>
<CAPTION>
1996 1995 1994
--------------------------------------------
<S> <C> <C> <C>
Current tax provision.................................................,, $284,846 $ 826,117 $1,296,709
Deferred tax provision (benefit)........................................ 290,700 (151,600) 58,968
--------------------------------------------
Total......................................................... $575,546 $ 674,517 $1,355,677
============================================
</TABLE>
The components of the net deferred tax liability at December 31, 1996 and
1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Deferred tax assets:
Unrealized loss on securities available for sale............................................. $ 266,818 $ 194,500
Accrued pension.............................................................................. - 118,810
Other........................................................................................ 9,534 28,222
--------------------------
Total................................................................................ 276,352 341,532
--------------------------
Deferred tax liabilities:
Deferred loan fees......................................................................... 578,299 667,345
Allowance for loan losses.................................................................. 394,412 181,075
FHLB stock................................................................................. 212,381 238,190
Excess servicing fees...................................................................... 24,011 9,276
Excess of book over tax basis of equipment................................................. 143,132 103,146
--------------------------
Total................................................................................ 1,352,235 1,199,032
--------------------------
Net deferred tax liability........................................................... $1,075,883 $ 857,500
==========================
</TABLE>
Reconciliations of income taxes computed at the statutory federal income
tax rate (34%) to the provisions for income tax for the years ended
December 31, 1996 and 1995 and the nine months ended December 31, 1994 are
as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Income taxes at federal tax rate........................................ $ (909,265) $577,625 $1,306,460
Increase (decrease) resulting from:
Amortizaiton and impairment of goodwill............................... 1,216,807 99,303 74,478
State income taxes, net of federal income tax benefit................. 59,071 20,130 90,237
Other................................................................. 208,933 (22,541) (115,498)
--------------------------------------------
Total......................................................... $ 575,546 $ 674,517 $1,355,677
============================================
</TABLE>
31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. INCOME TAXES (CONTINUED)
On August 21, 1996, The Small Business Job Protection Act was signed into
law which repeals the favorable tax bad debt deduction method available to
savings banks. The Company will be required to change its tax bad debt
method to the experience method under Internal Revenue Code Section 585
effective for fiscal year ended December 31, 1996. It is anticipated that
the change in method will result in taxable income of approximately
$2,166,000 representing the excess of the Company's tax bad debt reserve
at December 31, 1996 over the reserve that arose in tax years beginning
before December 31, 1987 (base year amount). Generally, the income will be
recognized for tax purposes ratably over a six-year period. A deferred tax
liability has been established for the effect of this new legislation.
As of December 31, 1996, the Bank's bad debt reserve for federal tax
purposes was approximately $5,169,000 which represents the base year
amount. A deferred tax liability has not been recognized for the base year
amount. If the Bank uses the base year reserve for any reason other than
to avoid loan losses, a tax liability could be incurred. It is not
anticipated that the reserve will be used for any other purpose.
12. STOCK OPTION PLANS
The stockholders of the Company adopted a Stock Option Plan (the "Option
Plan") for selected employees of the Company and for the nonemployee
directors. The purpose of the Option Plan is to attract and retain the
best available personnel for positions of substantial responsibility and
to provide additional incentive to key employees and directors by
facilitating their purchase of a stock interest in the Company.
The Option Plan provides for a term of ten years, after which no awards
may be made, unless earlier terminated by the Board of Directors pursuant
to the Option Plan. The option exercise price is the market price of the
common stock on the date the option is granted. Options are fully vested
upon being granted.
The Plan is administered by the Option Plan Committee, a group consisting
of four nonemployee directors of the Company, who are "disinterested
persons" within the meaning of the federal securities law.
No options were granted or exercised during the years ended December 31,
1996 and December 31, 1995, or the nine months ended December 31, 1994. At
December 31, 1996, all outstanding stock options are exercisable and
exercise prices range from $3.55 to $15.00. On January 1, 1996 the Company
adopted Statement of Financial Accounting Standards No. 123, "Accounting
for Stock Based Compensation". As permitted by SFAS 123, the Company has
chosen to apply APB opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations. The proforma disclosure
requirements of SFAS are not applicable as there were no grants in the
periods presented. Stock options, after giving retroactive effect to stock
dividends and splits, are summarized as follows:
<TABLE>
<CAPTION>
All Directors
who are not
All Officers Executive Officers Reserved
as a group as a group for future
(6 persons) (7 persons) Total issuance
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance, December 31, 1996 and 1995 and 1994.............. 113,260 25,141 138,401 5,824
=================================================================
</TABLE>
The weighted average exercise price of these options is $5.66.
32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCK OPTION PLANS (CONTINUED)
The following table summarizes additional information about the Plan's
stock options at December 31, 1996:
<TABLE>
<CAPTION>
NUMBER REMAINING NUMBER
OUTSTANDING CONTRACTUAL EXERCISABLE
EXERCISE PRICE AT 12/31/96 LIFE AT 12/31/96
- -------------- -----------------------------------------------
<S> <C> <C> <C>
$ 3.55..................................................................... 106,977 4.75 years 106,977
$ 5.33..................................................................... 3,712 4.75 years 3,712
$ 6.40..................................................................... 3,712 4.75 years 3,712
$15.00..................................................................... 24,000 4.75 years 24,000
-----------------------------------------------
138,401 138,401
========= ===========
</TABLE>
13. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of Cooperative Bankshares, Inc., the
parent company, at December 31, 1996 and 1995 and for the years ended
December 31, 1996 and 1995, and the nine months ended December 31, 1994 is
presented below:
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF FINANCIAL CONDITION
1996 1995
---------------------------
<S> <C> <C>
Assets:
Cash......................................................................................... $ 4,072 $ 16,649
Equity investment in subsidiary.............................................................. 25,426,326 29,011,934
Deferred organization costs.................................................................. 39,152 54,307
---------------------------
$25,469,550 $29,082,890
===========================
Liabilities and Stockholders' Equity:
Stockholders' equity......................................................................... $25,469,550 $29,082,890
===========================
</TABLE>
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF OPERATIONS
1996 1995 1994
----------------------------------------------
<S> <C> <C> <C>
Equity in earnings (loss) of subsidiary............................... $(3,222,121) $1,052,137 $2,507,477
Miscellaneous expenses................................................ 27,732 27,756 20,624
----------------------------------------------
Net income (loss)........................................... $(3,249,853) $1,024,381 $2,486,853
==============================================
</TABLE>
33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF CASH FLOWS
1996 1995 1994
-------------------------------------------
<S> <C> <C> <C>
Operating Activities
Net income (loss) ........................................... $(3,249,853) $ 1,024,381 $ 2,486,853
Equity in undistributed earnings of subsidiary .............. 3,222,121 (1,052,137) (2,507,477)
Amortization of deferred organization costs ................. 15,155 15,156 6,315
Payment of deferred organization costs ...................... - - (75,778)
-------------------------------------------
Cash flows used in operating activities ..................... (12,577) (12,600) (90,087)
Investing Activities
Dividends received from subsidiary .......................... - - 119,336
-------------------------------------------
Increase (decrease) in cash and cash equivalents ............ (12,577) (12,600) 29,249
Cash and cash equivalents, beginning of period ................... 16,649 29,249 -
-------------------------------------------
Cash and cash equivalents, end of period ......................... $ 4,072 $ 16,649 $ 29,249
===========================================
</TABLE>
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments
is made in accordance with the requirements of Statement of Financial
Accounting Standards No. 107, "Disclosures About Fair Value of Financial
Instruments". The estimated fair value amounts have been determined by the
Company using the methods and assumptions described below. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
that value.
Cash and Cash Equivalents
The carrying amount is a reasonable estimate of fair value.
Securities, Mortgage-Backed and Related Securities, and Other Investments
For investments in debt securities, fair values are based on quoted
market prices or dealer quotes. For other securities, fair value
equals quoted market price, if available. If a quoted market price is
not available, fair value is estimated using quoted market prices for
similar securities.
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Loans Receivable
The fair value of loans receivable is estimated by discounting the
future cash flows using the current rates at which similar loans would
be made to borrowers with similar credit ratings and for the same
remaining maturities.
Deposits
The fair value of NOW, savings, and money market deposit accounts is
the amount payable on demand at the reporting date. The fair value of
fixed-maturity certificates of deposit is estimated using the rates
currently offered for deposits of similar remaining maturities.
Borrowed Funds and ESOP Note Payable
Borrowed funds consist of FHLB borrowings with varying maturities.
The fair values of these liabilities and the ESOP note payable are
estimated using the discounted values of the contractual cash flows.
The discount rate is estimated using the rates currently in effect for
similar borrowings.
Off-Balance Sheet Financial Instruments
The fair value of off-balance sheet financial instruments has not been
considered in determining on balance sheet fair value. As discussed
in Note 5, these off-balance sheet financial instruments are
commitments to extend credit and are either short term in nature or
subject to immediate repricing.
35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 1996 and 1995 are as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
------------------------- -------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents ............. $ 11,507 $ 11,507 $ 11,889 $ 11,889
Securities:
Available for sale ................. 5,946 5,946 - -
Held to maturity ................... 21,054 19,706 21,063 19,886
Mortgage-backed and related securities:
Available for sale ................. 28,825 28,825 30,907 30,907
Loans receivable:
Gross loans ........................ 264,120 266,467 234,745 237,686
Allowance for loan losses .......... (807) (807) (737) (737)
------------------------ ------------------------
Loans receivable, net .............. 263,313 265,660 234,008 236,949
Other investments...................... 2,435 2,435 2,587 2,587
------------------------ ------------------------
Total ...................... $333,080 $334,079 $300,454 $302,218
======================== ========================
Financial liabilities:
Deposits .............................. $278,139 $272,503 $270,071 $270,567
Borrowed funds ........................ 35,435 35,252 10,089 10,094
------------------------ ------------------------
Total ...................... $313,574 $307,755 $280,160 $280,661
======================== ========================
</TABLE>
The Company's remaining assets and liabilities are not considered financial
instruments.
36
<PAGE>
BLANK
37
<PAGE>
DIRECTORS, OFFICERS AND OFFICE LOCATIONS
BOARD OF DIRECTORS
FREDERICK WILLETTS, JR., CHAIRMAN
Cooperative Bankshares, Inc. and
Cooperative Bank For Savings, Inc., SSB
FREDERICK WILLETTS, III JAMES D. HUNDLEY, M.D.
President and Chief Executive Officer, Partner, Wilmington Orthopaedic
Cooperative Bankshares, Inc. and Group P.A.
Cooperative Bank for Savings, Inc., SSB
CHARLES H. BONEY H.T. KING, III
President and Chief Executive Officer, President, Hanover Iron Works,
Boney Architects Inc.
PAUL G. BURTON DR. WILLIAM H. WAGONER
President, Burton Steel Company Chancellor Emeritus of the
University of North Carolina
at Wilmington
F. PETER FENSEL, JR. O. RICHARD WRIGHT, JR.
President, F. P. Fensel Supply Company Attorney, McGougan Wright Worley
& Harper
OFFICERS OF COOPERATIVE BANK FOR SAVINGS, INC., SSB
Frederick Willetts, Jr. ..... Chairman of the Board & Executive Vice President
Frederick Willetts, III ..... President & Chief Executive Officer
O .C. Burrell, Jr. .......... Senior Vice President - Retail Banking
Daniel W. Eller ............. Senior Vice President - Corporate Secretary
Eric R. Gray ................ Senior Vice President - Mortgage Lending
Edward E. Maready ........... Senior Vice President - Treasurer
Linda B. Garland ............ Vice President - Marketing
Carl N. Mathis, Jr. ......... Vice President - Appraising
Donna H. Mitchell ........... Vice President - Mortgage Operations
Dare C. Rhodes .............. Vice President - Human Resources
Todd L. Sammons ............. Vice President - Auditing
Raymond A. Martin ........... Assistant Vice President - Data Processing
OFFICE LOCATIONS
(Number of offices in parentheses)
Beaufort Morehead City
Belhaven Robersonville
Corolla Tabor City
Elizabethtown Wallace
Jacksonville (2) Washington (2)
Kill Devil Hills Wilmington (4)
38
<PAGE>
CORPORATE INFORMATION
CORPORATE HEADQUARTERS
Cooperative Bankshares, Inc.
201 Market Street
P. O. Box 600
Wilmington, North Carolina 28402
(910)343-0181
TRANSFER AGENT SPECIAL COUNSEL
First Citizens Bank Housley Kantarian & Bronstein, P.C.
Corporate Trust Department Suite 700
P.O. Box 29522 1220 19th Street, NW
Raleigh, North Carolina 27626-0522 Washington, DC 20036
ANNUAL MEETING
The Annual Meeting of Stockholders of Cooperative Bankshares, Inc. will be held
at the Wilmington Hilton, 301 N. Water Street, Wilmington, North Carolina on
April 25, 1997 at 11:00 a.m. All stockholders are cordially invited to attend.
FORM 10-K
Copies of Cooperative Bankshares, Inc. Form 10-K may be obtained by stockholders
without charge by writing to Linda B. Garland at the Corporate Headquarters
address.
ADDITIONAL INFORMATION
For additional information please contact Frederick Willetts, III, Daniel W.
Eller or Linda B. Garland at (910) 343-0181
CAPITAL STOCK
Cooperative's common stock is traded on the NASDAQ National Market under the
symbol "COOP". As of December 31, 1996 there were 1,491,698 shares outstanding
which were held by 576 stockholders of record. No cash dividends have been paid
on the common stock since its issuance. Stock performance for 1996 and 1995 is
given in the following table. All prices have been adjusted by the stock
dividend and stock splits as described in the notes to the consolidated
financial statements.
QUARTERLY COMMON STOCK DATA
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
-------------- --------------
QUARTERS ENDED HIGH LOW HIGH LOW
- --------------------------------------------------------------
<S> <C> <C> <C> <C>
December.............. $20.88 $18.25 $22.25 $19.50
September ............ 19.00 16.50 22.50 18.00
June ................. 18.75 17.00 18.75 15.00
March ................ 20.50 18.00 17.25 13.75
</TABLE>
- --------------------------------------------------------------------------------
39
<PAGE>
MAP OF BRANCHES
40
<PAGE>
EXHIBIT 21
<PAGE>
SUBSIDIARIES
State or Other
Jurisdiction of
Incorporation
---------------
Cooperative Bank for Savings, Inc., SSB North Carolina
CS&L Services, Inc. (1) North Carolina
- ----------------
(1) Wholly owned subsidiary of Cooperative Bank for Savings, Inc., SSB.
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
Cooperative Bankshares, Inc. on Form S-8 (File No. 333-22335) of our report
dated January 31, 1997, on our audits of the consolidated financial statements
of Cooperative Bankshares, Inc. as of December 31, 1996 and 1995, and for the
years ended December 31, 1996 and 1995 and the nine months ended December 31,
1994, which is included in this Annual Report on Form 10-K.
/s/ Coopers & Lybrand L.L.P.
Raleigh, North Carolina
March 21, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,423,067
<INT-BEARING-DEPOSITS> 9,084,216
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 37,206,168
<INVESTMENTS-CARRYING> 21,053,628
<INVESTMENTS-MARKET> 19,705,700
<LOANS> 264,120,269
<ALLOWANCE> 807,539
<TOTAL-ASSETS> 341,299,858
<DEPOSITS> 278,138,909
<SHORT-TERM> 35,434,522
<LIABILITIES-OTHER> 2,256,877
<LONG-TERM> 0
0
0
<COMMON> 1,491,698
<OTHER-SE> 23,977,852
<TOTAL-LIABILITIES-AND-EQUITY> 341,299,858
<INTEREST-LOAN> 18,926,560
<INTEREST-INVEST> 3,866,897
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 22,793,457
<INTEREST-DEPOSIT> 12,669,984
<INTEREST-EXPENSE> 13,630,392
<INTEREST-INCOME-NET> 9,163,065
<LOAN-LOSSES> 155,809
<SECURITIES-GAINS> 52,496
<EXPENSE-OTHER> 12,251,079
<INCOME-PRETAX> (2,674,307)
<INCOME-PRE-EXTRAORDINARY> (2,674,307)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,249,853)
<EPS-PRIMARY> (2.18)
<EPS-DILUTED> (2.18)
<YIELD-ACTUAL> 2.97
<LOANS-NON> 787,290
<LOANS-PAST> 664,957
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 737,000
<CHARGE-OFFS> 85,270
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 807,539
<ALLOWANCE-DOMESTIC> 807,539
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
