<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 1-5735
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Union Financial Bancshares, Inc.
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(Name of small business issuer in its charter)
<TABLE>
<CAPTION>
<S> <C>
Delaware 57-1001177
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
203 West Main Street, Union, South Carolina 29379
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (864) 427-9000
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</TABLE>
Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
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value $.01 per
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share
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(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during
the past 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
------- -------
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
other information statements incorporated by reference in Part III of this Form
10-KSB or any amendments to this Form 10-KSB. X
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The registrant's gross revenues for the fiscal year ended September 30,
1998 were approximately $14,443,000.
As of September 30, 1998, there were issued and outstanding 1,278,250
shares of the registrant's Common Stock. The aggregate market value of the
voting stock, including that held by insiders, computed by reference to the
average bid and asked price on September 30, 1998, was approximately $18,215,062
(1,278,250 shares at $14.25 per share).
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Shareholders for the Fiscal Year Ended
September 30, 1998 (Parts I and II).
2. Portions of the Proxy Statement for the 1999 Annual Meeting of Shareholders
(Part III).
<PAGE>
PART I
ITEM 1. BUSINESS
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GENERAL
Union Financial Bancshares, Inc. ("Union Financial") was incorporated in
the State of Delaware in April 1994 for the purpose of becoming a savings and
loan holding company for Provident Community Bank (formerly known as Union
Federal Savings Bank, (the "Bank"). On August 24, 1994, the stockholders of the
Bank approved a plan to reorganize the Bank into the holding company form of
ownership. The reorganization was completed on November 9, 1994, on which date
the Bank became the wholly-owned subsidiary of Union Financial, and the
shareholders of the Bank became shareholders of Union Financial. Prior to
completion of the reorganization, Union Financial had no material assets or
liabilities and engaged in no business activities. Subsequent to the
acquisition of Union Federal, Union Financial has engaged in no significant
activity other than holding the stock of the Bank and certain passive investment
activities. Accordingly, the information set forth in this report, including
financial statements and related data, relates primarily to the Bank. Union
Financial and the Bank are collectively referred to as "the Corporation" herein.
The Bank is a federally-chartered, capital stock savings bank headquartered
in Union, South Carolina. The Bank, which was originally chartered in 1934 as a
mutual savings and loan association, converted from mutual to stock form in
1987. The Bank was known as Union Federal Savings and Loan Association until
1992, when it converted its charter to a federal savings bank charter and
changed its name to Union Federal Savings Bank. In 1997, the Bank changed its
name to Provident Community Bank. The Bank conducts its operations through its
main office, which is located at 203 West Main Street, Union, South Carolina,
and three full service banking centers located in Union, Jonesville, and
Laurens, South Carolina. The Jonesville banking center was approved by the OTS
in March 1994 and opened with a temporary office in July 1994. A permanent
facility is being constructed on the site with a projected completion date of
April, 1999. The Bank acquired its Laurens banking center in 1997 in a purchase
and assumption agreement with First Union National Bank of South Carolina. For
additional information, see "Properties." The Bank is a member of the Federal
Home Loan Bank ("FHLB") and its deposits are insured up to applicable limits by
the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance
Corporation ("FDIC").
The business of the Bank consists primarily of attracting deposits from the
general public and originating mortgage loans on residential properties located
in Laurens and Union County, South Carolina. The Bank also makes commercial
real estate, construction and consumer loans and invests in obligations of the
federal government and its agencies and of state and local municipalities. The
Bank purchases both fixed and adjustable rate mortgage-backed securities issued
by Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage
Association ("FNMA") and Government National Mortgage Association ("GNMA"). The
Bank has purchased fixed and variable rate mortgages originated by other
organizations. Historically, the Bank's primary lending focus has been on the
origination of long-term, fixed-rate mortgage loans for its portfolio.
Beginning in fiscal year 1989, the Bank began originating adjustable-rate
mortgage loans ("ARMs") and in 1992 began selling its fixed-rate loans in the
secondary market. See "Lending Activities." The principal sources of funds for
the Bank's lending activities include deposits received from the general public,
interest and principal repayments on loans and, to a lesser extent, borrowings
from the FHLB-Atlanta. The Bank's primary source of income is interest earned
on loans and investments. The Bank's principal expense is interest paid on
deposit accounts and borrowings and expenses incurred in operating the Bank.
RECENT DEVELOPMENTS
On October 5, 1998, the Corporation, through its subsidiary, Provident
Community Bank, entered into a definitive agreement with CCB Financial's wholly-
owned subsidiary, American Federal Bank, FSB to purchase the deposits of
American Federal's Union, South Carolina banking center. At September 30, 1998,
this branch had $14,756,000 in deposits. This transaction is expected to close
in February, 1999.
2
<PAGE>
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS/COST
The following table sets forth certain information for the periods
indicated regarding average balances of assets and liabilities as well as the
total dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and average yields and
costs. Such yields and costs for the periods indicated are derived by dividing
income or expense by the average monthly balance of assets or liabilities,
respectively, for the periods presented. Average balances are derived from
month-end balances. Management does not believe that the use of month-end
balances instead of daily balances results in any material difference in the
information presented.
3
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------------------ ------------------------------ --------------------------
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>
(Dollars in Thousands)
Interest-earning assets:
Loans receivable, net (1)... $146,515 $11,865 8.10% $120,542 $ 9,747 8.08% $ 73,026 $6,436 8.81%
Mortgage-backed securities 8,610 599 6.96% 8,079 546 6.76 16,867 1,105 6.55
Investment securities:
Taxable..................... 12,432 814 6.55% 19,691 1,462 7.42 18,891 1,249 6.61
Nontaxable.................. 449 17 3.88% 952 37 3.92 2,665 122 4.58
-------- ------- -------- ------- -------- ------
Total investment securities 12,881 831 6.45% 20,643 1,499 7.26 21,556 1,371 6.36
-------- ------- -------- ------- -------- ------
Overnight deposits.......... 3,103 110 3.54% 2,076 63 3.03 2,747 92 3.35
-------- ------- -------- ------
Total interest-earning
assets................... 171,109 13,406 7.83% 151,340 11,855 7.83 114,196 9,004 7.88
Non-interest-earning assets 6,055 5,072 3,821
-------- -------- --------
Total assets.............. $177,164 :$156,412 $118,017
======== ========
Interest-bearing
liabilities:
Savings accounts............ 11,527 253 2.20% 11,611 274 2.36 $ 11,641 302 2.59
Negotiable order of
withdrawal ("NOW")
accounts................... 24,056 411 1.71% 20,493 353 1.72 12,581 264 2.10
Certificate accounts........ 88,492 4,880 5.51% 75,008 4,038 5.38 70,069 3,913 5.58
FHLB advances and other
borrowings................. 35,197 2,005 5.70% 35,237 1,982 5.62 9,499 571 6.01
-------- ------- -------- ------- -------- ------
Total interest-bearing
liabilities.............. 159,272 7,549 4.74% 142,349 6,647 4.67 103,790 5,050 4.87
------
Non-interest-bearing
liabilities................ 3,494 1,180 1,936
-------- -------- --------
Total liabilities......... 162,766 143,529 105,726
-------- --------
Shareholders' equity........ 14,398 12,883 12,291
-------- -------- --------
Total liabilities and
shareholders' equity..... $177,164 $156,412 $118,017
======== ======== ========
Net interest income......... $ 5,856 $ 5,208 $3,954
======= ======= ======
Interest rate spread (2).... 3.09% 3.16% 3.01%
Net interest margin (3)..... 3.42% 3.44% 3.46%
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities................ 1.07x 1.06x 1.10x
- ---------------------------
</TABLE>
(1) Average loans receivable includes nonaccruing loans. Interest income does
not include interest on loans 90 days or more past due.
(2) Represents difference between weighted average yield on all interest-
earning assets and weighted average rate on all interest-bearing
liabilities.
(3) Represents net interest income before provision for loan losses as a
percentage of average interest-earning assets.
4
<PAGE>
LENDING ACTIVITIES
GENERAL. The principal lending activity of the Corporation has
historically been the origination of conventional single family residential
mortgage loans. The Corporation's net loan portfolio totaled approximately
$142.2 million at September 30, 1998, representing approximately 75.0% of total
assets. At September 30, 1998, approximately $65.7 million, or 46.2% of the
Corporation's total loan portfolio, consisted of long-term, fixed-rate mortgage
loans. As of September 30, 1998, ARMs represented approximately $48.7 million,
or 34.2% of the total loan portfolio. See "Real Estate Loans."
Set forth below is selected data relating to the composition of the
Corporation's loan portfolio on the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
At September 30,
---------------------------------------------------------------
1998 1997 1996
---------------------- ------------------- ------------------
Amount Percent Amount Percent Amount Percent
----------- -------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
First mortgage loans:
Conventional................... $114,383 80.44% $105,242 80.98% $70,959 82.51%
Construction loans............. 12,838 9.03 13,508 10.39 4,627 5.38
Participation loans purchased.. 665 0.47 1,002 .77 1,133 1.32
-------- ------ -------- ------ ------- ------
Total mortgage loans......... 127,886 89.94 119,752 92.14 76,719 89.21
-------- ------ -------- ------ ------- ------
Second mortgage loans............ 5,857 4.12 4,478 3.45 1,484 1.73
Consumer and installment
loans.......................... 14,218 10.00 12,990 10.00 9,871 11.48
Savings account loans............ 1.551 1.09 183 .14 414 0.48
-------- ------ -------- ------ ------- ------
Total loans.................. 149,512 105.15 137,403 105.73 88,488 102.90
------ ------- ------
Less:
Undisbursed loans in process... (6,625) (4.66) (6,598) (5.08) (1,644) (1.91)
Allowance for loan losses...... (827) (.59) (928) (.71) (799) (0.93)
Deferred loan fees............. 142 .10 80 .06 (48) (0.06)
-------- ------ -------- ------ ------- ------
Net loans receivable......... $142,202 100.00% $129,957 100.00% $85,997 100.00%
======== ====== ======== ====== ======= ======
</TABLE>
5
<PAGE>
The following table sets forth, at September 30, 1998, certain information
regarding the dollar amount of principal repayments for loans becoming due
during the periods indicated (in thousands). Demand loans (loans having no
stated schedule of repayments and no stated maturity) and overdrafts are
reported as due in one year or less.
<TABLE>
<CAPTION>
Due After Due After Due After
Due 1 Year 3 Years 5 Years
Within Through Through Through Due After
One Year 3 Years 5 Years 10 Years 10 Years Total
-------- ------- ------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
First mortgage loans:
Conventional loans............ $15,206 $16,270 $17,537 $45,053 $20,317 $114,383
Construction loans (a)........ 12,838 12,838
Participation loans
purchased..................... 665 665
Second mortgage loans........... 5,857 5,857
Consumer and installment loans.. 4,965 3,782 2,333 2,031 1,107 14,218
Savings account loans........... 1,551 ----- 1,551
-------- ------- ------- -------- -------- ---------
Total......................... $34,560 $20,052 $19,870 $47,084 $27,946 $149,512
======= ======= ======= ======== ======== =========
</TABLE>
- ------------------------
(a) These construction loans include construction/permanent loans.
The actual average life of mortgage loans is substantially less than their
contractual term because of loan repayments and because of enforcement of due-
on-sale clauses which give the Corporation the right to declare a loan
immediately due and payable in the event, among other things, that the borrower
sells the real property subject to the mortgage and the loan is not repaid. The
average life of mortgage loans tends to increase, however, when current mortgage
loan rates substantially exceed rates on existing mortgage loans.
The following table sets forth the dollar amount of loans due after
September 30, 1999 which have fixed rates of interest and which have adjustable
rates of interest (in thousands).
<TABLE>
<CAPTION>
Fixed Rate Adjustable Rate Total
---------- --------------- --------
<S> <C> <C> <C>
Real estate mortgage loans.. $50,506 $48,671 $ 99,177
Consumer and other loans.... 9,918 5,857 15,775
------- ------- --------
Total $60,424 $54,528 $114,952
======= ======= ========
</TABLE>
6
<PAGE>
REAL ESTATE LOANS. The primary lending activity of the Corporation has been
the origination of conventional mortgage loans to enable borrowers to purchase
existing single family homes or to construct new homes. The Corporation's
residential real estate loan portfolio also includes loans on multi-family
dwellings (more than five units). At September 30, 1998, approximately 85.9% of
the Corporation's total loan portfolio consisted of loans secured by residential
real estate (net of undisbursed principal).
OTS regulations limit the amount which federally chartered savings
institutions may lend in relationship to the appraised value of the real estate
securing the loan, as determined by an appraisal at the time of loan
origination. Federal regulations permit a maximum loan-to-value ratio of 100%
for one- to four-family dwellings and 80% for all other real estate loans. The
Corporation's lending policies, however, limit the maximum loan-to-value ratio
on one-to four-family real estate mortgage loans to 80% of the lesser of the
appraised value or the purchase price. Any single-family loan made in excess of
an 80% loan-to-value ratio and any commercial real estate loan in excess of a
75% loan-to-value ratio is required to have private mortgage insurance or
additional collateral. In the past, the Corporation has originated some
commercial real estate loans in excess of a 75% loan-to-value ratio without
private mortgage insurance or additional collateral.
The loan-to-value ratio, maturity and other provisions of the loans made by
the Corporation have generally reflected a policy of making less than the
maximum loan permissible under applicable regulations, market conditions, and
underwriting standards established by the Corporation. Mortgage loans made by
the Corporation are generally long-term loans (15-30 years), amortized on a
monthly basis, with principal and interest due on each month. In the
Corporation's experience, real estate loans remain outstanding for significantly
shorter periods than their contractual terms. Borrowers may refinance or prepay
loans, at their option, with no prepayment penalty.
The Corporation offers a full complement of mortgage lending products with
both fixed and adjustable rates. Due to the nature of the Corporation's
marketplace, only a small percentage of "local" loans are adjustable-rate loans.
The majority of adjustable-rate loans in the portfolio are originated outside of
Union and Laurens County by third party originators. The Corporation has
established a network of third party loan brokers who originate loans for the
Corporation, as well as other originators, throughout the state of South
Carolina. These loans are originated and underwritten using the same terms and
conditions as loans originated by the Corporation. The Corporation offers ARMs
tied to U.S. Treasury Bills with a maximum interest rate adjustment of 2%
annually and 6% over the life of the loan. At September 30, 1998, the
Corporation had approximately $48.7 million of ARMs, or 34.2% of the
Corporation's total outstanding loan portfolio.
At September 30, 1998, 46.2% of the Corporation's loan portfolio consisted
of long-term, fixed-rate real estate loans. Because of this high concentration
of fixed-rate loans, the Corporation is more vulnerable to a reduction in net
interest income during periods of increasing market interest rates. Net
interest income depends to a large extent on how successful the Corporation is
in "matching" interest-earning assets and interest-bearing liabilities. The
Corporation has taken steps to reduce its exposure to rising interest rates.
For a discussion of these steps, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Annual Report.
Beginning in fiscal year 1992, the Corporation began selling a portion of
current year loan production to the FHLMC. The Corporation sells fixed-rate
loans with maturities ranging from ten to 30 years. This activity is one method
used by the Corporation to reduce its interest rate risk exposure. The loans
are sold without recourse and the Corporation retains 25 basis points for
servicing these loans. During the year ended September 30, 1998, the
Corporation sold approximately $123.7 million of its fixed-rate mortgage loans.
The Corporation purchases participation interests from other financial
institutions on a selected basis. These purchased interests are adjustable-rate
loans and are collaterized by either residential or commercial real estate. At
September 30, 1998, these interests totaled approximately $665,000.
7
<PAGE>
Commercial real estate loans constituted approximately $4.2 million, or
2.9% of Union Financial's loan portfolio at September 30, 1998. Commercial real
estate loans consist of permanent loans secured by multi-family properties,
generally apartment houses, as well as commercial and industrial properties,
including office buildings, warehouses, shopping centers, hotels, motels and
other special purpose properties. Commercial real estate loans have been
originated and purchased for inclusion in the Corporation's portfolio. These
loans generally have 20 to 30 year amortization schedules and are callable or
have balloon payments of five to ten years. Typically, the loan documents
provide for adjustment of the interest rate every one to three years. Fixed-
rate loans secured by multi-family residential and commercial properties have
terms ranging from 20 to 25 years.
Loans secured by commercial properties may involve greater risk than single-
family residential loans. Such loans generally are substantially larger than
single-family residential loans. The payment experience on loans secured by
commercial properties typically depends on the successful operation of the
properties, and thus may be subject to a greater extent to adverse conditions in
the real estate market or in the economy generally.
CONSTRUCTION LOANS. The Corporation engages in construction lending that is
primarily secured by single family residential real estate and, to a much lesser
extent, commercial real estate. These loans are made for a maximum 12-month
construction period and require monthly interest payments. In some cases these
loans automatically convert to a permanent loan requiring monthly principal and
interest payments. The Corporation also grants construction loans to
individuals with a takeout for permanent financing from another financial
institution, and to approved builders on both presold and unsold properties.
Loan brokers are the Corporation's primary source for construction loans.
The loan broker sends the Corporation both individuals seeking construction
financing for their personal dwelling or builders seeking lines of credit for
the construction of single family residences on both presold and unsold
properties. Individuals are made construction loans that mature in one year or
less or construction/permanent loans that convert to permanent loans at the end
of the construction period. Builders are made construction loans for a term not
to exceed 12 months. Generally, all draw inspections are handled by the
appraiser who initially appraised the property; however, in some instances the
draw inspections are performed by the originating brokerage firm.
Construction financing overall is generally considered to involve a higher
degree of credit risk than the long-term financing of residential properties.
The Corporation's risk of loss on a construction loan is dependent largely upon
the accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. If the estimate of construction cost or the salability of the
property upon completion of the project proves to be inaccurate, the Corporation
may be required to advance funds beyond the amount originally committed to
permit completion of the development. If the estimate of value proves to be
inaccurate, the Corporation may be confronted at or prior to the maturity of the
loan with a projection of a value which is insufficient to assure full
repayment. Although these loans afford the Corporation the opportunity to
achieve higher interest rates and fees with shorter terms to maturity than do
single-family permanent mortgage loans, construction loans are generally
considered to involve a higher degree of risk than single-family permanent
mortgage lending due to (i) the concentration of principal among relatively few
borrowers and development projects, (ii) the increased difficulty at the time
the loan is made of estimating the building costs and selling price of the
residence to be built, (iii) the increased difficulty and costs of monitoring
the loan, (iv) the higher degree of sensitivity to increases in market rates of
interest and (v) the increased difficulty of working out loan problems.
Speculative construction loans have the added risk associated with identifying
an end-purchaser for the finished home.
At September 30, 1998, the Corporation had approximately $12.8 million
outstanding in construction loans, including approximately $6.6 million in
undisbursed proceeds. Of the $12.8 million in construction loans at September
30, 1998, approximately $2.1 million were "speculative," meaning that, at the
time the loan was made, there was no sales contract or permanent loan in place
for the finished home. Substantially all of these loans were secured by one- to
four-family residences.
8
<PAGE>
CONSUMER LOANS. Federal regulations permit federally chartered thrift
institutions to make secured and unsecured consumer loans up to 35% of the
institution's assets. In addition, a federal thrift institution has lending
authority above the 35% category for certain consumer loans, such as home equity
loans, property improvement loans, mobile home loans and loans secured by
savings accounts. The Corporation's consumer loan portfolio consists primarily
of automobile loans on new and used vehicles, mobile home loans, boat loans,
home equity loans, property improvement loans, loans secured by savings accounts
and unsecured loans. As of September 30, 1998, consumer loans amounted to $14.2
million, or 10% of the Corporation's total loan portfolio. The Corporation
makes consumer loans to serve the needs of its customers and as a way to improve
the interest-rate sensitivity of the Corporation's loan portfolio. Consumer
loans tend to bear higher rates of interest and have shorter terms to maturity
than residential mortgage loans; however, nationally, consumer loans have
historically tended to have a higher rate of default than residential mortgage
loans.
LOAN SOLICITATION AND PROCESSING. Loan originations come from both walk-in
customers and loan brokers. The loan origination process for walk-in customers
includes an initial interview with an officer of the Corporation for the purpose
of obtaining a formal application. Upon receipt of a loan application from a
prospective borrower, a credit report is ordered to verify specific information
relating to the loan applicant's employment, income and credit standing. This
information may be further verified by personal contacts with other reference
sources. An appraisal of the real estate intended to secure the proposed loan
is undertaken by pre-approved, independent fee appraisers. As soon as the
required information has been obtained and the appraisal completed, the loan is
submitted to the authorized officer, loan committees or full Board of Directors
for review. The Corporation utilizes various officers and loan committees for
the approval of real estate loans. The President/Chief Executive Officer has
the authority to approve loan requests up to and including $500,000 in secured
credit and up to and including $150,000 in unsecured credit. The Board of
Directors has appointed an Executive Loan Committee comprised of seven senior
executive Bank officers consisting of the President/Chief Executive Officer, the
Executive Vice President/Chief Financial Officer, the Vice President/Chief
Operating Officer, the Vice President/Credit Administration Manager, Assistant
Vice President/Consumer Loan Manager, Vice President/Mortgage Loan Acquisitions
and and Vice President/Mortgage Lending Sales Manager. This Committee has the
authority to approve all loan requests up to and including $500,000 in secured
credit and up to and including $150,000 in unsecured credit. A quorum of two
members is required for any action. The Board of Directors has also appointed a
Board Loan Committee comprised of two members elected annually from the Board of
Directors and four senior executive officers of the Bank. A quorum of three
members, including at least one Board member, is required for any action. This
Committee has the authority to approve all secured and unsecured loan requests
up to the Bank's legal lending limit with the exception of a single loan request
exceeding $1,000,000 in secured credit and exceeding $300,000 in unsecured
credit. Single loan requests exceeding $1,000,000 in secured credit and
$300,000 in unsecured credit require approval of the entire Board of Directors.
Loan applicants are promptly notified of the decision of the Corporation by
telephone, setting forth the terms and conditions of the decision. If approved,
these terms and conditions include the amount of the loan, interest rate,
amortization term, and a brief description of the real estate to be mortgaged to
the Corporation. The Corporation also issues a commitment letter to the
potential borrower which typically remains in effect for 60 days. The
Corporation's experience is that very few commitments go unfunded. See "Loan
Commitments." The borrower is required to pay all costs of the Corporation, as
well as his/her own costs, incurred in connection with the particular loan
closing. The Corporation originated approximately $20.2 million in mortgage
loans from walk-in customers during fiscal year 1998.
The Board of Directors has appointed a second review loan committee to
review all denied loan applications. This committee reviews the rationale used
to deny credit and reviews denied applications for the possibility of being able
to supply credit under a different loan program, or under different terms and
conditions. Every attempt is made to supply credit to creditworthy applicants
in a manner consistent with their needs.
LOAN ORIGINATIONS, PURCHASES AND SALES. Prior to fiscal year 1992, all
mortgage loans originated by the Corporation were retained in the Corporation's
loan portfolio. Most of these loans were long-term, fixed-rate real estate
loans. Beginning in 1992, the Corporation began selling a portion of its
current long-term, fixed-rate loan production
9
<PAGE>
to FHLMC on a servicing-retained basis. These were cash sales with no recourse
provisions. The Corporation receives 25 basis points for servicing these loans.
During fiscal year 1997 the Corporation established Provident Mortgage
Corporation as a division of Provident Community Bank. The primary purpose of
the mortgage division is to purchase residential mortgage loans that will be
packaged as securities and sold in the secondary market. The mortgage division
purchases the loans from mortgage brokers primarily located in South Carolina.
The loan types purchased are primarily fixed rate residential along with some
adjustable rate residential. In addition, construction/permanent loans will also
be purchased. The mortgage division had total purchases through the broker
network of $141.4 million with loan sales of $123.7 million. The mortgage
division will limit the Bank's interest rate risk exposure by purchasing
forward commitments whereby approximately 50% to 75% of projected closings will
be presold. The mortgage division retains the servicing of the loans in order to
generate additional fee income for the Bank. At September 30, 1998 the Bank was
servicing $164.4 million of loans for others.
The Corporation purchases participation interests in loans originated by
other institutions. These participation interests are on both residential and
commercial properties and carry either a fixed or adjustable interest rate.
The following table sets forth the Corporation's loan origination and sale
activity for the periods indicated (in thousands):
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------
1998 1997 1996
-------- -------- -------
<S> <C> <C> <C>
Loans originated:
First mortgage loans:
Loans on existing property......................... $150,924 $ 83,419 $25,853
Construction loans................................. 10,728 17,649 2,516
-------- -------- -------
Total mortgage loans
originated (1)................................. 161,652 101,068 28,369
Consumer and other loans............................ 23,351 15,984 8,139
-------- -------- -------
Total loans originated........................... $185,003 $117,052 $36,508
======== ======== =======
Loans purchased....................................... -- -- $ 570
Loans sold............................................ $123,676 $ 46,763 $ 810
</TABLE>
(1) Includes mortgage division loans purchased.
LOAN COMMITMENTS. The Corporation's commitments to make conventional
mortgage loans on existing residential dwellings are normally made for periods
of up to 30 days from the date of loan approval. Union Financial's total loan
commitments outstanding as of September 30, 1998 were approximately $2,736,000.
See "Financial Condition, Liquidity and Capital Resources" in the Annual Report.
LOAN ORIGINATION AND OTHER FEES. In addition to interest earned on loans
and fees for making loan commitments, the Corporation charges origination fees
or "points" for originating loans. Loan origination fees are usually a
percentage of the principal amount of the mortgage loan, typically between .5%
and 2%, depending on the terms and conditions. The Corporation does not receive
origination fees on broker loans, but does receive a $150 review fee. The
Corporation also offers loan products that require no origination fees to walk-
in customers. Other fees collected include late charges applied to delinquent
payments and fees collected in connection with loan modifications. The
Corporation charges a 5% late charge fee on payments delinquent 15 days or more
on new loan originations, loan modifications, loan assumptions and loans
currently in the Corporation's portfolio where applicable. The 5% late charge
is calculated on the delinquent monthly principal and interest payment amount.
Late charges and modification
10
<PAGE>
fees do not constitute a material source of income. Current accounting standards
require fees received (net of certain loan origination costs) for originating
loans to be deferred and amortized into interest income over the contractual
life of the loan. As of September 30, 1998, the Corporation had net deferred
loan fees of approximately $142,000.
PROBLEM ASSETS AND ASSET CLASSIFICATION. When a borrower fails to make a
required payment on a loan, the Corporation attempts to cure the default by
contacting the borrower. In general, borrowers are contacted after a payment is
more than 30 days past due. In most cases, defaults are cured promptly. If the
delinquency on a mortgage loan is not cured through the Corporation's normal
collection procedures, or an acceptable arrangement is not worked out with the
borrower, the Corporation will institute measures to remedy the default,
including commencing a foreclosure action. The Corporation generally does not
accept voluntary deeds of the secured property in lieu of foreclosure.
Loans are reviewed on a regular basis and an allowance for uncollectible
interest is established against accrued interest receivable when, in the opinion
of management, the collection of additional interest is doubtful. An allowance
for uncollectible interest on real estate loans and consumer loans is
established when either principal or interest is more than 90 days past due.
Subsequent payments are either applied to the outstanding principal balance or
recorded as interest income, depending on the assessment of the ultimate
collectibility of the loan. See Note 3 of Notes to Financial Statements.
The Corporation generally determines a loan to be impaired at the time
management believes that it is probable that the principal and interest may be
uncollectible. Management has determined that, generally, a failure to make a
payment within a 90-day period constitutes a minimum delay or shortfall and does
not generally constitute an impaired loan. However, management reviews each
past due loan on a loan-by-loan basis and may determine a loan to be impaired
prior to the loan becoming over 90 days past due, depending upon the
circumstances of that particular loan. A loan is classified as a nonaccrual at
the time management believes that the collection of interest is improbable,
generally when a loan becomes 90 days past due. The Corporation's policy for
charge-off of impaired loans is on a loan-by-loan basis. At the time management
believes the collection of interest and principal is remote, the loan is charged
off. The Corporation's policy is to evaluate impaired loans based on the fair
value of the collateral. Interest income from impaired loans is recorded using
the cash method.
Real estate acquired by the Corporation as a result of foreclosure or by
deed in lieu of foreclosure is classified as real estate acquired in the
settlement of loans. When such property is acquired it is recorded at the lower
of the unpaid principal balance of the related loan or its fair market value.
Any subsequent write-down of the property is charged to income.
The following table sets forth information with respect to the Corporation's
non-performing assets for the periods indicated (dollars in thousands). It is
the policy of the Corporation to cease accruing interest on loans 90 days or
more past due. At the dates indicated, there were no restructured loans within
the meaning of Statement of Financial Accounting Standards ("SFAS") No. 15 and
no impaired loans as defined by SFAS No. 114 and SFAS No. 118. Also, at the
dates indicated, there were no loans which are not disclosed in the following
table about which there was known information of possible credit problems of the
borrowers' ability to comply with the present repayment terms:
<TABLE>
<CAPTION>
At September 30,
----------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Loans accounted for
on a nonaccrual basis:
Real estate:
Residential............. $ 581 $ 751 $1,049
Commercial.............. -- -- 74
Construction............ -- -- --
</TABLE>
11
<PAGE>
<TABLE>
<S> <C> <C> <C>
Consumer.................. 115 27 --
----- ----- ------
Total................. $ 696 $ 778 $1,123
----- ----- ------
Accruing loans which are
contractually past due
90 days or more............. -- -- --
Real estate owned, net....... 35 1 19
----- ----- ------
Total non-performing assets.. $ 779 $ 1 $ 142
===== ===== ======
Percentage of loans
receivable net............ .55% .60% 1.33%
===== ===== ======
</TABLE>
Interest income that would have been recorded for the year ended September
30, 1998 had non-accruing loans been current in accordance with their original
terms amounted to approximately $20,000. The amount of interest included in
interest income on such loans for the year ended September 30, 1998 amounted to
approximately $0.
ALLOWANCE FOR LOAN LOSSES. In originating loans, the Corporation
recognizes that losses will be experienced and that the risk of loss will vary
with, among other things, the type of loan being made, the creditworthiness of
the borrower over the term of the loan, general economic conditions and, in the
case of a secured loan, the quality of the security for the loan. To cover
losses inherent in the portfolio of performing loans, the Corporation maintains
an allowance for loan losses. Management's periodic evaluation of the adequacy
of the allowance is based on a number of factors, including management's
evaluation of the collectibility of the loan portfolio, the nature of the
portfolio, credit concentrations, trends in historical loss experience, specific
impaired loans and economic conditions. Specific valuation allowances are
established to absorb losses on loans for which full collectibility may not be
reasonably assured. The amount of the allowance is based on the estimated value
of the collateral securing the loan and other analysis pertinent to each
situation.
The Corporation increases its allowance for loan losses by charging
provisions for loan losses against income. The allowance for loan losses is
maintained at an amount management considers adequate to absorb losses inherent
in the portfolio. Although management believes that it uses the best information
available to make such determinations, future adjustments to the allowance for
loan losses may be necessary and results of operations could be significantly
and adversely affected if circumstances differ substantially from the
assumptions used in making the determinations.
While the Bank believes it has established its existing allowance for loan
losses in accordance with GAAP, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to increase
significantly its allowance for loan losses. In addition, because future events
affecting borrowers and collateral cannot be predicted with certainty, there can
be no assurance that the existing allowance for loan losses is adequate or that
substantial increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above. Any material increase
in the allowance for loan losses may adversely affect the Corporation's
financial condition and results of operations. Management periodically
evaluates the adequacy of the allowance based upon historical delinquency rates,
the size of the Corporation's loan portfolio and various other factors. See
Notes 1 and 3 of Notes to Consolidated Financial Statements for information
concerning the Corporation's provision and allowance for possible loan losses.
The following table sets forth an analysis of the Corporation's allowance
for loan losses for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
At September 30,
----------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Balance at beginning of period: $ 928 $ 799 $ 878
----- ----- -----
Loans charged-off:
</TABLE>
12
<PAGE>
<TABLE>
<S> <C> <C> <C>
Real estate:
Residential...................... -- -- (6)
Commercial....................... -- -- --
Consumer........................... (127) (165) (88)
----- ----- -----
Total charge-offs.............. (127) (165) (94)
----- ----- -----
Recoveries:
Real estate:
Residential...................... -- -- --
Commercial....................... -- -- --
Consumer........................... 26 51 15
----- ----- -----
Total recoveries............... 26 51 15
----- ----- -----
Net (charge-offs) recoveries......... (101) (114) (79)
----- ----- -----
Provision for loan losses(1)......... -- 243 --
----- ----- -----
Balance at end of period............. $ 827 $ 928 $ 799
===== ===== =====
Ratio of net charge-offs to average
gross loans outstanding during
the period......................... .07% .09% .11%
===== ===== =====
</TABLE>
- ---------------------------
(1) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in the Annual Report for a discussion of the factors
responsible for changes in the provision for loan losses between the
periods.
13
<PAGE>
The following table sets forth the breakdown of the allowance for loan
losses by loan category and the percentage of loans in each category to total
loans for the periods indicated. Management believes that the allowance can be
allocated by category only on an approximate basis. The allocation of the
allowance to each category is not necessarily indicative of further losses and
does not restrict the use of the allowance to absorb losses in any category
(dollars in thousands):
<TABLE>
<CAPTION>
At September 30,
-------------------------------------------------------------------------
1998 1997 1996
----------------------- ----------------------- -----------------------
% of Loans in % of Loans in % of Loans in
Each Category Each Category Each Category
Amount to Total Loans Amount to Total Loans Amount to Total Loans
------ --------------- ------ --------------- ------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Real estate:
Residential.............. $ 400 85.90% $ 400 83.49% $400 82.81%
Commercial............... 100 2.90 162 4.88 125 3.50
Consumer................. 277 11.20 266 11.63 174 13.69
Unallocated............... 50 N/A 100 N/A 100 N/A
----- ------ ----- ------ ---- ------
Total allowance for loan
losses.................. $ 827 100.00% $ 928 100.00% $799 100.00%
===== ====== ===== ====== ==== ======
</TABLE>
The Corporation maintains an allowance for losses on real estate acquired
in settlement of loans when needed. At September 30, 1998, Union Financial had
an allowance for losses on real estate acquired in settlement of loans of
approximately $0. These values reflect current market conditions and sales
experience. See Notes 1 and 3 of Notes to Consolidated Financial Statements.
The OTS requires savings institutions to classify problem assets. Under
this classification system, problem assets of insured institutions are
classified as "substandard," "doubtful" or "loss," depending on the presence of
certain characteristics discussed below.
ASSET CLASSIFICATION. An asset is considered "substandard" if inadequately
protected by the current net worth and paying capacity of the borrower or of the
collateral pledged, if any. "Substandard" assets include those characterized by
the "distinct possibility" that the institution will sustain some loss if the
deficiencies are not corrected. Assets classified as "doubtful" have all of the
weaknesses inherent in those classified as "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted.
When an institution classifies problem assets as either substandard or
doubtful, it is required to establish general allowances for loan losses in an
amount deemed prudent by management. General allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an institution classifies problem
assets or a portion of assets as loss, it is required either to establish a
specific allowance for losses equal to 100% of the amount of the asset or a
portion thereof so classified or to charge-off such amount. An institution's
determination as to the classification of its assets and the amount of its
valuation allowances is subject to review by the OTS which can order the
establishment of additional general or specific loss allowances.
As of September 30, 1998, the Corporation had approximately $1,446,000 of
loans classified as substandard assets, which included real estate loans
totaling $1,195,000 and consumer loans totaling $251,000. The Corporation had
loans totaling approximately $182,000 classified as doubtful and approximately
$1,979,000 designated as special mention at September 30, 1998, which included
real estate loans totaling $1,491,000 and consumer loans totaling
14
<PAGE>
$488,000. The Corporation carefully monitors its delinquent loans and real
estate owned account as to changes in collectibility and other characteristics
of asset and borrower quality.
INVESTMENT ACTIVITIES
The Corporation is required under OTS regulations to maintain a minimum
amount of liquid assets which may be invested in specified short-term securities
and is also permitted to make certain other investments. The Corporation's
liquidity requirement at September 30, 1998 was $5.2 million. At that date the
Corporation held approximately $19.1 million in liquid funds, well in excess of
regulatory requirements. Such funds consisted of United States Treasury and
Agency obligations, certificates of deposits, overnight deposits, mortgage-
backed securities and municipal bonds.
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," requires that investments be categorized as "held to maturity,"
"trading securities" or "available for sale," based on management's intent as to
the ultimate disposition of each security. SFAS No. 115 allows debt securities
to be classified as "held to maturity" and reported in financial statements at
amortized cost only if the reporting entity has the positive intent and ability
to hold those securities to maturity. Securities that might be sold in response
to changes in market interest rates, changes in the security's prepayment risk,
increases in loan demand, or other similar factors cannot be classified as "held
to maturity." Debt and equity securities held for current resale are classified
as "trading securities." Such securities are reported at fair value, and
unrealized gains and losses on such securities would be included in earnings.
Debt and equity securities not classified as either "held to maturity" or
"trading securities" are classified as "available for sale." Such securities are
reported at fair value, and unrealized gains and losses on such securities are
excluded from earnings and reported as a net amount in a separate component of
equity.
15
<PAGE>
The following table sets forth the Corporation's investment and mortgage-
backed securities portfolio at the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------------
1998 1997 1996
----------------------- --------------------- ---------------------
Carrying Percent of Carrying Percent of Carrying Percent of
Value Portfolio Value Portfolio Value Portfolio
---------- ----------- -------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE:
Investment securities:
U.S. Agency obligations...... $ 7,682 28.60% $10,341 65.22% $12,221 55.12%
Municipal securities........ 451 1.68 447 2.82 1,444 6.51
------- ------ ------- ------ ------- ------
Total investment securities.. 8,133 30.28 10,788 68.04 13,665 61.63
------- ------ ------- ------ ------- ------
Mortgage-backed securities.... 18,723 69.72 5,067 31.96 8,509 38.37
------- ------ ------- ------ ------- ------
Total available for sale...... $26,856 100.00% $15,855 100.00% $22,174 100.00%
======= ====== ======= ====== ======= ======
HELD TO MATURITY:
Investment securities:
U.S. Agency obligations...... $ 1,500 55.58 $ 5,995 76.75% $ 5,473 47.09%
Mortgage-backed securities... 1,199 44.42 1,816 23.25 6,149 52.91
------- ------ ------- ------ ------- ------
Total held to maturity........ $ 2,699 100.00% $ 7,811 100.00% $11,622 100.00%
======= ====== ======= ====== ======= ======
</TABLE>
The Corporation purchases mortgage-backed securities, both fixed-rate and
adjustable-rate, from FHLMC, FNMA and GNMA with maturities from five to 30
years. The Corporation also purchases adjustable-rate Small Business
Administration ("SBA") securities that are backed by the full faith and credit
of the U.S. government.
The Corporation also purchases mortgage derivative securities in the form
of collateralized mortgage obligations ("CMOs") and structured notes. While
these securities possess minimal credit risk due to the Federal guarantee
backing the U. S. government agencies, they do posses liquidity risk and
interest rate risk. The amortized cost of the CMOs on the books at September 30,
1998 was approximately $7,896,000 with a fair value of $7,958,000. The
Corporation has purchased structured notes for investment purposes. These
include step-up bonds, single-index floaters and dual-index floaters. While all
financial instruments are subject to interest rate risk and liquidity risk,
structured notes are more sensitive to changes in interest rates and differing
note structures (call provision, rate adjustments, etc.). The Corporation had
approximately $2.1 million in structured notes as of September 30, 1998 with a
fair value of approximately $2.1 million as of that date. See Note 2 of Notes
to Consolidated Financial Statements for more information regarding investment
and mortgage-backed securities.
16
<PAGE>
The following table sets forth at amortized cost the maturities and
weighted average yields of the Corporation's investment and mortgage-backed
securities portfolio at September 30, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
Amount Due or Repricing within:
------------------------------------------------------------------------------------------------------
One Year Over One to Over Five to Over
or Less Five Years Ten Years Ten Years Total
-------------------- ------------------- ------------------ ------------------ -------------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------- ---------- --------- -------- -------- -------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE:
Investment Securities:
U.S. Agency Obligations.. $500 3.03% $1,546 5.05% $ 220 6.21% $ 5,416 7.50% $ 7,682 6.68%
Municipal Securities(a).. 250 5.30 131 5.93 -- -- 70 8.32 451 5.95
-------- --------- --------- ------- ------ ---- ------- ---- ------- ----
Total Investment
Securities............... 750 3.79 1,677 5.12 220 6.21 5,486 7.51 8,133 6.64
Mortgage-backed Securities 111 7.02 728 7.40 262 5.51 17,622 7.04 18,723 7.03
-------- --------- --------- ------- ------ ---- ------- ---- ------- ----
Total Available for Sale.. 861 4.20% 2,405 5.81 482 5.83 23,108 7.15 26,856 6.91
HELD TO MATURITY:
Investment Securities
U.S. Agency Obligations.. -- -- -- -- 1,500 7.58% -- -- 1,500 7.58
Mortgage-backed
Securities.............. -- -- -- -- -- -- 1,199 7.87 1,199 7.87
-------- --------- --------- ------- ------ ---- ------- ---- ------- ----
Total Held to Maturity... $ -- --% $ -- --% $1,500 7.58% $ 1,199 7.87% $ 2,699 7.71%
</TABLE>
- --------------------------
(a) Yields are presented on a fully taxable equivalent basis.
17
<PAGE>
At September 30, 1998, approximately $1.4 million of debt securities and
$751,000 of mortgage-backed securities were adjustable-rate securities.
At September 30, 1998, the Corporation held obligations of Union County,
South Carolina, in the amount of approximately $99,000 with a fair value of
approximately $102,000 as of the same date.
DEPOSITS AND BORROWINGS
Deposits are the major source of the Corporation's funds for lending and
other investment purposes. In addition to deposits, the Corporation derives
funds from principal repayments and interest payments on loans and investment
and mortgage-backed securities. Principal repayments and interest payments are
a relatively stable source of funds, although principal repayments tend to slow
when interest rates increase. Deposit inflows and outflows may be significantly
influenced by general market interest rates and money market conditions. During
fiscal year 1998, the Corporation experienced a net increases in deposits of
approximately $11.9 million. The Corporation borrowed funds to support the
remaining growth experienced in fiscal 1998.
DEPOSITS. Local deposits are, and traditionally have been, the primary
source of the Corporation's funds for use in lending and for other general
business purposes. The Corporation offers a number of deposit accounts
including NOW accounts, money market savings accounts, passbook and statement
savings accounts, individual retirement accounts ("IRAs") and certificate of
deposit accounts. Deposit accounts vary as to terms regarding withdrawal
provisions, deposit provisions and interest rates.
The Corporation adjusts the interest rates offered on its deposit accounts
as necessary so as to remain competitive with other financial institutions in
Union and Laurens County.
Savings deposits in the Corporation at September 30, 1998 were represented
by the various types of savings programs described below:
<TABLE>
<CAPTION>
Weighted
Average Minimum Percentage
Interest Balance of Total
Deposits Rate Required Balances Balances
- ----------------------------------- --------- -------- -------- -----------
(in thousands)
<S> <C> <C> <C> <C>
NOW accounts:
Commercial non-interest-bearing.. 0.00% $ -- $ 7,119 5.48%
Noncommercial.................... 1.33 250 10,925 8.41%
Money market
checking accounts................ 3.40 1,000 6,832 5.26
Regular savings accounts........... 1.97 100 11,849 9.12
------- -----
Total demand and
savings deposits.............. 1.60 36,725 28.28%
---- ------- -----
Certificates of deposit:
91-day........................... 4.42 500 800 .86%
6 months......................... 4.78 500 18,392 19.72
9-12 months...................... 5.50 500 22,768 24.42
15-19 months..................... 5.70 500 19,833 21.27
20-30 months..................... 5.73 500 12,460 13.36
36-40 months..................... 5.72 500 2,277 2.44
</TABLE>
(table continued on following page)
18
<PAGE>
<TABLE>
<CAPTION>
Weighted
Average Minimum Percentage
Interest Balance of Total
Deposits Rate Required Balances Balances
- ----------------------- --------- -------- -------- -----------
(in thousands)
<S> <C> <C> <C> <C>
48 months............ 5.86% $500 539 .55
60 months............ 6.38 500 3,839 4.25
IRAs................... 5.58 100 12,240 10.57
Total certificates
of deposits....... 5.51 93,148 71.72%
Total deposits......... 4.40 $129,873 100.00%
</TABLE>
TIME DEPOSITS BY RATES AND MATURITY. The following table sets forth the
time deposits of the Corporation classified by rates as of the dates indicated
(in thousands):
<TABLE>
<CAPTION>
At September 30,
---------------------------------
1998 1997 1996
---------- ----------- --------
<S> <C> <C> <C>
Up to 4%.......................................................... $ 37 $ 22 $ 125
4.01% to 6.0%..................................................... 89,155 77,401 61,794
6.01% to 8.0%..................................................... 3,956 5,342 7,139
------- ------- -------
Total savings certificates $93,148 $82,765 $69,058
======= ======= =======
The following table sets forth the maturities of time deposits at
September 30, 1998 (in thousands):
Amount
-------
Within three months.............................................. $27,611
After three months but within six months......................... 29,953
After six months but within one year............................. 17,120
After one year but within three years............................ 14,508
After three years but within five years.......................... 3,956
After five years but within ten years............................ --
-------
Total..................................................... $93,148
=======
</TABLE>
Certificates of deposit with maturities of less than one year increased
from $60.8 million at September 30, 1997 to $74.6 million at September 30, 1998.
Historically, the Bank has been able to retain a significant amount of its
deposits as they mature. In addition, management of the Bank believes that it
can adjust the offering rates of savings certificates to retain deposits in
changing interest rate environments.
19
<PAGE>
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of September 30, 1998 (in
thousands). Jumbo certificates of deposit are certificates in amounts of
$100,000 or more.
<TABLE>
<CAPTION>
Maturity Period Amount
- ------------------------------- -------
<S> <C>
Three months or less........... $ 5,581
Over three through six months.. 6,055
Over six through 12 months..... 3,461
Over 12 months................. 3,732
-------
Total jumbo certificates
of deposit............... $18,829
=======
</TABLE>
See Note 5 of Notes to Consolidated Financial Statements for additional
information about deposit accounts.
BORROWINGS. The Corporation utilizes advances from the FHLB and other
borrowings (treasury, tax and loan deposits) to supplement its supply of
lendable funds for granting loans, making investments and meeting deposit
withdrawal requirements. See "Regulation -- Federal Home Loan Bank System."
The following tables sets forth certain information regarding borrowings by
the Bank at the dates and for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
At September 30,
----------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Balance outstanding at end of period:
FHLB advances and other borrowings........ $41,441 $37,979 $20,488
Weighted average rate paid on:
FHLB advances and other borrowings........ 5.69% 6.00% 6.30%
<CAPTION>
Year Ended September 30,
---------------------------
1998 1997 1996
------- ------- -------
Maximum amount of borrowings
outstanding at any month end:
FHLB advances and other borrowings........ $41,441 $37,979 $20,488
Approximate average short-term borrowings
outstanding with respect to:
FHLB advances and other borrowings........ 35,197 35,237 9,499
Approximate weighted average rate paid on:
FHLB advances and other borrowings........ 5.70% 5.62% 6.01%
</TABLE>
At September 30, 1998, the Corporation had unused short-term lines of credit to
purchase federal funds from unrelated banks totaling $4 million. These lines of
credit are available on a one-to-ten day basis for general purposes of the
Corporation. All of the lenders have reserved the right to withdraw these lines
at their option. At September 30, 1998, the Corporation had unused lines of
credit with the FHLB of Atlanta totaling $8 million.
20
<PAGE>
COMPETITION
The Corporation faces competition in both the attraction of deposit
accounts and in the origination of mortgage and consumer loans. Its most direct
competition for savings deposits has historically derived from other thrift
institutions and commercial banks located in and around Union County, South
Carolina. The Corporation faces additional significant competition for investor
funds from money market instruments and mutual funds. It competes for savings
by offering depositors a variety of savings accounts, convenient office
locations and other services.
The Corporation competes for loans principally through the interest rates
and loan fees it charges and the efficiency and quality of the services it
provides borrowers, real estate brokers and home builders. The Corporation's
competition for real estate loans comes principally from other thrift
institutions, commercial banks and mortgage banking companies.
As of September 30, 1998, a local commercial bank, one branch office of a
regional commercial bank and an office of a regional savings and loan
association were located in Union County, South Carolina. The Corporation is
the largest financial institution based in Union County, South Carolina.
During the fiscal year 1997, the Corporation expanded to Laurens County
with the purchase of a First Union banking center. The makeup of the area and
the competition is similar to that of Union County.
The State of South Carolina has a reciprocity law with twelve other states
and the District of Columbia that allows for interstate mergers between
financial institutions. As of June 30, 1997, federal law permits bank holding
companies from any state to acquire banks in South Carolina. These statutes
have created, and are expected to continue to create, additional competition
from large, out of state, financial institutions.
SUBSIDIARY ACTIVITIES
Under OTS regulations, the Bank generally may invest up to 3% of its assets
in service corporations, provided that at least one-half of the investment in
excess of 1% is used primarily for community, inner-city and community
development projects. In 1997, the Bank formed Provident Financial Services,
Inc. for the purpose of engaging in securities brokerage activities for the
benefit of the Bank's customers.
YEAR 2000 ISSUES
The approach of the year 2000 ("Year 2000") presents significant issues for
many financial, information, and operational systems. Many systems in use today
may not be able to interpret dates after December 31, 1999, appropriately,
because such systems allow only two digits to indicate the year in a date. The
Year 2000 problems may occur in computer programs, computer hardware, or
electronic devices that utilize computer chips to process any information that
contains dates. Therefore, the issue is not limited to dates in computer
programs but is a complex combination of problems that may exist in computer
programs, data files, computer hardware, and other devices essential to the
operation of the business. Further, companies must consider the potential
impact that Year 2000 may have on services provided by third parties.
Substantially all of the Year 2000 risk is related to the Bank's
activities. The Bank has a formal Year 2000 Plan which includes a Year 2000 Task
Force. The Plan has been reviewed by the senior management and the Board of
Directors. Included in the Plan is a listing of all systems (whether in-house or
provided/supported by third parties) which may be impacted by Year 2000 and a
categorization of the systems by their potential impact on Bank operations. The
Task Force has received Year 2000 plans from third parties identified during
21
<PAGE>
the assessment phase of the Year 2000 Plan. For systems that have been
classified as critical to the operations of the Bank, contingency plans have
been developed. Contingency plans may include utilization of alternate third
party vendors, alternate processing methods and software, or manual processing.
The plans have various activation dates (e.g., the date on which a third party
processor fails to meet its Year 2000 compliance deadline). In addition to
addressing its own Year 2000 issues, the Bank is in the process of assessing the
impact of the Year 2000 on significant commercial borrowers. The Bank's Year
2000 readiness is reviewed and monitored by the Office of Thrift Supervision
("OTS").
The Bank core processing systems are outsourced through a contract with The
BISYS Group, Inc. ("BISYS"). BISYS has developed a Year 2000 Plan and provides
the Bank with periodic updates. BISYS also has held Year 2000 workshops, whose
objectives have been to assist the Bank in the development of its Year 2000
Plan, to provide updates on the BISYS Year 2000 plan, and training on the use of
the BISYS Year 2000 test facility, whose function is to allow BISYS clients to
test their systems' compatibility with the BISYS system. BISYS completed all
program maintenance associated with Year 2000 prior to October 31, 1998, and
expects a full year of testing prior to January 1, 2000. Like the Bank, BISYS
Year 2000 activities are subject to OTS oversight.
The incremental cost associated with the Bank's compliance is expected to
be less than $25,000 to $50,000. The majority of all hardware upgrades began in
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1995 as a result of the Bank's plan to increase efficiencies and eliminate
obsolescence of some system components. Should the Bank or any of its third
party service providers fail to complete Year 2000 measures in a timely manner,
it would likely have a material adverse effect, which amount cannot be
reasonably estimated at this time.
EMPLOYEES
The Corporation had 65 full-time employees as of September 30, 1998. None
of the employees are represented by a collective bargaining unit. The
Corporation believes that relations with its employees are excellent.
REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by
the OTS as its chartering agency, and the FDIC, as the insurer of its deposits.
The activities of federal savings institutions are governed by the Home Owners'
Loan Act, as amended ("HOLA") and, in certain respects, the Federal Deposit
Insurance Act ("FDIA") and the regulations issued by the OTS and the FDIC to
implement these statutes. These laws and regulations delineate the nature and
extent of the activities in which federal savings associations may engage.
Lending activities and other investments must comply with various statutory and
regulatory capital requirements. In addition, the Bank's relationship with its
depositors and borrowers is also regulated to a great extent, especially in such
matters as the ownership of deposit accounts and the form and content of the
Bank's mortgage documents. The Bank must file reports with the OTS and the FDIC
concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other financial institutions. There are periodic
examinations by the OTS and the FDIC to review the Bank's compliance with
various regulatory requirements. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such policies, whether by
the OTS, the FDIC or Congress, could have a material adverse impact on the
Corporation, the Bank and their operations. The Corporation, as a savings and
loan holding company, is also required to file certain
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reports with, and otherwise comply with the rules and regulations of, the OTS
and the Securities and Exchange Commission ("SEC").
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS
OFFICE OF THRIFT SUPERVISION. The OTS is an office in the Department of
the Treasury subject to the general oversight of the Secretary of the Treasury.
The OTS generally possesses the supervisory and regulatory duties and
responsibilities formerly vested in the Federal Home Loan Bank Board. Among
other functions, the OTS issues and enforces regulations affecting federally
insured savings associations and regularly examines these institutions.
FEDERAL HOME LOAN BANK SYSTEM. The FHLB System, consisting of 12 FHLBs, is
under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The
designated duties of the FHFB are to: supervise the FHLBs; ensure that the
FHLBs carry out their housing finance mission; ensure that the FHLBs remain
adequately capitalized and able to raise funds in the capital markets; and
ensure that the FHLBs operate in a safe and sound manner. The Bank, as a member
of the FHLB-Atlanta, is required to acquire and hold shares of capital stock in
the FHLB-Atlanta in an amount equal to the greater of (i) 1.0% of the aggregate
outstanding principal amount of residential mortgage loans, home purchase
contracts and similar obligations at the beginning of each year, or (ii) 1/20 of
its advances (borrowings) from the FHLB-Atlanta. The Bank is in compliance with
this requirement with an investment in FHLB-Atlanta stock of $2.0 million at
September 30, 1998. Among other benefits, the FHLB-Atlanta provides a central
credit facility primarily for member institutions. 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-Atlanta.
FEDERAL DEPOSIT INSURANCE CORPORATION. The FDIC is an independent federal
agency that insures the deposits, up to prescribed statutory limits, of
depository institutions. The FDIC maintains two separate insurance funds: the
Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF").
As insurer of the Bank's deposits, the FDIC has examination, supervisory and
enforcement authority over the Bank.
The Bank's deposit accounts are insured by the FDIC under the SAIF to the
maximum extent permitted by law. The Bank pays deposit insurance premiums to
the FDIC based on a risk-based assessment system established by the FDIC for all
SAIF-member institutions. Under applicable regulations, institutions are
assigned to one of three capital groups that are based solely on the level of an
institution's capital ("well capitalized," "adequately capitalized" or
"undercapitalized"), which are defined in the same manner as the regulations
establishing the prompt corrective action system under the Federal Deposit
Insurance Act as discussed below. The matrix so created results in nine
assessment risk classifications, with rates that until September 30, 1996 ranged
from 0.23% for well capitalized, financially sound institutions with only a few
minor weaknesses to 0.31% for undercapitalized institutions that pose a
substantial risk of loss to the SAIF unless effective corrective action is
taken.
Pursuant to the Deposit Insurance Fund Act ("DIF Act"), which was enacted
on September 30, 1996, the FDIC imposed a special assessment on each depository
institution with SAIF-assessable deposits which resulted in the SAIF achieving
its designated reserve ratio. In connection therewith, the FDIC reduced the
assessment schedule for SAIF members, effective January 1, 1997, to a range of
0% to 0.27%, with most institutions, including the Bank, paying 0%. This
assessment schedule is the same as that for the BIF, which reached its
designated reserve ratio in 1995. In addition, since January 1, 1997, SAIF
members are charged an assessment of 0.065% of SAIF-assessable deposits for the
purpose of paying interest on the obligations issued by the Financing
Corporation ("FICO") in the 1980's to help fund the thrift industry cleanup.
BIF-assessable deposits will be charged an assessment to help pay interest on
the FICO bonds at a rate of approximately .013% until the earlier of December
31, 1999 or the date upon which the last savings association ceases to exist,
after which time the assessment will be the same for all insured deposits.
The DIF Act provides for the merger of the BIF and the SAIF into the
Deposit Insurance Fund on January 1, 1999, but only if no insured depository
institution is a savings association on that date. The DIF Act contemplates
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the development of a common charter for all federally chartered depository
institutions and the abolition of separate charters for national banks and
federal savings associations. It is not known what form the common charter may
take and what effect, if any, the adoption of a new charter would have on the
operation of the Bank.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations, or has violated any applicable law, regulation, order or
any condition imposed by an agreement with the FDIC. It also may suspend
deposit insurance temporarily during the hearing process for the permanent
termination of insurance, if the institution has no tangible capital. If
insurance of accounts is terminated, the accounts at the institution at the time
of termination, less subsequent withdrawals, shall continue to be insured for a
period of six months to two years, as determined by the FDIC. Management is
aware of no existing circumstances that could result in termination of the
deposit insurance of the Bank.
LIQUIDITY REQUIREMENTS. Under OTS regulations, each savings institution is
required to maintain an average daily balance of liquid assets (cash, certain
time deposits and savings accounts, bankers' acceptances, and specified U.S.
Government, state or federal agency obligations and certain other investments)
equal to a monthly average of not less than a specified percentage (currently
4.0%) of its net withdrawable accounts plus short-term borrowings. Monetary
penalties may be imposed for failure to meet liquidity requirements.
PROMPT CORRECTIVE ACTION. Under the FDIA, each federal banking agency is
required to implement a system of prompt corrective action for institutions that
it regulates. The federal banking agencies have promulgated substantially
similar regulations to implement this system of prompt corrective action. Under
the regulations, an institution shall be deemed to be (i) "well capitalized" if
it has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-
based capital ratio of 6.0% or more, has a leverage ratio of 5.0% or more and is
not subject to specified requirements to meet and maintain a specific capital
level for any capital measure; (ii) "adequately capitalized" if it has a total
risk-based capital ratio of 8.0% or more, has a Tier I risk-based capital ratio
of 4.0% or more, has a leverage ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized", (iii)
"undercapitalized" if it has a total risk-based capital ratio that is less than
8.0%, has a Tier I risk-based capital ratio that is less than 4.0% or a leverage
ratio that is less than 4.0% (3.0% under certain circumstances); (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio that
is less than 6.0%, has a Tier I risk-based capital ratio that is less than 3.0%
or a leverage ratio that is less than 3.0%; and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%.
A federal banking agency may, after notice and an opportunity for a
hearing, reclassify a well capitalized institution as adequately capitalized and
may require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category if the institution is in an unsafe or unsound condition or has received
in its most recent examination, and has not corrected, a less than satisfactory
rating for asset quality, management, earnings or liquidity. The OTS may not,
however, reclassify a significantly undercapitalized institution as critically
undercapitalized.
An institution generally must file a written capital restoration plan that
meets specified requirements, as well as a performance guaranty by each company
that controls the institution, with the appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. Immediately upon becoming undercapitalized, an
institution shall become subject to various mandatory and discretionary
restrictions on its operations.
At September 30, 1998, the Bank was categorized as "well capitalized" under
the prompt corrective action regulations of the OTS.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking regulatory
agencies have prescribed, by regulation, standards for all insured depository
institutions relating to: (i) internal controls, information systems and
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internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv)
interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii)
earnings, and (viii) compensation, fees and benefits. The regulations set forth
the safety and soundness standards that the federal banking agencies use to
identify and address problems at insured depository institutions before capital
becomes impaired. If the OTS determines that the Bank fails to meet any
standard prescribed by the regulations, the agency may require the Bank to
submit to the agency an acceptable plan to achieve compliance with the standard.
OTS regulations establish deadlines for the submission and review of such safety
and soundness compliance plans.
QUALIFIED THRIFT LENDER TEST. All savings associations are required to
meet a qualified thrift lender ("QTL") test to avoid certain restrictions on
their operations. A savings institution that fails to become or remain a QTL
shall either become a national bank or be subject to the following restrictions
on its operations: (i) the association may not make any new investment or
engage in activities that would not be permissible for national banks; (ii) the
association may not establish any new branch office where a national bank
located in the savings institution's home state would not be able to establish a
branch office; (iii) the association shall be ineligible to obtain new advances
from any FHLB; and (iv) the payment of dividends by the association shall be
subject to the statutory and regulatory dividend restrictions applicable to
national banks. Also, beginning three years after the date on which the savings
institution ceases to be a QTL, the savings institution would be prohibited from
retaining any investment or engaging in any activity not permissible for a
national bank and would be required to repay any outstanding advances to any
FHLB. In addition, within one year of the date on which a savings association
controlled by a company ceases to be a QTL, the company must register as a bank
holding company and become subject to the rules applicable to such companies. A
savings institution may requalify as a QTL if it thereafter complies with the
QTL test.
Currently, the QTL test requires that either an institution qualify as a
domestic building and loan association under the Internal Revenue Code of 1986,
as amended ("Code") or that 65% of an institution's "portfolio assets" (as
defined) consist of certain housing and consumer-related assets on a monthly
average basis in nine out of every 12 months. Assets that qualify without limit
for inclusion as part of the 65% requirement are loans made to purchase,
refinance, construct, improve or repair domestic residential housing and
manufactured housing; home equity loans; mortgage-backed securities (where the
mortgages are secured by domestic residential housing or manufactured housing);
FHLB stock; direct or indirect obligations of the FDIC; and loans for
educational purposes, loans to small businesses and loans made through credit
cards. In addition, the following assets, among others, may be included in
meeting the test subject to an overall limit of 20% of the savings institution's
portfolio assets: 50% of residential mortgage loans originated and sold within
90 days of origination; 100% of consumer loans; and stock issued by Federal Home
Loan Mortgage Corporation or FNMA. Portfolio assets consist of total assets
minus the sum of (i) goodwill and other intangible assets, (ii) property used by
the savings institution to conduct its business, and (iii) liquid assets up to
20% of the institution's total assets. At September 30, 1998, the Bank was in
compliance with the QTL test.
CAPITAL REQUIREMENTS. Under OTS regulations a savings association must
satisfy three minimum capital requirements: core capital, tangible capital and
risk-based capital. Savings associations must meet all of the standards in
order to comply with the capital requirements. The Corporation is not subject
to any minimum capital requirements.
OTS capital regulations establish a 3% core capital or leverage ratio
(defined as the ratio of core capital to adjusted total assets). Core capital
is defined to include common stockholders' equity, noncumulative perpetual
preferred stock and any related surplus, and minority interests in equity
accounts of consolidated subsidiaries, less (i) any intangible assets, except
for certain qualifying intangible assets; (ii) certain mortgage servicing
rights; and (iii) equity and debt investments in subsidiaries that are not
"includable subsidiaries," which is defined as subsidiaries engaged solely in
activities not impermissible for a national bank, engaged in activities
impermissible for a national bank but only as an agent for its customers, or
engaged solely in mortgage-banking activities. In calculating adjusted total
assets, adjustments are made to total assets to give effect to the exclusion of
certain assets from capital and to account appropriately for the investments in
and assets of both includable and nonincludable subsidiaries. An institution
that fails to meet the core capital requirement would be required to file with
the OTS a capital plan that details the steps they will take to reach
compliance. In addition, the OTS's prompt corrective action regulation provides
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that a savings institution that has a leverage ratio of less than 4% (3% for
institutions receiving the highest CAMEL examination rating) will be deemed to
be "undercapitalized" and may be subject to certain restrictions. See " Prompt
Corrective Action."
Savings associations also must maintain "tangible capital" not less than
1.5% of the Bank's adjusted total assets. "Tangible capital" is defined,
generally, as core capital minus any "intangible assets" other than purchased
mortgage servicing rights.
Each savings institution must maintain total risk-based capital equal to at
least 8% of risk-weighted assets. Total risk-based capital consists of the sum
of core and supplementary capital, provided that supplementary capital cannot
exceed core capital, as previously defined. Supplementary capital includes (i)
permanent capital instruments such as cumulative perpetual preferred stock,
perpetual subordinated debt and mandatory convertible subordinated debt, (ii)
maturing capital instruments such as subordinated debt, intermediate-term
preferred stock and mandatory convertible subordinated debt, subject to an
amortization schedule, and (iii) general valuation loan and lease loss
allowances up to 1.25% of risk-weighted assets.
The risk-based capital regulation assigns each balance sheet asset held by
a savings institution to one of four risk categories based on the amount of
credit risk associated with that particular class of assets. Assets not
included for purposes of calculating capital are not included in calculating
risk-weighted assets. The categories range from 0% for cash and securities that
are backed by the full faith and credit of the U.S. Government to 100% for
repossessed assets or assets more than 90 days past due. Qualifying residential
mortgage loans (including multi-family mortgage loans) are assigned a 50% risk
weight. Consumer, commercial, home equity and residential construction loans
are assigned a 100% risk weight, as are nonqualifying residential mortgage loans
and that portion of land loans and nonresidential construction loans that do not
exceed an 80% loan-to-value ratio. The book value of assets in each category is
multiplied by the weighting factor (from 0% to 100%) assigned to that category.
These products are then totaled to arrive at total risk-weighted assets. Off-
balance sheet items are included in risk-weighted assets by converting them to
an approximate balance sheet "credit equivalent amount" based on a conversion
schedule. These credit equivalent amounts are then assigned to risk categories
in the same manner as balance sheet assets and included risk-weighted assets.
The OTS has incorporated an interest rate risk component into its
regulatory capital rule. Under the rule, savings associations with "above
normal" interest rate risk exposure would be subject to a deduction from total
capital for purposes of calculating their risk-based capital requirements. A
savings association's interest rate risk is measured by the decline in the net
portfolio value of its assets (i.e., the difference between incoming and
----
outgoing discounted cash flows from assets, liabilities and off-balance sheet
contracts) that would result from a hypothetical 200 basis point increase or
decrease in market interest rates divided by the estimated economic value of the
association's assets, as calculated in accordance with guidelines set forth by
the OTS. A savings association whose measured interest rate risk exposure
exceeds 2% must deduct an interest rate risk component in calculating its total
capital under the risk-based capital rule. The interest rate risk component is
an amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
association's assets. That dollar amount is deducted from an association's
total capital in calculating compliance with its risk-based capital requirement.
Under the rule, there is a two quarter lag between the reporting date of an
institution's financial data and the effective date for the new capital
requirement based on that data. A savings association with assets of less than
$300 million and risk-based capital ratios in excess of 12% is not subject to
the interest rate risk component, unless the OTS determines otherwise. The rule
also provides that the Director of the OTS may waive or defer an association's
interest rate risk component on a case-by-case basis. Under certain
circumstances, a savings association may request an adjustment to its interest
rate risk component if it believes that the OTS-calculated interest rate risk
component overstates its interest rate risk exposure. In addition, certain
"well-capitalized" institutions may obtain authorization to use their own
interest rate risk model to calculate their interest rate risk component in lieu
of the OTS-calculated amount. The OTS has postponed the date that the component
will first be deducted from an institution's total capital.
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LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose uniform
limitations on the ability of all savings associations to engage in various
distributions of capital such as dividends, stock repurchases and cash-out
mergers. In addition, OTS regulations require the Bank to give the OTS 30 days
advance notice of any proposed declaration of dividends, and the OTS has the
authority under its supervisory powers to prohibit the payment of dividends.
The regulation utilizes a three-tiered approach which permits various levels of
distributions based primarily upon a savings association's capital level.
A Tier 1 savings association has capital in excess of its fully phased-in
capital requirement (both before and after the proposed capital distribution).
A Tier 1 savings association may make (without application but upon prior notice
to, and no objection made by, the OTS) capital distributions during a calendar
year up to 100% of its net income to date during the calendar year plus one-half
its surplus capital ratio (i.e., the amount of capital in excess of its fully
----
phased-in requirement) at the beginning of the calendar year or the amount
authorized for a Tier 2 association. Capital distributions in excess of such
amount require advance notice to the OTS. A Tier 2 savings association has
capital equal to or in excess of its minimum capital requirement but below its
fully phased-in capital requirement (both before and after the proposed capital
distribution). Such an association may make (without application) capital
distributions up to an amount equal to 75% of its net income during the previous
four quarters depending on how close the association is to meeting its fully
phased-in capital requirement. Capital distributions exceeding this amount
require prior OTS approval. A Tier 3 savings association has capital below the
minimum capital requirement (either before or after the proposed capital
distribution). A Tier 3 savings association may not make any capital
distributions without prior approval from the OTS.
The Bank currently meets the criteria to be designated a Tier 1 association
and, consequently, could at its option (after prior notice to, and no objection
made by, the OTS) distribute up to 100% of its net income during the calendar
year plus 50% of its surplus capital ratio at the beginning of the calendar year
less any distributions previously paid during the year.
LOANS TO ONE BORROWER. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans to one borrower. Generally, this
limit is 15% of the Bank's unimpaired capital and surplus, plus an additional
10% of unimpaired capital and surplus, if such loan is secured by readily-
marketable collateral, which is defined to include certain financial instruments
and bullion. The OTS by regulation has amended the loans to one borrower rule
to permit savings associations meeting certain requirements, including capital
requirements, to extend loans to one borrower in additional amounts under
circumstances limited essentially to loans to develop or complete residential
housing units. At September 30, 1998, the Bank's limit on loans to one borrower
was $1.9 million. At September 30, 1998, the Bank's largest aggregate amount of
loans to one borrower was $1.4 million.
ACTIVITIES OF SAVINGS ASSOCIATIONS AND THEIR SUBSIDIARIES. When a savings
association establishes or acquires a subsidiary or elects to conduct any new
activity through a subsidiary that the association controls, the savings
association must notify the FDIC and the OTS 30 days in advance and provide the
information each agency may, by regulation, require. Savings associations also
must conduct the activities of subsidiaries in accordance with existing
regulations and orders.
The OTS may determine that the continuation by a savings association of its
ownership control of, or its relationship to, the subsidiary constitutes a
serious risk to the safety, soundness or stability of the association or is
inconsistent with sound banking practices or with the purposes of the FDIA.
Based upon that determination, the FDIC or the OTS has the authority to order
the savings association to divest itself of control of the subsidiary. The FDIC
also may determine by regulation or order that any specific activity poses a
serious threat to the SAIF. If so, it may require that no SAIF member engage in
that activity directly.
TRANSACTIONS WITH AFFILIATES. Savings associations must comply with
Sections 23A and 23B of the Federal Reserve Act relative to transactions with
affiliates in the same manner and to the same extent as if the savings
association were a Federal Reserve member bank. A savings and loan holding
company, its subsidiaries and any other
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company under common control are considered affiliates of the subsidiary savings
association under the HOLA. Generally, Sections 23A and 23B: (I) limit the
extent to which the insured association or its subsidiaries may engage in
certain covered transactions with an affiliate to an amount equal to 10% of such
institution's capital and surplus and place an aggregate limit on all such
transactions with affiliates to an amount equal to 20% of such capital and
surplus, and (ii) require that all such transactions be on terms substantially
the same, or at least as favorable to the institution or subsidiary, as those
provided to a non-affiliate. The term "covered transaction" includes the making
of loans, the purchase of assets, the issuance of a guarantee and similar types
of transactions. Any loan or extension of credit by the Bank to an affiliate
must be secured by collateral in accordance with Section 23A.
Three additional rules apply to savings associations: (i) a savings
association may not make any loan or other extension of credit to an affiliate
unless that affiliate is engaged only in activities permissible for bank holding
companies; (ii) a savings association may not purchase or invest in securities
issued by an affiliate (other than securities of a subsidiary); and (iii) the
OTS may, for reasons of safety and soundness, impose more stringent restrictions
on savings associations but may not exempt transactions from or otherwise
abridge Section 23A or 23B. Exemptions from Section 23A or 23B may be granted
only by the Federal Reserve Board, as is currently the case with respect to all
FDIC-insured banks. The Bank has not been significantly affected by the rules
regarding transactions with affiliates.
The Bank's authority to extend credit to executive officers, directors and
10% shareholders, as well as entities controlled by such persons, is governed by
Sections 22(g) and 22(h) of the Federal Reserve Act, and Regulation O
thereunder. Among other things, these regulations generally require that such
loans be made on terms and conditions substantially the same as those offered to
unaffiliated individuals and not involve more than the normal risk of repayment.
Generally, Regulation O also places individual and aggregate limits on the
amount of loans the Bank may make to such persons based, in part, on the Bank's
capital position, and requires certain board approval procedures to be followed.
The OTS regulations, with certain minor variances, apply Regulation O to savings
institutions.
COMMUNITY REINVESTMENT ACT. Under the federal CRA, all federally-insured
financial institutions have a continuing and affirmative obligation consistent
with safe and sound operations to help meet all the credit needs of its
delineated community. The CRA does not establish specific lending requirements
or programs nor does it limit an institution's discretion to develop the types
of products and services that it believes are best suited to meet all the credit
needs of its delineated community. The CRA requires the federal banking
agencies, in connection with regulatory examinations, to assess an institution's
record of meeting the credit needs of its delineated community and to take such
record into account in evaluating regulatory applications to establish a new
branch office that will accept deposits, relocate an existing office, or merge
or consolidate with, or acquire the assets or assume the liabilities of, a
federally regulated financial institution, among others.
SAVINGS AND LOAN HOLDING COMPANY REGULATIONS
HOLDING COMPANY ACQUISITIONS. The HOLA and OTS regulations issued
thereunder generally prohibit a savings and loan holding company, without prior
OTS approval, from acquiring more than 5% of the voting stock of any other
savings association or savings and loan holding company or controlling the
assets thereof. They also prohibit, among other things, any director or officer
of a savings and loan holding company, or any individual who owns or controls
more than 25% of the voting shares of such holding company, from acquiring
control of any savings association not a subsidiary of such savings and loan
holding company, unless the acquisition is approved by the OTS.
HOLDING COMPANY ACTIVITIES. As a unitary savings and loan holding company,
the Corporation generally is not subject to activity restrictions under the
HOLA. If the Corporation acquires control of another savings association as a
separate subsidiary other than in a supervisory acquisition, it would become a
multiple savings and loan holding company. There generally are more
restrictions on the activities of a multiple savings and loan holding company
than on those of a unitary savings and loan holding company. The HOLA provides
that, among other things, no multiple savings and loan holding company or
subsidiary thereof which is not an insured association shall commence or
continue for more than two years after becoming a multiple savings and loan
association holding
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company or subsidiary thereof, any business activity other than: (i) furnishing
or performing management services for a subsidiary insured institution, (ii)
conducting an insurance agency or escrow business, (iii) holding, managing, or
liquidating assets owned by or acquired from a subsidiary insured institution,
(iv) holding or managing properties used or occupied by a subsidiary insured
institution, (v) acting as trustee under deeds of trust, (vi) those activities
previously directly authorized by regulation as of March 5, 1987 to be engaged
in by multiple bank holding companies or (vii) those activities authorized by
the Federal Reserve Board as permissible for bank holding companies, unless the
OTS by regulation, prohibits or limits such activities for savings and loan
holding companies. Those activities described in (vii) above also must be
approved by the OTS prior to being engaged in by a multiple savings and loan
holding company.
QUALIFIED THRIFT LENDER TEST. The HOLA provides that any savings and loan
holding company that controls a savings association that fails the QTL test, as
explained under "-- Federal Regulation of Savings Associations --Qualified
Thrift Lender Test," must, within one year after the date on which the
association ceases to be a QTL, register as and be deemed a bank holding company
subject to all applicable laws and regulations.
TAXATION
FEDERAL TAXATION
GENERAL. Union Financial and the Bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or Union Financial.
TAX BAD DEBT RESERVES. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrift") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have been
deducted in arriving at their taxable income. The Bank's deduction with respect
to "qualifying loans," which are generally loans secured by certain interests in
real property, may have been computed using an amount based on the Bank's actual
loss experience, or a percentage equal to 8% of the Bank's taxable income,
computed with certain modifications and reduced by the amount of any permitted
additions to the nonqualifying reserve. The Bank's deductions with respect to
"qualifying real property loans," which are generally loans secured by certain
interest in real property, were computed using an amount based on the Bank's
actual loss experience, or a percentage equal to 8% of the Bank's taxable
income, computed with certain modifications and reduced by the amount of any
permitted additions to the non-qualifying reserve.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." The new
rules eliminated the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all thrifts for tax years beginning after December 31,
1995. These rules also require that all institutions recapture all or a portion
of their bad debt reserves added since the base year (last taxable year
beginning before January 1, 1988). The Bank has previously recorded a deferred
tax liability equal to the bad debt recapture and as such the new rules will
have no effect on the net income or federal income tax expense. For taxable
years beginning after December 31, 1995, the Bank's bad debt deduction has been
determined under the experience method using a formula based on actual bad debt
experience over a period of years. The new rules allow an institution to
suspend bad debt reserve recapture for the 1996 and 1997 tax years if the
institution's lending activity for those years is equal to or greater than the
institution's average mortgage lending activity for the six taxable years
preceding 1996, adjusted for inflation. For this purpose, only home purchase or
home improvement loans are included and the institution can elect to have the
tax years with the highest and lowest lending activity removed from the average
calculation. If an institution is permitted to postpone the reserve recapture,
it must begin its six year recapture no later than the 1998 tax year. The
unrecaptured base year reserves will not be subject to recapture as long as the
institution continues to carry on the business of banking. In addition, the
balance of the pre-1988 bad debt reserves continue to
29
<PAGE>
be subject to provisions of present law referred to below that require recapture
in the case of certain excess distributions to shareholders.
DISTRIBUTIONS. To the extent that the Bank makes "nondividend
distributions" to Union Financial that are considered as made: (i) from the
reserve for losses on qualifying real property loans, to the extent the reserve
for such losses exceeds the amount that would have been allowed under the
experience method; or (ii) from the supplemental reserve for losses on loans
("Excess Distributions"), then an amount based on the amount distributed will be
included in the Bank's taxable income. Nondividend distributions include
distributions in excess of the Bank's current and accumulated earnings and
profits, distributions in redemption of stock, and distributions in partial or
complete liquidation. However, dividends paid out of the Bank's current or
accumulated earnings and profits, as calculated for federal income tax purposes,
will not be considered to result in a distribution from the Bank's bad debt
reserve. Thus, any dividends to Union Financial that would reduce amounts
appropriated to the Bank's bad debt reserve and deducted for federal income tax
purposes would create a tax liability for the Bank. The amount of additional
taxable income attributable to an Excess Distribution is an amount that, when
reduced by the tax attributable to the income, is equal to the amount of the
distribution. Thus, if the Bank makes a "nondividend distribution," then
approximately one and one-half times the amount so used would be includable in
gross income for federal income tax purposes, assuming a 34% corporate income
tax rate (exclusive of state taxes). See "REGULATION" for limits on the
payment of dividends by the Bank. The Bank does not intend to pay dividends
that would result in a recapture of any portion of its tax bad debt reserve.
CORPORATE ALTERNATIVE MINIMUM TAX. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. The excess of the tax bad
debt reserve deduction using the percentage of taxable income method over the
deduction that would have been allowable under the experience method is treated
as a preference item for purposes of computing the AMTI. In addition, only 90%
of AMTI can be offset by net operating loss carryovers. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). For taxable years beginning after December
31, 1986, and before January 1, 1996, an environmental tax of .12% of the excess
of AMTI (with certain modification) over $2.0 million is imposed on
corporations, including the Bank, whether or not an Alternative Minimum Tax
("AMT") is paid.
DIVIDENDS-RECEIVED DEDUCTION AND OTHER MATTERS. Union Financial may
exclude from its income 100% of dividends received from the Bank as a member of
the same affiliated group of corporations. The corporate dividends-received
deduction is generally 70% in the case of dividends received from unaffiliated
corporations with which Union Financial and the Bank will not file a
consolidated tax return, except that if Union Financial or the Bank owns more
than 20% of the stock of a corporation distributing a dividend, then 80% of any
dividends received may be deducted.
OTHER FEDERAL TAX MATTERS. Other recent changes in the federal tax system
could also affect the business of the Bank. These changes include limitations
on the deduction of personal interest paid or accrued by individual taxpayers,
limitations on the deductibility of losses attributable to investment in certain
passive activities and limitations on the deductibility of contributions to
individual retirement accounts. The Bank does not believe these changes will
have a material effect on its operations.
There have not been any IRS audits of Union Financial's or the Bank's
federal income tax returns during the past five years.
30
<PAGE>
STATE TAXATION
SOUTH CAROLINA. The Bank is subject to tax under South Carolina law.
South Carolina law allows a savings and loan association to use the federal bad
debt deduction method for the purpose of computing net income subject to state
tax, and the present South Carolina tax rate on taxable income is 6 percent. In
order to calculate taxable income for South Carolina taxation purposes, a
corporation begins with its federal taxable income and then modifies it to take
into account certain adjustments. Adjustments which would be common to most
financial institutions include an addition for state taxes deducted on the
federal return, and a subtraction for interest on certain federal obligations
and securities. South Carolina income tax is deductible for federal income tax
purposes. In addition, Union Financial is subject to South Carolina taxes as a
regular corporation and pays taxes based on its shareholders' equity.
DELAWARE. As a Delaware holding company not earning income in Delaware,
Union Financial is exempted from Delaware corporate income tax, but is required
to file an annual report with and pay an annual franchise tax to the State of
Delaware.
ITEM 2. DESCRIPTION OF PROPERTY
- --------------------------------
The Corporation owns its main office, located at 203 West Main Street in
Union, South Carolina, which was opened in 1977. The Corporation also owns a
banking center which opened in April 1989, located at 508 North Duncan By-Pass,
Union, South Carolina and a branch office, acquired in 1997, in Laurens, South
Carolina. The Corporation purchased property in Jonesville, South Carolina and
opened a temporary office in July 1994. The net book value of the Corporation's
investment in premises and equipment totaled approximately $4 million at
September 30, 1998. See Note 4 of Notes to Consolidated Financial Statements.
All property is in good condition and meets the operating needs of the
Corporation.
The Corporation owns various bookkeeping and accounting equipment. Certain
data processing services are provided by an outside data processing center under
a long-term contract.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
Neither Union Financial nor the Bank is engaged in any legal proceedings of
a material nature at the present time. From time to time, the Bank is involved
in routine legal proceedings occurring in the ordinary course of business
wherein it enforces the Bank's security interest in mortgage loans the Bank has
made.
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 September 30, 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
- --------------------------------------------------------------------------
MATTERS
- -------
The information contained under the section captioned "Common Stock and
Dividend Information" in the Annual Report to Shareholders ("Annual Report") is
incorporated herein by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- -------------------------------------------------------------------------
RESULTS OF OPERATIONS
- ---------------------
The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report is incorporated herein by reference.
31
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
- -----------------------------
The financial statements contained in the Annual Report are incorporated
herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
No disagreement with the Corporation's independent accountants on
accounting and financial disclosure has occurred during the two most recent
fiscal years.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- ----------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
- -------------------------------------------------
For information concerning the Board of Directors of Union Financial, the
information contained under the section captioned "Proposal I -- Election of
Directors" and "Directors' Compensation" in the Proxy Statement is incorporated
herein by reference. Reference is made to the cover page of this Form 10-KSB
for information regarding compliance with section 16(a) of the Exchange Act.
Certain executive officers of the Bank also serve as executive officers of
Union Financial. The day-to-day management duties of the executive officers of
Union Financial and the Bank relate primarily to their duties as to the Bank.
The executive officers of Union Financial are as follows:
<TABLE>
<CAPTION>
Position as of
Name Age(a) September 30, 1998
- ---- ------ ------------------
<S> <C> <C>
Dwight V. Neese 48 President, Chief Executive Officer and Director
Richard H. Flake 50 Executive Vice President - Chief Financial Officer
Gerald L. Bolin 36 Vice President - Chief Operating Officer
Wanda J. Wells 42 Vice President - Corporate Secretary
</TABLE>
- --------------------
(a) At September 30, 1998.
DWIGHT V. NEESE was appointed as President and Chief Executive Officer of
the Bank effective September 5, 1995. Prior to joining Union Financial, Mr.
Neese was Executive Vice President and Chief Operating Officer of Home Federal
Savings Bank of South Carolina in Rock Hill. As President and Chief Executive
Officer of Provident Community Bank and the Corporation, Mr. Neese is
responsible for daily operations of the Bank and implementation of the policies
and procedures approved by the Board of Directors.
RICHARD H. FLAKE joined Union Financial in September 1995. Prior to
joining Union Financial, Mr. Flake was Senior Vice President and Corporate
Accounting Manager for United Financial Corporation in Greenwood, South
Carolina.
GERALD L. BOLIN joined Union Financial in September 1995. Prior to joining
Union Financial, Mr. Bolin was Vice President and Director of Internal Audit and
Compliance with Home Federal Savings Bank of South Carolina in Rock Hill.
WANDA J. WELLS has been employed by Union Financial since 1975 and serves
as the Corporation's Corporate Secretary.
32
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
- ---------------------------------
The information contained under the section captioned "Executive
Compensation" in the Proxy Statement is incorporated herein by reference.
ITEM 11. 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 section captioned "Securities Ownership of Certain Beneficial
Owners and Management" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference
to the sections captioned "Proposal I -- Election of Directors" and
"Securities Ownership of Certain Beneficial Owners and Management" in
the Proxy Statement.
(c) Management of Union Financial knows of no arrangements, including any
pledge by any person of securities of Union Financial, the operation of
which may at a subsequent date result in a change in control of the
registrant.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors" and "Transactions
with Management" in the Proxy Statement.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
- -------------------------------------------
(a) Exhibits
3(a) Certificate of Incorporation(1)
3(b) Bylaws(1)
3(c) Certificate of Amendment of Certificate of Incorporation dated
January 22, 1997(2)
10(a) Employment Agreement with Dwight V. Neese(3)
10(b) Union Federal Savings and Loan Association 1987 Stock
Option Plan(3)
10(c) Union Financial Bancshares, Inc. 1995 Stock Option Plan(4)
13 1998 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of Independent Auditor
27 Financial Data Schedule
(b) No reports on Form 8-K have been filed during the last quarter of the
fiscal year covered by this report.
- -----------------------------------
(1) Incorporated herein by reference to Union Financial's Registration
Statement on Form S-4 (File No. 33-80808) filed with the Securities and
Exchange Commission on June 29, 1994.
(2) Incorporated herein by reference to Exhibit 3 (c) to Union Financial's
Form 10-KSB for the year ended September 30, 1997.
(3) Incorporated herein by reference to Union Financial's Form 10-KSB for the
year ended September 30, 1996.
(4) Incorporated herein by reference to Exhibit A to Union Financial's
Proxy Statement for its 1996 Annual Meeting of Stockholders.
33
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
UNION FINANCIAL BANCSHARES, INC.
Date: December 28, 1998 By: /s/ Dwight V. Neese
-----------------------------------
Dwight V. Neese
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.
By: /s/ Dwight V. Neese By:
--------------------------- -----------------------------------
Dwight V. Neese James W. Edwards
Principal Executive Officer Director
Date: December 28, 1998 Date: December __, 1998
By: /s/ Richard H. Flake By:
--------------------------- -----------------------------------
Richard H. Flake David G. Russell
(Principal Financial and Director
Accounting Officer)
Date: December 28, 1998 Date: December __, 1998
By: /s/ Mason G. Alexander By: /s/ Louis M. Jordan
--------------------------- -----------------------------------
Mason G. Alexander Louis M. Jordan
Director Director
Date: December 28, 1998 Date: December __, 1998
By: /s/ William M. Graham By:
--------------------------- -----------------------------------
William M. Graham Carl L. Mason
Director Director
Date: December 28, 1998 Date: December __, 1998
<PAGE>
EXHIBIT NO. 13
1998 ANNUAL REPORT TO SHAREHOLDERS
<PAGE>
EXHIBIT 13
December, 1998
Dear Fellow Shareholder:
Union Financial Bancshares is a company focused on the future.
With the clarity of a single vision to be the financial services provider of
choice in the communities we serve, we are focused on building a strong
foundation to sustain and strengthen Union Financial Bancshares and Provident
Community Bank both now, and well into the new millennium. As Peter Drucker has
said, "The best way to predict the future is to create it," and we are focused
on aggressively creating Union Financial Bancshares' future.
Before going into depth about our initiatives to secure the future, I am pleased
to report on the current condition of our company and the impressive progress
made during the last year.
Net income increased from $1.444 million in fiscal 1997 to $1.550 million in
fiscal 1998, an increase of 7.34%. Earnings per share increased from $1.17 in
fiscal 1997 to $1.23 in fiscal 1998. Return on average assets for fiscal 1998
was 0.87%, down slightly from the previous year. Return on average
shareholders' equity was 10.77%, also down slightly from the previous year, but
well ahead of peers as identified by the America's Community Bankers' Policy
Development and Economic Research Department and SNL Securities, a leading trade
publication. Total assets of $189.286 million at fiscal year end were up
$18.042 million over the total assets of $171.244 million at the end of 1997, an
increase of 10.54%. The continued growth in total assets is primarily the
result of 9.42% growth in the loan portfolio.
The steady growth and increased earnings of Union Financial Bancshares are a
result of good planning and hard work. The company utilizes a five-year
Strategic Business Plan that is completely reviewed and rewritten each year
through a collaborative effort of the officers and Board of Directors. The
Board reviews the progress being made on the Strategic Business Plan on a
quarterly basis and monitors the company's progress on meeting the goals of the
Financial and Operating Plan on a monthly basis. Although the goals and
objectives of the Strategic Business Plan and Financial and Operating Plan are
long-term by design, the officers and Board of Directors are continually
monitoring the market and regulatory environment to adjust the short-term goals
and objectives when appropriate.
The primary initiative of 1998 was the re-engineering of Provident Community
Bank's retail delivery system. Although the existing branch network had served
the company and market well for many years, the time had come to rethink the
delivery of financial services and how to most effectively and efficiently serve
the Bank's clients. The redesign and rebuilding of the Bank's facilities were
wrapped around the concept of providing exceptional client service and state of
the art financial products. The Bank's two largest branches, the North Duncan
Bypass and Laurens Office, were gutted and totally rebuilt to cater to the
Bank's clients and their ever changing financial needs. Central to the new
theme was maintaining the warm atmosphere and personal attention that Provident
had built its heritage on, while providing high tech automation and alternative
methods of banking for those on the go. In addition, an innovative idea for
banking in South Carolina was introduced with the opening of Provident's new
Lending and Investment Center. This newest addition to Provident's network was
customized to become a "boutique" of retail products and services. The Lending
and Investment Center does not offer traditional teller services because it was
designed to offer a full spectrum of consumer, commercial and mortgage loans and
a complete line of alternative investment products. To make banking more
accessible to those whose schedules make it difficult to do their banking
during traditional banking hours, the Lending and
<PAGE>
Investment Center opens early each morning and stays open several evenings each
week. This new facility also has a free-standing ATM for those who need to
conduct their banking business 24 hours a day, 7 days a week.
Another innovation for 1998 was the creation of Business Resource Centers in
the remodeled North Duncan Bypass and Laurens Banking Centers. Provident
recognized the vacuum being created by the consolidation in the banking industry
and has repositioned itself to provide commercial services to existing clients
and other businesses in the communities the Bank serves. The Business Resource
Centers are equipped with computers, business software, video equipment,
numerous business publications and many other planning and analytical tools for
the business owner or manager. Provident associates have been trained to
provide assistance to those interested in utilizing the new Business Resource
Centers and many of the Bank's Lending Specialists are receiving extended
commercial loan training.
A final retail banking initiative for 1998 was the revamping and bundling of the
Bank's products and services. Traditionally, banks have provided broad menus of
products and services that have grown over time as deregulation, re-regulation,
and consolidation have occurred. Provident recognized how complicated and
disjointed banking had become for most people and decided to make it simple and
more economical, once again. Provident also recognized that most people
progress though normal life-cycles, or life-styles, and that their banking needs
were similar and changed over time. Provident responded to this need by
packaging its products and services into a progression of simple, but value-
added "product bundles." Even though individual products and services are still
available, the Bank's clients are quickly discovering the value of the new
STARTING OUT, BUILDING A FOUNDATION, SECURING THE FUTURE, and REAPING THE
BENEFITS product bundles.
Three significant corporate initiatives were consummated in fiscal 1998 to
further enhance the long-term value of the Corporation's common stock. First,
Union Financial began offering its shareholders a Dividend Reinvestment Plan, or
DRIP as it is often called, at the end of fiscal 1997. During fiscal 1998,
26,780 new shares of common stock were issued through automatic reinvestment of
dividends and the option to purchase new shares. A total of $427,000 in new
equity capital was raised through the DRIP Plan during 1998. Second, a 3-for-2
stock split was declared in January on the Corporation's outstanding shares of
common stock. And third, Union Financial Bancshares announced in July that its
common stock would be listed on the Nasdaq SmallCap Market under the symbol
UFBS. Although the global economy weakened during the last half of the fiscal
year and the stock market posted its worst quarterly returns in eight years,
each of these initiatives was targeted at making shares of Union Financial
Bancshares a more attractive investment for its' shareholders.
At the close of fiscal 1998, two new initiatives were announced that will carry
into the new year. First, it was announced that Provident Community Bank had
entered into an agreement with CCB Financial's wholly-owned subsidiary, American
Federal Bank, FSB, to purchase the deposits of American Federal's Union, South
Carolina branch. This $14.6 million acquisition, while subject to regulatory
approval, is expected to close in the first quarter of 1999. Second, it was
announced that Provident would replace its modular office in Jonesville, South
Carolina with a new facility designed to incorporate high tech automation in a
warm atmosphere of exceptional client service. Construction of the new
Jonesville Banking Center is expected to be finished in the second quarter of
1999.
These are exciting times for Union Financial Bancshares and Provident Community
Bank. We are focused on the future and have a clear vision of where we are
going and how to get there. We manage our business in a long-term context, as
an integrated whole, with the ultimate objective to enhance shareholder value.
We understand that exceptional client service is essential to enhancing
shareholder value and can only be delivered on a consistent basis by highly
motivated associates working as an integrated team. The integration of the
whole is brought full circle with our corporate philosophy of social
responsibility to the growth and well-being of the communities we serve.
Thank you for your continued interest and support.
Sincerely,
/s/ Dwight V. Neese
Dwight V. Neese
President & Chief Executive Officer
<PAGE>
TABLE OF CONTENTS
Business........................................... 3
Selected Financial and Other Data.................. 4
Management's Discussion and Analysis of Financial
Condition and Results of Operations............ 6
Independent Auditor's Report....................... 11
Consolidated Financial Statements.................. 12
Notes to Consolidated Financial Statements......... 17
Directors and Leadership Group..................... 35
Corporation Information............................ 36
Notice of Annual Meeting........................... 36
10-KSB Information................................. 36
Common Stock Information........................... 36
==============
BUSINESS
Union Financial Bancshares, Inc. ("Union Financial") is the savings and loan
holding company for Provident Community Bank (formerly known as Union Federal
Savings Bank), ("the Bank"). Union Financial has engaged in no significant
activity other than holding the stock of the Bank and engaging in certain
passive investment activities. Union Financial and the Bank are collectively
referred to as "the Corporation" in this annual report.
The Bank is a federally-chartered capital stock savings bank headquartered in
Union, South Carolina. The Bank, originally chartered in 1934, is a member of
the Federal Home Loan Bank System. Its deposits are insured to the maximum
limits allowable by the Federal Deposit Insurance Corporation ("FDIC") through
the Savings Association Insurance Fund ("SAIF"). In August 1987, the Bank
converted from a federal mutual savings and loan association to a federal
capital stock savings and loan association. The Bank was known as Union Federal
Savings and Loan Association until January 1992, when its shareholders approved
a change to a federally chartered savings bank. In January, 1997, the Bank
changed its name to Provident Community Bank.
The business of the Bank consists primarily of attracting deposits from the
general public and originating mortgage loans on residential properties located
in South Carolina. The Bank also makes consumer and commercial loans,
commercial real estate loans, construction loans, invests in federal government
and agency obligations and purchases fixed and variable rate mortgage
participation certificates. The principal sources of funds for the Bank's
lending activities include deposits received from the general public and
advances from the Federal Home Loan Bank. The Bank's principal expenses are
interest paid on deposit accounts and other borrowings and expenses incurred in
the operation of the Bank. The Bank's operations are conducted through its
main office and three full-service banking centers, a mortgage banking center,
and a lending and investment center, all of which are located in the upstate
area of South Carolina.
<PAGE>
SELECTED FINANCIAL AND OTHER DATA
The following tables set forth selected financial data of the Corporation for
the periods indicated.
<TABLE>
<CAPTION>
OPERATIONS DATA:
- ---------------
Years Ended September 30,
--------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(Dollars In Thousands - Except Share Amounts)
<S> <C> <C> <C> <C> <C>
Interest income $ 13,405 $ 11,855 $ 9,004 $ 9,265 $ 8,767
Interest expense 7,549 6,647 5,050 5,260 3,888
---------- ---------- ---------- ---------- ----------
Net interest income 5,856 5,208 3,954 4,005 4,879
Provision for loan losses -- (243) -- (105) (335)
---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan losses 5,856 4,965 3,954 3,900 4,544
Other income 1,038 953 506 381 275
Other expense (4,447) (3,616) (3,224) (2,588) (2,727)
---------- ---------- ---------- ---------- ----------
Income before income taxes and
cumulative effect of a change
in accounting principle 2,447 2,302 1,236 1,693 2,092
Income tax expense 897 858 374 639 776
---------- ---------- ---------- ---------- ----------
Income before cumulative effect
of a change in accounting 1,550 1,444 862 1,054 1,316
principle
Cumulative effect of a change in
accounting principle (2) -- -- -- -- 208
---------- ---------- ---------- ---------- ----------
Net income $ 1,550 $ 1,444 $ 862 $ 1,054 $ 1,524
---------- ---------- ---------- ---------- ----------
Income per common share: (1)
Income before cumulative effect
of a change in accounting $ 1.23 $ 1.17 $ 0.71 $ 0.89 $ 1.10
principle
Cumulative effect of a change in
accounting principle (2) -- -- -- -- 0.18
---------- ---------- ---------- ---------- ----------
Net income per common share (Basic) $ 1.23 $ 1.17 $ 0.71 $ 0.89 $ 1.28
---------- ---------- ---------- ---------- ----------
Net income per common share $ 1.15 $ 1.09 $ 0.69 $ 0.89 $ 1.28
(Diluted) ---------- ---------- ---------- ---------- ----------
Weighted average number of common
shares outstanding (Basic) 1,264,615 1,230,747 1,212,460 1,181,859 1,189,251
Weighted average number of common
shares outstanding (Diluted) 1,343,008 1,325,703 1,288,272 1,181,859 1,189,251
</TABLE>
(1) All share and per share amounts have been restated for the 2:1 stock
split occurring in July 1996 and the 3:2 stock split occurring in
February 1998.
(2) The Bank adopted Statement of Financial Standards No. 109, Accounting for
Income Taxes ("SFAS 109"), effective October 1, 1993. The cumulative
effect on prior years of adopting SFAS 109 on the Bank's financial
statements was to increase net income by $208,000 ($0.26 per share) for
the year ended September 30, 1994.
-4-
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL CONDITION:
- -------------------
September 30,
--------------------------------------------------
1998 1997 1996 1995 1994
--------- -------- -------- -------- --------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets $189,286 $171,244 $128,133 $120,879 $122,313
Short-term interest-bearing deposits 1,124 6,213 1,938 3,552 2,383
Investment securities 9,633 16,783 19,138 21,264 23,194
Mortgage-backed securities 19,922 6,883 14,658 18,616 19,946
Loans (net) 142,202 129,957 85,997 73,431 71,006
Deposit accounts 129,873 117,914 93,715 94,750 97,310
Shareholders' equity 15,300 13,527 12,254 11,856 10,693
Number of:
Real estate loans outstanding 1,651 1,706 1,615 1,641 1,749
Deposit accounts 17,686 16,443 13,095 13,062 12,760
Banking centers 4 4 3 3 3
<CAPTION>
OTHER SELECTED DATA:
- ----------------------
Years Ended September 30,
--------------------------------------------------
1998 1997 1996 1995 1994
--------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Interest rate spread during the year 3.11% 3.29% 3.01% 2.96% 4.04%
Net yield on average interest-
earning assets 3.42% 3.57% 3.46% 3.27% 4.29%
Return on average assets 0.87% 0.92% 0.73% 0.83% 1.30%
Return on average shareholders' equity 10.77% 11.21% 7.01% 9.38% 14.56%
Dividend payout ratio 30.08% 30.13% 46.87% 37.40% 29.92%
Operating expense to average assets 2.52% 2.31% 2.73% 2.05% 2.33%
Ratio of average shareholders'
equity to average assets 8.12% 8.24% 10.41% 8.88% 8.94%
Cash dividends declared and paid
per share of common stock (1) $ 0.37 $ 0.35 $ 0.33 $ 0.33 $ 0.38
</TABLE>
(1) Restated to reflect 2:1 and 3:2 stock split.
-5-
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
ASSET AND LIABILITY MANAGEMENT
- ------------------------------
The Corporation is committed to following a program of asset and liability
management in an effort to manage the fluctuations in earnings caused by
movements in interest rates. A significant portion of the Corporation's income
results from the spread, or net interest income, between the yield realized on
its interest-earning assets and the rate of interest paid on its deposits.
Differences in the timing and volume of repricing assets versus the timing and
volume of repricing liabilities expose the Corporation to interest rate risk.
Management's policies are directed at minimizing the impact of movements in
interest rates on earnings.
The Corporation continues to work to shorten the average life of its assets and
to extend the term on its liabilities in an effort to help minimize the effects
of rising interest rates. The Corporation enjoys an increasing net interest
rate spread during periods of falling interest rates. The Corporation
experiences a shrinking net interest rate spread in a rising interest rate
environment.
The Corporation's Asset and Liability Committee makes weekly pricing and
marketing decisions on deposit and loan products in conjunction with managing
the Corporation's interest rate risk. The Asset/Liability Committee of the Board
of Directors reviews the Bank's securities portfolio, FHLB advances and other
borrowings as well as the Bank's asset and liability policies.
The Corporation has established policies and monitors results to control
interest rate sensitivity. Although the Corporation utilizes measures such as
static gap, which is simply the measurement of the difference between interest-
sensitive assets and interest-sensitive liabilities repricing for a particular
time period, just as important a process is the evaluation of how particular
assets and liabilities are impacted by changes in interest rates or selected
indices as they reprice. Asset/liability modeling techniques are utilized by
the Corporation to assess varying interest rate and balance sheet mix
assumptions.
At September 30, 1998 the Corporation's exposure to interest rate risk, as
calculated by the OTS and measured by the impact of changing interest rates on
the Market Value of Portfolio Equity ("MVPE"), was as follows:
<TABLE>
<CAPTION>
Rate Environment
----------------
Minus 200 Basis Points Flat Plus 200 Basis Points
---------------------- --------- ---------------------
(In Thousands)
<S> <C> <C> <C>
Estimated Market Value of Assets $201,680 $194,640 $186,728
Estimated Market Value of Liabilities $177,011 $174,256 $171,069
MVPE $ 24,669 $ 20,384 $ 15,659
Increase/(decrease) in MVPE $ 4,285 $ -- $ (4,725)
</TABLE>
The analysis above indicates that the Corporation would be negatively affected
by an increase in interest rates and positively affected by a decrease in
interest rates.
YIELDS EARNED AND RATES PAID
- ----------------------------
The Corporation's pretax earnings depend primarily on its net interest income,
the difference between the income it receives on its loan portfolio and other
investments and its cost of money, consisting primarily of interest paid on
savings deposits and borrowings. Net interest income is affected by the average
yield on interest-earning assets, the average rate on interest-bearing
liabilities, and the ratio of interest-earning assets to interest-bearing
liabilities.
The following table sets forth, at or for the periods and dates indicated, the
weighted average yields earned on the Corporation's interest-earning assets, the
weighted average interest rates paid on the Corporation's deposit accounts and
borrowings, the interest rate spread and net yield on interest-earning assets.
-6-
<PAGE>
<TABLE>
<CAPTION>
At September 30, Years Ended September 30,
---------------- -------------------------------
1998 1998 1997 1996
---------------- -------- -------- --------
<S> <C> <C> <C> <C>
Average yield on earnings assets:
Loans 8.01% 8.10% 8.24% 8.81%
Investments (1) 5.41% 5.89% 6.88% 6.55%
Mortgage-backed securities 7.20% 6.96% 6.76% 6.02%
Total interest-earning assets 7.69% 7.83% 7.96% 7.88%
------ -------- -------- --------
Less:
Average rate paid on deposits 4.40% 4.45% 4.36% 4.75%
Average rate paid on borrowings 5.69% 5.70% 5.62% 6.01%
Average Cost of Funds 4.70% 4.73% 4.67% 4.87%
------ -------- -------- --------
Average interest rate spread 2.99% 3.11% 3.29% 3.01%
------ -------- -------- --------
Net yield on average interest-
earning assets 3.25% 3.42% 3.57% 3.46%
------ -------- -------- --------
</TABLE>
(1) Includes investment securities, federal funds sold, interest-bearing time
deposits, overnight interest-bearing deposits and Federal Home Loan Bank
(FHLB) stock.
RATE/VOLUME ANALYSIS
- --------------------
The following table sets forth certain information regarding changes in interest
income and interest expense of the Corporation for the periods indicated. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in volume
(changes in volume multiplied by old rate); (2) changes in rate (changes in rate
multiplied by old volume); and (3) the total. Changes in rate/volume (change in
rate multiplied by the change in volume) have been allocated to rate and volume
variances consistently on a proportionate basis.
<TABLE>
<CAPTION>
Years Ended September 30,
---------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
------------- -------------
Volume Rate Total Volume Rate Total
-------- ------- ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Change in interest income:
Loans $ 2,100 $ 18 $ 2,118 $ 4,186 $ (875) $ 3,311
Mortgage-backed securities 36 18 54 (575) 17 (558)
Investments (463) (159) (622) (95) 193 98
-------- ------- ------- ------- ------- -------
Total interest income 1,673 (123) 1,550 3,516 (665) 2,851
-------- ------- ------- ------- ------- -------
Change in interest expense:
Deposits 758 120 878 609 (422) 187
Borrowings and other (2) 26 24 1,546 (136) 1,410
-------- ------- ------- ------- ------- -------
Total interest expense 756 146 902 2,155 (558) 1,597
-------- ------- ------- ------- ------- -------
Change in net interest income $ 917 $ (269) $ 648 $ 1,361 $ (107) $ 1,254
-------- ------- ------- ------- ------- -------
</TABLE>
-7-
<PAGE>
RESULTS OF OPERATIONS
- ---------------------
COMPARISON OF YEARS ENDED SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1997
- -------------------------------------------------------------------
Net income increased $106,000 from $1,444,000 in fiscal 1997 to $1,550,000 in
fiscal 1998 primarily as a result of increased interest income from loans and
increased non-interest income. Earnings per share (basic) increased $0.06 to
$1.23 for the year ended September 30, 1998 from $1.17 for the same period in
1997.
Total interest income increased $1,550,000, or 13.07%, from $11,855,000 in
fiscal 1997 to $13,405,000 in fiscal 1998 due to the increase in the level of
interest-earning average assets that more than offset a slight decrease in
average yields. Average earning assets increased due primarily to higher loan
production from the Mortgage Division. The loan production was financed by
increased deposits and additional advances from the FHLB. Interest income on
loans increased $2,118,000, or 21.73%, from $9,747,000 in fiscal 1997 to
$11,865,000 in fiscal 1998. Interest income on investment and mortgage-backed
securities decreased $615,000, or 30.07%, from $2,045,000 in fiscal 1997 to
$1,430,000 in fiscal 1998. This reduction was due to a high level of security
calls that occurred during fiscal 1998 along with declining interest rates on
new securities.
Interest expense increased 13.57% to $7,549,000 for fiscal 1998 from $6,647,000
for fiscal 1997. Interest expense increased $878,000 for deposits and $24,000
for other borrowings, respectively. Interest expense for deposits increased due
to higher volumes (10.14% increase from fiscal 1997) along with a slight
increase in the costs of deposits. Interest expense on other borrowings
increased due to higher volumes and rates on FHLB advances throughout fiscal
1998 as compared to fiscal 1997.
Provisions for loan losses are charges to earnings to bring the total allowance
for loan losses to a level considered by management as adequate to provide for
estimated loan losses based on management's evaluation of the collectibility of
the loan portfolio. Provisions for loan losses decreased from $243,000 in fiscal
1997 to $0 in fiscal 1998. The decrease in the provision was due to the
reduction in the Bank loan portfolio that is held for investment, along with
the reduction in losses experienced in consumer loans. The Corporation
experienced bad debt charge-offs, net of recoveries, of approximately $101,000
in fiscal 1998 compared to $114,000 for fiscal 1997. The loan reserves to total
loans ratio excluding loans held for sale for fiscal 1998 was .79% compared to
.80% for fiscal 1997.
Non-interest income increased 8.92% to $1,038,000 for the year ended September
30, 1998 from $953,000 for the year ended September 30, 1997. Service charges
and fees increased $81,000 to $791,000 primarily as a result of increased
deposit account fees. Loan servicing fees (net) decreased $199,000 to $(111,000)
for the year ended September 30, 1998 from $88,000 for the year ended September
30, 1997 primarily as a result of the establishment of a $108,000 loss provision
for the Bank's loan servicing portfolio. Gain on sale of loans increased to
$358,000 during the year ended September 30, 1998 from $96,000 for the year
ended September 30, 1997 due to increased conventional mortgage loan sales.
Non-interest expense increased 22.98% to $4,447,000 in fiscal 1998 from
$3,616,000 in fiscal 1997. The increase in non-interest expense is the result
of additional expenses absorbed with the purchase of the Laurens, S. C. branch
along with the startup of the Mortgage Division. Both operations were
established during the third quarter of fiscal 1997.
COMPARISON OF YEARS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996
- -------------------------------------------------------------------
Net income increased $582,000 from $862,000 in fiscal 1996 to $1,444,000 in
fiscal 1997. Earnings per share increased $0.46 (basic) to $1.17 for the year
ended September 30, 1997 from $.71 for the same period in 1996. Fiscal 1996 net
income included a one-time FDIC assessment of $606,000 ($395,000 after taxes).
On September 30, 1996 President Clinton signed the Omnibus Appropriations Bill
which called for all financial institutions to share in recapitalizing the FDIC
fund that insures deposits. Earnings before income taxes, gains and losses on
the sale of loans and the effect of the FDIC special assessment were
approximately $1,837,000 for fiscal 1996 and approximately $2,206,000 for fiscal
1997 or an increase of $369,000 or 20.09%.
Total interest income increased $2,851,000, or 31.66%, from $9,004,000 in fiscal
1996 to $11,855,000 in fiscal 1997 due to the increased level of interest-
earning assets more than offsetting a slight decrease in average yields.
Average interest-earning assets increased due primarily to the purchase of
adjustable rate loans during the year along with higher loan production as a
result of the startup of a Mortgage Division within the Bank. The loan
production was financed by advances from the FHLB. Interest income on loans
increased $3,311,000, or 51.44%, from $6,436,000 in fiscal 1996 to $9,747,000 in
fiscal 1997. Interest income on investment securities increased $136,000, or
9.97%, from $1,363,000 in fiscal 1996 to $1,499,000 in fiscal 1997. The
increases in interest income on loans and investment securities were offset by
decreases of $559,000 and $37,000 in interest income on mortgage-backed
securities and on deposits and federal funds sold, respectively.
Interest expense increased 31.62% to $6,647,000 for fiscal 1997 from $5,050,000
for fiscal 1996. Interest expense increased $187,000 and $1,410,000 for
deposits and for other borrowings, respectively. Interest expense for deposits
increased due to
-8-
<PAGE>
increasing volumes as a result of the acquisition of a banking center location
in Laurens, SC with acquired deposits of $20,144,000. Interest expense on other
borrowings increased due to higher volumes required by the Mortgage Division and
rates on FHLB advances throughout fiscal 1997.
Provisions for loan losses increased $243,000 from $0 in fiscal 1996 to $243,000
in fiscal 1997. The provision was larger in fiscal 1997 due to the increased
size of the loan portfolio. In fiscal 1997, the Corporation experienced bad debt
charge-offs, net of recoveries, of approximately $114,000. The Corporation
experienced bad debt charge-offs, net of recoveries, of approximately $79,000 in
fiscal 1996. While future losses in the loan portfolio are probable, management
feels that provisions for loan losses are adequate.
Non-interest income increased 88.34% to $953,000 for the year ended September
30, 1997 from $506,000 for the year ended September 30, 1996. This increase was
due primarily to increased fees from financial services from $411,000 in fiscal
1996 to $710,000 in fiscal 1997. In addition, gains recognized on the sale of
loans and investments in the current year were $155,000 compared to $25,000
recognized in fiscal 1996.The servicing of loans purchased during the year was
outsourced and therefore resulted in net servicing fee expense of $24,000 in
fiscal 1997 compared to net servicing fee income in fiscal 1996 of $70,000.
Non-interest expense increased 12.15% to $3,616,000 in fiscal 1997 from
$3,224,000 in fiscal 1996. The increase in non-interest expense is a result of
additional expenses absorbed with the purchase of the Laurens, S.C. banking
center along with the startup of the Mortgage Division.
YEAR 2000
- ---------
The approach of the year 2000 ("Year 2000") presents significant issues for many
financial, information, and operational systems. Many systems in use today may
not be able to interpret dates after December 31, 1999, appropriately, because
such systems allow only two digits to indicate the year in a date. The
Year 2000 problems may occur in computer programs, computer hardware, or
electronic devices that utilize computer chips to process any information that
contains dates. Therefore, the issue is not limited to dates in computer
programs but is a complex combination of problems that may exist in computer
programs, data files, computer hardware, and other devices essential to the
operation of the business. Further, companies must consider the potential impact
that Year 2000 may have on services provided by third parties.
Substantially all of the Year 2000 risk is related to the Bank's activities.
The Bank has a formal Year 2000 Plan which includes a Year 2000 Task Force. The
Plan has been reviewed by the senior management and the Board of Directors.
Included in the Plan is a listing of all systems (whether in-house or
provided/supported by third parties) which may be impacted by Year 2000 and a
categorization of the systems by their potential impact on Bank operations. The
Task Force has received Year 2000 plans from third parties identified during the
assessment phase of the Year 2000 Plan. For systems that have been classified
as critical to the operations of the Bank, contingency plans have been
developed. Contingency plans may include utilization of alternate third party
vendors, alternate processing methods and software, or manual processing. The
plans have various activation dates (e.g., the date on which a third party
processor fails to meet its Year 2000 compliance deadline). In addition to
addressing its own Year 2000 issues, the Bank is in the process of assessing the
impact of the Year 2000 on significant commercial borrowers. The Bank's
Year 2000 readiness is reviewed and monitored by the Office of Thrift
Supervision ("OTS").
The Bank's core processing systems are outsourced through a contract with The
BISYS Group, Inc. ("BISYS"). BISYS has developed a Year 2000 Plan and provides
the Bank with periodic updates. BISYS also has held Year 2000 workshops, whose
objectives have been to assist the Bank in the development of its Year 2000
Plan, to provide updates on the BISYS Year 2000 plan, and training on the use of
the BISYS Year 2000 test facility, whose function is to allow BISYS clients to
test their systems' compatibility with the BISYS system. BISYS completed all
program maintenance associated with Year 2000 prior to October 31, 1998, and
expects a full year of testing prior to January 1, 2000. Like the Bank, BISYS
Year 2000 activities are subject to OTS oversight.
The incremental cost associated with the Bank's compliance is expected to be
less than $50,000. The majority of all hardware upgrades began in 1995 as a
result of the Bank's plan to increase efficiencies and eliminate obsolescence of
some system components. Should the Bank or any of its third party service
providers fail to complete Year 2000 measures in a timely manner, it would
likely have a material adverse effect, whose amount cannot be reasonably
estimated at this time.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
- ----------------------------------------------------
At September 30, 1998, the Corporation's assets totaled $189,286,000, an
increase of $18,042,000, or 10.54%, as compared to $171,244,000 at September 30,
1997. Investment and mortgage-backed securities increased $5,889,000 to
$29,555,000 from $23,666,000 at September 30, 1997. Loans held for sale, net,
increased $22,540,000 to $37,584,000 from $15,044,000 at September 30, 1997.
The increase in loans held for sale, net, was partially funded by advances from
the Federal Home Loan Bank and other borrowings which increased $3,462,000 from
September 30, 1997 to the same period in 1998. The majority of the
-9-
<PAGE>
increase in loans held for sale, net, represents fixed rate product purchased
from other organizations through the Bank's Mortgage Division that will be sold
into loan commitments. Loans held for investment, net, decreased $10,295,000 to
$104,618,000 from $114,913,000 at September 30, 1997. The decrease was due to
the high volume of refinancing activity in fixed rate product during fiscal
1998. Total deposits increased $11,959,000 from $117,944,000 at September 30,
1997 to $129,873,000 on September 30, 1998. The Bank experienced the significant
deposit growth as a result of ongoing marketing promotions throughout fiscal
1998. There was also a 13.11% growth in shareholders' equity from September 30,
1997 to September 30, 1998. During fiscal 1998 the Corporation implemented a
dividend reinvestment program that allows existing shareholders to reinvest
dividends and make additional cash contributions to purchase stock.
The Bank's liquidity, as measured by the ratio of cash, cash equivalents (not
committed, pledged or required to liquidate specific liabilities) and investment
securities to total deposits was approximately 14.66% at September 30, 1998.
Assets that qualify as eligible liquidity are defined by applicable federal
regulation and include cash and cash equivalents and certain types of United
States Treasury and agency obligations, and other similar investments. The
required ratio of such liquid investments is currently 4% of certain of the
Bank's liabilities as defined by the OTS. The liquidity requirement is changed
periodically by the OTS to reflect economic conditions. The Bank has relied
upon deposit growth and loan repayments as its principal sources of liquidity.
If deposit growth and loan repayments do not generate sufficient liquid funds in
the future, the Bank may borrow additional funds from the FHLB or liquidate
short-term investments. These sources of funds are intended to provide a
secondary source of relatively liquid funds upon which the Bank may rely, if
necessary. Commitments to fund loans in the ordinary course of business at
September 30, 1998 were approximately $2,736,000. See Note 10 to the financial
statements for further information about commitments and contingencies.
As of September 30, 1998, the Bank exceeded the OTS's capital requirements. See
Note 13 to the financial statements for further discussion of these capital
requirements.
IMPACT OF INFLATION AND CHANGING PRICES
- ---------------------------------------
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles, which require the
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation. Unlike industrial companies, virtually all of the
assets and liabilities of a financial institution are monetary in nature. As a
result, interest rates have a more significant impact on a financial
institution's performance than the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the prices of goods and services. However, non-interest expenses
do reflect general levels of inflation.
SUBSEQUENT EVENT
- ----------------
On October 5, 1998, the Corporation, through its subsidiary, Provident Community
Bank, entered into a definitive agreement with CCB Financial's wholly-owned
subsidiary, American Federal Bank, FSB to purchase the deposits of American
Federal's Union, South Carolina branch. The purchase is subject to regulatory
approval and is anticipated to close by February, 1999. The acquisition will be
accounted for as a purchase.
-10-
<PAGE>
[LETTERHEAD OF ELLIOTT, DAVIS & COMPANY, L.L.P.]
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Shareholders and Board of Directors
Union Financial Bancshares, Inc. and Subsidiary
Union, South Carolina
We have audited the accompanying consolidated balance sheets of UNION
FINANCIAL BANCSHARES, INC. AND SUBSIDIARY as of September 30, 1998 and 1997, and
the related consolidated statements of income, shareholders' equity, and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY as of September 30, 1998 and
1997 and the consolidated results of their operations and their cash flows for
the years then ended in conformity with generally accepted accounting
principles.
/s/ Elliott, Davis & Company, LLP
Elliott, Davis & Company, LLP
Greenville, South Carolina
November 6, 1998
-11-
<PAGE>
UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
---------------------------
<TABLE>
<CAPTION>
September 30,
--------------------------
1998 1997
-------- --------
(In Thousands)
<S> <C> <C>
Assets
- ------
Cash $ 2,469 $ 1,608
Short term interest-bearing deposits 1,124 6,213
-------- --------
Total cash and cash equivalents 3,593 7,821
-------- --------
Investment and mortgage-backed securities:
Held to maturity, at amortized cost (fair value 1998 - $2,744, 1997 - $7,927) 2,699 7,811
Available for sale, at fair value (amortized cost 1998 - $26,516, 1997 - $15,945) 26,856 15,855
-------- --------
Total investment and mortgage-backed securities 29,555 23,666
-------- --------
Loans, net
Held for sale 37,584 15,044
Held for investment 104,618 114,913
-------- --------
Total loans, net 142,202 129,957
Office properties and equipment, net 4,020 3,009
Federal Home Loan Bank Stock, at cost 2,023 2,105
Accrued interest receivable 1,197 1,317
Mortgage servicing rights 3,270 805
Other assets 3,426 2,564
-------- --------
Total assets $189,286 $171,244
======== ========
Liabilities
- -----------
Deposit accounts $129,873 $117,914
Securities sold under repurchase agreements 895 504
Advances from the Federal Home Loan Bank and other borrowings 41,441 37,979
Accrued interest payable 336 314
Advances from borrowers for taxes and insurance 496 389
Other liabilities 945 617
-------- --------
Total liabilities 173,986 157,717
-------- --------
Commitments and contingencies - note 12
Shareholders' equity
- --------------------
Serial preferred stock, no par value,
authorized - 500,000 shares, issued
and outstanding - None
Common stock - $0.01 par value,
authorized - 2,500,000 shares,
issued and outstanding - 1,278,250 shares in 1998 and 827,700 shares in 1997 13 8
Additional paid-in capital 4,471 3,993
Accumulated other comprehensive income 148 (63)
Retained earnings, substantially restricted 10,668 9,589
-------- --------
Total shareholders' equity 15,300 13,527
-------- --------
Total liabilities and shareholders' equity $189,286 $171,244
======== ========
</TABLE>
See notes to consolidated financial statements.
-12-
<PAGE>
UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
<TABLE>
<CAPTION>
For the Years Ended September 30,
------------------------------------
1998 1997 1996
---------- ---------- ----------
(In Thousands, Except Share Data)
<S> <C> <C> <C>
Interest Income:
Loans $ 11,865 $ 9,747 $ 6,436
Deposits and federal funds sold 110 63 100
Securities available for sale:
State and municipal 17 37 122
Other investments 980 1,128 1,832
Securities held to maturity:
Other investments 433 880 514
---------- ---------- ----------
Total interest income 13,405 11,855 9,004
---------- ---------- ----------
Interest Expense:
Deposit accounts 5,544 4,666 4,479
Advances from the FHLB and other 2,005 1,981 571
---------- ---------- ----------
Total interest expense 7,549 6,647 5,050
---------- ---------- ----------
Net Interest Income 5,856 5,208 3,954
Provision for loan losses -- (243) --
---------- ---------- ----------
Net interest income after provision for loan losses 5,856 4,965 3,954
---------- ---------- ----------
Non Interest Income:
Fees for financial services 791 710 411
Loan servicing fees (111) 88 70
Net gains on sale of investments -- 59 20
Gains on sale of loans 358 96 5
---------- ---------- ----------
Total non interest income 1,038 953 506
---------- ---------- ----------
Non Interest Expense:
Compensation and employee benefits 2,301 1,768 1,265
Occupancy and equipment 972 702 557
Deposit insurance premiums 54 93 821
Professional services 275 332 173
Real estate operations 10 (3) (2)
Other 835 724 410
---------- ---------- ----------
Total non interest expense 4,447 3,616 3,224
---------- ---------- ----------
Income before income taxes 2,447 2,302 1,236
Provision for income taxes 897 858 374
---------- ---------- ----------
Net Income $ 1,550 $ 1,444 $ 862
========== ========== ==========
Net Income per common share (Basic) $1.23 $1.17 $0.71
========== ========== ==========
Net Income per common share (Diluted) $1.15 $1.09 $0.69
========== ========== ==========
Dividends per common share $0.37 $0.35 $0.33
========== ========== ==========
Weighted average number of common shares outstanding 1,264,615 1,230,747 1,212,460
(Basic) ========== ========== ==========
Weighted average number of common shares outstanding 1,343,008 1,325,703 1,288,272
(Diluted) ========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
-13-
<PAGE>
UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
-----------------------------------------------
<TABLE>
<CAPTION>
Retained Accumulated
Common Stock Additional Earnings Other Total
--------------------- Paid-In Substantially Comprehensive Shareholders'
Shares Amount Capital Restricted Income Equity
------- ------ --------- ------------ -------- --------
(In Thousands, Except Share Data)
<S> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1995 $ 403,322 $ 4 $ 3,860 $ 8,120 $ (128) $ 11,856
Net income -- -- -- 862 -- 862
Other comprehensive income
Unrealized losses on securities:
Unrealized holding losses arising
during period -- -- -- -- (101) --
-----
Other comprehensive income -- -- -- -- (101) (101)
----- ------
Comprehensive income 761
-----
Options exercised 2,321 -- 41 -- -- 41
Two-for-one stock split 405,643 4 (4) - - --
Cash dividend ($.33 per share) -- -- -- (404) -- (404)
------- ------ ------ ------- ------ -------
Balance at September 30, 1996 811,286 8 3,897 8,578 (229) 12,254
Net income -- -- -- 1,444 -- 1,444
Other comprehensive income
Unrealized losses on securities:
Unrealized holding gains arising
during period -- -- -- -- 166 --
-----
Other comprehensive income -- -- -- -- 166 166
----- ------
Comprehensive income 1,610
-----
Options exercised 16,414 -- 96 -- -- 96
Cash dividend ($.35 per share) -- -- -- (433) -- (433)
------- ------ ------ ------- ------ -------
Balance at September 30, 1997 827,700 8 3,993 9,589 (63) 13,527
Net income -- -- -- 1,550 -- 1,550
Other comprehensive income
Unrealized losses on securities:
Unrealized holding losses arising
during period -- -- -- -- (211) --
-----
Other comprehensive income -- -- -- -- (211) (211)
----- ------
Comprehensive income 1,761
-----
Options exercised 9,920 -- 51 -- -- 51
Three-for-two stock split 413,850 4 -- (4) -- --
Dividend reinvestment plan contributions 26,780 1 427 -- -- 428
Cash dividend ($.37 per share) -- -- -- (467) -- (467)
--------- ------ ------ ------- ------ -------
Balance at September 30, 1998 1,278,250 13 4,471 10,668 148 15,300
========= ====== ====== ======= ====== =======
</TABLE>
See notes to consolidated financial statements.
-14-
<PAGE>
UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
<TABLE>
<CAPTION>
For the Years Ended September 30,
------------------------------------------
1998 1997 1996
----------- ----------- -----------
(In Thousands)
<S> <C> <C> <C>
Operating activities:
Net income $ 1,550 $ 1,444 $ 862
Adjustments to reconcile net income to
net cash (used in) provided by operating activities:
Provision for loan losses -- 243 --
Amortization expense 561 106 --
Depreciation expense 221 188 165
Recognition of deferred income, net of costs (140) (7) (111)
Deferral of fee income, net of costs 77 29 244
Gain on investment transactions -- (59) (20)
Loans originated for sale (141,436) (61,806) (805)
Proceeds from sale of loans 123,677 46,762 810
Gain on sale of loans held for sale (358) (96) (5)
(Increase) decrease in accrued interest receivable 120 (196) (241)
(Increase) decrease in other assets (862) 598 (614)
(Increase) decrease in accrued interest payable (22) 235 49
Increase (decrease) in other liabilities 434 (830) 426
----------- ----------- -----------
Net cash (used in) provided by operating activities (16,178) (13,389) 760
----------- ----------- -----------
</TABLE>
-15-
<PAGE>
UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
-------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended September 30,
----------------------------------------
1998 1997 1996
------------ ---------- ----------
(In Thousands)
<S> <C> <C> <C>
Investing activities:
Maturities of time deposits $ -- $ -- $ 99
Purchase of investment and mortgage-backed securities:
Held to maturity -- (2,000) (11,617)
Available for sale (20,368) (2,950) (10,228)
Proceeds from maturity of investment and mortgage- backed securities:
Held to maturity 4,497 500 500
Available for sale 7,978 4,450 4,568
Proceeds from sale of investment and mortgage-backed securities,
Available for sale -- 8,281 16,563
Principal repayments on mortgage-backed securities:
Held to maturity 616 137 242
Available for sale 1,388 1,712 6,387
Loan originations (43,568) (53,449) (37,078)
Principal repayments of loans 49,520 24,588 23,951
Proceeds from sale of real estate acquire in settlement of loans 27 7 36
Purchase of mortgage servicing rights (2,814) -- --
Purchase of FHLB stock -- (1,380) (197)
Redemption of FHLB stock 82 225 --
Purchase of office properties and equipment (1,231) (1,534) (116)
------------ ---------- ----------
Net cash used in investing activities (3,873) (21,413) (6,890)
------------ ---------- ----------
Financing activities:
Proceeds from the exercise of stock options 51 96 41
Proceeds from dividend reinvestment plan 427 -- --
Dividends paid in cash (467) (433) (404)
Proceeds from FHLB advances and other borrowings 117,891 99,440 43,763
Repayment of FHLB advances and other borrowings (114,038) (81,443) (36,355)
Acquired deposits from purchased branch -- 17,223 --
Increase (decrease) in deposit accounts 11,959 4,055 (1,035)
------------ ---------- ----------
Net cash provided by financing activities 15,823 38,938 6,010
------------ ---------- ----------
Net (decrease) increase in cash and cash equivalents (4,228) 4,136 (120)
Cash and cash equivalents at beginning of year 7,821 3,685 3,805
------------ ---------- ----------
Cash and cash equivalents at end of year $ 3,593 $ 7,821 $ 3,685
============ ========== ==========
</TABLE>
See notes to consolidated financial statements.
-16-
<PAGE>
UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization - Union Financial Bancshares, Inc. ("Union Financial") was
- ------------
incorporated in the State of Delaware in April 1994, for the purpose of becoming
a thrift holding company for Provident Community Bank (formerly known as Union
Federal Savings Bank), a federally chartered savings bank ("the Bank").
Provident Community Bank, founded in 1934, offers a complete array of financial
services throughout four full service banking centers in two counties in South
Carolina. The Bank offers a full range of financial services including
checking, savings, time deposits, individual retirement accounts (IRAs),
investment services, and secured and unsecured consumer loans. The Bank
originates and services home loans and provides financing for small businesses
and affordable housing.
Accounting Principles - The accounting and reporting policies of the Corporation
- ---------------------
conform to generally accepted accounting principles and to general practice
within the banking industry. In preparing the consolidated financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and expenses and
disclosure of commitments and contingencies. Actual results could differ from
those estimates. The following summarizes the more significant policies.
Basis of Consolidation - The accompanying consolidated financial statements
- ----------------------
include the accounts of Union Financial Bancshares, Inc. (the "Corporation") and
its wholly owned subsidiary, Provident Community Bank (the "Bank") and its
wholly owned subsidiary, Provident Financial Services, Inc. ("PFS"). PFS
consists primarily of investment brokerage services. All inter corporation
amounts and balances have been eliminated in consolidation.
Cash and Cash Equivalents - Cash and cash equivalents include cash on hand and
- -------------------------
amounts due from depository institutions, federal funds sold and short term,
interest-bearing deposits. From time to time, the Corporation's cash deposits
with other financial institutions may exceed the FDIC insurance limits.
Investments - The Bank accounts for investment securities in accordance with
- -----------
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for
--------------
Certain Investments in Debt and Equity Securities ("SFAS 115"). In accordance
- -------------------------------------------------
with the Statement, debt securities that the Bank has the positive intent and
ability to hold to maturity are classified as "held to maturity" securities and
reported at amortized cost. Debt and equity securities that are bought and held
principally for the purpose of selling in the near term are classified as
"trading" securities and reported at fair value, with unrealized gains and
losses included in earnings. Debt and equity securities not classified as
either held to maturity 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 shareholders'
equity. Transfers of securities between classifications will be accounted for
at fair value. No securities have been classified as trading securities.
Premiums and discounts on debt securities are amortized or accreted as
adjustments to income over the estimated life of the security using a method
approximating the level yield method. Gains or losses on the sale of securities
are based on the specific identification method. The fair value of securities
is based on quoted market prices or dealer quotes. If a quoted market price is
not available, fair value is estimated using quoted market prices for similar
securities.
Loans - Loans held for investment are recorded at cost. Mortgage loans consist
- -----
principally of conventional one-to-four family residential loans and interim and
permanent financing of non-residential loans that are secured by real estate.
Commercial loans are made primarily on the strength of the borrower's general
credit standing, the ability to generate repayment from income sources and the
collateral securing such loans. Consumer loans generally consist of home equity
loans, automobile and other personal loans.
In many lending transactions, collateral is taken to provide an additional
measure of security. Generally, the cash flow or earning power of the borrower
represents the primary source of repayment, and collateral liquidation serves as
a secondary source of repayment. The Corporation determines the need for
collateral on a case-by-case or product-by-product basis. Factors considered
include the current and prospective credit worthiness of the customer, terms of
the instrument and economic conditions.
Mortgage loans held for sale are valued at the aggregate lower of cost or market
as determined by outstanding commitments from investors or current investor
yield requirements calculated on the aggregate loan basis.
-17-
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Allowances for Estimated Losses - The Corporation maintains allowances for
- -------------------------------
estimated loan losses, uncollected accrued interest receivable and losses on
real estate acquired in settlement of loans. Loss provisions are charged to
income when, in the opinion of management, such losses for which no provision
has been made are probable.
The allowance for loan losses is based upon an evaluation of the loan portfolio.
The evaluation considers such factors as the delinquency status of loans,
current economic conditions, the net realizable value of the underlying
collateral and prior loan loss experience.
The Corporation provides an allowance for uncollectible interest on accrued
interest which is primarily related to loans more than ninety days delinquent
and other loans determined by management to be uncollectible. This allowance is
deducted from accrued interest for financial statement purposes.
Recovery of the carrying value of loans is dependent to some extent on the
future economic environment and operating and other conditions that may be
beyond the Corporation's control. Unanticipated future adverse changes in such
conditions could result in material adjustments to allowances (and future
results of operation).
Accounting for Impaired Loans - Impaired loans are accounted for in accordance
- -----------------------------
with SFAS No. 114, Accounting by Creditors for Impairment of a Loan
------------------------------------------------
("SFAS 114"), which was amended by SFAS No. 118. SFAS 114 requires that impaired
loans be measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate or, as a practical matter, at
the loan's observable market value or fair value of the collateral if the loan
is collateral dependent. The Corporation maintains an allowance for impaired
loans based on a combination of evaluation of impairment of smaller balance,
homogeneous loans (primarily consumer loans and 1-4 family real estate
mortgages) and specific identification of impaired loans based on delinquency
status and other factors related to the borrower's ability to repay the loan.
The risk characteristics used to aggregate loans are collateral type, borrower's
financial condition and geographic location.
The Corporation generally determines a loan to be impaired at the time
management believes that it is probable that the principal and interest may be
uncollectible. Management has determined that, generally, a failure to make a
payment within a 90-day period constitutes a minimum delay or shortfall and does
not generally constitute an impaired loan. However, management reviews each
past due loan on a loan-by-loan basis and may determine a loan to be impaired
prior to the loan becoming over 90 days past due, depending upon the
circumstances of that particular loan. A loan is classified as a nonaccrual
loan at the time management believes that the collection of interest is
improbable, generally when a loan becomes 90 days past due. The Corporation's
policy for charge-off of impaired loans is on a loan-by-loan basis. At the time
management believes the collection of interest and principal is remote, the loan
is charged off. The Corporation's policy is to evaluate impaired loans based on
the fair value of the collateral. Interest income from impaired loans is
recorded using the cash method.
As of and for the years ended September 30, 1998 and 1997, there were no
impaired loans and the Corporation had recognized no interest income from
impaired loans.
Office Properties and Equipment - Office properties and equipment are presented
- -------------------------------
at cost less accumulated depreciation. Depreciation is provided on the straight-
line basis over the estimated useful lives of the assets. Estimated useful
lives are 20-50 years for buildings and improvements and generally five to ten
years for furniture, fixtures and equipment.
The cost of maintenance and repairs is charged to expense as incurred, and
improvements and other expenditures, which materially increase property lives,
are capitalized. The costs and accumulated depreciation applicable to office
properties and equipment retired or otherwise disposed of are eliminated from
the related accounts, and any resulting gains or losses are credited or charged
to income.
Mortgage Servicing Rights - Effective October 1, 1996, the Corporation adopted
- -------------------------
SFAS No. 122, Accounting for Mortgage Servicing Rights. The statement
----------------------------------------
eliminates the distinction between originated and purchased mortgage servicing
rights. Since the adoption of SFAS 122, the Corporation capitalizes the
allocated cost of originated mortgage servicing rights and records a
corresponding increase in mortgage banking income.
Purchased mortgage servicing rights are recorded at the lower of cost or market.
Originated mortgage servicing rights are capitalized based on the allocated cost
which is determined when the underlying loans are sold or securitized. MSRs
are amortized in proportion to and over the period of estimated net servicing
income using a method that is designed to approximated a level-yield method,
taking into consideration the estimated prepayment of the underlying loans. For
purposes of measuring impairment, MSRs are periodically reviewed for impairment
based upon quarterly valuations. Such valuations are based on projections using
a discounted cash flow method that includes assumptions regarding prepayments,
servicing costs and other factors. Impairment is measured on a disaggregated
basis for each pool of rights.
-18-
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Real Estate Acquired Through Foreclosure - Real estate acquired through
- ----------------------------------------
foreclosure is stated at the lower of cost or estimated fair value less
estimated costs to sell. Any accrued interest on the related loan at the date
of acquisition is charged to operations. Costs relating to the development and
improvement of property are capitalized to the extent that such costs do not
exceed the estimated fair value less selling costs of the property, whereas
those relating to holding the property are charged to expense.
Deferred Loan Origination Fees - Nonrefundable loan fees and certain direct loan
- ------------------------------
origination costs are deferred and recognized over the lives of the loans using
the level yield method. Amortization of these deferrals is recognized as
interest income.
Sale of Loans - The Corporation frequently sells and retains servicing rights on
- -------------
certain mortgage loans. Gains or losses on the sale of such loans are
recognized when substantially all risks and rewards of ownership are
transferred. If loan servicing is retained, the value of future servicing
rights are considered in the determination of the amount of gain or loss.
Income Taxes - The Bank accounts for income taxes in accordance with SFAS
- ------------
No. 109, Accounting for Income Taxes. Under SFAS 109, deferred income taxes
---------------------------
reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. A valuation allowance is established for
deferred tax assets that may not be realized. Also, SFAS 109 eliminates, on a
prospective basis, the exception from the requirement to record deferred taxes
on tax basis bad debt reserves in excess of the base year amounts. The tax basis
bad debt reserve that arose prior to the fiscal year 1988 (the base year amount)
is frozen, and the book reserves at that date and all subsequent changes in book
and tax basis reserves are included in the determination of deferred taxes.
Fair Values of Financial Instruments - The following methods and assumptions
- ------------------------------------
were used by the Corporation in estimating fair values of financial instruments
as disclosed herein:
Cash and short-term instruments - The carrying amounts of cash and short-term
instruments approximate their fair value.
Available for sale and held to maturity securities - Fair values for
securities are based on quoted market prices. The carrying values of
restricted equity securities approximate fair values.
Loans - For variable rate loans that reprice frequently and have no
significant change in credit risk, fair values are based on carrying values.
Fair values for certain mortgage loans (for example, one-to-four-family
residential), credit-card loans, and other consumer loans are based on quoted
market prices of similar loans sold in conjunction with securitization
transactions, adjusted for differences in loan characteristics. Fair values
for commercial real estate and commercial loans are estimated using
discounted cash flow analysis, using interest rates currently being offered
for loans with similar terms to borrowers of similar credit quality. Fair
values for impaired loans are estimated using discounted cash flow analysis
or underlying collateral values, where applicable.
Deposit liabilities - The fair values disclosed for demand deposits are, by
definition, equal to the amount payable on demand at the reporting date (that
is, their carrying amounts). The carrying amounts of variable-rate, fixed-
term money-market accounts and certificates of deposit (CD's) approximate
their fair values at the reporting date. Fair values for fixed-rate CD's are
estimated using a discounted cash flow calculation that applies interest
rates currently being offered on certificates to a schedule of aggregated
expected monthly maturities on time deposits.
Short-term borrowings - The carrying amounts of other short-term borrowings
maturing within 90 days approximate their fair values. Fair values of other
short-term borrowings are estimated using discounted cash flow analysis based
on the Corporation's current incremental borrowing rates for similar types of
borrowing arrangements.
Long-term debt - The fair values of the Corporation's long-term debt are
estimated using discounted cash flow analysis based on the Corporation's
current incremental borrowing rates for similar types of borrowing
arrangements.
Accrued interest - The carrying amounts of accrued interest approximate their
fair values.
Off-balance-sheet instruments - Fair values for off-balance-sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counter parties' credit standings.
Per-Share Data - SFAS 128, Earnings Per Share, issued in February 1997,
- -------------- ------------------
simplifies the standard for computing earnings per share and makes them
comparable to international earnings per share standards. It also requires the
dual presentation of basic and diluted earnings per share on the face of the
income statement.
-19-
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Basic earnings per share is computed by dividing net income by the weighted-
average number of shares outstanding for the period. Diluted earnings per share
is similar to the computation of basic earnings per share except that the
denominator is increased to include the number of additional common share that
would have been outstanding if the dilutive potential common shares had been
issued. The dilutive effect of options outstanding under the Corporation's stock
option plan is reflected in diluted earnings per share by the application of
the treasury stock method.
SFAS128 became effective for the Corporation as of September 30, 1998. As
required by SFAS 128, all prior period earnings per share data presented has
been restated to conform with the provisions of the statement.
Share and per-share data have been restated to reflect stock splits issued in
July 1996 and February 1998.
Intangible Assets - Intangible assets, included in other assets, consist of core
- -----------------
deposit premiums resulting from the Corporation's branch acquisition.
During 1998, $212,000 of intangible expense was charged to operations. Core
deposit intangibles are being amortized over 10 years using the straight-line
method.
Interest Income - Interest on loans is accrued and credited to income monthly
- ---------------
based on the principal balance outstanding and the contractual rate on the loan.
The Corporation places loans on non-accrual status when they become greater than
ninety days delinquent or when in the opinion of management, full collection of
principal or interest is unlikely. The Corporation provides an allowance for
uncollectible accrued interest on loans which are ninety days delinquent for all
interest accrued prior to the loan being placed on non-accrual status. The
loans are returned to an accrual status when full collection of principal and
interest appears likely.
Comprehensive Income - In June, 1997, the FASB issued SFAS No. 130, Reporting
- -------------------- ---------
Comprehensive Income, which establishes standards for reporting and display of
- --------------------
comprehensive income and its components in a full set of general purposes
financial statements. Under this statement, enterprises are required to
classify items of "other comprehensive income" by their nature in the financial
statement and display the balance of other comprehensive income separately in
the equity section of a statement of financial position. Statement 130 is
effective for both interim and annual periods beginning after December 15, 1997.
Comparative financial statements provided for earlier periods are required to be
reclassified to reflect the provisions of the statement. The adoption of this
standard did not have a material effect on the Corporation.
Reclassifications - Certain amounts in prior years' financial statements have
- -----------------
been reclassified to conform with current year classifications.
-20-
<PAGE>
2. INVESTMENT AND MORTGAGE-BACKED SECURITIES
Held to Maturity - Securities classified as held to maturity consisted of the
- ----------------
following (in thousands):
<TABLE>
<CAPTION>
September 30, 1998
-----------------------------------------
Gross Unrealized
Amortized ------------------ Fair
Cost Gains Losses Value
---------- -------- -------- --------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Agency Obligations $ 1,500 $24 -- $1,524
Mortgage-backed Securities:
GNMA 1,199 21 -- 1,220
---------- -------- -------- --------
Total held to maturity $ 2,699 $45 -- $2,744
========== ======== ======== ========
<CAPTION>
September 30, 1997
-----------------------------------------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Agency Obligations $5,995 $ 51 ($29) $6,017
---------- -------- -------- --------
Mortgage-backed Securities:
GNMA 1,816 94 -- 1,910
Total held to maturity $7,811 $145 ($29) $7,927
========== ======== ======== ========
</TABLE>
Available for Sale - Securities classified as available for sale consisted of
- ------------------
the following (in thousands):
<TABLE>
<CAPTION>
September 30, 1998
-------------------------------------------
Gross Unrealized
Amortized ------------------ Fair
Cost Gains Losses Value
---------- -------- -------- --------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Agency Obligations $ 7,668 $ 45 ($31) $ 7,682
Municipal Securities 449 2 -- 451
---- -- --- ----
Total Investment Securities 8,117 47 (31) 8,133
---------- -------- -------- --------
Mortgage-backed Securities:
FHLMC 9,713 158 -- 9,871
FNMA 880 16 (2) 894
CMOs 7,806 157 (5) 7,958
----- --- --- -----
Total Mortgage-backed Securities 18,399 331 (7) 18,723
---------- -------- -------- --------
Total available for sale $26,516 $378 ($38) $26,856
========== ======== ======== ========
<CAPTION>
September 30, 1997
-------------------------------------------
Gross Unrealized
Amortized ------------------ Fair
Cost Gains Losses Value
---------- -------- -------- --------
<S> <C> <C> <C> <C>
Investment Securities:
U.S. Agency Obligations $10,429 $21 ($109) $10,341
Municipal Securities 449 -- (2) 447
---- --- --- ----
Total Investment Securities 10,878 21 (111) 10,788
---------- -------- -------- --------
Mortgage-backed Securities
FHLMC 2,783 11 (8) 2,786
FNMA 1,388 11 (3) 1,396
CMOs 896 5 (16) 885
---- --- ---- ----
Total Mortgage-backed Securities 5,067 27 (27) 5,067
Total available for sale $15,945 $48 ($138) $15,855
========== ======== ======== ========
</TABLE>
-21-
<PAGE>
2. INVESTMENT AND MORTGAGE-BACKED SECURITIES (CONTINUED)
Proceeds, gross gains and gross losses realized from the sales, calls and
prepayments of available for sale securities were as follows for the years ended
(in thousands):
<TABLE>
<CAPTION>
September 30,
-------------------------------
1998 1997 1996
------ ------ -------
<S> <C> <C> <C>
Proceeds $7,978 $8,281 $21,131
------ ------ -------
Gross gains -- 76 168
Gross losses -- 17 148
------ ------ -------
Net gain on investment transactions $ 0 $ 59 $ 20
====== ====== =======
</TABLE>
<TABLE>
<CAPTION>
The maturities of securities at September 30, 1998 are as follows (in thousands):
Held to Maturity Available for Sale
----------------- -------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------ ------ ------- -------
<S> <C> <C> <C> <C>
Due in one year or less $ 0 $ 0 $ 863 $ 861
Due after one year through five years 0 0 2,402 2,405
Due after five years through ten years 1,500 1,524 474 482
Due after ten years 1,199 1,220 22,777 23,108
------ ------ ------- -------
Total investment and mortgage-backed
securities $2,699 $2,744 $26,516 $26,856
====== ====== ======= =======
</TABLE>
The mortgage-backed securities held at September 30, 1998 mature between one and
thirty years. The actual lives of those securities may be significantly shorter
as a result of principal payments and prepayments.
At September 30, 1998 and 1997, $10,383,000 and $9,013,000, respectively, of
securities were pledged as collateral for certain deposits.
At September 30, 1998, approximately $1,395,000 of the debt securities and
$751,000 of mortgage-backed securities were adjustable rate securities. The
adjustment periods range from monthly to annually and rates are adjusted based
on the movement of a variety of indices.
Investments in collateralized mortgage obligations ("CMOs") represent securities
issued by agencies of the federal government.
-22-
<PAGE>
3. LOANS, NET
Loans receivable consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
Conventional real estate loans:
Fixed rate residential
Held for sale $ 37,584 $ 8,044
Held for investment 24,075 30,036
Fixed rate commercial 4,053 3,629
Adjustable rate residential
Held for sale -- 7,000
Held for investment 48,531 57,365
Adjustable rate commercial 140 170
Construction loans 12,838 13 ,508
-------- --------
Total real estate loans 127,221 119,752
-------- --------
Other loans:
Consumer and installment loans 9,797 9,957
Commercial loans 3,539 2,550
Consumer lines of credit 7,404 4,961
Loans secured by deposit accounts 1,551 183
-------- --------
Total other loans 22,291 17,651
-------- --------
Total loans 149,512 137,403
-------- --------
Less:
Undisbursed portion of interim
construction loans (6,625) (6,598)
Allowance for loan losses (827) (928)
Net deferred loan origination costs 142 80
-------- --------
Total, net $142,202 $129,957
======== ========
Weighted-average interest rate of loans 8.01% 8.05%
</TABLE>
Participations sold and serviced by the Corporation at September 30, 1998 and
1997 were approximately $164,396,000 and $64,730,000, respectively. The
Corporation sells loans in the secondary market without recourse and retains
servicing rights. Servicing loans for others consists of collecting mortgage
payments, maintaining escrow accounts, disbursing payments to investors and
foreclosure processing. Loan servicing income is recorded on the accrual basis
and includes servicing fees received from the investors as well as certain
charges collected from the borrowers, such as late payment fees. In connection
with these loans serviced for others, the Corporation held borrowers' escrow
balances of $496,000 at September 30, 1998 and $389,000 at September 30, 1997.
Adjustable rate real estate loans (approximately $48,671,000 and $64,535,000 at
September 30, 1998 and 1997, respectively) are subject to rate adjustments
annually and generally are adjusted based on movement of the Federal Home Loan
Bank National Monthly Median Cost of Funds rate or the Constant Maturity
Treasury index. The maximum loan rates can be adjusted is 200 basis points in
any one year with a lifetime cap of 600 basis points.
The Corporation made commercial real estate loans which totaled approximately
$4,193,000 and $3,799,000 at September 30, 1998 and 1997, respectively. These
loans are considered by management to contain a somewhat greater risk of
uncollectibility due to the dependency on income production or future
development and sale of the real estate. These commercial real estate loans are
collateralized by housing for the aged, churches, motels, apartments and other
improved real estate.
Mortgage loans held for sale are stated at the lower of aggregate cost or
market, net of discounts and deferred loan fees and are included in net loans in
the consolidated balance sheets. Nonrefundable deferred origination fees and
cost and discount points collected at loan closing, net of commitment fees paid,
are deferred and recognized at the time of sale of the mortgage loans. Gain or
loss on sales of mortgage loans is recognized based upon the difference between
the selling price and the
-23-
<PAGE>
3. LOANS NET (CONTINUED)
carrying amount of the mortgage loans sold. Other fees earned during the loan
origination process are also included in net gain or loss on sales of mortgage
loans.
Mortgage servicing rights are accounted for in accordance with SFAS No. 122,
Accounting for Mortgage Servicing Rights. SFAS No. 122 requires that an entity
- ----------------------------------------
recognize, as separate assets, rights to service mortgage loans for others,
whether purchased or originated, by allocating the total cost of loans between
the loan and the mortgage servicing rights ("MSR") based on their relative fair
values.
Capitalized MSRs are amortized based on a method which approximates the
proportion of current net servicing revenues to the total estimated net
servicing revenues expected to be recognized over the average estimated
remaining lives of the underlying loans. Capitalized MSRs are assessed for
impairment based on their fair values.
The Bank paid $2,687,000 for mortgage servicing rights for approximately
$141,436,000 of loans in 1998. The amortization of servicing rights and excess
servicing rights included in loan servicing fees amounted to $348,764, $19,171,
and $0 in 1998, 1997, and 1996 respectively.
The fair value of mortgage servicing rights at September 30, 1998 is
approximately $3,270,000.
Under OTS regulations, the Bank may not make loans to one borrower in excess of
15% of unimpaired capital. This limitation does not apply to loans made before
August 9, 1989. At September 30, 1998, the Bank had loans outstanding to one
borrower ranging up to $1,485,000 and was in compliance with this regulation.
Also under current regulations, the Bank's aggregate commercial real estate
loans may not exceed 400% of its capital as determined under regulatory
requirements. These limitations are not expected to have a material impact on
the Bank's ongoing operations.
At September 30, 1998 and 1997, loans which are accounted for on a non-accrual
basis or contractually past due ninety days or more totaled approximately
$696,000 and $778,000, respectively. The amount the Corporation will ultimately
realize from these loans could differ materially from their carrying value
because of future developments affecting the underlying collateral or the
borrower's ability to repay the loans. During the years ended September 30,
1998, 1997, and 1996, the Corporation recognized no interest income on loans
past due 90 days or more, whereas, under the original terms of these loans, the
Corporation would have recognized additional interest income of approximately
$20,000, $36,000, and $34,000, respectively.
The changes in the allowance for loan losses consisted of the following (in
thousands):
<TABLE>
<CAPTION>
Years Ended September 30,
----------------------------
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Balance at beginning of year $ 928 $ 799 $878
Provision for loan losses -- 243 --
(Charge-offs) recoveries, net (101) (114) (79)
----- ----- -----
Balance at end of year $ 827 $ 928 $799
===== ===== =====
</TABLE>
Directors and officers of the Corporation are customers of the Corporation in
the ordinary course of business. Loans of directors and officers have terms
consistent with those offered to other customers. Loans to officers and
directors of the Corporation are summarized as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1998 1997
------- ------
<S> <C> <C>
Balance at beginning of year $ 1,014 $ 712
Loans originated during the year 1,908 685
Loan repayments during the year (1,003) (383)
------- ------
Balance at end of year $ 1,919 $1,014
======= ======
</TABLE>
-24-
<PAGE>
4. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30,
--------------------------
1998 1997
------- -------
<S> <C> <C>
Land $ 660 $ 422
Building and improvements 2,859 2,096
Office furniture, fixtures and equipment 2,151 1,922
------- -------
Total 5,670 4,440
Less accumulated depreciation (1,650) (1,431)
------- -------
Office properties and equipment - net $ 4,020 $ 3,009
======= =======
</TABLE>
5. DEPOSIT ACCOUNTS
Deposit accounts at September 30, were as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------------------------------- --------------------------------
Rate Balance % Rate Balance %
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Account Type
- ------------
NOW accounts:
Commercial noninterest-bearing 0.00% $ 7,119 5.48% 0.00% $ 6,502 5.52%
Noncommercial 1.33% 10,925 8.41% 1.33% 9,982 8.47%
Money market checking accounts 3.40% 6,832 5.26% 3.89% 6,913 5.86%
Regular savings 1.97% 11,849 9.13% 2.43% 11,652 9.88%
------- ------ -------- ------
Total demand and savings deposits 1.60% 36,725 28.28% 1.95% 35,049 29.73%
------- ------ -------- ------
Savings certificates:
Up to 3.00% 29 0.02% 22 0.02%
3.01 %- 4.00% 55 0.04% -- 0.00%
4.01 %- 5.00% 19,393 14.93% -- 0.00%
5.01 %- 6.00% 68,969 53.11% 77,401 65.64%
6.01 %- 7.00% 4,702 3.62% 5,342 4.61%
-------- ------ -------- ------
Total savings certificates 5.51% $ 93,148 71.72% 5.39% 82,765 70.27%
-------- ------ -------- ------
Total deposit accounts 4.40% $129,873 100.00% 4.39% $117,914 100.00%
====== ======== ====== ====== ======== ======
</TABLE>
As of September 30, 1998 and 1997, total deposit accounts include approximately
$1,432,000 and $1,528,000, respectively, of deposits from the Corporation's
officers, shareholders, employees or parties related to them.
At September 30, 1998 and 1997, deposit accounts with balances of $100,000 and
over totaled approximately $18,829,000 and $13,238,000, respectively.
Savings certificates by maturity were as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
------------------------
1998 1997
------- -------
<S> <C> <C>
Maturity Date
- -------------
Within 1 year $74,647 $60,910
After 1 but within 2 years 11,408 14,178
After 2 but within 3 years 2,038 4,017
Thereafter 5,055 3,660
------- -------
Total certificate accounts $93,148 $82,765
======= =======
</TABLE>
-25-
<PAGE>
5. DEPOSITS ACCOUNTS (CONTINUED)
Interest expense on deposits consisted of the following (in thousands):
<TABLE>
<CAPTION>
Years Ended September 30,
--------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Account Type
- ------------
NOW accounts and money market deposit accounts $ 410 $ 353 $ 264
Passbook and statement savings accounts 253 275 302
Certificate accounts 4,912 4,062 3,926
Early withdrawal penalties (31) (24) (13)
------ ------ ------
Total $5,544 $4,666 $4,479
====== ====== ======
</TABLE>
6. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
Securities sold under repurchase agreements at September 30, 1998 and 1997,
amounted to $895,000 and $504,000, respectively. U.S. government securities
with a book value of $1,000,000 ($1,001,000 market value) at September 30, 1998,
are used as collateral for the agreements.
The Corporation enters into sales of securities under agreements to repurchase
(reverse repurchase agreements). Fixed coupon reverse repurchase agreements are
treated as financings. The obligations to repurchase securities sold are
reflected as a liability and securities underlying the agreements continue to be
reflected as assets in the Consolidated Balance Sheets.
7. ADVANCES FROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
At September 30, 1998 and 1997, the Bank had $41,441,000 and $37,979,000,
respectively, of advances outstanding from the Federal Home Loan Bank and
treasury, tax and loan deposits. The maturity of the advances from the Federal
Home Loan Bank and treasury, tax and loan deposits is as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
--------------------------
1998 1997
---- ----
<S> <C> <C>
Contractual Maturity:
Within one year - fixed rate $19,441 $15,979
Within one year - adjustable rate 16,000 0
After one but within two years - fixed rate 1,000 5,000
After one but within two years - adjustable rate 5,000 17,000
------- -------
Total Advances $41,441 $37,979
======= =======
Weighted average rate 5.69% 6.00%
</TABLE>
The Bank pledges as collateral to the advances their Federal Home Loan Bank
Stock, and has entered into a blanket collateral agreement with the Federal Home
Loan Bank whereby the Bank maintains, free of other encumbrances, qualifying
mortgages (as defined) with unpaid principal balances equal to, when discounted
at 75% of the unpaid principal balances, 100% of total advances. The amount of
qualifying mortgages was $117,840,000 and $106,880,000, respectively, at
September 30, 1998 and 1997.
-26-
<PAGE>
8. INCOME TAXES
Income tax expense is summarized as follows (in thousands):
<TABLE>
<CAPTION>
For the Years Ended September 30,
----------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Current $1,094 $ 755 $ 540
Deferred 197 103 (166)
------ ----- -----
Total income taxes $ 897 $ 858 $ 374
====== ===== =====
</TABLE>
The provision for income taxes differed from amounts computed by applying the
statutory federal rate of 34% to income before income taxes as follows (in
thousands):
<TABLE>
<CAPTION>
For the Years Ended September 30,
----------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Tax at federal income tax rate $832 $783 $420
Increase (decrease) resulting from:
State income taxes, net of federal benefit 96 91 57
Interest on municipal bonds (6) (10) (37)
Other, net (25) (6) (66)
---- ---- ----
Total $897 $858 $374
==== ==== ====
</TABLE>
The tax effects of significant items comprising the Corporation's deferred taxes
as of September 30, 1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
---------------------
1998 1997
---- ----
<S> <C> <C>
Deferred tax assets:
Deferred loan fees $ -- $ 32
Book reserves in excess of tax basis bad debt reserves 331 177
Mark to market adjustment on securities 136 --
Book reserves in excess of tax basis mortgage servicing rights reserves 67 --
Total deferred tax asset 534 209
---- -----
Deferred tax liabilities:
Difference between book and tax property basis 210 157
Difference between book and tax Federal Home Loan Bank stock basis 100 100
Deferred loan fees 57 -
Mark to market adjustment on securities -- 17
Tax bad debt reserve in excess of base year reserve - 94
Other 3 --
---- -----
Total deferred tax liability 370 368
---- -----
Net deferred tax asset (liability) $164 ($159)
==== =====
</TABLE>
Net deferred tax assets of $164,000 at September 30, 1998, are included in other
assets in the balance sheet. Net deferred tax liabilities of $159,000 at
September 30, 1997, are included in other liabilities in the balance sheet.
Legislation has been passed which repeals the "reserve" method of accounting for
thrift bad debt reserves for the first tax year beginning after December 31,
1995 (the fiscal year ending September 30, 1999 for the Corporation which
qualifies for deferral of the recapture under the "residential loan
requirement"). This legislation requires all thrifts (including the
Corporation) to account for bad debts using either the specific charge-off
method (available to all thrifts) or the experience method (available only to
thrifts that qualify as "small banks," i.e. under $500 million in assets). The
Corporation currently uses the experience method of accounting for its tax bad
debt reserves. The legislation also suspends recapture of bad debt reserves
taken through 1987 (i.e., the base year reserve), but requires thrifts to
recapture or repay bad debt deductions taken after 1987 over six years.
<PAGE>
8. INCOME TAXES (CONTINUED)
As of September 30, 1998, the bad debt reserve subject to recapture, for which
deferred taxes have previously been provided, totaled approximately $275,000.
As permitted under SFAS 109, no deferred tax liability is provided for
approximately $1,636,000 ($621,000 approximate tax effect) of such tax bad debt
reserves that arose prior to October 1, 1988.
9. EMPLOYEE BENEFITS
The Corporation has a contributory profit-sharing plan which is available to all
eligible employees. Annual employer contributions to the plan consist of an
amount which matches participant contributions up to a maximum of 5% of a
participant's compensation and a discretionary amount determined annually by the
Corporation's Board of Directors. In addition, the corporation implemented a
money purchase pension plan, effective October 1, 1996, in which all eligible
employees participate. The annual contributions to the pension plan will be 5%
of a participant's compensation. Employer expensed contributions to the plans
were $182,000, $91,000, and $38,000 for the years ended September 30, 1998, 1997
and 1996, respectively.
10. FINANCIAL INSTRUMENTS
The Corporation is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments are commitments to extend credit. Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. The Corporation evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if it is deemed
necessary by the Corporation upon extension of credit, is based on management's
credit evaluation of the counter-party. Collateral held varies but may include
accounts receivable, inventory, property, plant, and equipment and income-
producing commercial properties.
Those instruments involve, to varying degrees, elements of credit and interest-
rate-risk in excess of the amount recognized in the Consolidated Balance Sheets.
The contract amounts of those instruments reflect the extent of the
Corporation's involvement in particular classes of financial instruments.
The Corporation's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Corporation
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments.
The Corporation had loan commitments as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
-----------------------
1998 1997
---- ----
<S> <C> <C>
Fixed interest rate commitments to extend credit $ 2,736 $ 1,290
Undisbursed portion of interim construction loans 6,393 6,598
Unused portion of credit lines (principally variable-rate
consumer lines secured by real estate) 5,767 4,463
------- -------
Total $14,896 $12,351
======= =======
</TABLE>
The Corporation has no additional financial instruments with off-balance sheet
risk.
The Corporation has not been required to perform on any financial guarantees
during the past two years. The Corporation has not incurred any losses on its
commitments in 1998, 1997 or 1996.
-28-
<PAGE>
10. FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values of the Corporation's financial instruments were as
follows at September 30, 1998 (in thousands):
<TABLE>
<CAPTION>
September 30, 1998
-------------------------------------
Carrying Amount Fair Value
--------------- ----------
<S> <C> <C>
Financial assets
- ----------------
Cash and cash equivalents $ 3,593 $ 3,593
Securities available for sale 26,856 26,856
Securities held to maturity 2,699 2,744
FHLB Stock 2,023 2,023
Loans 142,202 144,634
Accrued interest receivable 1,197 1,197
Financial liabilities
- ---------------------
Deposits $129,873 $128,850
Advances from FHLB and other borrowings 41,441 41,547
Securities sold under repurchase agreements 895 895
Off-balance-sheet asset (liabilities)
- -------------------------------------
Commitments to extend credit $ 14,896 $ 14,896
</TABLE>
<TABLE>
<CAPTION>
September 30, 1997
-------------------------------------
Carrying Amount Fair Value
--------------- ----------
<S> <C> <C>
Financial assets
- ----------------
Cash and cash equivalents $ 7,821 $ 7,821
Securities available for sale 15,855 15,855
Securities held to maturity 7,811 7,927
FHLB Stock 2,105 2,105
Loans 129,957 131,887
Accrued interest receivable 1,317 1,317
Financial liabilities
- ---------------------
Deposits 117,914 115,332
Advances from FHLB and other borrowings 37,979 38,457
Securities sold under repurchase agreements 504 504
Off-balance-sheet asset (liabilities)
Commitments to extend credit $ 12,351 $ 12,351
</TABLE>
11. SUPPLEMENTAL CASH FLOW DISCLOSURES
<TABLE>
<CAPTION>
For the Years Ended September 30,
----------------------------------
1998 1997 1996
--------- -------- ----------
<S> <C> <C> <C>
Cash paid for:
Income taxes, net of refund $ 792 $ 873 $1,139
Interest 7,213 6,333 5,001
Non-cash transactions:
Loans foreclosed -- -- 17
Unrealized gain (loss) on securities available for sale $ 340 $ 166 ($353)
</TABLE>
-29-
<PAGE>
12. COMMITMENTS AND CONTINGENCIES
Concentrations of Credit Risk - The Corporation's business activity is
- -----------------------------
principally with customers located in South Carolina. Except for residential
loans in the Corporation's market area, the Corporation has no other significant
concentrations of credit risk.
Litigation - The Corporation is involved in legal actions in the normal course
- ----------
of business. In the opinion of management, based on the advice of its general
counsel, the resolution of these matters will not have a material adverse impact
on future results of operations or the financial position of the Corporation.
Potential Impact of Changes in Interest Rates - The Corporation's profitability
- ---------------------------------------------
depends to a large extent on its net interest income, which is the difference
between interest income from loans and investments and interest expense on
deposits and borrowings. Like most financial institutions, the Corporation's
interest income and interest expense are significantly affected by changes in
market interest rates and other economic factors beyond its control. The
Corporation's interest-earning assets consist primarily of long-term, fixed rate
mortgage loans and investments which adjust more slowly to changes in interest
rates than its interest-bearing liabilities which are primarily term deposits
and advances. Accordingly, the Corporation's earnings would be adversely
affected during periods of rising interest rates.
13. STOCK OPTION AND OWNERSHIP PLANS
The Corporation has a stock option incentive compensation plan through which the
Board of Directors may grant stock options to officers and employees to purchase
common stock of the Corporation at prices not less than 100 percent of the fair
market value on the date of grant. The outstanding options expire ten years
from the date of grant. The Corporation applies Accounting Principles Board
(APB) Opinion 25 and related Interpretations in accounting for the plan.
Accordingly, no compensation cost has been charged to operations. Had
compensation cost for the plan been determined based on the fair value at the
grant dates for awards under the plan consistent with the accounting method
available under SFAS No. 123, Accounting for Stock-Based Compensation, the
---------------------------------------
Corporations's net income and net income per common share would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income (in thousands)
As reported $1,550 $1,444 $ 862
Pro forma 1,532 1,443 859
Basic net income per common share
As reported 1.23 1.17 .071
Pro forma 1.21 1.17 .071
Diluted net income per common share
As reported $ 1.15 $ 1.09 $0.69
Pro forma 1.14 1.09 0.69
</TABLE>
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Dividend yield 2% 2% 2%
Expected volatility 17% 17% 10%
Risk-free interest rate 6% 6% 5%
Expected lives 10 years 10 years 10 years
</TABLE>
A summary of the status of the plan as of September 30, 1998 and 1997, and
changes during the years ending on those dates is presented below (all shares
have been adjusted for the 2 for 1 stock split in July 1996 and 3:2 stock split
in February 1998):
<TABLE>
<CAPTION>
Shares Average Option Price Expiration
Grant Date Granted Per Share Date
- ---------- -------------------- ---------------- ---------------
<S> <C> <C> <C>
October, 1995 128,500 6.08 October, 2005
January, 1996 2,100 6.08 January, 2006
April, 1996 6,000 7.00 April, 2006
March, 1997 6,150 10.50 March, 2007
May, 1998 40,000 16.63 May, 2008
-------
Total Shares Granted 182,750
</TABLE>
- 30 -
<PAGE>
13. STOCK OPTION AND OWNERSHIP PLANS (CONTINUED)
As of September 30, 1998, the number of shares exercisable were 79,557.
Options were exercised as follows:
<TABLE>
<CAPTION>
Average Exercise
For the Years Ended September 30, Shares Exercised Price Per Share
- ---------------------------------- ---------------- ---------------
<S> <C> <C>
1998 9,920 $5.09
1997 24,621 $3.94
1996 6,963 $5.93
</TABLE>
No stock options have been forfeited during the years ended September 30, 1998,
1997, and 1996. At September 30, 1998, 8,900 shares were available for grant.
The Plan also provides for stock appreciation rights ("SARs"). To date, no SARs
have been granted. Employees participate in stock ownership through the profit
sharing plan (see Note 9).
During the fiscal year 1998, the Corporation implemented a dividend reinvestment
plan that allows existing shareholders to reinvest their dividends for the
purchase of additional Union Financial Bancshares stock. In addition, the plan
can accept cash contributions up to a maximum of $50,000 annually for the
purchase of Union Financial Bancshares stock. The plan currently offers a
5% discount on all purchases and does not charge purchase fees.
14. SHAREHOLDERS' EQUITY, DIVIDEND RESTRICTIONS AND REGULATORY MATTERS
On August 7, 1987, the Bank completed its conversion from a federally chartered
mutual association to a federally chartered stock association. A special
liquidation account was established by the Bank for the preconversion retained
earnings of approximately $3,718,000. The liquidation account will be
maintained for the benefit of depositors who held a savings or demand account as
of the March 31, 1986 eligibility or the June 30, 1987 supplemental eligibility
record dates who continue to maintain their deposits at the Bank after the
conversion. In the event of a future liquidation (and only in such an event),
each eligible and supplemental eligible account holder who continues to maintain
his or her savings account will be entitled to receive a distribution from the
liquidation account. The total amount of the liquidation account will be
decreased in an amount proportionately corresponding to decreases in the savings
account balances of eligible and supplemental eligible account holders on each
subsequent annual determination date. Except for payment of dividends by the
Bank to Union Financial and repurchase of the Bank's stock, the existence of the
liquidation account will not restrict the use or application of such net worth.
The Bank is prohibited from declaring cash dividends on its common stock or
repurchasing its common stock if the effect thereof would cause its net worth to
be reduced below either the amount required for the liquidation account or the
minimum regulatory capital requirement. In addition, the Bank is also
prohibited from declaring cash dividends and repurchasing its own stock without
prior regulatory approval in any amount in a calendar year in excess of 100% of
its current year's net income to the date of any such dividend or repurchase,
plus 50% of the excess of its capital at the beginning of the year over its
regulatory capital requirement.
Under present regulations of the Office of Thrift Supervision ("OTS"), the Bank
must have core capital (leverage requirement) equal to 4.0% of assets, of which
1.5% must be tangible capital, excluding goodwill. The Bank must also maintain
risk-based regulatory capital as a percent of risk weighted assets at least
equal to 8.0%. In measuring compliance with capital standards, certain
adjustments must be made to capital and total assets.
- 31 -
<PAGE>
14. SHAREHOLDERS' EQUITY, DIVIDEND RESTRICTIONS AND REGULATORY MATTERS
(CONTINUED)
At September 30, 1998 and 1997, the Bank had the following actual and required
capital amounts and ratios (in thousands):
<TABLE>
<CAPTION>
September 30, 1998
--------------------------------------
Tangible Core Risk-Based
Capital Capital Capital
---------- ---------- ----------
<S> <C> <C> <C>
Actual Capital $14,945 $14,945 $14,945
Unrealized gains on available for sale securities (148) (148) (148)
Goodwill and other intangible assets (1,873 (1,873) (1,873)
Allowances for loan and lease losses (1) -- -- 994
--- --- ---
Total Adjusted capital 12,924 12,924 13,918
Minimum Capital Requirement 2,824 7,530 8,454
------- ------- -------
Regulatory Capital Excess $10,100 $ 5,394 $ 5,464
------- ------- -------
Regulatory Capital Ratio 6.86% 6.86% 13.17%
<CAPTION>
September 30, 1997
--------------------------------------
Tangible Core Risk-Based
Capital Capital Capital
---------- ---------- ----------
<S> <C> <C> <C>
Actual Capital $13,088 $13,088 $13,088
Unrealized losses on available for sale securities 63 63 63
Goodwill and other intangible assets (2,009) (2,009) (2,009)
General allowance for loan losses (1) -- -- 928
--- --- ---
Total Adjusted capital 11,142 11,142 12,070
Minimum Capital Requirement 2,556 5,111 7,310
------- ------- -------
Regulatory Capital Excess $ 8,586 $ 6,031 $ 4,760
------- ------- -------
Regulatory Capital Ratio 6.54% 6.54% 13.21%
</TABLE>
(1) Limited to 1.25% of risk-weighted assets
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and discretionary actions by regulators that, if
undertaken, could have a material adverse effect on the corporation. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classifications are also subject to qualitative judgements by the regulators
about components, risk weightings and other factors. As of the most recent
regulatory examination, the Bank was in compliance with the regulatory capital
requirements. There are no conditions or events that management believes have
changed the Bank's compliance with the guidelines since that examination.
15. RECENTLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board recently issued four new accounting
standards that will affect accounting, reporting, and disclosure of financial
information by the Bank. Adoption of these standards is not expected to have a
material impact on financial condition or results of operations. The following
is a summary of the standards and their required implementation dates:
SFAS No. 131, Disclosure about Segments of an Enterprise and Related
------------------------------------------------------
Information -- This statement establishes standards for the way public
- -----------
enterprises are to report information about operating segments in annual
financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports issued to
shareholders. Statement 131 is effective for financial statements for periods
beginning after December 15, 1997. In the initial year of application,
comparative information for earlier years is to be restated unless it is
impractical to do so.
-32-
<PAGE>
15. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED)
SFAS No. 132, Employers' Disclosures about Pensions and other Post-Retirement
---------------------------------------------------------------
Benefits- This statement deals principally with employers' disclosures about
- --------
defined benefit plans and other post-retirement benefit plans. This statement is
effective for the Bank for the fiscal year beginning October 1, 1998.
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities-This
------------------------------------------------------------
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. The accounting for changes in the fair value of
a derivative depends on the intended use of the derivative. The statement is
effective for the Bank for the fiscal year beginning October 1, 1999 and may
not be applied retroactively.
SFAS No. 134, Accounting for Mortgage-Backed Securities Retained after the
------------------------------------------------------------
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise-
- -------------------------------------------------------------------------------
This statement is effective for the first quarter beginning after December 15,
1998. This statement conforms the subsequent accounting for securities retained
after the securitization of mortgage loans by a mortgage banking enterprise with
the subsequent accounting for securities retained after the securitization of
other types of assets by a non mortgage banking enterprise. The adoption of this
standard is not expected to have a material effect on the Bank's financial
statements.
16. UNION FINANCIAL BANCSHARES, INC. FINANCIAL INFORMATION
(PARENT CORPORATION ONLY)
Condensed financial information for Union Financial is presented as follows (in
thousands):
<TABLE>
<CAPTION>
Condensed Balance Sheets September 30,
- ------------------------ ------------------------------
1998 1997
---------- ----------
<S> <C> <C>
Assets:
Cash and cash equivalents $ 35 $ 400
Investment in subsidiary 14,922 13,086
Other 28 42
------- -------
Total Assets $15,300 $13,528
======= =======
Liabilities and Shareholders' Equity:
Liabilities $ -- $ --
Shareholders' Equity 15,300 13,528
------- -------
Total Liabilities and Shareholders' Equity $15,300 $13,528
======= =======
<CAPTION>
Condensed Statements of Income For Years Ended September 30,
- ------------------------------------------------ ----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Equity in undistributed earnings of subsidiary $ 1,610 $ 1,477 $ 893
Other expense, net (60) (33) (31)
------- ------- -------
Net income $ 1,550 $ 1,444 $ 862
======= ======= =======
</TABLE>
-33-
<PAGE>
16. UNION FINANCIAL BANCSHARES, INC. FINANCIAL INFORMATION
(PARENT CORPORATION ONLY) (CONTINUED)
<TABLE>
<CAPTION>
Condensed Statements of Cash Flows For Years Ended September 30,
- ---------------------------------- ----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Operating Activities:
Net income $ 1,550 $ 1,444 $ 862
Adjustments to reconcile net income to
net cash used by operating activities:
Equity in undistributed earnings of subsidiary (1,610) (1,477) (893)
Decrease in other assets (1) (1) 14 18
------- ------- -------
Net cash used by operating activities (61) (19) (13)
------- ------- -------
Financing Activities:
Dividends received from subsidiary -- 500 500
Dividend reinvestment plan contributions 427 -- --
Dividends paid (467) (433) (404)
Proceeds from the exercise of stock options 51 96 41
------- ------- -------
Net cash provided by financing activities 11 163 137
------- ------- -------
Net increase (decrease) in cash and cash equivalents (50) 144 124
Cash and cash equivalents at beginning of year 400 256 132
------- ------- -------
Cash and cash equivalents at end of year $ 350 $ 400 $ 256
======= ======= =======
</TABLE>
-34-
<PAGE>
BOARD OF DIRECTORS
UNION FINANCIAL BANCSHARES AND SUBSIDIARIES
<TABLE>
<CAPTION>
<S> <C>
MASON G. ALEXANDER CARL L. MASON
Director, Mid-South Management Company CHAIRMAN
Retired
JAMES W. EDWARDS
Dean of Academics, USC-Union DWIGHT V. NEESE
President and Chief Executive Officer
WILLIAM M. GRAHAM Provident Community Bank
Owner, Graham's Flowers
DAVID G. RUSSELL
LOUIS M. JORDAN Self-employed accountant
President, Jordan's Ace Hardware, Inc.
<CAPTION>
LEADERSHIP GROUP
PROVIDENT COMMUNITY BANK
<S> <C>
BENJAMIN D. AIKEN DAVID L. GARRETT
Assistant Vice President Vice President
Internal Audit & Compliance Manager Mortgage Loan Acquisitions Manager
CAROLYN H. BELUE ROBERT J. GREGORY, JR.
Assistant Vice President Assistant Vice President
Operational & Systems Administration Manager Mortgage Lending Specialist
GERALD L. BOLIN GEORGE E. HALL, JR.
Vice President Vice President
Chief Operating Officer Retail Banking Manager
CLEMMIE W. BOYD SUZANNE M. LOWERY
Assistant Vice President Assistant Vice President
Jonesville Banking Center Manager Wholesale Lending Processing Manager
HOLLY COFFER DWIGHT V. NEESE
Assistant Vice President President
Financial Accounting Manager Chief Executive Officer
GREGORY S. DUNCAN MICHAEL H. VANDERFORD
Vice President Vice President
Credit Administration Manager Mortgage Lending Manager
RICHARD H. FLAKE WANDA J. WELLS
Executive Vice President Vice President & Corporate Secretary
Chief Financial Officer Human Resource Manager
EMMA S. GARNER GERALD B. WYATT
Assistant Vice President Vice President
Collections Officer Consumer Lending Manager
</TABLE>
-35-
<PAGE>
CORPORATE INFORMATION
COMMON STOCK INFORMATION
- ------------------------
Union Financial Bancshares, Inc.'s (UFBS) common stock is quoted on the Nasdaq
SmallCap market.. As of September 30, 1998, the bid and ask prices for Union
Financial Bancshares, Inc. was $13.50 and $15.00, respectively. Quotations are
obtained form the National Daily Quotation Service. These quotations reflect
inter-dealer prices, without retail mark-up, mark-down, or commissions and may
not necessarily reflect actual transactions.
As of September 30, 1998, there were 523 shareholders of record and
1,278,250 shares of common stock issued and outstanding. This does not reflect
the number of persons or entities who held their stock in nominee or "street"
names.
DIVIDEND INFORMATION
- --------------------
During the year ended September 30, 1998, the Corporation declared and paid a
cash dividend of $.37 per share. See Note 13 to the financial statements for
information regarding certain limitations imposed on the Bank's ability to pay
cash dividends to the holding company
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
- ---------------------------------------------
The Corporation has a dividend reinvestment program that allow shareholders to
purchase additional shares with corporate dividends and additional cash
purchases. Details of the program are outlined in the dividend reinvestment
prospectus. To receive more information, please contact Shareholder Services at
the corporate address.
10-KSB INFORMATION
------------------
A copy of the Form 10-KSB filed with the Securities and Exchange Commission,
will be furnished to shareholders upon written request to the Corporate
Secretary, Union Financial Bancshares, Inc., 203 West Main Street, Union, South
Carolina 29379.
ANNUAL MEETING OF SHAREHOLDERS
------------------------------
The Annual Meeting of Shareholders will convene at the Community Room of the
University of South Carolina, Union Campus, Academy and North Mountain Street,
Union, South Carolina on January 20, 1999 at 2:00 p.m..
ADDITIONAL INFORMATION
----------------------
If you are receiving duplicate mailing of shareholder reports due to multiple
accounts, we can consolidate the mailings without affecting your account
registration. To do this, or for additional information, contact our
Shareholder Relations Officer, at the Corporate address shown below.
CORPORATE OFFICES
- -----------------
203 West Main Street
Union, South Carolina 29379
(888) 427-9002
TRANSFER AGENT
- --------------
Registrar & Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
(800) 456-0596
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
- ----------------------------------------
Elliott, Davis & Company, LLP
870 South Pleasantburg Drive
Greenville, SC 29607-6286
(864) 242-3370
SPECIAL COUNSEL
- ---------------
Muldoon, Murphy & Faucette
5101 Wisconsin Avenue, N.W.
Washington, D.C. 20016
(202) 362-0840
GENERAL COUNSEL
- ---------------
Whitney, White and Diamaduros
203 West South Street
Union, South Carolina 29379
(864) 427-5661
STOCK INFORMATION
- -----------------
Interstate/Johnson Lane
Interstate Tower
P. O. Box 1012
Charlotte, NC 28201-10123
(800) 929-1003
Trident Securities, Inc.
4601 Six Forks Road
Raleigh, NC 27609
(800) 222-2618
Wheat First Union
P. O. Box 10586
Greenville, SC 29603
(800) 695-5104
SHAREHOLDER SERVICES OFFICER
- ----------------------------
Wanda J. Wells
Union Financial Bancshares, Inc.
203 West Main Street
Union, SC 29379
(864) 429-1861
- 36 -
<PAGE>
EXHIBIT NO. 21
SUBSIDIARIES OF REGISTRANT
<TABLE>
<CAPTION>
Percentage Jurisdiction or State
Subsidiaries Owned of Incorporation
------ ----------------
<S> <C> <C>
Provident Community Bank 100% United States
Provident Financial Services, Inc. (a) 100% South Carolina
</TABLE>
- ---------------
(a) A wholly-owned subsidiary of Provident Community Bank.
<PAGE>
[ELLIOTT, DAVIS & COMPANY, L.L.P. APPEARS HERE]
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement on
Form S-8 (No. 333-3628) pertaining to the 1987 Stock Option Plan and the 1995
Stock Option Plan of Union Financial Bancshares, Inc. of our report dated
November 6, 1998, with respect to the consolidated financial statements of Union
Financial Bancshares, Inc. and subsidiary incorporated by reference in the
Annual Report on Form 10-KSB for the year ended September 30, 1998.
/s/ Elliott, Davis & Company, L.L.P.
December 28, 1998
Greenville, South Carolina
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
This schedule contains financial information extracted from the consolidated
financial statements of Union Financial Bancshares, Inc. for the year ended
September 30, 1998 and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 2,469
<INT-BEARING-DEPOSITS> 1,124
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 26,856
<INVESTMENTS-CARRYING> 2,699
<INVESTMENTS-MARKET> 2,744
<LOANS> 142,202
<ALLOWANCE> 827
<TOTAL-ASSETS> 189,286
<DEPOSITS> 129,873
<SHORT-TERM> 41,441
<LIABILITIES-OTHER> 2,672
<LONG-TERM> 0
0
0
<COMMON> 15,300
<OTHER-SE> 0
<TOTAL-LIABILITIES-AND-EQUITY> 189,286
<INTEREST-LOAN> 11,865
<INTEREST-INVEST> 997
<INTEREST-OTHER> 543
<INTEREST-TOTAL> 13,405
<INTEREST-DEPOSIT> 5,544
<INTEREST-EXPENSE> 7,549
<INTEREST-INCOME-NET> 5,856
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 4,447
<INCOME-PRETAX> 2,447
<INCOME-PRE-EXTRAORDINARY> 2,447
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,550
<EPS-PRIMARY> 1.23
<EPS-DILUTED> 1.15
<YIELD-ACTUAL> 3.42
<LOANS-NON> 696
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,979
<ALLOWANCE-OPEN> 928
<CHARGE-OFFS> (127)
<RECOVERIES> 26
<ALLOWANCE-CLOSE> 827
<ALLOWANCE-DOMESTIC> 827
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
