UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1998
Commission file number 1-14070
PIEDMONT BANCORP, INC.
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(Exact name of registrant as specified in its charter)
North Carolina 56-1936232
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
260 South Churton Street, P.O. Box 1000
Hillsborough, North Carolina 27278
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (919) 732-2143
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
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(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days Yes [ X ] No [ ]
State the aggregate market value of the and non-voting common equity voting
stock held by non-affiliates of the registrant. The aggregate market value shall
be computed by reference to the price at which the stock was sold, or the
average bid and asked prices of such common equity, as of a specified date
within 60 days prior to the date of filing. $26,085,100 common stock, no par
value, based on the closing price of such common stock on September 1, 1998.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 2,745,800 shares of common
stock, no par value, outstanding at September 1, 1998. Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report of Piedmont Bancorp, Inc. (the "1998 Annual
Report") for the year ended June 30, 1998, are incorporated by reference into
Part I, Part II and Part IV.
Portions of the Proxy Statement for the 1998 Annual Meeting of Shareholders of
Piedmont Bancorp, Inc. to be held on November 19, 1998, are incorporated by
reference into Part III.
<PAGE>
PART I
ITEM 1. BUSINESS
General
Piedmont Bancorp, Inc. (the "Parent") is a one-bank holding company
whose principal business is the ownership and operation of Hillsborough Savings
Bank, Inc., SSB (the "Bank") located in Hillsborough, North Carolina. The Parent
was incorporated in July 1995 for the purpose of acquiring all of the common
stock of the Bank in its mutual to stock conversion which was completed on
December 7, 1995 (the "Conversion").
The Bank is a state-chartered stock savings bank originally organized
under the laws of North Carolina in 1913. The Bank is headquartered in
Hillsborough, North Carolina and is centrally located in its primary market of
central and northern Orange County, North Carolina. The Bank is a
community-oriented financial institution which offers a variety of financial
services to meet the needs of the community it serves. The Bank is principally
engaged in the business of attracting deposits from the general public and using
those deposits to make one-to-four family residential real estate loans, loans
secured by nonresidential real estate, home equity line of credit loans, and
other loans and investments. At June 30, 1998, all of the loans in the Bank's
portfolio which were secured by real estate were secured by properties located
in North Carolina. Revenues are derived primarily from interest on loans. The
Bank also receives interest income from investment securities, mortgage-backed
securities, and interest-bearing deposit balances. The major expenses of the
Bank are interest on deposits and borrowings and noninterest expenses such as
salaries, employee benefits, data processing expenses, and occupancy expenses.
The Bank conducts its business through its one office in Hillsborough, North
Carolina.
Piedmont Bancorp, Inc. and its wholly-owned bank subsidiary,
Hillsborough Savings Bank, Inc., SSB are collectively referred to as the
"Company". For additional information regarding the Company's business, see the
1998 Annual Report and the accompanying financial statements.
The Parent is also registered under the savings bank holding company
laws of North Carolina. Accordingly, the Parent is also subject to regulation
and supervision by the Administrator.
Market Area and Competition
The Company's primary market area consists of central and northern
Orange County, North Carolina. Hillsborough is located approximately ten miles
northwest of Durham, North Carolina and ten miles north of Chapel Hill, North
Carolina. North Carolina's Research Triangle Park is located about 20 miles
eastward between the cities of Chapel Hill, Durham and Raleigh. Chapel Hill and
Durham are home to the University of North Carolina at Chapel Hill and Duke
University, respectively. The economy of Orange County is significantly impacted
by these universities and the employment opportunities they generate. However,
the economy in Orange County is varied with employment spread among
manufacturing, agricultural, retail and wholesale trade, government, services
and utilities.
<PAGE>
The Company faces strong competition both in attracting deposits and
making real estate and other loans. Its most direct competition for deposits has
historically come from other savings institutions, credit unions and commercial
banks located in its primary market area, including large financial institutions
which have greater financial and marketing resources available to them. The
Company has also faced additional significant competition for investors' funds
from short-term money market securities and other corporate and government
securities. The ability of the Company to attract and retain savings deposits
depends on its ability to generally provide a rate of return, liquidity and risk
comparable to that offered by competing investment opportunities. The Company
experiences strong competition for real estate loans from other savings
institutions, commercial banks, and mortgage banking companies. Competition may
increase as a result of the continuing reduction of restrictions on the
interstate operations of financial institutions.
Management believes that its image as "the hometown bank" gives it
certain advantages over its local competition. The Company, its directors and
employees actively participate in local civil affairs. Long-time employment of
local personnel have enabled the Bank to establish and maintain long-term
relationships with customers. In many cases, the Bank offers quicker loan
decisions and more flexible underwriting standards than the competition.
SUPERVISION AND REGULATION
Regulation of the Parent
Bank holding companies and state savings banks are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes and rules and regulations that affect or will affect the Parent
and the Bank. This summary is qualified in its entirety by reference to the
particular statute and regulatory provisions referred to below and is not
intended to be an exhaustive description of the statutes or regulations
applicable to the business of the Parent and the Bank. Supervision, regulation
and examination of the Parent and the Bank by the regulatory agencies are
intended primarily for the protection of depositors rather than shareholders of
the Parent.
General. The Parent was organized for the purpose of acquiring and
holding all of the capital stock of the Bank. As a bank holding company subject
to the Bank Holding Company Act of 1956, as amended (the "BHCA"), the Parent is
subject to certain regulations of the Federal Reserve Board. Under the BHCA, the
Parent's activities and those of its subsidiaries are limited to banking,
managing or controlling banks, furnishing services to or performing services for
its subsidiaries or engaging in any other activity which the Federal Reserve
Board determines to be so closely related to banking or managing or controlling
banks as to be a proper incident thereto. The BHCA prohibits the Parent from
acquiring direct or indirect control of more than 5% of the outstanding voting
stock or substantially all of the assets of any bank or savings bank or merging
or consolidating with another bank holding company or savings and loan holding
company without prior approval of the Federal Reserve Board.
<PAGE>
Additionally, the BHCA prohibits the Parent from engaging in, or
acquiring ownership or control of, more than 5% of the outstanding voting stock
of any company engaged in a nonbanking business unless such business is
determined by the Federal Reserve Board to be so closely related to banking as
to be properly incident thereto. The BHCA generally does not place territorial
restrictions on the activities of such nonbanking related activities.
Similarly, Federal Reserve Board approval (or, in certain cases,
non-disapproval) must be obtained prior to any person acquiring control of the
Parent. Control is conclusively presumed to exist if, among other things, a
person acquires more than 25% of any class of voting stock of the Parent or
controls in any manner the election of a majority of the directors of the
Parent. Control is presumed to exist if a person acquires more than 10% of any
class of voting stock and the stock is registered under Section 12 of the
Exchange Act or the acquiror will be the largest shareholder after the
acquisition.
Capital Maintenance. There are a number of obligations and restrictions
imposed on bank holding companies and their depository institution subsidiaries
by law and regulatory policy that are designed to minimize potential loss to the
depositors of such depository institutions and the Federal Deposit Insurance
Corporation (the "FDIC") insurance funds in the event the depository institution
becomes in danger of default or in default. For example, under the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("1991 Banking Law"), to
avoid receivership of an insured depository institution subsidiary, a bank
holding company is required to guarantee the compliance of any insured
depository institution subsidiary that may become "undercapitalized" with the
terms of any capital restoration plan filed by such subsidiary with its
appropriate federal banking agency up to the lesser of (i) an amount equal to 5%
of the institution's total assets at the time the institution became
undercapitalized or (ii) the amount which is necessary (or would have been
necessary) to bring the institution into compliance with all acceptable capital
standards as of the time the institution fails to comply with such capital
restoration plan. Under a policy of the Federal Reserve Board with respect to
bank holding company operations, a bank holding company is required to serve as
a source of financial strength to its subsidiary depository institutions and to
commit resources to support such institutions in circumstances where it might
not do so absent such policy. The Federal Reserve Board under the BHCA, also has
the authority to require a bank holding company to terminate any activity or to
relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a
bank) upon the Federal Reserve Board's determination that such activity or
control constitutes a serious risk to the financial soundness and stability of
any bank subsidiary of the bank holding company.
In addition, the "cross-guarantee" provisions of the Federal Deposit
Insurance Act, as amended ("FDIA") require insured depository institutions under
common control to reimburse the FDIC for any loss suffered by either the Savings
Association Insurance Fund (the "SAIF") or the Bank Insurance Fund (the "BIF")
as a result of the default of a commonly controlled insured depository
institution or for any assistance provided by the FDIC to a commonly controlled
insured depository institution in danger of default. The FDIC may decline to
enforce the cross-guarantee provisions if it determines that a waiver is in the
best interest of the SAIF or the BIF or both. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
<PAGE>
In connection with the Administrator's approval of the Parent's
application to acquire control of the Bank, the Parent was required to execute a
Capital Maintenance Agreement whereby it has agreed to maintain the Bank's
capital in an amount sufficient to enable the Bank to satisfy all regulatory
capital requirements.
Capital Adequacy Guidelines for Holding Companies. The Federal Reserve
has adopted capital adequacy guidelines for bank holding companies and banks
that are members of the Federal Reserve system and have consolidated assets of
$150 million or more. Bank holding companies subject to the Federal Reserve
Board's capital adequacy guidelines are required to comply with the Federal
Reserve Board's risk-based capital regulations. Under these regulations, the
minimum ratio of total capital to risk-weighted assets (including certain
off-balance sheet activities, such as standby letters of credit) is eight
percent. At least half of the total capital is required to be "Tier I capital,"
principally consisting of common stockholders' equity, noncumulative perpetual
preferred stock, and a limited amount of cumulative perpetual preferred stock,
less certain goodwill items. The remainder ("Tier II capital") may consist of a
limited amount of subordinated debt, certain hybrid capital instruments and
other debt securities, perpetual preferred stock, and a limited amount of the
general loan loss allowance. In addition to the risk-based capital guidelines,
the Federal Reserve Board has adopted a minimum Tier I (leverage) capital ratio,
under which a bank holding company must maintain a minimum level of Tier I
capital to average total consolidated assets of at least three percent in the
case of a bank holding company which has the highest regulatory examination
rating and is not contemplating significant growth or expansion. All other bank
holding companies are expected to maintain a Tier I (leverage) capital ratio of
at least one percent to two percent above the stated minimum.
Dividend and Repurchase Limitations. The Parent's sources of income
consist of dividends paid by the Bank to the Parent. Consequently, declarations
of cash dividends by the Parent may depend upon dividend payments by the Bank to
the Parent, which are subject to various restrictions. See " -- Regulation of
the Bank -- Restrictions on Dividends and Other Capital Distributions." The
Parent must obtain Federal Reserve Board approval prior to repurchasing Common
Stock for in excess of ten percent of its net worth during any twelve-month
period unless the Parent (i) both before and after the redemption satisfies
capital requirements for "well capitalized" state member banks; (ii) received a
one or two rating in its last examination; and (iii) is not the subject of any
unresolved supervisory issues.
The Parent is prohibited, under the North Carolina Business Corporation
Act, from paying a dividend if such payment would (i) cause the Parent to be
unable to pay its debts as they become due in the ordinary course of business or
(ii) reduce the Parent's total assets below the sum of the Parent's total
liabilities plus any amounts which would be needed, if the Parent were to be
dissolved at the time of distribution, to satisfy the preferential rights that
are superior to holders of the Common Stock.
Neither the Administrator nor the FDIC have promulgated any regulations
specifically limiting the right of the Parent to pay dividends and repurchase
shares. However, at the Administrator's request, the Company has provided prior
notice to the Administrator of each dividend paid by the Company.
<PAGE>
Federal Securities Law. The Parent has registered its Common Stock with
the SEC pursuant to Section 12(g) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act") and will not deregister the Common Stock for a
period of three years following the completion of the Conversion. As a result of
such registration, the proxy and tender offer rules, insider trading reporting
requirements, annual and periodic reporting and other requirements of the
Exchange Act are applicable to the Parent.
The registration under the Securities Act of 1933, as amended (the
"Securities Act") of the Common Stock does not cover the resale of such shares.
Shares of the Common Stock purchased by persons who are not affiliates of the
Parent may be resold without registration. Shares purchased by an affiliate of
the Parent are subject to the resale provisions of Rule 144 under the Securities
Act. So long as the Parent meets the current public information requirements of
Rule 144 under the Securities Act, each affiliate of the Parent who complies
with the other conditions of Rule 144 (including those that require the
affiliate's sale to be aggregated with those of certain other persons) will be
able to sell in the public market, without registration, a number of shares not
to exceed, in any three-month period, the greater of (i) one percent of the
outstanding shares of the Parent or (ii) the average weekly volume of trading in
such shares during the preceding four calendar weeks. Provision may be made in
the future by the Parent to permit affiliates to have their shares registered
for sale under the Securities Act under certain circumstances. There are
currently no demand registration rights outstanding. However, in the event the
Parent at some future time determines to issue additional shares from its
authorized but unissued shares, the Parent might offer registration rights to
certain of its affiliates who want to sell their shares.
Regulation of the Bank
General. Federal and state legislation and regulation have
significantly affected the operations of federally insured savings institutions
and other federally regulated financial institutions in the past several years
and have increased competition among savings institutions, commercial banks and
other providers of financial services. In addition, federal legislation has
imposed new limitations on investment authority, and higher insurance and
examination assessments on savings institutions and has made other changes that
may adversely affect the future operations and competitiveness of savings
institutions with other financial institutions, including commercial banks and
their holding companies. The operations of regulated depository institutions,
including the Bank, will continue to be subject to changes in applicable
statutes and regulations from time to time.
The Bank is a North Carolina-chartered savings bank, is a member of the
Federal Home Loan Bank ("FHLB") system, and its deposits are insured by the FDIC
through the Savings Association Insurance Fund ("SAIF"). It is subject to
examination and regulation by the FDIC and the Administrator and to regulations
governing such matters as capital standards, mergers, establishment of branch
offices, subsidiary investments and activities, and general investment
authority. Such examination and regulation is intended primarily for the
protection of depositors and the federal deposit insurance funds.
The Bank is subject to various regulations promulgated by the Federal
Reserve Board including, without limitation, Regulation B (Equal Credit
Opportunity), Regulation D (Reserves), Regulation E (Electronic Fund Transfers),
Regulation O (Loans to Executive Officers, Directors and Principal
<PAGE>
Shareholders), Regulation Z (Truth in Lending), Regulation CC (Availability of
Funds) and Regulation DD (Truth in Savings). As holders of loans secured by real
property and as owners of real property, financial institutions, including the
Bank, may be subject to potential liability under various statutes and
regulations applicable to property owners generally, including statutes and
regulations relating to the environmental condition of real property.
The FDIC has extensive enforcement authority over the Bank. This
enforcement authority includes, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated in
response to violations of laws and regulations and unsafe or unsound practices.
The grounds for appointment of a conservator or receiver for a North
Carolina savings bank on the basis of an institution's financial condition
include: (i) insolvency, in that the assets of the savings bank are less than
its liabilities to depositors and others; (ii) substantial dissipation of assets
or earnings through violations of law or unsafe or unsound practices; (iii)
existence of an unsafe or unsound condition to transact business; (iv)
likelihood that the savings bank will be unable to meet the demands of its
depositors or to pay its obligations in the normal course of business; and (v)
insufficient capital or the incurring or likely incurring of losses that will
deplete substantially all of the institution's capital with no reasonable
prospect of replenishment of capital without federal assistance.
Transactions with Affiliates. Under current federal law, transactions
between savings institutions and any affiliate are governed by Sections 23A and
23B of the Federal Reserve Act. An affiliate of a savings institution is any
company or entity that controls, is controlled by or is under common control
with the savings institution. In a holding company context, the parent holding
company of a savings institution and any companies which are controlled by such
parent holding company are affiliates of the savings institution. Generally,
Sections 23A and 23 B (i) establish certain collateral requirements for loans to
affiliates; (ii) limit the extent to which the savings institution or its
subsidiaries may engage in "covered transactions" with any one affiliate to an
amount equal to 10% of such savings institution's capital stock and surplus, and
contain an aggregate limit on all such transactions with all affiliates to an
amount equal to 20% of such capital stock and surplus and (iii) require that all
such transactions be on terms substantially the same, or at least as favorable
to the savings institution or the subsidiary, as those provided to a
nonaffiliate. The term "covered transaction" includes the making of loans or
other extensions of credit to an affiliate, the purchase of assets from an
affiliate, the purchase of, or an investment in, the securities of an affiliate,
the acceptance of securities of an affiliate as collateral for a loan or
extension of credit to any person, or issuance of a guarantee, acceptance or
letter of credit on behalf of an affiliate.
Further, current federal law has extended to savings institutions the
restrictions contained in Section 22(h) of the Federal Reserve Act with respect
to loans to directors, executive officers and principal stockholders. Under
Section 22(h), loans to directors, executive officers and stockholders who own
more than 10% of a savings institution and certain affiliated entities of any of
the foregoing, may not exceed, together with all other outstanding loans to such
person and affiliated entities, the savings institution's loans-to-one borrower
limit as established by federal law (generally equal to 15% of the institution's
unimpaired capital and surplus). Section 22(h) also prohibits loans above
amounts prescribed by the appropriate federal banking agency to directors,
<PAGE>
executive officers and stockholders who own more than 10% of a savings
institution, and their respective affiliates, unless such loan is approved in
advance by a majority of the board of directors of the savings institution. Any
"interested" director may not participate in the voting. The Federal Reserve has
prescribed the loan amount (which includes all other outstanding loans to such
person), as to which such prior board of director approval is required, as being
the greater of $25,000 or 5% of unimpaired capital and unimpaired surplus (up to
$500,000). Further, pursuant to Section 22(h) the Federal Reserve requires that
loans to directors, executive officers, and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons and not involve more than the normal risk of repayment or present other
unfavorable features.
Deposit Insurance. The Bank's deposit accounts are insured by the FDIC
through 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
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 to the SAIF unless effective corrective action is taken.
Pursuant to the Deposit Insurance Fund Act (the "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 1980s 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 0.013% 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 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
<PAGE>
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.
Community Reinvestment Act. The Bank, like other financial
institutions, is subject to the Community Reinvestment Act, as amended ("CRA").
A purpose of this Act is to encourage financial institutions to help meet the
credit needs of its entire community, including the needs of low- and
moderate-income neighborhoods. A savings bank is evaluated and rated under three
categories: a lending test, an investment test and a service test. For each of
these three tests, the savings bank is given a rating of either "outstanding,"
"high satisfactory," "low satisfactory," "needs to improve" or "substantial
non-compliance." A set of criteria for each rating is included in the
regulation. If an institution disagrees with a particular rating, the
institution has the burden of rebutting the presumption by clearly establishing
that the quantative measures do not accurately present its actual performance,
or that demographics, competitive conditions or economic or legal limitations
peculiar to the service area should be considered. The ratings received under
the three tests are used to determine the overall composite CRA rating or
"outstanding," "satisfactory," "needs to improve" or "substantial
non-compliance."
During the Bank's last compliance examination, which was performed by
the FDIC under the old CRA regulations in September 1995, the Bank received a
"satisfactory" rating with respect to CRA compliance. The Bank's rating with
respect to CRA compliance would be a factor to be considered by the Federal
Reserve and FDIC in considering applications submitted by the Bank to acquire
branches or to acquire or combine with other financial institutions and take
other actions and could result in the denial of such applications.
Capital Requirements. The FDIC requires the Bank to have a minimum
leverage ratio of Tier I capital (principally consisting of common stockholders'
equity, noncumulative perpetual preferred stock and minority interests in
consolidated subsidiaries, less certain intangible and goodwill items), to total
assets of at least three percent; provided, however that all institutions, other
than those (i) receiving the highest rating during the examination process and
(ii) not anticipating or experiencing any significant growth, are required to
maintain a ratio of one percent or two percent above the stated minimum, with an
absolute minimum leverage ratio of not less than four percent. The FDIC also
requires the Bank to have a ratio of total capital to risk-weighted assets,
including certain off-balance sheet activities, such as standby letters of
credit, of at least eight percent. At least half of the total capital is
required to be Tier I capital. The remainder (Tier II capital) may consist of a
limited amount of subordinated debt, certain hybrid capital instruments, other
debt securities, certain types of preferred stock and a limited amount of
general loan loss allowance.
An institution which fails to meet minimum capital requirements may be
subject to a capital directive which is enforceable in the same manner and to
the same extent as a final cease and desist order, and must submit a capital
plan within 60 days to the FDIC. If the leverage ratio falls to two percent or
less, the institution may be deemed to be operating in an unsafe or unsound
condition, allowing the FDIC to take various enforcement actions, including
possible termination of insurance or placement of the institution in
receivership.
<PAGE>
The Administrator requires that net worth equal at least five percent
of total assets. Intangible assets must be deducted from net worth and assets
when computing compliance with this requirement.
At June 30, 1998, the Bank complied with each of the capital
requirements of the FDIC and the Administrator. For a description of the Bank's
required and actual capital levels on June 30, 1998, see Note 8 captioned
"Stockholders Equity" on page 35 of the 1998 Annual Report.
Each federal banking agency was required by law to revise its
risk-based capital standards to ensure that those standards take adequate
account of interest rate risk, concentration of credit risk, and the risk of
nontraditional activities, as well as reflect the actual performance and
expected risk of loss on multi-family mortgages. On August 2, 1995, the federal
banking agencies issued a joint notice of adoption of final risk-based capital
rules to take account of interest rate risk. The final regulation required an
assessment of the need for additional capital on a case-by-case basis,
considering both the level of measured exposure and qualitative risk factors.
The final rule also stated an intent to, in the future, establish an explicit
minimum capital charge for interest rate risk based on the level of a bank's
measured interest rate risk exposure. The final regulation has not had a
material impact on the Bank's capital requirements.
Effective June 26, 1996, the federal banking agencies issued a joint
policy statement announcing the agencies' election not to adopt a standardized
measure and explicit capital charge for interest rate risk at that time. Rather,
the policy statement (i) identifies the main elements of sound interest rate
risk management, (ii) describes prudent principles and practices for each of
those elements, and (iii) describes the critical factors affecting the agencies'
evaluation of a bank's interest rate risk when making a determination of capital
adequacy. The joint policy statement has not had a material impact on the Bank's
management of interest rate risk.
In December 1994, the FDIC adopted a final rule changing its risk-based
capital rules to recognize the effect of bilateral netting agreements in
reducing the credit risk of two types of financial derivatives interest and
exchange rate contracts. Under the rule, savings banks are permitted to net
positive and negative mark-to-market values of rate contracts with the same
counterparty, subject to legally enforceable bilateral netting contracts that
meet certain criteria. This represents a change from the prior rules which
recognized only a very limited form of netting. This rule has not had a material
effect upon its financial condition or results of operations.
Loans-to-One-Borrower. The Bank is subject to the Administrator's
loans-to-one-borrower limits. Under these limits, no loans and extensions of
credit to any borrower outstanding at one time and not fully secured by readily
marketable collateral shall exceed 15% of the net worth of the savings bank.
Loans and extensions of credit fully secured by readily marketable collateral
may comprise an additional 10% of net worth. These limits also authorize savings
banks to make loans to one borrower, for any purpose, in an amount not to exceed
$500,000. A savings institution also is authorized to make loans to one borrower
to develop domestic residential housing units, not to exceed the lesser of $30
million, or 30% of the savings institution's net worth, provided that (i) the
purchase price of each single-family dwelling in the development does not exceed
$500,000; (ii) the savings institution is in compliance with its fully phased-in
<PAGE>
capital requirements; (iii) the loans comply with applicable loan-to-value
requirements; (iv) the aggregate amount of loans made under this authority does
not exceed 150% of net worth; and (v) the institution's regulator issues an
order permitting the savings institution to use this higher limit. These limits
also authorize a savings bank to make loans to one borrower to finance the sale
of real property acquired in satisfaction of debts in an amount up to 50% of net
worth.
As of June 30, 1998, the largest aggregate amount of loans which the
Bank had to any one borrower was $664,000. The Bank had no loans outstanding
which management believes violate the applicable loans to one borrower limits.
Federal Home Loan Bank System. The FHLB system provides a central
credit facility for member institutions. As a member of the FHLB of Atlanta, the
Bank is required to own capital stock in the FHLB of Atlanta in an amount at
least equal to the greater of one percent of the aggregate principal amount of
its unpaid residential mortgage loans, home purchase contracts and similar
obligations at the end of each calendar year, or five percent of its outstanding
advances (borrowings) from the FHLB of Atlanta. On June 30, 1998, the Bank was
in compliance with this requirement with an investment in FHLB of Atlanta stock
of $1,152,000.
Federal Reserve System. Federal Reserve Board regulations require
savings banks, not otherwise exempt from the regulations, to maintain reserves
against their transaction accounts (primarily negotiable order of withdrawal
accounts) and certain nonpersonal time deposits. The reserve requirements are
subject to adjustment by the Federal Reserve Board. As of June 30, 1998, the
Bank was in compliance with the applicable reserve requirements of the Federal
Reserve Board.
Restrictions on Acquisitions. Federal law generally provides that no
"person," acting directly or indirectly or through or in concert with one or
more other persons, may acquire "control," as that term is defined in FDIC
regulations, of a state savings bank without giving at least 60 days' written
notice to the FDIC and providing the FDIC an opportunity to disapprove the
proposed acquisition. Pursuant to regulations governing acquisitions of control,
control of an insured institution is conclusively deemed to have been acquired,
among other things, upon the acquisition of more than twenty five percent of any
class of voting stock. In addition, control is presumed to have been acquired,
subject to rebuttal, upon the acquisition of more than ten percent of any class
of voting stock, and the issuer's securities are registered under Section 12 of
the Exchange Act or the person would be the single largest shareholder. Such
acquisitions of control may be disapproved if it is determined, among other
things, that (i) the acquisition would substantially lessen competition; (ii)
the financial condition of the acquiring person might jeopardize the financial
stability of the savings bank or prejudice the interests of its depositors; or
(iii) the competency, experience or integrity of the acquiring person or the
proposed management personnel indicates that it would not be in the interest of
the depositors or the public to permit the acquisition of control by such
person.
For three years following the Bank's conversion from mutual to stock
form, North Carolina conversion regulations require the prior written approval
of the Administrator before any person may directly or indirectly offer to
acquire or acquire the beneficial ownership of more than ten percent of any
class of an equity security of the Bank. If any person were to so acquire the
beneficial ownership of more than ten percent of any class of any equity
<PAGE>
security without prior written approval, the securities beneficially owned in
excess of ten percent would not be counted as shares entitled to vote and would
not be voted or counted as voting shares in connection with any matter submitted
to stockholders for a vote. Approval is not required for (i) any offer with a
view toward public resale made exclusively to the Bank or its underwriters or
the selling group acting on its behalf or (ii) any offer to acquire or
acquisition of beneficial ownership of more than ten percent of the common stock
of the Bank by a corporation whose ownership is or will be substantially the
same as the ownership of the Bank, provided that the offer or acquisition is
made more than one year following the consummation of the conversion. During the
second and third years after the conversion, the Administrator may approve such
an acquisition of more than ten percent of beneficial ownership upon a finding
that (i) the acquisition is necessary to protect the safety and soundness of the
Parent and the Bank or the Boards of Directors of the Parent and the Bank
support the acquisition and (iii) the acquiror is of good character and
integrity and possesses satisfactory managerial skills, the acquiror will be a
source of financial strength to the Holding Company and the Bank and the public
interests will not be adversely affected.
Liquidity. The Bank is subject to the Administrator's requirement that
the ratio of liquid assets to total assets equal at least ten percent. The
computation of liquidity under North Carolina regulation allows the inclusion of
mortgage-backed securities and investments which, in the judgment of the
Administrator, have a readily marketable value, including investments with
maturities in excess of five years. At June 30, 1998, the Bank's liquidity
ratio, calculated in accordance with North Carolina regulations, was
approximately 13%.
Additional Limitations on Activities. FDIC law and regulations
generally provide that the Bank may not engage as principal in any type of
activity, or in any activity in an amount, not permitted for national banks, or
directly acquire or retain any equity investment of a type or in an amount not
permitted for national banks. The FDIC has authority to grant exceptions from
these prohibitions (other than with respect to non-service corporation equity
investments) if it determines no significant risk to the insurance fund is posed
by the amount of the investment or the activity to be engaged in and if the Bank
is and continues to be in compliance with fully phased-in capital standards.
National banks are generally not permitted to hold equity investments other than
shares of service corporations and certain federal agency securities. Moreover,
the activities in which service corporations for savings banks are permitted to
engage are limited to those of service corporations for national banks.
Savings banks are also required to notify the FDIC at least 30 days
prior to the establishment or acquisition of any subsidiary, or at least 30 days
prior to conducting any such new activity. Any such activities must be conducted
in accordance with the regulations and orders of the FDIC and the Administrator.
Savings banks are also generally prohibited from directly or indirectly
acquiring or retaining any corporate debt security that is not of investment
grade (generally referred to as "junk bonds").
Prompt Corrective Regulatory Action. Federal law provides the federal
banking agencies with broad powers to take corrective action to resolve problems
of insured depository institutions. The extent of these powers depends upon
whether the institutions in question are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized," or
"critically undercapitalized." Under the FDIC regulations applicable to the
Bank, an institution is considered "well capitalized" if it has (i) a total
risk-based capital ratio of ten percent or greater, (ii) a Tier I risk-based
<PAGE>
capital ratio of six percent or greater, (iii) a leverage ratio of five percent
or greater and (iv) is not subject to any order or written directive to meet and
maintain a specific capital level for any capital measure. An "adequately
capitalized" institution is defined as one that has (i) a total risk-based
capital ratio of eight percent or greater, (ii) a Tier I risk-based capital
ratio of four percent or greater and (iii) a leverage ratio of four percent or
greater (or three percent or greater in the case of an institution with the
highest examination rating and which is not experiencing or anticipating
significant growth). An institution is considered (A) "undercapitalized" if it
has (i) a total risk-based capital ratio of less than eight percent, (ii) a Tier
I risk-based capital ratio of less than four percent or (iii) a leverage ratio
of less than four percent (or three percent in the case of an institution with
the highest examination rating and which is not experiencing or anticipating
significant growth); (B) "significantly undercapitalized" if the institution has
(i) a total risk-based capital ratio of less than six percent, or (ii) a Tier I
risk-based capital ratio of less than three percent or (iii) a leverage ratio of
less than three percent and (C) "critically undercapitalized" if the institution
has a ratio of tangible equity to total assets equal to or less than two
percent.
Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Banking Act"), effective September 29,
1995, permits adequately capitalized bank and savings bank holding companies to
acquire control of banks and savings banks in any state. The states may
specifically permit interstate acquisitions prior to September 29, 1995, by
enacting legislation that provides for such transactions. North Carolina adopted
nationwide reciprocal interstate acquisition legislation in 1994.
Such interstate acquisitions are subject to certain restrictions.
States may require the bank or savings bank being acquired to have been in
existence for a certain length of time but not in excess of five years. In
addition, no bank or savings bank may acquire more than 10% of the insured
deposits in the United States or more than 30% of the insured deposits in any
one state, unless the state has specifically legislated a higher deposit cap.
States are free to legislate stricter deposit caps.
The Interstate Banking Act also provides for interstate branching,
effective June 1, 1997, allowing interstate branching in all states, provided
that a particular state has not specifically denied interstate branching by
legislation prior to such time. Unlike interstate acquisitions, a state may deny
interstate branching if it specifically elects to do so by June 1, 1997. States
may choose to allow interstate branching prior to June 1, 1997 by opting-in to a
group of states that permits these transactions. These states generally allow
interstate branching via a merger of an out-of-state bank with an in-state bank,
or on a de novo basis. North Carolina has enacted legislation permitting
branching transactions.
It is anticipated that the Interstate Banking Act will increase
competition within the markets in which the Bank now operates, although the
extent to which such competition will increase in such markets or the timing of
such increase cannot be predicted. To date the Bank has not experienced
significant increased competition as a result of the passage of the Interstate
Banking Act.
<PAGE>
Restrictions on Dividends and Other Capital Distributions. A North
Carolina-chartered stock savings bank may not declare or pay a cash dividend on,
or repurchase any of, its capital stock if the effect of such transaction would
be to reduce the net worth of the institution to an amount which is less than
the minimum amount required by applicable federal and state regulations. See
"--Capital Requirements." In addition, a North Carolina-chartered stock savings
bank, for a period of five years after its conversion from mutual to stock form,
must obtain the written approval from the Administrator before declaring or
paying a cash dividend on its capital stock in an amount in excess of one-half
of the greater of (i) the institution's net income for the most recent fiscal
year end, or (ii) the average of the institution's net income after dividends
for the most recent fiscal year end and not more than two of the immediately
preceding fiscal year ends, if applicable. The Bank has obtained the
Administrator's prior approval for each dividend paid by the Bank to the Parent.
Retained income at June 30, 1998, includes approximately $2,777,000
million for which no provision for federal income tax has been made. This amount
represents an allocation of income to bad debt deductions for tax purposes only.
Payment of dividends by the Bank out of this bad debt allocation would create
taxable income equal to approximately 164% of the dividend for the Bank.
At the time of the Conversion, the Bank established a liquidation
account in an amount equal to its net worth at June 30, 1995. The liquidation
account is maintained for the benefit of eligible deposit account holders who
continue to maintain their deposit accounts in the Bank after the Conversion.
Only in the event of a complete liquidation would each eligible deposit account
holder be entitled to receive a liquidating distribution in the amount of the
then current adjusted subaccount balance for the deposit accounts before any
liquidation distribution may be made with respect to the Common Stock. Dividends
paid by the Bank to the Parent cannot reduce the net worth of the Bank below the
amount required for this liquidation account.
Also, without the prior written approval of the Administrator, a North
Carolina-chartered stock savings bank, for a period of five years after its
conversion from mutual to stock form, may not repurchase any of its capital
stock. The Administrator will give approval to repurchase only upon a showing
that the proposed repurchase will not adversely affect the safety and soundness
of the institution.
Other North Carolina Regulation. As a North Carolina-chartered savings
bank, the Bank derives its authority from, and is regulated by, the
Administrator. The Administrator has the right to promulgate rules and
regulations necessary for the supervision and regulation of North Carolina
savings banks under his jurisdiction and for the protection of the public
investing in such institutions. The regulatory authority of the Administrator
includes, but is not limited to: the establishment of reserve requirements; the
regulation of the payment of dividends; the regulation of stock repurchases, the
regulation of incorporators, stockholders, directors, officers and employees;
the establishment of permitted types of withdrawable accounts and types of
contracts for savings programs, loans and investments; and the regulation of the
conduct and management of savings banks, chartering and branching of
institutions, mergers, conversions and conflicts of interest. North Carolina law
requires that the Bank maintain federal deposit insurance as a condition of
doing business.
<PAGE>
The Administrator conducts regular examinations of North
Carolina-chartered savings banks. The purpose of such examinations is to assure
that institutions are being operated in compliance with applicable North
Carolina law and regulations and in a safe and sound manner. These examinations
are usually conducted on a joint basis with the FDIC. In addition, the
Administrator is required to conduct an examination of any institution when he
has good reason to believe that the standing and responsibility of the
institution is of doubtful character or when he otherwise deems it prudent. The
Administrator is empowered to order the revocation of the license of an
institution if he finds that it has violated or is in violation of any North
Carolina law or regulation and that revocation is necessary in order to preserve
the assets of the institution and protect the interests of its depositors. The
Administrator has the power to issue cease and desist orders if any person or
institution is engaging in, or has engaged in, any unsafe or unsound practice or
unfair and discriminatory practice in the conduct of its business or in
violation of any other law, rule or regulation.
A North Carolina-chartered savings bank must maintain net worth,
computed in accordance with the Administrator's requirements, of five percent of
total assets and liquidity of ten percent of total assets, as discussed above.
Additionally, a North Carolina-chartered savings bank is required to maintain
general valuation allowances and specific loss reserves in the same amounts as
required by the FDIC.
Subject to limitation by the Administrator, North Carolina-chartered
savings banks may make any loan or investment or engage in any activity which is
permitted to federally chartered institutions. However, a North
Carolina-chartered savings bank cannot invest more than 15% of its total assets
in business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutorily permitted
investments, including but not limited to (i) obligations of the United States,
or those guaranteed by it; (ii) obligations of the State of North Carolina;
(iii) bank demand or time deposits; (iv) stock or obligations of the federal
deposit insurance fund or a FHLB; (v) savings accounts of any savings
institution as approved by the board of directors; and (vi) stock or obligations
of any agency of the State of North Carolina or of the United States or of any
corporation doing business in North Carolina whose principal business is to make
education loans.
North Carolina law provides a procedure by which savings institutions
may consolidate or merge, subject to approval of the Administrator. The approval
is conditioned upon findings by the Administrator that, among other things, such
merger or consolidation will promote the best interests of the members or
stockholders of the merging institutions. North Carolina law also provides for
simultaneous mergers and conversions and for supervisory mergers conducted by
the Administrator.
Future Requirements. Statutes and regulations are regularly introduced
which contain wide-ranging proposals for altering the structures, regulations
and competitive relationships of financial institutions. It cannot be predicted
whether or what form any proposed statute or regulation will be adopted or the
extent to which the business of the Company may be affected by such statute or
regulation.
<PAGE>
Subsidiaries
The Bank is the only subsidiary of the Parent. The Bank has one
subsidiary, HSB Financial Services, Inc., that was incorporated in January of
1998. HSB Financial Services, Inc. was established for the primary purpose of
selling mutual funds and other retail nondeposit investments. HSB Financial
Services, Inc. currently has one employee.
Employees
As of June 30, 1998, the Bank had 30 full-time employees and 3
part-time employees. The Bank provides its employees with basic and major
medical insurance, life insurance, sick leave and vacation benefits. In
addition, the Bank maintains a 401(k) retirement plan pursuant to which the Bank
matches one-half of employees' contributions, with its contribution limited to
three percent of each employee's salary.
The Bank also has a Employee Stock Ownership Plan (the "ESOP"), which
provides benefits to employees of the Bank. Also, the directors, officers and
employees of the Bank participate in the Management Recognition Plan and the
Stock Option Plan, under which 105,800 shares of restricted stock have been
awarded and options to purchase 262,354 shares of Common Stock have been
granted, respectively.
Employees are not represented by any union or collective bargaining
group, and the Company considers its employee relations to be good.
Federal Income Taxation
Savings institutions such as the Bank are subject to the taxing
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), for
corporations, as modified by certain provisions specifically applicable for
financial or thrift institutions. Income is reported using the accrual method of
accounting. The maximum corporate federal income tax rate is 35%.
For fiscal years beginning prior to December 31, 1995, thrift
institutions which qualified under certain definitional tests and other
conditions of the Code were permitted certain favorable provisions regarding
their deductions from taxable income for annual additions to their bad debt
reserve. A reserve could be established for bad debts on qualifying real
property loans (generally loans secured by interests in real property improved
or to be improved) under (i) a method based on a percentage of the institution's
taxable income, as adjusted (the "percentage of taxable income method") or (ii)
a method based on actual loss experience (the "experience method"). The reserve
for nonqualifying loans was computed using the experience method.
The percentage of taxable income method was limited to 8% of taxable
income. This method could not raise the reserve to exceed 6% of qualifying real
property loans at the end of the year. Moreover, the additions for qualifying
real property loans, when added to nonqualifying loans, could not exceed 12% of
the amount by which total deposits or withdrawable accounts exceed the sum of
surplus, undivided profits and reserves at the beginning of the year. The
experience method was the amount necessary to increase the balance of the
reserve at the close of the year to the greater of (i) the amount which bore the
same ratio to loans outstanding at the close of the year as the total net bad
debts sustained during the current and five preceding years bore to the sum of
the loans outstanding at the close of such six years or (ii) the balance in the
reserve account at the close of the last taxable year beginning before 1988
(assuming that the loans outstanding have not declined since such date).
<PAGE>
In order to qualify for the percentage of income method, an institution
had to have at least 60% of its assets as "qualifying assets" which generally
included, cash, obligations of the United States government or an agency or
instrumentality thereof or of a state or political subdivision, residential real
estate-related loans, or loans secured by savings accounts and property used in
the conduct of its business. In addition, it had to meet certain other
supervisory tests and operate principally for the purpose of acquiring savings
and investing in loans.
As a result of changes in law, thrift institutions were required to
change to either the reserve method or the specific charge-off method that
applied to banks. Large thrift institutions, those generally exceeding $500
million in assets, had to convert to the specific charge-off method. In
computing its bad debt reserve for federal income taxes, the Bank used the
reserve method in fiscal years 1996, 1997 and 1998.
Bad debt reserve balances in excess of the balance computed under the
experience method or amounts maintained in a supplemental reserve built up prior
to 1962 ("excess bad debt reserve") require inclusion in taxable income upon
certain distributions to shareholders. Distributions in redemption or
liquidation of stock or distributions with respect to its stock in excess of
earnings and profits accumulated in years beginning after December 31, 1951, are
treated as a distribution from the excess bad debt reserve. When such a
distribution takes place and it is treated as from the excess bad debt reserve,
the thrift is required to reduce its reserve by such amount and simultaneously
recognize the amount as an item of taxable income increased by the amount of
income tax imposed on the inclusion. Dividends not in excess of earnings and
profits accumulated since December 31, 1951 will not require inclusion of part
or all of the bad debt reserve in taxable income. The Bank has accumulated
earnings and profits since December 31, 1951 and has an excess in its bad debt
reserve. Distributions in excess of current and accumulated earnings and profits
will increase taxable income. Net retained earnings at June 30, 1998 includes
approximately $2,777,000 for which no provision for federal income tax has been
made.
Legislation passed by the U.S. Congress and signed by the President in
August 1996 contains a provision that repeals the percentage of taxable income
method of accounting for thrift bad debt reserves for tax years beginning after
December 31, 1995. The legislation will trigger bad debt reserve recapture for
post-1987 excess reserves over a six-year period. At June 30, 1998, the Bank's
post-1987 excess reserves amounted to approximately $281,000. A special
provision suspends recapture of post-1987 excess reserves for up to two years
if, during those years, the institution satisfies a "residential loan
requirement." This requirement will be met if the principal amount of the
institution's residential loans exceeds a base year amount, which is determined
by reference to the average of the institution's residential loans during the
six taxable years ending before January 1, 1996. However, notwithstanding this
special provision, recapture must begin no later than the first taxable year
beginning after December 31, 1997.
The Bank may also be subject to the corporate alternative minimum tax
("AMT"). This tax is applicable only to the extent it exceeds the regular
corporate income tax. The AMT is imposed at the rate of 20% of the corporation's
alternative minimum taxable income ("AMTI") subject to applicable statutory
exemptions. AMTI is calculated by adding certain tax preference items and making
certain adjustments to the corporation's regular taxable income. Preference
items and adjustments generally applicable to financial institutions include,
<PAGE>
but are not limited to, the following: (i) the excess of the bad debt deduction
over the amount that would have been allowable on the basis of actual
experience; (ii) interest on certain tax-exempt bonds issued after August 7,
1986; and (iii) 75% of the excess, if any, of a corporation's adjusted earnings
and profits over its AMTI (as otherwise determined with certain adjustments).
Net operating loss carryovers, subject to certain adjustments, may be utilized
to offset up to 90% of the AMTI. Credit for AMT paid may be available in future
years to reduce future regular federal income tax liability. The Bank has not
been subject to the AMT in recent years.
The Bank's federal income tax returns have not been audited in the last
ten tax years. The Parent's 1996 federal income tax return is currently under
examination by the Internal Revenue Service.
State Taxation
Under North Carolina law, the corporate income tax in 1997 was 7.50% of
federal taxable income as computed under the Code, subject to certain prescribed
adjustments. The North Carolina corporate tax rate will drop to 7.25% in 1998,
7.00% in 1999 and 6.90% thereafter. An annual state franchise tax is imposed at
a rate of 0.15% applied to the greatest of the institution's (i) capital stock,
surplus and undivided profits, (ii) investment in tangible property in North
Carolina or (iii) appraised valuation of property in North Carolina.
ITEM 2. PROPERTIES
At June 30, 1998, the Company conducted its business from its one
office in Hillsborough, North Carolina. The following table sets forth certain
information regarding the Company's property as of June 30, 1998. This property
is owned by the Company.
Net Book
Value of
Address Property
------- --------
260 South Churton Street $989,000
Hillsborough, North Carolina 27278
In addition to the properties described above, the Company owns two
additional office buildings located in Hillsborough, North Carolina, one at 112
North Churton Street (former branch location) and another directly adjacent to
the North Churton Street building. These properties have net book values of
$40,000 and $15,000, respectively, as of June 30, 1998 and were both used for
rental office space. The total net book value of the Company's furniture,
fixtures and equipment on June 30, 1998 was $1,413,000. The properties are
considered by the Company's management to be in good condition.
ITEM 3. LEGAL PROCEEDINGS
In the opinion of management, the Company is not involved in any
pending legal proceedings other than routine, non-material proceedings occurring
in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's stockholders during
the quarter ended June 30, 1998.
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The information required by this Item is set forth under the section
captioned "Capital Stock" in the Company's 1998 Annual Report which is
incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth in the table
captioned "Five Year Summary" on the inside cover of the Company's 1998 Annual
Report which is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
See the information set forth under Item 1 above and the information
set forth under the section captioned "Management's Discussion and Analysis of
Financial Condition and Results of Operation" in the Company's 1998 Annual
Report which section is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
N/A
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and supplementary
data set forth in the Company's 1998 Annual Report are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on
accounting and financial disclosure during the fiscal year ended June 30, 1998
and the interim subsequent period.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is set forth under the section
captioned "Proposal 1 - Election of Directors" in the Proxy Statement for the
1998 Annual Meeting of Shareholders of Piedmont Bancorp, Inc. to be held on
November 19, 1998 (the "Proxy Statement") and the section captioned "Compliance
with Section 16(a) of the Exchange Act of 1934" in the Proxy Statement, which
sections are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the sections
captioned "Proposal 1 - Election of Directors - Directors' Compensation" and " -
Management Compensation" in the Proxy Statement, which sections are incorporated
herein by reference.
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference from the section captioned "Security Ownership of Certain Beneficial
Owners" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There have been no reportable transactions since the beginning of the
Company's last fiscal year nor are any reportable transactions proposed as of
the date of this Form 10-K. See also the section captioned "Proposal 1 -
Election of Directors - Certain Indebtedness and Transactions of Management" in
the Proxy Statement, which section is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
14(a) Consolidated Financial Statements (contained in the Company's
Company's 1998 Annual Report attached hereto as Exhibit (13)
and incorporated herein by reference)
(1) Independent Auditors' Report
(2) Consolidated Balance Sheets as of June 30, 1998 and 1997
(3) Consolidated Statements of Income for the Years Ended
June 30, 1998, 1997 and 1996
(4) Consolidated Statements of Stockholders' Equity for
the Years Ended June 30, 1998, 1997 and 1996
(5) Consolidated Statements of Cash Flows for the Years
Ended June 30, 1998, 1997 and 1996
(6) Notes to Consolidated Financial Statements
14(a)2. Financial Statement Schedules
All schedules have been omitted as the required information is
either inapplicable or included in the Notes to Consolidated
Financial Statements.
<PAGE>
14(a)3. Exhibits
Exhibit (3)(i) Articles of Incorporation, incorporated
herein by reference to Exhibit 3.1 of
the Company's Registration Statement on
Form S-1 (No. 33-94512) filed on July
12, 1995 and amended on September 27,
1995 and October 6, 1995
Exhibit (3)(ii) Bylaws, incorporated herein by reference
to Exhibit 3.2 of the Company's
Registration Statement on Form S-1 (No.
33-94512) filed on July 12, 1995 and
amended on September 27, 1995 and
October 6, 1995
Exhibit (4) Specimen Stock Certificate, incorporated
herein by reference to Exhibit 4.1 of
the Company's Registration Statement on
Form S-1 (No. 33-94512) filed on July
12, 1995 and amended on September 27,
1995 and October 6, 1995
Exhibit (10)(ii)(a) Piedmont Bancorp, Inc. Stock Option
Plan, incorporated herein by reference
to Exhibit (10)(ii)(a) of the
Registrant's Form 10-K for the year
ended June 30, 1996
Exhibit (10)(ii)(b) Hillsborough Savings Bank, Inc., SSB
Management Recognition Plan,
incorporated herein by reference to
Exhibit (10)(ii)(b) of the Registrant's
Form 10-K for the year ended June 30,
1996
Exhibit (10)(ii)(c) Employment Agreement between
Hillsborough Savings Bank, Inc., SSB and
D. Tyson Clayton, incorporated herein by
reference to Exhibit 10.2 of the
Company's Registration Statement on Form
S-1 (No. 33-94512) filed on July 12,
1995 and amended on September 27, 1995
and October 6, 1995
Exhibit (10)(ii)(d) Employment Agreement between
Hillsborough Savings Bank, Inc., SSB and
Peggy S. Walker, incorporated herein by
reference to Exhibit 10.2 of the
Company's Registration Statement on Form
S-1 (No. 33-94512) filed on July 12,
1995 and amended on September 27, 1995
and October 6, 1995
<PAGE>
Exhibit (10)(ii)(e) Employment Agreement between
Hillsborough Savings Bank, Inc., SSB and
Ted R. Laws, incorporated herein by
references to Exhibit (10)(ii)(e) of the
Registrant's Form 10-K for the year
ended June 30, 1997
Exhibit (10)(ii)(f) Employment Agreement between
Hillsborough Savings Bank, Inc., SSB and
Thomas W. Wayne
Exhibit (11) Portions of 1998 Annual Report to
Security Holders
Exhibit (21) Subsidiaries of the Registrant
Exhibit (23) Consent of KPMG Peat Marwick LLP
Exhibit (27) Financial Data Schedule
14(b) The Company filed no reports on Form 8-K during the last quarter
of the fiscal year ended June 30, 1998.
<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.
PIEDMONT BANCORP, INC.
Date: September 17, 1998 By: /s/ D. Tyson Clayton
--------------------
D. Tyson Clayton
President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ D. Tyson Clayton President, Chief Executive September 17, 1998
- -------------------- Officer and Director
D. Tyson Clayton
/s/ Peggy S. Walker Executive Vice President, September 17, 1998
- ------------------- Secretary and Director
Peggy S. Walker
/s/ Thomas W. Wayne Vice President, Treasurer and September 17, 1998
- ------------------- Principal Financial Officer
Thomas W. Wayne
/s/ M. Marion Clark Director September 17, 1998
- -------------------
M. Marion Clark
/s/ Robert B. Nichols, Jr. Director September 17, 1998
- --------------------------
Robert B. Nichols, Jr.
/s/ Alfred L. Carr Director September 17, 1998
- ------------------
Alfred L. Carr
/s/ Everett H. Kennedy Director September 17, 1998
- ----------------------
Everett H. Kennedy
/s/ Donald W. Pope Director September 17, 1998
- ------------------
Donald W. Pope
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ James P. Ray Director September 17, 1998
- ----------------
James P. Ray
/s/ William Larry Rogers Director September 17, 1998
- ------------------------
William Larry Rogers
</TABLE>
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
(10)(ii)(f) Employment Agreement between Hillsborough Savings
Bank, Inc., SSB and Thomas W. Wayne
(13) 1998 Annual Report to Security Holders
(21) Subsidiaries of the Registrant
(27) Financial Data Schedule
COPIES OF EXHIBITS ARE AVAILABLE UPON WRITTEN REQUEST TO THOMAS W. WAYNE, VICE
PRESIDENT, TREASURER, AND PRINCIPAL FINANCIAL OFFICER OF PIEDMONT BANCORP, INC.
EXHIBIT (10)((ii)(f)
HILLSBOROUGH SAVINGS BANK, INC., SSB
EMPLOYMENT AGREEMENT
THIS AGREEMENT entered into as of December 1, 1997, by and between HILLSBOROUGH
SAVINGS BANK, INC., SSB (hereinafter referred to as the "SavingsBank") and
Thomas W. Wayne (hereinafter referred to as the "Officer") and is joined in by
PIEDMONT BANCORP, INC., the parent holding company of theSavings Bank
(hereinafter referred to as the "Holding Company").
WHEREAS, the Savings Bank is a state-chartered stock savings bank and
the wholly-owned subsidiary of the Holding Company, and
WHEREAS, the Savings Bank desires to retain the services of the Officer
as Vice President and Chief Financial Officer of the Savings Bank upon the terms
and conditions set forth herein; and
WHEREAS, the services of the Officer, his experience and knowledge of
the affairs of the Savings Bank, and his reputation and contacts in the industry
and the local community are extremely valuable to the Savings Bank, and
WHEREAS, the Savings Bank wishes to attract and retain such
well-qualified executives and it is in the best interest of the Savings Bank and
of the Officer to secure the continued services of the Officer notwithstanding
any change in control of the Savings Bank or the Holding Company; and
WHEREAS, the Savings Bank considers the establishment and maintenance
of a sound and vital management to be part of its overall corporate strategy and
to be essential to protecting and enhancing the best interests of the Holding
Company, the Savings Bank and their stockholders; and
WHEREAS, the parties desire to enter into this Agreement in order to
set forth the terms and conditions of the Officer's employment relationship with
the Savings Bank.
NOW, THEREFORE, for and in consideration of the premises and mutual
promises, covenants and conditions hereinafter set forth and other good and
valuable considerations, the receipt and sufficiency of which hereby are
acknowledged, the parties hereby do agree as follows:
1. Employment. The Savings Bank hereby agrees to employ the Officer and
the Officer hereby agrees to accept employment, upon the terms and conditions
stated herein, as Vice President and Chief Financial Officer of the Savings
Bank. The Officer shall render such administrative and management services to
the Savings Bank as are customarily performed by persons situated in a similar
executive capacity. The Officer shall promote the business of the Savings Bank
and perform such other duties as shall, from time to time, be reasonably
prescribed by the Board of Directors of the Savings Bank (the "Board").
2. Compensation. The Savings Bank shall pay the Officer during the term
of this agreement, as compensation for all service rendered by him to the
Savings Bank, a base salary at the rate of $59,000.00 per annum, payable in cash
not less frequently than monthly; provided that the rate of salary shall be
reviewed by the Board not less often than annually. Such rate of salary, or
<PAGE>
increased rate of salary, as the case may be, may be further increased from time
to time in such amounts as the Board, in its discretion, may decide. In
determining salary increases, the Board shall compensate the Officer for
increases in the cost of living and may also provide for performance or merit
increases. Participation in incentive compensation, deferred compensation,
discretionary bonus, profit-sharing, retirement, stock option and other employee
benefit plans that the Savings Bank or the Holding Company have adopted or may
from time to time adopt, and participation in any fringe benefits, shall not
reduce that salary payable to the Officer under this Section. The Officer will
be entitled to such customary fringe benefits, vacation, sick leave as are
consistent with the normal practices and established policies of the Savings
Bank. In the event of a Change of Control (as defined in Section 10), the
Officer's rate of salary shall be increased not less than six percent (6%)
annually during the term of this Agreement.
3. Discretionary Bonuses. During the term of this Agreement, the
Officer shall be entitled in an equitable manner with all other key management
personnel of the Savings Bank, to such discretionary bonuses as may be
authorized, declared and paid by the Directors to the Savings Bank's key
management employees. No other compensation provided for in this Agreement shall
be deemed a substitute for the Officer's right to such discretionary bonuses
when and as declared by the Directors.
4. Participation in Retirement and Employee Benefit Plans: Fringe
Benefits. The Officer shall be entitled to participate in any plan relating to
deferred compensation, stock awards, stock options, stock purchases, pension,
thrift, profit sharing, group life insurance, medical and dental coverage,
disability coverage, education, or other retirement or employee benefits that
the Savings Bank or the Holding Company have adopted, or may, from time to time
adopt, for benefit of their executive employees and for employees generally,
subject to the eligibility rules of such plans. The Officer shall also be
entitled to participate in any other fringe benefits which are now or may be or
become applicable to the Officer or the Savings Bank's other executive
employees, including the payment of reasonable expenses for attending annual and
periodic meetings of trade associations, and any other benefits which are
commensurate with the duties and responsibilities to be performed by the Officer
under this Agreement. Additionally, the Officer shall be entitled to such
vacation and sick leave as shall be established under uniform employee policies
promulgated by the Directors. The Savings Bank shall reimburse the Officer for
all out-of-pocket reasonable and necessary business expenses which the Officer
may incur in connection with his services on behalf of the Savings Bank.
5. Term. The initial term of employment under this Agreement shall be
for the period commencing upon the effective date of this Agreement and ending
three (3 ) calendar years from the effective date of this Agreement. On each
anniversary of the effective date of this Agreement of the Savings Bank, the
term of this Agreement shall automatically be extended for an additional one
year period beyond the then effective expiration date unless written notice from
the Savings Bank or the Officer is received 90 days prior to an anniversary date
advising the other party that this Agreement shall not be further extended;
provided that the Directors shall review the Officer's performance annually and
make a specific determination pursuant to such review to renew this Agreement
prior to the 90 day notice period.
6. Loyalty. The Officer shall devote his full efforts and entire
business time to the performance of his duties and responsibilities under this
Agreement. The Officer agrees that he will hold in confidence all knowledge or
<PAGE>
information of a confidential nature with respect to the respective businesses
of the Holding Company, the Savings Bank or of their subsidiaries, if any,
received by him during the term of this Agreement and will not disclose or make
use of such information, except in the ordinary course of his duties under this
Agreement, without the prior written consent of the Holding Company or the
Savings Bank.
7. Standards. The Officer shall perform his duties and responsibilities
under this Agreement in accordance with such reasonable standards expected of
employees with comparable positions in comparable organizations and as may be
established from time to time by the Board. The Savings Bank will provide the
Officer with the working facilities and staff customary for similar executives
and necessary for him to perform his duties.
8. Termination and Termination Pay. (a) The Officer's employment under
this Agreement shall be terminated upon the death of the Officer during the term
of this Agreement, in which event, the Officer's estate shall be entitled to
receive the compensation due the Officer through the last day of the calendar
month in which his death shall have occurred and for a period of one month
thereafter. (b) The Officer's employment under this Agreement may be terminated
at any time by the Officer upon sixty (60) days' written notice to the Board of
Directors. Upon such termination, the Officer shall be entitled to receive
compensation through the effective date of such termination. (c) The Board may
terminate the Officer's employment at any time, but any termination by the
Board, other than termination for cause, shall not prejudice the Officer's right
to compensation or other benefits under this Agreement for the remaining period
which would have been covered by this Agreement if such termination had not
occurred. The Officer shall have no right to receive compensation or other
benefits for any period after termination for "cause." Termination for "cause"
shall include termination because of the Officer's personal dishonesty,
incompetence, willful misconduct, breach of fiduciary duty involving personal
profit, intentional failure to perform stated duties, willful violation of any
law, rule, regulation (other than traffic violations or similar offenses) or
final cease-and-desist order, or material breach of any provisions of this
Agreement.
9. Additional Regulatory Requirements. (a) If the Officer is suspended
and/or temporarily prohibited from participating in the conduct of the Savings
Bank's affairs by a notice served under Section 8(e)(3) or Section 8(g)(1) of
the Federal Deposit Insurance Act (12 U.S.C. 1818(e)(3) and (g)(l)), the Savings
Bank's obligations under this Agreement shall be suspended as of the date of
service, unless stayed by appropriate proceedings. If the charges in the notice
are dismissed, the Savings Bank shall (i) pay the Officer all of the
compensation withheld while its contract obligations were suspended and (ii)
reinstate (in whole or in part) any of its obligations which were suspended. (b)
If the Officer is removed and/or permanently prohibited from participating in
the conduct of the Savings Bank's affairs by an order issued under Section
8(e)(4) of Section 8(g)(l) of the Federal Deposit lnsurance Act
(12U.S.C.1818(e)(4) and (g)(1)), all obligations of the Savings Bank under this
Agreement shall terminate as of the effective date of the order, but vested
rights of the contracting parties shall not be affected (c) If the Savings Bank
is in default as defined in Section 3(x)(1) of the Federal Deposit Insurance Act
(12U.S.C. ss. 1818(x)(1)), all obligations under this Agreement shall terminate
as of the date of default, but this paragraph shall not affect any vested rights
of the contracting parties. (d) All obligations under this Agreement shall be
terminated, except to the extent determined that continuation of the Agreement
<PAGE>
is necessary for the continued operation of the Savings Bank, (i) by the Federal
Deposit Insurance Corporation (the "Corporation"), at the time the Corporation
enters into an agreement to provide assistance to or on behalf of the Savings
Bank under the authority contained in Section 13(c) of the Federal Deposit
Insurance Act (12 U.S.C. ss. 1818(c)); or (ii) by the Administrator of the
Savings Institution Division of the North Carolina Department of Commerce (the
"Administrator"), at the time the Administrator approves a supervisory merger to
resolve problems related to operation of the Savings Bank or when the Savings
Bank is determined by the Administrator to be in an unsafe or unsound condition.
Any rights of the parties that have already vested, however, shall not be
affected by such action.
10. Change in Control.
(a) In the event of a "Change in Control" (as defined in Subsection (b)
below), the acquiror shall be prohibited, during the remainder of the term of
this Agreement, from:
(i) Assigning Officer any duties and/or responsibilities that are
inconsistent with his position, duties, responsibilities or
status at the time of the Change in Control or with his
reporting responsibilities or equivalent titles with the
Savings Bank in effect at such time; or
(ii) Adjusting Officer's annual base salary rate other than in
accordance with the provisions of Section 2 of this Agreement;
or
(iii) Reducing in level, scope or coverage or eliminating Officer's
life insurance, medical or hospitalization insurance,
disability insurance, profit sharing plans, stock option
plans, stock purchase plans, deferred compensation plans,
management retention plans, retirement plans or similar plans
or benefits being provided by the Savings Bank or the Holding
Company to the Officer as of the effective date of the Change
in Control; or
(iv) Transferring Officer to a location outside of Orange County,
North Carolina, without the Officer's express written consent.
(b) For the purposes of this Agreement, the term "Change in
Control" shall mean any of the following events:
(i) a change in control of a nature that would be required to be
reported in response to Item 1 of the Current Report on Form
8K, as in effect on the date hereof, pursuant to Section 13 or
1 5(d) of the Exchange Act; or
(ii) such time as any "person" (as such term is used in Sections
13(d) and 14(d) of the Exchange Act) is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under the
Exchange Act), directly or indirectly, of securities of the
Holding Company or Savings Bank representing 25 percent or
more of the combined voting power of the outstanding Common
Stock of the Holding Company or Common Stock of the Savings
Bank, as applicable; or
<PAGE>
(iii) individuals who constitute the Board or board of directors of
the Holding Company on the date hereof (the "Incumbent Board"
and "Incumbent Holding Company Board," respectively) cease for
any reason to constitute at least a majority thereof, provided
that any person becoming a director subsequent to the date
hereof whose election was approved by a vote of at least three
quarters of the directors comprising the Incumbent Board or
Incumbent Holding Company Board, as applicable, or whose
nomination for election by the Savings Bank's or Holding
Company's shareholders was approved by the Savings Bank's or
Holding Company's Board of Directors or Nominating Committee,
as applicable, shall be considered as though he or she were a
member of the Incumbent Board or Incumbent Holding Company
Board, as applicable; or
(iv) either the Holding Company or the Savings Bank consolidates or
merges with or into another corporation, association or entity
or is otherwise reorganized, where neither the Holding Company
nor the Savings Bank, respectively, is the surviving
corporation in such transaction; or
(v) all or substantially all of the assets of either the Holding
Company or the Savings Bank are sold or otherwise transferred
to or are acquired by any other entity or group.
Notwithstanding the other provisions of this Section 10, a transaction
or event shall not be considered a Change in Control if, prior to the
consummation or occurrence of such transaction or event, Officer and Savings
Bank agree in writing that the same shall not be treated as a Change in Control
for purposes of this Agreement.
(c) If, after the occurrence of a Change in Control, (i) the
employment of the Officer shall be terminated by the Savings
Bank or its successor for any reason other than for "cause" as
defined in Section 8(c) or (ii) the employment of the Officer
shall be terminated by the Officer as a result of a breach of
this Agreement by the Savings Bank or its successor, and as a
result of such termination, the Officer shall not become fully
vested in benefits provided to the Officer under any
retirement plan, restricted stock plan, stock option plan,
stock ownership plan, or other employee benefit plan, then in
addition to any liability arising under this Agreement, the
Savings Bank or its successor shall pay to the Officer an
amount equal to the value of the benefits in which the Officer
shall not become fully vested as a result of such termination.
(d) In the event any dispute shall arise between the Officer and
the Savings Bank as to the terms or interpretation of this
Agreement, including this Section 10, whether instituted by
formal legal proceedings or otherwise, including any action
taken by the Officer to enforce the terms of this Section 10
or in defending against any action taken by the Savings Bank,
the Savings Bank shall reimburse the Officer for all costs and
expenses incurred in such proceedings or actions, including
attorney's fees, in the event the Officer prevails in any such
action.
<PAGE>
11. Successors and Assigns.
(a) This Agreement shall inure to the benefit of and be binding upon
any corporate or other successor of the Savings Bank which shall
acquire, directly or indirectly, by conversion, merger,
consolidation, purchase or otherwise, all or substantially all of
the assets of the Holding Company or the Savings Bank.
(b) Since the Savings Bank is contracting for the unique and personal
skills of the Officer, the Officer shall be precluded from
assigning or delegating his rights or duties hereunder without
first obtaining the written consent of the Savings Bank.
12. Modification: Waiver: Amendments. No provision of this Agreement
may be modified, waived or discharged unless such waiver, modification or
discharge is agreed to in writing, signed by the Officer and on behalf of the
Savings Bank by such officer as may be specifically designated by the Directors.
No waiver by either party hereto, at any time, of any breach by the other party
hereto of, or compliance with, any condition or provision of this Agreement to
be performed by such other party shall be deemed a waiver of similar or
dissimilar provisions or conditions at the same or at any prior or subsequent
time. No amendments or additions to this Agreement shall be binding unless in
writing and signed by both parties, except as herein otherwise provided.
13. Applicable Law. This Agreement shall be governed in all respects
whether as to validity, construction, capacity, performance or otherwise, by the
laws of North Carolina, except to the extent that federal law shall be deemed to
apply.
14. Severability. The provisions of this Agreement shall be deemed
severable and the invalidity or unenforceability of any provision shall not
affect the validity or enforceability of the other provisions hereof.
IN WlTNESS WHEREOF, the parties have executed this Agreement as of the
day and year first herein above written.
HILLSBOROUGH SAVINGS BANK, INC., SSB
By: /s/M. Marion Clark
----------------------
M. Marion Clark
Chairman of the Board
By: /s/Thomas W. Wayne (SEAL)
------------------
Thomas W. Wayne
The foregoing Agreement is consented and agreed to by Piedmont
Bancorp, Inc., the parent holding company of Hillsborough Savings Bank, Inc.,
SSB.
PIEDMONT BANCORP, INC.
By: /s/ M. Marion Clark
-------------------
M. Marion Clark
Chairman of the Board
Exhibit 13
PIEDMONT BANCORP, INC.
1998 ANNUAL REPORT
<PAGE>
"The evidence is clear that well-managed smaller banks can, and will,
exist side by side with larger banks and other financial services providers,
often maintaining or increasing local market share. Technological change has
facilitated this process by providing smaller banks with low-cost access to new
products and services. In short, the record shows that well-managed smaller
banks have little to fear from technology, deregulation, or consolidation. Most
projections of the future United States banking structure call for a substantial
reduction in the number of American banks. But these same projections also
predict that thousands of banks will survive the consolidation trend, reflecting
both their individual efficiencies and competitive skills, on the one hand, and
the preferences of the marketplace on the other. Such conclusions of the Federal
Reserve Board's staff and others reinforce my own view that the franchise value
of the U.S. community bank--based on its intimate and personalized knowledge of
local markets and customers, its organizational flexibility, and, most of all,
its management skills--will remain high, assuring that community banks continue
to play a significant role in the U.S. financial system. Technology can never
fully displace the value of personal contact, the hallmark of community
banking."
Federal Reserve Chairman Alan Greenspan
At the Charlotte Chamber of Commerce, Charlotte, North Carolina
July 10, 1998
WHO WE ARE
Piedmont Bancorp, Inc. is the holding company for Hillsborough Savings
Bank, Inc. SSB ("HSB"). From its beginning in 1913 out of the small drug store
in Hillsborough, pictured on the cover, HSB has grown into a full service
community bank that offers a complete line of banking and investment services to
individuals, small businesses and charitable organizations located in Orange and
Durham counties. We like to think that HSB provides the best of the old and the
new. We are proud of our eighty-five years of rich history in the historic town
of Hillsborough, North Carolina.
We have been hard at work during the past year adding exciting new
products and services for our customers. If you are interested in a specific
product and would like more information please call us at (919) 732-2143 or just
stop by. In addition, you can also reach us at our web site at
www.hillsboroughbank.com, email at [email protected], fax at (919) 732-6001
and 24 hour telephone banking at (800) 375-8017. For your convenience, a
complete list of services offered is listed below:
Services for individuals:
Checking and deposit products
A complete range of checking account options designed with you in mind
A money market account with competitive interest rates
A complete line of savings, certificate of deposit and IRA products
ATM card with access to thousands of ATM machines nationwide
Banking by telephone with our Telebancing(TM) center
<PAGE>
Loan products
Mortgage and consumer loans
Home equity lines of credit
Mastercard(TM) and Visa(TM) credit cards
Investor services
We provide full and discount securities brokerage services through a
partnership with UVEST Investment Services, Inc. We also offer free
financial planning for retirement and college. Turn to us for stocks,
mutual funds, annuities, estate planning and life insurance.
Services for Small Businesses and Charitable Organizations
A complete line of checking and savings accounts
Loans
Merchant card services
Incoming and outgoing wiring of funds
We offer full and discount brokerage services through a partnership
with UVEST Investment Services, Inc. Turn to us for all your small
business investment needs.
<PAGE>
<TABLE>
<CAPTION>
Piedmont Bancorp, Inc.
Selected Financial Data
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Summary of Operations:
Interest income ................................... $ 10,217 $ 9,535 $ 9,248 $ 7,811 $ 6,864
Interest expense .................................. 5,191 4,603 4,414 3,682 3,262
--------- --------- --------- --------- ---------
Net interest income ............................... 5,026 4,932 4,834 4,129 3,602
Provision for loan losses ......................... 96 658 96 120 87
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses 4,930 4,274 4,738 4,009 3,515
Other income ...................................... 606 225 255 336 255
Other expenses .................................... 2,963 4,716 2,449 2,265 2,027
--------- --------- --------- --------- ---------
Income (loss) before income tax expense ........... 2,573 (217) 2,544 2,080 1,743
Income tax expense ................................ 930 317 849 837 710
--------- --------- --------- --------- ---------
Net income (loss) .............................. $ 1,643 $ (534) $ 1,695 $ 1,243 $ 1,033
========= ========= ========= ========= =========
Net income (loss) per share - basic ............... $ 0.61 $ (0.20) $ 0.61 n/a n/a
========= ========= ========= ========= =========
Net income (loss) per share - diluted ............. $ 0.61 $ (0.20) $ 0.61 n/a n/a
========= ========= ========= ========= =========
Selected Year-end Balances:
Total assets ...................................... $ 130,541 $ 122,761 $ 128,711 $ 104,013 $ 97,368
Loans receivable, net ............................. 106,500 100,173 91,187 84,713 81,733
Investments (1) ................................... 18,846 17,973 32,564 15,043 11,338
Deposits .......................................... 89,840 84,860 73,361 76,745 74,287
FHLB Advances ..................................... 18,000 16,500 17,250 13,000 10,500
Stockholders' equity .............................. 21,606 20,416 37,050 13,646 12,195
Average Balance Sheet Data:
Total assets ...................................... $ 128,871 $ 123,896 $ 119,252 $ 100,359 $ 97,827
Total earning assets .............................. 125,585 120,700 116,010 96,745 95,046
Loans receivable, net ............................. 107,510 95,937 87,917 83,326 83,534
Investments (1) ................................... 17,013 23,869 27,297 12,633 10,733
Deposits .......................................... 86,648 78,720 77,221 75,110 73,137
Borrowings ........................................ 20,119 16,481 13,248 10,628 11,603
Stockholders' equity .............................. 21,212 25,893 27,557 12,810 11,959
Selected Financial Ratios:
Return on average assets .......................... 1.27% (0.43)% 1.42% 1.24% 1.06%
Return on average equity .......................... 7.75 (2.06) 6.15 9.70 8.64
Average equity to average assets .................. 16.46 20.90 23.11 12.76 12.22
Interest rate spread (tax equivalent basis) ....... 3.26 3.13 3.16 3.72 3.32
Net interest margin (tax equivalent basis) ........ 4.10 4.24 4.33 4.29 3.80
Dividend payout ratio ............................. 68.85 n/a 48.89 n/a n/a
Cash dividends declared per common share .......... $ 0.42 $ 7.42 0.22 n/a n/a
</TABLE>
(1) Includes investment securities, mortgage-backed securities, and
interest-bearing deposits.
<PAGE>
Piedmont Bancorp, Inc.
1998 Annual Report to Shareholders Table of Contents
President's Message.............................................. 2
Management's Discussion and Analysis............................. 4
Independent Auditor's Report..................................... 20
Consolidated Financial Statements................................ 21
Notes to Consolidated Financial Statements....................... 25
Directors, Officers and Office Location.......................... 42
Corporate Information............................................. 42
Capital Stock.................................................... 43
<PAGE>
A Message From Your President and Chief Executive Officer:
To Our Stockholders:
The comment from Alan Greenspan, the Chairman of the Federal Reserve
Bank, on the inside cover of this year's annual report, provides insight into
Piedmont Bancorp, Inc.'s (the "Parent") and its wholly-owned subsidiary,
Hillsborough Savings Bank, Inc. SSB's (the "Bank") (collectively referred to as
the "Company"), feelings about the future of community banks in this country.
Since 1913 we have demonstrated our commitment to Hillsborough and the
surrounding communities by evolving into a diversified, full service community
bank serving the needs of consumers, small businesses and charitable
organizations.
For the year ended June 30, 1998, your Company reported a 4.7% increase
in consolidated net income to $1,643,000 or $0.61 basic and diluted earnings per
share, compared to consolidated net income before non recurring items of
$1,569,000 or $0.61 basic and diluted earnings per share for the year ended June
30, 1997.
In the year ended June 30, 1997 the Company recorded a net loss and
basic and diluted loss per share after nonrecurring items of $534,000 and $0.20,
respectively. Earnings for the year ended June 30, 1997 were adversely impacted
by the following nonrecurring items: (1) $1,496,000 of compensation expense
associated with the release and allocation of approximately 126,000 shares of
common stock of the Company to participants of the Hillsborough Savings Bank,
Inc. Employee Stock Ownership Plan during the quarter ended December 31, 1996,
(2) a provision for loan losses of $597,000 recorded during the quarter ended
December 31, 1996 that resulted primarily from the charge off of approximately
$510,000 in unsecured loans to a single borrower, (3) losses of $106,000 on the
sale of investments that were sold in December of 1996 to fund the special
dividend of $7.00 a share, and (4) a special $487,000 assessment paid in the
first quarter of fiscal 1997 to the Federal Deposit Insurance Corporation to
recapitalize the Savings Association Insurance Fund.
Total assets increased 6.3% to $130.5 million at June 30, 1998 compared
to $122.8 million at June 30, 1997. The primary contributor to the growth was an
increase of 6.3% in net loans receivable to $106.5 million at June 30, 1998 from
$100.2 million at June 30, 1997. Funding the majority of the loan growth was (1)
a $5.0 million or 5.9% increase in deposits from June 30, 1997 to June 30, 1998
and (2) a $1.5 million or 9.1% increase in advances from the Federal Home Loan
Bank during the same period.
Beyond the financial results discussed above and in much more detail
after this letter, your Company and its employees began and completed a number
of significant initiatives as a result of the approval and adoption of a
strategic plan by the Board of Directors in October of 1997. These are discussed
in more detail as follows:
In November of 1997 the Bank made the decision to convert our loan and
deposit systems to a new vendor that is better able to respond to the
technological opportunities and challenges that face the financial services
industry. The actual conversion occurred in February of 1998, and thanks to the
hard work and effort of all employees I am happy to say that the conversion went
very well.
2
<PAGE>
In conjunction with the conversion noted above, the Bank also installed
a new local area network and acquired new computer workstations for
substantially all employees. We firmly believe that the investment in the local
area network and computer workstations will serve us well in the future,
especially with respect to our efforts in achieving Year 2000 compliance.
Our new system comes with a relational Microsoft Access(TM) database
designed to identify cross sale candidates for profitable bank or fee based
investment products offered by the Bank. The Bank already has done several
direct mail campaigns and has surveyed its customer's satisfaction and product
needs since the system has been installed.
In March of 1998 the Bank introduced a wide range of new checking
products that are designed for customers at every stage of their lives. If you
are a local shareholder and not a customer we encourage you to come by and look
closely at our new checking products.
Also in March of 1998, the Bank established and incorporated a wholly
owned subsidiary, HSB Financial Services, Inc., that provides a complete range
of investment and brokerage services to individuals and small businesses through
a partnership with UVEST Investment Services, Inc. Again, if you are a local
shareholder and not a customer we encourage you to come by the Bank and see our
Investment Counselor, Dan Ferris.
The Bank developed a web site in March of 1998 for current and future
use as another delivery channel for products and services to current and
potential customers. Our web address is www.hillsboroughbank.com and we welcome
your comments and suggestions on changes we can make that will make our web site
accessible to shareholders and customers.
Consistent with its financial strategy of increasing earnings per share
and return on equity to shareholders, the Parent's Board of Directors approved a
stock repurchase plan on June 30, 1998. The plan will enable the Parent to
repurchase stock from time to time in the open market or through privately
negotiated transactions. Current market conditions make this an excellent time
to initiate this plan, however, the timing and extent of the stock repurchased
will depend upon financial market conditions.
Also in June of 1998, the Parent's Board of Directors approved an
increase in the quarterly dividend rate from $0.10 to $0.12 per common share.
The purpose of the increase is twofold in that it is another tool to manage the
Parent's capital and increase the dividend yield to shareholders.
As you can see, the last year was a very busy one for the Company. In
fiscal 1999, we intend to focus on existing and new customers to continue our
solid growth. While our large competitors are worrying about pending
acquisitions and exposure to faraway countries we will continue to focus on our
niche as a strong, solid community bank serving Orange and Durham counties.
We thank you for your continued support of Piedmont Bancorp, Inc. and
will continue to seek your support and suggestions on how we can provide the
greatest value to both our shareholders and customers.
Sincerely,
/s/D. Tyson clayton
- -------------------
D. Tyson Clayton
President and Chief Executive Officer
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
The purpose of this discussion and analysis is to provide the reader
with a description of the financial conditions and changes therein and results
of operations of Piedmont Bancorp, Inc. (the "Parent") and its wholly-owned
subsidiary, Hillsborough Savings Bank, Inc., SSB (the "Bank") (collectively
referred to as the "Company"). This discussion and analysis of financial
condition and results of operation should be read in conjunction with the
audited consolidated financial statements and accompanying notes included in
this report and the supplemental financial data appearing throughout this
discussion and analysis.
RESULTS OF OPERATIONS
The Company's results of operations depend primarily on net interest
income, which is the difference between interest income from interest-earning
assets and interest expense on interest-bearing liabilities. Operations are also
affected by non-interest income, such as income from customer service charges,
loan servicing fee income, gains and losses on the sale of loans and
investments, and other sources of income. The Company's principal operating
expenses, aside from interest expense, consist of compensation and employee
benefits, federal deposit insurance premiums, data processing expenses, office
occupancy costs, and income taxes.
Performance Overview
The Company ended fiscal year 1998 with net income of $1,643,000 or
$0.61 basic and diluted earnings per share compared to consolidated net income
before nonrecurring items of $1,569,000 or $0.61 basic and diluted earnings per
share for the year ended June 30, 1997. For the year ended June 30, 1996 the
Company had net income of $1,695,000, and basic and diluted earnings per share
for the post conversion period from December 7, 1995 to June 30, 1996 of $0.45
per share. In the year ended June 30, 1997 the Company recorded a net loss and
basic and diluted loss per share after nonrecurring items of $534,000 and $0.20,
respectively. Earnings for the year ended June 30, 1997 were adversely impacted
by the following nonrecurring items: (1) $1,496,000 of compensation expense
associated with the release and allocation of approximately 126,000 shares of
common stock of the Company to participants of the Hillsborough Savings Bank,
Inc. Employee Stock Ownership Plan during the quarter ended December 31, 1996,
(2) a provision for loan losses of $597,000 recorded during the quarter ended
December 31, 1996 that resulted primarily from the charge off of approximately
$510,000 in unsecured loans to a single borrower, (3) losses of $106,000 on the
sale of investments that were sold in December of 1996 to fund the special
dividend of $7.00 a share, and (4) a special $487,000 assessment paid in the
first quarter of fiscal 1997 to the Federal Deposit Insurance Corporation to
recapitalize the Savings Association Insurance Fund.
<PAGE>
Net Interest Income
Net interest income is one of the major determining factors in a
financial institution's performance as it is its principal source of earnings.
Net interest income is impacted by a variety of elements: volume, yield/cost and
relative mix of both interest-earning assets and interest-bearing and
noninterest-bearing sources of funds. Table 1 presents average balance sheets
and a net interest income analysis on a tax-equivalent basis for each of the
years in the three-year period ended June 30, 1998.
As shown in Table 1, net interest income, on a fully tax-equivalent
basis, amounted to $5.2 million in 1998, $5.1 million in 1997, and $5.0 million
in 1996. Total interest income increased to $10.3 million in 1998 from $9.7
million in 1997 and $9.4 million in 1996, but the growth in interest income was
almost matched by a comparable increase in interest expense over the same period
of time. Total interest expense increased to $5.2 million in 1998 from $4.6
million in 1997 and $4.4 million in 1996.
Growth in average loans receivable of $11.6 million or 12.1% from 1997
to 1998 is responsible for the majority of the increase in total interest
income. The weighted average tax-equivalent yield increased from 8.06% in 1997
to 8.23% in 1998. The increase was primarily caused by two factors. First,
average loans accounted for 85.6% of the interest-earning assets of the Company
in 1998 compared to 79.5% of interest-earning assets in 1997. The shift in
interest-earning assets toward higher yielding loans accounts for part of the
increase in the weighted average tax-
4
<PAGE>
equivalent yield from 1997 to 1998. The second factor that contributed to the
increase was an increase in the average yield on loans receivable from 8.40% in
1997 to 8.49% in 1998.
Average taxable and tax exempt investment securities declined $2.8 and
$3.3 million, respectively, from 1997 to 1998. This decline was due to the
liquidation of investments in 1997 to facilitate payment of the special dividend
of $7.00 per share.
The increase in interest expense of $588,000 or 12.8% in 1998 was due
primarily to the increased volume of both deposits and FHLB advances to fund
loan growth. Average interest-bearing liabilities increased by $11.2 million or
12.0% in 1998 while the average rate paid on those liabilities increased by four
basis points.
Interest rate spread (on a tax-equivalent basis) increased to 3.26% in
1998 from 3.13% in 1997 as the increase in the yield on interest-earning assets
outpaced the increase in the cost of interest-bearing liabilities. The net
interest margin (on a tax-equivalent basis) decreased to 4.10% in 1998 from
4.24% in 1997, and 4.33% in 1996 due to increased funding of interest-earning
asset growth with deposits and FHLB advances in 1998 and 1997 compared to the
use of conversion proceeds in 1996. Through the payment of the special dividend
in December 1996, average stockholder's equity to assist in funding decreased
$1.7 million or 6.0% to $25.9 million in 1997 or 21.5% of total interest-earning
assets compared to $27.6 million or 23.8% of total interest-earning assets in
1996. The payment of the special dividend in December of 1996 had the effect of
decreasing average stockholder's equity $4.7 million or 18.1% to $21.2 million
in 1998 or 16.9% of total interest-earning assets in 1998.
<PAGE>
TABLE 1
NET INTEREST INCOME ANALYSIS - TAX EQUIVALENT
<TABLE>
<CAPTION>
1998 1997 1996
----------------------------- ---------------------------- ---------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- ------- ---- --------- ------- ---- --------- ------- ----
Assets: (dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable $107,510 $ 9,127 8.49% $ 95,937 $ 8,060 8.40% $ 87,917 $ 7,591 8.63%
Taxable investment securities 11,469 747 6.51 14,271 959 6.72 14,993 1,020 6.80
Tax-exempt investment securities(1) 3,937 317 8.05 7,193 542 7.54 7,754 546 7.04
Interest-bearing deposits 1,607 70 4.36 2,405 99 4.12 4,550 226 4.97
FHLB common stock 1,062 78 7.34 894 65 7.27 796
-------- ------- --------- ------- --------- -------
Total interest-earning assets 125,585 10,339 8.23 120,700 9,725 8.06 116,010 9,441 8.14
Non-interest-earning assets 3,286 3,196 3,242
-------- --------- ---------
$128,871 $ 123,896 $ 119,252
TOTAL ======== ========= =========
Liabilities and retained earnings:
Interest-bearing liabilities:
Deposit accounts $ 84,357 $ 3,991 4.73% $ 76,819 $ 3,615 4.71% $ 75,365 $ 3,614 4.80%
FHLB advances 20,119 1,200 5.96 16,481 988 5.99 13,248 800 6.04
-------- ------- --------- ------- --------- -------
Total interest-bearing liabilities 104,476 5,191 4.97 93,300 4,603 4.93 88,613 4,414 4.98
Non-interest-bearing liabilities 3,183 4,703 3,082
Stockholder's equity 21,212 25,893 27,557
-------- --------- --------
TOTAL $128,871 $ 123,896 $119,252
======== ========= ========
Net interest income and interest $ 5,148 3.26% $ 5,122 3.13% $ 5,027 3.16%
rate spread ======= ======= =======
Net interest-earning assets
and net interest margin $ 21,109 4.10% $ 27,400 4.24% $ 27,397 4.33%
======== ======== ========
Ratio of interest-earning assets
to interest-bearing liabilities 120.2% 129.37% 130.92%
</TABLE>
(1) Interest earned on tax-exempt investment securities has been adjusted to a
tax-equivalent basis using the applicable combined federal and state rates of
34.00% and 7.50%, respectively, and reduced by the nondeductible portion of
interest expense.
<PAGE>
In summary, the small increase in net interest income from 1997 to 1998
is primarily due to an increase in the average yield/rate on total
interest-earning assets mitigated by a decline in volume during the same period
of time. The total increase in net interest income from 1996 to 1997 is
primarily attributable to an increase in volume mitigated by a decline in the
average yield/rate during the same period. Table 2 shows the effect of variances
in volume and rate on taxable-equivalent interest income, interest expense, and
net interest income. The table shows that increases in net interest income were
primarily due to rate in 1998 and volume in 1997.
5
<PAGE>
TABLE 2
RATE / VOLUME ANALYSIS
<TABLE>
<CAPTION>
1998 1997
---------------------------------------- ----------------------------------------
Rate/ Rate/
Volume Rate Volume Net Volume Rate Volume Net
------ ---- ------ --- ------ ---- ------ ---
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income (tax-equivalent) on:
Loans .................................. $ 972 $ 85 $ 10 $ 1,067 $ 693 $ (205) $ (19) $ 469
Taxable investment securities .......... (188) (30) 6 (212) (49) (12) -- (61)
Tax-exempt investment securities ....... (245) 37 (17) (225) (40) 38 (2) (4)
Interest-bearing deposits .............. (33) 6 (2) (29) (107) (39) 19 (127)
FHLB common stock ...................... 12 1 -- 13 7 -- -- 7
------- ------- ------- ------- ------- ------- ------- -------
Total interest income ............... 518 99 (3) 614 504 (218) (2) 284
------- ------- ------- ------- ------- ------- ------- -------
Deposit accounts ....................... 355 19 2 376 70 (68) (1) 1
FHLB advances .......................... 218 (5) (1) 212 195 (7) -- 188
------- ------- ------- ------- ------- ------- ------- -------
Total interest expense .............. 573 14 1 588 265 (75) (1) 189
------- ------- ------- ------- ------- ------- ------- -------
Increase (decrease) in net interest income $ (55) $ 85 $ (4) $ 26 $ 239 $ (143) $ (1) $ 95
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
Provisions for Loan Losses
The provision for loan losses is charged to earnings to maintain the
total allowance for loan losses at a level considered adequate to cover loan
losses based on existing loan levels and types of loans outstanding,
nonperforming loans, prior loan loss experience, industry standards, and general
economic conditions. Provisions for loan losses totaled $96,000 in 1998 compared
to $658,000 in 1997, and $96,000 in 1996. The unusually high provision in 1997
resulted primarily from the reprovision of the allowance for loan losses after
charge offs of approximately $510,000 of loans to a single borrower in December
of 1996. The Company received approximately $63,000 and $45,000 of recoveries
from this single borrower during the years ended June 30, 1998 and 1997,
respectively. In both 1998 and 1996, the provision for loan losses was recorded
based primarily on loan portfolio growth.
<PAGE>
Other Income
Other income increased to $606,000 in 1998 compared to $225,000 in 1997
and $255,000 in 1996. In 1998 other income included a gain on sale of real
estate owned and gains on sale of loans of $114,000 and $75,000, respectively,
that were not present in 1997 or 1996. Other income included gains realized on
the sale of investments and mortgage-backed securities of $6,000 in 1998 and
losses realized on the sale of investments and mortgage-backed securities of
$135,000 and $47,000 in 1997 and 1996, respectively. The net losses on the sale
of investments and mortgage-backed securities in 1997 were primarily
attributable to partial liquidation of invested conversion proceeds to
facilitate payment of the special dividend in December 1996. Net losses were
incurred in 1996 as management, in response to higher prevailing market interest
rates, restructured the Company's investment portfolio to achieve higher yields
in future periods. Other income also includes lower-of-cost-or-market
adjustments on loans held-for-sale. In 1998 and 1997, the Bank recognized
$36,000 and $4,000, respectively, in lower-of-cost-or-market recoveries
resulting from the falling interest rate environment during the two years. This
compares to $40,000 of lower-of-cost-or-market writedowns in 1996. Mortgage loan
servicing fees were $63,000, $87,000 and $96,000 in 1998, 1997, and 1996,
respectively. The decline in mortgage loan servicing fees is attributable to a
decline in the Company's average loan servicing portfolio during this time.
Other income was positively affected by the growth in customer service and other
fees of $6,000 or 3.0% to $207,000 in 1998, and $26,000 or 14.9% to $201,000 in
1997 from $175,000 in 1996. This increase is attributable to increases in the
volume of deposit accounts with the Bank and the implementation of a new
deposit-related fee schedule in July 1996. "Other" other income increased to
$105,000 in 1998 from $68,000 and $71,000 in 1997 and 1996, respectively. The
increase is primarily attributable to the Company's former branch facility being
leased for twelve months in 1998 compared to seven months in 1997.
6
<PAGE>
Other Expenses
Other expenses totaled $2,963,000 in 1998 compared to $4,716,000 and
$2,449,000 in 1997 and 1996, respectively. Two large non-recurring expenses that
occurred in the first and second quarters of fiscal year 1997 were the primary
reason for the significant increase in other expenses from 1996 to 1997. First,
in 1997, the Company recorded $1,702,000 of compensation expense related to the
Company's employee stock ownership plan ("ESOP"), primarily associated with the
release and allocation of approximately 126,000 shares of common stock of the
Parent to participants of the ESOP during the second quarter of 1997. The
special dividend paid on the Parent's stock on December 6, 1996 and management's
decision to use the special dividends paid on the unallocated shares of the
Parent's common stock held by the ESOP to pre-pay the ESOP loan from the Parent
to the ESOP resulted in a significant portion of that share release,
approximately 103,000 shares. As a result, approximately $1,428,000 of the
ESOP-related compensation expense was deemed to be non-recurring in nature.
The second non-recurring other expense in 1997 was the $487,000
one-time FDIC special assessment for the recapitalization of the SAIF. The
assessment was levied on all depository institutions with SAIF-insured deposits
and amounted to 65.7 basis points on assessable deposits as of March 31, 1995.
The Company's quarterly FDIC premiums have decreased since the recapitalization
of the SAIF.
Without the effect of the non-recurring SAIF assessment and the
non-recurring portion of ESOP-related compensation expense, other expenses would
have totaled $2,801,000 in 1997, a $352,000 increase from 1996. Compensation and
fringe benefits, excluding non-recurring items, increased by $371,000 to
$1,724,000 in 1997 compared to $1,353,000 in 1996, primarily related to the ESOP
and the Company's management recognition plan ("MRP"). The ESOP, which was
established in conjunction with the Conversion in the middle of the prior fiscal
year, provides a potentially higher level of retirement benefits to employees
than the previous retirement plan. The recurring portion of ESOP-related
compensation expense for 1997 totaled $274,000 compared to $179,000 recorded for
1996. Also contributing to the increase in compensation expense was $237,000 of
amortization of deferred compensation associated with the MRP implemented August
29, 1996.
Professional fees increased to $185,000 in 1998 from $129,000 in 1997.
The increase is primarily attributable to fees paid for assistance in developing
a strategic plan and branch feasibility studies for the Company in 1998.
Other "other" expenses increased $121,000 to $529,000 in 1998 from
$408,000 in 1997 due to increases in marketing expenses, employee education
associated with the conversion to a new data center, and office supplies and
forms. These increased expenses are mitigated by a $18,000 decrease in
FDIC-insurance premiums to $53,000 for 1998 from $71,000 for 1997. Deposit
insurance premiums decreased starting with the quarter ended December 31, 1996.
The reduced level of FDIC-insurance premiums is anticipated to continue into the
future.
Income Tax Expense
The Company recorded income tax expense of $930,000 in 1998, compared
to $317,000 in 1997 and $849,000 in 1996. The 1997 tax expense reflects the
pre-tax loss and the fact that a significant portion of the ESOP-related
compensation expense is not tax-deductible.
7
<PAGE>
ANALYSIS OF FINANCIAL CONDITION
Total assets increased 6.3% to $130.5 million at June 30, 1998 compared
to $122.8 million at June 30, 1997. The primary contributor to the growth was an
increase of 6.3% in net loans receivable to $106.5 million at June 30, 1998 from
$100.2 million at June 30, 1997. Funding the majority of the loan growth was (1)
a $5.0 million or 5.9% increase in deposits from June 30, 1997 to June 30, 1998
and (2) a $1.5 million or 9.1% increase in advances from the Federal Home Loan
Bank during the same period.
Loans
The Company's primary source of revenue is interest and fee income from
lending activities, consisting primarily of one-to-four family residential
mortgage loans located in its primary market area. The Company also makes loans
secured by improved nonresidential real estate, construction loans, loans
secured by undeveloped real estate, home equity loans, and consumer loans, both
secured and unsecured.
At June 30, 1998, the loan portfolio totaled $106.5 million and
represented 81.6% of total assets. As mentioned above, during 1998 loans
increased by $6.3 million or 6.3% . Loan originations increased to $50.0 million
in 1998 from $33.2 million in 1997, largely in response to the Company's
continued efforts to expand its loan programs into adjacent counties through
increased marketing. As presented in Table 3, the relative composition of the
loan portfolio continued to change in 1998 from prior years. One-to-four family
loans increased as a percentage of the portfolio in the current year to 84.67%
from 77.48% in 1997 and 73.58% in 1996. All other loan types decreased as a
percentage of the portfolio from 1997 to 1998. The shift in the loan mix towards
one-to-four family loans is attributable to the growth in the Hillsborough and
surrounding market areas. Table 3 sets forth the composition of the loan
portfolio at the dates indicated.
<PAGE>
TABLE 3
TYPES OF LOANS
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------- ------------------- ------------------ --------------- ---------------
Real estate loans: (dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential 1-4 family $ 90,175 84.67% $ 77,621 77.48% $ 67,095 73.58% $ 62,379 73.63% $ 59,842 73.22%
Nonresidential real estate 6,795 6.38 6,649 6.64 8,818 9.67 8,623 10.18 7,574 9.27
Home equity and other
second mortgage 10,588 9.94 10,997 10.98 11,616 12.74 11,916 14.07 12,027 14.71
Construction 7,552 7.09 9,638 9.62 5,026 5.51 1,805 2.13 2,769 3.39
--------- ----- --------- ----- -------- ----- -------- ----- -------- -----
Total real estate loans 115,110 108.08 104,905 104.72 92,555 101.50 84,723 100.01 82,212 100.59
Other installment loans 850 0.80 1,061 1.06 1,719 1.89 1,635 1.93 1,635 2.00
Less:
Unearned fees and discounts 412 0.39 348 0.35 281 0.31 185 0.22 268 0.33
Loans in process 8,097 7.60 4,649 4.64 2,198 2.41 945 1.11 1,442 1.76
Allowance for loan losses 951 0.89 796 0.79 608 0.67 515 0.61 404 0.50
--------- ----- --------- ----- -------- ----- -------- ----- -------- -----
Total reductions 9,460 8.88 5,793 5.78 3,087 3.39 1,645 1.94 2,114 2.59
--------- -------- -------- ------ -------- ----- -------- ----- -------- -----
Total loans, net $ 106,500 100.00 $100,173 100.00 $ 91,187 100.00 $ 84,713 100.00 $ 81,733 100.00
========= ======= ======== ====== ======== ====== ======== ====== ====== ======
</TABLE>
In order to protect the Company's net interest margin, management has,
as part of its interest rate risk management program, placed an emphasis on
maintaining adjustable rate mortgage loans and home equity lines of credit in
its portfolio. This strategy has resulted in more consistent net interest income
and lower net interest income sensitivity than experienced by most traditional
fixed-rate residential mortgage lenders. In 1998 the Company sold approximately
$10.0 million in fixed rate mortgage loans in the secondary market. In 1997 and
1996, the Company did not sell any of its mortgage loan production into the
secondary market as sufficient liquidity and interest rate protection was
provided through the investment of conversion proceeds in shorter term
investments. In the future the Company expects to sell selected current loan
production to both provide for sufficient liquidity and protection of the net
interest margin.
8
<PAGE>
The following table sets forth the time to contractual maturity of the
Company's loan portfolio at June 30, 1998. All loans, fixed and floating, are
shown as due in the period of contractual maturity. Demand loans, loans having
no stated maturity and overdrafts are reported as due in one year or less. The
table does not include prepayments or scheduled principal repayments. Amounts in
the table are net of loans in process and are net of unamortized loan fees.
<TABLE>
<CAPTION>
TABLE 4
LOAN MATURITIES
June 30, 1998
--------------------------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or Less 3 Years 5 Years 10 Years Years Total
--------- ---------- --------- --------- --------- ---------
Real estate loans: (dollars in thousands)
Residential 1-4 family
<S> <C> <C> <C> <C> <C> <C>
Fixed ..................... $ 12 $ 97 $ 264 $ 3,097 $ 51,287 $ 54,757
Floating .................. 100 161 547 4,106 26,950 31,864
Nonresidential real estate
Fixed ..................... 1 -- 14 423 1,215 1,653
Floating .................. 200 249 735 1,944 2,274 5,402
Home equity and other second
mortgage
Fixed ..................... 59 6 -- -- -- 65
Floating .................. 89 577 2,858 6,302 11 9,837
Construction
Fixed ..................... -- -- -- -- -- --
Floating .................. 1,958 -- 286 -- 773 3,017
--------- --------- --------- --------- --------- ---------
Total real estate loans 2,419 1,090 4,704 15,872 82,510 106,595
Other installment loans:
Fixed ..................... 219 346 169 53 69 856
Floating .................. -- -- -- -- -- --
Less:
Allowance for loan losses .... (951) -- -- -- -- (951)
--------- --------- --------- --------- --------- ---------
Total loans, net ........ $ 1,687 $ 1,436 $ 4,873 $ 15,925 $ 82,579 $ 106,500
========= ========= ========= ========= ========= =========
</TABLE>
9
<PAGE>
Asset Quality and Allowance for Loan Losses
The following table sets forth information with respect to
nonperforming assets, including nonaccrual loans and real estate owned, and risk
assets at the dates indicated.
TABLE 5
SUMMARY OF NONPERFORMING AND RISK ASSETS
<TABLE>
<CAPTION>
June 30,
----------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total nonaccrual loans $ 928 $ 803 $ 758 $ 30 $ 139
Total restructured loans -- -- -- -- --
-------- -------- -------- -------- --------
Total nonperforming loans 928 803 758 30 139
-------- -------- -------- -------- --------
Real estate owned -- -- -- -- 161
-------- -------- -------- -------- --------
Total nonperforming assets $ 928 $ 803 $ 758 $ 30 $ 300
Accruing loans, delinquent 90 days or more -- 244 301 571 41
-------- -------- -------- -------- --------
Total risk assets $ 928 $ 1,047 $ 1,059 $ 601 $ 341
======== ======== ======== ======== ========
Nonperforming loans to total loans, net 0.87% 0.80% 0.83% 0.04% 0.17%
Nonperforming assets to total assets
0.71 0.65 0.59 0.03 0.31
Risk assets to total assets
0.71 0.85 0.82 0.58 0.35
Allowance for loan losses to:
Total nonperforming assets 1.02x 0.99x 0.80x 17.17x 1.35x
Total risk assets 1.02x 0.76x 0.57x 0.86x 1.18x
Total assets $130,541 $122,761 $128,711 $104,013 $ 97,368
Total loans, net 106,500 100,173 91,187 84,713 81,733
Allowance for loan losses 951 796 608 515 404
</TABLE>
Nonperforming assets increased to $928,000 at June 30, 1998 compared to
$803,000 and $758,000 at June 30, 1997 and 1996, respectively. Nonperforming and
risk assets at June 30, 1998 are primarily composed of small loans secured by
residential real estate totaling $858,000. The remainder of nonperforming and
risk assets are composed of smaller installment and line of credit loans. At
June 30, 1997, nonperforming assets are comprised of one large credit totaling
$461,000 secured by commercial real estate and several smaller credits secured
by residential real estate where the borrowers have declared Chapter 13
bankruptcy. Management has reviewed the collateral for nonaccrual loans and
believes that collateral values related to the nonperforming loans exceed the
loan balances. Management has included this review among the factors considered
in the evaluation of the allowance for possible loan losses as discussed below.
<PAGE>
At June 30, 1998 and 1997, the recorded investment in loans that are
considered to be impaired under Statement of Financial Accounting Standards No.
114, "Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114") was
$118,000 and $119,000, respectively. There were no impaired loans in non-accrual
status at June 30, 1998 and 1997. There was no related allowance for credit
losses associated with these loans as determined in accordance with SFAS No.
114. The average recorded investment in impaired loans during the year ended
June 30, 1998 and 1997 was approximately $118,500 and $121,000. The Company
recognized interest income on the impaired loans of approximately $9,500 and
$9,700 during the year ended June 30, 1998 and 1997, respectively.
The allowance for loan losses represents management's estimate of an
amount adequate to provide for potential losses inherent in the loan portfolio.
The adequacy of the allowance for loan losses and the related provision are
based upon management's evaluation of the risk characteristics of the loan
portfolio under current economic conditions. Among the factors determining the
level of the allowance are loan growth, projected net charge offs, delinquency
trends, the financial condition of borrowers, collateral values, the amount of
nonperforming and past due loans, and current and anticipated economic
conditions. Management believes that the allowance for loan losses is adequate.
While management uses all available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in economic
conditions. Various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examination.
10
<PAGE>
The provision for loan losses is calculated and charged to earnings to
maintain the total allowance for loan losses at a level considered adequate to
cover potential loan losses based on an analysis of existing loan levels, types
of loans outstanding, nonperforming loans, prior loan loss experience, industry
standards and general economic conditions. Provisions for loan losses were
$96,000 in 1998, compared to $658,000 in 1997, and $96,000 in 1996. The
unusually high provision in 1997 resulted primarily from the charge off of
approximately $510,000 of loans to a single borrower in December 1996. No
further charge offs related to this borrower have occurred or are anticipated at
this time. The Company received approximately $63,000 and $45,000 of recoveries
from this single borrower during 1998 and 1997, respectively. In both 1998 and
1996, the provision for loan losses was recorded based primarily on loan
portfolio growth. At this time, management is unaware of any significant
potential problem loans except as noted above or any other concentrations of
credit risk which may exist in the portfolio.
The following tables describe the activity related to the allowance for
loan losses and the allocation of the allowance for loan losses to various
categories of loans for the periods indicated.
TABLE 6
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period 796 $ 608 $ 515 $ 404 $ 317
Provision for loan losses 96 658 96 120 87
Charge-offs (8) (519) (4) (14) (4)
Recoveries 67 49 1 5 4
----- ----- ----- ----- -----
Balance, end of period $ 951 $ 796 $ 608 $ 515 $ 404
===== ===== ===== ===== =====
Allowance as a percentage of loans 0.89% 0.79% 0.66% 0.60% 0.49%
</TABLE>
<PAGE>
TABLE 7
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Residential 1-4 family $533 $382 $256 $216 $170
Nonresidential real estate 124 233 170 155 121
Home equity and other second mortgage 142 83 97 82 65
Construction 95 54 36 16 12
---- ---- ---- ---- ----
Total real estate loans 894 752 559 469 368
Other installment loans 57 44 49 46 36
---- ---- ---- ---- ----
Total allowance for loan losses $951 $796 $608 $515 $404
</TABLE>
The allocation of the allowance for loan losses to the respective loan
classifications is not necessarily indicative of future losses or future
allocations. Refer to Table 3 for percentages of loans in each category to total
loans.
11
<PAGE>
Investment Securities
Interest and dividend income from investment securities generally
provides the second largest source of income to the Company after interest on
loans. The Company's portfolio of investment securities includes U.S. government
and agency securities, mortgage-backed securities, and obligations of states and
local governments. The mortgage-backed securities consist of mortgage-backed
securities issued by the Federal National Mortgage Association ("FNMA").
Investment securities increased $2.8 million to $17.0 million at June
30, 1998 from $14.2 million at June 30, 1997. This increase is attributable to
normal growth to meet the Company's liquidity and growth needs. Approximately
81% of the Company's investment portfolio is classified as available-for-sale in
order to provide flexibility to meet liquidity needs. Generally securities
issued by the state of North Carolina and local municipalities in North Carolina
are the only ones classified by the Company as held-to-maturity. At June 30,
1998, net unrealized gains of $126,000 were included in the carrying value of
securities classified available-for-sale compared to net unrealized losses of
$138,000 on such securities at June 30, 1997. These net unrealized gains and
losses are the result of fluctuations in market interest rates rather than
concerns about the issuers' ability to meet their obligations.
Table 8 shows maturities of investment securities held by the Company
at June 30, 1998 and the weighted average tax-equivalent yields for each type of
security and maturity. Additional information about the Company's investment
securities as of June 30, 1998 and 1997 is presented in Note 2 of the notes to
the consolidated financial statements.
TABLE 8
INVESTMENT SECURITIES - MATURITY/YIELD SCHEDULE
<TABLE>
<CAPTION>
More than More than
One year or Less 1 Year to 5 Years 5 years to 10 years Over 10 Years
------------------- -------------------- ------------------- ------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- -----
Available-for-sale: (dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government and agency $ 755 6.69% $ 2,756 6.44% $ 4,517 6.70% $ - -%
State and local government (1) - - - - - - 1,052 8.52
Mortgage-backed securities (2) - - 3,013 6.44 1,165 7.09 517 6.55
------ ---- ------- ---- ------- ---- ------- ----
Total available-for-sale $ 755 6.69 $ 5,769 6.44 $ 5,682 6.78 $ 1,569 7.86
------ ---- ------- ---- ------- ---- ------- ----
Held-to-maturity:
U.S. government and agency $ - - % $ - -% $ - - % $ - -%
State and local government (3) 76 5.53 1,773 6.58 709 7.88 692 7.78
Mortgage-backed securities - - - - - - -
- - - - - - - -
------ ---- ------- ---- ------- ---- ------- ----
Total held-to-maturity $ 76 5.53 $ 1,773 6.58 $ 709 7.88 $ 692 7.78
------ ---- ------- ---- ------- ---- ------- ----
Total investments,
at carrying value $ 831 $ 7,542 $ 6,391 $ 2,261
====== ======= ======= =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Total
------------------
Weighted
Carrying Average
Value Yield
--------- -----
<S> <C> <C>
Available-for-sale:
U.S. government and agency $ 8,028 6.61%
State and local government (1) 1,052 8.52
Mortgage-backed securities (2) 4,695 6.61
-------- ----
Total available-for-sale $ 13,775 6.75
-------- ----
Held-to-maturity:
U.S. government and agency $ - -%
State and local government (3) 3,250 7.10
Mortgage-backed securities - -
-------- ----
Total held-to-maturity $ 3,250 7.10
-------- ----
Total investments,
at carrying value $ 17,025
========
</TABLE>
(1) Yields are stated on a taxable equivalent basis assuming statutory tax
rates of 34% for federal and 7.50% for state purposes. Book yields without
regard to tax-equivalent adjustments are: over ten years, 5.63%; total
5.63%.
(2) Mortgage-backed securities are shown at their weighted average expected
life obtained from an outside evaluation of the average remaining life of
each security based on historic prepayment speeds of the underlying
mortgages at June 30, 1998.
(3) Yields are stated on a taxable equivalent basis assuming statutory tax
rates of 34% for federal and 7.50% for state purposes. Book yields without
regard to tax- equivalent adjustments are: one year or less, 3.65%; one to
five years, 4.79%; six to ten years, 5.20%, over ten years, 5.13%; total,
4.92%.
In addition to the investment securities discussed above, the Company
also earns interest on its correspondent bank account at the Federal Home Loan
Bank ("FHLB") of Atlanta and dividends on its FHLB stock. The Bank is required
to maintain, as a condition of membership, an investment in stock of the FHLB of
Atlanta equal to the greater of 1% of its outstanding home loan balances or 5%
of its outstanding advances. No ready market exists for such stock, which is
carried at cost. As of June 30, 1998, the Company's investment in stock of the
FHLB of Atlanta was $1,152,000.
12
<PAGE>
Funding Sources
Deposits are the primary source of the Company's funds for lending and
other investment purposes. The Company attracts both short-term and long-term
deposits from the general public by offering a variety of accounts and rates
including savings accounts, NOW accounts, money market accounts, and fixed
interest rate certificates with varying maturities. General interest rates,
economic conditions, and competitive market conditions significantly influence
deposit inflows and outflows. As competition for deposits has increased both
from larger financial institutions in the Company's local market place and from
mutual funds and other investments, borrowings have provided an additional
source of funding. Borrowed funds provide liquidity and assist the Company in
matching interest rates on its assets and liabilities as interest rates on most
borrowed funds are fixed and therefore more predictable than the rates on
deposits, which are subject to change based upon market conditions and other
factors.
Deposits
Deposits totaled $89.8 million at June 30, 1998 compared to $84.9
million at June 30, 1997, and $73.4 million at June 30, 1996. The following
table sets forth certain information regarding the Company's average savings
deposits for the last three years.
TABLE 9
AVERAGE DEPOSITS
<TABLE>
<CAPTION>
1998 1997 1996
---------------------- ---------------------- ---------------------
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing checking accounts $ 6,930 1.04% $ 6,011 1.48% $ 6,412 1.84%
Savings and money market deposits 23,610 3.68 20,050 3.36 18,980 3.22
Certificates of deposit 53,817 5.67 50,758 5.62 49,973 5.78
---------- ---- --------- ---- -------- ----
Total interest-bearing deposits 84,357 4.73 76,819 4.71 75,365 4.80
Non-interest-bearing deposits 2,291 - 1,901 - 1,856 -
---------- ---- --------- ---- -------- ----
Total deposits $ 86,648 4.61 $ 78,720 4.59 $ 77,221 4.68
---------- ---- --------- ---- -------- ----
</TABLE>
As of June 30, 1998, the Company held $9,556,000 in time certificates
of deposit of $100,000 or more. Maturities of certificates of deposits of
$100,000 or more at June 30, 1998 were as follows: three months or less,
$1,663,000; over three months through six months, $3,976,000; over six months
through twelve months, $1,925,000; over twelve months through twenty-four
months, $1,655,000; and over twenty-four months, $337,000.
<PAGE>
Borrowings
The Company's principal source of long-term borrowings are advances
from the FHLB of Atlanta. As a requirement for membership, the Bank is required
to own capital stock in the FHLB of Atlanta and is authorized to apply for
advances on the security of that stock and a floating lien on its 1-4 family
residential mortgage loans. Each credit program has its own interest rate and
range of maturities. At June 30, 1998, FHLB of Atlanta advances totaled $18.0
million compared to $16.5 million at June 30, 1997. Additional information on
borrowings is provided in Note 6 of the notes to the consolidated financial
statements.
Liquidity and Interest Rate Risk Management
Liquidity is the ability to raise funds or convert assets to cash in
order to meet customer and operating needs. The Company's primary sources of
liquidity are its portfolio of investment securities available-for-sale,
principal and interest payments on loans and mortgage-backed securities,
interest income from investment securities, maturities of investment securities
held-to-maturity, increases in deposits, and advances from the FHLB of Atlanta.
At June 30, 1998, the Bank had $12,000,000 of credit available from the FHLB of
Atlanta that would be collateralized by a blanket lien on qualifying loans
secured by first mortgages on 1-4 family residences. Additional amounts may be
made available under this blanket floating lien or by using investment
securities as collateral. Management believes that it will have sufficient funds
available to meet its anticipated future loan commitments as well as other
liquidity needs.
13
<PAGE>
Interest rate risk is the sensitivity of interest income and interest
expense to changes in interest rates. Management has structured its assets and
liabilities in an attempt to protect net interest income from large fluctuations
associated with changes in interest rates. Table 10 shows the amount of
interest-earning assets and interest-bearing liabilities outstanding at June 30,
1998 which are projected to reprice or mature in each of the future time periods
shown. At June 30, 1998, the Company had a cumulative one year
liability-sensitive gap position of $9.0 million or 7.09% of interest-earning
assets. This generally indicates that net interest income would experience
downward pressure in a rising rate environment and would increase in a declining
rate environment, as interest-sensitive liabilities would generally reprice
faster than interest-sensitive assets.
It should be noted that this table reflects the interest-sensitivity of
the balance sheet as of a specific date and is not necessarily indicative of
future results. Because of this and other limitations, management also monitors
interest rate sensitivity through the use of a model which estimates the change
in net portfolio value and net interest income in response to a range of assumed
changes in market interest rates. Based on interest sensitivity measures as of
June 30, 1998, management believes that its interest rate risk is at an
acceptable level.
<PAGE>
TABLE 10
INTEREST SENSITIVITY
<TABLE>
<CAPTION>
June 30, 1998
---------------------------------------------------------------------------------
More than More than
3 Months 4 to 12 1 Year to 3 Years to Over
Or Less Months 3 Years 5 Years 5 Years Total
-------- -------- -------- -------- -------- --------
Interest-earning assets: (dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Loans receivable $ 16,087 $ 29,666 $ 28,378 $ 12,456 $ 20,864 $107,451
Interest-bearing deposits 1,821 -- -- -- -- 1,821
Investment securities (1) 402 3,435 1,559 1,795 9,834 17,025
FHLB common stock -- --
-- -- -- -- 1,152 1,152
-------- -------- -------- -------- -------- --------
Total interest-earning assets $ 18,310 $ 33,101 $ 29,937 $ 14,251 $ 31,850 $127,449
======== ======== ======== ======== ======== ========
Interest-bearing liabilities
Deposits:
Fixed maturity deposits $ 9,445 $ 32,634 $ 10,885 $ 1,232 $ -- $ 54,196
Savings and money market accounts 4,058 10,312 10,312 4,058 4,060 32,800
-------- -------- -------- -------- -------- --------
Total deposits 13,503 42,946 21,197 5,290 4,060 86,996
FHLB advances 2,000 2,000 1,000 1,000 12,000 18,000
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities $ 15,503 $ 44,946 $ 22,197 $ 6,290 $ 16,060 $104,996
======== ======== ======== ======== ======== ========
Interest sensitivity gap per period $ 2,807 $(11,845) $ 7,740 $ 7,961 $ 15,790 $ 22,453
Cumulative interest sensitivity gap 2,807 (9,038) (1,298) 6,663 22,453 22,453
Cumulative gap as a percentage of
total interest-earning assets 2.20% (7.09)% (1.02)% 5.23% 17.62% 17.62%
Cumulative interest-earning assets as a
percentage of interest-bearing liabilities 118.11% 85.05% 98.43% 111.19% 121.38% 121.38%
</TABLE>
(1) Includes investment and mortgage-backed securities
This table was prepared using the assumptions regarding loan prepayment rates,
loan repricing and deposit decay rates which are used by the Company in making
its gap computations. These assumptions should not be regarded as indicative of
the actual prepayments and withdrawals that may be experienced by the Company.
However, management believes that these assumptions approximate actual
experience.
14
<PAGE>
Market Risk
Market risk reflects the risk of economic loss resulting from adverse
changes in market price and interest rates. This risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods.
The Company's market risk arises primarily from interest rate risk
inherent in its lending and deposit-taking activities. The structure of the
Company's loan and deposit portfolios is such that a significant decline in
interest rates may adversely impact net market values and net interest income.
The Company does not maintain a trading account nor is the Company subject to
currency exchange risk or commodity price risk. Interest rate risk is monitored
as part of the Company's asset/liability management function, which is discussed
in "Liquidity and Interest Rate Risk Management" above.
Table 11 presents information about the contractual maturities, average
interest rates and estimated fair values of financial instruments considered
market risk sensitive at June 30, 1998.
TABLE 11
MARKET RISK ANALYSIS OF FINANCIAL INSRUMENTS
<TABLE>
<CAPTION>
Contractual Maturities at June 30, 1998
-------------------------------------------------------------------
Beyond Average Estimated
Five Interest Fair
1999 2000 2001 2002 2003 Years Total Rate Value
-------- -------- -------- -------- -------- -------- -------- ---- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Financial Assets
Debt securities (2) $ 828 $ 815 $ 306 $ 616 $ 5,808 $ 8,652 $ 17,025 6.90% $ 17,106
Loans (3):
Fixed rate 213 196 389 262 332 52,221 53,613 8.28 55,713
Variable rate 2,299 237 613 1,425 3,156 46,520 54,250 8.70 51,270
-------- -------- -------- -------- -------- -------- -------- ---- --------
Total $ 3,340 $ 1,248 $ 1,308 $ 2,303 $ 9,296 $107,393 $124,888 8.27 $124,089
======== ======== ======== ======== ======== ======== ======== ==== ========
Financial Liabilities
Savings, NOW and MMDA $ 32,800 $ -- $ -- $ -- $ -- $ -- $ 32,800 3.18 $ 31,734
Fixed rate certificates 42,107 9,719 1,139 1,231 -- -- 54,196 5.67 54,570
of deposit
Advances from the Federal
Home Loan Bank 5,000 2,000 -- 1,000 9,000 1,000 18,000 5.96 17,940
-------- -------- -------- -------- -------- -------- -------- ---- --------
Total $ 79,907 $ 11,719 $ 1,139 $ 2,231 $ 9,000 $ 1,000 $104,996 4.97 $104,244
======== ======== ======== ======== ======== ======== ======== ==== ========
</TABLE>
(1) The average interest rate related to debt securities is stated on a fully
taxable basis, assuming a 34% federal income tax rate and applicable
state income tax rate, reduced by the nondeductible portion of interest
expense.
(2) Debt securities are reported on the basis of amortized cost.
(3) Nonaccrual loans are included in the balance of loans. The allowance
for loan loss and unearned fees and discounts are excluded.
15
<PAGE>
Capital Resources
Stockholders' equity increased from $20,416,000 at June 30, 1997 to
$21,606,000 at June 30, 1998.
As a state savings bank holding company, the Parent is regulated by the
Board of Governors of the Federal Reserve Board ("FRB") and is subject to
securities registration and public reporting regulations of the Securities and
Exchange Commission. The Bank is regulated by the FDIC and the Savings
Institutions Division, North Carolina Department of Commerce ("the
Administrator").
The Bank must comply with the capital requirements of the FDIC and the
Administrator. The FDIC requires the Bank to maintain minimum ratios of Tier I
capital to total risk-weighted assets and total capital to risk-weighted assets
of 4% and 8%, respectively. To be "well-capitalized", the FDIC requires ratios
of Tier I capital to total risk-weighted assets and total capital to
risk-weighted assets of 6% and 10%, respectively. Tier I capital consists of
total stockholders' equity calculated in accordance with generally accepted
accounting principles less intangible assets, and total capital is comprised of
Tier I capital plus certain adjustments, the only one of which applicable to the
Bank is the allowance for loan losses. Risk-weighted assets reflect the Bank's
on- and off-balance sheet exposures after such exposures have been adjusted for
their relative risk levels using formulas set forth in FDIC regulations. The
Bank is also subject to a leverage capital requirement, which calls for a
minimum ratio of Tier I capital (as defined above) to quarterly average total
assets of 3% and a ratio of 5% to be "well-capitalized". The Administrator
requires a net worth equal to at least 5% of assets.
At June 30, 1998 and 1997, the Bank was in compliance with all of the
aforementioned capital requirements of both the FDIC and the Administrator and
is deemed to be "well-capitalized". Refer to note 8 to the consolidated
financial statements for additional discussion of the Bank's capital resources.
Impact of Inflation and Changing Prices
The consolidated financial statements and accompanying footnotes 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 consideration of changes in the relative purchasing
power of money over time due to inflation. The assets and liabilities of the
Company are primarily monetary in nature, and changes in interest rates have a
greater impact on the Company's performance than do the effects of inflation.
Regulatory Matters
Management is not presently aware of any current recommendation to the
Company by regulatory authorities, which, if they were implemented, would have a
material effect on the Company's liquidity, capital resources, or operations.
<PAGE>
Year 2000 Issue
The Company recognizes and is addressing the potentially severe
implications of the "Year 2000 Issue." The "Year 2000 Issue" is a general term
used to describe the various problems that may result from the improper
processing of dates and date-sensitive calculations as the Year 2000 approaches.
This issue is caused by the fact that many of the world's existing computer
programs use only two digits to identify the year in the date field of a
program. These programs were designed and developed without considering the
impact of the upcoming change in the century and could experience serious
malfunctions when the last two digits of the year change to "00" as a result of
identifying a year designated "00" as the year 1900 rather than the Year 2000.
This misidentification could prevent the Company from being able to engage in
normal business operations, including, among other things, miscalculating
interest accruals and the inability to process customer transactions. Because of
the potentially serious ramifications of the Year 2000 Issue, the Company is
taking the Year 2000 Issue very seriously. The Company formed a Year 2000
Committee, which is comprised of a cross-section of the Company's employees, in
November of 1997. This Committee is leading the Company's Year 2000 efforts to
ensure that the Company is properly prepared for the Year 2000. The Company's
Board of Directors has approved a plan submitted by the Year 2000 Committee that
was developed in accordance with guidelines set forth by the Federal Financial
Institutions Examination Council. This plan, which is described in further
detail on the following page, has five primary phases related to internal Year
2000 compliance:
16
<PAGE>
1. Awareness - this phase is ongoing and is designed to inform the Company's
Board of Directors (the "Board") and Executive management ("Management"),
employees, customers and vendors of the impact of the Year 2000 Issue. The
awareness phase is an ongoing one that is designed to provide ongoing
information about the Year 2000 issue to the Board of Directors,
Management, employees and customers. Since December of 1997 the Board has
been apprised of the Company's efforts at their regular meetings. In
addition, all customers were updated with respect to the Company's Year
2000 efforts through a mailing sent in June of 1998.
2. Assessment - during this phase an inventory was conducted of all known
Company processes that could reasonably be expected to be impacted by the
Year 2000 Issue and their related vendors, if applicable. This inventory of
processes and vendors included not only typical computer processes such as
the Company's transaction applications systems, but all known processes
that could be impacted by micro-chip malfunctions. These include but are
not limited to the Company's alarm system, phone system, check ordering
process, and ATM network. The Company inventoried all the systems listed
above in December of 1997 and performed an initial assessment of potential
risks from either under or nonperformance arising from incorrect processing
and usage of dates after December 31, 1999. At this time the Company had
already made the decision to convert in February of 1998 to a new computer
service provider for processing all loan, deposit and general ledger
transactions. In conjunction with the conversion, the Company purchased and
installed new computers, printers and related software in January of 1998.
New hardware and software for a local area network was also purchased and
installed in January of 1998. The total cost of the hardware and software
purchased by the Company in fiscal 1998 totaled $296,000 and was
capitalized. Most of the hardware and software purchased by the Company
either is Year 2000 compliant or will be with minor modifications or
upgrades. The assessment phase is complete, although it is updated
periodically as necessary.
3. Renovation and/or replacement - this phase includes programming code
enhancements, hardware and software upgrades, system replacements, vendor
certification and any other changes necessary to make any hardware,
software and other equipment Year 2000 compliant. The Company does not
perform in-house programming, and thus is dependent on external vendors to
ensure and modify, if needed, the hardware, software or other services it
provides to the Company for Year 2000 compliance. As a result of the
assessment performed above, the Company contacted all third party vendors,
requested documentation regarding their Year 2000 compliance efforts, and
analyzed their responses. The responses from third party vendors generally
include an overview of renovation efforts to their systems that the Company
utilizes. In addition, some third party software vendors have notified the
Company that upgrades of their software will be necessary to ensure
reliable and accurate Year 2000 processing. One third party computer vendor
(the "primary service provider") processes, either directly, or indirectly
through other computer vendors, all loan, deposit and general ledger
transactions. The primary service provider has notified the Company that
the renovation and replacement of their systems is complete and has been
tested for Year 2000 compliance.
<PAGE>
4. Testing - The next phase for the Company under the plan is to complete a
comprehensive testing of all known processes. As noted in the renovation
and/or replacement phase above, the Company's primary service provider has
already tested their system for Year 2000 compliance. The next step, which
is scheduled for the first and second quarters of fiscal 1999, is to test
the Company's network and core service provider software applications and
hardware. The Company has performed Year 2000 testing of all employee
computer work stations, and all but one are Year 2000 compliant. The
testing of the remainder of the Company's processes is expected to be
substantially complete by the end of the second quarter of fiscal 1999.
5. Implementation - this phase will occur when Year 2000 processing commences.
On some applications the Company is already entering dates greater than
December 31, 1999 into their systems. In these situations no adverse events
have been noted. The significant part of the implementation phase will
occur after December 31, 1999. The Company is in the process of developing
contingency plans for processes that do not process information reliably
and accurately after December 31, 1999. The contingency plans for all
systems should be substantially complete by the end of the second quarter
of fiscal 1999.
The Company is also in the process of assessing the year 2000 readiness
of significant borrowers and depositors. In the second quarter of 1999 the
Company plans on making a list of significant borrowers and depositors.
Customers who the Company has Year 2000 concerns about will be counseled on the
Year 2000 issue and urged to take corrective action. Since the majority of the
Company's loans are to individuals and secured by one to four family residences
this step is not expected to require a significant amount of time or resources.
17
<PAGE>
Excluding the hardware and software purchases noted above, the Company
expensed $2,000 on Year 2000 costs in fiscal 1998. Based on an analysis of
projected expenses performed in the last quarter of fiscal 1998, the total cost
of the Year 2000 project is currently estimated at $50,000. Funding of the Year
2000 project costs will come from normal operating cash flow, however the
expenses associated with the Year 2000 Issue will directly reduce otherwise
reported net income for the Company.
Management of the Company believes that the potential effects on the
Company's internal operations of the Year 2000 Issue can and will be addressed
prior to the Year 2000. However, if required modifications or conversions are
not made or are not completed on a timely basis prior to the Year 2000, the Year
2000 Issue could disrupt normal business operations. The most reasonably likely
worst case Year 2000 scenarios foreseeable at this time would include the
Company temporarily not being able to process, in some combination, various
types of customer transactions. This could affect the ability of the Company to,
among other things, originate new loans, post loan payments, accept deposits or
allow immediate withdrawals, and, depending on the amount of time such a
scenario lasted, could have a material adverse effect on the Company. Because of
the serious implications of these scenarios, the primary emphasis of the
Company's Year 2000 efforts is to correct, with complete replacement if
necessary, any systems or processes whose Year 2000 test results are not
satisfactory prior to the Year 2000. Nevertheless, should one of the most
reasonably likely worst case scenarios occur in the Year 2000, the Company, as
noted above, is in the process of formalizing a contingency plan that would
allow for limited transactions, including the ability to make certain deposit
withdrawals, until the Year 2000 problems are fixed. The costs of the Year 2000
project and the date on which the Company plans to complete Year 2000 compliance
are based on management's best estimates, which were derived using numerous
assumptions of future events such as the availability of certain resources
(including internal and external resources), third party vendor plans and other
factors. However, there can be no guarantee that these estimates will be
achieved at the cost disclosed or within the timeframe indicated, and actual
results could differ materially from these plans. Factors that might affect the
timely and efficient completion of the Company's Year 2000 project include, but
are not limited to, vendors' abilities to adequately correct or convert software
and the effect on the Company's ability to test its systems, the availability
and cost of personnel trained in the Year 2000 area, the ability to identify and
correct all relevant computer programs and similar uncertainties.
Accounting Issues
The Company prepares its consolidated financial statements and related
disclosures in conformity with standards established by, among others, the
Financial Accounting Standards Board (the "FASB"). Because the information
needed by users of financial reports is dynamic, the FASB frequently has new
rules and proposed new rules for companies to apply in reporting their
activities. The following discussion addresses such changes as of June 30, 1998
that will affect the Company's future reporting.
<PAGE>
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 128 ("SFAS 128"), "Earnings per Share". SFAS 128 establishes
standards of computing and presenting earnings per share (EPS) and applies to
entities with publicly held common stock or potential common stock. This
statement simplifies the standards for computing earnings per share previously
found in APB Opinion No. 15, "Earnings per Share", and makes them comparable to
international EPS standards. It replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic and
diluted EPS on the face of the income statement for all entities with complex
capital structures and requires a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. SFAS 128 is effective for financial statements issued
for periods ending after December 15, 1997 and requires restatement of all prior
period EPS data presented. The Company adopted SFAS 128 in fiscal year and made
the required disclosures.
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 129 ("SFAS 129"), "Disclosure of Information about Capital
Structure". SFAS 129 establishes standards for disclosing information about an
entity's capital structure and is applicable to all entities. It contains no
change in disclosure requirements for entities that were previously subject to
the requirements of APB Opinion No. 10, "Omnibus Opinion - 1966", APB Opinion
No. 15, "Earnings Per Share", and Statement of Financial Accounting Standards
No. 47, "Disclosure of Long-Term Obligations". SFAS 129 is effective for
financial statements for periods ending after December 15, 1997. The Company
adopted SFAS 129 in fiscal year 1998 without any impact on its consolidated
financial statements.
18
<PAGE>
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income". SFAS 130
establishes standards for reporting and displaying comprehensive income and its
components (revenues, expenses, gains, and losses) in a full set of
general-purpose financial statements. This Statement requires that an enterprise
(a) classify items of other comprehensive income by their nature in the
financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional
paid-in-capital in the equity section of a statement of financial position. SFAS
130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. The Company plans to adopt the SFAS 130 in
fiscal year 1999 and has not determined the impact on its consolidated financial
statements.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and
Related Information". SFAS 131 establishes standards for the way that public
businesses report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. This Statement is effective for financial
statements for periods beginning after December 15, 1997 and in the initial year
of application, comparative information for earlier years is to be restated. The
Company plans to adopt SFAS 131 in fiscal year 1999 without any significant
impact on its consolidated financial statements as it operates as one segment.
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132 ("SFAS 132"), "Employers Disclosures about Pensions and Other
Postretirement Benefits". This statement standardizes the disclosure
requirements of pensions and other postretirement benefits. This statement does
not change any measurement or recognition provisions, and thus will not
materially impact the Company. This statement is effective for fiscal years
beginning after December 15, 1997. The Company plans to adopt SFAS 132 in fiscal
year 1999 without any significant impact on its consolidated financial
statements.
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and
Hedging Activities". SFAS No. 133 establishes accounting and reporting standards
for derivative instruments and for hedging activities. SFAS No. 133 is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. The
Company plans to adopt SFAS 133 in fiscal year 2000 without any impact on its
consolidated financial statements as the Company does not have any derivative
financial instruments and is not involved in any hedging activities.
Forward Looking Statements
The foregoing discussion may contain statements that could be deemed
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act, which
statements are inherently subject to risks and uncertainties. Forward-looking
statements are statements that include projections, predictions, expectations or
beliefs about future events or results or otherwise are not statements of
<PAGE>
historical fact. Such statements are often characterized by the use of
qualifying words (and their derivatives) such as "expect," "believe,"
"estimate," "plan," "project," or other statements concerning opinions or
judgment of the Company and its management about future events. Factors that
could influence the accuracy of such forward-looking statements include, but are
not limited to, the financial success or changing strategies of the Company's
customers, actions of government regulators, the level of market interest rates,
and general economic conditions.
19
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Piedmont Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Piedmont Bancorp
Inc. and subsidiary as of June 30, 1998 and 1997, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the years
in the three-year period ended June 30, 1998. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Piedmont Bancorp,
Inc. and subsidiary as of June 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended June 30, 1998, in conformity with generally accepted accounting
principles.
/s/KPMG Peat Marwick LLP
------------------------
KPMG Peat Marwick LLP
Raleigh, North Carolina
July 21, 1998
20
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
June 30, 1998 and 1997
1998 1997
--------- ---------
(dollars in thousands)
<S> <C> <C>
ASSETS
Cash $ 823 $ 879
Interest-bearing deposits in other financial institutions 1,821 3,766
Investment securities (note 2):
Available-for-sale (cost: $13,649 in 1998 and
$11,004 in 1997) 13,775 10,866
Held-to-maturity (market value: $3,331 in 1998
and $3,395 in 1997) 3,250 3,341
Loans receivable (net of allowance for loan losses of
$951 in 1998 and $796 in 1997) (note 3) 106,500 100,173
Federal Home Loan Bank stock, at cost 1,152 920
Premises and equipment (note 4) 1,414 1,205
Prepaid expenses and other assets (note 9) 1,806 1,611
--------- ---------
Total assets $ 130,541 $ 122,761
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (note 5):
Demand, non-interest bearing 2,844 2,074
Savings, NOW and MMDA 32,800 28,594
Certificates of deposit 54,196 54,192
--------- ---------
84,840 84,860
Advances from the Federal Home Loan Bank (note 6) 18,000 16,500
Accrued expenses and other liabilities 1,095 985
--------- ---------
Total liabilities 108,935 102,345
--------- ---------
Stockholders' Equity (note 8):
Preferred stock, no par value, 5,000,000 shares authorized;
none issued -- --
Common stock, no par value, 20,000,000 shares authorized;
2,750,800 shares issued and outstanding as of June 30,
1998 and 1997 9,121 9,143
Unearned ESOP shares (679) (933)
Unamortized deferred compensation (953) (1,269)
Unallocated restricted stock (61) (21)
Retained earnings, substantially restricted (note 9) 14,101 13,580
Unrealized holding gains (losses) on available-for-sale securities, net 77 (84)
--------- ---------
Total stockholders' equity 21,606 20,416
--------- ---------
Commitments and contingencies (note 3)
Total liabilities and stockholders' equity $ 130,541 $ 122,761
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
Years ended June 30, 1998, 1997 and 1996
1998 1997 1996
------- ------- -------
(dollars in thousands,
except per share data)
<S> <C> <C> <C>
Interest income:
Interest on loans $ 9,127 $ 8,060 $ 7,591
Interest on deposits in other financial institutions 70 99 226
Interest and dividends on investment securities:
Taxable 825 1,024 1,078
Non-taxable 195 352 353
------- ------- -------
Total interest income 10,217 9,535 9,248
Interest expense:
Interest on deposits (note 5) 3,991 3,615 3,614
Interest on borrowings 1,200 988 800
------- ------- -------
Total interest expense 5,191 4,603 4,414
------- ------- -------
Net interest income 5,026 4,932 4,834
Provision for loan losses (note 3) 96 658 96
------- ------- -------
Net interest income after provision for loan losses 4,930 4,274 4,738
------- ------- -------
Other income:
Customer service and other fees 207 201 175
Mortgage loan servicing fees 63 87 96
Gains (losses) on sales of investment securities 6 (135) (47)
Lower-of-cost or market adjustment on loans held-for-sale 36 4 (40)
Gain on sale of real estate owned 114 -- --
Gain on sale of loans 75 -- --
Other 105 68 71
------- ------- -------
Total other income 606 225 255
------- ------- -------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Other expenses:
Compensation and fringe benefits (note 7) 1,713 3,152 1,353
SAIF recapitalization assessment (note 5) -- 487 --
Data and items processing 256 241 239
Deposit insurance premiums 53 71 176
Occupancy expense 114 113 123
Furniture and equipment expense 113 115 100
Professional fees 185 129 120
Other 529 408 338
------- ------- -------
Total other expenses 2,963 4,716 2,449
------- ------- -------
Income (loss) before income tax expense 2,573 (217) 2,544
Income tax expense (note 9) 930 317 849
------- ------- -------
Net income (loss) $ 1,643 $ (534) $ 1,695
======= ======= =======
Net income (loss) per share - basic (note 7) $ 0.61 $ (0.20) $ 0.45
======= ======= =======
Net income (loss) per share - diluted (note 7) $ 0.61 $ (0.20) $ 0.45
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended June 30, 1998, 1997 and 1996
Unearned Unamortized Unallocated
Shares Common ESOP Deferred Restricted
Outstanding Stock Shares Compensation Stock
----------- ----- ------ ------------ -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at June 30, 1995 -- $ -- $ -- $ -- $ --
Net income -- -- -- -- --
Net proceeds from
issuance of no par
common stock 2,645,000 25,398 -- -- --
Common stock acquired by ESOP -- -- (2,731) -- --
Release of ESOP shares -- -- 179 -- --
Cash dividends ($0.22 per share) -- -- -- -- --
Change in unrealized holding gains
(losses), net of income taxes of $387 -- -- -- -- --
--------- ----- ---- ------ ---
Balance at June 30, 1996 2,645,000 25,398 (2,552) -- --
Net loss -- -- -- -- --
Issuance of restricted stock 105,800 1,587 -- (1,587) --
Release of ESOP shares -- 83 1,619 -- --
Amortization of unearned
compensation -- -- -- 237 --
Forfeiture of restricted stock
and related dividends -- 107 -- 224 (224)
Allocation of restricted stock -- (60) -- (143) 203
Tax benefit of dividends on
restricted stock -- 261 -- -- --
Cash dividends ($7.42 per share)** -- (18,233) -- -- --
Change in unrealized holding gains
(losses), net of -- -- -- -- --
--------- ----- ---- ------ ---
Balance at June 30, 1997 2,750,800 9,143 (933) (1,269) (21)
Net income -- -- -- -- --
Release of ESOP shares -- (45) 254 -- --
Amortization of unearned
compensation -- -- -- 265 --
Forfeiture of restricted stock -- -- -- 146 (146)
Allocation of restricted stock -- (11) -- (95) 106
Tax benefit of dividends on
restricted stock -- (2) -- -- --
Cash dividends declared, net of
forfeited dividends on
restricted stock
($0.42 per share) -- 36 -- -- --
Change in unrealized
holding gains
(losses), net of income
taxes of $104 -- -- -- -- --
--------- ----- ---- ------ ---
Balance at June 30, 1998 2,750,800 $ 9,121 $ (679) $ (953) $ (61)
========== ========== ========== ========== ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Unrealized
holding Total
Retained gains Stockholders'
Earnings (losses) Equity
-------- -------- ------
<S> <C> <C> <C>
Balance at June 30, 1995 $ 13,624 $ 22 $ 13,646
Net income 1,695 -- 1,695
Net proceeds from
issuance of no par
common stock -- -- 25,398
Common stock acquired by ESOP -- -- (2.731)
Release of ESOP shares -- -- 179
Cash dividends ($0.22 per share) (536) -- (536)
Change in unrealized holding gains
(losses), net of income taxes of $387 -- (601) (601)
---------- ---------- ----------
Balance at June 30, 1996 14,783 (579) 37,050
Net loss (534) -- (534)
Issuance of restricted stock -- -- --
Release of ESOP shares -- -- 1,702
Amortization of unearned
compensation -- -- 237
Forfeiture of restricted stock
and related dividends -- -- 107
Allocation of restricted stock -- -- --
Tax benefit of dividends on
restricted stock -- -- 261
Cash dividends ($7.42 per share)** (669) -- (18,902)
Change in unrealized holding gains
(losses), net of -- 495 495
---------- ---------- ----------
Balance at June 30, 1997 13,580 (84) 20,416
Net income 1,643 -- 1,643
Release of ESOP shares -- -- 209
Amortization of unearned
compensation -- -- 265
Forfeiture of restricted stock -- -- --
Allocation of restricted stock -- -- --
Tax benefit of dividends on
restricted stock -- -- (2)
Cash dividends declared, net of
forfeited dividends on
restricted stock
($0.42 per share) (1,122) -- (1,086)
Change in unrealized
holding gains
(losses), net of income
taxes of $104 -- 161 161
---------- ---------- ----------
Balance at June 30, 1998 $ 14,101 $ 77 $ 21,606
========== ========== ==========
</TABLE>
** includes $7.00 special dividend paid on December 6, 1996.
See accompanying notes to consolidated financial statements.
25
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended June 30, 1998, 1997, and 1996
1998 1997 1996
-------- -------- --------
Operating activities: (dollars in thousands)
<S> <C> <C> <C>
Net income (loss) $ 1,643 $ (534) $ 1,695
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 94 93 90
Net amortization (accretion) 119 98 154
Provision for loan losses 96 658 96
Deferred income taxes (5) (163) (56)
Gain on sale of fixed assets (2) -- --
Net (gain) loss on sale of investment and mortgage-backed securities (6) 135 47
Gain on sale of real estate owned (114) -- --
Gain on sale of loans (75) -- --
Release of ESOP shares 209 1,702 179
Compensation earned under MRP 265 237 --
Net decrease (increase) in mortgage loans held for sale 264 519 (1,667)
Decrease (increase) in other assets (328) 585 (291)
Increase (decrease) in other liabilities 53 (40) 136
-------- -------- --------
Net cash provided by operating activities 2,213 3,290 383
-------- -------- --------
Investing activities:
Net increase in loans held for investment (7,198) (10,230) (4,995)
Principal collected on mortgage-backed securities 620 628 753
Purchases of investment securities classified as available-for-sale (2,254) (504) (23,968)
Purchases of investment securities classified as held-to-maturity (307) -- (1,815)
Purchases of mortgage-backed securities classified as available-for-sale (2,517) (1,658) (1,482)
Proceeds of sales of investment securities classified as available-for-sale - 13,601 2,946
Proceeds from maturities of investment securities -- 78 75
Proceeds from investment securities called by issuer 380 1,085 4,500
Proceeds of sales of mortgage-backed securities classified as available-for-sale 1,508 3,847 --
Purchases of FHLB Stock (232) (57) (77)
Purchases of premises and equipment (318) (34) (75)
Proceeds from sale of real estate owned 636 -- --
Proceeds from sale of fixed assets 17 -- --
-------- -------- --------
Net cash provided (used) by investing activities (9,665) 6,756 (24,138)
-------- -------- --------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Financing activities:
Net increase (decrease) in time deposits 4 5,776 (4,703)
Net increase (decrease) in other deposits 4,976 5,723 1,319
Proceeds from borrowings 18,000 14,000 12,750
Repayments of borrowings (16,500) (14,750) (8,500)
Proceeds from issuance of no par common stock -- -- 25,398
Purchase of common stock for ESOP -- -- (2,731)
Cash dividends paid to shareholders (1,029) (18,820) (244)
-------- -------- --------
Net cash provided (used) by financing activities 5,451 (8,071) 23,289
-------- -------- --------
Increase (decrease) in cash and cash equivalents (2,001) 1,975 (466)
Cash and cash equivalents at beginning of period 4,645 2,670 3,136
-------- -------- --------
Cash and cash equivalents at end of period $ 2,644 $ 4,645 $ 2,670
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 5,217 $ 4,592 $ 4,448
======== ======== ========
Income taxes $ 977 $ 342 $ 828
======== ======== ========
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on available-for-sale securities, net of deferred
taxes of $104 for 1998, $318 for 1997 and $387 for 1996 $ 161 $ 495 $ (601)
======== ======== ========
Dividends declared but unpaid $ (324) $ (267) $ (292)
======== ======== ========
Transfer of bank premises no longer in use from fixed assets to other
assets at net book value $ -- $ 60 $ --
======== ======== ========
Transfer from loans receivable to real estate owned
assets at net book value $ 522 $ -- $ --
======== ======== ========
</TABLE>
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Significant Accounting Policies
(a) Organization and Operations
Piedmont Bancorp, Inc., ("the Parent") is a bank holding company, formed in
December 1995, that owns all of the outstanding common stock of Hillsborough
Savings Bank, Inc. SSB ("the Bank"). The Bank amended and restated its charter
to effect its conversion from a North Carolina chartered mutual savings bank to
a North Carolina chartered stock savings bank in December 1995 ("the
Conversion"). The Bank is primarily engaged in the business of obtaining
deposits and providing loans to the general public. The principal activity of
the Parent is ownership of the Bank.
(b) Basis of Presentation
The consolidated financial statements include the accounts of the Parent and the
Bank, together referred to as "the Company". All significant intercompany
transactions and balances are eliminated in consolidation. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the balance sheets and the reported amounts of
income and expenses for the periods presented. Actual results could differ
significantly from those estimates. Material estimates that are particularly
susceptible to significant changes in the near-term relate to the determination
of the allowance for loan losses.
(c) Investment and Mortgage-Backed Securities
Management determines the appropriate classification of investment and
mortgage-backed securities at the time of purchase. Securities are classified as
held-to-maturity when the Company has both the positive intent and ability to
hold the securities to maturity. Held-to-maturity securities are stated at
amortized cost. Securities not classified as held-to-maturity are classified as
available-for-sale. Available-for-sale securities are stated at fair value, with
the unrealized gains and losses, net of tax, reported in a separate component of
stockholders' equity. The Company has no trading securities.
The amortized cost of securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or, in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest income
from investments. Realized gains and losses, and declines in value judged to be
other-than-temporary are included in net securities gains (losses).
The cost of securities sold is based on the specific identification method.
(d) Mortgage Servicing Rights
Mortgage servicing rights ("MSR") are the rights to service mortgage loans for
others which are capitalized and included in "other assets" on the Consolidated
Balance Sheets at the lower of their carrying value or fair value. The carrying
value of mortgage loans originated or purchased is allocated between the
<PAGE>
carrying value of the loans and the MSR. Capitalization of the allocated
carrying value of MSR occurs when the underlying loans are sold or securitized.
MSR's are amortized over the estimated period of and in proportion to net
servicing revenues. MSR for loans originated by the Bank prior to 1997 were not
capitalized in accordance with the then current accounting standards.
The Company periodically evaluates MSR for impairment by estimating the fair
value based on a discounted cash flow methodology. This analysis incorporates
current market assumptions, including discount, prepayment and delinquency rates
with net cash flows. The predominant characteristics used as the basis for
stratifying MSR are investor type, product type and interest rate. If the
carrying value of the MSR's exceed the estimated fair value, a valuation
allowance is established. Changes to the valuation allowance are charged against
or credited to mortgage servicing income and fees up to the original carrying
value of the MSR.
28
<PAGE>
(1) Significant Accounting Policies, Continued
(e) Loans Receivable
Loans held for investment are carried at their principal amount outstanding, net
of deferred loan origination fees.
Interest on loans is recorded as borrowers' monthly payments become due. Accrual
of interest income on loans (including impaired loans) is suspended when, in
management's judgment, doubts exist as to the collectibility of principal and
interest. Interest received on nonaccrual and impaired loans is generally
applied against principal or may be reported as interest income depending on
management's judgment as to the collectibility of principal. Loans are returned
to accrual status when management determines, based on an evaluation of the
underlying collateral together with the borrower's payment record and financial
condition, that the borrower has the capability and intent to meet the
contractual obligations of the loan agreement.
Loan origination fees and certain direct loan origination costs are deferred and
the net amount amortized as an adjustment of the related loans' yield over the
life of the related loans using a level-yield method. Unamortized net loan fees
or costs on loans sold are recorded as gain or loss on sale in the year of
disposition.
(f) Allowance for Loan Losses
The Company provides for loan losses on the allowance method. Accordingly, all
loan losses are charged to the allowance and all recoveries are credited to it.
Additions to the allowance for loan losses are provided by charges to operating
expense. The provision is based upon management's evaluation of the risk
characteristics of the loan portfolio under current economic conditions and
considers such factors as financial condition of the borrower, collateral
values, growth and composition of the loan portfolio, the relationship of the
allowance for loan losses to outstanding loans, and delinquency trends.
At June 30, 1998, substantially all of the Company's loans were collateralized
by real estate in Orange County, North Carolina and adjacent counties. The
collateral is predominately owner-occupied residential real estate in which the
borrower does not rely on underlying cash flows from the property to satisfy
debt service. The ultimate collectibility of a substantial portion of the loan
portfolio is susceptible to changes in market conditions in the Company's market
area. While management uses available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in economic
conditions. Various regulatory agencies, as an integral part of their
examination processes, periodically review the Company's allowance for loan
losses. Such agencies may require the Company to recognize additions to the
allowance based on their judgments about information available to them at the
time of their examinations.
For all specifically reviewed loans for which it is probable that the Bank will
be unable to collect all amounts due according to the terms of the loan
agreement, the Bank determines fair value either based on discounted cash flows
using the loans' initial interest rate or the fair value of the collateral if
the loan is collateral dependent. Large groups of smaller balance homogenous
<PAGE>
loans that are collectively evaluated for impairment (such as residential
mortgage and consumer installment loans) are excluded from impairment
evaluation, and their allowance for loan losses is calculated in accordance with
the allowance for loan losses policy described above.
(g) Investment in Federal Home Loan Bank Stock
As a requirement for membership, the Bank invests in stock of the Federal Home
Loan Bank of Atlanta (FHLB) in the amount of 1% of its outstanding residential
loans or 5% of its outstanding advances from the FHLB, whichever is greater. At
June 30, 1998, the Bank owned 11,520 shares of the FHLB's $100 par value capital
stock. No ready market exists for such stock, which is carried at cost.
(h) Premises and Equipment
Premises and equipment are stated at cost. Provisions for depreciation are
computed principally using the straight-line method and charged to operations
over the estimated useful lives of the assets which range from 5 to 40 years for
office buildings and 3 to 10 years for furniture, fixtures, and equipment and
other improvements.
29
<PAGE>
(1) Significant Accounting Policies, Continued
(i) Income Taxes
The provision for income taxes is based on income and expense reported for
financial statement purposes after adjustment for permanent differences such as
tax exempt interest income. Deferred income taxes are provided when there is a
difference between the periods items are reported for financial statement
purposes and when they are reported for tax purposes and are recorded at the
enacted tax rates expected to apply to taxable income in years in which these
temporary differences are expected to be recovered or settled. Subsequent
changes in tax rates will require adjustment to these assets and liabilities.
(j) Retirement Plans
The Bank has an employee stock ownership plan which covers substantially all of
its employees. Contributions to the plan are determined annually by the Board of
Directors based on employee compensation. Prior to establishment of the employee
stock ownership plan, the Company had a self-administered, defined contribution
retirement plan that covered all eligible employees. This plan was terminated as
of July 31, 1995 in conjunction with the Conversion. The Bank also has a 401(k)
plan that covers all eligible employees. The Bank matches voluntary
contributions by participating employees.
The Company records compensation expense for shares released to employees, as a
result of contributions by the Company or dividends paid on unreleased shares in
the employee stock ownership plan, equal to the fair value of the shares.
(k) Cash and Cash Equivalents
For purposes of reporting cash flows, the Company considers cash and
interest-bearing deposits in other institutions with original maturities of
three months or less to be cash equivalents.
(l) Earnings (Loss) Per Share
In 1998, the Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings Per Share", which establishes standards for
computing and presenting earnings per share (EPS) data. SFAS No. 128 simplifies
the standards for computing EPS previously found in APB Opinion No. 15 "Earnings
Per Share", and makes them comparable to international EPS standards. Under SFAS
No. 128, basic EPS replaces the former presentation of primary EPS. Also, a dual
presentation of of basic and diluted EPS is required on the face of the income
statement for all entities with complex capital structures, and a reconciliation
must be provided of the numerator and denominator of the basic EPS computation
to the numerator and denominator of the diluted EPS computation. In accordance
with SFAS No. 128, all prior period EPS data has been restated.
(m) Reclassifications
Certain reclassifications have been made for 1997 and 1996 to conform with the
1998 presentation. The reclassifications had no effect on previously reported
net income or stockholders' equity.
30
<PAGE>
(2) Investment Securities
The following is a summary of the investment securities portfolios by major
classification:
<TABLE>
<CAPTION>
June 30, 1998
-------------------------------------------------
(dollars in thousands)
Estimated
Amortized Unrealized Unrealized market
cost gains losses value
---- ----- ------ -----
<S> <C> <C> <C> <C>
Securities available for sale:
US government and agency securities $ 8,005 $ 26 $ 3 $ 8,028
Mortgage-backed securities 4,668 32 5 4,695
State and local governments 976 76 -- 1,052
------- ------- ------- -------
Total securities available-for-sale $13,649 $ 134 $ 8 $13,775
======= ======= ======= =======
Securities held-to-maturity:
State and local governments $ 3,250 $ 85 $ 4 $ 3,331
======= ======= ======= =======
<CAPTION>
June 30, 1997
-------------------------------------------------
(dollars in thousands)
Estimated
Amortized Unrealized Unrealized market
cost gains losses value
---- ----- ------ -----
<S> <C> <C> <C> <C>
Securities available for sale:
US government and agency securities $ 5,754 $ -- $ 101 $ 5,653
Mortgage-backed securities 4,275 10 88 4,197
State and local governments 975 41 -- 1,016
------- ------- ------- -------
Total securities available-for-sale $11,004 $ 51 $ 189 $10,866
======= ======= ======= =======
Securities held-to-maturity:
State and local governments $ $ 3,341 $ 58 $ 4 $ 3,395
======= ======= ======= =======
</TABLE>
31
<PAGE>
(2) Investment Securities, Continued
The aggregate amortized cost and approximate market value of the
available-for-sale and held-to-maturity securities portfolios at June 30, 1998,
by remaining contractual maturity are as follows:
<TABLE>
<CAPTION>
Securities available-for-sale Securities held-to-maturity
----------------------------- ---------------------------
(dollars in thousands)
Estimated Estimated
Amortized market Amortized market
cost value cost value
---- ----- ---- -----
<S> <C> <C> <C> <C>
US government and agency securities:
Due in 1 year or less $ 752 $ 755 $ -- $ --
Due in 1 year through 5 years 2,753 2,756 -- --
Due after 5 through 10 years 4,500 4,517 -- --
Obligations of states and local governments:
Due in 1 year or less -- -- 76 75
Due 1 year through 5 years -- -- 1,773 1,791
Due after 5 through 10 years -- -- 709 745
Due after 10 years 976 1,052 692 720
Mortgage-backed securities 4,668 4,695 -- --
Total securities $13,649 $13,775 $ 3,250 $ 3,331
======= ======= ======= =======
</TABLE>
At June 30, 1998 and 1997, investment securities with book values of $8,311,000
and $4,825,000, respectively, were pledged as collateral for public deposits.
Summarized below is the sales activity in investment securities:
<TABLE>
<CAPTION>
Year ended June 30,
------------------------------------
1998 1997 1996
-------- -------- --------
(dollars in thousands)
<S> <C> <C> <C>
Proceeds from sales of available-for-sale securities $ 1,508 $ 17,448 $ 2,946
Realized gains (6) (55) (7)
Realized losses -- 190 54
-------- -------- --------
Cost of available-for-sale securities sold $ 1,502 $ 17,583 $ 2,993
======== ======== ========
</TABLE>
32
<PAGE>
(3) Loans Receivable
<TABLE>
<CAPTION>
June 30,
------------------------
Loans receivable consist of the following: 1998 1997
---- ----
(dollars in thousands)
<S> <C> <C>
Loans secured by first mortgages on real estate:
Mortgage loans held for sale $ 2,797 $ 2,986
Mortgage loans held for investment, primarily one-to-four family 87,378 74,635
Construction loans 7,552 9,638
Commercial and agricultural loans 6,472 6,379
Participation loans purchased 323 270
--------- ---------
104,522 93,908
Home equity lines of credit 9,879 10,423
Other second mortgage loans 709 574
Other installment loans 850 1,061
--------- ---------
115,960 105,966
Undisbursed proceeds on loans in process (8,097) (4,649)
Deferred loan fees (412) (348)
Allowance for loan losses (951) (796)
--------- ---------
$ 106,500 $ 100,173
========= =========
</TABLE>
An analysis of the allowance for loan losses follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of period $ 796 $ 608 $ 515
Provision for loan losses 96 658 96
Loans charged off (8) (519) (4)
Recoveries 67 49 1
----- ----- -----
Balance at end of period $ 951 $ 796 $ 608
===== ===== =====
</TABLE>
At June 30, 1998 and 1997, the Company had loans totaling approximately $928,000
and $803,000, respectively, which were in nonaccrual status and $244,000 which
were contractually delinquent for 90 days or more and still accruing at June 30,
1997. There were no loans that were contractually delinquent for 90 days or more
and still accruing at June 30, 1998.
<PAGE>
Additional interest income that would have been recorded on nonaccrual loans for
the years ended June 30, 1998, 1997 and 1996 had they performed in accordance
with their original terms throughout each of the periods amounted to
approximately $46,000, $61,000 and $57,000, respectively.
At June 30, 1998, the Company had fixed rate mortgage loan commitments
outstanding of $1,781,000. Preapproved but unused lines of credit totaled
$10,027,000, and standby letters of credit totaled $14,650 at June 30, 1998. The
Company's exposure to credit losses for commitments to extend credit and standby
letters of credit is the contractual amount of those financial instruments. The
Company uses the same credit policies for making commitments and issuing standby
letters of credit as it does for on-balance sheet financial instruments. Each
customer's creditworthiness is evaluated on an individual basis. The amount and
type of collateral, if deemed necessary by management, is based upon this
evaluation of creditworthiness. Collateral obtained varies but may include
marketable securities, deposits, real estate, investment assets, and property
and equipment. In management's opinion, these commitments, and undisbursed
proceeds on loans in process reflected above, represent no more than normal
lending risk to the Company and will be funded from normal sources of liquidity.
33
<PAGE>
(3) Loans Receivable, Continued
At June 30, 1998 and 1997, the recorded investment in loans that are considered
to be impaired under SFAS No. 114 was $118,000 and $119,000, respectively. There
were no impaired loans in non-accrual status at June 30, 1998 and 1997. There
was no related allowance for credit losses associated with these loans as
determined in accordance with SFAS No. 114. The average recorded investment in
impaired loans during the year ended June 30, 1998 and 1997 was approximately
$118,500 and $121,000. The Company recognized interest income on the impaired
loans of approximately $9,500 and $9,700 during the year ended June 30, 1998 and
1997, respectively.
The Company serviced loans for others of approximately $18,256,000, $10,913,000,
and $12,719,000 at June 30, 1998, 1997 and 1996, respectively. The June 30, 1998
balance of loans sold with recourse was approximately $433,000.
Certain of the Company's mortgage loans are pledged as collateral for advances
from the Federal Home Loan Bank (see note 6).
The Bank makes loans to executive officers and directors of the Company and to
their associates. It is management's opinion that such loans are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unrelated persons and do
not involve more than the normal risk of collectibility. Following is a
reconciliation of loans outstanding to executive officers, directors, and their
associates for the year ending June 30, 1998:
Balance at June 30, 1997 $ 394,000
New loans 81,000
Repayments (17,000)
-------
Balance at June 30, 1998 $ 458,000
=======
(4) Premises and Equipment
Premises and equipment consist of the following:
<TABLE>
<CAPTION>
June 30, 1998 June 30, 1997
----------------------------------- ----------------------------------
Accumulated Net book Accumulated Net book
Cost depreciation value Cost depreciation value
---- ------------ ----- ---- ------------ -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Land and land improvements $ 407 $ 63 $ 344 $ 407 $ 57 $ 350
Office buildings and improvements 891 246 645 891 222 669
Furniture, fixtures, and equipment 1,042 617 425 752 566 186
------ ------ ------ ------ ------ ------
$2,340 $ 926 $1,414 $2,050 $ 845 $1,205
====== ====== ====== ====== ====== ======
</TABLE>
<PAGE>
(5) Deposits
Contractual maturities of time deposits are as follows:
Total
Year Ending June 30 Maturities
------------------- ----------
(dollars in thousands)
1998 $ 42,107
1999 9,719
2000 1,139
2001 1,231
2002 and thereafter
---------
Total time deposits $ 54,196
=========
34
<PAGE>
(5) Deposits, Continued
Time deposits of $100,000 or more totaled $9,556,000 and $9,636,000 at June 30,
1998 and 1997, respectively.
Interest expense on deposits includes $563,000, $406,000, and $312,000 for the
years ended June 30, 1998, 1997, and 1996, respectively, on time deposits of
$100,000 or more.
On September 30, 1996, President Clinton signed into law the Deposit Insurance
Funds Act allowing a special assessment to be levied by the FDIC to recapitalize
the SAIF. The special assessment was based on the level of SAIF deposits a
financial institution had as of March 31, 1995 subject to a 20% reduction for
certain qualifying deposits. The Bank's special assessment in 1997 totaled
$487,000. On December 11, 1996, the FDIC approved a final rule retroactive to
October 1, 1996 which lowered rates on assessments paid to the SAIF.
(6) Advances from the Federal Home Loan Bank
Advances from the Federal Home Loan Bank of Atlanta, with weighted average
interest rates, are as follows:
June 30,
----------------------------
1998 1997
---- ----
(dollars in thousands)
5.96% due on or before June 30, 1998 $ - $ 16,500
5.91% due on or before June 30, 1999 5,000 -
6.14% due on or before June 30, 2000 2,000 -
5.86% due on or before June 30, 2002 1,000 -
5.88% July 1, 2003 and thereafter 10,000 -
------ ------
$ 18,000 $ 16,500
====== ======
At June 30, 1998, the Bank had additional credit availability from the Federal
Home Loan Bank of $12,000,000.
All advances are secured by stock in the Federal Home Loan Bank and a blanket
floating lien on the Bank's one-to-four family residential mortgage loans.
(7) Employee and Director Benefit Plans
401(k) Plan
The Bank sponsors a 401(k) plan that covers all eligible employees. The Bank
matches 50% of employee contributions, with the Bank's contribution limited to
3% of each employee's salary. Matching contributions are funded when accrued.
Matching expense totalled approximately $15,000 in 1998, $18,000 in 1997, and
$16,000 in 1996.
<PAGE>
Employee Stock Ownership Plan ("ESOP")
The Bank has an ESOP whereby an aggregate number of shares amounting to 211,600
were purchased for future allocation to employees. Contributions to the ESOP are
made by the Bank on a discretionary basis and are allocated among ESOP
participants on the basis of relative compensation in the year of allocation.
Benefits under the ESOP vest in full upon five years of service with credit
given for years of service prior to the conversion.
The ESOP was funded by a $40,000 cash contribution made by the Bank in December
1995 and a loan from the Parent in the amount of $2,690,677. The loan is secured
by shares of stock purchased by the ESOP and is not guaranteed by the Bank.
Principal and interest payments on this loan are funded primarily from
discretionary contributions by the Bank. Dividends, if any, paid on shares held
by the ESOP may also be used to reduce the loan. Dividends on unallocated shares
are used by the ESOP to repay the debt to the Parent and are not reported as
dividends in the consolidated financial statements. Dividends on allocated
shares are credited to the accounts of the participants and reported as
dividends in the consolidated financial statements.
36
<PAGE>
(7) Employee and Director Benefit Plans, Continued
On December 31, 1996, the Bank made a $1,710,000 contribution to the ESOP,
representing the normal principal payment due for the year and the application
of dividends on unallocated shares to the principal balance of the loan. This
contribution resulted in the release of 125,819 shares to individual participant
accounts. On December 31, 1997, the Bank made a $212,000 contribution to the
ESOP, representing the normal principal payment due for the year and the
application of dividends on unallocated shares to the principal balance of the
loan. This contribution resulted in the release of 19,918 shares to individual
participant accounts. At June 30, 1998, a total of 148,837 shares have been
released and allocated to participants and 62,763 shares remain unallocated, of
which 18,430 shares are committed to be released on December 31, 1998.
Total compensation expense associated with the ESOP for the years ended June 30,
1998 and 1997 was $209,000 and $1,702,000, respectively. At June 30, 1998, there
were 62,763 unallocated ESOP shares with a total fair value of approximately
$624,000.
Management Recognition Plan ("MRP")
The Bank's MRP was approved by stockholders of the Parent and by the Parent's
and the Bank's Boards of Directors during fiscal year 1997. The MRP serves as a
means of providing existing directors and employees of the Bank with an
ownership interest in the Company. Shares of the Company's common stock awarded
under the MRP vest equally over a five year period. Compensation expense related
to those shares is recognized on a straight-line basis corresponding with the
vesting period. Prior to vesting, each participant granted shares under the MRP
may direct the voting of the shares allocated to the participant and will be
entitled to receive any dividends or other distributions paid on such shares. On
August 29, 1996, 105,800 shares were awarded but unearned to participants under
the MRP. During fiscal year 1997, 14,914 shares were forfeited under the MRP. Of
those shares forfeited, 13,500 were subsequently reallocated to new participants
under the MRP in 1997. During fiscal year 1998, 19,417 shares vested to
participants in the MRP and 11,645 shares were forfeited under the MRP. Of those
shares forfeited, 9,000 were subsequently reallocated to new participants under
the MRP in 1998. Total compensation expense associated with the MRP for the
years ended June 30, 1998 and 1997 was $265,000 and $237,000, respectively.
Stock Option Plan
The Company adopted a Stock Option Plan which has also been approved by the
stockholders of the Parent and by the Parent's and the Bank's Boards of
Directors. The Stock Option Plan makes available options to purchase 264,500
shares, or 10% of the shares issued in the conversion to employees and
directors. Options granted under the Stock Option Plan have a vesting schedule
which provides that 20% of the options granted vest in the first year, and 20%
will vest on each subsequent anniversary date, so that options would be
completely vested within five years from the date of grant. Options become 100%
vested upon death or disability, if earlier. Unexercised options expire within
ten years from the date of grant.
The Company has elected to follow APB Opinion No. 25 ("APB 25"), "Accounting for
Stock Issued to Employees" and related interpretations in accounting for its
stock options as permitted under SFAS No. 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation". In accordance with APB 25, no compensation cost is
recognized by the Company when stock options are granted because the exercise
price of the Company's stock options equals the market price of the underlying
<PAGE>
common stock on the date of grant. As required by SFAS 123, disclosures are
presented below for the effect on the net income (loss) and net income (loss)
per share that would result from the use of the fair value based method to
measure compensation cost related to stock option grants. The effects of
applying the provisions of SFAS 123 are not necessarily indicative of future
effects.
Net income (loss) 1998 1997
---- ----
As reported $ 1,643,000 $ (534,000)
Pro forma 1,563,000 (569,000)
Net income (loss) per share
As reported - basic 0.61 (0.20)
Pro forma - basic 0.58 (0.21)
As reported - diluted 0.61 (0.20)
Pro forma - diluted 0.58 (0.21)
37
<PAGE>
(7) Employee and Director Benefit Plans, Continued
The weighted-average fair value per share of options granted in 1998 and 1997
amounted to $2.45 and $2.74, respectively. Fair values were estimated on the
date of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:
1998 1997
---- ----
Risk-free interest rate 5.77% 6.75%
Dividend yield 4.83 3.90
Volatility 30.00 30.00
Expected life 7 years 7 years
A summary of the Company's stock option activity and related information for the
year ended June 30, 1998 and 1997 follows:
<TABLE>
<CAPTION>
Outstanding Exercisable
-------------------------- --------------------------
Weighted Weighted
Average Average
Option Exercise Option Exercise
Shares Price Shares Price
<S> <C> <C> <C> <C>
At June 30, 1996 -- $ -- -- $ --
Granted 262,354 9.52 -- --
Exercised -- -- -- --
Forfeited -- -- -- --
------- ----------- ------ --------
At June 30, 1997 262,354 9.52 -- --
Granted 27,172 10.38 -- --
Became exercisable -- -- 39,856 9.45
Exercised -- -- -- --
Forfeited (32,102) 10.15 (226) 9.25
------- ----------- ------ --------
At June 30, 1998 257,424 $ 9.52 39,630 $ 9.46
======== =========== ======== ========
</TABLE>
Directors' Deferred Compensation Plan
The Bank has in place two deferred compensation plans for its directors. Under
the first plan directors are to be paid specified amounts during the ten-year
period following the latter of the date that the director becomes 65 years of
age, or five years from adoption of the plan. During 1995, the Bank established
another deferred compensation plan for certain of its directors under which the
directors would be paid specified amounts during the ten-year period following
the latter of the date that the director meets a specified age requirement, or
five years from adoption of the plan. The Bank has purchased life insurance
policies with the Bank named as beneficiary to fund the benefits under both
plans. Total expense related to these plans was approximately $84,000 for 1998,
$73,000 for 1997, and $89,000 for 1996.
<PAGE>
Employment Agreements
The Bank has entered into employment agreements with four executive officers in
order to ensure a stable and competent management base. The agreements provide
for a three-year term, but upon each anniversary, the agreements automatically
extend so that the remaining term shall always be three years. The agreements
provide that the nature of the covered employee's compensation, duties or
benefits cannot be diminished following a change in control of the Company.
These employement agreements are considered contingent liabilities which are not
reflected in the consolidated financial statements.
Severance Plan
In connection with the Conversion, the Bank adopted a Severance Plan for the
benefit of its employees. The Plan provides for severance pay benefits in the
event of a change in control which results in the termination of such employees
or diminished compensation, duties, or benefits within two years of a change in
control. The employees covered would be entitled to a severance benefit of the
greater of (a) the amount equal to two weeks' salary at the existing salary rate
multiplied by the employee's number of complete years of service or (b) the
amount of one month's salary at the employee's salary rate at the time of
termination, subject to a maximum payment equal to two times the employee's
annual salary. This severance plan is considered a contingent liability which is
not reflected in the consolidated financial statements.
39
<PAGE>
(8) Stockholders' Equity
Earnings Per Share (EPS)
Basic net income per share, or basic EPS, is computed by dividing net income by
the weighted average number of common shares outstanding for the period. ESOP
shares that are unallocated and are not committed to be released are not
included in weighted average shares outstanding. Diluted EPS reflects the
potential dilution that could occur if the Company's dilutive stock options were
exercised. The numerator of the basic EPS computation is the same as the
numerator of the diluted EPS computation for all periods presented. A
reconciliation of the denominators of the basic and diluted EPS computations is
as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Basic EPS denominator-Weighted average number of common
shares outstanding 2,686,537 2,665,277 2,446,832
Dilutive share effect arising from assumed exercise of stock options 24,182 - -
--------- --------- ---------
Diluted EPS denominator 2,710,719 2,665,277 2,446,382
========= ========= =========
</TABLE>
Common Stock
The Company is authorized to issue 20,000,000 shares of common stock. The common
stock has no par value. As of June 30, 1998 and 1997, there were 2,750,800
shares of common stock issued and outstanding.
Preferred Stock
The Company is authorized to issue up to 5,000,000 shares of preferred stock. No
shares of preferred stock have been issued or were outstanding at June 30, 1998
or 1997. Such preferred stock may be issued in one or more series with such
rights, preferences, and designations as the Board of Directors of the Parent
may from time to time determine subject to applicable law and regulations. If
and when such shares are issued, holders of such shares may have certain
preferences, powers, and rights (including voting rights) senior to the rights
of the holders of the common stock of the Company. The Board of Directors of the
Parent can (without stockholder approval) issue preferred stock with voting and
conversion rights which could, among other things, adversely affect the voting
power of the holders of the common stock of the Company and assist management in
impeding an unfriendly takeover or attempted change in control of the Company
that some stockholders may consider to be in their best interest but to which
management is opposed. The Company has no current plans to issue preferred
stock.
Capital Adequacy
The Parent is regulated by the Board of Governors of the Federal Reserve System
("FRB") and is subject to securities registration and public reporting
regulations of the Securities and Exchange Commission. The Bank is regulated by
the FDIC and the Administrator, Savings Institutions Division, North Carolina
Department of Commerce (the "Administrator").
<PAGE>
The Bank is subject to the capital requirements of the FDIC and the
Administrator. The FDIC requires the Bank to maintain minimum ratios of Tier 1
capital to total risk-weighted assets and total capital to risk-weighted assets
of 4% and 8%, respectively. Tier 1 capital consists of total shareholders'
equity calculated in accordance with generally accepted accounting principles
less intangible assets, and total capital is comprised of Tier 1 capital plus
certain adjustments, the only one of which applicable to the Bank is the
allowance for possible loan losses. Risk-weighted assets refer to the on- and
off-balance sheet exposures of the Bank adjusted for their relative risk levels
using formulas set forth in FDIC regulations. The Bank is also subject to a FDIC
leverage capital requirement, which calls for a minimum ratio of Tier 1 capital
(as defined above) to quarterly average total assets of 4% and a ratio of 5% to
be "well-capitalized". The Administrator requires a net worth equal to at least
5% of total assets.
40
<PAGE>
(8) Stockholders' Equity (continued)
As summarized below, at June 30, 1998 and 1997, the Bank was in compliance with
all of the aforementioned capital requirements.
As of June 30, 1998, the FDIC categorized the Bank as "well-capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
well-capitalized, the Bank must meet minimum ratios for total risk-based, and
Tier I leverage (the ratio of Tier I capital to average assets) as set forth in
the following table. There are no events or conditions since the notification
that management believes have changed the Bank's category.
<TABLE>
<CAPTION>
Minimum Ratios
-----------------------------
For To Be Well
Capital Amount Ratio Capital Capitalized Under
---------------- ---------------- Adequacy Prompt Corrective
1998 1997 1998 1997 Purposes Action Provisions
---- ---- ---- ---- -------- -----------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
As of June 30:
Tier I Capital (to risk-weighted assets): $ 19,949 $ 18,942 27.12% 27.66% 4.00% 6.00%
Total Capital - Tier II capital (to risk-
weighted assets): 20,900 19,738 28.41 28.82 8.00 10.00
Leverage - Tier I capital (to average
assets): 19,949 18,942 14.87 15.67 4.00 5.00
</TABLE>
Liquidation Account
At the time of Conversion, the Bank established a liquidation account in an
amount equal to its net worth at June 30, 1995. The liquidation account will be
maintained for the benefit of eligible deposit account holders who continue to
maintain their deposit accounts in the Bank after the Conversion. Only in the
event of a complete liquidation will each eligible deposit account holder be
entitled to receive a liquidation distribtuion from the liquidation account in
the amount of the then current adjusted subaccount balance for deposit accounts
then held before any liquidation distribution may be made to stockholders of the
Parent's common stock. Dividends cannot be paid from this liquidation account.
Dividends
Subject to applicable law, the Boards of Directors of the Bank and the Parent
may each provide for the payment of dividends. Future declarations of cash
dividends, if any, by the Parent may depend upon dividend payments by the Bank
to the Parent. Subject to regulations of the Administrator, the Bank may not
declare or pay a cash dividend on or repurchase any of its common stock if its
stockholders' equity would thereby be reduced below either the aggregate amount
then required for the liquidation account or the minimum regulatory capital
requirements imposed by federal and state regulations. In addition, for a period
<PAGE>
of five years after the Conversion, the Bank will be required, under existing
North Carolina regulations, to obtain prior written approval of the
Administrator before it can declare and pay a cash dividend on its capital stock
in an amount in excess of one-half of the greater of (i) its net income for the
most recent fiscal year, or (ii) the average of its net income after dividends
for the most recent fiscal year and not more than two of the immediately
preceding fiscal years, if applicable. As a result of this limitation, the Bank
cannot pay a dividend without the approval of the Administrator. The Bank has
obtained the Administrator's approval for each dividend paid by the Bank to the
Parent.
41
<PAGE>
(9) Income Taxes
The components of income tax expense (benefit) were as follows:
<TABLE>
<CAPTION>
Year ended June 30,
-------------------------------------
(dollars in thousands)
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Currently payable:
Federal $ 805 $ 419 $ 782
State 130 61 123
----- ----- -----
935 480 905
----- ----- -----
Deferred:
Federal (4) (136) (45)
State (1) (27) (11)
----- ----- -----
(5) (163) (56)
----- ----- -----
$ 930 $ 317 $ 849
===== ===== =====
</TABLE>
The tax effects of temporary differences that give rise to significant portions
of the deferred tax (liabilities) are shown below:
<TABLE>
<CAPTION>
June 30
------------------
1998 1997
---- ----
(dollars in thousands)
<S> <C> <C>
Allowance for loan losses $ 219 $ 198
Unrealized holding losses on securities available-for-sale -- 54
Deferred compensation 183 165
Management recognition plan 115 92
Capital loss carryforward 4 28
Excess servicing 19 23
Other 18 26
----- -----
Gross deferred tax assets 558 586
Valuation allowance -- --
----- -----
Net deferred tax assets 558 586
----- -----
Accelerated depreciation (47) (52)
FHLB stock dividends (79) (106)
Deferred loan origination fees (99) (46)
Unrealized holding gains on securities available-for-sale (49) --
Other (8) (8)
----- -----
Gross deferred tax liabilities (282) (212)
----- -----
Net deferred tax asset $ 276 $ 374
===== =====
</TABLE>
<PAGE>
The Company has no valuation allowance at June 30, 1998 or 1997 because it has
sufficient taxable income in the carry back period to support the realizability
of the net deferred tax asset.
The reconciliation of income taxes (benefit) at statutory tax rates to income
tax expense reported in the statements of income follows:
<TABLE>
<CAPTION>
June 30,
----------------------------------------
1998 1997 1996
---- ---- ----
(dollars in thousands)
<S> <C> <C> <C>
Income taxes at the statutory federal tax rate $ 875 $ (74) $ 865
State income taxes less federal benefit 85 23 74
Nondeductible ESOP compensation - 518 -
Tax exempt interest (55) (104) (107)
Other 25 (46) 17
--- --- ----
Total tax expense $ 930 $ 317 $ 849
=== === ===
</TABLE>
43
<PAGE>
(9) Income Taxes (continued)
Retained earnings at June 30, 1998 includes approximately $2,777,000 for which
no provision for federal income tax has been made. This amount represents
allocations of income to bad debt deductions for tax purposes only. Reduction of
such amount for purposes other than tax bad debt losses could create taxable
income in certain remote instances, which will be subject to the then current
corporate income tax rate. Payment of dividends by the Bank out of this bad debt
allocation would create taxable income equal to approximately 164% of the
dividend for the Bank.
(10) Quarterly Financial Data (Unaudited)
Summarized unaudited quarterly financial data for the year ended June 30, 1998
is as follows:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Operating Summary: (dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest income $ 2,454 $ 2,515 $ 2,599 $ 2,649
Interest expense 1,259 1,293 1,302 1,337
-------- -------- -------- --------
Net interest income 1,195 1,222 1,297 1,312
Provision for loan losses 24 24 24 24
-------- -------- -------- --------
Net interest income after provision for loan losses 1,171 1,198 1,273 1,288
Other income 137 97 207 165
Other expenses 671 730 786 776
-------- -------- -------- --------
Income before income tax expense 637 565 694 677
Income taxes 223 202 247 258
-------- -------- -------- --------
Net income $ 414 $ 363 $ 447 $ 419
======== ======== ======== ========
Per Share Data:
Earnings-basic 0.15 0.13 0.17 0.16
Earnings-diluted 0.15 0.13 0.16 0.15
Cash dividends declared 0.10 0.10 0.10 0.12
Dividend payout 67% 77% 63% 80%
Book value per share 7.56 7.66 7.77 7.85
Selected Average Balances:
Assets $123,947 $128,122 $130,796 $132,621
Investment securities 17,836 18,208 18,141 18,111
Loans 102,242 106,595 109,161 111,220
Interest-bearing deposits 82,229 83,562 85,330 85,780
Advances 17,574 20,326 21,126 21,451
Stockholders' equity 20,777 21,045 21,370 21,657
</TABLE>
<PAGE>
Summarized unaudited quarterly financial data for the year ended June 30, 1997
is as follows:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Operating Summary: (dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest income $ 2,463 $ 2,430 $ 2,298 $ 2,344
Interest expense 1,111 1,148 1,158 1,186
--------- --------- --------- ---------
Net interest income 1,352 1,282 1,140 1,158
Provision for loan losses 21 597 20 20
--------- --------- --------- ---------
Net interest income after provision for loan losses 1,331 685 1,120
1,138
Other income (expense) 102 (19) 70 72
Other expenses 1,214 2,261 617 624
--------- --------- --------- ---------
Income (loss) before income tax expense 219 (1,595) 573 586
Income taxes (benefit) 36 (164) 201 244
--------- --------- --------- ---------
Net income (loss) $ 183 $ (1,431) $ 372 $ 342
========= ========= ========= =========
Per Share Data:
Earnings - basic 0.07 (0.54) 0.14 0.13
Earnings - diluted 0.07 (0.54) 0.14 0.13
Cash dividends declared 0.12 7.10 0.10 0.10
Dividend payout 171% n/a 71% 77%
Book value per share 13.54 7.14 7.31 7.42
Selected Average Balances:
Assets $ 129,823 $ 128,579 $ 118,974 $ 119,454
Investment securities 30,897 27,202 16,116 15,335
Loans 93,110 94,422 96,657 98,087
Interest-bearing deposits 72,231 73,953 79,217 80,171
Advances 16,889 16,731 16,713 15,752
Stockholders' equity 37,462 31,644 19,928 20,358
</TABLE>
<PAGE>
(11) Parent Company Financial Data
Condensed financial information for Piedmont Bancorp, Inc. (Parent Company) is
as follows:
<TABLE>
<CAPTION>
June 30,
--------------------
1998 1997
---- ----
Condensed Balance Sheet (dollars in thousands)
<S> <C> <C>
Assets:
Cash on deposit with bank subsidiary $ 750 $ 486
Investment in bank subsidiary 20,794 19,839
Other 393 366
------- -------
Total assets 21,937 20,691
======= =======
Liabilities and stockholders' equity:
Accrued taxes, expenses and other liabilities 330 275
Stockholders' equity 21,607 20,416
------- -------
Total liabilities and stockholders' equity $21,937 $20,691
======= =======
<CAPTION>
June 30,
--------------------------
1998 1997
---- ----
Condensed Statement of Income (dollars in thousands)
Dividends from bank subsidiary $ 1,155 $ 8,050
Interest income from bank subsidiary 27 153
Interest on loan from bank subsidiary ESOP 79 172
Interest on investment securities -- 88
------- -------
Total income 1,261 8,463
Interest on short-term borrowing -- 41
Loss on sale of investment securities -- 81
Operating expenses 70 84
------- -------
Income before income taxes 1,191 8,257
Income tax expense 15 47
------- -------
Income before equity in undistributed net income of subsidiary 1,176 8,210
Equity in undistributed net income (loss) of bank subsidiary 467 (8,744)
------- -------
Net income (loss) $ 1,643 $ (534)
======= =======
</TABLE>
45
<PAGE>
(11) Parent Company Financial Data, Continued
<TABLE>
<CAPTION>
Year Ended June 30,
1998 1997
---- ----
Condensed Statement of Cash Flows (dollars in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,643 $ (534)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Undistributed loss (earnings) of bank subsidiary (467) 8,744
Loss on sale of available-for-sale securities -- 81
Payments on ESOP loan receivable from bank subsidiary 213 1,709
Increase in other assets (27) (132)
Decrease in other liabilities (2) (105)
-------- --------
Net cash provided by operating activities
1,360 9,763
-------- --------
Cash flows from investing activities:
Proceeds from sale of available-for-sale securities -- 5,543
-------- --------
Net cash provided by investing activities -- 5,543
-------- --------
Cash flows from financing activities:
Cash dividends paid to stockholders (1,096) (20,435)
-------- --------
Net cash used by financing activities (1,096) (20,435)
-------- --------
Net increase (decrease) in cash and cash equivalents 264 (5,129)
Cash and cash equivalents at beginning of year 486 5,615
-------- --------
Cash and cash equivalents at end of year $ 750 $ 486
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 24 $ 160
======== ========
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on securities available for sale
net of deferred taxes of $88 in 1997 $ -- $ 138
======== ========
Unrealized gains on bank subsidiary's securities available-
for-sale net of deferred taxes of $104 in 1998 and $230 in 1997 $ 161 $ 357
======== ========
Dividends declared but unpaid $ (324) $ (267)
======== ========
</TABLE>
<PAGE>
(12) Fair Value of Financial Instruments
Fair value estimates are made by management at a specific point in time, based
on relevant information about the financial instrument and the market. These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Company's entire holdings of a particular financial
instrument nor are protential taxes and other expenses that would be incurred in
an actual sale considered. Fair value estimates are based on judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions and/or the methodology used could significantly affect the
estimates disclosed. Similarly, the fair values disclosed could vary
significantly from amounts realized in actual transactions.
Fair value estimates are based on existing on- and off-balance sheet financial
instruments without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments.
46
<PAGE>
(12) Fair Value of Financial Instruments, Continued
The following table presents the carrying values and estimated fair values of
the Company's financial instruments at June 30, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---- ----
Carrying Estimated Fair Carrying Estimated Fair
Value Value Value Value
----- ----- ----- -----
(dollars in thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and interest bearing deposits 2,644 2,644 4,645 4,645
Investment securities:
Available-for-sale
13,775 13,775 10,866 10,866
Held-to-maturity
3,250 3,331 3,341 3,395
Net loans 105,840
106,500 100,173 100,949
Federal Home Loan Bank Stock
1,152 1,152 920 920
Financial liabilities:
Deposits 89,840 88,937 84,860 82,579
Federal Home Loan Bank advances 18,000 17,940 16,500 16,510
</TABLE>
The estimated fair values of net loans and deposits are based on cash flows
discounted at market interest rates. The carrying values of other financial
instruments, including various receivables and payables, approximate fair value.
At June 30, 1998, the Company had outstanding standby letters of credit and
commitments to extend credit. These off-balance sheet financial instruments are
generally exercisable at the market rate prevailing at the date the underlying
transaction will be complete, and, therefore, they are deemed to have no current
fair market value. Refer to note 3.
47
<PAGE>
BOARD OF DIRECTORS
M. Marion Clark, Chairman of the Board
Retired President, Hillsborough Savings Bank, Inc., SSB
Robert B. Nichols, Jr.
Vice Chairman of the Board
Retired Farmer
Peggy S. Walker
Secretary of Company
Executive Vice President of Bank
William L. Rogers
Farmer
Alfred L. Carr
Retired Merchant
D. Tyson Clayton
President and Chief Executive Officer
of Company and Bank
James P. Ray
Owner and Operator
Occoneechee Golf Club, Inc.
Donald W. Pope
Owner, Pope's Tire Service
Everett H. Kennedy
Retired Realtor
- --------------------------------------------------------------------------------
EXECUTIVE OFFICERS
D. Tyson Clayton
President and Chief Executive Officer
of Company and Bank
Thomas W. Wayne
Treasurer of Company
Vice President and Chief Financial Officer of Bank
Peggy S. Walker
Secretary of Company
Executive Vice President of Bank
Ted R. Laws
Vice President of Company
and Bank
<PAGE>
CORPORATE OFFICE INDEPENDENT CERTIFIED
PIEDMONT BANCORP, INC. PUBLIC ACCOUNTANTS
260 South Churton Street KPMG Peat Marwick LLP
Hillsborough, NC 27278-2507 Suite 1200, 150 Fayetteville Street Mall
Phone: (919) 732-2143 Raleigh, NC 27601
Fax: (919) 732-6001
web address: www.hillsboroughbank.com
Email: [email protected]
FORM 10-K
A copy of the the Company's annual
STOCK TRANSFER AGENT report on Form 10-K including the
Registrar and Transfer Company financial statements and financial
Commerce Drive statement schedules as filed with the
Cranford, New Jersey 07016-3572 Securities and Exchange Commis-
Phone: (800) 346-6084 Press "1" sion pursuant to Rule 13a-1 of the
Securities and Exchange Act of
1933 will be furnished without
charge to stockholders upon
SPECIAL LEGAL COUNSEL written request to:
Brooks, Pierce, McLendon, Humphrey
and Leonard, LLP D. Tyson Clayton
Post Office Box 26000 260 South Churton Street
Greensboro, North Carolina 27420 Hillsborough, NC 27278-2507
ANNUAL MEETING
The 1998 Annual Meeting of stockholders of Piedmont Bancorp, Inc. will be held
at 6:30 p.m. on November 19, 1998 at the Corporate Office, 260 South Churton
Street, Hillsborough North Carolina.
48
<PAGE>
CAPITAL STOCK
The Parent's common stock is traded on the American Stock Exchange under the
symbol "PDB". As of June 30, 1998, there were 2,750,800 shares outstanding and
703 shareholders of record, not including the number of persons or entities
whose stock is held in nominee or street name through various brokerage firms or
banks. Payment of dividends by the Bank subsidiary to the Parent is subject to
various restrictions. Under applicable banking regulations, the Bank may not
declare a cash dividend if the effect thereof would be to reduce its net worth
to an amount less than the minimum required by federal and state banking
regulations. In addition, for a period of five years after the consummation of
the Bank's stock conversion, which occurred on December 7, 1995, the Bank will
be required to obtain prior written approval from the Administrator of the
Savings Institutions Division, North Carolina Department of Commerce, before it
can declare a cash dividend in an amount in excess of one-half the greater of
(i) its net income for the most recent fiscal year or (ii) the average of its
net income after dividends for the most recent fiscal year and not more than two
of the immediately preceding fiscal years, as applicable. As a result of this
limitation, the Bank cannot pay a dividend without the approval of the
Administrator. The Bank has obtained the Administrator's approval for each
dividend paid by the Bank to the Parent.
Quarterly Common Stock Performance and Dividends Declared
For the Year Ended June 30, 1998
<TABLE>
<CAPTION>
Stock Price Dividends Declared, Per Share
----------- -----------------------------
High Low
---- ---
<S> <C> <C> <C>
First quarter ended September 30 11 1/8 10 1/8 $ 0.10
Second quarter ended December 31 11 5/8 10 3/8 0.10
Third quarter ended March 31 11 3/8 10 5/8 0.10
Fourth quarter ended June 30 10 9/16 9 1/2 0.12
<CAPTION>
Quarterly Common Stock Performance and Dividends Declared
For the Year Ended June 30, 1997
Stock Price Dividends Declared, Per Share
----------- -----------------------------
High Low
---- ---
<S> <C> <C> <C>
First quarter ended September 30 8 3/4 5 $ 0.12
Second quarter ended December 31 11 5/8 10 3/8 ** 7.10
Third quarter ended March 31 11 1/8 9 1/4 0.10
Fourth quarter ended June 30 11 10 1/8 0.10
</TABLE>
** includes $7.00 special dividend paid on December 6, 1996.
49
EXHIBIT (21)
SUBSIDIARIES OF THE REGISTRANT
The Bank is the only subsidiary of the Parent. The Bank has one subsidiary, HSB
Financial Services, Inc., that was incorporated in January of 1998. HSB
Financial Services, Inc. was established for the primary purpose of selling
mutual funds and other retail nondeposit investments. HSB Financial Services,
Inc. currently has one employee.
Consent of Independent Auditors12
The Board of Directors
Piedmont Bancorp, Inc.
We consent to incorporation by reference in the registration statement on Form
S-8 of Piedmont Bancorp, Inc. of our report dated July 21, 1998, relating to the
consolidated balance sheets of Piedmont Bancorp, Inc. as of June 30 1998 and
1997, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the years in th the three-year period ended June 30,
1998, which is incorporated by reference in the June 30, 1998 annual report on
Form 10-K of Piedmont Bancorp, Inc.
/s/KPMG Peat Marwick LLP
------------------------
KPMG Peat Marwick LLP
Raleigh, North Carolina
September 28, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 823
<INT-BEARING-DEPOSITS> 1,821
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 13,775
<INVESTMENTS-CARRYING> 3,250
<INVESTMENTS-MARKET> 3,331
<LOANS> 106,500
<ALLOWANCE> 951
<TOTAL-ASSETS> 130,541
<DEPOSITS> 89,840
<SHORT-TERM> 18,000
<LIABILITIES-OTHER> 1,095
<LONG-TERM> 0
0
0
<COMMON> 7,428
<OTHER-SE> 14,178
<TOTAL-LIABILITIES-AND-EQUITY> 130,541
<INTEREST-LOAN> 9,127
<INTEREST-INVEST> 1,020
<INTEREST-OTHER> 70
<INTEREST-TOTAL> 10,217
<INTEREST-DEPOSIT> 3,991
<INTEREST-EXPENSE> 5,191
<INTEREST-INCOME-NET> 5,026
<LOAN-LOSSES> 96
<SECURITIES-GAINS> 6
<EXPENSE-OTHER> 2,963
<INCOME-PRETAX> 2,573
<INCOME-PRE-EXTRAORDINARY> 2,573
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,643
<EPS-PRIMARY> 0.61
<EPS-DILUTED> 0.61
<YIELD-ACTUAL> 4.10
<LOANS-NON> 928
<LOANS-PAST> 928
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,669
<ALLOWANCE-OPEN> 796
<CHARGE-OFFS> 8
<RECOVERIES> 67
<ALLOWANCE-CLOSE> 951
<ALLOWANCE-DOMESTIC> 951
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
