UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
September 30, 1999
---------------------
Commission File Number 001-14070
PIEDMONT BANCORP, INC.
----------------------
(Exact Name of Registrant as Specified in its Charter)
North Carolina 56-1936232
-------------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
260 South Churton Street, Hillsborough, NC 27278
- ------------------------------------------ -----
(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, including area code) (919) 732-2143
--------------
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.
[ X ] Yes [ ] No
As of November 4, 1999, 2,502,700 shares of the registrant's common stock, no
par value, were outstanding. The registrant has no other classes of securities
outstanding.
This Form 10-Q report has 23 pages.
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
September 30, June 30,
1999 1999
(unaudited) *
----------- -----------
Assets (in thousands, except shares)
<S> <C> <C>
Cash $ 1,539 $ 1,706
Interest-bearing deposits in other financial institutions 1,445 1,866
Investment securities
Available-for-sale 25,197 25,810
Held-to-maturity 3,337 3,362
Loans receivable (net of allowance for loan losses of $1,127 and
$1,054 at September 30, 1999 and June 30, 1999, respectively) 101,748 100,717
Federal Home Loan Bank stock, at cost 1,036 1,036
Premises and equipment 3,241 3,213
Prepaid expenses and other assets 2,635 2,379
----------- -----------
Total assets $ 140,178 $ 140,089
=========== ===========
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand, non-interest bearing 3,234 3,390
Savings, NOW and MMDA 40,832 39,915
Certificates of Deposit 58,830 56,034
----------- -----------
102,896 99,339
Advances from the Federal Home Loan Bank 16,791 20,162
Accrued expenses and other liabilities 1,190 1,027
----------- -----------
Total liabilities 120,877 120,528
----------- -----------
Stockholders' Equity
Preferred stock, no par value, 5,000,000 shares authorized;
none issued -- --
Common stock, no par value, 20,000,000 shares authorized; 2,502,700 and 2,687,633
shares issued and outstanding at September 30 and June 30, 1999 , respectively 6,764 7,035
Unearned ESOP shares (395) (450)
Unamortized deferred compensation (581) (655)
Unallocated restricted stock (95) (87)
Retained earnings, substantially restricted 14,040 14,081
Accumulated other comprehensive income (432) (363)
----------- -----------
Total stockholders' equity 19,301 19,561
----------- -----------
Commitments and contingencies
Total liabilities and stockholders' equity $ 140,178 $ 140,089
=========== ===========
</TABLE>
* Derived from audited financial statements
See accompanying notes to consolidated financial statements.
2
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Three months ended
September 30,
-----------------------
1999 1998
---- ----
<S> <C> <C>
Interest income:
Interest on loans $ 2,154 $ 2,299
Interest on deposits in other financial institutions 14 22
Interest and dividends on investment securities:
Taxable 399 233
Non-taxable 56 48
------- -------
Total interest income 2,623 2,602
------- -------
Interest expense:
Interest on deposits 1,091 1,042
Interest on borrowings 261 271
------- -------
Total interest expense 1,352 1,313
------- -------
Net interest income 1,271 1,289
Provision for loan losses 3 24
------- -------
Net interest income after provision for loan losses 1,268 1,265
------- -------
Other income:
Customer service and other fees 68 51
Mortgage loan servicing fees 32 6
Gain on sale of investment securities 8 --
Lower-of-cost or market adjustment on loans held-for-sale 71 --
Gain (loss) on sale of loans (153) 40
Stock and mutual fund commissions 14 24
Other 33 30
------- -------
Total other income 73 151
------- -------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Other expenses:
Compensation and fringe benefits 565 457
Data and items processing 114 87
Deposit insurance premiums 13 13
Occupancy expense 56 26
Furniture and equipment expense 66 43
Professional fees 23 43
Other 158 114
------- -------
Total other expenses 995 783
------- -------
Income before income tax expense 346 633
Income tax expense 93 219
------- -------
Net income $ 253 $ 414
======= =======
Net income per share - basic $ 0.10 $ 0.15
======= =======
Net income per share - diluted $ 0.10 $ 0.15
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
Unearned Unamortized Unallocated
Shares Common ESOP Deferred Restricted Retained
Outstanding Stock Shares Compensation Stock Earnings
----------- ----- ------ ------------ ----- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1998 2,750,800 $ 9,121 $ (679) $ (953) $ (61) $ 14,101
Net income - - - - - 414
Other comprehensive income - change in
unrealized holding gains (losses),net of
income taxes
Total comprehensive income
Purchase and retirement of common stock (63,167) (623) - - - -
Release of ESOP shares - (14) 59 - - -
Amortization of unearned compensation - - - 63 - -
Forfeiture of restricted stock - - - 26 (26) -
Tax benefit of dividends on restricted stock - (1) - - - -
Cash dividends declared, net of
forfeited dividends on restricted stock - 12 - - - (314)
-- --- -- -- -- -----
Balance at September 30, 1998 2,687,633 $ 8,495 $ (620) $ (864) $ (87) $ 14,201
========== ======= ======= ====== ===== ========
Balance at June 30, 1999 2,532,000 $ 7,035 $ (450) $ (655) $ (87) $ 14,081
Net income - - - - - 253
Other comprehensive income - change in
unrealized holding gains (losses),net of
income taxes
Total comprehensive income
Purchase and retirement of common stock (29,300) (259) - - - -
Release of ESOP shares - (18) 55 - - -
Amortization of unearned compensation - - - 66 - -
Forfeiture of restricted stock - - - 8 (8) -
Tax benefit of dividends on restricted stock - 3 - - - -
Cash dividends declared, net of
forfeited dividends on restricted stock - 2 - - - (293)
---------- ------- ------ ------ ----- --------
Balance at September 30, 1999 2,502,700 $ 6,763 $ (395) $ (581) $ (95) $ 14,041
========== ======= ====== ====== ===== ========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Accumulated
other Total
comprehensive Stockholders'
income Equity
------ ------
<S> <C> <C>
Balance at June 30, 1998 $ 77 $ 21,606
Net income - 414
Other comprehensive income - change in
unrealized holding gains (losses),net of
income taxes 45 45
--
Total comprehensive income 459
Purchase and retirement of common stock - (623)
Release of ESOP shares - 45
Amortization of unearned compensation - 63
Forfeiture of restricted stock - -
Tax benefit of dividends on restricted stock - (1)
Cash dividends declared, net of
forfeited dividends on restricted stock - (302)
-- -----
Balance at September 30, 1998 $ 122 $ 21,247
===== ========
Balance at June 30, 1999 $(363) $ 19,561
Net income - 253
Other comprehensive income - change in
unrealized holding gains (losses),net of
income taxes (69) (69)
--------
Total comprehensive income 184
Purchase and retirement of common stock - (259)
Release of ESOP shares - 37
Amortization of unearned compensation - 66
Forfeiture of restricted stock - -
Tax benefit of dividends on restricted stock - 3
Cash dividends declared, net of
forfeited dividends on restricted stock - (291)
------ --------
Balance at September 30, 1999 $ (432) $ 19,301
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
PIEDMONT BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended
September 30,
1999 1998
------- -------
<S> <C> <C>
Operating activities:
Net income $ 253 $ 414
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 60 39
Net amortization 6 13
Provision for loan losses 3 24
Gain on sale of investments and mortgage-backed securities (8) --
Net (gain) loss on sale of loans 153 (40)
Release of ESOP shares 37 45
Compensation earned under MRP 66 63
Net decrease (increase) in mortgage loans held for sale 1,537 (880)
Increase in other assets (204) (251)
Increase in other liabilities 161 235
------- -------
Net cash provided (used in) operating activities 2,064 (338)
------- -------
Investing activities:
Net (increase) decrease in loans held for investment (2,724) 4,607
Principal collected on mortgage-backed securities 432 290
Principal collected on collateralized mortgage-backed securities 22 --
Purchases of investment securities classified as available-for-sale (1,926) (500)
Purchases of mortgage-backed securities classified as available-for-sale -- (782)
Proceeds from investment securities called by issuer 1,997 280
Purchases of premises and equipment (88) (65)
------- -------
Net cash provided (used in) investing activities (2,287) 3,830
------- -------
Financing activities:
Net increase in time deposits 2,796 571
Net increase (decrease) in other deposits 761 (1,300)
Repayments of borrowings (3,371) (2,071)
Repurchase of no par common stock (259) (623)
Cash dividends paid to shareholders (292) (324)
------- -------
Net cash used in financing activities (365) (3,747)
------- -------
Decrease in cash and cash equivalents (588) (255)
Cash and cash equivalents at beginning of period 3,572 2,644
------- -------
Cash and cash equivalents at end of period $ 2,984 $ 2,389
======= =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 1,028 $ 1,287
======= =======
Income taxes $ 108 $ 59
======= =======
Supplemental disclosure of noncash transactions:
Unrealized gains on available-for-sale securities,
net of deferred taxes of $278 and $53 $ 69 $ 122
======= =======
Dividends declared but unpaid $ 294 $ 314
======= =======
</TABLE>
See accompanying notes to financial statements.
5
<PAGE>
PIEDMONT BANCORP, INC. and SUBSIDIARY
Notes to Consolidated Financial Statements
1) 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.
2) 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. In
management's opinion, the financial information, which is unaudited,
reflects all adjustments (consisting solely of normal recurring adjustments)
necessary for a fair presentation of the financial information as of
September 30, 1999 and for the three month periods ending September 30, 1999
and September 30, 1998 in conformity with generally accepted accounting
principles. Operating results for the three month period ending September
30, 1999 are not necessarily indicative of the results that may be expected
for the fiscal year ending June 30, 2000.
3) Cash and Cash Equivalents
- ----------------------------
For purposes of reporting cash flows, the Company considers cash and
interest-bearing deposits in other financial institutions with original
maturities of three months or less to be cash equivalents.
6
<PAGE>
PIEDMONT BANCORP, INC. and SUBSIDIARY
Notes to Consolidated Financial Statements
4) Employee and Director Benefit Plans
- --------------------------------------
The Company has an employee stock ownership plan ("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 will 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 from
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 which are used to repay
debt are not reported as dividends in the consolidated financial statements
but rather are recorded as an element of compensation expense. Dividends on
allocated shares are credited to the accounts of the participants and
reported as dividends in the consolidated financial statements. For the
three month period ending September 30, 1999 and 1998, ESOP-related
compensation expense totaled $37,000 and $45,000, respectively. On December
31, 1998, the Bank made a $207,000 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 18,448 shares to individual
participant accounts. At June 30, 1999, a total of 167,285 shares have been
released and allocated to participants and 44,315 shares remain unallocated,
of which 16,840 shares are committed to be released on December 31, 1999.
The Bank has a management recognition plan ("MRP") which serves as a means
of providing existing directors and employees of the Bank with an ownership
interest in the Company. On August 29, 1996, restricted stock awards of
105,800 shares were made to 38 directors, officers, and employees of the
Bank. The shares awarded under the MRP were issued from authorized but
unissued shares of common stock at no cost to recipients. The shares granted
vest at a rate of 20% each year on the anniversary of the initial award of
shares so that the shares will be completely vested at the end of five
years. During the first three months of fiscal 2000, one MRP participant
forfeited 580 restricted, non-vested shares of the Company's stock and
$4,500 of dividends previously paid to the participant on the restricted
shares. The dividends refunded to the Bank have been reflected as an
addition to common stock. The shares forfeited during the three months ended
September 30, 1999, combined with shares previously forfeited, leaves 6,358
restricted shares unallocated under the MRP. Compensation expense of $66,000
and $63,000 was recorded during the three months ended September 30, 1999
and 1998, respectively.
7
<PAGE>
PIEDMONT BANCORP, INC. and SUBSIDIARY
Notes to Consolidated Financial Statements
5) Regulatory Restrictions
- --------------------------
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 conversion.
Only in the event of a complete liquidation will each eligible deposit
account holder be entitled to receive a liquidation distribution from the
liquidation account in the amount of the current adjusted subaccount balance
for deposit accounts then held before any liquidation distribution may be
made with respect to common stock. Dividends paid subsequent to the
conversion cannot be paid from this liquidation account.
The Bank may not declare or pay a cash dividend on or repurchase any of its
common stock if its net worth 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 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.
Management is not aware of any other trends, events, uncertainties, or
current recommendations by regulatory authorities that will have or that are
reasonably likely to have a material effect on the Company's liquidity,
capital resources, or other operations.
6) Earnings per Share
- ---------------------
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:
Three Months Ended
September 30,
------------------------
1999 1998
--------- ---------
Basic EPS denominator: weighted average
number of common shares outstanding 2,422,136 2,684,045
Dilutive effect of stock options and
unvested stock grants 54,125 9,738
--------- ---------
Diluted EPS denominator 2,476,261 2,693,783
========= =========
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Comparison of Results of Operations for the Three Months Ended September 30,
1999 and 1998
Summary
- -------
For the quarter ended September 30, 1999, the Company recorded net income of
$253,000, or $0.10 per share, compared to $414,000, or $0.15 per share for the
same quarter last year.
Net Interest Income
- -------------------
As shown in the table below, tax-equivalent net interest income decreased
$13,000 to $1,306,000 for the quarter ended September 30, 1999 from $1,319,000
for the same period in 1998. Net interest income is analyzed on a tax-equivalent
basis to adjust for the nontaxable status of income earned on certain
investments such as municipal bonds.
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30,
---------------------------------------------
1999
---------------------------------------------
Average
Average Yield/
Balance Interest Rate(1)
------- -------- -------
Assets: (dollars in thousands)
<S> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits $ 1,499 $ 14 3.74%
FHLB common stock 1,036 20 7.72
Taxable investment securities 24,490 379 6.19
Tax-exempt investment securities (2) 4,642 91 7.84
Loans receivable 102,264 2,154 8.43
-------- ------ ----
Total interest-earning assets 133,931 2,658 7.94
------ ----
Non-interest-earning assets 6,324
----------
Total $ 140,255
==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Deposit accounts 98,478 1,091 4.40
Borrowings 18,181 261 5.74
------- ------ ----
Total interest-bearing liabilities 116,659 1,352 4.64
------ ----
Non-interest-bearing liabilities 4,208
Stockholders' equity 19,388
----------
Total $ 140,255
==========
Net interest income and interest rate spread $1,306 3.30%
======
Net interest-earning assets and net interest margin $ 17,272 3.93%
==========
Ratio of interest-earning assets to interest-bearing liabilities 114.81%
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30,
-----------------------------------------
1998
-----------------------------------------
Average
Average Yield/
Balance Interest Rate(1)
------- -------- -------
Assets: (dollars in thousands)
<S> <C> <C> <C>
Interest-earning assets: $ 1,438 $ 22 6.12%
Interest-bearing deposits 1,150 22 7.65
FHLB common stock 12,665 211 6.66
Taxable investment securities 3,863 78 8.08
Tax-exempt investment securities (2) 108,196 2,299 8.50
Loans receivable ---------- ------ ----
127,312 2,632 8.27
Total interest-earning assets ------ ----
3,631
Non-interest-earning assets ----------
$ 130,943
Total ==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities: 86,089 1,042 4.80
Deposit accounts 19,022 271 5.70
Borrowings ---------- ------ ----
105,111 1,313 5.00
Total interest-bearing liabilities ------ ----
4,187
Non-interest-bearing liabilities 21,645
Stockholders' equity ----------
$ 130,943
Total ==========
$ 1,319 3.27%
Net interest income and interest rate spread =======
$ 22,201 4.17%
Net interest-earning assets and net interest margin ==========
121.12%
Ratio of interest-earning assets to interest-bearing liabilities
</TABLE>
(1) All information presented in this column is annualized with the exception of
the ratio of interest-earning assets to interest bearing liabilities.
(2) Interest earned on tax-exempt investment securities has been adjusted to a
tax-equivalent basis using the applicable federal and state rates of 34% and
7.25%, respectively, and reduced by the nondeductible portion of interest
expense.
9
<PAGE>
The decrease in net interest income is due to a lower level of average net
interest-earning assets as well as a lower average yield during the quarter
ended September 30, 1999 compared to the same quarter last year. The increase in
average interest-earning assets from September 30, 1998 to September 30, 1999 is
due primarily to an increase of $11,825,000 in taxable investment securities
mitigated by a decline in loans receivable of $5,932,000. The increase in
interest-bearing liabilities is primarily due to a $12,389,000 increase in
interest-bearing deposits from September 30, 1998 to September 30, 1999.
Interest rate spread (on a tax-equivalent basis) increased to 3.30% for the
quarter ended September 30, 1999 from 3.27% for the same quarter in 1998 due to
36 basis point decline in the average rate on total interest-bearing liabilities
mitigated by a 33 basis point decline in the average yield on total
interest-earning assets. Net interest margin decreased to 3.93% for the three
months ended September 30, 1999 from 4.17% for the three months ended September
30, 1998.
Provision for Loan Losses
- -------------------------
The provision for loan losses for the three months ended September 30, 1999
totaled $3,000 compared to $24,000 for the same period in 1998. The provision
for loan losses is based on management's evaluation of the loan portfolio as
discussed under "Financial Condition".
Other Income
- ------------
Other income totaled $73,000 for the quarter ended September 30, 1999 compared
to $151,000 for the same period in 1998. The general increase in long-term
interest rates during the quarter caused losses of $153,000 on sales of loans
during the quarter ended September 30, 1999, compared with gains on sales of
loans of $40,000 during the quarter ended September 30, 1998. The loss on sale
of loans was offset by a $71,000 positive lower-of-cost or market adjustment on
loans held-for-sale during the same quarter. A $26,000 increase in mortgage
servicing fees from the first quarter ended September 30, 1998 compared to the
first quarter ended September 30, 1999 also mitigated the losses on sales of
mortgage loans.
Other Expenses
- --------------
Other expenses totaled $995,000 for the three months ended September 30, 1999
compared to $783,000 for the same period in 1998. Most of the remainder of the
decline in net income was caused by a $212,000 increase in total other expenses.
Approximately $182,000 of the total increase in total other expenses was caused
by the opening of two new branches in Chapel Hill and Durham that occurred in
April and June of 1999. Of the total $108,000 increase in compensation expense,
$97,000 was attributable to the new branch openings. The remaining increase was
due to normal compensation increases and additional administrative support at
the Bank's headquarters and main branch in Hillsborough. $7,000 of the total
$27,000 increase in data and items processing expenses was due to the two new
branches, with the remainder due to greater use of technology at the Bank's
headquarters and main branch in Hillsborough. $25,000 of the total $30,000
increase in occupancy expense, and $15,000 of the total $23,000 in furniture and
equipment expense was due to the two new branches. Professional fees declined
$20,000 due to a branch consulting study that was performed during the first
quarter of fiscal 1999. Of the total increase of $44,000 in other other expenses
$38,000 was due to the two new branches.
10
<PAGE>
Income Tax Expense
- ------------------
Income tax expense was $93,000 for the quarter ended September 30, 1999
resulting in an effective rate of 26.9% compared to $219,000 or 34.6% for the
same period in 1998. The decline in the effective tax rate from 1998 to 1999 was
due to a higher level of interest income from Federal Home Loan Bank agency
investment securities for the quarter ended September 30, 1999 as compared to
the same quarter in 1998. Interest income from Federal Home Loan Bank agency
investment securities is exempt from North Carolina income tax.
11
<PAGE>
Financial Condition
CHANGES IN FINANCIAL CONDITION
- ------------------------------
Total assets increased .06% to $140.2 million at September 30, 1999 compared to
$140.1 million at June 30, 1999. Total liabilities increased .29%, with the
primary contributors being a 3.58% or $3.6 million increase in total deposits
offset by a 16.72% or $3.4 million decline in advances from the Federal Home
Loan Bank.
Total stockholders' equity decreased $300,000 to $19.3 million at September 30,
1999 from $19.6 million at June 30, 1999. Under a previously announced stock
repurchase plan, the Company repurchased and retired 29,300 shares of its common
stock during the quarter ended September 30, 1999. The average cost of the
shares repurchased was $8.84 per share for a total cost of $259,000. The Company
has now completed its repurchase plan. The implementation of the share
repurchase plan, cash dividends declared of $291,000 and change in unrealized
holding losses of $69,000 were the primary factors contributing to the decline
in stockholders' equity during the quarter ended September 30, 1998. Mitigating
these decreases were quarterly net income of $253,000, and release of ESOP
shares and amortization of unearned compensation of $55,000 and $74,000,
respectively.
ASSET QUALITY
- -------------
Nonperforming Assets and Risk Assets
- ------------------------------------
Nonperforming assets include nonaccrual loans, restructured loans and real
estate owned. The table on the following page presents information on
nonperforming assets and loans contractually past due but still accruing at
September 30, 1999 and June 30, 1999.
12
<PAGE>
<TABLE>
<CAPTION>
September 30, June 30
1999 1999
(in thousands)
<S> <C> <C>
Total nonaccrual loans $ 1,050 $ 973
Total restructured loans -- --
-------- --------
Total nonperforming loans 1,050 973
Real estate owned -- --
-------- --------
Total nonperforming assets 1,050 973
Accruing loans, delinquent 90 days or more -- --
-------- --------
Total risk assets $ 1,050 $ 973
======== ========
Nonperforming loans to total loans 1.03% 0.97%
Nonperforming assets to total assets 0.75% 0.69%
Risk assets to total assets 0.75% 0.69%
Allowance for loan losses to:
Total nonperforming assets 1.07x 1.08x
Total risk assets 1.07x 1.08x
Total assets $140,178 $140,089
Total loans, net 101,748 100,717
Allowance for loan losses 1,127 1,054
</TABLE>
There were no significant changes in nonperforming assets outstanding from June
30, 1999 to September 30, 1999. Management has reviewed the collateral for
nonperforming assets and believes that collateral values related to the loans
exceeds such balances. The recorded investment in loans that are considered to
be impaired under SFAS No. 114 (Statement of Financial Accounting Standards No.
114, "Accounting by Creditors for Impairment of a Loan") were $117,000 at both
September 30, 1999 and June 30, 1999. There was no related allowance for credit
losses associated with these loans as determined in accordance with SFAS No.
114. Management has included this review among the factors considered in the
evaluation of the allowance for possible loan losses.
13
<PAGE>
Provision and Allowance for Loan Losses
- ---------------------------------------
The following table summarizes the activity in the allowance for loan losses for
the three months ended September 30, 1999 and 1998, respectively.
<TABLE>
<CAPTION>
Three months ended
September 30,
1999 1998
------- -------
<S> <C> <C>
Balance at the beginning of period $ 1,054 $ 951
Provision for loan losses 3 24
Recoveries 75 30
Loans charged off (5) --
------- -------
Balance at the end of period $ 1,127 $ 1,005
======= =======
</TABLE>
At September 30, 1999, the allowance for loan losses was 1.11% of total loans,
compared to 1.05% of total loans at June 30, 1999 and 0.97% of total loans at
September 30, 1998.
The levels of the provision and allowance for loan losses are based on
management's ongoing evaluation of the risk characteristics of the loan
portfolio considering current economic conditions, financial condition of
borrowers, growth and composition of the loan portfolio, collateral values, the
relationship of the allowance for loan losses to outstanding loans, the level of
nonperforming loans that have been identified as potential problems, past and
expected loss experience, results of the most recent regulatory examinations,
and other factors deemed relevant by management. Management actively maintains a
current loan watch list and knows of no other loans which are (1) material and
represent or result from trends or uncertainties which management reasonably
expects will materially impact future operating results, liquidity, or capital
resources, or (2) represent material credits about which management has serious
doubts as to the ability of such borrowers to comply with the loan repayment
terms. Based on management's evaluation of the loan portfolio, as described
above, the Company recorded a $3,000 provision for loan losses for the three
months ended September 30, 1999 compared to a $24,000 provision for the same
period in 1998.
14
<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 the
Company's management team, in November of 1997. Other employees are actively
involved in the Company's Year 2000 efforts on an as needed basis. The 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 below, has
five primary phases related to internal Year 2000 compliance:
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.
Since December of 1997 the Board has been apprised of the Company's efforts
at their regular monthly meetings. Employees are informed of the Company's
Year 2000 efforts through scheduled employee meetings. In addition, all
customers were updated with respect to the Company's Year 2000 efforts
through mailings sent in June of 1998 and April of 1999. The Company has
also placed Year 2000 information on the Bank's World Wide Web site. A
final Year 2000 mailing will be sent to all customers of the Bank as of
September 30, 1999.
15
<PAGE>
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 also all known
processes that could be impacted by microchip 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.
16
<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 currently in process, is to test the Company's network and core service
provider software applications and hardware. A first test of the company's
core service provider software applications and hardware was performed on
September 20, 1998 using a future date of January 3, 2000. The Company has
reviewed the results of this test, and this review indicated that the
system performed reliably and accurately when using the future date of
January 3, 2000. The Company performed follow up tests with its core
service provider during the third quarter of fiscal 1999 using future dates
of February 29, 2000 and March 1, 2000. The Company has reviewed the
results of this test, and this review indicated that the system performed
reliably and accurately when using the future dates of February 29, 2000
and March 1, 2000. The testing of the remainder of the Company's processes
was substantially complete as of June 30, 1999, with follow up testing to
be performed as needed in the remainder of calendar year 1999.
5. Implementation - this phase occurred when the Company's vendors certified
their present systems as Year 2000 compliant. All of the systems the
Company is presently using have been certified as Year 2000 compliant by
the respective vendors. 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 Company has developed a
Business Resumption Contingency plan for critical processes in the event
they do not process information reliably and accurately after December 31,
1999. This plan was approved by the Bank's Board of Directors in late May
of 1999 and tested by the Company in July of 1999.
The Company has also assessed the year 2000 readiness of significant borrowers
and depositors. In the second quarter of 1999 the Company prepared a list of
significant borrowers and depositors. After verbal and/or written inquiries of
these customers, any that the Company had Year 2000 concerns about were
counseled on the Year 2000 issue and urged to take corrective action. Since most
of the Company's loans are to individuals and secured by one to four family
residences this step did not require a significant amount of time or resources.
Excluding the hardware and software purchases noted above, the Company expensed
$6,000 on Year 2000 costs for the quarter ended September 30, 1998. There were
no Year 2000 costs for the quarter ended September 30, 1999. The Year 2000 costs
do not include the time of Bank personnel related to the Year 2000 issue. Based
on an analysis of projected expenses performed in the second quarter of fiscal
1999, the total cost of the Year 2000 project is currently estimated at $28,000.
Funding of the Year 2000 project costs has come from normal operating cash flow,
and the expenses associated with the Year 2000 Issue has and will directly
reduce otherwise reported net income for the Company.
17
<PAGE>
Management of the Company believes that the potential effects on the Company's
internal operations of the Year 2000 Issue has been addressed prior to the Year
2000. However, notwithstanding the time and effort expended to date by the
Company and its vendors, 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 has been to correct 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, has formalized 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.
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 September 30,
1999, the Bank had $13.2 million of credit available from the FHLB 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.
18
<PAGE>
Interest rate risk is the sensitivity of interest income and interest expense to
changes in interest rates. Management structures the Company's assets and
liabilities in an attempt to protect net interest income from large fluctuations
associated with changes in interest rates. At September 30, 1999, the Company
had a cumulative one-year liability-sensitive gap position of $14.4 million or
10.75% of interest-earning assets. A liability-sensitive gap position generally
indicates that net interest income would increase in a declining rate
environment and decrease in a rising rate environment. The Company had a
cumulative one-year liability-sensitive gap position of $5.9 million or 4.44% of
interest-earning assets at June 30, 1999. The Company will continue to actively
manage its balance sheet in order protect net interest income from changes in
interest rates.
It should be noted that these measures reflect the interest-sensitivity of the
balance sheet as of a specific date and are 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
September 30, 1999, management believes that its interest rate risk is at an
acceptable level.
CAPITAL RESOURCES
- -----------------
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 Federal Deposit Insurance Corporation ("FDIC") and the Administrator,
Savings Institutions Division, North Carolina Department of Commerce, (the
"Administrator"). 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 I capital to total risk-weighted assets and total capital to risk-weighted
assets of 4% and 8%, 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 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 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 total assets. At September 30, 1999, the Bank was in compliance with all
of the aforementioned capital requirements.
As of September 30, 1999, 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). There are no
events or conditions since September 30, 1999 that management believes have
changed the Bank's category.
19
<PAGE>
CURRENT 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, 1999
that will affect the Company's future reporting.
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. Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133 - and
amendment of FASB No. 133" delayed the effective date of this statement for one
year. This Statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. The Company plans to adopt SFAS 133 in fiscal
year 2001 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.
In October 1998, the FASB issued Statement of Financial Accounting
Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise," establishes accounting and reporting standards for certain mortgage
banking activities. It also conforms the subsequent accounting for securities
retained after the securitization of other types of assets. This statement is
effective for financial statements for fiscal years beginning after December 15,
1998. The Company adopted SFAS 134 in fiscal year 1999 without any impact on its
consolidated financial statements.
20
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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 above in Item
2 "Management's Discussion and Analysis of Financial Condition and Results of
Operations" under the heading "Liquidity and Interest Rate Risk Management".
Management does not believe there has been any significant change in the overall
analysis of financial instruments considered market risk sensitive, as measured
by the factors of contractual maturities, average interest rates and estimated
fair values, since the analysis prepared and presented in conjunction with the
Form 10-K Annual report for the fiscal year ended June 30, 1999.
21
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
22
<PAGE>
SIGNATURES
Under the requirements 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
Date: November 12, 1999 By: /s/ D. Tyson Clayton
--------------------
D. Tyson Clayton
President
Date: November 12, 1999 By: /s/ Thomas W. Wayne
-------------------
Thomas W. Wayne
Vice President and principal
financial officer
23
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-END> SEP-30-1999
<CASH> 1,539
<INT-BEARING-DEPOSITS> 1,445
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 25,197
<INVESTMENTS-CARRYING> 3,337
<INVESTMENTS-MARKET> 3,343
<LOANS> 101,748
<ALLOWANCE> 1,036
<TOTAL-ASSETS> 140,178
<DEPOSITS> 102,896
<SHORT-TERM> 16,791
<LIABILITIES-OTHER> 1,190
<LONG-TERM> 0
0
0
<COMMON> 5,724
<OTHER-SE> 13,608
<TOTAL-LIABILITIES-AND-EQUITY> 140,178
<INTEREST-LOAN> 2,154
<INTEREST-INVEST> 455
<INTEREST-OTHER> 14
<INTEREST-TOTAL> 2,623
<INTEREST-DEPOSIT> 1,091
<INTEREST-EXPENSE> 1,352
<INTEREST-INCOME-NET> 1,271
<LOAN-LOSSES> 3
<SECURITIES-GAINS> 8
<EXPENSE-OTHER> 995
<INCOME-PRETAX> 346
<INCOME-PRE-EXTRAORDINARY> 346
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 253
<EPS-BASIC> 0.10
<EPS-DILUTED> 0.10
<YIELD-ACTUAL> 3.93
<LOANS-NON> 1,050
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,054
<CHARGE-OFFS> 5
<RECOVERIES> 75
<ALLOWANCE-CLOSE> 1,127
<ALLOWANCE-DOMESTIC> 1,127
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
