SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1998
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _______________ to _______________.
Commission file number 0-20378
CENIT BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 54-1592546
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
225 West Olney Road
Norfolk, Virginia 23510
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 757-446-6600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(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 _____.
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. [ ]
Based on the closing price of $20.625 of the registrant's common stock on
February 26, 1999, as reported on the Nasdaq Stock Market under the symbol
"CNIT," the aggregate market value of the voting stock held by non-affiliates of
the registrant was $81,929,327. Solely for purposes of this calculation, all
executive officers and directors of the registrant are considered to be
affiliates. Also included are certain shares held by various employee benefit
plans.
The number of shares of the registrant's common stock outstanding as of
February 26, 1999 was 4,790,476.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Definitive Proxy Statement for its 1999 Annual Meeting of
Stockholders will be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year covered by this Form 10-K
pursuant to Rule G(3) of the General Instructions for Form 10-K. Information
from such Definitive Proxy Statement is hereby incorporated by reference into
Part III, Items 10, 11, 12, and 13.
PART I
Item 1 - Business
General
CENIT Bancorp, Inc. (the "Company") is a Delaware corporation that was
organized in July, 1991 for the purpose of becoming the unitary savings and loan
holding company for CENIT Bank, FSB. On July 28, 1992, the members of CENIT
Bank, FSB adopted a plan of conversion pursuant to which CENIT Bank, FSB
converted, effective August 5, 1992, from a federally chartered mutual savings
bank to a federally chartered stock savings bank (the "Conversion") with the
concurrent issuance of all of the capital stock of CENIT Bank, FSB to the
Company. On August 5, 1992, the Company issued and sold 1,236,250 shares of
common stock to subscribers in a Subscription and Community Offering. The
Company used $11.7 million of the net proceeds to acquire all the capital stock
of CENIT Bank, FSB. Prior to the Conversion, the Company did not engage in any
business, other than that of an organizational nature.
On September 26, 1996 and November 7, 1996, CENIT Bank, FSB assumed the
deposits of five Essex Savings Bank, FSB ("Essex") branches pursuant to a Branch
Purchase and Deposit Assumption Agreement dated July 2, 1996. As part of these
transactions, CENIT Bank, FSB assumed approximately $68.1 million of deposits,
acquired certain other assets and liabilities, and received approximately $65.5
million of cash. See Note 3 of the Notes to Consolidated 1998 Financial
Statements filed with this report.
On August 1, 1995, the Company acquired Princess Anne Bank ("Princess
Anne"), a Virginia commercial bank. Under the terms of the agreement, Princess
Anne's shareholders received 0.3364 shares of CENIT Bancorp common stock for
each share of Princess Anne common stock. This resulted in the issuance of
353,779 shares of CENIT Bancorp common stock. This combination was accounted for
as a pooling of interests. As part of this transaction, effective August 1,
1995, Princess Anne began operating as a wholly-owned subsidiary of the Company.
At August 1, 1995, Princess Anne reported total assets of $94.1 million and
stockholders' equity of $6.9 million. In February 1998, Princess Anne changed
its name to CENIT Bank. See Note 1 of the Notes to Consolidated 1998 Financial
Statements filed with this report.
As a result of the Princess Anne merger, the Company became a bank holding
company subject to the Bank Holding Company Act of 1956 (the "BHCA"), as
amended, and became subject to regulation by the Federal Reserve Board (the
"Federal Reserve").
In March 1998, the Boards of Directors of CENIT Bank and CENIT Bank, FSB,
as well as the Board of Directors of the Company, as the sole shareholder of the
Banks, voted to merge CENIT Bank into CENIT Bank, FSB (the "Banks"). On June 3,
1998, the Company merged CENIT Bank into CENIT Bank, FSB. Following the merger,
the Company ceased to be regulated by the Federal Reserve, and is now a
registered savings and loan holding company regulated pursuant to the Home
Owners' Loan Act, as amended (the "HOLA"). As such, the Company is now subject
to regulation, examination, supervision and reporting requirements by the
federal Office of Thrift Supervision ("OTS"). See "Regulation and
Supervision--Regulation of the Company--General."
In July 1998, CENIT Bank, FSB ceased the use of "FSB" and became CENIT Bank
(the "Bank").
The Company currently conducts its business from its corporate headquarters
in Norfolk, Virginia, and through twenty retail offices and two mortgage
origination offices located in southeastern Virginia. The Company operates in
one business segment, providing retail and commercial banking services to
customers within its market. At December 31, 1998, the Company had total
deposits of $496.8 million. The Bank's deposits are insured up to the maximum
allowable amount by the Federal Deposit Insurance Corporation (the "FDIC")
through the Savings Association Insurance Fund ("SAIF") and the Bank Insurance
Fund ("BIF"). The Bank is regulated by the OTS, the FDIC, and the Securities and
Exchange Commission (the "SEC"). The Bank is a member of the Federal Home Loan
Bank of Atlanta (the "FHLB-Atlanta") and is subject to the Board of Governors of
the Federal Reserve Board concerning reserves required to be maintained against
deposits and certain other matters.
At December 31, 1998, the Company had total assets of $641.1 million and
total stockholders' equity of $50.1 million. The Company's office is located at
the corporate headquarters of CENIT Bank at 225 West Olney Road, Norfolk,
Virginia, 23510. The telephone number is (757) 446-6600.
2
Market Area
The Company is located in the Norfolk-Virginia Beach-Newport News
Metropolitan Statistical Area ("MSA"), which extends approximately 65 miles from
Williamsburg, Virginia to Virginia Beach, Virginia, and Currituck County, North
Carolina. This MSA is the 27th largest MSA in the United States and the fourth
largest MSA in the southeastern United States with a population in 1997 of
approximately 1.5 million persons. The Company's principal market within this
region is the Hampton Roads area, which is composed of the cities of Norfolk,
Portsmouth, Virginia Beach, Chesapeake, Suffolk, Hampton, and Newport News. The
Company has its corporate headquarters in Norfolk, Virginia and the Bank
currently has a total of twenty retail offices and twenty-one automated teller
machines located in the cities of Norfolk, Portsmouth, Virginia Beach,
Chesapeake, Hampton, Newport News and in York County, Virginia. In addition, the
Company has a mortgage loan origination office located in the city of
Chesapeake. One of the Company's York County retail offices also includes a
mortgage loan origination office.
Although the Hampton Roads area supports a wide range of industrial and
commercial activities, the area's principal employer is the United States Navy
and other branches of the Armed Forces of the United States. Recent cutbacks in
defense spending and the realignment of domestic military installations have not
had an adverse impact on the Company's market area. However, future significant
cutbacks in defense spending and future consolidations of domestic military
installations could affect the general economy of the Company's market area.
Depending on whether the Hampton Roads area experiences an overall increase or
decrease in military and federal wages and salaries, the potential future impact
of any such cutbacks or consolidations could be either favorable or unfavorable.
Competition
The Company faces significant competition both in making loans and in
attracting deposits. The Company's competition for loans comes from commercial
banks, savings banks, mortgage banking subsidiaries of regional commercial
banks, national mortgage bankers, insurance companies, and other institutional
lenders. The Company's most direct competition for deposits has historically
come from savings banks, commercial banks, credit unions and other financial
institutions. Based upon total assets at December 31, 1998, the Bank constitutes
the largest bank or thrift institution with their parent company headquartered
in their MSA. The Company may face an increase in competition as a result of the
continuing reduction in the restrictions on the interstate operations of
financial institutions. The Company also faces competition for deposits from
short-term money market mutual funds and other corporate and government
securities funds.
Net Interest Income
Net interest income, the primary source of the Company's earnings,
represents the difference between income on interest-earning assets (primarily
loans and investments) and expense on interest-bearing liabilities (primarily
deposits and borrowings). Net interest income is affected by both the interest
rate spread (the difference between the rates of interest earned on
interest-earning assets and the rates of interest paid on interest-bearing
liabilities) and by the Company's net interest position (the difference between
the average amount of interest-earning assets and the average amount of
interest-bearing liabilities). Changes in the volume and mix of interest-
earning assets and interest-bearing liabilities, market interest rates, the
volume of noninterest-earning assets and the volume of noninterest-bearing
liabilities available to support interest-earning assets all affect net interest
income.
Average Balance Sheet
The following table sets forth, for the years indicated, information
regarding: (i) the total dollar amounts of interest income from interest-earning
assets and the resulting average yields; (ii) the total dollar amounts of
interest expense from interest-bearing liabilities and the resulting average
costs; (iii) net interest income; (iv) interest rate spread; (v) net interest
position; (vi) the net yield earned on interest-earning assets; and (vii) the
ratio of total interest-earning assets to total interest-bearing liabilities.
Average balances shown in the following table have been calculated using daily
average balances.
3
Year ended December 31,
-----------------------------------------------------------------------------------------
1996 1997 1998
----------------------------- ----------------------------- --------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ----- ------- -------- ----- ------- -------- ------
(Dollars in Thousands)
Interest-earning assets:
Loans (1) $ 352,153 $30,243 8.59% $ 470,594 $38,220 8.12% $507,694 $39,931 7.87%
Mortgage-backed certificates 197,562 13,224 6.69 124,761 8,685 6.96 46,967 3,208 6.83
U.S. Treasury, other U.S.
Government agency and other
debt securities 56,826 3,657 6.44 44,489 2,775 6.24 44,542 2,664 5.98
Federal funds sold 7,618 405 5.32 8,109 450 5.55 13,292 705 5.30
Federal Home Loan Bank and
Federal Reserve Bank stock 8,913 642 7.20 8,959 646 7.21 7,078 523 7.39
-------- ------ -------- ------ -------- ------
Total interest-earning assets 623,072 48,171 7.73 656,912 50,776 7.73 619,573 47,031 7.59
-------- ------ -------- ------ -------- ------
Noninterest-earning assets:
REO 2,015 1,794 710
Other 38,178 38,784 41,095
-------- -------- --------
Total noninterest-earning assets 40,193 40,578 41,805
-------- -------- --------
Total assets $ 663,265 $ 697,490 $661,378
======== ======== ========
Interest-bearing liabilities:
Passbook and statement savings $ 45,816 1,558 3.40 $ 45,050 1,522 3.38 $ 39,700 1,250 3.15
Checking accounts 26,951 677 2.51 29,167 602 2.06 34,861 606 1.74
Money market deposit accounts 43,057 1,398 3.25 46,790 1,566 3.35 64,109 2,397 3.74
Certificates of deposit 293,336 15,607 5.32 329,477 17,282 5.25 292,456 15,318 5.24
-------- ------ -------- ------ -------- ------
Total interest-bearing deposits 409,160 19,240 4.70 450,484 20,972 4.66 431,126 19,571 4.54
Advances from the Federal Home
Loan Bank 154,854 8,423 5.44 140,077 7,819 5.58 103,592 5,622 5.43
Other borrowings 295 22 7.46 1,461 110 7.53 1,008 77 7.64
Securities sold under agreements
to repurchase 8,616 402 4.67 8,893 409 4.60 12,026 535 4.45
-------- ------ -------- ------ -------- ------
Total interest-bearing liabilities 572,925 28,087 4.90 600,915 29,310 4.88 547,752 25,805 4.71
-------- ------ -------- ------ -------- ------
Noninterest-bearing liabilities:
Deposits 38,133 42,725 56,407
Other liabilities 4,477 3,832 6,413
-------- -------- --------
Total noninterest-bearing liabilities 42,610 46,557 62,820
-------- -------- --------
Total liabilities 615,535 647,472 610,572
Stockholders' equity 47,730 50,018 50,806
-------- -------- --------
Total liabilities and stockholders' equity $ 663,265 $ 697,490 $661,378
======== ======== ========
Net interest income/interest rate spread $20,084 2.83% $21,466 2.85% $21,226 2.88%
======= ===== ======= ===== ======= =====
Net interest position/net interest margin $ 50,147 3.22% $ 55,997 3.27% $ 71,821 3.43%
======== ===== ======== ===== ======== =====
Ratio of average interest-earning assets to
average interest-bearing liabilities 108.75% 109.30% 113.11%
======== ======== ========
<FN>
(1) Includes nonaccrual loans and loans held for sale.
</FN>
4
Volume/Rate Analysis
The following table analyzes changes in interest income and interest
expense in terms of: (i) changes in the volume of interest- earning assets and
interest-bearing liabilities and (ii) changes in rate. The table reflects the
extent to which changes in the Company's interest income and interest expense
are attributable to changes in volume (changes in volume multiplied by prior
period's rate) and changes in rate (changes in rate multiplied by prior period's
volume). Changes attributable to the combined impact of volume and rate have
been allocated proportionately to changes due to volume and changes due to rate.
Year ended December 31,
------------------------------------------------------------------------
1996 vs. 1997 1997 vs. 1998
------------------------------- --------------------------------
Increase (decrease) Increase (decrease)
due to due to
------------------------------- --------------------------------
Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
(Dollars in Thousands)
Interest Income:
Loans (1) $ 9,697 $(1,720) $ 7,977 $2,946 $(1,235) $ 1,711
Mortgage-backed certificates (5,049) 510 (4,539) (5,316) (161) (5,477)
U.S. Treasury, other U.S.
Government agency and other
debt securities (779) (103) (882) 3 (114) (111)
Federal funds sold 27 18 45 276 (21) 255
Federal Home Loan Bank and
Federal Reserve Bank stock 4 - 4 (139) 16 (123)
------- ------- ------- ----- ------- -------
Total interest income 3,900 (1,295) 2,605 (2,230) (1,515) (3,745)
------- ------- ------- ----- ------- -------
Interest Expense:
Passbook and statement savings (26) (10) (36) (172) (100) (272)
Checking accounts 53 (128) (75) 109 (105) 4
Money market deposit accounts 124 44 168 632 199 831
Certificates of deposit 1,900 (225) 1,675 (1,938) (26) (1,964)
Advances from the Federal Home Loan Bank (820) 216 (604) (1,985) (212) (2,197)
Other borrowings 88 - 88 (33) - (33)
Securities sold under agreements to
repurchase 13 (6) 7 140 (14) 126
------- ------- ------- ----- ------- -------
Total interest expense 1,332 (109) 1,223 (3,247) (258) (3,505)
------- ------- ------- ----- ------- -------
Net interest income $ 2,568 $(1,186) $ 1,382 $1,017 $(1,257) $ (240)
======= ======= ======= ===== ======= =======
<FN>
___________________________
(1) Includes nonaccrual loans and loans held for sale.
</FN>
5
Interest Rate Risk Management
For discussion, See Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Market Risk Management."
Lending Activities
General. The Company engages in a wide range of lending activities, which
include the origination, primarily in its market area, of one to four-family and
multi-family residential mortgage loans, commercial real estate loans,
construction loans, land acquisition and development loans, consumer loans, and
commercial business loans; and the bulk purchase of residential loans primarily
located outside its market area. At December 31, 1998, the Company's total gross
loans held for investment in all categories equaled $522.9 million.
Set forth on the following page is selected data relating to the
composition of the Company's loan portfolio by type of loan and type of security
on the dates indicated.
6
Loan Portfolio Composition. The following table sets forth the composition
of the Company's loans held for investment in dollar amounts and as a percentage
of the Company's total loans held for investment at the dates indicated.
At December 31,
-------------------------------------------------------------------------------------
1994 1995 1996 1997 1998
---------------- --------------- ---------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Real estate loans:
Residential permanent 1- to 4-family:
Adjustable rate $ 91,657 26.28% $98,093 27.44% $157,542 33.63% $213,682 40.20% $181,104 34.63%
Fixed rate
Conventional 48,241 13.83 47,633 13.32 98,952 21.12 89,356 16.81 66,041 12.63
Guaranteed by VA or insured by FHA 8,594 2.46 7,691 2.15 7,004 1.50 5,487 1.03 3,972 0.76
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total permanent 1- to 4-family 148,492 42.57 153,417 42.91 263,498 56.25 308,525 58.04 251,117 48.02
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Residential permanent 5 or more family 11,043 3.16 9,343 2.61 7,100 1.52 6,374 1.20 7,874 1.51
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total permanent residential loans 159,535 45.73 162,760 45.52 270,598 57.77 314,899 59.24 258,991 49.53
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Commercial real estate loans:
Hotels 6,303 1.81 9,652 2.70 9,651 2.06 10,240 1.93 9,208 1.76
Office and warehouse facilities 27,153 7.78 30,483 8.52 27,178 5.80 26,710 5.02 36,659 7.01
Retail facilities 16,987 4.87 17,450 4.88 18,181 3.88 18,249 3.43 22,823 4.37
Other 1,983 0.57 5,459 1.53 3,304 0.71 2,714 0.51 7,921 1.51
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total commercial real estate loans 52,426 15.03 63,044 17.63 58,314 12.45 57,913 10.89 76,611 14.65
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Construction loans:
Residential 1- to 4-family 53,900 15.45 51,637 14.44 43,807 9.35 44,208 8.32 47,232 9.03
Residential 5 or more family 2,234 0.64 4,224 1.18 8,855 1.89 12,784 2.40 19,621 3.75
Nonresidential 50 0.02 50 0.02 3,365 0.72 1,420 0.27 4,101 0.79
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total construction loans 56,184 16.11 55,911 15.64 56,027 11.96 58,412 10.99 70,954 13.57
Land acquisition and development loans:
Consumer lots 5,906 1.69 5,646 1.58 5,396 1.15 4,573 0.86 3,703 0.71
Acquisition and development 14,950 4.29 14,961 4.18 16,010 3.42 13,327 2.51 11,444 2.19
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total land acquisition and
development loans 20,856 5.98 20,607 5.76 21,406 4.57 17,900 3.37 15,147 2.90
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total real estate loans 289,001 82.85 302,322 84.55 406,345 86.75 449,124 84.49 421,703 80.65
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Consumer loans:
Boats 12,004 3.44 9,766 2.73 7,814 1.67 5,685 1.07 4,275 0.82
Home equity and second mortgage 23,252 6.67 20,811 5.82 29,578 6.31 45,194 8.50 52,845 10.11
Mobile homes 392 0.11 206 0.06 137 0.03 95 0.02 52 0.01
Other 7,052 2.02 5,211 1.46 6,606 1.41 7,250 1.36 10,537 2.01
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total consumer loans 42,700 12.24 35,994 10.07 44,135 9.42 58,224 10.95 67,709 12.95
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Commercial business loans 17,129 4.91 19,259 5.38 17,922 3.83 24,222 4.56 33,485 6.40
------- ----- ------- ----- ------- ----- ------- ----- ------- -----
Total loans 348,830 100.00% 357,575 100.00% 468,402 100.00% 531,570 100.00% 522,897 100.00%
------- ====== ------- ====== ------- ====== ------- ====== ------- ======
Less:
Allowance for loan losses 3,789 3,696 3,806 3,783 4,024
Undisbursed portion of construction and
acquisition and development loans 39,397 34,728 42,309 42,067 35,463
Unearned discounts, premiums, and
loan fees, net 66 (43) 68 (767) (1,373)
------- ------- ------- ------- -------
43,252 38,381 46,183 45,083 38,114
------- ------- ------- ------- -------
Total loans, net $305,578 $319,194 $422,219 $486,487 $484,783
======= ======= ======= ======= =======
7
Loan Maturities and Interest Rate Sensitivity. The following tables set
forth the fixed-rate and adjustable-rate composition and the contractual
maturities by general loan categories of the Company's loan portfolio at
December 31, 1998. Loans shown in the second table as including a "call"
provision are fixed-rate loans that permit the Company to demand payment of the
loan on one or more specified dates as set forth in the loan documents. Such
loans are included in the category in which they first may be called by the
Company. The amounts shown for each period do not take into account loan
prepayments. The contractual maturities of the loans indicated in the following
tables do not necessarily reflect the actual average life of loans in the
Company's loan portfolio because of loan prepayments and other factors.
Maturity in:
--------------------------------------------------------------------------
Over one Over five Over ten Over
One year to five to ten to twenty twenty
or less years years years years Total
-------- -------- -------- -------- ------ -----
(Dollars in Thousands)
Permanent 1- to 4-family $13,247 $ 30,847 $ 34,860 $ 87,405 $ 84,758 $251,117
Permanent 5 or more family 591 1,796 2,313 3,164 10 7,874
Commercial real estate 7,328 21,980 22,731 23,676 896 76,611
Construction 70,954 - - - - 70,954
Land acquisition and development 11,287 943 635 1,449 833 15,147
Consumer 36,881 17,274 6,636 4,243 2,675 67,709
Commercial business 23,581 8,934 707 263 - 33,485
------ ------ ------ ------ ------ -------
Total $163,869 $ 81,774 $ 67,882 $120,200 $ 89,172 $522,897
======= ======= ====== ======= ======== ========
Maturity after December 31, 1999:
----------------------------------------------------------------------------
Floating
or
Fixed Adjustable
Rates Rates Calls Total
-------- ---------- ----- -----
(Dollars in Thousands)
Permanent 1- to 4-family $45,851 $178,126 $13,893 $237,870
Permanent 5- or more family 281 4,673 2,329 7,283
Commercial real estate 12,543 29,707 27,033 69,283
Construction - - - -
Land acquisition and development 464 56 3,340 3,860
Consumer 21,690 268 8,870 30,828
Commercial business 8,525 1,171 208 9,904
------- ------- ------ -------
Total $89,354 $214,001 $55,673 $359,028
======= ======== ======= =======
CENIT Bancorp Credit Policy. The Company's credit policy establishes
minimum requirements for credit policies and provides for appropriate
limitations on overall concentration of credit within the Company. The policy
provides guidance in general credit policies, underwriting policies and risk
management, credit approval, and administrative and problem asset management
policies. The overall goal of the Company's credit policy is to ensure that loan
growth is accompanied by acceptable asset quality with uniform and consistently
applied approval, administration, and documentation practices and standards.
8
Origination, Purchase, and Sale of Loans. The Company originates
residential mortgage loans both for investment and for sale in the secondary
mortgage market. The Company originates permanent residential ARM loans secured
by one- to four-family residences ("residential ARM loans") generally for
investment because the adjustable interest rate feature is compatible with the
Company's interest rate risk management program. The Company also originates
permanent residential fixed-rate mortgage loans secured by one-to four-family
residences ("residential fixed-rate mortgage loans") generally for sale in the
secondary mortgage market. This lending activity enables the Company to offer
its customers a more complete range of mortgage loan products while reducing the
Company's exposure to interest rate risk and also enabling the Company to
continue to make certain types of mortgage loans for which funds would not
otherwise be available. Generally, residential fixed-rate mortgage loans sold in
the secondary mortgage market are sold for cash to private institutional
investors or to government agencies. When the Company originates and sells
residential fixed-rate mortgage loans in the secondary mortgage market, the
Company acts as a mortgage broker rather than as a mortgage banker. This
arrangement between the Company and its correspondents in the secondary mortgage
market protects the Company from changes in interest rates after a mortgage
customer accepts a commitment from the Company for a residential fixed- rate
mortgage loan. This enables the Company to offer residential fixed-rate mortgage
loans to its customers with little risk to the Company. The Company's general
practice is to sell most residential fixed-rate mortgage loans on a
servicing-released basis, which results in the payment of a premium to the
Company that the Company accounts for as a gain on mortgage loans sold.
In 1998, the Company purchased a total of approximately $54.4 million in
residential mortgage loans which included $48.7 million of loans which were
purchased on a bulk basis from two other financial institutions. The loans
acquired on a bulk basis consisted of adjustable-rate residential mortgage
loans, of which 97.1% are secured by real estate located primarily outside the
Company's primary market area.
The Company will continue to make bulk purchases of single family
residential mortgage loans located outside its market area for investment, as
needed, to supplement its origination of mortgage loans. In January 1999, the
Company purchased $22.5 million of residential single-family mortgage loans
secured by real estate located primarily outside the Company's primary market
area.
9
The following table sets forth information about originations, purchases,
sales, and principal reductions for the Company's loans for the years indicated:
Year ended December 31,
----------------------------------
1996 1997 1998
-------- -------- --------
(Dollars in Thousands)
Loans originated:
Real estate:
Permanent:
Residential 1- to 4-family $73,949 $ 71,802 $ 98,150
Residential 5 or more family - 840 2,093
-------- -------- --------
Total 73,949 72,642 100,243
-------- -------- --------
Commercial real estate 5,622 8,450 25,154
-------- -------- --------
Construction:
Residential 1- to 4-family 17,938 14,200 24,630
Residential 5 or more family 4,094 2,772 12,750
Nonresidential 3,487 1,249 6,153
-------- -------- --------
Total 25,519 18,221 43,533
-------- -------- --------
Land acquisition:
Consumer lots 1,176 584 1,048
Acquisition and development 3,756 6,646 4,559
-------- -------- --------
Total 4,932 7,230 5,607
-------- -------- --------
Total real estate loans originated 110,022 106,543 174,537
-------- -------- --------
Consumer:
Home equity and second mortgage 19,909 32,715 35,512
Other 5,357 6,422 9,316
-------- -------- --------
Total 25,266 39,137 44,828
-------- -------- --------
Commercial business 34,978 38,896 46,406
-------- -------- --------
Total loans originated 170,266 184,576 265,771
Loans purchased 105,889 83,584 55,323
-------- -------- --------
Total loans originated and purchased 276,155 268,160 321,094
-------- -------- --------
Principal reductions:
Repayments and other principal reductions 120,322 158,565 246,555
Real estate loans sold 46,085 45,184 82,512
-------- -------- --------
Total principal reductions 166,407 203,749 329,067
-------- -------- --------
Net increase (decrease) in total loans $109,748 $ 64,411 $ (7,973)
======== ======== ========
Net increase (decrease) in loans held for sale $(1,079) $ 1,243 $ 700
Net increase (decrease) in gross loans held
for investment 110,827 63,168 (8,673)
-------- -------- --------
$109,748 $ 64,411 $ (7,973)
======== ======== ========
10
Residential Mortgage Lending. A major lending activity of the Company is
the origination of residential mortgage loans secured by properties located in
its primary market area in southeastern Virginia. Originations are supplemented
by the bulk purchase of residential mortgage loans outside of the Company's
market area. The Company originates mortgage loans through its branch managers
and its loan officers. The Company currently offers both fixed-rate and
adjustable-rate mortgage loans. At December 31, 1998, $251.1 million were
invested in one-to-four family residential mortgage loans. Of these residential
mortgage loans, $181.1 million or 72.1% were invested in ARM loans and $70.0
million or 27.9% were invested in fixed-rate mortgage loans.
Fixed-rate mortgage loans are offered with 15-year and 30-year terms and
are underwritten by the Company on terms consistent with prevailing secondary
mortgage market standards. The Company's current policy is to sell the majority
of the fixed-rate mortgage loans that it originates to private institutional
investors and government agencies in the secondary mortgage market. See -
"Origination, Purchase, and Sale of Loans" above.
The Company also currently offers ARM loans with terms of up to 30 years.
Generally, the Company's ARM loans have an initial fixed interest rate for a
one-year, a three-year or a five-year period. After the first year (or third or
fifth year, if appropriate) of the term of the loan, and once every year
thereafter, the interest rate is adjusted by the Company to an index typically
based on the weekly average yield on United States Treasury securities adjusted
to a constant maturity of one year as made available by the Federal Reserve
Board, plus a margin of (typically) 2.75% for one year ARM loans. The amount of
any increase or decrease in the interest rate on ARM loans is generally limited
to 2% per adjustment period, with a maximum increase of 6% over the initial
interest rate for the duration of the loan. The terms and conditions, including
the index for interest rates of ARM loans offered by the Company, may and do
vary from time to time. Some of the ARM loans offered by the Company contain
provisions that permit the borrower to convert the loan from an adjustable-rate
loan to a fixed-rate loan. The Company does not offer ARM loans that contain
provisions permitting negative amortization. ARM loans generally decrease the
Company's exposure to interest rate risk arising from increases in prevailing
interest rates but create other potential risks for the Company in a steadily
rising interest rate environment. If interest rates were to rise steadily over
several years, interest rates on the Company's ARM portfolio could reach fully
indexed levels and the resulting higher mortgage payments for the Company's
borrowers could increase the potential for loan defaults.
The Company has established written, non-discriminatory loan origination
and underwriting policies for residential mortgage loans. Before making a
residential mortgage loan, the Company assesses the applicant's ability to repay
the loan and the value of the property securing the loan. The Company offers ARM
loans with an interest rate during the first year of the loan that is generally
one and one half to three percentage points below the interest rate for a
similar fixed-rate mortgage loan in order to encourage public acceptance of such
ARM loans. For one-year ARM loans that the Company intends to retain in its loan
portfolio, however, the Company generally qualifies an applicant based on the
applicant's ability to repay the loan at the initial index rate plus 2.75% (this
is also known as the fully-indexed rate). For ARM loans that the Company intends
to sell in the secondary mortgage market, the Company qualifies the applicant
based on the applicable underwriting criteria established by the investor. The
Company obtains a detailed, written loan application to determine a borrower's
ability to repay the loan and verifies the more significant items on the loan
application through the use of credit reports, financial statements, and
employment and income verifications.
The Company requires appraisals or evaluations on all property securing
residential first mortgage loans. The Company has specific appraisal guidelines
for use by appraisers evaluating real property securing residential mortgage
loans made by the Company. Appraisals are performed by outside appraisers
approved by the Company. The Company's policy is also to obtain a physical
survey and a title insurance policy on all residential first mortgage loans. The
Company will, however, waive the physical survey requirement if the title
insurance company will not take exception to not having a new physical survey.
Borrowers must obtain paid hazard insurance policies before closing as well as
paid flood insurance policies before closing when the real property that secures
the loan is located in a designated flood plain. In addition to the monthly
payment of principal and interest, borrowers are generally required to pay on a
monthly basis money sufficient to fund a mortgage escrow account from which the
Company makes disbursements for items such as real estate taxes and hazard and
flood insurance.
The Company's policy is generally to make residential mortgage loans in
amounts up to 80% of the appraised value of the real property securing the loan
where such properties are to be occupied by the borrower and up to 75% of the
appraised value of the real property securing the loan where the property will
not be occupied by the borrower. When the loan-to-value ratio for a residential
mortgage loan exceeds these amounts, the Company generally requires the borrower
to purchase private mortgage insurance to secure further the repayment of the
loan.
11
The Company' s Loan Committee reviews and approves mortgage loan
applications on conforming and nonconforming residential mortgage loans above
certain amounts designated by the Company's Board of Directors. Conforming
refers to standard guidelines for underwriting and loan-to-value ratios that are
approved by the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal
National Mortgage Association ("FNMA") or private investors. Conforming and
nonconforming loans less than the amounts designated by the Company's Board of
Directors may be approved by a residential underwriter; however, the residential
underwriter must have the additional approval of a chief lending officer or the
manager of the Mortgage Loan Department on nonconforming loans.
The Company also originates residential mortgage loans through its private
banking groups. These loans are generally nonconforming jumbos (in excess of
$240,000) to high income and/or net worth borrowers. These loans also may exceed
80% loan- to-value ratio without requiring private mortgage insurance when
lending to high income, creditworthy private banking customers.
Construction Lending. At December 31, 1998, $71.0 million of the Company's
total loans held for investment were construction loans, of which $31.9 million
were undisbursed loan proceeds. Of these construction loans, $47.2 million were
for one- to four-family residences. The following is a discussion of the
Company's construction lending programs.
The Company has an active construction lending program. The Company makes
loans for the construction of one- to four-family residences and, to a lesser
extent, multi-family dwellings. The Company also makes construction loans for
office and warehouse facilities and other nonresidential projects generally
limited to the borrowers that present other business opportunities for the
Company.
The amounts, interest rates and terms for construction loans vary,
depending upon market conditions, the size and complexity of the project, and
the financial strength of the borrower and the guarantors of the loan. The term
for the Company's typical construction loan ranges from 9 to 12 months for the
construction of an individual residence and from 18 months to a maximum of three
years for larger residential or commercial projects. Revolving construction
lines of credit are normally reviewed annually by the Company to determine
whether the line of credit should be renewed. The Company does not typically
amortize its construction loans, and the borrower pays interest monthly on the
outstanding principal balance of the loan. The Company's construction loans
generally have a floating or variable rate of interest plus a margin but
occasionally have a fixed interest rate. The Company's construction loans are
almost always further secured by one or more unconditional personal guarantees.
The Company does not generally finance the construction of commercial real
estate projects built on a speculative basis. For residential builder loans, the
Company limits the number of models and/or speculative units allowed depending
on market conditions, the builder's financial strength and track record, and
other factors. The maximum loan-to-value ratio established by the Company for
one-to-four family residential construction loans is 80% of the property's fair
market value, or 85% of the property's fair market value if the property will be
the borrower's primary residence. The fair market value of a project is
determined on the basis of an appraisal of the project usually conducted by an
independent, outside appraiser acceptable to the Company. For larger projects
where unit absorption or leasing is a concern, the Company may also obtain a
feasibility study or other acceptable information from the borrower or other
sources about the likely disposition of the property following the completion of
construction. The Company has adopted a detailed, written appraisal policy that
appraisers must follow, and it periodically approves appraisers who are
qualified to perform appraisals for the Company, and monitors and reviews the
appraisals which they submit.
As in the case of residential mortgage lending, the Company has established
written, non-discriminatory loan origination and underwriting policies for
construction loans made by the Company. Although some of these policies and
procedures are similar to those for residential mortgage lending, the Company's
construction loan policies and procedures require more detailed examination of
the reputation, financial condition and creditworthiness of the borrower and all
guarantors of the loan, the value and condition of the property securing the
loan before improvements are made, the nature and quality of the improvements to
be made by the borrower, and the value of and market for the property after
construction is completed. Construction loan applications are reviewed and
approved by the Company's Loan Committee. The Company's loan officer principally
responsible for residential construction lending also has the authority to
approve individual, residential one-to-four family construction loans where
there is a binding commitment for a permanent loan upon completion of
construction.
Construction loans for nonresidential projects and multi-unit residential
projects are generally larger and involve a greater degree of risk to the
Company than residential mortgage loans. The Company attempts to minimize such
risks by making construction loans in accordance with the Company's underwriting
standards to established customers in its primary market area and by monitoring
the quality, progress, and cost of construction. Out of market projects to
strong, creditworthy builders or developers may be considered
12
on an exception basis. These loans must be additionally approved by the Bank's
Board of Directors. The maximum loan-to-value established by the Company for
non-residential projects and multi-unit residential projects is 75%; however,
this maximum can be waived for particularly strong borrowers on an exception
basis. Such waivers are reported to the Bank's Board of Directors.
Commercial Real Estate Lending. At December 31, 1998, the Company had $76.6
million of commercial real estate loans. The following is a discussion of the
Company's commercial real estate lending programs.
The Company's commercial real estate loans are primarily secured by the
value of real property and the income arising therefrom. The proceeds of
commercial real estate loans are generally used by the borrower to finance or
refinance the cost of acquiring and/or improving a commercial property. The
properties that typically secure these loans are office and warehouse
facilities, hotels, retail facilities, restaurants and other commercial
properties. The Company's present policy is generally to restrict the making of
commercial real estate loans to borrowers who will occupy or use the financed
property in connection with their normal business operations. However, the
Company will consider making commercial real estate loans under the following
two conditions. First, the Company will consider making commercial real estate
loans for other purposes if the borrower is in strong financial condition and
presents a substantial business opportunity for the Company. Second, the Company
will consider making commercial real estate loans to creditworthy borrowers who
have substantially pre-leased the improvements to recognized credit quality
tenants. Generally, such loans require full amortization over a fifteen-year
term compared to the normal twenty-five year amortization period.
The Company has established written, non-discriminatory loan origination
and underwriting policies for commercial real estate loans. These policies and
procedures are similar in philosophy to those for construction loans. As is the
case with most construction loans, the Company requires specific information
about the financial condition and creditworthiness of the borrower and all
guarantors of the loan. The Company also requires the borrower to provide
detailed information about the cost of the project, the estimated remaining
useful life and replacement costs for the property, the operating history of the
project, the revenues, receipts, and operating expenses for the project, current
and projected occupancy rates, verification of leases where appropriate, and
such other information as is necessary to demonstrate the ability of the project
to generate sufficient cash flows to cover both the operating expenses and the
repayment of the loan.
Commercial real estate loans are usually amortized over a period of time
ranging from fifteen years to twenty-five years and usually have a term to
maturity ranging from five years to fifteen years. These loans normally have
provisions for interest rate adjustments generally after the loan is three to
five years old. The Company's maximum loan-to-value ratio for a commercial real
estate loan is 80%; however, this maximum can be waived for particularly strong
borrowers on an exception basis. Such waivers are reported to the Bank's Board
of Directors. Most commercial real estate loans are further secured by one or
more unconditional personal guarantees. The Company's commercial real estate
loans are approved by its Loan Committee.
In recent years, the Company has structured many of its commercial real
estate loans as mini-permanent loans. The amortization period, term, and
interest rates for these loans vary based on borrower preferences and the
Company's assessment of the loan and the degree of risk involved. If the
borrower prefers a fixed rate of interest, the Company usually offers a loan
with a fixed rate of interest for a term of three to five years, with required
monthly payments of interest only, or principal and interest with an
amortization period of up to twenty-five years. The remaining balance of the
loan is due and payable in a single balloon payment at the end of the initial
term. Additionally, the Company offers a fixed rate of interest for up to
fifteen years for loans that fully amortize during the fifteen- year term. If
the borrower prefers a variable or floating rate of interest, the Company
usually offers a loan with an interest rate indexed to the Company's prime rate
or the Company's average cost of funds plus a margin for a term of five years
with the remaining balance of the loan due and payable in a single balloon
payment at the end of five years. Management of the Company believes that
shorter maturities for commercial real estate loans are necessary to give the
Company some protection from changes in the borrower's business and income as
well as changes in general economic conditions. In the case of fixed-rate
commercial real estate loans, shorter maturities also provide the Company with
an opportunity to adjust the interest rate on this type of interest-earning
asset in accordance with the Company's asset/liability management strategies.
Loans secured by commercial real estate are generally larger and involve a
greater degree of risk than residential mortgage loans. Because payments on
loans secured by commercial real estate are usually dependent on successful
operation or management of the properties securing such loans, repayment of such
loans is subject to changes in both general and local economic conditions and
the borrower's business and income. As a result, events beyond the control of
the Company, such as a downturn in the local economy, could adversely affect the
performance of the Company's commercial real estate loan portfolio. The Company
seeks to minimize
13
these risks by lending to established customers and generally restricting its
commercial real estate loans to its primary market area. Emphasis is placed on
the income producing characteristics and capacity of the collateral.
Consumer Lot Lending. Consumer lot loans are loans made to individuals for
personal use for the purpose of acquiring an unimproved building site for the
construction of a residence to be occupied by the borrower. At December 31,
1998, the Company had $3.7 million of consumer lot loans. Consumer lot loans are
made only to individual borrowers, and each borrower generally must certify to
the Company his intention to build and occupy a single-family residence on his
lot generally within three or five years of the date of origination of the loan.
These loans typically have a maximum term of either three or five years with a
balloon payment of the entire balance of the loan being due in full at the end
of the initial term. The interest rate for these loans is usually a fixed rate
that is slightly higher than prevailing fixed rates for one- to four-family
residential mortgage loans. The maximum loan-to-value ratio for a consumer lot
loan is 80% of the fair market value of the lot determined in accordance with
the Company's appraisal or evaluation policies. The maximum loan-to-value ratio
can be waived for particularly strong borrowers on an exception basis with such
waivers reported to the Bank's Board of Directors. Consumer lot loans up to
$300,000 may be approved by designated residential underwriters and other
designated officers. The Company's consumer lot loans in excess of $300,000 must
be approved by the Company's Loan Committee. Management does not view consumer
lot loans as bearing as much risk as land acquisition and development loans
because such loans are not made for the construction of residences for immediate
resale, are not made to developers and builders, and are not concentrated in any
one subdivision or community.
Land Acquisition and Development Lending. Land acquisition and development
loans are loans made to builders and developers for the purpose of acquiring
unimproved land to be developed for residential building sites, residential
housing subdivisions, multi-family dwellings, and a variety of commercial uses.
At December 31, 1998, the Company had $11.4 million of land acquisition and
development loans, of which $3.6 million were undisbursed loan proceeds. The
Company's present policy is to make land loans to borrowers for the purpose of
acquiring developed lots for single-family, townhouse or condominium
construction or to facilitate the sale of real estate owned ("REO"). The Company
will also make land acquisition and development loans to residential builders
and to experienced developers in strong financial condition in order to provide
additional construction and mortgage lending opportunities for the Company.
Land acquisition and development loans are underwritten and processed by
the Company in much the same manner as commercial construction loans and
commercial real estate loans. The Company uses a lower loan-to-value ratio for
these types of loans, which is a maximum of 65% for unimproved land, and 75% for
developed lots for single-family or townhouse construction, respectively, of the
discounted appraised value of the property as determined in accordance with the
Company's appraisal policies. The maximum loan-to-value ratio can be waived for
particularly strong borrowers on an exception basis with such waivers reported
to the Bank's Board of Directors. The term of land acquisition and development
loans ranges from a maximum of two years for loans relating to the acquisition
of unimproved land to a maximum of five years for other types of projects. All
land acquisition and development loans are generally further secured by one or
more unconditional personal guarantees, and all land acquisition and development
loans are approved by the Company's Loan Committee. Because these loans are
usually in a larger amount and involve more risk than consumer lot loans, the
Company carefully evaluates the borrower's assumptions and projections about
market conditions and absorption rates in the community in which the property is
located and the borrower's ability to carry the loan if the borrower's
assumptions prove inaccurate.
Consumer Lending. The Company offers a variety of consumer loans, including
home equity and second mortgage loans, and other consumer loans, which include
automobile, personal (secured and unsecured), credit card, and loans secured by
savings accounts or certificates of deposit. At December 31, 1998, the balance
of all consumer loans was $67.7 million. The Company offers consumer loans to
its customers as part of its consumer and small business banking strategy and
because the shorter terms and generally higher interest rates on such loans help
the Company maintain a profitable spread between its average loan yield and its
cost of funds. The Company's underwriting standards for consumer loans (other
than loans secured by savings accounts or certificates of deposit) include
detailed, written loan applications, a determination of the applicant's payment
history on other debts, and an assessment of the borrower's ability to meet
existing obligations and payments on the proposed loan. Consumer loans in excess
of $200,000 must be approved by the Company's Loan Committee, and consumer loans
in excess of $400,000 require prior approval by a committee of the Bank's Board
of Directors.
Consumer loans generally have shorter terms and higher interest rates than
residential mortgage loans. Consumer loans secured by collateral other than a
personal residence generally involve more credit risk than residential mortgage
loans because of the type and nature of the collateral or, in certain cases, the
absence of collateral. However, the Company believes the higher yields generally
14
earned on such loans compensate for the increased credit risk associated with
such loans. Home equity loans, second mortgage loans, and other consumer loans
secured by a personal residence do not present as much risk to the Company as
other types of consumer loans.
Boat Loans. At December 31, 1998, the Company had a portfolio of boat loans
totaling $4.3 million. The Company's portfolio of boat loans consists of loans
made by the Company predominantly in its local market area. These loans were
made with fixed or adjustable interest rates and with terms ranging from five to
fifteen years. For the last several years, the Company has made boat loans
primarily to its existing customers and has not marketed or promoted its boat
loan programs at the same level as it once did. As a result, the outstanding
balance of boat loans has gradually decreased over time.
Home Equity and Second Mortgage Lending. The Company offers its customers
home equity lines of credit and second mortgage loans that enable customers to
borrow funds secured by the equity in their homes. Currently, home equity lines
of credit are offered with adjustable rates of interest that are generally
priced at the prime lending rate plus .5%, with the rate for the first 12 months
set at 6.74%. Second mortgage loans are offered with fixed and adjustable rates.
Call option provisions are included in the loan documents for some longer-term,
fixed-rate second mortgage loans, and these provisions allow the Company to make
interest rate adjustments for such loans. The balance of the home equity line of
credit or second mortgage loan, when combined with the balance of the first
mortgage loan, generally may not exceed 80% (90% if the borrower purchases
private mortgage insurance) of the appraised value of the property at the time
the loan commitment is made. Second mortgage loans are granted for a fixed
period of time, usually between five and twenty years, and home equity lines of
credit are made on an open-end, revolving basis under which the borrower is
obligated to pay each month a variable amount equal to accrued interest on the
outstanding principal plus three fourths of one percent of the outstanding
principal. Underwriting procedures similar to those used for first mortgage
loans are followed for all home equity loans and second mortgage loans. At
December 31, 1998, the Company's outstanding home equity and second mortgage
loans totaled $52.8 million.
Commercial Business Lending. Commercial business loan products include
revolving lines of credit to provide working capital, term loans to finance the
purchase of vehicles and equipment, letters of credit to guarantee payment and
performance, and other commercial loans. In general, all of these credit
facilities carry the unconditional guaranty of owners/stockholders. As of
December 31, 1998, the Company had a total of $33.5 million of commercial
business loans.
Revolving, operating lines of credit are typically secured by all current
assets of the borrower, provide for the acceleration of repayment upon any event
of default, are monitored monthly or quarterly to ensure compliance with loan
covenants, and are re- underwritten/renewed annually. Interest rates generally
will float at a spread tied to the Company's prime lending rate. Term loans are
generally advanced for the purchase of, and are secured by, vehicles and
equipment and are normally fully amortized over a two- to five-year term, on
either a fixed or floating rate basis. Loan covenants and cross default triggers
to other bank indebtedness are often established. General business assets of the
borrower may also secure these loans.
The Company's commercial business loan program is administered pursuant to
written, non-discriminatory loan origination and underwriting policies adopted
by the Company's Board of Directors. Commercial business loan applications for
loans are generally approved by the Company's Loan Committee or its Board of
Directors.
Asset Quality
Each month management of the Company prepares detailed written asset
quality reports for the Company's Board of Directors. These reports contain
information about loan production, loan maturities, delinquent loans,
nonperforming loans, and REO and other repossessed assets. These reports also
provide information about the steps management is taking or intends to take with
respect to the collection of delinquent and nonperforming loans and the
disposition of REO and other repossessed assets. Management constantly monitors
and reviews all delinquent and nonperforming loans and all REO and other
repossessed assets in order to develop appropriate plans to collect delinquent
loans or to dispose of foreclosed or repossessed properties as promptly as
possible.
Loan Collection. When a borrower fails to make a required payment on a
loan, the Company takes a number of steps to have the borrower cure the
delinquency and restore the loan to current status. In the case of residential
mortgage loans and consumer loans, the Company generally sends the borrower a
written notice of nonpayment after the loan is first past due. Following the
mailing of written notice, if the loan is still past due, the Company generally
attempts to contact the borrower by telephone. If the loan is not brought
current and it becomes necessary for the Company to take legal action, the
Company will generally commence foreclosure
15
proceedings against any real property that secures the loan and attempt to
repossess any personal property that secures a consumer loan. If a foreclosure
action is instituted and the loan is not brought current, paid in full, or
refinanced before the foreclosure sale, the real property securing the loan is
sold at foreclosure, at which time the real property may be purchased by one of
the Company's service corporations.
In the case of commercial real estate loans, construction loans, land
acquisition and development loans, and commercial business loans, the Company
generally attempts to contact the borrower by telephone after any loan payment
is seven days past due. Because these loans are often larger in amount and more
complex than residential mortgage loans or consumer loans, the loan officer for
the delinquent account is usually involved in all collection efforts from the
time the loan first becomes delinquent. Decisions on when to commence
foreclosure actions for commercial real estate loans, other commercial loans,
and construction loans are made on a case by case basis. The Company will
consider loan work-out arrangements with commercial customers in appropriate
cases.
Delinquent Loans. The following table sets forth certain information at the
dates indicated relating to delinquent loans and the percentage of such loans to
total gross loans held for investment. The information presented below excludes
matured loans for which the borrowers are still making required monthly payments
of interest or principal and interest. At December 31, 1998, there were no such
amounts. At December 31, 1997 and December 31, 1996, such amounts totaled $6,000
for 90 days and over, and $185,000 for loans 30-59 days delinquent,
respectively.
At December 31,
----------------------------------------------------------------------------------------------
1996 1997 1998
---------------------- ----------------------- -----------------------
(Dollars in Thousands)
Amount Percent Amount Percent Amount Percent
------ ----- ------ ----- ------ -----
30-59 days $1,004 0.21% $ 729 0.14% $ 985 0.19%
60-89 days 727 0.16 859 0.16 490 0.09
90 days and over 2,822 0.60 1,097 0.21 1,076 0.21
------ ----- ------ ----- ------ ----
Total $4,553 0.97% $2,685 0.51% $2,551 0.49%
====== ===== ====== ===== ====== =====
Nonperforming Assets. The Company's nonperforming assets include
nonperforming loans, REO, other repossessed assets, and claims receivable
property. The Company does not generally accrue interest on loans that are 90
days or more past due and does not include in its interest income interest on
such loans that accrued during the first 90 days after the loan became
delinquent (with the exception of certain VA-guaranteed or FHA-insured one- to
four-family permanent mortgage loans, certain credit card loans, and matured
loans for which the borrowers are still making required monthly payments of
interest, or principal and interest, and with respect to which the Company is
negotiating extensions or refinancings with the borrowers).
Real property purchased or acquired by foreclosure or by deed in lieu of
foreclosure is classified as REO until sold. REO is recorded at the lower of
cost or estimated fair value as determined by independent appraisals. If the
fair value of REO is less than the book value of the loan formerly secured by
such REO, the fair value becomes the new cost basis of the REO, and the
difference is charged against the allowance for loan losses on the date of
foreclosure or completion of the appraisal. Subsequent valuations are
periodically performed and valuation allowances are established if the carrying
value of the real estate exceeds estimated fair value less estimated costs of
sales. Other repossessed assets (boats, mobile homes, automobiles, etc.) are
carried at the lower of cost or estimated fair value as determined by
independent surveys or appraisals at the time of repossession. If the fair value
of the repossessed asset is less than the book value of the loan formerly
secured by such repossessed asset, the difference between the book value and the
fair value is charged to the allowance for loan losses on the date of
repossession.
16
The following table sets forth information about the Company's
nonperforming loans, REO, other repossessed assets, and troubled debt
restructurings at the dates indicated. Effective January 1, 1995, the Company
adopted Statement of Financial Accounting Standards No. 114 (FAS 114),
"Accounting by Creditors for Impairment of a Loan." The effect of this adoption
was to reclassify as loans $3.4 million of insubstance foreclosure loans which
were previously classified as real estate owned (REO).
At December 31,
----------------------------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(Dollars in Thousands)
Nonperforming loans:
Real estate loans:
Permanent residential 1- to 4-family:
Nonaccrual $ 437 $ 420 $ 1,172 $ 528 $ 359
Accruing loans 90 days or more past due 490 77 246 53 511
-------- -------- -------- -------- --------
Total 927 497 1,418 581 870
-------- -------- -------- -------- --------
Permanent residential 5 or more family:
Nonaccrual 90 - - - -
Accruing loans 90 days or more past due 46 - - - -
-------- -------- -------- -------- --------
Total 136 - - - -
-------- -------- -------- -------- --------
Commercial real estate:
Nonaccrual 139 - 457 - -
-------- -------- -------- -------- --------
Total 139 - 457 - -
-------- -------- -------- -------- --------
Construction:
Nonaccrual 53 - - - -
Accruing loans 90 days or more past due - - 170 - -
-------- -------- -------- -------- --------
Total 53 - 170 - -
-------- -------- -------- -------- --------
Land acquisition and development:
Nonaccrual 527 200 200 200 -
-------- -------- -------- -------- --------
Total 527 200 200 200 -
-------- -------- -------- -------- --------
Consumer loans:
Boats - - - 10 37
Home equity and second mortgage 18 107 - - 57
Credit cards (accruing loans 90 days or
more past due) 23 13 9 5 2
Other 310 137 100 62 46
-------- -------- -------- -------- --------
Total 351 257 109 77 142
-------- -------- -------- -------- --------
Commercial business loans:
Nonaccrual 65 70 483 240 64
Accruing loans 90 days or more past due 16 4 - 5 -
-------- -------- -------- -------- --------
Total 81 74 483 245 64
-------- -------- -------- -------- --------
Total nonperforming loans:
Nonaccrual 1,639 934 2,412 1,040 563
Accruing loans 90 days or more past due 575 94 425 63 513
-------- -------- -------- -------- --------
Total 2,214 1,028 2,837 1,103 1,076
Real estate owned, net 5,718 1,828 2,769 1,098 377
Other repossessed assets, net 233 1 55 228 21
-------- -------- -------- -------- --------
Total nonperforming assets, net 8,165 2,857 5,661 2,429 1,474
Total troubled debt restructurings - - - - -
-------- -------- -------- -------- --------
Total nonperforming assets, net, and
troubled debt restructurings $ 8,165 $ 2,857 $ 5,661 $ 2,429 $ 1,474
======== ======== ======== ======== ========
Total nonperforming assets, net, and troubled
debt restructurings, to total assets 1.42% .45% .80% .34% .23%
======== ======== ======== ======== ========
17
Nonperforming Loans. At December 31, 1998, the Company's nonaccrual loans
totaled $563,000. This was comprised of $416,000 of single-family and home
equity loans, $15,000 of purchased mobile home loans, $64,000 of commercial
business loans, and $68,000 of other consumer loans. Total nonperforming loans
were $1.1 million at December 31, 1998. Interest income on nonaccrual loans at
December 31, 1998 would have approximated $61,000 for the year ended December
31, 1998, if such loans had been current and performing under their stated,
contractual terms throughout the year. Interest income actually recognized on
nonaccrual loans at December 31, 1998 approximated $36,000.
Classified Assets. In accordance with applicable regulations and
guidelines, the Company has adopted a detailed, written policy (the
"Classification Policy") concerning the internal review and classification of
assets. Pursuant to this policy, an asset is considered "substandard" if it (i)
is inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged and (ii) is characterized by the "distinct
possibility" that the insured institution will sustain "some loss" if the
deficiencies are not corrected. Assets classified as "doubtful" have all of the
weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted.
The Company's Internal Review Committee meets each quarter to identify any
assets that have undergone a change in circumstances. The Company's objective is
to identify problem assets early in order to minimize losses. Assets that are
classified by the Company are reviewed at least quarterly to determine whether
corrective action has had the effect of improving the quality of the classified
asset. At December 31, 1998, the Company had $1.9 million of assets classified
as substandard, including $754,000 of REO, other repossessed assets, and claims
receivable property, $17,000 of assets classified as doubtful, and $28,000 of
assets classified as loss. All assets classified as loss have been fully
reserved. These amounts compare with $4.3 million, $97,000 and $90,000 of assets
classified as substandard, doubtful, and loss, respectively, at December 31,
1997.
Real Estate Owned, Other Repossessed Assets and Claims Receivable Property.
The Company's REO includes real estate acquired by foreclosure or deed in lieu
of foreclosure. The Company's REO decreased from $1.1 million at December 31,
1997 to $377,000 at December 31, 1998. REO at December 31, 1998 is comprised of
three residential single-family properties and land of $105,000.
Repossessed assets at December 31, 1998 totaled $21,000. Repossessed assets
at December 31, 1997 totaled $228,000 and was comprised primarily of a boat
which was sold in 1998.
Claims receivable property at December 31, 1998 is $356,000. This
represents a purchased loan on a single-family property in Stone Mountain, GA.
The Company is pursuing legal remedies against the originator of the loan for
misrepresentation of the loan. Management of the Company believes it will
recover all principal and costs associated with the loan.
Loans. Loans classified as substandard at December 31, 1998 were comprised
of $566,000 (eleven loans) of permanent one-to-four family real estate loans,
$404,000 (2 loans) of commercial real estate loans, a $31,000 commercial
business loan, and $154,000 (thirteen loans) of consumer loans.
Allowance for Loan Losses. In establishing the allowance for loan losses,
the Company's current evaluation procedures segregate certain outstanding loans
into pools based on similar risk and loss characteristics. These pools of loans
are established with regard to the homogeneity of certain types of loans and
other factors such as the nature of the collateral and other specific risk
factors. Under the pool approach, management considers various risk factors and
attempts to estimate an allowance sufficient to provide for future losses in the
class being evaluated taken as whole. This allowance includes specific
allowances for assets criticized under the Company's Classification Policy, as
well as a general allowance for noncriticized assets in the pool based on
certain general risk factors, historical trends in the portfolio, and other
factors deemed relevant by the Company's Internal Review Committee. This
allowance also includes a specific allowance for those assets criticized as loss
under the Classification Policy. The specific allowances are established based
on a review of individual loans and the estimated fair value of the collateral
for those loans.
In addition to reviewing loans by pools based on similar risk and loss
characteristics, all nonaccrual construction loans, commercial real estate
loans, acquisition and development loans, and commercial loans are analyzed
monthly on a loan-by-loan basis. In addition, all performing classified assets
of these loan types are analyzed at least quarterly. The loan-by-loan method is
utilized by the Company for these types of loans because such loans are
generally originated in greater principal amounts and the types of borrowers and
purpose of the loans are generally dissimilar. Management reviews the status of
these loans and any charge-offs included in these
18
categories in the quarterly meeting of the Internal Review Committee to
establish general allowances and to determine whether its existing allowances
are adequate. Management also reviews and evaluates local business and economic
trends in its market area as part of its analysis of the adequacy of its
allowance for loan losses for these types of loans. When necessary, specific
allowances for loan losses relating to these loans are established based on the
fair values of the specific collateral.
At December 31, 1998, the Company had total valuation allowances of $4.0
million, including $28,000 of specific allowances. In evaluating the adequacy of
its allowance for loan losses, management takes into account the types of loans
the Company is presently making, the risks inherent in those types of loans,
specific delinquency and historical loss trends of which management is aware,
and future interest rate, economic, and other conditions that may adversely
affect the performance of the Company's loans.
The Company's provision for loan losses was $510,000 in 1998 compared to
$600,000 in 1997. Net chargeoffs decreased from $623,000 in 1997 to $269,000 in
1998.
At December 31, 1998, the Company's total allowance for loan losses was
$4.0 million and nonperforming loans totaled $1.1 million, resulting in a
coverage ratio of 374.0%. At December 31, 1997, the Company's total allowance
for loan losses was $3.8 million and nonperforming loans totaled $1.1 million,
resulting in a coverage ratio of 343.0%.
The Company's total allowance for loan losses at December 31, 1998 included
$1.6 million not specifically allocated to a particular loan type, compared to
$1.5 million not allocated to a particular loan type at December 31, 1997.
19
The following table sets forth an analysis of the Company's allowance for
loan losses for the periods indicated.
Year ended December 31,
-------------------------------------------------------------------------
1994 1995 1996 1997 1998
-------- ------- ------- -------- --------
(Dollars in Thousands)
Balance at beginning of year $ 4,039 $ 3,789 $ 3,696 $ 3,806 $ 3,783
-------- ------- ------- -------- --------
Charge-offs:
Real estate:
Residential 201 474 312 359 173
Commercial - - 75 181 -
Mobile home 198 91 50 22 26
Other consumer 573 371 199 180 143
Commercial 52 59 102 94 40
-------- ------- ------- -------- --------
Total charge-offs 1,024 995 738 836 382
Recoveries 127 205 471 213 113
-------- ------- ------- -------- --------
Total charge-offs, net 897 790 267 623 269
Allowance for loans acquired in business
combination 157 - - - -
Provision for loan losses 490 697 377 600 510
-------- ------- ------- -------- --------
Balance at end of year $ 3,789 $ 3,696 $ 3,806 $ 3,783 $ 4,024
======== ======= ======= ======== ========
Ratio of net charge-offs during the year to
average loans receivable during the year 0.30% 0.24% 0.08% 0.13% 0.05%
Ratio of allowance for loan losses to total
outstanding loans (gross) at end of year 1.09% 1.03% 0.81% 0.71% 0.77%
Allowance for loan losses as a percentage
of nonperforming loans 171.14% 359.53% 134.16% 342.97% 373.98%
20
The following table sets forth the allocation of the allowance for loan
losses at the dates indicated by category of loans and as a percentage of the
Company's total loans. The entire allowance for loan losses is available to
absorb losses from any type of loan.
At December 31,
---------------------------------------------------------------------------------------
1994 1995 1996 1997 1998
---------------- --------------- ---------------- --------------- ----------------
Percent Percent Percent Percent Percent
of loans of loans of loans of loans of loans
in each in each in each in each in each
category category category category category
to total to total to total to total to total
Amount loans Amount loans Amount loans Amount loans Amount loans
------ ------- ------- -------- ------ --------- ------- -------- ------ --------
(Dollars in Thousands)
Real estate loans:
Permanent:
Residential 1- to 4-family $ 514 42.57% $ 451 42.91% $ 512 56.25% $ 484 58.04% $ 350 48.02%
Residential 5 or more family 79 3.16 36 2.61 21 1.52 25 1.20 6 1.51
Commercial real estate 764 15.03 869 17.63 799 12.45 698 10.89 824 14.65
Construction loans:
Residential 1- to 4-family 329 15.45 337 14.44 251 9.35 243 8.32 472 9.03
Residential 5 or more family 22 0.64 42 1.18 89 1.89 128 2.40 196 3.75
Nonresidential 1 0.02 1 0.02 34 .72 14 .27 41 .79
Land acquisition:
Individual lots 15 1.69 18 1.58 23 1.15 20 .86 37 .71
Acquisition and development 178 4.29 137 4.18 127 3.42 133 2.51 114 2.19
Consumer loans:
Mobile homes 293 0.11 116 0.06 43 .03 40 .02 1 .01
Other consumer 265 12.13 195 10.01 283 9.39 161 10.93 122 12.94
Commercial business loans 327 4.91 350 5.38 316 3.83 342 4.56 237 6.40
Unallocated 1,002 - 1,144 - 1,308 - 1,495 - 1,624 -
------ ------ ------ ------ ------ ------- ------ ------ ------ -------
$3,789 100.00% $3,696 100.00% $3,806 100.00% $3,783 100.00% $4,024 100.00%
====== ====== ====== ====== ====== ======= ====== ====== ====== =======
21
Mortgage-Backed Certificates
The Company invests in mortgage-backed certificates that are insured or
guaranteed by FNMA, FHLMC, or the Government National Mortgage Association
("GNMA"). On December 31, 1998, mortgage-backed certificates available for sale
totaled $17.0 million. The weighted average yield on the total mortgage-backed
certificate portfolio at December 31, 1998 was 7.67%.
The following table sets forth the composition of the Company's portfolio
of mortgage-backed certificates at the dates indicated.
At December 31,
------------------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998
------------------ ---------------- ---------------- ----------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Mortgage-backed certificates
available for sale:
FHLMC:
Fixed rate $ 342 0.19% $ 24,963(2) 12.29% $ 20,033 (3) 11.27% $ 3,825(4) 4.16% $ 1,329 7.81%
Adjustable rate - - 154,891 76.23 144,020 81.04 78,435 85.41 10,330 60.70
FNMA:
Fixed rate - - 965 0.48 830 0.47 727 .79 569 3.34
Adjustable rate - - 17,909 8.81 9,283 5.22 6,067 6.61 2,776 16.31
GNMA:
Fixed rate - - 4,448 2.19 3,540 2.00 2,787 3.03 2,015 11.84
Adjustable rate - - - - - - - - - -
------- ---- ------- ------ ------- ------ ------ ------ ------ ------
Total available for sale 342 0.19 203,176 100.00 177,706 100.00 91,841 100.00 17,019 100.00
------- ---- ------- ------ ------- ------ ------ ------ ------ ------
Mortgage-backed certificates
held to maturity:
FHLMC:
Fixed rate 94,448(1) 53.74 - - - - - - - -
Adjustable rate 57,305 32.60 - - - - - - - -
FNMA:
Fixed rate 1,048 0.60 - - - - - - - -
Adjustable rate 17,686 10.06 - - - - - - - -
GNMA:
Fixed rate 4,934 2.81 - - - - - - - -
Adjustable rate - - - - - - - - - -
------- ---- ------- ------ ------- ------ ------ ------ ------ ------
Total held to maturity 175,421 99.81 - - - - - - - -
------- ---- ------- ------ ------- ------ ------ ------ ------ ------
Total mortgage-backed
certificates $175,763 100.00% $ 203,176 100.00% $ 177,706 100.00% $ 91,841 100.00% $ 17,019 100.00%
======== ====== ========= ====== ========= ====== ======== ====== ======== ======
_______________
<FN>
(1) Includes $77.6 million and $13.9 million with five- and seven-year balloon provisions, respectively.
(2) Includes $10.5 million and $11.9 million with five- and seven-year balloon provisions, respectively.
(3) Includes $7.7 million and $10.3 million with five- and seven-year balloon provisions, respectively.
(4) Includes $2.1 million and $6,000 with five- and seven-year balloon provisions, respectively.
</FN>
Mortgage-backed certificates present limited credit risk to the Company
because of the insurance or guarantees that stand behind them. However, the
value of the Company's mortgage-backed certificates fluctuates in response to
changing economic and interest rate conditions and the rate of prepayment of the
underlying mortgages. It has been the Company's experience that most
mortgage-backed certificates prepay substantially in advance of their scheduled
amortizations. Mortgage-backed certificates can also be used as collateral for
borrowings. Mortgage-backed certificates constitute a "qualified thrift
investment" for purposes of the qualified thrift lender test and carry a
relatively low risk-weight for purposes of determining compliance with the
risk-based capital standard established by the Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 ("FIRREA"). See "Regulation and
Supervision--Regulation of the Bank--Regulatory Capital Requirements" and
"--Qualified Thrift Lender Test."
22
The following table sets forth information about purchases, sales,
principal repayments, and changes in unrealized gains on securities available
for sale with respect to the Company's mortgage-backed certificates for the
periods indicated.
Year ended December 31,
--------------------------------------------------------------
1996 1997 1998
---- ---- ----
(Dollars in Thousands)
Mortgage-backed certificates purchased $ 48,772 $ - $ 27,656
Mortgage-backed certificates sold (6,739) (35,362) (66,588)
Principal repayments and (amortization)/
accretion of (premiums)/discounts (67,416) (50,104) (35,102)
Change in unrealized gains (losses) on available
for sale securities (87) (399) (788)
--------- ---------- ----------
Net decrease in mortgage-backed certificates $ (25,470) $ (85,865) $ (74,822)
========= ========== ==========
The following table sets forth certain yield, maturity and market value
information concerning the Company's mortgage-backed certificates at December
31, 1998:
Principal maturing in (1):
------------------------------------------------------
Estimated
Market Average
Over five Total Value at Life
One year Over one to to ten Over Carrying December 31, to
or less five years years ten years Amount 1998 Maturity
--------- --------- --------- --------- ---------- ---------- ----------
(Dollars in Thousands) (years)
Held to maturity: $ - $ - $ - $ - $ - $ - -
Available for sale:
FHLMC:
Fixed rate 364 768 197 - 1,329 1,329 2.7
Adjustable rate 5,362 4,875 93 - 10,330 10,330 1.4
FNMA:
Fixed rate 138 362 69 - 569 569 2.6
Adjustable rate 1,499 1,273 4 - 2,776 2,776 1.3
GNMA:
Fixed rate 591 1,416 8 - 2,015 2,015 2.2
Adjustable rate - - - - - - -
--------- --------- --------- --------- ---------- ----------
Total available for sale 7,954 8,694 371 - 17,019 17,019 1.6
--------- --------- --------- --------- ---------- ----------
Total $ 7,954 $ 8,694 $ 371 $ - $ 17,019 $ 17,019 1.6
========= ========= ========= ========= ========== ==========
Weighted average yield 7.58% 7.73% 8.57% -% 7.67%
_______________
<FN>
(1) Reflects estimated average life to maturity based on recent prepayment experience of the Company (approximately 14% to
52%). It has been the Company's experience that most mortgage-backed certificates prepay substantially in advance of their
scheduled amortizations.
</FN>
Investment Activities
The Company is authorized to invest in various types of liquid assets,
including United States Treasury obligations, securities issued by various
federal agencies, certain certificates of deposit of insured banks and savings
institutions, certain bankers' acceptances, repurchase agreements, federal
funds, and FHLB stock. Subject to certain restrictions, the Company may also
invest its assets in commercial paper, corporate debt securities, and mutual
funds. The Company's investment policies do not permit investment in
noninvestment grade bonds.
23
The Company's investment policies were adopted by its Board of Directors,
are approved annually, and authorize the Company to invest in obligations issued
or guaranteed by the United States Government, and the agencies and
instrumentalities thereof, provided that the maturity of such obligations is
less than five years. At December 31, 1998, the Company's investment portfolio
totaled $95.5 million.
The Bank's investment activities are structured in part to enable the Bank
to meet the liquidity requirements mandated under OTS regulations. See
"Regulation and Supervision--Regulation of the Bank--Liquidity." In addition,
the amount of the Company's investments at any time will depend in part upon the
Company's loan originations at that time and the availability of attractive
long- term investments. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Market Rate Risk Management."
The following table sets forth certain information concerning the Company's
investment portfolio at the dates and for the years indicated.
At or for the year ended December 31,
---------------------------------------------------------------------
1996 1997 1998
------------------- -------------------- -------------------
(Dollars in Thousands)
Carrying Average Carrying Average Carrying Average
Value Yield (1) Value Yield (1) Value Yield(1)
------------------- -------------------- -------------------
Investment securities available for sale:
U.S. Treasury securities $ 40,296 6.45% $ 39,343 6.25% $ 26,396 6.07
Other U.S. Government agency securities 6,009 6.36 6,004 6.28 21,471 5.71
Other debt security 250 9.26
Federal funds sold 6,003 5.32 37,118 5.55 42,289 5.30
Federal Home Loan Bank and Federal
Reserve Bank stock 7,861 7.20 8,711 7.21 5,066 (2) 7.39
-------- -------- --------
Total investments $ 60,169 6.42 $ 91,176 6.30 $ 95,472 6.00
======== ======== ========
__________
<FN>
(1) Yields are calculated during the years indicated.
(2) Due to the merger of the Company's subsidiary banks in 1998, investment in Federal Reserve Bank Stock is no longer required
and stock was redeemed in 1998.
</FN>
The following table presents certain yield, maturity, and market value data
for the U.S. Treasury securities and other U.S. Government agency securities in
the Company's investment portfolio at December 31, 1998. Investment securities
with "call" provisions that permit the issuer to demand payment on one or more
specified dates are included in the category in which they may first be called
by the issuer.
Over One Over Five After Total
One Year to Five to Ten Ten Carrying Market
or Less Years Years Years Value Value
--------- --------- ------- ------- -------- --------
(Dollars in Thousands)
Investment securities available for sale:
U.S. Treasury securities $ 12,079 $ 14,317 $ - $ - $ 26,396 $ 26,396
========= ========= ======== ======= ======= ========
Weighted average yield 5.99% 6.15% -% -% 6.07%
Other U.S. Government agency
securities $ 6,365 $ 15,106 $ - $ - $ 21,471 $ 21,471
========= ========= ======== ======= ======= ========
Weighted average yield 6.21% 5.47% -% -% 5.69%
Other debt security $ - $ - $ 250 $ - $ 250 $ 250
========= ========= ======== ======= ======= ========
Weighted average yield -% -% 9.26% -% 9.26%
24
Sources of Funds
General. The Company's lending and investment activities are funded
primarily by deposits, principal and interest payments on loans and investments,
and borrowings from the FHLB-Atlanta.
Deposits. The Company's primary market for attracting deposits is the
Hampton Roads area. The Company attracts short-term and long-term deposits from
the general public by offering a wide variety of deposit accounts, competitive
interest rates, and convenient office locations and service hours. The Company
offers savings accounts, personal and commercial checking accounts, money market
deposit accounts, and certificates of deposit with terms ranging from 180 days
to 60 months. The Company relies on deposits obtained on a retail basis through
its offices and does not rely significantly on jumbo deposits. Jumbo deposits
are viewed as a less reliable source of deposits because they tend to be more
sensitive to variations in the interest rates paid by the Company and its
competitors. As a matter of policy, the Company does not accept brokered
deposits, which management views to be a highly interest rate sensitive source
of funds.
The Company's ability to attract and maintain deposits at favorable rates
is affected by competitive interest rates in the Company's market area and
general economic conditions.
The following table sets forth the distribution and the weighted average
interest rates of the Company's deposit accounts at the dates indicated.
At December 31,
-----------------------------------------------------------------------------------------------------------
1996 1997 1998
--------------------------------- --------------------------------- ---------------------------------
Weighted Weighted Weighted
Percent of Average Percent of Average Percent of Average
Total Nominal Total Nominal Total Nominal
Amount Deposits Rate Amount Deposits Rate Amount Deposits Rate
------ -------- ---- ------ -------- ---- ------ -------- ----
(Dollars in Thousands)
Commercial checking $ 40,130 8.04% -% $ 47,499 9.36% -% $ 69,801 14.05% -%
Savings 48,042 9.62 3.38 44,118 8.69 3.34 36,588 7.37 2.46
Personal checking 36,290 7.29 2.24 40,129 7.90 2.05 50,673 10.20 1.18
Money market deposits 44,815 8.98 3.25 47,726 9.40 3.25 73,896 14.87 3.36
-------- ------ -------- ------ -------- ------
Subtotal 169,277 33.93 2.30 179,472 35.35 2.14 230,958 46.49 1.72
Certificate accounts 329,688 66.07 5.37 328,198 64.65 5.41 265,814 53.51 5.21
-------- ------ -------- ------ -------- ------
Total deposits $498,965 100.00% 4.33 $507,670 100.00% 4.26 $496,772 100.00% 3.59%
======== ====== ======== ====== ======== ======
25
The following table sets forth the activity in the Company's deposits
during the periods indicated.
Year Ended December 31,
----------------------------------------------
1996 1997 1998
-------- -------- --------
(Dollars in Thousands)
Beginning balance $450,530 $498,965 $507,670
-------- -------- --------
Deposits acquired 68,101 - -
Net decrease before interest credited (35,692) (9,071) (27,883)
Interest credited (1) 16,026 17,776 16,985
-------- -------- --------
Net increase (decrease) in savings deposits 48,435 8,705 (10,898)
-------- -------- --------
Ending balance $498,965 $507,670 $496,772
======== ======== ========
_________________
<FN>
(1) Does not include interest on deposit accounts paid directly to depositors and not credited to their deposit accounts.
</FN>
The following table sets forth, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1998.
At December 31, At December 31, 1998, Maturing in
------------------------------ ---------------------------------------------------
Greater
One year than three
1996 1997 1998 or less Two years Three years years
---- ---- ---- -------- --------- ----------- -----------
(Dollars in Thousands)
Certificate accounts:
3.99% or less $ 451 $ 519 $ 345 $ 311 $ 12 $ 22 $ -
4.00% to 4.99% 100,302 70,286 121,862 114,228 5,356 1,261 1,017
5.00% to 5.99% 179,399 218,016 113,417 93,632 6,172 6,280 7,333
6.00% to 6.99% 37,244 27,210 18,818 5,047 10,735 1,797 1,239
7.00% to 7.99% 10,280 10,369 9,958 2,543 7,071 344 -
8.00% to 8.99% 775 668 294 58 236 - -
9.00% to 9.99% 1,237 1,130 1,120 1,120 - - -
-------- -------- -------- -------- ------- ------- -------
Total certificates $329,688 $328,198 $265,814 $216,939 $29,582 $9,704 $ 9,589
======== ======== ======== ======== ======= ====== =======
26
At December 31, 1998, the Company had outstanding $24.9 million in
certificate accounts in amounts greater than $100,000 maturing as follows (which
amount includes $1.2 million of jumbo certificates of deposit with negotiable
rates of interest):
Amount
---------------------
(Dollars in Thousands)
Three months or less $ 7,130
Over three months to six months 4,914
Over six months to twelve months 9,043
Over twelve months 3,853
---------
Total $ 24,940
=========
Borrowings. Deposits are the Company's primary source of funds. The Company
also uses borrowings as an additional source of funds. The Company obtains
advances from the FHLB-Atlanta which can be collateralized by certain of its
mortgage loans or mortgage-backed certificates. See "Regulation and
Supervision--Regulation of the Bank--Federal Home Loan Bank System." Such
advances are made pursuant to several credit programs that have specific
interest rates and ranges of maturities. The maximum amount that the
FHLB-Atlanta will advance to member institutions, including the Bank, fluctuates
from time to time in accordance with the policies of the Federal Home Financing
Board and the FHLB-Atlanta and the current financial and operating condition of
the Bank.
The Company's current maximum credit availability from the FHLB-Atlanta is
$192.0 million. At December 31, 1998, the Company had $75.0 million of
outstanding advances from the FHLB-Atlanta.
The following table sets forth certain information regarding FHLB advances
at the dates indicated:
At or for the year ended December 31,
---------------------------------------------------------------
1996 1997 1998
---------- ---------- ----------
(Dollars in Thousands)
Adjustable-rate advances:
One year or less $ 123,000 $ 85,000 $ -
Fixed-rate advances:
One year or less 25,000 - -
Over one year - 60,000 (1) 75,000 (2)
---------- ---------- ----------
Total advances $ 148,000 $ 145,000 $ 75,000
========== ========== ==========
Maximum balance outstanding at any month-end $ 192,000 $ 156,000 $ 158,000
Average amount outstanding during the year $ 154,854 $ 140,077 $ 103,592
Weighted average cost of advances for the year 5.44% 5.58% 5.43%
<FN>
(1) The $60,000,000 fixed-rate advance was convertible to an adjustable-rate advance at the option of the FHLB beginning in
September, 1998, and is convertible quarterly thereafter until the advance's maturity in September, 2007. Through December 31,
1998, the FHLB has not exercised its option.
(2) Consists of the $60,000,000 fixed-rate advance discussed above and a $15,000,000 fixed-rate advance subject, in December 2001,
to a one-time option by the FHLB to convert to an adjustable-rate advance. The advance matures in December, 2003.
</FN>
In 1997, the Company borrowed $4,000,000 from an unrelated third party
lender for general corporate purposes. The loan balance was paid in full during
1998.
27
Securities Sold Under Agreements to Repurchase. From time to time, the
Company enters into reverse repurchase agreements with nationally recognized
primary securities dealers and financial institutions. The Company also enters
into reverse repurchase agreements with commercial deposit customers to enable
these customers to earn interest on excess funds on deposit with the Company.
Reverse repurchase agreements are accounted for as borrowings by the Company and
are generally secured by mortgage- backed certificates. The Company's borrowing
policy sets forth various terms and limitations with respect to reverse
repurchase agreements, including acceptable types and maturities of collateral
securities and the maximum amount of borrowings from any one approved broker.
The following table presents certain information regarding reverse
repurchase agreements during the years indicated:
At or for the year ended December 31,
-------------------------------------
1996 1997 1998
---- ---- ----
(Dollars in Thousands)
Maximum amount outstanding at any month-end $ 30,382 $ 12,199 $ 22,913
Balance at end of year 7,138 9,664 13,084
Average amount outstanding during the year 8,616 8,893 12,026
Weighted average interest rate:
Amount outstanding at end of year 4.40% 4.57% 3.96%
Average amount outstanding during the year 4.67% 4.60% 4.45%
Activities of Subsidiary Companies of CENIT Bank
CENIT Bank is permitted by current OTS regulations to invest a maximum of
two percent of its assets in stock, paid-in surplus, and secured and unsecured
loans to service corporations. CENIT Bank may also invest an additional one
percent of its assets in its service corporations when the additional funds are
used for community or inner city purposes. In addition, federally chartered
savings institutions under certain circumstances also may make conforming loans
to service corporations in which the lender owns or holds more than 10% of the
capital stock in an aggregate amount of up to 50% of regulatory capital. As of
December 31, 1998, CENIT Bank's initial investment in and loans outstanding to
its service corporations totaled $1.9 million. These loans are primarily to
finance the acquisition of REO by CENIT Bank's subsidiaries and the sale of REO
by such subsidiaries and are eliminated in accordance with generally accepted
accounting principles on the Company's Consolidated Financial Statements.
CENIT Bank has a total of seven direct or indirect subsidiaries:
Independent Investors, Inc. ("Independent Investors"); Olney-Duke Investors,
Inc. ("Olney-Duke"); Independent Developers, Ltd. ("Independent Developers");
CENIT Equity Company ("CENIT Equity"); CENIT Mortgage Corporation of North
Carolina ("CENIT Mortgage"), which is a wholly owned subsidiary of CENIT Equity;
CENIT Commercial Mortgage Corporation ("CENIT Commercial Mortgage"); and
Princess Anne Equity Company ("Princess Anne Equity").
Independent Investors is a Virginia corporation incorporated in 1981, which
acts as a corporate trustee on various deeds of trust that secure loans made by
the Bank. At December 31, 1998, CENIT Bank's initial investment in Independent
Investors was $15,000.
Olney-Duke is a Virginia corporation incorporated in 1986 for the original
purpose of owning and marketing certain unsold units in a condominium complex
acquired at foreclosure following the default of the original developer/builder.
In 1993 Olney-Duke entered into an arrangement with L. M. Associates, a
subsidiary of Legg Mason, Inc., to offer full-service stock and investment
brokerage to customers of CENIT Bank in its retail branches. Olney-Duke's 1998
activities consisted of transactions with L. M. Associates. At
December 31, 1998, CENIT Bank's initial investment in and loans outstanding to
Olney-Duke totaled $25,500.
CENIT Equity is a Virginia corporation incorporated in 1977 which primarily
acquires properties at foreclosure sales or by deeds in lieu of foreclosure
following borrower defaults on loans made by CENIT Bank. CENIT Equity then
markets such REO for resale. At December 31, 1998, CENIT Equity held REO with a
total net book value of $377,000, and the Company's initial investment in and
loans outstanding to CENIT Equity amounted to $1.8 million.
28
Independent Developers is a Virginia corporation incorporated in 1977.
Independent Developers and a local builder and developer were involved in a
partnership in the development of unimproved land into residential building
sites and in the construction of townhouses and other single-family dwellings.
In 1986, CENIT Bank and Independent Developers discontinued new real estate
development projects and in 1995 wound up the business and affairs of the
partnership and liquidated its assets. The corporation is currently inactive.
CENIT Mortgage is a North Carolina corporation incorporated in 1985 to act
as a mortgage loan originator for CENIT Bank on the Outer Banks of North
Carolina. CENIT Mortgage is a wholly owned subsidiary of CENIT Equity. CENIT
Mortgage closed its office in 1995 and is currently inactive. At December 31,
1998, CENIT Equity's initial investment in CENIT Mortgage equaled $50,000.
CENIT Commercial Mortgage is a Virginia corporation incorporated in 1990
for the purpose of engaging in commercial mortgage loan brokerage transactions.
At December 31, 1998, CENIT Bank's initial investment in and loans outstanding
to CENIT Commercial Mortgage totaled $50,000.
Princess Anne Equity is a Virginia corporation incorporated in 1997 for the
purpose of acquiring properties at foreclosure sales or by deeds in lieu of
foreclosure following borrower defaults on loans made originally by Princess
Anne. Princess Anne Equity then markets such REO for sale. In June 1998,
Princess Anne Equity became a wholly-owned subsidiary of CENIT Bank. At
December 31, 1998, Princess Anne Equity held no REO and its initial investment
and loans outstanding amounted to $31,000.
Personnel. At December 31, 1998, the Company and its subsidiaries had 217
full-time and 69 part-time employees. The Company's employees are not
represented by a collective bargaining unit, and the Company considers its
relationship with its employees to be excellent.
REGULATION AND SUPERVISION
Set forth below is a brief description of certain laws and regulations that
relate to the regulation of the Company and CENIT Bank. The descriptions of
these laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, do not purport to be complete and are qualified in
their entirety by reference to applicable laws and regulations.
Regulation of the Company
General. On June 3, 1998, CENIT Bank (formerly Princess Anne Bank) merged
into the Bank. See "Item 1 - Business--General." At that time, the Company
ceased to be a bank holding company subject to regulation under the Bank Holding
Company Act of 1956 and again became a unitary savings and loan holding company
pursuant to the Home Owners' Loan Act, as amended (the "HOLA"). As such, the
Company is subject to OTS regulation, examination, supervision and reporting
requirements. The OTS is now the "appropriate banking agency" for the Company
for purposes of many federal banking regulations. The Company is also required
to file certain reports with and otherwise comply with the rules and regulations
of the SEC under the federal securities laws. As a subsidiary of a savings and
loan holding company, the Bank is subject to certain restrictions in its
dealings with the Company and affiliates thereof.
Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company, such as the Company, that
holds only one subsidiary savings association. If the Director of the OTS
determines that there is reasonable cause to believe that the continuation by a
savings and loan holding company of an activity constitutes a serious risk to
the financial safety, soundness or stability of its subsidiary savings
association, the Director may impose such restrictions as deemed necessary to
address such risk. In addition, if the savings association subsidiary of such a
holding company fails to meet a qualified thrift lender ("QTL") test, then such
unitary holding company also shall become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings association requalifies as a QTL within one year thereafter, shall
register as, and become subject to the restrictions applicable to, a bank
holding company. See "--Regulation of the Bank--Qualified Thrift Lender Test."
Finally, if the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company
subject to regulation under the BCHA. Except where such acquisition is pursuant
to the authority to approve emergency thrift acquisitions and where each
subsidiary savings association meets the QTL test, the activities of the Company
and any of its subsidiaries (other than the Bank or other subsidiary savings
associations) would thereafter be subject to further restrictions.
29
Limitations on Transactions with Affiliates. Transactions between financial
institutions such as the Bank and any affiliate are governed by Sections 23A and
23B of the Federal Reserve Act (the "FRA"). An affiliate of an institution is
any company or entity that controls, is controlled by or is under common control
with the institution. In a holding company context, the parent holding company
of an institution (such as the Company) and any companies that are controlled by
such parent holding company are affiliates of the institution. Generally,
Sections 23A and 23B of the FRA (i) limit the extent to which the institution or
its subsidiaries may engage in "covered transactions" with any one affiliate to
an amount equal to 10% of such institution's capital stock and surplus, and
contain an aggregate limit on all such transactions with all affiliates to an
amount equal to 20% of such capital stock and surplus and (ii) require that all
such transactions be on terms substantially the same, or at least as favorable,
to the institution or subsidiary as those provided to a non-affiliate. The term
"covered transaction" includes the making of loans, purchase of assets, issuance
of a guarantee and other similar types of transactions. In addition to the
restrictions imposed by Sections 23A and 23B of the FRA, no institution may (i)
loan or otherwise extend credit to an affiliate, except for any affiliate which
engages only in activities that are permissible for bank holding companies, or
(ii) purchase or invest in any stocks, bonds, debentures, notes or similar
obligations of any affiliate, except for affiliates that are subsidiaries of the
institution.
The restrictions contained in Section 22(h) of the FRA on loans to
executive officers, directors and principal stockholders also apply to the Bank.
Under Section 22(h), loans to a director, an executive officer and to a greater
than 10% stockholder of a financial institution, and certain affiliated
interests of either, may not exceed, together with all other outstanding loans
to such person and affiliated interests, the institution's loans to one borrower
limit (generally equal to 15% of the institution's unimpaired capital and
surplus). Section 22(h) also prohibits loans above prescribed amounts to
directors, executive officers and greater than 10% stockholders of an
institution, and their respective affiliates, unless such loan is approved in
advance by a majority of the board of directors of the institution, with any
"interested" director not participating in the voting. The prescribed loan
amount (which includes all other outstanding loans to such person) as to which
such prior board of director approval is required generally is the greater of
$25,000 or 5% of capital and surplus (up to $500,000). Section 22(h) also
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.
Restrictions on Acquisitions. Savings and loan holding companies are
prohibited from acquiring, without prior approval of the director of the OTS (i)
control of any other savings association or savings and loan holding company or
substantially all of the assets thereof or (ii) more than 5% of the voting
shares of a savings association or holding company thereof that is not a
subsidiary. The director of the OTS may only approve acquisitions resulting in
the formation of a multiple savings and loan holding company that controls
savings associations in more than one state if (i) the multiple savings and loan
holding company involved controls a savings association that operated a home or
branch office located in the state of the association to be acquired as of March
5, 1987; (ii) the acquirer is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
association to be acquired is located specifically permit institutions to be
acquired by state-chartered associations or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings associations).
FIRREA amended provisions of the BHCA to specifically authorize the Federal
Reserve to approve an application by a bank holding company to acquire control
of a savings association. FIRREA also authorized a bank holding company that
controls a savings association to merge or consolidate the assets and
liabilities of the savings association with, or transfer assets and liabilities
to, any subsidiary Company that is a member of the BIF with the approval of the
appropriate federal banking agency and the Federal Reserve. As a result of these
provisions, there have been a number of acquisitions of savings associations by
bank holding companies in recent years.
Regulation of the Bank
General. The Bank is a federally chartered savings bank, and its deposit
accounts are insured up to applicable limits by the FDIC through the SAIF and
BIF. The Bank is subject to extensive regulation by the OTS and the FDIC, and
must file reports with the OTS concerning its activities and financial
condition, in addition to obtaining regulatory approvals before entering into
certain transactions such as mergers with or acquisitions of other financial
institutions. The OTS and the FDIC conduct periodic examinations to test the
Bank's compliance with various regulatory requirements. The OTS completed its
most recent regular supervisory examination in January, 1998. In addition, the
OTS conducted on-site Year 2000 examinations in June 1998 and March 1999. In
February, 1998, a multi-agency compliance examination of the Bank was completed.
The Bank is also a member of the FHLB-Atlanta and is subject to certain limited
regulation by the Federal Reserve.
30
FIRREA. FIRREA, which was signed into law in 1989, substantially changed
the structure of regulatory oversight and supervision of all financial
institutions, including the Bank, and of holding companies of financial
institutions. Under FIRREA, most of the regulatory authority previously
exercised by the Federal Home Loan Bank Board (the "FHLBB") was transferred to
the OTS, an office of the Department of the Treasury. In addition, FIRREA
abolished the Federal Savings and Loan Insurance Corporation (the "FSLIC") and
transferred its functions with respect to deposit insurance to the FDIC, which
administers the SAIF and BIF. As a result, the FDIC was granted certain
regulatory and examination authority over the Bank. The FDIC fund existing prior
to the enactment of FIRREA is now known as the BIF, which continues to insure
the deposits of commercial banks and certain savings banks and is also
administered by the FDIC. Although the FDIC administers both funds, the assets
and liabilities of the two funds are not commingled.
The enforcement authority available to regulators was substantially
enhanced by FIRREA. The OTS, as the primary regulator of savings institutions,
has extensive enforcement authority over all savings institutions and all
savings and loan holding companies, including the Bank. The FDIC also has
authority to impose enforcement action on savings institutions and banks in
certain situations. This enforcement authority applies to all
"institution-affiliated parties", including directors, officers, controlling
stockholders, and other persons or entities participating in the affairs of the
institution, as well as attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution.
FDIC Improvement Act of 1991. On December 19, 1991, the FDIC Improvement
Act of 1991 (the "FDIC Improvement Act") became law. While the FDIC Improvement
Act primarily addressed additional sources of funding for the BIF, it also
imposed a number of mandatory supervisory measures on savings associations and
banks.
Improved Examinations. All insured institutions must now undergo a
full-scope, on site examination by their appropriate Federal banking agency
("appropriate agency") at least once every eighteen months. The cost of
examinations of insured depository institutions and any affiliates may be
assessed by the appropriate agency against each institution or affiliate as it
deems necessary or appropriate.
Financial Reporting. Insured institutions with $500 million or more in
total assets are required to submit independently audited annual reports to the
FDIC and the appropriate agency (and state supervisor when applicable). These
publicly available reports must include (a) annual financial statements prepared
in accordance with generally accepted accounting principles and such other
disclosure requirements as required by the FDIC or the appropriate agency and
(b) a management report signed by the Chief Executive Officer and the Chief
Financial Officer or Chief Accounting Officer of the institution that contains a
statement of the management's responsibilities for (i) preparing the annual
financial statements; (ii) establishing and maintaining an adequate internal
control structure and procedures for financial reporting; and (iii) complying
with the laws and regulations designated by the FDIC relating to safety and
soundness and an assessment of (aa) the effectiveness of the internal control
structure and procedures for financial reporting as of the end of the fiscal
year and (bb) the institution's compliance during the fiscal year with
applicable laws and regulations designated by the FDIC relating to safety and
soundness. With respect to any internal control report, the institution's
independent public accountants must attest to, and report separately on, certain
assertions of the institution's management contained in such report. Any
attestation by the independent accountant pursuant to this section would be made
in accordance with generally accepted auditing standards for attestation
engagements. At December 31, 1998, the Bank's assets exceeded $500 million;
accordingly, the Bank is required to prepare the aforementioned reports in 1999.
Large insured institutions, as determined by the FDIC, are required to
monitor the above activities through an independent audit committee which has
access to independent legal counsel.
Standards for Safety and Soundness. The FDIC Improvement Act requires the
federal banking regulatory agencies to prescribe, by regulation, standards for
all insured depository institutions and depository institution holding
companies.
Effective August 9, 1995, the federal banking regulatory agencies jointly
implemented Interagency Guidelines Establishing Standards for Safety and
Soundness ("Guidelines") for all insured depository institutions relating to
internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate risk exposure, asset growth,
compensation, fees and benefits, and employment contracts and other compensation
arrangements of executive officers, employees, directors and principal
stockholders of insured depository institutions that would prohibit compensation
and benefits and arrangements that are excessive or that could lead to a
material financial loss for the institution. The federal banking regulatory
agencies also adopted asset quality and earnings standards within the
Guidelines, which became effective October 1, 1996. The Interagency Guidelines
31
Establishing Year 2000 Standards for Safety and Soundness ("Year 2000
Guidelines") were implemented in 1998 and set forth safety and soundness
standards to ensure that insured depository institutions will be able to achieve
Yeaar 2000 readiness and to successfully continue business operations after
January 1, 2000. If an insured depository institution fails to meet any of the
prescribed standards as described above, it may be required to submit to the
appropriate federal banking agency a compliance plan specifying the steps that
will be taken to cure the deficiency and the time within which these steps will
be taken. If an institution fails to submit an acceptable plan or fails to
implement the plan, the appropriate federal banking agency will require the
institution or holding company to correct the deficiency and until corrected,
may impose restrictions on the institution or holding company, including any of
the restrictions applicable under the prompt corrective action provisions of
FDIC Improvement Act. At December 31, 1998, the Bank was in compliance with the
Guidelines and is actively taking all steps required by the Year 2000
Guidelines. See "Impact of the Year 2000 Issue" filed with this report.
Prompt Corrective Regulatory Action. The FDIC Improvement Act requires each
appropriate agency and the FDIC to take prompt corrective action to resolve the
problems of insured depository institutions that fall below a certain capital
ratio. Such action must be accomplished at the least possible long-term cost to
the appropriate deposit insurance fund. In connection with such action, each
agency promulgated regulations defining the following five categories in which
an insured depository institution will be placed, based on the adequacy of their
regulatory capital level: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. Based upon the applicable regulations, at December 31, 1998,
the Bank would be considered well capitalized.
FIRREA and the FDIC Improvement Act revised many other substantive
requirements and limitations to which the Bank is subject. Certain of these
regulatory requirements and restrictions are discussed below.
Deposit Insurance Funds Act of 1996. One of the primary purposes of the
Deposit Insurance Funds Act of 1996 was to provide a means for recapitalizing
the SAIF. See"--Insurance of Accounts, Assessments and Regulation by the FDIC."
This act also had the effect of eliminating dual regulation of bank holding
companies and savings and loan holding companies. As a savings and loan holding
company, the Company is subject to the primary regulation of the OTS, which is
now the "appropriate banking agency" for the Company for purposes of many
federal banking regulations.
Other Investment Limitations. Federally chartered savings institutions such
as the Bank are also subject to various other restrictions on their investment
and lending activities. Federally chartered savings institutions may make
secured or unsecured loans for commercial, corporate, business or agricultural
purposes in an amount not in excess of 10% of the institution's assets. In
addition, the aggregate investment in nonresidential real estate loans may not
exceed 400% of a federally chartered savings institution's total capital;
however, an institution may be permitted to exceed the 400% limitation if the
OTS determines that any relief from this restriction poses no significant risk
to the safe and sound operations of the savings institution and is consistent
with prudent operating practices. Federally chartered savings institutions may
make loans for personal, family or household purposes, but such holdings and
investments may not exceed 35% of the savings institution's assets. At
December 31, 1998, the Bank was in compliance with the above requirements.
Loans-to-One-Borrower Limitations. FIRREA imposed limitations on the
aggregate amount of loans that a savings association could make to any one
borrower, including related entities. Under FIRREA, the permissible amount of
loans-to-one-borrower now follows the national bank standard for all loans made
by savings associations, as compared to the pre-FIRREA rule which applied the
national bank standard only to commercial loans made by federally chartered
savings associations. The national bank standard generally does not permit
loans-to-one-borrower to exceed 15% of unimpaired capital and surplus. Loans in
an amount equal to an additional 10% of unimpaired capital and surplus also may
be made to a borrower if the loans are fully secured by readily marketable
securities. At December 31, 1998, the Bank had no borrowers to which it had
outstanding loans in excess of its loans-to-one-borrower limit.
Regulatory Capital Requirements. Federally insured savings associations and
banks are required to maintain minimum levels of regulatory capital. Pursuant to
FIRREA, the OTS and the FDIC have established capital standards applicable to
the Bank. The OTS is also authorized to impose capital requirements in excess of
these standards on individual institutions on a case-by-case basis. As of
December 31, 1998, the Bank exceeded all minimum levels of regulatory capital.
See Note 20 of the Consolidated 1998 Financial Statements filed with this
report.
32
In August 1993, the OTS adopted a final rule incorporating an interest-rate
risk component into the risk-based capital regulation. Under the rule, an
institution with greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating its risk-based capital requirement. As a result,
such an institution will be required to maintain additional capital in order to
comply with the risk-based capital requirement. The final rule was effective
January 1, 1994. However, the date that institutions are first required to
deduct the interest rate risk component has been postponed indefinitely until a
final rule is published by the OTS. Pursuant to the rule, the Bank would have
not been subject to the interest rate risk component as of December 31, 1998.
Effective December 1, 1998, the OTS updated the guidance that it provides to
savings institutions such as the Bank to provide savings institutions with
additional, detailed information concerning the management of interest rate
risk, investment securities, and derivatives activities.
Capital Distributions. Limitations are imposed upon all "capital
distributions" by savings institutions, including cash dividends, payments to
repurchase or otherwise acquire its shares, payments by an institution to
shareholders of another institution in a cash-out merger, and other
distributions charged against capital. Generally, the regulation creates a safe
harbor for specified levels of capital distributions from savings institutions
meeting at least their minimum capital requirements, so long as such
institutions notify the OTS and receive no objection to the distribution from
the OTS. Savings institutions that do not qualify for the safe harbor are
required to obtain prior OTS approval before making any capital distributions.
Under the capital distribution regulation, an institution that has capital
at least equal to its fully phased-in capital requirement before and after
giving effect to the proposed capital distribution is a Tier 1 institution. An
institution that has capital at least equal to each of its minimum capital
requirements but fails to meet all of its fully phased-in capital requirements
is a Tier 2 institution. An institution having capital less than any of its
minimum regulatory capital requirements is a Tier 3 institution. The Bank is
currently classified as a Tier 1 institution for these purposes.
A Tier 1 institution may make capital distributions during a calendar year
up to the greater of (i) 100 percent of its net income to date during the
calendar year plus the amount that would reduce by one-half its surplus capital
ratio at the beginning of the calendar year, or (ii) 75 percent of its net
income over the most recent four quarter period. The "surplus capital ratio" is
defined to mean the percentage by which the savings institution's ratio of total
capital to assets exceeds the ratio of its fully phased-in capital requirement
to assets and "fully phased-in capital requirement" is defined to mean a savings
institution's capital requirement under the statutory and regulatory standards
now applicable, as modified to reflect any applicable individual capital
requirement imposed upon the institution. In order to make distributions under
these safe harbors, the Bank must submit a 30 day written notice to the OTS
prior to making the distribution. The OTS may object to the distribution during
that 30-day period based on safety and soundness concerns.
OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained for the liquidation account established by it for certain depositors
in connection with its conversion from mutual to stock form. For additional
information, See Note 21 of the Notes to the Consolidated Financial Statements
included with this report. Effective April 1, 1999, the OTS has updated,
simplified and streamlined its regulation concerning capital distributions by
the Bank and has modified the application and notice requirements for capital
distributions.
Qualified Thrift Lender Test. The QTL test requires that qualified thrift
investments represent 65% of portfolio assets. Portfolio assets are defined as
total assets less intangibles, properties used to conduct the institution's
business, and liquid assets (up to 20% of total assets). The penalties for
failure to meet the QTL test are substantial. Any savings institution that fails
to meet the test either must convert to a commercial bank charter or comply with
the restrictions imposed for noncompliance. If the institution does not convert
to a commercial bank, its new investments and activities shall be limited to
those permissible for a national bank, and it shall be subject to national bank
branching limitations. Both the investment and activities powers and the
branching rights available to national banks are generally more restrictive than
those available to savings institutions. In addition, the institution is
immediately ineligible to receive any new FHLB advances and is subject to
national bank limits on the payment of dividends. If such institution has not
requalified as a QTL or converted to a commercial bank charter within three
years after the failure, it then must divest all investments and cease all
activities not permissible for a national bank and must repay promptly any
outstanding FHLB advances. If any institution that fails the QTL test is
controlled by a holding company, then within one year after the failure, the
holding company must register as a bank holding company and thereby become
subject to all restrictions on bank holding companies.
At December 31, 1998, approximately 77.60% of the Bank's assets were
invested in qualified thrift investments, which was in excess of the percentage
required to qualify the Bank under the QTL test in effect at that time. The Bank
will remain in compliance
33
unless its monthly average percentage of qualified thrift investments to
portfolio assets falls below 65% in nine months out of any 12-month period.
Liquidity. All savings institutions, including the Bank, are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings institutions. At the present time, the required liquid
asset ratio is 4%. At December 31, 1998, the Bank was in compliance with these
requirements, with an overall liquidity ratio of 9.3%.
Insurance of Accounts, Assessments and Regulation by the FDIC. The Bank's
deposits are insured up to $100,000 per insured depositor (as defined by law and
regulation) by the FDIC through the SAIF and the BIF. The SAIF and the BIF are
administered and managed by the FDIC. As insurer, the FDIC is authorized to
conduct examinations of and to require reporting by SAIF and BIF- insured
institutions. FIRREA also authorizes the FDIC to prohibit any SAIF and
BIF-insured institution from engaging in any activity that the FDIC determines
by regulation or order to pose a serious threat to the SAIF and BIF. The FDIC
also has the authority to initiate enforcement actions against savings
institutions, after first giving the OTS an opportunity to take such action.
Through the SAIF, the FDIC insures deposits at savings institutions such as
the Bank, and through the BIF, the FDIC insures deposits at other financial
institutions (principally commercial banks, state-chartered banks, and certain
federally chartered savings banks).
Effective September 30, 1996, the Congress and the Clinton administration
completed the process of recapitalizing the SAIF by enacting into law the
Deposit Insurance Funds Act of 1996. This legislation established the method for
recapitalizing the SAIF and increasing its net worth to 1.25 percent of
SAIF-insured deposits as of March 31, 1995, phasing in the pro rata sharing of
Financing Corporation ("FICO") obligations between SAIF and BIF institutions,
and merging the SAIF and BIF into the Deposit Insurance Fund effective on
January 1, 1999. As a result of this legislation and the adoption by the FDIC of
a final rule effective October 8, 1996 establishing a special assessment for
SAIF institutions, the Bank incurred a special, pre-tax deposit insurance
premium of $2.3 million for the SAIF assessable deposits that it held on March
31, 1995. At such time as the SAIF recapitalization reaches the 1.25 percent
target, SAIF deposit insurance premiums will drop substantially, placing SAIF
insured deposits on an equal footing with BIF insured deposits.
FICO assessment rates for the first semiannual period of 1998 were set at
.01176% annually for BIF-assessable deposits and .0588% annually for
SAIF-assessable deposits. These rates may be adjusted quarterly to reflect
changes in assessment bases for the BIF and SAIF. By law, the FICO rate on
BIF-assessable deposits must be one-fifth the rate on SAIF assessable deposits
until the insurance funds are merged or until January 1, 2000, whichever occurs
first. There was no FDIC assessment for either SAIF- assessable or
BIF-assessable deposits for the first semiannual period of 1998.
From time to time, there are various proposals that involve increasing the
deposit insurance premiums paid by banks and/or savings institutions. The
Company is unable to predict whether or to what extent the rates that the Bank
pays for federal deposit insurance may increase in future periods as a result of
such proposals. Such increases would adversely affect its operations.
Federal Home Loan Bank System. The Bank is a member of the FHLB-Atlanta,
which is one of twelve regional FHLBs that administers the home financing credit
functions of savings associations. As a member of the FHLB system, the Bank is
required to purchase and maintain stock in the FHLB-Atlanta in an amount equal
to the greater of 1% of its aggregate unpaid residential mortgage loans and
mortgage-backed securities, 0.3% of its assets or 5% (or such greater fraction
as established by the FHLB) of its outstanding FHLB advances. At December 31,
1998, the Bank held $5.1 million in FHLB stock, which was in compliance with
these requirements.
Federal Reserve System. The Federal Reserve requires all depository
institutions to maintain reserves against their transaction accounts (primarily
NOW and Super NOW checking accounts) and non-personal time deposits. At
December 31, 1998, the Bank was in compliance with such requirements. The
balances maintained to meet the reserve requirements imposed by the Federal
Reserve may be used to satisfy applicable liquidity requirements. However,
because required reserves must be maintained in the form of either vault cash, a
noninterest-bearing account at a Federal Reserve Bank or a pass-through account
as defined by the Federal Reserve, the effect of this reserve requirement is to
reduce the Company's interest-earning assets.
34
Savings institutions are authorized to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve regulations require institutions to
exhaust other reasonable alternative sources of funds, including FHLB advances,
before borrowing from the Federal Reserve Bank.
Accounting and Investment Portfolio Policy. FIRREA requires the federal
banking agencies to establish accounting standards to be applicable to all
financial institutions for purposes of complying with regulations, except to the
extent otherwise specified in the capital regulations. Such standards must
incorporate generally accepted accounting principles to the same degree as is
prescribed by the federal banking agencies for banks or may be more stringent
than such requirements. The Bank believes that its investment activities are
conducted in accordance with the applicable policies concerning investments and
securities and in accordance with generally accepted accounting principles.
Federal Securities Laws
The Company's Common Stock is registered with the SEC under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). The Company is subject to
the information, proxy solicitation, insider trading restrictions and other
requirements of the SEC under the Exchange Act. Under the Securities Enforcement
and Penny Stock Reform Act of 1990, the Company may be subject, among other
things, to civil money penalties for violations of the federal securities laws.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank are subject to the applicable corporate
tax provisions of the Internal Revenue Code of 1986, as amended (the "Code"), as
well as certain additional provisions of the Code that apply to thrifts and
other types of financial institutions. The following discussion of tax matters
is intended only as a summary and does not purport to be a comprehensive
description of the tax rules applicable to the Company and the Bank.
Under the applicable statutes of limitation, the Company's federal income
tax returns for 1995 through 1997 are open to examination by the Internal
Revenue Service (the "Service"). The Company is unaware, however, of any current
or pending Service examinations of the Company's returns for any of those open
years.
The Company reports its income and expenses on the accrual method of
accounting and files a consolidated federal income tax return on a December 31
calendar year basis. Consolidated tax returns have the effect of eliminating
intercompany distributions, including dividends, from the computation of
consolidated taxable income for the taxable year in which the distributions
occur.
Bad Debt Reserves. Prior to 1996, savings institutions such as the Bank
that met certain definitional tests primarily relating to their assets and the
nature of their business ("Qualifying Thrifts") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which additions
could, within specified formula limits, be deducted by the savings institutions
in arriving at their taxable income. For purposes of the bad debt deduction,
loans were separated into "qualifying real property loans" (which are, in
general, loans secured by interests in improved real property or real property
which is to be improved out of the proceeds of the loan) and "nonqualifying
loans" (which are all other loans).
During 1996, new tax legislation was enacted that repealed the reserve
method of accounting for bad debts of qualified thrift institutions and, for
years after 1995, the Bank is only eligible to claim tax deductions for bad
debts under the rules for banks. Because the Bank is a "large bank" as that term
is defined in the Code, it is required to compute its bad debt deduction based
only on actual chargeoffs. Additionally, the new legislation required a thrift
institution to recapture over a six-year period its reserve as of December 31,
1995, to the extent it exceeds its reserve balance at December 31, 1987. The
Bank is recapturing the excess reserve of approximately $139,000 over six years.
Thrift Charter Conversion. The Bank's retained earnings at December 31,
1998 included $6,134,000 representing that portion of the Bank's reserve for bad
debts for which no provision for income taxes has been made. Under legislation
passed in 1996, this amount would not be subject to federal income taxes if the
Bank were to convert to, or merge with, a commercial bank. This amount would be
subject to federal income taxes if the Bank were to use the reserve for purposes
other than to absorb losses.
35
Corporate Minimum Tax. The Company and its subsidiary could be subject to
an alternative minimum tax ("AMT") which is imposed to the extent that it
exceeds the consolidated group's regular tax liability for a year. The
alternative minimum tax generally will apply at a rate of 20% to a base of
regular taxable income plus certain tax preferences and adjustments
("alternative minimum taxable income" or "AMTI"), less an exemption amount.
Currently no more than 90% of the AMTI may be offset by net operating losses (as
determined for AMTI purposes). Payment of the AMT may be used as a credit
against a portion of the regular tax liabilities in future years. The Code
provisions relating to the AMT also: (i) treat as a preference item interest on
certain tax-exempt private activity bonds issued on or after August 8, 1986; and
(ii) include in AMTI (for tax years beginning after 1989) an amount equal to 75%
of the amount by which a corporation's adjusted current earnings exceed its AMTI
(determined without regard to this preference and before reduction for the
alternative tax net operating losses). The consolidated group was not subject to
the AMT in 1998.
Distributions. If the Bank's reserve for losses on qualifying real property
loans exceeds the amount that would have been allowed under the Experience
Method and makes a distribution to the Company that is considered to be drawn
from its excess bad debt reserve or from the Bank's supplemental reserve
("Excess Distributions"), then an amount based on the Excess Distribution will
be included in the Bank's taxable income during the year of distribution.
Distributions by the Bank in excess of its current and accumulated earnings and
profits and distributions in redemption of stock would cause a portion of the
Bank's bad debt reserves to be recaptured into taxable income. However,
dividends paid out of the Bank's current or accumulated earnings and profits, as
calculated for federal income tax purposes, will not be considered to result in
a distribution from the Bank's bad debt reserves. In addition, the payment of a
dividend to stockholders by the Company, or the repurchase of shares of Common
Stock by the Company, would not normally cause any amount of bad debt reserve
recapture at the Bank's level provided that the Bank's payment to the Company of
funds used for such purposes did not exceed the amount of the Bank's available
earnings and profits.
The amount of additional taxable income created in the event of a
distribution by the Bank to the Company of an amount in excess of the Bank's
available earnings and profits, is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. At
current corporate income tax rates this amount equals approximately 150% of the
amount of the distribution. Thus, if certain portions of the Bank's bad debt
reserve are used for any purpose other than to absorb qualified bad debt loans,
such as for the payment of nondividend distributions with respect to the Bank's
capital stock (including distributions upon redemption or liquidation), a
portion of those distributions may be includable in the Bank's gross income for
federal income tax purposes. Neither the Bank nor the Company anticipates paying
dividends or making distributions with respect to the Bank's capital stock which
would give rise to that type of federal tax liability. See "Regulation and
Supervision--Regulation of the Bank--Capital Distributions" for limits on the
payment of dividends by the Company.
Corporate Dividends Received Deduction. The Company is permitted to exclude
from its taxable income 100% of any dividends received from the Bank, and the
Bank may exclude from its income dividends received from its subsidiaries
pursuant to the regulations applicable to consolidated income tax returns. The
Company and the Bank may deduct from their income 80% of any dividends received
from an unaffiliated corporation if they own at least 20% of the stock of the
corporation. If they own less than 20% of the stock of a corporation paying a
dividend, 70% of any dividends received may be excluded from income.
State and Local Taxation
The Company, the Bank and its subsidiaries (other than CENIT Mortgage of
North Carolina) are subject to Virginia corporate income taxes. The Virginia
corporate income tax is imposed at a rate of 6% on the combined net income of
the Company, the Bank and its subsidiaries (other than CENIT Mortgage of North
Carolina) as reported for federal income tax purposes with certain
modifications. CENIT Mortgage of North Carolina is subject to North Carolina
corporate income taxes at an annual rate of 7.25% on its separately computed
federal taxable income with certain modifications.
36
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information with respect to the executive
officers of the Bank as of December 31, 1998. Messrs. Ives and Guthrie hold
substantially identical positions for both the Bank and the Company. Mr. Woods
serves as Senior Vice President/Credit Policy and Administration for the
Company.
Name Age Position Held
- --------------- --- -------------------------
Michael S. Ives 46 President/Chief Executive
Officer/Director
Barry L. French 55 Senior Vice President/
Retail Banking Group Manager
John O. Guthrie 49 Senior Vice President/
Chief Financial Officer and
Finance and Administration Group Manager
Patrick L. Hillard 38 Senior Vice President/
CENIT Mortgage Company
Roger J. Lambert 49 Senior Vice President/
Information Services Group Manager
Barbara N. Lane 49 Senior Vice President
Alvin D. Woods 54 Senior Vice President/
Chief Lending Officer and
Lending Group Manager
Winfred O. Stant, Jr. 45 First Vice President/
Chief Accounting Officer
37
Set forth below is certain information with respect to the executive
officers of the Bank and the Company. Unless otherwise indicated, the principal
occupation listed for each person below has been his or her principal occupation
for the past five years.
Michael S. Ives has been President and Chief Executive Officer of CENIT
Bank since January, 1987. Mr. Ives also became President and Chief Executive
Officer of the Company after its incorporation in 1991. Mr. Ives is also a
director of the Bank and the Company.
Barry L. French joined CENIT Bank in November, 1991, and is a Senior Vice
President and Retail Banking Group Manager. In this position, Mr. French is
responsible for Retail Banking Operations. Before assuming this position in
November 1992, Mr. French shared responsibility for Retail Commercial Lending.
Mr. French came to CENIT Bank after a long affiliation with Crestar Bank in
Newport News, Virginia, where he was employed from 1971 until 1991. From 1987
until 1991, Mr. French was Crestar's regional president and Commercial Division
Manager in Newport News, Virginia, where he was responsible for establishing
Crestar's policies and procedures in the region and for the direction of
Crestar's commercial banking operations in the region.
John O. Guthrie joined CENIT Bank in 1972. He has served in a number of
capacities with CENIT Bank, and since 1988, has been Senior Vice President and
CENIT Bank's Chief Financial Officer. In his present position, he is responsible
for overseeing CENIT Bank's asset/liability and investment management, for
budgeting, and for administering CENIT Bank's external and internal reporting.
From 1983 to 1988, Mr. Guthrie served as Senior Vice President and Manager of
CENIT Bank's Finance/Administrative Division. He also acted as Manager of the
Retail Banking Division from 1986 to 1989. Mr. Guthrie is also Senior Vice
President, Chief Financial Officer, Finance and Administration Group Manager,
and Secretary for the Company.
Patrick L. Hillard, a Senior Vice President, is Manager of CENIT Mortgage
Division. Mr. Hillard is responsible for all phases of the mortgage operation
including origination, secondary marketing and wholesale. Mr. Hillard joined
CENIT Bank through the merger with Homestead in April 1994. He had been employed
with Homestead since January 1985 and held several positions including Loan
Officer and Vice President. At the time of merger, Mr. Hillard served Homestead
as Senior Vice President/Manager of Mortgage Lending.
Roger J. Lambert joined CENIT Bank in January, 1980, and is a Senior Vice
President and Information Services Group Manager. In this position, Mr. Lambert
is responsible for data processing, electronic funds transfer and proof
operations, voice and data communications, and all forms of electronic banking
such as automated teller machines. Before assuming this position, Mr. Lambert
was a Systems Engineer for the N.C.R. Corporation.
Barbara N. Lane, who has been employed by CENIT Bank since 1969, is a
Senior Vice President. Before assuming this position in June 1989, Ms. Lane was
CENIT Bank's Vice President for Marketing Research from June 1988 through June
1989, and was an Assistant Vice President and CENIT Bank's Planning and
Procedures Coordinator from 1984 until June 1988. Ms. Lane manages and
coordinates the activities of the departments and areas in the Administrative
Operations group.
Alvin D. Woods, a Senior Vice President, joined CENIT Bank in March 1992
and is CENIT Bank's Chief Lending Officer and Lending Group Manager. Mr. Woods
is responsible for all lending activities of CENIT Bank, including collections
and special assets. Mr. Woods also serves as Senior Vice President/Credit Policy
and Administration for the Company. Prior to assuming these positions, Mr. Woods
was in charge of CENIT Bank's residential construction and mortgage lending.
Before joining CENIT Bank, Mr. Woods had been employed by NationsBank Financial
Corporation and its predecessor institutions, including C&S Sovran Financial
Corporation, Sovran Financial Corporation and Sovran Company, N.A. and Virginia
National Bank, since 1970. Since January 1991, he had served as Executive Vice
President and Manager of the Metro D.C. Real Estate Finance Division of C&S
Sovran, and from 1984 until January 1991, managed Sovran's real estate finance
lending activities in the Hampton Roads area.
Winfred O. Stant, Jr. joined Princess Anne in May 1992 and served as Senior
Vice President and Chief Financial Officer of Princess Anne until its merger
with CENIT Bank in 1998. Before joining Princess Anne, Mr. Stant had been
employed since March 1989 by Independent Banks of Virginia, Inc. in Norfolk,
Virginia. Mr. Stant was Vice President and Chief Financial Officer of
Independent Banks of Virginia, Inc., which was the parent company of Princess
Anne and two other banks prior to the spin-off of Princess Anne in August of
1992. Currently, Mr. Stant serves as First Vice President and Chief Accounting
Officer of CENIT Bank.
38
Item 2 - Properties
The Company neither owns nor leases any real property. The Company
currently uses the property and equipment of the Bank without payment to the
Bank.
The Company conducts its business through its corporate headquarters and
twenty retail branch offices, all of which are located in the Hampton Roads
area. The following table sets forth information about each of the Bank's
offices at December 31, 1998. The total net book value of the Bank's property
and equipment at December 31, 1998 was approximately $13.0 million.
39
Owned Expiration Net Book
or Date of Value
Location Year Office Opened Leased Lease (Dollars in thousands)
- --------------------- -------------------- -------- ----------- ---------------------
Corporate Headquarters
225 W. Olney Road
Norfolk, Virginia 1979 Leased 3rd Fl.-Dec.1999 $ -
2nd Fl.-Dec.2001
Retail Branch Offices
745 Duke Street
Norfolk, Virginia 1889 (Relocated in 1979) Owned - 793
2203 E. Little Creek Road
Norfolk, Virginia 1959 (Relocated in 1980) Owned - 432
300 E. Main Street
Norfolk, Virginia 1993 (Relocated in 1995) Leased April, 2005 91
3315 High Street
Portsmouth, Virginia 1955
(Relocated in 1989 and 1994) Leased August, 2000 61
675 N. Battlefield Blvd.
Chesapeake, Virginia 1989 Owned - 808
2600 Taylor Road
Chesapeake, Virginia 1988 Owned - 363
3220 Churchland Blvd.
Chesapeake, Virginia 1986 Leased December, 2000 50
2205 Executive Drive
Hampton, Virginia 1973 (Relocated in 1989) Owned - 759
110 Ottis Road
York County, Virginia 1994 Owned - 1,768
(Retail/Mortgage Office)
5007 Victory Boulevard
York County, Virginia 1995 Leased November, 2010 186
13307 Warwick Blvd.
Newport News, Virginia 1996 Owned 407
6101 Military Highway
Norfolk, Virginia 1996 Leased August, 2011 226
550 Settlers Landing Road
Hampton, Virginia 1996 Owned 587
1616 Laskin Road Land-
Virginia Beach, Virginia 1975 Leased June, 2005 -
Building and improvements owned 131
699 Independence Boulevard
Virginia Beach, Virginia 1975 Owned - 649
905 Kempsville Road
Virginia Beach, Virginia 1978 Owned - 386
641 Lynnhaven Parkway
Virginia Beach, Virginia 1985 Leased March, 2000 234
4801 Columbus Street
Virginia Beach, Virginia 1987 Leased March, 2003 55
3001 Shore Drive
Virginia Beach, Virginia 1989 (Relocated in 1996) Leased January, 2002 47
3901 Holland Road
Virginia Beach, Virginia 1997 Leased January, 2012 252
Mortgage Branch Office
2612 Taylor Road
Chesapeake, Virginia 1993 Owned - 517
Other Real Property 798
---------
Total Real Property 9,600
Other Fixed Assets
Furniture, fixtures, equipment and vehicles 3,402
---------
Total $ 13,002
=========
40
Item 3 - Legal Proceedings
The Company is not involved in any pending legal proceedings other than
routine legal proceedings arising in the ordinary course of business. In the
opinion of management, pending legal proceedings against the Company in the
aggregate do not involve amounts that are material to the financial condition or
results of operations of the Company.
Item 4 - Submission of Matters to a Vote of Security Holders
During the fourth quarter ended December 31, 1998, no matters were
submitted to a vote of security holders through a solicitation of proxies or
otherwise.
PART II
Item 5 - Market for Registrant's Common Stock and Related Stockholder Matters
The Company's Common Stock trades on The Nasdaq Stock Market(R) under the
symbol CNIT. The following table presents the reported high and low sales prices
of the Company's Common Stock by quarters in fiscal years 1998 and 1997.
1998(2) 1997 (2)
---------------- ------------------
Quarter High (1) Low (1) High (1) Low (1)
------- ---- ---- ---- ----
First $ 29.00 $ 23.33 $ 15.92 $ 13.33
Second 28.67 20.50 16.88 13.17
Third 24.63 16.75 21.00 15.83
Fourth 21.50 14.13 27.15 19.33
(1) The source for the high and low sales prices by quarter is The Nasdaq Stock
Market(R).
(2) Sales prices have been restated for the 3-for-1 stock split declared on
March 24, 1998.
The Company paid a quarterly cash dividend on its Common Stock of $.10,
$.10, $.10 and $.11 per share for the first, second, third and fourth quarters,
respectively, of 1998 and $.08 per share for each quarter in 1997. The Company
also declared quarterly cash dividends of $.15 per share for the first quarter
of 1999. If the Company experiences quarterly results in line with projections,
the Company intends to continue the quarterly dividend at $.15 per share.
However, no assurance can be given that such dividends will be paid at all or,
if paid, that such dividends will not be reduced or eliminated in future
periods. The declaration of dividends by the Board of Directors of the Company
will depend upon a variety of factors, including, but not limited to, the
Company's current and projected results of operations and financial condition,
regulatory capital requirements, applicable statutory and regulatory
restrictions on the payment of dividends, alternative uses of capital, tax
considerations, and general economic conditions. The declaration of dividends by
the Company in the future initially will depend upon dividend payments by the
Bank to the Company. Pursuant to OTS regulations, all capital distributions by
savings institutions, including the declaration of dividends, are subject to
limitations that depend largely on the level of the institution's capital
following such distribution. For information concerning these regulations, see
"Item 1.--Business-Regulation and Supervision--Regulation of the Bank--Capital
Distributions." Moreover, the Bank will not be permitted to pay dividends on, or
repurchase, any of its capital stock if such dividends or repurchases would
cause the total capital of the Bank to be reduced below the amount required for
its liquidation account established in connection with the Conversion. See note
21 of the Notes to the Consolidated Financial Statements filed with this report.
Unlike the Bank, the Company is not subject to these regulatory
restrictions on the payment of dividends to its shareholders, although the
source of such dividends is dependent upon dividends received from the Bank. The
Company is subject, however, to the restrictions of Delaware law, which
generally limit dividends to the amount of a corporation's surplus or, in the
case where no such surplus exists, the amount of a corporation's net profits for
the fiscal year in which the dividend is declared and/or the preceding fiscal
year.
Earnings appropriated for bad debt reserves and deducted for federal income
tax purposes cannot be used by the Bank to pay cash dividends to the Company
without the payment of income taxes by the Bank on the amount deemed
distributed, which would include the amount of any federal income taxes
attributable to the distribution. Neither the Company nor the Bank anticipates
creating federal tax liabilities in this manner. See "Item 1-Business--Federal
and State Taxation" and note 16 of the notes to Consolidated Financial
Statements filed with this report.
As of February 5, 1999, there were approximately 1,154 holders of record of
the Company's Common Stock.
41
Item 6 - Selected Financial Data
The following table presents selected financial data for the five years
ended December 31, 1998.
At or for the year ended December 31, (1)
1998 1997 1996 1995 1994
(Dollars in thousands, except per share)
Financial Condition Data:
Total assets $ 641,056 $ 718,083 $707,100 $ 639,812 $ 575,675
Securities available for sale:
U.S. Treasury, other U.S. Government agency
and other debt securities, net 48,117 45,347 46,305 65,118 44,650
Mortgage-backed certificates, net 17,019 91,841 177,706 203,176 175,763
Loans held for investment, net 484,783 486,487 422,219 319,194 305,578
Real estate owned, net 377 1,098 2,769 1,828 5,718
Deposits 496,772 507,670 498,965 450,530 420,422
Borrowings 88,084 157,239 155,138 138,171 109,035
Stockholders' equity 50,076 49,937 49,608 46,729 42,217
Operating Data:
Interest income $ 47,031 $ 50,776 $ 48,171 $ 45,527 $ 37,826
Interest expense 25,805 29,310 28,087 27,476 19,496
----------------------------------------------------------------------
Net interest income 21,226 21,466 20,084 18,051 18,330
Provision for loan losses 510 600 377 697 490
----------------------------------------------------------------------
Net interest income after provision for loan losses 20,716 20,866 19,707 17,354 17,840
Other income 7,013 5,713 3,894 2,944 2,765
Other expenses 18,197 17,312 18,172 16,174 14,402
----------------------------------------------------------------------
Income before income taxes 9,532 9,267 5,429 4,124 6,203
Provision for income taxes 3,417 3,264 1,821 1,652 2,226
----------------------------------------------------------------------
Net income $ 6,115 $ 6,003 $ 3,608 $ 2,472 $ 3,977
======================================================================
Earnings per share:
Basic $ 1.30 $ 1.24 $ .74 $ .52 $ .84
======================================================================
Diluted $ 1.27 $ 1.20 $ .72 $ .50 $ .82
Cash dividends per share ======================================================================
$ .41 $ .33 $ .25 $ .13 $ .12
======================================================================
Selected Financial Ratios and Other Data:
Return on average assets 0.92% 0.86% (2) 0.54% (3) 0.40% (4) 0.72%
Return on average stockholders' equity 12.04 12.00 (2) 7.56 (3) 5.57 (4) 9.75
Average stockholders' equity to average assets 7.68 7.17 7.20 7.21 7.40
Stockholders' equity to total assets at year end 7.81 6.95 7.02 7.30 7.33
Interest rate spread 2.88 2.85 2.83 2.60 3.10
Net interest margin 3.43 3.27 3.22 3.07 3.47
Other expenses to average assets 2.75 2.48 (2) 2.74 (3) 2.63 (4) 2.61
Net interest income to other expenses 116.65 123.99 (2) 110.52 (3) 111.61 (4) 127.27
Nonperforming assets to total assets .23 .34 .80 .45 1.42
Allowance for loan losses to total net loans .83 .78 .90 1.16 1.24
Dividend payout ratio (5) 31.54 26.95 33.63 25.81 14.23
Book value per share $ 10.93 (6) $ 10.57 $ 10.11 $ 9.76 $ 8.89
Tangible book value per share 10.13 (6) 9.72 9.22 9.38 8.48
Number of retail branch offices 20 20 19 16 15
________
<FN>
(1) On August 1, 1995, Princess Anne became a wholly-owned subsidiary of the Company in a merger accounted for by the pooling
of interests method of accounting. Accordingly, the consolidated financial data presented gives effect to this merger and
the accounts of Princess Anne have been combined with those of the Company for all periods presented. Also, on April 1,
1994, CENIT Bank, FSB merged with Homestead. This merger was accounted for by the purchase method of accounting. The
consolidated financial data presented above includes the results of Homestead's operations and
financial condition from the date of acquisition.
(2) Exclusive of the $405 of expenses related to the proxy contest and other matters and the related tax effect, the return on
average assets and return on average stockholders' equity for the year ended December 31, 1997 would have been .90% and
12.50%, respectively, and the ratio of other expenses to average assets and net interest income to other expenses would have
been 2.42% and 126.97%, respectively.
(3) Exclusive of the $2,340 one-time SAIF special assessment paid in November, 1996 and the related tax effect, the return on
average assets and return on average stockholders' equity for the year ended December 31, 1996 would have been .76% and
10.52%, respectively, and the ratio of other expenses to average assets and net interest income to other expenses would have
been 2.39% and 126.86%, respectively.
(4) Exclusive of the $757 of merger expenses and the $563 loss on the sale of securities and the related tax effect, the return
on average assets and return on average stockholders' equity for the year ended December 31, 1995 would have been .57% and
7.91%, respectively. Exclusive of the $757 of merger expenses relating to the Princess Anne combination, the ratio of other
expenses to average assets and net interest income to other expenses would have been 2.50% and 117.09%, respectively.
(5) Represents dividends per share divided by basic income per share. Dividends per share represent historical dividends declared
by the Company.
(6) Book value per share and tangible book value per share, computed by including unallocated common stock held by the Company's
Employee Stock Ownership Plan at December 31, 1998, were $10.41 and $9.65, respectively.
</FN>
42
Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Financial Condition of the Company
Total Assets. At December 31, 1998, the Company had total assets of $641.1
million, a decrease of $77.0 million since December 31, 1997. This decrease
results primarily from sales, maturities and principal repayments of
mortgage-backed securities. Proceeds from mortgage-backed securities were used
to reduce borrowings rather than to seek alternative investment opportunities.
Securities Available For Sale. Securities available for sale totaled $65.1
million at December 31, 1998 compared to $137.2 million at December 31, 1997.
The net decrease of $72.1 million from December 31, 1997 resulted primarily from
the net effect of $66.7 million of sales, $34.9 million of repayments, $18.0
million of proceeds from maturities or calls, and $48.2 million of purchases.
The portfolio of securities available for sale at December 31, 1998 was
comprised primarily of $21.5 million of other U.S. Government agency securities,
$26.4 million of U.S. Treasury securities and $17.0 million of mortgage-backed
certificates.
Loans. The balance of net loans held for investment decreased slightly from
$486.5 million at December 31, 1997 to $484.8 million at December 31, 1998.
Single-family first mortgage loans decreased $57.4 million from $308.5 million
at December 31, 1997 to $251.1 million at December 31, 1998, while all other net
loans increased by $55.7 million from $178.0 million at December 31, 1997 to
$233.7 million at December 31, 1998. The increase in other net loans is the
result of the Company's emphasis on originating consumer and commercial loans
during 1998.
Deposits. During 1998, the Company's total deposits decreased from $507.7
million at December 31, 1997 to $496.8 million at December 31, 1998. The
Company's noninterest-bearing deposits increased by 43.4% from $54.9 million at
December 31, 1997 to $78.7 million at December 31, 1998. The balance of all
checking, savings and money market accounts at December 31, 1998 was $231.0
million, an increase of $51.5 million compared to the balance of these accounts
at December 31, 1997. Certificate of deposit balances decreased $62.4 million,
or 19.0% from $328.2 million at December 31, 1997 to $265.8 million at December
31, 1998. This increase in noninterest-bearing deposits and decrease in
certificates of deposit resulted from the Company's ongoing strategy to seek
lower-cost deposits to further enhance the Company's profitability.
Borrowed Funds. The Company's borrowed funds, which include Federal Home
Loan Bank ("FHLB") advances, other borrowings, and securities sold under
agreements to repurchase, decreased from $157.2 million at December 31, 1997 to
$88.1 million at December 31, 1998. FHLB advances decreased from $145.0 million
to $75.0 million during this period, while other borrowings and securities sold
under agreements to repurchase increased by $845,000. The primary source of
funds used to pay down FHLB advances was the sales, maturities and repayments of
mortgage-backed securities.
Capital. The Company's and Bank's capital ratios significantly exceeded
applicable regulatory requirements at both December 31, 1998 and 1997. During
1998, the Company repurchased 231,500 shares of its outstanding common stock.
Asset Quality. The Company's total nonperforming assets decreased by 39%,
to a total of $1.5 million, or .23% of assets, at December 31, 1998 compared to
$2.4 million, or .34% of assets, at December 31, 1997. Real estate owned ("REO")
and other repossessed assets decreased by 70.0%, from $1.3 million at December
31, 1997 to $398,000 at December 31, 1998. Nonperforming loans were $1.1 million
at both December 31, 1998 and 1997.
Comparison of Operating Results for the Years Ended December 31, 1998 and 1997
General. The Company's pre-tax income increased by 2.9% to $9.5 million for
the year ended December 31, 1998 from $9.3 million for 1997. This increase was
attributable primarily to a $1.3 million increase in other income, offset by a
$885,000 increase in other expenses and a $150,000 decrease in net interest
income after provision for loan losses.
Net Interest Income. The Company's net interest income before provision for
loan losses decreased by $240,000 for the year ended December 31, 1998, a 1.1%
decrease from 1997. This decrease resulted from a $3.7 million decrease in
interest income, which exceeded a $3.5 million decrease in interest expense. The
Company sold a substantial portion of its lower-yielding mortgage-backed
certificate portfolio during 1998 and used proceeds from the sale to fund other
interest-earning assets and to pay down borrowings, thereby reducing the asset
size of the Company. Interest on the Company's portfolio of mortgage-backed
certificates decreased by $5.5 million in 1998 primarily due to a $77.8 million
decrease in their average balances. This decrease was not totally offset by
reductions in interest expense or interest income from other sources.
43
Interest on loans increased by approximately $1.7 million, or 4.5%, from
$38.2 million in the year ended 1997 to $39.9 million in 1998. This increase was
attributable to a $37.1 million increase in the average balance of loans, the
effect of which more than offset a decrease in the yield on the Company's loan
portfolio from 8.12% in 1997 to 7.87% in 1998. The increase in the average
balance of loans resulted from both an increase in originations and from the
purchase of residential single-family loans. The weighted average yield on the
loan portfolio for the month of December 1998 was 7.56%.
Interest on investment securities decreased $133,000 in 1998 compared to
1997. This decrease resulted primarily from a decrease in the yield on the
portfolio from 6.24% in 1997 to 5.93% in 1998.
The Company's interest expense decreased by $3.5 million, as a result of a
decrease in interest on both deposits and borrowings. The average balance of
interest bearing deposits decreased by $19.4 million in 1998 compared to 1997,
while the average costs of interest bearing deposits decreased from 4.66% in
1997 to 4.54% in 1998. The average balance of borrowings decreased by $33.8
million in 1998 compared to 1997, while the average cost of the borrowings
decreased from 5.54% in 1997 to 5.35% in 1998.
The Company's net interest margin increased from 3.27% for the year ended
December 31, 1997 to 3.43% for the year ended December 31, 1998. This resulted
primarily from the sale of lower-yielding mortgage-backed certificates and
reduction in the asset size of the Company, and also a $13.7 million increase in
the average balance of noninterest-bearing deposits. For the fourth quarter of
1998, the Company's net interest margin was 3.57% compared to 3.31% in the
fourth quarter of 1997. The Company's interest rate spread increased from 2.85%
in the year ended December 31, 1997 to 2.88% in the comparable 1998 period. The
increase in the Company's interest rate spread occurred because the Company's
overall yield on its interest-earning assets decreased from 7.73% to 7.59%,
while the overall cost of its interest-bearing liabilities decreased from 4.88%
in 1997 to 4.71% in 1998. The Company's net interest spread in the fourth
quarter of 1998 was 2.95% compared to 2.86% in the fourth quarter of 1997. The
Company's calculations of interest rate spread and net interest rate margin
include nonaccrual loans as interest-earning assets.
Provision for Loan Losses. The Company's provision for loan losses
decreased from $600,000 in 1997 to $510,000 in 1998. Net chargeoffs totaled
$269,000 in 1998 compared to $623,000 in 1997. At December 31, 1998, the
Company's total allowance for loan losses was $4.0 million and nonperforming
loans totaled $1.1 million, resulting in a coverage ratio of 374%, compared to a
coverage ratio of 343% at December 31, 1997.
The provision for loan losses decreased by $90,000 in 1998 compared to
1997. The Company considered a number of factors in determining the 1998 loan
loss provision and the adequacy of the allowance for loan losses at December 31,
1998, including: (a) the level of nonperforming loans at December 31, 1998 and
1997, (b) the increase in the percentage of non-residential mortgage loans in
the loan portfolio, which have more inherent risk in comparison to residential
mortgage loans and, (c) the decrease in net loan chargeoffs during 1998.
Other Income. Total other income increased by 22.8%, from $5.7 million in
1997 to $7.0 million in 1998. Gain on sales of loans increased $482,000 in 1998
due primarily to the increased volume of mortgage loan originations. Deposit
fees and merchant processing fees increased by $414,000 and $671,000,
respectively, in 1998 compared to 1997. Deposit fees increased in 1998 as a
result of additional transaction accounts and increases in the Company's deposit
fee schedule. Merchant processing fees increased in 1998 as the Company
continued to experience substantial growth in its merchant portfolio. Brokerage
fees recognized by the Bank's commercial mortgage loan brokerage subsidiary
decreased by $382,000 in 1998 compared to 1997, primarily as a result of a
decrease in the volume of brokerage activity.
Other Expenses. Total other expenses increased from $17.3 million in the
year ended December 31, 1997 to $18.2 million in 1998. Total other expenses for
1997 includes $405,000 of expenses relating to the proxy contest and other
matters. Merchant processing expenses increased by $636,000 in 1998 as a result
of increased volume. Expenses related to professional fees increased by $266,000
during 1998 due, in part, to a recovery of legal costs in 1997 related to
previous problem assets. Equipment, data processing and supply expenses
increased by $158,000 in 1998, reflecting increases primarily in depreciation
and maintenance.
Income Taxes. The Company's income tax expense for the year ended
December 31, 1998 was $3.4 million, which represents an effective tax rate of
35.8%. The Company's income tax expense for 1997 was $3.3 million, which
represented an effective tax rate of 35.2%. The effective tax rate increased
during 1998 primarily as a result of the increase in the income of the Bank
subject to state tax.
44
Comparison of Operating Results for the Years Ended December 31, 1997 and 1996
General. The Company's pre-tax income increased by 70.7% to $9.3 million
for the year ended December 31, 1997 from $5.4 million for 1996. This increase
was attributable primarily to a $1.4 million increase in net interest income, a
$1.8 million increase in other income and an $860,000 decrease in other
expenses, the effect of which more than offset a $223,000 increase in the
provision for loan losses. Other expenses decreased in 1997 primarily as a
result of a reduction in federal deposit insurance premiums. Expenses in 1996
included a one-time assessment of $2.3 million in connection with the federal
legislation to recapitalize SAIF.
Net Interest Income. The Company's net interest income before provision for
loan losses increased by $1.4 million for the year ended December 31, 1997, a
6.9% increase from 1996. This increase resulted from a $2.6 million increase in
interest income, which exceeded a $1.2 million increase in interest expense. The
increase in interest income was primarily attributable to an increase in the
average balance of loans.
Interest on the Company's portfolio of mortgage-backed certificates
decreased by approximately $4.5 million from $13.2 million for the year ended
December 31, 1996 to $8.7 million for the comparable 1997 period. The decrease
resulted from a $72.8 million decrease in the average balance of the portfolio
which was partially offset by an increase in the average yield of the portfolio
from 6.69% in 1996 to 6.96% in 1997. The decrease in the average balance was a
consequence of the Company's sale of mortgage-backed certificates and
repayments. No mortgage-backed certificates were purchased in 1997.
The mortgage-backed certificate portfolio at December 31, 1997 had a total
amortized cost of $90.7 million and had a weighted average yield of 7.01% for
the month of December, 1997. The portfolio includes $5.1 million, or 5.6% of the
total portfolio, of fixed- rate mortgage-backed certificates; $83.6 million, or
92.2% of the total portfolio, of adjustable-rate mortgage-backed certificates;
and $2.1 million, or 2.2% of the total portfolio, of fixed-rate mortgage-backed
certificates with balloon provisions. The weighted average yields for the month
of December 1997 for these three classifications were 8.43%, 6.94%, and 6.51%,
respectively.
Interest on loans increased by approximately $8.0 million, or 26.4%, from
$30.2 million in the year ended 1996 to $38.2 million in 1997. This increase was
attributable to a $118.4 million increase in the average balance of loans, the
effect of which more than offset a decrease in the yield on the Company's loan
portfolio from 8.59% in 1996 to 8.12% in 1997. The increase in the average
balance of loans resulted from both an increase in originations and from the
purchase of residential single-family loans. The weighted average yield on the
loan portfolio for the month of December 1997 was 8.17%.
Interest on investment securities decreased $882,000 in 1997 compared to
1996. This decrease resulted from a $12.4 million decrease in the average
balance of the portfolio and a decrease in the yield on the portfolio from 6.44%
in 1996 to 6.25% in 1997.
The Company's interest expense increased by $1.2 million, primarily as a
result of an increase in interest on deposits, the effect of which was partially
offset by a decrease in interest on borrowings. The average balance of interest
bearing deposits increased by $41.3 million in 1997 compared to 1996, while the
average costs of interest bearing deposits decreased from 4.70% in 1996 to 4.66%
in 1997. The average balance of borrowings decreased by $13.3 million in 1997
compared to 1996, while the average cost of the borrowings increased from 5.40%
in 1996 to 5.54% in 1997.
The Company's net interest margin increased from 3.22% for the year ended
December 31, 1996 to 3.27% for the year ended December 31, 1997. This increase
was the result of an increase in the Company's interest rate spread from 2.83%
in the year ended December 31, 1996 to 2.85% in the comparable 1997 period. The
increase in the Company's interest rate spread occurred because the Company's
overall yield on its interest-earning assets remained level at 7.73%, while the
overall cost of its interest-bearing liabilities decreased from 4.90% in 1996 to
4.88% in 1997. The Company's calculations of interest rate spread and net
interest rate margin include nonaccrual loans as interest-earning assets.
The Company's net interest margin remained substantially unchanged during
1997. For the three months ended December 31, 1997, the Company's net interest
margin was 3.31% and the interest rate spread was 2.86%. For the three months
ended December 31, 1996, the Company's net interest margin was 3.30% and the
interest rate spread was 2.91%.
Provision for Loan Losses. The Company's provision for loan losses
increased from $377,000 in 1996 to $600,000 in 1997. Net chargeoffs totaled
$623,000 in 1997 compared to $267,000 in 1996. The Company's 1996 provision for
loan losses was positively impacted by a $288,000 recovery relating to one loan.
At December 31, 1997, the Company's total allowance for loan losses was $3.8
million and nonperforming loans totaled $1.1 million, resulting in a coverage
ratio of 343.0%.
45
Other Income. Total other income increased by 46.7%, from $3.9 million in
1996 to $5.7 million in 1997. Deposit fees and merchant processing fees
increased by $615,000 and $653,000, respectively, in 1997 compared to 1996.
Deposit fees increased in 1997 as a result of additional transaction accounts,
the addition of two ATMs, full implementation of ATM surcharges and increases in
the Company's deposit fee schedule. Merchant processing fees increased in 1997
as the Company continued to experience substantial growth in its merchant
portfolio. Brokerage fees recognized by the Bank's commercial mortgage loan
brokerage subsidiary increased by $437,000 in 1997 compared to 1996.
Other Expenses. Total other expenses decreased from $18.2 million in the
year ended December 31, 1996 to $17.3 million in 1997. Total other expenses for
1996 includes the $2.3 million SAIF special assessment and for 1997 includes
$405,000 of expenses relating to the proxy contest and other matters. Exclusive
of the SAIF special assessment in 1996 and the proxy and other expenses in 1997,
total other expenses were $15.8 million in 1996 and $16.9 million in 1997.
Salaries and employee benefits increased by $551,000 in 1997 primarily as a
result of overall increases in wages and benefits, expansion of the retail
banking group, including the opening of two new Super Kmart offices, one in
August 1996 and one in November 1997, and additional commissions from the Bank's
commercial mortgage loan brokerage subsidiary related to the increase in
mortgage loan brokerage revenue. Merchant processing expenses increased by
$544,000 in 1997 as a result of increased volume. Expenses related to real
estate owned increased by $177,000 during 1997 due to disposal of properties
during the year. Net occupancy expenses of premises increased by $133,000 in
1997, reflecting the incremental costs associated with additional retail
locations and the renovation of certain existing locations. The impact of the
increases in the above expenses was partially offset by a $570,000 decrease in
federal deposit insurance premiums in 1997 due primarily to lower premium rates,
and a $129,000 decrease in professional fees.
Income Taxes. The Company's income tax expense for the year ended
December 31, 1997 was $3.3 million, which represents an effective tax rate of
35.2%. The Company's income tax expense for 1996 was $1.8 million, which
represented an effective tax rate of 33.5%. The effective tax rate increased
during 1997 primarily as a result of the increase in the income of the Bank
subject to state tax.
Liquidity
The principal sources of funds for the Company for the year ended December
31, 1998, included $587.0 million in proceeds from FHLB advances, $34. 9 million
in principal repayments of securities available for sale, $84.7 million in
proceeds from sales, maturities and calls of securities available for sale, and
$82.9 million in proceeds from the sale of loans. Funds were used primarily to
repay FHLB advances totaling $657.0 million, to fund purchases of investment
securities available for sale totaling $48.2 million, and to originate loans
held for sale of $82.6 million.
Savings institutions, such as the Bank, are required to maintain an average
daily balance of liquid assets equal to a certain percentage of the sum of its
average daily balance of net withdrawable deposit accounts and borrowings
payable in one year or less. The liquidity requirements may vary from time to
time (between 4% and 10%) depending upon economic conditions and savings flows
of all savings institutions. At the present time, the required liquid asset
ratio is 4%. The Bank's liquid asset ratio was 9.3% and 8.8% at December 31,
1998 and 1997, respectively.
At December 31, 1998, the Company had outstanding mortgage and nonmortgage
loan commitments, including unused lines of credit, of $44.7 million,
outstanding commitments to purchase loans of $27.6 million and outstanding
commitments to sell mortgage loans of $5.9 million, if such loans close. The
Company anticipates that it will have sufficient funds available to meet its
current commitments.
Certificates of deposit that are scheduled to mature within one year
totaled $216.9 million at December 31, 1998. The Company believes that a
significant portion of the certificates of deposit maturing in this period will
remain with the Company. The Company's liquidity could be impacted by a decrease
in the renewals of deposits or general deposit runoff. However, the Company has
the ability to raise deposits by conducting deposit promotions. In the event the
Company requires funds beyond its ability to generate them internally, the
Company could obtain additional advances from the FHLB. The Company could also
obtain funds through the sale of investment securities from its available for
sale portfolio.
Market Risk Management
The Company's primary market risk exposure is interest rate risk.
Fluctuations in interest rates will impact both the level of interest income and
interest expense and the market value of the Company's interest-earning assets
and interest-bearing liabilities.
46
The primary goal of the Company's asset/liability management strategy is to
maximize its net interest income over time while keeping interest rate risk
exposure within levels established by the Company's management. The Company's
ability to manage its interest rate risk depends generally on the Company's
ability to match the maturities and repricing characteristics of its assets and
liabilities while taking into account the separate goals of maintaining asset
quality and liquidity and achieving the desired level of net interest income.
The principal variables that affect the Company's management of its interest
rate risk include the Company's existing interest rate gap position,
management's assessment of future interest rates, the need for the Company to
replace assets that may prepay before their scheduled maturities, and the
withdrawal of liabilities over time.
One technique used by the Company in managing its interest rate risk
exposure is the management of the Company's interest sensitivity gap. The
interest sensitivity gap is defined as the difference between the amount of
interest-earning assets anticipated, based upon certain assumptions, to mature
or reprice within a specific time period and the amount of interest-bearing
liabilities anticipated, based upon certain assumptions, to mature or reprice
within that time period. At December 31, 1998, the Company's one year "positive
gap" (interest-earning assets maturing within a period exceed interest-bearing
liabilities repricing within the same period) was approximately $120.9 million,
or 18.9% of total assets. Thus, during periods of rising interest rates, this
implies that the Company's net interest income would be positively affected
because the yield of the Company's interest-earning assets is likely to rise
more quickly than the cost on its interest-bearing liabilities. In periods of
falling interest rates, the opposite effect on net interest income is likely to
occur. The interest sensitivity gap position of the Company is a static analysis
at December 31, 1998. Because many factors affect the composition of the
Company's assets and liabilities, a change in prevailing interest rates will not
necessarily result in the corresponding change in net interest income that would
be projected using only the interest sensitivity gap table for the Company at
December 31, 1998.
At December 31, 1997, the Company's one year "positive gap" was
approximately $25.0 million, or 3.5% of total assets. The increase in the one
year "positive gap" of approximately $95.9 million was primarily the result of:
(a) faster prepayment assumptions in 1998 regarding prepayment of loans which
has resulted in an increase in one year interest sensitive loans of $45.7
million, (b) a decrease in mortgage-backed securities with one year interest
sensitivity of $72.7 million due primarily to sales, maturities and principal
repayments, (c) a decrease of $33.1 million of one year interest sensitive
deposits due primarily to a decrease in the outstanding balances of certificates
of deposit and, (d) a decrease of $85.0 million in one year interest sensitive
advances from the Federal Home Loan Bank as proceeds from mortgage-backed
certificates were used to pay down advances.
The Company manages its interest rate risk by influencing the adjustable
and fixed rate mix of its loans, securities, deposits and borrowings. The
Company can add loans or securities with adjustable, balloon or call features,
as well as fixed rate loans and mortgage securities if the yield on such loans
and securities is consistent with the Company's asset/liability management
strategy. Also, the Company can manage its interest rate risk by extending the
maturity of its borrowings or selling certain assets and repaying borrowings.
Certain shortcomings are inherent in any method of analysis used to
estimate a financial institution's interest rate gap. The analysis is based at a
given point in time and does not take into consideration that changes in
interest rates do not affect all assets and liabilities equally. For example,
although certain assets and liabilities may have similar maturities or
repricing, they may react differently to changes in market interest rates. The
interest rates on certain types of assets and liabilities also may fluctuate in
advance of changes in market interest rates, while interest rates on other types
may lag behind changes in market rates. The interest rates on loans with balloon
or call features may or may not change depending upon their interest rates
relative to market interest rates. Additionally, certain assets, such as
adjustable-rate mortgages, have features that may restrict changes in interest
rates on a short-term basis and over the life of the asset.
The Company is also subject to prepayment risk, particularly in falling
interest rate environments or in environments where the slope of the yield curve
is relatively flat or negative. Such changes in the interest rate environment
can cause substantial changes in the level of prepayments of loans and
mortgage-backed certificates, which may also affect the Company's interest rate
gap position.
As part of its borrowings, the Company may utilize from time-to-time,
convertible advances from the FHLB-Atlanta. Convertible advances generally
provide for a fixed-rate of interest for a portion of the term of the advance,
an ability for the FHLB-Atlanta to convert the advance from a fixed rate to an
adjustable rate at some predetermined time during the remaining term of the
advance (the "conversion" feature), and a concurrent opportunity for the Company
to prepay the advance with no prepayment penalty in the event the FHLB-Atlanta
elects to exercise the conversion feature. Changes in interest rates from those
at December 31, 1998 may result in a change in the estimated maturity of
convertible advances and, therefore, the Company's interest rate gap position.
47
Also, the methodology used estimates various rates of withdrawal (or
"decay") for money market deposit, savings, and checking accounts, which may
vary significantly from actual experience.
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1998 that are subject
to repricing or that mature in each of the future time periods shown. The table
reflects certain assumptions regarding prepayment of loans and mortgage-backed
certificates that are outside of actual contractual terms, and are based on the
1998 prepayment experience of the Company. Additionally, loans and securities
with call or balloon provisions are included in the period in which they balloon
or may first be called. Except as stated above, the amount of assets and
liabilities shown that reprice or mature during a particular period were
determined in accordance with the contractual terms of the asset or liability.
Interest Sensitivity Analysis
December 31, 1998
(Dollars in thousands, except footnotes)
Over
Over One Three
Total Year to Years or
0-3 4-6 7-12 Within Three Non-
Months Months Months One Year Years Sensitive Total
-------------------------------------------------------------------------------
Assets
Interest-earning assets:
Loans (1) $170,816 $ 55,313 $ 85,915 $312,044 $ 125,665 $ 54,413 $492,122
Securities available for sale:
U.S. Treasury securities 3,001 3,021 6,057 12,079 14,317 - 26,396
Other U.S. Government agency
securities 1,001 2,359 3,005 6,365 11,119 3,987 21,471
Other debt security - - - - - 250 250
Mortgage-backed certificates 6,527 4,072 3,269 13,868 1,465 1,686 17,019
Federal funds sold 42,289 - - 42,289 - - 42,289
Federal Home Loan Bank stock - - - - - 5,066 5,066
-------------------------------------------------------------------------------
Total interest-earning assets 223,634 64,765 98,246 386,645 152,566 65,402 604,613
===============================================================================
Liabilities
Interest-bearing liabilities:
Interest-bearing deposits:
Passbook, statement savings
and checking accounts (2) 3,141 3,141 6,282 12,564 19,337 46,449 78,350
Money market deposits 5,792 5,792 11,584 23,168 26,822 23,906 73,896
Certificates of deposits 76,019 59,392 81,528 216,939 39,286 9,589 265,814
-------------------------------------------------------------------------------
Total interest-bearing deposits 84,952 68,325 99,394 252,671 85,445 79,944 418,060
Advances from the Federal Home Loan Bank - - - - - 75,000 75,000
Securities sold under
agreements to repurchase 13,084 - - 13,084 - - 13,084
-------------------------------------------------------------------------------
Total interest-bearing liabilities 98,036 68,325 99,394 265,755 85,445 154,944 506,144
===============================================================================
Interest sensitivity gap $125,598 $ (3,560) $ (1,148) $120,890 $ 67,121 $(89,542) $ 98,469
===============================================================================
Cumulative interest sensitivity gap $125,598 $122,038 $120,890 $120,890 $ 188,011
========================================================
Cumulative interest sensitivity gap as a
percentage of total assets 19.6% 19.0% 18.9% 18.9% 29.3%
______________________
<FN>
(1) Excludes nonaccrual loans of $563,000
(2) Excludes $78.7 million of noninterest-bearing deposits.
</FN>
48
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates as of December 31,
1998, based on the information and assumptions set forth in the notes to the
table. Totals as of December 31, 1997 are included for comparative purposes. The
Company had no derivative financial instruments, foreign currency exposure or
trading portfolio as of December 31, 1998 and 1997. The amounts included under
each expected maturity date for loans, mortgage-backed certificates, and other
investments were calculated by adjusting the instrument's contractual maturity
date for expectations of prepayments, as set forth in the notes to the table.
Similarly, expected maturity date amounts for interest-bearing core deposits
were calculated based upon estimates of the period over which the deposits would
be outstanding as set forth in the notes. With respect to the Company's
adjustable rate instruments, amounts included under each expected maturity date
were measured by adjusting the instrument's contractual maturity date for
expectations of prepayments, as set forth in the notes.
Interest-earning assets maturing in one year increased and those maturing
after five years decreased at December 31, 1998 due primarily to an increase in
the loan prepayment rate assumptions at December 31, 1998. These prepayment
rates increased as a result of lower interest rates which also contributed to
the overall decreases in yields on average interest-earning assets between
December 31, 1997 and 1998.
Interest-bearing liabilities maturing in one year decreased at December 31,
1998 primarily as a result of the reduction in interest- bearing deposits and
short-term borrowings which resulted primarily from increases in
noninterest-bearing deposits and the sale of mortgage-backed certificates.
Interest-bearing liabilities maturing in years three and four changed primarily
from the assumption that Federal Home Loan Bank convertible advances were
estimated to mature in year four at December 31, 1998 instead of year three at
December 31, 1997. A lower cost mix of interest-bearing liabilities contributed
to the decrease in the average rate paid on interest- bearing liabilities at
December 31, 1998 compared to those paid at December 31, 1997.
49
Amount maturing in:
------------------------------------------------------------------------
There- Fair
(Dollars in thousands) 1 Year 2 Years 3 Years 4 Years 5 Years after Total Value
------ ------- ------- ------- ------- ------- ------- --------
Interest-earning assets:
Loans (1) (2)
Fixed rate $ 43,228 $ 26,406 $ 13,366 $ 8,583 $ 5,573 $ 9,643 $106,799 $108,022
Average interest rate 8.20% 8.20% 8.15% 8.11% 8.00% 7.62% 8.13%
Adjustable rate 178,405 75,129 42,430 28,584 18,761 42,014 385,323 388,915
Average interest rate 7.76% 7.66% 7.71% 7.87% 7.95% 8.02% 7.78%
Mortgage-backed certificates (3)
Fixed rate 1,093 793 673 578 502 274 3,913 3,913
Average interest rate 7.23% 8.42% 8.42% 8.42% 8.42% 8.95% 8.13%
Adjustable rate 6,861 3,190 1,647 857 454 97 13,106 13,106
Average interest rate 6.73% 7.44% 7.44% 7.45% 7.45% 7.49% 7.07%
Investments (4) 18,444 17,378 8,058 3,987 - 5,316 53,183 53,183
Average interest rate 6.06% 6.07% 5.40% 5.40% -% 7.58% 6.07%
Federal funds sold 42,289 - - - - - 42,289 42,289
Average interest rate 5.30% -% -% -% -% -% 5.30%
-------------------------------------------------------------------------------------
Total - December 31, 1998 $290,320 $122,896 $ 66,174 $ 42,589 $ 25,290 $ 57,344 $604,613 $609,428
Average interest rate 7.33% 7.55% 7.52% 7.68% 7.96% 7.92% 7.50%
=====================================================================================
Total - December 31, 1997 $230,405 $109,602 $ 88,599 $ 53,471 $ 40,778 $152,559 $675,414 $683,134
Average interest rate 7.58% 7.70% 7.57% 7.91% 7.91% 7.94% 7.73%
=====================================================================================
Interest-bearing liabilities:
Interest-bearing deposits (5) (6) $252,671 $ 56,012 $ 29,433 $ 19,997 $ 15,203 $ 44,744 $418,060 $419,849
Average interest rate 4.76% 4.55% 3.62% 3.43% 3.22% 2.30% 4.27%
Borrowings (7) 13,084 - - 75,000 - - 88,084 90,312
Average interest rate 3.96% -% 5.18% 5.11% -% -% 4.94%
-------------------------------------------------------------------------------------
Total - December 31, 1998 $265,755 $ 56,012 $ 29,433 $ 94,997 $ 15,203 $ 44,744 $506,144 $510,161
Average interest rate 4.72% 4.54% 3.62% 4.76% 3.22% 2.30% 4.38%
=====================================================================================
Total - December 31, 1997 $383,057 $ 51,634 $ 99,394 $ 20,763 $ 14,668 $ 40,519 $610,035 $612,728
Average interest rate 5.19% 4.65% 5.14% 4.07% 4.03% 2.93% 4.92%
=====================================================================================
____________________
<FN>
(1) Assumes the following annual prepayment rates:
-For single-family residential adjustable loans which adjust based upon
changes in the one-year constant maturity treasury index, 47%;
-For single-family fixed-rate first mortgage loans, from 22% to 32%;
-For commercial real estate loans, an average of 14%;
-For consumer loans, an average of 27%; and
-For most other loans, from 2% to 64%.
(2) Excludes nonaccrual loans of $563,000.
(3) Assumes prepayment rates for adjustable mortgage-backed certificates of 48%
to 52% and for fixed-rate mortgage-backed certificates of 14% to 19%.
(4) Totals include the Companys investment in FHLB Stock. Investment securities
with call features are reflected in the maturity period in which the
security is expected to be called based on interest rates at December 31,
1998.
(5) For money market deposits, savings and checking accounts, assumes
annual decay rates of 31%, 14% and 18%, respectively. These estimated rates
are those last published by the Office of Thrift Supervision in November,
1994.
(6) Excludes $78.7 million of noninterest-bearing deposits.
(7) The estimated expected maturity at December 31, 1998 of the $75 million of
convertible FHLB advances is 3.3 years based on information from
FHLB-Atlanta.
</FN>
50
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes presented herein have been
prepared in accordance with generally accepted accounting principles, which
generally require the measurement of financial position and operating results in
terms of historical dollars without considering the changes in the relative
purchasing power of money over time due to inflation. The impact of inflation is
reflected in the increased cost of the Company's operations. Unlike most
industrial companies, nearly all of the assets and liabilities of the Company
are monetary. As a result, interest rates have a greater impact on the Company's
performance than do the effects of general levels of inflation.
Impact of New Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. The Statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. This Statement is not
currently applicable to the Company, because the Company does not have any
derivative instruments and is not involved in hedging activities.
Impact of the Year 2000 Issue
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. As a result, such
computer programs will not recognize the correct date after December 31, 1999.
Also, systems and equipment that are not typically thought of as "computer
related" (referred to as "non-IT") contain imbedded hardware or software that
may have a time element.
In 1997, the Company implemented a four phase project of inventory,
assessment, renovation and testing/implementation to address the Year 2000
Issue. The scope of the project includes: ensuring the compliance of all
applications, operating systems and hardware on the mainframe, PC and LAN
systems; addressing issues related to non-IT embedded software and equipment;
and addressing the compliance of the Company's significant borrowers and third
party providers. A summary of significant milestones is presented below:
* The first three phases of inventory, assessment and renovation have been
substantially completed. The final phase, testing and implementation, is in
process and is expected to be substantially completed by March 31, 1999. The
Company plans to conduct additional testing throughout the year.
* The majority of the Company's non-IT related systems and equipment
are currently Year 2000 compliant based primarily on communications with
vendors. Compilation of written documentation regarding compliance is underway
and is scheduled to be substantially completed by the end of the first quarter
of 1999, as is any testing of critical systems that the Company determines needs
to be conducted.
* The potential impact of Year 2000 will depend not only on the corrective
measures the Company undertakes but also on other entities who provide data to
or receive data from the Company and on those whose operational capability or
financial conditions are important to the Company. The Company has received
assurances from all major third party vendors that they are either Year 2000
compliant or expect to be in compliance prior to the end of the second quarter
of 1999. In addition, management has reviewed significant lending and deposit
relationships and consulted with these customers as to their plans to address
Year 2000 issues. The plans of such parties are currently being monitored, and
any fundamental impact on the Company will be evaluated.
* The Company has established an internal review process to evaluate its
Year 2000 testing results. Monthly progress reports are made to the Company's
senior management and Board of Directors.
* The Company estimates, based on current projections of allocations of
existing resources and known direct costs, that total costs related to the Year
2000 project will be approximately $1,150,000. The Company estimates that
approximately 78% of these costs will be related to the redeployment of existing
personnel to address Year 2000 Issues, while approximately 22% of these costs
will represent incremental expenses to the Company since inception of the Year
2000 project. Since inception, the Company has incurred approximately $500,000
of costs related to its Year 2000 project, of which approximately $40,000
represents incremental expenses. Of the $500,000 of Year 2000 project costs
incurred since inception, approximately $160,000 and approximately $340,000 were
51
incurred in 1997 and 1998, respectively. Some computer related initiatives have
been delayed due to the allocation of resources towards Year 2000 issues.
Management believes there has not been an adverse impact on the Company's
financial condition or day to day operations as a result of computer projects
being deferred due to reallocation of resources to the Year 2000 project.
* The Company has established a Customer Awareness Program to inform
customers of Year 2000 issues and provide status reports as to the Bank's Year
2000 efforts.
The Company expects its critical systems to be compliant well before
December 31, 1999. In the unlikely event that a critical system should not
perform as expected or if there is non-compliance by a major third party
provider, the Company is developing a contingency plan to address the possible
failure of critical systems. The Company expects to complete its contingency
plan by the end of the second quarter of 1999.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Information contained in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations," other than historical
information, may contain forward-looking statements that involve risks and
uncertainties including, but not limited to, the Company's interest rate risk
position, and future credit and economic trends including inflation and changing
prices and the Company's compliance with Year 2000 data processing standards.
These statements are made pursuant to the safe harbor provisions of the Private
Litigation Reform Act of 1995, and are provided to assist the reader in
understanding anticipated future financial and operational results. Although the
Company believes that the assumptions underlying the forward-looking statements
contained herein are reasonable, any of these assumptions could ultimately prove
to be inaccurate. The Company's actual results may differ materially from those
projected in forward-looking statements.
Item 7A - Quantitative and Qualitative Disclosures About Market Risk
See Item 7 - "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Market Risk Management" on pages 46 to 50.
52
Item 8 - Financial Statements and Supplementary Data
Index to Financial Statements
Page
Financial Statements:
Report of Independent Accountants................................................................................. 54
Consolidated Statement of Financial Condition as of December 31, 1998 and December 31, 1997....................... 55
Consolidated Statement of Operations for the three years ended December 31, 1998.................................. 56
Consolidated Statement of Comprehensive Income for the three years ended December 1998............................ 57
Consolidated Statement of Changes in Stockholders' Equity for the three years ended
December 31, 1998............................................................................................. 58
Consolidated Statement of Cash Flows for the three years ended December 31, 1998.................................. 59
Notes to Consolidated Financial Statements........................................................................ 60
<FN>
Financial Statement Schedules:
All schedules are omitted because they are not applicable or the required information is shown in the financial statements
or notes thereto.
</FN>
53
Report of Independent Accountants
[LETTERHEAD OF PRICEWATERHOUSECOOPERS LLP APPEARS HERE]
To the Board of Directors and Stockholders of CENIT Bancorp, Inc.
Norfolk, Virginia
In our opinion, the accompanying consolidated statement of financial
condition and the related consolidated statements of operations, of
comprehensive income, of changes in stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of CENIT
Bancorp, Inc. and its subsidiary at December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Virginia Beach, Virginia
January 29, 1999
54
Consolidated Statement of Financial Condition
(Dollars in thousands, except per share data)
December 31,
1998 1997
----------------------------
Assets
Cash $ 14,656 $ 16,993
Federal funds sold 42,289 37,118
Securities available for sale at fair value (adjusted cost
of $64,327 and $135,861, respectively) 65,136 137,188
Loans, net:
Held for investment 484,783 486,487
Held for sale 3,878 3,167
Interest receivable 3,723 4,888
Real estate owned, net 377 1,098
Federal Home Loan Bank and Federal Reserve
Bank stock, at cost 5,066 8,711
Property and equipment, net 13,002 14,230
Goodwill and other intangibles, net 3,647 4,010
Other assets 4,499 4,193
----------------------------
Total assets $ 641,056 $ 718,083
============================
Liabilities and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing $ 78,712 $ 54,874
Interest-bearing 418,060 452,796
----------------------------
Total deposits 496,772 507,670
Advances from the Federal Home Loan Bank 75,000 145,000
Other borrowings - 2,575
Securities sold under agreements to repurchase 13,084 9,664
Advance payments by borrowers for taxes and insurance 599 720
Other liabilities 5,525 2,517
----------------------------
Total liabilities 590,980 668,146
----------------------------
Commitments (Note 19)
Stockholders' equity:
Preferred stock, $.01 par value; authorized 3,000,000
shares; none outstanding - -
Common stock, $.01 par value; authorized 7,000,000
shares; issued and outstanding 4,808,806
and 4,971,243, respectively 48 50
Additional paid-in capital 14,177 18,119
Retained earnings - substantially restricted 39,600 35,416
Common stock acquired by Employees Stock
Ownership Plan (ESOP) (4,052) (4,232)
Common stock acquired by Management
Recognition Plan (MRP) (199) (271)
Net unrealized gain on securities available for sale,
net of income taxes 502 855
----------------------------
Total stockholders' equity 50,076 49,937
----------------------------
$ 641,056 $ 718,083
============================
The notes to consolidated financial statements are an integral part of this statement.
55
Consolidated Statement of Operations
(Dollars in thousands, except per share data)
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Interest and fees on loans $ 39,931 $ 38,220 $ 30,243
Interest on mortgage-backed certificates 3,208 8,685 13,224
Interest on investment securities 2,664 2,775 3,657
Dividends and other interest income 1,228 1,096 1,047
-------------------------------------------
Total interest income 47,031 50,776 48,171
-------------------------------------------
Interest on deposits 19,571 20,972 19,240
Interest on borrowings 6,234 8,338 8,847
-------------------------------------------
Total interest expense 25,805 29,310 28,087
-------------------------------------------
Net interest income 21,226 21,466 20,084
Provision for loan losses 510 600 377
-------------------------------------------
Net interest income after provision for loan losses 20,716 20,866 19,707
-------------------------------------------
Other income:
Deposit fees 2,454 2,040 1,425
Gains on sales of:
Securities, net 72 84 77
Loans, net 1,030 548 629
Loan servicing fees and late charges 318 322 353
Other 3,139 2,719 1,410
-------------------------------------------
Total other income 7,013 5,713 3,894
-------------------------------------------
Other expenses:
Salaries and employee benefits 8,301 8,313 7,762
Equipment, data processing, and supplies 2,861 2,703 2,529
Federal deposit insurance premiums, including
one-time SAIF special assessment of $2,340
in 1996 260 277 3,187
Expenses related to proxy contest and other
matters - 405 -
Other 6,775 5,614 4,694
-------------------------------------------
Total other expenses 18,197 17,312 18,172
-------------------------------------------
Income before income taxes 9,532 9,267 5,429
Provision for income taxes 3,417 3,264 1,821
-------------------------------------------
Net income $ 6,115 $ 6,003 $ 3,608
===========================================
Earnings per share:
Basic $ 1.30 $ 1.24 $ .74
===========================================
Diluted $ 1.27 $ 1.20 $ .72
===========================================
Dividends per common share $ .41 $ .33 $ .25
===========================================
The notes to consolidated financial statements are an integral part of this statement.
56
Consolidated Statement of Comprehensive Income
(Dollars in thousands)
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Net income $ 6,115 $ 6,003 $ 3,608
-------------------------------------------
Other comprehensive loss, before income taxes:
Unrealized losses on securities available for sale
Unrealized holding losses arising during the period (445) (233) (713)
Less: reclassification adjustment for gains included in
net income (72) (84) (77)
-------------------------------------------
Other comprehensive loss, before income taxes (517) (317) (790)
Income tax benefit related to items of other
comprehensive loss 164 109 242
-------------------------------------------
Other comprehensive loss, net of income taxes (353) (208) (548)
-------------------------------------------
Comprehensive income $ 5,762 $ 5,795 $ 3,060
===========================================
The notes to consolidated financial statements are an integral part of this statement.
57
Consolidated Statement of Changes in Stockholders' Equity
(Dollars in thousands)
Common Accumulated
Stock Other
Common Common Additional Acquired Comprehensive
Stock Stock Paid-In Retained by ESOP Income (Loss),Net
Shares Amount Capital Earnings and MRP of Income Taxes Total
----------------------------------------------------------------------------------------------
Balance, December 31, 1995,
as originally reported 1,596,675 $ 16 $ 16,903 $ 28,641 $ (442) $1,611 $ 46,729
Common stock issued in 1998
three-for-one stock split 3,193,350 32 (32) - - - -
----------------------------------------------------------------------------------------------
Balance at December 31, 1995
as restated 4,790,025 48 16,871 28,641 (442) 1,611 46,729
Comprehensive income - - - 3,608 - (548) 3,060
Cash dividends paid, net of
tax benefits relating to -
dividends paid on unallocated
shares held by ESOP - - (1,209) - - (1,209)
Principal payments on ESOP
loan - - - - 300 - 300
Exercise of stock options, stock
warrants, and related tax
benefits 115,107 1 766 - - - 767
Other - - - - (39) - (39)
----------------------------------------------------------------------------------------------
Balance, December 31, 1996 4,905,132 49 17,637 31,040 (181) 1,063 49,608
Comprehensive income - - - 6,003 - (208) 5,795
Cash dividends paid - - - (1,627) - - (1,627)
Purchase of Common Stock
by ESOP - - - - (4,232) - (4,232)
Exercise of stock options
and related tax benefits 66,111 1 482 - - - 483
Other - - - - (90) - (90)
----------------------------------------------------------------------------------------------
Balance, December 31, 1997 4,971,243 50 18,119 35,416 (4,503) 855 49,937
Comprehensive income - - - 6,115 - (353) 5,762
Cash dividends paid - - - (1,931) - - (1,931)
Exercise of stock options
and related tax benefits 69,063 - 602 - - - 602
Stock repurchases (231,500) (2) (4,667) - - - (4,669)
Other - - 123 - 252 - 375
----------------------------------------------------------------------------------------------
Balance, December 31, 1998 4,808,806 $ 48 $ 14,177 $ 39,600 $ (4,251) $ 502 $ 50,076
==============================================================================================
The notes to consolidated financial statements are an integral part of this statement.
58
Consolidated Statement of Cash Flows
(Dollars in thousands)
Year Ended December 31,
1998 1997 1996
------------------------------------------------
Cash flows from operating activities:
Net income $ 6,115 $ 6,003 $ 3,608
Add (deduct) items not affecting cash during the year:
Provision for loan losses 510 600 377
Provision for losses on real estate owned 15 81 136
Amortization of loan yield adjustments 381 158 (98)
Depreciation, amortization and accretion, net 1,930 2,593 2,481
Net (gains) losses on sales/disposals of:
Securities (72) (84) (77)
Loans (1,030) (548) (629)
Real estate, property and equipment 36 16 160
Proceeds from sales of loans held for sale 82,893 45,338 46,685
Originations of loans held for sale (82,608) (46,097) (45,003)
Change in assets/liabilities, net
Decrease (increase) in interest receivable and other assets 1,168 (1,121) (3,689)
Increase (decrease) in other liabilities 3,176 (46) (532)
------------------------------------------------
Net cash provided by operating activities 12,514 6,893 3,419
------------------------------------------------
Cash flows from investing activities:
Purchases of securities available for sale (48,237) (16,087) (67,906)
Proceeds from sales of securities available for sale 66,660 35,447 14,792
Principal repayments on securities available for sale 34,855 49,243 66,519
Proceeds from maturities and calls of securities available
for sale 18,000 17,000 29,160
Net increase in loans held for investment 2,307 (64,572) (105,602)
Net proceeds on sales of real estate owned 597 1,224 1,837
Additions to real estate owned (86) (129) (398)
Purchases of Federal Home Loan Bank stock
and Federal Reserve Bank stock (1,650) (1,850) (7,942)
Redemption of Federal Home Loan Bank stock 5,295 1,000 7,110
Purchases of property and equipment (1,273) (2,727) (2,662)
Proceeds from sales of property and equipment 453 10 -
------------------------------------------------
Net cash provided by (used for) investing activities 76,921 18,559 (65,092)
------------------------------------------------
Cash flows from financing activities:
Proceeds from exercise of stock options and warrants 173 357 583
Net (decrease) increase in deposits (10,898) 8,705 48,435
Proceeds from Federal Home Loan Bank advances 587,000 1,255,000 1,918,000
Repayment of Federal Home Loan Bank advances (657,000) (1,258,000) (1,903,000)
Proceeds from other borrowings - 4,000 -
Repayment of other borrowings (2,575) (1,425) (300)
Net increase in securities sold under agreement
to repurchase 3,420 2,526 2,267
Cash dividends paid (1,931) (1,627) (1,215)
Purchase of common stock by ESOP - (4,232) -
Common stock repurchases (4,669) - -
Other, net (121) (123) (24)
------------------------------------------------
Net cash (used for) provided by financing activities (86,601) 5,181 64,746
------------------------------------------------
Increase in cash and cash equivalents 2,834 30,633 3,073
Cash and cash equivalents, beginning of year 54,111 23,478 20,405
------------------------------------------------
Cash and cash equivalents, end of year $ 56,945 $ 54,111 $ 23,478
================================================
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 8,910 $ 11,624 $ 11,883
Cash paid during the year for income taxes 2,855 2,820 1,595
Schedule of noncash investing and financing activities:
Real estate acquired in settlement of loans 312 1,603 3,920
Loans to facilitate sale of real estate owned 470 2,058 1,622
Loan to facilitate sale of property 1,336 - -
The notes to consolidated financial statements are an integral part of this statement.
59
Notes To Consolidated Financial Statements
Note 1
Summary of Significant Accounting Policies
CENIT Bancorp, Inc. (the "Holding Company" or the "Company") is a Delaware
corporation that owns CENIT Bank, a federally chartered stock savings bank.
On June 3, 1998, the Company, as the sole shareholder of its two subsidiary
banks, merged Princess Anne Bank ("Princess Anne") into CENIT Bank, FSB. In July
1998, CENIT Bank FSB ceased the use of "FSB" and became CENIT Bank (the "Bank").
The Company operates in one business segment, providing retail and
commercial banking services to customers within its market area.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and that affect the reported amounts of income and expenses during
the reporting period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiary, the Bank, and the Bank's wholly-owned subsidiaries.
All significant intercompany balances and transactions have been eliminated.
Investment Securities
Investment securities are accounted for in accordance with Statement of
Financial Accounting Standards No. 115 (FAS 115), "Accounting for Certain
Investments in Debt and Equity Securities." FAS 115 requires that certain
securities be classified into one of three categories: held to maturity,
available for sale, or trading. Securities classified as held to maturity are
carried at amortized cost; securities classified as available for sale are
carried at their fair value with the amount of unrealized gains and losses, net
of income taxes, reported as a separate component of stockholders' equity; and
securities classified as trading are carried at fair value with the unrealized
gains and losses included in earnings.
Premium amortization and discount accretion are included in interest income
and are calculated using the interest method over the period to maturity of the
related asset. The adjusted cost of specific securities sold is used to compute
realized gain or loss on sale. The gain or loss realized on sale is recognized
on the trade date.
Loans
Loans held for investment are carried at their outstanding principal
balance. Unearned discounts, premiums, deferred loan fees and costs, and the
allowance for loan losses are treated as adjustments of loans in the
consolidated statement of financial condition.
At December 31, 1998 and 1997, approximately seventy-five percent and
seventy-one percent, respectively, of the principal balance of the Bank's real
estate loans were to residents of or secured by properties located in Virginia.
This geographic concentration is also considered in management's establishment
of loan loss reserves.
Interest on loans is credited to income as earned. Interest receivable is
accrued only if deemed collectible. Generally, interest is not accrued on loans
over ninety days past due. Uncollectible interest on loans that are
contractually past due is charged-off or an allowance is established based on
management's periodic evaluation. The allowance is established by a charge to
interest income equal to all interest previously accrued, and income is
subsequently recognized only to the extent that cash payments are received
until, in management's judgment, the borrower has reestablished the ability to
make periodic interest and principal payments, in which case the loan is
returned to accrual status. Interest income is recognized on loans which are
ninety days or more past due only if management considers the principal and
interest balance to be fully collectible. Loan origination and commitment fees
and certain direct loan origination costs and premiums and discounts related to
purchased loans are deferred and amortized as an adjustment of yield over the
contractual life of the related loan. The unamortized portion of net deferred
fees is recognized in income if loans prepay or if commitments expire unfunded.
The amortization of net fees or costs is included in interest and fees on loans
in the consolidated statement of operations.
Loans held for sale are carried at the lower of cost or market on an
aggregate basis. Loan fees collected and direct origination costs incurred with
respect to loans held for sale are deferred as an adjustment of the carrying
value of the loans and are included in the determination of gain or loss on
sale.
60
Impaired Loans
Impaired loans are specifically reviewed loans for which it is probable
that the Company will be unable to collect all amounts due according to the
terms of the loan agreement. The specific factors that influence management's
judgment in determining when a loan is impaired include evaluation of the
financial strength of the borrower and the fair value of the collateral.
Impaired loans are measured and reported based on the present value of expected
cash flows discounted at the loan's effective interest rate, or at the fair
value of the loan's collateral if the loan is deemed "collateral dependent." A
valuation allowance is required to the extent that the measure of the impaired
loans is less than the recorded investment.
Allowance for Loan Losses
The allowance for loan losses represents management's estimate of an amount
adequate to absorb potential losses on loans that may become uncollectible.
Factors considered in the establishment of the allowance for loan losses include
management's evaluation of specific loans, the level and composition of
classified loans, historical loss experience, expectations of future economic
conditions, concentrations of credit, the relative inherent risk of loan types
that comprise the loan portfolio, and other judgmental factors. The allowance
for loan losses is increased by charges to income and decreased by charge-offs,
net of recoveries. Actual future losses may differ from estimates as a result of
unforeseen events.
Real Estate Owned
Real estate acquired in settlement of loans is recorded at the lower of the
unpaid loan balance or estimated fair value less estimated costs of sale at the
date of foreclosure. Subsequent valuations are periodically performed and
valuation allowances are established if the carrying value of the real estate
exceeds estimated fair value less estimated costs of sale. Costs related to
development and improvement of real estate are capitalized. Net costs related to
holding assets are expensed.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Major renewals or betterments are capitalized and depreciated over
their estimated useful lives. Repairs and maintenance are charged to expense in
the year incurred. Depreciation and amortization are computed principally on the
straight-line basis over the estimated useful lives of the related assets.
Goodwill and other intangibles
Goodwill represents the excess of cost over the fair value of net assets
acquired and is amortized on a straight-line basis over 15 years. The core
deposit intangible represents the estimated fair value of certain customer
relationships acquired and is amortized on an accelerated basis over 10 years.
Long-Lived Assets
Long-lived assets to be held and those to be disposed of and certain other
intangibles are evaluated for impairment using the guidance of Statement of
Financial Accounting Standards No. 121 (FAS 121), "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which was
adopted by the Company on January 1, 1996. FAS 121 establishes when an
impairment loss should be recognized and how an impairment loss should be
measured. The adoption of FAS 121 did not have a significant impact on the
financial statements of the Company.
Deposits
Interest on deposits is accrued and compounded according to the contractual
term of the deposit account and either paid to the depositor or added to the
deposit account. On term accounts, the forfeiture of interest (because of
withdrawal prior to maturity) is offset as of the date of withdrawal against
interest expense.
61
Securities Sold Under Agreements to Repurchase
The Bank enters into sales of securities under agreements to repurchase
(reverse repurchase agreements). Fixed-coupon reverse repurchase agreements are
treated as financing transactions, and the obligations to repurchase securities
sold are reflected as liabilities in the statement of financial condition. The
securities underlying the agreements continue to be recorded as assets.
Income Taxes
The provision for income taxes is based upon income taxes estimated to be
currently payable and certain changes in deferred income tax assets and
liabilities. The deferred tax assets and liabilities relate principally to the
use of different reporting methods for bad debts, depreciation, and Federal Home
Loan Bank stock dividends.
Statement of Cash Flows
For purposes of the statement of cash flows, the Company considers cash and
federal funds sold to be cash and cash equivalents.
Earnings Per Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" (FAS 128). FAS 128 replaced
the primary and fully diluted earnings per share ("EPS") calculations with two
new calculations, basic EPS and diluted EPS. Basic EPS excludes dilution and is
computed by dividing income by the weighted average number of shares outstanding
for the period. Diluted EPS reflects the potential dilution of stock options
computed using the treasury stock method. In accordance with FAS 128, all prior
periods have been restated. Basic earnings per share for the years ended
December 31, 1998, 1997, and 1996 were determined by dividing net income for the
respective year by 4,715,697 shares, 4,853,484 shares, and 4,850,151 shares,
respectively. Diluted earnings per share for the years ended December 31, 1998,
1997, and 1996 were determined by dividing net income for the respective year by
4,829,641 shares, 4,986,066 shares, and 4,998,495 shares, respectively. The
difference in the number of shares used for basic earnings per share and diluted
earnings per share calculations for each of the three years results solely from
the dilutive effect of stock options and warrants. Options on approximately
65,000 shares were not included in computing diluted earnings per share for the
year ended December 31, 1998 because their effects were antidilutive. There were
no options on shares at December 31, 1997 and 1996 that were antidilutive.
Comparative Financial Statements
The financial statements for 1996 and 1997 have been reclassified to
conform to the 1998 presentation. Such reclassifications had no impact on
previously reported net income.
Note 2
Cash
The Bank is required by the Federal Reserve Bank to maintain average
reserve balances. The average amount of these reserve balances for the year
ended December 31, 1998 was $2,703,000. On December 31, 1998, the required
reserve balance was $5,108,000.
Note 3
Acquisition of Deposits
On September 26, 1996 and November 7, 1996, the Bank assumed the deposits
of five Essex Savings Bank, FSB ("Essex") branches pursuant to a Branch Purchase
and Deposit Assumption Agreement dated July 2, 1996. As part of these
transactions, the Bank assumed approximately $68.1 million of deposits, acquired
certain other assets and liabilities, received approximately $65.5 million of
cash and recorded total intangible assets of approximately $2.8 million. The
Bank used the majority of the cash proceeds received in connection with the
deposit assumptions to reduce its Federal Home Loan Bank (FHLB) advances.
The Bank still operates the former Essex offices located in downtown
Hampton, Virginia and in the Denbigh area of Newport News, Virginia. The
deposits associated with Essex's Norfolk and Portsmouth, Virginia offices were
consolidated into existing Bank
62
retail offices in those neighborhoods, and the deposits associated ated into the
Bank's existing Kiln Creek office located in York County, Virginia.with Essex's
Grafton, Virginia office were consolidated into the Bank's existing Kiln Creek
office located in York County, Virginia.
Note 4
Intangible Assets
Goodwill and core deposit intangibles, and the related amortization, are as
follows (in thousands):
Core Deposit
Goodwill Intangible Total
-----------------------------------------------------------
Balance, December 31, 1996 $ 3,944 $ 437 $ 4,381
Amortization (290) (81) (371)
-----------------------------------------------------------
Balance, December 31, 1997 3,654 356 4,010
Amortization (290) (73) (363)
-----------------------------------------------------------
Balance, December 31, 1998 $ 3,364 $ 283 $ 3,647
===========================================================
At December 31, 1998, the Company had recorded $1,162,000 of accumulated
amortization.
63
Note 5
Securities Available for Sale
Securities available for sale are as follows (in thousands):
December 31,
1998 1997
-------------------------------------------- -------------------------------------------------
Gross Gross Gross Gross
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
-------------------------------------------- -------------------------------------------------
U.S. Treasury securities $ 26,043 $ 353 $ - $ 26,396 $ 39,139 $ 215 $ (11) $ 39,343
----------------------------------------------- -------------------------------------------------
Other U. S. Government agency
securities 21,344 134 (7) 21,471 5,999 6 (1) 6,004
----------------------------------------------- -------------------------------------------------
Other debt security 250 - - 250 - - - -
----------------------------------------------- -------------------------------------------------
Mortgage-backed certificates:
Federal Home Loan
Mortgage Corporation
participation certificates 11,445 214 - 11,659 81,382 880 (2) 82,260
Federal National Mortgage
Association pass-through
certificates 3,293 53 (1) 3,345 6,646 150 (2) 6,794
Government National
Mortgage Association
pass-through certificates 1,952 63 - 2,015 2,695 92 - 2,787
----------------------------------------------- -------------------------------------------------
Total mortgage-backed
certificates 16,690 330 (1) 17,019 90,723 1,122 (4) 91,841
----------------------------------------------- -------------------------------------------------
$ 64,327 $ 817 $ (8) $ 65,136 $ 135,861 $ 1,343$ (16) $ 137,188
=============================================== =================================================
During 1998, 1997, and 1996, the Company recognized gross gains of
$143,000, $111,000, and $140,000, respectively, and gross losses of $71,000,
$27,000, and $63,000, respectively, on the sale of available for sale
securities.
The amortized cost and fair value of securities available for sale at
December 31, 1998 are shown below by contractual maturity (in thousands):
Amortized Fair
Cost Value
--------------------------
Due in one year or less $ 12,010 $ 12,079
Due after 1 year through 5 years 35,377 35,788
Due after 5 years 250 250
Mortgage-backed certificates 16,690 17,019
---------------------------
$ 64,327 $ 65,136
===========================
64
Note 6
Loans
Loans held for investment consist of the following (in thousands):
December 31,
1998 1997
-----------------------------
First mortgage loans:
Single family $ 251,117 $ 308,525
Multi-family 7,874 6,374
Construction:
Residential 66,853 56,992
Nonresidential 4,101 1,420
Commercial real estate 76,611 57,913
Consumer lots 3,703 4,573
Acquisition and development 11,444 13,327
Equity and second mortgage 52,845 45,194
Purchased mobile home 52 95
Boat 4,275 5,685
Other consumer 10,537 7,250
Commercial business 33,485 24,222
----------------------------
522,897 531,570
Undisbursed portion of construction
and acquisition and development loans (35,463) (42,067)
Allowance for loan losses (4,024) (3,783)
Unearned discounts, premiums, and loan
fees, net 1,373 767
----------------------------
$ 484,783 $ 486,487
============================
At December 31, 1998, the Company's gross loan portfolio contains
$215,833,000 of adjustable-rate mortgage loans and $55,022,000 of loans which
are callable or balloon at various dates over the next seven years. Prime-based
loans, net of the undisbursed portion of construction and acquisition and
development loans, totaled $98,595,000 at December 31, 1998.
65
Nonaccrual loans are as follows (in thousands):
December 31,
1998 1997 1996
-------------------------------------------
Single family $ 416 $ 528 $ 1,172
Commercial real estate - - 457
Land acquisition - 200 200
Purchased mobile home 15 48 83
Other consumer 68 24 17
Commercial business 64 240 483
------------------------------------------
$ 563 $ 1,040 $ 2,412
==========================================
Interest income that would have been recorded under the contractual terms
of such nonaccrual loans and the interest income actually recognized are
summarized as follows (in thousands):
Year Ended December 31,
1998 1997 1996
-----------------------------
Interest income based on contractual terms $ 61 $ 92 $ 252
Interest income recognized 36 30 114
-----------------------------
Interest income foregone $ 25 $ 62 $ 138
=============================
Changes in the allowance for loan losses are as follows (in thousands):
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Balance at beginning of year $ 3,783 $ 3,806 $ 3,696
Provision for loan losses 510 600 377
Losses charged to allowance (382) (836) (738)
Recovery of prior losses 113 213 471
---------------------------------------------
Balance at end of year $ 4,024 $ 3,783 $ 3,806
==============================================
There were no impaired loans at December 31, 1998 and 1997.
Loans serviced for others approximate $13,826,000 at December 31, 1998,
$16,013,000 at December 31, 1997, and $17,740,000 at December 31, 1996.
66
Note 7
Interest Receivable
The components of interest receivable are as follows (in thousands):
December 31,
1998 1997
---------------------------
Interest on loans $ 2,766 $ 3,054
Interest on mortgage-backed certificates 178 1,090
Interest on investments and interest-bearing
deposits 819 909
----------------------------
3,763 5,053
Less: Allowance for uncollected interest (40) (165)
----------------------------
$ 3,723 $ 4,888
============================
Note 8
Real Estate Owned
Real estate owned is as follows (in thousands):
December 31,
1998 1997
---------------------------
Residential - Single family $ 325 $ 1,204
Land 105 -
---------------------------
430 1,204
Less: Valuation allowance (53) (106)
----------------------------
$ 377 $ 1,098
============================
Changes in the valuation allowance for real estate owned are as follows (in
thousands):
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Balance at beginning of year $ 106 $ 200 $ 161
Provision for losses 15 81 136
Losses charged to allowance (68) (175) (97)
--------------------------------------------
Balance at end of year $ 53 $ 106 $ 200
============================================
The provision for losses on real estate owned is included in other expense
in the accompanying consolidated statement of operations.
67
Note 9
Federal Home Loan Bank and Federal Reserve Bank Stock
Investment in the stock of the Federal Home Loan Bank (FHLB) is required by
law for federally insured savings associations such as the Bank. No ready market
exists for the stock and it has no quoted market value. The FHLB is required
under the Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") to use its future earnings in various government-mandated programs
including low to moderate income housing. These programs and other uses of the
FHLB's future earnings could impair its ability to pay dividends to the Company
on this investment.
Investment in the stock of the Federal Reserve Bank is required by law for
insured institutions such as Princess Anne. Due to the merger of Princess Anne
with the Bank in 1998, investment in the stock of the Federal Reserve Bank is no
longer required and the stock has been redeemed.
Note 10
Property and Equipment
Property and equipment consist of the following (in thousands):
December 31,
1998 1997
---------------------------
Buildings and leasehold improvements $ 9,857 $ 11,829
Furniture and equipment 9,845 8,904
----------------------------
19,702 20,733
Less: Accumulated depreciation and
amortization (9,404) (9,318)
----------------------------
10,298 11,415
Land 2,704 2,815
----------------------------
$ 13,002 $ 14,230
============================
Depreciation and amortization expense is $1,251,000, $1,154,000, and
$1,037,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
In December 1998, the Company sold its corporate office building and leased
back a portion of the building over a three-year period that ends December 31,
2001. The transaction was accounted for as a sale-leaseback. Accordingly, gain
on the sale of $404,000 has been deferred and will be recognized in proportion
to the related gross rent charged to expense over the lease term.
68
Note 11
Deposits
Deposit balances by type and range of interest rates at December 31, 1998
and 1997 are as follows (in thousands):
December 31,
1998 1997
---------------------------
Noninterest-bearing:
Commercial checking $ 69,801 $ 47,499
Personal checking 8,911 7,375
---------------------------
Total noninterest-bearing deposits 78,712 54,874
---------------------------
Interest-bearing:
Passbook and statement savings
(interest rates of 2.46% at 1998 and
3.34% at 1997) 36,588 44,118
Checking accounts (interest rates of 1.43% at
1998 and 2.05% at 1997) 41,762 32,754
Money market deposits (interest rates of
3.36% at 1998 and 3.25% at 1997) 73,896 47,726
Certificates:
3.99% or less 345 519
4.00% to 4.99% 121,862 70,286
5.00% to 5.99% 113,417 218,016
6.00% to 6.99% 18,818 27,210
7.00% to 7.99% 9,958 10,369
8.00% to 8.99% 294 668
9.00% to 9.99% 1,120 1,130
---------------------------
Total certificates 265,814 328,198
---------------------------
Total interest-bearing deposits 418,060 452,796
---------------------------
Total deposits $ 496,772 $ 507,670
===========================
Certificates in denominations greater than $100,000 aggregated $24,940,000
and $28,831,000 at December 31, 1998 and 1997, respectively. The weighted
average cost of deposits approximates 4.54% and 4.66% for the years ended
December 31, 1998 and 1997, respectively.
69
The following is a summary of interest expense on deposits (in thousands):
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Passbook and statement savings $ 1,235 $ 1,522 $ 1,558
Checking accounts 605 602 677
Money market deposits 2,412 1,566 1,398
Certificates 15,373 17,351 15,678
Less: Early withdrawal penalties (54) (69) (71)
--------------------------------------------
$ 19,571 $ 20,972 $ 19,240
============================================
At December 31, 1998, remaining maturities on certificates are as follows
(in thousands):
1999 $ 216,939
2000 29,582
2001 9,704
2002 5,406
2003 4,183
-----------
$ 265,814
===========
At December 31, 1998, the Bank has pledged mortgage-backed certificates, U.
S. Treasury securities, and other U. S. Government agency securities with a
total carrying value of $2,763,000 to the State Treasury Board as collateral for
certain public deposits.
Note 12
Advances from the Federal Home Loan Bank
At December 31, 1998, advances from the Federal Home Loan Bank (FHLB)
consist of a $60,000,000 convertible fixed-rate advance with an interest rate of
5.18% and a $15,000,000 convertible fixed-rate advance with an interest rate of
4.84%. The $60,000,000 fixed-rate advance was convertible to an adjustable-rate
advance at the option of the FHLB beginning in September, 1998, and quarterly
thereafter until the advance's maturity in September, 2007. Through December 31,
1998, the FHLB has not exercised its option. The $15,000,000 fixed-rate advance
matures in December 2003 and is subject, in December 2001, to a one-time option
by the FHLB to convert to an adjustable-rate advance. These advances are
collateralized by mortgage-backed certificates with a net book value of
approximately $2,421,000 and by first mortgage loans with a net book value of
approximately $244,203,000.
The weighted average cost of advances from the FHLB is 5.43% and 5.58% for
the years ended December 31, 1998 and 1997, respectively.
Note 13
Other Borrowings
In 1997, the Company borrowed $4,000,000 from an unrelated third party
lender for general corporate purposes. The loan balance was paid in full during
1998.
70
Note 14
Securities Sold under Agreements to Repurchase
At December 31, 1998, mortgage-backed certificates sold under agreements to
repurchase had a carrying value of $12,717,000 and a market value of
$13,346,000. The mortgage-backed certificates underlying these repurchase
agreements were delivered to a branch of the Federal Reserve Bank which is
acting as custodian in the transaction. The Company enters into reverse
repurchase agreements with dealers and certain commercial deposit customers. The
reverse repurchase agreements executed with commercial deposit customers do not
constitute savings accounts or deposits and are not insured by the Federal
Deposit Insurance Corporation. At December 31, 1998, all of the Company's
reverse repurchase agreements were with commercial customers.
The following is a summary of certain information regarding the Company's
reverse repurchase agreements (dollars in thousands):
December 31,
1998 1997
---------------------------
Balance at end of year $ 13,084 $ 9,664
Average amount outstanding during the year 12,026 8,893
Maximum amount outstanding at any month end 22,913 12,199
Weighted average interest rate during the year 4.45% 4.60%
Weighted average interest rate at end of year 3.96% 4.57%
Weighted average maturity at end of year daily daily
Note 15
Other Income and Other Expense
The components of other income and other expense are as follows (in thousands):
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Other income:
Brokerage fees $ 468 $ 850 $ 413
Merchant processing fees 2,062 1,391 738
Other miscellaneous 609 478 259
-------------------------------------------
$ 3,139 $ 2,719 $ 1,410
===========================================
Other expense:
Net occupancy expense of premises 1,901 $ 1,848 $ 1,715
Professional fees 611 345 474
Expenses, gains/losses on sales,
and provision for losses on real
estate owned, net 89 215 38
Merchant processing 1,766 1,130 586
Other miscellaneous 2,408 2,076 1,881
-------------------------------------------
$ 6,775 $ 5,614 $ 4,694
============================================
71
Note 16
Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial and income
tax reporting purposes.
Significant components of the Company's deferred tax assets and liabilities
are as follows (in thousands):
December 31,
1998 1997 1996
-------------------------------------------
Deferred tax assets:
Bad debt reserves $ 1,474 $ 1,251 $ 1,297
Other 324 219 34
-------------------------------------------
1,798 1,470 1,331
-------------------------------------------
Deferred tax liabilities:
Federal Home Loan Bank
stock dividends (696) (696) (696)
Unrealized gains on securities
available for sale (308) (472) (580)
Depreciation (344) (296) (327)
Other (251) (299) (106)
--------------------------------------------
(1,599) (1,763) (1,709)
--------------------------------------------
Net deferred tax asset (liability) $ 199 $ (293) $ (378)
============================================
The provision for income taxes consists of the following (in thousands):
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Current:
Federal $ 3,452 $ 3,109 $ 1,810
State 294 131 -
-------------------------------------------
3,746 3,240 1,810
-------------------------------------------
Deferred:
Federal (277) 20 8
State (52) 4 3
-------------------------------------------
(329) 24 11
-------------------------------------------
$ 3,417 $ 3,264 $ 1,821
===========================================
The reconciliation of "expected" federal income tax computed at the
statutory rate (34%) to the reported provision for income taxes is as follows
(in thousands):
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Computed "expected" tax provision $ 3,241 $ 3,151 $ 1,846
Increase (decrease) in taxes
resulting from:
State income taxes, net of
federal tax benefit 194 86 2
Other (18) 27 (27)
--------------------------------------------
Provision for income taxes $ 3,417 $ 3,264 $ 1,821
============================================
72
For tax purposes, the Bank may only deduct bad debts as charged off. This
amount may differ significantly from the amount deducted for book purposes.
Retained earnings at December 31, 1998 includes $6,134,000 representing that
portion of the Bank's tax bad debt allowance for which no provision for income
taxes has been made. This amount would be subject to federal income taxes if the
Bank were to use the reserve for purposes other than to absorb losses.
Note 17
Employee Benefit Plans
Employees Stock Ownership Plan
The following summarizes information relating to the Company's Employee
Stock Ownership Plan, which covers substantially all employees after they have
met certain eligibility requirements.
Stock Purchase - 1992
The Company recognized compensation expense on an accrual basis based upon
the annual number of shares to be released valued at historical cost, plus
estimated annual administrative expenses of the ESOP, less estimated annual
dividends to be used for debt service and administrative expenses. ESOP related
compensation expense recognized by the Company totaled $238,000 in 1996. The
Company recognized interest expense on the ESOP loan and made quarterly
contributions to the ESOP sufficient to fund such interest payments. Total
contributions to the ESOP, which were used to fund principal and interest
payments on the ESOP loan and administrative expenses of the ESOP, totaled
$254,000 in 1996. There were no contributions to the ESOP nor any ESOP related
compensation expense recognized in 1998 or 1997.
In 1998 and 1997, dividends received by the ESOP, all of which related to
allocated shares, were first used for administrative expenses, and dividends
remaining were distributed to plan participants. Dividends received on allocated
shares in 1998 totaled $93,000, of which $72,000 was distributed to
participants. Dividends received on allocated shares in 1997 totaled $81,000, of
which $63,000 was distributed to participants. In 1996, dividends received on
both unallocated and allocated shares were used for debt service. Dividends
received in 1996 totaled $63,000. The tax benefit relating to dividends paid on
unallocated shares held by the ESOP is reflected as an addition to retained
earnings. Shares were released and allocated to eligible participants on an
annual basis. The number of additional shares released and allocated annually
was based upon the pro rata amount of the total ESOP loan principal paid in that
year as compared to the ESOP loan principal balance at the beginning of that
year. At December 31, 1998, the ESOP has 216,950 allocated shares. A total of
14,581 shares were distributed in 1998 to terminated employees. All shares held
by the ESOP relating to the 1992 stock purchase are considered outstanding for
earnings per share calculations.
Stock Purchase - 1997
The Company recognizes compensation expense on an accrual basis based upon
the estimated annual number of shares to be released valued at the shares' fair
value. ESOP related compensation expense recognized by the Company totaled
$467,933 in 1998.
The loan between the ESOP and the holding company has a fifteen-year term
with monthly principal and interest payments which commenced as of January 1998.
Shares are released and allocated to eligible participants annually. The number
of shares released and allocated annually is based upon the pro rata amount of
the total principal and interest paid in that year as compared to the total
estimated principal and interest to be paid over the entire term of the loan.
Dividends received on unallocated shares were used for debt service.
All of the 248,157 shares purchased in 1997 were unallocated at December
31, 1997. In 1998, 20,709 shares were allocated and were included in earnings
per share calculations. At December 31, 1998, the fair value of unearned shares
approximated $4,890,000.
401(k) Plan
The Company has a 401(k) plan to which eligible employees may contribute a
specified percentage of their gross earnings each year. For the years ended
December 31, 1998, 1997 and 1996, the maximum percentage that could be
contributed by employees was 15%, 10%, and 7%, respectively. The Company
contributed a total of $207,000, and $154,000 to these plans during the years
ended December 31, 1997, and 1996, respectively. In 1998, no contribution was
made.
73
Postretirement Benefit Plan
The Company sponsors a postretirement health care and life insurance
benefit plan. This plan is unfunded and the Company retains the right to modify
or eliminate these benefits. Participating retirees and eligible dependents
under the age of 65 are covered under the Company's regular medical and dental
plans. Participating retirees and eligible dependents age 65 or older are
eligible for a Medicare supplement plan. The medical portion of the plan is
contributory for retirees, with retiree contributions adjusted annually, and
contains other cost-sharing features such as deductibles and copays. The life
insurance portion of the plan is noncontributory.
As permitted by FAS 106, the Company elected to amortize its unrecognized
transition obligation over 20 years. At December 31, 1998 and December 31, 1997,
the Company's unfunded accumulated postretirement benefit obligation totaled
$804,000 and $537,000, respectively, and the accrued postretirement benefit cost
recognized in the statement of financial condition totaled $177,000 and
$136,000, respectively. Postretirement benefit cost was $97,000, $69,000, and
$71,000 in 1998, 1997 and 1996, respectively.
Note 18
Stock Options and Awards
At December 31, 1998, the Company has two stock-based compensation plans,
the CENIT Stock Option Plan and the Management Recognition Plan, which are
described below. Princess Anne also had three stock option plans prior to the
merger with the Company. The Company has elected not to adopt the recognition
provisions of Statement of Financial Accounting Standards No. 123 (FAS 123),
"Accounting for Stock-Based Compensation," which requires a fair-value based
method of accounting for stock options and similar equity awards, and will
continue to follow Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations to account for its
stock-based compensation plans.
Stock Option Plans
In conjunction with the Bank's 1992 conversion, the Company adopted the
CENIT Stock Option Plan for the benefit of non- employee directors and key
officers. During the period 1992-1997, the Company granted options relating to
370,875 shares of common stock, which is the total number of shares reserved for
issuance under the Stock Option Plan. Options granted in 1992 in connection with
the conversion became exercisable in full from two to five years after the date
of grant, options granted in 1993 became exercisable in full two years after the
date of grant, and options granted in 1994, 1995, 1996 and 1997 are exercisable
25% each year over the four-year period after the applicable date of grant. In
addition, limited stock appreciation rights were granted with the options issued
under the Stock Option Plan. These rights may be exercised in lieu of the
related stock options only in the event of a change in control of the Company,
as defined in the Stock Option Plan.
In 1998, the Company adopted the CENIT Long-Term Incentive Plan for the
benefit of non-employee directors and key officers and employees. The total
number of shares of common stock reserved for issuance under the Long-Term
Incentive Plan is 251,238. Options granted in 1998 are exercisable 25% each year
over the four-year period after the date of grant. The Long-Term Incentive Plan
and 1998 option awards are subject to the ratification and approval of the plan
by the stockholders of the Company. In the alternative, the Company granted to
the same optionees stock appreciation rights in amounts corresponding to the
1998 option awards, subject to expiration upon the Long-Term Incentive Plan's
approval by the Company's stockholders.
Under both the Stock Option Plan and the Long-Term Incentive Plan, the
option price cannot be less than the fair market value of the common stock on
the date of the grant, and options expire no later than ten years after the date
of the grant.
74
Year Ended December 31,
1998 1997 1996
----------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------------------------------------------------------------------------------------------
Outstanding at beginning
of year 271,938 $ 6.09 343,149 $ 5.40 399,681 $ 4.95
Granted 67,000 22.25 12,705 15.00 18,702 11.54
Exercised (84,798) 5.31 (83,916) 4.63 (73,923) 4.49
Forfeited (5,030) 15.65 - - (1,311) 5.94
---------- ---------- ---------
Outstanding at end of year 249,110 10.50 271,938 6.09 343,149 5.40
========== ========== =========
Options exercisable at
year end 164,331 233,424 289,983
The weighted average fair value of options granted during 1998, 1997 and
1996 was $6.09, $4.89 and $3.73, respectively.
The weighted average fair value of all of the options granted during the
period 1995 through 1998 has been estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions:
Year Ended December 31,
1998 1997 1996
--------------------------------------------------------------------
Annual dividend yield 2.70% 2.22% 2.31%
Weighted average risk-free interest rate 4.76% 6.47% 6.55%
Weighted average expected volatility 29.00% 28.00% 29.00%
Weighted average expected life in years 6.0 6.3 6.0
The provisions of FAS 123 require pro forma disclosure of compensation
expense for the Company based on the fair value of the awards at the date of the
grant. Under those provisions, the Company's net income and earnings per share
would have been reduced to the following pro forma amounts (in thousands, except
per share data):
Year Ended December 31,
1998 1997 1996
-------------------------------------------------------------------
Net income:
As reported $6,115 $6,003 $3,608
Pro forma 6,071 5,973 3,590
Basic earnings per share:
As reported $ 1.30 $ 1.24 $ 0.74
Pro forma 1.29 1.23 0.74
Diluted earnings per share:
As reported $ 1.27 $ 1.20 $ 0.72
Pro forma 1.26 1.20 0.72
75
The following table summarizes information about the options outstanding at
December 31, 1998:
Options Outstanding Options Exercisable
----------------------------------------------------------- ---------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- --------------------------------------------------------------------------------------------------------------------------
$3.84 107,266 3.58 $ 3.84 107,266 $ 3.84
$5.95 16,527 2.45 5.95 16,527 5.95
$7.09 to $7.73 21,056 5.08 7.44 21,056 7.44
$11.55 to $12.34 29,004 7.58 12.04 17,223 11.67
$15.00 10,257 8.17 15.00 2,259 15.00
$22.25 65,000 9.75 22.25 - 22.25
------- -------
249,110 5.90 10.50 164,331 5.49
======= =======
Management Recognition Plan
The objective of the MRP is to enable the Company to retain personnel of
experience and ability in key positions of responsibility. The MRP was
authorized to acquire up to 2% of the shares of common stock of the Company
issued in the conversion. The Bank contributed $247,250 to the MRP to enable the
MRP trustees to acquire a total of 64,500 shares of the common stock in the
conversion at $3.84 per share. As a result of an oversubscription in the
subscription offering, the MRP was able to acquire only 45,000 shares in the
conversion. In 1997 and 1996, the MRP purchased 14,118 and 10,605 additional
shares, respectively, at an average price of approximately $15.13 and $11.26 per
share, respectively. No shares were purchased in 1998.
A total of 37,086 shares were granted in 1992 and vested 20% each year over
five years beginning in 1993. The shares granted in 1996 and 1997 vest at the
end of three to five years. Compensation expense, which is recognized as shares
vest, totaled $72,320, $122,000, and $82,000 for 1998, 1997 and 1996,
respectively. The unamortized cost of the shares purchased, which represents
deferred compensation, is reflected as a reduction of stockholders' equity in
the Company's consolidated statement of financial condition.
A summary of MRP grants is as follows:
Year Ended December 31,
1998 1997 1996
--------------------------------------
Outstanding at beginning of year 34,182 30,393 27,204
Granted - 14,118 10,605
Exercised (2,907) (10,329) (7,416)
--------------------------------------
Outstanding at end of year 31,275 34,182 30,393
======================================
No grants were forfeited during 1997 and 1996 and no grants were
exercisable at December 31, 1998, 1997, and 1996. During 1998, 3,783 shares were
forfeited and returned to the outstanding balance. At December 31, 1998, the
weighted average period until the awards become vested is approximately one and
one-half years. The weighted average fair value of shares granted in 1997 and
1996 was $15.00, and $11.54, respectively.
76
Note 19
Commitments and Financial Instruments With Off-Balance Sheet Credit Risk
The Company is a party to financial instruments with off-balance sheet
credit risk in the normal course of business to meet the financing needs of its
customers and, to a lesser extent, to reduce its own exposure to fluctuations in
interest rates. These financial instruments include commitments to extend credit
in the form of loans or through letters of credit, interest rate caps and
interest rate swaps. At December 31, 1998, financial instruments with
off-balance sheet risk are limited to outstanding loan commitments and letters
of credit. There are no open interest rate cap or interest rate swap positions
at December 31, 1998.
Loan commitments are agreements to extend credit to a customer provided
that there are no violations of the terms of the contracts prior to funding.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee by the customer. Because certain of the
commitments are expected to be withdrawn or expire unused, the total commitment
amount does not necessarily represent future cash requirements. The Company
evaluates each customer's creditworthiness on a case- by-case basis. The type
and amount of collateral obtained varies but generally includes real estate or
personal property.
The Company had loan commitments, excluding the undisbursed portion of
construction and acquisition and development loans, as follows (in thousands):
December 31,
1998 1997
--------------------------
Commitments outstanding:
Mortgage loans:
Fixed rate (rates between 6.00% and 8.25% at
1998 and between 7.00% and 9.50% at 1997) $ 4,615 $ 2,766
Variable rate 1,219 1,745
Commercial business loans 5,617 2,857
---------------------------
$ 11,451 $ 7,368
===========================
At December 31, 1998, the Company has granted unused consumer and
commercial lines of credit of $29,577,000 and $4,684,000, respectively, and has
commitments to purchase loans totaling $27,551,000.
Standby letters of credit are written unconditional commitments issued to
guarantee the performance of a customer to a third party and total approximately
$3,964,000 at December 31, 1998. The credit risk involved in issuing standby
letters of credit is essentially the same as that involved in extending a loan
and the collateral obtained, if any, varies but generally includes real estate
or personal property. Because most of these letters of credit expire without
being drawn upon, they do not necessarily represent future cash requirements.
Commitments to purchase securities are contracts for delayed delivery of
securities in which the seller agrees to make delivery on a specified future
date of a specified instrument, with a specified coupon, for a specified price.
At December 31, 1998, the Company had no such commitments.
Rent expense under long-term operating leases for property approximates
$713,000, $709,000, and $620,000 for the years ended December 31, 1998, 1997 and
1996, respectively. The minimum rental commitments under noncancelable leases
with an initial term of more than one year for the years ending December 31, are
as follows (in thousands):
1999 $ 856
2000 693
2001 597
2002 374
2003 312
Thereafter 1,423
-----------
$ 4,255
===========
77
Note 20
Regulatory matters
Capital Adequacy
The Bank is subject to various regulatory capital requirements administered
by the OTS. Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Company's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classifications are also subject to qualitative
judgments by regulators about components, risk weighting and other factors.
As set forth in the table below, quantitative measures established by
regulation to ensure capital adequacy require the Bank to maintain minimum
amounts and ratios of tier 1 (core) capital to adjusted total assets, of tier 1
risk-based and total risk-based capital to risk-weighted assets and tangible
equity capital to adjusted total assets. As of December 31, 1998, the Bank
exceeded all capital adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the framework for prompt
corrective action. To be considered well capitalized under prompt corrective
action provisions, the Bank must maintain capital ratios as set forth in the
following table. There are no conditions or events since that notification that
management believes have changed the Bank's categorizations.
The Bank's actual capital amounts and ratios are as follows (dollars in
thousands):
Required for
Actual Required Well Capitalized
--------------------------- --------------------------- ---------------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 1998:
Tier 1 (core) capital $ 45,271 7.1% $ 25,481 4.0% $ 31,851 5.0%
Tier 1 risk-based capital 45,271 10.5 17,221 4.0 25,832 6.0
Total risk-based capital 49,074 11.4 34,442 8.0 43,053 10.0
Tangible equity capital 45,271 7.1 12,740 2.0 - -
As of December 31, 1997:
Core capital $ 32,302 6.6% $ 14,744 3.0% $ 24,575 5.0%
Tier 1 risk-based capital 32,302 11.1 11,610 4.0 17,416 6.0
Total risk-based capital 34,799 12.0 23,221 8.0 29,026 10.0
Tangible capital 32,302 6.6 7,372 1.5 - -
The regulatory capital of the Bank increased during 1998 primarily as a
result of the merger of the Company's two subsidiary banks.
78
Dividend Restrictions
The Bank's capital exceeds all of the capital requirements imposed by
FIRREA. OTS regulations provide that an association that exceeds all fully
phased-in capital requirements before and after a proposed capital distribution
can, after prior notice but without the approval by the OTS, make capital
distributions during the calendar year of up to the higher of (i) 100% of its
net income to date during the calendar year plus the amount that would reduce by
one-half its "surplus capital ratio" (the excess capital over its fully
phased-in capital requirements) at the beginning of the calendar year, or (ii)
75% of its net income during the most recent four-quarter period. Any additional
capital distributions require prior regulatory approval.
The Company is subject to the restrictions of Delaware law, which generally
limit dividends to the amount of a corporation's surplus or, in the case where
no such surplus exists, the amount of a corporation's net profits for the fiscal
year in which the dividend is declared and/or the preceding fiscal year.
Note 21
Stockholders' Equity
As part of the Bank's conversion from a federally chartered mutual savings
bank to a federally chartered stock savings bank, the Bank established a
liquidation account for the benefit of eligible depositors who continue to
maintain their deposit accounts in the Company after conversion. In the unlikely
event of a complete liquidation of the Bank, each eligible depositor will be
entitled to receive a liquidation distribution from the liquidation account, in
the proportionate amount of the then current adjusted balance for deposit
accounts held, before distribution may be made with respect to the Bank's
capital stock. The Bank may not declare or pay a cash dividend to the Company
on, or repurchase any of, its capital stock if the effect thereof would cause
the retained earnings of the Bank to be reduced below the amount required for
the liquidation account. Except for such restrictions, the existence of the
liqui dation account does not restrict the use or application of the Bank's
retained earnings. At December 31, 1998, the liquidation account balance was
$3,243,000.
79
Note 22
Related Party Transactions
The Company has made loans to executive officers, directors, and to
companies in which the executive officers and directors have a financial
interest. The following is a summary of related party loans (in thousands):
Balance at January 1, 1998 $ 2,892
Originations - 1998 2,581
Repayments - 1998 (1,178)
-----------
Balance at December 31, 1998 $ 4,295
===========
Under the Company's current policy, related party loans are made on
substantially the same terms, including interest rate and collateral
requirements, as are available to the general public. The Company believes loans
to related parties do not involve more than the normal risk of collectibility.
Commitments to extend credit and letters of credit to related parties totaled
$944,000 at December 31, 1998.
Note 23
Disclosures About Fair Value of Financial Instruments
The following summary presents the methodologies and assumptions used to
estimate the fair value of the Company's financial instruments presented below.
The Company operates as a going concern and except for its investment securities
portfolio and certain residential loans, no active market exists for its
financial instruments. Much of the information used to determine fair value is
highly subjective and judgmental in nature and therefore the results may not be
precise. The subjective factors include, among other things, estimates of cash
flows, risk characteristics, credit quality, and interest rates, all of which
are subject to change. Since the fair value is estimated as of December 31,
1998, the amounts which will actually be realized or paid upon settlement or
maturity of the various instruments could be significantly different.
Cash and Federal Funds Sold
For cash and federal funds sold, the carrying amount is a reasonable
estimate of fair value.
Investment Securities
Fair values are based on quoted market prices or dealer quotes for U.S.
Treasury securities, other U.S. government agency securities, and
mortgage-backed certificates. As required by FAS 115, securities available for
sale are recorded at fair value.
80
Loans
The fair value of loans is estimated by discounting the future cash flows
using the current rates at which similar loans would be made to borrowers with
similar credit ratings for the same remaining maturities, or based on quoted
market prices for mortgage- backed certificates securitized by similar loans,
adjusted for differences in loan characteristics. The risk of default is
measured as an adjustment to the discount rate, and no future interest income is
assumed for nonaccrual loans.
The fair value of loans does not include the value of the customer
relationship or the right to fees generated by the account.
Federal Home Loan Bank Stock
The carrying value of Federal Home Loan Bank stock is a reasonable estimate
of the fair value.
Deposit Liabilities
The fair value of deposits with no stated maturities (which includes demand
deposits, savings accounts, and money market deposits) is the amount payable on
demand at the reporting date. The fair value of fixed-maturity certificates of
deposit is estimated using a discounted cash flow model based on the rates
currently offered for deposits of similar maturities.
FAS 107 requires deposit liabilities with no stated maturity to be reported
at the amount payable on demand without regard for the inherent funding value of
these instruments. The Company believes that significant value exists in this
funding source.
Short-term Borrowings
For short-term borrowings (which include short-term advances from the
Federal Home Loan Bank and securities sold under agreements to repurchase), the
carrying amount is a reasonable estimate of fair value.
Long-term Borrowings
Rates currently available to the Company for borrowings with similar terms
and remaining maturities are used to estimate fair value of existing borrowings.
Loan Commitments and Standby Letters of Credit
The Company has reviewed its loan commitments and standby letters of credit
and determined that differences between the fair value and notional principal
amounts are not significant.
81
The estimated fair values of the Company's financial instruments that
differ from their carrying amount are as follows (in thousands):
December 31,
1998 1997
--------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------------------------- --------------------------
Financial assets:
Loans held for investment, net $ 484,783 $ 489,598 $ 486,487 $ 494,207
Financial liabilities:
Deposits with stated maturities 265,814 267,603 328,198 330,314
Long-term borrowings 75,000 77,228 62,575 63,152
As mentioned in the assumptions above, the estimated fair value of loans
and deposits does not include any value for the customer relationship or the
right to future fee income which may be generated by these relationships.
Note 24
Condensed Parent Company Only Financial Statements
The following condensed financial statements for CENIT Bancorp, Inc. should
be read in conjunction with the consolidated financial statements and the notes
thereto.
Condensed Statement of Financial Condition
(In thousands)
December 31,
1998 1997
---------------------------
Assets:
Cash $ 56 $ 1
Securities available for sale at fair value 250 -
Equity in net assets of the Bank 49,420 51,173
Other assets 776 1,908
---------------------------
$ 50,502 $ 53,082
===========================
Liabilities:
Other borrowings $ - $ 2,575
Other liabilities 426 570
---------------------------
426 3,145
---------------------------
Stockholders' equity 50,076 49,937
---------------------------
$ 50,502 $ 53,082
===========================
82
Condensed Statement of Operations
(In thousands)
Year Ended December 31,
1998 1997 1996
-------------------------------------------
Equity in earnings of the Bank $ 6,520 $ 6,767 $ 3,943
Interest income 22 - -
Interest expense (76) (110) (16)
Salaries and employee benefits (296) (349) (276)
Expenses related to proxy contest
and other matters - (405) -
Professional fees (202) (247) (108)
Other expenses (86) (87) (122)
-------------------------------------------
Income before income taxes 5,882 5,569 3,421
Benefit from income taxes 233 434 187
-------------------------------------------
Net income $ 6,115 $ 6,003 $ 3,608
===========================================
Condensed Statement of Cash Flows
(In thousands)
Year Ended December 31,
1998 1997 1996
--------------------------------
Cash flows from operating activities:
Net income $ 6,115 $ 6,003 $ 3,608
Add (deduct) items not affecting cash:
Distributions in excess of earnings
(undistributed earnings) of the Bank 1,399 (3,157) (1,941)
Amortization 6 3 26
Decrease (increase) in other assets 1,860 (114) (1,192)
(Decrease) increase in liabilities (73) 189 121
--------------------------------
Net cash provided by operations 9,307 2,924 622
--------------------------------
Cash flows from investing activities:
Purchase of securities available for sale (250) - -
--------------------------------
Net cash used for investing activities (250) - -
--------------------------------
Cash flows from financing activities:
Cash dividends paid (1,931) (1,627) (1,215)
Net proceeds from issuance of common stock 173 357 583
Increase in other borrowings - 4,000 -
Principal payments on other borrowings (2,575) (1,425) -
Common stock repurchases (4,669) - -
-
Purchase of common stock by ESOP - (4,232) -
--------------------------------
Net cash used for financing activities (9,002) (2,927) (632)
--------------------------------
Net increase (decrease) in cash and cash
equivalents 55 (3) (10)
Cash and cash equivalents at beginning of period 1 4 14
--------------------------------
Cash and cash equivalents at end of period $ 56 $ 1 $ 4
================================
83
Note 25
Quarterly Results of Operations (Unaudited)
(Dollars in thousands, except per share data)
Year Ended December 31, 1998
First Second Third Fourth
Quarter Quarter Quarter Quarter
-----------------------------------------------------------
Total interest income $ 12,564 $ 12,317 $ 11,367 $ 10,783
Total interest expense 7,177 7,014 6,006 5,608
-----------------------------------------------------------
Net interest income 5,387 5,303 5,361 5,175
Provision for loan losses 204 136 100 70
-----------------------------------------------------------
Net interest income after provision
for loan losses 5,183 5,167 5,261 5,105
Other income 1,565 1,869 1,803 1,776
Other expenses 4,498 4,701 4,506 4,492
-----------------------------------------------------------
Income before income taxes 2,250 2,335 2,558 2,389
Provision for income taxes 793 831 934 860
-----------------------------------------------------------
Net income $ 1,457 $ 1,504 $ 1,624 $ 1,529
===========================================================
Earnings per share:
Basic $ .31 $ .32 $ .34 $ .33
===========================================================
Diluted $ .30 $ .31 $ .33 $ .33
===========================================================
Dividends per common share $ .10 $ .10 $ .10 $ .11
===========================================================
Year Ended December 31, 1997
First Second Third Fourth
Quarter Quarter Quarter Quarter
-----------------------------------------------------------
Total interest income $ 12,551 $ 12,766 $ 12,858 $ 12,601
Total interest expense 7,221 7,385 7,461 7,243
-----------------------------------------------------------
Net interest income 5,330 5,381 5,397 5,358
Provision for loan losses 150 150 150 150
-----------------------------------------------------------
Net interest income after provision
for loan losses 5,180 5,231 5,247 5,208
Other income 971 1,359 1,376 2,007
Other expenses 4,527 4,194 3,979 4,612
-----------------------------------------------------------
Income before income taxes 1,624 2,396 2,644 2,603
Provision for income taxes 570 848 935 911
-----------------------------------------------------------
Net income $ 1,054 $ 1,548 $ 1,709 $ 1,692
===========================================================
Earnings per share:
Basic $ .22 $ .31 $ .35 $ .36
===========================================================
Diluted $ .21 $ .30 $ .34 $ .35
===========================================================
Dividends per common share $ .08 $ .08 $ .08 $ .08
===========================================================
NOTE: May not add to total for year due to rounding.
84
Item 9 - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10 - Directors and Executive Officers of the Registrant
The information contained under the caption "Election of Directors" to
appear in the Company's definitive proxy statement relating to the Company's
1999 Annual Meeting of Stockholders, which definitive proxy statement will be
filed with the Securities and Exchange Commission not later than 120 days after
the end of the Company's fiscal year covered by this report on Form 10-K
(hereinafter referred to as the "Annual Meeting Proxy Statement"), is
incorporated herein by reference. Information concerning the executive officers
of the Company is included in Part I of this Report on Form 10-K.
Item 11 - Executive Compensation
The information contained under the caption "Directors' Fees" and
"Executive Compensation" to appear in the Annual Meeting Proxy Statement is
incorporated herein by reference.
Item 12 - Security Ownership of Certain Beneficial Owners and Management
The information contained under the caption "Security Ownership of Certain
Beneficial Owners" and "Information with Respect to Nominees and Continuing
Directors" to appear in the Annual Meeting Proxy Statement is incorporated
herein by reference.
Item 13 - Certain Relationships and Related Transactions
The information contained under the captions "Transactions with Certain
Related Persons" and "Compensation Committee Interlocks and Insider
Participation" to appear in the Annual Meeting Proxy Statement is incorporated
herein by reference.
PART IV
Item 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) Financial Statements
(a) (2) Financial Statement Schedules
See Item 8 - Financial Statements and Supplementary Data
(a) (3) Exhibits
The following exhibits are either filed as part of this report or are
incorporated herein by reference:
Exhibit No. 3 Certificate of Incorporation, incorporated herein by
reference to this report from the Exhibits to Form S-1, Registration
Statement filed on July 31, 1991, Registration No. 33-41848 and Amendment
No. 2 to Form S-1 Registration Statement, filed on June 11, 1992, Exhibits
to Form 10-Q filed on November 3, 1997, and Exhibits to Form 8-K filed
December 31, 1998.
3.1 Certificate of Incorporation of CENIT Bancorp, Inc.
3.3 Certificate of Amendment to Certificate of Incorporation of
CENIT Bancorp, Inc.
3.4 Amended Bylaws of CENIT Bancorp, Inc.
85
Exhibit No. 10. Material Contracts, incorporated herein by reference to
this document from the Exhibits to Form S-1, Registration Statement, as
amended, filed on July 31, 1991, Registration No. 33-41848, Exhibits to
Amendment No. 1 to Form S-1 filed on April 29, 1992, Exhibits to Amendment
No. 2 to Form S-1 filed on June 11, 1992, Exhibits to Form 8-K filed on
October 22, 1993, Exhibits to Form 8-K filed on November 18, 1994, Exhibits
to Form S-4 filed on April 4, 1995, Registration No. 033-90922, Exhibits to
Form 10-Q filed on November 14, 1995, Exhibits to Form 8-K filed on July 9,
1996, Exhibits to Form 10-K filed on March 25, 1997, and Exhibits to Form
10-Q filed on May 5, 1998.
10.1 Employment Agreement with Michael S. Ives
10.2 CENIT Stock Option Plan
10.3 CENIT Employees Stock Ownership Plan and Trust Agreement
10.4 ESOP Loan Commitment Letter
10.5 CENIT Management Recognition Plan
10.6 ESOP Loan Agreement
10.7 Agreement and Plan of Reorganization between Princess Anne Company
and CENIT Bancorp, Inc.
10.9 Branch Purchase and Deposit Assumption Agreement between CENIT
Bancorp, Inc. and Essex Savings Bank, F.S.B.
10.10 Amendment to Employment Agreement with Michael S. Ives
10.12 Consulting Agreement with J. Morgan Davis
10.13 Non-Competition and Non-Disclosure Agreement with J. Morgan Davis
Exhibit 10.14 Amendment to Employment Agreement with Michael S. Ives
The Amendment to Employment Agreement with Michael S. Ives is attached as
Exhibit 10.14
Exhibit 10.15 CENIT Long Term Incentive Plan
The CENIT Long Term Incentive Plan is attached as Exhibit 10.15
Exhibit 10.16 Key Executive Change of Control Agreement with Barry L. French
The Key Executive Change of Control Agreement with Barry L. French is
attached as Exhibit 10.16
Exhibit 10.17 Key Executive Change of Control Agreement with John O. Guthrie
The Key Executive Change of Control Agreement with John O. Guthrie is
attached as Exhibit 10.17
Exhibit 10.18 Key Executive Change of Control Agreement with Roger J. Lambert
The Key Executive Change of Control Agreement with Roger J. Lambert is
attached as Exhibit 10.18
Exhibit 10.19 Key Executive Change of Control Agreement with Alvin D. Woods
The Key Executive Change of Control Agreement with Alvin D. Woods is
attached as Exhibit 10.19
Exhibit 10.20 Alternative Stock Appreciation Rights Program for Non-Employee
Directors
The Alternative Stock Appreciation Rights Program for Non-Employee
Directors is attached as Exhibit 10.20
Exhibit 10.21 Alternative Stock Appreciation Right Agreement (officers) with
Michael S. Ives
The Alternative Stock Appreciation Right Agreement (officers) with
Michael S. Ives is attached as Exhibit 10.21
Exhibit 10.22 Alternative Stock Appreciation Right Agreement (officers) with
Barry L. French
The Alternative Stock Appreciation Right Agreement (officers) with
Barry L. French is attached as Exhibit 10.22
Exhibit 10.23 Alternative Stock Appreciation Right Agreement (officers) with
John O. Guthrie
The Alternative Stock Appreciation Right Agreement (officers) with
John O. Guthrie is attached as Exhibit 10.23
Exhibit 10.24 Alternative Stock Appreciation Right Agreement (officers) with
Roger J. Lambert
The Alternative Stock Appreciation Right Agreement (officers) with
Roger J. Lambert is attached as Exhibit 10.24
Exhibit 10.25 Alternative Stock Appreciation Right Agreement (officers) with
Alvin D. Woods
The Alternative Stock Appreciation Right Agreement (officers) with
Alvin D. Woods is attached as Exhibit 10.21
Exhibit No. 11 Statement Re: Computation of Per Share Earnings
The 1998 statement Re: Computation of per share earnings is attached as
Exhibit 11
Exhibit No. 21 Subsidiaries of the Registrant. CENIT Bank is the only
subsidiary of the Registrant. Information regarding CENIT Bank is included
in Part I, Item 1 under the captions "Activities of Subsidiary Companies of
CENIT Bank" which is incorporated by reference
Exhibit No. 23.1 Consent of Independent Accountants.
The consent of PricewaterhouseCoopers LLP, independent accountants for the
Company, is attached as Exhibit 23.1
86
Exhibit No. 27 Financial Data Schedule Article 9
The Financial Data Schedule Article 9 is attached as Exhibit 27
(b) Reports on Form 8-K filed in the fourth quarter of 1998
A report on Form 8-K was filed on December 31, 1998, dated December 28,
1998, which included Item 5, a news release reporting the filing of a
shareholder proposal and Item 7, the Amended Bylaws of CENIT Bancorp, Inc.
(c) Exhibits
Exhibits to this Form 10-K are either filed as part of this Report or are
incorporated herein by reference.
(d) Financial Statements Excluded from Annual Report to Shareholders pursuant
to Rule 14a3(b)
Not applicable.
Supplemental Information
As of the date of filing of this report on Form 10-K, no annual report or
proxy material has been sent to security holders. Such material will be
furnished to security holders and the Securities and Exchange Commission
subsequent to the filing of this report on Form 10-K.
87
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.
CENIT Bancorp, Inc.
By: /s/ Michael S. Ives
--------------------------
Michael S. Ives, President
and Chief Executive Officer
March 30, 1999
--------------
(Date)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By:/s/ John O. Guthrie March 30, 1999
--------------------------- --------------
John O. Guthrie (Date)
Senior Vice President and
Chief Financial Officer
By:/s/ Winfred O. Stant, Jr. March 30, 1999
--------------------------- --------------
Winfred O. Stant, Jr. (Date)
First Vice President and
Chief Accounting Officer
By:/s/ C. L. Kaufman, Jr. March 30, 1999
--------------------------- --------------
C. L. Kaufman, Jr. (Date)
Chairman of the Board/Director
By:/s/ Michael S. Ives March 30, 1999
--------------------------- --------------
Michael S. Ives (Date)
Director
By:/s/ David L. Bernd March 30, 1999
--------------------------- --------------
David L. Bernd (Date)
Director
By:/s/ Patrick E. Corbin March 30, 1999
--------------------------- --------------
Patrick E. Corbin (Date)
Director
By:/s/ William J. Davenport, III March 30, 1999
--------------------------- --------------
William J. Davenport, III (Date)
Director
By:/s/ Thomas J. Decker, Jr. March 30, 1999
--------------------------- --------------
Thomas J. Decker, Jr. (Date)
Director
By:/s/ John F. Harris March 30, 1999
--------------------------- --------------
John F. Harris (Date)
Director
88
By:/s/ William H. Hodges March 30, 1999
--------------------------- --------------
William H. Hodges (Date)
Director
By:/s/ Charles R. Malbon, Jr. March 30, 1999
--------------------------- --------------
Charles R. Malbon, Jr. (Date)
Director
By:/s/ Roger C. Reinhold March 30, 1999
--------------------------- --------------
Roger C. Reinhold (Date)
Director
By:/s/ Anne B. Shumadine March 30, 1999
--------------------------- --------------
Anne B. Shumadine (Date)
Director
By:/s/ David R. Tynch March 30, 1999
--------------------------- --------------
David R. Tynch (Date)
Director
89