UNITED STATES
SECURITIES EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number 1-14230
STONE STREET BANCORP, INC.
(Exact name of registrant as specified in its charter)
North Carolina 56-1949352
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State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
232 South Main Street
Mocksville, North Carolina 27028
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (336) 751-5936
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, no par value
(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 in response 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. [ ]
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. The aggregate market value shall be computed by reference to the
price at which the stock was sold, or the average bid and ask prices of such
stock, as of a specified date within 60 days prior to the date of filing.
$23,143,135 common stock, no par value, based on the closing price of such
common stock on March 18, 1999.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 1,638,452 shares of common
stock, no par value, outstanding at March 18,1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report of Stone Street Bancorp, Inc. for the year ended
December 31, 1998, (the "1998 Annual Report") are incorporated by reference into
Part I, Part II and Part IV.
Portions of the Proxy Statement for the 1999, Annual Meeting of Shareholders of
Stone Street Bancorp, Inc. to be held on April 20, 1999 (the "Proxy Statement"),
are incorporated by reference into Part III.
PART I
ITEM 1. BUSINESS
General
Prior to March 29, 1996, Stone Street Bank and Trust (formerly
Mocksville Savings Bank, Inc. SSB) (the "Bank") operated as a mutual North
Carolina-chartered savings bank. On March 29, 1996, the Bank converted from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank (the "Conversion"). In connection with the Conversion, all of the
issued and outstanding capital stock of the Bank was acquired by Stone Street
Bancorp, Inc., a North Carolina corporation (the "Company") which was organized
to become the holding company for the Bank. At that time, the Company had an
initial public offering of its common stock, no par value (the "Common Stock").
The Company is a bank holding company registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve") under the Bank
Holding Company Act of 1956, as amended (the "BHCA") and the savings bank
holding company laws of North Carolina. The Company's and the Bank's principal
office is located at 232 South Main Street, Mocksville, North Carolina. The
Company's activities consist of investing the proceeds of its initial public
offering which were retained at the holding company level and owning the Bank.
The Company's principal source of income is earnings on its investments. In
addition, the Company will receive any dividends which are declared and paid by
the Bank on its capital stock. The Company did not commence operations until
March 29, 1996 and conducted business from that date through the year ended
December 31, 1996 in its first year. The following general business discussion
pertains primarily to Stone Street Bank and Trust.
The Bank was originally chartered in 1921. It has been a member of the
Federal Home Loan Bank ("FHLB") system since 1946 and its deposits are federally
insured up to allowable limits.
The Bank is engaged primarily in the business of attracting deposits
from the general public and using such deposits to make mortgage loans secured
by real estate. Stone Street makes mortgage loans secured by residential real
property, including one-to-four family residential real estate loans, home
equity line of credit loans and other subordinate lien loans, loans secured by
improved nonresidential real property, loans secured by undeveloped real
property and construction loans. Stone Street also makes a limited number of
loans which are not secured by real property, such as loans secured by pledged
deposit accounts, and other personal property, mobile home loans and unsecured
loans. Stone Street's primary source of revenue is interest income from its
lending activities. Stone Street's other major sources of revenue are interest
and dividend income from investments and mortgage-backed securities, interest
income from its interest-bearing deposit balances in other depository
institutions and fee income from its lending and deposit activities. The major
expenses of Stone Street are interest on deposits and borrowings and noninterest
expenses such as compensation and fringe benefits, federal deposit insurance
premiums, data processing expenses and branch occupancy and related expenses.
The operations of the Bank and depository institutions in general are
significantly influenced by general economic conditions and by related monetary
and fiscal policies of depository institution regulatory agencies, including the
Federal Reserve, the Federal Deposit Insurance Corporation (the "FDIC") and the
North Carolina Administrator, Savings Institutions Divisions, North Carolina
Department of Commerce (the "Administrator"). Deposit flows and cost of funds
are influenced by interest rates on competing investments and general market
rates of interest. Lending activities are affected by the demand for financing
of real estate and other types of loans, which in turn are affected by the
interest rates at which such financing may be offered and other factors
affecting local demand and availability of funds.
2
Interest Rate Risk Management
Quantitative Aspects of Market Risk. The Bank does not maintain a
trading account for any class of financial instrument. Further, it is not
currently subject to foreign currency exchange rate risk or commodity price
risk. The stock in the FHLB of Atlanta does not have equity price risk because
it is issued only to members and is redeemable for its $100 par value. The
following table illustrates quantitative sensitivity to interest rate risk for
financial instruments other than cash and cash equivalents, FHLB stock and
demand accounts for the Bank as of December 31, 1998.
Maturing or Repricing in Years Ended December 31,
----------------------------------------------------------------------------------------
2000- 2002- 2004-
1999 2001 2003 2008 Thereafter Total
---------- --------- -------- ---------- ---------- ----------
(Dollars in Thousands)
Assets
Loans receivable:
Amount .................. $ 4,394 $ 1,649 $ 4,559 $ 42,350 $ 49,597 $ 102,549
Average interest rate ... 8.66% 8.72% 8.40% 7.52% 7.47% 7.60%
Mortgage-backed securities:
Amount .................. 9,662 -- -- -- 1,744 11,406
Average interest rates .. 5.79% --% -- % -- 7.24% 6.02%
Investment Securities:
Amount .................. 748 386 378 -- -- 1,512
Average interest rates .. 6.35% 4.73% 4.25% -- -- % 5.41%
Liabilities
Deposit Certificate Accounts:
Amount .................. 49,853 7,965 1,454 -- -- 59,272
Average interest rates .. 5.48% 5.51% 5.30% -- --% 5.48%
FHLB Advances:
Amount .................. 6,967 -- 2,000 15,000 -- 23,967
Average interest rates .. 5.78% --% 5.52% 5.09% --% 5.33%
Qualitative Aspects of Market Risk. One of the Bank's principal
financial objectives is to achieve long-term profitability while reducing its
exposure to fluctuations in interest rates. The Bank has sought to reduce
exposure of its earnings to changes in market interest rates by managing the
mismatch between asset and liability maturities and interest rates. The
principal element in achieving this objective has been to increase the
interest-rate sensitivity of the Bank's assets by originating loans with
interest rates subject to periodic repricing to market conditions and shortening
the term of its fixed rate loans to 20 years and including a 10 year call option
on all other fixed rate residential real estate loans. Accordingly, the Bank has
emphasized the origination of home equity loans, adjustable rate mortgage loans,
shorter term fixed rate residential loans with call provisions, short term and
adjustable-rate commercial loans, and consumer loans for retention in its
portfolio.
An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If the Bank's
assets mature or reprice more quickly or to a greater extent than its
liabilities, the Bank's net portfolio value and net interest income would tend
to increase during the periods of rising interest rates but decrease during
periods of falling interest rates. If the Bank's assets mature or reprice more
slowly or to a lesser extent than its liabilities, the Bank's net portfolio
value and net interest income would tend to decrease during periods of rising
interest rates but increase during periods of falling interest rates.
The Bank's Board of Directors has formulated in Interest Rate Risk
Management policy designed to promote long-term profitability while managing
interest-rate risk. The Board of Directors has established an Asset/Liability
Committee which consists primarily of the management team of the Bank. This
committee meets periodically and reports to the Board of Directors quarterly
concerning asset/liability policies, strategies and the Bank's current interest
rate risk position. The committee's first priority is to structure and price the
Bank's assets and liabilities to maintain an acceptable interest rate spread
while reducing the net effects of changes in interest rates.
3
Management's principal strategy in managing the Bank's interest rate
risk has been to maintain short and intermediate term assets in the portfolio,
including one year adjustable rate mortgage loans, as well as increased levels
of commercial and consumer loans, which typically are for short or intermediate
terms and carry higher interest rates than residential mortgage loans. In
addition, in managing the Bank's portfolio of investment securities and
mortgage-backed and related securities, management seeks to purchase securities
that mature on a basis that approximates as closely as possible the estimated
maturities of the Bank's liabilities or purchase securities that have adjustable
rate provisions. The Bank does not engage in hedging activities.
In addition to shortening the average repricing of its assets, the Bank
has sought to lengthen the average maturity of its liabilities by adopting a
tiered pricing program for its certificates of deposit, which provides higher
rates of interest on its longer term certificates in order to encourage
depositors to invest in certificates with longer maturities. This policy is
blended with management's strategy for reducing the overall balance in
certificate accounts in order to reduce the Bank's interest expense.
There have been no significant changes in the Bank's primary market
risk exposures or methods for managing those exposures since December 31, 1998.
The Board of Directors is responsible for reviewing the Bank's asset
and liability policies. On at least a quarterly basis, the Board reviews
interest rate risk and trends, as well as liquidity and capital ratios and
requirements. The management is responsible for administering the policies and
determinations of the Board of Directors with respect to its asset and liability
goals and strategies.
Market Area
The Bank's primary market area consists of Davie County, North
Carolina. Mocksville is located between Winston-Salem, North Carolina and
Statesville, North Carolina on Interstate 40. Employment in Davie County
includes furniture manufacturing, machine tooling, equipment assembly, and the
opportunities generated by Wake Forest University and Bowman Gray Medical School
in Winston-Salem. In addition, home construction and real estate development are
major industries because Davie County attracts many retirees. Bermuda Run Golf
and Country Club in Davie County is the home of the Bing Crosby Invitational
Golf Tournament. In addition, six other golf courses are in or near Davie
County, including Tanglewood Park Golf Course, the site of the PGA Vantage
Tournament. Major area employers include Lee Jeans, Jockey International,
Reynolds Tobacco, Sara Lee and Ingersol-Rand.
Lending Activities
General. The Bank's primary source of revenue is interest and fee
income from its lending activities, consisting primarily of mortgage loans for
the purchase or refinancing of single family homes located in its primary market
area. The Bank also makes loans secured by multi-family residential properties,
improved nonresidential real estate, construction loans, loans secured by
undeveloped real estate, and other personal property, mobile home (including
land) loans, savings account loans and other loans. Over 98.77% of the Bank's
net loan portfolio is secured by real estate. As of December 31, 1998, all of
the loans in the Bank's real estate loan portfolio were secured by properties in
North Carolina. On December 31, 1998, the Bank's largest single outstanding loan
had a balance of approximately $1,223,400. This loan was performing in
accordance with its original terms. In addition to interest earned on loans, the
Bank receives fees in connection with loan originations, loan modifications,
late payments, loan assumptions and other miscellaneous services.
Loan Portfolio Composition. The Bank's net loan portfolio totaled
approximately $102.5 million at December 31, 1998 representing 80.57% of Stone
Street's total assets at such date. At December 31, 1998, 82.00% of Stone
Street's net loan portfolio was composed of one-to-four family residential
mortgage loans. Home equity and subordinate lien loans represented 2.42% of the
Bank's net loan portfolio, and nonresidential real estate loans represented
9.38% of the Bank's net loan portfolio on such date.
4
As part of its interest rate risk management program, the Bank
continues to offer adjustable rate mortgage loans to its customers. As of
December 31, 1998, the Bank had approximately $926,000 of adjustable rate
mortgage loans outstanding.
The following table sets forth the composition of the Bank's loan
portfolio by type of loan at the dates indicated.
At December 31,
---------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------- ------------------ -------------------- ------------------- -------------------
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
(Dollars in Thousands)
Real estate loans:
Residential
1-4 family ....... $ 84,094 82.00% $ 76,894 82.71% $ 67,844 81.75% $ 63,329 84.33% $ 54,321 82.34%
Residential multi-
family and
nonresidential
real estate ..... 9,619 9.38 9,541 10.26 5,716 6.88 4,260 5.67 4,987 7.56
Other subordinate
lien loans ...... 2,477 2.42 2,675 2.88 2,473 2.98 2,185 2.91 1,423 2.16
Residential
construction .... 12,670 12.35 8,571 9.22 12,492 15.05 11,735 15.63 11,589 17.56
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate
loans: .......... 108,860 106.15 97,681 105.07 88,525 106.66 81,509 108.54 72,320 109.62
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Other installment
loans ........... 1,265 1.23 632 .68 372 .45 222 .30 197 0.30
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Less:
Unearned fees and
discounts ........ 1,212 1.18 1,058 1.14 1,009 1.22 962 1.29 1,095 1.66
Loans in process . 5,614 5.47 3,718 4.00 4,385 5.28 5,211 6.94 5,334 8.09
Allowance for
loan losses ..... 750 .73 570 .61 511 .61 462 .61 115 0.17
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total reductions . 7,576 7.38 5,346 5.75 5,905 7.11 6,635 8.84 6,544 9.92
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans
receivable net .. $102,549 100.00% $ 92,967 100.00% $ 82,992 100.00% $ 75,096 100.00% $ 65,973 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
The following table sets forth the time to contractual maturity of the
Bank's loan portfolio at December 31, 1998. Loans which have adjustable rates
are shown as being due in the period during which rates are next subject to
change while fixed rate and other loans are shown as due over the contractual
maturity. Demand loans, loans having no stated maturity and overdrafts are
reported as due in one year or less. The table does not include prepayments,
however, it does include scheduled principal repayments. Prepayments and
scheduled repayments in the loan portfolio totaled $33.7 million, $18.1 million
and $16.2 million in fiscal years ended December 31, 1998, 1997 and 1996,
respectively. Amounts in the table are net of loans in process and are net of
unamortized loan fees.
5
At December 31, 1998
--------------------------------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or less 3 Years 5 Years 10 Years Years Total
--------- --------- --------- --------- --------- ---------
Mortgage loans:
Fixed rate 1-4 family
residential ............ $ 22 $ 1,134 $ 4,246 $ 38,953 $ 44,249 $ 88,604
Adjustable rate 1-4 family
residential ............ 1,455 -- -- -- -- 1,455
Adjustable home equity
loans ................... 2,356 -- -- -- -- 2,356
Other fixed rate loans ... 46 515 313 3,397 5,348 9,619
Other loans ................ 1,265 -- -- -- -- 1,265
Less:
Allowance for loan losses (750) -- -- -- -- (750)
--------- --------- --------- --------- --------- ---------
$ 4,394 $ 1,649 $ 4,559 $ 42,350 $ 49,597 $ 102,549
========= ========= ========= ========= ========= =========
The following table sets forth the dollar amount at December 31, 1998
of all loans maturing or repricing on or after December 31, 1999.
Fixed Adjustable
Rates Rates
----------- -----------
(In Thousands)
Mortgage loans $ 88,582 $ -
Other loans 9,573 -
----------- -----------
$ 98,155 $ -
=========== ===========
Origination of Loans. Historically, the Bank has not originated its
one-to-four family residential mortgage or other loans with the intention that
they will be sold in the secondary market. Accordingly, the Bank originates
fixed rate one-to-four family residential real estate loans which satisfy the
Bank's underwriting requirements and are tailored to its local community, but do
not necessarily satisfy various technical FHLMC and FNMA underwriting
requirements and purchase requirements not related to documentation.
Although the Bank believes that many of its nonconforming loans are
salable in the secondary market, some of such nonconforming loans could be sold
only after the Bank incurred certain costs and/or discounted the purchase price.
As a result, the Bank's loan portfolio is less liquid than would be the case if
it was composed entirely of loans originated in conformity with secondary market
requirements. In addition, certain types of nonconforming loans are generally
thought to have greater risks of default and nonperformance. However, such loans
generally produce a higher yield than would be produced by conforming loans, and
the Bank has historically found that its origination of such loans has not
resulted in a high level of nonperforming assets. These nonconforming loans
satisfy a need in the Bank's local community, and the Bank intends to continue
to originate nonconforming loans.
6
Substantially all of the one-to-four family residential mortgage loans
originated by the Bank have a fixed rate of interest because there is very
little demand for adjustable rate loans in the Bank's market area. As a result,
Mocksville limits the term of substantially all of its fixed rate residential
real estate loans to a shorter term, 20 years, and, includes a 10-year call
provision in all other fixed rate residential real estate loans over 20 years.
The Bank has instituted a new marketing program in which all of the
Bank's loan officers visit local realtors to promote the Bank's residential
mortgage products.
The table below sets forth the Bank's loan origination, purchase
activity and loan portfolio repayment experience during the periods indicated.
December 31,
December 31,
-------------------------------------
1998 1997 1996
---------- ---------- -----------
(In Thousands)
Loans receivable, net beginning of period $ 92,967 $ 82,992 $ 75,096
Loan originations:
Residential 1-4 family 26,932 12,575 11,880
Residential multifamily and
nonresidential real estate 3,818 4,772 1,730
Home equity and second mortgage 793 1,038 901
Residential construction 10,019 7,975 8,412
Consumer 2,079 1,195 410
---------- ---------- -----------
Total loan originations 43,641 27,555 23,333
Principal repayments (33,725) (18,139) (16,167)
Other changes, net (334) 559 730
---------- ---------- -----------
Increase in loans receivable 9,582 9,975 7,896
---------- ---------- -----------
Loans receivable, net, end of period $ 102,549 $ 92,967 $ 82,992
========== ========== ===========
One-to-Four Family Residential Real Estate Lending. The Bank's primary
lending activity, which it intends to continue to emphasize, is the origination
of fixed and adjustable rate first mortgage loans to enable borrowers to
purchase or refinance single family homes. The Bank also makes loans secured by
two-to-four family residential properties. Consistent with the Bank's emphasis
on being a community-oriented financial institution, it is and has been the
Bank's strategy to focus its lending efforts in Davie County, North Carolina and
in contiguous counties. On December 31, 1998, approximately 82.00% of the Bank's
total net real estate loan portfolio consisted of one-to-four family residential
real estate loans. These include both loans secured by detached single-family
residences and condominiums and loans secured by housing containing not more
than four separate dwelling units. Of such loans .35% had adjustable interest
rates.
The Bank originates some adjustable rate mortgage loans secured by
owner occupied property generally having terms of 30 years in amounts of up to
90% of the value of the property. Private mortgage insurance is generally
required if the loan amount exceeds 80% of the value of the property
7
Interest rates on adjustable rate residential mortgage loans are tied
to the weekly average yield on United States Treasury securities adjusted to a
constant maturity of one year. Rates are subject to change annually. The loans
have rate adjustment caps which limit the amount of rate adjustments at any one
time and over the lives of the loans.
Adjustable rate loans are generally considered to involve a greater
degree of risk than fixed rate loans because borrowers may have difficulty
meeting their payment obligations if interest rates and required payment amounts
increase substantially.
The Bank primarily originates fixed-rate mortgage loans secured by
owner occupied property having terms generally ranging from 15 to 30 years in
amounts of up to 90% of the value of the property. Any fixed rate loan with a
term greater than 20 years includes a ten-year call option. Private mortgage
insurance is generally required if the loan amount exceeds 80% of the value of
the property. In addition, the Bank makes fixed-rate loans secured by non-owner
occupied residential real estate generally having terms of 15 years in amounts
of up to 80% of the value of the property. Substantially all of the fixed-rate
loans in the Bank's mortgage loan portfolio have due on sale provisions allowing
the Bank to declare the unpaid balance due and payable in full upon the sale or
transfer of an interest in the property securing the loan.
While one-to-four family residential loans are normally originated for
15 or 30 year terms with a ten-year call option, such loans customarily remain
outstanding for substantially shorter periods because borrowers often prepay
their loans in full upon sale of the property pledged as security or upon
refinancing the original loan. Thus, average loan maturity is a function of,
among other factors, the level of purchase and sale activity in the real estate
market, prevailing interest rates, and the interest rates payable on outstanding
loans. The thrift and mortgage banking industries have generally used 12-year
and 7-year average loan lives in calculations calling for prepayment assumption
for 30-year residential loans and 15-year residential loans, respectively.
Management believes that the Bank's recent loan prepayment experience has been
shorter than these assumed average loan lives due to recent periods of low
interest rates and resulting high rates of refinancing.
The Bank generally requires title insurance for its one-to-four family
residential loans. The Bank generally requires that fire and extended coverage
casualty insurance (and, if appropriate, flood insurance) be maintained in an
amount at least equal to the loan amount or replacement cost, whichever is less,
of the improvements on the property securing the loans.
Multifamily Residential and Nonresidential Real Estate Lending. On
December 31, 1998, the Bank had $9.6 million in outstanding loans secured by
nonresidential real estate, including undeveloped land, comprising approximately
of 9.38% of its net loan portfolio as of that date. Most of these loans are
secured by land, church properties, apartments and commercial real estate, and
normally have fixed interest rates.
The loans generally do not exceed 75% of the appraised value of the
real estate securing the loans. Loans secured by commercial real estate and
undeveloped land generally are larger than one-to-four family residential loans
and involve a greater degree of risk. Payments on these loans depend to a large
degree on results of operations and management of the properties and may be
affected to a greater extent by adverse conditions in the real estate market or
the economy in general. As a result, the Bank has re-evaluated its
nonresidential lending policies and revised its commercial loan underwriting
procedures in order to, among other things, improve loan documentation. As of
December 31, 1998, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $1,223,400. This loan was performing in accordance with
the original loan contract. See "-Lending Activities-Nonperforming Assets and
Asset Classification."
Home Equity Lines of Credit and Subordinate Lien Loans. At December 31,
1998, the Bank had approximately $2.5 million in home equity and other
subordinate lien loans, representing approximately 2.42% of its net loan
portfolio. Of this amount, $2.2 million was composed of home equity line of
credit loans. These loans are often originated at the time of the closing of a
one-to-four family residential real estate loan secured by the same property.
The Bank's home equity lines of credit have adjustable interest rates tied to
prime interest rates plus a margin. The home equity lines of credit require
monthly payments of 2% of the outstanding balance or $100, whichever is greater.
These loans mature in fifteen years. Home equity lines of credit are generally
secured
8
by subordinate liens against residential real property. The Bank may require
title insurance in connection with these loans, but in the past only required
opinions of title from attorneys. The Bank requires that fire and extended
coverage casualty insurance (and, if appropriate, flood insurance) be maintained
in an amount at least sufficient to cover its loan. Home equity loans are
generally limited so that the amount of such loans, along with any senior
indebtedness, does not exceed 80% of the value of the real estate security.
Because home equity loans involve revolving lines of credit which can be drawn
over a period of time, the Bank faces risks associated with changes in the
borrower's financial condition. The Bank intends to continue to emphasize its
home equity program. The presence of home equity loans in the Bank's portfolio
has assisted the institution in improving the interest sensitivity of its assets
and liabilities because home equity liens of credit have adjustable rates which
are subject to change monthly and without any significant rate caps.
Construction Lending. The Bank makes construction loans primarily for
the construction of single-family dwellings. The aggregate outstanding balance
of such loans on December 31, 1998 was approximately $12.7 million, representing
approximately 12.35% of the Bank's net loan portfolio. Most of these loans were
made to persons who are constructing properties for the purpose of occupying
them; some were made to builders who were constructing properties for sale.
Loans made to individual property owners and builders are
"construction-permanent" loans which generally provide for the payment of
interest only during a construction period, after which the loans convert to a
permanent loan at fixed interest rates having terms similar to other one-to-four
family residential loans.
Construction loans made to builders who are building to resell
generally have a maximum loan-to-value ratio of 80% of the appraised value of
the property. Construction loans to persons who intend to occupy the finished
premises generally have a maximum loan-to-value ratio of 80% without private
mortgage insurance and up to 90% with private mortgage insurance.
Construction loans are generally considered to involve a higher degree
of risk than long-term financing secured by real estate which is already
occupied. A lender's risk of loss on a construction loan is dependent largely
upon the accuracy of the initial estimate of the property's value at the
completion of construction and the estimated cost (including interest) of
construction. If the estimate of construction costs proves to be inaccurate, the
lender may be required to advance funds beyond the amount originally committed
in order to permit completion of construction. If the estimate of anticipated
value proves to be inaccurate, the lender may have security which has value
insufficient to assure full repayment.
In addition, repayment of loans made to builders to finance
construction of properties is often dependent upon the builder's ability to sell
the property once construction is completed.
Other Installment Loans. In addition to the loans described above, the
Bank also offers loans which are primarily secured by savings deposits held by
the Bank or which are unsecured. As of December 31, 1998, the Bank had
approximately $235,200 of such loans outstanding, representing approximately
.23% of its net loan portfolio.
Financing of new mobile homes generally does not exceed 75% of the
purchase price or the retail invoice value of the mobile home, including land
value, and has a maximum term of 15 years. The Bank also makes other secured
consumer loans such as automobiles, campers and boats and generally lends up to
90% of the purchase price.
The Bank makes unsecured consumer loans in amounts of up to $25,000.
These loans require monthly payments and have a term of up to 24 months. In
addition, the Bank provides overdraft lines of credit in amounts of up to
$10,000. Payments are required in amounts of 2% of the outstanding balance or
$100, whichever is greater.
Loan Solicitation, Processing and Underwriting. Loan originations were
derived from a number of sources such as referrals from real estate brokers,
present depositors and borrowers, builders, attorneys, walk-in customers and in
some instances, other lenders.
9
During its loan approval process, the Bank assesses the applicant's
ability to make principal and interest payments on the loan and the value of the
property securing the loan. The Bank obtains detailed written loan applications
to determine the borrower's ability to repay and verifies responses on the loan
application through the use of credit reports, financial statements, and other
confirmations. Under current practice, the responsible officer or loan officer
of the Bank analyzes the loan application and the property involved, and an
appraiser inspects and appraises the property. The Bank generally requires
independent fee appraisals on all loans originated primarily on the basis of
real estate collateral. The Bank also obtains information concerning the income,
financial condition, employment and the credit history of the applicant.
The Bank has developed the following lending thresholds to approve
loans. All loans, regardless of type, are approved based on the following
lending limits, assuming the loan meets all of the Bank's underwriting
guidelines. Loan officers may approve loans up to $85,000. The Senior Vice
President of lending approves loans up to $100,000. The President and Senior
Vice President of the bank have the authority to approve loans up to $150,000.
The Bank's Directors' Loan Committee, which is composed of its President and
three outside directors appointed by the Chairman of the Board, approve loans
from $150,000 to $250,000. All remaining loan requests over $250,000 up to the
legal lending limit of the bank must be approved by the bank's full Board of
Directors.
Normally, upon approval of a residential mortgage loan application,
Stone Street gives a commitment to the applicant that it will make the approved
loan at a stipulated rate any time within a 30-day period. The loan is typically
funded at such rate of interest and on other terms which are based on market
conditions existing as of the date of the commitment. As of December 31, 1998,
the Bank had $5.6 million in such unfunded mortgage loan commitments. In
addition, on such date the Bank had $2.8 million in unfunded commitments for
unused lines of credit and letters of credit.
Interest Rates, Terms, Points and Fees. Interest rates and fees charged
on the Bank's loans are affected primarily by the market demand for loans,
competition, the supply of money available for lending purposes and the Bank's
cost of funds. These factors are affected by, among other things, general
economic conditions and the policies, of the federal government, including the
Federal Reserve, tax policies and governmental budgetary matters.
In addition to earning interest on loans, the Bank receives fees in
connection with originating loans. Fees for loan modifications, late payments,
loan assumptions and other miscellaneous services in connection with loans are
also charged by the Bank.
Nonperforming Assets and Asset Classification. When a borrower fails to
make a required payment on a loan and does not cure the delinquency promptly,
the loan is classified as delinquent. In this event, the normal procedure
followed by the Bank is to make contact with the borrower at prescribed
intervals in an effort to bring the loan to a current status, and late charges
are assessed as allowed by law. In most cases, delinquencies are cured promptly.
If a delinquency is not cured, the Bank normally, subject to any required prior
notice to the borrowers, commences foreclosure proceedings. If the loan is not
reinstated within the time permitted for reinstatement, or the property is not
redeemed prior to sale, the property may be sold at a foreclosure sale. In
foreclosure sales, the Bank may acquire title to the property through
foreclosure, in which case the property so acquired is offered for sale and may
be financed by a loan involving terms more favorable to the borrower than those
normally offered. Any property acquired as a result of foreclosure or by deed in
lieu of foreclosure is classified as real estate owned until such time as it is
sold or otherwise disposed of by the Bank to recover its investment. As of
December 31, 1998, the Bank did not own any real estate acquired in settlement
of loans. Real estate acquired through, or in lieu of, loan foreclosure is
initially recorded at the lower cost or fair value at the date of foreclosure,
establishing a new cost basis. After foreclosure, valuations are periodically
performed by management, and the real estate is carried at the lower of cost or
fair value minus costs to sell. Revenue and expenses from holding the properties
and additions to the valuation allowance are included in operations.
Interest on loans is recorded as borrowers' monthly payments become
due. Accrual of interest income on loans is suspended, when, in management's
judgment, doubts exist as to the collectibility of additional interest within
reasonable time. Loans are returned to accrual status when management
determines, based upon an
10
evaluation of the underlying collateral, together with the borrower's payment
record and financial condition, that the borrower has the capability and intent
to meet the contractual obligations of the loan agreement. The Bank continues to
accrue interest on loans delinquent 90 days or more if the loans are well
secured and the Bank is in the process of collecting payments on the loans.
Interest on loans placed on nonaccrual status is generally charged off. The
allowance is established by a charge to interest income equal to all interest
previously accrued, and income is subsequently recognized only to the extend
cash payments are received until the loan is returned to accrual status.
The following table sets forth information with respect to
nonperforming assets identified by the Bank, including nonaccrual loans and real
estate owned at the dates indicated.
At December 31,
-------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ----------- ----------- ---------- -----------
(Dollars in Thousands)
Total nonaccrual loans
Mortgage loans delinquent 90 days or more $ - $ - $ - $ - $ -
Consumer loans delinquent 90 days or more - - - - -
Real estate owned - - - - -
---------- ----------- ----------- ---------- -----------
Total non-performing assets $ - $ - $ - $ - $ -
========== =========== =========== ========== ===========
Accruing loans, delinquent 90 days or more $ 243 $ 295 $ 423 $ 201 $ 280
========== =========== =========== ========== ===========
Non-performing loans to total loans 0.00% 0.00% 0.00% 0.00% 0.00%
Non-performing assets to total assets 0.00% 0.00% 0.00% 0.00% 0.00%
Total assets $ 127,273 $ 108,092 $ 105,807 $ 87,751 $ 81,560
Total loans, net $ 102,549 $ 92,967 $ 82,992 $ 75,097 $ 65,973
Applicable regulations require the Bank to "classify" its own assets on
a regular basis. In addition, in connection with examinations of savings
institutions, regulatory examiners have authority to identify problem assets
and, if appropriate, classify them. Problem assets are classified as
"substandard," "doubtful" or "loss," depending on the presence of certain
characteristics as discussed below.
An asset is considered "substandard" if not adequately protected by the
current net worth and paying capacity of the obligor or the collateral pledged,
if any. "Substandard" assets include those 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
"uncollectable" and of such little value that their continuance as assets
without the establishment of a loss reserve is not warranted.
As of December 31, 1998, the Bank had approximately $243,000 of loans
internally classified as "substandard", and no loans classified as "doubtful" or
"loss". The Bank also identifies assets which possess credit deficiencies or
potential weaknesses deserving close attention by management. These assets may
be considered "special mention" assets and do not yet warrant adverse
classification. At December 31, 1998, the Bank had no loans in the "special
mention" category.
When an insured institution classifies problem assets as either
substandard or doubtful, it is required to establish general allowances for loan
losses in an amount deemed prudent by management. These allowances represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities and the risks associated with particular
problem assets. When an insured institution classifies problem assets as "loss,"
it charges off the balance of the asset. The Bank's determination as to the
classification of its
11
assets and the amount of its valuation allowances is subject to review by the
FDIC and the Administrator which can order the establishment of additional loss
allowances.
The following table sets forth at December 31, 1998, the Bank's
aggregate carrying value of the assets classified as substandard, doubtful, loss
or "special mention":
Special Mention List Substandard Doubtful Loss
------------------------- ---------------------- ----------------------- --------------------
Number Amount Number Amount Number Amount Number Amount
--------- --------- --------- -------- --------- --------- --------- ---------
(In thousands)
Real estate loans:
Residential 1-4 family - $ -- - $ 243 - $ - - $ -
Residential multifamily
and nonresidential
real estate - - - - - - - -
Home equity and second
mortgage - - - - - - - -
Residential construction - - - - - - - -
--------- --------- --------- -------- --------- --------- --------- ---------
Total real estate loans - - - $ 243 - - - -
--------- --------- --------- -------- --------- --------- --------- ---------
Consumer loan - - - - - - - -
--------- --------- --------- -------- --------- --------- --------- ---------
Total - $ - - $ 243 - $ - - $ -
========= ========= ========= ======== ========= ========= ========= =========
Allowance for Loan Losses. In originating the loans, the Bank
recognizes that credit losses will be experienced and that the risk of loss will
vary with, among other things, the type of loan being made, the creditworthiness
of the borrower over the term of the loan and, in the case of a secured loan,
the quality of the security for the loan as well as general economic conditions.
It is management's policy to maintain an adequate allowance for loan losses
based on, among other things, the Bank's historical loan loss experience,
evaluation of economic conditions and regular reviews of delinquencies and loan
portfolio quality. Specific allowances are provided for individual loans when
ultimate collection is considered in doubt by management after reviewing the
current status of loans which are contractually past due and considering the
fair value of the security for the loans.
Management continues to actively monitor the Bank's asset quality, to
charge off loans against the allowance for loan losses when appropriate and to
provide specific loss reserves when necessary. Although management believes it
uses the best information available to make determinations with respect to the
allowance for loan losses, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations.
12
The following table describes the activity related to the Bank's
allowance for loan losses for the periods indicated.
Year Ended December 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- ------ --------
Balance, beginning of period $ 570 $ 511 $ 462 $ 115 $ 89
Provision for loan losses 180 60 50 350 26
Charge-offs:
Residential 1-4 family - - - - -
Consumer - 1 1 3 -
Recoveries:
Residential 1-4 family - - - - -
Consumer - - - - -
-------- -------- -------- ------- --------
Balance, end of period $ 750 $ 570 $ 511 $ 462 $ 115
======== ======== ======== ======= ========
Net charge-offs as a % of average
loans outstanding - - - - -
Allowance at period end as a % of
nonperforming loans - - - - -
Allowance at period end as a % of
nonperforming assets - - - - -
Allowance at period end as a % of
total gross loans .69% .58% .57% .57% .16%
The following table sets forth the composition of the allowance for
loan losses by type of loan at the dates indicated. The allowance is allocated
to specific categories of loans for statistical purposes only, and may be
applied to loan losses incurred in any loan category.
13
At December 31,
-----------------------------------------------------------------------------------------------------
1998 1997 1996 1995
------------------------- ----------------------- ----------------------- -----------------------
(In Thousands)
Amount of Amount of Amount of Amount of
Amount of Loans to Amount of Loans to Amount of Loans to Amount of Loans to
Allowance Gross Loans Allowance Gross Loans Allowance Gross Loans Allowance Gross Loans
--------- ----------- --------- ----------- --------- ----------- --------- -----------
Real estate loans:
Residential
1-4 family $ 188 76.37% $ 154 78.21% $ 138 76.32% $ 127 77.48%
Residential multifamily
and nonresidential
real estate 263 8.74 171 9.71 153 6.43 138 5.21
Home equity and
second mortgage 53 2.25 58 2.72 52 2.78 46 2.67
Residential construction 188 11.50 143 8.72 128 14.05 115 14.36
------- ------ ------- ------ ------ ------ -------- ------
Total real estate loans 692 98.86 526 99.36 471 99.58 426 99.72
Consumer loans 58 1.14 44 .64 40 .42 36 .28
------- ------ ------- ------ ------ ------ -------- ------
Total $ 750 100.00% $ 570 100.00% $ 511 100.00% $ 462 100.00%
======= ====== ======= ====== ====== ====== ======== ======
At December 31,
------------------------
Amount of
Amount of Loans to
Allowance Gross Loans
--------- -----------
Real estate loans:
Residential
1-4 family $ 45 74.91%
Residential multifamily
and nonresidential
real estate 23 6.88
Home equity and
second mortgage 12 1.96
Residential construction 24 15.98
------- ------
Total real estate loans 104 99.73
Consumer loans 11 0.27
------- ------
Total $ 115 100.00%
======= ======
14
Investment Securities
Interest and dividend income from investment securities generally
provides the second largest source of income to the Bank after interest on
loans. In addition, the Bank receives interest income from deposits in other
financial institutions. On December 31, 1998, the carrying value of the Bank's
investment securities portfolio totaled $19.7 million and consisted of
interest-bearing deposits, U.S. government and agency securities,
mortgage-backed securities, federal funds sold and stock in the FHLB of Atlanta.
The mortgage-backed securities consist of mortgage-backed securities issued by
the GNMA, FHLMC and SBA.
The investment securities portfolio includes interest-bearing deposits
of $4.4 million at December 31, 1998. Investments in mortgage-backed securities
involve a risk that, because of changes in the interest rate environment, actual
prepayments may be greater than estimated prepayments over the life of the
security, which may require adjustments to the amortization of any premium or
accretion of any discount relating to such instruments, thereby reducing the
interest yield on such securities. There is also reinvestment risk associated
with the cash flows from such securities. In addition, the market value of such
securities may be adversely affected by changes in interest rates.
The FASB has issued Statement of Financial Accounting Standards No. 115
(SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities"
which addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values and for all investments in
debt securities. These investments are to be classified in three categories and
accounted for as follows: (1) debt securities that the entity has the positive
intent and ability to hold to maturity are classified as held-to-maturity and
reported at amortized cost; (2) debt and equity securities that are bought and
held principally for the purpose of selling them in the near term are classified
as trading securities and reported at fair value, with net unrealized gains and
losses included in earnings; and (3) debt securities not classified as either
held-to-maturity or trading securities and equity securities not classified as
trading securities are classified as securities available-for-sale and reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of equity. The Bank has no trading securities.
The amortized cost of securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest income
from investments. Realized gains and losses, and declines in value judged to be
other than temporary are included in net securities gains (losses). The cost of
securities sold is based on the specific identification method.
As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in stock of the FHLB of Atlanta equal to the greater of 1% of the
Bank's outstanding home loans or 5% of its outstanding advances form the FHLB of
Atlanta. No ready market exists for such stock, which is carried at cost but the
Bank may redeem the stock with the FHLB at its par value. As of December 31,
1998, the Bank's investment in stock of the FHLB of Atlanta was $1,569,800.
North Carolina regulations require the Bank to maintain a minimum
amount of liquid assets which may be invested in specified short-term
securities. The Bank is also permitted to make certain other securities
investments. The Bank's current investment policy states that the Bank's
investments will be limited to U.S. Treasury obligations, federal agency
securities, mortgage backed securities, municipal securities, corporate notes
and time deposits in the FHLB.
Investment decisions are made by authorized officers of the Bank under
policies established by the Board of Directors. Such investments are managed in
an effort to produce the highest yield consistent with maintaining safety of
principal and compliance with regulations governing the savings industry.
15
The following table sets forth certain information regarding the Bank's
interest-bearing deposits and the amortized cost and market values of the Bank's
investment and mortgage-backed securities portfolios at the dates indicated.
December 31,
--------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- ---------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
------- ------- ------- ------- ------- -------
Interest-bearing
deposits in other
financial
institutions ............. $ 4,406 $ 4,406 $ 2,701 $ 2,701 $ 7,916 $ 7,916
------- ------- ------- ------- ------- -------
Securities available-
for-sale:
Obligations of states
and political
subdivisions ........... $ 764 $ 783 $ 1,854 $ 1,859 $ 2,019 $ 2,011
Mortgage-backed securities 9,662 9,575 -- -- -- --
Mutual funds ............. 0 0 0 0 712 712
------- ------- ------- ------- ------- -------
Total securities
available-for-
sale ................... $10,426 $10,358 $ 1,854 $ 1,859 $ 2,731 $ 2,723
------- ------- ------- ------- ------- -------
Securities held-
to-maturity:
U.S. government
and agency
securities ............. $ 748 $ 750 $ 3,489 $ 3,494 $ 4,753 $ 4,756
Mortgage-backed
securities ............. 1,744 1,741 2,400 2,446 2,983 3,024
------- ------- ------- ------- ------- -------
Total securities
held-to-maturity ......... $ 2,492 $ 2,491 $ 5,889 $ 5,940 $ 7,736 $ 7,780
======= ======= ======= ======= ======= =======
December 31
--------------------------------------------
1995 1994
--------------------------------------------
Amortized Market Amortized Market
Cost Value Cost Value
------- ------- ------- -------
Interest-bearing
deposits in other
financial
institutions ............. $ 2,737 $ 2,737 $ 3,941 $ 3,941
------- ------- ------- -------
Securities available-
for-sale:
Obligations of states
and political
subdivisions ........... $ 1,629 $ 1,630 $ 2,644 $ 2,521
Mortgage-backed securities -- -- -- --
Mutual funds ............. 670 672 616 616
------- ------- ------- -------
Total securities
available-for-
sale ................... $ 2,299 $ 2,302 $ 3,260 $ 3,137
------- ------- ------- -------
Securities held-
to-maturity:
U.S. government
and agency
securities ............. $ 2,995 $ 3,016 $ 4,799 $ 4,635
Mortgage-backed
securities ............. 274 274 319 334
------- ------- ------- -------
Total securities
held-to-maturity ......... $ 3,269 $ 3,290 $ 5,118 $ 4,969
======= ======= ======= =======
(1) The net unrealized gain (loss) at December 31, 1998 and 1997 relates to
available for sale securities in accordance with SFAS No. 115. The net
unrealized gain (loss) is represented in order to reconcile the "Amortized
Cost" of the Bank's securities portfolio in the "Carrying Cost," as
reflected in the Statements of Financial Condition.
16
The following table sets forth certain information regarding the
carrying value, weighted average yields and contractual maturities of the Bank's
interest-bearing deposits, investment and mortgage-backed securities as of
December 31, 1998.
After One Year Through After Five Years Through
One Year or Less Five Years Ten Years After Ten Years
--------------------- --------------------- ----------------------- ----------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- -----
Interest-bearing deposits
in other financial
institutions $ 4,406 4.90% $ - -% $ - -% $ - -%
Securities available-
for-sale:
Obligations of states
and political
subdivisions(1) $ - -% $ 386 4.73% $ 378 4.25% $ - -%
Mortgage backed securities - - - - - - 9,662 5.79
Total securities
available-for-sale $ - -% $ 386 4.73% $ 378 4.25% $ 9,662 5.79%
Securities held-to-
maturity:
U.S. government and
agency securities $ 748 6.35% $ - -% $ - -% $ - -%
Mortgage-backed
securities - - - - - - 1,744 7.24
Total securities
held-to-maturity $ 748 6.35% $ - -% $ - -% $ 1,744 7.24%
Total investments, at
carrying value $ 748 6.35% $ 386 4.73% $ 378 4.25% $ 11,406 6.01%
Total interest-bearing
deposits and
investments $ 5,154 5.11% $ 386 4.73% $ 378 4.25% $ 11,406 6.01%
Total
----------------------
Weighted
Carrying Average
Value Yield
----- -----
Interest-bearing deposits
in other financial
institutions $ 4,406 4.90%
Securities available-
for-sale:
Obligations of states
and political
subdivisions(1) $ 764 4.49%
Mortgage backed securities 9,662 5.79
Total securities
available-for-sale $ 10,426 5.69%
Securities held-to-
maturity:
U.S. government and
agency securities $ 748 6.37%
Mortgage-backed
securities 1,744 7.24
Total securities
held-to-maturity $ 2,492 6.98%
Total investments, at
carrying value $ 12,918 5.94%
Total interest-bearing
deposits and
investments $ 17,324 5.68%
(1) Yields on obligations of sates and political subdivisions are not calculated
on a tax-equivalent basis.
17
Deposits and Borrowings
General. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank derives
funds from loan principal repayments, loan interest income, the stock offering,
investment income, interest-bearing deposit income, interest income from
mortgage-backed securities and otherwise from its operations. Loan repayments
are a relatively stable source of funds while deposit inflows and outflows may
be significantly influenced by general interest rates and money market
conditions. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources. They may also be
used on a longer term basis for general business purposes. The Bank had
borrowings outstanding of $24.0 million at December 31, 1998 with the FHLB of
Atlanta.
Deposits. On December 31, 1998, 1997 and 1996, the Bank's deposits
totaled $73.2 million, $67.0 million and $66.5 million, respectively.
The following table sets forth information relating to the Bank's
deposit flows during the periods shown and total deposits at the end of the
periods shown.
At or For the Year Ended December 31,
----------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ --------------
Total deposits at
beginning of period $ 66,973 $ 66,564 $ 73,035 $ 69,140 $ 64,282
Net increase (decrease)
before interest credited 3,823 (2,713) (9,518) 914 3,021
Interest credited 2,380 3,122 3,047 2,981 1,837
------------ ------------ ------------ ------------ --------------
Total deposits at end of
period $ 73,176 $ 66,973 $ 66,564 $ 73,035 $ 69,140
============ ============ ============ ============ ==============
The Bank attracts both short-term and long-term deposits from the
general public by offering a variety of accounts and rates. The Bank offers
passbook and statement savings accounts, negotiable order of withdrawal
accounts, money market accounts, and fixed interest rate certificates with
varying maturities. All deposit flows are greatly influenced by economic
conditions, the general level of interest rates, competition, and other factors,
including the restructuring of the thrift industry. The Bank's savings deposits
traditionally have been obtained primarily from its primary market area. The
Bank utilizes traditional marketing methods to attract new customers and savings
deposits, including print media advertising, local radio and direct mailings.
The Bank does not advertise for deposits outside of its local market area or
utilize the services of deposit brokers. The vast majority of the Bank's
depositors are residents of North Carolina. In the unlikely event the Bank is
liquidated following the Conversion, depositors will be entitled to full payment
of their deposit accounts prior to any payment being made to stockholders.
18
The following table sets forth certain information regarding the Bank's
savings deposits at the dates indicated.
At December 31,
------------------------------ ----------------------------- -----------------------------
1998 1997 1996
------------------------------ ----------------------------- -----------------------------
Weighted Weighted Weighted
Average % of Average % of Average % of
Amount Rate Deposits Amount Rate Deposits Amount Rate Deposits
------ ---- -------- ------ ---- -------- ------ ---- --------
(Dollars in Thousands)
Demand Accounts
Passbook and statement accounts $ 8,696 2.84% 12.26% $ 9,189 3.00% 13.72% $11,377 3.00% 16.06%
NOW accounts .................. 4,367 .54 5.90 2,242 .61 3.35 1,514 0.73 2.14
Money market deposit accounts . 841 2.45 1.14 2,463 2.46 3.68 2,416 2.45 3.41
------- ---- ------ ------- ---- ------ ------- ---- ------
Total demand deposits .... 13,904 2.09 19.30 13,894 2.61 20.75 15,307 2.69 21.61
------- ---- ------ ------- ---- ------ ------- ---- ------
Time Deposits:
Certified accounts with
original maturities of:
3 months or less ......... 599 4.67 1.54 1,348 4.80 2.01 3,786 4.86 5.34
3-6 months ............... 13,502 4.90 18.22 7,894 5.33 11.79 9,205 5.23 12.99
11-12 months ............. 13,853 5.38 18.69 14,924 5.53 22.28 17,089 5.40 24.13
13 months ................ 10,128 5.72 13.66 3,494 5.94 5.22
18 months ................ 3,658 5.49 4.93 4,908 5.74 7.33 5,183 5.59 7.32
24 months ................ 3,171 5.64 4.28 3,508 5.70 5.24 3,483 5.98 4.92
25 months ................ 2,035 5.94 2.75 2,017 5.84 3.01
30 months ................ 12,197 5.75 16.46 14,986 5.7 22.37 16,781 6.16 23.69
36 months ................ 129 5.00 .17 -- --
------- ---- ------ ------- ---- ------ ------- ---- ------
Total certificates ..... 59,272 5.44 80.70 53,079 5.62 79.25 55,527 5.62 78.39
------- ---- ------ ------- ---- ------ ------- ---- ------
Total deposits ...... $73,176 4.80% 100.00% $66,973 4.88% 100.00% $70,834 4.99% 100.00%
======= ==== ====== ======= ==== ====== ======= ==== ======
19
As of December 31, 1998, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $8.3 million.
Amount
-----------
(In Thousands)
3 Months or less $ 958
Over three months through 6 months 1,065
Over 6 months through 12 months 1,831
Over 12 months 4,419
-----------
Total $ 8,273
===========
Borrowings. The FHLB system functions in a reserve credit capacity for
savings institutions. As a member, the Bank is required to own capital stock in
the FHLB of Atlanta and is authorized to apply for advances from the FHLB of
Atlanta on the security of that stock and a floating lien on certain of its real
estate secured loans and other assets. Each credit program has its own interest
rate and range of maturities. Depending on the program, limitations on the
amount of advances are based either on a fixed percentage of an institution's
net worth or on the FHLB of Atlanta's assessment of the institution's
creditworthiness. At December 31, 1998 the Bank had outstanding borrowings from
the FHLB of Atlanta totaling $23,967,000.
The following table sets forth information relating to the weighted
average rates and the maturities of the borrowings at December 31, 1998:
Amount
------------
(In thousands)
5.78% due on or before December 31, 1999 $ 6,967
5.52% due on or before August 2, 2003 2,000
5.09% due on or before August 28, 2008 15,000
------------
Total $ 23,967
============
Subsidiaries
The Bank is the only subsidiary of the Company. The Bank has one
wholly-owned subsidiary, Stone Street Financial Services, Inc. which was
established in 1997 to provide investment discount brokerage services to the
public.
Competition
The Bank faces strong competition both in attracting deposits and
making real estate and other loans. Its most direct competition for deposits has
historically come from other savings institutions, credit unions and commercial
banks located in its primary market area, including large financial institutions
which have greater financial and marketing resources available to them. The Bank
has also faced additional significant competition for investors' funds for
short-term money market securities and other corporate and government
securities. At December 31, 1998 there were at least six other commercial banks,
credit unions and mortgage companies as well as numerous other financial
services providers located in the Bank's market area. At December 31, 1998, the
Bank had a deposit market share of approximately 25.14% in Davie County. The
ability of the Bank to attract and retain savings deposits depends on its
ability to generally provide a rate of return, liquidity and risk comparable to
that offered by competing investment opportunities.
The Bank experiences strong competition for real estate loans form
other savings institutions, commercial banks, and mortgage banking companies.
The Bank competes for loans primarily through the interest rates and loan fees
it charges, the efficiency and quality of services it provides borrowers, and
its more flexible underwriting
20
standards. Competition may increase as a result of the continuing reduction of
restrictions on the interstate operations of financial institutions.
Employees
As of December 31, 1998, the Bank had 22 full-time employees. All
full-time employees of the Bank are covered as a group for basic
hospitalization, including major medical, dental, accidental death and
dismemberment insurance as well as life and long term disability insurance.
Optional medical and dental insurance is available for dependents which must be
partially paid by the employee. In addition, in connection with the Conversion,
the Bank adopted an employment stock ownership plan which will provide benefits
to the Bank's employees.
Employees are not represented by any union or collective bargaining
group, and the Bank considers its employee relations to be good.
Federal Income Taxation
Savings institutions such as the Bank are subject to the taxing
provisions of the Code, for corporations, as modified by certain provisions
specifically applicable for financial or thrift institutions. Income is reported
using the accrual method of accounting. The maximum corporate federal income tax
rate is 34%.
For fiscal years beginning prior to December 31, 1995, thrift
institutions which qualified under certain definitional tests and other
conditions of the Code were permitted certain favorable provisions regarding
their deductions from taxable income for annual additions to their bad debt
reserve. A reserve could be established for bad debts on qualifying real
property loans (generally loans secured by interests in real property improved
or to be improved) under (i) a method based on a percentage of the institution's
taxable income as adjusted (the "percentage of taxable income method") or (ii) a
method based on actual loss experience (the "experience method"). The reserve
for nonqualifying loans was computed using the experience method.
The percentage of taxable income method was limited to 8% of taxable
income. This method could not raise the reserve to exceed 6% of qualifying real
property loans at the end of the year. Moreover, the additions for qualifying
real property loans, when added to nonqualifying loans, could not exceed 12% of
the amount by which total deposits or withdrawable accounts exceed the sum of
surplus, undivided profits and reserves at the beginning of the year. This
limitation precluded the Bank from taking a bad debt deduction in its 1998 and
1997 tax returns. The experience method was the amount necessary to increase the
balance of the reserve at the close of the year to the greater of (i) the amount
which bore the same ratio to loans outstanding at the close of the year as the
total net bad debts sustained during the current and five preceding years bore
to the sum of the loans outstanding at the close of such six years or (ii) the
balance in the reserve account at the close of the last taxable year beginning
before 1988 (assuming that the loans outstanding have not declined since such
date).
In order to qualify for the percentage of income method, an institution
had to have at least 60% of its net assets as "qualifying assets" which
generally included, cash, obligations of the United States government or an
agency or instrumentality thereof or of a state or political subdivision,
residential real estate-related loans, or loans secured by savings accounts and
property used in the conduct of its business. In addition, it had to meet
certain other supervisory tests and operate principally for the purpose of
acquiring savings and investing loans.
Institutions which became ineligible to use the percentage of income
method had to change to either the reserve method or the specific charge-off
method that applied to banks. Large thrift institutions, those generally
exceeding $500 million in assets, had to convert to the specific charge-off
method. In computing its bad debt reserve for federal income taxes, the Bank
used the reserve method in fiscal years 1998, 1997 and 1996.
Bad debt reserve balances in excess of the balance computed under the
experience method or amounts maintained in a supplemental reserve built up prior
to 1962 ("excess bad debt reserve") require inclusion in taxable income upon
certain distributions to its stockholders. Distributions in redemption or
liquidation of stock or distributions with respect to its stock in excess of
earnings and profits accumulated in years beginning after December 31, 1951, are
treated as a distribution from the excess bad debt reserve. When such a
distribution takes place and it is treated as from the excess bad debt reserve,
the thrift is required to reduce its reserve by such amount
21
and simultaneously recognize the amount as an item of taxable income increased
by the amount of income tax imposed on the inclusion. Dividends not in excess of
earnings and profits accumulated since December 31, 1951 will not require
inclusion in part or all of the bad debt reserve in taxable income. The Bank has
accumulated earnings and profits since December 31, 1951 and has an excess in
its bad debt reserve. Distribution in excess of current and accumulated earnings
and profits will increase taxable income. Net retained earnings at December 31,
1998 includes approximately $2.6 million for which no provision for federal
income tax has been made. See Note 8 to "Notes to Financial Statements".
Legislation passed by the U.S. Congress and signed by the President in
August 1996 contains a provision that repeals the percentage of taxable income
method of accounting for thrift bad debt reserves for tax years beginning after
December 31, 1995. The legislation will trigger bad debt reserve recapture for
post-1987 excess reserves over a six-year period. At December 31, 1998, the Bank
had no post-1987 excess reserves. A special provision suspends recapture of
post-1987 excess reserves for up to two years if, during those years, the
institution's residential loans exceeds a base year amount, which is determined
by reference to the average of the institution's residential loans during the
six taxable years ending January 1, 1996.
The Bank may also be subject to the corporate alternative minimum tax
("AMT"). This tax is applicable only to the extent it exceeds the regular
corporate income tax. The AMT is imposed at the rate of 20% of the corporation's
alternative minimum taxable income ("AMTI") subject to applicable statutory
exemptions. AMTI is calculated by adding certain tax preference items and making
certain adjustments to the corporation's regular taxable income. Preference
items and adjustments generally applicable to financial institutions include,
but are not limited to, the following: (i) the excess of the bad debt deduction
over the amount that would have been allowable on the basis of actual
experience; (ii) interest on certain tax-exempt bonds issued after August 7,
1986; and (iii) 75% of the excess, if any, of a corporation's adjusted earnings
and profits over its AMTI (as otherwise determined with certain adjustments).
Net operating loss carryovers, subject to certain adjustments, may be utilized
to offset up to 90% of the AMTI. Credit for AMT paid may be available in future
years to reduce future years to reduce regular federal income tax liability. The
Bank has not been subject to the AMT in recent years.
The Bank's federal income tax returns have not been audited in over ten
years.
State Taxation
Under North Carolina law, the corporate income tax is 7.25% of federal
taxable income as computed under the Code, subject to certain prescribed
adjustments. An annual state franchise tax is imposed at a rate of 0.15% applied
to the greatest of the institutions (i) capital stock, surplus and undivided
profits, (ii) investment in tangible property in North Carolina or (iii)
appraised valuation of property in North Carolina.
The North Carolina corporate tax rate will drop to 7.00% in 1999 and
6.90% thereafter.
SUPERVISION AND REGULATION
Regulation of the Company
General. The Company was organized for the purpose of acquiring and
holding all of the capital stock of the Bank to be issued in the Conversion. As
a bank holding company subject to the Bank Holding Company Act of 1956, as
amended ("BLHCA"), the Company will become subject to certain regulations of the
Federal Reserve. Under the BHCA, the Company's activities and those of its
subsidiaries are limited to banking, managing or controlling banks, furnishing
services to or performing services for its subsidiaries or engaging in any other
activity which the Federal Reserve determines to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto. The
BHCA prohibits the Company from acquiring direct or indirect control of more
than 5% of the outstanding voting stock or substantially all of the assets of
any bank or savings bank or merging or consolidating with another bank holding
company or savings bank holding company without prior approval of the Federal
Reserve.
22
Additionally, the BHCA prohibits the Company from engaging in, or
acquiring ownership or control of, more than 5% of the outstanding voting stock
of any company engaged in nonbanking business unless such business is determined
by the Federal Reserve to be so closely related to banking as to be properly
incident thereto. The BHCA generally does not place territorial restrictions on
the activities of such nonbanking related activities.
Similarly, Federal Reserve approval (or, in certain cases,
non-disapproval) must be obtained prior to any person acquiring control of the
Company. Control is conclusively presumed to exist if, among other things, a
person acquired more than 25% of any class of voting stock of the holding
company or controls in any manner the election of a majority of the directors of
the holding company. Control is presumed to exist if a person acquires more than
10% of any class of voting stock and the stock is registered under Section 12 of
the Exchange Act or the acquiror will be the largest shareholder after the
acquisition.
There are a number of obligations and restrictions imposed on bank
holding companies and their depository institution subsidiaries by law and
regulatory policy that are designed to minimize potential loss to the depositors
of such depository institutions and the FDIC insurance funds in the event the
depository institution becomes in danger of default or in default. For example,
under the 1991 Banking Law, to avoid receivership of an insured depository
institution subsidiary, a bank holding company is required to guarantee the
compliance of any insured depository institution subsidiary that may become
"undercapitalized" with the terms of any capital restoration plan filed by such
subsidiary with its appropriate federal banking agency up to the lesser of (i)
an amount equal to 5% of the institution's total assets at the time the
institution became undercapitalized or (ii)the amount which is necessary (or
would have been necessary) to bring the institution into compliance with all
acceptable capital standards as of the time the institution fails to comply with
such capital restoration plan. Under a policy of the Federal Reserve with
respect to bank holding company operations, a bank holding company is required
to serve as a source of financial strength to its subsidiary depository
institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. The Federal Reserve
under the BHCA also has the authority to require a bank holding company to
terminate any activity or to relinquish control of a nonbank subsidiary (other
than a nonbank subsidiary of a bank) upon the Federal Reserve's determination
that such activity or control constitutes a serious risk to the financial
soundness and stability of any bank subsidiary of the bank holding company.
In addition, the "cross-guarantee" provisions of the Federal Deposit
Act, as amended ("FDA") require insured depository institutions under common
control to reimburse the FDIC for any loss suffered by either the Savings
Association Insurance Fund (the "SAIF") or the Bank Insurance Fund (the "BIF")
as a result of the default of a commonly controlled insured depository
institution or for any assistance provided by the FDIC to a commonly controlled
insured depository institution in danger of default. The FDIC may decline to
enforce the cross-guarantee provisions if it determines that a waiver is in the
best interest of the SAIF or the BIF or both. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
As a result of the Company's ownership of the Bank, the Company will be
registered under the savings bank holding company laws of North Carolina.
Accordingly, the Company is also subject to regulation and supervision by the
Administrator.
Federal regulations require that the Company must notify the Federal
Reserve Bank of Richmond prior to repurchasing Common Stock in excess of 10% of
its net worth during a rolling 12 month period.
Capital Adequacy Guidelines for Holding Companies. The Federal Reserve
has adopted capital adequacy guidelines for bank holding companies. For bank
holding companies with less than $150 million in consolidated assets, the
guidelines are applied on a bank-only basis unless the parent bank holding
company (i) is engaged in nonbank activity involving significant leverage or
(ii) has a significant amount of outstanding debt that is held by the general
public.
Bank holding companies are required to comply with the Federal
Reserve's risk-based capital guidelines. Under these regulations, the minimum
ratio of total capital to risk-weighted assets (including certain off-balance
23
sheet activities, such as standby letters of credit) is 8%. At least half of the
total capital is required to be "Tier I capital," principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock, and a
limited amount of cumulative perpetual preferred stock, less certain goodwill
items and other intangible assets.
The remainder ("Tier II capital") may consist of a limited amount of
subordinated debt, certain hybrid capital instruments and other debt securities,
perpetual preferred stock, and a limited amount of the general loan loss
allowance. In addition to the risk-based capital guidelines, the Federal Reserve
has adopted a minimum Tier I capital (leverage) ratio, under which a bank
holding company must maintain a minimum level of Tier I capital to average total
consolidated assets of at least 3% in the case of a bank holding company which
has the highest regulatory examination rating and is not contemplating
significant growth or expansion. All other bank holding companies are expected
to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the
stated minimum.
Federal Securities Law. The Company has registered its Common Stock
with the SEC pursuant to Section 12(b) of the Exchange Act and will not
deregister the Common Stock for a period of three years following the completion
of the Conversion. As a result of such registration, the proxy and tender offer
rules, insider trading reporting requirements, annual and periodic reporting and
other requirements of the Exchange Act are applicable to the Company.
The registration under the Securities Act of the Offerings of the
Common Stock does not cover the resale of such shares. Shares of the Common
Stock purchased by persons who are not affiliates of the Company may be resold
without registration. Shares purchased by an affiliate of the Company are
subject to the resale provisions of Rule 144 under the Securities Act. So long
as the Company meets the current public information requirements of Rule 144
under the Securities Act, each affiliate of the Company who complies with the
other conditions of Rule 144 (including those that require the affiliate's sale
to be aggregated with those of certain other persons) will be able to sell in
the public market, without registration, a number of shares not to exceed, in
any three-month period, the greater of (i) 1% of the outstanding shares of the
Company or (ii) the average weekly volume of trading in such shares during the
preceding four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under the
Securities Act under certain circumstances. There are currently no demand
registration rights outstanding. However, in the event the Company at some
future time determines to issue additional shares from its authorized but
unissued shares, the Company might offer registration rights to certain of its
affiliates who want to sell their shares.
Regulation of the Bank
General. Federal and state legislation and regulation have
significantly affected the operations of federally insured savings institutions
and other federally regulated financial institutions in the past several years
and have increased competition among savings institutions, commercial banks and
other providers of financial services. In addition, federal legislation has
imposed new limitations on investment authority, and higher insurance and
examination assessments on savings institutions and has made other changes that
may adversely affect the future operations and competitiveness of savings
institutions with other financial institutions, including commercial banks and
their holding companies. The operations of regulated depository institutions,
including the Bank, will continue to be subject to changes in applicable
statutes and regulations form time to time.
The Bank is a North Carolina-chartered savings bank, is a member of the
FHLB system, and its deposits are insured by the FDIC through the SAIF. It is
subject to examination and regulation by the FDIC and the Administrator and to
regulations governing such matters as capital standards, mergers, establishment
of branch offices, subsidiary investments and activities, and general investment
authority. Generally, North Carolina state chartered savings banks whose
deposits are insured by the SAIF are subject to restrictions with respect to
activities and investments, transactions with affiliates and loans-to-one
borrower similar to those applicable to SAIF insured savings associations. Such
examination and regulation is intended primarily for the protection of
depositors and the federal deposit insurance funds.
The Bank is subject to various regulations promulgated by the Federal
Reserve including, without limitation, Regulation B (Equal Credit Opportunity),
Regulation D (Reserves), Regulation E (Electronic Fund
24
Transfers), Regulation O (Loans to Executive Officers, Directors and Principal
Shareholders), Regulation Z (Truth in Lending), Regulation CC (Availability of
Funds) and Regulation DD (Truth in Savings). As creditors of loans secured by
real property and as owners of real property, financial institutions, including
the Bank, may be subject to potential liability under various statutes and
regulations applicable to property owners generally, including statutes and
regulations relating to the environmental condition of real property.
The FDIC has extensive enforcement authority over North Carolina
state-chartered savings banks, including the Bank. This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease and desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated in response to violations of
laws and regulations and unsafe or unsound practices.
The grounds for appointment of a conservator or receiver for a North
Carolina savings bank on the basis of an institution's financial condition
include: (i) insolvency, in that the assets of the savings bank are less than
its liabilities to depositors and others; (ii) substantial dissipation of assets
or earnings through violations of law or unsafe or unsound practices; (iii)
existence of an unsafe or unsound condition to transact business; (iv)
likelihood that the savings bank will be unable to meet the demands of its
depositors or to pay its obligations in the normal course of business; and (v)
insufficient capital or the incurring or likely incurring of losses that will
deplete substantially all of the institution's capital with no reasonable
prospect of replenishment of capital without federal assistance.
Transactions with Affiliates. Under current federal law, transactions
between the Bank and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of the Bank is any company or entity that
controls, is controlled by or is under common control with the savings bank.
Generally, subsidiaries of a bank, other than a bank subsidiary, and certain
types of companies are not considered to be affiliates. Generally, Sections 23A
and 23B (i) establish certain collateral requirements for loans to affiliates;
(ii) limit the extent to which the Bank or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
the Bank's capital stock and surplus, and contain an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital stock
and surplus and (iii) require that all such transactions be on terms
substantially the same, or at least as favorable, to the Bank or the subsidiary
as those provided to a nonaffiliate. The term "covered transaction" includes the
making of loans or other extensions of credit to an affiliate, the acceptance of
securities of an affiliate as collateral for a loan or extension of credit to
any person, or issuance of a guarantee, acceptance or letter of credit on behalf
or an affiliate.
Further, current federal law has extended to saving banks the
restrictions contained in Section 22(h) of the Federal Reserve Act with respect
to loans to directors, executive officers and principal stockholders. Under
Section 22(h), loans to directors, executive officers and stockholders who,
directly or indirectly, own more than 10% of any class of voting securities of a
savings bank, and certain affiliated entities of any of the foregoing, may not
exceed, together with all other outstanding loans to such person and affiliated
entities, the savings bank's loans-to-one borrower limit as established by
federal law (as discussed below). Section 22(h) also prohibits loans above
amounts prescribed by the appropriate federal banking agency to directors,
executive officers or stockholders who own more than 10% of a savings bank, and
their respective affiliates, unless such loan is approved in advance by a
majority of the disinterested directors of the board of directors of the savings
bank and the Company. Any "interested" director may not participate in the
voting. The Federal Reserve has prescribed the loan amount (which includes all
other outstanding loans to such person), as to which such prior board of
director approval is required, as being the greater of $25,000 or 5% of
unimpaired capital and unimpaired surplus (up to $500,000). Further, pursuant to
Section 22(h) the Federal Reserve requires that loans to directors, executive
officers, and principal stockholders be based on underwriting standards not less
stringent than those applied in comparable transactions with other persons and
be made on terms substantially the same as offered in comparable transactions to
other persons and not involve more than the normal risk of repayment or present
other unfavorable features.
Deposit Insurance. The Bank's deposit accounts are insured by the FDIC
under the SAIF to the maximum extent permitted by law. The Bank pays deposit
insurance premiums to the FDIC based on a risk-based assessment system
established by the FDIC for all SAIF-member institutions. Under applicable
regulations, institutions are assigned to one of three capital groups that are
based solely on the level of an institution's capital
25
("well capitalized," "adequately capitalized" or "undercapitalized"), which are
defined in the same manner as the regulations establishing the prompt corrective
action system discussed below. The matrix so created results in nine assessment
risk classifications, with rates that, until September 30, 1996, ranged from
0.23% for well capitalized, financially sound institutions with only a few minor
weaknesses to 0.31% for undercapitalized institutions that pose a substantial
risk to the SAIF unless effective corrective action is taken.
Pursuant to the DIF Act, which was enacted on September 30, 1996, the
FDIC imposed a special assessment on each depository institution with
SAIF-assessable deposits which resulted in the SAIF achieving its designated
reserve ratio. In connection therewith, the FDIC reduced the assessment schedule
for SAIF members, effective January 1, 1997, to a range of 0% to 0.27%, with
most institutions paying 0%. This assessment schedule is the same as that for
the BIF, which reached its designated reserve ratio in 1995. In addition, since
January 1, 1997, SAIF members are charged an assessment of 0.065% of
SAIF-assessable deposits for the purpose of paying interest on the obligations
issued by the Financing Corporation ("FICO") in the 1980s to help fund the
thrift industry cleanup. BIF-assessable deposits will be charged an assessment
to help pay interest on the FICO bonds at a rate of approximately .013% until
the earlier of December 31, 1999 or the date upon which the last savings
association ceases to exist, after which time the assessment will be the same
for all insured deposits.
The DIF Act provided for the merger of the BIF and the SAIF into the
Deposit Insurance Fund on January 1, 1999, but only if no insured depository
institution is a savings association on that date. The DIF Act contemplates the
development of a common charter for all federally chartered depository
institutions and the abolition of separate charters for national banks and
federal savings associations. It is not known what form the common charter may
take and what effect, if any, the adoption of a new charter would have on the
operation of the Bank.
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations, or has violated any applicable law, regulation, order or
any condition imposed by an agreement with the FDIC. It also may suspend deposit
insurance temporarily during the hearing process for the permanent termination
of insurance, if the institution has no tangible capital. If insurance of
accounts is terminated, the accounts at the institution at the time of
termination, less subsequent withdrawals, shall continue to be insured for a
period of six months to two years, as determined by the FDIC. Management is
aware of no existing circumstances that could result in termination of the
deposit insurance of the Bank.
Community Reinvestment Act. The Bank, like other financial
institutions, is subject to the Community Reinvestment Act, as amended ("CRA").
A purpose of this Act is to encourage financial institutions to help meet the
credit needs of its entire community, including the needs of low- and
moderate-income neighborhoods. A savings bank is evaluated and rated under three
categories: a lending test, an investment test and a service test. For each of
these three tests, the savings bank is given a rating of either "outstanding,"
"high satisfactory," "low satisfactory," "needs to improve" or "substantial
non-compliance." A set of criteria for each rating is included in the
regulation. If an institution disagrees with a particular rating, the
institution has the burden of rebutting the presumption by clearly establishing
that the quantitative measures do not accurately present its actual performance,
or that demographics, competitive conditions or economic or legal limitations
peculiar to the service area should be considered. The ratings received under
the three tests are used to determine the overall composite CRA rating or
"outstanding," "satisfactory," "needs to improve" or "substantial
non-compliance."
During the Bank's last compliance examination, which was performed by
the FDIC under the new CRA regulations in October 1997, the Bank received a
"satisfactory" rating with respect to CRA compliance. The Bank's rating with
respect to CRA compliance would be a factor to be considered by the Federal
Reserve and FDIC in considering applications submitted by the Bank to acquire
branches or to acquire or combine with other financial institutions and take
other actions and could result in the denial of such applications.
Capital Requirements Applicable To The Bank. The FDIC requires the Bank
to have a minimum leverage ratio of Tier I capital (principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock and
minority interests in consolidated subsidiaries, less certain intangible items,
goodwill items, identified losses and investments in securities subsidiaries) to
total assets of at least 3%; provided, however that all
26
institutions, other than those (i) receiving the highest rating during the
examination process and (ii) not anticipating or experiencing any significant
growth, are required to maintain a ratio of 1% or 2% above the stated minimum,
with an absolute minimum leverage ratio of not less than 4%. The FDIC also
requires the Bank to have a ratio of total capital to risk-weighted assets,
including certain off-balance sheet activities, such as standby letters of
credit, of at least 8%. At least half of the total capital is required to be
Tier I capital. The remainder (Tier II capital") may consist of a limited amount
of subordinated debt, certain hybrid capital instruments, other debt securities,
certain types of preferred stock and a limited amount of loan loss allowance.
An institution which fails to meet minimum capital requirements may be
subject to a capital directive which is enforceable in the same manner and to
the same extent as a final cease and desist order, and must submit a capital
plan within 60 days to the FDIC. If the leverage ratio falls to 2% or less, the
bank may be deemed to be operating in an unsafe or unsold condition, allowing
the FDIC to take various enforcement actions, including possible termination of
insurance or placement of the institution in receivership. At December 31, 1998,
the Bank had a leverage ratio of 21.35%.
The Administrator requires that net worth equal at least 5% of total assets.
Intangible assets must be deducted from net worth and assets when computing
compliance with this requirement.
At December 31, 1998, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.
Each federal banking agency was required by law to revise its
risk-based capital standards to ensure that those standards take adequate
account of interest rate risk, concentration of credit risk, and the risk of
nontraditional activities, as well as reflect the actual performance and
expected risk of loss on multi-family mortgages. On August 2, 1995, the federal
banking agencies issued a joint notice of adoption of final risk based capital
rules to take account of interest rate risk. The final regulation required an
assessment of the need for additional capital on a case-by-case basis,
considering both the level of measured exposure and qualitative risk factors.
The final rule also stated an intent to, in the future, establish an explicit
minimum capital charge for interest rate risk based on the level of a bank's
measured interest rate risk exposure.
Effective June 26, 1996, the federal banking agencies issued a joint
policy statement announcing the agencies' election not to adopt a standardized
measure and explicit capital charge for interest rate risk at that time. Rather,
the policy statement (i) identifies the main elements of sound interest rate
risk management, (ii) describes prudent principles and practices for each of
those elements, and (iii) describes the critical factors affecting the agencies'
evaluation of a bank's interest rate risk when making a determination of capital
adequacy. The joint policy statement is not expected to have a material impact
on the Bank's management of interest rate risk.
The FDIC has adopted a final rule changing its risk-based capital rules
to recognize the effect of bilateral netting agreements in reducing the credit
risk of two types of financial derivatives - interest and exchange rate
contracts. Under the rule, savings banks are permitted to net positive and
negative mark-to-market values of rate contracts with the same counterparty,
subject to legally enforceable bilateral netting contracts that meet certain
criteria. This represents a change from the prior rules which recognized only a
very limited form of netting. The Bank does not anticipate that this rule will
have a material effect upon its financial statements.
Loans-To-One-Borrower. The Bank is subject to the Administrator's
loans-to-one-borrower limits. Under these limits, no loans and extensions of
credit to any borrower outstanding at one time and not fully secured by readily
marketable collateral shall exceed 15% of the net worth of the savings bank.
Loans and extensions of credit fully secured by readily marketable collateral
may comprise an additional 10% of net worth. These limits also authorize savings
banks to make loans-to-one-borrower, for any purpose, in an amount not to exceed
$500,000. A savings bank also is authorized to make loans-to-one-borrower to
develop domestic residential housing units, not to exceed the lesser of $30
million or 30% of the savings bank's net worth, provided that the purchase price
of each single-family dwelling in the development does not exceed $500,000 and
aggregate amount of loans made under this authority does not exceed 150% of net
worth. These limits also authorize a savings bank to make loans-to-one-borrower
to finance the sale or real property acquired in satisfaction of debts in an
amount up to 50% of net worth.
27
As of December 31, 1998, the largest aggregate amount of loans which
the Bank had to any one borrower was $1.2 million. The Bank had no loans
outstanding which management believes violate the applicable loans-to-borrower
limits. The Bank does not believe that the loans-to-one-borrower limits will
have a significant impact on its business, operations and earnings.
Federal Home Loan Bank Systems. The FHLB system provides a central
credit facility for member institutions. As a member of the FHLB of Atlanta, the
Bank is required to own capital stock in the FHLB of Atlanta in an amount at
least equal to the greater of 1% of the aggregate principal amount of its unpaid
residential mortgage loans, home purchase contracts and similar obligations at
the end of each calendar year, or 5% of its outstanding advances (borrowings)
from the FHLB of Atlanta. On December 31, 1998, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of approximately
$1,569,800.
FIRREA has had the effect of reducing the dividends that the Bank
receives on its stock in the FHLB of Atlanta. During fiscal 1998 and 1997, the
Bank recorded dividend income of $79,449 and $52,600 respectively, with respect
to its FHLB of Atlanta stock. FIRREA requires the FHLB to contribute a certain
amount of its reserves and undivided profits to fund the principal and a portion
of the interest on certain bonds and certain other obligations which are used to
fund the resolution of troubled savings association cases. In addition, FIRREA
requires each FHLB to transfer a percentage of its annual net earnings to the
Affordable Housing Program. That amount will increase from 5% of the annual net
income of the FHLB in 1990 to at least 10% of its annual net income in 1995 and
subsequent years. As a result of these FIRREA requirements, it is anticipated
that the FHLB of Atlanta's earnings will be reduced and that the Bank will
receive reduced dividends on its FHLB of Atlanta stock in future periods.
Federal Reserve Systems. Federal Reserve regulations require savings
banks, not otherwise exempt from the regulations, to maintain reserves against
their transaction accounts (primarily negotiable order of withdrawal accounts)
and certain nonpersonal time deposits. The reserve requirements are subject to
adjustment by the Federal Reserve. As of December 31, 1998, the Bank was in
compliance with the applicable reserve requirements of the Federal Reserve.
Restrictions on Acquisitions. Federal law generally provides that no
"person," acting directly or indirectly or through or in concert with one or
more other persons, may acquire "control," as that term is defined in FDIC
regulations, of an insured institution, such as the Bank, without giving at
least 60 days' written notice to the FDIC and providing the FDIC an opportunity
to disapprove the proposed acquisition. Pursuant to regulations governing
acquisitions of control, control of an insured institution is conclusively
deemed to have been acquired by, among other things, the acquisition of more
than 25% of any class of voting stock. In addition, control generally is
presumed to have been acquired, subject to rebuttal, upon the acquisition of
more than 10% of any class voting stock. Such acquisitions of control may be
disapproved if it is determined, among other things, that (i) the acquisition
would substantially lessen competition; (ii) the financial condition of the
acquiring person might jeopardize the financial stability of the savings bank or
prejudice the interests of its depositors; or (iii) the competency, experience
or integrity of the acquiring person or the proposed management personnel
indicates that it would not be in the interest of the depositors or the public
to permit the acquisition of control by such person.
For three years following completion of the Conversion, North Carolina
conversion regulations require the prior written approval of the Administrator
before any person may directly or indirectly offer to acquire or acquire the
beneficial ownership of more than 10% of any class of an equity security of the
Bank. If any person were to so acquire the beneficial ownership of more than 10%
of any class of any equity security without prior written approval, the
securities beneficially owned in excess of 10% would not be counted as shares
entitled to vote and would not be voted or counted as voting shares in
connection with any matter submitted to stockholders for a vote. Approval is not
required for (i) any offer with a view toward public resale made exclusively to
the bank or its underwriters or the selling group acting on its behalf or (ii)
any offer to acquire or acquisition of beneficial ownership of more than 10% of
the common stock of the Bank by a corporation whose ownership is or will be
substantially the same as the ownership of the Bank, provided that the offer or
acquisition is made more than one year following the consummation of the
Conversion. The regulation provides that within one year following the
Conversion, the Administrator would approve the acquisition of more than 10% of
beneficial ownership only to
28
protect the safety and soundness of the institution. During the second and third
years after the Conversion, the Administrator may approve such an acquisition
upon a finding that (i) the acquisition is necessary to protect the safety and
soundness of the Company and the Bank or the Boards of Directors of the Company
and the Bank support the acquisition, (ii) the acquiror is of good character and
integrity and possesses satisfactory managerial skills, and will be a source of
financial strength to the Company and the Bank; and (iii) the public interests
will not be adversely affected.
Liquidity. The Bank is subject to the Administrator's requirement that
the ratio of liquid assets to total assets equal at least 10%. The computation
of liquidity under North Carolina regulation allows the inclusion of
mortgage-backed securities and investments which, in the judgment of the
Administrator, have a readily marketable value, including investments with
maturities in excess of five years. On December 31, 1998, the Bank's liquidity
ratio, calculated in accordance with North Carolina regulations, was
approximately 11.39%.
Additional Limitations on Activities. Recent FDIC law and regulations
generally provide that the Bank may not engage as principal in any type of
activity, or in any activity in an amount, not permitted for national banks, or
directly acquire or retain any equity investment of a type or in an amount not
permitted for national banks. The FDIC has authority to grant exceptions from
these prohibitions (other than with respect to non-service corporation equity
investments) if it determines no significant risk to the insurance fund is posed
by the amount of the investment or the activity to be engaged in and if the Bank
is and continues to be in compliance with fully phased-in capital standards.
National banks are generally not permitted to hold equity investments other than
shares of service corporations and certain federal agency securities. Moreover,
the activities in which service corporations are permitted to engage are limited
to those of service corporations for national banks.
Savings banks are also generally prohibited from directly or indirectly
acquiring or retaining any corporate debt security that is not investment grade
(generally referred to as "junk bonds"). State savings banks are also required
to notify the FDIC at least 30 days prior to the establishment or acquisition of
any subsidiary, or at least 30 days prior to conducting any such new activity.
Any such activities must be conducted in accordance with the regulations and
orders of the FDIC and the Administrator.
Prompt Corrective Regulatory Action. Federal law provides the federal
banking agencies with broad powers to take corrective action to resolve problems
of insured depository institutions. The extent of these powers depends upon
whether the institutions in question are "well capitalized," "adequately
capitalized", "undercapitalized," "significantly undercapitalized," or
"critically undercapitalized." Under the FDIC regulations applicable to the
Bank, an institution is considered "well capitalized" if it has (i) a total
risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital
ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not
subject to any order of written directive to meet and maintain a specific
capital level for any capital measure. An "adequately capitalized" institution
is defined as one that has (i) a total risk-based capital ratio of 8% or
greater, (ii) a Tier I risk-based capital ratio of 4% or greater and (iii) a
leverage ratio of 4% or greater (or 3% or greater in the case of an institution
with the highest examination rating and which is not experiencing or
anticipating significant growth). An institution is considered (A)
"undercapitalized" if it has (i) total risk-based capital ratio of less that 8%,
(ii) a Tier I risk-based capital ratio or less than 4% of (iii) a leverage ratio
of less than 4% (or 3% in the case of an institution with the highest
examination rating and which is not experiencing or anticipating significant
growth); (B) "significantly undercapitalized" if the institution has (i) a total
risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based capital
ratio of less than 3% or (iii) a leverage ratio of less than 3% and (C)
critically undercapitalized" if the institution has a ratio of tangible equity
to total assets equal to or less than 2%. As of December 31, 1998, the most
recent notification received by the Bank from the FDIC categorized the Bank as
well-capitalized.
The 1991 Banking Law further requires the federal banking agencies to
develop regulations requiring disclosure of contingent assets and liabilities
and, to the extent feasible and practicable, supplemental disclosure of the
estimated fair market value of assets and liabilities. The 1991 Banking Law also
requires annual examinations of all insured depository institutions by the
appropriate federal banking agency, with some exceptions for small,
well-capitalized institutions and state chartered institutions examined by state
regulators. Moreover, the 1991 Banking Law, as modified by the Federal Housing
Enterprises Financial Security and Soundness Act, requires the federal banking
agencies to set operational and managerial, asset quality, earnings and stock
valuation standards
29
for insured depository institutions and depository institution holding
companies, as well as compensation standards (but not dollar levels of
compensation) for insured depository institutions that prohibit excessive
compensation, fees or benefits to officers, directors, employees, and principal
stockholders. The federal banking agencies have issued final regulations,
effective August 9, 1995, implementing these standards in accordance with the
1991 Banking Law. Those agencies have also issued a joint advance notice of
proposed rule making soliciting comments on the addition of asset quality and
earnings guidelines to these safety and soundness standards.
The foregoing necessarily is a general description of certain provisions of the
1991 Banking Law and does not purport to be complete. The effect of the 1991
Banking Law on the Bank has not yet been fully ascertained.
Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Banking Act"), effective September 29,
1995, permits adequately capitalized bank and savings bank holding companies to
acquire control of banks and savings banks in any state. The states may
specifically permit interstate acquisitions prior to September 29, 1995, by
enacting legislation that provides for such transactions. North Carolina adopted
nationwide reciprocal interstate acquisition legislation in 1994.
Such interstate acquisitions are subject to certain restrictions.
States may require the bank or savings bank being acquired to have been in
existence for a certain length of time but not in excess of five years. In
addition, no bank or savings bank may acquire more than 10% of the insured
deposits in the United States or more than 30% of the insured deposits in any
one state, unless the state has specifically legislated a higher deposit cap.
States are free to legislate stricter deposit caps.
The Interstate Banking Act also provides for interstate branching,
effective June 1, 1997, allowing interstate branching in all states, provided
that a particular state has not specifically denied interstate branching by
legislation prior to such time. Unlike interstate acquisitions, a state may deny
interstate branching if it specifically elects to do so by June 1, 1997. States
may choose to allow interstate branching prior to June 1, 1997 by opting-in to a
group of states that permits these transactions. These states generally allow
interstate branching via a merger of an out-of-state bank with an in-state bank,
or on a de novo basis. North Carolina has enacted legislation permitting
branching transactions.
It is anticipated that the Interstate Banking Act will increase
competition within the markets in which the Bank now operates, although the
extent to which such competition will increase in such markets or the timing of
such increase cannot be predicted.
Restrictions on Benefit Plans. FDIC regulations provide that for a
period of one year from the date of the Conversion, the Bank may not implement
or adopt a stock option plan or restricted stock plan, other than a
tax-qualified plan or ESOP, unless: (1) the plans are fully disclosed in the
Conversion proxy soliciting and stock offering material, (2) all such plans are
approved by a majority of the Company's stockholders prior to implementation and
no earlier than six months following the Conversion, (3) for stock option plans,
the exercise price must be at least equal to the market price of the stock at
the time of grant, and (4) for restricted stock plans, no stock issued in
connection with the Conversion may be used to fund the plan.
The FDIC regulations provide that, in reviewing plans submitted to the
stockholders within one year after the consummation of the Conversion, the FDIC
will presume that excessive compensation will result if stock based benefit
plans fail to satisfy percentage limitations on management stock-based benefit
plans set forth in the regulations of the Office of Thrift Supervision ("OTS").
Those regulations provide that (1) for stock option plans, the total number of
shares for which options may be granted may not exceed 10% of the shares issued
in the Conversion, (2) for restricted stock plans, the shares issued may not
exceed 3% of the shares issued in the Conversion (4% for institutions with
tangible capital of 10% or greater after the Conversion), (3) the aggregate
amount of stock purchased by the ESOP shall not exceed 10% (8% for
well-capitalized institutions utilizing a 4% restricted stock plan), (4) no
individual employee may receive more than 25% of the available awards under any
plan, and (5) directors who are not employees may not receive more than 5%
individually or 25% in the aggregate of the awards under any plan. The awards
and grants to be made under the Management Recognition Plan ("MRP") and Stock
Option Plan will conform to these requirements if such plans are submitted for
stockholder approval within one year after the Conversion is consummated.
30
Restrictions on Dividends and other Capital Distributions. A North
Carolina state-chartered stock savings bank may not declare or pay a cash
dividend on, or repurchase any of, its capital stock if the effect of such
transaction would be to reduce the net worth of the institution to an amount
which is less than the minimum amount required by applicable federal and state
regulations. In addition, a North Carolina-chartered stock savings bank, for a
period of five years after its conversion from mutual to stock form, must obtain
the written approval from the Administrator before declaring or paying a cash
dividend on its capital stock in an amount in excess of one-half of the greater
of (i) the institution's net income for the most recent fiscal year end, or (ii)
the average of the institution's net income after dividends for the most recent
fiscal year end and not more than two of the immediately preceding fiscal year
ends, if applicable. Under FDIC regulations, stock repurchases may be made by
the savings bank only upon receipt of FDIC approval.
Also, without the prior written approval of the Administrator, a North
Carolina-chartered stock savings bank, for a period of five years after its
conversion from mutual to stock form, may not repurchase any of its capital
stock. The Administrator will give approval to repurchase only upon a showing
that the proposed repurchase will not adversely affect the safety and soundness
of the institution.
In addition, the Bank is not permitted to declare or pay a cash
dividend on or repurchase any of its capital stock if the effect thereof would
be to cause its net worth to be reduced below the amount required for the
liquidation account established in connection with the Bank's conversion from
mutual to stock ownership.
In connection with the Conversion, the Company and the Bank had agreed
with the FDIC that, during the first year after the Conversion, the Bank would
not pay any dividend or make any other distribution to its stockholder which
represents, is characterized as or is treated for federal tax purposes as, a
return of capital. Subsequent to this one year period, in July, 1997 the Company
did pay a special dividend representing a $4.00 return of capital to its
stockholders.
Other North Carolina Regulations. As a North Carolina-chartered savings
bank, the Bank derives its authority from, and is regulated by, the
Administrator. The Administrator has the right to promulgate rules and
regulations necessary for the supervision and regulation of North Carolina
savings banks under his jurisdiction and for the protection of the public
investing in such institutions. The regulatory authority of the Administrator
includes, but is not limited to, the establishment of reserve requirements; the
regulation of the payment of dividends; the regulation of stock repurchases, the
regulation of incorporators, stockholders, directors, officers and employees;
the establishment of permitted types of withdrawable accounts and types of
contracts for savings programs, loans and investments; and the regulation of the
conduct and management of savings banks, chartering and branching of
institutions, mergers, conversions and conflicts of interest. North Carolina law
requires that the Bank maintain federal deposit insurance as a condition of
doing business.
The Administrator conducts regular annual examinations of North
Carolina-chartered savings banks. The purpose of such examinations is to assure
that institutions are being operated in compliance with applicable North
Carolina law and regulations and in a safe and sound manner. These examinations
are usually conducted on an alternating basis with the FDIC. In addition, the
Administrator is required to conduct an examination of any institution when he
has good reason to believe that the standing and responsibility of the
institution is of doubtful character or when he otherwise deems it prudent. The
Administrator is empowered to order the revocation of the license of an
institution if he finds that it has violated or is in violation of any North
Carolina law or regulation and that revocation is necessary in order to preserve
the assets of the institution and protect the interests of its depositors. The
Administrator has the power to issue cease and desist orders if any person or
institution is engaging in, or has engaged in, and unsafe or unsound practice or
unfair and discriminatory practice in the conduct of its business or in
violation of any other law, rule or regulation.
A North Carolina-chartered savings bank must maintain net worth,
computed in accordance with the Administrator's requirements, of 5% of total
assets and liquidity of 10% of total assets, as discussed above. Additionally, a
North Carolina-chartered savings bank is required to maintain general valuation
allowances and specific loss reserves in the same amounts as required by the
FDIC.
31
Subject to limitation by the Administrator, North Carolina-chartered
savings banks may make any loan or investment or engage in any activity which is
permitted to federally chartered institutions. However, a North
Carolina-chartered savings bank cannot invest more than 15% of its total assets
in business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutory permitted
investments, including but not limited to (i) obligations of the United States,
or those guaranteed by it; (ii) obligations of the State of North Carolina;
(iii) bank demand or time deposits; (iv) stock or obligations of the federal
deposit insurance fund or a FHLB; (v) savings accounts of any savings
institution as approved by the board of directors; and (vi) stock or obligations
of any agency of the State of North Carolina or of the United States or of any
corporation doing business in North Carolina whose principal business is to make
education loans.
North Carolina law provides a procedure by which savings institutions
may consolidate or merge, subject to approval of the Administrator. The approval
is conditioned upon findings by the Administrator that, among other things, such
merger or consolidation will promote the best interests of the members or
stockholders of the merging institutions. North Carolina law also provides for
simultaneous mergers and conversions and for supervisory mergers conducted by
the Administrator.
Future Requirements. Statutes and regulations are regularly introduced
which contain wide-ranging proposals for altering the structures, regulations
and competitive relationships of financial institutions. It cannot be predicted
whether or what form any proposed statute or regulation will be adopted or the
extent to which the business of the Company and the Bank may be affected by such
statute or regulation.
ITEM 2. PROPERTIES
At December 31, 1998, the Company conducted its business from its two
offices in Mocksville and Advance, North Carolina. The following table sets
forth certain information regarding the Company's properties as of December 31,
1998. All properties are owned by the Company.
Net Book Value Deposits
Address of Property (In Thousands)
------- ----------- --------------
Mocksville: $ 44,875 $ 57,279
232 South Main Street
Mocksville, North Carolina 27028
Advance: $ 591,613 $ 15,897
5361 U.S. Highway 158
Advance, North Carolina 27006
The Bank's management considers the property to be in very good
condition. The total net book value of the Bank's furniture, fixtures, equipment
and vehicles on December 31, 1998 was $258,690.
ITEM 3. LEGAL PROCEEDINGS
In the opinion of management, neither the Company nor the Bank is
involved in any pending legal proceedings other than routine, non-material
proceedings occurring in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's stockholders during
the quarter ended December 31, 1998.
32
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
See the information under the section captioned "Capital Stock" in the
Company's 1998 Annual Report, which section is incorporated herein by reference.
See "Item 1, BUSINESS--Regulation of the Bank--Restrictions on Dividends and
Other Capital Distributions" above for regulatory restrictions which limit the
ability of the Bank to pay dividends to the Company.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth in the table captioned
"Selected Financial Data" in the Company's 1998 Annual Report which is
incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
OPERATING RESULTS
Year Ended December 31,
---------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------ -------
Return on Average Assets (Net income divided
by average total assets) 1.37% 1.45% 1.43% .88% 1.40%
Return on Average Equity (Net income divided
by average shareholders' equity) 4.97% 4.52% 4.48% 6.00% 9.78%
Average Equity to Average Assets Ratio
(Average shareholders' equity divided by
average total assets) 27.53% 32.07% 31.88% 14.64% 14.34%
Interest Rate Spread for the Period 3.20% 3.16% 2.62% 2.86% 3.59%
Average Interest-Earning Assets to Average
Interest-Bearing Liabilities 133.32% 147.04% 147.90% 117.49% 114.11%
Net Interest Margin 4.48% 4.77% 4.32% 3.62% 4.12%
See also the information set forth under Item 1 above and the
information set forth under the section captioned "Management's Discussion and
Analysis" on pages 4 through 16 in the Company's 1998 Annual Report which
section is incorporated herein by reference.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See also the information set forth under Item 1 above and the
information set forth under the section captioned "Management's Discussion and
Analysis" on pages 4 through 16 in the Company's 1998 Annual Report which
section is incorporated herein by reference.
Interest Rate Risk Management
The Company's net income is dependent on its net interest income. Net
interest income is susceptible to interest rate risk to the degree that
interest-bearing liabilities mature or reprice on a different basis than
interest-earning assets. When interest-bearing liabilities mature or reprice
more quickly than interest-earning assets in a given period, a significant
increase in market rates of interest could adversely affect net interest income.
Similarly,
33
when interest-earning assets mature or reprice more quickly than
interest-bearing liabilities, falling interest rates could result in a decrease
in net income.
In an attempt to manage its exposure to changes in interest rates,
management monitors the Company's interest rate risk. Management meets monthly
to review the Company's interest rate risk position and profitability, and to
recommend adjustments for consideration by the Board of Directors. Management
also reviews the Bank's securities portfolio, formulates investment strategies,
and oversees the timing and implementation of transactions to assure attainment
of the Board's objectives in the most effective manner. Notwithstanding the
Company's interest rate risk management activities, the potential for changing
interest rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company's asset/liability position, the Board and
management attempt to manage the Company's interest rate risk while enhancing
net interest margins. At times, depending on the level of general interest
rates, the relationship between long and short-term interest rates, market
conditions and competitive factors, the Board and management may determine to
increase the Company's interest rate risk position somewhat in order to increase
its net interest margin. The Company's results of operations and net portfolio
values remain vulnerable to increases in interest rates and to fluctuations in
the difference between long-and short-term interest rates.
Consistent with the asset/liability management philosophy described
above, the Company has taken several steps to manage its interest rate risk.
First, the Company has structured the security portfolio to shorten the lives of
its interest-earning assets. The Company recently purchased securities, includes
$9.7 million of adjustable rate mortgage-backed securities. At December 31,
1998, the Company had securities totaling $12.9 million, of which $10.4 million
either have adjustable rates or mature in five years of less. Mortgage-backed
securities amortize and experience prepayments of principal; the Company has
received average cash flows from principal paydowns, sales, maturities of
securities of $2.6 million annually over the past three fiscal years. The
Company also controls interest rate risk reduction by emphasizing
non-certificate depositor accounts. The Board and management believe that such
accounts carry a lower cost than certificate accounts, and that a material
portion of such accounts may be more resistant to changes in interest rates than
are certificate accounts. At December 31, 1998, the Company had $8.7 million of
regular savings accounts, and $5.2 million of money market, demand and NOW
accounts representing 1.90% of total depositor accounts.
The Company does not currently engage in trading activities or use
derivative instruments to control interest rate risk. Even though such
activities may be permitted with the approval of the Board of Directors, the
Company does not intend to engage in such activities in the immediate future.
Interest rate risk is the most significant market risk affecting the Company.
Other types of market risk, such as foreign currency exchange rate risk and
commodity price risk, do not arise in the normal course of the Company's
business activities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The consolidated financial statements of the Bank set forth on pages 17
through 39 of the Company's 1998 Annual Report are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on accounting and
financial disclosure during the fiscal year ended December 31, 1998 and
subsequent interim period.
34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item regarding directors and executive
officers of the Company is set forth under the sections captioned "Proposal 1
Election of Directors-General" and "Executive Officers" contained in the Proxy
Statement, which sections are incorporated herein by reference.
The information required by this Item regarding compliance with Section
16(a) of the Securities Exchange Act of 1934 is set forth under the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy
Statement, which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION AND TRANSACTIONS
The information required by this Item is set forth under the sections
captioned "Proposal 1 - Election of Directors - Directors' Compensation" and
"Executive Compensation" contained in the Proxy Statement, which sections are
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from
the section captioned "Security Ownership of Certain Beneficial Owners"
contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There have been no reportable transactions during the two most recent
fiscal years nor are any reportable transactions proposed as of the date of this
Form 10-K. See also the section captioned "Proposal 1 - Election of Directors -
Certain Indebtedness and Transactions of Management" contained in the Proxy
Statement, which section is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
14(a)1 Consolidated Financial Statements are contained in the Bank's
1998 Annual Report attached hereto as Exhibit (13) and
incorporated herein by reference
(a) Independent Auditors' Report
(b) Consolidated Balance Sheets as of December 31, 1998 and
1997
(c) Consolidated Statements of Income for the Years Ended
December 31, 1998, 1997 and 1996
(d) Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1998, 1997 and 1996
(e) Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996
(f) Notes to Consolidated Financial Statements
14(a)2 Financial Statement Schedules
All schedules have been omitted as the required information is
either inapplicable or included in the Notes to Consolidated Financial
Statements.
35
14(a)3 Exhibits
Exhibit (3)(i) Articles of Incorporation, incorporated
herein by reference to Exhibit 3.1 of the
Company's Registration Statement on Form S-1
(No. 33-80085) filed on December 5, 1995 and
amended on January 31, 1996 and February 8,
1996 (Previously Filed)
Exhibit (3)(ii) Bylaws, incorporated herein by reference to
Exhibit 3.2 of the Company's Registration
Statement on Form S-1 (No. 33-80085) filed on
December 5, 1995 and amended January 31, 1996
and February 8, 1996 (Previously Filed)
Exhibit (4) Specimen Stock Certificate, incorporated
herein by reference to Exhibit 4.1 of the
Company's Registration Statement on Form S-1
(No. 33-80085) filed on December 5, 1995 and
amended on January 31, 1996 and February 8,
1996 (Previously Filed)
Exhibit (10)(ii)(a) Stone Street Bancorp, Inc. Stock Option Plan
(Previously Filed)
Exhibit (10)(ii)(b) Mocksville Savings Bank, Inc., SSB Management
Recognition Plan (Previously Filed)
Exhibit (10)(ii)(c) Employment Agreement between Mocksville
Savings Bank, Inc., SSB and J. Charles Dunn,
incorporated herein by reference to Exhibit
10.2 of the Company's Registration Statement
on Form S-1 (No. 33-80085) filed on December
5, 1996 and amended on January 31, 1996 and
February 8, 1996 (Previously Filed)
Exhibit (11) Statement Regarding Computation of Per Share
Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) Portions of 1998 Annual Report to Security
Holders
Exhibit (23) Consent of Independent Certified Public
Accountants
Exhibit (21) Subsidiaries of the Registrant
Exhibit (27) Financial Data Schedule
14(b) The Company filed no reports on Form 8-K during the last quarter of
the fiscal year ended December 31, 1998.
36
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.
STONE STREET BANCORP, INC.
Date: March 29, 1999 By: /s/ J. Charles Dunn
-------------------
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
Signature Title Date
- --------- ----- ----
/s/ J. Charles Dunn President, Chief Executive Officer March 29, 1999
- ------------------- and Director
J. Charles Dunn
/s/ Allen W. Carter Senior Vice President March 29, 1999
- ------------------
Allen W. Carter
/s/ Marjorie D. Foster Vice President and Controller March 29, 1999
- ----------------------
Marjorie D. Foster
/s/ Robert B. Hall Director March 29, 1999
- ------------------
Robert B. Hall
/s/ William F. Junker Director March 29, 1999
- ---------------------
William F. Junker
/s/ Donald G. Bowles Director March 29, 1999
- --------------------
Donald G. Bowles
/s/ Claude R. Horn, Jr. Director March 29, 1999
- -----------------------
Claude R. Horn, Jr.
/s/ George W. Martin Director March 29, 1999
- --------------------
George W. Martin
/s/ Terry Bralley Director March 29, 1999
Terry B. Bralley
/s/ Ronald H. Vogler Director March 29, 1999
- --------------------
Ronald H. Vogler
37
INDEX TO EXHIBITS
Exhibit No. Description
Exhibit (11) Statement Regarding Computation of Per Share Earnings
Exhibit (12) Statement Regarding Computation of Ratios
Exhibit (13) 1998 Annual Report
Exhibit (21) Subsidiary of the Registrant
Exhibit (23) Consent of Independent Certified Public Accountants
Exhibit (27) Financial Data Schedule
38