________________________________
PEOPLES BANCORP
OF NORTH CAROLINA, INC.
________________________________
Notice of 2000 Annual Meeting
_______________________
Proxy Statement
_______________________
Annual Financial Statements
and Review of Operations
PEOPLES BANCORP OF NORTH CAROLINA, INC.
General Description of Business
Peoples Bancorp of North Carolina, Inc. (the "Company" or "Peoples
Bancorp"), was formed in 1999 to serve as the holding company for Peoples Bank
(the "Bank"). 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"). The Company's sole
activity consists of owning the Bank. The Company's principal source of income
is any dividends which are declared and paid by the Bank on its capital stock.
The Bank, founded in 1912, is a state-chartered commercial bank serving the
citizens and business interests of the Catawba Valley and surrounding
communities. The Bank's deposits are insured by the Bank Insurance Fund (the
"BIF") of the Federal Deposit Insurance Corporation (the "FDIC") to the maximum
amount permitted by law. It is also a member of the Federal Home Loan Bank
system. The Bank conducts its business from its corporate headquarters located
at 218 South Main Avenue, Newton, North Carolina and ten additional offices in
Newton, Denver, Triangle, Catawba, Conover, Maiden, Claremont, Hiddenite, and
Hickory, North Carolina. Ten branch offices provide automated teller machine
(ATM) access to Bank customers. The Bank also has a stand alone ATM located in a
retail establishment in Sherrills Ford. The Bank's training, mortgage loan
administration, bank card, finance department, and network systems operations
are operated in leased office space in Newton and Hickory. At December 31, 1999,
the Company had total assets of $432.4 million, net loans of $335.3 million,
deposits of $376.6 million, investment securities of $63.8 million, and
shareholders' equity of $38.0 million.
The Bank is engaged primarily in the business of attracting retail and
commercial deposits from the general public and using those deposits to make
secured and unsecured loans. The Bank offers a full range of loan and deposit
products as well as non-deposit investment products. The Bank makes automobile,
credit card, mobile home, securities, first and second mortgage, boat and
recreational vehicle and deposit secured, as well as unsecured, consumer loans.
The Bank also offers a broad range of secured and unsecured commercial loan
products, including commercial construction/permanent loans, Small Business
Administration loans, Rural Economic and Community Development guaranteed loans,
commercial and standby letters of credit, equipment leasing for businesses and
municipalities, special community development loans, and agricultural loans.
The Bank has a diversified loan portfolio, with no foreign loans and few
agricultural loans. Real estate loans are predominately variable rate commercial
property loans. Commercial loans are spread throughout a variety of industries
with no one particular industry or group of related industries accounting for a
significant portion of the commercial loan portfolio. At December 31, 1999,
approximately 9% of the Bank's portfolio was unsecured. Unsecured loans
generally involve higher credit risk than secured loans, and in the event of
customer default, the Bank has a higher exposure to potential loan losses. The
Bank has sold, servicing retained, approximately 31% of its loan portfolio.
The majority of the Bank's deposit and loan customers are individuals and
small to medium-sized businesses located in the Bank's market area. Management
does not believe the Bank is dependent on a single customer or group of
customers concentrated in a particular industry whose loss or insolvency would
have a material adverse impact on operations.
The Bank's primary source of revenue is interest income from its lending
activities. The Bank's other major sources of revenue are interest and dividend
income from investments, interest-earning deposits in other depository
institutions, and transaction and fee income from lending, deposit and
subsidiary activities. The major expenses of the Bank are interest on deposits
and general and administrative expenses such as employee compensation and
benefits, and occupancy 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 FDIC and the North Carolina Commissioner of Banks (the
"Commissioner"). 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, which in turn are affected
by the interest rates at which financing may be offered and other factors
affecting local demand and availability of funds.
At December 31, 1999, the Bank employed 196 full-time equivalent employees.
The Company has no operations and conducts no business of its own other
than owning the Bank. Accordingly, the discussion of the business which follows
concerns the business conducted by the Bank, unless otherwise indicated.
A-1
Subsidiaries
The Bank is the Company's only subsidiary. The Bank has two subsidiaries,
Peoples Investment Services, Inc. and Peoples Real Estate and Appraisal
Services, Inc. Through a relationship with Raymond James Financial Services,
Inc, Peoples Investment Services, Inc. provides the Bank's customers access to
investment counseling and non-deposit investment products such as stocks, bonds,
mutual funds, tax deferred annuities, and related brokerage services. Peoples
Real Estate and Appraisal Services, Inc. provides real estate appraisal services
to customers of the Bank.
Market Area
The Bank's primary market consists of the communities in an approximately
25-mile radius around its headquarters office in Newton, North Carolina. This
area includes Catawba County, Alexander County, the western portion of Iredell
County, the northern portion of Lincoln County, and portions of northeast Gaston
County. The Bank is located only 40 miles north of Charlotte, North Carolina
and the Bank's primary market area is and will continue to be significantly
affected by its close proximity to this major metropolitan area.
Employment in the Bank's primary market area is diversified among
manufacturing, agricultural, retail and wholesale trade, technology, services
and utilities. Siecor (manufacturer of fiber optic cable and accessories) is the
largest employer in Catawba County. Other major employers include CommScope,
Inc. (manufacturer of fiber optic cable and accessories), Catawba County
Schools, and Frye Regional Medical Center, Inc. Employment in the Bank's primary
market area as of January 2000 was strong, with an unemployment rate below that
of North Carolina and national averages.
Competition
The Bank has operated in the Catawba Valley region for more than 85 years
and is the only financial institution headquartered in Newton. However, the Bank
faces strong competition both in attracting deposits and making loans. Its most
direct competition for deposits has historically come from other commercial
banks, credit unions and brokerage firms located in its primary market area,
including large financial institutions. Two national money center commercial
banks are headquartered in Charlotte, North Carolina, only 40 miles from the
Bank's primary market area. Based upon June 30, 1999 comparative data, the Bank
had 17.49% of the deposits in Catawba County, placing it second in deposit size
among a total of eleven banks with branch offices in Catawba County.
The Bank has also faced additional significant competition for investors'
funds from short-term money market securities and other corporate and government
securities. The Bank's deposit base has grown principally due to economic growth
in the Bank's market area coupled with the implementation of new and competitive
deposit products. The ability of the Bank to attract and retain 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 loans from commercial banks and
mortgage banking companies. The Bank competes for loans primarily through the
interest rates and loan fees it charges and the efficiency and quality of
services it provides borrowers. Competition may increase as a result of the
continuing reduction of restrictions on the interstate operations of financial
institutions.
This Annual Report contains forward-looking statements. These statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those anticipated in the forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
changes in the interest rate environment, management's business strategy,
national, regional and local market conditions and legislative and regulatory
conditions.
Readers should not place undue reliance on forward-looking statements, which
reflect management's view only as of the date hereof. The Company undertakes no
obligation to publicly revise these forward-looking statements to reflect
subsequent events or circumstances. Readers should also carefully review the
risk factors described in other documents the Company files from time to time
with the Securities and Exchange Commission
A-2
SELECTED
FINANCIAL DATA
Dollars in Thousands Except Per Share Amounts
1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
Summary of Operations
Interest income 32,302 29,215 23,783 18,956 16,407
Interest expense 14,790 14,540 11,179 8,586 7,027
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income 17,512 14,675 12,604 10,370 9,380
Provision for loan losses 425 445 696 980 700
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 17,087 14,230 11,908 9,390 8,680
Non-interest income 3,380 3,646 2,060 1,475 1,111
Non-interest expense 13,832 12,020 10,413 8,118 7,404
- ----------------------------------------------------------------------------------------------------------------------------------
Income before taxes 6,635 5,856 3,555 2,747 2,387
Income taxes 2,093 1,847 1,149 722 653
- ----------------------------------------------------------------------------------------------------------------------------------
Net income 4,542 4,009 2,406 2,025 1,734
- ----------------------------------------------------------------------------------------------------------------------------------
Selected Year-End Balances
Assets 432,435 402,273 326,853 257,467 222,096
Available-for-sale securities 62,498 63,228 53,307 56,995 57,125
Loans 336,959 306,748 238,449 179,304 143,777
Interest-earning assets 411,734 383,270 308,852 244,038 208,702
Deposits 376,634 350,067 275,393 231,346 198,283
Interest-bearing liabilities 339,243 315,387 258,685 197,255 166,684
Shareholders' equity 37,998 35,924 24,930 22,911 22,120
Shares outstanding* 2,926,318 2,926,500 2,553,000 2,321,225 2,321,225
- ----------------------------------------------------------------------------------------------------------------------------------
Selected Average Balances
Assets 417,387 369,864 295,879 243,094 204,352
Available-for-sale securities 60,642 59,824 57,508 53,294 50,302
Loans 324,651 271,819 215,789 164,865 133,960
Interest-earning assets 396,606 351,730 281,215 229,631 192,144
Deposits 363,692 321,371 252,998 216,052 180,914
Interest-bearing liabilities 326,164 293,631 233,901 186,101 152,690
Shareholders' equity 39,348 33,303 24,117 22,478 21,348
Shares outstanding* 2,926,318 2,780,145 2,553,000 2,553,000 2,553,000
- ----------------------------------------------------------------------------------------------------------------------------------
Profitability Ratios
Return on average total assets 1.09% 1.08% 0.81% 0.83% 0.85%
Return on average shareholders' equity 11.54% 12.04% 9.98% 9.01% 8.12%
Dividend payout ratio 23.84% 22.61% 33.18% 36.67% 38.65%
- ----------------------------------------------------------------------------------------------------------------------------------
Liquidity and Capital Ratios (averages)
Loans to deposit 89.27% 84.58% 85.29% 76.31% 74.05%
Shareholders' equity to total assets 9.43% 9.00% 8.15% 9.25% 10.45%
- ----------------------------------------------------------------------------------------------------------------------------------
Per share of common stock*
Net income 1.55 1.44 0.94 0.79 0.68
Cash dividends 0.37 0.32 0.31 0.29 0.26
Book value 12.99 12.28 9.77 9.87 9.53
- ----------------------------------------------------------------------------------------------------------------------------------
* Shares outstanding and per share computations have been restated to reflect a
3 for 2 stock split during first quarter 1999, the 10% stock dividend
distributed during second quarter 1997 and the 15% stock dividend in fourth
quarter 1995. Prior to 1999 represents Bank only.
A-3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introduction
Management's discussion and analysis of earnings and related data are
presented to assist in understanding the consolidated financial condition and
results of operations of Peoples Bancorp of North Carolina, Inc. (the
"Company"), for the years ended December 31, 1999, 1998 and 1997. The Company is
a registered bank holding company operating under the supervision of the Federal
Reserve Board and the parent company of Peoples Bank (the "Bank"). The Bank is a
North Carolina-chartered bank, with offices in Catawba, Lincoln and Alexander
Counties, operating under the banking laws of North Carolina and the Rules and
Regulations of the Federal Deposit Insurance Corporation (the "FDIC").
This discussion and related financial data should be read in conjunction
with the audited consolidated financial statements and related footnotes.
Results of Operations
Summary
The Company reported earnings of $4.5 million in 1999, or $1.55 basic
income per share, a 13% increase as compared to $4.0 million, or $1.44 basic
income per share, for 1998. Net income for 1998 represented an increase of 22%
as compared to 1997 net income of $2.4 million before recurring charges for
$855,000 associated with the Bank's profit sharing plan. Net income for 1998
increased 67% over 1997 after giving effect to the one-time charge to earnings
in 1997. The growth in net income in 1999 was due to effective management of the
Bank's net interest margin combined with an improvement in the Bank's loan
portfolio, resulting in increased net interest income. This increase was
partially offset by growth in non-interest expense during 1999. The increase in
net income in 1998 compared to 1997 resulted from increased net interest income
and non-interest income, partially offset by non-interest expense.
Return on average assets in 1999 was 1.09%, compared to 1.08% in 1998 and
0.81% in 1997. Return on average shareholders' equity was 11.54% in 1999
compared to 12.04% in 1998 and 9.98% in 1997, including recurring charges.
Net Interest Income
Net interest income, the largest component of the Company's income, is the
amount by which interest and fees generated by earning assets exceed the total
cost of funds used to carry them. Net interest income is affected by changes in
the volume and mix of earning assets and interest bearing liabilities, as well
as changes in the yields earned and rates paid. Net interest margin is
calculated by dividing tax-equivalent net interest income by average earning
assets, and represents the Company's net yield on its earning assets.
Net interest income on a tax-equivalent basis totaled $18.0 million in
1999, an increase of 19% or $2.8 million over the comparable figure in 1998. The
increase in net interest income on a tax equivalent basis in 1998 over 1997 was
$2.0 million or 16%. The interest rate spread, which represents the rate earned
on interest earning assets less the rate paid on interest bearing liabilities
increased to 3.74% during 1999 compared to 3.49% during 1998, slightly lower
than the 3.85% achieved in 1997. The net interest margin on earning assets
increased to 4.54% in 1999 from 4.30% in 1998, following a decrease from the
1997 net interest margin of 4.65%.
A-4
Table 1 sets forth for each category of earning assets and interest-bearing
liabilities, the average amounts outstanding, the interest incurred on such
amounts and the average rate earned or incurred for the years ended December 31,
1999, 1998 and 1997. The table also sets forth the average rate earned on total
earning assets, the average rate paid on total interest-bearing liabilities, and
the net interest margin on average total earning assets for the same periods.
Nonaccrual loans and the interest income that was recorded on these loans, if
any, are included in the yield calculations for loans in all periods reported.
December 31, 1999 December 31, 1998 December 31, 1997
-------------------------------------------------------------------------------------
Average Yield / Average Yield / Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------------------------------------------------------------------------------------
Earning Assets:
Loans: Net of unearned income 324,651 28,375 8.74% $271,819 $24,885 9.16% $215,789 $19,991 9.27%
Investments - taxable 39,122 2,348 6.00% 40,434 2,322 5.74% 37,448 2,390 6.38%
Investments - nontaxable 21,520 1,475 6.86% 19,390 1,335 6.88% 20,060 1,420 7.08%
Federal funds sold 6,780 339 5.00% 5,950 323 5.43% 2,603 144 5.55%
Other 4,533 266 5.87% 14,137 804 5.69% 5,315 320 6.03%
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 396,606 32,803 8.27% 351,730 29,669 8.44% 281,215 24,265 8.63%
Cash and due from banks 10,667 9,677 8,448
Other assets 14,192 13,053 10,311
Allowance for loan losses (4,079) (4,596) (4,095)
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $417,387 $369,864 $295,879
====================================================================================================================================
Interest bearing liabilities:
Deposits:
NOW accounts $31,003 $429 1.38% $27,642 $547 1.98% $23,820 $585 2.45%
Regular savings accounts 26,258 490 1.87% 26,302 625 2.37% 29,031 698 2.40%
Insured money market accounts 54,757 2,435 4.45% 37,264 1,848 4.96% 12,426 388 3.12%
Certificates of deposit $100,000 or more 83,845 4,475 5.34% 72,628 2,993 4.12% 55,037 3,228 5.87%
Other time deposits 115,786 6,178 5.34% 113,597 7,603 6.69% 95,132 5,254 5.52%
FHLB borrowings 13,532 736 5.44% 15,277 875 5.73% 16,749 966 5.78%
Demand notes payable to U.S. Treasury 899 41 4.56% 898 47 5.23% 1,125 24 2.13%
Other 83 5 5.95% 23 2 8.70% 581 35 6.02%
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 326,163 14,789 4.53% 293,631 14,540 4.95% 233,901 11,177 4.78%
Demand deposits 51,988 43,938 37,552
Other liabilities 2,166 1,088 309
Shareholder's equity 39,348 33,303 24,117
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholder's equity $419,665 $371,960 $295,879
====================================================================================================================================
Net interest spread 18,014 3.74% 15,129 3.49% 13,088 3.85%
====================================================================================================================================
Net yield on earning assets 4.54% 4.30% 4.65%
====================================================================================================================================
Taxable equivalent adjustment
Investment securities 454 454 483
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 17,560 14,675 12,605
====================================================================================================================================
A-5
Changes in interest income and interest expense can result from variances
in both volume and rates. Table 2 describes the impact on the Company's tax
equivalent net interest income resulting from changes in average balances and
average rates for the periods indicated. The changes in interest due to both
volume and rate have been allocated to volume and rate changes in proportion to
the relationship of the absolute dollar amounts of the changes in each.
Table 2 - Rate/Volume Variance Analysis
Tax Equivalent Basis
December 31, 1999 December 31, 1998
--------------------------------------- ----------------------------------------
Changes in Changes in Total Changes in Changes in Total
average average Increase average average Increase
volume rates (Decrease) volume rates (Decrease)
--------------------------------------- ----------------------------------------
Interest Income:
Loans: Net of unearned income $4,724 ($1,234) $3,490 $5,169 (275) $4,894
Investments - taxable (77) 103 26 181 (249) (68)
Investments - nontaxable 146 (6) 140 (47) (38) (85)
Federal funds sold 43 (27) 16 184 (5) 179
Other (512) (26) (538) 449 35 484
--------------------------------------- ---------------------------------------
Total interest income $4,324 (1,190) $3,134 $5,936 (532) $5,404
Interest bearing liabilities:
Deposits:
NOW accounts 57 (174) (117) 85 (123) (38)
Regular savings accounts (1) (134) (135) (65) (8) (73)
Insured money market accounts 823 (236) 587 1,003 457 1,460
Certificates of deposit $100,000 or more 530 952 1,482 878 (1,113) (235)
Other time deposits 132 (1,557) (1,425) 1,128 1,221 2,349
FHLB Borrowings (95) (44) (139) (84) (7) (91)
Demand notes payable to U.S. Treasury 0 (6) (6) (8) 31 23
Other 3 (0) 3 (269) 236 (33)
--------------------------------------- ---------------------------------------
Total interest expense $1,449 (1,199) $250 $2,668 694 $3,362
--------------------------------------- ---------------------------------------
Net interest income $2,875 9 $2,884 $3,268 (1,226) $2,042
The increase in net interest income in 1999 was primarily attributable to
an increase in the volume of loans. The yield on earning assets decreased to
8.27% in 1999 from 8.44% in 1998. This decrease reflects a decrease in the
Company's average prime commercial lending rate in 1999, when compared to 1998.
The average balance of earning assets increased by $44.9 million, to $396.6
million in 1999 from $351.7 million in 1998. The increase in average loans
comprised $52.8 million of this amount. Interest-bearing liabilities increased
by $32.5 million, to $326.2 million in 1999 from $293.6 million in 1998. This
growth in interest-bearing liabilities is a direct result of the increase in
interest bearing deposits, which increased by $34.3 million, to $311.7 million
in 1999 from $277.4 million in 1998. The increase in interest bearing deposits
was primarily attributable to the growth in insured money market accounts which
increased $17.5 million to $54.8 million in 1999 from $37.3 million in 1998, as
well as the growth in certificates of deposit over $100,000 and other time
deposits which increased $13.4 million to $199.6 million in 1999 from $186.2
million in 1998. The cost of funds decreased from 4.95% in 1998 to 4.53% in
1999, mainly as a result of the decrease in the cost of deposits. The increase
in net interest margin in 1999 is primarily attributable to the increase in
volume of average interest earning assets, combined with a decrease in the
average rate paid on interest bearing liabilities.
Tax-equivalent interest income on loans in 1999 increased $3.5 million or
14% from the $24.9 million recorded for 1998, following an increase of $4.9
million or 25% in 1998 over 1997. This increase was due to a $52.8 million
increase in average loans outstanding in 1999 compared to 1998, slightly offset
by a lower tax-equivalent yield on loans of 8.74% in 1999 compared to 9.16% in
1998. The increase in the net interest spread to 3.74% in 1999 from 3.49% in
1998 resulted from the decrease in the yield on earning assets to 8.27% in 1999
from 8.44% in 1998, while the cost of funds decreased to 4.53% in 1999 from
4.95% in 1998.
Interest expense on FHLB borrowings totaled $736,000 during 1999 at an
average rate of 5.44% compared to $875,000 in 1998 at an average rate of 5.73%,
and $967,000 in 1997 at an average rate of 5.78%. Interest expense on federal
funds purchased, promissory notes and demand notes payable to the U.S. Treasury
totaled $46,000, $49,000 and $59,000 for 1999, 1998 and 1997, respectively.
A-6
Provision for Loan Losses
Provisions for loan losses are charged to income in order to bring the
total allowance for loan losses to a level deemed appropriate by management of
the Company based on such factors as management's judgment as to losses within
the Company's loan portfolio, loan growth, net charge-offs, changes in the
composition of the loan portfolio, delinquencies and management's assessment of
the quality of the loan portfolio and general economic climate.
The provision for loan losses was $425,000, $445,000, and $696,500 for the
years ended December 31, 1999, 1998 and 1997, respectively. The ratio of net
charge-offs to total loans was 0.20% in 1999, 0.25% in 1998 and 0.03% in 1997.
Net charge-offs for 1999 were $638,000. Included in this amount is approximately
$476,000, which represents a charge-off related to one borrower. The ratio of
non-performing loans to total loans was 1.03% at December 31, 1999, as compared
to 1.20% and 1.52% at December 31, 1998 and 1997, respectively.
on-interest Income
Non-interest income for 1999 totaled $3.4 million, a decrease of $265,000
or 6% from non-interest income of $3.7 million for 1998. The decrease in non-
interest income for 1999 resulted from a reduction in mortgage banking income of
$309,000 from 1998 due to an increase on mortgage loan rates during third
quarter of 1999 which resulted in a decrease in mortgage loan applications as
well as a loss on mortgage loans sold in the secondary market. The Company also
recognized a loss on sale on securities of approximately $35,000 during 1999
compared to a gain on sale of securities of approximately $168,000 during 1998.
During 1997 a loss of sale of securities of approximately $8,000 was recognized.
Non-interest income for 1998 increased $1.6 million or 76% over non-interest
income of $2.1 million for 1997. Service charge income increased $140,000, or
12% from 1998 to 1999, as a result of an increase in deposit volume and
associated charges.
Increases in non-interest income for 1998 were attributable to an increase
in service charge income and mortgage banking income. Service charge income
increased $275,000, or 30% in 1998 compared to 1997. Mortgage banking income
increased $659,000 or 169% over 1997 levels, due to the growth of the Company's
mortgage operations during 1998.
Non-interest Expense
Total non-interest expense for 1999 amounted to $13.8 million. This was a
15% increase over the $12.0 million reported in 1998, and followed a 15%
increase in 1998 over the $10.4 million reported in 1997.
Salary and employee benefit expense was $7.7 million in 1999, compared to
$6.4 million during 1998, an increase of $1.3 million or 20%, following a $1.7
million or 36% increase in salary and employee benefit expense in 1998 over
1997. The increase during 1999 resulted from merit increases, additional
participation in management and employee incentive plans, and increased staffing
levels to support overall Company growth. Increases during 1998 reflect merit
increases and the cost of additional personnel to staff two new branches.
The Company recorded occupancy expense of $2.2 million in 1999, compared to
$2.0 million during 1998, an increase of $275,000 or 14%, following a $392,000
or 25% increase in occupancy expenses in 1998 over 1997. The increase in 1999
reflects additional leased properties due to Company growth, an increase in
property tax rates during 1999 and a full year of depreciation expense on a
teller platform and wide area network implemented in 1998. The increase during
1998 represents depreciation expense associated with new branches opened in 1997
and 1998 and implementation of a new teller platform system and wide area
network in 1998.
The total of all other operating expenses increased $153,000 or 4% during
1999. This increase is primarily attributable to expenses associated with Year
2000 preparation incurred in 1999. Other operating expense decreased $407,000 or
10% in 1998 over 1997. Included in the 1997 amount is approximately $855,000 in
nonrecurring charges associated with the Bank's profit sharing plan.
Income Taxes
Total income tax expense was $2.1 million in 1999 compared with $1.8
million in 1998 and $1.1 million in 1997. The primary reason for the increase in
taxes was the increase in pretax income. The Company's effective tax rates were
31.55%, 31.53% and 32.32% in 1999, 1998 and 1997, respectively.
Liquidity
The Company's liquidity position is generally determined by the need to
respond to short term demand for funds created by deposit withdrawals and the
need to provide resources to fund assets, typically in the form of loans. How
the Company responds to these needs is affected by the Company's ability to
attract deposits, the maturity of the loans and securities, the
A-7
flexibility of assets within the securities portfolio, the current earnings of
the Company, and the ability to borrow funds from other sources. The Company's
primary sources of liquidity are cash and cash equivalents, available-for-sale
securities, deposit growth, and the cash flows from principal and interest
payments on loans and other earning assets. In addition, the Company is able, on
a short-term basis, to borrow funds from the Federal Reserve System, the Federal
Home Loan Bank of Atlanta (the "FHLB") and The Banker's Bank, and is also able
to purchase federal funds from other financial institutions. The liquidity ratio
for the Company, which is defined as net cash, interest bearing deposits with
banks, Federal Funds sold, certain investment securities and certain FHLB
advances, as a percentage of net deposits and short-term liabilities was 20.41%
at December 31, 1999, 26.49% at December 31, 1998, and 21.23% at December 31,
1997.
As disclosed in the Company's Consolidated Statements of Cash Flows
included elsewhere herein, net cash provided by operating activities was
approximately $13.6 million during 1999. Net cash used in investing activities
of $42.1 million consisted primarily of a net change in loans of $38.3 million
and securities purchased of $23.7 million funded largely by sales, maturities
and paydowns of investment securities of $15.1 million. These changes resulted
from management's continued efforts to reinvest new funds in higher-yielding
loans rather than investment securities. Net cash provided by financing
activities consisted primarily of a $26.6 million net increase in deposits.
Asset Liability Management
The Company's asset liability management strategies are designed to
minimize interest rate risk between interest-earning assets and interest-bearing
liabilities at various maturities, while maintaining the objective of assuring
adequate liquidity and maximizing net interest income. Table 3 presents an
interest rate sensitivity analysis for the interest earning assets and interest-
bearing liabilities for the year ended December 31, 1999.
Table 3 - Interest Sensitivity Analysis
Over 5 years
(Dollars in Thousands) Immediate 1-3 months 4-12 months 1 - 5 years & non-sensitive Total
- ------------------------------------------------------------------------------------------------------------------------------------
Earning Assets:
Loans $223,376 $9,599 $19,668 $42,711 $43,844 $339,198
Mortgage loans available for sale 1,685 0 0 0 0 1,685
Investment securities 0 596 1,831 24,528 35,543 62,498
Federal funds sold 2,930 0 0 0 0 2,930
Interest bearing deposit account -FHLB 3,383 0 0 0 0 3,383
Other earning assets 0 0 0 0 1,345 1,345
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets $231,374 $10,195 $21,499 $67,239 $80,732 $411,039
- ------------------------------------------------------------------------------------------------------------------------------------
Interest bearing liabilities:
NOW, savings, and money market deposits $109,309 $0 $0 $0 $0 $109,309
Certificates of deposit of $100,000 or more 7,816 14,068 56,498 10,924 0 89,306
Other time deposits 7,725 16,117 80,068 20,602 0 124,512
Other short term borrowings 1,616 0 0 0 0 1,616
Other borrowed money 0 10,000 0 1,500 3,000 14,500
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $126,466 $40,185 $136,566 $33,026 $3,000 $339,243
- ------------------------------------------------------------------------------------------------------------------------------------
Interest-sensitive gap 104,908 (29,990) (115,067) 34,213 77,732 71,796
Cumulative interest-sensitive gap 104,908 74,918 (40,149) (5,936) 71,796
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative interest-sensitive gap
to total earning assets 25.52% 18.23% -9.83% -1.44% 17.47%
Management tries to minimize interest rate risk between interest earning
assets and interest bearing liabilities by attempting to minimize wide
fluctuations in net interest income due to interest rate movements. The ability
to control these fluctuations has a direct impact on the profitability of the
Company. Management monitors this activity on a regular basis through analysis
of its portfolios to determine the difference between rate sensitive assets and
rate sensitive liabilities.
In addition, the Company performs analysis on a monthly basis to determine
the approximate change in net interest income based upon a presumed positive and
negative shift in interest rates of 100 basis points. This analysis model is
based on an immediate change in interest rate levels of rate sensitive assets
and liabilities, with the change in rate levels sustained for a period of one
year. Management uses the rate sensitive gap (interest-earning assets less
interest-bearing liabilities) as a percentage of total assets to measure the
rate sensitivity of the Company's assets and liabilities. Management believes
that if this ratio is within a range of positive 15% to negative 15%, the rise
or fall in interest rates should not have a material impact on the Company's net
income. However, if the rate sensitive gap is greater than positive 15%, the
Company's net income will have a direct relationship with the rise or fall in
interest rates. If the rate sensitive gap is less than negative 15%, the
Company's net income will have an indirect relationship with the rise or fall in
interest rates.
A-8
To determine the impact of interest rate changes to net interest income,
each category of interest-earning assets and interest-bearing liabilities is
weight adjusted by an earnings change ratio, which represents the approximate
rate sensitivity of that asset or liability type in the banking industry. Due to
their diversity and composition, the pricing indexes of the different types of
interest-earning assets and interest-bearing liabilities do not respond to a
change in interest rates in the same manner. The impact of changes in interest
rates for each type may also be different in a rising interest rate environment
than in a declining interest rate environment. The Company therefore utilizes
earnings change ratios to appropriately account for these varying rate
sensitivities. Management relies on information provided by several banking
industry publications to determine the earnings change ratios for its gap
analysis model.
At December 31, 1999, the Company's gap analysis indicated that an
immediate downward shift of 100 basis points in the Company's prime rate of
interest would result in a decrease in net interest income of $352,000 over the
next twelve months. An immediate upward shift of 100 basis points in the prime
rate of interest would subsequently result in an increase in net interest income
of $308,000 over the next twelve months. On December 31, 1999, the one year
cumulative interest sensitivity gap was a negative $53.4 million, for a ratio of
interest sensitive assets to interest sensitive liabilities of 82.45%. At
December 31, 1999, the Company's adjusted rate sensitive gap in a declining rate
environment was positive 8.13%, while the adjusted rate sensitive gap in a
rising rate environment was positive 7.12%.
Peoples Bancorp's rate sensitive assets are those earning interest at
variable rates and those maturing within one year. Rate sensitive assets
therefore include both loans and available-for-sale securities. Rate sensitive
liabilities include interest-bearing checking accounts, money market deposit
accounts, savings accounts, certificates of deposit and borrowed funds. At
December 31, 1999, 64% of the Company's interest earning assets, excluding non-
accrual loans could be repriced within one year, compared to 89% of interest-
bearing liabilities. Rate sensitive assets at December 31, 1999 totaled $411.7
million, exceeding rate sensitive liabilities of approximately $339.2 million by
$72.5 million.
Based upon the Company's asset liability management strategies, sensitivity
comparisons, and rate shift analysis, management does not anticipate the
Company's net interest margins to be materially affected by inflation and
changing prices.
An analysis of the Company's financial condition and growth can be made by
examining the changes and trends in interest-earning assets and interest-bearing
liabilities, and a discussion of these changes and trends follows.
Analysis of Financial Condition
Investment Securities
All of the Company's investment securities are held in the available-for-
sale ("AFS") category. At December 31, 1999 the market value of AFS securities
totaled $62.5 million, compared to $63.2 million and $53.3 million at December
31, 1998 and 1997, respectively. Table 4 presents the market value of the
presently held AFS securities for the years ended December 31, 1999, 1998 and
1997.
Table 4 - Summary of Investment Portfolio
Year ended Year ended Year ended
December 31, December 31, December 31,
(Dollars in Thousands) 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
United States government securities:
Market Value 900 912 2,118
Obligations of United States government
agencies and corporations:
Market Value 23,374 20,169 10,983
Obligations of states and political subdivisions:
Market Value 22,012 22,192 20,141
Mortgage backed securities:
Market Value 16,212 19,955 20,065
Total securities:
Market Value 62,498 63,228 53,307
A-9
The composition of the investment securities portfolio reflects the
Company's investment strategy of maintaining an appropriate level of liquidity
while providing a relatively stable source of income. The investment portfolio
also provides a balance to interest rate risk and credit risk in other
categories of the balance sheet while providing a vehicle for the investment of
available funds, furnishing liquidity, and supplying securities to pledge as
required collateral for certain deposits.
The Company's investment portfolio consists of U.S. government agency
securities, municipal securities, U.S. government agency sponsored mortgage-
backed securities, and U.S. Treasury securities. At December 31, 1999 and 1998,
U.S. government agency securities and municipal securities represented
substantially all of the Company's investment portfolio, with U.S. Treasury
securities representing approximately 1.4% of the portfolio at December 31, 1999
and 1998. AFS securities averaged $60.6 million in 1999, $59.8 million in 1998
and $53.3 million in 1997. Table 5 presents the AFS securities held by the
Company by maturity category at December 31, 1999.
Table 5 - Maturity Distribution and Weighted Average Yield on Investments
One Year or Less After One Year After 5 Years After 10 Years Totals
Through 5 Years Through 10 Years
(Dollars in Thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
- ------------------------------------------------------------------------------------------------------------------------------------
Book Value:
United States Government securities $ 900 5.60% $ - - $ - - $ - - $900 5.60%
United States Government agencies - - 14,487 6.09% 9,344 7.08% - - 23,831 6.48%
States and political subdivisions 1,522 7.44% 10,340 6.96% 7,197 6.66% 3,329 6.96% 22,388 6.90%
Mortgage backed securities - - - - - - 16,887 6.22% 16,887 6.21%
====================================================================================================================================
Total securities $2,422 6.76% $24,827 6.45% $16,541 6.90% $20,216 6.34% $64,006 6.54%
Loans
The loan portfolio is the largest category of the Company's earnings assets
and is comprised of commercial loans, real estate mortgage loans, real estate
construction loans and consumer loans. The Company restricts its primary lending
market to within the Catawba Valley region of North Carolina, which encompasses
Catawba and Alexander counties and portions of Iredell and Lincoln counties. The
mix of the loan portfolio consists primarily of loans secured by real estate and
commercial loans. In management's opinion, there are no significant
concentrations of credit with particular borrowers engaged in similar
activities.
In the normal course of business, there are various commitments outstanding
to extend credit that are not reflected in the financial statements. At December
31, 1999, outstanding loan commitments totaled $68.3 million. Commitments to
extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in a contract. Commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. Since many of the commitments may expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash requirements.
The composition of the Company's loan portfolio is presented in Table 6.
A-10
Table 6 - Loan Portfolio
Year ended Year ended Year ended Year ended Year ended
December 31, 1999 December 31, 1998 December 31, 1997 December 31, 1996 December 31, 1995
(Dollars in Thousands) Amount % of Loans Amount % of Loans Amount % of Loans Amount % of Loans Amount % of Loans
- ------------------------------------------------------------------------------------------------------------------------------------
Breakdown of loan receivables:
Commercial, financial &
agricultural $83,644 24.66% $89,536 29.68% $80,230 33.42% $59,624 32.57% $55,241 37.41%
Real Estate - Mortgage 190,921 56.29% 157,167 52.11% 115,768 48.22% 90,156 49.25% 64,266 43.52%
Real Estate - Construction 39,340 11.60% 29,927 9.92% 24,291 10.12% 14,875 8.13% 9,198 6.23%
Consumer 25,293 7.46% 24,995 8.29% 19,793 8.24% 18,394 10.05% 18,952 12.84%
-----------------------------------------------------------------------------------------------
Total loans $339,198 100.00% $301,625 100.00% $240,082 100.00% $183,049 100.00% $147,657 100.00%
Less: Allowance for Loan Losses 3,924 4,137 4,375 3,745 3,880
--------- --------- ---------- ---------- ---------
Net Loans $335,274 $297,488 $235,707 $179,304 $143,777
========= ========= ========== ========== =========
As of December 31, 1999, gross loans outstanding were $339.2 million, an
increase of $37.6 million or 12% over the December 31, 1998 balance of $301.6
million. Most of this growth was attributable to growth in real estate loans.
Real estate mortgage loans grew $33.8 million in 1999, while real estate
construction loans grew $9.4 million in 1999. The Company experienced a slight
decrease of $5.9 million in the commercial loan portfolio arising from
management's efforts to securitize various relationships in its loan portfolio.
This decrease was primarily attributable to the pay down of one significant
relationship due to industry consolidation activities. As a percentage of the
Company's total loan portfolio, real estate mortgage loans represented 56.29% in
1999, 52.11% in 1998 and 48.22% in 1997. Over the same period commercial loans
represented 24.66%, 29.68% and 33.42% of the Company's total loan portfolio,
respectively. Real estate construction loans made up 11.60%, 9.92% and 10.12% of
the Company's total loan portfolio at December 31, 1999, 1998 and 1997,
respectively. Consumer loans represented 7.46%, 8.29% and 8.24% of the Company's
total loan portfolio at December 31, 1999, 1998 and 1997, respectively.
Mortgage loans held for sale were $1.7 million at December 31, 1999, a
decrease of $7.6 million over the December 31, 1998 balance of $9.3 million
which represented an increase of $6.6 million over the December 31, 1997 balance
of $2.7 million.
Table 7 identifies the maturities of all loans as of December 31, 1999 and
addresses the sensitivity of these loans to changes in interest rates.
Table 7 - Maturity and Repricing Data for Loans
After one year
Within one through five After five
(Dollars in Thousands) year or less years years Total Loans
- -----------------------------------------------------------------------------------------------------------
Commercial, financial & agricultural $69,920 $8,530 $5,194 $83,644
Real Estate - Mortgage 131,694 12,835 46,392 190,921
Real Estate - Construction 33,671 1,801 3,868 39,340
Consumer 10,108 11,707 3,478 25,293
- -----------------------------------------------------------------------------------------------------------
Total Loans $245,393 $34,873 $58,932 $339,198
===========================================================================================================
Total fixed rate loans 10,433 34,873 58,932 104,238
Total floating rate loans 234,960 0 0 234,960
- -----------------------------------------------------------------------------------------------------------
Total loans $245,393 $34,873 $58,932 $339,198
===========================================================================================================
Asset Quality
At December 31, 1999, approximately 9% of the Company's portfolio was not
secured by any type of collateral. Unsecured loans generally involve higher
credit risk than secured loans and, in the event of customer default, the
Company has a higher exposure to potential loan losses. Additionally, the real
estate loan portfolio can be affected by the condition of the local real estate
markets. Non-real estate commercial loans also can be affected by local economic
conditions.
A-11
The allowance for loan losses is established through charges to expense in
the form of a provision for loan losses. Loan losses and recoveries are charged
and credited directly to the allowance. The amount of the provision and level of
the allowance is based on management's judgment of potential losses within the
Company's loan portfolio, loan growth, net charge-offs, changes in the
composition of the loan portfolio, delinquencies, management's assessment of the
quality of the loan portfolio and general economic climate.
Non-performing Assets
Nonperforming assets, comprised of nonaccrual loans, other real estate owned
and loans for which payments are more than 90 days past due totaled $3.6 million
at December 31, 1999 compared to $4.2 million at December 31, 1998.
It is the general policy of the Company to stop accruing interest income
and place the recognition of interest on a cash basis when a loan is placed on
nonaccrual status and any interest previously accrued but not collected is
reversed against current income.
A summary of non-performing assets at December 31 for each of the years
presented is shown in table 8.
Table 8 - Non-performing Assets
(Dollars in Thousands)
- ------------------------------------------------------------------------------------------------------------------
Year 1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
Nonaccrual loans $2,866 $3,292 $3,075 $3,961 $4,389
Loans 90 days or more past due and still accruing 645 328 586 1,143 261
Total non-performing loans 3,511 3,620 3,661 5,094 4,650
All other real estate owned 44 545 - 333 67
Total non-performing assets 3,555 4,165 $3,661 $5,427 $4,717
As a percent of total loans at year end
Non-accrual loans 0.84% 1.09% 1.28% 2.16% 2.97%
Loans 90 days or more past due and still accruing 0.19% 0.11% 0.24% 0.62% 0.18%
Total non-performing assets 1.05% 1.38% 1.52% 2.96% 3.20%
At December 31, 1999 the Company had non-performing loans, defined as non-
accrual and accruing loans past due more than ninety days, of $3.5 million or
1.03% of total loans. Non-performing loans for 1998 and 1997 were $3.6 million,
or 1.20% of total loans and $3.7 million, or 1.52% of total loans, respectively.
Interest that would have been recorded on non-accrual loans for the years ended
December 31, 1999, 1998 and 1997, had they performed in accordance with their
original terms, amounted to approximately $333,000, $398,000 and $326,000
respectively. Interest income on non-accrual loans included in the results of
operations for 1999, 1998, and 1997 amounted to approximately $61,000, $305,000
and $64,000, respectively. The interest income collected on non-accrual loans
in 1998 consists primarily of income collected through the restructuring of one
large commercial relationship in December 1998.
Management continually monitors the loan portfolio to ensure that all loans
potentially having a material adverse impact on future operating results,
liquidity or capital resources have been classified as non-performing. Should
economic conditions deteriorate, the inability of distressed customers to
service their existing debt could cause higher levels of non-performing loans.
Allowance for Loan Losses
The allowance for loan losses totaled $3.9 million, representing 1.16% of
total loans outstanding at December 31, 1999. For December 31, 1998 and 1997,
the allowance for loan losses amounted to $4.1 million, or 1.37% of total loans
outstanding
A-12
and $4.4 million, or 1.82% of total loans outstanding, respectively. To
determine the allowance needed, management evaluates the risk characteristics of
the loan portfolio under current economic conditions and considers such factors
as the financial condition of the borrower, fair market value of collateral and
other items that, in management's opinion, deserve current recognition in
estimating possible credit losses.
Whenever a loan, or portion thereof, is considered by management to be
uncollectible, it is charged against the allowance for loan losses. Management
considers the established allowance for loan losses adequate to absorb inherent
losses that relate to loans outstanding at December 31, 1999, although future
additions to the reserve may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Company's allowance for loan
losses. Such agencies may require the Company's to recognize additions to the
allowances based on their judgments about information available to them at the
time of their examination.
The Company does not currently allocate the allowance for loan losses to
the various loan categories. There were no significant changes in the methods
and assumptions used to determine the adequacy of the allowance during 1999.
Management does not expect the level of net loan charge-offs as a percentage of
total loans for 2000 to be significantly different from the amount recorded in
1999.
The reduction in the allowance for loan losses during 1999 reflects
management's belief in the improved quality of the loan portfolio, changes in
underwriting policies, and the belief that the allowance for loan losses
adequately covers anticipated losses. The Company has experienced a declining
trend of non-performing assets as a percentage of total loans. Management has
also increased staffing at the executive level to provide additional credit
administration oversight. Total non-performing assets were $3.6 million in 1999,
$4.2 million in 1998 and $3.7 million in 1997. The ratio of net charge-offs to
average total loans was 0.20% in 1999, 0.25% in 1998 and 0.03% in 1997. The
ratio of non-performing assets to total loans was 1.05% at December 31, 1999, as
compared to 1.38% and 1.52% at December 31, 1998 and 1997, respectively.
Table 9 presents an analysis of the allowance for loan losses, including
charge-off activity.
Table 9 - Analysis of Allowance for Loan Losses
Year ended Year ended Year ended Year ended Year ended
December 31, December 31, December 31, December 31, December 31,
(Dollars in Thousands) 1999 1998 1997 1996 1995
====================================================================================================================================
Reserve for loan losses at beginning $4,137 $4,375 $3,745 $3,880 $3,360
Loans charged off:
Commercial, financial, and agriculture 485 608 8 1,012 133
Real estate - mortgage 25 - - - 38
Real estate - construction - - - - -
Consumer 195 138 131 129 98
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans charged off $ 705 $ 746 $ 139 $1,141 $ 269
- ------------------------------------------------------------------------------------------------------------------------------------
Recoveries of losses previously charged off:
Commercial, financial, and agriculture 24 39 60 - 23
Real estate - mortgage - - - - 38
Real estate - construction - - - - -
Consumer 43 24 12 26 28
- ------------------------------------------------------------------------------------------------------------------------------------
Total recoveries $ 67 $ 63 $ 72 $ 26 $ 89
- ------------------------------------------------------------------------------------------------------------------------------------
Net loans charged off 638 $ 683 $ 67 $1,115 $ 180
Provision for loan losses 425 445 697 980 700
- ------------------------------------------------------------------------------------------------------------------------------------
Reserve for loan losses at end of year $3,924 $4,137 $4,375 $3,745 $3,880
- ------------------------------------------------------------------------------------------------------------------------------------
Loans charged off net of recoveries, as
a percent of average loans outstanding 0.20% 0.25% 0.03% 0.68% 0.13%
Deposits
The Company primarily uses deposits to fund its loans and investment
portfolio. The Company offers a variety of deposit accounts to individuals and
businesses. Deposit accounts include checking, savings, money market and
certificates of
A-13
deposit. Certificates of deposit in amounts of $100,000 or more totaled $89.3
million at December 31, 1999, $75.1 million and $65.2 million at December 31,
1998 and 1997, respectively. Many of these deposits are from long-standing
customers and, therefore, are believed by the bank to be as stable as, and for
all practical purposes, no more rate sensitive than core deposits.
As of December 31, 1999, total deposits were $376.6 million, an increase of
$26.5 million or 8% increase over the December 31, 1998 balance of $350.1
million. The increase in deposits in 1999 was a result of a deposit growth
campaign implemented in the fourth quarter of 1999.
Table 10 is a summary of the maturity distribution of certificates of deposit in
amounts of $100,000 or more as of December 31, 1999.
Table 10 - Maturities of Time Deposits over $100,000
(Dollars in Thousands)
- -------------------------------------------------------------------------------
Maturity Period Amount
- -------------------------------------------------------------------------------
Three months or less $21,884
Over three months through six months 23,286
Over six months through twelve months 33,212
Over twelve months 10,924
----------------
Total $89,306
=======
Borrowed Funds
The Company has access to various short-term borrowings, including the
purchase of Federal Funds and borrowing arrangements from the FHLB and other
financial institutions. At December 31, 1999, FHLB borrowings totaled $14.5
million compared to $13.6 million at December 31, 1998 and $21.8 million at
December 31, 1997. Average FHLB borrowings for 1999 were $13.5 million, compared
to average balances of $15.3 million for 1998 and $16.7 million for 1997. The
maximum amount of outstanding FHLB borrowings was $14.5 million in 1999, and
$21.8 in 1998 and 1997. The FHLB advances outstanding at December 31, 1999 had
both fixed and adjustable interest rates ranging from 4.55% to 5.86%.
Approximately $11 million of the FHLB advances outstanding mature prior to
December 31, 2000. Additional information regarding FHLB advances is provided in
note 7 to the consolidated financial statements.
Demand notes payable to the U. S. Treasury amounted to approximately $1.6
million, $139,000, and $1.8 million at December 31, 1999, 1998 and 1997
respectively.
Capital Resources
Shareholders' equity at December 31, 1999 was $38.0 million compared to
$35.9 million and $24.9 million at December 31, 1998 and 1997, respectively. At
December 31, 1999, unrealized gains and losses in the available-for-sale
securities portfolio amounted to a loss of $920,000. For the years ended
December 31, 1998 and 1997, unrealized gains and losses in the available-for-
sale securities portfolio amounted to gains of $459,000 and $355,000,
respectively. Average shareholders' equity as a percentage of total average
assets is one measure used to determine capital strength. The return on average
shareholders' equity to average assets was 11.54% at December 31, 1999 as
compared to 12.04% and 9.98% as of December 31, 1998 and December 31, 1997,
respectively.
Under the regulatory capital guidelines of the FDIC, financial institutions
are currently required to maintain a total risk-based capital ratio of 8.0% or
greater, with a Tier 1 risk-based capital ratio of 4.0% or greater. Tier 1
capital is generally defined as shareholders' equity less all intangible assets
and goodwill. The Company's Tier I capital ratio was 10.99%, 11.04% and 9.41% at
December 31, 1999, 1998 and 1997, respectively. Total risk based capital is
defined as Tier 1 capital plus supplementary capital. Supplementary capital, or
Tier 2 capital, consists of the Company's allowance for loan losses, not
exceeding 1.25% of the Company's risk-weighted assets. Total risk-based capital
ratio is therefore defined as the ratio of total capital (Tier 1 capital and
Tier 2 capital) to risk-weighted assets. The Company's total risk based capital
ratio was 12.11%, 12.29% and 10.67% at December 31, 1999, 1998 and 1997,
respectively. In addition to the Tier I and total risk-based capital
requirements, financial institutions are also required by the FDIC to maintain a
leverage ratio of Tier 1 capital to total average assets of 4.0% or greater. The
Company's Tier I leverage capital ratio was 9.21%, 9.41% and 7.40% at
December 31, 1999, 1998 and 1997, respectively.
A-14
A Bank is considered to be "well capitalized" if it has a total risk-based
capital ratio of 10.0 % or greater, a Tier I risk-based capital ratio of 6.0% or
greater, and has a leverage ratio of 5.0% or greater. Based upon these
guidelines, the Bank was considered to be "well capitalized" at December 31,
1999, 1998 and 1997, respectively.
The Company's key equity ratios as of December 31, 1999, 1998 and 1997 are
presented in Table 11:
Table 11 - Equity Ratios
Years Ended December 31,
1999 1998 1997
- ----------------------------------------------------------------------------
Return on average assets 1.09% 1.08% 0.81%
Return on average equity 11.54% 12.04% 9.98%
Dividend payout ratio 23.84% 22.61% 33.18%
Average equity to average assets 9.43% 9.00% 8.15%
Company Reorganization
Effective August 31, 1999, the Bank completed the process of converting to
the holding company form of organization. The Bank is now a subsidiary of the
Company, a one-bank holding company, headquartered in Newton, North Carolina.
As a result of the reorganization, each share of the Bank's common stock
was automatically converted into one share of the Company's common stock. The
Company is now the sole shareholder of the Bank. The corporate reorganization
was accounted for in a manner similar to a pooling of interests.
The Company's Board of Directors is composed of the same persons who are
directors of the Bank. Robert C. Abernethy, Chairman of the Board of the Bank,
is also Chairman of the Company's Board of Directors. The Bank's President and
Chief Executive Officer, Tony W. Wolfe, is also President and Chief Executive
Officer of the Company. Joseph F. Beaman, Jr., who serves as Executive Vice
President and Corporate Secretary of the Bank will also serve as Executive Vice
President, Corporate Secretary and Treasurer of the Company.
Change in Accountants
On October 21, 1998, the Board of Directors approved the dismissal of the
KPMG LLP, accounting firm ("KPMG"). On the same date, the Board engaged Porter
Keadle Moore, LLP ("PKM"). During the two years ended December 31, 1997 and
1996, and the subsequent interim period ended October 31, 1998, the Bank had not
consulted PKM with regard to either: (i) application of accounting principles to
a specified transaction, either completed or proposed; or the type of audit
opinion that might be rendered on the Bank's financial statements, or (ii) any
matter that was either the subject of a disagreement or a reportable event.
KPMG's report on the financial statements for either of the two years ended
December 31, 1997 and 1996, contained neither an adverse opinion nor a
disclaimer of opinion, nor was it qualified as to uncertainty, audit scope, or
accounting principles. Furthermore, there were no disagreements with the former
accountant on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure during the Bank's two most
recent fiscal years and any subsequent interim period through October 21, 1998.
A-15
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk reflects the risk of economic loss resulting from adverse
changes in market prices and interest rates. This risk of loss can be reflected
in either diminished current market values or reduced potential net interest
income in future periods.
The Company's market risk arises primarily from interest rate risk inherent
in its lending and deposit taking activities. The structure of the Company's
loan and deposit portfolios is such that a significant decline (increase) in
interest rates may adversely impact net market values and interest income.
Management seeks to manage the risk through the utilization of its investment
securities and off balance sheet derivative instruments. During the years ended
December 31, 1999, 1998 and 1997, the Company has used interest rate contracts
to manage market risk. Interest rate floors are used to protect certain
designated variable rate financial instruments from the downward effects of
their repricing in the event of a decreasing rate environment. The Company is
using this financial instrument as a hedge against variable rate commercial
loans. In 1998, the Company entered into an interest rate cap to protect certain
designated deposit accounts from the upward effects of repricing in the event of
an increasing rate environment. The total cost of the interest rate floor and
cap arrangements was $92,000 and $21,600, respectively, which will be expensed
on a straight-line basis for the life of the instrument. For the years ended
December 31, 1999, 1998 and 1997, the Company expensed $22,944, $31,747 and
$30,667, respectively, related to these financial instruments.
Table 12 presents in tabular form the contractual balances and the
estimated fair value of the Company's on-balance sheet financial instruments and
the notional amount and estimated fair value of the Company's off-balance sheet
derivative instruments at their expected maturity dates for the period ended
December 31, 1999. The expected maturity categories take into consideration
historical prepayment experience as well as management's expectations based on
the interest rate environment at December 31, 1999. For core deposits without
contractual maturity (i.e. interest bearing checking, savings, and money market
accounts), the table presents principal cash flows based on management's
judgment concerning their most likely runoff or repricing behaviors.
Table 12- Market Risk Table
(In Thousands) Principal/Notional Amount Maturing in:
Year Ended
Year Ended Year Ended Year Ended December 31, 2003 &
Loans Receivable December 31, 2000 December 31, 2001 December 31, 2002 2004
=========================================================================================================================
Fixed rate $ 22,678 $ 9,672 $ 8,081 $ 20,268
Average interest rate 9.43% 9.01% 8.99% 8.75%
Variable rate $ 233,294 $ 436 $ 608 $ 2,333
Average interest rate 8.08% 9.21% 8.10% 7.81%
Investment Securities
=========================================================================================================================
Interest bearing cash $ 3,383 $ - - $ -
Average interest rate 4.97% - - -
Federal funds sold $ 2,930 $ - $ - $ -
Average interest rate 5.10% - - -
Securities available for sale $ 2,427 $ 2,017 $ 4,026 $ 18,485
Average interest rate 6.76% 5.08% 6.45% 6.45%
Nonmarketable equity securities $ - $ - $ - $ -
Average interest rate - - - -
Debt Obligations
=========================================================================================================================
Deposits $ 216,575 $ 58,548 $ 36,186 $ 32,761
Average interest rate 5.41% 5.67% 5.33% 5.45%
Advances from FHLB $ 11,000 $ - $ - $ 500
Average interest rate 4.93% - - 5.86%
Derivative Financial Instruments
=========================================================================================================================
Interest rate cap $ - $ - $ - $ 4,000
Average interest rate - - - n/a
Interest rate floor $ - $ - $ - $ -
Average interest rate - - - -
Thereafter Total Fair Value
===============================================================================================
Loans Receivable
Fixed rate $ 38,370 $ 99,068 $ 96,904
Average interest rate 8.44%
Variable rate $ 3,460 $ 240,130 $ 239,996
Average interest rate 8.16%
Investment Securities
===============================================================================================
Interest bearing cash $ - $ 3,383 $ 3,383
Average interest rate -
Federal funds sold $ - $ 2,930 $ 2,930
Average interest rate -
Securities available for sale $ 35,543 $ 62,498 $ 62,498
Average interest rate 6.60%
Nonmarketable equity securities $ 1,345 $ 1,345 $ 1,345
Average interest rate
Debt Obligations
===============================================================================================
Deposits $ 32,564 $ 376,634 $ 384,430
Average interest rate 5.00%
Advances from FHLB $ 3,000 $ 14,500 $ 14,195
Average interest rate 5.07%
Derivative Financial Instruments
===============================================================================================
Interest rate cap $ - $ 4,000 $ 28
Average interest rate -
Interest rate floor $ - $ - $ -
Average interest rate -
A-16
MARKET FOR THE COMPANY'S COMMON EQUITY
AND RELATED SHAREHOLDER MATTERS
Peoples Bancorp common stock is traded on the over-the counter (OTC) market
and quoted on the Nasdaq National Market, under the symbol "PEBK". Peoples
Bancorp stock is marketed by IJL/Wachovia and Scott & Stringfellow, Inc.
Although the payment of dividends by the Company is subject to certain
requirements and limitations of North Carolina corporate law, except as set
forth in this paragraph, neither the Commissioner nor the FDIC have promulgated
any regulations specifically limiting the right of the Company to pay dividends
and repurchase shares. However, the ability of the Company to pay dividends and
repurchase shares may be dependent upon the Company's receipt of dividends from
the Bank. The Bank's ability to pay dividends is limited.
As of March 1, 2000, the Company had 623 shareholders of record, not
including the number of persons or entries whose stock is held in nominee or
street name through various brokerage firms or banks. The market price for the
Company's common stock was $13.88 on March 16, 2000.
Following is certain market and dividend information for the last two
fiscal years. Information for quarters prior to the third quarter of 1999
relates to the Bank's common stock. Over-the-counter quotations reflect inter-
dealer prices, without retail mark-up, mark down or commission and may not
necessarily represent actual transactions.
MARKET AND DIVIDEND DATA
Cash Dividend
Low Bid High Bid Per Share *
1999
First Quarter $ 16.833 $ 21.50 $ 0.09
Second Quarter 19.00 21.50 0.09
Third Quarter 17.50 20.00 0.09
Fourth Quarter 14.50 18.00 0.10
1998
First Quarter $ 21.17 $ 22.93 $ 0.07
Second Quarter 21.17 24.25 0.08
Third Quarter 17.33 22.50 0.08
Fourth Quarter 16.67 18.92 0.08
* Shares outstanding and per share computations have been restated to reflect
a 3 for 2 stock split during first quarter 1999.
A-17
DIRECTORS AND OFFICERS OF THE COMPANY
DIRECTORS
- ---------
Robert C. Abernethy - Chairman
- ------------------------------
Chairman of the Board, Peoples Bancorp of North Carolina, Inc. and Peoples Bank;
President, Secretary and Treasurer, Carolina Glove Company, Inc. (glove
manufacturer)
James S. Abernethy
- ------------------
President and Assistant Secretary, Midstate Contractors, Inc. (paving company)
Bruce R. Eckard
- ---------------
President, Eckard Vending Company, Inc. (vending machine servicer)
John H. Elmore, Jr.
- -------------------
Chairman of the Board, Chief Executive Officer and Treasurer; Elmore
Construction Co., Inc.
B. E. Matthews
- --------------
President and Director, Matthews Construction Company of Conover, Inc.
Charles F. Murray
- -----------------
President, Murray's Hatchery, Inc.
Larry E. Robinson
- -----------------
President and Chief Executive Officer, Blue Ridge Distributing Co., Inc. (beer
and wine distributor) & President and Chief Executive Officer, Associated
Brands, Inc. (beer and wine distributor)
Fred L. Sherrill, Jr.
- ---------------------
President and Chief Executive Officer, Conover Chair Company, Inc.
Dan Ray Timmerman, Sr.
- ----------------------
President, Timmerman Manufacturing, Inc. (wrought iron furniture manufacturer)
Benjamin I. Zachary
- -------------------
General Manager, Treasurer, Secretary and Member of the Board of Directors,
Alexander Railroad Company
OFFICERS
- --------
Tony W. Wolfe
- -------------
President and Chief Executive Officer
Joseph F. Beaman, Jr.
- ---------------------
Executive Vice President, Chief Financial Officer, Corporate Secretary and
Treasurer
George S. Earp
- --------------
Vice President - Finance and Assistant Treasurer
N. Michael Hamra
- ----------------
Vice President - Risk Management Services and Assistant Corporate Secretary
Krissy O. Price
- ---------------
Assistant Vice President and Assistant Corporate Secretary
A-18
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
Peoples Bancorp of North Carolina, Inc.
Newton, North Carolina:
We have audited the accompanying consolidated balance sheets of Peoples Bancorp
of North Carolina, Inc. as of December 31, 1999 and 1998, and the related
consolidated statements of earnings, changes in shareholders' equity,
comprehensive income and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The consolidated financial statements for 1997 were audited by other
auditors whose report dated January 30, 1998 expressed an unqualified opinion on
those statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 1999 and 1998 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Peoples Bancorp of North Carolina, Inc. as of December 31, 1999 and 1998, and
the results of its operations and its cash flows for the years then ended, in
conformity with generally accepted accounting principles.
/s/ Porter Keadle Moore, LLP
Atlanta, Georgia
January 14, 2000
A-19
[LEFT INTENTIONALLY BLANK]
A-20
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Balance Sheets
December 31, 1999 and 1998
Assets
------
1999 1998
---- ----
Cash and due from banks, including reserve requirements
of $4,009,000 and $3,907,000 $ 14,067,311 11,844,077
Federal funds sold 2,930,000 5,910,000
------------ -----------
Cash and cash equivalents 16,997,311 17,754,077
Investment securities available for sale 62,498,359 63,227,690
Other investments 1,345,100 1,495,300
Mortgage loans held for sale 1,685,472 9,259,817
Loans, net 335,273,577 297,488,443
Premises and equipment, net 9,342,582 7,806,827
Accrued interest receivable and other assets 5,292,453 5,240,878
------------ -----------
$432,434,854 402,273,032
============ ===========
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Demand $ 53,506,430 48,474,480
Interest-bearing demand 31,752,477 31,034,112
Savings 77,556,576 78,686,479
Time, $100,000 or more 89,306,653 75,099,131
Other time 124,512,233 116,773,176
------------ ------------
Total deposits 376,634,369 350,067,378
Demand notes payable to U. S. Treasury 1,600,000 139,235
FHLB borrowings 14,500,000 13,642,857
Accrued interest payable and other liabilities 1,702,006 2,499,427
------------ -----------
Total liabilities 394,436,375 366,348,897
------------ -----------
Commitments
Shareholders' equity:
Preferred stock, no par value; authorized 5,000,000 shares;
no shares issued and outstanding - -
Common stock, no par value; authorized 20,000,000 shares;
issued and outstanding 2,926,318 in 1999 and 2,926,500 in 1998 31,729,462 31,730,372
Retained earnings 7,189,417 3,735,171
Accumulated other comprehensive income (920,400) 458,592
------------ -----------
Total shareholders' equity 37,998,479 35,924,135
------------ -----------
$432,434,854 402,273,032
============ ===========
See accompanying notes to consolidated financial statements.
A-21
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Earnings
For the Years Ended December 31, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
Interest income:
Interest and fees on loans $28,375,391 24,885,434 19,991,450
Interest on federal funds sold 338,941 323,149 144,483
Interest on investment securities:
U. S. Treasuries 50,221 85,079 346,660
U. S. Government agencies 2,297,645 2,236,446 2,043,005
State and political subdivisions 973,744 881,058 937,123
Other 266,097 803,939 320,190
----------- ---------- ----------
Total interest income 32,302,039 29,215,105 23,782,911
----------- ---------- ----------
Interest expense:
Interest-bearing demand deposits 430,253 547,343 584,578
Savings deposits 2,925,123 2,472,910 1,085,808
Time deposits 10,653,642 10,596,180 8,482,758
FHLB borrowings 735,752 874,896 966,437
Other 45,501 48,639 59,132
----------- ---------- ----------
Total interest expense 14,790,271 14,539,968 11,178,713
----------- ---------- ----------
Net interest income 17,511,768 14,675,137 12,604,198
Provision for loan losses 425,000 445,000 696,500
----------- ---------- ----------
Net interest income after provision for loan losses 17,086,768 14,230,137 11,907,698
----------- ---------- ----------
Other income:
Service charges 1,326,810 1,186,600 911,102
Other service charges and fees 298,454 281,542 205,581
Gain (loss) on sale of securities (34,824) 168,448 (8,438)
Mortgage banking income 740,031 1,049,402 389,917
Insurance and brokerage commissions 129,786 152,630 135,711
Miscellaneous 919,804 807,331 426,571
----------- ---------- ----------
Total other income 3,380,061 3,645,953 2,060,444
----------- ---------- ----------
Other expenses:
Salaries and employee benefits 7,737,404 6,353,745 4,731,154
Occupancy 2,230,448 1,955,803 1,563,902
Other operating 3,863,652 3,710,861 4,117,785
----------- ---------- ----------
Total other expenses 13,831,504 12,020,409 10,412,841
----------- ---------- ----------
Earnings before income taxes 6,635,325 5,855,681 3,555,301
Income tax expense 2,093,380 1,846,483 1,148,904
----------- ---------- ----------
Net earnings $ 4,541,945 4,009,198 2,406,397
=========== ========== ==========
Net earnings per share $ 1.55 1.44 0.94
=========== ========== ==========
See accompanying notes to consolidated financial statements.
A-22
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Changes in Shareholders' Equity
For the Years Ended December 31, 1999, 1998 and 1997
Accumulated
Other
Common Stock Retained Comprehensive
------------
Shares Amount Earnings Income Total
------ ------ -------- ------ -----
Balance, December 31, 1996 2,321,225 $20,389,014 2,583,806 (62,266) 22,910,554
Cash dividends declared
($.31 per share) - - (798,419) - (798,419)
10% stock dividend 231,775 3,553,891 (3,553,891) - -
Cash paid in lieu of
fractional shares - - (5,320) - (5,320)
Net earnings - - 2,406,397 - 2,406,397
Change in net unrealized
gain (loss) on investment
securities available for
sale, net of tax - - - 417,277 417,277
--------- ----------- ---------- ----------- ----------
Balance, December 31, 1997 2,553,000 23,942,905 632,573 355,011 24,930,489
Issuance of common stock 373,500 7,787,467 - - 7,787,467
Cash dividends declared
($.32 per share) - - (906,600) - (906,600)
Net earnings - - 4,009,198 - 4,009,198
Change in net unrealized
gain (loss) on investment
securities available for
sale, net of tax - - - 103,581 103,581
--------- ----------- ---------- ----------- ----------
Balance, December 31, 1998 2,926,500 31,730,372 3,735,171 458,592 35,924,135
Redemption of fractional shares
associated with stock split (182) (910) (4,961) - (5,871)
Cash dividends declared
($0.37 per share) - - (1,082,738) - (1,082,738)
Net earnings - - 4,541,945 - 4,541,945
Change in net unrealized
gain (loss) on investment
securities available for
sale, net of tax - - - (1,378,992) (1,378,992)
--------- ----------- ---------- ----------- ----------
Balance, December 31, 1999 2,926,318 $31,729,462 7,189,417 (920,400) 37,998,479
========= =========== ========== =========== ==========
See accompanying notes to consolidated financial statements.
A-23
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
Net earnings $ 4,541,945 4,009,198 2,406,397
----------- --------- ---------
Other comprehensive income, net of tax:
Unrealized gains (losses) on investment
securities available for sale: (2,293,615) 338,115 672,238
Less reclassification adjustment for gains (losses) on
sales of investment securities available for sale (34,824) 168,448 (8,438)
----------- --------- ---------
Total other comprehensive income (loss),
before income taxes (2,258,791) 169,667 680,676
----------- --------- ---------
Income tax expense (benefit) related to other comprehensive income:
Unrealized holding gains (losses) on investment
securities available for sale (893,363) 131,696 260,112
Less reclassification adjustment for gains (losses) on
sales of investment securities available for sale (13,564) 65,610 (3,287)
----------- --------- ---------
Total income tax expense (benefit) related to
other comprehensive income (879,799) 66,086 263,399
----------- --------- ---------
Total other comprehensive income (loss),
net of tax (1,378,992) 103,581 417,277
----------- --------- ---------
Total comprehensive income $ 3,162,953 4,112,779 2,823,674
=========== ========= =========
See accompanying notes to consolidated financial statements.
A-24
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1999, 1998 and 1997
1999 1998 1997
---- ---- ----
Cash flows from operating activities:
Net earnings $ 4,541,945 4,009,198 2,406,397
Adjustments to reconcile net earnings to net
cash provided (used) by operating activities:
Depreciation, amortization and accretion 1,794,646 1,642,559 1,268,566
Provision for loan losses 425,000 445,000 696,500
Provision for deferred taxes 915,285 359,486 (382,654)
Loss (gain) on sale of loans - - 3,495
Loss (gain) on sale of investment securities 34,824 (168,448) 8,438
Loss (gain) on sale of premises and equipment 12,925 (1,503) (90)
Loss (gain) on sale of mortgage loans 369,583 44,659 (8,421)
Loss (gain) on sale of other real estate 64,943 (30,009) -
Change in:
Other assets (1,006,947) (763,080) (317,361)
Other liabilities (797,420) (427,536) 1,155,805
Mortgage loans held for sale 7,204,762 (6,562,004) (2,734,051)
------------ ----------- -----------
Net cash provided (used) by operating activities 13,559,546 (1,451,678) 2,096,624
------------ ----------- -----------
Cash flows from investing activities:
Purchase of investment securities available for sale (23,737,969) (43,374,408) (11,617,463)
Proceeds from calls and maturities of investment securities
available for sale 15,076,886 25,818,882 12,841,737
Proceeds from sales of investment securities available
for sale 6,896,296 7,616,174 2,991,562
Change in other investments 150,200 1,524,300 (2,293,600)
Net change in loans (38,273,585) (62,974,283) (58,306,616)
Purchases of premises and equipment (1,857,657) (2,109,610) (2,429,224)
Proceeds from sale of premises and equipment 4,500 4,900 419,633
Construction in progress (870,284) - -
Proceeds from sale of loans - - 1,135,071
Improvements to other real estate (241,951) (167,445) -
Proceeds from sale of other real estate 740,962 400,138 -
------------ ----------- -----------
Net cash used by investing activities (42,112,602) (73,261,352) (57,258,900)
------------ ----------- -----------
Cash flows from financing activities:
Net change in deposits 26,566,991 74,674,475 44,132,391
Net change in demand notes payable to U. S. Treasury 1,460,765 (1,677,366) 885,225
Net change in FHLB borrowings 857,143 (8,142,823) 20,857,108
Cash dividends (1,082,738) (906,600) (798,419)
Proceeds from issuance of common stock, net of offering costs - 7,787,467 -
Cash paid in lieu of fractional shares (5,871) - (5,320)
------------ ----------- -----------
Net cash provided by financing activities 27,796,290 71,735,153 65,070,985
------------ ----------- -----------
Net change in cash and cash equivalents (756,766) (2,977,877) 9,908,709
Cash and cash equivalents at beginning of year 17,754,077 20,731,954 10,823,245
------------ ----------- -----------
Cash and cash equivalents at end of year $ 16,997,311 17,754,077 20,731,954
============ =========== ===========
A-25
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Cash Flows, continued
For the Years Ended December 31, 1999, 1998 and 1997
1999 1998 1997
------------ ---------- ----------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $14,812,486 14,563,557 11,152,480
Income taxes $ 1,000,000 2,029,431 1,154,147
Noncash investing and financing activities:
Change in net unrealized gain (loss) on investment
securities available for sale, net of tax $(1,378,992) 103,581 417,277
Transfer of loans to other real estate $ 123,451 747,538 -
Financed sales of other real estate $ 60,000 - -
See accompanying notes to consolidated financial statements.
A-26
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
Organization
------------
Peoples Bancorp of North Carolina, Inc. (Bancorp) received regulatory
approval to operate as a bank holding company on July 22, 1999, and became
effective August 31, 1999. Bancorp is primarily regulated by the Federal
Reserve Bank, and serves as the one bank holding company for Peoples Bank.
Peoples Bank (the "Bank") commenced business in 1912 upon receipt of its
banking charter from the North Carolina State Banking Commission (the
"SBC"). The Bank is primarily regulated by the SBC and the Federal Deposit
Insurance Corporation and undergoes periodic examinations by these
regulatory agencies. The Bank, whose main office is in Newton, North
Carolina, provides a full range of commercial and consumer banking services
primarily in Catawba, Alexander and Lincoln counties in North Carolina.
Peoples Investment Services, Inc. is a wholly owned subsidiary of the Bank
which began operations in 1996 to provide investment and trust services
through agreements with an outside party.
Peoples Real Estate and Appraisal Services, Inc. is a wholly owned
subsidiary of the Bank which began operations in 1997 to provide real
estate appraisal and property management services to individuals and
commercial customers of the Bank.
Principles of Consolidation
---------------------------
The consolidated financial statements include the financial statements of
Peoples Bancorp of North Carolina, Inc. and its wholly owned subsidiary,
Peoples Bank, along with its wholly owned subsidiaries, Peoples Investment
Services, Inc. and Peoples Real Estate and Appraisal Services, Inc.
(collectively called the "Company"). All significant intercompany balances
and transactions have been eliminated in consolidation.
Basis of Presentation
---------------------
The accounting principles followed by the Company, and the methods of
applying these principles, conform with generally accepted accounting
principles ("GAAP") and with general practices in the banking industry. In
preparing the financial statements in conformity with GAAP, management is
required to make estimates and assumptions that affect the reported amounts
in the financial statements. Actual results could differ significantly from
these estimates. Material estimates common to the banking industry that are
particularly susceptible to significant change in the near term include,
but are not limited to, the determination of the allowance for loan losses
and valuation of real estate acquired in connection with or in lieu of
foreclosure on loans.
Investment Securities
---------------------
The Company classifies its securities in one of three categories: trading,
available for sale, or held to maturity. Trading securities are bought and
held principally for sale in the near term. Held to maturity securities are
those securities for which the Company has the ability and intent to hold
the security until maturity. All other securities not included in trading
or held to maturity are classified as available for sale. At December 31,
1999 and 1998, the Company had classified all of its investment securities
as available for sale.
Available for sale securities are recorded at fair value. Held to maturity
securities are recorded at cost, adjusted for the amortization or accretion
of premiums or discounts. Unrealized holding gains and losses, net of the
related tax effect, on securities available for sale are excluded from
earnings and are reported as a separate component of shareholders' equity
until realized.
A decline in the market value of any available for sale investment below
cost that is deemed other than temporary is charged to earnings and
establishes a new cost basis for the security.
Premiums and discounts are amortized or accreted over the life of the
related security as an adjustment to the yield. Realized gains and losses
for securities classified as available for sale are included in earnings
and are derived using the specific identification method for determining
the cost of securities sold.
Other Investments
-----------------
Other investments include equity securities with no readily determinable
fair value. These investments are carried at cost.
A-27
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(1) Summary of Significant Accounting Policies, continued
Mortgage Loans Held for Sale
----------------------------
Mortgage loans held for sale are carried at the lower of aggregate cost or
market value. At December 31, 1999 and 1998, the cost of mortgage loans
held for sale approximates the market value.
Loans and Allowance for Loan Losses
-----------------------------------
Loans are stated at principal amount outstanding, net of the allowance for
loan losses. Interest on loans is calculated by using the simple interest
method on daily balances of the principal amount outstanding.
Impaired loans are measured based on the present value of expected future
cash flows, discounted at the loan's effective interest rate, or at the
loan's observable market price, or the fair value of the collateral if the
loan is collateral dependent. A loan is impaired when, based on current
information and events, it is probable that all amounts due according to
the contractual terms of the loan will not be collected.
Accrual of interest is discontinued on a loan when management believes,
after considering economic conditions and collection efforts, that the
borrower's financial condition is such that collection of interest is
doubtful. Interest previously accrued but not collected is reversed against
current period earnings when such loans are placed on nonaccrual status.
The allowance for loan losses is established through a provision for loan
losses charged to earnings. Loans are charged against the allowance for
loan losses when management believes that the collectibility of the
principal is unlikely. The allowance represents an amount which, in
management's judgment, will be adequate to absorb probable losses on
existing loans that may become uncollectible.
Management's judgment in determining the adequacy of the allowance is based
on evaluations of the collectibility of loans. These evaluations take into
consideration such factors as changes in the nature and volume of the loan
portfolio, current economic conditions that may affect the borrower's
ability to pay, overall portfolio quality, and review of specific problem
loans.
While management uses available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in
economic conditions. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the Bank to recognize
additions to the allowance based on judgments different than those of
management.
Mortgage Banking Activities
---------------------------
Mortgage banking income represents net gains from the sale of mortgage
loans and fees received from borrowers and loan investors related to the
Company's origination of single-family residential mortgage loans.
As of December 31, 1999 and 1998, $970,318 and $574,027, respectively, were
capitalized in connection with originating and acquiring the right to
service mortgage loans.
Mortgage loans serviced for others are not included in the accompanying
balance sheets. The unpaid principal balances of mortgage loans serviced
for others was $91,194,374 and $49,724,063 at December 31, 1999 and 1998,
respectively.
A-28
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(1) Summary of Significant Accounting Policies, continued
Premises and Equipment
----------------------
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed primarily using the straight-line method over the
estimated useful lives of the assets. When assets are retired or otherwise
disposed of, the cost and related accumulated depreciation are removed from
the accounts, and any gain or loss is reflected in earnings for the period.
The cost of maintenance and repairs which do not improve or extend the
useful life of the respective asset is charged to income as incurred,
whereas significant renewals and improvements are capitalized. The range of
estimated useful lives for premises and equipment are generally as follows:
Buildings and improvements 10 - 50 years
Furniture and equipment 3 - 10 years
Income Taxes
------------
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. Additionally, the recognition of future tax benefits, such as
net operating loss carryforwards, is required to the extent that
realization of such benefits is more likely than not. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which the assets and liabilities are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income tax expense in
the period that includes the enactment date.
In the event the future tax consequences of differences between the
financial reporting bases and the tax bases of the Company's assets and
liabilities results in deferred tax assets, an evaluation of the
probability of being able to realize the future benefits indicated by such
asset is required. A valuation allowance is provided for the portion of the
deferred tax asset when it is more likely than not that some portion or all
of the deferred tax asset will not be realized. In assessing the
realizability of the deferred tax assets, management considers the
scheduled reversals of deferred tax liabilities, projected future taxable
income, and tax planning strategies.
Intangible Assets
-----------------
Deposit base premiums, representing the cost of acquiring deposits from
other financial institutions, are being amortized by charges to earnings
over seven years using the straight-line method. Amortization of deposit
base premiums was approximately $174,000 for 1999, 1998 and 1997.
Derivative Financial Instruments
--------------------------------
All derivative financial instruments held by the Company are held for
purposes other than trading. The Company uses interest rate floors and caps
for interest rate risk management. The net interest payable or receivable
on floors and caps is accrued and recognized as an adjustment to interest
income or interest expense of the related asset or liability. Premiums paid
for purchased floors and caps are amortized over the shorter of the term of
the instrument or the related asset or liability. Upon early termination,
the net proceeds received or paid, including premiums, are deferred and
included in other assets or liabilities and amortized over the shorter of
the remaining contract life or the maturity of the related asset or
liability. Upon disposition or settlement of the asset or liability being
hedged, deferral accounting is discontinued and any other related premium
is recognized in earnings.
A-29
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(1) Summary of Significant Accounting Policies, continued
Net Earnings Per Common Share
-----------------------------
The Company is required to report earnings per common share on the face of
the statements of earnings with and without the dilutive effects of
potential common stock issuances from instruments such as options,
convertible securities and warrants. Earnings per common share is based on
the weighted average number of common shares outstanding during the period
while the effects of potential common shares outstanding during the period
are included in diluted earnings per share. Additionally, the Company must
reconcile the amounts used in the computation of both "basic earnings per
share" and "diluted earnings per share."
Stock options granted in 1999 have not been included in the computation of
"diluted earnings per share" as the effect of inclusion would be
antidilutive. Additionally, the Company had no potential common stock
issuances outstanding for the years ended December 31, 1998 and 1997.
Therefore, since "basic earnings per share" and "diluted earnings per
share" are the same for the years ended December 31, 1999, 1998 and 1997,
the Company has chosen to present the calculation of basic earnings per
share as follows:
Net Earnings Common Share Per Share
(Numerator) (Denominator) Amount
------------- ------------- ---------
For the Year Ended December 31, 1999 $4,541,945 2,926,318 $1.55
For the Year Ended December 31, 1998 $4,009,198 2,780,145 $1.44
For the Year Ended December 31, 1997 $2,406,397 2,553,000 $0.94
During 1997, the Company declared and distributed a 10% stock dividend to
its shareholders. Additionally, the Company declared a 3 for 2 stock split
in February, 1999. All previously reported per share amounts have been
restated to reflect the stock dividend and stock split.
Recent Accounting Pronouncements
--------------------------------
In 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 establishes
accounting and reporting standards for hedging derivatives and for
derivative instruments including derivative instruments embedded in other
contracts. It requires the fair value recognition of derivatives as assets
or liabilities in the financial statements. The accounting for the changes
in the fair value of a derivative depends on the intended use of the
derivative instruments at inception. Fair value changes on instruments used
as fair value hedges are recorded in the earnings of the period
simultaneous with accounting for the fair value change of the item being
hedged. Fair value changes on cash flow hedges are recorded in
comprehensive income rather than earnings. Fair value changes on derivative
instruments that are not intended as a hedge are recorded in the earnings
of the period of the change. In 1999, the FASB issued SFAS No. 137 which
deferred implementation of SFAS No. 133 to become effective for all fiscal
quarters beginning after June 15, 2000, but initial application of the
Statement must be made as of the beginning of the quarter. At the date of
initial application, an entity may transfer any held to maturity security
into the available for sale or trading categories without calling into
question the entity's intent to hold other securities to maturity in the
future. The Company believes the adoption of these standards will not have
a material impact on its financial position, results of operations or
liquidity.
A-30
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(2) Corporate Reorganization
Effective August 31, 1999, Peoples Bank completed the process of converting
to a holding company form of operation. Peoples Bancorp of North Carolina,
Inc. has become the parent of Peoples Bank. Bancorp is a North Carolina,
one-bank holding company, headquartered in Newton, North Carolina.
Peoples Bank's shareholders approved the holding company reorganization at
the Bank's annual meeting held in May, 1999. Regulatory approval was
received on July 22, 1999. The holding company conversion was completed
successfully on August 31, 1999. As a result of the conversion, each share
of Bank $5 par value common stock was converted into one share of Bancorp
no par value stock, and the Bank's common stock and additional paid-in
capital accounts were combined into Bancorp's common stock account. Certain
shareholders representing 182 shares were paid cash of $5,871 in lieu of
the issuance of fractional shares. Bancorp is now the sole shareholder of
the Bank.
(3) Investment Securities
Investment securities available for sale at December 31, 1999 and 1998 are
as follows:
December 31, 1999
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- ----------
U.S. Treasuries $ 900,117 - 398 899,719
U.S. Government agencies 23,830,736 - 456,322 23,374,414
Mortgage-backed securities 16,886,862 22,058 696,722 16,212,198
States and political subdivisions 22,388,260 96,955 473,187 22,012,028
----------- ------- --------- ----------
Total $64,005,975 119,013 1,626,629 62,498,359
=========== ======= ========= ==========
December 31, 1999
-----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- ----------
U.S. Treasuries $ 900,473 11,902 - 912,375
U.S. Government agencies 20,032,421 136,137 - 20,168,558
Mortgage-backed securities 19,894,887 82,923 23,309 19,954,501
States and political subdivisions 21,648,735 572,049 28,528 22,192,256
----------- ------- ------ ----------
Total $62,476,516 803,011 51,837 63,227,690
=========== ======= ====== ==========
The amortized cost and fair value of investment securities available for
sale at December 31, 1999, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because
borrowers have the right to call or prepay obligations with or without call
or prepayment penalties.
Amortized Estimated
Cost Fair Value
----------- ----------
Due within one year $ 2,422,170 2,427,262
Due from one to five years 24,826,931 24,527,774
Due from five to ten years 16,541,074 16,274,569
Due after ten years 3,328,938 3,056,556
Mortgage-backed securities 16,886,862 16,212,198
----------- ----------
$64,005,975 62,498,359
=========== ==========
Proceeds from sales of securities available for sale during 1999, 1998 and
1997 were $6,896,296, $7,616,174 and $2,991,562, respectively. Gross gains
of $39,788 and $168,448 for 1999 and 1998, respectively, along with gross
losses of $74,612 and $8,438 for 1999 and 1997, respectively, were realized
on those sales.
Securities with a carrying value of approximately $20,113,000 and
$14,787,000 at December 31, 1999 and 1998, respectively, were pledged to
secure public deposits and for other purposes as required by law.
A-31
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(4) Loans
Major classifications of loans at December 31, 1999 and 1998 are summarized
as follows:
1999 1998
---- ----
Commercial $ 83,644,317 89,535,616
Real estate - mortgage 190,920,815 157,167,284
Real estate - construction 39,339,857 29,927,275
Consumer 25,292,936 24,994,958
------------ -----------
Total loans 339,197,925 301,625,133
Less allowance for loan losses 3,924,348 4,136,690
------------ -----------
Total net loans $335,273,577 297,488,443
============ ===========
The Company grants loans and extensions of credit primarily within the
Catawba Valley region of North Carolina which encompasses Catawba and
Alexander counties and portions of Iredell and Lincoln counties.
At December 31, 1999 and 1998, the Company had nonaccrual loans
approximating $2,866,000 and $3,292,000, respectively. In addition, the
Company had approximately $645,000 and $328,000 in loans past due more than
ninety days and still accruing interest at December 31, 1999 and 1998,
respectively. Interest income that would have been recorded on nonaccrual
loans for the years ended December 31, 1999, 1998 and 1997, had they
performed in accordance with their original terms, amounted to
approximately $333,000, $398,000 and $326,000, respectively. Interest
income on nonaccrual loans included in the results of operations for 1999,
1998 and 1997 amounted to approximately $61,000, $305,000 and $64,000,
respectively.
At December 31, 1999 and 1998, the recorded investment in loans that were
considered to be impaired under SFAS No. 114 was approximately $3,718,000
and $3,670,000, respectively, of which approximately $2,866,000 at December
31, 1999 and $3,292,000 at December 31, 1998 was on nonaccrual. The related
allowance for loan losses on these loans was approximately $711,000 and
$866,000 at December 31, 1999 and 1998, respectively. The average recorded
investment in impaired loans for the twelve months ended December 31, 1999
and 1998 was approximately $4,000,000 and $5,097,000, respectively. For the
years ended December 31, 1999, 1998 and 1997, the Company recognized
approximately $61,000, $264,000 and $82,000, respectively, of interest
income on impaired loans.
Changes in the allowance for loan losses were as follows:
1999 1998 1997
---- ---- ----
Balance at beginning of year $4,136,690 4,374,641 3,745,211
Amounts charged off (705,277) (746,280) (139,415)
Recoveries on amounts previously charged off 67,935 63,329 72,345
Provision for loan losses 425,000 445,000 696,500
---------- --------- ---------
Balance at end of year $3,924,348 4,136,690 4,374,641
========== ========= =========
A-32
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(5) Premises and Equipment
Major classifications of premises and equipment are summarized as follows:
1999 1998
---- ----
Land $ 2,655,024 1,964,996
Buildings and improvements 5,744,736 5,438,922
Furniture and equipment 7,751,921 6,954,135
----------- ----------
16,151,681 14,358,053
Less accumulated depreciation 7,679,383 6,551,226
----------- ----------
8,472,298 7,806,827
Construction in progress 870,284 -
----------- ----------
$ 9,342,582 7,806,827
=========== ==========
Depreciation expense was $1,174,761, $988,988 and $947,603 for the years
ended December 31, 1999, 1998 and 1997, respectively.
(6) Deposits
At December 31, 1999, the scheduled maturities of certificates of deposit
are as follows:
2000 $182,291,995
2001 27,701,335
2002 3,623,378
2003 53,618
2004 and thereafter 148,560
------------
$213,818,886
============
(7) FHLB Borrowings
FHLB borrowings at December 31, 1999 and 1998 consist of the following:
Interest Rate
Maturity Date Rate Type 1999 1998
------------------------------------------------------------------------------------------------
March 27, 2000 5.31% Adjustable $10,000,000 10,000,000
December 20, 2000 4.55% Adjustable Daily 1,000,000 -
September 24, 2002 5.66% Fixed - 3,000,000
February 3, 2003 (with semi-annual
principal payments of $71,429) 5.86% Fixed 500,000 642,857
September 30, 2009 5.07% Fixed 3,000,000 -
----------- ----------
$14,500,000 13,642,857
=========== ==========
These borrowings are extended to the Bank under a $30,000,000 extension of
credit. The Bank is required to purchase and hold certain amounts of FHLB
stock in order to obtain FHLB borrowings. No ready market exists for the
FHLB stock, and it has no quoted market value. The stock is redeemable at
$100 per share subject to certain limitations set by the FHLB. At December
31, 1999 and 1998 the Bank owned FHLB stock amounting to approximately
$1,206,900 and $1,436,000, respectively.
At December 31, 1999 and 1998, a blanket assignment on all residential
first mortgage loans that the Bank owns was pledged as collateral for these
borrowings.
Additionally, the Company has $11,000,000 available for the purchase of
overnight federal funds from two correspondent financial institutions.
A-33
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(8) Income Taxes
The provision for income taxes is summarized as follows:
1999 1998 1997
---- ---- ----
Current:
Federal $1,134,834 1,368,106 1,344,907
State 43,261 118,891 186,651
---------- --------- ---------
1,178,095 1,486,997 1,531,558
---------- --------- ---------
Deferred:
Federal 814,506 290,996 (210,105)
State 100,779 68,490 (172,549)
---------- --------- ---------
915,285 359,486 (382,654)
---------- --------- ---------
Total $2,093,380 1,846,483 1,148,904
========== ========= =========
The differences between the provision for income taxes and the amount
computed by applying the statutory federal income tax rate to earnings
before income taxes are as follows:
1999 1998 1997
---- ---- ----
Pre-tax income at statutory rates (34%) $2,256,010 1,990,932 1,208,802
Differences:
Tax exempt interest income (343,143) (299,560) (319,570)
Nondeductible interest and other expense 54,805 32,789 295,475
Other, net 30,642 (1,349) 4,763
State taxes, net of federal benefit 95,066 123,671 106,122
Change in the beginning of year valuation allowance
for deferred tax assets - - (146,688)
---------- --------- ---------
Total $2,093,380 1,846,483 1,148,904
========== ========= =========
The following summarizes the tax effects of temporary differences that give
rise to significant portions of the deferred tax assets and deferred tax
liabilities. The net deferred tax asset is included as a component of other
assets at December 31, 1999 and 1998.
1999 1998
---- ----
Deferred tax assets:
Allowance for loan losses $1,124,657 1,258,707
Amortizable intangible assets 199,584 139,169
Accrued retirement expense 245,784 279,340
Accrued contingent liabilities 85,098 104,254
Foreclosed real estate 25,098 36,656
Income from non-accrual loans 155,826 88,242
Unrealized loss on available for sale securities 587,216 -
Other 41,308 11,273
---------- ---------
Total gross deferred tax assets 2,464,571 1,917,641
---------- ---------
Deferred tax liabilities:
Unrealized gain on available for sale securities - 292,583
Prepaid FDIC premiums - 9,466
Deferred loan fees 1,200,305 522,167
Fixed assets 219,430 164,256
Deferred income from servicing rights 374,737 223,584
---------- ---------
Total gross deferred tax liabilities 1,794,472 1,212,056
---------- ---------
Net deferred tax asset $ 670,099 705,585
========== =========
A-34
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(9) Related Party Transactions
The Company conducts transactions with directors and executive officers,
including companies in which they have beneficial interests, in the normal
course of business. It is the policy of the Company that loan transactions
with directors and officers be made on substantially the same terms as
those prevailing at the time made for comparable loans to other persons.
The following is a summary of activity for related party loans for 1999:
Beginning balance $ 12,235,842
New loans 15,664,125
Repayments (15,391,497)
------------
Ending balance $ 12,508,470
============
At December 31, 1999 and 1998, the Company had deposit relationships with
related parties of $7,949,415 and $8,186,192, respectively.
(10) Commitments
The Company leases various office space for banking and operational
facilities under operating lease arrangements. Future minimum lease
payments required for all operating leases having a remaining term in
excess of one year at December 31, 1999 are as follows:
Year Amount
---- ------
2000 $ 253,216
2001 210,428
2002 222,428
2003 222,428
2004 222,428
Thereafter 1,337,750
----------
Total minimum obligation $2,468,678
==========
The total rent expense was approximately $262,000, $249,000 and $38,000 for
1999, 1998 and 1997, respectively.
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend
credit, standby letters of credit and financial guarantees. Those
instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized in the balance sheet. The contract amounts of
those instruments reflect the extent of involvement the Company has in
particular classes of financial instruments.
The exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and
standby letters of credit and financial guarantees written is represented
by the contractual amount of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments.
In most cases, the Company does require collateral or other security to
support financial instruments with credit risk.
Contractual Amount
------------------
1999 1998
---- ----
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $68,330,000 66,828,000
Standby letters of credit $ 4,006,000 3,456,000
A-35
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(10) Commitments, continued
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments may
expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Company, upon extension of
credit is based on management's credit evaluation. Collateral held varies
but may include unimproved and improved real estate, certificates of
deposit, or personal property.
Standby letters of credit and financial guarantees written are conditional
commitments issued by the Company to guarantee the performance of a
customer to a third party. Those guarantees are primarily issued to
businesses in the Company's delineated trade area. The credit risk involved
in issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers. The Company holds real estate,
equipment, automobiles and customer deposits as collateral supporting those
commitments for which collateral is deemed necessary.
(11) Employee and Director Benefit Programs
The Company has a 401(k) plan for the use of employees. Under this plan,
the Company matches employee contributions to a maximum of five percent of
annual compensation. The Company's contribution pursuant to this formula
was approximately $163,000, $138,000 and $130,000 for the years of 1999,
1998 and 1997, respectively. Investments of the plan are determined by the
compensation committee consisting of selected outside directors and senior
executive officers. No investments in Company stock have been made by the
plan.
The Company also has a profit sharing plan covering substantially all
employees who have at least one year of continuous service. The Board of
Directors elected not to make a discretionary contribution in 1999, 1998 or
1997. Investments of the plan are determined by the compensation committee
consisting of selected outside directors and senior executive officers. No
investments in Company stock have been made by the plan.
Both the 401(k) and the profit sharing plans for the Company require that
the employee be employed for one full year in order to meet
eligibility/participation requirements. The vesting schedule for both plans
begins at 20 percent after three years of employment and graduates 20
percent each year until reaching 100 percent after seven years of
employment.
The Company is currently paying medical benefits for certain retired
employees. Postretirement benefits, including amortization of the
transition obligation, were approximately $28,830, $25,253 and $23,010 for
the years ended December 31, 1999, 1998 and 1997, respectively. The
following table sets forth the accumulated postretirement benefit
obligation as of December 31, 1999 and 1998, which represents the liability
for accrued postretirement benefit costs:
1999 1998
---- ----
Accumulated postretirement benefit obligation $179,815 175,637
Unrecognized transition obligation (52,231) (69,643)
Unrecognized gain 2,029 9,306
-------- -------
Net liability recognized at
December 31, 1999 and 1998 $129,613 115,300
======== =======
Effective May 13, 1999, the Company adopted an Omnibus Stock Ownership and
Long Term Incentive Plan (the "Plan") whereby certain stock-based rights,
such as stock options, restricted stock, performance units, stock
appreciation rights, or book value shares, may be granted to eligible
directors and employees. A total of 292,600 shares were reserved for
possible issuance under this Plan. All rights must be granted or awarded
within ten years from the effective date.
Under the Plan, the Company awarded 4,877 book value shares to each of its
ten directors with vesting for nine of the directors over a five year
period, effective September 28, 1999, and immediate vesting for one
director. Any recipient of book value shares shall have no rights as a
shareholder with respect to such book value shares. The initial value of
the book value shares awarded during 1999 was determined to be $12.60 per
share. The Company recorded an expense of $3,414 associated with the
benefits of this plan in the year ended December 31, 1999.
A-36
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(11) Employee and Director Benefit Programs, continued
Also under the Plan, the Company granted incentive stock options to certain
eligible employees in order that they may purchase Company stock at a price
equal to the fair market value on the date of the grant. The options vest
over a five year period and expire after ten years.
A total of 25,136 incentive stock options were granted to certain eligible
employees in 1999 at an option price of $18.00 per share. The weighted
average grant-date fair value of options granted in 1999 was $6.48. The
total number of employee incentive stock options outstanding at December
31, 1999 was 25,136, none of which are currently exercisable. The options
have a weighted average remaining contractual life of approximately 10
years.
The Plan is accounted for under Accounting Principles Board Opinion No. 25
and related interpretations. No compensation expense has been recognized
related to the grant of the incentive stock options. Had compensation cost
been determined based upon the fair value of the options at the grant
dates, the Company's net earnings and net earnings per share would have
been reduced to the proforma amounts indicated below.
1999
----
Net earnings As reported $4,541,945
Proforma $4,440,959
Basic earnings per share As reported $ 1.55
Proforma $ 1.52
Diluted earnings per share As reported $ 1.55
Proforma $ 1.52
The fair value of each option is estimated on the date of grant using the
Black-Scholes options-pricing model with the following weighted average
assumptions used for grants in 1999 - dividend yield of 2.5%, risk free
interest rate of 7%, and an expected life of 10 years. For disclosure
purposes, the Company immediately recognized the expense associated with
the option grants assuming that all awards will vest.
(12) Derivative Financial Instruments
Off-balance-sheet derivative financial instruments, such as interest rate
swaps, interest rate floor and cap arrangements and interest rate futures
and option contracts are available to the Company to assist in managing
interest rate risks. In 1998, the Company entered into an interest rate cap
to protect certain designated deposit accounts from the upward effects of
repricing in the event of an increasing rate environment. The total cost of
the interest rate cap arrangement was $21,600, which is expensed on a
straight-line basis for the life of the instrument. For the years ended
December 31, 1999, 1998 and 1997, the Company expensed $22,944, $31,747 and
$30,667, respectively, related to derivative financial instruments. The
table below summarizes the Company's off-balance-sheet derivative financial
instruments at December 31, 1999.
Remaining
Notional Floor/Cap Contractual
Amount Rate Term (Years)
------ ---- ------------
Interest rate cap $4,000,000 7.10% 3.75
A-37
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(13) Regulatory Matters
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective
action, the Company must meet specific capital guidelines that involve
quantitative measures of the assets, liabilities and certain off-balance-
sheet items as calculated under regulatory accounting practices. The
capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital to
average assets (as defined). Management believes, as of December 31, 1999,
that Bancorp and the Bank meet all capital adequacy requirements to which
they are subject.
As of December 31, 1999 the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank
must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
institution's category.
The Bank's actual capital amounts and ratios are presented in the following
table as the consolidated ratios are not materially different than the
Bank's ratios:
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions
--------------- ------------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------- ------ --------- -------- -------- --------
(dollars in thousands)
As of December 31, 1999:
Total Capital
(to Risk Weighted Assets) $42,319 12.11% 27,949 8.0% 34,937 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 38,395 10.99% 13,975 4.0% 20,962 6.0%
Tier 1 Capital
(to Average Assets) 38,395 9.21% 16,675 4.0% 20,843 5.0%
As of December 31, 1998:
Total Capital
(to Risk Weighted Assets) 38,741 12.29% 25,228 8.0% 31,534 10.0%
Tier 1 Capital
(to Risk Weighted Assets) 34,800 11.04% 12,614 4.0% 18,921 6.0%
Tier 1 Capital
(to Average Assets) 34,800 9.41% 14,795 4.0% 18,493 5.0%
A-38
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(14) Shareholders' Equity
On June 12, 1998, the Company completed a public offering of 373,500 shares
of common stock at a price of $23.00 per share. The net proceeds of this
offering of $7,787,467 (after deducting issuance costs of $803,033) were
used to increase the Bank's regulatory capital ratios and for general
corporate purposes.
On February 11, 1999, the Board of Directors of the Company declared a 3
for 2 stock split to be effected in the form of a 50% stock dividend. On
the date of distribution, 182 shares, representing all fractional shares,
were paid cash of $5,871 representing the February 22, 1999 market price.
In 1997, the Company declared and distributed a 10% stock dividend to its
shareholders. All share and per share amounts have been changed to reflect
the stock split and stock dividend as if it had occurred on December 31,
1996.
The Board of Directors, at its discretion, can issue shares of preferred
stock up to a maximum of 5,000,000 shares. The Board is authorized to
determine the number of shares, voting powers, designations, preferences,
limitations and relative rights.
The Board of Directors of the Bank may declare a dividend of all of its
retained earnings as it may deem appropriate, subject to the requirements
of the General Statutes of North Carolina, without prior approval from the
requisite regulatory authorities. As of December 31, 1999, this amount was
approximately $ 7,338,000.
(15) Other Operating Expense
Other operating expense for the years ended December 31 included the
following items that exceeded one percent of total revenues:
1999 1998 1997
---- ---- ----
Advertising $207,425 272,924 269,682
Office supplies 317,670 300,117 263,365
Telephone 353,536 358,506 256,511
Education and Consulting 366,488 214,918 211,989
During 1997, other operating expense also included nonrecurring charges of
approximately $855,000 associated with the Company's profit sharing plan.
(16) Fair Value of Financial Instruments
The Company is required to disclose fair value information about financial
instruments, whether or not recognized on the face of the balance sheet,
for which it is practicable to estimate that value. The assumptions used in
the estimation of the fair value of the Company's financial instruments are
detailed below. Where quoted prices are not available, fair values are
based on estimates using discounted cash flows and other valuation
techniques. The use of discounted cash flows can be significantly affected
by the assumptions used, including the discount rate and estimates of
future cash flows. The following disclosures should not be considered a
surrogate of the liquidation value of the Company, but rather a good faith
estimate of the increase or decrease in value of financial instruments held
by the Company since purchase, origination, or issuance.
Cash and Cash Equivalents
-------------------------
For cash, due from banks and federal funds sold, the carrying amount is a
reasonable estimate of fair value.
Investment Securities
---------------------
Fair values for investment securities are based on quoted market prices.
Other Investments
-----------------
The carrying amount of other investments approximates fair value.
Loans and Mortgage Loans Held for Sale
--------------------------------------
The fair value of fixed rate loans is estimated by discounting the future
cash flows using the current rates at which similar loans would be made to
borrowers with similar credit ratings. For variable rate loans, the
carrying amount is a reasonable estimate of fair value. Mortgage loans held
for sale are valued based on the current price at which these loans could
be sold into the secondary market.
A-39
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(16) Fair Value of Financial Instruments, continued
Interest Rate Contracts
-----------------------
The fair value of the interest rate contracts is obtained from dealer
quotes. This value represents the estimated amount the Company would
receive to terminate the agreement, taking into account current interest
rates and, when appropriate, the current credit worthiness of the
counterparty.
Mortgage Servicing Rights
-------------------------
Fair value of mortgage servicing rights is determined by estimating the
present value of the future net servicing income, on a disaggregated basis,
using anticipated prepayment assumptions.
Deposits and Demand Notes Payable
---------------------------------
The fair value of demand deposits, interest-bearing demand deposits,
savings, and demand notes payable to U.S. Treasury is the amount payable on
demand at the reporting date. The fair value of fixed maturity certificates
of deposit is estimated by discounting the future cash flows using the
rates currently offered for deposits of similar remaining maturities.
FHLB Borrowings
---------------
The fair value of FHLB borrowings is estimated based upon discounted future
cash flows using a discount rate comparable to the current market rate for
such borrowings.
Commitments to Extend Credit and Standby Letters of Credit
----------------------------------------------------------
Because commitments to extend credit and standby letters of credit are made
using variable rates, the contract value is a reasonable estimate of fair
value.
Limitations
-----------
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result
from offering for sale at one time the Company's entire holdings of a
particular financial instrument. Because no market exists for a significant
portion of the Company's financial instruments, fair value estimates are
based on many judgments. These estimates are subjective in nature and
involve uncertainties and matters of significant judgment and therefore
cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. Significant assets and
liabilities that are not considered financial instruments include the
deferred income taxes and premises and equipment. In addition, the tax
ramifications related to the realization of the unrealized gains and losses
can have a significant effect on fair value estimates and have not been
considered in the estimates.
A-40
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(16) Fair Value of Financial Instruments, continued
The carrying amount and estimated fair values of the Company's financial
instruments at December 31, 1999 and 1998 are as follows:
1999 1998
---- ----
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
(In thousands) (In thousands)
Assets:
Cash and cash equivalents $ 16,997 16,997 17,754 17,754
Investment securities available for sale 62,498 62,498 63,228 63,228
Other investments 1,345 1,345 1,495 1,495
Loans 335,274 332,975 297,488 297,154
Mortgage loans held for sale 1,685 1,685 9,260 9,260
Mortgage servicing rights 970 970 574 574
Interest rate contracts 16 28 49 50
Liabilities:
Deposits and demand notes payable 378,234 386,030 350,207 351,217
FHLB borrowings 14,500 14,195 13,643 13,593
Unrecognized financial instruments:
Commitments to extend credit 68,330 68,330 66,828 66,828
Standby letters of credit 4,006 4,006 3,456 3,456
(17) Quarterly Operating Results (unaudited)
1999 1998
---- ----
(in thousands, except per share amounts)
First Second Third Fourth First Second Third Fourth
----- ------ ----- ------ ----- ------ ----- ------
Total interest income $7,551 7,851 8,187 8,713 6,769 7,319 7,651 7,476
Total interest expense 3,653 3,600 3,656 3,881 3,318 3,670 3,803 3,749
------ ----- ----- ----- ----- ----- ----- -----
Net interest income 3,898 4,251 4,531 4,832 3,451 3,649 3,848 3,727
Provision for loan losses - - 25 400 175 165 80 25
Other income 902 868 866 744 667 754 920 1,305
Other expense 3,218 3,434 3,719 3,461 2,596 2,753 3,183 3,488
------ ----- ----- ----- ----- ----- ----- -----
Income before income taxes 1,582 1,685 1,653 1,715 1,347 1,485 1,505 1,519
Income taxes 507 542 526 518 480 451 513 403
------ ----- ----- ----- ----- ----- ----- -----
Net income $1,075 1,143 1,127 1,197 867 1,034 992 1,116
====== ===== ===== ===== ===== ===== ===== =====
Net income per share $ 0.37 0.39 0.38 0.41 0.34 0.38 0.34 0.38
====== ===== ===== ===== ===== ===== ===== =====
A-41
PEOPLES BANCORP OF NORTH CAROLINA, INC.
Notes to Consolidated Financial Statements, continued
(18) Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed
Financial Statements
Balance Sheet
December 31, 1999
Assets
------
Investment in Bank $37,998,479
===========
Liabilities and Stockholders' Equity
------------------------------------
Stockholders' equity $37,998,479
===========
Statement of Earnings
For the Year Ended December 31, 1999
Dividends from Bank $ 1,082,738
-----------
Income before equity in undistributed income of Bank 1,082,738
Equity in undistributed income of Bank 3,459,207
-----------
Net earnings $ 4,541,945
===========
Statement of Cash Flows
For the Year Ended December 31, 1999
Cash flows from operating activities:
Net earnings $ 4,541,945
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Equity in undistributed income of the Bank (3,459,207)
Change in other 5,871
-----------
Net cash provided by operating activities $ 1,088,609
-----------
Cash flows from financing activities:
Cash paid in lieu of fractional shares (5,871)
Dividends paid (1,082,738)
-----------
Net cash used in financing activities $(1,088,609)
-----------
Net change in cash -
Cash at beginning of year -
-----------
Cash at end of year $ -
===========
A-42