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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number
0-24744
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LIFE BANCORP, INC.
(Exact name of registrant as specified in its charter)
VIRGINIA 54-1711207
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
109 East Main Street
Norfolk, Virginia 23510
(Address of principal executive offices) (Zip Code)
(757) 858-1000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b)
of the Act:
Not applicable
Securities registered pursuant to Section 12(g)
of the Act:
Common Stock, (par value $0.01 per share)
(Title of Class)
--------------------------------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X].
As of March 7, 1997, the aggregate value of the 8,585,729 shares of Common Stock
of the Registrant issued and outstanding on such date, which excludes 1,261,111
shares held by all directors and executive officers of the Registrant and the
Registrant's Employee Stock Ownership Plan ("ESOP") as a group, was
approximately $171.7 million. This figure is based on the last known trade price
of $20.00 per share of the Registrant's Common Stock on March 7, 1997. Although
directors and executive officers and the ESOP were assumed to be "affiliates" of
the Registrant for purposes of this calculation, the classification is not to be
interpreted as an admission of such status.
Number of shares of Common Stock outstanding as of March 7, 1997: 9,846,840.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:
(1) Portions of the Annual Report to Stockholders for the fiscal year ended
December 31, 1996, are incorporated into Parts II and IV.
(2) Portions of the definitive proxy statement for the Annual Meeting of
Stockholders are incorporated into Part III.
LIFE BANCORP, INC.
FORM 10-K ANNUAL REPORT FOR 1996
TABLE OF CONTENTS
Page
PART I................................................................. 1
Item 1. Business...................................................... 1
General........................................................... 1
Acquisition of Seaboard Bancorp, Inc.............................. 1
Lending Activities................................................ 2
General....................................................... 2
Activity in Loans............................................. 2
Contractual Principal Repayments.............................. 3
Loan Portfolio Composition.................................... 4
Single-Family Residential Loans............................... 5
Multi-Family Residential and Commercial Real Estate Loans..... 6
Construction Loans............................................ 7
Land Loans.................................................... 8
Consumer Loans................................................ 8
Mortgage Banking.............................................. 9
Loans-to-One Borrower Limitations............................. 10
Asset Quality..................................................... 10
General....................................................... 10
Impaired Loans................................................ 11
Troubled Debt Restructurings.................................. 12
Non-Performing Assets......................................... 12
Potential Problem Loans....................................... 13
Allowance for Loan Losses..................................... 13
Other Classified Assets....................................... 15
Allowance for Losses on Real Estate Owned..................... 15
Investments and Mortgage-Backed Securities........................ 16
Investments................................................... 16
Mortgage-Backed Securities.................................... 16
Sources of Funds.................................................. 20
General....................................................... 20
Deposits...................................................... 20
Borrowings.................................................... 22
Stockholders' Equity.......................................... 23
Subsidiaries...................................................... 24
The First Colony Service Corporation.......................... 24
Life Financial Services Corporation........................... 24
Life Capital Corporation...................................... 24
Life Products Corp............................................ 24
Seaboard Equity Corporation................................... 24
Employees......................................................... 24
Competition....................................................... 24
Regulation........................................................ 25
The Company................................................... 25
Federal Activities Restrictions.............................. 25
Limitations on Transactions with Affiliates.................. 26
Restrictions on Acquisitions................................. 26
The Bank...................................................... 27
Insurance of Accounts........................................ 27
Regulatory Capital Requirements.............................. 29
i
Prompt Corrective Action..................................... 31
Safety and Soundness......................................... 32
Brokered Deposits............................................ 32
Liquidity Requirements....................................... 32
Qualified Thrift Lender Test................................. 33
Restrictions on Capital Distributions........................ 33
Loans-to-One Borrower........................................ 34
Classified Assets............................................ 34
Community Reinvestment....................................... 35
Nationwide Banking........................................... 35
Policy Statement on Nationwide Branching..................... 35
Federal Home Loan Bank System................................ 35
Federal Reserve System....................................... 35
Federal Taxation.................................................. 36
General....................................................... 36
Fiscal Year................................................... 36
Method of Accounting.......................................... 36
Bad Debt Reserves............................................. 36
Distributions................................................. 37
Minimum Tax................................................... 37
Audit by Internal Revenue Service............................. 37
State Taxation.................................................... 37
Item 2. Properties.................................................... 38
Item 3. Legal Proceedings............................................. 40
Item 4. Submission of Matters to a Vote of Security Holders........... 40
PART II................................................................ 40
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.......................................... 40
Item 6. Selected Financial Data....................................... 40
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 40
Item 8. Financial Statements and Supplementary Data................... 40
Item 9. Changes in and Disagreements on Accounting and Financial
Disclosure.................................................. 40
PART III............................................................... 40
Item 10. Directors and Executive Officers of the Registrant............ 40
Item 11. Executive Compensation........................................ 40
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 41
Item 13. Certain Relationships and Related Transactions................ 41
PART IV................................................................ 41
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K.................................................... 41
SIGNATURES............................................................. 43
ii
PART I
Item 1. Business
General
Life Bancorp, Inc. (the "Company") is a Virginia corporation organized
in May 1994, by Life Savings Bank, FSB ("Life Savings" or the "Bank") for the
purpose of acquiring all of the capital stock of the Bank issued in the
conversion of the Bank to stock form (the "Conversion"), which was completed on
October 11, 1994. At such date, the Company offered 10,910,625 shares of common
stock, in connection with the Conversion of the Bank from mutual to stock
ownership, and the Bank reorganized into the holding company form of
organization with the Company becoming the holding company for the Bank. The
only significant assets of the Company are the capital stock of the Bank, the
Company's loan to an Employee Stock Ownership Plan ("ESOP"), and the net
conversion proceeds retained by the Company. To date, the business of the
Company has consisted of the business of the Bank. At December 31, 1996, the
Company had consolidated assets of $1.4 billion, deposits of $732.3 million and
stockholders' equity of $150.9 million.
Life Savings operates twenty retail banking offices in its immediate
market area - South Hampton Roads, Virginia, which consists of the cities of
Chesapeake, Norfolk, Portsmouth, Suffolk and Virginia Beach. Hampton, Newport
News and Williamsburg are also a part of Hampton Roads, the Bank's primary
market area, which, with 1.5 million residents, is the fourth largest
metropolitan statistical area in the Southeast region of the United States and
the 27th largest in the Nation.
Through its retail banking offices, Life Savings delivers a wide range
of banking products and services to meet the needs of individuals, businesses
and organizations. The Bank attracts retail deposits from the general public and
the business community through a variety of deposit products. Deposits are
insured by the Savings Association Insurance Fund ("SAIF"), administered by the
Federal Deposit Insurance Corporation ("FDIC"), within applicable limits.
The Bank's lending activities focus on meeting the needs of individuals
and businesses in its market area by offering permanent and construction
residential loans, second mortgages and equity lines of credit, consumer loans,
commercial real estate and business loans, and lines of credit.
The Company's common stock trades on the Nasdaq National Market tier of
The Nasdaq Stock Market(sm) under the symbol "LIFB." The Bank has been in
business since 1935. It is the largest financial institution headquartered in
Hampton Roads and the largest savings bank in Virginia.
The Company, as a registered savings and loan holding company, is
subject to examination and regulation by the Office of Thrift Supervision
("OTS") and is subject to various reporting and other requirements of the
Securities and Exchange Commission ("SEC"). The Bank is subject to examination
and comprehensive regulation by the OTS, which is the Bank's chartering
authority and primary regulator. The Bank is also regulated by the FDIC, the
administrator of the SAIF. The Bank is subject to certain reserve requirements
established by the Board of Governors of the Federal Reserve System ("FRB") and
is a member of the Federal Home Loan Bank ("FHLB") of Atlanta, which is one of
the 12 regional banks comprising the FHLB System.
Acquisition of Seaboard Bancorp, Inc.
On January 31, 1996, the Company completed its acquisition of Seaboard
Bancorp, Inc. ("Seaboard"), the holding company for Seaboard Savings Bank,
F.S.B., ("Seaboard Savings"). Seaboard Savings, headquartered in Virginia Beach,
operated three offices, one each in the Virginia cities of Chesapeake, Virginia
Beach and Portsmouth, The operations of Seaboard Savings were merged into the
1
Bank effective February 1, 1996, representing a natural extension of the Bank's
existing operations and strengthening its presence in the Hampton Roads market.
Results of operations of Seaboard, beginning February 1, 1996, are included in
the results of the Company. For additional information regarding the Seaboard
acquisition, see Note 2 to the Consolidated Financial Statements included in
Item 8 hereof.
Lending Activities
General. At December 31, 1996, the Bank's net loans held for investment
totaled $622.4 million, or 43.8% of the total assets at such date. The Bank
originates conventional loans secured by first liens on single-family residences
located primarily in the Hampton Roads area. Conventional residential real
estate loans are loans which are neither insured by the Federal Housing
Administration ("FHA") nor partially guaranteed by the Veterans Administration
("VA"). The Bank also originates loans secured by commercial real estate and
multi-family (over four units) residential properties, consumer loans (including
home equity loans) and construction loans. Virtually all of the Bank's mortgage
loans are secured by properties located in Virginia.
Additional information regarding the Company's loans receivable is
provided in Management's Discussion and Analysis of Financial Condition and
Results of Operations and in Note 5 to the Consolidated Financial Statements
included in Items 7 and 8 hereof.
Activity in Loans. The following table shows the Bank's loan
originations, sales and repayments during the periods indicated. The Bank did
not purchase any loans during the periods indicated.
Year Ended December 31,
-----------------------------------------------------
1996 1995 1994
-------------- --------------- --------------
(Dollars in Thousands)
Gross loans at beginning of period $491,350 $442,055 $386,314
Originations of loans for
investment:
Single-family residential:
Conventional 62,493 54,511 82,014
FHA and VA 4,707 4,228 7,564
Multi-family residential 1,012 365 153
Commercial real estate 32,219 14,369 9,052
Construction 5,902 4,132 8,523
Land loans 2,102 3,320 2,104
Consumer loans 35,777 17,848 13,317
-------- -------- --------
Total originations for investment 144,212 98,773 122,727
Loans originated for sale 880 10,451 5,881
-------- -------- --------
Total originations 145,092 109,224 128,608
Loans acquired from Seaboard 69,525 -- --
Repayments (37,311) (49,478) (59,400)
Loan sales (880) (10,451) (13,467)
-------- -------- --------
Net activity in loans 176,426 49,295 55,741
-------- -------- --------
Gross loans at end of period $667,776 $491,350 $442,055
======== ======== ========
The lending activities of Life Savings are subject to written
underwriting standards and loan origination procedures established by the Bank's
Board of Directors and management. Applications for consumer loans are taken at
all of the Bank's branch offices by the branch manager or other designated loan
officer. Applications for single-family residential first mortgage loans are
obtained through designated branch offices and loan originators who are
employees of the Bank. The Bank's loan originators will take loan applications
outside of the Bank's offices at the customer's convenience and are compensated
on a salary plus commission basis. Loan applications are forwarded to the Loan
Processing Department, which supervises the process of obtaining credit reports,
appraisals and other documentation supporting the loan request. The Bank
requires that a property's market value be determined in
2
connection with all new mortgage loans. Such values generally are determined by
an independent appraiser selected from an appraisal panel approved by the Bank's
Board of Directors or by a member of the Bank's internal appraisal staff. Life
Savings requires that title insurance and hazard insurance be maintained on all
security properties and that flood insurance be maintained if the improvements
are within a designated flood hazard area.
Residential mortgage loan applications are obtained through referrals
from real estate brokers and builders, existing customers and walk-in customers.
Residential mortgage loans also are originated through correspondents.
Commercial and multi-family real estate loan applications are obtained from
previous borrowers, direct solicitations by Bank personnel, commercial mortgage
brokers and through referrals. Consumer loans originated by the Bank are
obtained through existing and walk-in customers who have been made aware of the
Bank's programs by advertising and other means. Automobile and boat loans are
also obtained indirectly through an established network of automobile and boat
dealers located in the Hampton Roads area.
Applications for residential and commercial mortgage loans are approved
in accordance with the Bank's Board of Directors' authorization to a Loan
Approval Committee, a committee comprised of certain designated officers of the
Bank. Residential and commercial mortgage loans in excess of $350,000 must be
approved by the Bank's Board of Directors. Loans under $150,000 may be approved
by certain designated officers of the Bank, while loans not exceeding $350,000
may be approved by the Loan Approval Committee. All loans which do not require
approval of the Bank's Board of Directors are submitted to the Board at its next
meeting for review, acknowledgement and approval ratification.
Contractual Principal Repayments. The following table sets forth
scheduled contractual amortization of the Bank's loans at December 31, 1996, as
well as the dollar amount of such loans which are scheduled to mature after one
year which have fixed or adjustable interest rates. Demand loans and loans
having no schedule of repayments and no stated maturity are reported as due in
one year or less. Loans which are callable at the Bank's option at specified
dates are reported at their contractual maturity date and are treated as
adjustable rate loans for purposes of this table.
Principal Repayments Contractually Due
in Year(s) Ended December 31,
-----------------------------------------------------------------------------------
Total at
December 31, 2000- 2002- 2008-
1996 1997 1998 1999 2001 2007 2013 Thereafter
---------- -------- -------- -------- -------- --------- --------- ----------
(Dollars in Thousands)
Loans receivable:
First mortgage
loans $589,134 $68,603 $29,502 $24,500 $39,509 $ 95,756 $89,590 $241,674
Consumer and
other loans 78,642 20,606 16,089 12,330 15,440 9,194 3,411 1,572
-------- ------- ------- ------- ------- -------- ------- --------
Total(1) $667,776 $89,209 $45,591 $36,830 $54,949 $104,950 $93,001 $243,246
======== ======= ======= ======= ======= ======== ======= ========
- -----------------------------
<FN>
(1) Of the $578.6 million of loan principal repayments contractually due
after December 31, 1997, $247.7 million have fixed rates of interest
and $330.9 million have adjustable rates of interest.
</FN>
The scheduled contractual amortization of loans does not reflect the
expected term of the Bank's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments, call
features and due-on-sale clauses, which give the Bank the right to declare a
conventional loan immediately due and payable in the event, among other things,
that the borrower sells the real property subject to the mortgage and the loan
is not repaid. The average life of mortgage loans tends to increase when current
mortgage loan rates are higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgage loans are higher than
current mortgage loan rates (due to refinancings at lower rates). Under the
latter circumstances, the weighted average yield on loans decreases as
higher-yielding loans are repaid or refinanced at lower rates.
3
Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loans held in portfolio at the dates indicated.
December 31,
----------------------------------------------------------------------------------------------------
1996 (1) 1995 1994 1993 1992
------------------- ------------------- ----------------- ------------------ ------------------
Percent of Percent of Percent of Percent of Percent of
Amount Total Amount Total Amount Total Amount Total Amount Total
------ ------- ------ ------- ------ ------- ------ ------- ------ ------
(Dollars in Thousands)
Mortgage loans:
Single-family residential:
Conventional $370,956 55.55% $307,584 62.60% $281,507 63.68% $234,085 62.10% $280,261 63.27%
FHA/VA 22,582 3.38 22,209 4.52 21,993 4.97 22,217 5.89 24,205 5.46
Multi-family 22,686 3.40 24,926 5.07 22,663 5.13 23,786 6.31 24,452 5.52
Construction 58,228 8.72 25,351 5.16 21,748 4.92 3,937 1.04 6,046 1.36
Commercial real estate 110,991 16.62 51,239 10.43 44,543 10.08 41,607 11.04 46,634 10.53
Land loans 3,691 0.55 4,986 1.01 2,877 0.65 2,261 0.60 3,758 0.85
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage loans 589,134 88.22 436,295 88.80 395,331 89.43 327,893 86.98 385,356 86.99
Consumer loans:
Home equity 34,425 5.16 27,826 5.66 23,768 5.38 26,998 7.16 33,071 7.47
Automobile 31,072 4.65 15,970 3.25 11,402 2.58 11,612 3.08 13,437 3.03
Lines of credit 5,608 0.84 5,803 1.18 6,358 1.44 6,414 1.70 6,765 1.53
Other 7,537 1.13 5,456 1.11 5,196 1.17 4,051 1.08 4,324 0.98
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans 78,642 11.78 55,055 11.20 46,724 10.57 49,075 13.02 57,597 13.01
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable 667,776 100.00% 491,350 100.00% 442,055 100.00% 376,968 100.00% 442,953 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Allowance for loan
losses 9,656 4,438 4,459 3,274 2,741
Loans-in-process 31,631 16,062 11,991 2,703 3,492
Purchase accounting
discount 757 481 581 865 1,343
Unearned discount 1,134 595 579 1,157 2,127
Net deferred loan
origination fees 2,142 2,068 2,875 1,975 2,604
Discount on loans
purchased 51 282 379 484 595
-------- -------- -------- -------- --------
Loans receivable, net $622,405 $467,424 $421,191 $366,510 $430,051
======== ======== ======== ======== ========
<FN>
(1) Includes loans obtained in the Seaboard acquisition.
</FN>
4
Single-Family Residential Loans. The Bank's single-family residential
mortgage loans consist of conventional loans and, to a lesser extent,
FHA-insured and VA-guaranteed loans. At December 31, 1996, the Bank's
conventional single-family loans amounted to $371.0 million, or 55.6% of the
total loan portfolio, an increase of $63.4 million, or 20.6%, compared to
December 31, 1995. This increase resulted from the acquisition of Seaboard and a
lower volume of loan sales as well as internal growth in the Bank's loan
portfolio. FHA/VA loans amounted to $22.6 million, or 3.4% of the total loan
portfolio. Substantially all of the Bank's single-family residential mortgage
loans are secured by properties located in Virginia, primarily in the Bank's
Hampton Roads market area and, to a lesser extent, the Richmond, Lynchburg and
Roanoke metropolitan areas. The vast majority of residential mortgage loans
originated by the Bank are originated under terms and documentation which permit
their sale to the Federal Home Loan Mortgage Corporation ("FHLMC") or the
Government National Mortgage Association ("GNMA"). During 1994, and 1995, and,
to a much lesser extent, 1996, the Bank, consistent with its asset/liability
management strategies, sold certain of its longer term fixed-rate residential
mortgage loans. See "- Mortgage Banking Activities."
The single-family residential mortgage loans offered by the Bank
currently consist of fixed-rate loans, adjustable-rate mortgage ("ARM") loans,
loans which have a one-time adjustment feature, and convertible ARMs which
permit the borrower to convert the loan to a fixed-rate.
Fixed-rate loans generally have maturities ranging from ten to thirty
years and are fully amortizing with monthly loan payments sufficient to repay
the total amount of the loan with interest by the end of the loan term. The
Bank's fixed-rate loans are originated under terms, conditions and documentation
which permit them to be sold to U.S. Government-sponsored agencies, such as the
FHLMC and the GNMA, or other investors in the secondary market for mortgages. At
December 31, 1996, $152.5 million, or 39.0%, of the Bank's single-family
residential mortgage loans were fixed-rate loans.
The adjustable-rate loans currently offered by the Bank have interest
rates which initially adjust every one, three, five, seven or ten years in
accordance with a designated index, such as U.S. Treasury obligations, adjusted
to a constant maturity ("CMT"), plus a stipulated margin. The Bank's
adjustable-rate single-family residential real estate loans generally have a cap
of 2% on any increase or decrease in the interest rate at any adjustment date,
and a cap of 6% over the life of the loan, except for certain seven and ten year
ARMs on which the caps are 3% and 5%, respectively. The Bank's adjustable-rate
loans require that any payment adjustment resulting from a change in the
interest rate of an adjustable-rate loan be sufficient to result in full
amortization of the loan by the end of the loan term and, thus, do not permit
any of the increased payment to be added to the principal amount of the loan, or
so-called negative amortization. Certain ARMs permit the borrower, at his or her
option, upon payment of a pre-determined fee, to convert the loan during a
limited time period to a fixed-rate loan based upon a designated index plus a
margin. At December 31, 1996, $241.0 million or 61.0% of the Bank's
single-family residential mortgage loans were adjustable-rate loans.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because, as interest rates
increase, the borrower's required loan payment increases to the extent permitted
by the terms of the loan, thereby increasing the potential for default.
Moreover, as interest rates increase, the marketability of the underlying
collateral property may be adversely affected by higher interest rates. The Bank
believes that these risks, which have not had a material adverse effect on the
Bank to date because of the generally declining and lower interest rate
environment in recent years, generally are less than the risks associated with
holding fixed-rate loans in an increasing interest rate environment.
The Bank currently will lend up to 95% of the appraised value of the
property securing a single-family residential loan with a principal amount up to
$300,000. The Bank requires that private mortgage insurance be obtained if the
principal amount of the loan exceeds 80% of the value of the security property,
except for certain special Community Reinvestment loan programs. The Bank's
current policy
5
is that single-family residential loans with principal amounts greater than
$300,000 and up to $350,000 generally will have loan-to-value ratios of 90% or
less and that single-family residential loans with principal amounts greater
than $350,000 will have loan-to-value ratios of 75% or less.
Multi-Family Residential and Commercial Real Estate Loans. The Bank's
multi-family residential and commercial real estate loans generally are
one-year, three-year or five-year adjustable-rate loans indexed to U.S. Treasury
obligations of similar terms plus a margin. Usually, fees of 1% to 2% of the
principal loan balances are charged to the borrower upon closing. Although terms
for multi-family residential and commercial real estate loans may vary, the
Bank's underwriting standards generally provide for terms of up to 25 years with
amortization of principal over the term of the loan and loan-to-value ratios of
not more than 85% for commercial real estate and multi-family residential loans.
While the Bank originates long-term multi-family residential and commercial real
estate loans, such loans typically include provisions which permit the Bank, at
its sole discretion, to call the loan at predetermined dates, ranging from
annually to up to a ten-year period, throughout the term of the loan. Such call
provisions reduce the interest-rate risk to the Bank of such loans by allowing
the Bank to require repayment of the loan or, more typically, permit the Bank to
renegotiate the interest rate. Generally, the Bank obtains personal guarantees
of the principals as additional security for commercial real estate and
multi-family residential loans and requires that the borrower have at least a
15% equity investment in any commercial real estate property and 10% for any
multi-family property.
The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of a property's cash flow history, future operating projections,
current and projected occupancy, location and physical condition. The Bank
generally imposes a debt coverage ratio (the ratio of net cash from operations
before payment of debt service to debt service) of not less than 110% for
multi-family loans and commercial real estate loans. The underwriting analysis
also includes credit checks and a review of the financial condition of the
borrower and guarantor(s), if applicable. To substantiate property values for
every commercial real estate and multi-family loan transaction, an appraisal
report is prepared by a state-licensed and certified appraiser commissioned by
the Bank or by the Bank's appraisal staff. All appraisal reports are reviewed by
the Bank's appraisal department prior to the closing of the loan.
At December 31, 1996, loans secured by commercial real estate amounted
to $111.0 million, or 16.6%, of the Bank's total loan portfolio, an increase of
$59.8 million, or 116.6%, compared to $51.2 million, or 10.4%, of the total
portfolio, at December 31, 1995. This increase resulted from the acquisition of
Seaboard as well as the Bank's strategy to increase its market share of well
underwritten commercial real estate loans. The Bank's commercial real estate
loans are secured by office buildings, shopping centers, warehouses and other
industrial buildings, hotels, motels and other commercial properties located
primarily in the Bank's market area.
Multi-family residential loans amounted to $22.7 million, or 3.4%, of
the Bank's total loan portfolio at December 31, 1996, compared to $24.9 million,
or 5.1%, of the total portfolio, at December 31, 1995. Of the Bank's
multi-family residential loans at December 31, 1996, $10.9 million were secured
by properties with 20 units or less and $11.8 million were secured by properties
with 21 units or more.
Multi-family and commercial real estate loans generally have higher
rates and entail different and significant risks when compared to single-family
residential lending because such loans typically involve larger loan balances to
individual borrowers and because the payment experience on such loans is
typically dependent on the successful operation of the project or the borrower's
business. These risks can also be significantly affected by supply and demand
conditions in the local market for apartments, offices, warehouses or other
commercial space. The Bank attempts to minimize its risk exposure by limiting
such lending to proven developers/owners, primarily considering borrowers with
existing
6
operating performance which can be analyzed, requiring conservative debt
coverage ratios, and periodically monitoring the operation and physical
condition of the collateral.
Construction Loans. The Bank's construction loan portfolio consists of
loans to individuals to construct their primary residences, to custom home
builders and to developers. The loans to individuals and custom home builders
generally have a maximum term of twelve months, have variable rates of interest
based upon the prime rate as quoted in the eastern edition of The Wall Street
Journal ("Prime Rate") plus a margin, have loan-to-value ratios of 85% or less
of the appraised value upon completion and generally do not require the
amortization of principal during the term. The Bank typically requires that
permanent financing, with the Bank or some other lender, be in place prior to
closing a construction loan to an individual, but may make loans without such
requirement to custom home builders or developers.
At December 31, 1996, the majority of the Bank's construction loan
portfolio consisted of construction loans and lines of credit to developers.
Such loans generally have terms of 36 months or less, have maximum loan-to-value
ratios of the lesser of 75% of the appraised value upon completion or 85% of the
discounted prospective future value upon completion and generally do not require
the amortization of the principal during the term. Generally, the loans are made
with adjustable rates of interest based on the Prime Rate plus a margin. The
Bank generally receives origination fees, which range from 0.5% to 2.0% of the
commitment. The majority of such loans consist of loans to selected local
developers with whom the Bank is familiar to build single-family dwellings on
either a pre-sold or speculative basis; however, the Bank generally limits the
number of unsold units which are under construction. The borrower is required to
have a minimum of 15% equity in the project. Loan proceeds are disbursed in
stages after inspections of the project indicate that such disbursements are for
costs already incurred and which have added to the value of the project. The
Bank's construction loans include loans to developers to acquire the necessary
land, develop the site and construct the residential units ("ADC loans"). Upon
the release of any lot to a buyer, the Bank generally requires the developer to
make a payment on the loan equal to the greater of 110% of the pro rata loan
advanced on such lot or 70% of the sales price. The Bank also originates
construction loans for the construction of commercial properties.
At December 31, 1996, construction loans totaled $58.2 million, or 8.7%,
of the total loan portfolio, an increase of $32.9 million, or 129.7%, compared
to $25.4 million, or 5.2% of the loan portfolio at December 31, 1995. This
increase resulted from the acquisition of Seaboard as well as the Bank's
strategy to increase its market share in construction lending. At December 31,
1996, the construction loan portfolio consisted of $53.3 million, which were
secured by commercial properties and $4.9 million, which were secured by
residential properties.
Prior to making a commitment to fund a construction loan, the Bank
requires an appraisal of the property by the Bank's appraisal staff or
independent state-licensed and certified appraisers approved by the Board of
Directors. Officers of the Bank also review and inspect each project prior to
the commencement of construction. In addition, the project is inspected by at
least one officer or contract agent of the Bank prior to every disbursement of
funds during the term of the construction loan. Such inspection includes a
review for compliance with the construction plans, including materials
specifications.
Construction financing usually has higher interest rates and is
generally considered to involve a higher degree of risk of loss than long-term
financing on improved, owner-occupied real estate. Risk of loss on a
construction loan is dependent largely upon the accuracy of the initial estimate
of the property's value at completion of construction or development and the
estimated cost (including interest) of construction. During the construction
phase, a number of factors could result in delays and cost overruns. If the
estimate of value proves to be inaccurate, the Bank may be confronted, at or
prior to the maturity of the loan, with a project, when completed, having a
value which is insufficient to assure full repayment.
7
Land Loans. The Bank funds land loans to individuals and
builders/developers for their use in future construction activity. Loans in this
category include: residential consumer lot loans; loans for the acquisition and
development of land (loans to finance the purchase of land and the
accomplishment of all improvements required to convert it to developed building
lots); loans for the acquisition of developed building lots; and loans secured
by vacant land. Residential consumer lot loans generally are secured by
unimproved lots in the Bank's market area. Such loans are funded for the purpose
of constructing a residence to be occupied by the borrower. The Bank also makes
land acquisition and development loans to experienced and financially strong
builders and developers in order to provide additional construction and mortgage
lending opportunities for the Bank. Loans are also made available to qualified
builders and developers for the purpose of acquiring unimproved land to be
developed for residential building sites, residential housing subdivisions,
multi-family dwellings, and a variety of commercial uses. Land loans are also
available to facilitate the acquisition of developed lots for the purpose of
single family, townhomes and condominium construction. Land loans are
underwritten and processed by the Bank in much the same manner as commercial
construction and commercial real estate loans. Land lending generally involves
additional risks compared to loans secured by single family properties;
therefore, the Bank carefully evaluates the borrowers' assumptions and their
ability to service the loans if the original assumptions are incorrect due to
changes in market conditions and absorption rates. Land loans amounted to $3.7
million, or 0.6%, of the Bank's total loan portfolio at December 31, 1996.
Consumer Loans. The Bank offers consumer loans in its primary market
area in order to provide a full range of retail financial services to its
customers. At December 31, 1996, consumer loans amounted to $78.6 million, or
11.8%, of the Bank's total loan portfolio, an increase of $23.6 million, or
42.8%, compared to $55.1 million, or $11.2% of the total loan portfolio at
December 31, 1995. This increase resulted from the acquisition of Seaboard as
well as the Bank's strategy to increase its market share in consumer loans.
The largest component of the Bank's consumer loan portfolio is home
equity loans, which are secured by the underlying equity in the borrower's
residence or second home. Home equity loans are amortizing loans and generally
have fixed interest rates for fixed-term loans up to 15 years. Home equity loans
with terms greater than 15 years and up to 30 years have a provision allowing
for the loan to be called every three or five years. At December 31, 1996, home
equity loans amounted to $34.4 million, or 5.2%, of the Bank's total loan
portfolio.
The second largest component of the Bank's consumer loan portfolio is
automobile loans, both for new and used vehicles. The majority of such loans are
originated indirectly through automobile dealers located in the Bank's primary
market area. The term of such loans generally cannot exceed 72 months with
respect to new car financing and 48 months with respect to used car financing.
The Bank requires all borrowers to maintain automobile insurance, including
collision, fire and theft, with the Bank listed as loss payee. At December 31,
1996, automobile loans totaled $31.1 million, or 4.7%, of the total loan
portfolio.
At December 31, 1996, the Bank's remaining consumer loan portfolio was
comprised of secured and unsecured lines of credit, which amounted to $5.6
million, or 0.8%, of the Bank's total loan portfolio, and other consumer loans,
which amounted to $7.5 million, or 1.1%, of the Bank's total loan portfolio at
such date. The secured revolving lines of credit offered by the Bank consist
solely of home equity lines of credit in amounts of up to $100,000. Other
consumer loans include both MasterCard and VISA credit cards, which totaled $1.6
million at December 31, 1996, and other loans such as boat loans and personal
and other consumer credit.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. These risks are not as prevalent in the case of the
Bank's consumer loan portfolio, however, because a high percentage of the
portfolio is comprised of home equity
8
loans and home equity lines of credit which are secured by real estate and
underwritten in a manner such that they result in a lending risk which is
substantially similar to single-family residential loans.
Mortgage Banking. Due to customer preference for fixed-rate loans,
especially during the declining and relatively lower interest rate environment
in recent years, the Bank continued to originate such loans, and sold a
substantial amount of the long-term (15 years or more), fixed-rate mortgage
loans originated during 1994 and 1995, and, to a lesser extent, during 1996. The
Bank's net gains on sales of mortgage loans amounted to $12,000, $142,000 and
$95,000 during the years ended December 31, 1996, 1995 and 1994, respectively.
The Bank had no mortgage loans held for sale at either December 31, 1996,
December 31, 1995 or December 31, 1994.
The Bank's mortgage loans sold to others are sold in groups or on a
loan-by-loan basis primarily to the FHLMC. A period of 30 to 90 days generally
lapses between the closing of the loan by the Bank and its purchase by an
investor. Mortgages with established interest rates generally will decrease in
value during periods of increasing interest rates. Accordingly, fluctuations in
prevailing interest rates may result in a gain or loss to the Bank as a result
of adjustments to the carrying value of loans held for sale or on sale of loans.
Because of the increasing volatility in interest rates during 1994, the Bank
determined to originate and retain for portfolio more ARM loans and to retain
for portfolio a larger portion of newly originated long-term, fixed-rate
mortgage loans.
During 1995, the flattening yield curve had a dramatic effect on
lending, by making ARM loans less attractive for potential borrowers than fixed
rate loans; however, the Bank was able to originate a total of $109.2 million in
loans, of which $36.7 million were fixed-rate and $72.5 million were
adjustable-rate. Because of the concern for the impact on the net interest
margin and the interest-rate risk position of the Bank, approximately $10.5
million of lower yielding fixed-rate loans were originated for sale in the
secondary market during 1995, compared to $5.9 million during 1994.
Nevertheless, the Bank's net loans receivable rose $46.2 million, or 11.0%, from
$421.2 million ($177.0 million fixed-rate and $244.2 million adjustable-rate) at
the end of 1994, to $467.4 million ($193.2 million fixed-rate and $274.2 million
adjustable-rate) at the end of 1995.
In 1996 the interest rate yield curve steepened slightly to the level
that many potential borrowers preferred ARM loans once again. The Bank
originated $145.1 million in loans during the year, of which $93.2 million were
ARM loans. In an effort to leverage the Company, all except $880,000 of the
loans were retained in its portfolio. The result was that average loans
increased $130.0 million during the year, including the $69.2 million in loans
from the Seaboard acquisition.
Borrowers are generally charged an origination fee, which is a
percentage of the principal balance of the loan. In accordance with the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 91,
"Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases," the various fees received
by the Bank in connection with the origination of loans are deferred and
amortized as a yield adjustment over the lives of the related loans using the
interest method. However, when such loans are sold, the remaining unamortized
fees (which are all or substantially all of such fees due to the relatively
short period during which such loans are held) are recognized as income.
The Bank generally retains the servicing on loans sold. In addition, the
Bank services substantially all of the loans which are retained in its
portfolio. Loan servicing includes collecting and remitting loan payments,
accounting for principal and interest, making advances to cover delinquent
payments, making inspections as required of mortgaged premises, contacting
delinquent mortgagors, supervising foreclosures and property dispositions in the
event of unremedied defaults and generally administering the loans. Funds that
have been escrowed by borrowers for the payment of mortgage-related expenses,
such as property taxes and hazard and mortgage insurance premiums, are
maintained in noninterest-bearing
9
accounts at the Bank. At December 31, 1996, the Bank had $644,000 deposited in
escrow accounts for its loans serviced for others.
The following table presents information regarding the loans serviced by
the Bank for others at the dates indicated.
December 31,
-------------------------------------------------------
1996 1995 1994
--------------- --------------- ------------
(Dollars in Thousands)
Mortgage loans serviced for others:
FHLMC $131,514 $147,871 $152,359
Virginia Housing Development
Authority ("VHDA") 7,640 7,838 7,960
GNMA 17,646 19,352 20,883
Other investors 166 291 244
-------- -------- --------
Total loans serviced for others $156,966 $175,352 $181,446
======== ======== ========
The Bank receives fees for servicing mortgage loans, which generally
amount to 0.25% per annum, (0.44% in the case of loans serviced for the GNMA),
on the declining principal balance of the mortgage loans. Such fees serve to
compensate the Bank for the costs of performing the servicing function. Other
sources of loan servicing revenues include late charges on delinquent payments.
For the years ended December 31, 1996, 1995 and 1994, the Bank earned gross fees
of $577,000, $636,000 and $674,000, respectively, from loan servicing.
During 1995 and 1996, in an effort to price conventional, VA and FHA
fixed-rate, fixed-term loans more competitively, the Bank began pricing selected
loans for sale "servicing released." By selling servicing, the Bank is able to
offer a more competitive rate to borrowers resulting in an increased demand for
loans. Relationships were established with several wholesale loan purchasers.
During 1996 and 1995, $781,000 and $1.9 million, respectively, of VA and FHA
fixed-rate, fixed-term loans were sold servicing released to wholesalers.
Loans-to-One Borrower Limitations. Current regulations impose
limitations on the aggregate amount of loans that a savings institution could
make to any one borrower, including related entities. The permissible amount of
loans-to-one borrower follows the national bank standard for all loans made by
savings institutions, which generally does not permit loans-to-one borrower to
exceed 15% of unimpaired capital and surplus. Loans in an amount equal to an
additional 10% of unimpaired capital and surplus also may be made to a borrower
if the loans are fully secured by readily marketable securities. At December 31,
1996, Life Savings' five largest loans or groups of loans-to-one borrower,
including related entities, ranged from an aggregate of $6.3 million to $9.2
million, and the Bank's loans-to-one borrower limit was $18.2 million at such
date. Of the Bank's five largest loans or groups of loans-to-one borrower at
December 31, 1996, none were deemed to be non-accruing, although one borrower
had an outstanding balance of $6.4 million, of which $1.3 million was classified
as substandard and $3.4 million was designated as special mention due to past
delinquencies and financial difficulties of certain of the principals. See "-
Asset Quality - Potential Problem Loans."
Asset Quality
General. When a borrower fails to make a required payment on a loan, the
Bank attempts to cure the deficiency by contacting the borrower and seeking
payment. These contacts are generally made 15 days after a payment is due. In
most cases, deficiencies are cured promptly. If a delinquency continues, late
charges are assessed and additional efforts are made to collect the loan. While
the Bank prefers to work with borrowers to resolve such problems, when the
account becomes 90 days delinquent, the Bank generally pursues foreclosure or
other proceedings, as necessary, to minimize any potential loss.
10
Impaired Loans. Effective January 1, 1995, the Company adopted SFAS No.
114, as amended by SFAS No. 118. SFAS No. 114, as amended, provides that a loan
is impaired when, based on current information and events, it is probable that
the creditor will be unable to collect all principal and interest amounts due
according to the contractual terms of the loan agreement. SFAS No. 114, as
amended, requires that impaired loans be measured based on the present value of
the expected future cash flows, discounted at the loan's effective interest
rate. The effective interest rate of a loan is defined as the contractual
interest rate, adjusted for any deferred loan fees or costs, premiums or
discounts existing at the inception or acquisition of the loan. If the loan is
collateral dependent, as a practical expedient, impairment can be based on a
loan's observable market price or the fair value of the collateral. The value of
the loan is adjusted through a valuation allowance created through a charge
against income. Residential mortgages, consumer installment obligations and
credit cards may be excluded. Loans that were treated as in-substance
foreclosures under previous accounting pronouncements are considered to be
impaired loans and under SFAS No. 114, as amended, will remain in the loan
portfolio.
A loan may be placed on non-accrual status and not classified as an
impaired loan when in the opinion of management, based on current information
and events, it is probable that the Bank will collect all principal and interest
amounts due substantially consistent with the contractual terms of the loan
agreement. Interest income for impaired loans is generally recognized on an
accrual basis unless it is deemed inappropriate to do so. In those cases in
which the receipt of interest payments is deemed more uncertain, the cash basis
of income recognition is utilized. Loans are placed on non-accrual status when,
in the judgment of management, the probability of timely collection of interest
is deemed to be insufficient to warrant further accrual. As a matter of policy,
the Bank does not accrue interest on loans past due 90 days or more except when
the estimated value of the collateral and collection efforts are deemed
sufficient to ensure full recovery. When a loan is placed on non-accrual status,
previously accrued but unpaid interest is deducted from interest income.
The following table sets forth information relating to the Bank's
recorded investment in impaired loans at or during the periods indicated. Since
the data relating to impaired loans was not collected until January 1, 1995, the
date the Company adopted SFAS No. 114, as amended, certain data for periods
prior to such date is not available.
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1996 (1) 1995 1994
--------------- --------------- ---------------
(Dollars in Thousands)
Impaired loans for which there is a related
allowance for credit losses $9,022 $4,223 $4,129
Impaired loans for which there is no related
allowance for credit losses -- -- --
Total impaired loans $9,022 $4,223 $4,129
====== ====== ======
Allowance for credit losses on impaired
loans $3,500 $ 768 $ 702
====== ====== ======
Average impaired loans during the period $9,659 $4,493 N/A
====== ====== ======
Interest income recognized on impaired
loans during the time within the period that
the loans were impaired $ 506 $ 430 N/A
====== ====== ======
Interest income recognized on impaired
loans using a cash-basis method of
accounting during the time within the
period that the loans were impaired $ 506 $ 430 N/A
====== ====== ======
<FN>
- -----------------------------
(1) Includes loans obtained in the Seaboard acquisition which were designated as impaired loans by the Bank.
</FN>
11
Troubled Debt Restructurings. Under Generally Accepted Accounting
Principles ("GAAP"), the Bank is required to account for certain loan
modifications or restructurings as "troubled debt restructurings." In general,
the modification or restructuring of a debt constitutes a troubled debt
restructuring if the Bank, for economic or legal reasons related to the
borrower's financial difficulties, grants a concession to the borrower that the
Bank would not otherwise consider under current market conditions. Debt
restructurings or loan modifications for a borrower do not necessarily always
constitute troubled debt restructurings, however, and troubled debt
restructurings do not necessarily result in non-accrual loans. The Bank had $2.5
million of troubled debt restructurings, net of specific reserves, at December
31, 1996. Included in the Bank's troubled debt restructurings at December 31,
1996, is one loan with a carrying value of $1.1 million, net of specific
reserves, which is secured by an office warehouse complex. At December 31, 1996,
this loan was classified substandard. The loan was added as a troubled debt
restructuring as a result of the purchase of Seaboard Savings. At December 31,
1996, this loan was current. The remaining $1.4 million of troubled debt
restructurings at December 31, 1996, consisted of multi-family and commercial
properties located in Virginia Beach and Norfolk.
Non-Performing Assets. The following table sets forth information
relating to the Bank's net carrying value of its non-performing assets and
troubled debt restructurings at the dates indicated.
December 31,
---------------------------------------------------------------------------------
1996 (1) 1995 1994 1993 1992
------------ ------------ ------------ ------------ ------------
(Dollars in Thousands)
Non-performing assets:
Non-accruing loans:
Mortgage loans:
Single-family:
Conventional $1,498 $ 859 $ 341 $ 943 $ 1,554
FHA/VA 698 245 102 163 139
Multi-family -- -- 297 185 --
Commercial 46 436 778 39 1,812
Consumer loans 308 195 98 182 151
------ ------ ------- ------- -------
Total non-accruing loans 2,550 1,735 1,616 1,512 3,656
Real estate owned, net (2) 1,202 622 870 9,368 15,016
------ ------ ------- ------- -------
Total non-performing assets $3,752 $2,357 $ 2,486 $10,880 $18,672
====== ====== ======= ======= =======
Troubled debt restructurings, net (3) $2,464 $4,525 $ 8,511 $ 9,698 $ 8,857
====== ====== ======= ======= =======
Total non-performing assets and
troubled debt restructurings $6,216 $6,882 $10,997 $20,578 $27,529
====== ====== ======= ======= =======
Non-accruing loans to total loans
held for investment 0.41% 0.37% 0.38% 0.41% 0.85%
====== ====== ======= ======= =======
Total non-performing assets to total
assets 0.26% 0.21% 0.25% 1.41% 2.70%
====== ====== ======= ======= =======
Total non-performing assets and
troubled debt restructurings to
total assets 0.44% 0.63% 1.10% 2.67% 3.98%
====== ====== ======= ======= =======
<FN>
- -----------------------------
(1) Includes assets obtained in the Seaboard acquisition.
(2) Amounts are net of the allowance for real estate owned which amounted to $30,000, $33,000, $0, $5.1
million and $386,000 at December 31, 1996, 1995, 1994, 1993 and 1992, respectively.
(3) Amounts are net of specific valuation allowances which totaled $3.5 million, $719,000, $990,000, $0 and
$0 at December 31, 1996, 1995, 1994, 1993 and 1992, respectively.
</FN>
12
The Bank's real estate owned ("REO") at December 31, 1996, consisted of
18 properties, substantially each of which had carrying values of less than
$175,000. During 1996, the Bank sold 12 properties (8 single family residences,
2 hotel condominiums, 1 multi-family dwelling and one parcel of land which was
acquired through a deed in lieu of foreclosure) for an aggregate sales price of
approximately $4.0 million. After satisfying superior liens, deductions for
valuation allowances, repairs, holding costs and settlement expenses, the Bank
realized a net gain on the sale of these properties of $300,000. Additional
information regarding the Company's REO is in Management's Discussion and
Analysis of Financial Condition and Results of Operations and in Note 7 to the
Consolidated Financial Statements included in Items 7 and 8 hereof.
Potential Problem Loans. In addition to the loans included in the above
impaired loans and non-performing assets and troubled debt restructurings
tables, at December 31, 1996, the Bank had loans totaling $10.2 million which,
even though they were not impaired or categorized as a non-performing asset or
troubled debt restructuring, were designated as substandard or special mention.
At December 31, 1996, the Bank had eight performing loans totaling $5.5
million to five borrowers, which the Bank had designated as substandard. One
such loan, a performing construction loan, is secured by a retirement home under
construction in Virginia Beach. In August 1996 the partially constructed
building was substantially destroyed by fire and the Bank classified the loan as
substandard. At December 31, 1996, the loan was current as the borrower
continues to fund the interest payments and plans to rebuild. Of the remaining
seven loans, two loans totaling $1.5 million are secured by commercial
properties located in Norfolk, Virginia; three loans, totaling $600,000, are
secured by commercial properties in Virginia Beach; and two loans, totaling
$200,000, are secured by various multi-family properties and developed lots in
Norfolk, Virginia. At this time, the Bank does not anticipate losses on any of
these loans.
Additionally, at December 31, 1996, there were three performing loans,
totaling $4.7 million, to two borrowers which the Bank had designated as special
mention. All three of these loans are secured by multi-family dwelling units in
Norfolk and Virginia Beach. At this time, the Bank does not anticipate losses on
any of these loans.
Allowance for Loan Losses. Provisions for loan losses are charged to
earnings to bring the total allowance for loan losses to a level considered
appropriate by management based on historical experience, the volume and type of
lending conducted by the Company, the amount of the Company's classified assets,
the status of past due principal and interest payments, general economic
conditions, particularly as they relate to the Company's market area, and other
factors related to the collectibility of the Company's loan portfolio.
Management reviews the allowance for loan losses on a monthly basis and makes
provisions for loan losses as deemed appropriate in order to maintain the
adequacy of the allowance.
Effective December 21, 1993, the OTS, in conjunction with the Office of
the Comptroller of the Currency ("OCC"), the FDIC and the FRB, issued the Policy
Statement regarding an institution's allowance for loan and lease losses. The
Policy Statement, which reflects the position of the issuing regulatory agencies
and does not necessarily constitute GAAP, includes guidance (i) on the
responsibilities of management for the assessment and establishment of an
adequate allowance and (ii) for the agencies' examiners to use in evaluating the
adequacy of such allowance and the policies utilized to determine such
allowance. The Policy Statement sets forth the following quantitative measures
which examiners may use to determine the reasonableness of an allowance: (i) 50%
of the portfolio that is classified doubtful; (ii) 15% of the portfolio that is
classified substandard; and (iii) for the portions of the portfolio that have
not been classified (including loans designated special mention), estimated
credit losses over the upcoming twelve months based on facts and circumstances
available on the evaluation date. While the Policy Statement sets forth this
quantitative measure, such guidance is not intended as a "floor" or "ceiling."
Upon review of the Policy Statement, in 1994, the Bank reconsidered its policy
for establishing its
13
allowance for loan losses and made certain adjustments to the model it uses in
order to make provisions to the allowance.
The following table sets forth the activity in the Bank's allowance for
loan losses during the periods indicated.
Year Ended December 31,
---------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------- ------------- ------------- ------------- -------------
(Dollars in Thousands)
Allowance at beginning of
period $4,438 $4,459 $3,274 $2,741 $3,102
Allowance acquired from
Seaboard 5,185 -- -- -- --
Provisions (credited) charged to
operations (265) 454 1,431 715 894
Loans charged-off:
Mortgage loans:
Single-family (159) (157) (278) (109) (91)
Multi-family (38) (174) (291) (5) (194)
Construction -- -- -- -- --
Commercial -- (291) (233) (167) (840)
Residential lots -- -- -- (4) (3)
Consumer loans (395) (166) (266) (167) (358)
------ ------ ------ ------ ------
Total (592) (788) (1,068) (452) (1,486)
Other charge-off (837) -- -- -- --
Recoveries:
Mortgage loans:
Single-family 11 21 162 24 161
Multi-family -- 58 333 63 2
Construction -- -- -- -- --
Commercial 1,657 158 218 73 10
Consumer loans 59 76 109 110 58
------ ------ ------ ------ ------
Total 1,727 313 822 270 231
------ ------ ------ ------ ------
Allowance at end of period $9,656 $4,438 $4,459 $3,274 $2,741
====== ====== ====== ====== ======
Allowance for loan losses to
total non-accruing loans at
end of period 378.67% 255.79% 275.93% 216.53% 74.97%
====== ====== ====== ====== ======
Allowance for loan losses
to total impaired loans
at end of period (1) 107.03% 105.09% 108.00% N/A N/A
====== ====== ====== ======= =======
Allowance for loan losses
to total loans held for
investment at end of period 1.55% 0.95% 1.06% 0.89% 0.64%
====== ====== ====== ======= =======
- -----------------------------
<FN>
(1) Since the data relating to impaired loans was not collected until
January 1, 1995, the date the Company adopted SFAS No. 114, as amended,
certain data for periods prior to such date is not available.
</FN>
The Bank's model for calculating the minimum loan loss allowance applies
varying ratios to different types of loans, which are aggregated. However, the
Bank does not currently allocate its allowance for loan losses individually to
its various categories of loans.
14
The other charge-off in 1996 recognizes a potential loss from a fraud
perpetrated upon the Bank, of which $137,000 was recovered in the first quarter
of 1997. Additional claims and recoveries are pending, and the Bank continues to
diligently pursue all areas of collection; however, there can be no assurance
that there will be additional recoveries.
In July 1996, the Bank acquired by deed in lieu of foreclosure certain
properties located in Williamsburg, Virginia in settlement of a previously
charged-off deficiency relating to three Williamsburg hotels sold in October
1994. The acquired property was subsequently sold for $3.3 million and settled
on September 30, 1996. After satisfying superior liens on the property and other
costs associated with the acquisition and sale, the Bank netted a loan loss
recovery of $1.4 million and a gain on sale of REO of $206,000. This sizable
recovery during 1996 more than offset normally determined adjustments to the
Bank's loan loss allowance and resulted in a net loan loss credit for 1996 of
$265,000.
As of December 31, 1996, the Bank's allowance for loan losses amounted
to 54.0% of its substandard loans and 378.7% of total non-accruing loans.
Based on facts and circumstances currently available to the Company,
management believes that the allowance for loan losses was adequate at December
31, 1996. However, there can be no assurances that additions to such allowance
will not be necessary in future periods, which would adversely affect the
Company's results of operations.
Other Classified Assets. Federal regulations require that each insured
savings association review the classification of its assets on a regular basis.
In addition, in connection with examinations of insured institutions, federal
examiners have authority to identify problem assets and, if appropriate, require
re-classification. There are three classifications for problem assets:
"substandard," "doubtful" and "loss." Substandard assets have one or more
defined weaknesses and have the distinct possibility that the institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristics that
the weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions and values, questionable, and there is a high
possibility of loss. An asset classified loss is considered uncollectible and of
such little value that its continuance as an asset is not warranted. Another
category designated "special mention" also must be established and maintained
for assets which do not currently require classification as substandard,
doubtful or loss, but have potential weaknesses or risk characteristics that
could result in future problems.
At December 31, 1996, the Bank had $17.9 million of assets classified
substandard, and $135,000 classified as doubtful and $45,000 classified as loss.
In addition, at such date, $4.7 million were categorized as special mention.
Allowance for Losses on Real Estate Owned. In 1992, the Bank established
an allowance for losses on REO.
The following table sets forth the activity in the allowance for losses
on REO during the periods indicated.
Year Ended December 31,
----------------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------ ------------ ------------ ------------ ------------
(Dollars in Thousands)
Allowance at beginning of period $ 33 $ -- $ 5,060 $ 386 $ --
Allowance acquired from
Seaboard 8 -- -- -- --
Provisions charged to operations 61 41 746 6,290 3,177
Losses charged-off (72) (11) (5,808) (1,701) (3,047)
Recoveries -- 3 2 85 256
---- ---- ------- ------- -------
Allowance at end of period $ 30 $ 33 $ -- $ 5,060 $ 386
==== ==== ======= ======= =======
15
The 1995 provision and $230,000 of the 1994 provision were made to
absorb periodic charges to the allowance for losses on REO necessary to reflect
the fair value of the Bank's REO. Substantially all the Bank's allowance for
losses on REO at December 31, 1993, were related to three hotel properties owned
by the Bank, which were sold during 1994. Additionally, $516,000 of the 1994
provision and the provisions during 1993 and 1992 were related to those same
hotel properties. The provision in 1994 reflected a final valuation upon the
sale of the hotel properties, while the provisions in 1993 reflect, to a large
extent, an outside valuation received by management of the Bank as well as sales
negotiations with respect to the hotels and, to a lesser extent, an OTS
examination in the fourth quarter of 1993 which resulted in the Bank making
provisions with respect to certain other REO properties. The provision in 1992
was due primarily to adjustments to the carrying values of the hotels upon the
Bank's consideration of the results of an OTS examination during the fourth
quarter of that year. See " - Non-Performing Assets."
Investments and Mortgage-Backed Securities
Investments. Federally-chartered savings institutions have authority to
invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies and state and municipal
governments, certificates of deposit at federally-insured banks and savings
institutions, certain bankers' acceptances and Federal funds. Subject to various
restrictions, federally-chartered savings institutions may also invest a portion
of their assets in commercial paper, corporate debt securities and mutual funds,
the assets of which conform to the investments that federally-chartered savings
institutions are otherwise authorized to make directly.
At December 31, 1996, investment securities totaled $30.7 million all of
which were classified as available-for-sale. At such date, the remaining
investment securities had a contractual maturity of between 1 month and 9.2
years, and the portfolio had a weighted average yield of 6.82%.
The following table sets forth information regarding the amortized cost
and estimated market value of the Company's investment securities at the dates
indicated.
December 31,
---------------------------------------------------------------------------------------------
1996 1995 1994
---------------------------- ---------------------------- ---------------------------
Estimated Estimated Estimated
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
----------- ----------- ----------- ----------- ----------- -----------
(Dollars in Thousands)
U.S. Government and
federal agency
obligations:
Held-to-maturity -- -- -- -- $18,414 $17,984
Available-for-sale $31,316 $30,742 $17,957 $18,025 -- --
Mutual Funds:
Available-for-sale -- -- 5,000 5,015 -- --
------- ------- ------- ------- ------- -------
$31,316 $30,742 $22,957 $23,040 $18,414 $17,984
======= ======= ======= ======= ======= =======
Additional information regarding the Company's investments is discussed
in the "Financial Condition" section of Management's Discussion and Analysis of
Financial Condition and Results of Operations and in Notes 3 and 4 to the
Consolidated Financial Statements included in Items 7 and 8 hereof.
Mortgage-Backed Securities.The Bank maintains a significant portfolio of
mortgage-backed securities as a means of investing in housing-related mortgage
instruments without the costs associated
16
with originating mortgage loans for portfolio retention and with limited credit
risk of default which arises in holding a portfolio of loans to maturity.
Mortgage-backed securities (which also are known as mortgage participation
certificates or pass-through certificates) represent a participation interest in
a pool of single-family or multi-family mortgages. The principal and interest
payments on mortgage-backed securities are passed from the mortgage servicer,
through intermediaries (generally U.S. Government agencies and
government-sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Bank. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and interest to investors, primarily include the FHLMC, the
Federal National Mortgage Association ("FNMA") and the GNMA. The Bank also
invests in certain privately issued, credit enhanced mortgage-backed securities
rated AAA or AA by national securities rating agencies.
The FHLMC, a public corporation chartered by the U.S. Government, issues
participation certificates backed principally by conventional mortgage loans.
The FHLMC guarantees the timely payment of interest and the ultimate return of
principal on participation certificates. The FNMA is a private corporation
chartered by the U.S. Congress with a mandate to establish a secondary market
for mortgage loans. The FNMA guarantees the timely payment of principal and
interest on FNMA securities. FHLMC and FNMA securities are not backed by the
full faith and credit of the United States, but, because the FHLMC and the FNMA
are U.S. Government-sponsored enterprises, these securities are considered to be
among the highest quality investments with minimal credit risks. The GNMA is a
government agency within the Department of Housing and Urban Development which
is intended to help finance government-assisted housing programs. GNMA
securities are backed by FHA-insured and VA-guaranteed loans, and the timely
payment of principal and interest on GNMA securities are guaranteed by the GNMA
and backed by the full faith and credit of the U.S. Government. Because the
FHLMC, the FNMA and the GNMA were established to provide support for low- and
middle-income housing, there are limits to the maximum size of loans that
qualify for these programs, which limit is currently $214,600. A number of
private institutions have also established their own home securitization
programs.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a specified range and have varying
maturities. The underlying pool of mortgages can be composed of either
fixed-rate or adjustable-rate loans. As a result, the risk characteristics of
the underlying pool of mortgages, (i.e., fixed-rate or adjustable rate) as well
as prepayment risk, are passed on to the certificate holder. The life of a
mortgage-backed, pass-through security thus approximates the life of the
underlying mortgages.
Mortgage-backed securities include regular and residual interests in
Collateralized Mortgage Obligations ("CMO"), including CMOs which qualify as a
Real Estate Mortgage Investment Conduit ("REMIC") under the Internal Revenue
Code of 1986, as amended ("Code") (CMOs and REMICs sometimes are referred to
collectively as "mortgage-related securities"). CMOs have been developed in
response to investor concerns regarding the uncertainty of cash flows associated
with the prepayment option of the underlying mortgagor and are typically issued
by governmental agencies, governmental sponsored enterprises and special purpose
entities, such as trusts, corporations or partnerships, established by financial
institutions or other similar institutions. A CMO can be collateralized with
loans or by securities which are insured or guaranteed by the FNMA, the FHLMC or
the GNMA. In contrast to pass-through mortgage-backed securities, in which cash
flow is received pro rata by all security holders, the cash flow from the
mortgages underlying a CMO is segmented and paid in accordance with a
predetermined priority to investors holding various CMO classes. By allocating
the principal and interest cash flows from the underlying collateral among the
separate CMO classes, different classes of bonds are created, each with its own
stated maturity, estimated average life, coupon rate and prepayment
characteristics.
The short-term classes of a CMO usually carry a lower coupon rate than
the longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the
17
CMO. As the early coupon classes are extinguished, the residual cash flow
declines. Thus, the longer the lower coupon classes remain outstanding, the
greater the cash flow accruing to CMO residuals. Generally, as interest rates
decline, prepayments accelerate, the interest differential narrows, and the
future cash flow from the CMO declines. Conversely, as interest rates increase,
prepayments generally decrease, generating a larger future cash flow to the
residual class.
A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by the FNMA, FHLMC or GNMA. These structures divide mortgage pools
into two risk classes: a senior class and one or more subordinated classes. The
subordinated classes provide protection to the senior class. When cash flow is
impaired, debt service goes first to the holders of senior classes. In addition,
incoming cash flows also may go into a reserve fund to meet any future
shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any funds until the holders of senior
classes have been paid and, when appropriate, until a specified level of funds
has been contributed to the reserve fund.
Certain mortgage-related securities, including REMIC residuals, are
classified as "high-risk mortgage securities" under OTS Thrift Bulletin 52 ("TB
52"). Pursuant to TB 52, a savings institution such as the Bank generally may
only acquire high-risk mortgage securities, which are defined as any
mortgage-related security that at the time of purchase, or at any subsequent
date, meets any of the three tests set forth therein, to reduce its overall
interest-rate risk. An institution with strong capital and earnings and adequate
liquidity and that has a closely supervised trading department may acquire such
securities if they are reported as trading assets or available-for-sale at
market value. At December 31, 1996, the Bank had one mortgage-related security
designated as a high-risk mortgage security under TB 52. This security had a
carrying value of approximately $332,000 and was acquired by the Bank in the
acquisition of Seaboard.
Mortgage-backed securities generally yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which minimize credit risk. In addition, mortgage-backed securities
are more liquid than individual mortgage loans and may be used to collateralize
certain obligations of the Bank. At December 31, 1996, $291.4 million, or 41.5%,
of the Bank's mortgage-backed securities were pledged to secure various
obligations of the Bank. Mortgage-backed securities issued or guaranteed by the
FNMA or the FHLMC (except interest-only securities or the residual interests in
CMOs) are weighted at no more than 20.0% for risk-based capital purposes,
compared to a weight of 50.0% to 100.0% for residential loans. See "Regulation -
The Bank Regulatory Capital Requirements."
In addition to mortgage-backed securities issued by FNMA, FHLMC or GNMA,
commonly called agency securities, the Bank invests in highly rated, investment
grade, private label mortgage-backed securities structured in the form of a
REMIC. At December 31, 1996, included in the Company's aggregate total of $706.1
million mortgage-backed securities there were $168.5 million ($139.6 million
fixed-rate and $28.9 million adjustable-rate) in REMICs. Of this amount $147.4
million were rated AAA by at least two nationally recognized rating agencies.
The remaining $21.1 million were rated AA.
The Bank's mortgage-backed securities are classified as either
"held-to-maturity" or "available-for-sale" based upon the Bank's intent and
ability to hold such securities to maturity at the time of purchase, in
accordance with GAAP. At December 31, 1996, mortgage-backed securities (both
held-to-maturity and available-for-sale) totaled $706.1 million. At such date,
the held-to-maturity mortgage-backed securities totaled $141.0 million ($10.2
million adjustable-rate and $130.8 million fixed-rate), and the available-for
sale totaled $565.1 million ($390.9 million adjustable-rate and $174.2 million
fixed-rate). The Bank classified all mortgage-backed securities purchased during
1996 as available-for-sale, providing the Bank with increased asset and
liability management flexibility to react to yield curve and interest rate
changes. At December 31, 1996, the Company's mortgage-backed securities
available-for-sale had an unrealized gain of $2.3 million, net of taxes, which
was added to stockholders' equity at such date per
18
SFAS No. 115. Higher interest rates will cause the carrying value of the
available-for-sale portfolio to be reduced, which will result in an adjustment
to stockholders' equity. Additional information on Life's mortgage-backed
securities portfolio may be found in Notes 3, 4 and 22 of the Notes to
Consolidated Financial Statements included in Item 8 hereof. The tables below
present the Bank's mortgage-backed securities on the basis of these
classifications, which are included in the Bank's Consolidated Financial
Statements. In accordance with SFAS No. 115, the mortgage-backed securities of
the Bank, which are held-to-maturity, are carried at cost, adjusted for the
amortization of premiums and the accretion of discounts using a method which
approximates a level yield, while mortgage-backed securities available-for-sale
are carried at the current market value, net of taxes.
The following table sets forth the composition of the Bank's
mortgage-backed securities at the dates indicated.
December 31,
-----------------------------------------------------------------------------------------
1996 1995 1994
----------------------------- --------------------------- ---------------------------
Held to Available for Held to Available for Held to Available for
Maturity Sale Maturity Sale Maturity Sale
------------ ------------- ------------ ------------ ------------ ------------
(Dollars in Thousands)
Mortgage-backed securities:
FHLMC $ 71,457 $179,930 $ 88,934 $169,961 $212,870 $ 47,735
FNMA 58,007 156,503 67,907 92,007 177,251 47,552
GNMA 1,485 64,631 1,738 3,538 2,089 3,581
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 130,949 401,064 158,574 265,506 392,210 98,868
-------- -------- -------- -------- -------- --------
REMICs:
FHLMC 10,025 1,363 10,028 -- 10,034 --
FNMA -- 9,743 -- 10,612 -- 11,398
Private label -- 149,153 -- 114,607 -- 3,439
-------- -------- -------- -------- -------- --------
Total REMICs 10,025 160,259 10,028 125,219 10,034 14,837
-------- -------- -------- -------- -------- --------
Total mortgage-backed and
REMICs, net $140,974(1) $561,323(1) $168,602(2) $390,725(2) $402,244(3) $113,705(3)
======== ======== ======== ======== ======== ========
Total market value $141,269 $565,086 $169,195 $393,587 $388,252 $107,264
======== ======== ======== ======== ======== ========
<FN>
(1) At December 31, 1996, $165.2 million and $366.8 million of the Bank's
mortgage-backed securities had fixed rates and adjustable rates,
respectively, and $141.4 million and $28.9 million of the Bank's REMICs
had fixed rates and adjustable rates, respectively.
(2) At December 31, 1995, $219.5 million and $204.5 million of the Bank's
mortgage-backed securities had fixed rates and adjustable rates,
respectively, and $87.3 million and $48.1 million of the Bank's REMICs
had fixed rates and adjustable rates, respectively.
(3) At December 31, 1994, $299.0 million and $192.1 million of the Bank's
mortgage-backed securities had fixed rates and adjustable rates,
respectively, and $17.8 million and $7.0 million of the Bank's REMICs
had fixed rates and adjustable rates, respectively.
</FN>
At December 31, 1996, the weighted average contractual maturity of the
Bank's mortgage-backed securities and REMICs was approximately 22 years. The
actual maturity of a mortgage-backed security is less than its stated maturity
due to prepayments of the underlying mortgages. At such date, the estimated
average life and duration of the Bank's mortgage-backed securities and REMICs
were 4.4 and 3.1 years, respectively. Prepayments that are faster than
anticipated may shorten the life of the security and could adversely affect its
yield to maturity. The yield is based upon the interest income and the
amortization of any premium or discount related to the mortgage-backed security.
In accordance with GAAP, premiums and discounts are amortized to provide a level
yield over the estimated lives of the mortgage-backed securities, which decrease
and increase interest income, respectively. The prepayment assumptions used to
determine the amortization period for premiums and discounts can significantly
affect the yield of the mortgage-backed security; therefore, these assumptions
are reviewed periodically to reflect actual prepayments. Although prepayments of
underlying mortgages depend on many factors,
19
including the type of mortgages, the coupon rate, the age of mortgages, the
geographical location of the real estate collateralizing the mortgages and
general levels of market interest rates, the difference between the interest
rates on the underlying mortgages and the prevailing mortgage interest rates
generally is the most significant determinant of the rate of prepayments. During
periods of falling mortgage interest rates, if the coupon rate of the underlying
mortgages exceeds the prevailing market interest rates offered for mortgage
loans, refinancing generally increases and accelerates the prepayment of the
underlying mortgages and the related security. Under such circumstances, the
Bank may be subject to reinvestment risk because, to the extent that the Bank's
mortgage-related securities amortize or prepay faster than anticipated, the Bank
may not be able to reinvest the proceeds of such repayments and prepayments at
comparable rates. The declining yields earned during recent periods is a direct
response to falling interest rates and accelerated prepayments.
In an effort to reduce the Bank's exposure to interest-rate risk, during
1994, 1995 and 1996, the Bank increased its investment in adjustable rate
mortgage-backed securities and REMICs. At December 31, 1996, of the Bank's
$706.1 million in mortgage-backed securities and REMICs, net, $401.1 million, or
56.8%, had adjustable rate features. As of December 31, 1996, $359.7 million of
the Bank's adjustable securities were backed by mortgages which adjust to a
margin over the one-year U.S. Treasury obligation adjusted to a CMT.
Additional information regarding the Company's mortgage-backed
securities is discussed in Management's Discussion and Analysis of Financial
Condition and Results of Operations and in Notes 3 and 4 to the Consolidated
Financial Statements included in items 7 and 8 hereof.
Sources of Funds
General. The Company's principal source of funds for use in lending,
investments and for other general business purposes includes deposits,
borrowings from the FHLB of Atlanta and other sources, including securities sold
under agreements to repurchase ("Repos") and stockholders' equity. The Company
also derives funds from amortization and prepayments of outstanding loans and
mortgage-backed securities, from sales of loans and from maturing investment
securities. Loan repayments are a relatively stable source of funds, while
deposits inflows and outflows are significantly influenced by general interest
rates and money market conditions. The Company uses borrowings to supplement
deposits.
Deposits. The Bank's current deposit products include passbook accounts,
negotiable order of withdrawal ("NOW") accounts, money market deposit accounts,
certificates of deposit ranging in terms from 14 days to 10 years and
noninterest-bearing personal and business checking accounts. The Bank's deposit
products also include Individual Retirement Account ("IRA") certificates, Keogh
accounts and other retirement accounts.
The Bank's deposits are obtained from residents in its immediate market
area and, with respect to larger (over $95,000 certificates of deposit), from
depositors throughout the United States. The Bank attracts local deposit
accounts by offering a wide variety of accounts, competitive interest rates, and
convenient branch office locations and service hours. The Bank utilizes
traditional marketing methods to attract new customers and savings deposits,
including print media, radio and television advertising and direct mail. The
Bank also accepts a substantial amount of its deposits from out-of-state through
deposit brokers; however, the Bank does not actively solicit such funds nor does
it pay any brokerage fees in accepting such deposits.
The Bank has been competitive in the types of accounts and interest
rates it has offered on its deposit products, but does not necessarily seek to
match the highest rates paid by competing institutions. During 1996, deposits
increased by $125.2 million or 20.6%, including $66.8 million from the
acquisition of Seaboard. The overall increase in deposits was primarily due to
increases in certificates
20
of deposit which totaled $578.9 million or 79.1% of the Bank's deposit portfolio
at December 31, 1996. During 1996, the majority of this increase was in
certificates of deposit with remaining maturities of less than one year.
Certificates of deposit with remaining maturities of one year or less increased
from 57.1% of the Bank's total certificates of deposit at December 31, 1994, to
64.1% of the Bank's total certificates of deposit at December 31, 1995 and to
69.2% at December 31, 1996. Additionally, the Bank's money market accounts
increased both in terms of dollars and as a percent of total deposits as a
result of the Bank's successful marketing campaign offering a tiered money
market account having rates highly competitive with money market funds. The Bank
intends to continue its efforts to attract certificates of deposit and checking
accounts as a principal source of funds for supporting its lending and
investment activities.
The following table sets forth certain information relating to the
Bank's deposits at the dates indicated.
December 31,
-----------------------------------------------------------------------------------------------
1996 (1) 1995 1994
---------------------------- ----------------------------- ----------------------------
Percent Percent Percent
of Total of Total of Total
Amount Deposits Amount Deposits Amount Deposits
------------ ------------ ------------ ------------ ------------ -----------
(Dollars in Thousands)
NOW accounts $ 29,496 4.03% $ 26,294 4.33% $ 23,445 3.98%
Money market accounts 68,704 9.38 34,025 5.60 39,274 6.68
Noninterest-bearing
checking accounts 2,557 0.35 1,403 0.23 909 0.16
-------- ------ -------- ------- -------- ------
Total demand deposits 100,757 13.76 61,722 10.16 63,628 10.82
-------- ------ -------- ------- -------- ------
Passbook savings
deposits 52,521 7.17 58,208 9.59 65,441 11.12
-------- ------ -------- ------- -------- ------
Certificates of deposit:
6 months or less 277,716 37.92 216,139 35.60 173,287 29.46
7-12 months 122,624 16.74 96,038 15.82 88,842 15.10
13-36 months 141,348 19.30 127,827 21.05 144,083 24.49
More than 36 months 37,189 5.08 47,205 7.78 52,981 9.01
-------- ------ -------- ------- -------- ------
Total certificates 578,877 79.05 487,209 80.25 459,193 78.06
-------- ------ -------- ------- -------- ------
Purchase accounting -
Seaboard 167 .02 N/A N/A
-------- ------ -------- --------
Total deposits $732,322 100.00% $607,139 100.00% $588,262 100.00%
======== ====== ======== ====== ======== ======
<FN>
- -----------------------------
(1) Includes deposits from the acquisition of Seaboard
</FN>
The following table sets forth the activity in the Bank's deposits
during the periods indicated.
Year Ended December 31,
-----------------------------------------
1996 1995 1994
------------ ------------ ------------
(Dollars in Thousands)
Beginning balance $607,139 $588,262 $528,932
Deposits acquired from Seaboard 66,854 N/A N/A
Net increase (decrease)
before interest credited 35,291 (611) 43,610
Interest credited 23,038 19,488 15,720
-------- -------- --------
Net increase in deposits 125,183 18,877 59,330
-------- -------- --------
Ending balance $732,322 $607,139 $588,262
======== ======== ========
21
The following table sets forth, by various interest rate categories, the
certificates of deposit with the Bank at the dates indicated.
December 31,
-----------------------------------------------
1996 1995 1994
------------ ------------ ------------
(Dollars in Thousands)
3.00% to 3.99% $ 68 $ 1,370 $ 36,262
4.00% to 4.99% 32,834 49,946 199,631
5.00% to 6.99% 521,509 401,781 186,033
7.00% to 8.99% 21,703 29,747 29,694
9.00% to 10.99% 2,763 4,365 7,562
11.00% and over -- -- 11
-------- -------- --------
$578,877 $487,209 $459,193
======== ======== ========
The following table sets forth the amount and maturities of the Bank's
certificates of deposit at December 31, 1996.
Over Six Over One Over Two
Months Year Years
Six Months Through Through Through Over
and Less One Year Two Years Three Years Three Years
-------------- -------------- -------------- --------------- ---------------
(Dollars in Thousands)
3.00% to 3.99% $ 5 $ -- $ 62 $ -- $ 1
4.00% to 4.99% 21,546 9,993 1,140 155 --
5.00% to 6.99% 253,299 107,300 89,319 42,255 29,336
7.00% to 8.99% 2,229 5,331 1,286 5,005 7,852
9.00% to 10.99% 637 -- 1,448 678 --
-------- -------- ------- ------- -------
$277,716 $122,624 $93,255 $48,093 $37,189
======== ======== ======= ======= =======
At December 31, 1996, the Bank had $84.0 million of certificates of
deposit in amounts of $100,000 or more, of which $24.0 million was scheduled to
mature in three months, $17.3 million was scheduled to mature in over three
months through six months, $15.7 million was scheduled to mature in over six
months through 12 months and $27.0 million was scheduled to mature in over 12
months.
Additional information regarding the Company's deposits is discussed in
Management's Discussion and Analysis of Financial Condition and Results of
Operations and in Note 10 to the Consolidated Financial Statements included in
Items 7 and 8 hereof.
Borrowings. The Company's borrowings are comprised of (i) advances from
the FHLB of Atlanta, which totaled $261.7 million at December 31, 1996; (ii)
Repos considered as borrowings, which totaled $259.0 million at December 31,
1996; and (iii) other borrowings, which totaled $5.2 million at December 31,
1996. The Company's borrowings are generally used to fund lending, investments
and other ordinary course of business activities.
The Bank may obtain advances from the FHLB of Atlanta upon the security
of the common stock it owns in that bank and certain of its residential mortgage
loans and securities, provided certain standards related to credit-worthiness
have been met. Such advances are made pursuant to several credit programs, each
of which has its own interest rate and range of maturities. From time to time
the Company also enters into agreements to sell securities under terms which
require it to repurchase the same or substantially similar securities by a
specified date. Repos are considered borrowings which are secured by the sold
securities. Historically, Repos were generally short-term (90 days or less) in
nature;
22
however, longer-term (greater than 90 days up to three years) Repos have
recently become available, and the Company has utilized such in managing its
asset and liability structure. The Company continuously reviews alternative
sources of borrowings and in this regard has more recently increased its use of
advances from the FHLB of Atlanta relative to Repos due to the FHLB of Atlanta's
lower costing advances.
In addition to FHLB advances and Repos, the Company's borrowings at
December 31, 1996, include $5.2 million of a long-term CMO financing originated
in 1985, for $32.1 million through a wholly owned, single purpose finance
subsidiary of the Bank. Such obligation, which had an average rate of 11.6%
during the year ended December 31, 1996, is not due to mature until 2016, but,
due to significant prepayments, the balance has been amortized much more rapidly
than initially anticipated.
Additional information regarding the Company's borrowings, including
maturities, is discussed in Management's Discussion and Analysis of Financial
Condition and Results of Operations and in Notes 11, 12 and 13 to the
Consolidated Financial Statements included in Items 7 and 8 hereof.
The following table sets forth certain information relating to the
Company's borrowings at the dates or for the periods indicated.
At or For the Year Ended December 31,
-------------------------------------------------------------------------------------------
1996 1995 1994
-------------------------- ------------------------- -------------------------
(Dollars in Thousands)
FHLB advances:
Maximum balance $261,711 $185,336 $196,727
Average balance $161,646 $166,725 $180,741
Balance at end of period $261,711 $148,636 $174,977
Weighted average rate:
at end of period 5.67% 6.16% 6.16%
during the period 6.14% 6.11% 5.04%
Repurchase agreements:
Maximum balance $361,145 $195,000 $ 65,468
Average balance $258,417 $114,058 $ 11,475
Balance at end of period $259,000 $162,000 $ 65,468
Weighted average rate:
at end of period 5.60% 6.02% 6.03%
during the period 5.67% 6.17% 6.45%
Other borrowings:
Maximum balance $ 6,518 $ 7,015 $ 9,590
Average balance $ 5,869 $ 6,807 $ 8,660
Balance at end of period $ 5,227 $ 6,518 $ 7,744
Weighted average rate:
at end of period 11.63% 11.64% 11.65%
during the period 11.63% 11.63% 11.61%
Stockholders' Equity. Stockholders' equity provides a source of
permanent funding, allows for future growth and provides the Company with a
cushion to withstand unforeseen, adverse developments. At December 31, 1996,
stockholders' equity totaled $150.9 million or 10.6% of total assets.
Additional information regarding the Company's stockholders' equity is
discussed in the "Financial Condition" section of Management's Discussion and
Analysis of Financial Condition and Results of Operations and in Note 4 to the
Consolidated Financial Statements included in Items 7 and 8 hereof.
23
Subsidiaries
The Bank is permitted to invest up to 2% of its assets in the capital
stock of, or in secured or unsecured loans to, subsidiary corporations, with an
additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. Under such limitations,
as of December 31, 1996, the Bank was authorized to invest up to approximately
$28.4 million in the stock of, or in loans to, service corporations. As of
December 31, 1996, the net book value of the Bank's investment in stock,
unsecured loans, and conforming loans in its service corporations was $2.5
million.
The Bank has five active, wholly-owned subsidiaries. A brief description
of the activities of these five subsidiaries is set forth as follows.
The First Colony Service Corporation. The First Colony Service
Corporation ("First Colony") engages in activities permissible for service
corporations under OTS regulations. First Colony acts as trustee for the Bank's
secured lending activity. As of December 31, 1996, First Colony's total assets
amounted to $124,000.
Life Financial Services Corporation. Life Financial Services Corporation
("Life Financial") was incorporated in November 1993, for the purpose of
offering the Bank's accountholders and the general public a full range of
non-FDIC insured investment products including annuities, insurance, general
securities, mutual funds and financial planning services. Life Financial is a
duly licensed insurance agent/agency under the laws of the Commonwealth of
Virginia. As of December 31, 1996, Life Financial's total assets amounted to
$433,000.
Life Capital Corporation. Life Capital Corporation ("Life Capital") is a
single-purpose finance subsidiary of the Bank. During 1985, Life Capital issued
$32.1 million of debt securities secured principally by mortgage-backed
securities. At December 31, 1996, $5.2 million of such long-term debt remained
outstanding. See "- Sources of Funds - Borrowings." As of December 31, 1996,
Life Capital's total assets amounted to $7.5 million.
Life Products Corp. The activities of Life Products Corp. ("Life
Products") consisted of owning and operating three hotel properties located in
Williamsburg, Virginia, each acquired by the Bank through foreclosure, which
were sold in 1994. As of December 31, 1996, Life Products' total assets amounted
to $450. See "- Asset Quality - Non-Performing Assets."
Seaboard Equity Corporation. Seaboard Equity Corporation ("Seaboard
Equity") engages in activities permissible for service corporations under OTS
regulations and acts as trustee on certain of the loans acquired from Seaboard.
At December 31, 1996, Seaboard Equity's total assets amounted to $575.
Employees
The Company and the Bank (including the Bank's wholly-owned
subsidiaries) had an aggregate of 227 full-time employees and 14 part-time
employees as of December 31, 1996. None of these employees is represented by a
collective bargaining agreement. The Company and the Bank each believes that it
enjoys excellent relations with its personnel.
Competition
The Bank faces strong competition both in attracting deposits and making
real estate loans. Its most direct competition for deposits has historically
come from other savings associations, credit unions and commercial banks located
in the Hampton Roads area of Virginia, including many large financial
institutions which have greater financial and marketing resources available to
them. In addition, during
24
times of high interest rates, the Bank has faced additional significant
competition for investors' funds from short-term money market securities, mutual
funds and other corporate and government securities. The ability of the Bank to
attract and retain savings deposits depends on its ability to generally provide
a rate of return, liquidity and risk comparable to that offered by competing
investment opportunities.
The Bank experiences strong competition for real estate loans
principally from other savings associations, commercial banks and mortgage
banking companies. The Bank competes for loans principally through the interest
rates and loan fees it charges, the efficiency and quality of services it
provides borrowers and the convenient locations of its branch office network.
Competition may increase as a result of the continuing reduction of restrictions
on the interstate operations of financial institutions.
Regulation
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of the Company and the Bank. The description of
these laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, does not purport to be complete and is qualified in
its entirety by reference to applicable laws and regulations.
The Company. The Company is a registered savings and loan holding
company and is subject to OTS regulations, examinations, supervision and
reporting requirements. As a subsidiary of a savings and loan holding company,
the Bank is subject to certain restrictions in its dealings with the Company and
affiliates thereof.
Federal Activities Restrictions. There are generally no restrictions on
the activities of a savings and loan holding company with only one subsidiary
savings association. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association; (ii)
transactions between the savings association and its affiliates; and (iii) any
activities of the savings association that might create a serious risk such that
the liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet a qualified
thrift lender ("QTL") test, then such unitary holding company also shall become
subject to the activities restrictions applicable to multiple savings and loan
holding companies and, unless the savings association requalifies as a QTL
within one year thereafter, shall register as, and become subject to the
restrictions applicable to, a bank holding company. See "- The Bank - Qualified
Thrift Lender Test."
If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the regulatory authority to approve
emergency thrift acquisitions and where each subsidiary savings association
meets the QTL test, as set forth below, the activities of the Company and any of
its subsidiaries (other than the Bank or other subsidiary savings associations)
would thereafter be subject to further restrictions. No multiple savings and
loan holding company or subsidiary thereof, which is not a savings association,
shall commence or continue for a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof any business
activity, other than: (i) furnishing or performing management services for a
subsidiary savings association; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings association; (iv) holding or managing properties used
or occupied by a subsidiary savings association; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987, to be engaged in by multiple savings and loan holding companies; or (vii)
unless the Director of the OTS by regulation
25
prohibits or limits such activities for savings and loan holding companies,
those activities authorized by the Federal Reserve Board as permissible for bank
holding companies. The activities described in (i) through (vi) above may only
be engaged in after giving the OTS prior notice and being informed that the OTS
does not object to such activities. In addition, the activities described in
(vii) above also must be approved by the Director of the OTS prior to being
engaged in by a multiple savings and loan holding company.
Limitations on Transactions with Affiliates. Transactions between
savings associations and any affiliate are governed by Sections 23A and 23B of
the Federal Reserve Act ("FRA"). An affiliate of a savings association is any
company or entity which controls, is controlled by or is under common control
with the savings association. In a holding company context, the parent holding
company of a savings association (such as the Company) and any companies which
are controlled by such parent holding company are affiliates of the savings
association. Generally, Sections 23A and 23B (i) limit the extent to which the
savings association or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such association's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the association or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar transactions. In
addition to the restrictions imposed by Sections 23A and 23B, no savings
association may (i) loan or otherwise extend credit to an affiliate, except for
any affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the savings association.
In addition, Sections 22(h) and (g) of the FRA place restrictions on
loans to executive officers, directors and principal stockholders. Under Section
22(h), loans to a director, an executive officer and to a greater than 10%
stockholder of a savings institution (a "principal stockholder"), and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the savings
institution's loans-to-one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons and also requires prior board approval for certain loans. In addition,
the aggregate amount of extensions of credit by a savings institution to all
insiders cannot exceed the institution's unimpaired capital and surplus.
Furthermore, Section 22(g) places additional restrictions on loans to executive
officers. At December 31, 1996, the Bank was in compliance with the above
restrictions.
Restrictions on Acquisitions. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS, (i) control of any other savings
association or savings and loan holding company or substantially all the assets
thereof or (ii) more than 5% of the voting shares of a savings association or
holding company thereof which is not a subsidiary. Except with the prior
approval of the Director of the OTS, no director or officer of a savings and
loan holding company or person owning or controlling by proxy or otherwise more
than 25% of such company's stock, may acquire control of any savings
association, other than a subsidiary savings association, or of any other
savings and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
associations in more than one state if (i) the multiple savings and loan holding
company involved controls a savings association which operated a home or branch
office located in the state of the association to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the
association to be acquired is located specifically permit institutions to be
acquired by the state-chartered
26
associations or savings and loan holding companies located in the state where
the acquiring entity is located (or by a holding company that controls such
state-chartered savings associations).
The FRB may approve an application by a bank holding company to acquire
control of a savings association. A bank holding company that controls a savings
association may merge or consolidate the assets and liabilities of the savings
association with, or transfer assets and liabilities to, any subsidiary bank
which is a member of the Bank Insurance Fund ("BIF") with the approval of the
appropriate federal banking agency and the FRB. As a result of these amended
provisions, there have been a number of acquisitions of savings associations by
bank holding companies in recent years.
The Bank. The OTS has extensive regulatory authority over the operations
of savings associations. As part of this authority, savings associations are
required to file periodic reports with the OTS and are subject to periodic
examinations by the OTS. The investment and lending authority of savings
associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.
The OTS' enforcement authority over all savings associations and their
holding companies includes, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS.
Insurance of Accounts. The deposits of the Bank are insured to the
maximum extent permitted by the SAIF, and are backed by the full faith and
credit of the United States Government. As insurer, the FDIC is authorized to
conduct examinations of, and to require reporting by, FDIC-insured institutions.
It also may prohibit any FDIC-insured institution from engaging in any activity
the FDIC determines by regulation or order to pose a serious threat to the FDIC.
The FDIC also has the authority to initiate enforcement actions against savings
associations, after giving the OTS an opportunity to take such action.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which could result in
termination of the Bank's deposit insurance.
On September 30, 1996, the President signed into law the Omnibus
Consolidated Appropriations Act. Part of this act, the Deposit Insurance Funds
Act of 1996 ("BIF/SAIF Legislation"), provides for, among other things, the
resolution of the FDIC premium disparity between BIF and SAIF insured financial
institutions. Prior to the legislation, most insured depository institutions
holding BIF-assessable deposits paid the statutory minimum of $2,000 for deposit
insurance while most insured depository institutions with SAIF-assessable
deposits, such as the Bank, paid the statutory minimum of 23 basis points (100
basis points being equal to 1%).
The BIF/SAIF Legislation required a one-time special assessment to
recapitalize the SAIF. The assessment, based on the amount of SAIF-assessable
deposits held by an institution as of March 31, 1995, was effective on September
30, 1996, and, in accordance with final rules adopted by the FDIC, was paid
27
in November 1996. The FDIC determined that, in order to fully capitalize the
SAIF to statutorily mandated levels, all SAIF insured depository institutions
(except certain "weak institutions") were assessed 65.7 basis points on
SAIF-assessable deposits as of March 31, 1995. If an institution had merged with
or acquired another institution since March 31, 1995, it was required to add to
its special assessment base the March 31, 1995 assessable deposits of the
institution that was acquired.
The Emerging Issues Task Force ("EITF") of the Financial Accounting
Standards Board ("FASB") previously discussed the financial reporting issues
relating to a special assessment, and, in November 1995, indicated that
institutions with SAIF-assessable deposits should accrue the liability when the
legislation is enacted and the related charge should be reported as a component
of operating expenses in the period that includes the enactment date. The EITF
further determined that the charge should not be reported as an extraordinary
item.
Consistent with the BIF/SAIF Legislation, the Bank's pro-rata one-time
special assessment to recapitalize the SAIF was $4.4 million. In conformity with
the applicable FASB guidelines, the Bank accrued this liability on September 30,
1996, resulting in the additional one-time increase in FDIC premiums, and paid
the assessment in November 1996.
Effective January 1, 1997, the BIF/SAIF Legislation requires that SAIF
members have the same risk-based assessment schedule as BIF members, ranging
from 0 basis points for "well-capitalized institutions" to 27 basis points for
"weak institutions." Additionally, the legislation provides for a sharing
formula to meet the Financing Corporation bond obligation ("FICO Bonds")1
between members of the SAIF and the BIF. Beginning January 1, 1997, FICO Bond
assessments of 6.4 and 1.3 basis points will be added to any regular premium for
SAIF-assessable institutions and BIF-assessable institutions, respectively,
until December 31, 1999. Thereafter, about 2.4 basis points will be added to
regular premium assessments for all insured depositories, achieving full
pro-rata FICO sharing. The BIF/SAIF Legislation also provides for the
conditional merger of the BIF and the SAIF no earlier than January 1, 1999. When
the funds are merged, the FICO Bond premium will be equal for all members of the
new fund.
As a "well capitalized institution", the Bank previously paid the lowest
SAIF insurance premium rate of 23 basis points on insured deposits for the
fourth quarter of 1996. Since the SAIF became fully capitalized as of October 1,
1996, the regular assessment rate for SAIF-member institutions was lowered
retroactively to that date. Until January 1, 1997, FICO payments could be made
only from assessments on SAIF-member institutions; therefore, during the fourth
quarter of 1996 the SAIF premium assessment should have been only the amount
necessary to cover the FICO obligations. Overpayment of fourth quarter FDIC
premiums (currently estimated at approximately 1.25 basis points, or $88,300 for
the Bank) will be refunded or credited toward future FDIC insurance premiums.
Beginning January 1, 1997, unless the base rate for "well capitalized
institutions" is modified, the Bank's FDIC premium should be 6.4 basis points
(the FICO Bond obligation). Based on deposit levels at December 31, 1996, this
will reduce the Bank's annual premium assessment by approximately $1.2 million.
The BIF/SAIF Legislation provides for the conditional merger of the BIF
and the SAIF on January 1, 1999, depending upon the outcome of re-chartering
issues associated with the legislation. By March 31, 1997, the Secretary of the
Treasury is required to conduct a study and prepare a report to Congress
addressing all issues which the Secretary considers relevant with respect to the
development of
- -----------------------------
1 FICO Bonds were issued in an attempt undertaken between 1987 and 1989 to
provide funds for the ailing Federal Savings and Loan Insurance Corporation
("FSLIC") without a direct taxpayer expense. Since the establishment of the SAIF
in 1989, a portion of the SAIF premiums has been earmarked to satisfy the $780
million in annual interest obligations on FICO Bonds, interest that continues
until 2019.
28
a common charter for all insured depository institutions and the abolition of
separate and distinct charters between banks and savings institutions.
Regulatory Capital Requirements. Federally insured savings associations
are required to maintain minimum levels of regulatory capital. The OTS has
established capital standards applicable to all savings associations. These
standards generally must be as stringent as the comparable capital requirements
imposed on national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.
Current OTS capital standards require savings associations to satisfy
three different capital requirements. Under these standards, savings
associations must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3% of adjusted total assets and "total" capital
(a combination of core and "supplementary" capital) equal to 8.0% of
"risk-weighted" assets. For purposes of the regulation, core capital generally
consists of common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, minority interests
in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings association's intangible assets, with only a limited exception
for purchased mortgage servicing rights ("PMSRs"). The Bank had no PMSRs at
December 31, 1996. Both core and tangible capital are further reduced by an
amount equal to a savings association's debt and equity investments in
subsidiaries engaged in activities not permissible to national banks (other than
subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies). At December 31, 1996, the Bank had no investment in
subsidiaries which was impermissible and required to be deducted from its
capital calculation. See Note 14 of the Notes to Consolidated Financial
Statements included in Item 8 hereof.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital does not exceed the savings association's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
repossessed assets or loans more than 90 days past due. Single-family
residential real estate loans which are not past-due or non-accruing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
OTS policy imposes a limitation on the amount of net deferred tax assets
under SFAS No. 109 that may be included in regulatory capital. (Net deferred tax
assets represent deferred tax assets, reduced by any valuation allowances, in
excess of deferred tax liabilities). Application of the limit depends on the
possible sources of taxable income available to an institution to realize
deferred tax assets. Deferred tax assets that can be realized from the following
generally are not limited: taxes paid in prior carryback years and future
reversals of existing taxable temporary differences. To the extent that the
realization of deferred tax assets depends on an institution's future taxable
income (exclusive of reversing temporary differences and carryforwards), or its
tax-planning strategies, such deferred tax assets are limited for regulatory
capital purposes to the lesser of the amount that can be realized within one
year of the quarter-end report date or 10% of core capital. At December 31,
1996, the Bank had $64,000 of net deferred tax assets under SFAS No. 109
included in the Bank's other assets. See Note 16 of the Notes to Consolidated
Financial Statements included in Item 8 hereof.
29
Effective November 28, 1994, the OTS revised its interim policy issued
in August 1993, under which savings institutions computed their regulatory
capital in accordance with SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." Under the revised OTS policy, savings institutions
must value securities available-for-sale at amortized cost for regulatory
capital purposes. This means that in computing regulatory capital, savings
institutions should add back any unrealized losses and deduct any unrealized
gains, net of income taxes, on securities reported as a separate component of
GAAP capital. The Bank adopted SFAS No. 115 on January 1, 1994. At December 31,
1996, the application of SFAS No. 115 resulted in a net increase in retained
earnings of $2.0 million ($3.2 million net of income tax of $1.2 million) on
mortgage-backed securities available-for-sale.
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest-rate risk
will be subject to a deduction of its interest-rate risk component from total
capital for purposes of calculating risk-based capital requirement. As a result,
such an institution will be required to maintain additional capital in order to
comply with the risk-based capital requirement. An institution with a greater
than "normal" interest-rate risk is defined as an institution that would suffer
a loss of net portfolio value exceeding 2.0% of the estimated market value of
its assets in the event of a 200 basis point increase or decrease (with certain
minor exceptions) in interest rates. The interest-rate risk component will be
calculated, on a quarterly basis, as one-half of the difference between an
institution's measured interest-rate risk and 2.0%, multiplied by the market
value of its assets. The rule also authorizes the Director of the OTS, or his
designee, to waive or defer an institution's interest-rate risk component on a
case-by-case basis. The final rule was originally effective as of January 1,
1994, subject however to a two quarter "lag" time between the reporting date of
the data used to calculate an institution's interest-rate risk and the effective
date of each quarter's interest-rate risk component. However, in October 1994,
the Director of the OTS indicated that it would waive the capital deductions for
institutions with a greater than "normal" risk until the OTS publishes an
appeals process. The OTS has indicated that no savings institution will be
required to deduct capital for interest-rate risk until further notice. In any
event, management of the Bank does not believe that the OTS' adoption of an
interest-rate risk component to the risk-based capital requirement will
adversely affect the Bank's regulatory capital position.
30
The following is a reconciliation of the Bank's equity determined in
accordance with GAAP to the four components of regulatory capital at December
31, 1996.
Tier 1
Equity Tangible Core Risk-Based Risk-Based
Capital Capital Capital Capital Capital
------------ ------------- ------------- ------------- -----------
Stockholders' equity,
substantially $ 127,844 $ 127,844 $ 127,844 $127,844 $127,844
restricted
Unrealized gain on securities
available-for-sale, net of tax (1,968) (1,968) (1,968) (1,968) (1,968)
---------- ---------- ---------- -------- --------
Adjusted GAAP capital $ 125,876 125,876 125,876 125,876 125,876
==========
Unallowable land loans -- -- -- (787)
Intangible assets (4,821) (4,821) (4,821) (4,821)
General valuation allowances -- -- -- 5,973
---------- ---------- -------- --------
Regulatory capital measure 121,055 121,055 121,055 126,241
Minimum capital required 21,195 42,390 23,570 47,139
---------- ---------- -------- --------
Excess $ 99,860 $ 78,665 $ 97,485 $ 79,102
========== ========== ======== ========
Total assets per Thrift Report $1,418,659
Total risk-weighted assets ========== $589,241 $589,241
======== ========
Total tangible assets $1,412,973 $1,412,973
========== ==========
Capital ratio 8.9% 8.6% 8.6% 20.5% 21.4%
Regulatory capital category:
Well capitalized, equal
to or greater than N/A 5.0% 6.0% 10.0%
---------- ---------- -------- --------
Excess N/A 3.6% 14.5% 11.4%
========== ========== ======== ========
Any savings association that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on an association's operations and
the appointment of a conservator or receiver. The OTS' capital regulation
provides that such actions, through enforcement proceedings or otherwise, could
require one or more of a variety of corrective actions.
Prompt Corrective Action. Under Section 38 of the FDIA as added by the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), each
federal banking agency is required to implement a system of prompt corrective
action for institutions which it regulates. In early September 1992, the federal
banking agencies, including the OTS, adopted substantially similar regulations
which are intended to implement Section 38 of the FDIA. These regulations became
effective December 19, 1992. Under the regulations, an institution shall be
deemed to be (i) "well capitalized" if it has total risk-based capital of 10.0%
or more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I
leverage capital ratio of 5.0% or more and is not subject to any order or final
capital directive to meet and maintain a specific capital level for any capital
measure, (ii) "adequately capitalized" if it has a total risk-based capital
ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a
Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances)
and does not meet the definition of "well capitalized," (iii) "undercapitalized"
if it has a total risk-based capital ratio that is less than 8.0%, a Tier I
risk-based capital ratio that is less than 4.0% or a Tier I leverage capital
ratio that is less than 4.0% (3.0% under certain circumstances), (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio that
is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a
Tier I leverage capital ratio that is less than 3.0%, and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. Section 38 of the FDIA and the regulations
promulgated thereunder also specify circumstances under which a federal banking
agency may
31
reclassify a well capitalized institution as adequately capitalized and may
require an adequately capitalized institution or an undercapitalized institution
to comply with supervisory actions as if it were in the next lower category
(except that the FDIC may not reclassify a significantly undercapitalized
institution as critically undercapitalized). At December 31, 1996, the Bank was
in the "well capitalized" category.
Safety and Soundness. FDICIA requires each federal banking regulatory
agency to prescribe, by regulation or guideline, standards for all insured
depository institutions and depository institution holding companies relating to
(i) internal controls, information systems and audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) interest-rate risk exposure; (v)
asset growth; (vi) compensation, fees and benefits; and (vii) such other
operational and managerial standards as the agency determines to be appropriate.
The compensation standards would prohibit employment contracts or other
compensatory arrangements that provide excess compensation, fees or benefits or
could lead to material financial loss. In addition, each federal banking
regulatory agency must prescribe, by regulation or guideline, standards relating
to asset quality, earnings and stock valuation as the agency determines to be
appropriate. Effective August 9, 1995, the federal banking agencies, including
the OTS, implemented final rules and guidelines concerning standards for safety
and soundness required to be prescribed by regulation pursuant to Section 39 of
the FDIA. In general, the standards relate to (1) operational and managerial
matters; (2) asset quality and earnings; and (3) compensation. The operational
and managerial standards cover (a) internal controls and information systems,
(b) internal audit systems, (c) loan documentation, (d) credit underwriting, (e)
interest rate exposure, (f) asset growth, and (g) compensation, fees and
benefits. Under the asset quality and earnings standards, the Savings Bank would
be required to establish and maintain systems to (i) identify problem assets and
prevent deterioration in those assets, and (ii) evaluate and monitor earnings
and ensure that earnings are sufficient to maintain adequate capital reserves.
Finally, the compensation standard states that compensation will be considered
excessive if it is unreasonable or disproportionate to the services actually
performed by the individual being compensated. Effective October 1, 1996, the
federal banking agencies also adopted quality and earnings standards. If a
savings institution fails to meet any of the standards promulgated by
regulation, then such institution will be required to submit a plan within 30
days to the OTS specifying the steps it will take to correct the deficiency. In
the event that a savings institution fails to submit or fails in any material
respect to implement a compliance plan within the time allowed by the federal
banking agency, Section 39 of the FDIA provides that the OTS must order the
institution to correct the deficiency and may (1) restrict asset growth; (2)
require the savings institution to increase its ratio of tangible equity to
assets; (3) restrict the rates of interest that the savings institution may pay;
or (4) take any other action that would better carry out the purpose of prompt
corrective action. The Bank believes that it has been and will continue to be in
compliance with each of the standards as they have been adopted by the OTS.
Brokered Deposits. The FDIC has promulgated regulations implementing
limitations on brokered deposits pursuant to FDICIA. Under the regulations,
well-capitalized institutions are subject to no brokered deposit limitations,
while adequately capitalized institutions are able to accept, renew or roll over
brokered deposits only (i) with a waiver from the FDIC, and (ii) subject to the
limitation that they do not pay an effective yield on any such deposit which
exceeds by more than (a) 75 basis points the effective yield paid on deposits of
comparable size and maturity in such institution's normal market area for
deposits accepted in its normal market area, or (b) by 120 percent for retail
deposits and 130 percent for wholesale deposits, respectively, of the current
yield on comparable maturity U.S. treasury obligations for deposits accepted
outside the institution's normal market area. Undercapitalized institutions are
not permitted to accept brokered deposits and may not solicit deposits by
offering an effective yield that exceeds by more than 75 basis points the
prevailing effective yields on insured deposits of comparable maturity in the
institution's normal market area or in the market area in which such deposits
are being solicited. At December 31, 1996, the Bank was a well-capitalized
institution and was not subject to restrictions on brokered deposits. See
"Business - Sources of Funds - Deposits."
Liquidity Requirements. All savings associations are required to maintain
an average daily balance of liquid assets equal to a certain percentage of the
sum of its average daily balance of net withdrawable
32
deposit accounts and borrowings payable in one year or less. The liquidity
requirement may vary from time to time (between 4% and 10%) depending upon
economic conditions and savings flows of all savings associations. At the
present time, the required minimum liquid asset ratio is 5%. Additionally,
current regulations require that short-term liquid assets must continue at least
1% of the average daily balance of net withdrawable accounts and current
borrowings. The Bank, as a component of its overall asset and liability
management strategy, maintains qualifying liquid assets at levels which exceed
regulatory requirements and at December 31, 1996, had a total regulatory
liquidity of 9.2% and a short-term regulatory liquidity of 1.1%.
Qualified Thrift Lender Test. Under legislation adopted by Congress in
1996, a savings association can comply with the QTL test by either meeting the
QTL test set forth in the Home Owners' Loan Act, as amended ("HOLA") and
implementing regulations or qualifying as a domestic building and loan
association as defined in the Code. A savings association that does not comply
with the QTL test must either convert to a bank charter or comply with the
following restrictions on its operations: (i) the association may not engage in
any new activity or make any new investment, directly or indirectly, unless such
activity or investment is permissible for a national bank; (ii) the branching
powers of the association shall be restricted to those of a national bank; (iii)
the association shall not be eligible to obtain any advances from its FHLB; and
(iv) payment of dividends by the association shall be subject to the rules
regarding payment of dividends by a national bank. Upon the expiration of three
years from the date the association ceases to be a QTL, it must cease any
activity and not retain any investment not permissible for a national bank and
immediately repay any outstanding FHLB advances (subject to safety and soundness
considerations).
The QTL test set forth in the HOLA requires that Qualified Thrift
Investments ("QTIs") represent 65% of portfolio assets on a monthly average
basis in nine out of every 12 months. Portfolio assets are defined as total
assets less intangibles, property used by a savings association in its business
and liquidity investments in an amount not exceeding 20% of assets. Generally,
QTIs are residential housing related assets. The 1996 amendments allow small
business loans, credit card loans, student loans and loans for personal, family
and household purposes to be included without limitation as qualified
investments. At December 31, 1996, 95.1% of the Bank's assets were invested in
QTIs which exceeded the percentage required to qualify the Bank under the QTL
test.
Restrictions on Capital Distributions. OTS regulations govern capital
distributions by savings associations, which include cash dividends, stock
redemptions or repurchases, cash-out mergers, interest payments on certain
convertible debt and other transactions charged to the capital account of a
savings association to make capital distributions. Generally, the regulation
creates a safe harbor for specified levels of capital distributions from
associations meeting at least their minimum capital requirements, so long as
such associations notify the OTS and receive no objection to the distribution
from the OTS. Savings institutions and distributions that do not qualify for the
safe harbor are required to obtain prior OTS approval before making any capital
distributions.
Generally, savings associations that before and after the proposed
distribution meet or exceed their fully phased-in capital requirements, or Tier
1 associations, may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
is defined to mean the percentage by which the association's ratio of total
capital to assets exceeds the ratio of its fully phased-in capital requirement
to assets. "Fully phased-in capital requirement" is defined to mean an
association's capital requirement under the statutory and regulatory standards
applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the association. Failure to
meet fully phased-in or minimum capital requirements will result in further
restrictions on capital distributions including possible prohibition without
explicit OTS approval. See "- Regulatory Capital Requirements."
33
Tier 2 associations, which are associations that before and after the
proposed distribution meet or exceed their minimum capital requirements, may
make capital distributions during any calendar year up to 75% of net income over
the most recent four-quarter period.
In order to make distributions under these safe harbors, Tier 1 and Tier 2
associations must submit written notice to the OTS 30 days prior to making the
distribution. The OTS may object to the distribution during that 30-day period
based on safety and soundness concerns. In addition, a Tier 1 association deemed
to be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 association (a Tier 3 association is an association that does
not meet current minimum capital requirements or has been notified by the OTS
that it will be treated as a Tier 3 association because it is in need of more
than normal supervision and, consequently, a Tier 3 association cannot make any
capital distribution without obtaining prior OTS approval) as a result of such a
determination. The Bank currently is a Tier 1 institution for purposes of the
regulation dealing with capital distributions.
On December 5, 1994, the OTS published a notice of proposed rulemaking to
amend its capital distribution regulation. Under the proposal, institutions
would only be permitted to make capital distributions that would not result in
their capital being reduced below the level required to remain "adequately
capitalized," as defined under "- Prompt Corrective Action" above. Because the
Bank is a subsidiary of a holding company, the proposal would require the Bank
to provide notice to the OTS of its intent to make a capital distribution. The
Bank does not believe that the proposal will adversely affect its ability to
make capital distributions if it is adopted substantially as proposed.
OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained for the liquidation account established by it for certain depositors
in connection with its conversion from mutual to stock form.
Loans-to-One Borrower. The permissible amount of loans-to-one borrower
generally follows the national bank standard for all loans made by savings
institutions. The national bank standard generally does not permit loans-to-one
borrower to exceed the greater of $500,000 or 15% of unimpaired capital and
surplus. Loans in an amount equal to an additional 10% of unimpaired capital and
surplus also may be made to a borrower if the loans are fully secured by readily
marketable securities. For information about the largest borrowers from the
Bank, see "Business - Lending Activities - Loans-to-One Borrower Limitations."
Classified Assets. Federal regulations require that each insured savings
institution classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets, with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. Another category
designated "special mention" also must be established and maintained for assets
which do not currently expose an insured institution to a sufficient degree of
risk to warrant classification as substandard, doubtful or loss. Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses. If an asset or portion thereof is classified
loss, the insured institution must either establish specific allowances for loan
losses in the amount of 100% of the portion of the asset classified loss, or
charge-off such amount. General loss allowances established to cover possible
losses related to assets classified substandard or doubtful may be included in
determining an institution's regulatory capital up to certain amounts, while
specific valuation allowances for loan losses do not qualify as regulatory
capital. Federal examiners may disagree
34
with an insured institution's classifications and amounts reserved. See
"Business - Asset Quality - Other Classified Assets."
Community Reinvestment. Under the Community Reinvestment Act of 1977, as
amended ("CRA"), as implemented by OTS regulations, a savings association has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The CRA requires the OTS, in connection with its examination of a savings
institution, to assess the institution's record of meeting the credit needs of
its community and to take such record into account in its evaluation of certain
applications by such institution. Public disclosure of an institution's CRA
rating is required, and the OTS is required to provide a written evaluation of
an institution's CRA performance utilizing a four tiered descriptive rating
system. The Bank received an "outstanding" rating as a result of its last
evaluation in June 1996.
Nationwide Banking. The Bank may face additional competition from
commercial banks headquartered outside of the Commonwealth of Virginia as a
result of the enactment of the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994, which becomes fully effective on June 1, 1997, and which
will allow banks and bank holding companies headquartered outside of Virginia to
enter the Bank's market through acquisition, merger or de novo branching. For
further information about the Bank's competition, see "Business - Competition."
Policy Statement on Nationwide Branching. Currently, OTS regulations
permit nationwide branching to the extent allowed by federal statute which
generally permits a federally chartered savings association to establish branch
offices outside of its home state if the association meets the domestic building
and loan test in Section 7701(a)(19) of the Code or the asset composition test
of subparagraph (c) of that section, and if, with respect to each state outside
of its home state where the association has established branches, the branches,
taken alone, also satisfy one of the two tax tests. An association seeking to
take advantage of this authority would have to have a branching application
approved by the OTS, which would consider the regulatory capital of the
association and its record under the CRA, as amended, among other things.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Atlanta, which is one of 12 regional FHLBs that administers a home financing
credit function for savings associations. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Atlanta in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of its advances from the FHLB of Atlanta,
whichever is greater. At December 31, 1996, the Bank had $13.1 million in FHLB
stock, which was in compliance with this requirement.
Federal Reserve System. The FRB requires all depository institutions to
maintain reserves against their transaction accounts (primarily NOW checking
accounts) and non-personal time deposits. At December 31, 1996, the Bank was in
compliance with applicable requirements. However, because required reserves must
be maintained in the form of vault cash or a noninterest-bearing account at a
Federal Reserve Bank, the effect of this reserve requirement is to reduce an
institution's earning assets.
35
Federal Taxation
General. The Company and the Bank are subject to the corporate tax
provisions of the Code, as well as certain additional provisions of the Code
which apply to thrift and other types of financial institutions. The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Company and
the Bank.
Fiscal Year. The Company and the Bank and its subsidiaries file a
consolidated federal income tax return on a calendar year basis.
Method of Accounting. The Bank maintains its books and records for federal
income tax purposes using the accrual method of accounting. The accrual method
of accounting, for income tax purposes, generally requires that items of income
be recognized when all events have occurred that establish the right to receive
the income and the amount of income can be determined with reasonable accuracy,
and that items of expense be deducted at the later of (i) the time when all
events have occurred that establish the liability to pay the expense and the
amount of such liability can be determined with reasonable accuracy or (ii) the
time when economic performance with respect to the item of expense has occurred.
Bad Debt Reserves. On August 20, 1996, as part of the Small Business Job
Protection Act of 1996 ("SBJPA"), Congress enacted legislation which, among
other things, substantially changed the method savings institutions use to
compute deductions for bad debt. Since 1952, savings institutions have received
special tax treatment with respect to calculating deductions for bad debt
reserves. Generally, most businesses compute bad debt deductions by using the
specific charge-off method, which allows a taxpayer to deduct the amount of any
debt that becomes wholly or partially worthless during the year. Under previous
law, a qualified savings institution, such as the Bank, could elect to use one
of two reserve methods of accounting, -- the experience method or the percentage
of taxable income method. To qualify, 60% of a savings institution's assets had
to consist of "qualifying assets" such as cash, government obligations, or loans
secured by residential real property. If a savings institution used the reserve
method, it was required to establish and maintain a reserve for bad debts and
charge actual losses against the reserve. Regardless of whether a savings
institution experienced actual losses, it was allowed to deduct annual additions
to its bad debt reserve that were computed by using either the percentage of
taxable income method or the experience method. A savings institution's reserve,
however, was subject to recapture if it converted to a commercial bank, was
acquired by a commercial bank, or failed to satisfy the 60% qualified asset
test. The SBJPA prohibits the continued use of the percentage of taxable income
method for all savings institutions. While savings institutions with less than
$500 million in assets may still use the experience method, all others will be
required to use the specific charge-off method.
Additionally, the SBJPA changes the law regarding the recapture of bad
debt reserves accumulated before 1988 and requires all savings institutions to
recapture their post-1987 reserves. Reserves accumulated after 1987 must be
restored to taxable income ratably over a six-year period starting after
December 31, 1995, unless the institution meets a residential loan requirement,
in which case the recapture may be suspended on a per annum basis for up to two
years. A savings institution with more than $500 million in assets, such as the
Bank, is generally required to recapture its entire post-1987 additions to its
bad debt reserve. The Bank has determined that approximately $1.4 million of
post-1987 tax reserves are subject to recapture. Since the Bank previously
established a deferred tax liability corresponding to its post-1987 tax
reserves, the effects of the recapture are not material to the Bank's financial
condition or results of operations. These new recapture provisions make it
substantially easier for savings institutions to convert to a commercial bank
charter, diversify their assets, or merge into a commercial bank.
The SBJPA also repeals certain other provisions in present tax law
applicable only to savings institutions, including special rules applicable to
foreclosures; a reduction in the dividends received deduction; the ability of a
savings institution to use net operating losses to offset its income from a
36
residual interest in a REMIC; and the denial of a portion of certain tax credits
to a savings institution. The Bank has not determined what effect, if any, these
changes may have on its financial condition or results of operations.
Distributions. While the Bank maintains a bad debt reserve, if it were to
distribute cash or property to its sole stockholder having a total fair market
value in excess of its accumulated tax-paid earnings and profits, or were to
distribute cash or property to its stockholder in redemption of its stock, the
Bank would generally be required to recognize as income an amount which, when
reduced by the amount of federal income tax that would be attributable to the
inclusion of such amount in income, is equal to the lesser of: (i) the amount of
the distribution or (ii) the sum of (a) the amount of the accumulated bad debt
reserve of the Bank with respect to qualifying real property loans (to the
extent that additions to such reserve exceed the additions that would be
permitted under the experience method) and (b) the amount of the Bank's
supplemental bad debt reserve.
Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%
on a base of regular taxable income plus certain tax preferences ("alternative
minimum taxable income" or "AMTI"). The alternative minimum tax is payable to
the extent such AMTI is in excess of an exemption amount. The Code provides that
an item of tax preference is the excess of the bad debt deduction allowable for
a taxable year pursuant to the percentage of taxable income method over the
amount allowable under the experience method. The other items of tax preference
that constitute AMTI include (a) tax exempt interest on newly-issued (generally,
issued on or after August 8, 1986,) private activity bonds other than certain
qualified bonds and (b) for taxable years beginning after 1989, 75% of the
excess (if any) of (i) adjusted current earnings as defined in the Code, over
(ii) AMTI (determined without regard to this preference and prior to reduction
by net operating losses). Net operating losses can offset no more than 90% of
AMTI. Certain payments of alternative minimum tax may be used as credits against
regular tax liabilities in future years.
Audit by Internal Revenue Service. The Bank's consolidated federal income
tax returns for taxable years through December 31, 1990, have been closed for
the purpose of correct examination by the Internal Revenue Service.
State Taxation
The Commonwealth of Virginia imposes a tax at the rate of 6.0% on the
"Virginia taxable income" of the Bank and the Company. Virginia taxable income
is equal to federal taxable income with certain adjustments. Significant
modifications include the subtraction from federal taxable income of interest or
dividends on obligations or securities of the United States that are exempt from
state income taxes.
37
Item 2. Properties
The following table sets forth certain information relating to the
Company's offices at December 31, 1996.
Net Book Value of
Property and
Leasehold
Owned or Improvements at Deposits at
Location Leased December 31, 1996 December 31, 1996
- -------------------------------- --------- ------------------ ------------------
(Dollars in Thousands)
Main Office:
109 East Main Street Owned (1) $ 6,728 $142,606
Norfolk, Virginia 23510
Branch Offices:
7420 Granby Street Owned 358 88,102
Norfolk, Virginia 23505
944 Independence Boulevard Owned 617 57,124
Virginia Beach, Virginia 23455
3225 High Street Owned 467 48,262
Portsmouth, Virginia 23707
6056 East Indian River Road Owned 136 44,536
Virginia Beach, Virginia 23462
Military Circle Shopping Center Owned 206 39,182
East Ring Road
Norfolk, Virginia 23502
213 Battlefield Boulevard, South Owned 44 38,683
Chesapeake, Virginia 23320
3921 Poplar Hill Road Owned 153 37,153
Chesapeake, Virginia 23321
2336 East Little Creek Road Owned (2) 29 34,010
Norfolk, Virginia 23518
2008 Cromwell Drive Owned 199 33,903
Norfolk, Virginia 23509
1316 North Great Neck Road Owned (3) 116 30,697
Virginia Beach, Virginia 23454
501 S. Independence Boulevard Owned 730 27,284
Virginia Beach, Virginia 23452
6201 Portsmouth Boulevard Owned 182 25,276
Portsmouth, Virginia 23701
728 West 21st Street Leased (4) 6 23,107
Norfolk, Virginia 23517
(Footnotes on following page)
38
3801 Pacific Avenue Owned $ 208 $ 14,966
Virginia Beach, Virginia 23451
330 West Constance Road Owned 507 13,587
Suffolk, Virginia 23434
601 Lynnhaven Parkway Owned 418 13,427
Virginia Beach, Virginia 23452
1400 Kempsville Road Leased (5) 28 7,673
Chesapeake, Virginia 23320
4530 East Virginia Beach Boulevard Owned (6) 2,368 7,327
Norfolk, Virginia 23502
2089 General Booth Boulevard Owned 273 5,417
Virginia Beach, Virginia
23454-5801
Other Properties:
120 East Main Street Owned 1,809 N/A
------- -------
Norfolk, Virginia 23510
$15,582 $732,322
======= ========
<FN>
- -----------------------------
(1) Building is an eight-story office building with Bank operations occupying
two stories. Approximately 70% of the space currently is leased and the
Bank anticipates entering into additional leases within the next few
months.
(2) The branch office building is owned by the Bank and the land is leased.
The land lease expires in September 2000.
(3) The branch office building is owned by the Bank and the land is leased.
The land lease expires in March 2008; the Bank has options through March
2028.
(4) Lease expires in December 1999; the Bank has options through December
2019.
(5) Lease expires in March 2001; the Bank has options through March 2011.
(6) Building also serves as the Bank's operations center.
</FN>
39
Item 3. Legal Proceedings.
The Company and the Bank are involved in routine legal proceedings
occurring in the ordinary course of business which, in the aggregate, are
believed by management to be immaterial to the financial condition of the
Company.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.
The information required herein is incorporated by reference from page 64
of the Registrant's 1996 Annual Report to Stockholders ("Annual Report").
Item 6. Selected Financial Data.
The information required herein is incorporated by reference from the
table on page 5 of the Registrant's 1996 Annual Report.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The information required herein is incorporated by reference from pages 6
through 22 of the Registrant's 1996 Annual Report.
Item 8. Financial Statements and Supplementary Data.
The information required herein is incorporated by reference from pages
23 through 62 of the Registrant's 1996 Annual Report.
Item 9. Changes in and Disagreements on Accounting and Financial
Disclosure.
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required herein is incorporated by reference from pages 4
to 7 of the Registrant's Proxy Statement dated March 17, 1997, ("Proxy
Statement").
Item 11. Executive Compensation.
The information required herein is incorporated by reference from pages 8
through 16 of the Registrant's Proxy Statement.
40
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required herein is incorporated by reference from pages 2
and 3 of the Registrant's Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
The information required herein is incorporated by reference to pages 13
and 14 of the Registrant's Proxy Statement.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents filed as part of this Report.
1. Financial Statements.
The following financial statements are filed as part of this report and
are incorporated herein by reference from the Registrant's 1996 Annual
Report.
Annual Report
Page Number
Index to Consolidated Financial Statements:
Report of Independent Auditor....................................................... 23
Consolidated Balance Sheets as of December 31, 1996 and 1995........................ 24
Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994.................................................. 25
Consolidated Statement of Changes in Stockholders' Equity for
the years ended December 31, 1996, 1995 and 1994.................................. 26
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994.................................................. 27 and 28
Notes to Consolidated Financial Statements.......................................... 29 through 62
2. Supplementary Data and Financial Statement Schedules.
All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are omitted because
they are not applicable or the required information is included in the
Consolidated Financial Statements or notes thereto.
41
3. Exhibits required by Item 601 of Regulation S-K.
No. Description
- ---------- ---------------------------------------------------------------
The following such Exhibits are filed as part of this Form 10-K and
attached hereto as Exhibits, and this list includes the Exhibit Index:
13 1996 Annual Report to Stockholders
23 Consent of Edmondson, LedBetter & Ballard, L.L.P. independent
auditor to the Company
27 Financial Data Schedule
The following such Exhibits are filed as part of this Form 10-K and are
incorporated herein by reference:
3.1 Articles of Incorporation of Life Bancorp, Inc. *
3.2 Bylaws of Life Bancorp, Inc. *
10.1 Life Bancorp, Inc. Employee Stock Ownership Plan and Trust 1/ **
10.2 Employment Agreement among the Registrant, Life Savings Bank,
FSB and Edward E. Cunningham 1/ **
10.3 Employment Agreement among the Registrant, Life Savings Bank,
FSB and Tollie W. Rich, Jr. 1/ **
10.4 Severance Agreement among the Registrant, Life Savings Bank,
FSB and Nelson R. Arnold (representative of similar agreements
entered into with T. Frank Clements, Ralph T. Dempsey, Jr.,
Emory J. Dunning, Jr. and Edward M. Locke) 1/ **
10.5 1982 Deferred Compensation Plan, as amended and restated 1/ **
10.6 1991 Deferred Compensation Plan, as amended and restated 1/ **
10.7 Directors' Retirement Plan 1/ *
10.8 Consulting Agreement by and among Life Savings Bank, FSB and
William J. Fanney 1/ **
10.9 Life Bancorp, Inc. 1995 Stock Option Plan, as amended 1/ ***
10.10 Life Bancorp, Inc. Recognition and Retention Plan and Trust
Agreement, as amended 1/ ***
21 Subsidiaries of the Registrant - Reference is made to Item 1.
"Business" for the required information
- -----------------------------
1/ Management contract or compensatory plan or arrangement.
* Incorporated by reference from the Registration Statement on Form S-1
(Registration No. 33-80772) filed by the Registrant with the Securities
and Exchange Commission on June 27, 1994, as amended.
** Incorporated by reference from the Form 10-K of the Registrant for the
year ended December 31, 1994, filed with the Commission on March 31,
1995.
*** Incorporated by reference from the Form 8-K of the Registrant, filed with
the Commission on July 26, 1996.
(b) Reports filed on Form 8-K.
No reports on Form 8-K were filed during the last quarter of the
period covered by this Form 10-K.
(c) Exhibits.
See (a)3. above for all Exhibits filed herewith and the Exhibit Index.
(d) Financial Statement Schedules.
All financial statement schedules required by Regulation S-X are
included in the Annual Report to Stockholders.
42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
LIFE BANCORP, INC.
By: /s/ Edward E. Cunningham
-------------------------------------
Edward E. Cunningham
President, Chief Executive Officer
and Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Edward E. Cunningham March 27, 1997
- ------------------------------------------
Edward E. Cunningham
President, Chief Executive Officer and
Chairman of the Board
(Principal Executive Officer)
/s/ Emory J. Dunning, Jr. March 27, 1997
- ------------------------------------------
Emory J. Dunning, Jr.
Senior Vice President, Treasurer and
Chief Financial Officer
(Principal Financial Officer)
/s/ Joseph C. Addington, Jr. March 27, 1997
- ------------------------------------------
Joseph C. Addington, Jr.
Director
/s/ Charles M. Earley, Jr., M.D. March 27, 1997
- ------------------------------------------
Charles M. Earley, Jr., M.D.
Director
43
/s/ E. Saunders Early, Jr. March 27, 1997
- ------------------------------------------
E. Saunders Early, Jr.
Director
/s/ William J. Fanney March 27, 1997
- ------------------------------------------
William J. Fanney
Director
March 27, 1997
/s/ Donald I. Fentress
- ------------------------------------------
Donald I. Fentress
Director
/s/ William J. Jonak, Jr. March 27, 1997
- ------------------------------------------
William J. Jonak, Jr.
Director
/s/ Frederick V. Martin March 27, 1997
- ------------------------------------------
Frederick V. Martin
Director
/s/ Tollie W. Rich, Jr. March 27, 1997
- ------------------------------------------
Tollie W. Rich, Jr.
Executive Vice President, Chief
Operating Officer and Director
/s/ Braden Vandeventer March 27, 1997
- ------------------------------------------
Braden Vandeventer
Director
44