EXHIBIT 13
1996 ANNUAL REPORT TO SECURITY HOLDERS
SELECTED FINANCIAL DATA
Six
Months Year
Ended Ended
Year Ended December 31, Dec. 31, June 30,
1996 1995 1994 1993 1992 1992
- ----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
SUMMARY OF OPERATIONS:
Interest income $ 8,008 $ 6,602 $ 5,996 $ 5,680 $ 2,745 $ 5,399
Interest expense 3,610 3,607 2,862 2,730 1,401 3,118
-------- ------- ------- ------- ------- -------
Net interest income 4,398 2,995 3,134 2,950 1,344 2,281
Provision for loan losses 50 350 26 25 17 9
-------- ------- ------- ------- ------- -------
Net interest income after provision for loan losses 4,348 2,645 3,108 2,925 1,327 2,272
Other income 114 127 111 125 54 311
Other expenses (1) 2,123 1,605 1,495 1,202 528 1,052
-------- ------- ------- ------- ------- -------
Income before tax expense 2,339 1,167 1,724 1,848 853 1,531
Income tax expense 858 430 617 700 326 573
Cumulative effect of a change in accounting
principle (24)
-------- ------- ------- -------- ------- -------
Net income $ 1,481 $ 737 $ 1,107 $ 1,124 $ 527 $ 958
======== ======= ======= ======= ======= =======
SELECTED YEAR-END BALANCES:
Total assets $105,807 $87,751 $81,560 $75,826 $64,445 $61,913
Loans receivable, net 82,992 75,097 65,973 55,890 50,004 47,274
Investments (2) 16,889 8,884 12,693 17,022 11,906 12,258
Deposits 66,564 73,035 69,140 64,282 54,475 52,367
FHLB Advances - 1,000 - - - -
Stockholders' equity 37,368 12,562 11,729 10,719 9,595 9,068
AVERAGE BALANCE SHEET DATA:
Total assets $103,874 $83,921 $78,890 $70,256 $63,859 $58,856
Total earning assets 102,336 83,058 76,125 67,128 61,192 56,798
Loans receivable, net 78,797 70,397 61,301 52,288 49,030 46,145
Investments (2) 22,907 12,481 14,825 14,840 12,163 10,654
Deposits 68,684 70,541 66,713 59,301 53,877 49,739
FHLB Advances 83 167 - - - -
Stockholders' equity 33,115 12,283 11,317 10,219 9,379 8,589
SELECTED FINANCIAL RATIOS:
Return on average assets 1.43% .88% 1.40% 1.60% 1.65% 1.64%
Return on average equity 4.48% 6.00% 9.78% 11.00% 11.24% 11.06%
Average equity to average assets 31.88% 14.64% 14.34% 14.54% 14.69% 14.87%
Interest rate spread (tax equivalent basis) 2.62% 2.86% 3.59% 3.86% 3.77% 4.08%
Net interest margin (tax equivalent basis) 4.32% 3.62% 4.12% 4.39% 4.39% 4.09%
Dividend payout ratio 54.32 N/A N/A N/A N/A N/A
Cash dividends declared per common share $ 0.44 N/A N/A N/A N/A N/A
Earnings per share (3) $ 0.82 N/A N/A N/A N/A N/A
- -------------
(1) Of the amounts in 1996, $456,000 resulted from a one time special assessment
imposed on Savings Association Insurance Fund (SAIF) insured institutions
to recapitalize the SAIF.
(2) Includes investment securities, mortgage backed-securities, interest-bearing
deposits, and federal funds
(3) Earnings per share were computed as if the 1,825,050 shares issued on March
29, 1996 had been outstanding on January 1, 1996.
1
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
Management's discussion and analysis is intended to assist readers in the
understanding and evaluation of the financial condition and results of
operations of Stone Street Bancorp, Inc. and Mocksville Savings Bank, Inc., SSB
(collectively referred to as the "Company"). It should be read in conjunction
with the audited consolidated financial statements and accompanying notes
included in this report and the supplemental financial data appearing throughout
this discussion and analysis.
ANALYSIS OF RESULTS OF OPERATIONS
The Company's results of operations depend primarily on net interest income,
which is the difference between interest income from interest-earning assets and
interest expense on interest-bearing liabilities. Operations are also affected
by non-interest income, such as income from customer service charges, loan fee
income and other sources of income. The Company's principal operating expenses,
aside from interest expense, consist of compensation and employee benefits,
federal deposit insurance premiums, data processing expenses, office occupancy
costs, equipment expense and income taxes.
The Company completed its first year as a public company with record earnings.
Net income increased to $1.5 million for the year ended December 31, 1996
compared to $.7 million in 1995 and $1.l million in 1994. Growth in net
interest income outpaced a decline in other income and an increase in other
expense to make 1996 the most profitable year in the Company's seventy-five year
history.
Income and Expense
------------------
Net interest income is the Company's primary source of earnings. Table 1
shows that tax-equivalent net interest income increased by $1.4 million or 46.8%
in 1996 to $4.4 million from $3.0 million in 1995. Tax equivalent net interest
income in 1995 was $136,000 or 4.3% lower than in 1994. Net interest income is
analyzed on a tax-equivalent basis to adjust for the nontaxable status of income
earned on certain investments such as municipal bonds.
The increase in tax-equivalent interest income in 1996 as compared to 1995 was
primarily the result of a $18.8 million or 22.7% increase in average earning
assets. Average loans increased by $8.4 million or 11.9% to $78.8 million.
Average investments increased by $10.4 million or 83.5% as stock conversion
proceeds were invested primarily in liquid interest bearing deposits in the FHLB
due to liquidity needs for funding loan growth. The weighted average yield on
interest-earning assets decreased by .10% in 1996, largely due to a reduction in
loan rates. In 1995, tax-equivalent interest income rose 10.2% primarily due to
increases in the average yield which increased by 9 basis points.
Interest expense increased by only $4,000 in 1996. Average interest-bearing
liabilities decreased by $1.8 million or 2.74% in 1996 while the average rate
paid on those liabilities increased by 14 basis points. As a result, the
increase in interest expense in 1996 was due primarily to increases in deposit
rates. In 1995, interest expense rose 26.0% due to increases in deposit rates
and the average balance.
Interest rate spread (on a tax equivalent basis) declined to 2.62% in 1996 from
2.86% in 1995 and 3.59% in 1994 as the increase in the cost of interest-bearing
liabilities outpaced the increase in the yield on interest-earning assets.
Despite the decline in interest rate spread, net interest margin (on a tax
equivalent basis) increased to 4.32% in 1996 from 3.62% in 1995, and 4.12% in
1994. While Conversion proceeds were invested at yields somewhat less than the
weighted average yield on total interest-earning assets, those investments
contributed to the increase in net interest margin.
Table 2 shows the effect of variances in volume and rate on taxable-equivalent
interest income, interest expense, and net interest income. The table shows
that increases in net interest income were primarily due to volume changes in
1996 while decreases in net interest income in 1995 were primarily due to rate
changes.
2
TABLE 1: NET INTEREST INCOME ANALYSIS-TAX EQUIVALENT
- -----------------------------------------------------
1996 1995 1994
--------------------------- -------------------------- -----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- -------- ------- ------- -------- ------- ------- ------- ------
(dollars in thousands)
Assets:
Interest-earning assets:
Loans receivable (1) $ 78,797 $6,662 8.45% $70,397 $5,983 8.50% $61,301 $5,289 8.63%
Investment securities (2) 7,617 607 7.97% 8,646 383 4.43% 9,159 423 4.62%
Interest-bearing deposits 14,645 692 4.72% 3,273 198 6.04% 5,169 253 4.89%
FHLB common stock 645 47 7.29% 562 41 7.30% 496 31 6.16%
-------- ------ ------ ------- ------ ------ ------- ------ ------
Total interest-earning assets 101,704 8,008 7.87% 82,878 6,605 7.97% 76,125 5,996 7.88%
Non-interest-earning assets 2,170 1,043 2,765
-------- ------- -------
TOTAL $103,874 $83,921 $78,890
======== ======= =======
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Deposit accounts $ 68,684 3,604 5.24% $70,541 $3,607 5.11% $66,713 $2,862 4.29%
FHLB advances 83 7 8.43%
-------- ------ ------
Total interest-bearing liabilities 68,767 3,611 5.25% 70,541 3,607 5.11% 66,713 2,862 4.29%
Non-interest-bearing liabilities 1,992 1,097 860
Stockholders' equity 33,115 12,283 11,317
-------- ------- -------
TOTAL $103,874 $83,921 $78,890
======== ======= =======
Net interest income and interest rate
spread $4,397 2.62% $2,998 2.86% $3,134 3.59%
====== ====== ====== ====== ====== ======
Net interest-earning assets
and net interest margin $ 32,937 4.32% $12,337 3.62% $ 9,412 4.12%
======== ====== ======= ====== ======= ======
Ratio of interest-earning assets
to interest bearing liabilities 147.90% 117.49% 114.11%
====== ====== ======
- -----------
(1) Includes nonaccrual loans
(2) Interest earned on tax-exempt investment securities has been adjusted to a
tax-equivalent basis using the applicable combined federal and state rates
of 34% and 7.75%, respectively, and reduced by the nondeductible portion of
interest expense.
TABLE 2: RATE/VOLUME ANALYSIS
- ------------------------------
1996 vs 1995 1995 vs 1994
------------- ------------- ---------------- -----------------------------
Rate/ Rate/
Volume Rate Volume Net Volume Rate Volume Net
------------- ------------- ------- ------- ------- ------ ------- ------
(dollars in thousands)
Interest income (tax-equivalent) on:
Loans $ 714 (31) $ (4) $ 679 $785 $ (79) $(12) $ 694
Investment securities (45) 306 (37) 224 (24) (17) 1 (40)
Interest-bearing deposits 687 (43) (150) 494 (93) 59 (21) (55)
FHLB common stock 6 - - 6 2 7 1 10
------ ---- ----- ------ ---- ----- ---- -----
Total interest income 1,362 232 (191) 1,403 670 (30) (31) 609
------ ---- ----- ------ ---- ----- ---- -----
Deposit accounts (95) 92 - (3) 165 548 32 745
FHLB advances 7 - - 7 - - - -
------ ---- ----- ------ ---- ----- ---- -----
Total interest expense (88) 92 - 4 165 548 32 745
------ ---- ----- ------ ---- ----- ---- -----
Increase (decrease) in net interest income $1,450 $140 $(191) $1,399 $505 $(578) $(63) $(136)
====== ==== ===== ====== ==== ===== ==== =====
3
INCOME AND EXPENSES Continued
PROVISION FOR LOAN LOSSES
The provision for loan losses is charged to earnings to maintain the total
allowance for loan losses at a level considered adequate to cover loan losses
based on existing loan levels and types of loans outstanding, nonperforming
loans, prior loan loss experience, industry standards and general economic
conditions. Provisions for loan losses were $50,000 in 1996 compared to
$350,000 in 1995, and $26,000 in 1994. During 1995, the provision and resulting
allowance for loan losses were increased based on management's efforts to
reflect industry practices regarding the allowance for loan losses. During
1996, the provision was lowered, largely as a result of an improved level of the
relationship between the allowance and outstanding loans.
OTHER INCOME
Other income decreased from $127,000 in 1995 to $114,000 in 1996, and was
$111,000 in 1994. The reduction in other income was primarily in loan fees and
charges which decreased $8,000 in 1996 from the 1995 level. Other income in
1995 increased $16,000 over the 1994 amount. This increase was primarily in
loan fees and charges that totaled $53,000 in 1995 compared to $41,000 in 1994.
OTHER EXPENSES
Other expenses increased by 32.3% in 1996 compared to an increase of 7.4% in
1995. As a percent of average assets, other expense for 1996 was 2.0% as
compared to 1.9% in 1995 and 1.9% in 1994.
Compensation and fringe benefits, in 1996 representing over 47.72% of total
other expenses increased, by $56,000 or 5.9% over 1995. Compensation and fringe
benefits in 1995 increased $52,000 or 5.7% over 1994. Salaries decreased by
$41,800 in 1996 but increased by $28,000 in 1995 over 1994, while retirement
expense increased by $24,000 in 1996 but decreased by $21,000 in 1995.
Retirement expense in 1996 reflects the implementation of the Bank's Employee
Stock Ownership Plan ("ESOP") which provides a higher level of retirement
benefits to employees than the retirement plan which was in place in previous
years. Director's compensation increased by $21,500 in 1996 due to extra
meetings associated with the Conversion and employee benefit programs.
The Company plans to award 4% of the outstanding stock or approximately 73,002
shares upon stockholder approval under the Mocksville Saving's Bank, Inc., SSB
Management Recognition Plan ("MRP") which has been approved by the board of
directors. Management estimates that pre-tax expenses associated with the MRP
will total approximately $300,000 per year for a period of five years.
Occupancy and equipment expense decreased by $26,000 in 1996 while increasing by
$26,000 in 1995. Reasons for the increase in 1995 included investments in
technology primarily the installation of an ATM machine, and related costs.
Deposit insurance premiums increased $423,000 over the 1995 level due to the
special one time assessment by the FDIC in September, 1996. Deposit insurance
premiums totaled $158,000 in 1995 compared to $148,000 in 1994, a $10,000 or
6.8% increase. Professional fees increased by $5,000 in 1996 and $21,000 in
1995 as the Company obtained assistance in making the transition from mutual to
stock ownership.
Management continues to look for ways to improve cost efficiency while offering
new services to its customers.
INCOME TAX EXPENSE
Income tax expense increased 99.5% to $858,000 in 1996 from $430,000 in 1995.
The effective tax rate declined from 36.8% in 1995 to 36.7% in 1996, reflecting
a higher level of tax-exempt income in 1996. Income tax expense totaled
$617,000 in 1994, and the effective tax rate was 35.8%. Changes in income tax
expenses were caused primarily by changes in net income.
4
ANALYSIS OF FINANCIAL CONDITION
-------------------------------
On March 29, 1996 Mocksville Savings Bank,, Inc., SSB (the "Bank") completed
its conversion from a mutual to a stock saving bank through the sale of
1,825,050 shares of no par common stock of Stone Street Bancorp, Inc. (the
"Parent"). Total proceeds of $27,375,750 were reduced by Conversion expenses of
$1,116,905. The Parent retained 50% of the net conversion proceeds after
deducting the proceeds of a loan to the Bank's Employee Stock Ownership Plan
("ESOP") and paid the balance to the Bank in exchange for the common stock of
the Bank issued in the Conversion. The increase in assets from $87.8 million at
December 31, 1995 to $105.8 million at December 31, 1996 is directly
attributable to proceeds of the Conversion which were invested in loans and
investment securities.
LOANS
The Company's primary source of revenue is interest and fee income from
lending activities, consisting primarily of one-to-four family residential
mortgage loans located in its primary market area. The Company also makes loans
secured by improved nonresidential real estate, construction loans, loans
secured by undeveloped real estate, home equity loans, and consumer loans, both
secured and unsecured.
At December 31, 1996, the net loan portfolio totaled $83.0 million and
represented 78% of total assets. During 1996, loans increased by $7.9 million
or 11%. Loan originations increased from $21.4 million in 1995 to $23.3 million
in 1996, largely in response to the Company's efforts to expand its loan
programs into adjacent counties. The relative composition of the Company's loan
portfolio has remained consistent during recent years, with residential one-to-
four family loans comprising approximately 82% of the portfolio as of December
31, 1996. Table 3 sets forth the composition of the loan portfolio at the dates
indicated.
TABLE 3: TYPES OF LOANS
- --------------------------------------------------------------------------------
December 31,
---------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------- --------------- --------------- --------------- ---------------
(dollars in thousands)
Real estates loans:
Residential 1-4 family $67,844 81.75% $63,329 84.33% $54,321 82.34% $45,724 81.81% $41,355 82.70%
Nonresidential real estate 5,716 6.88 4,260 5.67 4,987 7.56 5,312 9.50 5,059 10.12
Home equity and other
second mortgage 2,473 2.98 2,185 2.91 1,423 2.16 1,447 2.59 1,492 2.98
Construction 12,492 15.05 11,735 15.63 11,589 17.56 8,033 14.37 6,433 12.87
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate loans 88,525 106.66 81,509 108.54 72,320 109.62 60,516 108.27 54,339 108.67
Other installment loans 372 .45 222 .30 197 0.30 133 0.24 201 0.40
Less:
Unearned fees 1,009 1.22 962 1.29 1,095 1.66 711 1.27 577 1.15
Loans in process 4,385 5.28 5,211 6.94 5,334 8.09 3,959 7.08 3,894 7.79
Allowance for loan losses 511 .61 462 .61 115 0.17 89 0.16 65 .13
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total reductions 5,905 7.11 6,635 8.84 6,544 9.92 4,759 8.51 4,536 9.07
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans, net $82,992 100.00% $75,096 100.00% $65,973 100.00% $55,890 100.00% $50,004 100.00%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
- --------------------------------------------------------------------------------
In order to protect the Company's net interest margin, management has, as part
of its interest rate risk management program, placed an emphasis on increasing
adjustable rate mortgage loans and home equity lines of credit in its portfolio.
This strategy will result in more consistent net interest income and lower
interest sensitivity than experienced by traditional fixed-rate residential
mortgage lending.
The following table sets forth the time to repricing or contractual maturity of
the Company's loan portfolio at December 31, 1996. Loans which have adjustable
rates are shown as being due in the period during which rates are next subject
to change while fixed rate and other loans are shown as due in the period of
contractual maturity. Demand loans, loans having no stated maturity and
overdrafts are reported as due in one year or less. The table does not include
prepayments or scheduled principle repayments. Amounts in the table are net of
loans in process.
5
TABLE 4: LOAN MATURITIES
- -------------------------
December 31, 1996
-------------------------------------------------------
Over 1 Over 3 Over 5
One Year Year to Years to Years to Over 10
Or Less 3 Years 5 Years 10 Years Years Total
------- ------- -------- -------- -------- --------
(dollars in thousands)
Mortgage loans:
Fixed rate 1-4 family $ 6,260 $479 $1,356 $21,647 $36,465 $66,207
Adjustable rate 1-4 family 629 629
Adjustable home equity 2,191 2,191
Other fixed rate loans 2,158 48 841 815 10,243 14,105
Other loans 45 55 115 137 20 372
Less:
Allowance for loan losses (511) (511)
------- -------
Total Loans $10,772 $582 $2,312 $22,599 $46,728 $82,993
======= ==== ====== ======= ======= =======
- --------------------------------------------------------------------------------
ASSET QUALITY AND ALLOWANCE FOR LOAN LOSSES
The following table sets forth information with respect to nonperforming assets
including nonaccrual loans and real estate owned at the dates indicated.
TABLE 5: SUMMARY OF NONPERFORMING AND PROBLEM ASSETS
- -----------------------------------------------------
December 31,
-------------------------------------------------
1996 1995 1994 1993 1992
--------- -------- -------- -------- --------
(dollars in thousands)
Total nonaccrual loans $ - $ - $ - $ - $ 53
Total restructured loans - - - - -
-------- ------- ------- ------- -------
Total nonperforming loans - - - - 53
-------- ------- ------- ------- -------
Real estate owned - - - - -
In-substance foreclosures - - - - -
-------- ------- ------- ------- -------
Total foreclosed property - - - - -
-------- ------- ------- ------- -------
Total nonperforming assets $ - $ - $ - $ - $ 53
======== ======= ======= ======= =======
Accruing loans, delinquent 90 days or more $ 423 $ 201 $ 280 $ 292 $ 437
======== ======= ======= ======= =======
Nonperforming loans to total loans 0.00% 0.00% 0.00% 0.00% 0.11%
Nonperforming assets to total assets 0.00% 0.00% 0.00% 0.00% 0.08%
Total assets $105,807 $87,751 $81,560 $75,826 $64,445
Total loans, net $ 82,992 $75,097 $65,973 $55,890 $50,004
6
- -------------------------------------------------------------------------------
The allowance for loan losses represents management's estimate of an amount
adequate to provide for potential losses inherent in the loan portfolio. The
adequacy of the allowance for loan losses and the related provision are based
upon management's evaluation of the risk characteristics of the loan portfolio
under current economic conditions with consideration to such factors as
financial condition of the borrowers, collateral values, growth and composition
of the loan portfolio, the relationship of the allowance for loan losses to
outstanding loans, and delinquency trends. Management believes that the
allowance for loan losses is adequate. While management uses all available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. Various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's allowance for loan losses. Such agencies may require the Company
to recognize additions to the allowance based on their judgments about
information available to them at the time of their examination.
The provision for loan losses is calculated and charged to earnings to maintain
the total allowance for loan losses at a level considered adequate to cover loan
losses based on existing loan levels, types of loans outstanding, nonperforming
loans, prior loan loss experience, industry standards and general economic
conditions. Provisions for loan losses were $50,000 in 1996 compared to
$350,000 in 1995, and $26,000 in 1994. During 1995, the provision and resulting
allowance for loan losses were increased based on management's efforts to
reflect industry practices regarding the allowance for loan losses. During
1996, the provision was lowered, largely as a result of an improved level of the
relationship between the allowance and outstanding loans.
The following tables describe the activity related to the allowance for loan
losses and the allocation of the allowance for loan losses to various categories
of loans for the periods indicated.
TABLE 6: ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
- ---------------------------------------------------
Six Months Year Ended
Ended Ended
December 31, June 30,
1996 1995 1994 1993 1992 1992
---- ---- ---- ---- ------------ --------
(in thousands)
Balance, beginning of period $ 462 $ 115 $ 89 $ 65 $ 48 $ 38
Provision for loan losses 50 350 26 25 17 10
Charge-offs 1 3 - 1 - -
Recoveries - - - - - -
----- ----- ----- ----- ----- -----
Balance, end of period $ 511 $ 462 $ 115 $ 89 $ 65 $ 48
===== ===== ===== ===== ===== =====
Allowance as a percentage of loans .62% .62% .17% .16% .13% .10%
7
TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
- -----------------------------------------------------
December 31,
---------------------------------
1996 1995 1994 1993 1992
----- ----- ----- ----- -----
(in thousands)
Residential 1-4 family $ 138 $ 127 $ 45 $ 35 $ 26
Nonresidential real estate 153 138 23 19 15
Home equity and other second mortgage 52 46 12 10 7
Construction 128 115 24 16 11
----- ----- ----- ----- -----
Total real estate loans 471 426 104 80 59
Other loans 40 36 11 9 6
----- ----- ----- ----- -----
Total allowance for loan losses $ 511 $ 462 $ 115 $ 89 $ 65
===== ===== ===== ===== =====
The allocation of the allowance for loan losses to the respective loan
classifications is not necessarily indicative of future losses or future
allocations. Refer to Table 3 for percentages of loans in each category to
total loans.
INVESTMENT SECURITIES
Interest and dividend income from interest bearing deposits and investment
securities generally provides the second largest source of income to the Company
after interest on loans. The Company's interest bearing deposits primarily
include deposits with the FHLB of Atlanta and federal funds while its portfolio
of investment securities includes U.S. government and agency securities,
mortgage-backed securities, obligations of states and local governments and
mutual funds. The mortgage-backed securities consist of collateralized mortgage
obligations issued by the GNMA and FHLMC which are secured by mortgage-backed
securities guaranteed by the GNMA or FHLMC.
Interest bearing deposits totaled $7.9 at December 31, 1996, an increase of $5.2
million over 1995. The Company also had $570,000 of federal funds sold at
December 31, 1996.
Investment securities totaled $10.5 million at December 31, 1996, an increase of
$4.9 million from $5.6 million at December 31, 1995. This growth is
attributable to management placing in investment securities the net Conversion
proceeds over and above the amounts needed to fund anticipated loan demand which
was placed in federal funds and interest bearing deposits. At December 31,
1996, net unrealized losses of $7,600 were included in the carrying value of
securities classified available-for-sale compared to net unrealized gains of
$3,000 on such securities at December 31, 1995. Net unrealized losses were
caused by fluctuations in market interest rates rather than by concerns about
the issuer's ability to meet their obligations.
Table 8 shows maturities of investment securities held by the Company at
December 31, 1996 and the weighted average tax-equivalent yields for each type
of security and maturity. Further information about the Company's investment
securities as of December 31, 1996 and 1995 is presented in Note 2 of the notes
to the consolidated financial statements.
8
TABLE 8: INVESTMENT SECURITIES - MATURITY/YIELD SCHEDULE
- ---------------------------------------------------------
More Than More Than
One Year or Less 1 Year to 5 Years 5 Years to 10 Years Over 10 Years Total
------------------ ------------------ ------------------- ------------------ -----------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- --------- -------- --------- -------- --------- -------- ---------
(dollars in thousands)
Held-to-Maturity:
U.S. government and agency $2,009 6.54% $2,744 5.59% $ - -% $ - - % $ 4,753 5.99%
Mortgage-backed
securities (1) - - - - - - $2,983 - 2,983 7.03
------ ---- ------ ---- -------- -------- -------- -------- ------- ----
Total held-to-maturity $2,009 6.54% $2,744 5.59% $ - -% $2,983 - % $ 7,736 6.39%
------ ---- ------ ---- -------- -------- -------- -------- ------- ----
Available-for-sale:
State and local
government (1) $ 164 5.90 $1,088 6.38 $759 6.16 $ - - $ 2,011 6.26
Mutual funds 712 5.87 712 5.87
------ ---- ------- ----
Total available-for-sale $ 876 5.88 1,088 6.38 759 6.16 - - 2,723 6.16
------ ---- ------ ---- -------- -------- -------- -------- ------- ----
Total investments
at carrying value $2,885 6.34% $3,832 5.81% $759 6.16% $2,983 7.03% $10,459 6.33%
====== ==== ====== ==== ======== ======== ======== ======== ======= ====
(1) Mortgage-backed securities are shown at their weighted average expected
life obtained from an outside evaluation of the average remaining life of each
security based on historic prepayment speeds of the underlying mortgages at
December 31, 1996.
(2) Yields are stated on taxable equivalent basis assuming statutory tax rates
of 34% for federal and 7.75% for state purposes. Book yields without regard to
tax-equivalent adjustments are: one year or less, 3.60%; two to five years,
4.29%; six to ten years, 4.60%; total, 4.35%
In addition to the investment securities discussed above, the Company also earns
interest on its correspondent bank account at the Federal Home Loan Bank
("FHLB") of Atlanta and dividends on its FHLB stock. The Bank is required to
maintain, as a condition of membership, an investment in stock of the FHLB of
Atlanta equal to the greater of 1% of outstanding home loans or 5% of its
outstanding advances. No ready market exists for such stock, which is carried
at cost. As of December 31, 1996, the Company's investment in stock of the FHLB
of Atlanta was $667,000.
FUNDING SOURCES
Deposits are the primary source of the Company's funds for lending and other
investment purposes. The Company attracts both short-term and long-term
deposits from the general public by offering a variety of accounts with varying
maturities. Deposit inflows and outflows are significantly influenced by
general interest rates and other market conditions, primarily competition. As
competition for deposits has increased both from larger financial institutions
in its local market place and from mutual funds and other investments,
borrowings have provided an additional source of funding. The use of borrowed
funds to provide liquidity assists the Company in matching the interest rates on
its assets and liabilities because the interest rates on most borrowed funds are
fixed and therefore more predictable than the costs of deposits which are
subject to change based upon market conditions and other factors.
DEPOSITS
Deposits totaled $66.6 million at December 31, 1996, compared to $73.0
million at December 31, 1995. The decrease reflects approximately $6.8 million
of deposits which customers used to purchase the Parent's stock in the
Conversion. The following table sets forth certain information regarding the
Company's average savings deposits for the last three years.
9
TABLE 9: AVERAGE DEPOSITS
- -----------------------------------------------
1996 1995 1994
----------------- ----------------- -----------------
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate
------- ------- ------- ------- ------ -------
(dollars in thousands)
NOW and money market deposit account $ 3,996 1.80% $ 4,521 1.81% $ 4,849 1.98%
Savings account 9,270 3.51 9,525 3.02 14,314 3.25
Certificates of deposit 55,418 5.84 56,495 5.73 47,550 4.84
------- ---- ------- ---- ------- ----
Total deposits $68,684 5.24% $70,541 5.11% $66,713 4.29%
======= ==== ======= ==== ======= ====
As of December 31, 1996, the Company had outstanding $5,145,000 in time
certificates of deposit of $100,000 or more. Maturities of certificates of
deposits of $100,000 or more at December 31, 1996 were as follows: three months
or less, $1,989,000, over three months through six months, $1,264,000, over six
months through twelve months $1,032,000: and over twelve months through twenty-
four months, $860,000.
BORROWINGS
The Company's principal source of long-term borrowings are advances from the
FHLB of Atlanta. As a requirement for membership, the Bank is required to own
capital stock in the FHLB of Atlanta and is authorized to apply for advances on
the security of that stock and a floating lien on its family residential
mortgage loans. Each credit program has its own interest rate and range of
maturities. At December 31, 1996, the Company had no outstanding FHLB advances,
compared to $1 million at December 31, 1995. Additional information on
borrowings is provided in Note 6 of the notes to the consolidated financial
statements.
LIQUIDITY AND INTEREST RATE RISK MANAGEMENT
------------------------------------------
Liquidity is the ability to raise funds or convert assets to cash in order to
meet customer and operating needs. The Company's primary sources of liquidity
are its portfolio of investment securities available-for-sale, principal and
interest payments on loans and mortgage-backed securities, interest income from
investment securities, maturities of investment securities held-to-maturity,
increases in deposits, and advances from the FHLB of Atlanta. At December 31,
1996, the Bank had $12 million of credit available from the FHLB which would be
collateralized by a blanket lien on qualifying loans secured by first mortgages
on family residences. Additional amounts may be made available under this
blanket floating lien or by using investment securities as collateral.
Management believes that it will have sufficient funds available to meet its
anticipated future loan commitments as well as other liquidity needs.
Interest rate risk is the sensitivity of interest income and interest expense to
changes in interest rates. Management continues to structure its assets and
liabilities in an attempt to protect net interest income from large fluctuations
associated with changes in interest rates. Table 10 shows the amount of
interest-earning assets and interest-bearing liabilities outstanding at December
31, 1996 which are projected to reprice or mature in each of the future time
periods shown. At December 31, 1996, the Company had a negative cumulative one
year asset-sensitive gap position of $14.9 million or 14.28% of interest-earning
assets. This generally indicates that net interest income would decrease in a
rising rate environment and would experience upward trend in a declining rate
environment.
A static interest rate "gap" analysis may not be an accurate indicator of how
net interest income will react to changes in interest rates. A static gap
computation uses contractual maturities and does not make assumptions for
prepayments, scheduled loan principal payments or deposit decays. Income
associated with interest-earning assets and costs associated with interest-
bearing liabilities may not react uniformly to changes in interest rates. In
addition, the magnitude and duration of changes in interest rates may have a
significant impact on net interest income. For example, although certain assets
and liabilities may have similar maturities or periods to repricing, they may
react in different degrees to changes in market interest rates. Interest rates
on certain types of assets and liabilities typically fluctuate in advance of
changes in general market interest rates, while interest rates on other types
may lag behind changes in general market rates.
10
It should be noted that this table reflects the interest-sensitivity of the
balance sheet as of a specific date and is not necessarily indicative of future
results. The computations were made without using assumptions for loan
repayments or deposit delays. Except as stated below, the amounts of assets and
liabilities shown which reprice or mature within a given period were determined
in accordance with contractual terms of the assets or liabilities. In making
the computations, all adjustable rate loans were considered to be due at the end
of the next upcoming adjustment period. Fixed rate loans were considered to
reprice at their contractual maturities with no consideration given to
prepayments or scheduled payments. Liquid interest-earning investments with no
contractual maturities are assumed to be subject to immediate repricing.
Statement savings and money market accounts are subject to immediate
availability and repricing and have been placed in the earliest gap category.
In addition, fixed maturity deposits were assumed to reprice at their
contractual maturities without consideration for early withdrawals. The
interest rate sensitivity of the Company's assets and liabilities illustrated in
the following table would vary substantially if different assumptions were used
or if actual experience differs from that indicated by such assumptions.
Because of these and other limitations, management also monitors interest rate
sensitivity through the use of a model which estimates the change in net
portfolio value and net interest income in response to a range of assumed
changes in market interest rates. Based on interest sensitivity measures as of
December 31, 1996, management realizes its need to improve the Company's
interest rate exposure and has developed strategies to address this issue.
TABLE 10: INTEREST SENSITIVITY
- -------------------------------
December 31, 1996
-----------------------------------------------------------------------------------
More than More than
3 Months 4 to 12 1 Year to 3 Years to Over Over
Or Less Months 3 Years 5 Years 5 Years 10 years Total
---------- ---------- ----------- ------------ ---------- --------- ---------
(dollars in thousands)
Interest earning assets
Mortgage loans:
Fixed rate residential 1-4 family $ - $ 6,260 $ 479 $ 1,355 $ 21,647 $36,465 $ 66,206
Adjustable rate residential 1-4 family - 629 - - - - 629
Adjustable home equity 2,191 - - - - - 2,191
Other fixed rate loans - 2,158 48 841 815 10,243 14,105
-------- -------- -------- -------- -------- ------- --------
Total mortgage loans 2,191 9,047 527 2,196 22,462 46,708 83,131
Other loans 45 55 115 137 20 372
-------- -------- -------- -------- ------- --------
Total loans 2,191 9,092 582 2,311 22,599 46,728 83,503
Interest-bearing deposits(2) 8,486 8,486
Investment securities (1) - 2,885 - 3,832 759 2,983 10,459
FHLB common stock 667 - - - - - 667
-------- -------- -------- -------- -------- ------- --------
Total interest-earning assets $ 11,344 $ 11,977 $ 582 $ 6,143 $ 23,358 $49,711 $103,115
-------- -------- -------- -------- -------- ------- --------
Interest-bearing liabilities
Deposits:
Fixed maturity deposits $ 13,424 $ 27,726 $ 12,621 $ - $ - $ - $ 53,771
NOW accounts money market accounts 3,932 - - - - - 3,932
Savings accounts 8,861 - - - - - 8,861
-------- -------- -------- -------- -------- ------- --------
Total deposits 26,217 27,726 12,621 - - - 66,564
-------- -------- -------- -------- -------- ------- --------
Total interest-bearing liabilities $ 26,217 $ 27,726 $ 12,621 $ - $ - $ - $ 66,564
-------- -------- -------- -------- -------- ------- --------
Interest sensitivity gap per period $(14,873) $(15,749) $(12,039) $ 6,143 $ 23,358 $49,711 $ 36,551
Cumulative interest-sensitivity gap $(14,873) $(30,622) $(42,661) $(36,518) $(13,160) $36,551 $ 36,551
Cumulative gap as a percentage of
total interest-earning assets (14.42%) (29.70%) (41.37%) (35.41%) (12.67%) 35.45% 35.45%
Cumulative interest-earning assets as a
percentage of interest-bearing liabiliti 43.27% 43.23% 35.91% 45.14% 80.23% 154.91% 154.91%
(1) Includes investments and mortgage-backed securities
(2) Includes interest-bearing deposits and federal funds
11
CAPITAL RESOURCES
-----------------
Stockholders' equity increased from $12.6 million at December 31, 1995 to
$37.4 million at December 31, 1996, largely as a result of the Conversion.
As a state savings bank holding company, the Parent is regulated by the Board of
Governors of the Federal Reserve Board ("FRB") and is subject to securities
registration and public reporting regulations of the Securities and Exchange
Commission. The Bank is regulated by the Federal Deposit Insurance Corporation
("FDIC)" and the Savings Institutions Division, North Carolina Department of
Commerce ("the Administrator").
The Bank must comply with the capital requirements of the FDIC and the
Administrator. The FDIC requires the Bank to maintain minimum ratios of Tier I
capital to total risk-weighted assets and total capital to risk-weighted assets
of 4% and 8%, respectively. Tier I capital consists of total stockholders'
equity calculated in accordance with generally accepted accounting principles
less intangible assets, and total capital is comprised of Tier 1 capital plus
certain adjustments, the only one of which applicable to the Bank is the
allowance for loan losses. Risk weighted assets reflect the Bank's on-and off-
balance sheet exposures after such exposures have been adjusted for their
relative risk levels using formulas set forth in FDIC regulations. The Bank is
also subject to a leverage capital requirement, which calls for a minimum ratio
of Tier I capital (as defined above) to quarterly average total assets of 3% to
5%, depending on the institution's composite ratings as determined by its
regulators. The Administrator requires a net worth equal to at least 5% of
assets.
At December 31, 1996 and 1995, the Bank was in compliance with all of the
aforementioned capital requirements as summarized in Table 11. Refer note 7 to
the consolidated financial statements for a discussion of other matters that may
affect the Company's capital resources.
TABLE 11: REGULATORY CAPITAL
- ------------------------------------------------------------------------
At December 31,
-----------------------
1996 1995
---------- ----------
(dollars in thousands)
Risk-Based and Leverage Capital
Tier I capital:
Common stockholders' equity $ 24,967 $ 12,563
Unrealized holding loss (gain) on securities available-for-sale (7) (1)
---------- ----------
Total Tier I leverage capital 24,960 12,562
Tier II Capital:
Qualifying allowances for loan losses
Tier II capital additions 511 462
---------- ----------
Total risk-based capital $ 25,471 $ 13,024
Risk-weighted assets 48,072 41,214
Fourth quarter average assets 96,363 86,864
Risk-based capital ratios:
Tier-I capital as a percent of risk-weighted assets 51.92% 30.48%
Minimum Required Tier I capital 4.00% 4.00%
Total risk-based capital as a percent of risk-weighted assets 52.99% 31.60%
Minimum required total risk-based capital 8.00% 8.00%
Leverage capital ratios:
Tier I leverage capital as a percent of fourth quarter average assets 25.90% 14.46%
Minimum required Tier I leverage capital 3.00-5.00% 3.00-5.00%
North Carolina regulatory capital:
Total risk-based capital as a percent of fourth quarter average assets 26.43% 14.99%
Minimum required North Carolina capital 5.00% 5.00%
12
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and accompanying footnotes have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without consideration for changes in the relative purchasing
power of money over time due to inflation. The assets and liabilities of the
Company are primarily monetary in nature, and changes in interest rates have a
greater impact on the Company's performance than do the effects of inflation.
Accounting Issues
-----------------
The Company prepares its consolidated financial statements and related
disclosures in conformity with standards established by, among others, the
Financial Accounting Standards Board (the "FASB"). Because the information
needed by users of financial reports is dynamic, the FASB frequently has new
rules and proposed new rules for companies to apply in reporting their
activities. The following discussion addresses such changes as of December 31,
1996 that will affect the Company's future reporting.
The FASB has issued Statement of Financial Accounting Standards ("SFAS") No 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." SFAS 121 requires that long-lived assets and certain
identifiable intangibles to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. In evaluating
recoverability, if estimated future cash flows, undiscounted and without
interest charges, are less than the carrying amount of the asset, an impairment
loss is recognized. SFAS 121 also requires that certain long-lived assets and
certain identifiable intangibles to be disposed of be reported at the lower of
carrying amount or fair value less cost to sell. SFAS 121 applies prospectively
for fiscal years beginning after December 15, 1995. The adoption of this
accounting standard did not affect the financial statements for 1996.
The FASB has also issued SFAS NO. 122, "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65," which provides guidance for the
capitalization of originated as well as purchased mortgage servicing rights and
the measurement of impairment of those rights. SFAS 122 requires that an entity
recognize as separate assets the rights to service mortgage loans for others,
however those servicing rights are acquired. SFAS 122 also requires that an
entity assess its capitalized mortgage servicing rights for impairment based on
the fair value of those rights. It should satisfy its mortgage servicing rights
based on one or more predominant risk characteristics of the underlying loans,
and recognize impairment through a valuation allowance for each impaired
stratum. SFAS 122 applies prospectively for fiscal years beginning after
December 15, 1995. The adoption of this accounting standard did not affect the
financial statements in 1996
In October, 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation". The Statement defines a fair value method of accounting for an
employee stock option or similar equity instrument and encourages all entities
to adopt that method of accounting for all of their employee stock compensation
plans. It also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed in
Accounting Principles Board Opinion Number 25 ("APB No. 25") "Accounting for
Stock Issued to Employees". SFAS No. 123 requires that an employers' financial
statements include certain disclosures about stock-based compensation
arrangements regardless of the method used to account for them. Entities
electing to remain with the accounting in APB No. 25 must make pro forma
disclosures of net income and, if presented, earnings per share, as if the fair
value based method of accounting defined in SFAS No. 123 had been applied. The
disclosure requirements of the statement are effective for financial statements
for fiscal years beginning after December 15, 1995, or for an earlier fiscal
year for which this statement is initially adopted for recognizing compensation
cost. Pro forma disclosures required for entities that elect to continue to
measure compensation cost using APB No. 25 must include the effects of all
awards granted in fiscal years that begin after December 15, 1994. The adoption
of this accounting standard did not affect the financial statements in 1996.
13
- --------------------------------------------------------------------------------
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" was issued in June 1996. This statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control. It
distinguishes transfers of financial assets that are sales from transfers that
are secured borrowings. Under the financial-components approach, after a
transfer of financial assets, an entity recognizes all financial and servicing
assets it controls and liabilities it has incurred and derecognizes financial
assets it no longer controls and liabilities that have been extinguished. The
financial-components approach focuses on the assets and liabilities that exist
after the transfer. If a transfer does not meet the criteria for a sale, the
transfer is accounted for as a secured borrowing with pledge of collateral.
This statement is effective for transfer and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, and is to be
applied prospectively. Management anticipates that the adoption of the
statement should have no material impact on its consolidated financial
statements.
14
INDEPENDENT AUDITORS' REPORT
----------------------------
The Board of Directors and Stockholders
Stone Street Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Stone Street
Bancorp, Inc. and subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the years in the three-year period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Stone Street
Bancorp, Inc. and subsidiary as of December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the years in the three year
period ended December 31, 1996, in conformity with generally accepted accounting
principles.
As discussed in notes 2 and 8, respectively, to the consolidated financial
statements, on July 1, 1993, the Company adopted the provisions of the Financial
Accounting Standards Board's Statement of Financial Accounting Standards No 115,
"Accounting for Certain Investments in Debt and Equity Securities," and the
provisions of the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes".
/s/ Weir Smith Jones Miller & Elliott
Weir Smith Jones Miller & Elliott
Statesville, North Carolina
January 31, 1997
15
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31, 1996 and 1995
Notes 1996 1995
----- --------- --------
(in thousands)
ASSETS
Cash $ 1,319 $ 2,162
Federal funds sold 570
Interest-bearing deposits in other financial institutions 7,916 2,737
Investment securities 2
Held-to-maturity (Market value: $7,780 in 1996
and $3,290 in 1995) 7,736 3,269
Available-for-sale (Cost: $2,731 in 1996
and $2,299 in 1995) 2,723 2,302
Loans receivable (net of allowance for loan losses of
$511 in 1996 and $462 in 1995) 3 82,992 75,096
Federal Home Loan Bank stock at cost 667 576
Premises and equipment 4 900 949
Accrued interest receivable 310 104
Deferred income tax 376 334
Refundable income tax 77 21
Prepaid expenses and other assets 8 93 137
Cash surrender value of life insurance 128 64
-------- -------
Total assets $105,807 $87,751
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits: 5
Savings accounts 8,861 9,309
NOW and MMDA 3,932 4,348
Other certificates of deposit 48,626 54,344
Certificates of deposit, $100,000 and over 5,145 5,034
-------- -------
Total deposits 66,564 73,035
Advances from the Federal Home Loan Bank 6 1,000
Amounts payable under remittance service agreement 636 595
Accrued interest payable 170 147
Accrued expenses and other liabilities 667 412
Accrued cash dividends payable 402
--------
Total liabilities 68,439 75,189
-------- -------
Stockholders' Equity:
Common stock, no par value 20,000,000 shares authorized:
1,825,050 shares issued and outstanding 1 26,333
Note receivable from ESOP for purchase of common stock (2,198)
Retained earnings, substantially restricted 7,8 13,241 12,563
Unrealized holding gains (losses) on available-for-sale securities, net (8) (1)
-------- -------
Total stockholders' equity 37,368 12,562
-------- -------
Commitments and contingencies 3,9
Total liabilities and stockholders' equity $105,807 $87,751
======== =======
See accompanying notes to consolidated financial statements.
16
CONSOLIDATED FINANCIAL STATEMENTS OF INCOME
-------------------------------------------
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Notes 1996 1995 1994
----- ------ ------ ------
(in thousands)
Interest income:
Interest on loans $6,662 $5,980 $5,289
Interest on deposits in other financial institutions 692 198 312
Interest and dividends on investment securities:
Taxable 563 336 302
Non-taxable 91 88 93
------ ------ ------
Total interest income 8,008 6,602 5,996
------ ------ ------
Interest expense:
Interest on deposits 5 3,604 3,607 2,862
Interest on borrowings 6
------ ------ ------
Total interest expense 3,610 3,607 2,862
------ ------ ------
Net interest income 4,398 2,995 3,134
Provision for loan losses 3 50 350 26
------ ------ ------
Net interest income after provision for loan losses 4,348 2,645 3,108
------ ------ ------
Other income:
Loan fees and charges 45 53 41
Customer service and other fees 56 57 54
Other 13 17 16
------ ------ ------
Total other income 114 127 111
------ ------ ------
Other expenses:
Compensation and related benefits 1,013 957 805
Deposit insurance premiums 581 158 148
Occupancy and equipment expense 216 242 216
Professional fees 36 31 10
Other 277 217 316
------ ------ ------
Total other expenses 2,123 1,605 1,495
------ ------ ------
Income before income tax expense 2,339 1,167 1,724
Income tax expense 8 858 430 617
------ ------ ------
Net income $1,481 $ 737 $1,107
====== ====== ======
Net income per share 1 $0.82 N/A N/A
====== ====== ======
See accompanying notes to consolidated financial statements.
17
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
For the Years ended December 31, 1996, 1995 and 1994
Note Unrealized Total
Shares Common Receivable Retained Holding Stockholders'
Outstanding Stock ESOP Earnings Gains/Losses Equity
----------- ------- ----------- --------- ------------- --------------
(in thousands, except shares outstanding)
Balance at December 31, 1993 - $ - $ - $10,719 $ - $10,719
Net income - - - 1,107 - 1,107
Change in unrealized holding
gains (losses), net of
income taxes of $25 - - - - (97) (97)
----------- ------- ---------- ------- ------------ -------
Balance at December 31, 1994 - - - 11,826 (97) 11,729
Net income - - - 737 - 737
Change in unrealized holding
gains (losses), net of income
taxes of $24 - - - - 96 96
----------- ------- ---------- ------- ------------ -------
Balance at December 31, 1995 - - - 12,563 (1) 12,562
Net income - - - 1,481 - 1,481
Net proceeds from issuance of
no par common stock 1,825,050 26,333 - - - 26,333
Common stock acquired by
ESOP - - (2,198) - - (2,198)
Cash dividends declared
($.44 per share) - - - (803) - (803)
Change in unrealized holding
gains (losses),net of income
taxes of $3 - - - - (7) (7)
----------- ------- ---------- ------- ------------ -------
Balance at December 31, 1996 1,825,050 $26,333 $(2,198) $13,241 $ (8) $37,368
=========== ======= ========== ======= ============ =======
See accompanying notes to consolidated financial statements.
18
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
-------- ------- --------
(in thousands)
Operating activities:
Net income $ 1,481 $ 737 $ 1,107
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 96 85 88
Provision for loan losses 350 26
Deferred income taxes (42) (66) (102)
Decrease (increase) in accrued interest receivable (206) 28 (44)
Increase in cash surrender value of life insurance (64) (64)
Decrease (increase) in refundable income taxes (56) 40 (55)
Increase (decrease) in amounts payable under remittance
service agreement 41 296 (290)
(Increase) decrease in other assets 44 (90) (17)
Increase (decrease) in accrued interest payable 23 25 34
Accrued cash dividends payable 402
Increase (decrease) in other liabilities 281 143 122
-------- ------- --------
Net cash provided by operating activities 2,000 1,484 869
-------- ------- --------
Investing activities:
Net increase in loans held for investment (7,946) (9,474) (12,130)
Principal collected on mortgage-backed securities 108
Purchase of investment securities classified as available-for-sale (860) (630)
Purchase of investment securities classified as held-to-maturity (2,760) (500)
Purchase of mortgage-backed securities classified as held-to-maturity (2,298)
Proceeds from maturities of investment securities classified
as available-for-sale 439
Proceeds from maturities of investment securities held-to-maturity 500 3,280 1,700
Purchase of FHLB Stock (91) (79)
Purchase of premises and equipment (47) (92) (35)
-------- ------- --------
Net cash used by investing activities (12,955) (6,865) (11,095)
-------- ------- --------
Financing activities:
Net increase (decrease) in deposits (6,471) 3,895 4,858
Proceeds from borrowings 1,000
Repayments of borrowings (1,000)
Proceeds from issuance of no par common stock 26,333
Loan to ESOP for the purchase of common stock (2,198)
Cash dividends paid to shareholders (803)
--------
Net cash provided by financing activities 15,861 4,895 4,858
-------- ------- --------
Increase (decrease) in cash and cash equivalents 4,906 (486) (5,368)
Cash and cash equivalents at beginning of period 4,899 5,385 10,753
-------- ------- --------
Cash and cash equivalents at end of period $ 9,805 $ 4,899 $ 5,385
======== ======= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 3,587 $ 3,581 $ 2,828
======== ======= ========
Income taxes $ 914 $ 390 $ 737
======== ======= ========
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on available-for-sale securities, net of deferred
taxes (benefit) of $3 for 1996, $24 for 1995 and $25 for 1994 $ 8 $ 95 $ (97)
======== ======= ========
Dividends declared but unpaid $ 402 $ - $ -
======== ======= ========
See accompanying notes to consolidated financial statements.
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(1) Significant Accounting Policies
-------------------------------
Organization and Operations
---------------------------
In March 29, 1996, pursuant to a Plan of Conversion approved by its members
and regulators, Mocksville Savings Bank, Inc., SSB (the "Bank") amended and
restated its charter to effect its conversion from a North Carolina chartered
mutual savings bank to a North Carolina chartered stock savings bank (the
"Conversion"), and became a wholly-owned subsidiary of Stone Street Bancorp,
Inc. (the "Parent"), a holding company formed in connection with the
Conversion. The Bank is primarily engaged in the business of obtaining
savings deposits and providing loans to the general public. The principal
activity of the Parent is ownership of the Bank.
Basis of Presentation
---------------------
The consolidated financial statements include the accounts of the Parent and
the Bank, together referred to as "the Company". All significant
intercompany transactions and balances are eliminated in consolidation. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the balance sheets and
the reported amounts of income and expenses for the periods presented.
Actual results could differ significantly from those estimates. Material
estimates that are particularly susceptible to significant changes in the
near-term relate to the determination of the allowance for loan losses.
Investment and Mortgage-Backed Securities
-----------------------------------------
Management determines the appropriate classification of investment and
mortgage-backed securities at the time of purchase and reevaluates such
designation at each reporting date. Securities are classified as held-to-
maturity when the Company has both the positive intent and ability to hold
the securities to maturity. Held-to-maturity securities are stated at
amortized cost. Securities not classified as held-to-maturity are classified
as available-for-sale. Available-for-sale securities are stated at fair
value, with the unrealized gains and losses, net of tax, reported in a
separate component of stockholders' equity. The Company has no trading
securities.
The amortized cost of securities classified as held-to-maturity or available-
for-sale is adjusted for amortization of premiums and accretion of discounts
to maturity, or in the case of mortgage-backed securities, over the estimated
life of the security. Such amortization is included in interest income from
investments. Realized gains and losses, and declines in value judged to be
other-than-temporary are included in net securities gains (losses). The cost
of securities sold is based on the specific identification method.
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
Loans Receivable
----------------
Loans held for investment are carried at their principal amount outstanding,
net of deferred loan origination fees.
Interest on loans is recorded as borrowers' monthly payments become due.
Accrual of interest income on loans is suspended when, in management's
judgment, doubts exist as to the collectibility of principal and interest.
Loans are returned to accrual status when management determines, based on an
evaluation of the underlying collateral together with the borrower's payment
record and financial condition, that the borrower has the capability and
intent to meet the contractual obligations of the loan agreement.
Loan fees are accounted for in accordance with Statement of Financial
Accounting Standards No. 91. Loan origination fees and certain direct loan
origination costs are deferred and the net amount amortized as an adjustment
of the related loans' yield over the life of the related loans using a level-
yield method. Unamortized net loan fees or costs on loans sold are recorded
as gain or loss on sale in the year of disposition.
Allowance for Loan Losses
-------------------------
The Company provides for loan losses on the allowance method. Accordingly,
all loan losses are charged to the allowance and all recoveries are credited
to it. Additions to the allowance for loan losses are provided by charges to
operating expense. The provision is based upon management's evaluation of
the risk characteristics of the loan portfolio under current economic
conditions and considers such factors as financial condition of the borrower,
collateral values, growth and composition of the loan portfolio, the
relationship of the allowance for loan losses to outstanding loans, and
delinquency trends.
At December 31, 1996, substantially all of the Company's loans were
collateralized by real estate in Davie and adjacent counties. The collateral
is predominately owner-occupied residential real estate in which the borrower
does not rely on underlying cash flows from the property to satisfy debt
service. The ultimate collectibility of a substantial portion of the loan
portfolio is susceptible to changes in market conditions in the Company's
market area. While management uses available information to recognize losses
on loans, future additions to the allowance may be necessary based on changes
in economic conditions. Various regulatory agencies, as an integral part of
their examination processes, periodically review the Company's allowance for
loan losses. Such agencies may require the Company to recognize additions to
the allowance based on their judgments about information available to them at
the time of their examinations.
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(1) Significant Accounting Policies, Continued
------------------------------------------
Effective January 1, 1995, as required, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan," as amended by Statement of Financial Accounting
Standards No. 118, "Accounting by Creditors for Impairment of a Loan: Income
Recognition" (collectively referred to hereafter as "SFAS No. 114"). The
adoption of SFAS No. 114 did not have a material effect on the Company's
financial condition or results of operations. Under the provisions of SFAS
No. 114, the 1996 provision for loan losses related to loans that are
identified for impairment in accordance with SFAS No. 114 is based on
discounted cash flows using the loans' initial interest rate or the fair
value of the collateral if the loan is collateral dependent. Large groups of
smaller balance homogenous loans that are collectively evaluated for
impairment (such as residential mortgage and consumer installment loans) are
excluded from this impairment evaluation in accordance with SFAS No. 114, and
their allowance for loan losses is calculated in accordance with the
allowance for loan losses policy described above.
Investment in Federal Home Loan Bank Stock
------------------------------------------
As a requirement for membership, the Bank invests in stock of the Federal
Home Loan Bank of Atlanta (FHLB) in the amount of 1% of its outstanding
residential loans or 5% of its outstanding advances from the FHLB, whichever
is greater. At December 31, 1996, the Bank owned 6,669 shares of the FHLB's
$100 par value capital stock.
Premises and Equipment
----------------------
Premises and equipment are stated at cost. Provisions for depreciation are
computed principally using the straight-line method and charged to operations
over the estimated useful lives of the assets over 20 years for office
buildings and 3 to 10 years for furniture, fixtures, and equipment and other
improvements.
Income Taxes
------------
In February of 1992, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for
Income Taxes". Statement 109 requires a change from the deferred method of
accounting for income taxes of APB Opinion 11 to the asset and liability
method of accounting for income taxes. Under the asset and liability method
of Statement 109, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under
Statement 109, the effect on deferred tax assets and liabilities of a change
in tax rates is recognized in income in the period that includes the
enactment date. Effective January 1, 1993, the Company adopted Statement
109.
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(1) Significant Accounting Policies, Continued
------------------------------------------
Retirement Plan
---------------
The Bank has an employee stock ownership plan which covers substantially all
of its employees. Contributions to the plan are determined annually by the
Board of Directors based on employee compensation. Prior to establishment of
the employee stock ownership plan, the Company had a self-administered,
defined contribution retirement plan that covered all eligible employees.
This plan was terminated as of January 1, 1996 in conjunction with the
Conversion. The Bank also has a 401(k) plan that covers all eligible
employees.
Cash and Cash Equivalents
-------------------------
For purposes of reporting cash flows, the Company considers cash, Federal
funds sold and interest-bearing deposits in other institutions with original
maturities of three months or less to be cash equivalents.
Earnings Per Share
------------------
Earnings per share has been computed as if the 1,825,050 shares issued on
March 29, 1996 had been outstanding for the full year. For purposes of this
computation, the number of shares purchased by the Bank's employee stock
ownership plan which were purchased with a loan by the Parent Company are not
assumed to be outstanding.
New Accounting Pronouncements
-----------------------------
The FASB has issued SFAS No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-lived Assets to be Disposed Of". SFAS 121 requires
that long-lived assets and certain identifiable intangibles to be held and
used by an entity be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In evaluating recoverability, if estimated future cash flows,
undiscounted and without interest charges, are less than the carrying amount
of the asset, an impairment loss is recognized. SFAS 121 also requires that
certain long-lived assets and certain identifiable intangibles to be disposed
of be reported at the lower of carrying amount or fair value less cost to
sell. SFAS 121 applies prospectively for fiscal years beginning after
December 15, 1995. The adoption of this accounting standard did not affect
the 1996 financial statements.
The FASB has also issued SFAS No. 122, "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65," which provides guidance for
the capitalization of originated as well as purchased mortgage servicing
rights and the measurement of impairment of those rights. SFAS 122 requires
that an entity recognize as separate assets the rights to service mortgage
loans for others, however those servicing rights are acquired. SAFS 122 also
requires that an entity assess its capitalized mortgage servicing rights for
impairment based on the fair value of those rights. It should stratify its
mortgage servicing rights based on one or more predominant risk
characteristics of the underlying loans, and recognize impairment through a
valuation allowance for each impaired stratum. SFAS 122 applies
prospectively for fiscal years beginning after December 15, 1995. The
adoption of this accounting standard did not affect the 1996 financial
statements.
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(1) Significant Accounting Policies, Continued
------------------------------------------
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation". The statement defines a fair value method of accounting for
an employee stock option or similar equity instrument and encourages all
entities to adopt that method of accounting for all of their employee stock
compensation plans. It also allows an entity to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting prescribed in Accounting Principles Board Opinion Number 25 ("APB
No. 25"). "Accounting for Stock Issued to Employees". SFAS No. 123 requires
that an employers' financial statements include certain disclosures about
stock-based compensation arrangements regardless of the method used to
account for them. Entities electing to remain with the accounting in APB No.
25 must make pro forma disclosures of net income and, if presented, earnings
per share, as if the fair value based method of accounting defined in SFAS
No. 123 had been applied. The disclosure requirements of the statement are
effective for financial statements for fiscal years beginning after December
15, 1995, or for an earlier fiscal year for which this statement is initially
adopted for recognizing compensation cost. Pro forma disclosures required
for entities that elect to continue to measure compensation cost using APB
No. 25 must include the effects of all awards granted in fiscal years that
begin after December 15, 1994. The adoption of this accounting standard had
no material impact on the 1996 financial statements.
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" was issued in June 1996. This statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control. It
distinguishes transfers of financial assets that are sales from transfers
that are secured borrowings. Under the financial-components approach, after
a transfer of financial assets, an entity recognizes all financial and
servicing assets it controls and liabilities it has incurred and does not
recognize financial assets it no longer controls and liabilities that have
been extinguished. The financial-components approach focuses on the assets
and liabilities that exist after the transfer. If a transfer does not meet
the criteria for a sale, the transfer is accounted for as a secured borrowing
with pledge of collateral. This statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring
after December 31, 1996, and is to be applied prospectively. Management
anticipates that the adoption of the statement should have no material impact
on its consolidated financial statements.
Reclassifications
-----------------
Certain reclassifications have been made for 1995 and 1994 to conform with
the 1996 presentation. The reclassifications had no effect on previously
reported net income or stockholders' equity.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(2) Investment Securities
---------------------
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments
in Debt and Equity Securities". This statement addresses the accounting and
reporting for investments in equity securities that have readily determinable
fair values and for all investments in debt securities. These investments
are to be classified in three categories and accounted for as follows: (1)
debt securities that the entity has the positive intent and ability to hold
to maturity are classified as held-to-maturity and reported at amortized
cost; (2) debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
securities and reported at fair value, with net unrealized gains and losses
included in earnings; and (3) debt and equity securities not classified as
either held-to-maturity or trading securities are classified as securities
available-for-sale and reported at fair value, with unrealized gains and
losses excluded from earnings and reported as a separate component of equity.
The Company adopted SFAS 115 on January 1, 1993. The adoption affected only
the held-to-maturity and available-for-sale classifications, with the net
unrealized securities gains on the securities available-for-sale of $122,855
net of related deferred taxes of $25,230, reported as a separate component of
equity at December 31, 1993. The Company has no trading securities.
The following is a summary of the securities portfolios by major
classification:
December 31, 1996
--------------------------------------------
(in thousands)
Estimated
Amortized Unrealized Unrealized market
cost gains losses value
--------- ---------- ---------- ---------
Securities held-to-maturity:
US government and agency securities $4,753 $21 $18 $4,756
Mortgage-backed securities (1) 2,983 41 - 3,024
------ --- --- ------
Total securities held-to-maturity 7,736 62 18 7,780
====== === === ======
Securities available-for-sale:
States and local governments $2,019 $ 4 $12 $2,011
Mutual funds 712 - - 712
------ --- --- ------
Total securities available-for-sale $2,731 $ 4 $12 $2,723
====== === === ======
December 31, 1995
-----------------------------------------------
(in thousands)
Estimated
Amortized Unrealized Unrealized market
cost gains losses value
--------- ---------- ---------- ---------
Securities held-to-maturity:
US government and agency securities $2,995 $24 $ - $3,016
Mortgage-backed securities (1) 274 - - 274
------ --- --- ------
Total securities $3,269 $24 $ - $3,290
====== === === ======
Securities available-for-sale:
State and local governments $1,629 $ 3 $ 2 $1,630
Mutual funds 670 2 - 672
------ --- --- ------
Total securities available-for-sale $2,299 $ 5 $ 2 $2,302
====== === === ======
(1) At December 31, 1996 and 1995, the Company owned mortgage-backed securities
issued by the General National Mortgage Association (GNMA) and the Federal Home
Loan Mortgage Corporation (FHLMC) with an aggregate amortized cost of $2,801,000
and $183,000 respectively, and a market value of $2,825,000 and $199,500.
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(2) Investment Securities, Continued
--------------------------------
The aggregate amortized cost and approximate market value of the available-
for-sale and held-to-maturity securities portfolios at December 31, 1996, by
remaining contractual maturity are as follows:
Securities available-for-sale Securities held-to-maturity
----------------------------- ---------------------------
(in thousands)
Estimated Estimated
Amortized market Amortized market
cost value cost value
--------- ---------- ------------ -----------
US government securities:
Due in 1 year or less $ - $ - $ 998 $1,003
Due in 1 year through 5 years - - 499 495
US government agencies securities:
Due in 1 year or less - - 1,011 1,012
Due in 1 year through 5 years - - 2,245 2,246
Obligations of states local governments:
Due in 1 year or less 165 164 - -
Due 1 year through 5 years 1,475 1,478 - -
Due after 5 through 10 years 379 369 - -
Mortgage-backed securities 2,983 3,024
Mutual funds 712 712 - -
------ ------ ------ ------
Total securities $2,731 $2,723 $7,736 $7,780
====== ====== ====== ======
There was no sales activity for held-to-maturity or available-for-sale
securities for the years ended December 31, 1996, 1995 and 1994.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(3) Loans Receivable
Loans receivable consist of the following:
December 31,
-----------------
1996 1995
------- -------
(in thousands)
Loans secured by first mortgages on real estate:
Mortgage loans held for investment, primarily one-to-four family $67,844 $63,329
Construction loans 12,492 11,735
Nonresidential real estate 5,716 4,260
------- -------
86,052 79,324
Home equity lines of credit 2,191 1,890
Other second mortgage loans 282 295
Other installment loans 372 222
------- -------
88,897 81,731
Undisbursed proceeds on loans in process (4,385) (5,211)
Deferred loan fees (1,009) (962)
Allowance for loan losses (511) (462)
------- -------
$82,992 $75,096
======= =======
An analysis of the allowance for loan losses follows:
1996 1995 1994
----- ------- -------
(in thousands)
Balance at beginning of period $ 462 $ 115 $ 89
Provision for loan losses 50 350 26
Loans charged off (1) (3) -
Recoveries - - -
----- ------- -------
Balance at end of period $ 511 $ 462 $ 115
===== ======= =======
At December 31, 1996 and 1995, the Company had no loans which were in
nonaccrual status and $486,875 and $248,645, respectively, which were
contractually delinquent for 90 days or more and still accruing.
At December 31, 1996, the Company had mortgage loan commitments outstanding of
$4,383,000, and preapproved but unused lines of credit totaled $1,700,000.
The Company's exposure to credit loss for commitments to extend credit and
standby letters of credit is the contractual amount of those financial
instruments. The Company uses the same credit policies for making commitments
and issuing standby letters of credit as it does for on-balance sheet
financial instruments. Each customer's creditworthiness is evaluated on an
individual basis. The amount and type of collateral, if deemed necessary by
management, is based upon this evaluation of creditworthiness. Collateral
obtained varies but may include marketable securities, deposits, real estate,
investment assets, and property and equipment. In management's opinion, these
commitments, and undisbursed proceeds on loans in process reflected above,
represent no more than normal lending risk to the Company and will be funded
from normal sources of liquidity.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(3) Loans Receivable, Continued
---------------------------
The Bank makes loans to executive officers and directors of the Company and to
their associates. It is management's opinion that such loans are made on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with unrelated
persons and do not involve more than the normal risk of collectibility.
Following is a reconciliation of loans outstanding to executive officers,
directors, and their associates for the year ending December 31, 1996.
Balance at December 31, 1995 $1,762,792
New loans 835,534
Repayments (694,444)
----------
Balance at December 31, 1996 $1,903,882
==========
(4) Premises and Equipment
----------------------
Premises and equipment consist of the following:
December 31, 1996 December 31, 1995
------------------------------- ----------------------------------
Accumulated Net book Accumulated Net book
Cost depreciation value Cost depreciation value
------ ------------ --------- ---------- ------------ --------
(in thousands)
Land $ 258 $ - $258 $ 258 $ - $258
Office buildings and improvements 834 386 448 834 348 486
Furniture, fixtures and equipment 500 330 170 478 276 202
Vehicles 26 2 24 13 10 3
------ ------------ ---- ---------- ------------ --------
$1,618 $718 $900 $ 1,583 $634 $949
====== ============ ==== ========== ============ ========
(5) Deposits
--------
Time deposits of $100,000 or more totaled $5,144,587 and $5,033,864 at
December 31, 1996 and 1995, respectively.
Interest expense on deposits includes $343,000, $431,000 and $275,000 for the
years ended December 31, 1996, 1995 and 1994, respectively, on time deposits
of $100,000 or more.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(6) Advances from the Federal Home Loan Bank
----------------------------------------
Advances from the Federal Home Loan Bank of Atlanta, with weighted average
interest rates, are as follows:
December 31, 1995
-----------------
(in thousands)
6.25% due on or before December 20, 1996 $ 500
5.85% due on or before December 28, 1996 500
------
$1,000
======
There were no FHLB advances outstanding at December 31, 1996. At December 31,
1996, the Bank had additional credit availability from the Federal Home Loan
Bank of $12,000,000.
All advances are secured by all stock in the Federal Home Loan Bank and a
blanket floating lien on the Bank's one-to-four family residential mortgage
loans.
(7) Regulatory Restrictions
-----------------------
CAPITAL REQUIREMENTS: The Parent is regulated by the Board of Governors of
the Federal Reserve System ("FRB") and is subject to securities registration
and public reporting regulations of the Securities and Exchange Commission.
The Bank is regulated by the Federal Deposit Insurance Corporation ("FDIC")
and the Administrator, Savings Institutions Division, North Carolina
Department of Commerce (the "Administrator").
The Bank is subject to capital requirements of the FDIC and the Administrator.
The FDIC requires the Bank to maintain minimum ratios of Tier 1 capital to
total risk-weighted assets and total capital to risk-weighted assets of 4% and
8%, respectively. Tier 1 capital consists of total shareholders' equity
calculated in accordance with generally accepted accounting principles less
intangible assets, and total capital is comprised of Tier 1 capital plus
certain adjustments, the only one of which applicable to the Bank is the
allowance for possible loan losses. Risk-weighted assets refer to the on- and
off-balance sheet exposures of the Bank adjusted for their relative risk
levels using formulas set forth in FDIC regulations. The Bank is also subject
to a FDIC leverage capital requirement, which calls for a minimum ratio of
Tier 1 capital (as defined above) to quarterly average total assets of 3% to
5%, depending on the institution's composite ratings as determined by its
regulators. The Administrator requires a net worth equal to at least 5% of
total assets.
At December 31, 1996, the Bank was in compliance with all of the
aforementioned capital requirements.
LIQUIDATION ACCOUNT: At the time of Conversion, the Bank established a
liquidation account in an amount equal to its net worth at December 31, 1995.
The liquidation account will be maintained for the benefit of eligible deposit
account holders who continue to maintain their deposit accounts in the Bank
after Conversion. Only in the event of a complete liquidation will each
eligible deposit account holder be entitled to receive a liquidation
distribution from the liquidation account in the amount of the then current
adjusted subaccount balance for deposit accounts then held before any
liquidation distribution may be made with respect to the Parent's common
stock. Dividends cannot be paid from this liquidation account.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(7) Regulatory Restrictions, continued
----------------------------------
DIVIDENDS: Subject to applicable law, the Boards of Directors of the Bank and
the parent may each provide for the payment of dividends. Future declarations
of cash dividends, if any, by the Parent may depend upon dividend payments by
the Bank to the Parent. Subject to regulations of the Administrator, the Bank
may not declare or pay a cash dividend on or repurchase any of its common
stock if its stockholders' equity would thereby be reduced below either the
aggregate amount then required for the liquidation account or the minimum
regulatory capital requirements imposed by federal and state regulations. In
addition, for a period of five years after the Conversion, the Bank will be
required, under existing North Carolina regulations, to obtain prior written
approval of the Administrator before it can declare and pay a cash dividend on
its capital stock in an amount in excess of one-half of the greater of (i) its
net income for the most recent fiscal year, or (ii) the average of its net
income after dividends for the most recent fiscal year and not more than two
of the immediately preceding fiscal years, if applicable. As a result of this
limitation, the Bank cannot pay a dividend in excess of $563,500 without the
approval of the Administrator.
(8) Income Taxes
------------
As discussed in note 1, effective January 1, 1993, the Company adopted
Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting
for Income Taxes". There was a cumulative effect of the change in accounting
for income taxes totaling $23,539 in 1993.
The components of income tax expense (benefit) were as follows:
Year ended December 31,
-----------------------
(in thousands)
1996 1995 1994
------ ------ ------
Currently payable:
Federal $ 757 $ 530 $ 583
State 139 80 93
----- ----- -----
896 610 676
----- ----- -----
Deferred:
Federal (31) (147) (47)
State (7) (33) (12)
----- ----- -----
(38) (180) (59)
----- ----- -----
$ 858 $ 430 $ 617
===== ===== =====
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(8) Income Taxes, Continued
-----------------------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are shown
below:
December 31,
--------------
1996 1995
------ ------
(in thousands)
Allowance for loan losses (net) $ 204 $ 184
Deferred loan origination fees, net of deferred costs
Gross deferred tax assets 404 384
Valuation allowance 608 568
----- -----
Net deferred tax assets 608 568
----- -----
Accelerated depreciation 52 72
FHLB stock dividends 180 162
----- -----
Gross deferred tax liabilities 232 234
----- -----
Net deferred tax asset $ 376 $ 334
===== =====
The Company has no valuation allowance at December 31, 1996 or 1995 because it
has sufficient taxable income in the carryback period to support the
realizability of the net deferred tax asset.
The reconciliation of income taxes at statutory tax rates to income tax
expense reported in the statements of income follows:
December 31,
----------------------
1996 1995 1994
------ ------ ------
(in thousands)
Income taxes at the statutory federal tax rate $ 798 $ 397 $ 586
State income taxes less federal benefit 120 59 88
Tax exempt interest (38) (40) (70)
Other (22) 14 13
----- ----- -----
Total tax expense $ 858 $ 430 $ 617
===== ===== =====
Retained earnings at December 31, 1996 includes approximately $2,577,990 for
which no provision for federal income tax has been made. This amount
represents allocations of income to bad debt deductions for tax purposes only.
Reduction of such amount for purposes other than tax bad debt losses will
create income for tax purposes only, which will be subject to the then current
corporate income tax rate. Legislation passed in 1996 eliminates the
percentage of taxable income method as an option for computing bad debt
deductions for 1996 and in all future years. The Bank will still be permitted
to take deductions for bad debts, but will be required to compute such
deductions using an experience method.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(9) Employee and Director Benefit Plans
-----------------------------------
DEFINED CONTRIBUTION RETIREMENT PLAN: The Bank has had a self-administered,
defined contribution retirement plan that covered all eligible employees. The
Bank's policy has been to fund retirement costs accrued. Under the plan, the
Bank contributed an actuarially determined amount based on a participants
compensation and years service. In conjunction with the Conversion, the
defined contribution retirement plan was terminated as of January 1, 1996.
Funds were distributed in 1996. There was no gain or loss upon the
termination of the defined contribution retirement plan. Retirement expense
of this plan totaled approximately $84,000 in 1995, and $58,000 in 1994.
401(k) PLAN: During 1994, the Bank implemented a 401(k) plan that covers all
eligible employees. During years prior to 1996, the Bank has matched 50% of
employee contributions, with the Bank's contribution limited to 3% of each
employee's salary. 401(k) matching contributions are funded when accrued.
Matching expense totalled approximately $1,900 in 1996, $10,000 in 1995, and
$8,000 in 1994.
EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP"): The Bank has an ESOP whereby an
aggregate number of shares amounting to $130,400 were purchased for future
allocation to employees. Contributions to the ESOP are made by the Bank on a
discretionary basis, and are allocated among ESOP participants on the basis of
relative compensation in the year of allocation. Benefits will vest in full
upon five years of service with credit given for years of service prior to the
conversion.
The ESOP has been funded by a loan from the Parent in the amount of
$2,198,064. The loan is secured by shares of stock purchased by the ESOP and
is not guaranteed by the Bank. Principal and interest payments on this loan
are funded primarily from discretionary contributions by the Bank. Dividends,
if any, paid on shares held by the ESOP may also be used to reduce the loan.
The $175,000 cash contribution was used to allocate 7,205 shares to ESOP
participants in December 1996. At December 31, 1996, there remain 123,195
unearned ESOP shares with a total fair value of approximately $2,525,500.
Dividends on unallocated shares are used by the ESOP to repay the debt to the
Parent and are not reported as dividends in the consolidated financial
statements. Dividends on allocated shares are credited to the accounts of
the participants and reported as dividends in the consolidated financial
statements.
MANAGEMENT RECOGNITION PLAN: The Company plans to adopt a Management
Recognition Plan ("MRP") which has been approved by the Parent's and the
Bank's Boards of Directors and will be submitted to the stockholders of the
Parent for approval. The MRP serves as a means of providing existing
directors and employees of the Bank with an ownership interest in the Company.
Approximately 4% of shares outstanding or 73,002 shares can be awarded under
the Plan. No amounts were charged to expense in 1996, 1995 or 1994 in
connection with this plan.
STOCK OPTION PLAN: The Company plans to adopt a Stock Option Plan which has
also been approved by the Parent's and the Bank's Boards of Directors and will
be submitted to the stockholders of the Parent for approval. The Stock Option
Plan is to provide for the granting of options to purchase 182,505 shares, or
10% of the shares issued in the Conversion to employees and directors. No
amounts have been charged to expense in 1996, 1995, or 1994 in connection
with this plan.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(9) Employee and Director Benefit Plans, continued
----------------------------------------------
DIRECTOR 'S DEFERRED COMPENSATION PLAN: The Bank has a deferred compensation
plan for its directors under which the directors would be paid specified
amounts during the ten year period following the date that the director
becomes 65 years of age. The Bank has purchased life insurance policies with
the Bank named as beneficiary to fund the benefits. Total expense related to
these plans was approximately $48,000 for 1996, $70,000 for 1995, and $120,000
for 1994.
EMPLOYMENT AGREEMENTS: In connection with the Conversion, the Bank entered
into an employment agreement with its chief executive officer in order to
ensure a stable and competent management base. The agreement provides for a
three-year term, but upon each anniversary, the agreement automatically
extends so that the remaining term shall always be three years. The agreement
provides that the nature of the covered employee's compensation, duties or
benefits cannot be diminished following a change in control of the Company.
SEVERANCE PLAN: In connection with the Conversion, the Bank adopted a
Severance Plan for the benefit of its employees. The Plan provides for
severance pay benefits in the event of a change in control which results in
the termination of such employees or diminished compensation, duties, or
benefits within two years of a change in control. The employees covered would
be entitled to a severance benefit of the greater of (a) the amount equal to
two weeks' salary at the existing salary rate multiplied by the employee's
number of completed years of service or (b) the amount of one month's salary
at the employee's salary rate at the time of termination, subject to a maximum
payment equal to two times the employee's annual salary.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(10) Quarterly Financial Data (Unaudited)
------------------------------------
Summarized unaudited quarterly financial data for the year ended December 31,
1996 is as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- -------- --------- ----------
(in thousands except per share amounts)
OPERATING SUMMARY:
Interest income $ 1,774 $ 2,082 $ 2,086 $ 2,066
Interest expense 1,016 884 860 850
Net interest income 758 1,198 1,226 1,216
Provision for loan losses - 15 15 20
Net interest income after provision for
loan losses 758 1,183 1,211 1,196
Other income 26 29 31 27
Other expenses 439 368 847 468
Income before income tax expense 345 844 395 755
Income taxes 141 305 126 286
Net income 204 539 269 469
PER SHARE DATA:
Earnings N/A .30 .15 .26
Cash dividends declared N/A .11 .11 .22
Dividend payout N/A 37% 73% 85%
Book value per share N/A 21.00 20.18 20.47
SELECTED AVERAGE BALANCES:
Assets $92,835 $108,766 $108,343 $105,691
Investment securities 14,871 28,281 25,237 21,296
Loans, net 75,883 77,704 79,520 82,081
Interest-bearing deposits 72,692 67,951 67,613 66,480
Stockholders' equity 16,621 39,401 38,944 37,494
Summarized unaudited quarterly financial data for the year ended December 31,
1995 is as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- -------- -------- --------
(in thousands except per share amounts)
OPERATING SUMMARY:
Interest income $ 1,581 $ 1,615 $ 1,684 $ 1,722
Interest expense 825 883 928 971
Net interest income 756 732 756 751
Provision for loan losses - - 335 15
Net interest income after provision for
loan losses 756 732 421 736
Other income 28 38 33 28
Other expenses 373 399 382 451
Income before income tax expense 411 371 72 313
Income taxes 153 140 20 117
Net income 258 231 52 196
PER SHARE DATA:
Earnings N/A N/A N/A N/A
Cash dividends declared N/A N/A N/A N/A
Dividend payout N/A N/A N/A N/A
Book value per share N/A N/A N/A N/A
SELECTED AVERAGE BALANCES:
Assets $82,162 $ 82,685 $ 84,300 $ 86,594
Investment securities 9,469 9,259 8,411 7,445
Loans, net 66,918 68,654 71,768 74,249
Interest-bearing deposits 69,596 69,387 70,769 72,410
Stockholders' equity 11,931 12,209 12,475 12,516
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(11) Parent Company Financial Data
-----------------------------
Condensed financial information for Stone Street Bancorp, Inc. (Parent
Company) is as follows:
December 31, 1996
-----------------
(in thousands)
CONDENSED BALANCE SHEET
Assets:
Cash on deposit with bank subsidiary $ 4,272
Interest bearing deposits 7,531
Investment securities available for sale at market value:
Obligations of states and local governments, cost $860,000 859
Investment in bank subsidiary 25,230
Other assets 164
-------
Total assets $38,056
=======
Liabilities and stockholders' equity:
Accrued taxes, expenses and other liabilities $ 418
Stockholders' equity, net 37,638
-------
Total liabilities and stockholders' equity $38,056
=======
Year Ended
December 31, 1996
-----------------
(in thousands)
CONDENSED STATEMENT OF INCOME
Interest income from bank subsidiary $ 30
Interest on interest bearing deposits 483
Interest on loan from bank subsidiary ESOP 93
Interest on investment securities 5
-------
Total income 611
Operating expenses 30
-------
Income before income taxes 581
Income tax expense 227
-------
Income before equity in undistributed net income of subsidiary 354
Equity in undistributed net income of bank subsidiary 1,127
-------
Net income $ 1,481
=======
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(11) Parent Company Financial Data, Continued
----------------------------------------
Yearr Ended
December 31, 1996
-----------------
(in thousands)
Cash flows from operating activities:
Net income $ 1,481
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary (1,127)
Increase in other assets (164)
Increase in other liabilities 418
--------
Net cash provided by operating activities 608
--------
Cash flows from investing activities:
Purchase of available for sale securities (860)
--------
Net cash used by investing activities (860)
Cash flows from financing activities:
Proceeds of issuance of no par common stock 26,333
Loan to ESOP for purchase of common stock (2,198)
Capital contribution to Mocksville Savings Bank (11,277)
Cash dividends paid to stockholders (803)
--------
Net cash provided by financing activities 12,055
--------
Net increase in cash and cash equivalents 11,803
Cash and cash equivalents at beginning of year -
--------
Cash and cash equivalents at end of year $ 11,803
========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 283
========
Supplemental disclosure of noncash transactions:
Unrealized gains (losses) on securities available for sale
net of deferred tax benefit of $1 $ 1
========
Unrealized gains (losses) on subsidiary's securities
available for sale, net of deferred tax benefit of $3 $ 7
========
Dividends declared but unpaid $ 418
========
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
------------------------------------------
(12) Fair Value of Financial Instruments
-----------------------------------
Fair value estimates are made by management at a specific point in time,
based on relevant information about the financial instrument and the market.
These estimates do not reflect any premium or discount that could result from
offering for sale at one time the Company's entire holdings of a particular
financial instrument nor are potential taxes and other expenses that would be
incurred in an actual sale considered. Fair value estimates are based on
judgements regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions and/or the methodology used could
significantly affect the estimates disclosed. Similarly, the fair values
disclosed could vary significantly from amounts realized in actual
transactions.
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not
considered financial instruments.
The following table presents the carrying values and estimated fair values of
the Company's financial instruments at December 31, 1996:
Carrying Estimated
value fair value
--------- ----------
(in thousands)
Financial assets:
Cash and interest-bearing deposits $ 9,805 $ 9,805
Investment securities:
Available-for-sale 2,723 2,723
Held-to-maturity 7,736 7,780
Net loans 82,992 82,617
Federal Home Loan Bank stock 667 667
Federal liabilities:
Deposits 66,564 66,667
The estimated fair values of net loans and deposits are based on cash flows
discounted at market interest rates. The carrying values of other financial
instruments, including various receivables and payables, approximate fair
value.
At December 31, 1996, the Company had outstanding commitments to extend
credit. These off-balance sheet financial instruments are generally
exercisable at the market rate prevailing at the date the underlying
transaction will be complete, and, therefore, they are deemed to have no
current fair market value. Refer to note 3.
37
CAPITAL STOCK
-----------------------
Stone Street Bancorp's common stock is traded on the American Stock Exchange
under the symbol SSM. As of December 31, 1996, there were 1,825,050 shares
outstanding and 721 shareholders of record, not including the number of
persons or entities whose stock is held in nominee or street name through
various brokerage firms or banks. Payment of dividends by the Bank subsidiary
to the Parent is subject to various restrictions. Under applicable banking
regulations, the Bank may not declare a cash dividend if the effect thereof
would be to reduce its net worth to an amount less than the minimum required
by federal and state banking regulations. In addition, for a period of five
years after the consummation of the Bank's stock conversion, which occurred on
March 29, 1996, the Bank will be required to obtain prior written approval
from the Administrator of the Savings Institutions Division, North Carolina
Department of Commerce, before it can declare a cash dividend in an amount in
excess of one-half the greater of (i) its net income for the most recent
fiscal year of (ii) the average of its net income after dividends for the most
recent fiscal year and not more than two of the immediately preceding fiscal
years, as applicable.
QUARTERLY COMMON STOCK PERFORMANCE AND DIVIDENDS DECLARED
FOR THE YEAR ENDED DECEMBER 31, 1996
Stock Price
------------------
High Low Dividends Declared, Per Share
------- ------- -----------------------------
Second quarter ended June 30* $18 5/8 $16 1/2 $.11
Third quarter ended September 30 18 16 .11
Fourth quarter ended December 31 (1) 20 5/8 18 1/8 .22
- -----------------
*The common stock did not begin trading until April 1, 1996
(1) Includes regular cash dividend of $.11 per share and special dividend of
$.11.
38