1
EXHIBIT 13
1998 ANNUAL REPORT
(PHOTO)
CHARTER
NEW
TERRITORY
FIRST
CHARTER
2
CORPORATE PROFILE
(PHOTO)
First Charter Corporation is the holding
company for First Charter National Bank and
Home Federal Savings and Loan Association.
A super-community bank headquartered in
Concord N.C., First Charter has served
businesses and individuals in the Charlotte
metropolitan region for over 110 years.
Common stock for First Charter Corporation
is traded on the NASDAQ National Market
under the symbol "FCTR".
3
WHERE YOU NEED US.
WHEN YOU NEED US.
First Charter customers can receive a broad
array of financial services through 33 branch
offices and 65 ATM locations.
[MAP]
FIRST
CHARTER
CORPORATION
Map of selected locations
in North Carolina
4
MARKETS SERVED
[MAP]
Map of selected locations
in North Carolina
5
MISSION
(PHOTO)
(l to r) Brenda Kinley,
Linda Gibson, Steve Calhoun,
Pat Horton, Patty Blackwell
YOU WILL KNOW US BY THE MISSION
WE HAVE CHOSEN...
We are dedicated to providing the exceptional financial
services preferred by our business and individual customers.
We are committed to a work environment that encourages
enthusiasm and offers opportunities for professional growth and
development.
We are determined to create superior value for our
shareholders.
1
6
First Charter Corporation and Subsidiaries
Selected Consolidated Financial Data
The following table sets forth certain selected consolidated financial
data concerning First Charter Corporation (the "Corporation") for the five years
ended December 31, 1998. All financial data have been adjusted to reflect the
acquisition of Bank of Union in 1995, the acquisition of Carolina State Bank in
1997 and the acquisition of HFNC Financial Corp. in 1998, each of which was
accounted for as a pooling of interests. Additionally, all per share data have
been adjusted to reflect a 6-for-5 stock split declared in the second quarter of
1997 and a stock split effected in the form of a 33 1/3% stock dividend declared
in the fourth quarter of 1994. This information should be read in conjunction
with Management's Discussion and Analysis of Financial Condition and Results of
Operations appearing elsewhere in this report, and is qualified in its entirety
by reference to the more detailed consolidated financial statements of the
Corporation and notes thereto.
Years ended December 31,
(Dollars in thousands, except per share amounts) 1998 1997 1996 1995 1994
Income Statement Data:
Interest income $ 136,509 $ 123,130 $ 116,371 $ 98,209 $ 82,174
Interest expense 70,623 62,827 57,416 47,844 37,516
------------------------------------------------------------------
Net interest income 65,886 60,303 58,955 50,365 44,658
Provision for loan losses 2,376 2,684 1,481 2,328 1,591
------------------------------------------------------------------
Net interest income after provision for loan losses 63,510 57,619 57,474 48,037 43,067
Noninterest income 13,650 15,082 8,156 7,125 6,428
Noninterest expense 59,166 42,765 39,169 31,817 29,757
------------------------------------------------------------------
Income before income taxes 17,994 29,936 26,461 23,345 19,738
Income taxes 8,758 10,765 9,028 7,467 6,510
------------------------------------------------------------------
Net income $ 9,236 $ 19,171 $ 17,433 $ 15,878 $ 13,228
------------------------------------------------------------------
Per Share Data:
Basic net income $ 0.51 $ 1.06 $ 0.95 $ 0.95 $ 0.81
Diluted net income 0.50 1.03 0.94 0.94 0.80
Cash dividends declared(1) 0.61 0.53 0.50 0.43 0.34
Period-end book value 13.34 12.79 12.25 7.08 6.18
Balance Sheet Data (at period-end):
Securities available for sale $ 331,799 $ 315,565 $ 325,825 $ 399,694 $ 55,452
Investment securities held to maturity -- -- 13,940 8,959 202,504
Loans, net 1,406,967 1,246,228 1,108,311 913,892 782,420
Allowance for loan losses 15,554 15,263 14,140 13,552 13,144
Total assets 1,864,357 1,672,641 1,573,177 1,415,368 1,125,894
Deposits 1,123,035 1,059,262 1,013,696 964,005 941,552
Borrowed funds 469,944 350,079 309,895 124,714 35,374
Total liabilities 1,618,385 1,428,732 1,340,396 1,104,460 989,990
Total shareholders' equity 245,972 243,909 232,781 311,075 135,904
Ratios:
Net income to average shareholders' equity 3.68 7.47 6.20 7.44 10.14
Net income to average total assets 0.52 1.21 1.16 1.34 1.22
Net interest income to average earning assets
(tax equivalent) 4.11 4.12 4.23 4.34 5.04
Average loans to average deposits 139.05 111.96 104.68 86.33 88.41
Net loans charged off during period to average loans 0.15 0.16 0.09 0.23 0.13
(1) First Charter Corporation historical cash dividends declared.
See accompanying notes to the consolidated financial statements.
2
7
SHAREHOLDERS
Dear Fellow Shareholders,
In 1998 First Charter completed the first steps on a journey into new
territories: New products, New markets and a New strategic focus. 1998 was also
a year of setting records. Not only did we complete the largest acquisition in
our company's history, more than doubling our size, but we also posted record
recurring earnings.
In preparation for this journey, we invested aggressively in
technology, significantly strengthened our senior management team, created an
insurance services subsidiary and opened 22 ATMs in selected Food Lion
supermarkets. Additionally, we broke ground for the First Charter Center, a $35
million state-of-the-art customer support facility.
First Charter is located in one of the most dynamic business markets in
the country. While this is certainly an advantage, our long term success will
depend primarily upon how well we meet the needs and exceed the expectations of
our customers. Success begins with getting to know them more intimately through
the gathering and refining of information. Success is achieved by acting upon
that information in ways that help to improve their lives.
The year ahead will be full of challenges and opportunities:
- - We will focus on delivering exceptional service to businesses by
building on our existing strengths in that market.
- - We will concentrate on expanding our base of customer knowledge and
improving the ability of our sales staff to respond quickly to customer
needs, and even anticipating them.
- - We will strengthen our presence in key markets through targeted
marketing and advertising strategies, communicating the message that
First Charter is both different from and better than the competition.
- - We will hold ourselves to the highest standards of customer service
quality.
Success will be achieved through hard work, commitment and strength of will.
(PHOTO)
Lawrence M. Kimbrough
(TOTAL ASSETS CHART)
3
8
YEAR IN REVIEW
Our financial performance in 1998 demonstrates the strength of our core
businesses. We plan for this trend to continue in 1999.
(PHOTO)
Debbie Alexander, Team Leader
FINANCIAL RESULTS
In 1998, total assets grew 11.5% to $1.9 billion. Recurring earnings
totaled $23.0 million, up 22.4% from 1997 recurring earnings of $18.8 million.
This growth was driven by an increase in net loans of 12.9% during the year to
$1.4 billion and an increase in total deposits of 6.0% to $1.1 billion.
Excluding nonrecurring charges and gains, First Charter produced a return on
average assets of 1.29% and a return on average equity of 9.17%. In 1997 these
ratios were 1.18% and 7.32%, respectively. The 1998 results above exclude the
nonrecurring costs of our merger with HFNC Financial Corp. ("HFNC"), the holding
company for Home Federal Savings and Loan Association ("Home Federal"). The full
impact of these costs is discussed in detail later in this report.
At the end of 1998, total shareholders' equity was $246.0 million,
which represents a book value per share of $13.34 and an equity-to-assets ratio
of 13.2%. As of December 31, 1998, First Charter Corporation had a market
capitalization of $318.1 million.
The acquisition of HFNC on September 30, 1998 enabled First Charter to
enter the dynamic Charlotte market. We believe that our combination of
exceptional customer service and competitive products will be successful in that
market. In addition to doubling our size in assets, the merger significantly
enhanced the liquidity of First Charter common stock. However, this acquisition
presents unique financial challenges as well as significant business
opportunities.
Several traditional indicators of financial performance changed
dramatically with the acquisition. The process of aggressive financial
management that will return these measures back to their previous levels of high
performance began in 1998 when 1,004,000 shares of HFNC stock were purchased and
retired. In addition, 154,117 shares of First Charter common stock were
purchased and retired.
In 1999, our plans include generating more commercial loans, increasing
net interest margin and emphasizing growth in fee income. Our focus on
maintaining a very competitive efficiency ratio will continue.
(PHOTO)
Telephone Bank Represatives
(l to r) Jeslyn Williams, Gloria Lozano,
Cindy Riley
EXPANDING OUR REACH
Whenever we meet more of the financial needs of our customers or
deliver our services more conveniently, we become more competitive. In 1998 we
broadened the financial solutions available to our business and individual
customers by launching First Charter Insurance Services, Inc. ("FCIS").
Headquartered in Huntersville (NC), FCIS has acquired three well-respected
insurance agencies located in the Charlotte metropolitan region. Additional
agency acquisitions will be made in 1999.
4
9
In 1998 we brought more convenient banking to two towns in our
marketplace. We opened a branch office in the town of Mint Hill, and moved our
office in Matthews to a new, more visible location. Both branches are located on
highly trafficked main thoroughfares.
Lastly, First Charter opened 22 new ATMs in selected Food Lion
supermarkets. These sites not only offer our customers greater convenience, but
also advertise our services to non-customers. Three more Food Lion ATMs will
open in the second quarter of 1999.
BUILDING OUR TEAM
As our company grows, the leadership needed to sustain our commitment
to exceptional service and performance continues to change. In the past year, we
strengthened our management team by recruiting a number of senior executives,
including new Directors of Human Resources, Funds Management, Insurance
Services, Training, Strategic Initiatives, Marketing and Commercial Sales. These
experienced leaders will help us shape the First Charter organization that will
enter the new millennium.
With our new strategic focus on the commercial market and the addition
of the Charlotte market to our sales area through the acquisition of Home
Federal, the need to expand our commercial sales force has grown rapidly. Seven
experienced, successful commercial sales and lending officers have been
recruited for the markets in Charlotte, Monroe and North Mecklenburg county.
The cornerstone of our growth plans for the future is the ongoing
development of a superior sales culture. We recognized that the development
process could be accelerated if we added an experienced sales management
executive to our leadership team. We were fortunate to recruit Robert E. James,
Jr., who joined First Charter in February 1999 as Group Executive Vice President
- - Sales. Bob spent the majority of his career at Centura Bank, where he was a
key player in the creation of the highly successful sales program at that bank.
He will manage sales for our company, while Robert O. Bratton, Group Executive
Vice President - Service, will continue to manage the technology and support
functions.
GROWING INTO THE FUTURE
The extraordinary growth of First Charter over the past three years has
been exciting. Among the most exciting events of 1998 took place on December
2nd, when we broke ground for the First Charter Center. The Center is designed
to provide state-of-the-art customer support services. Just as important, it is
designed to provide a convenient, comfortable work environment for our
employees.
[PHOTO OF A FIRST CHARTER SIGN]
The key to our success has always been the spirit, dedication and hard
work of our First Charter family. I am delighted and honored to work with them.
More than ever, our future success relies on their passion and enthusiasm. I
believe our future is in good hands.
Sincerely,
/s/ Lawrence M. Kimbrough
Lawrence M. Kimbrough
President and Chief Executive Officer
5
10
SETTING A NEW DIRECTION
Deciding upon which direction to take is the first crucial step in a
successful journey. After careful consideration and extensive customer research,
we developed a new strategic focus. First Charter will focus on the exceptional
delivery of financial services to businesses. Our goal is to meet all the
financial needs of businesses, their owners and their employees.
(PHOTO)
Nancy Mills, First Charter Trust Department
Robert Griggs, Owner, Kramer & Eugenes
First Charter is known for delivering superior service to businesses
already. Market research indicates that First Charter business customers are
significantly more satisfied with our service than are the business customers of
competing banks with the service they receive from them. We are building on a
demonstrated corporate competency.
(PHOTO)
Our current sales area contains over 40,000 businesses and this number
grows each year. By offering fast, flexible service in a customer-oriented
atmosphere, First Charter can become the best choice for businesses that expect
more from their bank.
6
11
INVESTING FOR THE JOURNEY
(PHOTO)
First Charter Center
In 1998, First Charter made significant investments in preparation for
the journey into the new millennium.
- - Acquiring Home Federal, which enabled us to enter the Charlotte market
and created new opportunities to sell our products and services.
- - Breaking ground for the First Charter Center, which will open in July
of 2000 and provide a spacious, comfortable, state-of-the-art workplace
for over 300 service, administrative and support employees.
- - Recruiting new senior executives to help us work smarter, grow faster
and succeed as a larger, more complex organization.
- - Creating First Charter Insurance Services in order to meet more of the
financial needs of businesses and individuals.
And in 1999 we will continue to invest for the future.
- - Creating a strong, meaningful brand presence in our markets through the
use of advertising targeted to business owners.
- - Implementing technologies that help us communicate better and enable us
to use information more effectively on behalf of customers and in our
business decision making.
- - Developing the knowledge and skills of our staff and finding ways that
can make First Charter an even better place to work.
- - Continuously improving upon our ability to provide exceptional
financial services to our business and individual customers.
Expect More From Us.
(Charter New Territory Photo)
7
12
MEETING THE Y2K CHALLENGE
With every second that passes, the world draws closer to the challenge
of Year 2000 ("Y2K"). On January 1, 2000, computers all over the world may have
difficulty reading the date (01/01/00) and, consequently, may not function
properly. All businesses and individuals that use computers face this challenge,
including banks.
OUR SOLUTION
[PHOTO OF YEAR CLOCK 2000]
First Charter created TEAM 2000 in January 1997 to spearhead our
response to the Y2K challenge. After completing an exhaustive inventory of the
hardware, software and imbedded systems that could potentially be affected by
the Y2K problem, TEAM 2000 then developed and implemented a three-phase plan for
the comprehensive testing of all critical computer applications:
- Phase I - Vendor Testing
(Gathering test results from vendors)
Status: Completed
- Phase II - Unit Testing
Status: Completed
- Phase III - Integrated Testing
Status: Completion scheduled for May 31, 1999
All computer software applications, PCs and printers that did not pass
Phase II testing will be corrected by May 1, 1999.
CLEAN MANAGEMENT AND BEYOND
First Charter has implemented a Clean Management program. Clean
Management means we do not add or change computer software after testing has
been completed. However, if business needs compel us to add or change computer
applications, we will submit the new application to rigorous compliance testing.
Clean Management assures that the computer programs that were tested
successfully today will be the same ones in place on January 1, 2000.
Just in case external events such as the loss of telecommunications
cause problems at First Charter on January 1, 2000, we are creating a detailed
response plan that will facilitate full business resumption as soon as possible.
CUSTOMER COMMUNICATION
We are dedicated to keeping our customers fully informed regarding our
preparations for Year 2000. In addition to periodic updates inserted in account
statements, current information on First Charter's preparations for Y2K are
available on our Website at www.firstcharter.com and via telephone through the
TEAM 2000 Hotline at 1-877-322-2548.
First Charter has been providing information regarding our Year 2000
progress to the public on a regular basis. Please be advised that First Charter
designates such information as Year 2000 Readiness Disclosures.
8
13
INDEPENDENT AUDITORS' REPORT
The Board of Directors
First Charter Corporation
We have audited the accompanying consolidated balance sheets of First Charter
Corporation and subsidiaries (the "Company") as of December 31, 1998 and 1997,
and the related consolidated statements of income, shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1998. 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 First Charter
Corporation and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
KPMG LLP
Charlotte, North Carolina
January 13, 1999
14
FIRST CHARTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
- --------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks ....................................... $ 41,884 $ 35,392
Federal funds sold ............................................ 6,402 8,195
Interest bearing bank deposits ................................ 11,713 15,143
Securities available for sale, cost of $321,357 in 1998
and $306,528 in 1997 ..................................... 331,799 315,565
Loans ......................................................... 1,422,676 1,261,764
Less: Unearned income .................................... (155) (273)
Allowance for loan losses .......................... (15,554) (15,263)
-----------------------------------
Loans, net ............................................... 1,406,967 1,246,228
-----------------------------------
Premises and equipment, net ................................... 30,603 26,057
Other assets .................................................. 34,989 26,061
-----------------------------------
Total assets ......................................... $ 1,864,357 $ 1,672,641
===================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits, domestic:
Noninterest bearing demand ............................... $ 119,519 $ 103,005
Interest bearing ......................................... 1,003,516 956,257
-----------------------------------
Total deposits ....................................... 1,123,035 1,059,262
Other borrowings .............................................. 469,944 350,079
Other liabilities ............................................. 25,406 19,391
-----------------------------------
Total liabilities .................................... 1,618,385 1,428,732
-----------------------------------
Shareholders' equity:
Common stock - no par value; authorized: 50,000,000 shares
in 1998 and 25,000,000 shares in 1997; issued and
outstanding: 18,442,202 shares in 1998 and 19,068,298
shares in 1997 ........................................... 121,416 139,712
Unearned ESOP and unvested restricted stock ................... -- (21,234)
Retained earnings ............................................. 118,078 119,899
Accumulated other comprehensive income:
Unrealized gains on securities available for sale, net ... 6,478 5,532
-----------------------------------
Total shareholders' equity ........................... 245,972 243,909
-----------------------------------
Total liabilities and shareholders' equity ........... $ 1,864,357 $ 1,672,641
===================================
See accompanying notes to consolidated financial statements.
15
FIRST CHARTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------------
Interest income:
Loans ................................................. $ 116,376 $ 100,921 $ 90,545
Federal funds sold .................................... 1,026 1,012 1,102
Interest bearing bank deposits ........................ 201 795 908
Securities available for sale ......................... 18,906 19,581 23,109
Investment securities held to maturity ................ -- 821 707
---------------------------------------------------------
Total interest income ............................. 136,509 123,130 116,371
---------------------------------------------------------
Interest expense:
Deposits .............................................. 46,141 46,332 44,708
Federal funds purchased and securities
sold under agreements to repurchase ............... 6,957 7,689 7,790
Federal Home Loan Bank and other borrowings ................ 17,525 8,806 4,918
---------------------------------------------------------
Total interest expense ..................................... 70,623 62,827 57,416
---------------------------------------------------------
Net interest income ...................... 65,886 60,303 58,955
Provision for loan losses .................................. 2,376 2,684 1,481
---------------------------------------------------------
Net interest income after provision for loan losses ... 63,510 57,619 57,474
---------------------------------------------------------
Noninterest income:
Trust income .......................................... 2,006 1,901 1,490
Service charges on deposit accounts ................... 4,320 4,116 3,496
Insurance and other commissions ....................... 1,121 959 701
Securities available for sale transactions, net ....... 2,222 5,694 306
Other ................................................. 3,981 2,412 2,163
---------------------------------------------------------
Total noninterest income .......................... 13,650 15,082 8,156
---------------------------------------------------------
Noninterest expense:
Salaries and fringe benefits .......................... 22,904 21,721 20,070
Occupancy and equipment ............................... 6,205 5,436 4,448
Restructuring and merger-related costs ................ 18,192 3,356 --
Other ................................................. 11,865 12,252 14,651
---------------------------------------------------------
Total noninterest expense ......................... 59,166 42,765 39,169
---------------------------------------------------------
Income before income taxes .................. 17,994 29,936 26,461
Income taxes ............................................... 8,758 10,765 9,028
---------------------------------------------------------
Net income ........................................ $ 9,236 $ 19,171 $ 17,433
=========================================================
Net income per share:
Basic ............................................. $ 0.51 $ 1.06 $ 0.95
Diluted ........................................... $ 0.50 $ 1.03 $ 0.94
Weighted average common and common equivalent shares:
Basic ............................................. 18,273,281 18,154,131 18,301,085
Diluted ........................................... 18,571,805 18,697,448 18,586,086
See accompanying notes to consolidated financial statements.
16
FIRST CHARTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Unearned
ESOP and Accumulated
Common Stock Unvested Other
------------ Retained Restricted Comprehensive
(Dollars in thousands) Shares Amount Earnings Stock Income Total
- ------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 as
originally reported .................... 17,126,075 $ 210,758 $ 107,534 $ (8,700) $ 1,484 $ 311,076
Common stock issued in 1997
6-for-5 stock split .................... 1,247,133 5,809 (5,809) -- -- --
------------------------------------------------------------------------
Balance, December 31, 1995 as adjusted ..... 18,373,208 216,567 101,725 (8,700) 1,484 311,076
Comprehensive income:
Net income for 1996 .................... -- -- 17,433 -- -- 17,433
Unrealized gain on securities available
for sale, net ........................ -- -- -- -- 2,799 2,799
Total comprehensive income ........ -------
20,232
Cash dividends ............................. -- -- (5,730) -- -- (5,730)
Purchase and retirement of common stock .... (27,430) (486) -- -- -- (486)
Shares released from ESOP and restricted
stock trusts ........................... -- 221 -- 300 -- 521
Stock options exercised and Dividend
Reinvestment Plan stock issued ......... 105,668 1,390 -- -- -- 1,390
Pre-merger transactions of pooled bank ..... 205 2 -- -- -- 2
Equity adjustment to conform fiscal periods -- (78,644) (2,198) (14,738) 1,356 (94,224)
------------------------------------------------------------------------
Balance, December 31, 1996 ................. 18,451,651 139,050 111,230 (23,138) 5,639 232,781
Comprehensive income:
Net income for 1997 .................... -- -- 19,171 -- -- 19,171
Unrealized gain on securities available
for sale, net ........................ -- -- -- -- 1,249 1,249
Total comprehensive income ........ -------
20,420
Cash dividends ............................. -- (78,918) (8,619) -- -- (87,537)
Purchase and retirement of common stock .... (64,118) (1,126) (194) -- -- (1,320)
Purchase of shares by ESOP and restricted
stock trust ............................ -- -- -- (17,707) -- (17,707)
Shares released from ESOP and restricted
stock trusts ........................... -- 332 -- 4,873 -- 5,205
Stock options exercised and Dividend
Reinvestment Plan stock issued ......... 69,560 1,263 17 -- -- 1,280
Pre-merger transactions of pooled bank ..... 611,205 467 -- -- -- 467
Equity adjustment to conform fiscal periods -- 78,644 (1,706) 14,738 (1,356) 90,320
------------------------------------------------------------------------
Balance, December 31, 1997 ................. 19,068,298 139,712 119,899 (21,234) 5,532 243,909
Comprehensive income:
Net income for 1998 .................... -- -- 9,236 -- -- 9,236
Unrealized gain on securities available
for sale, net ........................ -- -- -- -- 946 946
Total comprehensive income ........ -------
10,182
Cash dividends ............................. -- -- (11,057) -- -- (11,057)
Purchase and retirement of common stock .... (759,650) (18,074) -- -- -- (18,074)
Shares released from ESOP and restricted
stock trusts ........................... (51,072) (3,407) -- 21,234 -- 17,827
Stock options exercised and Dividend
Reinvestment Plan stock issued ......... 184,626 3,185 -- -- -- 3,185
------------------------------------------------------------------------
Balance, December 31, 1998 ................. 18,442,202 $ 121,416 $ 118,078 $ -- $ 6,478 $ 245,972
========================================================================
See accompanying notes to consolidated financial statements.
17
FIRST CHARTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
- ----------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ...................................................... $ 9,236 $ 19,171 $ 17,433
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses ................................... 2,376 2,684 1,481
Depreciation and amortization ............................... 3,167 2,611 1,842
Premium amortization, net ................................... 295 119 612
Net gain on securities available for sale transactions ...... (2,222) (5,694) (306)
Amortization of unearned stock compensation ................. 17,827 5,205 3,764
Net gain on sale of other real estate ....................... (621) (104) (139)
Net (gain) loss on sale of premises and equipment ........... 98 (12) 4
Origination of mortgage loans held for sale ................. (85,698) (11,843) (11,011)
Proceeds from sale of mortgage loans held for sale .......... 79,925 10,671 10,946
Increase in other assets .................................... (9,084) (2,782) (2,097)
Increase in other liabilities ............................... 6,015 2,665 1,233
---------------------------------------
Net cash provided by operating activities ............... 21,314 22,691 23,762
---------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale ............ 29,186 155,917 73,371
Proceeds from maturities and issuer calls of
investment securities held to maturity ...................... -- 1,500 --
Proceeds from maturities of securities available for sale ....... 94,269 59,433 62,144
Purchase of investment securities held to maturity .............. -- (1,813) (4,948)
Purchase of securities available for sale ....................... (136,356) (113,673) (49,863)
Net increase in loans ........................................... (160,978) (205,633) (195,549)
Proceeds from sales of other real estate ........................ 4,919 1,655 119
Proceeds from sales of premises and equipment ................... 102 254 2,986
Purchase of premises and equipment .............................. (8,879) (5,863) (8,508)
---------------------------------------
Net cash used by investing activities ....................... (177,737) (108,223) (120,248)
---------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand, money market, and savings accounts ...... 69,627 41,466 31,219
Net increase (decrease) in certificates of deposit .............. (5,854) 3,987 18,471
Net increase in securities sold under repurchase
agreements and other borrowings ............................. 119,865 120,183 185,181
Purchase and retirement of common stock ......................... (18,074) (1,320) (486)
Proceeds from issuance of common stock .......................... 3,185 1,280 1,390
Pre-merger transactions of pooled bank .......................... -- 467 2
Purchase of shares by ESOP and restricted stock trust ........... -- (17,707) (17,707)
Dividends paid .................................................. (11,057) (87,537) (86,846)
---------------------------------------
Net cash provided by financing activities ................... 157,692 60,819 131,224
---------------------------------------
Net increase (decrease) in cash and cash equivalents ........ 1,269 (24,713) 34,738
Cash and cash equivalents at beginning of period ............ 58,730 83,443 46,514
---------------------------------------
Cash and cash equivalents at end of period .................. $ 59,999 $ 58,730 $ 81,252
=======================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest .................................................... $ 70,255 $ 58,159 $ 57,101
=======================================
Income taxes ................................................ $ 11,079 $ 9,199 $ 7,458
=======================================
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Transfers of loans and premises and equipment
to other real estate owned .................................. $ 4,602 $ 3,445 $ 1,825
=======================================
Investment securities transferred to available for sale following
business combination ........................................ $ -- $ 13,491 $ --
=======================================
Unrealized gain on securities available for sale, net ........... $ 946 $ 1,249 $ 2,799
=======================================
See accompanying notes to consolidated financial statements.
18
FIRST CHARTER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the more significant accounting and
reporting policies which First Charter Corporation (the "Corporation") and its
subsidiaries, First Charter National Bank ("FCNB"), and Home Federal Savings and
Loan Association ("Home Federal") (collectively referred to as the "Banks"),
follow in preparing and presenting their consolidated financial statements. A
previous wholly-owned banking subsidiary of the Corporation, Bank of Union
("Union"), was merged with and into FCNB on September 10, 1998. In
consolidation, all significant intercompany accounts and transactions have been
eliminated. All historical financial data has been adjusted to reflect the
mergers with HFNC Financial Corp. ("HFNC") in 1998 and Carolina State Bank
("CSB") in 1997, each of which was accounted for as a pooling of interests (Note
2).
(a) Securities - The Corporation accounts for investment securities under
the provisions of the Financial Accounting Standards Board's (FASB) Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." For all periods presented, all of
the Corporation's securities are categorized as available-for-sale and,
accordingly, are reported at fair value, with any unrealized gains or losses,
net of taxes, reflected as an element of other comprehensive income. The
Corporation intends to hold these available-for-sale securities for an
indefinite period of time, but may sell them prior to maturity in response to
changes in interest rates, changes in prepayment risk, changes in the liquidity
needs of the Banks, and other factors.
Gains and losses on sales of securities are recognized when realized at
trade date on a specific identification basis. Premiums and discounts are
amortized into interest income using a level yield method.
(b) Loans - Loans are carried at their principal amount outstanding.
Interest income is recorded as earned on an accrual basis. The determination to
discontinue the accrual of interest is based on a review of each loan.
Generally, interest is discontinued on loans 90 days past due as to principal or
interest unless in management's opinion collection of both principal and
interest is assured by way of collateralization, guarantees or other security
and the loan is in the process of collection. 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 ability and intent to meet the contractual obligations
of the loan agreement.
Management considers a loan to be impaired when, based on current
information and events, it is probable that a creditor will be unable to collect
all amounts due according to contractual terms of the loan agreement. Factors
that influence management's judgment include, but are not limited to, loan
payment pattern, source of repayment, and value of collateral. A loan would not
be considered impaired if an insignificant delay in loan payment occurs and
management expects to collect all amounts due. The major sources for
identification of loans to be evaluated for impairment include past due and
nonaccrual reports, internally generated lists of loans of certain risk grades,
and regulatory reports of examination.
The Corporation uses the allowance method to provide for loan losses.
Accordingly, all loan losses are charged to the allowance for loan losses and
all recoveries are credited to it. The provision for loan losses is based on
past loan loss experience and other factors which, in management's judgment,
deserve current recognition in estimating probable loan losses. Such other
factors considered by management include the growth and composition of the loan
portfolio, the relationship of the allowance for loan losses to outstanding
loans, and current economic conditions.
Allowances for loan losses related to loans that are identified as impaired
in accordance with the policy set forth above are based on discounted cash flows
using the loans' initial interest rates or the fair value of the collateral if
the loans are collateral dependent. Large groups of smaller-balance, homogenous
loans that are collectively evaluated for impairment (residential mortgage and
consumer installment loans) are excluded from this impairment evaluation and
their allowance is calculated in accordance with the allowance for loan losses
policy discussed above.
19
Management considers the December 31, 1998 allowance for loan losses
adequate to cover inherent losses in the Banks' loan portfolios. Management
believes it has established the allowance in accordance with generally accepted
accounting principles and in consideration of the current economic environment.
While Management uses the best information available to make evaluations, future
additions to the allowance may be necessary based on changes in economic and
other conditions. Additionally, various regulatory agencies, as an integral part
of their examination process, periodically review the Banks' allowances for loan
losses. Such agencies may require the recognition of adjustments to the
allowance based on their judgments of information available to them at the time
of their examinations.
Mortgage loans held for sale are valued at the lower of cost or market as
determined by outstanding commitments from investors or current investor yield
requirements, calculated on an aggregate loan basis.
(c) Depreciation - Depreciation and amortization of premises and equipment
are computed using the straight-line method over the estimated useful lives.
Useful lives range from three to ten years for furniture and equipment, from
fifteen to fifty years for buildings and over the terms of the respective
leases.
(d) Foreclosed Properties - Foreclosed properties are included in other
assets and represent real estate acquired through foreclosure or deed in lieu
thereof and are carried at the lower of cost (principal balance of the former
loan plus costs of obtaining title and possession) or fair value, less estimated
costs to sell. Generally the fair values of such properties are evaluated
annually and the carrying value, if greater than the estimated fair value less
costs to sell, is adjusted with a charge to income.
(e) Income Taxes - Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using the
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
(f) Loan Fees and Costs - Nonrefundable loan fees and certain direct costs
associated with originating or acquiring loans are deferred and recognized over
the contractual life of the related loans as an adjustment to interest income.
(g) Cash Flows - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks and federal funds sold.
Generally, federal funds are sold for one-day periods. Due to the conforming of
HFNC's year-end to December 31 from June 30, as further discussed in Note 2,
cash and cash equivalents at the beginning of period ended December 31, 1997 do
not equal the amount of cash and cash equivalents at the end of the period ended
December 31, 1996.
(h) Derivative Financial Instruments - All derivative financial instruments
held by the Corporation are held for purposes other than trading. The
Corporation currently uses interest rate floors on a limited basis for interest
rate risk management. Interest rate floors are designated as a hedge of variable
rate commercial loans. The net interest payable or receivable on floors is
accrued and recognized as an adjustment to interest income of the related asset.
Premiums paid for purchased floors are amortized over the shorter of the term of
the floor or the related asset. Upon the early termination of floors, the net
proceeds received or paid, including premiums, are deferred and included in
other assets or liabilities and amortized over the shorter of the remaining
contract life or the maturity of the related asset. Upon disposition or
settlement of the asset being hedged, deferral accounting would be discontinued
and changes in the fair value of the contract would be recognized in earnings.
(i) Net Income Per Share - Basic net income per share is computed by
dividing net income by the weighted average number of shares of common stock
outstanding for the year. Diluted net income per share reflects the potential
dilution that could occur if the Corporation's potential common stock and
contingently issuable shares, which consist of dilutive stock options and
restricted stock, were issued. Unallocated shares associated with an Employee
Stock Ownership Plan established by Home Federal (See Note 14) are excluded from
weighted average shares outstanding for purposes of computing basic and diluted
earnings per share. The numerators of the basic net income per share
computations are the same as the numerators of the diluted net income per share
computations for
20
all periods presented. A reconciliation of the denominator of the basic EPS
computations to the denominator of the diluted EPS computations is as follows:
Years Ended December 31,
---------------------------------------------------------
1998 1997 1996
---------------------------------------------------------
Basic EPS denominator - weighted average
number of common shares outstanding....... 18,273,281 18,154,131 18,301,085
Dilutive effect of assumed exercise of
stock options............................. 100,355 208,969 117,873
Dilutive effect of restricted stock assumed
to be issued.............................. 198,169 334,348 167,128
---------------------------------------------------------
Diluted EPS denominator......................... 18,571,805 18,697,448 18,586,086
=========================================================
Income per share for periods prior to 1997 has been restated to reflect the
6-for-5 stock split declared by the Corporation in the second quarter of 1997.
(j) Dividends Per Share - Dividends declared by the Corporation were $0.61
per share, $0.53 per share and $0.50 per share for the years ended December 31,
1998, 1997 and 1996, respectively. Dividends declared by HFNC were $0.24 per
share, $5.28 per share and $0.12 per share for the years ended December 31,
1998, 1997 and 1996, as adjusted to conform to the Corporation's December 31
fiscal year-end. Dividends declared by HFNC in the year ended December 31, 1997
included a special distribution of $5.00 per share to HFNC shareholders,
substantially all of which was deemed to represent a return of capital to
shareholders.
(k) Stock-Based Compensation - SFAS No. 123, "Accounting for Stock-Based
Compensation" requires that the fair value of employee stock-based compensation
plans be recorded as a component of compensation expense in the statement of
income as of the date of grant of awards related to such plans or that the
impact of such fair value on net income and earnings per share be disclosed on a
pro forma basis in a footnote to the financial statements for awards granted
after December 15, 1994, if the accounting for such awards continues to be in
accordance with Accounting Principles Board Opinion No. 25, (APB 25). The
Corporation adopted SFAS No. 123 on January 1, 1996 and has elected to continue
accounting for stock-based compensation under the provisions of APB 25. The pro
forma impact on net income and earnings per share is disclosed in Note 14.
(l) Comprehensive Income - On January 1, 1998 the Corporation adopted SFAS
No. 130, "Reporting Comprehensive Income". As required by the SFAS No. 130,
prior year information has been modified to conform to the new presentation.
Comprehensive income includes net income and all non-owner changes to the
Corporation's equity. The Corporation's only component of other comprehensive
income is the change in unrealized gains and losses on available-for-sale
securities.
The Corporation's total comprehensive income for the years ended December
31, 1998, 1997, and 1996 was $10,182,000, $20,420,000 and $20,232,000,
respectively. Information concerning the Corporation's other comprehensive
income for the years ended December 31, 1998, 1997, and 1996 is as follows:
(Dollars in thousands) Years Ended December 31,
---------------------------------
1998 1997 1996
---------------------------------
Unrealized holding gains arising during
the period .................................. $ 3,621 $ 7,615 $ 4,612
Less: tax expense on holding gains
arising during the period ............... (1,231) (2,665) (1,614)
---------------------------------
2,390 4,950 2,998
---------------------------------
Less: reclassification adjustment for realized
gains included in net income ................ 2,222 5,694 306
Less: tax expense on realized gains ....... (778) (1,993) (107)
---------------------------------
1,444 3,701 199
---------------------------------
Other comprehensive income ..................... $ 946 $ 1,249 $ 2,799
=================================
21
(m) Segment Reporting -- The Corporation has two reportable segments: a
bank and trust company (FCNB) and a savings and loan association (Home Federal).
FCNB offers a full array of financial services to business and individual
customers, with its loan products consisting predominately of short-term
business and individual loans. Home Federal has traditionally offered a more
limited group of loan and deposit products to individuals, consisting primarily
of mortgage loans and savings accounts. Home Federal was acquired through the
Company's merger with Home Federal's holding company, HFNC Financial Corp., on
September 30, 1998 (See Note 2), and has been operated as a separate entity
since that time. The two segments have had no significant intercompany
transactions. Both segments operate within the greater Charlotte metropolitan
area, and the accounting policies of both segments are the same as those
described herein. The Corporation's chief operating decision maker evaluates the
segments separately based on earnings from interest earning assets, the cost of
interest bearing liabilities, noninterest sources of income and expense, as well
as total segment profitability.
Information regarding the reportable segments' separate results of
operations and segment assets is illustrated in the following tables:
1998
-----------------------------------------------------------
HOME
(Dollars in thousands) FCNB FEDERAL OTHER(1) TOTALS
-----------------------------------------------------------
Total interest income............................ $ 61,156 $ 75,004 $ 349 $ 136,509
Total interest expense........................... 26,707 43,852 64 70,623
-----------------------------------------------------------
Net interest income.............................. 34,449 31,152 285 65,886
Provision for loan losses........................ 2,300 76 -- 2,376
Total noninterest income......................... 10,590 2,552 508 13,650
Total noninterest expense........................ 27,825 27,506 3,835 59,166
-----------------------------------------------------------
Net income before income taxes................... 14,914 6,122 (3,042) 17,994
Income taxes..................................... 4,318 4,845 (405) 8,758
-----------------------------------------------------------
Net income....................................... $ 10,596 $ 1,277 (2,637) $ 9,236
===========================================================
Total loans, net................................. $ 586,342 $ 820,625 $ -- $ 1,406,967
Total assets..................................... 848,587 996,476 19,294 1,864,357
1997
-----------------------------------------------------------
Home
(Dollars in thousands) FCNB Federal Other(1) Totals
-----------------------------------------------------------
Total interest income............................ $ 55,869 $ 67,176 $ 85 $ 123,130
Total interest expense........................... 24,788 38,076 (37) 62,827
-----------------------------------------------------------
Net interest income.............................. 31,081 29,100 122 60,303
Provision for loan losses........................ 2,702 (18) -- 2,684
Total noninterest income......................... 10,141 5,630 (689) 15,082
Total noninterest expense........................ 27,037 17,124 (1,396) 42,765
-----------------------------------------------------------
Net income before income taxes................... 11,483 17,624 829 29,936
Income taxes..................................... 3,660 6,855 250 10,765
-----------------------------------------------------------
Net income....................................... $ 7,823 $ 10,769 $ 579 $ 19,171
===========================================================
Total loans, net................................. $ 515,799 $ 730,429 $ -- $ 1,246,228
Total assets..................................... 752,151 910,947 9,543 1,672,641
22
1996
----------------------------------------------------------
Home
(Dollars in thousands) FCNB Federal Other(1) Totals
----------------------------------------------------------
Total interest income............................ $ 50,907 $ 61,824 $ 3,640 $ 116,371
Total interest expense........................... 22,797 34,017 602 57,416
----------------------------------------------------------
Net interest income.............................. 28,110 27,807 3,038 58,955
Provision for loan losses........................ 1,540 (59) -- 1,481
Total noninterest income......................... 6,963 1,545 (352) 8,156
Total noninterest expense........................ 19,354 18,372 1,443 39,169
----------------------------------------------------------
Net income before income taxes................... 14,179 11,039 1,243 26,461
Income taxes..................................... 4,418 4,250 360 9,028
----------------------------------------------------------
Net income....................................... $ 9,761 $ 6,789 $ 883 $ 17,433
==========================================================
(1) Included in "other" are revenues, expenses and assets of the parent
company.
(2) MERGERS
(a) HFNC Financial Corp. The Corporation and HFNC entered into a definitive
agreement and plan of merger (the "Merger Agreement") dated as of May 17, 1998,
as amended and restated on July 29, 1998, pursuant to which HFNC merged with and
into the Corporation (the "Merger"). On September 30, 1998, the Merger was
completed and was accounted for as a pooling of interests. Accordingly, all
current and prior periods' financial statements have been restated to combine
the accounts of HFNC with those of the Corporation.
As of September 30, 1998, there were 16,949.000 shares of HFNC common stock
outstanding. Each share of HFNC common stock was converted into 0.57 shares of
the Corporation's common stock.
HFNC, a North Carolina corporation, was a unitary holding company organized
in August 1995 in connection with the conversion of Home Federal from mutual to
stock form (the "Conversion"). The Conversion was effected on December 28, 1995,
at which time Home Federal converted to a federal stock savings and loan
association and became a wholly-owned subsidiary of HFNC. Home Federal conducted
its business from its main office, eight branch offices, and a loan origination
office, all located in Mecklenburg County, North Carolina. During 1999, Home
Federal will be merged with and into First Charter National Bank and Home
Federal's offices will become those of First Charter National Bank. At September
30, 1998, HFNC had total consolidated assets of approximately $1.03 billion,
total consolidated loans of approximately $819.5 million, total consolidated
deposits of approximately $437.3 million, and total consolidated shareholders'
equity of $174.2 million. In the third quarter of 1998, the Corporation
recognized approximately $17.6 million of costs associated with the acquisition
of HFNC. The primary components of these merger-related expenses were
transaction and professional expenses and various severance-related obligations.
The following table indicates the primary components of these charges, including
the amounts incurred through December 31, 1998, and the amounts remaining as
accrued expenses in other liabilities at December 31, 1998:
Total Incurred Remaining
Merger and Through Accrual at
(Dollars in thousands) Restructuring December 31, December 31,
Charges 1998 1998
-----------------------------------------------------
ESOP and MRRP termination costs.......... $ 8,528 $ (8,528) --
Severance costs.......................... 1,000 (380) $ 620
Contract termination costs............... 3,069 (162) 2,907
Investment banker costs.................. 2,471 (2,356) 115
Professional costs....................... 1,429 (938) 491
Other merger expenses.................... 1,135 (529) 606
-----------------------------------------------------
Total.................................. $ 17,632 $ (12,893) $ 4,739
=====================================================
23
The ESOP and MRRP termination costs are related to the accelerated vesting
of benefits offered under these two plans pursuant to the requirements of the
respective plans following a change in control. The MRRP was settled in the
fourth quarter of 1998. The severance costs include accruals for payments to be
made in connection with the involuntary termination of approximately 25
employees who had been notified that their positions were redundant within the
combined organizations and therefore no longer needed. Management expects that
most of these remaining payments will be made during the first half of 1999. The
contract termination costs are primarily comprised of payments required to be
made to certain executives of Home Federal pursuant to their employment
contracts.
In addition to the charges related to the Merger, the Corporation incurred
approximately $560,000 of merger expenses associated with its integration of
Union into FCNB during the third quarter of 1998. These costs were incurred in
1998 because Union was not merged into FCNB until 1998.
For purposes of preparing the 1997 consolidated financial statements,
HFNC's year-end was conformed from a June 30 year-end to the December 31
year-end of the Corporation. In conforming the fiscal periods, the results of
operations of HFNC for six months ended June 30, 1997 are included in both the
December 31, 1996 fiscal period and the December 31, 1997 fiscal period of the
Corporation. As a result, $90.3 million was reversed from shareholders' equity
in 1997 comprised of the following HFNC elements for the six months ended June
30, 1997 (in thousands):
Net income:
Net interest income after provision for loan losses.................... $ 14,751
Noninterest income..................................................... 569
Noninterest expense.................................................... 8,976
Taxes.................................................................. 2,440
------------
Net income............................................................. 3,904
------------
Other changes in shareholders' equity:
Shares released from ESOP and restricted stock trusts.................. 3,243
Shares purchased by ESOP and restricted stock trusts................... (17,707)
Cash dividends......................................................... (80,916)
Unrealized gains on securities available for sale, net................. 1,356
Other.................................................................. (200)
------------
Total other changes in shareholders' equity............................ (94,224)
------------
Total equity adjustment to conform fiscal periods in 1997.................. $ 90,320
============
In presenting the statement of shareholders' equity for the year ended
December 31, 1996, the changes in shareholders' equity (other than net income)
occurring during the six months ended June 30, 1997 are presented as a single
line, and the components are set forth under "Other changes in shareholders'
equity" above.
Separate results of operations of the combined entities for the six months
ended June 30, 1998 and years ended December 31, 1997 and 1996 were as follows
(dollars in thousands, except per share data):
Six Months Ended June 30, Years Ended December 31,
--------------------------- ----------------------------------------------------------
1998 1997 1996
--------------------------- --------------------------- ---------------------------
Pre-merger Pre-merger Pre-merger
---------------- ---------------- ----------------
Corp- Corp- Corp-
oration HFNC Restated oration HFNC Restated oration HFNC Restated
----------------------------------------------------------------------------------------
Net interest income..... $15,940 $15,541 $31,481 $31,203 $29,100 $60,303 $28,110 $30,845 $58,955
Net income ............. 6,201 6,602 12,803 8,401 10,770 19,171 10,069 7,364 17,433
Basic income
per share ............. 0.66 0.42 0.70 0.91 0.69 1.06 1.10 0.46 0.95
Diluted income
per share............... 0.66 0.41 0.68 0.90 0.66 1.03 1.09 0.45 0.94
(b) Carolina State Bank. On August 15, 1997, the Corporation entered into
an Agreement and Plan of Merger with CSB, pursuant to which CSB merged with and
into FCNB (the "CSB Merger"). On December 22, 1997, the
24
CSB Merger was completed and was accounted for as a pooling-of-interests.
Accordingly, all current and prior years' consolidated financial statements have
been restated to combine the accounts of CSB with those of the Corporation.
As of December 22, 1997, there were 1,663,992 shares of CSB common stock
outstanding. In the CSB merger, each share of CSB common stock was converted
into 1.023 shares of the Corporation's common stock.
CSB was a North Carolina-chartered commercial bank providing general
banking services through a network of four branch offices located in Shelby,
Kings Mountain, Boiling Springs and Forest City, North Carolina, which are now
branches of FCNB. At December 31, 1996, CSB had total assets of approximately
$133 million and total deposits of approximately $115 million. In the fourth
quarter of 1997, the Corporation recognized $3.4 million of costs associated
with the acquisition of CSB. The primary components of these merger-related
expenses were transaction and professional expenses and various
severance-related obligations. Substantially all of these expenses and
obligations were funded or settled in 1998, and no accrued liabilities related
to these costs remain at December 31, 1998.
(3) FINANCIAL STATEMENT PRESENTATION AND RELATED MATTERS
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent liabilities at the date of the financial statements, as
well as the amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
Reclassifications of certain amounts in the previously issued consolidated
financial statements have been made to conform to the financial statement
presentation for 1998. Such reclassifications had no effect on the net income or
shareholders' equity of the combined entity as previously reported.
As discussed in Note 2, the Corporation completed a pooling-of-interests
merger with HFNC on September 30, 1998. The accompanying consolidated financial
statements have been restated to include the effects of this merger for all
periods presented. HFNC's fiscal period was conformed from its June 30 year-end
to the December 31 year-end of the Corporation for the preparation of the 1998
and 1997 consolidated financial statements. See Note 2 for additional
discussion.
25
(4) SECURITIES AVAILABLE FOR SALE
Securities available for sale at December 31, 1998 and 1997 are summarized
as follows:
GROSS GROSS
(Dollars in thousands) AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------------------------------------------------------
1998
U.S. government obligations ........... $ 10,021 $ 184 $ -- $ 10,205
U.S. government agency obligations .... 153,915 1,093 355 154,653
Mortgage-backed securities ............ 35,697 539 36 36,200
State, county and municipal obligations 94,016 3,484 65 97,435
Equity securities ..................... 27,708 5,656 58 33,306
-------------------------------------------------------
Total ............................ $ 321,357 $ 10,956 $ 514 $ 331,799
=======================================================
1997
U.S. government obligations ........... $ 22,072 $ 267 $ 6 $ 22,333
U.S. government agency obligations .... 120,805 188 255 120,738
Mortgage-backed securities ............ 58,787 812 50 59,549
State, county and municipal obligations 83,796 1,897 161 85,532
Equity securities ..................... 21,068 6,345 -- 27,413
-------------------------------------------------------
Total ............................ $ 306,528 $ 9,509 $ 472 $ 315,565
=======================================================
A schedule of debt securities by contractual maturity at December 31, 1998
is shown below on an amortized cost basis and on a fair value basis. Actual
maturities could differ from contractual maturities due to call or prepayment
provisions.
Amortized Fair
(Dollars in thousands) Cost Value
----------- ------------
Due in one year or less............................ $ 14,641 $ 14,800
Due from one to five years......................... 96,032 97,330
Due from five to ten years......................... 83,196 85,434
Due after ten years................................ 64,083 64,729
Mortgage-backed securities......................... 35,697 36,200
----------- ------------
Total.............................................. $ 293,649 $ 298,493
=========== ============
Securities with an aggregate carrying value of $195,738,000 at December 31,
1998 were pledged to secure public deposits, securities sold under agreements to
repurchase and Federal Home Loan Bank ("FHLB") borrowings. Proceeds from the
sale of securities available for sale were $29,186,000 in 1998, $155,917,000 in
1997, and $73,371,000 in 1996. Gross gains of $2,258,000 and gross losses of
$36,000 were realized in 1998. Gross gains of $6,825,000 and gross losses of
$1,131,000 were realized in 1997. Gross gains of $1,024,000 and gross losses of
$718,000 were realized in 1996. At December 31, 1998 and 1997, the Banks owned
stock in the Federal Home Loan Bank of Atlanta with a cost basis of $18,006,500
and $15,214,000, respectively, which is included in equity securities.
Following the merger with CSB in 1997, FCNB transferred CSB's investment
securities with an amortized cost of $13,464,188 and unrealized gains of $27,073
to securities available for sale.
26
(5) LOANS
The Corporation's primary market area includes the states of North and
South Carolina, and predominately centers on the Metro region of Charlotte,
North Carolina. At December 31, 1998, the majority of the total loan portfolio,
as well as a substantial portion of the commercial and real estate loan
portfolios, were to borrowers within this region. The diversity of the region's
economic base tends to provide a stable lending environment. An area of
significant concentration of credit risk has not been specified due to the
diverse industrial base in the region.
Loans at December 31, 1998 and 1997 are as follows:
(Dollars in thousands) 1998 1997
- ----------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural................................... $ 94,425 $ 80,675
Real estate - construction............................................... 180,475 132,758
Real estate - commercial................................................. 194,624 163,464
Real estate - residential................................................ 882,420 796,321
Installment.............................................................. 70,732 88,546
-------------------------------
Total............................................................... $ 1,422,676 $ 1,261,764
===============================
Nonaccrual loans included above.......................................... $ 5,758 $ 6,119
Other real estate........................................................ 3,537 4,006
Loans 90 days or more past due and still accruing included above......... 2,270 2,109
Restructured loans....................................................... 577 587
-------------------------------
Total problem assets................................................ $ 12,142 $ 12,821
===============================
Residential real estate loans are presented net of loans serviced for
others totaling $21.0 million and $28.0 million at December 31, 1998 and 1997,
respectively. Loans sold into the secondary market are generally sold without
recourse, and the terms of such sales generally include the release of the right
to service the loans. The Corporation does not have any recorded mortgage
servicing rights at December 31, 1998 or 1997.
Interest income that would have been recorded on nonaccrual loans and
restructured loans for the years ended December 31, 1998, 1997, and 1996, had
they performed in accordance with their original terms, amounted to
approximately $480,000, $767,000, and $1,118,000, respectively. Interest income
on all such loans included in the results of operations for 1998, 1997, and 1996
amounted to approximately $124,000, $383,000, and $155,000, respectively.
The recorded investment in impaired loans was $3,897,240 (of which
$2,836,487 was on nonaccrual status) and $4,725,248 (of which $4,448,641 was on
nonaccrual status) at December 31, 1998 and 1997, respectively. The related
allowance for loan losses on these loans was $1,259,600 and $1,281,139 at
December 31, 1998 and 1997, respectively. The average recorded investment in
impaired loans for 1998 was $4,531,475, and the income recognized during 1998
was $107,275, $59,620 of which was recognized using the cash method of income
recognition. The average recorded investment in impaired loans for 1997 was
$4,795,144, and the income recognized during 1997 was $66,616, $36,496 of which
was recognized using the cash method of income recognition. The average recorded
investment in impaired loans for 1996 was $7,370,027, and the income recognized
during 1996 was $249,905, $143,562 of which was recognized using the cash method
of income recognition.
The following is a reconciliation of loans outstanding to executive
officers, directors and their associates for the year ended December 31, 1998:
(Dollars in thousands)
Balance at December 31, 1997................................................................. $ 3,364
New loans.................................................................................... 1,518
Principal repayments......................................................................... (389)
-----------
Balance at December 31, 1998................................................................. $ 4,493
===========
27
In the opinion of management, these loans were made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other borrowers. Such loans, in the
opinion of management, do not involve more than the normal risks of
collectibility.
(6) ALLOWANCE FOR LOAN LOSSES
The following is a summary of the changes in the allowance for loan losses
for each of the years in the three-year period ended December 31, 1998:
(Dollars in thousands) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
Beginning balance............................................. $ 15,263 $ 14,140 $ 13,552
Provision charged to operations............................... 2,376 2,684 1,481
Adjustment for merged bank.................................... -- 269 --
Charge-offs................................................... 2,737 2,261 1,810
Recoveries.................................................... 652 431 917
-------------------------------------------
Net charge-offs.......................................... 2,085 1,830 893
-------------------------------------------
Ending balance................................................ $ 15,554 $ 15,263 $ 14,140
===========================================
(7) PREMISES AND EQUIPMENT
Premises and equipment at December 31, 1998 and 1997 are summarized as
follows:
(Dollars in thousands) 1998 1997
- ------------------------------------------------------------------------------------------------------------
Land............................................................................ $ 10,011 $ 7,957
Buildings....................................................................... 19,746 18,871
Furniture and equipment......................................................... 18,635 15,262
Leasehold improvements.......................................................... 1,222 1,005
--------------------------
Total premises and equipment............................................... 49,614 43,095
Less accumulated depreciation and amortization.................................. 19,011 17,038
--------------------------
Premises and equipment, net..................................................... $ 30,603 $ 26,057
==========================
(8) DEPOSITS
A summary of deposit balances at December 31, 1998 and 1997 is as follows:
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------------------------------
Noninterest bearing demand...................................................... $ 119,519 $ 103,005
Interest bearing demand......................................................... 132,581 111,566
Insured money market accounts................................................... 142,077 113,326
Savings deposits................................................................ 134,623 131,276
Certificates of deposit......................................................... 594,235 600,089
----------------------------
Total........................................................................... $ 1,123,035 $ 1,059,262
============================
The aggregate amount of certificates of deposit with denominations greater
than $100,000 was $201,918,000 and $146,496,000 at December 31, 1998 and 1997,
respectively.
28
At December 31, 1998, the scheduled maturities of all certificates of
deposit are as follows:
(Dollars in thousands)
1999...................................... $ 502,802
2000...................................... 73,249
2001...................................... 11,448
2002...................................... 5,032
2003 and after............................ 1,704
------------
$ 594,235
============
(9) OTHER BORROWINGS
The following is a schedule of other borrowings:
INTEREST MAXIMUM
BALANCE RATE AVERAGE OUTSTANDING
AS OF AS OF AVERAGE INTEREST AT ANY
(Dollars in thousands) DECEMBER 31, DECEMBER 31, BALANCE RATE MONTH-END
- ------------------------------------------------------------------------------------------------------------------
1998
FEDERAL FUNDS PURCHASED AND SECURITIES
SOLD UNDER AGREEMENTS
TO REPURCHASE ................. $ 122,355 5.69% $ 125,401 5.55% $ 130,713
FHLB BORROWINGS..................... 344,999 5.44% 306,021 5.67% 345,899
OTHER............................... 2,590 7.09% 2,838 6.47% 8,315
------------ ------------ ------------
TOTAL.......................... $ 469,944 $ 434,260 $ 484,927
============ ============ ============
1997
Federal funds purchased and securities
sold under agreements
to repurchase ................. $ 113,146 5.20% $ 136,193 5.67% $ 148,855
FHLB borrowings..................... 236,933 5.77% 136,473 5.85% 236,934
Other............................... -- -- 10,500 9.00% 28,000
------------ ------------ ------------
Total.......................... $ 350,079 $ 283,166 $ 413,789
============ ============ ============
Federal funds purchased represent unsecured overnight borrowings from other
financial institutions by the Banks. Securities sold under agreement to
repurchase represent short-term borrowings by the Banks with maturities ranging
from 1 to 89 days collateralized by a portion of the Corporation's securities of
the United States government or its agencies, which have been delivered to a
third party custodian for safekeeping.
At December 31, 1998, the Banks had two available lines of credit with the
FHLB totaling $405,000,000 with approximately $345,000,000 outstanding. The
outstanding amounts consist of $202,152,000 maturing in 1999, $857,000 maturing
in 2001, $102,000,000 maturing in 2002, $13,500,000 maturing in 2003,
$26,000,000 maturing in 2008, and $490,000 maturing in 2011. In addition, the
Banks are required to pledge collateral to secure the advances as described in
the line of credit agreements. The collateral consists of FHLB stock and
qualifying 1-4 family residential mortgage loans.
29
(10) DERIVATIVE FINANCIAL INSTRUMENTS
Off-balance sheet derivative financial instruments, such as interest rate
swaps, interest rate floor and cap arrangements and interest rate futures and
option contracts, are available to the Corporation to assist in managing
interest rate risks. As of December 31, 1998 and 1997, the Corporation has only
used interest rate floors. Interest rate floors are used to protect certain
designated variable rate financial instruments from the downward effects of
their repricing in the event of a decreasing rate environment. The Corporation
is using this financial instrument as a hedge of certain designated variable
rate loans. The total cost of this arrangement was $130,000, which is being
amortized on a straight-line basis for the life of the commercial instrument.
The Corporation expensed $26,000 related to this financial instrument for each
of the years ended December 31, 1998, 1997 and 1996. During part of 1998, the
index rate was below the floor rate, and the Corporation recognized $31,297 as
additional interest income on its variable rate loans. The fair value of this
financial instrument was $212,380 compared to a book value of $26,000 at
December 31, 1998 and a fair value of $91,000 compared to a book value of
$52,000 at December 31, 1997. The table below summarizes the Corporation's
off-balance sheet derivative financial instrument at December 31, 1998 and 1997.
Interest rate floor agreements at December 31, 1998:
Current
Notional Floor Index Maturity
(Dollars in thousands) Amount Rate Rate Date
- -------------------------------------------------------------------------------------------------------------------
Interest rate floors........................... $ 20,000 8.50% 7.75% 1/23/2000
=============================================================
Interest rate floor agreements at December 31, 1997:
Current
Notional Floor Index Maturity
(Dollars in thousands) Amount Rate Rate Date
- -------------------------------------------------------------------------------------------------------------------
Interest rate floors........................... $ 20,000 8.50% 8.50% 1/23/2000
=============================================================
30
(11) OTHER NONINTEREST EXPENSE
Components of other noninterest expense in excess of one percent of the
aggregate amount of total interest income and total noninterest income follow:
(Dollars in thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------
Advertising............................................. $ 1,312 $ 1,996 $ 1,515
Data processing......................................... 1,493 1,192 886
Professional services................................... 2,491 3,515 3,330
FDIC insurance.......................................... 342 353 686
Special one-time SAIF recapitalization assessment....... -- -- 3,077
Stationery and supplies................................. 1,281 1,009 1,062
All other items......................................... 4,946 4,187 4,095
------------------------------------------
Total.............................................. $ 11,865 $ 12,252 $ 14,651
==========================================
(12) INCOME TAX
Income tax expense (benefit) consisted of the following:
(Dollars in thousands) Current Deferred Total
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1998
FEDERAL................................................. $ 8,385 $ (751) $ 7,634
STATE................................................... 1,268 (144) 1,124
-------------------------------------------
TOTAL.............................................. $ 9,653 $ (895) $ 8,758
===========================================
Year ended December 31, 1997
Federal................................................. $ 10,949 $ (1,635) $ 9,314
State................................................... 1,789 (338) 1,451
-------------------------------------------
Total.............................................. $ 12,738 $ (1,973) $ 10,765
===========================================
Year ended December 31, 1996
Federal................................................. $ 8,425 $ (155) $ 8,270
State................................................... 780 (22) 758
-------------------------------------------
Total.............................................. $ 9,205 $ (177) $ 9,028
===========================================
Income tax expense differed from the amounts computed by applying the U.S.
federal income tax rate of 35% to pretax income as a result of the following:
1998 1997 1996
-----------------------------------------------------------------------
% OF % of % of
PRETAX Pretax Pretax
(Dollars in thousands) AMOUNT INCOME Amount Income Amount Income
- ----------------------------------------------------------------------------------------------------------------------
Income before income taxes.............. $ 17,994 $ 29,936 $ 26,461
========= ========== ==========
Tax at federal income tax rate.......... 6,280 35.0% 10,477 35.0% 9,261 35.0%
Reasons for differences:
Tax exempt income.................. (1,398) (7.7) (1,199) (4.0) (1,088) (4.1)
Nondeductible merger expenses...... 3,104 17.3 459 1.5 -- --
State income tax, net of
federal benefit................ 730 4.1 943 3.2 498 1.9
Change in deferred tax assets
valuation allowance............ -- -- -- -- -- --
Other.............................. 42 0.1 85 0.3 357 1.3
-----------------------------------------------------------------------
Total.......................... $ 8,758 48.8% $ 10,765 36.0% $ 9,028 34.1%
=======================================================================
31
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1998 and 1997 are presented below.
(Dollars in thousands) 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
Deferred Tax Assets:
Allowance for loan losses.................................................. $ 6,073 $ 5,620
Deferred loan fees......................................................... 657 590
Accrued expenses deductible when paid for tax purposes..................... 2,366 1,062
Deferred compensation...................................................... 1,895 1,541
Net operating loss carryforward............................................ -- 568
Restricted stock plan compensation accrual................................. -- 966
Other...................................................................... 570 394
-----------------------------
Total gross deferred tax assets........................................ 11,561 10,741
Less valuation allowance................................................... -- --
-----------------------------
Deferred tax asset, net of valuation allowance......................... 11,561 10,741
-----------------------------
Deferred Tax Liabilities:
Unrealized gains on securities available for sale, net..................... (3,958) (3,505)
Fixed assets, primarily due to difference in depreciation.................. (82) (127)
Federal Home Loan Bank of Atlanta stock.................................... (877) (876)
Other...................................................................... (47) (78)
-----------------------------
Total gross deferred tax liability..................................... (4,964) (4,586)
-----------------------------
Net deferred tax asset................................................. $ 6,597 $ 6,155
=============================
A portion of the current year change in the net deferred tax asset relates
to unrealized gains and losses on securities available for sale. The related
current period deferred tax expense of $453,000 has been recorded directly to
shareholders' equity. The balance of the change in the net deferred tax asset
results from the current period deferred tax benefit of $895,000.
There was no valuation allowance for deferred tax assets as of December 31,
1998 and 1997. There was no change in the total valuation allowance during 1998
and 1997. It is management's belief that realization of the deferred tax asset
is more likely than not.
Tax returns for 1995 and subsequent years are subject to examination by
taxing authorities.
Retained income at December 31, 1998 and 1997 includes approximately $6.8
million (tax effect) representing pre-1988 tax bad debt reserve base year
reserve amounts for which no deferred income tax liability has been provided
since these reserves are not expected to reverse and may never reverse.
Circumstances that would require an accrual of a portion or all of this
unrecorded tax liability are a reduction in qualifying loan levels relative to
the end of 1987, failure to meet the definition of a bank, dividend payments in
excess of current year or accumulated tax earnings and profits, or other
distributions in dissolution, liquidation or redemption of the Corporation's
stock.
32
(13) EMPLOYEE BENEFIT PLANS
401(k) Plan. The Corporation has a qualified Retirement Savings Plan
(401(k) Plan) for all eligible employees of the Corporation. Subsequent to the
merger of the Corporation with HFNC, employees of Home Federal are also eligible
to participate in the 401(k) Plan. Pursuant to the Savings Plan, an eligible
employee may elect to defer between 1% and 10% of compensation. At the
discretion of the Board of Directors, the Corporation may contribute an amount
necessary to match all or a portion of a participant's elective deferrals in an
amount to be determined by the Board of Directors from time to time, up to a
maximum of 6% of a participant's compensation. In addition, the Corporation may
contribute an additional amount to each participant's Savings Plan account as
determined at the discretion of the Board of Directors. The Corporation adopted
a qualified Money Purchase Pension Plan effective January 1, 1997 for all
eligible employees of the Corporation. Pursuant to the Money Purchase Plan, the
Corporation contributes annually to each participant's Plan account an amount
equal to 3% of the participant's compensation. Prior to 1997, such contributions
were made to the Savings Plan. The Corporation's aggregate contribution to the
Savings Plan and Money Purchase Pension Plan (excluding Home Federal) amounted
to $871,557, $626,941, and $559,566 for 1998, 1997, and 1996, respectively.
Profit Sharing Plan. Home Federal sponsored a contributory 401(k)
profit sharing plan ("Profit Sharing Plan"). The Profit Sharing Plan permitted
all full time employees with at least one year of service to contribute up to 9%
of their salary to the plan each year. The plan provided for matching
contributions by Home Federal equal to 100% of employee contributions up to the
first 3% of compensation. Home Federal could, at its discretion, make profit
sharing contributions to the plan. Plan participants' accounts were 100% vested
in Company contributions after 5 years of qualifying service. Home Federal's
matching contributions charged to expense for 1998, 1997, and 1996 were
approximately $80,000, $52,000, and $76,000, respectively. The Profit Sharing
Plan is anticipated to be merged into First Charter's 401(k) Plan during 1999.
(14) COMMON STOCK
On May 21, 1997, the Board of Directors of the Corporation declared a
6-for-5 stock split payable on July 15, 1997 to shareholders of record on June
20, 1997. All equity and per share data in the consolidated financial statements
have been retroactively adjusted for the stock split.
On September 29, 1998, the shareholders of the Corporation approved Amended
and Restated Articles of Incorporation for the Corporation which included an
amendment to increase the number of shares of common stock that the Corporation
is authorized to issue from 25,000,000 to 50,000,000.
The Corporation maintains the Dividend Reinvestment and Stock Purchase Plan
(the "DRIP"), pursuant to which 1,000,000 shares of common stock of the
Corporation have been reserved for issuance. Shareholders may elect to
participate in the DRIP and have dividends on shares of common stock reinvested
and may make optional cash payments of up to $3,000 per calendar quarter to be
invested in common stock of the Corporation. Pursuant to the terms of the DRIP,
upon reinvestment of the dividends and optional cash payments, either the
Corporation can issue new shares valued at the then current market value of the
common stock or the administrator of the DRIP can purchase shares of common
stock in the open market. During 1998, the Corporation issued 52,368 shares and
the administrator of the DRIP purchased 28,189 shares in the open market.
Under the terms of the First Charter Corporation Comprehensive Stock Option
Plan (the "Comprehensive Plan"), stock options (which can be incentive stock
options or non-qualified stock options) may be periodically granted to key
employees of the Corporation or its subsidiaries. The terms and vesting
schedules of options granted under the Comprehensive Plan generally shall be
determined by the Compensation Committee of the Board of Directors of the
Corporation (the "Compensation Committee"). However, no options may be
exercisable prior to six months following the grant date, and certain additional
restrictions, including the term and exercise price, apply with respect to any
incentive stock options. In May 1996, the shareholders of the Corporation
approved an increase in the number of shares reserved for issuance under the
Comprehensive Plan from 288,000 shares (as adjusted for the stock split) to
480,000 shares (as adjusted for the stock split). Accordingly, on January 1,
1996, the summary stock option activity table, included in this Note, has been
adjusted to reflect an increase of 192,000 shares available for grant.
33
In April 1995, the shareholders approved the First Charter Corporation
Restricted Stock Award Program (the "Restricted Stock Plan"). Awards of
restricted stock may be made under the Restricted Stock Plan at the discretion
of the Compensation Committee of the Board of Directors of the Corporation,
which shall determine the key participants, the number of shares awarded to
participants, and the vesting terms and conditions applicable to such awards. A
maximum of 360,000 shares of common stock (as adjusted to reflect the stock
split) are reserved for issuance under the Restricted Stock Plan. Compensation
expense of approximately $29,000 was recognized during 1998. The following table
presents the status of the Restricted Stock Plan as of December 31, 1998 and
changes during the year then ended:
Weighted Average
First Charter Restricted Stock Award Program Shares Grant Price
- ------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 1997.................................. -- $ --
Granted...................................................... 5,583 25.00
Vested....................................................... (1,117) 25.00
Forfeited.................................................... -- --
------
Outstanding at December 31, 1998.................................. 4,466 25.00
======
In April 1997, the shareholders approved the First Charter Corporation
Stock Option Plan for Non-Employee Directors (the "Director Plan"). Under the
Director Plan, non-statutory stock options may be granted to non-employee
Directors of the Corporation and its subsidiaries. The terms and vesting
schedules of any options granted under the Director Plan generally shall be
determined by the Compensation Committee. The exercise price for each option
granted, however, shall be the fair value of the common stock as of the date of
grant. A maximum of 180,000 shares (as adjusted to reflect the stock split) are
reserved for issuance under the Director Plan.
Periodically, the Corporation adopts an Employee Stock Purchase Plan (the
"ESPP"), pursuant to which stock options are granted to employees, based on
their eligibility and compensation, at a price of 85% to 90% of the fair market
value of the shares at the date of grant. The option and vesting period is
generally for a term of two years. A maximum of 180,000 shares (as adjusted to
reflect the stock split) are reserved for issuance under the 1996 ESPP and
180,000 shares (as adjusted to reflect stock split) are reserved for issuance
under the 1998 ESPP, which was approved by the shareholders of the Corporation
in April 1997. Activity related to the ESPP is included in the table reflecting
activity in all stock option plans below.
The Board of Directors of the Corporation has determined that it is in the
best interests of the Corporation to implement a new employee stock purchase
plan that can continue beyond a two-year period, to allow more flexibility with
the timing of the grant of, and the exercise periods for, options granted to
employees. The 1999 ESPP proposed by the Board of Directors and described below
allows for multiple grants of options thereunder and is designed to remain in
effect as long as there are shares available under the 1999 ESPP to be granted.
Pursuant to the terms of the 1999 ESPP, a maximum of 300,000 shares of the
Corporation's Common Stock may be issued to employees under the 1999 ESPP,
subject to adjustment generally to protect against dilution in the event of
changes in the capitalization of the Corporation.
The 1999 ESPP will be administered by the Compensation Committee. The
Compensation Committee will be able to prescribe rules and regulations for such
administration and to decide questions with respect to the interpretation or
application of the 1999 ESPP.
The Corporation intends that options granted under the 1999 ESPP will
satisfy the requirements of Section 423 of the Internal Revenue Code of 1986, as
amended (the "Code"), and the regulations thereunder. The 1999 ESPP, however, is
not qualified under the provisions of Section 401(a) of the Code and is not
subject to any of the provisions of the Employee Retirement Income Security Act
of 1974, as amended.
The Management Recognition and Retention Plan ("MRRP") was sponsored by
Home Federal and provided for Home Federal's Board of Directors to award
restricted stock to officers and key employees of Home Federal as well as
non-employee directors of Home Federal. The MRRP authorized Home Federal to
grant up to 391,590 shares of Corporation stock. One-fifth of the shares granted
vested immediately upon grant, with the remainder vesting at a rate of 25% per
year over the next four anniversary dates of the grants. Approximately
$2,200,000, $3,200,000, and
34
$3,200,000 in compensation expense related to the MRRP was recognized during the
years ended December 31, 1998, 1997 and 1996, respectively. In addition, the
Corporation recognized approximately $6,500,000 in merger expenses during 1998
related to the accelerated vesting of shares in connection with the merger with
HFNC, in accordance with the terms of the MRRP. Subsequent to the consummation
of the merger of the Corporation with HFNC, no further grants of MRRP shares
will be made. The following table presents the status of the MRRP as of December
31, 1998, 1997, and 1996 and changes during the years then ended:
Weighted Average
Management Recognition and Retention Plan Shares Grant Price
- ------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 1995.................................. -- $ --
Granted...................................................... 353,138 30.54
Vested....................................................... (70,628) 31.70
Forfeited.................................................... (342) 30.26
--------
Outstanding at December 31, 1996.................................. 282,168
Granted...................................................... -- --
Vested....................................................... (35,313) 30.26
Forfeited.................................................... (228) 30.26
--------
Outstanding at December 31, 1997.................................. 246,627
Granted...................................................... -- --
Vested....................................................... (246,171) 30.26
Forfeited.................................................... (456) 30.26
--------
Outstanding at December 31, 1998 --
========
In connection with its conversion to a stock savings and loan
association, Home Federal established an Employee Stock Ownership Plan ("ESOP").
Concurrent with the conversion, 900,000 shares of the Corporation's common stock
were purchased on December 28, 1995 by the ESOP with the proceeds of a $9.0
million loan from Home Federal's wholly owned subsidiary, HFNC Investment Corp.
A corresponding amount related to unearned ESOP shares of $11,343,587 at
December 31, 1997 is included as a reduction of shareholders' equity. In
accordance with the terms of the ESOP, all shares were considered allocated to
participants (after repayment of the debt) concurrent with the consummation of
the Merger; accordingly, there is no reduction of shareholders' equity at
December 31, 1998. As the loan is internally leveraged, the note receivable from
the ESOP is not reported as an asset nor is the ESOP's debt reported as a
liability at December 31, 1997. However, because the shares are considered
earned at the time of the Merger, the Corporation has a receivable from the ESOP
of $7,400,000 at December 31, 1998, which is payable once the ESOP has sold
sufficient shares to repay the note. Compensation expense related to the ESOP
was approximately $990,000, $1,670,000, and $1,500,000 for each of the years
ended December 31, 1998, 1997, and 1996, respectively. Additionally, the
Corporation recognized $2,000,000 in merger expenses during 1998 related to the
termination of the ESOP in connection with the merger with HFNC.
At December 31, 1998, as described above, the Corporation has various
stock-based compensation plans. The Corporation adopted SFAS 123, "Accounting
for Stock-Based Compensation" on January 1, 1996, and elected to continue to
measure compensation cost relative to these plans using APB 25. The disclosure
of the pro forma net income and earnings per share as if the fair value based
accounting method of SFAS 123 had been used to account for stock-based
compensation is required only for awards granted after December 31, 1994, and is
provided below. Consequently, the effects of applying SFAS 123 pro forma
disclosures during the initial phase-in period may not be representative of the
effects on reported net income in future years.
35
The following table presents the pro forma effect on net income and on
basic and diluted income per share of applying the fair value provisions of SFAS
No. 123 discussed above:
Years Ended December 31,
---------------------------------------------
(Dollars in thousands, except per share data) 1998 1997 1996
---------------------------------------------------------------------------------------------------
Net income:
As reported............................. $ 9,236 $ 19,171 $ 17,433
Pro forma............................... $ 7,995 $ 18,257 $ 16,901
Basic income per share:
As reported............................. $ 0.51 $ 1.06 $ 0.95
Pro forma............................... $ 0.44 $ 1.01 $ 0.92
Diluted income per share:
As reported............................. $ 0.50 $ 1.03 $ 0.94
Pro forma............................... $ 0.43 $ 0.98 $ 0.91
The fair value of each option granted during 1998, 1997 and 1996 was
estimated using the Black-Scholes option-pricing model with the following
weighted average assumptions:
Years Ended December 31,
------------------------------------------------------
1998 1997 1996
------------------------------------------------------
1997 Employee Stock Option Plan
Dividend yield.............................. N/A N/A 1.7%
Risk free interest rates.................... N/A N/A 6.28%
Expected lives.............................. N/A N/A 4 years
Volatility.................................. N/A N/A 18%
1996 Employee Stock Purchase Plan
Dividend yield.............................. N/A N/A 2.9%
Risk free interest rates.................... N/A N/A 5.11%
Expected lives.............................. N/A N/A 2 years
Volatility.................................. N/A N/A 25%
Comprehensive Stock Option Plan
Dividend yield.............................. 2.4% 3.0% 2.9%
Risk free interest rates.................... 5.50% to 6.65% 5.88% to 6.89% 6.14%
Expected lives.............................. 6 years 6 years 6 years
Volatility.................................. 25% 23% 21%
Director Plan
Dividend yield.............................. 2.2% 3.0% N/A
Risk free interest rates.................... 5.64% 6.57% to 6.67% N/A
Expected lives.............................. 6 years 6 years N/A
Volatility.................................. 25% 23% N/A
36
The following is a summary of activity under the Comprehensive Plan,
Director Plan and the 1998 and 1996 ESPP's during the periods indicated. All
options outstanding have been adjusted to reflect the 1997 stock split. For
comparison purposes, HFNC and the Corporation were consolidated using conforming
calendar years.
Option Option Price Weighted Average
Shares Per Share Exercise Price
------------------------------------------------------------
Outstanding at December 31, 1995 229,965 $ 3.64 - 17.92 $ 10.86
Granted................................ 964,550 16.50 - 25.93 23.85
Exercised.............................. 14,307 3.64 - 12.40 6.37
Forfeited.............................. 8,920 5.34 - 17.92 8.35
---------
Outstanding at December 31, 1996............ 1,171,288 3.64 - 25.93 22.31
Granted................................ 89,134 17.60 - 25.00 20.98
Exercised.............................. 35,662 3.64 - 18.85 13.40
Forfeited.............................. 8,227 8.75 - 17.92 17.60
---------
Outstanding at December 31, 1997............ 1,216,533 3.64 - 25.93 22.54
Granted................................ 48,788 22.63 - 26.75 25.76
Exercised.............................. 41,778 3.64 - 18.85 8.85
Forfeited.............................. 23,636 17.71 - 26.75 20.10
---------
Outstanding at December 31, 1998............ 1,199,907 3.64 - 26.75 22.47
=========
Shares exercisable at December 31, 1998..... 1,092,665 $ 3.64 - 26.75 $ 22.52
=========
The weighted average remaining contractual lives of stock options were
7.01, 7.24, and 7.47 years at December 31, 1998, 1997 and 1996, respectively.
37
(15) COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
Commitments and Off-Balance Sheet Risk. The Corporation is party to various
financial instruments with off-balance-sheet risk in the normal course of
business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit,
and involve, to varying degrees, elements of credit and interest rate risk in
excess of the amounts recognized in the consolidated financial statements. The
Corporation uses the same credit policies in making commitments and conditional
obligations as it does for instruments reflected in the consolidated financial
statements. The creditworthiness of each customer is evaluated on a case-by-case
basis.
At December 31, 1998, the Corporation's exposure to credit risk was
represented by preapproved but unused lines of credit for loans totaling
$238,925,000 and standby letters of credit aggregating $9,082,000. Management
expects that these commitments can be funded through normal operations. The
amount of collateral obtained if deemed necessary by the Corporation upon
extension of credit is based on management's credit evaluation of the borrower
at that time. The Corporation generally extends credit on a secured basis.
Collateral obtained may include, but may not be limited to, accounts receivable,
inventory and commercial and residential real estate.
The Banks grant primarily commercial and installment loans to customers
throughout their market areas. The Corporation's primary market area includes
the states of North and South Carolina, and predominately centers on the Metro
region of Charlotte, North Carolina. The real estate loan portfolio can be
affected by the condition of the local real estate markets.
Average daily Federal Reserve balance requirements for the year ended
December 31, 1998 amounted to $2,114,050.
Contingencies. In June 1995, a lawsuit was initiated against Home Federal
by a borrower's affiliated companies in which the plaintiffs alleged that Home
Federal wrongfully set-off certain funds in an account being held and maintained
by Home Federal. In addition, the plaintiffs alleged that as a result of the
wrongful set-off, Home Federal wrongfully dishonored a check in the amount of
$270,000. Plaintiffs further alleged that the actions on behalf of Home Federal
constituted unfair and deceptive trade practices, thereby entitling plaintiffs
to recover treble damages and attorneys' fees. Home Federal denied any
wrongdoing and filed a motion for summary judgment. Upon consideration of the
motion, the United States Bankruptcy Judge entered a Recommended Order Granting
Summary Judgement, recommending the dismissal of all claims asserted against
Home Federal. In October 1997, the United States District Court entered an order
granting summary judgment in favor of Home Federal. The plaintiff has appealed
the order of summary judgment and the case is presently pending in the Fourth
Circuit Court of Appeals.
In December 1996, Home Federal filed a suit against the borrower and his
company and against the borrower's wife, daughters, and a company owned by his
wife and daughter, alleging transfers of assets to the wife, daughter, and their
company in fraud of creditors, and asking that the fraudulent transfers be set
aside. The objective of the lawsuit is to recover assets which may be used to
satisfy a portion of the judgments obtained in favor of Home Federal prior to
litigation. The borrower's wife filed a counterclaim against Home Federal
alleging that she borrowed $750,000 from another financial institution, secured
by a deed of trust on her principal residence, the proceeds of which were paid
to Home Federal for application on a debt owed by one of her husband's
corporations, claiming that officers of Home Federal promised to resume making
loans to her husband's corporation after the payment. Home Federal and its
officers vigorously deny all of her allegations. Home Federal filed a motion for
summary judgment and dismissal of the counterclaim. The motion for summary
judgment was heard in the Superior Court division of the Mecklenburg County
General Court of Justice in April 1998; however, an order has not been entered.
In June 1998, Home Federal removed this case to the United States Bankruptcy
Court for the Western District of North Carolina, Charlotte Division, due to the
fact that the defendant was the debtor in a pending bankruptcy case. Home
Federal believes it has strong defenses to the defendant's counterclaim.
In February 1997, two companies affiliated with those referred to in the
first paragraph above filed an additional action against two executive officers
of Home Federal and against an officer of another financial institution. The
action was removed from the state court to the United States Bankruptcy Court
for the Western District of North
38
Carolina. At the same time, the borrower, who is affiliated with all of these
companies, also filed an action in the Superior Court of Mecklenburg County,
North Carolina against the two executive officers of Home Federal and against an
officer of another financial institution. The Complaints in both actions assert
virtually identical claims. The plaintiffs in both lawsuits allege that the
officers of both financial institutions engaged in a conspiracy to wrongfully
declare loans to be in default so as to eliminate those companies as borrowers
of Home Federal. Plaintiffs claim actual damages, treble damages, and punitive
damages together with interest, attorneys' fees, and other costs. Plaintiffs
allege misrepresentation, breach of fiduciary duty, constructive fraud,
interference with business expectancy, wrongful bank account set-off, and unfair
and deceptive acts and practices. The action pending in the bankruptcy court has
been stayed. All defendants filed motions for summary judgment in the state
court action which were granted, and that lawsuit was dismissed in January 1998
by the Superior Court of Mecklenburg County. The plaintiff appealed the order
granting summary judgment to the North Carolina Court of Appeals. In July 1998,
the defendants removed the state court case to the United States Bankruptcy
Court for the Western District of North Carolina, Charlotte Division, due to the
fact that the plaintiff was a debtor in a pending bankruptcy case. As a result
of the removal, the North Carolina Court of Appeals entered an order staying
further proceedings in the North Carolina Court of Appeals in August 1998. Home
Federal has agreed to indemnify both of its officers with respect to costs,
expense, and liability which might arise in connection with both of these cases.
In July 1997, the above borrower and affiliated companies filed an
additional action against HFNC, Home Federal, and the other financial
institution referred to in the paragraph above, alleging that previous judgments
in favor of Home Federal and the other financial institution obtained in prior
litigation were obtained by the perpetration of fraud on the Bankruptcy Court,
U.S. District Court, and the Fourth Circuit Court of Appeals. The plaintiffs are
seeking to have the judgments set aside on that basis. All defendants filed
motions for summary judgment and dismissal which were granted, and the lawsuit
was dismissed on September 24, 1998. The borrower, individually, has appealed
the Order dismissing the lawsuit to the Fourth Circuit Court of Appeals. That
appeal is pending.
Management continues to deny any liability in the above-described cases and
continues to vigorously defend against the claims. However, there can be no
assurance of the ultimate outcome of the litigation, or the range of potential
loss, if any.
The Corporation and the Banks are defendants in certain other claims and
legal actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of
these other matters is not expected to have a material adverse effect on the
consolidated operations, liquidity or financial position of the Corporation or
the Banks.
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates of financial instruments are made at a specific point
in time, based on relevant market information and information about the
financial instrument. These estimates do not reflect any premium or discount
that could result from offering for sale at one time the Corporation's entire
holdings of a particular financial instrument. Because no market exists for a
significant portion of the Corporation's financial instruments, fair value
estimates are based on judgments 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 could significantly affect
the estimates. Where information regarding the fair value of a financial
instrument is available, those values are used, as is the case with investment
securities and residential mortgage loans. In these cases, an open market exists
in which those financial instruments are actively traded.
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. For example, FCNB has a substantial trust department that
contributes net fee income annually. The trust department is not considered a
financial instrument, and its value has not been incorporated into the fair
value estimates. Other significant assets and liabilities that are not
considered financial assets or liabilities include the mortgage broker
operations and premises and equipment. In addition, tax ramifications related to
the realization of the unrealized gains and losses can have a significant effect
on fair value estimates and have not been considered in any of the estimates.
39
The Corporation's fair value methods and assumptions are as follows:
Cash and due from banks, federal funds sold, interest bearing bank
deposits, accrued interest receivable, and accrued interest payable -
the carrying value is a reasonable estimate of fair value due to the
short term nature of these financial instruments.
Securities available for sale - fair value is based on available quoted
market prices or quoted market prices for similar securities if a
quoted market price is not available.
Loans - the carrying value for variable rate loans that are performing
is a reasonable estimate of fair value due to contractual interest
rates being based on current indices. Fair value for fixed rate loans
is estimated based upon discounted future cash flows using discount
rates comparable to rates currently offered for such loans. The fair
value of nonperforming loans is based on the book value of each loan,
less an applicable reserve for credit losses. The reserve for credit
losses is determined on a loan by loan basis for nonperforming assets
based on one or a combination of the following: external appraisals,
internal assessments using available market information and specific
borrower information, or discounted cash flow analysis.
Deposit accounts - the fair value of certificates of deposit is
estimated using rates currently offered for deposits of similar
remaining maturities. The fair value of all other deposit account types
is the amount payable on demand at year-end.
Other borrowings - the carrying value for shorter-term borrowings is a
reasonable estimate of fair value because these instruments are
generally payable in 90 days or less. The fair value for borrowings
with maturities greater than one year is estimated based upon
discounted future cash flows using a discount rate comparable to the
current market rate for such borrowings.
Commitments to extend credit and standby letters of credit - the large
majority of commitments to extend credit and standby letters of credit
are at variable rates and/or have relatively short terms to maturity.
Therefore, the fair value of these financial instruments is considered
to approximate the carrying value.
Based on the limitations, methods, and assumptions noted above, the
following table presents the carrying amounts and fair values of the
Corporation's financial instruments at December 31, 1998 and 1997:
December 31,
------------------------------------------------------
(Dollars in thousands) 1998 1997
- -------------------------------------------------------------------------------------------------------------------
CARRYING FAIR Carrying Fair
AMOUNT VALUE Amount Value
------------------------------------------------------
Financial assets:
Cash and due from banks................................. $ 41,884 $ 41,884 $ 35,392 $ 35,392
Federal funds sold...................................... 6,402 6,402 8,195 8,195
Interest bearing bank deposits.......................... 11,713 11,713 15,143 15,143
Securities available for sale........................... 331,799 331,799 315,565 315,565
Loans, net of allowance for loan losses................. 1,406,967 1,444,782 1,246,228 1,254,204
Financial liabilities:
Deposits................................................ 1,123,035 1,126,039 1,059,261 1,054,762
Other borrowings........................................ 469,944 472,342 350,079 348,391
See Note 10 for fair value information on derivative financial
instruments used by the Corporation at December 31, 1998 and 1997.
40
(17) REGULATORY MATTERS
The Corporation and the Banks are subject to various regulatory capital
requirements administered by federal and state banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Corporation and the Banks must meet specific capital guidelines that involve
quantitative measures of assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. The capital amounts
and classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Banks to maintain minimum amounts and ratios
(set forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to adjusted average assets (as defined). Management believes, as of
December 31, 1998, that the Corporation and the Banks meet all capital adequacy
requirements to which they are subject.
As of December 31, 1998, the most recent notifications from the
Corporation's various regulators categorized the Corporation, FCNB and Home
Federal, as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, each entity must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed any of the institutions'
categories.
41
The Corporation's and each Bank's actual capital amounts and ratios are also
presented in the table below:
To Be Well Capitalized
For Capital Under Current Prompt
Adequacy Purposes Corrective Action Provisions
Actual ----------------- ----------------------------
------------------ Minimum Minimum
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
At December 31, 1998:
Total Capital (to Risk Weighted Assets)
Consolidated ............................ $251,965 20.59% $97,913 8.00% $122,391 10.00%
First Charter National Bank ............. 67,016 10.09 53,138 8.00 66,425 10.00
Home Federal ............................ 159,540 29.40 43,419 8.00 54,274 10.00
Tier I Capital (to Risk Weighted Assets)
Consolidated ............................ $236,666 19.34% $48,957 4.00% $ 73,435 6.00%
First Charter National Bank ............. 58,713 8.84 26,569 4.00 39,854 6.00
Home Federal ............................ 152,756 28.16 21,710 4.00 32,564 6.00
Tier I Capital (to Adjusted Average Assets)
Consolidated ............................ $236,666 13.36% $70,850 4.00% $ 88,562 5.00%
First Charter National Bank ............. 58,713 7.63 30,791 4.00 38,488 5.00
Home Federal ............................ 152,756 15.42 39,618 4.00 49,522 5.00
At December 31, 1997:
Total Capital (to Risk Weighted Assets)
Consolidated ............................ $249,342 23.21% $85,935 8.00% $107,418 10.00%
First Charter National Bank ............. 73,981 13.06 45,328 8.00 56,660 10.00
Home Federal ............................ 153,020 30.60 40,010 8.00 50,012 10.00
Tier I Capital (to Risk Weighted Assets)
Consolidated ............................ $235,927 21.98% $42,934 4.00% $ 64,400 6.00%
First Charter National Bank ............. 66,898 11.83 22,664 4.00 33,996 6.00
Home Federal ............................ 146,789 29.35 20,005 4.00 30,007 6.00
Tier I Capital (to Adjusted Average Assets)
Consolidated ............................ $235,927 14.94% $63,156 4.00% $ 78,945 5.00%
First Charter National Bank ............. 66,898 9.61 27,912 4.00 34,890 5.00
Home Federal ............................ 146,789 16.61 35,359 4.00 44,199 5.00
(18) FIRST CHARTER CORPORATION (PARENT COMPANY)
The principal assets of the Parent Company are its investment in the Banks,
and its principal source of income is dividends from the Banks. Certain
regulatory and other requirements restrict the lending of funds by the Banks to
the Parent Company and the amount of dividends which can be paid to the Parent
Company. In addition, certain regulatory agencies may prohibit the payment of
dividends by the Banks if they determine that such payment would constitute an
unsafe or unsound practice. At December 31, 1998, the Banks had available
undivided profits of approximately $25.0 million for payment of dividends
without obtaining prior regulatory approval. Accordingly, at December 31, 1998,
approximately $202.9 million of the Parent Company's $227.9 million investment
in subsidiaries is restricted as to transfer to the Parent Company without
obtaining prior regulatory approval.
42
The Parent Company's balance sheet data as of December 31, 1998 and 1997
and related income and cash flow statement data for each of the years in the
three-year period ended December 31, 1998 are as follows:
(Dollars in thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA:
Cash................................................. $ 96 $ 375
Securities available for sale........................ 11,795 8,569
Investment in subsidiaries........................... 227,891 235,052
Receivable from subsidiaries......................... 7,677 1,700
Premises and equipment............................... 316 316
Other assets......................................... 3,146 1,826
----------------------------
$ 250,921 $ 247,838
============================
Borrowed funds....................................... 2,590 --
Accrued liabilities.................................. $ 2,359 $ 3,929
Shareholders' equity................................. 245,972 243,909
----------------------------
$ 250,921 $ 247,838
============================
INCOME STATEMENT DATA:
Dividends from subsidiaries.......................... $ 29,160 $ 111,905 $ 80,513
Other operating income (expense)..................... (2,685) (1,669) (14)
-----------------------------------------
Income before equity in undistributed (excess of
dividends over) net income of subsidiaries....... 26,475 110,236 80,499
Excess of dividends over net income of subsidiaries.. (17,239) (91,065) (63,066)
-----------------------------------------
Net income....................................... $ 9,236 $ 19,171 $ 17,433
=========================================
CASH FLOW STATEMENT DATA:
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................... $ 9,236 $ 19,171 $ 17,433
Net gain on securities available for sale
transactions....................................... (409) (752) (265)
Amortization of unearned stock compensation.......... 17,827 5,205 3,764
Increase (decrease) in accrued liabilities........... (1,570) 1,826 (188)
Increase in other assets............................. (1,305) (10,585) (7,386)
Increase in receivable from subsidiaries............. (5,977) (500) (405)
Increase in investment in subsidiaries............... 8,130 90,773 63,066
-----------------------------------------
Net cash provided by operating activities............ 25,932 105,138 76,019
-----------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available for sale............ (3,406) (3,444) (762)
Proceeds from sale of securities available for sale.. 551 1,311 733
Purchase of premises and equipment................... -- (2) --
Proceeds from sale of premises and equipment......... -- 239 30
-----------------------------------------
Net cash provided (used) by investing activities..... (2,855) (1,896) 1
-----------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of common stock............................. (18,074) (1,320) (486)
Purchase of shares by ESOP and restricted
stock trust...................................... -- (17,707) (17,707)
Proceeds from issuance of common stock upon
exercise of stock options........................ 3,185 1,280 1,390
Proceeds from note payable........................... 9,329 28,000 28,000
Repayment of note payable............................ (6,739) (28,000) --
Pre-merger transactions of pooled banks.............. -- 467 2
Cash dividends paid.................................. (11,057) (87,537) (86,846)
-----------------------------------------
Net cash used by financing activities................ (23,356) (104,817) (75,647)
-----------------------------------------
Net increase (decrease) in cash.................. (279) (1,575) 373
Cash at beginning of year............................ 375 1,950 1,068
-----------------------------------------
Cash at end of year.................................. $ 96 $ 375 $ 1,441
=========================================
43
FIRST CHARTER CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
First Charter Corporation (the "Corporation") is a multi-bank holding
company established as a North Carolina Corporation in 1983, with two
wholly-owned banking subsidiaries, First Charter National Bank ("FCNB") and
Home Federal Savings and Loan Association ("Home Federal") (collectively
referred to as the "Banks"). The Corporation's principal executive offices are
located in Concord, North Carolina. FCNB is a full-service bank and trust
company with twenty-two branch offices and two limited service facilities
located in Cabarrus, Rowan, Union, Cleveland, Rutherford and northern
Mecklenburg counties, North Carolina. Home Federal operates nine branch offices
all located in Mecklenburg County, North Carolina.
During 1998, the Corporation acquired HFNC Financial Corp. ("HFNC"), a
North Carolina Corporation organized in August 1995 by Home Federal for the
purpose of becoming the unitary holding company of Home Federal. Home Federal's
conversion to stock form and the concurrent offer and sale of HFNC's common
stock was consummated on December 28, 1995. HFNC was merged into the
Corporation effective September 30, 1998. Home Federal's branches continue to
operate as Home Federal offices until the planned merger of the Banks in 1999.
During 1995, the Corporation acquired Bank of Union ("Union"), a full
service bank with five offices located in Union and southern Mecklenburg
counties of North Carolina. In September 1998, Union was merged into FCNB.
During 1997, the Corporation acquired Carolina State Bank ("CSB"), which was
merged into FCNB at that time. CSB was a state-chartered commercial bank with
four banking offices in Cleveland and Rutherford Counties, North Carolina.
These offices of both Union and CSB now operate as FCNB offices.
Each of these mergers was accounted for as a pooling-of-interests and,
accordingly, all financial data for the periods prior to the respective dates
of the mergers have been restated to combine the accounts of Union, CSB and
Home Federal with those of the Corporation. In the third quarter of 1998, the
Corporation recognized pretax charges of $17.6 million associated with the
merger of HFNC and pretax charges of $560,000 associated with the merger of
Union into FCNB. The Corporation recognized pretax charges of $3.4 million in
the fourth quarter of 1997 associated with the acquisition of CSB.
Through their branch locations, the Banks provide a wide range of
banking products, including interest bearing and non-interest bearing checking
accounts; "Money Market Rate" accounts; certificates of deposit; individual
retirement accounts; overdraft protection; commercial, consumer, agricultural,
real estate, residential mortgage and home equity loans; personal and corporate
trust services; safe deposit boxes; and automated banking. In addition, through
a subsidiary of FCNB, the Banks also offer discount brokerage services,
insurance and annuity sales and financial planning services pursuant to a third
party arrangement with UVEST Investment Services.
The following discussion and analysis should be read in conjunction
with the consolidated financial statements of the Corporation and the notes
thereto, as restated
44
to reflect the aforementioned poolings of interests. In addition, the following
discussion contains certain forward-looking statements. See "Factors that May
Affect Future Results."
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
1998 VERSUS 1997
OVERVIEW
The Corporation earned $9.2 million in 1998, or $0.50 diluted income
per share, a 51.8% decrease from $19.2 million, or $1.03 diluted income per
share, in 1997. Primary factors contributing to the decrease in net income were
an increase in noninterest expenses of $16.4 million and a decrease in
noninterest income of $1.4 million, which was partially offset by an increase
in net interest income of $5.6 million. The increase in noninterest expenses
included charges of $18.2 million associated with the mergers of HFNC into the
Corporation and of Union into FCNB in 1998, compared to charges of $3.4 million
incurred in the prior year associated with the acquisition of CSB. Excluding
net nonrecurring charges primarily associated with merger costs, 1998 diluted
income per share increased 24.0% to $1.24, compared to $1.00 diluted income per
share in 1997. Earnings in 1998, excluding the nonrecurring charges, equated to
a return on average assets of 1.29%, compared to 1.21% for 1997, and a return
on average equity of 9.17% in 1998, versus 7.47% in 1997.
Total assets at December 31, 1998, were $1.9 billion, up 11.5% from
$1.7 billion at December 31, 1997. Gross loans increased $160.9 million, or
12.8%, to $1.4 billion. Total deposits increased $63.8 million, or 6.0%, to
$1.1 billion and other borrowings increased $119.9 million, or 34.2%, to $469.9
million.
LIQUIDITY
Liquidity is the ability to maintain cash flows adequate to fund
operations and meet obligations and other commitments on a timely and
cost-effective basis. Liquidity is provided by the ability to attract deposits,
flexible repricing schedules in a sizable portion of the loan portfolio,
current earnings, a strong capital base and the ability to use alternative
funding sources that complement normal sources. Management's asset-liability
policy is to maximize net interest income while continuing to provide adequate
liquidity to meet continuing loan demand and deposit withdrawal requirements
and to service normal operating expenses.
If additional funding sources are needed, the Banks have access to
federal fund lines at correspondent banks and borrowings from the Federal
Reserve discount window. In addition to these sources, the Banks are members of
the Federal Home Loan Bank ("FHLB") System, which provides access to FHLB
lending sources. At December 31, 1998, the Banks had two available lines of
credit with the FHLB totaling $405.0 million with $60.0 million available.
Another source of liquidity is the securities available for sale
portfolio. See "BALANCE SHEET ANALYSIS Securities Available for Sale" for a
further discussion. Management believes the Banks' sources of liquidity are
adequate to meet loan demand, operating needs and deposit withdrawal
requirements.
45
ASSET-LIABILITY MANAGEMENT AND INTEREST
RATE SENSITIVITY
The primary objective of the Corporation's asset-liability management
strategy is to reduce the risk of a significant decrease in net interest income
caused by interest rate changes without unduly penalizing current earnings. One
method used to manage interest rate sensitivity is to measure, over various
time periods, the interest rate sensitivity positions, or gaps; however, this
method addresses only the magnitude of timing differences and does not address
earnings or market value. Management uses an earnings simulation model to
assess the amount of earnings at risk due to changes in interest rates. This
model is updated at least quarterly and is based on a range of interest rate
scenarios. Under the Corporation's policy, the limit for interest rate risk is
10% of net interest income when considering an increase or decrease in interest
rates of 300 basis points over a twelve-month period. Management believes this
method more accurately measures interest rate risk. Interest rate risk was
within guidelines at approximately 6.5% of net interest income at December 31,
1998.
The Banks' balance sheets are liability sensitive, meaning that in a
given period there will be more liabilities than assets subject to immediate
repricing as market rates change. Because immediately rate sensitive interest
bearing liabilities exceed rate sensitive assets, the earnings position could
improve in a declining rate environment and could deteriorate in a rising rate
environment, depending on the correlation of rate changes in these two
categories. At December 31, 1998 total rate sensitive liabilities due within
one year were $1.2 billion compared to rate sensitive assets of $492.4 million,
for a negative one-year cumulative gap of approximately $713.9 million.
Interest sensitivity of the Corporation's balance sheet as of a specific date
is not necessarily indicative of the Corporation's position on other dates.
Management is developing a plan to reduce the Corporation's negative one-year
cumulative gap.
From time to time, the Corporation may use derivative financial
instruments including futures, forwards, interest rate swaps, option contracts,
and other financial instruments with similar characteristics. The Corporation
currently has an interest rate floor transaction arrangement, which it uses as
a hedge against variable rate loans. This interest rate floor transaction has a
notional amount of $20 million and a floor rate of 8.50%, compared to the
current index of 7.75%, maturing on January 23, 2000. Additionally, the
Corporation is party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve to varying degrees elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheets. Commitments to extend credit are agreements to
lend to a customer so long as there is no violation of any condition
established in the contract. Commitments generally have fixed expiration dates
and may require collateral from the borrower if deemed necessary by the
Corporation. Standby letters of credit are conditional commitments issued by
the Corporation to guarantee the performance of a customer to a third party up
to a stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not
recorded as an asset or liability by the Corporation until the instrument is
exercised. See "BALANCE SHEET ANALYSIS - Loans".
46
The following table presents the scheduled maturity of market risk
sensitive instruments at December 31, 1998:
(Dollars in thousands)
There
Maturing in: 1999 2000 2001 2002 2003 -after Total
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Debt securities .............. $ 41,600 $ 56,659 $ 18,961 $ 20,200 $ 25,645 $ 130,584 $ 293,649
Loans ........................ 263,149 80,309 87,952 79,600 92,546 803,411 1,406,967
-------------------------------------------------------------------------------------------------
Total ..................... $ 304,749 $ 136,968 $ 106,913 $ 99,800 $ 118,191 $ 933,995 $ 1,700,616
=================================================================================================
LIABILITIES
Savings, NOW
and IMMA's ................ $ 496,539 $ 31,682 $ 579 $ -- $ -- $ -- $ 528,800
CDs .......................... 493,174 55,711 36,523 5,324 3,430 73 594,235
Short-term
borrowings ................ 327,045 -- -- -- -- -- 327,045
Long-term
borrowings ................ -- -- -- 103,899 13,000 26,000 142,899
-------------------------------------------------------------------------------------------------
Total ................... $ 1,316,758 $ 87,393 $ 37,102 $ 109,223 $ 16,430 $ 26,073 $ 1,592,979
=================================================================================================
The following table presents the average interest rate and estimated
fair value of market risk sensitive instruments at December 31, 1998:
Carrying Average Estimated
(Dollars in thousands) Value Interest Rate Fair Value
- -----------------------------------------------------------------------------
ASSETS
Debt securities ......... $ 298,493 6.02% $ 298,493
Loans ................... 1,406,967 7.94 1,444,782
----------- -----------
Total .............. $ 1,705,460 7.61 $ 1,743,275
=========== ===========
LIABILITIES
Savings, NOW
and IMMA's ............ $ 528,800 2.50% $ 529,162
CDs ..................... 594,235 5.60 596,877
Short-term
borrowings ............ 327,045 5.38 329,495
Long-term
borrowings ............ 142,899 5.37 142,847
----------- -----------
Total .............. $ 1,592,979 4.50 $ 1,598,381
=========== ===========
=============================================================================
CAPITAL RESOURCES
At December 31, 1998, total shareholders' equity was $246.0 million, a
0.85% increase from December 31, 1997. The increase in capital is primarily
attributable to 1998 earnings. Cash dividends declared per share in 1998 by the
Corporation excluding HFNC were $0.61 compared to $0.53 in 1997.
The principal asset of the parent company is its investment in the
Banks. Thus, the parent company derives its principal source of income through
dividends from the Banks. Certain regulatory and other requirements restrict
the lending of funds by the Banks to the parent company and the amount of
47
dividends which can be paid to the parent company. In addition, certain
regulatory agencies may prohibit the payment of dividends by the Banks if they
determine that such payment would constitute an unsafe or unsound practice. At
December 31, 1998, the Banks had available undivided profits of approximately
$25.0 million for payments of dividends without obtaining prior regulatory
approval.
The Corporation and the Banks must comply with regulatory capital
requirements established by the applicable federal regulatory agencies. Under
the Federal Reserve Board (the "FRB") standards, the Corporation must maintain
a minimum ratio of Tier I Capital (as defined) to total risk-weighted assets of
4.00% and a minimum ratio of Total Capital (as defined) to risk-weighted assets
of 8.00%. Tier I Capital is comprised of total shareholders' equity calculated
in accordance with generally accepted accounting principles less certain
intangible assets and excluding unrealized gains or losses on securities
available for sale. Total Capital is comprised of Tier I Capital plus certain
adjustments, the largest of which for the Corporation is the allowance for loan
losses (up to 1.25% of risk weighted assets). Tier 1 Capital must consist of at
least 50% of Total Capital. Risk-weighted assets refer to the on- and
off-balance sheet exposures of the Corporation adjusted for their related risk
levels using amounts set forth in FRB regulations.
In addition to the aforementioned risk-based capital requirements, the
Corporation is subject to a leverage capital requirement, requiring a minimum
ratio of Tier I Capital (as defined previously) to total adjusted average
assets of 3.00% to 5.00%.
===============================================================================
At December 31, 1998, the Corporation and the Banks were in compliance
with all existing capital requirements. The Corporation's consolidated capital
requirements are summarized in the table below:
Risk-Based Capital
------------------------------------------------------
Leverage Capital Tier 1 Capital Total Capital
- --------------------------------------------------------------------------------------------------------------------
Amount Percentage (1) Amount Percentage (2) Amount Percentage (2)
- --------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Actual ............. $ 236,666 13.36% $ 236,666 19.34% $ 251,965 20.59%
Required ........... 70,850 4.00 48,957 4.00 97,913 8.00
Excess ............. 165,816 9.36 187,709 15.34 154,052 12.59
(1) Percentage of total adjusted average assets. The FRB minimum
leverage ratio requirement is 3.00% to 5.00%, depending on
the institution's composite rating as determined by its
regulators. The FRB has not advised the Corporation of any
specific requirement applicable to it.
(2) Percentage of risk-weighted assets.
===============================================================================
REGULATORY RECOMMENDATIONS
Management is not presently aware of any current recommendations to
the Corporation or to the Banks by regulatory authorities, which, if they were
to be implemented, would have a material effect on the Corporation's liquidity,
capital resources, or operations.
48
BALANCE SHEET ANALYSIS
SECURITIES AVAILABLE FOR SALE
Securities available for sale are a component of the Corporation's
asset-liability management strategy and may be sold in response to liquidity
needs, changes in interest rates, changes in prepayment risk, and other
factors. They are accounted for at fair value, with unrealized gains and losses
recorded net of tax as a component of other comprehensive income.
Following the acquisition of CSB, all investment securities at CSB
were reclassified to securities available for sale, pursuant to Financial
Accounting Standards Board (FASB)'s Statement of Financial Accounting Standards
(SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". Consequently, all securities are now classified as available for
sale. As maturities, sales, or paydowns occur on securities, the proceeds are
utilized to meet loan demand and to reinvest in additional securities.
At December 31, 1998, securities available for sale were $331.8
million or 17.8% of total assets, compared to $315.6 million, or 18.9% of total
assets, at December 31, 1997. The fair value of these securities was
approximately $10.4 million and $9.0 million above their amortized cost at
December 31, 1998 and 1997, respectively. The tax equivalent average yield on
the securities available for sale portfolio was 6.96% for 1998 and 6.72% for
1997. The weighted-average life of the portfolio was 9.45 years at December 31,
1998 compared to 10.06 years at year-end 1997.
LOANS
As a result of continued strong loan demand during 1998, gross loans
increased $160.9 million, or 12.8%, to $1.42 billion at December 31, 1998, from
$1.26 billion at December 31, 1997, with the majority of the growth originating
in the single family residential mortgage portfolio. While the Corporation does
anticipate that loan growth may continue in the future, it does not anticipate
that loan growth will increase at the same rate as experienced in the previous
years.
The loan portfolio at December 31, 1998 was composed of 6.6%
commercial, financial, and agricultural loans, 12.7% real estate construction
loans, 75.7% real estate mortgage loans, and 5.0% installment loans. This
compares to a composition of 6.4% commercial, financial and agricultural, 10.5%
real estate construction, 76.1% real estate mortgage, and 7.0% installment at
December 31, 1997. Approximately $66.7 million of the real estate mortgage
loans at December 31, 1998 are loans for which the principal source of
repayment comes from the sale of real estate. The remaining $1.2 billion of
real estate mortgage loans at December 31, 1998 are (i) other commercial loans
for which the primary source of repayment is derived from the ongoing cash flow
of the business and which are also collateralized by real estate - $246.3
million, (ii) personal installment loans which are collateralized by real
estate - $47.2 million, (iii) home equity loans - $75.1 million, and (iv)
individual residential mortgage loans - $822.2 million.
The Corporation's primary market area includes the states of North and
South Carolina, and predominately centers on the Metro region of Charlotte. At
December 31, 1998, the majority of the total loan portfolio, as well as a
substantial portion of the commercial and real estate loan portfolio,
represents loans to borrowers within this region. The diversity of the region's
economic base tends to provide a stable lending environment. No significant
concentration of credit risk has been identified due to the diverse industrial
base in the region.
49
In the normal course of business, there are various outstanding
commitments to extend credit, which are not reflected in the consolidated
financial statements. At December 31, 1998, pre-approved but unused lines of
credit for loans totaled $238.9 million and standby letters of credit
aggregated $9.1 million. These amounts represent the Banks' exposure to credit
risk, and in the opinion of management, have no more than the normal lending
risk that the Banks commit to their borrowers. If these commitments are drawn,
the Banks will obtain collateral if it is deemed necessary based on
management's credit evaluation of the borrower. Such obtained collateral
varies, but may include accounts receivable, inventory, and commercial or
residential real estate. Management expects that these commitments can be
funded through normal operations.
ASSET QUALITY
Nonperforming assets, which consist of foreclosed assets, nonaccrual
loans, and restructured loans, were $9.9 million at December 31, 1998, as
compared to $10.7 million at December 31, 1997. Nonperforming assets as a
percentage of loans and foreclosed assets at year-end amounted to 0.69% in 1998
and 0.85% in 1997. Total problem assets (nonperforming assets and loans 90 days
or more past due) amounted to $12.1 million at December 31, 1998 and $12.8
million at December 31, 1997. Total problem assets represented 0.85% of loans
and foreclosed assets at December 31, 1998, compared to 1.02% at December 31,
1997.
The components of nonperforming and problem assets are presented in
the table following:
December 31, December 31,
(Dollars in thousands) 1998 1997
- --------------------------------------------------------
Nonaccrual loans $ 5,758 $ 6,119
Restructured loans 577 587
Other real estate 3,537 4,006
-------- --------
Total non-
performing assets 9,872 10,712
Loans 90 days or more
past due and still
accruing 2,270 2,109
-------- --------
Total problem assets $ 12,142 $ 12,821
======== ========
Nonaccrual loans decreased primarily due to several residential
construction loans reclassified from nonaccrual to other real estate. Other
real estate also declined as a portion of these properties was sold during the
year. Interest income that would have been recorded on all nonaccrual loans for
the year ended December 31, 1998, had they performed according to their
original terms, amounted to approximately $457,000, a decrease of 40.4% from
$767,000 for the year ended December 31, 1997. Interest income on nonaccrual
loans included in the results of operations for the years ended December 31,
1998 and 1997, amounted to approximately $124,000 and $383,000, respectively.
Accruing loans 90 days or more past due decreased to 0.16% of gross
loans at December 31, 1998, compared to 0.17% of gross loans at December 31,
1997.
Management's policy for any accruing loan greater than 90 days past
due is to perform an analysis of the loan, including a consideration of the
financial position of the borrower(s) and any guarantor(s) as well as the value
of the collateral, and use this information to make an assessment as to whether
collectibility of the principal and the interest appears probable. Based on
such a review, Management has determined it is probable that
50
the principal as well as the accruing interest on these loans will be collected
in full.
Other real estate decreased to $3.5 million at December 31, 1998 from
$4.0 million at December 31, 1997. The primary reason for the $0.5 million
decrease is due to the sale of several foreclosed properties during 1998 which
was partially offset by the reclassification of property totaling $553,000 that
was originally purchased for the construction of a branch location. Management
decided not to construct a branch on this property; and therefore, the carrying
value of this property was reclassified from premises and equipment to other
real estate. This property is currently being marketed and the gain or loss
from its sale is not expected to be significant. Additionally, two residential
construction loans were foreclosed in December 1998.
CREDIT ADMINISTRATION AND ALLOWANCE
FOR LOAN LOSSES
All estimates of the loan portfolio risk, including the adequacy of
the allowance for loan losses, are subject to general and local economic
conditions, among other factors, which are unpredictable and beyond
management's control. Since a significant portion of the loan portfolio is
comprised of real estate loans and loans to area businesses, a continued risk
is that the real estate market and economic conditions could change and could
result in future losses or require increases in the provision for loan losses.
Management currently uses several measures to assess and control the
loan portfolio risk. For example, all loans over a certain dollar amount must
receive an in-depth review by an analyst in the Banks' Credit Administration
department. Any issues regarding risk assessments of those credits are
addressed by the Banks' loan administration and senior credit officer and
factored into management's decision to originate or renew the loan.
Furthermore, large commitments are reviewed and approved by a Senior Loan
Committee comprised of senior management, the senior credit officer and senior
lending officers of the Banks. The Loan Committee of the Board of Directors
reviews loans above predetermined amounts. The Corporation also continues to
employ an independent third party risk assessment group to review the
underwriting, documentation and risk grading analysis and render an annual
opinion of the adequacy of the allowances for loan losses. This third party
group reviews all loan relationships above a certain dollar amount and a
sampling of all other credits. The third party's evaluation and report is
shared with Senior Management and the Loan and Audit Committee of the
respective Bank and, ultimately, is reported to the respective Bank and
Corporation Board of Directors.
Management uses the information developed from the procedures
described above in evaluating and grading the loan portfolio. This continual
grading process is used to monitor the credit quality of the loan portfolio and
to assist management in determining the appropriate levels of the allowance for
loan losses.
As part of the continual grading process, an analysis is performed
monthly independently from any analysis in conjunction with the origination of
loans. Individual loans are assigned a risk grade based on their credit
quality, which is subject to change as conditions warrant. Any changes in those
risk assessments as determined by the outside risk assessment group are also
considered. Each grade determines the percentage of the outstanding loan
balance allocated to the loan loss reserve. Loans with the weaker credit
quality are individually analyzed to determine a specific allowance, which
reflects management's best estimate of the risk associated with each credit. An
estimate of an allowance is made for all other loans in the portfolio based on
their assigned
51
risk grade, type of loan and other matters related to credit risk. In the
allowance for loan loss analysis process, the Banks also aggregate the loans
into pools of similar credits and review the historical loss experience
associated with these pools as additional criteria to allocate the allowance to
each category. The model also takes into consideration off-balance-sheet credit
risk.
The allowance for loan losses as a percentage of gross loans
outstanding was 1.09% at December 31, 1998, compared to 1.20% at year-end 1997.
The decrease in the allowance as a percentage of gross loans at December 31,
1998 compared to December 31, 1997 is largely attributable to the charge-off in
1998 of certain loans acquired in the 1997 CSB merger. Such loans had been
identified as impaired and specifically reserved for at December 31, 1997.
Total problem assets as a percentage of gross loans outstanding was 0.85% at
December 31, 1998, compared to 1.02% at December 31, 1997.
Management considers the December 31, 1998 allowance for loan losses
adequate to cover inherent losses in the Banks' loan portfolio. Management
believes it has established the allowance in accordance with generally accepted
accounting principles and in consideration of the current economic environment.
While Management uses the best information available to make evaluations,
future additions to the allowance may be necessary based on changes in economic
and other conditions. Additionally, various regulatory agencies, as an integral
part of their examination process, periodically review the Banks' allowances
for loan losses. Such agencies may require the recognition of adjustments to
the allowances based on their judgments of information available to them at the
time of their examinations.
DEPOSITS
Total deposits at December 31, 1998 were $1.1 billion, a 6.0% increase
from December 31, 1997. Demand deposits increased $37.5 million or 17.5%;
insured money market accounts increased $28.8 million or 25.4%; and savings
deposits increased $3.3 million or 2.5%; while certificates of deposit
decreased $5.9 million or 1.0%. Increases in demand and money market accounts
were due to marketing campaigns directed toward packaging and promoting these
accounts more effectively, while the reduction in certificates of deposits was
due to the Corporation's management of interest rates paid as the certificates
matured during the year.
OTHER BORROWINGS
Other borrowings increased $119.9 million during the year, to $469.9
million at December 31, 1998, from $350.1 million at December 31, 1997. The
components of this increase consisted of $11.8 million in short term borrowings
consisting primarily of Federal funds purchased and securities sold under
agreements to repurchase, and $108.1 million in Federal Home Loan Bank
advances. These borrowings were principally used to fund loan growth.
EARNINGS PERFORMANCE
NET INTEREST INCOME
Net interest income, the difference between total interest income and
total interest expense, is the Corporation's principal source of earnings. For
the year ended December 31, 1998, net interest income amounted to $65.9
million, an increase of 9.3% from net interest income of $60.3 million in 1997.
This was attributable to an increase in average interest earning assets of
$177.9 million, from $1.5 billion during 1997 to approximately $1.7
52
billion during 1998. This increase reflects the growth in the Corporation's
average loan portfolio, which increased $215.8 million, offset somewhat by
decreases in other interest earning assets, such as average securities, which
declined $13.6 million. The decline in average yield on these assets to 8.15%
during 1998, compared to 8.29% during 1997, resulted from reductions in the
prime rate of interest during the latter part of 1998. The average yield earned
on loans was 8.65% in 1998, compared to 8.83% in 1997.
In addition to the increase in average interest earning assets, the
Corporation experienced an increase in average interest-bearing liabilities of
$194.0 million, or 15.9% from the prior year, due to the use of Federal Home
Loan Bank advances and increases in deposits to fund loan growth. The average
rate paid on interest bearing liabilities declined during the period to 5.00%
in 1998, compared to 5.16% in 1997. The average rate paid on interest-bearing
deposits was 4.73% in 1998, down from 4.96% in 1997. Similarly, the rate paid
on other borrowed funds declined to 5.61% in 1998, compared to 5.83% in 1997.
The net interest margin (tax adjusted net interest income divided by
average interest-earning assets) declined somewhat to 3.96% in 1998, from 4.12%
in 1997. This reflects the overall compression of margins experienced by the
financial services industry as a whole during the past two years. See
"Asset-Liability Management and Interest Rate Sensitivity" for additional
discussion on the Corporation's management of rate sensitive assets and
liabilities.
PROVISION FOR LOAN LOSSES
The provision for loan losses in 1998 was $2.4 million compared to
$2.7 million in 1997. The decrease was due to an incremental $1.4 million
provision for loan losses in 1997 for loans specifically identified in the CSB
loan portfolio which were deemed to have impairment losses, and, in some cases,
required charging off. When excluding the effect of this prior year incremental
provision, the current year provision increased over 1997 largely due to growth
in the Banks' loan portfolios.
Net charge-offs for 1998 were $2.1 million or 0.15% of average loans
compared to $1.8 million or 0.16% of average loans in 1997. The increase in the
whole dollar amount of net charge-offs in 1998 was primarily due to loans
acquired through the merger of Carolina State Bank in December 1997 and in the
opinion of management are not necessarily indicative of worsening trends in
asset quality.
NONINTEREST INCOME
Noninterest income was $13.7 million in 1998 compared to $15.1 million
in 1997, a decrease of 9.5%. This decrease is principally attributable to a
reduced level of securities gains in 1998 as compared to the prior year,
partially offset by an increase in other noninterest income. Home Federal sold
securities at a net gain in the latter half of 1997 as part of a balance sheet
restructuring plan. Securities sales were reduced during 1998, reducing the
amount of related gains to $2.2 million in 1998 compared to $5.7 million in
1997. The improvement in other noninterest income included increases in service
charge income, trust income and mortgage loan fees. In addition, the
Corporation recorded a one-time gain during 1998 of approximately $450,000 from
the sale of its merchant card program.
NONINTEREST EXPENSE
Other noninterest expense increased $16.4 million in 1998 as compared
to 1997. The majority of this increase involved merger costs of $18.2 million
in 1998 primarily related to the HFNC merger, compared to $3.4 million in 1997
for the CSB merger.
53
Other components of the current year increase in noninterest expense
included salaries and fringe benefits, which increased $1.2 million, or 5.4%,
and occupancy and equipment costs, which increased $769,000, or 14.1%. The
salary and benefits costs increased due to regular salary increases and
investment in additional personnel, as well as the increased commissions paid
on higher levels of mortgage and brokerage activity. Occupancy and equipment
increases reflect the costs associated with additional facilities and added
technology.
Total income tax expense for 1998 was $8.8 million versus $10.8
million in 1997. The decrease is attributable to a decrease in taxable income
resulting from the merger expenses. The reduction in tax expense, however, was
not proportionate with the reduction in income because portions of the merger
and acquisition costs were not deductible. This created an increase in the
effective tax rate from 36.0% in 1997 to 48.8% in 1998. The 1997 rate was
likewise higher than the Corporation's "normal" tax rate due to similar
nondeductible costs associated with its 1997 merger with CSB.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
1997 VERSUS 1996
The Corporation earned $19.2 million or $1.06 basic income per share
in 1997, a 10.0% increase from $17.4 million or $0.95 basic income per share in
1996. Excluding the nonrecurring charges associated with the acquisition of
CSB, 1997 earnings per share increased 23.5% to $1.18 per share compared to
1996. Key factors contributing to the increase in net income, excluding the
nonrecurring charges, were an increase of 2.3% in net interest income and an
increase in noninterest income of 85.0%. These increases were partially offset
by an increase of 81.0% in the provision for loan losses and an increase of
9.2% in noninterest expense. Earnings in 1997, excluding the nonrecurring
charges, equate to a return on average assets of 1.21% for 1997, compared to
1.16% for 1996, and a return on average equity of 7.47% in 1997, versus 6.20%
in 1996.
Total assets at December 31, 1997, were $1.67 billion, up 6.3% from
the level at year-end 1996. Gross loans increased 12.3% to $1.27 billion and
total deposits increased 4.5% to $1.06 billion.
At December 31, 1997, securities available for sale were $315.6
million or 18.9% of total assets, compared to $325.8 million, or 20.7% of total
assets, at year-end 1996. The fair value of these assets was approximately $9.0
million and $9.2 million above their amortized cost at December 31, 1997 and
1996, respectively. The tax equivalent average yield on the securities
available for sale portfolio was 6.72% for 1997 and 6.75% for 1996. The average
life of the portfolio was 10.06 years at December 31, 1997 compared to 9.00
years at year-end 1996.
As a result of the reclassification of CSB's investment securities to
securities available for sale subsequent to the acquisition of CSB, there was
no balance in investment securities held to maturity at December 31, 1997.
Investment securities held to maturity totaled $13.9 million or 0.9% of total
assets at December 31, 1996. The average yield earned on investment securities
held to maturity in 1997 was 5.80% compared to 5.85% in 1996, with an average
maturity of 1.53 years at December 31, 1996.
The loan portfolio at December 31, 1997 was composed of 6.4%
commercial, financial, and agricultural loans, 10.5% real estate construction
loans, 76.1% real estate mortgage loans, and 7.0% installment loans.
54
This compares to a composition of 5.6% commercial, financial, and agricultural,
9.1% real estate construction, 77.1% real estate mortgage, and 8.2% installment
at December 31, 1996.
Problem assets at December 31, 1997 were $12.8 million, or 1.02% of
gross loans and foreclosed properties, compared to $10.9 million, or 0.97% at
December 31, 1996. The components of problem assets are presented in the table
below:
December 31, December 31,
(Dollars in thousands) 1997 1996
- -----------------------------------------------------
Nonaccrual loans $ 6,119 $ 7,949
Restructured loans 587 643
Other real estate 4,006 1,627
-------- --------
Total non-
performing assets 10,712 10,219
Loans 90 days or more
past due and still
accruing 2,109 685
-------- --------
Total problem assets $ 12,821 $ 10,904
======== ========
Interest income that would have been recorded on nonaccrual loans for
the years ended December 31, 1997 and 1996, had they performed according to
their original terms, amounted to approximately $767,000 and $1,118,000,
respectively. Interest income on nonaccrual loans included in the results of
operations for the years ended December 31, 1997 and 1996, amounted to
approximately $383,000 and $155,000, respectively.
Accruing loans 90 days or more past due increased to 0.17% of gross
loans at December 31, 1997 compared to 0.06% of gross loans at December 31,
1996.
Net charge-offs for 1997 were $1.8 million or 0.16% of average loans
compared to $893,000 or 0.09% of average loans in 1996.
Other real estate increased to 4.0 million at December 31, 1997 from
$1.6 million at December 31, 1996. The primary reason for the $2.4 million
increase is due to $456,000 of net foreclosure activity related to the CSB loan
portfolio. Seven properties with balances ranging from $7,400 to $250,000
aggregated $456,000 and nine properties from HFNC ranging from $16,000 to
$902,961 aggregated $2.3 million. Based on a review of recent appraisals of
these properties, management has determined that they are properly carried at
the lower of cost or fair value less costs to sell.
Total deposits at December 31, 1997 were $1.06 billion, a 4.5%
increase from a 1996 year-end level of $1.01 billion. Average demand deposits
increased $7.3 million or 7.5%; average insured money market accounts increased
$8.6 million or 11.1%; average savings deposits decreased $2.0 million or 1.5%;
and average certificates of deposit increased $25.5 million or 4.4%. The
majority of deposit growth was in certificates of deposit ("CD") products. The
increase in average CD's was primarily attributable to several CD promotions in
1997, which raised new deposits with maturities of nine, eighteen or
twenty-four months, and to the increase in public deposits with maturities of
six months that were opened in 1997.
For the year ended December 31, 1997, net interest income was $60.3
million, an increase of 2.3% from net interest income of $59.0 million in 1996.
The increase is attributable to an increase in the volume of average interest
earning assets of approximately $72.0 million mitigated by a decrease in the
net interest margin (tax adjusted net interest income divided by average
interest earning assets) to 4.12% in 1997 from 4.23% in 1996.
The average yield on interest-earning assets was 8.29% in 1997
compared to 8.22% in 1996. The average rate paid on interest-bearing
liabilities was 5.16% in 1997, compared to 5.16% in 1996. The average yield
earned on loans was 8.83% in 1997, compared to 8.86% in 1996. The average rate
55
paid on interest-bearing deposits was 5.75% in 1997, from 6.66% in 1996.
The provision for loan losses for 1997 was $2.7 million compared to
$1.5 million in 1996. A portion of the increase in the provision was necessary
to reflect the growth in the Banks' loan portfolio and higher levels of
nonperforming assets. Additionally, a $1.4 million provision for loan losses
was recorded for the CSB loan portfolio in 1997 in recognition of increased
1997 charge-offs and portfolio growth.
Noninterest income was $15.1 million in 1997 compared to $8.2 million
in 1996, for an increase of 84.9%. The increase in other noninterest income is
attributable to higher securities gains due to the sale of equity securities
held by the Corporation, higher service charge income on deposit accounts
resulting from an increase in non-sufficient fund income, higher trust income
due to greater assets under management and higher commissions earned on
brokerage services resulting from increased sales volumes.
Excluding the $3.4 million in nonrecurring costs associated with the
acquisition of CSB, total noninterest expense in 1997 was $39.4 million,
compared to $39.2 million in 1996, representing a 0.5% increase. The increase
was primarily attributable to increases in costs associated with salaries and
benefits, occupancy and equipment and other noninterest expense.
Salaries and fringe benefits increased primarily due to higher
full-time equivalents and annual merit increases.
Occupancy and equipment increased approximately $988,000 or 22.2%. A
primary reason for the increase is due to an increase in depreciation expense
in connection with the local area network (LAN) and the wide area network (WAN)
which were added in mid-1996. This technology continues to improve the Banks'
ability to service loan and deposit customers and to gain greater operating
efficiency. Additionally, with the Banks' continued growth, additional office
space was required. The Corporation entered into several leasing agreements for
office space.
Excluding the $3.4 million in costs associated with the acquisition of
CSB, other noninterest expense decreased $2.4 million, or 16.7% in 1997, when
compared to 1996. The three major components of change in this category are
advertising, data processing and professional services. During 1997, the Banks
incurred additional advertising expense primarily related to costs associated
with promoting certificates of deposit and equity line products. Data
processing and professional services costs increased due to the aforementioned
technology added in mid-1996 and throughout 1997.
Total income tax expense for 1997 was $10.8 million versus $9.0
million in 1996. The increase is attributable to an increase in taxable income,
slightly offset by an increase in the effective tax rate to 36.0% in 1997 from
34.1% in 1996. The change in the effective rate is primarily attributable to
certain nondeductible merger and acquisition costs incurred in 1997, and an
increase in state income taxes, which were partially offset by an increase in
tax-exempt income from municipal securities in 1997.
ACCOUNTING AND REGULATORY MATTERS
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities," establishes accounting and
reporting standards for derivatives and hedging activities. It requires that
all derivatives be included as assets or liabilities in the balance sheet and
that such instruments be carried at fair market value through adjustments to
either other comprehensive income or current earnings or both, as appropriate.
The Corporation is in the
56
process of assessing the impact of this Standard. The Standard is effective for
financial statements issued for all fiscal quarters of fiscal years beginning
after June 15, 1999.
Statement of Financial Accounting Standards No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise," establishes accounting and
reporting standards for certain mortgage banking activities. It conforms the
subsequent accounting for securities retained after the securitization of other
types of assets. The Corporation is in the process of assessing the impact of
this Standard. The Standard is effective for financial statements for the first
fiscal quarter beginning after December 15, 1998.
From time to time, the Financial Accounting Standards Board (FASB)
also issues exposure drafts for proposed statements of financial accounting
standards. Such exposure drafts are subject to comment from the public, to
revisions by the FASB and to final issuance by the FASB as statements of
financial accounting standards. Management considers the effect of the proposed
statements on the consolidated financial statements of the Corporation and
monitors the status of changes to issued exposure drafts and to proposed
effective dates.
YEAR 2000 CONSIDERATION
YEAR 2000 COMPLIANCE
The "Year 2000 Issue" is a general term used to describe the various
problems that may result from the improper processing of dates and
date-sensitive calculations by computers and other machinery as the Year 2000
approaches. These problems generally arise because most computer hardware and
software historically have used only two digits to identify the applicable
year. Since there may be no accommodation for the full four-digit year,
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather that the year 2000. This error could result in
system failure or miscalculations causing disruption of operations, including,
among other things a temporary inability to process customer transactions,
properly accrue interest income and expense or engage in similar normal banking
activities. In addition, non-banking systems, such as security alarms,
telephones, vaults, etc., are also subject to malfunction due to their
dependence upon software that utilizes special codes and conventions using the
date field.
STATE OF READINESS
The Corporation recognizes the potentially severe implications of the
Year 2000 Issue. The Board of Directors of the Corporation has approved a Year
2000 Action Plan ("Action Plan") that has been developed in accordance with the
Federal Financial Institutions Examination Council ("FFIEC") guidelines. The
Action Plan consists of five phases: (1) awareness, (2) assessment, (3)
remediation, (4) validation, and (5) implementation. The Corporation has
completed phases 1 and 2 of its Action Plan. In completing phase 2, the
Corporation performed a thorough inventory of its Information Technology ("IT)
and non-IT systems to identify all potential Year 2000 exposed systems and
equipment. The items identified in the inventory were then categorized as
"mission critical" or "non-mission critical" depending on the Corporation's
dependence on the system or equipment to perform daily operations and conduct
business. This classification allowed the Corporation to prioritize its efforts
in remediating systems and dealing with third party vendors.
57
The Corporation is currently working on phases 3, 4, and 5 of the
Action Plan. Since the Corporation generally does not perform in-house
programming of its core operating systems, it is dependent on its third-party
vendors for modifications and conversions of its existing systems to correct
the effects of the Year 2000 Issue. Accordingly, the vast majority of phases 3
and 4 involve receiving and testing them with the Corporation's operating
systems and equipment. The Corporation divided phase 4 validation, or testing,
into its own Y2K Test Plan. In step 1 of the Y2K Test Plan, the Corporation
procured written documentation from its software and hardware vendors, as well
as the providers of facilities using embedded chip technology, with respect to
its Year 2000 compliance plan. Step 1 of the Y2K Test Plan also included the
initial remediation phase 3. Upgrades and patches were installed to existing
equipment. Step 2 of the Y2K Test Plan tested all of the applications in the
Corporation's technology environment. For those vendors that supply
functionality as third-party processors, FFIEC proxy testing guidelines were
implemented. Step 2 of the Y2K Test Plan has been completed. The Corporation
recognizes the need for data and information exchange between applications. In
recognition of this constant flow data and information, the Corporation has
included Step 3 in its Y2K Test Plan. Step 3 is an integrated test in which
applications with interfaces have been linked in a test environment to emulate
the Corporation's technology environment. Step 3 testing has begun, and the
completion date is May 22, 1999. Phase 5 implementation includes the business
user acceptance outlined in the FFIEC guidelines, and the Corporation has
included business user acceptance in all steps of the Y2K Test Plan. Phase 5
also includes the Corporation's Clean Management strategy, which recognizes the
need to protect the integrity and validity of the test results by keeping the
production environment the same as the testing environment. The Corporation
fully expects that all phases the Action Plan to be completed no later than May
22, 1999. The Corporation's Clean Management strategy will remain in place
throughout 1999.
The merger with Home Federal is not expected to significantly impact
the Action Plan or the Corporation's state of readiness for Year 2000
compliance. The Corporation currently plans to convert most of Home Federal's
operating systems in March 1999. The Corporation has incorporated all surviving
Home Federal IT and non-IT systems in all phases of its Year 2000 Action Plan.
Steps 1 and 2 of the Y2K Test Plan have been applied to these surviving
systems.
The Corporation also has developed a communication and assessment plan
for its customers. Pursuant to the plan, the Corporation has initiated contact
with many of its key customers to determine such customers' plans with respect
to the Year 2000 Issue and the Corporation's vulnerability to any such
customer's failure to remediate its own Year 2000 Issue. As most corporate
customers depend on computer systems that must be Year 2000 compliant, a
disruption in their businesses may result in potentially significant financial
difficulties that could affect their creditworthiness. The Corporation has also
implemented underwriting procedures to reflect the importance of the Year 2000
Issue in evaluating new credit relationships. Significant business
interruptions or failures by key business customers, suppliers, trading
partners or governmental agencies resulting from the effects of the Year 2000
Issue could have a material adverse effect on the Corporation.
YEAR 2000 COSTS
Since the Corporation relies on third party vendors for substantially
all of its IT systems, the expected cost to the Corporation of the Year 2000
project is not expected to exceed $500,000. Included in this amount are costs
for hardware, software and facilities
58
upgrades, customer communications, testing, and other direct, incremental costs
required to pursue the Action Plan. Not included in this estimate are the
indirect costs associated with the involvement of existing employees in daily
Year 2000 Action Plan activities, an amount that has not been quantified by
management. All remediation costs will be expensed in the period incurred and
will be funded through normal operating cash flow. Year 2000 project costs
during the twelve months ended December 31, 1998 were $125,000.
RISKS OF YEAR 2000 ISSUES
The Year 2000 Issue is widespread throughout the entire global
economy, potentially affecting almost any company with any dependence on
information technology. The Corporation has attempted to assess the risk to the
Corporation of the most reasonably likely worst-case scenarios involving Year
2000 noncompliance on the part of the Corporation or entities with which it
does significant business. Such risks generally fall into one of two
categories: internal risk, or the risk that the Corporation's IT and/or non-IT
systems will fail and will have a material impact on the Corporation's
financial condition or results of operations, and external risk, or the risk
that the IT or non-IT systems of parties external to the Corporation will fail,
resulting in a material impact on the Corporation's financial condition or
results of operations. In the opinion of the management of the Corporation, the
internal risk of Year 2000 non-compliance, in a reasonable worst-case scenario,
could involve either (i) credit losses arising from borrowers inability to
perform under the terms of their loan agreements due to Year 2000-related
problems having a material impact on their cash flows, or (ii) the inability to
perform certain routine customer transactions due to the Year 2000
non-compliance of parties external to the Corporation (e.g., utility or
communications vendors). To mitigate these risks, the Corporation is developing
a contingency plan.
The costs of the Year 2000 project and the schedule for achieving Year
2000 compliance are based on management's best estimates, which were derived
using numerous assumptions of future events, such as the availability of
certain resources (including internal and external resources), third-party
vendor plans and other factors. However, there can be no guarantee that these
estimates will be achieved at the cost disclosed or within the timeframes
indicated, and actual results could differ materially from these plans.
CONTINGENCY PLANNING
Contingency plans are being developed to mitigate the potential
effects of a disruption in normal business operations. Contingency planning
includes developing alternate solutions should a vendor not become compliant,
as well as plans for the resumption of business if, despite the Corporation's
best efforts, a business operation disruption occurs.
The Corporation will have a detailed plan by March 31, 1999.
YEAR 2000 READINESS DISCLOSURE
All Year 2000 discussion is designated as Year 2000 Readiness
Disclosures. Year 2000 Readiness Disclosures are covered under the Year 2000
Information and Readiness Disclosure Act passed on October 19, 1998.
LEGAL PROCEEDINGS
In June 1995, a lawsuit was initiated against Home Federal by a
borrower's affiliated companies in which the plaintiffs alleged that Home
Federal wrongfully set-off certain funds in an account being held and maintained
by Home Federal. In addition, the plaintiffs alleged that as a result of the
wrongful set-off, Home Federal wrongfully dishonored a check in the amount of
$270,000. Plaintiffs further alleged that the actions on behalf of Home Federal
constituted unfair and deceptive trade practices, thereby entitling
59
plaintiffs to recover treble damages and attorneys' fees. Home Federal denied
any wrongdoing and filed a motion for summary judgment. Upon consideration of
the motion, the United States Bankruptcy Judge entered a Recommended Order
Granting Summary Judgement, recommending the dismissal of all claims asserted
against Home Federal. In October 1997, the United States District Court entered
an order granting summary judgment in favor of Home Federal. The plaintiff has
appealed the order of summary judgment and the case is presently pending in the
Fourth Circuit Court of Appeals.
In December 1996, Home Federal filed a suit against the borrower and
his company and against the borrower's wife, daughters, and a company owned by
his wife and daughter, alleging transfers of assets to the wife, daughter, and
their company in fraud of creditors, and asking that the fraudulent transfers be
set aside. The objective of the lawsuit is to recover assets, which may be used
to satisfy a portion of the judgments obtained in favor of Home Federal prior to
litigation. The borrower's wife filed a counterclaim against Home Federal
alleging that she borrowed $750,000 from another financial institution, secured
by a deed of trust on her principal residence, the proceeds of which were paid
to Home Federal for application on a debt owed by one of her husband's
corporations, claiming that officers of Home Federal promised to resume making
loans to her husband's corporation after the payment. Home Federal and its
officers vigorously deny all of her allegations. Home Federal filed a motion for
summary judgment and dismissal of the counterclaim. The motion for summary
judgment was heard in the Superior Court division of the Mecklenburg County
General Court of Justice in April 1998; however, an order has not been entered.
In June 1998, Home Federal removed this case to the United States Bankruptcy
Court for the Western District of North Carolina, Charlotte Division, due to the
fact that the defendant was the debtor in a pending bankruptcy case. Home
Federal believes it has strong defenses to the defendant's counterclaim.
In February 1997, two companies affiliated with those referred to in
the first paragraph above filed an additional action against two executive
officers of Home Federal and against an officer of another financial
institution. The action was removed from the state court to the United States
Bankruptcy Court for the Western District of North Carolina. At the same time,
the borrower, who is affiliated with all of these companies, also filed an
action in the Superior Court of Mecklenburg County, North Carolina against the
two executive officers of Home Federal and against an officer of another
financial institution. The Complaints in both actions assert virtually identical
claims. The plaintiffs in both lawsuits allege that the officers of both
financial institutions engaged in a conspiracy to wrongfully declare loans to be
in default so as to eliminate those companies as borrowers of Home Federal.
Plaintiffs claim actual damages, treble damages, and punitive damages together
with interest, attorneys' fees, and other costs. Plaintiffs allege
misrepresentation, breach of fiduciary duty, constructive fraud, interference
with business expectancy, wrongful bank account set-off, and unfair and
deceptive acts and practices. The action pending in the bankruptcy court has
been stayed. All defendants filed motions for summary judgment in the state
court action which were granted, and that lawsuit was dismissed in January 1998
by the Superior Court of Mecklenburg County. The plaintiff appealed the order
granting summary judgment to the North Carolina Court of Appeals. In July 1998,
the defendants removed the state court case to the United States Bankruptcy
Court for the Western District of North Carolina, Charlotte Division, due to the
fact that the plaintiff was a debtor in a pending bankruptcy case. As a result
of the removal, the North Carolina Court of Appeals entered an order staying
further proceedings in the
60
North Carolina Court of Appeals in August 1998. Home Federal has agreed to
indemnify both of its officers with respect to costs, expense, and liability
which might arise in connection with both of these cases.
In July 1997, the above borrower and affiliated companies filed an
additional action against HFNC, Home Federal, and the other financial
institution referred to in the paragraph above, alleging that previous
judgments in favor of Home Federal and the other financial institution obtained
in prior litigation were obtained by the perpetration of fraud on the
Bankruptcy Court, U.S. District Court, and the Fourth Circuit Court of Appeals.
The plaintiffs are seeking to have the judgments set aside on that basis. All
defendants filed motions for summary judgment and dismissal, which were
granted, and the lawsuit was dismissed on September 24, 1998. The borrower,
individually, has appealed the Order dismissing the lawsuit to the Fourth
Circuit Court of Appeals. That appeal is pending.
Management continues to deny any liability in the above-described cases
and continues to vigorously defend against the claims. However, there can be no
assurance of the ultimate outcome of the litigation, or the range of potential
loss, if any.
The Corporation and the Banks are defendants in certain other claims
and legal actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of
these other matters is not expected to have a material adverse effect on the
consolidated operations, liquidity or financial position of the Corporation or
the Banks.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The foregoing discussion contains certain forward-looking statements
about the Corporation's financial condition and results of operations, which
are subject to certain risks and uncertainties that could cause actual results
to differ materially from those reflected in the forward-looking statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's judgment only as of the date hereof. The
Corporation undertakes no obligation to publicly revise these forward-looking
statements to reflect events and circumstances that arise after the date
hereof.
Factors that may cause actual results to differ materially from these
forward-looking statements include, but are not limited to, the passage of
unforeseen state or federal legislation or regulation applicable to the
Corporation's operations, the Corporation's ability to accurately predict the
adequacy of the loan loss allowance needs using its present risk grading
system, the ability to generate liquidity if necessary to meet loan demand, the
ability to manage unforeseen domestic and global rapid changes in interest
rates, the reliance on third party vendors to become Year 2000 compliant and,
with respect to the merger with Home Federal, the inability of the Corporation
to consolidate the operations of Home Federal with the Corporation in an
efficient manner.
61
FIRST CHARTER CORPORATION OFFICERS
PRESIDENT AND CHIEF EXECUTIVE OFFICER SENIOR VICE PRESIDENT
Lawrence M. Kimbrough Laura N. Blalock
James T. Mathews, Jr.
EXECUTIVE VICE PRESIDENT,
CHIEF OPERATING OFFICER AND CORPORATE SECRETARY
CHIEF FINANCIAL OFFICER James W. Townsend, Jr.
Robert O. Bratton
ASSISTANT CORPORATE SECRETARY
EXECUTIVE VICE PRESIDENT Rose W. Edwards
Phillip M. Floyd Anne C. Forrest
Robert G. Fox, Jr.
Robert E. James, Jr. ASSISTANT TREASURER
Edward B. McConnell David E. Keul
SENIOR AUDITOR
Brian A. Ingold
FIRST CHARTER NATIONAL BANK OFFICERS
PRESIDENT VICE PRESIDENT Jan G. Griffin
CHIEF EXECUTIVE OFFICER Harvey E. Baker Karen F. Hodge
Lawrence M. Kimbrough John R. Baker D. Jean Hovis
James L. Brewer Brian A. Ingold
GROUP EXECUTIVE VICE PRESIDENT Steven C. Calhoun Robin S. Leslie
Robert O. Bratton E. Stephen Costner Richard A. Magda
Robert E. James, Jr. Deborah R. Deese Sandra J. Mansur
Brian J. Doran Eleanor McIntire
EXECUTIVE VICE PRESIDENT C. Eugene Efrid, Jr. Jesse F. Milliken
Phillip M. Floyd Kenneth L. Frie Mary Ann Morgan
Robert G. Fox, Jr. Linda S. Gibson Dawn W. O'Dell
Edward B. McConnell R. Dwight Henry Lisa C. Parker
John R. Kell Philip Presson
SENIOR VICE PRESIDENT Brenda K. Kinley Elizabeth G. Quesenberry
Laura N. Blalock Nancy L. Mills Brian F. Riggins
Lisa B. Boylen Michael J. Mittelman, Jr. Pamela P. Sanders
Kenneth W. Caldwell Danny H. Patton Gordon M. Stallings
Bob Doby, Jr. Elizabeth K. Reed Linda H. Thomas
Thomas J. Elkins Linda V. Ritter Nancy S. Verble
Kathleen M. Harris Tammy D. Scruggs Ann K. Williams
Patricia K. Horton Arnold B. Sharar Charles H. Wingo
Phillip R. Jurney Gregory L. Silliman
Donna J. Kenney James E. Steere, III CORPORATE SECRETARY
Maggie H. Kensil William W. Swink J. W. Townsend, Jr.(*)
David E. Keul Patricia G. Witter
Earl H. Lutz, Jr.
Jerold L. Marlow ASSISTANT VICE PRESIDENT
James T. Mathews, Jr. Cheryl P. Barbee
Darren M. Radson Steven L. Barnes
A. Ray Singleton Patricia H. Blackwell
J. Kevin Toomb Julie J. Carter
J. W. Townsend, Jr. Elizabeth L. Cline
Will Weill, III Deborah W. Craig
L. Eugene Willard Anne C. Forrest
John M. Woods Laurie A. Gagliano
58
62
(PHOTO)
(l to r) Mercedes Ikard, Ellie McIntire, Phillip Jurney
FIRST CHARTER NATIONAL BANK OFFICERS (CONTINUED)
ASSISTANT CORPORATE SECRETARY ASSISTANT TRUST OFFICER FIRST CHARTER INSURANCE
Cheryl P. Barbee(*) Carolyn M. Craver Services, Inc.
Patricia H. Blackwell(*) Robin L. Gibbons Clarkson B. McLean
Lisa P. Bryant President
Rose W. Edwards BANKING OFFICER Robert C. Boyd
Amy P. Elam Wendy T. Barnhardt Senior Vice President
Kathleen M. Erickson Kati W. Beaver Jonathan W. Cooper
Phillip M. Floyd(*) Leah P. Berry Vice President
Anne C. Forrest(*) Deborah Starr Cloninger David E. Keul
Jan G. Griffin(*) James A. Fletcher Treasurer
Donel T. Holcomb Melba M. Funderburk Richard H. Martin
David E. Keul(*) JoAnn J. Hall Vice President
Earl H. Lutz, Jr.(*) Sharon J. Hanson
Judy E. Montague Robin T. Hinson FIRST CHARTER BROKERAGE
Lisa C. Moore(*) Mercedes D. Ikard SERVICES, INC.
Lisa C. Parker(*) Gayle S. Love Phillip M. Floyd
Andria C. Rhymer Angela R. Lovelace President
Pamela P. Sanders(*) Paul A. Lyle Ronnie L. Franks
Tammy D. Scruggs Lisa C. Moore Vice President
Mavadell D. Newsome Michael E. Lenahan
SENIOR AUDITOR James Rhodes Vice President
Brian A. Ingold(*) Marilyn L. Robertson Nancy L. Mills
Katherine L. Schiele Vice President
TRUST OFFICER SueAnn Schoening Harvey F. Whitley
Nancy B. Smith V. Yvette Springs Vice President
Danny H. Patton(*) Matthew J. Triplett Julie A. Belsky
Elizabeth K. Reed(*) Kim J. Wertheimer Brokerage Officer
David E. Keul
(*) Indicates Duplicate Position Treasurer
59
63
FIRST CHARTER CORPORATION BOARD OF DIRECTORS
WILLIAM R. BLACK, M.D. JOHN J. GODBOLD, JR. JOE M. LOGAN
Oncologist Retired McGuire Properties
RAY W. BRADLEY CHARLES F. HARRY, III JOHN M. MCCASKILL
Retired President Retired
Grover Enterprises
MICHAEL R. COLTRANE JERRY E. MCGEE
President FRANK H. HAWFIELD, JR. President
Chief Executive Officer Owner Wingate University
CT Communications, Inc. President
Vice Chairman Firestone Home and HUGH H. MORRISON
First Charter Corporation Auto Supply Store President
E. L. Morrison Co., Inc.
J. ROY DAVIS, JR. J. KNOX HILLMAN, JR.
Owner Owner THOMAS R. REVELS
Chief Executive Officer Chief Executive Officer President
S&D Coffee, Inc. Shuford Insurance Agency, Inc. Chief Executive Officer
Chairman Novant/Presbyterian
First Charter Corporation LAWRENCE M. KIMBROUGH Health Services
President
T. CARL DEDMON Chief Executive Officer W. E. ROYAL
President First Charter Corporation Retired
N/S Carolina Storage First Charter National Bank
Systems, Inc.
FIRST CHARTER NATIONAL BANK BOARD OF DIRECTORS
JANE B. BROWN LARRY D. HAMRICK, SR. T. DAVID PROPST
Private Investor Owner President
Warlick and Hamrick Associates, Earl's Tire Store, Inc.
GRADY S. CARPENTER Insurance and Real Estate
President JAMES M. ROSE, SR.
Security Oil Company, Inc. LAWRENCE M. KIMBROUGH President
President Leasing Services, Inc.
J. Roy Davis, Jr. Chief Executive Officer
Owner First Charter Corporation DAVID H. STEWART, JR.
Chief Executive Officer First Charter National Bank General Manager
S&D Coffee, Inc. Berkshire Weaving, Inc.
Chairman ROBERT F. LOWRANCE
First Charter National Bank Owner LANE D. VICKERY
President Vice President
THEODORE C. DELLINGER A&A Realty Company Scott Wholesale Co.
Owner
Chief Executive Officer ELLEN LINN MESSINGER ROBERT L. WALL
Dellinger, Inc. Private Investor Retired
JOE B. GODFREY, M.D. HUGH H. MORRISON PHILIP L. WALLY
Family Practice President Executive Vice President
E. L. Morrison Co., Inc. General Manager
H. CLARK GOODWIN Vice Chairman Union Electric Membership
Retired First Charter National Bank Corporation
60
64
CORPORATE INFORMATION
CORPORATE HEADQUARTERS TRANSFER AGENT
First Charter Corporation Registrar and Transfer Company
22 Union Street, North 10 Commerce Drive
PO Box 228 Cranford, NJ 07016
Concord, NC 28026-0228 (800) 368-5948
(800) 422-4650
SHAREHOLDERS' MEETING
AUDITORS The Hilton at University Place
KPMG LLP 8629 J.M. Keynes Drive
Suite 2800 Charlotte, NC 28262
Two First Union Center (704) 547-7444
Charlotte, NC 28282 April 27, 1999 at 5:00 p.m.
CORPORATE COUNSEL
Smith Helms Mulliss & Moore, L.L.P. FORM 10-K
30th Floor Copies of First Charter Corporation's Annual
201 North Tryon Street Report to the Securities and Exchange
Charlotte, NC 28202 Commission, Form 10-K, may be obtained
without charge by writing:
SUBSIDIARIES
First Charter National Bank Robert O. Bratton
22 Union Street, North Chief Financial Officer
Concord, NC 28025 First Charter Corporation
PO Box 228
HOME FEDERAL SAVINGS AND LOAN ASSOCIATION Concord, NC 28026-0228
139 South Tryon Street
Charlotte, NC 28202 STOCK INFORMATION AND DIVIDENDS
STOCK LISTING First Charter Corporation's common
The NASDAQ National Market stock, no par value (the "Common Stock"), is
Symbol: "FCTR" reported on The Nasdaq National Market as a
National Market Security under the symbol
MARKET MAKERS "FCTR". The following table sets forth the
Morgan Stanley Dean Witter high and low sales prices for the Common
Interstate/Johnson Lane Corporation Stock for the periods indicated, as
Legg Mason Wood Walker, Inc. reported. The table also sets forth per
Trident Securities share cash dividend information for the
Sandler O'Neill & Partners, L.P. periods indicated (as adjusted for the stock
Wheat First Union split). See "Management's Discussion and
Analysis of Financial Condition and Results
of Operations - Capital Resources" contained
elsewhere in this report for a description
of limitations on the ability of the
Corporation to pay dividends.
As of February 19, 1999, there were
5,213 shareholders of record of the
Corporation's Common Stock.
QUARTERLY COMMON STOCK PRICE RANGES AND DIVIDENDS
1998 (1) 1997 (1)
- --------------------------------------------------------------------------------
Quarter High Low Dividend High Low Dividend
- --------------------------------------------------------------------------------
First $26.25 $23.00 $.140 $18.54 $17.71 $.125
Second 27.00 18.75 .150 24.25 18.13 .125
Third 25.63 18.38 .150 24.25 22.00 .140
Fourth 19.50 12.50 .170 26.75 23.50 .140
(1) Represents historical cash dividends declared by First Charter Corporation.
65
1998 ANNUAL REPORT
FIRST CHARTER CORPORATION
P.O. Box 228
Concord, North Carolina 28026-0228
FIRST
CHARTER
CORPORATION