-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H8ZQwNEGspk5UyJ4dSWg8fEqrPGKylFAbscw0jHDMgjzm2Z8wMPoYyfrXNMCxKEf mrQtqfGSbsxEeMmZZwUEEA== 0000914317-97-000481.txt : 19971003 0000914317-97-000481.hdr.sgml : 19971003 ACCESSION NUMBER: 0000914317-97-000481 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19971002 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HFNC FINANCIAL CORP CENTRAL INDEX KEY: 0001001582 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 561937349 STATE OF INCORPORATION: NC FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27388 FILM NUMBER: 97690025 BUSINESS ADDRESS: STREET 1: 139 SOUTH TRYON STREET CITY: CHARLOTTE STATE: NC ZIP: 28202 BUSINESS PHONE: 7043730400 MAIL ADDRESS: STREET 1: 139 SOUTH TRYON STREET CITY: CHARLOTTE STATE: NC ZIP: 28202 10-K 1 HFNC FINANCIAL CORP. FORM 10-K 6/30/97 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to _______________ Commission File No.: 0-27388 HFNC Financial Corp. (Exact name of registrant as specified in its charter) North Carolina 56-1937349 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 139 South Tryon Street Charlotte, North Carolina 28202 (Address) (Zip Code) Registrant's telephone number, including area code: (704) 373-0400 Securities registered pursuant to Section 12(b) of the Act: Not Applicable Securities registered pursuant to Section 12(g) of the Act Common Stock (par value $.01 per share) --------------------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] Based upon the $16.00 closing price of the Registrant's common stock as of September 26, 1997, the aggregate market value of the 14,775,901 shares of the Registrant's common stock deemed to be held by non-affiliates of the Registrant was: $236.4 million. Although directors and executive officers of the Registrant and certain of its employee benefit plans were assumed to be "affiliates" of the Registrant for purposes of this calculation, the classification is not to be interpreted as an admission of such status. Number of shares of Common Stock outstanding as of September 26, 1997: 17,192,500 DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated. (1) Portions of the Annual Report to Stockholders for the year ended June 30, 1997 are incorporated into Part II, Items 5 through 8 of this Form 10-K. (2) Portions of the definitive proxy statement for the 1997 Annual Meeting of Stockholders to be filed within 120 days of June 30, 1997 are incorporated into Part III, Items 9 through 13 of this Form 10-K. PART I Item 1. Business. General HFNC Financial Corp. (the "Company") is a North Carolina corporation organized in August 1995 by Home Federal Savings and Loan Association ("Home Federal" or the "Association") for the purpose of becoming a unitary holding company of the Association. The Association's conversion to stock form and the concurrent offer and sale of the Company's common stock was consummated on December 28, 1995 (the "Conversion"). The only significant assets of the Company are the capital stock of the Association and the capital stock of HFNC Investment Corp., a Delaware chartered finance subsidiary ("Investment Corp."). The business and management of the Company consists of the business and management of the Association and Investment Corp. At June 30, 1997, the Company had $892.9 million in total assets, $731.9 million in total liabilities and $161.1 million in total equity. Home Federal conducts business from its main office and eight branch offices and a loan origination office, all located in Mecklenberg County, North Carolina. All but one of the Association's offices are located in Charlotte. The region has become a major center for financial services, distribution and transportation. Home Federal's deposits are insured by the Savings Association Insurance Fund ("SAIF"), which is administered by the Federal Deposit Insurance Corporation ("FDIC"), to the maximum extent permitted by law. The Association is a community oriented savings institution which has traditionally offered a wide variety of savings products to its retail customers while concentrating its lending activities on the origination of loans secured by one- to four-family residential dwellings, including an emphasis on loans for construction of residential dwellings. To a significantly lesser extent, the Association's activities have also included origination of commercial real estate, land and consumer loans. In addition, the Company maintains a significant portfolio of investment securities, which amounted to $175.7 million or 19.7% of total assets at June 30, 1997, approximately 37% of which have maturities of under five years. In addition to interest income on loans and investments, the Company receives other income primarily from loan fees and various service charges. The Association currently exceeds all minimum regulatory capital requirements. At June 30, 1997, the Association had tangible, core and risk-based capital ratios of 18.9%, 18.9% and 36.5%, respectively, as compared to the minimum requirements of 1.5%. 3.0% and 8.0%, respectively. The Association is subject to examination and comprehensive regulation by the Office of Thrift Supervision ("OTS"), which is the Association's chartering authority and primary regulator. The Association is also regulated by the FDIC, the administrator of the SAIF. The Association is also subject to certain reserve requirements established by the Federal Reserve Board and is a member of the Federal Home Loan Bank ("FHLB") of Atlanta, which is one of the 12 regional banks comprising the FHLB System. Lending Activities General. At June 30, 1997, the Association's total loans receivable portfolio ("total loan portfolio") amounted to $704.3 million, or 78.9% of total assets at such date. The Association has traditionally concentrated its lending activities on conventional first mortgage loans secured by single-family residential properties. Consistent with its lending orientation, $561.4 million or 79.7% of the Association's total loan portfolio consisted of one-to-four family residential loans at June 30, 1997. In addition, the Association originates residential construction loans, commercial real estate loans, land loans and consumer loans. At June 30, 1997, such loan categories amounted to $68.4 million, $30.6 million, $20.0 million and $23.9 million, respectively, or 9.7%, 4.3%, 2.8% and 3.5% of the total loan portfolio, respectively. The Association does not offer loans which are insured by the Federal Housing Administration or partially guaranteed by the Office of Veterans Affairs. Virtually all of the Association's mortgage loans are secured by properties located in its primary market area. 1 Loan Portfolio Composition. The following table sets forth the composition of the Association's loan portfolio by type of loan at the dates indicated.
June 30, -------------------------------------------------------------------------------- 1997 1996 1995 ----------------------------- --------------------- ------------------- Amount % Amount % Amount % ---------------- ----------- --------- --------- --------- ------- (Dollars in Thousands) Residential real estate $561,352 79.7% $416,711 75.4% $353,801 74.7% Construction 68,366 9.7 61,015 11.1 50,068 10.6 Commercial real estate (1) 30,631 4.3 29,343 5.3 25,403 5.4 Land 19,992 2.8 22,844 4.1 19,326 4.1 Consumer loans: Home equity 14,495 2.1 13,697 2.5 15,370 3.2 Credit cards 6,198 0.9 5,644 1.0 5,349 1.1 Other 3,255 0.5 3,278 0.6 4,356 0.9 -------- ----- --------- ----- ------- ----- Total loans receivable 704,289 100.0% 552,532 100.0% 473,673 100.0% -------- ===== --------- ===== ------- ===== Less: Allowance for loan losses 7,612 7,496 8,088 Loans in process 33,030 34,846 24,643 Deferred loan fees 5,324 5,059 4,934 Other -- -- -- -------- -------- -------- Loans receivable, net $658,323 $505,131 $436,008 ======== ======== ======== June 30, ------------------------------------------------ 1994 1993 -------------------- ---------------------- Amount % Amount % -------- --------- -------- ---------- (Dollars in Thousands) Residential real estate $346,599 72.0% $371,883 71.0% Construction 51,557 10.7 53,488 10.2 Commercial real estate (1) 30,631 6.4 37,762 7.2 Land 27,066 5.6 25,635 4.9 Consumer loans: Home equity 14,245 3.0 16,368 3.1 Credit cards 5,863 1.2 7,044 1.3 Other 5,301 1.1 11,844 2.3 -------- ----- -------- ----- Total loans receivable 481,262 100.0% 524,024 100.0% -------- ===== -------- ===== Less: Allowance for loan losses 7,828 7,181 Loans in process 31,304 28,297 Deferred loan fees 5,453 6,600 Other 35 50 -------- -------- Loans receivable, net $436,642 $481,896 ======= ========
- ---------------------- (1) Includes $134,000, $191,000, $640,000, $419,000 and $761,000 of commercial business loans (i.e., working capital and inventory loans) at June 30, 1997, 1996, 1995, 1994 and 1993, respectively. 2 Contractual Principal Repayments and Interest Rates. The following table sets forth certain information at June 30, 1997 regarding the dollar amount of loans maturing in the Association's total loan portfolio, based on the contractual terms to maturity. Loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
Due 5 or more Due 1 year Due 1-5 years years after or less after June 30, 1997 June 30, 1997 Total --------------------- ----------------------- ----------------- ------------- (In Thousands) First mortgage loans: Residential real estate $ 12,467 $ 23,975 $524,910 $561,352 Construction 62,967 4,967 432 68,366 Commercial real estate 11,449 17,610 1,572 30,631 Land 9,204 10,788 -- 19,992 Consumer 22,284 1,147 517 23,948 -------- -------- -------- -------- Total $118,371 $ 58,487 $527,431 $704,289 ======== ======== ======== ========
The following table sets forth the dollar amount of total loans due after one year from June 30, 1997, as shown in the preceding table, which have fixed interest rates or which have floating or adjustable interest rates.
Fixed rate Floating or adjustable-rate Total ----------------------- --------------------------- ----------------------- (In Thousands) First mortgage loans: Residential real estate $425,882 $123,003 $548,885 Construction 5,399 -- 5,399 Commercial real estate 18,661 521 19,182 Land 10,788 -- 10,788 Consumer 1,664 -- 1,664 -------- -------- -------- Total $462,394 $123,524 $585,918 ======== ======== ========
Scheduled contractual maturities of loans do not necessarily reflect the actual term of the Association's portfolio. The average life of mortgage loans is substantially less than their average contractual terms because of loan prepayments and enforcement of due-on-sale clauses, which give the Association the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan rates substantially exceed rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans substantially exceed current mortgage loan rates. In addition, management believes that a significant number of the Association's residential mortgage loans are outstanding for a period significantly less than their contractual terms. The Association attributes this to the mobile nature of the people who reside in its market area which, over the past decade, has developed as a regional corporate and banking center. 3 Origination, Purchase and Sale of Loans. The lending activities of the Association are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by the Association's Board of Directors and management. Loan originations are obtained from a variety of sources, including builders, realtors, walk-in customers, loan officers, outside loan correspondents and advertising. In its marketing, the Association emphasizes its community ties, customized, personal service and an efficient underwriting and approval process. The Association uses its in-house appraisal staff for most residential real estate loans and construction loans secured by property located in Mecklenberg County, North Carolina and outside appraisers for most residential real estate loans and construction loans secured by property located outside of Mecklenberg County and all commercial real estate and land loans. The Association requires hazard, title and, to the extent applicable, flood insurance on all security property. Mortgage loan applications are initially processed by loan officers and are required to be approved by the Association's Loan Committee, a management committee consisting of the Association's mortgage lending manager and two additional senior officers with lending expertise. Mortgage loans must be approved by two of the three members of the Loan Committee. In addition, the Association's President or Executive Vice President may act in the place of one of the existing members of the Loan Committee. Notwithstanding the foregoing, all loans over $1.0 million must be approved in advance by the Board of Directors. Consumer loans are initially processed by consumer loan officers and are required to be approved by designated officers of the Association depending on both the amount and nature of the loan. All loans are ratified by the Association's Board of Directors. Historically, the Association has not been an active purchaser of loans or participation interests in loans. The Association purchased $4.4 million of loans during fiscal 1997, none during 1996, and $53,000 during 1995. Loans have, from time to time, been sold by the Association primarily to the Federal National Mortgage Association ("FNMA"), a quasi-governmental agency, with servicing retained and without recourse. The Association did not sell any loans during fiscal 1997, 1996 or 1995. However, management may sell loans in the future to the extent that it believes the interest rate environment is unfavorable and interest rate risk is unacceptable. When loans are sold to the FNMA, the Association retains the responsibility for servicing the loans, including collecting and remitting mortgage loan payments, accounting for principal and interest and holding and disbursing escrow or impound funds for real estate taxes and insurance premiums. The Association receives a servicing fee for performing these services for others. The Association's servicing portfolio amounted to $735.2 million at June 30, 1997, including $30.9 million of loans serviced for others. 4 The following table shows total loans originated, purchased, sold and repaid during the periods indicated.
Year Ended June 30, ----------------------------------- 1997 1996 1995 --------- --------- --------- (In Thousands) Loan originations: Residential real estate $ 170,561 $ 107,029 $ 28,100 Construction 74,114 65,508 56,677 Commercial real estate 8,072 10,105 2,500 Land 13,624 16,071 4,145 Consumer 5,494 4,117 6,332 --------- --------- --------- Total loans originated 271,865 202,830 97,754 Loans purchased 4,366 -- 53 --------- --------- --------- Total loans originated and purchased 276,231 202,830 97,807 Loan principal reductions (123,360) (121,845) (101,315) Transfer of loans to real estate owned (1,114) (2,127) (4,081) --------- --------- --------- Net increase (decrease) in total loan portfolio(1) $ 151,757 $ 78,858 $ (7,589) ========= ========= =========
- ---------------------------- (1) The increase in the Association's loan portfolio in fiscal 1997 and 1996 was due to the use of loan correspondents in the origination process and to the development of new mortgage loan products. A savings institution generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable securities. At June 30, 1997, the Association's limit on loans to one borrower was approximately $28.0 million. At June 30, 1997, the Association's largest loan or groups of loans to one borrower, including persons or entities related to the borrower, amounted to $6.2 million. This amount consists of $3.0 million on construction loans for single-family residences, $2.2 million in acquisition and development loans, and $1.0 million in miscellaneous other loans, including land, commercial real estate and consumer loans. One-to-Four Family Residential Real Estate Loans. The Association has historically concentrated its lending activities on the origination of loans secured by first mortgage liens on existing one-to-four family residences located in its market area. At June 30, 1997, $561.4 million or 79.7% of the Association's total loan portfolio consisted of permanent one-to-four family residential real estate loans. The Association originated $170.6 million, $107.0 million and $28.1 million of one-to-four family residential real estate loans in fiscal 1997, 1996 and 1995, respectively. The increase in residential real estate loan originations during fiscal 1997 and 1996 over prior years was due to the use of loan correspondents in the origination process and to the development of new mortgage loan products. The Association intends to continue to emphasize the origination of permanent loans secured by first mortgage liens on one-to-four family residential properties in the future. 5 The Association's fixed-rate loans generally have maturities ranging from 15 to 30 years and are fully amortizing with monthly payments sufficient to repay the total amount of the loan with interest by the end of the loan term. Such loans are originated under terms, conditions and documentation which permit them to be sold to U.S. Government sponsored agencies such as the FNMA. The Association's fixed-rate loans customarily include "due on sale" clauses, which give the Association the right to declare a loan immediately due and payable in the event the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. The Association also originates for its portfolio one-to-four family residential real estate loans which provide for an interest rate which adjusts every year or which is fixed for a three or five year period and adjusts every year after the initial period (such adjustable-rate loans are referred to as "ARMs"). The Association's one-year ARM adjusts every year in accordance with the national monthly median cost of funds index while the interest rate adjustment for its three and five year ARMs after the initial fixed period is based on the one year U.S. Treasury securities rate. The Association's ARMs are typically based on a 30-year amortization schedule. The amount of any increase or decrease in rate after the initial term is limited to 2% per year, with a limit of 6% over the life of the loan. The Association qualifies the borrowers on its loans which are fixed for three or five years based on the initial rate and qualifies its borrowers for its one-year ARM based on the fully indexed rate. The adjustable rate loans offered by the Association may generally be converted to a fixed-rate loan within five years from the start of the initial adjustment period. The Association does not offer deep discount rates and its adjustable rate loans do not provide for negative amortization. Adjustable-rate loans decrease the risks associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates. The Association believes that these risks, which have not had a material adverse effect on the Association to date, generally are less than the risks associated with holding fixed-rate loans in an increasing interest rate environment. The Association's residential mortgage loans typically do not exceed 80% of the appraised value of the security property. Pursuant to underwriting guidelines adopted by the Board of Directors, the Association can lend up to 95% of the appraised value of the property securing a one-to-four family residential loan; however, the Association generally obtains private mortgage insurance on the portion of the principal amount that exceeds 80% of the appraised value of the security property. Construction Loans. The Association originates primarily residential construction loans to local real estate builders, generally with whom it has an established relationship. To a significantly lesser extent, the Association originates such loans to individuals who have a contract with a builder for the construction of their residence. The Association's construction loans are secured by property located primarily in the Association's primary market area. At June 30, 1997, construction loans amounted to $68.4 million or 9.7% of the Association's total loan portfolio. In addition, at such date, the Association had $33.0 million of undisbursed funds for construction loans in process. The Association originated $74.1 million, $65.5 million and $56.7 million of construction loans in fiscal 1997, 1996 and 1995, respectively. The Association's construction loans generally have fixed interest rates for a term of one year. Construction loans to builders are typically made with a maximum loan-to-value ratio of 75%. Construction loans to individuals are typically made in connection with the granting of the permanent financing on the property. Such loans convert to a fully amortizing adjustable or fixed-rate loan at the end of the construction term. The Association typically requires that permanent financing with the Association or some other lender be in place prior to origination of any construction loan to an individual. The Association's construction loans to local builders are made on either a pre-sold or speculative (unsold) basis. However, the Association generally limits the number of unsold homes under construction to its builders, with the amount dependent on the Association's prior experience with the builder, the Association's present exposure to the 6 builder, the location of the property and the number of unsold homes in the development. The Association originates a significant portion of its construction loans to builders on a speculative basis. Prior to making a commitment to fund a construction loan, the Association requires an appraisal of the property by the Association's appraisal staff or independent state-licensed and qualified appraisers approved by the Board of Directors. The Association's appraisal staff also reviews and inspects each project at the commencement of construction and prior to every disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspections of the project based on a percentage of completion. The Association requires monthly interest payments during the construction term. The amount of funds available for advance under the Association's construction loans usually include an amount from which the borrower can pay the stated interest due thereon until completion of the loan term. Construction lending is generally considered to involve a higher level of risk as compared to permanent one-to-four family residential lending, due to the concentration of principal in a limited number of borrowers and the effects of general economic conditions on developers and builders. Moreover, a construction loan can involve additional risks because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost (including interest) of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. In addition, speculative construction loans to a builder are not pre-sold and thus pose a greater potential risk to the Association than construction loans to individuals on their personal residences. The Association has attempted to minimize the foregoing risks by, among other things, limiting the extent of its construction lending generally and by limiting its construction lending to primarily residential properties. In addition, the Association has adopted underwriting guidelines which impose stringent loan-to-value, debt service and other requirements for loans which are believed to involve higher elements of credit risk, by limiting the geographic area in which the Association will do business to its existing market and by working primarily with builders with whom it has established relationships. It is also the Association's general policy to obtain personal guarantees from the principals of its corporate borrowers on its construction loans. Commercial Real Estate Loans. The Association originates mortgage loans for the acquisition and refinancing of commercial real estate properties. The Association generally offers such loans to accommodate its present customers. At June 30, 1997, $30.6 million or 4.3% of the Association's total loan portfolio consisted of loans secured by existing commercial real estate properties. The majority of the Association's commercial real estate loans are secured by office buildings, warehouses and manufacturing facilities, all of which are secured by property located in the Association's market area. Management does not anticipate that commercial real estate loans will comprise a substantial portion of the loan portfolio in the future. The Association requires appraisals of all properties securing commercial real estate loans. Appraisals are performed by an independent appraiser designated by the Association, all of which are reviewed by management. The Association considers the quality and location of the real estate, the credit of the borrower, the cash flow of the project and the quality of management involved with the property. The Association will primarily originate commercial real estate loans with fixed interest rates subject to call provisions after three or five years. Such loans are typically based on a 15 or 25 year amortization schedule. Loan-to- value ratios on the Association's commercial real estate loans are generally limited to 75%. As part of the criteria for underwriting commercial real estate loans, the Association generally imposes a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of not less than 1.2. It is also the Association's general policy to obtain personal guarantees from the principals of its corporate borrowers on its commercial real estate loans. Commercial real estate lending entails significant additional risks as compared with single-family residential property lending. Such loans typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience on such loans is typically dependent on the successful operation of the real estate project. The 7 success of such projects is sensitive to changes in supply and demand conditions in the market for and commercial real estate as well as regional and economic conditions generally. At June 30, 1997, the Association had $969,000 of non-performing commercial real estate loans, which constituted 15.3% of total non-performing loans at such date. Land Loans. The Association originates land loans to local developers for the purpose of developing the land (i.e., roads, sewer and water) for sale. Such loans are secured by a lien on the property, are generally limited to 75% of the developed value of the secured property and are typically made for a period of three years with an interest rate that adjusts every year. The Association requires monthly interest payments during the term of the land loan. The amount of funds available under the Association's land loans usually include an amount from which the borrower can pay the stated interest due thereon until completion of the loan term. The principal of the loan is reduced as lots are developed, sold and released. The Association's land loans are structured so that the Association is repaid in full upon the sale of approximately 85% of the available lots by the borrower. All of the Association's land loans are secured by property located in its primary market area. In addition, the Association attempts to obtain personal guarantees from its borrowers and originates such loans to developers with whom it has established relationships. At June 30, 1997, the Association had $3.1 million of non-accruing land loans, which constituted 48.7% of total non-performing loans at such date. Such amount primarily consists of land loans to one borrower who has experienced financial difficulties and is involved in litigation with the Association. See Item 3 - Legal Proceedings. Consumer Loans. The Association offers consumer loans in order to provide a full range of financial services to its customers. The consumer loans offered by the Association primarily consist of home equity loans and unsecured loans through both MasterCard and VISA credit cards. Consumer loans amounted to $23.9 million or 3.5% of the total loan portfolio at June 30, 1997, $14.5 million and $6.2 million of which consisted of home equity loans and credit card debt, respectively. The largest component of the Association's consumer loan portfolio is home equity loans, which are secured by the underlying equity in the borrower's home or second residence. Home equity loans are revolving loans and generally have variable interest rates based on the prime rate plus a margin and maximum terms of 15 years. The Association's home equity loans generally require loan-to-value ratios of 80% or less after taking into consideration the first mortgage loan. Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more credit risk than mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. These risks are not as prevalent in the case of the Association's consumer loan portfolio, however, because a high percentage of the portfolio is comprised of home equity loans which are secured by real estate and underwritten in a manner such that they result in a lending risk which is substantially similar to single-family residential loans. Loan Fee Income. In addition to interest earned on loans, the Association receives income from fees in connection with loan originations, loan modifications, late payments and for miscellaneous services related to its loans. Income from these activities varies from period to period depending upon the volume and type of loans made and competitive conditions. The Association charges loan origination fees which are generally calculated as a percentage of the amount borrowed. Loan origination and commitment fees, as well as loan origination costs, are deferred and recognized over the contractual remaining lives of the related loans on a level yield basis. Discounts and premiums on loans purchased are accreted and amortized in the same manner. In accordance with FASB Statement No. 91, the Association recognized $1.7 million, $2.0 million and $1.7 million of deferred loan fees during fiscal 1997, 1996 and 1995, respectively, in connection with loan refinancing, payoffs and ongoing amortization of outstanding loans. 8 Asset Quality When a borrower fails to make a required payment on a loan, the Association attempts to cure the deficiency by contacting the borrower and seeking the payment. Contacts are generally made 15 days after a payment is due. In most cases, deficiencies are cured promptly. If a delinquency continues, additional contact is made either through a notice or other means and the Association will attempt to work out a payment schedule. While the Association generally prefers to work with borrowers to resolve such problems, the Association will institute foreclosure or other proceedings, as necessary, to minimize any potential loss. The Association generally initiates such proceedings when a loan becomes 90 days delinquent. Loans are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. Presently, the Association does not accrue interest on real estate loans past due 90 days or more. Loans may be reinstated to accrual status when payments are under 90 days past due and, in the opinion of management, collection of the remaining balance can be reasonably expected. Real estate acquired by the Association as a result of foreclosure or by deed in lieu of foreclosure is classified as other real estate owned until sold. Pursuant to a statement of position ("SOP 92-3") issued by the AICPA in April 1992, which provides guidance on determining the balance sheet treatment of foreclosed assets in annual financial statements for periods ending on or after December 15, 1992, there is a rebuttable presumption that foreclosed assets are held for sale and such assets are recommended to be carried at the lower of fair value minus estimated costs to sell the property, or cost (generally the balance of the loan on the property at the date of acquisition). After the date of acquisition, all costs incurred in maintaining the property are expensed and costs incurred for the improvement or development of such property are capitalized up to the extent of their net realizable value. The Association's accounting for its real estate acquired by foreclosure complies with the guidance set forth in SOP 92-3. Under generally accepted accounting principles, the Association is required to account for certain loan modifications or restructurings as "troubled debt restructurings." In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if the Association for economic or legal reasons related to the borrower's financial difficulties grants a concession to the borrower that the Association would not otherwise consider. Debt restructurings or loan modifications for a borrower do not necessarily always constitute troubled debt restructurings, however, and troubled debt restructurings do not necessarily result in non-accrual loans. The Association had $643,000 of troubled debt restructurings as of June 30, 1997. Federal regulations require that each insured savings association classify its assets on a regular basis. There are three classifications for problem assets: "substandard," "doubtful" and "loss." At June 30, 1997, the Association had $10.9 million of classified assets. 9 Non-Performing Assets. The following table sets forth the amounts and categories of the Association's non-performing assets at the dates indicated.
June 30, --------------------------------------------------- 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- (Dollars in Thousands) Non-accruing loans: Residential real estate $ 1,856 $ 2,632 $ 2,365 $ 5,516 $ 6,625 Construction 130 350 149 2,026 4,622 Commercial real estate 969 967 1,138 2,647 3,792 Land 3,076 4,082 4,405 6,847 7,623 Consumer 288 13 344 363 1,948 ------- ------- ------- ------- ------- Total non-accruing loans 6,319 8,044 8,401 17,399 24,610 ------- ------- ------- ------- ------- Real estate acquired in settlement of loans, net of reserves 868 2,539 2,034 2,636 6,579 ------- ------- ------- ------- ------- Total non-performing assets $ 7,187 $10,583 $10,435 $20,035 $31,189 ------- ======= ======= ======= ======= Troubled debt restructurings $ 643 $ 525 $ 2,422 $ 1,208 $ 949 ======= ======= ======= ======= ======= Total non-performing loans and troubled debt restructurings as a percentage of total net loans 1.06% 1.70% 2.48% 4.26% 5.30% ======= ======= ======= ======= ======= Total non-performing assets and troubled debt restructurings as a percentage of total assets 0.87% 1.41% 2.17% 3.70% 5.46% ======= ======= ======= ======= =======
10 For the year ended June 30, 1997, approximately $472,000 in gross interest income would have been recorded on loans accounted for on a non-accrual basis and troubled debt restructurings if such loans had been current in accordance with their original terms and had been outstanding throughout the year or since origination if held for part of the year. For the year ended June 30, 1997, $113,000 was included in net income for these same loans prior to the time they were placed on non-accrual status or were restructured as a troubled debt restructuring. Total non-performing loans and troubled debt restructurings as a percentage of total net loans have decreased significantly to 1.06% at June 30, 1997 from 5.30% at June 30, 1993. Correspondingly, total non-performing assets and troubled debt restructurings as a percentage of total assets decreased to 0.87% from 5.46% during the same period. As discussed below, the decrease during this period in non-performing construction and land loans was primarily due to the resolution or reduction of large concentrations of loans to one local developer who was experiencing debt service problems. The decrease in non-performing residential real estate loans during the same period was primarily due to the resolution or reduction of a large concentration of loans to one borrower, including related entities, and, to a lesser extent, to the continued improvement in the local economy. In fiscal 1992, with the down-turn then being experienced in the economy generally, and in the real estate market in particular, one local developer began experiencing debt service problems with respect to his loans from the Association and eventually filed for bankruptcy. At June 30, 1993, this borrower's non-performing loans amounted to $1.6 million in residential loans, $1.1 million in construction loans, $6.3 million in land loans and $1.8 million in commercial loans, totaling more than $10.8 million of the $24.6 million in total non-performing loans at June 30, 1993. As a result of charge-offs, repayments and transfers to real estate owned since fiscal 1993, the Association has substantially reduced its loans to this borrower to $3.3 million at June 30, 1997, consisting of nine non-accruing land loans amounting to $3.1 million and three non-accruing commercial real estate loans amounting to $232,000. In addition, during fiscal 1992 and 1993, the Association experienced similar difficulties with respect to a large concentration of non-performing loans to another borrower, including $1.6 million in residential real estate loans, $2.4 million in construction loans, $1.2 million in land loans and $1.0 million in consumer and commercial real estate loans at June 30, 1993. These loans totaled $6.2 million of the $24.6 million in total non-performing loans at June 30, 1993. As of June 30, 1997, the loans outstanding to this borrower have been reduced to $1.2 million in residential rental real estate properties, all of which are now fully performing. At June 30, 1997, the $1.9 million of non-accruing residential real estate loans consisted of 16 loans secured by single-family residential real estate located primarily in the Association's market area. The largest outstanding loan balance at such date amounted to $405,000, and the average outstanding loan balance amounted to $116,000. Substantially all of such loans were made to separate borrowers. The $3.1 million of non-accruing land loans at June 30, 1997 consisted of the nine loans to the local developer referred to above. All of such loans are presently subject to litigation between the borrower and the Association. See Item 3 - Legal Proceedings. The $868,000 of real estate acquired in settlement of loans at June 30, 1997 consists of developed and undeveloped residential property and single-family residential properties. Allowance for Loan Losses. It is management's policy to maintain an allowance for estimated losses based on the perceived risk of loss in the loan portfolio and the adequacy of the allowance. Management's periodic evaluation of the adequacy of the allowance is based on the Association's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of the underlying collateral and current economic conditions. The allowance is increased by provisions for loan losses which are charged against income. Although management uses the best information available to make determinations with respect to the provisions for loan losses, additional provisions for loan losses may be required to be established in the future should 11 economic or other conditions change substantially. In addition, the OTS and the FDIC, as an integral part of their examination process, periodically review the Association's allowance for possible loan losses. Such agencies may require the Association to recognize additions to such allowance based on their judgments about information available to them at the time of their examination. The following table sets forth an analysis of the Association's allowance for loan losses during the periods indicated.
Year Ended June 30, --------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- (Dollars in Thousands) Balance at beginning of period $ 7,496 $ 8,088 $ 7,828 $ 7,181 $ 4,013 ------- ------- ------- ------- ------- Charge-offs: Residential real estate (16) (16) (63) (368) (1,204) Construction -- -- -- -- -- Commercial real estate (233) (1,086) (145) (127) (304) Land -- (349) (16) -- (27) Consumer (95) (41) (171) (247) (142) ------- ------- ------- ------- ------- Total charge-offs (344) (1,492) (395) (742) (1,677) ------- ------- ------- ------- ------- Recoveries: Residential real estate 11 -- 80 -- -- Construction -- -- -- -- -- Commercial real estate 50 -- 85 24 42 Land 450 25 -- -- -- Consumer 8 538 4 13 12 ------- ------- ------- ------- ------- Total recoveries 519 563 169 37 54 ------- ------- ------- ------- ------- Net (charge-offs) recoveries 175 (929) (226) (705) (1,623) ------- ------- ------- ------- ------- Provision (recovery) for losses on loans (59) 337 486 1,352 4,791 ------- ------- ------- ------- ------- Balance at end of period $ 7,612 $ 7,496 $ 8,088 $ 7,828 $ 7,181 ======= ======= ======= ======= ======= Allowance for loan losses as a percent of total loans outstanding 1.08% 1.36% 1.71% 1.63% 1.37% ======= ======= ======= ======= ======= Allowance for loan losses as a percent of nonperforming loans and troubled debt restructurings 109.33% 87.48% 74.73% 42.07% 28.10% ======= ======= ======= ======= ======= Ratio of net charge-offs (recoveries) to average loans outstanding (0.03)% 0.20% 0.05% 0.16% 0.33% ======= ======= ======= ======= =======
12 The following table sets forth information concerning the allocation of the Association's allowance for loan losses by loan category at the dates indicated.
June 30, ------------------------------------------------------------------------------------- 1997 1996 1995 ----------------------- -------------------------- ------------------------ Percent of Percent of Percent of Loans in Loans in Loans in Each Each Each Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- ------ ----------- (Dollars in Thousands) Residential real estate $4,319 79.7% $3,474 75.4% $3,029 74.7% Construction 780 9.7 350 11.1 351 10.6 Commercial real estate 543 4.3 444 5.3 1,068 5.4 Land 1,697 2.8 3,012 4.1 3,265 4.1 Consumer 273 3.5 216 4.1 375 5.2 ------ ----- ------ ----- ------ ----- Total $7,612 100.0% $7,496 100.0% $8,088 100.0% ------ ----- ====== ===== ====== ===== June 30, ------------------------------------------------------- 1994 1993 ------------------------ ------------------------ Percent of Percent of Loans in Loans in Each Each Category to Category to Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- (Dollars in Thousands) Residential real estate $2,336 72.0% $2,767 71.0% Construction 220 10.7 440 10.2 Commercial real estate 760 6.4 743 7.2 Land 4,075 5.6 2,469 4.9 Consumer 437 5.3 762 6.7 ------ ----- ------ ----- Total $7,828 100.0% $7,181 100.0% ====== ===== ====== =====
13 Investment Securities The investment policy of the Company, as established by the Board of Directors, is designed primarily to provide and maintain liquidity and to generate a favorable return on investments without incurring undue interest rate risk, credit risk, and investment portfolio asset concentrations. The Company's investment policy is currently implemented by the Association's President and Chief Financial Officer within the parameters set by the Board of Directors. The Association is authorized to invest in obligations issued or fully guaranteed by the U.S. Government, certain federal agency obligations, certain time deposits, negotiable certificates of deposit issued by commercial banks and other insured financial institutions, investment grade corporate debt securities and other specified investments. Securities that management has the intent and positive ability to hold to maturity are classified as held to maturity and are reported at amortized cost. Securities classified as available for sale are reported at fair value, with unrealized gains and losses, net of deferred income taxes, excluded from earnings and reported as a separate component of equity. At June 30, 1997, all $175.7 million of the Company's investment securities were classified as available for sale. On December 31, 1995, management of the Company reevaluated its intent with respect to its investment portfolio and, accordingly, reclassified all investments and mortgage-backed securities from the held to maturity classification to the available for sale classification. Prior to this election, the majority of the Company's securities were included in its held to maturity portfolio. At June 30, 1997, investments in the debt and/or equity securities of any one issuer did not exceed more than 10% of the Company's stockholders' equity. See Notes 1 and 2 of the Notes to the Consolidated Financial Statements in the 1997 Annual Report to Stockholders filed as Exhibit 13 hereto (the "1997 Annual Report"). During fiscal 1997, the Company also invested its funds in mortgage-backed securities. Mortgage-backed securities (which also are known as mortgage participation certificates or pass-through certificates) typically represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which are passed from the mortgage originators, through intermediaries (generally U.S. Government agencies and government sponsored enterprises) that pool and repackage the participation interests in the form of securities, to investors such as the Association. Such U.S. Government agencies and government sponsored enterprises, which guarantee the payment of principal and interest to investors, primarily include the FNMA, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. Mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The underlying pool of mortgages, i.e., fixed rate or adjustable rate, as well as the prepayment risk, are passed on to the certificate holder. Accordingly, the life of a mortgage-backed pass-through security approximates the life of the underlying mortgages. The actual maturity of a mortgage-backed security may be less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and adversely affect its yield to maturity. The yield is based upon the interest income and the amortization of any premium or discount related to the mortgage-backed security. In accordance with generally accepted accounting principles, premiums and discounts are amortized over the estimated lives of the loans, which decrease and increase interest income, respectively. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security, and these assumptions are reviewed periodically to reflect actual prepayments. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of falling mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the 14 prepayment of the underlying mortgages and the related security. Under such circumstances, the Association may be subject to reinvestment risk because to the extent that the Association's mortgage-backed securities amortize or prepay faster than anticipated, the Association may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate. For additional information relating to the Company's mortgage-backed securities, see Note 2 of the Notes to the Consolidated Financial Statements in the 1997 Annual Report. The following table sets forth certain information relating to the Company's investment portfolio at the dates indicated. At June 30, 1997, all of the Company's investment securities were classified as available for sale.
June 30, ------------------------------------------------- 1997 1996 1995 --------------- -------------- -------------- (In Thousands) U.S. Government and agency obligations $114,261 $119,805 $109,963 Mortgage-backed securities 53,197 123,087 -- FHLMC stock 8,252 5,553 4,424 -------- ------- -------- Total $175,710(1) $248,445 $114,387 ======== ======== ========
- ----------------- (1) Such amount includes $8.5 million of unrealized gains and $2.1 million of unrealized losses. 15 The following table sets forth the amount of the Company's investment securities which mature during each of the periods indicated and the weighted average yields for each range of maturities at June 30, 1997. The actual maturity of the Company's investment securities may differ from contractual maturity since certain of the Company's investment securities are subject to call provisions which allow the issuer to accelerate the maturity date of the security.
Contractually Maturing ------------------------------------------------------------------------------------- Weighted Weighted Average Average Under 1 Year Yield 1-5 Years Yield 5-10 Years --------------- ------------ ------------------- ----------- ------------- (Dollars in Thousands) U.S. Government and agency $10,959 4.93% $65,423 5.59% $6,831 obligations Mortgage-backed securities -- -- -- -- -- FHLMC stock 8,252 1.39 -- -- -- ------- ------- ------ Total $19,211 3.41% $65,423 5.59% $6,831 ======= ==== ======= ==== ====== Contractually Maturing ----------------------------------------------- Weighted Weighted Average Greater Than Average Yield 10 Years Yield ---------- -------------- --------------- (Dollars in Thousands) U.S. Government and agency 6.86% $31,049 7.39% obligations Mortgage-backed securities -- 53,197 7.40 FHLMC stock -- -- -- ------- Total 6.86% $84,246 7.40% ==== ======= ====
16 Sources of Funds General. Deposits are the primary source of the Association's funds for lending and other investment purposes. In addition to deposits, the Association derives funds from loan principal repayments and prepayments, securities sold under repurchase agreements and advances from the FHLB of Atlanta. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used to compensate for reductions in the availability of funds from other sources and for general business purposes. Deposits. The Association's deposit products include a broad selection of deposit instruments, including negotiable order of withdrawal ("NOW") accounts, money market accounts, regular savings accounts and term certificate accounts. Deposit account terms vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit and the interest rate. The Association utilizes traditional marketing methods to attract new customers and savings deposits. The Association does not advertise for deposits outside of its primary market area and management believes that an insignificant number of deposit accounts were held by non-residents of North Carolina at June 30, 1997. The Association does accept deposits placed by deposit brokers but does not pay fees to such brokers for obtaining deposits. The Association's management believes that the amount of deposits received through brokers amounted to approximately $34.5 million at June 30, 1997. Although such deposits have not been a volatile source of funds, deposits received from brokers are not generally considered core deposits. The Association has been competitive in the types of accounts and in interest rates it has offered on its deposit products. Deposit levels were higher during fiscal 1995 primarily as a result of an increase in rates offered by the Association during that year as part of a special marketing program as well as in response to a general increase in market interest rates. While the average rate paid during fiscal 1995 was 4.74%, the weighted average rate at June 30, 1995 was 5.67%. The effect of these rates continued in fiscal 1996, resulting in an average rate paid during the year of 5.54%, compared to 4.74% during fiscal 1995. The weighted average rate of deposits at June 30, 1996, however, declined to 5.42%. During fiscal 1997, the downward trend in deposit rates continued as the Association sought to moderate its cost of deposits by not renewing high rate certificates of deposit as they have matured, or by renewing them at market rates. As a result, the cost of deposits declined to 5.34% for the fiscal year ended June 30, 1997, with a year end weighted average cost of 5.24%. Although market demand generally dictates which deposit maturities and rates will be accepted by the public, the Association intends to continue to promote checking and NOW accounts as well as longer term certificates of deposit to the extent possible and consistent with its asset and liability management goals. 17 The following table sets forth the dollar amount of deposits in the various types of deposit programs offered by the Association at the dates indicated.
June 30, -------------------------------------------------------------------------------------------- 1997 1996 1995 ----------------------------- -------------------------- -------------------------- Amount Percentage Amount Percentage Amount Percentage -------------- ------------- ---------- -------------- --------- ------------- (Dollars in Thousands) Checking accounts $ 9,193 2.1% $ 9,326 2.1% $ 7,348 1.5% NOW accounts 15,168 3.4 13,638 3.0 13,187 2.7 Passbook accounts 14,447 3.3 15,141 3.4 16,099 3.3 Money market 34,760 7.8 32,315 7.2 40,683 8.3 Certificates of deposit 370,272 83.4 378,151 84.3 413,249 84.2 -------- -------- -------- Total deposits $443,840 100.0% $448,571 100.0% $490,566 100.0% ======== ===== ======== ===== ======== =====
The following table presents the average balance of each deposit type and the average rate paid on each deposit type for the periods indicated.
June 30, --------------------------------------------------------------------------------------- 1997 1996 1995 --------------------------- ------------------------ -------------------------- Average Average Average Average Average Average Balance Rate Paid Balance Rate Paid Balance Rate Paid ------------- ----------- ---------- ----------- ------------ ------------ (Dollars in Thousands) Checking $ 8,451 --% $ 7,565 --% $ 7,148 --% NOW accounts 14,749 2.79 22,828 2.82 13,902 2.78 Passbook accounts 14,929 2.50 16,574 2.50 17,326 2.50 Money market 30,813 2.87 38,082 2.92 53,446 2.99 Certificates of deposit 371,957 5.90 406,016 6.17 360,675 5.28 -------- -------- -------- Total deposits $440,899 5.34% $491,065 5.54% $452,497 4.74% ======== ==== ======== ==== ======== ====
The following table sets forth the savings activities of the Association during the periods indicated.
Year Ended June 30, ------------------------------------------- 1997 1996 1995 -------- -------- ------- (In Thousands) Net increase (decrease) before interest credited $(19,939) $(60,148) $31,405 Interest credited 15,208 18,152 13,665 -------- -------- ------- Net increase (decrease) in deposits $ (4,731) $(41,996) $45,070 ======== ======== =======
18 The following table shows the interest rate and maturity information for the Association's certificates of deposit at June 30, 1997.
Maturity Date ----------------------------------------------------------------------------------- One Year Over 1-2 Over 2-3 Over 3 or Less Years Years Years Total --------------- --------------- ------------- ------------- ----------- (In Thousands) 2.00 - 4.00% $ 3,932 $ 8 $ -- $ -- $ 3,940 4.01 - 6.00% 196,403 28,513 1,849 1,660 228,425 6.01 - 8.00% 91,280 26,052 11,146 5,830 134,308 8.01 - 10.00% 35 991 2,373 -- 3,399 10.01% - or more -- 200 -- -- 200 -------- -------- -------- -------- -------- Total $291,650 $ 55,764 $ 15,368 $ 7,490 $370,272 ======== ======== ======== ======== ========
The following table sets forth the maturities of the Association's certificates of deposit having principal amounts of $100,000 or more at June 30, 1997.
Amount ------ (In Thousands) Certificates of deposit maturing in quarter ending: September 30, 1997 $ 51,756 December 31, 1997 23,066 March 31, 1998 18,700 June 30, 1998 20,420 After June 30, 1998 31,159 -------- Total certificates of deposit with balances of $100,000 or more $145,101 ========
19 Borrowings. The Association may also obtain advances from the FHLB of Atlanta upon the security of the common stock it owns in that bank and certain of its residential mortgage loans, provided certain standards related to creditworthiness have been met. Such advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities. Such advances are generally available to meet seasonal and other withdrawals of deposit accounts and to permit increased lending. The Association has also utilized securities sold under repurchase agreements. These are agreements to sell securities under terms which require the Association to repurchase the same or substantially similar securities by a specified date. The following table sets forth information with respect to the Association's FHLB advances and securities sold under repurchase agreements at and during the periods indicated.
At or For the Year Ended June 30, ------------------------------------------------------------------------------- 1997 1996 1995 ------------------------ ------------------------ ----------------------- (Dollars in Thousands) FHLB Advances: Maximum balance $129,000 $10,000 $55,000 Average balance 61,093 1,038 46,197 Year end balance $129,000 $ -- $10,000 Weighted average interest rate: At end of year 5.90% --% 6.75% During the year 5.92% 5.89% 5.80% Repurchase Agreements: Maximum balance $120,000 $85,000 $ 8,000 Average balance 117,397 13,385 1,644 Year end balance $120,000 $85,000 $ -- Weighted average interest rate: At end of year 5.81% 5.55% --% During the year 5.78% 5.35% 6.63%
Employees The Company had 118 full-time employees and 10 part-time employees at June 30, 1997. None of these employees is represented by a collective bargaining agent, and the Company believes that it enjoys good relations with its personnel. 20 Subsidiaries The Company has two wholly owned subsidiaries consisting of the Association and Investment Corp. Investment Corp. was formed in December 1995 as a Delaware-chartered finance subsidiary. In addition to funds held by Investment Corp. which were contributed to Investment Corp. by the Company in connection with the Conversion, Investment Corp. also loaned $9.0 million to the Employee Stock Ownership Plan. Investment Corp. generated net income of approximately $2.3 million during fiscal 1997. The Association is permitted to invest up to 2% of its assets in the capital stock of, or secured or unsecured loans to, subsidiary corporations, with an additional investment of 1% of assets when such additional investment is utilized primarily for community development purposes. The Association's only subsidiary, Home Federal Savings Service Corporation ("Service Corporation"), was formed in 1972. Service Corporation is involved in the sale of annuities and various insurance products to the Association's customers and others. Service Corporation generated net income of approximately $129,000 during fiscal 1997. Competition Charlotte is the third largest financial center in the nation after New York and San Francisco. The Association faces strong competition in its local market area both in attracting deposits and making real estate loans. Its most direct competition for deposits has historically come from commercial banks and other savings associations, including many large financial institutions which have greater financial and marketing resources available to them. In addition, during times of low interest rates, the Association has faced additional significant competition for investors' funds from short-term money market securities, mutual funds and other corporate and government securities. The ability of the Association to attract and retain savings deposits depends on its ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities. The Association experiences strong competition for real estate loans principally from commercial banks and mortgage companies. The Association competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers. REGULATION Set forth below is a brief description of those laws and regulations which relate to the Company and the Association. The description of the laws and regulations hereunder, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations. The Company General. The Company is a savings and loan holding company within the meaning of the Home Owners Loan Act ("HOLA") and is subject to OTS regulations, examinations, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, the Association is subject to certain restrictions in its dealings with the Company and affiliates thereof. Activities Restrictions. There are generally no restrictions on the activities of a savings and loan holding company which holds only one subsidiary savings institution. However, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution, the Director may impose such restrictions as deemed necessary to address such risk, including limiting (i) payment of dividends by the savings institution; (ii) transactions between the savings institution and its affiliates; and (iii) any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Notwithstanding the above rules as to permissible business activities of unitary savings and 21 loan holding companies, if the savings institution subsidiary of such a holding company fails to meet the QTL test, as discussed under "- The Association - Qualified Thrift Lender Test", then such unitary holding company also shall become subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the savings institution requalifies as a QTL within one year thereafter, shall register as, and become subject to the restrictions applicable to, a bank holding company. See "- The Association - Qualified Thrift Lender Test." If the Company were to acquire control of another savings institution, other than through merger or other business combination with the Association, the Company would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority to approve emergency thrift acquisitions and where each subsidiary savings institution meets the QTL test, as set forth below, the activities of the Company and any of its subsidiaries (other than the Association or other subsidiary savings institutions) would thereafter be subject to further restrictions. Among other things, no multiple savings and loan holding company or subsidiary thereof which is not a savings institution shall commence or continue for a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof any business activity, upon prior notice to, and no objection by the OTS, other than: (i) furnishing or performing management services for a subsidiary savings institution; (ii) conducting an insurance agency or escrow business; (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings institution; (iv) holding or managing properties used or occupied by a subsidiary savings institution; (v) acting as trustee under deeds of trust; (vi) those activities authorized by regulation as of March 5, 1987 to be engaged in by multiple savings and loan holding companies; or (vii) unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies, those activities authorized by the Federal Reserve Board as permissible for bank holding companies. Those activities described in (vii) above also must be approved by the Director of the OTS prior to being engaged in by a multiple savings and loan holding company. Limitations on Transactions with Affiliates. Transactions between savings institutions and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings institution is any company or entity which controls, is controlled by or is under common control with the savings institution. In a holding company context, the parent holding company of a savings institution (such as the Company) and any companies which are controlled by such parent holding company are affiliates of the savings institution. Generally, Sections 23A and 23B (i) limit the extent to which the savings institution or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and other similar transactions. In addition to the restrictions imposed by Sections 23A and 23B, no savings institution may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, or (ii) purchase or invest in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings institution. In addition, Sections 22(h) and (g) of the Federal Reserve Act places restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% stockholder of a savings institution, and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the savings institution's loans to one borrower limit (generally equal to 15% of the institution's unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons and also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a savings institution to all insiders cannot exceed the institution's unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At June 30, 1997, the Association was in compliance with the above restrictions. 22 Restrictions on Acquisitions. Except under limited circumstances, savings and loan holding companies are prohibited from acquiring, without prior approval of the Director of the OTS, (i) control of any other savings institution or savings and loan holding company or substantially all the assets thereof or (ii) more than 5% of the voting shares of a savings institution or holding company thereof which is not a subsidiary. Except with the prior approval of the Director of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock, may acquire control of any savings institution, other than a subsidiary savings institution, or of any other savings and loan holding company. The Director of the OTS may only approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings institutions in more than one state if (i) the multiple savings and loan holding company involved controls a savings institution which operated a home or branch office located in the state of the institution to be acquired as of March 5, 1987; (ii) the acquiror is authorized to acquire control of the savings institution pursuant to the emergency acquisition provisions of the Federal Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the institution to be acquired is located specifically permit institutions to be acquired by the state-chartered institutions or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings institutions). Under the Bank Holding Company Act of 1956, the FRB is authorized to approve an application by a bank holding company to acquire control of a savings institution. In addition, a bank holding company that controls a savings institution may merge or consolidate the assets and liabilities of the savings institution with, or transfer assets and liabilities to, any subsidiary bank which is a member of the Bank Insurance Fund ("BIF") with the approval of the appropriate federal banking agency and the FRB. As a result of these provisions, there have been a number of acquisitions of savings institutions by bank holding companies in recent years. The Association General. The OTS has extensive authority over the operations of federally chartered savings institutions. As part of this authority, savings institutions are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS and the FDIC. The investment and lending authority of savings institutions are prescribed by federal laws and regulations, and such institutions are prohibited from engaging in any activities not permitted by such laws and regulations. Those laws and regulations generally are applicable to all federally chartered savings institutions and may also apply to state-chartered savings institutions. Such regulation and supervision is primarily intended for the protection of depositors. The OTS' enforcement authority over all savings institutions and their holding companies includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Insurance of Accounts. The deposits of the Association are insured to the maximum extent permitted by the SAIF, which is administered by the FDIC, and are backed by the full faith and credit of the U.S. Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action. The BIF fund met its target reserve level in September 1995, but the SAIF was not expected to meet its target reserve level until at least 2002. Consequently, in late 1995, the FDIC approved a final rule regarding deposit insurance premiums which, effective with respect to the semiannual premium assessment beginning January 1, 1996, reduced 23 deposit insurance premiums for BIF member institutions in the lowest risk category. Deposit insurance premiums for SAIF members were maintained at their existing levels (23 basis points for institutions in the lowest risk category). On September 30, 1996, President Clinton signed into law legislation to eliminate the premium differential between SAIF-insured institutions and BIF-insured institutions by recapitalizing the SAIF's reserves to the required ratio of 1.25% of insured deposits. The legislation provided that the holders of SAIF-assessable deposits pay a one-time special assessment to recapitalize the SAIF. The legislation also provided for the merger of the BIF and the SAIF, with such merger being conditioned upon the prior elimination of the thrift charter. Effective October 8, 1996, FDIC regulations imposed a one-time special assessment equal to 65.7 basis points for all SAIF-assessable deposits as of March 31, 1995, which was collected on November 27, 1996. Following the imposition of the one-time special assessment, the FDIC lowered assessment rates for SAIF members to reduce the disparity in the assessment rates paid by BIF and SAIF members. Beginning October 1, 1996, effective BIF and SAIF rates both range from zero basis points to 27 basis points. From 1997 through 1999, FDIC- insured institutions will pay approximately 1.3 basis points of their BIF-assessable deposits and 6.4 basis points of their SAIF-assessable deposits to fund the Financing Corporation. The FDIC may terminate the deposit insurance of any insured depository institution, including the Association, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the Association's deposit insurance. Regulatory Capital Requirements. Federally insured savings institutions are required to maintain minimum levels of regulatory capital. The OTS has established capital standards applicable to all savings institutions. These standards generally must be as stringent as the comparable capital requirements imposed on national banks. The OTS also is authorized to impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. Current OTS capital standards require savings institutions to satisfy three different capital requirements. Under these standards, savings institutions must maintain "tangible" capital equal to at least 1.5% of adjusted total assets, "core" capital equal to at least 3.0% of adjusted total assets and "total" capital (a combination of core and "supplementary" capital) equal to at least 8.0% of "risk-weighted" assets. For purposes of the regulation, core capital generally consists of common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged deposits and "qualifying supervisory goodwill." Tangible capital is given the same definition as core capital but does not include qualifying supervisory goodwill and is reduced by the amount of all the savings institution's intangible assets, with only a limited exception for purchased mortgage servicing rights. The Association had no goodwill or other intangible assets at June 30, 1997. Both core and tangible capital are further reduced by an amount equal to a savings institution's debt and equity investments in subsidiaries engaged in activities not permissible to national banks (other than subsidiaries engaged in activities undertaken as agent for customers or in mortgage banking activities and subsidiary depository institutions or their holding companies). These adjustments do not materially affect the Association's regulatory capital. In determining compliance with the risk-based capital requirement, a savings institution is allowed to include both core capital and supplementary capital in its total capital, provided that the amount of supplementary capital included does not exceed the savings institution's core capital. Supplementary capital generally consists of hybrid capital instruments; perpetual preferred stock which is not eligible to be included as core capital; subordinated debt and 24 intermediate-term preferred stock; and general allowances for loan losses up to a maximum of 1.25% of risk-1eighted assets. In determining the required amount of risk-based capital, total assets, including certain off-balance sheet items, are multiplied by a risk weight based on the risks inherent in the type of assets. The risk weights assigned by the OTS for principal categories of assets are (i) 0% for cash and securities issued by the U.S. Government or unconditionally backed by the full faith and credit of the U.S. Government; (ii) 20% for securities (other than equity securities) issued by U.S. Government-sponsored agencies and mortgage-backed securities issued by, or fully guaranteed as to principal and interest by, the FNMA or the FHLMC, except for those classes with residual characteristics or stripped mortgage-related securities; (iii) 50% for prudently underwritten permanent one- to four-family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by the FNMA or the FHLMC, qualifying residential bridge loans made directly for the construction of one- to four-family residences and qualifying multi-family residential loans; and (iv) 100% for all other loans and investments, including consumer loans, commercial loans, and one- to four-family residential real estate loans more than 90 days delinquent, and for repossessed assets. In August 1993, the OTS adopted a final rule incorporating an interest-rate risk component into the risk-based capital regulation. Under the rule, an institution with a greater than "normal" level of interest rate risk will be subject to a deduction of its interest rate risk component from total capital for purposes of calculating its risk-based capital. As a result, such an institution will be required to maintain additional capital in order to comply with the risk-based capital requirement. An institution with a greater than "normal" interest rate risk is defined as an institution that would suffer a loss of net portfolio value exceeding 2.0% of the estimated economic value of its assets in the event of a 200 basis point increase or decrease (with certain minor exceptions) in interest rates. The interest rate risk component will be calculated, on a quarterly basis, as one-half of the difference between an institution's measured interest rate risk and 2.0% multiplied by the economic value of its assets. The rule also authorizes the Director of the OTS, or his designee, to waive or defer an institution's interest rate risk component on a case-by-case basis. The final rule was originally effective as of January 1, 1994, subject however to a two quarter "lag" time between the reporting date of the data used to calculate an institution's interest rate risk and the effective date of each quarter's interest rate risk component. However, in October 1994 the Director of the OTS indicated that it would waive the capital deductions for institutions with a greater than "normal" risk until the OTS publishes an appeals process. On August 21, 1995, the OTS released Thrift Bulletin 67 which established (i) an appeals process to handle "requests for adjustments" to the interest rate risk component and (ii) a process by which "well-capitalized" institutions may obtain authorization to use their own interest rate risk model to determine their interest rate risk component. The Director of the OTS indicated, concurrent with the release of Thrift Bulletin 67, that the OTS will continue to delay the implementation of the capital deduction for interest rate risk pending the testing of the appeals process set forth in Thrift Bulletin 67. Any savings institution that fails any of the capital requirements is subject to possible enforcement actions by the OTS or the FDIC. Such actions could include a capital directive, a cease and desist order, civil money penalties, the establishment of restrictions on the institution's operations, termination of federal deposit insurance and the appointment of a conservator or receiver. The OTS' capital regulation provides that such actions, through enforcement proceedings or otherwise, could require one or more of a variety of corrective actions. Liquidity Requirements. All savings institutions are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. The liquidity requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings institutions. At the present time, the required minimum liquid asset ratio is 5%. At June 30, 1997, the Association' liquidity ratio was 10.8%. Capital Distributions. OTS regulations govern capital distributions by savings institutions, which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of a savings institution to make capital distributions. Generally, the regulation creates a safe harbor for specified levels of capital distributions from institutions meeting at least their minimum capital requirements, so long as such institutions notify the OTS and receive no objection to the distribution 25 from the OTS. Savings institutions and distributions that do not qualify for the safe harbor are required to obtain prior OTS approval before making any capital distributions. Generally, a savings institution that before and after the proposed distribution meets or exceeds its fully phased-in capital requirements (Tier 1 institutions) may make capital distributions during any calendar year equal to the higher of (i) 100% of net income for the calendar year-to-date plus 50% of its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of net income over the most recent four-quarter period. The "surplus capital ratio" is defined to mean the percentage by which the institution's ratio of total capital to assets exceeds the ratio of its fully phased-in capital requirement to assets. "Fully phased-in capital requirement" is defined to mean an institution's capital requirement under the statutory and regulatory standards applicable on December 31, 1994, as modified to reflect any applicable individual minimum capital requirement imposed upon the institution. Failure to meet fully phased-in or minimum capital requirements will result in further restrictions on capital distributions, including possible prohibition without explicit OTS approval. See "- Regulatory Capital Requirements." Tier 2 institutions, which are institutions that before and after the proposed distribution meet or exceed their minimum capital requirements, may make capital distributions up to a specified percentage of their net income during the most recent four quarter period, depending on how close the institution is to meeting its fully phased-in capital requirements. Tier 3 institutions, which are institutions that do not meet current minimum capital requirements, or which have been otherwise notified by the OTS that it will be treated as a Tier 3 institution because they are in need of more than normal supervision, cannot make any capital distribution without obtaining OTS approval prior to making such distributions. In order to make distributions under these safe harbors, Tier 1 and Tier 2 institutions must submit 30 days written notice to the OTS prior to making the distribution. The OTS may object to the distribution during that 30-day period based on safety and soundness concerns. At June 30, 1997, the Association was a Tier 1 institution for purposes of this regulation. Loans to One Borrower. The permissible amount of loans to one borrower now generally follows the national bank standard for all loans made by savings institutions. The national bank standard generally does not permit loans to one borrower to exceed the greater of $500,000 or 15% of unimpaired capital and surplus. Loans in an amount equal to an additional 10% of unimpaired capital and surplus also may be made to a borrower if the loans are fully secured by readily marketable securities. Classified Assets. Federal regulations require that each insured savings institution classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: "substandard," "doubtful" and "loss." Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets, with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Another category designated "special mention" also must be established and maintained for assets which do not currently expose an insured institution to a sufficient degree of risk to warrant classification as substandard, doubtful or loss. Assets classified as substandard or doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge-off such amount. General loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institution's regulatory capital up to certain amounts, while specific valuation allowances for loan losses do not qualify as regulatory capital. Federal examiners may disagree with an insured institution's classifications and amounts reserved. 26 Branching by Federal Savings Institutions. OTS policy permits interstate branching to the full extent permitted by statute (which is essentially unlimited). Generally, federal law prohibits federal savings institutions from establishing, retaining or operating a branch outside the state in which the federal institution has its home office unless the institution meets the IRS' domestic building and loan test (generally, 60% of a thrift's assets must be housing-related) ("IRS Test"). The IRS Test requirement does not apply if, among other things, the law of the state where the branch would be located would permit the branch to be established if the federal savings institution were chartered by the state in which its home office is located. Furthermore, the OTS will evaluate a branching applicant's record of compliance with the Community Reinvestment Act of 1977 ("CRA"). An unsatisfactory CRA record may be the basis for denial of a branching application. Qualified Thrift Lender Test. All savings institutions are required to meet a QTL test to avoid certain restrictions on their operations. A savings institution that does not meet the QTL test must either convert to a bank charter or comply with the following restrictions on its operations: (i) the institution may not engage in any new activity or make any new investment, directly or indirectly, unless such activity or investment is permissible for a national bank; (ii) the branching powers of the institution shall be restricted to those of a national bank; (iii) the institution shall not be eligible to obtain any advances from its FHLB; and (iv) payment of dividends by the institution shall be subject to the rules regarding payment of dividends by a national bank. Upon the expiration of three years from the date the savings institution ceases to be a QTL, it must cease any activity and not retain any investment not permissible for a national bank and immediately repay any outstanding FHLB advances (subject to safety and soundness considerations). Currently, the QTL test requires that 65% of an institution's "portfolio assets" (as defined) consist of certain housing and consumer-related assets on a monthly average basis in nine out of every 12 months. Assets that qualify without limit for inclusion as part of the 65% requirement are loans made to purchase, refinance, construct, improve or repair domestic residential housing and manufactured housing; home equity loans; mortgage-backed securities (where the mortgages are secured by domestic residential housing or manufactured housing); stock issued by the FHLB of Atlanta; and direct or indirect obligations of the FDIC. In addition, the following assets, among others, may be included in meeting the test subject to an overall limit of 20% of the savings institution's portfolio assets: 50% of residential mortgage loans originated and sold within 90 days of origination; 100% of consumer and educational loans (limited to 10% of total portfolio assets); and stock issued by the FHLMC or the FNMA. Portfolio assets consist of total assets minus the sum of (i) goodwill and other intangible assets, (ii) property used by the savings institution to conduct its business, and (iii) liquid assets up to 20% of the institution's total assets. At June 30, 1997, the qualified thrift investments of the Association were approximately 88.3% of its portfolio assets. Accounting Requirements. Applicable OTS accounting regulations and reporting requirements apply the following standards: (i) regulatory reports will incorporate GAAP when GAAP is used by federal banking agencies; (ii) savings institution transactions, financial condition and regulatory capital must be reported and disclosed in accordance with OTS regulatory reporting requirements that will be at least as stringent as for national banks; and (iii) the Director of the OTS may prescribe regulatory reporting requirements more stringent than GAAP whenever the Director determines that such requirements are necessary to ensure the safe and sound reporting and operation of savings institutions. The accounting principles for depository institutions are currently undergoing review to determine whether the historical cost model or market-based measure of valuation is the appropriate measure for reporting the assets of such institutions in their financial statements. Such proposal is controversial because any change in applicable accounting principles which requires depository institutions to carry mortgage-backed securities and mortgage loans at fair market value could result in substantial losses to such institutions and increased volatility in their liquidity and operations. Currently, it cannot be predicted whether there may be any changes in the accounting principles for depository institutions in this regard beyond those imposed by SFAS No. 115 or when any such changes might become effective. Federal Home Loan Bank System. The Association is a member of the FHLB of Atlanta, which is one of 12 regional FHLBs that administers the home financing credit function of savings institutions. Each FHLB serves as a 27 reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the Board of Directors of the FHLB. At June 30, 1997, the Association had FHLB advances amounting to $129.0 million. See "Business - Sources of Funds - Borrowings." As a member, the Association is required to purchase and maintain stock in the FHLB of Atlanta in an amount equal to 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of FHLB advances, whichever is greater. At June 30, 1997, the Association had $6.5 million in FHLB stock, which was in compliance with this requirement. The FHLBs are required to provide funds for the resolution of troubled savings institutions and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid in the past and could continue to do so in the future. These contributions also could have an adverse effect on the value of FHLB stock in the future. Federal Reserve System. The FRB requires all depository institutions to maintain reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. As of June 30, 1997, no reserves were required to be maintained on the first $4.3 million of transaction accounts, reserves of 3% were required to be maintained against the next $52.0 million of net transaction accounts (with such dollar amounts subject to adjustment by the FRB), and a reserve of 10% (which is subject to adjustment by the FRB to a level between 8% and 14%) against all remaining net transaction accounts. Because required reserves must be maintained in the form of vault cash or a noninterest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce an institution's earning assets. TAXATION Federal Taxation General. The Company and Association are subject to the generally applicable corporate tax provisions of the Code, and Association is subject to certain additional provisions of the Code which apply to thrift and other types of financial institutions. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters material to the taxation of the Company and the Association and is not a comprehensive discussion of the tax rules applicable to the Company and Association. Year. The Company and Association file a federal income tax return on the basis of a fiscal year ending on June 30. Bad Debt Reserves. Savings institutions, such as the Association, which meet certain definitional tests primarily relating to their assets and the nature of their businesses, historically have been permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions may, within specified formula limits, be deducted in arriving at the institution's taxable income. For purposes of computing the deductible addition to its bad debt reserve, the institution's loans are separated into "qualifying real property loans" (i.e., generally those loans secured by certain interests in real property) and all other loans ("non-qualifying loans"). The deduction with respect to non-qualifying loans must be computed under the experience method, while, prior to fiscal 1997, a deduction with respect to qualifying loans may be computed using a percentage based on actual loss experience or a percentage of taxable income. Recently enacted legislation will affect the Association's method of establishing a tax reserve for bad debts and its ability to make annual additions thereto. Pursuant to such legislation, the percentage of taxable income method has been repealed. In addition, the Association is permitted to deduct bad debts only as they occur and is required to 28 recapture (i.e. take into income) over a six-year period the excess of the balance of its bad debt reserves as of June 30, 1996 over the balance of such reserves as of June 30, 1988. It is anticipated that any recapture of the Association's bad debt reserves accumulated after 1987 would not have a material adverse effect on the Company's financial condition and results of operations. Under the previous percentage of taxable income method, the bad debt deduction equals 8% of taxable income determined without regard to that deduction and with certain adjustments. The availability of the percentage of taxable income method permits a qualifying savings institution to be taxed at a lower effective federal income tax rate than that applicable to corporations in general. This resulted generally in an effective federal income tax rate payable by a qualifying savings institution fully able to use the maximum deduction permitted under the percentage of taxable income method, in the absence of other factors affecting taxable income, of 32.2% exclusive of any minimum tax or environmental tax (as compared to 35% for corporations generally). Any savings institution at least 60% of whose assets are qualifying assets, as described in the Code, was generally eligible for the full deduction of 8% of taxable income. At June 30, 1997, the federal income tax reserves of the Company included $16.9 million for which no federal income tax has been provided. Because of these federal income tax reserves the stockholders' equity of the Company is substantially restricted. Distributions. If the Association were to distribute cash or property to its sole stockholder, and the distribution was treated as being from its accumulated bad debt reserves, the distribution would cause the Association to have additional taxable income. A distribution is deemed to have been made from accumulated bad debt reserves to the extent that (a) the reserves exceed the amount that would have been accumulated on the basis of actual loss experience, and (b) the distribution is a "non-qualified distribution." A distribution with respect to stock is a non-qualified distribution to the extent that, for federal income tax purposes, (i) it is in redemption of shares, (ii) it is pursuant to a liquidation of the institution, or (iii) in the case of a current distribution, together with all other such distributions during the taxable year, it exceeds the institution's current and post-1951 accumulated earnings and profits. The amount of additional taxable income created by a non-qualified distribution is an amount that when reduced by the tax attributable to it is equal to the amount of the distribution. Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%. The alternative minimum tax generally applies to a base of regular taxable income plus certain tax preferences ("alternative minimum taxable income" or "AMTI") and is payable to the extent such AMTI is in excess of an exemption amount. The Code provides that an item of tax preference is the excess of the bad debt deduction allowable for a taxable year pursuant to the percentage of taxable income method over the amount allowable under the experience method. Other items of tax preference that constitute AMTI include (a) tax-exempt interest on newly issued (generally, issued on or after August 8, 1986) private activity bonds other than certain qualified bonds and (b) 75% of the excess (if any) of (i) adjusted current earnings as defined in the Code, over (ii) AMTI (determined without regard to this preference and prior to reduction by net operating losses). Net Operating Loss Carryovers. A financial institution may carry back net operating losses ("NOLs") to the preceding three taxable years and forward to the succeeding 15 taxable years. This provision applies to losses incurred in taxable years beginning after 1986. At June 30, 1997, the Company had no NOL carryforwards for federal income tax purposes. Capital Gains and Corporate Dividends-Received Deduction. Corporate net capital gains are taxed at a maximum rate of 35%. The corporate dividends-received deduction is 80% in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, and corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct only 70% of dividends received or accrued on their behalf. However, a corporation may deduct 100% of dividends from a member of the same affiliated group of corporations. 29 Other Matters. Federal legislation is introduced from time to time that would limit the ability of individuals to deduct interest paid on mortgage loans. Individuals are currently not permitted to deduct interest on consumer loans. Significant increases in tax rates or further restrictions on the deductibility of mortgage interest could adversely affect the Association. The Association's federal income tax returns for the tax years ended June 30, 1995 forward are open under the statute of limitations and are subject to review by the IRS. State Taxation Unless authorized under special circumstances by the North Carolina Department of Revenue, the filing of a consolidated state income tax return is not permitted. Accordingly, each of the Company and its subsidiaries, including the Association, but excluding Investment Corp., is subject to an annual corporate income tax of 7.75% of its federal taxable income as computed under the Code, subject to certain prescribed adjustments. In addition to the state corporate income tax, the Company and the Association will be subject to an annual state franchise tax, which is imposed at a rate of .15% applied to the greatest of each institution's (i) capital stock, surplus and undivided profits, (ii) investment in property in North Carolina or (iii) appraised valuation of property in North Carolina. Investment Corp. is subject to a Delaware franchise tax based on Investment Corp.'s authorized capital stock or on its assumed par and no-par capital, whichever yields a lower result. Under the authorized capital method, each share is taxed at a graduated rate based on the number of authorized shares with a maximum aggregate tax of $150,000 per year. Under the assumed par-value capital method, Delaware taxes each $1,000,000 of assumed par-capital at the rate of $200. 30 PART II. Item 2. Properties. At June 30, 1997, the Company conducted its business from its executive office in Charlotte, North Carolina, nine full service offices and one mortgage loan office. The following table sets forth the net book value (including leasehold improvements and equipment) and certain other information with respect to the offices and other properties of the Company at June 30, 1997.
Leased/ Net Book Value Description/Address Owned of Property Amount of Deposits - ---------------------------------------------- --------------- ----------------------- --------------------- (In Thousands) Main Office: 139 South Tryon Street Charlotte, North Carolina Owned $1,531 $116,961 Branch Offices: 6342 Carmel Road Charlotte, North Carolina 28226 Owned 386 24,092 4400 Randolph Road Charlotte, North Carolina 28211 Owned 249 68,140 5601 Reddman Road Charlotte, North Carolina 28212 Owned 559 71,088 I-77 and Route 73 Cornelius, North Carolina 28031 Owned 344 26,199 4323 Park Road Charlotte, North Carolina 28209 Leased(1) -- 80,500 4519 Sharon Road Charlotte, North Carolina 28211 Leased(2) 166 37,916 8601 John Maynard Keynes Drive Charlotte, North Carolina 28262 Owned 1,527 18,046 Mortgage Loan Office: 6310 Fairview Road Charlotte, North Carolina 28211(3) Owned 4,475 898
- ------------------------------------ (1) This property is subject to a lease that expires in 1999. (2) This property is subject to a lease that expires in 2002 and the Association has an option to renew the lease for one additional period of five years. (3) This property is also used as a branch office. 31 Item 3. Legal Proceedings. In June 1995, a lawsuit was initiated against the Association by a borrower's affiliated companies in which the plaintiffs alleged that the Association wrongfully set-off certain funds in an account being held and maintained by the Association. In addition, the plaintiffs alleged that as a result of the wrongful set-off, the Association wrongfully dishonored a check in the amount of $270,000. Plaintiffs further alleged that the actions on behalf of the Association constituted unfair and deceptive trade practices, thereby entitling plaintiffs to recover treble damages and attorneys' fees. The Association 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 Judgment, recommending the dismissal of all claims asserted against the Association. The Recommended Order is now before the United States District Court for the Western District of North Carolina and the parties are awaiting the Federal District Court's decision of whether to enter an Order Granting Summary Judgment in accordance with the Recommended Order by the United States Bankruptcy Judge. In December 1996, the Association filed a suit against the borrower and his company and against the borrower's wife, daughter 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 the Association in prior litigation. The borrower's wife filed a counterclaim against the Association 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 the Association for application on debt owed by one of her husband's corporations, claiming that officers of the Association promised to resume making loans to her husband's corporation after the payment. Home Federal and its officers vigorously deny all of her allegations. The case is scheduled for discovery in September 1997, after which the Association intends to file a motion for summary judgment for dismissal of the 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 the Association and against an officer of another financial institution. The action was removed from the state court and is presently pending in 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 against the two executive officers of the Association 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 the Association. 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. Plaintiffs claim actual damages, treble damages and punitive damages together with interest, attorneys' fees and other costs. The Association 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 Financial Corp., the Association, 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 4th Circuit Court of Appeals. The plaintiffs are seeking to have the judgments set aside on that basis. Home Federal has not yet filed a responsive pleading. The Association vehemently denies that any fraud was perpetrated upon the courts and intends to vigorously contest this matter. The Association and its officers continue to deny any liability in the above described cases and continue to vigorously defend against the claims. However, based on the advice of legal counsel, the Association is unable to give an opinion as to the likely outcome of the litigation or estimate the amount or range of potential loss, if any. See Note 11 of the Notes to the Consolidated Financial Statements. 32 Except as set forth above, the Association is not involved in any legal proceedings other than those occurring in the ordinary course of business. Management believes that such other legal proceedings will not have a material adverse impact on the Association's financial condition or results of operations. Item 4. Submission of Matters to a Vote of Security-Holders. Not applicable. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The information required herein, to the extent applicable, is incorporated by reference from page 45 of the Company's 1997 Annual Report ("1997 Annual Report"). Item 6. Selected Financial Data. The information required herein is incorporated by reference from page 1 of the 1997 Annual Report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information required herein is incorporated by reference from pages 2 to 15 of the 1997 Annual Report. Item 8. Financial Statements and Supplementary Data. The information required herein is incorporated by reference from pages 16 to 44 of the 1997 Annual Report. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. Not applicable. PART III. Item 10. Directors and Executive Officers of the Registrant. The information required herein is incorporated by reference from pages 3 to 7 of the definitive proxy statement of the Company for the Annual Meeting of Stockholders to be held on October 24, 1997, which was filed on October 3, 1997 ("Definitive Proxy Statement"). Item 11. Executive Compensation. The information required herein is incorporated by reference from pages 11 to 16 of the Definitive Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required herein is incorporated by reference from pages 8 to 10 of the Definitive Proxy Statement. Item 13. Certain Relationships and Related Transactions. The information required herein is incorporated by reference from page 16 of the Definitive Proxy Statement. 33 PART IV. Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) Documents Filed as Part of this Report (1) The following financial statements are incorporated by reference from Item 8 hereof (see Exhibit 13): Report of Independent Auditors. Consolidated Balance Sheets as of June 30, 1997 and 1996. Consolidated Statements of Income for the Fiscal Periods Ended June 30, 1997, 1996 and 1995. Consolidated Statements of Changes in Shareholders' Equity for the Fiscal Periods Ended June 30, 1997, 1996 and 1995. Consolidated Statements of Cash Flows for the Fiscal Periods ended June 30, 1997, 1996 and 1995. Notes to Consolidated Financial Statements. (2) All schedules for which provision is made in the applicable accounting regulation of the SEC are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements and related notes thereto. (3) The following exhibits are filed as part of this Form 10-K, and this list includes the Exhibit Index:
Exhibit Index ------------- Page ---- 2.0 Plan of Conversion * 3.1 Articles of Incorporation of HFNC Financial Corp. * 3.2 Bylaws of HFNC Financial Corp. * 4.0 Specimen Stock Certificate of HFNC Financial Corp. ** 10.1 Employment Agreement among HFNC Financial Corp., Home Federal Savings and Loan Association and H. Joe King, Jr. * 10.2 Employment Agreement among HFNC Financial Corp., Home Federal Savings and Loan Association and J. Harold Barnes, Jr. * 13.0 1997 Annual Report to Stockholders E-1 21.0 Subsidiaries of the Registrant - Reference is made to "Item 2. Business" for the required information (*) Incorporated herein by reference from the Company's Registration Statement on Form S-1 (Registration No. 33-97497) filed by the Company with the SEC on September 20, 1995, as subsequently amended. (**) Incorporated herein by reference from the Company's Annual Report on Form 10-K for the year ended June 30, 1996.
34 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HFNC FINANCIAL CORP. By: /s/H. Joe King, Jr. --------------------------------------- H. Joe King, Jr. President, Chief Executive Officer and Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
Name Title Date - ---- ----- ---- /s/H. Joe King, Jr. President, Chief Executive Officer September 29, 1997 - ------------------------------ and Chairman of the Board H. Joe King, Jr. /s/J. Harold Barnes, Jr. Executive Vice President and September 29, 1997 - ------------------------------ Director J. Harold Barnes, Jr. /s/Ray W. Bradley, Jr. - ------------------------------ Director September 29, 1997 Ray W. Bradley, Jr. /s/Joe M. Logan - ------------------------------ Director September 29, 1997 Joe M. Logan /s/John M. McCaskill - ------------------------------ Director September 29, 1997 John M. McCaskill /s/Lewis H. Parham, Jr. - ----------------------------- Director September 29, 1997 Lewis H. Parham, Jr. /s/Willie E. Royal - ----------------------------- Director September 29, 1997 Willie E. Royal /s/A. Burton Mackey, Jr. Vice President and Treasurer September 29, 1997 - ----------------------------- (principal financial officer) A. Burton Mackey, Jr.
EX-13 2 HFNC Financial Corp. - -------------------------------------------------------------------------------- 1997 ANNUAL REPORT Letter to Shareholders - -------------------------------------------------------------------------------- Dear Fellow Shareholders: We are pleased to present to you our second annual report, covering the fiscal year ended June 30, 1997. Our first full fiscal year of operation as a public company has been an eventful one. We have seen substantial progress in resolving the deposit insurance premium disparity between thrifts and banks. Though the $3.1 million up-front cost was considerable, our deposit insurance cost in the future will be greatly reduced. Also during this year, we have been able to return $5.26 per share to our shareholders through dividends, of which 95% represents a non-taxable return of capital. Our assets have increased to $893 million, an increase of 13%, even after payment of the special distribution of approximately $86 million. The asset growth occurred primarily in the loan portfolio, which has grown by more than $153 million, an increase of over 30% during this year alone. Contributing to the growth in our loan portfolio was the opening of our Fairview Office, which is a meaningful addition to our customer service delivery infrastructure. At this very desirable location, we have opened a new branch and consolidated our mortgage loan department. Fiscal 1997 Results Consolidated net income for the year amounted to $7.4 million, or $.46 per share, compared to $7.6 million for the 1996 fiscal year. The fiscal 1997 net earnings, however, were impacted by a one time cost of $3.1 million ($1.9 million or $.12 per share after tax) pertaining to a special assessment by the Federal Deposit Insurance Corporation to recapitalize the Savings Association Insurance Fund. Earnings for the 1997 fiscal year were also lessened due to the liquidation of securities to fund the $86 million special dividend paid to shareholders on March 18, 1997. After-tax earnings were reduced by approximately $1.1 million, or $.07 per share, due to this reduction in interest income. Net interest income for the year totaled $30.7 million, an increase of $6.6 million, or 27%, over the prior year. Of significance this year has been our continued improvement in asset quality. Nonperforming assets have declined 29.5% during the year, to $7.8 million at June 30, 1997 from $11.1 million at June 30, 1996. This represents a decline from 1.4% of total assets to 0.9% during the twelve month period. The June 30, 1997 allowance for loan losses stands at 109.3% of nonperforming loans, as compared to 87.5% a year ago. Outlook Looking to the year ahead we will continue to look for ways to enhance shareholder value while maintaining our commitment to provide the very best quality service to our customers. Interest rates have remained relative stable and the area real estate market continues to be very good. As a result, loan demand is expected to continue to be brisk. Through the variety of loan programs that we are now offering, combined with the outstanding location of our new loan center, we expect continued growth in loan production while maintaining our emphasis on asset quality. In the past year there were several extraordinary charges as we have reported to you. With these costs behind us, we anticipate earnings improvements in the year ahead. This has been a good year for your company and its shareholders. We were delighted to be able to pay the $5 special distribution and will continue to look for ways to increase shareholder value. We look ahead with anticipation. We solicit your business and ask that you recommend Home Federal to others. You can thus play a part in the growth and success of your company. I am grateful to our directors, officers and employees for their commitment to service. I appreciate your support and welcome your comments. Sincerely, /s/H. Joe King, Jr. H. Joe King, Jr. Chairman of the Board, President and Chief Executive Officer Corporate Profile - -------------------------------------------------------------------------------- HFNC Financial Corp. (the "Company") was incorporated in August 1995 under North Carolina law for the purpose of acquiring all of the capital stock issued by Home Federal Savings and Loan Association ("Home Federal" or the "Association") in connection with its conversion from a federally chartered mutual savings and loan association to a federally chartered stock savings and loan association (the "Conversion"). The Conversion was consummated on December 28, 1995 and, as a result, the Company became a unitary savings and loan holding company of the Association. The Company has no significant assets other than the shares of the Association's common stock acquired in the Conversion and the common stock of HFNC Investment Corp., a wholly-owned, Delaware chartered finance subsidiary of the Company. The Company has no significant liabilities. The Association is a federally chartered stock savings and loan association which believes that it is the oldest thrift presently operating in the Carolinas. The Association dates back to 1883 with the founding of Mechanics Perpetual Building and Loan Association. Home Federal conducts business from its main office and eight branch offices and a loan origination office, all located in Mecklenburg County, North Carolina. The Association is a community oriented savings institution which has traditionally offered a wide variety of savings products to its retail customers while concentrating its lending activities on the origination of loans secured by one- to four-family residential dwellings, including an emphasis on loans for construction of residential dwellings. To a significantly lesser extent, the Association's activities have also included origination of commercial real estate, land and consumer loans. In addition, the Association maintains a significant portfolio of investment securities which are issued by the United States government or agencies thereof, or government sponsored enterprises. At June 30, 1997, the Company had total assets of $892.9 million, total deposits of $443.8 million and shareholders' equity of $161.1 million. The Company's and the Association's principal executive offices are located at 139 South Tryon Street, Charlotte, North Carolina 28202, and their telephone number is (704) 373-0400. Table of Contents President's Letter to Shareholders Corporate Profile PAGE Selected Consolidated Financial Highlights 1 Management's Discussion and Analysis of Financial Condition and Results of Operations 2 Report of Independent Certified Public Accountants 17 Financial Statements 18 Home Federal Savings and Loan Association Account Services Shareholder Information HFNC Financial Corp. Directors and Officers Home Federal Savings and Loan Association Officers and Banking Locations
SELECTED CONSOLIDATED FINANCIAL HIGHLIGHTS - ------------------------------------------------------------------------------------------------------------------------------------ AS OF OR FOR THE YEAR ENDED JUNE 30, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------------------------------------------------------------------------- 1997 1996 1995 1994 1993 Selected Consolidated Financial Data: Total assets ................................... $ 892,920 $788,878 $589,659 $574,676 $588,337 Securities ..................................... 175,710 248,445 114,387 101,249 61,277 Loans receivable, net .......................... 658,323 505,131 436,008 436,642 481,896 Real estate .................................... 868 2,539 2,804 3,818 7,960 Deposits ....................................... 443,840 448,571 490,566 445,496 465,434 Other borrowings ............................... 277,000 85,000 10,000 50,000 56,000 Shareholders' equity ........................... 161,060 246,504 81,812 73,172 60,803 Book value, per share .......................... $ 9.37 $ 14.34 N/A N/A N/A Nonperforming assets ........................... 7,830 11,108 12,857 21,243 32,138 Selected Operating Data: Net interest and dividend income ............... $ 30,697 $ 24,133 $ 21,870 $ 27,462 $ 28,717 Provision for loan losses (recovery of allowance) ....................... (59) 337 486 1,352 4,791 Other operating income ......................... 1,202 1,817 1,430 2,636 1,341 Other operating expenses ....................... 19,985 12,423 12,807 12,051 11,476 Net income ..................................... $ 7,364 $ 7,574 $ 6,150 $ 12,369 $ 6,578 Earnings per share: Excluding SAIF assessment .................... 0.58 N/A N/A N/A N/A Including SAIF assessment .................... 0.46 N/A N/A N/A N/A Dividends per share ............................ 5.26 N/A N/A N/A N/A Selected Operating Ratios: Average interest rate spread * ................. 2.35% 2.34% 3.35% 4.64% 4.77% Net interest margin * .......................... 3.70 3.65 3.89 5.01 5.08 Ratio of interest-earning assets to interest-bearing liabilities ............... 1.32 1.31 1.12 1.10 1.07 Return on average assets: Excluding SAIF assessment .................... 1.08 1.11 1.05 2.15 1.11 Including SAIF assessment .................... 0.86 1.11 1.05 2.15 1.11 Return on average equity: Excluding SAIF assessment .................... 4.34 4.22 7.89 17.57 11.18 Including SAIF assessment .................... 3.46 4.22 7.89 17.57 11.18 Full-service offices at end of period .......... 9 8 8 8 8 SELECTED CONSOLIDATED FINANCIAL HIGHLIGHTS - ------------------------------------------------------------------------------------------------------------------------------------ AS OF OR FOR THE YEAR ENDED JUNE 30, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------------------------------------------------------------------------- 1997 1996 1995 1994 1993 Asset Quality Ratios: Nonperforming loans and troubled debt restructurings as a percent of net loans .................................. 1.06% 1.70% 2.48% 4.26% 5.30% Nonperforming assets and troubled debt restructurings as a percent of total assets ....................... 0.87 1.41 2.17 3.70 5.46 Allowance for loan losses as a percent of nonperforming loans and troubled debt restructurings .................. 109.33 87.47 74.73 42.07 28.10
* Average yield information has been computed using the historical cost balances of investments available for sale and does not give effect to changes in fair value that are reflected as a component of shareholders' equity. - 1 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The operating results of the Company depend primarily upon its net interest income, which is determined by the difference between interest and dividend income on interest-earning assets, which consist principally of loans, and securities and other investments, and interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Company's net income also is affected by its provision for loan losses, as well as the level of its other operating income, including loan fees and service charges, gains on sale of loans and on sale of real estate owned ("REO"), and its other operating expenses, including personnel expenses, occupancy expense, federal deposit insurance premiums, net cost of real estate operations and miscellaneous other expenses, and income taxes. The following discussion provides an overview of the financial condition and results of operations of the Company, and should be read in conjunction with the Company's consolidated financial statements presented elsewhere herein. Summary of Changes in Financial Condition The Company's assets increased by $104.0 million, or 13.2%, to $892.9 million at June 30, 1997 from $788.9 million at June 30, 1996. The increase in assets primarily reflects the leveraging of the Company's capital through growth in loans receivable. Net loan originations amounted to $152.5 million during the year, compared to $70.1 million in fiscal 1996. The growth in loans was offset somewhat by the payment of a $5 per share special distribution to shareholders on March 18, 1997. This distribution was partially funded by the sale of securities, which declined $72.7 million to $175.7 million at June 30, 1997. Total liabilities increased $189.5 million, or 34.9%, during the 1997 fiscal year due to an increase in other borrowed funds of $192.0 million. These borrowings were used to fund the loan portfolio growth and a portion of the cost of the special distribution. Shareholders' equity decreased $85.4 million to $161.1 million or 18.0% of total assets at June 30, 1997. This decrease reflects the payment of $83.1 millon in distributions to shareholders during the fiscal year (including the special distribution discussed above) and the net increase in cost of unearned Employee Stock Ownership Plan ("ESOP") shares and unvested restricted stock in the Recognition and Retention Plan amounting to approximately $14.4 million, offset somewhat by an increase in unrealized gain on securities available for sale of $4.2 million and earnings during the period of $7.4 million. Securities. At June 30, 1997, total securities amounted to $175.7 million, a decrease of $72.7 million, or 29.3%, from the prior year level. This decrease was due to the liquidation of securities to partially fund the special distribution to shareholders in March 1997. Securities at June 30, 1997 consisted of $53.2 million of mortgage-backed securities, with the remaining $122.5 million invested primarily in agency securities held principally for liquidity purposes. The corresponding amounts at June 30, 1996 were $125.7 million and $123.2 million, respectively. The Company's securities have been classified by management as "available for sale." Under this classification, management may utilize these securities for various asset/liability management purposes, and they may be sold in response to liquidity needs, changes in interest rates, and other factors. They are accounted for at fair value, with unrealized gains and losses recorded as a separate component of shareholders' equity. - 2 - Loans. Net loans receivable increased $153.2 million, or 30.3% , to $658.3 million at June 30, 1997, compared to $505.1 million at June 30, 1996. This increase primarily resulted from the use of outside loan correspondents to supplement the efforts of the Association's own loan officers. These correspondent loans were originated using the Association's normal underwriting standards, rates, and terms, and were approved by the Association's loan committee prior to origination. The subject properties were all in the Association's market area. The Association intends to continue its use of loan correspondents as long as management deems their use to be beneficial to the Association. However, the Association has no agreement or obligation to continue their use. A significant portion of the new loans are adjustable rate loans that are fixed for the first three or five years, then adjust annually for the remainder of the life of the loan. Most of these loans are convertible to a fixed rate during the first five years of the adjustable period, upon payment of a one-time fee. Adjustable rate loans amounted to $139.6 million at June 30, 1997, compared to $67.4 million at June 30, 1996, an increase of $72.2 million, or 107.1%. As a result of the growth in permanent residential mortgage loans in the fiscal 1997 year, these loans have increased as a percentage of the total loan portfolio to 79.7% at June 30, 1997, up from 75.4% at June 30, 1996. The remainder of the loan portfolio at June 30, 1997 consisted of construction loans (9.7%), commercial real estate loans (4.3%) land loans (2.8%), and consumer loans (3.5%). The comparable percentages at June 30, 1996 were construction loans (11.1%), commercial real estate loans (5.3%), land loans (4.1%), and consumer loans (4.1%). Unearned loan fee income at June 30, 1997 was $5.3 million, up from $5.1 million at June 30, 1996. These unearned fees are recognized as an adjustment to yield over the contractual lives of the related loans. Undisbursed amounts of loans in process (primarily construction loans) were $33.0 million at June 30, 1997, compared to $34.8 million at June 30, 1996. Borrowed Funds. Borrowed funds increased $192.0 million, to $277.0 million at June 30, 1997 from $85.0 million at June 30, 1996. The additional borrowings during fiscal 1997 consisted of $35.0 million in securities sold under repurchase agreements, $129.0 million in Federal Home Loan Bank advances, and a $28.0 million short-term bank loan. These borrowings were used to fund loan growth and a portion of the special distribution to shareholders. - 3 - Average Balances, Net Interest Income and Yields Earned and Rates Paid. The following table sets forth, for the periods and at the date indicated, information regarding the Company's average balance sheet. Information is based on average daily balances during the periods presented.
Year Ended June 30, At ------------------------------------------- June 30, 1997 1997 ------------ ------------------------------------------- Weighted Average Yield/ Average Yield/ Rate(1) Balance Interest Rate ------------ ------------- ----------- ------- (Dollars in Thousands) Interest-earning assets: Investment securities 5.79% $119,816 $ 7,443 6.21% Mortgage-backed securities 7.40 101,010 6,990 6.92 Loans receivable 7.97 584,418 49,101 8.40 Other interest-earning assets 5.91 25,216 1,781 7.06 ------- ------- Total interest-earning assets 7.57% 830,460 65,315 7.87% ==== ======= ==== Noninterest-earning assets 24,315 -------- Total assets $854,775 ======== Interest-bearing liabilities: Deposits 5.24% $440,899 $23,565 5.34% Other borrowed funds 5.85 186,657 11,054 5.92 -------- ------- Total interest-bearing liabilities 5.46% $627,556 $34,619 5.52% ==== ======= ==== Noninterest-bearing liabilities 14,130 -------- Total liabilities 641,686 Equity 213,089 -------- Total liabilities and equity $854,775 ======== Net interest-earning assets $202,904 ======== Net interest income/interest rate spread $30,696 2.35% ======= ==== Net interest margin (2) 3.70% ==== Ratio of average interest-earning assets to average interest-bearing liabilities 1.32 ==== Year Ended June 30, ------------------------------------------------------------------------------------- 1996 1995 ----------------------------------------- --------------------------------------- Average Average Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ---------- ---------- ---------- -------- ----------- ----------- (Dollars in Thousands) Interest-earning assets: Investment securities $119,069 $ 6,818 5.73% $114,483 $ 6,246 5.46% Mortgage-backed securities 38,912 2,730 7.02 -- -- -- Loans receivable 454,168 39,995 8.81 433,081 38,909 8.98 Other interest-earning assets 49,873 2,599 5.21 15,353 966 6.29 -------- ------- -------- ------ Total interest-earning assets 662,022 $52,142 7.88% 562,917 $46,121 8.19% ======= ==== ====== ==== Noninterest-earning assets 24,696 24,605 -------- -------- Total assets $686,718 $587,522 ======== ======== Interest-bearing liabilities: Deposits $491,065 $27,218 5.54% $452,497 $ 21,464 4.74% Other borrowed funds 14,423 790 5.48 48,101 2,787 5.79 -------- ------- -------- ------- Total interest-bearing liabilities $505,488 $28,008 5.54% 500,598 $ 24,251 4.84% ======= ==== ======= ==== Noninterest-bearing liabilities 11,786 8,933 -------- -------- Total liabilities 517,274 509,531 Equity 169,444 77,991 -------- -------- Total liabilities and equity $686,718 $587,522 ======== ======== Net interest-earning assets $156,534 $ 62,319 ======== ======== Net interest income/interest rate spread $ 24,134 2.34% $ 21,870 3.35% ======== ==== ======= ==== Net interest margin (2) 3.65% 3.89% ==== ==== Ratio of average interest-earning assets to average interest-bearing liabilities 1.31 1.12 ==== ====
(1) Includes non-accrual loans. (2) Net interest income divided by average interest-earning assets. - 4 - Rate/Volume Analysis. The following table sets forth the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected the Company's interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate) and (ii) changes in rate (change in rate multiplied by prior year volume). The net change attributable to the combined impact of volume and rate has been allocated proportionately to the change due to volume and the change due to rate.
Year Ended June 30, ----------------------------------------------------------------------------------------- 1997 vs. 1996 1996 vs. 1995 Increase Increase (Decrease) Due to (Decrease) Due to ---------------------- ------------------------ Total Total Increase Increase Rate Volume (Decrease) Rate Volume (Decrease) ---------- --------- ----------- ----------- ----------- ----------- (In Thousands) Interest-earnings assets: Investment securities $ 582 $ 43 $ 625 $ 316 $ 256 $ 572 Mortgage-backed securities (37) 4,297 4,260 -- 2,730 2,730 Loans receivable, net (1,737) 10,843 9,106 (753) 1,830 1,077 Other interest-earning assets 2,089 (2,907) (818) (129) 1,771 1,642 ----- ------- ------- -------- -------- Total interest-earning assets 897 12,276 13,173 (566) 6,587 6,021 ------- ------ ------ -------- -------- -------- Interest-bearing liabilities: Deposits (954) (2,699) (3,653) 3,823 1,931 5,754 Other borrowed funds 69 10,195 10,264 (141) (1,855) (1,996) ----- ------ ------ -------- -------- -------- Total interest-bearing liabilities (885) 7,496 6,611 3,682 76 3,758 ----- ----- ------ -------- -------- -------- Increase (decrease) in net interest income $1,782 $4,780 $6,562 $ (4,248) $ 6,511 $ 2,263 ----- ----- ----- ======== ======== ========
- 5 - Results of Operations Net Income. The Company reported net income of $7.4 million for the fiscal year ended June 30, 1997, compared to $7.6 million for the fiscal year ended June 30, 1997, a decrease of $210,000, or 2.8%. This decrease was attributable to a decrease in other operating income of $615,000, or 33.8%, and an increase in other operating expenses of $7.6 million, or 60.9%. The increase in other operating expenses included a $3.1 million one-time federal deposit insurance assessment, as discussed below. These changes were partially offset by an increase in net interest income of $6.6 million, or 27.2%, and a decrease in the provision for loan losses of $396,000. The Company reported net income of $7.6 million for the fiscal year ended June 30, 1996, compared to $6.2 million for the fiscal year ended June 30, 1995, an increase of $1.4 million or 23.2%. This increase was attributable to an increase in net interest and dividend income of $2.3 million, or 10.3%, an increase in other operating income of $386,000, or 27.0%, and a decrease in other operating expenses of $384,000, or 3.0%. Such results were partially offset by an increase in the income tax provision of $709,000, or 18.4%, and an after-tax one-time cost of $1.1 million resulting from the adoption of Statement of Financial Accounting Standard ("SFAS") No. 106 related to post-retirement benefits. The current year was impacted by a $3.1 million one-time special assessment by the Federal Deposit Insurance Corporation ("FDIC") to recapitalize the Savings Association Insurance Fund ("SAIF"). Due to this recapitalization of the SAIF, annual insurance premiums for savings and loan associations were reduced from $.23 per $100 of deposits to approximately $.064 per $100, a level more comparable to that of commercial banks. The reduced premiums took effect in January 1997 and will benefit the Company's net income in future periods. Net Interest Income. Net interest income is determined by the Company's interest rate spread (i.e., the difference between the yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. The Company's net interest income increased $6.6 million, or 27.2%, to $30.7 million for the year ended June 30, 1997, compared to $24.1 million for the prior year. This increase consisted of a $13.2 million, or 25.3%, increase in interest income, offset somewhat by a $6.6 million, or 23.6%, increase in interest expense. The Company's net interest income increased $2.3 million, or 10.3%, to $24.1 million for the year ended June 30, 1996, compared to $21.9 million for the prior year. This consisted of a $6.0 million or 13.1% increase in interest income, offset somewhat by a $3.8 million or 15.5% increase in interest expense. During the current year, the Company's net interest margin increased slightly to 3.70% from 3.65% during the prior year, and the net interest rate spread increased similarly to 2.35% from 2.34%. These minor changes were due to relatively consistent overall yields and costs on interest-earning assets and interest-bearing liabilities. The net interest margin declined, however, to 3.28% during the quarter ended June 30, 1997 due to the payment of the special distribution to shareholders in March 1997, which decreased interest-earning assets without a corresponding decline in interest-bearing liabilities. The ratio of average interest-earning assets to average interest-bearing liabilities declined to 1.2 during the quarter ended June 30, 1997, compared to 1.3 during the prior fiscal year. The net interest margin in future periods will continue to be impacted by this payment of interest-earning funds. During fiscal 1996, the Company's net interest margin declined to 3.65% from 3.89% in the fiscal year ended June 30, 1995 and the net interest rate spread decreased to 2.34% from 3.35%. These decreases were due to the continuing effects of the interest rate increases and flattening of the yield curve - 6 - experienced during late 1994 and early 1995, which increased the Association's cost of funds during that period. Fiscal 1996 net interest and dividend income increased over the prior year, however, because the decrease in spread was more than offset by an increase in the ratio of average interest earning assets to average interest-bearing liabilities to 1.3 for the year ended June 30, 1996 from 1.1 for the year ended June 30, 1995. This increase was primarily due to investment of the proceeds of the Conversion and a significant increase in loan originations during the year, which combined to increase interest earning assets to an average of $662.0 million in 1996 from $562.9 million in 1995. In addition, the Company experienced a moderation in the cost of deposits during the period, with the weighted average cost of deposits dropping to 5.42% at June 30, 1996, compared to 5.67% at June 30, 1995, though the average rate paid for the year was higher than the average rate for fiscal year 1995. Consequently, the net interest margin improved over the course of fiscal 1996, amounting to 4.23% during the quarter ended June 30, 1996, compared to 3.54% during the quarter ended June 30, 1995. Interest Income. During fiscal 1997, interest income increased $13.2 million, or 25.3%, from the prior year due primarily to continued loan growth and to a lesser extent, to a higher average balance in mortgage-backed securities. Average loans outstanding increased during the current fiscal year to $584.4 million from $454.2 million in the prior year due to continued leveraging of the Company's capital (discussed more extensively at "Summary of Changes in Financial Condition -- Loans"). The average balance of mortgage-backed securities increased to $101.0 million in the current year, compared to $38.9 million in the prior year. These securities were purchased with a portion of the proceeds of the stock conversion during the third quarter of the 1996 fiscal year and were therefore outstanding for less than two quarters of fiscal 1996. Approximately one-half of these securities were sold during the third quarter of fiscal 1997 to fund a portion of the special distribution to shareholders, while the remainder continued to be outstanding throughout fiscal 1997. Consequently, the average for the current year was significantly higher than the average for the prior year. These increases in average earning assets were complemented by an increase in the average yield on securities, and offset to some extent by a decrease in average yield on loans. The average yield on securities increased to 6.59% in the current year, compared to 5.84% in the prior year, due to increased investment in longer term, and higher yielding, securities, including mortgage-backed securities, than in the time period prior to the conversion to stock ownership in fiscal 1996. The average yield on loans declined during the current year to 8.40% from 8.81% due to two primary factors. First, the initial rate of the new adjustable rate loan products introduced during the last two years is at a moderate discount compared to the rate for fixed rate loans. These initial rates are fixed for the first three or five years before adjusting to market rates. Secondly, current interest rates for new loan originations in the overall market are lower than the average rate of the portfolio, so that new originations reduce the portfolio's average rate. During fiscal 1996, interest and dividend income increased $6.0 million or 13.1% from the prior year due to the investment of the conversion proceeds into interest-earning assets, including loans and securities. The positive impact of an increase in the average balance of interest-earning assets was somewhat offset by moderate declines in the yields on loans and other interest-earnings assets. The average balance of investment securities amounted to $119.1 million during the year ended June 30, 1996, compared to an average balance of $114.5 million during the prior year, while the average yield increased to 5.73% from 5.46%. The average balance increased due to the temporary deployment of conversion proceeds, while the average yield increased due to investment in longer term and higher yielding securities than in the 1995 year. The average balance of mortgage-backed securities increased from none during the prior year to $38.9 million during fiscal 1996 due to investment of a portion of the conversion proceeds in these securities during the latter half of the year. The average yield on these securities was 7.02%. Net loans receivable averaged $454.2 million during the year ended June 30, 1996, compared to an average of $433.1 million during the year ended June 30, 1995, while the average yield declined to 8.81% from 8.98%. The - 7 - increase in the average balance was largely due to the heavy volume of loan originations during the last quarter of fiscal 1996, during which time net loans outstanding increased $43.1 million. This growth resulted from new loan products and from the use of outside loan correspondents in generating new loans. The average yield generally declined due to the flattening of the yield curve noted above and to the new adjustable rate loan products that were originated at lower initial rates then fixed rate loans, though allowing greater interest rate sensitivity in future periods. Interest Expense. During fiscal 1997, interest expense increased $6.6 million, or 23.6%, compared to the prior year primarily due to an increase in the average balance of other borrowed funds and an increase in the average rate paid on these funds. The average balance of other borrowings increased to $186.7 million in the current year from $14.4 million in the prior year in order to fund the growth in assets and therefore leverage the Company's capital. The average rate paid on these borrowings increased to 5.92%, compared to 5.48% in fiscal 1996. This increase in the average rate of borrowings was somewhat offset by a decrease in the cost of deposits. The Association has sought to moderate its cost of deposits by not renewing high rate certificates of deposit as they have matured, or by renewing them at market rates. As a result, the cost of deposits declined to 5.34% for the fiscal year ended June 30, 1997 from 5.54% in the prior year. Interest expense for the year ended June 30, 1996 increased $3.8 million, or 15.5% compared to the prior year primarily due to an increase in interest paid on customer deposits of $5.8 million, offset somewhat by a decrease in the interest on other borrowings of $2.0 million. Interest on deposits primarily increased due to an increase in the average rate paid to 5.54% in fiscal 1996 from 4.74% in the prior year. An increase in the average balance of deposits to $491.1 million during the year ended June 30, 1996 from $452.5 million during the year ended June 30, 1995 also contributed to the increase in interest expense. The increase in the average balance was partially due to stock subscription funds that were temporarily held in deposit accounts pending the close of the stock conversion in December 1995. The increase in the average rate paid primarily resulted from the continuing effects of the higher rates paid on certain certificates of deposit opened during the third and fourth quarters of fiscal 1995. As noted above, many of these certificates have matured and have either not been renewed or have been renewed at lower rates, but a portion of these products remain on the Association's books and will continue to impact the Association's interest expense through the second quarter of the 1997 fiscal year. Interest on other borrowings decreased due to a decrease in the average balance outstanding to $14.4 million for the year ended June 30, 1996 from $48.1 million in the prior year as well as a decline in average rate paid to 5.48% in 1996 from 5.79% in 1995. Provision for Loan Losses. The Company establishes provisions for loan losses, which are charged to operations, in order to maintain the allowance for loan losses at a level which is deemed to be appropriate by the Company considering industry standards, past due loans, economic conditions in its market area, and other factors related to the collectibility of the loan portfolio. The Company recorded a $59,000 recovery of allowance during the year ended June 30, 1997 compared to a provision for loan losses of $337,000 during the year ended June 30, 1996. The recovery of allowance in the current year was due to improvements in the level and nature of the Company's non-performing loans, particularly related to one large borrower who has been involved in a legal dispute with the Company since 1991. Overall, nonperforming loans declined $1.6 million during fiscal year ended June 30, 1997, to $7.0 million from $8.6 million at the prior year end. The allowance for loan losses amounted to $7.6 million at June 30, 1997, or 109.3% of nonperforming loans at June 30, 1997, compared to $7.5 million, or 87.5% of nonperforming loans at June 30, 1996. The Company recorded a $175,000 net recovery of charged-off loans during the 1997 fiscal year, compared to a net charge-off of $929,000 in the 1996 fiscal year. The 1996 charge-offs included a charge-off of $909,000 related to one borrower. - 8 - Other Operating Income. Total other operating income amounted to $1.2 million during the fiscal year ended June 30, 1997, compared to $1.8 million in the prior year, a decrease of $615,000, or 33.8%. This decrease was due primarily to a fiscal 1996 gain of $658,000 on the sale of excess land adjacent to a branch office, with no such sale in the current year. In fiscal 1996, total other operating income increased $387,000, or 27.0% over the prior year, due primarily to a gain of $658,000 on the sale of excess land adjacent to a branch office. This was offset somewhat by a decline of $124,000 in other miscellaneous items of operating income, the most significant of which was a reduction of $262,000 in commissions from the sale of annuities and various insurance products by the Association's wholly owned subsidiary. Other Operating Expenses. Total other operating expenses during the current year increased $7.6 million, or 60.9%, as compared to the 1996 fiscal year. This increase resulted from a $4.4 million increase in personnel expenses, a $3.1 million one-time assessment to recapitalize the SAIF and an increase in other miscellaneous expenses category of $882,000. These increases were partially offset by a $449,000 decrease in federal deposit insurance premiums and a $272,000 decrease in the net cost of real estate operations. The fiscal 1997 increase in personnel expenses included the $2.2 million fair market value of 61,953 vested shares of stock granted to the Company's three executive officers in December 1996 and 61,955 vested shares granted to the Company's Board of Directors and various employees and members of management during the quarter ended March 31, 1997 pursuant to the Recognition and Retention Plan and Trust adopted by the shareholders on December 30, 1996. An additional cost of $1.0 million was accrued during the third and fourth quarters for shares awarded under the plan that will vest in fiscal 1998. Due to the vesting schedule and accrual of fiscal 1998 cost, the current fiscal year included approximately 1.5 years of cost related to the plan. Costs related to the ESOP represent the other significant component of the increase in personnel expenses. Generally accepted accounting principles require recognition of compensation expense for shares released from the ESOP at the fair value of the shares at the time they are committed to be released rather than at the cost of the shares to the ESOP. Because the ESOP was in existence for the full fiscal year in 1997 and only two quarters of the 1996 fiscal year and due to the significant increase in stock price during the 1997 fiscal year, the accounting cost recognized for the ESOP increased markedly, to $1.5 million in the 1997 fiscal year compared to a fiscal 1996 cost of $425,000. The increase in fiscal 1997 other miscellaneous expenses is attributable to two primary factors. The Company experienced a $460,000 increase in legal and professional fees to determine the nature, tax treatment, and other implications of the special distribution to shareholders paid in March 1997 and for legal costs associated with the ongoing lawsuit by a former borrower. The Company also experienced $237,000 in new corporate costs during the current year such as a new franchise tax, annual and special meeting costs, quarterly and annual reports, shareholder mailings, and stock market listing fees. The $449,000 decrease in the federal deposit insurance premiums was due to a reduction in the annual rate paid by the Association for FDIC insurance premiums beginning in January 1997, resulting from the special assessment in the first fiscal quarter. The net cost of real estate operations declined primarily due to a $149,000 net gain on the sale of foreclosed real estate in the current year compared to a $179,000 net loss in the prior year, a difference of $328,000 from fiscal 1996 to fiscal 1997. Total other operating expenses during fiscal 1996 declined $384,000, or 3.0%, resulting from a decline in the net cost of real estate operations of $916,000 and a decline in personnel expenses of $255,000, which were partially offset by an increase in the "other" category of $571,000 and several less significant increases in other components of non-interest expenses. The primary component of the - 9 - cost of real estate operations is the provision for losses on foreclosed properties, which declined from $1.2 million in the prior year to $140,000 in the current year. This decline resulted from the resolution of several significant groups of foreclosed properties during the 1995 fiscal year and a lower level of additional foreclosures in the 1996 year. The decline in personnel expenses was due to several changes. A retirement plan for the Board of Directors and several officers was implemented in the year ended June 30, 1995, resulting in the recognition of an initial implementation cost of $751,000, compared to a periodic cost in fiscal 1996 of only $25,000. This decline in cost was substantially offset by increases in the periodic cost of post-retirement benefits following the implementation of SFAS No. 106 with a year-to-date cost of $251,000 (see "Change in Accounting Principle" below) and to costs associated with the employee stock ownership plan adopted in connection with the Conversion. Such costs amounted to $425,000 in fiscal 1996. Other miscellaneous operating expenses increased due to the accumulated effect of several cost factors. Provision for Income Taxes. The Company recorded a provision for income taxes of $4.6 million, $4.6 million, $3.9 million for the fiscal years ended June 30, 1997, 1996 and 1995, respectively. The effective tax rates for these years were 38.5%, 34.6% and 38.5%, respectively. Change in Accounting Principle. The Company adopted SFAS No. 106, "Employers' Accounting for Post-retirement Benefits Other Than Pensions" during the 1996 fiscal year. As a result, the Company recognized a $1.7 million accumulated post-retirement benefit obligation effective July 1, 1995. On an after-tax basis, this charge amounted to approximately $1.1 million and is reported as a change in accounting principle for the year ended June 30, 1996. Ongoing periodic costs of such benefits are included in operating expenses subsequent to adoption. Asset and Liability Management The Company's principal business is the making of loans, funded by customer deposits and, to the extent necessary, other borrowed funds. Consequently, a significant portion of the Company's assets and liabilities are monetary in nature and fluctuations in interest rates will affect the Company's future net interest income and cash flows. This interest rate risk is the Company's primary market risk exposure. The Company manages this risk principally through the use of simulation modeling under various rate scenarios. Using this model, the Company computes, among other things, the change in projected net interest income over a rolling 12 month period, taking into consideration asset and liability maturity dates and repricing opportunities, as well as assumptions utilized by the FHLB of Atlanta regarding core deposit decay rates, loan prepayment rates, etc. The analyses comprehend all interest rate sensitive assets and liabilities such as securities, loans, deposits and other borrowed funds. The Company holds none of these assets in a trading portfolio; all are held to maturity or available for sale. Certain shortcomings, however, are inherent in any modeling technique. The model utilized by the Company assumes an instantaneous and sustained change in rates, various assumptions about customer behavior in varied market environments, and assumes no subsequent actions by management to respond to changes in rates. At June 30, 1997, the Company's simulation model indicated that a 200 basis point increase in interest rates would reduce the Company's projected net interest income over the next twelve months by $4.4 million, or 18.9%. A 200 basis point change in rates was used because management considers this to be a reasonably possible near-term change in rates. The Company also measures interest rate sensitivity as the difference between amounts of interest-earning assets and interest-bearing liabilities which either reprice or mature - 10 - within a given period of time. The difference, or the interest rate repricing "gap," provides an indication of the extent to which an institution's interest rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities, and is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets. Generally, during a period of rising interest rates, a negative gap within shorter maturities would adversely affect net interest income, while a positive gap within shorter maturities would result in an increase in net interest income, and during a period of falling interest rates, a negative gap within shorter maturities would result in an increase in net interest income while a positive gap within shorter maturities would have the opposite effect. As of June 30, 1997, the amount of the Company's interest-bearing liabilities which were estimated to mature or reprice within one year exceeded the Company's interest-earning assets with the same characteristics by $391.1 million or 43.7% of the Company's total assets. The Company's actions with respect to interest rate risk and its asset/liability gap management are taken under the guidance of the Asset/Liability Management Committee, which is comprised of certain members of senior management. This committee meets quarterly to review the Company's current composition of assets and liabilities in light of the prevailing interest rate environment and to devise a quarterly interest rate risk strategy which is reviewed by the Board of Directors. The Company has historically emphasized the origination of fixed-rate residential real estate loans and other fixed-rate loans for retention in its portfolio. As a result, at June 30, 1997, $564.7 million or 80.2% of the Company's total loan portfolio consisted of fixed-rate loans. Although the Company anticipates that a majority of its loan portfolio will continue to consist of fixed-rate loans, the Company has recently attempted to mitigate the interest rate risk of holding a significant portion of fixed-rate loans in its portfolio through the origination of ARMs, commercial real estate loans with call provisions after three or five years and short-term consumer loans. Historically, however, consumers tend to favor fixed-rate loans in a decreasing interest rate environment and, as a result, the origination of adjustable-rate loans will typically be negatively impacted in such an interest rate environment. In addition, while consumer loans generally have shorter terms and higher interest rates than mortgage loans, such loans generally involve more credit risk than mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. At June 30, 1997, $175.7 million or 19.7% of the Company's total assets consisted of investment securities. The classification of such securities as available for sale and the relatively short-term nature of such portfolio permits reinvestment of such funds into securities or other assets at then market rates. Notwithstanding the foregoing, the Company's present negative gap will continue to expose the Company to material and prolonged increases in interest rates and will adversely affect net interest income in an increasing interest rate environment. During periods of rising interest rates, the Company has historically relied and will continue to rely on its strong capital base. - 11 - The following table summarizes the anticipated maturities or repricing of the Company's interest-earning assets and interest-bearing liabilities as of June 30, 1997, based on the information and assumptions set forth in the notes to the table.
More Than More Than Three Years Within Six Six to Twelve One Year to to Five Over Five Months Months Three Years Years Years Total ------------ ------------ ------------- ------------ ------------ -------- (Dollars in Thousands) Interest-earning assets: Investment and $17,918 $8,411 $66,391 $20,012 $62,438 $175,710 mortgage-backed securities(1) Loans receivable, net(2) 64,342 95,864 160,380 141,958 195,779 658,323 Other interest-earning assets 31,370 -- -- -- -- 31,370 ---------- ------------ ------------ ---------- ----------- ------- Total interest-earning assets 113,630 104,275 227,311 161,970 258,217 865,403 ---------- ---------- ------- ------- ------- ------- Interest-bearing liabilities: Deposits(3) 131,879 200,152 86,346 13,621 11,842 443,840 Other borrowings 173,000 104,000 -- -- -- 277,000 ---------- ---------- ---------- -------- --------- ------- Total interest-bearing liabilities 304,879 304,152 86,346 13,621 11,842 720,840 ---------- --------- --------- --------- --------- ------- Excess (deficiency) of interest-earning assets over interest-bearing liabilities $(191,249) $(199,877) $ 140,965 $ 148,349 $ 246,375 ======== ======== ======== ======== ======== Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities $(191,249) $(391,126) $(250,161) $(101,812) $144,563 ======== ======== ======== ======== ======= Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities as a percentage of total assets (21.4)% (43.8)% (28.0)% (11.4)% 16.2% ==== ==== ==== ==== ====
- --------------------------- (1) Reflects repricing or contractual maturity. (2) Fixed rate loans are included in the periods in which they are scheduled to be repaid, based on scheduled amortization, adjusted to take into account estimated prepayments. Adjustable-rate loans are included in the periods in which interest rates are next scheduled to adjust rather than in the period in which they are due. Non-accruing loans are assumed to reprice within six months. (3) Although the Company's negotiable order of withdrawal ("NOW") accounts, money market deposit ("MMDA") accounts, and passbook savings accounts are subject to immediate withdrawal, management considers a substantial amount of such accounts to be core deposits having significantly longer effective maturities based on the Company's retention of such deposits in changing interest rate environments. Based on decay rate assumptions utilized by the FHLB of Atlanta, the above table assumes that funds will be withdrawn from deposit accounts as follows: NOW and noninterest-bearing checking accounts -- 37% during periods within the first 12 months, 33.87% during the more than one year- to three-year period, 9.06% during the more than three- years to five-year period, and 20.07% thereafter; MMDA accounts -- 79% during periods within the first twelve months, 11% during the more than one-year to three-year period, 5.24% during the more than three-year to five-year period, and 4.76% thereafter; and passbook accounts -- 17% during periods within the first twelve months, 25.82% during the more than one-year to three-year period, 16.83% during the more than three-year to five-year period and 40.35% thereafter. - 12 - The preceding table was summarized from data provided by the FHLB of Atlanta using certain assumptions based on data for the second calendar quarter of 1997. Certain shortcomings are inherent in the method of analysis presented in the above table. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The OTS adopted a final rule in August 1993 incorporating an interest rate risk component into the risk-based capital rules. Under the rule, an institution with a greater than "normal" level of interest rate risk will be subject to a deduction of its interest rate component from total capital for purposes of calculating the risk-based capital requirement. An institution with a greater than "normal" interest rate risk is defined as an institution that would suffer a loss of net portfolio value ("NPV") exceeding 2.0% of the estimated market value of its assets in the event of a 200 basis point increase or decrease in interest rates. NPV is the difference between incoming and outgoing discounted cash flows from assets, liabilities, and off-balance sheet contracts. A resulting change in NPV of more than 2% of the estimated market value of an institution's assets will require the institution to deduct from its capital 50% of that excess change for regulatory capital purposes. The rule provides that the OTS will calculate the interest rate risk component quarterly for each institution. The OTS has recently indicted that no institution will be required to deduct capital for interest rate risk until further notice. However, utilizing this measurement concept, at June 30, 1997, there would be a decrease in the Company's NPV of approximately 6.8% of the estimated market value of the Company's assets, assuming a 200 basis point increase in interest rates. Accordingly, if the regulation had been implemented as of June 30, 1997, the Company would have been required to deduct 50% of the excess amount (2.4% or $21.7 million) from its risk-based capital. Liquidity and Capital Resources The Company's primary sources of funds are deposits, repayments, prepayments and maturities of outstanding loans, maturities of investment securities and other short-term investments, and funds provided from operations. While scheduled loan repayments and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the movement of interest rates in general, economic conditions and competition. The Company manages the pricing of its deposits to maintain a deposit balance deemed appropriate and desirable. In addition, the Company's available for sale securities and short-term interest-earning assets provide liquidity to meet lending and other operational requirements. Although the Company's deposits have historically represented the majority of its total liabilities, the Company also utilizes other borrowing sources, primarily FHLB advances and securities sold under repurchase agreements. At June 30, 1997, the Company had $120.0 million of securities sold under repurchase agreements, FHLB advances totalling $129.0 million and a $28.0 million short-term bank loan. Liquidity management is both a daily and long-term function. Excess liquidity is generally invested in short-term investments such as cash and cash equivalents, and U.S. Government agency securities. On a longer-term basis, the Company invests in various lending products and investment securities. The Company uses its sources of funds primarily to meet its ongoing commitments to pay maturing savings certificates and savings withdrawals, fund loan commitments and maintain an investment securities portfolio. At June 30, 1997, the total approved loan commitments outstanding (excluding undisbursed portions of loans in process) amounted to $15.7 million. At the same date, the unadvanced portion of loans in process approximated $33.0 million. Certificates of deposit scheduled to mature in one - 13 - year or less at June 30, 1997, totalled $291.7 million. Management of the Company believes that the Company has adequate resources, including principal prepayments and repayments of loans and maturing investments, to fund all of its commitments to the extent required. Based upon its historical run-off experience, management believes that a significant portion of maturing deposits will remain with the Company. See Note 6 of the Notes to the Consolidated Financial Statements of the 1997 Annual Report. The Association is required by the OTS to maintain average daily balances of liquid assets and short-term liquid assets (as defined) in amounts equal to 5% and 1%, respectively, of net withdrawable deposits and borrowings payable in one year or less to assure its ability to meet demand for withdrawals and repayment of short-term borrowings. The liquidity requirements may vary from time to time at the direction of the OTS depending upon economic conditions and deposit flows. The Association's average monthly liquidity ratio and short-term liquid assets for June 1996, was 10.8% and 2.5%, respectively. As of June 30, 1997, the Company had regulatory capital which was in excess of applicable limits. At June 30, 1997, the Association's tangible, core and risk-based capital ratios amounted to 18.9%, 18.9% and 36.5%, respectively, compared to regulatory requirements of 1.5%, 3.0% and 8.0%, respectively. See also Note 12 to the Notes to the Consolidated Financial Statement to the 1997 Annual Report. Recent Accounting Pronouncements In May 1993, the Financial Accounting Standards Board ("FASB") issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," affecting the accounting for investments in debt and equity securities, which are to be classified into one of three categories. Securities which management has positive intent and ability to hold until maturity are to be classified as held to maturity and reported at amortized cost. Securities that are bought and held principally for the purpose of selling them in the near term are to be classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. All other securities are to be classified as available for sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of equity until realized. The Company adopted SFAS No. 115 as of July 1, 1994. The Company had previously classified its debt and equity securities in its Consolidated Statements of Financial Condition as held for investment. However, on December 31, 1995, management of the Company reevaluated its intent with respect to its investment portfolio, and, accordingly, reclassified all investments and mortgage-backed securities to the available for sale classification. As of June 30, 1997, the Company had designated $122.5 million of investment securities and $53.2 million of mortgage-backed securities as "available for sale." The Company classifies its investment and mortgage-backed securities at the time of purchase of such assets. As a result of its adoption of SFAS No. 115, the Company included in stockholders' equity at June 30, 1997 an unrealized gain net of taxes of $4.0 million on securities available for sale. See also Note 1 of the Notes to the Consolidated Financial Statements. In November 1993, the AICPA issued SOP 93-6, Employers' Accounting for Employee Stock Ownership Plans, which applied to the Company for its fiscal year beginning July 1, 1995. SOP 93-6 requires the measurement of compensation expense recorded by employers for leveraged ESOPs at the fair value of ESOP shares. Under SOP 93-6, the Company recognizes compensation cost equal to the fair value of the ESOP shares during the periods in which they become committed to be released. To the extent that fair value of the Company's ESOP shares differ from the cost of such shares, this differential will be charged or credited to equity. Employers with internally leveraged ESOPs such as the Company will not report the loan receivable from the ESOP as an asset and will not report the ESOP debt from the - 14 - employer as a liability. The application of SOP 93-6 has not had a material impact on the Company's financial condition. Impact of Inflation and Changing Prices The Consolidated Financial Statements of the Company and related notes presented herein have been prepared in accordance with generally accepted accounting principles ("GAAP") which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates. In the current interest rate environment, management of liquidity and the maturity structure of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels. - 15 - [PAGE 16 INTENTIONALLY LEFT BLANK] INDEPENDENT AUDITORS' REPORT The Board of Directors HFNC Financial Corp. Charlotte, North Carolina We have audited the consolidated statements of financial position of HFNC Financial Corp. and its subsidiaries (the "Company") as of June 30, 1997 and 1996, and the related consolidated statements of income, equity, and cash flows for each of the three years in the period ended June 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at June 30, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 1997 in conformity with generally accepted accounting principles. As discussed in Note 11 to the consolidated financial statements, the Company is a defendant in certain litigation in which the ultimate outcome cannot presently be determined. Accordingly, no provision for any loss that may result upon resolution of these matters has been made in the accompanying financial statements. As discussed in Note 1 to the consolidated financial statements, effective July 1, 1995, the Company changed its method of accounting for postretirement benefits to conform with the provisions of Statement of Financial Accounting Standards No. 106 and effective July 1, 1994, the Company changed its method of accounting for investments in debt and equity securities to conform with the provisions of Statement of Financial Accounting Standards No. 115. August 12, 1997 -17-
HFNC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION JUNE 30, 1997 AND 1996 - ------------------------------------------------------------------------------------------------------------------------------------ 1997 1996 CASH AND CASH EQUIVALENTS: Cash $ 9,934,359 $ 6,769,598 Federal funds sold 21,436,000 2,836,000 ------------- ------------- Total cash and cash equivalents 31,370,359 9,605,598 ------------- ------------- SECURITIES - Available for sale, at fair value (amortized cost: $169,285,103 and $248,922,746, at June 30, 1997 and 1996, respectively) 175,710,104 248,445,333 LOANS RECEIVABLE, NET (allowance for loan losses: $7,611,675 and $7,495,515, at June 30, 1997 and 1996, respectively) 658,323,320 505,130,813 REAL ESTATE, NET 867,876 2,539,014 OFFICE PROPERTIES AND EQUIPMENT, NET 10,099,107 5,846,103 STOCK OF FEDERAL HOME LOAN BANK OF ATLANTA - At cost 6,450,000 5,062,100 NET DEFERRED INCOME TAX ASSET 3,390,125 5,805,502 OTHER ASSETS 6,709,218 6,443,605 ------------- ------------- TOTAL $ 892,920,109 $ 788,878,068 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY DEPOSITS $ 443,839,542 $ 448,570,916 OTHER BORROWED FUNDS 277,000,000 85,000,000 OTHER LIABILITIES 11,020,650 8,802,696 ------------- ------------- Total liabilities 731,860,192 542,373,612 ------------- ------------- SHAREHOLDERS' EQUITY: Common stock, par value $0.01 per share: 25,000,000 shares authorized; 17,192,500 shares issued and outstanding 171,925 171,925 Additional paid-in capital 89,967,883 168,390,571 ESOP loan and unvested restricted stock (23,137,490) (8,700,000) Retained income 90,106,224 86,896,095 Unrealized gain (loss) on securities available for sale (net of deferred taxes: $2,473,626 and $223,278 at June 30, 1997 and 1996, respectively) 3,951,375 (254,135) ------------- ------------- Total shareholders' equity 161,059,917 246,504,456 ------------- ------------- TOTAL $ 892,920,109 $ 788,878,068 ============= =============
See notes to consolidated financial statements. - 18 -
HFNC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED JUNE 30, 1997, 1996 AND 1995 - ------------------------------------------------------------------------------------------------------------------------------------ 1997 1996 1995 INTEREST INCOME: Interest on loans $ 49,101,206 $ 39,995,122 $ 38,918,640 Interest on securities 16,214,450 12,146,926 7,202,264 ------------ ------------ ------------ Total 65,315,656 52,142,048 46,120,904 ------------ ------------ ------------ INTEREST EXPENSE: Interest on customer deposits 23,564,888 27,218,333 21,464,269 Interest on other borrowed funds 11,053,822 790,224 2,786,523 ------------ ------------ ------------ Total 34,618,710 28,008,557 24,250,792 ------------ ------------ ------------ NET INTEREST INCOME 30,696,946 24,133,491 21,870,112 PROVISION FOR LOAN LOSSES (RECOVERY OF ALLOWANCE) (59,286) 336,957 486,101 ------------ ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES (RECOVERY OF ALLOWANCE) 30,756,232 23,796,534 21,384,011 ------------ ------------ ------------ OTHER OPERATING INCOME: Service charges and fees 715,265 735,362 689,840 Gain on sale of office properties and equipment -- 657,616 192,436 Gain on sale of securities 19,379 -- -- Other income 467,209 423,619 547,737 ------------ ------------ ------------ Total 1,201,853 1,816,597 1,430,013 ------------ ------------ ------------ OTHER OPERATING EXPENSES: Personnel expenses 10,429,710 6,046,919 6,302,236 Federal deposit insurance premiums 664,860 1,113,602 1,027,961 Special SAIF recapitalization assessment 3,077,275 -- -- Occupancy 1,817,445 1,937,129 1,752,760 Net cost of real estate operations 70,249 341,800 1,257,792 Advertising 841,896 797,040 869,141 Data processing 420,862 406,429 387,380 Other expenses 2,662,324 1,780,266 1,209,561 ------------ ------------ ------------ Total 19,984,621 12,423,185 12,806,831 ------------ ------------ ------------ HFNC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED JUNE 30, 1997, 1996 AND 1995 - ------------------------------------------------------------------------------------------------------------------------------------ 1997 1996 1995 INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE 11,973,464 13,189,946 10,007,193 PROVISION FOR INCOME TAXES 4,609,783 4,565,844 3,857,182 ------------ ------------ ------------ INCOME BEFORE CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE 7,363,681 8,624,102 6,150,011 CUMULATIVE EFFECT ON PRIOR YEARS OF A CHANGE IN ACCOUNTING PRINCIPLE -- (1,050,000) -- ------------ ------------ ------------ NET INCOME $ 7,363,681 $ 7,574,102 $ 6,150,011 ============ ============ ============ NET INCOME PER SHARE OF COMMON STOCK $ 0.46 N/A N/A ============ AVERAGE NUMBER OF SHARES OUTSTANDING 15,995,345 N/A N/A ==========
See notes to consolidated financial statements. - 19 -
HFNC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY YEARS ENDED JUNE 30, 1997, 1996 AND 1995 - ------------------------------------------------------------------------------------------------------------------------------------ Unearned Net Unrealized ESOP and Gain (Loss) on Additional Unvested Securities Common Paid-In Retained Restricted Available for Stock Capital Income Shares Sale (1) Total ----- ------- ------ ------ -------- ----- BALANCE, JUNE 30, 1994 $73,171,982 $73,171,982 Net income 6,150,011 6,150,011 Net unrealized gain on securities available for sale upon adoption of SFAS No. 115 -- 2,207,105 2,207,105 Change in net unrealized gain on securities available for sale -- 283,013 283,013 ----------- ---------- ------------ BALANCE, JUNE 30, 1995 79,321,993 2,490,118 81,812,111 Net income 7,574,102 -- 7,574,102 Net proceeds of common stock issued $171,925 $168,266,013 -- (9,000,000) -- 159,437,938 Shares released from ESOP -- 124,558 -- 300,000 -- 424,558 Net unrealized gain on securities transferred to available for sale portfolio -- -- -- -- 248,231 248,231 Change in net unrealized gain on securities available for sale -- -- -- -- (2,992,484) (2,992,484) -------- ----------- ----------- ------------ ---------- ------------ BALANCE, JUNE 30, 1996 171,925 168,390,571 86,896,095 (8,700,000) (254,135) 246,504,456 -------- ----------- ----------- ------------ ---------- ------------ Net income -- -- 7,363,681 -- -- 7,363,681 Shares released from ESOP and restricted stock trusts -- 494,810 -- 3,269,211 -- 3,764,021 Dividends paid -- (78,917,498) (4,153,552) -- -- (83,071,050) Purchase of ESOP and restricted stock -- -- -- (17,706,701) -- (17,706,701) Change in net unrealized loss on securities available for sale -- -- -- -- 4,205,510 4,205,510 -------- ----------- ----------- ------------ ---------- ------------ BALANCE, JUNE 30, 1997 $171,925 $89,967,883 $90,106,224 $(23,137,490) $3,951,375 $161,059,917 ======== =========== =========== ============ ========== ============
(1) Net of deferred income taxes. See notes to consolidated financial statements. - 20 -
HFNC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 1997, 1996 AND 1995 - ------------------------------------------------------------------------------------------------------------------------------------ 1997 1996 1995 OPERATING ACTIVITIES: Net income $ 7,363,681 $ 7,574,102 $ 6,150,011 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of a change in accounting principle -- 1,050,000 -- Depreciation and amortization 901,982 533,049 511,339 Amortization of net deferred loan fees (1,788,109) (2,038,329) (1,718,914) Provision for losses on loans (recovery of allowance) (59,286) 336,957 486,101 Provision for losses on real estate 92,379 139,812 1,236,027 Deferred income tax (benefit) provision (281,527) 329,276 (427,055) Amortization of unearned stock compensation 3,764,021 424,558 -- (Gain) loss on sales of: Fixed assets -- (657,616) (192,436) Real estate owned (149,136) 179,258 (29,497) Investments (19,379) (15,157) -- Increase in other assets (265,613) (1,474,967) (2,124,908) Increase in other liabilities 2,217,954 472,522 2,932,697 ------------- ------------- ------------- Net cash provided by operating activities 11,776,967 6,853,465 6,823,365 ------------- ------------- ------------- INVESTING ACTIVITIES: Proceeds from maturities of investment securities 8,394,737 42,469,426 6,000,000 Proceeds from sales of securities available for sale 67,279,572 7,515,157 -- Purchases of securities available for sale (6,950,000) (193,170,501) (14,987,327) Purchases of Federal Home Loan Bank stock (1,387,900) -- -- Principal repayment on mortgage-backed securities 10,584,525 4,449,592 -- Proceeds from sales of real estate held for development -- 700,000 412,565 Proceeds from sales of real estate owned 2,841,885 1,911,353 3,475,871 Net loan originations (152,459,102) (70,086,708) (2,213,974) Proceeds from disposals of office properties and equipment -- 1,497,098 361,804 Purchases of office properties and equipment (4,806,798) (98,415) (157,473) ------------- ------------- ------------- Net cash used in investing activities (76,503,081) (204,812,998) (7,108,534) ------------- ------------- ------------- - 21 - HFNC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 1997, 1996 AND 1995 - ------------------------------------------------------------------------------------------------------------------------------------ 1997 1996 1995 FINANCING ACTIVITIES: (Decrease) increase in deposits (4,731,374) (41,995,531) 45,070,553 Proceeds from other borrowed funds 192,000,000 85,000,000 60,000,000 Purchases of restricted stock for benefit plan (17,706,701) -- -- Repayments of Federal Home Loan Bank advances -- (10,000,000) (100,000,000) Net proceeds from the sale of stock -- 159,437,938 -- Dividends paid (83,071,050) -- -- ------------- ------------- ------------- Net cash provided by financing activities 86,490,875 192,442,407 5,070,553 ------------- ------------- ------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS- 21,764,761 (5,517,126) 4,785,384 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 9,605,598 15,122,724 10,337,340 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 31,370,359 $ 9,605,598 $ 15,122,724 ============= ============= ============= SUPPLEMENTAL DISCLOSURES: Cash paid during the year for: Interest $ 49,205,450 $ 28,048,607 $ 23,343,529 Income taxes 4,696,284 2,482,214 3,985,685 Non-cash investing activities: Transfers from loans to real estate acquired in settlement of loans 1,113,990 2,127,081 4,080,832 Unrealized net gain (loss) on securities available for sale, net of deferred income taxes 4,205,510 2,744,253 (2,490,118) Investment securities transferred from held to maturity to available for sale, at fair value (amortized cost $0, $108,288,966 and $2,745,308, respectively) -- 108,537,197 4,952,413
See notes to consolidated financial statements. - 22 - HFNC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 1997 AND 1996 - -------------------------------------------------------------------------------- 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Principles of Consolidation - HFNC Financial Corp. (the "Corporation") was incorporated under North Carolina law in August 1995 by Home Federal Savings and Loan Association (the "Association") in connection with the conversion of the Association from a federally chartered mutual savings and loan association to a federally chartered stock savings and loan association, the issuance of the Association's stock to the Corporation and the offer and sale of the Corporation's common stock by the Corporation (the "Conversion"). The Conversion, completed on December 28, 1995, resulted in the issuance and sale of 17,192,500 shares of $0.01 par value common stock. The accompanying consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, HFNC Investment Corp. and Home Federal Savings and Loan Association (collectively referred to herein as the "Company"). The Company's consolidated financial statements also include the accounts of the Association's wholly owned subsidiary, Home Federal Savings Service Corporation ("HFSS"). HFSS participates in real estate joint ventures for the development and sale of residential lots, and the sale of annuities and various insurance products. All significant intercompany balances and transfers have been eliminated in consolidation. The following is a description of the more significant accounting policies which the Company follows in preparing and presenting its consolidated statements. Accounting Principles - The accounting and reporting policies of the Company conform to generally accepted accounting principles and to the general practices within the savings and loan industry. Financial Statement Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents - Cash and cash equivalents include cash on hand and on deposit and federal funds sold with a maturity date of three months or less. Investment Securities - The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities, effective July 1, 1994. SFAS No. 115 requires investments to be classified in three categories. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as "held to maturity securities" and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as "trading securities" and reported at fair value, with unrealized gains and losses included in earnings. Debt securities not classified as either held to maturity securities or trading securities and equity securities not classified as trading securities are to be classified as "available for sale securities" and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity. As of June 30, 1997, all investments are classified as available for sale. - 23 - In November 1995, the FASB issued a Special Report, A Guide to Implementation of Statement 115 on Accounting for Certain Debt and Equity Securities, which included a transition provision allowing all entities to reassess the appropriateness of the classifications of all securities held and account for any resulting reclassifications at fair value. Reclassifications from the held to maturity category resulting from this one-time reassessment will not call into question, or "taint," the intent of the entity to hold other debt securities to maturity in the future. In accordance with this Special Report, the Association transferred securities with a fair value and amortized cost of approximately $108 million from held to maturity to available for sale. This transfer is disclosed as a noncash transaction in the statements of cash flows. Realized gains and losses on investment securities are recognized at the time of sale based upon the specific identification method. Premiums and discounts are amortized to expense and accreted to income over the lives of the securities. Loans - Loans held for investment are recorded at cost. Mortgage loans held for sale are valued at the aggregate lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. No loans have been classified as held for sale. Nonaccrual loans are those loans on which the accrual of interest has ceased. Loans are placed on nonaccrual status if, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the loan agreement, or when principal or interest is past due 90 days or more. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed against interest income in the current period. Interest income on nonaccrual loans is recognized only to the extent received in cash. However, where there is doubt regarding the ultimate collectibility of the loan principal, cash receipts, whether designated as principal or interest, are thereafter applied to reduce the carrying value of the loan. Loans are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured. Restructured loans are those for which concessions, such as the reduction of interest rates or deferral of interest or principal payments, have been granted due to a deterioration in the borrower's financial condition. Interest on restructured loans is accrued at the restructured rates. The difference between interest that would have recognized under the original terms of nonaccrual and restructured loans and interest actually recognized on such loans was not a material amount for the years ended June 30, 1997, 1996 and 1995. Effective July 1, 1995, the Company adopted SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. SFAS No. 114 requires that the carrying value of an impaired loan be based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral, if the loan is collateral-dependent. Under SFAS No. 114, a loan is considered impaired when, based on current information, it is probable that the borrower will be unable to pay contractual interest or principal payments as scheduled in the loan agreement. SFAS No. 114 applies to all loans except smaller-balance homogenous mortgage and consumer loans, loans carried at fair value or the lower of cost or fair value, debt securities, and leases. Generally, the Company applies SFAS No. 114 to nonaccrual commercial loans and restructured loans. - 24 - SFAS No. 118 permits a creditor to use existing methods for recognizing interest revenue on impaired loans. The Company recognizes interest income on impaired loans pursuant to the discussion above for nonaccrual and renegotiated loans. Allowance for Loan Losses - The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance, and all recoveries are credited to the allowance. Additions to the allowance for loan losses are provided by charges to operations based on various factors which, in management's judgment, deserve current recognition in estimating losses. Because of the uncertainty inherent in the estimation process, management's estimate of the allowance for loan losses may change in the near term. However, the amount of the change that is reasonably possible cannot be estimated. Real Estate Acquired in Settlement of Loans - Real estate acquired in settlement of loans is initially recorded at fair value at the date of acquisition, establishing a new cost basis. After acquisition, valuations are performed periodically by management and the real estate is carried at the lower of cost or fair value minus estimated costs of disposal. Revenues, expenses and additions to the valuation allowance related to real estate acquired in settlement of loans are included in net cost of real estate operations. Real Estate Held for Development or Resale - Real estate held for development or resale is carried at the lower of cost or estimated net realizable value. Costs related to the development or improvement of property are capitalized to the extent such costs are estimated to be recoverable, whereas those costs related to holding the property are expensed. Office Properties and Equipment - Office properties and equipment are carried at cost, net of accumulated depreciation and amortization. Depreciation is computed primarily on the straight-line method over estimated useful lives of up to fifty years for buildings, ten years for building improvements, four to ten years for furniture, fixtures and equipment and four years for automobiles. Leasehold improvements are amortized on the straight-line method over the term of the lease. Interest Income and Fees - Interest income on loans is accrued on a monthly basis. Servicing fees are credited to income as earned. Loan Origination Fees - The Company defers loan origination fees, as well as certain direct loan origination costs and amortizes such costs and fees to interest income as an adjustment to yield over the contractual lives of the related loans utilizing a method of amortization that approximates the level yield method. Postretirement Benefits - Effective July 1, 1995, the Company adopted SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. SFAS No. 106 requires the Company to accrue the estimated cost of retiree benefit payments during the years the employee provides services. The Company previously expensed the cost of these benefits, which are principally health care, as premiums were paid. SFAS No. 106 allows recognition of the cumulative effect of the liability in the year of adoption or the amortization of the obligation over a period of up to twenty years. The Company has elected to recognize the cumulative effect of this obligation upon adoption. The cumulative effect of adopting SFAS No. 106 as of July 1, 1995 was an increase in accrued postretirement health care costs of $1,700,000 and a decrease in net income of $1,050,000 (net of deferred income taxes of $650,000) for the year ended June 30, 1996. Advertising Costs - The Company expenses advertising costs as incurred. - 25 - Income Taxes - Provisions for income taxes are based on amounts reported in the consolidated statements of income (after exclusion of nontaxable income such as interest on state and municipal securities) and include changes in deferred income taxes. Deferred taxes are computed using the asset and liability approach. The tax effects of differences between the tax and financial accounting basis of assets and liabilities are reflected in the balance sheets at the tax rates expected to be in effect when the differences reverse. Earnings Per Share - For the year ended June 30, 1997, earnings per share of common stock is based on the weighted average number of common shares outstanding during the year. As the Company did not complete its stock conversion from a mutual association until December 28, 1995, no earnings per share have been shown for any periods prior to the year ended June 30, 1997. Accounting Standards Implemented in the Year Ended June 30, 1997 - The Company implemented SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, effective July 1, 1996. SFAS No. 121 establishes accounting standards for the impairment of long-lived assets, certain identifiable intangible assets and goodwill related to those assets to be held and used and for long-lived assets to be held and certain intangible assets to be disposed of. The adoption of this standard did not have a significant impact on financial condition or results of operations. The Company also implemented SFAS No. 122, Accounting for Mortgage Servicing Rights, prospectively effective July 1, 1996. SFAS No. 122 amends SFAS No. 65 and the principal effect for the Company is the elimination of the accounting distinction between rights to service mortgage loans for others that are acquired through loan origination activities and those acquired through purchase transactions. When a mortgage banking enterprise purchases or originates mortgage loans and sells or securitizes those loans with servicing rights retained, it should allocate the total cost of the mortgage loans to the mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values if it is practicable to estimate those fair values. Any cost allocated to mortgage servicing rights should be recognized as a separate asset and amortized in proportion to and over the period of the estimated net servicing income. Implementation of the provisions of SFAS No. 122 did not have a material impact on the Company's financial condition or results of operations. In June 1996, the FASB issued SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. It requires that liabilities and derivatives incurred or obtained by transferors as part of financial assets be initially measured at fair value, if practicable. It also requires that servicing assets and other retained interests in the transferred assets be measured by allocating the previous carrying amount between the assets sold, if any, and retained interests, if any, based on their relative fair values at the date of the transfer. Servicing assets and liabilities must be subsequently measured by amortization in proportion to and over the period of estimated net servicing income or loss and assessment for asset impairment or increased obligation based on their fair values. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996. In December 1996, the FASB issued SFAS No. 127, Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125. This Statement defers the effective date of application of certain transfer and collateral provisions of SFAS No. 125 until January 1, 1998. On January 1, 1997, the Company implemented the provisions of SFAS No. 125 which were not deferred by SFAS No. 127. Its adoption did not have a significant impact on financial position or results of operations. - 26 - Recently Issued Accounting Standards - The FASB has recently issued three new accounting standards that will affect the reporting and disclosure of financial information by the Company. Management has not determined the effects of adopting these statements, but their adoption will not impact financial condition or results of operations because they deal with reporting and disclosure. The following is a summary of the standards and their required implementation dates: SFAS No. 128, Earnings Per Share - This statement establishes standards for computing and presenting earnings per share ("EPS"). It will require the presentation of basic EPS on the face of the income statement with dual presentation of both basic and diluted EPS for entities with complex capital structures. Basic EPS excludes the dilutive effect that could occur if any securities or other contracts to issue common stock were exercised or converted into or resulted in the issuance of common stock. Basic EPS is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. The computation of diluted EPS is similar to the computation of basic EPS except the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. In the case of certain convertible securities, the numerator may also be increased by related interest or dividends. This statement will be effective for interim and annual periods ending after December 31, 1997. SFAS No. 130, Reporting Comprehensive Income - This statement establishes standards for reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses). This statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income (including, for example, unrealized holding gains and losses on available for sale securities) be reported in a financial statement similar to the statement of income and retained income. The accumulated balance of other comprehensive income will be disclosed separately from retained income in the shareholders' equity section of the balance sheet. This statement is effective for the Company for the fiscal year beginning July 1, 1998. SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information - This statement establishes standards for the way public business enterprises report information about operating segments and establishes standards for related disclosures about products and services, geographic areas and major customers. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Information required to be disclosed includes segment profit or loss, certain specific revenue and expense items, segment assets and certain other information. This statement is effective for the Company for financial statements issued for the fiscal year beginning July 1, 1998. Reclassifications - Certain June 30, 1996 and 1995 amounts have been reclassified to conform to the June 30, 1997 presentation. - 27 - 2. SECURITIES The maturities, amortized cost, unrealized gains, unrealized losses and fair values of securities at June 30, 1997 and 1996 were as follows:
1997 ------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ------------ ------------ ------------ United States Government Agency debt securities: Due within one year $ 11,000,000 $ 4,165 45,579 $ 10,958,586 Due after one year but within five years 66,013,428 91,680 682,172 65,422,936 Due after five years but within ten years 7,000,000 -- 169,373 6,830,627 Due after ten years 31,971,799 -- 923,042 31,048,757 Federal Home Loan Mortgage Corporation common and preferred stocks 249,358 8,002,792 -- 8,252,150 ------------ ------------ ------------ ------------ Total investment securities 116,234,585 8,098,637 1,820,166 122,513,056 ------------ ------------ ------------ ------------ Mortgage-backed securities: Federal National Mortgage Association 12,939,158 -- 75,957 12,863,201 Government National Mortgage Association 40,111,360 405,425 182,938 40,333,847 ------------ ------------ ------------ ------------ Total mortgage-backed securities 53,050,518 405,425 258,895 53,197,048 ------------ ------------ ------------ ------------ Total $169,285,103 $ 8,504,062 $ 2,079,061 $175,710,104 ============ ============ ============ ============
- 28 -
1996 --------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ------------ ------------ ------------ United States Government Agency debt securities: Due within one year $ 2,000,000 -- $ 5,140 $ 1,994,860 Due after one year but within five years 82,935,029 $ 166,528 1,692,814 81,408,743 Due after five years but within ten years 8,000,000 -- 267,511 7,732,489 Due after ten years 29,969,822 -- 1,300,699 28,669,123 Federal Home Loan Mortgage Corporation common and preferred stocks 273,905 5,279,533 -- 5,553,438 ------------ ------------ ------------ ------------ Total investment securities 123,178,756 5,446,061 3,266,164 125,358,653 ------------ ------------ ------------ ------------ Mortgage-backed securities: Federal National Mortgage Association 28,328,508 -- 494,668 27,833,840 Government National Mortgage Association 97,415,482 -- 2,162,642 95,252,840 ------------ ------------ ------------ ------------ Total mortgage-backed securities 125,743,990 -- 2,657,310 123,086,680 ------------ ------------ ------------ ------------ Total $248,922,746 $ 5,446,061 $ 5,923,474 $248,445,333 ============ ============ ============ ============
As of June 30, 1997, there were approximately $73 million of investments with call options, all of which are callable within one year. As of June 30, 1996, there were approximately $93 million of investments with call options, of which $90 million are callable within one year. Gross realized gains and losses on sales of securities were $714,527 and $695,148, respectively, in fiscal 1997. Gross realized gains and losses on sales of securities were $30,782 and $15,625, respectively, in fiscal 1996. There were no sales of investment securities for the year ended June 30, 1995. - 29 - 3. LOANS RECEIVABLE Loans receivable at June 30, 1997 and 1996 consisted of the following:
1997 1996 Residential (1 - 4 family) real estate loans $ 561,352,476 $ 416,710,946 Construction loans 68,365,540 61,015,061 Commercial loans 30,631,001 29,342,750 Land loans 19,991,562 22,843,531 Consumer loans: Home equity 14,494,824 13,696,894 Credit card 6,198,263 5,644,392 Other 3,255,459 3,277,814 Total 704,289,125 552,531,388 Deduct: Allowance for loan losses (7,611,675) (7,495,515) Undisbursed portion of loans in process (33,029,829) (34,846,054) Unearned loan fees, net (5,324,301) (5,059,006) ------------- ------------- Loans receivable, net $ 658,323,320 $ 505,130,813 ============= =============
The changes in the allowance for loan losses consisted of the following:
1997 1996 1995 Allowance, beginning of year $ 7,495,515 $ 8,088,462 $ 7,828,492 Provision for loan losses (recovery of allowance) (59,286) 336,957 486,101 Write-offs (344,230) (1,493,125) (395,182) Recoveries 519,676 563,221 169,051 ----------- ----------- ----------- Allowance, end of year $ 7,611,675 $ 7,495,515 $ 8,088,462 =========== =========== ===========
Residential real estate loans are presented net of loans serviced for others totaling $30.9 million, $36.6 million and $43.0 million at June 30, 1997, 1996 and 1995, respectively. Loans sold in the secondary market are generally sold without recourse. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and foreclosure processing. In connection with these loans serviced for others, the Company held borrowers' escrow balances of $339,899, $393,826 and $476,131 at June 30, 1997, 1996 and 1995, respectively. Loans not currently accruing interest at June 30, 1997 and June 30, 1996 amounted to $6.3 million and $8.0 million, respectively. Interest income that would have been accrued on these loans if they were fully accruing amounted to $472,000 and $791,000 for the 1997 and 1996 fiscal years, respectively. In accordance with SFAS Nos. 114 and 118, the recorded investment in impaired loans was $4,385,280 and $6,275,358 at June 30, 1997 and 1996, respectively. The related allowance for loan losses on these loans was $1,979,647 and $2,804,497 at June 30, 1997 and 1996, respectively. All impaired loans required an allowance for loan loss and were evaluated using the fair value of the collateral. The average recorded investment in impaired loans was $4,896,308 and $6,346,184 at June 30, 1997 and 1996, respectively, and the cash income recognized for the years ended June 30, 1997 and 1996 was $68,000 and $121,000, respectively. - 30 - The Company is not committed to lend additional funds to debtors whose loans have been modified. 4. REAL ESTATE Real estate consisted of the following:
1997 1996 Acquired in settlement of loans $ 1,138,277 $ 3,682,554 Less allowance for estimated losses (270,401) (1,143,540) ----------- ----------- Real estate, net $ 867,876 $ 2,539,014 =========== ===========
The changes in the allowance for losses on real estate acquired in settlement of loans consisted of the following:
1997 1996 1995 Allowance, beginning of year $ 1,143,540 $ 1,542,253 $ 1,920,257 Provision 92,379 139,812 1,236,027 Write-offs (965,518) (538,525) (1,614,031) ----------- ----------- ----------- Allowance, end of year $ 270,401 $ 1,143,540 $ 1,542,253 =========== =========== ===========
5. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment consisted of the following:
1997 1996 Land $ 2,863,967 $ 1,921,737 Office buildings and improvements 9,741,536 6,463,490 Office equipment and leasehold improvements 2,922,692 2,336,170 Automobiles 100,388 100,388 ------------ ------------ Total 15,628,583 10,821,785 Less accumulated depreciation and amortization (5,529,476) (4,975,682) ------------ ------------ Office properties and equipment, net $ 10,099,107 $ 5,846,103 ============ ============
- 31 - 6. DEPOSITS Customer deposits at June 30, 1997 and 1996 consisted of the following:
1997 1996 Checking accounts $ 9,192,647 $ 9,326,000 NOW accounts - 2.50% at June 30, 1997 and 1996 11,798,817 10,109,446 Flexible rate checking: Money market deposit accounts, 2.50% to 4.89% at June 30, 1997 and 2.50% to 2.90% at June 30, 1996 34,759,502 32,315,154 Other - 2.50% to 2.55% at June 30, 1997 and 2.50% to 2.55% at June 30, 1996 3,369,134 3,528,117 ------------ ------------ Total checking accounts 59,120,100 55,278,717 ------------ ------------ Passbook accounts - 2.50% at June 30, 1997 and 1996 14,447,314 15,141,246 ------------ ------------ Certificate accounts: 2.50% - 3.95% 3,940,677 1,764,422 4.00% - 4.95% 15,680,883 33,454,451 5.00% - 6.95% 320,077,671 284,252,015 7.00% - 8.95% 29,712,983 57,854,550 9.00% and over 859,914 825,515 ------------ ------------ Total certificate accounts 370,272,128 378,150,953 ------------ ------------ Total deposits $443,839,542 $448,570,916 ============ ============
- 32 - The weighted average coupon rate on customer deposits at June 30, 1997 and 1996 was 5.24% and 5.42%, respectively. Scheduled maturities of certificate accounts at June 30, 1997 were as follows: Year Ending June 30, Amount - -------------------- ------ 1998 $291,650,026 1999 55,764,166 2000 15,368,010 2001 3,529,827 2002 2,968,272 Thereafter 991,827 ------------ Total certificate accounts $370,272,128 ============ The aggregate amount of certificate accounts in excess of $100,000 was $145,100,828 and $129,249,220 at June 30, 1997 and 1996, respectively. Deposits in excess of $100,000 are not federally insured. - 33 - Interest expense by type of deposit for the years ended June 30, 1997, 1996 and 1995 was as follows:
1997 1996 1995 ------------ ------------ ------------ Checking accounts $ 1,349,244 $ 1,510,906 $ 2,029,954 Passbook accounts 237,366 341,530 374,275 Certificate accounts 22,035,269 25,429,660 19,194,800 Less: Penalty income (56,991) (63,763) (134,760) ------------ ------------ ------------ Total interest expense $ 23,564,888 $ 27,218,333 $ 21,464,269 ============ ============ ============
7. OTHER BORROWED FUNDS At June 30, 1997, the Company had $129.0 million of outstanding advances from the Federal Home Loan Bank of Atlanta ("FHLB"). No advances were outstanding at June 30, 1996. Advances were at fixed rates. The maximum amount of outstanding advances at any month-end during 1997 and 1996 was $129.0 million and $10.0 million, respectively, and the average balance outstanding for such years was approximately $61.1 million and $1.0 million respectively. The weighted average interest rate during fiscal years 1997 and 1996 was 5.90% and 5.89%, respectively. The Company pledges as collateral for these borrowings their FHLB stock and has entered into blanket collateral agreements with the FHLB whereby the Company maintains, free of other encumbrances, qualifying mortgages (as defined) with unpaid principal balances, when discounted at 75% of the unpaid principal balances, of at least 100% of total advances. The Company also borrowed funds using securities sold under repurchase agreements during 1997 and 1996. At June 30, 1997 and 1996, $120.0 million and $85.0 million of such borrowings were outstanding, respectively. The maximum amount of outstanding agreements at any month-end during 1997 and 1996 was $120.0 million and $85.0 million, respectively, and the average outstanding balance of such agreements for the years were approximately $117.4 million and $13.4 million, respectively. Collateral for the securities sold under repurchase agreements consisted of U.S. Government Agency securities and mortgage-backed securities which were transferred to a third party for safekeeping during the terms of the agreements. At June 30, 1997, the market value of such collateralized securities totaled approximately $114.4 million (amortized cost of approximately $115.6 million). During the 1997 fiscal year, the Company also borrowed $28.0 million in short term funds from a commercial bank to fund a portion of a $5 per share special distribution paid to shareholders on March 18, 1997. The loan, at prime rate less .5%, was obtained on March 18, 1997 and was paid off subsequent to June 30, 1997. 8. INCOME TAXES The provision for income taxes is summarized as follows: - 34 -
Year Ended June 30, ---------------------------------------- 1997 1996 1995 Current provision: Federal $ 4,656,460 $ 3,925,383 $ 3,907,273 State 234,850 311,185 376,964 ----------- ----------- ----------- Total current 4,891,310 4,236,568 4,284,237 ----------- ----------- ----------- Year Ended June 30, ---------------------------------------- 1997 1996 1995 Deferred (benefit) provision: Federal $ (225,828) $ 253,845 $ (331,675) State (55,699) 75,431 (95,380) ----------- ----------- ----------- Total deferred (281,527) 329,276 (427,055) ----------- ----------- ----------- Total provision for income taxes $ 4,609,783 $ 4,565,844 $ 3,857,182 =========== =========== ===========
For the years ended June 30, 1997 and 1996, deferred tax liabilities (assets) of $2,473,626 and $(223,278), respectively, were allocated to equity for the tax effect of the unrealized gain (loss) on investment securities available for sale. Income taxes differed from amounts computed by applying the statutory federal rate (34%) to income before income taxes and cumulative effect of a change in accounting principle (see Note 1) as follows:
Year Ended June 30, --------------------------------------- 1997 1996 1995 Tax at federal income tax rate $4,070,978 $4,484,581 $3,402,446 (Decrease) increase resulting from: Statutory bad debt deduction for tax purposes -- (520,000) -- State income tax expense, net of federal benefit 118,240 255,166 185,845 Other, net 420,565 346,097 268,891 ---------- ---------- ---------- Total $4,609,783 $4,565,844 $3,857,182 ========== ========== ========== Effective tax rate 38.5% 34.6% 38.5% ========== ========== ==========
The tax effects of significant items comprising the Company's net deferred tax asset at June 30, 1997 and 1996 are as follows: - 35 -
1997 1996 Deferred tax assets: Differences between book and tax basis bad debt reserves $ 3,290,767 $ 3,606,805 Difference between book and tax basis of deferred loan fees 966,132 1,183,796 Deferred compensation 2,011,241 1,466,286 Net operating loss carryforward 677,562 -- Other (160,101) 247,187 ----------- ----------- Total deferred tax assets 6,785,601 6,504,074 ----------- ----------- Deferred tax liabilities: Differences between book and tax basis of Federal Home Loan Bank of Atlanta stock 921,850 921,850 Unrealized gain (loss) on securities available for sale 2,473,626 (223,278) ----------- ----------- Total deferred tax liabilities 3,395,476 698,572 ----------- ----------- Net deferred tax asset $ 3,390,125 $ 5,805,502 =========== ===========
- 36 - The realization of the entire amount of the deferred tax asset is considered to be more likely than not; therefore, no valuation allowance has been provided. The Company is permitted a bad debt deduction in determining federal taxable income that may differ from actual experience, subject to certain limitations. If the amounts that qualify as bad debt deductions for federal income tax purposes are later used for purposes other than for bad debt losses, they will be subject to federal income tax at the then current statutory rate. As permitted under SFAS No. 109, no deferred tax liability is provided for approximately $16.9 million (approximately $6.4 million tax effect) of such tax basis bad debt reserves that arose prior to June 30, 1988. 9. BENEFIT PLANS 401(k)/Profit Sharing Plan - Effective November 30, 1995, the Company modified its non-contributory qualified defined contribution retirement plan to a contributory 401(k) profit sharing plan. The profit sharing plan permits 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 provides for matching contributions by the Company equal to 100% of employee contributions up to the first 3% of compensation. The Company may, at its discretion, make profit sharing contributions to the plan. Plan participants' accounts are 100% vested in Company contributions after 5 years of qualifying service. The Company's matching contribution charged to expense for the years ended June 30, 1997 and 1996 was approximately $76,000 and $69,000, respectively. The plan, prior to modification, was a non-contributory plan which covered all full time employees with at least one year of service. Annual employer contributions under the plan were based on a percentage of compensation of all regular employees (as defined) less termination credits. Retirement expenses relating to this plan were funded as accrued and amounted to $352,094 and $608,782 for the years ended June 30, 1996 and 1995, respectively. Stock Option and Management Recognition and Retention Plans - In December, 1996, the Company's shareholders approved the Stock Option Plan ("SOP") and Management Recognition and Retention Plan ("MRRP"). Stock Option Plan - The SOP provides for the Company's Board of Directors to award incentive stock options, non-qualified or compensatory stock options and stock appreciation rights representing up to 1,719,250 shares of Company stock. One-third of the options granted vested immediately upon grant, with the balance vesting in equal amounts on the two subsequent anniversary dates of the grant. Options granted vest immediately in the event of retirement, disability, or death. Outstanding stock options can be exercised over a ten year period. Under the SOP, options have been granted to directors and key employees to purchase common stock of HFNC Financial Corp. The exercise price in each case equals the fair market value of the Corporation's stock at the date of grant which has been adjusted for the impact of the $5 per share special distribution to shareholders on March 18, 1997. Options granted in the current year have exercise prices ranging from $13.67 to $14.78, and a weighted average contract life of 8.5 years. - 37 - A summary of the status of the Company's stock option plan as of June 30, 1997 and changes during the year ending on that date is presented below: Weighted Average Exercise Options Shares Price Outstanding at beginning of year -- -- Granted 1,548,471 $13.92 Exercised -- -- Forfeited (1,398) 14.78 --------- Outstanding at June 30, 1997 1,547,073 $13.92 ========= ====== Options exercisable at June 30, 1997 516,157 $13.92 ========= ======
The Company applies the provisions of APB Opinion No. 25 in accounting for its stock option plan, as allowed under SFAS No. 123, Accounting for Stock-Based Compensation. Accordingly, no compensation cost has been recognized for options granted to employees. Had compensation cost for these plans been determined based on the fair value at the grant dates for awards under those plans consistent with the methods of SFAS No. 123, the Company's pro forma net income and pro forma earnings per share would have been as follows:
1997 -------------------------- As Reported Proforma Net income $7,363,681 $6,510,387 Earnings per share $ .46 $ .41
In determining the above pro forma disclosure, the fair value of options granted during the year was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: expected volatility - 18.23%, expected life of grant - 3.83 years, risk-free interest rate - 6.28%, and expected dividend rate - 1.70%. The weighted average fair value of options granted during the fiscal year ended June 30, 1997 was $2.69 per share. Management Recognition and Retention Plan - The MRRP provides for the Company's Board of Directors to award restricted stock to officers and key employees as well as non-employee directors. The MRRP authorizes the Company to grant up to 687,700 shares of Company stock. One-fifth of the shares granted to date vested immediately on the date of grant. The remainder will vest at a rate of 25% per year over the next four anniversary dates of the grants. As is the case with the SOP, shares granted will - 38 - be deemed vested in the event of retirement, disability, or death. The shares available for award under this plan were purchased on the open market at a total cost of $13.0 million. An additional 25,704 shares at a cost of $472,000 were purchased using a portion of the $5 per share special distribution attributable to ungranted shares. Approximately $3.2 million in compensation expense was recognized during the current year related to the MRRP. The following table presents the status of the MRRP as of June 30, 1997, and changes during the year:
Weighted Average Grant Restricted Stock Award Plan Shares Price Outstanding at beginning of year -- -- Granted 619,540 $ 17.41 Vested (123,908) 18.07 Forfeited (600) 17.25 -------- Outstanding at June 30, 1997 495,032 $ 17.25 ======== =========
Employee Stock Ownership Plan - In connection with the Conversion (Note 1), the Company established an Employee Stock Ownership Plan ("ESOP"). In order to fund the ESOP, 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 the Corporation's wholly owned subsidiary, HFNC Investment Corp. Unearned ESOP shares are shown as a reduction of shareholders' equity. 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. An additional 230,154 shares,costing $4.2 million, were purchased by the plan using the $5 per share special distribution attributable to unallocated shares in the plan. Expense related to the ESOP was $1.5 million and $424,000 for the years ended June 30, 1997 and 1996, respectively. Other Postretirement Benefits - The Company provides certain health care and life insurance benefits for substantially all of its retired employees. The Company's postretirement plans currently are not funded. As discussed in Note 1, the Company adopted SFAS No. 106, resulting in an increase in accrued postretirement health care costs of $1.7 million and a decrease in net income of $1.1 million (after deeferred income tax credits of $650,000), which has been included in the Company's consolidated statement of income for the year ended June 30, 1996. The status of the plans were as follows: Accumulated postretirement benefit obligation at June 30, 1997 and June 30, 1996: 1997 1996 ---------- ---------- Retirees $ 457,067 $ 460,129 Fully eligible active plan participants 572,783 629,967 Other active plan participants 830,975 836,692 ---------- ---------- Accumulated postretirement benefit obligation 1,860,825 1,926,788 Unrealized net gain 260,081 8,103 ---------- ---------- Accrued postretirement benefit liability $2,120,906 $1,934,891 ========== ========== - 39 - Net periodic postretirement benefit cost for the period ended June 30, 1997 and June 30, 1996 consisted of the following components: 1997 1996 ---------- ---------- Service cost - benefits earned during the year $ 91,491 $ 115,169 Interest cost on accumulated postretirement benefit obligation 132,418 135,406 Unrecognized gain (5,537) --- --------- --------- Net periodic postretirement benefit cost $ 218,372 $ 250,575 ========= ========= The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation as of June 30, 1997 was 9%, decreasing linearly each successive year until it reaches 6% in 2000, after which it remains constant. A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of June 30, 1997 by approximately $327,000 and net annual postretirement benefit cost by approximately $46,000. The assumed discount rate used in determining the accumulated postretirement benefit obligation for both years was 8%. 10. DEFERRED COMPENSATION AGREEMENTS AND NON-EMPLOYEE DIRECTORS' RETIREMENT PLAN The Company has entered into deferred compensation agreements with the President and CEO, Executive Vice President, Vice President and Treasurer, and certain other Vice Presidents and is providing for the present value of such benefits over the anticipated remaining periods of employment. The agreements will be funded through life insurance policy investments owned by the Company, on the lives of such employees. Deferred compensation expense was approximately $32,000, $31,000 and $115,000 for the years ended June 30, 1997, 1996 and 1995, respectively. On August 25, 1994, the Company adopted the Non-employee Directors' Retirement Plan (the "Directors' Plan"). Under the Directors' Plan, a non-employee director becomes a participant upon completion of ten years of continuous service as a director. Full benefits under the Director's Plan are payable at the later of attaining age 65 or retiring from the Board of Directors. Retirement with reduced benefits is available beginning at age 62. The annual benefit for a retired director is equal to the amount of compensation to which the director was entitled to receive in the twelve months preceding retirement. This annual benefit is to be paid quarterly for a ten year period. The Directors' Plan also contains provisions for death benefits to a surviving spouse at 100% of the retirement benefit that would have been paid to the director upon retirement or would be payable over the remaining term if the director was already receiving retirement benefits. In the year ended June 30, 1995, the Company accrued approximately $750,000 related to the Directors' Plan. This accrual represented vested benefits as of the adoption date and benefits accumulated from the date of adoption through June 30, 1995. Such pension expense for the years ended June 30, 1997 and 1996 was approximately $54,000 and $25,000, respectively. - 40 - 11. COMMITMENTS AND CONTINGENCIES Loan Commitments - The Company, in the normal course of business, is a party to financial instruments and commitments which involve, to varying degrees, elements of risk in excess of the amounts recognized in the consolidated financial statements. These financial instruments and commitments include unused consumer lines of credit and commitments to extend credit. Loan commitments, excluding undisbursed portions of loans in process, were approximately $15.7 million at June 30, 1997. Commitments, which are disbursed subject to certain limitations, extend over periods of time with the majority of such commitments disbursed within a six-month period. Also, at June 30, 1997, the Company had commitments approximating $12.7 million representing available credit under open line loans and approximately $600,000 under outstanding letters of credit. Concentrations of Credit Risk - Most of the Company's business activity is with customers in the Charlotte, North Carolina area. The majority of the Company's loans are residential mortgage loans, construction loans for residential property and land loans for development of residential real estate. The Company's policy generally permits mortgage loans up to 80% of the value of the real estate that is pledged as collateral or up to 95% with private mortgage insurance. Interest Rate Risk - The Company's profitability depends to a large extent on its net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and other borrowed funds. Like most financial institutions, the Company's interest income and interest expense are significantly affected by changes in market interest rates and other economic factors beyond its control. The Company's interest-earning assets consist primarily of long-term, fixed-rate mortgage loans and investments which adjust more slowly to changes in interest rates than its interest-bearing liabilities which are primarily term deposits and advances. Accordingly, the Company's earnings would be adversely affected during periods of rising interest rates and would be positively impacted during periods of declining interest rates. Litigation - In June 1995, a lawsuit was initiated against the Association by a borrower's affiliated companies in which the plaintiffs alleged that the Association wrongfully set-off certain funds in an account being held and maintained by the Association. In addition, the plaintiffs alleged that as a result of the wrongful set-off, the Association wrongfully dishonored a check in the amount of $270,000. Plaintiffs further alleged that the actions on behalf of the Association constituted unfair and deceptive trade practices, thereby entitling plaintiffs to recover treble damages and attorney fees. The Association 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 Judgment, recommending the dismissal of all claims asserted against the Association. The Recommended Order is now before the United States District Court for the Western District of North Carolina and the parties are awaiting the Federal District Court's decision of whether to enter an Order Granting Summary Judgment in accordance with the Recommended Order by the United States Bankruptcy Judge. In December 1996, the Association filed a suit against the borrower and his company and against the borrower's wife, daughter 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 the Association in prior litigation. The borrower's wife filed a - 41 - counterclaim against the Association 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 the Association for application on a debt owed by one of her husband's corporations, claiming that officers of the Association promised to resume making loans to her husband's corporation after the payment. Home Federal and its officers vigorously deny all of her allegations. The case is scheduled for discovery in September 1997, after which the Association intends to file a motion for summary judgment for dismissal of the 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 the Association and against an officer of another financial institution. The action was removed from the state court and is presently pending in 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 against the two executive officers of the Association 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 the Association. 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. Plaintiffs claim actual damages, treble damages and punitive damages together with interest, attorneys' fees and other costs. The Association 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 Financial Corp., the Association, and the other financial institution referred to in the paragraph above, alleging that previous judgments in favor of the Association 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 4th Circuit Court of Appeals. The plaintiffs are seeking to have the judgments set aside on that basis. The Association has not yet filed a responsive pleading. The Association vehemently denies that any fraud was perpetrated upon the courts and intends to vigorously contest this matter. In August 1997, the borrower filed a lawsuit against attorneys for the Association, attorneys for the other financial institution, and two United States Bankruptcy Judges in which the borrower alleges that the defendants have conspired against him and his corporations by allowing the Association to obtain judgments against him and his various corporations. The Association and its officers continue to deny any liability in the above described cases and continue to vigorously defend against the claims. However, based on the advice of legal counsel, the Association is unable to give an opinion as to the likely outcome of the litigation or estimate the amount or range of potential loss, if any. 12. REGULATORY CAPITAL REQUIREMENTS The Association is subject to various regulatory capital requirements imposed by the federal financial institution agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory - 42 - framework for prompt corrective action, the Association must meet specific capital guidelines that involve quantitative measures of the Association's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Association's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Association to maintain minimum amounts and ratios. Under regulations of the OTS, the Association must have: (i) core capital equal to 3% of adjusted total assets, (ii) tangible capital equal to 1.5% of adjusted total assets and (iii) total capital equal to 8.0% of risk-weighted assets. In measuring compliance with all three capital standards, institutions must deduct from their capital (with several exceptions primarily for mortgage banking subsidiaries and insured depository institution subsidiaries) their investments in, and advances to, subsidiaries engaged (as principal) in activities not permissible for national banks, and certain other adjustments. Management believes, as of June 30, 1997, that the Association meets all capital adequacy requirements to which it is subject. The following is a reconciliation of the Association's equity reported in the consolidated financial statements under generally accepted accounting principles to OTS regulatory capital requirements (dollars in thousands):
Tangible Core Risk-Based Capital Capital Capital --------- --------- --------- June 30, 1997 Total equity as reported in the consolidated financial statements $ 172,894 $ 172,894 $ 172,894 General allowance for loan losses -- -- 5,936 Unrealized loss on available for sale securities (3,951) (3,951) (3,951) Investments not includable in regulatory capital (1,716) (1,716) (1,746) --------- --------- --------- Regulatory capital $ 167,227 $ 167,227 $ 173,133 ========= ========= ========= June 30, 1996 Total equity as reported in the consolidated financial statements $ 161,163 $ 161,163 $ 161,163 General allowance for loan losses -- -- 4,770 Unrealized loss on available for sale securities (787) (787) (787) Investments not includable in regulatory capital (1,587) (1,587) (1,667) --------- --------- --------- Regulatory capital $ 158,789 $ 158,789 $ 163,479 ========= ========= =========
- 43 - The Association's actual and required capital amounts and ratios are summarized as follows (in thousands):
Minimum Actual Requirement --------------------------- ------------------------ Amount Ratio Amount Ratio June 30, 1997 Tangible capital (to total assets) $167,227 18.9% $13,291 1.5% Core capital (to adjusted total assets) $167,227 18.9% $26,582 3.0% Risk-based capital (to risk-weighted assets) $173,133 36.5% $37,960 8.0% June 30, 1996 Tangible capital (to total assets) $158,789 22.3% $10,667 1.5% Core capital (to adjusted total assets) $158,789 22.3% $21,332 3.0% Risk-based capital (to risk-weighted assets) $163,479 42.9% $30,462 8.0%
As of June 30, 1997 and 1996, the most recent respective notifications from the OTS classified the Association as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the most recent notification that management believes have changed the Association's category. To be categorized as well capitalized, the Association must maintain minimum ratios of total capital to risk-weighted assets, core capital to risk-weighted assets and core capital to adjusted total assets. The Association's actual and minimum capital requirements to be well capitalized under prompt corrective action provisions are as follows (dollars in thousands):
Minimum Actual Requirement --------------------------- ------------------------- Amount Ratio Amount Ratio June 30, 1997 Tier I Capital (to adjusted total assets) $167,227 18.9% $44,303 5.0% Tier I Capital (to risk-weighted assets) $167,227 35.2% $28,470 6.0% Total Capital (to risk-weighted assets) $173,133 36.5% $47,450 10.0% June 30, 1996 Tier I Capital (to adjusted total assets) $158,789 22.3% $35,555 5.0% Tier I Capital (to risk-weighted assets) $158,789 41.7% $22,847 6.0% Total Capital (to risk-weighted assets) $163,479 42.9% $38,078 10.0%
On September 30, 1996, legislation was enacted to recapitalize the Savings Association Insurance Fund. The effect of this legislation is to require a one-time assessment on all federally insured savings associations' deposits and was levied by the Federal Depository Insurance Corporation ("FDIC") at .657% of insured deposits at June 30, 1996. The amount of the Association's assessment was approximately $3.1 million. The assessment was accrued as a charge to earnings in the quarter ended September 30, 1996 and paid on November 27, 1996. - 44 - 13. FAIR VALUE DISCLOSURE The carrying and estimated fair value amounts of financial instruments as of June 30, 1997 and 1996, are summarized below:
1997 1996 ---------------------------------------- ---------------------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value Assets: Cash and cash equivalents $ 31,370,359 $ 31,370,359 $ 9,605,598 $ 9,605,598 Securities available for sale 175,710,104 175,710,104 248,445,333 248,445,333 Loans receivable 658,323,320 653,393,693 505,130,813 491,177,000 Stock of Federal Home Loan Bank of Atlanta 6,450,000 6,450,000 5,062,100 5,062,100 Other assets 6,151,280 6,151,280 5,907,147 5,907,147 Liabilities: Demand deposits $ 73,567,414 $ 73,567,414 $ 70,419,963 $ 70,419,963 Time deposits 370,272,128 370,720,757 378,150,953 380,838,000 Other borrowed funds 277,000,000 277,354,949 85,000,000 84,975,000 Other liabilities 4,961,756 4,961,756 4,361,974 4,361,974
Cash and cash equivalents have maturities of three months or less, and accordingly, the stated amount of such instruments is deemed to be a reasonable estimate of fair value. The fair value of securities is based on quoted market prices obtained from independent pricing services. The fair values of loans, time deposits and other borrowings are estimated based on present values using applicable risk-adjusted spreads to the U.S. Treasury curve and other applicable market rates to approximate current entry-value interest rates applicable to each category of such financial instruments. Investment in stock of the Federal Home Loan Bank is required by law for every federally insured savings institution. No ready market exists for this stock, and it has no quoted market value. However, redemption of this stock has historically been at par value. Accordingly, the stated amount is deemed to be a reasonable estimate of fair value. Other assets primarily represent accrued interest receivable; other liabilities primarily represent advances from borrowers for taxes and insurance and accrued interest payable. Since these financial instruments will typically be received or paid within three months, the stated amounts of such instruments are deemed to be a reasonable estimate of fair value. The Company had off-balance sheet financial commitments to originate loans and fund unused consumer lines of credit (see Note 11) of $29.0 million and $31.0 million at June 30, 1997 and 1996, respectively. Since the loan commitments are at interest rates that approximate current market rates, the estimated fair value of the commitments have no other financial statement impact. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Company's entire holdings of a particular financial instrument. Because no active market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic - 45 - conditions, current interest rates and prepayment trends, 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 any of these assumptions used in calculating fair value also would significantly affect the estimates. Further, the fair value estimates were calculated as of June 30, 1997 and 1996. Changes in market interest rates and prepayment assumptions could change significantly the fair value. 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, the Company has significant assets and liabilities that are not considered financial assets or liabilities including real estate, deferred tax liabilities and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates. 14. SPECIAL DISTRIBUTION TO SHAREHOLDERS On March 18, 1997, the Company paid to its shareholders a special distribution of $78.9 million, or $5 per share. The Company has determined that 95% of all shareholder distributions during the year represent a return of shareholder capital. Consequently, the return of capital portion has been reflected in the Company's financial records as a reduction of additional paid-in capital and the remainder has been reflected as a reduction of retained income. 15. HFNC FINANCIAL CORP. The following condensed statements of financial condition, as of June 30, 1997 and 1996 and condensed statements of income and cash flows for the year ended June 30, 1997 and for the period from August 29, 1995 (date of incorporation) to June 30, 1996 for HFNC Financial Corp. should be read in conjunction with the consolidated financial statements and the notes thereto.
Statement of Financial Position 1997 1996 Assets Cash and cash equivalents $ 42,904 $ 553,980 Equity investment in subsidiaries 188,324,313 245,950,476 Deferred tax asset 990,521 -- ------------ ------------ Total $189,357,738 $246,504,456 ============ ============ Liabilities and Shareholders' Equity Note payable $ 28,000,000 Other liabilities 297,821 Shareholders' equity 161,059,917 $246,504,456 ------------ ------------ Total $189,357,738 $246,504,456 ============ ============ - 46 - Statement of Income 1997 1996 Dividends from subsidiaries $ 75,912,925 $ 50,000 Interest income 14,365 3,980 ------------ ------------ Total income 75,927,290 53,980 ------------ ------------ Interest expense 651,778 -- Other expense 674,150 -- ------------ ------------ Total expense 1,325,928 -- Income before taxes and equity in undistributed earnings of subsidiaries 74,601,362 53,980 Income tax benefit 988,963 -- ------------ ------------ Income before equity in earnings of subsidiaries 75,590,325 53,980 Equity in undistributed earnings of subsidiaries (excess of dividends from subsidiaries over earnings from subsidiaries) (68,226,644) 7,520,122 ------------ ------------ Total $ 7,363,681 $ 7,574,102 ============ ============ Statement of Cash Flows 1997 1996 Operating activities: Net income $ 7,363,681 $ 7,574,102 Adjustments to reconcile net income to net cash provided by operating activities: Deferred income tax benefit (990,521) -- Dividends on unallocated ESOP and MRRP shares, net (6,394,971) -- Amortization of unearned stock compensation 3,764,021 -- Increase in other liabilities 297,821 Equity in undistributed earnings of subsidiaries (excess of dividends from subsidiaries over earnings from subsidiaries) 68,226,644 (7,520,122) ------------- ------------- Net cash provided by operating activities 72,266,675 53,980 Investing activities: Purchase of capital stock of subsidiaries -- (167,937,938) ------------- ------------- Net cash used in investing activities -- (167,887,938) ------------- ------------- Financing activities: Net proceeds from sale of common stock -- 168,437,938 Proceeds from note payable 28,000,000 -- Dividends paid (83,071,050) -- Purchases of restricted stock for benefit plans (17,706,701) -- ------------- ------------- Net cash (used in ) provided by financing activities (72,777,751) 168,437,938 Net increase in cash and cash equivalents (511,076) 553,980 Cash and cash equivalents at beginning of period 553,980 -- ------------- ------------- Cash and cash equivalents at end of period $ 42,904 $ 553,980 ============= =============
********** - 47 - Shareholder Information - -------------------------------------------------------------------------------- HFNC Financial Corp. is a unitary savings and loan holding company conducting business through its wholly-owned subsidiary, Home Federal Savings and Loan Association. The Association is a federally-chartered, SAIF-insured savings institution operating through its main office and eight branch offices and a loan origination office. The Company's headquarters are located at 139 South Tryon Street, Charlotte, North Carolina 28202. ------------------------------------------------- TRANSFER AGENT / REGISTRAR ------------------------------------------------- Registrar and Transfer Company 10 Commerce Drive Cranford, New Jersey 07016 - -------------------------------------------------------------------------------- Shareholder Requests - -------------------------------------------------------------------------------- Shareholders needing assistance with stock records, transfers or lost certificates, please contact the Company's transfer agent, Registrar and Transfer Company. Requests for annual reports, quarterly reports and related shareholder literature should be directed to Corporate Secretary, HFNC Financial Corp., 139 South Tryon Street, Charlotte, North Carolina 28202. Common Stock Information - -------------------------------------------------------------------------------- Shares of HFNC Financial Corp.'s common stock are traded nationally under the symbol "HFNC" on the Nasdaq National Market System. At September 5, 1997, the Company had 17,192,500 shares of common stock outstanding and had approximately 2,625 shareholders of record. Such holdings do not reflect the number of beneficial owners of common stock. The following table sets forth the reported high and low sale prices of a share of the Company's common stock as reported by Nasdaq (the common stock commenced trading on the Nasdaq National Market System on December 28, 1995).
- ----------------------------------------------------------------------------------------------------------------- QUARTER ENDED FISCAL YEAR ENDED JUNE 30, 1997 FISCAL YEAR ENDED JUNE 30, 1996 - ----------------------------------------------------------------------------------------------------------------- HIGH LOW DIVIDEND HIGH LOW DIVIDEND ---------------------------------------------------------------------------------------- September 30 $18.38 $15.75 $0.05 - - - December 31 18.13 17.00 0.07 $13.38 $12.63 - March 31 22.25 16.63 5.07 15.13 12.88 - June 30 19.88 15.88 0.07 16.63 13.75 - - -----------------------------------------------------------------------------------------------------------------
EX-27 3 FINANCIAL DATA SCHEDULE
9 YEAR JUN-30-1997 JUN-30-1997 9,934,359 0 21,436,000 0 175,710,104 0 0 665,934,995 7,611,675 892,920,109 443,839,542 277,000,000 11,020,650 0 0 0 171,925 160,887,992 892,920,109 49,101,206 16,214,450 0 65,315,656 23,564,888 34,618,710 30,696,946 (59,286) 19,379 19,984,621 11,973,464 11,973,464 0 0 7,363,681 .46 .46 7.87 6,319,367 0 642,885 0 7,495,515 344,229 519,675 7,611,675 7,611,675 0 0
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