Back to GetFilings.com
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT
OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1998
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from __________ to __________
Commission file number 0-26016
PALMETTO BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
South Carolina 74-2235055
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
301 Hillcrest Drive, Laurens, South Carolina 29360
(Address of principal executive offices) (Zip Code)
Registrant's telephone number - (864) 984 - 4551
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $5.00 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
State the aggregate market value of the voting stock held by
non-affiliates of the registrant. The aggregate market value shall be computed
by reference to the price at which the stock was sold, or the average bid and
asked prices of such stock, as of February 23, 1999, $103,418,178 based on the
most recent sales price of $38.00 per share. There is no established public
trading market for the shares. See Part II, Item 5.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. 3,102,795 February
23, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
The Company's Proxy Statement dated March 19, 1999 with respect to an
Annual Meeting of Shareholders to be held April 20, 1999: Incorporated by
reference in Part III of this Form 10-K.
PALMETTO BANCSHARES, INC.
AND SUBSIDIARIES
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PART I
Page No.
Item 1. Business 3
Item 2. Properties 8
Item 3. Legal Proceedings 8
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters 9
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations 11
Item 8. Financial Statements and Supplementary Data 27
PART III
Item 10. Directors and Executive Officers of the Registrant 54
Item 11. Executive Compensation 54
Item 12. Security Ownership of Certain Beneficial Owners and Management 54
Item 13. Certain Relationships and Related Transactions 54
PART IV
Item 14. Exhibits and Financial Statement Schedules and Reports on Form 8-K 54
2
PART I
(Dollars in Thousands, except per share data, throughout document)
Item 1. Business
Palmetto Bancshares, Inc. ("Bancshares" or the "Company") is a bank holding
company organized in 1982 under the laws of South Carolina. Through its
wholly-owned subsidiary, The Palmetto Bank (the "Bank"), and the Bank's
wholly-owned subsidiary, Palmetto Capital, Inc. ("Palmetto Capital"), Bancshares
engages in the general banking business in the upstate South Carolina market of
Laurens, Greenville, Spartanburg, Greenwood, Anderson, and Cherokee counties.
The Bank is a state, non-member bank which was organized and chartered under
South Carolina law in 1906. There are 26 full service branch offices in addition
to the headquarters located in Laurens, South Carolina.
The Bank performs a full range of banking activities, including such services as
checking, savings, money market, and other time deposits of various types of
consumer and commercial depositors; loans for business, real estate, and
personal uses; safe deposit box rental and various electronic funds transfer
services. The Bank also offers both individual and commercial trust services
through an active trust department. Palmetto Capital is a brokerage subsidiary
of the Bank, which offers customers stocks, treasury and municipal bonds, mutual
funds and insurance annuities, as well as college and retirement planning. The
Bank's Dealer Finance Department establishes relationships with Upstate
automobile dealers to provide customer financing of automobile purchases. In the
later part of 1995, the Bank started a mortgage banking operation to continue to
meet a broader range of its customers' financial service needs. This mortgage
banking operation was in full operation by March 1996: originating, selling, and
servicing mortgage loans. Due to a reorganization in the Bank's mortgage
servicing department in 1997, the Bank did not actively purchase and originate
loans to be sold in 1997. The Bank re-engaged in these originating and selling
activities in 1998. The Bank continues to service its portfolio of loans sold.
Financial Information
See Item 8., "Financial Statements and Supplementary Data."
Competition
The upstate South Carolina market is a highly competitive banking market in
which all of the largest financial institutions in the state are represented.
The competition among the various financial institutions is based upon interest
rates offered on deposit accounts, interest rates charged on loans, credit and
service charges, the quality of service rendered and the convenience of banking
facilities. The Bank believes it has competed effectively in its market.
Interstate Banking
In 1986, South Carolina adopted legislation which permits banks and bank holding
companies in certain southern states to acquire banks in South Carolina to the
extent that such other states have reciprocal legislation applicable to South
Carolina banks and bank holding companies. The legislation resulted in a number
of the Bank's competitor banks being purchased by large, out-of-state bank
holding companies. Size gives the larger banks certain advantages in competing
for business from larger corporations. These advantages include higher lending
limits and the ability to offer services in other areas of South Carolina and
the region. As a result, the Bank does not generally attempt to compete for the
banking relationships of larger corporations, but concentrates its efforts on
small and medium-size businesses and individuals. The Bank believes it has
competed effectively in this market segment by offering quality, personalized
service. It is management's intention to remain a locally-based, independent,
South Carolina Bank.
Customers
The majority of the Bank's customers are individuals and small to medium-sized
businesses headquartered within its service area. The Bank is not dependent upon
a single or a very few customers, the loss of which would have a material
adverse effect on the Bank. No customer accounts for more than 5% of the Bank's
total deposits at any time. Management does not believe that the Bank's loan
portfolio is dependent on a single customer or group of customers concentrated
in a particular industry whose loss or insolvency would have a material adverse
effect on the Bank.
3
Growth
For a discussion of growth in the current year, please see the "General" heading
in Managements' Discussion and Analysis, page 12.
Management continually reviews opportunities to expand in the upstate South
Carolina market that it believes to be in the best interest of the Bank and its
customers.
Systems
During 1998, the Company completely tested all of its core application systems
for Year 2000 readiness. For further information, please see the "General"
heading in Managements' Discussion and Analysis, page 12.
In November 1996, the Bank began operating its Telephone Banking Center (the
"TBC"), an in-house sales and service center. The TBC provides the Bank's
customers with more options to do their banking business and offers extended
service hours. The telephone bankers are qualified to answer account inquiries,
process transactions, and provide updated rate and service information.
In 1999, the Bank plans to offer internet banking services to its customers. The
Company also plans on installing a wide area network in the coming year.
Employees
At December 31, 1998, the Bank had 306 full-time equivalent employees, none of
whom are subject to a collective bargaining agreement. Management believes its
relationship with its employees is excellent.
Monetary Policy
The results of operations of Bancshares and the Bank are affected by credit
policies of monetary authorities, particularly the Federal Reserve. The
instruments of monetary policy employed by the Federal Reserve include open
market operations in U.S. Government securities, changes in the discount rate on
member bank borrowings, changes in reserve requirements against member bank
deposits and limitations on interest rates which member banks may pay on time
and savings deposits. In view of changing conditions in the national economy and
in the money markets, as well as the effect of action by monetary and fiscal
authorities, including the Federal Reserve, no prediction can be made as to
possible future changes in interest rates, deposit levels, loan demand or the
business and earnings of Bancshares and the Bank.
Regulatory Environment
GENERAL
Bancshares and its subsidiaries are extensively regulated under federal and
state law. To the extent that the following information describes statutory or
regulatory provisions, it is qualified in its entirety by reference to the
particular statutory and regulatory provisions. Any change in applicable laws
may have a material effect on the business and prospects of Bancshares. The
operations of Bancshares may be affected by possible legislative and regulatory
changes and by the monetary policies of the United States.
Bancshares. As a bank holding company registered under the Bank Holding Company
Act of 1956, as amended (the "BHCA"), Bancshares is subject to regulation and
supervision by the Federal Reserve. Under the BHCA, Bancshares' activities and
those of its subsidiaries are limited to banking, managing or controlling banks,
furnishing services to or performing services for its subsidiaries or engaging
in any other activity that the Federal Reserve determines to be so closely
related to banking, managing or controlling banks as to be a proper incident
thereto. The BHCA also restricts the ability of Bancshares to acquire ownership
or control of more than 5% of the outstanding voting stock of banks or certain
other nonbanking businesses.
There are a number of obligations and restrictions imposed on bank holding
companies and their depository institution subsidiaries by law and regulatory
policy that are designed to minimize potential loss exposure to the depositors
of such depository institutions and to the Federal Deposit Insurance Corporation
("FDIC") insurance funds in the event the depository institution becomes in
danger of defaulting or in default under its obligations to repay deposits. For
example, under current federal law, to reduce the likelihood of receivership of
an insured depository institution subsidiary, a bank holding company is required
to guarantee the compliance of any insured depository institution subsidiary
that may become "undercapitalized:" with the terms of any capital restoration
plan filed by such subsidiary
4
with its appropriate federal banking agency up to the lesser of (i) an amount
equal to 5% of the institution's total assets at the time the institution became
undercapitalized, or (ii) the amount that is necessary (or would have been
necessary) to bring the institution into compliance with all applicable capital
standards as of the time the institution fails to comply with such capital
restoration plan. Under a policy of the Federal Reserve with respect to bank
holding company operations, a bank holding company is required to serve as a
source of financial strength to its subsidiary depository institutions and to
commit resources to support such institutions in circumstances where it might
not do so absent such policy. The Federal Reserve also has the authority under
the BHCA to require a bank holding company to terminate any activity or
relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a
bank) upon the Federal Reserve's determination that such activity or control
constitutes a serious risk to the financial soundness or stability of any
subsidiary depository institution of the bank holding company. Further, federal
law grants federal bank regulatory authorities additional discretion to require
a bank holding company to divest itself of any bank or nonbank subsidiary if the
agency determines that divestiture may aid the depository institution's
financial condition.
Bancshares is subject to the obligations and restrictions described above.
However, management currently does not expect that any of those provisions will
have any material impact on its operations.
As a bank holding company registered under the South Carolina Bank Holding
Company Act, Bancshares also is subject to regulation by the State Board.
Bancshares must file with the State Board periodic reports with respect to its
financial condition and operations, management and intercompany relationships
between Bancshares and its subsidiaries.
The Bank. The Bank is a FDIC-insured, South Carolina-chartered banking
corporation and is subject to various statutory requirements and rules and
regulations promulgated and enforced primarily by the State Board and the FDIC.
These statutes, rules and regulations relate to insurance of deposits, required
reserves, allowable investments, loans, mergers, consolidations, issuance of
securities, payment of dividends, establishment of branches and other aspects of
the business of the Bank. The FDIC has broad authority to prohibit the Bank from
engaging in what it determines to be unsafe or unsound banking practices. In
addition, federal law imposes a number of restrictions on state-chartered,
FDIC-insured banks and their subsidiaries. These restrictions range from
prohibitions against engaging as a principal in certain activities to the
requirement of prior notification of branch closings. The Bank also is subject
to various other state and federal laws and regulations, including state usury
laws, laws relating to fiduciaries, consumer credit and equal credit and fair
credit reporting laws. The Bank is not a member of the Federal Reserve System.
Dividends. The holders of Bancshares common stock are entitled to receive
dividends when and if declared by the Board of Directors out of funds legally
available therefor. Bancshares is a legal entity separate and distinct from the
Bank and Palmetto Capital and depends for its revenues on the payment of
dividends from the Bank. Current federal law would prohibit, except under
certain circumstances and with prior regulatory approval, an insured depository
institution, such as the Bank, from paying dividends or making any other capital
distribution if, after making the payment or distribution, the institution would
be considered "undercapitalized," as that term is defined in applicable
regulations. In addition, as a South Carolina-chartered bank, the Bank is
subject to legal limitations on the amount of dividends it is permitted to pay.
In particular, the Bank must receive the approval of the South Carolina
Commissioner of Banking prior to paying dividends to Bancshares.
CAPITAL ADEQUACY
Bancshares. The Federal Reserve has adopted risk-based capital guidelines for
bank holding companies. Under these guidelines, the minimum ratio of total
capital to risk-weighted assets (including certain off-balance sheet activities,
such as standby letters of credit) is 8%. At least half of the total capital is
required to be "Tier 1 capital," principally consisting of common shareholders'
equity, noncumulative preferred stock, a limited amount of cumulative perpetual
preferred stock and minority interest in the equity accounts of consolidated
subsidiaries, less certain goodwill items. The remainder (Tier 2 capital) may
consist of a limited amount of subordinated debt and intermediate-term preferred
stock, certain hybrid capital instruments and other debt securities, perpetual
preferred stock and a limited amount of the general loan loss allowance. In
addition to the risk-based capital guidelines, the Federal Reserve has adopted a
minimum Tier 1 (leverage) capital ratio under which a bank holding company must
maintain a minimum level of Tier 1 capital (as determined under applicable
rules) to average total consolidated assets of at least 3% in the case of bank
holding companies which have the highest regulatory examination ratios and are
not contemplating significant growth or expansion. All other bank holding
companies are required to maintain a ratio of at least 100 to 200 basis points
5
above the stated minimum. At December 31, 1998, Bancshares was in compliance
with both the risk-based capital guidelines and the minimum leverage capital
ratio.
The Bank. As a state-chartered, FDIC-insured institution which is not a member
of the Federal Reserve System, the Bank is subject to capital requirements
imposed by the FDIC. The FDIC requires state-chartered nonmember banks to comply
with risk-based capital standards substantially similar to those required by the
Federal Reserve, as described above. The FDIC also requires state-chartered
nonmember banks to maintain a minimum leverage ratio similar to that adopted by
the Federal Reserve. Under the FDIC's leverage capital requirement, state
nonmember banks that (a) receive the highest rating during the examination
process and (b) are not anticipating or experiencing any significant growth are
required to maintain a minimum leverage ratio of 3% of Tier 1 capital to total
assets; all other banks are required to maintain a minimum leverage ratio of not
less than 4%. As of December 31, 1998, the Bank was in compliance with both the
risk-based capital guidelines and the minimum leverage capital ratio. For
further discussion on the Bank's current capital rating, see notes to
consolidated financial statements number 17.
INSURANCE
As an FDIC-insured institution, the Bank is subject to insurance assessments
imposed by the FDIC. Under current law, the insurance assessment to be paid by
insured institutions shall be as specified in a schedule required to be issued
by the FDIC that specifies, at semiannual intervals, target reserve ratios
designed to increase the FDIC insurance fund's reserve ratio to 1.25% of
estimated insured deposits (or such higher ratio as the FDIC may determine in
accordance with the statute) in 15 years. Further, the FDIC is authorized to
impose one or more special assessments in any amount deemed necessary to enable
repayment of amounts borrowed by the FDIC from the United States Department of
the Treasury (the "Treasury Department").
Effective January 1, 1993, the FDIC implemented a risk-based assessment
schedule, having assessments ranging from 0.23% to 0.31% of an institution's
average assessment base. The actual assessment to be paid by each FDIC-insured
institution is based on the institution's assessment risk classification, which
is determined based on whether the institution is considered "well capitalized,"
"adequately capitalized" or "undercapitalized," as such terms have been defined
in applicable federal regulations adopted to implement the prompt corrective
action provisions of FEDERAL DEPOSIT INSURANCE CORPORATION INSURANCE ACT
("FDICIA") (see "Other Safety and Soundness Regulations -- Prompt Corrective
Action" below), and whether such institution is considered by its supervisory
agency to be financially sound or to have supervisory concerns. In August 1995,
the FDIC approved a reduction in the insurance assessments for Bank Insurance
Fund ("BIF") deposits. This reduction decreased the Bank's insurance assessment
for BIF deposits from 0.26% to 0.04% of the average assessment base. During
1996, the insurance assessment for the Bank's BIF deposits was set at zero
(although banks pay a $2 annual fee) due to the fact that it was "well
capitalized." In 1997 and most of 1998, the Bank was "adequately capitalized,"
and paid insurance premiums ranging from 0.00% to 0.27% of the average
assessment base. Now the Bank has returned to the "well capitalized" category
and should see a reduction in FDIC insurance premiums in 1999.
Under the DEPOSIT INSURANCE FUND ACT, BIF-assessable deposits are subject to
assessment for payment on the $780 million annual Financing Corporation ("FICO")
bond obligation at 1/5 the rate of Savings Association Insurance Fund-assessable
deposits. Accordingly, the FDIC has estimated that the annual FICO rate will be
1.30 basis points per $100 of BIF-assessable deposits in the years 1997 -- 1999.
Starting in the year 2000 until the FICO bonds are retired, banks and thrifts
will pay the assessment on a pro rata basis (estimated at 2.5 basis points for
banks).
OTHER SAFETY AND SOUNDNESS REGULATIONS
Prompt Corrective Action. Current law provides the federal banking agencies with
broad powers to take prompt corrective action to resolve problems of insured
depository institutions. The extent of these powers depends upon whether the
institutions in question are "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Under uniform regulations defining such capital levels issued
by each of the federal banking agencies, a bank is considered "well capitalized"
if it has (i) a total risk-
6
based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of
6% or greater, (iii) a leverage ratio of 5% or greater, and (iv) is not subject
to any order or written directive to meet and maintain a specific capital level
for any capital measure. An "adequately capitalized" bank is defined as one that
has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1
risk-
based capital ratio of 4% or greater, and (iii) a leverage ratio of 4% or
greater (or 3% or greater in the case of a bank with a composite CAMELS rating
of 1). A bank is considered (A) "undercapitalized" if it has (i) a total
risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio
of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of
a bank with a composite CAMELS rating of 1); (B) "significantly
undercapitalized" if the bank has (i) a total risk-based capital ratio of less
than 6%, or (ii) a Tier 1 risk-based capital ratio of less than 3%, or (iii) a
leverage ratio of less than 3%; and (C) "critically undercapitalized" if the
bank has a ratio of tangible equity to total assets equal to or less than 2%. At
December 31, 1998, Bancshares and the Bank each currently meet the definition of
well capitalized.
Brokered Deposits. Current federal law also regulates the acceptance of brokered
deposits by insured depository institutions to permit only a "well capitalized"
depository institution to accept brokered deposits without prior regulatory
approval. Under FDIC regulations, "well capitalized" insured depository
institutions may accept brokered deposits without restriction, "adequately
capitalized" insured depository institutions may accept brokered deposits with a
waiver from the FDIC (subject to certain restrictions on payments of interest
rates), while "undercapitalized" insured depository institutions may not accept
brokered deposits. The regulations provide that the definitions of "well
capitalized," "adequately capitalized" and "undercapitalized" are the same as
the definitions adopted by the agencies to implement the prompt corrective
action provisions of FDICIA (as described in the previous paragraph). Bancshares
does not believe that these regulations will have a material adverse effect on
its current operations.
Other FDICIA Regulations. To facilitate the early identification of problems,
FDICIA required the federal banking agencies to prescribe more stringent
reporting requirements. The FDIC final regulations implementing those
provisions, among other things, require that management report on the
institution's responsibility for preparing financial statements and establishing
and maintaining an internal control structure and procedures for financial
reporting and compliance with designated laws and regulations concerning safety
and soundness, and that independent auditors attest to and report separately on
assertions in management's reports concerning compliance with such laws and
regulations, using FDIC approved audit procedures. These regulations apply to
financial institutions with greater than $500 million in assets at the beginning
of their fiscal year. Accordingly, the Bank is now subject to these regulations.
COMMUNITY REINVESTMENT ACT
The Bank is subject to the requirements of the COMMUNITY REINVESTMENT ACT
("CRA"). The CRA requires that financial institutions have an affirmative and
ongoing obligation to meet the credit needs of their local communities,
including low-income and moderate-income neighborhoods, consistent with the safe
and sound operation of those institutions. Each financial institution's efforts
in meeting community credit needs are evaluated as part of the examination
process pursuant to twelve assessment factors. These factors are also considered
in evaluating mergers, acquisitions and applications to open a branch or
facility. The Bank received an "outstanding" rating in its most recent
evaluation dated April 15, 1996.
TRANSACTIONS BETWEEN BANCSHARES, ITS SUBSIDIARIES AND AFFILIATES
Bancshares' subsidiaries are subject to certain restrictions on extensions of
credit to executive officers, directors, principal shareholders or any related
interest of such persons. Extensions of credit (i) must be made on substantially
the same terms, including interest rates and collateral, as those prevailing at
the time for comparable transactions with unaffiliated persons; and (ii) must
not involve more than the normal risk of repayment or present other unfavorable
features. Aggregate limitations on extensions of credit also may apply.
Bancshares' subsidiaries also are subject to certain lending limits and
restrictions on overdrafts to such persons.
Subsidiary banks of a bank holding company are subject to certain restrictions
imposed by the Federal Reserve Act on extensions of credit to the bank holding
company or its nonbank subsidiary, on investments in their securities and on the
use of their securities as collateral for loans to any borrower. Such
restrictions may limit Bancshares' ability to obtain funds from its bank
subsidiary for its cash needs, including funds for acquisitions, interest and
operating expenses.
In addition, under the BHCA and certain regulations of the Federal Reserve, a
bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with any extension of credit, lease or
sale of property or furnishing of services. For example, a subsidiary may not
generally require a customer to obtain other services from any other subsidiary
or Bancshares, and may not require the customer to promise not to obtain other
services from a competitor, as a condition to an extension of credit to the
customer.
7
Item 2. Properties
The corporate headquarters, the telephone banking center, and the finance,
operations, data processing, trust, human resources, loan administration,
internal audit and marketing departments are located in a facility at 301
Hillcrest Drive, Laurens, South Carolina ("Corporate Center"). The main office
of the Bank is located in a facility at 101 West Main Street, Laurens, South
Carolina which also contains a three lane drive-in facility.
The Bank has twenty-six full-service branches in the Upstate region of South
Carolina in the following locations: Laurens (3), Duncan, Clinton, Greenwood
(2), Ninety-Six, Fountain Inn, Hodges, Mauldin, Simpsonville, Anderson (2),
Greenville (5), Pendleton, Spartanburg (3), Inman, Blacksburg and Gaffney.
The Bank has automatic teller machines at the following branches: Church Street
(Laurens), Clinton, Montague Avenue (Greenwood), South Main (Greenwood),
Ninety-Six, Fountain Inn, Mauldin, Simpsonville, Woodruff Road (Greenville),
Haywood Road (Greenville), East North Street at Howell Road (Greenville), Grove
Road (Greenville), Blackstock Road (Spartanburg), Hillcrest (Spartanburg),
Duncan, Inman, Blacksburg, Gaffney, Pendleton, Anderson and North Anderson
branches. The Bank also has ATM's at three non-branch locations: the Flour
Daniel office complex (Greenville), and the Cato Corners Shopping Center
(Laurens). In addition, the Bank owns five limited service branches in various
retirement centers located in the Upstate region of South Carolina.
The Bank owns all of its facilities except the following leased facilities,
which have annual rental expenses from $1 to $115:
East North Street, Haywood Road, East North Street at Howell Road, Woodruff Road
offices - Greenville
Spartan Centre, Blackstock Road, Fernwood, Hillcrest offices - Spartanburg
Gaffney office - Gaffney
South Main Street and Ninety-Six offices - Greenwood
North Main office - North Anderson
Offices range in size from branch locations of approximately 800 to 10,000
square feet, to the Corporate Center location of approximately 55,000 square
feet. The Corporate Center underwent renovations in 1996 totalling approximately
$700 (thousand). Because of the renovations, this location houses the corporate
offices, finance department, and telephone banking center. All facilities are
protected by alarm and security systems which meet or exceed regulatory
standards. Each facility is in good condition and capable of handling increased
volume. All of the locations are considered suitable and adequate for their
intended purposes.
Item 3. Legal Proceedings
Bancshares is not currently engaged in legal proceedings. From time to time the
Bank is involved in legal proceedings incidental to its normal course of
business as a bank. Management believes none of these proceedings is likely to
have a materially adverse effect on the business of Bancshares or the Bank.
8
PART II
Item 5. Market for Registrant's Common Stock and Related Shareholder Matters
There is no public market for the common stock of Bancshares or the Bank. The
last known selling price of Bancshares' common stock, based on information
available to Bancshares' management, was $38.00 per share on February 17, 1999.
As of February 23, 1999, the Company had 746 shareholders with 3,102,795 shares
outstanding.
Bancshares, or its predecessor, the Bank, has paid regular dividends on common
stock since 1909. For the years ended December 31, 1998, 1997 and 1996,
Bancshares paid cash dividends of $1,544 or $0.50 per share, $1,165 or $0.38 per
share, and $842 or $0.28 per share, respectively. These dollars equate to
dividend payout ratios (dividends declared divided by net income) of 22.54%,
19.66% and 17.72% in 1998, 1997 and 1996, respectively. Certain other
information concerning dividends and historical trading prices is set forth
below.
QUARTERLY COMMON STOCK DATA
Set forth below is information concerning high and low sales prices by quarter
for each of the last two fiscal years and dividend information for the last two
fiscal years. The Company's common stock is not traded on any established public
trading market. The Company acts as its own transfer agent, and the information
concerning sales prices set forth below is derived from the Company's stock
transfer records. As of December 31, 1998, there were 748 shareholders of
record.
SALES PRICES BY QUARTER
Fiscal Year 1998 HIGH LOW
---------------- ----------------------
First Quarter $29.00 $28.00
Second Quarter $35.00 $29.00
Third Quarter $37.00 $35.00
Fourth Quarter $37.00 $35.00
Fiscal Year 1997
First Quarter $22.50 $20.00
Second Quarter $26.50 $20.00
Third Quarter $26.00 $26.00
Fourth Quarter $28.00 $26.00
DIVIDENDS PAID PER SHARE
Fiscal Year 1998 Fiscal Year 1997
---------------- ----------------
March 31 $.12 March 28 $.08
June 30 $.12 June 30 $.09
September 30 $.13 September 30 $.10
December 28 $.13 December 26 $.11
The ability of Bancshares to pay dividends depends upon the amount of dividends
that is received from the Bank. The only restrictions on the amount of dividends
available for payment to Bancshares are guidelines established by the regulatory
authorities for capital to asset ratios. As of December 31, 1998, the Bank's
primary capital to asset ratio was 8.06%.
9
Item 6. Selected Financial Data
5 Year Summary
FOR THE YEAR 1998 1997 1996 1995 1994
---------------------------------------------------------------------------------------
Total interest income $ 40,829 36,969 32,191 26,268 21,293
Total interest expense 16,440 15,841 13,810 10,842 7,208
Net interest income 24,389 21,128 18,381 15,426 14,085
Provision for loan losses 1,877 1,331 1,450 1,140 819
Total non-interest income 6,468 5,628 5,018 4,192 4,029
Total non-interest expense 19,130 17,085 15,544 13,630 13,625
Income before income taxes 9,850 8,340 6,405 4,848 3,670
Income tax provision 3,000 2,415 1,652 1,246 910
Net income 6,850 5,925 4,753 3,602 2,760
- ----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income per share-basic, not subject to put/call $ 2.10 1.97 1.54 1.20 0.92
Net income per share-dilutive, not subject to put/call 2.04 1.93 1.51 1.18 0.91
Cash dividends declared 0.50 0.38 0.28 0.22 0.18
Book value at year end (1) 13.62 11.99 10.45 9.27 8.07
Average common shares outstanding (1) 3,089,159 3,054,877 3,007,661 3,010,320 3,000,690
- ----------------------------------------------------------------------------------------------------------------------------------
AT YEAR END
Total assets $ 577,400 513,207 468,377 376,241 312,143
Investment securities 112,542 97,731 82,447 83,404 63,909
Loans 410,012 367,585 332,986 255,187 215,408
Total deposits 499,673 449,390 412,386 329,659 274,527
Total shareholders' equity (2) 42,085 36,616 31,438 27,909 24,213
Total shareholders' equity 37,353 32,832 28,124 25,138 24,213
Common shares outstanding 3,099,695 3,089,552 3,023,841 3,014,940 3,013,452
Full-time equivalent employees 306 281 257 219 210
- ----------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Assets $ 541,799 493,737 430,718 342,374 304,883
Investment securities 102,635 97,136 86,655 73,395 67,364
Loans 389,767 350,493 301,839 230,908 204,959
Deposits 467,749 432,031 373,244 294,608 264,785
Total shareholders' equity (2) 39,552 33,858 29,131 26,142 22,868
- ----------------------------------------------------------------------------------------------------------------------------------
KEY RATIOS (1)
Return on average assets 1.26% 1.20% 1.10% 1.05% 0.91%
Return on average equity 17.32% 17.50% 16.32% 13.78% 12.07%
Primary capital to assets at year end 8.21% 8.06% 7.65% 8.33% 8.64%
Net interest margin (fully tax-equivalent) 5.07% 4.80% 4.88% 5.23% 5.33%
Allowance for loan losses to total loans 1.41% 1.40% 1.42% 1.45% 1.40%
Nonperforming assets to total assets 0.33% 0.25% 0.24% 0.20% 0.20%
Net charge-offs to average loans 0.32% 0.26% 0.14% 0.20% 0.10%
Average equity to average asset ratio 7.30% 6.86% 6.76% 7.64% 7.50%
(1) These numbers are calculated using balances and shares of total common
stock outstanding excluding reclassification of ESOP stock for $4,732,
$3,784 and $3,314 at December 31, 1998, 1997 and 1996, respectively.
(2) Excluding reclassification of ESOP stock for $4,732, $3,784 and $3,314 at
December 31, 1998, 1997 and 1996, respectively.
10
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto. The consolidated financial
statements of Palmetto Bancshares, Inc. and subsidiaries (the "Company"),
represent account balances for Palmetto Bancshares, Inc., (the "Parent
Company"), and its wholly-owned subsidiary, The Palmetto Bank, (the "Bank"), and
the Bank's wholly-owned subsidiary, Palmetto Capital, Inc.
Year 2000 Readiness Disclosure
The Year 2000 problem consists of the inability or potential inability of
various software and hardware, including non-computer equipment using embedded
microprocessors, to function properly or at all when dealing with dates beyond
December 31, 1999. The problem has arisen because until recently most software
and hardware was designed to accept only two-digit date codes for the year and
to assume that the first two digits were "19."
The Company has completed a study to determine the remedial action necessary to
deal with the year 2000 problem with respect to its information technology
systems and business relationships. While most view the project as a data
processing or computer concern, every department and function of the Company are
affected and have been included in the Company's analysis and compliance
process. The significance of the risks for noncompliance are substantial and
include both business and legal risks to the Company. The process of assessing
the problem has been completed. Year 2000 project progress has been and will
continue to be reported to the Board of Directors at least quarterly until
complete. The historical and estimated direct costs of remediation are not
expected to exceed $150.
INFORMATION TECHNOLOGY SYSTEMS
The Company's information technology ("IT") systems consist of proprietary and
third-party software installed on a mainframe, three local area networks
("LANs") and over 125 terminals, most of which are also personal computers
("PCs"). The mainframe vendor has assured the Company that the mainframe and its
operating system software are Year 2000 compliant, and have been certified as
such by the Information Technology Association of America ("ITAA"). ITAA is a
consortium of more than 11,000 IT professionals committed to developing and
standardizing some of the best IT practices in the world. ITAA is currently the
only independent provider of a Year 2000 certification program. All of the
Company's testing of the network hardware and software associated with the LANs
indicates that such hardware and software is now Year 2000 ready. With respect
to PCs, the Company has identified which PC hardware and software is specified
by the manufacturer as Year 2000 compliant and is in the process of upgrading as
necessary, depending generally on the extent to which specific hardware or
software is mission critical for the Company.
The Company has successfully advanced the core application systems' "test bank"
to April 4, 2000, with such testing revealing no Year 2000 problems. This "test
bank" emulates a production environment, involving relevant applications
software, system software, hardware and critical internal and external
interfaces. Company employees also participate in the user group of the vendor
of this core banking applications system. This user group has also successfully
tested the vendor's systems for Year 2000 readiness. The costs of rennovating
the core system to make it Year 2000 ready were included as part of the
Company's on-going maintenance agreement with the vendor. In addition to the
core banking applications system, the Company has successfully tested its credit
decision making and trust operations software.
ATMS
To address potential Year 2000 problems, the Company has reconfigured its
automatic teller machines ("ATMs") to utilize the mainframe's Year 2000
compliant operating system.
TRANSACTIONS WITH THIRD PARTIES
Other primary areas where Year 2000 compliance is a material issue for the
Company include transactions with the Federal Reserve, payroll processing and
management of the Company's investment portfolio. Testing of the Company's
ability to conduct transactions with the Federal Reserve via the Fedline has not
uncovered any Year 2000 problems. In addition, the Company recently transferred
its payroll processing to a new vendor willing to assure Year 2000 compliance.
The new payroll processing system has been certified Year 2000 ready by ITAA,
and over the next several months, the Company will be conducting Year 2000
testing of the new system. Finally, the Company has
11
reviewed results of Year 2000 testing performed by the Company's agent for its
portfolio account. Those results indicate that the portfolio agent's systems are
Year 2000 ready.
YEAR 2000 IMPACT ON THE LOAN PORTFOLIO
The Company is evaluating the Year 2000 readiness of its borrowers and the
potential effect of such readiness, or lack thereof, on the credit quality of
its loan portfolio. A Year 2000 credit risk policy has been developed requiring
that a risk assessment be performed on new and existing borrowers, with the
exception of certain borrowers that are not significantly exposed to the Year
2000 problem or whose aggregate outstanding debt to the Company is relatively
minimal. As of December 31, 1998, all borrowers covered by the Year 2000 credit
risk policy had been assigned a Year 2000 credit risk rating.
BUSINESS RESUMPTION CONTINGENCY PLANS
Based on the results of the system-wide testing conducted so far and the
Business Resumption Contingency Plans being developed, the Company believes it
will be Year 2000 ready by December 31, 1999. By June 30, 1999, all Business
Resumption Contingency Plans will be completed. These contingency plans will
include consideration of the most reasonably likely worst case scenario that the
Company could encounter.
General
On April 13, 1998, the Bank opened a new office on Butler Road in Mauldin, South
Carolina, which is located in Greenville County. On April 17, 1998, the Bank
assumed the deposits of Greenwood Bank & Trust's Ninety-Six office located in
Greenwood County, South Carolina. This assumption of approximately $2 million
increased the Bank's presence in this market. On April 20, 1998, the Bank opened
a new office on Woodruff Road in Greenville, South Carolina. These openings
bring the Bank's total number of branches to 26.
The Company's assets grew $64,193, or 13%, total loans grew $42,427, or 12%, and
deposits grew $50,283, or 11% in 1998 as a result of growth in all geographic
markets. In 1997, total assets grew $44,830, or 10%, total loans grew $34,599,
or 10%, and deposits grew $37,004, or 9%.
Results of Operations
Three Years Ended December 31, 1998, 1997 and 1996
Net income for 1998 was $6,850, an increase of 16% from the $5,925 reported in
1997. Net income in 1997 increased 25% from the $4,753 reported in 1996. Net
income per common share-basic, not subject to put/call was $2.10 in 1998,
compared with $1.97 in 1997, and $1.54 in 1996. Net income per common
share-dilutive, not subject to put/call was $2.04 in 1998, compared with $1.93
in 1997, and $1.51 in 1996. Return on average assets before effect of the ESOP
adjustment (discussed on page 25) was 1.26% in 1998 compared with 1.20% in 1997
and 1.10% in 1996.
Net Interest Income
The largest component of the Company's net income is the Bank's net interest
income, defined as the difference between gross interest and fees on earning
assets (primarily loans and investment securities), and interest paid on
deposits and borrowed funds. Net interest income is affected by the interest
rate earned or paid and by volume changes in loans, securities, deposits and
borrowed funds.
In 1998, net interest income was $24,389, which represented a 15% increase over
the $21,128 earned in 1997. This increase is due to increases in the volume of
earning assets and an increase in the net interest margin. In 1997, net interest
income increased $2,747 or 15%, over the $18,381 earned in 1996.
During 1998, the average tax equivalent yield on all interest-earning assets was
8.38%, up from 8.29% and down from 8.42% in 1997 and 1996, respectively. The
prime interest rate remained constant at 8.25% for most of 1998, compared to an
average prime rate of 8.5% and 8.25% for 1997 and 1996, respectively. The Bank's
average effective rate paid on all interest-bearing liabilities decreased in
1998 to 3.86%, from 4.06% and 4.05% in 1997 and 1996, respectively. The Bank's
net tax equivalent yield on interest-earning assets (net interest margin) was
5.07%, 4.80%
12
and 4.88% in 1998, 1997 and 1996, respectively. The Company was able to increase
its net interest margin through strategic asset-liability management as
discussed on page 16.
Interest and fees on loans increased $3,840, or 12% from 1997 to 1998, and
increased $3,908, or 15% from 1996 to 1997 due to loan growth of 12% in 1998 and
10% in 1997. Interest on investment securities increased $38 or 1% from 1997 to
1998 due to a 15% growth in securities, offset by a decrease in the fully
tax-equivalent weighted average rate on the security portfolio from 6.72% in
1997 to 6.59% in 1998. Interest on investment securities increased $616 or 12%
from 1996 to 1997 due to an 19% growth in securities. Interest income on federal
funds sold decreased $79 or 27% due to lower average balances invested. This
compares to an increase of $198, or 213%, from 1996 to 1997 due to higher
average balances invested.
Total interest expense increased 4% or $599 from 1997 to 1998 and 15% or $2,031
from 1996 to 1997. The largest component of total interest expense is interest
expense on deposits, which increased $342 or 2% from 1997 to 1998 due to a 11%
growth in deposits, offset by effective management of the cost of deposits.
Interest expense on deposits increased $2,092 or 16% from 1996 to 1997 due to a
9% growth in deposits. The average rate paid on deposits was 3.24%, 3.43% and
3.41% in 1998, 1997 and 1996, respectively.
Interest on securities sold under agreements to repurchase increased $81, or 14%
from 1997 to 1998 due to an increase in the average balances outstanding, offset
by a decrease in the average rate paid from 4.01% to 3.97%. This compares to an
increase of $99, or 22% from 1996 to 1997 due to an increase in the average rate
paid from 3.84% to 4.01%. Interest on commercial paper increased $139, or 37%,
from 1997 to 1998 due to an increase in the average rate paid from 4.06% to
4.11% and an increase in the average balances outstanding during the year. This
compares to an increase of $68, or 22%, from 1996 to 1997 due to an increase in
the average rate paid from 3.88% to 4.06%. For more information on short term
borrowings, please see notes to consolidated financial statements number 9.
Rate/Volume Analysis
The following table includes, for the years ended December 31, 1998, 1997 and
1996 interest income on earning assets and related average yields, as well as
interest expense on liabilities and related average rates paid. Also shown are
the dollar amounts of change due to rate and volume variances. The effect of the
combination of rate and volume change has been divided equally between the rate
change and volume change.
13
TABLE 1
Rate Volume Analysis
1998 1997
-------------------------------------------------------- ---------------
Average Income/ Volume Rate Average
Assets Balances Expense Yield Change Change Balances
-------- ------- ----- ------ ------ --------
Cash and due from banks $ 22,145 $ 20,098
Federal funds sold 3,876 $ 211 5.44% $ (86) $ 6 5,465
Federal Home Loan Bank stock 1,520 118 7.76% 55 7 779
Taxable investment securities 53,756 3,357 6.24% (452) (85) 60,915
Non-taxable investment securities 48,879 3,408 6.97% 902 (131) 36,221
Loans, net of unearned discount 389,767 34,600 8.88% 3,467 373 350,493
Less: allowance for loan losses (5,393) (4,876)
------------ ---------------
Net loans 384,374 345,617
Premises and equipment, net 14,255 12,679
Accrued Interest 4,065 3,563
Other assets 8,929 8,400
------------ ---------------
Total assets $ 541,799 $ 493,737
============ ===============
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Non-interest bearing demand 73,266 66,333
Interest-bearing demand 147,580 2,788 1.89% 392 (334) 128,098
Savings 28,718 663 2.31% 26 (39) 27,639
Time 218,185 11,706 5.37% 444 (148) 209,961
-------------------------------------------------------- ---------------
Total deposits 467,749 15,157 3.24% 1,191 (850) 432,031
Federal funds purchased and
securities sold under
agreements to repurchase 18,747 762 4.06% 144 (26) 15,279
Commercial paper 12,668 521 4.11% 134 6 9,382
Other liabilities 3,083 3,187
------------ ---------------
Total liabilities 502,247 459,879
Shareholders' equity:
Common stock - $5.00 par value 15,445 15,288
Capital surplus 302 325
Retained earnings 23,547 18,101
Less: Treasury stock - (37)
Accumulated other
comprehensive income 258 181
------------ ---------------
Total shareholders' equity 39,552 33,858
------------ ---------------
Total liabilities and
shareholders' equity $ 541,799 $ 493,737
============ ===============
Average yield on all interest-earning assets (fully taxable equivalent) 8.38%
Average effective rate paid on all interest-bearing liabilities 3.86%
Net yield on interest-earning assets (fully taxable equivalent) 5.07%
Yields on non-taxable investment securities are stated on a fully taxable
equivalent basis, assuming a federal tax rate of 34% for the three years
reported on. The adjustments made to convert to a fully taxable equivalent basis
were $865, $669 and $655 for 1998, 1997 and 1996, respectively.
The effect of foregone interest income as a result of loans on non-accrual was
not considered in the above analysis.
14
TABLE 1
(CONTINUED)
1997 1996
- -------------------------------------------------------- --------------------------------------------------------------------
Income/ Volume Rate Average Income/ Volume Rate
Expense Yield Change Change Balances Expense Yield Change Change
------- ----- ------ ------ -------- ------- ----- ------ ------
$ 23,743
$ 291 5.32% $ 197 $ 1 1,758 $ 93 5.29% $ (150) $ (137)
56 7.19% 28 28 - - - - -
3,894 6.39% 293 283 56,145 3,318 5.91% 532 (338)
2,637 7.28% 450 (396) 30,510 2,583 8.47% 387 164
30,760 8.78% 4,299 (391) 301,839 26,852 8.90% 6,445 (1,016)
(4,088)
------------
297,751
11,670
3,260
5,881
------------
$ 430,718
============
58,440
2,730 2.13% 277 (240) 115,674 2,693 2.33% 371 (157)
676 2.45% 32 (9) 26,331 653 2.48% 127 (74)
11,410 5.43% 2,018 13 172,799 9,379 5.43% 2,389 83
- ---------------------------------------------------- ----------------------------------------------------------------
14,816 3.43% 2,010 82 373,244 12,724 3.41% 2,673 65
644 4.21% (103) (25) 17,668 773 4.37% 241 30
381 4.06% 52 16 8,075 313 3.88% 2 (30)
2,600
------------
401,587
15,165
334
13,671
(312)
273
------------
29,131
------------
$ 430,718
============
8.29% 8.42%
4.06% 4.05%
4.80% 4.88%
15
Asset-Liability Management and Market Risk Sensitivity
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises principally from interest rate risk inherent in
its lending, deposit and borrowing activities. Management actively monitors and
manages its inherent rate risk exposure. Although the Company manages other
risks, as in credit quality and liquidity risk, in the normal course of
business, management considers interest rate risk to be its most significant
market risk and could potentially have the largest material effect on the
Company's financial condition and results of operations. Other types of market
risks, such as foreign currency exchange rate risk and commodity price risk, do
not arise in the normal course of the Company's business activities.
The Company's profitability is affected by fluctuations in interest rates.
Management's goal is to maintain a reasonable balance between exposure to
interest rate fluctuations and earnings. A sudden and substantial increase in
interest rates may adversely impact the Company's earnings to the extent that
the interest rates on interest-earning assets and interest-bearing liabilities
do not change at the same speed, to the same extent or on the same basis. The
Company monitors the impact of changes in interest rates on its net interest
income using several tools.
The Bank's goal is to minimize interest rate risk between interest bearing
assets and liabilities at various maturities through its Asset-Liability
Management (ALM). ALM involves managing the mix and pricing of assets and
liabilities in the face of uncertain interest rates and an uncertain economic
outlook. It seeks to achieve steady growth of net interest income with an
acceptable amount of interest rate risk and sufficient liquidity. The process
provides a framework for determining, in conjunction with the profit planning
process, which elements of the Company's profitability factors can be controlled
by management. Understanding the current position and implications of past
decisions is necessary in providing direction for the future financial
management of the Company. The Company uses an asset-liability model to
determine the appropriate strategy for current conditions.
Interest sensitivity management is part of the asset-liability management
process. Interest sensitivity gap (GAP) is the difference between total rate
sensitive assets and rate sensitive liabilities in a given time period. The
Company's rate sensitive assets are those repricing within one year and those
maturing within one year. Rate sensitive liabilities include insured money
market accounts, savings accounts, interest-bearing transaction accounts, time
deposits and borrowings. The profitability of the Company is influenced
significantly by management's ability to manage the relationship between rate
sensitive assets and liabilities. At December 31, 1998, approximately 27% of the
Company's earning assets could be repriced within one year compared to
approximately 92% of its interest-bearing liabilities. This compares to 26% and
95%, respectively, in 1997 and 28% and 93%, respectively, in 1996.
The Company's current GAP analysis reflects that in periods of increasing
interest rates, rate sensitive assets will reprice slower than rate sensitive
liabilities. The Company's GAP analysis also shows that at the interest
repricing of one year, the Company's net interest margin would be adversely
impacted. This analysis, however, does not take into account the dynamics of the
marketplace. GAP is a static measurement that assumes if the prime rate
increases by 100 basis points, all assets and liabilities that are due to
reprice will increase by 100 basis points at the next opportunity. However, the
Company is actually able to experience a benefit from rising rates in the short
term because deposit rates do not follow the national money market. They are
controlled by the local market. Loans do follow the money market; so when rates
increase they reprice immediately, but the Company is able to manage the deposit
side. The Company generally does not raise deposit rates as fast or as much. The
Company also has the ability to manage its funding costs by choosing alternative
sources of funds.
The Company's current GAP position would also be interpreted to mean that in
periods of declining interest rates, the Company's net interest margin would
benefit. However, competitive pressures in the local market may not allow the
Company to lower rates on deposits, but force the Company to lower rates on
loans.
Because the Company's management feels that GAP analysis is a static
measurement, it manages its interest income through its asset-liability
strategies which focus on a net interest income model based on management's
projections. The Company has a targeted net interest income range of plus or
minus twenty percent based on a 300 basis point shock over twelve months. At
December 31, 1998, this model shows that if interest rates rose by 300 basis
points over the next twelve months, net interest margin would be adversely
affected by approximately 10%. The asset-liability committee meets weekly to
address interest pricing issues, and this model is reviewed monthly. Management
will continue to monitor its liability sensitive position in times of higher
interest rates which might adversely affect its net interest margin.
16
Computation of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay rates, and should not be relied upon
as indicative of actual results. Further, the computations do not contemplate
any actions the Company could undertake in response to changes in interest
rates.
On the following pages, Table 2 shows the Company's financial instruments that
are sensitive to changes in interest rates, categorized by expected maturity,
and the instruments' fair values at December 31, 1998. Market risk sensitive
instruments are generally defined as on- and off-balance sheet derivatives and
other financial instruments.
Notes to Market Risk Sensitivity table:
o Expected maturities are contractual maturities adjusted for prepayments of
principal when possible. The Company uses certain assumptions to estimate
fair values and expected maturities.
o For loans, the Company has used contractual maturities due to the fact that
the Company has no historical information on prepayment speeds. Since most
of these loans are consumer and commercial loans, and since the Company's
customer base is community-based, the Company feels its prepayment rates
are insignificant.
o For mortgage-backed securities, expected maturities are based upon
contractual maturity, projected repayments and prepayment of principal. The
prepayment experience herein is based on industry averages as provided by
the Company's investment trustee.
o Loans receivable includes non-performing loans and unamortized deferred
loan costs, and is reduced by unamortized discounts. It does not include
Loans Held for Sale as those are not considered to be interest-sensitive
given that the Bank already has commitments to sell these loans at agreed
upon rates.
o Interest-bearing liabilities are included in the period in which the
balances are expected to be withdrawn as a result of contractural
maturities. For accounts with no stated maturities, the balances are
included in the one day category.
o The interest rate sensitivity gap represents the difference between total
interest-earning assets and total interest-bearing liabilities.
An important aspect of achieving satisfactory net interest income is the
composition and maturities of rate sensitive assets and liabilities. Table 2
generally reflects that in periods of rising interest rates, rate sensitive
liabilities will reprice faster than rate sensitive assets, thus having a
negative effect on net interest income. It must be understood, however, that
such an analysis is only a snapshot picture and does not reflect the dynamics of
the market place. Therefore, management reviews simulated earnings statements on
a monthly basis to more accurately anticipate its sensitivity to changes in
interest rates.
The table below shows the amounts of loans included in Table 2, except for real
estate-mortgage and installment loans to individuals, due to mature and
available for repricing within the time period stated.
TABLE 3
Maturities and Sensitivity of Selected Loans to Changes in Interest Rates
After 1 Year
1 Year Through After 5
or Less Five Years Years Total
------- ---------- ----- -----
Commercial, financial and agricultural $ 42,721 40,318 9,569 92,608
Real estate-construction 6,634 2,924 702 10,260
--------- --------- -------- --------
Total $ 49,355 43,242 10,721 102,868
========= ========== ======== ========
The amounts of the preceding loans with a maturity over one year which have a
predetermined interest rate or a floating or adjustable interest rate are as
follows:
December 31, 1998
Predetermined interest rate $ 53,513
Floating or adjustable interest rate -
Total $ 53,513
=========
Thirty-three percent of total loans are repricable within one year.
17
TABLE 2
Market Risk Sensitivity
Expected Maturity/Repricing/Principal Repayments at December 31, 1998
1999
-----------------------------------------------------------
Average 2 Days to 3 to 6 6 to 12
Rate 1 Day 3 Months Months Months
---- ----- -------- ------ ------
Interest-sensitive assets:
Federal funds sold 5.44% $ 110 - - -
Federal Home Loan Bank stock 7.76% - - - -
Mortgage-backed investment securities 6.15% 171 3,406 - -
Other investment securities 7.02% 185 - 1,085 2,042
Loans receivable 8.88% 54,043 35,251 31,682 12,794
===========================================================
Total interest-earning assets 8.38% $ 54,509 38,657 32,767 14,836
===========================================================
Interest-sensitive liabilities:
Interest-bearing demand 1.15% 99,762 - - -
Insured money markets 3.05% 56,258 - - -
Savings deposits 2.31% 27,939 - - -
Time deposits over $100 - 21,467 9,609 8,490
Other time deposits 53 67,544 50,888 36,554
===========================================================
Total time deposits 5.37% 53 89,011 60,497 45,044
===========================================================
Short-term borrowings 4.14% 32,489 - - -
===========================================================
Total interest-bearing
liabilities 3.86% $ 216,501 89,011 60,497 45,044
===========================================================
Interest rate sensitivity gap $(161,992) (50,354) (27,730) (30,208)
================================================
Cumulative interest rate sensitivity gap $(161,992) (212,346) (240,076) (270,284)
================================================
Cumulative interest rate sensitive gap
as a % of total interest-earning assets -30.90% -40.51% -45.80% -51.56%
================================================
Off-balance sheet items:
Commitments to extend credit * - - - -
Unused lines of credit 7.94% - - - -
- -----------------------------------------
* There is no way to determine the rates on the commitments because they
have not been set yet. The rates will vary according to prime.
NOTE: For information regarding how fair values were determined, please
see notes to consolidated financial statements, number 15.
18
TABLE 2
(CONTINUED)
- -----------------------------------------------------------------
There- Carrying Fair
2000 2001 2002 2003 after Value Value
---- ---- ---- ---- ----- ----- -----
- - - - - 110 110
- - - - 1,541 1,541 1,541
1,646 1,714 8,381 15,141 - 30,459 30,596
5,180 7,370 6,475 2,568 57,178 82,083 84,228
41,035 42,510 86,056 31,576 75,065 410,012 408,354
-
=========================================================================================
47,861 51,594 100,912 49,285 133,784 524,205 524,829
=========================================================================================
- - - - - 99,762 99,762
- - - - - 56,258 56,258
- - - - - 27,939 27,939
5,978 540 628 - - 46,712
21,226 4,553 4,383 - 13 185,214
=========================================================================================
27,204 5,093 5,011 - 13 231,926 234,101
=========================================================================================
- - - - - 32,489 32,489
=========================================================================================
27,204 5,093 5,011 - 13 448,374 450,549
=========================================================================================
20,657 46,501 95,901 49,285 133,771 75,831
==============================================================================
(249,627) (203,126) (107,225) (57,940) 75,831 -
==============================================================================
-47.62% -38.75% -20.45% -11.05% 14.47% 0.00%
==============================================================================
- - - - 73,539 73,539 73,539
- - - - 15,839 15,839 15,839
19
Provision For Loan Losses
The allowance for possible loan losses is established through charges to expense
in the form of a provision for loan losses. The provision for loan losses was
$1,877, $1,331 and $1,450, respectively, for the years ended December 31, 1998,
1997 and 1996. The provision in 1998 reflects replenishing the allowance for
loan losses to cover net charge-offs of $1,234, plus providing for the 12%
increase in total loans outstanding. The allowance for loan losses totaled
$5,795, $5,152 and $4,729 at December 31, 1998, 1997 and 1996, respectively. The
level of the allowance for loan losses to total loans outstanding is 1.41% at
December 31, 1998. This compares to 1.40% and 1.42% as of December 31, 1997 and
1996, respectively. Net charge-offs to average loans are 0.32% for 1998 as
compared to 0.26% for 1997 and 0.14% for 1996.
TABLE 4
Summary of Loan Loss and Recovery Experience
(Dollars in Thousands)
The allowance for loan losses is based on an in-depth analysis of the loan
portfolio. Specifically, included in that analysis are the following types of
loans: loans determined to be of a material amount, loans commented on by
regulatory authorities, loans which are past due more than 60 days and loans
which are in a non-accrual status. The unallocated portion of the reserve has
been established for other credit risks that are not related to individual
credits but is necessary to provide for probable losses inherent in the loan
portfolio. Based on the above analysis, management makes a provision for
possible loan losses which will bring the allowance for loan losses to an
adequate level.
The following table summarizes the activity in the allowance for loan losses for
the years indicated:
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Average loans, net of unearned discount $ 389,767 350,493 301,839 230,908 204,959
========== ========== ========== ========== ========
Allowance for loan losses:
Beginning balance $ 5,152 4,729 3,700 3,016 2,394
Add provision for loan losses 1,877 1,331 1,450 1,140 819
Loan charge-offs:
Commercial, financial and agricultural 344 158 131 262 100
Real estate - construction - - - - -
Real estate - mortgage - - 92 14 -
Installment loans to individuals 1,018 891 487 337 357
---------- ---------- ---------- ---------- --------
Total loan charge-offs 1,362 1,049 710 613 457
Recoveries of loans previously charged-off:
Commercial, financial and agricultural 5 56 42 60 123
Real estate - construction - - - - -
Real estate - mortgage - - 65 33 -
Installment loans to individuals 123 85 182 64 137
---------- ---------- ---------- ---------- --------
Total recoveries of loans previously charged off 128 141 289 157 260
---------- ---------- ---------- ---------- --------
Net charge-offs 1,234 908 421 456 197
---------- ---------- ---------- ---------- --------
Ending balance $ 5,795 5,152 4,729 3,700 3,016
========== ========== ========== ========== ========
Net charge-offs to average loans, net 0.32% 0.26% 0.14% 0.20% 0.10%
Allowance for loan losses to average
loans, net 1.49 1.47 1.57 1.60 1.47
Allowance for loan losses to total loans at
period-end 1.41 1.40 1.42 1.45 1.40
Losses and recoveries are charged or credited to the allowance at the time
realized.
20
The following table summarizes the allocation of the allowance for loan losses
at December 31:
1998 1997 1996 1995 1994
% of % of % of % of % of
Total Total Total Total Total Total Total Total Total Total
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Balance applicable to:
Commercial,
financial and
agricultural$ 1,309 22.59% 1,145 22.22% 974 20.61% 658 17.78% 457 15.15%
Real estate -
construction 145 2.50 123 2.39 136 2.88 79 2.14 27 0.90
Real estate -
mortgage 3,025 52.20 2,739 53.17 2,582 54.59 2,161 58.40 1,887 62.60
Installment loans
to individuals 1,316 22.71 1,145 22.22 1,037 21.92 802 21.68 644 21.35
------ ------- ------- -------- ------- ------- ----- -------- ------ ------
Total $ 5,795 100.00% 5,152 100.00% 4,729 100.00% 3,700 100.00% 3,016 100.00%
====== ======= ======= ======== ======= ======= ===== ======== ====== ======
Non-Interest Income
Non-interest income for 1998 increased by $840 or 15% over 1997, as compared to
an increase in 1997 of $610 or 12% over 1996. These increases generally resulted
from increased fees for trust services, which continued to increase in 1998 to
$1,343 from $986 in 1997 and $861 in 1996. Fees for trust services increased 36%
as a result of the generation of new trust business and additional assets under
management, which increased 25%. The trust department had assets under
management of $190,866, $152,968 and $122,667 at December 31, 1998, 1997 and
1996, respectively.
A significant contributor to non-interest income is service charges on deposit
accounts which increased 7% as a result of increases in the volume of deposit
relationships. Management views deposit fee income as a critical influence on
profitability. Periodic monitoring of competitive fee schedules and examination
of alternative opportunities insure that the Company realizes the maximum
contribution to profits from this area.
There were $150, $40 and $21 of gains from sales of investment securities during
1998, 1997 and 1996, respectively. These gains were in response to the market
rebound in the recent years. The larger gain in 1998 was due to a conscientious
restructuring of the investment portfolio. In 1998, the Company sold $6 million
of "over-priced" U.S. Treasury notes in order to reinvest in more
economically-priced, shorter-term municipal securities.
Non-Interest Expenses
Non-interest expenses totaled $19,130 in 1998 as compared to $17,085 in 1997 and
$15,544 in 1996. This represented a 12% increase from 1997 to 1998, and a 10%
increase from 1996 to 1997. The overall increases during the year were due to
growth in all geographic markets, which is evidenced by the growth in deposits
of 11% from 1997 to 1998 and 9% from 1996 to 1997. Salaries and other personnel
expense, which comprised 49% of total non-interest expenses for 1998, were up
$960 or 11% over 1997 due to normal salary increases and increased personnel due
to the two new branches. During 1997 and 1996, salaries and other personnel
expenses accounted for 50% and 48%, of total other operating expenses,
respectively.
Combined net occupancy and furniture and equipment expenses increased $381, or
12% from 1997 to 1998, as compared to an increase of $179, or 6%, in 1997. The
increase in 1998 is due to the opening of two new branches. The increase in 1997
is due to normal growth and activity.
Postage and supplies expense increased 22% from $885 in 1997 to $1,081 in 1998.
This increase can be attributed to growth in all geographical markets, as well
as the opening of two new branches in 1998. Postage and supplies expense
increased by only 1% from 1996 to 1997.
21
Income Taxes
Income tax expense totaled $3,000 in 1998 as compared to $2,415 in 1997 and
$1,652 in 1996. The changes in income tax expense for all three years were due
to changes in taxable income for each respective year. Taxable income is
affected by net income, income on tax exempt investment securities and loans,
and the provision for loan losses. For tax purposes, the Bank can only recognize
actual loan losses. The Company works actively with outside tax consultants to
minimize tax expense.
Financial Condition
As of December 31, 1998, 1997 and 1996
At December 31, 1998, Bancshares had total assets of $577.4 million, loans
outstanding of $410.0 million and deposits of $499.7 million. This compares with
total assets of $513.2 million, loans outstanding of $367.6 million and deposits
of $449.4 million, at December 31, 1997; and with total assets of $468.4
million, loans outstanding of $333.0 million and deposits of $412.4 million, at
December 31, 1996. The table on the following page shows the average balances
and distributions of the Company's assets and liabilities for each of the last
four years.
Loans and Asset Quality
Management of the Company believes that the loan portfolio is adequately
diversified. Commercial loans are spread through numerous types of businesses
with no particular industry concentrations. Loans to individuals are made
primarily to finance consumer goods purchased. At December 31, 1998, total
loans, net of unearned discounts, were 78% of total earning assets. Loans
secured by real estate accounted for 55% of total loans as of December 31, 1998.
Most of the loans classified as real estate-mortgage are commercial loans where
real estate provides additional collateral.
Non-accrual loans are those loans which management, through its continuing
evaluation of loans, has determined offer a more than normal risk of
collectability of future interest. Interest income on non-accrual loans is
recognized only as received. Interest on past due loans continues to accrue
until such time that the loans are either charged-off or placed in non-accrual
status. The non-accrual loan policy provides that it is the responsibility of
the chief credit officer to administer the placing of loans on non-accrual
status. Loans which become ninety days past due will be placed on non-accrual.
Loans on which bankruptcy notices are received will also be placed on
non-accrual. In addition, other loans on which repayment appears doubtful may be
placed on non-accrual at the discretion of the chief credit officer.
Non-performing loans for 1998, 1997 and 1996 were approximately $1,572 or 0.38%
(of total loans), $862 or 0.23% and $1,113 or 0.33%, respectively. The majority
of these non-performing loans are smaller-balance homogeneous consumer loans.
For information on impaired loans, please see footnote number 5.
Table 6 on page 24 sets forth, for each loan category, the amounts of total
loans 90 days or more past due and on non-accrual, the amounts of total loans 90
days or more past due and accruing, total loans outstanding, the percentage of
each type of loan 90 days or more past due and the amount of foregone interest
income for each of the five years for December 31, 1994 through December 31,
1998.
22
Table 5
Distribution of Assets and Liabilities
(DOLLARS IN THOUSANDS)
Years Ended December 31,
1998 1998 1997 1997 1996 1996 1995 1995
Average % of Average % of Average % of Average % of
ASSETS Balance Total Balance Total Balance Total Balance Total
------- ----- ------- ----- ------- ----- ------- -----
Cash and due from banks $22,145 4.09% 20,098 4.07% 23,743 5.51% 21,724 6.35%
Federal funds sold 3,876 0.72% 5,465 1.11% 1,758 0.41% 3,684 1.08%
Federal Home Loan Bank stock 1,520 0.28% 779 0.16% - - - -
Taxable investment securities 53,756 9.92% 60,915 12.34% 56,145 13.04% 47,618 13.91%
Non-taxable investment securities 48,879 9.02% 36,221 7.34% 30,510 7.08% 25,777 7.53%
Loans, net of unearned discount 389,767 71.94% 350,493 70.99% 301,839 70.08% 230,908 67.44%
Less: allowance for loan losses (5,393) -1.00% (4,876) -0.99% (4,088) -0.95% (3,247) -0.95%
--------------------------------------------------------------------------------
Net loans 384,374 70.94% 345,617 70.00% 297,751 69.13% 227,661 66.49%
Premises and equipment, net 14,255 2.63% 12,679 2.57% 11,670 2.71% 10,275 3.00%
Accrued Interest 4,065 0.75% 3,563 0.72% 3,260 0.76% 2,495 0.73%
Other assets 8,929 1.65% 8,400 1.70% 5,881 1.37% 3,140 0.92%
--------------------------------------------------------------------------------
Total assets $541,799 100.00% 493,737 100.00% 430,718 100.00% 342,374 100.00%
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits:
Non-interest-bearing deposits 73,266 13.52% 66,333 13.43% 58,440 13.57% 44,299 12.94%
Interest-bearing demand 147,580 27.24% 128,098 25.94% 115,674 26.86% 100,236 29.28%
Savings 28,718 5.30% 27,639 5.60% 26,331 6.11% 21,518 6.28%
Time 218,185 40.27% 209,961 42.52% 172,799 40.12% 128,555 37.55%
--------------------------------------------------------------------------------
Total deposits 467,749 86.33% 432,031 87.50% 373,244 86.66% 294,608 86.05%
Federal funds purchased and securities sold under
agreements to repurchase 18,747 3.46% 15,279 3.09% 17,668 4.10% 12,020 3.51%
Commercial paper 12,668 2.34% 9,382 1.90% 8,075 1.87% 8,017 2.34%
Note payable to a bank - - - - - - 107 0.03%
Other liabilities 3,083 0.57% 3,187 0.65% 2,600 0.60% 1,480 0.43%
--------------------------------------------------------------------------------
Total liabilities 502,247 92.70% 459,879 93.14% 401,587 93.24% 316,232 92.36%
Shareholders equity:
Common stock - $5.00 par value 15,445 2.85% 15,288 3.10% 15,165 3.52% 15,163 4.43%
Capital surplus 302 0.06% 325 0.07% 334 0.08% 333 0.10%
Retained earnings 23,547 4.35% 18,101 3.67% 13,671 3.17% 10,615 3.10%
Less: Treasury stock - - (37) -0.01% (312) -0.07% (239) -0.07%
Accumulated other comprehensive income 258 0.05% 181 0.04% 273 0.06% 270 0.08%
--------------------------------------------------------------------------------
Total shareholders' equity 39,552 7.30% 33,858 6.86% 29,131 6.76% 26,142 7.64%
--------------------------------------------------------------------------------
Total liabilities and shareholders' equity $541,799 100.00% 493,737 100.00% 430,718 100.00% 342,374 100.00%
===============================================================================
23
TABLE 6
Nonperforming Loans
(Dollars in Thousands)
90 Days Foregone
or More Interest
Past Due Percentage Income
and not on Total 90 Days From
Non- Non- Loans or More Non-
Accrual Accrual Outstanding Past Due Accrual
December 31, 1998:
Commercial, financial and agricultural $ 223 - 92,608 0.24% 26
Real estate - construction - - 10,260 0.00 -
Real estate - mortgage 445 - 214,010 0.21 22
Installment loans to individuals 817 87 93,134 0.97 82
--------- ------- --------- -------- ---------
Total $ 1,485 87 410,012 0.38% 130
========= ======= ========= ======== =========
December 31, 1997:
Commercial, financial and agricultural 63 - 81,678 0.08 2
Real estate - construction - - 8,799 0.00 -
Real estate - mortgage 256 - 195,462 0.13 26
Installment loans to individuals 399 144 81,646 0.67 38
--------- ------- --------- -------- ---------
Total $ 718 144 367,585 0.23% 66
========= ======= ========= ======== =========
December 31, 1996:
Commercial, financial and agricultural 140 - 68,617 0.20 4
Real estate - construction - - 9,598 0.00 -
Real estate - mortgage 428 - 181,775 0.24 25
Installment loans to individuals 545 - 72,996 0.75 23
--------- ------- --------- -------- ---------
Total $ 1,113 - 332,986 0.33% 52
========= ======= ========= ======== =========
December 31, 1995:
Commercial, financial and agricultural 146 - 45,377 0.32 20
Real estate - construction - - 5,453 0.00 -
Real estate - mortgage 241 - 149,017 0.16 11
Installment loans to individuals 409 3 55,340 0.74 35
--------- ------- --------- -------- ---------
Total $ 796 3 255,187 0.31% 66
========= ======= ========= ======== =========
December 31, 1994:
Commercial, financial and agricultural 295 - 32,672 0.90 14
Real estate - construction - - 1,941 0.00 -
Real estate - mortgage - - 134,789 0.00 9
Installment loans to individuals 341 18 46,006 0.78 27
--------- ------- --------- -------- ---------
Total $ 636 18 215,408 0.30% 50
========= ======= ========= ======== =========
24
Deposits
For the average balances and average rates paid by category of deposit for the
years ended December 31, 1998, 1997 and 1996, please see Table 1 on pages 14-15.
The company has no foreign deposits.
The following table sets forth, by time remaining to maturity, domestic
certificates of deposit over $100, as of December 31, 1998, 1997 and 1996.
TABLE 7
Maturities of Time Deposits Over $100
1998 1997 1996
---- ---- ----
Maturities:
3 months or less $ 21,467 23,062 18,082
3 through 6 months 9,609 12,206 8,569
6 through 12 months 8,490 11,004 11,286
Over 12 months 7,146 3,680 4,163
------------- ------------- -------------
$ 46,712 49,952 42,100
============= ============= =============
Liquidity
The liquidity ratio is an indication of a company's ability to meet its
short-term funding obligations. The Company's policy is to maintain a liquidity
ratio between 15% - 25%. At December 31, 1998, the Company's liquidity ratio was
approximately 21%.
The Company's liquidity position is dependent upon its debt servicing needs and
dividends declared. The Company had no outstanding debt at December 31, 1998 and
1997, respectively.
During 1991 the Company began selling commercial paper as an alternative
investment tool for its commercial customers (Master note program). The
commercial paper is issued only in conjunction with the automated sweep account
customer agreement on deposits at the Bank level. At December 31, 1998, the
Company had $10,859 in commercial paper with a weighted average rate of 3.06%,
as compared to $11,289 in 1997 with a weighted average of 3.69% and $7,435 in
1996 with a weighted average rate of 4.69%.
The Parent Company's liquidity needs are met through the payment of dividends
from the Bank. At December 31, 1998, the Bank had available retained earnings of
$6,191 for payment of dividends. Prior approval of the Office of the
Commissioner of Banking, State Board of Financial Institutions is required for
any payment of dividends by a state bank.
The Bank's liquidity is affected by its ability to attract deposits, the
maturity of its loan portfolio, the flexibility of its investment securities,
lines of credit from correspondent banks, and current earnings. Sufficient
liquidity must be available to meet continuing loan demand and deposit
withdrawal requirements. Competition for deposits is intense in the markets
served by the Bank. However, the Bank has been able to attract deposits as
needed through pricing adjustments and expansion of its geographic market area.
The deposit base is comprised of diversified customer deposits with no one
deposit or type of customer accounting for a significant portion. Therefore,
withdrawals are not expected to fluctuate from historical levels. The loan
portfolio of the Bank is a source of liquidity through maturities and repayments
by existing borrowers. The investment securities portfolio is a source of
liquidity through scheduled maturities and sales of securities, and prepayment
of principal on mortgage-backed securities. Approximately 62% of the securities
portfolio was pledged to secure liabilities as of December 31, 1998, as compared
to 63% at December 31, 1997. Management believes that its sources of liquidity
are adequate to meet operational needs. Additional sources of short-term
liquidity are existing lines of credit from correspondent banks totaling $80
million, all of which are available. Loan demand has been constant and loan
originations can be controlled through pricing decisions.
25
Capital Resources
At December 31, 1998 the Company and the Bank were each categorized as "well
capitalized," under the regulatory framework for prompt corrective action. At
December 31, 1997 the Company and the Bank were each categorized as "adequately
capitalized," under the regulatory framework for prompt corrective action. There
are no current conditions or events that management believes would change the
Company's or the Bank's category.
The Company was categorized as "adequately capitalized" due to the infusion of
approximately $54,000 in deposits related to the acquisition of the three
branches in 1996. As a result of this change in capital adequacy, the Bank
incurred higher FDIC insurance premiums in 1998 and 1997 compared to 1996. The
Company's strategic plan for controlled growth and profit improvement generated
enough internal capital to return the risk-weighted ratios to the
"well-capitalized" guidelines during 1998. Please see notes to consolidated
financial statements number 17 for the Company's and the Bank's various capital
ratios at December 31, 1998.
Pursuant to the Internal Revenue Code of 1986, as amended, and the regulations
thereunder, the stock in the Employee Stock Option Plan (the "ESOP") has a put
and a call feature if the stock is not "readily tradable on an established
market." This term was clarified in 1995 as a result of a private letter ruling,
to mean publicly listed on a national securities exchange. Since the Company's
stock is not listed on a national securities exchange, the shares in the ESOP
Plan and those recently distributed are subject to the put/call feature.
Accordingly, 270,384 shares of common stock are now recorded outside
shareholders' equity at their fair value, which is determined by an independent
valuation. The Company's Board of Directors voted to terminate the ESOP
effective February 28, 1997. The shares distributed in 1998 due to the
termination of the ESOP are subject to the put/call until June 29, 1999.
In the coming year, the Company plans on making various capital expenditures to
enhance its computer systems in order to improve its service to its customers.
The Company plans on offering internet banking to its customers in 1999. The
estimated costs for the hardware, software, installation and consulting services
needed to complete this project are approximately $62. The Company also plans on
installing a wide area network at an estimated cost of $350 for the hardware and
engineering services required. The source of financing for both projects will be
current earnings.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars, without considering changes in relative
purchasing power over time due to inflation. Virtually all of the assets and
liabilities of the Bank are monetary in nature and, as a result, its operations
can be significantly affected by interest rate fluctuations as discussed above.
Therefore, inflation will affect the Bank only to the extent that interest rates
change and according to the Bank's sensitivity to such changes. The Company
attempts to manage the effects of inflation through its asset/liability
management as described above in "Asset-Liability Management and Market Risk
Sensitivity."
Accounting and Reporting Changes
In June 1997, the FASB issued SFAS Nos. 130, Reporting Comprehensive Income. The
statement is effective for annual and quarterly financial statements for fiscal
years beginning after December 15, 1997, with earlier application permitted. For
the Company, the statement became effective in the first quarter of 1998 and
required reclassification of earlier financial statements for comparative
purposes. SFAS No. 130 requires that changes in the amounts of comprehensive
income items be shown in a primary financial statement. Comprehensive income is
defined by the statement as "the change in equity (net assets) of a business
enterprise during a period from transactions and other events and circumstances
from nonowner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners." While
the adoption of this statement changed the look of the Company's financial
statements, it did not have a material effect on the Company.
Also, in June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. The statement is effective for financial
statements for fiscal years beginning after December 15, 1997, with earlier
application permitted. SFAS No. 131 changes the way public companies report
information about segments of their business in their annual financial
statements and requires them to report selected segment
26
information in their quarterly reports issued to shareholders. A company is
required to report on operating segments based on the management approach. An
operating segment is defined as any component of an enterprise that engages in
business activities from which it may earn revenues and incur expenses. The
management approach is based on the way that management organizes the segments
within the enterprise for making operating decisions and assessing performance.
The adoption of this standard did not have a material effect on the Company.
In February 1998, the FASB issued SFAS No. 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits. The statement is effective for
fiscal years beginning after December 15, 1997. SFAS No. 132 provides additional
information to facilitate financial analysis and eliminates certain disclosures
which are no longer useful. To the extent practical, the statement also
standardizes disclosures for retiree benefits. Although the adoption of this
standard changed the look of note number 11 to the consolidated financial
statements, the adoption of this standard did not have a material effect on the
Company.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. The statement is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999, with earlier
adoption permitted. SFAS No. 133 establishes accounting and reporting standards
for derivative instruments and for hedging activities. The statement requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
Company adopted SFAS No. 133 in its entirety effective January 1, 1999. On
January 1, 1999, the Company transferred 100% of its held-to-maturity investment
securities to the available-for-sale category at fair value as allowed by SFAS
No. 133. Such transfers from the held-to-maturity category at the date of
initial adoption shall not call into question the Company's intent to hold other
debt securties to maturity in the future. The adoption of this standard did not
have a material effect on the Company.
In October 1998, the FASB issued SFAS No. 134, Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise, an amendment to SFAS No. 65. This statement is
effective for the first fiscal quarter beginning after December 15, 1998, (or
January 1, 1999 for the Company). The statement requires that after the
securitization of mortgage loans held for sale, any retained mortgage-backed
securities be classified in accordance with SFAS No. 115, based on the entity's
ability and intent to sell or hold those investments. Prior to this statement,
mortgage banking entities were required to classify these securities as trading
only. The adoption of this standard did not have a material effect on the
Company.
Industry Developments
Certain recently-enacted and proposed legislation could have an effect on both
the costs of doing business and the competitive factors facing the financial
institution's industry. Because of the uncertainty of the final terms and
likelihood of passage of the proposed legislation, the Company is unable to
assess the impact of any proposed legislation on its financial condition or
operations at this time.
Item 8. Financial Statements and Supplementary Data
The information required by this item is set forth on the following pages, 28
through 53.
27
Independent Auditors' Report
The Board of