-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, VdD/FCPJk5ZHn5NeRuPB7DOIi7SS/YY7pzSJO4DIO8yk9S17h0N+sJtyNuQNu+dT qPmfa9MKjyODOhU1bxwBAA== 0000916641-94-000103.txt : 19940926 0000916641-94-000103.hdr.sgml : 19940926 ACCESSION NUMBER: 0000916641-94-000103 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19940923 ITEM INFORMATION: Financial statements and exhibits FILED AS OF DATE: 19940923 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CRESTAR FINANCIAL CORP CENTRAL INDEX KEY: 0000101880 STANDARD INDUSTRIAL CLASSIFICATION: 6022 IRS NUMBER: 540722175 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-07083 FILM NUMBER: 94550175 BUSINESS ADDRESS: STREET 1: 919 E MAIN ST STREET 2: PO BOX 26665 CITY: RICHMOND STATE: VA ZIP: 23261 BUSINESS PHONE: 8047825000 MAIL ADDRESS: STREET 1: 919 EAST MAIN STREET STREET 2: P O BOX 26665 CITY: RICHMOND STATE: VA ZIP: 23261-6665 FORMER COMPANY: FORMER CONFORMED NAME: UNITED VIRGINIA BANKSHARES INC DATE OF NAME CHANGE: 19871115 8-K 1 CRESTAR 8-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ___________________ FORM 8-K CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported): September 23, 1994 CRESTAR FINANCIAL CORPORATION (Exact name of as specified in charter) Virginia 1-7083 54-0722175 (State or other (Commission (IRS Employer jurisdiction of File Number) Identification No.) incorporation) 919 East Main Street, P.O.Box 26665, Richmond, Virginia 23261-6665 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 804-782-5000 ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS (c) Exhibits The following exhibits are filed solely to permit incorporation by reference into a registration statement on Form S-4 covering the issuance of Registrant's common stock in connection with the assumption of Jefferson Savings and Loan Association, F.A. ("Jefferson"). These exhibits were prepared by Jefferson, were not prepared by Registrant, and are not to be considered as being filed as part of Registrant's disclosure obligations under the Securities Exchange Act of 1934. (99)(i) Report on Form 10-KSB for the year ended December 31, 1993 filed by Jefferson with the Office of Thrift Supervision of the Department of the Treasury. (99)(ii) Jefferson's Annual Report to Stockholders for the year ended December 31, 1993. (99)(iii) Notice of Meeting and Proxy Statement for Jefferson's 1994 annual meeting of stockholders held on January 27, 1994. (99)(iv) Report on Form 10-QSB for the quarter ended June 30, 1994 filed by Jefferson with the Office of Thrift Supervision of the Department of the Treasury. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. CRESTAR FINANCIAL CORPORATION (Registrant) By: /s/ John C. Clark, III John C. Clark, III Senior Vice President, General Counsel and Secretary Date: September 23, 1994 EX-99 2 EXHIBIT 99I Department of the Treasury Office of Thrift Supervision Washington, D.C. FORM 10-KSB X Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 OR Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______ to ________ For the fiscal year ended: Office of Thrift Supervision September 30, 1993 Docket Number: 6498 JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. (Exact name of registrant as specified in its charter) United States 54-0680877 (State or other jurisdiction (I.R.S. Employer or of incorporation or organization) Identification Number) 550 Broadview Avenue Warrenton, Virginia 22186 (Address of principal executive office) (Zip Code) (703) 347-3531 (Registrant's telephone number, including area code) 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 $3.00 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 Transitional Small Business Disclosure Format (check one): YES X NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B 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-KSB or any amendment to this Form 10-KSB. X Issuer's revenues for its most recent fiscal year. $24,258,000 As of December 13, 1993, the aggregate value of the 885,074 shares of Common Stock of the Registrant issued and outstanding on such date, excluding shares held by all directors and officers of the Registrant as a group, was approximately $7.1 million. This figure is based on the sales price of $8.00 per share of the Registrant's Common Stock on December 13, 1993. The number of shares of Common Stock outstanding as of December 13, 1993 was 1,310,876. DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents incorporated by reference and the Part of the Form 10-KSB into which the document is incorporated: (1) Portions of the Annual Report to Stockholders for the fiscal year ended September 30, 1993 are incorporated into Part II, Items 5-7 of this Form 10-KSB. (2) Portions of the definitive proxy statement for the 1993 AnnualMeeting of Stockholders are incorporated into Part III, Items 9-12 of this Form 10-KSB. PART I Item 1. Business General. Jefferson Savings and Loan Association, F.A. ("Jefferson" or the "Association") is a federally-chartered stock savings and loan association headquartered in Warrenton, Virginia with six branch offices in Warrenton, Luray, Leesburg, Culpeper and Charlottesville, Virginia. The deposit accounts of Jefferson are insured by the Savings Association Insurance Fund ("SAIF"), which is administered by the Federal Deposit Insurance Corporation ("FDIC"). Jefferson was incorporated in Virginia in October, 1959, and opened for business in October, 1960 as Fauquier Savings and Loan Association. The Association acquired and merged several other financial institutions into it over the years including Jefferson Savings and Loan Association of Culpeper in 1972, Home Savings and Loan Association of Roanoke in 1975, and Charlottesville Savings and Loan Association in 1982. The Association converted to a federal stock charter in 1990 which was approved by stockholders at the 1991 Annual Meeting. Currently, Jefferson is the largest financial institution headquartered in Fauquier County, Virginia. At September 30, 1993, Jefferson had total assets of $284.3 million, deposits of $241.5 million, and stockholders' equity of $12.7 million or 4.46% of total assets at such date. The Association's executive offices are located at 550 Broadview Avenue, Warrenton, Virginia and its telephone number is (703) 347-3531. Jefferson's principal business currently consists of attracting deposits from the general public and using such funds, together with borrowings, to originate primarily residential real estate loans secured by first liens on residential real estate located in its market area and to invest in mortgage-backed securities. Jefferson also originates consumer loans, residential construction loans and non-residential loans (commercial real estate loans). In addition to the origination of loans and the investment in mortgage-backed securities, Jefferson invests its funds in the securities of the U.S. Government and its agencies and other investments permitted by law. Jefferson also operates four wholly-owned subsidiaries. Two of such subsidiaries, Jefferson Insurance Services, Inc. and Jefferson Investment Service Corp. are involved to a limited extent in insurance brokerage or acting as trustee for deeds of trust securing loans originated by the Association. The other two subsidiaries, Jefferson Funding Corporation ("JFC") and Jefferson Funding Corporation II ("JFC II") are finance subsidiaries which issued notes payable and mortgage collateral bonds, respectively, as sources of funds in 1985 and 1988, respectively. See "Sources of Funds - Borrowings." Jefferson's primary sources of income are derived from interest earned on its loan and investment securities portfolios and, to a lesser extent, fees charged for lending activities and for financial services. Its major expense categories are interest paid on deposits and borrowings and operating expenses. Deposits with Jefferson are insured to the maximum extent provided by law through the SAIF. The Association is subject to examination and comprehensive regulation by the Office of Thrift Supervision ("OTS") and the FDIC. Jefferson is a member of the Federal Home Loan Bank of Atlanta ("FHLB of Atlanta" or "FHLB"), which is one of the 12 regional banks comprising the Federal Home Loan Bank System ("FHLB System"). Jefferson is further subject to regulations of the Board of Governors of the Federal Reserve System governing reserves required to be maintained against deposits and certain other matters. Market Area The Association considers its primary market area to be the northern and central Virginia communities extending from Charlottesville west to Staunton and north to Washington, D.C. and the Maryland state line. The Association maintains its headquarters and one branch in Warrenton with additional branch offices in Leesburg, Culpeper, Luray and Charlottesville. Its branches are located in communities that can be characterized as either suburban and/or rural. Management believes that the Association's franchise lies within some of the best economic and geographic areas in the Commonwealth of Virginia. Per capita incomes and real estate values have historically been significantly above average compared with the rest of the state and the nation. The proximity to the Washington, D.C. area affords a strong potential for continued economic benefit from the major positive influence of the U.S. Government and the ancillary businesses and services which support our national government. However, excess commercial office and housing inventory, coupled with a regional economic decline, have adversely affected the Mid-Atlantic real estate market. The real estate market in this and other parts of the country has been weak since 1991 and it may take substantial time for the market to absorb the existing real estate inventory. Recovery of the Mid- Atlantic real estate market also may be adversely affected in the future by the disposition of a substantial amount of real estate by financially troubled financial institutions, as well as by the Resolution Trust Corporation ("RTC"). Certain Ratios The following table sets forth certain financial ratios of the Association for the periods indicated. Averages are based on year-end balances. Year Ended September 30, 1991 1992 1991 Return on assets (net income (loss) divided by average total assets) .29% (.31)% .19% Return on equity (net income (loss) divided by average equity) 6.93% (10.65)% 10.33% Equity to assets ratio (average equity divided by average total assets) 4.17% 2.92% 1.81% Dividend payout ratio (dividends declared per share divided by net income per share) N/A N/A N/A Mortgage-Backed Securities Jefferson purchases mortgage-backed securities ("mortgage-backed securities" or "MBSs") and/or exchanges residential real estate mortgage loans for such securities from time to time. At September 30, 1993, Jefferson's investment of $51.2 million MBSs consisted of $36.1 million of Federal Home Loan Mortgage Corporation ("FHLMC") participation certificates ("PCs"), $12.2 million in Federal National Mortgage Association ("FNMA") REMIC MBSs, and $2.9 million in FNMA certificates. Fixed-rate MBSs totaled $28.7 million and variable-rate MBSs totaled $22.5 million at September 30, 1993. At September 30, 1993, MBSs available-for-sale totalled $8.9 million, and MBSs held-to-maturity totalled $42.3 million. The following table sets forth the carrying value and market value of the Association's MBS's at the dates indicated. At September 30, 1993 1992 1991 (Dollars in Thousands) Carrying value $51,173 $50,589 $79,491 Gross unrealized gains (held-to-maturity) 1,355 2,694 1,324 Gross unrealized loss (held-to-maturity) (115) -- (294) Market value $52,413 $5,283 $80,521 Of the MBS's with a carrying value of $51.2 million at September 30, 1993, $4.8 million are pledged to secure deposits by government agencies and $25.4 million are pledged as collateral for other borrowings. For further information on MBSs, see Note 3 in the Notes to Consolidated Financial Statements in the Association's 1993 Annual Report to Stockholders ("Annual Report"). Lending Activities General. Although federal laws and regulations permit federally chartered savings institutions, such as Jefferson, to originate and purchase loans secured by real estate located throughout the United States, substantially all of the Association's current lending is done within the Commonwealth of Virginia, and in particular within the proximity of its branch locations. Subject to the Association's loans-to-one borrower limitation, the Association is permitted to invest without limitation in residential mortgage loans and up to 400% of its capital in loans secured by non-residential or commercial real estate. Jefferson may also invest in secured and unsecured consumer loans in an amount not exceeding 35% of the Association's total assets; however, such limit may be exceeded for certain types of consumer loans, such as home equity loans secured by residential real property. In addition, the Association may invest up to 10% of its total assets in secured and unsecured loans for commercial, corporate, business or agricultural purposes. The Association's lending activities have been focused on residential real estate lending, both permanent and construction, and, to a lesser extent, consumer lending, including home equity loans. However, during fiscal 1994, the Association intends to emphasize the origination of non-residential real estate loans. Although the amount of such originations will depend on market conditions and other factors although, the Association does not presently anticipate such originations to exceed $15.0 million in fiscal 1994. Generally, individual 3 loans would be limited to $800,000 and would be secured by real property located primarily in the Association's market area. Loan Portfolio Composition. At September 30, 1993, Jefferson's net loan portfolio, which is total loans (including MBS's amounting to $51.2 million) less loans in process, allowance for loan losses, unearned discount and deferred fees, totaled $221.1 million ("net loan portfolio"), representing approximately 77.8% of its total assets of $284.3 million at that date. At September 30, 1993, Jefferson's total loan portfolio (including MBS's) amounted to $226.0 million. The Association's total loan portfolio at September 30, 1993 consisted primarily of one-to-four family residential mortgage loans (including $51.2 million of MBSs), non- residential and commercial loans and home equity loans. At September 30, 1993, $160.4 million or 72.5% and $32.4 million or 14.7% of the Association's net loan portfolio consisted of one-to-four family residential real estate loans (including $8.1 million of construction loans) and non-residential and commercial loans, respectively. At such date, the Association had $24.7 million or 11.1% of its net loan portfolio invested in consumer loans, which included, among other things, loans secured by real estate (including home equity loans), loans secured by deposit accounts, vehicle loans and unsecured loans (including lines of credit). The following table sets forth the composition of the Association's loan portfolio by type of security and type of loan at the dates indicated.
September 30, 1993 1992 1991 1990 1989 Amount % Amount % Amount % Amount % Amount % (Dollars in Thousands) Loans by Type of Security: Mortgage loans: One-to four-family $160,389 72.5% $167,481 70.7% $213,938 74.2% $242,764 77.2% $268,663 81.5% Multi-family 8,457 3.8 8,165 3.4 9,129 3.2 5,988 1.9 6,050 1.8 Non-residential and commercial 32,442 14.7 37,176 15.7 39,676 13.8 45,787 14.6 47,150 14.3 Total mortgage loans 201,288 91.0 212,822 89.8 262,743 91.2 294,539 93.7 321,863 97.6 Consumer loans: Deposit 1,014 0.4 1,099 0.5 1,150 0.4 931 0.3 875 0.3 Home equity 21,102 9.5 23,616 10.0 23,563 8.2 17,385 5.5 7,476 2.3 Other 2,599 1.2 3,878 1.6 5,869 2.0 8,052 2.6 6,894 2.1 4 TOTAL LOANS 226,003 102.1 241,415 101.9 293,325 101.8 320,907 102.1 337,108 102.3 Less: Loans in process (3,118) (1.4) (3,193) -1.4 (3,665) -1.3 (4,848) -1.5 (5,357) -1.6 Deferred fees (124) -- (57) -- (114) -.- (358) -0.1 (1,054) -0.3 Unearned discount (21) -- (103) -- (279) -0.1 (580) -0.2 (783) -0.2 Allowance for losses (1,602) (0.7) (1,288) -0.5 (1,135) -0.4 (873) -0.3 (798) -0.2 NET LOANS $221,138 100.0% $236,774 100.0% $288,132 100.0% $314,248 100.0% $329,116 100.0% Loans by Type of Loan: Mortgage loans: Fixed-rate $ 34,579 15.6% $ 46,747 19.7% $ 41,865 14.5% $ 46,549 14.8% $ 88,050 26.8% Adjustable-rate 107,416 48.6 105,523 44.6 127,221 44.2 151,684 48.2 136,528 41.3 Construction loans 8,120 3.7 9,963 4.2 14,166 4.9 16,906 5.4 13,691 4.2 Mortgage-backed securities: Fixed-rate 28,722 13.0 38,907 16.4 64,032 22.2 67,419 21.5 83,594 25.4 Adjustable-rate 22,451 10.1 11,682 4.9 15,459 5.4 11,981 3.8 - - Consumer loans: Home equity 21,102 9.5 23,616 10.0 23,563 8.2 17,385 5.5 7,476 2.3 Deposit and other 3,613 1.6 4,977 2.1 7,019 2.4 8,983 2.9 7,769 2.3 TOTAL LOANS 226,003 102.1 241,415 101.9 293,325 101.8 320,907 102.1 337,108 102.3 Less: Loans in process (3,118) (1.4) (3,193) -1.4 (3,665) -1.3 (4,848) -1.5 (5,357) -1.6 Deferred fees (124) -- (57) -- (114) -.- (358) -0.1 (1,054) -0.3 Unearned discount (21) -- (103) -- (279) -0.1 (580) -0.2 (783) -0.2 Allowance for losses (1,602) (0.7) (1,288) -0.5 (1,135) -0.4 (873) -0.3 (798) -0.2 NET LOANS $221,138 100.0% $236,774 100.0% $288,132 100.0% $314,248 100.0% $329,116 100.0%
5 Contractual Repayments. The following table sets forth the contractual principal repayments of the total loan portfolio of the Association as of September 30, 1993 by categories of loans. Adjustable and floating-rate loans are included in the period in which such loans are contractually due.
Principal Repayments Contractually Due Principal In Year(s) Ending September30, Balance 1997- 1999- 2004 and September 30, 1994 1995 1996 1998 2003 Thereafter 1993 (Dollars in Thousands) Real estate $141,995 $ 2,920 $1,608 $2,495 $20,964 $18,776 $95,232 mortgage loans Real estate 8,120 8,120 -- -- -- -- -- construction loans Mortgage-backed 51,173 -- -- -- -- -- 51,173 securities Consumer 24,715 22,975 530 482 728 -- -- loans(1) Total(2) 226,003 $34,015 $2,138 $2,977 $21,692 $18,776 $146,405
___________________ (1) Loans secured by deposit accounts and home equity loans aggregating $22.1 million at September 30, 1993 are assumed to contractually mature in 1994. (2) Of the $192.0 million of principal repayments contractually due on or after September 30, 1994, $63.9 million have fixed-rates of interest and $128.1 million have adjustable or floating-rates of interest. Contractual principal loan repayments do not necessarily reflect the actual term of the Association's loan portfolio. The average life of loans is substantially less than their contractual terms because of loan payoffs and prepayments and because of enforcement of the due-on-sale clause, which gives 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. The average life of mortgage loans tends to increase, however, when market mortgage loan rates substantially exceed rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans substantially exceed market mortgage loan rates. Originations, Purchases, Repayments and Sales of Loans. The Association has general authority to originate and purchase loans secured by real estate located throughout the United States. However, consistent with its emphasis on being a community-oriented financial institution, the Association generally concentrates its lending activities in its primary market area. The Association generally has not originated loans secured by real estate located outside the Commonwealth of Virginia although it has, 6 to a limited extent, purchased whole loans or participations therein secured by property located outside the Commonwealth of Virginia. Residential real estate loans typically are originated through salaried loan officers, or are attributable to depositors, walk-in customers, advertising and referrals from real estate brokers and developers. Consumer loan originations are attributable largely to depositors, walk-in customers and advertising. Construction and non- residential loan originations are typically attributable to referrals from builders and developers. All loan applications are evaluated by the Association's staff to ensure compliance with the Association's underwriting standards. See "- Loan Underwriting Policies." The Association did not purchase any whole loans or participations therein in fiscal 1993, 1992 or 1991. In recent years, the Association has sold participation interests in loans to institutional investors, primarily the FNMA. As a result of competitive pressures, the interest rate environment and customer preference in the Association's primary market area for fixed-rate mortgage loans, the Association has continued to originate long-term, fixed-rate residential mortgage loans. Substantially all of such loans are originated under terms and conditions which will permit their sale in the secondary mortgage market in order to (i) reduce the proportion of the Association's loan portfolio comprised of fixed-rate assets, (ii) replenish funds for continued residential lending activity and (iii) generate noninterest income. The Association is a qualified servicer for the FHLMC and the FNMA. Jefferson has participated in various programs of FHLMC and FNMA and, at September 30, 1993, serviced $70.9 million of mortgage loans for FHLMC and FNMA, and $7.1 million of mortgage loans for other investors. The Association periodically packages portions of its adjustable-rate and fixed-rate residential mortgage loan portfolio, exchanging it for FHLMC PCs. Jefferson retains the servicing of the mortgage loans and pays a negotiated management and guarantee fee to FHLMC. Jefferson exchanged $4.1 million of residential mortgage loans for FHLMC PCs during fiscal 1993. The Association may conduct such exchanges in future periods with FHLMC or FNMA in order to meet its goal of facilitating liquidity, creating collateral for governmental deposits, and reducing its risk-based capital requirement. Although assets such as FHLMC PCs and other MBS's can improve the Association's liquidity by being saleable in the secondary market, such assets have an interest rate risk similar to that of the underlying mortgages collateralizing the MBSs. At September 30, 1993, the Association owned $51.2 million of MBSs. Jefferson has primarily used the MBSs in its reverse repurchase agreement transactions and as collateral for governmental deposits and other borrowings. See "Sources of Funds - Borrowings." 7 The following table sets forth the changes in the composition of Jefferson's loan and MBS's portfolios (including loans held for sale) during the periods indicated. Year Ended September 30, 1993 1992 1991 (Dollars in Thousands) Loans Receivable Additions: Loan originations:(1) Residential (one-to four-family) $ 88,055 $ 83,771 $ 37,194 Residential (five or more) 613 -- -- Non-residential and commercial 476 -- 2,164 Land 1,973 1,343 499 Consumer 11,902 12,147 8,758 Total originations 103,019 97,261 48,615 Transfer from real estate owned 1,256 -- -- Changes in loans in process 75 472 1,183 Total additions 104,350 97,733 49,798 Reductions: Loans sold 63,859 57,227 26,512 Principal repayments on loans 50,651 58,871 32,303 Transfer to mortgage-backed 4,055 -- 13,161 securities Transfer to real estate owned 1,412 2,724 2,893 Amortization of deferred fees and 15 233 544 unearned discount Changes in loan loss allowance 314 153 262 Other changes 264 981 330 Total reductions 120,570 120,189 76,005 Net decrease in loans receivable $(16,220) $(22,456) $(26,207) Mortgage-backed securities Additions: Mortgage-backed securities purchased $ 22,661 $ -- $ 32,277 Transfer from loans receivable 4,055 -- 13,161 Net unrealized gain 161 -- -- Amortization of premiums and discounts, net 71 82 49 Total additions 26,948 82 45,487 Reductions: Mortgage-backed securities sold, net 8,267 15,869 37,298 Principal repayments on mortgage- 18,097 13,115 8,098 backed securities Total reductions 26,364 28,984 45,396 Net increase (decrease) in mortgage- $ 584 $(28,902) $ 91 backed securities _______________________ (1) The Association did not purchase any loans in fiscal 1993, 1992 or 1991. 8 Loan Underwriting Policies. The Association's lending activities are subject to the Association's written, non-discriminatory underwriting standards and to loan origination procedures prescribed by the Association's Board of Directors and its management. Detailed loan applications are obtained to determine the borrower's ability to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations. Property valuations are performed by independent outside appraisers approved by the Association's Board of Directors. The Loan Committee consists of the President, Senior Vice Presidents of Lending and Retail Banking, a Vice President for Loan Origination, and one rotating member of the Board of Directors. The Loan Committee is authorized to approve real estate loans up to $500,000, construction loans up to $250,000, and other secured and unsecured loans up to $100,000. Any loan in excess of these amounts must be approved by the Board of Directors. It is the Association's policy to obtain a mortgage creating a valid lien on real estate and to obtain a title insurance policy that insures the property is free of prior encumbrances. When a title insurance policy is not obtained, an attorney's certificate of title is received. Borrowers must also obtain hazard insurance policies prior to closing and, when the property is in a flood plain as designated by the Department of Housing and Urban Development, flood insurance policies. Most borrowers are also required to advance funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which the Association makes disbursements for items such as real estate taxes, private mortgage insurance and hazard insurance. Other escrow account disbursements may include life insurance or flood insurance. The Association is permitted to lend up to 100% of the appraised value of the real property securing a mortgage loan. However, if the amount of a residential loan originated or refinanced exceeds 90% of the appraised value, the Association is required by federal regulations to obtain private mortgage insurance of that portion on the principal amount of the loan that exceeds 90% of the appraised value of the property. The Association generally limits the loan-to-value ratio on a single-family residential mortgage loan to 80% although the Association will make a single-family ( also referred to as one-to four-family) residential mortgage loan with up to a 95% loan-to-value ratio if the required private insurance is obtained. The Association has generally limited the loan-to-value ratio on commercial real estate mortgages to 75%. Under federal regulations prior to the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") on 9 August 9, 1989, the aggregate amount of loans that the Association could make to any one borrower, including related entities, generally was limited to the lesser of 10% of the Association's withdrawable deposits or 100% of its capital for regulatory purposes. However, as a result of FIRREA, the aggregate amount of loans that the Association may make to one borrower is limited to 15% of the Association's unimpaired capital and surplus. For a discussion of FIRREA and its impact on the Association, see "Regulation." Loans in an additional amount equal to 10% of the Association's unimpaired capital and surplus also may be made to a borrower if the loans are fully secured by readily marketable securities. Under the provisions of FIRREA, loans which exceeded the permitted limit on the effective date of the new rules were deemed not to be in violation of the new rules, but the aggregate principal balance of such loans cannot be increased beyond the amount legally committed to prior to FIRREA. However, the institution must use its best efforts to reduce its interest therein in order to bring such loans into compliance with the new standard. The maximum amount of loans which the Association could have made to one borrower as of September 30, 1993 was approximately $1.9 million based on 15% of its unimpaired capital and surplus. As of September 30, 1993, the largest aggregate amount of any such loan by the Association to any one borrower was $2.7 million which consists of one commercial real estate loan secured by a 156 room full- service hotel in Asheville, North Carolina. At September 30, 1993, the loan was 60 days delinquent. On December 31, 1993, the loan was current. The loan was originated prior to FIRREA and was within the Association's loans-to-one borrower limit at such time. The Association will continue to use its best efforts to bring this nonconforming loan into compliance with the new loans-to-one borrower limitations. Interest rates charged by the Association on loans are affected principally by competitive factors, the demand for such loans and the supply of funds available for lending purposes. These factors are, in turn, affected by general economic conditions, monetary policies of the federal government, including the Federal Reserve Board, tax policies, budgetary matters and deficit spending. Residential Real Estate Lending. The Association historically has been and continues to be primarily an originator of single-family residential real estate loans in its primary market area. The Association currently originates fixed-rate residential mortgage loans and ARMS for terms of up to 30 years, although a substantial portion of such loans are amortized over 15 years. At September 30, 1993, $160.4 million or 72.5% of the Association's total loan portfolio consisted of single-family, residential loans (including mortgage-backed securities and residential construction loans). The Association originated $88.1 million of single- family residential mortgage loans and loans for the construction of single- family residential properties in fiscal 1993 compared to $83.8 million and $37.2 million of such loans in fiscal 1992 and 1991, respectively. The increased originations in fiscal 1993 and 1992 reflected a heavy volume of refinancings caused by low interest rates. The Association intends to continue to emphasize the origination of permanent loans secured by first mortgage liens on single-family residential properties in the future. 10 The residential ARMs currently offered by the Association have interest rates which adjust annually based upon changes in an index based on the weekly average yield on United States Treasury securities adjusted to a constant comparable maturity of one year, as made available by the Federal Reserve Board, plus a margin. The amount of any increase or decrease in the interest rate is, in most cases, presently limited to 2% per year, with a limit of 5% or 6% over the life of the loan. The ARMs offered by the Association, as well as many other savings institutions, provide for initial rates of interest below the rates which would prevail when the index used for repricing is applied. However, the Association underwrites the loan on the basis of the borrower's ability to pay at the initial rate which would be in effect without the discount. The Association has emphasized and will continue to emphasize the origination of ARMs as well as other types of loans with adjustable rates or call provisions in order to reduce the impact of rapid increases in market rates of interest on its results of operations. ARM originations totalled $34.1 million, $13.6 million and $8.4 million during fiscal 1993, 1992 and 1991, respectively, and constituted 62%, 84% and 77%, respectively, of the Association's total originations of single-family residential mortgage loans and construction loans for single-family residential properties during such periods. At September 30, 1993, $138.0 million or 69% of the Association's total mortgage loan portfolio (excluding consumer loans), had adjustable interest rates. However, the interest rates of the Association's ARMs may not adjust as rapidly as changes in its cost of funds. Furthermore, although the Association believes that the 5% or 6% lifetime limit on the increase in the interest rate on the loan is sufficient to protect the Association from substantial long-term increases in interest rates, it is possible that such caps may restrict the interest-rate sensitivity of the loans in the event of rapid and substantial increases in market rates of interest. Although the Association has continued to emphasize the origination of ARMs, competitive market pressures and historically low interest rates have resulted in the Association's continued origination of fixed-rate mortgage loans with 15- and 30-year terms. Virtually all fixed-rate residential mortgage loans are originated under terms and conditions which permit their sale in the secondary market and include due-on-sale clauses as a means of increasing the rate of interest on existing lower rate loans by negotiating new interest rates and terms at the time of sale. Since September 30, 1991, the Association has originated $149.6 million of mortgage loans held for sale, which consist primarily of fixed-rate mortgage loans, of which $147.6 million have been sold in the secondary market, with servicing retained, and none have been sold in the secondary market with servicing released. At September 30, 1993, $63.3 million or 28.6% of the Association's total mortgage loan portfolio consisted of long-term, fixed- rate residential mortgage loans. Consumer Lending. Under applicable law, the Association may make secured and unsecured consumer loans in an aggregate amount up to 35% of the institution's total assets. The 35% limitation does not include home equity loans (loans secured by the equity in the borrower's residence but 11 not necessarily for the purpose of improvement), home improvement loans or loans secured by deposits. The Association offers consumer loans in order to provide a range of financial services to its customers and because the shorter term and normally higher interest rates on such loans help the Association earn a higher interest rate spread between its average loan yield and its cost of funds. On all consumer loans originated, the Association's underwriting standards include a determination of the applicant's payment history on other debts and an assessment of the borrower's ability to meet existing obligations and payments on the proposed loan. Jefferson has emphasized a wide variety of consumer loans in recent years in order to provide a full range of financial services to its customers. Consumer loan products offered include home equity lines of credit, installment loans, second trusts, personal loans, automobile loans, credit card loans, and loans secured by deposit accounts. Jefferson has expanded its consumer lending operations primarily by emphasizing home equity lines of credit. Certain individual income tax changes in recent years have resulted in increased demand for home equity lines of credit, as Jefferson's customers sought to take advantage of the interest deductibility on such loans. Also, competition from non-financial entities in terms of rates and maturity terms have affected Jefferson's ability to attract other types of consumer loans, such as automobile loans and unsecured loans. Therefore, Jefferson has focused its consumer lending on home equity lines of credit. As of September 30, 1993, Jefferson's consumer loan portfolio totaled $24.7 million or 11.1% of the total loan portfolio. At September 30, 1993, the composition of the portfolio consisted of $21.1 million of home equity lines of credit, $800,000 of automobile loans, $1.6 million of miscellaneous consumer loans, $215,000 of credit card loans and $1.0 million of loans secured by deposit accounts. Construction Lending. In order to provide diversification and sensitivity to interest rate changes, Jefferson provides acquisition and construction financing for unimproved and improved properties to be used for residential purposes. These loans have interest rates which adjust to changing market rates and are limited to the Association's local market area. The terms of the Association's construction loans range from three to twelve months and generally do not include an interest reserve to cover the cost of borrowing. The maximum loan-to-value ratio for the Association's construction loans is presently 80% of the appraised value of the property on an as completed basis. Jefferson's construction loans are subject to underwriting criteria which include reviews of previous projects and past performance of the borrower, the amount of borrower's equity in the project, independent appraisals and review and valuation of the cost estimates, pre-construction sale and leasing data, and cash flow projections expected from the project. Also, Jefferson requires personal guarantees by the borrowers. As of September 30, 1993, the Association's construction loan portfolio totaled $8.1 million, or 3.7% of the total loan portfolio. Of such amount, approximately $424,000 represents residential construction loans for pre- 12 sold single-family residential homes and $5.1 million represents construction/permanent loans to the borrower who will be the owner resident. The remaining $2.6 million represents primarily developed lots, land loans and model homes. Prior to making a commitment to fund the loan, the Association requires an appraisal of the property by appraisers approved by the Commonwealth of Virginia and the Board of Directors. The Association 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. Advances are made on a basis of cost to complete. Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Association may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, the Association may be confronted, at or prior to the maturity of the loan, with a property having a value which is insufficient to assure full repayment. Generally, Jefferson attempts to limit these risks by, among other things, adopting conservative underwriting standards and originating such loans primarily in its market area and requiring affirmative lien coverage by an approved title insurance company. In addition, as stated above, a majority of Jefferson's construction loans are originated on a pre-sold basis in which the Association makes the permanent mortgage loan as well. Non-Residential Real Estate and Commercial Lending. Non-residential real estate loans originated by the Association are primarily secured by small office buildings, hotels, light industrial properties and warehouses. These loans are generally for a term of up to 20 years with an interest rate that adjusts annually based upon changes in an index based on the weekly average yield on United States Treasury securities adjusted to a constant maturity of one year plus a margin. Originations of such loans are presently limited to the local market area and are done on an individual exception only basis. Jefferson originates commercial loans on a very limited basis. As of September 30, 1993, commercial and non- residential mortgage loans totaled $32.5 million or 14.7% of the net loan portfolio. Jefferson originated $476,000, $0 and $2.2 million of commercial and non-residential real estate loans in fiscal 1993, 1992 and 1991, respectively. However, during fiscal 1994, the Association intends to emphasize the origination of non-residential real estate loans. Although the amount of such originations will depend on market conditions and other factors. However, the Association does not presently anticipate such originations to exceed $15.0 million in fiscal 1994. Generally, individual loans would be limited to $800,000 and would be secured by property located in its market area. Commercial real estate lending entails significant additional risks as compared with residential property lending. Commercial real estate 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. These risks can be significantly impacted by supply and demand conditions in the market for office and retail space, and as such may be subject to a greater extent to adverse conditions in the economy generally. To minimize these risks, Jefferson generally limits itself to a real estate market and/or to borrowers with which it has substantial experience. The Association is permitted under FIRREA to make loans to any borrower in an amount up to 15% of its unimpaired capital and surplus (approximately $1.9 million at September 30, 1993). The Association has not originated loans to any one borrower or project in excess of its applicable limit since the enactment of FIRREA. At September 30, 1993, nonperforming non-residential real estate loans amounted to $1.3 million or approximately 48.7% of total nonperforming loans of $2.7 million at such time. See "- Nonperforming Loans and Real Estate Owned." Jefferson evaluates all aspects of non-residential real estate loan transactions in order to mitigate risk. The Association seeks to ensure that the property securing the loan will generate sufficient cash flow to adequately cover operating expenses and debt service payments. To this end, permanent commercial real estate loans are generally originated with a loan-to-value ratio of 75% or less. In addition, the Association also seeks to obtain the personal guarantee of the borrower. In underwriting non-residential real estate loans, consideration is given to the property's operating history, future operating projections, current and projected occupancy, position in the local and regional market, location and physical condition. The underwriting analysis also includes credit checks and a review of the financial condition of the borrower. A narrative appraisal report, prepared by an outside appraiser who must be certified by the Commonwealth of Virginia with a general appraisers designation selected from a list of appraisers approved by the Association's Board of Directors, is commissioned by the Association to substantiate property values for commercial real estate loan transactions, which appraisal, in final form, the Association obtains prior to closing the loan. Land Development and Acquisition Loans. To a limited extent, the Association originates loans to builders and developers for the acquisition and/or development of vacant land. The proceeds of the loan are used to acquire the land and/or to make site improvements necessary to develop the land into saleable lots and to comply with bonding requirements of local governments. The term of such loans ranges from three years to 15 years with some requiring interest only payments during the term of the loan and the principal balance due at the end of the term. Originations of land development and acquisition loans have been limited to $2.0 million, $1.4 million and $499,000 in fiscal 1993, 1992 and 1991, respectively. 14 Land development and acquisition loans involve significant additional risks when compared with loans on existing residential properties. These loans typically involve large loan balances to single borrowers, and the payment experience is dependent on the successful development of the land and the sale of the lots. These risks can be significantly impacted by supply and demand conditions. To minimize these risks, Jefferson generally limits the loans to builders and developers with whom it has substantial experience or who are otherwise well-known to the Association. The Association also requires feasibility studies and market analyses to be performed with respect to the project and requires affirmative lien coverage from a title insurance company. The amount of the loan is limited to 75% or less of the value of developed land or 65% or less on the value of raw land. All of the Association's land acquisition and development loans are secured by property located within the Association's market area. Such loans amounted to $5.9 million or 2.7% of the total loan portfolio at September 30, 1993. Such amount is included in the Association's non- residential and commercial loan portfolio at September 30, 1993. Fee Income. In addition to interest earned on loans, Jefferson receives income from fees in connection with loan service fees, loan modifications and extensions, late payments, credit report fees, changes of property ownership and for miscellaneous services related to its loans. Income from these activities varies from period to period consistent with the volume and type of loans made and purchased. Jefferson charges loan origination fees which are calculated as a percentage of the amount borrowed and such fees are accounted for in accordance with generally accepted accounting principles. Loan origination fees generally range from one to three percent of the amount borrowed in the case of a mortgage loan. Such fees are usually not obtained in connection with consumer loans. At September 30, 1993, Jefferson was servicing $78.0 million of loans owned by others compared to $109 million and $62 million at September 30, 1992 and 1991, respectively. As the portfolio of ARMs grows and seasons, and FHLMC and FNMA develop new programs for securitizing ARMs, Jefferson may exchange ARM loans for MBSs, thus increasing loans serviced for others. Loan servicing fee income amounted to $355,000 and $268,000 during fiscal 1993 and fiscal 1992, respectively. In September, 1993, the Association sold $63 million of mortgage loan servicing rights for mortgage loans previously sold to FNMA. This transaction resulted in a gain of $770,000. The servicing was internally originated, and there was no intangible asset associated with the servicing rights sold. The loans had an average servicing fee of 25 basis points. There were no such sales in fiscal 1992. Nonperforming Loans and Real Estate Owned When a borrower fails to make a required loan payment, the Association attempts to cause the default to be cured by contacting the borrower. In general, contacts are made after a payment is more than 15 days past due at 15 which time a late charge is assessed. Defaults are cured promptly in most cases. If the delinquency on a mortgage loan exceeds 90 days and is not cured through the Association's normal collection procedures, or an acceptable arrangement is not worked out with the borrower, the Association will institute measures to remedy the default, including commencing a foreclosure action or, in special circumstances, accepting from the borrower a voluntary deed of the secured property in lieu of foreclosure with respect to mortgage loans or titles and possession of collateral in the case of consumer loans. If foreclosure is effected, the property is sold at a public auction in which the Association may participate as a bidder. If the Association is the successful bidder, the acquired real estate property is then included in the Association's real estate owned account until it is sold. The Association is permitted under federal regulations to finance sales of real estate owned by "loans to facilitate," which may involve more favorable interest rates and terms than generally would be granted under the Association's underwriting guidelines. At September 30, 1993, the Association had loans to facilitate amounting to approximately $2.3 million, which, if necessary, have been appropriately adjusted to reflect market interest rates for accounting purposes. Loans are placed on nonaccrual status after being delinquent 90 days. When a loan is placed on a nonaccrual status, interest accrued but not received is reversed against interest income. A nonaccrual loan may be restored to an accrual basis when principal and interest payments are current and full payment of principal and interest is expected. Jefferson's loss and delinquency experience on its residential real estate loan portfolio has been limited by a number of factors, including Jefferson's underwriting standards. Whether Jefferson's loss and delinquency experience increases significantly depends upon the value of the real estate securing its loans, economic factors such as an increase in unemployment, and the ability of borrowers with ARM loans to make increased payments if interest rates increase. In addition, the value of real estate fluctuates and could decline significantly. Significant reductions in real estate values could also substantially increase the risk associated with home equity loans. As a result of economic conditions and other factors beyond Jefferson's control, Jefferson's future loss and delinquency experience cannot be accurately predicted. Real estate acquired by the Association as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired, it is recorded at the lower of carrying or market value at the date of acquisition and any resulting write-down is charged to the allowance for loan losses. To the extent there is further decline in value, that amount is charged to operating expense. All costs incurred in maintaining the Association's interest in the property are capitalized between the date the loan becomes delinquent and the date of acquisition in an amount which may not exceed the estimated fair value. After the date of acquisition, all costs incurred in maintaining the property are expensed and costs incurred for the 16 improvement or development of such property are capitalized in an amount which may not exceed the estimated fair value less the estimated disposition costs. The accounting profession has issued Statement of Position SOP 92-3 ("SOP 92-3") which provides guidance on measuring foreclosed assets and in- substance foreclosed assets after foreclosure. The Statement applies to all assets obtained through foreclosure or repossession, except for inventories, marketable equity securities and real estate previously owned by the lender under certain conditions. Under SOP 92-3 there is a rebuttable presumption that foreclosed assets are held for sale. SOP 92-3 recommends that foreclosed assets held for sale be carried at the lower of (a) fair value minus estimated costs to sell, or (b) cost. Foreclosed assets held for the production of income are treated the same way they would be had the assets been acquired in a manner other than through foreclosure. The Association's accounting for its real estate owned complies with the guidance set forth in SOP 92-3. In May 1993, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan." This statement addresses the accounting by creditors for impairment of all loans, uncollateralized as well as collateralized, loans that are measured at fair value or at the lower of cost or fair value, leases, loans restructured in a troubled debt restructuring, and debt securities. It requires that impaired loans be measured 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. The creditor should also evaluate the collectibility of both contractual interest and contractual principal when assessing loss accruals. The Statement is effective for fiscal years beginning after December 15, 1994. Management of the Association does not believe that implementation of the Statement, when adopted, will have a materially adverse effect on the Association's financial condition or results of operations. The following table sets forth information regarding non-accrual loans and real estate owned held by the Association at the dates indicated. At September 30, 1993, the Association did not have any troubled debt restructurings. September 30, 1993 1992 1991 (Dollars in Thousands) Nonaccural loans Residential $ 1,205 $ 626 $ 1,338 Non-residential 1,298 1,204 4,305 17 Construction 154 112 263 Consumer 9 24 523 Subtotal 2,666 1,966 6,429 Real estate owned Residential 770 2,775 1,948 Non-residential 6,938 6,308 7,764 In-substance 611 1,365 -- foreclosure Subtotal 8,319 10,448 9,712 Total nonperforming $10,985 $ 12,414 $16,141 assets Total nonperforming assets 3.86% 4.12% 4.98% to total assets Loans are treated as in-substance foreclosure if the borrower has little or no equity in the collateral, the cash flow to repay the loan can only be expected to come from the operation or sale of the collateral, and the borrower has abandoned control of the collateral or it is doubtful that the borrower will be able to repay the loan in the foreseeable future. The one loan of $611,000 classified as an in-substance foreclosure at September 30, 1993 is a single-family residence located in Warrenton, Virginia. The Association obtained title to the property in October, 1993. If the nonaccrual loans and loans deemed to be in-substance foreclosures at September 30, 1993 had been current in accordance with their terms for the year ended September 30, 1993 (or from the date of origination if originated during such period), the total interest income on such loans for fiscal 1993 would have increased $670,300. The Association did not accrue any interest income on such loans in fiscal 1993. Nonaccrual loans. The $1.2 million of nonperforming residential real estate loans at September 30, 1993 consists of twelve loans secured by single-family property located primarily in the Association's market area. As of September 30, 1993, the Association had established approximately $170,000 of interest reserves based on these loans, but had not established any specific loan loss reserves. No loan exceeded $198,000. The $1.3 million of nonperforming non-residential real estate loans at September 30, 1993 primarily consists of one loan secured by a bowling alley. At September 30, 1993, the Association had established approximately $458,000 in interest reserves and had not established any specific loan loss reserves on this loan. This loan, with an outstanding principal balance of $1.1 million at September 30, 1993, is collateralized by a bowling alley in Grafton, Virginia (near Newport News). Such amount represents the Association's 60% participation interest in the loan. The loan is serviced by the FDIC and was 38 months delinquent at September 30, 18 1993. The borrower filed for bankruptcy on September 17, 1992 in advance of a scheduled foreclosure date of September 18, 1992. The bowling alley is presently operational and an appraisal in December, 1991 indicated a value in excess of the loan carrying value. The bankruptcy court has approved the borrower's plan of reorganization which requires the borrower to pay the loan in full prior to June, 1994, and the borrower began making monthly interest payments in October, 1993. The remaining three non- residential real estate loans had outstanding principal balances less than $100,000, with the borrowers in bankruptcy. The two construction loans amounted to $112,000 and $42,000, and no nonaccrual consumer loan exceeded $3,000. However, the Association does have five loans outstanding to one borrower totalling approximately $420,000, all of which are in the process of foreclosure. Restructured loans amounted to $3.8 million at September 30, 1993. These are loans for which concessions, including deferral of interest or principal payments, have been granted due to the borrower's financial condition. The $3.8 million consisted of two commercial real estate loans. One loan of $2.7 million had a modified interest rate of 8.0%, while the second loan of $1.1 million had a modified interest rate of 6.5% at September 30, 1993. There were no outstanding commitments to lend additional funds to borrowers with restructured loans. During fiscal 1992, the Association established a specific valuation allowance of $380,000 relating to the loan of $1.1 million. The gross interest income that would have been recorded if the loans had been current per their original terms was $330,000 for the year ended September 30, 1993. Interest income recorded for these loans amounted to $288,000 for the year ended September 30, 1993. Real estate owned. The $8.2 million of REO, net of a $100,000 general valuation allowance, consisted of three single-family residences with an aggregate carrying value $336,000, 22 condominiums in Dallas, Texas with an aggregate carrying value of $434,000, a Knight's Inn Motel in Monroe, Michigan with a carrying value of $1.7 million, the Ocean One Hotel in Virginia Beach, Virginia with a carrying value of $3.8 million, office and residential property in Leesburg, Virginia with a carrying value of $276,000, warehouse and land in Chantilly, Virginia with a carrying value of $414,000, seven lots near Fredricksburg, Virginia with a carrying value of $305,000, partially developed land in Charlottesville, Virginia with an aggregate carrying value of $453,000, and a single-family residence in Warrenton, Virginia with a carrying value of $611,000. In November, 1993 the Association sold the Knight's Inn Motel in Monroe, Michigan for $1.8 million. The Association accepted a cash payment of $150,000 and extended a loan for $1,650,000. In October, 1993, the Association purchased the land and the land lease for the Knight's Inn for $340,000. The Association expects to receive a minimum of $30,000 in annual rental payments from this land lease. The office and residential property in Leesburg, Virginia is vacant and has been evaluated by experts for soil contamination. The carrying 19 value of $276,000 is net of a specific reserve of $80,000 relating to the resolution of this problem. The Ocean One Hotel, a 102-unit beachfront hotel, was acquired by foreclosure in June, 1991, and reopened for business in July, 1992 after being closed for twenty months. The outstanding loan at the time of foreclosure amounted to $2.7 million. In fiscal 1992, the Association expensed $2.2 million in renovation expenditures, with $1.1 million charged to expense, and the remainder of $1.1 million capitalized as part of the REO balance, resulting in a new carrying value of $3.8 million at September 30, 1992. During fiscal 1993, the Association spent approximately $1.1 million in further renovation expenditures for an indoor swimming pool, meeting rooms, a restaurant and restaurant equipment, a lounge and bar, exterior painting, and replacement of certain hotel furnishings. The hotel was operational during fiscal 1993, and despite major construction activity, the hotel operated at 35% occupancy at an average room rate of approximately $69 for an operational profit of $128,000. The Association does not plan significant further renovation expenditures, and has listed the property for sale. The Association is unable to project the future expenditures, if any, that may be necessary to franchise or sell the property. The property is being managed by a professional hotel operator. The Association will evaluate the benefits of affiliating the hotel with a national franchise in fiscal 1994. At September 30, 1993, the Association has under contract or was negotiating the sale of approximately $2.5 million of REO, including the Knights Inn Motel. Based on carrying values at September 30, 1993 and the contract price of properties under contract, the Association does not presently anticipate that it will incur any significant losses on the sale of such properties. Allowance for loan losses. The total allowance for loan losses amounted to $1.6 million at September 30, 1993, as compared to $1.3 million and $1.1 million at September 30, 1992 and 1991, respectively. The allowance for loan losses as a percent of loans outstanding was .92% at September 30, 1993 as compared to .67% at September 30, 1992 and .53% at September 30, 1991. The increase during the past two fiscal years reflects management's decision to increase the ratio of the allowance for loan losses to total loans because of the Association's exposure through its real estate mortgage loan portfolio and the recent downturn in the real estate market. The $533,000 and $1.1 million provisions during fiscal 1993 and 1992, respectively, were also due to the significant charge-offs during such periods. Net charge-offs, which reduce the allowance for loan losses, amounted to $219,000, $962,000 and $236,000 in fiscal 1993, 1992 and 1991, respectively. Recoveries of loans receivable previously charged-off were not material in the years ended September 30, 1993, 1992 and 1991. The allowance for loan losses is maintained at a level believed adequate by management to absorb losses in the loan portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loan loss experience, current economic conditions, volume, growth and composition of the loan portfolio, and other relevant 20 factors. The allowance is increased by provisions for loan losses which are charged against income. The Association does not allocate the allowance for loan losses by category of loan. An overall assessment of the allowance for loan losses includes the development of risk factors by type of loan to evaluate the adequacy of the general valuation allowance. The Association also reviews historical ratios of delinquency and nonperforming assets to further evaluate loan loss reserves. Further, the Association utilizes regulatory measures to determine the adequacy of loan loss reserves. The Association believes that the allowance for loan losses as of September 30, 1993 was adequate and further believes that the net carrying values of real estate owned are stated at their fair values. However, future additions to the allowance for loan losses or reductions in net carrying values may be necessary based on the performance of the Association's loan portfolio and changes in economic conditions. In addition, in connection with periodic examinations of the Association, the staff of the OTS and the FDIC consider the adequacy of the allowance for loan losses and the net carrying value of investment in real estate. Such agencies may require the Association to recognize additions to the allowance or reductions in the net carrying value of investment in real estate based on their judgements at the time of such examinations. On September 1, 1992, the OTS proposed a revision to its guidance to savings associations and OTS examination staff regarding the appropriate level of general valuation allowances an association should maintain. The current policy of the OTS is to require that a savings association classify its assets on a regular basis and establish prudent general valuation allowances that are adequate to absorb probable losses that have not been identified but that are inherent in the loan portfolio. The proposed OTS policy requires associations to maintain general valuation allowances that are adequate to absorb probable losses on their portfolios that are not clearly attributable to specific loans. For classified assets and assets subject to special mention, the OTS has proposed general valuation allowances within the following ranges: (i) 0% to 5% of assets subject to special mention; (ii) 5% to 25% of assets classified substandard; and (iii) 40% to 60% of assets classified doubtful. For unclassified and unreviewed assets, the OTS proposes general valuation allowances equal to expected net charge-offs during the next year, which should be based on the level of annual net charge-offs experienced by the association over the previous three to five years or similar assets adjusted for current economic conditions and trends and certain qualitative factors. Effective December 21, 1993, the OTS, in conjunction with the Office of the Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued an Interagency Policy Statement on the Allowance for Loan and Lease Losses ("Policy Statement"). The Policy Statement, which effectively supersedes the proposed guidance issued on September 1, 1992, includes guidance (i) on the responsibilities of management for the assessment and establishment of an adequate allowance and (ii) for the agencies' examiners to use in evaluating the adequacy of such allowance and the policies 21 utilized to determine such allowance. The Policy Statement also sets forth quantitative measures for the allowance with respect to assets classified substandard and doubtful and with respect to the remaining portion of an institution's loan portfolio. Specifically, the Policy Statement sets forth the following quantitative measures which examiners may use to determine the reasonableness of an allowance: (i) 50% of the portfolio that is classified doubtful; (ii) 15% of the portfolio that is classified substandard and (iii) for the portions of the portfolio that have not been classified (including loans designated special mention), estimated credit losses over the upcoming twelve months based on facts and circumstances available on the evaluation date. While the Policy Statement sets forth this quantitative measure, such guidance is not intended as a "floor" or "ceiling". A summary of litigation regarding certain real estate owned at September 30, 1993 is contained herein under Item 3. Legal Proceedings. For further information on the Association's allowance for losses on loans and a summary of the net cost of operations for real estate owned, see Notes (4) and (6), respectively, in the Notes to Consolidated Financial Statements in the Annual Report). The following table summarizes activity in the Association's allowance for loan losses during the periods indicated. Year Ended September 30, 1993 1992 1991 (Dollars in Thousands) Allowance at beginning $ 1,288 $ 1,135 $ 873 of year Provision for loan losses charged to operating expenses 533 1,115 498 Sub-total 1,821 2,250 1,371 Charge-offs: Residential real -- (538) (72) estate loans Non-residential real estate (100) -- (40) loans Construction loans (70) -- -- Consumer loans (49) (424) (124) Total loans charged- (219) (962) (236) off(1) Allowance at end of $ 1,602 $ 1,288 $ 1,135 year 22 Average outstanding balance $180,039 $204,964 $226,042 of loans receivable Ratio of net charge- offs to average outstanding .12% .47% .10% balance of loans receivable Period-end loans $174,830 $190,826 $213,834 receivable Ratio of allowance to period- .92% .67% .53% end loans receivable _______________________ (1) Recoveries of loans receivable previously charged-off were not material. Investment Activities Interest income and dividends from investment securities provides the second largest source of income after interest on loans. The Association is required to maintain certain liquidity ratios and does so by investing in securities that qualify as liquid assets under OTS regulations. Such securities include obligations issued by or are fully guaranteed by the United States government, certain federal agency obligations, certain time deposits and negotiable certificates of deposit issued by commercial banks and other specified investments, including commercial paper and corporate debt securities. See "Regulation - Liquidity Requirements." The balance of investment securities maintained by Jefferson in excess of regulatory requirements reflects management's objective of maintaining adequate liquidity to afford future flexibility to meet withdrawal requests and loan commitments or to make other investments. Such liquid funds are managed in an effort to produce the highest yield consistent with maintaining safety of principal and adherence to applicable regulations. The income from investments depends on the yield on investments purchased and the size of the investment portfolio. The Association adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" as of September 30, 1993. Investments in debt securities are classified as held-to-maturity when the Association has the positive intent and ability to hold those securities to maturity. Held-to-maturity investments are measured at amortized cost with gains and losses recognized at the time of sale. Investment in stock of the Federal Home Loan Bank of Atlanta is stated at cost. Investments identified as available-for-sale are measured at market value with unrealized holding gains and losses reported as a net amount in 23 a separate component of stockholders' equity until realized. Trading securities are bought and held principally for the purpose of selling in the near term. Unrealized gains and losses on trading securities are included in earnings. Dividend and interest income for all three categories, including amortization of the premium and discount arising at acquisition, are reported in earnings. The effect of adoption of FASB Statement No. 115 was to record a net unrealized gain of $154,000 in investment securities and mortgage-backed securities, a deferred income tax liability of $53,000 and an increase of $101,000 in stockholders' equity. The Association had no trading securities as of September 30, 1993. The following table sets forth the carrying value of Jefferson's investment portfolio at the dates indicated. See also Note 2 of Notes to Consolidated Financial Statements in the Annual Report for additional information with respect to the Association's investment securities classification as available-for-sale or held-to-maturity. In addition, information on carrying value, gross unrealized gains, gross unrealized losses, market value, gross proceeds from sales, and gross realized gains and losses are also disclosed. September 30, 1993 1992 1991 (Dollars In Thousands) FHLB overnight funds $ 14,958 $2,494 $ 143 Certificates of deposit 24 43 15 Trust accounts - CMO & 2,401 1,241 1,509 REMIC Commercial paper and subordinated -- 1,113 1,339 debentures Adjustable-rate mortgage mutual 10,676 -- -- funds United States government and agency obligations 14,011 30,009 -- FHLB Stock 3,600 3,396 3,168 Other (1) -- -- 16 Total $45,670 $38,296 $6,190 _______________ (1) Consists of stock of an unconsolidated subsidiary. 24 Sources of Funds General. Historically, deposits have been the principal source of Jefferson's funds for use in lending and for other general business purposes. In addition to deposits, the Association derives funds from loan repayments and prepayments, sales of whole loans, loan participations, investment securities and mortgage-backed securities, advances from the FHLB and other borrowings, including reverse repurchase agreements. The availability of funds from sales of loans and debt instruments is influenced by general interest rates and other market conditions. Loan principal and interest payments are a relatively stable source of funds, while savings inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions and may fluctuate widely. Borrowings may be used on a short- term basis to match short-term lending such as non-residential and construction loans, to compensate for reductions in normal sources of funds such as savings inflows and to meet liquidity requirements. On a long-term basis, borrowings may be used to support expanded lending activities. Deposits. Various regulatory changes have authorized thrift institutions to offer innovative deposit accounts with shorter terms and market sensitive interest rates in order to reduce the outflow of such funds into alternative investment instruments, such as money market funds and mutual funds, in higher interest rate environments. These new types of deposits have proven to be more costly than historical types of deposits, thus subjecting the Association to greater fluctuations in short-term deposit flows. In recent years, the Association has experienced deposit outflows primarily from transaction accounts, as such funds were invested by depositors in alternative financial instruments. The reductions in short- term rates resulting from the Federal Reserve Board's action to encourage economic growth enabled money market funds, bond funds and equity funds, which, unlike financial institutions, are not required to maintain reserve requirements or pay premiums to regulatory agencies for depository insurance, to offer higher interest rates and potentially higher returns on such investments. Jefferson offers a variety of rates and deposit programs, short- term and long-term, designed to attract customers in its market area. Rates on deposits offered by Jefferson are evaluated on a weekly basis and are priced based on investment opportunities, competitive rates available at other depository institutions and the cost of alternative sources of funds. Jefferson relies upon its branch network and advertising in its primary market area to generate its deposit flows. Jefferson's objective is to obtain stable deposits from local sources, although some deposits are gathered from non-local sources. Jefferson has not sought deposits from institutional brokerage programs in the last three fiscal years and had no brokered funds at September 30, 1993. Deposits with balances in excess of 25 $100,000 totaled $17.3 million or 7.2% of total deposits at September 30, 1993. In October, 1993, Jefferson acquired $9.3 million of deposits from another savings institution in Leesburg, Virginia at a premium of 1.25%. These accounts were transferred to the Association's existing branch office in Leesburg, Virginia. The following table shows the deposit activity for Jefferson for the periods indicated. Year Ended September 30, 1993 1992 1991 (Dollars in Thousands) Net withdrawals $(17,360) $(7,119) $(6,833) Interest credited 9,661 12,241 14,192 Net increase (decrease) $ (7,699) $ 5,122 $ 7,359 in deposits Jefferson offers a variety of deposit accounts, including passbook accounts, Negotiable Order of Withdrawal ("NOW") accounts, Money Market Deposit Accounts ("MMDAs") and a variety of fixed-term certificate accounts with different rates and maturities. Jefferson also provides Individual Retirement Accounts (IRAs), Simplified Employee Pension Plans (SEPPs) and Keogh Plan Accounts. During fiscal 1990, the Association introduced a new passbook account which featured a guaranteed one-year interest rate floor and certain free services such as free checking. Such floor was established on October 1st of each year and as a result of the decline of market interest rates below this floor during fiscal 1992, the balance of these deposits amounted to $77.4 million as of September 30, 1992. The interest rate floor for fiscal 1992 was 5.75%. However, in fiscal 1993, the interest rate was adjusted quarterly on the passbook account and was 3.25% for the quarter ended December 31, 1993 and will be 3.15% for the quarter ended March 31, 1994. The balance of these deposits amounted to $70.7 million as of September 30, 1993. NOW accounts, MMDAs and passbook and statement accounts are subject to various fees depending upon the type of account, transaction activity and minimum balance maintained. All fixed-term certificates are subject to a forfeiture of interest in the event of a withdrawal of principal prior to the maturity date. These interest penalties amount to the loss of interest for periods of one to six months depending upon the term of the certificates. 26 At September 30, 1993, approximately 46% of Jefferson's total deposits consisted of time deposits and demand deposits represented the remaining 54% of the deposit base. The weighted average nominal interest rate for all accounts at September 30, 1993, was 3.84%. In fiscal 1993, the excess of withdrawals over deposits was $17.4 million and interest credited amounted $9.7 million, resulting in a net decline in deposits of $7.7 million. The fiscal 1993 decrease included a withdrawal of $4.0 million of funds from national institution sources, as the Association intentionally posted less aggressive deposit rates. The remaining decline in deposits was primarily attributable to a decline in demand accounts as depositors were withdrawing funds for cash needs and other opportunities for a higher yield. At September 30, 1993, the Association had $15.5 million of time deposits in "Bump Rate" certificates of deposit, which allows a depositor to adjust his rate to market once during the deposit term, and $10.8 million in "Prime Rate" certificates of deposit, which are tied to changes in prime rate less 150-175 basis points. The following table sets forth at September 30, 1993, deposit account balances (excluding accrued interest payable) by account type, scheduled maturity and weighted average interest rate. Weighted Percent of Average Total Interest Type of Account Total Deposits Rate (Dollars in Thousands) Demand deposits: Passbook Accounts $83,780 35% 3.21% NOW Accounts 15,888 7 2.59 MMDAs 29,806 12 2.82 Total demand deposits 129,474 54 3.05 Time deposits: Certificates maturing in: Year ending September 67,021 28 4.53 30, 1994 Year ending September 29,974 12 5.05 30, 1995 Year ending September 10,660 4 5.05 30, 1996 Thereafter 4,338 2 5.58 Total time deposits 111,993 46 4.76 Total deposits $241,467 100% 3.84% 27 The following table sets forth the amount of scheduled maturities of time deposits at September 30, 1993. Balance as of Twelve Months Ended September 30, September 30, Interest Rate 1992 1993 1994 1995 1996 There after (Dollars in Thousands) Less than 4% $ 9,988 $ 24,410 $24,277 $ 133 $ -- $ -- 4.00 - 6.00% 57,931 72,056 32,097 26,240 10,025 3,694 6.01 - 8.00% 32,766 12,426 8,615 2,772 458 581 8.01 - 10.00% 12,306 3,092 2,032 820 177 63 Greater than 10% 34 9 -- 9 -- -- Total maturities $113,025 $111,993 $67,021 $29,974 $10,660 $4,338 Borrowings. The FHLB System functions in a reserve credit capacity for savings institutions and other member financial institutions. As a member, Jefferson is required to own capital stock in the FHLB of Atlanta, and is authorized to apply for advances from the FHLB on the security of such stock and certain of its home mortgages and other assets. Such borrowings may be made pursuant to numerous credit programs offered by the FHLB. Each credit program has its own interest rate and range of maturities, and the FHLB prescribes the acceptable uses to which the advances pursuant to each program may be put as well as limitations on the size of the advances. Depending upon the credit program used, FHLB advances bear interest at fixed rates or at rates that vary with market conditions. A prepayment penalty may be imposed for early repayment of advances. The FHLB offers a full range of maturities up to ten years at generally competitive rates. At September 30, 1993 and 1992, the Association did not have any outstanding FHLB advances. See Note (9) to the Notes to Consolidated Financial Statements in the Annual Report for a summary of FHLB advances. 28 Securities sold under agreements to repurchase ("reverse repurchase agreements") involve the transfer of securities to a lender in exchange for cash under an agreement to repay the cash plus interest in exchange for the return of the same or substantially the same securities on the maturity date. Jefferson deals only with financially strong securities dealers and commercial banks when entering into these transactions. Generally, the securities used in these transactions have been government agency MBSs. Funds from this source have been used to provide additional liquidity and to engage in arbitrage transactions which match the maturities of assets and liabilities at positive interest rate spreads. Reverse repurchase transactions are treated as borrowings with the repurchase obligations reflected as a liability on the Consolidated Balance Sheets, and the related "interest" expense included in interest on borrowings. At September 30, 1993 and 1992, the Association did not have any securities sold under agreements to repurchase. See Note (10) to the Notes to Consolidated Financial Statements in the Annual Report for a summary of the Association's reverse repurchase agreements. The Association's other borrowings primarily represent notes payable ("Notes") of JFC and mortgage collateral bonds ("Bonds") issued by JFC II. On June 6, 1985, JFC, in effect, borrowed $20.3 million from Thrift Financing Corporation ("TFC"), an investment program established by Craigie, Inc., which indebtedness was evidenced by the Notes. Consequently, TFC issued CMOs secured by the Notes which, in turn, are collateralized by FHLMC PCs. The maturity of the Notes correspond to the principal repayment of the FHLMC PCs. At September 30, 1993, the outstanding indebtedness on the Notes was $5.3 million, with an unamortized discount of $76,000. The Notes are collateralized by a trust cash account and $5.5 million of FHLMC PCs which had a weighted average rate of 9.07% at September 30, 1993. The Notes had an effective interest cost to Jefferson of 11.27% in fiscal 1993. On May 9, 1988, JFC II issued the Bonds with a gross balance of $47.1 million which were secured by FHLMC PCs with below market rates. As a result, the Bonds were initially issued at a discount of $5.0 million, or 10.625% of the outstanding amount payable on the Bonds. The discount represented the difference between the weighted average interest rate of the FHLMC PCs and the cost of borrowing. The maturity of the Bonds corresponds to the maturity of the FHLMC PCs. The unamortized discount on the Bonds is reduced in proportion to the reduction of the outstanding balance of the Bonds which increases interest expense. At September 30, 1993, the outstanding indebtedness on the Bonds was $21.2 million, with an unamortized discount of $2.3 million and had an effective interest cost to Jefferson of 12.87% in fiscal 1993. The Bonds are collateralized by a trust cash account and $19.9 million of FHLMC PCs which had a weighted average rate of 8.33% at September 30, 1993. A material and prolonged decrease in interest rates could have an adverse effect on the Association's interest expense primarily as a result 29 of the Bonds issued by JFC II. Due to the paydown of the Bonds of $25.9 million in the 65 months since issuance, the unamortized discount amounted to $2.3 million at September 30, 1993. The maturity of the Bonds, as well as the amortization of the discount, correspond to the principal repayments of the mortgage-backed securities. Average annual repayments on the Bonds since issuance has amounted to $4.8 million and, correspondingly, average annual accretion of the discount has amounted to approximately $510,000. To the extent that interest rates spur significant repayments of the mortgage-backed securities collateralizing the Bonds, the amortization of the discount would correspondingly accelerate. The weighted average interest rate of the mortgage-backed securities collateral was 8.33% at September 30, 1993. Since the amortization of the discount is accounted for as interest expense, an acceleration of the amortization of the discount would have an adverse affect on interest expense and, correspondingly, net interest income in the short-term. The following table sets forth the effect on net interest income of decreases and increases of repayment on the Bonds based on the historical average annual repayment of $4.8 million. Percent of Amortization Historical of Discount at Net Interest Average Annual Amount of 10.625% of Income Repayment of Repayment of Repayment of Increase Bonds Payable Bonds Bonds (Decrease) 75% $ 3,600,000 $ 382,500 $ 127,500 100% $ 4,800,000 $ 510,000 $ -- 125% $ 6,000,000 $ 637,500 $(127,500) 150% $ 7,200,000 $ 765,000 $(255,000) 175% $ 8,400,000 $ 892,500 $(382,500) 200% $ 8,400,000 $1,020,000 $(510,000) 225% $10,800,000 $1,147,500 $(637,500) 250% $12,000,000 $1,275,000 $(765,000) 30 The annual repayment rate in fiscal 1993 was approximately 200% of the historical annual repayment rate. The following table summarizes the consolidated borrowings of Jefferson at the dates indicated.
September 30, 1993 1992 1991 1990 1989 (Dollars in Thousands) FHLB Advances $ -- $ -- $13,750 $ 51,050 $ 46,000 Securities sold under agreements to repurchase -- -- 14,001 17,077 17,038 Jefferson Funding Corporation notes payable, (Collateralized mortgage obligation) 5,212 6,761 8,614 9,505 10,797 Jefferson Funding Corporation II (Real Estate Mortgage Investment Certificate) 18,867 27,360 31,853 34,721 37,654 Wrap around mortgages -- 37 38 84 123 Total $24,079 $34,158 $68,256 $112,437 $111,612
Competition Jefferson experiences substantial competition in attracting and retaining savings deposits and in making real estate, consumer and non- residential loans. The primary factors in competing for savings deposits are interest rates and convenience of office locations. Direct competition for savings comes from other savings institutions, commercial banks, credit unions and more recently other financial-service concerns. Additional significant competition for savings deposits comes from corporate and government securities and mutual funds which may yield higher interest rates than instruments offered by savings institutions. The primary factors in competing for loans are interest rates, rate adjustment provisions, loan maturity, loan fees, convenience and the quality of service to borrowers. Competition for origination of real estate loans normally comes from other savings institutions, commercial banks, mortgage banking companies, insurance companies and real estate investment trusts. Subsidiaries 31 OTS regulations permit a savings institution to invest up to 2% of its assets in the capital stock, paid-in surplus and unsecured obligations of subsidiary corporations or service corporations and an additional 1% of its assets when the additional funds are utilized for community or inner-city development or investment. In addition, a federally chartered, SAIF-insured savings institution meeting its minimum regulatory capital requirements also may make conforming loans to service corporations in which the lender owns or holds more than 10% of the capital stock, in an aggregate amount of up to 50% of regulatory capital. The Association is also authorized to invest up to 30% of its assets in finance subsidiaries whose sole purpose is to issue debt or equity securities that the Association is authorized to issue directly, subject to certain limitations. At September 30, 1993, the Association was authorized to have a maximum investment of $5.7 million (2% of assets) in the capital stock and other securities of service corporation subsidiaries and no conforming loans. In addition, the Association is permitted to invest up to $85.3 million (30% of assets) in finance subsidiaries such as JFC and JFC II. As of that date, Jefferson's investment in service corporation subsidiaries was $4.6 million, of which $1.0 million and $2.8 million were invested in JFC and the JFC II, respectively. The $1.0 million and $2.8 million represent the amounts by which JFC and the JFC II have over-collateralized their respective borrowings. Jefferson currently has four wholly-owned service corporations as follows: Subsidiary Primary Business Activity Jefferson Insurance Services, Inc. Sales of multiple lines of insurance to the public Jefferson Investment Service Corp. Trustee on savings institution mortgages Jefferson Funding Corporation Finance subsidiary (CMO) Jefferson Funding Corporation II Finance subsidiary (REMIC) At September 30, 1993, Jefferson Insurance Services, Inc. and Jefferson Investment Service Corp. had combined total assets of $695,340, of which $692,439 is cash and investment securities. Total equity of the two above nonfinance service corporations at such time was $695,340. During fiscal 1993, such subsidiaries generated aggregate net income of approximately $37,000. The nonfinance service corporations are not engaged in any nonpermissible regulatory activities. Employees At September 30, 1993, Jefferson employed 102 full-time and 13 part- time employees. Management considers its relations with its employees to be good. 32 Jefferson currently maintains a comprehensive employee benefit program providing, among other items, health, disability, life insurance, and educational assistance. In fiscal 1991, a 401(k) plan was made effective for qualified employees. Jefferson's employee benefits are considered by management to be generally comparable with employee benefits provided by other major employers in Jefferson's market area. Jefferson's employees are not represented by any collective bargaining group. The Association does not provide post-retirement benefits. REGULATION Set forth below is a brief description of certain laws and regulations which relate to the regulation of Jefferson. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations. General The Association is a federally chartered savings association, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, the Association is subject to broad federal regulation and oversight by the OTS and the FDIC extending to all aspects of its operations. The Association is a member of the FHLB of Atlanta and is subject to certain limited regulation by the Federal Reserve Board. The OTS has extensive authority over the operations of savings associations. As part of this authority, savings associations are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS and the FDIC. The investment and lending authority of the Association is prescribed by federal laws and regulations, and it is prohibited from engaging in any activities not permitted by such laws and regulations. These laws and regulations generally are applicable to all federally chartered savings associations and many also apply to state- chartered savings associations. Such regulation and supervision is primarily intended for the protection of depositors. Certain of the investment and lending authorities for federal associations were amended significantly by FIRREA. FIRREA provides that no savings association may invest in corporate debt securities not rated in one of the four highest rating categories by a nationally-recognized rating organization. In addition, FIRREA reduced the permissible level of investment in loans secured by non-residential real property by federal associations from 40% of assets to 400% of regulatory capital, with authority in the OTS to increase that investment level on a case-by-case basis. FIRREA also revised the authority of savings associations to engage in transactions with affiliates or to make loans to certain insiders by making such transactions subject to certain provisions of the Federal Reserve Act. Among other things, those provisions require that these transactions with affiliates be on terms and conditions comparable to those for similar transactions with non-affiliates, as discussed below. 33 FIRREA imposed limitations on the aggregate amount of loans that a savings association could make to any one borrower, including related entities. Under FIRREA, the permissible amount of loans-to-one borrower now follows the national bank standard for all loans made by savings associations, as compared to the pre-FIRREA rule that applied that standard only to commercial loans made by federally chartered savings associations. The national bank standard generally does not permit loans-to-one borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount equal to an additional 10% of unimpaired capital and surplus also may be made to a borrower if the loans are fully secured by readily marketable securities. For information about the Association's largest loan or group of loans, see "Business - Lending Activities - Loan Underwriting Policies." The OTS' enforcement authority over all savings associations and their holding companies was substantially enhanced by FIRREA. This enforcement authority 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. FIRREA significantly increased the amount of and grounds for civil money penalties. FIRREA requires, except under certain circumstances, public disclosure of final enforcement actions by the OTS. Recent Legislation. On December 19, 1991, the Federal Deposit Insurance Corporation Act of 1991 ("FDICIA") was enacted into law. The FDICIA provides for, among other things, the recapitalization of the Bank Insurance Fund ("BIF"); the authorization of the FDIC to make emergency special assessments under certain circumstances against BIF members and members of the SAIF; the establishment of risk-based deposit insurance premiums; and improved examinations and reporting requirements. The FDICIA also provides for enhanced federal supervision of depository institutions based on, among other things, an institution's capital level. Under the FDICIA, new safety and soundness standards are to be adopted by the federal banking regulators, including the imposition by December 1, 1993 of a maximum ratio of classified assets to total capital, minimum earnings sufficient to absorb losses without impairing capital, and to the extent feasible, a minimum ratio of market value to book value for publicly traded shares of an institution or holding company, and such other standards relating to asset quality, earnings and valuation as the regulators find appropriate. The FDICIA also liberalized the qualified thrift lender ("QTL") test; imposed greater restrictions on transactions with insiders; revised the limitations on the includability of purchased mortgage servicing rights as regulatory capital; mandated consumer protection disclosures with respect to deposit accounts; and permitted federal savings institutions to acquire or be acquired by any insured depository institution. In many of these areas, implementing regulations must be adopted by the relevant banking regulator. 34 On June 19, 1993, a joint notice of proposed rulemaking was issued by the OTS, the FDIC, the Office of the Comptroller of the Currency and the Federal Reserve Board (collectively, the "agencies") concerning standards for safety and soundness required to be prescribed by regulation pursuant to Section 39 of the Federal Deposit Insurance Act ("FDIA"). In general, the standards relate to (1) operational and managerial matters; (2) asset quality and earnings; and (3) compensation. The operational and managerial standards cover (a) internal controls and information systems, (b) internal audit system, (c) loan documentation, (d) credit underwriting, (e) interest rate exposure, (f) asset growth, and (g) compensation, fees and benefits. Under the proposed asset quality and earnings standards, Jefferson would be required to maintain (1) a maximum ratio of classified assets (assets classified substandard, doubtful and to the extent that related losses have not been recognized, assets classified loss) to total capital of .75, and (2) minimum earnings sufficient to absorb losses without impairing capital. The last ratio concerning market value to book value was determined by the agencies not to be feasible. Finally, the proposed compensation standard states that compensation will be considered excessive if it is unreasonable or disproportionate to the services actually performed by the individual being compensated. If an insured depository institution or its holding company fail to meet any of the standards promulgated by regulation, then such institution or company will be required to submit a plan within 30 days to the FDIC specifying the steps it will take to correct the deficiency. In the event that an institution or company fails to submit or fails in any material respect to implement a compliance plan within the time allowed by the agency, Section 39 of the FDIA provides that the FDIC must order the institution or company to correct the deficiency and may (1) restrict asset growth; (2) require the institution or company to increase its ratio of tangible equity to assets; (3) restrict the rates of interest that the institution or company may pay; or (4) take any other action that would better carry out the purpose of prompt corrective action. On November 18, 1993, the agencies issued proposed regulations which are substantially similar to the advance notice of proposed rulemaking in June 1993, set forth above. However, pursuant to the proposed regulations issued in November, the Association would be allowed a maximum ratio of classified assets to total capital of 1.0 rather than .75 proposed in June 1993. The Association is unable to predict at this time what effect, if any, these standards will have on its business, results of operations or management. However, the Association's classified assets to total capital currently exceed the proposed ratio of 1.0. Management is presently evaluating the alternatives available to the Association in order to comply with the proposed requirement, including reducing classified assets, and increasing capital though earnings and issuance of additional shares of common stock or other capital instruments. The Association has included a proposal in the proxy statement for the 1994 Annual Meeting requesting stockholder approval for a proposed private placement offering. While the Association does not have any immediate specific plans to issue shares of capital stock, the Association believes that approval of this proposal will provide the Association with corporate flexibility to respond on a timely basis to potentially valuable business opportunities which may include the 35 purchase of deposits, branch office properties and other assets of the Resolution Trust Corporation. Any such private placement offering, if initiated, is not expected to exceed $5.0 million. Insurance of Accounts The deposits of the Association are insured up to $100,000 per insured member (as defined by law and regulation) by the SAIF and are backed by the full faith and credit of the United States Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action. The annual assessment for SAIF members for deposit insurance for the period from January 1, 1991 through December 31, 1992 was equal to .23% of insured deposits, which was payable on a semi-annual basis. FDICIA eliminated limitations on increases in federal deposit insurance premiums and authorized the FDIC to increase the assessment rates to the extent necessary to protect the SAIF (as well as the comparable fund administered by the FDIC which insures the deposits of commercial banks). The FDIC has issued a final regulation which was effective for the first semi-annual period of 1993 and thereafter, and which is intended to be a preliminary step toward the risk-based assessment system required to be implemented by January 1, 1994. Under the regulation, institutions are assigned to one of three capital groups which are based solely on the level of an institution's capital--"well capitalized," "adequately capitalized," and "undercapitalized"--which are defined in the same manner as the regulations establishing the prompt corrective action system under Section 38 of the FDIA. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications, with rates ranging from .23% for well capitalized, healthy institutions to .31% for undercapitalized institutions with substantial supervisory concerns. The insurance premium for the Association for the first semi-annual period beginning January 1, 1993 was .30% of insured deposits and is .30% for the second semi-annual period ending December 31, 1993. 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 36 a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which could result in termination of the Association's deposit insurance. Federal Home Loan Bank System The Association is a member of the FHLB System which consists of 12 regional FHLBs, with each subject to supervision and regulation by the newly created Federal Housing Finance Board. The FHLBs provide a central credit facility primarily for member savings institutions. The Association, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in that FHLB in an amount equal to at least 1% of the aggregate principal amount of its unpaid residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or 5% of its advances (borrowings) from the FHLB of Atlanta, whichever is greater. At September 30, 1993, Jefferson had a $3.6 million investment in the stock of the FHLB of Atlanta and was in compliance with this requirement. Advances from the FHLB of Atlanta are secured by certain types of mortgages and other assets. Interest rates charged for advances vary depending upon maturity, the cost of funds to the FHLB of Atlanta and the purpose of the borrowing. At September 30, 1993, the Association had no borrowings from the FHLB of Atlanta outstanding. Liquidity Requirements The Association is required to maintain a daily average balance of liquid assets (cash, certain time deposits, corporate debt securities and commercial paper, securities of certain mutual funds, banker's acceptances, and specified United States government, state or federal agency obligations), equal to at least 5% of the average daily balance of its net withdrawable savings deposits plus short-term borrowings. This liquidity requirement may be changed from time to time by the OTS to any amount within the range of 4% to 10% and is currently 5%. Short-term liquid assets currently must consist of 1% of the liquidity base. Monetary penalties may be imposed for failure to meet liquidity requirements. The Association's average month-end liquidity ratio for the year ended September 30, 1993 was 7.7% and its short-term liquidity ratio at September 30, 1993 exceeded the regulatory requirement of 1%. The Association has consistently maintained liquidity levels in excess of the minimum requirements. 37 Regulatory Capital Requirements Federally insured savings associations are required to maintain minimum levels of regulatory capital. Pursuant to FIRREA, the OTS has established three capital standards applicable to all savings associations. These standards generally must be as stringent as the comparable capital requirements imposed on national banks. The OTS also is authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. Current OTS capital standards require savings associations to satisfy three different capital requirements. Under these standards, savings associations must maintain "tangible" capital equal to 1.5% of adjusted total assets, "core" capital equal to 3% of adjusted total assets and "total" capital (a combination of core and "supplementary" capital) equal to 8% of "risk-weighted" assets. For purposes of the regulation, core capital generally consists of common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged deposits and "qualifying supervisory goodwill." Tangible capital is given the same definition as core capital but does not include qualifying supervisory goodwill and is reduced by the amount of all the savings association's intangible assets, with only a limited exception for purchased mortgage servicing rights. Both core and tangible capital are further reduced by an amount equal to a savings association's debt and equity investments in subsidiaries engaged in activities not permissible to national banks (other than subsidiaries engaged in activities undertaken as agent for customers or in mortgage banking activities and subsidiary depository institutions or their holding companies). Supplementary capital generally consists of hybrid capital instruments; perpetual preferred stock which is not eligible to be included as core capital; subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with the categories ranging from 0% (requiring no additional capital) for assets such as cash to 100% for repossessed assets or loans more than 90 days past due. Single-family residential real estate loans which are not past-due or non-performing and which have been made in accordance with prudent underwriting standards are assigned a 50% level in the risk-weighing system, as are certain privately- issued mortgage-backed securities representing indirect ownership of such loans. High quality MBSs and FHLB stock are assigned a 20% risk-weighting. Off-balance sheet items also are adjusted to take into account certain risk characteristics. In August 1993, the OTS adopted a final rule incorporating an interest-rate risk component into the risk-based capital regulation. Under the rule, an institution with a greater than "normal" level of interest rate risk will be subject to a deduction of its interest rate risk component from total capital for purposes of calculating risk-based capital requirement. As a result, such an institution will be required to maintain additional capital in order to comply with the risk-based capital 38 requirement. An institution with a greater than "normal" interest rate risk is defined as an institution that would suffer a loss of net portfolio value exceeding 2.0% of the estimated market value of its assets in the event of a 200 basis point increase or decrease (with certain minor exceptions) in interest rates. The interest rate risk component will be calculated, on a quarterly basis, as one-half of the difference between an institution's measured interest rate risk and 2.0%, multiplied by the market value of its assets. The rule also authorizes the director of the OTS, or his designee, to waive or defer an institution's interest rate risk component on a case-by-case basis. The final rule is 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. Thus, an institution with greater than "normal" risk will not be subject to any deduction from total capital until July 1, 1994 (based on the calculation of the interest rate risk component using data as of December 31, 1993). Finally, the OTS indicated in the final rule that it intended to lower the leverage ratio requirement (in its prompt corrective action regulation) to 3.0% from the current level of 4.0%, on July 1, 1994. Management of the Association does not believe it will be adversely impacted by this new regulation upon the effectiveness of the regulation in July, 1994. However, any actual requirement for July, 1994 will depend on the composition of assets and level of interest rates in December, 1993, and in the future, portfolio composition, and OTS filing requirements. 39 The following table sets forth the Association's compliance with each of the above-described capital requirements as of September 30, 1993. Tangible Core Risk-Based Capital Capital(1) Capital(2) (Dollars in Thousands) Capital under GAAP $12,682 $12,682 $12,682 Additional capital items: General valuation allowances(3) -- -- 1,602 Regulatory capital 12,682 12,682 14,284 Minimum required regulatory capital(4) 4,264 8,528 11,68 Excess regulatory capital $ 8,418 $ 4,154 $ 2,597 Regulatory capital as a percentage 4.46% 4.46% 9.77% Minimum capital required as a percentage (4) 1.5 3.0 8.0 Regulatory capital as a percentage in excess of requirements 2.96% 1.46% 1.77% _______________ (1) Does not reflect amendments which were proposed by the OTS in April 1991, which may increase this requirement to between 4% and 5%, as discussed below. (2) Does not reflect amendments to the risk-based capital requirement which were adopted by the OTS in August 1993, as discussed above. (3) Limited to 1.25% of risk-weighted assets ($1.8 million at September 30, 1993). (4) Tangible and core capital are computed as a percentage of adjusted total assets of $284.3 million at September 30, 1993. Risk-based capital is computed as a percentage of adjusted risk-weighted assets of $146.1 million at September 30, 1993. Any savings association that fails any of the capital requirements is subject to possible enforcement actions by the OTS or the FDIC. Such actions could include a capital directive, a cease and desist order, civil money penalties, the establishment of restrictions on an association's operations, 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. Proposed Federal Regulatory Capital Requirements. In April 1991, the OTS proposed to modify the 3% of adjusted total assets core capital requirement in the same manner as was done by the Comptroller of the Currency for national banks. Under the OTS proposal, only savings associations rated composite 1 under the OTS MACRO rating system will be permitted to operate at the regulatory minimum core capital ratio of 3%. For all other savings associations, the minimum core capital ratio will be 3% plus at least an additional 100 to 200 basis points, which will increase the core capital ratio requirement from 3% to 4% to 5% of adjusted total assets or more. In determining the amount of additional capital, the OTS will assess both the quality of risk management systems and the level of overall risk in each individual savings association through the supervisory process on a case-by-case basis. Prompt Corrective Action 40 Under Section 38 of the FDIA, as added by the FDICIA each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. In early September 1992, the federal banking agencies, including the OTS, adopted substantially similar regulations which are intended to implement the system of prompt corrective action established by Section 38 of the FDIA. These regulations are effective December 19, 1992. Under the regulations, an institution shall be deemed to be (i) "well capitalized" if it has total risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure; (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized," (iii) "undercapitalized" if it has a total risk- based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under certain circumstances), (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Section 38 of the FDIA and the regulations promulgated thereunder also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized). The Association is currently categorized as an adequately capitalized institution. An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate federal banking agency within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the agency. An institution which fails to submit a written capital restoration plan within the requisite period, or fails in any material respect to implement a capital restoration plan, shall be subject to the restrictions in Section 38 of the FDIA which are applicable to significantly undercapitalized institutions. Immediately upon becoming undercapitalized, an institution shall become subject to the provisions of Section 38 of the FDIA (i) restricting payment of capital distributions and management fees, (ii) requiring that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of 41 the institution's assets and (v) requiring prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the deposit insurance fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: requiring the institution to raise additional capital; restricting transactions with affiliates; restricting interest rates paid by the institution on deposits; requiring replacement of senior executive officers and directors; restricting the activities of the institution and its affiliates; requiring divestiture of the institution or the sale of the institution to a willing purchaser; and any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions. Accounting Requirements FIRREA requires the OTS to establish accounting standards to be applicable to all savings associations for purposes of complying with regulations, except to the extent otherwise specified in the capital standards. Such standards must incorporate GAAP to the same degree as is prescribed by the Federal banking agencies for banks or may be more stringent than such requirements. Such standards must be fully implemented by January 1, 1994 and must be phased in as provided in federal regulations in effect on May 1, 1989. On September 2, 1992, the OTS amended a number of its accounting regulations and reporting requirements (effective October 2, 1992). The amendments reflected the adoption by the OTS of the following standards: (i) regulatory reports will incorporate generally accepted accounting principles ("GAAP") when GAAP is used by federal banking agencies; (ii) savings association 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 associations. Effective February 10, 1992, the OTS adopted a statement of policy ("Statement") set forth in Thrift Bulletin 52 concerning (i) procedures to be used in the selection of a securities dealer, (ii) the need to document and implement prudent policies and strategies for securities, whether held for investment, trading or for sale, and to establish systems and internal controls to ensure that securities activities are consistent with the financial institution's policies and strategies, (iii) securities trading and sales practices that may be unsuitable in connection with securities held in an investment portfolio, (iv) high-risk mortgage securities that are not suitable for investment portfolio holdings for financial institutions, and (v) disproportionately large holdings of long-term, zero- 42 coupon bonds that may constitute an imprudent investment practice. The Statement applies to investment securities, high-yield, corporate debt securities, loans, mortgage-backed securities and derivative securities, and provides guidance concerning the proper classification of an accounting for securities held for investment, sale, and trading. Securities held for investment, sale or trading may be differentiated based upon an institution's desire to earn an interest yield (held for investment), to realize a holding gain from assets held for indefinite periods of time (held for sale), or to earn a dealer's spread between the bid and asked prices (held for trading). Depository institution investment portfolios are maintained to provide earnings consistent with the safety factors of quality, maturity, marketability and risk diversification. Securities that are purchased to accomplish these objectives may be reported at their amortized cost only when the depository institution has both the intent and ability to hold the assets for long-term investment purposes. Securities held for investment purposes may be accounted for at amortized cost, securities held for sale are to be accounted for at the lower of cost or market, and securities held for trading are to be accounted for at market. The Association believes that its investment activities have been and will continue to be conducted in accordance with the requirements of OTS policies and generally accepted accounting principles. See "Business - Investment Activities." The accounting principles for depository institutions are currently undergoing review to determine whether the historical cost model or market- based measures of valuation is the appropriate measure for reporting the assets of such institutions in their financial statements. Such a 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 will be any changes in the accounting principles for depository institutions in this regard or when any such changes might become effective. The Association adopted FASB Statement 115 effective September 30, 1993. In September 1991, the FASB issued for comment an exposure draft entitled "Accounting for Investments with Prepayment Risk." The proposed Statement addresses the post-acquisition measurement of investments in loans, receivables or other debt securities with cash flows that may vary due to prepayments. The proposed Statement would establish standards for the measurement of the carrying amount and income associated with such investments. Comments on the proposed Statement were accepted by the FASB until December 31, 1991. A substantial portion of the assets of the Association are investments in loans and other investments with prepayment risk. Management of the Association does not believe that implementation of the Statement, if adopted as proposed, will have a material adverse effect on the Association's financial condition or results of operations. On June 30, 1993, the FASB issued a proposed Statement of Financial Accounting Standards, "Accounting for Stock-based Compensation." The proposal would establish financial accounting and reporting standards for 43 stock-based compensation paid to employees. It would require recognition of compensation cost for the fair value of stock-based compensation paid to employees for their services. This fair value would be recognized at the date the award is granted. Amounts attributable to future service would be recognized as an asset, prepaid compensation, and would be amortized ratably over the period that the related employee services are rendered. If the award is for past services, the related compensation cost would be recognized in the period in which the award is granted. Stock price changes after the measurement date would have no effect on measuring the stock option or the related compensation cost. The disclosure provisions would be effective for years beginning after December 31, 1993, and recognition provisions after December 31, 1996. Recently, a committee of the U.S. Senate heard testimony on this issue and certain members thereof indicated that, in the absence of action by the FASB, they may introduce legislation in the U.S. Congress which requires companies to recognize compensation expense from employee stock option plans, which currently generally do not result in expense for financial reporting purposes either at the time of grant or exercise of options thereunder. In fiscal 1993, the Association adopted the 1993 Stock Incentive Plan subject to approval by the shareholders at the 1994 Annual Meeting. Management believes that the proposed FASB accounting for stock options, if adopted in its proposed form, would adversely affect financial statements issued after the three year disclosure period ending after December 31, 1996. In May, 1993, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan." This statement addresses the accounting by creditors for impairment of all loans, uncollateralized as well as collateralized, loans that are measured at fair value or at the lower of cost of fair value, leases, loans restructured in a troubled debt restructuring, and debt securities. It requires that impaired loans be measured based on the present value of expected 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. The creditor should also evaluate the collectibility of both contractual interest and contractual principal when assessing loss accruals. The statement is effective for fiscal years beginning after December 15, 1994. Management of the Association does not believe that implementation of the Statement, when adopted, may have a material adverse effect on the Association's financial condition or results of operations. Federal Qualified Thrift Lender Test A savings association that does not meet the Qualified Thrift Lender ("QTL") Test set forth in the HOLA and implementing regulations must either convert to a bank charter or comply with the following restrictions on its operations: (i) the association may not engage in any new activity or make any new investment, directly or indirectly, unless such activity or investment is permissible for a national bank; (ii) the branching powers of the association shall be restricted to those of a national bank; (iii) the association shall not be eligible to obtain any advances from its FHLB; and 44 (iv) payment of dividends by the association shall be subject to the rules regarding payment of dividends by a national bank. Upon the expiration of three years from the date the association ceases to be a QTL, it must cease any activity and not retain any investment not permissible for a national bank and immediately repay any outstanding FHLB advances (subject to safety and soundness considerations). Effective December 19, 1991, the definition of Qualified Thrift Investments was amended in its entirety and the QTL Test was amended to require that Qualified Thrift Investments ("QTIs") represent 65% of portfolio assets, rather than 60% and 70% of tangible assets as previously required before and after July 1, 1991, respectively. Portfolio assets are defined as total assets less intangibles, property used by a savings association in its business and liquidity investments in an amount not exceeding 20% of assets. Generally, QTIs are residential housing related assets. At September 30, 1993, approximately 80.6% of the Association's assets were invested in QTIs, which was in excess of the percentage required toqualify the Association under theQTL Test in effectat that time. Classification of Assets Under current federal regulations, an institution's problem assets are subject to classification according to one of three categories: "substandard," "doubtful" and "loss." For assets classified "substandard" and "doubtful," the institution is required to establish prudent general loan loss reserves in accordance with generally accepted accounting principles. Assets classified "loss" must be either completely written off or supported by a 100% specific reserve. A classification category designated "special mention" also must be established and maintained for assets not currently requiring classification but having potential weaknesses or risk characteristics that could result in future problems. An institution is required to develop an in-house program to classify its assets, including investments in subsidiaries, on a regular basis and set aside appropriate loss reserves on the basis of such classification. Management believes it is in compliance with these requirements. Transactions with Affiliates Transactions between savings associations and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings association is any company or entity which controls, is controlled by or is under common control with the savings association. In a holding company context, the parent holding company of a savings association (such as the Corporation) and any companies which are controlled by such parent holding company are affiliates of the savings association. Generally, Sections 23A and 23B (i) limit the extent to which the savings association or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such association's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus and (ii) require that all such transactions be on terms substantially the same or at least as favorable, to the association or subsidiary as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions. In addition to the 45 restrictions imposed by Sections 23A and 23B, no savings association may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, or (ii) purchase or invest in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings association. In addition, Sections 22(h) and (g) of the 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 association, and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the association'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 association to all insiders cannot exceed the association's unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At September 30, 1993, the Association was in compliance with the above restrictions. Restrictions on Capital Distributions Effective August 1, 1990, the OTS promulgated a regulation governing capital distributions by savings associations, which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of a savings association. Generally, the regulation creates a safe harbor for specified levels of capital distributions from associations meeting at least their minimum capital requirements, so long as such associations notify the OTS and receive no objection to the distribution from the OTS. Associations and distributions that do not qualify for the safe harbor are required to obtain prior OTS approval before making any capital distributions. Generally, Tier 1 associations, which are savings associations that before and after the proposed distribution meet or exceed their fully phased-in capital requirements, may make capital distributions during any calendar year equal to the higher of (i) 100% of net income for the calendar year-to-date plus 50% of its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of net income over the most recent four-quarter period. The "surplus capital ratio" is defined to mean the percentage by which the association's ratio of total capital to assets exceeds the ratio of its fully phased-in capital requirement to assets, and "fully phased-in capital requirement" is defined to mean an association's capital requirement under the statutory and regulatory standards to be applicable on December 31, 1994, as modified to reflect any applicable individual minimum capital requirement imposed upon the association. Tier 2 associations, which are associations that before and after the proposed distribution meet or exceed their minimum capital requirements, may make capital distributions over the most recent four quarter period up 46 to a specified percentage of their net income during that four quarter period, depending on how close the association is to meeting its fully phased-in capital requirements. Tier 2 associations that meet the capital requirements to be in effect on January 1, 1993 (including the 8% risk- based requirement and then-applicable exclusions of nonpermissible subsidiary investments and goodwill) are permitted to make distributions totaling up to 75% of net income over the four quarter period. Tier 2 associations that meet the January 1, 1991 capital requirements (including the 7.2% risk-based requirement and the then-applicable exclusions of nonpermissible subsidiary investments and goodwill) are permitted to make distributions totaling up to 50% of net income over the four quarter period. Tier 2 associations that meet current minimum requirements, but not the January 1, 1991 standard, may make distributions totaling up to 25% of net income over the four quarter period. Tier 3 associations, which are associations that do not meet current minimum capital requirements or that have capital in excess of either their fully phased-in capital requirement or minimum capital requirement but which have been notified by the OTS that it will be treated as a Tier 3 association 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 associations 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. In addition, a Tier 1 association deemed to be in need of more than normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association as a result of such a determination. Federal Reserve System The Federal Reserve Board requires all depository institutions to maintain reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. At September 30, 1993, the Association was in compliance with the applicable requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy applicable liquidity requirements. 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 the Association's earning assets. Interstate Acquisitions OTS regulations recently have been amended to provide federally chartered savings associations with essentially unlimited, subject to federal law, ability to open branch offices in any state. Generally, federal law prohibits federal thrifts from establishing, retaining or operating a branch outside the state in which the federal association has its home office unless the association meets the Internal Revenue's domestic building and loan test (generally, at least 60% of a thrift's 47 assets must be housing-related) ("IRS Test"). The IRS Test requirement does not apply if: (i) the branch(es) result(s) from an emergency acquisition of a troubled thrift (however, if the troubled association is acquired by a bank holding company, does not have its home office in the state of the bank holding company's bank subsidiary and does not qualify under the IRS Test, its branching is limited to the branching laws for state-chartered banks in the state where the thrift is located); (ii) the law of the state where the branch would be located would permit the branch to be established if the federal association were chartered by the state in which its home office is located; or (iii) the branch was operated lawfully as a branch under state law prior to the association's conversion to a federal charter. Furthermore, the OTS will evaluate a branching applicant's record of compliance with the Community Reinvestment Act ("CRA"). A poor CRA record may be the basis for denial of a branching application. TAXATION Federal Taxation General. The Association is subject to federal income taxation under the Internal Revenue Code of 1986, as amended (the "Code"), in the same general manner as other corporations with some exceptions, including particularly the reserve for bad debts discussed below. The following discussion of federal taxation is intended only to summarize certain federal income tax matters and is not a comprehensive description of the tax rules applicable to the Association. Accrual Method of Accounting. For federal income tax purposes, the Association currently reports its income and expenses on the accrual basis method of accounting and uses a tax year ending September 30 for filing its federal income tax returns. Jefferson files consolidated federal income tax returns with its wholly-owned subsidiaries, except for JFC II, which is a real estate mortgage investment conduit. 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, are 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 Association's taxable income. For purposes of computing the deductible addition to its bad debt reserve, the Association's loans are separated into "qualifying real property loans" (i.e., generally those loans secured by interests in real property) and all other loans ("nonqualifying loans"). The deduction with respect to nonqualifying loans must be computed under the experience method, which essentially allows a deduction for the Association's actual charge-offs, while a deduction with respect to qualifying loans may be computed using a percentage based on actual loss experience or a percentage of taxable income. Reasonable additions to the reserve for losses on nonqualifying loans must be based upon actual loss experience and would reduce the current year's addition to the reserve for losses on qualifying real property loans, unless that addition is also determined under the experience method. The sum of the additions to each reserve for each year is the Association's annual bad debt deduction. 48 Under the experience method, the deductible annual addition to the Association's bad debt reserves is the amount necessary to increase the balance of the reserve at the close of the taxable year to the greater of (a) the amount which bears the same ratio to loans outstanding at the close of the taxable year as the total net bad debts sustained during the current and five preceding taxable years bear to the sum of the loans outstanding at the close of those six years or (b) the lower of (i) the balance in the reserve account at the close of the last taxable year prior to the most recent adoption of the experience method (the "base year"), except that for taxable years beginning after 1987, the base year is the last taxable year before 1988, or (ii) if the amount of loans outstanding at the close of the taxable year is less than the amount of loans outstanding at the close of the base year, the amount which bears the same ratio to loans outstanding at the close of the taxable year as the balance of the reserve at the close of the base year bears to the amount of loans outstanding at the close of the base year. Under the 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 has historically permitted a qualifying savings institution to be taxed at a lower maximum effective marginal federal income tax rate than that applicable to corporations in general. The maximum effective marginal 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, is 31.3% (as compared with 34% for corporations generally). Any savings institution at least 60% of whose assets are qualifying assets, as described in Section 7701(a)(19)(c) of the Code, will generally be eligible for the full 8% of taxable income deduction. As of September 30, 1993, at least 60% of the Association's assets were "qualifying assets" described in Section 7701(a)(19)(C) of the Code, and the Association anticipates that at least 60% of its assets will continue to be qualifying assets in the immediate future. If this ceases to be the case, the Association may be required to restore some portion of its bad debt reserve to taxable income in the future. Under the percentage of taxable income method, the bad debt deduction for an addition to the reserve for qualifying real property loans cannot exceed the amount necessary to increase the balance in this reserve to an amount equal to 6% of such loans outstanding at the end of the taxable year. The bad debt deduction is also limited to the amount which when added to the addition to the reserve for losses on nonqualifying loans, equals the amount by which 12% of deposits at the close of the year exceeds the sum of surplus, undivided profits and reserves at the beginning of the year. Based on experience, it is not expected that these restrictions will be a limiting factor for the Association in the foreseeable future. In addition, the deduction for qualifying real property loans is reduced by an amount equal to the deduction for nonqualifying loans. In fiscal 1992 and 1991, the Association used the experience method with respect to qualifying real property loans. In fiscal 1993, the Association intends to utilize the percentage of taxable income method. 49 Distributions. If the Association distributes cash or property to stockholders, and the distribution is treated as being from its accumulated bad debt reserves, the distribution will cause the Association to have additional taxable income. As of September 30, 1993, retained earnings included approximately $3.2 million of accumulated bad debt reserves. A distribution to stockholders 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-dividend distribution." A distribution in respect of stock is a non-dividend 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, exceeds the Association's current and accumulated earnings and profits. The amount of additional taxable income created by a nondividend distribution is an amount that when reduced by the tax attributable to it is equal to the amount of the distribution. Alternate Minimum Tax. The Code imposes an alternative minimum tax ("AMT") at a rate of 20% on a base of regular taxable income plus certain tax preferences ("alternative minimum taxable income" or "AMTI") and will be payable to the extent such AMTI is in excess of an exemption amount. The Code provides that an item of tax preference is the excess of the bad debt deduction allowable for a taxable year pursuant to the percentage of taxable income method over the amount allowable under the experience method. The other items of tax preference that constitute AMTI include (a) tax-exempt interest on newly issued (generally, issued on or after August 8, 1986) private activity bonds other than certain qualified bonds and (b) for taxable years after 1989, 75% of the excess (if any) of (i) adjusted current earnings as defined in the Code, over (ii) AMTI (determined without regard to this preference and prior to reduction by net operating losses). Net operating losses can offset no more than 90% of AMTI. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. In addition, for taxable years after 1986 and before 1992, corporations, including thrift institutions, are also subject to an environmental tax equal to 0.12% of the excess of AMTI for the taxable year (determined without regard to net operating losses and the deduction for the environmental tax) over $2.0 million. The Association incurred a minimum tax expense of $40,000 in fiscal 1991 which will be utilized as a credit carryover against regular tax in fiscal 1993. 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. Losses incurred by savings institutions in years beginning after 1981 and before 1986 may be carried back 10 years and forward eight years. As of September 30, 1993, the Association had $1.3 million of net operating loss carryforwards for federal income tax purposes. For income tax purposes, the availability of the Association's tax credit carryforwards to offset current taxable income has been recorded as restricted by Internal Revenue Code Section 382. In general, Section 382 provides that following an "ownership change" in a "loss corporation" the tax credit carryforwards of that corporation will be available to offset taxable income in each taxable year following the "ownership change" only up to the amount of the Section 382 limitation 50 (generally, the product of the corporation's market value at the time of the "ownership change" and the long-term tax-exempt bond rate at such time) for such year. The $1.3 million carryforward for income tax purposes would therefore be limited to a maximum of $430,000 in any one year. Capital Gains and Corporate Dividends-Received Deduction. The capital gains income tax which was previously imposed at a tax rate of 28% on a corporation's net long-term capital gains was repealed effective December 31, 1986. Consequently, corporate net capital gains will be taxed at a maximum rate of 34%. 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 eliminate from income 100% of dividends from a member of the same affiliated group of corporations. Tax Returns. The federal income tax returns of the Association, for its tax years beginning after September 30, 1987 and subsequent periods are open under the statute of limitations and are subject to review by the Internal Revenue Service. Recent Tax Developments. In August, 1993, the Revenue Reconciliation Act of 1993 became law, and effects tax changes for individuals and businesses. Key provisions affecting financial institutions include the following: (1) an increase in the tax rate on corporate taxable income from 34% to 35% for taxable income over $10.0 million; (2) provides a 15-year straight line amortization period for intangible assets acquired in a taxable purchase; (3) requires security dealers (to include financial institutions) to value securities not held as inventory to be marked to market; (4) requires thrifts to file information returns with the Internal Revenue Service reporting any discharge of indebtedness of $600 or more; (5) repeals the "stock for debt" exception to the recognition of cancellation of debt income; (6) relaxes seller-financing restriction on sales of foreclosed real property to pensions and exempt organizations; (7) increases the required estimated tax payments by corporations to 100%; (8) limits deductibility of business meals and entertainment to 50%; (9) repeals the deduction for club dues; (10) denies the deduction for spousal travel expenses; (11) repeals the deduction for lobbying expenses; (12) increases the cost-recovery period of non-residential real property to 39 years from its present 31.5 years; (13) extends the employer provided educational assistance programs; (14) adds entirely new capital gains provisions for the sale and exchange of certain small business stock; (15) limits deductions for executive compensation to $1.0 million per executive; (16) eliminates the ceiling on the Medicare portion (2.9%) of the FICA tax; and (17) lowers the maximum amount of annual compensation to $150,000 when determining the size and allocation of retirement plan contributions. The enactment of this legislation will result in increased tax expense to the Association. 51 State Taxation Virginia imposes a corporate income tax on a base which is similar to federal income tax, as adjusted by adding back the federal bad debt deduction but taking into account a state bad debt deduction of 40%. The state corporate tax rate is 6% of Virginia taxable income. Item 2. Properties. Offices and Other Material Properties At September 30, 1993, the Association conducted its business from its main office in Warrenton, Virginia and six branch offices. The following table sets forth certain information with respect to the offices of the Association as of September 30, 1993. Net Book Value of Owned Lease Property or Leasehold or Expiration Improvements as of Office Location Leased Date September 30, 1993 (Dollars in Thousands) Main Office: 550 Broadview Avenue Owned -- $ 898 Warrenton, Virginia 22186 Branch Offices: Warrenton Center Leased 11/30/97 $ 38 Warrenton, Virginia 22186 701 South Main Street Owned -- $ 323 Culpeper, Virginia 22701 1705 Seminole Trail Owned -- $ 642 Rio Road & 29 North Charlottesville, Virginia 22906 300 Preston Avenue Leased 7/31/96 $ 13 Commonwealth Center Charlottesville, Virginia 22901 9-J Catoctin Circle, S.W. Leased 10/31/94 $ 51 Village Square Shopping Center Leesburg, Virginia 22075 20 East Luray Shopping Center Leased 9/30/97 $ 6 Luray, Virginia 22835 52 Future Loan Production Location 8500 Sudley Road Owned -- $ 392 Manassas, Virginia 22110 Item 3. Legal Proceedings Jefferson is a party to the following legal proceedings which management believes will not have a material adverse impact on the consolidated financial statements. a. Max Greenhalgh, et al. v. Virginia Beach Savings and Loan Bank, et al. This suit is filed in the Third Judicial District of Summit County, Utah. This is a suit instituted by plaintiffs calling themselves "Founding Members" of the Jeremy Ranch Golf Club. The Founding Members seek to protect what they allege to be their golfing and club privileges incident to their Membership in the Jeremy Ranch Golf Club. Though a named defendant, Jefferson has never been served. The only participant to be served was the lead lender, Virginia Beach Federal Savings Bank. Jefferson was one of the four participants in a loan transaction that was initially entered into in November, 1982 by and between Jeremy Ltd., a Utah limited partnership, Richards Woodbury Mortgage Corporation, a Utah corporation, the loan originator and servicing agent, and Virginia Beach Federal Savings Bank, the lead lender. The loan was secured by real estate known as Jeremy Ranch, including the Jeremy Ranch Golf Course. Jefferson held a 23.59% interest in this loan. Because the loan was in default, the lenders foreclosed on the property on November 28, 1988. The Founding Members' suit was filed prior to the foreclosure sale, and the plaintiffs sought a temporary restraining order to prevent the foreclosure sale. The court refused to issue such an order. The action continued on the Founding Members' multiple legal theories that the lenders, including Jefferson, lost their security interest in the property and are precluded from enforcing such security interest so as to adversely affect the Founding Members' privileges. In the alternative, the Founding Members sought compensatory damages against the lenders in excess of $2,000,000. By memorandum decision dated July 11, 1991, the court entered Summary Judgment in favor of the Plaintiffs and found that the "Founding Members" of the Jeremy Ranch Club hold easements in gross on the golf course. No damages were awarded. In November, 1991, Jefferson entered into an agreement with Virginia Beach Federal Savings Bank whereby Virginia Beach Federal Savings Bank purchased Jefferson's interest in all of the Jeremy Ranch property and agreed to indemnify and hold Jefferson harmless in this litigation. The matter was tried in February and March of 1993. The court found that approximately one-third of the Plaintiffs were not entitled to an easement, but confirmed that the other Plaintiffs did have easements and 53 who were also awarded damages. Both sides appealed. In November of 1993, Virginia Beach Federal Savings Bank settled the case with 179 of the 180 Plaintiffs in part by selling them the golf course. The matter is still on appeal as to the one remaining Plaintiff. b. William T. Blair, Jr. v. Virginia Beach Federal Savings Bank et al., Civil No. 900901684. This action was filed in the Third Judicial District Court of Salt Lake County, Utah. Plaintiff's claim arises from an employment agreement he entered into in April of 1985 with the Jeremy Service Corporation. The Jeremy Service Corporation was the general partner of Jeremy Ltd., which at the time owned the Jeremy Ranch. Plaintiff alleges that the Jeremy Service Corporation was the alter ego of the participating lenders, including Jefferson, in the Jeremy Ranch loan. Plaintiff asserts various legal theories against the lenders and seeks damages in the following amounts: 1. Breach of contract: $155,126 2. Breach of covenant of good faith and fair dealings: $228,581 3. Fraud: $228,581 4. Compensatory: $862,013 punitive 5. Negligent misrepresentation: $1,090,594 6. Promissory estoppel: $182,000 7. Indemnification: $11,119 In November, 1991, Jefferson entered into an agreement with Virginia Beach Federal Savings Bank whereby Virginia Beach Federal purchased Jefferson's interest in all of the Jeremy Ranch property and agreed to indemnify and hold Jefferson harmless in this litigation. Other The Association has resolved to indemnify and hold harmless those officers of the Association serving on boards of directors of other corporations where such service is at the request of, and in the best interests of, the Association. Two officers of the Association are or were directors of Jeremy Service Corporation which is involved in one or more of the law suits referred to above. Item 4. Submission of Matters to Vote of Security Holders. Not applicable. PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The information required herein is incorporated by reference from the inside back cover of the Association's Annual Report. 54 Item 6. Management's Discussion and Analysis. The information required herein is incorporated by reference from pages 3 to 17 of the Annual Report. Item 7. Financial Statements. The information required herein is incorporated by reference from pages 18 to 43 of the Annual Report. Item 8. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. Not applicable. PART III. Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act. The information required herein is incorporated by reference from pages 3 to 8 of the definitive proxy statement of the Association filed on January 11, 1994 ("Definitive Proxy Statement"). Item 10. Executive Compensation. The information required herein is incorporated by reference from pages 9 to 12 of the Definitive Proxy Statement. Item 11. Security Ownership of Certain Beneficial Owners and Management. The information required herein is incorporated by reference from pages 1 to 3 of the Definitive Proxy Statement. Item 12. Certain Relationships and Related Transactions. The information required herein is incorporated by reference from pages 12 and 13 of the Definitive Proxy Statement. Item 13. Exhibits, List and Reports on Form 8-K. (a) Exhibits Required by Item 601 of Regulation S-B. (1) The following financial statements are incorporated by reference from Item 7 hereof (see Exhibit 13): Consolidated Balance Sheets at September 30, 1993 and 1992 Consolidated Statements of Operations for Each of the Three Years in the Period Ended September 30, 1993 55 Consolidated Statements of Stockholders' Equity for Each of the Three Years in the Period Ended September 30, 1993 Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended September 30, 1993 Notes to Consolidated Financial Statements Report of Independent Certified Public Accountants (2) The following exhibits are filed as part of this Form 10-KSB and this list includes the Exhibit Index. No. Exhibits Page 3.1 Federal Stock Charter * 3.2 Federal Stock Bylaws E-1 4 Specimen Stock Certificate ** 10.1 Employment agreement with Thomas W. Winfree E-11 10.2 Form of severance agreement with Craig A. Mason E-19 10.3 Form of severance agreement with Walter E. Monroe E-23 10.4 Form of severance agreement with Benny N. Werner E-27 10.5 Form of severance agreement with James A. Yergin E-31 10.6 Form of severance agreement with John E. Meyer E-35 10.7 Form of severance agreement with Carol J. Smith E-39 10.8 Form of severance agreement with Melanie K. Smith E-43 10.9 Form of severance agreement with Shirley B. Stalnaker E-47 10.10 Form of severance agreement with JoDale Favara E-51 10.11 Form of severance agreement with Douglas R. Lawrence E-55 13 Annual Report to Stockholders E-59 22 Subsidiaries of the Registrant - Reference is made to "Item 1. Subsidiaries" for the required information. * Incorporated by reference to the Association's Form 10-K for the year ended September 30, 1992. ** Incorporated by reference to the Association's Form 10-K for the year ended September 30, 1991. (b) Not applicable. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Jefferson has duly caused this report to be signed on its behalf of the undersigned, thereunto duly authorized. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. By: /s/ Thomas W. Winfree Thomas W. Winfree, President and Chief Executive Officer 56 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on behalf of the Registrant by the following persons in the capacities on the dates indicated. Name Title Date /s/ Robin C. Gulick Director and Chairman December 31, 1993 Robin C. Gulick of the Board /s/ Thomas W. Winfree Director, President December 31, 1993 Thomas W. Winfree and Chief Executive Officer /s/ Calvin P. Burton Director December 31, 1993 Calvin P. Burton /s/ Charles H. Jones, Jr. Director December 31, 1993 Charles H. Jones, Jr. /s/ Robert F. Kube Director December 31, 1993 Robert F. Kube /s/ William M. Rider Director December 31, 1993 William M. Rider /s/ Saul J. Robinson Director December 31, 1993 Saul J. Robinson Director December 31, 1993 John Sheldon Clark Director December 31, 1993 Arthur J. Shadek /s/ Craig A. Mason Senior Vice President, December 31, 1993 Craig A. Mason Chief Financial Officer and Principal Accounting Officer EX-99 3 EXHIBIT 99II (JEFFERSON SAVINGS & LOAN LOGO) January 4, 1994 To Our Stockholders: We are pleased to report that fiscal 1993 was profitable for Jefferson Savings and Loan Association. In addition, it appears that the economic forces which have been restraining financial institution earnings in the last few years began receding during 1993. The benefits of Jefferson's market position, conservative operations, and business momentum from the successful stock offering completed in October, 1992 became increasingly evident. While work remains in continuing to improve operations and enhance shareholder value, we remain committed to making Jefferson a more important factor in our communities' financial decisions. Jefferson's 1993 net income of $846,000 was a dramatic increase from the 1992 loss of $973,000. This significant improvement was the result of higher net interest income, reduced losses on loans, a gain on the sale of mortgage loan servicing, and a decrease in real estate owned expense. Total assets were $284 million at September 30, 1993. Stockholders' equity increased to $12.7 million at September 30, 1993, resulting in a book value of $9.67 per share. In April 1993, the Association effected a one-for-three reverse stock split, reducing outstanding shares to 1,310,876. In October, 1993 Jefferson successfully acquired $9.3 million of deposits from another savings institution in Leesburg, Virginia. We welcome these new customers to the Jefferson family. We also acquired a vacant branch facility in Manassas, Virginia from the Resolution Trust Corporation, and plan to open a loan production facility there in 1994. During 1994, we will be evaluating other opportunities available for expansion in our contiguous market areas. However, we will only pursue opportunities that make economic and regulatory sense. Our retail system has been Jefferson's strength and we intend to continue doing what we do best, making mortgage and consumer loans, and servicing our deposit customers. This expansion will need to be supported by capital growth as well. Our plans include an offering of stock if it becomes likely that asset and liability growth will take place. During this past year, we have begun to transform Jefferson into an institution which embraces a strong sales culture with recognition of the importance of efficiently serving our customers. Our goal is to have the people in our communities use Jefferson whenever a financial need arises. Since 1960, Jefferson has served the people of Warrenton, Culpeper, Luray, Leesburg and Charlottesville. As a result of the challenging regulatory and competitive environments, it has become clear that only the best managed and strongest financial institutions will survive. Jefferson intends to remain in that elite group. We would like to express our thanks to all Jefferson employees for their hard work that was a major factor in our success in 1993. We also salute the Board of Directors for their policy guidance and devotion to Jefferson's future. Finally, we would like to thank our stockholders for your continuing support. Management and the Board of Directors has placed enhancement of shareholder value as a top priority in planning Jefferson's future. Sincerely, (SIG) (SIG) Robin C. Gulick Thomas W. Winfree Chairman of the President and Board Chief Executive Officer JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (Dollars in Thousands, Except Per Share Amounts) September 30, 1993 1992 1991 1990 1989 Assets: Cash and investments . . . . . $48,596 $48,192 $13,498 $32,240 $36,025 Loans receivable, net . . . . . 169,965 186,185 208,641 234,848 245,522 Mortgage-backed securities . . 51,173 50,589 79,491 79,400 83,594 Other assets . . . . . . . . . 14,516 16,654 22,560 16,631 18,943 $284,250 $301,620 $324,190 $363,119 $384,084 Liabilities and Stockholders' Equity: Deposits . . . . . . . . . . . $241,467 $249,166 $244,139 $236,780 $257,983 FHLB advances . . . . . . . . . 13,750 51,050 46,000 Other borrowings . . . . . . . 24,079 34,158 54,506 61,387 65,612 Other liabilities . . . . . . . 6,022 6,558 5,260 8,009 8,436 Stockholders' equity . . . . . 12,682 11,738 6,535 5,893 6,053 $284,250 $301,620 $324,190 $363,119 $384,084
Year Ended September 30, 1993 1992 1991 1990 1989 Summary of Income and Expense: Interest income . . . . . . . . $21,168 $26,712 $32,820 $34,717 $36,191 Interest expense . . . . . . . 13,725 20,007 26,983 30,038 32,133 Net interest income . . . . . . 7,443 6,705 5,837 4,679 4,058 Provision for losses on loans . 533 1,115 498 667 603 Noninterest income . . . . . . 3,090 2,257 2,549 1,577 1,761 Operating expenses . . . . . . 8,239 8,820 7,206 6,253 8,771 Income (loss) before income tax expense (benefit) and extraordinary item . . . . . 1,761 (973) 682 (664) (3,555) Income tax expense (benefit) . 915 500 (504) (1,430) Income (loss) before extraordinary item . . . . . 846 (973) 182 (160) (2,125) Extraordinary item . . . . . . 460 Net income (loss) . . . . . . . $846 $(973) $642 $(160) $(2,125)
At or for the Year Ended September 30, 1993 1992 1991 1990 1989 Book value per common share (1) $9.67 $8.95 $36.64 $33.04 $33.93 Outstanding shares (1) . . . . 1,310,876 1,310,876(2) 178,377 178,377 178,377 Earnings (loss) per share before extraordinary item (1) $.65 $(5.45) $1.02 $(.90) $(11.91) Extraordinary item per share (1) . . . . . . . . . . . . . 2.58 Net earnings (loss) per share (1) . . . . . . . . . . . . . $.65 $(5.45) $3.60 $(.90) $(11.91) Return on average assets (net income divided by average total assets) . . . . . . . . .29% (.31)% .19% (.04)% (.53)% Return on equity (net income divided by average equity) . 6.93% (10.65)% 10.33% (2.68)% (29.86)% Equity-to-average assets (average equity divided by average total assets) . . . . 4.17% 2.92% 1.81% 1.60% 1.78% Number of offices . . . . . . . 6 6 7 7 7 Regulatory Capital: Tangible . . . . . . . . . . . $12,682 $11,738 $6,535 $5,893 N/A Core . . . . . . . . . . . . . 12,682 11,738 6,535 5,893 N/A Risk-based . . . . . . . . . . 14,284 13,026 7,670 6,691 N/A
___________ (1) All periods presented have been adjusted to give effect to the one-for-three reverse stock split in April, 1993. (2) At September 30, 1992, outstanding shares totaled 1,310,876, while the weighted average shares outstanding for the year ended September 30, 1992 totaled 178,377. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General Jefferson Savings and Loan Association, F.A. ("Jefferson" or the "Association") is a federally chartered savings and loan association headquartered in Warrenton, Virginia with branch offices in Warrenton, Luray, Leesburg, Culpeper and Charlottesville. The Association's principal business consists of attracting deposits and using such funds, together with borrowings, to originate primarily residential real estate loans secured by property located mainly in Virginia. However, during fiscal 1994, the Association intends to emphasize the origination of nonresidential real estate loans secured by property in its market area. Currently, Jefferson is the largest financial institution headquartered in Fauquier County, Virginia. In recent years, management has pursued various strategies in connection with an overall plan to meet more stringent regulatory capital requirements. As part of this plan, the Association successfully completed a common stock offering resulting in net proceeds of $6.2 million, reduced high cost borrowings, increased net interest income, increased net interest spread, reduced its reliance on national deposits, increased local core deposits, sold newly originated fixed interest-rate mortgage loans, with servicing retained, reduced real estate owned, and increased noninterest income. In the future, management intends to concentrate its efforts on reducing expenses related to real estate owned, upgrading the mortgage origination capability of the Association, and moderately increasing branch and deposit growth in Virginia markets contiguous to those markets presently served by the Association. During fiscal 1993, the Association recorded net income of $846,000 versus a net loss of $973,000 in fiscal 1992. The major contributing factors for this improvement were an increase in net interest income of $738,000, a decrease in provision for losses on loans of $582,000, a gain on the sale of mortgage loan servicing of $770,000, an increase on gains on sale of mortgage loans of $381,000 and a decrease of $1.0 million in real estate owned expense. Such benefits were partially offset by a decrease of $467,000 in gains on sale of investment securities and mortgage- backed securities, an increase in operating expenses other than real estate owned expense of $427,000, and an increase in income tax expense of $915,000. Financial Condition at September 30, 1993 and 1992 The Association's total assets decreased $17.4 million, or 5.8%, to $284.3 million at September 30,1993 from $301.6 million at September 30, 1992 due primarily to a $16.2 million decrease in loans receivable, a $7.0 million decrease in cash held in escrow, and a $2.2 million decrease in real estate owned, which decreases were partially offset by an increase of $7.4 million in investment securities. On September 30, 1992, the Association successfully completed a subscription rights and community stock offering which resulted in the sale of approximately 3.4 million shares of common stock. At September 30, 1992, the funds from the stock offering, amounting to approximately $6.8 million were held in an interest-earning escrow account. These funds were released to the Association on October 5, 1992, and re-invested in other interest-earning assets after payment of offering expenses. The portfolio of $45.7 million in investment securities at September 30, 1993 consisted primarily of $14.0 million in U.S. Government and agency obligations, $15.0 million in Federal Home Loan Bank of Atlanta ("FHLB") overnite funds, $3.6 million in FHLB stock, $10.7 million in adjustable-rate mortgage mutual funds, and $2.4 million in finance subsidiary trust cash accounts. At September 30, 1993, the Association adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities", which requires investments to be classified as held-to-maturity, trading, or available-for-sale. Investments held- to-maturity are reported at amortized cost; investments classified as trading are reported at fair value, with unrealized gains and losses included in earnings; and investments classified as available-for-sale are reported at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders' equity, net of income tax effect. At September 30, 1993, investments available-for-sale totalled $24.7 million, with an unrealized loss of $7,000, and investments held- to-maturity totalled $21.0 million, with no unrealized gain or loss. There were no investments classified as trading. The Association has continued its past policy of investing in short- term overnite funds, high quality government and government agency obligations on a direct basis or through mutual funds. At September 30, 1992 the investment portfolio of $38.3 million consisted of $30.0 million of U.S. Treasury bills, $2.5 million in FHLB overnite funds, $3.4 million in FHLB stock, $1.1 million in a corporate note, and $1.3 million in finance subsidiary trust cash accounts and other investments. For further information concerning the Association's investment securities, see Note 2 in the Notes to Consolidated Financial Statements contained herein. The mortgage-backed securities ("MBSs" or "mortgage-backed securities") portfolio of $51.2 million consists entirely of Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA") instruments. At September 30, 1993, MBSs classified as available-for-sale totalled $8.7 million with an unrealized gain of $161,000, and MBSs classified as held-to-maturity totalled $42.3 million with a net unrealized gain of $1,240,000. At September 30, 1993, there were no MBSs classified as trading. Approximately $25.3 million of the MBSs classified as held-to-maturity are placed with trustees as part of collateralized mortgage obligation ("CMO") and real estate mortgage investment conduit ("REMIC") transactions through Jefferson's wholly-owned finance subsidiaries. The finance subsidiaries' MBSs decreased $12.3 million in fiscal 1993 as a result of prepayments due to the low interest rate environment which prevailed in fiscal 1993. However, the balance of MBSs at September 30, 1993 compared to September 30, 1992 remained virtually unchanged due to purchases of MBSs of $22.7 million, and the securitization of portfolio mortgage loans of $4.1 million into MBSs, which were offset by repayments of $18.1 million (including the $12.3 million of prepayments referred to above) and sales of $8.3 million. The sales of MBSs in fiscal 1993 were effected in late December, 1992 to increase the Association's risk-based capital ratios to meet increased regulatory capital standards and offset loss provisions on mortgage loans and real estate owned. The sales of $15.4 million in fiscal 1992 were effected to reduce assets and increase risk-based capital ratios in accordance with a capital plan filed with the Office of Thrift Supervision ("OTS"). Loans receivable decreased $16.2 million or 8.7% in fiscal 1993 to $170.0 million at September 30, 1993. This decline was attributable to a continuing decline in mortgage interest rates, which has spurred record refinancing activity, and a high level of loan repayments. Loan originations increased to $103.0 million in fiscal 1993 compared to $97.3 million in fiscal 1992. Sales of loans increased to $64.8 million in fiscal 1993 compared to $57.8 million in fiscal 1992 and loan repayments totalled $50.7 million in fiscal 1993 compared to $58.9 million in fiscal 1992. The Association has continued to sell newly originated fixed-rate mortgage loans in the secondary market while retaining servicing. However, in September, 1993, the Association sold servicing rights to $63 million of loans previously sold. In 1993, the Association continued to focus its lending activities on single-family residential loans, construction loans, and consumer loans, and originated only $476,000 of nonresidential loans during fiscal 1993 and 1992. Nonresidential loans decreased to $32.4 million or 18.6% of outstanding loans at September 30, 1993 from $37.1 million or 19.5% of outstanding loans at September 30, 1992. However, during fiscal 1994, the Association intends to emphasize the origination of nonresidential real estate loans. The amount of such originations will depend on market conditions and other factors. However, the Association does not presently anticipate such originations to exceed $15.0 million in fiscal 1994. Generally, individual loans would be limited to $800,000 and would be secured by property located in its market area. For information regarding loan loss provisions and nonperforming assets, see "Nonperforming Assets" contained within this report. In August, 1993, the Association implemented a systems conversion for mortgage loan origination software and hardware. A computer network will be completed in fiscal 1994 to facilitate the goal of higher loan originations in future periods. In addition, teller platform hardware and software will be operational in January, 1994. The cost of these office equipment additions in fiscal 1993 and fiscal 1994 will be approximately $800,000. The Association expects to increase staff and develop correspondent sources to achieve increased loan production targets. Real estate owned ("REO") decreased $2.2 million or 21.3% during fiscal 1993 to $8.2 million. During fiscal 1993, sales of REO totalled $3.5 million, while additions totalled $1.6 million. During fiscal 1993, the Association established a general valuation allowance ("GVA") equal to $100,000, which is netted against the aggregate REO fair value of $8.3 million. However, the individual properties are carried at fair value without consideration of the GVA. During fiscal 1993, the Association directly expensed approximately $1.0 million in renovation expenditures for an REO property, the Ocean One Hotel in Virginia Beach, Virginia (See "Results of Operations-Operating Expenses."). Direct write-offs of properties other than the Ocean One totalled $372,000 in fiscal 1993. Office properties and equipment increased $473,000 reflecting the purchase of computer hardware and software for mortgage originations and the purchase of land and a building in Manassas, Virginia for use as a loan production office. During fiscal 1993, total liabilities decreased $18.3 million or 6.3% to $271.6 million at September 30, 1993 due primarily to a decrease of $7.7 million in deposits and a decrease of $10.1 million in other borrowings (CMO and REMIC). Deposits decreased $7.7 million or 3.1% during fiscal 1993 to $241.5 million at September 30, 1993. Jumbo time deposits (accounts in excess of $100,000) decreased $5.4 million in fiscal 1993, with national funds representing $4.0 million of the jumbo time deposit decline. However, other time deposits increased $4.4 million in fiscal 1993. Demand accounts represented 54% of total deposits, while time deposits totalled 46%. At September 30, 1993, the Association had $15.5 million of time deposits in "Bump Rate" certificates of deposit, which allows a depositor to adjust his or her rate to a current rate once during the deposit term, and $10.8 million in "Prime Rate" certificates of deposit, which are tied to changes in prime rate less 150-175 basis points. The weighted average cost of deposits at September 30, 1993 was 3.84%, a decline of 110 basis points from the weighted average cost of 4.94% at September 30, 1992. The Association has continued pricing its deposits within a mid-range of rates offered by its competitors except for selective promotions. In October, 1993, the Association purchased approximately $9.3 million of deposits from another savings institution in Leesburg, Virginia at a premium of 1.25%. These accounts were transferred to the Association's existing branch in Leesburg, Virginia. There were no outstanding advances from the FHLB or securities sold under agreements to repurchase at September 30, 1993 or 1992. Due to the high liquidity from loan sales and repayments, the Association utilized only $2 million in FHLB advances in fiscal 1993. Other borrowings declined $10.1 million or 29.5% in fiscal 1993 to $24.1 million at September 30, 1993. This repayment of the CMO and REMIC borrowings of Jefferson's wholly owned subsidiaries was accelerated by the heavy refinancing of real estate mortgage loans due to the decline in market interest rates. The unamortized discount related to these borrowings declined approximately $1.0 million to $2.3 million at September 30, 1993. As a result, the costs of other borrowings rose to approximately 12.55% in fiscal 1993. Heavy refinancing activity in fiscal 1994 is expected to continue, which will result in continuing higher amortization of the unamortized discount, and a high cost of other borrowings. In April, 1993, the Association completed a one-for-three reverse stock split approved by the stockholders at the 1993 Annual Meeting, reducing outstanding shares to 1,310,876. Book value per share at September 30, 1993 was $9.67. In June, 1993, the National Association of Securities Dealers, Inc. accepted the Association's application to list the Association's common stock in its small cap issues (NASDAQ:JEFF). Present market makers are Branch Cabell & Co., Scott & Stringfellow Investment Corporation, Anderson and Strudwick, and Wheat First Securities, all of Richmond, Virginia, Ryan Beck and Co. Inc. of West Orange, New Jersey and Herzog, Heine, Geduld, Inc. of New York, New York. Jefferson does not invest in high-yield financing (junk bonds), real estate joint ventures, interest rate swaps or futures contracts, and had no goodwill or purchased mortgage servicing rights at September 30, 1993. Nonperforming assets Nonperforming assets consist of nonaccrual loans, real estate acquired by foreclosure or deed-in-lieu of foreclosure, in- substance foreclosures and repossessed assets. The Association does not accrue interest on loans which are 90 days or more delinquent. Excess commercial office inventory, coupled with a regional economic decline, adversely affected the real estate market in the Washington, D.C. metropolitan area and contributed to the level of the Association's nonperforming assets in fiscal 1991, 1992 and 1993. The real estate in the metropolitan Washington, D.C. area may take substantial time to absorb the existing real estate inventory and may also be adversely affected in the future by the disposition of a significant amount of real estate by financially troubled institutions, as well as by the Federal Deposit Insurance Corporation ("FDIC") and the Resolution Trust Corporation ("RTC"). The real estate market in the Association's market area and the overall economy are expected to be significant determinants of the quality of the Association's assets in future periods and, thus, its results of operations. The following table sets forth information regarding the Association's nonaccrual loans and real estate owned at the dates indicated. September 30, 1993 1992 1991 (Dollars in Thousands) Nonaccrual loans Residential . . . . . . . . . . . . . . . . . . . . . . $1,205 $626 $1,338 Nonresidential . . . . . . . . . . . . . . . . . . . . 1,298 1,204 4,305 Construction . . . . . . . . . . . . . . . . . . . . . 154 112 263 Consumer . . . . . . . . . . . . . . . . . . . . . . . 9 24 523 Subtotal . . . . . . . . . . . . . . . . . . . . . . 2,666 1,966 6,429 Real estate owned Residential . . . . . . . . . . . . . . . . . . . . . . 770 2,775 1,948 Nonresidential . . . . . . . . . . . . . . . . . . . . 6,938 6,308 7,764 In-substance foreclosure . . . . . . . . . . . . . . . 611 1,365 Subtotal . . . . . . . . . . . . . . . . . . . . . . 8,319 10,448 9,712 Total nonperforming assets . . . . . . . . . . . . . . . $10,985 $12,414 $16,141 Total nonperforming assets to total assets . . . . . . . 3.86% 4.12% 4.98%
If the nonaccrual loans and loans deemed in-substance foreclosure assets at September 30, 1993 had been current in accordance with their terms for the year ended September 30, 1993 (or from the date of origination if originated during such period), the total interest income on such loans for fiscal 1993 would have been $670,300. The Association did not accrue any interest income on such loans in fiscal 1993. The $2.7 million of nonaccrual loans at September 30, 1993 consisted of twelve residential loans, four nonresidential loans, two construction loans, and five consumer loans. The largest of these nonaccrual loans, with an outstanding principal balance of $1.1 million at September 30, 1993, is collateralized by a bowling alley in Grafton, Virginia (near Newport News). Such amount represents the Association's 60% participation interest in the loan. The loan is serviced by the FDIC and was 38 months delinquent at September 30, 1993. The borrower filed bankruptcy in September, 1992. The bankruptcy court has approved the borrower's plan of reorganization which requires the borrower to refinance the loan prior to June, 1994, and the borrower began making monthly interest payments in October, 1993. The bowling alley is operational, with a December, 1991 appraisal value in excess of loan carrying value. At September 30, 1993, all twelve residential loans had outstanding principal balances less than $198,000, the remaining three nonresidential loans had outstanding principal balances less than $100,000, the two construction loans amounted to $112,000 and $42,000, and no nonaccrual consumer loans exceeded $3,000. However, the Association does have five loans outstanding to one borrower totalling approximately $420,000. These loans are in the process of foreclosure. Other than the bowling alley loan, all loans are secured by property located in the Association's market areas. The $8.2 million of REO at September 30, 1993, net of a $100,000 general valuation allowance, consisted of three single-family residences with an aggregate carrying value of $336,000, 22 condominiums in Dallas, Texas with an aggregate carrying value of $434,000, a Knight's Inn motel in Monroe, Michigan with a carrying value of $1.7 million, the Ocean One hotel in Virginia Beach, Virginia with a carrying value of $3.8 million, office and residential property in Leesburg, Virginia with a carrying value of $276,000, warehouse and land in Chantilly, Virginia with a carrying value of $414,000, seven lots near Warrenton, Virginia with a carrying value of $305,000, partially developed land in Charlottesville, Virginia with an aggregate carrying value of $453,000, and a single-family residence in Warrenton, Virginia with a carrying value of $611,000. In November, 1993, the Association sold the Knight's Inn motel in Monroe, Michigan for $1.8 million. The Association accepted a cash payment of $150,000 and extended a loan of $1,650,000 for the remainder of the purchase price. In October, 1993, the Association purchased the land and the land lease for the Knight's Inn motel for $340,000. As a result, the Association expects to receive a minimum of $30,000 in annual rental payments from this land lease. The office and residential property in Leesburg, Virginia is vacant and has been evaluated by experts for soil contamination. The carrying value of $276,000 is net of a specific reserve of $80,000 relating to the resolution of this problem. The Ocean One Hotel is a 102-room beachfront hotel which was acquired by foreclosure in June, 1991 and reopened for business in July, 1992 after being closed for twenty months. The outstanding loan at the time of the foreclosure amounted to $2.7 million. In fiscal 1992, the Association spent $2.2 million in renovation expenditures, with $1.1 million charged to expense, and the remainder of $1.1 million capitalized as part of the REO balance, resulting in a new carrying value of $3.8 million at September 30, 1992. During fiscal 1993, the Association expensed $1.1 million in further renovation expenditures for an indoor swimming pool, meeting rooms, a restaurant and restaurant equipment, a lounge and bar, exterior painting, and replacement of certain hotel furnishings. The Association does not plan further significant renovation expenditures, and has listed the property for sale. However, the Association is unable to project, if any, additional expenditures which may be necessary to sell the property. The property is being managed by a professional hotel operator. The Association is evaluating the benefits of affiliating the hotel with a national franchise in fiscal 1994. Results of Operations General The operating results of the Association depend primarily on its net interest income, which is the difference between interest and dividend income on interest-earning assets, consisting primarily of loans, investment securities and mortgage- backed securities, and interest expense on interest-bearing liabilities, consisting primarily of deposits, FHLB advances, and other borrowings. The Association's results of operations also are affected by the provision for loan losses, resulting from the Association's assessment of the adequacy of the allowance for loan losses; the level of its noninterest income, including gains on the sale of loans, investments, and mortgage-backed securities, and mortgage loan servicing, deposit and other fees and service charges; the level of its operating expenses, including compensation, occupancy and equipment, Federal deposit insurance, REO expense, advertising, and miscellaneous expenses; and income tax expenses. Each of these principal components of the Association's operating results is discussed below. Jefferson experienced net income of $846,000 or $0.65 per share for the year ended September 30, 1993, as compared with a net loss of $973,000 or $5.45 per share for the year ended September 30, 1992, and net income of $642,000 or $3.60 per share in the year ended September 30, 1991. Earnings per share have been adjusted for all periods to reflect a one-for-three reverse stock split effected in April, 1993. Net income in fiscal 1993 resulted from higher net interest income, lower provision for loan losses, gains from sale of mortgage loan servicing, and lower REO expenses, which were partially offset by higher income tax expense. The net loss in fiscal 1992 resulted from higher provision for loan losses, increased REO expenses and the absence of gain on the sale of mortgage loan servicing rights. Net Interest Income Net interest income before provision for loan losses improved to $7.4 million in fiscal 1993, from $6.7 million in fiscal 1992 and from $5.8 million in fiscal 1991. The increases in fiscal 1993 and fiscal 1992 compared to the prior periods, were due primarily to a decrease in the average balance of interest-bearing liabilities at a greater rate than the decrease in interest-earning assets and, to a lesser extent, to a more rapid decrease in the cost of interest-bearing liabilities than the decline in yield on interest- earning assets. The yield on interest-earning assets declined 114 basis points in fiscal 1993 compared to fiscal 1992, versus a decline of 151 basis points of the cost of interest-bearing liabilities, causing an increase in net interest spread of 37 basis points to 2.64% in fiscal 1993. The yield on interest-earning assets declined 80 basis points in fiscal 1992 compared to fiscal 1991 versus a decline of 128 basis points in the cost of interest- bearing liabilities, causing an increase in the net interest spread of 48 basis points to 2.27% in fiscal 1992 compared to 1.79% in fiscal 1991. The following table sets forth for the periods indicated information regarding average balances of and weighted average yields on loans, mortgage-backed securities and investment securities and balances of and weighted average interest rates paid on deposits and borrowings as well as the dollar difference between such average balances, and the net interest rate spread between the weighted average yields earned and rates paid. Average balances are calculated on an average daily balance. Nonperforming loans have been included in the table as loans carrying a zero yield. Year Ended September 30, 1993 1992 1991 Average Average Average Average Average Average Balance Yield/Rate Balance Yield/Rate Balance Yield/Rate (Dollars in Thousands) Interest-earning assets: Loans receivable . . $180,039 8.58% $204,964 9.54% $226,042 10.24% Mortgage-backed securities . . . . 45,980 7.46 68,657 8.33 90,599 8.63 Investment securities 50,062 4.61 29,310 4.90 24,985 7.45 Total interest-earning assets . . . . . 276,081 7.67 302,931 8.81 341,626 9.61 Interest-bearing liabilities: Deposits . . . . . . 243,442 4.12 250,316 5.78 238,243 7.35 Borrowings . . . . . 29,420 12.54 55,720 9.96 107,052 8.86 Total interest-bearing liabilities . . . 272,862 5.03 306,036 6.54 345,295 7.82 Average dollar difference between interest-earning assets and interest-bearing liabilities . . . . . $3,219 $(3,105) $(3,669) Interest rate spread . 2.64% 2.27% 1.79%
1993 Compared to 1992 Increase 1992 Compared to 1991 Increase (Decrease) Due to (Decrease) Due to Volume Rate Total Volume Rate Total (Dollars in Thousands) (Dollars in Thousands) Interest income: Loans receivable . . . . . . . $(2,137) $(1,984) $(4,121) $(2,012) $(1,582) $(3,594) Mortgage-backed securities . . (1,692) (601) (2,293) (1,831) (272) (2,103) Investment securities . . . . . 957 (87) 870 251 (662) (411) Total interest income . . . . (2,872) (2,672) (5,544) (3,592) (2,516) (6,108) Interest expense: Deposits . . . . . . . . . . . (283) (4,138) (4,421) 700 (3,740) (3,040) Borrowings . . . . . . . . . . (3,298) 1,437 (1,861) (5,113) 1,177 (3,936) Total interest expense . . . (3,581) (2,701) (6,282) (4,413) (2,563) (6,976) Net interest income . . . . . . . $709 $29 738 $821 $47 $868
Interest Income Interest income decreased $5.5 million or 20.8% to $21.2 million in fiscal 1993 compared to fiscal 1992. Interest income decreased $6.1 million or 18.6% to $26.7 million in fiscal 1992 compared to $32.8 million in fiscal 1991. Such decreases were due to both declines in the average balance of the Association's interest-earning assets and the average yield earned thereon. The average balance of loans receivable decreased $24.9 million or 12.2% to $180.0 million in fiscal 1993, and decreased $21.1 million or 9.3% to $205.0 million in fiscal 1992 compared to the prior respective years. Such decreases in the average balance of loans receivable were primarily due to increased loan repayment and refinancing activity, an increase in loan sales reflecting management's decision to sell newly-originated fixed-rate mortgage loans, and the reluctance of borrowers to select adjustable-rate mortgages. The average balance of mortgage-backed securities decreased $22.7 million or 33.0% to $46.0 million in fiscal 1993, and decreased $21.9 million or 24.2% to $68.7 million in fiscal 1992 compared to the prior respective years. Such decreases in the average balance of mortgage-backed securities were primarily due to increased principal repayments caused by refinancing activity of the underlying collateral, especially those collateralizing the CMO and REMIC borrowings. During fiscal 1993, the Association purchased approximately $22.7 million in mortgage-backed securities, mostly variable-rate, to reinvest funds received as a result of heavy prepayments of loans and mortgage-backed securities. The average balance of investment securities increased $20.8 million or 70.8% to $50.1 million in fiscal 1993, and increased $4.3 million or 17.3% to $29.3 million in fiscal 1992 compared to the respective prior periods. Such increases reflected management's decision to place excess funds received from the heavy prepayments of loans and mortgage-backed securities in short-term and variable-rate investments as part of its asset/liability management and reduction of interest rate risk. The yields on all interest-earning assets declined in fiscal 1993 and fiscal 1992 reflecting the general decline in market interest rates, decreases from annual adjustments of adjustable- rate mortgages, origination of new loans at an interest rate lower than existing portfolio yield, and refinancing of higher yielding loans to lower yields. Interest Expense Interest expense decreased $6.3 million or 31.4% to $13.7 million in fiscal 1993 and decreased by $7.0 million or 25.9% to $20.0 million in fiscal 1992 compared to the respective prior periods. Such decreases were due to both a decrease in the average balance of the Association's interest-bearing liabilities and the rate paid thereon. During fiscal 1993, the average balance of deposits decreased $6.9 million or 2.7% to $243.4 million, and during fiscal 1993 the average balance of borrowings decreased $26.3 million or 47.2% to $29.4 million. The decline in deposits was primarily attributable to a decrease in jumbo time deposits and Presidential passbook deposits. The cost of deposits decreased 166 basis points reflecting the decline of market interest rates and a less aggressive deposit pricing policy by Jefferson. The decrease in borrowings reflected the accelerated paydown of the CMO and REMIC indebtedness due to the heavy prepayment activity of the underlying FHLMC PC collateral. The prepayment of CMO and REMIC borrowings also accelerated the amortization of the related discount, significantly increasing the cost of borrowings. The excess liquidity created from high loan and MBS repayments and the decrease in loans receivable eliminated the need for material outside borrowings. During fiscal 1992, compared to fiscal 1991, the increase in the average balance of deposits of $12.1 million or 5.1% to $250.3 million was more than offset by a decrease of $51.3 million, or 48.0%, in the average balance of borrowings during such period to $55.7 million. Deposits increased due to an increase in demand accounts, such as the Presidential passbook account, which were aggressively priced. The decrease in the average balance of borrowings was due to the repayment of high cost FHLB advances and CMO and REMIC borrowings. In addition, reverse repurchase agreements were repaid. Deposit costs declined reflecting the decrease in market interest rates, while CMO and REMIC prepayments caused borrowing costs to increase due to accelerated amortization of the related discount. Due to excess liquidity, the need to increase regulatory capital ratios, and the lack of portfolio loan demand, the Association utilized excess funds in fiscal 1992 to reduce liabilities and improve net interest income. Due to the significant drop in interest rates in fiscal 1993 and fiscal 1992, the Association does not expect further significant decreases in deposit costs in future periods. However, the current level of mortgage rates continues to provide an impetus for refinancing activity and will probably result in continued high costs of borrowings on the CMO and REMIC. As a result, the Association may experience a decrease in its interest rate spread in fiscal 1994. Approximately $944,000 of the unamortized discount was amortized to expense in fiscal 1993, with a remaining outstanding balance to be expensed of $2.3 million at September 30, 1993. Provision for Loan Losses The provision for loan losses in fiscal 1993 totalled $533,000 compared to $1.1 million and $498,000 during fiscal 1992 and 1991, respectively. The increase in fiscal 1992 was primarily attributable to the charge-off of $380,000 for a Dallas, Texas office building and $424,000 with respect to certain consumer loans. In fiscal 1993, the Association charged-off $70,000 on a construction loan, $100,000 on a nonresidential loan, $49,000 with respect to certain consumer loans, and increased the general valuation allowance by $314,000. At September 30, 1993, the Association's allowance for loan losses amounted to $1.6 million or 60.1% of nonperforming loans and 0.92% of total loans. Management's determination of the adequacy of the allowance for loan losses is based on an evaluation of the loan portfolio, past loan loss experience, current economic conditions, volume, growth and composition of the loan portfolio, and other relevant factors. The allowance is increased by provisions for loan losses which are charged against income. The Association believes that the allowance for loan losses as of September 30, 1993 was adequate and further believes that the carrying value of REO is stated at fair value. However, future additions to the allowance for loan losses or reductions in net carrying values may be necessary based on the performance of the Association's loan portfolio and changes in economic conditions. In addition, in connection with periodic examinations of the Association, the staff of the OTS and the FDIC consider the adequacy of the allowance for loan losses and the carrying value of REO. Such agencies may require the Association to recognize additions to the allowance or reductions in the net carrying value of REO based on their judgments at the time of such examinations. The last completed OTS and FDIC examinations were December, 1992. Noninterest Income Noninterest income increased $833,000 to $3.1 million in fiscal 1993 compared to $2.3 million in fiscal 1992, and decreased $261,000 in fiscal 1992 from $2.5 million in fiscal 1991. The increase in noninterest income in fiscal 1993 of $833,000 was due primarily to a $770,000 gain on the sale of mortgage loan servicing rights with respect to $63 million of mortgage loans previously sold to FNMA. There were no such sales in fiscal 1992. Fees and service charges increased $98,000 in fiscal 1993 primarily due to an increase of $87,000 in mortgage loan service fees due to a higher average balance of loans serviced in fiscal 1993 compared to fiscal 1992. The gain on sale of loans in fiscal 1993 and fiscal 1992 resulted entirely from loans held for sale, and increased $381,000 in fiscal 1993 versus fiscal 1992 due to more favorable market conditions and timing of sale considerations. The gain on sale of MBSs decreased $158,000 in fiscal 1993 compared to fiscal 1992. See "Financial Condition at September 30, 1993 and 1992" contained within this report and Note 2 in the Notes to Consolidated Financial Statements contained herein. The gain on sale of investment securities decreased $309,000 in fiscal 1993 compared to fiscal 1992. These gains arose from investments in mutual funds, with fiscal 1992 gains resulting from timely, opportunistic decisions on market rate changes. The decrease in noninterest income in fiscal 1992 was due primarily to a $618,000 decrease in gain on the sale of mortgage loan servicing rights, a decrease of $173,000 in miscellaneous other income and a $127,000 decrease in gain on sale of loans, which decreases were partially offset by a $667,000 increase in gain on sale of MBSs and investment securities. The decrease in gain on the sale of mortgage loan servicing rights in fiscal 1992 was due to the lack of such sales of servicing rights in fiscal 1992. The decrease in miscellaneous other income was due primarily to the inclusion of interest income of $121,000 from prior year's income tax refunds in fiscal 1991. The decrease in gain on sale of loans was due primarily to changing market interest rate movements and timing of sale considerations. In fiscal 1992, the Association recorded an aggregate increase of $667,000 in gains on sale of MBSs and investment securities. See "Financial Condition at September 30, 1993 and 1992" contained in this report and Notes 2 and 3 in the Notes to Consolidated Financial Statements contained herein. Future gains, if any, on the sale of investment securities, MBSs, loans receivable or mortgage loan servicing rights will depend on the amount and classificaton of such assets, market conditions and timing of sale considerations. Operating Expenses Operating expenses decreased $581,000 or 6.6% to $8.2 million in fiscal 1993 compared to $8.8 million in fiscal 1992, and increased $1.6 million or 22.9% from $7.2 million in fiscal 1991. The primary cause of these changes was the decrease of $1.0 million in net cost of REO in fiscal 1993 compared to fiscal 1992, and the increase of $1.6 million in net cost of REO in fiscal 1992 compared to fiscal 1991. Operating expenses as a percentage of average assets were 2.81%, 2.82%, and 2.10% in fiscal 1993, 1992, and 1991, respectively. Excluding the net cost of REO, the ratios were 2.37%, 2.08% and 1.88% in fiscal 1993, 1992, and 1991, respectively. Compensation and employee benefits increased $198,000 in fiscal 1993 compared to fiscal 1992, and increased $101,000 in fiscal 1992 compared to fiscal 1991. The increase in fiscal 1993 resulted from pay increases for existing staff after a pay freeze in fiscal 1992, increased staffing in certain administrative positions, and increased staffing in loan origination positions. Group insurance costs declined $80,000 in fiscal 1993 compared to fiscal 1992. Group insurance costs increased $118,000 in fiscal 1992 compared to fiscal 1991 reflecting an adverse experience in health costs. Occupancy and equipment expense increased $105,000 to $1.2 million in fiscal 1993 compared to fiscal 1992, and was stable in fiscal 1992 compared to fiscal 1991. The fiscal 1993 increase resulted from an increase in the Warrenton branch rental expense, and an increase in repairs and maintenance on buildings and equipment. Federal deposit insurance premiums increased $126,000 in fiscal 1993 compared to fiscal 1992 and was stable in fiscal 1992 compared to fiscal 1991. This increase reflects the higher rate assigned to the Association due to a risk-based rate schedule adopted by the FDIC effective January, 1993. Net cost of REO decreased $1.0 million to $1.3 million in fiscal 1993 compared to fiscal 1992, and increased $1.6 million to $2.3 million in fiscal 1992 compared to fiscal 1991. The high level of REO expense in fiscal 1993 and fiscal 1992 primarily related to the renovation of the Ocean One hotel in Virginia Beach, Virginia. In fiscal 1992, the Association expensed $1.1 million in renovation expenses, and in fiscal 1993 further renovation expenditures totalled approximately $1.1 million (See "Nonperforming Assets" herein). The hotel was operational during fiscal 1993, and despite major construction activity, operated at 35% occupancy at an average room rate of approximately $69 for an operational profit of $128,000. The Association does not plan further significant renovation expenditures, and has listed the property for sale. The business of the hotel is seasonal, with losses in the winter months, and profits in the peak summer months. The Association believes that occupancy should improve in future periods with the absence of construction activity, higher advance reservations, and possible affiliation with a national franchise. The fiscal 1992 net costs also included $261,000 for a motel in Monroe, Michigan, $241,000 for an apartment complex in Dallas, Texas, $233,000 for land in Dallas, Texas, and $160,000 for two land developments in Warrenton, Virginia. As of November 20, 1993, the assets referred to in this paragraph were sold by the Association at no material loss. The fiscal 1993 costs also included expenses of $103,000 for an office and residential property in Leesburg, Virginia, $101,000 for a warehouse and land in Chantilly, Virginia, and $75,000 for a single-family residence in Warrenton, Virginia. The Monroe, Michigan motel operated at a net profit to the Association in fiscal 1993 of $83,000. Advertising expense amounted to $233,000, $228,000 and $234,000 in fiscal 1993, 1992 and 1991, respectively. In fiscal 1994, the Association will utilize an in-house marketing officer to improve its marketing efforts. Other operating expense amounted to $1.6 million in fiscal 1993 and 1992, and $1.7 million in fiscal 1991. The largest expense in this category was legal expense which totalled $311,000, $239,000 and $264,000 in fiscal 1993, 1992 and 1991, respectively. Income Tax Expense and Extraordinary Item The Association adopted FASB Statement No. 109,"Accounting for Income Taxes" in the year ended September 30, 1993. See Notes 1 and 12 in the Notes to Consolidated Financial Statements contained herein. The Association recorded tax expense of $915,000 in fiscal 1993, none in fiscal 1992, and $500,000 in fiscal 1991. Due to a net operating loss carryforward ("NOL"), an extraordinary item benefit was realized in the amount of $460,000 in fiscal 1991. The Association utilized all remaining book NOLs in fiscal 1991, and had a remaining tax NOL of $1.3 million at September 30, 1993. However, this tax NOL is restricted to an annual usage of approximately $430,000 due to an ownership change provision of the Internal Revenue Code, further explained in Note 12. Also, Note 12 discloses the components of the Association's effective tax rate, and the tax effects of deferred tax assets and liabilities. Asset and Liability Management Financial institutions are subject to interest rate risk to the degree that their interest-bearing liabilities, consisting primarily of deposits, FHLB advances and other borrowings, mature or reprice more rapidly, or on a different basis, than their interest-earning assets, which consist predominantly of intermediate or long-term real estate loans. While having liabilities that mature or reprice more frequently on average than assets may be beneficial in times of declining interest rates, such an asset/liability structure may result in declining net earnings during periods of rising interest rates, unless offset by increases in loan originations and purchases or in noninterest income. The long-term objectives of Jefferson include the reduction of sensitivity of earnings to interest rate fluctuations by diversifying its sources of funds, improving its interest rate spread, improving the ratio of interest-earning assets to interest- bearing liabilities, and achieving a better matching of the maturities and interest rate sensitivities of its assets and liabilities. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring the institution's interest rate sensitivity gap. An asset or liability is said to be interest rate sensitive within a specified time period, if it will mature or reprice within that time period. The interest rate sensitivity gap ("gap") is defined as the difference between interest-sensitive assets and interest-sensitive liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds interest rate sensitive liabilities. A gap is considered when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to result in an decrease in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to decrease net interest income. Jefferson's one-year maturity gap was a positive $68.6 million or 24.1% of total assets at September 30, 1993 compared to a positive $64.9 million or 21.5% of total assets at September 30, 1992. The Association has pursued a strategy of retaining adjustable-rate real estate loans, home equity loans, consumer loans, and adjustable-rate MBSs in its asset portfolio, and seeking long-term deposits and borrowings. Jefferson was not involved with interest-rate futures or interest-rate swaps at September 30, 1993. The following table summarizes the contractual maturities or repricing characteristics of the Association's interest-earning assets and interest-bearing liabilities adjusted for the effects of hedging at September 30, 1993. The principal balance of adjustable- rate assets are included in the period in which they are first scheduled to adjust rather than in the period in which they mature. Other material assumptions are set forth in the footnote to the table. September 30, 1993 Within 1 1 to 3 3 to 5 5 to 10 10 to 20 More than Year Years Years Years Years 20 Years Total (Dollars in Thousands) Interest-Sensitive Assets: Investment securities $45,670 $ $ $ $ $ $45,670 Mortgage-backed securities . . . . 20,416 15,226 10,267 5,264 51,173 Loans receivable . . 119,806 31,257 10,522 8,380 169,965 Total . . . . . . . . 185,892 46,483 20,789 13,644 266,808 Non-interest-sensitiv e assets . . . . . 17,442 Total assets . $284,250 Interest-sensitive liabilities: Deposits . . . . . . 110,664 70,927 21,368 21,131 13,664 3,713 $241,467 Borrowings . . . . . 6,615 9,382 6,036 2,046 24,079 Total . . . . . . . . 117,279 80,309 27,404 23,177 13,664 3,713 265,546 Non-interest-sensitive liabilities . . 6,022 Total liabilities . 271,568 Stockholders' equity 12,682 Total liabilities and stockholders' equity . . . $284,250 Hedged gap . . . . . $68,613 $(33,826) $(6,615) $(9,533) $(13,664) $(3,713) Cumulative hedged gap $68,613 $34,787 $28,172 $18,639 $4,975 $1,262 Cumulative hedged gap to total assets . 24.14% 12.24% 9.91% 6.56% 1.75% 0 .44%
___________ (1) Estimated maturity/repricing amounts are based on contractual maturity and amortization, as well as estimated loan prepayment rates and estimated deposit erosion rates. Liquidity and Capital Resources As required by OTS regulations, Jefferson maintains cash and eligible liquid investments in an amount equal to 5% of net withdrawable savings and borrowings payable in one year or less to assure its ability to meet demand for withdrawals and repayment of short-term borrowings. The Association has consistently exceeded this regulatory liquidity requirement, and the Association's average month-end liquidity ratio during the year ended September 30, 1993 was 7.77%. The Association's principal sources of funds are deposits, loan repayments and prepayments, proceeds from the sale of loans, MBSs, investment securities, mortgage servicing rights and REO, FHLB advances, reverse repurchase agreements, other borrowings and net income. The availability of funds from the sale of loans, investment securities, MBSs, mortgage servicing rights and REO is influenced by general interest rates, market conditions, and accounting and regulatory considerations. Borrowing may be used for hedging purposes with respect to changes in prevailing interest rates. At September 30, 1993, the Association had $3.1 million of undisbursed loan funds and $8.3 million of approved loan commitments with $3.8 million at variable-rate and $4.5 million at fixed-rate. The amount of time deposits which are scheduled to mature in fiscal 1994 is $67.0 million. In addition, the Association was contingently liable under unfunded lines of credit for $14.1 million and standby letters of credit aggregating $341,000 at September 30, 1993. The Association is subject to regulations of the OTS that impose certain minimum regulatory capital requirements. These standards are: (a) tangible capital of 1.5% of adjusted total assets; (b) core capital of 3% of adjusted total assets; and (c) a risk-based capital requirement of 8% of risk-weighted assets. As indicated in the following table, the Association exceeded all regulatory capital requirements which were in effect as of September 30, 1993. Tangible Capital Core Capital Risk-Based Capital Amount Percent Amount Percent Amount Percent (Dollars in Thousands) Actual . . . . . . . . . . . . . . $12,682 4.46% $12,682 4.46% $14,284 9.77% Required . . . . . . . . . . . . . 4,264 1.50 8,528 3.00 11,687 8.00 Excess . . . . . . . . . . . . . . $8,418 2.96% $4,154 1.46% $2,597 1.77%
In April, 1993 the Association effected a one-for-three reverse stock split reducing outstanding common shares to 1,310,876 from 3,934,291 and increasing par value from $1 to $3 per share. In June, 1993 the common stock of Jefferson began trading on the National Association of Securities Dealers Automated Quotation System under the symbol "JEFF". It is currently listed under the small issues grouping. In June, 1993 the Board of Directors adopted the 1993 stock incentive plan to be submitted to a vote of shareholders at the Annual Meeting in January, 1994. The plan reserves 131,088 shares of authorized but unissued common stock (10% of outstanding common shares) for future issuance to employees. The plan would remain in effect for ten years, and allow grant of incentive stock options, stock options and stock appreciation rights. On August 3, 1993, incentive stock options of 64,500 shares at $6 per share were awarded subject to approval of the 1993 stock incentive plan by shareholders. The August 3, 1993 option agreements provide for a vesting schedule of 20% for each year of employment after August 3, 1993. If the 1993 stock incentive plan is approved, the 1988 stock option plan will be frozen with outstanding options of 3,833 at $6 per share. Under a separate agreement, one director retains a stock option of 6,917 shares at $6 per share as part of his efforts in the successful 1992 stock offering. The Association has not paid any cash or stock dividends since 1984. The payment of cash dividends is subject to regulation by the OTS. See Note 15 in the Notes to Consolidated Financial Statements contained herein. In August, 1993, the OTS adopted a final rule incorporating an interest-rate risk component into the risk-based capital regulation. See Note 15 in the Notes to Consolidated Financial Statements contained herein. Management does not presently believe that the implementation of the interest-rate risk component on July 1, 1994 will have a material adverse effect on its financial condition or its results of operations. Proposed Federal Regulatory Capital Requirements On April 22, 1991, the OTS published a notice of proposed rule making, which would establish a 3.0% leverage ratio (core capital ratio) only for savings institutions in the strongest financial and managerial condition as determined by the OTS. All other savings institutions would be required to maintain leverage ratios of at least 4.0% to 5.0%. While the amount of any addition to the core capital ratio that might be required of the Association cannot be determined at this time, if the OTS adopts the rule as proposed, it is anticipated the Association's core capital requirement will increase to at least 4.0% and perhaps more. As set forth above, the Association's core capital ratio at September 30, 1993 was 4.46%. Marketplace Trends and Economic Conditions Real estate market values in the domestic and global economies continued to experience further erosion in fiscal 1993 resulting from deflationary trends. Among the primary factors currently affecting real estate values are excessive supply of commercial properties available for leasing purposes, changes in the 1986 Tax Reform Act, increased scrutiny by the banking industry's regulatory authorities resulting in continued high levels of provisions for loan losses, decreased credit availability to small businesses and, more recently, increased unemployment in defense-related businesses. The aforementioned economic problems have continued to negatively impact real estate values in the Association's marketplace resulting in additional loan loss provisions in fiscal 1993. Given the inherent weaknesses in the domestic and global economies, the Association's marketplace may continue to experience real estate valuation problems until stabilization in the unemployment rates and overall asset values occurs. Interest rates in fiscal 1993 continued to decline as the Federal Reserve Board continued to maintain policies designed to keep short-term interest rates low. These policies are in direct response to economic weakness in the U.S. economy. In response to such policies undertaken by the Federal Reserve Board, the Association has experienced a more rapid drop in the cost of deposits than in the yield on loans, MBSs, and investment securities, thus, increasing interest rate spread or the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. However, the Association does not expect further significant reductions in deposit costs in future periods and , as a result, the Association may experience a decrease in its interest rate spread in the future. Accounting Issues and Recent Developments In May, 1993, the FASB issued Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan." This statement addresses the accounting by creditors for impairment of all loans, uncollateralized as well as collateralized, loans that are measured at fair value or at the lower of cost or fair value, leases, loans restructured in a troubled debt restructuring, and debt securities. It requires that impaired loans be measured based on the present value of expected 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. The creditor should also evaluate the collectibility of both contractual interest and contractual principal when assessing loss accruals. The statement is effective for fiscal years beginning after December 15, 1994. Management of the Association does not believe that implementation of the Statement, when adopted, will have a materially adverse effect on the Association's financial condition or results of operations. Recent Legislation On December 19, 1991, the Federal Deposit Insurance Corporation Act of 1991 ("FDICIA") was enacted into law. The FDICIA provides for, among other things, the recapitalization of the Bank Insurance Fund; the authorization of the FDIC to make emergency special assessments under certain circumstances against federally insured depository institutions, the establishment of risk-based deposit premiums; the issuance of certain examination and reporting requirements; and enhanced federal supervision of depository institutions based on capital levels. The Association is exempt from many of the new audit, accounting and regulatory reports and requirements since the Association has less than $500 million in total assets. However, the Association would be subject to a proposed safety and soundness requirement concerning asset quality which requires that classified assets (assets classified substandard, doubtful and to the extent that related losses have not been recognized, assets classified loss) do not exceed 100% of capital. If an insured depository institution fails to meet this standard, such institution would be required to submit a plan within 30 days to the FDIC specifying the steps it will take to correct the deficiency. In the event that an institution fails to submit or fails in any material respect to implement a compliance plan within the time allowed by the FDIC, the FDIC must order the institution to correct the deficiency and may (1) restrict asset growth; (2) require the institution to increase its ratio of tangible equity to assets; (3) restrict the rates of interest that the institution may pay; or (4) take any other action that would better carry out the purpose of prompt corrective action. The Association's classified assets currently exceed the 100% threshold. Management is presently evaluating the alternatives available to the Association in order to comply with the proposed requirement, including reducing classified assets, and increasing capital through earnings and issuance of additional shares of common stock or other capital instruments. The Association has included a proposal in the proxy statement for the 1994 Annual Meeting requesting stockholder approval for a proposed private placement offering. While the Association does not have any immediate specific plans to issue shares of capital stock, the Association believes that approval of this proposal will provide the Association with corporate flexibility to respond on a timely basis to potentially valuable business opportunities which may include the purchase of deposits, branch office properties and other assets of the Resolution Trust Corporation. Any such private placement offering, if initiated, is not expected to exceed $5.0 million. Impact of Inflation, Deflation and Changing Prices The consolidated financial statements and related notes presented elsewhere 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 the relative purchasing power of money over time due to inflation. Unlike many industrial companies, substantially all of the assets and virtually all of the liabilities of the Association are monetary in nature. As a result, interest rates have a more significant impact on the Association's performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, noninterest expenses do reflect general levels of inflation. Deflation, which is having a detrimental effect on the domestic and global economy, resulted from excessive debt leverage incurred in the 1980s. The impact of deflation negatively affects the underlying values of real estate-related assets utilized as collateral or security on loans to borrowers and, therefore, may devalue the overall market value of the Association's loan portfolio and other assets. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 1993 AND 1992 1993 1992 (Dollars in thousands) ASSETS Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,926 $2,916 Cash held in escrow (Note 15) . . . . . . . . . . . . . . . . . . . 6,980 Investment securities, market values of $45,670 in 1993 and $38,288 in 1992 (Note 2) . . . . . . . . . . . . . . . . . . . . . . . . 45,670 38,296 Mortgage-backed securities, market values of $52,413 in 1993 and $53,283 in 1992 (Notes 3, 10 and 11) . . . . . . . . . . . . . . 51,173 50,589 Loans receivable, net (Notes 4 and 9) . . . . . . . . . . . . . . . 169,965 186,185 Accrued interest receivable (Note 5) . . . . . . . . . . . . . . . 1,759 2,128 Real estate owned (Note 6) . . . . . . . . . . . . . . . . . . . . 8,219 10,448 Office properties and equipment, net (Note 7) . . . . . . . . . . . 3,474 3,001 Prepaid expenses and other assets (Note 13) . . . . . . . . . . . . 1,064 1,077 $284,250 $301,620 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits (Note 8) . . . . . . . . . . . . . . . . . . . . . . . . . $241,467 $249,166 Other borrowings (Note 11) . . . . . . . . . . . . . . . . . . . . 24,079 34,158 Advance payments from borrowers for taxes and insurance . . . . . . 1,630 1,704 Accrued expenses and other liabilities . . . . . . . . . . . . . . 4,392 4,854 Total liabilities . . . . . . . . . . . . . . . . . . . . . . 271,568 289,882 Commitments and contingent liabilities (Notes 13 and 14) Stockholders' Equity (Note 15): Common stock, par value $3 per share, authorized 5,000,000 shares at September 30, 1993 and September 30, 1992, issued and outstanding 1,310,876 shares at September 30, 1993 and 3,934,291 shares at September 30, 1992 . . . . . . . . . . . . . . . . . . . . . . . 3,933 3,934 Preferred stock, par value $1 per share, authorized 2,500,000 shares at September 30, 1993 and September 30, 1992, issued and outstanding -0- shares at September 30, 1993 and 1992 . . . . . . Additional paid-in capital . . . . . . . . . . . . . . . . . . . . 3,380 3,382 Retained earnings, substantially restricted . . . . . . . . . . . . 5,268 4,422 Net unrealized gain on assets available-for-sale . . . . . . . . . 101 Total stockholders' equity . . . . . . . . . . . . . . . . . 12,682 11,738 $284,250 $301,620
See accompanying notes to consolidated financial statements. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED SEPTEMBER 30, 1993, 1992 AND 1991 1993 1992 1991 (Dollars in thousands, except per share data) Interest income Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . $15,440 $19,561 $23,155 Mortgage-backed securities . . . . . . . . . . . . . . . . . 3,422 5,715 7,818 Investment securities . . . . . . . . . . . . . . . . . . . . 2,027 952 1,398 Other investments . . . . . . . . . . . . . . . . . . . . . . 279 484 449 Total interest income . . . . . . . . . . . . . . . . . . 21,168 26,712 32,820 Interest expense Deposits (Note 8) . . . . . . . . . . . . . . . . . . . . . . 10,035 14,456 17,496 Borrowed money (Note 9) . . . . . . . . . . . . . . . . . . . 3,690 5,551 9,487 Total interest expense . . . . . . . . . . . . . . . . . 13,725 20,007 26,983 Net interest income . . . . . . . . . . . . . . . . . . . 7,443 6,705 5,837 Provision for losses on loans (Note 4) . . . . . . . . . . . . 533 1,115 498 Net interest income after provision for losses on loans . . . . 6,910 5,590 5,339 Noninterest income Fees and service charges . . . . . . . . . . . . . . . . . . 846 748 758 Gain on sale of: Investment securities (Note 2) . . . . . . . . . . . . . . 12 321 57 Mortgage-backed securities (Note 3) . . . . . . . . . . . . 313 471 68 Loans receivable . . . . . . . . . . . . . . . . . . . . . 954 573 700 Mortgage servicing rights . . . . . . . . . . . . . . . . . 770 618 Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . 195 144 317 3,090 2,257 2,518 Operating expenses Compensation and employee benefits (Note 13) . . . . . . . . 3,230 3,032 2,931 Occupancy and equipment (Note 14) . . . . . . . . . . . . . . 1,184 1,079 1,074 Federal deposit insurance . . . . . . . . . . . . . . . . . . 697 571 535 Net cost of real estate owned (Note 6) . . . . . . . . . . . 1,309 2,317 740 Advertising . . . . . . . . . . . . . . . . . . . . . . . . . 233 228 234 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,586 1,593 1,661 8,239 8,820 7,175 Income (loss) before income tax expense and extraordinary item 1,761 (973) 682 Income tax expense (Note 12) . . . . . . . . . . . . . . . . . 915 500 Income (loss) before extraordinary item . . . . . . . . . . . . 846 (973) 182 Extraordinary item reduction of income taxes arising from carryforward of operating losses (Note 12) . . . . . . . . . 460 Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . $846 $(973) $642 Earnings (loss) per share before extraordinary item . . . . . . $0.65 $(5.45) $1.02 Earnings per share extraordinary item . . . . . . . . . . . . . 2.58 Net earnings (loss) per share . . . . . . . . . . . . . . . . . $0.65 $(5.45) $3.60
See accompanying notes to consolidated financial statements. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED SEPTEMBER 30, 1993, 1992 AND 1991 Additional Net Unrealized Total Common paid-in Retained gain on assets stockholders' stock capital earnings available-for-sale equity (Dollars in Thousands) Balance at September 30, 1990 . . . . . . . . . . $535 $605 $4,753 $ $5,893 Net income . . . . . . . . 642 642 Balance at September 30, 1991 . . . . . . . . . . 535 605 5,395 6,535 Net loss . . . . . . . . . (973) (973) Issuance of 3,399,160 shares of common stock . . . . . 3,399 2,777 6,176 Balance at September 30, 1992 . . . . . . . . . . 3,934 3,382 4,422 11,738 Increase in net unrealized gain on assets available-for-sale . . . 101 101 Net income . . . . . . . . 846 846 Redemption of 554 fractional shares in one-for-three reverse stock split . . . (1) (2) (3) Balance at September 30, 1993 . . . . . . . . . . $3,933 $3,380 $5,268 $101 $12,682
See accompanying notes to consolidated financial statements. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED SEPTEMBER 30, 1993, 1992 AND 1991 1993 1992 1991 (Dollars in Thousands) Operating activities Net income (loss) . . . . . . . . . . . . . . . . . . $846 $(973) $642 Adjustments to reconcile net income (loss) to net cash used by operating activities: Provision for losses on loans . . . . . . . . . . . 533 1,115 498 Provision for losses on real estate owned . . . . . 472 1,849 464 Depreciation and amortization . . . . . . . . . . . 384 372 306 Amortization of investment security premiums and discounts, net . . . . . . . . . . . . . . . . . 5 (8) Amortization of mortgage-backed-securities premiums and discounts, net . . . . . . . . . . . . . . . (71) (82) (49) Deferred loan fees . . . . . . . . . . . . . . . . (15) (234) (244) Net (gain) loss on sales of: Loan participation interests . . . . . . . . . . (954) (573) (700) Mortgage-backed securities . . . . . . . . . . . (313) (471) (68) Investment securities . . . . . . . . . . . . . . (12) (321) (57) Real estate owned . . . . . . . . . . . . . . . . (150) (40) Branch offices and equipment . . . . . . . . . . (2) Receipt of stock dividends from FHLB of Atlanta . . (204) (228) (241) Decrease in accrued interest receivable . . . . . . 369 742 359 Decrease in other assets . . . . . . . . . . . . . 13 130 2,039 Increase (decrease) in other liabilities . . . . . (515) 1,537 (1,217) Disbursements for originations of loans held for sale . . . . . . . . . . . . . . . . . . . . . . (62,890) (60,632) (26,087) Proceeds from sales of loans held for sale . . . . 64,813 57,800 27,212 Net cash provided (used) by operating activities 2,304 (4) 2,849 Investing activities Proceeds from sales of: Investment securities . . . . . . . . . . . . . . . 10,073 331 38,417 Mutual funds . . . . . . . . . . . . . . . . . . . 105,166 57,326 Maturities of investment securities . . . . . . . . . 30,009 240 240 Purchases of: Investment securities . . . . . . . . . . . . . . . (22,997) (30,049) (16,020) Mutual funds . . . . . . . . . . . . . . . . . . . (115,792) (57,326) (Increase) decrease in CMO & REMIC trust funds . . . (1,160) 268 (125) Increase in FHLB overnite funds . . . . . . . . . . . (12,464) (2,351) (59) Purchases of mortgage-backed securities . . . . . . . (22,661) (32,277) Principal payments on mortgage-backed securities . . 18,097 13,115 8,098 Proceeds from sales of mortgage-backed securities . . 8,580 21,872 31,833 Loan originations . . . . . . . . . . . . . . . . . . (40,129) (36,629) (22,528) Principal payments on loans . . . . . . . . . . . . . 50,651 58,871 32,303 Purchases of property and equipment . . . . . . . . . (860) (153) (882) Proceeds from sale of branch offices and fixed assets 5 18 2 Proceeds from sales of real estate owned . . . . . . 2,276 2,299 206 Additions to real estate owned . . . . . . . . . . . (213) (2,120) Other . . . . . . . . . . . . . . . . . . . . . . . . (300) Net cash provided by investing activities . . . 8,581 25,712 38,908 Financing activities Net increase (decrease) in deposits . . . . . . . . . $(7,699) $5,026 $7,359 Decrease in securities sold under agreements to repurchase . . . . . . . . . . . . . . . . . . . . (14,001) (3,076) Proceeds from advances from FHLB of Atlanta . . . . . 2,000 47,000 93,000 Repayments of advances from FHLB of Atlanta . . . . . (2,000) (60,750) (130,300) Decrease in advance payments from borrowers for taxes and insurance . . . . . . . . . . . . . . . . . . . (74) (224) (1,532) Decrease in other borrowings . . . . . . . . . . . . (10,079) (6,347) (3,805) Proceeds from sale (repurchase) of common stock . . . (3) 6,176 Net cash used by financing activities . . . . . (17,855) (23,120) (38,354) Increase (decrease) in cash and cash equivalents (6,970) 2,588 3,403 Cash and cash equivalents at beginning of year . . . . 9,896 7,308 3,905 Cash and cash equivalents at end of year . . . . . . . $2,926 $9,896 $7,308 Supplemental disclosures: Cash paid (received) during year for: Interest on deposits and all borrowings . . . . . . $13,869 $20,293 $27,366 Income taxes . . . . . . . . . . . . . . . . . . . (34) 68 (923) Non-cash investing activities: Transfers from loans receivable to real estate owned . . . . . . . . . . . . . . . . . . . . . . $1,412 $2,724 $2,893 Additions to mortgage-backed securities from securitization of loans receivable . . . . . . . 4,055 13,161 Transfers from real estate owned to loans receivable . . . . . . . . . . . . . . . . . . . 1,256 Unrealized net gain on investment securities and mortgage-backed securities . . . . . . . . . . . 101 Sale of mortgage-backed securities recorded on an accrual basis in fiscal 1991 with proceeds of sale received in 1992 . . . . . . . . . . . . . . (5,532) (continued on following page)
See accompanying notes to consolidated financial statements. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation The consolidated financial statements include the accounts of Jefferson Savings and Loan Association, F.A. ("Jefferson" or the "Association") and its wholly owned subsidiaries: Jefferson Insurance Services, Inc., Jefferson Investment Service Corporation, Jefferson Funding Corporation, and Jefferson Funding Corporation II. All significant intercompany balances and transactions have been eliminated in consolidation. During the year ended September 30, 1991, the Association converted from a Virginia state charter to a federal charter. Basis of Financial Statement Presentation The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. In the normal course of business, the Association encounters two significant types of risk: economic and regulatory. Economic risk is comprised of interest rate risk, credit risk, and market risk. The Association is subject to interest rate risk to the degree that its interest-bearing liabilities reprice on a different basis than its interest-earning assets. Credit risk is the risk of default on the Association's loan portfolio that results from the borrowers' inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of the Association's real estate owned. The determination of the allowance for loan losses and the valuation of real estate owned are based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that, as of September 30, 1993, the allowance for loan losses and the valuation of real estate owned are adequate based on the information currently available. A worsening or protracted economic decline could increase the likelihood of losses due to credit and market risks and could create the need for substantial increases to the allowance for loan losses. The Association is subject to the regulations of various regulatory agencies which can change significantly from year to year. In addition, these regulatory agencies, as an integral part of their examination process, periodically review the Association's allowances for losses. Such agencies may require the Association to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Investment securities and mortgage-backed securities The Association adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" as of September 30, 1993. Investments in debt securities are classified as held-to-maturity when the Association has the positive intent and ability to hold those securities to maturity. Held-to-maturity investments are measured at amortized cost with gains and losses recognized at the time of sale. Investment in stock of the Federal Home Loan Bank of Atlanta is stated at cost. Investments identified as available-for-sale are measured at market value with unrealized holding gains and losses reported as a net amount in a separate component of shareholders' equity until realized. Trading securities are bought and held principally for the purpose of selling in the near term. Unrealized gains and losses on trading securities are included in earnings. Dividend and interest income for all three categories, including amortization of the premium and discount arising at acquisition, are reported in earnings. The effect of adoption of FASB Statement No. 115 was to record a net unrealized gain of $154,000 in investment securities and mortgage-backed securities, a deferred income tax liability of $53,000 and an increase of $101,000 in stockholders' equity. Loans receivable and allowance for loan losses Loans receivable are carried at cost, as the Association has both the intent and the ability to hold them to maturity. Interest is recorded as income when earned; however, interest receivable is accrued only if deemed collectible. Generally, the Association's policy is to exclude from interest income the interest on loans delinquent over 90 days. Such interest, if ultimately collected, is recorded as income in the period received. Loan origination fees and the related incremental direct costs of originating loans are deferred and amortized over the contractual lives of the related loans using the interest method. The allowance for loan losses is maintained at an amount considered adequate to provide for potential losses. The provision for loan losses is based on a periodic analysis of the loan portfolio by management. In this regard, management considers numerous factors, including, but not necessarily limited to, general economic conditions, loan portfolio composition, prior loss experience, and independent appraisals. In addition to specific allowances for estimated losses on identified problem loans, an overall unallocated allowance is established to provide for unidentified credit losses. In estimating such losses, management considers various risk factors including geographical location, loan collateral, and payment history. Loan sales The Association periodically generates funds for lending by selling whole and/or participating interests in real estate loans. Loans held for sale are carried at the lower of cost or market. Gains or losses on such sales are recognized at the time of sale and are determined by the difference between the net sales proceeds and the unpaid principal balance of the loans sold adjusted for yield differential, such as servicing fees. Loans held for sale are designated during origination or shortly after funding. Real estate owned Real estate acquired in settlement of loans and in- substance foreclosure are recorded at the lower of cost or fair value less estimated costs to sell, at the time of acquisition or in-substance foreclosure. Specific valuation allowances on real estate owned are recorded through a charge to earnings if there is a further deterioration in fair value. Costs relating to development and improvement of real estate are capitalized, whereas those related to holding the real estate are expensed as incurred. Recognition of gains on sale of real estate is dependent upon the transaction meeting certain criteria relating to the nature of property sold and the terms of sale. Under certain circumstances, the gain, or a portion thereof, is deferred until the necessary criteria are met. Loans are treated as in-substance foreclosure if the borrower has little or no equity in the collateral, the cash flow to repay the loan can only be expected to come from the operation or sale of the collateral, and the borrower has abandoned control of the collateral or it is doubtful that the borrower will be able to repay the loan in the foreseeable future. Office properties and equipment Office properties and equipment are stated at cost less accumulated depreciation and amortization. Land is carried at cost. Depreciation of office properties and equipment has been charged to income on both the straight-line and accelerated methods at rates calculated to recover the cost of the properties over their estimated useful lives. Leasehold improvements are capitalized and are amortized over the shorter of their estimated useful lives or the terms of the leases. Estimated useful lives are fifteen to forty years for buildings and improvements and three to ten years for furniture, fixtures, equipment and automobiles. Income taxes In 1992 the FASB issued Statement of Financial Accounting Standards No. 109, "Accounting for income Taxes." This statement requires a change from the deferred method of accounting for income taxes of the Accounting Principles Board Opinion 11, to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The recognition of net deferred assets is reduced, if necessary, by a valuation allowance for the amount of any tax benefits that, based on available evidence, are not expected to be realized (See Note 12). Additionally, under Statement 109, deferred tax liabilities will be provided for bad debt reserves for income tax reporting purposes that arose in tax years beginning before December 15, 1987 (base year). Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. The Association adopted Statement 109 in the year ended September 30, 1993. There was no cumulative effect of adopting Statement 109 in the year ended September 30, 1993. The Association files a consolidated Federal and Virginia income tax return, except for Jefferson Funding Corporation II, a real estate mortgage investment conduit. Statement of Cash Flows For the purposes of reporting cash flows, the Association has defined cash and cash equivalents as cash on hand, cash due from banks and federal funds sold. Earnings Per Share Earnings per share of common stock are presented based on the weighted average number of shares outstanding during the periods presented, a total of 1,310,876, 178,377 and 178,377 shares for fiscal years ended September 30, 1993, 1992 and 1991, respectively. These outstanding shares have been restated to reflect a one-for-three reverse stock split effected in April, 1993. The assumed exercise of stock options would not have a material effect on the per share amounts. Accounting Issues In May, 1993, the FASB issued Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan." This statement addresses the accounting by creditors for impairment of all loans, uncollateralized as well as collateralized, loans that are measured at fair value or at the lower of cost or fair value, leases, loans restructured in a troubled debt restructuring, and debt securities. It requires that impaired loans be measured based on the present value of expected 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. The creditor should also evaluate the collectibility of both contractual interest and contractual principal when assessing loss accruals. The statement is effective for fiscal years beginning after December 15, 1994. Management of the Association does not believe that implementation of the Statement, when adopted, will have a material adverse effect on the Association's financial condition or results of operations. Reclassifications Certain reclassifications of prior years' information have been made to conform with the 1993 presentation. The reclassifications have no effect upon previously reported results of operations. NOTE 2 INVESTMENT SECURITIES Investment securities consist of the following: September 30, 1993 1992 Gross Gross Gross Gross Carrying Unrealized Unrealized Market Carrying Unrealized Unrealized Market Value Gains Losses Value Value Gains Losses Value (Dollars in thousands) Available-for-Sale U.S. Government and agency obligations due: one to five years $5,018 $ $18 $5,000 five to ten years 9,000 11 9,011 Adjustable-rate mortgage mutual fund . 10,676 10,676 Subtotal 24,694 11 18 24,687 Held-to-maturity U.S. Government and agency obligations due: one to five years $30,009 $ $ $30,009 Trust accounts CMO & REMIC . 2,401 2,401 1,241 1,241 Commercial paper & subordinated debentures . 1,113 8 1,105 Federal Home Loan Bank overnight funds . 14,958 14,958 2,494 2,494 Federal Home Loan Bank stock, at cost . . . 3,600 3,600 3,396 3,396 Other . . 24 24 43 43 Subtotal 20,983 20,983 38,296 8 38,288 45,677 $11 $18 $45,670 $38,296 $ $8 $38,288 Available-for-sale net unrealized loss . . . . (7) $45,670
Results from the sale and maturities of investment securities are as follows: Year Ended September 30, 1993 1992 1991 (Dollars in thousands) Gross proceeds from sales of: Mutual funds . . . . . . . . . . . . . . . . . . . $105,166 $57,326 $ Other investment securities . . . . . . . . . . . . 10,073 331 38,417 115,439 57,657 38,417 Maturities of investment securities . . . . . . . . . 30,009 240 240 $145,448 $57,897 $38,657 Gross realized gains . . . . . . . . . . . . . . . . $146 $380 $94 Gross realized losses . . . . . . . . . . . . . . . . (134) (59) (37) Net realized gains . . . . . . . . . . . . . . . . . $12 $321 $57
The weighted average interest rate on investment securities was 4.04% and 5.16% at September 30, 1993 and 1992, respectively. The investment securities described above were neither pledged nor otherwise encumbered as of September 30, 1993. NOTE 3 MORTGAGE-BACKED SECURITIES Mortgage-backed securities consist of the following: September 30, 1993 Gross Gross Principal Unamortized Unearned Carrying Unrealized Unrealized Market Balance Premium Discount Value Gains Losses Value (Dollars in thousands) Available-for-sale FHLMC participation certificates . . $3,223 $ $ $3,223 $161 $ $3,384 FNMA REMIC . . . . . 5,517 5,517 5,517 Subtotal . . . . 8,740 8,740 161 8,901 Held-to-maturity FHLMC participation certificates . . 32,604 187 102 32,689 1,355 (71) 33,973 FNMA REMIC . . . . . 6,772 8 75 6,705 (9) 6,696 FNMA certificates . 2,791 87 2,878 (35) 2,843 Subtotal . . . . 42,167 282 177 42,272 1,355 (115) 43,512 Total . . . . . . $50,907 $282 $177 51,012 $1,516 $(115) $52,413 Available-for-sale net unrealized gain . . . . 161 $51,173
September 30, 1992 Gross Gross Principal Unamortized Unearned Carrying Unrealized Unrealized Market Balance Premium Discount Value Gains Losses Value (Dollars in thousands) FHLMC participation certificates . . . . $50,804 $30 $245 $50,589 $2,694 $ $53,283
The weighted average interest rate on mortgage backed securities was 7.99% and 8.30% for the year ended September 30, 1993 and 1992, respectively. Results from the sales of mortgage-backed securities are as follows: Year Ended September 30, 1993 1992 1991 (Dollars in thousands) Gross proceeds from sales . . . . . . . . . . . . . . . $8,580 $15,828 $31,833 Gross realized gains . . . . . . . . . . . . . . . . . $313 $471 $68 Gross realized losses . . . . . . . . . . . . . . . . . Net realized gains . . . . . . . . . . . . . . . . . . $313 $471 $68
The Association has pledged certain mortgage-backed securities with a carrying value of $4.8 million and $4.5 million on September 30, 1993 and 1992, respectively, to secure deposits by government entities. The Association has also pledged mortgage- backed securities with carrying values of $5.5 million and $7.5 million at September 30, 1993 and 1992, respectively, to secure notes payable held by Jefferson Funding Corporation. In addition, $19.9 million and $30.2 million of mortgage-backed securities at September 30, 1993 and 1992, respectively, are pledged to secure bonds payable held by Jefferson Funding Corporation II. NOTE 4 LOANS RECEIVABLE Loans receivable consists of the following: September 30, 1993 1992 (Dollars in thousands) First mortgage loans: One-to-four family . . . . . . . . . . . . . . . . . . . . $101,096 $106,929 Multi-family . . . . . . . . . . . . . . . . . . . . . . . 8,457 8,165 Non-residential and commercial . . . . . . . . . . . . . . 32,442 37,176 141,995 152,270 Construction loans . . . . . . . . . . . . . . . . . . . . . 8,120 9,963 Loans secured by deposit accounts . . . . . . . . . . . . . . 1,014 1,099 Home equity loans . . . . . . . . . . . . . . . . . . . . . . 21,102 23,616 Consumer loans . . . . . . . . . . . . . . . . . . . . . . . 2,599 3,878 174,830 190,826 Less: Due borrowers on loans in process . . . . . . . . . . . . . (3,118) (3,193) Deferred loan fees . . . . . . . . . . . . . . . . . . . . (124) (57) Unearned discounts . . . . . . . . . . . . . . . . . . . . (21) (103) Allowance for losses . . . . . . . . . . . . . . . . . . . (1,602) (1,288) (4,865) (4,641) Total . . . . . . . . . . . . . . . . . . . . . . . . . . $169,965 $186,185 Loans held for sale . . . . . . . . . . . . . . . . . . . . . $6,248 $7,217 Loans receivable, net . . . . . . . . . . . . . . . . . . . . 163,717 178,968 $169,965 $186,185
Loans held for sale are all single-family fixed-rate mortgage loans which are carried at the lower of cost or market. There was no related unrealized loss at September 30, 1993 or 1992. Activity in the allowance for losses on loans is summarized as follows: 1993 1992 1991 (Dollars in thousands) Balance, beginning of period . . . . . . . . . . . . . . $1,288 $1,135 $873 Provision . . . . . . . . . . . . . . . . . . . . . . . 533 1,115 498 Charge-offs, net . . . . . . . . . . . . . . . . . . . (219) (962) (236) Balance, end of period . . . . . . . . . . . . . . . . . $1,602 $1,288 $1,135
Recoveries of loans receivable previously charged-off were not material in the years ended September 30, 1993, 1992 and 1991. The allowance for uncollected interest established for mortgage loans which are delinquent for a period in excess of 90 days amounted to $670,300, $605,800, and $603,500 as of September 30, 1993, 1992 and 1991, respectively. Principal balances of non- performing loans and loans classified as in-substance foreclosure related to reserves for uncollected interest totalled $3.3 million, $3.5 million and $6.4 million as of September 30, 1993, 1992 and 1991, respectively. The amount of loans serviced for others totalled $78 million, $109 million, and $62 million as of September 30, 1993, 1992 and 1991, respectively. Restructured loans amounted to $3.8 million at September 30, 1993 and consisted of two commercial loans which were delinquent less than 90 days at September 30, 1993. There were no outstanding commitments to lend additional funds to borrowers with restructured loans. One loan of $2.7 million had a modified interest rate of 8.0%, while the second loan of $1.1 million had a modified interest rate of 6.5% at September 30, 1993. During fiscal 1992, the Association established a specific valuation allowance of $380,000 relating to the loan of $1.1 million. The gross interest income on these loans that would have been recorded if the interest rates on the loans had not been reduced was $330,000, $442,000, and $420,000 for the years ended September 30, 1993, 1992 and 1991, respectively. Interest income recorded for these loans amounted to $288,000, $314,100, and $257,000 for the years ended September 30, 1993, 1992 and 1991, respectively. NOTE 5 ACCRUED INTEREST RECEIVABLE Accrued interest receivable consists of the following: September 30, 1993 1992 (Dollars in thousands) Investment securities . . . . . . . . . . . . . . . . . . . . . . $151 $63 Mortgage-backed securities . . . . . . . . . . . . . . . . . . . 471 693 Loans receivable . . . . . . . . . . . . . . . . . . . . . . . . 1,137 1,372 $1,759 $2,128
NOTE 6 REAL ESTATE OWNED All assets in real estate owned are held for sale and are summarized as follows: September 30, 1993 1992 (Dollars in thousands) Real estate acquired through settlements of loans . . . . . . . $7,255 $8,839 Real estate held for development . . . . . . . . . . . . . . . 453 244 In-substance foreclosure . . . . . . . . . . . . . . . . . . . 611 1,365 Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . 8,319 10,448 Less: General valuation allowance . . . . . . . . . . . . . . . (100) $8,219 $10,448
The cost of operations for real estate owned in the consolidated statements of operations consists of the following: September 30, 1993 1992 1991 (Dollars in thousands) Income: Rental income . . . . . . . . . . . . . . . . . . . . . $626 $450 $428 Gain on sale . . . . . . . . . . . . . . . . . . . . . 169 40 795 490 428 Expense: Provision for loss . . . . . . . . . . . . . . . . . . 472 1,849 464 Operating expenses . . . . . . . . . . . . . . . . . . 1,614 958 Loss on sale . . . . . . . . . . . . . . . . . . . . . 18 704 2,104 2,807 1,168 Net cost . . . . . . . . . . . . . . . . . . . . . . $1,309 $2,317 $740
NOTE 7 OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are summarized as follows: September 30, 1993 1992 (Dollars in thousands) Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $771 $510 Office building . . . . . . . . . . . . . . . . . . . . . . . . . 2,319 2,183 Leasehold improvements . . . . . . . . . . . . . . . . . . . . . 223 187 Furniture and equipment . . . . . . . . . . . . . . . . . . . . . 3,474 3,098 Automobiles . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 56 6,849 6,034 Less accumulated depreciation and amortization . . . . . . . . . 3,375 3,033 $3,474 $3,001
NOTE 8 DEPOSITS A summary of deposits follows: September 30, 1993 1992 Weighted Weighted Amount Average Average Rate % Amount Rate % (Dollars in thousands) Demand deposits: Passbook & statement accounts . . . . . . . $83,780 3.21% 35% $86,991 5.05% 35% NOW accounts . . . . . . 15,888 2.59 7 17,334 2.58 7 Money market deposit accounts . . . . . . . 29,806 2.82 12 31,816 3.32 13 Total demand deposits . . . 129,474 3.05 54 136,141 4.32 55 Time deposits . . . . . . . 111,993 4.76 46 113,025 5.68 45 $241,467 3.84% 100% $249,166 4.94% 100%
Time deposits as of September 30, 1993 mature as follows: Year ending September 30, (Dollars in thousands) 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . $67,021 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . 29,974 Thereafter . . . . . . . . . . . . . . . . . . . . . . . 14,998 $111,993
Interest expense on deposit accounts is summarized as follows: September 30, 1993 1992 1991 (Dollars in thousands) Passbook and statement accounts . . . . . . . . . . . . $3,055 $3,331 $1,384 NOW and money market deposit accounts . . . . . . . . . 1,423 2,138 3,338 Time deposits . . . . . . . . . . . . . . . . . . . . . 5,557 8,987 12,774 $10,035 $14,456 $17,496
Deposits with balances in excess of $100,000 were $17.3 million and $17.5 million at September 30, 1993 and 1992, respectively. At September 30, 1992, brokered deposits totalled $98,000. There were no brokered deposits at September 30, 1993. NOTE 9 ADVANCES FROM FEDERAL HOME LOAN BANK OF ATLANTA There were no outstanding advances from the Federal Home Loan Bank of Atlanta (FHLB) at September 30,1993 or September 30, 1992. The following assets were pledged as collateral under a security agreement to secure the FHLB advances: September 30, 1993 1992 (Dollars in thousands) First mortgage loans . . . . . . . . $34,738 $47,333 Interest expense on borrowed money is summarized as follows: September 30, 1993 1992 1991 (Dollars in thousands) FHLB Advances . . . . . . . . . . . . . . . . . $1 $1,257 $3,180 Securities sold under agreements to repurchase 24 1,912 Jefferson Funding Corporation-CMO . . . . . . . 677 930 1,159 Jefferson Funding Corporation II-REMIC . . . 3,012 3,340 3,236 $3,690 $5,551 $9,487 NOTE 10 SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE There were no outstanding securities sold under agreements to repurchase at September 30, 1993 or September 30, 1992. The Association occasionally enters into sales of securities under agreements to repurchase (agreements). Fixed- coupon agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the consolidated balance sheet. The dollar amount of securities underlying the agreements remains in the asset accounts. These agreements mature within one year. The dealer may have sold, loaned, or otherwise disposed of such securities to other parties in the normal course of their operations, and have agreed to resell to the Association identical or substantially identical securities at the maturities of the agreements. Securities sold under agreements to repurchase averaged $-0- and $744,000 during 1993 and 1992, respectively. The maximum amounts outstanding at any month-end during 1993 and 1992 were $-0- and $-0-, respectively, and the average interest rates were - -0-% and 3.24% during 1993 and 1992, respectively. The Association has not utilized this type of borrowing since October, 1991. NOTE 11 OTHER BORROWINGS Other borrowings consist of the following: September 30, 1993 1992 (Dollars in thousands) Jefferson Funding Corporation notes payable, net of discount of $76,000 in 1993 and $97,000 in 1992 . . . . . . . . . . . . . . . . . . . . . $5,212 $6,761 Jefferson Funding Corporation II notes payable, net of discount of $2.3 million in 1993 and $3.3 million in 1992 . . . . . . . . . . . . 18,867 27,360 Wrap-around first mortgage loans . . . . . . . . . . . . . . . . . . . 37 $24,079 $34,158
On June 6, 1985, Jefferson Funding Corporation, a finance subsidiary of the Association, issued notes payable with a gross balance of $20.3 million to Thrift Financing Corporation ("TFC"), an investment program established by Craigie, Inc. TFC issued collateralized mortgage obligations secured by notes issued by Jefferson Funding Corporation. The notes are collateralized by $5.5 million and $7.5 million of mortgage-backed securities at September 30, 1993 and 1992 respectively. The maturity of the notes corresponds to the principal repayment of the collateral. The notes had an effective interest cost to the Association of 11.27% and 11.85% in fiscal 1993 and fiscal 1992, respectively. The weighted average interest rate of the mortgage-backed securities was 8.68% and 8.87% during fiscal 1993 and fiscal 1992, respectively. On May 9, 1988, Jefferson Funding Corporation II, a real estate mortgage investment conduit, issued mortgage collateral bonds with a gross balance of $47.1 million. The bonds payable had an effective rate of 12.87% and 11.13% for the years ended September 30, 1993 and 1992, respectively, and were collateralized by FHLMC participation certificates of $19.9 million and $30.2 million at September 30, 1993 and 1992, respectively. The maturity of the notes corresponds to the principal repayment of the collateral. The weighted average interest rate of the mortgage- backed securities was 8.41% and 8.26% during fiscal 1993 and fiscal 1992, respectively. NOTE 12 INCOME TAXES The following is a summary of the provision for income tax expense: September 30, 1993 1992 1991 (Dollars in Thousands) Current Federal income tax expense . . . . . . . . . . . . . . . . . . $915 $ - $ 40 Deferred Federal and state income tax benefit . . . . . . . . . . . . . - - 460 $915 $ - $500
Deferred income taxes result from timing differences in the recognition of income and expense for tax and financial reporting purposes. The sources of these timing differences and the tax effects for years prior to the adoption of Statement 109 are as follows: September 30, 1992 1991 (Dollars in Thousands) Loss on sale of loans to real estate mortgage investment conduit (REMIC) recognized as a financing transaction for financial statement purposes, recognized as a sale for tax purposes . . . . . . . . . . . . . . . . . . . $181 $103 Gain on pension plan curtailment recognized currently for financial statement purposes, deferred for tax purposes . . . . . . . . . . . . . . . . . . . . - - Loan origination and commitment fees, deferred for financial statement purposes, recognized on the cash basis for tax purposes . . . . . . . . . . (25) 103 Loan interest income recognized currently for financial statement purposes, deferred for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . - 58 Imputed gain (net of imputed losses) on sale of participating interests in mortgage loans, recognized currently for financial statement purposes, deferred for tax purposes . . . . . . . . . . . . . . . . . . . . . . . . . - 275 Directors' fee expense, recognized currently for financial statement purposes, deferred for tax purposes . . . . . . . . . . . . . . . . . . . . (4) 1 FHLB stock dividends, deferred for financial statement purposes, recognized on the cash basis for tax purposes . . . . . . . . . . . . . . . . . . . . (72) (80) Utilization of net operating loss carryforward . . . . . . . . . . . . . . . - - Other timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . (80) - $ - $460
A reconciliation from the statutory Federal income tax rate to the effective income tax rate follows: September 30, 1993 1992 1991 Statutory Federal income tax rate . . . . . . . . . . . . . . . . 34.0% (34.0)% 34.0% Increases (reductions) in taxes resulting from: State income taxes . . . . . . . . . . . . . . . . . . . . . . - - 3.8 Provision for losses on loans and real estate owned . . . . . . 14.1 29.3 28.1 Gain on sale of real estate owned . . . . . . . . . . . . . . . (2.9) (1.4) - FHLB stock dividends . . . . . . . . . . . . . . . . . . . . . (3.8) - - Loss on sale of loans to REMIC . . . . . . . . . . . . . . . . 19.2 - - Net operating loss carryforward . . . . . . . . . . . . . . . . (8.4) - - Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (.2) 6.1 7.4 Effective income tax rate . . . . . . . . . . . . . . . . . . . . 52.0% -% 73.3%
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at September 30,1993 are summarized as follows: Amount (Dollars in thousands) Deferred tax assets: Allowance for loan losses . . . . . . . . . . . . . . . $ 613 Deferred loan fees . . . . . . . . . . . . . . . . . . 107 Accrued vacation pay . . . . . . . . . . . . . . . . . 25 Net operating loss carryforward . . . . . . . . . . . . 448 Total gross deferred tax assets . . . . . . . . . . 1,193 Deferred tax liabilities: Unamortized discount on REMIC bonds . . . . . . . . . . 692 FHLB stock dividends . . . . . . . . . . . . . . . . . 309 Prepaid pension contribution . . . . . . . . . . . . . 92 Total deferred tax liabilities . . . . . . . . . . 1,093 Net deferred tax asset before valuation allowance . 100 Less: Valuation allowance . . . . . . . . . . . . . (100) Net deferred tax asset . . . . . . . . . . . . . . $ -
A valuation allowance of $100,000 was established as of September 30, 1993 since it is more likely than not that the entire amount of gross deferred tax assets will not be realized. As of September 30, 1990, the Association had net operating loss carryforwards for financial reporting purposes of approximately $1,400,000 which were utilized in 1991 to offset deferred federal and state income tax expense resulting in an extraordinary item of $460,000. Carryforwards for income tax purposes approximate $1.3 million as of September 30, 1993, and expire in 2007. For income tax purposes, the availability of the Association's tax credit carryforwards to offset current taxable income has been recorded as restricted by Internal Revenue Code Section 382. In general, Section 382 provides that following an "ownership change" in a "loss corporation" the tax credit carryforwards of that corporation will be available to offset taxable income in each taxable year following the "ownership change" only up to the amount of the Section 382 limitation (generally, the product of the corporation's market value at the time of the "ownership change" and the long-term tax-exempt bond rate at such time) for such year. The $1.3 million carryforward for income tax purposes would therefore be limited to a maximum of $430,000 in any one year. The Tax Reform Act of 1986 enacted an alternative minimum tax system, generally effective for taxable years beginning after December 31, 1986. The Association is subject to the alternative minimum tax for financial reporting purposes resulting in an alternative minimum tax expense of $40,000 for the year ended September 30, 1991. This amount will be utilized as a credit carryover against regular tax in 1993. The Association has met certain requirements of the Internal Revenue Code which permit a bad debt deduction (unrelated to the amount of losses actually anticipated and charged to earnings) based on a percentage (currently 8%) of taxable income before such deduction. In the years ended September 30, 1992 and 1991, the deduction was computed under the experience method as it resulted in the deduction of an amount in excess of that permitted under the percentage of taxable income method. In the year ended September 30, 1993, the deduction was computed under the percentage of taxable income method. NOTE 13 BENEFIT PLANS Employee Pension Plan Prior to February 5, 1990, the Association funded and maintained a defined benefit plan for all qualified full-time employees hired before the age of 60. As of February 5, 1990, the accrual of benefits under the pension plan was frozen. Thus, all compensation after that date is not used to compute benefits. However, the plan continues to be in existence. Jefferson plans to continue the retirement plan with the frozen accrual of benefits indefinitely, but reserves the right to revise or discontinue the plan. Assets of the plan will not revert to the Association, and cannot be diluted by merger. The net periodic pension cost includes the following components: September 30, 1993 1992 1991 (Dollars in Thousands) Service cost of benefits earned during the period . . . . . . . . $ - $ - $ - Interest cost on projected benefit obligation . . . . . . . . . . 152 141 131 Actual return on plan assets . . . . . . . . . . . . . . . . . . (120) (107) (334) Net amortization and deferral . . . . . . . . . . . . . . . . . . (11) 204 Recognition of gain on plan curtailment . . . . . . . . . . . . . - - - Net periodic pension cost . . . . . . . . . . . . . . . . . . . . $32 $23 $1
Employee Pension Plan Assumptions used in the accounting for net periodic pension costs for 1993, 1992 and 1991 were as follows: 1993 1992 1991 Weighted average discount rate . . . . . . . . . . . . . . . . . . . 7.5% 7.5% 8.5% Weighted average rate of increase in compensation levels . . . . . . N/A N/A N/A Weighted average expected long-term rate of return on plan assets . . 6% 6% 8%
The following table sets forth the Plan's funded status: September 30, 1993 1992 (Dollars in Thousands) Actuarial present value of benefit obligations: Vested benefit obligation . . . . . . . . . . . . . . . . . . . . . . . $2,138 $1,990 Non-vested benefit obligation . . . . . . . . . . . . . . . . . . . . . - - Accumulated benefit obligation . . . . . . . . . . . . . . . . . . . 2,138 1,990 Effect of projected future compensation levels . . . . . . . . . . . . . Projected benefit obligation . . . . . . . . . . . . . . . . . . . . . 2,138 1,990 Plan assets at fair value . . . . . . . . . . . . . . . . . . . . . . . . 2,140 2,040 Unrecognized net loss and effects of changes in assumptions . . . . . . . 269 304 Prepaid pension cost . . . . . . . . . . . . . . . . . . . . . . . . . . $271 $354
The assets of the plan at September 30, 1993 consist of cash (13%), bonds (58%), stocks (20%), and annuities (9%). Stock Option Plan During the fiscal year ended September 30, 1988, the Board of Directors and stockholders approved a stock option and incentive plan. Under the terms of the 1987 Plan, the Stock Option Committee may grant options for the purchase of shares up to 10% of total stock outstanding of the Association. Incentive stock options may be granted to full-time officers and other key employees at a price of not less than 100% of market value at the date of grant, and the aggregate fair market value cannot exceed $100,000 per employee the first year that the employee is granted an incentive stock option. Non-incentive stock options may be granted to full-time officers and other key employees at a price that the Stock Option Committee may determine at its sole discretion. All stock options granted must be exercised within 10 years. The Plan terminates ten years from inception. At September 30, 1993, 1992 and 1991, the following table summarizes information on the stock option plan: Average Price Per Share Shares Outstanding at September 30, 1990 . . . . . . . . . . . . . $14.00 13,375 Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . 14.00 (1,000) Outstanding at September 30, 1991 . . . . . . . . . . . . . 14.00 12,375 Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . 14.00 (375) Exercised . . . . . . . . . . . . . . . . . . . . . . . . . 14.00 (1) Outstanding at September 30, 1992 . . . . . . . . . . . . . 14.00 11,999 Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . 14.00 (499) One-for-three reverse stock split . . . . . . . . . . . . . (7,667) Outstanding at September 30, 1993 . . . . . . . . . . . . . 6.00 3,833
On October 6, 1992, the Board of Directors voted to reduce the average price of all outstanding options under the 1987 Plan from $14.00 per share to $2.00 per share. In April, 1993, the outstanding shares of the stock option plan were reduced to reflect a one-for-three reverse stock split. As part of the successful common stock offering in fiscal 1992, the Board of Directors awarded stock options to a director for 6,917 shares of common stock at $6.00 per share. These stock options remain outstanding at September 30, 1993. On August 3, 1993 the Board of Directors adopted the Jefferson Savings and Loan Association, F.A. 1993 Stock Incentive Plan (the "1993 Plan") subject to approval by the shareholders. The 1993 Plan reserves an aggregate of 131,088 shares of authorized but unissued common stock, which is approximately equal to 10% of outstanding common stock. The 1993 Plan would remain in effect for a term of ten years unless sooner terminated. Three kinds of rights are available for grant: incentive stock options, stock options and stock appreciation rights. If the 1993 Plan is approved, the 1987 Plan will be discontinued and no further awards will be made under the 1987 Plan. Awards already made under the 1987 Plan which are still outstanding will continue to be governed by the terms of the 1987 Plan. On August 3, 1993, stock options under the 1993 Plan totalling 64,500 were awarded at a price of $6.00. The August 3, 1993 option agreements provide for a vesting schedule of 20% for each year of employment after August 3, 1993. Employee 401-K Plan Effective October 1, 1990, the Association implemented a qualified 401(k) plan for all employees. In fiscal years 1993,1992 and 1991, the Association matched 50% of salary reductions elected by the employee up to 3% of salary, and 25% of salary reductions elected for 3% to 6% of salary. No matching was made for salary reduction in excess of 6%. The Association incurred $30,010, $20,166 and $21,690 in matching and administration expense for the years ended September 30, 1993, 1992 and 1991, respectively. Postretirement Benefits The Association does not provide post-retirement benefits and therefore does not accrue any liability for these type of benefits. NOTE 14 COMMITMENTS, CONTINGENCIES AND RELATED PARTIES Financial instruments with off-balance-sheet risk The Association is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, financial guarantees, interest rate caps and floors, and forward contracts. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Association has in particular classes of financial instruments. The Association's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual notional amount of those instruments. The Association uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. For interest rate caps and floors, and forward contracts, the contract or notional amounts do not represent exposure to credit loss. The Association controls the credit risk of its forward contracts through credit approvals, limits and monitoring procedures. At September 30, 1993, the Association had outstanding commitments of $8.3 million to originate loans with variable interest rates aggregating approximately $3.8 million and with fixed interest rates aggregating approximately $4.5 million. Fixed rate commitments are at market rates as of the commitment dates and generally expire within 60 days. Concentrations of Credit Risk The Association's primary business activity is with customers located in Virginia, Maryland and the District of Columbia. The Association grants residential, commercial and consumer loans to customers throughout these areas, most of whom are residents local to the Association's business locations. The Association's largest loans are concentrated in the hospitality industry, however these loans comprise less than 5% of total loans at September 30, 1993. Management diligently monitors all loans in this industry, including, when possible, making inspections of the properties, maintaining current operating statements, and performing net realizable value calculations, with allowances for losses established as necessary to properly reflect the value of the properties. Management believes the current loss allowances are sufficient to cover the credit risk estimated to exist at September 30, 1993. In addition, the Association was contingently liable under unfunded lines of credit for $14.1 million and standby letters of credit aggregating $341 thousand at September 30, 1993. Rental Commitments Minimum rental commitments under noncancelable operating leases for five branch offices in effect at September 30, 1993 are shown below: Year ending September 30, Amount (Dollars in Thousands) 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $170,243 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88,643 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84,518 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64,791 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,448 Total minimum commitments . . . . . . . . . . . . . . . . . . . . . . $416,643
Total rent expense was $171,707 for 1993, $146,104 for 1992 and $143,482 for 1991. Related Party The Association, like many financial institutions, has followed a policy of granting loans to its officers, directors and employees, generally for the financing of their personal residences and for certain consumer purposes. These loans are made in the ordinary course of business, and on substantially the same terms as those of comparable transactions prevailing at the time, except that employees other than officers and directors may borrow money at an interest rate which is related to the Association's cost of funds. They do not involve more than the normal risk of collectibility or present other unfavorable features. The following is a summary of loan transactions with directors and executive officers which equal or exceed $60,000 in the aggregate. Year Ended September 30, 1993 1992 1991 (Dollars in Thousands) Balance at beginning of year . . . . . . . . . . . . . . . . . $750 $743 $763 Originations . . . . . . . . . . . . . . . . . . . . . . . . . 36 68 14 Repayments . . . . . . . . . . . . . . . . . . . . . . . . . . (48) (61) (34) Balance at end of year . . . . . . . . . . . . . . . . . . . . $738 $750 $743
NOTE 15 STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL The Director of the Office of Thrift Supervision requires all thrift institutions to maintain capital in accordance with capital standards which include maintenance of: (1) tangible capital equal to at least 1.5% of adjusted total assets, (2) core capital equal to at least 3.0% of adjusted total assets, and (3) total capital equal to percentages of risk-weighted assets to at least 8.0% On September 30, 1992, the Association successfully completed a subscription rights and community stock offering which resulted in the sale of approximately 3.4 million shares of common stock. At September 30, 1992, the funds from the stock offering, amounting to approximately $7 million, were held in an escrow account. These funds were subsequently released to the Association on October 5, 1992. As a result of the capital infusion and current earnings, the Association exceeds all three of its regulatory capital requirements as of September 30, 1993. The required and actual amounts and ratios of capital pertaining to the Association as of September 30, 1993 are set forth as follows: Current Capital Actual Association Requirement Capital Capital Excess Amount Percent Amount Percent Amount Percent (Dollars in Thousands) Tangible . . . . . . . . . . . . . $4,264 1.5% $12,682 4.46% $8,418 2.96% Core . . . . . . . . . . . . . . . 8,528 3.0 12,682 4.46 4,154 1.46 Risk-based . . . . . . . . . . . . 11,687 8.0 14,284 9.77 2,597 1.77
The Association's capital for generally accepted accounting principles of $12,682,000 equals tangible and core capital in reports of regulatory capital to the OTS. Risk-based capital is the sum of $12,682,000 and the general valuation allowance of $1,602,000, which totals $14,284,000. Due to its regulatory capital deficiency prior to September 30, 1992, Jefferson was required to file a capital restoration plan ("CRP") with the OTS. The initial CRP was approved in May, 1990, and a revised CRP was approved in October, 1991. On December 10, 1992, the Association received written confirmation from the OTS that its CRP was terminated and that it was no longer under the restrictions of the capital plan. Under current regulations, if the Association should fail to meet regulatory capital requirements in the future it would be required to file a capital plan outlining the actions necessary to increase capital to the required standards. In April, 1993 the Association effected a one-for-three reverse stock split reducing outstanding common shares to 1,310,876 from 3,934,291, and increasing par value from $1 to $3 per share. Retained earnings at September 30, 1993 included approximately $3.2 million of actual additions to bad debt reserves for Federal income tax purposes which may be subject to income taxes at the then current Federal income tax rate if used for any purpose other than to absorb bad debt losses. As of September 30, 1993 management did not contemplate that this portion of retained earnings will be used in a manner that will create any additional income tax liability. The payment of cash dividends by the Association is subject to regulation by the OTS. The OTS has promulgated a regulation that measures an institution's ability to make capital distributions, which includes the payment of cash dividends, according to the institution's capital position. The rule establishes "safe harbor" amounts of capital distributions that institutions can make after providing notice to the OTS, but without needing prior approval. Institutions can distribute amounts in excess of the safe harbor only with the prior approval of the OTS. The Association has not paid any cash dividends since 1984. On April 22, 1991, the OTS published a notice of proposed rulemaking, "Regulatory Capital;Leverage Ratio Requirement." The proposed rule would establish a 3.0% leverage ratio (core capital ratio) only for savings institutions in the strongest financial and managerial condition as determined by the OTS. All other savings institutions would be required to maintain leverage ratios of at least 4.0% to 5.0%. While the amount of any addition to the core capital ratio that might be required of the Association cannot be determined at this time, if the OTS adopts the rule as proposed, it is anticipated the Association's core capital requirement will increase to at least 4.0% and perhaps more. 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 the risk-based capital requirement. As a result, such an institution will be required to maintain additional capital in order to comply with the risk-based capital requirement. An institution with a greater than "normal" interest rate risk is defined as an institution that would suffer a loss of net portfolio value exceeding 2.0% of the estimated market value of its assets in the event of a 200 basis point increase or decrease (with certain minor exceptions) in interest rates. The interest rate risk component will be calculated, on a quarterly basis, as one-half of the difference between an institution's measured interest rate risk and 2.0%, multiplied by the market value of its assets. The rule also authorizes the Director of the OTS to waive or defer an institution's interest rate risk component on a case- by-case basis. The final rule is 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. Thus, an institution with greater than "normal" risk will not be subject to any deduction from total capital until July 1, 1994 (based on the calculation of the interest rate risk component using data as of December 31, 1993). Finally, the OTS indicated in the final rule that it intended to lower the leverage ratio requirement (in its prompt corrective action regulation) to 3.0% from the current level of 4.0%, on July 1, 1994. NOTE 16 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregated fair value amounts presented do not represent the underlying value of the Association. The carrying value and fair value of financial instrument assets and liabilities as of September 30, 1993 are as follows: September 30, 1993 Carrying Value Fair Value (Dollar amounts in thousands) Assets: Cash . . . . . . . . . . . . . . . . . . . . . . . $2,926 $2,926 Investment securities . . . . . . . . . . . . . . . 45,670 45,670 Mortgage-backed securities . . . . . . . . . . . . 51,173 52,413 Loans receivable,net . . . . . . . . . . . . . . . 169,965 172,574 Liabilities: Deposits . . . . . . . . . . . . . . . . . . . . . 241,467 240,374 Other borrowings . . . . . . . . . . . . . . . . . 24,079 24,420
The fair value of cash is the book value. The fair value of investment securities and mortgage-backed securities is determined by reference to quoted market prices. The fair value of loans receivable is determined by discounting the future cash flows, using the current rates at which similar loans would be made to borrowers with similar credit ratings, and for the same remaining terms to maturity. The fair value of construction, home equity line, and consumer loans is book value. The fair value of Federal Home Loan Bank Stock is book value. The fair value of demand deposits, including passbook and statement accounts, NOW accounts, and money market deposit accounts, is book value. For time deposits, including fixed maturity certificates of deposit, fair value is determined by discounting the future cash flows, using the rates currently offered for deposits with similar remaining terms to maturities. The fair value of other borrowings is determined by discounting the future cash flows, using the current rates offered for similar maturities. The Association had $22.4 million of off-balance sheet financial commitments, which are commitments to originate loans and unused consumer lines of credit. Since these obligations are based on current market rates, the carrying amount is considered to be a reasonable estimate of fair market value. NOTE 17 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Condensed quarterly financial data for the years ended September 30, 1993 and 1992 are shown as follows: Three months ended Dec. 31, Mar. 31, June 30, Sept. 30, (Dollars in Thousands) 1993 Total interest income . . . . . . . $5,745 $5,290 $5,221 $4,912 Total interest expense . . . . . . 3,754 3,479 3,256 3,236 Net interest income . . . . . . . 1,991 1,811 1,965 1,676 Provision for losses on loans . . . 55 97 77 304 Net interest income after provision for losses on loans 1,936 1,714 1,888 1,372 Noninterest income . . . . . . . . 625 504 601 1,360 Operating expenses . . . . . . . . (1,771) (1,885) (2,323) (2,260) Income before income tax expense 790 333 166 472 Income tax expense . . . . . . . . 285 155 61 414 Net income . . . . . . . . . . . . $505 $178 $105 $58 Earnings per share . . . . . . . . $.38 $.14 $.08 $.05 1992 Total interest income . . . . . . . $7,160 $6,858 $6,470 $6,224 Total interest expense . . . . . . 5,645 5,011 4,874 4,477 Net interest income . . . . . . 1,515 1,847 1,596 1,747 Provision for losses on loans . . . 44 215 169 687 Net interest income after provision for losses on loans 1,471 1,632 1,427 1,060 Noninterest income . . . . . . . . 411 379 666 801 Operating expenses . . . . . . . . (1,827) (1,762) (1,820) (3,411) Income before income tax expense 55 249 273 (1,550) Income tax expense and extraordinary item, net . . . . . 13 107 136 (256) Net income . . . . . . . . . . . . $42 $142 $137 $(1,294) Earnings per share . . . . . . . . $.23 $.80 $.77 $(7.25)
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Stockholders Jefferson Savings and Loan Association, F.A. Warrenton, Virginia We have audited the accompanying consolidated balance sheets of Jefferson Savings and Loan Association, F.A. and subsidiaries as of September 30, 1993 and 1992, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended September 30, 1993, 1992 and 1991. These consolidated financial statements are the responsibility of the Association'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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jefferson Savings and Loan Association and subsidiaries at September 30, 1993 and 1992, and the results of their operations and their cash flows for the years ended September 30, 1993, 1992 and 1991, in conformity with generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, in fiscal 1993, the Association adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." BDO Seidman Washington, D.C. November 24, 1993 DIRECTORS AND OFFICERS DIRECTORS OFFICERS Calvin P. Burton Thomas W. Winfree Anne F. Brower Insurance Agent President and Assistant Vice President and Chief Executive Officer Asst. Manager, Warrenton Branch John Sheldon Clark Private Investor Craig A. Mason Patricia M. Coury Senior Vice President and Assistant Vice President and Robin C. Gulick, Esq. Chief Financial Officer Manager, Consumer Loans Chairman of the Board Attorney Walter E. Monroe Marcia G. Grant Senior Vice President and Assistant Vice President Charles H. Jones, Jr. Chief Lending Officer Secondary Marketing Managing Partner Edge Partners, L.P. Benny N. Werner Diana M. Lesko Senior Vice President Assistant Vice President and Robert F. Kube Retail Banking Manager, Loan Servicing Treasurer Builder and Investor James A. Yergin, Esq. William G. Mayo Senior Vice President and Assistant Vice President William M. Rider General Counsel REO and Special Projects Secretary President, R.L. Rider Jodale Favara Michael W. Morris Construction, Inc. Vice President and Manager Assistant Vice President and Loan Operations Manager, Leesburg Branch Saul J. Robinson President Dan W. Jeff Imogene K. O'Toole Skyline Group, Inc. Vice President and Assistant Vice President and Marketing Director Manager, Culpeper Branch Arthur J. Shadek Private Investor Douglas R. Lawrence Linda R. Sorrells Vice President and Controller Assistant Vice President and Thomas W. Winfree Manager, Charlottesville President and John E. Meyer Rio Road Branch Chief Executive Officer Vice President and Systems Manager Shirley G. Stewart DIRECTORS EMERITI Assistant Vice President and Carol J. Smith Manager, Luray Branch A.R. Anderson, Jr. DDS Vice President and Director William D. Doeller of Deposit Accounts Bonnie J. Curtis John J. Huckle, DVM Assistant Secretary J.B. Hudson, Jr. Esq. Melanie K. Smith Warrenton Branch Harold D. Kube Vice President and L.A. Lacy Director of Human Resources Helen B. Jones Harvey L. Pearson Assistant Secretary Walter B. Potter, Sr. Shirley B. Stalnaker Executive Secretary W.W. Sanders, Jr. Vice President, Administrative Assistant Patricia L. Texter Assistant Secretary and Lucille B. Travers Asst. Manager, Leesburg Branch Vice President and Manager Warrenton Branch
OFFICES AND SERVICES OFFICES SERVICES Charlottesville Personal Financial Management Commercial Services 1705 Seminole Trail Rio Road and 29 North Basic Checking Business Checking Charlottesville, Virginia 22901 Interest Checking Simplified Employee (804) 937-1331 Premier Money Fund Pension Plan SEP Jefferson Reserve VISA/MasterCard and 300 Preston Avenue (Overdraft Protection) POS Merchant Service Commonwealth Center Holiday Club Savings Construction/Permanent Loans Charlottesville, Virginia 22906 Presidential Savings Commercial Real Estate Loans (804) 971-4900 Regular Savings Bump Rate Certificates Services for Your Culpeper Jumbo Certificates Convenience No Penalty Certificates 701 South Main Street Prime Certificates Automated Teller Machines Culpeper, Virginia 22701 Regular Certificates Automatic Funds Transfer (703) 825-1001 Retirement Certificates Automatic Loan Payment Individual Retirement Bank by Mail Leesburg Accounts IRA and Certified Checks Spousal IRA Coupon Redemption 9-J Catoctin Circle, SW Direct Deposit Village Square Consumer Lending Drive-Up Windows Leesburg, Virginia 22075 Electronic Banking Card with (703) 777-3777 Home Equity Lines of Credit access to MOST, Plus and and Installment Loans The Exchange Networks Luray Automobile Loans Federal Tax Deposit Personal Loans Night Depository 20 East Luray Shopping Center Savings/CD Loans Notary Public Luray, Virginia 22835 VISA Classic and Gold Note Collection (703) 743-4558 Sight Drafts Mortgage Lending Telephone Transfer Warrenton Travelers Cheques Community Homebuyer Loans U.S. Savings Bonds Warrenton Center First Trust Loans VISA Cash Advance Warrenton, Virginia 22186 Second Mortgage Loans Wire Transfer (703) 347-7173 Investment Property Loans FDIC INSURED Refinancing EQUAL HOUSING LENDER Construction Loans MEMBER FEDERAL HOME Jumbo Residential Loans LOAN BANK SYSTEM
STOCKHOLDER INFORMATION BUSINESS OF THE ASSOCIATION Jefferson Savings and Loan Association, F.A., with corporate offices at 550 Broadview Avenue, Warrenton, Virginia, is a federally-chartered stock savings and loan association, which began operations in 1960, and currently operates six branches in Virginia. The Association is primarily engaged in the business of obtaining funds in the form of deposits and investing such funds in mortgage loans on residential real estate and, to a lesser extent, commercial, nonresidential real estate and consumer loans. The Association is a member and a stockholder of the Federal Home Loan Bank System, and its deposits are insured by the Federal Deposit Insurance Corporation up to its applicable limits. Corporate Counsel James A. Yergin, Esq. Jefferson Savings and Loan Association, F.A. 550 Broadview Avenue Warrenton, VA 22186 Special Counsel Elias, Matz, Tiernan & Herrick 734 15th Street, N.W. 12th Floor Washington, D.C. 20005 Independent Auditors BDO Seidman 1707 L Street, N.W. 8th Floor Washington, DC 20036-4301 Registrar and Transfer Agent Mellon Financial Services Securities Transfer Services 85 Challenger Road Overpeck Centre Ridgefield Park, NJ 07660 Market Makers Anderson & Strudwick, Inc. 1108 East Main Street Richmond, Virginia 23219 (804) 643-2400 Branch Cabell & Co. 919 East Main Street Richmond, Virginia 23219 (804) 225-1400 Scott & Stringfellow, Inc. 909 East Main Street Richmond, Virginia 23219 (804) 643-1811 Wheat First Securities, Inc. 901 East Byrd Street Richmond, Virginia 23219 (804) 649-2311 Ryan Beck & Co. Inc. 80 Main Street West Orange, New Jersey 07052 (201)325-3000 Herzog, Heine, Geduld, Inc. 26 Broadway New York, New York 10004 (212) 908-5195 FORM 10-K A copy of the Form 10-K as filed with the Office of Thrift Supervision will be furnished without charge to stockholders as of the record date for voting at the Annual Meeting of Stockholders upon written request to the Chief Financial Officer, Jefferson Savings and Loan Association, F.A., 550 Broadview Avenue, Warrenton, Virginia 22186. The Annual Meeting of Stockholders of Jefferson Savings and Loan Association, F.A. will be held on January 27, 1994 at 4 p.m., Eastern Time, at the Fauquier Springs Country Club. STOCK AND DIVIDEND INFORMATION The Association may not declare or pay a cash dividend on any of its stock if the effect thereof would cause the Association's regulatory capital to be reduced below the regulatory capital requirement imposed by the Office of Thrift Supervision. See Note 15 of Notes to Consolidated Financial Statements for further information regarding restrictions on cash dividends. There have been no cash or stock dividends paid in the seven years ended September 30, 1993. In April, 1993, the Association effected a one-for-three reverse stock split which reduced outstanding shares of common stock to 1,310,876 from 3,934,291. The Association's common stock trades on the National Association of Securities Dealers Automated Quotation (NASDAQ) System under the symbol JEFF. As of December 15, 1993, there were 1355 registered stockholders of record not including the number of persons or entities whose stock is held in nominee or "street" name through various brokerage firms or banks. Prior to July, 1993, the Association's common stock was not listed on any exchange, and traded privately. The following table sets forth the high and low closing price of the common stock for the periods indicated. Quotations were obtained from the NASDAQ. Year ended September 30, 1993 High Low 4th Quarter . . . . . . . . . . . . . . . . . . . . 6.75 6.00 EX-99 4 EXHIBIT 99III January 10, 1994 To The Stockholders of Jefferson Savings and Loan Association, F.A.: You are cordially invited to attend the Annual Meeting of Stockholders of Jefferson Savings and Loan Association, F.A. which will be held at the Fauquier Springs Country Club in Fauquier County, Virginia on Thursday, January 27, 1994 at 4:00 P.M. The formal Notice of the Annual Meeting of Stockholders and Proxy Statement appear on the following pages and contain details of the business to be conducted at the meeting. I urge you to read it carefully. At this year's Annual Meeting you will be asked to (i) vote on the election of three directors; (ii) approve a Stock Incentive Plan; (iii) approve a proposal to conduct a private placement offering; and (iv) ratify the appointment of BDO Seidman as the Association's auditors. The interest and participation of stockholders in the affairs of Jefferson Savings are very important if we are to do the best job possible as managers of Jefferson Savings and Loan Association, F.A. Therefore, whether or not you will be able to join us on January 27, 1994, please take a moment now to vote on each of the proposals and to sign, date and mail the enclosed proxy card in the postage prepaid envelope provided for that purpose. PLEASE REPLY BY JANUARY 20, 1994. We look forward to your participation at the meeting, either in person or by proxy. Thank you for your cooperation. Sincerely, Robin C. Gulick Chairman of the Board of Directors JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. 550 Broadview Avenue Warrenton, Virginia 22186 (703) 347-3531 NOTICE OF ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON JANUARY 27, 1994 Notice is hereby given that the Annual Meeting of Stock- holders of Jefferson Savings and Loan Association, F.A., a Federal stock savings association, will be held at the Fauquier Springs Country Club, Fauquier County, Virginia, on January 27, 1994, at 4:00 P.M., Eastern Standard Time, for the following purposes, all of which are more completely set forth in the accompanying Proxy Statement: 1. To elect three persons as directors for terms of three years and until their successors are elected and qualified; 2. To approve a Stock Incentive Plan; 3. To approve a proposed private placement offering; 4. To ratify the selection of BDO Seidman, Independent Certified Public Accountants, as auditors for the Association for the fiscal year ending September 30, 1994; and 5. To transact such other business as properly may come before the 1994 Annual Meeting or any adjournments thereof. Only stockholders of record at the close of business on December 15, 1993 are entitled to receive notice of and to vote at the Annual Meeting or any adjournments thereof. Jefferson Savings and Loan Association, F.A.'s Proxy Statement is submitted herewith. The Annual Report for the year ended September 30, 1993 is also enclosed. By Order of the Board of Directors, Robin C . Gulick, Chairman Warrenton, Virginia January 10, 1994 YOU ARE CORDIALLY INVITED TO ATTEND THE ANNUAL MEETING. IT IS IMPORTANT THAT YOUR SHARES BE REPRESENTED REGARDLESS OF THE NUMBER YOU OWN. EVEN IF YOU PLAN TO BE PRESENT, YOU ARE URGED TO COMPLETE, DATE, AND SIGN THE ENCLOSED PROXY AND RETURN IT PROMPTLY TO JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. IN THE ENVELOPE PROVIDED. IF YOU ATTEND THE MEETING, YOU MAY VOTE EITHER IN PERSON OR BY YOUR PROXY. ANY PROXY GIVEN MAY BE REVOKED BY YOU IN WRITING OR IN PERSON AT ANY TIME PRIOR TO THE EXERCISE THEREOF. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. PROXY STATEMENT FOR ANNUAL MEETING OF STOCKHOLDERS SOLICITATION AND REVOCATION OF PROXY The enclosed proxy, for use only at the Annual Meeting of Stockholders of Jefferson Savings and Loan Association, F.A. ("Jefferson" or the "Association") to be held on January 27, 1994, and any and all adjournments thereof, is solicited on behalf of the Board of Directors of Jefferson. Such solicitation is being made by mail and may also be made in person or by telephone by officers, directors, and regular employees of Jefferson. All expenses incurred in such solicitation will be paid by Jefferson. This Proxy Statement is expected to be mailed to stockholders on January 10, 1994. Any stockholder executing a proxy retains the right to revoke it by notice in writing to the Secretary of Jefferson at any time prior to its use, by submitting a duly executed proxy bearing a later date or by attending the meeting and voting in person. Proxies solicited hereby may be exercised only at the Annual Meeting and any adjournment thereof and will not be used for any other meeting. Each proxy solicited hereby, if properly signed and returned to the Association and not revoked prior to its use, will be voted in accordance with the instructions contained therein. If no contrary instructions are given, each proxy received by the Board of Directors will be voted for the election as directors of the nominees listed below, for the approval of the Stock Incentive Plan, for the approval of the proposal to conduct a private placement offering, and for the ratification of the selection of BDO Seidman as the Association's independent certified public accountants, all of which are discussed herein. VOTING SECURITIES, PRINCIPAL HOLDERS THEREOF AND OWNERSHIP BY MANAGEMENT Only stockholders of record at the close of business on December 15, 1993 will be entitled to vote at the Annual Meeting. As of such date, there were 1,310,876 shares of common stock, $3.00 par value per share ("Common Stock"), of the Association outstanding, and the Association had no other class of equity securities outstanding. With respect to the election of directors, stockholders have cumulative voting rights. Cumulative voting means the right to vote, in person or by proxy, the number of shares owned by a stockholder for as many persons as there are directors to be elected (3) and for whose election the stockholder has a right to vote, or to cumulate votes by giving one candidate as many votes as the number of such directors to be elected multiplied by the number of shares held by such stockholder or by distributing such votes on the same principle among any number of candidates. With respect to the approval of the Stock Incentive Plan, the proposal to conduct a private placement offering and the ratification of BDO Seidman as the Association's independent auditors, each share of Common Stock is entitled to one vote at the Annual Meeting. The following persons are known to the Association to be the beneficial owner of more than 5% of the issued and outstanding shares of the Association's Common Stock as of December 15, 1993:
Name and Address of Amount and Nature Percent of Beneficial Owner of Beneficial Ownership(1)(2) Class Charles H. Jones, Jr. 137,600(3) 10.50% Rock Hedge Farms Route 1, Box 110 Bluemont, VA 22102 Arthur J. Shadek 135,332 10.32% Katherine F. Shadek 688 Ocean Road Vero Beach, FL 32963 Value Partners, Ltd. 131,011 9.99% 2200 Ross Ave., Suite 4600W Dallas, TX 75201 Josiah T. Austin 128,666 9.81% Valer C. Austin El Coronado Ranch Star Route Pearce, AZ 85625 John Sheldon Clark 118,238(4) 8.97% 4311 W. Lawther Drive Dallas, TX 75214
(1) Information is based on Schedule 13D filings made pursuant to the Securities Exchange Act of 1934, as amended, or other information available to the Association. (2) Unless otherwise noted, all shares are owned directly by the named individuals or by their spouse and minor children residing with the named individual, over which shares the named individuals effectively exercise voting and investment power. (3) Includes 87,600 shares owned by Edge Partners, Ltd. of which Mr. Jones is the Managing Partner. (4) Includes 6,917 shares of Common Stock subject to stock options which are currently exercisable. Such shares are deemed to be beneficially owned by Mr. Clark but are not deemed to be outstanding for the purpose of computing the percentage of Common Stock owned by any other person or group. It also includes 5,031 shares held in five separate trusts for which Mr. Clark acts as co-trustee. 2 As of December 15, 1993, all directors and executive officers as a group (13 persons) beneficially owned 425,801 shares or approximately 32% of the issued and outstanding Common Stock, which includes 1,249 shares subject to currently exercisable and outstanding stock options granted to officers and directors under the Association's Stock Option Plan and 6,917 shares of Common Stock subject to currently exercisable and outstanding stock options held by Director Clark. For information regarding the beneficial ownership of the Common Stock by individual directors of the Association, see "Information with Respect to Nominees for Director and Executive Officers." INFORMATION WITH RESPECT TO NOMINEES FOR DIRECTOR AND EXECUTIVE OFFICERS The Bylaws of the Association were amended by the Board of Directors on November 2, 1993 to decrease the number of members of the Board of Directors from eleven to nine. The Bylaws also provide that the Board of Directors shall be divided into three classes as nearly equal in number as possible with one class to be elected for a term of three years and until their successors are elected and qualified. The terms of the three classes are staggered so that one class of directors is elected annually. Unless otherwise directed, each proxy executed and returned by a stockholder will be voted for the election of the nominees listed below. If any person named as a nominee should be unable or unwilling to stand for election at the time of the Annual Meeting, the proxies will nominate and vote for a replacement nominee or nominees recommended by the Board of Directors. There are no arrangements or understandings between the Association and any person pursuant to which such person has been elected a director and no director is related to any other director or executive officer of the Association by blood, marriage or adoption. At this time, the Board of Directors knows of no reason why any of the nominees listed below may not be able to serve as a director if elected. Three directors are to be elected at the Annual Meeting to serve for terms of three years expiring at the Annual Meeting in 1997. The Board of Directors has nominated Messrs. Robert F. Kube, Thomas W. Winfree and Saul J. Robinson. THE BOARD OF DIRECTORS RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" THE NOMINEES. 3 Nominees for Terms Expiring in 1997
Position with the Association and/or Shares Beneficially Principal Occupation Director Owned as of Name During The Past Five Years Age Since December 15, 1993(1) Amount Percent Saul Robinson President, Skyline Group, Inc., 64 1992 2,033 .15% a tourist attraction business, Front Royal, VA. Robert F. Kube Treasurer of the Association; 56 1988 10,943 .83% Builder and Appraiser. Thomas W. Winfree President and Chief Executive 49 1986 5,231(2) .40% Officer of the Association since January 1990; Executive Vice President of the Association from September 1989 to January 1990; Senior Vice President of the Association from 1984 to September 1989.
Members of the Board of Directors Continuing in Office Directors Whose Terms Expire in 1995
Position with the Association and/or Shares Beneficially Principal Occupation Director Owned as of Name During The Past Five Years Age Since December 15, 1993(1) Amount Percent William M. Rider Secretary of the Association; 66 1978 2,676(3) .17% President, R.L. Rider Const. Co., Warrenton, VA. Robin C. Gulick Chairman of the Board of the 41 1988 5,828(4) .44% Association; Partner, law firm of Gulick, Carson and Pearson, Warrenton, VA. Arthur J. Shadek Private Investor, 69 1992 135,332 10.32% Vero Beach, FL.
4 Directors Whose Terms Expire in 1996
Position with the Association and/or Shares Beneficially Principal Occupation Director Owned as of Name During The Past Five Years Age Since December 15, 1993(1) Amount Percent Calvin P. Burton Insurance Agent, Carr & Hyde 48 1991 2,206 .17% Inc. Insurance Agency, Warrenton, VA. Charles J. Jones, Jr. Managing Partner, Edge Partners, 60 1992 137,600(5) 10.50% L.P., an investment partnership, Shrewsbury, NJ. John Sheldon Clark Private Investor, Dallas, TX. 47 1992 118,238(6) 8.97%
(1) Unless otherwise noted, all shares are owned directly by the named individuals or by their spouse and minor children residing with the named individual, over which shares the named individuals effectively exercise voting and investment power. (2) Includes 500 shares of Common Stock subject to stock options which are currently exercisable. Such shares are deemed to be beneficially owned by Mr. Winfree but are not deemed to be outstanding for the purpose of computing the percentage of Common Stock owned by any other person or group. (3) Includes 381 shares held by R. L. Rider Construction Company. (4) Includes 2,498 shares held in trusts for which Mr. Gulick serves as trustee and 1,666 shares held by a corporation of which Mr. Gulick is a director. (5) Includes 87,600 shares owned by Edge Partners, Ltd. of which Mr. Jones is the managing partner. (6) Includes 6,917 shares of Common Stock subject to stock options which are currently exercisable. Such shares are deemed to be beneficially owned by Mr. Clark but are not deemed to be outstanding for the purpose of computing the percentage of Common Stock owned by any other person or group. It also includes 5,031 shares held in five separate trusts for which Mr. Clark acts as co-trustee. Stockholder Nominations Article II, Section 14 of the Association's Bylaws provides that stockholders entitled to vote for the election of directors may propose nominees for election to the Board of Directors. Any such nominations must be submitted to the Secretary of the Association in 5 writing at least five days prior to the Annual Meeting. The Association is not required to include nominations of stockholders in its proxy statement. However, if such a nomination is properly made, ballots will be provided for use by stockholders at the Annual Meeting bearing the name of such nominee or nominees. Board Meetings and Committees The Board of Directors has Executive, Personnel and Audit Committees. Functions of a nominating committee and budget committee are performed by the Board of Directors as a whole, at regular meetings, and the Board met once in its capacity as a nominating committee and once in its capacity as a budget committee during fiscal 1993. The Executive Committee consists of Messrs. Gulick, Clark, Kube, Winfree and Rider, all of whom are non-employee directors with the exception of Mr. Winfree. The Executive Committee meets at the direction of the Chairman or President, and has authority to act on most matters during the intervals between Board Meetings. The Committee met eight times in fiscal 1993. The Personnel Committee, which met five times during fiscal year 1993, consists of Messrs. Kube, Burton, Jones and Shadek, all of whom are non-employee directors. The committee approves the compensation of all employees with the exception of the President and Senior Vice Presidents. Their compensation is approved by the entire Board of Directors. The Audit Committee consists of Messrs. Burton, Rider, Jones and Robinson, all of whom are non-employee directors. The committee meets with the Association's internal auditor, management and independent auditors and insures that there are adequate internal controls. The committee met four times during fiscal 1993. The Board of Directors has the responsibility for establishing broad corporate policies and for the overall performance of Jefferson. Members of the Board are kept informed of Jefferson's business by various reports and documents presented to them each month, as well as by operating and financial reports made at Board and Committee Meetings by the Chief Executive Officer and other officers. Regular meetings of the Board of Directors are held once each month. There were fourteen meetings of the Board during the year ending September 30, 1993. No director attended fewer than 75% of the Board of Directors and Committee meetings at which his attendance was required. Compensation of Directors Directors of the Association receive fees of $300 per month, plus $200 for each Board meeting attended. Directors who are members of committees receive $100 per committee meeting attended other than members of the Major Loan Committee, who receive $200 per committee meeting attended. 6 On October 5, 1993, the Board of Directors adopted a resolution providing that in lieu of the compensation described above, each board member would receive an annual retainer of $5,000 ($7,500 for the Chairman); $250 for each Board meeting attended in person; $100 for each loan committee meeting attended in person; and $1,250 for committee assignment, other than loan committee, subject to a $2,500 annual limit provided that the member attends not fewer than 75% of the Board of Directors' and Committee meetings at which his or her attendance is required. Salaried officers who serve on the Board will not receive compensation for service as a director. Compliance with Section 16(a) of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Association's officers and directors, and persons who own more than 10% of the Association's Common Stock, to file reports of ownership and changes in ownership with the Office of Thrift Supervision. Officers, directors and greater than 10% stockholders are required by regulations to furnish the Association with copies of all Section 16(a) forms they file. Based solely on a review of the copies of such forms furnished to the Association, the Association believes that during fiscal 1993, all Section 16(a) filing requirements applicable to its officers, directors and 10% stockholders were complied with. Executive Officers The following table sets forth certain information concer- ning the executive officers of Jefferson as of December 15, 1993. There is no family relationship between any of the directors or executive officers, and there are no arrangements or understandings with others under which any person was selected as an officer. Officers of the Association are appointed annually by the Board of Directors to serve for one-year terms.
Officer Name Age Since Title Thomas W. Winfree 49 1984 President and Chief Executive Officer Craig A. Mason 48 1990 Senior Vice President and Chief Financial Officer Walter E. Monroe 57 1988 Senior Vice President and Chief Lending Officer Benny N. Werner 44 1978 Senior Vice President of Retail Banking James A. Yergin 39 1988 Senior Vice President and General Counsel
7 Mr. Winfree has been the President and Chief Executive Officer of Jefferson since January 1990, was the Executive Vice President and Chief Executive Officer from September 1989 to January 1990 and was a Senior Vice President of Jefferson from 1984 to September, 1989. In addition, Mr. Winfree was Vice President and Director, First Federal Savings Bank of Virginia from 1983 to 1984, and Executive Vice President, Chief Executive Officer and Director, Security Savings and Loan from 1979 to 1983. Mr. Mason was employed as Senior Vice President and Chief Financial Officer in January, 1990. He was previously employed by Columbia First Bank from April, 1985 to January, 1990 as Vice President. Mr. Mason is a certified public accountant. Mr. Monroe was employed as Senior Vice President and the Chief Lending Officer of the Association in 1988. He was Vice President and Director of Commercial Real Estate Lending of Citicorp Savings of Washington, D.C from July, 1986 to September, 1988, and Executive Vice President of National Permanent Bank, F.S.B. (predecessor to Citicorp Savings of Washington, D.C.) from January, 1984 to July, 1986. Mr. Werner joined Jefferson in 1978 as a loan consultant. From 1979 to 1985 he served as Branch Manager, Assistant Vice President at the King Street branch in Leesburg, and as Branch Coordinator, Vice President from 1985 to 1989. Mr. Werner was promoted to Senior Vice President/Retail Banking in October, 1989. Mr. Yergin joined the Association in October, 1988 as the Association's Staff Counsel and was promoted to Senior Vice President and General Counsel in January, 1992. Prior thereto, Mr. Yergin was employed as an associate attorney by the law firm of Dixon and Smith of Fairfax, Virginia from 1984 to September, 1988. 8 EXECUTIVE COMPENSATION Remuneration of Executive Officer Summary Compensation Table. The Summary Compensation Table below includes compensation information on the President and Chief Executive Officer of the Association during the fiscal years ended September 30, 1993, 1992 and 1991. There were no other executive officers of the Association whose total compensation exceeded $100,000 for services rendered in all capacities during the fiscal years ended September 30, 1993, 1992 and 1991.
Annual Compensation Name and Principal Fiscal Other Annual All Other Position Year Salary Bonus Compensation(2) Compensation(1) Thomas W. Winfree, 1993 $93,760 $12,690 0 $27,169 President and Chief 1992 82,100 0 0 16,530 Executive Officer 1991 81,337 9,630 0 9,832
(1) Includes employer matching contributions accrued pursuant to the Association's defined contribution pension plan. See "Employee 401(k) Plan." Also includes director's fees paid to Mr. Winfree for his services as a director of the Association and, for 1993, a $14,728 payment for accrued but unused vacation time. (2) Does not include amounts attributable to miscellaneous benefits received by the named executive officer, including the use of automobiles leased or owned by the Association and payment of club dues. In the opinion of management of the Association, the costs to the Association of providing such benefits to Mr. Winfree during the year ended September 30, 1993 did not exceed the lesser of $50,000 or 10% of the total annual salary and bonus reported for Mr. Winfree. Option Grants in Last Fiscal Year. On August 3, 1993, a Committee of the Board of Directors adopted a resolution directing the issuance of stock options to Mr. Winfree for 20,000 shares under the proposed 1993 Stock Incentive Plan. The issuance of such options is subject to approval of the 1993 Stock Incentive Plan by shareholders at this Annual Meeting. The options are also subject to a vesting schedule of 20% for each year of employment after August 3, 1993 with automatic 100% vesting in the event of a change of control of the Association. The option price was set at $6.00 per share, the market price for a share of Common Stock on the date of grant. See "Proposal to Adopt the Jefferson Savings and Loan Association, F.A., 1993 Stock Incentive Plan." 9 Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values. Mr. Winfree did not exercise any options during the last fiscal year. The following table sets forth for Mr. Winfree information with respect to the aggregate number of unexercised options at the end of the fiscal year and the value with respect thereto.
Number of Unexercised Value of Unexercised Options at Fiscal Year End Options at Fiscal Year End Name Exercisable/Unexercisable(1) Exercisable/Unexercisable(2) Thomas W. Winfree 500/20,000 $0/$0
(1) The unexercisable options are contingent upon stockholder approval of the proposed 1993 Stock Incentive Plan and have a vesting schedule of 20% for each year of employment after August 3, 1993. (2) Based upon the average of the closing bid and asked prices for the Association's Common Stock as of September 30, 1993 of $6.00. Pension Plan Prior to February 5, 1990, the Association funded and maintained a defined benefit plan ("Plan") for all qualified full-time employees hired before the age of 60. As of February 5, 1990, the accrual of benefits under the Plan was frozen. Thus, all compensation after that date is not used to compute benefits. However, the Plan continues to be in existence. Jefferson plans to continue the Plan with the frozen accrual of benefits indefinitely, but reserves the right to revise or discontinue the Plan. Assets of the Plan will not revert to the Association, and cannot be diluted by merger. Employee 401(k) Plan Effective October 1, 1990, the Association implemented a qualified 401(k) plan for all employees. In fiscal 1992, the Association matched 50% of salary reduction elected by the employee up to 3% of salary, and 25% of salary reduction elected for 4% to 6% of salary. No matching was made for salary reduction in excess of 6%. The Association incurred $30,010 in matching and administration expense in the year ended September 30, 1993. Matching contributions become 20% vested after three (3) years of service, 40% vested after four (4) years of service, 60% vested after five (5) years of service, 80% vested after six (6) years of service and 100% vested after seven (7) years of service. Employee Stock Compensation Program As a performance incentive and to encourage ownership in its Common Stock, the Board of Directors adopted in 1988 an Employee Stock Options and Incentive Plan (the "1988 Plan") for the benefit of officers and other full-time employees of the Association who 10 are deemed to be responsible for the future growth of the Association. The stockholders of the Association approved the 1988 Plan at the 1988 Annual Meeting. Three kinds of rights are contained in the 1988 Plan and are available for grant: incentive stock options, non-incentive stock options and stock appreciation rights. As of October 1, 1993, an aggregate of 22,833 shares of authorized but unissued Common Stock of the Association were available for issuance under the 1988 Plan (which amount has been adjusted to reflect the effect of the 1993 one for three reverse stock split) pursuant to the exercise of stock options and/or the granting of stock appreciation rights, subject to further modification or adjustment to reflect changes in the Association's capitalization. As of October 1, 1993, options covering 3,833 shares were outstanding to certain officers and employees (which amount reflects an adjustment for the 1993 one for three reverse stock split). On August 3, 1993, the Board of Directors adopted the Jefferson Savings and Loan Association, F.A. 1993 Stock Incentive Plan (the "1993 Plan") subject to approval by the shareholders. The 1993 Plan is more fully described below. On December 7, 1993, the Board adopted a resolution discontinuing the 1988 Plan if the 1993 Plan is approved by the shareholders. Employment Agreement Jefferson has a written employment agreement with Thomas W. Winfree as the Association's President and Chief Executive Officer for the period ending September 30, 1995. Mr. Winfree's base salary under the contract for fiscal 1994 is $115,000 per year subject to annual upward adjustment by Jefferson's directors but in no case more than an amount allowed by the appropriate federal regulators. Mr. Winfree is entitled to additional compensation equal to two percent of Jefferson's net income after taxes for the then current fiscal year provided that the Board of Directors makes an annual determination that such additional compensation is not the result of unreasonable risk-taking to achieve short-term profits. The contract permits Mr. Winfree to be terminated for cause; however, such termination, if any, would not affect his vested rights in the pension plan or certain other employee benefits granted under the contract. Mr. Winfree's contract may also be terminated upon the occurrence of certain events as specified in federal regulations. If Jefferson does not amend, renew or extend Mr. Winfree's contract when it expires, he is entitled to receive additional compensation equal to six months' salary. Any payments made to Mr. Winfree are subject to and conditioned upon their compliance with 12 U.S.C. Section 1828(k) and any regulations promulgated thereunder. The Board of Directors and Mr. Winfree have also agreed that Mr. Winfree will not receive any additional compensation for his services on the Board. Employee Agreements in the Event of an Acquisition The Board of Directors, concerned that certain key employees, most of whom are not among Jefferson's most highly compensated executive officers earning over $60,000 annually, might consider alternative employment if the Association was to be acquired by 11 a third party or group, authorized execution of letter agreements with ten key employees as of October 1, 1993 for a period of one year. These agreements are with four senior vice presidents and six other key employees whose continued employment are considered essential to continuing operations. All agreements provide for severance pay of six months salary, beginning with the date of acquisition until 90 days after acquisition, if employment is terminated by the acquiror. The agreements will become null and void 90 days after an acquisition. Acquisition is defined in each of the agreements as the acquisition, by a third person or group, of beneficial ownership of 20% or more of the Common Stock of the Association. All payments made to the employee under the agreement are subject to and conditional upon their compliance with 12 U.S.C Section 1828(k) and any regulations promulgated thereunder. These agreements may tend to discourage a non-negotiated takeover attempt of the Association due to possible increased expenses arising out of a takeover opposed by management of the Association. Transactions With Certain Related Persons Jefferson offers or has offered loans to its officers, directors, and employees for the financing of their homes and consumer loans. These loans are made in the ordinary course of business and, in the opinion of management, do not involve more than the normal risk of collectability, or present other unfavorable features. Such loans are made on the same terms as those prevailing at the time for comparable transactions with non-affiliated persons, except that employees of Jefferson, after one year of service, receive a waiver of 1 point on the origination fees for an adjustable-rate mortgage loan, one- quarter point on the origination fees for a fixed-rate mortgage loan and fixed-rate second trust loan, and a document review fee for all loans is also waived. On a one year adjustable-rate mortgage loan, the interest rate charged an employee with at least one year's service will equal the total of the Federal Home Loan Bank of Atlanta cost of funds plus one-half of one percent rounded to the next higher one-eighth of one percent with the rate adjusted annually thereafter, but in no event is the interest rate less than Jefferson's cost of funds. On consumer loans, after six months of employment, employees of Jefferson receive a discount of two percent on Jefferson Reserve Accounts, a discount of one percent on home equity lines of credit, a discount of one-half of one percent on credit cards and a one percent discount for all other consumer loan products. In no event is the discount interest rate less than Jefferson's cost of funds. If an employee leaves the employment of the Association, the interest rate reverts to the rate that would have been charged at the loan's inception had such person not been employed by Jefferson. As a result of the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"), as of August 9, 1989, the loan policy for employees of Jefferson no longer applied to directors and executive officers. As of August 9, 1989, directors and executive officers are offered loans only on the same terms as those offered 12 to non-affiliated persons. However, loans made to directors or executive officers with preferential terms prior to the enactment of FIRREA are unaffected. The following executive officers and directors have been indebted to Jefferson as a result of home mortgage loans and consumer loans since the beginning of the last fiscal year in an amount in excess of $60,000:
Balance as of Balance as of Name and Type Year Original September 30, Principal September 30, Annual of loan Made Loan Balance 1992 New Advances Repayments 1993 Interest Rate Thomas W. Winfree Mortgage 1986 $120,000 $113,134 $ - $ 2,140 $110,994 5.75% Consumer 1988 10,000 6,817 15,038 15,000 6,855 10.00 Home Equity 1988 60,000 30,124 13,826 185 43,765 8.00 Robert F. Kube Mortgage 1978 70,000 46,271 - 3,232 43,039 10.50 Mortgage 1985 475,000 409,354 - 15,058 394,296 10.00 Mortgage 1987 23,500 18,629 - 1,224 17,405 10.00 Consumer 1988 10,000 6,027 7,100 9,015 4,112 10.00 Calvin P. Burton Mortgage 1986 125,000 119,407 - 1,752 117,655 7.50
PROPOSAL TO ADOPT THE JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. 1993 STOCK INCENTIVE PLAN General As a performance incentive and to encourage ownership of its Common Stock and to replace the existing 1988 Stock Option Incentive Plan, the Board of Directors has adopted the Jefferson Savings and Loan Association, F.A. 1993 Stock Incentive Plan (the "1993 Plan") for the benefit of employees of the Association. An aggregate of 131,087 shares of authorized but unissued Common Stock has been reserved for future issuance under the 1993 Plan, which is equal to approximately 10% of the Common Stock outstanding on August 3, 1993, the date the 1993 Plan was adopted by the Board. Shares will be issuable under the 1993 Plan pursuant to the exercise of stock options and/or the granting of stock appreciation rights, subject to modification or adjustment to reflect changes in the Association's capitalization as, for example, in the case of a merger, reorganization, stock split or stock dividend. The 1993 Plan shall remain in effect for a term of ten years unless sooner terminated in accordance with its provisions. Three kinds of rights are contained in the 1993 Plan and are available for grant: incentive stock options, compensatory stock options and stock appreciation rights. The 1988 Plan originally provided for a limit of 80,000 shares subject to awards made under that plan. When the one for three reverse stock split was approved by the 13 stockholders in 1993, under the provisions of the 1988 Plan, that limit was reduced to one third of that amount or 26,666 shares. In order to allow for greater flexibility and the use of stock options as incentives, plus a desire to update the 1988 Plan, the Board of Directors decided to replace the 1988 Plan with the proposed 1993 Plan. If the 1993 Plan is approved, the 1988 Plan will be discontinued and no further awards will be made under the 1988 Plan. Awards already made under the 1988 Plan which are still outstanding will continue to be governed by the terms of the 1988 Plan for a period of ten years from the date of the original grant. Upon the expiration of such ten year period, such options under the 1988 Plan will be void. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. 1993 STOCK INCENTIVE PLAN Administration and Eligibility The 1993 Plan will be administered by a committee appointed by the Board of Directors composed of not less than two directors of the Association, none of whom is a full-time officer or employee of the Association (the "Committee"), who are given absolute discretion under the 1993 Plan to select the persons to whom options, rights and awards will be granted and to determine the number of shares subject to each option or right. The Association estimates that there are approximately 100 persons eligible to receive awards under the 1993 Plan. The initial Committee consists of Messrs. Kube, Burton, Shadek and Jones. Description of the 1993 Stock Incentive Plan The following description of the 1993 Plan is a summary of its terms and is qualified in its entirety by reference to the 1993 Plan. A copy of the 1993 Plan is available upon request to the Association by a stockholder of record. Any such request should be directed to Thomas W. Winfree, President, Jefferson Savings and Loan Association, F.A., 550 Broadview Avenue, Warrenton, VA 22186. Incentive and Compensatory Options. One or more options may be granted under the 1993 Plan to any eligible person, provided that the aggregate fair market value (determined at the time the options are granted) of the stock for which incentive options (defined below) are first exercisable by any employee during any calendar year under the terms of the 1993 Plan and all such plans of the Association shall not exceed $100,000. Options granted within the foregoing limitation are intended to qualify as "incentive stock options" as defined in Section 422 of the Code. Additional nonstatutory stock options may be granted as nonqualified options. As described below, the tax treatment of these types of options differs significantly. An incentive stock option is defined in the Code as an option granted to an employee in connection with his or her employment to purchase stock in the Association and which 14 satisfies certain conditions. The incentive stock option must be granted pursuant to a plan specifying the aggregate number of shares to be issued and the employees, or class of employees, eligible to receive options. The plan must be approved by the stockholders of the granting corporation within twelve months of the date of adoption of the plan. The incentive stock option price must be not less than the fair market value of the stock at the date of the grant, the incentive stock option must be granted within ten years from the date of adoption of the plan and, by its terms, the incentive stock option must not be exercisable after ten years from the date it was granted. In the case of any employee who owns more than 10% of the combined voting power of all classes of stock of the Association or of its subsidiaries, the option price may not be less than 110% of the fair market value of the stock at the date of the grant and the employee must exercise any options within five years from the date of the grant. The incentive stock option cannot be transferable, except by will or by the laws of descent and distribution, and must be exercised only by the aggregate fair market value (determined at the time of the grant) of stock for which incentive options first become exercisable by any employee during any calendar year under the terms of the 1993 Plan and all such plans of the Association shall not exceed $100,000. The 1993 Plan conforms with the above requirements. Nonqualified stock options granted under the 1993 Plan shall expire no later than ten years from the date on which such compensatory stock options were granted. The purchase price for shares acquired pursuant to the exercise of nonqualified stock options can be no less than the greater of par value or eighty- five percent (85%) of the fair market value of a share of Common Stock at the time such nonqualified option is granted. Like incentive stock options, nonqualified stock options are not transferable, except by will and the laws of descent and distribution, and must be exercised only by the optionee during his or her lifetime. Under the 1993 Plan, all nonqualified stock options may not vest and become exercisable until at least six months shall have elapsed from the date the option was granted. In the event of a change in control of the Association (defined as a change in control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Exchange Act, whether or not the Association in fact is required to comply with Regulation 14A thereunder; provided that, without limitation, such a change in control shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than the Association, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Association representing 25% or more of the combined voting power of the Association's then outstanding securities, or (ii) during any period of twenty-four consecutive months during the term of an Option, individuals who at the beginning of such period constitute the Board of the Association cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election by the Association's stockholders, of each director who was not a director at the date of grant has been approved in advance by directors representing at least 15 two- thirds of the directors then in office who were directors at the beginning of the period) or a threatened change of control (defined as any set of circumstances which in the opinion of the Board as expressed through a resolution, poses a real, substantial and immediate possibility of leading to a change in control of the Association as defined above), all incentive and nonqualified stock options previously granted will become immediately exercisable notwithstanding any existing installment limitation which may be established by the Program Administrators. If an optionee's employment is terminated for any reason other than death, disability or retirement, both incentive and nonqualified stock options must be exercised within three months after the date of termination, unless the Committee in its discretion decides at the time of the grant or thereafter to extend such period of exercise from three (3) months to a period not exceeding five (5) years. Payment for shares purchased under the 1993 Plan may be made either in cash, or at the discretion of the Committee, by delivering shares of Common Stock (including shares acquired pursuant to the exercise of an Option) or other property equal in fair market value to the purchase price of the shares to be acquired pursuant to the Option, by withholding some of the shares of Common Stock which are being purchased upon exercise of an Option, or any combination of the foregoing. To the extent an optionee already owns shares of Common Stock prior to the exercise of his or her option, such shares could be used (if permitted by the Committee) as payment for the exercise price of the option. If the fair market value of a share of Common Stock at the time of exercise is greater than the exercise price per share, this feature would enable the optionee to acquire a number of shares of Common Stock upon exercise of the option which is greater than the number of shares delivered as payment for the exercise price. In addition, an optionee can partially exercise his or her option and then deliver the shares acquired upon such exercise (if permitted by the Program Administrators) as payment for the exercise price of the remaining option. Again, if the fair market value of a share of Common Stock at the time of exercise is greater than the exercise price per share, this feature would enable the optionee to either (1) reduce the amount of cash required to receive a fixed number of shares upon exercise of the option or (2) receive a greater number of shares upon exercise of the option for the same amount of cash that would have otherwise been used. Because options may be exercised in part from time to time, the ability to deliver Common Stock as payment of the exercise price would enable the optionee to turn a relatively small number of shares into a large number of shares. The granting of a stock option does not confer upon the optionee any right to remain in the employ of the Association. The optionee will have no dividend or voting rights with respect to the shares until the option price has been paid in full upon exercise. Stock Appreciation Rights. Under the 1993 Plan, the Committee may, in its sole discretion, accept surrender of the right to exercise any option by an optionee in return for payment by the Association to the optionee of cash or, subject to certain conditions, Common Stock of the Association in an amount equal to the excess of the fair market value of the shares of Common Stock subject to option at the time over the option price of such 16 shares, or a combination of cash and Common Stock. An optionee may exercise such stock appreciation rights only during the period beginning on the third business day following the release of certain quarterly or annual financial information and ending on the twelfth business day following such date. Upon the exercise of a stock appreciation right, the stock option to which it relates terminates with respect to the number of shares as to which the right is so exercised. Conversely, upon the exercise of a stock option, any related stock appreciation right shall terminate as to any number of shares subject to the right that exceeds the total number of shares for which the stock option remains unexercised. Stock appreciation rights which relate to incentive stock options must be granted concurrently with the incentive stock options, while stock appreciation rights which relate to compensatory stock options may be granted concurrently with the option or at any time thereafter which is prior to the exercise or expiration of such options. Potential Anti-takeover Effect As described above, the 1993 Plan contains provisions which provide for the acceleration of stock options granted under the 1993 Plan in the event of an actual or threatened change in control, as defined. Pursuant to these provisions, the Committee, in its discretion, could accelerate or increase the number of stock options, thereby potentially increasing the number of shares of Common Stock outstanding. Such an increase in the number of shares of Common Stock outstanding would increase the cost of acquiring a controlling interest in the Association. In addition, the provisions of the 1993 Plan may have the effect of entrenching management and deterring a non- negotiated takeover attempt, due to management's ability to potentially grant options to persons likely to support management's position. Awards Under the 1993 Plan On August 3, 1993, the Committee awarded incentive stock options effective August 3, 1993, subject to shareholder approval of the 1993 Plan, to the individuals then occupying the following positions in the amounts indicated next to their titles:
President 20,000 shares Senior Vice Presidents 5,000 shares Vice Presidents 1,000 shares Asst. Vice Presidents 500 shares All Executive Officers as a Group 40,000 shares All Employees as a Group 64,500 shares(1)
(1) Of this amount, 13,000 have been awarded to non-officer employees of the Association. 17 The Committee further directed that those option agreements are to provide for a vesting schedule of 20% for each year of employment after August 3, 1993 with an automatic 100% vesting in the event of a change in control and that the option price is to be the fair market value as of August 3, 1993 which was $6.00 per share as reported on the NASDAQ Small CAP Market Exchange. Amendments The Board of Directors may, by resolution, at any time terminate, amend or revise the 1993 Plan with respect to any shares of Common Stock as to which Awards have not been granted, provided, however, that no amendment which (a) changes the maximum number of shares that may be sold or issued under the Plan (other than in accordance with the provisions of the 1993 Plan, or (b) changes the class of persons that may be granted Options, shall become effective until it received the approval of the stockholders of the Association, and further provided that the Board of Directors may determine that stockholder approval for any other amendment to this Plan may be advisable for any reason, such as for the purpose of obtaining or retaining any statutory or regulatory benefits under tax, securities or other laws or satisfying any applicable stock exchange listing requirements. The Board of Directors may not, without the consent of the holder of an Award, alter or impair any Award previously granted or awarded under this Plan as specifically authorized herein. Federal Income Tax Consequences Under current provisions of the Code, the federal income tax treatment of incentive stock options and nonqualified stock options is substantially different. As regards incentive stock options, an optionee who does not dispose of the shares within two years after the option was granted, or within one year after the option was exercised, will not recognize income at the time the option is exercised, and no federal income tax deduction will be available to the Association at any time as a result of such grant or exercise. However, the excess of the fair market value of the stock subject to an incentive stock option on the date such option is exercised over the exercise price of the option will be treated as an item of tax preference in the year of exercise for purposes of the alternative minimum tax. If stock acquired pursuant to an incentive stock option is disposed of before the holding periods described above expire, then the excess of the fair market value (but not in excess of the sales proceeds) of such stock on the option exercise date over the option exercise price will be treated as compensation income to the optionee in the year in which such disposition occurs and, if it complies with applicable withholding requirements, the Association will be entitled to a commensurate income tax deduction. In such event, any difference between the sales proceeds and the fair market value of the stock on the option exercise date will be treated as long-term capital gain or loss if the shares were held more than one year after the option exercise date. 18 With respect to nonqualified stock options, the difference between the fair market value of the Common Stock on the date of exercise and the option exercise price generally will be treated as compensation income upon exercise, and the Association will be entitled to a deduction in the amount of income so recognized by the optionee. Upon a subsequent disposition of the shares, the difference between the amount received by the optionee and the fair market value on the option exercise date will be treated as long or short-term capital gain or loss, depending on whether the shares were held for more than one year. When an officer who is subject to Section 16(b) of the Exchange Act exercises a nonqualified option within six months of the date the option was granted, no income is recognized for federal income tax purposes at the time of the exercise of the compensatory stock option unless the optionee makes an appropriate election within 30 days after the date of exercise, in which case the rules described in the preceding paragraph would apply. If such an election is not made, the optionee will recognize ordinary income on the date that is six months after the date of grant (generally, the first date that sale of such shares would not be subject to potential liability under Section 16(b) of the Exchange Act). The ordinary income recognized will be the excess, if any, of the fair market value of the shares on such later date over the option exercise price, and the Association's tax deduction also will be deferred until such later date. No federal income tax consequences are incurred by the Association or the holder at the time a stock appreciation right is granted. However, upon the exercise of a stock appreciation rights, the holder will realize income for federal income tax purposes equal to the amount received by him, whether in cash, shares of stock or both, and the Association will be entitled to a deduction for federal income tax purposes at the same time and in the same amount. The above description of tax consequences is necessarily general in nature and does not purport to be complete. Moreover, statutory provisions are subject to change, as are their interpretations, and their application may vary in individual circumstances. Finally, the consequences under applicable state and local income tax laws may not be the same as under the federal income tax laws. Accounting Treatment Generally accepted accounting principles require that the estimated costs of stock appreciation rights be charged to the Association's earnings based on the change in the market price of the Common Stock at the beginning (or grant date if granted during the period) and end of each accounting period, if it is higher than the exercise price. In the event of a decline in the market price of the Association's Common Stock subsequent to a charge against earnings related to the estimated costs of stock appreciation rights, a reversal of prior charges is made in the amount of such decline (but not to exceed aggregate prior increases). The grant of performance share awards similarly may result in charges against earnings. 19 Neither the grant nor the exercise of an incentive stock option or a nonqualified stock option under the 1993 Plan requires any charge against earnings. The Association may, however, recognize an expense for compensatory options in the event that the exercise price of such options is less than the fair market value of the Common Stock on the date of the grant of such options. The Financial Accounting Standards Board ("FASB") has issued an exposure draft proposing that companies be required to recognize an expense for all stock-based compensation awards, including stock options. The expense would be measured as the fair value of the award at the grant date and would be recognized over the vesting period of the award. The proposal would provide for a three-year period of disclosure in footnotes of the expense measure beginning no earlier than calendar 1994. After that three-year disclosure period, the expense would have to be included in the determination of net income. VOTE REQUIRED The affirmative vote of a majority of the total votes eligible to be cast at this Annual Meeting is necessary in order to adopt the 1993 Stock Incentive Plan. In order for a quorum to exist, a majority of the outstanding shares of Common Stock entitled to vote must be represented at the meeting in person or by proxy. Abstentions and broker non-votes will have the same effect as a vote against the proposal. THE BOARD OF DIRECTORS RECOMMENDS THAT THE STOCKHOLDERS VOTE FOR ADOPTION OF THE 1993 STOCK INCENTIVE PLAN. PROPOSAL TO APPROVE A PROPOSED PRIVATE PLACEMENT OFFERING The Board of Directors is soliciting stockholder approval of this proposal at the Annual Meeting to provide the Association with corporate flexibility to respond to potentially valuable business opportunities which may include the purchase of deposits, branch office properties and other assets from third parties, including properties and other assets of the Resolution Trust Corporation ("RTC"). While the Association does not have any immediate, specific plans to issue shares of capital stock, the corporate flexibility provided for in this proposal will allow the Association to respond on a timely basis to those business opportunities and avoid the time and expense of soliciting stockholder approval at a special meeting. Although the Association presently does not have specific plans with respect to a private placement offering, the Association may conduct a non-public offering in compliance with the rules and regulations of the OTS which encompass non-public offerings pursuant to Regulation D promulgated pursuant to the Securities Act of 1933, as amended ("Regulation D"). Regulation D sets forth various alternative ways to conduct a non-public 20 offering and includes varying limitations related to the aggregate price of the securities offered, the number of purchasers, the types of purchasers and the manner of sale. Generally, a private placement offering avoids the time, effort and expense associated with the preparation of an offering circular for use in a public offering. Any such private placement offering, if initiated, is not expected to exceed $5.0 million. In addition, the Association would only offer shares of capital stock to accredited investors, which may include directors and controlling persons of the Association as well as others. Section 5 of the Association's Federal Stock Charter requires the approval of the stockholders of the Association by a majority of the total votes eligible to be cast at a legal meeting before shares of the Association's capital stock may be issued to directors, officers, or controlling persons of the Association. If adopted, this proposal would provide that required approval. The Association presently believes that the commencement of a private offering, if any, would occur in the next 18 months. As stated above, a private offering, if any, would be initiated in connection with the purchase of deposits, branch office properties and other assets from third parties, including properties and other assets of the RTC. Since the offering of deposits or assets by such third parties is not within the control of the Association, the Association is unable at this time to predict with any certainty the proposed timing of a private placement offering. However, the Association will not undertake any private placement offering beyond 18 months from the date of the 1994 Annual Meeting without additional stockholder approval. The offer of capital stock may include authorized but unissued shares of the Association's Common Stock or Preferred Stock, $1.00 par value per share ("Preferred Stock"). Shares of Common Stock would be offered at the then current market price as determined by the most recent sale price or the average of the bid and asked prices as quoted on the NASDAQ Small CAP Market Exchange. The relative rights and preferences, and the price per share for the shares of Preferred Stock, if any, would be determined by the Association's Board of Directors. Based on the closing sale price of the Common Stock on the NASDAQ Small CAP Market Exchange on December 13, 1993 of $8.00 per share, a $5.0 million offering would result in the issuance of an additional 625,000 shares of Common Stock. As of the close of business on December 15, 1993, there were 1,310,876 shares of Common Stock outstanding. THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR APPROVAL OF THIS PROPOSAL. THE APPROVAL OF THIS PROPOSAL REQUIRES THE AFFIRMATIVE VOTE OF A MAJORITY OF THE TOTAL VOTES ELIGIBLE TO BE CAST AT THIS ANNUAL MEETING. ABSTENTIONS AND BROKER NON-VOTES WILL HAVE THE SAME EFFECT AS A VOTE AGAINST THE PROPOSAL. 21 RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS The Board of Directors has appointed BDO Seidman, independent certified public accountants, to be its independent auditors for the current fiscal year ending September 30, 1994, subject to ratification by the stockholders. A representative of BDO Seidman will be present, the representative will have the opportunity to make a statement if the representative desires to do so and will be available to respond to appropriate questions from stockholders. During the two most recent fiscal years there were no unresolved issues, scope restrictions or unanswered questions between Jefferson and BDO Seidman on any matter of accounting principles, practices, audit procedures or financial statement disclosures which have not been resolved. THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR RATIFICATION OF THE APPOINTMENT OF BDO SEIDMAN AS INDEPENDENT AUDITORS FOR THE CURRENT FISCAL YEAR ENDING SEPTEMBER 30, 1994. THE RATIFICATION OF BDO SEIDMAN AS THE ASSOCIATION'S INDEPENDENT AUDITORS FOR FISCAL 1994 REQUIRES APPROVAL BY A MAJORITY OF SHARES REPRESENTED IN PERSON OR BY PROXY. FORM 10-K ANNUAL REPORT A copy of Jefferson's Annual Report on Form 10-K (including financial statements and schedules thereto) as filed with the Office of Thrift Supervision for the fiscal year ended September 30, 1993, will be furnished to stockholders upon written request directed to Chief Financial Officer, Jefferson Savings and Loan Association, F.A. 550 Broadview Avenue, Warrenton, VA 22186. ADDITIONAL INFORMATION No person is authorized to give any information or to make any representations on behalf of Jefferson other than those contained in this Proxy Statement, and if given or made, such information may not be relied upon as having been authorized. The Association's Annual Report to Stockholders has been mailed, along with this Proxy Statement, to all those who were stockholders of record as of December 15, 1993. Any stockholder who has not received a copy of such Annual Report to Stockholders may obtain a copy by writing the Association. Such Annual Report to Stockholders is not to be treated as a part of the proxy solicitation material nor as having been incorporated herein by reference. 22 STOCKHOLDER PROPOSALS Any proposal which a stockholder wishes to have presented at the next annual meeting of the Association, which is expected to be held in January 1995, must be received at the main office of the Association, 550 Broadview Avenue, Warrenton, Virginia 22186 no later than September 13, 1994. If the Board of Directors of the Association determines that such proposal is in compliance with all of the requirements of Rule 14a-8 of the Securities Exchange Act of 1934, as amended it will be included in the Proxy Statement and set forth on the form of proxy issued for the next Annual Meeting of Stockholders. It is urged that any such proposals be sent by certified mail, return receipt requested. OTHER MATTERS THAT MAY COME BEFORE THE MEETING Each proxy solicited hereby also confers discretionary authority on the Board of Directors of the Association to vote the proxy with respect to the approval of the minutes of the last meeting of stockholders, the election of any person as director if a nominee is unable to serve or for good cause will not serve, matters incident to the conduct of the Annual Meeting, and upon such other matters as may properly come before the Annual Meeting. Management is not aware of any business that may properly come before the Annual Meeting other than those matters described in this Proxy Statement. However, if any other matters should properly come before the Annual Meeting, it is intended that the proxies solicited hereby will be voted with respect to those other matters in accordance with the judgment of the persons voting the proxies. By Order of the Board of Directors Robin C. Gulick Chairman of the Board Warrenton, Virginia January 10, 1994 23 EX-99 5 EXHIBIT 99IV DEPARTMENT OF THE TREASURY OFFICE OF THRIFT SUPERVISION Washington, D.C. FORM 10-QSB x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1994 or TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Office of Thrift Supervision Docket Number 6498 JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. (Exact name of small business issuer as specified in its charter) United States 54-0680877 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 550 Broadview Avenue, Warrenton, Virginia 22186 (Address of principal executive offices) (Zip Code) (703) 347-3531 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 The number of shares outstanding of the registrant's common stock, ($3.00 par value) on June 30, 1994 was 1,310,876. Transitional Small Business Disclosure Yes No X PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Jefferson Savings and Loan Association, F.A. Consolidated Balance Sheets (Dollars in thousands) June 30, September 30, Assets 1994 1993 (Unaudited) Cash $ 4,065 $ 2,926 Investment securities 37,968 45,670 Mortgage-backed securities 39,468 51,173 Loans receivable, net 201,944 169,965 Accrued interest receivable 1,766 1,759 Real estate owned 7,329 8,219 Office properties and equipment, net 4,212 3,474 Prepaid expenses and other assets 1,362 1,064 Total assets $298,114 $284,250 Liabilities and Stockholders' Equity Liabilities Deposits $268,920 $241,467 Other borrowings 14,789 24,079 Advance payments from borrowers for taxes and insurance 1,515 1,630 Accrued expenses and other liabilities 1,176 4,392 Total liabilities 286,400 271,568 Stockholders' Equity Common stock, par value $3 per share, authorized 5,000,000 shares, issued and outstanding, 1,310,876 shares at June 30, 1994 and September 30, 1993 3,933 3,933 Preferred stock, par value $1 per share, authorized 2,500,000 shares at June 30, 1994 and September 30, 1993, issued and outstanding -0- shares at June 30, 1994 and September 30, 1993 - - Additional paid-in capital 3,380 3,380 Retained earnings 5,063 5,268 Net unrealized gain (loss) on assets available-for-sale (662) 101 Total stockholders' equity 11,714 12,682 Total liabilities and stockholders' equity $298,114 $284,250 See accompanying notes to unaudited consolidated financial statements. Jefferson Savings and Loan Association, F.A. Consolidated Statements of Operations (Unaudited) Three months ended Nine months ended June 30, June 30, (Dollars in thousands) 1994 1993 1994 1993 Interest income Loans $ 3,712 $ 3,780 $10,765 $11,846 Mortgage-backed securities 661 869 2,194 2,659 Investment securities 411 485 1,278 1,562 Other investments 68 87 183 189 Total interest income 4,852 5,221 14,420 16,256 Interest expense Deposits 2,400 2,438 7,072 7,662 Borrowed money 619 818 2,379 2,828 Total interest expense 3,019 3,256 9,451 10,490 Net interest income 1,833 1,965 4,969 5,766 Provision for losses on loans 66 77 70 229 Net interest income after provision for losses on loans 1,767 1,888 4,899 5,537 Noninterest income Fees and service charges 192 222 529 631 Gain (loss) on sale of: Investment securities - 40 (65) (26) Mortgage-backed securities - - - 300 Loans receivable 22 314 193 698 Mortgage loan servicing - - (11) - Office properties and equipment 70 (3) 72 (3) Miscellaneous 16 28 111 130 Total noninterest income 300 601 829 1,730 Operating expenses Compensation and employee benefits 1,011 778 2,797 2,389 Occupancy and equipment 316 310 920 866 Federal deposit insurance 189 178 556 514 Net cost of real estate owned 75 598 236 913 Advertising 47 49 125 150 Other 423 410 1,164 1,147 Total operating expenses 2,061 2,323 5,798 5,979 Income(loss) before income taxes 6 166 (70) 1,288 Income tax expense 137 61 135 500 Net income(loss) $ (131) $ 105 $(205) $ 788 Earnings(loss) per share $ (0.10) $ 0.08 $(0.16) $ 0.60 Weighted average shares of common stock 1,310,876 1,310,876 1,310,876 1,310,876 See accompanying notes to unaudited consolidated financial statements. Jefferson Savings and Loan Association, F.A. Consolidated Statements of Cash Flows (Unaudited) (Dollars in thousands) Nine months ended June 30, 1994 1993 Operating activities Net income(loss) $ (205) $ 788 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for losses on loans 70 229 Provision for losses on real estate owned 45 297 Depreciation and amortization 349 282 Amortization of premiums and discounts, net of investment securities and mortgage- backed securities 127 - Net (gain) loss on sales of: Investment securities 65 26 Mortgage-backed securities - (300) Loans receivable (193) (698) Office properties and equipment (72) 3 (Increase) decrease in accrued interest receivable (7) 202 (Increase) decrease in other assets (298) 657 Decrease in advance payments from borrowers for taxes and insurance (115) (529) Decrease in other liabilities (3,216) (1,235) Receipt of stock dividends from FHLB of Atlanta (91) (151) Disbursements for originations of loans held for sale (4,811) (36,980) Proceeds from sales of loans held for sale 11,252 44,896 Net cash provided (used) by operating activities 2,900 7,487 Investing activities Proceeds from sales of: Investment securities - 1,100 Mutual funds 15,090 61,816 Maturities of investment securities 14 34,065 Purchases of: Investment securities (4,000) (20,416) Mutual Funds (15,562) (85,610) (Increase) decrease in FHLB overnite funds 9,540 (9,190) (Increase) decrease in CMO & REMIC trust funds 1,785 (3) Purchases of mortgage-backed securities (6,039) (10,235) Proceeds from sale of mortgage-backed securities - 9,086 Principal payments on mortgage-backed securities 17,715 11,651 Loan originations (81,664) (40,906) Principal payments on loans 44,907 43,985 Purchases of property and equipment (1,087) (158) Proceeds from sale of property and equipment 72 - Additions to real estate owned (894) (97) Proceeds from sales of real estate owned 199 2,900 Net cash provided by investing activities (19,924) (2,012) Financing activities Net increase (decrease) in deposits 27,453 (4,584) Proceeds from advances from FHLB of Atlanta 15,000 2,000 Repayments of advances from FHLB of Atlanta (15,000) (2,000) Decrease in other borrowings (9,290) (7,374) Redemption of common stock - (3) Net cash used by financing activities 18,163 (11,961) Increase (decrease) in cash 1,139 (6,486) Cash at beginning of period 2,926 9,896 Cash at end of period $ 4,065 $ 3,410 See accompanying notes to unaudited consolidated financial statements. Jefferson Savings and Loan Association, F.A. Consolidated Statements of Cash Flows (Unaudited) Supplemental disclosures of information: (Dollars in thousands) Nine months ended June 30, Cash paid for the period: 1994 1993 Interest on deposits and all borrowings $ 9,684 $10,776 Income taxes $ 1,125 12 Non-cash investing activities: Transfers from loans receivable to real estate owned $ 470 $ 1,418 Transfers from real estate owned to loans receivable $ 2,010 - Additions to mortgage-backed securities from securitization of loans receivable - $4,055 Unrealized net gain (loss) on assets held-for-sale recorded as an increase (decrease) of stockholders' equity $ (764) $ 12 See accompanying notes to unaudited consolidated financial statements. Jefferson Savings and Loan Association, F.A. Notes to Consolidated Financial Statements June 30, 1994 (Unaudited) Note 1. Basis of Presentation The foregoing financial statements are unaudited. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the financial statements have been included. The operating results for the three and nine months ended June 30, 1994 are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the consolidated financial statements and the notes included in the Association's Annual Report for the year ended September 30, 1993. Note 2. Earnings Per Share Earnings per share has been computed on outstanding shares of common stock of 1,310,876 for the three and nine months ended June 30, 1994 and 1993, respectively. The outstanding shares have been adjusted to reflect a one-for- three reverse stock split effected in April, 1993. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Condition The total assets of Jefferson Savings and Loan Association, F.A. ("Jefferson" or the "Association") increased $13.9 million, or 4.9%, to $298.1 million at June 30, 1994 from $284.3 million at September 30, 1993, due primarily to an $32.0 million increase in loans receivable, which was partially offset by a decrease in investment securities of $7.7 million, a decrease in mortgage-backed securities of $11.7 million, and a decrease in real estate owned of $0.9 million. The decrease in investment securities, primarily overnite funds, was used to increase loans receivable. The decrease in mortgage-backed securities was primarily caused by a $8.9 million reduction in assets collateralizing the CMO and REMIC borrowings in wholly owned finance subsidiaries. Investment securities decreased $7.7 million to $38.0 million during the nine months ended June 30, 1994. The primary factor causing this decrease was a decline of $9.5 million in Federal Home Loan Bank overnite funds. At June 30, 1994, investment securities consisted primarily of $5.4 million in Federal Home Loan Bank overnite funds, $9.0 million in Federal Home Loan Bank notes, $3.7 million in Federal Home Loan Bank stock, $11.1 million in mutual funds primarily invested in government-agency adjustable-rate mortgage-backed securities, $9.0 million in Federal Home Loan Mortgage Corporation("FHLMC") and Federal National Mortgage Association("FNMA") adjustable-rate notes, and $.6 million in overnite cash investments. All investment securities except the overnite cash funds, and the FHLB stock are classified as available-for- sale. These $25.0 million of investment securities available-for-sale had an unrealized net loss of $864,700 at June 30, 1994. Mortgage-backed securities ("MBSs") decreased $11.7 million to $39.5 million during the nine months ended June 30, 1994. Purchases of MBSs during the nine months ended June 30, 1994 totalled $6.0 million. Principal repayments during the nine months ended June 30, 1994 amounted to $17.6 million. There were no sales of MBSs in the nine months ended June 30, 1994. All purchases consisted of government-agency variable-rate securities collateralized by one-year adjustable-rate mortgages. MBSs classified as available-for-sale totalled $6.6 million and had an unrealized net loss of $205,100 at June 30, 1994. MBSs collateralizing the CMO and REMIC borrowings in wholly owned finance subsidiaries totalled $16.4 million. MBSs owned by the Association totalled $23.2 million, of which $16.8 million were variable- rate and $6.4 were fixed rate. Loans receivable, net, increased $32.0 million during the nine months ended June 30, 1994 due primarily to a change in portfolio management. The Board of Directors directed management to place approximately $20 million of long-term fixed-rate mortgage loans which were originated between December, 1993 and March 31, 1994 in the portfolio to be held-to-maturity. Lower market rates of interest spurred increased refinancing and repayment of mortgage loans held in portfolio in the quarter ended December 31, 1993. However, an increase in mortgage interest rates during the six months ended June 30, 1994 contributed to a decline in mortgage loan originations, slowed refinancings and loan repayments, and increased origination of adjustable-rate-mortgages. There were no loans held-for-sale at June 30, 1994. Real estate owned declined $0.9 million to $7.3 million during the nine months ended June 30, 1994 primarily due to the November, 1993 sale of the Knight's Inn Motel in Monroe, Michigan for $1.8 million. The Association accepted a cash payment of $150,000 and granted a loan of $1,650,000 for the remainder of the purchase price. In October, 1993, the Association purchased the land and land lease for the Knight's Inn Motel for $340,000. As a result, the Association expects to receive a minimum of $30,000 in annual rental payments from this land lease, which expires on 9/30/22, with six consecutive options to extend for five years each (30 years). Land in Charlottesville, Virginia classified as real estate owned totalling $710,000 is expected to be sold for cash prior to September 30, 1994 at no loss. Total liabilities increased in the nine months ended June 30, 1994 by $14.8 million, or 5.5%, due primarily to an increase in deposits of $27.5 million, which was partially offset by a decline of $9.3 million in other borrowings, a decrease of $115,000 in advance payments from borrowers for taxes and insurance, and a decrease of $3.2 million in accrued expenses and other liabilities . Deposits increased in the nine months ended June 30, 1994 by $27.5 million to $268.9 million at June 30, 1994, due primarily to the acquisition in October, 1993 of approximately $9.3 million of deposits from another savings institution in Leesburg, Virginia at a premium of 1.25%, and the acquisition of approximately $14.2 million of deposits in Front Royal and Culpeper, Virginia at a premium of $48,000, or 0.03%. The Leesburg accounts were transferred to the Association's existing branch in Leesburg, Virginia. Unamortized goodwill from such purchases totalled $152,000 at June 30, 1994, and is being amortized over a sixty month period. The remainder of the $4.0 million deposit increase resulted from an improvement of market share at existing branches utilizing current product offerings. The Association had no brokered deposits at June 30, 1994. Other borrowings, consisting of notes payable ("Notes") of Jefferson Funding Corporation ("JFC") and mortgage collateral bonds ("Bonds") issued by Jefferson Funding Corporation II ("JFCII") net of unamortized discount, decreased $9.3 million or 38.6% to $14.8 million at June 30, 1994. JFC and JFC II are both wholly-owned finance subsidiaries of the Association. The Notes and Bonds are secured by mortgage-backed securities and outstanding indebtedness on the Notes and Bonds are reduced as the mortgage-backed securities are repaid. Lower market interest rates in the Fall of 1993 resulted in increased levels of principal repayments of the mortgage loans securing mortgage-backed securities. The outstanding bonds payable balance declined from $26.5 million at September 30, 1993 to $16.2 million at June 30, 1994. The unamortized discount on bonds payable declined from $2.4 million at September 30, 1993 to $1.4 million at June 30, 1994. The amortization of the discount of $1.0 million is recorded as interest expense. Accrued expenses and other liabilities decreased $3.2 million due primarily to a decline of current income tax liability of $0.8 million, and a reduction in checks outstanding for mortgage loan disbursements of $1.4 million. At the Association's annual meeting on January 28, 1993, the stockholders approved a one-for-three reverse stock split. In April, 1993 the Association's transfer agent issued new certificates to existing stockholders. As a result, the total number of shares outstanding decreased to 1,310,876, a decline from the previously outstanding total of 3,934,291. Total cash of $3,523 was deducted from paid-in capital to settle 554 fractional shares, at a price of $6.36 per share. Nonperforming Loans and Real Estate Owned The following table sets forth information regarding nonaccrual loans and real estate owned held by the Association at the dates indicated. June 30, September 30, 1994 1993 (Dollars in Thousands) Nonaccrual Loans Residential $ 614 $ 1,205 Nonresidential 1,116 1,298 Construction 638 154 Consumer 19 9 Subtotal 2,387 2,666 Real estate owned Residential 1,010 770 Nonresidential 6,319 6,938 In-substance foreclosure - 611 Subtotal 7,329 8,319 Total nonperforming assets $ 9,716 $10,985 Total nonperforming assets to total assets 3.26% 3.86% Real estate owned decreased $0.9 million or 10.8% during the nine months ended June 30, 1994 due primarily to the sale of the Knights Inn Motel discussed above. At June 30, 1994, approximately $1.2 million of real estate owned was under contract to sell at no loss, which primarily consists of a land development project in Charlottesville, Virginia and a warehouse and land in Chantilly, Virginia. In the nine months ended June 30, 1994 the Association wrote off $145,000 of real estate owned, of which $100,000 was offset by the reduction of the general valuation allowance for real estate owned in a corresponding amount. The total of nonaccrual loans declined $279,000, or 10.5%. The decrease in nonaccrual residential loans of $591,000 was partially offset by an increase in nonaccrual construction loans of $484,000. The construction loans consist primarily of two land loans to one builder in Warrenton, Virginia. The largest loan of $467,000 was secured by land in Warrenton, Virginia. The Association currently expects a full recovery of the outstanding nonaccrual loan balances. Allowance for Loan Losses The total allowance for loan losses amounted to $1.5 million at June 30, 1994 and $1.6 million at September 30, 1993. The allowance for loan losses as a percent of loans outstanding was .75% at June 30, 1994, compared to .94% at September 30, 1993. At June 30, 1994, the allowance for loan losses as a percentage of nonperforming loans was 63%. The provision for loan losses amounted to $66,000 and $70,000 during the three and nine months ended June 30, 1994, respectively, compared to $77,000 and $229,000 for the same periods in 1993. The Association believes that the allowance for loan losses as of June 30, 1994 was adequate and further believes that the net carrying values of real estate owned are stated at their fair values. However, future additions to the allowance for loan losses or reductions in net carrying values may be necessary based on the performance of the Association's loan portfolio and changes in economic conditions. In addition, in connection with periodic examinations of the Association, the staff of the OTS and the Federal Deposit Insurance Corporation("FDIC") consider the adequacy of the allowance for loan losses and the net carrying value of real estate owned. Such agencies may require the Association to recognize additions to the allowance or reductions in the net carrying value of real estate owned based on their judgements at the time of such examinations. Based upon an examination completed in January, 1994, the OTS did not require the Association to increase the allowance for loan losses, or reduce the net carrying value of real estate owned. Results of Operations Jefferson recorded a net loss of $205,000 for the nine months ended June 30, 1994, compared to net income of $788,000 for the nine months ended June 30, 1993, a decrease of $993,000. Net loss and net earnings per share were $0.16 and $0.60 for the three months ended June 30, 1994 and 1993, respectively. Jefferson recorded a net loss of $131,000 for the three months ended June 30, 1994, compared to net income of $105,000 for the three months ended June 30, 1993, a decrease of $236,000. Net loss and net earnings per share were $0.10 and $0.08 for the three months ended June 30, 1994 and 1993, respectively. Outstanding shares of common stock were 1,310,876 shares for the three and nine months ended June 30, 1994 and 1993, respectively, as adjusted for a one-for-three reverse stock split effected in April, 1993. Net Interest Income Net interest income declined $797,000 or 13.8% to $5.0 million in the nine months ended June 30, 1994, compared with $5.8 million in the nine months ended June 30, 1993. The decrease in net interest income resulted primarily from a decline in the interest rate spread to 2.37% for the nine months ended June 30, 1994 compared to 2.77% for the nine months ended June 30, 1993, a decrease of 40 basis points. The yield on interest-earning assets for the nine months ended June 30, 1994 was 6.93%, a decline of 94 basis points from 7.87% for the nine months ended June 30, 1993. This decrease was the result of prepayment and refinancing of high yield mortgage loans, declining yields on adjustable-rate mortgages, and declining yields on consumer loans. The cost of interest-bearing liabilities for the nine months ended June 30, 1994 was 4.56%, a decline of 54 basis points from 5.10% for the nine months ended June 30, 1993. The cost of deposits for the nine months ended June 30, 1994 was 3.69%, a decline of 51 basis points from 4.20% for the nine months ended June 30, 1993. However, the cost of borrowed money was 16.04% for the nine months ended June 30, 1994, an increase of 377 basis points from 12.27% for the nine months ended June 30, 1993. The increase in the rate paid on other borrowings was due to the amortization of the CMO and REMIC borrowings, as discussed in "Financial Condition." Deposit costs in fiscal 1994 decreased compared to fiscal 1993 primarily due to the rollover of maturing certificates of deposit to lower rates, and the reduction of the cost of passbook accounts. However, management expects that the increase in general interest rates, and in particular, the rising yield on U.S. Treasury obligations, from January, 1994 to the present will probably result in an increase in deposit costs in future periods. The costs of borrowed money increased in the nine months ended June 30, 1994 compared to the nine months ended June 30, 1993 primarily due to an increase in amortization of the discount related to the bonds and the notes due to a higher repayment of the underlying collateral, FHLMC Participation Certificates("PCs"). The negative impact of the amortization of the discount of the notes and bonds on net interest income in the nine months ended June 30, 1994 was $(1,112,000), compared to $(707,000) in the nine months ended June 30, 1993. Management expects that repayments of the FHLMC PCs collateralizing the bonds will decline in the remaining three months of fiscal 1994, which will enhance interest rate spread and net interest income. Interest-earning assets in the nine months ended June 30, 1994 averaged $277.6 million while interest-bearing liabilities averaged $276.4 million, a difference of $1.2 million. Interest-earning assets in the nine months ended June 30, 1993 averaged $275.5 million, while interest-bearing liabilities in the nine months ended June 30, 1993 averaged $274.3 million, a difference of $1.2 million. Net interest income in the three months ended June 30, 1994 decreased $132,000 to $1.8 million or 6.7% compared to the three months June 30, 1993. This decline was caused by a lower interest rate spread in the 1994 period as compared to the 1993 period, as discussed above. Noninterest Income Noninterest income decreased $901,000 or 52% in the nine months ended June 30, 1994 compared to the nine months ended June 30, 1993, and decreased $301,000 or 50% in the three months ended June 30, 1994 compared to the same period in 1993. Contributing to the decline in the nine month period ended June 30, 1994 was a fiscal 1993 gain of $300,000 on the sale of mortgage- backed securities in December, 1992, while there was no sale of mortgage- backed securities in fiscal 1994. In addition, gains on the sale of loans receivable held-for-sale totalled $193,000 in the nine months ended June 30, 1994, compared to $698,000 in the nine months ended June 30, 1993, a decrease of $505,000. Gains on the sale of loans receivable held-for-sale totalled $22,000 in the three months ended June 30, 1994, compared to $314,000 in the three months ended June 30, 1993, a decrease of $292,000. All profits resulted from the sale of loans classified as held-for-sale, which were newly originated fixed-rate mortgage loans sold in the secondary market. However, as noted above, the Association originated $20 million of long-term, fixed- rate mortgage loans for its portfolio during January, 1994 through April, 1994 and as a result, gains on sales of loans decreased in fiscal 1994. The net loss on sales of investment securities was $65,000 in the nine months ended June 30, 1994, compared to a loss of $26,000 in the nine months ended June 30, 1993, an increase of $39,000. Fees and service charges declined $102,000 in fiscal 1994 compared to fiscal 1993 primarily due to a decrease of $92,000 in mortgage loan service fees. The Association sold $63 million of mortgage loan servicing in September, 1993. Operating Expenses Operating expenses decreased $181,000 or 3.0% to $5.80 million in the nine months ended June 30, 1994 compared to $5.98 million the nine months ended June 30, 1993. Operating expenses decreased $262,000 or 11.3% to $2.06 million in the three months ended June 30, 1994 compared to $2.32 million in the three months ended June 30, 1993. These decreases were primarily due to decreases of real estate owned expenses, which were partially offset by increases in compensation and employee benefits expense. Compensation and employee benefits expense increased $408,000, or 17.1% in the nine months ended June 30, 1994, compared to the nine months ended June 30, 1993. Compensation and employee benefits expense increased $233,000, or 29.9% in the three months ended June 30, 1994, compared to the three months ended June 30, 1993. The primary reason for the higher amounts in the three and nine months ended June 30, 1994 compared to the same periods in 1993 were the addition of fourteen employees in two newly acquired branches in Front Royal and Culpeper, Virginia on May 20, 1994, an increase in staff to initiate a mortgage banking operation, a 4.0% salary increase for fiscal 1994 employees, and the addition of a marketing director. In addition, pension costs increased $62,000, payroll taxes increased $22,000 and group insurance costs increased $22,000 in the nine months ended June 30, 1994 compared the same period in 1993. Occupancy and equipment expense increased $54,000 or 6.2% in the nine months ended June 30, 1994, compared to the nine months ended June 30, 1993. The primary reasons for these changes in the nine months ended June 30, 1994 compared to the same period in 1993 were an increase in furniture and fixture depreciation of $53,000, an increase in personal property taxes of $18,000, an increase in building depreciation of $8,000, and an increase of office rent expense of $12,000, which increases were partially offset by a decrease of $47,000 in repairs and maintenance. Federal deposit insurance expense increased approximately $42,000 or 8.2% in the nine months ended June 30, 1994 compared to the nine months ended June 30, 1993, and increased $11,000 or 6.2% in the three months ended June 30, 1994 compared to the same period in 1993. These increases reflect higher premiums as a result of the implementation of a risk-based formula as required by federal legislation in January, 1993, and the addition of deposits acquired by the Association during fiscal 1994. The net cost of real estate owned decreased $677,000 or 74.2% to $236,000 in the nine months ended June 30, 1994 compared to the same period in 1993, and decreased $523,000 or 87.5% to $75,000 in the three months ended June 30, 1994 compared to the same period in 1993. The decline resulted from a reduction of costs incurred in a 1993 refurbishing of the Ocean One hotel in Virginia Beach, Virginia, and approximately $100,000 income in fiscal 1994 from operations of the Knights Inn in Monroe, Michigan which was sold in November, 1993. The Ocean One hotel affiliated with the Howard Johnson's franchise in June, 1994, after further renovation costs of approximately $175,000 which are being written off over a fifteen month period ending September 30, 1995. In the nine months ended June 30, 1994, the Ocean One hotel has operated at approximately 33% occupancy at a loss of $112,000. Management anticipates profit from hotel operations in excess of $275,000 in the quarter ended September 30, 1994. Income Tax Expense The Association recorded income tax expense of $135,000 and $500,000 in the nine months ended June 30, 1994 and 1993, respectively. The Association recorded income tax expense of $137,000 and $61,000 in the three months ended June 30, 1994 and 1993, respectively. The lower tax expense in the nine months ended June 30, 1994 reflected the net loss before income tax expense in 1994 as compared with net income before tax expense in 1993. In addition, temporary differences affect the recognition of income and expense for tax and financial reporting purposes. The significant temporary differences which affected tax expense include the amortization of the discount on REMIC bonds, amortization of prepaid pension amounts, receipt of FHLB stock dividends, the difference between tax and book bad debt deductions, and the limitation on the utilization of net operating loss carryforwards. The Association had a deferred tax asset recorded at June 30, 1994 of $180,000. Liquidity and Capital Resources Jefferson is required by OTS regulations to maintain cash and eligible liquid investments in an amount equal to 5% of net withdrawable savings and borrowings payable in one year or less to assure its ability to meet demands for withdrawals and repayment of short-term borrowings. The Association has consistently exceeded such regulatory liquidity requirements, and for the nine months ended June 30, 1994 had a weighted average liquidity ratio of 6.43%. At June 30, 1994, the Association had $14.8 million of approved loan commitments, and $5.0 million of undisbursed residential construction loans- in-process. The amount of deposits which are scheduled to mature during the next twelve month period totals approximately $72.6 million. Management believes that, by evaluating competitive instruments and pricing in its market area, it can, in most circumstances, manage and control maturing deposits so that a substantial amount of such deposits are retained by Jefferson. Standby letters of credit outstanding at June 30, 1994 totalled $311,000. The Association does not engage in transactions involving interest rate futures or swap transactions. The Association is subject to regulations of the OTS that impose certain minimum regulatory capital requirements. The following table presents the Association's capital requirements and the current excess(deficiency), on both a dollar and percentage basis, as of June 30, 1994. Current Actual Capital Capital Association Excess Requirement Capital (Deficiency) Amount Percent Amount Percent Amount Percent Tangible $ 4,476 1.50% $11,562 3.87% $ 7,086 2.37% Core $ 8,952 3.00% $11,562 3.87% $ 2,610 0.87% Risk-based $13,000 8.00% $12,465 7.67% $ (535) (0.33)% Stockholders' equity of $11.7 million at June 30, 1994 under generally accepted accounting principles was reduced by $152,000 of goodwill to arrive at tangible capital for regulatory purposes. Risk-based capital included stockholders' equity of $11.7 million, increased by the general loan loss allowance of $1.5 million, and reduced by goodwill of $152,000 and a land development investment of $612,000. Risk-weight assets totalled $162.5 million at June 30, 1994. At June 30, 1994, the Association exceeded tangible and core capital regulatory requirements, but did not exceed the risk-based regulatory capital requirement. The Association expects to file a capital plan in September, 1994, summarizing the actions it plans on taking to once again comply with all regulatory capital requirements. Impact of Inflation, Deflation and Changing Prices The consolidated financial statements and related notes presented elsewhere 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 the relative purchasing power of money over time due to inflation. Unlike many industrial companies, substantially all of the assets and virtually all of the liabilities of the Association are monetary in nature. As a result, interest rates have a more significant impact on the Association's performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, noninterest expenses do reflect general levels of inflation. PART II. OTHER INFORMATION Item 1. Legal Proceedings Legal proceedings are more fully described in Form 10-KSB for the year ended September 30, 1993 filed on January 13, 1994. There have been no material changes since that date, other than that noted below. MORRISSEY, ET AL V. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A., ET AL, At Law No. 133899, Circuit Court of Fairfax County, Virginia. This suit was filed on July 29, 1994 by the principals of a Texas partnership (5930 Prestionview Joint Venture) and the Guarantors of the 1984 loan made to that partnership. The plaintiffs claim that Jefferson violated Virginia's Equal Credit Opportunity Act by requiring spousal guarantees of the loan and requiring reaffirmation of those guarantees when the terms of the loan were subsequently modified. The plaintiffs seek to have their guarantees declared unenforceable and to have three deeds of trust on Virginia property securing $300,000 of the $1,400,000 loan released. Jefferson intends to contest the suit and management does not anticipate any material impact to the financial statements as a result of the litigation. Management does not anticipate any material impact to the financial statements as a result of litigation. Item 5. Other Information On January 11, 1994, the Association signed an agreement to acquire the Front Royal and Culpeper, Virginia branches of First Union National Bank of Virginia, which involved the transfer of approximately $14.2 million in deposits and the acquisition of branch buildings and equipment. The transaction was approved by the OTS, and was completed on May 20, 1994. At the April 5, 1994 meeting of the Board of Directors, the bylaws of the Association were amended to increase the members of the board from nine to ten. The Board of Directors then elected William H. Savage to fill this vacancy and to serve until the next annual meeting of stockholders. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None (b) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. JEFFERSON SAVINGS AND LOAN ASSOCIATION, F.A. (Registrant) Date: August 15, 1994 Thomas W. Winfree Thomas W. Winfree, President and Chief Executive Officer Date: August 15, 1994 Craig A. Mason Craig A. Mason, Senior Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----